[Title 26 CFR ]
[Code of Federal Regulations (annual edition) - April 1, 2015 Edition]
[From the U.S. Government Publishing Office]



[[Page i]]

          

          Title 26

Internal Revenue


________________________

Part 1 (Sec. Sec.  1.641 to 1.850)

                         Revised as of April 1, 2015

          Containing a codification of documents of general 
          applicability and future effect

          As of April 1, 2015
                    Published by the Office of the Federal Register 
                    National Archives and Records Administration as a 
                    Special Edition of the Federal Register

[[Page ii]]

          U.S. GOVERNMENT OFFICIAL EDITION NOTICE

          Legal Status and Use of Seals and Logos
          
          
          The seal of the National Archives and Records Administration 
              (NARA) authenticates the Code of Federal Regulations (CFR) as 
              the official codification of Federal regulations established 
              under the Federal Register Act. Under the provisions of 44 
              U.S.C. 1507, the contents of the CFR, a special edition of the 
              Federal Register, shall be judicially noticed. The CFR is 
              prima facie evidence of the original documents published in 
              the Federal Register (44 U.S.C. 1510).

          It is prohibited to use NARA's official seal and the stylized Code 
              of Federal Regulations logo on any republication of this 
              material without the express, written permission of the 
              Archivist of the United States or the Archivist's designee. 
              Any person using NARA's official seals and logos in a manner 
              inconsistent with the provisions of 36 CFR part 1200 is 
              subject to the penalties specified in 18 U.S.C. 506, 701, and 
              1017.

          Use of ISBN Prefix

          This is the Official U.S. Government edition of this publication 
              and is herein identified to certify its authenticity. Use of 
              the 0-16 ISBN prefix is for U.S. Government Publishing Office 
              Official Editions only. The Superintendent of Documents of the 
              U.S. Government Publishing Office requests that any reprinted 
              edition clearly be labeled as a copy of the authentic work 
              with a new ISBN.

              
              
          U . S . G O V E R N M E N T P U B L I S H I N G O F F I C E

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

          U.S. Superintendent of Documents  Washington, DC 
              20402-0001

          http://bookstore.gpo.gov

          Phone: toll-free (866) 512-1800; DC area (202) 512-1800

[[Page iii]]




                            Table of Contents



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

  Title 26:
          Chapter I--Internal Revenue Service, Department of 
          the Treasury (Continued)                                   3
  Finding Aids:
      Table of CFR Titles and Chapters........................     909
      Alphabetical List of Agencies Appearing in the CFR......     929
      Table of OMB Control Numbers............................     939
      List of CFR Sections Affected...........................     957

[[Page iv]]





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

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

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

[[Page v]]



                               EXPLANATION

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

Title 1 through Title 16.................................as of January 1
Title 17 through Title 27..................................as of April 1
Title 28 through Title 41...................................as of July 1
Title 42 through Title 50................................as of October 1

    The appropriate revision date is printed on the cover of each 
volume.

LEGAL STATUS

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

HOW TO USE THE CODE OF FEDERAL REGULATIONS

    The Code of Federal Regulations is kept up to date by the individual 
issues of the Federal Register. These two publications must be used 
together to determine the latest version of any given rule.
    To determine whether a Code volume has been amended since its 
revision date (in this case, April 1, 2015), consult the ``List of CFR 
Sections Affected (LSA),'' which is issued monthly, and the ``Cumulative 
List of Parts Affected,'' which appears in the Reader Aids section of 
the daily Federal Register. These two lists will identify the Federal 
Register page number of the latest amendment of any given rule.

EFFECTIVE AND EXPIRATION DATES

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

OMB CONTROL NUMBERS

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

[[Page vi]]

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

PAST PROVISIONS OF THE CODE

    Provisions of the Code that are no longer in force and effect as of 
the revision date stated on the cover of each volume are not carried. 
Code users may find the text of provisions in effect on any given date 
in the past by using the appropriate List of CFR Sections Affected 
(LSA). For the convenience of the reader, a ``List of CFR Sections 
Affected'' is published at the end of each CFR volume. For changes to 
the Code prior to the LSA listings at the end of the volume, consult 
previous annual editions of the LSA. For changes to the Code prior to 
2001, consult the List of CFR Sections Affected compilations, published 
for 1949-1963, 1964-1972, 1973-1985, and 1986-2000.

``[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 
``[Reserved]'' location at any time. Occasionally ``[Reserved]'' is used 
editorially to indicate that a portion of the CFR was left vacant and 
not accidentally dropped due to a printing or computer error.

INCORPORATION BY REFERENCE

    What is incorporation by reference? Incorporation by reference was 
established by statute and allows Federal agencies to meet the 
requirement to publish regulations in the Federal Register by referring 
to materials already published elsewhere. For an incorporation to be 
valid, the Director of the Federal Register must approve it. The legal 
effect of incorporation by reference is that the material is treated as 
if it were published in full in the Federal Register (5 U.S.C. 552(a)). 
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 
you have any problem locating or obtaining a copy of material listed as 
an approved incorporation by reference, please contact the agency that 
issued the regulation containing that incorporation. If, after 
contacting the agency, you find the material is not available, please 
notify the Director of the Federal Register, National Archives and 
Records Administration, 8601 Adelphi Road, College Park, MD 20740-6001, 
or call 202-741-6010.

CFR INDEXES AND TABULAR GUIDES

    A subject index to the Code of Federal Regulations is contained in a 
separate volume, revised annually as of January 1, entitled CFR Index 
and Finding Aids. This volume contains the Parallel Table of Authorities 
and Rules. A list of CFR titles, chapters, subchapters, and parts and an 
alphabetical list of agencies publishing in the CFR are also included in 
this volume.

[[Page vii]]

    An index to the text of ``Title 3--The President'' is carried within 
that volume.
    The Federal Register Index is issued monthly in cumulative form. 
This index is based on a consolidation of the ``Contents'' entries in 
the daily Federal Register.
    A List of CFR Sections Affected (LSA) is published monthly, keyed to 
the revision dates of the 50 CFR titles.

REPUBLICATION OF MATERIAL

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

INQUIRIES

    For a legal interpretation or explanation of any regulation in this 
volume, contact the issuing agency. The issuing agency's name appears at 
the top of odd-numbered pages.
    For inquiries concerning CFR reference assistance, call 202-741-6000 
or write to the Director, Office of the Federal Register, National 
Archives and Records Administration, 8601 Adelphi Road, College Park, MD 
20740-6001 or e-mail [email protected].

SALES

    The Government Publishing Office (GPO) processes all sales and 
distribution of the CFR. For payment by credit card, call toll-free, 
866-512-1800, or DC area, 202-512-1800, M-F 8 a.m. to 4 p.m. e.s.t. or 
fax your order to 202-512-2104, 24 hours a day. For payment by check, 
write to: US Government Publishing Office - New Orders, P.O. Box 979050, 
St. Louis, MO 63197-9000.

ELECTRONIC SERVICES

    The full text of the Code of Federal Regulations, the LSA (List of 
CFR Sections Affected), The United States Government Manual, the Federal 
Register, Public Laws, Public Papers of the Presidents of the United 
States, Compilation of Presidential Documents and the Privacy Act 
Compilation are available in electronic format via www.ofr.gov. For more 
information, contact the GPO Customer Contact Center, U.S. Government 
Publishing Office. Phone 202-512-1800, or 866-512-1800 (toll-free). E-
mail, [email protected].
    The Office of the Federal Register also offers a free service on the 
National Archives and Records Administration's (NARA) World Wide Web 
site for public law numbers, Federal Register finding aids, and related 
information. Connect to NARA's web site at www.archives.gov/federal-
register.
    The e-CFR is a regularly updated, unofficial editorial compilation 
of CFR material and Federal Register amendments, produced by the Office 
of the Federal Register and the Government Publishing Office. It is 
available at www.ecfr.gov.

    Amy P. Bunk,
    Acting Director,
    Office of the Federal Register.
    April 1, 2015.







[[Page ix]]



                               THIS TITLE

    Title 26--Internal Revenue is composed of twenty-two volumes. The 
contents of these volumes represent all current regulations issued by 
the Internal Revenue Service, Department of the Treasury, as of April 1, 
2015. The first fifteen volumes comprise part 1 (Subchapter A--Income 
Tax) and are arranged by sections as follows: Sec. Sec.  1.0-1.60; 
Sec. Sec.  1.61-1.139; Sec. Sec.  1.140-1.169; Sec. Sec.  1.170-1.300; 
Sec. Sec.  1.301-1.400; Sec. Sec.  1.401-1.409; Sec. Sec.  1.410-1.440; 
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 
sixteenth 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, Bonnie Fritts was Chief Editor. The Code of Federal 
Regulations publication program is under the direction of John Hyrum 
Martinez, assisted by Stephen J. Frattini.

[[Page 1]]



                       TITLE 26--INTERNAL REVENUE
                       




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

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

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

[[Page 3]]



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




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


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

Supplementary Publications: Internal Revenue Service Looseleaf 
  Regulations System.

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

[[Page 5]]



                   SUBCHAPTER A_INCOME TAX (CONTINUED)





PART 1_INCOME TAXES (CONTINUED)--Table of Contents



                  Normal Taxes and Surtaxes (CONTINUED)

              ESTATES, TRUSTS, BENEFICIARIES, AND DECEDENTS

                   ESTATES, TRUSTS, AND BENEFICIARIES

            General Rules For Taxation Of Estates And Trusts

Sec.
1.641 [Reserved]
1.641(a)-0 Scope of subchapter J.
1.641(a)-1 Imposition of tax; application of tax.
1.641(a)-2 Gross income of estates and trusts.
1.641(b)-1 Computation and payment of tax; deductions and credits of 
          estates and trusts.
1.641(b)-2 Filing of returns and payment of the tax.
1.641(b)-3 Termination of estates and trusts.
1.641(c)-0 Table of contents.
1.641(c)-1 Electing small business trust.
1.642(a)(1)-1 Partially tax-exempt interest.
1.642(a)(2)-1 Foreign taxes.
1.642(a)(3)-1 Dividends received by an estate or trust.
1.642(a)(3)-2 Time of receipt of dividends by beneficiary.
1.642(a)(3)-3 Cross reference.
1.642(b)-1 Deduction for personal exemption.
1.642(c)-0 Effective dates.
1.642(c)-1 Unlimited deduction for amounts paid for a charitable 
          purpose.
1.642(c)-2 Unlimited deduction for amounts permanently set aside for a 
          charitable purpose.
1.642(c)-3 Adjustments and other special rules for determining unlimited 
          charitable contributions deduction.
1.642(c)-4 Nonexempt private foundations.
1.642(c)-5 Definition of pooled income fund.
1.642(c)-6 Valuation of a remainder interest in property transferred to 
          a pooled income fund.
1.642(c)-7 Transitional rules with respect to pooled income funds.
1.642(d)-1 Net operating loss deduction.
1.642(e)-1 Depreciation and depletion.
1.642(f)-1 Amortization deductions.
1.642(g)-1 Disallowance of double deductions; in general.
1.642(g)-2 Deductions included.
1.642(h)-1 Unused loss carryovers on termination of an estate or trust.
1.642(h)-2 Excess deductions on termination of an estate or trust.
1.642(h)-3 Meaning of ``beneficiaries succeeding to the property of the 
          estate or trust''.
1.642(h)-4 Allocation.
1.642(h)-5 Example.
1.642(i)-1 Certain distributions by cemetery perpetual care funds.
1.642(i)-2 Definitions.
1.643(a)-0 Distributable net income; deduction for distributions; in 
          general.
1.643(a)-1 Deduction for distributions.
1.643(a)-2 Deduction for personal exemption.
1.643(a)-3 Capital gains and losses.
1.643(a)-4 Extraordinary dividends and taxable stock dividends.
1.643(a)-5 Tax-exempt interest.
1.643(a)-6 Income of foreign trust.
1.643(a)-7 Dividends.
1.643(a)-8 Certain distributions by charitable remainder trusts.
1.643(b)-1 Definition of income.
1.643(b)-2 Dividends allocated to corpus.
1.643(c)-1 Definition of ``beneficiary''.
1.643(d)-1 Definition of ``foreign trust created by a United States 
          person''.
1.643(d)-2 Illustration of the provisions of section 643.
1.643(h)-1 Distributions by certain foreign trusts through 
          intermediaries.

    pooled income fund actuarial tables applicable before may 1, 2009

1.642(c)-6A Valuation of charitable remainder interests for which the 
          valuation date is before May 1, 2009.

              Election to treat trust as part of an estate

1.645-1 Election by certain revocable trusts to be treated as part of 
          estate.

               Trusts which distribute current income only

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

[[Page 6]]

   estates and trusts which may accumulate income or which distribute 
                                 corpus

1.661(a)-1 Estates and trusts accumulating income or distributing 
          corpus; general.
1.661(a)-2 Deduction for distributions to beneficiaries.
1.661(b)-1 Character of amounts distributed; in general.
1.661(b)-2 Character of amounts distributed when charitable 
          contributions are made.
1.661(c)-1 Limitation on deduction.
1.661(c)-2 Illustration of the provisions of section 661.
1.662(a)-1 Inclusion of amounts in gross income of beneficiaries of 
          estates and complex trusts; general.
1.662(a)-2 Currently distributable income.
1.662(a)-3 Other amounts distributed.
1.662(a)-4 Amounts used in discharge of a legal obligation.
1.662(b)-1 Character of amounts; when no charitable contributions are 
          made.
1.662(b)-2 Character of amounts; when charitable contributions are made.
1.662(c)-1 Different taxable years.
1.662(c)-2 Death of individual beneficiary.
1.662(c)-3 Termination of existence of other beneficiaries.
1.662(c)-4 Illustration of the provisions of sections 661 and 662.
1.663(a)-1 Special rules applicable to sections 661 and 662; exclusions; 
          gifts, bequests, etc.
1.663(a)-2 Charitable, etc., distributions.
1.663(a)-3 Denial of double deduction.
1.663(b)-1 Distributions in first 65 days of taxable year; scope.
1.663(b)-2 Election.
1.663(c)-1 Separate shares treated as separate trusts or as separate 
          estates; in general.
1.663(c)-2 Rules of administration.
1.663(c)-3 Applicability of separate share rule to certain trusts.
1.663(c)-4 Applicability of separate share rule to estates and qualified 
          revocable trusts.
1.663(c)-5 Examples.
1.663(c)-6 Effective dates.
1.664-1 Charitable remainder trusts.
1.664-2 Charitable remainder annuity trust.
1.664-3 Charitable remainder unitrust.
1.664-4 Calculation of the fair market value of the remainder interest 
          in a charitable remainder unitrust.

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

1.665(a)-0 Excess distributions by trusts; scope of subpart D.
1.665(a)-1 Undistributed net income.
1.665(b)-1 Accumulation distributions of trusts other than certain 
          foreign trusts; in general.
1.665(b)-2 Exclusions from accumulation distributions in the case of 
          trusts (other than a foreign trust created by a U.S. person).
1.665(b)-3 Exclusions under section 663(a) (1).
1.665(c)-1 Accumulation distributions of certain foreign trusts; in 
          general.
1.665(c)-2 Indirect payments to the beneficiary.
1.665(d)-1 Taxes imposed on the trust.
1.665(e)-1 Preceding taxable year.
1.665(e)-2 Application of separate share rule.
1.666(a)-1A Amount allocated.
1.666(b)-1A Total taxes deemed distributed.
1.666(c)-1A Pro rata portion of taxes deemed distributed.
1.666(c)-2A Illustration of the provisions of section 666 (a), (b), and 
          (c).
1.666(d)-1A Information required from trusts.
1.666(a)-1 Amount allocated.
1.666(b)-1 Total taxes deemed distributed.
1.666(c)-1 Pro rata portion of taxes deemed distributed.
1.666(c)-2 Illustration of the provisions of section 666.
1.667-1 Denial of refund to trusts.
1.667(a)-1A Denial of refund to trusts.
1.667(b)-1A Authorization of credit to beneficiary for taxes imposed on 
          the trust.
1.668(a)-1A Amounts treated as received in prior taxable years; 
          inclusion in gross income.
1.668(a)-2A Allocation among beneficiaries; in general.
1.668(a)-3A Determination of tax.
1.668(b)-1A Tax on distribution.
1.668(b)-2A Special rules applicable to section 668.
1.668(b)-3A Computation of the beneficiary's income and tax for a prior 
          taxable year.
1.668(b)-4A Information requirements with respect to beneficiary.
1.668(a)-1 Amounts treated as received in prior taxable years; inclusion 
          in gross income.
1.668(a)-2 Allocation among beneficiaries; in general.
1.668(a)-3 Excluded amounts.
1.668(a)-4 Tax attributable to throwback.
1.668(b)-1 Credit for taxes paid by the trust.
1.668(b)-2 Illustration of the provisions of subpart D.
1.669(a)-1A Amount allocated.
1.669(b)-1A Tax on distribution.
1.669(c)-1A Special rules applicable to section 669.
1.669(c)-2A Computation of the beneficiary's income and tax for a prior 
          taxable year.
1.669(c)-3A Information requirements with respect to beneficiary.
1.669(d)-1A Total taxes deemed distributed.
1.669(e)-1A Pro rata portion of taxes deemed distributed.
1.669(e)-2A Illustration of the provisions of section 669.

[[Page 7]]

1.669(f)-1A Character of capital gain.
1.669(f)-2A Exception for capital gain distributions from certain 
          trusts.
1.669(a)-1 Limitation on tax.
1.669(a)-2 Rules applicable to section 669 computations.
1.669(a)-3 Tax computed by the exact throwback method.
1.669(a)-4 Tax attributable to short-cut throwback method.
1.669(b)-1 Information requirements.
1.669(b)-2 Manner of exercising election.

         unitrust actuarial tables applicable before may 1, 2009

1.664-4A Valuation of charitable remainder interests for which the 
          valuation date is before May 1, 2009.

treatment of excess distributions of trusts applicable to taxable years 
                  beginning on or after January 1, 1969

1.665(a)-0A Excess distributions by trusts; scope of subpart D.
1.665(a)-1A Undistributed net income.
1.665(b)-1A Accumulation distributions.
1.665(b)-2A Special rules for accumulation distributions made in taxable 
          years beginning before January 1, 1974.
1.665(c)-1A Special rule applicable to distributions by certain foreign 
          trusts.
1.665(d)-1A Taxes imposed on the trust.
1.665(e)-1A Preceding taxable year.
1.665(f)-1A Undistributed capital gain.
1.665(g)-1A Capital gain distribution.
1.665(g)-2A Application of separate share rule.

            grantors and others treated as substantial owners

1.671-1 Grantors and others treated as substantial owners; scope.
1.671-2 Applicable principles.
1.671-3 Attribution or inclusion of income, deductions, and credits 
          against tax.
1.671-4 Method of reporting.
1.671-5 Reporting for widely held fixed investment trusts.
1.672(a)-1 Definition of adverse party.
1.672(b)-1 Nonadverse party.
1.672(c)-1 Related or subordinate party.
1.672(d)-1 Power subject to condition precedent.
1.672(f)-1 Foreign persons not treated as owners.
1.672(f)-2 Certain foreign corporations.
1.672(f)-3 Exceptions to general rule.
1.672(f)-4 Recharacterization of purported gifts.
1.672(f)-5 Special rules.
1.673(a)-1 Reversionary interests; income payable to beneficiaries other 
          than certain charitable organizations; general rule.
1.673(b)-1 Income payable to charitable beneficiaries (before amendment 
          by Tax Reform Act of 1969).
1.673(c)-1 Reversionary interest after income beneficiary's death.
1.673(d)-1 Postponement of date specified for reacquisition.
1.674(a)-1 Power to control beneficial enjoyment; scope of section 674.
1.674(b)-1 Excepted powers exercisable by any person.
1.674(c)-1 Excepted powers exercisable only by independent trustees.
1.674(d)-1 Excepted powers exercisable by any trustee other than grantor 
          or spouse.
1.674(d)-2 Limitations on exceptions in section 674 (b), (c), and (d).
1.675-1 Administrative powers.
1.676(a)-1 Power to revest title to portion of trust property in 
          grantor; general rule.
1.676(b)-1 Powers exercisable only after a period of time.
1.677(a)-1 Income for benefit of grantor; general rule.
1.677(b)-1 Trusts for support.
1.678(a)-1 Person other than grantor treated as substantial owner; 
          general rule.
1.678(b)-1 If grantor is treated as the owner.
1.678(c)-1 Trusts for support.
1.678(d)-1 Renunciation of power.
1.679-0 Outline of major topics.
1.679-1 U.S. transferor treated as owner of foreign trust.
1.679-2 Trusts treated as having a U.S. beneficiary.
1.679-3 Transfers.
1.679-4 Exceptions to general rule.
1.679-5 Pre-immigration trusts.
1.679-6 Outbound migrations of domestic trusts.
1.679-7 Effective dates.

                              miscellaneous

1.681(a)-1 Limitation on charitable contributions deductions of trusts; 
          scope of section 681.
1.681(a)-2 Limitation on charitable contributions deduction of trusts 
          with trade or business income.
1.681(b)-1 Cross reference.
1.682(a)-1 Income of trust in case of divorce, etc.
1.682(b)-1 Application of trust rules to alimony payments.
1.682(c)-1 Definitions.
1.683-1 Applicability of provisions; general rule.
1.683-2 Exceptions.
1.683-3 Application of the 65-day rule of the Internal Revenue Code of 
          1939.
1.684-1 Recognition of gain on transfers to certain foreign trusts and 
          estates.
1.684-2 Transfers.
1.684-3 Exceptions to general rule of gain recognition.
1.684-4 Outbound migrations of domestic trusts.

[[Page 8]]

1.684-5 Effective date.

                     Income in Respect of Decedents

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

                        PARTNERS AND PARTNERSHIPS

                     Determination of Tax Liability

1.701-1 Partners, not partnership, subject to tax.
1.701-2 Anti-abuse rule.
1.702-1 Income and credits of partner.
1.702-2 Net operating loss deduction of partner.
1.702-3T 4-Year spread (temporary).
1.703-1 Partnership computations.
1.704-1 Partner's distributive share.
1.704-2 Allocations attributable to nonrecourse liabilities.
1.704-3 Contributed property.
1.704-4 Distribution of contributed property.
1.705-1 Determination of basis of partner's interest.
1.705-2 Basis adjustments coordinating sections 705 and 1032.
1.706-1 Taxable years of partner and partnership.
1.706-2T Temporary regulations; question and answer under the Tax Reform 
          Act of 1984.
1.707-0 Table of contents.
1.707-1 Transactions between partner and partnership.
1.707-2 Disguised payments for services. [Reserved]
1.707-3 Disguised sales of property to partnership; general rules.
1.707-4 Disguised sales of property to partnership; special rules 
          applicable to guaranteed payments, preferred returns, 
          operating cash flow distributions, and reimbursements of 
          preformation expenditures.
1.707-5 Disguised sales of property to partnership; special rules 
          relating to liabilities.
1.707-6 Disguised sales of property by partnership to partner; general 
          rules.
1.707-7 Disguised sales of partnership interests. [Reserved]
1.707-8 Disclosure of certain information.
1.707-9 Effective dates and transitional rules.
1.708-1 Continuation of partnership.
1.709-1 Treatment of organization and syndication costs.
1.709-2 Definitions.

               Contributions, Distributions, and Transfers

                     contributions to a partnership

1.721-1 Nonrecognition of gain or loss on contribution.
1.721-2 Noncompensatory options.
1.722-1 Basis of contributing partner's interest.
1.723-1 Basis of property contributed to partnership.

                     distributions by a partnership

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

                 transfers of interests in a partnership

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

[[Page 9]]

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

1.751-1 Unrealized receivables and inventory items.
1.752-0 Table of contents.
1.752-1 Treatment of partnership liabilities.
1.752-2 Partner's share of resource liabilities.
1.752-3 Partner's share of nonrecourse liabilities.
1.752-4 Special rules.
1.752-5 Effective dates and transition rules.
1.752-6 Partnership assumption of partner's section 358(h)(3) liability 
          after October 18, 1999, and before June 24, 2003.
1.752-7 Partnership assumption of partner's Sec. 1.752-7 liability on 
          or after June 24, 2003.
1.753-1 Partner receiving income in respect of decedent.
1.754-1 Time and manner of making election to adjust basis of 
          partnership property.
1.755-1 Rules for allocation of basis.

                               definitions

1.761-1 Terms defined.
1.761-2 Exclusion of certain unincorporated organizations from the 
          application of all or part of subchapter K of chapter 1 of the 
          Internal Revenue Code.
1.761-3 Certain option holders treated as partners.

         effective date for subchapter k, chapter 1 of the code

1.771-1 Effective date.

                           INSURANCE COMPANIES

                        Life Insurance Companies

                         definition; tax imposed

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

                            investment income

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

                      gain and loss from operations

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

                      distributions to shareholders

1.815-1 Taxable years affected.
1.815-2 Distributions to shareholders.
1.815-3 Shareholders surplus account.
1.815-4 Policyholders surplus account.
1.815-5 Other accounts defined.
1.815-6 Special rules.

                        miscellaneous provisions

1.817-1 Taxable years affected.
1.817-2 Treatment of capital gains and losses.

[[Page 10]]

1.817-3 Gain on property held on December 31, 1958, and certain 
          substituted property acquired after 1958.
1.817-4 Special rules.
1.817-5 Diversification requirements for variable annuity, endowment, 
          and life insurance contracts.
1.817A-0 Table of contents.
1.817A-1 Certain modified guaranteed contracts.
1.818-1 Taxable years affected.
1.818-2 Accounting provisions.
1.818-3 Amortization of premium and accrual of discount.
1.818-4 Election with respect to life insurance reserves computed on 
          preliminary term basis.
1.818-5 Short taxable years.
1.818-6 Transitional rule for change in method of accounting.
1.818-7 Denial of double deductions.
1.818-8 Special rules relating to consolidated returns and certain 
          capital losses.
1.819-1 Taxable years affected.
1.819-2 Foreign life insurance companies.

Mutual Insurance Companies (Other Than Life and Certain Marine Insurance 
Companies and Other Than Fire or Flood Insurance Companies Which Operate 
           on Basis of Perpetual Policies or Premium Deposits)

1.821-1 Tax on mutual insurance companies other than life or marine or 
          fire insurance companies subject to the tax imposed by section 
          831.
1.821-2 Taxable years affected.
1.821-3 Tax on mutual insurance companies other than life or marine or 
          fire insurance companies subject to the tax imposed by section 
          831.
1.821-4 Tax on mutual insurance companies other than life insurance 
          companies and other than fire, flood, or marine insurance 
          companies, subject to tax imposed by section 831.
1.821-5 Special transitional underwriting loss.
1.822-1 Taxable income and deductions.
1.822-2 Real estate owned and occupied.
1.822-3 Amortization of premium and accrual of discount.
1.822-4 Taxable years affected.
1.822-5 Mutual insurance company taxable income.
1.822-6 Real estate owned and occupied.
1.822-7 Amortization of premium and accrual of discount.
1.822-8 Determination of taxable investment income.
1.822-9 Real estate owned and occupied.
1.822-10 Amortization of premium and accrual of discount.
1.822-11 Net premiums.
1.822-12 Dividends to policyholders.
1.823-1 Net premiums.
1.823-2 Dividends to policyholders.
1.823-3 Taxable years affected.
1.823-4 Net premiums.
1.823-5 Dividends to policyholders.
1.823-6 Determination of statutory underwriting income or loss.
1.823-7 Subscribers of reciprocal underwriters and interinsurers.
1.823-8 Special transitional underwriting loss; cross reference.
1.825-1 Unused loss deduction; in general.
1.825-2 Unused loss carryovers and carrybacks.
1.825-3 Examples.
1.826-1 Election by reciprocal underwriters and interinsurers.
1.826-2 Special rules applicable to electing reciprocals.
1.826-3 Attorney-in-fact of electing reciprocals.
1.826-4 Allocation of expenses.
1.826-5 Attribution of tax.
1.826-6 Credit or refund.
1.826-7 Examples.

                        Other Insurance Companies

1.831-1 Tax on insurance companies (other than life or mutual), mutual 
          marine insurance companies, and mutual fire insurance 
          companies issuing perpetual policies.
1.831-2 Taxable years affected.
1.831-3 Tax on insurance companies (other than life or mutual), mutual 
          marine insurance companies, mutual fire insurance companies 
          issuing perpetual policies, and mutual fire or flood insurance 
          companies operating on the basis of premium deposits; taxable 
          years beginning after December 31, 1962.
1.831-4 Election of multiple line companies to be taxed on total income.
1.832-1 Gross income.
1.832-2 Deductions.
1.832-3 Taxable years affected.
1.832-4 Gross income.
1.832-5 Deductions.
1.832-6 Policyholders of mutual fire or flood insurance companies 
          operating on the basis of premium deposits.
1.832-7T Treatment of salvage and reinsurance in computing ``losses 
          incurred'' deduction, taxable years beginning before January 
          1, 1990 (temporary).
1.833-1 Medical Loss Ratio under section 833(c)(5).
1.846-0 Outline of provisions.
1.846-1 Application of discount factors.
1.846-2 Election by taxpayer to use its own historical loss payment 
          pattern.
1.846-2T Election by taxpayer to use its own historical loss payment 
          pattern (temporary).
1.846-3 Fresh start and reserve strengthening.
1.846-4 Effective/applicability date.
1.846-4T Effective dates (temporary).

[[Page 11]]

1.848-0 Outline of regulations under section 848.
1.848-1 Definitions and special provisions.
1.848-2 Determination of net premiums.
1.848-3 Interim rules for certain reinsurance agreements.
1.849-1.850 [Reserved]

    Authority: 26 U.S.C. 7805, unless otherwise noted.
    Section 1.642(c)-6 also issued under 26 U.S.C. 642(c)(5).
    Section 1.643(a)-8 also issued under 26 U.S.C. 643(a)(7).
    Section 1.643(h)-1 also issued under 26 U.S.C. 643(a)(7).
    Section 1.642(c)-6A also issued under 26 U.S.C. 642(c)(5).
    Section 1.645-1 also issued under 26 U.S.C. 645.
    Sections 1.663(c)-1, 1.663(c)-2, 1.663(c)-3, 1.663(c)-4, 1.663(c)-5, 
and 1.663(c)-6 also issued under 26 U.S.C. 663(c).
    Section 1.664-1 also issued under 26 U.S.C. 664(a).
    Section 1.664-2 also issued under 26 U.S.C. 664(a).
    Section 1.664-3 also issued under 26 U.S.C. 664(a).
    Section 1.664-4 also issued under 26 U.S.C. 664(a).
    Section 1.664-4A also issued under 26 U.S.C. 664(a).
    Section 1.671-2 also issued under 26 U.S.C. 643(a)(7) and 672(f)(6).
    Section 1.672(f)-1 also issued under 26 U.S.C. 643(a)(7) and 
672(f)(6).
    Section 1.672(f)-2 also issued under 26 U.S.C. 643(a)(7) and 
672(f)(3) and (6).
    Section 1.672(f)-3 also issued under 26 U.S.C. 643(a)(7) and 
672(f)(2) and (6).
    Section 1.672(f)-4 also issued under 26 U.S.C. 643(a)(7) and 
672(f)(4) and (6).
    Section 1.672(f)-5 also issued under 26 U.S.C. 643(a)(7) and 
672(f)(6).
    Section 1.679-1 also issued under 26 U.S.C. 643(a)(7) and 679(d).
    Section 1.679-2 also issued under 26 U.S.C. 643(a)(7) and 679(d).
    Section 1.679-3 also issued under 26 U.S.C. 643(a)(7) and 679(d).
    Section 1.679-4 also issued under 26 U.S.C. 643(a)(7), 679(a)(3) and 
679(d).
    Section 1.679-5 also issued under 26 U.S.C. 643(a)(7) and 679(d).
    Section 1.679-6 also issued under 26 U.S.C. 643(a)(7) and 679(d).
    Section 1.684-1 also issued under 26 U.S.C. 643(a)(7) and 684(a).
    Section 1.684-2 also issued under 26 U.S.C. 643(a)(7) and 684(a).
    Section 1.684-3 also issued under 26 U.S.C. 643(a)(7) and 684(a).
    Section 1.684-4 also issued under 26 U.S.C. 643(a)(7) and 684(a).
    Section 1.684-5 also issued under 26 U.S.C. 643(a)(7) and 684(a).
    Section 1.701-2 also issued under 26 U.S.C. 701 through 761.
    Section 1.704-3 also issued under 26 U.S.C. 704(c).
    Section 1.704-3T also issued under 26 U.S.C. 704(c).
    Section 1.704-4 also issued under 26 U.S.C. 704(c).
    Section 1.705-2 also issued under 26 U.S.C. 705 and 1032.
    Section 1.706-1T also issued under 26 U.S.C. 706(b).
    Section 1.706-3T also issued under 26 U.S.C. 444(f).
    Sections 1.707-2 through 1.707-9 also issued under 26 U.S.C. 
707(a)(2).
    Section 1.721-1 also issued under 26 U.S.C. 721.
    Section 1.731-2 also issued under 26 U.S.C. 731(c).
    Section 1.732-1 also issued under 26 U.S.C. 732.
    Section 1.732-2 also issued under 26 U.S.C. 732.
    Section 1.732-3 also issued under 26 U.S.C. 732(f).
    Section 1.734-1 also issued under 26 U.S.C. 734.
    Section 1.743-1 also issued under 26 U.S.C. 743.
    Section 1.751-1 also issued under 26 U.S.C. 751.
    Section 1.752-1(a) also issued under Public Law 106-554, 114 Stat. 
2763, 2763A-638 (2001).
    Section 1.752-6 also issued under Public Law 106-554, 114 Stat. 
2763, 2763A-638 (2001).
    Section 1.752-7 also issued under Public Law 106-554, 114 Stat. 
2763, 2763A-638 (2001).
    Section 1.755-1 also issued under 26 U.S.C. 755.
    Section 1.755-2 also issued under 26 U.S.C. 755 and 26 U.S.C. 1060.
    Section 1.761-2 also issued under 26 U.S.C. 446(b) and 26 U.S.C. 
761(a).
    Section 1.807-2 also issued under 26 U.S.C. 817A(e).
    Section 1.809-10 also issued under 26 U.S.C. 809(b)(2) and (g)(3).
    Section 1.811-3 also issued under 26 U.S.C. 817A(e).
    Section 1.812-9 also issued under 26 U.S.C. 817A(e).
    Section 1.817-5 also issued under 26 U.S.C. 817(h).
    Section 1.817A-1 also issued under 26 U.S.C. 817A(e).
    Section 1.832-4 also issued under 26 U.S.C. 832(b)(5)(A).
    Sections 1.846-1 through 1.846-4 also issued under 26 U.S.C. 846.
    Section 1.848-2 also issued under 26 U.S.C. 845(b) and 26 U.S.C. 
848(d)(4)(B).
    Section 1.846-2(d) also issued under 26 U.S.C. 846.
    Section 1.848-3 also issued under 26 U.S.C. 848(d)(4)(B).

[[Page 12]]


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

              ESTATES, TRUSTS, BENEFICIARIES, AND DECEDENTS

                   Estates, Trusts, and Beneficiaries

            General Rules for Taxation of Estates and Trusts



Sec. 1.641  [Reserved]



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

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

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

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



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

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

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

[[Page 13]]



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

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



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

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



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

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

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



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

    (a) The income of an estate of a deceased person is that which is 
received by the estate during the period of administration or 
settlement. The period of administration or settlement is the period 
actually required by the administrator or executor to perform the 
ordinary duties of administration, such as the collection of assets and 
the payment of debts, taxes, legacies, and bequests, whether the period 
required is longer or shorter than the period specified under the 
applicable local law for the settlement of estates. For example, where 
an executor who is also named as trustee under a will fails to obtain 
his discharge as executor, the period of administration continues only 
until

[[Page 14]]

the duties of administration are complete and he actually assumes his 
duties as trustee, whether or not pursuant to a court order. However, 
the period of administration of an estate cannot be unduly prolonged. If 
the administration of an estate is unreasonably prolonged, the estate is 
considered terminated for Federal income tax purposes after the 
expiration of a reasonable period for the performance by the executor of 
all the duties of administration. Further, an estate will be considered 
as terminated when all the assets have been distributed except for a 
reasonable amount which is set aside in good faith for the payment of 
unascertained or contingent liabilities and expenses (not including a 
claim by a beneficiary in the capacity of beneficiary). Notwithstanding 
the above, if the estate has joined in making a valid election under 
section 645 to treat a qualified revocable trust, as defined under 
section 645(b)(1), as part of the estate, the estate shall not terminate 
under this paragraph prior to the termination of the section 645 
election period. See section 645 and the regulations thereunder for 
rules regarding the termination of the section 645 election period.
    (b) Generally, the determination of whether a trust has terminated 
depends upon whether the property held in trust has been distributed to 
the persons entitled to succeed to the property upon termination of the 
trust rather than upon the technicality of whether or not the trustee 
has rendered his final accounting. A trust does not automatically 
terminate upon the happening of the event by which the duration of the 
trust is measured. A reasonable time is permitted after such event for 
the trustee to perform the duties necessary to complete the 
administration of the trust. Thus, if under the terms of the governing 
instrument, the trust is to terminate upon the death of the life 
beneficiary and the corpus is to be distributed to the remainderman, the 
trust continues after the death of the life beneficiary for a period 
reasonably necessary to a proper winding up of the affairs of the trust. 
However, the winding up of a trust cannot be unduly postponed and if the 
distribution of the trust corpus is unreasonably delayed, the trust is 
considered terminated for Federal income tax purposes after the 
expiration of a reasonable period for the trustee to complete the 
administration of the trust. Further, a trust will be considered as 
terminated when all the assets have been distributed except for a 
reasonable amount which is set aside in good faith for the payment of 
unascertained or contingent liabilities and expenses (not including a 
claim by a beneficiary in the capacity of beneficiary).
    (c)(1) Except as provided in subparagraph (2) of this paragraph, 
during the period between the occurrence of an event which causes a 
trust to terminate and the time when the trust is considered as 
terminated under this section, whether or not the income and the excess 
of capital gains over capital losses of the trust are to be considered 
as amounts required to be distributed currently to the ultimate 
distributee for the year in which they are received depends upon the 
principles stated in Sec. 1.651(a)-2. See Sec. 1.663-1 et seq. for 
application of the separate share rule.
    (2)(i) Except in cases to which the last sentence of this 
subdivision applies, for taxable years of a trust ending before 
September 1, 1957, subparagraph (1) of this paragraph shall not apply 
and the rule of subdivision (ii) of this subparagraph shall apply unless 
the trustee elects to have subparagraph (1) of this paragraph apply. 
Such election shall be made by the trustee in a statement filed on or 
before April 15, 1959, with the district director with whom such trust's 
return for any such taxable year was filed. The election provided by 
this subdivision shall not be available if the treatment given the 
income and the excess of capital gains over capital losses for taxable 
years for which returns have been filed was consistent with the 
provisions of subparagraph (1) of this paragraph.
    (ii) The rule referred to in subdivision (i) of this subparagraph is 
as follows: During the period between the occurrence of an event which 
causes a trust to terminate and the time when a trust is considered as 
terminated under this section, the income and the excess of capital 
gains over capital losses of the trust are in general considered as 
amounts required to be distributed for

[[Page 15]]

the year in which they are received. For example, a trust instrument 
provides for the payment of income to A during her life, and upon her 
death for the payment of the corpus to B. The trust reports on the basis 
of the calendar year. A dies on November 1, 1955, but no distribution is 
made to B until January 15, 1956. The income of the trust and the excess 
of capital gains over capital losses for the entire year 1955, to the 
extent not paid, credited, or required to be distributed to A or A's 
estate, are treated under sections 661 and 662 as amounts required to be 
distributed to B for the year 1955.
    (d) If a trust or the administration or settlement of an estate is 
considered terminated under this section for Federal income tax purposes 
(as for instance, because administration has been unduly prolonged), the 
gross income, deductions, and credits of the estate or trust are, 
subsequent to the termination, considered the gross income, deductions, 
and credits of the person or persons succeeding to the property of the 
estate or trust.

[T.D. 6500, 25 FR 11814, Nov. 26, 1960; 25 FR 14021, Dec. 31, 1960, as 
amended by T.D. 9032, 67 FR 78376, Dec. 24, 2002]



Sec. 1.641(c)-0  Table of contents.

    This section lists the major captions contained in Sec. 1.641(c)-1.

             Sec. 1.641(c)-1Electing small business trust.

    (a) In general.
    (b) Definitions.
    (1) Grantor portion.
    (2) S portion.
    (3) Non-S portion.
    (c) Taxation of grantor portion.
    (d) Taxation of S portion.
    (1) In general.
    (2) Section 1366 amounts.
    (3) Gains and losses on disposition of S stock.
    (4) State and local income taxes and administrative expenses.
    (e) Tax rates and exemption of S portion.
    (1) Income tax rate.
    (2) Alternative minimum tax exemption.
    (f) Adjustments to basis of stock in the S portion under section 
1367.
    (g) Taxation of non-S portion.
    (1) In general.
    (2) Dividend income under section 1368(c)(2).
    (3) Interest on installment obligations.
    (4) Charitable deduction.
    (h) Allocation of state and local income taxes and administration 
expenses.
    (i) Treatment of distributions from the trust.
    (j) Termination or revocation of ESBT election.
    (k) Effective date.
    (l) Examples.

[T.D. 8994, 67 FR 34394, May 14, 2002]



Sec. 1.641(c)-1  Electing small business trust.

    (a) In general. An electing small business trust (ESBT) within the 
meaning of section 1361(e) is treated as two separate trusts for 
purposes of chapter 1 of the Internal Revenue Code. The portion of an 
ESBT that consists of stock in one or more S corporations is treated as 
one trust. The portion of an ESBT that consists of all the other assets 
in the trust is treated as a separate trust. The grantor or another 
person may be treated as the owner of all or a portion of either or both 
such trusts under subpart E, part I, subchapter J, chapter 1 of the 
Internal Revenue Code. The ESBT is treated as a single trust for 
administrative purposes, such as having one taxpayer identification 
number and filing one tax return. See Sec. 1.1361-1(m).
    (b) Definitions--(1) Grantor portion. The grantor portion of an ESBT 
is the portion of the trust that is treated as owned by the grantor or 
another person under subpart E.
    (2) S portion. The S portion of an ESBT is the portion of the trust 
that consists of S corporation stock and that is not treated as owned by 
the grantor or another person under subpart E.
    (3) Non-S portion. The non-S portion of an ESBT is the portion of 
the trust that consists of all assets other than S corporation stock and 
that is not treated as owned by the grantor or another person under 
subpart E.
    (c) Taxation of grantor portion. The grantor or another person who 
is treated as the owner of a portion of the ESBT includes in computing 
taxable income items of income, deductions, and credits against tax 
attributable to that portion of the ESBT under section 671.

[[Page 16]]

    (d) Taxation of S portion--(1) In general. The taxable income of the 
S portion is determined by taking into account only the items of income, 
loss, deduction, or credit specified in paragraphs (d)(2), (3), and (4) 
of this section, to the extent not attributable to the grantor portion.
    (2) Section 1366 amounts--(i) In general. The S portion takes into 
account the items of income, loss, deduction, or credit that are taken 
into account by an S corporation shareholder pursuant to section 1366 
and the regulations thereunder. Rules otherwise applicable to trusts 
apply in determining the extent to which any loss, deduction, or credit 
may be taken into account in determining the taxable income of the S 
portion. See Sec. 1.1361-1(m)(3)(iv) for allocation of those items in 
the taxable year of the S corporation in which the trust is an ESBT for 
part of the year and an eligible shareholder under section 
1361(a)(2)(A)(i) through (iv) for the rest of the year.
    (ii) Special rule for charitable contributions. If a deduction 
described in paragraph (d)(2)(i) of this section is attributable to an 
amount of the S corporation's gross income that is paid by the S 
corporation for a charitable purpose specified in section 170(c) 
(without regard to section 170(c)(2)(A)), the contribution will be 
deemed to be paid by the S portion pursuant to the terms of the trust's 
governing instrument within the meaning of section 642(c)(1). The 
limitations of section 681, regarding unrelated business income, apply 
in determining whether the contribution is deductible in computing the 
taxable income of the S portion.
    (iii) Multiple S corporations. If an ESBT owns stock in more than 
one S corporation, items of income, loss, deduction, or credit from all 
the S corporations are aggregated for purposes of determining the S 
portion's taxable income.
    (3) Gains and losses on disposition of S stock--(i) In general. The 
S portion takes into account any gain or loss from the disposition of S 
corporation stock. No deduction is allowed under section 1211(b)(1) and 
(2) for capital losses that exceed capital gains.
    (ii) Installment method. If income from the sale or disposition of 
stock in an S corporation is reported by the trust on the installment 
method, the income recognized under this method is taken into account by 
the S portion. See paragraph (g)(3) of this section for the treatment of 
interest on the installment obligation. See Sec. 1.1361-1(m)(5)(ii) 
regarding treatment of a trust as an ESBT upon the sale of all S 
corporation stock using the installment method.
    (iii) Distributions in excess of basis. Gain recognized under 
section 1368(b)(2) from distributions in excess of the ESBT's basis in 
its S corporation stock is taken into account by the S portion.
    (4) State and local income taxes and administrative expenses--(i) In 
general. State and local income taxes and administrative expenses 
directly related to the S portion and those allocated to that portion in 
accordance with paragraph (h) are taken into account by the S portion.
    (ii) Special rule for certain interest. Interest paid by the trust 
on money borrowed by the trust to purchase stock in an S corporation is 
allocated to the S portion but is not a deductible administrative 
expense for purposes of determining the taxable income of the S portion.
    (e) Tax rates and exemption of S portion--(1) Income tax rate. 
Except for capital gains, the highest marginal trust rate provided in 
section 1(e) is applied to the taxable income of the S portion. See 
section 1(h) for the rates that apply to the S portion's net capital 
gain.
    (2) Alternative minimum tax exemption. The exemption amount of the S 
portion under section 55(d) is zero.
    (f) Adjustments to basis of stock in the S portion under section 
1367. The basis of S corporation stock in the S portion must be adjusted 
in accordance with section 1367 and the regulations thereunder. If the 
ESBT owns stock in more than one S corporation, the adjustments to the 
basis in the S corporation stock of each S corporation must be 
determined separately with respect to each S corporation. Accordingly, 
items of income, loss, deduction, or credit of an S corporation that are 
taken into account by the ESBT under section 1366 can only result in an 
adjustment

[[Page 17]]

to the basis of the stock of that S corporation and cannot affect the 
basis in the stock of the other S corporations held by the ESBT.
    (g) Taxation of non-S portion--(1) In general. The taxable income of 
the non-S portion is determined by taking into account all items of 
income, deduction, and credit to the extent not taken into account by 
either the grantor portion or the S portion. The items attributable to 
the non-S portion are taxed under subparts A through D of part I, 
subchapter J, chapter 1 of the Internal Revenue Code. The non-S portion 
may consist of more than one share pursuant to section 663(c).
    (2) Dividend income under section 1368(c)(2). Any dividend income 
within the meaning of section 1368(c)(2) is includible in the gross 
income of the non-S portion.
    (3) Interest on installment obligations. If income from the sale or 
disposition of stock in an S corporation is reported by the trust on the 
installment method, the interest on the installment obligation is 
includible in the gross income of the non-S portion. See paragraph 
(d)(3)(ii) of this section for the treatment of income from such a sale 
or disposition.
    (4) Charitable deduction. For purposes of applying section 642(c)(1) 
to payments made by the trust for a charitable purpose, the amount of 
gross income of the trust is limited to the gross income of the non-S 
portion. See paragraph (d)(2)(ii) of this section for special rules 
concerning charitable contributions paid by the S corporation that are 
deemed to be paid by the S portion.
    (h) Allocation of state and local income taxes and administration 
expenses. Whenever state and local income taxes or administration 
expenses relate to more than one portion of an ESBT, they must be 
allocated between or among the portions to which they relate. These 
items may be allocated in any manner that is reasonable in light of all 
the circumstances, including the terms of the governing instrument, 
applicable local law, and the practice of the trustee with respect to 
the trust if it is reasonable and consistent. The taxes and expenses 
apportioned to each portion of the ESBT are taken into account by that 
portion.
    (i) Treatment of distributions from the trust. Distributions to 
beneficiaries from the S portion or the non-S portion, including 
distributions of the S corporation stock, are deductible under section 
651 or 661 in determining the taxable income of the non-S portion, and 
are includible in the gross income of the beneficiaries under section 
652 or 662. However, the amount of the deduction or inclusion cannot 
exceed the amount of the distributable net income of the non-S portion. 
Items of income, loss, deduction, or credit taken into account by the 
grantor portion or the S portion are excluded for purposes of 
determining the distributable net income of the non-S portion of the 
trust.
    (j) Termination or revocation of ESBT election. If the ESBT election 
of the trust terminates pursuant to Sec. 1.1361-1(m)(5) or the ESBT 
election is revoked pursuant to Sec. 1.1361-1(m)(6), the rules 
contained in this section are thereafter not applicable to the trust. 
If, upon termination or revocation, the S portion has a net operating 
loss under section 172; a capital loss carryover under section 1212; or 
deductions in excess of gross income; then any such loss, carryover, or 
excess deductions shall be allowed as a deduction, in accordance with 
the regulations under section 642(h), to the trust, or to the 
beneficiaries succeeding to the property of the trust if the entire 
trust terminates.
    (k) Effective date. This section generally is applicable for taxable 
years of ESBTs beginning on and after May 14, 2002. However, paragraphs 
(a), (b), (c), and (l) Example 1 of this section are applicable for 
taxable years of ESBTs that end on and after December 29, 2000. ESBTs 
may apply paragraphs (d)(4) and (h) of this section for taxable years of 
ESBTs beginning after December 31, 1996.
    (l) Examples. The following examples illustrate the rules of this 
section:

    Example 1. Comprehensive example. (i) Trust has a valid ESBT 
election in effect. Under section 678, B is treated as the owner of a 
portion of Trust consisting of a 10% undivided fractional interest in 
Trust. No other person is treated as the owner of any other portion of 
Trust under subpart E. Trust owns stock in X, an S corporation, and in 
Y, a C corporation. During 2000, Trust receives a

[[Page 18]]

distribution from X of $5,100, of which $5,000 is applied against 
Trust's adjusted basis in the X stock in accordance with section 
1368(c)(1) and $100 is a dividend under section 1368(c)(2). Trust makes 
no distributions to its beneficiaries during the year.
    (ii) For 2000, Trust has the following items of income and 
deduction:

Ordinary income attributable to X under section 1366...........   $5,000
Dividend income from Y.........................................     $900
Dividend from X representing C corporation earnings and profits     $100
Total trust income.............................................   $6,000
 
Charitable contributions attributable to X under section 1366..     $300
Trustee fees...................................................     $200
State and local income taxes...................................     $100
 

    (iii) Trust's items of income and deduction are divided into a 
grantor portion, an S portion, and a non-S portion for purposes of 
determining the taxation of those items. Income is allocated to each 
portion as follows:
    B must take into account the items of income attributable to the 
grantor portion, that is, 10% of each item, as follows:

Ordinary income from X.........................................     $500
Dividend income from Y.........................................      $90
Dividend income from X.........................................      $10
                                                                --------
    Total grantor portion income...............................     $600
 

    The total income of the S portion is $4,500, determined as follows:

Ordinary income from X.........................................   $5,000
Less: Grantor portion..........................................   ($500)
                                                                --------
    Total S portion income.....................................   $4,500
 

    The total income of the non-S portion is $900 determined as follows:

Dividend income from Y (less grantor portion)..................     $810
Dividend income from X (less grantor portion)..................      $90
                                                                --------
    Total non-S portion income.................................     $900
 

    (iv) The administrative expenses and the state and local income 
taxes relate to all three portions and under state law would be 
allocated ratably to the $6,000 of trust income. Thus, these items would 
be allocated 10% (600/6000) to the grantor portion, 75% (4500/6000) to 
the S portion and 15% (900/6000) to the non-S portion.
    (v) B must take into account the following deductions attributable 
to the grantor portion of the trust:

Charitable contributions from X................................      $30
Trustee fees...................................................      $20
State and local income taxes...................................      $10
 

    (vi) The taxable income of the S portion is $4,005, determined as 
follows:

Ordinary income from X.........................................   $4,500
Less: Charitable contributions from X (less grantor portion)...   ($270)
75% of trustee fees............................................   ($150)
75% of state and local income taxes............................    ($75)
Taxable income of S portion....................................   $4,005
 

    (vii) The taxable income of the non-S portion is $755, determined as 
follows:

Dividend income from Y.........................................     $810
Dividend income from X.........................................      $90
Total non-S portion income.....................................     $900
Less: 15% of trustee fees......................................    ($30)
15% state and local income taxes...............................    ($15)
Personal exemption.............................................   ($100)
Taxable income of non-S portion................................     $755
 

    Example 2. Sale of S stock. Trust has a valid ESBT election in 
effect and owns stock in X, an S corporation. No person is treated as 
the owner of any portion of Trust under subpart E. In 2003, Trust sells 
all of its stock in X to a person who is unrelated to Trust and its 
beneficiaries and realizes a capital gain of $5,000. This gain is taken 
into account by the S portion and is taxed using the appropriate capital 
gain rate found in section 1(h).
    Example 3. (i) Sale of S stock for an installment note. Assume the 
same facts as in Example 2, except that Trust sells its stock in X for a 
$400,000 installment note payable with stated interest over ten years. 
After the sale, Trust does not own any S corporation stock.
    (ii) Loss on installment sale. Assume Trust's basis in its X stock 
was $500,000. Therefore, Trust sustains a capital loss of $100,000 on 
the sale. Upon the sale, the S portion terminates and the excess loss, 
after being netted against the other items taken into account by the S 
portion, is made available to the entire trust as provided in section 
641(c)(4).
    (iii) Gain on installment sale. Assume Trust's basis in its X stock 
was $300,000 and that the $100,000 gain will be recognized under the 
installment method of section 453. Interest income will be recognized 
annually as part of the installment payments. The portion of the 
$100,000 gain recognized annually is taken into account by the S 
portion. However, the annual interest income is includible in the gross 
income of the non-S portion.
    Example 4. Charitable lead annuity trust. Trust is a charitable lead 
annuity trust which is not treated as owned by the grantor or another 
person under subpart E. Trust acquires stock in X, an S corporation, and 
elects to be an ESBT. During the taxable year, pursuant to its terms, 
Trust pays $10,000 to a charitable organization described in section 
170(c)(2). The non-S portion of Trust receives an income tax deduction 
for the charitable contribution under section 642(c) only to the extent 
the amount is paid out of the gross income of the non-S portion. To the 
extent the amount is paid from the S portion by distributing S 
corporation stock, no charitable deduction is available to the S 
portion.
    Example 5. ESBT distributions. (i) As of January 1, 2002, Trust owns 
stock in X, a C corporation. No portion of Trust is treated as owned by 
the grantor or another person under subpart E. X elects to be an S 
corporation effective January 1, 2003, and Trust elects to be an ESBT 
effective January 1, 2003. On February 1, 2003, X makes an $8,000

[[Page 19]]

distribution to Trust, of which $3,000 is treated as a dividend from 
accumulated earnings and profits under section 1368(c)(2) and the 
remainder is applied against Trust's basis in the X stock under section 
1368(b). The trustee of Trust makes a distribution of $4,000 to 
Beneficiary during 2003. For 2003, Trust's share of X's section 1366 
items is $5,000 of ordinary income. For the year, Trust has no other 
income and no expenses or state or local taxes.
    (ii) For 2003, Trust has $5,000 of taxable income in the S portion. 
This income is taxed to Trust at the maximum rate provided in section 
1(e). Trust also has $3,000 of distributable net income (DNI) in the 
non-S portion. The non-S portion of Trust receives a distribution 
deduction under section 661(a) of $3,000, which represents the amount 
distributed to Beneficiary during the year ($4,000), not to exceed the 
amount of DNI ($3,000). Beneficiary must include this amount in gross 
income under section 662(a). As a result, the non-S portion has no 
taxable income.

[T.D. 8994, 67 FR 34395, May 14, 2002]



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

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



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

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



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

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

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



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

    In general, dividends are deemed received by a beneficiary in the 
taxable year in which they are includible in his gross income under 
section 652 or 662. For example, a simple trust, reporting on the basis 
of a fiscal year ending October 30, receives quarterly dividends on 
November 3, 1954, and February 3, May 3, and August 3, 1955. These 
dividends are all allocable to beneficiary A, reporting on a calendar 
year basis, under section 652 and are deemed received by A in 1955. See 
section 652(c). Accordingly, A may take all these dividends into account 
in determining his credit for dividends received under section 34 and 
his dividends exclusion under section 116. However, solely for purposes 
of determining whether dividends deemed received by individuals from 
trusts or estates qualify under the time limitations of section 34(a) or 
section 116(a), section 642(a)(3) provides that the time of receipt of 
the dividends by the trust or estate is also considered the time of 
receipt by the beneficiary. For example, a simple trust reporting on the 
basis of a fiscal year ending October 30 receives quarterly dividends on 
December 3, 1953, and March 3, June 3, and September 3, 1954. These 
dividends are all allocable to beneficiary A, reporting on the calendar 
year basis, under section 652 and are includible in his income for 1954.

[[Page 20]]

However, for purposes of section 34(a) or section 116(a), these 
dividends are deemed received by A on the same dates that the trust 
received them. Accordingly, A may take into account in determining the 
credit under section 34 only those dividends received by the trust on 
September 3, 1954, since the dividend received credit is not allowed 
under section 34 for dividends received before August 1, 1954 (or after 
December 31, 1964). Section 642(a)(3) and this section do not apply to 
amounts received by an estate or trust as dividends after December 31, 
1964. However, the rules in this section relating to time of receipt of 
dividends by a beneficiary are applicable to dividends received by an 
estate or trust prior to January 1, 1965, and accordingly, such 
dividends are deemed to be received by the beneficiary (even though 
received after December 31, 1964) on the same dates that the estate or 
trust received them for purposes of determining the credit under section 
34 or the exclusion under section 116.

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



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

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



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

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

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



Sec. 1.642(c)-0  Effective dates.

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

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



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

    (a) In general. (1) Any part of the gross income of an estate, or 
trust which, pursuant to the terms of the governing instrument is paid 
(or treated under paragraph (b) of this section as paid) during the 
taxable year for a purpose specified in section 170(c) shall be allowed 
as a deduction to such estate or trust in lieu of the limited charitable 
contributions deduction authorized by section 170(a). In applying this 
paragraph without reference to paragraph (b) of this section, a 
deduction shall be allowed for an amount paid during the taxable year in 
respect of gross income received in a previous taxable year, but only if 
no deduction was allowed for any previous taxable year to the estate or 
trust, or in the case of a section 645 election, to a related estate, as 
defined under Sec. 1.645-1(b), for the amount so paid.
    (2) In determining whether an amount is paid for a purpose specified 
in section 170(c)(2) the provisions of section 170(c)(2)(A) shall not be 
taken

[[Page 21]]

into account. Thus, an amount paid to a corporation, trust, or community 
chest, fund, or foundation otherwise described in section 170(c)(2) 
shall be considered paid for a purpose specified in section 170(c) even 
though the corporation, trust, or community chest, fund, or foundation 
is not created or organized in the United States, any State, the 
District of Columbia, or any possession of the United States.
    (3) See section 642(c)(6) and Sec. 1.642(c)-4 for disallowance of a 
deduction under this section to a trust which is, or is treated under 
section 4947(a)(1) as though it were a private foundation (as defined in 
section 509(a) and the regulations thereunder) and not exempt from 
taxation under section 501(a).
    (b) Election to treat contributions as paid in preceding taxable 
year--(1) In general. For purposes of determining the deduction allowed 
under paragraph (a) of this section, the fiduciary (as defined in 
section 7701(a)(6)) of an estate or trust may elect under section 
642(c)(1) to treat as paid during the taxable year (whether or not such 
year begins before January 1, 1970) any amount of gross income received 
during such taxable year or any preceding taxable year which is 
otherwise deductible under such paragraph and which is paid after the 
close of such taxable year but on or before the last day of the next 
succeeding taxable year of the estate or trust. The preceding sentence 
applies only in the case of payments actually made in a taxable year 
which is a taxable year beginning after December 31, 1969. No election 
shall be made, however, in respect of any amount which was deducted for 
any previous taxable year or which is deducted for the taxable year in 
which such amount is paid.
    (2) Time for making election. The election under subparagraph (1) of 
this paragraph shall be made not later than the time, including 
extensions thereof, prescribed by law for filing the income tax return 
for the succeeding taxable year. Such election shall, except as provided 
in subparagraph (4) of this paragraph, become irrevocable after the last 
day prescribed for making it. Having made the election for any taxable 
year, the fiduciary may, within the time prescribed for making it, 
revoke the election without the consent of the Commissioner.
    (3) Manner of making the election. The election shall be made by 
filing with the income tax return (or an amended return) for the taxable 
year in which the contribution is treated as paid a statement which:
    (i) States the name and address of the fiduciary,
    (ii) Identifies the estate or trust for which the fiduciary is 
acting,
    (iii) Indicates that the fiduciary is making an election under 
section 642(c)(1) in respect of contributions treated as paid during 
such taxable year,
    (iv) Gives the name and address of each organization to which any 
such contribution is paid, and
    (v) States the amount of each contribution and date of actual 
payment or, if applicable, the total amount of contributions paid to 
each organization during the succeeding taxable year, to be treated as 
paid in the preceding taxable year.
    (4) Revocation of certain elections with consent. An application to 
revoke with the consent of the Commissioner any election made on or 
before June 8, 1970, must be in writing and must be filed not later than 
September 2, 1975.

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

[[Page 22]]

    (iv) The reason for revoking the election.

[T.D. 7357, 40 FR 23739, June 2, 1975; 40 FR 24361, June 6, 1975; T.D. 
9032, 67 FR 78376, Dec. 24, 2002]



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

    (a) Estates. Any part of the gross income of an estate which 
pursuant to the terms of the will:
    (1) Is permanently set aside during the taxable year for a purpose 
specified in section 170(c), or
    (2) Is to be used (within or without the United States or any of its 
possessions) exclusively for religious, charitable, scientific, 
literary, or educational purposes, or for the prevention of cruelty to 
children or animals, or for the establishment, acquisition, maintenance, 
or operation of a public cemetery not operated for profit,

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

shall be allowed, subject to the limitation provided in subparagraph (2) 
of this paragraph, as a deduction to the trust in lieu of the limited 
charitable contributions deduction authorized by section 170(a). The 
preceding sentence applied only to a trust which is required by the 
terms of its governing instrument to set amounts aside. See section 
642(c)(6) and Sec. 1.642(c)-4 for disallowance of a deduction under 
this section to a trust which is, or is treated under section 4947(a)(1) 
as though it were, a private foundation (as defined in section 509(a) 
and the regulations thereunder) that is not exempt from taxation under 
section 501(a).
    (2) Limitation of deduction. Subparagraph (1) of this paragraph 
applies only to the gross income earned by a trust with respect to 
amounts transferred to the trust under a will executed on or before 
October 9, 1969, and satisfying the requirements of subparagraph (4) of 
this paragraph or transferred to the trust on or before October 9, 1969. 
For such purposes, any income, gains, or losses, which are derived at 
any time from the amounts so transferred to the trust shall also be 
taken into account in applying subparagraph (1) of this paragraph. If 
any such amount so transferred to the trust is invested or reinvested at 
any time, any asset received by the trust upon such investment or 
reinvestment shall also be treated as an amount which was so transferred 
to the trust. In the case of a trust to which this paragraph applies 
which contains (i) amounts transferred pursuant to transfers described 
in the first sentence of this subparagraph and (ii) amounts transferred 
pursuant to transfers not so described, subparagraph (1) of this 
paragraph shall apply only if the amounts described in subdivision (i) 
of this subparagraph, together with all income, gains, and losses 
derived therefrom, are separately accounted for from the amounts 
described in subdivision (ii) of this subparagraph, together with all 
income, gains, and losses derived therefrom. Such separate accounting 
shall be carried out consistently with the principles of paragraph 
(c)(4) of Sec. 53.4947-1 of this chapter (Foundation Excise Tax 
Regulations), relating to accounting for segregated amounts of split-
interest trusts.
    (3) Trusts created on or before October 9, 1969. A trust to which 
this subparagraph applies is a trust, testamentary or otherwise, which 
was created on or before October 9, 1969, and which qualifies under 
either subdivision (i) or (ii) of this subparagraph.
    (i) Transfer of irrevocable remainder interest to charity. To 
qualify under this subdivision the trust must have been created under 
the terms of an instrument granting an irrevocable remainder interest in 
such trust to or for the

[[Page 23]]

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

[[Page 24]]

    (iii) Testator under a mental disability to republish his will. To 
qualify under this subdivision the trust must have been established by 
the will of a testator who died after October 8, 1972, without having 
amended any dispositive provision of such will after October 9, 1969, 
and before October 9, 1972, by codicil or otherwise, and who is under a 
mental disability at all times after October 8, 1972, to amend such 
will, by codicil or otherwise. The provisions of subparagraph (3)(ii) of 
this paragraph with respect to mental incompetence apply for purposes of 
this subdivision.
    (iv) Amendment of dispositive provisions. The provisions of 
paragraph (e) (4) and (5) of Sec. 20.2055-2 of this chapter (Estate Tax 
Regulations) are to be applied under subdivisions (i) and (iii) of this 
subparagraph in determining whether there has been an amendment of a 
dispositive provision of a will.
    (c) Pooled income funds. Any part of the gross income of a pooled 
income fund to which Sec. 1.642(c)-5 applies for the taxable year that 
is attributable to net long-term capital gain (as defined in section 
1222(7)) which, pursuant to the terms of the governing instrument, is 
permanently set aside during the taxable year for a purpose specified in 
section 170(c) shall be allowed as a deduction to the fund in lieu of 
the limited charitable contributions deduction authorized by section 
170(a). No amount of net long-term capital gain shall be considered 
permanently set aside for charitable purposes if, under the terms of the 
fund's governing instrument and applicable local law, the trustee has 
the power, whether or not exercised, to satisfy the income 
beneficiaries' right to income by the payment of either: an amount equal 
to a fixed percentage of the fair market value of the fund's assets 
(whether determined annually or averaged on a multiple year basis); or 
any amount that takes into account unrealized appreciation in the value 
of the fund's assets. In addition, no amount of net long-term capital 
gain shall be considered permanently set aside for charitable purposes 
to the extent the trustee distributes proceeds from the sale or exchange 
of the fund's assets as income within the meaning of Sec. 1.642(c)-
5(a)(5)(i). No deduction shall be allowed under this paragraph for any 
portion of the gross income of such fund which is (1) attributable to 
income other than net long-term capital gain (2) earned with respect to 
amounts transferred to such fund before August 1, 1969. However, see 
paragraph (b) of this section for a deduction (subject to the 
limitations of such paragraph) for amounts permanently set aside by a 
pooled income fund which meets the requirements of that paragraph. The 
principles of paragraph (b) or (2) of this section with respect to 
investment, reinvestment, and separate accounting shall apply under this 
paragraph in the case of amounts transferred to the fund after July 31, 
1969.
    (d) Disallowance of deduction for certain amounts not deemed to be 
permanently set aside for charitable purposes. No amount will be 
considered to be permanently set aside, or to be used, for a purpose 
described in paragraph (a) or (b)(1) of this section unless under the 
terms of the governing instrument and the circumstances of the 
particular case the possibility that the amount set aside, or to be 
used, will not be devoted to such purpose or use is so remote as to be 
negligible. Thus, for example, where there is possibility of the 
invasion of the corpus of a charitable remainder trust, as defined in 
Sec. 1.664-1(a)(1)(ii), in order to make payment of the annuity amount 
or unitrust amount, no deduction will be allowed under paragraph (a) of 
this section in respect of any amount set aside by an estate for 
distribution to such a charitable remainder trust.
    (e) Effective dates. Generally, the second sentence of paragraph (c) 
of this section, concerning the loss of any charitable deduction for 
long-term capital gains if the fund's income may be determined by a 
fixed percentage of the fair market value of the fund's assets or by any 
amount that takes into account unrealized appreciation in the value of 
the fund's assets, applies for taxable years beginning after January 2, 
2004. In a state whose statute permits income to be determined by 
reference to a fixed percentage of, or the unrealized appreciation in, 
the value of the fund's assets, net long-term capital gain of a pooled 
income fund may be considered to be permanently set aside

[[Page 25]]

for charitable purposes if the fund's governing instrument is amended or 
reformed to eliminate the possibility of determining income in such a 
manner and if income has not been determined in this manner. For this 
purpose, a judicial proceeding to reform the fund's governing instrument 
must be commenced, or a nonjudicial reformation that is valid under 
state law must be completed, by the date that is nine months after the 
later of January 2, 2004 or the effective date of the state statute 
authorizing determination of income in such a manner.

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

[T.D. 7357, 40 FR 23740, June 2, 1975; 40 FR 24361, June 6, 1975, as 
amended by T.D. 9102, 69 FR 17, Jan. 2, 2004]



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

    (a) Income in respect of a decedent. For purposes of Sec. Sec. 
1.642(c)-1 and 1.642(c)-2, an amount received by an estate or trust 
which is includible in its gross income under section 691(a)(1) as 
income in respect of a decedent shall be included in the gross income of 
the estate or trust.
    (b) Determination of amounts deductible under section 642(c) and the 
character of such amounts--(1) Reduction of charitable contributions 
deduction by amounts not included in gross income. If an estate, pooled 
income fund, or other trust pays, permanently sets aside, or uses any 
amount of its income for a purpose specified in section 642(c) (1), (2) 
or (3) and that amount includes any items of estate or trust income not 
entering into the gross income of the estate or trust, the deduction 
allowable under Sec. 1.642(c)-1 or Sec. 1.642(c)-2 is limited to the 
gross income so paid, permanently set aside, or used. In the case of a 
pooled income fund for which a deduction is allowable under paragraph 
(c) of Sec. 1.642(c)-2 for amounts permanently set aside, only the 
gross income of the fund which is attributable to net long-term capital 
gain (as defined in section 1222(7)) shall be taken into account.
    (2) Determination of the character of an amount deductible under 
section 642(c). In determining whether the amounts of income so paid, 
permanently set aside, or used for a purpose specified in section 
642(c)(1), (2), or (3) include particular items of income of an estate 
or trust, whether or not included in gross income, a provision in the 
governing instrument or in local law that specifically provides the 
source out of which amounts are to be paid, permanently set aside, or 
used for such a purpose controls for Federal tax purposes to the extent 
such provision has economic effect independent of income tax 
consequences. See Sec. 1.652(b)-2(b). In the absence of such specific 
provisions in the governing instrument or in local law, the amount to 
which section 642(c) applies is deemed to consist of the same proportion 
of each class of the items of income of the estate or trust as the total 
of each class bears to the total of all classes. See Sec. 1.643(a)-5(b) 
for the method of determining the allocable portion of exempt income and 
foreign income. This paragraph (b)(2) is illustrated by the following 
examples:

    Example 1. A charitable lead annuity trust has the calendar year as 
its taxable year, and is to pay an annuity of $10,000 annually to an 
organization described in section 170(c). A provision in the trust 
governing instrument provides that the $10,000 annuity should be deemed 
to come first from ordinary income, second from short-term capital gain, 
third from fifty percent of the unrelated business taxable income, 
fourth from long-term capital gain, fifth from the balance of unrelated 
business taxable income, sixth from tax-exempt income, and seventh from 
principal. This provision in the governing instrument does not have 
economic effect independent of income tax consequences, because the 
amount to be paid to the charity is not dependent upon the type of 
income from which it is to be paid. Accordingly, the amount to which 
section 642(c) applies is deemed to consist of the same proportion of 
each class of the items of income of the trust as the total of each 
class bears to the total of all classes.
    Example 2. A trust instrument provides that 100 percent of the 
trust's ordinary income must be distributed currently to an organization 
described in section 170(c) and that all remaining items of income must 
be distributed currently to B, a noncharitable beneficiary. This income 
ordering provision has economic effect independent of income tax 
consequences because the amount to be

[[Page 26]]

paid to the charitable organization each year is dependent upon the 
amount of ordinary income the trust earns within that taxable year. 
Accordingly, for purposes of section 642(c), the full amount distributed 
to charity is deemed to consist of ordinary income.

    (3) Other examples. For examples showing the determination of the 
character of an amount deductible under Sec. 1.642(c)-1 or Sec. 
1.642(c)-2, see examples 1 and 2 in Sec. 1.662(b)-2 and paragraph (e) 
of the example in Sec. 1.662(c)-4.
    (c) Capital gains included in charitable contribution. Where any 
amount of the income paid, permanently set aside, or used for a purpose 
specified in section 642(c) (1), (2), or (3), is attributable to net 
long-term capital gain (as defined in section 1222(7)), the amount of 
the deduction otherwise allowable under Sec. 1.642(c)-1 or Sec. 
1.642(c)-2, must be adjusted for any deduction provided in section 1202 
of 50 percent of the excess, if any, of the net long-term capital gain 
over the net short-term capital loss. For determination of the extent to 
which the contribution to which Sec. 1.642(c)-1 or Sec. 1.642(c)-2 
applies is deemed to consist of net long-term capital gains, see 
paragraph (b) of this section. The application of this paragraph may be 
illustrated by the following examples:

    Example 1. Under the terms of the trust instrument, the income of a 
trust described in Sec. 1.642(c)-2 (b)(3)(i) is currently distributable 
to A during his life and capital gains are allocable to corpus. No 
provision is made in the trust instrument for the invasion of corpus for 
the benefit of A. Upon A's death the corpus of the trust is to be 
distributed to M University, an organization described in section 
501(c)(3) which is exempt from taxation under section 501(a). During the 
taxable year ending December 31, 1970, the trust has long-term capital 
gains of $100,000 from property transferred to it on or before October 
9, 1969, which are permanently set aside for charitable purposes. The 
trust includes $100,000 in gross income but is allowed a deduction of 
$50,000 under section 1202 for the long-term capital gains and a 
charitable contributions deduction of $50,000 under section 642(c)(2) 
($100,000 permanently set aside for charitable purposes less $50,000 
allowed as a deduction under section 1202 with respect to such 
$100,000).
    Example 2. Under the terms of the will, $200,000 of the income 
(including $100,000 capital gains) for the taxable year 1972 of an 
estate is distributed, one-quarter to each of two individual 
beneficiaries and one-half to N University, an organization described in 
section 501(c)(3) which is exempt from taxation under section 501(a). 
During 1972 the estate has ordinary income of $200,000, long-term 
capital gains of $100,000, and no capital losses. It is assumed that for 
1972 the estate has no other items of income or any deductions other 
than those discussed herein. The entire capital gains of $100,000 are 
included in the gross income of the estate for 1972, and N University 
receives $100,000 from the estate in such year. However, the amount 
allowable to the estate under section 642(c)(1) is subject to 
appropriate adjustment for the deduction allowable under section 1202. 
In view of the distributions of $25,000 of capital gains to each of the 
individual beneficiaries, the deduction allowable to the estate under 
section 1202 is limited by such section to $25,000 [($100,000 capital 
gains less $50,000 capital gains includible in income of individual 
beneficiaries under section 662) x 50%]. Since the whole of this $25,000 
deduction under section 1202 is attributable to the distribution of 
$50,000 of capital gains to N University, the deduction allowable to the 
estate in 1972 under section 642(c)(1) is $75,000 [$100,000 (distributed 
to N) less $25,000 (proper adjustment for section 1202 deduction)].
    Example 3. Under the terms of the trust instrument, 30 percent of 
the gross income (exclusive of capital gains) of a trust described in 
Sec. 1.642(c)-2(b)(3)(i) is currently distributed to B, the sole income 
beneficiary. Net capital gains (capital gain net income for taxable 
years beginning after December 31, 1976) and undistributed ordinary 
income are allocable to corpus. No provision is made in the trust 
instrument for the invasion of corpus for the benefit of B. Upon B's 
death the remainder of the trust is to be distributed to M Church. 
During the taxable year 1972, the trust has ordinary income of $100,000, 
long-term capital gains of $15,000, short-term capital gains of $1,000, 
long-term capital losses of $5,000, and short-term capital losses of 
$2,500. It is assumed that the trust has no other items of income or any 
deductions other than those discussed herein. All the ordinary income 
and capital gains and losses are attributable to amounts transferred to 
the trust before October 9, 1969. The trust includes in gross income for 
1972 the total amount of $116,000 [$100,000 (ordinary income)+$16,000 
(total capital gains determined without regard to capital losses)]. 
Pursuant to the terms of the governing instrument the trust distributes 
to B in 1972 the amount of $30,000 ($100,000x30%). The balance of 
$78,500 [($116,000 less $7,500 capital losses) -030,000 distribution] is 
available for the set-aside for charitable purposes. In determining 
taxable income for 1972 the capital losses of $7,500 ($5,000+$2,500) are 
allowable in full under section 1211(b)(1). The net capital gain 
(capital gain net income for taxable years beginning after December 31, 
1976) of $8,500 ($16,000 less

[[Page 27]]

$7,500) is the excess of the net long-term capital gain of $10,000 
($15,000 less $5,000) over the net short-term capital loss of $1,500 
($2,500 less $1,000). The deduction under section 1202 is $4,250 
($8,500x50%), all of which is attributable to the set-aside for 
charitable purposes. Accordingly, for 1972 the deduction allowable to 
the trust under section 642(c)(2) is $74,250 [$78,500 (set-aside for M) 
less $4,250 (proper adjustment for section 1202 deduction)].
    Example 4. During the taxable year a pooled income fund, as defined 
in Sec. 1.642(c)-5, has in addition to ordinary income long-term 
capital gains of $150,000, short-term capital gains of $15,000, long-
term capital losses of $100,000, and short-term capital losses of 
$10,000. Under the Declaration of Trust and pursuant to State law net 
long-term capital gain is allocable to corpus and net short-term capital 
gain is to be distributed to the income beneficiaries of the fund. All 
the capital gains and losses are attributable to amounts transferred to 
the fund after July 31, 1969. In view of the distribution of the net 
short-term capital gain of $5,000 ($15,000 less $10,000) to the income 
beneficiaries, the deduction allowed to the fund under section 1202 is 
limited by such section to $25,000 [($150,000 (long-term capital gains) 
less $100,000 (long-term capital losses))x50%]. Since the whole of this 
deduction under section 1202 is attributable to the set-aside for 
charitable purposes, the deduction of $50,000 ($150,000 less $100,000) 
otherwise allowable under section 642(c)(3) is subject to appropriate 
adjustment under section 642(c)(4) for the deduction allowable under 
section 1202. Accordingly, the amount of the set-aside deduction is 
$25,000 [$50,000 (set-aside for public charity) less $25,000 (proper 
adjustment for section 1202 deduction)].
    Example 5. The facts are the same as in example 4 except that under 
the Declaration of Trust and pursuant to State law all the net capital 
gain (capital gain net income for taxable years beginning after December 
31, 1976) for the taxable year is allocable to corpus of the fund. The 
fund would thus include in gross income total capital gains of $165,000 
($150,000+$15,000). In determining taxable income for the taxable year 
the capital losses of $110,000 ($100,000+$10,000) are allowable in full 
under section 1211(b)(1). The net capital gain of $55,000 ($165,000 less 
$110,000) is available for the set-aside for charitable purposes under 
section 642(c)(3) only in the amount of the net long-term capital gain 
of $50,000 ($150,000 long-term gains less $100,000 long-term losses). 
The deduction under section 1202 is $25,000 ($50,000x50%), all of which 
is attributable to the set-aside for charitable purposes. Accordingly, 
the deduction allowable to the fund under section 642(c)(3) is $25,000 
[$50,000 (set-aside for public charity) less $25,000 (proper adjustment 
for section 1202 deduction)]. The $5,000 balance of net capital gain 
(capital gain net income for taxable years beginning after December 31, 
1976) is taken into account in determining taxable income of the pooled 
income fund for the taxable year.

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

[T.D. 7357, 40 FR 23741, June 2, 1975; 40 FR 24361, June 6, 1975, as 
amended by T.D. 7728, 45 FR 72650, Nov. 3, 1980; T.D. 9582, 77 FR 22484, 
Apr. 16, 2012]



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

    In the case of a trust which is, or is treated under section 
4947(a)(1) as though it were, a private foundation (as defined in 
section 509(a) and the regulations thereunder) that is not exempt from 
taxation under section 501(a) for the taxable year, a deduction for 
amounts paid or permanently set aside, or used for a purpose specified 
in section 642(c) (1), or (2) shall not be allowed under Sec. 1.642(c)-
1 or Sec. 1.642(c)-2, but such trust shall, subject to the provisions 
applicable to individuals, be allowed a deduction under section 170 for 
charitable contributions paid during the taxable year. Section 642(c)(6) 
and this section do not apply to a trust described in section 4947(a)(1) 
unless such trust fails to meet the requirements of section 508(e). 
However, if on October 9, 1969, or at any time thereafter, a trust is 
recognized as being exempt from taxation under section 501(a) as an 
organization described in section 501(c)(3), if at such time such trust 
is a private foundation, and if at any time thereafter such trust is 
determined not to be

[[Page 28]]

exempt from taxation under section 501(a) as an organization described 
in section 501(c)(3), section 642(c)(6) and this section will apply to 
such trust. See Sec. 1.509 (b)-1 (b).

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



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

    (a) In general--(1) Application of provisions. Section 642(c)(5) 
prescribes certain rules for the valuation of contributions involving 
transfers to certain funds described in that section as pooled income 
funds. This section sets forth the requirements for qualifying as a 
pooled income fund and provides for the manner of allocating the income 
of the fund to the beneficiaries. Section 1.642(c)-6 provides for the 
valuation of a remainder interest in property transferred to a pooled 
income fund. Section 1.642(c)-7 provides transitional rules under which 
certain funds may be amended so as to qualify as pooled income funds in 
respect to transfers of property occurring after July 31, 1969.
    (2) Tax status of fund and its beneficiaries. Notwithstanding any 
other provision of this chapter, a fund which meets the requirements of 
a pooled income fund, as defined in section 642(c)(5) and paragraph (b) 
of this section, shall not be treated as an association within the 
meaning of section 7701(a)(3). Such a fund, which need not be a trust 
under local law, and its beneficiaries shall be taxable under part I, 
subchapter J, chapter 1 of the Code, but the provisions of subpart E 
(relating to grantors and others treated as substantial owners) of such 
part shall not apply to such fund.
    (3) Recognition of gain or loss on transfer to fund. No gain or loss 
shall be recognized to the donor on the transfer of property to a pooled 
income fund. In such case, the fund's basis and holding period with 
respect to property transferred to the fund by a donor shall be 
determined as provided in sections 1015(b) and 1223(2). If, however, a 
donor transfers property to a pooled income fund and, in addition to 
creating or retaining a life income interest therein, receives property 
from the fund, or transfers property to the fund which is subject to an 
indebtedness, this subparagraph shall not apply to the gain realized by 
reason of (i) the receipt of such property or (ii) the amount of such 
indebtedness, whether or not assumed by the pooled income fund, which is 
required to be treated as an amount realized on the transfer. For 
applicability of the bargain sale rules, see section 1011(b) and the 
regulations thereunder.
    (4) Charitable contributions deduction. A charitable contributions 
deduction for the value of the remainder interest, as determined under 
Sec. 1.642(c)-6, may be allowed under section 170, 2055, 2106, or 2522, 
where there is a transfer of property to a pooled income fund. For a 
special rule relating to the reduction of the amount of a charitable 
contribution of certain ordinary income property or capital gain 
property, see section 170(e)(1) (A) or (B)(i) and the regulations 
thereunder.
    (5) Definitions. For purposes of this section, Sec. Sec. 1.642(c)-6 
and 1.642(c)-7:
    (i) The term income has the same meaning as it does under section 
643(b) and the regulations thereunder, except that income generally may 
not include any long-term capital gains. However, in conformance with 
the applicable state statute, income may be defined as or satisfied by a 
unitrust amount, or pursuant to a trustee's power to adjust between 
income and principal to fulfill the trustee's duty of impartiality, if 
the state statute both provides for a reasonable apportionment between 
the income and remainder beneficiaries of the total return of the trust 
and meets the requirements of Sec. 1.643(b)-1. In exercising a power to 
adjust, the trustee must allocate to principal, not to income, the 
proceeds from the sale or exchange of any assets contributed to the fund 
by any donor or purchased by the fund at least to the extent of the fair 
market value of those assets on the date of their contribution to the 
fund or of the purchase price of those assets purchased by the fund. 
This definition of income applies for taxable years beginning after 
January 2, 2004.
    (ii) The term donor includes a decedent who makes a testamentary 
transfer of property to a pooled income fund.
    (iii) The term governing instrument means either the governing plan 
under

[[Page 29]]

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

[[Page 30]]

the same public charity to or for the use of which the remainder 
interest is contributed. No charitable contributions deduction shall be 
allowed to the donor for the value of such income interest of the public 
charity or for the amount of any such income paid to such organization.
    (3) Commingling of property required. The property transferred to 
the fund by each donor must be commingled with, and invested or 
reinvested with, other property transferred to the fund by other donors 
satisfying the requirements of subparagraphs (1) and (2) of this 
paragraph. The governing instrument of the pooled income fund must 
contain a provision requiring compliance with the preceding sentence. 
The public charity to or for the use of which the remainder interest is 
contributed may maintain more than one pooled income fund, provided that 
each such fund is maintained by the organization and is not a device to 
permit a group of donors to create a fund which may be subject to their 
manipulation. The fund must not include property transferred under 
arrangements other than those specified in section 642(c)(5) and this 
paragraph. However, a fund shall not be disqualified as a pooled income 
fund under this paragraph because any portion of its properties is 
invested or reinvested jointly with other properties, not a part of the 
pooled income fund, which are held by, or for the use of, the public 
charity which maintains the fund, as for example, with securities in the 
general endowment fund of the public charity to or for the use of which 
the remainder interest is contributed. Where such joint investment or 
reinvestment of properties occurs, records must be maintained which 
sufficiently identify the portion of the total fund which is owned by 
the pooled income fund and the income earned by, and attributable to, 
such portion. Such a joint investment or reinvestment of properties 
shall not be treated as an association or partnership for purposes of 
the Code. A bank which serves as trustee of more than one pooled income 
fund may maintain a common trust fund to which section 584 applies for 
the collective investment and reinvestment of moneys of such funds.
    (4) Prohibition against exempt securities. The property transferred 
to the fund by any donor must not include any securities, the income 
from which is exempt from tax under subtitle A of the Code, and the fund 
must not invest in such securities. The governing instrument of the fund 
must contain specific prohibitions against accepting or investing in 
such securities.
    (5) Maintenance by charitable organization required. The fund must 
be maintained by the same public charity to or for the use of which the 
irrevocable remainder interest is contributed. The requirement of 
maintenance will be satisfied where the public charity exercises control 
directly or indirectly over the fund. For example, this requirement of 
control shall ordinarily be met when the public charity has the power to 
remove the trustee or trustees of the fund and designate a new trustee 
or trustees. A national organization which carries out its purposes 
through local organizations, chapters, or auxiliary bodies with which it 
has an identity of aims and purposes may maintain a pooled income fund 
(otherwise satisfying the requirements of this paragraph) in which one 
or more local organizations, chapters, or auxiliary bodies which are 
public charities have been named as recipients of the remainder 
interests. For example, a national church body may maintain a pooled 
income fund where donors have transferred property to such fund and 
contributed an irrevocable remainder interest therein to or for the use 
of various local churches or educational institutions of such body. The 
fact that such local organizations or chapters have been separately 
incorporated from the national organization is immaterial.
    (6) Prohibition against donor or beneficiary serving as trustee. The 
fund must not have, and the governing instrument must prohibit the fund 
from having, as a trustee a donor to the fund or a beneficiary (other 
than the public charity to or for the use of which the remainder 
interest is contributed) of an income interest in any property 
transferred to such fund. Thus, if a donor or beneficiary (other than 
such public charity) directly or indirectly

[[Page 31]]

has general responsibilities with respect to the fund which are 
ordinarily exercised by a trustee, such fund does not meet the 
requirements of section 642(c)(5) and this paragraph. The fact that a 
donor of property to the fund, or a beneficiary of the fund, is a 
trustee, officer, director, or other official of the public charity to 
or for the use of which the remainder interest is contributed ordinarily 
will not prevent the fund from meeting the requirements of section 
642(c)(5) and this paragraph.
    (7) Income of beneficiary to be based on rate of return of fund. 
Each beneficiary entitled to income of any taxable year of the fund must 
receive such income in an amount determined by the rate of return earned 
by the fund for such taxable year with respect to his income interest, 
computed as provided in paragraph (c) of this section. The governing 
instrument of the fund shall direct the trustee to distribute income 
currently or within the first 65 days following the close of the taxable 
year in which the income is earned. Any such payment made after the 
close of the taxable year shall be treated as paid on the last day of 
the taxable year. A statement shall be attached to the return of the 
pooled income fund indicating the date and amount of such payments after 
the close of the taxable year. Subject to the provisions of part I, 
subchapter J, chapter 1 of the Code, the beneficiary shall include in 
his gross income all amounts properly paid, credited, or required to be 
distributed to the beneficiary during the taxable year or years of the 
fund ending within or with his taxable year. The governing instrument 
shall provide that the income interest of any designated beneficiary 
shall either terminate with the last regular payment which was made 
before the death of the beneficiary or be prorated to the date of his 
death.
    (8) Termination of life income interest. Upon the termination of the 
income interest retained or created by any donor, the trustee shall 
sever from the fund an amount equal to the value of the remainder 
interest in the property upon which the income interest is based. The 
value of the remainder interest for such purpose may be either (i) its 
value as of the determination date next succeeding the termination of 
the income interest or (ii) its value as of the date on which the last 
regular payment was made before the death of the beneficiary if the 
income interest is terminated on such payment date. The amount so 
severed from the fund must either be paid to, or retained for the use 
of, the designated public charity, as provided in the governing 
instrument. However, see subparagraph (3) of this paragraph for rules 
relating to commingling of property.
    (c) Allocation of income to beneficiary--(1) In general. Every 
income interest retained or created in property transferred to a pooled 
income fund shall be assigned a proportionate share of the annual income 
earned by the fund, such share, or unit of participation, being based on 
the fair market value of such property on the date of transfer, as 
provided in this paragraph.
    (2) Units of participation--(i) Unit plan. (a) On each transfer of 
property by a donor to a pooled income fund, one or more units of 
participation in the fund shall be assigned to the beneficiary or 
beneficiaries of the income interest retained or created in such 
property, the number of units of participation being equal to the number 
obtained by dividing the fair market value of the property by the fair 
market value of a unit in the fund at the time of the transfer.
    (b) The fair market value of a unit in the fund at the time of the 
transfer shall be determined by dividing the fair market value of all 
property in the fund at such time by the number of units then in the 
fund. The initial fair market value of a unit in a pooled income fund 
shall be the fair market value of the property transferred to the fund 
divided by the number of units assigned to the income interest in that 
property. The value of each unit of participation will fluctuate with 
each new transfer of property to the fund in relation to the 
appreciation or depreciation in the fair market value of the property in 
the fund, but all units in the fund will always have equal value.
    (c) The share of income allocated to each unit of participation 
shall be determined by dividing the income of the fund for the taxable 
year by the outstanding number of units in the fund at the end of such 
year, except that, consistently with paragraph (b)(7) of this

[[Page 32]]

section, income shall be allocated to units outstanding during only part 
of such year by taking into consideration the period of time such units 
are outstanding. For this purpose the actual income of such part of the 
taxable year, or a prorated portion of the annual income, may be used, 
after making such adjustments as are reasonably necessary to reflect 
fluctuations during the year in the fair market value of the property in 
the fund.
    (ii) Other plans. The governing instrument of the fund may provide 
any other reasonable method not described in subdivision (i) of this 
subparagraph for assigning units of participation in the fund and 
allocating income to such units which reaches a result reasonably 
consistent with the provisions of such subdivision.
    (iii) Transfers between determination dates. For purposes of 
subdivisions (i) and (ii) of this subparagraph, if a transfer of 
property to the fund by a donor occurs on other than a determination 
date, the number of units of participation assigned to the income 
interest in such property may be determined by using the fair market 
value of the property in the fund on the determination date immediately 
preceding the date of transfer (determined without regard to the 
property so transferred), subject, however, to appropriate adjustments 
on the next succeeding determination date. Such adjustments may be made 
by any reasonable method, including the use of a method whereby the fair 
market value of the property in the fund at the time of the transfer is 
deemed to be the average of the fair market values of the property in 
the fund on the determination dates immediately preceding and succeeding 
the date of transfer. For purposes of determining such average any 
property transferred to the fund between such preceding and succeeding 
dates, or on such succeeding date, shall be excluded. The application of 
this subdivision may be illustrated by the following example:

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

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

    Example 1. On July 1, 1970, A and B transfer separate properties 
with a fair market value of $20,000 and $10,000, respectively, to a 
newly created pooled income fund which is maintained by Y University and 
uses as its taxable year the fiscal year ending June 30. A and B each 
retain in themselves for life an income interest in such property, the 
remainder interest being contributed to Y University. The pooled income 
fund assigns an initial value of $100 to each unit of participation in 
the fund, and under the governing instruments A receives 200 units, and 
B receives 100 units, in the fund. On October 1, 1970, which is a 
determination date, C transfers property to the fund with a fair market 
value of $12,000, retaining in himself for life an income interest in 
such property and contributing the remainder interest to Y University. 
The fair market value of the property in the fund at the time of C's 
transfer is $36,000. The fair market value of A's and B's units at the 
time of such transfer is $120 each ($36,000 / 300). By reason of his 
transfer of property C is assigned 100 units of participation in the 
fund ($12,000 / $120).

[[Page 33]]

    Example 2. Assume that the pooled income fund in example 1 earns 
$2,600 for its taxable year ending June 30, 1971, and there are no 
further contributions of property to the fund in such year. Further 
assume $300 is earned in the first quarter ending September 30, 1970. 
Therefore, the fund earns $1 per unit for the first quarter ($300 
divided by 300 units outstanding) and $5.75 per unit for the remainder 
of the taxable year ([$2,600 - $300] divided by 400 units outstanding). 
If the fund distributes its income for the year based on its actual 
earnings per quarter, the income must be distributed as follows:

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

    Example 3. (a) On July 1, 1970, A and B transfer separate properties 
with a fair market value of $10,000 and $20,000, respectively, to a 
newly created pooled income fund which is maintained by X University and 
uses as its taxable year the fiscal year ending June 30. A and B each 
retain in themselves an income interest for life in such property, the 
remainder interest being contributed to X University. The governing 
instrument provides that each unit of participation in the fund shall 
have a value of not more than its initial fair market value; the 
instrument also provides that the income allocable to appreciation in 
the fair market value of such unit (to the extent in excess of its 
initial fair market value) at the end of each quarter of the fiscal year 
is to be distributed currently to X University. On October 1, 1970, 
which is a determination date, C contributes to the fund property with a 
fair market value of $60,000 and retains in himself an income interest 
for life in such property, the remainder interest being contributed to X 
University. The initial fair market value of the units assigned to A, B, 
and C is $100. A, B, and C's units of participation are as follows:

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

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

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

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

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


[T.D. 7105, 36 FR 6477, Apr. 6, 1971; 36 FR 7004, Apr. 13, 1971, as 
amended by T.D. 7125, 36 FR 11032, June 8, 1971; T.D. 7357, 40 FR 23742, 
June 2, 1975; T.D. 7633, 44 FR 57925, Oct. 9, 1979; T.D. 9102, 69 FR 18, 
Jan. 2, 2004]



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

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

[[Page 34]]

this and in related sections provide tables of actuarial factors and 
examples that illustrate the use of the tables in determining the value 
of remainder interests in property. Section 1.7520-1(c)(2) refers to 
government publications that provide additional tables of factors and 
examples of computations for more complex situations. If the computation 
requires the use of a factor that is not provided in this section, the 
Commissioner may supply the factor upon a request for a ruling. A 
request for a ruling must be accompanied by a recitation of the facts 
including the pooled income fund's highest yearly rate of return for the 
3 taxable years immediately preceding the date of transfer, the date of 
birth of each measuring life, and copies of the relevant documents. A 
request for a ruling must comply with the instructions for requesting a 
ruling published periodically in the Internal Revenue Bulletin (see 
Sec. Sec. 601.201 and 601.601(d)(2)(ii)(b) of this chapter) and include 
payment of the required user fee. If the Commissioner furnishes the 
factor, a copy of the letter supplying the factor should be attached to 
the tax return in which the deduction is claimed. If the Commissioner 
does not furnish the factor, the taxpayer must furnish a factor computed 
in accordance with the principles set forth in this section.
    (c) Computation of pooled income fund's yearly rate of return. (1) 
For purposes of determining the present value of the life income 
interest, the yearly rate of return earned by a pooled income fund for a 
taxable year is the percentage obtained by dividing the amount of income 
earned by the pooled income fund for the taxable year by an amount equal 
to--
    (i) The average fair market value of the property in such fund for 
that taxable year; less
    (ii) The corrective term adjustment.
    (2) The average fair market value of the property in a pooled income 
fund for a taxable year shall be the sum of the amounts of the fair 
market value of all property held by the pooled income fund on each 
determination date, as defined in paragraph (a)(5)(vi) of Sec. 
1.642(c)-5, of such taxable year divided by the number of determination 
dates in such taxable year. For such purposes the fair market value of 
property held by the fund shall be determined without including any 
income earned by the fund.
    (3)(i) The corrective term adjustment shall be the sum of the 
products obtained by multiplying each income payment made by the pooled 
income fund within its taxable year by the percentage set forth in 
column (2) of the following table opposite the period within such year, 
set forth in column (1), which includes the date on which that payment 
is made:

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

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

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

[[Page 35]]



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

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

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

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

$5,000/$100,000-$3,050=0.05157
    Example 2. (a) The pooled income fund maintained by X University has 
established determination dates on the first day of each calendar 
quarter. The pooled income fund is on a calendar-year basis. The pooled 
income fund earned $5,000 of income during 1971 and paid out $3,000 on 
December 15, 1971, and $2,000 on January 15, 1972, the last amount being 
treated under paragraph (b)(7) of Sec. 1.642(c)-5 as paid on December 
31, 1971. The fair market value of its property (determined without 
including any income earned by the fund) on the determination dates in 
1971 and the income paid out during 1971 are as follows:

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

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

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

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

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

    (d) Valuation. The present value of the remainder interest in 
property transferred to a pooled income fund on or after May 1, 2009, is 
determined under paragraph (e) of this section. The present value of the 
remainder interest in property transferred to a pooled income fund for 
which the valuation date is before May 1, 2009, is determined under the 
following sections:

------------------------------------------------------------------------
                Valuation dates
------------------------------------------------  Applicable regulations
             After                   Before
------------------------------------------------------------------------
--.............................        01-01-52  1.642(c)-6A(a).
12-31-51.......................        01-01-71  1.642(c)-6A(b).
12-31-70.......................        12-01-83  1.642(c)-6A(c).
11-30-83.......................        05-01-89  1.642(c)-6A(d).
04-30-89.......................        05-01-99  1.642(c)-6A(e).
04-30-99.......................        05-01-09  1.642(c)-6A(f).
------------------------------------------------------------------------

    (e) Present value of the remainder interest in the case of transfers 
to pooled income funds for which the valuation date is on or after May 
1, 2009--(1) In general. In the case of transfers to pooled income funds 
for which the valuation date is on or after May 1, 2009, the present 
value of a remainder interest is determined under this section. See, 
however, Sec. 1.7520-3(b) (relating to exceptions to the use of 
prescribed tables under certain circumstances). The present value of a 
remainder interest that is dependent on the termination of the life of 
one individual is computed by the use of Table S in paragraph (e)(6) of 
this section. For purposes of the computations under this section, the 
age of an individual is the age at the individual's nearest birthday.
    (2) Transitional rules for valuation of transfers to pooled income 
funds. (i) For purposes of sections 2055, 2106, or 2624, if on May 1, 
2009, the decedent was mentally incompetent so that the disposition of 
the property could not be changed, and the decedent died on or after May 
1, 2009, without having regained competency to dispose of the decedent's 
property, or the decedent died within 90 days of the date that the

[[Page 36]]

decedent first regained competency on or after May 1, 2009, the present 
value of a remainder interest is determined as if the valuation date 
with respect to the decedent's gross estate is either before or after 
May 1, 2009, at the option of the decedent's executor.
    (ii) For purposes of sections 170, 2055, 2106, 2522, or 2624, in the 
case of transfers to a pooled income fund for which the valuation date 
is on or after May 1, 2009, and before July 1, 2009, the present value 
of the remainder interest under this section is determined by use of the 
appropriate yearly rate of return for the month in which the valuation 
date occurs (see Sec. Sec. 1.7520-1(b) and 1.7520-2(a)(2)) and the 
appropriate actuarial tables under either paragraph (e)(6) of this 
section or Sec. 1.642(c)-6A(f)(6), at the option of the donor or the 
decedent's executor, as the case may be.
    (iii) For purposes of paragraphs (e)(2)(i) and (e)(2)(ii) of this 
section, where the donor or decedent's executor is given the option to 
use the appropriate actuarial tables under either paragraph (e)(6) of 
this section or Sec. 1.642(c)-6A(f)(6), the donor or decedent's 
executor must use the same actuarial table with respect to each 
individual transaction and with respect to all transfers occurring on 
the valuation date (for example, gift and income tax charitable 
deductions with respect to the same transfer must be determined based on 
the same tables, and all assets includible in the gross estate and/or 
estate tax deductions claimed must be valued based on the same tables).
    (3) Present value of a remainder interest. The present value of a 
remainder interest in property transferred to a pooled income fund is 
computed on the basis of--
    (i) Life contingencies determined from the values of lx that are set 
forth in Table 2000CM in Sec. 20.2031-7(d)(7) of this chapter (see 
Sec. 20.2031-7A for certain prior periods); and
    (ii) Discount at a rate of interest, compounded annually, equal to 
the highest yearly rate of return of the pooled income fund for the 3 
taxable years immediately preceding its taxable year in which the 
transfer of property to the fund is made. For purposes of this paragraph 
(e), the yearly rate of return of a pooled income fund is determined as 
provided in paragraph (c) of this section unless the highest rate of 
return is deemed to be the rate described in paragraph (e)(4) of this 
section for funds in existence less than 3 taxable years. For purposes 
of this paragraph (e)(3)(ii), the first taxable year of a pooled income 
fund is considered a taxable year even though the taxable year consists 
of less than 12 months. However, appropriate adjustments must be made to 
annualize the rate of return earned by the fund for that period. Where 
it appears from the facts and circumstances that the highest yearly rate 
of return of the fund for the 3 taxable years immediately preceding the 
taxable year in which the transfer of property is made has been 
purposely manipulated to be substantially less than the rate of return 
that would otherwise be reasonably anticipated with the purpose of 
obtaining an excessive charitable deduction, that rate of return may not 
be used. In that case, the highest yearly rate of return of the fund is 
determined by treating the fund as a pooled income fund that has been in 
existence for less than 3 preceding taxable years.
    (4) Pooled income funds in existence less than 3 taxable years. If a 
pooled income fund has been in existence less than 3 taxable years 
immediately preceding the taxable year in which the transfer is made to 
the fund and the transfer to the fund is made after April 30, 1989, the 
highest rate of return is deemed to be the interest rate (rounded to the 
nearest two-tenths of one percent) that is 1 percent less than the 
highest annual average of the monthly section 7520 rates for the 3 
calendar years immediately preceding the calendar year in which the 
transfer to the pooled income fund is made. The deemed rate of return 
for transfers to new pooled income funds is recomputed each calendar 
year using the monthly section 7520 rates for the 3-year period 
immediately preceding the calendar year in which each transfer to the 
fund is made until the fund has been in existence for 3 taxable years 
and can compute its highest rate of return for the 3 taxable years 
immediately preceding the taxable year in which the transfer of property 
to the fund is made in accordance

[[Page 37]]

with the rules set forth in the first sentence of paragraph (e)(3)(ii) 
of this section.
    (5) Computation of value of remainder interest. (i) The factor that 
is used in determining the present value of a remainder interest that is 
dependent on the termination of the life of one individual is the factor 
from Table S in paragraph (e)(6) of this section under the appropriate 
yearly rate of return opposite the number that corresponds to the age of 
the individual upon whose life the value of the remainder interest is 
based (See Sec. 1.642(c)-6A for certain prior periods). The tables in 
paragraph (e)(6) of this section include factors for yearly rates of 
return from 0.2 to 14 percent. Many actuarial factors not contained in 
the tables in paragraph (e)(6) of this section are contained in Table S 
in Internal Revenue Service Publication 1457, ``Actuarial Valuations 
Version 3A'' (2009). This publication is available, at no charge, 
electronically via the IRS Internet site at http://www.irs.gov. For 
other situations, see paragraph (b) of this section. If the yearly rate 
of return is a percentage that is between the yearly rates of return for 
which factors are provided, a linear interpolation must be made. The 
present value of the remainder interest is determined by multiplying the 
fair market value of the property on the valuation date by the 
appropriate remainder factor.
    (ii) This paragraph (e)(5) may be illustrated by the following 
example:

    Example. A, who is 54 years and 8 months, transfers $100,000 to a 
pooled income fund, and retains a life income interest in the property. 
The highest yearly rate of return earned by the fund for its 3 preceding 
taxable years is 9.47 percent. In Table S, the remainder factor opposite 
55 years under 9.4 percent is .16192 and under 9.6 percent is .15755. 
The present value of the remainder interest is $16,039.00, computed as 
follows:
[GRAPHIC] [TIFF OMITTED] TR10AU11.001

    (6) Actuarial tables. In the case of transfers for which the 
valuation date is on or after May 1, 2009, the present

[[Page 38]]

value of a remainder interest dependent on the termination of one life 
in the case of a transfer to a pooled income fund is determined by use 
of the following Table S:
[GRAPHIC] [TIFF OMITTED] TR10AU11.002


[[Page 39]]


[GRAPHIC] [TIFF OMITTED] TR10AU11.003


[[Page 40]]


[GRAPHIC] [TIFF OMITTED] TR10AU11.004


[[Page 41]]


[GRAPHIC] [TIFF OMITTED] TR10AU11.005


[[Page 42]]


[GRAPHIC] [TIFF OMITTED] TR10AU11.006


[[Page 43]]


[GRAPHIC] [TIFF OMITTED] TR10AU11.007


[[Page 44]]


[GRAPHIC] [TIFF OMITTED] TR10AU11.008


[[Page 45]]


[GRAPHIC] [TIFF OMITTED] TR10AU11.009


[[Page 46]]


[GRAPHIC] [TIFF OMITTED] TR10AU11.010


[[Page 47]]


[GRAPHIC] [TIFF OMITTED] TR10AU11.011


[[Page 48]]


[GRAPHIC] [TIFF OMITTED] TR10AU11.012


[[Page 49]]


[GRAPHIC] [TIFF OMITTED] TR10AU11.013


[[Page 50]]


[GRAPHIC] [TIFF OMITTED] TR10AU11.014


[[Page 51]]


[GRAPHIC] [TIFF OMITTED] TR10AU11.015


[[Page 52]]


[GRAPHIC] [TIFF OMITTED] TR10AU11.016


[[Page 53]]


[GRAPHIC] [TIFF OMITTED] TR10AU11.017


[[Page 54]]


[GRAPHIC] [TIFF OMITTED] TR10AU11.018


[[Page 55]]


[GRAPHIC] [TIFF OMITTED] TR10AU11.019


[[Page 56]]


[GRAPHIC] [TIFF OMITTED] TR10AU11.020


[[Page 57]]


[GRAPHIC] [TIFF OMITTED] TR10AU11.021


[[Page 58]]


[GRAPHIC] [TIFF OMITTED] TR10AU11.022


[[Page 59]]


    (f) Effective/applicability date. This section applies on and after 
May 1, 2009.

[T.D. 7105, 36 FR 6480, Apr. 6, 1971; 36 FR 9512, May 26, 1971; 36 FR 
12290, June 30, 1971, as amended by T.D. 7955, 49 FR 19976, May 11, 
1984; T.D. 8540, 59 FR 30105, June 10, 1994; T.D. 8819, 64 FR 23190, 
Apr. 30, 1999; T.D. 8886, 65 FR 36910, June 12, 2000; T.D. 9448, 74 FR 
21440, May 7, 2009; T.D. 9540, 76 FR 49572, Aug. 10, 2011]



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

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

[[Page 60]]

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

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

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

    (b) On September 30, 1970, the trustees decide to separate the 
property of X fund from the other property. The fair market value of all 
the commingled property is $1 million on September 30, 1970, and there 
were no additional transfers to the fund after November 11, 1969. 
Accordingly, the fair market value of the property required to be 
allocated to X fund must be $750,000 ($600,000/$800,000x$1,000,000), and 
X fund's percentage share of the commingled property is 75 percent 
($750,000/$1,000,000). Accordingly, assuming that the commingled 
property consists of Y stock with a fair market value of $800,000 and Z 
bonds with a fair market value of $200,000, there must be allocated to X 
fund at the close of September 30, 1970, Y stock with a value of 
$600,000 ($800,000x75%) and Z bonds with a value of $150,000 
($200,000x75%).

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

[[Page 61]]

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

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



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

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



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

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

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



Sec. 1.642(f)-1  Amortization deductions.

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

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



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

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

[[Page 62]]

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



Sec. 1.642(g)-2  Deductions included.

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



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

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

[[Page 63]]

trust (whether or not a short taxable year). For the treatment of the 
net operating loss carryover when the last taxable year of the estate or 
trust is the last taxable year to which such loss can be carried over, 
see Sec. 1.642(h)-2.
    (c) The application of this section may be illustrated by the 
following examples:

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

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



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

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

[[Page 64]]

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

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



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

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



Sec. 1.642(h)-4  Allocation.

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

[[Page 65]]

trust as to the amount with respect to which he qualifies. The 
application of this section may be illustrated by the following example:

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



Sec. 1.642(h)-5  Example.

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

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

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

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

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


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

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



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

    (a) In general. Section 642 (i) provides that amounts distributed 
during taxable years ending after December 31, 1963, by a cemetery 
perpetual care fund trust for the care and maintenance of gravesites 
shall be treated as distributions solely for purposes of sections 651 
and 661. The deduction for such a distribution is allowable only if the 
fund is taxable as a trust. In addition, the fund must have been created 
pursuant to local law by a taxable cemetery corporation (as defined in 
Sec. 1.642 (i)-2 (a)) expressly for the care and maintenance of 
cemetery property. A care fund will be treated as having been created by 
a

[[Page 66]]

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

    Example. A, a calendar-year perpetual care fund trust, meeting the 
requirements of section 642 (i), makes a $10,000 distribution on 
December 1, 1978 to X, a taxable cemetery corporation operating on a May 
31 fiscal year. From this $10,000 distribution, the cemetery makes the 
following expenditures for the care and maintenance of gravesites: 
$2,000 on December 20, 1978; $4,000 on June 1, 1979; $2,000 on October 
1, 1979; and $1,000 on April 1, 1980. In addition, as authorized by the 
trust instrument, A itself makes a direct $1,000 payment to a contractor 
on September 1, 1979 for qualifying care and maintenance work performed. 
As a result of these transactions, A will be allowed an $8,000 deduction 
for its 1978 taxable year attributable to the cemetery's expenditures, 
and a $1,000 deduction for its 1979 taxable year attributable to the 
fund's direct payment. A will not be allowed a deduction for its 1978 
taxable year for the cemetery's expenditure of either the $1,000 
expended on April 1, 1980 or the remaining unspent portion of the 
original $10,000 distribution. The trustee may request a 6-month 
extension in order to allow the

[[Page 67]]

fund until October 15, 1979 to file its return for 1978.

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

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



Sec. 1.642(i)-2  Definitions.

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

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

[[Page 68]]



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

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



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

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



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

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



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

    (a) In general. Except as provided in Sec. 1.643(a)-6 and paragraph 
(b) of this section, gains from the sale or exchange of capital assets 
are ordinarily excluded from distributable net income and are not 
ordinarily considered as paid, credited, or required to be distributed 
to any beneficiary.
    (b) Capital gains included in distributable net income. Gains from 
the sale or exchange of capital assets are included in distributable net 
income to the extent they are, pursuant to the terms of the governing 
instrument and applicable local law, or pursuant to a reasonable and 
impartial exercise of discretion by the fiduciary (in accordance with a 
power granted to the fiduciary by applicable local law or by the 
governing instrument if not prohibited by applicable local law)--
    (1) Allocated to income (but if income under the state statute is 
defined as, or consists of, a unitrust amount, a discretionary power to 
allocate gains to income must also be exercised consistently and the 
amount so allocated may not be greater than the excess of the unitrust 
amount over the amount of distributable net income determined without 
regard to this subparagraph Sec. 1.643(a)-3(b));
    (2) Allocated to corpus but treated consistently by the fiduciary on 
the trust's books, records, and tax returns as part of a distribution to 
a beneficiary; or
    (3) Allocated to corpus but actually distributed to the beneficiary 
or utilized by the fiduciary in determining the amount that is 
distributed or required to be distributed to a beneficiary.
    (c) Charitable contributions included in distributable net income. 
If capital gains are paid, permanently set aside, or to be used for the 
purposes specified in section 642(c), so that a charitable deduction is 
allowed under that section in respect of the gains, they must be 
included in the computation of distributable net income.
    (d) Capital losses. Losses from the sale or exchange of capital 
assets shall first be netted at the trust level against any gains from 
the sale or exchange of capital assets, except for a capital gain that 
is utilized under paragraph (b)(3) of this section in determining the 
amount that is distributed or required to be distributed to a particular 
beneficiary. See Sec. 1.642(h)-1 with respect to capital loss 
carryovers in the year of final termination of an estate or trust.
    (e) Examples. The following examples illustrate the rules of this 
section:

    Example 1. Under the terms of Trust's governing instrument, all 
income is to be paid to A for life. Trustee is given discretionary 
powers to invade principal for A's benefit and to deem discretionary 
distributions to be made from capital gains realized during the year. 
During Trust's first taxable year, Trust has $5,000 of dividend income 
and $10,000 of capital gain from the sale of securities. Pursuant to the 
terms of the governing instrument and applicable local law, Trustee 
allocates the $10,000 capital gain to principal.

[[Page 69]]

During the year, Trustee distributes to A $5,000, representing A's right 
to trust income. In addition, Trustee distributes to A $12,000, pursuant 
to the discretionary power to distribute principal. Trustee does not 
exercise the discretionary power to deem the discretionary distributions 
of principal as being paid from capital gains realized during the year. 
Therefore, the capital gains realized during the year are not included 
in distributable net income and the $10,000 of capital gain is taxed to 
the trust. In future years, Trustee must treat all discretionary 
distributions as not being made from any realized capital gains.
    Example 2. The facts are the same as in Example 1, except that 
Trustee intends to follow a regular practice of treating discretionary 
distributions of principal as being paid first from any net capital 
gains realized by Trust during the year. Trustee evidences this 
treatment by including the $10,000 capital gain in distributable net 
income on Trust's federal income tax return so that it is taxed to A. 
This treatment of the capital gains is a reasonable exercise of 
Trustee's discretion. In future years Trustee must treat all 
discretionary distributions as being made first from any realized 
capital gains.
    Example 3. The facts are the same as in Example 1, except that 
Trustee intends to follow a regular practice of treating discretionary 
distributions of principal as being paid from any net capital gains 
realized by Trust during the year from the sale of certain specified 
assets or a particular class of investments. This treatment of capital 
gains is a reasonable exercise of Trustee's discretion.
    Example 4. The facts are the same as in Example 1, except that 
pursuant to the terms of the governing instrument (in a provision not 
prohibited by applicable local law), capital gains realized by Trust are 
allocated to income. Because the capital gains are allocated to income 
pursuant to the terms of the governing instrument, the $10,000 capital 
gain is included in Trust's distributable net income for the taxable 
year.
    Example 5. The facts are the same as in Example 1, except that 
Trustee decides that discretionary distributions will be made only to 
the extent Trust has realized capital gains during the year and thus the 
discretionary distribution to A is $10,000, rather than $12,000. Because 
Trustee will use the amount of any realized capital gain to determine 
the amount of the discretionary distribution to the beneficiary, the 
$10,000 capital gain is included in Trust's distributable net income for 
the taxable year.
    Example 6. Trust's assets consist of Blackacre and other property. 
Under the terms of Trust's governing instrument, Trustee is directed to 
hold Blackacre for ten years and then sell it and distribute all the 
sales proceeds to A. Because Trustee uses the amount of the sales 
proceeds that includes any realized capital gain to determine the amount 
required to be distributed to A, any capital gain realized from the sale 
of Blackacre is included in Trust's distributable net income for the 
taxable year.
    Example 7. Under the terms of Trust's governing instrument, all 
income is to be paid to A during the Trust's term. When A reaches 35, 
Trust is to terminate and all the principal is to be distributed to A. 
Because all the assets of the trust, including all capital gains, will 
be actually distributed to the beneficiary at the termination of Trust, 
all capital gains realized in the year of termination are included in 
distributable net income. See Sec. 1.641(b)-3 for the determination of 
the year of final termination and the taxability of capital gains 
realized after the terminating event and before final distribution.
    Example 8. The facts are the same as Example 7, except Trustee is 
directed to pay B $10,000 before distributing the remainder of Trust 
assets to A. Because the distribution to B is a gift of a specific sum 
of money within the meaning of section 663(a)(1), none of Trust's 
distributable net income that includes all of the capital gains realized 
during the year of termination is allocated to B's distribution.
    Example 9. The facts are the same as Example 7, except Trustee is 
directed to distribute one-half of the principal to A when A reaches 35 
and the balance to A when A reaches 45. Trust assets consist entirely of 
stock in corporation M with a fair market value of $1,000,000 and an 
adjusted basis of $300,000. When A reaches 35, Trustee sells one-half of 
the stock and distributes the sales proceeds to A. All the sales 
proceeds, including all the capital gain attributable to that sale, are 
actually distributed to A and therefore all the capital gain is included 
in distributable net income.
    Example 10. The facts are the same as Example 9, except when A 
reaches 35, Trustee sells all the stock and distributes one-half of the 
sales proceeds to A. If authorized by the governing instrument and 
applicable state statute, Trustee may determine to what extent the 
capital gain is distributed to A. The $500,000 distribution to A may be 
treated as including a minimum of $200,000 of capital gain (and all of 
the principal amount of $300,000) and a maximum of $500,000 of the 
capital gain (with no principal). Trustee evidences the treatment by 
including the appropriate amount of capital gain in distributable net 
income on Trust's federal income tax return. If Trustee is not 
authorized by the governing instrument and applicable state statutes to 
determine to what extent the capital gain is distributed to A, one-half 
of the capital gain attributable to the sale is included in 
distributable net income.

[[Page 70]]

    Example 11. The applicable state statute provides that a trustee may 
make an election to pay an income beneficiary an amount equal to four 
percent of the fair market value of the trust assets, as determined at 
the beginning of each taxable year, in full satisfaction of that 
beneficiary's right to income. State statute also provides that this 
unitrust amount shall be considered paid first from ordinary and tax-
exempt income, then from net short-term capital gain, then from net 
long-term capital gain, and finally from return of principal. Trust's 
governing instrument provides that A is to receive each year income as 
defined under state statute. Trustee makes the unitrust election under 
state statute. At the beginning of the taxable year, Trust assets are 
valued at $500,000. During the year, Trust receives $5,000 of dividend 
income and realizes $80,000 of net long-term gain from the sale of 
capital assets. Trustee distributes to A $20,000 (4% of $500,000) in 
satisfaction of A's right to income. Net long-term capital gain in the 
amount of $15,000 is allocated to income pursuant to the ordering rule 
of the state statute and is included in distributable net income for the 
taxable year.
    Example 12. The facts are the same as in Example 11, except that 
neither state statute nor Trust's governing instrument has an ordering 
rule for the character of the unitrust amount, but leaves such a 
decision to the discretion of Trustee. Trustee intends to follow a 
regular practice of treating principal, other than capital gain, as 
distributed to the beneficiary to the extent that the unitrust amount 
exceeds Trust's ordinary and tax-exempt income. Trustee evidences this 
treatment by not including any capital gains in distributable net income 
on Trust's Federal income tax return so that the entire $80,000 capital 
gain is taxed to Trust. This treatment of the capital gains is a 
reasonable exercise of Trustee's discretion. In future years Trustee 
must consistently follow this treatment of not allocating realized 
capital gains to income.
    Example 13. The facts are the same as in Example 11, except that 
neither state statutes nor Trust's governing instrument has an ordering 
rule for the character of the unitrust amount, but leaves such a 
decision to the discretion of Trustee. Trustee intends to follow a 
regular practice of treating net capital gains as distributed to the 
beneficiary to the extent the unitrust amount exceeds Trust's ordinary 
and tax-exempt income. Trustee evidences this treatment by including 
$15,000 of the capital gain in distributable net income on Trust's 
Federal income tax return. This treatment of the capital gains is a 
reasonable exercise of Trustee's discretion. In future years Trustee 
must consistently treat realized capital gain, if any, as distributed to 
the beneficiary to the extent that the unitrust amount exceeds ordinary 
and tax-exempt income.
    Example 14. Trustee is a corporate fiduciary that administers 
numerous trusts. State statutes provide that a trustee may make an 
election to distribute to an income beneficiary an amount equal to four 
percent of the annual fair market value of the trust assets in full 
satisfaction of that beneficiary's right to income. Neither state 
statutes nor the governing instruments of any of the trusts administered 
by Trustee has an ordering rule for the character of the unitrust 
amount, but leaves such a decision to the discretion of Trustee. With 
respect to some trusts, Trustee intends to follow a regular practice of 
treating principal, other than capital gain, as distributed to the 
beneficiary to the extent that the unitrust amount exceeds the trust's 
ordinary and tax-exempt income. Trustee will evidence this treatment by 
not including any capital gains in distributable net income on the 
Federal income tax returns for those trusts. With respect to other 
trusts, Trustee intends to follow a regular practice of treating any net 
capital gains as distributed to the beneficiary to the extent the 
unitrust amount exceeds the trust's ordinary and tax-exempt income. 
Trustee will evidence this treatment by including net capital gains in 
distributable net income on the Federal income tax returns filed for 
these trusts. Trustee's decision with respect to each trust is a 
reasonable exercise of Trustee's discretion and, in future years, 
Trustee must treat the capital gains realized by each trust consistently 
with the treatment by that trust in prior years.

    (f) Effective date. This section applies for taxable years of trusts 
and estates ending after January 2, 2004.

[T.D. 9102, 69 FR 18, Jan. 2, 2004]



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

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

[[Page 71]]

dividends upon subsequent distribution.

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



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

    (a) There is included in distributable net income any tax-exempt 
interest excluded from gross income under section 103, reduced by 
disbursements allocable to such interest which would have been 
deductible under section 212 but for the provisions of section 265 
(relating to disallowance of deductions allocable to tax-exempt income).
    (b) If the estate or trust is allowed a charitable contributions 
deduction under section 642(c), the amounts specified in paragraph (a) 
of this section and Sec. 1.643(a)-6 are reduced by the portion deemed 
to be included in income paid, permanently set aside, or to be used for 
the purposes specified in section 642(c). If the governing instrument or 
local law specifically provides as to the source out of which amounts 
are paid, permanently set aside, or to be used for such charitable 
purposes, the specific provision controls for Federal tax purposes to 
the extent such provision has economic effect independent of income tax 
consequences. See Sec. 1.652(b)-2(b). In the absence of such specific 
provisions in the governing instrument or local law, an amount to which 
section 642(c) applies is deemed to consist of the same proportion of 
each class of the items of income of the estate or trust as the total of 
each class bears to the total of all classes. For illustrations showing 
the determination of the character of an amount deductible under section 
642(c), see Examples 1 and 2 of Sec. 1.662(b)-2 and Sec. 1.662(c)-
4(e).

[T.D. 6500, 25 FR 11814, Nov. 26, 1960; 25 FR 14021, Dec. 31, 1960, as 
amended by T.D. 9582, 77 FR 22485, Apr. 16, 2012]



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

    (a) Distributable net income of a foreign trust. In the case of a 
foreign trust (see section 7701(a)(31)), the determination of 
distributable net income is subject to the following rules:
    (1) There is included in distributable net income the amounts of 
gross income from sources without the United States, reduced by 
disbursements allocable to such foreign income which would have been 
deductible but for the provisions of section 265 (relating to 
disallowance of deductions allocable to tax exempt income). See 
paragraph (b) of Sec. 1.643(a)-5 for rules applicable when an estate or 
trust is allowed a charitable contributions deduction under section 
642(c).
    (2) In the case of a distribution made by a trust before January 1, 
1963, for purposes of determining the distributable net income of the 
trust for the taxable year in which the distribution is made, or for any 
prior taxable year;
    (i) Gross income from sources within the United States is determined 
by taking into account the provisions of section 894 (relating to income 
exempt under treaty); and
    (ii) Distributable net income is determined by taking into account 
the provisions of section 643(a)(3) (relating to exclusion of certain 
gains from the sale or exchange of capital assets).
    (3) In the case of a distribution made by a trust after December 31, 
1962, for purposes of determining the distributable net income of the 
trust for any taxable year, whether ending before January 1, 1963, or 
after December 31, 1962;
    (i) Gross income (for the entire foreign trust) from sources within 
the United States is determined without regard to the provisions of 
section 894 (relating to income exempt under treaty);
    (ii) In respect of a foreign trust created by a U.S. person (whether 
such trust constitutes the whole or only a portion of the entire foreign 
trust) (see section 643(d) and Sec. 1.643(d)-1), there shall be 
included in gross income gains from the sale or exchange of capital 
assets reduced by losses from such sales or exchanges to the extent such 
losses do not exceed gains from such sales or exchanges, and the 
deduction under section 1202 (relating to deduction for capital gains) 
shall not be taken into account; and
    (iii) In respect of a foreign trust created by a person other than a 
U.S. person (whether such trust constitutes the whole or only a portion 
of the entire foreign trust) (see section 643(d) and Sec. 1.643(d)-1), 
distributable net income is determined by taking into account all of the 
provisions of section 643 except

[[Page 72]]

section 643(a)(6)(C) (relating to gains from the sale or exchange of 
capital assets by a foreign trust created by a U.S. person).
    (b) Examples. The application of this section, showing the 
computation of distributable net income for one of the taxable years for 
which such a computation must be made, may be illustrated by the 
following examples:

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

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

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

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

    (3) In determining the distributable net income of $70,000, the 
taxable income of the trust is computed with the following 
modifications: No deduction is allowed for the personal exemption of the 
trust (section 643(a)(2)); the interest received on bonds of a U.S. 
corporation is included in the trust gross income despite the fact that 
such interest is exempt from U.S. tax under the provisions of the tax 
treaty between Country X and the United States (section 643(a)(6) (see 
H. Con. Res. (B)); the excess of net long-term capital gain over net 
short-term capital loss allocable to corpus is included in distributable 
net income, but such excess is not subject to the deduction under 
section 1202 (section 643(a)(6)(C)); and the amount representing gross 
income from investments in Country X is included, but such amount is 
reduced by the amount of the disbursements allocable to such income 
(section 643(a)(6)(A)).
    Example 2. (1) The facts are the same as in example 1 except that 
money or property has also been transferred to the trust by a person 
other than a U.S. person and, pursuant to the provisions of Sec. 
1.643(d)-1, during 1964 only 60 percent of the entire trust constitutes 
a foreign trust created by a U.S. person.
    (2) The distributable net income for the taxable year 1964 of the 
foreign trust created by a U.S. person, determined under section 643(a), 
is $42,000 computed as follows:

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

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

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

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

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


[[Page 73]]


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

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



Sec. 1.643(a)-7  Dividends.

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

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



Sec. 1.643(a)-8  Certain distributions by charitable remainder trusts.

    (a) Purpose and scope. This section is intended to prevent the 
avoidance of the purposes of the charitable remainder trust rules 
regarding the characterizations of distributions from those trusts in 
the hands of the recipients and should be interpreted in a manner 
consistent with this purpose. This section applies to all charitable 
remainder trusts described in section 664 and the beneficiaries of such 
trusts.
    (b) Deemed sale by trust. (1) For purposes of section 664(b), a 
charitable remainder trust shall be treated as having sold, in the year 
in which a distribution of an annuity or unitrust amount is made from 
the trust, a pro rata portion of the trust assets to the extent that the 
distribution of the annuity or unitrust amount would (but for the 
application of this paragraph (b)) be characterized in the hands of the 
recipient as being from the category described in section 664(b)(4) and 
exceeds the amount of the previously undistributed
    (i) Cash contributed to the trust (with respect to which a deduction 
was allowable under section 170, 2055, 2106, or 2522); plus
    (ii) Basis in any contributed property (with respect to which a 
deduction was allowable under section 170, 2055, 2106, or 2522) that was 
sold by the trust.
    (2) Any transaction that has the purpose or effect of circumventing 
the rules in this paragraph (b) shall be disregarded.
    (3) For purposes of paragraph (b)(1) of this section, trust assets 
do not include cash or assets purchased with the proceeds of a trust 
borrowing, forward sale, or similar transaction.
    (4) Proper adjustment shall be made to any gain or loss subsequently 
realized for gain or loss taken into account under paragraph (b)(1) of 
this section.
    (c) Examples. The following examples illustrate the rules of 
paragraph (b) of this section:

    Example 1. Deemed sale by trust. Donor contributes stock having a 
fair market value of $2 million to a charitable remainder unitrust with 
a unitrust amount of 50 percent of the net fair market value of the 
trust assets and a two-year term. The stock has a total adjusted basis 
of $400,000. In Year 1, the trust receives dividend income of $20,000. 
As of the valuation date, the trust's assets have a net fair market 
value of $2,020,000 ($2 million in stock, plus $20,000 in cash). To 
obtain additional cash to pay the unitrust amount to the noncharitable 
beneficiary, the trustee borrows $990,000 against the value of the 
stock. The trust then distributes $1,010,000 to the beneficiary before 
the end of Year 1. Under section 664(b)(1), $20,000 of the distribution 
is characterized in the hands of the beneficiary as dividend income. The 
rest of the distribution, $990,000, is attributable to an amount 
received by the trust that did not represent either cash contributed to 
the trust or a return of basis in any contributed asset sold by the 
trust during Year 1. Under paragraph (b)(3) of this section, the stock 
is a trust asset because it was not purchased with the proceeds of the 
borrowing. Therefore, in Year 1, under paragraph (b)(1) of this section, 
the trust is treated as having sold $990,000 of stock and as having 
realized $792,000 of capital gain (the trust's basis in the shares 
deemed sold is $198,000). Thus, in the hands of the beneficiary, 
$792,000 of the distribution is characterized as capital gain under 
section 664(b)(2) and $198,000 is characterized as a tax-free return of 
corpus under section 664(b)(4). No part of the $990,000 loan is treated 
as acquisition indebtedness under section 514(c) because the entire loan 
has been recharacterized as a deemed sale.

[[Page 74]]

    Example 2. Adjustment to trust's basis in assets deemed sold. The 
facts are the same as in Example 1. During Year 2, the trust sells the 
stock for $2,100,000. The trustee uses a portion of the proceeds of the 
sale to repay the outstanding loan, plus accrued interest. Under 
paragraph (b)(4) of this section, the trust's adjusted basis in the 
stock is $1,192,000 ($400,000 plus the $792,000 of gain recognized in 
Year 1). Therefore, the trust recognizes capital gain (as described in 
section 664(b)(2)) in Year 2 of $908,000.
    Example 3. Distribution of cash contributions. Upon the death of D, 
the proceeds of a life insurance policy on D's life are payable to T, a 
charitable remainder annuity trust. The terms of the trust provide that, 
for a period of three years commencing upon D's death, the trust shall 
pay an annuity amount equal to $x annually to A, the child of D. After 
the expiration of such three-year period, the remainder interest in the 
trust is to be transferred to charity Z. In Year 1, the trust receives 
payment of the life insurance proceeds and pays the appropriate pro rata 
portion of the $x annuity to A from the insurance proceeds. During Year 
1, the trust has no income. Because the entire distribution is 
attributable to a cash contribution (the insurance proceeds) to the 
trust for which a charitable deduction was allowable under section 2055 
with respect to the present value of the remainder interest passing to 
charity, the trust will not be treated as selling a pro rata portion of 
the trust assets under paragraph (b)(1) of this section. Thus, the 
distribution is characterized in A's hands as a tax-free return of 
corpus under section 664(b)(4).

    (d) Effective date. This section is applicable to distributions made 
by a charitable remainder trust after October 18, 1999.

[T.D. 8926, 66 FR 1037, Jan. 5, 2001]



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

    For purposes of subparts A through D, part I, subchapter J, chapter 
1 of the Internal Revenue Code, ``income,'' when not preceded by the 
words ``taxable,'' ``distributable net,'' ``undistributed net,'' or 
``gross,'' means the amount of income of an estate or trust for the 
taxable year determined under the terms of the governing instrument and 
applicable local law. Trust provisions that depart fundamentally from 
traditional principles of income and principal will generally not be 
recognized. For example, if a trust instrument directs that all the 
trust income shall be paid to the income beneficiary but defines 
ordinary dividends and interest as principal, the trust will not be 
considered one that under its governing instrument is required to 
distribute all its income currently for purposes of section 642(b) 
(relating to the personal exemption) and section 651 (relating to simple 
trusts). Thus, items such as dividends, interest, and rents are 
generally allocated to income and proceeds from the sale or exchange of 
trust assets are generally allocated to principal. However, an 
allocation of amounts between income and principal pursuant to 
applicable local law will be respected if local law provides for a 
reasonable apportionment between the income and remainder beneficiaries 
of the total return of the trust for the year, including ordinary and 
tax-exempt income, capital gains, and appreciation. For example, a state 
statute providing that income is a unitrust amount of no less than 3% 
and no more than 5% of the fair market value of the trust assets, 
whether determined annually or averaged on a multiple year basis, is a 
reasonable apportionment of the total return of the trust. Similarly, a 
state statute that permits the trustee to make adjustments between 
income and principal to fulfill the trustee's duty of impartiality 
between the income and remainder beneficiaries is generally a reasonable 
apportionment of the total return of the trust. Generally, these 
adjustments are permitted by state statutes when the trustee invests and 
manages the trust assets under the state's prudent investor standard, 
the trust describes the amount that may or must be distributed to a 
beneficiary by referring to the trust's income, and the trustee after 
applying the state statutory rules regarding the allocation of receipts 
and disbursements to income and principal, is unable to administer the 
trust impartially. Allocations pursuant to methods prescribed by such 
state statutes for apportioning the total return of a trust between 
income and principal will be respected regardless of whether the trust 
provides that the income must be distributed to one or more 
beneficiaries or may be accumulated in whole or in part, and regardless 
of which alternate permitted method is actually used, provided the trust 
complies with all requirements of

[[Page 75]]

the state statute for switching methods. A switch between methods of 
determining trust income authorized by state statute will not constitute 
a recognition event for purposes of section 1001 and will not result in 
a taxable gift from the trust's grantor or any of the trust's 
beneficiaries. A switch to a method not specifically authorized by state 
statute, but valid under state law (including a switch via judicial 
decision or a binding non-judicial settlement) may constitute a 
recognition event to the trust or its beneficiaries for purposes of 
section 1001 and may result in taxable gifts from the trust's grantor 
and beneficiaries, based on the relevant facts and circumstances. In 
addition, an allocation to income of all or a part of the gains from the 
sale or exchange of trust assets will generally be respected if the 
allocation is made either pursuant to the terms of the governing 
instrument and applicable local law, or pursuant to a reasonable and 
impartial exercise of a discretionary power granted to the fiduciary by 
applicable local law or by the governing instrument, if not prohibited 
by applicable local law. This section is effective for taxable years of 
trusts and estates ending after January 2, 2004.

[T.D. 9102, 69 FR 19, Jan. 2, 2004]



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

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

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



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

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



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

    (a) In general. For the purpose of part I, subchapter J, chapter 1 
of the Internal Revenue Code, the term foreign trust created by a United 
States person means that portion of a foreign trust (as defined in 
section 7701(a)(31)) attributable to money or property (including all 
accumulated earnings, profits, or gains attributable to such money or 
property) of a U.S. person (as defined in section 7701(a)(30)) 
transferred directly or indirectly, or under the will of a decedent who 
at the date of his death was a U.S. citizen or resident, to the foreign 
trust. A foreign trust created by a person who is not a U.S. person, to 
which a U.S. person transfers his money or property, is a foreign trust 
created by a U.S. person to the extent that the fair market value of the 
entire foreign trust is attributable to money or property of the U.S. 
person transferred to the foreign trust. The transfer of money or 
property to the foreign trust may be made either directly or indirectly 
by a U.S. person. Transfers of money or property to a foreign trust do 
not include transfers of money or property pursuant to a sale or 
exchange which is made for a full and adequate consideration. Transfers 
to which section 643(d) and this section apply are transfers of money or 
property which establish or increase the corpus of a foreign trust. The 
rules set forth in this section with respect to

[[Page 76]]

transfers by a U.S. person to a foreign trust also are applicable with 
respect to transfers under the will of a decedent who at the date of his 
death was a U.S. citizen or resident. For provisions relating to the 
information returns which are required to be filed with respect to the 
creation of or transfers to foreign trusts, see section 6048 and Sec. 
16.3-1 of this chapter (Temporary Regulations under the Revenue Act of 
1962).
    (b) Determination of a foreign trust created by a U.S. person--(1) 
Transfers of money or property only by a U.S. person. If all the items 
of money or property constituting the corpus of a foreign trust are 
transferred to the trust by a U.S. person, the entire foreign trust is a 
foreign trust created by a U.S. person.
    (2) Transfers of money or property by both a U.S. person and a 
person other than a U.S. person; transfers required to be treated as 
separate funds. Where there are transfers of money or property by both a 
U.S. person and a person other than a U.S. person to a foreign trust, 
and it is necessary, either by reason of the provisions of the governing 
instrument of the trust or by reason of some other requirement such as 
local law, that the trustee treat the entire foreign trust as composed 
of two separate funds, one consisting of the money or property 
(including all accumulated earnings, profits, or gains attributable to 
such money or property) transferred by the U.S. person and the other 
consisting of the money or property (including all accumulated earnings, 
profits, or gains attributable to such money or property) transferred by 
the person other than the U.S. person, the foreign trust created by a 
U.S. person shall be the fund consisting of the money or property 
transferred by the U.S. person. See example 1 in paragraph (c) of this 
section.
    (3) Transfers of money or property by both a U.S. person and a 
person other than a U.S. person; transfers not required to be treated as 
separate funds. Where the corpus of a foreign trust consists of money or 
property transferred to the trust (simultaneously or at different times) 
by a U.S. person and by a person who is not a U.S. person, the foreign 
trust created by a U.S. person within the meaning of section 643(d) is 
that portion of the entire foreign trust which, immediately after any 
transfer of money or property to the trust, the fair market value of 
money or property (including all accumulated earnings, profits, or gains 
attributable to such money or property) transferred to the foreign trust 
by the U.S. person bears to the fair market value of the corpus 
(including all accumulated earnings, profits, or gains attributable to 
the corpus) of the entire foreign trust.
    (c) Examples. The provisions of paragraph (b) of this section may be 
illustrated by the following examples. Example 1 illustrates the 
application of paragraph (b)(2) of this section. Example (2) illustrates 
the application of paragraph (b)(3) of this section in a case where 
there is no provision in the governing instrument of the trust or 
elsewhere which would require the trustee to treat the corpus of the 
trust as composed of more than one fund.

    Example 1. On January 1, 1964, the date of the creation of a foreign 
trust, a U.S. person transfers to it stock of a U.S. corporation with a 
fair market value of $50,000. On the same day, a person other than a 
U.S. person transfers to the trust Country X bonds with a fair market 
value of $25,000. The governing instrument of the trust provides that 
the income from the stock of the U.S. corporation is to be accumulated 
until A, a U.S. beneficiary, reaches the age of 21 years, and upon his 
reaching that age, the stock and income accumulated thereon are to be 
distributed to him. The governing instrument of the trust further 
provides that the income from the Country X bonds is to be accumulated 
until B, a U.S. beneficiary, reaches the age of 21 years, and upon his 
reaching that age, the bonds and income accumulated thereon are to be 
distributed to him. To comply with the provisions of the governing 
instrument of the trust that the income from the stock of the U.S. 
corporation be accumulated and distributed to A and that the income from 
the Country X bonds be accumulated and distributed to B, it is necessary 
that the trustee treat the transfers as two separate funds. The fund 
consisting of the stock of the U.S. corporation is a foreign trust 
created by a U.S. person.
    Example 2. On January 1, 1964, the date of the creation of a foreign 
trust, a U.S. person transfers to it property having a fair market value 
of $60,000 and a person other than a U.S. person transfers to it 
property having a fair market value of $40,000. Immediately

[[Page 77]]

after these transfers, the foreign trust created by a U.S. person is 60 
percent of the entire foreign trust, determined as follows:

$60,000 (Value of property transferred by U.S. person)/$100,000 (Value 
          of entire property transferred to trust)=60 percent


The undistributed net income for the calendar years 1964 and 1965 is 
$20,000 which increases the value of the entire foreign trust to 
$120,000 ($100,000 plus $20,000). Accordingly, as of December 31, 1965, 
the portion of the foreign trust created by the U.S. person is $72,000 
(60 percent of $120,000). On January 1, 1966, the U.S. person transfers 
property having a fair market value of $40,000 increasing the value of 
the entire foreign trust to $160,000 ($120,000 plus $40,000) and 
increasing the value of the portion of the foreign trust created by the 
U.S. person to $112,000 ($72,000 plus $40,000). Immediately, after this 
transfer, the foreign trust created by the U.S. person is 70 percent of 
the entire foreign trust, determined as follows:

$112,000 (Value of property transferred by U.S. person)/$160,000 (Value 
          of entire property transferred to the trust)=70 percent

[T.D. 6989, 34 FR 732, Jan. 17, 1969]



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

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

    Example. (1) Under the terms of the trust instrument, the income of 
a trust is required to be currently distributed to W during her life. 
Capital gains are allocable to corpus and all expenses are charges 
against corpus. During the taxable year the trust has the following 
items of income and expenses:

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

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

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


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

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

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



Sec. 1.643(h)-1  Distributions by certain foreign trusts through 
intermediaries.

    (a) In general--(1) Principal purpose of tax avoidance. Except as 
provided in paragraph (b) of this section, for purposes of part I of 
subchapter J, chapter 1 of the Internal Revenue Code, and section 6048, 
any property (within the meaning of paragraph (f) of this section) that 
is transferred to a United States person by another person (an 
intermediary) who has received property from a foreign trust will be 
treated as property transferred directly by the foreign trust to the 
United States person if the intermediary received the property from the 
foreign trust pursuant to a plan one of the principal purposes of which 
was the avoidance of United States tax.
    (2) Principal purpose of tax avoidance deemed to exist. For purposes 
of paragraph (a)(1) of this section, a transfer will be deemed to have 
been made pursuant to a plan one of the principal purposes of which was 
the avoidance of United States tax if the United States person--
    (i) Is related (within the meaning of paragraph (e) of this section) 
to a

[[Page 78]]

grantor of the foreign trust, or has another relationship with a grantor 
of the foreign trust that establishes a reasonable basis for concluding 
that the grantor of the foreign trust would make a gratuitous transfer 
(within the meaning of Sec. 1.671-2(e)(2)) to the United States person;
    (ii) Receives from the intermediary, within the period beginning 
twenty-four months before and ending twenty-four months after the 
intermediary's receipt of property from the foreign trust, either the 
property the intermediary received from the foreign trust, proceeds from 
such property, or property in substitution for such property; and
    (iii) Cannot demonstrate to the satisfaction of the Commissioner 
that--
    (A) The intermediary has a relationship with the United States 
person that establishes a reasonable basis for concluding that the 
intermediary would make a gratuitous transfer to the United States 
person;
    (B) The intermediary acted independently of the grantor and the 
trustee of the foreign trust;
    (C) The intermediary is not an agent of the United States person 
under generally applicable United States agency principles; and
    (D) The United States person timely complied with the reporting 
requirements of section 6039F, if applicable, if the intermediary is a 
foreign person.
    (b) Exceptions--(1) Nongratuitous transfers. Paragraph (a) of this 
section does not apply to the extent that either the transfer from the 
foreign trust to the intermediary or the transfer from the intermediary 
to the United States person is a transfer that is not a gratuitous 
transfer within the meaning of Sec. 1.671-2(e)(2).
    (2) Grantor as intermediary. Paragraph (a) of this section does not 
apply if the intermediary is the grantor of the portion of the trust 
from which the property that is transferred is derived. For the 
definition of grantor, see Sec. 1.671-2(e).
    (c) Effect of disregarding intermediary--(1) General rule. Except as 
provided in paragraph (c)(2) of this section, the intermediary is 
treated as an agent of the foreign trust, and the property is treated as 
transferred to the United States person in the year the property is 
transferred, or made available, by the intermediary to the United States 
person. The fair market value of the property transferred is determined 
as of the date of the transfer by the intermediary to the United States 
person. For purposes of section 665(d)(2), the term taxes imposed on the 
trust includes any income, war profits, and excess profits taxes imposed 
by any foreign country or possession of the United States on the 
intermediary with respect to the property transferred.
    (2) Exception. If the Commissioner determines, or if the taxpayer 
can demonstrate to the satisfaction of the Commissioner, that the 
intermediary is an agent of the United States person under generally 
applicable United States agency principles, the property will be treated 
as transferred to the United States person in the year the intermediary 
receives the property from the foreign trust. The fair market value of 
the property transferred will be determined as of the date of the 
transfer by the foreign trust to the intermediary. For purposes of 
section 901(b), any income, war profits, and excess profits taxes 
imposed by any foreign country or possession of the United States on the 
intermediary with respect to the property transferred will be treated as 
having been imposed on the United States person.
    (3) Computation of gross income of intermediary. If property is 
treated as transferred directly by the foreign trust to a United States 
person pursuant to this section, the fair market value of such property 
is not taken into account in computing the gross income of the 
intermediary (if otherwise required to be taken into account by the 
intermediary but for paragraph (a) of this section).
    (d) Transfers not in excess of $10,000. This section does not apply 
if, during the taxable year of the United States person, the aggregate 
fair market value of all property transferred to such person from all 
foreign trusts either directly or through one or more intermediaries 
does not exceed $10,000.
    (e) Related parties. For purposes of this section, a United States 
person is treated as related to a grantor of a foreign trust if the 
United States person

[[Page 79]]

and the grantor are related for purposes of section 643(i)(2)(B), with 
the following modifications--
    (1) For purposes of applying section 267 (other than section 267(f)) 
and section 707(b)(1), ``at least 10 percent'' is used instead of ``more 
than 50 percent'' each place it appears; and
    (2) The principles of section 267(b)(10), using ``at least 10 
percent'' instead of ``more than 50 percent,'' apply to determine 
whether two corporations are related.
    (f) Definition of property. For purposes of this section, the term 
property includes cash.
    (g) Examples. The following examples illustrate the rules of this 
section. In each example, FT is an irrevocable foreign trust that is not 
treated as owned by any other person and the fair market value of the 
property that is transferred exceeds $10,000. The examples are as 
follows:

    Example 1. Principal purpose of tax avoidance. FT was created in 
1980 by A, a nonresident alien, for the benefit of his children and 
their descendants. FT's trustee, T, determines that 1000X of accumulated 
income should be distributed to A's granddaughter, B, who is a resident 
alien. Pursuant to a plan with a principal purpose of avoiding the 
interest charge that would be imposed by section 668, T causes FT to 
make a gratuitous transfer (within the meaning of Sec. 1.671-2(e)(2)) 
of 1000X to I, a foreign person. I subsequently makes a gratuitous 
transfer of 1000X to B. Under paragraph (a)(1) of this section, FT is 
deemed to have made an accumulation distribution of 1000X directly to B.
    Example 2. United States person unable to demonstrate that 
intermediary acted independently. GM and her daughter, M, are both 
nonresident aliens. M's daughter, D, is a resident alien. GM creates and 
funds FT for the benefit of her children. On July 1, 2001, FT makes a 
gratuitous transfer of XYZ stock to M. M immediately sells the XYZ stock 
and uses the proceeds to purchase ABC stock. On January 1, 2002, M makes 
a gratuitous transfer of the ABC stock to D. D is unable to demonstrate 
that M acted independently of GM and the trustee of FT in making the 
transfer to D. Under paragraph (a)(2) of this section, FT is deemed to 
have distributed the ABC stock to D. Under paragraph (c)(1) of this 
section, M is treated as an agent of FT, and the distribution is deemed 
to have been made on January 1, 2002.
    Example 3. United States person demonstrates that specified 
conditions are satisfied. Assume the same facts as in Example 2, except 
that M receives 1000X cash from FT instead of XYZ stock. M gives 1000X 
cash to D on January 1, 2002. Also assume that M receives annual income 
of 5000X from her own investments and that M has given D 1000X at the 
beginning of each year for the past ten years. Based on this and 
additional information provided by D, D demonstrates to the satisfaction 
of the Commissioner that M has a relationship with D that establishes a 
reasonable basis for concluding that M would make a gratuitous transfer 
to D, that M acted independently of GM and the trustee of FT, that M is 
not an agent of D under generally applicable United States agency 
principles, and that D timely complied with the reporting requirements 
of section 6039F. FT will not be deemed under paragraph (a)(2) of this 
section to have made a distribution to D.
    Example 4. Transfer to United States person less than 24 months 
before transfer to intermediary. Several years ago, A, a nonresident 
alien, created and funded FT for the benefit of his children and their 
descendants. A has a close friend, C, who also is a nonresident alien. 
A's granddaughter, B, is a resident alien. On December 31, 2001, C makes 
a gratuitous transfer of 1000X to B. On January 15, 2002, FT makes a 
gratuitous transfer of 1000X to C. B is unable to demonstrate that C has 
a relationship with B that would establish a reasonable basis for 
concluding that C would make a gratuitous transfer to B or that C acted 
independently of A and the trustee of FT in making the transfer to B. 
Under paragraph (a)(2) of this section, FT is deemed to have distributed 
1000X directly to B. Under paragraph (c)(1) of this section, C is 
treated as an agent of FT, and the distribution is deemed to have been 
made on December 31, 2001.
    Example 5. United States person receives property in substitution 
for property transferred to intermediary. GM and her son, S, are both 
nonresident aliens. S's daughter, GD, is a resident alien. GM creates 
and funds FT for the benefit of her children and their descendants. On 
July 1, 2001, FT makes a gratuitous transfer of ABC stock with a fair 
market value of approximately 1000X to S. On January 1, 2002, S makes a 
gratuitous transfer of DEF stock with a fair market value of 
approximately 1000X to GD. GD is unable to demonstrate that S acted 
independently of GM and the trustee of FT in transferring the DEF stock 
to GD. Under paragraph (a)(2) of this section, FT is deemed to have 
distributed the DEF stock to GD. Under paragraph (c)(1) of this section, 
S is treated as an agent of FT, and the distribution is deemed to have 
been made on January 1, 2002.
    Example 6. United States person receives indirect loan from foreign 
trust. Several years ago, A, a nonresident alien, created and funded FT 
for the benefit of her children and their descendants. A's daughter, B, 
is a resident alien. B needs funds temporarily while she is

[[Page 80]]

starting up her own business. If FT were to loan money directly to B, 
section 643(i) would apply. FT deposits 500X with FB, a foreign bank, on 
June 30, 2001. On July 1, 2001, FB loans 400X to B. Repayment of the 
loan is guaranteed by FT's 500X deposit. B is unable to demonstrate to 
the satisfaction of the Commissioner that FB has a relationship with B 
that establishes a reasonable basis for concluding that FB would make a 
loan to B or that FB acted independently of A and the trustee of FT in 
making the loan. Under paragraph (a)(2) of this section, FT is deemed to 
have loaned 400X directly to B on July 1, 2001. Under paragraph (c)(1) 
of this section, FB is treated as an agent of FT. For the treatment of 
loans from foreign trusts, see section 643(i).
    Example 7. United States person demonstrates that specified 
conditions are satisfied. GM, a nonresident alien, created and funded FT 
for the benefit of her children and their descendants. One of GM's 
children is M, who is a resident alien. During the year 2001, FT makes a 
gratuitous transfer of 500X to M. M reports the 500X on Form 3520 as a 
distribution received from a foreign trust. During the year 2002, M 
makes a gratuitous transfer of 400X to her son, S, who also is a 
resident alien. M files a Form 709 treating the gratuitous transfer to S 
as a gift. Based on this and additional information provided by S, S 
demonstrates to the satisfaction of the Commissioner that M has a 
relationship with S that establishes a reasonable basis for concluding 
that M would make a gratuitous transfer to S, that M acted independently 
of GM and the trustee of FT, and that M is not an agent of S under 
generally applicable United States agency principles. FT will not be 
deemed under paragraph (a)(2) of this section to have made a 
distribution to S.M
    Example 8. Intermediary as agent of trust; increase in FMV. A, a 
nonresident alien, created and funded FT for the benefit of his children 
and their descendants. On December 1, 2001, FT makes a gratuitous 
transfer of XYZ stock with a fair market value of 85X to B, a 
nonresident alien. On November 1, 2002, B sells the XYZ stock to a third 
party in an arm's length transaction for 100X in cash. On November 1, 
2002, B makes a gratuitous transfer of 98X to A's grandson, C, a 
resident alien. C is unable to demonstrate to the satisfaction of the 
Commissioner that B acted independently of A and the trustee of FT in 
making the transfer. Under paragraph (a)(2) of this section, FT is 
deemed to have made a distribution directly to C. Under paragraph (c)(1) 
of this section, B is treated as an agent of FT, and FT is deemed to 
have distributed 98X to C on November 1, 2002.
    Example 9. Intermediary as agent of United States person; increase 
in FMV. Assume the same facts as in Example 8, except that the 
Commissioner determines that B is an agent of C under generally 
applicable United States agency principles. Under paragraph (c)(2) of 
this section, FT is deemed to have distributed 85X to C on December 1, 
2001. C must take the gain of 15X into account in the year 2002.
    Example 10. Intermediary as agent of trust; decrease in FMV. Assume 
the same facts as in Example 8, except that the value of the XYZ stock 
on November 1, 2002, is only 80X. Instead of selling the XYZ stock to a 
third party and transferring cash to C, B transfers the XYZ stock to C 
in a gratuitous transfer. Under paragraph (c)(1) of this section, FT is 
deemed to have distributed XYZ stock with a value of 80X to C on 
November 1, 2002.
    Example 11. Intermediary as agent of United States person; decrease 
in FMV. Assume the same facts as in Example 10, except that the 
Commissioner determines that B is an agent of C under generally 
applicable United States agency principles. Under paragraph (c)(2) of 
this section, FT is deemed to have distributed XYZ stock with a value of 
85X to C on December 1, 2001.

    (h) Effective date. The rules of this section are applicable to 
transfers made to United States persons after August 10, 1999.

[T.D. 8831, 64 FR 43272, Aug. 10, 1999, as amended by T.D. 8890, 65 FR 
41332, July 5, 2000]

    pooled income fund actuarial tables applicable before may 1, 2009



Sec. 1.642(c)-6A  Valuation of charitable remainder interests for
which the valuation date is before May 1, 2009.

    (a) Valuation of charitable remainder interests for which the 
valuation date is before January 1, 1952. There was no provision for the 
qualification of pooled income funds under section 642 until 1969. See 
Sec. 20.2031-7A(a) of this chapter (Estate Tax Regulations) for the 
determination of the present value of a charitable remainder interest 
created before January 1, 1952.
    (b) Valuation of charitable remainder interests for which the 
valuation date is after December 31, 1951, and before January 1, 1971. 
No charitable deduction is allowable for a transfer to a pooled income 
fund for which the valuation date is after the effective dates of the 
Tax Reform Act of 1969 unless the pooled income fund meets the 
requirements of section 642(c)(5). See Sec. 20.2031-7A(b) of this 
chapter (Estate Tax Regulations) for the determination of the present

[[Page 81]]

value of a charitable remainder interest for which the valuation date is 
after December 31, 1951, and before January 1, 1971.
    (c) Present value of remainder interest in the case of transfers to 
pooled income funds for which the valuation date is after December 31, 
1970, and before December 1, 1983. For the determination of the present 
value of a remainder interest in property transferred to a pooled income 
fund for which the valuation date is after December 31, 1970, and before 
December 1, 1983, see Sec. 20.2031-7A(c) of this chapter (Estate Tax 
Regulations) and former Sec. 1.642(c)-6(e) (as contained in the 26 CFR 
part 1 edition revised as of April 1, 1994).
    (d) Present value of remainder interest dependent on the termination 
of one life in the case of transfers to pooled income funds made after 
November 30, 1983, for which the valuation date is before May 1, 1989--
(1) In general. For transfers to pooled income funds made after November 
30, 1983, for which the valuation date is before May 1, 1989, the 
present value of the remainder interest at the time of the transfer of 
property to the fund is determined by computing the present value (at 
the time of the transfer) of the life income interest in the transferred 
property (as determined under paragraph (d)(2) of this section) and 
subtracting that value from the fair market value of the transferred 
property on the valuation date. The present value of a remainder 
interest that is dependent on the termination of the life of one 
individual is computed by use of Table G in paragraph (d)(4) of this 
section. For purposes of the computation under this section, the age of 
an individual is to be taken as the age of the individual at the 
individual's nearest birthday.
    (2) Present value of life income interest. The present value of the 
life income interest in property transferred to a pooled income fund 
shall be computed on the basis of:
    (i) Life contingencies determined from the values of lx that are set 
forth in Table LN of Sec. 20.2031-7A(d)(6) of this chapter (Estate Tax 
Regulations); and
    (ii) Discount at a rate of interest, compounded annually, equal to 
the highest yearly rate of return of the pooled income fund for the 3 
taxable years immediately preceding its taxable year in which the 
transfer of property to the fund is made. For purposes of this paragraph 
(d)(2), the yearly rate of return of a pooled income fund is determined 
as provided in Sec. 1.642(c)-6(c) unless the highest yearly rate of 
return is deemed to be 9 percent. For purposes of this paragraph (d)(2), 
the first taxable year of a pooled income fund is considered a taxable 
year even though the taxable year consists of less than 12 months. 
However, appropriate adjustments must be made to annualize the rate of 
return earned by the fund for that period. Where it appears from the 
facts and circumstances that the highest yearly rate of return for the 3 
taxable years immediately preceding the taxable year in which the 
transfer of property is made has been purposely manipulated to be 
substantially less than the rate of return that would otherwise be 
reasonably anticipated with the purpose of obtaining an excessive 
charitable deduction, that rate of return may not be used. In that case, 
the highest yearly rate of return of the fund is determined by treating 
the fund as a pooled income fund that has been in existence for less 
than 3 preceding taxable years. If a pooled income fund has been in 
existence less than 3 taxable years immediately preceding the taxable 
year in which the transfer of property to the fund is made, the highest 
yearly rate of return is deemed to be 9 percent.
    (3) Computation of value of remainder interest. The factor which is 
used in determining the present value of the remainder interest is the 
factor under the appropriate yearly rate of return in column (2) of 
Table G opposite the number in column (1) which corresponds to the age 
of the individual upon whose life the value of the remainder interest is 
based. If the yearly rate of return is a percentage which is between 
yearly rates of return for which factors are provided in Table G, a 
linear interpolation must be made. The present value of the remainder 
interest is determined by multiplying, by the factor determined under 
this paragraph (d)(3), the fair market value on the appropriate 
valuation date. If the yearly rate of return is below 2.2 percent or 
above 14 percent, see Sec. 1.642(c)-

[[Page 82]]

6(b). This paragraph (d)(3) may be illustrated by the following example:

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

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

[GRAPHIC] [TIFF OMITTED] TC14NO91.133


Factor at 9.8 percent for person aged 50.....................    0.15653
Less:
  Interpolation adjustment...................................     .00198
                                                              ----------
  Interpolated factor........................................     .15455
                                                              ==========
Present value of remainder interest ($100,000x.15455.........    $15,455
 

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

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

[[Page 83]]

 
92............................................................    .92822    .92222    .91630    .91045    .90469
93............................................................    .93170    .92597    .92032    .91474    .90923
94............................................................    .93477    .92929    .92387    .91853    .91325
95............................................................    .93743    .93216    .92695    .92181    .91673
96............................................................    .93967    .93458    .92955    .92458    .91966
97............................................................    .94167    .93674    .93186    .92704    .92228
98............................................................    .94342    .93863    .93389    .92921    .92457
99............................................................     94508     94041    .93580    .93124    .92673
100...........................................................    .94672    .94218    .93770    .93326    .92887
101...........................................................    .94819    .94377    .93940    .93508    .93080
102...........................................................    .94979    .94550    .94125    .93704    .93288
103...........................................................    .95180    .94766    .94357    .93952    .93550
104...........................................................    .95377    .94979    .94585    .94194    .93806
105...........................................................    .95663    .95288    .94916    .94547    .94181
106...........................................................    .96101    .95762    .95425    .95091    .94760
107...........................................................    .96688    .96398    .96110    .95824    .95539
108...........................................................    .97569    .97354    .97141    .96928    .96717
109...........................................................    .98924    .98828    .98733    .98638    .98544
----------------------------------------------------------------------------------------------------------------


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

[[Page 84]]

 
101...........................................................    .92656    .92236    .91821    .91410    .91003
102...........................................................    .92875    .92467    .92063    .91662    .91266
103...........................................................    .93152    .92758    .92367    .91980     91597
104...........................................................    .93423    .93042    .92665    .92291    .91920
105...........................................................    .93818    .93458    .93101    .92747    .92395
106...........................................................    .94430    .94104    .93779    .93457    .93127
107...........................................................     95256    .94975    .94696    .94418    .94143
108...........................................................    .96507     96298    .96090    .95883    .95676
109...........................................................    .98450    .98356    .98263    .98170    .98077
----------------------------------------------------------------------------------------------------------------


                                                     Table G
 Table G--Single Life, Unisex--Table Showing the Present Worth of the Remainder Interest in Property Transferred
   to a Pooled Income Fund Having the Yearly Rate of Return Shown--Applicable for Transfers After November 30,
                                          1983, and Before May 1, 1989
----------------------------------------------------------------------------------------------------------------
                                                                            (2) Yearly rate of return
                            (1) Age                            -------------------------------------------------
                                                                  4.2%      4.4%      4.6%      4.8%      5.0%
----------------------------------------------------------------------------------------------------------------
0.............................................................    .08811    .08132    .07534    .07006    .06539
1.............................................................    .07283    .06576    .05952    .05400    .04912
2.............................................................    .07471    .06746    .06106    .05539    .05037
3.............................................................    .07704    .06962    .06304    .05722    .05205
4.............................................................    .07962    .07202    .06528    .05930    .05398
5.............................................................    .08243    .07464    .06773    .06159    .05612
6.............................................................    .08542    .07745    .07037    .06406    .05844
7.............................................................    .08857    .08042    .07316    .06669    .06091
8.............................................................    .09189    .08355    .07612    .06948    .06354
9.............................................................    .09540    .08687    .07926    .07245    .06635
10............................................................    .09908    .09037    .08258    .07560    .06934
11............................................................    .10296    .09406    .08609    .07894    .07251
12............................................................    .10701    .09793    .08977    .08245    .07586
13............................................................    .11119    .10191    .09358    .08608    .07932
14............................................................    .11544    .10597    .09745    .08978    .08285
15............................................................    .11972    .11007    .10136    .09350    .08640
16............................................................    .12402    .11416    .10527    .09723    .08995
17............................................................    .12832    .11827    .10919    .10096    .09351
18............................................................    .13268    .12243    .11315    .10474    .09711
19............................................................    .13712    .12667    .11720    .10860    .10078
20............................................................    .14170    .13105    .12138    .11259    .10459
21............................................................    .14642    .13557    .12570    .11671    .10853
22............................................................    .15129    .14024    .13017    .12099    .11261
23............................................................    .15634    .14508    .13481    .12544    .11687
24............................................................    .16159    .15013    .13967    .13009    .12133
25............................................................    .16709    .15543    .14477    .13500    .12604
26............................................................    .17286    .16101    .15014    .14018    .13103
27............................................................    .17891    .16686    .15580    .14564    .13630
28............................................................    .18525    .17301    .16175    .15140    .14187
29............................................................    .19183    .17940    .16796    .15742    .14770
30............................................................    .19867    .18606    .17443    .16370    .15380
31............................................................    .20574    .19295    .18114    .17023    .16013
32............................................................    .21307    .20010    .18811    .17702    .16674
33............................................................    .22064    .20751    .19535    .18407    .17362
34............................................................    .22846    .21516    .20283    .19138    .18075
35............................................................    .23653    .22307    .21058    .19896    .18816
36............................................................    .24484    .23124    .21859    .20681    .19584
37............................................................    .25340    .23966    .22685    .21492    .20379
38............................................................    .26219    .24831    .23536    .22328    .21199
39............................................................    .27120    .25720    .24411    .23188    .22044
40............................................................    .28045    .26633    .25311    .24075    .22916
41............................................................    .28992    .27569    .26236    .24986    .23814
42............................................................    .29965    .28532    .27188    .25926    .24741
43............................................................    .30960    .29518    .28163    .26890    .25693
44............................................................    .31977    .30527    .29164    .27880    .26671
45............................................................    .33013    .31557    .30185    .28892    .27673
46............................................................    .34071    .32609    .31230    .29929    .28700
47............................................................    .35148    .33681    .32296    .30988    .29750
48............................................................    .36246    .34777    .33387    .32072    .30826
49............................................................    .37364    .35893    .34499    .33179    .31927
50............................................................    .38503    .37030    .35634    .34310    .33053
51............................................................    .39659    .38187    .36790    .35462    .34201
52............................................................    .40832    .39362    .37965    .36636    .35371
53............................................................    .42021    .40554    .39158    .37829    .36562
54............................................................    .43222    .41760    .40367    .39039    .37771
55............................................................    .44436    .42980    .41591    .40264    .38997
56............................................................    .45660    .44212    .42828    .41504    .40239
57............................................................    .46897    .45456    .44079    .42760    .41498
58............................................................    .48142    .46712    .45342    .44030    .42771
59............................................................    .49399    .47980    .46620    .45314    .44062
60............................................................    .50666    .49260    .47910    .46613    .45367
61............................................................    .51944    .50552    .49214    .47927    .46690
62............................................................    .53232    .51856    .50531    .49256    .48028
63............................................................    .54529    .53169    .51860    .50598    .49381
64............................................................    .55832    .54491    .53198    .51950    .50746
65............................................................    .57140    .55819    .54544    .53312    .52121
66............................................................    .58451    .57152    .55895    .54681    .53506
67............................................................    .59763    .58486    .57251    .56054    .54896
68............................................................    .61076    .59823    .58609    .57432    .56292
69............................................................    .62390    .61162    .59971    .58816    .57695
70............................................................    .63705    .62503    .61337    .60204    .59104
71............................................................    .65023    .63849    .62709    .61600    .60522
72............................................................    .66344    .65199    .64086    .63003    .61949
73............................................................    .67661    .66547    .65463    .64407    .63378
74............................................................    .68964    .67882    .66827    .65798    .64796
75............................................................    .70243    .69193    .68168    .67168    .66192
76............................................................    .71495    .70477    .69482    .68511    .67563
77............................................................    .72717    .71731    .70768    .69826    .68905
78............................................................    .73912    .72959    .72026    .71114    .70221
79............................................................    .75083    .74163    .73262    .72379    .71515
80............................................................    .76235    .75348    .74479    .73627    .72792
81............................................................    .77360    .76506    .75669    .74848    .74043
82............................................................    .78452    .77632    .76827    .76036    .75260
83............................................................    .79513    .78725    .77952    .77192    .76446
84............................................................    .80547    .79792    .79051    .78322    .77606
85............................................................    .81557    .80836    .80126    .79429    .78742
86............................................................    .82524    .81835    .81157    .80489    .79832
87............................................................    .83423    .82764    .82115    .81477    .80847
88............................................................    .84253    .83623    .83002    .82390    .81787
89............................................................    .85033    .84430    .83836    .83250    .82672
90............................................................    .85784    .85208    .84639    .84079    .83525
91............................................................    .86502    .85951    .85408    .84871    .84342
92............................................................    .87164    .86638    .86118    .85605    .85098
93............................................................    .87761    .87257    .86759    .86267    .85781
94............................................................    .88290    .87806    .87327    .86854    .86386
95............................................................    .88750    .88282    .87820    .87364    .86913
96............................................................    .89136    .88683    .88236    .87793    .87355
97............................................................    .89481    .89041    .88606    .88176    .87750
98............................................................    .89783    .89354    .88930    .88511    .88096
99............................................................    .90067    .89649    .89235    .88826    .88420
100...........................................................    .90349    .89941    .89538    .89138    .88743
101...........................................................    .90600    .90202    .89807    .89416    .89029
102...........................................................    .90873    .90484    .90099    .89717    .89339
103...........................................................    .91217    .90841    .90468    .90099    .99733
104...........................................................    .91553    .91188    .90827    .90469    .90114
105...........................................................    .92047    .91701    .91358    .91018    .90680
106...........................................................    .92819    .92504    .92191    .91880    .91571
107...........................................................    .93868    .93596    .93325    .93056    .92788
108...........................................................    .95471    .95267    .95064    .94862    .94661
109...........................................................    .97985    .97893    .97801    .97710    .97619
----------------------------------------------------------------------------------------------------------------


[[Page 85]]


                                                     Table G
 Table G--Single Life, Unisex--Table Showing the Present Worth of the Remainder Interest in Property Transferred
   to a Pooled Income Fund Having the Yearly Rate of Return Shown--Applicable for Transfers After November 30,
                                          1983, and Before May 1, 1989
----------------------------------------------------------------------------------------------------------------
                                                                            (2) Yearly rate of return
                            (1) Age                            -------------------------------------------------
                                                                  5.2%      5.4%      5.6%      5.8%      6.0%
----------------------------------------------------------------------------------------------------------------
0.............................................................    .06126    .05759    .05433    .05143    .04884
1.............................................................    .04480    .04096    .03754    .03450    .03179
2.............................................................    .04591    .04194    .03841    .03527    .03246
3.............................................................    .04745    .04336    .03972    .03646    .03355
4.............................................................    .04924    .04502    .04125    .03789    .03487
5.............................................................    .05124    .04689    .04300    .03952    .03639
6.............................................................    .05342    .04893    .04492    .04131    .03808
7.............................................................    .05574    .05112    .04697    .04324    .03990
8.............................................................    .05822    .05346    .04918    .04533    .04186
9.............................................................    .06089    .05598    .05156    .04759    .04400
10............................................................    .06372    .05866    .05411    .05000    .04630
11............................................................    .06673    .06153    .05684    .05260    .04877
12............................................................    .06992    .06457    .05973    .05536    .05141
13............................................................    .07322    .06772    .06274    .05824    .05415
14............................................................    .07659    .07093    .06581    .06117    .05695
15............................................................    .07998    .07417    .06890    .06411    .05976
16............................................................    .08337    .07739    .07197    .06704    .06255
17............................................................    .08675    .08062    .07504    .06996    .06533
18............................................................    .09018    .08387    .07813    .07290    .06813
19............................................................    .09367    .08720    .08130    .07591    .07099
20............................................................    .09730    .09065    .08458    .07904    .07397
21............................................................    .10106    .09423    .08800    .08229    .07707
22............................................................    .10496    .09796    .09155    .08568    .08030
23............................................................    .10903    .10185    .09526    .08923    .08368
24............................................................    .11330    .10594    .09918    .09297    .08726
25............................................................    .11782    .11028    .10334    .09696    .09108
26............................................................    .12262    .11489    .10778    .10122    .09518
27............................................................    .12771    .11979    .11249    .10576    .09955
28............................................................    .13309    .12499    .11751    .11060    .10421
29............................................................    .13873    .13044    .12278    .11570    .10914
30............................................................    .14464    .13617    .12833    .12107    .11433
31............................................................    .15079    .14214    .13412    .12668    .11977
32............................................................    .15722    .14838    .14018    .13256    .12548
33............................................................    .16391    .15490    .14652    .13873    .13147
34............................................................    .17087    .16168    .15312    .14515    .13772
35............................................................    .17811    .16874    .16001    .15186    .14426
36............................................................    .18562    .17608    .16717    .15886    .15108
37............................................................    .19340    .18369    .17462    .16613    .15819
38............................................................    .20144    .19157    .18233    .17368    .16557
39............................................................    .20974    .19971    .19031    .18149    .17322
40............................................................    .21830    .20812    .19856    .18959    .18115
41............................................................    .22714    .21681    .20710    .19797    .18938
42............................................................    .23627    .22579    .21594    .20665    .19791
43............................................................    .24566    .23505    .22505    .21562    .20673
44............................................................    .25532    .24458    .23445    .22488    .21585
45............................................................    .26522    .25436    .24410    .23440    .22523
46............................................................    .27538    .26441    .25402    .24420    .23490
47............................................................    .28579    .27471    .26421    .25427    .24484
48............................................................    .29647    .28529    .27469    .26463    .25508
49............................................................    .30739    .29613    .28543    .27527    .26562
50............................................................    .31859    .30724    .29646    .28620    .27645
51............................................................    .33001    .31860    .30774    .29740    .28755
52............................................................    .34167    .33020    .31928    .30886    .29893
53............................................................    .35355    .34204    .33105    .32057    .31056
54............................................................    .36562    .35407    .34304    .33250    .32243
55............................................................    .37787    .36630    .35523    .34465    .33452
56............................................................    .39029    .37870    .36761    .35699    .34682
57............................................................    .40289    .39130    .38020    .36956    .35935
58............................................................    .41565    .40408    .39297    .38231    .37208
59............................................................    .42859    .41704    .40595    .39529    .38504
60............................................................    .44170    .43019    .41912    .40847    .39822
61............................................................    .45499    .44353    .43250    .42187    .41164
62............................................................    .46845    .45706    .44607    .43548    .42527
63............................................................    .48208    .47076    .45984    .44930    .43913
64............................................................    .49583    .48461    .47377    .46329    .45317
65............................................................    .50971    .49859    .48784    .47744    .46738
66............................................................    .52369    .51269    .50204    .49173    .48175
67............................................................    .53774    .52688    .51635    .50614    .49625
68............................................................    .55187    .54115    .53075    .52066    .51088
69............................................................    .56607    .55551    .54526    .53530    .52563
70............................................................    .58035    .56997    .55987    .55006    .54053
71............................................................    .59474    .58455    .57463    .56498    .55559
72............................................................    .60923    .59924    .58952    .58004    .57082
73............................................................    .62375    .61398    .60446    .59518    .58613
74............................................................    .63818    .62864    .61933    .61026    .60140
75............................................................    .65240    .64310    .63402    .62515    .61649
76............................................................    .66636    .65731    .64846    .63981    .63135
77............................................................    .68005    .67124    .66263    .65420    .64596
78............................................................    .69347    .68492    .67655    .66836    .66033
79............................................................    .70669    .69840    .69028    .68232    .67452
80............................................................    .71973    .71171    .70384    .69613    .68856
81............................................................    .73252    .72477    .71717    .70970    .70237
82............................................................    .74499    .73751    .73016    .72295    .71587
83............................................................    .75713    .74992    .74284    .73589    .72905
84............................................................    .76901    .76208    .75527    .74857    .74198
85............................................................    .78067    .77402    .76748    .76104    .75471
86............................................................    .79185    .78548    .77921    .77304    .76695
87............................................................    .80228    .79617    .79015    .78423    .77838
88............................................................    .81193    .80607    .80029    .79460    .78899
89............................................................    .82102    .81540    .80985    .80438    .79899
90............................................................    .82979    .82441    .81909    .81384    .80867
91............................................................    .83820    .83304    .82795    .82292    .81796
92............................................................    .84598    .84104    .83616    .83134    .82657
93............................................................    .85300    .84826    .84357    .83894    .83437
94............................................................    .85924    .85468    .85017    .84570    .84130
95............................................................    .86466    .86025    .85589    .85158    .84732
96............................................................    .86922    .86494    .86071    .85652    .85238
97............................................................    .87329    .86913    .86501    .86093    .85690
98............................................................    .87685    .87279    .86877    .86479    .86085
99............................................................    .88019    .87622    .87230    .86841    .86456
100...........................................................    .88351    .87964    .87580    .87200    .86824
101...........................................................    .88646    .88267    .87891    .87519    .87150
102...........................................................    .88965    .88594    .88227    .87863    .87503
103...........................................................    .89370    .89011    .88654    .88301    .87952
104...........................................................    .89763    .89414    .89068    .88725    .88385
105...........................................................    .90345    .90013    .89683    .89356    .89032
106...........................................................    .91265    .90961    .90658    .90358    .90060
107...........................................................    .92522    .92258    .91995    .91734    .91474
108...........................................................    .94461    .94262    .94063    .93866    .93670
109...........................................................    .97529    .97438    .97348    .97259    .97170
----------------------------------------------------------------------------------------------------------------


                                                     Table G
 Table G--Single Life, Unisex--Table Showing the Present Worth of the Remainder Interest in Property Transferred
   to a Pooled Income Fund Having the Yearly Rate of Return Shown--Applicable for Transfers After November 30,
                                          1983, and Before May 1, 1989
----------------------------------------------------------------------------------------------------------------
                                                                            (2) Yearly rate of return
                            (1) Age                            -------------------------------------------------
                                                                  6.2%      6.4%      6.6%      6.8%      7.0%
----------------------------------------------------------------------------------------------------------------
0.............................................................    .04653    .04447    .04262    .04095    .03946
1.............................................................    .02937    .02720    .02525    .02351    .02194
2.............................................................    .02994    .02769    .02567    .02385    .02221
3.............................................................    .03094    .02860    .02650    .02460    .02290
4.............................................................    .03216    .02973    .02755    .02558    .92380
5.............................................................    .03359    .03106    .02879    .02674    .02488
6.............................................................    .03517    .03255    .03019    .02805    .02612
7.............................................................    .03688    .03416    .03171    .02949    .02747
8.............................................................    .03874    .03592    .03337    .03106    .02896

[[Page 86]]

 
9.............................................................    .04077    .03784    .03519    .03279    .03061
10............................................................    .04295    .03992    .03717    .03467    .03240
11............................................................    .04531    .04217    .03931    .03672    .03436
12............................................................    .04782    .04457    .04161    .03892    .02647
13............................................................    .05045    .04708    .04402    .04122    .03868
14............................................................    .05312    .04964    .04646    .04357    .04093
15............................................................    .05581    .05220    .04891    .04591    .04317
16............................................................    .05847    .05474    .05134    .04822    .04538
17............................................................    .06111    .05726    .05374    .05051    .04756
18............................................................    .06378    .05979    .05615    .05280    .04974
19............................................................    .06650    .06238    .05861    .05514    .05196
20............................................................    .06933    .06507    .06117    .05758    .05429
21............................................................    .07228    .06788    .06384    .06013    .05671
22............................................................    .07535    .07081    .06664    .06279    .05925
23............................................................    .07858    .07389    .06958    .06559    .06192
24............................................................    .08201    .07717    .07270    .06858    .06477
25............................................................    .08567    .08067    .07606    .07179    .06785
26............................................................    .08960    .08444    .07968    .07527    .07118
27............................................................    .09380    .08849    .08357    .07901    .07478
28............................................................    .09830    .09283    .08775    .08304    .07867
29............................................................    .10306    .09742    .09218    .08732    .08280
30............................................................    .10808    .10228    .09688    .09187    .08720
31............................................................    .11335    .10738    .10182    .09665    .09182
32............................................................    .11889    .11275    .10704    .10170    .09672
33............................................................    .12471    .11840    .11252    .10703    .10189
34............................................................    .13079    .12432    .11827    .11261    .10732
35............................................................    .13716    .13052    .12431    .11849    .11305
36............................................................    .14381    .13701    .13063    .12465    .11905
37............................................................    .15075    .14378    .13724    .13110    .12534
38............................................................    .15796    .15083    .14412    .13782    .13190
39............................................................    .16545    .15815    .15129    .14483    .13875
40............................................................    .17322    .16576    .15874    .15212    .14589
41............................................................    .18129    .17367    .16649    .15971    .15332
42............................................................    .18967    .18190    .17456    .16763    .16108
43............................................................    .19834    .19041    .18293    .17585    .16915
44............................................................    .20731    .19924    .19160    .18437    .17753
45............................................................    .21655    .20834    .20055    .19318    .18619
46............................................................    .22608    .21773    .20981    .20229    .19516
47............................................................    .23590    .22741    .21935    .21170    .20443
48............................................................    .24602    .23741    .22922    .22144    .21403
49............................................................    .25644    .24770    .23939    .23148    .22394
50............................................................    .26716    .25831    .24989    .24185    .23419
51............................................................    .27816    .26921    .26068    .25253    .24475
52............................................................    .28945    .28040    .27176    .26351    .25562
53............................................................    .30100    .29187    .28313    .27478    .26679
54............................................................    .31279    .30357    .29475    .28631    .27822
55............................................................    .32482    .31553    .30663    .29810    .28992
56............................................................    .33707    .32771    .31875    .31014    .30188
57............................................................    .34955    .34015    .33112    .32244    .31411
58............................................................    .36225    .35280    .34372    .33499    .32659
59............................................................    .37519    .36571    .35659    .34781    .33936
60............................................................    .38836    .37886    .36971    .36089    .35239
61............................................................    .40177    .39226    .38309    .37425    .36572
62............................................................    .41542    .40591    .39674    .38788    .37932
63............................................................    .42930    .41981    .41064    .40178    .39321
64............................................................    .44338    .43392    .42477    .41591    .40734
65............................................................    .45765    .44823    .43910    .43027    .42171
66............................................................    .47208    .46271    .45364    .44483    .43630
67............................................................    .48666    .47736    .46834    .45958    .45108
68............................................................    .50138    .49215    .48320    .47450    .46605
69............................................................    .51624    .50711    .49824    .48961    .48122
70............................................................    .53125    .52223    .51345    .50491    .49660
71............................................................    .54645    .53755    .52889    .52045    .51223
72............................................................    .56183    .55307    .54453    .53621    .52809
73............................................................    .57731    .56870    .56030    .55211    .54412
74............................................................    .59275    .58431    .57606    .56801    .56015
75............................................................    .60803    .59976    .59168    .58379    .57607
76............................................................    .62308    .61500    .60709    .59936    .59179
77............................................................    .63789    .63000    .62227    .61470    .60730
78............................................................    .65247    .64477    .63723    .62984    .62261
79............................................................    .66687    .65938    .65203    .64483    .63777
80............................................................    .68114    .67386    .66672    .65971    .65284
81............................................................    .69518    .68812    .68119    .67438    .66770
82............................................................    .70891    .70207    .69535    .68875    .68227
83............................................................    .72232    .71572    .70922    .70283    .69655
84............................................................    .73550    .72913    .72285    .71668    .71061
85............................................................    .74847    .74234    .73630    .73035    .72449
86............................................................    .76096    .75506    .74925    .74353    .73789
87............................................................    .77263    .76696    .76137    .75585    .75042
88............................................................    .78345    .77799    .77261    .76730    .76207
89............................................................    .79367    .78842    .78323    .77812    .77308
90............................................................    .80356    .79851    .79353    .78862    .78376
91............................................................    .81306    .80821    .80344    .79871    .79405
92............................................................    .82187    .81722    .81263    .80810    .80361
93............................................................    .82984    .82538    .82096    .81659    .81228
94............................................................    .83694    .83263    .82837    .82416    .81999
95............................................................    .84310    .83893    .83481    .83073    .82670
96............................................................    .84829    .84424    .84023    .83626    .83234
97............................................................    .85291    .84897    .84506    .84120    .83738
98............................................................    .85696    .85310    .84929    .84551    .84177
99............................................................    .86075    .85698    .85325    .84956    .84590
100...........................................................    .86452    .86084    .85719    .85357    .85000
101...........................................................    .86785    .86424    .86066    .85711    .85360
102...........................................................    .87146    .86792    .86442    .86094    .85750
103...........................................................    .87605    .87261    .86921    .86583    .86248
104...........................................................    .88047    .87713    .87382    .87053    .86727
105...........................................................    .88710    .88390    .88073    .87758    .87446
106...........................................................    .89764    .89471    .89179    .88889    .88601
107...........................................................    .91216    .90960    .90705    .90451    .90199
108...........................................................    .93474    .93280    .93086    .92894    .92702
109...........................................................    .97081    .96992    .96904    .96816    .96729
----------------------------------------------------------------------------------------------------------------


                                                     Table G
 Table G--Single Life, Unisex--Table Showing the Present Worth of the Remainder Interest in Property Transferred
   to a Pooled Income Fund Having the Yearly Rate of Return Shown--Applicable for Transfers After November 30,
                                          1983, and Before May 1, 1989
----------------------------------------------------------------------------------------------------------------
                                                                            (2) Yearly rate of return
                            (1) Age                            -------------------------------------------------
                                                                  7.2%      7.4%      7.6%      7.8%      8.0%
----------------------------------------------------------------------------------------------------------------
0.............................................................    .03811    .03689    .03579    .03479    .03388
1.............................................................    .02052    .01924    .01809    .01704    .01609
2.............................................................    .02074    .01940    .01819    .01710    .01611
3.............................................................    .02136    .01996    .01870    .01756    .01652
4.............................................................    .02219    .02074    .01942    .01822    .01713
5.............................................................    .02321    .02169    .02031    .01905    .01791
6.............................................................    .02437    .02278    .02134    .02003    .01883
7.............................................................    .02565    .02399    .02248    .02111    .01986
8.............................................................    .02706    .02533    .02376    .02232    .02101
9.............................................................    .02863    .02682    .02518    .02367    .02230
10............................................................    .03034    .02846    .02674    .02517    .02373
11............................................................    .03221    .03025    .02846    .02682    .02532
12............................................................    .03424    .03219    .03032    .02861    .02704
13............................................................    .03635    .03422    .03228    .03049    .02885
14............................................................    .03851    .03630    .03427    .03240    .03069
15............................................................    .04066    .03836    .03624    .03430    .03252
16............................................................    .04277    .04037    .03817    .03615    .03429
17............................................................    .04485    .04236    .04007    .03796    .03602

[[Page 87]]

 
18............................................................    .04693    .04434    .04196    .03976    .03773
19............................................................    .04904    .04635    .04387    .04159    .03947
20............................................................    .05125    .04845    .04588    .04349    .04129
21............................................................    .05356    .05065    .04797    .04549    .04319
22............................................................    .05597    .05295    .05016    .04758    .04519
23............................................................    .05853    .05539    .05248    .04979    .04730
24............................................................    .06124    .05799    .05497    .05217    .04957
25............................................................    .06420    .06081    .05767    .05475    .05205
26............................................................    .06739    .06388    .06062    .05758    .05476
27............................................................    .07086    .06721    .06382    .06067    .05773
28............................................................    .07460    .07082    .06730    .06402    .06097
29............................................................    .07859    .07467    .07102    .06762    .06444
30............................................................    .08284    .07879    .07500    .07146    .06815
31............................................................    .08733    .08312    .07920    .07553    .07209
32............................................................    .09207    .08773    .08366    .07986    .07629
33............................................................    .09709    .09260    .08839    .08445    .08075
34............................................................    .10237    .09773    .09338    .08929    .08546
35............................................................    .10794    .10315    .09865    .09442    .09045
36............................................................    .11379    .10884    .10420    .09983    .09572
37............................................................    .11992    .11483    .11003    .10552    .10126
38............................................................    .12633    .12108    .11614    .11148    .10708
39............................................................    .13302    .12762    .12253    .11772    .11318
40............................................................    .14000    .13445    .12921    .12425    .11957
41............................................................    .14728    .14158    .13619    .13109    .12626
42............................................................    .15490    .14904    .14350    .13825    .13328
43............................................................    .16260    .15680    .15111   .145072    .14060
44............................................................     17104    .16488    .15905    .15351    .14825
45............................................................    .17955    .17326    .16727    .16159    .15619
46............................................................    .18838    .18194    .17582    .16999    .16445
47............................................................    .19751    .19093    .18467    .17870    .17302
48............................................................    .20698    .20026    .19386    .18776    .18194
49............................................................    .21676    .20991    .20338    .19715    .19119
50............................................................    .22689    .21991    .21325    .20689    .20080
51............................................................    .23732    .23023    .22344    .21695    .21074
52............................................................    .24808    .24086    .23396    .22735    .22102
53............................................................    .25914    .25181    .24479    .23807    .24252
54............................................................    .27047    .26304    .25591    .24908    .25372
55............................................................    .28208    .27455    .26733    .26039    .25372
56............................................................    .29395    .28633    .37901    .27197    .26521
57............................................................    .30610    .29840    .29099    .28386    .27700
58............................................................    .31851    .31074    .30325    .29604    .28909
59............................................................    .33122    .32337    .31581    .30853    .30150
60............................................................    .34420    .33630    .32867    .32132    .31422
61............................................................    .35748    .34953    .34185    .33444    .32727
62............................................................    .37106    .36307    .35535    .34788    .34066
63............................................................    .38492    .37691    .36915    .36165    .35438
64............................................................    .39905    .39102    .38324    .37571    .36841
65............................................................    .41342    .40539    .39760    .39005    .38272
66............................................................    .42803    .42000    .41221    .40465    .39731
67............................................................    .44283    .43483    .42705    .41949    .41215
68............................................................    .45784    .44987    .44211    .43457    .42724
69............................................................    .47307    .46513    .45741    .44990    .44254
70............................................................    .48851    .48063    .47296    .46549    .45821
71............................................................    .50422    .49641    .48880    .48139    .47416
72............................................................    .52018    .51246    .50493    .49758    .49042
73............................................................    .53631    .52870    .52126    .51400    .50691
74............................................................    .55247    .54497    .53764    .53048    .52347
75............................................................    .56852    .56115    .55393    .54687    .53997
76............................................................    .58439    .57714    .57005    .56311    .55632
77............................................................    .60005    .59294    .58599    .57917    .57249
78............................................................    .61551    .60856    .60174    .59506    .58851
79............................................................    .63084    .62405    .61739    .61085    .60443
80............................................................    .64609    .63946    .63296    .62657    .62030
81............................................................    .66114    .65469    .64835    .64213    .63602
82............................................................    .67589    .66963    .66347    .65742    .65146
83............................................................    .60937    .68429    .67831    .67243    .66664
84............................................................    .70463    .69875    .69296    .68726    .68165
85............................................................    .71872    .71304    .70745    .70194    .69651
86............................................................    .73233    .72685    .72146    .71614    .71089
87............................................................    .74507    .73978    .73458    .72944    .72438
88............................................................    .75691    .75181    .74679    .74183    .73694
89............................................................    .76810    .76319    .75834    .75355    .74883
90............................................................    .77897    .77424    .76957    .76496    .76040
91............................................................    .78945    .78490    .78040    .77596    .77158
92............................................................    .79919    .79481    .79048    .78621    .78198
93............................................................    .80801    .80380    .79963    .79550    .79143
94............................................................    .81587    .81180    .80777    .80379    .79985
95............................................................    .82271    .81877    .81487    .81100    .80719
96............................................................    .82846    .82462    .82083    .81707    .81335
97............................................................    .83360    .82985    .82615    .82248    .81885
98............................................................    .33808    .83441    .83079    .82720    .82365
99............................................................    .84228    .83869    .83514    .83163    .82815
100...........................................................    .84645    .84294    .83947    .83603    .83262
101...........................................................    .85012    .84668    .84327    .83988    .83653
102...........................................................    .85409    .85072    .84737    .84405    .84077
103...........................................................    .85917    .85588    .85262    .84939    .84619
104...........................................................    .86403    .86083    .85765    .85449    .85136
105...........................................................    .87136    .86829    .86524    .86221    .85921
106...........................................................    .88315    .88032    .87750    .87470    .87192
107...........................................................    .89949    .89700    .89452    .89206    .88961
108...........................................................    .92511    .92321    .92132    .91944    .91757
109...........................................................    .96642    .96555    .96468    .96382    .96296
----------------------------------------------------------------------------------------------------------------


                                                     Table G
 Table G--Single Life, Unisex--Table Showing the Present Worth of the Remainder Interest in Property Transferred
   to a Pooled Income Fund Having the Yearly Rate of Return Shown--Applicable for Transfers After November 30,
                                          1983, and Before May 1, 1989
----------------------------------------------------------------------------------------------------------------
                                                                            (2) Yearly rate of return
                            (1) Age                            -------------------------------------------------
                                                                  8.2%      8.4%      8.6%      8.8%      9.0%
----------------------------------------------------------------------------------------------------------------
0.............................................................    .03305    .03230    .03161    .03098    .03040
1.............................................................    .01523    .01444    .01372    .01307    .01247
2.............................................................    .01520    .01438    .01362    .01294    .01230
3.............................................................    .01557    .01470    .01391    .01319    .01253
4.............................................................    .01613    .01522    .01439    .01363    .01294
5.............................................................    .01687    .01591    .01504    .01424    .01351
6.............................................................    .01774    .01674    .01582    .01498    .01421
7.............................................................    .01871    .01766    .01670    .01581    .01500
8.............................................................    .01980    .01870    .01769    .01676    .01591
9.............................................................    .02104    .01989    .01883    .01785    .01695
10............................................................    .02241    .02120    .02009    .01906    .01812
11............................................................    .02394    .02267    .02150    .02042    .01943
12............................................................    .02560    .02427    .02305    .02192    .02088
13............................................................    .02734    .02595    .02467    .02349    .02240
14............................................................    .02912    .02766    .02632    .02509    .02394
15............................................................    .03087    .02935    .02795    .02666    .02546
16............................................................    .03257    .03099    .02952    .02817    .02691
17............................................................    .03423    .03257    .03104    .02962    .02831
18............................................................    .03586    .03414    .03253    .03105    .02967
19............................................................    .03752    .03572    .03404    .03249    .03105
20............................................................    .03925    .03737    .03562    .03399    .03248
21............................................................    .04107    .03910    .03727    .03557    .03398
22............................................................    .04297    .04091    .03899    .03722    .03556
23............................................................    .04498    .04283    .04083    .03897    .03723
24............................................................    .04715    .04491    .04282    .04087    .03905
25............................................................    .04953    .04718    .04499    .04295    .04105
26............................................................    .05213    .04968    .04740    .04527    .04327

[[Page 88]]

 
27............................................................    .05499    .05243    .05005    .04782    .04573
28............................................................    .05811    .05545    .05295    .05062    .04844
29............................................................    .06146    .05868    .05608    .05365    .05136
30............................................................    .06506    .06217    .05945    .05691    .05452
31............................................................    .06888    .06586    .06303    .06038    .05789
32............................................................    .07295    .06981    .06687    .06410    .06149
33............................................................    .07728    .07401    .07095    .06806    .06535
34............................................................    .08185    .07846    .07527    .07227    .06944
35............................................................    .08671    .08319    .07988    .07675    .07380
36............................................................    .09184    .08819    .08475    .08150    .07843
37............................................................    .09725    .09347    .08989    .08652    .08332
38............................................................    .10293    .09901    .09531    .09180    .08848
39............................................................    .10889    .10483    .10099    .09736    .09391
40............................................................    .11514    .11094    .10697    .10320    .09963
41............................................................    .12168    .11735    .11324    .10934    .10564
42............................................................    .12856    .12409    .11984    .11581    .11197
43............................................................    .13574    .13113    .12675    .12258    .11862
44............................................................    .14325    .13850    .13398    .12967    .12558
45............................................................    .15105    .14616    .14150    .13706    .13283
46............................................................    .15917    .15414    .14935    .14478    .14041
47............................................................    .16760    .16244    .15751    .15280    .14831
48............................................................    .17639    .17109    .16602    .16119    .15656
49............................................................    .18551    .18007    .17488    .16991    .16516
50............................................................    .19499    .18942    .18410    .17900    .17412
51............................................................    .20480    .19911    .19366    .18844    .18343
52............................................................    .21495    .20914    .20357    .19822    .19309
53............................................................    .22544    .21951    .21381    .20835    .20309
54............................................................    .23622    .23018    .22437    .21878    .21341
55............................................................    .24732    .24116    .23524    .22954    .22406
56............................................................    .25870    .25244    .24641    .24060    .23501
57............................................................    .27040    .26404    .25791    .25200    .24630
58............................................................    .28239    .27594    .26971    .26370    .25791
59............................................................    .29472    .28817    .28186    .27576    .26987
60............................................................    .30736    .30074    .29434    .28816    .28218
61............................................................    .32035    .31365    .30718    .30092    .29486
62............................................................    .33368    .32692    .32038    .31405    .30791
63............................................................    .34735    .34054    .33394    .32754    .32134
64............................................................    .36133    .35448    .34783    .34138    .33512
65............................................................    .37562    .36873    .36204    .35554    .34924
66............................................................    .39019    .38327    .37655    .37002    .36367
67............................................................    .40502    .39809    .39134    .38479    .37841
68............................................................    .42011    .41317    .40642    .39985    .39345
69............................................................    .43547    .42854    .42179    .41522    .40882
70............................................................    .45112    .44421    .43748    .43091    .42451
71............................................................    .46711    .46023    .45352    .44698    .44059
72............................................................    .48342    .47659    .46992    .46341    .45705
73............................................................    .49998    .49321    .48660    .48014    .47382
74............................................................    .51663    .50994    .50339    .49699    .49073
75............................................................    .53322    .52661    .52014    .51381    .50762
76............................................................    .54967    .54315    .53678    .53053    .52440
77............................................................    .56595    .55954    .55326    .54710    .54106
78............................................................    .58209    .57579    .56961    .56355    .55761
79............................................................    .59814    .59196    .58590    .57995    .57410
80............................................................    .61415    .60810    .60217    .59633    .59060
81............................................................    .63001    .62410    .61830    .61260    .60699
82............................................................    .64561    .63985    .63419    .62862    .62314
83............................................................    .66095    .65535    .64983    .64441    .63907
84............................................................    .67612    .67068    .66533    .66005    .65486
85............................................................    .69116    .68589    .68070    .67559    .67055
86............................................................    .70573    .70063    .69561    .69066    .68578
87............................................................    .71939    .71446    .70961    .70481    .70009
88............................................................    .73211    .72735    .72265    .71801    .71343
89............................................................    .74417    .73956    .73501    .73053    .72609
90............................................................    .75590    .75146    .74707    .74273    .73845
91............................................................    .76724    .76296    .75873    .75454    .75041
92............................................................    .77781    .77368    .76960    .76556    .76158
93............................................................    .78740    .78342    .77948    .77558    .77173
94............................................................    .79596    .79210    .78829    .78452    .78079
95............................................................    .80341    .79967    .79597    .79231    .78869
96............................................................    .80967    .80603    .80242    .79885    .79532
97............................................................    .81526    .81170    .80818    .80470    .80125
98............................................................    .82013    .81665    .81320    .80979    .80641
99............................................................    .82470    .82129    .81791    .81456    .81125
100...........................................................    .82924    .82590    .82258    .81930    .81605
101...........................................................    .83322    .82993    .82667    .82344    .82024
102...........................................................    .83751    .83428    .83108    .82791    .82477
103...........................................................    .84301    .83986    .83674    .83365    .83058
104...........................................................    .84826    .84518    .84213    .83910    .83610
105...........................................................    .85623    .85327    .85033    .84741    .84452
106...........................................................    .86915    .86641    .86369    .86098    .85829
107...........................................................    .88718    .88476    .88236    .87997    .87759
108...........................................................    .91571    .91385    .91201    .91017    .90834
109...........................................................    .96211    .96125    .96041    .95956    .95872
----------------------------------------------------------------------------------------------------------------


                                                     Table G
 Table G--Single Life, Unisex--Table Showing the Present Worth of the Remainder Interest in Property Transferred
   to a Pooled Income Fund Having the Yearly Rate of Return Shown--Applicable for Transfers After November 30,
                                          1983, and Before May 1, 1989
----------------------------------------------------------------------------------------------------------------
                                                                            (2) Yearly rate of return
                            (1) Age                            -------------------------------------------------
                                                                  9.2%      9.4%      9.6%      9.8%      10.0%
----------------------------------------------------------------------------------------------------------------
0.............................................................    .02987    .02938    .02893    .02851    .02812
1.............................................................    .01192    .01141    .01094    .01051    .01012
2.............................................................    .01173    .01119    .01070    .01025    .00983
3.............................................................    .01192    .01136    .01084    .01036    .00992
4.............................................................    .01229    .01170    .01116    .01066    .01019
5.............................................................    .01283    .01221    .01164    .01111    .01062
6.............................................................    .01350    .01284    .01224    .01168    .01116
7.............................................................    .01425    .01356    .01292    .01233    .01178
8.............................................................    .01512    .01439    .01372    .01309    .01252
9.............................................................    .01612    .01535    .01464    .01398    .01337
10............................................................    .01724    .01644    .01569    .01499    .01435
11............................................................    .01851    .01766    .01688    .01615    .01547
12............................................................    .01991    .01902    .01819    .01742    .01671
13............................................................    .02139    .02045    .01958    .01877    .01802
14............................................................    .02288    .02190    .02098    .02013    .01934
15............................................................    .02435    .02331    .02235    .02146    .02063
16............................................................    .02575    .02466    .02366    .02272    .02185
17............................................................    .02709    .02595    .02490    .02391    .02300
18............................................................    .02839    .02721    .02610    .02507    .02410
19............................................................    .02971    .02846    .02730    .02621    .02520
20............................................................    .03108    .02977    .02855    .02741    .02635
21............................................................    .03251    .03114    .02986    .02866    .02755
22............................................................    .03402    .03258    .03123    .02998    .02880
23............................................................    .03562    .03410    .03269    .03137    .03014
24............................................................    .03735    .03577    .03428    .03290    .03159
25............................................................    .03927    .03761    .03605    .03459    .03322
26............................................................    .04141    .03966    .03803    .03649    .03505
27............................................................    .04377    .04194    .04023    .03861    .03710
28............................................................    .04639    .04447    .04267    .04098    .03938
29............................................................    .04922    .04721    .04532    .04354    .04187
30............................................................    .05228    .05017    .04819    .04633    .04457
31............................................................    .05554    .05334    .05126    .04930    .04746
32............................................................    .05904    .05674    .05456    .05251    .05058
33............................................................    .06279    .06038    .05810    .05595    .05392
34............................................................    .06677    .06435    .06187    .05962    .05750
35............................................................    .07102    .06839    .06590    .06355    .06132

[[Page 89]]

 
36............................................................    .07553    .07278    .07019    .06773    .06540
37............................................................    .08030    .07745    .07474    .07217    .06974
38............................................................    .08534    .08237    .07955    .07687    .07433
39............................................................    .09065    .08755    .08462    .08182    .07917
40............................................................    .09624    .09302    .08996    .08706    .08429
41............................................................    .10212    .09878    .09560    .09258    .08970
42............................................................    .10833    .10486    .10156    .09842    .09543
43............................................................    .11484    .11125    .10783    .10456    .10145
44............................................................    .12167    .11795    .11441    .11102    .10779
45............................................................    .12880    .12495    .12128    .11777    .11442
46............................................................    .13625    .13227    .12847    .12484    .12137
47............................................................    .14402    .13991    .13599    .13223    .12863
48............................................................    .15214    .14791    .14385    .13997    .13626
49............................................................    .16060    .15625    .15207    .14806    .14422
50............................................................    .16944    .16496    .16065    .15653    .15257
51............................................................    .17862    .17401    .16959    .16534    .16126
52............................................................    .18816    .18343    .17888    .17451    .17031
53............................................................    .19805    .19320    .18853    .18404    .17972
54............................................................    .20825    .20328    .19850    .19390    .18946
55............................................................    .21878    .21370    .20881    .20409    .19954
56............................................................    .22963    .22443    .21943    .21460    .20994
57............................................................    .24081    .23551    .23040    .22546    .22069
58............................................................    .25231    .24691    .24170    .23665    .23178
59............................................................    .26418    .25868    .25336    .24822    .24325
60............................................................    .27640    .27081    .26540    .26016    .25509
61............................................................    .28899    .28332    .27782    .27249    .26733
62............................................................    .30197    .29622    .29064    .28523    .27998
63............................................................    .31533    .30950    .30385    .29836    .29304
64............................................................    .32905    .32316    .31743    .31188    .30648
65............................................................    .34311    .33716    .33138    .32576    .32030
66............................................................    .35751    .35151    .34568    .34001    .33449
67............................................................    .37221    .36618    .36030    .35459    .34902
68............................................................    .38723    .38116    .37526    .36950    .36390
69............................................................    .40257    .39649    .39056    .38478    .37914
70............................................................    .41826    .41217    .40623    .40043    .39478
71............................................................    .43435    .42827    .42233    .41652    .41086
72............................................................    .45084    .44478    .43885    .43305    .42739
73............................................................    .46765    .46161    .45571    .44994    .44429
74............................................................    .48460    .47861    .47274    .46700    .46138
75............................................................    .50155    .49561    .48979    .48409    .47851
76............................................................    .51841    .51253    .50677    .50112    .49559
77............................................................    .53514    .52934    .52364    .51806    .51258
78............................................................    .55177    .54605    .54043    .53492    .52951
79............................................................    .56837    .56273    .55720    .55177    .54643
80............................................................    .58497    .57944    .57401    .56866    .56341
81............................................................    .60148    .59606    .59073    .58548    .58033
82............................................................    .61775    .61245    .60723    .60210    .59705
83............................................................    .63381    .62863    .62354    .61852    .61358
84............................................................    .64974    .64470    .63973    .63484    .63002
85............................................................    .66558    .66068    .65586    .65110    .64641
86............................................................    .68096    .67622    .67154    .66692    .66236
87............................................................    .69542    .69082    .68628    .68180    .67738
88............................................................    .70891    .70445    .70005    .69570    .69141
89............................................................    .72172    .71739    .71312    .70891    .70474
90............................................................    .73422    .73004    .72591    .72182    .71779
91............................................................    .74632    .74229    .73829    .73435    .73045
92............................................................    .75763    .75373    .74988    .74606    .74229
93............................................................    .76791    .76414    .76042    .75673    .75308
94............................................................    .77710    .77345    .76983    .76626    .76272
95............................................................    .78510    .78155    .77804    .77457    .77113
96............................................................    .79183    .78837    .78494    .78155    .77819
97............................................................    .79783    .79445    .79110    .78779    .78450
98............................................................    .80306    .79975    .79647    .79322    .79000
99............................................................    .80797    .80471    .80149    .79830    .79514
100...........................................................    .81283    .80964    .80648    .80335    .80025
101...........................................................    .81708    .81394    .81082    .80774    .80468
102...........................................................    .82165    .81856    .81550    .81247    .80946
103...........................................................    .82754    .82452    .82153    .81857    .81563
104...........................................................    .83312    .83017    .82723    .82433    .82144
105...........................................................    .84165    .83880    .83597    .83316    .83038
106...........................................................    .85562    .85297    .85034    .84772    .84512
107...........................................................    .87523    .87288    .87054    .86822    .86591
108...........................................................    .90652    .90471    .90291    .90111    .89932
109...........................................................    .95788    .95704    .95620    .95537    .95455
----------------------------------------------------------------------------------------------------------------


                                                     Table G
 Table G--Single Life, Unisex--Table Showing the Present Worth of the Remainder Interest in Property Transferred
   to a Pooled Income Fund Having the Yearly Rate of Return Shown--Applicable for Transfers After November 30,
                                          1983, and Before May 1, 1989
----------------------------------------------------------------------------------------------------------------
                                                                            (2) Yearly rate of return
                            (1) Age                            -------------------------------------------------
                                                                  10.2%     10.4%     10.6%     10.8%     11.0%
----------------------------------------------------------------------------------------------------------------
0.............................................................    .02776    .02743    .02712    .02682    .02655
1.............................................................    .00975    .00941    .00909    .00880    .00852
2.............................................................    .00945    .00909    .00875    .00844    .00816
3.............................................................    .00952    .00914    .00879    .00846    .00815
4.............................................................    .00976    .00936    .00899    .00865    .00832
5.............................................................    .01016    .00974    .00935    .00898    .00864
6.............................................................    .01068    .01023    .00981    .00943    .00907
7.............................................................    .01128    .01080    .01036    .00995    .00957
8.............................................................    .01198    .01148    .01101    .01058    .01017
9.............................................................    .01281    .01228    .01179    .01133    .01090
10............................................................    .01375    .01319    .01267    .01219    .01173
11............................................................    .01483    .01425    .01370    .01318    .01270
12............................................................    .01604    .01542    .01484    .01430    .01379
13............................................................    .01732    .01666    .01605    .01548    .01494
14............................................................    .01860    .01792    .01727    .01667    .01610
15............................................................    .01986    .01913    .01845    .01782    .01723
16............................................................    .02103    .02027    .01956    .01889    .01827
17............................................................    .02214    .02134    .02059    .01989    .01923
18............................................................    .02320    .02236    .02157    .02084    .02014
19............................................................    .02426    .02337    .02254    .02177    .02104
20............................................................    .02536    .02442    .02355    .02273    .02197
21............................................................    .02650    .02552    .02460    .02374    .02293
22............................................................    .02770    .02667    .02570    .02479    .02394
23............................................................    .02898    .02789    .02687    .02591    .02501
24............................................................    .03037    .02923    .02815    .02714    .02619
25............................................................    .03194    .03073    .02960    .02853    .02752
26............................................................    .03370    .03243    .03123    .03010    .02904
27............................................................    .03568    .03434    .03307    .03188    .03076
28............................................................    .03789    .03647    .03514    .03389    .03271
29............................................................    .04029    .03880    .03740    .03608    .03483
30............................................................    .04291    .04135    .03987    .03848    .03716
31............................................................    .04572    .04407    .04252    .04105    .03966
32............................................................    .04875    .04702    .04538    .04384    .04237
33............................................................    .05200    .05019    .04847    .04684    .04530
34............................................................    .05548    .05358    .05177    .05006    .04843
35............................................................    .05921    .05722    .05532    .05352    .05181
36............................................................    .06319    .06110    .05911    .05722    .05543
37............................................................    .06743    .06524    .06315    .06117    .05929
38............................................................    .07191    .06962    .06744    .06536    .06338
39............................................................    .07665   .074425    .07197    .06980    .06773
40............................................................    .08166    .07916    .07677    .07450    .07233
41............................................................    .08696    .08434    .08185    .07947    .07721
42............................................................    .09257    .08985    .08725    .08477    .08239
43............................................................    .09848    .09564    .09293    .09034    .08787
44............................................................    .10470    .10175    .09893    .09623    .09365

[[Page 90]]

 
45............................................................    .11121    .10815    .10522    .10241    .09972
46............................................................    .11805    .11486    .11182    .10890    .10610
47............................................................    .12519    .12189    .11873    .11569    .11279
48............................................................    .13269    .12927    .12600    .12285    .11983
49............................................................    .14054    .13600    .13361    .13035    .12721
50............................................................    .14876    .14511    .14160    .13822    .13497
51............................................................    .15734    .15356    .14994    .14645    .14309
52............................................................    .16627    .16238    .15864    .15504    .15156
53............................................................    .17557    .17156    .16770    .16399    .16040
54............................................................    .18519    .18107    .17710    .17327    .16957
55............................................................    .19515    .19092    .18684    .18290    .17909
56............................................................    .20544    .20110    .19691    .19286    .18894
57............................................................    .21609    .21164    .20734    .20318    .19916
58............................................................    .22707    .22252    .21811    .21385    .20972
59............................................................    .23844    .23378    .22928    .22491    .22068
60............................................................    .25018    .24543    .24082    .23636    .23203
61............................................................    .26233    .25749    .25279    .24823    .24381
62............................................................    .27490    .26996    .26517    .26052    .25601
63............................................................    .28787    .28286    .27798    .27325    .26865
64............................................................    .30124    .29615    .29120    .28639    .28171
65............................................................    .31500    .30983    .30481    .29993    .29517
66............................................................    .32912    .32390    .31881    .31386    .30904
67............................................................    .34360    .33832    .33318    .32817    .32328
68............................................................    .35843    .35311    .34791    .34285    .33791
69............................................................    .37365    .36828    .36305    .35794    .35296
70............................................................    .38925    .38386    .37860    .37346    .36844
71............................................................    .40532    .39991    .39463    .38946    .38442
72............................................................    .42185    .41644    .41115    .40597    .40091
73............................................................    .43876    .43336    .42807    .42289    .41782
74............................................................    .45588    .45050    .44522    .44005    .43499
75............................................................    .47304    .46769    .46244    .45729    .45225
76............................................................    .49016    .48485    .47963    .47451    .46949
77............................................................    .50721    .50193    .49676    .49168    .48670
78............................................................    .52419    .51898    .51385    .50882    .50388
79............................................................    .54119    .53604    .53097    .52600    .52111
80............................................................    .55825    .55318    .54819    .54328    .53846
81............................................................    .57526    .57027    .56536    .56053    .55578
82............................................................    .59208    .58718    .58236    .57762    .57295
83............................................................    .60871    .60392    .59920    .59455    .58997
84............................................................    .62527    .62059    .61597    .61143    .60695
85............................................................    .64179    .63723    .63273    .62830    .62393
86............................................................    .65787    .65344    .64907    .64475    .64050
87............................................................    .67302    .66871    .66446    .66026    .65612
88............................................................    .68717    .68298    .67885    .67477    .67074
89............................................................    .70063    .69656    .69255    .68858    .68466
90............................................................    .71380    .70986    .70597    .70212    .69831
91............................................................    .72659    .72278    .71901    .71528    .71160
92............................................................    .73856    .73488    .73123    .72762    .72405
93............................................................    .74947    .74590    .74236    .73887    .73541
94............................................................    .75922    .75575    .75233    .74893    .74557
95............................................................    .76773    .76436    .76102    .75772    .75445
96............................................................    .77487    .77158    .76832    .76510    .76190
97............................................................    .78125    .77803    .77485    .77169    .76856
98............................................................    .78681    .78365    .78052    .77742    .77435
99............................................................    .79201    .78891    .78583    .78279    .77977
100...........................................................    .79717    .79412    .79111    .78811    .78515
101...........................................................    .80165    .79865    .79568    .79273    .78981
102...........................................................    .80648    .80353    .80060    .79769    .79481
103...........................................................    .81271    .80982    .80695    .80411    .80129
104...........................................................    .81858    .81574    .81292    .81013    .80736
105...........................................................    .83761    .82487    .82214    .81943    .81675
106...........................................................    .84254    .83998    .83743    .83490    .83238
107...........................................................    .86362    .86133    .85906    .85681    .85456
108...........................................................    .89755    .89577    .89401    .89226    .89051
109...........................................................    .95372    .95290    .95208    .95126    .95045
----------------------------------------------------------------------------------------------------------------


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

[[Page 91]]

 
66............................................................    .30434    .29976    .29530    .29096    .28672
67............................................................    .31852    .31388    .30935    .30494    .30063
68............................................................    .33310    .32840    .32381    .31933    .31496
69............................................................    .34809    .34334    .33870    .33417    .32975
70............................................................    .36353    .35874    .35405    .34948    .34500
71............................................................    .37948    .37466    .36994    .36532    .36081
72............................................................    .39595    .39111    .38636    .38172    .37718
73............................................................    .41286    .40801    .40325    .39859    .39403
74............................................................    .43004    .42518    .42042    .41575    .41118
75............................................................    .44730    .44245    .43770    .43304    .42846
76............................................................    .46457    .45974    .45500    .45035    .44579
77............................................................    .48181    .47700    .47229    .46766    .46311
78............................................................    .49903    .49426    .48958    .48497    .48045
79............................................................    .51631    .51159    .50694    .50238    .49789
80............................................................    .53371    .52905    .52446    .51994    .51550
81............................................................    .55110    .54650    .54197    .53752    .53313
82............................................................    .56835    .56382    .55937    .55497    .55065
83............................................................    .58546    .58101    .57663    .57231    .56806
84............................................................    .60253    .59817    .59388    .58965    .58547
85............................................................    .61961    .61536    .61116    .60703    .60294
86............................................................    .63630    .63215    .62806    .62402    .62004
87............................................................    .65203    .64800    .64401    .64007    .63619
88............................................................    .66676    .66282    .65894    .65510    .65131
89............................................................    .68079    .67696    .67318    .66944    .66574
90............................................................    .69455    .69084    .68716    .68353    .67993
91............................................................    .70795    .70435    .70078    .69726    .69377
92............................................................    .72052    .71703    .71357    .71015    .70677
93............................................................    .73198    .72860    .72524    .72192    .71864
94............................................................    .74225    .73896    .73570    .73248    .72928
95............................................................    .75121    .74801    .74483    .74169    .73858
96............................................................    .75874    .75561    .75250    .74943    .74639
97............................................................    .76546    .76240    .75936    .75635    .75336
98............................................................    .77131    .76830    .76531    .76235    .75942
99............................................................    .77678    .77382    .77088    .76798    .76509
100...........................................................    .78221    .77930    .77642    .77356    .77072
101...........................................................    .78691    .78404    .78119    .77837    .77557
102...........................................................    .79196    .78912    .78632    .78353    .78077
103...........................................................    .79849    .79572    .79297    .79024    .78753
104...........................................................    .80460    .80188    .79917    .79648    .79381
105...........................................................    .81408    .81143    .80881    .80620    .80361
106...........................................................    .82989    .82740    .82494    .82249    .82006
107...........................................................    .85233    .85012    .84791    .84572    .84353
108...........................................................    .88877    .88704    .88532    .88361    .88190
109...........................................................    .94964    .94883    .94803    .94723    .94643
----------------------------------------------------------------------------------------------------------------


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

[[Page 92]]

 
75............................................................    .42398    .41958    .41526    .41102    .40686
76............................................................    .44131    .43691    .43259    .42825    .42419
77............................................................    .45864    .45425    .44994    .44571    .44155
78............................................................    .47601    .47164    .46734    .46312    .45897
79............................................................    .49348    .48914    .48487    .48067    .47654
80............................................................    .51112    .50682    .50259    .49842    .49432
81............................................................    .52881    .52455    .52036    .51624    .51218
82............................................................    .54639    .54219    .53805    .53398    .52996
83............................................................    .56386    .55973    .55566    .55164    .54768
84............................................................    .58136    .57730    .57329    .56934    .56545
85............................................................    .59891    .59494    .59102    .58715    .58333
86............................................................    .61610    .61222    .60839    .60460    .60086
87............................................................    .62335    .62856    .62481    .62111    .61746
88............................................................    .64757    .64386    .64021    .63659    .63302
89............................................................    .66209    .65848    .65491    .65139    .64790
90............................................................    .67638    .67287    .66939    .66596    .66256
91............................................................    .69032    .68691    .68353    .68019    .67689
92............................................................    .70342    .70011    .69683    .69359    .69038
93............................................................    .71539    .71217    .70899    .70584    .70271
94............................................................    .72612    .72299    .71989    .71683    .71379
95............................................................    .73550    .43245    .72943    .72643    .72347
96............................................................    .74337    .74039    .73743    .73450    .73160
97............................................................    .75041    .74748    .74458    .74171    .73886
98............................................................    .74652    .75364    .75079    .74797    .74517
99............................................................    .76224    .75941    .75660    .75382    .75106
100...........................................................    .76791    .76513    .76237    .75963    .75692
101...........................................................    .77280    .77005    .76732    .67462    .76194
102...........................................................    .77804    .77532    .77263    .76996    .76732
103...........................................................    .78485    .78218    .77954    .77692    .77432
104...........................................................    .79117    .78854    .78594    .78335    .78078
105...........................................................    .80103    .79848    .78595    .79343    .79093
106...........................................................    .81764    .81524    .81285    .81048    .80813
107...........................................................    .84137    .93921    .83706    .83493    .83281
108...........................................................    .88020    .87851    .87682    .87515    .87348
109...........................................................    .94563    .94484    .94405    .94326    .94248
----------------------------------------------------------------------------------------------------------------


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

[[Page 93]]

 
84............................................................    .56160    .55781    .55407    .55038    .54674
85............................................................    .57956    .57584    .57216    .56854    .56496
86............................................................    .59717    .59353    .58993    .58638    .58287
87............................................................    .61385    .61028    .60676    .60328    .59984
88............................................................    .62950    .62601    .62256    .61915    .61578
89............................................................    .64445    .64104    .63767    .63434    .63105
90............................................................    .65920    .65588    .65259    .64934    .64612
91............................................................    .67362    .67039    .66719    .66402    .66089
92............................................................    .68720    .68405    .68094    .67786    .67481
93............................................................    .69962    .69657    .69354    .69054    .68757
94............................................................    .71078    .70780    .70485    .70193    .69903
95............................................................    .72053    .71763    .71475    .71189    .70906
96............................................................    .72872    .72587    .72305    .72026    .71748
97............................................................    .73604    .73325    .73048    .72773    .72501
98............................................................    .74239    .73964    .73692    .73422    .73154
99............................................................    .74833    .74562    .74294    .74028    .73764
100...........................................................    .75423    .75156    .74892    .74630    .74370
101...........................................................    .75928    .75664    .75403    .75144    .74887
102...........................................................    .76469    .76209    .75950    .75694    .75440
103...........................................................    .77174    .76918    .76664    .76413    .76163
104...........................................................    .77824    .77571    .77320    .77071    .76824
105...........................................................    .78845    .78599    .78354    .78111    .77870
106...........................................................    .80579    .80346    .80115    .79885    .79657
107...........................................................    .83070    .82860    .82652    .82444    .82238
108...........................................................    .87182    .87016    .86852    .86688    .86525
109...........................................................    .94170    .94092    .94014    .93937    .93860
----------------------------------------------------------------------------------------------------------------

    (e) Present value of the remainder interest in the case of transfers 
to pooled income funds for which the valuation date is after April 30, 
1989, and before May 1, 1999--(1) In general. In the case of transfers 
to pooled income funds for which the valuation date is after April 30, 
1989, and before May 1, 1999, the present value of a remainder interest 
is determined under this section. See, however, Sec. 1.7520-3(b) 
(relating to exceptions to the use of prescribed tables under certain 
circumstances). The present value of a remainder interest that is 
dependent on the termination of the life of one individual is computed 
by the use of Table S in paragraph (e)(5) of this section. For purposes 
of the computations under this section, the age of an individual is the 
age at the individual's nearest birthday. If the valuation date of a 
transfer to a pooled income fund is after April 30, 1989, and before 
June 10, 1994, a transferor can rely on Notice 89-24, 1989-1 C.B. 660, 
or Notice 89-60, 1989-1 C.B. 700, in valuing the transferred interest. 
(See Sec. 601.601(d)(2)(ii)(b) of this chapter.)
    (2) Present value of a remainder interest. The present value of a 
remainder interest in property transferred to a pooled income fund is 
computed on the basis of--
    (i) Life contingencies determined from the values of lx that are set 
forth in Table 80CNSMT in Sec. 20.2031-7A(e)(4) of this chapter (Estate 
Tax Regulations); and
    (ii) Discount at a rate of interest, compounded annually, equal to 
the highest yearly rate of return of the pooled income fund for the 3 
taxable years immediately preceding its taxable year in which the 
transfer of property to the fund is made. The provisions of Sec. 
1.642(c)-6(c) apply for determining the yearly rate of return. However, 
where the taxable year is less than 12 months, the provisions of Sec. 
1.642(c)-6(e)(3)(ii) apply for the determining the yearly rate of 
return.
    (3) Pooled income funds in existence less than 3 taxable years. The 
provisions of Sec. 1.642(c)-6(e)(4) apply for determining the highest 
yearly rate of return when the pooled income fund has been in existence 
less than three taxable years.
    (4) Computation of value of remainder interest. The factor that is 
used in determining the present value of a remainder interest that is 
dependent on the termination of the life of one individual is the factor 
from Table S in paragraph (e)(5) of this section under the appropriate 
yearly rate of return opposite the number that corresponds to the age of 
the individual upon whose life the value of the remainder interest is 
based. Table S in paragraph (e)(5) of this section includes factors for 
yearly rates of return from 4.2 to 14 percent. Many actuarial factors 
not contained in Table S in paragraph (e)(5) of this section are 
contained in Table S in Internal Revenue Service Publication 1457, 
``Actuarial Values, Alpha Volume,'' (8-89). Publication 1457 is no 
longer available for purchase from the Superintendent of Documents, 
United States Government Printing Office, Washington, DC 20402. However, 
pertinent factors in this publication may be obtained by a written 
request to: CC:DOM:CORP:R (IRS Publication 1457), room 5226, Internal 
Revenue Service, POB 7604, Ben Franklin Station, Washington, DC 20044. 
For other situations, see Sec. 1.642(c)-6(b). If the yearly rate of 
return is a percentage

[[Page 94]]

that is between the yearly rates of return for which factors are 
provided, a linear interpolation must be made. The present value of the 
remainder interest is determined by multiplying the fair market value of 
the property on the valuation date by the appropriate remainder factor. 
For an example of a computation of the present value of a remainder 
interest requiring a linear interpolation adjustment, see Sec. 
1.642(c)-6(e)(5).
    (5) Actuarial tables. In the case of transfers for which the 
valuation date is after April 30, 1989, and before May 1, 1999, the 
present value of a remainder interest dependent on the termination of 
one life in the case of a transfer to a pooled income fund is determined 
by use of the following tables:

                                           Table S--Based on Life Table 80CNSMT Single Life Remainder Factors
                                                [Applicable After April 30, 1989, and Before May 1, 1999]
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                 Interest rate
                         Age                         ---------------------------------------------------------------------------------------------------
                                                        4.2%      4.4%      4.6%      4.8%      5.0%      5.2%      5.4%      5.6%      5.8%      6.0%
--------------------------------------------------------------------------------------------------------------------------------------------------------
0...................................................    .07389    .06749    .06188    .05695    .05261    .04879    .04541    .04243    .03978    .03744
1...................................................    .06494    .05832    .05250    .04738    .04287    .03889    .03537    .03226    .02950    .02705
2...................................................    .06678    .05999    .05401    .04874    .04410    .03999    .03636    .03314    .03028    .02773
3...................................................    .06897    .06200    .05587    .05045    .04567    .04143    .03768    .03435    .03139    .02875
4...................................................    .07139    .06425    .05796    .05239    .04746    .04310    .03922    .03578    .03271    .02998
5...................................................    .07401    .06669    .06023    .05451    .04944    .04494    .04094    .03738    .03421    .03137
6...................................................    .07677    .06928    .06265    .05677    .05156    .04692    .04279    .03911    .03583    .03289
7...................................................    .07968    .07201    .06521    .05918    .05381    .04903    .04477    .04097    .03757    .03453
8...................................................    .08274    .07489    .06792    .06172    .05621    .05129    .04689    .04297    .03945    .03630
9...................................................    .08597    .07794    .07079    .06443    .05876    .05370    .04917    .04511    .04148    .03821
10..................................................    .08936    .08115    .07383    .06730    .06147    .05626    .05159    .04741    .04365    .04027
11..................................................    .09293    .08453    .07704    .07035    .06436    .05900    .05419    .04988    .04599    .04250
12..................................................    .09666    .08807    .08040    .07354    .06739    .06188    .05693    .05248    .04847    .04486
13..................................................    .10049    .09172    .08387    .07684    .07053    .06487    .05977    .05518    .05104    .04731
14..................................................    .10437    .09541    .08738    .08017    .07370    .06788    .06263    .05791    .05364    .04978
15..................................................    .10827    .09912    .09090    .08352    .07688    .07090    .06551    .06064    .05623    .05225
16..................................................    .11220    .10285    .09445    .08689    .08008    .07394    .06839    .06337    .05883    .05472
17..................................................    .11615    .10661    .09802    .09028    .08330    .07699    .07129    .06612    .06144    .05719
18..................................................    .12017    .11043    .10165    .09373    .08656    .08009    .07422    .06890    .06408    .05969
19..................................................    .12428    .11434    .10537    .09726    .08992    .08327    .07724    .07177    .06679    .06226
20..................................................    .12850    .11836    .10919    .10089    .09337    .08654    .08035    .07471    .06959    .06492
21..................................................    .13282    .12248    .11311    .10462    .09692    .08991    .08355    .07775    .07247    .06765
22..................................................    .13728    .12673    .11717    .10848    .10059    .09341    .08686    .08090    .07546    .07049
23..................................................    .14188    .13113    .12136    .11248    .10440    .09703    .09032    .08418    .07858    .07345
24..................................................    .14667    .13572    .12575    .11667    .10839    .10084    .09395    .08764    .08187    .07659
25..................................................    .15167    .14051    .13034    .12106    .11259    .10486    .09778    .09130    .08536    .07991
26..................................................    .15690    .14554    .13517    .12569    .11703    .10910    .10184    .09518    .08907    .08346
27..................................................    .16237    .15081    .14024    .13056    .12171    .11359    .10614    .09930    .09302    .08724
28..................................................    .16808    .15632    .14555    .13567    .12662    .11831    .11068    .10366    .09720    .09125
29..................................................    .17404    .16208    .15110    .14104    .13179    .12329    .11547    .10827    .10163    .09551
30..................................................    .18025    .16808    .15692    .14665    .13721    .12852    .12051    .11313    .10631    .10002
31..................................................    .18672    .17436    .16300    .15255    .14291    .13403    .12584    .11827    .11127    .10480
32..................................................    .19344    .18090    .16935    .15870    .14888    .13980    .13142    .12367    .11650    .10985
33..................................................    .20044    .18772    .17598    .16514    .15513    .14587    .13730    .12936    .12201    .11519
34..................................................    .20770    .19480    .18287    .17185    .16165    .15221    .14345    .13533    .12780    .12080
35..................................................    .21522    .20215    .19005    .17884    .16846    .15883    .14989    .14159    .13388    .12670
36..................................................    .22299    .20974    .19747    .18609    .17552    .16571    .15660    .14812    .14022    .13287
37..................................................    .23101    .21760    .20516    .19360    .18286    .17288    .16358    .15492    .14685    .13933
38..................................................    .23928    .22572    .21311    .20139    .19048    .18032    .17085    .16201    .15377    .14607
39..................................................    .24780    .23409    .22133    .20945    .19837    .18804    .17840    .16939    .16097    .15310
40..................................................    .25658    .24273    .22982    .21778    .20654    .19605    .18624    .17706    .16847    .16043
41..................................................    .26560    .25163    .23858    .22639    .21499    .20434    .19436    .18502    .17627    .16806
42..................................................    .27486    .26076    .24758    .23525    .22370    .21289    .20276    .19326    .18434    .17597
43..................................................    .28435    .27013    .25683    .24436    .23268    .22172    .21143    .20177    .19270    .18416
44..................................................    .29407    .27975    .26633    .25373    .24191    .23081    .22038    .21057    .20134    .19265
45..................................................    .30402    .28961    .27608    .26337    .25142    .24019    .22962    .21966    .21028    .20144
46..................................................    .31420    .29970    .28608    .27326    .26120    .24983    .23913    .22904    .21951    .21053
47..................................................    .32460    .31004    .29632    .28341    .27123    .25975    .24892    .23870    .22904    .21991
48..................................................    .33521    .32058    .30679    .29379    .28151    .26992    .25897    .24862    .23883    .22957
49..................................................    .34599    .33132    .31746    .30438    .29201    .28032    .26926    .25879    .24888    .23949
50..................................................    .35695    .34224    .32833    .31518    .30273    .29094    .27978    .26921    .25918    .24966
51..................................................    .36809    .35335    .33940    .32619    .31367    .30180    .29055    .27987    .26973    .26010
52..................................................    .37944    .36468    .35070    .33744    .32486    .31292    .30158    .29081    .28057    .27083
53..................................................    .39098    .37622    .36222    .34892    .33629    .32429    .31288    .30203    .29170    .28186
54..................................................    .40269    .38794    .37393    .36062    .34795    .33590    .32442    .31349    .30308    .29316
55..................................................    .41457    .39985    .38585    .37252    .35983    .34774    .33621    .32522    .31474    .30473

[[Page 95]]

 
56..................................................    .42662    .41194    .39796    .38464    .37193    .35981    .34824    .33720    .32666    .31658
57..................................................    .43884    .42422    .41028    .39697    .38426    .37213    .36053    .34945    .33885    .32872
58..................................................    .45123    .43668    .42279    .40951    .39682    .38468    .37307    .36196    .35132    .34114
59..................................................    .46377    .44931    .43547    .42224    .40958    .39745    .38584    .37471    .36405    .35383
60..................................................    .47643    .46206    .44830    .43513    .42250    .41040    .39880    .38767    .37699    .36674
61..................................................    .48916    .47491    .46124    .44814    .43556    .42350    .41192    .40080    .39012    .37985
62..................................................    .50196    .48783    .47427    .46124    .44874    .43672    .42518    .41408    .40340    .39314
63..................................................    .51480    .50081    .48736    .47444    .46201    .45006    .43856    .42749    .41684    .40658
64..................................................    .52770    .51386    .50054    .48773    .47540    .46352    .45208    .44105    .43043    .42019
65..................................................    .54069    .52701    .51384    .50115    .48892    .47713    .46577    .45480    .44422    .43401
66..................................................    .55378    .54029    .52727    .51472    .50262    .49093    .47965    .46876    .45824    .44808
67..................................................    .56697    .55368    .54084    .52845    .51648    .50491    .49373    .48293    .47248    .46238
68..................................................    .58026    .56717    .55453    .54231    .53049    .51905    .50800    .49729    .48694    .47691
69..................................................    .59358    .58072    .56828    .55624    .54459    .53330    .52238    .51179    .50154    .49160
70..................................................    .60689    .59427    .58205    .57021    .55874    .54762    .53683    .52638    .51624    .50641
71..................................................    .62014    .60778    .59578    .58415    .57287    .56193    .55131    .54100    .53099    .52126
72..................................................    .63334    .62123    .60948    .59808    .58700    .57624    .56579    .55563    .54577    .53617
73..................................................    .64648    .63465    .62315    .61198    .60112    .59056    .58029    .57030    .56059    .55113
74..................................................    .65961    .64806    .63682    .62590    .61527    .60492    .59485    .58504    .57550    .56620
75..................................................    .67274    .66149    .65054    .63987    .62948    .61936    .60950    .59990    .59053    .58140
76..................................................    .68589    .67495    .66429    .65390    .64377    .63390    .62427    .61487    .60570    .59676
77..................................................    .69903    .68841    .67806    .66796    .65811    .64849    .63910    .62993    .62097    .61223
78..................................................    .71209    .70182    .69179    .68199    .67242    .66307    .65393    .64501    .63628    .62775
79..................................................    .72500    .71507    .70537    .69588    .68660    .67754    .66867    .65999    .65151    .64321
80..................................................    .73768    .72809    .71872    .70955    .70058    .69180    .68320    .67479    .66655    .65849
81..................................................    .75001    .74077    .73173    .72288    .71422    .70573    .69741    .68926    .68128    .67345
82..................................................    .76195    .75306    .74435    .73582    .72746    .71926    .71123    .70335    .69562    .68804
83..................................................    .77346    .76491    .75654    .74832    .74026    .73236    .72460    .71699    .70952    .70219
84..................................................    .78456    .77636    .76831    .76041    .75265    .74503    .73756    .73021    .72300    .71592
85..................................................    .79530    .78743    .77971    .77212    .76466    .75733    .75014    .74306    .73611    .72928
86..................................................    .80560    .79806    .79065    .78337    .77621    .76917    .76225    .75544    .74875    .74216
87..................................................    .81535    .80813    .80103    .79404    .78717    .78041    .77375    .76720    .76076    .75442
88..................................................    .82462    .81771    .81090    .80420    .79760    .79111    .78472    .77842    .77223    .76612
89..................................................    .83356    .82694    .82043    .81401    .80769    .80147    .79533    .78929    .78334    .77747
90..................................................    .84225    .83593    .82971    .82357    .81753    .81157    .80570    .79991    .79420    .78857
91..................................................    .85058    .84455    .83861    .83276    .82698    .82129    .81567    .81013    .80466    .79927
92..................................................    .85838    .85263    .84696    .84137    .83585    .83040    .82503    .81973    .81449    .80933
93..................................................    .86557    .86009    .85467    .84932    .84405    .83884    .83370    .82862    .82360    .81865
94..................................................    .87212    .86687    .86169    .85657    .85152    .84653    .84160    .83673    .83192    .82717
95..................................................    .87801    .87298    .86801    .86310    .85825    .85345    .84872    .84404    .83941    .83484
96..................................................    .88322    .87838    .87360    .86888    .86420    .85959    .85502    .85051    .84605    .84165
97..................................................    .88795    .88328    .87867    .87411    .86961    .86515    .86074    .85639    .85208    .84782
98..................................................    .89220    .88769    .88323    .87883    .87447    .87016    .86589    .86167    .85750    .85337
99..................................................    .89612    .89176    .88745    .88318    .87895    .87478    .87064    .86656    .86251    .85850
100.................................................    .89977    .89555    .89136    .88722    .88313    .87908    .87506    .87109    .86716    .86327
101.................................................    .90326    .89917    .89511    .89110    .88712    .88318    .87929    .87543    .87161    .86783
102.................................................    .90690    .90294    .89901    .89513    .89128    .88746    .88369    .87995    .87624    .87257
103.................................................    .91076    .90694    .90315    .89940    .89569    .89200    .88835    .88474    .88116    .87760
104.................................................    .91504    .91138    .90775    .90415    .90058    .89704    .89354    .89006    .88661    .88319
105.................................................    .92027    .91681    .91337    .90996    .90658    .90322    .89989    .89659    .89331    .89006
106.................................................    .92763    .92445    .92130    .91816    .91506    .91197    .90890    .90586    .90284    .89983
107.................................................    .93799    .93523    .93249    .92977    .92707    .92438    .92170    .91905    .91641    .91378
108.................................................    .95429    .95223    .95018    .94814    .94611    .94409    .94208    .94008    .93809    .93611
109.................................................    .97985    .97893    .97801    .97710    .97619    .97529    .97438    .97348    .97259    .97170
--------------------------------------------------------------------------------------------------------------------------------------------------------


                                           Table S--Based on Life Table 80CNSMT Single Life Remainder Factors
                                                [Applicable After April 30, 1989, and Before May 1, 1999]
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                 Interest rate
                         Age                         ---------------------------------------------------------------------------------------------------
                                                        6.2%      6.4%      6.6%      6.8%      7.0%      7.2%      7.4%      7.6%      7.8%      8.0%
--------------------------------------------------------------------------------------------------------------------------------------------------------
0...................................................    .03535    .03349    .03183    .03035    .02902    .02783    .02676    .02579    .02492    .02413
1...................................................    .02486    .02292    .02119    .01963    .01824    .01699    .01587    .01486    .01395    .01312
2...................................................    .02547    .02345    .02164    .02002    .01857    .01727    .01609    .01504    .01408    .01321
3...................................................    .02640    .02429    .02241    .02073    .01921    .01785    .01662    .01552    .01451    .01361
4...................................................    .02753    .02535    .02339    .02163    .02005    .01863    .01735    .01619    .01514    .01418
5...................................................    .02883    .02656    .02453    .02269    .02105    .01956    .01822    .01700    .01590    .01490

[[Page 96]]

 
6...................................................    .03026    .02790    .02578    .02387    .02215    .02060    .01919    .01792    .01677    .01572
7...................................................    .03180    .02935    .02714    .02515    .02336    .02174    .02027    .01894    .01773    .01664
8...................................................    .03347    .03092    .02863    .02656    .02469    .02300    .02146    .02007    .01881    .01766
9...................................................    .03528    .03263    .03025    .02810    .02615    .02438    .02278    .02133    .02000    .01880
10..................................................    .03723    .03449    .03201    .02977    .02774    .02590    .02423    .02271    .02133    .02006
11..................................................    .03935    .03650    .03393    .03160    .02949    .02757    .02583    .02424    .02279    .02147
12..................................................    .04160    .03865    .03598    .03356    .03136    .02936    .02755    .02589    .02438    .02299
13..................................................    .04394    .04088    .03811    .03560    .03331    .03123    .02934    .02761    .02603    .02458
14..................................................    .04629    .04312    .04025    .03764    .03527    .03311    .03113    .02933    .02768    .02617
15..................................................    .04864    .04536    .04238    .03968    .03721    .03496    .03290    .03103    .02930    .02773
16..................................................    .05099    .04759    .04451    .04170    .03913    .03679    .03466    .03270    .03090    .02926
17..................................................    .05333    .04982    .04662    .04370    .04104    .03861    .03638    .03434    .03247    .03075
18..................................................    .05570    .05207    .04875    .04573    .04296    .04044    .03812    .03599    .03404    .03225
19..................................................    .05814    .05438    .05095    .04781    .04494    .04231    .03990    .03769    .03565    .03378
20..................................................    .06065    .05677    .05321    .04996    .04698    .04424    .04173    .03943    .03731    .03535
21..................................................    .06325    .05922    .05554    .05217    .04907    .04623    .04362    .04122    .03901    .03697
22..................................................    .06594    .06178    .05797    .05447    .05126    .04831    .04559    .04309    .04078    .03865
23..................................................    .06876    .06446    .06051    .05688    .05355    .05048    .04766    .04505    .04265    .04042
24..................................................    .07174    .06729    .06321    .05945    .05599    .05281    .04987    .04715    .04465    .04233
25..................................................    .07491    .07031    .06609    .06219    .05861    .05530    .05224    .04941    .04680    .04438
26..................................................    .07830    .07355    .06918    .06515    .06142    .05799    .05481    .05187    .04915    .04662
27..................................................    .08192    .07702    .07250    .06832    .06446    .06090    .05759    .05454    .05170    .04906
28..................................................    .08577    .08071    .07603    .07171    .06772    .06402    .06059    .05740    .05445    .05170
29..................................................    .08986    .08464    .07981    .07534    .07120    .06736    .06380    .06049    .05742    .05456
30..................................................    .09420    .08882    .08383    .07921    .07492    .07095    .06725    .06381    .06061    .05763
31..................................................    .09881    .09327    .08812    .08335    .07891    .07479    .07095    .06738    .06405    .06095
32..................................................    .10369    .09797    .09267    .08774    .08315    .07888    .07491    .07120    .06774    .06451
33..................................................    .10885    .10297    .09750    .09241    .08767    .08325    .07913    .07529    .07170    .06834
34..................................................    .11430    .10824    .10261    .09736    .09246    .08790    .08363    .07964    .07592    .07243
35..................................................    .12002    .11380    .10800    .10259    .09754    .09282    .08841    .08428    .08041    .07679
36..................................................    .12602    .11963    .11366    .10809    .10288    .09800    .09344    .08917    .08516    .08140
37..................................................    .13230    .12574    .11961    .11387    .10850    .10347    .09876    .09433    .09018    .08628
38..................................................    .13887    .13214    .12584    .11994    .11441    .10922    .10436    .09978    .09549    .09145
39..................................................    .14573    .13883    .13237    .12630    .12061    .11527    .11025    .10553    .10109    .09690
40..................................................    .15290    .14583    .13920    .13297    .12712    .12162    .11644    .11157    .10698    .10266
41..................................................    .16036    .15312    .14633    .13994    .13393    .12827    .12294    .11792    .11318    .10871
42..................................................    .16810    .16071    .15375    .14720    .14103    .13522    .12973    .12456    .11967    .11505
43..................................................    .17614    .16858    .16146    .15475    .14842    .14245    .13682    .13149    .12645    .12169
44..................................................    .18447    .17675    .16948    .16261    .15613    .15000    .14421    .13873    .13355    .12864
45..................................................    .19310    .18524    .17780    .17078    .16414    .15787    .15192    .14630    .14096    .13591
46..................................................    .20204    .19402    .18644    .17926    .17247    .16604    .15995    .15418    .14870    .14350
47..................................................    .21128    .20311    .19538    .18806    .18112    .17454    .16830    .16238    .15676    .15141
48..................................................    .22080    .21249    .20462    .19716    .19007    .18335    .17696    .17090    .16513    .15964
49..................................................    .23059    .22214    .21413    .20653    .19930    .19244    .18591    .17970    .17379    .16816
50..................................................    .24063    .23206    .22391    .21617    .20881    .20180    .19514    .18879    .18274    .17697
51..................................................    .25095    .24225    .23398    .22610    .21861    .21147    .20466    .19818    .19199    .18609
52..................................................    .26157    .25275    .24436    .23636    .22874    .22147    .21453    .20791    .20159    .19556
53..................................................    .27249    .26357    .25505    .24694    .23919    .23180    .22474    .21799    .21154    .20537
54..................................................    .28369    .27466    .26604    .25782    .24995    .24244    .23526    .22839    .22181    .21552
55..................................................    .29518    .28605    .27734    .26900    .26103    .25341    .24611    .23912    .23243    .22601
56..................................................    .30695    .29774    .28893    .28050    .27242    .26469    .25728    .25019    .24338    .23685
57..................................................    .31902    .30973    .30084    .29232    .28415    .27632    .26881    .26161    .25469    .24805
58..................................................    .33138    .32203    .31306    .30446    .29621    .28829    .28069    .27339    .26637    .25962
59..................................................    .34402    .33461    .32558    .31691    .30859    .30059    .29290    .28550    .27839    .27155
60..................................................    .35690    .34745    .33836    .32963    .32124    .31317    .30540    .29792    .29073    .28379
61..................................................    .36999    .36050    .35137    .34259    .33414    .32601    .31817    .31062    .30334    .29633
62..................................................    .38325    .37374    .36458    .35576    .34726    .33907    .33117    .32356    .31621    .30912
63..................................................    .39669    .38717    .37799    .36913    .36060    .35236    .34441    .33674    .32933    .32217
64..................................................    .41031    .40078    .39159    .38272    .37415    .36588    .35789    .35016    .34270    .33548
65..................................................    .42416    .41464    .40545    .39656    .38798    .37968    .37166    .36390    .35639    .34912
66..................................................    .43825    .42876    .41958    .41070    .40211    .39380    .38576    .37797    .37043    .36312
67..................................................    .45260    .44315    .43399    .42513    .41655    .40824    .40019    .39238    .38482    .37749
68..................................................    .46720    .45779    .44868    .43985    .43129    .42299    .41494    .40713    .39956    .39221
69..................................................    .48197    .47263    .46357    .45478    .44625    .43798    .42995    .42215    .41458    .40722
70..................................................    .49686    .48760    .47861    .46988    .46140    .45316    .44516    .43738    .42983    .42248
71..................................................    .51182    .50265    .49374    .48508    .47666    .46847    .46051    .45276    .44523    .43790
72..................................................    .52685    .51778    .50896    .50038    .49203    .48390    .47599    .46829    .46079    .45349
73..................................................    .54194    .53298    .52426    .51578    .50751    .49946    .49161    .48397    .47652    .46926
74..................................................    .55714    .54832    .53972    .53134    .52317    .51520    .50744    .49986    .49247    .48527

[[Page 97]]

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


                                           Table S--Based on Life Table 80CNSMT Single Life Remainder Factors
                                                [Applicable After April 30, 1989, and Before May 1, 1999]
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                 Interest rate
                         Age                         ---------------------------------------------------------------------------------------------------
                                                        8.2%      8.4%      8.6%      8.8%      9.0%      9.2%      9.4%      9.6%      9.8%      10.0%
--------------------------------------------------------------------------------------------------------------------------------------------------------
0...................................................    .02341    .02276    .02217    .02163    .02114    .02069    .02027    .01989    .01954    .01922
1...................................................    .01237    .01170    .01108    .01052    .01000    .00953    .00910    .00871    .00834    .00801
2...................................................    .01243    .01172    .01107    .01048    .00994    .00944    .00899    .00857    .00819    .00784
3...................................................    .01278    .01203    .01135    .01073    .01016    .00964    .00916    .00872    .00832    .00795
4...................................................    .01332    .01253    .01182    .01116    .01056    .01001    .00951    .00904    .00862    .00822
5...................................................    .01400    .01317    .01241    .01172    .01109    .01051    .00998    .00949    .00904    .00862
6...................................................    .01477    .01390    .01310    .01238    .01171    .01110    .01054    .01002    .00954    .00910
7...................................................    .01563    .01472    .01389    .01312    .01242    .01178    .01118    .01064    .01013    .00966
8...................................................    .01660    .01564    .01477    .01396    .01322    .01254    .01192    .01134    .01081    .01031
9...................................................    .01770    .01669    .01577    .01492    .01414    .01342    .01276    .01216    .01159    .01107
10..................................................    .01891    .01785    .01688    .01599    .01517    .01442    .01372    .01308    .01249    .01194
11..................................................    .02026    .01915    .01814    .01720    .01634    .01555    .01481    .01414    .01351    .01293
12..................................................    .02173    .02056    .01950    .01852    .01761    .01678    .01601    .01529    .01463    .01402
13..................................................    .02326    .02204    .02092    .01989    .01895    .01807    .01726    .01651    .01582    .01517
14..................................................    .02478    .02351    .02234    .02126    .02027    .01935    .01850    .01771    .01698    .01630
15..................................................    .02628    .02495    .02372    .02259    .02155    .02058    .01969    .01886    .01810    .01738
16..................................................    .02774    .02635    .02507    .02388    .02279    .02178    .02084    .01997    .01917    .01842
17..................................................    .02917    .02772    .02637    .02513    .02399    .02293    .02194    .02103    .02018    .01940
18..................................................    .03059    .02907    .02767    .02637    .02517    .02406    .02302    .02207    .02118    .02035
19..................................................    .03205    .03046    .02899    .02763    .02637    .02521    .02412    .02312    .02218    .02131
20..................................................    .03355    .03188    .03035    .02892    .02760    .02638    .02524    .02419    .02320    .02229
21..................................................    .03509    .03334    .03173    .03024    .02886    .02758    .02638    .02527    .02424    .02328
22..................................................    .03669    .03487    .03318    .03162    .03017    .02882    .02757    .02640    .02532    .02430
23..................................................    .03837    .03646    .03470    .03306    .03154    .03013    .02881    .02759    .02644    .02538
24..................................................    .04018    .03819    .03634    .03463    .03303    .03155    .03016    .02888    .02767    .02655

[[Page 98]]

 
25..................................................    .04214    .04006    .03812    .03633    .03465    .03309    .03164    .03029    .02902    .02784
26..................................................    .04428    .04210    .04008    .03820    .03644    .03481    .03328    .03186    .03052    .02928
27..................................................    .04662    .04434    .04223    .04025    .03841    .03670    .03509    .03360    .03219    .03088
28..................................................    .04915    .04677    .04456    .04249    .04056    .03876    .03708    .03550    .03403    .03264
29..................................................    .05189    .04941    .04709    .04493    .04291    .04102    .03925    .03760    .03604    .03458
30..................................................    .05485    .05226    .04984    .04757    .04546    .04348    .04162    .03988    .03825    .03671
31..................................................    .05805    .05535    .05282    .05045    .04824    .04616    .04421    .04238    .04067    .03905
32..................................................    .06149    .05867    .05603    .05356    .05124    .04906    .04702    .04510    .04329    .04160
33..................................................    .06520    .06226    .05950    .05692    .05449    .05221    .05007    .04806    .04616    .04438
34..................................................    .06916    .06609    .06322    .06052    .05799    .05560    .05336    .05125    .04926    .04738
35..................................................    .07339    .07020    .06720    .06439    .06174    .05925    .05690    .05469    .05260    .05063
36..................................................    .07787    .07455    .07143    .06850    .06573    .06313    .06068    .05836    .05617    .05411
37..................................................    .08262    .07917    .07593    .07287    .06999    .06727    .06470    .06228    .05999    .05783
38..................................................    .08765    .08407    .08069    .07751    .07451    .07167    .06899    .06646    .06407    .06180
39..................................................    .09296    .08925    .08574    .08243    .07931    .07635    .07356    .07092    .06841    .06604
40..................................................    .09858    .09472    .09109    .08765    .08440    .08132    .07841    .07565    .07303    .07055
41..................................................    .10449    .10050    .09673    .09316    .08978    .08658    .08355    .08067    .07794    .07535
42..................................................    .11069    .10656    .10265    .09895    .09544    .09212    .08896    .08596    .08312    .08041
43..................................................    .11718    .11291    .10887    .10503    .10140    .09794    .09466    .09154    .08858    .08576
44..................................................    .12399    .11958    .11540    .11143    .10766    .10407    .10067    .09743    .09434    .09141
45..................................................    .13111    .12656    .12224    .11814    .11423    .11052    .10699    .10362    .10042    .09736
46..................................................    .13856    .13387    .12941    .12516    .12113    .11728    .11362    .11013    .10680    .10363
47..................................................    .14633    .14150    .13690    .13252    .12835    .12438    .12059    .11697    .11352    .11022
48..................................................    .15442    .14945    .14471    .14020    .13589    .13179    .12787    .12412    .12055    .11713
49..................................................    .16280    .15769    .15281    .14816    .14373    .13949    .13544    .13157    .12787    .12433
50..................................................    .17147    .16622    .16121    .15643    .15186    .14749    .14331    .13931    .13548    .13182
51..................................................    .18045    .17507    .16993    .16501    .16030    .15580    .15150    .14737    .14342    .13963
52..................................................    .18979    .18427    .17899    .17394    .16911    .16448    .16004    .15579    .15172    .14780
53..................................................    .19947    .19383    .18842    .18324    .17828    .17352    .16896    .16458    .16038    .15635
54..................................................    .20950    .20372    .19819    .19288    .18779    .18291    .17822    .17372    .16940    .16524
55..................................................    .21986    .21397    .20831    .20288    .19767    .19266    .18785    .18322    .17878    .17450
56..................................................    .23058    .22457    .21879    .21324    .20791    .20278    .19785    .19310    .18854    .18414
57..................................................    .24167    .23554    .22965    .22399    .21854    .21329    .20824    .20338    .19870    .19419
58..................................................    .25314    .24690    .24090    .23512    .22956    .22420    .21904    .21407    .20927    .20464
59..................................................    .26497    .25863    .25252    .24664    .24097    .23550    .23023    .22515    .22024    .21551
60..................................................    .27712    .27068    .26448    .25849    .25272    .24716    .24178    .23659    .23158    .22674
61..................................................    .28956    .28304    .27674    .27067    .26480    .25913    .25366    .24837    .24325    .23831
62..................................................    .30228    .29567    .28929    .28312    .27717    .27141    .26584    .26045    .25524    .25020
63..................................................    .31525    .30857    .30211    .29586    .28982    .28397    .27832    .27284    .26754    .26240
64..................................................    .32851    .32176    .31522    .30890    .30278    .29685    .29111    .28555    .28016    .27493
65..................................................    .34209    .33528    .32868    .32229    .31610    .31010    .30429    .29865    .29317    .28787
66..................................................    .35604    .34918    .34253    .33609    .32983    .32377    .31788    .31217    .30663    .30124
67..................................................    .37037    .36347    .35678    .35028    .34398    .33786    .33191    .32614    .32053    .31508
68..................................................    .38508    .37815    .37142    .36489    .35854    .35237    .34638    .34055    .33488    .32937
69..................................................    .40008    .39313    .38638    .37982    .37344    .36724    .36120    .35533    .34961    .34405
70..................................................    .41533    .40838    .40162    .39504    .38864    .38241    .37634    .37043    .36468    .35907
71..................................................    .43076    .42382    .41705    .41047    .40405    .39780    .39171    .38578    .38000    .37436
72..................................................    .44638    .43945    .43269    .42611    .41969    .41344    .40733    .40138    .39558    .38991
73..................................................    .46218    .45527    .44854    .44197    .43556    .42931    .42321    .41725    .41143    .40575
74..................................................    .47823    .47137    .46466    .45812    .45173    .44549    .43940    .43345    .42763    .42195
75..................................................    .49459    .48777    .48112    .47462    .46826    .46205    .45598    .45004    .44424    .43856
76..................................................    .51127    .50452    .49793    .49148    .48517    .47900    .47297    .46706    .46129    .45563
77..................................................    .52823    .52157    .51505    .50867    .50243    .49632    .49033    .48447    .47873    .47311
78..................................................    .54541    .53885    .53242    .52613    .51996    .51392    .50800    .50220    .49652    .49094
79..................................................    .56267    .55621    .54989    .54369    .53762    .53166    .52582    .52009    .51448    .50897
80..................................................    .57987    .57354    .56733    .56125    .55527    .54941    .54366    .53802    .53248    .52705
81..................................................    .59685    .59065    .58457    .57860    .57274    .56699    .56134    .55579    .55035    .54499
82..................................................    .61351    .60746    .60151    .59567    .58993    .58429    .57875    .57331    .56796    .56270
83..................................................    .62978    .62387    .61806    .61236    .60675    .60123    .59581    .59047    .58523    .58007
84..................................................    .64567    .63992    .63426    .62869    .62321    .61783    .61253    .60731    .60218    .59713
85..................................................    .66125    .65565    .65014    .64472    .63938    .63413    .62896    .62387    .61886    .61392
86..................................................    .67636    .67092    .66557    .66030    .65511    .65000    .64496    .64000    .63511    .63030
87..................................................    .69081    .68554    .68034    .67522    .67018    .66520    .66031    .65548    .65071    .64602
88..................................................    .70468    .69957    .69453    .68956    .68466    .67983    .67507    .67037    .66574    .66117
89..................................................    .71821    .71326    .70838    .70357    .69882    .69414    .68952    .68495    .68045    .67601
90..................................................    .73153    .72676    .72204    .71739    .71280    .70827    .70379    .69938    .69502    .69071
91..................................................    .74447    .73986    .73532    .73083    .72640    .72202    .71770    .71343    .70921    .70504
92..................................................    .75669    .75225    .74787    .74354    .73927    .73504    .73087    .72674    .72267    .71864
93..................................................    .76807    .76379    .75957    .75540    .75127    .74719    .74317    .73918    .73524    .73135

[[Page 99]]

 
94..................................................    .77849    .77437    .77030    .76627    .76229    .75835    .75446    .75061    .74680    .74303
95..................................................    .78792    .78394    .78001    .77611    .77226    .76845    .76468    .76096    .75727    .75362
96..................................................    .79630    .79244    .78863    .78485    .78112    .77742    .77377    .77015    .76657    .76303
97..................................................    .80391    .80016    .79646    .79280    .78917    .78559    .78203    .77852    .77504    .77160
98..................................................    .81076    .80712    .80352    .79996    .79643    .79294    .78948    .78606    .78267    .77931
99..................................................    .81709    .81354    .81004    .80657    .80313    .79972    .79635    .79302    .78971    .78644
100.................................................    .82296    .81950    .81609    .81270    .80934    .80602    .80273    .79947    .79624    .79304
101.................................................    .82855    .82518    .82185    .81854    .81526    .81201    .80880    .80561    .80245    .79932
102.................................................    .83438    .83110    .82785    .82462    .82142    .81826    .81512    .81200    .80892    .80586
103.................................................    .84056    .83737    .83420    .83106    .82795    .82487    .82181    .81878    .81577    .81279
104.................................................    .84743    .84433    .84127    .83822    .83521    .83221    .82924    .82630    .82338    .82048
105.................................................    .85591    .85295    .85001    .84709    .84419    .84132    .83846    .83563    .83282    .83003
106.................................................    .86816    .86540    .86266    .85993    .85723    .85454    .85187    .84922    .84659    .84397
107.................................................    .88592    .88348    .88105    .87863    .87623    .87384    .87147    .86911    .86676    .86443
108.................................................    .91493    .91306    .91119    .90934    .90749    .90566    .90383    .90201    .90020    .89840
109.................................................    .96211    .96125    .96041    .95956    .95872    .95788    .95704    .95620    .95537    .95455
--------------------------------------------------------------------------------------------------------------------------------------------------------


                                           Table S--Based on Life Table 80CNSMT Single Life Remainder Factors
                                                  [Applicable After April 30, 1989, Before May 1, 1999]
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                 Interest rate
                         Age                         ---------------------------------------------------------------------------------------------------
                                                        10.2%     10.4%     10.6%     10.8%     11.0%     11.2%     11.4%     11.6%     11.8%     12.0%
--------------------------------------------------------------------------------------------------------------------------------------------------------
0...................................................    .01891    .01864    .01838    .01814    .01791    .01770    .01750    .01732    .01715    .01698
1...................................................    .00770    .00741    .00715    .00690    .00667    .00646    .00626    .00608    .00590    .00574
2...................................................    .00751    .00721    .00693    .00667    .00643    .00620    .00600    .00580    .00562    .00544
3...................................................    .00760    .00728    .00699    .00671    .00646    .00622    .00600    .00579    .00560    .00541
4...................................................    .00786    .00752    .00721    .00692    .00665    .00639    .00616    .00594    .00573    .00554
5...................................................    .00824    .00788    .00755    .00724    .00695    .00668    .00643    .00620    .00598    .00578
6...................................................    .00869    .00832    .00796    .00764    .00733    .00705    .00678    .00654    .00630    .00608
7...................................................    .00923    .00883    .00846    .00811    .00779    .00749    .00720    .00694    .00669    .00646
8...................................................    .00986    .00943    .00904    .00867    .00833    .00801    .00771    .00743    .00716    .00692
9...................................................    .01059    .01014    .00972    .00933    .00897    .00863    .00831    .00801    .00773    .00747
10..................................................    .01142    .01095    .01051    .01009    .00971    .00935    .00901    .00869    .00840    .00812
11..................................................    .01239    .01189    .01142    .01098    .01057    .01019    .00983    .00950    .00918    .00889
12..................................................    .01345    .01292    .01243    .01197    .01154    .01113    .01075    .01040    .01007    .00975
13..................................................    .01457    .01401    .01349    .01300    .01255    .01212    .01172    .01135    .01100    .01067
14..................................................    .01567    .01508    .01453    .01402    .01354    .01309    .01267    .01227    .01190    .01155
15..................................................    .01672    .01610    .01552    .01498    .01448    .01400    .01356    .01314    .01275    .01238
16..................................................    .01772    .01707    .01646    .01589    .01536    .01486    .01439    .01396    .01354    .01315
17..................................................    .01866    .01798    .01734    .01674    .01618    .01566    .01516    .01470    .01427    .01386
18..................................................    .01958    .01886    .01818    .01755    .01697    .01641    .01590    .01541    .01495    .01452
19..................................................    .02050    .01974    .01903    .01837    .01775    .01717    .01662    .01611    .01563    .01517
20..................................................    .02143    .02064    .01989    .01919    .01854    .01793    .01735    .01681    .01630    .01582
21..................................................    .02238    .02154    .02075    .02002    .01933    .01868    .01807    .01750    .01696    .01646
22..................................................    .02336    .02247    .02164    .02087    .02014    .01946    .01882    .01821    .01764    .01711
23..................................................    .02438    .02345    .02257    .02176    .02099    .02027    .01959    .01895    .01835    .01778
24..................................................    .02550    .02451    .02359    .02273    .02192    .02115    .02044    .01976    .01913    .01853
25..................................................    .02673    .02569    .02472    .02381    .02295    .02214    .02138    .02067    .01999    .01936
26..................................................    .02811    .02701    .02598    .02502    .02411    .02326    .02246    .02170    .02098    .02031
27..................................................    .02965    .02849    .02741    .02639    .02543    .02452    .02367    .02287    .02211    .02140
28..................................................    .03134    .03013    .02898    .02790    .02689    .02593    .02503    .02418    .02338    .02262
29..................................................    .03322    .03193    .03072    .02958    .02851    .02750    .02654    .02564    .02479    .02398
30..................................................    .03527    .03391    .03264    .03143    .03030    .02923    .02821    .02726    .02635    .02550
31..................................................    .03753    .03610    .03475    .03348    .03228    .03115    .03008    .02907    .02811    .02720
32..................................................    .04000    .03849    .03707    .03573    .03446    .03326    .03213    .03105    .03004    .02907
33..................................................    .04269    .04111    .03961    .03819    .03685    .03558    .03438    .03325    .03217    .03115
34..................................................    .04561    .04394    .04236    .04087    .03946    .03812    .03685    .03565    .03451    .03342
35..................................................    .04877    .04702    .04535    .04378    .04229    .04087    .03953    .03826    .03706    .03591
36..................................................    .05215    .05031    .04856    .04690    .04533    .04384    .04242    .04108    .03980    .03859
37..................................................    .05578    .05384    .05200    .05025    .04860    .04703    .04553    .04411    .04276    .04148
38..................................................    .05965    .05761    .05568    .05385    .05211    .05045    .04888    .04738    .04595    .04460
39..................................................    .06379    .06165    .05962    .05770    .05587    .05412    .05247    .05089    .04939    .04795
40..................................................    .06820    .06596    .06383    .06181    .05989    .05806    .05631    .05465    .05307    .05155
41..................................................    .07288    .07054    .06832    .06620    .06418    .06226    .06042    .05868    .05701    .05541
42..................................................    .07784    .07539    .07306    .07085    .06873    .06671    .06479    .06295    .06119    .05952
43..................................................    .08308    .08052    .07808    .07576    .07355    .07143    .06941    .06748    .06564    .06387

[[Page 100]]

 
44..................................................    .08861    .08594    .08340    .08097    .07865    .07644    .07432    .07230    .07036    .06851
45..................................................    .09445    .09167    .08901    .08648    .08406    .08174    .07953    .07741    .07538    .07343
46..................................................    .10060    .09770    .09494    .09230    .08977    .08735    .08503    .08281    .08068    .07865
47..................................................    .10707    .10406    .10119    .09843    .09579    .09327    .09085    .08853    .08630    .08417
48..................................................    .11386    .11073    .10774    .10487    .10213    .09949    .09697    .09455    .09222    .08999
49..................................................    .12094    .11769    .11458    .11160    .10874    .10600    .10337    .10084    .09842    .09609
50..................................................    .12831    .12494    .12172    .11862    .11565    .11280    .11006    .10743    .10490    .10247
51..................................................    .13600    .13251    .12917    .12596    .12288    .11991    .11706    .11432    .11169    .10915
52..................................................    .14405    .14044    .13698    .13366    .13046    .12738    .12442    .12157    .11883    .11619
53..................................................    .15247    .14875    .14517    .14172    .13841    .13522    .13215    .12919    .12635    .12360
54..................................................    .16124    .15740    .15370    .15014    .14671    .14341    .14023    .13717    .13421    .13136
55..................................................    .17039    .16642    .16261    .15893    .15539    .15198    .14868    .14551    .14244    .13948
56..................................................    .17991    .17583    .17190    .16811    .16445    .16092    .15752    .15423    .15106    .14799
57..................................................    .18984    .18564    .18160    .17769    .17392    .17029    .16677    .16338    .16010    .15692
58..................................................    .20018    .19587    .19172    .18770    .18382    .18007    .17645    .17295    .16956    .16628
59..................................................    .21093    .20652    .20225    .19812    .19414    .19028    .18655    .18294    .17945    .17606
60..................................................    .22206    .21753    .21316    .20893    .20483    .20087    .19703    .19332    .18972    .18624
61..................................................    .23353    .22890    .22442    .22009    .21589    .21182    .20788    .20407    .20037    .19678
62..................................................    .24532    .24059    .23601    .23158    .22728    .22311    .21907    .21515    .21135    .20767
63..................................................    .25742    .25260    .24793    .24339    .23900    .23473    .23060    .22658    .22268    .21890
64..................................................    .26987    .26495    .26019    .25556    .25107    .24671    .24248    .23837    .23438    .23050
65..................................................    .28271    .27771    .27286    .26815    .26357    .25912    .25480    .25059    .24651    .24254
66..................................................    .29601    .29093    .28600    .28120    .27654    .27200    .26760    .26331    .25913    .25507
67..................................................    .30978    .30462    .29961    .29474    .29000    .28539    .28090    .27653    .27227    .26813
68..................................................    .32401    .31879    .31371    .30877    .30396    .29927    .29471    .29027    .28593    .28171
69..................................................    .33863    .33336    .32822    .32322    .31835    .31359    .30896    .30445    .30005    .29576
70..................................................    .35361    .34829    .34310    .33804    .33311    .32830    .32361    .31903    .31457    .31021
71..................................................    .36886    .36349    .35826    .35316    .34818    .34332    .33858    .33394    .32942    .32500
72..................................................    .38439    .37899    .37373    .36858    .36356    .35866    .35387    .34919    .34461    .34015
73..................................................    .40021    .39479    .38950    .38432    .37927    .37433    .36950    .36478    .36016    .35565
74..................................................    .41639    .41096    .40565    .40046    .39538    .39042    .38556    .38081    .37616    .37161
75..................................................    .43301    .42758    .42226    .41706    .41198    .40699    .40212    .39734    .39267    .38809
76..................................................    .45009    .44467    .43937    .43417    .42908    .42410    .41921    .41443    .40974    .40514
77..................................................    .46761    .46221    .45693    .45175    .44667    .44170    .43682    .43203    .42734    .42274
78..................................................    .48548    .48013    .47488    .46973    .46468    .45972    .45486    .45009    .44541    .44082
79..................................................    .50356    .49826    .49306    .48795    .48294    .47802    .47319    .46845    .46379    .45922
80..................................................    .52171    .51647    .51133    .50628    .50132    .49644    .49166    .48695    .48233    .47779
81..................................................    .53974    .53457    .52950    .52451    .51961    .51479    .51006    .50541    .50083    .49633
82..................................................    .55753    .55245    .54745    .54254    .53771    .53296    .52828    .52369    .51917    .51472
83..................................................    .57500    .57001    .56510    .56026    .55551    .55083    .54623    .54170    .53724    .53285
84..................................................    .59216    .58726    .58245    .57770    .57304    .56844    .56391    .55945    .55506    .55074
85..................................................    .60906    .60428    .59956    .59492    .59034    .58583    .58139    .57702    .57270    .56845
86..................................................    .62555    .62088    .61627    .61173    .60725    .60284    .59849    .59420    .58997    .58580
87..................................................    .64139    .63683    .63233    .62790    .62352    .61921    .61495    .61076    .60661    .60253
88..................................................    .65666    .65221    .64783    .64350    .63923    .63502    .63086    .62675    .62270    .61871
89..................................................    .67163    .66730    .66304    .65882    .65466    .65055    .64650    .64249    .63854    .63463
90..................................................    .68646    .68226    .67812    .67402    .66998    .66599    .66204    .65814    .65430    .65049
91..................................................    .70093    .69686    .69285    .68888    .68496    .68108    .67725    .67347    .66973    .66604
92..................................................    .71466    .71073    .70684    .70300    .69920    .69545    .69173    .68806    .68444    .68085
93..................................................    .72750    .72370    .71994    .71622    .71254    .70890    .70530    .70174    .69822    .69474
94..................................................    .73931    .73562    .73198    .72838    .72481    .72129    .71780    .71434    .71093    .70755
95..................................................    .75001    .74644    .74291    .73941    .73595    .73253    .72914    .72579    .72247    .71919
96..................................................    .75953    .75606    .75262    .74923    .74586    .74253    .73924    .73598    .73275    .72955
97..................................................    .76819    .76481    .76147    .75816    .75489    .75165    .74844    .74526    .74211    .73899
98..................................................    .77599    .77270    .76944    .76621    .76302    .75986    .75672    .75362    .75054    .74750
99..................................................    .78319    .77998    .77680    .77365    .77053    .76744    .76437    .76134    .75833    .75535
100.................................................    .78987    .78673    .78362    .78054    .77748    .77446    .77146    .76849    .76555    .76263
101.................................................    .79622    .79315    .79010    .78708    .78409    .78113    .77819    .77528    .77239    .76953
102.................................................    .80283    .79983    .79685    .79390    .79097    .78807    .78519    .78234    .77951    .77671
103.................................................    .80983    .80690    .80399    .80111    .79825    .79541    .79260    .78981    .78705    .78430
104.................................................    .81760    .81475    .81192    .80912    .80633    .80357    .80083    .79810    .79541    .79273
105.................................................    .82726    .82451    .82178    .81907    .81638    .81371    .81106    .80843    .80582    .80322
106.................................................    .84137    .83879    .83623    .83368    .83115    .82863    .82614    .82366    .82119    .81874
107.................................................    .86211    .85981    .85751    .85523    .85297    .85071    .84847    .84624    .84403    .84182
108.................................................    .89660    .89481    .89304    .89127    .88950    .88775    .88601    .88427    .88254    .88081
109.................................................    .95372    .95290    .95208    .95126    .95045    .94964    .94883    .94803    .94723    .94643
--------------------------------------------------------------------------------------------------------------------------------------------------------


[[Page 101]]


                                           Table S--Based on Life Table 80CNSMT Single Life Remainder Factors
                                                [Applicable After April 30, 1989, and Before May 1, 1999]
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                 Interest rate
                         Age                         ---------------------------------------------------------------------------------------------------
                                                        12.2%     12.4%     12.6%     12.8%     13.0%     13.2%     13.4%     13.6%     13.8%     14.0%
--------------------------------------------------------------------------------------------------------------------------------------------------------
0...................................................    .01683    .01669    .01655    .01642    .01630    .01618    .01607    .01596    .01586    .01576
1...................................................    .00559    .00544    .00531    .00518    .00506    .00494    .00484    .00473    .00464    .00454
2...................................................    .00528    .00513    .00499    .00485    .00473    .00461    .00449    .00439    .00428    .00419
3...................................................    .00524    .00508    .00493    .00479    .00465    .00453    .00441    .00429    .00419    .00408
4...................................................    .00536    .00519    .00503    .00488    .00473    .00460    .00447    .00435    .00423    .00412
5...................................................    .00558    .00540    .00523    .00507    .00492    .00477    .00464    .00451    .00439    .00427
6...................................................    .00588    .00569    .00550    .00533    .00517    .00502    .00487    .00473    .00460    .00448
7...................................................    .00624    .00604    .00584    .00566    .00549    .00532    .00517    .00502    .00488    .00475
8...................................................    .00668    .00646    .00626    .00606    .00588    .00570    .00554    .00538    .00523    .00509
9...................................................    .00722    .00699    .00677    .00656    .00636    .00617    .00600    .00583    .00567    .00552
10..................................................    .00785    .00761    .00737    .00715    .00694    .00674    .00655    .00637    .00620    .00604
11..................................................    .00861    .00835    .00810    .00786    .00764    .00743    .00723    .00704    .00686    .00668
12..................................................    .00946    .00918    .00891    .00866    .00843    .00820    .00799    .00779    .00760    .00741
13..................................................    .01035    .01006    .00978    .00951    .00927    .00903    .00880    .00859    .00839    .00819
14..................................................    .01122    .01091    .01061    .01034    .01007    .00982    .00958    .00936    .00914    .00894
15..................................................    .01203    .01171    .01140    .01110    .01082    .01056    .01031    .01007    .00985    .00963
16..................................................    .01279    .01244    .01211    .01181    .01151    .01123    .01097    .01072    .01048    .01025
17..................................................    .01347    .01311    .01276    .01244    .01213    .01184    .01156    .01130    .01104    .01081
18..................................................    .01411    .01373    .01336    .01302    .01270    .01239    .01210    .01182    .01155    .01130
19..................................................    .01474    .01434    .01396    .01359    .01325    .01293    .01262    .01233    .01205    .01178
20..................................................    .01537    .01494    .01454    .01415    .01379    .01345    .01313    .01282    .01252    .01224
21..................................................    .01598    .01553    .01510    .01470    .01432    .01396    .01361    .01329    .01298    .01268
22..................................................    .01660    .01613    .01568    .01525    .01485    .01446    .01410    .01375    .01343    .01312
23..................................................    .01725    .01674    .01627    .01581    .01539    .01498    .01460    .01423    .01388    .01355
24..................................................    .01796    .01742    .01692    .01644    .01599    .01556    .01515    .01476    .01439    .01404
25..................................................    .01876    .01819    .01765    .01714    .01666    .01621    .01577    .01536    .01497    .01460
26..................................................    .01967    .01907    .01850    .01796    .01745    .01696    .01650    .01606    .01565    .01525
27..................................................    .02072    .02008    .01948    .01890    .01836    .01784    .01735    .01688    .01644    .01601
28..................................................    .02190    .02122    .02057    .01996    .01938    .01883    .01831    .01781    .01734    .01689
29..................................................    .02322    .02249    .02181    .02116    .02054    .01996    .01940    .01887    .01836    .01788
30..................................................    .02469    .02392    .02319    .02250    .02184    .02122    .02062    .02006    .01952    .01900
31..................................................    .02634    .02552    .02475    .02401    .02331    .02264    .02201    .02140    .02083    .02028
32..................................................    .02816    .02729    .02647    .02568    .02494    .02423    .02355    .02291    .02229    .02170
33..................................................    .03018    .02926    .02838    .02755    .02675    .02600    .02528    .02459    .02393    .02331
34..................................................    .03239    .03142    .03048    .02960    .02875    .02795    .02718    .02645    .02575    .02508
35..................................................    .03482    .03378    .03279    .03185    .03095    .03009    .02928    .02850    .02775    .02704
36..................................................    .03743    .03633    .03528    .03428    .03333    .03242    .03155    .03072    .02992    .02916
37..................................................    .04026    .03909    .03798    .03692    .03591    .03494    .03401    .03313    .03228    .03147
38..................................................    .04330    .04207    .04089    .03977    .03869    .03767    .03668    .03574    .03484    .03398
39..................................................    .04658    .04528    .04403    .04284    .04170    .04061    .03957    .03857    .03762    .03670
40..................................................    .05011    .04873    .04741    .04615    .04495    .04379    .04269    .04163    .04061    .03964
41..................................................    .05389    .05244    .05104    .04971    .04844    .04721    .04604    .04492    .04384    .04281
42..................................................    .05791    .05638    .05491    .05350    .05216    .05086    .04962    .04844    .04729    .04620
43..................................................    .06219    .06057    .05902    .05754    .05612    .05475    .05344    .05218    .05098    .04981
44..................................................    .06673    .06503    .06340    .06184    .06034    .05890    .05752    .05619    .05491    .05368
45..................................................    .07157    .06978    .06806    .06642    .06484    .06332    .06186    .06046    .05911    .05781
46..................................................    .07669    .07481    .07301    .07128    .06962    .06802    .06649    .06501    .06358    .06221
47..................................................    .08212    .08015    .07826    .07645    .07470    .07302    .07140    .06984    .06834    .06690
48..................................................    .08784    .08578    .08380    .08190    .08006    .07830    .07660    .07496    .07338    .07186
49..................................................    .09384    .09169    .08961    .08762    .08570    .08384    .08206    .08034    .07868    .07708
50..................................................    .10013    .09787    .09570    .09361    .09160    .08966    .08779    .08598    .08424    .08256
51..................................................    .10671    .10436    .10209    .09991    .09780    .09577    .09381    .09192    .09009    .08832
52..................................................    .11365    .11120    .10883    .10655    .10435    .10222    .10017    .09819    .09628    .09442
53..................................................    .12095    .11840    .11593    .11355    .11126    .10904    .10689    .10482    .10282    .10088
54..................................................    .12860    .12595    .12338    .12090    .11851    .11619    .11396    .11179    .10970    .10767
55..................................................    .13663    .13386    .13120    .12862    .12613    .12372    .12138    .11912    .11694    .11482
56..................................................    .14503    .14217    .13940    .13672    .13413    .13162    .12919    .12683    .12456    .12235
57..................................................    .15385    .15089    .14801    .14523    .14254    .13994    .13741    .13496    .13259    .13029
58..................................................    .16311    .16004    .15706    .15418    .15139    .14868    .14606    .14352    .14105    .13866
59..................................................    .17279    .16961    .16654    .16355    .16066    .15786    .15514    .15250    .14994    .14745
60..................................................    .18286    .17958    .17640    .17332    .17033    .16743    .16462    .16188    .15922    .15664
61..................................................    .19330    .18992    .18665    .18347    .18038    .17738    .17447    .17164    .16889    .16622
62..................................................    .20409    .20061    .19724    .19396    .19078    .18768    .18467    .18175    .17891    .17614
63..................................................    .21522    .21165    .20818    .20480    .20152    .19833    .19523    .19221    .18928    .18642
64..................................................    .22672    .22306    .21949    .21602    .21265    .20937    .20617    .20306    .20003    .19708
65..................................................    .23867    .23491    .23125    .22769    .22423    .22085    .21757    .21437    .21125    .20821
66..................................................    .25112    .24727    .24353    .23988    .23632    .23286    .22948    .22619    .22299    .21986
67..................................................    .26409    .26016    .25633    .25260    .24896    .24541    .24195    .23857    .23528    .23206
68..................................................    .27760    .27359    .26968    .26586    .26214    .25851    .25497    .25151    .24814    .24484

[[Page 102]]

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

    (f) Present value of the remainder interest in the case of transfers 
to pooled income funds for which the valuation date is after April 30, 
1999, and before May 1, 2009--(1) In general. In the case of transfers 
to pooled income funds for which the valuation date is after April 30, 
1999, and before May 1, 2009, the present value of a remainder interest 
is determined under this section. See, however, Sec. 1.7520-3(b) 
(relating to exceptions to the use of prescribed tables under certain 
circumstances). The present value of a remainder interest that is 
dependent on the termination of the life of one individual is computed 
by the use of Table S in paragraph (f)(6) of this section. For purposes 
of the computations under this section, the age of an individual is the 
age at the individual's nearest birthday.
    (2) Transitional rules for valuation of transfers to pooled income 
funds. (i) For purposes of sections 2055, 2106, or 2624, if on May 1, 
1999, the decedent was mentally incompetent so that the disposition of 
the property could not be changed, and the decedent died after April 30, 
1999, without having regained competency to dispose of the decedent's 
property, or the decedent died within 90 days of the date that the 
decedent first regained competency after April 30, 1999, the present 
value of a remainder interest is determined as if the valuation date 
with respect to the decedent's gross estate is either before

[[Page 103]]

May 1, 1999, or after April 30, 1999, at the option of the decedent's 
executor.
    (ii) For purposes of sections 170, 2055, 2106, 2522, or 2624, in the 
case of transfers to a pooled income fund for which the valuation date 
is after April 30, 1999, and before July 1, 1999, the present value of 
the remainder interest under this section is determined by use of the 
section 7520 interest rate for the month in which the valuation date 
occurs (see Sec. Sec. 1.7520-1(b) and 1.7520-2(a)(2)) and the 
appropriate actuarial tables under either paragraph (e)(5) or (f)(6) of 
this section, at the option of the donor or the decedent's executor, as 
the case may be.
    (iii) For purposes of paragraphs (f)(2)(i) and (f)(2)(ii) of this 
section, where the donor or decedent's executor is given the option to 
use the appropriate actuarial tables under either paragraph (e)(5) or 
(f)(6) of this section, the donor or decedent's executor must use the 
same actuarial table with respect to each individual transaction and 
with respect to all transfers occurring on the valuation date (for 
example, gift and income tax charitable deductions with respect to the 
same transfer must be determined based on the same tables, and all 
assets includible in the gross estate and/or estate tax deductions 
claimed must be valued based on the same tables).
    (3) Present value of a remainder interest. The present value of a 
remainder interest in property transferred to a pooled income fund is 
computed on the basis of--
    (i) Life contingencies determined from the values of lx that are set 
forth in Table 90CM in Sec. 20.2031-7A(f)(4); and
    (ii) Discount at a rate of interest, compounded annually, equal to 
the highest yearly rate of return of the pooled income fund for the 3 
taxable years immediately preceding its taxable year in which the 
transfer of property to the fund is made. The provisions of Sec. 
1.642(c)-6(c) apply for determining the yearly rate of return. However, 
where the taxable year is less than 12 months, the provisions of Sec. 
1.642(c)-6(e)(3)(ii) apply for the determining the yearly rate of 
return.
    (4) Pooled income funds in existence less than 3 taxable years. The 
provisions of Sec. 1.642(c)-6(e)(4) apply for determining the highest 
yearly rate of return when the pooled income fund has been in existence 
less than 3 taxable years.
    (5) Computation of value of remainder interest. The factor that is 
used in determining the present value of a remainder interest that is 
dependent on the termination of the life of one individual is the factor 
from Table S in paragraph (f)(6) of this section under the appropriate 
yearly rate of return opposite the number that corresponds to the age of 
the individual upon whose life the value of the remainder interest is 
based. Table S in paragraph (f)(6) of this section includes factors for 
yearly rates of return from 4.2 to 14 percent. Many actuarial factors 
not contained in Table S in paragraph (f)(6) of this section are 
contained in Table S in Internal Revenue Service Publication 1457, 
``Actuarial Values, Book Aleph,'' (7-99). Publication 1457 is no longer 
available for purchase from the Superintendent of Documents, United 
States Government Printing Office. However, pertinent factors in this 
publication may be obtained by a written request to: CC:PA:LPD:PR (IRS 
Publication 1457), Room 5205, Internal Revenue Service, P.O. Box 7604, 
Ben Franklin Station, Washington, DC 20044. For other situations, see 
Sec. 1.642(c)-6(b). If the yearly rate of return is a percentage that 
is between the yearly rates of return for which factors are provided, a 
linear interpolation must be made. The present value of the remainder 
interest is determined by multiplying the fair market value of the 
property on the valuation date by the appropriate remainder factor. For 
an example of a computation of the present value of a remainder interest 
requiring a linear interpolation adjustment, see Sec. 1.642(c)-6(e)(5).
    (6) Actuarial tables. In the case of transfers for which the 
valuation date is after April 30, 1999, and before May 1, 2009, the 
present value of a remainder interest dependent on the termination of 
one life in the case of a transfer to a pooled income fund is determined 
by use of the following tables:

[[Page 104]]



                                             Table S--Based on Life Table 90CM Single Life Remainder Factors
                                                [Applicable After April 30, 1999, and Before May 1, 2009]
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                      Interest rate
                              Age                              -----------------------------------------------------------------------------------------
                                                                  4.2%     4.4%     4.6%     4.8%     5.0%     5.2%     5.4%     5.6%     5.8%     6.0%
--------------------------------------------------------------------------------------------------------------------------------------------------------
0.............................................................   .06752   .06130   .05586   .05109   .04691   .04322   .03998   .03711   .03458   .03233
1.............................................................   .06137   .05495   .04932   .04438   .04003   .03620   .03283   .02985   .02721   .02487
2.............................................................   .06325   .05667   .05088   .04580   .04132   .03737   .03388   .03079   .02806   .02563
3.............................................................   .06545   .05869   .05275   .04752   .04291   .03883   .03523   .03203   .02920   .02668
4.............................................................   .06784   .06092   .05482   .04944   .04469   .04048   .03676   .03346   .03052   .02791
5.............................................................   .07040   .06331   .05705   .05152   .04662   .04229   .03845   .03503   .03199   .02928
6.............................................................   .07310   .06583   .05941   .05372   .04869   .04422   .04025   .03672   .03357   .03076
7.............................................................   .07594   .06849   .06191   .05607   .05089   .04628   .04219   .03854   .03528   .03236
8.............................................................   .07891   .07129   .06453   .05853   .05321   .04846   .04424   .04046   .03709   .03407
9.............................................................   .08203   .07423   .06731   .06115   .05567   .05079   .04643   .04253   .03904   .03592
10............................................................   .08532   .07734   .07024   .06392   .05829   .05326   .04877   .04474   .04114   .03790
11............................................................   .08875   .08059   .07331   .06683   .06104   .05587   .05124   .04709   .04336   .04002
12............................................................   .09233   .08398   .07653   .06989   .06394   .05862   .05385   .04957   .04572   .04226
13............................................................   .09601   .08748   .07985   .07304   .06693   .06146   .05655   .05214   .04816   .04458
14............................................................   .09974   .09102   .08322   .07624   .06997   .06435   .05929   .05474   .05064   .04694
15............................................................   .10350   .09460   .08661   .07946   .07303   .06725   .06204   .05735   .05312   .04930
16............................................................   .10728   .09818   .09001   .08268   .07608   .07014   .06479   .05996   .05559   .05164
17............................................................   .11108   .10179   .09344   .08592   .07916   .07306   .06755   .06257   .05807   .05399
18............................................................   .11494   .10545   .09691   .08921   .08227   .07601   .07034   .06521   .06057   .05636
19............................................................   .11889   .10921   .10047   .09259   .08548   .07904   .07322   .06794   .06315   .05880
20............................................................   .12298   .11310   .10417   .09610   .08881   .08220   .07622   .07078   .06584   .06135
21............................................................   .12722   .11713   .10801   .09976   .09228   .08550   .07935   .07375   .06866   .06403
22............................................................   .13159   .12130   .11199   .10354   .09588   .08893   .08260   .07685   .07160   .06682
23............................................................   .13613   .12563   .11612   .10748   .09964   .09250   .08601   .08009   .07468   .06975
24............................................................   .14084   .13014   .12043   .11160   .10357   .09625   .08958   .08349   .07793   .07284
25............................................................   .14574   .13484   .12493   .11591   .10768   .10018   .09334   .08708   .08135   .07611
26............................................................   .15084   .13974   .12963   .12041   .11199   .10431   .09728   .09085   .08496   .07956
27............................................................   .15615   .14485   .13454   .12513   .11652   .10865   .10144   .09484   .08878   .08322
28............................................................   .16166   .15016   .13965   .13004   .12124   .11319   .10580   .09901   .09279   .08706
29............................................................   .16737   .15567   .14497   .13516   .12617   .11792   .11035   .10339   .09699   .09109
30............................................................   .17328   .16138   .15048   .14047   .13129   .12286   .11510   .10796   .10138   .09532
31............................................................   .17938   .16728   .15618   .14599   .13661   .12799   .12004   .11272   .10597   .09974
32............................................................   .18568   .17339   .16210   .15171   .14214   .13333   .12520   .11769   .11076   .10435
33............................................................   .19220   .17972   .16824   .15766   .14790   .13889   .13058   .12289   .11578   .10920
34............................................................   .19894   .18627   .17460   .16383   .15388   .14468   .13618   .12831   .12102   .11426
35............................................................   .20592   .19307   .18121   .17025   .16011   .15073   .14204   .13399   .12652   .11958
36............................................................   .21312   .20010   .18805   .17691   .16658   .15701   .14814   .13990   .13225   .12514
37............................................................   .22057   .20737   .19514   .18382   .17331   .16356   .15450   .14608   .13825   .13096
38............................................................   .22827   .21490   .20251   .19100   .18031   .17038   .16113   .15253   .14452   .13705
39............................................................   .23623   .22270   .21013   .19845   .18759   .17747   .16805   .15927   .15108   .14344
40............................................................   .24446   .23078   .21805   .20620   .19516   .18487   .17527   .16631   .15795   .15013
41............................................................   .25298   .23915   .22626   .21425   .20305   .19259   .18282   .17368   .16514   .15715
42............................................................   .26178   .24782   .23478   .22262   .21125   .20062   .19069   .18138   .17267   .16450
43............................................................   .27087   .25678   .24360   .23129   .21977   .20898   .19888   .18941   .18053   .17220
44............................................................   .28025   .26603   .25273   .24027   .22860   .21766   .20740   .19777   .18873   .18023
45............................................................   .28987   .27555   .26212   .24953   .23772   .22664   .21622   .20644   .19724   .18858
46............................................................   .29976   .28533   .27179   .25908   .24714   .23591   .22536   .21542   .20606   .19725
47............................................................   .30987   .29535   .28171   .26889   .25682   .24546   .23476   .22468   .21518   .20621
48............................................................   .32023   .30563   .29190   .27897   .26678   .25530   .24447   .23425   .22460   .21549
49............................................................   .33082   .31615   .30234   .28931   .27702   .26543   .25447   .24412   .23434   .22509
50............................................................   .34166   .32694   .31306   .29995   .28756   .27586   .26479   .25432   .24441   .23502
51............................................................   .35274   .33798   .32404   .31085   .29838   .28658   .27541   .26482   .25479   .24528
52............................................................   .36402   .34924   .33525   .32200   .30946   .29757   .28630   .27561   .26547   .25584
53............................................................   .37550   .36070   .34668   .33339   .32078   .30882   .29746   .28667   .27643   .26669
54............................................................   .38717   .37237   .35833   .34500   .33234   .32031   .30888   .29801   .28766   .27782
55............................................................   .39903   .38424   .37019   .35683   .34413   .33205   .32056   .30961   .29918   .28925
56............................................................   .41108   .39631   .38227   .36890   .35617   .34405   .33250   .32149   .31099   .30097
57............................................................   .42330   .40857   .39455   .38118   .36844   .35629   .34469   .33363   .32306   .31297
58............................................................   .43566   .42098   .40699   .39364   .38089   .36873   .35710   .34600   .33538   .32522
59............................................................   .44811   .43351   .41956   .40623   .39350   .38133   .36968   .35855   .34789   .33768
60............................................................   .46066   .44613   .43224   .41896   .40624   .39408   .38243   .37127   .36058   .35033
61............................................................   .47330   .45887   .44505   .43182   .41914   .40699   .39535   .38418   .37347   .36318
62............................................................   .48608   .47175   .45802   .44485   .43223   .42011   .40848   .39732   .38660   .37629
63............................................................   .49898   .48478   .47115   .45807   .44550   .43343   .42184   .41069   .39997   .38966
64............................................................   .51200   .49793   .48442   .47143   .45895   .44694   .43539   .42427   .41357   .40326
65............................................................   .52512   .51121   .49782   .48495   .47255   .46062   .44912   .43805   .42738   .41709
66............................................................   .53835   .52461   .51137   .49862   .48634   .47449   .46307   .45206   .44143   .43118
67............................................................   .55174   .53818   .52511   .51250   .50034   .48860   .47727   .46633   .45576   .44556
68............................................................   .56524   .55188   .53899   .52654   .51452   .50291   .49168   .48083   .47034   .46020

[[Page 105]]

 
69............................................................   .57882   .56568   .55299   .54071   .52885   .51737   .50627   .49552   .48513   .47506
70............................................................   .59242   .57951   .56703   .55495   .54325   .53193   .52096   .51034   .50004   .49007
71............................................................   .60598   .59332   .58106   .56918   .55767   .54651   .53569   .52520   .51503   .50516
72............................................................   .61948   .60707   .59504   .58338   .57206   .56108   .55043   .54009   .53004   .52029
73............................................................   .63287   .62073   .60895   .59751   .58640   .57561   .56513   .55495   .54505   .53543
74............................................................   .64621   .63435   .62282   .61162   .60073   .59015   .57985   .56984   .56009   .55061
75............................................................   .65953   .64796   .63671   .62575   .61510   .60473   .59463   .58480   .57523   .56591
76............................................................   .67287   .66160   .65063   .63995   .62954   .61940   .60952   .59989   .59050   .58135
77............................................................   .68622   .67526   .66459   .65419   .64404   .63415   .62450   .61509   .60590   .59694
78............................................................   .69954   .68892   .67856   .66845   .65858   .64895   .63955   .63036   .62140   .61264
79............................................................   .71278   .70250   .69246   .68265   .67308   .66372   .65457   .64563   .63690   .62836
80............................................................   .72581   .71588   .70618   .69668   .68740   .67833   .66945   .66077   .65227   .64396
81............................................................   .73857   .72899   .71962   .71045   .70147   .69268   .68408   .67566   .66741   .65933
82............................................................   .75101   .74178   .73274   .72389   .71522   .70672   .69840   .69024   .68225   .67441
83............................................................   .76311   .75423   .74553   .73700   .72864   .72044   .71240   .70451   .69678   .68919
84............................................................   .77497   .76645   .75809   .74988   .74183   .73393   .72618   .71857   .71110   .70377
85............................................................   .78665   .77848   .77047   .76260   .75487   .74728   .73982   .73250   .72530   .71823
86............................................................   .79805   .79025   .78258   .77504   .76764   .76036   .75320   .74617   .73925   .73245
87............................................................   .80904   .80159   .79427   .78706   .77998   .77301   .76615   .75940   .75277   .74624
88............................................................   .81962   .81251   .80552   .79865   .79188   .78521   .77865   .77220   .76584   .75958
89............................................................   .82978   .82302   .81636   .80980   .80335   .79699   .79072   .78455   .77847   .77248
90............................................................   .83952   .83309   .82676   .82052   .81437   .80831   .80234   .79645   .79064   .78492
91............................................................   .84870   .84260   .83658   .83064   .82479   .81902   .81332   .80771   .80217   .79671
92............................................................   .85716   .85136   .84563   .83998   .83441   .82891   .82348   .81812   .81283   .80761
93............................................................   .86494   .85942   .85396   .84858   .84326   .83801   .83283   .82771   .82266   .81767
94............................................................   .87216   .86690   .86170   .85657   .85149   .84648   .84153   .83664   .83181   .82704
95............................................................   .87898   .87397   .86902   .86412   .85928   .85450   .84977   .84510   .84049   .83592
96............................................................   .88537   .88060   .87587   .87121   .86659   .86203   .85751   .85305   .84864   .84427
97............................................................   .89127   .88672   .88221   .87775   .87335   .86898   .86467   .86040   .85618   .85200
98............................................................   .89680   .89245   .88815   .88389   .87968   .87551   .87138   .86730   .86326   .85926
99............................................................   .90217   .89803   .89393   .88987   .88585   .88187   .87793   .87402   .87016   .86633
100...........................................................   .90738   .90344   .89953   .89567   .89183   .88804   .88428   .88056   .87687   .87322
101...........................................................   .91250   .90876   .90504   .90137   .89772   .89412   .89054   .88699   .88348   .88000
102...........................................................   .91751   .91396   .91045   .90696   .90350   .90007   .89668   .89331   .88997   .88666
103...........................................................   .92247   .91912   .91579   .91249   .90922   .90598   .90276   .89957   .89640   .89326
104...........................................................   .92775   .92460   .92148   .91839   .91532   .91227   .90924   .90624   .90326   .90031
105...........................................................   .93290   .92996   .92704   .92415   .92127   .91841   .91558   .91276   .90997   .90719
106...........................................................   .93948   .93680   .93415   .93151   .92889   .92628   .92370   .92113   .91857   .91604
107...........................................................   .94739   .94504   .94271   .94039   .93808   .93579   .93351   .93124   .92899   .92675
108...........................................................   .95950   .95767   .95585   .95404   .95224   .95045   .94867   .94689   .94512   .94336
109...........................................................   .97985   .97893   .97801   .97710   .97619   .97529   .97438   .97348   .97259   .97170
--------------------------------------------------------------------------------------------------------------------------------------------------------


                                             Table S--Based on Life Table 90CM Single Life Remainder Factors
                                                [Applicable After April 30, 1999, and Before May 1, 2009]
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                      Interest rate
                              Age                              -----------------------------------------------------------------------------------------
                                                                  6.2%     6.4%     6.6%     6.8%     7.0%     7.2%     7.4%     7.6%     7.8%     8.0%
--------------------------------------------------------------------------------------------------------------------------------------------------------
0.............................................................   .03034   .02857   .02700   .02559   .02433   .02321   .02220   .02129   .02047   .01973
1.............................................................   .02279   .02094   .01929   .01782   .01650   .01533   .01427   .01331   .01246   .01168
2.............................................................   .02347   .02155   .01983   .01829   .01692   .01569   .01458   .01358   .01268   .01187
3.............................................................   .02444   .02243   .02065   .01905   .01761   .01632   .01516   .01412   .01317   .01232
4.............................................................   .02558   .02349   .02163   .01996   .01846   .01712   .01590   .01481   .01382   .01292
5.............................................................   .02686   .02469   .02275   .02101   .01945   .01804   .01677   .01562   .01458   .01364
6.............................................................   .02825   .02600   .02398   .02217   .02053   .01906   .01773   .01653   .01544   .01445
7.............................................................   .02976   .02742   .02532   .02343   .02172   .02019   .01880   .01754   .01640   .01536
8.............................................................   .03137   .02894   .02675   .02479   .02301   .02140   .01995   .01864   .01744   .01635
9.............................................................   .03311   .03059   .02832   .02627   .02442   .02274   .02122   .01985   .01859   .01745
10............................................................   .03499   .03237   .03001   .02788   .02595   .02420   .02262   .02118   .01987   .01867
11............................................................   .03700   .03428   .03183   .02961   .02760   .02578   .02413   .02262   .02125   .02000
12............................................................   .03913   .03632   .03377   .03146   .02937   .02748   .02575   .02418   .02275   .02144
13............................................................   .04135   .03843   .03579   .03339   .03122   .02924   .02744   .02580   .02431   .02294
14............................................................   .04359   .04057   .03783   .03534   .03308   .03102   .02915   .02744   .02587   .02444
15............................................................   .04584   .04270   .03986   .03728   .03493   .03279   .03083   .02905   .02742   .02593
16............................................................   .04806   .04482   .04187   .03919   .03674   .03452   .03248   .03063   .02892   .02736
17............................................................   .05029   .04692   .04387   .04108   .03855   .03623   .03411   .03218   .03040   .02877
18............................................................   .05253   .04905   .04588   .04299   .04036   .03795   .03574   .03373   .03187   .03017

[[Page 106]]

 
19............................................................   .05484   .05124   .04796   .04496   .04222   .03972   .03742   .03532   .03339   .03161
20............................................................   .05726   .05354   .05013   .04702   .04418   .04158   .03919   .03700   .03498   .03313
21............................................................   .05980   .05595   .05242   .04920   .04625   .04354   .04105   .03877   .03667   .03473
22............................................................   .06246   .05847   .05482   .05147   .04841   .04559   .04301   .04063   .03844   .03642
23............................................................   .06524   .06112   .05734   .05387   .05069   .04777   .04508   .04260   .04032   .03821
24............................................................   .06819   .06392   .06001   .05642   .05312   .05008   .04728   .04470   .04232   .04012
25............................................................   .07131   .06690   .06285   .05913   .05570   .05255   .04964   .04695   .04447   .04218
26............................................................   .07460   .07005   .06586   .06200   .05845   .05518   .05215   .04936   .04677   .04438
27............................................................   .07810   .07340   .06907   .06508   .06140   .05800   .05485   .05195   .04925   .04676
28............................................................   .08179   .07693   .07246   .06833   .06451   .06098   .05772   .05469   .05189   .04929
29............................................................   .08566   .08065   .07603   .07176   .06780   .06414   .06075   .05761   .05469   .05198
30............................................................   .08973   .08456   .07978   .07536   .07127   .06748   .06396   .06069   .05766   .05483
31............................................................   .09398   .08865   .08372   .07915   .07491   .07098   .06733   .06394   .06078   .05785
32............................................................   .09843   .09294   .08785   .08313   .07875   .07468   .07089   .06737   .06409   .06103
33............................................................   .10310   .09745   .09220   .08732   .08279   .07858   .07466   .07100   .06759   .06441
34............................................................   .10799   .10217   .09676   .09173   .08705   .08269   .07862   .07483   .07129   .06798
35............................................................   .11314   .10715   .10157   .09638   .09155   .08704   .08283   .07890   .07522   .07179
36............................................................   .11852   .11236   .10662   .10127   .09628   .09162   .08726   .08319   .07938   .07581
37............................................................   .12416   .11783   .11193   .10641   .10126   .09645   .09194   .08772   .08377   .08006
38............................................................   .13009   .12359   .11751   .11183   .10652   .10155   .09689   .09253   .08843   .08459
39............................................................   .13629   .12962   .12338   .11753   .11206   .10693   .10212   .09761   .09337   .08938
40............................................................   .14281   .13597   .12955   .12355   .11791   .11262   .10766   .10299   .09860   .09447
41............................................................   .14966   .14264   .13606   .12989   .12409   .11864   .11352   .10870   .10417   .09989
42............................................................   .15685   .14966   .14291   .13657   .13061   .12500   .11972   .11475   .11006   .10564
43............................................................   .16437   .15702   .15010   .14360   .13747   .13171   .12627   .12115   .11631   .11174
44............................................................   .17224   .16472   .15764   .15098   .14469   .13876   .13317   .12789   .12290   .11819
45............................................................   .18042   .17274   .16550   .15867   .15223   .14615   .14040   .13496   .12982   .12496
46............................................................   .18893   .18110   .17370   .16671   .16011   .15387   .14796   .14238   .13708   .13207
47............................................................   .19775   .18975   .18220   .17505   .16830   .16190   .15584   .15010   .14466   .13950
48............................................................   .20688   .19873   .19102   .18373   .17682   .17027   .16406   .15817   .15258   .14727
49............................................................   .21633   .20804   .20018   .19274   .18568   .17898   .17262   .16658   .16084   .15539
50............................................................   .22612   .21769   .20969   .20210   .19490   .18805   .18155   .17536   .16948   .16388
51............................................................   .23625   .22769   .21955   .21182   .20448   .19749   .19084   .18452   .17849   .17275
52............................................................   .24669   .23799   .22973   .22186   .21438   .20726   .20047   .19400   .18784   .18196
53............................................................   .25742   .24861   .24022   .23222   .22461   .21735   .21043   .20383   .19753   .19151
54............................................................   .26845   .25952   .25101   .24290   .23516   .22777   .22072   .21399   .20756   .20140
55............................................................   .27978   .27074   .26212   .25389   .24604   .23853   .23136   .22450   .21793   .21166
56............................................................   .29140   .28227   .27355   .26522   .25725   .24963   .24233   .23535   .22867   .22227
57............................................................   .30333   .29411   .28529   .27686   .26879   .26106   .25365   .24656   .23976   .23324
58............................................................   .31551   .30621   .29731   .28878   .28061   .27278   .26528   .25807   .25116   .24453
59............................................................   .32790   .31854   .30956   .30095   .29269   .28477   .27716   .26986   .26284   .25610
60............................................................   .34050   .33107   .32202   .31334   .30500   .29699   .28929   .28190   .27478   .26794
61............................................................   .35331   .34384   .33473   .32598   .31757   .30948   .30170   .29422   .28701   .28007
62............................................................   .36639   .35688   .34772   .33892   .33044   .32229   .31443   .30687   .29958   .29255
63............................................................   .37974   .37020   .36101   .35216   .34363   .33542   .32750   .31986   .31250   .30539
64............................................................   .39334   .38378   .37456   .36568   .35711   .34884   .34087   .33317   .32574   .31857
65............................................................   .40718   .39761   .38838   .37947   .37087   .36257   .35455   .34681   .33932   .33208
66............................................................   .42128   .41172   .40249   .39357   .38496   .37663   .36858   .36079   .35326   .34597
67............................................................   .43569   .42616   .41694   .40803   .39941   .39107   .38299   .37518   .36761   .36028
68............................................................   .45038   .44089   .43170   .42281   .41419   .40585   .39777   .38994   .38235   .37499
69............................................................   .46531   .45587   .44672   .43786   .42927   .42094   .41286   .40503   .39743   .39006
70............................................................   .48040   .47103   .46194   .45312   .44456   .43626   .42820   .42038   .41278   .40540
71............................................................   .49558   .48629   .47727   .46851   .46000   .45174   .44371   .43591   .42832   .42095
72............................................................   .51082   .50162   .49268   .48399   .47554   .46733   .45934   .45157   .44401   .43666
73............................................................   .52607   .51697   .50813   .49952   .49114   .48299   .47506   .46733   .45981   .45249
74............................................................   .54139   .53241   .52367   .51515   .50686   .49879   .49092   .48325   .47578   .46849
75............................................................   .55683   .54798   .53936   .53095   .52276   .51477   .50698   .49938   .49197   .48474
76............................................................   .57243   .56373   .55524   .54696   .53888   .53100   .52330   .51579   .50846   .50130
77............................................................   .58819   .57965   .57132   .56318   .55523   .54747   .53988   .53247   .52523   .51815
78............................................................   .60408   .59572   .58755   .57957   .57177   .56414   .55668   .54939   .54225   .53527
79............................................................   .62001   .61184   .60385   .59604   .58840   .58092   .57360   .56644   .55943   .55256
80............................................................   .63582   .62786   .62007   .61244   .60497   .59765   .59048   .58347   .57659   .56985
81............................................................   .65142   .64367   .63608   .62864   .62135   .61421   .60721   .60034   .59361   .58701
82............................................................   .66673   .65920   .65182   .64458   .63748   .63052   .62368   .61698   .61041   .60395
83............................................................   .68175   .67444   .66728   .66024   .65334   .64656   .63991   .63338   .62696   .62066
84............................................................   .69657   .68950   .68256   .67574   .66904   .66246   .65599   .64964   .64340   .63727
85............................................................   .71128   .70446   .69775   .69116   .68467   .67830   .67204   .66587   .65982   .65386
86............................................................   .72576   .71919   .71272   .70636   .70010   .69394   .68789   .68193   .67606   .67029
87............................................................   .73981   .73349   .72726   .72114   .71511   .70917   .70333   .69757   .69190   .68632

[[Page 107]]

 
88............................................................   .75342   .74735   .74137   .73548   .72968   .72396   .71833   .71279   .70732   .70194
89............................................................   .76658   .76076   .75503   .74938   .74381   .73832   .73290   .72757   .72231   .71712
90............................................................   .77928   .77371   .76823   .76281   .75748   .75221   .74702   .74190   .73684   .73186
91............................................................   .79131   .78600   .78075   .77557   .77046   .76542   .76044   .75553   .75068   .74589
92............................................................   .80246   .79737   .79235   .78740   .78250   .77767   .77290   .76818   .76353   .75893
93............................................................   .81274   .80788   .80307   .79832   .79363   .78899   .78441   .77989   .77542   .77100
94............................................................   .82232   .81766   .81306   .80850   .80401   .79956   .79517   .79082   .78653   .78228
95............................................................   .83141   .82695   .82254   .81818   .81387   .80961   .80539   .80122   .79710   .79302
96............................................................   .83996   .83569   .83147   .82729   .82316   .81907   .81503   .81103   .80707   .80315
97............................................................   .84787   .84378   .83973   .83573   .83176   .82784   .82396   .82012   .81632   .81255
98............................................................   .85530   .85138   .84750   .84366   .83985   .83609   .83236   .82867   .82502   .82140
99............................................................   .86255   .85880   .85508   .85140   .84776   .84415   .84057   .83703   .83353   .83005
100...........................................................   .86960   .86601   .86246   .85894   .85546   .85200   .84858   .84519   .84183   .83849
101...........................................................   .87655   .87313   .86974   .86638   .86305   .85975   .85648   .85324   .85003   .84684
102...........................................................   .88338   .88012   .87689   .87369   .87052   .86738   .86426   .86116   .85809   .85505
103...........................................................   .89015   .88706   .88399   .88095   .87793   .87494   .87197   .86903   .86611   .86321
104...........................................................   .89737   .89446   .89157   .88871   .88586   .88304   .88024   .87745   .87469   .87195
105...........................................................   .90443   .90170   .89898   .89628   .89360   .89094   .88830   .88568   .88307   .88049
106...........................................................   .91351   .91101   .90852   .90605   .90359   .90115   .89873   .89632   .89392   .89154
107...........................................................   .92452   .92230   .92010   .91791   .91573   .91356   .91141   .90927   .90714   .90502
108...........................................................   .94161   .93987   .93814   .93641   .93469   .93298   .93128   .92958   .92790   .92622
109...........................................................   .97081   .96992   .96904   .96816   .96729   .96642   .96555   .96468   .96382   .96296
--------------------------------------------------------------------------------------------------------------------------------------------------------


                                             Table S--Based on Life Table 90CM Single Life Remainder Factors
                                                [Applicable After April 30, 1999, and Before May 1, 2009]
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                      Interest rate
                              Age                              -----------------------------------------------------------------------------------------
                                                                  8.2%     8.4%     8.6%     8.8%     9.0%     9.2%     9.4%     9.6%     9.8%    10.0%
--------------------------------------------------------------------------------------------------------------------------------------------------------
0.............................................................   .01906   .01845   .01790   .01740   .01694   .01652   .01613   .01578   .01546   .01516
1.............................................................   .01098   .01034   .00977   .00924   .00876   .00833   .00793   .00756   .00722   .00691
2.............................................................   .01113   .01046   .00986   .00930   .00880   .00834   .00791   .00753   .00717   .00684
3.............................................................   .01155   .01084   .01020   .00962   .00909   .00860   .00816   .00775   .00737   .00702
4.............................................................   .01211   .01137   .01069   .01008   .00952   .00900   .00853   .00810   .00770   .00733
5.............................................................   .01279   .01201   .01130   .01065   .01006   .00952   .00902   .00856   .00814   .00775
6.............................................................   .01356   .01274   .01199   .01131   .01068   .01011   .00959   .00910   .00865   .00824
7.............................................................   .01442   .01356   .01277   .01205   .01140   .01079   .01023   .00972   .00925   .00881
8.............................................................   .01536   .01446   .01363   .01287   .01218   .01154   .01096   .01041   .00991   .00945
9.............................................................   .01641   .01546   .01460   .01380   .01307   .01240   .01178   .01120   .01068   .01019
10............................................................   .01758   .01659   .01567   .01484   .01407   .01336   .01270   .01210   .01154   .01103
11............................................................   .01886   .01781   .01686   .01598   .01517   .01442   .01373   .01310   .01251   .01196
12............................................................   .02024   .01915   .01814   .01721   .01636   .01558   .01485   .01419   .01357   .01299
13............................................................   .02168   .02054   .01948   .01851   .01762   .01679   .01603   .01533   .01467   .01407
14............................................................   .02313   .02193   .02083   .01981   .01887   .01801   .01721   .01646   .01578   .01514
15............................................................   .02456   .02330   .02214   .02107   .02009   .01918   .01834   .01756   .01684   .01617
16............................................................   .02593   .02462   .02340   .02229   .02126   .02030   .01942   .01860   .01785   .01714
17............................................................   .02728   .02590   .02463   .02346   .02238   .02138   .02046   .01960   .01880   .01806
18............................................................   .02861   .02717   .02584   .02462   .02348   .02243   .02146   .02056   .01972   .01894
19............................................................   .02998   .02847   .02708   .02580   .02461   .02351   .02249   .02154   .02066   .01984
20............................................................   .03142   .02984   .02839   .02704   .02580   .02465   .02357   .02258   .02165   .02079
21............................................................   .03295   .03130   .02978   .02837   .02706   .02585   .02473   .02368   .02271   .02180
22............................................................   .03455   .03283   .03124   .02976   .02839   .02712   .02594   .02484   .02382   .02286
23............................................................   .03626   .03446   .03279   .03124   .02981   .02847   .02723   .02608   .02500   .02400
24............................................................   .03809   .03620   .03446   .03283   .03133   .02993   .02863   .02741   .02628   .02522
25............................................................   .04005   .03808   .03625   .03456   .03298   .03151   .03014   .02887   .02768   .02656
26............................................................   .04216   .04010   .03819   .03641   .03476   .03322   .03178   .03044   .02919   .02802
27............................................................   .04444   .04229   .04029   .03843   .03670   .03508   .03357   .03217   .03085   .02962
28............................................................   .04687   .04463   .04254   .04059   .03877   .03708   .03550   .03402   .03263   .03133
29............................................................   .04946   .04712   .04493   .04289   .04099   .03922   .03756   .03600   .03455   .03318
30............................................................   .05221   .04976   .04748   .04534   .04335   .04149   .03975   .03812   .03659   .03515
31............................................................   .05511   .05255   .05017   .04794   .04585   .04390   .04208   .04037   .03876   .03725
32............................................................   .05818   .05551   .05302   .05069   .04851   .04647   .04455   .04276   .04107   .03948
33............................................................   .06144   .05866   .05606   .05363   .05135   .04921   .04720   .04532   .04355   .04188
34............................................................   .06489   .06200   .05928   .05674   .05436   .05212   .05002   .04805   .04619   .04444
35............................................................   .06857   .06555   .06273   .06007   .05758   .05524   .05304   .05097   .04902   .04718
36............................................................   .07246   .06932   .06638   .06361   .06101   .05856   .05626   .05409   .05205   .05012
37............................................................   .07659   .07332   .07025   .06737   .06466   .06210   .05969   .05742   .05528   .05325

[[Page 108]]

 
38............................................................   .08098   .07758   .07439   .07138   .06855   .06588   .06336   .06099   .05874   .05662
39............................................................   .08563   .08210   .07878   .07565   .07270   .06992   .06729   .06480   .06245   .06023
40............................................................   .09059   .08692   .08347   .08021   .07714   .07423   .07149   .06889   .06643   .06411
41............................................................   .09586   .09206   .08848   .08509   .08189   .07886   .07600   .07329   .07072   .06828
42............................................................   .10147   .09753   .09381   .09029   .08696   .08381   .08083   .07800   .07531   .07277
43............................................................   .10742   .10334   .09948   .09583   .09237   .08909   .08598   .08304   .08024   .07758
44............................................................   .11373   .10950   .10551   .10172   .09813   .09472   .09148   .08841   .08549   .08272
45............................................................   .12035   .11599   .11185   .10792   .10420   .10066   .09730   .09410   .09106   .08817
46............................................................   .12732   .12281   .11853   .11447   .11061   .10694   .10345   .10013   .09696   .09395
47............................................................   .13460   .12995   .12553   .12133   .11733   .11353   .10991   .10646   .10317   .10004
48............................................................   .14223   .13743   .13287   .12853   .12439   .12046   .11671   .11313   .10972   .10646
49............................................................   .15020   .14526   .14056   .13608   .13181   .12774   .12385   .12015   .11661   .11322
50............................................................   .15855   .15347   .14862   .14401   .13960   .13540   .13138   .12754   .12388   .12037
51............................................................   .16727   .16205   .15707   .15232   .14777   .14344   .13929   .13532   .13153   .12789
52............................................................   .17634   .17098   .16587   .16097   .15630   .15183   .14755   .14345   .13953   .13577
53............................................................   .18576   .18027   .17501   .16999   .16518   .16057   .15616   .15194   .14789   .14400
54............................................................   .19552   .18990   .18451   .17935   .17441   .16968   .16514   .16078   .15661   .15260
55............................................................   .20564   .19989   .19437   .18908   .18402   .17915   .17449   .17001   .16571   .16157
56............................................................   .21613   .21025   .20461   .19919   .19400   .18901   .18422   .17962   .17519   .17093
57............................................................   .22698   .22098   .21522   .20968   .20436   .19925   .19434   .18961   .18507   .18069
58............................................................   .23816   .23204   .22616   .22051   .21507   .20984   .20481   .19996   .19530   .19080
59............................................................   .24962   .24339   .23740   .23163   .22608   .22073   .21558   .21062   .20584   .20123
60............................................................   .26136   .25502   .24892   .24304   .23738   .23192   .22666   .22158   .21669   .21196
61............................................................   .27339   .26695   .26075   .25477   .24900   .24343   .23806   .23288   .22787   .22304
62............................................................   .28578   .27925   .27295   .26687   .26100   .25533   .24985   .24456   .23945   .23451
63............................................................   .29854   .29192   .28553   .27935   .27339   .26762   .26205   .25666   .25145   .24641
64............................................................   .31164   .30494   .29846   .29221   .28615   .28030   .27463   .26915   .26384   .25870
65............................................................   .32508   .31831   .31177   .30543   .29930   .29336   .28761   .28203   .27663   .27140
66............................................................   .33891   .33208   .32547   .31906   .31285   .30684   .30101   .29536   .28987   .28456
67............................................................   .35318   .34630   .33963   .33316   .32689   .32081   .31491   .30918   .30363   .29823
68............................................................   .36785   .36093   .35422   .34770   .34138   .33524   .32928   .32349   .31787   .31240
69............................................................   .38290   .37595   .36920   .36265   .35628   .35009   .34408   .33824   .33256   .32703
70............................................................   .39823   .39127   .38450   .37791   .37151   .36529   .35924   .35335   .34762   .34204
71............................................................   .41378   .40681   .40003   .39343   .38701   .38076   .37467   .36875   .36298   .35736
72............................................................   .42950   .42253   .41575   .40914   .40271   .39644   .39034   .38438   .37858   .37293
73............................................................   .44535   .43840   .43162   .42502   .41858   .41231   .40619   .40022   .39440   .38872
74............................................................   .46139   .45446   .44771   .44112   .43469   .42842   .42230   .41632   .41049   .40479
75............................................................   .47769   .47080   .46408   .45752   .45111   .44485   .43874   .43277   .42693   .42123
76............................................................   .49430   .48747   .48079   .47427   .46790   .46167   .45558   .44963   .44380   .43811
77............................................................   .51123   .50447   .49786   .49139   .48506   .47888   .47282   .46690   .46111   .45543
78............................................................   .52845   .52177   .51523   .50884   .50257   .49645   .49044   .48457   .47881   .47317
79............................................................   .54584   .53926   .53282   .52650   .52032   .51426   .50833   .50251   .49681   .49122
80............................................................   .56325   .55678   .55044   .54423   .53813   .53216   .52630   .52056   .51492   .50939
81............................................................   .58054   .57419   .56797   .56186   .55587   .54999   .54422   .53856   .53300   .52754
82............................................................   .59762   .59140   .58530   .57931   .57343   .56766   .56198   .55641   .55094   .54557
83............................................................   .61448   .60840   .60243   .59657   .59081   .58515   .57958   .57411   .56874   .56346
84............................................................   .63124   .62531   .61949   .61376   .60813   .60259   .59715   .59179   .58652   .58134
85............................................................   .64800   .64224   .63657   .63099   .62550   .62010   .61478   .60955   .60441   .59934
86............................................................   .66461   .65902   .65351   .64810   .64276   .63751   .63233   .62724   .62222   .61728
87............................................................   .68083   .67541   .67008   .66483   .65965   .65455   .64953   .64458   .63970   .63489
88............................................................   .69663   .69140   .68624   .68116   .67615   .67121   .66634   .66154   .65680   .65213
89............................................................   .71201   .70696   .70199   .69708   .69224   .68747   .68276   .67811   .67353   .66900
90............................................................   .72694   .72209   .71730   .71257   .70791   .70330   .69876   .69427   .68984   .68547
91............................................................   .74117   .73650   .73190   .72735   .72286   .71842   .71404   .70972   .70545   .70123
92............................................................   .75439   .74991   .74548   .74110   .73678   .73251   .72829   .72412   .72000   .71593
93............................................................   .76664   .76233   .75806   .75385   .74969   .74557   .74150   .73748   .73350   .72957
94............................................................   .77809   .77394   .76983   .76578   .76177   .75780   .75388   .75000   .74616   .74237
95............................................................   .78899   .78500   .78106   .77715   .77329   .76947   .76569   .76195   .75826   .75460
96............................................................   .79928   .79544   .79165   .78790   .78418   .78050   .77686   .77326   .76970   .76617
97............................................................   .80883   .80514   .80149   .79787   .79430   .79075   .78725   .78377   .78033   .77693
98............................................................   .81781   .81427   .81075   .80727   .80382   .80041   .79703   .79368   .79036   .78708
99............................................................   .82661   .82320   .81982   .81648   .81316   .80988   .80662   .80340   .80020   .79704
100...........................................................   .83519   .83192   .82868   .82547   .82228   .81913   .81600   .81290   .80982   .80678
101...........................................................   .84368   .84055   .83744   .83437   .83131   .82829   .82529   .82231   .81936   .81643
102...........................................................   .85203   .84904   .84607   .84313   .84021   .83731   .83444   .83159   .82876   .82596
103...........................................................   .86034   .85748   .85465   .85184   .84906   .84629   .84355   .84082   .83812   .83544
104...........................................................   .86923   .86653   .86385   .86119   .85855   .85593   .85333   .85074   .84818   .84563
105...........................................................   .87792   .87537   .87283   .87032   .86782   .86534   .86287   .86042   .85799   .85557
106...........................................................   .88918   .88683   .88450   .88218   .87987   .87758   .87530   .87304   .87079   .86855

[[Page 109]]

 
107...........................................................   .90291   .90082   .89873   .89666   .89460   .89255   .89051   .88849   .88647   .88447
108...........................................................   .92455   .92288   .92123   .91958   .91794   .91630   .91468   .91306   .91145   .90984
109...........................................................   .96211   .96125   .96041   .95956   .95872   .95788   .95704   .95620   .95537   .95455
--------------------------------------------------------------------------------------------------------------------------------------------------------


                                             Table S--Based on Life Table 90CM Single Life Remainder Factors
                                                [Applicable After April 30, 1999, and Before May 1, 2009]
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                      Interest rate
                              Age                              -----------------------------------------------------------------------------------------
                                                                 10.2%    10.4%    10.6%    10.8%    11.0%    11.2%    11.4%    11.6%    11.8%    12.0%
--------------------------------------------------------------------------------------------------------------------------------------------------------
0.............................................................   .01488   .01463   .01439   .01417   .01396   .01377   .01359   .01343   .01327   .01312
1.............................................................   .00662   .00636   .00612   .00589   .00568   .00548   .00530   .00513   .00497   .00482
2.............................................................   .00654   .00626   .00600   .00576   .00554   .00533   .00514   .00496   .00479   .00463
3.............................................................   .00670   .00641   .00613   .00588   .00564   .00542   .00522   .00502   .00484   .00468
4.............................................................   .00699   .00668   .00639   .00612   .00587   .00563   .00542   .00521   .00502   .00484
5.............................................................   .00739   .00706   .00675   .00646   .00620   .00595   .00571   .00550   .00529   .00510
6.............................................................   .00786   .00751   .00718   .00687   .00659   .00633   .00608   .00585   .00563   .00543
7.............................................................   .00841   .00803   .00769   .00736   .00706   .00678   .00652   .00627   .00604   .00582
8.............................................................   .00902   .00863   .00826   .00791   .00759   .00730   .00702   .00675   .00651   .00628
9.............................................................   .00973   .00931   .00892   .00856   .00822   .00790   .00760   .00733   .00706   .00682
10............................................................   .01055   .01010   .00969   .00930   .00894   .00861   .00829   .00799   .00772   .00746
11............................................................   .01146   .01099   .01055   .01014   .00976   .00940   .00907   .00875   .00846   .00818
12............................................................   .01246   .01196   .01150   .01106   .01066   .01028   .00993   .00960   .00928   .00899
13............................................................   .01351   .01298   .01249   .01204   .01161   .01121   .01084   .01049   .01016   .00985
14............................................................   .01455   .01400   .01348   .01300   .01255   .01213   .01173   .01136   .01102   .01069
15............................................................   .01555   .01497   .01443   .01392   .01345   .01300   .01259   .01220   .01183   .01148
16............................................................   .01648   .01587   .01530   .01477   .01427   .01380   .01336   .01295   .01257   .01220
17............................................................   .01737   .01673   .01612   .01556   .01504   .01455   .01408   .01365   .01324   .01286
18............................................................   .01822   .01754   .01691   .01632   .01576   .01525   .01476   .01430   .01387   .01347
19............................................................   .01908   .01837   .01770   .01708   .01650   .01595   .01544   .01495   .01450   .01407
20............................................................   .01999   .01924   .01854   .01788   .01726   .01669   .01615   .01564   .01516   .01471
21............................................................   .02096   .02017   .01943   .01874   .01809   .01748   .01691   .01637   .01586   .01539
22............................................................   .02197   .02114   .02036   .01963   .01895   .01830   .01770   .01713   .01660   .01610
23............................................................   .02306   .02218   .02136   .02059   .01987   .01919   .01855   .01795   .01739   .01686
24............................................................   .02424   .02331   .02245   .02163   .02087   .02016   .01948   .01885   .01825   .01769
25............................................................   .02552   .02455   .02364   .02278   .02197   .02122   .02051   .01984   .01920   .01861
26............................................................   .02692   .02589   .02493   .02403   .02318   .02238   .02162   .02091   .02025   .01961
27............................................................   .02846   .02738   .02636   .02541   .02451   .02367   .02287   .02212   .02141   .02074
28............................................................   .03012   .02898   .02791   .02690   .02595   .02506   .02422   .02342   .02267   .02196
29............................................................   .03190   .03070   .02957   .02851   .02751   .02656   .02567   .02483   .02404   .02329
30............................................................   .03381   .03254   .03135   .03023   .02917   .02817   .02723   .02634   .02551   .02471
31............................................................   .03583   .03450   .03324   .03206   .03094   .02989   .02890   .02796   .02707   .02623
32............................................................   .03799   .03659   .03527   .03402   .03284   .03173   .03068   .02968   .02874   .02785
33............................................................   .04031   .03883   .03744   .03612   .03488   .03371   .03260   .03155   .03055   .02961
34............................................................   .04279   .04123   .03976   .03838   .03707   .03583   .03465   .03354   .03249   .03149
35............................................................   .04545   .04382   .04227   .04081   .03943   .03812   .03688   .03571   .03459   .03354
36............................................................   .04830   .04658   .04495   .04341   .04196   .04058   .03927   .03803   .03685   .03573
37............................................................   .05134   .04953   .04782   .04620   .04467   .04321   .04183   .04052   .03928   .03809
38............................................................   .05462   .05272   .05092   .04921   .04760   .04606   .04461   .04322   .04191   .04066
39............................................................   .05812   .05613   .05424   .05245   .05075   .04913   .04760   .04614   .04475   .04343
40............................................................   .06190   .05981   .05782   .05594   .05415   .05245   .05083   .04929   .04783   .04643
41............................................................   .06597   .06378   .06170   .05972   .05784   .05605   .05435   .05272   .05118   .04970
42............................................................   .07035   .06806   .06587   .06380   .06182   .05994   .05815   .05644   .05481   .05326
43............................................................   .07505   .07265   .07036   .06818   .06611   .06414   .06225   .06045   .05874   .05710
44............................................................   .08008   .07757   .07518   .07290   .07072   .06865   .06667   .06478   .06298   .06125
45............................................................   .08542   .08279   .08029   .07791   .07563   .07346   .07138   .06940   .06750   .06569
46............................................................   .09108   .08834   .08573   .08324   .08085   .07858   .07640   .07432   .07233   .07043
47............................................................   .09705   .09419   .09147   .08886   .08637   .08399   .08172   .07954   .07745   .07545
48............................................................   .10335   .10038   .09754   .09482   .09222   .08973   .08735   .08507   .08288   .08078
49............................................................   .10999   .10690   .10394   .10111   .09840   .09581   .09332   .09093   .08864   .08644
50............................................................   .11701   .11380   .11073   .10778   .10496   .10225   .09965   .09716   .09477   .09247
51............................................................   .12441   .12108   .11789   .11482   .11189   .10907   .10636   .10376   .10126   .09886
52............................................................   .13217   .12871   .12540   .12222   .11916   .11623   .11341   .11071   .10810   .10560
53............................................................   .14028   .13670   .13327   .12997   .12680   .12375   .12082   .11801   .11529   .11268
54............................................................   .14875   .14505   .14150   .13808   .13480   .13163   .12859   .12566   .12284   .12012
55............................................................   .15760   .15378   .15011   .14657   .14317   .13989   .13674   .13370   .13077   .12794
56............................................................   .16684   .16290   .15911   .15546   .15194   .14855   .14528   .14213   .13909   .13615

[[Page 110]]

 
57............................................................   .17648   .17242   .16851   .16474   .16111   .15760   .15422   .15096   .14781   .14477
58............................................................   .18647   .18229   .17827   .17438   .17064   .16702   .16353   .16015   .15689   .15374
59............................................................   .19678   .19249   .18835   .18435   .18049   .17676   .17316   .16968   .16631   .16305
60............................................................   .20740   .20300   .19875   .19464   .19066   .18682   .18311   .17952   .17604   .17268
61............................................................   .21837   .21385   .20949   .20527   .20119   .19724   .19341   .18971   .18613   .18266
62............................................................   .22973   .22511   .22064   .21631   .21212   .20807   .20414   .20033   .19664   .19306
63............................................................   .24152   .23680   .23222   .22779   .22350   .21934   .21530   .21139   .20760   .20392
64............................................................   .25372   .24890   .24422   .23969   .23529   .23103   .22690   .22289   .21899   .21521
65............................................................   .26633   .26141   .25664   .25201   .24752   .24316   .23893   .23482   .23083   .22695
66............................................................   .27940   .27439   .26953   .26481   .26023   .25577   .25145   .24724   .24316   .23918
67............................................................   .29299   .28790   .28296   .27815   .27348   .26894   .26453   .26024   .25606   .25200
68............................................................   .30709   .30193   .29691   .29202   .28728   .28265   .27816   .27378   .26952   .26537
69............................................................   .32166   .31643   .31134   .30639   .30157   .29687   .29230   .28785   .28351   .27928
70............................................................   .33661   .33133   .32618   .32116   .31628   .31152   .30688   .30235   .29794   .29364
71............................................................   .35188   .34654   .34134   .33627   .33133   .32651   .32181   .31722   .31275   .30838
72............................................................   .36742   .36204   .35679   .35168   .34668   .34181   .33706   .33241   .32788   .32345
73............................................................   .38317   .37776   .37248   .36733   .36229   .35738   .35257   .34788   .34330   .33882
74............................................................   .39923   .39380   .38849   .38330   .37823   .37328   .36844   .36370   .35908   .35455
75............................................................   .41566   .41021   .40489   .39968   .39459   .38961   .38474   .37997   .37531   .37074
76............................................................   .43254   .42709   .42176   .41655   .41144   .40645   .40156   .39677   .39208   .38749
77............................................................   .44988   .44444   .43912   .43391   .42880   .42380   .41891   .41411   .40940   .40479
78............................................................   .46765   .46224   .45694   .45174   .44665   .44166   .43677   .43197   .42726   .42265
79............................................................   .48574   .48037   .47510   .46993   .46487   .45990   .45502   .45024   .44554   .44094
80............................................................   .50397   .49865   .49343   .48830   .48327   .47834   .47349   .46873   .46406   .45947
81............................................................   .52219   .51693   .51176   .50669   .50171   .49682   .49201   .48729   .48265   .47809
82............................................................   .54029   .53510   .53000   .52499   .52007   .51523   .51047   .50580   .50120   .49667
83............................................................   .55826   .55315   .54813   .54319   .53834   .53356   .52886   .52424   .51969   .51522
84............................................................   .57624   .57123   .56629   .56144   .55666   .55195   .54732   .54277   .53828   .53386
85............................................................   .59435   .58944   .58460   .57984   .57516   .57054   .56599   .56151   .55710   .55275
86............................................................   .61241   .60762   .60289   .59824   .59365   .58913   .58468   .58029   .57596   .57170
87............................................................   .63015   .62548   .62087   .61633   .61185   .60744   .60309   .59880   .59456   .59039
88............................................................   .64753   .64299   .63851   .63409   .62973   .62543   .62118   .61700   .61287   .60879
89............................................................   .66454   .66013   .65579   .65150   .64726   .64308   .63895   .63488   .63086   .62689
90............................................................   .68115   .67689   .67268   .66853   .66442   .66037   .65637   .65241   .64851   .64465
91............................................................   .69706   .69294   .68887   .68486   .68089   .67696   .67309   .66925   .66547   .66173
92............................................................   .71190   .70792   .70399   .70011   .69627   .69247   .68872   .68501   .68134   .67771
93............................................................   .72569   .72184   .71804   .71429   .71057   .70689   .70326   .69967   .69611   .69259
94............................................................   .73861   .73490   .73123   .72759   .72400   .72044   .71692   .71344   .71000   .70659
95............................................................   .75097   .74739   .74384   .74033   .73686   .73342   .73002   .72665   .72331   .72001
96............................................................   .76267   .75922   .75579   .75240   .74905   .74572   .74243   .73917   .73595   .73275
97............................................................   .77356   .77022   .76691   .76363   .76039   .75718   .75399   .75084   .74772   .74463
98............................................................   .78382   .78059   .77740   .77423   .77110   .76799   .76491   .76186   .75884   .75584
99............................................................   .79390   .79079   .78771   .78465   .78162   .77862   .77565   .77270   .76978   .76688
100...........................................................   .80376   .80076   .79779   .79485   .79193   .78904   .78617   .78333   .78051   .77771
101...........................................................   .81353   .81066   .80780   .80497   .80217   .79938   .79662   .79388   .79117   .78847
102...........................................................   .82318   .82042   .81768   .81496   .81227   .80960   .80694   .80431   .80170   .79911
103...........................................................   .83278   .83014   .82752   .82491   .82233   .81977   .81723   .81470   .81220   .80971
104...........................................................   .84310   .84059   .83810   .83563   .83317   .83073   .82831   .82591   .82352   .82115
105...........................................................   .85318   .85079   .84843   .84607   .84374   .84142   .83911   .83682   .83455   .83229
106...........................................................   .86633   .86413   .86193   .85975   .85758   .85543   .85329   .85116   .84904   .84694
107...........................................................   .88247   .88049   .87852   .87656   .87460   .87266   .87073   .86881   .86690   .86500
108...........................................................   .90825   .90666   .90507   .90350   .90193   .90037   .89881   .89727   .89572   .89419
109...........................................................   .95372   .95290   .95208   .95126   .95045   .94964   .94883   .94803   .94723   .94643
--------------------------------------------------------------------------------------------------------------------------------------------------------


                                             Table S--Based on Life Table 90CM Single Life Remainder Factors
                                                [Applicable After April 30, 1999, and Before May 1, 2009]
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                      Interest rate
                              Age                              -----------------------------------------------------------------------------------------
                                                                 12.2%    12.4%    12.6%    12.8%    13.0%    13.2%    13.4%    13.6%    13.8%    14.0%
--------------------------------------------------------------------------------------------------------------------------------------------------------
0.............................................................   .01298   .01285   .01273   .01261   .01250   .01240   .01230   .01221   .01212   .01203
1.............................................................   .00468   .00455   .00443   .00431   .00420   .00410   .00400   .00391   .00382   .00374
2.............................................................   .00448   .00435   .00421   .00409   .00398   .00387   .00376   .00366   .00357   .00348
3.............................................................   .00452   .00437   .00423   .00410   .00398   .00386   .00375   .00365   .00355   .00345
4.............................................................   .00468   .00452   .00437   .00423   .00410   .00397   .00386   .00375   .00364   .00354
5.............................................................   .00493   .00476   .00460   .00445   .00431   .00418   .00405   .00393   .00382   .00371
6.............................................................   .00524   .00506   .00489   .00473   .00458   .00444   .00430   .00418   .00406   .00394

[[Page 111]]

 
7.............................................................   .00562   .00543   .00525   .00508   .00492   .00477   .00462   .00449   .00436   .00423
8.............................................................   .00606   .00586   .00566   .00548   .00531   .00515   .00499   .00485   .00471   .00458
9.............................................................   .00659   .00637   .00616   .00597   .00579   .00561   .00545   .00529   .00514   .00500
10............................................................   .00721   .00698   .00676   .00655   .00636   .00617   .00600   .00583   .00567   .00552
11............................................................   .00792   .00767   .00744   .00722   .00701   .00682   .00663   .00645   .00628   .00612
12............................................................   .00871   .00845   .00821   .00797   .00775   .00754   .00735   .00716   .00698   .00681
13............................................................   .00955   .00928   .00902   .00877   .00854   .00831   .00810   .00790   .00771   .00753
14............................................................   .01038   .01009   .00981   .00955   .00930   .00907   .00885   .00864   .00843   .00824
15............................................................   .01116   .01085   .01056   .01028   .01002   .00977   .00954   .00932   .00910   .00890
16............................................................   .01186   .01153   .01123   .01094   .01066   .01040   .01015   .00992   .00969   .00948
17............................................................   .01250   .01215   .01183   .01152   .01124   .01096   .01070   .01045   .01022   .00999
18............................................................   .01308   .01272   .01238   .01206   .01175   .01147   .01119   .01093   .01068   .01044
19............................................................   .01367   .01329   .01293   .01259   .01227   .01196   .01167   .01140   .01113   .01088
20............................................................   .01428   .01388   .01350   .01314   .01280   .01248   .01217   .01188   .01161   .01134
21............................................................   .01494   .01451   .01411   .01373   .01337   .01303   .01271   .01240   .01211   .01183
22............................................................   .01562   .01517   .01475   .01435   .01397   .01361   .01326   .01294   .01263   .01233
23............................................................   .01635   .01588   .01543   .01501   .01460   .01422   .01386   .01351   .01319   .01287
24............................................................   .01716   .01665   .01618   .01573   .01530   .01489   .01451   .01415   .01380   .01347
25............................................................   .01804   .01751   .01701   .01653   .01608   .01565   .01524   .01485   .01448   .01413
26............................................................   .01902   .01845   .01792   .01741   .01693   .01648   .01604   .01563   .01524   .01487
27............................................................   .02011   .01951   .01895   .01841   .01790   .01742   .01696   .01652   .01610   .01571
28............................................................   .02129   .02066   .02006   .01949   .01895   .01844   .01795   .01748   .01704   .01662
29............................................................   .02258   .02191   .02127   .02067   .02009   .01955   .01903   .01853   .01806   .01762
30............................................................   .02396   .02325   .02257   .02193   .02132   .02074   .02019   .01966   .01916   .01869
31............................................................   .02543   .02467   .02396   .02328   .02263   .02201   .02143   .02087   .02034   .01983
32............................................................   .02701   .02621   .02545   .02472   .02404   .02338   .02276   .02217   .02160   .02106
33............................................................   .02871   .02786   .02706   .02629   .02556   .02487   .02420   .02357   .02297   .02240
34............................................................   .03054   .02964   .02879   .02797   .02720   .02646   .02576   .02509   .02445   .02383
35............................................................   .03253   .03158   .03067   .02981   .02898   .02820   .02745   .02674   .02606   .02541
36............................................................   .03467   .03366   .03269   .03178   .03090   .03007   .02928   .02852   .02779   .02710
37............................................................   .03697   .03590   .03488   .03391   .03298   .03209   .03125   .03044   .02967   .02893
38............................................................   .03947   .03833   .03725   .03622   .03524   .03430   .03340   .03254   .03172   .03094
39............................................................   .04217   .04096   .03982   .03873   .03768   .03669   .03573   .03482   .03395   .03312
40............................................................   .04510   .04383   .04262   .04146   .04035   .03930   .03828   .03732   .03639   .03550
41............................................................   .04830   .04695   .04567   .04445   .04327   .04215   .04108   .04005   .03907   .03812
42............................................................   .05177   .05035   .04900   .04770   .04646   .04527   .04413   .04304   .04200   .04100
43............................................................   .05553   .05404   .05261   .05123   .04992   .04866   .04746   .04630   .04520   .04413
44............................................................   .05960   .05802   .05651   .05506   .05368   .05235   .05107   .04985   .04867   .04754
45............................................................   .06395   .06229   .06069   .05917   .05770   .05630   .05495   .05365   .05241   .05121
46............................................................   .06860   .06685   .06517   .06356   .06202   .06053   .05911   .05774   .05643   .05516
47............................................................   .07353   .07169   .06992   .06823   .06660   .06504   .06353   .06209   .06070   .05936
48............................................................   .07877   .07684   .07498   .07320   .07149   .06984   .06826   .06673   .06527   .06385
49............................................................   .08433   .08231   .08036   .07849   .07669   .07495   .07329   .07168   .07013   .06864
50............................................................   .09026   .08814   .08609   .08413   .08224   .08042   .07867   .07698   .07535   .07378
51............................................................   .09655   .09433   .09219   .09013   .08815   .08624   .08440   .08262   .08091   .07926
52............................................................   .10318   .10086   .09863   .09647   .09439   .09239   .09046   .08860   .08680   .08506
53............................................................   .11017   .10774   .10541   .10315   .10098   .09888   .09686   .09491   .09302   .09120
54............................................................   .11750   .11498   .11254   .11019   .10792   .10572   .10361   .10156   .09958   .09767
55............................................................   .12522   .12258   .12005   .11759   .11522   .11294   .11072   .10859   .10652   .10451
56............................................................   .13332   .13059   .12794   .12539   .12292   .12054   .11823   .11599   .11383   .11174
57............................................................   .14183   .13899   .13624   .13359   .13102   .12853   .12613   .12380   .12154   .11936
58............................................................   .15070   .14775   .14490   .14215   .13948   .13689   .13439   .13197   .12962   .12734
59............................................................   .15990   .15685   .15389   .15103   .14826   .14558   .14298   .14046   .13801   .13564
60............................................................   .16942   .16626   .16321   .16024   .15737   .15459   .15189   .14927   .14673   .14426
61............................................................   .17929   .17603   .17287   .16981   .16684   .16395   .16115   .15844   .15580   .15324
62............................................................   .18960   .18623   .18297   .17980   .17673   .17375   .17085   .16803   .16530   .16264
63............................................................   .20035   .19688   .19352   .19025   .18708   .18400   .18100   .17809   .17525   .17250
64............................................................   .21154   .20797   .20451   .20114   .19787   .19469   .19159   .18859   .18566   .18281
65............................................................   .22318   .21951   .21595   .21249   .20912   .20584   .20265   .19955   .19652   .19358
66............................................................   .23532   .23156   .22790   .22434   .22088   .21751   .21422   .21102   .20791   .20487
67............................................................   .24804   .24419   .24044   .23679   .23324   .22977   .22640   .22311   .21990   .21678
68............................................................   .26133   .25740   .25356   .24983   .24618   .24263   .23917   .23579   .23250   .22929
69............................................................   .27516   .27114   .26723   .26341   .25969   .25605   .25251   .24905   .24567   .24237
70............................................................   .28945   .28536   .28137   .27747   .27367   .26996   .26633   .26279   .25934   .25596
71............................................................   .30412   .29996   .29590   .29193   .28806   .28427   .28057   .27696   .27343   .26998
72............................................................   .31913   .31491   .31078   .30675   .30281   .29895   .29519   .29150   .28790   .28438
73............................................................   .33444   .33016   .32597   .32188   .31788   .31396   .31013   .30638   .30271   .29913
74............................................................   .35012   .34579   .34155   .33741   .33335   .32938   .32549   .32168   .31795   .31430
75............................................................   .36628   .36190   .35762   .35343   .34932   .34530   .34136   .33750   .33372   .33001

[[Page 112]]

 
76............................................................   .38299   .37858   .37427   .37004   .36589   .36183   .35784   .35394   .35011   .34636
77............................................................   .40028   .39585   .39151   .38725   .38307   .37898   .37496   .37103   .36716   .36337
78............................................................   .41812   .41368   .40933   .40506   .40086   .39675   .39271   .38874   .38485   .38103
79............................................................   .43641   .43198   .42762   .42334   .41914   .41502   .41096   .40698   .40308   .39924
80............................................................   .45496   .45054   .44619   .44192   .43772   .43360   .42954   .42556   .42164   .41779
81............................................................   .47360   .46920   .46487   .46061   .45643   .45231   .44827   .44429   .44038   .43653
82............................................................   .49223   .48785   .48355   .47932   .47516   .47106   .46703   .46307   .45916   .45532
83............................................................   .51081   .50648   .50221   .49802   .49388   .48982   .48581   .48187   .47799   .47416
84............................................................   .52951   .52523   .52101   .51686   .51277   .50874   .50477   .50086   .49701   .49321
85............................................................   .54847   .54425   .54009   .53600   .53196   .52798   .52406   .52019   .51638   .51262
86............................................................   .56749   .56335   .55926   .55523   .55126   .54734   .54348   .53966   .53591   .53220
87............................................................   .58627   .58221   .57820   .57425   .57035   .56650   .56270   .55895   .55526   .55161
88............................................................   .60477   .60079   .59688   .59301   .58919   .58542   .58170   .57802   .57439   .57081
89............................................................   .62297   .61909   .61527   .61149   .60776   .60408   .60044   .59685   .59330   .58979
90............................................................   .64084   .63707   .63335   .62968   .62604   .62246   .61891   .61540   .61194   .60851
91............................................................   .65803   .65437   .65076   .64719   .64366   .64017   .63672   .63330   .62993   .62659
92............................................................   .67412   .67058   .66707   .66360   .66017   .65678   .65342   .65010   .64682   .64357
93............................................................   .68911   .68567   .68227   .67890   .67557   .67227   .66901   .66578   .66258   .65942
94............................................................   .70321   .69988   .69657   .69330   .69006   .68686   .68369   .68055   .67744   .67437
95............................................................   .71674   .71351   .71031   .70713   .70399   .70088   .69781   .69476   .69174   .68875
96............................................................   .72959   .72646   .72335   .72028   .71724   .71422   .71123   .70828   .70534   .70244
97............................................................   .74156   .73853   .73552   .73254   .72959   .72666   .72376   .72089   .71804   .71522
98............................................................   .75287   .74993   .74702   .74413   .74126   .73842   .73561   .73282   .73006   .72732
99............................................................   .76401   .76117   .75834   .75555   .75277   .75002   .74730   .74459   .74191   .73926
100...........................................................   .77494   .77219   .76946   .76676   .76408   .76142   .75878   .75616   .75357   .75099
101...........................................................   .78580   .78315   .78052   .77791   .77532   .77275   .77021   .76768   .76517   .76268
102...........................................................   .79654   .79399   .79146   .78894   .78645   .78397   .78152   .77908   .77666   .77426
103...........................................................   .80724   .80479   .80236   .79994   .79755   .79517   .79280   .79046   .78813   .78582
104...........................................................   .81879   .81646   .81413   .81183   .80954   .80726   .80501   .80276   .80054   .79832
105...........................................................   .83005   .82782   .82560   .82340   .82121   .81904   .81688   .81474   .81260   .81049
106...........................................................   .84485   .84277   .84071   .83866   .83662   .83459   .83257   .83057   .82857   .82659
107...........................................................   .86311   .86124   .85937   .85751   .85566   .85382   .85199   .85017   .84835   .84655
108...........................................................   .89266   .89114   .88963   .88812   .88662   .88513   .88364   .88216   .88068   .87922
109...........................................................   .94563   .94484   .94405   .94326   .94248   .94170   .94092   .94014   .93937   .93860
--------------------------------------------------------------------------------------------------------------------------------------------------------

    (7) Effective/applicability dates. Paragraphs (f)(1) through (f)(6) 
apply after April 30, 1999, and before May 1, 2009.

[Redesignated at 36 FR 6480, Apr. 6, 1971 as amended by T.D. 8540, 59 FR 
30102, 30105, 30116, June 10, 1994; T.D. 8819, 64 FR 23190, 23199, 
23228, Apr. 30, 1999; 64 FR 33196, June 22, 1999; T.D. 8886, 65 FR 
36943, June 12, 2000; T.D. 9448, 74 FR 21440, 21464, May 7, 2009; T.D. 
9540, 76 FR 49612, Aug. 10, 2011]

              Election to Treat Trust as Part of an Estate



Sec. 1.645-1  Election by certain revocable trusts to be treated as part of estate.

    (a) In general. If an election is filed for a qualified revocable 
trust, as defined in paragraph (b)(1) of this section, in accordance 
with the rules set forth in paragraph (c) of this section, the qualified 
revocable trust is treated and taxed for purposes of subtitle A of the 
Internal Revenue Code as part of its related estate, as defined in 
paragraph (b)(5) of this section (and not as a separate trust) during 
the election period, as defined in paragraph (b)(6) of this section. 
Rules regarding the use of taxpayer identification numbers (TINs) and 
the filing of a Form 1041, ``U.S. Income Tax Return for Estates and 
Trusts,'' for a qualified revocable trust are in paragraph (d) of this 
section. Rules regarding the tax treatment of an electing trust and 
related estate and the general filing requirements for the combined 
entity during the election period are in paragraph (e)(2) of this 
section. Rules regarding the tax treatment of an electing trust and its 
filing requirements during the election period if no executor, as 
defined in paragraph (b)(4) of this section, is appointed for a related 
estate are in paragraph

[[Page 113]]

(e)(3) of this section. Rules for determining the duration of the 
section 645 election period are in paragraph (f) of this section. Rules 
regarding the tax effects of the termination of the election are in 
paragraph (h) of this section. Rules regarding the tax consequences of 
the appointment of an executor after a trustee has made a section 645 
election believing that an executor would not be appointed for a related 
estate are in paragraph (g) of this section.
    (b) Definitions. For purposes of this section:
    (1) Qualified revocable trust. A qualified revocable trust (QRT) is 
any trust (or portion thereof) that on the date of death of the decedent 
was treated as owned by the decedent under section 676 by reason of a 
power held by the decedent (determined without regard to section 
672(e)). A trust that was treated as owned by the decedent under section 
676 by reason of a power that was exercisable by the decedent only with 
the approval or consent of a nonadverse party or with the approval or 
consent of the decedent's spouse is a QRT. A trust that was treated as 
owned by the decedent under section 676 solely by reason of a power held 
by a nonadverse party or by reason of a power held by the decedent's 
spouse is not a QRT.
    (2) Electing trust. An electing trust is a QRT for which a valid 
section 645 election has been made. Once a section 645 election has been 
made for the trust, the trust shall be treated as an electing trust 
throughout the entire election period.
    (3) Decedent. The decedent is the individual who was treated as the 
owner of the QRT under section 676 on the date of that individual's 
death.
    (4) Executor. An executor is an executor, personal representative, 
or administrator that has obtained letters of appointment to administer 
the decedent's estate through formal or informal appointment procedures. 
Solely for purposes of this paragraph (b)(4), an executor does not 
include a person that has actual or constructive possession of property 
of the decedent unless that person is also appointed or qualified as an 
executor, administrator, or personal representative of the decedent's 
estate. If more than one jurisdiction has appointed an executor, the 
executor appointed in the domiciliary or primary proceeding is the 
executor of the related estate for purposes of this paragraph (b)(4).
    (5) Related estate. A related estate is the estate of the decedent 
who was treated as the owner of the QRT on the date of the decedent's 
death.
    (6) Election period. The election period is the period of time 
during which an electing trust is treated and taxed as part of its 
related estate. The rules for determining the duration of the election 
period are in paragraph (f) of this section.
    (c) The election--(1) Filing the election if there is an executor--
(i) Time and manner for filing the election. If there is an executor of 
the related estate, the trustees of each QRT joining in the election and 
the executor of the related estate make an election under section 645 
and this section to treat each QRT joining in the election as part of 
the related estate for purposes of subtitle A of the Internal Revenue 
Code by filing a form provided by the IRS for making the election 
(election form) properly completed and signed under penalties of 
perjury, or in any other manner prescribed after December 24, 2002 by 
forms provided by the Internal Revenue Service (IRS), or by other 
published guidance for making the election. For the election to be 
valid, the election form must be filed not later than the time 
prescribed under section 6072 for filing the Form 1041 for the first 
taxable year of the related estate (regardless of whether there is 
sufficient income to require the filing of that return). If an extension 
is granted for the filing of the Form 1041 for the first taxable year of 
the related estate, the election form will be timely filed if it is 
filed by the time prescribed for filing the Form 1041 including the 
extension granted with respect to the Form 1041.
    (ii) Conditions to election. In addition to providing the 
information required by the election form, as a condition to a valid 
section 645 election, the trustee of each QRT joining in the election 
and the executor of the related estate agree, by signing the election 
form under penalties of perjury, that:
    (A) With respect to a trustee--

[[Page 114]]

    (1) The trustee agrees to the election;
    (2) The trustee is responsible for timely providing the executor of 
the related estate with all the trust information necessary to permit 
the executor to file a complete, accurate, and timely Form 1041 for the 
combined electing trust(s) and related estate for each taxable year 
during the election period;
    (3) The trustee of each QRT joining the election and the executor of 
the related estate have agreed to allocate the tax burden of the 
combined electing trust(s) and related estate for each taxable year 
during the election period in a manner that reasonably reflects the tax 
obligations of each electing trust and the related estate; and
    (4) The trustee is responsible for insuring that the electing 
trust's share of the tax obligations of the combined electing trust(s) 
and related estate is timely paid to the Secretary.
    (B) With respect to the executor--
    (1) The executor agrees to the election;
    (2) The executor is responsible for filing a complete, accurate, and 
timely Form 1041 for the combined electing trust(s) and related estate 
for each taxable year during the election period;
    (3) The executor and the trustee of each QRT joining in the election 
have agreed to allocate the tax burden of the combined electing trust(s) 
and related estate for each taxable year during the election period in a 
manner that reasonably reflects the tax obligations of each electing 
trust and the related estate;
    (4) The executor is responsible for insuring that the related 
estate's share of the tax obligations of the combined electing trust(s) 
and related estate is timely paid to the Secretary.
    (2) Filing the election if there is no executor--(i) Time and manner 
for filing the election. If there is no executor for a related estate, 
an election to treat one or more QRTs of the decedent as an estate for 
purposes of subtitle A of the Internal Revenue Code is made by the 
trustees of each QRT joining in the election, by filing a properly 
completed election form, or in any other manner prescribed after 
December 24, 2002 by forms provided by the IRS, or by other published 
guidance for making the election. For the election to be valid, the 
election form must be filed not later than the time prescribed under 
section 6072 for filing the Form 1041 for the first taxable year of the 
trust, taking into account the trustee's election to treat the trust as 
an estate under section 645 (regardless of whether there is sufficient 
income to require the filing of that return). If an extension is granted 
for the filing of the Form 1041 for the first taxable year of the 
electing trust, the election form will be timely filed if it is filed by 
the time prescribed for filing the Form 1041 including the extension 
granted with respect to the filing of the Form 1041.
    (ii) Conditions to election. In addition to providing the 
information required by the election form, as a condition to a valid 
section 645 election, the trustee of each QRT joining in the election 
agrees, by signing the election form under penalties of perjury, that--
    (A) The trustee agrees to the election;
    (B) If there is more than one QRT joining in the election, the 
trustees of each QRT joining in the election have appointed one trustee 
to be responsible for filing the Form 1041 for the combined electing 
trusts for each taxable year during the election period (filing trustee) 
and the filing trustee has agreed to accept that responsibility;
    (C) If there is more than one QRT, the trustees of each QRT joining 
in the election have agreed to allocate the tax liability of the 
combined electing trusts for each taxable year during the election 
period in a manner that reasonably reflects the tax obligations of each 
electing trust;
    (D) The trustee agrees to:
    (1) Timely file a Form 1041 for the electing trust(s) for each 
taxable year during the election period; or
    (2) If there is more than one QRT and the trustee is not the filing 
trustee, timely provide the filing trustee with all of the electing 
trust's information necessary to permit the filing trustee to file a 
complete, accurate, and timely Form 1041 for the combined electing 
trusts for each taxable year during the election period;
    (3) Insure that the electing trust's share of the tax burden is 
timely paid to the Secretary;

[[Page 115]]

    (E) There is no executor and, to the knowledge and belief of the 
trustee, one will not be appointed; and
    (F) If an executor is appointed after the filing of the election 
form and the executor agrees to the section 645 election, the trustee 
will complete and file a revised election form with the executor.
    (3) Election for more than one QRT. If there is more than one QRT, 
the election may be made for some or all of the QRTs. If there is no 
executor, one trustee must be appointed by the trustees of the electing 
trusts to file Forms 1041 for the combined electing trusts filing as an 
estate during the election period.
    (d) TIN and filing requirements for a QRT--(1) Obtaining a TIN. 
Regardless of whether there is an executor for a related estate and 
regardless of whether a section 645 election will be made for the QRT, a 
TIN must be obtained for the QRT following the death of the decedent. 
See Sec. 301.6109-1(a)(3) of this chapter. The trustee must furnish 
this TIN to the payors of the QRT. See Sec. 301.6109-1(a)(5) of this 
chapter for the definition of payor.
    (2) Filing a Form 1041 for a QRT--(i) Option not to file a Form 1041 
for a QRT for which a section 645 election will be made. If a section 
645 election will be made for a QRT, the executor of the related estate, 
if any, and the trustee of the QRT may treat the QRT as an electing 
trust from the decedent's date of death until the due date for the 
section 645 election. Accordingly, the trustee of the QRT is not 
required to file a Form 1041 for the QRT for the short taxable year 
beginning with the decedent's date of death and ending December 31 of 
that year. However, if a QRT is treated as an electing trust under this 
paragraph from the decedent's date of death until the due date for the 
section 645 election but a valid section 645 election is not made for 
the QRT, the QRT will be subject to penalties and interest for failing 
to timely file a Form 1041 and pay the tax due thereon.
    (ii) Requirement to file a Form 1041 for a QRT if paragraph 
(d)(2)(i) of this section does not apply--(A) Requirement to file Form 
1041. If the trustee of the QRT and the executor of the related estate, 
if any, do not treat the QRT as an electing trust as provided under 
paragraph (d)(2)(i) of this section, or if the trustee of the electing 
trust and the executor, if any, are uncertain whether a section 645 
election will be made for a QRT, the trustee of the QRT must file a Form 
1041 for the short taxable year beginning with the decedent's death and 
ending December 31 of that year (unless the QRT is not required to file 
a Form 1041 under section 6012 for this period).
    (B) Requirement to amend Form 1041 if a section 645 election is 
made--(1) If there is an executor. If there is an executor and a valid 
section 645 election is made for a QRT after a Form 1041 has been filed 
for the QRT as a trust (see paragraph (d)(2)(ii)(A) of this section), 
the trustee must amend the Form 1041. The QRT's items of income, 
deduction, and credit must be excluded from the amended Form 1041 filed 
under this paragraph and must be included on the Form 1041 filed for the 
first taxable year of the combined electing trust and related estate 
under paragraph (e)(2)(ii)(A) of this section.
    (2) If there is no executor. If there is no executor and a valid 
section 645 election is made for a QRT after a Form 1041 has been filed 
for the QRT as a trust (see paragraph (d)(2)(ii)(A) of this section) for 
the short taxable year beginning with the decedent's death and ending 
December 31 of that year, the trustee must file an amended return for 
the QRT. The amended return must be filed consistent with paragraph 
(e)(3) of this section and must be filed by the due date of the Form 
1041 for the QRT, taking into account the trustee's election under 
section 645.
    (e) Tax treatment and general filing requirements of electing trust 
and related estate during the election period--(1) Effect of election. 
The section 645 election once made is irrevocable.
    (2) If there is an executor--(i) Tax treatment of the combined 
electing trust and related estate. If there is an executor, the electing 
trust is treated, during the election period, as part of the related 
estate for all purposes of subtitle A of the Internal Revenue Code. 
Thus, for example, the electing trust is treated as part of the related 
estate for purposes of the set-aside deduction under

[[Page 116]]

section 642(c)(2), the subchapter S shareholder requirements of section 
1361(b)(1), and the special offset for rental real estate activities in 
section 469(i)(4).
    (ii) Filing requirements--(A) Filing the Form 1041 for the combined 
electing trust and related estate during the election period. If there 
is an executor, the executor files a single income tax return annually 
(assuming a return is required under section 6012) under the name and 
TIN of the related estate for the combined electing trust and the 
related estate. Information regarding the name and TIN of each electing 
trust must be provided on the Form 1041 as required by the instructions 
to that form. The period of limitations provided in section 6501 for 
assessments with respect to an electing trust and the related estate 
starts with the filing of the return required under this paragraph. 
Except as required under the separate share rules of section 663(c), for 
purposes of filing the Form 1041 under this paragraph and computing the 
tax, the items of income, deduction, and credit of the electing trust 
and related estate are combined. One personal exemption in the amount of 
$600 is permitted under section 642(b), and the tax is computed under 
section 1(e), taking into account section 1(h), for the combined taxable 
income.
    (B) Filing a Form 1041 for the electing trust is not required. 
Except for any final Form 1041 required to be filed under paragraph 
(h)(2)(i)(B) of this section, if there is an executor, the trustee of 
the electing trust does not file a Form 1041 for the electing trust 
during the election period. Although the trustee is not required to file 
a Form 1041 for the electing trust, the trustee of the electing trust 
must timely provide the executor of the related estate with all the 
trust information necessary to permit the executor to file a complete, 
accurate and timely Form 1041 for the combined electing trust and 
related estate. The trustee must also insure that the electing trust's 
share of the tax obligations of the combined electing trust and related 
estate is timely paid to the Secretary. In certain situations, the 
trustee of a QRT may be required to file a Form 1041 for the QRT's short 
taxable year beginning with the date of the decedent's death and ending 
December 31 of that year. See paragraph (d)(2) of this section.
    (iii) Application of the separate share rules--(A) Distributions to 
beneficiaries (other than to a share (or shares) of the combined 
electing trust and related estate). Under the separate share rules of 
section 663(c), the electing trust and related estate are treated as 
separate shares for purposes of computing distributable net income (DNI) 
and applying the distribution provisions of sections 661 and 662. 
Further, the electing trust share or the related estate share may each 
contain two or more shares. Thus, if during the taxable year, a 
distribution is made by the electing trust or the related estate, the 
DNI of the share making the distribution must be determined and the 
distribution provisions of sections 661 and 662 must be applied using 
the separately determined DNI applicable to the distributing share.
    (B) Adjustments to the DNI of the separate shares for distributions 
between shares to which sections 661 and 662 would apply. A distribution 
from one share to another share to which sections 661 and 662 would 
apply if made to a beneficiary other than another share of the combined 
electing trust and related estate affects the computation of the DNI of 
the share making the distribution and the share receiving the 
distribution. The share making the distribution reduces its DNI by the 
amount of the distribution deduction that it would be entitled to under 
section 661 (determined without regard to section 661(c)), had the 
distribution been made to another beneficiary, and, solely for purposes 
of calculating DNI, the share receiving the distribution increases its 
gross income by the same amount. The distribution has the same character 
in the hands of the recipient share as in the hands of the distributing 
share. The following example illustrates the provisions of this 
paragraph (e)(2)(iii)(B):

    Example. (i) A's will provides that, after the payment of debts, 
expenses, and taxes, the residue of A's estate is to be distributed to 
Trust, an electing trust. The sole beneficiary of Trust is C. The estate 
share has $15,000 of gross income, $5,000 of deductions, and $10,000 of 
taxable income and DNI for the taxable year based on the assets held in 
A's

[[Page 117]]

estate. During the taxable year, A's estate distributes $15,000 to 
Trust. The distribution reduces the DNI of the estate share by $10,000.
    (ii) For the same taxable year, the trust share has $25,000 of gross 
income and $5,000 of deductions. None of the modifications provided for 
under section 643(a) apply. In calculating the DNI for the trust share, 
the gross income of the trust share is increased by $10,000, the amount 
of the reduction in the DNI of the estate share as a result of the 
distribution to Trust. Thus, solely for purposes of calculating DNI, the 
trust share has gross income of $35,000, and taxable income of $30,000. 
Therefore, the trust share has $30,000 of DNI for the taxable year.
    (iii) During the same taxable year, Trust distributes $35,000 to C. 
The distribution deduction reported on the Form 1041 filed for A's 
estate and Trust is $30,000. As a result of the distribution by Trust to 
C, C must include $30,000 in gross income for the taxable year. The 
gross income reported on the Form 1041 filed for A's estate and Trust is 
$40,000.

    (iv) Application of the governing instrument requirement of section 
642(c). A deduction is allowed in computing the taxable income of the 
combined electing trust and related estate to the extent permitted under 
section 642(c) for--
    (A) Any amount of the gross income of the related estate that is 
paid or set aside during the taxable year pursuant to the terms of the 
governing instrument of the related estate for a purpose specified in 
section 170(c); and
    (B) Any amount of gross income of the electing trust that is paid or 
set aside during the taxable year pursuant to the terms of the governing 
instrument of the electing trust for a purpose specified in section 
170(c).
    (3) If there is no executor--(i) Tax treatment of the electing 
trust. If there is no executor, the trustee treats the electing trust, 
during the election period, as an estate for all purposes of subtitle A 
of the Internal Revenue Code. Thus, for example, an electing trust is 
treated as an estate for purposes of the set-aside deduction under 
section 642(c)(2), the subchapter S shareholder requirements of section 
1361(b)(1), and the special offset for rental real estate activities 
under section 469(i)(4). The trustee may also adopt a taxable year other 
than a calendar year.
    (ii) Filing the Form 1041 for the electing trust. If there is no 
executor, the trustee of the electing trust must, during the election 
period, file a Form 1041, under the TIN obtained by the trustee under 
Sec. 301.6109-1(a)(3) of this chapter upon the death of the decedent, 
treating the trust as an estate. If there is more than one electing 
trust, the Form 1041 must be filed by the filing trustee (see paragraph 
(c)(2)(ii)(B) of this section) under the name and TIN of the electing 
trust of the filing trustee. Information regarding the names and TINs of 
the other electing trusts must be provided on the Form 1041 as required 
by the instructions to that form. Any return filed in accordance with 
this paragraph shall be treated as a return filed for the electing trust 
(or trusts, if there is more than one electing trust) and not as a 
return filed for any subsequently discovered related estate. 
Accordingly, the period of limitations provided in section 6501 for 
assessments with respect to a subsequently discovered related estate 
does not start until a return is filed with respect to the related 
estate. See paragraph (g) of this section.
    (4) Application of the section 6654(l)(2) to the electing trust. 
Each electing trust and related estate (if any) is treated as a separate 
taxpayer for all purposes of subtitle F of the Internal Revenue Code, 
including, without limitation, the application of section 6654. The 
provisions of section 6654(l)(2)(A) relating to the two year exception 
to an estate's obligation to make estimated tax payments, however, will 
apply to each electing trust for which a section 645 election has been 
made.
    (f) Duration of election period--(1) In general. The election period 
begins on the date of the decedent's death and terminates on the earlier 
of the day on which both the electing trust and related estate, if any, 
have distributed all of their assets, or the day before the applicable 
date. The election does not apply to successor trusts (trusts that are 
distributees under the trust instrument).
    (2) Definition of applicable date--(i) Applicable date if no Form 
706 ``United States Estate (and Generation Skipping Transfer) Tax 
Return'' is required to be filed. If a Form 706 is not required to be 
filed as a result of the decedent's death, the applicable date is the 
day

[[Page 118]]

which is 2 years after the date of the decedent's death.
    (ii) Applicable date if a Form 706 is required to be filed. If a 
Form 706 is required to be filed as a result of the decedent's death, 
the applicable date is the later of the day that is 2 years after the 
date of the decedent's death, or the day that is 6 months after the date 
of final determination of liability for estate tax. Solely for purposes 
of determining the applicable date under section 645, the date of final 
determination of liability is the earliest of the following--
    (A) The date that is six months after the issuance by the Internal 
Revenue Service of an estate tax closing letter, unless a claim for 
refund with respect to the estate tax is filed within twelve months 
after the issuance of the letter;
    (B) The date of a final disposition of a claim for refund, as 
defined in paragraph (f)(2)(iii) of this section, that resolves the 
liability for the estate tax, unless suit is instituted within six 
months after a final disposition of the claim;
    (C) The date of execution of a settlement agreement with the 
Internal Revenue Service that determines the liability for the estate 
tax;
    (D) The date of issuance of a decision, judgment, decree, or other 
order by a court of competent jurisdiction resolving the liability for 
the estate tax unless a notice of appeal or a petition for certiorari is 
filed within 90 days after the issuance of a decision, judgment, decree, 
or other order of a court; or
    (E) The date of expiration of the period of limitations for 
assessment of the estate tax provided in section 6501.
    (iii) Definition of final disposition of claim for refund. For 
purposes of paragraph (f)(2)(ii)(B) of this section, a claim for refund 
shall be deemed finally disposed of by the Secretary when all items have 
been either allowed or disallowed. If a waiver of notification with 
respect to disallowance is filed with respect to a claim for refund 
prior to disallowance of the claim, the claim for refund will be treated 
as disallowed on the date the waiver is filed.
    (iv) Examples. The application of this paragraph (f)(2) is 
illustrated by the following examples:

    Example 1. A died on October 20, 2002. The executor of A's estate 
and the trustee of Trust, an electing trust, made a section 645 
election. A Form 706 is not required to be filed as a result of A's 
death. The applicable date is October 20, 2004, the day that is two 
years after A's date of death. The last day of the election period is 
October 19, 2004. Beginning October 20, 2004, Trust will no longer be 
treated and taxed as part of A's estate.
    Example 2. Assume the same facts as Example 1, except that a Form 
706 is required to be filed as the result of A's death. The Internal 
Revenue Service issues an estate tax closing letter accepting the Form 
706 as filed on March 15, 2005. The estate does not file a claim for 
refund by March 15, 2006, the day that is twelve months after the date 
of issuance of the estate tax closing letter. The date of final 
determination of liability is September 15, 2005, and the applicable 
date is March 15, 2006. The last day of the election period is March 14, 
2006. Beginning March 15, 2006, Trust will no longer be treated and 
taxed as part of A's estate.
    Example 3. Assume the same facts as Example 1, except that a Form 
706 is required to be filed as the result of A's death. The Form 706 is 
audited, and a notice of deficiency authorized under section 6212 is 
mailed to the executor of A's estate as a result of the audit. The 
executor files a petition in Tax Court. The Tax Court issues a decision 
resolving the liability for estate tax on December 14, 2005, and neither 
party appeals within 90 days after the issuance of the decision. The 
date of final determination of liability is December 14, 2005. The 
applicable date is June 14, 2006, the day that is six months after the 
date of final determination of liability. The last day of the election 
period is June 13, 2006. Beginning June 14, 2006, Trust will no longer 
be treated and taxed as part of A's estate.

    (g) Executor appointed after the section 645 election is made--(1) 
Effect on the election. If an executor for the related estate is not 
appointed until after the trustee has made a valid section 645 election, 
the executor must agree to the trustee's election, and the IRS must be 
notified of that agreement by the filing of a revised election form 
(completed as required by the instructions to that form) within 90 days 
of the appointment of the executor, for the election period to continue 
past the date of appointment of the executor. If the executor does not 
agree to the election or a revised election form is not timely filed as 
required by this paragraph, the election period terminates the day 
before the appointment of the

[[Page 119]]

executor. If the IRS issues other guidance after December 24, 2002 for 
notifying the IRS of the executor's agreement to the election, the IRS 
must be notified in the manner provided in that guidance for the 
election period to continue.
    (2) Continuation of election period--(i) Correction of returns filed 
before executor appointed. If the election period continues under 
paragraph (g)(1) of this section, the executor of the related estate and 
the trustee of each electing trust must file amended Forms 1041 to 
correct the Forms 1041 filed by the trustee before the executor was 
appointed. The amended Forms 1041 must be filed under the name and TIN 
of the electing trust and must reflect the items of income, deduction, 
and credit of the related estate and the electing trust. The name and 
TIN of the related estate must be provided on the amended Forms 1041 as 
required in the instructions to that Form. The amended return for the 
taxable year ending immediately before the executor was appointed must 
indicate that this Form 1041 is a final return. If the period of 
limitations for making assessments has expired with respect to the 
electing trust for any of the Forms 1041 filed by the trustee, the 
executor must file Forms 1041 for any items of income, deduction, and 
credit of the related estate that cannot be properly included on amended 
forms for the electing trust. The personal exemption under section 
642(b) is not permitted to be taken on these Forms 1041 filed by the 
executor.
    (ii) Returns filed after the appointment of the executor. All 
returns filed by the combined electing trust and related estate after 
the appointment of the executor are to be filed under the name and TIN 
of the related estate in accordance with paragraph (e)(2) of this 
section. Regardless of the change in the name and TIN under which the 
Forms 1041 for the combined electing trust and related estate are filed, 
the combined electing trust and related estate will be treated as the 
same entity before and after the executor is appointed.
    (3) Termination of the election period. If the election period 
terminates under paragraph (g)(1) of this section, the executor must 
file Forms 1041 under the name and TIN of the estate for all taxable 
years of the related estate ending after the death of the decedent. The 
trustee of the electing trust is not required to amend any returns filed 
for the electing trust during the election period. Following termination 
of the election period, the trustee of the electing trust must obtain a 
new TIN. See Sec. 301.6109-1(a)(4) of this chapter.
    (h) Treatment of an electing trust and related estate following 
termination of the election--(1) The share (or shares) comprising the 
electing trust is deemed to be distributed upon termination of the 
election period. On the close of the last day of the election period, 
the combined electing trust and related estate, if there is an executor, 
or the electing trust, if there is no executor, is deemed to distribute 
the share (or shares, as determined under section 663(c)) comprising the 
electing trust to a new trust in a distribution to which sections 661 
and 662 apply. All items of income, including net capital gains, that 
are attributable to the share (or shares) comprising the electing trust 
are included in the calculation of the distributable net income of the 
electing trust and treated as distributed by the combined electing trust 
and related estate, if there is an executor, or by the electing trust, 
if there is no executor, to the new trust. The combined electing trust 
and related estate, if there is an executor, or the electing trust, if 
there is no executor, is entitled to a distribution deduction to the 
extent permitted under section 661 in the taxable year in which the 
election period terminates as a result of the deemed distribution. The 
new trust shall include the amount of the deemed distribution in gross 
income to the extent required under section 662.
    (2) Filing of the Form 1041 upon the termination of the section 645 
election--(i) If there is an executor--(A) Filing the Form 1041 for the 
year of termination. If there is an executor, the Form 1041 filed under 
the name and TIN of the related estate for the taxable year in which the 
election terminates includes--
    (1) The items of income, deduction, and credit of the electing trust 
attributable to the period beginning with the first day of the taxable 
year of the

[[Page 120]]

combined electing trust and related estate and ending with the last day 
of the election period;
    (2) The items of income, deduction, and credit, if any, of the 
related estate for the entire taxable year; and
    (3) A deduction for the deemed distribution of the share (or shares) 
comprising the electing trust to the new trust as provided for under 
paragraph (h)(1) of this section.
    (B) Requirement to file a final Form 1041 under the name and TIN of 
the electing trust. If the electing trust terminates during the election 
period, the trustee of the electing trust must file a Form 1041 under 
the name and TIN of the electing trust and indicate that the return is a 
final return to notify the IRS that the electing trust is no longer in 
existence. The items of income, deduction, and credit of the trust are 
not reported on this final Form 1041 but on the appropriate Form 1041 
filed for the combined electing trust and related estate.
    (ii) If there is no executor. If there is no executor, the taxable 
year of the electing trust closes on the last day of the election 
period. A Form 1041 is filed in the manner prescribed under paragraph 
(e)(3)(ii) of this section reporting the items of income, deduction, and 
credit of the electing trust for the short period ending with the last 
day of the election period. The Form 1041 filed under this paragraph 
includes a distribution deduction for the deemed distribution provided 
for under paragraph (h)(1) of this section. The Form 1041 must indicate 
that it is a final return.
    (3) Use of TINs following termination of the election--(i) If there 
is an executor. Upon termination of the section 645 election, a former 
electing trust may need to obtain a new TIN. See Sec. 301.6109-1(a)(4) 
of this chapter. If the related estate continues after the termination 
of the election period, the related estate must continue to use the TIN 
assigned to the estate during the election period.
    (ii) If there is no executor. If there is no executor, the former 
electing trust must obtain a new TIN if the trust will continue after 
the termination of the election period. See Sec. 301.6109-1(a)(4) of 
this chapter.
    (4) Taxable year of estate and trust upon termination of the 
election--(i) Estate--Upon termination of the section 645 election 
period, the taxable year of the estate is the same taxable year used 
during the election period.
    (ii) Trust. Upon termination of the section 645 election, the 
taxable year of the new trust is the calendar year. See section 644.
    (i) [Reserved]
    (j) Effective date. Paragraphs (a), (b), (c), (d), (f), and (g) of 
this section apply to trusts and estates of decedents dying on or after 
December 24, 2002. Paragraphs (e) and (h) of this section apply to 
taxable years ending on or after December 24, 2002.

[T.D. 9032, 67 FR 78377, Dec. 24, 2002]

               trusts which distribute current income only



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

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

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

[[Page 121]]



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

    (a) The determination of whether trust income is required to be 
distributed currently depends upon the terms of the trust instrument and 
the applicable local law. For this purpose, if the trust instrument 
provides that the trustee in determining the distributable income shall 
first retain a reserve for depreciation or otherwise make due allowance 
for keeping the trust corpus intact by retaining a reasonable amount of 
the current income for that purpose, the retention of current income for 
that purpose will not disqualify the trust from being a ``simple'' 
trust. The fiduciary must be under a duty to distribute the income 
currently even if, as a matter of practical necessity, the income is not 
distributed until after the close of the trust's taxable year. For 
example: Under the terms of the trust instrument, all of the income is 
currently distributable to A. The trust reports on the calendar year 
basis and as a matter of practical necessity makes distribution to A of 
each quarter's income on the fifteenth day of the month following the 
close of the quarter. The distribution made by the trust on January 15, 
1955, of the income for the fourth quarter of 1954 does not disqualify 
the trust from treatment in 1955 under section 651, since the income is 
required to be distributed currently. However, if the terms of a trust 
require that none of the income be distributed until after the year of 
its receipt by the trust, the income of the trust is not required to be 
distributed currently and the trust is not a simple trust. For 
definition of the term ``income'' see section 643(b) and Sec. 1.643(b)-
1.
    (b) It is immaterial, for purposes of determining whether all the 
income is required to be distributed currently, that the amount of 
income allocated to a particular beneficiary is not specified in the 
instrument. For example, if the fiduciary is required to distribute all 
the income currently, but has discretion to ``sprinkle'' the income 
among a class of beneficiaries, or among named beneficiaries, in such 
amount as he may see fit, all the income is required to be distributed 
currently, even though the amount distributable to a particular 
beneficiary is unknown until the fiduciary has exercised his discretion.
    (c) If in one taxable year of a trust its income for that year is 
required or permitted to be accumulated, and in another taxable year its 
income for the year is required to be distributed currently (and no 
other amounts are distributed), the trust is a simple trust for the 
latter year. For example, a trust under which income may be accumulated 
until a beneficiary is 21 years old, and thereafter must be distributed 
currently, is a simple trust for taxable years beginning after the 
beneficiary reaches the age of 21 years in which no other amounts are 
distributed.
    (d) If a trust distributes property in kind as part of its 
requirement to distribute currently all the income as defined under 
section 643(b) and the applicable regulations, the trust shall be 
treated as having sold the property for its fair market value on the 
date of distribution. If no amount in excess of the amount of income as 
defined under section 643(b) and the applicable regulations is 
distributed by the trust during the year, the trust will qualify for 
treatment under section 651 even though property in kind was distributed 
as part of a distribution of all such income. This paragraph (d) applies 
for taxable years of trusts ending after January 2, 2004.

[T.D. 6500, 25 FR 11814, Nov. 26, 1960; 25 FR 14021, Dec. 31, 1960, as 
amended by T.D. 9102, 69 FR 20, Jan. 2, 2004]



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

    (a) A trust does not qualify for treatment under section 651 for any 
taxable year in which it actually distributes corpus. For example, a 
trust which is required to distribute all of its income currently would 
not qualify as a simple trust under section 651 in the year of its 
termination since in that year actual distributions of corpus would be 
made.
    (b) A trust, otherwise qualifying under section 651, which may make 
a distribution of corpus in the discretion of the trustee, or which is 
required under the terms of its governing instrument to make a 
distribution of corpus upon the happening of a specified

[[Page 122]]

event, will be disqualified for treatment under section 651 only for the 
taxable year in which an actual distribution of corpus is made. For 
example: Under the terms of a trust, which is required to distribute all 
of its income currently, half of the corpus is to be distributed to 
beneficiary A when he becomes 30 years of age. The trust reports on the 
calendar year basis. On December 28, 1954, A becomes 30 years of age and 
the trustee distributes half of the corpus of the trust to him on 
January 3, 1955. The trust will be disqualified for treatment under 
section 651 only for the taxable year 1955, the year in which an actual 
distribution of corpus is made.
    (c) See section 661 and the regulations thereunder for the treatment 
of trusts which distribute corpus or claim the charitable contributions 
deduction provided by section 642(c).



Sec. 1.651(a)-4  Charitable purposes.

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



Sec. 1.651(a)-5  Estates.

    Subpart B has no application to an estate.



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

    In computing its taxable income, a simple trust is allowed a 
deduction for the amount of income which is required under the terms of 
the trust instrument to be distributed currently to beneficiaries. If 
the amount of income required to be distributed currently exceeds the 
distributable net income, the deduction allowable to the trust is 
limited to the amount of the distributable net income. For this purpose 
the amount of income required to be distributed currently, or 
distributable net income, whichever is applicable, does not include 
items of trust income (adjusted for deductions allocable thereto) which 
are not included in the gross income of the trust. For determination of 
the character of the income required to be distributed currently, see 
Sec. 1.652(b)-2. Accordingly, for the purposes of determining the 
deduction allowable to the trust under section 651, distributable net 
income is computed without the modifications specified in paragraphs 
(5), (6), and (7) of section 643(a), relating to tax-exempt interest, 
foreign income, and excluded dividends. For example: Assume that the 
distributable net income of a trust as computed under section 643(a) 
amounts to $99,000 but includes nontaxable income of $9,000. Then 
distributable net income for the purpose of determining the deduction 
allowable under section 651 is $90,000 ($99,000 less $9,000 nontaxable 
income).



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

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

[[Page 123]]



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

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



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

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

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



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

    (a) The amounts specified in Sec. 1.652(a)-1 which are required to 
be included in the gross income of a beneficiary are treated as 
consisting of the same proportion of each class of items entering into 
distributable net income of the trust (as defined in section 643(a)) as 
the total of each class bears to such distributable net income, unless 
the terms of the trust specifically allocate different classes of income 
to different beneficiaries, or unless local law requires such an 
allocation. For example: Assume that under the terms of the governing 
instrument, beneficiary A is to receive currently one-half of the trust 
income and beneficiaries B and C are each to receive currently one-
quarter, and the distributable net income of the trust (after allocation 
of expenses) consists of dividends of $10,000, taxable interest of 
$10,000, and tax-exempt interest of $4,000. A will be deemed to have 
received $5,000 of dividends, $5,000 of taxable interest, and $2,000 of 
tax-exempt interest; B and C will each be deemed to have received $2,500 
of dividends, $2,500 of taxable interest, and $1,000 of tax-exempt 
interest. However, if the terms of the trust specifically allocate 
different classes of income to different beneficiaries, entirely or in 
part, or if local law requires such an allocation, each beneficiary will 
be deemed to have received those items of income specifically allocated 
to him.
    (b) The terms of the trust are considered specifically to allocate 
different

[[Page 124]]

classes of income to different beneficiaries only to the extent that the 
allocation is required in the trust instrument, and only to the extent 
that it has an economic effect independent of the income tax 
consequences of the allocation. For example:
    (1) Allocation pursuant to a provision in a trust instrument 
granting the trustee discretion to allocate different classes of income 
to different beneficiaries is not a specific allocation by the terms of 
the trust.
    (2) Allocation pursuant to a provision directing the trustee to pay 
all of one income to A, or $10,000 out of the income to A, and the 
balance of the income to B, but directing the trustee first to allocate 
a specific class of income to A's share (to the extent there is income 
of that class and to the extent it does not exceed A's share) is not a 
specific allocation by the terms of the trust.
    (3) Allocation pursuant to a provision directing the trustee to pay 
half the class of income (whatever it may be) to A, and the balance of 
the income to B, is a specific allocation by the terms of the trust.



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

    Items of deduction of a trust that enter into the computation of 
distributable net income are to be allocated among the items of income 
in accordance with the following principles:
    (a) All deductible items directly attributable to one class of 
income (except dividends excluded under section 116) are allocated 
thereto. For example, repairs to, taxes on, and other expenses directly 
attributable to the maintenance of rental property or the collection of 
rental income are allocated to rental income. See Sec. 1.642(e)-1 for 
treatment of depreciation of rental property. Similarly, all 
expenditures directly attributable to a business carried on by a trust 
are allocated to the income from such business. If the deductions 
directly attributable to a particular class of income exceed that 
income, the excess is applied against other classes of income in the 
manner provided in paragraph (d) of this section.
    (b) The deductions which are not directly attributable to a specific 
class of income may be allocated to any item of income (including 
capital gains) included in computing distributable net income, but a 
portion must be allocated to nontaxable income (except dividends 
excluded under section 116) pursuant to section 265 and the regulations 
thereunder. For example, if the income of a trust is $30,000 (after 
direct expenses), consisting equally of $10,000 of dividends, tax-exempt 
interest, and rents, and income commissions amount to $3,000, one-third 
($1,000) of such commissions should be allocated to tax-exempt interest, 
but the balance of $2,000 may be allocated to the rents or dividends in 
such proportions as the trustee may elect. The fact that the governing 
instrument or applicable local law treats certain items of deduction as 
attributable to corpus or to income not included in distributable net 
income does not affect allocation under this paragraph. For instance, if 
in the example set forth in this paragraph the trust also had capital 
gains which are allocable to corpus under the terms of the trust 
instrument, no part of the deductions would be allocable thereto since 
the capital gains are excluded from the computation of distributable net 
income under section 643(a)(3).
    (c) Examples of expenses which are considered as not directly 
attributable to a specific class of income are trustee's commissions, 
the rental of safe deposit boxes, and State income and personal property 
taxes.
    (d) To the extent that any items of deduction which are directly 
attributable to a class of income exceed that class of income, they may 
be allocated to any other class of income (including capital gains) 
included in distributable net income in the manner provided in paragraph 
(b) of this section, except that any excess deductions attributable to 
tax-exempt income (other than dividends excluded under section 116) may 
not be offset against any other class of income. See section 265 and the 
regulations thereunder. Thus, if the trust has rents, taxable interest, 
dividends, and tax-exempt interest, and the deductions directly 
attributable to the rents exceed the rental income, the excess may be 
allocated to the taxable

[[Page 125]]

interest or dividends in such proportions as the fiduciary may elect. 
However, if the excess deductions are attributable to the tax-exempt 
interest, they may not be allocated to either the rents, taxable 
interest, or dividends.



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

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



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

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



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

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



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

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

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

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

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

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


[[Page 126]]


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

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

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

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

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

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

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

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

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

[[Page 127]]

the portion (one-half) of the income of the trust distributed to him.

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

   estates and trusts which may accumulate income or which distribute 
                                 corpus



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

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



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

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

However, the total amount deductible under section 661(a) cannot exceed 
the distributable net income as computed under section 643(a) and as 
modified by section 661(c). See Sec. 1.661(c)-1.
    (b) The term income required to be distributed currently includes 
any amount required to be distributed which may be paid out of income or 
corpus (such as an annuity), to the extent it is paid out of income for 
the taxable year. See Sec. 1.651(a)-2 which sets forth additional rules 
which are applicable in determining whether income of an estate or trust 
is required to be distributed currently.
    (c) The term any other amounts properly paid, credited, or required 
to be distributed includes all amounts properly paid, credited, or 
required to be distributed by an estate or trust during the taxable year 
other than income required to be distributed currently. Thus, the term 
includes the payment of an annuity to the extent it is not paid out of 
income for the taxable year, and a distribution of property in kind (see 
paragraph (f) of this section). However, see section 663(a) and 
regulations thereunder for distributions which are not included. Where 
the income of an estate or trust may be accumulated or distributed in 
the discretion of the fiduciary, or where the fiduciary has a power to 
distribute corpus to a beneficiary, any such discretionary distribution 
would qualify under section 661(a)(2). The term also includes an amount 
applied or distributed for the support of a dependent of a grantor or of 
a trustee or cotrustee under the circumstances described in section 
677(b) or section 678(c) out of corpus or out of other than income for 
the taxable year.
    (d) The terms income required to be distributed currently and any 
other amounts properly paid or credited or required to be distributed 
also include any amount used to discharge or satisfy any person's legal 
obligation as that term is used in Sec. 1.662(a)-4.
    (e) The terms income required to be distributed currently and any 
other amounts properly paid or credited or required to be distributed 
include amounts paid, or required to be paid, during the taxable year 
pursuant to a court order or decree or under local law, by a decedent's 
estate as an allowance or award for the support of the decedent's widow 
or other dependent for a limited period during the administration of the 
estate. The term any other amounts properly paid or credited or required 
to be distributed does not include the value of any interest in real 
estate owned by a decedent, title to which under local law passes 
directly from the decedent to his heirs or devisees.

[[Page 128]]

    (f) Gain or loss is realized by the trust or estate (or the other 
beneficiaries) by reason of a distribution of property in kind if the 
distribution is in satisfaction of a right to receive a distribution of 
a specific dollar amount, of specific property other than that 
distributed, or of income as defined under section 643(b) and the 
applicable regulations, if income is required to be distributed 
currently. In addition, gain or loss is realized if the trustee or 
executor makes the election to recognize gain or loss under section 
643(e). This paragraph applies for taxable years of trusts and estates 
ending after January 2, 2004.

[T.D. 6500, 25 FR 11814, Nov. 26, 1960; 25 FR 14021, Dec. 31, 1960, as 
amended by T.D. 7287, 38 FR 26912, Sept. 27, 1973; T.D. 9102, 69 FR 20, 
Jan. 2, 2004]



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

    In the absence of specific provisions in the governing instrument 
for the allocation of different classes of income, or unless local law 
requires such an allocation, the amount deductible for distributions to 
beneficiaries under section 661(a) is treated as consisting of the same 
proportion of each class of items entering into the computation of 
distributable net income as the total of each class bears to the total 
distributable net income. For example, if a trust has distributable net 
income of $20,000, consisting of $10,000 each of taxable interest and 
royalties and distributes $10,000 to beneficiary A, the deduction of 
$10,000 allowable under section 661(a) is deemed to consist of $5,000 
each of taxable interest and royalties, unless the trust instrument 
specifically provides for the distribution or accumulation of different 
classes of income or unless local law requires such an allocation. See 
also Sec. 1.661(c)-1.



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

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



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

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

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



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

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

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

[[Page 129]]

in his discretion distributes $15,000 of income to A. The trust has the 
following items of income and expense for the taxable year 1955:

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

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

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

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

Rents............................  ...........  ...........      $20,000
Dividends........................  ...........  ...........       10,000
Partially tax-exempt interest....  ...........  ...........       10,000
Fully tax-exempt interest........  ...........      $10,000
Less:
  Expenses allocable thereto            $1,000
   (10,000/50,000x$5,000)........
  Charitable contributions               2,000
   allocable thereto (10,000/
   50,000x$10,000)...............
                                  --------------
                                   ...........        3,000
                                               --------------
                                   ...........  ...........        7,000
                                                            ------------
    Total........................  ...........  ...........       47,000
Deductions:
  Rental expenses................  ...........        2,000
  Depreciation of rental property  ...........        3,000
  Trustee's commissions ($5,000    ...........        4,000
   less $1,000 allocated to tax-
   exempt interest)..............
  Charitable contributions         ...........        8,000
   ($10,000 less $2,000 allocated
   to tax-exempt interest).......
                                               --------------
                                   ...........  ...........       17,000
                                                            ------------
    Distributable net income       ...........  ...........       30,000
     (section 643(a))............
 

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

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


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

[[Page 130]]

    (e) The taxable income of the trust is $11,375 computed as follows:

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

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



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

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

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



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

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

[[Page 131]]

be distributed currently also includes any amount required to be paid 
during the taxable year in all events (either out of income or corpus) 
pursuant to a court order or decree or under local law, by a decedent's 
estate as an allowance or award for the support of the decedent's widow 
or other dependent for a limited period during the administration of the 
estate to the extent there is income (as defined in section 643(b)) of 
the estate for the taxable year not paid, credited, or required to be 
distributed to other beneficiaries.
    (d) If an annuity is paid, credited, or required to be distributed 
tax free, that is, under a provision whereby the executor or trustee 
will pay the income tax of the annuitant resulting from the receipt of 
the annuity, the payment of or for the tax by the executor or trustee 
will be treated as income paid, credited, or required to be distributed 
currently to the extent it is made out of income.
    (e) The application of the rules stated in this section may be 
illustrated by the following examples:

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

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



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

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

[[Page 132]]

or decree or under local law, by a decedent's estate as an allowance or 
award for the support of the decedent's widow or other dependent for a 
limited period during the administration of the estate which is payable 
only out of corpus of the estate under the order or decree or local law.
    (c) If the sum of the amounts of income required to be distributed 
currently (as determined under Sec. 1.662(a)-2) and other amounts 
properly paid, credited, or required to be distributed (as determined 
under paragraph (a) of this section) exceeds distributable net income 
(as defined in section 643(a)), then such other amounts properly paid, 
credited, or required to be distributed are included in gross income of 
the beneficiary but only to the extent of the excess of such 
distributable net income over the amounts of income required to be 
distributed currently. If the other amounts are paid, credited, or 
required to be distributed to more than one beneficiary, each 
beneficiary includes in gross income his proportionate share of the 
amount includible in gross income pursuant to the preceding sentence. 
The proportionate share is an amount which bears the same ratio to 
distributable net income (reduced by amounts of income required to be 
distributed currently) as the other amounts (as determined under 
paragraphs (a) and (d) of this section) distributed to the beneficiary 
bear to the other amounts distributed to all beneficiaries. For 
treatment of excess distributions by trusts, see sections 665 to 668, 
inclusive, and the regulations thereunder.
    (d) The application of the rules stated in this section may be 
illustrated by the following example:

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

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



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

    Any amount which, pursuant to the terms of a will or trust 
instrument, is used in full or partial discharge or satisfaction of a 
legal obligation of any person is included in the gross income of such 
person under section 662(a) (1) or (2), whichever is applicable, as 
though directly distributed to him as a beneficiary, except in cases to 
which section 71 (relating to alimony payments) or section 682 (relating 
to income of a trust in case of divorce, etc.) applies. The term legal 
obligation includes a legal obligation to support another person if, and 
only if, the obligation is not affected by the adequacy of the 
dependent's own resources. For example, a parent has a ``legal 
obligation'' within the meaning of the preceding sentence to support his 
minor child if under local law property or income from property owned by 
the child cannot be used for his support so long as his parent is able 
to support him. On the other hand, if under local law a mother may use 
the resources of a child for the child's support in lieu of supporting 
him herself, no obligation of support exists within the meaning of this 
paragraph, whether or not income is actually used for support. 
Similarly, since under local law a child ordinarily is obligated to 
support his parent only if the parent's earnings and resources are 
insufficient for the purpose, no obligation exists whether or not the 
parent's earnings and resources are sufficient. In any event the amount 
of trust income which is included in the gross income of a person 
obligated to support a dependent is limited by the extent of his legal 
obligation under local law. In the case of a parent's obligation to 
support his child, to the extent that the parent's legal obligation of 
support, including education, is determined under local law by the 
family's station in life

[[Page 133]]

and by the means of the parent, it is to be determined without 
consideration of the trust income in question.



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

    In determining the amount includible in the gross income of a 
beneficiary, the amounts which are determined under section 662(a) and 
Sec. Sec. 1.662(a)-1 through 1.662(a)-4 shall have the same character 
in the hands of the beneficiary as in the hands of the estate or trust. 
The amounts are treated as consisting of the same proportion of each 
class of items entering into the computation of distributable net income 
as the total of each class bears to the total distributable net income 
of the estate or trust unless the terms of the governing instrument 
specifically allocate different classes of income to different 
beneficiaries, or unless local law requires such an allocation. For this 
purpose, the principles contained in Sec. 1.652(b)-1 shall apply.



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

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

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

[[Page 134]]



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

    If a beneficiary has a different taxable year (as defined in section 
441 or 442) from the taxable year of an estate or trust, the amount he 
is required to include in gross income in accordance with section 662 
(a) and (b) is based upon the distributable net income of the estate or 
trust and the amounts properly paid, credited, or required to be 
distributed to the beneficiary for any taxable year or years of the 
estate or trust ending with or within his taxable year. This rule 
applies as to so-called short taxable years as well as taxable years of 
normal duration. Income of an estate or trust for its taxable year or 
years is determined in accordance with its method of accounting and 
without regard to that of the beneficiary.



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

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



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

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



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

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

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

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

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

[[Page 135]]



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

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

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


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

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

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

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


[[Page 136]]

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

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

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

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

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

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

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



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

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

[[Page 137]]

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

    Example 1. Under the terms of a will, a legacy of $5,000 was left to 
A, 1,000 shares of X company stock was left to W, and the balance of the 
estate was to be divided equally between W and B. No provision was made 
in the will for the disposition of income of the estate during the 
period of administration. The estate had income of $25,000 during the 
taxable year 1954, which was accumulated and added to corpus for estate 
accounting purposes. During the taxable year, the executor paid the 
legacy of $5,000 in a lump sum to A, transferred the X company stock to 
W, and made no other distributions to beneficiaries. The distributions 
to A and W qualify for the exclusion under section 663(a)(1).
    Example 2. Under the terms of a will, the testator's estate was to 
be distributed to A. No provision was made in the will for the 
distribution of the estate's income during the period of administration. 
The estate had income of $50,000 for the taxable year. The estate 
distributed to A stock with a basis of $40,000 and with a fair market 
value of $40,000 on the date of distribution. No other distributions 
were made during the year. The distribution does not qualify for the 
exclusion under section 663(a)(1), because it is not a specific gift to 
A required by the terms of the will. Accordingly, the fair market value 
of the property ($40,000) represents a distribution within the meaning 
of sections 661(a) and 662(a) (see Sec. 1.661(a)-2(c)).
    Example 3. Under the terms of a trust instrument, trust income is to 
be accumulated for a period of 10 years. During the eleventh year, the 
trustee is to distribute $10,000 to B, payable from income or corpus, 
and $10,000 to C, payable out of accumulated income. The trustee is to 
distribute the balance of the accumulated income to A. Thereafter, A is 
to receive all the current income until the trust terminates. Only the 
distribution to B would qualify for the exclusion under section 
663(a)(1).

    (4) A gift or bequest of a specific sum of money or of specific 
property is not disqualified under this paragraph solely because its 
payment is subject to a condition. For example, provision for a payment 
by a trust to beneficiary A of $10,000 when he reaches age 25, and 
$10,000 when he reaches age 30, with payment over to B of any amount not 
paid to A because of his death, is a gift to A of a specific sum of 
money payable in two installments, within the meaning of this paragraph, 
even though the exact amount payable to A cannot be

[[Page 138]]

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

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

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

[T.D. 6500, 25 FR 11814, Nov. 26, 1960; 25 FR 14021, Dec. 31, 1960, as 
amended by T.D. 8849, 64 FR 72543, Dec. 28, 1999]



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

    Any amount paid, permanently set aside, or to be used for the 
charitable, etc., purposes specified in section 642(c) and which is 
allowable as a deduction

[[Page 139]]

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

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



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

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



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

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


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

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

    (ii) If an election is made with respect to a taxable year of a 
trust, this section shall apply only to those amounts which are properly 
paid or credited within the first 65 days following such year and which 
are so designated by the fiduciary in his election. Any amount 
considered under section 663(b) as having been distributed in the 
preceding taxable year shall be so treated for all purposes. For 
example, in determining the beneficiary's tax liability, such amount 
shall be considered as having been received by the beneficiary in his 
taxable year in which or with which the last day of the preceding 
taxable year of the trust ends.
    (b) Taxable years beginning before January 1, 1969. With respect to 
taxable

[[Page 140]]

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

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



Sec. 1.663(b)-2  Election.

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

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



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

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

[[Page 141]]

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

[T.D. 6500, 25 FR 11814, Nov. 26, 1960; 25 FR 14021, as amended by T.D. 
8849, 64 FR 72543, Dec. 28, 1999]



Sec. 1.663(c)-2  Rules of administration.

    (a) When separate shares come into existence. A separate share comes 
into existence upon the earliest moment that a fiduciary may reasonably 
determine, based upon the known facts, that a separate economic interest 
exists.
    (b) Computation of distributable net income for each separate 
share--(1) General rule. The amount of distributable net income for any 
share under section 663(c) is computed as if each share constituted a 
separate trust or estate. Accordingly, each separate share shall 
calculate its distributable net income based upon its portion of gross 
income that is includible in distributable net income and its portion of 
any applicable deductions or losses.
    (2) Section 643(b) income. This paragraph (b)(2) governs the 
allocation of the portion of gross income includible in distributable 
net income that is income within the meaning of section 643(b). Such 
gross income is allocated among the separate shares in accordance with 
the amount of income that each share is entitled to under the terms of 
the governing instrument or applicable local law.
    (3) Income in respect of a decedent. This paragraph (b)(3) governs 
the allocation of the portion of gross income includible in 
distributable net income that is income in respect of a decedent within 
the meaning of section 691(a) and is not income within the meaning of 
section 643(b). Such gross income is allocated among the separate shares 
that could potentially be funded with these amounts irrespective of 
whether the share is entitled to receive any income under the terms of 
the governing instrument or applicable local law. The amount of such 
gross income allocated to each share is based on the relative value of 
each share that could potentially be funded with such amounts.
    (4) Gross income not attributable to cash. This paragraph (b)(4) 
governs the allocation of the portion of gross income includible in 
distributable net income that is not attributable to cash received by 
the estate or trust (for example, original issue discount, a 
distributive share of partnership tax items, and the pro rata share of 
an S corporation's tax items). Such gross income is allocated among the 
separate shares in the same proportion as section 643(b) income from the 
same source would be allocated under the terms of the governing 
instrument or applicable local law.
    (5) Deductions and losses. Any deduction or any loss which is 
applicable solely to one separate share of the trust or estate is not 
available to any other share of the same trust or estate.
    (c) Computations and valuations. For purposes of calculating 
distributable net income for each separate share, the fiduciary must use 
a reasonable and equitable method to make the allocations, calculations, 
and valuations required by paragraph (b) of this section.

[T.D. 8849, 64 FR 72543, Dec. 28, 1999]



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

    (a) The applicability of the separate share rule provided by section 
663(c) to trusts other than qualified revocable trusts within the 
meaning of section 645(b)(1) will generally depend upon whether 
distributions of the trust are to be made in substantially the same 
manner as if separate trusts had been created. Thus, if an instrument 
directs a trustee to divide the testator's residuary estate into 
separate shares (which under applicable law do not constitute separate 
trusts) for each of the testator's children and the trustee is

[[Page 142]]

given discretion, with respect to each share, to distribute or 
accumulate income or to distribute principal or accumulated income, or 
to do both, separate shares will exist under section 663(c). In 
determining whether separate shares exist, it is immaterial whether the 
principal and any accumulated income of each share is ultimately 
distributable to the beneficiary of such share, to his descendants, to 
his appointees under a general or special power of appointment, or to 
any other beneficiaries (including a charitable organization) designated 
to receive his share of the trust and accumulated income upon 
termination of the beneficiary's interest in the share. Thus, a separate 
share may exist if the instrument provides that upon the death of the 
beneficiary of the share, the share will be added to the shares of the 
other beneficiaries of the trust.
    (b) Separate share treatment will not be applied to a trust or 
portion of a trust subject to a power to: (1) Distribute, apportion, or 
accumulate income, or (2) distribute corpus to or for one or more 
beneficiaries within a group or class of beneficiaries, unless payment 
of income, accumulated income, or corpus of a share of one beneficiary 
cannot affect the proportionate share of income, accumulated income, or 
corpus of any shares of the other beneficiaries, or unless substantially 
proper adjustment must thereafter be made (under the governing 
instrument) so that substantially separate and independent shares exist.
    (c) A share may be considered as separate even though more than one 
beneficiary has an interest in it. For example, two beneficiaries may 
have equal, disproportionate, or indeterminate interests in one share 
which is separate and independent from another share in which one or 
more beneficiaries have an interest. Likewise, the same person may be a 
beneficiary of more than one separate share.
    (d) Separate share treatment may be given to a trust or portion of a 
trust otherwise qualifying under this section if the trust or portion of 
a trust is subject to a power to pay out to a beneficiary of a share (of 
such trust or portion) an amount of corpus in excess of his 
proportionate share of the corpus of the trust if the possibility of 
exercise of the power is remote. For example, if the trust is subject to 
a power to invade the entire corpus for the health, education, support, 
or maintenance of A, separate share treatment is applied if exercise of 
the power requires consideration of A's other income which is so 
substantial as to make the possibility of exercise of the power remote. 
If instead it appears that A and B have separate shares in a trust, 
subject to a power to invade the entire corpus for the comfort, 
pleasure, desire, or happiness of A, separate share treatment shall not 
be applied.
    (e) For taxable years ending before December 31, 1978, the separate 
share rule may also be applicable to successive interests in point of 
time, as for instance in the case of a trust providing for a life estate 
to A and a second life estate or outright remainder to B. In such a 
case, in the taxable year of a trust in which a beneficiary dies items 
of income and deduction properly allocable under trust accounting 
principles to the period before a beneficiary's death are attributed to 
one share, and those allocable to the period after the beneficiary's 
death are attributed to the other share. Separate share treatment is not 
available to a succeeding interest, however, with respect to 
distributions which would otherwise be deemed distributed in a taxable 
year of the earlier interest under the throwback provisions of subpart D 
(section 665 and following), part I, subchapter J, chapter 1 of the 
Code. The application of this paragraph may be illustrated by the 
following example:

    Example. A trust instrument directs that the income of a trust is to 
be paid to A for her life. After her death income may be distributed to 
B or accumulated. A dies on June 1, 1956. The trust keeps its books on 
the basis of the calendar year. The trust instrument permits invasions 
of corpus for the benefit of A and B, and an invasion of corpus was in 
fact made for A's benefit in 1956. In determining the distributable net 
income of the trust for the purpose of determining the amounts 
includible in A's income, income and deductions properly allocable to 
the period before A's death are treated as income and deductions of a 
separate share; and for that purpose no account is taken of income

[[Page 143]]

and deductions allocable to the period after A's death.

[T.D. 6500, 25 FR 11814, Nov. 26, 1960; 25 FR 14021, Dec. 31, 1960, as 
amended by T.D. 7633, 44 FR 57926, Oct. 9, 1979; T.D. 8849, 64 FR 72543, 
Dec. 28, 1999]



Sec. 1.663(c)-4  Applicability of separate share rule to estates and
qualified revocable trusts.

    (a) General rule. The applicability of the separate share rule 
provided by section 663(c) to estates and qualified revocable trusts 
within the meaning of section 645(b)(1) will generally depend upon 
whether the governing instrument and applicable local law create 
separate economic interests in one beneficiary or class of beneficiaries 
of such estate or trust. Ordinarily, a separate share exists if the 
economic interests of the beneficiary or class of beneficiaries neither 
affect nor are affected by the economic interests accruing to another 
beneficiary or class of beneficiaries. Separate shares include, for 
example, the income on bequeathed property if the recipient of the 
specific bequest is entitled to such income and a surviving spouse's 
elective share that under local law is entitled to income and 
appreciation or depreciation. Furthermore, a qualified revocable trust 
for which an election is made under section 645 is always a separate 
share of the estate and may itself contain two or more separate shares. 
Conversely, a gift or bequest of a specific sum of money or of property 
as defined in section 663(a)(1) is not a separate share.
    (b) Special rule for certain types of beneficial interests. 
Notwithstanding the provisions of paragraph (a) of this section, a 
surviving spouse's elective share that under local law is determined as 
of the date of the decedent's death and is not entitled to income or any 
appreciation or depreciation is a separate share. Similarly, 
notwithstanding the provisions of paragraph (a) of this section, a 
pecuniary formula bequest that, under the terms of the governing 
instrument or applicable local law, is not entitled to income or to 
share in appreciation or depreciation constitutes a separate share if 
the governing instrument does not provide that it is to be paid or 
credited in more than three installments.
    (c) Shares with multiple beneficiaries and beneficiaries of multiple 
shares. A share may be considered as separate even though more than one 
beneficiary has an interest in it. For example, two beneficiaries may 
have equal, disproportionate, or indeterminate interests in one share 
which is economically separate and independent from another share in 
which one or more beneficiaries have an interest. Moreover, the same 
person may be a beneficiary of more than one separate share.

[T.D. 8849, 64 FR 72544, Dec. 28, 1999]



Sec. 1.663(c)-5  Examples.

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

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

[[Page 144]]

during 1955 exceeds the distributable net income of $5,000 allocated to 
his share, the trust is deemed to have distributed to him $5,000 of 1955 
income and $7,000 of amounts other than 1955 income. Accordingly, the 
trust is allowed a deduction of $5,000 under section 661. The taxable 
income of the trust for 1955 is $9,900, computed as follows:

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

    (v) In accordance with section 662, A must include in his gross 
income for 1955 an amount equal to the portion ($5,000) of the 
distributable net income of the trust allocated to his share. Also, the 
excess distribution of $7,000 made by the trust is subject to the 
throwback provisions of subpart D (section 665 and following), part I, 
subchapter J, chapter 1 of the Code, and the regulations thereunder.
    Example 2. (i) Facts. Testator, who dies in 2000, is survived by a 
spouse and two children. Testator's will contains a fractional formula 
bequest dividing the residuary estate between the surviving spouse and a 
trust for the benefit of the children. Under the fractional formula, the 
marital bequest constitutes 60% of the estate and the children's trust 
constitutes 40% of the estate. During the year, the executor makes a 
partial proportionate distribution of $1,000,0000, ($600,000 to the 
surviving spouse and $400,000 to the children's trust) and makes no 
other distributions. The estate receives dividend income of $20,000, and 
pays expenses of $8,000 that are deductible on the estate's federal 
income tax return.
    (ii) Conclusion. The fractional formula bequests to the surviving 
spouse and to the children's trust are separate shares. Because 
Testator's will provides for fractional formula residuary bequests, the 
income and any appreciation in the value of the estate assets are 
proportionately allocated between the marital share and the trust's 
share. Therefore, in determining the distributable net income of each 
share, the income and expenses must be allocated 60% to the marital 
share and 40% to the trust's share. The distributable net income is 
$7,200 (60% of income less 60% of expenses) for the marital share and 
$4,800 (40% of income less 40% of expenses) for the trust's share. 
Because the amount distributed in partial satisfaction of each bequest 
exceeds the distributable net income of each share, the estate's 
distribution deduction under section 661 is limited to the sum of the 
distributable net income for both shares. The estate is allowed a 
distribution deduction of $12,000 ($7,200 for the marital share and 
$4,800 for the trust's share). As a result, the estate has zero taxable 
income ($20,000 income less $8,000 expenses and $12,000 distribution 
deduction). Under section 662, the surviving spouse and the trust must 
include in gross income $7,200 and $4,800, respectively.
    Example 3. The facts are the same as in Example 2, except that in 
2000 the executor makes the payment to partially fund the children's 
trust but makes no payment to the surviving spouse. The fiduciary must 
use a reasonable and equitable method to allocate income and expenses to 
the trust's share. Therefore, depending on when the distribution is made 
to the trust, it may no longer be reasonable or equitable to determine 
the distributable net income for the trust's share by allocating to it 
40% of the estate's income and expenses for the year. The computation of 
the distributable net income for the trust's share should take into 
consideration that after the partial distribution the relative size of 
the trust's separate share is reduced and the relative size of the 
spouse's separate share is increased.
    Example 4. (i) Facts. Testator, who dies in 2000, is survived by a 
spouse and one child. Testator's will provides for a pecuniary formula 
bequest to be paid in not more than three installments to a trust for 
the benefit of the child of the largest amount that can pass free of 
Federal estate tax and a bequest of the residuary to the surviving 
spouse. The will provides that the bequest to the child's trust is not 
entitled to any of the estate's income and does not participate in 
appreciation or depreciation in estate assets. During the 2000 taxable 
year, the estate receives dividend income of $200,000 and pays expenses 
of $15,000 that are deductible on the estate's federal income tax 
return. The executor partially funds the child's trust by distributing 
to it securities that have an adjusted basis to the estate of $350,000 
and a fair market value of $380,000 on the date of distribution. As a 
result of this distribution, the estate realizes long-term capital gain 
of $30,000.
    (ii) Conclusion. The estate has two separate shares consisting of a 
formula pecuniary bequest to the child's trust and a residuary bequest 
to the surviving spouse. Because, under the terms of the will, no estate 
income is allocated to the bequest to the child's trust, the 
distributable net income for that trust's share is zero. Therefore, with 
respect to the $380,000 distribution to the child's trust, the estate is 
allowed no deduction under section 661, and no amount is included in the 
trust's gross income under section 662. Because no distributions were 
made to the spouse, there is no need to compute the distributable net 
income allocable to the marital share. The taxable income of the estate 
for the 2000 taxable year is $214,400 ($200,000 (dividend income) plus 
$30,000 (capital gain) minus $15,000 (expenses) and minus $600 (personal 
exemption)).

[[Page 145]]

    Example 5. The facts are the same as in Example 4, except that 
during 2000 the estate reports on its federal income tax return a pro 
rata share of an S corporation's tax items and a distributive share of a 
partnership's tax items allocated on Form K-1s to the estate by the S 
corporation and by the partnership, respectively. Because, under the 
terms of the will, no estate income from the S corporation or the 
partnership would be allocated to the pecuniary bequest to child's 
trust, none of the tax items attributable to the S corporation stock or 
the partnership interest is allocated to the trust's separate share. 
Therefore, with respect to the $380,000 distribution to the trust, the 
estate is allowed no deduction under section 661, and no amount is 
included in the trust's gross income under section 662.
    Example 6. The facts are the same as in Example 4, except that 
during 2000 the estate receives a distribution of $900,000 from the 
decedent's individual retirement account that is included in the 
estate's gross income as income in respect of a decedent under section 
691(a). The entire $900,000 is allocated to corpus under applicable 
local law. Both the separate share for the child's trust and the 
separate share for the surviving spouse may potentially be funded with 
the proceeds from the individual retirement account. Therefore, a 
portion of the $900,000 gross income must be allocated to the trust's 
separate share. The amount allocated to the trust's share must be based 
upon the relative values of the two separate shares using a reasonable 
and equitable method. The estate is entitled to a deduction under 
section 661 for the portion of the $900,000 properly allocated to the 
trust's separate share, and the trust must include this amount in income 
under section 662.
    Example 7. (i) Facts. Testator, who dies in 2000, is survived by a 
spouse and three adult children. Testator's will divides the residue of 
the estate equally among the three children. The surviving spouse files 
an election under the applicable state's elective share statute. Under 
this statute, a surviving spouse is entitled to one-third of the 
decedent's estate after the payment of debts and expenses. The statute 
also provides that the surviving spouse is not entitled to any of the 
estate's income and does not participate in appreciation or depreciation 
of the estate's assets. However, under the statute, the surviving spouse 
is entitled to interest on the elective share from the date of the court 
order directing the payment until the executor actually makes payment. 
During the estate's 2001 taxable year, the estate distributes to the 
surviving spouse $5,000,000 in partial satisfaction of the elective 
share and pays $200,000 of interest on the delayed payment of the 
elective share. During that year, the estate receives dividend income of 
$3,000,000 and pays expenses of $60,000 that are deductible on the 
estate's federal income tax return.
    (ii) Conclusion. The estate has four separate shares consisting of 
the surviving spouse's elective share and each of the three children's 
residuary bequests. Because the surviving spouse is not entitled to any 
estate income under state law, none of the estate's gross income is 
allocated to the spouse's separate share for purposes of determining 
that share's distributable net income. Therefore, with respect to the 
$5,000,000 distribution, the estate is allowed no deduction under 
section 661, and no amount is included in the spouse's gross income 
under section 662. The $200,000 of interest paid to the spouse must be 
included in the spouse's gross income under section 61. Because no 
distributions were made to any other beneficiaries during the year, 
there is no need to compute the distributable net income of the other 
three separate shares. Thus, the taxable income of the estate for the 
2000 taxable year is $2,939,400 ($3,000,000 (dividend income) minus 
$60,000 (expenses) and $600 (personal exemption)). The estate's $200,000 
interest payment is a nondeductible personal interest expense described 
in section 163(h).
    Example 8. The will of Testator, who dies in 2000, directs the 
executor to distribute the X stock and all dividends therefrom to child 
A and the residue of the estate to child B. The estate has two separate 
shares consisting of the income on the X stock bequeathed to A and the 
residue of the estate bequeathed to B. The bequest of the X stock meets 
the definition of section 663(a)(1) and therefore is not a separate 
share. If any distributions, other than shares of the X stock, are made 
during the year to either A or B, then for purposes of determining the 
distributable net income for the separate shares, gross income 
attributable to dividends on the X stock must be allocated to A's 
separate share and any other income must be allocated to B's separate 
share.
    Example 9. The will of Testator, who dies in 2000, directs the 
executor to divide the residue of the estate equally between Testator's 
two children, A and B. The will directs the executor to fund A's share 
first with the proceeds of Testator's individual retirement account. The 
date of death value of the estate after the payment of debts, expenses, 
and estate taxes is $9,000,000. During 2000, the $900,000 balance in 
Testator's individual retirement account is distributed to the estate. 
The entire $900,000 is allocated to corpus under applicable local law. 
This amount is income in respect of a decedent within the meaning of 
section 691(a). The estate has two separate shares, one for the benefit 
of A and one for the benefit of B. If any distributions are made to 
either A or B during the year, then, for purposes of determining the 
distributable net income for each separate share,

[[Page 146]]

the $900,000 of income in respect of a decedent must be allocated to A's 
share.
    Example 10. The facts are the same as in Example 9, except that the 
will directs the executor to fund A's share first with X stock valued at 
$3,000,000, rather than with the proceeds of the individual retirement 
account. The estate has two separate shares, one for the benefit of A 
and one for the benefit of B. If any distributions are made to either A 
or B during the year, then, for purposes of determining the 
distributable net income for each separate share, the $900,000 of gross 
income attributable to the proceeds from the individual retirement 
account must be allocated between the two shares to the extent that they 
could potentially be funded with those proceeds. The maximum amount of 
A's share that could potentially be funded with the income in respect of 
decedent is $1,500,000 ($4,500,000 value of share less $3,000,000 to be 
funded with stock) and the maximum amount of B's share that could 
potentially be funded with income in respect of decedent is $4,500,000. 
Based upon the relative values of these amounts, the gross income 
attributable to the proceeds of the individual retirement account is 
allocated $225,000 (or one-fourth) to A's share and $675,000 (or three-
fourths) to B's share.
    Example 11. The will of Testator, who dies in 2000, provides that 
after the payment of specific bequests of money, the residue of the 
estate is to be divided equally among the Testator's three children, A, 
B, and C. The will also provides that during the period of 
administration one-half of the income from the residue is to be paid to 
a designated charitable organization. After the specific bequests of 
money are paid, the estate initially has three equal separate shares. 
One share is for the benefit of the charitable organization and A, 
another share is for the benefit of the charitable organization and B, 
and the last share is for the benefit of the charitable organization and 
C. During the period of administration, payments of income to the 
charitable organization are deductible by the estate to the extent 
provided in section 642(c) and are not subject to the distribution 
provisions of sections 661 and 662.

[T.D. 6500, 25 FR 11814, Nov. 26, 1960; 25 FR 14021, Dec. 31, 1960. 
Redesignated and amended by T.D. 8849, 64 FR 72543, 72544, Dec. 28, 
1999; 65 FR 16317, Mar. 28, 2000]



Sec. 1.663(c)-6  Effective dates.

    Sections 1.663(c)-1 through 1.663(c)-5 are applicable for estates 
and qualified revocable trusts within the meaning of section 645(b)(1) 
with respect to decedents who die on or after December 28, 1999. 
However, for estates and qualified revocable trusts with respect to 
decedents who died after the date that section 1307 of the Tax Reform 
Act of 1997 became effective but before December 28, 1999, the IRS will 
accept any reasonable interpretation of the separate share provisions, 
including those provisions provided in 1999-11 I.R.B. 41 (see Sec. 
601.601(d)(2)(ii)(b) of this chapter). For trusts other than qualified 
revocable trusts, Sec. 1.663(c)-2 is applicable for taxable years of 
such trusts beginning after December 28, 1999.

[T.D. 8849, 64 FR 72545, Dec. 28, 1999; 65 FR 16317, Mar. 28, 2000]



Sec. 1.664-1  Charitable remainder trusts.

    (a) In general--(1) Introduction--(i) General description of a 
charitable remainder trust. Generally, a charitable remainder trust is a 
trust which provides for a specified distribution, at least annually, to 
one or more beneficiaries, at least one of which is not a charity, for 
life or for a term of years, with an irrevocable remainder interest to 
be held for the benefit of, or paid over to, charity. The specified 
distribution to be paid at least annually must be a sum certain which is 
not less than 5 percent of the initial net fair market value of all 
property placed in trust (in the case of a charitable remainder annuity 
trust) or a fixed percentage which is not less than 5 percent of the net 
fair market value of the trust assets, valued annually (in the case of a 
charitable remainder unitrust). A trust created after July 31, 1969, 
which is a charitable remainder trust, is exempt from all of the taxes 
imposed by subtitle A of the Code for any taxable year of the trust, 
except for a taxable year beginning before January 1, 2007, in which it 
has unrelated business taxable income. For taxable years beginning after 
December 31, 2006, an excise tax, treated as imposed by chapter 42, is 
imposed on charitable remainder trusts that have unrelated business 
taxable income. See paragraph (c) of this section.
    (ii) Scope. This section provides definitions, general rules 
governing the creation and administration of a charitable remainder 
trust, and rules governing the taxation of the trust and its 
beneficiaries. For the application of certain foundation rules to 
charitable remainder trusts, see paragraph (b) of

[[Page 147]]

this section. If the trust has unrelated business taxable income, see 
paragraph (c) of this section. For the treatment of distributions to 
recipients, see paragraph (d) of this section. For the treatment of 
distributions to charity, see paragraph (e) of this section. For the 
time limitations for amendment of governing instruments, see paragraph 
(f) of this section. For transitional rules under which particular 
requirements are inapplicable to certain trusts, see paragraph (g) of 
this section. Section 1.664-2 provides rules relating solely to a 
charitable remainder annuity trust. Section 1.664-3 provides rules 
relating solely to a charitable remainder unitrust. Section 1.664-4 
provides rules governing the calculation of the fair market value of the 
remainder interest in a charitable remainder unitrust. For rules 
relating to the filing of returns for a charitable remainder trust, see 
paragraph (a)(6) of Sec. 1.6012-3 and section 6034 and the regulations 
thereunder.
    (iii) Definitions. As used in this section and Sec. Sec. 1.664-2, 
1.664-3, and 1.664-4:
    (a) Charitable remainder trust. The term charitable remainder trust 
means a trust with respect to which a deduction is allowable under 
section 170, 2055, 2106, or 2522 and which meets the description of a 
charitable remainder annuity trust (as described in Sec. 1.664-2) or a 
charitable remainder unitrust (as described in Sec. 1.664-3).
    (b) Annuity amount. The term annuity amount means the amount 
described in paragraph (a)(1) of Sec. 1.664-2 which is payable, at 
least annually, to the beneficiary of a charitable remainder annuity 
trust.
    (c) Unitrust amount. The term unitrust amount means the amount 
described in paragraph (a)(1) of Sec. 1.664-3 which is payable, at 
least annually, to the beneficiary of a charitable remainder unitrust.
    (d) Recipient. The term recipient means the beneficiary who receives 
the possession or beneficial enjoyment of the annuity amount or unitrust 
amount.
    (e) Governing instrument. The term governing instrument has the same 
meaning as in section 508(e) and the regulations thereunder.
    (2) Requirement that the trust must be either a charitable remainder 
annuity trust or a charitable remainder unitrust. A trust is a 
charitable remainder trust only if it is either a charitable remainder 
annuity trust in every respect or a charitable remainder unitrust in 
every respect. For example, a trust which provides for the payment each 
year to a noncharitable beneficiary of the greater of a sum certain or a 
fixed percentage of the annual value of the trust assets is not a 
charitable remainder trust inasmuch as the trust is neither a charitable 
remainder annuity trust (for the reason that the payment for the year 
may be a fixed percentage of the annual value of the trust assets which 
is not a ``sum certain'') nor a charitable remainder unitrust (for the 
reason that the payment for the year may be a sum certain which is not a 
``fixed percentage'' of the annual value of the trust assets).
    (3) Restrictions on investments. A trust is not a charitable 
remainder trust if the provisions of the trust include a provision which 
restricts the trustee from investing the trust assets in a manner which 
could result in the annual realization of a reasonable amount of income 
or gain from the sale or disposition of trust assets. In the case of 
transactions with, or for the benefit of, a disqualified person, see 
section 4941(d) and the regulations thereunder for rules relating to the 
definition of self-dealing.
    (4) Requirement that trust must meet definition of and function 
exclusively as a charitable remainder trust from its creation. In order 
for a trust to be a charitable remainder trust, it must meet the 
definition of and function exclusively as a charitable remainder trust 
from the creation of the trust. Solely for the purposes of section 664 
and the regulations thereunder, the trust will be deemed to be created 
at the earliest time that neither the grantor nor any other person is 
treated as the owner of the entire trust under subpart E, part 1, 
subchapter J, chapter 1, subtitle A of the Code (relating to grantors 
and others treated as substantial owners), but in no event prior to the 
time property is first transferred to the trust. For purposes of the 
preceding sentence, neither the grantor nor his spouse shall be

[[Page 148]]

treated as the owner of the trust under such subpart E merely because 
the grantor or his spouse is named as a recipient. See examples 1 
through 3 of subparagraph (6) of this paragraph for illustrations of the 
foregoing rule.
    (5) Rules applicable to testamentary transfers--(i) Deferral of 
annuity or unitrust amount. Notwithstanding subparagraph (4) of this 
paragraph and Sec. Sec. 1.664-2 and 1.664-3, for purposes of sections 
2055 and 2106 a charitable remainder trust shall be deemed created at 
the date of death of the decedent (even though the trust is not funded 
until the end of a reasonable period of administration or settlement) if 
the obligation to pay the annuity or unitrust amount with respect to the 
property passing in trust at the death of the decedent begins as of the 
date of death of the decedent, even though the requirement to pay such 
amount is deferred in accordance with the rules provided in this 
subparagraph. If permitted by applicable local law or authorized by the 
provisions of the governing instrument, the requirement to pay such 
amount may be deferred until the end of the taxable year of the trust in 
which occurs the complete funding of the trust. Within a reasonable 
period after such time, the trust must pay (in the case of an 
underpayment) or must receive from the recipient (in the case of an 
overpayment) the difference between:
    (a) Any annuity or unitrust amounts actually paid, plus interest on 
such amounts computed at the rate of interest specified in paragraph 
(a)(5)(iv) of this section, compounded annually, and
    (b) The annuity or unitrust amounts payable, plus interest on such 
amounts computed at the rate of interest specified in paragraph 
(a)(5)(iv) of this section, compounded annually.

The amounts payable shall be retroactively determined by using the 
taxable year, valuation method, and valuation dates which are ultimately 
adopted by the charitable remainder trust. See subdivision (ii) of this 
subparagraph for rules relating to retroactive determination of the 
amount payable under a charitable remainder unitrust. See paragraph 
(d)(4) of this section for rules relating to the year of inclusion in 
the case of an underpayment to a recipient and the allowance of a 
deduction in the case of an overpayment to a recipient.
    (ii) For purposes of retroactively determining the amount under 
subdivision (i)(b) of this subparagraph, the governing instrument of a 
charitable remainder unitrust may provide that the amount described in 
subdivision (i)(b) of this subparagraph with respect to property passing 
in trust at the death of the decedent for the period which begins on the 
date of death of the decedent and ends on the earlier of the date of 
death of the last recipient or the end of the taxable year of the trust 
in which occurs the complete funding of the trust shall be computed by 
multiplying:
    (a) The sum of (1) the value, on the earlier of the date of death of 
the last recipient or the last day in such taxable year, of the property 
held in trust which is attributable to property passing to the trust at 
the death of the decedent, (2) any distributions in respect of unitrust 
amounts made by the trust or estate before such date, and (3) interest 
on such distributions computed at the rate of interest specified in 
paragraph (a)(5)(iv) of this section, compounded annually, from the date 
of distribution to such date by:
    (b)(1) In the case of transfers made after November 30, 1983, for 
which the valuation date is before May 1, 1989, a factor equal to 
1.000000 less the factor under the appropriate adjusted payout rate in 
Table D in Sec. 1.664-4(e)(6) opposite the number of years in column 1 
between the date of death of the decedent and the date of the earlier of 
the death of the last recipient or the last day of such taxable year.
    (2) In the case of transfers for which the valuation date is after 
April 30, 1989, a factor equal to 1.000000 less the factor under the 
appropriate adjusted payout rate in Table D in Sec. 1.664-4(e)(6) 
opposite the number of years in column 1 between the date of death of 
the decedent and the date of the earlier of the death of the last 
recipient or the last day of such taxable year. The appropriate adjusted 
payout rate is determined by using the appropriate Table F contained in 
Sec. 1.664-4(e)(6) for the section 7520 rate for the month of the 
valuation date.

[[Page 149]]

    (3) If the number of years between the date of death and the date of 
the earlier of the death of the last recipient or the last day of such 
taxable year is between periods for which factors are provided, a linear 
interpolation must be made.
    (iii) Treatment of distributions. The treatment of a distribution to 
a charitable remainder trust, or to a recipient in respect of an annuity 
or unitrust amount, paid, credited, or required to be distributed by an 
estate, or by a trust which is not a charitable remainder trust, shall 
be governed by the rules of subchapter J, chapter 1, subtitle A of the 
Code other than section 664. In the case of a charitable remainder trust 
which is partially or fully funded during the period of administration 
of an estate or settlement of a trust (which is not a charitable 
remainder trust), the treatment of any amount paid, credited, or 
required to be distributed by the charitable remainder trust shall be 
governed by the rules of section 664.
    (iv) Rate of interest. The following rates of interest shall apply 
for purposes of paragraphs (a)(5) (i) through (ii) of this section:
    (a) The section 7520 rate for the month in which the valuation date 
with respect to the transfer is (or one of the prior two months if 
elected under Sec. 1.7520-2(b)) after April 30, 1989;
    (b) 10 percent for instruments executed or amended (other than in 
the case of a reformation under section 2055(e)(3)) on or after August 
9, 1984, and before May 1, 1989, and not subsequently amended;
    (c) 6 percent or 10 percent for instruments executed or amended 
(other than in the case of a reformation under section 2055(e)(3)) after 
October 24, 1983, and before August 9, 1984; and
    (d) 6 percent for instruments executed before October 25, 1983, and 
not subsequently amended (other than in the case of a reformation under 
section 2055(e)(3)).
    (6) Examples. The application of the rules in paragraphs (a)(4) and 
(a)(5) of this section require the use of actuarial factors contained in 
Sec. Sec. 1.664-4(e) and 1.664-4A and may be illustrated by use of the 
following examples:

    Example 1. On September 19, 1971, H transfers property to a trust 
over which he retains an inter vivos power of revocation. The trust is 
to pay W 5 percent of the value of the trust assets, valued annually, 
for her life, remainder to charity. The trust would satisfy all of the 
requirements of section 664 if it were irrevocable. For purposes of 
section 664, the trust is not deemed created in 1971 because H is 
treated as the owner of the entire trust under subpart E. On May 26, 
1975, H predeceases W at which time the trust becomes irrevocable. For 
purposes of section 664, the trust is deemed created on May 26, 1975, 
because that is the earliest date on which H is not treated as the owner 
of the entire trust under subpart E. The trust becomes a charitable 
remainder trust on May 26, 1975, because it meets the definition of a 
charitable remainder trust from its creation.
    Example 2. The facts are the same as in example 1, except that H 
retains the inter vivos power to revoke only one-half of the trust. For 
purposes of section 664, the trust is deemed created on September 19, 
1971, because on that date the grantor is not treated as the owner of 
the entire trust under subpart E. Consequently, a charitable deduction 
is not allowable either at the creation of the trust or at H's death 
because the trust does not meet the definition of a charitable remainder 
trust from the date of its creation. The trust does not meet the 
definition of a charitable remainder trust from the date of its creation 
because the trust is subject to a partial power to revoke on such date.
    Example 3. The facts are the same as in example 1, except that the 
residue of H's estate is to be paid to the trust and the trust is 
required to pay H's debts. The trust is not a charitable remainder trust 
at H's death because it does not function exclusively as a charitable 
remainder trust from the date of its creation which, in this case, is 
the date it becomes irrevocable.
    Example 4. (i) In 1971, H transfers property to Trust A over which 
he retains an inter vivos power of revocation. Trust A, which is not a 
charitable remainder trust, is to provide income or corpus to W until 
the death of H. Upon H's death the trust is required by its governing 
instrument to pay the debts and administration expenses of H's estate, 
and then to terminate and distribute all of the remaining assets to a 
separate Trust B which meets the definition of a charitable remainder 
annuity trust.
    (ii) Trust B will be charitable remainder trust from the date of its 
funding because it will function exclusively as a charitable remainder 
trust from its creation. For purposes of section 2055, Trust B will be 
deemed created at H's death if the obligation to pay the annuity amount 
begins on the date of H's death. For purposes of section 664, Trust B 
becomes a charitable remainder trust as soon as it is partially or 
completely funded.

[[Page 150]]

Consequently, unless Trust B has unrelated business taxable income, the 
income of the trust is exempt from all taxes imposed by subtitle A of 
the Code, and any distributions by the trust, even before it is 
completely funded, are governed by the rules of section 664. Any 
distributions made by Trust A, including distributions to a recipient in 
respect of annuity amounts, are governed by the rules of subchapter J, 
chapter 1, subtitle A of the Code other than section 664.
    Example 5. In 1973, H dies testate leaving the net residue of his 
estate (after payment by the estate of all debts and administration 
expenses) to a trust which meets the definition of a charitable 
remainder unitrust. For purposes of section 2055, the trust is deemed 
created at H's death if the requirement to pay the unitrust amount 
begins on H's death and is a charitable remainder trust even though the 
estate is obligated to pay debts and administration expenses.
    For purposes of section 664, the trust becomes a charitable 
remainder trust as soon as it is partially or completely funded. 
Consequently, unless the trust has unrelated business taxable income, 
the income of the trust is exempt from all taxes imposed by subtitle A 
of the Code, and any distributions by the trust, even before it is 
completely funded, are governed by the rules of section 664. Any 
distributions made by H's estate, including distributions to a recipient 
in respect of unitrust amounts, are governed by the rules of subchapter 
J, chapter 1, subtitle A of the Code other than section 664.
    Example 6. (i) On January 1, 1974, H dies testate leaving the 
residue of his estate to a charitable remainder unitrust. The governing 
instrument provides that, beginning at H's death, the trustee is to make 
annual payments to W, on December 31 of each year of 5 percent of the 
net fair market value of the trust assets, valued as of December 31 of 
each year, for W's life and to pay the remainder to charity at the death 
of W. The governing instrument also provides that the actual payment of 
the unitrust amount need not be made until the end of the taxable year 
of the trust in which occurs the complete funding of the trust. The 
governing instrument also provides that the amount payable with respect 
to the period between the date of death and the end of such taxable year 
shall be computed under the special method provided in subparagraph 
(5)(ii) of this paragraph. The governing instrument provides that, 
within a reasonable period after the end of the taxable year of the 
trust in which occurs the complete funding of the trust, the trustee 
shall pay (in the case of an underpayment) or shall receive from the 
recipient (in the case of an overpayment) the difference between the 
unitrust amounts paid (plus interest at 6 percentage compounded 
annually) and the amount computed under the special method. The trust is 
completely funded on September 20, 1976. No amounts were paid before 
June 30, 1977. The trust adopts a fiscal year of July 1 to June 30. The 
net fair market value of the trust assets on June 30, 1977, is $100,000.
    (ii) Because no amounts were paid prior to the end of the taxable 
year in which the trust was completely funded, the amount payable at the 
end of such taxable year is equal to the net fair market value of the 
trust assets on the last day of such taxable year (June 30, 1977) 
multiplied by a factor equal to 1.0 minus the factor in Table D 
corresponding to the number of years in the period between the date of 
death and the end of such taxable year. The adjusted payout rate 
(determined under Sec. 1.664-4A(c)) is 5 percent. Because the last day 
of the taxable year in which the trust is completely funded in June 30, 
1977, there are 3 181/365 years in such period. Because there is no 
factor given in Table D for such a period, a linear interpolation must 
be made:

1.0 minus 0.814506 (factor at 5 percent for 4 years)........    0.185494
1.0 minus 0.857375 (factor at 5 percent for 3 years)........     .142625
                                                             -----------
    Difference..............................................     .042869
                           181/365=X/0.042869
 
                               X=0.021258
 
1.0 minus 0.857375 (factor at 5 percent for 3 years.........    0.142625
Plus: X.....................................................     .021258
                                                             -----------
    Interpolated factor.....................................     .163883
 


Thus, the amount payable for the period from January 1, 1974, to June 
30, 1977, is $16,388.30 ($100,000x0.163883). Thereafter, the trust 
assets must be valued on December 31 of each year and 5 percent of such 
value paid annually to W for her life.

    (7) Valuation of unmarketable assets--(i) In general. If 
unmarketable assets are transferred to or held by a trust, the trust 
will not be a trust with respect to which a deduction is available under 
section 170, 2055, 2106, or 2522, or will be treated as failing to 
function exclusively as a charitable remainder trust unless, whenever 
the trust is required to value such assets, the valuation is--
    (a) Performed exclusively by an independent trustee; or
    (b) Determined by a current qualified appraisal, as defined in Sec. 
1.170A-13(c)(3), from a qualified appraiser, as defined in Sec. 1.170A-
13(c)(5).
    (ii) Unmarketable assets. Unmarketable assets are assets that are 
not cash, cash equivalents, or other assets that can be readily sold or 
exchanged for

[[Page 151]]

cash or cash equivalents. For example, unmarketable assets include real 
property, closely-held stock, and an unregistered security for which 
there is no available exemption permitting public sale.
    (iii) Independent trustee. An independent trustee is a person who is 
not the grantor of the trust, a noncharitable beneficiary, or a related 
or subordinate party to the grantor, the grantor's spouse, or a 
noncharitable beneficiary (within the meaning of section 672(c) and the 
applicable regulations).
    (b) Application of certain foundation rules to charitable remainder 
trusts. See section 4947(a)(2) and section 4947(b)(3)(B) and the 
regulations thereunder for the application to charitable remainder 
trusts of certain provisions relating to private foundations. See 
section 508(e) for rules relating to required provisions in governing 
instruments prohibiting certain activities specified in section 
4947(a)(2).
    (c) Excise tax on charitable remainder trusts--(1) In general. For 
each taxable year beginning after December 31, 2006, in which a 
charitable remainder annuity trust or a charitable remainder unitrust 
has any unrelated business taxable income, an excise tax is imposed on 
that trust in an amount equal to the amount of such unrelated business 
taxable income. For this purpose, unrelated business taxable income is 
as defined in section 512, determined as if part III, subchapter F, 
chapter 1, subtitle A of the Internal Revenue Code applied to such 
trust. Such excise tax is treated as imposed by chapter 42 (other than 
subchapter E) and is reported and payable in accordance with the 
appropriate forms and instructions. Such excise tax shall be allocated 
to corpus and, therefore, is not deductible in determining taxable 
income distributed to a beneficiary. (See paragraph (d)(2) of this 
section.) The charitable remainder trust income that is unrelated 
business taxable income constitutes income of the trust for purposes of 
determining the character of the distribution made to the beneficiary. 
Income of the charitable remainder trust is allocated among the 
charitable remainder trust income categories in paragraph (d)(1) of this 
section without regard to whether any part of that income constitutes 
unrelated business taxable income under section 512.
    (2) Examples. The application of the rules in this paragraph (c) may 
be illustrated by the following examples:

    Example 1. For 2007, a charitable remainder annuity trust with a 
taxable year beginning on January 1, 2007, has $60,000 of ordinary 
income, including $10,000 of gross income from a partnership that 
constitutes unrelated business taxable income to the trust. The trust 
has no deductions that are directly connected with that income. For that 
same year, the trust has administration expenses (deductible in 
computing taxable income) of $16,000, resulting in net ordinary income 
of $44,000. The amount of unrelated business taxable income is computed 
by taking gross income from an unrelated trade or business and deducting 
expenses directly connected with carrying on the trade or business, both 
computed with modifications under section 512(b). Section 512(b)(12) 
provides a specific deduction of $1,000 in computing the amount of 
unrelated business taxable income. Under the facts presented in this 
example, there are no other modifications under section 512(b). The 
trust, therefore, has unrelated business taxable income of $9,000 
($10,000 minus the $1,000 deduction under section 512(b)(12)). 
Undistributed ordinary income from prior years is $12,000 and 
undistributed capital gains from prior years are $50,000. Under the 
terms of the trust agreement, the trust is required to pay an annuity of 
$100,000 for year 2007 to the noncharitable beneficiary. Because the 
trust has unrelated business taxable income of $9,000, the excise tax 
imposed under section 664(c) is equal to the amount of such unrelated 
business taxable income, $9,000. The character of the $100,000 
distribution to the noncharitable beneficiary is as follows: $56,000 of 
ordinary income ($44,000 from current year plus $12,000 from prior 
years), and $44,000 of capital gains. The $9,000 excise tax is allocated 
to corpus, and does not reduce the amount in any of the categories of 
income under paragraph (d)(1) of this section. At the beginning of year 
2008, the amount of undistributed capital gains is $6,000, and there is 
no undistributed ordinary income.
    Example 2. During 2007, a charitable remainder annuity trust with a 
taxable year beginning on January 1, 2007, sells real estate generating 
gain of $40,000. Because the trust had obtained a loan to finance part 
of the purchase price of the asset, some of the income from the sale is 
treated as debt-financed income under section 514 and thus constitutes 
unrelated business taxable income under section 512. The unrelated debt-
financed income computed under section 514 is $30,000. Assuming the 
trust receives no

[[Page 152]]

other income in 2007, the trust will have unrelated business taxable 
income under section 512 of $29,000 ($30,000 minus the $1,000 deduction 
under section 512(b)(12)). Except for section 512(b)(12), no other 
exceptions or modifications under sections 512-514 apply when 
calculating unrelated business taxable income based on the facts 
presented in this example. Because the trust has unrelated business 
taxable income of $29,000, the excise tax imposed under section 664(c) 
is equal to the amount of such unrelated business taxable income, 
$29,000. The $29,000 excise tax is allocated to corpus, and does not 
reduce the amount in any of the categories of income under paragraph 
(d)(1) of this section. Regardless of how the trust's income might be 
treated under sections 511-514, the entire $40,000 is capital gain for 
purposes of section 664 and is allocated accordingly to and within the 
second of the categories of income under paragraph (d)(1) of this 
section.

    (3) Effective/applicability date. This paragraph (c) is applicable 
for taxable years beginning after December 31, 2006. The rules that 
apply with respect to taxable years beginning before January 1, 2007, 
are contained in Sec. 1.664-1(c) as in effect prior to June 24, 2008. 
(See 26 CFR part 1, Sec. 1.664-1(c)(1) revised as of April 1, 2007.)
    (d) Treatment of annual distributions to recipients--(1) Character 
of distributions--(i) Assignment of income to categories and classes at 
the trust level. (a) A trust's income, including income includible in 
gross income and other income, is assigned to one of three categories in 
the year in which it is required to be taken into account by the trust. 
These categories are--
    (1) Gross income, other than gains and amounts treated as gains from 
the sale or other disposition of capital assets (referred to as the 
ordinary income category);
    (2) Gains and amounts treated as gains from the sale or other 
disposition of capital assets (referred to as the capital gains 
category); and
    (3) Other income (including income excluded under part III, 
subchapter B, chapter 1, subtitle A of the Internal Revenue Code).
    (b) Items within the ordinary income and capital gains categories 
are assigned to different classes based on the Federal income tax rate 
applicable to each type of income in that category in the year the items 
are required to be taken into account by the trust. For example, for a 
trust with a taxable year ending December 31, 2004, the ordinary income 
category may include a class of qualified dividend income as defined in 
section 1(h)(11) and a class of all other ordinary income, and the 
capital gains category may include separate classes for short-term and 
long-term capital gains and losses, such as a short-term capital gain 
class, a 28-percent long-term capital gain class (gains and losses from 
collectibles and section 1202 gains), an unrecaptured section 1250 long-
term capital gain class (long-term gains not treated as ordinary income 
that would be treated as ordinary income if section 1250(b)(1) included 
all depreciation), a qualified 5-year long-term capital gain class as 
defined in section 1(h)(9) prior to amendment by the Jobs and Growth Tax 
Relief Reconciliation Act of 2003 (JGTRRA), Public Law 108-27 (117 Stat. 
752), and an all other long-term capital gain class. After items are 
assigned to a class, the tax rates may change so that items in two or 
more classes would be taxed at the same rate if distributed to the 
recipient during a particular year. If the changes to the tax rates are 
permanent, the undistributed items in those classes are combined into 
one class. If, however, the changes to the tax rates are only temporary 
(for example, the new rate for one class will sunset in a future year), 
the classes are kept separate.
    (ii) Order of distributions. (a) The categories and classes of 
income (determined under paragraph (d)(1)(i) of this section) are used 
to determine the character of an annuity or unitrust distribution from 
the trust in the hands of the recipient irrespective of whether the 
trust is exempt from taxation under section 664(c) for the year of the 
distribution. The determination of the character of amounts distributed 
or deemed distributed at any time during the taxable year of the trust 
shall be made as of the end of that taxable year. The tax rate or rates 
to be used in computing the recipient's tax on the distribution shall be 
the tax rates that are applicable, in the year in which the distribution 
is required to be made, to the classes of income deemed to make up that 
distribution, and not the tax

[[Page 153]]

rates that are applicable to those classes of income in the year the 
income is received by the trust. The character of the distribution in 
the hands of the annuity or unitrust recipient is determined by treating 
the distribution as being made from each category in the following 
order:
    (1) First, from ordinary income to the extent of the sum of the 
trust's ordinary income for the taxable year and its undistributed 
ordinary income for prior years.
    (2) Second, from capital gain to the extent of the trust's capital 
gains determined under paragraph (d)(1)(iv) of this section.
    (3) Third, from other income to the extent of the sum of the trust's 
other income for the taxable year and its undistributed other income for 
prior years.
    (4) Finally, from trust corpus (with corpus defined for this purpose 
as the net fair market value of the trust assets less the total 
undistributed income (but not loss) in paragraphs (d)(1)(i)(a) (1) 
through (3) of this section).
    (b) If the trust has different classes of income in the ordinary 
income category, the distribution from that category is treated as being 
made from each class, in turn, until exhaustion of the class, beginning 
with the class subject to the highest Federal income tax rate and ending 
with the class subject to the lowest Federal income tax rate. If the 
trust has different classes of net gain in the capital gains category, 
the distribution from that category is treated as being made first from 
the short-term capital gain class and then from each class of long-term 
capital gain, in turn, until exhaustion of the class, beginning with the 
class subject to the highest Federal income tax rate and ending with the 
class subject to the lowest rate. If two or more classes within the same 
category are subject to the same current tax rate, but at least one of 
those classes will be subject to a different tax rate in a future year 
(for example, if the current rate sunsets), the order of that class in 
relation to other classes in the category with the same current tax rate 
is determined based on the future rate or rates applicable to those 
classes. Within each category, if there is more than one type of income 
in a class, amounts treated as distributed from that class are to be 
treated as consisting of the same proportion of each type of income as 
the total of the current and undistributed income of that type bears to 
the total of the current and undistributed income of all types of income 
included in that class. For example, if rental income and interest 
income are subject to the same current and future Federal income tax 
rate and, therefore, are in the same class, a distribution from that 
class will be treated as consisting of a proportional amount of rental 
income and interest income.
    (iii) Treatment of losses at the trust level--(a) Ordinary income 
category. A net ordinary loss for the current year is first used to 
reduce undistributed ordinary income for prior years that is assigned to 
the same class as the loss. Any excess loss is then used to reduce the 
current and undistributed ordinary income from other classes, in turn, 
beginning with the class subject to the highest Federal income tax rate 
and ending with the class subject to the lowest Federal income tax rate. 
If any of the loss exists after all the current and undistributed 
ordinary income from all classes has been offset, the excess is carried 
forward indefinitely to reduce ordinary income for future years and 
retains its class assignment. For purposes of this section, the amount 
of current income and prior years' undistributed income shall be 
computed without regard to the deduction for net operating losses 
provided by section 172 or 642(d).
    (b) Other income category. A net loss in the other income category 
for the current year is used to reduce undistributed income in this 
category for prior years and any excess is carried forward indefinitely 
to reduce other income for future years.
    (iv) Netting of capital gains and losses at the trust level. Capital 
gains of the trust are determined on a cumulative net basis under the 
rules of this paragraph (d)(1) without regard to the provisions of 
section 1212. For each taxable year, current and undistributed gains and 
losses within each class are netted to determine the net gain or loss 
for that class, and the classes of

[[Page 154]]

capital gains and losses are then netted against each other in the 
following order. First, a net loss from a class of long-term capital 
gain and loss (beginning with the class subject to the highest Federal 
income tax rate and ending with the class subject to the lowest rate) is 
used to offset net gain from each other class of long-term capital gain 
and loss, in turn, until exhaustion of the class, beginning with the 
class subject to the highest Federal income tax rate and ending with the 
class subject to the lowest rate. Second, either--
    (a) A net loss from all the classes of long-term capital gain and 
loss (beginning with the class subject to the highest Federal income tax 
rate and ending with the class subject to the lowest rate) is used to 
offset any net gain from the class of short-term capital gain and loss; 
or
    (b) A net loss from the class of short-term capital gain and loss is 
used to offset any net gain from each class of long-term capital gain 
and loss, in turn, until exhaustion of the class, beginning with the 
class subject to the highest Federal income tax rate and ending with the 
class subject to the lowest Federal income tax rate.
    (v) Carry forward of net capital gain or loss by the trust. If, at 
the end of a taxable year, a trust has, after the application of 
paragraph (d)(1)(iv) of this section, any net loss or any net gain that 
is not treated as distributed under paragraph (d)(1)(ii)(a)(2) of this 
section, the net gain or loss is carried over to succeeding taxable 
years and retains its character in succeeding taxable years as gain or 
loss from its particular class.
    (vi) Special transitional rules. To be eligible to be included in 
the class of qualified dividend income, dividends must meet the 
definition of section 1(h)(11) and must be received by the trust after 
December 31, 2002. Long-term capital gain or loss properly taken into 
account by the trust before January 1, 1997, is included in the class of 
all other long-term capital gains and losses. Long-term capital gain or 
loss properly taken into account by the trust on or after January 1, 
1997, and before May 7, 1997, if not treated as distributed in 1997, is 
included in the class of all other long-term capital gains and losses. 
Long-term capital gain or loss (other than 28-percent gain (gains and 
losses from collectibles and section 1202 gains), unrecaptured section 
1250 gain (long-term gains not treated as ordinary income that would be 
treated as ordinary income if section 1250(b)(1) included all 
depreciation), and qualified 5-year gain as defined in section 1(h)(9) 
prior to amendment by JGTRRA), properly taken into account by the trust 
before January 1, 2003, and distributed during 2003 is treated as if it 
were properly taken into account by the trust after May 5, 2003. Long-
term capital gain or loss (other than 28-percent gain, unrecaptured 
section 1250 gain, and qualified 5-year gain), properly taken into 
account by the trust on or after January 1, 2003, and before May 6, 
2003, if not treated as distributed during 2003, is included in the 
class of all other long-term capital gain. Qualified 5-year gain 
properly taken into account by the trust after December 31, 2000, and 
before May 6, 2003, if not treated as distributed by the trust in 2003 
or a prior year, must be maintained in a separate class within the 
capital gains category until distributed. Qualified 5-year gain properly 
taken into account by the trust before January 1, 2003, and deemed 
distributed during 2003 is subject to the same current tax rate as 
deemed distributions from the class of all other long-term capital gain 
realized by the trust after May 5, 2003. Qualified 5-year gain properly 
taken into account by the trust on or after January 1, 2003, and before 
May 6, 2003, if treated as distributed by the trust in 2003, is subject 
to the tax rate in effect prior to the amendment of section 1(h)(9) by 
JGTRRA.
    (vii) Application of section 643(a)(7). For application of the anti-
abuse rule of section 643(a)(7) to distributions from charitable 
remainder trusts, see Sec. 1.643(a)-8.
    (viii) Examples. The following examples illustrate the rules in this 
paragraph (d)(1):

    Example 1. (i) X, a charitable remainder annuity trust described in 
section 664(d)(1), is created on January 1, 2003. The annual annuity 
amount is $100. X's income for the 2003 tax year is as follows:

Interest income.................................................     $80

[[Page 155]]

 
Qualified dividend income.......................................      50
Capital gains and losses........................................       0
Tax-exempt income...............................................       0
 

    (ii) In 2003, the year this income is received by the trust, 
qualified dividend income is subject to a different rate of Federal 
income tax than interest income and is, therefore, a separate class of 
income in the ordinary income category. The annuity amount is deemed to 
be distributed from the classes within the ordinary income category, 
beginning with the class subject to the highest Federal income tax rate 
and ending with the class subject to the lowest rate. Because during 
2003 qualified dividend income is taxed at a lower rate than interest 
income, the interest income is deemed distributed prior to the qualified 
dividend income. Therefore, in the hands of the recipient, the 2003 
annuity amount has the following characteristics:

Interest income.................................................     $80
Qualified dividend income.......................................      20
 

    (iii) The remaining $30 of qualified dividend income that is not 
treated as distributed to the recipient in 2003 is carried forward to 
2004 as undistributed qualified dividend income.
    Example 2. (i) The facts are the same as in Example 1, and at the 
end of 2004, X has the following classes of income:

Interest income class...........................................      $5
Qualified dividend income class ($10 from 2004 and $30 carried        40
 forward from 2003).............................................
Net short-term capital gain class...............................      15
Net long-term capital loss in 28-percent class..................   (325)
Net long-term capital gain in unrecaptured section 1250 gain         175
 class..........................................................
Net long-term capital gain in all other long-term capital gain       350
 class..........................................................
 

    (ii) In 2004, gain in the unrecaptured section 1250 gain class is 
subject to a 25-percent Federal income tax rate, and gain in the all 
other long-term capital gain class is subject to a lower rate. The net 
long-term capital loss in the 28-percent gain class is used to offset 
the net capital gains in the other classes of long-term capital gain and 
loss, beginning with the class subject to the highest Federal income tax 
rate and ending with the class subject to the lowest rate. The $325 net 
loss in the 28-percent gain class reduces the $175 net gain in the 
unrecaptured section 1250 gain class to $0. The remaining $150 loss from 
the 28-percent gain class reduces the $350 gain in the all other long-
term capital gain class to $200. As in Example 1, qualified dividend 
income is taxed at a lower rate than interest income during 2004. The 
annuity amount is deemed to be distributed from all the classes in the 
ordinary income category and then from the classes in the capital gains 
category, beginning with the class subject to the highest Federal income 
tax rate and ending with the class subject to the lowest rate. In the 
hands of the recipient, the 2004 annuity amount has the following 
characteristics:

Interest income.................................................     $ 5
Qualified dividend income.......................................      40
Net short-term capital gain.....................................      15
Net long-term capital gain in all other long-term capital gain        40
 class..........................................................
 

    (iii) The remaining $160 gain in the all other long-term capital 
gain class that is not treated as distributed to the recipient in 2004 
is carried forward to 2005 as gain in that same class.
    Example 3. (i) The facts are the same as in Examples 1 and 2, and at 
the end of 2005, X has the following classes of income:

Interest income class...........................................     $ 5
Qualified dividend income.......................................      20
Net loss in short-term capital gain class.......................    (50)
Net long-term capital gain in 28-percent gain class.............      10
Net long-term capital gain in unrecaptured section 1250 gain         135
 class..........................................................
Net long-term capital gain in all other long-term capital gain       160
 class (carried forward from 2004)..............................
 

    (ii) There are no long-term capital losses to net against the long-
term capital gains. Thus, the net short-term capital loss is used to 
offset the net capital gains in the classes of long-term capital gain 
and loss, in turn, until exhaustion of the class, beginning with the 
class subject to the highest Federal income tax rate and ending with the 
class subject to the lowest rate. The $50 net short-term loss reduces 
the $10 net gain in the 28-percent gain class to $0. The remaining $40 
net loss reduces the $135 net gain in the unrecaptured section 1250 gain 
class to $95. As in Examples 1 and 2, during 2005, qualified dividend 
income is taxed at a lower rate than interest income; gain in the 
unrecaptured section 1250 gain class is taxed at 25 percent; and gain in 
the all other long-term capital gain class is taxed at a rate lower than 
25 percent. The annuity amount is deemed to be distributed from all the 
classes in the ordinary income category and then from the classes in the 
capital gains category, beginning with the class subject to the highest 
Federal income tax rate and ending with the class subject to the lowest 
rate. Therefore, in the hands of the recipient, the 2005 annuity amount 
has the following characteristics:

Interest income.................................................     $ 5
Qualified dividend income.......................................      20
Unrecaptured section 1250 gain..................................      75
 

    (iii) The remaining $20 gain in the unrecaptured section 1250 gain 
class and the $160 gain in the all other long-term capital gain class 
that are not treated as distributed to the recipient in 2005 are carried 
forward to 2006 as gains in their respective classes.
    Example 4. (i) The facts are the same as in Examples 1, 2 and 3, and 
at the end of 2006, X has the following classes of income:

Interest income class...........................................    $ 95
Qualified dividend income class.................................      10
Net loss in short-term capital gain class.......................    (20)
Net long-term capital loss in 28-percent gain class.............   (350)
Net long-term capital gain in unrecaptured section 1250 gain          20
 class (carried forward from 2005)..............................

[[Page 156]]

 
Net long-term capital gain in all other long-term capital gain       160
 class (carried forward from 2005)..............................
 

    (ii) A net long-term capital loss in one class is used to offset the 
net capital gains in the other classes of long-term capital gain and 
loss, in turn, until exhaustion of the class, beginning with the class 
subject to the highest Federal income tax rate and ending with the class 
subject to the lowest rate. The $350 net loss in the 28-percent gain 
class reduces the $20 net gain in the unrecaptured section 1250 gain 
class to $0. The remaining $330 net loss reduces the $160 net gain in 
the all other long-term capital gain class to $0. As in Examples 1, 2 
and 3, during 2006, qualified dividend income is taxed at a lower rate 
than interest income. The annuity amount is deemed to be distributed 
from all the classes in the ordinary income category and then from the 
classes in the capital gains category, beginning with the class subject 
to the highest Federal income tax rate and ending with the class subject 
to the lowest rate. In the hands of the recipient, the 2006 annuity 
amount has the following characteristics:

Interest income.................................................    $ 95
Qualified dividend income.......................................       5
 

    (iii) The remaining $5 of qualified dividend income that is not 
treated as distributed to the recipient in 2006 is carried forward to 
2007 as qualified dividend income. The $20 net loss in the short-term 
capital gain class and the $170 net loss in the 28-percent gain class 
are carried forward to 2007 as net losses in their respective classes.
    Example 5. (i) X, a charitable remainder annuity trust described in 
section 664(d)(1), is created on January 1, 2002. The annual annuity 
amount is $100. Except for qualified 5-year gain of $200 realized before 
May 6, 2003, but not distributed, X has no other gains or losses carried 
over from former years. X's income for the 2007 tax year is as follows:

Interest income class...........................................    $ 10
Net gain in short-term capital gain class.......................       5
Net long-term capital gain in 28-percent gain class.............       5
Net long-term capital gain in unrecaptured section 1250 gain          10
 class..........................................................
Net long-term capital gain in all other long-term capital gain        10
 class..........................................................
 

    (ii) The annuity amount is deemed to be distributed from all the 
classes in the ordinary income category and then from the classes in the 
capital gains category, beginning with the class subject to the highest 
Federal income tax rate and ending with the class subject to the lowest 
rate. In 2007, gains distributed to a recipient from both the qualified 
5-year gain class and the all other long-term capital gains class are 
taxed at a 15/5 percent tax rate. Since after December 31, 2008, gains 
distributed from the qualified 5-year gain class will be taxed at a 
lower rate than gains distributed from the other classes of long-term 
capital gain and loss, distributions from the qualified 5-year gain 
class are made after distributions from the other classes of long-term 
capital gain and loss. In the hands of the recipient, the 2007 annuity 
amount has the following characteristics:

Interest income.................................................     $10
Short-term capital gain.........................................       5
28-percent gain.................................................       5
Unrecaptured section 1250 gain..................................      10
All other long-term capital gain................................      10
Qualified 5-year gain (taxed as all other long-term capital           60
 gain)..........................................................
 

    (iii) The remaining $140 of qualified 5-year gain that is not 
treated as distributed to the recipient in 2007 is carried forward to 
2008 as qualified 5-year gain.

    (ix) Effective dates. The rules in this paragraph (d)(1) that 
require long-term capital gains to be distributed in the following 
order: first, 28-percent gain (gains and losses from collectibles and 
section 1202 gains); second, unrecaptured section 1250 gain (long-term 
gains not treated as ordinary income that would be treated as ordinary 
income if section 1250(b)(1) included all depreciation); and then, all 
other long-term capital gains are applicable for taxable years ending on 
or after December 31, 1998. The rules in this paragraph (d)(1) that 
provide for the netting of capital gains and losses are applicable for 
taxable years ending on or after December 31, 1998. The rule in the 
second sentence of paragraph (d)(1)(vi) of this section is applicable 
for taxable years ending on or after December 31, 1998. The rule in the 
third sentence of paragraph (d)(1)(vi) of this section is applicable for 
distributions made in taxable years ending on or after December 31, 
1998. All other provisions of this paragraph (d)(1) are applicable for 
taxable years ending after November 20, 2003.

    (2) Allocation of deductions. Items of deduction of the trust for a 
taxable year of the trust which are deductible in determining taxable 
income (other than the deductions permitted by sections 642(b), 642(c), 
661, and 1202) which are directly attributable to one or more classes of 
items within a category of income (determined under paragraph 
(d)(1)(i)(a) of this section) or to corpus shall be allocated to such 
classes of items or to corpus. All other allowable deductions for such 
taxable year which are not directly attributable to one or more classes 
of items within a category of income or to corpus (other than the

[[Page 157]]

deductions permitted by sections 642(b), 642(c), 661, and 1202) shall be 
allocated among the classes of items within the category (excluding 
classes of items with net losses) on the basis of the gross income of 
such classes for such taxable year reduced by the deductions allocated 
thereto under the first sentence of this subparagraph, but in no event 
shall the amount of expenses allocated to any class of items exceed such 
income of such class for the taxable year. Items of deduction which are 
not allocable under the above two sentences (other than the deductions 
permitted by sections 642(b), 642(c), 661, and 1202) may be allocated in 
any manner. All taxes imposed by chapter 42 of the Code (including 
without limitation taxes treated under section 664(c)(2) as imposed by 
chapter 42) and, for taxable years beginning prior to January 1, 2007, 
all taxes imposed by subtitle A of the Code for which the trust is 
liable because it has unrelated business taxable income, shall be 
allocated to corpus. Any expense which is not deductible in determining 
taxable income and which is not allocable to any class of items 
described in paragraph (d)(1)(i)(a)(3) of this section shall be 
allocated to corpus. The deductions allowable to a trust under sections 
642(b), 642(c), 661, and 1202 are not allowed in determining the amount 
or character of any class of items within a category of income described 
in paragraph (d)(1)(i)(a) of this section or to corpus.
    (3) Allocation of income among recipients. If there are two or more 
recipients, each will be treated as receiving his pro rata portion of 
the categories of income and corpus. The application of this rule may be 
illustrated by the following example:

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

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

[[Page 158]]

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

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

    (e) Other distributions--(1) Character of distributions. An amount 
distributed by the trust to an organization described in section 170(c) 
other than the annuity or unitrust amount shall be considered as a 
distribution of corpus and of those categories of income specified in 
paragraph (d)(1)(i)(a) of this section in an order inverse to that 
prescribed in such paragraph. The character of such amount shall be 
determined as of the end of the taxable year of the trust in which the 
distribution is made after the character of the annuity or unitrust 
amount has been determined.
    (2) Distributions in kind. In the case of a distribution of an 
amount to which subparagraph (1) of this paragraph applies, no gain or 
loss is realized by the trust by reason of a distribution in kind unless 
such distribution is in satisfaction of a right to receive a 
distribution of a specific dollar amount or in specific property other 
than that distributed.
    (f) Effective date--(1) General rule. The provisions of this section 
are effective with respect to transfers in trust made after July 31, 
1969. Any trust created (within the meaning of applicable local law) 
prior to August 1, 1969, is not a charitable remainder trust even if it 
otherwise satisfies the definition of a charitable remainder trust.
    (2) Transfers to pre-1970 trusts. Property transferred to a trust 
created (within the meaning of applicable local law) before August 1, 
1969, whose governing instrument provides that an organization described 
in section 170(c) receives an irrevocable remainder interest in such 
trust, shall, for purposes of subparagraphs (1) and (3) of this 
paragraph, be deemed transferred to a trust created on the date of such 
transfer provided that the transfer occurs after July 31, 1969, and 
prior to October 18, 1971, and the transferred property and any 
undistributed income therefrom is severed and placed in a separate trust 
before December 31, 1972, or if later, on or before the 30th day after 
the date on which any judicial proceedings begun before December 31, 
1972, which are required to sever such property, become final.

[[Page 159]]

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

See paragraph (d)(4) of this section for rules relating to the year of 
inclusion in the case of an underpayment to a recipient and the 
allowance of a deduction in the case of an overpayment to a recipient. A 
deduction for a transfer to a charitable remainder trust shall not be 
allowed until the requirements of this paragraph are met and then only 
if the deduction is claimed on a timely filed return (including 
extensions) or on a claim for refund filed within the period of 
limitations prescribed by section 6511(a).
    (4) Valuation of unmarketable assets. The rules contained in 
paragraph (a)(7) of this section are applicable for trusts created on or 
after December 10, 1998. A trust in existence as of December 10, 1998, 
whose governing instrument requires that an independent trustee value 
the trust's unmarketable assets may be amended or reformed to permit a 
valuation method that satisfies the requirements of paragraph (a)(7) of 
this section for taxable years beginning on or after December 10, 1998.

[[Page 160]]

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

[T.D. 7202, 37 FR 16913, Aug. 23, 1972]

    Editorial Note: For Federal Register citations affecting Sec. 
1.664-1, see the List of CFR Sections Affected, which appears in the 
Finding Aids section of the printed volume and at www.fdsys.gov.



Sec. 1.664-2  Charitable remainder annuity trust.

    (a) Description. A charitable remainder annuity trust is a trust 
which complies with the applicable provisions of Sec. 1.664-1 and meets 
all of the following requirements:
    (1) Required payment of annuity amount--(i) Payment of sum certain 
at least annually. The governing instrument provides that the trust will 
pay a sum certain not less often than annually to a person or persons 
described in paragraph (a)(3) of this section for each taxable year of 
the period specified in paragraph (a)(5) of this section.
    (a) General rule applicable to all trusts. A trust will not be 
deemed to have engaged in an act of self-dealing (within the meaning of 
section 4941), to have unrelated debt-financed income (within the 
meaning of section 514), to have received an additional contribution 
(within the meaning of paragraph (b) of this section), or to have failed 
to function exclusively as a charitable remainder trust (within the 
meaning of Sec. 1.664-1(a)(4)) merely because the annuity amount is 
paid after the close of the taxable year if such payment is made within 
a reasonable time after the close of such taxable year and the entire 
annuity amount in the hands of the recipient is characterized only as 
income from the categories described in section 664(b)(1), (2), or (3), 
except to the extent it is characterized as corpus described in section 
664(b)(4) because--
    (1) The trust pays the annuity amount by distributing property 
(other than cash) that it owned at the close of the taxable year to pay 
the annuity amount, and the trustee elects to treat any income generated 
by the distribution as occurring on the last day of the taxable year in 
which the annuity amount is due;
    (2) The trust pays the annuity amount by distributing cash that was 
contributed to the trust (with respect to which a deduction was 
allowable under section 170, 2055, 2106, or 2522); or
    (3) The trust pays the annuity amount by distributing cash received 
as a return of basis in any asset that

[[Page 161]]

was contributed to the trust (with respect to which a deduction was 
allowable under section 170, 2055, 2106, or 2522), and that is sold by 
the trust during the year for which the annuity amount is due.
    (b) Special rule for trusts created before December 10, 1998. In 
addition to the circumstances described in paragraph (a)(1)(i)(a) of 
this section, a trust created before December 10, 1998, will not be 
deemed to have engaged in an act of self-dealing (within the meaning of 
section 4941), to have unrelated debt-financed income (within the 
meaning of section 514), to have received an additional contribution 
(within the meaning of paragraph (b) of this section), or to have failed 
to function exclusively as a charitable remainder trust (within the 
meaning of Sec. 1.664-1(a)(4)) merely because the annuity amount is 
paid after the close of the taxable year if such payment is made within 
a reasonable time after the close of such taxable year and the sum 
certain to be paid each year as the annuity amount is 15 percent or less 
of the initial net fair market value of the property irrevocably passing 
in trust as determined for federal tax purposes.
    (c) Reasonable time. For this paragraph (a)(1)(i), a reasonable time 
will not ordinarily extend beyond the date by which the trustee is 
required to file Form 5227, ``Split-Interest Trust Information Return,'' 
(including extensions) for the taxable year.
    (d) Example. The following example illustrates the rules in 
paragraph (a)(1)(i)(a) of this section:

    Example. X is a charitable remainder annuity trust described in 
section 664(d)(1) that was created after December 10, 1998. The prorated 
annuity amount payable from X for Year 1 is $100. The trustee does not 
pay the annuity amount to the recipient by the close of Year 1. At the 
end of Year 1, X has only $95 in the ordinary income category under 
section 664(b)(1) and no income in the capital gain or tax-exempt income 
categories under section 664(b)(2) or (3), respectively. By April 15 of 
Year 2, in addition to $95 in cash, the trustee distributes to the 
recipient of the annuity a capital asset with a $5 fair market value and 
a $2 adjusted basis to pay the $100 annuity amount due for Year 1. The 
trust owned the asset at the end of Year 1. Under Sec. 1.664-1(d)(5), 
the distribution is treated as a sale by X, resulting in X recognizing a 
$3 capital gain. The trustee elects to treat the capital gain as 
occurring on the last day of Year 1. Under Sec. 1.664-1(d)(1), the 
character of the annuity amount for Year 1 in the recipient's hands is 
$95 of ordinary income, $3 of capital gain income, and $2 of trust 
corpus. For Year 1, X satisfied paragraph (a)(1)(i)(a) of this section.

    (e) Effective date. This paragraph (a)(1)(i) is applicable for 
taxable years ending after April 18, 1997. However, paragraphs 
(a)(1)(i)(a)(2) and (3) of this section apply only to distributions made 
on or after January 5, 2001.
    (ii) Definition of sum certain. A sum certain is a stated dollar 
amount which is the same either as to each recipient or as to the total 
amount payable for each year of such period. For example, a provision 
for an amount which is the same every year to A until his death and 
concurrently an amount which is the same every year to B until his 
death, with the amount to each recipient to terminate at his death, 
would satisfy the above rule. Similarly, provisions for an amount to A 
and B for their joint lives and then to the survivor would satisfy the 
above rule. In the case of a distribution to an organization described 
in section 170(c) at the death of a recipient or the expiration of a 
term of years, the governing instrument may provide for a reduction of 
the stated amount payable after such a distribution: Provided, That:
    (a) The reduced amount payable is the same either as to each 
recipient or as to the total amount payable for each year of the balance 
of such period, and
    (b) The requirements of subparagraph (2)(ii) of this paragraph are 
met.
    (iii) Sum certain stated as a fraction or percentage. The stated 
dollar amount may be expressed as a fraction or a percentage of the 
initial net fair market value of the property irrevocably passing in 
trust as finally determined for Federal tax purposes. If the stated 
dollar amount is so expressed and such market value is incorrectly 
determined by the fiduciary, the requirement of this subparagraph will 
be satisfied if the governing instrument provides that in such event the 
trust shall pay to the recipient (in the case of an undervaluation) or 
be repaid by the recipient (in the case of an overvaluation) an amount 
equal to the difference between the amount which the trust should have 
paid the recipient if the correct

[[Page 162]]

value were used and the amount which the trust actually paid the 
recipient. Such payments or repayments must be made within a reasonable 
period after the final determination of such value. Any payment due to a 
recipient by reason of such incorrect valuation shall be considered to 
be a payment required to be distributed at the time of such final 
determination for purposes of paragraph (d)(4)(ii) of Sec. 1.664-1. See 
paragraph (d)(4) of Sec. 1.664-1 for rules relating to the year of 
inclusion of such payments and the allowance of a deduction for such 
repayments. See paragraph (b) of this section for rules relating to 
future contributions. For rules relating to required adjustments for 
underpayments or overpayments of the amount described in this paragraph 
in respect of payments made during a reasonable period of 
administration, see paragraph (a)(5) of Sec. 1.664-1. The application 
of the rule permitting the stated dollar amount to be expressed as a 
fraction or a percentage of the initial net fair market value of the 
property irrevocably passing in trust as finally determined for Federal 
tax purposes may be illustrated by the following example:

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

    (iv) Computation of annuity amount in certain circumstances--(a) 
Short taxable years. The governing instrument provides that, in the case 
of a taxable year which is for a period of less than 12 months other 
than the taxable year in which occurs the end of the period specified in 
subparagraph (5) of this paragraph, the annuity amount determined under 
subdivision (i) of this subparagraph shall be the amount otherwise 
determined under that subdivision multiplied by a fraction the numerator 
of which is the number of days in the taxable year of the trust and the 
denominator of which is 365 (366 if February 29 is a day included in the 
numerator).
    (b) Last taxable year of period. The governing instrument provides 
that, in the case of the taxable year in which occurs the end of the 
period specified in subparagraph (5) of this paragraph, the annuity 
amount which must be distributed under subdivision (i) of this 
subparagraph shall be the amount otherwise determined under that 
subdivision multiplied by a fraction the numerator of which is the 
number of days in the period beginning on the first day of such taxable 
year and ending on the last day of the period specified in subparagraph 
(5) of this paragraph and the denominator of which is 365 (366 if 
February 29 is a day included in the numerator). See subparagraph (5) of 
this paragraph for a special rule allowing termination of payment of the 
annuity amount with the regular payment next preceding the termination 
of the period specified therein.
    (2) Minimum annuity amount--(i) General rule. The total amount 
payable under subparagraph (1) of this paragraph is not less than 5 
percent of the initial net fair market value of the property placed in 
trust as finally determined for Federal tax purposes.
    (ii) Reduction of annuity amount in certain cases. A trust will not 
fail to meet the requirements of this subparagraph by reason of the fact 
that it provides for a reduction of the stated

[[Page 163]]

amount payable upon the death of a recipient or the expiration of a term 
of years provided that:
    (a) A distribution is made to an organization described in section 
170(c) at the death of such recipient or the expiration of such term of 
years, and
    (b) The total amounts payable each year under subparagraph (1) of 
this paragraph after such distribution are not less than a stated dollar 
amount which bears the same ratio to 5 percent of the initial net fair 
market value of the trust assets as the net fair market value of the 
trust assets immediately after such distribution bears to the net fair 
market value of the trust assets immediately before such distribution.
    (iii) Rule applicable to inter vivos trust which does not provide 
for payment of minimum annuity amount. In the case where the grantor of 
an inter vivos trust underestimates in good faith the initial net fair 
market value of the property placed in trust as finally determined for 
Federal tax purposes and specifies a fixed dollar amount for the annuity 
which is less than 5 percent of the initial net fair market value of the 
property placed in trust as finally determined for Federal tax purposes, 
the trust will be deemed to have met the 5 percent requirement if the 
grantor or his representative consents, by appropriate agreement with 
the District Director, to accept an amount equal to 20 times the annuity 
as the fair market value of the property placed in trust for purposes of 
determining the appropriate charitable contributions deduction.
    (3) Permissible recipients--(i) General rule. The amount described 
in subparagraph (1) of this paragraph is payable to or for the use of a 
named person or persons, at least one of which is not an organization 
described in section 170(c). If the amount described in subparagraph (1) 
of this paragraph is to be paid to an individual or individuals, all 
such individuals must be living at the time of the creation of the 
trust. A named person or persons may include members of a named class 
provided that, in the case of a class which includes any individual, all 
such individuals must be alive and ascertainable at the time of the 
creation of the trust unless the period for which the annuity amount is 
to be paid to such class consists solely of a term of years. For 
example, in the case of a testamentary trust, the testator's will may 
provide that an amount shall be paid to his children living at his 
death.
    (ii) Power to alter amount paid to recipients. A trust is not a 
charitable remainder annuity trust if any person has the power to alter 
the amount to be paid to any named person other than an organization 
described in section 170(c) if such power would cause any person to be 
treated as the owner of the trust, or any portion thereof, if subpart E, 
part 1, subchapter J, chapter 1, subtitle A of the Code were applicable 
to such trust. See paragraph (a)(4) of this section for a rule 
permitting the retention by a grantor of a testamentary power to revoke 
or terminate the interest of any recipient other than an organization 
described in section 170(c). For example, the governing instrument may 
not grant the trustee the power to allocate the annuity among members of 
a class unless such power falls within one of the exceptions to section 
674(a).
    (4) Other payments. No amount other than the amount described in 
subparagraph (1) of this paragraph may be paid to or for the use of any 
person other than an organization described in section 170(c). An amount 
is not paid to or for the use of any person other than an organization 
described in section 170(c) if the amount is transferred for full and 
adequate consideration. The trust may not be subject to a power to 
invade, alter, amend, or revoke for the beneficial use of a person other 
than an organization described in section 170(c). Notwithstanding the 
preceding sentence, the grantor may retain the power exercisable only by 
will to revoke or terminate the interest of any recipient other than an 
organization described in section 170(c). The governing instrument may 
provide that any amount other than the amount described in subparagraph 
(1) of this paragraph shall be paid (or may be paid in the discretion of 
the trustee) to an organization described in section 170(c) provided 
that in the case of distributions in kind, the adjusted basis of the

[[Page 164]]

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

[[Page 165]]

section 170(c) or retained, in whole or in part, for such use.
    (ii) Treatment of trust. If all of the trust corpus is to be 
retained for such use, the taxable year of the trust shall terminate at 
the end of the period specified in subparagraph (5) of this paragraph 
and the trust shall cease to be treated as a charitable remainder trust 
for all purposes. If all or any portion of the trust corpus is to be 
transferred to or for the use of such organization or organizations, the 
trustee shall have a reasonable time after the period specified in 
subparagraph (5) of this paragraph to complete the settlement of the 
trust. During such time, the trust shall continue to be treated as a 
charitable remainder trust for all purposes, such as sections 664, 
4947(a)(2), and 4947(b)(3)(B). Upon the expiration of such period, the 
taxable year of the trust shall terminate and the trust shall cease to 
be treated as a charitable remainder trust for all purposes. If the 
trust continues in existence, it will be subject to the provisions of 
section 4947(a)(1) unless the trust is exempt from taxation under 
section 501(a). For purposes of determining whether the trust is exempt 
under section 501(a) as an organization described in section 501(c)(3), 
the trust shall be deemed to have been created at the time it ceases to 
be treated as a charitable remainder trust.
    (iii) Concurrent or successive remaindermen. Where interests in the 
corpus of the trust are given to more than one organization described in 
section 170(c) such interests may be enjoyed by them either concurrently 
or successively.
    (iv) Alternative remaindermen. The governing instrument shall 
provide that if an organization to or for the use of which the trust 
corpus is to be transferred or for the use of which the trust corpus is 
to be retained is not an organization described in section 170(c) at the 
time any amount is to be irrevocably transferred to or for the use of 
such organization, such amount shall be transferred to or for the use of 
one or more alternative organizations which are described in section 
170(c) at such time or retained for such use. Such alternative 
organization or organizations may be selected in any manner provided by 
the terms of the governing instrument.
    (b) Additional contributions. A trust is not a charitable remainder 
annuity trust unless its governing instrument provides that no 
additional contributions may be made to the charitable remainder annuity 
trust after the initial contribution. For purposes of this section, all 
property passing to a charitable remainder annuity trust by reason of 
death of the grantor shall be considered one contribution.
    (c) Calculation of the fair market value of the remainder interest 
of a charitable remainder annuity trust. For purposes of sections 170, 
2055, 2106, and 2522, the fair market value of the remainder interest of 
a charitable remainder annuity trust (as described in this section) is 
the net fair market value (as of the appropriate valuation date) of the 
property placed in trust less the present value of the annuity. For 
purposes of this section, valuation date means, in general, the date on 
which the property is transferred to the trust by the donor regardless 
of when the trust is created. In the case of transfers to a charitable 
remainder annuity trust for which the valuation date is after April 30, 
1989, if an election is made under section 7520 and Sec. 1.7520-2(b) to 
compute the present value of the charitable interest by use of the 
interest rate component for either of the 2 months preceding the month 
in which the transfer is made, the month so elected is the valuation 
date for purposes of determining the interest rate and mortality tables. 
For purposes of section 2055 or 2106, the valuation date is the date of 
death unless the alternate valuation date is elected in accordance with 
section 2032 in which event, and within the limitations set forth in 
section 2032 and the regulations under that section, the valuation date 
is the alternate valuation date. If the decedent's estate elects the 
alternate valuation date under section 2032 and also elects, under 
section 7520 and Sec. 1.7520-2(b), to use the interest rate component 
for one of the 2 months preceding the alternate valuation date, the 
month so elected is the valuation date for purposes of determining the 
interest rate and mortality tables. The present value of an annuity is 
computed under Sec. 20.2031-7(d)

[[Page 166]]

of this chapter for transfers for which the valuation date is on or 
after May 1, 2009, or under Sec. 20.2031-7A(a) through (f), whichever 
is applicable, for transfers for which the valuation date is before May 
1, 2009. See, however, Sec. 1.7520-3(b) (relating to exceptions to the 
use of prescribed tables under certain circumstances).
    (d) Deduction for transfers to a charitable remainder annuity trust. 
For rules relating to a deduction for transfers to a charitable 
remainder annuity trust, see section 170, 2055, 2106, or 2522 and the 
regulations thereunder. Any claim for deduction on any return for the 
value of a remainder interest in a charitable remainder annuity trust 
must be supported by a full statement attached to the return showing the 
computation of the present value of such interest. The deduction allowed 
by section 170 is limited to the fair market value of the remainder 
interest of a charitable remainder annuity trust regardless of whether 
an organization described in section 170(c) also receives a portion of 
the annuity. For a special rule relating to the reduction of the amount 
of a charitable contribution deduction with respect to a contribution of 
certain ordinary income property or capital gain property, see section 
170(e)(1)(A) or 170(e)(1)(B)(i) and the regulations thereunder. For 
rules for postponing the time for deduction of a charitable contribution 
of a future interest in tangible personal property, see section 
170(a)(3) and the regulations thereunder.
    (e) Effective/applicability date. Paragraph (c) applies after April 
30, 1989.

[T.D. 7202, 37 FR 16918, Aug. 23, 1972, as amended by T.D. 7955, 49 FR 
19983, May 11, 1984; T.D. 8540, 59 FR 30116, June 10, 1994; T.D. 8791, 
63 FR 68191, Dec. 10, 1998; T.D. 8819, 64 FR 23229, Apr. 30, 1999; T.D. 
8819, Mar. 9, 2000, 65 FR 12471; T.D. 8926, 66 FR 1037, Jan. 5, 2001; 
T.D. 9448, 74 FR 21464, May 7, 2009; T.D. 9540, 76 FR 49595, Aug. 10, 
2011]



Sec. 1.664-3  Charitable remainder unitrust.

    (a) Description. A charitable remainder unitrust is a trust which 
complies with the applicable provisions of Sec. 1.664-1 and meets all 
of the following requirements:
    (1) Required payment of unitrust amount--(i) Payment of fixed 
percentage at least annually--(a) General rule. The governing instrument 
provides that the trust will pay not less often than annually a fixed 
percentage of the net fair market value of the trust assets determined 
annually to a person or persons described in paragraph (a)(3) of this 
section for each taxable year of the period specified in paragraph 
(a)(5) of this section. This paragraph (a)(1)(i)(a) is applicable for 
taxable years ending after April 18, 1997.
    (b) Income exception. Instead of the amount described in (a) of this 
subdivision (i), the governing instrument may provide that the trust 
shall pay for any year either the amount described in (1) or the total 
of the amounts described in (1) and (2) of this subdivision (b).
    (1) The amount of trust income for a taxable year to the extent that 
such amount is not more than the amount required to be distributed under 
paragraph (a)(1)(i)(a) of this section.
    (2) An amount of trust income for a taxable year that is in excess 
of the amount required to be distributed under paragraph (a)(1)(i)(a) of 
this section for such year to the extent that (by reason of paragraph 
(a)(1)(i)(b)(1) of this section) the aggregate of the amounts paid in 
prior years was less than the aggregate of such required amounts.
    (3) For purposes of this paragraph (a)(1)(i)(b), trust income 
generally means income as defined under section 643(b) and the 
applicable regulations. However, trust income may not be determined by 
reference to a fixed percentage of the annual fair market value of the 
trust property, notwithstanding any contrary provision in applicable 
state law. Proceeds from the sale or exchange of any assets contributed 
to the trust by the donor must be allocated to principal and not to 
trust income at least to the extent of the fair market value of those 
assets on the date of their contribution to the trust. Proceeds from the 
sale or exchange of any assets purchased by the trust must be allocated 
to principal and not to trust income at least to the extent of the 
trust's purchase price of those assets. Except as provided in the two 
preceding sentences, proceeds from the sale or exchange of any assets 
contributed to the trust by the donor or

[[Page 167]]

purchased by the trust may be allocated to income, pursuant to the terms 
of the governing instrument, if not prohibited by applicable local law. 
A discretionary power to make this allocation may be granted to the 
trustee under the terms of the governing instrument but only to the 
extent that the state statute permits the trustee to make adjustments 
between income and principal to treat beneficiaries impartially.
    (4) The rules in paragraph (a)(1)(i)(b)(1) and (2) of this section 
are applicable for taxable years ending after April 18, 1997. The rule 
in the first sentence of paragraph (a)(1)(i)(b)(3) is applicable for 
taxable years ending after April 18, 1997. The rules in the second, 
fourth, and fifth sentences of paragraph (a)(1)(i)(b)(3) are applicable 
for taxable years ending after January 2, 2004. The rule in the third 
sentence of paragraph (a)(1)(i)(b)(3) is applicable for sales or 
exchanges that occur after April 18, 1997. The rule in the sixth 
sentence of paragraph (a)(1)(i)(b)(3) is applicable for trusts created 
after January 2, 2004.
    (c) Combination of methods. Instead of the amount described in 
paragraph (a)(1)(i)(a) or (b) of this section, the governing instrument 
may provide that the trust will pay not less often than annually the 
amount described in paragraph (a)(1)(i)(b) of this section for an 
initial period and then pay the amount described in paragraph 
(a)(1)(i)(a) of this section (calculated using the same fixed 
percentage) for the remaining years of the trust only if the governing 
instrument provides that--
    (1) The change from the method prescribed in paragraph (a)(1)(i)(b) 
of this section to the method prescribed in paragraph (a)(1)(i)(a) of 
this section is triggered on a specific date or by a single event whose 
occurrence is not discretionary with, or within the control of, the 
trustees or any other persons;
    (2) The change from the method prescribed in paragraph (a)(1)(i)(b) 
of this section to the method prescribed in paragraph (a)(1)(i)(a) of 
this section occurs at the beginning of the taxable year that 
immediately follows the taxable year during which the date or event 
specified under paragraph (a)(1)(i)(c)(1) of this section occurs; and
    (3) Following the trust's conversion to the method described in 
paragraph (a)(1)(i)(a) of this section, the trust will pay at least 
annually to the permissible recipients the amount described only in 
paragraph (a)(1)(i)(a) of this section and not any amount described in 
paragraph (a)(1)(i)(b) of this section.
    (d) Triggering event. For purposes of paragraph (a)(1)(i)(c)(1) of 
this section, a triggering event based on the sale of unmarketable 
assets as defined in Sec. 1.664-1(a)(7)(ii), or the marriage, divorce, 
death, or birth of a child with respect to any individual will not be 
considered discretionary with, or within the control of, the trustees or 
any other persons.
    (e) Examples. The following examples illustrate the rules in 
paragraph (a)(1)(i)(c) of this section. For each example, assume that 
the governing instrument of charitable remainder unitrust Y provides 
that Y will initially pay not less often than annually the amount 
described in paragraph (a)(1)(i)(b) of this section and then pay the 
amount described in paragraph (a)(1)(i)(a) of this section (calculated 
using the same fixed percentage) for the remaining years of the trust 
and that the requirements of paragraphs (a)(1)(i)(c)(2) and (3) of this 
section are satisfied. The examples are as follows:

    Example 1. Y is funded with the donor's former personal residence. 
The governing instrument of Y provides for the change in method for 
computing the annual unitrust amount as of the first day of the year 
following the year in which the trust sells the residence. Y provides 
for a combination of methods that satisfies paragraph (a)(1)(i)(c) of 
this section.
    Example 2. Y is funded with cash and an unregistered security for 
which there is no available exemption permitting public sale under the 
Securities and Exchange Commission rules. The governing instrument of Y 
provides that the change in method for computing the annual unitrust 
amount is triggered on the earlier of the date when the stock is sold or 
at the time the restrictions on its public sale lapse or are otherwise 
lifted. Y provides for a combination of methods that satisfies paragraph 
(a)(1)(i)(c) of this section.
    Example 3. Y is funded with cash and with a security that may be 
publicly traded under the Securities and Exchange Commission

[[Page 168]]

rules. The governing instrument of Y provides that the change in method 
for computing the annual unitrust amount is triggered when the stock is 
sold. Y does not provide for a combination of methods that satisfies the 
requirements of paragraph (a)(1)(i)(c) of this section because the sale 
of the publicly-traded stock is within the discretion of the trustee.
    Example 4. S establishes Y for her granddaughter, G, when G is 10 
years old. The governing instrument of Y provides for the change in 
method for computing the annual unitrust amount as of the first day of 
the year following the year in which G turns 18 years old. Y provides 
for a combination of methods that satisfies paragraph (a)(1)(i)(c) of 
this section.
    Example 5. The governing instrument of Y provides for the change in 
method for computing the annual unitrust amount as of the first day of 
the year following the year in which the donor is married. Y provides 
for a combination of methods that satisfies paragraph (a)(1)(i)(c) of 
this section.
    Example 6. The governing instrument of Y provides that if the donor 
divorces, the change in method for computing the annual unitrust amount 
will occur as of the first day of the year following the year of the 
divorce. Y provides for a combination of methods that satisfies 
paragraph (a)(1)(i)(c) of this section.
    Example 7. The governing instrument of Y provides for the change in 
method for computing the annual unitrust amount as of the first day of 
the year following the year in which the noncharitable beneficiary's 
first child is born. Y provides for a combination of methods that 
satisfies paragraph (a)(1)(i)(c) of this section.
    Example 8. The governing instrument of Y provides for the change in 
method for computing the annual unitrust amount as of the first day of 
the year following the year in which the noncharitable beneficiary's 
father dies. Y provides for a combination of methods that satisfies 
paragraph (a)(1)(i)(c) of this section.
    Example 9. The governing instrument of Y provides for the change in 
method for computing the annual unitrust amount as of the first day of 
the year following the year in which the noncharitable beneficiary's 
financial advisor determines that the beneficiary should begin receiving 
payments under the second prescribed payment method. Because the change 
in methods for paying the unitrust amount is triggered by an event that 
is within a person's control, Y does not provide for a combination of 
methods that satisfies paragraph (a)(1)(i)(c) of this section.
    Example 10. The governing instrument of Y provides for the change in 
method for computing the annual unitrust amount as of the first day of 
the year following the year in which the noncharitable beneficiary 
submits a request to the trustee that the trust convert to the second 
prescribed payment method. Because the change in methods for paying the 
unitrust amount is triggered by an event that is within a person's 
control, Y does not provide for a combination of methods that satisfies 
paragraph (a)(1)(i)(c) of this section.

    (f) Effective date--(1) General rule. Paragraphs (a)(1)(i)(c), (d), 
and (e) of this section are applicable for charitable remainder trusts 
created on or after December 10, 1998.
    (2) General rule regarding reformations of combination of method 
unitrusts. If a trust is created on or after December 10, 1998, and 
contains a provision allowing a change in calculating the unitrust 
amount that does not comply with the provisions of paragraph 
(a)(1)(i)(c) of this section, the trust will qualify as a charitable 
remainder unitrust only if it is amended or reformed to use the initial 
method for computing the unitrust amount throughout the term of the 
trust, or is reformed in accordance with paragraph (a)(1)(i)(f)(3) of 
this section. If a trust was created before December 10, 1998, and 
contains a provision allowing a change in calculating the unitrust 
amount that does not comply with the provisions of paragraph 
(a)(1)(i)(c) of this section, the trust may be reformed to use the 
initial method for computing the unitrust amount throughout the term of 
the trust without causing the trust to fail to function exclusively as a 
charitable remainder unitrust under Sec. 1.664-1(a)(4), or may be 
reformed in accordance with paragraph (a)(1)(i)(f)(3) of this section. 
Except as provided in paragraph (a)(1)(i)(f)(3) of this section, a 
qualified charitable remainder unitrust will not continue to qualify as 
a charitable remainder unitrust if it is amended or reformed to add a 
provision allowing a change in the method for calculating the unitrust 
amount.
    (3) Special rule for reformations of trusts that begin by June 8, 
1999. Notwithstanding paragraph (a)(1)(i)(f)(2) of this section, if a 
trust either provides for payment of the unitrust amount under a 
combination of methods that is not permitted under paragraph 
(a)(1)(i)(c) of this section, or provides for payment of the unitrust 
amount under only the method prescribed in

[[Page 169]]

paragraph (a)(1)(i)(b) of this section, then the trust may be reformed 
to allow for a combination of methods permitted under paragraph 
(a)(1)(i)(c) of this section without causing the trust to fail to 
function exclusively as a charitable remainder unitrust under Sec. 
1.664-1(a)(4) or to engage in an act of self-dealing under section 4941 
if the trustee begins legal proceedings to reform by June 8, 1999. The 
triggering event under the reformed governing instrument may not occur 
in a year prior to the year in which the court issues the order 
reforming the trust, except for situations in which the governing 
instrument prior to reformation already provided for payment of the 
unitrust amount under a combination of methods that is not permitted 
under paragraph (a)(1)(i)(c) of this section and the triggering event 
occurred prior to the reformation.
    (g) Payment under general rule for fixed percentage trusts. When the 
unitrust amount is computed under paragraph (a)(1)(i)(a) of this 
section, a trust will not be deemed to have engaged in an act of self-
dealing (within the meaning of section 4941), to have unrelated debt-
financed income (within the meaning of section 514), to have received an 
additional contribution (within the meaning of paragraph (b) of this 
section), or to have failed to function exclusively as a charitable 
remainder trust (within the meaning of Sec. 1.664-1(a)(4)) merely 
because the unitrust amount is paid after the close of the taxable year 
if such payment is made within a reasonable time after the close of such 
taxable year and the entire unitrust amount in the hands of the 
recipient is characterized only as income from the categories described 
in section 664(b)(1), (2), or (3), except to the extent it is 
characterized as corpus described in section 664(b)(4) because--
    (1) The trust pays the unitrust amount by distributing property 
(other than cash) that it owned at the close of the taxable year, and 
the trustee elects to treat any income generated by the distribution as 
occurring on the last day of the taxable year in which the unitrust 
amount is due;
    (2) The trust pays the unitrust amount by distributing cash that was 
contributed to the trust (with respect to which a deduction was 
allowable under section 170, 2055, 2106, or 2522); or
    (3) The trust pays the unitrust amount by distributing cash received 
as a return of basis in any asset that was contributed to the trust 
(with respect to which a deduction was allowable under section 170, 
2055, 2106, or 2522), and that is sold by the trust during the year for 
which the unitrust amount is due.
    (h) Special rule for fixed percentage trusts created before December 
10, 1998. When the unitrust amount is computed under paragraph 
(a)(1)(i)(a) of this section, a trust created before December 10, 1998, 
will not be deemed to have engaged in an act of self-dealing (within the 
meaning of section 4941), to have unrelated debt-financed income (within 
the meaning of section 514), to have received an additional contribution 
(within the meaning of paragraph (b) of this section), or to have failed 
to function exclusively as a charitable remainder trust (within the 
meaning of Sec. 1.664-1(a)(4)) merely because the unitrust amount is 
paid after the close of the taxable year if such payment is made within 
a reasonable time after the close of such taxable year and the fixed 
percentage to be paid each year as the unitrust amount is 15 percent or 
less of the net fair market value of the trust assets as determined 
under paragraph (a)(1)(iv) of this section.
    (i) Example. The following example illustrates the rules in 
paragraph (a)(1)(i)(g) of this section:

    Example. X is a charitable remainder unitrust that calculates the 
unitrust amount under paragraph (a)(1)(i)(a) of this section. X was 
created after December 10, 1998. The prorated unitrust amount payable 
from X for Year 1 is $100. The trustee does not pay the unitrust amount 
to the recipient by the end of the Year 1. At the end of Year 1, X has 
only $95 in the ordinary income category under section 664(b)(1) and no 
income in the capital gain or tax-exempt income categories under section 
664(b) (2) or (3), respectively. By April 15 of Year 2, in addition to 
$95 in cash, the trustee distributes to the unitrust recipient a capital 
asset with a $5 fair market value and a $2 adjusted basis to pay the 
$100 unitrust amount due for Year 1. The trust owned the asset at the 
end of Year 1. Under Sec. 1.664-1(d)(5), the distribution is treated as 
a sale by X, resulting in X recognizing a $3 capital gain. The trustee 
elects to treat the capital gain as occurring on the last day

[[Page 170]]

of Year 1. Under Sec. 1.664-1(d)(1), the character of the unitrust 
amount for Year 1 in the recipient's hands is $95 of ordinary income, $3 
of capital gain income, and $2 of trust corpus. For Year 1, X satisfied 
paragraph (a)(1)(i)(g) of this section.

    (j) Payment under income exception. When the unitrust amount is 
computed under paragraph (a)(1)(i)(b) of this section, a trust will not 
be deemed to have engaged in an act of self-dealing (within the meaning 
of section 4941), to have unrelated debt-financed income (within the 
meaning of section 514), to have received an additional contribution 
(within the meaning of paragraph (b) of this section), or to have failed 
to function exclusively as a charitable remainder trust (within the 
meaning of Sec. 1.664-1(a)(4)) merely because payment of the unitrust 
amount is made after the close of the taxable year if such payment is 
made within a reasonable time after the close of such taxable year.
    (k) Reasonable time. For paragraphs (a)(1)(i) (g), (h), and (j) of 
this section, a reasonable time will not ordinarily extend beyond the 
date by which the trustee is required to file Form 5227, ``Split-
Interest Trust Information Return,'' (including extensions) for the 
taxable year.
    (l) Effective date. Paragraphs (a)(1)(i) (g), (h), (i), (j), and (k) 
of this section are applicable for taxable years ending after April 18, 
1997. Paragraphs (a)(1)(i)(g)(2) and (3) apply only to distributions 
made on or after January 5, 2001.
    (ii) Definition of fixed percentage. The fixed percentage may be 
expressed either as a fraction or as a percentage and must be payable 
each year in the period specified in subparagraph (5) of this paragraph. 
A percentage is fixed if the percentage is the same either as to each 
recipient or as to the total percentage payable each year of such 
period. For example, provision for a fixed percentage which is the same 
every year to A until his death and concurrently a fixed percentage 
which is the same every year to B until his death, the fixed percentage 
to each recipient to terminate at his death, would satisfy the rule. 
Similarly, provision for a fixed percentage to A and B for their joint 
lives and then to the survivor would satisfy the rule. In the case of a 
distribution to an organization described in section 170(c) at the death 
of a recipient or the expiration of a term of years, the governing 
instrument may provide for a reduction of the fixed percentage payable 
after such distribution Provided That:
    (a) The reduced fixed percentage is the same either as to each 
recipient or as to the total amount payable for each year of the balance 
of such period, and
    (b) The requirements of subparagraph (2)(ii) of this paragraph are 
met.
    (iii) Rules applicable to incorrect valuations. The governing 
instrument provides that in the case where the net fair market value of 
the trust assets is incorrectly determined by the fiduciary, the trust 
shall pay to the recipient (in the case of an undervaluation) or be 
repaid by the recipient (in the case of an overvaluation) an amount 
equal to the difference between the amount which the trust should have 
paid the recipient if the correct value were used and the amount which 
the trust actually paid the recipient. Such payments or repayments must 
be made within a reasonable period after the final determination of such 
value. Any payment due to a recipient by reason of such incorrect 
valuation shall be considered to be a payment required to be distributed 
at the time of such final determination for purposes of paragraph 
(d)(4)(ii) of Sec. 1.664-1. See paragraph (d)(4) of Sec. 1.664-1 for 
rules relating to the year of inclusion of such payments and the 
allowance of a deduction for such repayments. See paragraph (b) of this 
section for rules relating to additional contributions.
    (iv) Rules applicable to valuation. In computing the net fair market 
value of the trust assets there shall be taken into account all assets 
and liabilities without regard to whether particular items are taken 
into account in determining the income of the trust. The net fair market 
value of the trust assets may be determined on any one date during the 
taxable year of the trust, or by taking the average of valuations made 
on more than one date during the taxable year of the trust, so long as 
the same valuation date or dates and valuation methods are used each 
year. If the governing instrument

[[Page 171]]

does not specify the valuation date or dates, the trustee must select 
such date or dates and indicate the selection on the first return on 
Form 5227, ``Split-Interest Trust Information Return,'' that the trust 
must file. The amount described in subdivision (i)(a) of this 
subparagraph which must be paid each year must be based upon the 
valuation for such year.
    (v) Computation of unitrust amount in certain circumstances--(a) 
Short taxable years. The governing instrument provides that, in the case 
of a taxable year which is for a period of less than 12 months other 
than the taxable year in which occurs the end of the period specified in 
subparagraph (5) of this paragraph:
    (1) The amount determined under subdivision (i)(a) of this 
subparagraph shall be the amount otherwise determined under that 
subdivision multiplied by a fraction the numerator of which is the 
number of days in the taxable year of the trust and the denominator of 
which is 365 (366 if February 29 is a day included in the numerator),
    (2) The amount determined under subdivision (i)(b) of this 
subparagraph shall be computed by using the amount determined under 
subdivision (a)(1) of this subdivision (v), and
    (3) If no valuation date occurs before the end of the taxable year 
of the trust, the trust assets shall be valued as of the last day of the 
taxable year of the trust.
    (b) Last taxable year of period. (1) The governing instrument 
provides that, in the case of the taxable year in which occurs the end 
of the period specified in subparagraph (5) of this paragraph:
    (i) The unitrust amount which must be distributed under subdivision 
(i)(a) of this subparagraph shall be the amount otherwise determined 
under that subdivision multiplied by a fraction the numerator of which 
is the number of days in the period beginning on the first day of such 
taxable year and ending on the last day of the period specified in 
subparagraph (5) of this paragraph and the denominator of which is 365 
(366 if February 29 is a day included in the numerator),
    (ii) The amount determined under subdivision (i)(b) of this 
subparagraph shall be computed by using the amount determined under 
(b)(1)(i) of this subdivision (v), and
    (iii) If no valuation date occurs before the end of such period, the 
trust assets shall be valued as of the last day of such period.
    (2) See subparagraph (5) of this paragraph for a special rule 
allowing termination of payment of the unitrust amount with the regular 
payment next preceding the termination of the period specified therein.
    (2) Minimum unitrust amount--(i) General rule. The fixed percentage 
described in subparagraph (1)(i) of this paragraph with respect to all 
beneficiaries taken together is not less than 5 percent.
    (ii) Reduction of unitrust amount in certain cases. A trust will not 
fail to meet the requirements of this subparagraph by reason of the fact 
that it provides for a reduction of the fixed percentage payable upon 
the death of a recipient or the expiration of a term of years Provided 
That:
    (a) A distribution is made to an organization described in section 
170(c) at the death of such recipient or the expiration of such term of 
years, and
    (b) The total of the percentage payable under subparagraph (1) of 
this paragraph after such distribution is not less than 5 percent.
    (3) Permissible recipients--(i) General rule. The amount described 
in subparagraph (1) of this paragraph is payable to or for the use of a 
named person or persons, at least one of which is not an organization 
described in section 170(c). If the amount described in subparagraph (1) 
of this paragraph is to be paid to an individual or individuals, all 
such individuals must be living at the time of creation of the trust. A 
named person or persons may include members of a named class except in 
the case of a class which includes any individual, all such individuals 
must be alive and ascertainable at the time of the creation of the trust 
unless the period for which the unitrust amount is to be paid to such 
class consists solely of a term of years. For example, in the case of a 
testamentary trust, the testator's will may provide that the required 
amount shall be paid to his children living at his death.

[[Page 172]]

    (ii) Power to alter amount paid to recipients. A trust is not a 
charitable remainder unitrust if any person has the power to alter the 
amount to be paid to any named person other than an organization 
described in section 170(c) if such power would cause any person to be 
treated as the owner of the trust, or any portion thereof, if subpart E, 
part 1, subchapter J, chapter 1, subtitle A of the Code were applicable 
to such trust. See paragraph (a)(4) of this section for a rule 
permitting the retention by a grantor of a testamentary power to revoke 
or terminate the interest of any recipient other than an organization 
described in section 170(c). For example, the governing instrument may 
not grant the trustee the power to allocate the fixed percentage among 
members of a class unless such power falls within one of the exceptions 
to section 674(a).
    (4) Other payments. No amount other than the amount described in 
subparagraph (1) of this paragraph may be paid to or for the use of any 
person other than an organization described in section 170(c). An amount 
is not paid to or for the use of any person other than an organization 
described in section 170(c) if the amount is transferred for full and 
adequate consideration. The trust may not be subject to a power to 
invade, alter, amend, or revoke for the beneficial use of a person other 
than an organization described in section 170(c). Notwithstanding the 
preceding sentence, the grantor may retain the power exercisable only by 
will to revoke or terminate the interest of any recipient other than an 
organization described in section 170(c). The governing instrument may 
provide that any amount other than the amount described in subparagraph 
(1) of this paragraph shall be paid (or may be paid in the discretion of 
the trustee) to an organization described in section 170(c) provided 
that, in the case of distributions in kind, the adjusted basis of the 
property distributed is fairly representative of the adjusted basis of 
the property available for payment on the date of payment. For example, 
the governing instrument may provide that a portion of the trust assets 
may be distributed currently, or upon the death of one or more 
recipients, to an organization described in section 170(c).
    (5) Period of payment of unitrust amount--(i) General rules. The 
period for which an amount described in subparagraph (1) of this 
paragraph is payable begins with the first year of the charitable 
remainder trust and continues either for the life or lives of a named 
individual or individuals or for a term of years not to exceed 20 years. 
Only an individual or an organization described in section 170(c) may 
receive an amount for the life of an individual. If an individual 
receives an amount for life, it must be solely for his life. Payment of 
the amount described in subparagraph (1) of this paragraph may terminate 
with the regular payment next preceding the termination of the period 
described in this subparagraph. The fact that the recipient may not 
receive such last payment shall not be taken into account for purposes 
of determining the present value of the remainder interest. In the case 
of an amount payable for a term of years, the length of the term of 
years shall be ascertainable with certainty at the time of the creation 
of the trust, except that the term may be terminated by the death of the 
recipient or by the grantor's exercise by will of a retained power to 
revoke or terminate the interest of any recipient other than an 
organization described in section 170(c). In any event, the period may 
not extend beyond either the life or lives of a named individual or 
individuals or a term of years not to exceed 20 years. For example, the 
governing instrument may not provide for the payment of a unitrust 
amount to A for his life and then to B for a term of years because it is 
possible for the period to last longer than either the lives of 
recipients in being at the creation of the trust or a term of years not 
to exceed 20 years. On the other hand, the governing instrument may 
provide for the payment of a unitrust amount to A for his life and then 
to B for his life or a term of years (not to exceed 20 years), whichever 
is shorter (but not longer), if both A and B are in being at the 
creation of the trust because it is not possible for the period to last 
longer than the lives of recipients in being at the creation of the 
trust.

[[Page 173]]

    (ii) Relationship to 5 percent requirement. The 5 percent 
requirement provided in subparagraph (2) of this paragraph must be met 
until the termination of all of the payments described in subparagraph 
(1) of this paragraph. For example, the following provisions would 
satisfy the above rules:
    (a) A fixed percentage of at least 5 percent to A and B for their 
joint lives and then to the survivor for his life;
    (b) A fixed percentage of at least 5 percent to A for life or for a 
term of years not longer than 20 years, whichever is longer (or 
shorter);
    (c) A fixed percentage of at least 5 percent to A for life or for a 
term of years not longer than 20 years and then to B for life (provided 
B was living at the creation of the trust);
    (d) A fixed percentage to A for his life and concurrently a fixed 
percentage to B for his life (the percentage to each recipient to 
terminate at his death) if the percentage given to each individual is 
not less than 5 percent;
    (e) A fixed percentage to A for his life and concurrently an equal 
percentage to B for his life, and at the death of the first to die, the 
trust to distribute one-half of the then value of its assets to an 
organization described in section 170(c) if the total of the percentages 
is not less than 5 percent for the entire period described in this 
subparagraph.
    (6) Permissible remaindermen--(i) General rule. At the end of the 
period specified in subparagraph (5) of this paragraph, the entire 
corpus of the trust is required to be irrevocably transferred, in whole 
or in part, to or for the use of one or more organizations described in 
section 170(c) or retained, in whole or in part, for such use.
    (ii) Treatment of trust. If all of the trust corpus is to be 
retained for such use, the taxable year of the trust shall terminate at 
the end of the period specified in subparagraph (5) of this paragraph 
and the trust shall cease to be treated as a charitable remainder trust 
for all purposes. If all or any portion of the trust corpus is to be 
transferred to or for the use of such organization or organizations, the 
trustee shall have a reasonable time after the period specified in 
subparagraph (5) of this paragraph to complete the settlement of the 
trust. During such time, the trust shall continue to be treated as a 
charitable remainder trust for all purposes, such as section 664, 
4947(a)(2), and 4947(b)(3)(B). Upon the expiration of such period, the 
taxable year of the trust shall terminate and the trust shall cease to 
be treated as a charitable remainder trust for all purposes. If the 
trust continues in existence, it will be subject to the provisions of 
section 4947(a)(1) unless the trust is exempt from taxation under 
section 501(a). For purposes of determining whether the trust is exempt 
under section 501(a) as an organization described in section 501(c)(3), 
the trust shall be deemed to have been created at the time it ceases to 
be treated as a charitable remainder trust.
    (iii) Concurrent or successive remaindermen. Where interests in the 
corpus of the trust are given to more than one organization described in 
section 170(c) such interests may be enjoyed by them either concurrently 
or successively.
    (iv) Alternative remaindermen. The governing instrument shall 
provide that if an organization to or for the use of which the trust 
corpus is to be transferred or for the use of which the trust corpus is 
to be retained is not an organization described in section 170(c) at the 
time any amount is to be irrevocably transferred to or for the use of 
such organization, such amount shall be transferred to or for the use of 
or retained for the use of one or more alternative organizations which 
are described in section 170(c) at such time. Such alternative 
organization or organizations may be selected in any manner provided by 
the terms of the governing instrument.
    (b) Additional contributions. A trust is not a charitable remainder 
annuity trust unless its governing instrument either prohibits 
additional contributions to the trust after the initial contribution or 
provides that for the taxable year of the trust in which the additional 
contribution is made:
    (1) Where no valuation date occurs after the time of the 
contribution and during the taxable year in which the contribution is 
made, the additional property shall be valued as of the time of 
contribution; and

[[Page 174]]

    (2) The amount described in paragraph (a)(1)(i)(a) of this section 
shall be computed by multiplying the fixed percentage by the sum of (i) 
the net fair market value of the trust assets (excluding the value of 
the additional property and any earned income from and any appreciation 
on such property after its contribution), and (ii) that proportion of 
the value of the additional property (that was excluded under 
subdivision (i) of this paragraph), which the number of days in the 
period which begins with the date of contribution and ends with the 
earlier of the last day of such taxable year or the last day of the 
period described in paragraph (a)(5) of this section bears to the number 
of days in the period which begins with the first day of such taxable 
year and ends with the earlier of the last day of such taxable year or 
the last day of the period described in paragraph (a)(5) of this 
section.


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

    Example 1. On March 2, 1971, X makes an additional contribution of 
property to a charitable remainder unitrust. The taxable year of the 
trust is the calendar year and the regular valuation date is January 1 
of each year. For purposes of computing the required payout with respect 
to the additional contribution for the year of contribution, the 
additional contribution is valued on March 2, 1971, the time of 
contribution. The property had a value on that date of $5,000. Income 
from such property in the amount of $250 was received on December 31, 
1971. The required payout with respect to the additional contribution 
for the year of contribution is $208 (5 percentx$5,000x305/365). The 
income earned after the date of the contribution and after the regular 
valuation date does not enter into the computation.
    Example 2. On July 1, 1971, X makes an additional contribution of 
$10,000 to a charitable remainder unitrust. The taxable year of the 
trust is the calendar year and the regular valuation date is December 31 
of each year. The fixed percentage is 5 percent. Between July 1, 1971, 
and December 31, 1971, the additional property appreciates in value to 
$12,500 and earns $500 of income. Because the regular valuation date for 
the year of contribution occurs after the date of the additional 
contribution, the additional contribution including income earned by it 
is valued on the regular valuation date. Thus, the required payout with 
respect to the additional contribution is $325.87 (5 
percentx[$12,500+$500]x183/365).

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

[T.D. 7202, 37 FR 16920, Aug. 23, 1972, as amended by T.D. 8791, 63 FR 
68192, Dec. 10, 1998; T.D. 8926, 66 FR 1038, Jan. 5, 2001; T.D. 9102, 69 
FR 20, Jan. 2, 2004]



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

    (a) Rules for determining present value. For purposes of sections 
170, 2055, 2106, and 2522, the fair market value of a remainder interest 
in a charitable remainder unitrust (as described in Sec. 1.664-3) is 
its present value determined under paragraph (d) of this section. The 
present value determined under this section shall be computed on the 
basis of--
    (1) Life contingencies determined as to each life involved, from the 
values of lx set forth in Table 2000CM contained in Sec. 20.2031-
7(d)(7) of this chapter in the case of transfers for which the

[[Page 175]]

valuation date is on or after May 1, 2009; or from Table 90CM contained 
in Sec. 20.2031-7A(f)(4) in the case of transfers for which the 
valuation date is after April 30, 1999, and before May 1, 2009. See 
Sec. 20.2031-7A(a) through (e), whichever is applicable, for transfers 
for which the valuation date is before May 1, 1999;
    (2) Interest at the section 7520 rate in the case of transfers for 
which the valuation date is after April 30, 1989, or 10 percent in the 
case of transfers to charitable remainder unitrusts made after November 
30, 1983, for which the valuation date is before May 1, 1989. See Sec. 
20.2031-7A (a) through (c) of this chapter, whichever is applicable, for 
transfers for which the valuation date is before December 1, 1983; and
    (3) The assumption that the amount described in Sec. 1.664-
3(a)(1)(i)(a) is distributed in accordance with the payout sequence 
described in the governing instrument. If the governing instrument does 
not prescribe when the distribution is made during the period for which 
the payment is made, for purposes of this section, the distribution is 
considered payable on the first day of the period for which the payment 
is made.
    (b) Actuarial Computations by the Internal Revenue Service. The 
regulations in this and in related sections provide tables of actuarial 
factors and examples that illustrate the use of the tables in 
determining the value of remainder interests in property. Section 
1.7520-1(c)(2) refers to government publications that provide additional 
tables of factors and examples of computations for more complex 
situations. If the computation requires the use of a factor that is not 
provided in this section, the Commissioner may supply the factor upon a 
request for a ruling. A request for a ruling must be accompanied by a 
recitation of the facts including the date of birth of each measuring 
life, and copies of the relevant documents. A request for a ruling must 
comply with the instructions for requesting a ruling published 
periodically in the Internal Revenue Bulletin (See Sec. 
601.601(d)(2)(ii)(b) of this chapter) and include payment of the 
required user fee. If the Commissioner furnishes the factor, a copy of 
the letter supplying the factor should be attached to the tax return in 
which the deduction is claimed. If the Commissioner does not furnish the 
factor, the taxpayer must furnish a factor computed in accordance with 
the principles set forth in this section.
    (c) Statement supporting deduction required. Any claim for a 
deduction on any return for the value of a remainder interest in a 
charitable remainder unitrust must be supported by a full statement 
attached to the return showing the computation of the present value of 
such interest.
    (d) Valuation. The fair market value of a remainder interest in a 
charitable remainder unitrust (as described in Sec. 1.664-3) for 
transfers for which the valuation date is on or after May 1, 2009, is 
its present value determined under paragraph (e) of this section. The 
fair market value of a remainder interest in a charitable remainder 
unitrust (as described in Sec. 1.664-3) for transfers for which the 
valuation date is before May 1, 2009, is its present value determined 
under the following sections:

------------------------------------------------------------------------
                     Valuation dates
---------------------------------------------------------   Applicable
                   After                        Before      regulations
------------------------------------------------------------------------
--.........................................     01-01-52     1.664-4A(a)
12-31-51...................................     01-01-71     1.664-4A(b)
12-31-70...................................     12-01-83     1.664-4A(c)
11-30-83...................................     05-01-89     1.664-4A(d)
04-30-89...................................     05-01-99     1.664-4A(e)
04-30-99...................................     05-01-09     1.664-4A(f)
------------------------------------------------------------------------

    (e) Valuation of charitable remainder unitrusts having certain 
payout sequences for transfers for which the valuation date is on or 
after May 1, 2009--(1) In general. Except as otherwise provided in 
paragraph (e)(2) of this section, in the case of transfers for which the 
valuation date is on or after May 1, 2009, the present value of a 
remainder interest is determined under paragraphs (e)(3) through (e)(7) 
of this section, provided that the amount of the payout as of any payout 
date during any taxable year of the trust is not larger than the amount 
that the trust could distribute on such date under Sec. 1.664-
3(a)(1)(v) if the taxable year of the trust were to end on such date. 
See, however, Sec. 1.7520-3(b) (relating to exceptions to the use of 
the prescribed tables under certain circumstances).

[[Page 176]]

    (2) Transitional rules for valuation of charitable remainder 
unitrusts. (i) For purposes of sections 2055, 2106, or 2624, if on May 
1, 2009, the decedent was mentally incompetent so that the disposition 
of the property could not be changed, and the decedent died on or after 
May 1, 2009, without having regained competency to dispose of the 
decedent's property, or the decedent died within 90 days of the date 
that the decedent first regained competency on or after May 1, 2009, the 
present value of a remainder interest under this section is determined 
as if the valuation date with respect to the decedent's gross estate is 
either before or after May 1, 2009, at the option of the decedent's 
executor.
    (ii) For purposes of sections 170, 2055, 2106, 2522, or 2624, in the 
case of transfers to a charitable remainder unitrust for which the 
valuation date is on or after May 1, 2009, and before July 1, 2009, the 
present value of a remainder interest based on one or more measuring 
lives is determined under this section by use of the section 7520 
interest rate for the month in which the valuation date occurs (see 
Sec. Sec. 1.7520-1(b) and 1.7520-2(a)(2)) and the appropriate actuarial 
tables under either paragraph (e)(7) of this section or Sec. 1.664-
4A(f)(6), at the option of the donor or the decedent's executor, as the 
case may be.
    (iii) For purposes of paragraphs (e)(2)(i) and (e)(2)(ii) of this 
section, where the donor or decedent's executor is given the option to 
use the appropriate actuarial tables under either paragraph (e)(7) of 
this section or Sec. 1.664-4A(f)(6), the donor or decedent's executor 
must use the same actuarial table with respect to each individual 
transaction and with respect to all transfers occurring on the valuation 
date (for example, gift and income tax charitable deductions with 
respect to the same transfer must be determined based on the same 
tables, and all assets includible in the gross estate and/or estate tax 
deductions claimed must be valued based on the same tables).
    (3) Adjusted payout rate. For transfers for which the valuation date 
is after April 30, 1989, the adjusted payout rate is determined by using 
the appropriate Table F in paragraph (e)(6) of this section, for the 
section 7520 interest rate applicable to the transfer. If the interest 
rate is between 4.2 and 14 percent, see paragraph (e)(6) of this 
section. If the interest rate is below 4.2 percent or greater than 14 
percent, see paragraph (b) of this section. The adjusted payout rate is 
determined by multiplying the fixed percentage described in Sec. 1.664-
3(a)(1)(i)(a) by the factor describing the payout sequence of the trust 
and the number of months by which the valuation date for the first full 
taxable year of the trust precedes the first payout date for such 
taxable year. If the governing instrument does not prescribe when the 
distribution or distributions shall be made during the taxable year of 
the trust, see paragraph (a) of this section. In the case of a trust 
having a payout sequence for which no figures have been provided by the 
appropriate table, and in the case of a trust that determines the fair 
market value of the trust assets by taking the average of valuations on 
more than one date during the taxable year, see paragraph (b) of this 
section.
    (4) Period is a term of years. If the period described in Sec. 
1.664-3(a)(5) is a term of years, the factor that is used in determining 
the present value of the remainder interest for transfers for which the 
valuation date is after November 30, 1983, is the factor under the 
appropriate adjusted payout rate in Table D of paragraph (e)(6) of this 
section corresponding to the number of years in the term. If the 
adjusted payout rate is an amount that is between adjusted payout rates 
for which factors are provided in Table D, a linear interpolation must 
be made. The present value of the remainder interest is determined by 
multiplying the net fair market value (as of the appropriate valuation 
date) of the property placed in trust by the factor determined under 
this paragraph. For purposes of this section, the valuation date is, in 
the case of an inter vivos transfer, the date on which the property is 
transferred to the trust by the donor. However, if an election is made 
under section 7520 and Sec. 1.7520-2(b) to compute the present value of 
the charitable interest by use of the interest rate component for either 
of the 2 months preceding the month in which the date of transfer

[[Page 177]]

falls, the month so elected is the valuation date for purposes of 
determining the interest rate and mortality tables. In the case of a 
testamentary transfer under section 2055, 2106, or 2624, the valuation 
date is the date of death, unless the alternate valuation date is 
elected under section 2032, in which event, and within the limitations 
set forth in section 2032 and the regulations thereunder, the valuation 
date is the alternate valuation date. If the decedent's estate elects 
the alternate valuation date under section 2032 and also elects, under 
section 7520 and Sec. 1.7520-2(b), to use the interest rate component 
for one of the 2 months preceding the alternate valuation date, the 
month so elected is the valuation date for purposes of determining the 
interest rate and mortality tables. The application of this paragraph 
(e)(4) may be illustrated by the following example:

    Example. D transfers $100,000 to a charitable remainder unitrust on 
January 1. The trust instrument requires that the trust pay 8 percent of 
the fair market value of the trust assets as of January 1st for a term 
of 12 years to D in quarterly payments (March 31, June 30, September 30, 
and December 31). The section 7520 rate for January (the month that the 
transfer occurred) is 9.6 percent. Under Table F(9.6) in paragraph 
(e)(6) of this section, the appropriate adjustment factor is .944628 for 
quarterly payments payable at the end of each quarter. The adjusted 
payout rate is 7.557 (8%x .944628). Based on the remainder factors in 
Table D in paragraph (e)(6) of this section, the present value of the 
remainder interest is $38,950.30, computed as follows:

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

    Interpolation adjustment:
    [GRAPHIC] [TIFF OMITTED] TR12JN00.002
    

Factor at 7.4 percent for 12 years...........................    .397495
Less: Interpolation adjustment...............................    .007992
                                                              ----------
  Interpolated factor........................................    .389503
 


    Present value of remainder interest:

($100,000x.389503)..........$38,950.30

    (5) Period is the life of one individual. (i) If the period 
described in Sec. 1.664-3(a)(5) is the life of one individual, the 
factor that is used in determining the present value of the remainder 
interest for transfers for which the valuation date is on or after May 
1, 2009, is the factor in Table U(1) in paragraph (e)(7) of this section 
under the appropriate adjusted payout. For purposes of the computations 
described in this paragraph (e)(5), the age of an individual is the age 
of that individual at the individual's nearest birthday. If the adjusted 
payout rate is an amount that is between adjusted payout rates for which 
factors are provided in the appropriate table, a linear interpolation 
must be made. The present value of the remainder interest is determined 
by multiplying the net fair market value (as of the valuation date as 
determined in paragraph (e)(4) of this section) of the property placed 
in trust by the factor determined under this paragraph (e)(5). If the 
adjusted payout rate is between 4.2 and 14 percent, see paragraph (e)(7) 
of this section. If the adjusted payout rate is below 4.2 percent or 
greater than 14 percent, see paragraph (b) of this section.
    (ii) The application of paragraph (e)(5)(i) of this section may be 
illustrated by the following example:

    Example. A, who is 44 years and 11 months old, transfers $100,000 to 
a charitable remainder unitrust on January 1st. The trust instrument 
requires that the trust pay to A semiannually (on June 30 and December 
31) 8 percent of the fair market value of the trust assets as of January 
1st during A's life. The section 7520 rate for January is 6.6 percent. 
Under Table F(6.6) in paragraph (e)(6) of this section, the appropriate 
adjustment factor is .953317 for semiannual payments payable at the end 
of the semiannual period. The adjusted payout rate is 7.627% (8% x 
.953317). Based on the remainder factors in Table U(1) in this section, 
the present value of the remainder interest is $11,075.00, computed as 
follows:

[[Page 178]]

[GRAPHIC] [TIFF OMITTED] TR10AU11.023

    (6) Actuarial Table D and F (4.2 through 14.0) for transfers for 
which the valuation date is after April 30, 1989. For transfers for 
which the valuation date is after April 30, 1989, the present value of a 
charitable remainder unitrust interest that is dependent upon a term of 
years is determined by using the section 7520 rate and the tables in 
this paragraph (e)(6). For transfers for which the valuation date is on 
or after May 1, 2009, where the present value of a charitable remainder 
unitrust interest is dependent on the termination of a life interest, 
see Paragraph (e)(5) of this section. See, however, Sec. 1.7520-3(b) 
(relating to exceptions to the use of prescribed tables under certain 
circumstances). Many actuarial factors not contained in the following 
tables are contained in Internal Revenue Service Publication 1458, 
``Actuarial Valuations Version 3B'' (2009). This publication will be 
available beginning May 1, 2009, at no charge, electronically via the 
IRS Internet site at http://www.irs.gov.

               Table D--Showing the Present Worth of a Remainder Interest Postponed for a Term Certain in a Charitable Remainder Unitrust
                                                            [Applicable after April 30, 1989]
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                             Adjusted payout rate
                        Years                        ---------------------------------------------------------------------------------------------------
                                                        4.2%      4.4%      4.6%      4.8%      5.0%      5.2%      5.4%      5.6%      5.8%      6.0%
--------------------------------------------------------------------------------------------------------------------------------------------------------
1...................................................   .958000   .956000   .954000   .952000   .950000   .948000   .946000   .944000   .942000   .940000
2...................................................   .917764   .913936   .910116   .906304   .902500   .898704   .894916   .891136   .887364   .883600
3...................................................   .879218   .873723   .868251   .862801   .857375   .851971   .846591   .841232   .835897   .830584
4...................................................   .842291   .835279   .828311   .821387   .814506   .807669   .800875   .794123   .787415   .780749
5...................................................   .806915   .798527   .790209   .781960   .773781   .765670   .757627   .749652   .741745   .733904
6...................................................   .773024   .763392   .753859   .744426   .735092   .725855   .716716   .707672   .698724   .689870
7...................................................   .740557   .729802   .719182   .708694   .698337   .688111   .678013   .668042   .658198   .648478
8...................................................   .709454   .697691   .686099   .674677   .663420   .652329   .641400   .630632   .620022   .609569
9...................................................   .679657   .666993   .654539   .642292   .630249   .618408   .606765   .595317   .584061   .572995
10..................................................   .651111   .637645   .624430   .611462   .598737   .586251   .573999   .561979   .550185   .538615
11..................................................   .623764   .609589   .595706   .582112   .568800   .555766   .543003   .530508   .518275   .506298
12..................................................   .597566   .582767   .568304   .554170   .540360   .526866   .513681   .500800   .488215   .475920

[[Page 179]]

 
13..................................................   .572469   .557125   .542162   .527570   .513342   .499469   .485942   .472755   .459898   .447365
14..................................................   .548425   .532611   .517222   .502247   .487675   .473496   .459701   .446281   .433224   .420523
15..................................................   .525391   .509177   .493430   .478139   .463291   .448875   .434878   .421289   .408097   .395292
16..................................................   .503325   .486773   .470732   .455188   .440127   .425533   .411394   .397697   .384427   .371574
17..................................................   .482185   .465355   .449079   .433339   .418120   .403405   .389179   .375426   .362131   .349280
18..................................................   .461933   .444879   .428421   .412539   .397214   .382428   .368163   .354402   .341127   .328323
19..................................................   .442532   .425304   .408714   .392737   .377354   .362542   .348282   .334555   .321342   .308624
20..................................................   .423946   .406591   .389913   .373886   .358486   .343690   .329475   .315820   .302704   .290106
--------------------------------------------------------------------------------------------------------------------------------------------------------


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


               Table D--Showing the Present Worth of a Remainder Interest Postponed for a Term Certain in a Charitable Remainder Unitrust
                                                            [Applicable after April 30, 1989]
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                             Adjusted payout rate
                        Years                        ---------------------------------------------------------------------------------------------------
                                                        8.2%      8.4%      8.6%      8.8%      9.0%      9.2%      9.4%      9.6%      9.8%      10.0%
--------------------------------------------------------------------------------------------------------------------------------------------------------
1...................................................   .918000   .916000   .914000   .912000   .910000   .908000   .906000   .904000   .902000   .900000
2...................................................   .842724   .839056   .835396   .831744   .828100   .824464   .820836   .817216   .813604   .810000
3...................................................   .773621   .768575   .763552   .758551   .753571   .748613   .743677   .738763   .733871   .729000
4...................................................   .710184   .704015   .697886   .691798   .685750   .679741   .673772   .667842   .661951   .656100
5...................................................   .651949   .644878   .637868   .630920   .624032   .617205   .610437   .603729   .597080   .590490
6...................................................   .598489   .590708   .583012   .575399   .567869   .560422   .553056   .545771   .538566   .531441
7...................................................   .549413   .541089   .532873   .524764   .516761   .508863   .501069   .493377   .485787   .478297
8...................................................   .504361   .495637   .487046   .478585   .470253   .462048   .453968   .446013   .438180   .430467
9...................................................   .463003   .454004   .445160   .436469   .427930   .419539   .411295   .403196   .395238   .387420
10..................................................   .425037   .415867   .406876   .398060   .389416   .380942   .372634   .364489   .356505   .348678
11..................................................   .390184   .380934   .371885   .363031   .354369   .345895   .337606   .329498   .321567   .313811
12..................................................   .358189   .348936   .339902   .331084   .322475   .314073   .305871   .297866   .290054   .282430
13..................................................   .328817   .319625   .310671   .301949   .293453   .285178   .277119   .269271   .261628   .254187
14..................................................   .301854   .292777   .283953   .275377   .267042   .258942   .251070   .243421   .235989   .228768
15..................................................   .277102   .268184   .259533   .251144   .243008   .235119   .227469   .220053   .212862   .205891
16..................................................   .254380   .245656   .237213   .229043   .221137   .213488   .206087   .198928   .192001   .185302
17..................................................   .233521   .225021   .216813   .208887   .201235   .193847   .186715   .179830   .173185   .166772
18..................................................   .214372   .206119   .198167   .190505   .183124   .176013   .169164   .162567   .156213   .150095
19..................................................   .196794   .188805   .181125   .173741   .166643   .159820   .153262   .146960   .140904   .135085

[[Page 180]]

 
20..................................................   .180657   .172946   .165548   .158452   .151645   .145117   .138856   .132852   .127096   .121577
--------------------------------------------------------------------------------------------------------------------------------------------------------


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


               Table D--Showing the Present Worth of a Remainder Interest Postponed for a Term Certain in a Charitable Remainder Unitrust
                                                            [Applicable after April 30, 1989]
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                             Adjusted payout rate
                        Years                        ---------------------------------------------------------------------------------------------------
                                                        12.2%     12.4%     12.6%     12.8%     13.0%     13.2%     13.4%     13.6%     13.8%     14.0%
--------------------------------------------------------------------------------------------------------------------------------------------------------
1...................................................   .878000   .876000   .874000   .872000   .870000   .868000   .866000   .864000   .862000   .860000
2...................................................   .770884   .767376   .763876   .760384   .756900   .753424   .749956   .746496   .743044   .739600
3...................................................   .676836   .672221   .667628   .663055   .658503   .653972   .649462   .644973   .640504   .636056
4...................................................   .594262   .588866   .583507   .578184   .572898   .567648   .562434   .557256   .552114   .547008
5...................................................   .521762   .515847   .509985   .504176   .498421   .492718   .487068   .481469   .475923   .470427
6...................................................   .458107   .451882   .445727   .439642   .433626   .427679   .421801   .415990   .410245   .404567
7...................................................   .402218   .395848   .389565   .383368   .377255   .371226   .365279   .359415   .353631   .347928
8...................................................   .353147   .346763   .340480   .334297   .328212   .322224   .316332   .310535   .304830   .299218
9...................................................   .310063   .303764   .297579   .291507   .285544   .279690   .273944   .268302   .262764   .257327
10..................................................   .272236   .266098   .260084   .254194   .248423   .242771   .237235   .231813   .226502   .221302
11..................................................   .239023   .233102   .227314   .221657   .216128   .210725   .205446   .200286   .195245   .190319
12..................................................   .209862   .204197   .198672   .193285   .188032   .182910   .177916   .173047   .168301   .163675
13..................................................   .184259   .178877   .173640   .168544   .163588   .158766   .154075   .149513   .145076   .140760
14..................................................   .161779   .156696   .151761   .146971   .142321   .137809   .133429   .129179   .125055   .121054
15..................................................   .142042   .137266   .132639   .128158   .123819   .119618   .115550   .111611   .107798   .104106
16..................................................   .124713   .120245   .115927   .111754   .107723   .103828   .100066   .096432   .092922   .089531
17..................................................   .109498   .105334   .101320   .097450   .093719   .090123   .086657   .083317   .080098   .076997
18..................................................   .096139   .092273   .088554   .084976   .081535   .078227   .075045   .071986   .069045   .066217
19..................................................   .084410   .080831   .077396   .074099   .070936   .067901   .064989   .062196   .059517   .056947
20..................................................   .074112   .070808   .067644   .064614   .061714   .058938   .056280   .053737   .051303   .048974
--------------------------------------------------------------------------------------------------------------------------------------------------------


[[Page 181]]


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


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


             Table F(4.6)--With Interest at 4.6 Percent, Showing Factors for Computation of the Adjusted Payout Rate for Certain Valuations
                                                            [Applicable after April 30, 1989]
--------------------------------------------------------------------------------------------------------------------------------------------------------
1 Number of months by which the valuation date for                             2 Factors for payout at the end of each period
 the first full taxable year of the trust precedes -----------------------------------------------------------------------------------------------------
                 the first payout
---------------------------------------------------       Annual period           Semiannual period         Quarterly period          Monthly period
        At least                But less than
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                             1                  1.000000                   .988882                   .983354                  .979680
                   1                         2                   .996259                   .985183                   .979676                  .976015
                   2                         3                   .992532                   .981498                   .976011
                   3                         4                   .988820                   .977826                   .972360
                   4                         5                   .985121                   .974168
                   5                         6                   .981436                   .970524
                   6                         7                   .977764                   .966894
                   7                         8                   .974107
                   8                         9                   .970463
                   9                        10                   .966832
                  10                        11                   .963216
                  11                        12                   .959613
                  12      ........................               .956023
--------------------------------------------------------------------------------------------------------------------------------------------------------


[[Page 182]]


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


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


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


[[Page 183]]


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


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


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


[[Page 184]]


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


             Table F(6.2)--With Interest at 6.2 Percent, Showing Factors for Computation of the Adjusted Payout Rate for Certain Valuations
                                                            [Applicable after April 30, 1989]
--------------------------------------------------------------------------------------------------------------------------------------------------------
1 Number of months by which the valuation date for                             2 Factors for payout at the end of each period
 the first full taxable year of the trust precedes -----------------------------------------------------------------------------------------------------
                 the first payout
---------------------------------------------------       Annual period           Semiannual period         Quarterly period          Monthly period
        At least                But less than
--------------------------------------------------------------------------------------------------------------------------------------------------------
 
                                             1                  1.000000                   .985185                   .977833                  .972952
                   1                         2                   .995000                   .980259                   .972944                  .968087
                   2                         3                   .990024                   .975358                   .968079
                   3                         4                   .985074                   .970481                   .963238
                   4                         5                   .980148                   .965628
                   5                         6                   .975247                   .960799
                   6                         7                   .970371                   .955995
                   7                         8                   .965519
                   8                         9                   .960691
                   9                        10                   .955887
                  10                        11                   .951107
                  11                        12                   .946352
                  12      ........................               .941620
--------------------------------------------------------------------------------------------------------------------------------------------------------


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

[[Page 185]]

 
                  12      ........................               .939850
--------------------------------------------------------------------------------------------------------------------------------------------------------


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


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


[[Page 186]]


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


             Table F(7.2)--With Interest at 7.2 Percent, Showing Factors for Computation of the Adjusted Payout Rate for Certain Valuations
                                                            [Applicable after April 30, 1989]
--------------------------------------------------------------------------------------------------------------------------------------------------------
1 Number of months by which the valuation date for                             2 Factors for payout at the end of each period
 the first full taxable year of the trust precedes -----------------------------------------------------------------------------------------------------
                 the first payout
---------------------------------------------------       Annual period           Semiannual period         Quarterly period          Monthly period
        At least                But less than
--------------------------------------------------------------------------------------------------------------------------------------------------------
 
                                             1                  1.000000                   .982917                   .974449                  .968830
                   1                         2                   .994223                   .977239                   .968819                  .963233
                   2                         3                   .988479                   .971593                   .963222
                   3                         4                   .982769                   .965980                   .957658
                   4                         5                   .977091                   .960400
                   5                         6                   .971446                   .954851
                   6                         7                   .965834                   .949335
                   7                         8                   .960255
                   8                         9                   .954707
                   9                        10                   .949192
                  10                        11                   .943708
                  11                        12                   .938256
                  12      ........................               .932836
--------------------------------------------------------------------------------------------------------------------------------------------------------


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

[[Page 187]]

 
                  12      ........................               .931099
--------------------------------------------------------------------------------------------------------------------------------------------------------


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


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


[[Page 188]]


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


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


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


[[Page 189]]


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


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


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


[[Page 190]]


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


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


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


[[Page 191]]


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


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


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


[[Page 192]]


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


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


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


[[Page 193]]


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


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


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


[[Page 194]]


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


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


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


[[Page 195]]


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


            Table F(12.4)--With Interest at 12.4 Percent, Showing Factors for Computation of the Adjusted Payout Rate for Certain Valuations
                                                            [Applicable after April 30, 1989]
--------------------------------------------------------------------------------------------------------------------------------------------------------
1 Number of months by which the valuation date for                             2 Factors for payout at the end of each period
 the first full taxable year of the trust precedes -----------------------------------------------------------------------------------------------------
                 the first payout
---------------------------------------------------       Annual period           Semiannual period         Quarterly period          Monthly period
        At least                But less than
--------------------------------------------------------------------------------------------------------------------------------------------------------
 
                                             1                  1.000000                   .971614                   .957623                  .948370
                   1                         2                   .990306                   .962195                   .948340                  .939176
                   2                         3                   .980706                   .952868                   .939147
                   3                         4                   .971199                   .943631                   .930043
                   4                         5                   .961785                   .934484
                   5                         6                   .952461                   .925425
                   6                         7                   .943228                   .916454
                   7                         8                   .934085
                   8                         9                   .925030
                   9                        10                   .916063
                  10                        11                   .907183
                  11                        12                   .898389
                  12      ........................               .889680
--------------------------------------------------------------------------------------------------------------------------------------------------------


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

[[Page 196]]

 
                  12      ........................               .888099
--------------------------------------------------------------------------------------------------------------------------------------------------------


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


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


[[Page 197]]


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


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


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


[[Page 198]]


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


            Table F(14.0)--With Interest at 14.0 Percent, Showing Factors for Computation of the Adjusted Payout Rate for Certain Valuations
                                                            [Applicable after April 30, 1989]
--------------------------------------------------------------------------------------------------------------------------------------------------------
1 Number of months by which the valuation date for                             2 Factors for payout at the end of each period
 the first rull taxable year of the trust precedes -----------------------------------------------------------------------------------------------------
                 the first payout
---------------------------------------------------       Annual period           Semiannual period         Quarterly period          Monthly period
        At least                But less than
--------------------------------------------------------------------------------------------------------------------------------------------------------
 
                                             1                  1.000000                   .968293                   .952691                  .942382
                   1                         2                   .989140                   .957778                   .942345                  .932148
                   2                         3                   .978399                   .947377                   .932111
                   3                         4                   .967774                   .937088                   .921989
                   4                         5                   .957264                   .926912
                   5                         6                   .946868                   .916846
                   6                         7                   .936586                   .906889
                   7                         8                   .926415
                   8                         9                   .916354
                   9                        10                   .906403
                  10                        11                   .896560
                  11                        12                   .886824
                  12      ........................               .877193
--------------------------------------------------------------------------------------------------------------------------------------------------------

    (7) Actuarial Table U(1) for transfers for which the valuation date 
is on or after May 1, 2009. For transfers for which the valuation date 
is on or after May 1, 2009, the present value of a charitable remainder 
unitrust interest that is dependent on the termination of a life 
interest is determined by using the section 7520 rate, Table U(1) in 
this paragraph (e)(7) and Table F(4.2) through (14.0) in paragraph 
(e)(6) of this section. See, however, Sec. 1.7520-3(b) (relating to 
exceptions to the use of prescribed tables under certain circumstances). 
Many actuarial factors not contained in the following tables are 
contained in Internal Revenue Service Publication 1458, ``Actuarial 
Valuations Version 3B'' (2009). This publication is available, at no 
charge, electronically via the IRS Internet site at http://www.irs.gov.

[[Page 199]]

[GRAPHIC] [TIFF OMITTED] TR10AU11.024


[[Page 200]]


[GRAPHIC] [TIFF OMITTED] TR10AU11.025


[[Page 201]]


[GRAPHIC] [TIFF OMITTED] TR10AU11.026


[[Page 202]]


[GRAPHIC] [TIFF OMITTED] TR10AU11.027


[[Page 203]]


[GRAPHIC] [TIFF OMITTED] TR10AU11.028


[[Page 204]]


[GRAPHIC] [TIFF OMITTED] TR10AU11.029


[[Page 205]]


[GRAPHIC] [TIFF OMITTED] TR10AU11.030


[[Page 206]]


[GRAPHIC] [TIFF OMITTED] TR10AU11.031


[[Page 207]]


[GRAPHIC] [TIFF OMITTED] TR10AU11.032


[[Page 208]]


[GRAPHIC] [TIFF OMITTED] TR10AU11.033


[[Page 209]]


[GRAPHIC] [TIFF OMITTED] TR10AU11.034


[[Page 210]]


[GRAPHIC] [TIFF OMITTED] TR10AU11.035


[[Page 211]]


[GRAPHIC] [TIFF OMITTED] TR10AU11.036


[[Page 212]]


[GRAPHIC] [TIFF OMITTED] TR10AU11.037


[[Page 213]]


[GRAPHIC] [TIFF OMITTED] TR10AU11.038


[[Page 214]]


    (f) Effective/applicability date. This section applies on and after 
May 1, 2009.

[T.D. 8540, 59 FR 30117, June 10, 1994, as amended by T.D. 8819, 64 FR 
23199, Apr. 30, 1999; T.D. 8886, 65 FR 36919, 36943, June 12, 2000; T.D. 
9448, 74 FR 21465, May 7, 2009; T.D. 9540, 76 FR 49595, Aug. 10, 2011]

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



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

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

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



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

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

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

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


[[Page 215]]


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

    (b) The undistributed net income of a foreign trust created by a 
U.S. person for any taxable year is the distributable net income of such 
trust (see Sec. 1.643(a)-6 and the examples set forth in paragraph (b) 
thereof), less:
    (1) The amount of income required to be distributed currently and 
any other amounts properly paid or credited or required to be 
distributed to beneficiaries in the taxable year as specified in 
paragraphs (1) and (2) of section 661(a), and
    (2) The amount of taxes imposed on such trust by chapter 1 of the 
Internal Revenue Code, which are attributable to items of income which 
are required to be included in such distributable net income. For 
purposes of subparagraph (2) of this paragraph, the amount of taxes 
imposed on the trust (for any taxable year), by chapter 1 of the 
Internal Revenue Code is the amount of taxes imposed pursuant to the 
provisions of section 871 which is properly allocable to the 
undistributed portion of the distributable net income. See Sec. 
1.665(d)-1. The amount of taxes imposed pursuant to the provisions of 
section 871 is the difference between the total tax imposed pursuant to 
the provisions of that section on the foreign trust created by a U.S. 
person for the year and the amount which would have been imposed on such 
trust had all the distributable net income, as determined under section 
643(a), been distributed. The application of the rule in this paragraph 
may be illustrated by the following examples:

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

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

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

Distributable net income (60% of each item of gross income of
 entire trust):
  60% of $10,000 U.S. dividends..............................     $6,000
  60% of $20,000 Country X capital gains.....................     12,000
  60% of $30,000 Country X dividends.........................     18,000
                                                   ------------
    Total....................................................     36,000

[[Page 216]]

 
Less:
  (i) Amounts distributed to the beneficiary--
  Income currently distributed to the beneficiary      $4,200
   (60% of $7,000)................................
  Other amounts distributed to the beneficiary         12,900
   (60% of $21,500)...............................
  Taxes under sec. 871 deemed distributed to the          900
   beneficiary (60% of $1,500)....................
                                                   -----------
    Total amounts distributed to the beneficiary..     18,000
  (ii) Amount of taxes imposed on the trust under        $900
   chapter 1 of the Code (See Sec. 1.665(d)-1)
   (60% of $1,500)................................
                                                              ----------
    Total....................................................    $18,900
                                                   ------------
    Undistributed net income.................................     17,100
 

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

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

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

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



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

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

[[Page 217]]

a foreign trust created by a U.S. person, the provisions of subpart D 
will not apply unless there is undistributed net income in at least one 
of the five preceding taxable years. See section 666 and the regulations 
thereunder.
    (c) The provisions of paragraphs (a) and (b) of this section may be 
illustrated by the following examples (it is assumed in each case that 
the exclusions provided in Sec. 1.665(b)-2 do not apply):

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

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

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

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

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

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

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

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



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

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

[[Page 218]]

required to be distributed to the extent, and only to the extent, that 
there is no undistributed net income for taxable years preceding the 
year of distribution other than undistributed net income accumulated 
while the beneficiary was under 21. If a distribution can be made from 
income accumulated either before or after a beneficiary reaches 21, it 
will be considered as made from the most recently accumulated income, 
and it will be so considered even though the governing instrument 
directs that distributions be charged first against the earliest 
accumulations.
    (ii) As was indicated in paragraph (a) of this section, a 
distribution of an amount excepted from the definition of an 
accumulation distribution will not reduce undistributed net income for 
the purpose of determining the effect of a future accumulation 
distribution. Thus, a distribution to a beneficiary of income 
accumulated before he reached 21 would not reduce the undistributed net 
income includible in a future accumulation distribution to another 
beneficiary. However, all future distributions to the same beneficiary, 
or to another beneficiary to whom a distribution would be excepted under 
the provisions of this subparagraph, would be excepted from the 
definition of an accumulation distribution to the extent that they could 
not be paid, credited, or required to be distributed from other 
accumulated income.
    (iii) The following examples illustrate the application of the 
foregoing rules of this subparagraph (in each of these examples it is 
assumed that the exceptions in section 665(b) (2), (3), and (4) do not 
apply):
    (a) Income is to be accumulated until A reaches 21 when the corpus 
and accumulated income are to be distributed to him. The distribution is 
not an accumulation distribution.
    (b) Income is to be accumulated until A is 21, when it is to be 
distributed to him but the corpus is to remain in trust. A distribution 
of the accumulated income to A when he reaches 21 is not an accumulation 
distribution.
    (c) Income is to be accumulated and added to corpus until A reaches 
21, when he is to receive one-third of the corpus (including 
accumulations). Thereafter all the income is to be paid to A until he is 
23 when the remaining corpus (including accumulations) is to be paid to 
him. If A dies under that age any undistributed portion is to be paid to 
B. Distributions to A at 21 and 23 out of accumulations are not 
accumulation distributions even though they include accumulated income. 
However, if A died at the age of 22, when B was 23, a distribution to B 
would be an accumulation distribution to the extent of income 
accumulations since B reached 21, and the amount of undistributed net 
income includible in the distribution will not be reduced by the 
previous distribution to A.
    (d) Income is to be accumulated and added to corpus until A is 21. 
After he is 21, he is entitled to all the income and, in addition, to 
distributions of corpus in the discretion of the trustee. When he 
reaches 25 he is entitled to the corpus. Distributions to A are not 
accumulation distributions, whether they are discretionary or upon 
termination of the trust.
    (e) The facts are the same as in the preceding example, except that 
income is to be accumulated until A is 23. Distributions to A are 
accumulation distributions to the extent of income accumulated after A 
reached 21.
    (f) Income may be distributed among a testator's children or 
accumulated and added to corpus until the youngest child is 21, when the 
corpus is to be distributed to the testator's then living descendants. 
Upon termination of the trust, the corpus is distributed to A, age 21; 
B, age 23; and C, the child of a deceased child, age 3. The 
distributions to A and C are not accumulation distributions. The 
distribution to B is an accumulation distribution to the extent of 
income accumulated after he reaches 21. (If the terms of the trust were 
such that it was subject to the separate share treatment under section 
663(c), the distribution to B would be an accumulation distribution only 
to the extent of income accumulated for B's separate share since he 
reached 21.)
    (g) Income may be distributed to A or accumulated and added to 
corpus during A's life. Upon the death of A the corpus is to be 
distributed to B. B is 23 at A's death. The distribution is an 
accumulation distribution to the extent

[[Page 219]]

of income accumulated since B reached 21.
    (2) Emergency distributions. The second exclusion from the 
definition of an accumulation distribution is for amounts properly paid 
or credited to a beneficiary to meet his emergency needs. Whether or not 
a distribution falls within this exclusion depends upon the facts and 
circumstances causing the distribution. A distribution based upon an 
unforeseen or unforeseeable combination of circumstances requiring 
immediate help to the beneficiary would qualify for the exclusion. 
However, the beneficiary must be in actual need of the distribution and 
the fact that he had other sufficient resources would tend to negate the 
conclusion that a distribution was to meet his emergency needs. Ordinary 
distributions for the support, maintenance, or education of the 
beneficiary would not qualify for the exclusion.
    (3) Certain distributions at specified ages. The third exclusion 
from the definition of an accumulation distribution is for amounts 
properly paid or credited to a beneficiary upon the beneficiary's 
attaining a specified age or ages; provided, (i) the total number of 
such distributions with respect to that beneficiary cannot exceed 4; 
(ii) the period between each such distribution is 4 years or more; and 
(iii) on January 1, 1954, such distributions were required by the 
specific terms of the governing instrument. Any discretionary invasion 
of corpus at other times is not excluded under this subparagraph, but 
does not affect the status of distributions that would otherwise be 
excluded. If more than four distributions are required to be made to a 
particular beneficiary at specified ages if he survives to receive them, 
none of the distributions will be excluded, even though the beneficiary 
dies before he receives more than four. On the other hand, a direction 
to make additional distributions to a remainderman will not affect the 
status of distributions required to be made to the primary beneficiary. 
For example, a trust agreement provided on January 1, 1954, that when A 
reached age 25 he would receive one-eighth of the corpus and accumulated 
income, as then constituted, and similar distributions at ages 30, 35, 
and 40. It also provided for similar distributions to B after A's death, 
and for additional discretionary distributions to both A and B. Required 
distributions to both A and B are excluded, regardless of whether 
discretionary distributions are made, but discretionary distributions 
are not excluded. On the other hand, if an additional distribution to A 
was directed when he reached 45, no distributions to him would be 
excluded, regardless of when he died.
    (4) Certain final distributions. (i) The last exception to the 
definition of an accumulation distribution is for amounts properly paid 
or credited to a beneficiary as a final distribution of a trust if the 
final distribution is made more than 9 years after the date of the last 
transfer to such trust.
    (ii) The term last transfer to such trust includes only transfers, 
whether by the original grantor or by a third person, made with a 
donative intent. A transfer arising out of a property right held by the 
trust is excluded, such as a transfer by a debtor in satisfaction of his 
indebtedness, or a distribution in liquidation or reorganization of a 
corporation. If the terms of two or more trusts include cross-remainders 
on the deaths of life beneficiaries, the donative transfers occurred at 
the time the trusts were created. The addition of the corpus of one 
trust to that of another when a remainder falls in is therefore not a 
new transfer within the meaning of section 665(b)(4).
    (iii) For example, under the terms of a trust created July 1, 1950, 
with an original corpus of $100,000, by H for the benefit of his wife, 
W, the income of the trust is to be accumulated and added to corpus. 
Upon the expiration of a 10-year period, the trust is to terminate and 
its assets, including all accumulated income, are to be distributed to 
W. No transfers were made by H or other persons to the trust after it 
was created. Both the trust and W file returns on the calendar year 
basis. In accordance with its terms, the trust terminated on June 30, 
1960, and on August 1, 1960, the trustee made a final distribution of 
the assets of the trust to W, consisting of investments derived from 
$100,000 of donated principal, accumulated income of $30,000 
attributable to the period July 1, 1950,

[[Page 220]]

through December 31, 1959, and income of $3,000 attributable to the 
period the trust was in existence during 1960. Subpart D is inapplicable 
to the $3,000 of income of the trust for 1960 since that amount would be 
deductible by the trust and includible in W's gross income for that year 
to the extent provided in subpart C. However, the balance of the 
distribution will qualify as an exclusion from the provisions of subpart 
D.

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



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

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



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

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

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



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

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

[[Page 221]]

received directly from a foreign trust created by a U.S. person.
    (b) Limitation. In the case of a distribution to a beneficiary who 
is a U.S. person, paragraph (a) of this section does not apply if the 
distribution is received by such beneficiary under circumstances 
indicating lack of intent on the part of the parties to circumvent the 
purposes for which section 7 of the Revenue Act of 1962 (76 Stat. 985) 
was enacted.

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



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

    (a) For the purpose of subpart D (section 665 and following), part 
I, subchapter J, chapter 1 of the Code, the term taxes imposed on the 
trust means (for any taxable year) the amount of Federal income taxes 
which are properly allocable to the undistributed portion of the 
distributable net income. This amount is the difference between the 
total taxes of the trust for the year and the amount which would have 
been paid by the trust had all of the distributable net income, as 
determined under section 643(a), been distributed. Thus, in determining 
the amount of taxes imposed on the trust for the purposes of subpart D, 
there is excluded the portion of the taxes paid by the trust which is 
attributable to items of gross income which are not includible in 
distributable net income, such as capital gains allocable to corpus. The 
rule stated in this paragraph may be illustrated by the following 
example:

    Example. (1) Under the terms of a trust which reports on the 
calendar year basis the income may be accumulated or distributed to A in 
the discretion of the trustee and capital gains are allocable to corpus. 
During the taxable year 1954, the trust had income of $20,000 from 
royalties, long-term capital gains of $10,000, and expenses of $2,000. 
The trustee in his discretion made a distribution of $10,000 to A. The 
taxes imposed on the trust for the purposes of this subpart are $2,713, 
determined as shown below.
    (2) The distributable net income of the trust computed under section 
643(a) is $18,000 (royalties of $20,000 less expenses of $2,000). The 
total taxes paid by the trust are $3,787, computed as follows:

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

    (3) The amount of taxes which would have been paid by the trust, had 
all of the distributable net income ($18,000) of the trust been 
distributed to A, is $1,074, computed as follows:

Taxable income of the trust..................................    $12,900
Less: Undistributed portion of distributable net income            8,000
 ($18,000-$10,000)...........................................
                                                   ------------
    Balance of taxable income................................      4,900
Income taxes on $4,900.......................................      1,074
 

    (4) The amount of taxes imposed on the trust as defined in this 
paragraph is $2,713, computed as follows:

Total taxes.......................................     $3,787
  Taxes which would have been paid by the trust         1,074
   had all of the distributable net income been
   distributed....................................
                                                   ------------
  Taxes imposed on the trust as defined in this         2,713
   paragraph......................................
 

    (b) If in any subsequent year an accumulation distribution is made 
by the trust which results in a throwback to the taxable year, the taxes 
of the taxable year allocable to the undistributed portion of 
distributable net income (the taxes imposed on the trust), after the 
close of the subsequent year, are the taxes prescribed in paragraph (a) 
of this section reduced by the taxes of the taxable year allowed as 
credits to beneficiaries on account of amounts deemed distributed on the 
last day of the taxable year under section 666. See paragraph (f)(4) of 
Sec. 1.668(b)-2 for an illustration of the application of this 
paragraph.

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



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

    (a) Definition. For purposes of subpart D (section 665 and 
following), part I, subchapter J, chapter 1 of the Internal Revenue Code 
of 1954, the term preceding taxable year does not include any taxable 
year to which such part I does not apply. See section 683 and 
regulations thereunder. Accordingly, the provisions of such subpart D 
may not, in general, be applied to any taxable year which begins before 
1954 or ends before

[[Page 222]]

August 17, 1954. For example, if a trust (reporting on the calendar year 
basis) makes a distribution during the calendar year 1955 of income 
accumulated during prior years and the distribution exceeds the 
distributable net income of 1955, the excess distribution may be 
allocated under such subpart D to 1954, but it may not be allocated to 
1953 and preceding years, since the Internal Revenue Code of 1939 
applies to those years.
    (b) Simple trusts subject to subpart D. An accumulation distribution 
may be properly allocated to a preceding taxable year in which the trust 
qualified as a simple trust (that is, qualified for treatment under 
subpart B (section 651 and following) of such part I). In such event, 
the trust is treated for such preceding taxable year in all respects as 
if it were a trust to which subpart C (section 661 and following) of 
such part I applies. An example of such a circumstance would be in the 
case of a trust (required under the trust instrument to distribute all 
of its income currently) which received in the preceding taxable year 
extraordinary dividends or taxable stock dividends which the trustee in 
good faith allocated to corpus, but which are subsequently determined to 
be currently distributable to the beneficiary. See section 643(a)(4) and 
Sec. 1.643(a)-4. The trust would qualify for treatment under such 
subpart C for the year of distribution of the extraordinary dividends or 
taxable stock dividends, because the distribution is not out of income 
of the current taxable year and would be treated as other amounts 
properly paid or credited or required to be distributed for such taxable 
year within the meaning of section 661(a)(2). Also, in the case of a 
trust other than a foreign trust created by a U.S. person, the 
distribution would qualify as an accumulation distribution for the 
purposes of such subpart D if in excess of $2,000 and not excepted under 
section 665(b) and the regulations thereunder. In the case of a foreign 
trust created by a U.S. person, the distribution, regardless of the 
amount, would qualify as an accumulation distribution for the purposes 
of subpart D. For the purposes only of such subpart D, the trust would 
be treated as subject to the provisions of such subpart C for the 
preceding taxable year in which the extraordinary or taxable stock 
dividends were received and in computing undistributed net income for 
such preceding year, the extraordinary or taxable stock dividends would 
be included in distributable net income under section 643(a). The rule 
stated in the preceding sentence would also apply if the distribution in 
the later year were made out of corpus without regard to a determination 
that the extraordinary dividends or taxable stock dividends in question 
were currently distributable to the beneficiary.

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



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

    In trusts to which the separate share rule of section 663(c) is 
applicable for any taxable year, subpart D (section 665 and following), 
part I, subchapter J, of the Code, is applied as if each share were a 
separate trust. Thus, ``undistributed net income'' and the amount of an 
``accumulation distribution'' are computed separately for each share. 
The ``taxes imposed on the trust'' are allocated as follows:
    (a) There is first allocated to each separate share that portion of 
the ``taxes imposed on the trust'', computed before the allowance of 
credits under section 642(a), which bears the same relation to the total 
that the distributable net income of the separate share bears to the 
distributable net income of the trust, adjusted for this purpose as 
follows:
    (1) There is excluded from distributable net income of the trust and 
of each separate share any tax-exempt interest, foreign income of a 
foreign trust, and excluded dividends, to the extent such amounts are 
included in distributable net income pursuant to section 643(a) (5), 
(6), and (7); and
    (2) The distributable net income of the trust is reduced by any 
deductions allowable under section 661 for amounts paid, credited, or 
required to be distributed during the taxable year, and the 
distributable net income of each separate share is reduced by any such 
deduction allocable to that share.

[[Page 223]]

    (b) The taxes so determined for each separate share are then reduced 
by that portion of the credits against tax allowable to the trust under 
section 642(a) in computing the ``taxes imposed on the trust'' which 
bear the same relation to the total that the items of income allocable 
to the separate share with respect to which the credit is allowed bear 
to the total of such items of the trust. The amount of taxes imposed on 
the trust allocable to a separate share as so determined is then reduced 
by the amount of the taxes allowed under sections 667 and 668 as a 
credit to a beneficiary of the separate share on account of any 
accumulation distribution determined for any taxable year intervening 
between the year for which the determination is made and the year of an 
accumulation distribution with respect to which the determination is 
made. See paragraph (b) of Sec. 1.665(d)-1.

[T.D. 6500, 25 FR 11814, Nov. 26, 1960, as amended by T.D. 6989, 34 FR 
741, Jan. 17, 1969. Redesignated by T.D. 6989, 34 FR 736, Jan. 17, 1969]



Sec. 1.666(a)-1A  Amount allocated.

    (a) In general. In the case of a trust that is subject to subpart C 
of part I of subchapter J of chapter 1 of the Code (relating to estates 
and trusts that may accumulate income or that distribute corpus), 
section 666(a) prescribes rules for determining the taxable years from 
which an accumulation distribution will be deemed to have been made and 
the extent to which the accumulation distribution is considered to 
consist of undistributed net income. In general, an accumulation 
distribution made in taxable years beginning after December 31, 1969, is 
deemed to have been made first from the earliest preceding taxable year 
of the trust for which there is undistributed net income. An 
accumulation distribution made in a taxable year beginning before 
January 1, 1970, is deemed to have been made first from the most recent 
preceding taxable year of the trust for which there is undistributed net 
income. See Sec. 1.665(e)-1A for the definition of ``preceding taxable 
year.''
    (b) Distributions by domestic trusts--(1) Taxable years beginning 
after December 31, 1973. An accumulation distribution made by a trust 
(other than a foreign trust created by a U.S. person) in any taxable 
year beginning after December 31, 1973, is allocated to the preceding 
taxable years of the trust (defined in Sec. 1.665(e)-1A(a)(1)(ii) as 
those beginning after December 31, 1968) according to the amount of 
undistributed net income of the trust for such years. For this purpose, 
an accumulation distribution is first to be allocated to the earliest 
such preceding taxable year in which there is undistributed net income 
and shall then be allocated, beginning with the next earliest, to any 
remaining preceding taxable years of the trust. The portion of the 
accumulation distribution allocated to the earliest preceding taxable 
year is the amount of the undistributed net income for that preceding 
taxable year. The portion of the accumulation distribution allocated to 
any preceding taxable year subsequent to the earliest such preceding 
taxable year is the excess of the accumulation distribution over the 
aggregate of the undistributed net income for all earlier preceding 
taxable years. See paragraph (d) of this section for adjustments to 
undistributed net income for prior distributions. The provisions of this 
subparagraph may be illustrated by the following example:

    Example. In 1977, a domestic trust reporting on the calendar year 
basis makes an accumulation distribution of $33,000. Therefore, years 
before 1969 are ignored. In 1969, the trust had $6,000 of undistributed 
net income; in 1970, $4,000; in 1971, none; in 1972, $7,000; in 1973, 
$5,000; in 1974, $8,000; in 1975, $6,000; and $4,000 in 1976. The 
accumulation distribution is deemed distributed $6,000 in 1969, $4,000 
in 1970, none in 1971, $7,000 in 1972, $5,000 in 1973, $8,000 in 1974, 
and $3,000 in 1975.

    (2) Taxable years beginning after December 31, 1969, and before 
January 1, 1974. If a trust (other than a foreign trust created by a 
U.S. person) makes an accumulation distribution in a taxable year 
beginning after December 31, 1969, and before January 1, 1974, the 
distribution will be deemed distributed in the same manner as 
accumulation distributions qualifying under subparagraph (1) of this 
paragraph, except that the first year to which the distribution may be 
thrown back cannot be earlier than the fifth taxable year of the trust

[[Page 224]]

preceding the year in which the accumulation distribution is made. Thus, 
for example, in the case of an accumulation distribution made in the 
taxable year of a domestic trust which begins on January 1, 1972, the 
taxable year of the trust beginning on January 1, 1967, would be the 
first year in which the distribution was deemed made, assuming that 
there was undistributed net income for 1967. See also Sec. 1.665(e)-
1A(a)(1). The provisions of this subparagraph may be illustrated by the 
following example:

    Example. In 1973, a domestic trust, reporting on the calendar year 
basis, makes an accumulation distribution of $25,000. In 1968, the fifth 
year preceding 1973, the trust had $7,000 of undistributed net income; 
in 1969, none; in 1970, $12,000; in 1971, $4,000; in 1972, $4,000. The 
accumulation distribution is deemed distributed in the amounts of $7,000 
in 1968, none in 1969, $12,000 in 1970, $4,000 in 1971, and $2,000 in 
1972.

    (3) Taxable years beginning after December 31, 1968, and before 
January 1, 1970. Accumulation distributions made in taxable years of the 
trust beginning after December 31, 1968, and before January 1, 1970, are 
allocated to prior years according to Sec. 1.666(a)-1.
    (c) Distributions by foreign trusts--(1) Foreign trusts created 
solely by U.S. persons--(i) Taxable years beginning after December 31, 
1969. If a foreign trust created by a U.S. person makes an accumulation 
distribution in any taxable year beginning after December 31, 1969, the 
distribution is allocated to the trust's preceding taxable years 
(defined in Sec. 1.665(e)-1A(a)(2) as those beginning after Dec. 31, 
1953, and ending after Aug. 16, 1954) according to the amount of 
undistributed net income of the trust for such years. For this purpose, 
an accumulation distribution is first allocated to the earliest such 
preceding taxable year in which there is undistributed net income and 
shall then be allocated in turn, beginning with the next earliest, to 
any remaining preceding taxable years of the trust. The portion of the 
accumulation distribution allocated to the earliest preceding taxable 
year is the amount of the undistributed net income for that preceding 
taxable year. The portion of the accumulation distribution allocated to 
any preceding taxable year subsequent to the earliest such preceding 
taxable year is the excess of the accumulation distribution over the 
aggregate of the undistributed net income for all earlier preceding 
taxable years. See paragraph (d) of this section for adjustments to 
undistributed net income for prior distributions. The provisions of this 
subdivision may be illustrated by the following example:

    Example. In 1971, a foreign trust created by a U.S. person, 
reporting on the calendar year basis, makes an accumulation distribution 
of $50,000. In 1961, the trust had $12,000 of undistributed net income; 
in 1962, none; in 1963, $10,000; in 1964, $8,000; in 1965, $5,000; in 
1966, $14,000; in 1967, none; in 1968, $3,000; in 1969, $2,000; and in 
1970, $1,000. The accumulation distribution is deemed distributed in the 
amounts of $12,000 in 1961, none in 1962, $10,000 in 1963, $8,000 in 
1964, $5,000 in 1965, $14,000 in 1966, none in 1967, and $1,000 in 1968.

    (ii) Taxable years beginning after December 31, 1968, and before 
January 1, 1970. Accumulation distributions made in taxable years of the 
trust beginning after December 31, 1968, and before January 1, 1970, are 
allocated to prior years according to Sec. 1.666(a)-1.
    (2) Foreign trusts created partly by U.S. persons--(i) Taxable years 
beginning after December 31, 1969. If a trust that is in part a foreign 
trust created by a U.S. person and in part a foreign trust created by a 
person other than a U.S. person makes an accumulation distribution in 
any year after December 31, 1969, the distribution is deemed made from 
the undistributed net income of the foreign trust created by a U.S. 
person in the proportion that the total undistributed net income for all 
preceding years of the foreign trust created by the U.S. person bears to 
the total undistributed net income for all years of the entire foreign 
trust. In addition, such distribution is deemed made from the 
undistributed net income of the foreign trust created by a person other 
than a U.S. person in the proportion that the total undistributed net 
income for all preceding years of the foreign trust created by a person 
other than a U.S. person bears to the total undistributed net income for 
all years of the entire foreign trust. Accordingly, an accumulation 
distribution of such a trust is composed of two portions with one 
portion relating to the undistributed net income of the

[[Page 225]]

foreign trust created by the U.S. person and the other portion relating 
to the undistributed net income of the foreign trust created by the 
person other than a U.S. person. For these purposes, each portion of an 
accumulation distribution made in any taxable year is first allocated to 
each of such preceding taxable years in turn, beginning with the 
earliest preceding taxable year, as defined in Sec. 1.665(e)-1A(a), of 
the applicable foreign trusts, to the extent of the undistributed net 
income for the such trust for each of those years. Thus, each portion of 
an accumulation distribution is deemed to have been made from the 
earliest accumulated income of the applicable trust. If the foreign 
trust created by a U.S. person makes an accumulation distribution in any 
year beginning after December 31, 1969, the distribution is included in 
the beneficiary's income for that year to the extent of the 
undistributed net income of the trust for the trust's preceding taxable 
years which began after December 31, 1953, and ended after August 16, 
1954. The provisions of this subdivision may be illustrated by the 
following example:

    Example. A trust is created in 1962 under the laws of Country X by 
the transfer to a trustee in Country X of property by both a U.S. person 
and a person other than a U.S. person. Both the trust and the only 
beneficiary of the trust (who is a U.S. person) report their taxable 
income on a calendar year basis. On March 31, 1974, the trust makes an 
accumulation distribution of $150,000 to the beneficiary. The 
distributable net income of both the portion of the trust which is a 
foreign trust created by a U.S. person and the portion of the trust 
which is a foreign trust created by a person other than a U.S. person 
for each year is computed in accordance with the provisions of paragraph 
(b)(3) of Sec. 1.643(d)-1 and the undistributed net income for each 
portion of the trust for each year is computed as described in paragraph 
(b) of Sec. 1.665(a)-1A. For taxable years 1962 through 1973, the 
portion of the trust which is a foreign trust created by a U.S. person 
and the portion of the trust which is a foreign trust created by a 
person other than a U.S. person had the following amounts of 
undistributed net income:

----------------------------------------------------------------------------------------------------------------
                                                                                            Undistributed net
                                                                    Undistributed net     income-portion of the
                              Year                                income-portion of the     trust created by a
                                                                    trust created by a     person other than a
                                                                       U.S. person             U.S. person
----------------------------------------------------------------------------------------------------------------
1962............................................................           $7,000                  $4,000
1963............................................................           12,000                   7,000
1964............................................................             None                    None
1965............................................................           11,000                   5,000
1966............................................................            8,000                   3,000
1967............................................................             None                    None
1968............................................................            4,000                   2,000
1969............................................................           17,000                   8,000
1970............................................................           16,000                   9,000
1971............................................................             None                    None
1972............................................................           25,000                  12,000
1973............................................................           20,000                  10,000
                                                                 -----------------------------------------------
 Totals.........................................................          120,000                  60,000
----------------------------------------------------------------------------------------------------------------


The accumulation distribution in the amount of $150,000 is deemed to 
have been distributed in the amount of $100,000 (120,000/
180,000x$150,000) from the portion of the trust which is a foreign trust 
created by a U.S. person and in the amount of $39,000, which is less 
than $50,000 (60,000/180,000x$150,000), from the portion of the trust 
which is a foreign trust created by a person other than a U.S. person 
computed as follows:

----------------------------------------------------------------------------------------------------------------
                                                                                          Throwback to preceding
                                                                        Throwback to     years of portion of the
                                                                     preceding years of    entire foreign trust
                               Year                                    foreign trust      which is not a foreign
                                                                     created by a U.S.   trust created by a U.S.
                                                                           person                 person
----------------------------------------------------------------------------------------------------------------
1962..............................................................          $7,000                   None
1963..............................................................          12,000                   None
1964..............................................................            None                   None
1965..............................................................         $11,000                   None
1966..............................................................           8,000                   None
1967..............................................................            None                   None
1968..............................................................           4,000                   None
1969..............................................................          17,000                 $8,000
1970..............................................................          16,000                  9,000
1971..............................................................            None                   None
1972..............................................................         $25,000                $12,000
1973..............................................................            None                 10,000
                                                                   ---------------------------------------------
 Totals...........................................................         100,000                 39,000
----------------------------------------------------------------------------------------------------------------

Pursuant to this paragraph, the accumulation distribution in the amount 
of $100,000 from the portion of the trust which is a foreign trust 
created by a U.S. person is included in the beneficiary's income for 
1974, as the amount represents undistributed net income of the trust for 
the trust's preceding taxable years which began after December 31, 1953, 
and ended after August 16, 1954. The accumulation distribution in the 
amount of $50,000 from the portion of the trust which is a foreign trust 
created by a person other than a U.S. person is included in the 
beneficiary's income for 1974 to the extent of the undistributed net 
income of the trust for the preceding years beginning after December 31, 
1968. Accordingly, with respect to the portion of the trust which is a 
foreign trust created by a person other than a U.S. person, only the 
undistributed net income for the years 1969 through 1973, which totals 
$39,000,

[[Page 226]]

is includible in the beneficiary's income for 1974. Thus, of the 
$150,000 distribution made in 1974, the beneficiary is required to 
include a total of $139,000 in his income for 1974. The balance of 
$11,000 is deemed to represent a distribution of corpus.

    (ii) Taxable years beginning after December 31, 1968, and before 
January 1, 1970. Accumulation distributions made in taxable years of the 
trust beginning after December 31, 1968, and before January 1, 1970, are 
allocated to prior years according to Sec. 1.666(a)-1.
    (3) Foreign trusts created by non-U.S. persons. To the extent that a 
foreign trust is a foreign trust created by a person other than a U.S. 
person, an accumulation distribution is included in the beneficiary's 
income for the year paid, credited, or required to be distributed to the 
extent provided under paragraph (b) of this section.
    (d) Reduction of undistributed net income for prior accumulation 
distributions. For the purposes of allocating to any preceding taxable 
year an accumulation distribution of the taxable year, the undistributed 
net income of such preceding taxable year is reduced by the amount from 
such year deemed distributed in any accumulation distribution of 
undistributed net income made in any taxable year intervening between 
such preceding taxable year and the taxable year. Accordingly, for 
example, if a trust has undistributed net income for 1974 and makes 
accumulation distributions during the taxable years 1978 and 1979, in 
determining that part of the 1979 accumulation distribution that is 
thrown back to 1974 the undistributed net income for 1974 is first 
reduced by the amount of the undistributed net income for 1974 deemed 
distributed in the 1978 accumulation distribution.
    (e) Rule when no undistributed net income. If, before the 
application of the provisions of subpart D to an accumulation 
distribution for the taxable year, there is no undistributed net income 
for a preceding taxable year, then no portion of the accumulation 
distribution is undistributed net income deemed distributed on the last 
day of such preceding taxable year. Thus, if an accumulation 
distribution is made during the taxable year 1975 from a trust whose 
earliest preceding taxable year is taxable year 1970, and the trust had 
no undistributed net income for 1970, then no portion of the 1975 
accumulation distribution is undistributed net income deemed distributed 
on the last day of 1970.

[T.D. 7204, 37 FR 17143, Aug. 25, 1972]



Sec. 1.666(b)-1A  Total taxes deemed distributed.

    (a) If an accumulation distribution is deemed under Sec. 1.666(a)-
1A to be distributed on the last day of a preceding taxable year and the 
amount is not less than the undistributed net income for such preceding 
taxable year, then an additional amount equal to the ``taxes imposed on 
the trust attributable to the undistributed net income'' (as defined in 
Sec. 1.665(d)-1A(b)) for such preceding taxable year is also deemed 
distributed under section 661(a)(2). For example, a trust has 
undistributed net income of $8,000 for the taxable year 1974. The taxes 
imposed on the trust attributable to the undistributed net income are 
$3,032. During the taxable year 1977, an accumulation distribution of 
$8,000 is made to the beneficiary, which is deemed under Sec. 1.666(a)-
1A to have been distributed on the last day of 1974. The 1977 
accumulation distribution is not less than the 1974 undistributed net 
income. Accordingly, the taxes of $3,032 imposed on the trust 
attributable to the undistributed net income for 1974 are also deemed to 
have been distributed on the last day of 1974. Thus, a total of $11,032 
will be deemed to have been distributed on the last day of 1974.
    (b) For the purpose of paragraph (a) of this section, the 
undistributed net income of any preceding taxable year and the taxes 
imposed on the trust for such preceding taxable year attributable to 
such undistributed net income are computed after taking into account any 
accumulation distributions of taxable years intervening between such 
preceding taxable year and the taxable year. See paragraph (d) of Sec. 
1.666(a)-1A.

[T.D. 7204, 37 FR 17145, Aug. 25, 1972]

[[Page 227]]



Sec. 1.666(c)-1A  Pro rata portion of taxes deemed distributed.

    (a) If an accumulation distribution is deemed under Sec. 1.666(a)-
1A to be distributed on the last day of a preceding taxable year and the 
amount is less than the undistributed net income for such preceding 
taxable year, then an additional amount is also deemed distributed under 
section 661(a)(2). The additional amount is equal to the ``taxes imposed 
on the trust attributable to the undistributed net income'' (as defined 
in Sec. 1.665(a)-1A(b)) for such preceding taxable year, multiplied by 
a fraction, the numerator of which is the amount of the accumulation 
distribution allocated to such preceding taxable year and the 
denominator of which is the undistributed net income for such preceding 
taxable year. See paragraph (b) of example 1 and paragraphs (c) and (f) 
of example 2 in Sec. 1.666(c)-2A for illustrations of this paragraph.
    (b) For the purpose of paragraph (a) of this section, the 
undistributed net income of any preceding taxable year and the taxes 
imposed on the trust for such preceding taxable year attributable to 
such undistributed net income are computed after taking into account any 
accumulation distributions of any taxable years intervening between such 
preceding taxable year and the taxable year. See paragraph (d) of Sec. 
1.666(a)-1A and paragraph (c) of example 1 and paragraphs (e) and (h) of 
example 2 in Sec. 1.666(c)-2A.

[T.D. 7204, 37 FR 17145, Aug. 25, 1972]



Sec. 1.666(c)-2A  Illustration of the provisions of section 666 (a),
(b), and (c).

    The application of the provisions of Sec. Sec. 1.666(a)-1A, 
1.666(b)-1A, and 1.666(c)-1A may be illustrated by the following 
examples:

    Example 1. (a) A trust created on January 1, 1974, makes 
accumulation distributions as follows:

1979..............................................................$7,000
1980..............................................................26,000


For 1974 through 1978, the undistributed portion of distributable net 
income, taxes imposed on the trust attributable to the undistributed net 
income, and undistributed net income are as follows:

----------------------------------------------------------------------------------------------------------------
                                                                                Taxes imposed on
                                                                Undistributed       the trust
                             Year                                 portion of     attributable to   Undistributed
                                                                distributable   the undistributed    net income
                                                                  net income       net income
----------------------------------------------------------------------------------------------------------------
1974..........................................................     $12,100            $3,400          $8,700
1975..........................................................      16,100             5,200          10,900
1976..........................................................       6,100             1,360           4,740
1977..........................................................        None              None            None
1978..........................................................      10,100             2,640           7,460
----------------------------------------------------------------------------------------------------------------

The trust has no undistributed capital gain.
    (b) Since the entire amount of the accumulation distribution for 
1979 ($7,000) is less than the undistributed net income for 1974 
($8,700), an additional amount of $2,736 (7,000/8,700x$3,400) is deemed 
distributed under section 666(c).
    (c) In allocating the accumulation distribution for 1980, the amount 
of undistributed net income for 1974 will reflect the accumulation 
distribution for 1979. The undistributed net income for 1974 will then 
be $1,700 and the taxes imposed on the trust for 1974 will be $664, 
determined as follows:

Undistributed net income as of the close of 1974............      $8,700
Less: Accumulation distribution (1979)......................       7,000
                                                             -----------
    Balance (undistributed net income as of the close of           1,700
     1979)..................................................
                                                             ===========
Taxes imposed on the trust attributable to the undistributed         664
 net income as of the close of 1979 (1,700/8,700x$3,400)....
 

    (d) The accumulation distribution of $26,000 for 1980 is deemed to 
have been made on the last day of the preceding taxable years of the 
trust to the extent of $24,800, the total of the undistributed net 
income for such years, as shown in the tabulation below. In addition, 
$9,864, the total taxes imposed on the trust attributable to the 
undistributed net income for such years is also deemed to have been 
distributed on the last day of such years, as shown below:

------------------------------------------------------------------------
                                Undistributed net   Taxes imposed on the
            Year                     income                 trust
------------------------------------------------------------------------
1974........................         $1,700                  $664
1975........................         10,900                 5,200
1976........................          4,740                 1,360
1977........................           None                  None
1978........................          7,460                 2,640
1979........................           None                  None
------------------------------------------------------------------------

    Example 2. (a) Under the terms of a trust instrument, the trustee 
has discretion to accumulate or distribute the income to X and to invade 
corpus for the benefit of X. The entire income of the trust is from 
royalties. Both X and the trust report on the calendar year basis. All 
of the income for 1974 was accumulated. The distributable net income of 
the trust for the taxable year 1974 is $20,100 and the income taxes paid 
by the trust for 1974 attributable to the undistributed net income are 
$7,260. All of the income for 1975 and 1976 was distributed and in 
addition the trustee made accumulation distributions

[[Page 228]]

within the meaning of section 665(b) of $5,420 for each year.
    (b) The undistributed net income of the trust determined under 
section 665(a) as of the close of 1974, is $12,840, computed as follows:

Distributable net income....................................     $20,100
Less: Taxes imposed on the trust attributable to the               7,260
 undistributed net income...................................
                                                             -----------
    Undistributed net income as of the close of 1974........      12,840
 

    (c) The accumulation distribution of $5,420 made during the taxable 
year 1975 is deemed under section 666(a) to have been made on December 
31, 1974. Since this accumulation distribution is less than the 1974 
undistributed net income of $12,840, a portion of the taxes imposed on 
the trust for 1974 is also deemed under section 666(c) to have been 
distributed on December 31, 1974. The total amount deemed to have been 
distributed to X on December 31, 1974 is $8,484, computed as follows:

Accumulation distribution...................................      $5,420
Taxes deemed distributed (5,420/ 12,840x$7,260).............       3,064
                                                             -----------
    Total...................................................       8,484
 

    (d) After the application of the provisions of subpart D to the 
accumulation distribution of 1975, the undistributed net income of the 
trust for 1974 is $7,420, computed as follows:

Undistributed net income as of the close of 1974............     $12,840
Less: 1975 accumulation distribution deemed distributed on         5,420
 December 31, 1974 (paragraph (c) of this example)..........
                                                             -----------
    Undistributed net income for 1974 as of the close of           7,420
     1975...................................................
 

    (e) The taxes imposed on the trust attributable to the undistributed 
net income for the taxable year 1974, as adjusted to give effect to the 
1975 accumulation distribution, amount to $4,196, computed as follows:

Taxes imposed on the trust attributable to undistributed net      $7,260
 income as of the close of 1974.............................
Less: Taxes deemed distributed in 1974......................       3,064
                                                             -----------
    Taxes attributable to the undistributed net income             4,196
     determined as of the close of 1975.....................
 

    (f) The accumulation distribution of $5,420 made during the taxable 
year 1976 is, under section 666(a), deemed a distribution to X on 
December 31, 1974, within the meaning of section 661(a)(2). Since the 
accumulation distribution is less than the 1974 adjusted undistributed 
net income of $7,420, the trust is deemed under section 666(c) also to 
have distributed on December 31, 1974, a portion of the taxes imposed on 
the trust for 1974. The total amount deemed to be distributed on 
December 31, 1974, with respect to the accumulation distribution made in 
1976, is $8,484, computed as follows:

Accumulation distribution...................................      $5,420
Taxes deemed distributed (5,420/ 7,420x$4,196)..............       3,064
                                                             -----------
    Total...................................................       8,484
 

    (g) After the application of the provisions of subpart D to the 
accumulation distribution of 1976, the undistributed net income of the 
trust for 1974 is $2,000, computed as follows:

Undistributed net income for 1974 as of the close of 1975...      $7,420
Less: 1976 accumulation distribution deemed distributed on         5,420
 December 31, 1974 (paragraph (f) of this example)..........
                                                             -----------
    Undistributed net income for 1974 as of the close of           2,000
     1976...................................................
 

    (h) The taxes imposed on the trust attributable to the undistributed 
net income of the trust for the taxable year 1974, determined as of the 
close of the taxable year 1976, amount to $1,132 ($4,196 less $3,064).

[T.D. 7204, 37 FR 17145, Aug. 25, 1972]



Sec. 1.666(d)-1A  Information required from trusts.

    (a) Adequate records required. For all taxable years of a trust, the 
trustee must retain copies of the trust's income tax return as well as 
information pertaining to any adjustments in the tax shown as due on the 
return. The trustee shall also keep the records of the trust required to 
be retained by section 6001 and the regulations thereunder for each 
taxable year as to which the period of limitations on assessment of tax 
under section 6501 has not expired. If the trustee fails to produce such 
copies and records, and such failure is due to circumstances beyond the 
reasonable control of the trustee or any predecessor trustee, the 
trustee may reconstruct the amount of corpus, accumulated income, etc., 
from competent sources (including, to the extent permissible, Internal 
Revenue Service records). To the extent that an accurate reconstruction 
can be made for a taxable year, the requirements of this paragraph shall 
be deemed satisfied for such year.
    (b) Rule when information is not available--(1) Accumulation 
distributions. If adequate records (as required by paragraph (a) of this 
section) are not available to determine the proper application of 
subpart D to an accumulation distribution made in a taxable year by a 
trust, such accumulation distribution

[[Page 229]]

shall be deemed to consist of undistributed net income earned during the 
earliest preceding taxable year (as defined in Sec. 1.665(e)-1A) of the 
trust in which it can be established that the trust was in existence. If 
adequate records are available for some years, but not for others, the 
accumulation distribution shall be allocated first to the earliest 
preceding taxable year of the trust for which there are adequate records 
and then to each subsequent preceding taxable year for which there are 
adequate records. To the extent that the distribution is not allocated 
in such manner to years for which adequate records are available, it 
will be deemed distributed on the last day of the earliest preceding 
taxable year of the trust in which it is established that the trust was 
in existence and for which the trust has no records. The provisions of 
this subparagraph may be illustrated by the following example:

    Example. A trust makes a distribution in 1975 of $100,000. The 
trustee has adequate records for 1973, 1974, and 1975. The records show 
that the trust is on the calendar year basis, had distributable net 
income in 1975 of $20,000, and undistributed net income in 1974 of 
$15,000, and in 1973 of $16,000. The trustee has no other records of the 
trust except for a copy of the trust instrument showing that the trust 
was established on January 1, 1965. He establishes that the loss of the 
records was due to circumstances beyond his control. Since the 
distribution is made in 1975, the earliest ``preceding taxable year'', 
as defined in Sec. 1.665(e)-1A, is 1969. Since $80,000 of the 
distribution is an accumulation distribution, and $31,000 thereof is 
allocated to 1974 and 1973, $49,000 is deemed to have been distributed 
on the last day of 1969.

    (2) Taxes. (i) If an amount is deemed under this paragraph to be 
undistributed net income allocated to a preceding taxable year for which 
adequate records are not available, there shall be deemed to be ``taxes 
imposed on the trust'' for such preceding taxable year an amount equal 
to the taxes that the trust would have paid if the deemed undistributed 
net income were the amount remaining when the taxes were subtracted from 
taxable income of the trust for such year. For example, assume that an 
accumulation distribution in 1975 of $100,000 is deemed to be 
undistributed net income from 1971, and that the taxable income required 
to produce $100,000 after taxes in 1971 would be $284,966. Therefore the 
amount deemed to be ``taxes imposed on the trust'' for such preceding 
taxable year is $184,966.
    (ii) The credit allowed by section 667(b) shall not be allowed for 
any amount deemed under this subparagraph to be ``taxes imposed on the 
trust.''

[T.D. 7204, 37 FR 17146, Aug. 25, 1972]



Sec. 1.666(a)-1  Amount allocated.

    (a)(1) If a trust other than a foreign trust created by a U.S. 
person makes an accumulation distribution in any taxable year, the 
distribution is included in the beneficiary's gross income for that year 
to the extent of the undistributed net income of the trust for the 
preceding 5 years. It is therefore necessary to determine the extent to 
which there is undistributed net income for the preceding 5 years. For 
this purpose, an accumulation distribution made in any taxable year is 
allocated to each of the 5 preceding taxable years in turn, beginning 
with the most recent year, to the extent of the undistributed net income 
of each of those years. Thus, an accumulation distribution is deemed to 
have been made from the most recently accumulated income of the trust.
    (2) If a foreign trust created by a U.S. person makes an 
accumulation distribution in any year after December 31, 1962, the 
distribution is included in the beneficiary's gross income for that year 
to the extent of the undistributed net income of the trust for the 
trust's preceding taxable years which began after December 31, 1953, and 
ended after August 16, 1954. It is therefore necessary to determine the 
extent to which there is undistributed net income for such preceding 
taxable years. For this purpose, an accumulation distribution made in 
any taxable year is first allocated to each of such preceding taxable 
years in turn, beginning with the most recent year, to the extent of the 
undistributed net income of each of those years. Thus, an accumulation 
distribution is deemed to have been made from the most recently 
accumulated income of the trust.
    (3) If a trust that is in part a foreign trust created by a U.S. 
person and in

[[Page 230]]

part a foreign trust created by a person other than a U.S. person makes 
an accumulation distribution in any year after December 31, 1962, the 
distribution is deemed made from the undistributed net income of the 
foreign trust created by a U.S. person in the proportion that the total 
undistributed net income for all preceding years of the foreign trust 
created by the U.S. person bears to the total undistributed net income 
for all years of the entire foreign trust. In addition, such 
distribution is deemed made from the undistributed net income of the 
foreign trust created by a person other than a U.S. person in the 
proportion that the total undistributed net income for all preceding 
years of the foreign trust created by a person other than a U.S. person 
bears to the total undistributed net income for all years of the entire 
foreign trust. Accordingly, an accumulation distribution of such a trust 
is composed of two portions with one portion relating to the 
undistributed net income of the foreign trust created by the U.S. person 
and the other portion relating to the undistributed net income of the 
foreign trust created by the person other than a U.S. person. For these 
purposes, each portion of an accumulation distribution made in any 
taxable year is first allocated to each of such preceding taxable years 
in turn, beginning with the most recent year, to the extent of the 
undistributed net income for the applicable foreign trust for each of 
those years. Thus, each portion of an accumulation distribution is 
deemed to have been made from the most recently accumulated income of 
the applicable trust. If the foreign trust created by a U.S. person 
makes an accumulation distribution in any year after December 31, 1962, 
the distribution is included in the beneficiary's gross income for that 
year to the extent of the undistributed net income of the trust for the 
trust's preceding taxable years which began after December 31, 1953, and 
ended after August 16, 1954. If the foreign trust created by a person 
other than a U.S. person makes an accumulation distribution in any 
taxable year, the distribution is included in the beneficiary's gross 
income for that year to the extent of the undistributed net income of 
the trust for the preceding 5 years.
    (b) If, before the application of the provisions of subpart D 
(section 665 and following), part I, subchapter J, chapter 1 of the 
Code, to an accumulation distribution for the taxable year, there is no 
undistributed net income for a preceding taxable year, then no portion 
of the accumulation distribution is deemed distributed on the last day 
of such preceding taxable year. Thus, if an accumulation distribution is 
made during the taxable year 1960 and the trust had no undistributed net 
income for the taxable year 1959, then no portion of the 1960 
accumulation distribution is deemed distributed on the last day of 1959. 
For purposes of subpart D, the term 5 preceding taxable years includes 
only the 5 taxable years immediately preceding the taxable year in which 
the accumulation distribution is made and which are subject to part I 
(section 641 and following) of such subchapter J even though the trust 
has no undistributed net income during one or more of those years.
    (c) Paragraphs (a) and (b) of this section may be illustrated by the 
following examples:

    Example 1. In 1964, a domestic trust, reporting on the calendar year 
basis, makes an accumulation distribution of $25,000. In 1963, the trust 
had $7,000 of undistributed net income; in 1962, none; in 1961, $12,000; 
in 1960, $4,000; in 1959, $4,000. The accumulation distribution is 
deemed distributed $7,000 in 1963, none in 1962, $12,000 in 1961, $4,000 
in 1960, and $2,000 in 1959.
    Example 2. In 1964, a foreign trust created by a U.S. person, 
reporting on the calendar year basis, makes an accumulation distribution 
of $50,000. In 1963, the trust had $12,000 of undistributed net income; 
in 1962, none; in 1961, $10,000; in 1960, $8,000; in 1959, $5,000; in 
1958, $14,000; in 1957, none; in 1956, $3,000; in 1955, $2,000; and in 
1954, $1,000. The accumulation distribution is deemed distributed 
$12,000 in 1963, none in 1962, $10,000 in 1961, $8,000 in 1960, $5,000 
in 1959, $14,000 in 1958, none in 1957, $1,000 in 1956.
    Example 3. A trust is created in 1952 under the laws of Country X by 
the transfer to a trustee in Country X of money and property by both a 
U.S. person and a person other than a U.S. person. Both the trust and 
the only beneficiary of the trust (who is a U.S. person) report their 
taxable income on a calendar year basis. On March 31, 1964, the trust 
makes an accumulation distribution of

[[Page 231]]

$150,000 to the U.S. beneficiary. The distributable net income of both 
the portion of the trust which is a foreign trust created by a U.S. 
person and the portion of the trust which is a foreign trust created by 
a person other than a U.S. person for each year is computed in 
accordance with the provisions of paragraph (b)(3) of Sec. 1.643(d)-1 
and the undistributed net income for each portion of the trust for each 
year is computed as described in paragraph (b) of Sec. 1.665(a)-1. For 
the taxable years 1952 through 1963, the portion of the trust which is a 
foreign trust created by a U.S. person and the portion of the trust 
which is a foreign trust created by a person other than a U.S. person 
had the following amounts of undistributed net income:

----------------------------------------------------------------------------------------------------------------
                                                                                             Undistributed net
                                                                      Undistributed net      income--portion of
                               Year                                   income--portion of    the trust created by
                                                                     the trust created by  a person other than a
                                                                        a U.S. person           U.S. person
----------------------------------------------------------------------------------------------------------------
1963..............................................................           $20,000                $10,000
1962..............................................................            25,000                 12,000
1961..............................................................              None                   None
1960..............................................................            16,000                  9,000
1959..............................................................            17,000                  8,000
1958..............................................................             4,000                  2,000
1957..............................................................              None                   None
1956..............................................................             8,000                  3,000
1955..............................................................            11,000                  5,000
1954..............................................................              None                   None
1953..............................................................            12,000                  7,000
1952..............................................................             7,000                  4,000
                                                                   ---------------------------------------------
  Totals..........................................................           120,000                 60,000
----------------------------------------------------------------------------------------------------------------


The accumulation distribution in the amount of $150,000 is deemed to 
have been distributed in the amount of $100,000 (120,000/
180,000x$150,000) from the portion of the trust which is a foreign trust 
created by a U.S. person, and in the amount of $50,000 (60,000/
180,000x$150,000) from the portion of the trust which is a foreign trust 
created by a person other than a U.S. person computed as follows:

----------------------------------------------------------------------------------------------------------------
                                                                                                Throwback to
                                                                                             preceding years of
                                                                         Throwback to      portion of the entire
                               Year                                   preceding years of    foreign trust which
                                                                    foreign trust created     is not a foreign
                                                                       by a U.S. person      trust created by a
                                                                                                U.S. person
----------------------------------------------------------------------------------------------------------------
1963..............................................................           $20,000                $10,000
1962..............................................................            25,000                 12,000
1961..............................................................              None                   None
1960..............................................................            16,000                  9,000
1959..............................................................            17,000                  8,000
1958..............................................................             4,000                  2,000
1957..............................................................              None                   None
1956..............................................................             8,000                  3,000
1955..............................................................            10,000                  5,000
1954..............................................................              None                   None
1953..............................................................              None                  1,000
1952..............................................................              None                   None
                                                                   ---------------------------------------------
  Totals..........................................................           100,000                 50,000
----------------------------------------------------------------------------------------------------------------

Pursuant to paragraph (a)(3) of this section, the accumulation 
distribution in the amount of $100,000 from the portion of the trust 
which is a foreign trust created by a U.S. person is included in the 
beneficiary's gross income for 1964, as this amount represents 
undistributed net income of the trust for the trust's preceding taxable 
years which began after December 31, 1953, and ended after August 16, 
1954. The accumulation distribution in the amount of $50,000 from the 
portion of the trust which is a foreign trust created by a person other 
than a U.S. person is included in the beneficiary's gross income for 
1964 to the extent of the undistributed net income of the trust for the 
preceding 5 years. Accordingly, with respect to the portion of the trust 
which is a foreign trust created by a person other than a U.S. person 
only the undistributed net income for the years 1959 through 1963 which 
totals $39,000 is includible in the beneficiary's gross income for 1964. 
Thus, of the $150,000 distribution made in 1964, the beneficiary is 
required to include a total of $139,000 in his gross income for 1964.
    Example 4. Assume the same facts as in example 3 and, in addition, 
that by December 31, 1964, the undistributed net income for 1964 is 
determined to be $20,000, and that in accordance with the provisions of 
paragraph (b)(3) of Sec. 1.643(d)-1 and paragraph (b) of Sec. 
1.665(a)-1, $10,000 is allocated to the portion of the trust which is a 
foreign trust created by a U.S. person and $10,000 is allocated to the 
portion of the trust which is a foreign trust created by a person other 
than a U.S. person. On March 31, 1965, the trust makes an accumulation 
distribution of $25,000 to the U.S. beneficiary. For the taxable years 
1952 through 1964, the portion of the trust which is a foreign trust 
created by a U.S. person and the portion of the trust which is a foreign 
trust created by a person other than a U.S. person had the following 
amounts of undistributed net income:

----------------------------------------------------------------------------------------------------------------
                                                                                             Undistributed net
                                                                      Undistributed net      income--portion of
                               Year                                   income--portion of    the trust created by
                                                                     the trust created by  a person other than a
                                                                        a U.S. person           U.S. person
----------------------------------------------------------------------------------------------------------------
1964..............................................................           $10,000                $10,000
1963..............................................................              None                   None
1962..............................................................              None                   None
1961..............................................................              None                   None
1960..............................................................              None                   None
1959..............................................................              None                   None
1958..............................................................              None                   None
1957..............................................................              None                   None
1956..............................................................              None                   None
1955..............................................................             1,000                   None
1954..............................................................              None                   None
1953..............................................................            12,000                  6,000
1952..............................................................             7,000                  4,000
                                                                   ---------------------------------------------
  Totals..........................................................            30,000                 20,000
----------------------------------------------------------------------------------------------------------------


The accumulation distribution is deemed to have been distributed in the 
amount of

[[Page 232]]

$15,000 (30,000/50,000x$25,000), from the portion of the trust which is 
a foreign trust created by a U.S. person, and in the amount of $10,000 
(20,000/50,000x$25,000) from the portion of the trust which is a foreign 
trust created by a person other than a U.S. person computed as follows:

----------------------------------------------------------------------------------------------------------------
                                                                                                Throwback to
                                                                                             preceding years of
                                                                         Throwback to      portion of the entire
                               Year                                   preceding years of    foreign trust which
                                                                    foreign trust created     is not a foreign
                                                                        by U.S. person       trust created by a
                                                                                                U.S. person
----------------------------------------------------------------------------------------------------------------
1964..............................................................           $10,000                $10,000
1963..............................................................              None                   None
1962..............................................................              None                   None
1961..............................................................              None                   None
1960..............................................................              None                   None
1959..............................................................              None                   None
1958..............................................................              None                   None
1957..............................................................              None                   None
1956..............................................................              None                   None
1955..............................................................             1,000                   None
1954..............................................................              None                   None
1953..............................................................             4,000                   None
1952..............................................................              None                   None
                                                                   ---------------------------------------------
  Totals..........................................................            15,000                 10,000
----------------------------------------------------------------------------------------------------------------

Pursuant to paragraph (a)(3) of this section, only $11,000 of the 
accumulation distribution in the amount of $15,000 from the portion of 
the trust which is a foreign trust created by a U.S. person is 
includible in the beneficiary's gross income for 1965 as the $11,000 
amount represents undistributed net income of the trust for the trust's 
preceding taxable years which began after December 31, 1953, and ended 
after August 16, 1954. The accumulation distribution in the amount of 
$10,000 from the portion of the trust which is a foreign trust created 
by a person other than a U.S. person is included in the beneficiary's 
gross income for 1965 to the extent of the undistributed net income of 
the trust for the preceding 5 years. Accordingly, the entire $10,000 
(representing the undistributed net income for the year 1964) is 
includible in the beneficiary's gross income for 1965. Thus, of the 
$25,000 distribution made in 1965, the beneficiary is required to 
include a total of $21,000 in his gross income for 1965.

    (d) For the purposes of allocating to any preceding taxable year an 
accumulation distribution of the taxable year, the undistributed net 
income of such preceding taxable year is computed without regard to the 
accumulation distribution of the taxable year or of taxable years 
following the taxable year. However, accumulation distributions of any 
taxable years intervening between such preceding taxable year and the 
taxable year are taken into account. Accordingly, if a trust has 
undistributed net income for the taxable year 1954 and makes an 
accumulation distribution during the taxable year 1955, the 
undistributed net income for 1954 is computed without regard to the 
accumulation distribution for 1955 or any subsequent year. If the trust 
makes a further accumulation distribution for 1956, the undistributed 
net income for 1954 is computed without regard to the accumulation 
distribution for 1956 or subsequent years; but in determining the 
undistributed net income for 1954 for purposes of the 1956 accumulation 
distribution the accumulation distribution for 1955 will be taken into 
account.

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



Sec. 1.666(b)-1  Total taxes deemed distributed.

    (a) If an accumulation distribution is deemed under Sec. 1.666(a)-1 
to be distributed on the last day of a preceding taxable year and the 
amount is not less than the undistributed net income for such preceding 
taxable year, then an additional amount equal to the ``taxes imposed on 
the trust'' (as defined in Sec. 1.665(d)-1) for such preceding taxable 
year is likewise deemed distributed under section 661(a)(2). For 
example, a trust has taxable income of $11,032 (not including any 
capital gains) and undistributed net income of $8,000 for the taxable 
year 1954. The taxes imposed on the trust are $3,032. During the taxable 
year 1955, an accumulation distribution of $8,000 is made to the 
beneficiary, which is deemed under Sec. 1.666(a)-1 to have been 
distributed on the last day of 1954. The taxes imposed on the trust for 
1954 of $3,032 are also deemed to have been distributed on the last day 
of 1954 since the 1955 accumulation distribution is not less than the 
1954 undistributed net income. Thus, a total of $11,032 will be deemed 
to have been distributed on the last day of 1954 because of the 
accumulation distribution of $8,000 made in 1955.
    (b) For the purpose of paragraph (a) of this section, the 
undistributed net income of any preceding taxable year is computed 
without regard to the accumulation distribution of the taxable year or 
any taxable year following such

[[Page 233]]

taxable year. However, any accumulation distribution of taxable years 
intervening between such preceding taxable year and the taxable year are 
taken into account. See paragraph (d) of Sec. 1.666(a)-1 and paragraphs 
(f)(5) and (g)(1) of Sec. 1.668(b)-2.

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



Sec. 1.666(c)-1  Pro rata portion of taxes deemed distributed.

    (a) If an accumulation distribution is deemed under Sec. 1.666(a)-1 
to be distributed on the last day of a preceding taxable year and the 
amount is less than the undistributed net income for such preceding 
taxable year, then an additional amount is likewise deemed distributed 
under section 661(a)(2). The additional amount is equal to the taxes 
imposed on the trust, as defined in Sec. 1.665(d)-1, for such preceding 
taxable year, multiplied by the fraction of which the numerator is the 
amount of the accumulation distribution and the denominator is the 
undistributed net income for such preceding taxable year. See paragraph 
(b) of example 1 and paragraphs (c) and (f) of example 2 in Sec. 
1.666(c)-2, and paragraph (f)(2) of Sec. 1.668(b)-2 for illustrations 
of this paragraph.
    (b) For the purpose of paragraph (a) of this section, the 
undistributed net income of any preceding taxable year is computed 
without regard to the accumulation distribution of the taxable year or 
any taxable year following the taxable year. However, accumulation 
distributions of any taxable years intervening between such preceding 
taxable year and the taxable year are taken into account. See paragraph 
(d) of Sec. 1.666(a)-1, paragraph (c) of example 1 and paragraphs (e) 
and (h) of example 2 in Sec. 1.666(c)-2 and paragraph (f)(5)(iii) of 
Sec. 1.668(b)-2.

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



Sec. 1.666(c)-2  Illustration of the provisions of section 666.

    The application of the provisions of Sec. Sec. 1.666(a)-1, 
1.666(b)-1, and 1.666(c)-1 may be illustrated by the following examples:

    Example 1. (a) A trust makes accumulation distributions as follows:

 1959.............................................................$7,000
 1960.............................................................25,000


For 1954 through 1958, the undistributed portion of distributable net 
income taxes imposed on the trust, and undistributed net income are as 
follows:

----------------------------------------------------------------------------------------------------------------
                                                                       Undistributed
                                                                        portion of        Taxes    Undistributed
                                Year                                   distributable   imposed on    net income
                                                                        net income      the trust
----------------------------------------------------------------------------------------------------------------
1958...............................................................     $12,100         $3,400        $8,700
1957...............................................................      16,100          5,200        10,900
1956...............................................................       6,100          1,360         4,740
1955...............................................................        None           None          None
1954...............................................................      10,100          2,640         7,460
----------------------------------------------------------------------------------------------------------------

    (b) Since the entire amount of the accumulation distribution for 
1959 ($7,000), determined without regard to the accumulation 
distribution for 1960, is less than the undistributed net income for 
1958 ($8,700), an additional amount of $2,736 (7,000/ 8,700x$3,400) is 
likewise deemed distributed under section 666(c).
    (c) In allocating the accumulation distribution for 1960, the 
undistributed net income for 1958 will take into account the 
accumulation distribution for 1959, and the additional amount of taxes 
imposed on the trust for 1958 deemed distributed. The undistributed net 
income for 1958 will then be $1,906; and the taxes imposed on the trust 
for 1958 will then be $458, determined as follows:

Undistributed portion of distributable net income as of the      $12,100
 close of 1958...............................................
Less:
  Accumulation distribution (1959)................     $7,000
  Taxes deemed distributed under section 666(c)         2,736
   (7,000/8,700x$3,400)...........................
                                                   -----------
                                                                   9,736
                                                   ------------
    Balance (undistributed portion of distributable net            2,364
     income as of the close of 1959).........................
Less: Personal exemption.....................................        100
                                                   ------------
    Balance..................................................      2,264
Taxes imposed on the trust (income taxes on $2,264)..........        458
                                                   ------------
Undistributed portion of distributable net income as of the        2,364
 close of 1959...............................................
Less: Income taxes attributable thereto......................        458
                                                   ------------
    Undistributed net income for 1958 as of the close of 1959      1,906
 

    (d) The accumulation distribution of $25,000 for 1960 is deemed to 
have been made on the last day of the 5 preceding taxable years of the 
trust to the extent of $17,546, the total of the undistributed net 
income for such years, as shown in the tabulation below. In addition, 
$7,018, the total taxes imposed on the trust for such years is also 
deemed to

[[Page 234]]

have been distributed on the last day of such years, as shown below:

------------------------------------------------------------------------
                                        Undistributed   Taxes imposed on
                Year                     net income         the trust
------------------------------------------------------------------------
1959................................        None              None
1958................................      $1,906              $458
1957................................      10,900             5,200
1956................................       4,740             1,360
1955................................        None              None
------------------------------------------------------------------------

    (e) No portion of the 1960 accumulation distribution is deemed made 
on the last day of 1954 because, as to 1960, 1954 is the sixth preceding 
taxable year.
    Example 2. (a) Under the terms of a trust instrument, the trustee 
has discretion to accumulate or distribute the income to X and to invade 
corpus for the benefit of X. The entire income of the trust is from 
royalties. Both X and the trust report on the calendar year basis. All 
of the income for 1954 was accumulated. The distributable net income of 
the trust for the taxable year 1954 is $20,100 and the income taxes paid 
by the trust for 1954 with respect to its distributable net income are 
$7,260. All of the income for 1955 and 1956 was distributed and in 
addition the trustee made accumulation distributions within the meaning 
of section 665(b) of $6,420 for each year.
    (b) The undistributed net income of the trust determined under 
section 665(a) as of the close of 1954, is $12,840, computed as follows:

Distributable net income....................................     $20,100
Less: Taxes imposed on the trust............................       7,260
                                                             -----------
    Undistributed net income as of the close of 1954........      12,840
 

    (c) The accumulation distribution of $6,420 made during the taxable 
year 1955 is deemed under section 666(a) to have been made on December 
31, 1954. Since this accumulation distribution is less than the 1954 
undistributed net income of $12,840, a portion of the taxes imposed on 
the trust for 1954 is also deemed under section 666(c) to have been 
distributed on December 31, 1954. The total amount deemed to have been 
distributed to X on December 31, 1954, is $10,050, computed as follows:

Accumulation distribution...................................      $6,420
Taxes deemed distributed (6,420/ 12,840x$7,260).............       3,630
                                                             -----------
    Total...................................................      10,050
 

    (d) After the application of the provisions of subpart D (section 
665 and following), part I, subchapter J, chapter 1 of the Code, to the 
accumulation distribution of 1955, the undistributed portion of the 
distributable net income of the trust for 1954, is $10,050, and the 
taxes imposed with respect thereto are $2,623, computed as follows:

Distributable net income as of the close of 1954............     $20,100
Less: 1955 accumulation distribution and taxes deemed             10,050
 distributed on December 31, 1954 (paragraph (c) of this
 example)...................................................
                                                             -----------
    Undistributed portion of the 1954 distributable net           10,050
     income adjusted as of the close of 1955................
Less: Personal exemption....................................         100
                                                             -----------
    Balance.................................................       9,950
Income taxes on $9,950......................................       2,623
 

    (e) The undistributed net income of the trust for the taxable year 
1954, as adjusted to give effect to the 1955 accumulation distribution, 
is $7,427, computed as follows:

Undistributed portion of distributable net income as of the      $10,050
 close of 1955..............................................
Less: Income taxes applicable thereto.......................       2,623
                                                             -----------
    Undistributed net income determined as of the close of         7,427
     1955...................................................
 

    (f) Inasmuch as all of the income of the trust for the taxable year 
1955 was distributed to X, the trust had no undistributed net income for 
that year. Accordingly, the accumulation distribution of $6,420 made 
during the taxable year 1956 is, under section 666(a), deemed a 
distribution to X on December 31, 1954, within the meaning of section 
661(a)(2). Since this accumulation distribution is less than the 1954 
adjusted undistributed net income of $7,427, the trust is deemed under 
section 666(c) also to have distributed on December 31, 1954, a portion 
of the taxes imposed on the trust for 1954. The total amount deemed to 
be distributed on December 31, 1954, with respect to the accumulation 
distribution made in 1956, is $8,687, computed as follows:

Accumulation distribution...................................      $6,420
Taxes deemed distributed (6,420/ 7,427x$2,623)..............       2,267
                                                             -----------
    Total...................................................       8,687
 

    (g) After the application of the provisions of subpart D to the 
accumulation distribution of 1956, the undistributed portion of the 
distributable net income of the trust for 1954, is $1,363, and the taxes 
imposed on the trust with respect thereto are $253, computed as follows:

Undistributed portion of distributable net income as of the      $10,050
 close of 1955..............................................
Less: 1956 accumulation distribution and taxes deemed              8,687
 distributed on December 31, 1954 (paragraph (f) of this
 example)...................................................
                                                             -----------
    Undistributed portion of distributable net income as of        1,363
     the close of 1956......................................
Less: Personal exemption....................................         100
                                                             -----------
    Balance.................................................       1,263
Income taxes on $1,263......................................         253
 

    (h) The undistributed net income of the trust for the taxable year 
1954, determined as of the close of the taxable year 1956, is $1,110 
($1,363 less $253).

[[Page 235]]



Sec. 1.667-1  Denial of refund to trusts.

    (a) If an amount is deemed under section 666 to be an amount paid, 
credited, or required to be distributed on the last day of a preceding 
taxable year, the trust is not allowed a refund or credit of the amount 
of ``taxes imposed on the trust'', as defined in Sec. 1.665(d)-1, which 
would not have been payable for the preceding taxable year had the trust 
in fact made such distribution on the last day of such year. However, 
such taxes are allowed as a credit under section 668(b) against the tax 
of the beneficiaries who are treated as having received the 
distributions in the preceding taxable year. The amount of taxes which 
may not be refunded or credited to the trust under this paragraph and 
which are allowed as a credit under section 668(b) against the tax of 
the beneficiaries, is an amount equal to the excess of:
    (1) The taxes imposed on the trust (as defined in section 665(d) and 
Sec. 1.655(d)-1) for any preceding taxable year (computed without 
regard to the accumulation distribution for the taxable year) over
    (2) The amount of taxes for such preceding taxable year which would 
be imposed on the undistributed portion of distributable net income of 
the trust for such preceding taxable year after the application of 
subpart D (section 665 and following), part I, subchapter J, chapter 1 
of the Code, on account of the accumulation distribution determined for 
the taxable year.

It should be noted that the credit under section 667 is computed by the 
use of a different ratio from that used for computing the amount of 
taxes deemed distributed under section 666(c).
    (b) Paragraph (a) of this section may be illustrated by the 
following examples:

    Example 1. In 1954, a trust of which A is the sole beneficiary has 
taxable income of $20,000 (including capital gains of $5,100 allocable 
to corpus less a personal exemption of $100), on which a tax of $7,260 
is paid.

The undistributed portion of distributable net income is $15,000, to 
which $6,160 of the tax is allocable under section 665. The 
undistributed net income is therefore $8,840 ($15,000 minus $6,160). In 
1955, the trust makes an accumulation distribution of $8,840. Under 
section 666(b), the total taxes for 1954 attributable to the 
undistributed net income are deemed distributed, so $15,000 is deemed 
distributed. The amount of the tax which may not be refunded to the 
trust under section 667 and the credit to which A is entitled under 
section 668(b) is the excess of $6,160 over zero, since after the 
distribution and the application of subpart D there is no remaining 
undistributed portion of distributable net income for 1954.
    Example 2. The same trust as in example 1 of this paragraph 
distributes $5,000 in 1955, rather than $8,840. The amount of the tax 
which may not be refunded to the trust but which is available to A as a 
credit is $4,044, computed as follows:

Accumulation distribution in 1955............................     $5,000
Taxes deemed distributed under section 666(c) (5,000/              3,484
 8,840x$6,160)...............................................
                                                   ------------
    Total amount deemed distributed out of the undistributed       8,484
     portion of distributable net income.....................
                                                   ============
Tax attributable to the undistributed portion of                   6,160
 distributable net income ($15,000) before 1955 distribution
 (see example 1 of this paragraph)...........................
Tax on $11,516 (taxable income of $20,000 minus        $3,216
 $8,484, amount deemed distributed)...............
Tax on $5,000 (capital gains of $5,100, less            1,100
 personal exemption of $100, allocable to corpus).
                                                   -----------
Tax attributable to undistributed portion of distributable         2,116
 net income after 1955 distribution..........................
                                                   ------------
    Refund disallowed to the trust and credit available to A       4,044
     in 1955.................................................
 


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



Sec. 1.667(a)-1A  Denial of refund to trusts.

    If an amount is deemed under section 666 or 669 to be an amount 
paid, credited, or required to be distributed on the last day of a 
preceding taxable year, the trust is not allowed a refund or credit of 
the amount of ``taxes imposed on the trust'', as defined in Sec. 
1.665(d)-1A. However, such taxes imposed on the trust are allowed as a 
credit under section 667(b) against the tax of certain beneficiaries who 
are treated as having received the distributions in the preceding 
taxable year.

[T.D. 7204, 37 FR 17147, Aug. 25, 1972]



Sec. 1.667(b)-1A  Authorization of credit to beneficiary for taxes
imposed on the trust.

    (a) Determination of credit--(1) In general. Section 667(b) allows 
under certain

[[Page 236]]

circumstances a credit (without interest) against the tax imposed by 
subtitle A of the Code on the beneficiary for the taxable year in which 
the accumulation distribution is required to be included in income under 
section 668(a). In the case of an accumulation distribution consisting 
only of undistributed net income, the amount of such credit is the total 
of the taxes deemed distributed to such beneficiary under section 666 
(b) and (c) as a result of such accumulation distribution for preceding 
taxable years of the trust on the last day of which such beneficiary was 
in being, less the amount of such taxes for such preceding taxable years 
taken into account in reducing the amount of partial tax determined 
under Sec. 1.668(b)-1A. In the case of an accumulation distribution 
consisting only of undistributed capital gain, the amount of such credit 
is the total of the taxes deemed distributed as a result of the 
accumulation distribution to such beneficiary under section 669 (d) and 
(e) for preceding taxable years of the trust on the last day of which 
such beneficiary was in being, less the amount of such taxes for such 
preceding taxable years taken into account in reducing the amount of 
partial tax determined under Sec. 1.669(b)-1A. In the case of an 
accumulation distribution consisting of both undistributed net income 
and undistributed capital gain, a credit will not be available unless 
the total taxes deemed distributed to the beneficiary for all preceding 
taxable years as a result of the accumulation distribution exceeds the 
beneficiary's partial tax determined under Sec. Sec. 1.668(b)-1A and 
1.669(b)-1A without reference to the taxes deemed distributed. A credit 
is not allowed for any taxes deemed distributed as a result of an 
accumulation distribution to a beneficiary by reason of sections 666 (b) 
and (c) or sections 669 (d) and (e) for a preceding taxable year of the 
trust before the beneficiary was born or created. However, if as a 
result of an accumulation distribution the total taxes deemed 
distributed under sections 668(a)(2) and 668(a)(3) in preceding taxable 
years before the beneficiary was born or created exceed the partial 
taxes attributable to amounts deemed distributed in such years, such 
excess may be used to offset any liability for partial taxes 
attributable to amounts deemed distributed as a result of the same 
accumulation distribution in preceding taxable years after the 
beneficiary was born or created.
    (2) Exact method. In the case of the tax computed under the exact 
method provided in Sec. Sec. 1.668(b)-1A(b) and 1.669(b)-1A(b), the 
credit allowed by this section is computed as follows:
    (i) Compute the total taxes deemed distributed under Sec. Sec. 
1.666(b)-1A and 1.666(c)-1A or Sec. Sec. 1.669(d)-1A and 1.669(e)-1A, 
whichever are appropriate, for the preceding taxable years of the trust 
on the last day of which the beneficiary was in being.
    (ii) Compute the total of the amounts of tax determined under Sec. 
1.668(b)-1A(b)(1) or Sec. 1.669(b)-1A(b) (1), whichever is appropriate, 
for the prior taxable years of the beneficiary in which he was in being.

If the amount determined under subdivision (i) of this subparagraph does 
not exceed the amount determined under subdivision (ii) of this 
subparagraph, no credit is allowable. If the amount determined under 
subdivision (i) of this subparagraph exceeds the amount determined under 
subdivision (ii) of this subparagraph, the credit allowable is the 
lesser of the amount of such excess or the amount of taxes deemed 
distributed to the beneficiary for all preceding taxable years to the 
extent that such taxes are not used in Sec. 1.668(b)-1A(b)(2) or Sec. 
1.669(b)-1A(b)(2) in determining the beneficiary's partial tax under 
section 668(a)(2) or 668(a)(3). The application of this subparagraph may 
be illustrated by the following example:

    Example. An accumulation distribution made in 1975 is deemed 
distribution in 1973 and 1974, years in which the beneficiary was in 
being. The taxes deemed distributed in such years are $4,000 and $2,000, 
respectively, totaling $6,000. The amounts of tax computed under Sec. 
1.668(b)-1A(b)(1) attributable to the amounts thrown back are $3,000 and 
$2,000, respectively, totaling $5,000. The credit allowable under this 
subparagraph is therefore $1,000 ($6,000 less $5,000).

    (3) Short-cut method. In the case of the tax computed under the 
short-cut method provided in Sec. 1.668(b)-1A(c) or

[[Page 237]]

Sec. 1.669(b)-1A(c), the credit allowed by this section is computed as 
follows:
    (i) Compute the total taxes deemed distributed in all preceding 
taxable years of the trust under Sec. Sec. 1.666(b)-1A and 1.666(c)-1A 
or Sec. Sec. 1.669(d)-1A and 1.669(e)-1A, whichever are appropriate.
    (ii) Compute the beneficiary's partial tax determined under either 
Sec. 1.668(b)-1A(c)(1)(v) or Sec. 1.669(b)-1A (c)(1)(v), whichever is 
appropriate.

If the amount determined under subdivision (i) of this subparagraph does 
not exceed the amount determined under subdivision (ii) of this 
subparagraph, no credit is allowable. If the amount determined under 
subdivision (i) of this subparagraph exceeds the amount determined under 
subdivision (ii) of this subparagraph,
    (iii) Compute the total taxes deemed distributed under Sec. Sec. 
1.666(b)-1A and 1.666(c)-1A or Sec. Sec. 1.669(d)-1A and 1.669(e)-1A, 
which are appropriate, for the preceding taxable years of the trust on 
the last day of which the beneficiary was in being.
    (iv) Multiply the amount by which subdivision (i) of this 
subparagraph exceeds subdivision (ii) of this subparagraph by a 
fraction, the numerator of which is the amount determined under 
subdivision (iii) of this subparagraph and the denominator of which is 
the amount determined under subdivision (i) of this subparagraph. The 
result is the allowable credit. The application of this subparagraph may 
be illustrated by the following example:

    Example. An accumulation distribution that consists only of 
undistributed net income is made in 1975. The taxes deemed distributed 
in the preceding years under Sec. Sec. 1.666(b)-1A and 1.666(c)-1A are 
$15,000. The amount determined under Sec. 1.668(b)-1A(c)(1)(v) is 
$12,000. The beneficiary was in being on the last day of all but one 
preceding taxable year in which the accumulation distribution was deemed 
made, and the taxes deemed distributed in those years was $10,000. 
Therefore, the excess of the subdivision (i) amount over the subdivision 
(ii) amount is $3,000, and is multiplied by 10,000/15,000, resulting in 
an answer of $2,000, which is the credit allowable when computed under 
the short-cut method.

    (b) Year of credit. The credit to which a beneficiary is entitled 
under this section is allowed for the taxable year in which the 
accumulation distribution (to which the credit relates) is required to 
be included in the income of the beneficiary under section 668(a). Any 
excess over the total tax liability of the beneficiary for such year is 
treated as an overpayment of tax by the beneficiary. See section 6401(b) 
and the regulations thereunder.

[T.D. 7204, 37 FR 17147, Aug. 25, 1972]



Sec. 1.668(a)-1A  Amounts treated as received in prior taxable years;
inclusion in gross income.

    (a) Section 668(a) provides that the total of the amounts treated 
under sections 666 and 669 as having been distributed by the trust on 
the last day of a preceding taxable year of the trust shall be included 
in the income of the beneficiary or beneficiaries receiving them. The 
total of such amounts is includable in the income of each beneficiary to 
the extent the amounts would have been included under section 662 (a)(2) 
and (b) as if the total had actually been an amount properly paid by the 
trust under section 661 (a)(2) on the last day of such preceding taxable 
year. The total is included in the income of the beneficiary for the 
taxable year of the beneficiary in which such amounts are in fact paid, 
credited, or required to be distributed unless the taxable year of the 
beneficiary differs from the taxable year of the trust (see section 
662(c) and the regulations thereunder). The character of the amounts 
treated as received by a beneficiary in prior taxable years, including 
taxes deemed distributed, in the hands of the beneficiary is determined 
by the rules set forth in section 662(b) and the regulations thereunder.
    (b) Any deduction allowed to the trust in computing distributable 
net income for a preceding taxable year (such as depreciation, 
depletion, etc.) is not deemed allocable to a beneficiary because of 
amounts included in a beneficiary's gross income under this section 
since the deduction has already been utilized in reducing the amount 
included in the beneficiary's income.
    (c) For purposes of applying section 668(a)(3), a trust shall be 
considered to be other than a ``trust which is not required to 
distribute all of its income currently'' for each taxable year prior to 
the first taxable year beginning

[[Page 238]]

after December 31, 1968, and ending after November 30, 1969, in which 
income is accumulated. Income will not be deemed to have been 
accumulated for purposes of applying section 668(a)(3) in a year if the 
trustee makes a determination, as evidenced by a statement on the 
return, to distribute all of the trust's income for such year and also 
makes a good faith determination as to the amount of such income and 
actually distributed for such year the entire amount so determined. The 
term ``income,'' as used in the preceding two sentences, is defined in 
Sec. Sec. 1.643(b)-1 and 1.643(b)-2. Since, under such definitions, 
certain items may be included in distributable net income but are not, 
under applicable local law, ``income'' (as, for example, certain 
extraordinary dividends), a trust that has undistributed net income from 
such sources might still qualify as a trust that has not accumulated 
income. Also, for example, if a trust establishes a reserve for 
depreciation or depletion and applicable local law permits the deduction 
for such reserve in the computation of ``income,'' amounts so added to 
the reserve do not constitute an accumulation of income. If a trust has 
separate shares, and any share accumulates income, all shares of the 
trust will be considered to have accumulated income for purposes of 
section 668(a)(3). Amounts retained by a trust or a portion of a trust 
that is subject to subpart E (sections 671-678) shall not be considered 
accumulated income.
    (d) See section 1302(a)(2)(B) to the effect that amounts included in 
the income of a beneficiary of a trust under section 668(a) are not 
eligible for income averaging.

[T.D. 7204, 37 FR 17148, Aug. 25, 1972]



Sec. 1.668(a)-2A  Allocation among beneficiaries; in general.

    The portion of the total amount includible in income under Sec. 
1.668(a)-1A which is includible in the income of a particular 
beneficiary is based upon the ratio determined under the second sentence 
of section 662(a)(2) for the taxable year (and not for the preceding 
taxable year). This section may be illustrated by the following example:

    Example. (a) Under the terms of a trust instrument, the trustee may 
accumulate the income or make distributions to A and B. The trustee may 
also invade corpus for the benefit of A and B. The distributable net 
income of the trust for taxable year 1975 is $10,000. The trust had 
undistributed net income for taxable year 1973, the first year of the 
trust, of $5,000, to which a tax of $1,100 was allocable. On May 1, 
1975, the trustee distributes $10,000 to A, and on November 29, 1975, he 
distributes $5,000 to B. Thus, of the total distribution of $15,000, A 
received two-thirds and B receives one-third.
    (b) For the purposes of determining the amounts includible in the 
beneficiaries' gross income for 1975, the trust is deemed to have made 
the following distributions:

Amount distributed out of 1975 income (distributable net         $10,000
 income).....................................................
Accumulation distribution deemed distributed by the trust on       5,000
 the last day of 1973 under section 666(a)...................
Taxes imposed on the trust attributable to the undistributed       1,100
 net income deemed distributed under section 666(b)..........
 

    (c) A will include in his income for 1975 two-thirds of each item 
shown in paragraph (b) of this example. Thus, he will include in gross 
income $6,666.67 (10,000/15,000x $10,000) of the 1975 distributable net 
income of the trust as provided in section 662(a)(2) (which is not an 
amount includable in his income under Sec. 1.668(a)-1A(a)). He will 
include in his income $3,333.33 (10,000/15,000x$5,000) of the 
accumulation distribution and $733.33 (10,000/15,000x $1,100) of the 
taxes imposed on the trust, as provided in section 668(a).
    (d) B will include in his income for 1975 one-third of each item 
shown in paragraph (b) of this example, computed in the manner shown in 
paragraph (c) of this example.
    (e) To the extent the total accumulation distribution consists of 
undistributed net income and undistributed capital gain, A and B shall 
be treated as receiving a pro rata share of each for the preceding 
taxable year 1973.

[T.D. 7204, 37 FR 17148, Aug. 25, 1972]



Sec. 1.668(a)-3A  Determination of tax.

    In a taxable year in which an amount is included in a beneficiary's 
income under Sec. 1.668(a)-1A(a), the tax on the beneficiary for such 
taxable year is determined only as provided in section 668 and consists 
of the sum of:
    (a) A partial tax computed on (1) the beneficiary's taxable income 
reduced by (2) an amount equal to the total amounts includible in his 
income under Sec. 1.668(a)-1A(a), at the rate and in the manner as if 
section 668 had not been enacted,

[[Page 239]]

    (b) A partial tax determined as provided in Sec. 1.668(b)-1A, and
    (c) In the case of a beneficiary of a trust which is not required to 
distribute all of its income currently, a partial tax determined as 
provided in Sec. 1.669(b)-1A.

[T.D. 7204, 37 FR 17148, Aug. 25, 1972]



Sec. 1.668(b)-1A  Tax on distribution.

    (a) In general. The partial tax imposed on the beneficiary by 
section 668(a)(2) shall be the lesser of:
    (1) The tax computed under paragraph (b) of this section (the 
``exact'' method), or
    (2) The tax computed under paragraph (c) of this section (the 
``short-cut'' method),

except as provided in Sec. 1.668(b)-4A (relating to failure to furnish 
proper information) and paragraph (d) of this section (relating to 
disallowance of short-cut method). For purposes of this paragraph, the 
method used in the return shall be accepted as the method that produces 
the lesser tax. The beneficiary's choice of the two methods is not 
dependent upon the method that he uses to compute his partial tax 
imposed by section 668(a)(3).
    (b) Computation of partial tax by the exact method. The partial tax 
referred to in paragraph (a)(1) of this section is computed as follows:
    (1) First, compute the tax attributable to the section 666 amounts 
for each of the preceding taxable years. For purposes of this paragraph, 
the ``section 666 amounts'' for a preceding taxable year are the amounts 
deemed distributed under section 666(a) on the last day of the preceding 
taxable year, plus the amount of taxes deemed distributed on such day 
under section 666 (b) or (c). The tax attributable to such amounts in 
each prior taxable year of the beneficiary is the difference between the 
tax for such year computed with the inclusion of the section 666 amounts 
in the beneficiary's gross income and the tax for such year computed 
without including them in such gross income. Tax computations for each 
such year shall reflect a taxpayer's marital, dependency, exemption, and 
filing status for such year. To the extent the undistributed net income 
of a trust deemed distributed in an accumulation distribution includes 
amounts received as an accumulation distribution from another trust, for 
purposes of this paragraph they shall be considered as amounts deemed 
distributed by the trust under section 666(a) on the last day of each of 
the preceding taxable years in which such amounts were accumulated by 
such other trust. For example, assume trust Z, a calendar year trust, 
received in its taxable year 1975 an accumulation distribution from 
trust Y, a calendar year trust, that included undistributed net income 
and taxes of trust Y for the taxable years 1972, 1973, and 1974. To the 
extent an accumulation distribution made by trust Z in its taxable year 
1976 includes such undistributed net income and taxes, it shall be 
considered an accumulation distribution by trust Z in the taxable year 
1976 and under section 666(a) will be deemed distributed on the last day 
of the preceding taxable years 1972, 1973, and 1974.
    (2) From the sum of the taxes for the prior taxable years 
attributable to the section 666 amounts (computed in accordance with 
subparagraph (1) of this paragraph), subtract so much of the amount of 
taxes deemed distributed to the beneficiary under Sec. Sec. 1.666(b)-1A 
and 1.666(c)-1A as does not exceed such sum. The resulting amount, if 
any, is the partial tax, computed under the exact method, for the 
taxable year in which the accumulation distribution is paid, credited, 
or required to be distributed to the beneficiary.
    (3) The provisions of this paragraph may be illustrated by the 
following example:

    Example. (i) Assume that in 1979 a trust makes an accumulation 
distribution of $15,000 to A. The accumulation distribution is allocated 
under section 666(a) in the amounts of $5,000 to 1971, $4,000 to 1972, 
and $6,000 to 1973. Under section 666 (b) and (c), taxes in the amounts 
of $935, $715, and $1,155 (totaling $2,805) are deemed distributed in 
1971, 1972, and 1973, respectively.
    (ii) A, the beneficiary, had taxable income and paid income tax in 
1971-73 as follows:

------------------------------------------------------------------------
               Year                   Taxable income          Tax
------------------------------------------------------------------------
1971..............................     $10,000             $2,190
1972..............................      12,000              2,830
1973..............................      14,000              3,550
------------------------------------------------------------------------


[[Page 240]]

    (iii) Taxes attributable to the section 666 amounts (paragraph (i) 
of this example) are $6,979, computed as follows:

                                  1971
 
Taxable income including section 666 amounts         $15,935
 ($10,000 + $5,000 + $935)........................
Tax on $15,935...............................................     $4,305
Less: Tax paid by A in 1971..................................      2,190
                                                   ------------
Tax attributable to 1971 section 666 amounts.................      2,115
 
                                  1972
 
Taxable income including section 666 amounts         $16,715
 ($12,000 + $4,000 + $715)........................
Tax on $16,715...............................................     $4,620
Less: Tax paid by A in 1972..................................      2,830
                                                   ------------
Tax attributable to 1972 section 666 amounts.................      1,790
 
                                  1973
 
Taxable income including section 666 amounts          $21,155
 ($14,000 + $6,000 + $1,155)......................
Tax on $21,155...............................................     $6,624
Less: Tax paid by A in 1973..................................      3,550
                                                   ------------
Tax attributable to 1973 section 666 amounts.................      3,074
Total tax attributable to section 666 amounts:
  1971............................................     $2,115
  1972............................................      1,790
  1973............................................      3,074
                                                   -----------
    Total.........................................      6,979
 

    (iv) The partial tax computed under the exact method is $4,174, 
computed by subtracting the taxes deemed distributed ($2,805) from the 
tax attributable to the section 666 amounts ($6,979).

    (c) Computation of tax by the short- cut method. (1) The tax 
referred to in paragraph (a)(2) of this section is computed as follows:
    (i) First, determine the number of preceding taxable years of the 
trust on the last day of which an amount is deemed under section 666(a) 
to have been distributed. For purposes of the preceding sentence, the 
preceding taxable years of a trust that has received an accumulation 
distribution from another trust shall include the taxable years of such 
other trust in which an amount was deemed distributed in such 
accumulation distribution. For example, assume trust Z, a calendar year 
trust, received in its taxable year 1975 an accumulation distribution 
from trust Y, a calendar year trust, that included undistributed net 
income of trust Y for the taxable years 1972, 1973, and 1974. To the 
extent an accumulation distribution made by trust Z in its taxable year 
1976 includes such undistributed net income, it shall be considered an 
accumulation distribution by trust Z in the taxable year 1976 and under 
section 666(a) will be deemed distributed on the last day of the 
preceding taxable years 1972, 1973, and 1974. For purposes of this 
subparagraph, such number of preceding taxable years of the trust shall 
not include any preceding taxable year of the trust in which the 
undistributed net income deemed distributed is less than 25 percent of 
(a) the total amounts deemed under section 666(a) to be undistributed 
net income from preceding taxable years divided by (b) the number of 
such preceding taxable years of the trust on the last day of which an 
amount is deemed under section 666(a) to have been distributed without 
application of this sentence. For example, assume that an accumulation 
distribution of $90,000 made to a beneficiary in 1979 is deemed 
distributed in the amounts of $29,000 in each of the years 1972, 1973, 
and 1974, and $3,000 in 1975. The number of preceding taxable years on 
the last day of which an amount was deemed distributed without reference 
to the second sentence of this subparagraph is four. However, the 
distribution deemed made in 1975 ($3,000) is less than $5,625, which is 
25 percent of (a) the total undistributed net income deemed distributed 
under section 666(a) ($90,000) divided by (b) the number of such 
preceding taxable years (4), or $22,500. Therefore, for purposes of this 
subparagraph the accumulation distribution is deemed distributed in only 
3 preceding taxable years (1972, 1973, and 1974).
    (ii) Second, divide the amount (representing the accumulation 
distribution and taxes deemed distributed) required under section 668(a) 
to be included in the income of the beneficiary for the taxable year by 
the number of preceding taxable years of the trust on the last day of 
which an amount is deemed under section 666(a) to have been distributed 
(determined as provided in subdivision (i) of this subparagraph). The 
amount determined under this subdivision, including taxes deemed 
distributed, consists of the same proportion of each class of income as 
the total of each class of income deemed distributed in the accumulation 
distribution bears to the total undistributed net income from such 
preceding taxable years deemed

[[Page 241]]

distributed in the accumulation distribution. For example, assume that 
an amount of $50,000 is deemed distributed under section 666(a) from 
undistributed net income of 5 preceding taxable years of the trust, and 
consists of $25,000 of interest, $15,000 of dividends, and $10,000 of 
net rental income. Taxes attributable to such amounts in the amount of 
$10,000 are also deemed distributed. The amount determined under this 
subdivision, $12,000 ($50,000 income plus $10,000 tax divided by 5 
years), is deemed to consist of $6,000 in interest, $3,600 in dividends, 
and $2,400 in net rental income.
    (iii) Third, compute the tax of the beneficiary for each of the 3 
taxable years immediately preceding the year in which the accumulation 
distribution is paid, credited, or required to be distributed to him,
    (a) With the inclusion in gross income of the beneficiary for each 
of such 3 years of the amount determined under subdivision (ii) of this 
subparagraph, and
    (b) Without such inclusion.


The difference between the amount of tax computed under (a) of this 
subdivision for each year and the amount computed under (b) of this 
subdivision for that year is the additional tax resulting from the 
inclusion in gross income for that year of the amount determined under 
subdivision (ii) of this subparagraph. For example, assume that a 
distribution of $12,000, is includible in the income of each of the 
beneficiary's 3 preceding taxable years when his income (without the 
inclusion of the accumulation distribution) was $20,000, $30,000, and 
$40,000. The inclusion of $12,000 in income would produce taxable income 
of $32,000, $42,000, and $52,000, and the tax attributable to such 
increases would be $4,000, $5,000, and $6,000, respectively.
    (iv) Fourth, add the additional taxes resulting from the application 
of subdivision (iii) of this subparagraph and then divide this amount by 
3. For example, if these additional taxes are $4,000, $5,000, and $6,000 
for the 3 preceding taxable years, this amount would be $5,000 
($4,000+$5,000+ $6,000 divided by 3).
    (v) Fifth, the resulting amount is then multiplied by the number of 
preceding taxable years of the trust on the last day of which an amount 
is deemed under section 666(a) to have been distributed (previously 
determined under subdivision (i) of this subparagraph). For example, if 
an amount is deemed distributed for 5 preceding taxable years, the 
resulting amount would be five times the $5,000 amount.
    (vi) Sixth, the resulting amount, less so much of the amount of 
taxes deemed distributed to the beneficiary under Sec. Sec. 1.666(b)-1A 
and 1.666(c)-1A as does not exceed such resulting amount, is the tax 
under the short-cut method provided in section 668(b)(1)(B).
    (2) The computation of the tax by the short-cut method may be 
illustrated by the following example:

    Example. In 1971, X creates a trust which is to accumulate its 
income and pay the income to Y when Y reaches 30. Y is 19. Over the 11 
years of the trust, the trust earns $1,200 of interest income annually 
and has expenses each year of $100 allocable to the production of 
income. The trust pays a total tax of $1,450 on the accumulated income. 
In 1981, when Y reaches 30, the $9,550 of accumulated undistributed net 
income and the $1,100 of current net income are distributed to Y. Y is 
treated as having received a total distribution of $11,000 (the $9,550 
accumulation distribution plus the taxes paid by the trust which are 
deemed to have been distributed to Y). The income of the current year 
(1981) is taxed directly to Y. The computation is as follows: $11,000 
(accumulation distribution plus taxes) divided by 10 (number of years 
out of which distribution was made) equals $1,100. The $1,100 added to 
the income of the beneficiary's preceding 3 years produces increases in 
tax as follows:

  1980................................................       $350
  1979................................................        300
  1978................................................        250
                                                       -----------------
    Total.............................................        900
 


$900 (total additional tax) divided by 3 equals $300 (average annual 
increase in tax). $300 (average annual increase in tax) times 10 equals 
$3,000, from which is deducted the amount of taxes ($1,450) paid by the 
trust attributable to the undistributed net income deemed distributed. 
The amount of tax to be paid currently under the short-cut method is 
therefore $1,550.

    (d) Disallowance of short-cut method. If, in any prior taxable year 
of the beneficiary in which any part of the accumulation distribution of 
undistributed net income is deemed to have been distributed under 
section 666(a) to such

[[Page 242]]

beneficiary, any part of prior accumulation distributions of 
undistributed net income by each of two or more other trusts is deemed 
under section 666(a) to have been distributed to such beneficiary, then 
the short-cut method under paragraph (c) of this section may not be used 
and the partial tax imposed by section 668(a)(2) shall be computed only 
under the exact method under paragraph (b) of this section. For example, 
assume that, in 1978, trust X makes an accumulation distribution of 
undistributed net income to A, who is on the calendar year basis, and 
part of the accumulation distribution is deemed under section 666(a) to 
have been distributed on March 31, 1974. In 1977, A had received an 
accumulation distribution of undistributed net income from both trust Y 
and trust Z. Part of the accumulation distribution from trust Y was 
deemed under section 666(a) to have been distributed to A on June 30, 
1974, and part of the accumulation distribution from trust Z was deemed 
under section 666(a) to have been distributed to A on December 31, 1974. 
Because there were portions of accumulation distributions of 
undistributed net income from two other trusts deemed distributed within 
the same prior taxable year of A (1974), the 1978 accumulation 
distribution from trust X may not be computed under the short-cut method 
provided in paragraph (c) of this section. Therefore the exact method 
under paragraph (b) of this section must be used to compute the tax 
imposed by section 666(a)(2).

[T.D. 7204, 37 FR 17149, Aug. 25, 1972]



Sec. 1.668(b)-2A  Special rules applicable to section 668.

    (a) Rule when beneficiary not in existence on the last day of a 
taxable year. If a beneficiary was not in existence on the last day of a 
preceding taxable year of the trust with respect to which a distribution 
is deemed made under section 666(a), it shall be assumed, for purposes 
of the computations under paragraphs (b) and (c) of Sec. 1.668(b)-1A, 
that the beneficiary:
    (1) Was in existence on such last day,
    (2) Was a calendar year taxpayer,
    (3) Had no gross income other than the amounts deemed distributed to 
him from such trust in his calendar year in which such last day occurred 
and from all other trusts from which amounts are deemed to have been 
distributed to him in such calendar year,
    (4) If an individual, was unmarried and had no dependents,
    (5) Had no deductions other than the standard deduction, if 
applicable, under section 141 for such calendar year, and
    (6) Was entitled to the personal exemption under section 151 or 
642(b).

For example, assume that part of an accumulation distribution made in 
1980 is deemed under section 666(a) to have been distributed to the 
beneficiary, A, in 1973; $10,000 of a prior accumulation distribution 
was deemed distributed in 1973. A was born on October 9, 1975. It will 
be assumed for purposes of Sec. 1.668(b)-1A that A was alive in 1973, 
was on the calendar year basis, had no income other than (i) the $10,000 
from the earlier accumulation distribution deemed distributed in 1973, 
and (ii) the part of the 1980 distribution deemed distributed in 1973, 
and had no deductions other than the personal exemption provided in 
section 151. It should be noted that the standard deduction for 1973 
will be available to A with respect to the distribution only to the 
extent it qualifies as ``earned income'' in the hands of the trust. See 
section 141(e) and the regulations thereunder and Sec. 1.652(b)-1. If A 
were a trust or estate created after 1973, the same assumptions would 
apply, except that the trust or estate would not be entitled to the 
standard deduction and would receive the personal exemption provided 
under section 642(b) in the same manner as allowed under such section 
for A's first actual taxable year.
    (b) Effect of other distributions. The income of the beneficiary, 
for any of his prior taxable years for which a tax is being recomputed 
under Sec. 1.668(b)-1A, shall include any amounts of prior accumulation 
distributions (including prior capital gain distributions) deemed 
distributed under sections 666 and 669 in such prior taxable year. For 
purposes of the preceding sentence, a ``prior accumulation 
distribution'' is a distribution from the same or another trust which 
was paid, credited, or required to be distributed in a prior taxable 
year of the beneficiary. The term ``prior accumulation distribution'' 
also

[[Page 243]]

includes accumulation distributions of other trusts which were paid, 
credited, or required to be distributed to the beneficiary in the same 
taxable year and which the beneficiary has determined under paragraph 
(c) of this section to treat as having been distributed before the 
accumulation distribution for which tax is being computed under Sec. 
1.668(b)-1A. Any capital gain distribution from the same trust paid, 
credited, or required to be distributed in the same taxable year of the 
beneficiary shall not be considered under this paragraph to be a ``prior 
capital gain distribution.''
    (c) Multiple distributions in the same taxable year. For purposes of 
paragraph (b) of this section, accumulation distributions made from more 
than one trust in the same taxable year of the beneficiary, regardless 
of when in the taxable year they were actually made, shall be treated as 
having been made consecutively, in whichever order the beneficiary may 
determine. However, the beneficiary must treat them as having been made 
in the same order for the purpose of computing the partial tax on the 
several accumulation distributions. The beneficiary shall indicate the 
order he has determined to deem the accumulation distributions to have 
been received by him on his return for the taxable year. A failure by 
him so to indicate, however, shall not affect his right to make such 
determination. The purpose of this rule is to assure that the tax 
resulting from the later (as so deemed under this paragraph) 
distribution is computed with the inclusion of the earlier distribution 
in the taxable base and that the tax resulting from the earlier (as so 
deemed under this paragraph) distribution is computed with the later 
distribution excluded from the taxable base.
    (d) Examples. The provisions of paragraphs (b) and (c) of this 
section may be illustrated by the following examples:

    Example 1. In 1978, trust X made an accumulation distribution of 
undistributed net income to A, a calendar year taxpayer, of which $3,000 
was deemed to have been distributed in 1974. In 1980, trust X makes 
another accumulation distribution of undistributed net income to A, 
$10,000 of which is deemed under section 666 to have been distributed in 
1974. Also in 1980, trust Y makes an accumulation distribution of 
undistributed net income to A, of which $5,000 is deemed under section 
666 to have been distributed in 1974. A determines to treat the 1980 
distribution from trust Y as having been made prior to the 1980 
distribution from trust X. In computing the tax on the 1980 trust Y 
distribution, A's gross income for 1974 includes (i) the $3,000 deemed 
distributed from the 1978 distribution, and (ii) the $5,000 deemed 
distributed in 1974 from the 1980 trust Y accumulation distribution. To 
compute A's tax under the exact method for 1974 on the $10,000 from the 
1980 trust X accumulation distribution deemed distributed in 1974, A's 
gross income for 1974 includes (i) the $10,000, (ii) the $3,000 
previously deemed distributed in 1974 from the 1978 trust X accumulation 
distribution, and (iii) the $5,000 deemed distribution in 1974 from the 
1980 trust Y accumulation distribution.
    Example 2. In 1978, trust T makes an accumulation distribution of 
undistributed net income to B, a calendar year taxpayer. Determination 
of the tax on the accumulation distribution under the short-cut method 
requires the use of B's gross income for 1975, 1976, and 1977. In 1977, 
B received an accumulation distribution of undistributed net income from 
trust U, of which $2,000 was deemed to have been distributed in 1975, 
and $3,000 in 1976. B's gross income for 1975, for purposes of using the 
short-cut method to determine the tax from the trust T accumulation 
distribution, will be deemed to include the $2,000 deemed distributed in 
1975 by trust U, and his gross income for 1976 will be deemed to include 
the $3,000 deemed distributed by trust U in 1976.

[T.D. 7204, 37 FR 17151, Aug. 25, 1972]



Sec. 1.668(b)-3A  Computation of the beneficiary's income and tax for
a prior taxable year.

    (a) Basis for computation. (1) The beneficiary's income and tax paid 
for any prior taxable year for which a recomputation is involved under 
either the exact method or the short-cut method shall be determined by 
reference to the information required to be furnished by him under Sec. 
1.668(b)-4A(a). The gross income, related deductions, and taxes paid for 
a prior taxable year of the beneficiary as finally determined shall be 
used for computation purposes. The term ``as finally determined'' has 
reference to the final status of the gross income, deductions, credits, 
and taxes of the taxable year after the expiration of the period of 
limitations or after completion of any

[[Page 244]]

court action regarding the tax for the taxable year.
    (2) If any computations rely on the beneficiary's return for a prior 
taxable year for which the applicable period of limitations on 
assessment under section 6501 has expired, and such return shows a 
mathematical error on its face which resulted in the wrong amount of tax 
being paid for such year, the determination of both the tax for such 
year computed with the inclusion of the section 666 amount in the 
beneficiary's gross income and the tax for such year computed without 
including such amounts in such gross income shall be based upon the 
return after the correction of such mathematical errors, and the 
beneficiary shall be credited for the correct amount of tax that should 
have been properly paid.
    (b) Effect of allocation of undistributed net income on items based 
on amount of income and with respect to a net operating loss, a 
charitable contributions carryover, or a capital loss carryover. (1) In 
computing the tax for any taxable year under either the exact method or 
the short-cut method, any item which depends upon the amount of gross 
income, adjusted gross income, or taxable income shall be recomputed to 
take into consideration the amount of undistributed net income allocated 
to such year. For example, if $1,000 of undistributed net income is 
allocated to 1970, adjusted gross income for 1970 is increased from 
$5,000 to $6,000. The allowable 50 percent charitable deduction under 
section 170(b)(1)(A) is then increased and the amount of the 
nondeductible medical expenses under section 213 (3 percent of adjusted 
gross income) is also increased.
    (2) In computing the tax attributable to the undistributed net 
income deemed distributed to the beneficiary in any of his prior taxable 
years under either the exact method or the short-cut method, the effect 
of amounts of undistributed net income on a net operating loss carryback 
or carryover, a charitable contributions carryover, or a capital loss 
carryback or carryover, shall be taken into account. In determining the 
amount of tax attributable to such deemed distribution, a computation 
shall also be made for any taxable year which is affected by a net 
operating loss carryback or carryover, by a charitable contributions 
carryover, or by a capital loss carryback or carryover determined by 
reference to the taxable year to which amounts are allocated under 
either method and which carryback or carryover is reduced or increased 
by such amounts so allocated. The provisions of this subparagraph may be 
illustrated by the following example:

    Example. In 1978, a trust makes an accumulation distribution of 
undistributed net income to X of $50,000 that is deemed under section 
666(a) to have been distributed in 1972. X had income in 1972, 1973, and 
1973, and had a net operating loss in 1975 that offset his taxable 
income (computed as provided in Sec. 1.172-5) for those years, as 
follows:

------------------------------------------------------------------------
                                                      Income after net
                                     Actual income     operating loss
               Year                    (or loss)          carryback
                                                        (n.o.l.c.b.)
------------------------------------------------------------------------
1972..............................     $10,000                  $0
1973..............................      50,000                   0
1974..............................      50,000              10,000
1975..............................   (100,000)                   0
------------------------------------------------------------------------

    As a result of the allocation of the 1973 accumulation distribution 
to 1972, X's income for 1972, 1973, 1974, and 1975, after taking into 
account the 1975 n.o.l.c.b., is deemed to be as follows:

------------------------------------------------------------------------
                                           Income deemed to have been
                                          earned after consideration of
                 Year                     n.o.l.c.b., and accumulation
                                                  distribution
------------------------------------------------------------------------
1972..................................  0 ($10,000+$50,000-$60,000
                                         n.o.l.c.b.).
1973..................................  $10,000 ($50,000-$40,000 balance
                                         of n.o.l.c.b.).
1974..................................  $50,000.
1975..................................  0.
------------------------------------------------------------------------

    Therefore, the tax on the 1978 accumulation distribution to X is the 
tax X would have paid in 1973 and 1974 had he had the above income in 
such years.

    (c) Averaging. A beneficiary who uses the exact method may recompute 
his tax for a prior taxable year by using income averaging for all of 
his actual income for that year, plus the amount deemed distributed in 
that year under section 666, even though he may not have actually used 
section 1301 to determine his income tax for such taxable year. For 
purposes of such recomputation, the beneficiary's income for all other 
taxable years involved must include any amounts deemed distributed in 
such years from the current and all prior accumulation distributions. 
See Sec. 1.668(b)-4A(c)(3) for additional information requirements. The

[[Page 245]]

beneficiary may not apply the provisions of this paragraph to a taxable 
year in which an amount is deemed to be income by reason of Sec. 
1.666(d)-1A(b). The accumulation distribution itself is not eligible for 
income averaging in the years in which it is paid, credited, or required 
to be distributed. See section 1302 (a)(2)(B) and the regulations 
thereunder.

[T.D. 7204, 37 FR 17151, Aug. 25, 1972]



Sec. 1.668(b)-4A  Information requirements with respect to beneficiary.

    (a) Information to be supplied by beneficiary--(1) In general. The 
beneficiary must supply the information required by subparagraph (3) of 
this paragraph for any prior taxable year for which a recomputation is 
required under either the exact method or the short-cut method. Such 
information shall be filed with the beneficiary's return for the year in 
which the tax under section 668(a)(2) is imposed.
    (2) Failure to furnish. If the beneficiary fails to furnish the 
information required by this paragraph for any prior year involved in 
the exact method, he may not use such method and the tax computed under 
paragraph (c) of Sec. 1.668(b)-1A (the short-cut method) shall be 
deemed to be the amount of partial tax imposed by section 668(a)(2). 
See, however, paragraph (b) of this section for an exception to this 
rule where the short-cut method is not permitted. If he cannot furnish 
the information required for a prior year involved in the short-cut 
method, such year will be recomputed on the basis of the best 
information available.
    (3) Information required. The beneficiary shall file the following 
items with his income tax return for the taxable year in which the 
accumulation distribution is included in income:
    (i) A statement showing the gross income, adjustments, deductions, 
credits, taxes paid, and computations for each of his taxable years for 
which a computation is required under the method by which he computes 
his partial tax imposed by section 668(a)(2). Such statement shall 
include such amounts for the taxable year as adjusted by any events 
subsequent to such year, such as any adjustment resulting from the 
determination of a deficiency or an overpayment, or from a court action 
regarding the tax.
    (ii) A copy of the statement required by this subparagraph to be 
furnished by the beneficiary for any prior taxable year in which an 
accumulation distribution was received by him which was also deemed 
distributed in whole or in part in the prior taxable year for which the 
statement under subdivision (i) of this subparagraph is required.
    (iii) A copy of any statements furnished the beneficiary by the 
trustee (such as schedules E and J of Form 1041, etc.) with regard to 
the current taxable year or any prior taxable year for which a statement 
is furnished under subdivision (i) of this subparagraph.
    (b) Exception. If by reason of Sec. 1.668(b)-1A(e) the beneficiary 
may not compute the partial tax on the accumulation distribution under 
Sec. 1.668(b)-1A(c) (the short-cut method), the provisions of 
subparagraph (2) of paragraph (a) of this section shall not apply. In 
such case, if the beneficiary fails to provide the information required 
by subparagraph (3) of paragraph (a) of this section for any prior 
taxable year, the district director shall, by utilizing whatever 
information is available to him (including information supplied by the 
beneficiary), determine the beneficiary's income and related expenses 
for such prior taxable year.
    (c) Records to be supplied by the beneficiary--(1) Year when return 
was filed. If the beneficiary filed an income tax return for a taxable 
year for which a recomputation is necessary, and the period of 
limitations on assessment under section 6501 for such year has expired 
as of the filing of the return for the year in which the accumulation 
distribution was made, then a copy of such return, plus proof of any 
changes of liability for such year due to the determination of a 
deficiency or an overpayment, court action, etc., shall, to the extent 
they verify the statements required under paragraph (a) of this section, 
serve as proof of such statements. If the period of limitations on 
assessment under section 6501 for a prior taxable year has not expired 
as of the filing of the beneficiary's return for the year in which the 
accumulation distribution was received, then the

[[Page 246]]

records required by section 6001 to be retained by the beneficiary for 
such prior taxable year shall serve as the basis of proof of the 
statements required to be filed under paragraph (a) of this section.
    (2) Year for which no return was filed. If the beneficiary did not 
file a return for a taxable year for which a recomputation is necessary, 
he shall be deemed to have had in such year, in the absence of proof to 
the contrary, gross income in the amount equal to the maximum amount of 
gross income that he could have received without having had to file a 
return under section 6012 for such year.
    (3) Distributions deemed averaged. In order for a beneficiary to use 
income averaging with respect to a prior taxable year (see Sec. 
1.668(b)-3A(c)), he must furnish all the information that would support 
the computation under section 1301 as if the distribution were actually 
received and averaged in such prior taxable year, even if a portion of 
the information relates to years in which no amount was deemed 
distributed to the beneficiary.

[T.D. 7204, 37 FR 17152, Aug. 25, 1972]



Sec. 1.668(a)-1  Amounts treated as received in prior taxable years;
inclusion in gross income.

    (a) Section 668(a) provides that the total of the amounts treated 
under section 666 as having been distributed by the trust on the last 
day of a preceding taxable year of the trust shall be included in the 
gross income of the beneficiary or beneficiaries receiving them. The 
total of such amounts is includible in the gross income of each 
beneficiary to the extent the amounts would have been included under 
section 662 (a)(2) and (b) if the total had actually been paid by the 
trust on the last day of such preceding taxable year. The total is 
included in the gross income of the beneficiary for the taxable year of 
the beneficiary in which such amounts are in fact paid, credited, or 
required to be distributed unless the taxable year of the beneficiary 
differs from the taxable year of the trust (see section 662(c) and the 
regulations thereunder). The character of the amounts treated as 
received by a beneficiary in prior taxable years, including taxes deemed 
distributed, in the hands of the beneficiary is determined by the rules 
set forth in section 662(b) and the regulations thereunder. See 
paragraphs (h)(1)(ii) and (j)(1)(ii) of Sec. 1.668(b)-2.
    (b) The total of the amounts treated under section 666 as having 
been distributed by the trust on the last day of a preceding taxable 
year of the trust are included as prescribed in paragraph (a) of this 
section in the gross income of the beneficiary even though as of that 
day the beneficiary would not have been entitled to receive them had 
they actually been distributed on that day.
    (c) Any deduction allowed to the trust in computing distributable 
net income for a preceding taxable year (such as depreciation, 
depletion, etc.) is not deemed allocable to a beneficiary because of 
amounts included in a beneficiary's gross income under this section 
since the deduction has already been utilized in reducing the amount 
included in the beneficiary's income.



Sec. 1.668(a)-2  Allocation among beneficiaries; in general.

    The portion of the total amount includible in gross income under 
Sec. 1.668 (a)-1 which is includible in the gross income of a 
particular beneficiary is based upon the ratio determined under the 
second sentence of section 662(a)(2) for the taxable year (and not for 
the preceding taxable year). This section may be illustrated by the 
following example:

    Example. (a) Under the terms of a trust instrument, the trustee may 
accumulate the income or make distributions to A and B. The trustee may 
also invade corpus for the benefit of A and B. The distributable net 
income of the trust for the taxable year 1955 is $10,000. The trust had 
undistributed net income for the taxable year 1954 of $5,000, to which a 
tax of $1,100 was allocable. During the taxable year 1955, the trustee 
distributes $10,000 to A and $5,000 to B. Thus, of the total 
distribution of $15,000, A received two-thirds and B received one-third.
    (b) For the purposes of determining the amounts includible in the 
beneficiaries' gross income for 1955, the trust is deemed to have made 
the following distributions:

Amount distributed out of 1955 income (distributable net         $10,000
 income).....................................................
Accumulation distribution deemed distributed by the trust on       5,000
 the last day of 1954 under section 666(a)...................

[[Page 247]]

 
Taxes imposed on the trust deemed distributed under section        1,100
 666(b)......................................................
 

    (c) A will include in his gross income for 1955 two-thirds of each 
item shown in paragraph (b) of this example. Thus, he will include in 
gross income $6,666.67 (10,000/ 15,000x$10,000) of the 1955 
distributable net income of the trust as provided in section 662(a)(2), 
and $3,333.33 (10,000/ 15,000x$5,000) of the accumulation distribution 
and $733.33 (10,000/15,000x$1,100) of the taxes imposed on the trust as 
provided in section 668(a).
    (d) B will include in his gross income for 1955 one-third of each 
item shown in paragraph (b) of this example, computed in the manner 
shown in paragraph (c) of this example.



Sec. 1.668(a)-3  Excluded amounts.

    When a trust pays, credits, or is required to distribute to a 
beneficiary amounts which are excluded under section 665(b) (1), (2), 
(3), or (4) from the computation of an accumulation distribution, the 
amount includible under subpart D (section 665 and following), part I, 
subchapter J, chapter 1 of the Code, in the gross income of the 
beneficiaries pursuant to Sec. 1.668(a)-1 is first allocated to the 
beneficiaries as provided in Sec. 1.668(a)-2 and, second, the amount 
allocable to the beneficiary receiving amounts which are excluded under 
section 665(b) (1), (2), (3), or (4) is reduced by the excluded amounts. 
This section may be illustrated by the following examples, in which it 
is assumed the trusts and beneficiaries report on the calendar year 
basis and the income of the trusts was derived entirely from taxable 
interest:

    Example 1. (a) A trust in 1957 has income as defined in section 
643(b) of $35,000 and expenses allocable to corpus of $5,000. Its 
distributable net income is, therefore, $30,000 ($35,000-$5,000). The 
undistributed net income of the trust and the taxes imposed on the trust 
were $12,840 and $7,260, respectively, for each of the years 1956, 1955, 
and 1954. The terms of the trust instrument provide for the accumulation 
of income during the minority of beneficiaries A and B. However, the 
trustee may make discretionary distributions to either beneficiary after 
he becomes 21 years of age. Also, the trustee may invade corpus for the 
benefit of A and B. B became 21 years of age on January 1, 1957, and, as 
of that date, A was 25 years old. The trustee distributed $50,000 each 
to A and B during 1957.
    (b) Since each beneficiary received one-half of the total amount 
distributed by the trust, each must include in gross income under 
section 662(a)(2) one-half ($15,000) of the distributable net income 
($30,000) of the trust for 1957.
    (c) The excess distribution of $35,000 ($50,000-$15,000) received by 
B is excluded from the determination of an accumulation distribution 
under section 665(b)(1) and accordingly is not includible in B's gross 
income under section 668(a). Nor is such amount treated as an 
accumulation distribution for the purpose of determining the amount 
includible in A's gross income under section 668(a).
    (d) The accumulation distribution of the trust is $35,000, computed 
as follows:

Total distribution by the trust.................  ..........    $100,000
Less:
  Distributable net income for 1957.............     $30,000
  Excess distribution to B......................      35,000
                                                 ------------
                                                                  65,000
                                                 -------------
    Accumulation distribution to A..........................      35,000
 

    (e) The accumulation distribution of $35,000 will be allocated to 
the preceding taxable years 1956, 1955, and 1954, and the trust will be 
deemed to have made the following distributions to A on the last day of 
those years:

------------------------------------------------------------------------
                                 1956       1955       1954      Total
------------------------------------------------------------------------
Undistributed net income....    $12,840    $12,840     $9,320    $35,000
Taxes imposed on the trust..      7,260      7,260      5,270     19,790
                             -------------------------------------------
Total.......................     20,100     20,100     14,590     54,790
------------------------------------------------------------------------


Thus, A will include $54,790 in his gross income for 1957 under section 
668(a). A will, however, receive credit against his tax under section 
668(b).
    Example 2. (a) Under the terms of a trust the trustee may make 
discretionary distributions out of income to A during her life. The 
balance of the income is to be accumulated during the minority of her 
son, B, and is to be distributed to him when he becomes 21 years of age. 
Thereafter the trustee may also make discretionary payments of income to 
B. Also, the trustee may invade corpus for the benefit of A and B. B 
became 21 years of age on December 31, 1955. The distributable net 
income of the trust for 1955 is $30,000. It had undistributed net income 
of $12,840 for the preceding taxable year 1954 and the taxes imposed on 
the trust for such year were $7,260. The trustee distributed $15,000 to 
A during 1955 and on December 31, 1955, he distributed $60,000 to B, 
which represented income accumulated during his minority.
    (b) Since B received four-fifths of the total amount ($75,000) 
distributed by the trust during 1955, he must include in his gross 
income under section 662(a)(2) four-fifths ($24,000) of

[[Page 248]]

the distributable net income ($30,000) of the trust for 1955. A will 
include in her gross income under section 662(a)(2) one-fifth ($6,000) 
of the distributable net income ($30,000) of the trust for 1955.
    (c) The excess distribution of $36,000 ($60,000-$24,000) received by 
B is excluded from the determination of an accumulation distribution 
under section 665(b)(1) and accordingly is not includible in his gross 
income under section 668(a).
    (d) The amount treated as an accumulation distribution for the 
purpose of determining the amount includible in A's gross income for 
1955 under section 668(a) is $9,000, computed as follows:

Total distribution by the trust.................  ..........     $75,000
Less:
  Distributable net income for 1955.............     $30,000
  Excess distribution to B......................      36,000
                                                 -------------
                                                                  66,000
                                                 -------------
    Amount treated as an accumulation distribution..........       9,000
 

    (e) Inasmuch as the amount of $9,000 is less than the total 
undistributed net income of the trust ($12,840) for the preceding 
taxable year 1954, a pro rata portion of the taxes imposed on the trust 
for that year are also deemed distributed by the trust. Thus, A will 
include $14,089 in her gross income for 1955 under section 668 (a) 
computed as follows:

                                  1954
Accumulation distribution...................................      $9,000
Taxes imposed on the trust (9,000/ 12,840x$7,260)...........       5,089
                                                 -------------
    Total...................................................      14,089
 


A will, however, receive credit against her tax under section 668(b).



Sec. 1.668(a)-4  Tax attributable to throwback.

    (a) The tax attributable to amounts deemed distributed under section 
666 is imposed on the beneficiary for the taxable year of the 
beneficiary in which the accumulation distribution is made unless the 
taxable year of the beneficiary is different from that of the trust (see 
section 662(c) and the regulations thereunder). In the case of a trust 
(other than a foreign trust created by a U.S. person), the tax cannot be 
greater than the aggregate of the taxes attributable to those amounts 
had they been included, in accordance with the provisions of section 662 
(a)(2) and (b), in the gross income of the beneficiary for the preceding 
taxable year or years in which they were deemed distributed. In the case 
of a foreign trust created by a U.S. person, the tax on the beneficiary 
shall be computed in accordance with the provisions of section 669 and 
the regulations thereunder. The tax liability of the beneficiary of a 
trust (other than a foreign trust created by a U.S. person), including 
the portion of an entire foreign trust which does not constitute a 
foreign trust created by a U.S. person (see Sec. 1.643(d)-1), for the 
taxable year is computed in the following manner:
    (1) First, compute the amount of tax for the taxable year 
attributable to the section 666 amounts which are included in the gross 
income of the beneficiary for the year. The tax attributable to those 
amounts is the difference between the tax for the taxable year computed 
with the inclusion of the section 666 amounts in gross income and the 
tax computed without including them in gross income.
    (2) Next, compute the tax attributable to the section 666 amounts 
for each of the preceding taxable years as if they had been included in 
gross income for those years. The tax attributable to such amounts in 
each such preceding taxable year is the difference between the tax for 
such preceding year computed with the inclusion of the section 666 
amounts in gross income and the tax for such year computed without 
including them in gross income. The tax computation for each preceding 
year shall reflect the taxpayer's marital and dependency status for that 
year.
    (3) The total tax for the taxable year is the tax for that year 
computed without including the section 666 amounts, plus:
    (i) The amount of the tax for the taxable year attributable to the 
section 666 amounts (computed in accordance with subparagraph (1) of 
this paragraph), or (ii) The sum of the taxes for the preceding taxable 
years attributable to the section 666 amounts (computed in accordance 
with subparagraph (2) of this paragraph),

whichever is the smaller.
    (b) The provisions of paragraph (a) of this section may be 
illustrated by the following example:

    Example. (1) During the taxable year 1956, $10,000 is deemed 
distributed under section 666 to a beneficiary, of which $6,000 is 
deemed

[[Page 249]]

distributed by the trust on the last day of 1955 and $4,000 on the last 
day of 1954. The beneficiary had taxable income (after deductions) from 
other sources of $5,000 for 1956, $10,000 for 1955, and $10,000 for 
1954. The beneficiary's tax liability for 1956 is $4,730 determined as 
follows:

                                Year 1956
 
Tax on $15,000 (taxable income including section 666 amounts)     $4,730
Tax on $5,000 (taxable income excluding section 666 amounts).      1,100
                                                   ------------
    Tax attributable to section 666 amounts..................      3,630
                                                   ============
                                Year 1955
 
Tax on $16,000 (taxable income including section 666 amounts)     $5,200
Tax on $10,000 (taxable income excluding section 666 amounts)      2,640
                                                   ------------
    Tax attributable to section 666 amounts..................      2,560
                                                   ============
                                Year 1954
 
Tax on $14,000 (taxable income including section 666 amounts)     $4,260
Tax on $10,000 (taxable income excluding section 666 amounts)      2,640
                                                   ------------
    Tax attributable to section 666 amounts..................      1,620
                                                   ============
 

    (2) Inasmuch as the tax of $3,630 attributable to the section 666 
amounts as computed at 1956 rates is less than the aggregate of the 
taxes of $4,180 ($2,560 plus $1,620) determined for the preceding 
taxable years the amount of $3,630 is added to the tax ($1,100) computed 
for 1956 without including the section 666 amounts.

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



Sec. 1.668(b)-1  Credit for taxes paid by the trust.

    (a) The taxes imposed on a complex trust for a taxable year which 
would not have been payable by the trust if amounts deemed under section 
666 to have been distributed in the year had in fact been distributed in 
the year are not allowable as a refund to the trust but are allowable as 
a credit against the tax of the beneficiaries to whom the amounts 
described in section 666(a) are distributed.
    (b) The credit to which a beneficiary is entitled under section 
668(b) is allowed for the taxable year in which the accumulation 
distribution (to which the credit relates) is required to be included in 
the gross income of the beneficiary. Any excess over the total tax 
liability of the beneficiary is treated as an overpayment of tax by the 
beneficiary.
    (c) The beneficiary is entitled to a portion of the credit described 
in paragraph (a) of this section in the ratio which the amount of the 
accumulation distribution to him bears to the accumulation distributions 
to all the beneficiaries.



Sec. 1.668(b)-2  Illustration of the provisions of subpart D.

    The provisions of subpart D (section 665 and following), part I, 
subchapter J, chapter 1 of the Code, other than provisions relating to a 
foreign trust created by a U.S. person, may be illustrated by the 
following example:

    Example. (a) Facts. (1) Under the terms of a trust instrument, one-
half of the trust income is required to be distributed currently to 
beneficiary A. The trustee may in his discretion accumulate the balance 
of the income of the trust or he may make distributions to B out of 
income or corpus. The trust is to terminate upon the death of A and the 
corpus is to be distributed to B. Capital gains are allocable to corpus. 
All of the expenses of the trust are charges against income. The trust 
instrument provides for a reserve for depreciation, so that depreciation 
is deductible in computing distributable net income. The trust and both 
beneficiaries report on the calendar year basis. The trust had long-term 
capital gains of $20,000 for 1954, and $10,000 for 1955, which were 
allocated to corpus. The distributable net income of the trust as 
determined under section 643(a) for 1954, 1955, 1956, and 1957 is deemed 
to consist of the following items of income:

----------------------------------------------------------------------------------------------------------------
                                                                                   Interest   Interest
                                                             Dividends    Rents   (taxable)   (exempt)    Total
----------------------------------------------------------------------------------------------------------------
1954.......................................................    $15,000   $20,000    $10,000     $5,000   $50,000
1955.......................................................     10,000    15,000     10,000      5,000    40,000
1956.......................................................     10,000    20,000     15,000      5,000    50,000
1957.......................................................     10,000    15,000     15,000      5,000    45,000
----------------------------------------------------------------------------------------------------------------

    (2) One-half ($7,500) of the dividends for 1954 was received by the 
trust on or before July 31, 1954, and the balance was received after 
that date.
    (3) The following distributions were made by the trustee to A and B 
during the taxable years 1954 through 1957:

------------------------------------------------------------------------
                                                 A               B
------------------------------------------------------------------------
1954....................................    $25,000            None
1955....................................     20,000            None
1956....................................     25,000         $45,000
1957....................................     22,500          29,550
------------------------------------------------------------------------

    (b) Distributions to A. A is deemed to have received one-half of 
each item of income entering into the computation of distributable

[[Page 250]]

net income as shown in paragraph (a)(1) of this example. See Sec. 
1.662(a)-2 for rules for the treatment of currently distributable income 
in the hands of the beneficiary.
    (c) Tax liability of the trust--(1) 1954. (i) The tax liability of 
the trust for the taxable year 1954 is $13,451, computed as follows:

Distributable net income under section 643(a) (paragraph         $50,000
 (a)(1) of this example).....................................
Less amounts not includible in gross income:
  Tax-exempt interest.............................     $5,000
  Dividend exclusion..............................         50
                                                   -----------
                                                                   5,050
                                                   ------------
    Distributable net income as adjusted.....................     44,950
Add: Capital gains (long-term)...............................     20,000
                                                   ------------
    Total....................................................     64,950
Deductions:
  Distributions to A..............................    $22,475
  Capital gain deduction..........................    $10,000
  Personal exemption..............................        100
                                                   -----------
                                                                  32,575
                                                   ------------
    Taxable income...........................................     32,375
Alternative tax..............................................     13,601
Dividend received credit.....................................        150
                                                   ------------
    Tax liability............................................     13,451
 

    (ii) See paragraph (b) of this example for character of income 
deemed distributed to A and section 661 for rules for computing the 
amount deductible by a trust for distributions to beneficiaries. 
Inasmuch as one-half of the dividends of the trust is deemed to be 
distributed to A, $25 of such distribution is deemed to be made from the 
dividend exclusion of $50, and the balance from dividends included in 
the gross income of the trust (that is, since the year 1954 is involved, 
$3,725 from dividends received on or before July 31, 1954, and $3,750 
from dividends received after July 31, 1954). The trust is entitled to a 
dividend received credit attributable to the dividends of $3,750 
received after July 31, 1954, which were not distributed to any 
beneficiary during the taxable year.
    (2) 1955. (i) The tax liability of the trust for the taxable year 
1955 is $8,189, computed as follows:

Distributable net income under section 643(a) (paragraph         $40,000
 (a)(1) of this example).....................................
Less amounts not includible in gross income:
  Tax-exempt interest.............................     $5,000
  Dividend exclusion..............................         50
                                                   -----------
                                                                   5,050
                                                   ------------
    Distributable net income as adjusted.....................     34,950
Add: Capital gains (long-term)...............................     10,000
                                                   ------------
    Total....................................................     44,950
Deductions:
  Distributions to A..............................    $17,475
  Capital gain deduction..........................      5,000
  Personal exemption..............................        100
                                                   -----------
                                                                  22,575
                                                   ------------
    Taxable income...........................................     22,375
Alternative tax..............................................      8,388
Dividend received credit.....................................        199
                                                   ------------
    Tax liability............................................      8,189
 

    (ii) See paragraph (b) of this example for character of income 
deemed distributed to A and section 661 for rules for computing the 
amount deductible by a trust for distributions to beneficiaries. 
Inasmuch as one-half ($4,975) of the dividends of $9,950 ($10,000 less 
dividend exclusion of $50) included in the gross income of the trust is 
deemed distributed to A, the trust is entitled to a dividend received 
credit with respect to the dividends of $4,975 which were not 
distributed to any beneficiary during the taxable year.
    (3) 1956 and 1957. The trust had no tax liability for the taxable 
years 1956 and 1957 since all of its income was distributed during such 
years.
    (d) Accumulation distributions. (1) Accumulation distributions of 
$20,000 and $7,050, as defined in section 665(b), were made to B during 
the years 1956 and 1957, respectively, computed as shown below:

------------------------------------------------------------------------
                                                       1956       1957
------------------------------------------------------------------------
Distributable net income of the trust as computed     $50,000    $45,000
 under section 643(a).............................
Less. Income currently distributable to A.........     25,000     22,500
                                                   ---------------------
    Balance of income.............................     25,000     22,500
Other amounts distributed to B....................     45,000     29,550
                                                   ---------------------
    Accumulation distributions to B...............     20,000      7,050
------------------------------------------------------------------------

    (2) B is deemed to have received one-half of each item of income 
entering into the computation of distributable net income (shown in 
paragraph (a)(1) of this example) for the years 1956 and 1957.
    (3) The accumulation distribution for 1956 must first be allocated 
to the preceding taxable years as provided in section 666. After the 
application of the provisions of subpart D to the 1956 accumulation 
distribution and to the undistributed net incomes of the preceding 
taxable years, a similar allocation must be made of the 1957 
accumulation distribution.
    (e) Throwback of 1956 accumulation distribution to 1955. The 
accumulation distribution of $20,000 for 1956 must be allocated to the 
first preceding taxable year 1955, before allocation is made to the 
second preceding taxable year 1954.
    (1) 1955 Undistributed net income. (i) The undistributed net income 
of the trust for 1955, determined as of the close of 1955, is $12,885, 
computed as follows:

  Distributable net income as computed under section 643(a)      $40,000
              (paragraph (a)(1) of this example)
Less:
  Distributions to A..............................    $20,000
  Taxes imposed on the trust......................      7,115
                                                   -----------

[[Page 251]]

 
                                                       27,115
                                                   ------------
    Undistributed net income as of the close of        12,885
     1955.........................................
 

    (ii) The taxes imposed on the trust of $7,115 are that portion of 
the taxes paid by the trust for 1955 which is attributable to the 
undistributed portion of distributable net income included in the 
taxable income of the trust (the ``balance'' in the computation below) 
and is determined as follows:

Taxable income (paragraph (c)(2)(i) of this example..........    $22,375
Capital gains allocable to corpus.................    $10,000
Less:
  Capital gain deduction...............     $5,000
  Personal exemption...................        100
                                        -----------
                                                        5,100
                                        -----------
Portion of taxable income allocable to corpus................      4,900
                                        ------------
    Balance..................................................     17,475
                                        ============
Total taxes paid by the trust................................      8,189
Taxes on income ($4,900) allocable to corpus.................      1,074
                                        ------------
    Taxes imposed on the trust (section 665(c))..............      7,115
 

    (iii) The amount of $1,074 is the taxes which the trust would have 
paid for 1955 had all of the distributable net income been distributed 
during the year.
    (2) Allocation of 1956 accumulation distribution to the preceding 
taxable year 1955. The portion of the 1956 accumulation distribution 
which is deemed under section 666(a) to be distributed to B on the last 
day of 1955 (the first preceding taxable year) is $12,885, an amount 
equal to the undistributed net income for 1955. An additional amount 
equal to the taxes imposed on the trust ($7,115) is, under section 
666(b), also deemed to be distributed to B on the last day of 1955. 
Thus, a total of $20,000 ($12,885 plus $7,115) is deemed to be 
distributed to B on December 31, 1955, by reason of the allocation of 
the 1956 accumulation distribution to the first preceding taxable year. 
See paragraph (h) of this example for the treatment of the amount of 
$20,000 in the hands of B.
    (3) Character of amounts deemed distributed. Inasmuch as one-half of 
the 1955 distributable net income of the trust as determined under 
section 643(a) was currently distributable to A and the balance of such 
income is deemed under section 666 to be distributed to B on December 
31, 1955, the distribution to B is deemed to consist of one-half of each 
item of income entering into the computation of the 1955 distributable 
net income; that is, dividends of $5,000, rents of $7,500, taxable 
interest of $5,000, and tax-exempt interest of $2,500.
    (4) Credit for taxes paid by the trust. The amount of the taxes for 
the year 1955 which may not be refunded or credited to the trust under 
section 667 and which is allowed as a credit against the tax of B for 
1956 under section 668(b) is $7,115. See also paragraph (h)(3) of this 
example.
    (5) Effect of application of provisions of subpart D to the year 
1955. After the allocation of the 1956 accumulation distribution to the 
preceding taxable year 1955, the undistributed portion of the 
distributable net income, the undistributed net income, and the taxes 
imposed on the trust for 1955 are zero. The portion of the 1956 
accumulation distribution which is unabsorbed by the 1955 undistributed 
net income is $7,115, determined as follows:

1956 accumulation distribution (paragraph (d)(1) of this         $20,000
 example)....................................................
Less: Amount allocable to 1955...............................     12,885
                                                   ------------
    Balance allocable to second preceding taxable year 1954..      7,115
 

    (f) Throwback of 1956 accumulation distribution to 1954. The 
unabsorbed portion of the 1956 accumulation distribution of $7,115 is 
allocable to the second preceding taxable year 1954 and is treated under 
section 666 as a distribution to B on the last day of such year.
    (1) 1954 Undistributed net income. (i) The undistributed net income 
of the trust for 1954, determined as of the close of 1954, is $14,155, 
computed as follows:

Distributable net income as computed under section 643(a)        $50,000
 (paragraph (a)(1) of this example)..........................
Less:
  Distributions to A..............................    $25,000
  Taxes imposed on the trust......................     10,845
                                                   -----------
                                                                  35,845
                                                   ------------
    Undistributed net income as of the close of 1954.........     14,155
 

    (ii) The taxes imposed on the trust of $10,845 are that portion of 
the taxes paid by the trust for 1954 which is attributable to the 
undistributed portion of distributable net income included in the 
taxable income of the trust (the ``balance'' in the computation below in 
this subdivision) and is determined as follows:

Taxable income (paragraph (c)(1)(i) of this example).........    $32,375
Capital gains allocable to corpus.................    $20,000
Less:
  Capital gain deduction...............    $10,000
  Personal exemption...................        100
                                        -----------
                                                       10,100
                                        -----------
    Portion of taxable income allocable to corpus............      9,900
                                        ------------
    Balance..................................................     22,475
                                        ============
Total taxes paid by the trust................................     13,451
Taxes on income ($9,900) allocable to corpus.................      2,606
                                        ------------
    Taxes imposed on the trust (section 665(c))..............     10,845
 

    (iii) The amount of $2,606 is the taxes which the trust would have 
paid for 1954 had all of the distributable net income been distributed 
during that year.

[[Page 252]]

    (2) Allocation of 1956 accumulation distribution to the second 
preceding taxable year 1954. Since the unabsorbed portion of the 1956 
accumulation distribution of $7,115 is less than the 1954 undistributed 
net income of $14,155, the trust is deemed under section 666(c) to have 
also distributed an additional amount ($5,451) equal to a pro rata 
portion (7,115/14,155x$10,845) of the taxes imposed on the trust for 
1954. Thus, a total of $12,566 ($7,115 plus $5,451) is deemed to be 
distributed to B on December 31, 1954, by reason of the throwback of the 
1956 accumulation distribution. See paragraph (h) of this example for 
the treatment of the amount of $12,566 in the hands of B.
    (3) Character of amounts deemed distributed to B. The amount of 
$12,566 which, under section 666, is deemed to be distributed to B on 
December 31, 1954, is deemed to be composed of the following items of 
income of the trust: Dividends, $3,770 (15,000/50,000x$12,566); rents, 
$5,026 (20,000/50,000x$12,566); taxable interest, $2,513 (10,000/
50,000x$12,566); and tax-exempt interest, $1,257 (5,000/50,000x$12,566). 
One-half of the dividends of $3,770 is considered as distributed from 
the dividends received by the trust on or before July 31, 1954, of which 
$13 (3,770/15,000x$50) is deemed distributed from the dividends excluded 
under section 116, and the other half as distributed from the dividends 
received after July 31, 1954. Thus, of the total of $12,566 deemed 
distributed to B, $11,296 is considered as made from income included in 
the gross income of the trust and $1,270 from non-taxable income of the 
trust.
    (4) Credit for taxes paid by the trust. The amount of the taxes for 
the year 1954 which may not be refunded or credited to the trust under 
section 667 and which is allowed as a credit against the tax of B for 
1956 under section 668(b), because of the allocation of the 1956 
accumulation distribution to 1954, is $5,401, computed as follows:

Taxable income of the trust as of the close of 1954              $32,375
 (paragraph (c)(1) of this example)..........................
Less: Amount deemed distributed to B under section 666 from       11,296
 the taxable income of the trust.............................
                                                   ------------
    Taxable income adjusted as of the close of 1956..........     21,079
                                                   ------------
(Taxes on $21,079 (alternative tax)..........................     $8,050
Taxes on income allocable to corpus (subparagraph (1)(ii) of      $2,606
 this paragraph).............................................
                                                   ------------
    Taxes imposed on the trust determined as of the close of       5,444
     1956....................................................
                                                   ============
Taxes imposed on the trust determined as of the close of 1954    $10,845
Taxes imposed on the trust determined as of the close of 1956      5,444
                                                   ------------
    Amount of taxes allowed as a credit to B under section         5,401
     668(b)..................................................
 

    (5) Effect of application of provisions of subpart D to the year 
1954. (i) The undistributed portion of the distributable net income of 
the trust for the year 1954, determined as of the close of 1956, is 
$12,434, computed as follows:

Distributable net income (section 643(a))....................    $50,000
Less:
  Amount currently distributable to A.............    $25,000
  Amount deemed distributed to B under section 666     12,566
                                                     --------     37,566
                                                   ------------
    Undistributed portion of distributable net income as of       12,434
     the close of 1956.......................................
 

    (ii) The amount of $12,434 is deemed to consist of dividends of 
$3,730, rents of $4,974, taxable interest of $2,487, and tax-exempt 
interest of $1,243, determined as follows:

----------------------------------------------------------------------------------------------------------------
                                                                          Interest      Interest
                                               Dividends      Rents       (taxable)     (exempt)        Total
----------------------------------------------------------------------------------------------------------------
Trust income...............................    $15,000      $20,000       $10,000        $5,000     \1\ $50,000
                                            ====================================================================
Distributions:
  To A.....................................      7,500       10,000         5,000         2,500     \2\ 25,000
  To B.....................................      3,770        5,026         2,513         1,257     \3\ 12,566
                                            ====================================================================
    Total..................................     11,270       15,026         7,513         3,757        37,566
                                            ====================================================================
Balance....................................      3,730        4,974         2,487         1,243        12,434
----------------------------------------------------------------------------------------------------------------
\1\ See paragraph (a)(1) of this example.
\2\ See paragraph (b) of this example.
\3\ See paragraph (f)(3) of this example.

    (iii) The undistributed net income of the trust for 1954, determined 
as of the close of 1956, is $6,990, computed as follows:

Undistributed portion of distributable net income as of the      $12,434
 close of 1956..............................................
Less: Taxes imposed on the trust determined as of the close        5,444
 of 1956 (subparagraph (4) of this paragraph)...............
                                                             -----------
  Undistributed net income as of the close of 1956..........       6,990
 

    (g) Throwback of 1957 accumulation distribution. Inasmuch as all of 
the income of the trust for the first preceding taxable year 1956 was 
distributed during such year and the trust had no undistributed net 
income for the second preceding taxable year 1955 after

[[Page 253]]

the application of subpart D to the accumulation distribution made 
during 1956, the 1957 accumulation distribution of $7,050 is allocable 
to the third preceding taxable year 1954. See paragraph (d)(1) of this 
example for computation of the accumulation distribution.
    (1) Allocation of 1957 accumulation distribution to the preceding 
taxable year 1954. The portion of the 1957 accumulation distribution 
which is deemed under section 666(a) to be distributed to B on the last 
day of 1954 is $6,990, an amount equal to the undistributed net income 
of the trust for 1954, determined as of the close of 1956. An additional 
amount equal to the taxes imposed on the trust ($5,444), determined as 
of the close of 1956, is under section 666(b) also deemed to be 
distributed to B on the last day of 1954. See paragraph (f) (4) and (5) 
of this example. Thus, a total of $12,434 ($6,990 plus $5,444) is deemed 
to be distributed to B on December 31, 1954, by reason of the allocation 
of the 1957 accumulation distribution to the taxable year 1954. See 
paragraph (j) of this example for the treatment of the amount of $12,434 
in the hands of B.
    (2) Character of amounts deemed distributed. Inasmuch as the balance 
of the 1954 distributable net income of the trust is deemed under 
section 666 to be distributed to B on December 31, 1954, the 
distribution is deemed to consist of dividends of $3,730, rents of 
$4,974, taxable interest of $2,487, and tax-exempt interest of $1,243. 
See paragraph (f)(5)(ii) of this example.
    (3) Credit for taxes paid by the trust. The amount of taxes for the 
year 1954 which may not be refunded or credited to the trust under 
section 667 and which is allowed as a credit against the tax of B under 
section 668(b) is $5,444, the amount of taxes imposed on the trust 
determined as of the close of 1956. See paragraph (f)(4) of this 
example.
    (4) Effect of application of provisions of subpart D to the year 
1954. After the allocation of the 1957 accumulation distribution to the 
preceding taxable year 1954, the undistributed portion of the 
distributable net income, the undistributed net income, and the taxes 
imposed on the trust for 1954 are zero. The balance of $60 ($7,050 less 
$6,990) of the 1957 accumulation distribution remaining after the 
allocation of the accumulation distribution to the year 1954, may not be 
allocated to the year 1953 since that year is not subject to the 
provisions of the Internal Revenue Code of 1954.
    (h) Determination of B's tax liability; taxable year 1956--(1) 
Amount of trust income includible in gross income. (i) Of the amount of 
$45,000 distributed by the trust to B during the taxable year 1956, 
$25,000 is treated as a distribution out of trust income for that year 
within the meaning of section 662(a)(2), and $20,000 as an accumulation 
distribution within the meaning of section 665(b) (see paragraph (d) of 
this example). However, $12,885 plus taxes of $7,115 is deemed 
distributed to B on December 31, 1955, and $7,115 plus taxes of $5,451 
on December 31, 1954, under section 666 by reason of the accumulation 
distribution made during 1956, and these amounts are includible in B's 
gross income for 1956 to the extent that they would have been includible 
in his gross income under section 662 (a)(2) and (b) for 1955 and 1954, 
respectively, had they been distributed on the last day of those years.
    (ii) The amounts distributed to B out of trust income for the year 
1956, and the amounts deemed distributed out of income for the preceding 
taxable years 1955 and 1954 have the following character for the purpose 
of determining the amount includible in B's gross income for 1956:

----------------------------------------------------------------------------------------------------------------
                                                                                   Interest  Interest
                            Year                             Dividends    Rents   (taxable)  (exempt)    Total
----------------------------------------------------------------------------------------------------------------
1956.......................................................    $5,000    $10,000     $7,500    $2,500        \1\
                                                                                                         $25,000
1955.......................................................     5,000      7,500      5,000     2,500        \2\
                                                                                                          20,000
1954.......................................................     3,770      5,026      2,513     1,257        \3\
                                                                                                          12,566
                                                            ----------------------------------------------------
Total......................................................    13,770     22,526     15,013     6,257    57,566
----------------------------------------------------------------------------------------------------------------
\1\ See paragraph (d)(2) of this example.
\2\ See paragraph (e)(3) of this example.
\3\ See paragraph (f)(3) of this example.


Thus, B will include in gross income for 1956 dividends of $13,770 
(subject to the dividend exclusion), rents of $22,526, and taxable 
interest of $15,013, and will exclude the tax-exempt interest of $6,257.
    (2) Computation of tax. (i) For the purpose of computing B's tax 
liability, it is assumed that he was single during the taxable years 
1954, 1955, and 1956, and that his taxable income (derived from salary) 
for each of the years 1954 and 1955 amounted to $13,400 on which a tax 
of $4,002 was paid for each year. It is also assumed that his income 
(other than distributions from the trust) for 1956 was $15,000 derived 
from salary, and he had allowable deductions of $10,600, which included 
the deduction for personal exemption.
    (ii) The computation of the tax for the taxable year 1956 
attributable to the section 666 amounts which are included in B's gross 
income for such year, as provided in paragraph (a)(1) of Sec. 1.668(a)-
4, is as follows:

------------------------------------------------------------------------
                                                      (1)         (2)
                                                    Section     Section
                                                      666         666
                                                    amounts     amounts
                                                   excluded    included
------------------------------------------------------------------------
Salary..........................................     $15,000     $15,000
Income from trust:
  Dividends ($50 excluded)......................       4,950      13,720
  Rents.........................................      10,000      22,526
  Taxable interest..............................       7,500      15,013
                                                 -----------------------
    Total.......................................      37,450      66,259
Less: Allowable deductions......................      10,600      10,600
                                                 -----------------------
    Taxable income..............................      26,850      55,659
                                                 =======================

[[Page 254]]

 
Total tax.......................................      11,267      31,064
Less: Dividend received credit..................         198         475
                                                 -----------------------
    Tax liability...............................     $11,069      30,589
Tax on income from which section 666 amounts are  ..........      11,069
 excluded.......................................
                                                 -----------------------
    1956 tax attributable to section 666 amounts  ..........      19,520
------------------------------------------------------------------------

Only that portion of the dividends received by the trust after July 31, 
1954, and deemed distributed to B under section 666, on the last day of 
such year is included in computing the dividend received credit shown in 
column (2). See paragraph (f)(3) of this example.
    (iii) The computation of the taxes for the preceding taxable years 
attributable to the section 666 amounts which are deemed distributed by 
the trust on the last day of these years, as provided in paragraph 
(a)(2) of Sec. 1.668(a)-4, is as follows:

------------------------------------------------------------------------
                                                     Preceding taxable
                                                           years
                                                 -----------------------
                                                                Second
                                                  First 1955     1954
------------------------------------------------------------------------
Taxable income previously reported..............     $13,400     $13,400
Section 666 amounts:
  Dividends ($50 excluded)......................       4,950       3,720
  Rents.........................................       7,500       5,026
  Taxable interest..............................       5,000       2,513
                                                 -----------------------
    Taxable income as adjusted..................      30,850      24,659
                                                 =======================
Total tax.......................................      13,747       9,949
Less: Dividend received credit..................         198          75
                                                 -----------------------
    Balance of tax..............................      13,549       9,874
Tax liability...................................       4,002       4,002
                                                 -----------------------
    Tax attributable to section 666 amounts.....       9,547       5,872
------------------------------------------------------------------------

Only that portion ($1,885) of the dividends received by the trust after 
July 31, 1954, and deemed distributed under section 666 on the last day 
of that year, is included in computing the dividend received credit of 
$75 for the year 1954. See paragraph (f)(3) of this example.
    (iv) Inasmuch as the aggregate of the taxes of $15,419 ($9,547 plus 
$5,872) attributable to the section 666 amounts as determined for the 
preceding taxable years is less than the tax of $19,520 determined for 
the taxable year 1956, the amount of $15,419 shall be added to the tax 
computed for 1956 without including the section 666 amounts. Thus, B's 
tax liability for 1956 is $26,488 ($11,069 plus $15,419).
    (3) Credits against the tax. B is allowed under section 668(b) a 
credit of $12,516 ($5,401 for 1954 and $7,115 for 1955) against his 1956 
tax liability for the taxes paid by the trust for the preceding taxable 
years and which may not be refunded or credited to the trust under 
section 667. See paragraphs (e)(4) and (f)(4) of this example.
    (i) [Reserved]
    (j) Taxable year 1957--(1) Amount of trust income includible in 
gross income. (i) Of the amount of $29,550 distributed by the trust to B 
during the taxable year 1957, $22,500 is treated as a distribution out 
of trust income for that year within the meaning of section 662(a)(2), 
and $7,050 as an accumulation distribution within the meaning of section 
665(b) (see paragraph (d) of this example). However, $6,990 plus taxes 
of $5,444 is deemed distributed to B on December 31, 1954, under section 
666 by reason of the accumulation distribution made during 1957, and 
that amount is includible in B's gross income for 1957, to the extent 
that it would have been includible in his gross income under section 662 
(a)(2) and (b) for 1954, had it been distributed on the last day of that 
year.
    (ii) The amounts deemed distributed to B out of trust income for the 
year 1957 and the preceding taxable year 1954 are deemed to have the 
following character for the purpose of determining the amount includible 
in B's gross income for 1957:

----------------------------------------------------------------------------------------------------------------
                                                                                   Interest  Interest
                            Year                              Dividends   Rents   (taxable)  (exempt)    Total
----------------------------------------------------------------------------------------------------------------
1957........................................................    $5,000    $7,500     $7,500    $2,500        \1\
                                                                                                         $22,500
1954........................................................     3,730     4,974      2,487     1,243        \2\
                                                                                                          12,434
                                                             ---------------------------------------------------
Total.......................................................     8,730    12,474      9,987     3,743    34,934
----------------------------------------------------------------------------------------------------------------
\1\ See paragraph (d)(2) of this example.
\2\ See paragraph (g)(2) of this example.

Thus, B will include in gross income for the year 1957 dividends of 
$8,730 (subject to the dividend exclusion), rents of $12,474, and 
taxable interest of $9,987 and will exclude the tax-exempt interest of 
$3,743.
    (2) Computation of tax. (i) For the purpose of computing B's tax 
liability for 1957, it is assumed that he was single for the entire year 
and had income (other than distributions from the trust) of $15,000 from 
salary. Also, he had allowable deductions of $8,100, which included the 
deductions for personal exemption.
    (ii) The computation of the tax for the taxable year 1957 
attributable to the section 666 amounts which are included in B's gross 
income for that year, as provided in paragraph (a)(1) of Sec. 1.668(a)-
4, is as follows:

------------------------------------------------------------------------
                                                    Section     Section
                                                      666         666
                                                    amounts     amounts
                                                   excluded    included
------------------------------------------------------------------------
Salary..........................................     $15,000     $15,000
Trust income:
  Dividends ($50 excluded)......................       4,950       8,680
  Rents.........................................       7,500      12,474

[[Page 255]]

 
  Taxable interest..............................       7,500       9,987
                                                 -----------------------
    Total.......................................      34,950      46,141
Less: Allowable deductions                             8,100       8,100
                                                 -----------------------
    Taxable income..............................      26,850      38,041
                                                 =======================
  Total tax.....................................      11,267      18,388
Less: Dividends received credit.................         198         275
                                                 -----------------------
    Tax liability...............................      11,069      18,113
Tax on income from which section 666 amounts are  ..........      11,069
 excluded.......................................
                                                 -----------------------
    1957 tax attributable to section 666 amounts  ..........       7,044
------------------------------------------------------------------------

See explanation following computation in paragraph (h)(2)(ii) of this 
example with respect to the computation of the dividend received credit 
on dividends received by the trust in 1954.
    (iii) The amount of tax, computed at 1954 rates, attributable to the 
section 666 amounts which are deemed to have been distributed by the 
trust on the last day of 1954, is $6,939, computed as follows:

1954 taxable income as adjusted (paragraph (h)(2)(iii) of        $24,659
 this example)..............................................
Section 666 amounts:
  Dividends.................................................       3,730
  Rents.....................................................       4,974
  Taxable interest..........................................       2,487
                                                 -------------
    Taxable income as adjusted..............................      35,850
                                                 =============
Total tax...................................................      16,963
Less: Dividends received credit.............................         150
                                                 -------------
    Balance of tax..........................................     16,813
Tax liability for 1954..........................      $4,002
Tax attributable to 1956 accumulation                  5,872
 distribution this example).....................
                                                 ------------
                                                                   9,874
                                                 -------------
  Tax attributable to the section 666 amounts distributed in       6,939
   1957.....................................................
 

Only that portion ($3,750) of the dividends received by the trust after 
July 31, 1954, and deemed distributed under section 666 on the last day 
of that year, is included in computing the dividend received credit of 
$150. See paragraphs (f)(3) and (g)(2) of this example.
    (iv) Inasmuch as the tax of $6,939 attributable to the section 666 
amounts as determined for the preceding taxable year 1954 is less than 
the tax of $7,044 attributable to these amounts for the year 1957, the 
amount of $6,939 shall be added to the tax computed for 1957 without 
including in gross income the section 666 amounts. Thus, B's tax 
liability for 1957 is $18,008 ($11,069 plus $6,939).
    (3) Credit against the tax. B is allowed under section 668(b) a 
credit of $5,444 against his 1957 tax liability for the balance of the 
taxes paid by the trust for 1954 and which may not be refunded or 
credited to the trust under section 667. See paragraph (g)(3) of this 
example.

(Sec. 669(a) as amended by sec. 331(a), Tax Reform Act 1969 (83 Stat. 
592))

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



Sec. 1.669(a)-1A  Amount allocated.

    (a) In general. After a trust has distributed all of its 
undistributed net income, the rules concerning the treatment of capital 
gain distributions (prescribed under section 669) may become applicable 
to an accumulation distribution. This section prescribes rules to 
determine from which years capital gain distributions are considered to 
be made. For the definition of ``capital gain distribution,'' see Sec. 
1.665(g)-1A. Section 669 does not apply to a trust that has distributed 
all of its income currently since its inception. See Sec. 1.668(a)-
1A(c). Capital gain retains its character in the hands of the 
beneficiary. See Sec. 1.669(f)-1A. A capital gain distribution to more 
than one beneficiary will be allocated among them. See Sec. 16.668(a)-
2A.
    (b) First-in, first-out rule. A capital gain distribution is 
allocated to the preceding taxable years of the trust (as defined in 
Sec. 1.665(e)-1A(a)(1)(iii)), according to the undistributed capital 
gain of the trust for such years. For this purpose, a capital gain 
distribution is first allocated to the earliest such preceding taxable 
year in which there is undistributed capital gain and shall then be 
allocated in turn, beginning with the next earliest, to any remaining 
preceding taxable years of the trust. The portion of the capital gain 
distribution allocated to the earliest preceding taxable year is the 
amount of undistributed capital gain for that preceding taxable year. 
The portion of the capital gain distribution allocated to any preceding 
taxable year subsequent to the earliest such preceding taxable year is 
the excess of the capital gain distribution over the aggregate of the 
undistributed capital gain for all earlier preceding taxable years. See 
paragraph (c) of this section for adjustments to undistributed capital 
gain for prior distributions.

[[Page 256]]

    (c) Reduction of undistributed capital gain for prior capital gain 
distributions. For the purposes of allocating to any preceding taxable 
year a capital gain distribution of the taxable year, the undistributed 
capital gain of such preceding taxable year is reduced by the amount 
from such year deemed distributed in any capital gain distribution made 
in any taxable year intervening between such preceding taxable year and 
the taxable year. Accordingly, for example, if a trust subject to the 
capital gain throwback has no undistributed net income but has 
undistributed capital gain for 1974, and makes capital gain 
distributions during the taxable years 1978 and 1979, then in 
determining that part of the 1979 capital gain distribution that is 
thrown back to 1974, the undistributed capital gain for 1974 is reduced 
by the amount of such undistributed capital gain for 1974 deemed 
distributed in the 1978 capital gain distribution.
    (d) Rule when no undistributed capital gain. If, before the 
application of the provisions of subpart D to a capital gain 
distribution for the taxable year, there is no undistributed capital 
gain for a preceding taxable year, then no portion of the capital gain 
distribution is deemed distributed on the last day of such preceding 
taxable year. Thus, for example, if a capital gain distribution is made 
during the taxable year 1975 from a trust whose earliest preceding 
taxable year is taxable year 1970, and the trust had no undistributed 
capital gain for 1970, then no portion of the 1975 capital gain 
distribution is deemed distributed on the last day of 1970.
    (e) Example. The provisions of this section may be illustrated by 
the following example:

    Example. In 1977, a trust reporting on the calendar year basis makes 
a capital gain distribution of $33,000. In 1969, the trust had $6,000 of 
undistributed capital gain; in 1970, $4,000; in 1971, none; in 1972, 
$7,000; in 1973, $5,000; in 1974, $8,000; in 1975, $6,000; in 1976, 
$4,000; and $6,000 in 1977. The capital gain distribution is deemed 
distributed $6,000 in 1969, $4,000 in 1970, none in 1971, $7,000 in 
1972, $5,000 in 1973, $8,000 in 1974, and $3,000 in 1975.

[T.D. 7204, 37 FR 17153, Aug. 25, 1972]



Sec. 1.669(b)-1A  Tax on distribution.

    (a) In general. The partial tax imposed on the beneficiary by 
section 668(a)(3) shall be the lesser of:
    (1) The tax computed under paragraph (b) of this section (the 
``exact'' method), or
    (2) The tax computed under paragraph (c) of this section (the 
``short-cut'' method),

except as provided in Sec. 1.669(c)-3A (relating to failure to furnish 
proper information) and paragraph (d) of this section (relating to 
disallowance of short-cut method). For purposes of this paragraph, the 
method used in the return shall be accepted as the method that produces 
the lesser tax. The beneficiary's choice of the two methods is not 
dependent upon the method that he uses to compute his partial tax 
imposed by section 668(a)(2).
    (b) Computation of partial tax by the exact method. The partial tax 
referred to in paragraph (a)(1) of this section is computed as follows:
    (1) First, compute the tax attributable to the section 669 amounts 
for each of the preceding taxable years. For purposes of this paragraph, 
the ``section 669 amounts'' for a preceding taxable year are the amounts 
deemed distributed under section 669(a) on the last day of such 
preceding taxable year, plus the amount of taxes deemed distributed on 
such day under section 669 (d) or (e). The tax attributable to such 
amounts in each prior taxable year of the beneficiary is the difference 
between the tax for such year computed with the inclusion of the section 
669 amounts in the beneficiary's gross income and the tax for such year 
computed with the inclusion of them in such gross income. Tax 
computations for each such year shall reflect a taxpayer's marital, 
dependency, exemption, and filing status for such year. To the extent 
the undistributed capital gain of a trust deemed distributed in a 
capital gain distribution includes amounts received as a capital gain 
distribution from another trust, for purposes of this paragraph they 
shall be considered as amounts deemed distributed by the trust under 
section 669(a) on the last day of each of the preceding taxable years in 
which such amounts were accumulated by such other trust.

[[Page 257]]

For example, assume trust Z, a calendar year trust received in its 
taxable year 1975 a capital gain distribution from trust Y, a calendar 
year trust, that included undistributed capital gain of trust Y for the 
taxable years 1972, 1973, and 1974. To the extent a capital gain 
distribution made by trust Z in its taxable year 1976 includes such 
undistributed capital gain, it shall be considered a capital gain 
distribution by trust Z in the taxable year 1976 and under section 
669(a) will be deemed distributed on the last day of the preceding 
taxable years 1972, 1973, and 1974.
    (2) From the sum of the taxes for the prior taxable years 
attributable to the section 669(a) amounts (computed in accordance with 
subparagraph (1) of this paragraph), subtract so much of the amount of 
taxes deemed distributed to the beneficiary under Sec. Sec. 1.669(d)-1A 
and 1.669(e)-1A as does not exceed such sum. The resulting amount, if 
any, is the partial tax on the beneficiary, computed under the exact 
method, for the taxable year in which the capital gain distribution is 
paid, credited, or required to be distributed to the beneficiary.
    (c) Computation of tax by the short-cut method. (1) The tax referred 
to in paragraph (a)(2) of this section is computed as follows:
    (i) First, determine the number of preceding taxable years of the 
trust on the last day of which an amount is deemed under section 669(a) 
to have been distributed. For purposes of the preceding sentence, the 
preceding taxable years of a trust that has received a capital gain 
distribution from another trust shall include the taxable years of such 
other trust in which an amount was deemed distributed in such capital 
gain distribution. For example, assume trust Z, a calendar year trust, 
received in its taxable year 1975 a capital gain distribution from trust 
Y, a calendar year trust, that included undistributed capital gain of 
trust Y for the taxable years 1972, 1973, and 1974. To the extent a 
capital gain distribution made by trust Z in its taxable year 1976 
includes such undistributed capital gain, it shall be considered a 
capital gain distribution by trust Z in the taxable year 1976 and under 
section 669(a) will be deemed distributed on the last day of the 
preceding taxable years 1972, 1973, and 1974. For purposes of this 
subparagraph, such number of preceding taxable years of the trust shall 
not include any preceding taxable year of the trust in which the 
undistributed capital gain deemed distributed is less than 25 percent of 
(a) the total amounts deemed under section 669(a) to be undistributed 
capital gain from preceding taxable years, divided by (b) the number of 
such preceding taxable years of the trust on the last day of which an 
amount is deemed under section 669(a) to have been distributed without 
application of this sentence. For example, assume that a capital gain 
distribution of $90,000 made to a beneficiary in 1979 is deemed 
distributed in the amounts of $29,000 in each of the years 1972, 1973, 
and 1974, and $3,000 in 1975. The number of preceding taxable years on 
the last day of which an amount was deemed distributed without reference 
to the second sentence of this subparagraph is 4. However, the 
distribution deemed made in 1975 ($3,000) is less than $5,625, which is 
25 percent of (a) the total undistributed capital gain deemed 
distributed under section 669(a) ($90,000) divided by (b) the number of 
such preceding taxable years (4), or $22,500. Therefore, for purposes of 
this subparagraph, the capital gain distribution is deemed distributed 
in only 3 preceding taxable years (1972, 1973, and 1974).
    (ii) Second, divide the amount (representing the capital gain 
distribution and taxes deemed distributed) required under section 668(a) 
to be included in the income of the beneficiary for the taxable year by 
the number of preceding taxable years of the trust on the last day of 
which an amount is deemed under section 669(a) to have been distributed 
(determined as provided in subdivision (i) of this paragraph). The 
amount determined under this subdivision, including taxes deemed 
distributed, consists of the same proportion of long-term and short-term 
capital gain as the total of each type of capital gain deemed 
distributed in the capital gain distribution bears to the total 
undistributed capital gain from such preceding taxable years deemed 
distributed in the capital gain distribution. For example, assume that 
an amount

[[Page 258]]

of $50,000 is deemed distributed under section 669(a) from undistributed 
capital gain of 5 preceding taxable years of the trust, and consists of 
$30,000 of long-term capital gain and $20,000 of short-term capital 
gain. Taxes attributable to such amounts in the amount of $10,000 are 
also deemed distributed. The amount determined under this subdivision, 
$12,000 ($50,000 income plus $10,000 tax, divided by 5 years), is deemed 
to consist of $7,200 of long-term capital gain and $4,800 in short-term 
capital gain.
    (iii) Third, compute the tax of the beneficiary for each of the 3 
taxable years immediately preceding the year in which the capital gain 
distribution is paid, credited, or required to be distributed to him,
    (a) With the inclusion in gross income of the beneficiary for each 
of such 3 years of the amount determined under subdivision (ii) of this 
subparagraph, and
    (b) Without such inclusion.


The difference between the amount of tax computed under (a) of this 
subdivision for each year and the amount computed under (b) of this 
subdivision for that year is the additional tax resulting from the 
inclusion in gross income for that year of the amount determined under 
subdivision (ii) of this subparagraph.
    (iv) Fourth, add the additional taxes resulting from the application 
of subdivision (iii) of this subparagraph and then divide this amount by 
3.
    (v) Fifth, the resulting amount is then multiplied by the number of 
preceding taxable years of the trust on the last day of which an amount 
is deemed under section 669(a) to have been distributed (previously 
determined under subdivision (i) of this subparagraph).
    (vi) The resulting amount, less so much of the amount of taxes 
deemed distributed to the beneficiary under Sec. Sec. 1.669(d)-1A and 
1.669(e)-1A as does not exceed such resulting amount, is the tax under 
the short-cut method provided in section 669(b)(1)(B).
    (2) See Sec. 1.668(b)-1A(c) for examples of the short-cut method in 
the context of an accumulation distribution.
    (d) Disallowance of short-cut method. If, in any prior taxable year 
of the beneficiary in which any part of the capital gain distribution is 
deemed to have been distributed under section 669(a) to such 
beneficiary, any part of prior capital gain distributions by each of two 
or more other trusts is deemed under section 669(a) to have been 
distributed to such beneficiary, then the short-cut method under 
paragraph (c) of this section may not be used and the partial tax 
imposed by section 668(a)(3) shall be computed only under the exact 
method under paragraph (b) of this section. For example, assume that, in 
1978, trust X makes a capital gain distribution to A, who is on the 
calendar year basis, and part of the distribution is deemed under 
section 669(a) to have been distributed on March 31, 1974. In 1977, A 
had received a capital gain distribution from both trust Y and trust Z. 
Part of the capital gain distribution from trust Y was deemed under 
section 669(a) to have been distributed to A on June 30, 1974, and part 
of the capital gain distribution from trust Z was deemed under section 
669(a) to have been distributed to A on December 31, 1974. Because there 
were portions of capital gain distributions from two other trusts deemed 
distributed within the same prior taxable year of A (1974), the 1978 
capital gain distribution from trust X may not be computed under the 
short-cut method provided in paragraph (c) of this section. Therefore 
the exact method under paragraph (b) of this section must be used to 
compute the tax imposed by section 668(a)(3).

[T.D. 7204, 37 FR 17153, Aug. 25, 1972]



Sec. 1.669(c)-1A  Special rules applicable to section 669.

    (a) Effect of other distributions. The income of the beneficiary, 
for any of his prior taxable years for which a tax is being recomputed 
under Sec. 1.669(b)-1A, shall include any amounts of prior accumulation 
distributions (including prior capital gain distributions) deemed 
distributed under sections 666 and 669 in such prior taxable year. For 
purposes of the preceding sentence, a prior accumulation distribution is 
a distribution from the same or another trust which was paid, credited, 
or required to be distributed in a prior taxable year of the 
beneficiary. The term prior accumulation distribution also includes 
accumulation distributions of

[[Page 259]]

the same or other trusts which were distributed to the beneficiary in 
the same taxable year. The term ``prior capital gain distribution'' also 
includes capital gain distributions of other trusts which were paid, 
credited, or required to be distributed to the beneficiary in the same 
taxable year and which the beneficiary has determined under paragraph 
(b) of this section to treat as having been distributed before the 
capital gain distribution for which tax is being computed under Sec. 
1.669(b)-1A.
    (b) Multiple distributions in the same taxable year. For purposes of 
paragraph (a) of this section, capital gain distributions made from more 
than one trust in the same taxable year of the beneficiary, regardless 
of when in the taxable year they were actually made, shall be treated as 
having been made consecutively, in whichever order the beneficiary may 
determine. However, the beneficiary must treat them as having been made 
in the same order for the purpose of computing the partial tax on the 
several capital gain distributions. The beneficiary shall indicate the 
order he has determined to deem the capital gain distributions to have 
been received by him on his return for the taxable year. A failure by 
him so to indicate, however, shall not affect his right to make such 
determination. The purpose of this rule is to assure that the tax 
resulting from the later (as so deemed under this paragraph) 
distribution is computed with the inclusion of the earlier distribution 
in the taxable base and that the tax resulting from the earlier (as so 
deemed under this paragraph) distribution is computed with the later 
distribution excluded from the taxable base.
    (c) Rule when beneficiary not in existence on the last day of a 
taxable year. If a beneficiary was not in existence on the last day of a 
preceding taxable year of the trust with respect to which a distribution 
is deemed made under section 669(a), it shall be assumed, for purposes 
of the computations under paragraphs (b) and (c) of Sec. 1.669(b)-1A, 
that the beneficiary:
    (1) Was in existence on such last day,
    (2) Was a calendar year taxpayer,
    (3) Had no gross income other than the amounts deemed distributed to 
him from such trust in his calendar year in which such last day occurred 
and from all other trusts from which amounts are deemed to have been 
distributed to him in such calendar year,
    (4) If an individual, was unmarried and had no dependents,
    (5) Had no deductions other than the standard deduction, if 
applicable, under section 141 for such calendar year, and
    (6) Was entitled to the personal exemption under section 151 or 
642(b).

For example, assume that part of a capital gain distribution made in 
1980 is deemed under section 669(a) to have been distributed to the 
beneficiary, A, in 1973. $10,000 of a prior accumulation distribution 
was deemed distributed in 1973. A was born on October 9, 1975. It will 
be assumed for purposes of Sec. 1.669(b)-1A that A was alive in 1973, 
was on the calendar year basis, had no income other than (i) the $10,000 
from the accumulation distribution deemed distributed in 1973 and (ii) 
the part of the 1980 distribution deemed distributed in 1973, and had no 
deductions other than the personal exemption provided in section 151. If 
A were a trust or estate created after 1973, the same assumptions would 
apply, except that the trust or estate would not be entitled to the 
standard deduction and would receive the personal exemption provided 
under section 642(b) in the same manner as allowed under such section 
for A's first actual taxable year.
    (d) Examples. The provisions of paragraphs (a) and (b) of this 
section may be illustrated by the following examples:

    Example 1. In 1978, trust X made a capital gain distribution to A, a 
calendar year taxpayer, of which $3,000 was deemed to have been 
distributed in 1974. In 1980, trust X makes another capital gain 
distribution to A, $10,000 of which is deemed under section 669(a) to 
have been distributed in 1974. Also in 1980, trust Y makes a capital 
gain distribution to A, of which $5,000 is deemed under section 669(a) 
to have been distributed in 1974. A determines to treat the 1980 
distribution from trust Y as having been made prior to the 1980 
distribution from trust X. In computing the tax on the 1980 trust Y 
distribution, A's gross income for 1974 includes (i) the $3,000 deemed 
distributed from the 1978 distribution, and (ii) the $5,000 deemed 
distributed in 1974 from the 1980 Trust Y capital gain distribution. To 
compute A's tax under the exact method for 1974 on the

[[Page 260]]

$10,000 from the 1980 trust X capital gain distribution deemed 
distributed in 1974. A's gross income for 1974 includes (i) the $10,000, 
(ii) the $3,000 previously deemed distributed in 1974 from the 1978 
trust X capital gain distribution, and (iii) the $5,000 deemed 
distributed in 1974 from the 1980 trust Y capital gain distribution.
    Example 2. In 1978, trust T makes a capital gain distribution to B, 
a calendar year taxpayer. Determination of the tax on the distribution 
under the short-cut method requires the use of B's gross income for 
1975, 1976, and 1977. In 1977, B received an accumulation distribution 
from trust U, of which $2,000 was deemed to have been distributed in 
1975, and $3,000 in 1976. B's gross income for 1975, for purposes of 
using the short-cut method to determine the tax from the trust T capital 
gain distribution, will be deemed to include the $2,000 deemed 
distributed in 1975 by trust U, and his gross income for 1976 will be 
deemed to include the $3,000 deemed distributed by trust U in 1976.

[T.D. 7204, 37 FR 17155, Aug. 25, 1972]



Sec. 1.669(c)-2A  Computation of the beneficiary's income and tax for
a prior taxable year.

    (a) Basis for computation. (1) The beneficiary's income and tax paid 
for any prior taxable year for which a recomputation is involved under 
either the exact method or the short-cut method shall be determined by 
reference to the information required to be furnished by him under Sec. 
1.669(c)-3A(a). The gross income, related deductions, and taxes paid for 
a prior taxable year of the beneficiary as finally determined shall be 
used for recomputation purposes. The term as finally determined shall 
have the same meaning for purposes of this section as in Sec. 1.668(b)-
3A(a).
    (2) If any computations rely on the beneficiary's return for a prior 
taxable year for which the applicable period of limitations on 
assessment under section 6501 has expired, and such return shows a 
mathematical error on its face which resulted in the wrong amount of tax 
being paid for such year, the determination of both the tax for such 
year computed with the inclusion of the section 669 amounts in the 
beneficiary's gross income, and the tax for such year computed without 
including such amounts in such gross income, shall be based upon the 
return after the correction of such mathematical errors.
    (b) Effect of allocation of undistributed capital gain on items 
based on amount of income and with respect to a net operating loss, a 
charitable contributions carryover, or a capital loss carryover. (1) In 
computing the tax for any taxable year under either the exact method or 
the short-cut method, any item which depends upon the amount of gross 
income, adjusted gross income, or taxable income shall be recomputed to 
take into consideration the amount of undistributed capital gain 
allocated to such year. For example, if $2,000 of undistributed long-
term capital gain is allocated to 1970, adjusted gross income for 1970 
is increased from $5,000 to $6,000. The allowable 50 percent charitable 
deduction under section 170(b)(1)(A) is then increased and the amount of 
the nondeductible medical expenses under section 213 (3 percent of 
adjusted gross income) is also increased.
    (2) In computing the tax attributable to the undistributed capital 
gain deemed distributed to the beneficiary in any of his prior taxable 
years under either the exact method or the short-cut method, the effect 
of amounts of undistributed capital gain on a net operating loss 
carryback or carryover, a charitable contributions carryover, or a 
capital loss carryback or carryover, shall be taken into account. In 
determining the amount of tax attributable to such deemed distribution, 
a computation shall also be made for any taxable year which is affected 
by a net operating loss carryback or carryover, by a charitable 
contributions carryover, or by a capital loss carryback or carryover 
determined by reference to the taxable year to which amounts are 
allocated under either method and which carryback or carryover is 
reduced or increased by such amounts so allocated.

[T.D. 7204, 37 FR 17155, Aug. 25, 1972]



Sec. 1.669(c)-3A  Information requirements with respect to beneficiary.

    (a) Information to be supplied by beneficiary--(1) Use of exact 
method. The beneficiary must supply the information required by 
subparagraph (3) of Sec. 1.668(b)-4A(a) for any prior taxable year for 
which a recomputation is required under either the exact method

[[Page 261]]

or the short-cut method. Such information shall be filed with the 
beneficiary's return for the year in which the tax under section 
668(a)(3) is imposed.
    (2) Failure to furnish. If the beneficiary fails to furnish the 
information required by this paragraph for any prior year involved in 
the exact method, he may not use such method and the tax computed under 
paragraph (c) of Sec. 1.669(b)-1A (the short-cut method) shall be 
deemed to be the amount of partial tax imposed by section 668(a)(3). 
See, however, paragraph (b) of this section for an exception to this 
rule where the short-cut method is not permitted. If he cannot furnish 
the information required for a prior year involved in the short-cut 
method, such year will be recomputed on the basis of the best 
information available.
    (b) Exception. If, by reason of Sec. 1.669(b)-1A(e), the 
beneficiary may not compute the partial tax on the capital gain 
distribution under Sec. 1.669(b)-1A(c) (the short-cut method), the 
provisions of subparagraph (2) of paragraph (a) of this section shall 
not apply. In such case, if the beneficiary fails to provide the 
information required by Sec. 1.668(b)-4A(a)(3) for any prior taxable 
year, the district director shall, by utilizing whatever information is 
available to him (including information supplied by the beneficiary), 
determine the beneficiary's income and related expenses for such prior 
taxable year.

[T.D. 7204, 37 FR 17156, Aug. 25, 1972]



Sec. 1.669(d)-1A  Total taxes deemed distributed.

    (a) If a capital gain distribution is deemed under Sec. 1.669(a)-1A 
to be distributed on the last day of a preceding taxable year and the 
amount is not less than the undistributed capital gain for such 
preceding taxable year, then an additional amount equal to the ``taxes 
imposed on the trust attributable to the undistributed capital gain'' 
(as defined in Sec. 1.665(d)-1A(c)) for such preceding taxable year is 
also deemed to have been properly distributed. For example, assume a 
trust has no distributable net income and has undistributed capital gain 
of $18,010 for the taxable year 1974. The taxes imposed on the trust 
attributable to the undistributed capital gain are $2,190. During the 
taxable year 1977, a capital gain distribution of $18,010 is made to the 
beneficiary which is deemed under Sec. 1.669(a)-1A to have been 
distributed on the last day of 1974. The 1977 capital gain distribution 
is not less than the 1974 undistributed capital gain. Accordingly, taxes 
of $2,190 imposed on the trust attributable to the undistributed capital 
gain for 1974 are also deemed to have been distributed on the last day 
of 1974. Thus, a total of $20,200 will be deemed to have been 
distributed on the last day of 1974.
    (b) For the purpose of paragraph (a) of this section, the 
undistributed capital gain of any preceding taxable year and the taxes 
imposed on the trust for such preceding taxable year attributable to 
such undistributed capital gain are computed after taking into account 
any capital gain distributions of taxable years intervening between such 
preceding taxable year and the taxable year. See paragraph (c) of Sec. 
1.669(a)-1A.

[T.D. 7204, 37 FR 17156, Aug. 25, 1972]



Sec. 1.669(e)-1A  Pro rata portion of taxes deemed distributed.

    (a) If a capital gain distribution is deemed under Sec. 1.669(a)-1A 
to be distributed on the last day of a preceding taxable year and the 
amount is less than the undistributed capital gain for such preceding 
taxable year, then an additional amount is also deemed to have been 
properly distributed. The additional amount is equal to the ``taxes 
imposed on the trust attributable to the undistributed capital gain'' 
(as defined in Sec. 1.665(d)-1A(c)) for such preceding taxable year, 
multiplied by a fraction, the numerator of which is the amount of the 
capital gain distribution allocated to such preceding taxable year and 
the denominator of which is the undistributed capital gain for such 
preceding taxable year. See paragraph (b) of example 1 and paragraphs 
(c) and (f) of example 2 in Sec. 1.669(e)-2A for illustrations of this 
paragraph.
    (b) For the purpose of paragraph (a) of this section, the 
undistributed capital gain of any preceding taxable year and the taxes 
imposed on the trust for such preceding taxable year attributable to 
such undistributed capital

[[Page 262]]

gain are computed after taking into account any capital gain 
distributions of any taxable years intervening between such preceding 
taxable year and the taxable year. See paragraph (c) of Sec. 1.669(a)-
1A, paragraph (c) of example 1 and paragraphs (e) and (h) of example 2 
in Sec. 1.669(e)-2A.

[T.D. 7204, 37 FR 17156, Aug. 25, 1972]



Sec. 1.669(e)-2A  Illustration of the provisions of section 669.

    The application of the provisions of Sec. Sec. 1.669(a)-1A, 
1.669(d)-1A, and 1.669(e)-1A may be illustrated by the following 
examples:

    Example 1. (a) A trust created on January 1, 1974, makes capital 
gain distributions as follows:

1979.............................................................$14,000
1980..............................................................60,000


The trust had accumulated income in 1974.

For 1974 through 1978, the undistributed portion of capital gain, taxes 
imposed on the trust attributable to the undistributed capital gain, and 
undistributed capital gain are as follows:

----------------------------------------------------------------------------------------------------------------
                                                                                 Taxes imposed on
                                                                 Undistributed      the trust
                              Year                                 portion of    attributable to   Undistributed
                                                                  capital gain  the undistributed   capital gain
                                                                                   capital gain
----------------------------------------------------------------------------------------------------------------
1974...........................................................   $24,200           $2,830          $21,370
1975...........................................................    32,200            4,330           27,870
1976...........................................................    12,200            1,130           11,070
1977...........................................................      None             None             None
1978...........................................................    10,200              910            9,290
----------------------------------------------------------------------------------------------------------------

    (b) Since the entire amount of the capital gain distribution for 
1979 ($14,000), determined without regard to the capital gain 
distribution for 1980, is less than the undistributed capital gain for 
1974 ($21,370), an additional amount of $1,854 (14,000/21,370x $2,830) 
is deemed distributed under section 669(e).
    (c) In allocating the capital gain distribution for 1980, the amount 
of undistributed capital gain for 1974 will reflect the capital gain 
distribution for 1979. The undistributed capital gain for 1974 will then 
be $7,370 and the taxes imposed on the trust for 1974 will be $976, 
determined as follows:

Undistributed capital gain as of the close of 1974..........     $21,370
Less: Capital gain distribution (1979)......................      14,000
                                                             -----------
    Balance (undistributed capital gain as of the close of         7,370
     1979)..................................................
Taxes imposed on the trust attributable to the undistributed         976
 capital gain as of the close of 1979 (7,370/ 21,370x2,830).
 

    (d) The capital gain distribution of $60,000 for 1980 is deemed to 
have been made on the last day of the preceding taxable years of the 
trust to the extent of $55,600, the total of the undistributed capital 
gain for such years, as shown in the tabulation below. In addition, 
$7,346, the total taxes imposed on the trust attributable to the 
undistributed capital gain for such years is also deemed to have been 
distributed on the last day of such years, as shown below:

------------------------------------------------------------------------
                                                       Taxes imposed on
                                                           the trust
                 Year                  Undistributed    attributable to
                                        capital gain   the undistributed
                                                         capital gain
------------------------------------------------------------------------
1974.................................    $7,370              $976
1975.................................    27,870             4,330
1976.................................    11,070             1,130
1977.................................      None              None
1978.................................     9,290               910
1979.................................      None              None
                                      ----------------------------------
    Total............................    55,600             7,346
------------------------------------------------------------------------

    Example 2. (a) Under the terms of a trust instrument, the trustee 
has discretion to accumulate or distribute the income to X and to invade 
corpus for the benefit of X. The trust is subject to capital gain 
throwback. Both X and the trust report on the calendar year basis. All 
of the income for 1974 was distributed and the capital gain was 
accumulated. The capital gain of the trust for the taxable year 1974 is 
$40,200 and the income taxes paid by the trust for 1974 attributable to 
the undistributed capital gain are $6,070. All of the income and capital 
gains for 1975 and 1976 were distributed and in addition the trustee 
made capital gain distributions within the meaning of section 665(g) of 
$8,000 for each year.
    (b) The undistributed capital gain of the trust determined under 
section 665(f) as of the close of 1974 is $34,130, computed as follows:

Capital gain................................................     $40,200
    Less: Taxes imposed on the trust attributable to the           6,070
     undistributed capital gain.............................
                                                             -----------
    Undistributed capital gain as of the close of 1974......      34,130
 

    (c) The capital gain distribution of $8,000 made during the taxable 
year 1975 is deemed under section 669(a) to have been made on December 
31, 1974. Since this capital gain distribution is less than the 1974 
undistributed capital gain of $34,130, a portion of the taxes imposed on 
the trust for 1974 is also deemed under section 669(e) to have been 
distributed on December 31, 1974. The total amount deemed to have been 
distributed to X on December 31, 1974, is $9,486, computed as follows:

Capital gain distribution...................................      $8,000
Taxes deemed distributed (8,000/ 34,130x$6,070).............       1,423
                                                             -----------
    Total...................................................       9,423
 


[[Page 263]]

    (d) After the application of the provisions of subpart D to the 
capital gain distribution of 1975, the undistributed capital gain of the 
trust for 1974 is $26,130, computed as follows:

Undistributed capital gain as of the close of 1974..........     $34,130
    Less: 1975 capital gain distribution deemed distributed        8,000
     on December 31, 1974 (paragraph (c) of this example)...
                                                             -----------
    Undistributed capital gain for 1974 as of the close of        26,130
     1975...................................................
 

    (e) The taxes imposed on the trust attributable to the undistributed 
capital gain for the taxable year 1974, as adjusted to give effective to 
the 1975 capital gain distribution, amount to $4,647, computed as 
follows:

Taxes imposed on the trust attributable to undistributed          $6,070
 capital gain as of the close of 1974.......................
    Less: Taxes deemed distributed in 1974..................       1,423
                                                             -----------
    Taxes attributable to the undistributed capital gain           4,647
     determined as of the close of 1975.....................
 

    (f) The capital gain distribution of $8,000 made during the taxable 
year 1976 is, under section 669(a), deemed an amount properly 
distributed to X on December 31, 1974. Since the capital gain 
distribution is less than the 1974 adjusted undistributed capital gain 
of $26,130, the trust is deemed under section 669(e) also to have 
distributed on December 31, 1974, a portion of the taxes imposed on the 
trust for 1974. The total amount deemed to be distributed on December 
31, 1974, with respect to the capital gain distribution made in 1976, is 
$9,423, computed as follows:

Capital gain distribution...................................      $8,000
Taxes deemed distributed (8,000/ 26,130x$4,647).............       1,423
                                                             -----------
    Total...................................................       9,423
 

    (g) After the application of the provisions of subpart D to the 
capital gain distribution of 1976, the undistributed capital gain of the 
trust for 1974 is $18,130, computed as follows:

Undistributed capital gain for 1974 as of the close of 1975.     $26,130
Less:
  1976 capital gain distribution deemed distributed on             8,000
   December 31, 1974 (paragraph (f) of this example)........
                                                             -----------
  Undistributed capital gain for 1974 as of the close of          18,130
   1976.....................................................
 

    (h) The taxes imposed on the trust attributable to the undistributed 
capital gain of the trust for the taxable year 1974, determined as of 
the close of the taxable year 1976, amount to $3,224 ($4,647 less 
$1,423).

[T.D. 7204, 37 FR 17156, Aug. 25, 1972]



Sec. 1.669(f)-1A  Character of capital gain.

    Amounts distributed as a capital gain distribution and the taxes 
attributable thereto (determined under Sec. 1.665(d)-1A(c)) retain the 
character that the gain had with respect to the trust. Thus, a capital 
gain that was taxed to the trust as a ``long-term'' capital gain and the 
pro rata amount of taxes attributable to such long-term gain shall be 
treated to the beneficiary as a ``long-term'' capital gain when they are 
deemed distributed as part of a capital gain distribution. If a trust 
has different types of capital gain for the same taxable year, and all 
of the capital gains are not deemed distributed for such year under 
section 669(a), the amount deemed distributed from such year (including 
taxes deemed distributed) shall be treated as consisting of the 
different types of gains in the ratio that the total of each such type 
of gains of the trust bears to the total of all such gains for the 
taxable year. For example, assume that in 1975 a trust had net long-term 
capital gains of $4,000 and net short-term capital gains of $2,000. 
Taxes attributable to such undistributed capital gain were $700. 
Therefore, undistributed capital gain for 1975 is $5,300. In 1980, the 
trust distributes $2,650 that is deemed to be undistributed capital gain 
from 1975. Such distribution is deemed to consist of long-term gain of 
$1,766.67 and short-term gain of $883.33. The taxes deemed distributed 
of $350 consist of long-term gain of $233.33 and short-term gain of 
$116.67.

[T.D. 7204, 37 FR 17157, Aug. 25, 1972]



Sec. 1.669(f)-2A  Exception for capital gain distributions from certain
trusts.

    (a) General rule. If a capital gain distribution is paid, credited, 
or required to be distributed before January 1, 1973, from a trust that 
was in existence on December 31, 1969, section 669 shall not apply and 
no tax shall be imposed on such capital gain distribution under section 
668(a)(3). If capital gain distributions from more than one such trust 
are paid, credited, or required to be distributed to a beneficiary 
before January 1, 1973, the exception under the preceding sentence shall 
apply only to the capital gain distributions from one of the trusts. The 
beneficiary shall indicate on his income tax return for the taxable year 
in which the distribution would otherwise be included in income under 
section 668(a) the trust to

[[Page 264]]

which the exception provided by this section shall apply.
    (b) Special rule for section 2056(b)(5) trust. A capital gain 
distribution paid, credited, or required to be distributed by a trust 
that qualifies under section 2056(b)(5) of the Code (commonly known as a 
``marital deduction trust'') to a surviving spouse shall, in general, 
not be taxed under section 668(a)(3) since such a trust is required to 
distribute all of its income annually or more often. See section 
2056(b)(5) and the regulations thereunder.
    (c) Effect of exception. If this section applies to a capital gain 
distribution from a trust, such distribution shall reduce the 
undistributed capital gain of the trust. Since section 669 does not 
apply to such capital gain distribution, no amount of taxes paid by the 
trust attributable to such capital gain distribution are deemed 
distributed under section 669 (d) and (e).

[T.D. 7204, 37 FR 17157, Aug. 25, 1972]



Sec. 1.669(a)-1  Limitation on tax.

    (a) In general. Section 669 provides that, at the election of a 
beneficiary who is a U.S. person (as defined in section 7701(a)(30)) and 
who satisfies the requirements of section 669(b) (that certain 
information with respect to the operation and accounts of the trust be 
supplied), the tax attributable to the amounts treated under section 
668(a) as having been received by him, from a foreign trust created by a 
U.S. person, on the last day of a preceding taxable year of the trust 
shall not be greater than the tax computed under section 669(a)(1)(A) 
(the computation under this provision will hereinafter be referred to as 
the ``exact throwback'' method) or under section 669(a)(1)(B) (the 
computation under this provision will hereinafter be referred to as the 
``short-cut throwback'' method). This election of the beneficiary with 
respect to the taxable year of the beneficiary in which the distribution 
is made shall be made with the district director before the expiration 
of the period of limitations for assessment provided in section 6501 for 
such taxable year.
    (b) Where no election is made. If the beneficiary does not make the 
election provided in section 669(a) in the manner required in section 
669(b) and Sec. 1.669(b)-2, or furnish the information with respect to 
the operation and accounts of the foreign trust created by a U.S. person 
required by section 669(b) and Sec. 1.669(b)-1, the tax on an 
accumulation distribution treated under section 668(a) as having been 
received by him from such foreign trust on the last day of a preceding 
taxable year of the trust shall be computed without reference to section 
668 or 669. In such case, the entire accumulation distribution will be 
included in the gross income of the beneficiary in the year in which it 
is paid, credited, or required to be distributed, and tax for such year 
will be computed on the basis of the beneficiary's total taxable income 
for the year after taking into account such inclusion in gross income.
    (c) Year for which tax is payable. The tax, regardless of the manner 
in which computed, of the beneficiary which is attributable to an 
accumulation distribution is imposed on the beneficiary for the taxable 
year of the beneficiary in which the accumulation distribution is made 
to him unless the taxable year of the beneficiary is different from that 
of the trust. See section 662(c) and Sec. 1.662(c)-1.

[T.D. 6989, 34 FR 738, Jan. 17, 1969]



Sec. 1.669(a)-2  Rules applicable to section 669 computations.

    (a) In general. (1) Section 668(a) provides that the total of the 
amounts treated under section 666 as having been distributed by the 
foreign trust created by a U.S. person on the last day of a preceding 
taxable year of such trust shall be included in the gross income of the 
beneficiary or the beneficiaries who are U.S. persons receiving them. 
The total of such amounts is includible in the gross income of each 
beneficiary to the extent the amount would have been included in his 
gross income under section 662 (a)(2) and (b) if the total had actually 
been paid by the trust on the last day of such preceding taxable year. 
The total is included in the gross income of the beneficiary for the 
taxable year of the beneficiary in which such amounts are in fact paid, 
credited, or required to be distributed unless the taxable year of the 
beneficiary differs from the taxable year of the trust (see section 
662(c) and

[[Page 265]]

Sec. 1.662(c)-1). The character of the amounts treated as received by a 
beneficiary in prior taxable years, including taxes deemed distributed, 
in the hands of the beneficiary is determined by the rules contained in 
section 662(b) and Sec. Sec. 1.662(b)-1 and 1.662(b)-2.
    (2) The total of the amounts treated under section 666 as having 
been distributed by the trust on the last day of a preceding taxable 
year of the trust are included as prescribed in subparagraph (1) of this 
paragraph in the gross income of the beneficiary even though as of that 
day the beneficiary would not have been entitled to receive them had 
they actually been distributed on that day.
    (3) Any deduction allowed to the trust in computing distributable 
net income for a preceding taxable year (such as depreciation, 
depletion, etc.) is not deemed allocable to a beneficiary because of the 
amounts included in a beneficiary's gross income under this section 
since the deduction has already been utilized in reducing the amount 
included in the beneficiary's income.
    (b) Allocation among beneficiaries of a foreign trust. Where there 
is more than one beneficiary the portion of the total amount includible 
in gross income under paragraph (a) of this section which is includible 
in the gross income of a beneficiary who is a U.S. person is based upon 
the ratio determined under the second sentence of section 662(a)(2) for 
the taxable year in which distributed (and not for the preceding taxable 
year). This paragraph may be illustrated by the example in Sec. 
1.668(a)-2.
    (c) Treatment of income taxes paid by the trust--(1) Current 
distributions. The income taxes imposed by the provisions of section 871 
on the income of a foreign trust created by a U.S. person shall be 
included in the gross income of the beneficiary, who is a U.S. person, 
for the taxable year in which such income is paid, credited, or required 
to be distributed to the beneficiary.
    (2) Accumulation distribution. (i) If an accumulation distribution 
is deemed under Sec. 1.666(a)-1 to be distributed on the last day of a 
preceding taxable year and the amount is not less than the undistributed 
net income for such preceding taxable year, then an additional amount 
equal to the taxes imposed on the trust pursuant to the provisions of 
section 871 for such preceding taxable year is likewise deemed 
distributed under section 661(a)(2).
    (ii) If an accumulation distribution is deemed under Sec. 1.666(a)-
1 to be distributed on the last day of a preceding taxable year and the 
amount is less than the undistributed net income for such preceding 
taxable year, then an additional amount (representing taxes) is likewise 
deemed distributed under section 661(a)(2). The additional amount is 
equal to the taxes imposed on the trust pursuant to the provisions of 
section 871 for such preceding taxable year, multiplied by the fraction 
the numerator of which is the amount of the accumulation distribution 
attributable to such preceding taxable year and the denominator of which 
is the undistributed net income for such preceding taxable year.
    (3) Credits under sections 32 and 668(b). Credit under section 32 is 
allowable to the beneficiary for income taxes withheld at source under 
subchapters A and B of chapter 3 and which are deemed distributed to 
him. Credit under section 668(b) is allowable to the beneficiary for 
income taxes imposed upon the foreign trust by section 871(b). These 
credits shall be allowed against the tax of the beneficiary for the 
taxable year of the beneficiary in which the income is paid, credited, 
or required to be distributed to him, or in which the accumulation 
distribution to which such taxes relate is made to him.
    (d) Credit for foreign income taxes paid by the trust. To the extent 
provided in section 901, credit under section 33 is allowable to the 
beneficiary for the foreign taxes paid or accrued by the trust to a 
foreign country.

[T.D. 6989, 34 FR 738, Jan. 17, 1969]



Sec. 1.669(a)-3  Tax computed by the exact throwback method.

    (a) Tax attributable to amounts treated as received in preceding 
taxable years. If a taxpayer elects to compute the tax, on amounts 
deemed distributed under section 666, by the exact throwback method 
provided in section 669(a)(1)(A), the tax liability of the beneficiary 
for the taxable year in which the accumulation distribution is paid, 
credited, or

[[Page 266]]

required to be distributed is computed as provided in paragraph (b) of 
this section. The beneficiary may not elect to use the exact throwback 
method of computing his tax on an accumulation distribution as provided 
in section 669(a)(1)(A) if he were not alive on the last day of each 
preceding taxable year of the foreign trust created by a U.S. person 
with respect to which a distribution is deemed made under section 
666(a). Thus, if a portion of an amount received as an accumulation 
distribution was accumulated by the trust during years before the 
beneficiary was born, the beneficiary is not permitted to elect the 
exact throwback method provided in section 669(a)(1)(A). See Sec. 
1.669(a)-4 for the computation of the tax on an accumulation 
distribution by the short-cut throwback method provided in section 
669(a)(1)(B) under these circumstances.
    (b) Computation of tax. The tax referred to in paragraph (a) of this 
section is computed as follows:
    (1) First, compute the tax attributable to the section 666 amounts 
for each of the preceding taxable years. To determine the section 666 
amounts attributable to each of the preceding taxable years, see Sec. 
1.666(a)-1. The tax attributable to such amounts in each such preceding 
taxable year is the difference between the tax for such preceding 
taxable year computed with the inclusion of the section 666 amounts in 
gross income, and the tax for such year computed without including them 
in gross income. Tax computations for each preceding year shall reflect 
the taxpayer's marital and dependency status for that year.
    (2) Second, add
    (i) The sum of the taxes for the preceding taxable years 
attributable to the section 666 amounts (computed in accordance with 
subparagraph (1) of this paragraph), and
    (ii) The tax for the taxable year of the beneficiary in which the 
accumulation distribution is paid, credited, or required to be 
distributed to him, computed without including the section 666 amounts 
in gross income.

The total of these amounts is the beneficiary's tax, computed under 
section 669(a)(1)(A) for the taxable year in which the accumulation 
distribution is paid, credited, or required to be distributed to him.
    (c) Effect of prior election. In computing the tax attributable to 
an accumulation distribution for the taxable year in which such 
accumulation distribution is paid, credited, or required to be 
distributed to him, the beneficiary in computing the tax attributable to 
section 666 amounts for each of the preceding taxable years, must 
include in his gross income for each such year the section 666 amounts 
deemed distributed to him in such year resulting from prior accumulation 
distributions made to him in taxable years prior to the current taxable 
year. These section 666 amounts resulting from such prior accumulation 
distributions must be included in the gross income for such preceding 
taxable year even though the tax on the accumulation distribution of 
such prior taxable year was computed by the short-cut throwback method 
provided in section 669(a)(1)(B) and Sec. 1.669(a)-4.

[T.D. 6989, 34 FR 739, Jan. 17, 1969]



Sec. 1.669(a)-4  Tax attributable to short-cut throwback method.

    (a) Manner of computing tax. If a beneficiary has elected under 
section 669(a) to compute the tax on the amounts deemed distributed 
under section 666 by the short-cut throwback method provided in section 
669(a)(1)(B), the tax liability of the beneficiary for the taxable year 
is computed in the following manner:
    (1) First, determine the number of preceding taxable years of the 
trust, on the last day of which an amount is deemed under section 666(a) 
to have been distributed. In any case where there has been a prior 
accumulation distribution with respect to which the beneficiary has 
elected to compute his tax either by the exact throwback method or by 
the short-cut throwback method, or to which the next to the last 
sentence of section 668(a) has applied, for purposes of an election to 
use the short-cut throwback method with respect to a subsequent 
accumulation distribution, in determining the number of preceding 
taxable years of the trust with respect to which an amount of the 
subsequent accumulation distribution is deemed distributed to a

[[Page 267]]

beneficiary under section 666(a), there shall be excluded any preceding 
taxable year during which any part of the prior accumulation 
distribution was deemed distributed to the beneficiary. For example, 
assume that an accumulation distribution of $90,000 made to a 
beneficiary in 1963 is deemed distributed in the amounts of $25,000 in 
each of the years 1962, 1961, and 1960, and in the amount of $15,000 in 
1959, and a subsequent accumulation distribution of $85,000 made to the 
same beneficiary in 1964 is deemed distributed in the amount of $10,000 
during 1959, and $25,000 during each of the years 1958, 1957, and 1956. 
The accumulation distribution made in 1963 is deemed distributed in 4 
preceding taxable years of the trust (1962, 1961, 1960, and 1959). 
Inasmuch as the year 1959 was a year during which part of the 1963 
accumulation distribution was deemed distributed, for purposes of 
determining the number of preceding taxable years in which the 
accumulation distribution of $85,000 made in 1964 is deemed distributed, 
the year 1959 is excluded and the $85,000 accumulation distribution is 
deemed distributed in three preceding taxable years (1958, 1957, and 
1956),
    (2) Second, divide the number of preceding taxable years of the 
trust, on the last day of which an amount is deemed under section 666(a) 
to have been distributed (determined as provided in subparagraph (1) of 
this paragraph) into the amount (representing an accumulation 
distribution made by a foreign trust created by a U.S. person) required 
to be included under section 669(a) in the gross income of the 
beneficiary for the taxable year,
    (3) Third, compute the tax of the beneficiary for the current 
taxable year (the year in which the accumulation distribution is paid, 
credited, or required to be distributed to him) and for each of the 2 
taxable years immediately preceding such year,
    (i) With the inclusion in gross income of the beneficiary for each 
of such 3 years of the amount determined under subparagraph (2) of this 
paragraph, and
    (ii) Without such inclusion.

The difference between the amount of tax computed under subdivision (i) 
of this subparagraph for each year and the amount computed under 
subdivision (ii) of this subparagraph for that year is the additional 
tax resulting from the inclusion in gross income for that year of the 
amount determined under subparagraph (2) of this paragraph. If the 
number of preceding taxable years of the trust, on the last day of which 
an amount is deemed under section 666(a) to have been distributed, is 
less than three, the taxable years of the beneficiary for which this 
recomputation is made shall equal the number of years in which an amount 
is deemed under section 666(a) to have been distributed, commencing with 
the taxable year of the beneficiary in which the accumulation 
distribution is paid, credited, or required to be distributed to him. If 
the beneficiary was not alive during one of the two taxable years 
immediately preceding the taxable year, the tax resulting from the 
inclusion of the amount determined in subparagraph (2) of this paragraph 
in the gross income of the beneficiary will be computed only for the 
taxable year in which the accumulation distribution was paid, credited, 
or required to be distributed to him and the preceding year during which 
the beneficiary was alive. In the event the beneficiary was not alive 
during either of the 2 years immediately preceding the taxable year in 
which the accumulation distribution was paid, credited, or required to 
be distributed, the tax shall be computed on the basis of the 
beneficiary's taxable year without regard to the inclusion in income 
required by section 668(a) of any amount other than pursuant to section 
669(a)(1)(B). For example, assume that a foreign trust created by a U.S. 
person accumulates $3,000 of income in 1964 and $7,000 in 1963 and then 
distributes the accumulated income on January 1, 1965, to a beneficiary 
who is a U.S. person. The limitation on tax is determined by recomputing 
the beneficiary's gross income for 1964 and 1965 by adding $5,000 to his 
gross income for each year. If the same distribution were made to an 
infant who was born in 1965, the limitation on tax would be computed by 
adding $5,000 to his gross income for such year. In the case of the 
infant, the resulting increase in tax would be multiplied by two to 
arrive at the limitation

[[Page 268]]

on the increase in his tax for 1965 attributable to such distribution.
    (4) Fourth, add the additional taxes resulting from the application 
of subparagraph (3) of this paragraph for the taxable year and the 2 
taxable years (or the 1 taxable year, where applicable) immediately 
preceding the year in which the accumulation distribution is paid, 
credited, or required to be distributed and then divide this amount by 
three (or two, where applicable). The resulting amount is then 
multiplied by the number of preceding taxable years of the trust on the 
last day of which an amount is deemed under section 666(a) to have been 
distributed (previously determined under subparagraph (1) of this 
paragraph). The resulting amount is the tax, under the short-cut 
throwback method provided in section 669(a)(1)(B), which is attributable 
to the amounts treated under section 668(a) as having been received by 
the beneficiary from a foreign trust created by a U.S. person on the 
last day of the preceding taxable year.
    (5) Fifth, add the amount determined under subparagraph (4) of this 
paragraph to the beneficiary's tax for the taxable year in which the 
accumulation distribution was paid, credited, or required to be 
distributed to him, computed without inclusion of the accumulation 
distribution in gross income for that year. The total is the 
beneficiary's income tax for such year.
    (b) Credit for tax paid by trust. The income taxes deemed 
distributed to a beneficiary in the manner described in paragraphs (c) 
and (d) of Sec. 1.669(a)-2 are included in the beneficiary's gross 
income for purposes of the computations required by this section. To the 
extent provided in Sec. 1.669(a)-2, credits for such taxes are 
allowable to the beneficiary. In the computations under the short-cut 
throwback method provided in section 669(a)(1)(B), the rules set forth 
in section 662(b) and Sec. 1.662(b)-1 shall be applied in determining 
the character, in the hands of the beneficiary, of the amounts, 
including taxes includible in the distribution or deemed distributed, 
treated as received by a beneficiary in prior taxable years. For 
example, if one-fifth of such amounts represents tax-free income, then 
one-fifth of the amount determined under paragraph (a)(2) of this 
section shall be treated as tax-free income.

[T.D. 6989, 34 FR 739, Jan. 17, 1969]



Sec. 1.669(b)-1  Information requirements.

    The election of a beneficiary who is a U.S. person to apply the 
limitations on tax provided in section 669(a) shall not be effective 
unless the beneficiary, at or before the time the election is made, 
supplies, in a letter addressed to the district director for the 
internal revenue district in which the taxpayer files his return (or the 
Director of International Operations where appropriate), or in a 
statement attached to his return, the following information with respect 
to the operation and accounts of the foreign trust created by a U.S. 
person for each of the preceding taxable years, on the last day of which 
an amount is deemed distributed under section 666(a):
    (a) The gross income of the trust: The gross income should be 
separated to show the amount of each type of income received by the 
trust and to identify its source. For example, the beneficiary should 
list separately, by type (dividends, rents, capital gains, taxable 
interest, exempt interest, etc.) and source (name and country of payor), 
each item of income included in the gross income of the trust. For this 
purpose, the gross income of the trust includes gross income from U.S. 
sources which is exempt from taxation under section 894.
    (b) The amount of tax withheld under section 1441 by the United 
States on income from sources within the United States.
    (c) The amount of the tax paid to each foreign country by the trust.
    (d) The expenses of the trust attributable to each type of income 
disclosed in paragraph (b) of this section, and the general expenses of 
the trust.
    (e) The distributions, if any, made by the trust to the 
beneficiaries (including those who are not U.S. persons). These 
distributions should be separated into amounts of income required to be 
distributed currently within the meaning of section 661(a)(1), and any 
other amounts properly paid, credited, or required to be distributed 
within the meaning of section 661(a)(2).

[[Page 269]]

    (f) Any other information which is necessary for the computation of 
tax on the accumulation distribution as provided in section 669(a).
    (g) If the foreign trust created by a U.S. person is less than the 
entire foreign trust, the information listed in paragraphs (a) through 
(f) of this section shall also be furnished with respect to that portion 
of the entire foreign trust which is not a foreign trust created by a 
U.S. person.

[T.D. 6989, 34 FR 740, Jan. 17, 1969]



Sec. 1.669(b)-2  Manner of exercising election.

    (a) By whom election is to be made. Except as otherwise provided in 
this paragraph, a taxpayer whose tax liability is affected by the 
election shall make the election provided in section 669(a). In the case 
of a partnership, or a corporation electing under the provisions of 
subchapter S, chapter 1 of the Code, the election shall be exercised by 
the partnership or such corporation.
    (b) Time and manner of making election. The election under section 
669(a) may be made, or revoked, at any time before the expiration of the 
period provided in section 6501 for assessment of the tax. If an 
election is revoked, a new election may be made at any time before the 
expiration of such period. The election (or a revocation of an election) 
may be made in a letter addressed to the district director of internal 
revenue for the district in which the taxpayer files his tax return (or 
the Director of International Operations where appropriate) or may be 
made in a statement attached to the return. In any case where all the 
information described in Sec. 1.669(b)-1 is not furnished at or before 
the time the beneficiary signifies his intention of making an election 
and by reason thereof an election has not been made, and subsequent 
thereto, but before the expiration of the period provided in section 
6501 for the assessment of the tax, there is furnished the required 
information not previously furnished, the election will be considered as 
made at the time such additional information is furnished.

[T.D. 6989, 34 FR 740, Jan. 17, 1969]

         unitrust actuarial tables applicable before may 1, 2009



Sec. 1.664-4A  Valuation of charitable remainder interests for which
the valuation date is before May 1, 2009.

    (a) Valuation of charitable remainder interests for which the 
valuation date is before January 1, 1952. There was no provision for the 
qualification of a charitable remainder unitrust under section 664 until 
1969. See Sec. 20.2031-7A(a) of this chapter (Estate Tax Regulations) 
for the determination of the present value of a charitable interest for 
which the valuation date is before January 1, 1952.
    (b) Valuation of charitable remainder interests for which the 
valuation date is after December 31, 1951, and before January 1, 1971. 
No charitable deduction is allowable for a transfer to a unitrust for 
which the valuation date is after the effective dates of the Tax Reform 
Act of 1969 unless the unitrust meets the requirements of section 664. 
See Sec. 20.2031-7A(b) of this chapter (Estate Tax Regulations) for the 
determination of the present value of a charitable remainder interest 
for which the valuation date is after December 31, 1951, and before 
January 1, 1971.
    (c) Valuation of charitable remainder unitrusts having certain 
payout sequences for transfers for which the valuation date is after 
December 31, 1970, and before December 1, 1983. For the determination of 
the present value of a charitable remainder unitrust for which the 
valuation date is after December 31, 1970, and before December 1, 1983, 
see Sec. 20.2031-7A(c) of this chapter (Estate Tax Regulations) and 
former Sec. 1.664-4(d) (as contained in the 26 CFR part 1 edition 
revised as of April 1, 1994).
    (d) Valuation of charitable remainder unitrusts having certain 
payout sequences for transfers for which the valuation date is after 
November 30, 1983, and before May 1, 1989--(1) In general. Except as 
otherwise provided in paragraph (d)(2) of this section, in the case of 
transfers made after November 30, 1983, for which the valuation date is 
before May 1, 1989, the present value of a remainder interest that is 
dependent on a term of years or the termination of the life of one 
individual is determined under

[[Page 270]]

paragraphs (d)(3) through (d)(6) of this section, provided that the 
amount of the payout as of any payout date during any taxable year of 
the trust is not larger than the amount that the trust could distribute 
on such date under Sec. 1.664-3(a)(1)(v) if the taxable year of the 
trust were to end on such date. The present value of the remainder 
interest in the trust is determined by computing the adjusted payout 
rate (as defined in paragraph (d)(3) of this section) and following the 
procedure outlined in paragraph (d)(4) or (d)(5) of this section, 
whichever is applicable. The present value of a remainder interest that 
is dependent on a term of years is computed under paragraph (d)(4) of 
this section. The present value of a remainder interest that is 
dependent on the termination of the life of one individual is computed 
under paragraph (d)(5) of this section. See paragraph (d)(2) of this 
section for testamentary transfers for which the valuation date is after 
November 30, 1983, and before August 9, 1984.
    (2) Rules for determining the present value for testamentary 
transfers where the decedent dies after November 30, 1983, and before 
August 9, 1984. For purposes of section 2055 or 2106, if--
    (i) The decedent dies after November 30, 1983, and before August 9, 
1984; or
    (ii) On December 1, 1983, the decedent was mentally incompetent so 
that the disposition of the property could not be changed, and the 
decedent died after November 30, 1983, without regaining competency to 
dispose of the decedent's property, or died within 90 days of the date 
on which the decedent first regained competency, the present value 
determined under this section of a remainder interest is determined in 
accordance with paragraph (d)(1) and paragraphs (d)(3) through (d)(6) of 
this section, or Sec. 1.664-4A(c), at the option of the taxpayer.
    (3) Adjusted payout rate. The adjusted payout rate is determined by 
multiplying the fixed percentage described in paragraph (a)(1)(i)(a) of 
Sec. 1.664-3 by the figure in column (2) of Table F(1) which describes 
the payout sequence of the trust opposite the number in column (1) of 
Table F(1) which corresponds to the number of months by which the 
valuation date for the first full taxable year of the trust precedes the 
first payout date for such taxable year. If the governing instrument 
does not prescribe when the distribution shall be made during the 
taxable year of the trust, see Sec. 1.664-4(a). In the case of a trust 
having a payout sequence for which no figures have been provided by 
Table F (1) and in the case of a trust which determines the fair market 
value of the trust assets by taking the average of valuations on more 
than one date during the taxable year, see Sec. 1.664-4(b).
    (4) Period is a term of years. If the period described in Sec. 
1.664-3(a)(5) is a term of years, the factor which is used in 
determining the present value of the remainder interest is the factor 
under the appropriate adjusted payout rate in Table D in Sec. 1.664-
4(e)(6) that corresponds to the number of years in the term. If the 
adjusted payout rate is an amount which is between adjusted payout rates 
for which factors are provided in Table D, a linear interpolation must 
be made. The present value of the remainder interest is determined by 
multiplying the net fair market value (as of the appropriate valuation 
date) of the property placed in trust by the factor determined under 
this paragraph (d)(4). For purposes of this section, the term 
appropriate valuation date means the date on which the property is 
transferred to the trust by the donor except that, for purposes of 
section 2055 or 2106, it means the date of death unless the alternate 
valuation date is elected in accordance with section 2032 and the 
regulations thereunder in which event it means the alternate valuation 
date. If the adjusted payout rate is greater than 14 percent, see Sec. 
1.664-4(b). The application of this paragraph (d)(4) may be illustrated 
by the following example:

    Example. D transfers $100,000 to a charitable remainder unitrust on 
January 1, 1985. The trust instrument requires that the trust pay to D 
semiannually (on June 30 and December 31) 10 percent of the fair market 
value of the trust assets as of June 30th for a term of 15 years. The 
adjusted payout rate is 9.767 percent (10%x0.976731). The present value 
of the remainder interest is $21,404.90, computed as follows:

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


[[Page 271]]

[GRAPHIC] [TIFF OMITTED] TC14NO91.134

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


X === .006004

Factor at 9.6 percent for 15 years...........................   0.220053
Less: X......................................................    .006004
    Interpolated factor......................................    .214049
 
Present value of remainder
 interest===$100,000x0.214049===$21,404.90
 

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

    Example. A, who will be 50 years old on April 15, 1985, transfers 
$100,000 to a charitable remainder unitrust on January 1, 1985. The 
trust instrument requires that the trust pay to A at the end of each 
taxable year of the trust 10 percent of the fair market value of the 
trust assets as of the beginning of each taxable year of the trust. The 
adjusted payout rate is 9.091 percent (10 percentx.909091). The present 
value of the remainder interest is $15,259.00 computed as follows:

Factor at 9 percent at age 50.................................   0.15472
Factor at 9.2 percent at age 50...............................    .15003
                                                               ---------
    Difference................................................    .00469
 
                        9.091%-9%/0.2%=X/0.00469
                                x=0.00213
 
Factor at 9 percent at age 50.................................    .15472
Less: X.......................................................    .00213
                                                               ---------
    Interpolated factor.......................................    .15259
 
                  Present value of remainder interest=
                       $100,000x0.15259=$15,259.00
 

    (6) Actuarial tables for transfers for which the valuation date is 
after November 30, 1983, and before May 1, 1989. Table D in Sec. 1.664-
4(e)(6) and the following tables shall be used in the application of the 
provisions of this section:

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

[[Page 272]]

 
53............................................................    .61026    .58488    .56080    .53793    .51620
54............................................................    .62025    .59528    .57154    .54897    .52750
55............................................................    .63022    .60567    .58230    .56004    .53884
56............................................................    .64018    .61606    .59306    .57113    .55021
57............................................................    .65012    .62644    .60384    .58225    .56163
58............................................................    .66004    .63681    .61461    .59337    .57306
59............................................................    .66993    .64717    .62538    .60452    .58453
60............................................................    .67979    .65751    .63615    .61567    .59602
61............................................................    .68963    .66784    .64692    .62683    .60754
62............................................................    .69944    .67815    .65769    .63801    .61908
63............................................................    .70922    .68844    .66843    .64918    .63063
64............................................................    .71893    .69868    .67915    .66032    .64217
65............................................................    .72859    .70886    .68982    .67144    .65369
66............................................................    .73817    .71897    .70043    .68250    .66517
67............................................................    .74766    .72901    .71096    .69350    .67660
68............................................................    .75706    .73896    .72142    .70443    .68796
69............................................................    .76637    .74882    .73181    .71530    .69928
70............................................................    .77559    .75861    .74212    .72610    .71053
71............................................................    .78475    .76833    .75237   1.73685   1.72176
72............................................................    .79383    .77799    .76257    .74756    .73294
73............................................................    .80279    .78753    .77266    .75816    .74403
74............................................................    .81158    .79689    .78256    .76858    .75494
75............................................................    .82013    .80602    .79223    .77876    .76561
76............................................................    .82844    .81488    .80163    .78867    .77599
77............................................................    .83648    .82347    .81075    .79829    .78609
78............................................................    .84428    .83182    .81961    .80764    .79592
79............................................................    .85187    .83994    .82824    .81677    .80552
80............................................................    .85927    .84787    .83668    .82569    .81491
81............................................................    .86645    .85556    .84487    .83437    .82404
82............................................................    .87336    .86299    .85278    .84275    .83288
83............................................................    .88003    .87014    .86042    .85084    .84142
84............................................................    .88648    .87708    .86782    .85870    .84971
85............................................................    .89273    .88381    .87501    .86633    .85778
86............................................................    .89868    .89021    .88185    .87360    .86547
87............................................................    .90417    .89613    .88818    .88034    .87260
88............................................................    .90923    .90158    .89402    .88655    .87917
89............................................................    .91396    .90668    .89948    .89237    .88533
90............................................................    .91849    .91156    .90471    .89794    .89124
91............................................................    .92278    .91620    .90968    .90324    .89686
92............................................................    .92673    .92046    .91426    .90812    .90204
93............................................................    .93027    .92429    .91837    .91251    .90670
94............................................................    .93341    .92768    .92201    .91639    .91082
95............................................................    .93612    .93062    .92516    .91976    .91440
96............................................................    .93841    .93309    .92782    .92259    .91740
97............................................................    .94044    .93529    .93018    .92512    .92009
98............................................................    .94223    .93723    .93226    .92733    .92244
99............................................................    .94392    .93905    .93421    .92942    .92466
100...........................................................    .94559    .94086    .93615    .93149    .92685
101...........................................................    .94709    .94248    .93790    .93334    .92882
102...........................................................    .94873    .94424    .93979    .93536    .93096
103...........................................................    .95077    .94645    .94216    .93789    .93365
104...........................................................    .95278    .94862    .94449    .94037    .93628
105...........................................................    .95570    .95178    .94787    .94399    .94012
106...........................................................    .96017    .95662    .95309    .94957    .94607
107...........................................................    .96616    .96313    .96010    .95709    .95408
108...........................................................    .97515    .97291    .97067    .96843    .96620
109...........................................................    .98900    .98800    .98700    .98600    .98500
----------------------------------------------------------------------------------------------------------------


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

[[Page 273]]

 
66............................................................    .64842    .63221    .61654    .60139    .58672
67............................................................    .66023    .64439    .62905    .61420    .59980
68............................................................    .67200    .65653    .64154    .62699    .61289
69............................................................    .68373    .66865    .65400    .63978    .62598
70............................................................    .69541    .68072    .66645    .65257    .63908
71............................................................    .70708    .69279    .67890    .66538    .65222
72............................................................    .71870    .70484    .69134    .67819    .66538
73............................................................    .73025    .71682    .70372    .69095    .67850
74............................................................    .74163    .72863    .71595    .70356    .69147
75............................................................    .75275    .74019    .72792    .71593    .70421
76............................................................    .76360    .75147    .73962    .72802    .71667
77............................................................    .77415    .76246    .75102    .73981    .72883
78............................................................    .78443    .77318    .76214    .75133    .74073
79............................................................    .79448    .78365    .77303    .76261    .75238
80............................................................    .80432    .79392    .78371    .77369    .76384
81............................................................    .81390    .80393    .79413    .78450    .77504
82............................................................    .82317    .81362    .80423    .79499    .78590
83............................................................    .83214    .82301    .81402    .80517    .79645
84............................................................    .84086    .83214    .82355    .81508    .80674
85............................................................    .84935    .84104    .83284    .82476    .81679
86............................................................    .85745    .84953    .84172    .83401    .82640
87............................................................    .86496    .85741    .84996    .84260    .83533
88............................................................    .87189    .86468    .85757    .85054    .84359
89............................................................    .87838    .87150    .86471    .85799    .85135
90............................................................    .88461    .87806    .87157    .86516    .85881
91............................................................    .89055    .88430    .87812    .87200    .86594
92............................................................    .89602    .89006    .88416    .87831    .87252
93............................................................    .90094    .89524    .88959    .88400    .87846
94............................................................    .90530    .89983    .89441    .88904    .88372
95............................................................    .90908    .90381    .89359    .89341    .88828
96............................................................    .91226    .90716    .90211    .89709    .89212
97............................................................    .91510    .91015    .90525    .90038    .89555
98............................................................    .91759    .91277    .90800    .90326    .89855
99............................................................    .91993    .91524    .91058    .90596    .90137
100...........................................................    .92225    .91768    .91315    .90865    .90417
101...........................................................    .92433    .91987    .91544    .91104    .90667
102...........................................................    .92659    .92225    .91793    .91364    .90938
103...........................................................    .92943    .92524    .92107    .91692    .91280
104...........................................................    .93221    .92816    .92413    .92012    .91614
105...........................................................    .93627    .93244    .92863    .92483    .92105
106...........................................................    .94257    .93909    .93562    .93217    .92872
107...........................................................    .95107    .94808    .94509    .94211    .93914
108...........................................................    .96396    .96173    .95950    .95728    .95505
109...........................................................    .98400    .98300    .98200    .98100    .98000
----------------------------------------------------------------------------------------------------------------


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

[[Page 274]]

 
75............................................................    .69275    .68156    .67061    .65990    .64944
76............................................................    .70557    .69470    .68407    .67366    .66348
77............................................................    .71809    .70756    .69724    .68714    .67724
78............................................................    .73033    .72014    .71015    .70036    .69075
79............................................................    .74235    .73251    .72284    .71336    .70405
80............................................................    .75417    .74468    .73535    .72619    .71718
81............................................................    .76573    .75659    .74759    .73875    .73006
82............................................................    .77696    .76816    .75951    .75099    .74261
83............................................................    .78787    .77942    .77110    .76291    .75484
84............................................................    .79852    .79042    .78243    .77457    .76681
85............................................................    .80893    .80118    .79353    .78599    .77856
86............................................................    .81889    .81148    .80417    .79695    .78983
87............................................................    .82816    .82107    .81408    .80716    .80034
88............................................................    .83673    .82994    .82324    .81662    .81007
89............................................................    .84478    .83828    .83186    .82551    .81923
90............................................................    .85253    .84632    .84018    .83410    .82808
91............................................................    .85994    .85401    .84813    .84232    .83656
92............................................................    .86679    .86111    .85549    .84993    .84441
93............................................................    .87296    .86752    .86213    .85679    .85150
94............................................................    .87844    .87321    .86803    .86289    .85780
95............................................................    .88319    .87815    .87314    .86818    .86327
96............................................................    .88719    .88230    .87745    .87264    .86787
97............................................................    .89076    .88601    .88129    .87661    .87197
98............................................................    .89388    .88925    .88465    .88009    .87556
99............................................................    .89682    .89230    .88781    .88336    .87894
100...........................................................    .89973    .89533    .89095    .88660    .88228
101...........................................................    .90233    .89802    .89374    .88948    .88526
102...........................................................    .90515    .90094    .89676    .89260    .88848
103...........................................................    .90871    .90464    .90059    .89656    .89256
104...........................................................    .91217    .90823    .90431    .90040    .89652
105...........................................................    .91729    .91354    .90981    .90610    .90240
106...........................................................    .92529    .92187    .91846    .91507    .91169
107...........................................................    .93617    .93322    .93027    .92732    .92439
108...........................................................    .95283    .95062    .94840    .94619    .94398
109...........................................................    .97900    .97800    .97700    .97600    .97500
----------------------------------------------------------------------------------------------------------------


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

[[Page 275]]

 
84............................................................    .75917    .75163    .74421    .73688    .72967
85............................................................    .77122    .76398    .75685    .74980    .74286
86............................................................    .78280    .77586    .76901    .76224    .75556
87............................................................    .79359    .78693    .78036    .77386    .76744
88............................................................    .80360    .79720    .79088    .78463    .77846
89............................................................    .81302    .80688    .80081    .79480    .78886
90............................................................    .82213    .81624    .81041    .80465    .79894
91............................................................    .83086    .82522    .81963    .81410    .80862
92............................................................    .83895    .83354    .82818    .82287    .81762
93............................................................    .84626    .84106    .83591    .83081    .82575
94............................................................    .85275    .84774    .84278    .83787    .83299
95............................................................    .85839    .85355    .84876    .84400    .83929
96............................................................    .86313    .85844    .85378    .84916    .84458
97............................................................    .86737    .86280    .85826    .85377    .84930
98............................................................    .87107    .86661    .86218    .85779    .85343
99............................................................    .87455    .87019    .86586    .86157    .85730
100...........................................................    .87800    .87374    .86951    .86532    .86115
101...........................................................    .88106    .87689    .87275    .86863    .86455
102...........................................................    .88437    .88030    .87625    .87222    .86822
103...........................................................    .88858    .88463    .88070    .87679    .87290
104...........................................................    .89266    .88882    .88500    .88120    .87741
105...........................................................    .89872    .89506    .89141    .88778    .88417
106...........................................................    .90832    .90496    .90161    .89828    .89496
107...........................................................    .92146    .91854    .91562    .91271    .90981
108...........................................................    .94177    .93956    .93736    .93516    .93296
109...........................................................    .97400    .97300    .97200    .97100    .97000
----------------------------------------------------------------------------------------------------------------


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

[[Page 276]]

 
93............................................................    .82074    .81578    .81086    .80598    .80115
94............................................................    .82816    .82337    .81862    .81391    .80924
95............................................................    .83461    .82997    .82537    .82081    .81629
96............................................................    .84003    .83552    .82105    .82661    .82221
97............................................................    .84487    .84048    .83612    .82179    .82750
98............................................................    .84910    .84481    .84054    .83631    .83211
99............................................................    .85307    .84887    .84469    .84055    .83644
100...........................................................    .85701    .85290    .84882    .84476    .84073
101...........................................................    .86049    .85645    .85244    .84846    .84451
102...........................................................    .86424    .86029    .85637    .85247    .84859
103...........................................................    .86904    .86520    .86138    .85758    .85381
104...........................................................    .87365    .86991    .86619    .86249    .85880
105...........................................................    .88058    .87700    .87343    .86988    .86635
106...........................................................    .89165    .88835    .88506    .88179    .87852
107...........................................................    .90692    .90404    .90116    .89829    .89542
108...........................................................    .93077    .92858    .92639    .92420    .92201
109...........................................................    .96900    .96800    .96700    .96600    .96500
----------------------------------------------------------------------------------------------------------------


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

[[Page 277]]

 
102...........................................................    .84474    .84091    .83710    .83332    .82956
103...........................................................    .85006    .84633    .84262    .83893    .83526
104...........................................................    .85514    .85150    .84787    .84427    .84068
105...........................................................    .86284    .85934    .85585    .85239    .84893
106...........................................................    .87527    .87204    .86881    .86559    .86239
107...........................................................    .89257    .88972    .88688    .88404    .88121
108...........................................................    .91983    .91765    .91547    .91330    .91113
109...........................................................    .96400    .96300    .96200    .96100    .96000
----------------------------------------------------------------------------------------------------------------


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


[[Page 278]]


                                                     Table E
 Table E--Single Life, Unisex--Table Showing the Present Worth of the Remainder Interest in Property Transferred
   to a Unitrust Having the Adjusted Payout Rate Shown--Applicable for Transfers After November 30, 1983, and
                                               Before May 1, 1989
----------------------------------------------------------------------------------------------------------------
                                                                            (2) Adjusted payout Rate
                            (1) Age                            -------------------------------------------------
                                                                  9.2%      9.4%      9.6%      9.8%      10.0%
----------------------------------------------------------------------------------------------------------------
0.............................................................    .02788    .02747    .02709    .02673    .02641
1.............................................................    .00987    .00945    .00906    .00871    .00838
2.............................................................    .00957    .00913    .00872    .00835    .00800
3.............................................................    .00965    .00918    .00875    .00836    .00799
4.............................................................    .00991    .00941    .00896    .00854    .00815
5.............................................................    .01031    .00979    .00931    .00887    .00846
6.............................................................    .01084    .01028    .00978    .00931    .00888
7.............................................................    .01144    .01086    .01032    .00983    .00937
8.............................................................    .01216    .01154    .01097    .01044    .00996
9.............................................................    .01299    .01234    .01174    .01118    .01067
10............................................................    .01395    .01326    .01262    .01204    .01149
11............................................................    .01504    .01432    .01364    .01302    .01245
12............................................................    .01626    .01549    .01478    .01413    .01352
13............................................................    .01755    .01674    .01599    .01530    .01466
14............................................................    .01885    .01800    .01721    .01648    .01581
15............................................................    .02011    .01922    .01839    .01762    .01691
16............................................................    .02130    .02036    .01949    .01869    .01794
17............................................................    .02243    .02144    .02052    .01967    .01888
18............................................................    .02350    .02246    .02150    .02061    .01978
19............................................................    .02457    .02348    .02247    .02153    .02065
20............................................................    .02569    .02454    .02347    .02248    .02156
21............................................................    .02685    .02564    .02452    .02347    .02250
22............................................................    .02806    .02679    .02561    .02451    .02348
23............................................................    .02936    .02802    .02677    .02561    .02453
24............................................................    .03078    .02937    .02805    .02683    .02569
25............................................................    .03236    .03087    .02949    .02820    .02699
26............................................................    .03415    .03258    .03112    .02975    .02848
27............................................................    .03615    .03450    .03295    .03151    .03017
28............................................................    .03838    .03664    .03502    .03350    .03208
29............................................................    .04081    .03898    .03727    .03567    .03416
30............................................................    .04346    .04154    .03973    .03804    .03646
31............................................................    .04630    .04427    .04237    .04059    .03892
32............................................................    .04936    .04723    .04523    .04335    .04159
33............................................................    .05264    .05041    .04831    .04633    .04448
34............................................................    .05615    .05381    .05160    .04952    .04757
35............................................................    .05992    .05746    .05514    .05296    .05090
36............................................................    .06393    .06135    .05892    .05663    .05447
37............................................................    .06820    .06550    .06295    .06055    .05828
38............................................................    .07272    .06990    .06723    .06471    .06233
39............................................................    .07749    .07454    .07175    .06912    .06662
40............................................................    .08254    .07946    .07655    .07379    .07117
41............................................................    .08787    .08466    .08162    .07073    .07599
42............................................................    .09352    .09018    .08700    .08399    .08112
43............................................................    .09947    .09599    .09268    .08953    .08654
44............................................................    .10573    .10211    .09866    .09539    .09227
45............................................................    .11229    .10852    .10494    .10152    .09827
46............................................................    .11916    .11525    .11153    .10798    .10459
47............................................................    .12634    .12229    .11843    .11474    .11122
48............................................................    .13388    .12969    .12568    .12186    .11820
49............................................................    .14177    .13743    .13329    .12932    .12553
50............................................................    .15003    .14555    .14126    .13716    .13322
51............................................................    .15865    .15402    .14959    .14534    .14127
52............................................................    .16763    .16286    .15828    .15390    .14969
53............................................................    .17696    .17205    .16734    .16281    .15847
54............................................................    .18662    .18157    .17672    .17206    .16758
55............................................................    .19662    .19144    .18645    .18165    .17703
56............................................................    .20695    .20163    .19651    .19157    .18682
57............................................................    .21763    .21218    .20693    .20186    .19698
58............................................................    .22865    .22307    .21769    .21250    .20749
59............................................................    .24005    .23435    .22885    .22353    .21839
60............................................................    .25183    .24601    .24038    .23494    .22969
61............................................................    .26401    .25808    .25234    .24678    .24141
62............................................................    .27661    .27056    .26471    .25905    .25356
63............................................................    .28961    .28347    .27752    .27175    .26615
64............................................................    .30300    .29677    .29072    .28486    .27916
65............................................................    .31678    .31046    .30433    .29837    .29259
66............................................................    .33093    .32454    .31832    .31228    .30641
67............................................................    .34542    .33897    .33268    .32657    .32062
68............................................................    .36027    .35376    .34742    .34124    .33522
69............................................................    .37550    .36894    .36255    .35632    .35024
70............................................................    .39111    .38452    .37809    .37182    .36570
71............................................................    .40719    .40058    .39412    .38782    .38166
72............................................................    .42372    .41710    .41064    .40432    .39814
73............................................................    .44062    .43402    .42756    .42124    .41506
74............................................................    .45774    .45116    .44471    .43840    .43223
75............................................................    .47489    .46834    .46193    .45565    .44949
76............................................................    .49199    .48550    .47913    .47288    .46675
77............................................................    .50902    .50258    .49626    .49006    .48397
78............................................................    .52598    .51962    .51336    .50721    .50117
79............................................................    .54295    .53667    .53049    .52441    .51843
80............................................................    .55999    .55380    .54771    .54171    .53581
81............................................................    .57697    .57088    .56489    .55899    .55317
82............................................................    .59375    .58778    .58190    .57610    .57039
83............................................................    .61036    .60451    .59875    .59306    .58746
84............................................................    .62687    .62116    .61553    .60997    .60448
85............................................................    .64335    .63779    .63230    .62688    .62152
86............................................................    .65939    .65398    .64864    .64337    .63816
87............................................................    .67449    .66924    .66405    .65892    .65384
88............................................................    .68860    .68350    .67845    .67346    .66852
89............................................................    .70202    .69706    .69216    .68731    .68250
90............................................................    .71515    .71035    .70559    .70088    .69622
91............................................................    .72790    .72325    .71865    .71409    .70957
92............................................................    .73982    .73533    .73087    .72646    .72208
93............................................................    .75069    .74634    .74202    .73774    .73350
94............................................................    .76040    .75618    .75199    .74784    .74372
95............................................................    .76888    .76477    .76070    .75666    .75265
96............................................................    .77599    .77199    .76801    .76406    .76014
97............................................................    .78235    .77843    .77454    .77067    .76684
98............................................................    .78789    .78404    .78022    .77642    .77266
99............................................................    .79307    .78929    .78554    .78181    .77811
100...........................................................    .79821    .79450    .79081    .78715    .78351
101...........................................................    .80268    .79902    .79539    .79178    .78819
102...........................................................    .80749    .80389    .80031    .79676    .79322
103...........................................................    .81370    .81018    .80668    .80319    .79973
104...........................................................    .81955    .81609    .81265    .80923    .80582
105...........................................................    .82855    .82520    .82187    .81856    .81526
106...........................................................    .84341    .84029    .83718    .83408    .83099
107...........................................................    .86439    .86162    .85884    .85608    .85332
108...........................................................    .89815    .89599    .89384    .89169    .88955
109...........................................................    .95400    .95300    .95200    .95100    .95000
----------------------------------------------------------------------------------------------------------------


                                                     Table E
 Table E--Single Life, Unisex--Table Showing the Present Worth of the Remainder Interest in Property Transferred
   to a Unitrust Having the Adjusted Payout Rate Shown--Applicable for Transfers After November 30, 1983, and
                                               Before May 1, 1989
----------------------------------------------------------------------------------------------------------------
                                                                            (2) Adjusted payout rate
                            (1) Age                            -------------------------------------------------
                                                                  10.2%     10.4%     10.6%     10.8%     11.0%
----------------------------------------------------------------------------------------------------------------
0.............................................................    .02610    .02582    .02556    .02531    .02508
1.............................................................    .00807    .00779    .00753    .00729    .00707
2.............................................................    .00769    .00739    .00712    .00686    .00663
3.............................................................    .00766    .00735    .00706    .00679    .00654
4.............................................................    .00780    .00747    .00716    .00688    .00662
5.............................................................    .00808    .00773    .00741    .00711    .00683
6.............................................................    .00848    .00811    .00776    .00744    .00715
7.............................................................    .00894    .00855    .00819    .00785    .00753
8.............................................................    .00951    .00909    .00871    .00835    .00801

[[Page 279]]

 
9.............................................................    .01019    .00975    .00934    .00896    .00860
10............................................................    .01099    .01052    .01008    .00967    .00930
11............................................................    .01191    .01142    .01095    .01052    .01012
12............................................................    .01295    .01243    .01194    .01148    .01106
13............................................................    .01406    .01351    .01299    .01251    .01206
14............................................................    .01518    .01459    .01405    .01354    .01306
15............................................................    .01625    .01563    .01506    .01452    .01402
16............................................................    .01724    .01659    .01599    .01542    .01489
17............................................................    .01815    .01747    .01683    .01624    .01568
18............................................................    .01901    .01829    .01761    .01699    .01640
19............................................................    .01984    .01908    .01837    .01771    .01709
20............................................................    .02070    .01990    .01915    .01846    .01780
21............................................................    .02160    .02075    .01996    .01923    .01854
22............................................................    .02253    .02164    .02080    .02003    .01930
23............................................................    .02352    .02258    .02170    .02088    .02010
24............................................................    .02462    .02362    .02269    .02182    .02100
25............................................................    .02586    .02481    .02382    .02289    .02203
26............................................................    .02729    .02617    .02512    .02414    .02322
27............................................................    .02891    .02772    .02662    .02558    .02460
28............................................................    .03074    .02949    .02832    .02722    .02618
29............................................................    .03276    .03143    .03019    .02902    .02792
30............................................................    .03497    .03357    .03225    .03102    .02985
31............................................................    .03735    .03587    .03448    .03317    .03193
32............................................................    .03993    .03837    .03690    .03551    .03420
33............................................................    .04273    .04108    .03952    .03806    .03667
34............................................................    .04572    .04399    .04234    .04079    .03933
35............................................................    .04896    .04713    .04539    .04376    .04221
36............................................................    .05243    .05049    .04867    .04694    .04530
37............................................................    .05613    .05410    .05217    .05035    .04862
38............................................................    .06007    .05793    .05591    .05399    .05217
39............................................................    .06425    .06200    .05987    .05785    .05593
40............................................................    .06869    .06633    .06409    .06197    .05995
41............................................................    .07339    .07092    .06857    .06634    .06421
42............................................................    .07840    .07581    .07335    .07101    .06878
43............................................................    .08370    .08099    .07841    .07595    .07361
44............................................................    .08930    .08646    .08377    .08119    .07874
45............................................................    .09517    .09222    .08940    .08670    .08413
46............................................................    .10136    .09828    .09533    .09252    .08983
47............................................................    .10786    .10464    .10157    .09864    .09582
48............................................................    .11470    .11136    .10816    .10510    .10216
49............................................................    .12189    .11842    .11509    .11190    .10884
50............................................................    .12946    .12585    .12239    .11907    .11588
51............................................................    .13737    .13363    .13003    .12659    .12327
52............................................................    .14565    .14177    .13805    .13447    .13103
53............................................................    .15429    .15028    .14642    .14271    .13914
54............................................................    .16327    .15912    .15513    .15129    .14759
55............................................................    .17259    .16831    .16419    .16022    .15639
56............................................................    .18225    .17784    .17358    .16948    .16553
57............................................................    .19227    .18773    .18335    .17912    .17503
58............................................................    .20265    .19798    .19347    .18911    .18490
59............................................................    .21343    .20863    .20400    .19951    .19518
60............................................................    .22460    .21968    .21492    .21032    .20586
61............................................................    .23620    .23117    .22629    .22156    .21698
62............................................................    .24824    .24309    .23810    .23325    .22856
63............................................................    .26073    .25546    .25036    .24540    .24060
64............................................................    .27364    .26827    .26306    .25800    .25308
65............................................................    .28696    .28150    .27619    .27103    .26601
66............................................................    .30070    .29515    .28974    .28449    .27937
67............................................................    .31483    .30919    .30371    .29836    .29316
68............................................................    .32936    .32365    .31808    .31266    .30737
69............................................................    .34432    .33854    .33290    .32741    .32204
70............................................................    .35972    .35389    .34820    .34264    .33721
71............................................................    .37565    .36977    .36403    .35842    .35294
72............................................................    .39210    .38619    .38042    .37477    .36924
73............................................................    .40900    .40308    .39728    .39161    .38605
74............................................................    .42618    .42025    .41444    .40876    .40318
75............................................................    .44345    .43753    .43173    .42604    .42046
76............................................................    .46073    .45483    .44904    .44336    .43779
77............................................................    .47799    .47212    .46635    .46069    .45513
78............................................................    .49524    .48941    .48368    .47805    .47252
79............................................................    .51256    .50678    .50110    .49551    .49001
80............................................................    .53001    .52429    .51867    .51313    .50769
81............................................................    .54745    .54181    .53626    .53079    .52541
82............................................................    .56476    .55921    .55374    .54835    .54303
83............................................................    .58193    .57648    .57110    .56579    .56056
84............................................................    .59907    .59373    .58845    .58325    .57811
85............................................................    .61624    .61102    .60586    .60077    .59574
86............................................................    .63300    .62791    .62289    .61791    .61300
87............................................................    .64883    .64387    .63896    .63411    .62932
88............................................................    .66363    .65880    .65402    .64929    .64461
89............................................................    .67775    .67304    .66838    .66377    .65921
90............................................................    .69160    .68703    .68250    .67802    .67357
91............................................................    .70509    .70066    .69626    .69191    .68760
92............................................................    .71775    .71345    .70919    .70496    .70078
93............................................................    .72929    .72512    .72099    .71689    .71282
94............................................................    .73964    .73559    .73157    .72758    .72362
95............................................................    .74867    .74472    .74081    .73692    .73306
96............................................................    .75625    .75239    .74856    .74476    .74099
97............................................................    .76303    .75925    .75550    .75177    .74807
98............................................................    .76892    .76521    .76152    .75786    .75422
99............................................................    .77443    .77078    .76715    .76355    .75998
100...........................................................    .77990    .77631    .77275    .76921    .76569
101...........................................................    .78463    .78109    .77757    .77407    .77060
102...........................................................    .78971    .78622    .78275    .77930    .77587
103...........................................................    .79629    .79287    .78947    .78608    .78272
104...........................................................    .80244    .79907    .79572    .79239    .78907
105...........................................................    .81198    .80871    .80546    .88222    .79900
106...........................................................    .82792    .82485    .82180    .81876    .81572
107...........................................................    .85057    .84783    .84509    .84237    .83964
108...........................................................    .88740    .88526    .88312    .88098    .87885
109...........................................................    .94900    .94800    .94700    .94600    .94500
----------------------------------------------------------------------------------------------------------------


                                                     Table E
 Table E--Single Life, Unisex--Table Showing the Present Worth of the Remainder Interest in Property Transferred
   to a Unitrust Having the Adjusted Payout Rate Shown--Applicable for Transfers After November 30, 1983, and
                                               Before May 1, 1989
----------------------------------------------------------------------------------------------------------------
                                                                            (2) Adjusted payout rate
                            (1) Age                            -------------------------------------------------
                                                                  11.2%     11.4%     11.6%     11.8%     12.0%
----------------------------------------------------------------------------------------------------------------
0.............................................................    .02487    .02466    .02447    .02429    .02412
1.............................................................    .00686    .00666    .00648    .00631    .00615
2.............................................................    .00641    .00620    .00601    .00583    .00566
3.............................................................    .00631    .00609    .00589    .00570    .00552
4.............................................................    .00637    .00614    .00593    .00573    .00554
5.............................................................    .00657    .00633    .00610    .00588    .00568
6.............................................................    .00687    .00661    .00637    .00614    .00593
7.............................................................    .00724    .00696    .00670    .00646    .00623
8.............................................................    .00770    .00740    .00713    .00687    .00663
9.............................................................    .00827    .00795    .00766    .00739    .00713
10............................................................    .00894    .00861    .00830    .00800    .00773
11............................................................    .00974    .00939    .00906    .00875    .00846
12............................................................    .01066    .01029    .00993    .00961    .00929
13............................................................    .01164    .01124    .01087    .01052    .01019
14............................................................    .01262    .01220    .01181    .01144    .01109
15............................................................    .01355    .01311    .01270    .01231    .01194
16............................................................    .01440    .01394    .01350    .01309    .01271
17............................................................    .01516    .01467    .01421    .01378    .01337

[[Page 280]]

 
18............................................................    .01585    .01534    .01485    .01440    .01397
19............................................................    .01651    .01597    .01546    .01498    .01453
20............................................................    .01719    .01662    .01608    .01557    .01510
21............................................................    .01789    .01728    .01672    .01618    .01568
22............................................................    .01861    .01797    .01737    .01680    .01627
23............................................................    .01938    .01870    .01806    .01746    .01689
24............................................................    .02023    .01951    .01883    .01819    .01759
25............................................................    .02121    .02045    .01973    .01905    .01841
26............................................................    .02236    .02155    .02078    .02006    .01938
27............................................................    .02368    .02282    .02200    .02124    .02051
28............................................................    .02521    .02429    .02342    .02261    .02183
29............................................................    .02689    .02591    .02499    .02412    .02330
30............................................................    .02875    .02772    .02674    .02581    .02494
31............................................................    .03076    .02966    .02863    .02764    .02671
32............................................................    .03297    .03180    .03070    .02965    .02866
33............................................................    .03536    .03412    .03295    .03184    .03079
34............................................................    .03794    .03663    .03539    .03421    .03309
35............................................................    .04074    .03935    .03803    .03678    .03559
36............................................................    .04375    .04228    .04089    .03956    .03830
37............................................................    .04699    .04543    .04395    .04255    .04122
38............................................................    .05044    .04879    .04723    .04575    .04433
39............................................................    .05411    .05238     .5073    .04916    .04766
40............................................................    .05802    .05620    .05445    .05279    .05121
41............................................................    .06219    .06026    .05843    .05668    .05550
42............................................................    .06665    .06462    .06269    .06084    .05908
43............................................................    .07138    .06924    .06721    .06526    .06341
44............................................................    .07639    .07415    .07202    .06997    .06801
45............................................................    .08168    .07933    .07708    .07493    .07287
46............................................................    .08726    .08480    .08244    .08018    .07802
47............................................................    .09313    .09056    .08809    .08572    .08345
48............................................................    .09935    .09666    .09408    .09160    .08922
49............................................................    .10591    .10309    .10039    .09780    .09531
50............................................................    .11282    .10989    .10707    .10436    .10176
51............................................................    .12009    .11703    .11409    .11127    .10855
52............................................................    .12772    .12454    .12147    .11853    .11569
53............................................................    .13571    .13340    .12922    .12615    .12319
54............................................................    .14403    .14060    .13729    .13410    .13102
55............................................................    .15270    .14914    .14571    .14240    .13920
56............................................................    .16171    .15802    .15447    .15103    .14771
57............................................................    .17109    .16728    .16360    .16004    .15660
58............................................................    .18083    .17690    .17309    .16941    .16585
59............................................................    .19098    .18692    .18299    .17919    .17551
60............................................................    .20154    .19736    .19331    .18938    .18558
61............................................................    .21254    .20824    .20407    .20003    .19610
62............................................................    .22400    .21958    .21530    .21113    .20709
63............................................................    .23593    .23139    .22699    .22272    .21856
64............................................................    .24830    .24366    .23915    .23476    .23050
65............................................................    .26113    .25638    .25176    .24727    .24290
66............................................................    .27439    .26955    .26483    .26023    .25576
67............................................................    .28808    .28314    .27833    .27364    .26906
68............................................................    .30221    .29718    .29228    .28750    .28283
69............................................................    .31681    .31170    .30672    .30185    .29710
70............................................................    .33190    .32673    .32167    .31672    .31189
71............................................................    .34758    .34234    .33721    .33220    .32731
72............................................................    .36384     35855    .35337    .34831    .34335
73............................................................    .38061    .37529    .37007    .36496    .35996
74............................................................    .39772    .39237    .38713    .38199    .37695
75............................................................    .41499    .40962    .40436    .39920    .39413
76............................................................    .43232    .42695    .42168    .41650    .41142
77............................................................    .44967    .44431    .43904    .43386    .42878
78............................................................    .46708    .46173    .45647    .45130    .44622
79............................................................    .48460    .47928    .47405    .46890    .46383
80............................................................    .50232    .49705    .49185    .48673    .48169
81............................................................    .52010    .51487    .50973    .50465    .49965
82............................................................    .53779    .53263    .52754    .52252    .51757
83............................................................    .55540    .55031    .54529    .54033    .53544
84............................................................    .57304    .56804    .56309    .55822    .55340
85............................................................    .59077    .58586    .58102    .57623    .57150
86............................................................    .60815    .60335    .59860    .59392    .58928
87............................................................    .62458    .61989    .61525    .61066    .60613
88............................................................    .63998    .63540    .63086    .62638    .62194
89............................................................    .65469    .65022    .64579    .64141    .63707
90............................................................    .66918    .66482    .66050    .65623    .65199
91............................................................    .68332    .67909    .67489    .67073    .66661
92............................................................    .69662    .69251    .68843    .68439    .68038
93............................................................    .70879    .70479    .70082    .69689    .69299
94............................................................    .71970    .71581    .71195    .70812    .70432
95............................................................    .72924    .72544    .72167    .71793    .71422
96............................................................    .73724    .73353    .72984    .72618    .72254
97............................................................    .74440    .74076    .73714    .73354    .72998
98............................................................    .75061    .74703    .74347    .73994    .73643
99............................................................    .75642    .75290    .74939    .74591    .74245
100...........................................................    .76219    .75872    .75527    .75184    .74844
101...........................................................    .76715    .76372    .76031    .75692    .75356
102...........................................................    .77246    .76908    .76571    .76236    .75904
103...........................................................    .77937    .77605    .77274    .76945    .76618
104...........................................................    .78577    .78249    .77923    .77598    .77275
105...........................................................    .79579    .79259    .78941    .78625    .78310
106...........................................................    .81270    .80969    .80670    .80371    .80073
107...........................................................    .83693    .83422    .83152    .82883    .82614
108...........................................................    .87672    .87459    .87246    .87034    .86822
109...........................................................    .94400    .94300    .94200    .94100    .94000
----------------------------------------------------------------------------------------------------------------


                                                     Table E
 Table E--Single Life, Unisex--Table Showing the Present Worth of the Remainder Interest in Property Transferred
   to a Unitrust Having the Adjusted Payout Rate Shown--Applicable for Transfers After November 30, 1983, and
                                               Before May 1, 1989
----------------------------------------------------------------------------------------------------------------
                                                                            (2) Adjusted payout rate
                            (1) Age                            -------------------------------------------------
                                                                  12.2%     12.4%     12.6%     12.8%     13.0%
----------------------------------------------------------------------------------------------------------------
0.............................................................    .02396    .02380    .02366    .02352    .02338
1.............................................................    .00600    .00585    .00572    .00559    .00547
2.............................................................    .00550    .00535    .00521    .00508    .00495
3.............................................................    .00536    .00520    .00505    .00491    .00478
4.............................................................    .00536    .00519    .00504    .00489    .00475
5.............................................................    .00549    .00532    .00515    .00499    .00484
6.............................................................    .00572    .00554    .00536    .00519    .00503
7.............................................................    .00602    .00582    .00563    .00545    .00528
8.............................................................    .00640    .00618    .00598    .00579    .00561
9.............................................................    .00688    .00665    .00644    .00623    .00604
10............................................................    .00747    .00723    .00699    .00678    .00657
11............................................................    .00818    .00792    .00767    .00744    .00722
12............................................................    .00900    .00873    .00846    .00822    .00798
13............................................................    .00988    .00959    .00931    .00905    .00880
14............................................................    .01077    .01046    .01017    .00989    .00963
15............................................................    .01160    .01127    .01097    .01067    .01040
16............................................................    .01234    .01200    .01167    .01137    .01108
17............................................................    .01299    .01263    .01229    .01197    .01166
18............................................................    .01357    .01319    .01283    .01249    .01217
19............................................................    .01410    .01370    .01332    .01297    .01263
20............................................................    .01465    .01422    .01382    .01345    .01309
21............................................................    .01520    .01475    .01433    .01393    .01355
22............................................................    .01576    .01529    .01484    .01442    .01402
23............................................................    .01636    .01586    .01538    .01493    .01450
24............................................................    .01703    .01649    .01599    .01551    .01505
25............................................................    .01781    .01724    .01670    .01619    .01571
26............................................................    .01874    .01813    .01756    .01701    .01650

[[Page 281]]

 
27............................................................    .01983    .01918    .01857    .01799    .01744
28............................................................    .02111    .02042    .01976    .01915    .01856
29............................................................    .02253    .02179    .02110    .02044    .01981
30............................................................    .02411    .02333    .02259    .02188    .02121
31............................................................    .02583    .02500    .02421    .02345    .02274
32............................................................    .02772    .02683    .02599    .02519    .02443
33............................................................    .02979    .02885    .02795    .02709    .02628
34............................................................    .03203    .03102    .03006    .02915    .02829
35............................................................    .03447    .03340    .03238    .03141    .03048
36............................................................    .03710    .03597    .03488    .03385    .03286
37............................................................    .03995    .03874    .03758    .03649    .03544
38............................................................    .04299    .04170    .04048    .03931    .03820
39............................................................    .04623    .04487    .04358    .04234    .04115
40............................................................    .04970    .04826    .04689    .04558    .04432
41............................................................    .05341    .05189    .05043    .04904    .04771
42............................................................    .05739    .05578    .05424    .05277    .05136
43............................................................    .06163    .05993    .05830    .05674    .05525
44............................................................    .06614    .06435    .06263    .06099    .05941
45............................................................    .07090    .06901    .06720    .06547    .06380
46............................................................    .07595    .07396    .07206    .07023    .06847
47............................................................    .08128    .07919    .07718    .07525    .07340
48............................................................    .08693    .08474    .08263    .08061    .07866
49............................................................    .09291    .09061    .08840    .08627    .08423
50............................................................    .09925    .09684    .09452    .09229    .09014
51............................................................    .10593    .10341    .10098    .09864    .09638
52............................................................    .11296    .11032    .10778    .10534    .10297
53............................................................    .12034    .11759    .11494    .11238    .10991
54............................................................    .12805    .12519    .12243    .11976    .11718
55............................................................    .13611    .13313    .13025    .12747    .12478
56............................................................    .14451    .14141    .13841    .13551    .13271
57............................................................    .15327    .15005    .14694    .14393    .14101
58............................................................    .16240    .15906    .15583    .15270    .14967
59............................................................    .17194    .16848    .16513    .16189    .15874
60............................................................    .18189    .17831    .17485    .17148    .16822
61............................................................    .19230    .18860    .18502    .18154    .17816
62............................................................    .20317    .19936    .19566    .19207    .18857
63............................................................    .21453    .21060    .20679    .20308    .19947
64............................................................    .22635    .22231    .21839    .21457    .21085
65............................................................    .23864    .23450    .23046    .22653    .22271
66............................................................    .25140    .24715    .24301    .23898    .23505
67............................................................    .26461    .26026    .25602    .25188    .24785
68............................................................    .27828    .27384    .26950    .26527    .26114
69............................................................    .29246    .28793    .28350    .27918    .27496
70............................................................    .30718    .30256    .29805    .29364    .28933
71............................................................    .32251    .31783    .31324    .30876    .30437
72............................................................    .33850    .33375    .32910    .32455    .32009
73............................................................    .35506    .35026    .34555    .34094    .33642
74............................................................    .37201    .36716    .36241    .35776    .35319
75............................................................    .38916    .38429    .37950    .37481    .37020
76............................................................    .40644    .40154    .39673    .39200    .38737
77............................................................    .42378    .41887    .41404    .40930    .40464
78............................................................    .44123    .43631    .43148    .42673    .42205
79............................................................    .45885    .45394    .44911    .44436    .43969
80............................................................    .47673    .47184    .46703    .46229    .45763
81............................................................    .49473    .48987    .48509    .48037    .47573
82............................................................    .51269    .50787    .50313    .49845    .49383
83............................................................    .53062    .52586    .52116    .51653    .51195
84............................................................    .54864    .54395    .53931    .53473    .53021
85............................................................    .56683    .56221    .55765    .55314    .54869
86............................................................    .58470    .58017    .57570    .57127    .56689
87............................................................    .60164    .59720    .59281    .58847    .58417
88............................................................    .61754    .61320    .60889    .60464    .60042
89............................................................    .63277    .62851    .62430    .62013    .61600
90............................................................    .64780    .64364    .63953    .63545    .63141
91............................................................    .66252    .65848    .65446    .65049    .64655
92............................................................    .67640    .67246    .66856    .66468    .66084
93............................................................    .68912    .68528    .68148    .67770    .67396
94............................................................    .70055    .69680    .69309    .68941    .68576
95............................................................    .71054    .70689    .70326    .69966    .69609
96............................................................    .71893    .71535    .71180    .70827    .70476
97............................................................    .72643    .72292    .71943    .71596    .71252
98............................................................    .73294    .72948    .72604    .72263    .71924
99............................................................    .73902    .73561    .73222    .72886    .72551
100...........................................................    .74506    .74170    .73836    .73504    .73174
101...........................................................    .75021    .74689    .74359    .74030    .73704
102...........................................................    .75573    .75244    .74918    .74593    .74270
103...........................................................    .76293    .75970    .75649    .75329    .75011
104...........................................................    .76954    .76634    .76316    .76000    .75685
105...........................................................    .77996    .77684    .77373    .77064    .76756
106...........................................................    .79777    .79481    .79187    .78894    .78602
107...........................................................    .82346    .82078    .81812    .81546    .81281
108...........................................................    .86610    .86398    .86187    .85976    .85765
109...........................................................    .93900    .93800    .93700    .93600    .93500
----------------------------------------------------------------------------------------------------------------


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

[[Page 282]]

 
36............................................................    .03193    .03103    .03017    .02936    .02858
37............................................................    .03444    .03348    .03257    .03170    .03087
38............................................................    .03714    .03612    .03515    .03422    .03333
39............................................................    .04002    .03894    .03791    .03692    .03597
40............................................................    .04312    .04197    .04087    .03891    .03880
41............................................................    .04643    .04521    .04404    .04292    .04185
42............................................................    .05001    .04871    .04747    .04628    .04514
43............................................................    .05382    .05245    .05113    .04987    .04865
44............................................................    .05789    .05644    .05505    .05371    .05242
45............................................................    .06220    .06067    .05919    .05777    .05641
46............................................................    .06678    .06516    .06360    .06210    .06065
47............................................................    .07162    .06991    .06826    .06668    .06515
48............................................................    .07678    .07498    .07324    .07157    .06996
49............................................................    .08225    .08035    .07852    .07676    .07506
50............................................................    .08807    .08607    .08415    .08229    .08050
51............................................................    .09421    .09211    .09009    .08814    .08625
52............................................................    .10070    .09850    .09637    .09432    .09234
53............................................................    .10753    .10523    .10300    .10085    .09877
54............................................................    .11468    .11227    .10994    .10769    .10551
55............................................................    .12218    .11966    .11722    .11487    .11258
56............................................................    .12999    .12737    .12483    .12236    .11998
57............................................................    .13818    .13545    .13279    .13022    .12773
58............................................................    .14673    .14388    .14112    .13844    .13584
59............................................................    .15568    .15272    .14985    .14706    .14435
60............................................................    .16505    .16198    .15899    .15609    .15327
61............................................................    .17488    .17169    .16859    .16558    .16265
62............................................................    .18518    .18187    .17866    .17554    .17251
63............................................................    .19596    .19255    .18923    .18600    .18285
64............................................................    .20723    .20371    .20028    .19694    .19368
65............................................................    .21898    .21535    .21181    .20836    .20500
66............................................................    .23121    .22748    .22383    .22028    .21681
67............................................................    .24392    .24008    .23633    .23267    .22910
68............................................................    .25711    .25317    .24932    .24556    .24189
69............................................................    .27083    .26680    .26285    .25900    .25523
70............................................................    .28512    .28100    .27697    .27302    .26916
71............................................................    .30007    .29587    .29176    .28773    .28378
72............................................................    .31572    .31145    .30726    .30315    .29913
73............................................................    .33199    .32765    .32340    .31923    .31514
74............................................................    .34871    .34431    .34000    .33577    .33162
75............................................................    .36568    .36124    .35688    .35260    .34840
76............................................................    .38281    .37833    .37393    .36961    .36537
77............................................................    .40006    .39555    .39113    .38677    .38249
78............................................................    .41745    .41293    .40848    .40410    .39980
79............................................................    .43508    .43055    .42609    .42170    .41737
80............................................................    .45303    .44850    .44404    .43964    .43531
81............................................................    .47115    .46663    .46218    .45779    .45347
82............................................................    .48928    .48479    .48036    .47599    .47168
83............................................................    .50744    .50298    .49858    .49424    .48995
84............................................................    .52575    .52134    .51698    .51268    .50843
85............................................................    .54429    .53994    .53564    .53139    .52720
86............................................................    .56257    .55829    .55406    .54988    .54574
87............................................................    .57993    .57572    .57156    .56745    .56338
88............................................................    .59625    .59212    .58804    .58399    .57999
89............................................................    .61191    .60786    .60384    .59987    .59594
90............................................................    .62741    .62344    .61952    .61562    .61177
91............................................................    .64264    .63877    .63493    .63113    .62736
92............................................................    .65703    .65326    .64951    .64580    .64212
93............................................................    .67024    .66656    .66291    .65928    .65568
94............................................................    .68213    .67854    .67497    .67142    .66791
95............................................................    .69255    .68903    .68554    .68207    .67863
96............................................................    .70128    .69783    .69440    .69100    .68762
97............................................................    .70910    .70570    .70233    .69899    .69566
98............................................................    .71587    .71252    .70920    .70590    .70263
99............................................................    .72219    .71889    .71562    .71236    .70913
100...........................................................    .72847    .72522    .72189    .71877    .71558
101...........................................................    .73380    .73058    .72738    .72420    .72104
102...........................................................    .73949    .73630    .73313    .72998    .72685
103...........................................................    .74695    .74381    .74068    .73758    .73449
104...........................................................    .75372    .75060    .74751    .74442    .74136
105...........................................................    .76449    .76144    .75840    .75538    .75237
106...........................................................    .78311    .78021    .77732    .77444    .77157
107...........................................................    .81016    .80752    .80489    .80227    .79965
108...........................................................    .85554    .85344    .85134    .84924    .84715
109...........................................................    .93400    .93300    .93200    .93100    .93000
----------------------------------------------------------------------------------------------------------------


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


[[Page 283]]

    (e) Valuation of charitable remainder unitrusts having certain 
payout sequences for transfers for which the valuation date is after 
April 30, 1989, and before May 1, 1999--(1) In general. Except as 
otherwise provided in paragraph (e)(2) of this section, in the case of 
transfers for which the valuation date is after April 30, 1989, and 
before May 1, 1999, the present value of a remainder interest is 
determined under paragraphs (e)(3) through (e)(6) of this section, 
provided that the amount of the payout as of any payout date during any 
taxable year of the trust is not larger than the amount that the trust 
could distribute on such date under Sec. 1.664-3(a)(1)(v) if the 
taxable year of the trust were to end on such date. See, however, Sec. 
1.7520-3(b) (relating to exceptions to the use of the prescribed tables 
under certain circumstances).
    (2) Transitional rules for valuation of charitable remainder 
unitrusts. (i) If the valuation date of a transfer to a charitable 
remainder unitrust is after April 30, 1989, and before June 10, 1994, a 
transferor can rely upon Notice 89-24, 1989-1 C.B. 660, or Notice 89-60, 
1989-1 C.B. 700, in valuing the transferred interest. (See Sec. 
601.601(d)(2)(ii)(b) of this chapter.)
    (ii) For purposes of sections 2055, 2106, or 2624, if on May 1, 
1989, the decedent was mentally incompetent so that the disposition of 
the property could not be changed, and the decedent died after April 30, 
1989, without having regained competency to dispose of the decedent's 
property, or the decedent died within 90 days of the date that the 
decedent first regained competency after April 30, 1989, the present 
value of a remainder interest determined under this section is 
determined as if the valuation date with respect to the decedent's gross 
estate is either before May 1, 1989, or after April 30, 1989, at the 
option of the decedent's executor.
    (3) Adjusted payout rate. For transfers for which the valuation date 
is after April 30, 1989, and before May 1, 1999, the adjusted payout 
rate is determined by using the appropriate Table F, contained in Sec. 
1.664-4(e)(6), for the section 7520 interest rate applicable to the 
transfer. If the interest rate is between 4.2 and 14 percent, see Sec. 
1.664-4(e)(6). If the interest rate is below 4.2 percent or greater than 
14 percent, see Sec. 1.664-4(b). See Sec. 1.664-4(e) for rules 
applicable in determining the adjusted payout rate.
    (4) Period is a term of years. If the period described in Sec. 
1.664-3(a)(5) is a term of years, the factor that is used in determining 
the present value of the remainder interest for transfers for which the 
valuation date is after April 30, 1989, and before May 1, 1999, is the 
factor under the appropriate adjusted payout rate in Table D in Sec. 
1.664-4(e)(6) corresponding to the number of years in the term. If the 
adjusted payout rate is an amount that is between adjusted payout rates 
for which factors are provided in Table D, a linear interpolation must 
be made. The present value of the remainder interest is determined by 
multiplying the net fair market value (as of the appropriate valuation 
date) of the property placed in trust by the factor determined under 
this paragraph. Generally, for purposes of this section, the valuation 
date is, in the case of an inter vivos transfer, the date on which the 
property is transferred to the trust by the donor, and, in the case of a 
testamentary transfer under sections 2055, 2106, or 2624, the valuation 
date is the date of death. See Sec. 1.664-4(e)(4) for additional rules 
regarding the valuation date. See Sec. 1.664-4(e)(4) for an example 
that illustrates the application of this paragraph (e)(4).
    (5) Period is the life of one individual. If the period described in 
Sec. 1.664-3(a)(5) is the life of one individual, the factor that is 
used in determining the present value of the remainder interest for 
transfers for which the valuation date is after April 30, 1989, and 
before May 1, 1999, is the factor in Table U(1) in paragraph (e)(6) of 
this section under the appropriate adjusted payout. For purposes of the 
computations described in this paragraph (e)(5), the age of an 
individual is the age of that individual at the individual's nearest 
birthday. If the adjusted payout rate is an amount that is between 
adjusted payout rates for which factors are provided in the appropriate 
table, a linear interpolation must be made. The rules provided in Sec. 
1.664-4(e)(5) apply for determining the

[[Page 284]]

present value of the remainder interest. See Sec. 1.664-4(e)(5) for an 
example illustrating the application of this paragraph (e)(5)(using 
current actuarial tables).
    (6) Actuarial tables for transfers for which the valuation date is 
after April 30, 1989, and before May 1, 1999. For transfers for which 
the valuation date is after April 30, 1989, and before May 1, 1999, the 
present value of a charitable remainder unitrust interest that is 
dependent on a term of years or the termination of a life interest is 
determined by using the section 7520 rate and Table D, Tables F(4.2) 
through F(14.0) in Sec. 1.664-4(e)(6) and Table U(1) of this paragraph 
(e)(6), as applicable. See, however, Sec. 1.7520-3(b) (relating to 
exceptions to the use of prescribed tables under certain circumstances). 
Many actuarial factors not contained in the following tables are 
contained in Internal Revenue Service Publication 1458, ``Actuarial 
Values, Beta Volume,'' (8-89). Publication 1458 is no longer available 
for purchase from the Superintendent of Documents, United States 
Government Printing Office, Washington, DC 20402. However, pertinent 
factors in this publication may be obtained by a written request to: 
CC:DOM:CORP:R (IRS Publication 1458), room 5226, Internal Revenue 
Service, POB 7604, Ben Franklin Station, Washington, DC 20044.

                                     Table U(1)--Unitrust Single Life Remainder Factors--Based on Life Table 80CNSMT
                                         [Applicable for Transfers After April 30, 1989, and Before May 1, 1999]
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                             Adjusted payout rate
                         Age                         ---------------------------------------------------------------------------------------------------
                                                        4.2%      4.4%      4.6%      4.8%      5.0%      5.2%      5.4%      5.6%      5.8%      6.0%
--------------------------------------------------------------------------------------------------------------------------------------------------------
0...................................................    .06797    .06181    .05645    .05177    .04768    .04410    .04096    .03820    .03578    .03364
1...................................................    .05881    .05243    .04686    .04199    .03773    .03400    .03072    .02784    .02531    .02308
2...................................................    .06049    .05394    .04821    .04319    .03880    .03494    .03155    .02856    .02593    .02361
3...................................................    .06252    .05579    .04990    .04473    .04020    .03621    .03270    .02961    .02688    .02446
4...................................................    .06479    .05788    .05182    .04650    .04183    .03771    .03408    .03087    .02804    .02553
5...................................................    .06724    .06016    .05393    .04845    .04363    .03937    .03562    .03230    .02936    .02675
6...................................................    .06984    .06257    .05618    .05054    .04557    .04117    .03729    .03385    .03080    .02809
7...................................................    .07259    .06513    .05856    .05276    .04764    .04310    .03909    .03552    .03236    .02954
8...................................................    .07548    .06784    .06109    .05513    .04985    .04517    .04102    .03733    .03405    .03113
9...................................................    .07854    .07071    .06378    .05765    .05221    .04738    .04310    .03928    .03588    .03285
10..................................................    .08176    .07374    .06663    .06033    .05473    .04976    .04533    .04138    .03786    .03471
11..................................................    .08517    .07695    .06966    .06319    .05743    .05230    .04772    .04364    .04000    .03673
12..................................................    .08872    .08031    .07284    .06619    .06026    .05498    .05026    .04604    .04227    .03889
13..................................................    .09238    .08378    .07612    .06929    .06320    .05776    .05289    .04853    .04463    .04113
14..................................................    .09608    .08728    .07943    .07243    .06616    .06056    .05554    .05104    .04701    .04338
15..................................................    .09981    .09081    .08276    .07557    .06914    .06337    .05820    .05356    .04938    .04563
16..................................................    .10356    .09435    .08612    .07874    .07213    .06619    .06086    .05607    .05176    .04787
17..................................................    .10733    .09792    .08949    .08192    .07513    .06902    .06353    .05858    .05413    .05010
18..................................................    .11117    .10155    .09291    .08515    .07817    .07189    .06623    .06113    .05652    .05236
19..................................................    .11509    .10526    .09642    .08847    .08130    .07484    .06901    .06375    .05899    .05469
20..................................................    .11913    .10908    .10003    .09188    .08452    .07788    .07188    .06645    .06154    .05708
21..................................................    .12326    .11300    .10375    .09539    .08784    .08101    .07483    .06923    .06416    .05955
22..................................................    .12753    .11705    .10758    .09902    .09127    .08426    .07789    .07212    .06688    .06212
23..................................................    .13195    .12125    .11156    .10279    .09484    .08763    .08109    .07514    .06973    .06481
24..................................................    .13655    .12563    .11573    .10675    .09860    .09119    .08446    .07833    .07274    .06766
25..................................................    .14136    .13022    .12010    .11091    .10255    .09495    .08802    .08171    .07595    .07069
26..................................................    .14640    .13504    .12471    .11530    .10674    .09893    .09181    .08531    .07937    .07394
27..................................................    .15169    .14011    .12956    .11994    .11117    .10316    .09584    .08915    .08302    .07742
28..................................................    .15721    .14542    .13465    .12482    .11583    .10762    .10010    .09322    .08691    .08112
29..................................................    .16299    .15097    .13999    .12994    .12075    .11233    .10461    .09753    .09104    .08507
30..................................................    .16901    .15678    .14559    .13533    .12592    .11729    .10937    .10210    .09541    .08926
31..................................................    .17531    .16287    .15146    .14099    .13137    .12254    .11441    .10694    .10006    .09372
32..................................................    .18186    .16921    .15759    .14691    .13709    .12804    .11972    .11205    .10497    .09844
33..................................................    .18869    .17584    .16401    .15312    .14309    .13384    .12531    .11744    .11017    .10345
34..................................................    .19578    .18273    .17070    .15961    .14937    .13992    .13119    .12312    .11565    .10874
35..................................................    .20315    .18990    .17767    .16637    .15593    .14628    .13735    .12908    .12142    .11431
36..................................................    .21076    .19732    .18490    .17340    .16276    .15291    .14377    .13531    .12745    .12016
37..................................................    .21863    .20501    .19239    .18071    .16987    .15982    .15049    .14182    .13377    .12628
38..................................................    .22676    .21296    .20016    .18828    .17725    .16701    .15748    .14862    .14037    .13269
39..................................................    .23515    .22118    .20820    .19614    .18492    .17448    .16476    .15571    .14727    .13940
40..................................................    .24379    .22967    .21652    .20428    .19288    .18225    .17234    .16310    .15447    .14641
41..................................................    .25270    .23842    .22511    .21270    .20112    .19031    .18021    .17078    .16197    .15372
42..................................................    .26184    .24742    .23395    .22137    .20962    .19864    .18836    .17875    .16975    .16132
43..................................................    .27123    .25666    .24305    .23031    .21840    .20724    .19679    .18700    .17782    .16921
44..................................................    .28085    .26616    .25241    .23952    .22745    .21613    .20551    .19554    .18618    .17739

[[Page 285]]

 
45..................................................    .29072    .27591    .26203    .24901    .23678    .22530    .21452    .20438    .19485    .18589
46..................................................    .30082    .28591    .27191    .25875    .24639    .23476    .22381    .21352    .20382    .19468
47..................................................    .31116    .29616    .28204    .26877    .25626    .24449    .23340    .22295    .21309    .20379
48..................................................    .32171    .30663    .29241    .27902    .26640    .25449    .24326    .23265    .22264    .21318
49..................................................    .33245    .31730    .30300    .28950    .27676    .26473    .25336    .24262    .23246    .22285
50..................................................    .34338    .32816    .31379    .30020    .28735    .27521    .26371    .25283    .24253    .23277
51..................................................    .35449    .33923    .32479    .31112    .29818    .28593    .27431    .26331    .25287    .24297
52..................................................    .36582    .35053    .33603    .32230    .30927    .29692    .28520    .27408    .26352    .25349
53..................................................    .37736    .36205    .34751    .33372    .32063    .30819    .29637    .28514    .27446    .26431
54..................................................    .38909    .37376    .35921    .34537    .33221    .31970    .30780    .29647    .28569    .27542
55..................................................    .40099    .38568    .37111    .35724    .34404    .33146    .31949    .30807    .29719    .28681
56..................................................    .41308    .39779    .38322    .36934    .35610    .34348    .33143    .31994    .30898    .29851
57..................................................    .42536    .41011    .39555    .38167    .36841    .35575    .34366    .33210    .32106    .31051
58..................................................    .43781    .42262    .40810    .39422    .38096    .36828    .35615    .34454    .33344    .32281
59..................................................    .45043    .43530    .42083    .40698    .39373    .38104    .36888    .35724    .34609    .33540
60..................................................    .46318    .44813    .43372    .41992    .40668    .39400    .38183    .37017    .35898    .34824
61..................................................    .47602    .46107    .44674    .43299    .41979    .40713    .39497    .38329    .37207    .36129
62..................................................    .48893    .47410    .45986    .44617    .43303    .42039    .40825    .39657    .38534    .37454
63..................................................    .50190    .48720    .47306    .45946    .44638    .43379    .42168    .41001    .39878    .38796
64..................................................    .51494    .50038    .48636    .47286    .45986    .44733    .43526    .42362    .41240    .40158
65..................................................    .52808    .51368    .49980    .48641    .47350    .46104    .44903    .43743    .42624    .41544
66..................................................    .54134    .52711    .51338    .50013    .48733    .47496    .46302    .45148    .44033    .42956
67..................................................    .55471    .54068    .52712    .51401    .50134    .48908    .47723    .46577    .45467    .44394
68..................................................    .56820    .55437    .54100    .52805    .51552    .50339    .49165    .48027    .46925    .45858
69..................................................    .58172    .56812    .55495    .54219    .52982    .51783    .50620    .49494    .48401    .47341
70..................................................    .59526    .58190    .56894    .55637    .54417    .53234    .52086    .50971    .49889    .48838
71..................................................    .60874    .59564    .58291    .57055    .55854    .54687    .53554    .52453    .51382    .50342
72..................................................    .62218    .60934    .59685    .58471    .57291    .56143    .55026    .53939    .52882    .51854
73..................................................    .63557    .62301    .61078    .59887    .58728    .57600    .56501    .55431    .54389    .53373
74..................................................    .64896    .63669    .62472    .61307    .60171    .59064    .57985    .56932    .55906    .54906
75..................................................    .66237    .65040    .63872    .62733    .61622    .60538    .59480    .58447    .57439    .56455
76..................................................    .67581    .66416    .65279    .64168    .63083    .62023    .60988    .59977    .58989    .58023
77..................................................    .68925    .67793    .66688    .65606    .64550    .63516    .62506    .61517    .60551    .59605
78..................................................    .70263    .69166    .68093    .67044    .66016    .65010    .64026    .63062    .62119    .61195
79..................................................    .71585    .70525    .69486    .68468    .67471    .66495    .65538    .64600    .63681    .62780
80..................................................    .72885    .71860    .70856    .69872    .68906    .67959    .67031    .66120    .65227    .64350
81..................................................    .74150    .73162    .72193    .71242    .70308    .69392    .68492    .67609    .66742    .65890
82..................................................    .75376    .74425    .73490    .72572    .71671    .70785    .69915    .69059    .68219    .67393
83..................................................    .76559    .75643    .74744    .73859    .72989    .72134    .71293    .70466    .69652    .68852
84..................................................    .77700    .76821    .75955    .75104    .74266    .73441    .72629    .71831    .71044    .70270
85..................................................    .78805    .77961    .77130    .76311    .75505    .74711    .73929    .73158    .72399    .71652
86..................................................    .79866    .79056    .78258    .77472    .76697    .75933    .75180    .74438    .73707    .72985
87..................................................    .80870    .80094    .79329    .78574    .77829    .77095    .76370    .75656    .74951    .74255
88..................................................    .81825    .81081    .80348    .79623    .78908    .78202    .77506    .76818    .76139    .75469
89..................................................    .82746    .82035    .81332    .80638    .79952    .79275    .78606    .77945    .77292    .76647
90..................................................    .83643    .82963    .82291    .81627    .80971    .80322    .79681    .79047    .78420    .77801
91..................................................    .84503    .83854    .83212    .82578    .81950    .81330    .80716    .80109    .79509    .78915
92..................................................    .85308    .84689    .84076    .83470    .82870    .82276    .81689    .81107    .80532    .79963
93..................................................    .86052    .85460    .84875    .84295    .83721    .83152    .82590    .82033    .81481    .80935
94..................................................    .86729    .86163    .85602    .85046    .84496    .83951    .83412    .82877    .82348    .81823
95..................................................    .87338    .86795    .86257    .85723    .85195    .84672    .84153    .83639    .83129    .82624
96..................................................    .87877    .87354    .86836    .86323    .85814    .85309    .84809    .84313    .83822    .83334
97..................................................    .88365    .87861    .87362    .86867    .86375    .85888    .85405    .84926    .84450    .83979
98..................................................    .88805    .88318    .87835    .87356    .86880    .86409    .85941    .85477    .85016    .84559
99..................................................    .89210    .88739    .88271    .87807    .87347    .86890    .86436    .85986    .85539    .85095
100.................................................    .89588    .89131    .88678    .88227    .87780    .87337    .86896    .86459    .86024    .85593
101.................................................    .89949    .89506    .89066    .88629    .88195    .87764    .87336    .86911    .86488    .86069
102.................................................    .90325    .89897    .89471    .89047    .88627    .88209    .87794    .87381    .86971    .86564
103.................................................    .90724    .90311    .89900    .89491    .89085    .88681    .88279    .87880    .87484    .87089
104.................................................    .91167    .90770    .90376    .89983    .89593    .89205    .88819    .88435    .88053    .87673
105.................................................    .91708    .91333    .90959    .90587    .90217    .89848    .89481    .89116    .88752    .88391
106.................................................    .92470    .92126    .91782    .91440    .91100    .90760    .90422    .90085    .89749    .89414
107.................................................    .93545    .93246    .92948    .92650    .92353    .92057    .91762    .91467    .91173    .90880
108.................................................    .95239    .95016    .94792    .94569    .94346    .94123    .93900    .93678    .93456    .93234
109.................................................    .97900    .97800    .97700    .97600    .97500    .97400    .97300    .97200    .97100    .97000
--------------------------------------------------------------------------------------------------------------------------------------------------------


[[Page 286]]


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

[[Page 287]]

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


                                     Table U(1)--Based on Life Table 80CNSMT Unitrust Single Life Remainder Factors
                                                            [Applicable after APRIL 30, 1989]
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                             Adjusted payout rate
                         Age                         ---------------------------------------------------------------------------------------------------
                                                        8.2%      8.4%      8.6%      8.8%      9.0%      9.2%      9.4%      9.6%      9.8%      10.0%
--------------------------------------------------------------------------------------------------------------------------------------------------------
0...................................................    .02130    .02075    .02025    .01980    .01939    .01901    .01867    .01835    .01806    .01779
1...................................................    .01017    .00960    .00908    .00861    .00819    .00780    .00745    .00712    .00683    .00655
2...................................................    .01011    .00951    .00897    .00848    .00803    .00762    .00725    .00690    .00659    .00630
3...................................................    .01035    .00971    .00914    .00862    .00815    .00771    .00732    .00696    .00663    .00632
4...................................................    .01076    .01009    .00948    .00894    .00843    .00798    .00756    .00718    .00683    .00650
5...................................................    .01130    .01059    .00996    .00938    .00885    .00836    .00792    .00752    .00714    .00680
6...................................................    .01193    .01119    .01051    .00990    .00934    .00883    .00836    .00793    .00754    .00717
7...................................................    .01265    .01187    .01116    .01051    .00992    .00938    .00888    .00842    .00800    .00762
8...................................................    .01347    .01264    .01189    .01121    .01058    .01001    .00948    .00900    .00856    .00815
9...................................................    .01440    .01353    .01274    .01201    .01135    .01075    .01019    .00968    .00921    .00877
10..................................................    .01544    .01453    .01369    .01293    .01223    .01159    .01101    .01046    .00997    .00950
11..................................................    .01662    .01566    .01478    .01398    .01324    .01257    .01195    .01137    .01085    .01036
12..................................................    .01791    .01690    .01597    .01513    .01435    .01364    .01298    .01238    .01182    .01131
13..................................................    .01926    .01820    .01722    .01634    .01552    .01477    .01408    .01344    .01285    .01231
14..................................................    .02059    .01948    .01846    .01752    .01667    .01588    .01515    .01448    .01386    .01328
15..................................................    .02189    .02072    .01965    .01867    .01777    .01694    .01617    .01547    .01481    .01421
16..................................................    .02315    .02192    .02080    .01977    .01882    .01795    .01714    .01640    .01572    .01508
17..................................................    .02436    .02308    .02190    .02082    .01982    .01891    .01806    .01728    .01656    .01589

[[Page 288]]

 
18..................................................    .02556    .02422    .02298    .02184    .02080    .01983    .01894    .01812    .01736    .01665
19..................................................    .02679    .02537    .02408    .02288    .02178    .02077    .01983    .01897    .01817    .01742
20..................................................    .02804    .02656    .02519    .02394    .02278    .02172    .02073    .01982    .01898    .01819
21..................................................    .02932    .02776    .02633    .02501    .02380    .02268    .02164    .02068    .01979    .01896
22..................................................    .03065    .02902    .02751    .02613    .02485    .02367    .02258    .02157    .02063    .01976
23..................................................    .03204    .03033    .02876    .02730    .02595    .02471    .02356    .02249    .02150    .02058
24..................................................    .03356    .03176    .03010    .02857    .02716    .02585    .02463    .02351    .02246    .02149
25..................................................    .03520    .03332    .03158    .02997    .02848    .02710    .02582    .02463    .02352    .02249
26..................................................    .03702    .03504    .03321    .03152    .02995    .02850    .02714    .02589    .02472    .02363
27..................................................    .03902    .03695    .03502    .03324    .03159    .03006    .02863    .02730    .02607    .02492
28..................................................    .04120    .03902    .03700    .03513    .03339    .03178    .03027    .02887    .02757    .02635
29..................................................    .04358    .04129    .03917    .03720    .03537    .03367    .03208    .03061    .02923    .02794
30..................................................    .04616    .04376    .04154    .03947    .03754    .03575    .03408    .03251    .03106    .02969
31..................................................    .04897    .04646    .04413    .04195    .03993    .03804    .03627    .03463    .03309    .03165
32..................................................    .05200    .04938    .04693    .04465    .04252    .04053    .03867    .03693    .03531    .03378
33..................................................    .05529    .05254    .04998    .04758    .04534    .04325    .04130    .03946    .03775    .03614
34..................................................    .05883    .05595    .05326    .05075    .04840    .04620    .04414    .04221    .04040    .03870
35..................................................    .06262    .05961    .05680    .05417    .05170    .04939    .04723    .04520    .04329    .04149
36..................................................    .06665    .06351    .06057    .05781    .05523    .05280    .05053    .04839    .04638    .04449
37..................................................    .07094    .06766    .06459    .06171    .05900    .05646    .05407    .05182    .04971    .04771
38..................................................    .07550    .07208    .06888    .06586    .06303    .06037    .05786    .05550    .05327    .05118
39..................................................    .08034    .07678    .07344    .07029    .06733    .06454    .06191    .05943    .05709    .05489
40..................................................    .08547    .08177    .07828    .07499    .07190    .06898    .06623    .06363    .06118    .05886
41..................................................    .09090    .08704    .08341    .07998    .07675    .07371    .07083    .06811    .06553    .06310
42..................................................    .09661    .09260    .08882    .08525    .08188    .07870    .07569    .07284    .07015    .06760
43..................................................    .10260    .09844    .09451    .09080    .08729    .08397    .08083    .07785    .07503    .07236
44..................................................    .10891    .10459    .10051    .09666    .09300    .08954    .08626    .08316    .08021    .07741
45..................................................    .11553    .11106    .10683    .10282    .09902    .09542    .09201    .08876    .08568    .08276
46..................................................    .12247    .11784    .11346    .10930    .10536    .10161    .09806    .09468    .09146    .08841
47..................................................    .12974    .12496    .12042    .11611    .11202    .10813    .10443    .10091    .09756    .09438
48..................................................    .13732    .13238    .12769    .12323    .11899    .11495    .11111    .10745    .10397    .10065
49..................................................    .14520    .14011    .13526    .13064    .12625    .12207    .11809    .11429    .11066    .10721
50..................................................    .15338    .14812    .14312    .13836    .13381    .12948    .12535    .12141    .11765    .11405
51..................................................    .16187    .15646    .15130    .14639    .14169    .13721    .13294    .12885    .12495    .12121
52..................................................    .17072    .16516    .15985    .15478    .14993    .14531    .14088    .13665    .13261    .12873
53..................................................    .17993    .17422    .16876    .16353    .15854    .15377    .14920    .14482    .14064    .13662
54..................................................    .18949    .18362    .17801    .17264    .16750    .16258    .15787    .15335    .14902    .14486
55..................................................    .19940    .19339    .18763    .18212    .17683    .17176    .16690    .16224    .15777    .15348
56..................................................    .20968    .20353    .19762    .19196    .18654    .18132    .17632    .17152    .16691    .16247
57..................................................    .22035    .21406    .20802    .20222    .19665    .19129    .18615    .18121    .17646    .17189
58..................................................    .23142    .22499    .21881    .21287    .20717    .20168    .19640    .19132    .18643    .18172
59..................................................    .24286    .23630    .23000    .22393    .21809    .21247    .20705    .20184    .19682    .19198
60..................................................    .25465    .24797    .24154    .23534    .22938    .22363    .21808    .21274    .20759    .20262
61..................................................    .26676    .25996    .25341    .24710    .24101    .23513    .22946    .22399    .21871    .21361
62..................................................    .27916    .27225    .26559    .25916    .25295    .24695    .24117    .23557    .23017    .22495
63..................................................    .29184    .28483    .27806    .27152    .26520    .25909    .25319    .24748    .24196    .23661
64..................................................    .30483    .29772    .29085    .28421    .27779    .27157    .26555    .25973    .25409    .24863
65..................................................    .31817    .31098    .30402    .29729    .29076    .28444    .27832    .27240    .26665    .26108
66..................................................    .33192    .32466    .31762    .31079    .30418    .29777    .29155    .28552    .27968    .27400
67..................................................    .34609    .33876    .33164    .32474    .31805    .31156    .30525    .29913    .29319    .28742
68..................................................    .36066    .35328    .34610    .33914    .33238    .32581    .31943    .31323    .30720    .30134
69..................................................    .37558    .36815    .36093    .35391    .34709    .34045    .33400    .32773    .32163    .31569
70..................................................    .39078    .38332    .37606    .36900    .36213    .35545    .34894    .34260    .33643    .33042
71..................................................    .40620    .39872    .39144    .38435    .37744    .37071    .36415    .35776    .35153    .34547
72..................................................    .42184    .41435    .40706    .39994    .39301    .38625    .37965    .37322    .36694    .36082
73..................................................    .43771    .43023    .42293    .41581    .40886    .40207    .39545    .38899    .38267    .37651
74..................................................    .45387    .44641    .43912    .43201    .42505    .41826    .41163    .40514    .39881    .39261
75..................................................    .47039    .46296    .45570    .44861    .44167    .43488    .42824    .42175    .41541    .40920
76..................................................    .48729    .47991    .47269    .46563    .45872    .45196    .44534    .43886    .43251    .42630
77..................................................    .50452    .49722    .49006    .48305    .47619    .46946    .46287    .45642    .45009    .44389
78..................................................    .52203    .51481    .50773    .50079    .49399    .48732    .48078    .47437    .46808    .46191
79..................................................    .53966    .53254    .52556    .51870    .51198    .50538    .49891    .49255    .48632    .48019
80..................................................    .55728    .55028    .54340    .53665    .53002    .52351    .51712    .51083    .50466    .49860
81..................................................    .57471    .56784    .56109    .55445    .54792    .54151    .53521    .52901    .52292    .51692
82..................................................    .59186    .58512    .57850    .57199    .56558    .55927    .55307    .54697    .54097    .53506
83..................................................    .60863    .60204    .59556    .58918    .58289    .57671    .57062    .56462    .55872    .55290
84..................................................    .62505    .61862    .61228    .60604    .59989    .59383    .58786    .58198    .57618    .57047
85..................................................    .64118    .63491    .62873    .62263    .61663    .61070    .60486    .59911    .59343    .58783

[[Page 289]]

 
86..................................................    .65685    .65075    .64473    .63879    .63294    .62716    .62145    .61583    .61027    .60479
87..................................................    .67187    .66594    .66008    .65430    .64859    .64296    .63739    .63190    .62647    .62112
88..................................................    .68631    .68054    .67485    .66923    .66367    .65818    .65276    .64740    .64211    .63688
89..................................................    .70042    .69483    .68930    .68384    .67845    .67311    .66784    .66262    .65747    .65237
90..................................................    .71434    .70894    .70359    .69830    .69307    .68790    .68278    .67772    .67271    .66775
91..................................................    .72789    .72266    .71750    .71239    .70733    .70232    .69736    .69246    .68760    .68280
92..................................................    .74070    .73567    .73068    .72574    .72085    .71601    .71121    .70647    .70176    .69711
93..................................................    .75266    .74780    .74298    .73821    .73348    .72880    .72417    .71957    .71502    .71051
94..................................................    .76363    .75893    .75428    .74967    .74510    .74057    .73608    .73163    .72722    .72285
95..................................................    .77356    .76901    .76451    .76005    .75562    .75123    .74688    .74257    .73829    .73405
96..................................................    .78237    .77797    .77360    .76927    .76497    .76071    .75648    .75229    .74813    .74401
97..................................................    .79039    .78612    .78187    .77766    .77348    .76934    .76523    .76115    .75710    .75308
98..................................................    .79762    .79345    .78932    .78522    .78115    .77711    .77310    .76913    .76518    .76126
99..................................................    .80429    .80023    .79620    .79220    .78823    .78429    .78038    .77649    .77264    .76881
100.................................................    .81047    .80651    .80258    .79867    .79479    .79094    .78712    .78332    .77955    .77580
101.................................................    .81636    .81249    .80865    .80483    .80104    .79727    .79352    .78981    .78611    .78244
102.................................................    .82250    .81872    .81497    .81124    .80754    .80386    .80020    .79656    .79295    .78936
103.................................................    .82900    .82532    .82167    .81804    .81442    .81083    .80726    .80371    .80018    .79667
104.................................................    .83622    .83266    .82911    .82558    .82207    .81858    .81510    .81165    .80821    .80479
105.................................................    .84517    .84174    .83833    .83494    .83156    .82819    .82485    .82151    .81820    .81489
106.................................................    .85814    .85494    .85175    .84857    .84540    .84225    .83911    .83598    .83286    .82975
107.................................................    .87704    .87420    .87136    .86853    .86571    .86290    .86009    .85729    .85450    .85171
108.................................................    .90812    .90593    .90375    .90156    .89939    .89721    .89504    .89286    .89070    .88853
109.................................................    .95900    .95800    .95700    .95600    .95500    .95400    .95300    .95200    .95100    .95000
--------------------------------------------------------------------------------------------------------------------------------------------------------


                                     Table U(1)--Based on Life Table 80CNSMT Unitrust Single Life Remainder Factors
                                                            [Applicable after APRIL 30, 1989]
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                             Adjusted payout rate
                         Age                         ---------------------------------------------------------------------------------------------------
                                                        10.2%     10.4%     10.6%     10.8%     11.0%     11.2%     11.4%     11.6%     11.8%     12.0%
--------------------------------------------------------------------------------------------------------------------------------------------------------
0...................................................    .01754    .01731    .01710    .01690    .01671    .01654    .01638    .01622    .01608    .01594
1...................................................    .00630    .00607    .00585    .00565    .00547    .00530    .00514    .00499    .00485    .00472
2...................................................    .00604    .00579    .00557    .00536    .00516    .00498    .00481    .00465    .00451    .00437
3...................................................    .00604    .00578    .00554    .00532    .00511    .00492    .00474    .00458    .00442    .00427
4...................................................    .00621    .00593    .00568    .00544    .00522    .00502    .00483    .00465    .00448    .00433
5...................................................    .00648    .00619    .00592    .00567    .00544    .00522    .00502    .00483    .00465    .00449
6...................................................    .00684    .00653    .00624    .00597    .00572    .00549    .00528    .00507    .00489    .00471
7...................................................    .00726    .00693    .00663    .00634    .00608    .00583    .00560    .00539    .00518    .00499
8...................................................    .00777    .00742    .00709    .00679    .00651    .00624    .00600    .00577    .00555    .00535
9...................................................    .00837    .00800    .00765    .00733    .00703    .00675    .00649    .00625    .00602    .00580
10..................................................    .00908    .00868    .00832    .00797    .00765    .00736    .00708    .00682    .00657    .00634
11..................................................    .00991    .00949    .00910    .00874    .00840    .00808    .00779    .00751    .00725    .00700
12..................................................    .01083    .01039    .00997    .00959    .00923    .00890    .00858    .00829    .00801    .00775
13..................................................    .01181    .01134    .01090    .01049    .01012    .00976    .00943    .00912    .00883    .00855
14..................................................    .01275    .01226    .01180    .01137    .01097    .01060    .01025    .00992    .00961    .00932
15..................................................    .01365    .01313    .01264    .01219    .01177    .01138    .01101    .01066    .01034    .01003
16..................................................    .01449    .01394    .01343    .01295    .01251    .01209    .01171    .01134    .01100    .01068
17..................................................    .01526    .01469    .01415    .01365    .01318    .01274    .01233    .01195    .01159    .01125
18..................................................    .01600    .01539    .01482    .01430    .01380    .01334    .01291    .01251    .01213    .01177
19..................................................    .01673    .01609    .01550    .01494    .01442    .01393    .01348    .01305    .01265    .01227
20..................................................    .01747    .01679    .01616    .01557    .01502    .01451    .01403    .01358    .01316    .01276
21..................................................    .01820    .01748    .01682    .01620    .01562    .01508    .01457    .01409    .01365    .01323
22..................................................    .01895    .01819    .01749    .01683    .01622    .01565    .01511    .01461    .01414    .01369
23..................................................    .01972    .01893    .01818    .01749    .01684    .01624    .01567    .01514    .01464    .01417
24..................................................    .02058    .01974    .01895    .01822    .01753    .01689    .01629    .01572    .01519    .01469
25..................................................    .02154    .02064    .01981    .01903    .01830    .01762    .01698    .01638    .01582    .01529
26..................................................    .02262    .02167    .02079    .01996    .01919    .01847    .01779    .01715    .01655    .01599
27..................................................    .02385    .02284    .02191    .02103    .02021    .01944    .01872    .01804    .01740    .01680
28..................................................    .02521    .02415    .02316    .02222    .02135    .02053    .01977    .01904    .01836    .01772
29..................................................    .02673    .02561    .02455    .02357    .02264    .02177    .02095    .02018    .01946    .01877
30..................................................    .02842    .02723    .02611    .02506    .02407    .02315    .02227    .02146    .02068    .01996
31..................................................    .03030    .02903    .02784    .02673    .02568    .02470    .02377    .02290    .02207    .02130
32..................................................    .03235    .03101    .02976    .02857    .02746    .02641    .02543    .02450    .02362    .02279
33..................................................    .03463    .03321    .03188    .03062    .02944    .02833    .02728    .02629    .02535    .02447
34..................................................    .03711    .03561    .03419    .03286    .03161    .03043    .02931    .02826    .02726    .02632

[[Page 290]]

 
35..................................................    .03981    .03822    .03672    .03531    .03398    .03273    .03154    .03042    .02936    .02836
36..................................................    .04271    .04103    .03945    .03796    .03655    .03522    .03396    .03277    .03164    .03057
37..................................................    .04584    .04407    .04239    .04081    .03932    .03791    .03657    .03531    .03411    .03297
38..................................................    .04920    .04733    .04556    .04389    .04231    .04082    .03940    .03806    .03679    .03558
39..................................................    .05280    .05083    .04897    .04721    .04554    .04396    .04246    .04103    .03968    .03840
40..................................................    .05667    .05459    .05263    .05077    .04901    .04733    .04575    .04424    .04280    .04144
41..................................................    .06080    .05861    .05655    .05459    .05272    .05096    .04928    .04768    .04617    .04472
42..................................................    .06518    .06289    .06071    .05864    .05668    .05482    .05305    .05136    .04975    .04822
43..................................................    .06982    .06742    .06513    .06296    .06089    .05893    .05706    .05528    .05358    .05196
44..................................................    .07475    .07223    .06983    .06754    .06537    .06330    .06133    .05945    .05766    .05595
45..................................................    .07998    .07733    .07481    .07242    .07014    .06796    .06588    .06390    .06202    .06021
46..................................................    .08550    .08273    .08010    .07758    .07519    .07290    .07072    .06864    .06665    .06474
47..................................................    .09134    .08845    .08569    .08306    .08055    .07815    .07586    .07367    .07157    .06957
48..................................................    .09748    .09446    .09158    .08882    .08619    .08368    .08128    .07898    .07678    .07467
49..................................................    .10391    .10076    .09775    .09487    .09212    .08949    .08697    .08456    .08225    .08003
50..................................................    .11062    .10734    .10420    .10120    .09832    .09557    .09293    .09041    .08798    .08566
51..................................................    .11764    .11423    .11096    .10783    .10483    .10195    .09919    .09655    .09401    .09158
52..................................................    .12503    .12148    .11807    .11481    .11168    .10868    .10581    .10304    .10039    .09784
53..................................................    .13278    .12909    .12556    .12216    .11891    .11578    .11278    .10989    .10712    .10445
54..................................................    .14088    .13706    .13339    .12986    .12648    .12322    .12009    .11709    .11419    .11141
55..................................................    .14936    .14540    .14159    .13793    .13442    .13103    .12778    .12464    .12163    .11872
56..................................................    .15821    .15412    .15018    .14639    .14274    .13923    .13584    .13258    .12944    .12642
57..................................................    .16749    .16326    .15918    .15526    .15148    .14784    .14433    .14094    .13768    .13453
58..................................................    .17719    .17282    .16862    .16456    .16065    .15688    .15324    .14973    .14634    .14306
59..................................................    .18731    .18281    .17847    .17429    .17025    .16634    .16258    .15894    .15543    .15203
60..................................................    .19782    .19319    .18872    .18440    .18023    .17621    .17231    .16855    .16491    .16139
61..................................................    .20869    .20393    .19934    .19489    .19060    .18644    .18242    .17854    .17477    .17113
62..................................................    .21990    .21502    .21029    .20573    .20131    .19703    .19289    .18887    .18499    .18123
63..................................................    .23144    .22644    .22159    .21690    .21236    .20796    .20370    .19956    .19556    .19167
64..................................................    .24335    .23823    .23326    .22845    .22379    .21927    .21489    .21063    .20651    .20250
65..................................................    .25568    .25045    .24537    .24044    .23566    .23103    .22653    .22216    .21791    .21379
66..................................................    .26850    .26316    .25797    .25293    .24804    .24329    .23868    .23420    .22984    .22560
67..................................................    .28182    .27637    .27108    .26594    .26095    .25609    .25137    .24678    .24231    .23797
68..................................................    .29565    .29011    .28472    .27949    .27439    .26943    .26461    .25991    .25534    .25089
69..................................................    .30991    .30429    .29882    .29349    .28830    .28325    .27833    .27354    .26887    .26432
70..................................................    .32457    .31887    .31332    .30791    .30264    .29750    .29249    .28760    .28284    .27820
71..................................................    .33955    .33378    .32816    .32267    .31732    .31210    .30701    .30204    .29719    .29246
72..................................................    .35485    .34902    .34333    .33778    .33236    .32707    .32190    .31686    .31193    .30711
73..................................................    .37049    .36461    .35887    .35326    .34778    .34242    .33719    .33207    .32707    .32218
74..................................................    .38656    .38064    .37485    .36920    .36366    .35825    .35296    .34778    .34272    .33776
75..................................................    .40312    .39717    .39136    .38566    .38009    .37464    .36930    .36407    .35895    .35394
76..................................................    .42022    .41426    .40842    .40271    .39711    .39163    .38625    .38099    .37583    .37077
77..................................................    .43782    .43187    .42603    .42031    .41470    .40920    .40380    .39851    .39332    .38823
78..................................................    .45586    .44992    .44410    .43839    .43278    .42728    .42188    .41658    .41138    .40627
79..................................................    .47418    .46828    .46248    .45679    .45120    .44572    .44033    .43503    .42983    .42472
80..................................................    .49264    .48679    .48103    .47538    .46982    .46436    .45900    .45372    .44853    .44343
81..................................................    .51103    .50524    .49954    .49394    .48843    .48301    .47768    .47243    .46727    .46219
82..................................................    .52925    .52352    .51789    .51235    .50690    .50153    .49624    .49104    .48591    .48087
83..................................................    .54718    .54154    .53598    .53051    .52512    .51981    .51459    .50943    .50436    .49936
84..................................................    .56484    .55930    .55383    .54844    .54313    .53789    .53273    .52764    .52262    .51767
85..................................................    .58231    .57686    .57149    .56619    .56096    .55581    .55072    .54571    .54076    .53588
86..................................................    .59939    .59405    .58878    .58358    .57845    .57339    .56839    .56346    .55858    .55377
87..................................................    .61583    .61061    .60545    .60035    .59532    .59035    .58545    .58060    .57581    .57108
88..................................................    .63171    .62661    .62156    .61658    .61165    .60678    .60196    .59721    .59251    .58786
89..................................................    .64733    .64235    .63742    .63255    .62774    .62298    .61827    .61361    .60900    .60444
90..................................................    .66285    .65801    .65321    .64847    .64377    .63913    .63453    .62998    .62548    .62103
91..................................................    .67804    .67334    .66868    .66407    .65950    .65498    .65050    .64607    .64169    .63735
92..................................................    .69250    .68793    .68341    .67893    .67450    .67011    .66575    .66144    .65718    .65295
93..................................................    .70604    .70162    .69723    .69288    .68858    .68431    .68008    .67589    .67174    .66762
94..................................................    .71852    .71422    .70997    .70575    .70156    .69742    .69331    .68923    .68519    .68119
95..................................................    .72984    .72567    .72154    .71744    .71337    .70934    .70534    .70137    .69744    .69354
96..................................................    .73992    .73586    .73183    .72784    .72388    .71995    .71605    .71218    .70835    .70454
97..................................................    .74910    .74514    .74122    .73733    .73346    .72963    .72582    .72205    .71830    .71458
98..................................................    .75737    .75351    .74967    .74587    .74209    .73835    .73463    .73093    .72727    .72363
99..................................................    .76501    .76123    .75748    .75376    .75007    .74640    .74276    .73914    .73555    .73198
100.................................................    .77208    .76838    .76471    .76107    .75745    .75385    .75028    .74673    .74321    .73971
101.................................................    .77879    .77517    .77157    .76800    .76444    .76092    .75741    .75392    .75046    .74702
102.................................................    .78579    .78224    .77871    .77521    .77173    .76827    .76483    .76141    .75801    .75463

[[Page 291]]

 
103.................................................    .79318    .78971    .78626    .78283    .77942    .77604    .77266    .76931    .76598    .76267
104.................................................    .80139    .79801    .79464    .79129    .78796    .78465    .78136    .77808    .77482    .77157
105.................................................    .81161    .80834    .80508    .80184    .79861    .79540    .79220    .78902    .78585    .78270
106.................................................    .82665    .82357    .82049    .81743    .81438    .81134    .80831    .80530    .80229    .79930
107.................................................    .84893    .84616    .84340    .84064    .83789    .83515    .83241    .82969    .82696    .82425
108.................................................    .88637    .88421    .88205    .87989    .87774    .87559    .87344    .87129    .86915    .86701
109.................................................    .94900    .94800    .94700    .94600    .94500    .94400    .94300    .94200    .94100    .94000
--------------------------------------------------------------------------------------------------------------------------------------------------------


                                     Table U(1)--Based on Life Table 80CNSMT Unitrust Single Life Remainder Factors
                                                            [Applicable after April 30, 1989]
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                             Adjusted payout rate
                         Age                         ---------------------------------------------------------------------------------------------------
                                                        12.2%     12.4%     12.6%     12.8%     13.0%     13.2%     13.4%     13.6%     13.8%     14.0%
--------------------------------------------------------------------------------------------------------------------------------------------------------
0...................................................    .01581    .01569    .01557    .01546    .01536    .01526    .01516    .01507    .01499    .01490
1...................................................    .00459    .00448    .00437    .00426    .00417    .00407    .00399    .00390    .00382    .00375
2...................................................    .00424    .00412    .00400    .00389    .00379    .00369    .00360    .00352    .00343    .00335
3...................................................    .00414    .00401    .00389    .00377    .00366    .00356    .00346    .00337    .00328    .00320
4...................................................    .00418    .00404    .00391    .00379    .00368    .00357    .00347    .00337    .00327    .00319
5...................................................    .00433    .00418    .00405    .00391    .00379    .00368    .00357    .00346    .00336    .00327
6...................................................    .00454    .00439    .00424    .00410    .00397    .00384    .00372    .00361    .00351    .00341
7...................................................    .00482    .00465    .00449    .00434    .00420    .00407    .00394    .00382    .00371    .00360
8...................................................    .00516    .00498    .00481    .00465    .00450    .00436    .00422    .00410    .00397    .00386
9...................................................    .00560    .00541    .00523    .00505    .00489    .00474    .00459    .00446    .00433    .00420
10..................................................    .00613    .00592    .00573    .00555    .00537    .00521    .00505    .00491    .00477    .00463
11..................................................    .00677    .00655    .00635    .00615    .00597    .00580    .00563    .00547    .00532    .00518
12..................................................    .00751    .00728    .00706    .00685    .00666    .00647    .00629    .00613    .00597    .00581
13..................................................    .00829    .00805    .00782    .00760    .00739    .00719    .00701    .00683    .00666    .00650
14..................................................    .00905    .00879    .00854    .00831    .00809    .00789    .00769    .00750    .00732    .00715
15..................................................    .00974    .00947    .00921    .00897    .00874    .00852    .00831    .00811    .00793    .00775
16..................................................    .01037    .01009    .00982    .00956    .00932    .00909    .00887    .00866    .00846    .00827
17..................................................    .01093    .01063    .01034    .01007    .00982    .00958    .00935    .00913    .00892    .00873
18..................................................    .01143    .01112    .01082    .01053    .01027    .01001    .00977    .00954    .00933    .00912
19..................................................    .01192    .01159    .01127    .01097    .01069    .01043    .01017    .00993    .00970    .00949
20..................................................    .01239    .01204    .01170    .01139    .01109    .01081    .01055    .01029    .01005    .00983
21..................................................    .01283    .01246    .01211    .01178    .01147    .01117    .01089    .01063    .01037    .01013
22..................................................    .01328    .01288    .01251    .01216    .01183    .01152    .01122    .01094    .01067    .01042
23..................................................    .01372    .01331    .01292    .01254    .01219    .01186    .01155    .01125    .01097    .01070
24..................................................    .01422    .01378    .01336    .01297    .01260    .01225    .01191    .01160    .01130    .01101
25..................................................    .01479    .01432    .01388    .01346    .01306    .01269    .01233    .01200    .01168    .01138
26..................................................    .01545    .01495    .01448    .01404    .01362    .01322    .01284    .01248    .01214    .01182
27..................................................    .01623    .01570    .01520    .01472    .01427    .01385    .01344    .01306    .01270    .01235
28..................................................    .01712    .01655    .01601    .01551    .01503    .01457    .01414    .01373    .01334    .01298
29..................................................    .01813    .01752    .01695    .01641    .01589    .01541    .01494    .01451    .01409    .01370
30..................................................    .01927    .01862    .01801    .01743    .01688    .01635    .01586    .01539    .01495    .01452
31..................................................    .02056    .01987    .01922    .01859    .01801    .01745    .01692    .01642    .01594    .01548
32..................................................    .02201    .02127    .02057    .01990    .01927    .01868    .01811    .01757    .01706    .01657
33..................................................    .02363    .02284    .02209    .02138    .02071    .02007    .01946    .01888    .01833    .01781
34..................................................    .02543    .02458    .02378    .02302    .02230    .02162    .02096    .02034    .01975    .01919
35..................................................    .02741    .02651    .02565    .02484    .02407    .02333    .02264    .02197    .02134    .02073
36..................................................    .02956    .02859    .02768    .02681    .02599    .02520    .02446    .02374    .02307    .02242
37..................................................    .03189    .03087    .02990    .02897    .02809    .02725    .02645    .02569    .02496    .02427
38..................................................    .03443    .03334    .03230    .03131    .03037    .02948    .02862    .02781    .02703    .02628
39..................................................    .03718    .03602    .03491    .03386    .03285    .03190    .03099    .03011    .02928    .02849
40..................................................    .04015    .03891    .03774    .03662    .03555    .03453    .03355    .03262    .03173    .03088
41..................................................    .04335    .04204    .04079    .03959    .03846    .03737    .03633    .03534    .03439    .03348
42..................................................    .04677    .04538    .04405    .04278    .04157    .04042    .03931    .03825    .03724    .03627
43..................................................    .05042    .04894    .04754    .04619    .04491    .04368    .04250    .04138    .04030    .03926
44..................................................    .05432    .05276    .05127    .04984    .04848    .04718    .04593    .04473    .04358    .04248
45..................................................    .05849    .05684    .05526    .05375    .05231    .05092    .04960    .04832    .04710    .04593
46..................................................    .06292    .06118    .05952    .05792    .05639    .05492    .05352    .05217    .05087    .04963
47..................................................    .06765    .06581    .06405    .06237    .06075    .05920    .05771    .05628    .05491    .05359
48..................................................    .07265    .07071    .06886    .06708    .06537    .06373    .06216    .06064    .05919    .05779
49..................................................    .07791    .07587    .07392    .07204    .07024    .06851    .06685    .06525    .06371    .06223
50..................................................    .08343    .08129    .07923    .07726    .07536    .07354    .07178    .07009    .06847    .06690
51..................................................    .08924    .08699    .08483    .08276    .08076    .07884    .07699    .07520    .07349    .07183

[[Page 292]]

 
52..................................................    .09539    .09303    .09076    .08858    .08648    .08446    .08251    .08064    .07883    .07708
53..................................................    .10189    .09942    .09704    .09475    .09255    .09043    .08838    .08640    .08450    .08266
54..................................................    .10872    .10614    .10365    .10126    .09894    .09672    .09456    .09249    .09049    .08855
55..................................................    .11592    .11322    .11062    .10811    .10569    .10335    .10110    .09892    .09682    .09478
56..................................................    .12350    .12068    .11796    .11534    .11281    .11036    .10800    .10571    .10350    .10137
57..................................................    .13148    .12855    .12572    .12298    .12033    .11777    .11530    .11291    .11060    .10836
58..................................................    .13990    .13685    .13389    .13104    .12828    .12561    .12303    .12053    .11811    .11576
59..................................................    .14875    .14557    .14250    .13953    .13665    .13387    .13118    .12856    .12604    .12359
60..................................................    .15799    .15469    .15150    .14841    .14542    .14253    .13972    .13700    .13436    .13180
61..................................................    .16761    .16419    .16088    .15768    .15457    .15156    .14864    .14580    .14305    .14039
62..................................................    .17758    .17404    .17062    .16729    .16407    .16094    .15791    .15496    .15210    .14932
63..................................................    .18791    .18425    .18071    .17726    .17392    .17068    .16753    .16447    .16150    .15861
64..................................................    .19862    .19484    .19118    .18762    .18417    .18081    .17754    .17437    .17129    .16829
65..................................................    .20979    .20590    .20212    .19845    .19487    .19140    .18802    .18474    .18154    .17843
66..................................................    .22149    .21748    .21359    .20980    .20612    .20253    .19904    .19564    .19233    .18911
67..................................................    .23374    .22962    .22562    .22172    .21792    .21423    .21062    .20712    .20370    .20037
68..................................................    .24656    .24234    .23822    .23422    .23031    .22651    .22280    .21919    .21566    .21222
69..................................................    .25988    .25556    .25134    .24724    .24323    .23932    .23551    .23179    .22816    .22461
70..................................................    .27367    .26925    .26493    .26073    .25662    .25261    .24870    .24488    .24115    .23750
71..................................................    .28784    .28333    .27892    .27462    .27042    .26631    .26230    .25839    .25456    .25082
72..................................................    .30241    .29781    .29332    .28893    .28464    .28044    .27634    .27233    .26841    .26457
73..................................................    .31740    .31272    .30815    .30368    .29930    .29502    .29084    .28674    .28273    .27880
74..................................................    .33291    .32817    .32352    .31897    .31452    .31016    .30589    .30171    .29762    .29361
75..................................................    .34903    .34422    .33951    .33490    .33038    .32595    .32161    .31735    .31318    .30909
76..................................................    .36581    .36095    .35619    .35152    .34694    .34245    .33805    .33373    .32949    .32533
77..................................................    .38324    .37835    .37354    .36883    .36420    .35966    .35520    .35083    .34654    .34232
78..................................................    .40126    .39634    .39150    .38676    .38210    .37752    .37302    .36861    .36427    .36001
79..................................................    .41970    .41476    .40992    .40515    .40047    .39587    .39135    .38690    .38253    .37823
80..................................................    .43842    .43348    .42864    .42387    .41918    .41456    .41002    .40556    .40117    .39685
81..................................................    .45719    .45228    .44744    .44267    .43799    .43337    .42883    .42436    .41996    .41562
82..................................................    .47590    .47101    .46619    .46145    .45677    .45217    .44764    .44317    .43877    .43443
83..................................................    .49443    .48957    .48478    .48007    .47542    .47084    .46632    .46187    .45748    .45315
84..................................................    .51279    .50798    .50324    .49856    .49394    .48939    .48490    .48048    .47611    .47180
85..................................................    .53106    .52630    .52161    .51698    .51241    .50790    .50345    .49906    .49473    .49045
86..................................................    .54902    .54434    .53971    .53514    .53062    .52616    .52176    .51741    .51312    .50888
87..................................................    .56640    .56178    .55722    .55271    .54826    .54386    .53951    .53521    .53097    .52677
88..................................................    .58326    .57872    .57423    .56979    .56541    .56107    .55678    .55254    .54834    .54420
89..................................................    .59994    .59548    .59107    .58671    .58240    .57813    .57391    .56973    .56560    .56152
90..................................................    .61662    .61226    .60794    .60367    .59944    .59526    .59112    .58702    .58296    .57894
91..................................................    .63305    .62879    .62457    .62040    .61627    .61217    .60812    .60411    .60013    .59619
92..................................................    .64876    .64461    .64050    .63643    .63239    .62839    .62443    .62051    .61662    .61277
93..................................................    .66355    .65950    .65550    .65153    .64759    .64369    .63983    .63600    .63220    .62843
94..................................................    .67722    .67328    .66938    .66551    .66167    .65786    .65409    .65035    .64664    .64296
95..................................................    .68967    .68583    .68203    .67825    .67451    .67079    .66711    .66345    .65983    .65623
96..................................................    .70076    .69701    .69330    .68961    .68595    .68231    .67871    .67513    .67158    .66806
97..................................................    .71089    .70722    .70359    .69998    .69640    .69284    .68931    .68581    .68234    .67888
98..................................................    .72001    .71642    .71286    .70933    .70582    .70233    .69887    .69544    .69203    .68864
99..................................................    .72844    .72492    .72143    .71796    .71452    .71110    .70770    .70433    .70098    .69765
100.................................................    .73623    .73278    .72935    .72594    .72256    .71920    .71586    .71254    .70924    .70597
101.................................................    .74361    .74021    .73684    .73349    .73016    .72685    .72356    .72029    .71704    .71382
102.................................................    .75128    .74794    .74463    .74133    .73806    .73480    .73157    .72835    .72515    .72198
103.................................................    .75938    .75610    .75284    .74961    .74639    .74319    .74000    .73684    .73369    .73056
104.................................................    .76835    .76514    .76194    .75877    .75561    .75246    .74934    .74623    .74313    .74005
105.................................................    .77956    .77643    .77332    .77023    .76714    .76408    .76102    .75798    .75496    .75195
106.................................................    .79632    .79334    .79038    .78743    .78449    .78157    .77865    .77575    .77285    .76997
107.................................................    .82154    .81884    .81615    .81346    .81079    .80811    .80545    .80279    .80014    .79750
108.................................................    .86487    .86274    .86061    .85848    .85635    .85423    .85210    .84998    .84787    .84575
109.................................................    .93900    .93800    .93700    .93600    .93500    .93400    .93300    .93200    .93100    .93000
--------------------------------------------------------------------------------------------------------------------------------------------------------

    (f) Valuation of charitable remainder unitrusts having certain 
payout sequences for transfers for which the valuation date is after 
April 30, 1999, and before May 1, 2009--(1) In general. Except as 
otherwise provided in paragraph (f)(2) of this section, in the case of 
transfers for which the valuation date is after April 30,

[[Page 293]]

1999, and before May 1, 2009, the present value of a remainder interest 
is determined under paragraphs (f)(3) through (f)(6) of this section, 
provided that the amount of the payout as of any payout date during any 
taxable year of the trust is not larger than the amount that the trust 
could distribute on such date under Sec. 1.664-3(a)(1)(v) if the 
taxable year of the trust were to end on such date. See, however, Sec. 
1.7520-3(b) (relating to exceptions to the use of the prescribed tables 
under certain circumstances).
    (2) Transitional rules for valuation of charitable remainder 
unitrusts. (i) For purposes of sections 2055, 2106, or 2624, if on May 
1, 1999, the decedent was mentally incompetent so that the disposition 
of the property could not be changed, and the decedent died after April 
30, 1999, without having regained competency to dispose of the 
decedent's property, or the decedent died within 90 days of the date 
that the decedent first regained competency after April 30, 1999, the 
present value of a remainder interest under this section is determined 
as if the valuation date with respect to the decedent's gross estate is 
either before May 1, 1999, or after April 30, 1999, at the option of the 
decedent's executor.
    (ii) For purposes of sections 170, 2055, 2106, 2522, or 2624, in the 
case of transfers to a charitable remainder unitrust for which the 
valuation date is after April 30, 1999, and before July 1, 1999, the 
present value of a remainder interest based on one or more measuring 
lives is determined under this section by use of the section 7520 
interest rate for the month in which the valuation date occurs (see 
Sec. Sec. 1.7520-1(b) and 1.7520-2(a)(2)) and the appropriate actuarial 
tables under either paragraph (e)(6) or (f)(6) of this section, at the 
option of the donor or the decedent's executor, as the case may be.
    (iii) For purposes of paragraphs (f)(2)(i) and (f)(2)(ii) of this 
section, where the donor or decedent's executor is given the option to 
use the appropriate actuarial tables under either paragraph (e)(6) or 
(f)(6) of this section, the donor or decedent's executor must use the 
same actuarial table with respect to each individual transaction and 
with respect to all transfers occurring on the valuation date (for 
example, gift and income tax charitable deductions with respect to the 
same transfer must be determined based on the same tables, and all 
assets includible in the gross estate and/or estate tax deductions 
claimed must be valued based on the same tables).
    (3) Adjusted payout rate. For transfers for which the valuation date 
is after April 30, 1999, and before May 1, 2009, the adjusted payout 
rate is determined by using the appropriate Table F, contained in Sec. 
1.664-4(e)(6), for the section 7520 interest rate applicable to the 
transfer. If the interest rate is between 4.2 and 14 percent, see Sec. 
1.664-4(e)(6). If the interest rate is below 4.2 percent or greater than 
14 percent, see Sec. 1.664-4(b). See Sec. 1.664-4(e) for rules 
applicable in determining the adjusted payout rate.
    (4) Period is a term of years. If the period described in Sec. 
1.664-3(a)(5) is a term of years, the factor that is used in determining 
the present value of the remainder interest for transfers for which the 
valuation date is after April 30, 1999, and before May 1, 2009, is the 
factor under the appropriate adjusted payout rate in Table D in Sec. 
1.664-4(e)(6) corresponding to the number of years in the term. If the 
adjusted payout rate is an amount that is between adjusted payout rates 
for which factors are provided in Table D, a linear interpolation must 
be made. The present value of the remainder interest is determined by 
multiplying the net fair market value (as of the appropriate valuation 
date) of the property placed in trust by the factor determined under 
this paragraph. Generally, for purposes of this section, the valuation 
date is, in the case of an inter vivos transfer, the date on which the 
property is transferred to the trust by the donor, and, in the case of a 
testamentary transfer under sections 2055, 2106, or 2624, the valuation 
date is the date of death. See Sec. 1.664-4(e)(4) for additional rules 
regarding the valuation date. See Sec. 1.664-4(e)(4) for an example 
that illustrates the application of this paragraph (f)(4).
    (5) Period is the life of one individual. If the period described in 
Sec. 1.664-3(a)(5) is the life of one individual, the factor that is 
used in determining the present value of the remainder interest for 
transfers for which the valuation date

[[Page 294]]

is after April 30, 1999, and before May 1, 2009, is the factor in Table 
U(1) in paragraph (f)(6) of this section under the appropriate adjusted 
payout. For purposes of the computations described in this paragraph 
(f)(5), the age of an individual is the age of that individual at the 
individual's nearest birthday. If the adjusted payout rate is an amount 
that is between adjusted payout rates for which factors are provided in 
the appropriate table, a linear interpolation must be made. The rules 
provided in Sec. 1.664-4(e)(5) apply for determining the present value 
of the remainder interest. See Sec. 1.664-4(e)(5) for an example 
illustrating the application of this paragraph (f)(5) (using current 
actuarial tables).
    (6) Actuarial Table U(1) for transfers for which the valuation date 
is after April 30, 1999, and before May 1, 2009. For transfers for which 
the valuation date is after April 30, 1999, and before May 1, 2009, the 
present value of a charitable remainder unitrust interest that is 
dependent on the termination of a life interest is determined by using 
the section 7520 rate, Table U(1) in this paragraph (f)(6), and Tables 
F(4.2) through F(14.0) in Sec. 1.664-4(e)(6). See, however, Sec. 
1.7520-3(b) (relating to exceptions to the use of prescribed tables 
under certain circumstances). Many actuarial factors not contained in 
the following tables are contained in Internal Revenue Service 
Publication 1458, ``Actuarial Values, Book Beth,'' (7-1999). Publication 
1458 is no longer available for purchase from the Superintendent of 
Documents, United States Government Printing Office. However, pertinent 
factors in this publication may be obtained by a written request to: 
CC:PA:LPD:PR (IRS Publication 1458), Room 5205, Internal Revenue 
Service, P.O.Box 7604, Ben Franklin Station, Washington, DC 20044.

                                       Table U(1)--Based on Life Table 90CM Unitrust Single Life Remainder Factors
                                                [Applicable After April 30, 1999, and Before May 1, 2009]
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                      Interest rate
                              Age                              -----------------------------------------------------------------------------------------
                                                                  4.2%     4.4%     4.6%     4.8%     5.0%     5.2%     5.4%     5.6%     .8%      6.0%
--------------------------------------------------------------------------------------------------------------------------------------------------------
0.............................................................   .06177   .05580   .05061   .04609   .04215   .03871   .03570   .03307   .03075   .02872
1.............................................................   .05543   .04925   .04388   .03919   .03509   .03151   .02838   .02563   .02321   .02109
2.............................................................   .05716   .05081   .04528   .04045   .03622   .03252   .02927   .02642   .02391   .02170
3.............................................................   .05920   .05268   .04699   .04201   .03765   .03382   .03046   .02750   .02490   .02260
4.............................................................   .06143   .05475   .04889   .04376   .03926   .03530   .03182   .02876   .02605   .02366
5.............................................................   .06384   .05697   .05095   .04567   .04103   .03694   .03334   .03016   .02735   .02487
6.............................................................   .06637   .05933   .05315   .04771   .04292   .03870   .03497   .03168   .02876   .02618
7.............................................................   .06905   .06183   .05547   .04987   .04494   .04058   .03673   .03332   .03029   .02761
8.............................................................   .07186   .06445   .05792   .05216   .04708   .04258   .03859   .03506   .03192   .02914
9.............................................................   .07482   .06722   .06052   .05460   .04936   .04471   .04060   .03694   .03369   .03079
10............................................................   .07793   .07015   .06327   .05718   .05179   .04700   .04274   .03896   .03559   .03259
11............................................................   .08120   .07323   .06617   .05991   .05435   .04942   .04502   .04111   .03762   .03450
12............................................................   .08461   .07645   .06920   .06277   .05706   .05197   .04744   .04339   .03978   .03655
13............................................................   .08812   .07976   .07234   .06574   .05985   .05461   .04993   .04576   .04202   .03867
14............................................................   .09168   .08313   .07552   .06874   .06269   .05729   .05247   .04815   .04428   .04081
15............................................................   .09527   .08652   .07872   .07176   .06554   .05999   .05501   .05055   .04655   .04296
16............................................................   .09886   .08991   .08192   .07478   .06839   .06267   .05754   .05294   .04880   .04508
17............................................................   .10249   .09334   .08515   .07782   .07126   .06537   .06008   .05533   .05105   .04720
18............................................................   .10616   .09680   .08842   .08090   .07415   .06809   .06264   .05774   .05332   .04933
19............................................................   .10994   .10037   .09178   .08407   .07714   .07091   .06529   .06023   .05566   .05153
20............................................................   .11384   .10406   .09527   .08737   .08025   .07383   .06805   .06283   .05811   .05384
21............................................................   .11790   .10790   .09891   .09080   .08349   .07690   .07094   .06555   .06068   .05626
22............................................................   .12208   .11188   .10267   .09436   .08686   .08008   .07395   .06839   .06336   .05879
23............................................................   .12643   .11601   .10659   .09808   .09038   .08342   .07710   .07138   .06618   .06146
24............................................................   .13095   .12031   .11069   .10197   .09408   .08692   .08042   .07452   .06915   .06427
25............................................................   .13567   .12481   .11497   .10605   .09795   .09060   .08392   .07784   .07230   .06726
26............................................................   .14058   .12950   .11945   .11032   .10202   .09447   .08760   .08134   .07563   .07042
27............................................................   .14571   .13442   .12415   .11481   .10631   .09856   .09149   .08505   .07916   .07379
28............................................................   .15104   .13953   .12904   .11949   .11078   .10284   .09558   .08895   .08288   .07733
29............................................................   .15656   .14484   .13414   .12438   .11546   .10731   .09986   .09304   .08679   .08106
30............................................................   .16229   .15034   .13943   .12946   .12034   .11198   .10433   .09732   .09089   .08498
31............................................................   .16821   .15605   .14493   .13474   .12541   .11685   .10900   .10179   .09517   .08909
32............................................................   .17433   .16196   .15063   .14023   .13069   .12193   .11387   .10647   .09966   .09339
33............................................................   .18068   .16810   .15655   .14595   .13620   .12723   .11897   .11137   .10437   .09791
34............................................................   .18724   .17446   .16270   .15189   .14193   .13275   .12430   .11650   .10930   .10265
35............................................................   .19405   .18107   .16910   .15808   .14791   .13853   .12987   .12187   .11448   .10764
36............................................................   .20109   .18791   .17574   .16451   .15414   .14456   .13569   .12749   .11990   .11287
37............................................................   .20838   .19500   .18263   .17120   .16062   .15083   .14177   .13337   .12558   .11835

[[Page 295]]

 
38............................................................   .21593   .20236   .18979   .17816   .16739   .15739   .14813   .13953   .13154   .12412
39............................................................   .22374   .20998   .19723   .18540   .17443   .16423   .15477   .14597   .13779   .13017
40............................................................   .23183   .21789   .20496   .19294   .18177   .17138   .16172   .15272   .14434   .13653
41............................................................   .24021   .22611   .21299   .20079   .18943   .17885   .16899   .15980   .15123   .14322
42............................................................   .24889   .23463   .22134   .20896   .19741   .18665   .17660   .16721   .15845   .15025
43............................................................   .25786   .24344   .23000   .21744   .20572   .19477   .18453   .17496   .16601   .15762
44............................................................   .26712   .25257   .23896   .22625   .21435   .20322   .19281   .18305   .17391   .16534
45............................................................   .27665   .26196   .24821   .23534   .22328   .21198   .20139   .19145   .18213   .17338
46............................................................   .28644   .27163   .25774   .24472   .23251   .22105   .21028   .20018   .19068   .18174
47............................................................   .29647   .28155   .26754   .25438   .24201   .23040   .21947   .20919   .19952   .19041
48............................................................   .30676   .29173   .27760   .26431   .25181   .24004   .22896   .21852   .20868   .19941
49............................................................   .31729   .30217   .28794   .27453   .26190   .24999   .23876   .22817   .21817   .20873
50............................................................   .32808   .31289   .29856   .28505   .27229   .26026   .24889   .23814   .22799   .21839
51............................................................   .33912   .32387   .30946   .29585   .28299   .27083   .25933   .24845   .23815   .22840
52............................................................   .35038   .33507   .32060   .30691   .29395   .28168   .27005   .25904   .24861   .23872
53............................................................   .36185   .34651   .33198   .31821   .30517   .29280   .28106   .26993   .25937   .24934
54............................................................   .37352   .35815   .34358   .32976   .31664   .30418   .29234   .28110   .27042   .26026
55............................................................   .38539   .37002   .35542   .34155   .32836   .31583   .30390   .29256   .28177   .27149
56............................................................   .39746   .38209   .36748   .35358   .34034   .32774   .31574   .30431   .29342   .28303
57............................................................   .40971   .39437   .37976   .36584   .35257   .33992   .32785   .31634   .30536   .29488
58............................................................   .42212   .40682   .39222   .37829   .36500   .35231   .34019   .32862   .31756   .30699
59............................................................   .43464   .41939   .40482   .39090   .37759   .36488   .35272   .34109   .32996   .31932
60............................................................   .44726   .43207   .41754   .40364   .39034   .37761   .36542   .35375   .34257   .33186
61............................................................   .45999   .44488   .43041   .41655   .40326   .39053   .37833   .36662   .35540   .34463
62............................................................   .47286   .45785   .44345   .42964   .41639   .40367   .39146   .37974   .36848   .35767
63............................................................   .48589   .47098   .45667   .44293   .42972   .41703   .40484   .39311   .38184   .37100
64............................................................   .49903   .48426   .47005   .45638   .44324   .43060   .41843   .40671   .39544   .38458
65............................................................   .51229   .49766   .48357   .47001   .45694   .44435   .43223   .42054   .40927   .39841
66............................................................   .52568   .51121   .49726   .48381   .47084   .45833   .44626   .43461   .42337   .41252
67............................................................   .53924   .52495   .51115   .49784   .48498   .47256   .46056   .44898   .43778   .42696
68............................................................   .55293   .53883   .52521   .51205   .49932   .48701   .47511   .46360   .45246   .44169
69............................................................   .56671   .55283   .53940   .52640   .51382   .50165   .48985   .47844   .46738   .45666
70............................................................   .58052   .56687   .55365   .54084   .52843   .51639   .50473   .49342   .48245   .47181
71............................................................   .59431   .58091   .56791   .55529   .54306   .53118   .51966   .50847   .49761   .48707
72............................................................   .60804   .59490   .58213   .56973   .55768   .54598   .53461   .52357   .51283   .50239
73............................................................   .62168   .60881   .59629   .58411   .57227   .56076   .54955   .53866   .52806   .51774
74............................................................   .63528   .62268   .61042   .59848   .58686   .57555   .56453   .55380   .54335   .53316
75............................................................   .64887   .63657   .62458   .61290   .60151   .59041   .57959   .56904   .55875   .54872
76............................................................   .66249   .65049   .63880   .62739   .61625   .60538   .59478   .58443   .57432   .56446
77............................................................   .67612   .66446   .65307   .64194   .63108   .62046   .61009   .59995   .59005   .58037
78............................................................   .68975   .67843   .66736   .65654   .64596   .63561   .62548   .61558   .60590   .59643
79............................................................   .70330   .69233   .68160   .67109   .66081   .65074   .64088   .63123   .62178   .61253
80............................................................   .71666   .70605   .69566   .68548   .67550   .66573   .65615   .64676   .63755   .62853
81............................................................   .72975   .71950   .70946   .69961   .68995   .68047   .67117   .66205   .65310   .64433
82............................................................   .74250   .73263   .72293   .71342   .70407   .69490   .68589   .67705   .66837   .65984
83............................................................   .75493   .74542   .73608   .72690   .71788   .70902   .70031   .69175   .68333   .67506
84............................................................   .76712   .75798   .74900   .74016   .73147   .72292   .71451   .70624   .69810   .69010
85............................................................   .77913   .77037   .76175   .75326   .74491   .73668   .72859   .72061   .71276   .70503
86............................................................   .79086   .78248   .77423   .76610   .75808   .75019   .74241   .73474   .72719   .71974
87............................................................   .80218   .79418   .78628   .77850   .77083   .76326   .75580   .74844   .74118   .73402
88............................................................   .81307   .80544   .79790   .79047   .78313   .77589   .76874   .76169   .75473   .74786
89............................................................   .82355   .81628   .80909   .80200   .79500   .78808   .78125   .77450   .76783   .76125
90............................................................   .83360   .82668   .81985   .81309   .80642   .79982   .79330   .78685   .78048   .77418
91............................................................   .84308   .83650   .83000   .82357   .81721   .81092   .80470   .79855   .79246   .78645
92............................................................   .85182   .84556   .83937   .83325   .82718   .82119   .81525   .80937   .80356   .79780
93............................................................   .85985   .85390   .84800   .84215   .83637   .83064   .82497   .81936   .81379   .80829
94............................................................   .86732   .86164   .85601   .85044   .84491   .83944   .83402   .82865   .82333   .81806
95............................................................   .87437   .86895   .86359   .85827   .85300   .84778   .84260   .83746   .83237   .82733
96............................................................   .88097   .87582   .87070   .86563   .86060   .85561   .85066   .84575   .84088   .83605
97............................................................   .88708   .88216   .87727   .87243   .86762   .86285   .85811   .85341   .84875   .84413
98............................................................   .89280   .88810   .88343   .87880   .87420   .86964   .86511   .86061   .85614   .85171
99............................................................   .89836   .89388   .88943   .88501   .88062   .87626   .87193   .86763   .86336   .85911
100...........................................................   .90375   .89948   .89525   .89103   .88685   .88269   .87856   .87445   .87037   .86632
101...........................................................   .90905   .90500   .90097   .89696   .89298   .88902   .88509   .88118   .87729   .87342
102...........................................................   .91424   .91040   .90658   .90278   .89900   .89524   .89150   .88778   .88408   .88040
103...........................................................   .91939   .91575   .91214   .90854   .90496   .90139   .89785   .89432   .89081   .88732
104...........................................................   .92485   .92144   .91805   .91467   .91131   .90796   .90463   .90131   .89800   .89471
105...........................................................   .93020   .92701   .92383   .92067   .91751   .91437   .91125   .90813   .90502   .90193

[[Page 296]]

 
106...........................................................   .93701   .93411   .93122   .92834   .92546   .92260   .91974   .91689   .91405   .91122
107...........................................................   .94522   .94268   .94013   .93760   .93507   .93254   .93002   .92750   .92499   .92249
108...........................................................   .95782   .95583   .95385   .95187   .94989   .94791   .94593   .94396   .94199   .94002
109...........................................................   .97900   .97800   .97700   .97600   .97500   .97400   .97300   .97200   .97100   .97000
--------------------------------------------------------------------------------------------------------------------------------------------------------


                                       Table U(1)--Based on Life Table 90CM Unitrust Single Life Remainder Factors
                                                [Applicable After April 30, 1999, and Before May 1, 2009]
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                      Interest rate
                              Age                              -----------------------------------------------------------------------------------------
                                                                  6.2%     6.4%     6.6%     6.8%     7.0%     7.2%     7.4%     7.6%     7.8%     8.0%
--------------------------------------------------------------------------------------------------------------------------------------------------------
0.............................................................   .02693   .02534   .02395   .02271   .02161   .02063   .01976   .01898   .01828   .01765
1.............................................................   .01922   .01756   .01610   .01480   .01365   .01263   .01171   .01090   .01017   .00951
2.............................................................   .01975   .01802   .01650   .01514   .01393   .01286   .01190   .01104   .01028   .00959
3.............................................................   .02056   .01876   .01717   .01575   .01449   .01336   .01235   .01145   .01064   .00992
4.............................................................   .02155   .01967   .01800   .01652   .01520   .01401   .01296   .01201   .01116   .01039
5.............................................................   .02266   .02071   .01896   .01741   .01603   .01479   .01368   .01269   .01179   .01098
6.............................................................   .02389   .02184   .02003   .01841   .01696   .01566   .01450   .01345   .01251   .01166
7.............................................................   .02522   .02309   .02120   .01950   .01799   .01663   .01540   .01431   .01332   .01242
8.............................................................   .02665   .02444   .02246   .02069   .01910   .01768   .01640   .01524   .01420   .01326
9.............................................................   .02821   .02590   .02384   .02199   .02033   .01884   .01750   .01629   .01520   .01421
10............................................................   .02990   .02750   .02535   .02342   .02169   .02013   .01872   .01745   .01631   .01526
11............................................................   .03172   .02922   .02698   .02497   .02316   .02153   .02006   .01872   .01752   .01643
12............................................................   .03365   .03106   .02872   .02663   .02474   .02303   .02149   .02010   .01884   .01769
13............................................................   .03566   .03297   .03054   .02835   .02638   .02460   .02299   .02154   .02021   .01901
14............................................................   .03770   .03490   .03237   .03010   .02804   .02619   .02450   .02298   .02159   .02033
15............................................................   .03973   .03682   .03419   .03182   .02968   .02775   .02599   .02439   .02294   .02162
16............................................................   .04173   .03871   .03598   .03352   .03129   .02926   .02743   .02576   .02424   .02286
17............................................................   .04372   .04059   .03775   .03519   .03287   .03076   .02884   .02710   .02551   .02406
18............................................................   .04573   .04248   .03953   .03686   .03444   .03224   .03024   .02842   .02676   .02524
19............................................................   .04780   .04443   .04137   .03859   .03607   .03378   .03169   .02978   .02804   .02646
20............................................................   .04997   .04647   .04329   .04040   .03778   .03539   .03321   .03122   .02940   .02773
21............................................................   .05226   .04862   .04532   .04232   .03958   .03709   .03481   .03274   .03083   .02909
22............................................................   .05465   .05088   .04745   .04432   .04148   .03888   .03650   .03433   .03234   .03052
23............................................................   .05716   .05325   .04969   .04645   .04348   .04077   .03830   .03603   .03394   .03203
24............................................................   .05983   .05578   .05208   .04871   .04562   .04280   .04021   .03784   .03566   .03367
25............................................................   .06266   .05846   .05463   .05112   .04791   .04497   .04227   .03980   .03752   .03543
26............................................................   .06566   .06131   .05734   .05369   .05035   .04729   .04448   .04189   .03951   .03732
27............................................................   .06887   .06436   .06024   .05646   .05298   .04979   .04686   .04416   .04168   .03939
28............................................................   .07225   .06758   .06331   .05938   .05577   .05245   .04940   .04658   .04398   .04159
29............................................................   .07581   .07099   .06656   .06248   .05873   .05528   .05210   .04916   .04645   .04394
30............................................................   .07956   .07457   .06998   .06575   .06186   .05827   .05495   .05189   .04906   .04644
31............................................................   .08348   .07833   .07358   .06920   .06515   .06142   .05797   .05478   .05182   .04908
32............................................................   .08761   .08228   .07736   .07282   .06863   .06475   .06116   .05783   .05475   .05189
33............................................................   .09195   .08645   .08136   .07666   .07231   .06828   .06454   .06108   .05786   .05488
34............................................................   .09651   .09082   .08557   .08070   .07619   .07200   .06812   .06452   .06117   .05805
35............................................................   .10131   .09545   .09002   .08498   .08030   .07596   .07193   .06818   .06469   .06144
36............................................................   .10635   .10031   .09470   .08949   .08465   .08015   .07596   .07206   .06842   .06503
37............................................................   .11165   .10542   .09963   .09424   .08923   .08457   .08022   .07617   .07238   .06885
38............................................................   .11722   .11081   .10484   .09927   .09409   .08926   .08475   .08054   .07661   .07293
39............................................................   .12308   .11648   .11032   .10458   .09922   .09422   .08955   .08518   .08109   .07726
40............................................................   .12925   .12246   .11612   .11020   .10466   .09949   .09465   .09011   .08587   .08189
41............................................................   .13575   .12877   .12225   .11614   .11043   .10508   .10007   .09537   .09097   .08683
42............................................................   .14259   .13542   .12871   .12243   .11654   .11101   .10583   .10097   .09640   .09210
43............................................................   .14977   .14242   .13552   .12905   .12298   .11729   .11193   .10690   .10217   .09771
44............................................................   .15731   .14976   .14269   .13604   .12979   .12391   .11838   .11318   .10828   .10367
45............................................................   .16516   .15743   .15017   .14334   .13691   .13086   .12516   .11979   .11472   .10994
46............................................................   .17334   .16544   .15800   .15099   .14438   .13816   .13228   .12674   .12150   .11656
47............................................................   .18184   .17375   .16613   .15895   .15217   .14576   .13972   .13400   .12860   .12349
48............................................................   .19066   .18240   .17461   .16724   .16029   .15371   .14749   .14161   .13604   .13077
49............................................................   .19981   .19138   .18342   .17588   .16875   .16201   .15562   .14956   .14383   .13839
50............................................................   .20931   .20072   .19259   .18489   .17759   .17067   .16412   .15790   .15199   .14639
51............................................................   .21917   .21042   .20212   .19426   .18679   .17971   .17299   .16660   .16054   .15477
52............................................................   .22933   .22043   .21198   .20395   .19633   .18909   .18220   .17566   .16943   .16350
53............................................................   .23981   .23076   .22216   .21399   .20621   .19881   .19176   .18506   .17867   .17258
54............................................................   .25060   .24141   .23267   .22434   .21642   .20886   .20166   .19480   .18826   .18201

[[Page 297]]

 
55............................................................   .26171   .25239   .24351   .23504   .22697   .21927   .21192   .20491   .19821   .19182
56............................................................   .27313   .26369   .25468   .24608   .23787   .23003   .22254   .21538   .20854   .20199
57............................................................   .28487   .27531   .26618   .25746   .24912   .24114   .23351   .22621   .21923   .21254
58............................................................   .29688   .28722   .27798   .26914   .26067   .25257   .24481   .23738   .23025   .22343
59............................................................   .30913   .29937   .29002   .28107   .27249   .26427   .25639   .24882   .24157   .23461
60............................................................   .32159   .31175   .30231   .29325   .28457   .27623   .26823   .26055   .25317   .24608
61............................................................   .33429   .32437   .31485   .30571   .29692   .28848   .28037   .27257   .26507   .25786
62............................................................   .34728   .33730   .32770   .31847   .30960   .30106   .29285   .28495   .27734   .27001
63............................................................   .36057   .35053   .34087   .33157   .32262   .31400   .30569   .29769   .28998   .28255
64............................................................   .37412   .36404   .35433   .34498   .33596   .32726   .31887   .31078   .30298   .29545
65............................................................   .38794   .37783   .36809   .35868   .34961   .34085   .33239   .32422   .31633   .30871
66............................................................   .40205   .39193   .38216   .37272   .36361   .35479   .34628   .33804   .33008   .32238
67............................................................   .41650   .40639   .39661   .38715   .37800   .36915   .36059   .35230   .34428   .33651
68............................................................   .43126   .42117   .41139   .40193   .39277   .38390   .37530   .36697   .35890   .35108
69............................................................   .44628   .43622   .42648   .41703   .40787   .39898   .39037   .38201   .37391   .36604
70............................................................   .46150   .45149   .44178   .43236   .42321   .41433   .40571   .39735   .38922   .38132
71............................................................   .47683   .46689   .45723   .44785   .43873   .42987   .42126   .41290   .40476   .39685
72............................................................   .49225   .48238   .47279   .46346   .45439   .44556   .43697   .42862   .42048   .41257
73............................................................   .50770   .49793   .48841   .47915   .47013   .46135   .45280   .44447   .43635   .42844
74............................................................   .52324   .51358   .50416   .49498   .48603   .47731   .46880   .46051   .45242   .44454
75............................................................   .53894   .52939   .52008   .51100   .50214   .49349   .48505   .47681   .46877   .46092
76............................................................   .55483   .54543   .53624   .52728   .51852   .50996   .50160   .49344   .48546   .47766
77............................................................   .57091   .56167   .55263   .54380   .53516   .52671   .51845   .51038   .50247   .49475
78............................................................   .58716   .57809   .56922   .56053   .55203   .54372   .53557   .52760   .51980   .51216
79............................................................   .60346   .59459   .58590   .57738   .56904   .56086   .55286   .54501   .53732   .52978
80............................................................   .61969   .61102   .60252   .59419   .58601   .57800   .57014   .56243   .55487   .54745
81............................................................   .63571   .62726   .61897   .61082   .60283   .59499   .58729   .57974   .57232   .56503
82............................................................   .65146   .64324   .63515   .62722   .61942   .61176   .60423   .59683   .58957   .58242
83............................................................   .66693   .65893   .65108   .64335   .63575   .62828   .62093   .61371   .60660   .59962
84............................................................   .68222   .67447   .66684   .65934   .65195   .64468   .63753   .63049   .62356   .61674
85............................................................   .69742   .68993   .68255   .67528   .66812   .66106   .65411   .64727   .64053   .63389
86............................................................   .71241   .70517   .69805   .69102   .68410   .67727   .67054   .66390   .65736   .65091
87............................................................   .72696   .72000   .71313   .70635   .69967   .69307   .68656   .68014   .67381   .66756
88............................................................   .74108   .73438   .72777   .72125   .71480   .70845   .70217   .69597   .68985   .68380
89............................................................   .75475   .74832   .74198   .73571   .72951   .72339   .71734   .71137   .70547   .69963
90............................................................   .76796   .76180   .75572   .74971   .74376   .73788   .73207   .72633   .72065   .71503
91............................................................   .78049   .77460   .76878   .76302   .75732   .75168   .74610   .74058   .73512   .72972
92............................................................   .79211   .78647   .78089   .77537   .76990   .76449   .75913   .75383   .74858   .74338
93............................................................   .80283   .79743   .79208   .78679   .78154   .77634   .77119   .76610   .76105   .75604
94............................................................   .81283   .80765   .80253   .79744   .79240   .78741   .78247   .77756   .77270   .76789
95............................................................   .82233   .81737   .81245   .80757   .80274   .79795   .79320   .78849   .78382   .77918
96............................................................   .83126   .82651   .82180   .81712   .81248   .80788   .80332   .79880   .79431   .78985
97............................................................   .83953   .83498   .83046   .82597   .82152   .81710   .81271   .80836   .80404   .79976
98............................................................   .84731   .84294   .83860   .83429   .83002   .82577   .82155   .81737   .81321   .80908
99............................................................   .85490   .85071   .84656   .84243   .83832   .83425   .83020   .82618   .82219   .81822
100...........................................................   .86229   .85828   .85431   .85035   .84642   .84252   .83864   .83478   .83095   .82714
101...........................................................   .86958   .86575   .86195   .85818   .85442   .85069   .84698   .84329   .83962   .83597
102...........................................................   .87674   .87310   .86947   .86587   .86229   .85873   .85518   .85166   .84815   .84466
103...........................................................   .88384   .88038   .87694   .87351   .87010   .86671   .86334   .85998   .85663   .85331
104...........................................................   .89143   .88817   .88492   .88169   .87847   .87526   .87207   .86889   .86573   .86258
105...........................................................   .89885   .89578   .89272   .88967   .88664   .88361   .88060   .87760   .87461   .87163
106...........................................................   .90840   .90559   .90278   .89999   .89720   .89442   .89165   .88888   .88613   .88338
107...........................................................   .91999   .91750   .91501   .91253   .91005   .90758   .90511   .90265   .90019   .89774
108...........................................................   .93805   .93609   .93412   .93216   .93020   .92824   .92629   .92434   .92239   .92044
109...........................................................   .96900   .96800   .96700   .96600   .96500   .96400   .96300   .96200   .96100   .96000
--------------------------------------------------------------------------------------------------------------------------------------------------------


                                       Table U(1)--Based on Life Table 90CM Unitrust Single Life Remainder Factors
                                                [Applicable After April 30, 1999, and Before May 1, 2009]
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                      Interest rate
                              Age                              -----------------------------------------------------------------------------------------
                                                                  8.2%     8.4%     8.6%     8.8%     9.0%     9.2%     9.4%     9.6%     9.8%    10.0%
--------------------------------------------------------------------------------------------------------------------------------------------------------
0.............................................................   .01709   .01658   .01612   .01570   .01532   .01497   .01466   .01437   .01410   .01386
1.............................................................   .00892   .00839   .00791   .00747   .00708   .00672   .00639   .00609   .00582   .00557
2.............................................................   .00896   .00840   .00790   .00744   .00702   .00664   .00629   .00598   .00569   .00542
3.............................................................   .00926   .00867   .00814   .00765   .00721   .00681   .00644   .00611   .00580   .00552

[[Page 298]]

 
4.............................................................   .00970   .00908   .00851   .00800   .00753   .00711   .00672   .00636   .00604   .00574
5.............................................................   .01026   .00960   .00900   .00846   .00796   .00751   .00710   .00672   .00637   .00606
6.............................................................   .01089   .01019   .00956   .00899   .00846   .00799   .00755   .00715   .00678   .00644
7.............................................................   .01161   .01088   .01021   .00960   .00905   .00854   .00808   .00765   .00726   .00690
8.............................................................   .01241   .01163   .01093   .01029   .00970   .00917   .00867   .00822   .00781   .00743
9.............................................................   .01331   .01249   .01175   .01107   .01045   .00988   .00936   .00889   .00845   .00804
10............................................................   .01432   .01346   .01268   .01196   .01131   .01071   .01016   .00965   .00918   .00875
11............................................................   .01543   .01453   .01370   .01295   .01226   .01162   .01104   .01051   .01001   .00956
12............................................................   .01664   .01569   .01482   .01403   .01330   .01263   .01202   .01145   .01093   .01045
13............................................................   .01791   .01691   .01600   .01516   .01440   .01369   .01304   .01245   .01190   .01139
14............................................................   .01918   .01813   .01717   .01629   .01548   .01474   .01406   .01343   .01285   .01231
15............................................................   .02041   .01931   .01831   .01738   .01653   .01576   .01504   .01437   .01376   .01320
16............................................................   .02160   .02044   .01938   .01841   .01752   .01670   .01595   .01525   .01460   .01401
17............................................................   .02274   .02152   .02041   .01940   .01846   .01760   .01680   .01607   .01539   .01476
18............................................................   .02386   .02258   .02142   .02035   .01936   .01846   .01762   .01685   .01613   .01547
19............................................................   .02500   .02367   .02245   .02132   .02029   .01933   .01845   .01764   .01689   .01619
20............................................................   .02621   .02481   .02353   .02235   .02126   .02025   .01933   .01847   .01768   .01694
21............................................................   .02749   .02603   .02468   .02344   .02229   .02124   .02026   .01936   .01852   .01774
22............................................................   .02884   .02730   .02589   .02458   .02338   .02227   .02124   .02029   .01940   .01859
23............................................................   .03028   .02867   .02718   .02581   .02454   .02337   .02229   .02128   .02035   .01949
24............................................................   .03183   .03013   .02857   .02713   .02580   .02456   .02342   .02236   .02138   .02047
25............................................................   .03350   .03172   .03008   .02857   .02717   .02587   .02467   .02355   .02251   .02155
26............................................................   .03530   .03344   .03172   .03013   .02865   .02729   .02602   .02484   .02375   .02273
27............................................................   .03727   .03532   .03351   .03183   .03028   .02885   .02751   .02627   .02511   .02404
28............................................................   .03937   .03732   .03543   .03367   .03204   .03052   .02911   .02780   .02658   .02545
29............................................................   .04162   .03947   .03748   .03564   .03392   .03233   .03084   .02946   .02818   .02698
30............................................................   .04401   .04176   .03967   .03773   .03593   .03425   .03269   .03124   .02988   .02861
31............................................................   .04654   .04419   .04200   .03996   .03807   .03630   .03466   .03312   .03169   .03035
32............................................................   .04923   .04676   .04447   .04233   .04034   .03849   .03676   .03514   .03363   .03221
33............................................................   .05210   .04952   .04711   .04487   .04278   .04083   .03901   .03731   .03571   .03422
34............................................................   .05515   .05245   .04993   .04758   .04538   .04333   .04142   .03962   .03794   .03637
35............................................................   .05841   .05558   .05295   .05048   .04818   .04603   .04401   .04212   .04035   .03869
36............................................................   .06187   .05892   .05616   .05358   .05116   .04890   .04678   .04480   .04293   .04118
37............................................................   .06555   .06247   .05958   .05688   .05435   .05198   .04975   .04766   .04570   .04385
38............................................................   .06949   .06627   .06325   .06043   .05777   .05528   .05295   .05075   .04868   .04674
39............................................................   .07368   .07032   .06717   .06421   .06143   .05882   .05637   .05406   .05189   .04984
40............................................................   .07816   .07465   .07137   .06827   .06537   .06263   .06006   .05764   .05535   .05320
41............................................................   .08295   .07930   .07587   .07264   .06960   .06674   .06405   .06150   .05910   .05683
42............................................................   .08807   .08427   .08069   .07733   .07415   .07116   .06833   .06567   .06315   .06077
43............................................................   .09352   .08957   .08585   .08233   .07902   .07589   .07294   .07014   .06750   .06500
44............................................................   .09932   .09521   .09134   .08768   .08423   .08096   .07787   .07495   .07218   .06956
45............................................................   .10543   .10117   .09715   .09334   .08974   .08634   .08311   .08005   .07716   .07441
46............................................................   .11189   .10747   .10329   .09933   .09559   .09204   .08867   .08548   .08245   .07958
47............................................................   .11866   .11408   .10974   .10564   .10174   .09805   .09454   .09121   .08805   .08504
48............................................................   .12577   .12103   .11654   .11228   .10823   .10439   .10074   .09727   .09397   .09083
49............................................................   .13323   .12833   .12368   .11926   .11506   .11107   .10728   .10366   .10022   .09695
50............................................................   .14107   .13601   .13120   .12663   .12228   .11813   .11419   .11043   .10685   .10344
51............................................................   .14928   .14407   .13910   .13437   .12987   .12558   .12149   .11758   .11386   .11031
52............................................................   .15785   .15248   .14735   .14247   .13781   .13337   .12913   .12508   .12122   .11752
53............................................................   .16678   .16124   .15597   .15093   .14612   .14153   .13714   .13294   .12893   .12509
54............................................................   .17606   .17037   .16493   .15974   .15478   .15004   .14550   .14116   .13700   .13302
55............................................................   .18570   .17986   .17428   .16893   .16382   .15893   .15424   .14976   .14546   .14134
56............................................................   .19573   .18974   .18400   .17851   .17325   .16821   .16338   .15875   .15430   .15004
57............................................................   .20613   .20000   .19412   .18848   .18307   .17789   .17291   .16814   .16355   .15914
58............................................................   .21688   .21060   .20458   .19880   .19325   .18792   .18280   .17788   .17316   .16861
59............................................................   .22793   .22151   .21535   .20943   .20374   .19827   .19301   .18795   .18309   .17840
60............................................................   .23927   .23272   .22642   .22036   .21454   .20893   .20354   .19834   .19334   .18851
61............................................................   .25092   .24425   .23782   .23163   .22567   .21993   .21440   .20907   .20393   .19898
62............................................................   .26295   .25616   .24961   .24329   .23721   .23134   .22568   .22021   .21494   .20985
63............................................................   .27538   .26847   .26180   .25537   .24916   .24316   .23738   .23179   .22639   .22117
64............................................................   .28817   .28116   .27438   .26783   .26150   .25539   .24949   .24377   .23825   .23291
65............................................................   .30134   .29423   .28735   .28069   .27426   .26803   .26201   .25618   .25054   .24508
66............................................................   .31493   .30772   .30075   .29399   .28746   .28113   .27500   .26906   .26331   .25774
67............................................................   .32899   .32170   .31464   .30780   .30118   .29475   .28852   .28248   .27663   .27095
68............................................................   .34349   .33614   .32901   .32209   .31538   .30887   .30256   .29643   .29047   .28469
69............................................................   .35841   .35100   .34381   .33683   .33005   .32346   .31707   .31085   .30481   .29894
70............................................................   .37366   .36620   .35896   .35193   .34509   .33844   .33197   .32568   .31957   .31362
71............................................................   .38916   .38167   .37440   .36732   .36043   .35372   .34720   .34084   .33466   .32864

[[Page 299]]

 
72............................................................   .40486   .39736   .39006   .38295   .37602   .36927   .36270   .35629   .35005   .34396
73............................................................   .42074   .41323   .40591   .39878   .39182   .38504   .37843   .37198   .36568   .35955
74............................................................   .43685   .42934   .42202   .41488   .40791   .40110   .39446   .38798   .38165   .37547
75............................................................   .45326   .44577   .43846   .43132   .42435   .41754   .41088   .40438   .39802   .39181
76............................................................   .47004   .46259   .45530   .44818   .44122   .43442   .42776   .42125   .41488   .40865
77............................................................   .48718   .47979   .47255   .46547   .45853   .45175   .44511   .43861   .43225   .42601
78............................................................   .50467   .49735   .49017   .48314   .47626   .46951   .46290   .45643   .45008   .44386
79............................................................   .52239   .51515   .50806   .50110   .49427   .48758   .48102   .47459   .46828   .46209
80............................................................   .54018   .53304   .52603   .51916   .51242   .50580   .49930   .49292   .48666   .48052
81............................................................   .55788   .55085   .54396   .53718   .53053   .52399   .51757   .51126   .50507   .49898
82............................................................   .57540   .56851   .56173   .55506   .54851   .54207   .53574   .52951   .52339   .51737
83............................................................   .59274   .58598   .57933   .57279   .56635   .56001   .55378   .54765   .54161   .53567
84............................................................   .61002   .60341   .59690   .59049   .58418   .57796   .57184   .56582   .55988   .55403
85............................................................   .62734   .62090   .61454   .60828   .60211   .59603   .59004   .58414   .57832   .57258
86............................................................   .64455   .63828   .63210   .62600   .61999   .61406   .60821   .60244   .59675   .59113
87............................................................   .66139   .65531   .64930   .64337   .63752   .63175   .62605   .62043   .61488   .60939
88............................................................   .67783   .67194   .66612   .66037   .65469   .64908   .64354   .63807   .63267   .62733
89............................................................   .69387   .68817   .68254   .67698   .67148   .66605   .66068   .65537   .65012   .64493
90............................................................   .70947   .70398   .69855   .69318   .68786   .68261   .67742   .67228   .66719   .66217
91............................................................   .72437   .71908   .71385   .70867   .70354   .69847   .69345   .68848   .68357   .67870
92............................................................   .73823   .73314   .72810   .72310   .71816   .71326   .70841   .70361   .69886   .69415
93............................................................   .75109   .74618   .74132   .73650   .73173   .72700   .72232   .71768   .71308   .70852
94............................................................   .76312   .75839   .75370   .74905   .74445   .73988   .73536   .73087   .72643   .72202
95............................................................   .77459   .77004   .76552   .76104   .75660   .75220   .74783   .74350   .73920   .73494
96............................................................   .78543   .78105   .77670   .77238   .76810   .76386   .75964   .75546   .75131   .74720
97............................................................   .79550   .79128   .78709   .78293   .77880   .77470   .77063   .76659   .76258   .75860
98............................................................   .80498   .80091   .79687   .79286   .78888   .78492   .78099   .77709   .77322   .76937
99............................................................   .81428   .81036   .80647   .80261   .79877   .79496   .79117   .78741   .78367   .77995
100...........................................................   .82336   .81959   .81586   .81214   .80845   .80478   .80113   .79751   .79390   .79032
101...........................................................   .83234   .82873   .82515   .82158   .81804   .81451   .81101   .80753   .80406   .80062
102...........................................................   .84119   .83774   .83431   .83089   .82750   .82412   .82076   .81742   .81409   .81078
103...........................................................   .84999   .84670   .84342   .84016   .83691   .83368   .83046   .82726   .82408   .82091
104...........................................................   .85944   .85632   .85321   .85011   .84703   .84396   .84090   .83786   .83483   .83182
105...........................................................   .86866   .86570   .86276   .85982   .85690   .85399   .85109   .84820   .84532   .84245
106...........................................................   .88065   .87792   .87520   .87248   .86978   .86708   .86440   .86172   .85905   .85638
107...........................................................   .89530   .89286   .89042   .88799   .88557   .88315   .88073   .87833   .87592   .87352
108...........................................................   .91849   .91654   .91460   .91266   .91072   .90879   .90685   .90492   .90299   .90106
109...........................................................   .95900   .95800   .95700   .95600   .95500   .95400   .95300   .95200   .95100   .95000
--------------------------------------------------------------------------------------------------------------------------------------------------------


                                       Table U(1)--Based on Life Table 90CM Unitrust Single Life Remainder Factors
                                                [Applicable After April 30, 1999, and Before May 1, 2009]
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                      Interest rate
                              Age                              -----------------------------------------------------------------------------------------
                                                                 10.2%    10.4%    10.6%    10.8%    11.0%    11.2%    11.4%    11.6%    11.8%    12.0%
--------------------------------------------------------------------------------------------------------------------------------------------------------
0.............................................................   .01363   .01342   .01323   .01305   .01288   .01272   .01258   .01244   .01231   .01219
1.............................................................   .00534   .00512   .00493   .00474   .00458   .00442   .00427   .00414   .00401   .00389
2.............................................................   .00518   .00495   .00474   .00455   .00437   .00421   .00405   .00391   .00377   .00365
3.............................................................   .00526   .00502   .00480   .00459   .00440   .00422   .00406   .00391   .00376   .00363
4.............................................................   .00546   .00521   .00497   .00475   .00455   .00436   .00419   .00402   .00387   .00373
5.............................................................   .00576   .00549   .00524   .00501   .00479   .00459   .00440   .00423   .00406   .00391
6.............................................................   .00613   .00584   .00557   .00532   .00509   .00488   .00468   .00449   .00432   .00415
7.............................................................   .00657   .00626   .00598   .00571   .00547   .00524   .00502   .00482   .00464   .00446
8.............................................................   .00707   .00675   .00644   .00616   .00590   .00565   .00542   .00521   .00501   .00482
9.............................................................   .00766   .00732   .00699   .00669   .00641   .00615   .00591   .00568   .00547   .00527
10............................................................   .00835   .00798   .00764   .00732   .00702   .00675   .00649   .00624   .00602   .00580
11............................................................   .00913   .00874   .00838   .00804   .00772   .00743   .00715   .00689   .00665   .00642
12............................................................   .01000   .00959   .00920   .00884   .00851   .00819   .00790   .00762   .00737   .00712
13............................................................   .01091   .01048   .01007   .00969   .00933   .00900   .00869   .00840   .00813   .00787
14............................................................   .01181   .01135   .01092   .01052   .01014   .00979   .00947   .00916   .00887   .00860
15............................................................   .01267   .01218   .01173   .01130   .01091   .01054   .01019   .00987   .00956   .00928
16............................................................   .01345   .01294   .01246   .01201   .01160   .01121   .01084   .01050   .01018   .00988
17............................................................   .01418   .01364   .01313   .01266   .01222   .01181   .01143   .01107   .01073   .01041
18............................................................   .01486   .01429   .01375   .01326   .01279   .01236   .01196   .01158   .01122   .01088
19............................................................   .01554   .01494   .01438   .01385   .01336   .01291   .01248   .01208   .01170   .01135
20............................................................   .01626   .01562   .01503   .01448   .01396   .01348   .01303   .01260   .01220   .01183

[[Page 300]]

 
21............................................................   .01702   .01635   .01573   .01514   .01460   .01409   .01361   .01316   .01274   .01235
22............................................................   .01782   .01711   .01645   .01584   .01526   .01472   .01422   .01374   .01330   .01288
23............................................................   .01868   .01793   .01724   .01658   .01597   .01540   .01487   .01437   .01390   .01345
24............................................................   .01962   .01883   .01809   .01740   .01675   .01615   .01558   .01505   .01455   .01408
25............................................................   .02065   .01981   .01903   .01830   .01762   .01698   .01638   .01581   .01528   .01478
26............................................................   .02178   .02089   .02006   .01929   .01856   .01789   .01725   .01665   .01609   .01556
27............................................................   .02303   .02209   .02122   .02040   .01963   .01891   .01824   .01760   .01700   .01644
28............................................................   .02439   .02339   .02247   .02160   .02079   .02002   .01931   .01863   .01800   .01740
29............................................................   .02585   .02480   .02382   .02290   .02204   .02123   .02047   .01976   .01908   .01845
30............................................................   .02742   .02631   .02527   .02430   .02339   .02253   .02172   .02096   .02025   .01957
31............................................................   .02910   .02793   .02683   .02579   .02482   .02391   .02306   .02225   .02149   .02077
32............................................................   .03089   .02965   .02849   .02739   .02636   .02540   .02449   .02363   .02282   .02206
33............................................................   .03282   .03151   .03028   .02912   .02803   .02701   .02604   .02513   .02427   .02346
34............................................................   .03489   .03350   .03220   .03097   .02982   .02873   .02771   .02674   .02583   .02497
35............................................................   .03713   .03567   .03429   .03299   .03177   .03061   .02953   .02850   .02753   .02661
36............................................................   .03953   .03798   .03653   .03515   .03386   .03263   .03148   .03039   .02936   .02838
37............................................................   .04211   .04048   .03894   .03748   .03611   .03481   .03359   .03243   .03134   .03030
38............................................................   .04490   .04318   .04155   .04001   .03856   .03719   .03589   .03466   .03350   .03239
39............................................................   .04791   .04609   .04437   .04274   .04120   .03975   .03837   .03707   .03583   .03466
40............................................................   .05116   .04924   .04742   .04571   .04408   .04254   .04108   .03970   .03839   .03714
41............................................................   .05469   .05267   .05075   .04894   .04722   .04559   .04405   .04258   .04119   .03987
42............................................................   .05851   .05638   .05436   .05245   .05063   .04891   .04728   .04573   .04425   .04285
43............................................................   .06263   .06039   .05827   .05625   .05433   .05252   .05079   .04915   .04759   .04610
44............................................................   .06707   .06472   .06248   .06035   .05834   .05642   .05459   .05286   .05121   .04963
45............................................................   .07180   .06933   .06698   .06474   .06262   .06059   .05867   .05684   .05509   .05342
46............................................................   .07685   .07425   .07178   .06943   .06720   .06507   .06304   .06110   .05926   .05750
47............................................................   .08218   .07946   .07687   .07440   .07205   .06981   .06768   .06564   .06369   .06183
48............................................................   .08784   .08499   .08228   .07969   .07722   .07487   .07262   .07047   .06842   .06646
49............................................................   .09382   .09085   .08801   .08530   .08271   .08024   .07788   .07562   .07346   .07140
50............................................................   .10018   .09707   .09410   .09127   .08856   .08597   .08349   .08112   .07885   .07667
51............................................................   .10691   .10367   .10057   .09761   .09477   .09206   .08946   .08697   .08459   .08231
52............................................................   .11399   .11061   .10738   .10429   .10132   .09849   .09577   .09316   .09066   .08826
53............................................................   .12142   .11791   .11454   .11132   .10823   .10526   .10242   .09969   .09707   .09456
54............................................................   .12921   .12556   .12206   .11870   .11548   .11239   .10942   .10657   .10383   .10120
55............................................................   .13738   .13359   .12995   .12646   .12311   .11989   .11679   .11382   .11096   .10820
56............................................................   .14595   .14202   .13824   .13462   .13113   .12778   .12456   .12146   .11847   .11560
57............................................................   .15491   .15084   .14693   .14317   .13955   .13607   .13272   .12949   .12638   .12338
58............................................................   .16424   .16004   .15599   .15209   .14834   .14473   .14125   .13789   .13465   .13153
59............................................................   .17390   .16955   .16537   .16134   .15746   .15371   .15010   .14662   .14325   .14001
60............................................................   .18387   .17939   .17507   .17091   .16689   .16302   .15927   .15566   .15217   .14880
61............................................................   .19420   .18958   .18513   .18084   .17669   .17268   .16881   .16506   .16145   .15795
62............................................................   .20494   .20020   .19561   .19119   .18691   .18277   .17877   .17490   .17115   .16753
63............................................................   .21613   .21126   .20654   .20199   .19758   .19331   .18918   .18518   .18131   .17757
64............................................................   .22774   .22274   .21791   .21322   .20869   .20429   .20004   .19592   .19192   .18805
65............................................................   .23979   .23467   .22971   .22490   .22025   .21573   .21135   .20710   .20299   .19899
66............................................................   .25233   .24709   .24202   .23709   .23231   .22767   .22318   .21881   .21457   .21045
67............................................................   .26543   .26009   .25489   .24985   .24496   .24021   .23560   .23111   .22676   .22252
68............................................................   .27908   .27363   .26833   .26319   .25819   .25332   .24860   .24400   .23954   .23519
69............................................................   .29324   .28769   .28230   .27705   .27195   .26699   .26216   .25746   .25288   .24843
70............................................................   .30783   .30219   .29671   .29137   .28618   .28112   .27619   .27139   .26672   .26216
71............................................................   .32277   .31706   .31150   .30608   .30079   .29564   .29063   .28573   .28096   .27631
72............................................................   .33803   .33225   .32661   .32112   .31575   .31052   .30542   .30044   .29559   .29084
73............................................................   .35356   .34772   .34201   .33645   .33101   .32571   .32053   .31547   .31053   .30571
74............................................................   .36943   .36354   .35778   .35215   .34666   .34129   .33604   .33091   .32590   .32100
75............................................................   .38574   .37980   .37400   .36833   .36278   .35735   .35205   .34686   .34178   .33681
76............................................................   .40256   .39660   .39076   .38505   .37947   .37400   .36864   .36340   .35827   .35324
77............................................................   .41991   .41394   .40808   .40235   .39674   .39124   .38585   .38056   .37539   .37032
78............................................................   .43777   .43180   .42594   .42020   .41457   .40906   .40365   .39834   .39314   .38803
79............................................................   .45602   .45007   .44422   .43849   .43287   .42735   .42193   .41661   .41139   .40627
80............................................................   .47449   .46856   .46275   .45704   .45143   .44592   .44051   .43519   .42997   .42484
81............................................................   .49300   .48712   .48134   .47566   .47008   .46460   .45921   .45391   .44870   .44357
82............................................................   .51145   .50563   .49990   .49427   .48873   .48328   .47792   .47265   .46746   .46235
83............................................................   .52983   .52407   .51841   .51284   .50735   .50195   .49663   .49139   .48624   .48116
84............................................................   .54828   .54261   .53702   .53151   .52609   .52075   .51549   .51030   .50519   .50015
85............................................................   .56693   .56135   .55586   .55044   .54510   .53983   .53464   .52952   .52447   .51949
86............................................................   .58560   .58013   .57474   .56943   .56418   .55901   .55390   .54886   .54389   .53898
87............................................................   .60398   .59864   .59337   .58817   .58303   .57795   .57294   .56799   .56310   .55828
88............................................................   .62206   .61685   .61170   .60662   .60159   .59663   .59173   .58688   .58209   .57736

[[Page 301]]

 
89............................................................   .63980   .63474   .62972   .62477   .61987   .61503   .61024   .60551   .60083   .59620
90............................................................   .65719   .65227   .64741   .64259   .63783   .63312   .62846   .62385   .61928   .61477
91............................................................   .67388   .66912   .66440   .65973   .65511   .65053   .64600   .64152   .63708   .63269
92............................................................   .68949   .68487   .68030   .67577   .67129   .66685   .66245   .65809   .65378   .64950
93............................................................   .70401   .69954   .69511   .69072   .68637   .68205   .67778   .67355   .66935   .66519
94............................................................   .71765   .71332   .70902   .70477   .70055   .69636   .69222   .68810   .68403   .67998
95............................................................   .73072   .72653   .72237   .71825   .71416   .71010   .70608   .70209   .69813   .69421
96............................................................   .74311   .73906   .73504   .73105   .72709   .72316   .71926   .71539   .71155   .70774
97............................................................   .75465   .75073   .74684   .74297   .73914   .73533   .73155   .72780   .72407   .72037
98............................................................   .76555   .76175   .75798   .75424   .75052   .74683   .74317   .73953   .73591   .73232
99............................................................   .77626   .77260   .76895   .76534   .76174   .75817   .75462   .75109   .74759   .74411
100...........................................................   .78676   .78323   .77971   .77622   .77274   .76929   .76586   .76245   .75906   .75569
101...........................................................   .79719   .79379   .79040   .78703   .78368   .78035   .77704   .77375   .77048   .76722
102...........................................................   .80749   .80422   .80096   .79772   .79450   .79130   .78811   .78494   .78178   .77864
103...........................................................   .81775   .81461   .81149   .80838   .80529   .80221   .79914   .79609   .79306   .79003
104...........................................................   .82881   .82582   .82284   .81988   .81693   .81399   .81106   .80815   .80525   .80236
105...........................................................   .83959   .83674   .83391   .83108   .82826   .82546   .82267   .81988   .81711   .81435
106...........................................................   .85373   .85108   .84844   .84581   .84319   .84058   .83797   .83537   .83278   .83020
107...........................................................   .87113   .86875   .86636   .86399   .86161   .85925   .85689   .85453   .85218   .84984
108...........................................................   .89913   .89721   .89529   .89337   .89145   .88953   .88762   .88571   .88380   .88189
109...........................................................   .94900   .94800   .94700   .94600   .94500   .94400   .94300   .94200   .94100   .94000
--------------------------------------------------------------------------------------------------------------------------------------------------------
--------------------------------------------------------------------------------------------------------------------------------------------------------


                                       Table U(1)--Based on Life Table 90CM Unitrust Single Life Remainder Factors
                                                [Applicable After April 30, 1999, and Before May 1, 2009]
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                      Interest rate
                              Age                              -----------------------------------------------------------------------------------------
                                                                 12.2%    12.4%    12.6%    12.8%    13.0%    13.2%    13.4%    13.6%    13.8%    14.0%
--------------------------------------------------------------------------------------------------------------------------------------------------------
0.............................................................   .01208   .01197   .01187   .01177   .01168   .01159   .01151   .01143   .01135   .01128
1.............................................................   .00378   .00367   .00358   .00348   .00340   .00331   .00323   .00316   .00309   .00302
2.............................................................   .00353   .00342   .00331   .00322   .00312   .00304   .00295   .00288   .00280   .00273
3.............................................................   .00350   .00339   .00327   .00317   .00307   .00298   .00289   .00281   .00273   .00265
4.............................................................   .00359   .00347   .00335   .00324   .00313   .00303   .00294   .00285   .00276   .00268
5.............................................................   .00377   .00363   .00351   .00339   .00327   .00317   .00306   .00297   .00288   .00279
6.............................................................   .00400   .00386   .00372   .00359   .00347   .00335   .00325   .00314   .00305   .00295
7.............................................................   .00430   .00414   .00400   .00386   .00373   .00360   .00349   .00338   .00327   .00317
8.............................................................   .00465   .00448   .00432   .00417   .00403   .00390   .00378   .00366   .00354   .00344
9.............................................................   .00508   .00490   .00473   .00457   .00442   .00428   .00414   .00402   .00389   .00378
10............................................................   .00560   .00541   .00523   .00506   .00490   .00475   .00460   .00446   .00433   .00421
11............................................................   .00620   .00600   .00581   .00563   .00546   .00529   .00514   .00499   .00485   .00472
12............................................................   .00689   .00668   .00647   .00628   .00610   .00593   .00576   .00560   .00545   .00531
13............................................................   .00763   .00740   .00718   .00698   .00678   .00660   .00642   .00626   .00610   .00595
14............................................................   .00834   .00810   .00787   .00766   .00745   .00726   .00707   .00689   .00673   .00657
15............................................................   .00901   .00875   .00851   .00828   .00807   .00786   .00767   .00748   .00730   .00714
16............................................................   .00959   .00932   .00907   .00883   .00860   .00839   .00818   .00799   .00780   .00762
17............................................................   .01011   .00983   .00956   .00930   .00907   .00884   .00862   .00842   .00822   .00804
18............................................................   .01057   .01027   .00999   .00972   .00947   .00923   .00900   .00879   .00858   .00839
19............................................................   .01101   .01070   .01040   .01012   .00985   .00960   .00936   .00914   .00892   .00871
20............................................................   .01148   .01115   .01083   .01054   .01026   .00999   .00974   .00950   .00927   .00905
21............................................................   .01197   .01162   .01129   .01098   .01068   .01040   .01014   .00988   .00964   .00941
22............................................................   .01249   .01211   .01176   .01143   .01112   .01082   .01054   .01027   .01002   .00978
23............................................................   .01304   .01264   .01227   .01192   .01159   .01127   .01098   .01069   .01042   .01017
24............................................................   .01364   .01322   .01283   .01246   .01210   .01177   .01145   .01115   .01087   .01060
25............................................................   .01431   .01387   .01345   .01306   .01268   .01233   .01199   .01168   .01137   .01109
26............................................................   .01506   .01459   .01415   .01373   .01333   .01295   .01260   .01226   .01194   .01163
27............................................................   .01591   .01541   .01494   .01449   .01407   .01367   .01329   .01293   .01259   .01226
28............................................................   .01684   .01631   .01580   .01533   .01488   .01445   .01405   .01367   .01330   .01296
29............................................................   .01785   .01728   .01675   .01624   .01577   .01531   .01488   .01447   .01408   .01372
30............................................................   .01893   .01833   .01776   .01723   .01672   .01623   .01578   .01534   .01493   .01453
31............................................................   .02010   .01946   .01885   .01828   .01773   .01722   .01673   .01627   .01582   .01540
32............................................................   .02134   .02066   .02002   .01940   .01883   .01828   .01776   .01726   .01679   .01634
33............................................................   .02270   .02197   .02128   .02063   .02002   .01943   .01887   .01835   .01784   .01736
34............................................................   .02415   .02338   .02265   .02195   .02130   .02067   .02008   .01951   .01897   .01846
35............................................................   .02574   .02492   .02414   .02340   .02270   .02203   .02140   .02080   .02022   .01967
36............................................................   .02746   .02658   .02575   .02496   .02422   .02350   .02283   .02218   .02157   .02098

[[Page 302]]

 
37............................................................   .02932   .02838   .02750   .02666   .02586   .02510   .02438   .02369   .02303   .02241
38............................................................   .03135   .03035   .02941   .02851   .02766   .02685   .02608   .02534   .02464   .02397
39............................................................   .03355   .03249   .03149   .03053   .02962   .02876   .02793   .02715   .02640   .02568
40............................................................   .03596   .03484   .03377   .03275   .03178   .03086   .02998   .02914   .02833   .02757
41............................................................   .03861   .03742   .03628   .03520   .03416   .03318   .03224   .03134   .03048   .02966
42............................................................   .04152   .04025   .03903   .03788   .03678   .03573   .03473   .03377   .03285   .03198
43............................................................   .04468   .04333   .04205   .04082   .03965   .03853   .03746   .03644   .03546   .03453
44............................................................   .04813   .04670   .04533   .04403   .04278   .04159   .04045   .03936   .03832   .03732
45............................................................   .05183   .05032   .04887   .04748   .04616   .04489   .04368   .04252   .04141   .04034
46............................................................   .05582   .05421   .05267   .05121   .04980   .04846   .04717   .04593   .04475   .04362
47............................................................   .06006   .05836   .05673   .05518   .05369   .05226   .05089   .04958   .04832   .04711
48............................................................   .06459   .06279   .06107   .05943   .05785   .05634   .05488   .05349   .05216   .05087
49............................................................   .06942   .06752   .06571   .06397   .06230   .06070   .05916   .05768   .05626   .05490
50............................................................   .07459   .07259   .07068   .06884   .06708   .06538   .06376   .06219   .06069   .05924
51............................................................   .08012   .07801   .07599   .07406   .07220   .07041   .06869   .06703   .06544   .06391
52............................................................   .08596   .08375   .08163   .07959   .07763   .07574   .07392   .07218   .07049   .06887
53............................................................   .09214   .08982   .08759   .08544   .08338   .08139   .07948   .07763   .07586   .07415
54............................................................   .09867   .09623   .09389   .09164   .08946   .08737   .08536   .08342   .08154   .07974
55............................................................   .10556   .10301   .10055   .09819   .09591   .09371   .09159   .08955   .08757   .08567
56............................................................   .11283   .11016   .10759   .10511   .10272   .10042   .09819   .09605   .09397   .09197
57............................................................   .12050   .11771   .11502   .11243   .10993   .10751   .10518   .10293   .10075   .09864
58............................................................   .12852   .12562   .12281   .12011   .11749   .11496   .11252   .11016   .10787   .10567
59............................................................   .13687   .13385   .13092   .12810   .12537   .12273   .12017   .11770   .11531   .11299
60............................................................   .14554   .14240   .13935   .13641   .13356   .13080   .12813   .12555   .12305   .12063
61............................................................   .15457   .15130   .14813   .14507   .14210   .13923   .13644   .13375   .13113   .12860
62............................................................   .16402   .16063   .15734   .15415   .15107   .14808   .14518   .14237   .13964   .13699
63............................................................   .17393   .17042   .16700   .16370   .16049   .15738   .15437   .15144   .14860   .14584
64............................................................   .18429   .18065   .17712   .17369   .17036   .16714   .16400   .16096   .15800   .15513
65............................................................   .19511   .19135   .18769   .18415   .18070   .17735   .17410   .17094   .16787   .16488
66............................................................   .20645   .20257   .19880   .19513   .19157   .18810   .18473   .18146   .17827   .17517
67............................................................   .21841   .21441   .21052   .20673   .20305   .19947   .19599   .19259   .18929   .18608
68............................................................   .23096   .22685   .22284   .21895   .21515   .21146   .20786   .20436   .20094   .19762
69............................................................   .24409   .23987   .23575   .23175   .22784   .22404   .22033   .21672   .21320   .20976
70............................................................   .25772   .25339   .24918   .24507   .24106   .23715   .23333   .22961   .22598   .22244
71............................................................   .27178   .26735   .26304   .25882   .25471   .25070   .24679   .24296   .23923   .23559
72............................................................   .28622   .28170   .27729   .27298   .26877   .26467   .26065   .25673   .25290   .24915
73............................................................   .30100   .29639   .29189   .28749   .28320   .27899   .27489   .27087   .26694   .26310
74............................................................   .31621   .31152   .30694   .30246   .29807   .29378   .28959   .28548   .28146   .27753
75............................................................   .33195   .32719   .32253   .31797   .31351   .30914   .30486   .30067   .29657   .29255
76............................................................   .34832   .34350   .33877   .33415   .32961   .32517   .32082   .31656   .31238   .30828
77............................................................   .36535   .36047   .35570   .35101   .34642   .34192   .33750   .33317   .32892   .32475
78............................................................   .38302   .37811   .37329   .36856   .36392   .35937   .35490   .35051   .34621   .34198
79............................................................   .40124   .39630   .39145   .38669   .38201   .37742   .37291   .36848   .36413   .35985
80............................................................   .41980   .41485   .40998   .40520   .40050   .39588   .39134   .38688   .38249   .37818
81............................................................   .43854   .43358   .42871   .42392   .41921   .41457   .41001   .40553   .40112   .39678
82............................................................   .45733   .45238   .44752   .44273   .43802   .43338   .42881   .42431   .41989   .41553
83............................................................   .47616   .47123   .46638   .46161   .45690   .45227   .44770   .44320   .43877   .43441
84............................................................   .49519   .49030   .48548   .48073   .47604   .47143   .46688   .46239   .45797   .45361
85............................................................   .51458   .50974   .50496   .50025   .49560   .49102   .48650   .48204   .47763   .47329
86............................................................   .53413   .52935   .52463   .51998   .51538   .51084   .50636   .50194   .49758   .49327
87............................................................   .55351   .54881   .54416   .53957   .53503   .53055   .52613   .52176   .51744   .51317
88............................................................   .57268   .56806   .56349   .55898   .55451   .55010   .54574   .54144   .53718   .53296
89............................................................   .59162   .58710   .58262   .57819   .57382   .56949   .56520   .56097   .55678   .55263
90............................................................   .61030   .60588   .60151   .59718   .59290   .58866   .58447   .58032   .57621   .57214
91............................................................   .62834   .62403   .61977   .61554   .61136   .60722   .60312   .59907   .59505   .59107
92............................................................   .64527   .64107   .63692   .63280   .62872   .62468   .62068   .61672   .61279   .60890
93............................................................   .66107   .65699   .65294   .64893   .64495   .64101   .63711   .63323   .62940   .62559
94............................................................   .67597   .67200   .66806   .66415   .66027   .65643   .65262   .64884   .64509   .64138
95............................................................   .69031   .68645   .68262   .67881   .67504   .67130   .66759   .66390   .66025   .65662
96............................................................   .70396   .70021   .69648   .69279   .68912   .68548   .68186   .67828   .67471   .67118
97............................................................   .71670   .71305   .70943   .70584   .70227   .69872   .69520   .69171   .68824   .68480
98............................................................   .72875   .72521   .72169   .71819   .71472   .71127   .70784   .70444   .70106   .69770
99............................................................   .74065   .73721   .73379   .73040   .72703   .72368   .72035   .71704   .71375   .71048
100...........................................................   .75234   .74901   .74570   .74241   .73914   .73589   .73265   .72944   .72625   .72307
101...........................................................   .76399   .76077   .75757   .75438   .75122   .74807   .74494   .74183   .73873   .73565
102...........................................................   .77552   .77241   .76932   .76625   .76319   .76015   .75712   .75411   .75111   .74813
103...........................................................   .78703   .78404   .78106   .77809   .77514   .77221   .76929   .76638   .76348   .76060
104...........................................................   .79948   .79662   .79377   .79093   .78810   .78528   .78248   .77969   .77691   .77414

[[Page 303]]

 
105...........................................................   .81159   .80885   .80612   .80340   .80069   .79799   .79530   .79262   .78995   .78729
106...........................................................   .82763   .82506   .82250   .81995   .81741   .81488   .81235   .80983   .80732   .80482
107...........................................................   .84749   .84516   .84283   .84051   .83819   .83587   .83356   .83126   .82896   .82666
108...........................................................   .87999   .87808   .87618   .87428   .87238   .87049   .86859   .86670   .86481   .86293
109...........................................................   .93900   .93800   .93700   .93600   .93500   .93400   .93300   .93200   .93100   .93000
--------------------------------------------------------------------------------------------------------------------------------------------------------

    (7) Effective/applicability dates. Paragraphs (f)(1) through (f)(6) 
apply after April 30, 1999, and before May 1, 2009.

[T.D. 8540, 59 FR 30102, 30116, 30117, 30148, June 10, 1994, as amended 
by T.D. 8819, 64 FR 23199, 23209, Apr. 30, 1999; T.D. 8886, 65 FR 36943, 
June 12, 2000; T.D. 9448, 74 FR 21465, 21482, May 7, 2009; T.D. 9540, 76 
FR 49612, Aug. 10, 2011]

treatment of excess distributions of trusts applicable to taxable years 
                  beginning on or after january 1, 1969



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

    (a) In general. (1) Subpart D (section 665 and following), part I, 
subchapter J, chapter 1 of the Code as amended by the Tax Reform Act of 
1969, is designed to tax the beneficiary of a trust that accumulates, 
rather than distributes, all or part of its income currently (i.e., an 
accumulation trust), in most cases, as if the income had been currently 
distributed to the beneficiary instead of accumulated by the trusts. 
Accordingly, subpart D provides special rules for the treatment of 
amounts paid, credited, or required to be distributed by a complex trust 
(one that is subject to subpart C (section 661 and following) of such 
part I) in any year in excess of ``distributable net income'' (as 
defined in section 643 (a)) for that year. Such an excess distribution 
is an ``accumulation distribution'' (as defined in section 665(b)). The 
special rules of subpart D are generally inapplicable to amounts paid, 
credited, or required to be distributed by a trust in a taxable year in 
which it qualifies as a simple trust (one that is subject to subpart B 
(section 651 and following) of such part I). However, see Sec. 
1.665(e)-1A(b) for rules relating to the treatment of a simple trust as 
a complex trust.
    (2) An accumulation distribution is deemed to consist of, first, 
``undistributed net income'' (as defined in section 665(a)) of the trust 
from preceding taxable years, and, after all the undistributed net 
income for all preceding taxable years has been deemed distributed, 
``undistributed capital gain'' (as defined in section 665(f)) of the 
trust for all preceding taxable years commencing with the first year 
such amounts were accumulated. An accumulation distribution of 
undistributed capital gain is a ``capital gain distribution'' (as 
defined in section 665(g)). To the extent an accumulation distribution 
exceeds the ``undistributed net income'' and ``undistributed capital 
gain'' so determined, it is deemed to consist of corpus.
    (3) The accumulation distribution is ``thrown back'' to the earliest 
``preceding taxable year'' of the trust, which, in the case of 
distributions made for a taxable year beginning after December 31, 1973, 
from a trust (other than a foreign trust created by a U.S. person), is 
any taxable year beginning after December 31, 1968. Special transitional 
rules apply for distributions made in taxable years beginning before 
January 1, 1974. In the case of a foreign trust created by a U.S. 
person, a ``preceding taxable year'' is any year of the trust to which 
the Code applies.
    (4) A distribution of undistributed net income (included in an 
accumulation distribution) and a capital gain distribution will be 
included in the income of the beneficiary in the year they are actually 
paid, credited, or required to be distributed to him. The

[[Page 304]]

tax on the distribution will be approximately the amount of tax the 
beneficiary would have paid with respect to the distribution had the 
income and capital gain been distributed to the beneficiary in the year 
earned by the trust. An additional amount equal to the ``taxes imposed 
on the trust'' for the preceding year is also deemed distributed. To 
prevent double taxation, however, the beneficiary receives a credit for 
such taxes.
    (b) Effective dates. All regulations sections under subpart D 
(sections 665 through 669) which have an ``A'' suffix (such as Sec. 
1.665(a)A and Sec. 1.666(b)-1A) are applicable to taxable years 
beginning on or after January 1, 1969, and all references therein to 
sections 665 through 669 are references to such sections as amended by 
the Tax Reform Act of 1969. Sections without the ``A'' suffix (such as 
Sec. 1.666(b)-1) are applicable only to taxable years beginning before 
January 1, 1969, and all references therein to sections 665 through 669 
are references to such sections before amendment by the Tax Reform Act 
of 1969.
    (c) Examples. Where examples contained in the regulations under 
subpart D refer to tax rates for years after 1968, such tax rates are 
not necessarily the actual rates for such years, but are only used for 
example purposes.
    (d) Applicability to estates. Subpart D does not apply to any 
estate.

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



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

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

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

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

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

For purposes of subparagraph (2) of this paragraph, the amount of taxes 
imposed on the trust for any taxable year by chapter 1 of the Internal 
Revenue Code is the amount of taxes imposed pursuant to section 871 
(relating to tax on non-resident alien individuals) which is properly 
allocable to the undistributed portion of the distributable net income. 
See Sec. 1.665(d)-1A. The amount of taxes imposed pursuant to section 
871 is the difference between the total tax imposed pursuant to that 
section on the foreign trust created by a U.S. person for the year and 
the

[[Page 305]]

amount which would have been imposed on such trust had all the 
distributable net income, as determined under section 643(a), been 
distributed. The application of the rule in this paragraph may be 
illustrated by the following examples:

    Example 1. A trust was created in 1952 under the laws of Country X 
by the transfer to a trustee in Country X of property by a U.S. person. 
The entire trust constitutes a foreign trust created by a U.S. person. 
The governing instrument of the trust provides that $7,000 of income is 
required to be distributed currently to a U.S. beneficiary and gives the 
trustee discretion to make additional distributions to the beneficiary. 
During the taxable year 1973 the trust had income of $10,000 from 
dividends of a U.S. corporation (on which Federal income taxes of $3,000 
were imposed pursuant to section 871 and withheld under section 1441, 
resulting in the receipt by the trust of cash in the amount of $7,000), 
$20,000 in capital gains from the sale of stock of a Country Y 
corporation and $30,000 from dividends of a Country X corporation, none 
of the gross income of which was derived from sources within the United 
States. No income taxes were required to be paid to Country X or Country 
Y in 1973. The trustee did not file a U.S. income tax return for the 
taxable year 1973. The distributable net income of the trust before 
distributions to the beneficiary for 1973 is $60,000 ($57,000 of which 
is cash). During 1973 the trustee made distributions to the U.S. 
beneficiary equaling one-half of the trust's distributable net income. 
Thus, the U.S. beneficiary is treated as having had distributed to him 
$5,000 (composed of $3,500 as a cash distribution and $1,500 as the tax 
imposed pursuant to section 871 and withheld under section 1441), 
representing one-half of the income from U.S. sources; $10,000 in cash, 
representing one-half of the capital gains from the sale of stock of the 
Country Y corporation; and $15,000 in cash, representing one-half of the 
income from Country X sources for a total of $30,000. The undistributed 
net income of the trust at the close of taxable year 1973 is $28,500 
computed as follows:

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

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

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

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

Distributable net income (40% of each item of gross income of
 entire trust)
  40% of $10,000 U.S. dividends..............................     $4,000
  40% of $20,000 Country X capital gains.....................      8,000
  40% of $30,000 Country X dividends.........................     12,000
                                                   ------------
    Total....................................................     24,000
Less:
  (i) Amounts distributed to the beneficiary--
  Income currently distributed to the beneficiary      $2,800
   (40% of $7,000)................................
  Other amounts distributed to the beneficiary          8,600
   (40% of $21,500)...............................

[[Page 306]]

 
  Taxes under sec. 871 deemed distributed to the          600
   beneficiary (40% of $1,500)....................
                                                   -----------
    Total amounts distributed to the beneficiary..     12,000
  (ii) Amount of taxes imposed on the trust under         600
   chapter 1 of the Code attributable to the
   undistributed net income (See Sec. 1.665 (d)-
   1A) (40% of $1,500)............................
                                                   -----------
    Total....................................................     12,600
                                                   ------------
    Undistributed net income.................................     11,400
 

    (c) Effect of prior distributions. The undistributed net income for 
any year to which an accumulation distribution for a later year may be 
thrown back will be reduced by accumulation distributions in intervening 
years that are required to be thrown back to such year. For example, if 
a trust has undistributed net income for 1975, and an accumulation 
distribution is made in 1980, there must be taken into account the 
effect on undistributed net income for 1975 of any accumulation 
distribution made in 1976, 1977, 1978, or 1979. However, undistributed 
net income for any year will not be reduced by any distributions in any 
intervening years that are excluded under section 663(a)(1), relating to 
gifts, bequests, etc. See paragraph (d) of Sec. 1.666(a)-1A for an 
illustration of the reduction of undistributed net income for any year 
by a subsequent accumulation distribution.
    (d) Distributions made in taxable years beginning before January 1, 
1974. For special rules relating to accumulation distributions of 
undistributed net income made in taxable years of the trust beginning 
before January 1, 1974, see Sec. 1.665(b)-2A.

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



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

    (a) In general. (1) For any taxable year of a trust the term 
accumulation distribution means an amount by which the amounts properly 
paid, credited, or required to be distributed within the meaning of 
section 661(a)(2) (i.e., all amounts properly paid, credited, or 
required to be distributed to the beneficiary other than income required 
to be distributed currently within the meaning of section 661(a)(1)) for 
that year exceed the distributable net income (determined under section 
643(a)) of the trust, reduced (but not below zero) by the amount of 
income required to be distributed currently. To the extent provided in 
section 663(b) and the regulations thereunder, distributions made within 
the first 65 days following a taxable year may be treated as having been 
distributed on the last day of such taxable year.
    (2) An accumulation distribution also includes, for a taxable year 
of the trust, any amount to which section 661(a)(2) and the preceding 
paragraph are inapplicable and which is paid, credited, or required to 
be distributed during the taxable year of the trust by reason of the 
exercise of a power to appoint, distribute, consume, or withdraw corpus 
of the trust or income of the trust accumulated in a preceding taxable 
year. No accumulation distribution is deemed to be made solely because 
the grantor or any other person is treated as owner of a portion of the 
trust by reason of an unexercised power to appoint, distribute, consume, 
or withdraw corpus or accumulated income of the trust. Nor will an 
accumulation distribution be deemed to have been made by reason of the 
exercise of a power that may affect only taxable income previously 
attributed to the holders of such power under subpart E (section 671 and 
following). See example 4 of paragraph (d) of this section for an 
example of an accumulation distribution occurring as a result of the 
exercise of a power of withdrawal.
    (3) Although amounts properly paid or credited under section 661(a) 
do not exceed the income of the trust during the taxable year, an 
accumulation distribution may result if the amounts properly paid or 
credited under section 661(a)(2) exceed distributable net income reduced 
(but not below zero) by the amount required to be distributed currently 
under section 661(a)(1). This may occur, for example, when expenses, 
interest, taxes, or other items allocable to corpus are taken into 
account in determining taxable income and hence causing distributable 
net income to be less than the trust's income.

[[Page 307]]

    (b) Payments that are accumulation distributions. The following are 
some instances in which an accumulation distribution may arise:
    (1) One trust to another. A distribution from one trust to another 
trust is generally an accumulation distribution. See Sec. 1.643(c)-1. 
This general rule will apply regardless of whether the distribution is 
to an existing trust or to a newly created trust and regardless of 
whether the trust to which the distribution is made was created by the 
same person who created the trust from which the distribution is made or 
a different person. However, a distribution made from one trust to a 
second trust will be deemed an accumulation distribution by the first 
trust to an ultimate beneficiary of the second trust if the primary 
purpose of the distribution to the second trust is to avoid the capital 
gain distribution provisions (see section 669 and the regulations 
thereunder). An amount passing from one separate share of a trust to 
another separate share of the same trust is not an accumulation 
distribution. See Sec. 1.665(g)-2A. For rules relating to the 
computation of the beneficiary's tax under section 668 by reason of an 
accumulation distribution from the second trust, see paragraphs (b)(1) 
and (c)(1)(i) of Sec. 1.668(b)-1A and paragraphs (b)(1) and (c)(1)(i) 
of Sec. 1.669(b)-1A.
    (2) Income accumulated during minority. A distribution of income 
accumulated during the minority of the beneficiary is generally an 
accumulation distribution. For example, if a trust accumulates income 
until the beneficiary's 21st birthday, and then distributes the income 
to the beneficiary, such a distribution is an accumulation distribution. 
However, see Sec. 1.665(b)-2A for rules governing income accumulated in 
taxable years beginning before January 1, 1969.
    (3) Amounts paid for support. To the extent that amounts forming all 
or part of an accumulation distribution are applied or distributed for 
the support of a dependent under the circumstances specified in section 
677(b) or section 678(c) or are used to discharge or satisfy any 
person's legal obligation as that term is used in Sec. 1.662(a)-4, such 
amounts will be considered as having been distributed directly to the 
person whose obligation is being satisfied.
    (c) Payments that are not accumulation distributions--(1) Gifts, 
bequests, etc., described in section 663(a)(1). A gift or bequest of a 
specific sum of money or of specific property described in section 
663(a)(1) is not an accumulation distribution.
    (2) Charitable payments. Any amount paid, permanently set aside, or 
used for the purposes specified in section 642(c) is not an accumulation 
distribution, even though no charitable deduction is allowed under such 
section with respect to such payment.
    (3) Income required to be distributed currently. No accumulation 
distribution will arise by reason of a payment of income required to be 
distributed currently even though such income exceeds the distributable 
net income of the trust because the payment is an amount specified in 
section 661(a)(1).
    (d) Examples. The provisions of this section may be illustrated by 
the following examples:

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

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

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

Total distribution...........................................    $20,000

[[Page 308]]

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

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

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

    Example 4. A dies in 1974 and bequeaths one-half the residue of his 
estate in trust. His widow, W, is given a power, exercisable solely by 
her, to require the trustee to pay her each year of the trust $5,000 
from corpus. W's right to exercise such power was exercisable at any 
time during the year but was not cumulative, so that, upon her failure 
to exercise it before the end of any taxable year of the trust, her 
right as to that year lapsed. The trust's taxable year is the calendar 
year. During the calendar years 1975 and 1976, W did not exercise her 
right and it lapsed as to those years. In the calendar years 1977 and 
1978, in which years the trust had not distributable net income, she 
exercised her right and withdrew $4,000 in 1977 and $5,000 in 1978. No 
accumulation distribution was made by the trust in the calendar years 
1975 and 1976. An accumulation distribution of $4,000 was made in 1977 
and an accumulation distribution of $5,000 was made in 1978. The 
accumulation distribution for the years 1977 and 1978 is not reduced by 
any amount of income of the trust attributable to her under section 678 
by reason of her power of withdrawal.

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



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

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

[[Page 309]]

be considered to be accumulation distributions. If an accumulation 
distribution is made in a taxable year of the trust beginning after 
December 31, 1968, and before January 1, 1974, and under section 666(a) 
such accumulation distribution would be allocated to a preceding taxable 
year beginning before January 1, 1969, no tax shall be imposed under 
section 668(a)(2) to the extent the income earned by the trust for such 
preceding taxable year would be deemed under Sec. 1.665(b)-2(b)(1) to 
have been accumulated before the beneficiary's birth or before his 21st 
birthday. The provisions of this subparagraph may be illustrated by the 
following example:

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

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

[[Page 310]]

final distribution was made more than 9 years after the date of the last 
transfer to such trust. The provisions of this subparagraph may be 
illustrated by the following example:

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

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



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

    (a) In general. Except as provided in paragraph (b) of this section, 
for purposes of section 665 any amount paid to a U.S. person which is 
from a payor who is not a U.S. person and which is derived directly or 
indirectly from a foreign trust created by a U.S. person shall be deemed 
in the year of payment to the U.S. person to have been directly paid to 
the U.S. person by the trust. For example, if a nonresident alien 
receives a distribution from a foreign trust created by a U.S. person 
and then pays the amount of the distribution over to a U.S. person, the 
payment of such amount to the U.S. person represents an accumulation 
distribution to the U.S. person from the trust to the extent that the 
amount received would have been an accumulation distribution had the 
trust paid the amount directly to the U.S. person in the year in which 
the payment was received by the U.S. person. This section also applies 
in a case where a nonresident alien receives indirectly an accumulation 
distribution from a foreign trust created by a U.S. person and then pays 
it over to a U.S. person. An example of such a transaction is one where 
the foreign trust created by a U.S. person makes the distribution to an 
intervening foreign trust created by either a U.S. person or a person 
other than a U.S. person and the intervening trust distributes the 
amount received to a nonresident alien who in turn pays it over to a 
U.S. person. Under these circumstances, it is deemed that the payment 
received by the U.S. person was received directly from a foreign trust 
created by a U.S. person.
    (b) Limitation. In the case of a distribution to a beneficiary who 
is a U.S. person, paragraph (a) of this section does not apply if the 
distribution is received by such beneficiary under circumstances 
indicating lack of intent on the part of the parties to circumvent the 
purposes for which section 7 of the Revenue Act of 1962 (76 Stat. 985) 
was enacted.

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



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

    (a) In general. (1) For purposes of subpart D, the term taxes 
imposed on the trust means the amount of Federal income taxes properly 
imposed for any taxable year on the trust that are attributable to the 
undistributed portions of distributable net income and gains in excess 
of losses from the sales or exchanges of capital assets. Except as 
provided in paragraph (c)(2) of this section, the minimum tax for tax 
preferences imposed by section 56 is not a tax attributable to the 
undistributed portions of distributable net income and gains in excess 
of losses from the sales or exchanges of capital assets. See section 56 
and the regulations thereunder.
    (2) In the case of a trust that has received an accumulation 
distribution from another trust, the term taxes imposed on the trust 
also includes the amount of taxes deemed distributed under Sec. Sec. 
1.666(b)-1A, 1.666(c)-1A, 1.669(d)-1A, and 1.669(e)-1A (whichever are 
applicable) as a result of such accumulation distribution, to the extent 
that they were taken into account under paragraphs (b)(2) or (c)(1)(vi) 
of Sec. 1.668 (b)-1A and (b)(2) or (c)(1)(vi) of Sec. 1.669(b)-1A in 
computing the partial tax on such accumulation distribution. For 
example, assume that trust A, a calendar year trust, makes an 
accumulation distribution in 1975 to trust B, also on the calendar year 
basis, in connection with which $500 of taxes are

[[Page 311]]

deemed under Sec. 1.666(b)-1A to be distributed to trust B. The partial 
tax on the accumulation distribution is computed under paragraph (b) of 
Sec. 1.668(b)-1A (the exact method) to be $600 and all of the $500 is 
used under paragraph (b)(2) of Sec. 1.668(b)-1A to reduce the partial 
tax to $100. The taxes imposed on trust B for 1975 will, in addition to 
the $100 partial tax, also include the $500 used to reduce the partial 
tax.
    (b) Taxes imposed on the trust attributable to undistributed net 
income. (1) For the purpose of subpart D, the term taxes imposed on the 
trust attributable to the undistributed net income means the amount of 
Federal income taxes for the taxable year properly allocable to the 
undistributed portion of the distributable net income for such taxable 
year. This amount is (i) an amount that bears the same relationship to 
the total taxes of the trust for the year (other than the minimum tax 
for tax preferences imposed by section 56), computed after the allowance 
of credits under section 642(a), as (a) the taxable income of the trust, 
other than the capital gains not included in distributable net income 
less their share of section 1202 deduction, bears to (b) the total 
taxable income of the trust for such year or, (ii) if the alternative 
tax computation under section 1201(b) is used and there are no net 
short-term gains, an amount equal to such total taxes less the amount of 
the alternative tax imposed on the trust and attributable to the capital 
gain. Thus, for the purposes of subpart D, in determining the amount of 
taxes imposed on the trust attributable to the undistributed net income, 
that portion of the taxes paid by the trust attributable to capital gain 
allocable to corpus is excluded. The rule stated in this subparagraph 
may be illustrated by the following example, which assumes that the 
alternative tax computation is not used:

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

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

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

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

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

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

    (c) Taxes imposed on the trust attributable to undistributed capital 
gain--(1) Regular tax. For the purpose of subpart D the term taxes 
imposed on the trust attributable to undistributed capital gain

[[Page 312]]

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


However, if the alternative tax computation under section 1201(b) is 
used and there are no net short-term gains, the amount is the amount of 
the alternative tax imposed on the trust and attributable to the capital 
gain. The application of this subparagraph may be illustrated by the 
following example, which assumes that the alternative tax computation is 
not used:

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

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

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

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

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



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

    (a) Definition--(1) Domestic trusts--(i) In general. For purposes of 
subpart D, in the case of a trust other than a foreign trust created by 
a U.S. person, the term preceding taxable year serves to identify and 
limit the taxable years of a trust to which an accumulation distribution 
consisting of undistributed net income or undistributed capital gain may 
be allocated (or ``thrown back'') under section 666(a) and 669(a). An 
accumulation distribution consisting of undistributed net income or 
undistributed capital gain may not be allocated or ``thrown back'' to a 
taxable year of a trust if such year is not a ``preceding taxable 
year.''
    (ii) Accumulation distributions. In the case of an accumulation 
distribution consisting of undistributed net income made in a taxable 
year beginning before January 1, 1974, any taxable year of the trust 
that precedes by more than

[[Page 313]]

5 years the taxable year of the trust in which such accumulation 
distribution was made is not a ``preceding taxable year.'' Thus, for a 
domestic trust on a calendar year basis, calendar year 1967 is not a 
``preceding taxable year'' with respect to an accumulation distribution 
made in calendar year 1973, whereas calendar year 1968 is a ``preceding 
taxable year.'' In the case of an accumulation distribution made during 
a taxable year beginning after December 31, 1973, any taxable year of 
the trust that begins before January 1, 1969, is not a ``preceding 
taxable year.'' Thus, for a domestic trust on a calendar year basis, 
calendar year 1968 is not a ``preceding taxable year'' with respect to 
an accumulation distribution made in calendar year 1975, whereas 
calendar year 1969 is a ``preceding taxable year.''
    (iii) Capital gain distributions. In the case of an accumulation 
distribution that is a capital gain distribution, any taxable year of 
the trust that (a) begins before January 1, 1969, or (b) is prior to the 
first year in which income is accumulated, whichever occurs later, is 
not a ``preceding taxable year.'' Thus, for the purpose of capital gain 
distributions and section 669, only taxable years beginning after 
December 31, 1968, can be ``preceding taxable years.'' See Sec. 
1.688(a)-1A(c).
    (2) Foreign trusts created by U.S. persons. For purposes of subpart 
D, in the case of a foreign trust created by a U.S. person, the term 
``preceding taxable year'' does not include any taxable year to which 
part I of subchapter J does not apply. See section 683 and regulations 
thereunder. Accordingly, the provisions of subpart D may not, in the 
case of a foreign trust created by a U.S. person, be applied to any 
taxable year which begins before 1954 or ends before August 17, 1954. 
For example, if a foreign trust created by a U.S. person (reporting on 
the calendar year basis) makes a distribution during the calendar year 
1970 of income accumulated during prior years, the earliest year of the 
trust to which the accumulation distribution may be allocated under such 
subpart D is 1954, but it may not be allocated to 1953 and prior years, 
since the Internal Revenue Code of 1939 applies to those years.
    (b) Simple trusts. A taxable year of a trust during which the trust 
was a simple trust (that is, was subject to subpart B) for the entire 
year shall not be considered a ``preceding taxable year'' unless during 
such year the trust received ``outside income'' or unless the trustee 
did not distribute all of the income of the trust that was required to 
be distributed currently for such year. In such event, undistributed net 
income for such year shall not exceed the greater of the ``outside 
income'' or income not distributed during such year. For purposes of 
this paragraph, the term outside income means amounts that are included 
in distributable net income of the trust for the year but that are not 
``income'' of the trust as that term is defined in Sec. 1.643(b)-1. 
Some examples of ``outside income'' are:
    (1) Income taxable to the trust under section 691;
    (2) Unrealized accounts receivable that were assigned to the trust; 
and
    (3) Distributions from another trust that include distributable net 
income or undistributed net income of such other trust.

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

    Example 1. By his will D creates a trust for his widow W. The terms 
of the trust require that the income be distributed currently (i.e., it 
is a simple trust), and authorize the trustee to make discretionary 
payments of corpus to W. Upon W's death the trust corpus is to be 
distributed to D's then living issue. The executor of D's will makes a 
$10,000 distribution of corpus to the trust that carries out estate 
income consisting of dividends and interest to the trust under section 
662(a)(2). The trust reports this income as its only income on its 
income tax return for its taxable year in which ends the taxable year of 
the estate in which the $10,000 distribution was made, and pays a tax 
thereon of $2,106. Thus, the trust has undistributed net income of 
$7,894 ($10,000 -$2,106). Several years later the trustee makes a 
discretionary corpus payment of $15,000 to W. This payment is an 
accumulation distribution under section

[[Page 314]]

665(b). However, since the trust had no ``outside income'' in the year 
of the estate distribution, such year is not a preceding taxable year. 
Thus, W is not treated as receiving undistributed net income of $7,894 
and taxes thereon of $2,106 for the purpose of including the same in her 
gross income under section 668. The result would be the same if the 
invasion power were not exercised and the accumulation distribution 
occurred as a result of the distribution of the corpus to D's issue upon 
the death of W.
    Example 2. Trust A, a simple trust on the calendar year basis, 
received in 1972 extraordinary dividends or taxable stock dividends that 
the trustee in good faith allocated to corpus, but that are determined 
in 1974 to have been currently distributable to the beneficiary. See 
section 643(a)(4) and Sec. 1.643(a)-4. Trust A would qualify for 
treatment under subpart C for 1974, the year of distribution of the 
extraordinary dividends or taxable stock dividends, because the 
distribution is not out of income of the current taxable year and is 
treated as another amount properly paid or credited or required to be 
distributed for such taxable year within the meaning of section 661(a) 
(2). Also, the distribution in 1974 qualifies as an accumulation 
distribution for the purposes of subpart D. For purposes only of such 
subpart D, trust A would be treated as subject to the provisions of such 
subpart C for 1972, the preceding taxable year in which the 
extraordinary or taxable stock dividends were received, and, in 
computing undistributed net income for 1972, the extraordinary or 
taxable stock dividends would be included in distributable net income 
under section 643(a). The rule stated in the preceding sentence would 
also apply if the distribution in 1974 was made out of corpus without 
regard to a determination that the extraordinary dividends or taxable 
stock dividends in question were currently distributable to the 
beneficiary.

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



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

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

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

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

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

    (2) For purposes of subparagraph (1) of this paragraph, the term 
losses for that year includes losses of the trusts

[[Page 315]]

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

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



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

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

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

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

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

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


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

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



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

    (a) In general. If the separate share rule of section 663(c) is 
applicable for any taxable year of a trust, subpart D is applied as if 
each share were a separate trust except as provided in paragraph (c) of 
this section and in Sec. 1.668(a)-1A(c). Thus, the amounts of an 
``accumulation distribution'', ``undistributed net income'', 
``undistributed capital gain'', and ``capital gain distribution'' are 
computed separately for each share.
    (b) Allocation of taxes--undistributed net income. The ``taxes 
imposed on the trust attributable to the undistributed net income'' are 
allocated as follows:
    (1) There is first allocated to each separate share that portion of 
the

[[Page 316]]

``taxes imposed on the trust attributable to the undistributed net 
income'' (as defined in Sec. 1.665(d)-1A(b)), computed before the 
allowance of any credits under section 642(a), that bears the same 
relation to the total of such taxes that the distributable net income of 
the separate share bears to the distributable net income of the trust, 
adjusted for this purpose as follows:
    (i) There is excluded from distributable net income of the trust and 
of each separate share any tax-exempt interest, foreign income of a 
foreign trust, and excluded dividends, to the extent such amounts are 
included in distributable net income pursuant to section 643(a) (5), 
(6), and (7); and
    (ii) The distributable net income of the trust is reduced by any 
deductions allowable under section 661 for amounts paid, credited, or 
required to be distributed during the taxable year, and the 
distributable net income of each separate share is reduced by any such 
deduction allocable to that share.
    (2) The taxes so determined for each separate share are then reduced 
by that portion of the credits against tax allowable to the trust under 
section 642(a) in computing the ``taxes imposed on the trust'' that 
bears the same relation to the total of such credits that the items of 
distributable net income allocable to the separate share with respect to 
which the credit is allowed bear to the total of such items of the 
trust.
    (c) Allocation of taxes--undistributed capital gain. The ``taxes 
imposed on the trust attributable to undistributed capital gain'' are 
allocated as follows:
    (1) There is first allocated to each separate share that portion of 
the ``taxes imposed on the trust attributable to undistributed capital 
gain'' (as defined in Sec. 1.665(d)-1A(c)), computed before the 
allowance of any credits under section 642(a), that bears the same 
relation to the total of such taxes that the undistributed capital gain 
(prior to the deduction of taxes under section 665(c)(2)) of the 
separate share bears to the total such undistributed capital gain of the 
trust.
    (2) The taxes so determined for each separate share are then reduced 
by that portion of the credits against tax allowable to the trust under 
section 642(a) in computing the ``taxes imposed on the trust'' that 
bears the same relation to the total of such credits that the capital 
gain allocable to the separate share with respect to which the credit is 
allowed bear to the total of such capital gain of the trust.
    (d) Termination of a separate share. (1) If upon termination of a 
separate share, an amount is properly paid, credited, or required to be 
distributed by the trust under section 661(a)(2) to a beneficiary from 
such share, an accumulation distribution will be deemed to have been 
made to the extent of such amount. In determining the distributable net 
income of such share, only those items of income and deduction for the 
taxable year of the trust in which such share terminates, properly 
allocable to such share, shall be taken into consideration.
    (2) No accumulation distribution will be deemed to have been made 
upon the termination of a separate share to the extent that the property 
constituting such share, or a portion thereof, continues to be held as a 
part of the same trust. The undistributed net income, undistributed 
capital gain, and the taxes imposed on the trust attributable to such 
items, if any, for all preceding taxable years (reduced by any amounts 
deemed distributed under sections 666(a) and 669(a) by reason of any 
accumulation distribution of undistributed net income or undistributed 
capital gain in prior years or the current taxable year), which were 
allocable to the terminating share, shall be treated as being applicable 
to the trust itself. However, no adjustment will be made to the amounts 
deemed distributed under sections 666 and 669 by reason of an 
accumulation distribution of undistributed net income or undistributed 
capital gain from the surviving share or shares made in years prior to 
the year in which the terminating share was added to such surviving 
share or shares.
    (3) The provisions of this paragraph may be illustrated by the 
following example:

    Example. A trust was established under the will of X for the benefit 
of his wife and upon her death the property was to continue in the same 
trust for his two sons, Y and Z. The separate share rule is applicable 
to this

[[Page 317]]

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

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

            grantors and others treated as substantial owners



Sec. 1.671-1  Grantors and others treated as substantial owners; scope.

    (a) Subpart E (section 671 and following), part I, subchapter J, 
chapter 1 of the Code, contains provisions taxing income of a trust to 
the grantor or another person under certain circumstances even though he 
is not treated as a beneficiary under subparts A through D (section 641 
and following) of such part I. Sections 671 and 672 contain general 
provisions relating to the entire subpart. Sections 673 through 677 
define the circumstances under which income of a trust is taxed to a 
grantor. These circumstances are in general as follows:
    (1) If the grantor has retained a reversionary interest in the 
trust, within specified time limits (section 673);
    (2) If the grantor or a nonadverse party has certain powers over the 
beneficial interests under the trust (section 674);
    (3) If certain administrative powers over the trust exist under 
which the grantor can or does benefit (section 675).
    (4) If the grantor or a nonadverse party has a power to revoke the 
trust or return the corpus to the grantor (section 676); or
    (5) If the grantor or a nonadverse party has the power to distribute 
income to or for the benefit of the grantor or the grantor's spouse 
(section 677).

Under section 678, income of a trust is taxed to a person other than the 
grantor to the extent that he has the sole power to vest corpus or 
income in himself.
    (b) Sections 671 through 677 do not apply if the income of a trust 
is taxable to a grantor's spouse under section 71 or 682 (relating 
respectively to alimony and separate maintenance payments, and the 
income of an estate or trust in the case of divorce, etc.).
    (c) Except as provided in such subpart E, income of a trust is not 
included in computing the taxable income and credits of a grantor or 
another person solely on the grounds of his dominion and control over 
the trust. However, the provisions of subpart E do not apply in 
situations involving an assignment of future income, whether or not the 
assignment is to a trust. Thus, for example, a person who assigns his 
right to future income under an employment contract may be taxed on that 
income even though the assignment is to a trust over which the assignor 
has retained none of the controls specified in sections 671 through 677. 
Similarly, a bondholder who assigns his right to interest may be taxed 
on interest payments even though the assignment is to an uncontrolled 
trust. Nor are the rules as to family partnerships affected by the 
provisions of subpart E, even though a partnership interest is held in 
trust. Likewise, these sections have no application in determining the 
right of a grantor to deductions for payments to a trust under a 
transfer and leaseback arrangement. In addition, the limitation of the 
last sentence of section 671 does not prevent any person from being 
taxed on the income of a trust when it is used to discharge his legal 
obligation. See Sec. 1.662 (a)-4. He is then treated as a beneficiary 
under subparts A through D or treated as an owner under section 677 
because the income is distributed for his benefit, and not because of 
his dominion or control over the trust.
    (d) The provisions of subpart E are not applicable with respect to a 
pooled income fund as defined in paragraph (5) of section 642(c) and the 
regulations thereunder, a charitable remainder annuity trust as defined 
in paragraph (1) of section 664(d) and the regulations thereunder, or a 
charitable remainder unitrust as defined in paragraph (2) of

[[Page 318]]

section 664(d) and the regulations thereunder.
    (e) For the effective date of subpart E see section 683 and the 
regulations thereunder.
    (f) For rules relating to the treatment of liabilities resulting on 
the sale or other disposition of encumbered trust property due to a 
renunciation of powers by the grantor or other owner, see Sec. 1.1001-
2.

[T.D. 6500, 25 FR 11814, Nov. 26, 1960, as amended by T.D. 7148, 36 FR 
20749, Oct. 29, 1971; T.D. 7741, 45 FR 81745, Dec. 12, 1980]



Sec. 1.671-2  Applicable principles.

    (a) Under section 671 a grantor or another person includes in 
computing his taxable income and credits those items of income, 
deduction, and credit against tax which are attributable to or included 
in any portion of a trust of which he is treated as the owner. Sections 
673 through 678 set forth the rules for determining when the grantor or 
another person is treated as the owner of any portion of a trust. The 
rules for determining the items of income, deduction, and credit against 
tax that are attributable to or included in a portion of the trust are 
set forth in Sec. 1.671-3.
    (b) Since the principle underlying subpart E (section 671 and 
following), part I, subchapter J, chapter 1 of the Code, is in general 
that income of a trust over which the grantor or another person has 
retained substantial dominion or control should be taxed to the grantor 
or other person rather than to the trust which receives the income or to 
the beneficiary to whom the income may be distributed, it is ordinarily 
immaterial whether the income involved constitutes income or corpus for 
trust accounting purposes. Accordingly, when it is stated in the 
regulations under subpart E that ``income'' is attributed to the grantor 
or another person, the reference, unless specifically limited, is to 
income determined for tax purposes and not to income for trust 
accounting purposes. When it is intended to emphasize that income for 
trust accounting purposes (determined in accordance with the provisions 
set forth in Sec. 1.643(b)-1 is meant, the phrase ``ordinary income'' 
is used.
    (c) An item of income, deduction, or credit included in computing 
the taxable income and credits of a grantor or another person under 
section 671 is treated as if it had been received or paid directly by 
the grantor or other person (whether or not an individual). For example, 
a charitable contribution made by a trust which is attributed to the 
grantor (an individual) under sections 671 through 677 will be 
aggregated with his other charitable contributions to determine their 
deductibility under the limitations of section 170(b)(1). Likewise, 
dividends received by a trust from sources in a particular foreign 
country which are attributed to a grantor or another person under 
subpart E will be aggregated with his other income from sources within 
that country to determine whether the taxpayer is subject to the 
limitations of section 904 with respect to credit for the tax paid to 
that country.
    (d) Items of income, deduction, and credit not attributed to or 
included in any portion of a trust of which the grantor or another 
person is treated as the owner under subpart E are subject to the 
provisions of subparts A through D (section 641 and following), of such 
part I.
    (e)(1) For purposes of part I of subchapter J, chapter 1 of the 
Internal Revenue Code, a grantor includes any person to the extent such 
person either creates a trust, or directly or indirectly makes a 
gratuitous transfer (within the meaning of paragraph (e)(2) of this 
section) of property to a trust. For purposes of this section, the term 
property includes cash. If a person creates or funds a trust on behalf 
of another person, both persons are treated as grantors of the trust. 
(See section 6048 for reporting requirements that apply to grantors of 
foreign trusts.) However, a person who creates a trust but makes no 
gratuitous transfers to the trust is not treated as an owner of any 
portion of the trust under sections 671 through 677 or 679. Also, a 
person who funds a trust with an amount that is directly reimbursed to 
such person within a reasonable period of time and who makes no other 
transfers to the trust that constitute gratuitous transfers is not 
treated as an owner of any portion of the trust under sections 671 
through 677 or 679. See also Sec. 1.672(f)-5(a).

[[Page 319]]

    (2)(i) A gratuitous transfer is any transfer other than a transfer 
for fair market value. A transfer of property to a trust may be 
considered a gratuitous transfer without regard to whether the transfer 
is treated as a gift for gift tax purposes.
    (ii) For purposes of this paragraph (e), a transfer is for fair 
market value only to the extent of the value of property received from 
the trust, services rendered by the trust, or the right to use property 
of the trust. For example, rents, royalties, interest, and compensation 
paid to a trust are transfers for fair market value only to the extent 
that the payments reflect an arm's length price for the use of the 
property of, or for the services rendered by, the trust. For purposes of 
this determination, an interest in the trust is not property received 
from the trust. In addition, a person will not be treated as making a 
transfer for fair market value merely because the transferor recognizes 
gain on the transaction. See, for example, section 684 regarding the 
recognition of gain on certain transfers to foreign trusts.
    (iii) For purposes of this paragraph (e), a gratuitous transfer does 
not include a distribution to a trust with respect to an interest held 
by such trust in either a trust described in paragraph (e)(3) of this 
section or an entity other than a trust.
    For example, a distribution to a trust by a corporation with respect 
to its stock described in section 301 is not a gratuitous transfer.
    (3) A grantor includes any person who acquires an interest in a 
trust from a grantor of the trust if the interest acquired is an 
interest in certain investment trusts described in Sec. 301.7701-4(c) 
of this chapter, liquidating trusts described in Sec. 301.7701-4(d) of 
this chapter, or environmental remediation trusts described in Sec. 
301.7701-4(e) of this chapter.
    (4) If a gratuitous transfer is made by a partnership or corporation 
to a trust and is for a business purpose of the partnership or 
corporation, the partnership or corporation will generally be treated as 
the grantor of the trust. For example, if a partnership makes a 
gratuitous transfer to a trust in order to secure a legal obligation of 
the partnership to a third party unrelated to the partnership, the 
partnership will be treated as the grantor of the trust. However, if a 
partnership or a corporation makes a gratuitous transfer to a trust that 
is not for a business purpose of the partnership or corporation but is 
for the personal purposes of one or more of the partners or 
shareholders, the gratuitous transfer will be treated as a constructive 
distribution to such partners or shareholders under federal tax 
principles and the partners or the shareholders will be treated as the 
grantors of the trust. For example, if a partnership makes a gratuitous 
transfer to a trust that is for the benefit of a child of a partner, the 
gratuitous transfer will be treated as a distribution to the partner 
under section 731 and a subsequent gratuitous transfer by the partner to 
the trust.
    (5) If a trust makes a gratuitous transfer of property to another 
trust, the grantor of the transferor trust generally will be treated as 
the grantor of the transferee trust. However, if a person with a general 
power of appointment over the transferor trust exercises that power in 
favor of another trust, then such person will be treated as the grantor 
of the transferee trust, even if the grantor of the transferor trust is 
treated as the owner of the transferor trust under subpart E of part I, 
subchapter J, chapter 1 of the Internal Revenue Code.
    (6) The following examples illustrate the rules of this paragraph 
(e). Unless otherwise indicated, all trusts are domestic trusts, and all 
other persons are United States persons. The examples are as follows:

    Example 1. A creates and funds a trust, T, for the benefit of her 
children. B subsequently makes a gratuitous transfer to T. Under 
paragraph (e)(1) of this section, both A and B are grantors of T.
    Example 2. A makes an investment in a fixed investment trust, T, 
that is classified as a trust under Sec. 301.7701-4(c)(1) of this 
chapter. A is a grantor of T. B subsequently acquires A's entire 
interest in T. Under paragraph (e)(3) of this section, B is a grantor of 
T with respect to such interest.
    Example 3. A, an attorney, creates a foreign trust, FT, on behalf of 
A's client, B, and transfers $100 to FT out of A's funds. A is 
reimbursed by B for the $100 transferred to FT. The trust instrument 
states that the trustee has discretion to distribute the income or

[[Page 320]]

corpus of FT to B and B's children. Both A and B are treated as grantors 
of FT under paragraph (e)(1) of this section. In addition, B is treated 
as the owner of the entire trust under section 677. Because A is 
reimbursed for the $100 transferred to FT on behalf of B, A is not 
treated as transferring any property to FT. Therefore, A is not an owner 
of any portion of FT under sections 671 through 677 regardless of 
whether A retained any power over or interest in FT described in 
sections 673 through 677. Furthermore, A is not treated as an owner of 
any portion of FT under section 679. Both A and B are responsible 
parties for purposes of the requirements in section 6048.
    Example 4. A creates and funds a trust, T. A does not retain any 
power or interest in T that would cause A to be treated as an owner of 
any portion of the trust under sections 671 through 677. B holds an 
unrestricted power, exercisable solely by B, to withdraw certain amounts 
contributed to the trust before the end of the calendar year and to vest 
those amounts in B. B is treated as an owner of the portion of T that is 
subject to the withdrawal power under section 678(a)(1). However, B is 
not a grantor of T under paragraph (e)(1) of this section because B 
neither created T nor made a gratuitous transfer to T.
    Example 5. A transfers cash to a trust, T, through a broker, in 
exchange for units in T. The units in T are not property for purposes of 
determining whether A has received fair market value under paragraph 
(e)(2)(ii) of this section. Therefore, A has made a gratuitous transfer 
to T, and, under paragraph (e)(1) of this section, A is a grantor of T.
    Example 6. A borrows cash from T, a trust. A has not made any 
gratuitous transfers to T. Arm's length interest payments by A to T will 
not be treated as gratuitous transfers under paragraph (e)(2)(ii) of 
this section. Therefore, under paragraph (e)(1) of this section, A is 
not a grantor of T with respect to the interest payments.
    Example 7. A, B's brother, creates a trust, T, for B's benefit and 
transfers $50,000 to T. The trustee invests the $50,000 in stock of 
Company X. C, B's uncle, purportedly sells property with a fair market 
value of $1,000,000 to T in exchange for the stock when it has 
appreciated to a fair market value of $100,000. Under paragraph 
(e)(2)(ii) of this section, the $900,000 excess value is a gratuitous 
transfer by C. Therefore, under paragraph (e)(1) of this section, A is a 
grantor with respect to the portion of the trust valued at $100,000, and 
C is a grantor of T with respect to the portion of the trust valued at 
$900,000. In addition, A or C or both will be treated as the owners of 
the respective portions of the trust of which each person is a grantor 
if A or C or both retain powers over or interests in such portions under 
sections 673 through 677.
    Example 8. G creates and funds a trust, T1, for the benefit of G's 
children and grandchildren. After G's death, under authority granted to 
the trustees in the trust instrument, the trustees of T1 transfer a 
portion of the assets of T1 to another trust, T2, and retain a power to 
revoke T2 and revest the assets of T2 in T1. Under paragraphs (e)(1) and 
(5) of this section, G is the grantor of T1 and T2. In addition, because 
the trustees of T1 have retained a power to revest the assets of T2 in 
T1, T1 is treated as the owner of T2 under section 678(a).
    Example 9. G creates and funds a trust, T1, for the benefit of B. G 
retains a power to revest the assets of T1 in G within the meaning of 
section 676. Under the trust agreement, B is given a general power of 
appointment over the assets of T1. B exercises the general power of 
appointment with respect to one-half of the corpus of T1 in favor of a 
trust, T2, that is for the benefit of C, B's child. Under paragraph 
(e)(1) of this section, G is the grantor of T1, and under paragraphs 
(e)(1) and (5) of this section, B is the grantor of T2.

    (7) The rules of this section are applicable to any transfer to a 
trust, or transfer of an interest in a trust, on or after August 10, 
1999.

[T.D. 6500, 25 FR 11814, Nov. 26, 1960; 25 FR 14021, Dec. 31, 1960, as 
amended by T.D. 8831, 64 FR 43274, Aug. 10, 1999; T.D. 8890, 65 FR 
41333, July 5, 2000]



Sec. 1.671-3  Attribution or inclusion of income, deductions,
and credits against tax.

    (a) When a grantor or another person is treated under subpart E 
(section 671 and following) as the owner of any portion of a trust, 
there are included in computing his tax liability those items of income, 
deduction, and credit against tax attributable to or included in that 
portion. For example:
    (1) If a grantor or another person is treated as the owner of an 
entire trust (corpus as well as ordinary income), he takes into account 
in computing his income tax liability all items of income, deduction, 
and credit (including capital gains and losses) to which he would have 
been entitled had the trust not been in existence during the period he 
is treated as owner.
    (2) If the portion treated as owned consists of specific trust 
property and its income, all items directly related to that property are 
attributable to the portion. Items directly related to trust property 
not included in the portion

[[Page 321]]

treated as owned by the grantor or other person are governed by the 
provisions of subparts A through D (section 641 and following), part I, 
subchapter J, chapter 1 of the Code. Items that relate both to the 
portion treated as owned by the grantor and to the balance of the trust 
must be apportioned in a manner that is reasonable in the light of all 
the circumstances of each case, including the terms of the governing 
instrument, local law, and the practice of the trustee if it is 
reasonable and consistent.
    (3) If the portion of a trust treated as owned by a grantor or 
another person consists of an undivided fractional interest in the 
trust, or of an interest represented by a dollar amount, a pro rata 
share of each item of income, deduction, and credit is normally 
allocated to the portion. Thus, where the portion owned consists of an 
interest in or a right to an amount of corpus only, a fraction of each 
item (including items allocated to corpus, such as capital gains) is 
attributed to the portion. The numerator of this fraction is the amount 
which is subject to the control of the grantor or other person and the 
denominator is normally the fair market value of the trust corpus at the 
beginning of the taxable year in question. The share not treated as 
owned by the grantor or other person is governed by the provisions of 
subparts A through D. See the last three sentences of paragraph (c) of 
this section for the principles applicable if the portion treated as 
owned consists of an interest in part of the ordinary income in contrast 
to an interest in corpus alone.
    (b) If a grantor or another person is treated as the owner of a 
portion of a trust, that portion may or may not include both ordinary 
income and other income allocable to corpus. For example:
    (1) Only ordinary income is included by reason of an interest in or 
a power over ordinary income alone. Thus, if a grantor is treated under 
section 673 as an owner by reason of a reversionary interest in ordinary 
income only, items of income allocable to corpus will not be included in 
the portion he is treated as owning. Similarly, if a grantor or another 
person is treated under sections 674-678 as an owner of a portion by 
reason of a power over ordinary income only, items of income allocable 
to corpus are not included in that portion. (See paragraph (c) of this 
section to determine the treatment of deductions and credits when only 
ordinary income is included in the portion.)
    (2) Only income allocable to corpus is included by reason of an 
interest in or a power over corpus alone, if satisfaction of the 
interest or an exercise of the power will not result in an interest in 
or the exercise of a power over ordinary income which would itself cause 
that income to be included. For example, if a grantor has a reversionary 
interest in a trust which is not such as to require that he be treated 
as an owner under section 673, he may nevertheless be treated as an 
owner under section 677(a)(2) since any income allocable to corpus is 
accumulated for future distribution to him, but items of income included 
in determining ordinary income are not included in the portion he is 
treated as owning. Similarly, he may have a power over corpus which is 
such that he is treated as an owner under section 674 or 676 (a), but 
ordinary income will not be included in the portion he owns, if his 
power can only affect income received after a period of time such that 
he would not be treated as an owner of the income if the power were a 
reversionary interest. (See paragraph (c) of this section to determine 
the treatment of deductions and credits when only income allocated to 
corpus is included in the portion.)
    (3) Both ordinary income and other income allocable to corpus are 
included by reason of an interest in or a power over both ordinary 
income and corpus, or an interest in or a power over corpus alone which 
does not come within the provisions of subparagraph (2) of this 
paragraph. For example, if a grantor is treated under section 673 as the 
owner of a portion of a trust by reason of a reversionary interest in 
corpus, both ordinary income and other income allocable to corpus are 
included in the portion. Further, a grantor includes both ordinary 
income and other income allocable to corpus in the portion he is treated 
as owning if he is treated under section 674 or 676 as an owner because 
of a power over corpus which can affect income received within a period 
such that he would be treated as an owner

[[Page 322]]

under section 673 if the power were a reversionary interest. Similarly, 
a grantor or another person includes both ordinary income and other 
income allocable to corpus in the portion he is treated as owning if he 
is treated as an owner under section 675 or 678 because of a power over 
corpus.
    (c) If only income allocable to corpus is included in computing a 
grantor's tax liability, he will take into account in that computation 
only those items of income, deductions, and credit which would not be 
included under subparts A through D in the computation of the tax 
liability of the current income beneficiaries if all distributable net 
income had actually been distributed to those beneficiaries. On the 
other hand, if the grantor or another person is treated as an owner 
solely because of his interest in or power over ordinary income alone, 
he will take into account in computing his tax liability those items 
which would be included in computing the tax liability of a current 
income beneficiary, including expenses allocable to corpus which enter 
into the computation of distributable net income. If the grantor or 
other person is treated as an owner because of his power over or right 
to a dollar amount of ordinary income, he will first take into account a 
portion of those items of income and expense entering into the 
computation of ordinary income under the trust instrument or local law 
sufficient to produce income of the dollar amount required. There will 
then be attributable to him a pro rata portion of other items entering 
into the computation of distributable net income under subparts A 
through D, such as expenses allocable to corpus, and a pro rata portion 
of credits of the trust. For examples of computations under this 
paragraph, see paragraph (g) of Sec. 1.677(a)-1.

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



Sec. 1.671-4  Method of reporting.

    (a) Portion of trust treated as owned by the grantor or another 
person. Except as otherwise provided in paragraph (b) of this section 
and Sec. 1.671-5, items of income, deduction, and credit attributable 
to any portion of a trust that, under the provisions of subpart E 
(section 671 and following), part I, subchapter J, chapter 1 of the 
Internal Revenue Code, is treated as owned by the grantor or another 
person, are not reported by the trust on Form 1041, ``U.S. Income Tax 
Return for Estates and Trusts,'' but are shown on a separate statement 
to be attached to that form. Section 1.671-5 provides special reporting 
rules for widely held fixed investment trusts. Section 301.7701-4(e)(2) 
of this chapter provides guidance regarding the application of the 
reporting rules in this paragraph (a) to an environmental remediation 
trust.
    (b) A trust all of which is treated as owned by one or more grantors 
or other persons--(1) In general. In the case of a trust all of which is 
treated as owned by one or more grantors or other persons, and which is 
not described in paragraph (b)(6) or (7) of this section, the trustee 
may, but is not required to, report by one of the methods described in 
this paragraph (b) rather than by the method described in paragraph (a) 
of this section. A trustee may not report, however, pursuant to 
paragraph (b)(2)(i)(A) of this section unless the grantor or other 
person treated as the owner of the trust provides to the trustee a 
complete Form W-9 or acceptable substitute Form W-9 signed under 
penalties of perjury. See section 3406 and the regulations thereunder 
for the information to include on, and the manner of executing, the Form 
W-9, depending upon the type of reportable payments made.
    (2) A trust all of which is treated as owned by one grantor or by 
one other person--(i) In general. In the case of a trust all of which is 
treated as owned by one grantor or one other person, the trustee 
reporting under this paragraph (b) must either--
    (A) Furnish the name and taxpayer identification number (TIN) of the 
grantor or other person treated as the owner of the trust, and the 
address of the trust, to all payors during the taxable year, and comply 
with the additional requirements described in paragraph (b)(2)(ii) of 
this section; or
    (B) Furnish the name, TIN, and address of the trust to all payors 
during the taxable year, and comply with the additional requirements 
described in paragraph (b)(2)(iii) of this section.

[[Page 323]]

    (ii) Additional obligations of the trustee when name and TIN of the 
grantor or other person treated as the owner of the trust and the 
address of the trust are furnished to payors. (A) Unless the grantor or 
other person treated as the owner of the trust is the trustee or a co-
trustee of the trust, the trustee must furnish the grantor or other 
person treated as the owner of the trust with a statement that--
    (1) Shows all items of income, deduction, and credit of the trust 
for the taxable year;
    (2) Identifies the payor of each item of income;
    (3) Provides the grantor or other person treated as the owner of the 
trust with the information necessary to take the items into account in 
computing the grantor's or other person's taxable income; and
    (4) Informs the grantor or other person treated as the owner of the 
trust that the items of income, deduction and credit and other 
information shown on the statement must be included in computing the 
taxable income and credits of the grantor or other person on the income 
tax return of the grantor or other person.
    (B) The trustee is not required to file any type of return with the 
Internal Revenue Service.
    (iii) Additional obligations of the trustee when name, TIN, and 
address of the trust are furnished to payors--(A) Obligation to file 
Forms 1099. The trustee must file with the Internal Revenue Service the 
appropriate Forms 1099, reporting the income or gross proceeds paid to 
the trust during the taxable year, and showing the trust as the payor 
and the grantor or other person treated as the owner of the trust as the 
payee. The trustee has the same obligations for filing the appropriate 
Forms 1099 as would a payor making reportable payments, except that the 
trustee must report each type of income in the aggregate, and each item 
of gross proceeds separately. See paragraph (b)(5) of this section 
regarding the amounts required to be included on any Forms 1099 filed by 
the trustee.
    (B) Obligation to furnish statement. (1) Unless the grantor or other 
person treated as the owner of the trust is the trustee or a co-trustee 
of the trust, the trustee must also furnish to the grantor or other 
person treated as the owner of the trust a statement that--
    (i) Shows all items of income, deduction, and credit of the trust 
for the taxable year;
    (ii) Provides the grantor or other person treated as the owner of 
the trust with the information necessary to take the items into account 
in computing the grantor's or other person's taxable income; and
    (iii) Informs the grantor or other person treated as the owner of 
the trust that the items of income, deduction and credit and other 
information shown on the statement must be included in computing the 
taxable income and credits of the grantor or other person on the income 
tax return of the grantor or other person.
    (2) By furnishing the statement, the trustee satisfies the 
obligation to furnish statements to recipients with respect to the Forms 
1099 filed by the trustee.
    (iv) Examples. The following examples illustrate the provisions of 
this paragraph (b)(2):

    Example 1. G, a United States citizen, creates an irrevocable trust 
which provides that the ordinary income is to be payable to him for life 
and that on his death the corpus shall be distributed to B, an unrelated 
person. Except for the right to receive income, G retains no right or 
power which would cause him to be treated as an owner under sections 671 
through 679. Under the applicable local law, capital gains must be added 
to corpus. Since G has a right to receive income, he is treated as an 
owner of a portion of the trust under section 677. The tax consequences 
of any items of capital gain of the trust are governed by the provisions 
of subparts A, B, C, and D (section 641 and following), part I, 
subchapter J, chapter 1 of the Internal Revenue Code. Because not all of 
the trust is treated as owned by the grantor or another person, the 
trustee may not report by the methods described in paragraph (b)(2) of 
this section.
    Example 2. (i)(A) On January 2, 1996, G, a United States citizen, 
creates a trust all of which is treated as owned by G. The trustee of 
the trust is T. During the 1996 taxable year the trust has the following 
items of income and gross proceeds:

Interest..........................................................$2,500
Dividends..........................................................3,205
Proceeds from sale of B stock......................................2,000

    (B) The trust has no items of deduction or credit.

[[Page 324]]

    (ii)(A) The payors of the interest paid to the trust are X ($2,000), 
Y ($300), and Z ($200). The payors of the dividends paid to the trust 
are A ($3,200), and D ($5). The payor of the gross proceeds paid to the 
trust is D, a brokerage firm, which held the B stock as the nominee for 
the trust. The B stock was purchased by T for $1,500 on January 3, 1996, 
and sold by T on November 29, 1996. T chooses to report pursuant to 
paragraph (b)(2)(i)(B) of this section, and therefore furnishes the 
name, TIN, and address of the trust to X, Y, Z, A, and D. X, Y, and Z 
each furnish T with a Form 1099-INT showing the trust as the payee. A 
furnishes T with a Form 1099-DIV showing the trust as the payee. D does 
not furnish T with a Form 1099-DIV because D paid a dividend of less 
than $10 to T. D furnishes T with a Form 1099-B showing the trust as the 
payee.
    (B) On or before February 28, 1997, T files a Form 1099-INT with the 
Internal Revenue Service on which T reports interest attributable to G, 
as the owner of the trust, of $2,500; a Form 1099-DIV on which T reports 
dividends attributable to G, as the owner of the trust, of $3,205; and a 
Form 1099-B on which T reports gross proceeds from the sale of B stock 
attributable to G, as the owner of the trust, of $2,000. On or before 
April 15, 1997, T furnishes a statement to G which lists the following 
items of income and information necessary for G to take the items into 
account in computing G's taxable income:

Interest..........................................................$2,500
Dividends..........................................................3,205
Gain from sale of B stock............................................500

    Information regarding sale of B stock:

Proceeds..........................................................$2,000
Basis..............................................................1,500
Date acquired....................................................1/03/96
Date sold.......................................................11/29/96

    (C) T informs G that any items of income, deduction and credit and 
other information shown on the statement must be included in computing 
the taxable income and credits of the grantor or other person on the 
income tax return of the grantor or other person.
    (D) T has complied with T's obligations under this section.
    (iii)(A) Same facts as paragraphs (i) and (ii) of this Example 2, 
except that G contributed the B stock to the trust on January 2, 1996. 
On or before April 15, 1997, T furnishes a statement to G which lists 
the following items of income and information necessary for G to take 
the items into account in computing G's taxable income:

Interest..........................................................$2,500
Dividends..........................................................3,205

    Information regarding sale of B stock:

Proceeds..........................................................$2,000
Date sold.......................................................11/29/96

    (B) T informs G that any items of income, deduction and credit and 
other information shown on the statement must be included in computing 
the taxable income and credits of the grantor or other person on the 
income tax return of the grantor or other person.
    (C) T has complied with T's obligations under this section.
    Example 3. On January 2, 1996, G, a United States citizen, creates a 
trust all of which is treated as owned by G. The trustee of the trust is 
T. The only asset of the trust is an interest in C, a common trust fund 
under section 584(a). T chooses to report pursuant to paragraph 
(b)(2)(i)(B) of this section and therefore furnishes the name, TIN, and 
address of the trust to C. C files a Form 1065 and a Schedule K-1 
(Partner's Share of Income, Credits, Deductions, etc.) showing the name, 
TIN, and address of the trust with the Internal Revenue Service and 
furnishes a copy to T. Because the trust did not receive any amounts 
described in paragraph (b)(5) of this section, T does not file any type 
of return with the Internal Revenue Service. On or before April 15, 
1997, T furnishes G with a statement that shows all items of income, 
deduction, and credit of the trust for the 1996 taxable year. In 
addition, T informs G that any items of income, deduction and credit and 
other information shown on the statement must be included in computing 
the taxable income and credits of the grantor or other person on the 
income tax return of the grantor or other person. T has complied with 
T's obligations under this section.

    (3) A trust all of which is treated as owned by two or more grantors 
or other persons--(i) In general. In the case of a trust all of which is 
treated as owned by two or more grantors or other persons, the trustee 
must furnish the name, TIN, and address of the trust to all payors for 
the taxable year, and comply with the additional requirements described 
in paragraph (b)(3)(ii) of this section.
    (ii) Additional obligations of trustee--(A) Obligation to file Forms 
1099. The trustee must file with the Internal Revenue Service the 
appropriate Forms 1099, reporting the items of income paid to the trust 
by all payors during the taxable year attributable to the portion of the 
trust treated as owned by each grantor or other person, and showing the 
trust as the payor and each grantor or other person treated as an owner 
of the trust as the payee. The trustee has the same obligations for 
filing the appropriate Forms 1099 as would a payor making reportable 
payments, except that the trustee must report each type of income in the 
aggregate, and each item of gross proceeds

[[Page 325]]

separately. See paragraph (b)(5) of this section regarding the amounts 
required to be included on any Forms 1099 filed by the trustee.
    (B) Obligation to furnish statement. (1) The trustee must also 
furnish to each grantor or other person treated as an owner of the trust 
a statement that--
    (i) Shows all items of income, deduction, and credit of the trust 
for the taxable year attributable to the portion of the trust treated as 
owned by the grantor or other person;
    (ii) Provides the grantor or other person treated as an owner of the 
trust with the information necessary to take the items into account in 
computing the grantor's or other person's taxable income; and
    (iii) Informs the grantor or other person treated as the owner of 
the trust that the items of income, deduction and credit and other 
information shown on the statement must be included in computing the 
taxable income and credits of the grantor or other person on the income 
tax return of the grantor or other person.
    (2) Except for the requirements pursuant to section 3406 and the 
regulations thereunder, by furnishing the statement, the trustee 
satisfies the obligation to furnish statements to recipients with 
respect to the Forms 1099 filed by the trustee.
    (4) Persons treated as payors--(i) In general. For purposes of this 
section, the term payor means any person who is required by any 
provision of the Internal Revenue Code and the regulations thereunder to 
make any type of information return (including Form 1099 or Schedule K-
1) with respect to the trust for the taxable year, including persons who 
make payments to the trust or who collect (or otherwise act as middlemen 
with respect to) payments on behalf of the trust.
    (ii) Application to brokers and customers. For purposes of this 
section, a broker, within the meaning of section 6045, is considered a 
payor. A customer, within the meaning of section 6045, is considered a 
payee.
    (5) Amounts required to be included on Forms 1099 filed by the 
trustee--(i) In general. The amounts that must be included on any Forms 
1099 required to be filed by the trustee pursuant to this section do not 
include any amounts that are reportable by the payor on an information 
return other than Form 1099. For example, in the case of a trust which 
owns an interest in a partnership, the trust's distributive share of the 
income and gain of the partnership is not includible on any Forms 1099 
filed by the trustee pursuant to this section because the distributive 
share is reportable by the partnership on Schedule K-1.
    (ii) Example. The following example illustrates the provisions of 
this paragraph (b)(5):

    Example. (i)(A) On January 2, 1996, G, a United States citizen, 
creates a trust all of which is treated as owned by G. The trustee of 
the trust is T. The assets of the trust during the 1996 taxable year are 
shares of stock in X, an S corporation, a limited partnership interest 
in P, shares of stock in M, and shares of stock in N. T chooses to 
report pursuant to paragraph (b)(2)(i)(B) of this section and therefore 
furnishes the name, TIN, and address of the trust to X, P, M, and N. M 
furnishes T with a Form 1099-DIV showing the trust as the payee. N does 
not furnish T with a Form 1099-DIV because N paid a dividend of less 
than $10 to T. X and P furnish T with Schedule K-1 (Shareholder's Share 
of Income, Credits, Deductions, etc.) and Schedule K-1 (Partner's Share 
of Income, Credits, Deductions, etc.), respectively, showing the trust's 
name, TIN, and address.
    (B) For the 1996 taxable year the trust has the following items of 
income and deduction:

Dividends paid by M..................................................$12
Dividends paid by N....................................................6
Administrative expense...............................................$20

    Items reported by X on Schedule K-1 attributable to trust's shares 
of stock in X:

Interest.............................................................$20
Dividends.............................................................35

    Items reported by P on Schedule K-1 attributable to trust's limited 
partnership interest in P:

Ordinary income.....................................................$300

    (ii)(A) On or before February 28, 1997, T files with the Internal 
Revenue Service a Form 1099-DIV on which T reports dividends 
attributable to G as the owner of the trust in the amount of $18. T does 
not file any other returns.
    (B) T has complied with T's obligation under paragraph 
(b)(2)(iii)(A) of this section to file the appropriate Forms 1099.

    (6) Trusts that cannot report under this paragraph (b). The 
following trusts cannot use the methods of reporting described in this 
paragraph (b)--

[[Page 326]]

    (i) A common trust fund as defined in section 584(a);
    (ii) A trust that has its situs or any of its assets located outside 
the United States;
    (iii) A trust that is a qualified subchapter S trust as defined in 
section 1361(d)(3);
    (iv) A trust all of which is treated as owned by one grantor or one 
other person whose taxable year is a fiscal year;
    (v) A trust all of which is treated as owned by one grantor or one 
other person who is not a United States person; or
    (vi) A trust all of which is treated as owned by two or more 
grantors or other persons, one of whom is not a United States person.
    (7) Grantors or other persons who are treated as owners of the trust 
and are exempt recipients for information reporting purposes--(i) Trust 
treated as owned by one grantor or one other person. The trustee of a 
trust all of which is treated as owned by one grantor or one other 
person may not report pursuant to this paragraph (b) if the grantor or 
other person is an exempt recipient for information reporting purposes.
    (ii) Trust treated as owned by two or more grantors or other 
persons. The trustee of a trust, all of which is treated as owned by two 
or more grantors or other persons, may not report pursuant to this 
paragraph (b) if one or more grantors or other persons treated as owners 
are exempt recipients for information reporting purposes unless--
    (A) At least one grantor or one other person who is treated as an 
owner of the trust is a person who is not an exempt recipient for 
information reporting purposes; and
    (B) The trustee reports without regard to whether any of the 
grantors or other persons treated as owners of the trust are exempt 
recipients for information reporting purposes.
    (8) Husband and wife who make a single return jointly. A trust all 
of which is treated as owned by a husband and wife who make a single 
return jointly of income taxes for the taxable year under section 6013 
is considered to be owned by one grantor for purposes of this paragraph 
(b).
    (c) Due date for Forms 1099 required to be filed by trustee. The due 
date for any Forms 1099 required to be filed with the Internal Revenue 
Service by a trustee pursuant to this section is the due date otherwise 
in effect for filing Forms 1099.
    (d) Due date and other requirements with respect to statement 
required to be furnished by trustee--(1) In general. The due date for 
the statement required to be furnished by a trustee to the grantor or 
other person treated as an owner of the trust pursuant to this section 
is the date specified by section 6034A(a). The trustee must maintain in 
its records a copy of the statement furnished to the grantor or other 
person treated as an owner of the trust for a period of three years from 
the due date for furnishing such statement specified in this paragraph 
(d).
    (2) Statement for the taxable year ending with the death of the 
grantor or other person treated as the owner of the trust. If a trust 
ceases to be treated as owned by the grantor, or other person, by reason 
of the death of that grantor or other person (decedent), the due date 
for the statement required to be furnished for the taxable year ending 
with the death of the decedent shall be the date specified by section 
6034A(a) as though the decedent had lived throughout the decedent's last 
taxable year. See paragraph (h) of this section for special reporting 
rules for a trust or portion of the trust that ceases to be treated as 
owned by the grantor or other person by reason of the death of the 
grantor or other person.
    (e) Backup withholding requirements--(1) Trustee reporting under 
paragraph (b)(2)(i)(A) of this section. In order for the trustee to be 
able to report pursuant to paragraph (b)(2)(i)(A) of this section and to 
furnish to all payors the name and TIN of the grantor or other person 
treated as the owner of the trust, the grantor or other person must 
provide a complete Form W-9 to the trustee in the manner provided in 
paragraph (b)(1) of this section, and the trustee must give the name and 
TIN shown on that Form W-9 to all payors. In addition, if the Form W-9 
indicates that the grantor or other person is subject to backup 
withholding, the trustee must notify all payors of reportable interest 
and dividend payments of the requirement to backup withhold. If the

[[Page 327]]

Form W-9 indicates that the grantor or other person is not subject to 
backup withholding, the trustee does not have to notify the payors that 
backup withholding is not required. The trustee should not give the Form 
W-9, or a copy thereof, to a payor because the Form W-9 contains the 
address of the grantor or other person and paragraph (b)(2)(i)(A) of 
this section requires the trustee to furnish the address of the trust to 
all payors and not the address of the grantor or other person. The 
trustee acts as the agent of the grantor or other person for purposes of 
furnishing to the payors the information required by this paragraph 
(e)(1). Thus, a payor may rely on the name and TIN provided to the payor 
by the trustee, and, if given, on the trustee's statement that the 
grantor is subject to backup withholding.
    (2) Other backup withholding requirements. Whether a trustee is 
treated as a payor for purposes of backup withholding is determined 
pursuant to section 3406 and the regulations thereunder.
    (f) Penalties for failure to file a correct Form 1099 or furnish a 
correct statement. A trustee who fails to file a correct Form 1099 or to 
furnish a correct statement to a grantor or other person treated as an 
owner of the trust as required by paragraph (b) of this section is 
subject to the penalties provided by sections 6721 and 6722 and the 
regulations thereunder.
    (g) Changing reporting methods--(1) Changing from reporting by 
filing Form 1041 to a method described in paragraph (b) of this section. 
If the trustee has filed a Form 1041 for any taxable year ending before 
January 1, 1996 (and has not filed a final Form 1041 pursuant to Sec. 
1.671-4(b)(3) (as contained in the 26 CFR part 1 edition revised as of 
April 1, 1995)), or files a Form 1041 for any taxable year thereafter, 
the trustee must file a final Form 1041 for the taxable year which ends 
after January 1, 1995, and which immediately precedes the first taxable 
year for which the trustee reports pursuant to paragraph (b) of this 
section, on the front of which form the trustee must write: ``Pursuant 
to Sec. 1.671-4(g), this is the final Form 1041 for this grantor 
trust.''.
    (2) Changing from reporting by a method described in paragraph (b) 
of this section to the filing of a Form 1041. The trustee of a trust who 
reported pursuant to paragraph (b) of this section for a taxable year 
may report pursuant to paragraph (a) of this section for subsequent 
taxable years. If the trustee reported pursuant to paragraph 
(b)(2)(i)(A) of this section, and therefore furnished the name and TIN 
of the grantor to all payors, the trustee must furnish the name, TIN, 
and address of the trust to all payors for such subsequent taxable 
years. If the trustee reported pursuant to paragraph (b)(2)(i)(B) or 
(b)(3)(i) of this section, and therefore furnished the name and TIN of 
the trust to all payors, the trustee must indicate on each Form 1096 
(Annual Summary and Transmittal of U.S. Information Returns) that it 
files (or appropriately on magnetic media) for the final taxable year 
for which the trustee so reports that it is the final return of the 
trust.
    (3) Changing between methods described in paragraph (b) of this 
section--(i) Changing from furnishing the TIN of the grantor to 
furnishing the TIN of the trust. The trustee of a trust who reported 
pursuant to paragraph (b)(2)(i)(A) of this section for a taxable year, 
and therefore furnished the name and TIN of the grantor to all payors, 
may report pursuant to paragraph (b)(2)(i)(B) of this section, and 
furnish the name and TIN of the trust to all payors, for subsequent 
taxable years.
    (ii) Changing from furnishing the TIN of the trust to furnishing the 
TIN of the grantor. The trustee of a trust who reported pursuant to 
paragraph (b)(2)(i)(B) of this section for a taxable year, and therefore 
furnished the name and TIN of the trust to all payors, may report 
pursuant to paragraph (b)(2)(i)(A) of this section, and furnish the name 
and TIN of the grantor to all payors, for subsequent taxable years. The 
trustee, however, must indicate on each Form 1096 (Annual Summary and 
Transmittal of U.S. Information Returns) that it files (or appropriately 
on magnetic media) for the final taxable year for which the trustee 
reports pursuant to paragraph (b)(2)(i)(B) of this section that it is 
the final return of the trust.

[[Page 328]]

    (4) Example. The following example illustrates the provisions of 
paragraph (g) of this section:

    Example. (i) On January 3, 1994, G, a United States citizen, creates 
a trust all of which is treated as owned by G. The trustee of the trust 
is T. On or before April 17, 1995, T files with the Internal Revenue 
Service a Form 1041 with an attached statement for the 1994 taxable year 
showing the items of income, deduction, and credit of the trust. On or 
before April 15, 1996, T files with the Internal Revenue Service a Form 
1041 with an attached statement for the 1995 taxable year showing the 
items of income, deduction, and credit of the trust. On the Form 1041, T 
states that ``pursuant to Sec. 1.671-4(g), this is the final Form 1041 
for this grantor trust.'' T may report pursuant to paragraph (b) of this 
section for the 1996 taxable year.
    (ii) T reports pursuant to paragraph (b)(2)(i)(B) of this section, 
and therefore furnishes the name, TIN, and address of the trust to all 
payors, for the 1996 and 1997 taxable years. T chooses to report 
pursuant to paragraph (a) of this section for the 1998 taxable year. On 
each Form 1096 (Annual Summary and Transmittal of U.S. Information 
Returns) which T files for the 1997 taxable year (or appropriately on 
magnetic media), T indicates that it is the trust's final return. On or 
before April 15, 1999, T files with the Internal Revenue Service a Form 
1041 with an attached statement showing the items of income, deduction, 
and credit of the trust. On the Form 1041, T uses the same TIN which T 
used on the Forms 1041 and Forms 1099 it filed for previous taxable 
years. T has complied with T's obligations under paragraph (g)(2) of 
this section.

    (h) Reporting rules for a trust, or portion of a trust, that ceases 
to be treated as owned by a grantor or other person by reason of the 
death of the grantor or other person--(1) Definition of decedent. For 
purposes of this paragraph (h), the decedent is the grantor or other 
person treated as the owner of the trust, or portion of the trust, under 
subpart E, part I, subchapter J, chapter 1 of the Internal Revenue Code 
on the date of death of that person.
    (2) In general. The provisions of this section apply to a trust, or 
portion of a trust, treated as owned by a decedent for the taxable year 
that ends with the decedent's death. Following the death of the 
decedent, the trust or portion of a trust that ceases to be treated as 
owned by the decedent, by reason of the death of the decedent, may no 
longer report under this section. A trust, all of which was treated as 
owned by the decedent, must obtain a new TIN upon the death of the 
decedent, if the trust will continue after the death of the decedent. 
See Sec. 301.6109-1(a)(3)(i) of this chapter for rules regarding 
obtaining a TIN upon the death of the decedent.
    (3) Special rules--(i) Trusts reporting pursuant to paragraph (a) of 
this section for the taxable year ending with the decedent's death. The 
due date for the filing of a return pursuant to paragraph (a) of this 
section for the taxable year ending with the decedent's death shall be 
the due date provided for under Sec. 1.6072-1(a)(2). The return filed 
under this paragraph for a trust all of which was treated as owned by 
the decedent must indicate that it is a final return.
    (ii) Trust reporting pursuant to paragraph (b)(2)(B) of this section 
for the taxable year of the decedent's death. A trust that reports 
pursuant to paragraph (b)(2)(B) of this section for the taxable year 
ending with the decedent's death must indicate on each Form 1096 
``Annual Summary and Transmittal of the U.S. Information Returns'' that 
it files (or appropriately on magnetic media) for the taxable year 
ending with the death of the decedent that it is the final return of the 
trust.
    (iii) Trust reporting under paragraph (b)(3) of this section. If a 
trust has been reporting under paragraph (b)(3) of this section, the 
trustee may not report under that paragraph if any portion of the trust 
has a short taxable year by reason of the death of the decedent and the 
portion treated as owned by the decedent does not terminate on the death 
of the decedent.
    (i) Effective date and transition rule--(1) Effective date. The 
trustee of a trust any portion of which is treated as owned by one or 
more grantors or other persons must report pursuant to paragraphs (a), 
(b), (c), (d)(1), (e), (f), and (g) of this section for taxable years 
beginning on or after January 1, 1996.
    (2) Transition rule. For taxable years beginning prior to January 1, 
1996, the Internal Revenue Service will not challenge the manner of 
reporting of--
    (i) A trustee of a trust all of which is treated as owned by one or 
more grantors or other persons who did not report in accordance with 
Sec. 1.671-4(a)

[[Page 329]]

(as contained in the 26 CFR part 1 edition revised as of April 1, 1995) 
as in effect for taxable years beginning prior to January 1, 1996, but 
did report in a manner substantially similar to one of the reporting 
methods described in paragraph (b) of this section; or
    (ii) A trustee of two or more trusts all of which are treated as 
owned by one or more grantors or other persons who filed a single Form 
1041 for all of the trusts, rather than a separate Form 1041 for each 
trust, provided that the items of income, deduction, and credit of each 
trust were shown on a statement attached to the single Form 1041.
    (3) Effective date for paragraphs (d)(2) and (h) of this section. 
Paragraphs (d)(2) and (h) of this section apply for taxable years ending 
on or after December 24, 2002.
    (j) Cross-reference. For rules relating to employer identification 
numbers, and to the obligation of a payor of income or proceeds to the 
trust to furnish to the payee a statement to recipient, see Sec. 
301.6109-1(a)(2) of this chapter.

[T.D. 8633, 60 FR 66087, Dec. 21, 1995, as amended by T.D. 8668, 61 FR 
19191, May 1, 1996; T.D. 9032, 67 FR 78381, Dec. 24, 2002; T.D. 9241, 71 
FR 4009, Jan. 24. 2006]



Sec. 1.671-5  Reporting for widely held fixed investment trusts.

    (a) Table of contents. This table of contents lists the major 
paragraph headings for this section.

(a) Table of contents.
(b) Definitions.
(c) Trustee's obligation to report information.
(1) In general.
(i) Calculation.
(ii) Calculation period.
(iii) Accounting method.
(iv) Gross income requirement.
(2) Information to be reported by all WHFITs.
(i) Trust identification and calculation period chosen.
(ii) Items of income, expense, and credit.
(iii) Non pro-rata partial principal payments.
(iv) Asset sales and dispositions.
(v) Redemptions and sales of WHFIT interests.
(vi) Information regarding bond premium.
(vii) Information regarding market discount.
(viii) Other information.
(3) Identifying the representative who will provide trust information.
(4) Time and manner of providing information.
(i) Time.
(ii) Manner.
(iii) Inclusion of information with respect to all calculation periods.
(5) Requesting information from a WHFIT.
(i) In general.
(ii) Manner of requesting information.
(iii) Period of time during which a requesting person may request WHFIT 
          information.
(6) Trustee's requirement to retain records.
(d) Form 1099 requirement for trustees and middlemen.
(1) Obligation to file Form 1099 with the IRS.
(i) In general.
(ii) Forms 1099 not required for exempt recipients.
(iii) Reporting and withholding with respect to foreign persons.
(2) Information to be reported.
(i) Determining amounts to be provided on Forms 1099.
(ii) Information to be provided on Forms 1099.
(3) Time and manner of filing Forms 1099.
(i) Time and place.
(ii) Reporting trust sales proceeds, redemption asset proceeds, 
          redemption proceeds, sales asset proceeds, sales proceeds, and 
          non pro-rata partial principal payments.
(e) Requirement to furnish a written tax information statement to the 
          TIH.
(1) In general.
(2) Information required.
(i) WHFIT information.
(ii) Identification of the person furnishing the statement.
(iii) Items of income, expense, and credit.
(iv) Non pro-rata partial principal payments.
(v) Asset sales and dispositions.
(vi) Redemption or sale of a trust interest.
(vii) Information regarding market discount and bond premium.
(viii) Other information.
(ix) Required statement.
(3) Due date and other requirements.
(4) Requirement to retain records.
(f) Safe harbor for providing information for certain NMWHFITs.
(1) Safe harbor for trustee reporting of NMWHFIT information.
(i) In general.
(ii) Reporting NMWHFIT income and expenses.
(iii) Reporting non pro-rata partial principal payments under the safe 
          harbor.
(iv) Reporting sales and dispositions of NMWHFIT assets under the safe 
          harbor.
(v) Reporting redemptions under the safe harbor.
(vi) Reporting the sale of a trust interest under the safe harbor.
(vii) Reporting OID information under the safe harbor.
(viii) Reporting market discount information under the safe harbor.

[[Page 330]]

(ix) Reporting bond premium information under the safe harbor.
(x) Reporting additional information.
(2) Use of information provided by trustees under the safe harbor for 
          NMWHFITs.
(i) In general.
(ii) Determining NMWHFIT income and expenses under the safe harbor.
(iii) Reporting non pro-rata partial principal payments under the safe 
          harbor.
(iv) Reporting sales and dispositions of NMWHFIT assets under the safe 
          harbor.
(v) Reporting redemptions under the safe harbor.
(vi) Reporting sales of trust interests under the safe harbor.
(vii) Reporting OID information under the safe harbor.
(viii) Reporting market discount information under the safe harbor.
(ix) Reporting bond premium information under the safe harbor.
(3) Example of the use of the safe harbor for NMWHFITs.
(i) Facts.
(ii) Trustee reporting.
(iii) Brokers' use of information provided by Trustee.
(g) Safe Harbor for certain WHMTs.
(1) Safe harbor for trustees of certain WHMTs for reporting information.
(i) In general.
(ii) Requirements.
(iii) Reporting WHMT income, expenses, non pro-rata partial principal 
          payments, and sales and dispositions under the safe harbor.
(iv) Reporting OID information under the safe harbor.
(v) Reporting market discount information under the safe harbor.
(vi) Reporting bond premium information under the safe harbor.
(2) Use of information provided by a trustee under the safe harbor.
(i) In general.
(ii) Reporting WHMT income, expenses, non pro-rata partial principal 
          payments, and sales and dispositions under the safe harbor.
(iii) Reporting OID information under the safe harbor.
(iv) Requirement to provide market discount information under the safe 
          harbor.
(v) Requirement to provide bond premium information under the safe 
          harbor.
(3) Example of safe harbor in paragraph (g)(1) of this section.
(i) Facts.
(ii) Trustee reporting.
(iii) Broker's use of the information provided by Trustee.
(h) Additional safe harbors.
(1) Temporary safe harbors.
(2) Additional safe harbors provided by other published guidance.
(i) Reserved.
(j) Requirement that middlemen furnish information to beneficial owners 
          that are exempt recipients and non calendar year beneficial 
          owners.
(1) In general.
(2) Time for providing information.
(3) Manner of providing information.
(4) Clearing organization.
(k) Coordination with other information reporting rules.
(l) Backup withholding requirements.
(m) Penalties for failure to comply.
(n) Effective date.

    (b) Definitions. Solely for purposes of this section:
    (1) An asset includes any real or personal, tangible or intangible 
property held by the trust, including an interest in a contract.
    (2) An affected expense is an expense described in Sec. 1.67-
2T(i)(1).
    (3) A beneficial owner is a trust interest holder (TIH) (as defined 
in paragraph (b)(20) of this section) that holds a beneficial interest 
in a widely held fixed investment trust (WHFIT) (as defined in paragraph 
(b)(22) of this section.)
    (4) The calculation period is the period the trustee chooses under 
paragraph (c)(1)(ii) of this section for calculating the trust 
information required to be provided under paragraph (c) of this section.
    (5) The cash held for distribution is the amount of cash held by the 
WHFIT (other than trust sales proceeds and proceeds from sales described 
in paragraphs (c)(2)(iv)(D)(4), (G), and (H) of this section) less 
reasonably required reserve funds as of the date that the amount of a 
distribution is required to be determined under the WHFIT's governing 
document.
    (6) A clean-up call is the redemption of all trust interests in 
termination of the WHFIT when the administrative costs of the WHFIT 
outweigh the benefits of maintaining the WHFIT.
    (7) An exempt recipient is--
    (i) Any person described in Sec. 1.6049-4(c)(1)(ii);
    (ii) A middleman (as defined in paragraph (b)(10) of this section);
    (iii) A real estate mortgage investment conduit (as defined in 
section 860(D)(a)) (REMIC);
    (iv) A WHFIT; or
    (v) A trust or an estate for which the trustee or middleman of the 
WHFIT is

[[Page 331]]

also required to file a Form 1041, ``U.S. Income Tax Return for Estates 
and Trusts,'' in its capacity as a fiduciary of that trust or estate.
    (8) An in-kind redemption is a redemption in which a beneficial 
owner receives a pro-rata share of each of the assets of the WHFIT that 
the beneficial owner is deemed to own under section 671. For example, 
for purposes of this paragraph (b)(8), if beneficial owner A owns a one 
percent interest in a WHFIT that holds 100 shares of X corporation 
stock, so that A is considered to own a one percent interest in each of 
the 100 shares, A's pro-rata share of the X corporation stock for this 
purpose is one share of X corporation stock.
    (9) An item refers to an item of income, expense, or credit as well 
as any trust event (for example, the sale of an asset) or any 
characteristic or attribute of the trust that affects the income, 
deductions, and credits reported by a beneficial owner in any taxable 
year that the beneficial owner holds an interest in the trust. An item 
may refer to an individual item or a group of items depending on whether 
the item must be reported separately under paragraphs (c)(1)(i) and 
(e)(1) of this section.
    (10) A middleman is any TIH, other than a qualified intermediary as 
defined in Sec. 1.1031(k)-1(g), who, at any time during the calendar 
year, holds an interest in a WHFIT on behalf of, or for the account of, 
another TIH, or who otherwise acts in a capacity as an intermediary for 
the account of another person. A middleman includes, but is not limited 
to--
    (i) A custodian of a person's account, such as a bank, financial 
institution, or brokerage firm acting as custodian of an account;
    (ii) A nominee;
    (iii) A joint owner of an account or instrument other than--
    (A) A joint owner who is the spouse of the other owner; and
    (B) A joint owner who is the beneficial owner and whose name appears 
on the Form 1099 filed with respect to the trust interest under 
paragraph (d) of this section; and
    (iv) A broker (as defined in section 6045(c)(1) and Sec. 1.6045-
1(a)(1)), holding an interest for a customer in street name.
    (11) A mortgage is an obligation that is principally secured by an 
interest in real property within the meaning of Sec. 1.860G-2(a)(5), 
except that a mortgage does not include an interest in another WHFIT or 
mortgages held by another WHFIT.
    (12) A non-mortgage widely held fixed investment trust (NMWHFIT) is 
a WHFIT other than a widely held mortgage trust (as defined in paragraph 
(b)(23) of this section).
    (13) A non pro-rata partial principal payment is any partial payment 
of principal received on a debt instrument which does not retire the 
debt instrument and which is not a pro-rata prepayment described in 
Sec. 1.1275-2(f)(2).
    (14) The redemption asset proceeds equal the redemption proceeds (as 
defined in paragraph (b)(15) of this section) less the cash held for 
distribution with respect to the redeemed trust interest.
    (15) The redemption proceeds equal the total amount paid to a 
redeeming TIH as the result of a redemption of a trust interest.
    (16) A requesting person is--
    (i) A middleman;
    (ii) A beneficial owner who is a broker;
    (iii) A beneficial owner who is an exempt recipient who holds a 
trust interest directly and not through a middleman;
    (iv) A noncalendar-year beneficial owner who holds a trust interest 
directly and not through a middleman; or
    (v) A representative or agent of a person specified in this 
paragraph (b)(16).
    (17) The sales asset proceeds equal the sales proceeds (as defined 
in paragraph (b)(18) of this section) less the cash held for 
distribution with respect to the sold trust interest at the time of the 
sale.
    (18) The sales proceeds equal the total amount paid to a selling TIH 
in consideration for the sale of a trust interest.
    (19) The start-up date is the date on which substantially all of the 
assets have been deposited with the trustee of the WHFIT.
    (20) A trust interest holder (TIH) is any person who holds a direct 
or indirect

[[Page 332]]

interest, including a beneficial interest, in a WHFIT at any time during 
the calendar year.
    (21) Trust sales proceeds equal the amount paid to a WHFIT for the 
sale or disposition of an asset held by the WHFIT, including principal 
payments received by the WHFIT that completely retire a debt instrument 
(other than a final scheduled principal payment) and pro-rata partial 
principal prepayments described under Sec. 1.1275-2(f)(2). Trust sales 
proceeds do not include amounts paid for any interest income that would 
be required to be reported under Sec. 1.6045-1(d)(3). Trust sales 
proceeds also do not include amounts paid to a NMWHFIT as the result of 
pro-rata sales of trust assets to effect a redemption described in 
paragraph (c)(2)(iv)(G) of this section or the value of assets received 
as a result of a tax-free corporate reorganization as described in 
paragraph (c)(2)(iv)(H) of this section.
    (22) A widely held fixed investment trust (WHFIT) is an arrangement 
classified as a trust under Sec. 301.7701-4(c) of this chapter, 
provided that--
    (i) The trust is a United States person under section 
7701(a)(30)(E);
    (ii) The beneficial owners of the trust are treated as owners under 
subpart E, part I, subchapter J, chapter 1 of the Internal Revenue Code; 
and
    (iii) At least one interest in the trust is held by a middleman.
    (23) A widely held mortgage trust (WHMT) is a WHFIT, the assets of 
which consist only of one or more of the following--
    (i) Mortgages;
    (ii) Regular interests in a REMIC;
    (iii) Interests in another WHMT;
    (iv) Reasonably required reserve funds;
    (v) Amounts received on the assets described in paragraphs 
(b)(23)(i), (ii), (iii), and (iv) of this section pending distribution 
to TIHs; and
    (vi) During a brief initial funding period, cash and short-term 
contracts for the purchase of the assets described in paragraphs 
(b)(23)(i), (ii), and (iii).
    (c) Trustee's obligation to report information--(1) In general. Upon 
the request of a requesting person (as defined in paragraph (b)(16) of 
this section), a trustee of a WHFIT must report the information 
described in paragraph (c)(2) of this section to the requesting person. 
The trustee must determine such information in accordance with the 
following rules--
    (i) Calculation. WHFIT information may be calculated in any manner 
that enables a requesting person to determine with reasonable accuracy 
the WHFIT items described in paragraph (c)(2) of this section that are 
attributable (or, if permitted under paragraphs (c)(2)(iv)(B) or 
(f)(2)(iii) of this section, distributed) to a beneficial owner for the 
taxable year of that owner. The manner of calculation must generally 
conform with industry practice for calculating the WHFIT items described 
in paragraph (c)(2) of this section for the type of asset or assets held 
by the WHFIT, and must enable a requesting person to separately state 
any WHFIT item that, if taken into account separately by a beneficial 
owner, would result in an income tax liability different from that which 
would result if the owner did not take the item into account separately.
    (ii) Calculation period--WHFIT information may be calculated on the 
basis of a calendar month, calendar quarter, or half or full calendar 
year, provided that a trustee uses the same calculation period for the 
life of the WHFIT and the information provided by the trustee meets the 
requirements of paragraph (c)(1)(i) of this section. Regardless of the 
calculation period chosen by the trustee, the trustee must provide 
information requested by a requesting person under paragraph (c)(5) on a 
calendar year basis. The trustee may provide additional information to 
requesting persons throughout the calendar year at the trustee's 
discretion.
    (iii) Accounting method--(A) General rule. WHFIT information must be 
calculated and reported using the cash receipts and disbursements method 
of accounting unless another method is required by the Internal Revenue 
Code or regulations with respect to a specific trust item. Accordingly, 
a trustee must provide information necessary for TIHs to comply with the 
rules of subtitle A, chapter 1, subchapter P, part V, subpart A of the 
Internal Revenue Code, which require the inclusion of accrued

[[Page 333]]

amounts with respect to OID, and section 860B(b), which requires the 
inclusion of accrued amounts with respect to a REMIC regular interest.
    (B) Exception for WHFITs marketed predominantly to taxpayers on the 
accrual method. If the trustee or the trust's sponsor knows or 
reasonably should know that a WHFIT is marketed primarily to accrual 
method TIHs and the WHFIT holds assets for which the timing of the 
recognition of income is materially affected by the use of the accrual 
method of accounting, the trustee must calculate and report trust 
information using the accrual method of accounting.
    (iv) Gross income requirement. The amount of income required to be 
reported by the trustee is the gross income (as defined in section 61) 
generated by the WHFIT's assets. Thus, in the case of a WHFIT that 
receives a payment of income from which an expense (or expenses) has 
been deducted, the trustee, in calculating the income to be reported 
under paragraph (c)(2)(ii) of this section, must report the income 
earned on the trusts assets unreduced by the deducted expense or 
expenses and separately report the deducted expense or expenses. See 
paragraph (c)(2)(iv) of this section regarding reporting with respect to 
sales and dispositions.
    (2) Information to be reported by all WHFITs. With respect to all 
WHFITs--
    (i) Trust identification and calculation period chosen. The trustee 
must report information identifying the WHFIT, including--
    (A) The name of the WHFIT;
    (B)The employer identification number of the WHFIT;
    (C) The name and address of the trustee;
    (D) The Committee on Uniform Security Identification Procedure 
(CUSIP) number, account number, serial number, or other identifying 
number of the WHFIT;
    (E) The classification of the WHFIT as either a WHMT or NMWHFIT; and
    (F) The calculation period used by the trustee.
    (ii) Items of income, expense, and credit. The trustee must report 
information detailing--
    (A) All items of gross income (including OID, except that OID is not 
required to be included for a WHMT that has a start-up date (as defined 
in paragraph (b)(19) of this section) prior to August 13, 1998).
    (B) All items of expense (including affected expenses); and
    (C) All items of credit.
    (iii) Non pro-rata partial principal payments. The trustee must 
report information detailing non pro-rata partial principal payments (as 
defined in paragraph (b)(13) of this section) received by the WHFIT.
    (iv) Asset sales and dispositions. The trustee must report 
information regarding sales and dispositions of WHFIT assets as required 
in this paragraph (c)(2)(iv). For purposes of this paragraph (c)(2)(iv), 
a payment (other than a final scheduled payment) that completely retires 
a debt instrument (including a mortgage held by a WHMT) or a pro-rata 
prepayment on a debt instrument (see Sec. 1.1275-2(f)(2)) held by a 
WHFIT must be reported as a full or partial sale or disposition of the 
debt instrument. Pro-rata sales of trust assets to effect redemptions, 
as defined in paragraph (c)(2)(iv)(G) of this section, or exchanges of 
trust assets as the result of a corporate reorganization under paragraph 
(c)(2)(iv)(H) of this section, are not reported as sales or dispositions 
under this paragraph (c)(2)(iv).
    (A) General rule. Except as provided in paragraph (c)(2)(iv)(B) 
(regarding the exception for certain NMWHFITs) or paragraph 
(c)(2)(iv)(C) (regarding the exception for certain WHMTs) of this 
section, the trustee must report with respect to each sale or 
disposition of a WHFIT asset--
    (1) The date of each sale or disposition;
    (2) Information that enables a requesting person to determine the 
amount of trust sales proceeds (as defined in paragraph (b)(21) of this 
section) attributable to a beneficial owner as a result of each sale or 
disposition; and
    (3) Information that enables a beneficial owner to allocate, with 
reasonable accuracy, a portion of the owner's basis in its trust 
interest to each sale or disposition.

[[Page 334]]

    (B) Exception for certain NMWHFITs. If a NMWHFIT meets paragraph 
(c)(2)(iv)(D)(1)(regarding the general de minimis test), paragraph 
(c)(2)(iv)(E) (regarding the qualified NMWHFIT exception), or paragraph 
(c)(2)(iv)(F) (regarding the NMWHFIT final calendar year exception) of 
this section, the trustee is not required to report under paragraph 
(c)(2)(iv)(A) of this section. Instead, the trustee must report 
sufficient information to enable a requesting person to determine the 
amount of trust sales proceeds distributed to a beneficial owner during 
the calendar year with respect to each sale or disposition of a trust 
asset. The trustee also must provide requesting persons with a statement 
that the NMWHFIT is permitted to report under this paragraph 
(c)(2)(iv)(B).
    (C) Exception for certain WHMTs. If a WHMT meets either the general 
or the special de minimis test of paragraph (c)(2)(iv)(D) of this 
section for the calendar year, the trustee is not required to report 
under paragraph (c)(2)(iv)(A) of this section. Instead, the trustee must 
report information to enable a requesting person to determine the amount 
of trust sales proceeds attributable to a beneficial owner as a result 
of the sale or disposition. The trustee also must provide requesting 
persons with a statement that the WHMT is permitted to report under this 
paragraph (c)(2)(iv)(C).
    (D) De minimis tests--(1) General WHFIT de minimis test. The general 
WHFIT de minimis test is satisfied if trust sales proceeds for the 
calendar year are not more than five percent of the net asset value of 
the trust (aggregate fair market value of the trust's assets less the 
trust's liabilities) as of the later of January 1 and the start-up date 
(as defined paragraph (b)(19) of this section); or, if the trustee 
chooses, the later of January 1 and the measuring date. The measuring 
date is the date of the last deposit of assets into the WHFIT (not 
including any deposit of assets into the WHFIT pursuant to a 
distribution reinvestment program), not to exceed 90 days after the date 
the registration statement of the WHFIT becomes effective under the 
Securities Act of 1933.
    (2) Special WHMT de minimis test. A WHMT that meets the asset 
requirement of paragraph (g)(1)(ii)(E) of this section satisfies the 
special WHMT de minimis test in this paragraph (c)(2)(iv)(D)(2) if trust 
sales proceeds for the calendar year are not more than five percent of 
the aggregate outstanding principal balance of the WHMT (as defined in 
paragraph (g)(1)(iii)(D) of this section) as of the later of January 1 
of that year or the trust's start-up date. For purposes of applying the 
special WHMT de minimis test in this paragraph (c)(2)(iv)(D)(2), amounts 
that result from the complete or partial payment of the outstanding 
principal balance of the mortgages held by the trust are not included in 
the amount of trust sales proceeds. The IRS and the Treasury Department 
may provide by revenue ruling, or by other published guidance, that the 
special de minimis test of this paragraph (c)(2)(iv)(D)(2) may be 
applied to WHFITs holding debt instruments other than those described in 
paragraph (g)(1)(ii)(E) of this section.
    (3) Effect of clean-up call. If a WHFIT fails to meet either de 
minimis test described in this paragraph (c)(2)(iv)(D) solely as the 
result of a clean-up call, as defined in paragraph (b)(6) of this 
section, the WHFIT will be treated as having met the de minimis test.
    (4) Exception for certain fully reported sales--(i) Rule. If a 
trustee of a NMWHFIT reports the sales described in paragraph 
(c)(2)(iv)(D)(4)(ii) of this section as provided under paragraph 
(c)(2)(iv)(A) of this section (regardless of whether the general minimis 
test in paragraph (c)(2)(iv)(D)(1) of this section is satisfied for a 
particular calendar year) consistently throughout the life of the WHFIT, 
a trustee may exclude the trust sales proceeds received by the WHFIT as 
a result of those sales from the trust sales proceeds used to determine 
whether a WHFIT has satisfied the general de minimis test in paragraph 
(c)(2)(iv)(D)(1) of this section.
    (ii) Applicable sales and dispositions. This paragraph 
(c)(2)(iv)(D)(4) applies to sales and dispositions resulting from 
corporate reorganizations and restructurings for which the trust 
receives cash, the sale of assets received

[[Page 335]]

by the trust in corporate reorganizations and restructurings (including 
conversions of closed-end investment companies to open-end investment 
companies), principal prepayments, bond calls, bond maturities, and the 
sale of securities by the trustee as required by the governing document 
or applicable law governing fiduciaries in order to maintain the sound 
investment character of the trust, and any other nonvolitional 
dispositions of trust assets.
    (iii) Certain small sales and dispositions. If the amount of trust 
sales proceeds from a sale or disposition described in paragraph 
(c)(2)(iv)(D)(4)(ii) of this section is less than .01 percent of the net 
fair market value of the WHFIT as determined for applying the de minimis 
test for the calendar year, the trustee is not required to report the 
sale or disposition under paragraph (c)(2)(iv)(A) of this section 
provided the trustee includes the trust sales proceeds, received for 
purposes of determining whether the trust has met the general de minimis 
test of paragraph (c)(2)(iv)(D)(1) of this section.
    (E) Qualified NMWHFIT exception. The qualified NMWHFIT exception is 
satisfied if--
    (1) The NMWHFIT has a start-up date (as defined in paragraph (b)(19) 
of this section) before February 23, 2006;
    (2) The registration statement of the NMWHFIT becomes effective 
under the Securities Act of 1933, as amended (15 U.S.C. 77a, et seq.) 
and trust interests are offered for sale to the public before February 
23, 2006; or
    (3) The registration statement of the NMWHFIT becomes effective 
under the Securities Act of 1933 and trust interests are offered for 
sale to the public on or after February 23, 2006, and before July 31, 
2006, and the NMWHFIT is fully funded before October 1, 2006. For 
purposes of determining whether a NMWHFIT is fully funded under this 
paragraph (c)(2)(iv)(E), deposits to the NMWHFIT after October 1, 2006, 
that are made pursuant to a distribution reinvestment program that is 
consistent with the requirements of Sec. 301.7701-4(c) of this chapter 
are disregarded.
    (F) NMWHFIT final calendar year exception. The NMWHFIT final 
calendar year exception is satisfied if--
    (1) The NMWHFIT terminates on or before December 31 of the year for 
which the trustee is reporting;
    (2) Beneficial owners exchange their interests for cash or are 
treated as having exchanged their interests for cash upon termination of 
the trust; and
    (3) The trustee makes reasonable efforts to engage in pro-rata sales 
of trust assets to effect redemptions.
    (G) Pro-rata sales of trust assets to effect a redemption--(1) Rule. 
Pro-rata sales of trust assets to effect redemptions are not required to 
be reported under this paragraph (c)(2)(iv).
    (2) Definition. Pro-rata sales of trust assets to effect redemptions 
occur when--
    (i) One or more trust interests are tendered for redemption;
    (ii) The trustee identifies the pro-rata shares of the trust assets 
that are deemed to be owned by the trust interest or interests tendered 
for redemption (See paragraph (b)(8) of this section for a description 
of how pro-rata is to be applied for purposes of this paragraph 
(c)(2)(iv)(G)) and sells those assets as soon as practicable;
    (iii) Proceeds from the sales of the assets identified in paragraph 
(c)(2)(iv)(G)(2)(ii) of this section are used solely to effect 
redemptions; and
    (iv) The redemptions are reported as required under paragraph 
(c)(2)(v) of this section by the trustee.
    (3) Additional rules--(i) Calendar month aggregation. The trustee 
may compare the aggregate pro-rata share of the assets deemed to be 
owned by the trust interests tendered for redemption during the calendar 
month with the aggregate sales of assets to effect redemptions for the 
calendar month to determine the pro-rata sales of trust assets to effect 
redemptions for the calendar month. If the aggregate pro-rata share of 
an asset deemed to be owned by the trust interests tendered for 
redemption for the month is a fractional amount, the trustee may round 
that number up to the next whole number for the purpose of determining 
the pro-rata sales to effect redemptions for the calendar month;
    (ii) Sales of assets to effect redemptions may be combined with 
sales of assets for other purposes. Sales of assets to effect 
redemptions may be combined with the

[[Page 336]]

sales of assets to obtain cash for other purposes but the proceeds from 
the sales of assets to effect redemptions must be used solely to provide 
cash for redemptions and the sales of assets to obtain cash for other 
purposes must be reported as otherwise provided in this paragraph 
(c)(2)(iv). For example, if a trustee sells assets and the proceeds are 
used by the trustee to pay trust expenses, these amounts are to be 
included in the amounts reported under paragraph (c)(2)(iv)(A) or (B), 
as appropriate.
    (4) Example--(i) January 1, 2008. Trust has one million trust 
interests and all interests have equal value and equal rights. The 
number of shares of stock in corporations A through J and the pro-rata 
share of each stock that a trust interest is deemed to own as of January 
1, 2008, is as follows:

------------------------------------------------------------------------
                                                   Total      Per trust
                     Stock                         shares      interest
------------------------------------------------------------------------
A.............................................       24,845      .024845
B.............................................       28,273      .028273
C.............................................       35,575      .035575
D.............................................       13,866      .013866
E.............................................       25,082      .025082
F.............................................       39,154      .039154
G.............................................       16,137      .016137
H.............................................       14,704      .014704
I.............................................       17,436      .017436
J.............................................       31,133      .031133
------------------------------------------------------------------------

    (ii) Transactions of January 2, 2008. On January 2, 2008, 50,000 
trust interests are tendered for redemption. The deemed pro-rata 
ownership of stocks A through J represented by the 50,000 redeemed trust 
interests and the stocks sold to provide cash for the redemptions are 
set out in the following table:

------------------------------------------------------------------------
                                                Deemed pro-
                     Stock                          rata     Shares sold
                                                 ownership
------------------------------------------------------------------------
A.............................................     1,242.25        1,242
B.............................................     1,413.65        1,413
C.............................................     1,778.75        1,779
D.............................................       693.30          694
E.............................................     1,254.10        1,254
F.............................................     1,957.70        1,957
G.............................................       806.85          807
H.............................................       735.20          735
I.............................................       871.80          872
J.............................................     1,556.65        1,557
------------------------------------------------------------------------

    (iii) Transactions on January 15 through 17, 2008. On January 15, 
2008, 10,000 trust interests are tendered for redemption. Trustee lends 
money to Trust for redemptions. On January 16, B merges into C at a rate 
of .55 per share. On January 17, Trustee sells stock to obtain cash to 
be reimbursed the cash loaned to Trust to effect the redemptions. The 
pro-rata share of the stock deemed to be owned by the 10,000 redeemed 
trust interests and the stock sold by the trustee to effect the 
redemptions are set out in the following table:

------------------------------------------------------------------------
                                                Deemed pro-
                    Stock                          rata      Shares sold
                                                 ownership
------------------------------------------------------------------------
A............................................        248.45          249
B............................................         00              00
C............................................        511.25          512
D............................................        138.66          138
E............................................        250.82          251
F............................................        391.54          392
G............................................        161.37          162
H............................................        147.04          148
I............................................        174.36          174
J............................................        311.33          311
------------------------------------------------------------------------

    (iv) Transactions on January 28 and 29, 2008. On January 28, 2008, 
the value of the H stock is $30.00 per share and Trustee, pursuant to 
Trust's governing document, sells the H stock to preserve the financial 
integrity of Trust and receives $414,630. Trustee intends to report this 
sale under paragraph (c)(2)(iv)(A) of this section and to distribute the 
proceeds of the sale pro-rata to trust interest holders on Trust's next 
scheduled distribution date. On January 29, 2008, while trustee still 
holds the proceeds from the January 28 sale, 10,000 trust interests are 
tendered for redemption. The pro-rata share of the stock deemed to be 
owned by the 10,000 redeemed trust interests and the stock sold by the 
trustee to effect the redemptions are set out in the following table:

------------------------------------------------------------------------
                                                Deemed pro-
                    Stock                          rata      Shares sold
                                                 ownership
------------------------------------------------------------------------
A............................................        248.45          248
B............................................          0               0
C............................................        511.25          511
D............................................        138.66          139
E............................................        250.82          251
F............................................        391.54          391
G............................................        161.37          161
H............................................      \1\ 0               0
I............................................        174.36          175
J............................................        311.33         312
------------------------------------------------------------------------
\1\Share of cash proceeds: $4,458.39.

    (v) Monthly amounts. To determine the pro-rata sales to effect 
redemptions

[[Page 337]]

for January, trustee compares the aggregate pro-rata share of stocks A 
through J (rounded to the next whole number) deemed to be owned by the 
trust interests tendered for redemption during the month of January with 
the sales of stocks A through J to effect redemptions:

------------------------------------------------------------------------
                                                Deemed pro-
                     Stock                          rata     Shares sold
                                                 ownership
------------------------------------------------------------------------
A.............................................         1740         1739
B.............................................            0            0
C.............................................         3579         3579
D.............................................          971          971
E.............................................         1756         1756
F.............................................         2741         2741
G.............................................         1130         1130
H.............................................          883          883
I.............................................         1221         1221
J.............................................         2180         2180
------------------------------------------------------------------------

    (vi) Pro-rata sales to effect redemptions for the month of January. 
For the month of January, the deemed pro-rata ownership of shares of 
stocks A through J equal or exceed the sales of stock to effect 
redemptions for the month. Accordingly, all of the sales to effect 
redemptions during the month of January are considered to be pro-rata 
and are not required to be reported under this paragraph (c)(2)(iv).
    (H) Corporate Reorganizations. The exchange of trust assets for 
other assets of equivalent value pursuant to a tax free corporate 
reorganization is not required to be reported as a sale or disposition 
under this paragraph (c)(2)(iv).
    (v) Redemptions and sales of WHFIT interests--(A) Redemptions--(1) 
In general. Unless paragraph (c)(2)(v)(C) of this section applies, for 
each date on which the amount of a redemption proceeds for the 
redemption of a trust interest is determined, the trustee must provide 
information to enable a requesting person to determine--
    (i) The redemption proceeds (as defined in paragraph (b)(15) of this 
section) per trust interest on that date;
    (ii) The redemption asset proceeds (as defined in paragraph (b)(14) 
of this section) per trust interest on that date; and
    (iii) The gross income that is attributable to the redeeming 
beneficial owner for the portion of the calendar year that the redeeming 
beneficial owner held its interest (including income earned by the WHFIT 
after the date of the last income distribution.
    (2) In kind redemptions. The value of the assets received with 
respect to an in-kind redemption (as defined in paragraph (b)(8) of this 
section) is not required to be reported under this paragraph 
(c)(2)(v)(A). Information regarding the income attributable to a 
redeeming beneficial owner must, however, be reported under paragraph 
(c)(2)(v)(A)(1)(iii) of this section.
    (B) Sale of a trust interest. Under paragraph (c)(2)(v)(C) of this 
section applies, if a secondary market for interests in the WHFIT is 
established, the trustee must provide, for each day of the calendar 
year, information to enable requesting persons to determine--
    (1) The sale assets proceeds (as defined in paragraph (b)(17) of 
this section) per trust interest on that date; and
    (2) The gross income that is attributable to a selling beneficial 
owner and to a purchasing beneficial owner for the portion of the 
calendar year that each held the trust interest.
    (C) Simplified Reporting for Certain NMWHFITs--(1) In general. The 
trustee of an NMWHFIT described in paragraph (c)(2)(v)(C)(2) of this 
section is not required to report the information described in paragraph 
(c)(2)(v)(A) of this section (regarding redemptions) or (c)(2)(v)(B) of 
this section (regarding sales). However, the trustee must report to 
requesting persons, for each date on which the amount of redemption 
proceeds to be paid for the redemption of a trust interest is 
determined, information that will enable requesting persons to determine 
the redemption proceeds per trust interest on that date. The trustee 
also must provide requesting persons with a statement that this 
paragraph applies to the NMWHFIT.
    (2) NMWHFITs that qualify for the exception. This paragraph 
(c)(2)(v)(C) applies to a NMWHFIT if--
    (i) Substantially all the assets of the NMWHFIT produce income that 
is treated as interest income (but only if these assets trade on a 
recognized exchange or securities market without a price component 
attributable to accrued interest) or produce dividend income (as defined 
in section 6042(b) and

[[Page 338]]

the regulations under that section). (Trust sales proceeds and gross 
proceeds from sales described in paragraphs (c)(2)(iv)(G) and (H) of 
this section are ignored for the purpose of determining if substantially 
all of a NMWHFIT's assets produce dividend or the interest income 
described in this paragraph); and
    (ii) The qualified NMWHFIT exception of paragraph (c)(2)(iv)(E) of 
this section is satisfied, or the trustee is required by the governing 
document of the NMWHFIT to determine and distribute all cash held for 
distribution (as defined in paragraph (b)(5) of this section) no less 
frequently than monthly. A NMWHFIT will be considered to have satisfied 
this paragraph (c)(2)(v)(C)(2)(i) notwithstanding that the governing 
document of the NMWHFIT permits the trustee to forego making a required 
monthly or more frequent distribution, if the cash held for distribution 
is less than 0.1 percent of the aggregate net asset value of the trust 
as of the date specified in the governing document for calculating the 
amount of the monthly distribution.
    (vi) Information regarding bond premium. The trustee generally must 
report information that enables a beneficial owner to determine, in any 
manner that is reasonably consistent with section 171, the amount of the 
beneficial owner's amortizable bond premium, if any, for each calendar 
year. However, if a NMWHFIT meets the general de minimis test in 
paragraph (c)(2)(iv)(D)(1) of this section, the qualified NMWHFIT 
exception of paragraph (c)(2)(iv)(E) of this section, or the NMWHFIT 
final calendar year exception of paragraph (c)(2)(iv)(F) of this 
section, the trustee of the NMWHFIT is not required to report 
information regarding bond premium.
    (vii) Information regarding market discount. The trustee generally 
must report information that enables a beneficial owner to determine, in 
any manner reasonably consistent with section 1276 (including section 
1276(a)(3)), the amount of market discount that has accrued during the 
calendar year. However, if a NMWHFIT meets the general de minimis test 
in paragraph (c)(2)(iv)(D) of this section, the qualified NMWHFIT 
exception of paragraph (c)(2)(iv)(E) of this section, or the NMWHFIT 
final calendar year exception of paragraph (c)(2)(iv)(F) of this 
section, the trustee of such NMWHFIT is not required to provide 
information regarding market discount.
    (viii) Other information. The trustee must provide any other 
information necessary for a beneficial owner of a trust interest to 
report, with reasonable accuracy, the items (as defined in paragraph 
(b)(9) of this section) attributable to the portion of the trust treated 
as owned by the beneficial owner under section 671.
    (3) Identifying the representative who will provide trust 
information. The trustee must identify a representative of the WHFIT who 
will provide the information specified in this paragraph (c). The 
trustee also may identify an Internet website at which the trustee will 
provide the information specified in this paragraph (c). This 
information must be--
    (i) Printed in a publication generally read by, and available to, 
requesting persons;
    (ii) Stated in the trust's prospectus; or
    (iii) Posted at the trustee's Internet website.
    (4) Time and manner of providing information--(i) Time--(A) In 
general. Except as provided in paragraph (c)(4)(i)(B) of this section, a 
trustee must provide the information specified in this paragraph (c) to 
requesting persons on or before the later of--
    (1) The 30th day after the close of the calendar year to which the 
request relates; or
    (2) The day that is 14 days after the receipt of the request.
    (B) Trusts holding interests in other WHFITs or in REMICs. If the 
WHFIT holds an interest in one or more other WHFITs or holds one or more 
REMIC regular interests, or holds both, a trustee must provide the 
information specified in this paragraph (c) to requesting persons on or 
before the later of--
    (1) The 44th day after the close of the calendar year to which the 
request relates; or
    (2) The day that is 28 days after the receipt of the request.

[[Page 339]]

    (ii) Manner. The information specified in this paragraph (c) must be 
provided--
    (A) By written statement sent by first class mail to the address 
provided by the requesting person;
    (B) By causing it to be printed in a publication generally read by 
and available to requesting persons and by notifying requesting persons 
in writing of the publication in which it will appear, the date on which 
it will appear, and, if possible, the page on which it will appear;
    (C) By causing it to be posted at an Internet website, provided the 
trustee identifies the website under paragraph (c)(3) of this section;
    (D) By electronic mail provided that the requesting person requests 
that the trustee furnish the information by electronic mail and the 
person furnishes an electronic address; or
    (E) By any other method agreed to by the trustee and the requesting 
person.
    (iii) Inclusion of information with respect to all calculation 
periods. If a trustee calculates WHFIT information using a calculation 
period other than a calendar year, the trustee must provide information 
for each calculation period that falls within the calendar year 
requested.
    (5) Requesting information from a WHFIT--(i) In general. Requesting 
persons may request the information specified in this paragraph (c) from 
a WHFIT.
    (ii) Manner of requesting information. In requesting WHFIT 
information, a requesting person must specify the WHFIT and the calendar 
year for which information is requested.
    (iii) Period of time during which a requesting person may request 
WHFIT information. For the life of the WHFIT and for five years 
following the date of the WHFIT's termination, a requesting person may 
request the information specified in this paragraph (c) for any calendar 
year of the WHFIT's existence beginning with the 2007 calendar year.
    (6) Trustee's requirement to retain records. For the life of the 
WHFIT and for five years following the date of termination of the WHFIT, 
the trustee must maintain in its records a copy of the information 
required to be provided to requesting persons this paragraph (c) for 
each calendar year beginning with the 2007 calendar year. For a period 
of five years following the close of the calendar year to which the data 
pertains, the trustee also must maintain in its records such 
supplemental data as may be necessary to establish that the information 
provided to requesting persons is correct and meets the requirements of 
this paragraph (c).
    (d) Form 1099 requirement for trustees and middlemen--(1) Obligation 
to file Form 1099 with the IRS--(i) In general. Except as provided in 
paragraphs (d)(1)(ii) and (iii) of this section--
    (A) The trustee must file with the IRS the appropriate Forms 1099, 
reporting the information specified in paragraph (d)(2) of this section 
with respect to any TIH who holds an interest in the WHFIT directly and 
not through a middleman; and
    (B) Every middleman must file with the IRS the appropriate Forms 
1099, reporting the information specified in paragraph (d)(2) of this 
section with respect to any TIH on whose behalf or account the middleman 
holds an interest in the WHFIT or acts as an intermediary.
    (ii) Forms 1099 not required for exempt recipients--(A) In general. 
A Form 1099 is not required with respect to a TIH who is an exempt 
recipient (as defined in paragraph (b)(7) of this section), unless the 
trustee or middleman backup withholds under section 3406 on payments 
made to an exempt recipient (because, for example, the exempt recipient 
has failed to furnish a Form W-9 on request). If the trustee or 
middleman backup withholds, then the trustee or middleman is required to 
file a Form 1099 under this paragraph (d) unless the trustee or 
middleman refunds the amount withheld in accordance with Sec. 
31.6413(a)-3 of this chapter.
    (B) Exempt recipients must include WHFIT information in computing 
taxable income. A beneficial owner who is an exempt recipient must 
obtain WHFIT information and must include the items (as defined in 
paragraph (b)(9) of this section) of the WHFIT in computing its taxable 
income on its federal income tax return. Paragraphs (c)(3) and (h) of 
this section provide rules for exempt recipients to obtain information 
from a WHFIT.

[[Page 340]]

    (iii) Reporting and withholding with respect to foreign persons. The 
items of the WHFIT attributable to a TIH who is not a United States 
person must be reported, and amounts must be withheld, as provided under 
subtitle A, chapter 3 of the Internal Revenue Code (sections 1441 
through 1464) and the regulations thereunder and not reported under this 
paragraph (d).
    (2) Information to be reported--(i) Determining amounts to be 
provided on Forms 1099. The amounts reported to the IRS for a calendar 
year by a trustee or middleman on the appropriate Form 1099 must be 
consistent with the information provided by the trustee under paragraph 
(c) of this section and must reflect with reasonable accuracy the amount 
of each item required to be reported on a Form 1099 that is attributable 
(or if permitted under paragraphs (d)(2)(ii)(D) and (E) of this section, 
distributed) to the TIH. If the trustee, in providing WHFIT information, 
uses the safe harbors in paragraph (f)(1) or (g)(1) of this section, 
then the trustee or middleman must calculate the information to be 
provided to the IRS on the Forms 1099 in accordance with paragraph 
(f)(2) or (g)(2) of this section, as appropriate.
    (ii) Information to be provided on Forms 1099. The trustee or 
middleman must include on the appropriate Forms 1099:
    (A) Taxpayer information. The name, address, and taxpayer 
identification number of the TIH;
    (B) Information regarding the person filing the Form 1099. The name, 
address, taxpayer identification number, and telephone number of the 
person required to file the Form 1099;
    (C) Gross income. All items of gross income of the WHFIT 
attributable to the TIH for the calendar year (including OID (unless the 
exception for certain WHMTs applies (see paragraph (c)(2)(ii)(A) of this 
section)) and all amounts of income attributable to a selling, 
purchasing, or redeeming TIH for the portion of the calendar year that 
the TIH held its interest (unless paragraph (c)(2)(v)(C) of this section 
(regarding an exception for certain NMWHFITs) applies));
    (D) Non pro-rata partial principal payments. All non pro-rata 
partial principal payments (as defined in paragraph (b)(13) of this 
section) received by the WHFIT that are attributable (or distributed, in 
the case of a trustee or middleman reporting under paragraph (f)(2)(iii) 
of this section) to the TIH;
    (E) Trust sales proceeds. All trust sales proceeds (as defined in 
paragraph (b)(21) of this section) that are attributable to the TIH for 
the calendar year, if any, or, if paragraph (c)(2)(iv)(B) of this 
section (regarding certain NMWHFITs) applies, the amount of trust sales 
proceeds distributed to the TIH for the calendar year;
    (F) Reporting Redemptions. All redemption asset proceeds (as defined 
in paragraph (b)(14) of this section) paid to the TIH for the calendar 
year, if any, or, if paragraph (c)(2)(v)(C) of this section (regarding 
an exception for certain NMWHFITs) applies, all redemption proceeds (as 
defined in paragraph (b)(15) of this section) paid to the TIH for the 
calendar year;
    (G) Reporting sales of a trust interest on a secondary market. All 
sales asset proceeds (as defined in paragraph (b)(17) of this section) 
paid to the TIH for the sale of a trust interest or interests on a 
secondary market established for the NMWHFIT for the calendar year, if 
any, or, if paragraph (c)(2)(v)(C) of this section (regarding an 
exception for certain NMWHFITs) applies, all sales proceeds (as defined 
in paragraph (b)(18) of this section) paid to the TIH for the calendar 
year; and
    (H) Other information. Any other information required by the Form 
1099.
    (3) Time and manner of filing Forms 1099--(i) Time and place. The 
Forms 1099 required to be filed under this paragraph (d) must be filed 
on or before February 28 (March 31, if filed electronically) of the year 
following the year for which the Forms 1099 are being filed. The returns 
must be filed with the appropriate Internal Revenue Service Center, at 
the address listed in the instructions for the Forms 1099. For 
extensions of time for filing returns under this section, see Sec. 
1.6081-1, the instructions for the Forms 1099, and applicable revenue 
procedures (see Sec. 601.601(d)(2) of this chapter). For magnetic media 
filing requirements, see Sec. 301.6011-2 of this chapter.

[[Page 341]]

    (ii) Reporting trust sales proceeds, redemption asset proceeds, 
redemption proceeds, sale asset proceeds, sales proceeds and non pro-
rata partial principal payments--(A) Form to be used. Trust sales 
proceeds, redemption asset proceeds, redemption proceeds, sale asset 
proceeds, sales proceeds, and non pro-rata partial principal payments 
are to be reported on the same type of Form 1099 as that required for 
reporting gross proceeds under section 6045.
    (B) Appropriate reporting for in-kind redemptions. The value of the 
assets distributed with respect to an in-kind redemption is not required 
to be reported to the IRS. Unless paragraph (c)(2)(v)(C) of this section 
applies, the trustee or middleman must report the gross income 
attributable to the redeemed trust interest for the calendar year up to 
the date of the redemption under paragraph (d)(2)(ii)(C) of this 
section.
    (e) Requirement to furnish a written tax information statement to 
the TIH--(1) In general. Every trustee or middleman required to file 
appropriate Forms 1099 under paragraph (d) of this section with respect 
to a TIH must furnish to that TIH (the person whose identifying number 
is required to be shown on the form) a written tax information statement 
showing the information described in paragraph (e)(2) of this section. 
The amount of a trust item reported to a TIH under this paragraph (e) 
must be consistent with the information reported to the IRS with respect 
to the TIH under paragraph (d) of this section. Information provided in 
this written statement must be determined in accordance with the rules 
provided in paragraph (d)(2)(i) of this section (regardless of whether 
the information was required to be provided on a Form 1099). Further, 
the trustee or middleman must separately state on the written tax 
information statement any items that, if taken into account separately 
by that TIH, would result in an income tax liability that is different 
from the income tax liability that would result if the items were not 
taken into account separately.
    (2) Information required. For the calendar year, the written tax 
information statement must meet the following requirements:
    (i) WHFIT information. The written tax information statement must 
include the name of the WHFIT and the identifying number of the WHFIT ;
    (ii) Identification of the person furnishing the statement. The 
written tax information statement must include the name, address, and 
taxpayer identification number of the person required to furnish the 
statement;
    (iii) Items of income, expense, and credit. The written tax 
information statement must include information regarding the items of 
income (that is, the information required to be reported to the IRS on 
Forms 1099), expense (including affected expenses), and credit that are 
attributable to the TIH for the calendar year;
    (iv) Non pro-rata partial principal payments. The written tax 
information statement must include the information required to be 
reported to the IRS on Forms 1099 under paragraph (d)(2)(ii)(D) of this 
section (regarding the non pro-rata partial principal payments that are 
attributable (or distributed, in the case of a trustee or middleman 
reporting under paragraph (f)(2)(iii) of this section) to the TIH for 
the calendar year).
    (v) Asset sales and dispositions--(A) General rule. Unless paragraph 
(c)(2)(iv)(B) (regarding the exception for certain NMWHFITs) or 
(c)(2)(iv)(C) (regarding the exception for certain WHMTs) of this 
section applies, the written tax information statement must include, 
with respect to each sale or disposition of a WHFIT asset for the 
calendar year--
    (1) The date of sale or disposition;
    (2) Information regarding the trust sales proceeds that are 
attributable to the TIH as a result of the sale or disposition; and
    (3) Information that will enable the TIH to allocate with reasonable 
accuracy a portion of the TIH's basis in the TIH's trust interest to the 
sale or disposition.
    (B) Special rule for certain NMWHFITs and WHMTs. In the case of a 
NMWHFIT to which paragraph (c)(2)(iv)(B) of this section applies or in 
the case of a WHMT to which paragraph (c)(2)(iv)(C) of this section 
applies, the written tax information statement must include,

[[Page 342]]

with respect to asset sales and dispositions, only the information 
required to be reported to the IRS on Form 1099 under paragraph 
(d)(2)(ii)(E) of this section.
    (vi) Redemption or sale of a trust interest. The written tax 
information statement must include the information required to be 
reported to the IRS on Forms 1099 under paragraphs (d)(2)(ii)(F) and (G) 
of this section (regarding the sales and redemptions of trust interests 
made by the TIH for the calendar year);
    (vii) Information regarding market discount and bond premium. The 
written tax information statement must include the information required 
to be reported by the trustee under paragraphs (c)(2)(vi) and (vii) of 
this section (regarding bond premium and market discount);
    (viii) Other information. The written tax information statement must 
include any other information necessary for the TIH to report, with 
reasonable accuracy for the calendar year, the items (as defined in 
paragraph (b)(9) of this section) attributable to the portion of the 
trust treated as owned by the TIH under section 671. The written tax 
information statement may include information with respect to a trust 
item on a per trust interest basis if the trustee has reported (or 
calculated) the information with respect to that item on a per trust 
interest basis and information with respect to that item is not required 
to be reported on a Form 1099; and
    (ix) Required statement. The written tax information statement must 
inform the TIH that the items of income, deduction, and credit, and any 
other information shown on the statement must be taken into account in 
computing the taxable income and credits of the TIH on the Federal 
income tax return of the TIH. If the written tax information statement 
reports that an amount of qualified dividend income is attributable to 
the TIH, the written tax information statement also must inform the TIH 
that the TIH must meet the requirements of section 1(h)(11)(B)(iii) to 
treat the dividends as qualified dividends.
    (3) Due date and other requirements. The written tax information 
statement must be furnished to the TIH on or before March 15 of the year 
following the calendar year for which the statement is being furnished.
    (4) Requirement to retain records. For a period of no less than five 
years from the due date for furnishing the written tax information 
statement, a trustee or middleman must maintain in its records a copy of 
any written tax information statement furnished to a TIH, and such 
supplemental data as may be required to establish the correctness of the 
statement.
    (f) Safe harbor for providing information for certain NMWHFITs--(1) 
Safe harbor for trustee reporting of NMWHFIT information. The trustee of 
a NMWHFIT that meets the requirements of paragraph (f)(1)(i) of this 
section is deemed to satisfy paragraph (c)(1)(i) of this section, if the 
trustee calculates and provides WHFIT information in the manner 
described in this paragraph (f) and provides a statement to a requesting 
person giving notice that information has been calculated in accordance 
with this paragraph (f)(1).
    (i) In general--(A) Eligibility to report under this safe harbor. 
Only NMWHFITs that meet the requirements set forth in paragraphs 
(f)(1)(i)(A)(1) and (2) of this section may report under this safe 
harbor. For purposes of determining whether the requirements of 
paragraph (f)(1)(i)(A)(1) of this section are met, trust sales proceeds 
and gross proceeds from sales described in paragraphs (c)(2)(iv)(G) and 
(H) of this section are ignored.
    (1) Substantially all of the NMWHFIT's income is from dividends or 
interest; and
    (2) All trust interests have identical value and rights.
    (B) Consistency requirements. The trustee must--
    (1) Calculate all trust items subject to the safe harbor consistent 
with the safe harbor; and, (2) Report under this paragraph (f)(1) for 
the life of the NMWHFIT; or, if the NMWHFIT has a start-up date before 
January 1, 2007, the NMWHFIT must begin reporting under this paragraph 
(f)(1) as of January 1, 2007 and must continue to report under this 
paragraph for the life of the NMWHFIT.

[[Page 343]]

    (ii) Reporting NMWHFIT income and expenses. A trustee must first 
determine the total amount of NMWHFIT distributions (both actual and 
deemed) for the calendar year and then express each income or expense 
item as a fraction of the total amount of NMWHFIT distributions. These 
fractions (hereinafter referred to as factors) must be accurate to at 
least four decimal places.
    (A) Step One: Determine the total amount of NMWHFIT distributions 
for the calendar year. The trustee must determine the total amount of 
NMWHFIT distributions (actual and deemed) for the calendar year. If the 
calculation of the total amount of NMWHFIT distributions under this 
paragraph (f)(1)(ii)(A) results in a zero or a negative number, the 
trustee may not determine income and expense information under this 
paragraph (f)(1)(ii)(A) (but may report all other applicable items under 
this paragraph (f)(1)). The total amount of NMWHFIT distributions equals 
the amount of NMWHFIT funds paid out to all TIHs (including all trust 
sales proceeds, all principal receipts, and all redemption proceeds) for 
the calendar year--
    (1) Increased by--
    (i) All amounts that would have been distributed during the calendar 
year, but were instead reinvested pursuant to a reinvestment plan; and
    (ii) All cash held for distribution to TIHs as of December 31 of the 
year for which the trustee is reporting; and
    (2) Decreased by--
    (i) All cash distributed during the current year that was included 
in a year-end cash allocation factor (see paragraph (f)(1)(ii)(C)(1) of 
this section) for a prior year;
    (ii) All redemption asset proceeds paid for the calendar year, or if 
paragraph (c)(2)(v)(C) of this section applies to the NMWHFIT, all 
redemption proceeds paid for the calendar year;
    (iii) All trust sales proceeds distributed during the calendar year; 
and
    (iv) All non pro-rata partial principal payments distributed during 
the calendar year.
    (3) For the purpose of determining the amount of all redemption 
asset proceeds or redemption proceeds paid for the calendar year with 
respect to paragraph (f)(1)(ii)(A)(2)(ii) of this section, the value of 
the assets (not including cash) distributed with respect to an in-kind 
redemption is disregarded. Any cash distributed as part of the 
redemption must be included in the total amount of NMWHFIT 
distributions.
    (B) Step Two: Determine factors that express the ratios of NMWHFIT 
income and expenses to the total amount of NMWHFIT distributions. The 
trustee must determine factors that express the ratios of NMWHFIT income 
and expenses to the total amount of NMWHFIT distributions as follows:
    (1) Income factors. For each item of income generated by the 
NMWHFIT's assets for the calendar year, the trustee must determine the 
ratio of the gross amount of that item of income to the total amount of 
NMWHFIT distributions for the calendar year; and
    (2) Expense factors. For each item of expense paid by a NMWHFIT 
during the calendar year, the trustee must determine the ratio of the 
gross amount of that item of expense to the total amount of NMWHFIT 
distributions for the calendar year.
    (C) Step Three: Determine adjustments for reconciling the total 
amount of NMWHFIT distributions (determined under Step One) with amounts 
actually paid to TIHs. Paragraph (f)(1)(ii)(B) of this section (Step 
Two) requires an item of income or expense to be expressed as a ratio of 
that item to the total amount of NMWHFIT distributions as determined in 
paragraph (f)(1)(ii)(A) of this section (Step One). A TIH's share of the 
total amount of NMWHFIT distributions may differ from the amount 
actually paid to that TIH. A trustee, therefore, must provide 
information that can be used to compute a TIH's share of the total 
amount of NMWHFIT distributions based on the amount actually paid to the 
TIH. A trustee satisfies this requirement by providing a current year-
end cash allocation factor, a prior year cash allocation factor, and the 
date on which the prior year cash was distributed to TIHs (prior year 
cash distribution date).
    (1) The current year-end cash allocation factor. The current year-
end cash allocation factor is the amount of cash held for distribution 
to TIHs by the NMWHFIT as of December 31 of the

[[Page 344]]

calendar year for which the trustee is reporting, divided by the number 
of trust interests outstanding as of that date.
    (2) The prior year cash allocation factor. The prior year cash 
allocation factor is the amount of the distribution during the calendar 
year for which the trustee is reporting that was included in determining 
a year-end cash allocation factor for a prior year, divided by the 
number of trust interests outstanding on the date of the distribution.
    (iii) Reporting non pro-rata partial principal payments under the 
safe harbor. The trustee must provide a list of dates on which non pro-
rata partial principal payments were distributed by the trust, and the 
amount distributed, per trust interest.
    (iv) Reporting sales and dispositions of NMWHFIT assets under the 
safe harbor--(A) NMWHFITs that must report under the general rule--(1) 
In general. If a NMWHFIT must report under the general rule of paragraph 
(c)(2)(iv)(A) of this section, the trustee must provide a list of dates 
(from earliest to latest) on which sales or dispositions of NMWHFIT 
assets occurred during the calendar year for which the trustee is 
reporting and, for each date identified, provide--
    (i) The trust sales proceeds received by the trust, per trust 
interest, with respect to the sales and dispositions, on that date;
    (ii) The trust sales proceeds distributed to TIHs, per trust 
interest, with respect to the sales and dispositions on that date, and 
the date that the trust sales proceeds were distributed to the TIHs; and
    (iii) The ratio (expressed as a percentage) of the assets sold or 
disposed of on that date to all assets held by the NMWHFIT.
    (2) Determination of the portion of all assets held by the NMWHFIT 
that the assets sold or disposed of represented--
    (i) If a NMWHFIT terminates within twenty-four months of its start-
up date, the ratio of the assets sold or disposed of on that date to all 
assets held by the NMWHFIT is based on the fair market value of the 
NMWHFIT's assets as of the start-up date; or
    (ii) If a NMWHFIT terminates more than twenty-four months after its 
start-up date, the ratio of the assets sold or disposed of on that date 
to all assets held by the NMWHFIT is based on the fair market value of 
the NMWHFIT's assets as of the date of the sale or disposition.
    (B) NMWHFITs excepted from the general rule. If paragraph 
(c)(2)(iv)(B) of this section applies to the NMWHFIT, the trustee must 
provide a list of dates on which trust sales proceeds were distributed, 
and the amount of trust sales proceeds, per trust interest, that were 
distributed on that date. The trustee also must also provide requesting 
persons with the statement required by paragraph (c)(2)(iv)(B) of this 
section.
    (v) Reporting redemptions under the safe harbor--(A) In general. The 
trustee must:
    (1) Provide a list of dates on which the amount of redemption 
proceeds paid for the redemption of a trust interest was determined and 
the amount of the redemption asset proceeds determined per trust 
interest on that date, or if paragraph (c)(2)(v)(C) of this section 
applies to the NMWHFIT, the amount of redemption proceeds determined on 
that date; or
    (2) Provide to each requesting person that held (either for its own 
behalf or for the behalf of a TIH) a trust interest that was redeemed 
during the calendar year, the date of the redemption and the amount of 
the redemption asset proceeds per trust interest determined on that 
date, or if paragraph (c)(2)(v)(C) of this section applies to the 
NMWHFIT, the amount of the redemption proceeds determined for that date; 
and
    (B) Paragraph (c)(2)(v)(C) statement. If paragraph (c)(2)(v)(C) of 
this section applies to the NMWHFIT, the trustee must provide a 
statement to requesting persons to the effect that the trustee is 
providing information consistent with paragraph (c)(2)(v)(C) of this 
section.
    (vi) Reporting the sale of a trust interest under the safe harbor. 
If paragraph (c)(2)(v)(C) of this section does not apply to the NMWHFIT, 
the trustee must provide, for each day of the calendar year, the amount 
of cash held for distribution, per trust interest, by the NMWHFIT on 
that date. If the trustee

[[Page 345]]

is able to identify the date on which trust interests were sold on the 
secondary market, the trustee alternatively may provide information for 
each day on which sales of trust interests occurred rather than for each 
day during the calendar year. If paragraph (c)(2)(v)(C) of this section 
applies to the NMWHFIT, the trustee is not required to provide any 
information under this paragraph (f)(1)(vi), other than a statement that 
the NMWHFIT meets the requirements to report under paragraph 
(c)(2)(v)(C) of this section.
    (vii) Reporting OID information under the safe harbor. The trustee 
must provide, for each calculation period, the average aggregate daily 
accrual of OID per $1,000 of original principal amount.
    (viii) Reporting market discount information under the safe harbor--
(A) In general--(1) Trustee required to provide market discount 
information. If the trustee is required to provide information regarding 
market discount under paragraph (c)(2)(vii) of this section, the trustee 
must provide--
    (i) The information required to be provided under paragraph 
(f)(1)(iv)(A)(1)(iii) of this section; and
    (ii) If the NMWHFIT holds debt instruments with OID, a list of the 
aggregate adjusted issue prices of the debt instruments per trust 
interest calculated as of the start-up date or measuring date (see 
paragraph (c)(2)(iv)(D)(4) of this section) (whichever provides more 
accurate information) and as of January 1 for each subsequent year of 
the NMWHFIT.
    (2) Trustee not required to provide market discount information. If 
the trustee is not required to provide market discount information under 
paragraph (c)(2)(vii) of this section (because the NMWHFIT meets the 
general de minimis test of paragraph (c)(2)(iv)(D)(1) of this section, 
the qualified NMWHFIT exception of paragraph (c)(2)(iv)(E) of this 
section, or the NMWHFIT final year exception of paragraph (c)(2)(iv)(F) 
of this section), the trustee is not required under this paragraph (f) 
to provide any information regarding market discount.
    (B) Reporting market discount information under the safe harbor when 
the yield of the debt obligations held by the WHFIT is expected to be 
affected by prepayments. [Reserved]
    (ix) Reporting bond premium information under the safe harbor. 
[Reserved]
    (x) Reporting additional information. If a requesting person cannot 
use the information provided by the trustee under paragraphs (f)(1)(ii) 
through (ix) of this section to determine with reasonable accuracy the 
trust items that are attributable to a TIH, the requesting person must 
request, and the trustee must provide, additional information to enable 
the requesting person to determine the trust items that are attributable 
to the TIH. See, for example, paragraph (f)(2)(ii)(A)(4) of this section 
which requires a middleman to request additional information from the 
trustee when the total amount of WHFIT distributions attributable to a 
TIH equals zero or less.
    (2) Use of information provided by trustees under the safe harbor 
for NMWHFITs--(i) In general. If a trustee reports NMWHFIT items in 
accordance with paragraph (f)(1) of this section, the information 
provided with respect to those items on the Forms 1099 required under 
paragraph (d) of this section to be filed with the IRS and on the 
statement required under paragraph (e) of this section to be furnished 
to the TIH must be determined as provided in this paragraph (f)(2).
    (ii) Determining NMWHFIT income and expense under the safe harbor. 
The trustee or middleman must determine the amount of each item of 
income and expense attributable to a TIH as follows--
    (A) Step One: Determine the total amount of NMWHFIT distributions 
attributable to the TIH. To determine the total amount of NMWHFIT 
distributions attributable to a TIH for the calendar year, the total 
amount paid to, or credited to the account of, the TIH during the 
calendar year (including amounts paid as trust sales proceeds or partial 
non-pro rata principal payments, redemption proceeds, and sales 
proceeds) is--
    (1) Increased by--
    (i) All amounts that would have been distributed during the calendar 
year to the TIH, but that were reinvested pursuant to a reinvestment 
plan (unless

[[Page 346]]

another person (for example, the custodian of the reinvestment plan) is 
responsible for reporting these amounts under paragraph (d) of this 
section); and
    (ii) An amount equal to the current year-end cash allocation factor 
(provided by the trustee in accordance with paragraph (f)(1)(ii)(C)(1) 
of this section) multiplied by the number of trust interests held by the 
TIH as of December 31 of the calendar year for which the trustee is 
reporting; and
    (2) Decreased by--
    (i) An amount equal to the prior year cash allocation factor 
(provided by the trustee in accordance with paragraph (f)(1)(ii)(C)(2) 
of this section) multiplied by the number of trust interests held by the 
TIH on the date of the distribution;
    (ii) An amount equal to all redemption asset proceeds paid to the 
TIH for the calendar year, or if paragraph (c)(2)(v)(C) of this section 
applies to the NMWHFIT, an amount equal to all redemption proceeds paid 
to the TIH for the calendar year;
    (iii) An amount equal to all sale asset proceeds paid to the TIH for 
the calendar year, or if paragraph (c)(2)(v)(C) of this section applies 
to the NMWHFIT, the amount of sales proceeds paid to the TIH for the 
calendar year;
    (iv) In the case of a TIH that purchased a trust interest in a 
NMWHFIT to which paragraph (c)(2)(v)(C) of this section does not apply, 
an amount equal to the cash held for distribution per trust interest on 
the date that the TIH acquired its interest, multiplied by the trust 
interests acquired on that date;
    (v) The amount of the trust sales proceeds distributed to the TIH, 
calculated as provided in paragraph (f)(2)(iv)(A)(3) of this section; 
and
    (vi) The amount of non pro-rata partial principal prepayments 
distributed to the TIH during the calendar year, calculated as provided 
in paragraph (f)(2)(iii) of this section.
    (3) Treatment of in-kind distributions under this paragraph 
(f)(2)(i). The value of the assets (not including cash) received with 
respect to an in-kind redemption is not included in the amount used in 
paragraph (f)(2)(ii)(A)(2)(ii) of this section. The cash distributed as 
part of the redemption, however, must be included in the total amount of 
NMWHFIT distributions paid to the TIH.
    (4) The total amount of distributions attributable to a TIH 
calculated under this paragraph (f)(2)(i)(A) equals zero or less. If the 
total amount of distributions attributable to a TIH, calculated under 
this paragraph (f)(2)(i)(A), equals zero or less, the trustee or 
middleman may not report the income and expense attributable to the TIH 
under this paragraph (f)(2)(i). The trustee or middleman must request 
additional information from the trustee of the NMWHFIT to enable the 
trustee or middleman to determine with reasonable accuracy the items of 
income and expense that are attributable to the TIH. The trustee or 
middleman must report the other items subject to paragraph (f)(1) of 
this section in accordance with this paragraph (f)(2).
    (B) Step Two: Apply the factors provided by the trustee to determine 
the items of income and expense that are attributable to the TIH. The 
amount of each item of income (other than OID) and each item of expense 
attributable to a TIH is determined as follows--
    (1) Application of income factors. For each income factor, the 
trustee or middleman must multiply the income factor by the total amount 
of NMWHFIT distributions attributable to the TIH for the calendar year 
(as determined in paragraph (f)(2)(i)(A) of this section).
    (2) Application of expense factors. For each expense factor, the 
trustee or middleman must multiply the expense factor by the total 
amount of NMWHFIT distributions attributable to the TIH for the calendar 
year (as determined in paragraph (f)(2)(i)(A) of this section).
    (iii) Reporting non pro-rata partial principal payments under the 
safe harbor. To determine the amount of non pro-rata partial principal 
payments that are distributed to a TIH for the calendar year, the 
trustee or middleman must aggregate the amount of non pro-rata partial 
principal payments distributed to a TIH for each day that non pro-rata 
principal payments were distributed. To determine the amount of non pro-
rata principal payments that

[[Page 347]]

are distributed to a TIH on each distribution date, the trustee or 
middleman must multiply the amount of non-pro rata principal payments 
per trust interest distributed on that date by the number of trust 
interests held by the TIH.
    (iv) Reporting sales and dispositions of NMWHFIT assets under the 
safe harbor--(A) Reporting under the safe harbor if the general rules 
apply to the NMWHFIT. Unless paragraph (c)(2)(iv)(B) of this section 
applies, the trustee or middleman must comply with paragraphs 
(f)(2)(iv)(A)(1), (2), and (3) of this section.
    (1) Form 1099. The trustee or middleman must report the amount of 
trust sales proceeds attributable to the TIH for the calendar year on 
Form 1099. To determine the amount of trust sales proceeds attributable 
to a TIH for the calendar year, the trustee or middleman must aggregate 
the total amount of trust sales proceeds attributable to the TIH for 
each date on which the NMWHFIT sold or disposed of an asset or assets. 
To determine the total amount of trust sales proceeds attributable to a 
TIH for each date that the NMWHFIT sold or disposed of an asset or 
assets, the trustee or middleman multiplies the amount of trust sales 
proceeds received by the NMWHFIT per trust interest on that date by the 
number of trust interests held by the TIH on that date.
    (2) The written tax information statement furnished to the TIH. The 
written tax information statement required to be furnished to the TIH 
under paragraph (e) of this section must include a list of dates (in 
order, from earliest to latest) on which sales or dispositions of trust 
assets occurred during the calendar year and provide, for each date 
identified--
    (i) The trust sales proceeds received by the trust, per trust 
interest, with respect to the sales or dispositions of trust assets on 
that date; and
    (ii) The information provided by the trustee under paragraph 
(f)(1)(iv)(B)(2) of this section regarding the ratio of the assets sold 
or disposed of on that date to all the assets of the NMWHFIT held on 
that date, prior to such sale or disposition.
    (3) Calculating the total amount of trust sales proceeds distributed 
to the TIH. To determine the total amount of NMWHFIT distributions 
attributable to a TIH, the trustee or middleman must calculate the 
amount of trust sales proceeds distributed to the TIH for the calendar 
year. (See paragraph (f)(2)(ii)(A)(2)(v) of this section.) To determine 
the amount of trust sales proceeds distributed to a TIH for the calendar 
year, the trustee or middleman must aggregate the total amount of trust 
sales proceeds distributed to the TIH for each date on which the NMWHFIT 
distributed trust sales proceeds. To determine the total amount of trust 
sales proceeds distributed to a TIH for each date that the NMWHFIT 
distributed trust sales proceeds, the trustee or middleman must multiply 
the amount of trust sales proceeds distributed by the NMWHFIT per trust 
interest on that date by the number of trust interests held by the TIH 
on that date.
    (B) Reporting under the safe harbor if paragraph (c)(2)(iv)(B) of 
this section applies to the NMWHFIT. If paragraph (c)(2)(iv)(B) of this 
section applies, the trustee or middleman must calculate, in the manner 
provided in paragraph (f)(2)(iv)(A)(3) of this section, the amount of 
trust sales proceeds distributed to the TIH for the calendar year. The 
trustee or middleman must report this amount on the Form 1099 filed for 
the TIH and on the written tax information statement furnished to the 
TIH.
    (v) Reporting redemptions under the safe harbor--(A) Except as 
provided in paragraph (f)(2)(v)(B) or (C) of this section, if the 
trustee has provided a list of dates for which the amount of the 
redemption proceeds to be paid for the redemption of a trust interest 
was determined and the redemption asset proceeds paid for that date, the 
trustee or middleman must multiply the redemption asset proceeds 
determined per trust interest for that date by the number of trust 
interests redeemed by the TIH on that date.
    (B) If paragraph (c)(2)(v)(C) of this section applies, and the 
trustee has provided a list of dates for which the amount of the 
redemption proceeds to be paid for the redemption of a trust

[[Page 348]]

interest was determined and the redemption proceeds determined per trust 
interest on each date, the trustee or middleman must multiply the 
redemption proceeds per trust interest for each date by the number of 
trust interests redeemed by the TIH on that date.
    (C) If the trustee has provided the requesting person with 
information regarding the redemption asset proceeds paid for each 
redemption of a trust interest held by the middleman for the calendar 
year, or if paragraph (c)(2)(v)(C) of this section applies and the 
trustee has provided the amount of redemption proceeds paid for each 
redemption of a trust interest held by the middleman during the calendar 
year, the requesting person may use this information to determine the 
amount of the redemption asset proceeds or redemption proceeds paid to 
the TIH for the calendar year.
    (vi) Reporting sales of trust interests under the safe harbor--(A) 
Except as provided in paragraph (f)(2)(vi)(B) of this section, the 
trustee or middleman must subtract the amount of cash held for 
distribution per trust interest on the date of the sale from the sales 
proceeds paid to the TIH to determine the sale asset proceeds that are 
to be reported to the TIH for each sale of a trust interest.
    (B) If paragraph (c)(2)(v)(C) of this section applies, the trustee 
or middleman must report the sales proceeds paid to the TIH as a result 
of each sale of a trust interest.
    (vii) Reporting OID information under the safe harbor--The trustee 
or middleman must aggregate the amounts of OID that are allocable to 
each trust interest held by a TIH for each calculation period. The 
amount of OID that is allocable to a trust interest, with respect to 
each calculation period, is determined by multiplying--
    (A) The product of the OID factor and the original principal balance 
of the trust interest, divided by 1,000; by
    (B) The number of days during the OID calculation period in that 
calendar year that the TIH held the trust interest.
    (viii) Reporting market discount information under the safe harbor--
(A) Except as provided in paragraph (f)(2)(viii)(B) of this section, the 
trustee or middleman must provide the TIH with the information provided 
under paragraph (f)(1)(viii) of this section.
    (B) If paragraph (c)(2)(iv)(B) of this section applies, the trustee 
and middleman are not required under this paragraph (f)(2) to provide 
any information regarding market discount.
    (ix) Reporting bond premium information under the safe harbor. 
[Reserved]
    (3) Example of the use of the safe harbor for NMWHFITs. The 
following example illustrates the use of the factors in this paragraph 
(f) to calculate and provide NMWHFIT information:

    Example. (i) Facts--(A) In general--(1) Trust is a NMWHFIT that 
holds common stock in ten different corporations and has 100 trust 
interests outstanding. The start-up date for Trust is December 15, 2006, 
and Trust's registration statement under the Securities Act of 1933 
became effective after July 31, 2006. Trust terminates on March 15, 
2008. The agreement governing Trust requires Trust to distribute cash 
held by Trust reduced by accrued but unpaid expenses on April 15, July 
15, and October 15 of the 2007 calendar year. The agreement also 
provides that the trust interests will be redeemed by the Trust for an 
amount equal to the value of the trust interest, as of the close of 
business, on the day the trust interest is tendered for redemption. 
There is no reinvestment plan. A secondary market for interests in Trust 
will be created by Trust's sponsor and Trust's sponsor will provide 
Trustee with a list of dates on which sales occurred on this secondary 
market.
    (2) As of December 31, 2006, Trust holds $12x for distribution to 
TIHs on the next distribution date and has no accrued but unpaid 
expenses. Trustee includes the $12x in determining the year-end cash 
allocation factor for December 31, 2006.
    (B) Events occurring during the 2007 calendar year--(1) As of 
January 1, 2007, Broker1 holds ten trust interests in Trust in street 
name for each of J and A and Broker2 holds ten trust interests in Trust 
in street name for S. J, A, and S; are individual, cash method 
taxpayers.
    (2) As of January 1, 2007, the fair market value of the Trust's 
assets equals $10,000x.
    (3) During 2007, Trust receives $588x in dividend income. Trustee 
determines that $400x of the dividend income received during 2007 meets 
the definition of a qualified dividend in section 1(h)(11)(B)(i) and the 
holding period requirement in section 1(h)(11)(B)(iii) with respect to 
the Trust. During 2007, Trust also receives $12x in interest income from 
investment of Trust's funds pending distribution to TIHs, and pays $45x 
in expenses, all of which are affected expenses.

[[Page 349]]

    (4) On April 15, 2007, Trustee distributes $135x, which includes the 
$12x included in determining the year-end cash allocation factor for 
December 31, 2006. As a result of the distribution, Broker1 credits J's 
account and A's account for $13.50x each. Broker2 credits S's account 
for $13.50x.
    (5) On June 1, 2007, Trustee sells shares of stock for $1000x to 
preserve the soundness of the trust. The stock sold on June 1, 2007, 
equaled 20% of the aggregate fair market value of the assets held by 
Trust on the start-up date of Trust. Trustee has chosen not to report 
sales described in paragraph (c)(2)(iv)(4)(ii) of Trust's assets under 
paragraph (c)(2)(iv)(D)(4) of this section.
    (6) On July 15, 2007, Trustee distributes $1,135x, which includes 
the $1,000x of trust sales proceeds received by Trust for the sale of 
assets on June 1, 2007. As a result of the distribution, Broker1 credits 
J's account and A's account for $113.50x each. Broker 2 credits S's 
account for $113.50x.
    (7) On September 30 2007, J, through Trust's sponsor, sells a trust 
interest to S for $115.35x. Trustee determines that the cash held for 
distribution per trust interest on September 30 is $1.35x. As a result 
of the sale, Broker1 credits J's account for $115.35x.
    (8) On October 15, 2007, Trustee distributes $123x. As a result of 
the distribution, Broker1 credits J's account for $11.07x and A's 
account for $12.30x. Broker2 credits S's account for $13.53x.
    (9) On December 10, 2007, J tenders a trust interest to Trustee for 
redemption through Broker1. Trustee determines that the amount of the 
redemption proceeds to be paid for a trust interest that is tendered for 
redemption on December 10, 2007 is $116x, of which $115x represents the 
redemption asset proceeds. Trustee pays this amount to Broker1 on J's 
behalf. On December 12, 2007, trustee engages in a non pro-rata sale of 
shares of common stock for $115x to effect J's redemption of a trust 
interest. The stock sold on December 12, 2007, equals 2% of the 
aggregate fair market value of all the assets of Trust as of the start-
up date.
    (10) On December 10, 2007, J, through Trust's sponsor, also sells a 
trust interest to S for $116x. Trustee determines that the cash held for 
distribution per trust interest on that date is $1x. As a result of the 
sale, Broker1 credits J's account for $116x.
    (11) As of December 31, 2007, Trust holds cash of $173x and has 
incurred $15x in expenses that Trust has not paid. J is the only TIH to 
redeem a trust interest during the calendar year. The sale of two trust 
interests in Trust by J to S are the only sales that occurred on the 
secondary market established by Trust's sponsor during 2007.
    (ii) Trustee reporting--(A) Summary of information provided by 
Trustee. Trustee meets the requirements of paragraph (f)(1) of this 
section if Trustee provides the following information to requesting 
persons:
    (1) Income and expense information:

Factor for ordinary dividend income........  0.3481
Factor for qualified dividend income.......  0.7407
Factor for interest income.................  0.0222
Factor for affected expenses...............  0.0833
Current year-end cash allocation factor....  1.5960
Prior year cash allocation factor..........  0.1200
Prior year cash distribution date..........  April 15
 

    (2) Information regarding asset sales and distributions:

------------------------------------------------------------------------
                                                 Trust sales
                                Trust sales        proceeds      Percent
        Date of sale              proceeds     distributed and  of trust
                                  received           date         sold
                                                 distributed
------------------------------------------------------------------------
June 1......................  $10.0000x......  $10.0000x (July        20
                                                15).
December 12.................  1.1616x........  0.0000x........         2
------------------------------------------------------------------------

    (3) Information regarding redemptions:

------------------------------------------------------------------------
                                                            Redemption
                          Date                            asset proceeds
------------------------------------------------------------------------
December 10.............................................           $115x
------------------------------------------------------------------------

    (4) Information regarding sales of trust interests

------------------------------------------------------------------------
                                                           Cash held for
                                                           distribution
                          Date                               per trust
                                                             interest
------------------------------------------------------------------------
September 30............................................          $1.35x
December 10.............................................           1.00x
------------------------------------------------------------------------

    (B) Trustee determines this information as follows:
    (1) Step One: Trustee determines the total amount of NMWHFIT 
distributions for the calendar year. The total amount of NMWHFIT 
distributions (actual and deemed) for the calendar year for purposes of 
determining the safe harbor factors is $540x. This amount consists of 
the amounts paid on each scheduled distribution date during the calendar 
year ($1135x, $135x, and $123x), plus the total amount paid to J as a 
result of J's redemption of a trust interest ($116x) ($1,135x + $135x + 
$123x + $116x = $1,509x)--
    (i) Increased by all cash held for distribution to TIHs as of 
December 31, 2007 ($158x), which is the cash held as of December 31, 
2007 ($173x) reduced by the accrued but unpaid expenses as of December 
31, 2007 ($15x), and
    (ii) Decreased by all amounts distributed during the calendar year 
but included in the year-end cash allocation factor from a prior year 
($12x); all redemption asset proceeds paid for the calendar year 
($115x); and all trust sales proceeds distributed during the calendar 
year ($1,000x).
    (2) Step Two: Trustee determines factors that express the ratio of 
NMWHFIT income (other than OID) and expenses to the total amount of 
NMWHFIT distributions. Trustee determines the factors for each item of 
income earned by Trust and each item of expense as follows:

[[Page 350]]

    (i) Ordinary dividend income factor. The ordinary dividend income 
factor is 0.3481, which represents the ratio of the gross amount of 
ordinary dividends ($188x) to the total amount of NMWHFIT distributions 
for the calendar year ($540x).
    (ii) Qualified dividend income factor. The qualified dividend income 
factor is 0.7407 which represents the ratio of the gross amount of 
qualified dividend income ($400x) to the total amount of NMWHFIT 
distributions for the calendar year ($540x).
    (iii) Interest income factor. The interest income factor is 0.0222, 
which represents the ratio of the gross amount of interest income ($12x) 
to the total amount of NMWHFIT distributions for the calendar year 
($540x).
    (iv) Expense factor. The affected expenses factor is 0.0833, which 
represents the ratio of the gross amount of affected expenses paid by 
Trust for the calendar year ($45x) to the total amount of NMWHFIT 
distributions for the calendar year ($540x).
    (3) Step Three: Trustee determines adjustments for reconciling the 
total amount of NMWHFIT distributions with amounts paid to TIHs. To 
enable requesting persons to determine the total amount of NMWHFIT 
distributions that are attributable to a TIH based on amounts actually 
paid to the TIH, the trustee must provide both a current year-end cash 
allocation factor and a prior year cash allocation factor.
    (i) Current year-end cash allocation factor. The adjustment factor 
for cash held by Trust at year end is 1.5960, which represents the cash 
held for distribution as of December 31, 2007 ($158x) (the amount of 
cash held by Trust on December 31, 2007 ($173x) reduced by accrued, but 
unpaid, expenses ($15x)), divided by the number of trust interests 
outstanding at year-end (99).
    (ii) Prior Year Cash Allocation Factor. The adjustment factor for 
distributions of year-end cash from the prior year is 0.1200, which 
represents the amount of the distribution during the current calendar 
year that was included in a year-end cash allocation factor for a prior 
year ($12x), divided by the number of trust interests outstanding at the 
time of the distribution (100). The prior year cash distribution date is 
April 15, 2007.
    (4) Reporting sales and dispositions of trust assets--(i) 
Application of the de minimis test. The aggregate fair market value of 
the assets of Trust as of January 1, 2007, was $10,000x. During the 2007 
calendar year, Trust received trust sales proceeds of $1115x. The trust 
sales proceeds received by Trust for the 2007 calendar year equal 11.15% 
of Trust's fair market value as of January 1, 2007. Accordingly, the de 
minimis test is not satisfied for the 2007 calendar year. The qualified 
NMWHFIT exception in paragraph (c)(2)(iv)(E) of this section and the 
NMWHFIT final calendar year exception in (c)(2)(iv)(F) of this section 
also do not apply to Trust for the 2007 calendar year.
    (ii) Information to be provided. To satisfy the requirements of 
paragraph (f)(1) of this section with respect to sales and dispositions 
of Trust's assets, Trustee provides a list of dates on which trust 
assets were sold during the calendar year, and provides, for each date: 
the trust sales proceeds (per trust interest) received on that date; the 
trust sales proceeds distributed to TIHs (per trust interest) with 
respect to sales or dispositions on that date; the date those trust 
sales proceeds were distributed, and the ratio of the assets sold or 
disposed of on that day to all the assets held by Trust. Because Trust 
will terminate within 15 months of its start-up date, Trustee must use 
the fair market value of the assets as of the start-up date to determine 
the portion of Trust sold or disposed of on any particular date.
    (5) Reporting redemptions. Because Trust is not required to make 
distributions at least as frequently as monthly, and Trust does not 
satisfy the qualified NMWHFIT exception in paragraph (c)(2)(iv)(E) of 
this section, the exception in paragraph (c)(2)(v)(C) does not apply to 
Trust. To satisfy the requirements of paragraph (f)(1) of this section, 
Trustee provides a list of dates for which the redemption proceeds to be 
paid for the redemption of a trust interest was determined for the 2007 
calendar year and the redemptions asset proceeds paid for each date. 
During 2007, Trustee only determined the amount of redemption proceeds 
paid for the redemption of a trust interest once, for December 10, 2007 
and the redemption asset proceeds determined for that date was $115x.
    (6) Reporting sales of trust interests. Because trust is not 
required to make distributions at least as frequently as monthly, and 
Trust does not satisfy the qualified NMWHFIT exception in paragraph 
(c)(2)(iv)(E) of this section, the exception in paragraph (c)(2)(v)(C) 
of this section does not apply to Trust. Sponsor, in accordance with the 
trust agreement, provides Trustee with a list of dates on which sales on 
the secondary market occurred. To satisfy the requirements of paragraph 
(f)(1) of this section, Trustee provides requesting persons with a list 
of dates on which sales on the secondary market occurred and the amount 
of cash held for distribution, per trust interest, on each date. The 
first sale during the 2007 calendar year occurred on September 30, 2007, 
and the amount of cash held for distribution, per trust interest, on 
that date is $1.35x. The second sale occurred on December 10, 2007, and 
the amount of cash held for distribution, per trust interest, on that 
date is $1.00x.
    (iii) Brokers' use of information provided by Trustee. (A) Broker1 
and Broker2 use the information furnished by Trustee under the safe 
harbor to determine that the following items are attributable to J, A, 
and S--

[[Page 351]]



With respect to J
    Ordinary Dividend Income............................         $17.89x
    Qualified Dividend Income...........................          38.07x
    Interest Income.....................................           1.14x
    Affected Expenses...................................           4.28x
    Trust sales proceeds reported on Form 1099..........         108.13x
    Redemption asset proceeds
        For redemption on December 10...................         115.00x
    Sale asset proceeds
        For sale on September 30........................         114.00x
        For sale on December 10.........................         115.00x
With respect to A
    Ordinary Dividend Income............................          18.82x
    Qualified Dividend Income...........................          40.04x
    Interest Income.....................................           1.20x
    Affected Expenses...................................           4.50x
    Trust sales proceeds reported on Form 1099..........          11.62x
With respect to S
    Ordinary Dividend Income............................          19.54x
    Qualified Dividend Income...........................          41.58x
    Interest Income.....................................           1.25x
    Affected Expenses...................................           4.68x
    Trust sales proceeds reported on Form 1099..........         113.94x
 

    With respect to J, A, and S (regarding the sales and dispositions 
executed by Trust during the calendar year)

------------------------------------------------------------------------
                                      Trust sales proceeds
                Date                   received per trust     Percent of
                                            interest          trust sold
------------------------------------------------------------------------
June 15............................  $10.0000x.............           20
December 12........................  1.1616x...............            2
------------------------------------------------------------------------

    (B) The brokers determine the information provided to J, A, and S as 
follows--
    (1) Step One: Brokers determine the total amount of NMWHFIT 
distributions attributable to J, A, and S. Broker1 determines that the 
total amount of NMWHFIT distributions attributable to J is $51.39x and 
the total amount of NMWHFIT distributions attributable to A is $54.06x. 
Broker2 determines that the total amount of NMWHFIT distributions 
attributable to S is $56.13x.
    (i) To calculate these amounts the brokers begin by determining the 
total amount paid to J, A, and S for the calendar year--
    (A) The total amount paid to J for the calendar year equals $485.42x 
and includes the April 15, 2007, distribution of $13.50x, the July 15, 
2007, distribution of $113.50x, the sales proceeds for the September 30, 
2007, sale of $115.35x, the October 15, 2007, distribution of $11.07x, 
and the redemption proceeds of $116x and sales proceeds of $116x for the 
redemption and sale on December 10, 2007.
    (B) The total amount paid to A for the calendar year equals $139.30x 
and includes the April 15, 2007, distribution of $13.50x, the July 15, 
2007, distribution of $113.50x and the October 15, 2007, distribution of 
$12.30x.
    (C) The total amount paid to S for the calendar year equals $140.53x 
and includes the April 15, 2007, distribution of $13.50x, the July 15, 
2007, distribution of $113.50x and the October 15, 2007, distribution of 
$13.53x.
    (ii) The brokers increase the total amount paid to J, A, and S by an 
amount equal to the current year-end cash allocation factor (1.5960) 
multiplied by the number of trust interests held by J (7), A (10), and S 
(12) as of December 31, 2007; that is for J, $11.17x; for A, $15.96x; 
and for S, $19.15x.
    (iii) The brokers reduce the amount paid to J, A, and S as follows--
    (A) An amount equal to the prior year cash allocation factor 
(0.1200), multiplied by the number of trust interests held by J (10), A 
(10), and S (10) on the date of the prior year cash distribution; that 
is for J, A, and S, $1.20x, each;
    (B) An amount equal to all redemption asset proceeds paid to a TIH 
for the calendar year; that is, for J, $115x;
    (C) An amount equal to all sales asset proceeds attributable to the 
TIH for the calendar year; that is for J, $229x (for the September 30, 
2007, sale: $115.35x-1.35x (cash held for distribution per trust 
interest on that date)-$114x; and for the December 10, 2007, sale: 
$116x-1.00 (cash held for distribution per trust interest on that 
date)=$115x));
    (D) In the case of a purchasing TIH, an amount equal to the amount 
of cash held for distribution per trust interest at the time the TIH 
purchased its trust interest, multiplied by the number of trust 
interests purchased; that is for S, $2.35x ($1.35x with respect to the 
September 30, 2007, sale and $1x with respect to the December 10, 2007, 
sale);
    (E) All amounts of trust sales proceeds distributed to the TIH for 
the calendar year; that is for J, A, and S, $100. ($100 each, with 
respect to the June 15, 2007, sale of assets by Trust, and $0 each, with 
respect to the December 12, 2007, sale of assets by Trust).
    (2) Step two: The brokers apply the factors provided by Trustee to 
determine the Trust's income and expenses that are attributable to J, A, 
and S. The amounts of each item of income

[[Page 352]]

(other than OID) and expense that are attributable to J, A, and S are 
determined by multiplying the factor for that type of income or expense 
by the total amount of NMWHFIT distributions attributable to J, A, and S 
as follows:
    (i) Application of factor for ordinary dividends. The amount of 
ordinary dividend income attributable to J is $17.89x, to A is $18.82x, 
and to S is $19.54x. The brokers determine these amounts by multiplying 
the total amount of NMWHFIT distributions attributable to J, A, and S 
($51.39x, $54.06x, and $56.13x, respectively) by the factor for ordinary 
dividends (0.3481).
    (ii) Application of factor for qualified dividend income. The amount 
of qualified dividend income attributable to J is $38.07x, to A is 
$40.04x, and to S is $41.58x. The brokers determine these amounts by 
multiplying the total amount of NMWHFIT distributions attributable to J, 
A, and S ($51.39x, $54.06x, and $56.13x, respectively) by the factor for 
qualified dividends (0.7407).
    (iii) Application of factor for interest income. The amount of 
interest income attributable to J is $1.14x, to A is $1.20x, and to S is 
$1.25x. The brokers determine these amounts by multiplying the total 
amount of NMWHFIT distributions attributable to J, A, and S ($51.39x, 
$54.06x, and $56.13x, respectively) by the factor for interest (0.0222).
    (iv) Application of factor for affected expenses. The amount of 
affected expenses attributable to J is $4.28x, to A is $4.50x, and to S 
is $4.68x. The brokers determine these amounts by multiplying the total 
amount of NMWHFIT distributions attributable to J, A, and S ($51.39x, 
$54.06x, and $56.13x, respectively) by the factor for affected expenses 
(0.0833).
    (3) Brokers reporting of sales and dispositions of trust assets--(i) 
Determining the amount of trust sales proceeds to be reported on Form 
1099 for J, A, and S. The amount of trust sales proceeds to be reported 
on Form 1099 with respect to J is $108.13x, to A is $111.62x, and to S 
is $113.94x. To determine these amounts, the brokers aggregate the 
amount of trust sales proceeds attributable to J, A, and S for each date 
on which Trust sold or disposed of assets. The brokers determine the 
amount of trust sales proceeds to be reported with respect to the June 
15, 2007, asset sale by multiplying the number of trust interests held 
by J (10), A (10) and S (10) on that date by the trust sales proceeds 
received per trust interest on that date ($10x). The brokers determine 
the amount of trust sales proceeds to be reported with respect to the 
December 12, 2007, asset sale by multiplying the number of trust 
interests held by J (7), A (10) and S (12) on that date by the trust 
sales proceeds received per trust interest on that date ($1.1616x).
    (ii) Information provided on the tax information statements 
furnished to J, A, and S. The tax information statements furnished to J, 
A, and S must include the dates of each sale or disposition (June 15, 
2007, and December 12, 2007); the amount of trust sales proceeds per 
trust interest received on those dates ($10.00x and $1.1616x, 
respectively); and, the percentage of Trust sold or disposed of on that 
date (20% and 2%, respectively).
    (4) Reporting redemptions. Broker1 reports on Form 1099 and on the 
written tax information statement furnished to J that J received $115x 
in redemption asset proceeds for the calendar year.
    (5) Reporting sales of trust interests on the secondary market. 
Broker1 reports on J's two sales of trust interests. With respect to the 
sale on September 30, 2007, the sale asset proceeds equals $114x 
($115.35x sale proceeds--$1.35x cash held for distribution on that date) 
and with respect to the sale on December 10, 2007, the sale asset 
proceeds equal $115x ($116x sale proceeds--$1x cash held for 
distribution on that date). Broker1 reports these amounts on Form 1099 
and on the tax information statement furnished to J.

    (g) Safe Harbor for certain WHMTs--(1) Safe harbor for trustee of 
certain WHMTs for reporting information--(i) In general. The trustee of 
a WHMT that meets the requirements of paragraph (g)(1)(ii) of this 
section is deemed to satisfy paragraph (c)(1)(i) of this section, if the 
trustee calculates and provides WHFIT information in the manner 
described in this paragraph (g) and provides a statement to the 
requesting person giving notice that information has been calculated in 
accordance with this paragraph (g)(1).
    (ii) Requirements. A WHMT must meet the following requirements--
    (A) The WHMT must make monthly distributions of the income and 
principal payments received by the WHMT to its TIHs;
    (B) All trust interests in the WHMT must represent the right to 
receive an equal pro-rata share of both the income and the principal 
payments received by the WHMT on the mortgages it holds (for example, a 
WHMT that holds or issues trust interests that qualify as stripped 
interests under section 1286 may not report under this safe harbor);
    (C) The WHMT must--
    (1) Report under this paragraph (g)(1)(ii) for the life of the WHMT; 
or
    (2) If the WHMT has a start-up date before January 1, 2007, the WHMT 
must begin reporting under this paragraph (g)(1)(ii) as of January 1, 
2007, and must

[[Page 353]]

continue to report under this paragraph for the life of the WHMT;
    (D) The WHMT must calculate all items subject to the safe harbor 
consistent with the safe harbor;
    (E) The assets of the WHMT must be limited to--
    (1) Mortgages with uniform characteristics;
    (2) Reasonably required reserve funds; and
    (3) Amounts received on mortgages or reserve funds and held for 
distribution to TIHs; and
    (F) The aggregate outstanding principal balance (as defined in 
paragraph (g)(1)(iii)(D) of this section) as of the WHMT's start-up date 
must equal the aggregate of the original face amounts of all issued 
trust interests.
    (iii) Reporting WHMT income, expenses, non pro-rata partial 
principal payments, and sales and dispositions under the safe harbor. A 
trustee must comply with each step provided in this paragraph 
(g)(1)(iii).
    (A) Step One: Determine monthly pool factors. The trustee must, for 
each month of the calendar year and for January of the following 
calendar year, calculate and provide the ratio (expressed as a decimal 
carried to at least eight places and called a pool factor) of--
    (1) The amount of the aggregate outstanding principal balance of the 
WHMT as of the first business day of the month; to
    (2) The amount of the aggregate outstanding principal balance of the 
WHMT as of the start-up date.
    (B) Step Two: Determine monthly expense factors. For each month of 
the calendar year and for each item of expense paid by the WHMT during 
that month, the trustee must calculate and provide the ratio (expressed 
as a decimal carried to at least eight places and called an expense 
factor) of--
    (1) The gross amount, for the month, of each item of expense; to
    (2) The amount that represents the aggregate outstanding principal 
balance of the WHMT as of the start-up date, divided by 1,000.
    (C) Step Three: Determine monthly income factors. For each month of 
the calendar year and for each item of gross income earned by the WHMT 
during that month, the trustee must calculate and provide the ratio 
(expressed as a decimal carried to at least eight places and called an 
income factor) of--
    (1) The gross amount, for the month, of each item of income, to
    (2) The amount that represents the aggregate outstanding principal 
balance of the WHMT as of the start-up date, divided by 1,000.
    (D) Definition of aggregate outstanding principal balance. For 
purposes of this paragraph (g)(1)(iii), the amount of the aggregate 
outstanding principal balance of a WHMT is the aggregate of--
    (1) The outstanding principal balance of all mortgages held by the 
WHMT;
    (2) The amounts received on mortgages as principal payments and held 
for distribution by the WHMT; and
    (3) The amount of the reserve fund (exclusive of undistributed 
income).
    (iv) Reporting OID information under the safe harbor--(A) Reporting 
OID prior to the issuance of final regulations under section 
1272(a)(6)(C)(iii)--(1) For calendar years prior to the effective date 
of final regulations under section 1272(a)(6)(C)(iii), the trustee must 
provide, for each month during the calendar year, the aggregate daily 
accrual of OID per $1,000 of aggregate outstanding principal balance as 
of the start-up date (daily portion). For purposes of this paragraph 
(g)(1)(iv), the daily portion of OID is determined by allocating to each 
day of the month its ratable portion of the excess (if any) of--
    (i) The sum of the present value (determined under section 
1272(a)(6)(B)) of all remaining payments under the mortgages held by the 
WHMT at the close of the month, and the payments during the month of 
amounts included in the stated redemption price of the mortgages, over
    (ii) The aggregate of each mortgage's adjusted issue price as of the 
beginning of the month.
    (2) In calculating the daily portion of OID, the trustee must use 
the prepayment assumption used in pricing the original issue of trust 
interests. If the WHMT has a start-up date prior to January 24, 2006, 
and the trustee, after a good faith effort to ascertain that 
information, does not know the prepayment assumption used in pricing the

[[Page 354]]

original issue of trust interests, the trustee may use any reasonable 
prepayment assumption to calculate OID provided it continues to use the 
same prepayment assumption consistently thereafter.
    (B) Reporting OID after the issuance of final regulations under 
section 1272(a)(6)(C)(iii). [Reserved]
    (v) Reporting market discount information under the safe harbor--(A) 
Reporting market discount information prior to the issuance of final 
regulations under sections 1272(a)(6)(C)(iii) and 1276(b)(3). For 
calendar years prior to the effective date of final regulations under 
sections 1272(a)(6)(C)(iii) and 1276(b)(3), the trustee must provide--
    (1) In the case of a WHMT holding mortgages issued with OID, the 
ratio (expressed as a decimal carried to at least eight places) of--
    (i) The OID accrued during the month (calculated in accordance with 
paragraph (g)(1)(iv) of this section); to
    (ii) The total remaining OID as of the beginning of the month (as 
determined under paragraph (g)(1)(v)(A)(3) of this section); or
    (2) In the case of a WHMT holding mortgages issued without OID, the 
ratio (expressed as a decimal carried to at least eight places) of--
    (i) The amount of stated interest paid to the WHMT during the month; 
to
    (ii) The total amount of stated interest remaining to be paid to the 
WHMT as of the beginning of the month (as determined under paragraph 
(g)(1)(v)(A)(3) of this section).
    (3) Computing the total amount of stated interest remaining to be 
paid and the total remaining OID at the beginning of the month. To 
compute the total amount of stated interest remaining to be paid to the 
WHMT as of the beginning of the month and the total remaining OID as of 
the beginning of the month, the trustee must use the prepayment 
assumption used in pricing the original issue of trust interests. If the 
WHMT has a start-up date prior to January 24, 2006, and the trustee, 
after a good faith effort to ascertain that information, does not know 
the prepayment assumption used in pricing the original issue of trust 
interests, the trustee may use any reasonable prepayment assumption to 
calculate these amounts provided it continues to use the same prepayment 
assumption consistently thereafter.
    (vi) Reporting bond premium information under the safe harbor. 
[Reserved]
    (2) Use of information provided by a trustee under the safe harbor--
(i) In general. If a trustee reports WHMT items in accordance with 
paragraph (g)(1) of this section, the information provided with respect 
to those items on the Forms 1099 required to be filed with the IRS under 
paragraph (d) of this section and on the statement required to be 
furnished to the TIH under paragraph (e) of this section must be 
determined as provided in this paragraph (g)(2).
    (ii) Reporting WHMT income, expenses, non pro-rata partial principal 
payments, and sales and dispositions under the safe harbor. The amount 
of each item of income, the amount of each item of expense, and the 
combined amount of non pro-rata partial principal payments and trust 
sales proceeds that are attributable to a TIH for each month of the 
calendar year must be computed as follows:
    (A) Step One: Determine the aggregate of the non pro-rata partial 
principal payments and trust sales proceeds that are attributable to the 
TIH for the calendar year. For each month of the calendar year that a 
trust interest was held on the record date--
    (1) Determine the monthly amounts per trust interest. The trustee or 
middleman must determine the aggregate amount of non pro-rata partial 
principal payments and the trust sales proceeds that are attributable to 
each trust interest for each month by multiplying--
    (i) The original face amount of the trust interest; by
    (ii) The difference between the pool factor for the current month 
and the pool factor for the following month.
    (2) Determine the amount for the calendar year. The trustee or 
middleman must multiply the monthly amount per trust interest by the 
number of trust interests held by the TIH on the record date of each 
month. The trustee or middleman then must aggregate these monthly 
amounts, and report the aggregate amount on the Form 1099 filed with the 
IRS and on the tax information statement furnished to the TIH as

[[Page 355]]

trust sales proceeds. No other information is required to be reported to 
the IRS or the TIH to satisfy the requirements of paragraphs (d) and (e) 
of this section under this paragraph (g) with respect to sales and 
dispositions and non pro-rata partial principal payments.
    (B) Step Two: Determine the amount of each item of expense that is 
attributable to a TIH--(1) Determine the monthly amounts per trust 
interest. For each month of the calendar year that a trust interest was 
held on the record date, the trustee or middleman must determine the 
amount of each item of expense that is attributable to each trust 
interest by multiplying--
    (i) The original face amount of the trust interest, divided by 1000; 
by
    (ii) The expense factor for that month and that item of expense.
    (2) Determine the amount for the calendar year. The trustee or 
middleman must multiply the monthly amount of each item of expense per 
trust interest by the number of trust interests held by the TIH on the 
record date of each month. The trustee or middleman then must aggregate 
the monthly amounts for each item of expense to determine the total 
amount of each item of expense that is attributable to the TIH for the 
calendar year.
    (C) Step Three: Determine the amount of each item of income that is 
attributable to the TIH for the calendar year--(1) Determine the monthly 
amounts per trust interest. For each month of the calendar year that a 
trust interest was held on the record date, the trustee or middleman 
must determine the amount of each item of income that is attributable to 
each trust interest by multiplying--
    (i) The original face amount of the trust interest, divided by 
1,000; by
    (ii) The income factor for that month and that item of income.
    (2) Determine the amount for the calendar year. The trustee or 
middleman must multiply the monthly amount of each item of income per 
trust interest by the number of trust interests held by the TIH on the 
record date of each month. The trustee or middleman then must aggregate 
the monthly amounts for each item of income to determine the total 
amount of each item of income that is attributable to the TIH for the 
calendar year.
    (D) Definitions for this paragraph (g)(2). For purposes of this 
paragraph (g)(2)(ii)--
    (1) The record date is the date used by the WHMT to determine the 
owner of the trust interest for the purpose of distributing the payment 
for the month.
    (2) The original face amount of the trust interest is the original 
principal amount of a trust interest on its issue date.
    (iii) Reporting OID information under the safe harbor. With respect 
to each month, trustee or middleman must determine the amount of OID 
that is attributable to each trust interest held by a TIH by 
multiplying--
    (A) The product of the OID factor multiplied by the original face 
amount of the trust interest, divided by 1,000; by
    (B) The number of days during the month that the TIH held the trust 
interest.
    (iv) Requirement to provide market discount information under the 
safe harbor. The trustee or middleman must provide the market discount 
information in accordance with paragraph (g)(1)(v) of this section to 
the TIH in, or with, the written statement required to be furnished to 
the TIH under paragraph (e) of this section.
    (v) Requirement to provide bond premium information under the safe 
harbor. [Reserved]
    (3) Example of safe harbor in paragraph (g)(1) of this section. The 
following example illustrates the use of the factors in this paragraph 
(g) to calculate and provide WHMT information:

    Example. (i) Facts--(A) In general. X is a WHMT. X's start-up date 
is January 1, 2007. As of that date, X's assets consist of 100 15-year 
mortgages, each having an unpaid principal balance of $125,000 and a 
fixed, annual interest rate of 7.25 percent. None of the mortgages were 
issued with OID. X's TIHs are entitled to monthly, pro-rata 
distributions of the principal payments received by X. X's TIHs are also 
entitled to monthly, pro-rata distributions of the interest earned on 
the mortgages held by X, reduced by expenses. Trust interests are issued 
in increments of $5,000 with a $25,000 minimum. The prepayment 
assumption used in pricing the original issue of trust interests is six 
percent. Broker holds a trust interest in X, with

[[Page 356]]

an original face amount of $25,000, in street name, for C during the 
entire 2007 calendar year.
    (B) Trust events during the 2007 calendar year. During the 2007 
calendar year, X collects all interest and principal payments when due 
and makes all monthly distributions when due. One mortgage is 
repurchased from X in July 2007 for $122,249, the mortgage's unpaid 
principal balance plus accrued, but unpaid, interest at the time. During 
November 2007, another mortgage is prepaid in full. X earns $80 interest 
income each month from the temporary investment of X's funds pending 
distribution to the TIHs. All of X's expenses are affected expenses. The 
aggregate outstanding principal balance of X's mortgages, X's interest 
income, and X's expenses, for each month of the 2007 calendar year, 
along with the aggregate outstanding principal balance of X as of 
January 2008, are as follows:

------------------------------------------------------------------------
                                       Principal
               Month                    balance       Income    Expenses
------------------------------------------------------------------------
January...........................     $12,500,000    $75,601     $5,288
February..........................      12,461,413     75,368      5,273
March.............................      12,422,593     75,133      5,256
April.............................      12,383,538     74,897      5,240
May...............................      12,344,247     74,660      5,244
June..............................      12,304,719     74,421      5,207
July..............................      12,264,952     74,181      5,191
August............................      12,102,696     73,200      5,122
September.........................      12,062,849     72,960      5,106
October...........................      12,022,762     72,718      5,089
November..........................      11,982,432     72,474      5,073
December..........................      11,821,234     71,500      5,006
January...........................      11,780,829  .........  .........
------------------------------------------------------------------------

    (ii) Trustee reporting. (A) Trustee, X's fiduciary, comes within the 
safe harbor of paragraph (g)(1)(ii) of this section by providing the 
following information to requesting persons:

------------------------------------------------------------------------
                                               Income
            Month              Pool factor     factor     Expense factor
------------------------------------------------------------------------
January......................   1.00000000    6.04806667      0.42304000
February.....................   0.99691304    6.02941628      0.42184000
March........................   0.99380744    6.01065328      0.42048000
April........................   0.99068304    5.99177670      0.41920000
May..........................   0.98753976    5.97278605      0.41952000
June.........................   0.98437752    5.95368085      0.41656000
July.........................   0.98119616    5.93446013      0.41528000
August.......................   0.96821564    5.85603618      0.40976000
September....................   0.96502792    5.83677704      0.40848000
October......................   0.96182096    5.81740161      0.40712000
November.....................   0.95859459    5.79790896      0.40584000
December.....................   0.94569875    5.71999659      0.40048000
January......................   0.94246631  ............  ..............
------------------------------------------------------------------------

    (B) Trustee determines this information as follows:
    (1) Step One: Trustee determines monthly pool factors. Trustee 
calculates and provides X's pool factor for each month of the 2007 
calendar year. For example, for the month of January 2007 the pool 
factor is 1.0, which represents the ratio of --
    (i) The amount that represents the aggregate outstanding principal 
balance of X ($12,500,000) as of the first business day of January; 
divided by
    (ii) The amount that represents the aggregate outstanding principal 
balance of X ($12,500,000) as of the start-up day.
    (2) Step Two: Trustee determines monthly expense factors. Trustee 
calculates and provides the expense factors for each month of the 2007 
calendar year. During 2007, X has only affected expenses, and therefore, 
will have only one expense factor for each month. For example, the 
expense factor for the month of January 2007 is 0.42304000, which 
represents the ratio of--
    (i) The gross amount of expenses paid during January by X ($5,288); 
divided by
    (ii) The amount that represents the aggregate outstanding principal 
balance of X as of the start-up date ($12,500,000) divided by 1,000 
($12,500).
    (3) Step Three: Trustee determines monthly income factors. Trustee 
calculates and provides the income factors for each month of the 2007 
calendar year. During 2007, X has only interest income, and therefore, 
will have only one income factor for each month. For example, the income 
factor for the month of January 2007 is 6.04806667, which represents the 
ratio of--
    (i) The gross amount of interest income earned by X during January 
($75,601); divided by
    (ii) The amount that represents that aggregate outstanding principal 
balance of X as of the start-up date ($12,500,000), divided by 1,000 
($12,500).
    (4) Step Four: Trustee calculates and provides monthly market 
discount fractions. Trustee calculates and provides a market discount 
fraction for each month of the 2007 calendar year using a prepayment 
assumption of 6% and a stated interest rate of 7.25%.
    (iii) Broker's use of the information provided by Trustee. (A) 
Broker uses the information provided by Trustee under paragraph (g) of 
this section to determine that the following trust items are 
attributable to C:

------------------------------------------------------------------------
                                  Aggregate trust
                                   sales proceeds                Gross
             Month                and non pro-rata   Affected   interest
                                 partial principal   expenses    income
                                      payments
------------------------------------------------------------------------
January........................             $77.17     $10.58    $151.20
February.......................              77.64      10.55     150.74
March..........................              78.11      10.51     150.27
April..........................              78.58      10.48     149.79
May............................              79.06      10.49     149.32
June...........................              79.53      10.41     148.84
July...........................             324.51      10.38     148.36
August.........................              79.69      10.24     146.40
September......................              80.17      10.21     145.92
October........................              80.66      10.18     145.43
November.......................             322.40      10.15     144.95
December.......................              80.81      10.01     143.00
                                ----------------------------------------
    Total......................            1438.33     124.19    1774.22
------------------------------------------------------------------------


[[Page 357]]

    (B) Broker determines this information as follows:
    (1) Step One: Broker determines the amount of the non pro-rata 
partial principal payments and trust sales proceeds received by X that 
are attributable to C for the 2007 calendar year. Broker determines the 
amount of the non pro-rata partial principal payments and trust sales 
proceeds received by X that are attributable to C for each month of the 
2007 calendar year. For example, for the month of January, Broker 
determines that the amount of principal receipts and the amount of trust 
sales proceeds that are attributable to C is $77.17. Broker determines 
this by multiplying the original face amount of C's trust interest 
($25,000) by 0.00308696, the difference between the pool factor for 
January 2007 (1.00000000) and the pool factor for the following month of 
February 2007 (0.99691304). Broker reports the aggregate of the monthly 
amounts of non pro-rata partial principal payments and trust sales 
proceeds that are attributable to C for the 2007 calendar year as trust 
sales proceeds on the Form 1099 filed with the IRS.
    (2) Step Two: Broker applies the expense factors provided by Trustee 
to determine the amount of expenses that are attributable to C for the 
2007 calendar year. Broker determines the amount of X's expenses that 
are attributable to C for each month of the calendar year. For example, 
for the month of January 2007, Broker determines that the amount of 
expenses attributable to C is $10.58. Broker determines this by 
multiplying the original face amount of C's trust interest ($25,000), 
divided by 1,000 ($25) by the expense factor for January 2007 
(0.42304000). Broker determines the expenses that are attributable to C 
for the 2007 calendar year by aggregating the monthly amounts.
    (3) Step Three: Broker applies the income factors provided by 
Trustee to determine the amount of gross interest income attributable to 
C for the 2007 calendar year. Broker determines the amount of gross 
interest income that is attributable to C for each month of the calendar 
year. For example, for the month of January 2007, Broker determines that 
the amount of gross interest income attributable to C is $151.20. Broker 
determines this by multiplying the original face amount of C's trust 
interest ($25,000), divided by 1,000 ($25), by the income factor for 
January 2007 (6.04806667). Broker determines the amount of the gross 
interest income that is attributable to C for the 2007 calendar year by 
aggregating the monthly amounts.
    (4) Step Four: Broker provides market discount information to C. 
Broker provides C with the market discount fractions calculated and 
provided by the trustee of X under paragraph (g)(3)(ii)(D) of this 
section.

    (h) Additional safe harbors--(1) Temporary safe harbor for WHMTs--
(i) Application. Pending the issuance of additional guidance, the safe 
harbor in this paragraph applies to trustees and middlemen of WHMTs that 
are not eligible to report under the WHMT safe harbor in paragraph (g) 
of this section because they hold interests in another WHFIT, in a 
REMIC, or hold or issue stripped interests.
    (ii) Safe harbor. A trustee is deemed to satisfy the requirements of 
paragraph (c) of this section, if the trustee calculates and provides 
trust information in a manner that enables a requesting person to 
provide trust information to a beneficial owner of a trust interest that 
enables the owner to reasonably accurately report the tax consequences 
of its ownership of a trust interest on its federal income tax return. 
Additionally, to be deemed to satisfy the requirements of paragraph (c) 
of this section, the trustee must calculate and provide trust 
information regarding market discount and OID by any reasonable manner 
consistent with section 1272(a)(6). A middleman or a trustee may satisfy 
its obligation to furnish information to the IRS under paragraph (d) of 
this section and to the trust interest holder under paragraph (e) of 
this section by providing information consistent with the information 
provided under this paragraph by the trustee.
    (2) Additional safe harbors provided by other published guidance. 
The IRS and the Treasury Department may provide additional safe harbor 
reporting procedures for complying with this section or a specific 
paragraph of this section by other published guidance (see Sec. 
601.601(d)(2) of this chapter).
    (i) [Reserved]
    (j) Requirement that middlemen furnish information to beneficial 
owners that are exempt recipients and noncalendar-year beneficial 
owners--(1) In general. A middleman that holds a trust interest on 
behalf of, or for the account of, either a beneficial owner that is an 
exempt recipient defined in paragraph (b)(7) of this section or a 
noncalendar-year beneficial owner, must provide to such beneficial 
owner, upon request, the information provided by the trustee to the 
middleman under paragraph (c) of this section.

[[Page 358]]

    (2) Time for providing information. The middleman must provide the 
requested information to any beneficial owner making a request under 
paragraph (h)(1) of this section on or before the later of the 44th day 
after the close of the calendar year for which the information was 
requested, or the day that is 28 days after the receipt of the request. 
A middleman must provide information with respect to a WHFIT holding an 
interest in another WHFIT, or a WHFIT holding an interest in a REMIC, on 
or before the later of the 58th day after the close of the calendar year 
for which the information was requested, or the 42nd day after the 
receipt of the request.
    (3) Manner of providing information. The requested information must 
be provided--
    (i) By written statement sent by first class mail to the address 
provided by the person requesting the information;
    (ii) By electronic mail provided that the person requesting the 
information requests that the middleman furnish the information by 
electronic mail and the person furnishes an electronic address;
    (iii) At an Internet website of the middleman or the trustee, 
provided that the beneficial owner requesting the information is 
notified that the requested information is available at the Internet 
website and is furnished the address of the site; or
    (iv) Any other manner agreed to by the middleman and the beneficial 
owner requesting the information.
    (4) Clearing organization. A clearing organization described in 
Sec. 1.163-5(c)(2)(i)(D)(8) is not required to furnish information to 
exempt recipients or non-calendar-year TIHs under this paragraph (h).
    (k) Coordination with other information reporting rules. In general, 
in cases in which reporting is required for a WHFIT under both this 
section and subpart B, part III, subchapter A, chapter 61 of the 
Internal Revenue Code (Sections 6041 through 6050S) (Information 
Reporting Sections), the reporting rules for WHFITs under this section 
must be applied. The provisions of the Information Reporting Sections 
and the regulations thereunder are incorporated into this section as 
applicable, but only to the extent that such provisions are not 
inconsistent with the provisions of this section.
    (l) Backup withholding requirements. Every trustee and middleman 
required to file a Form 1099 under this section is a payor within the 
meaning of Sec. 31.3406(a)-2, and must backup withhold as required 
under section 3406 and any regulations thereunder.
    (m) Penalties for failure to comply--(1) In general. Every trustee 
or middleman who fails to comply with the reporting obligations imposed 
by this section is subject to penalties under sections 6721, 6722, and 
any other applicable penalty provisions.
    (2) Penalties not imposed on trustees and middlemen of certain WHMTs 
for failure to report OID. Penalties will not be imposed as a result of 
a failure to provide OID information for a WHMT that has a start-up date 
on or after August 13, 1998 and on or before January 24, 2006, if the 
trustee of the WHMT does not have the historic information necessary to 
provide this information and the trustee demonstrates that it has 
attempted in good faith, but without success, to obtain this 
information. For purposes of calculating a market discount fraction 
under paragraph (g)(1)(v) of this section, for a WHMT described in this 
paragraph, it may be assumed that the WHMT is holding mortgages that 
were issued without OID. A trustee availing itself of this paragraph 
must include a statement to that effect when providing information to 
requesting persons under paragraph (c) of these regulations.
    (n) Effective date. These regulations are applicable January 1, 
2007. Trustees must calculate and provide trust information with respect 
to the 2007 calendar year and all subsequent years consistent with these 
regulations. Information returns required to be filed with the IRS and 
the tax information statements required to be furnished to trust 
interest holders after December 31, 2007 must be consistent with these 
regulations.

[T.D. 9241, 71 FR 4009, Jan. 24, 2006, as amended by T.D. 9279, 71 FR 
43971, Aug. 3, 2006; T.D. 9308, 71 FR 78356, Dec. 29, 2006]

[[Page 359]]



Sec. 1.672(a)-1  Definition of adverse party.

    (a) Under section 672(a) an adverse party is defined as any person 
having a substantial beneficial interest in a trust which would be 
adversely affected by the exercise or nonexercise of a power which he 
possesses respecting the trust. A trustee is not an adverse party merely 
because of his interest as trustee. A person having a general power of 
appointment over the trust property is deemed to have a beneficial 
interest in the trust. An interest is a substantial interest if its 
value in relation to the total value of the property subject to the 
power is not insignificant.
    (b) Ordinarily, a beneficiary will be an adverse party, but if his 
right to share in the income or corpus of a trust is limited to only a 
part, he may be an adverse party only as to that part. Thus, if A, B, C, 
and D are equal income beneficiaries of a trust and the grantor can 
revoke with A's consent, the grantor is treated as the owner of a 
portion which represents three-fourths of the trust; and items of 
income, deduction, and credit attributable to that portion are included 
in determining the tax of the grantor.
    (c) The interest of an ordinary income beneficiary of a trust may or 
may not be adverse with respect to the exercise of a power over corpus. 
Thus, if the income of a trust is payable to A for life, with a power 
(which is not a general power of appointment) in A to appoint the corpus 
to the grantor either during his life or by will, A's interest is 
adverse to the return of the corpus to the grantor during A's life, but 
is not adverse to a return of the corpus after A's death. In other 
words, A's interest is adverse as to ordinary income but is not adverse 
as to income allocable to corpus. Therefore, assuming no other relevant 
facts exist, the grantor would not be taxable on the ordinary income of 
the trust under section 674, 676, or 677, but would be taxable under 
section 677 on income allocable to corpus (such as capital gains), since 
it may in the discretion of a nonadverse party be accumulated for future 
distribution to the grantor. Similarly, the interest of a contingent 
income beneficiary is adverse to a return of corpus to the grantor 
before the termination of his interest but not to a return of corpus 
after the termination of his interest.
    (d) The interest of a remainderman is adverse to the exercise of any 
power over the corpus of a trust, but not to the exercise of a power 
over any income interest preceding his remainder. For example, if the 
grantor creates a trust which provides for income to be distributed to A 
for 10 years and then for the corpus to go to X if he is then living, a 
power exercisable by X to revest corpus in the grantor is a power 
exercisable by an adverse party; however, a power exercisable by X to 
distribute part or all of the ordinary income to the grantor may be a 
power exercisable by a nonadverse party (which would cause the ordinary 
income to be taxed to the grantor).



Sec. 1.672(b)-1  Nonadverse party.

    A nonadverse party is any person who is not an adverse party.



Sec. 1.672(c)-1  Related or subordinate party.

    Section 672(c) defines the term ``related or subordinate party''. 
The term, as used in sections 674(c) and 675(3), means any nonadverse 
party who is the grantor's spouse if living with the grantor; the 
grantor's father, mother, issue, brother or sister; an employee of the 
grantor; a corporation or any employee of a corporation in which the 
stock holdings of the grantor and the trust are significant from the 
viewpoint of voting control; or a subordinate employee of a corporation 
in which the grantor is an executive. For purposes of sections 674(c) 
and 675(3), these persons are presumed to be subservient to the grantor 
in respect of the exercise or nonexercise of the powers conferred on 
them unless shown not to be subservient by a preponderance of the 
evidence.



Sec. 1.672(d)-1  Power subject to condition precedent.

    Section 672(d) provides that a person is considered to have a power 
described in subpart E (section 671 and following), part I, subchapter 
J, chapter 1 of the Code, even though the exercise of the power is 
subject to a precedent giving of notice or takes effect only

[[Page 360]]

after the expiration of a certain period of time. However, although a 
person may be considered to have such a power, the grantor will 
nevertheless not be treated as an owner by reason of the power if its 
exercise can only affect beneficial enjoyment of income received after 
the expiration of a period of time such that, if the power were a 
reversionary interest, he would not be treated as an owner under section 
673. See sections 674(b)(2), 676(b), and the last sentence of section 
677(a). Thus, for example, if a grantor creates a trust for the benefit 
of his son and retains a power to revoke which takes effect only after 
the expiration of 2 years from the date of exercise, he is treated as an 
owner from the inception of the trust. However, if the grantor retains a 
power to revoke, exercisable at any time, which can only affect the 
beneficial enjoyment of the ordinary income of a trust received after 
the expiration of 10 years commencing with the date of the transfer in 
trust, or after the death of the income beneficiary, the power does not 
cause him to be treated as an owner with respect to ordinary income 
during the first 10 years of the trust or during the income 
beneficiary's life, as the case may be. See section 676(b).



Sec. 1.672(f)-1  Foreign persons not treated as owners.

    (a) General rule--(1) Application of the general rule. Section 
672(f)(1) provides that subpart E of part I, subchapter J, chapter 1 of 
the Internal Revenue Code (the grantor trust rules) shall apply only to 
the extent such application results in an amount (if any) being 
currently taken into account (directly or through one or more entities) 
in computing the income of a citizen or resident of the United States or 
a domestic corporation. Accordingly, the grantor trust rules apply to 
the extent that any portion of the trust, upon application of the 
grantor trust rules without regard to section 672(f), is treated as 
owned by a United States citizen or resident or domestic corporation. 
The grantor trust rules do not apply to any portion of the trust to the 
extent that, upon application of the grantor trust rules without regard 
to section 672(f), that portion is treated as owned by a person other 
than a United States citizen or resident or domestic corporation, unless 
the person is described in Sec. 1.672(f)-2(a) (relating to certain 
foreign corporations treated as domestic corporations), or one of the 
exceptions set forth in Sec. 1.672(f)-3 is met, (relating to: trusts 
where the grantor can revest trust assets; trusts where the only amounts 
distributable are to the grantor or the grantor's spouse; and 
compensatory trusts). Section 672(f) applies to domestic and foreign 
trusts. Any portion of the trust that is not treated as owned by a 
grantor or another person is subject to the rules of subparts A through 
D (section 641 and following), part I, subchapter J, chapter 1 of the 
Internal Revenue Code.
    (2) Determination of portion based on application of the grantor 
trust rules. The determination of the portion of a trust treated as 
owned by the grantor or other person is to be made based on the terms of 
the trust and the application of the grantor trust rules and section 671 
and the regulations thereunder.
    (b) Example. The following example illustrates the rules of this 
section:

    Example. (i) A, a nonresident alien, funds an irrevocable domestic 
trust, DT, for the benefit of his son, B, who is a United States 
citizen, with stock of Corporation X. A's brother, C, who also is a 
United States citizen, contributes stock of Corporation Y to the trust 
for the benefit of B. A has a reversionary interest within the meaning 
of section 673 in the X stock that would cause A to be treated as the 
owner of the X stock upon application of the grantor trust rules without 
regard to section 672(f). C has a reversionary interest within the 
meaning of section 673 in the Y stock that would cause C to be treated 
as the owner of the Y stock upon application of the grantor trust rules 
without regard to section 672(f). The trustee has discretion to 
accumulate or currently distribute income of DT to B.
    (ii) Because A is a nonresident alien, application of the grantor 
trust rules without regard to section 672(f) would not result in the 
portion of the trust consisting of the X stock being treated as owned by 
a United States citizen or resident. None of the exceptions in Sec. 
1.672(f)-3 applies because A cannot revest the X stock in A, amounts may 
be distributed during A's lifetime to B, who is neither a grantor nor a 
spouse of a grantor, and the trust is not a compensatory trust. 
Therefore, pursuant to paragraph (a)(1) of this section, A is not 
treated as an owner under subpart E

[[Page 361]]

of part I, subchapter J, chapter 1 of the Internal Revenue Code, of the 
portion of the trust consisting of the X stock. Any distributions from 
such portion of the trust are subject to the rules of subparts A through 
D (641 and following), part I, subchapter J, chapter 1 of the Internal 
Revenue Code.
    (iii) Because C is a United States citizen, paragraph (a)(1) of this 
section does not prevent C from being treated under section 673 as the 
owner of the portion of the trust consisting of the Y stock.

    (c) Effective date. The rules of this section are applicable to 
taxable years of a trust beginning after August 10, 1999.

[T.D. 8831, 64 FR 43275, Aug. 10, 1999]



Sec. 1.672(f)-2  Certain foreign corporations.

    (a) Application of general rule. Subject to the provisions of 
paragraph (b) of this section, if the owner of any portion of a trust 
upon application of the grantor trust rules without regard to section 
672(f) is a controlled foreign corporation (as defined in section 957), 
a passive foreign investment company (as defined in section 1297), or a 
foreign personal holding company (as defined in section 552), the 
corporation will be treated as a domestic corporation for purposes of 
applying the rules of Sec. 1.672(f)-1.
    (b) Gratuitous transfers to United States persons--(1) Transfer from 
trust to which corporation made a gratuitous transfer. If a trust (or 
portion of a trust) to which a controlled foreign corporation, passive 
foreign investment company, or foreign personal holding company has made 
a gratuitous transfer (within the meaning of Sec. 1.671-2(e)(2)), makes 
a gratuitous transfer to a United States person, the controlled foreign 
corporation, passive foreign investment company, or foreign personal 
holding company, as the case may be, is treated as a foreign corporation 
for purposes of Sec. 1.672(f)-4(c), relating to gratuitous transfers 
from trusts (or portions of trusts) to which a partnership or foreign 
corporation has made a gratuitous transfer.
    (2) Transfer from trust over which corporation has a section 678 
power. If a trust (or portion of a trust) that a controlled foreign 
corporation, passive foreign investment company, or foreign personal 
holding company is treated as owning under section 678 makes a 
gratuitous transfer to a United States person, the controlled foreign 
corporation, passive foreign investment company, or foreign personal 
holding company, as the case may be, is treated as a foreign corporation 
that had made a gratuitous transfer to the trust (or portion of a trust) 
and the rules of Sec. 1.672(f)-4(c) apply.
    (c) Special rules for passive foreign investment companies--(1) 
Application of section 1297. For purposes of determining whether a 
foreign corporation is a passive foreign investment company as defined 
in section 1297, the grantor trust rules apply as if section 672(f) had 
not come into effect.
    (2) References to renumbered Internal Revenue Code section. For 
taxable years of shareholders beginning on or before December 31, 1997, 
and taxable years of passive foreign investment companies ending with or 
within such taxable years of the shareholders, all references in this 
Sec. 1.672(f)-2 to section 1297 are deemed to be references to section 
1296.
    (d) Examples. The following examples illustrate the rules of this 
section. In each example, FT is an irrevocable foreign trust, and CFC is 
a controlled foreign corporation. The examples are as follows:

    Example 1. Application of general rule. CFC creates and funds FT. 
CFC is the grantor of FT within the meaning of Sec. 1.671-2(e). CFC has 
a reversionary interest in FT within the meaning of section 673 that 
would cause CFC to be treated as the owner of FT upon application of the 
grantor trust rules without regard to section 672(f). Under paragraph 
(a) of this section, CFC is treated as a domestic corporation for 
purposes of applying the general rule of Sec. 1.672(f)-1. Thus, Sec. 
1.672(f)-1 does not prevent CFC from being treated as the owner of FT 
under section 673.
    Example 2. Distribution from trust to which CFC made gratuitous 
transfer. A, a nonresident alien, owns 40 percent of the stock of CFC. 
A's brother B, a resident alien, owns the other 60 percent of the stock 
of CFC. CFC makes a gratuitous transfer to FT. FT makes a gratuitous 
transfer to A's daughter, C, who is a resident alien. Under paragraph 
(b)(1) of this section, CFC will be treated as a foreign corporation for 
purposes of Sec. 1.672(f)-4(c). For further guidance, see Sec. 
1.672(f)-4(g) Example 2 through Example 4.


[[Page 362]]


    (e) Effective date. The rules of this section are generally 
applicable to taxable years of shareholders of controlled foreign 
corporations, passive foreign investment companies, and foreign personal 
holding companies beginning after August 10, 1999, and taxable years of 
controlled foreign corporations, passive foreign investment companies, 
and foreign personal holding companies ending with or within such 
taxable years of the shareholders.

[T.D. 8831, 64 FR 43276, Aug. 10, 1999, as amended by T.D. 8890, 65 FR 
41334, July 5, 2000]



Sec. 1.672(f)-3  Exceptions to general rule.

    (a) Certain revocable trusts--(1) In general. Subject to the 
provisions of paragraph (a)(2) of this section, the general rule of 
Sec. 1.672(f)-1 does not apply to any portion of a trust for a taxable 
year of the trust if the power to revest absolutely in the grantor title 
to such portion is exercisable solely by the grantor (or, in the event 
of the grantor's incapacity, by a guardian or other person who has 
unrestricted authority to exercise such power on the grantor's behalf) 
without the approval or consent of any other person. If the grantor can 
exercise such power only with the approval of a related or subordinate 
party who is subservient to the grantor, such power is treated as 
exercisable solely by the grantor. For the definition of grantor, see 
Sec. 1.671-2(e). For the definition of related or subordinate party, 
see Sec. 1.672(c)-1. For purposes of this paragraph (a), a related or 
subordinate party is subservient to the grantor unless the presumption 
in the last sentence of Sec. 1.672(c)-1 is rebutted by a preponderance 
of the evidence. A trust (or portion of a trust) that fails to qualify 
for the exception provided by this paragraph (a) for a particular 
taxable year of the trust will be subject to the general rule of Sec. 
1.672(f)-1 for that taxable year and all subsequent taxable years of the 
trust.
    (2) 183-day rule. For purposes of paragraph (a)(1) of this section, 
the grantor is treated as having a power to revest for a taxable year of 
the trust only if the grantor has such power for a total of 183 or more 
days during the taxable year of the trust. If the first or last taxable 
year of the trust (including the year of the grantor's death) is less 
than 183 days, the grantor is treated as having a power to revest for 
purposes of paragraph (a)(1) of this section if the grantor has such 
power for each day of the first or last taxable year, as the case may 
be.
    (3) Grandfather rule for certain revocable trusts in existence on 
September 19, 1995. Subject to the rules of paragraph (d) of this 
section (relating to separate accounting for gratuitous transfers to the 
trust after September 19, 1995), the general rule of Sec. 1.672(f)-1 
does not apply to any portion of a trust that was treated as owned by 
the grantor under section 676 on September 19, 1995, as long as the 
trust would continue to be so treated thereafter. However, the preceding 
sentence does not apply to any portion of the trust attributable to 
gratuitous transfers to the trust after September 19, 1995.
    (4) Examples. The following examples illustrate the rules of this 
paragraph (a):

    Example 1. Grantor is owner. FP1, a foreign person, creates and 
funds a revocable trust, T, for the benefit of FP1's children, who are 
resident aliens. The trustee is a foreign bank, FB, that is owned and 
controlled by FP1 and FP2, who is FP1's brother. The power to revoke T 
and revest absolutely in FP1 title to the trust property is exercisable 
by FP1, but only with the approval or consent of FB. The trust 
instrument contains no standard that FB must apply in determining 
whether to approve or consent to the revocation of T. There are no facts 
that would suggest that FB is not subservient to FP1. Therefore, the 
exception in paragraph (a)(1) of this section is applicable.
    Example 2. Death of grantor. Assume the same facts as in Example 1, 
except that FP1 dies. After FP1's death, FP2 has the power to withdraw 
the assets of T, but only with the approval of FB. There are no facts 
that would suggest that FB is not subservient to FP2. However, the 
exception in paragraph (a)(1) of this section is no longer applicable, 
because FP2 is not a grantor of T within the meaning of Sec. 1.671-
2(e).
    Example 3. Trustee is not related or subordinate party. Assume the 
same facts as in Example 1, except that neither FP1 nor any member of 
FP1's family has any substantial ownership interest or other connection 
with FB. FP1 can remove and replace FB at any time for any reason. 
Although FP1 can replace FB with a related or subordinate party if FB 
refuses to approve or consent to FP1's decision to revest the trust 
property in himself, FB is not a related or subordinate

[[Page 363]]

party. Therefore, the exception in paragraph (a)(1) of this section is 
not applicable.
    Example 4. Unrelated trustee will consent to revocation. FP, a 
foreign person, creates and funds an irrevocable trust, T. The trustee 
is a foreign bank, FB, that is not a related or subordinate party within 
the meaning of Sec. 1.672(c)-1. FB has the discretion to distribute 
trust income or corpus to beneficiaries of T, including FP. Even if FB 
would in fact distribute all the trust property to FP if requested to do 
so by FP, the exception in paragraph (a)(1) of this section is not 
applicable, because FP does not have the power to revoke T.

    (b) Certain trusts that can distribute only to the grantor or the 
spouse of the grantor--(1) In general. The general rule of Sec. 
1.672(f)-1 does not apply to any trust (or portion of a trust) if at all 
times during the lifetime of the grantor the only amounts distributable 
(whether income or corpus) from such trust (or portion thereof) are 
amounts distributable to the grantor or the spouse of the grantor. For 
purposes of this paragraph (b), payments of amounts that are not 
gratuitous transfers (within the meaning of Sec. 1.671-2(e)(2)) are not 
amounts distributable. For the definition of grantor, see Sec. 1.671-
2(e).
    (2) Amounts distributable in discharge of legal obligations--(i) In 
general. A trust (or portion of a trust) does not fail to satisfy 
paragraph (b)(1) of this section solely because amounts are 
distributable from the trust (or portion thereof) in discharge of a 
legal obligation of the grantor or the spouse of the grantor. Subject to 
the provisions of paragraph (b)(2)(ii) of this section, an obligation is 
considered a legal obligation for purposes of this paragraph (b)(2)(i) 
if it is enforceable under the local law of the jurisdiction in which 
the grantor (or the spouse of the grantor) resides.
    (ii) Related parties--(A) In general. Except as provided in 
paragraph (b)(2)(ii)(B) of this section, an obligation to a person who 
is a related person for purposes of Sec. 1.643(h)-1(e) (other than an 
individual who is legally separated from the grantor under a decree of 
divorce or of separate maintenance) is not a legal obligation for 
purposes of paragraph (b)(2)(i) of this section unless it was contracted 
bona fide and for adequate and full consideration in money or money's 
worth (see Sec. 20.2043-1 of this chapter).
    (B) Exceptions--(1) Amounts distributable in support of certain 
individuals. Paragraph (b)(2)(ii)(A) of this section does not apply with 
respect to amounts that are distributable from the trust (or portion 
thereof) to support an individual who--
    (i) Would be treated as a dependent of the grantor or the spouse of 
the grantor under section 152(a)(1) through (9), without regard to the 
requirement that over half of the individual's support be received from 
the grantor or the spouse of the grantor; and
    (ii) Is either permanently and totally disabled (within the meaning 
of section 22(e)(3)), or less than 19 years old.
    (2) Certain potential support obligations. The fact that amounts 
might become distributable from a trust (or portion of a trust) in 
discharge of a potential obligation under local law to support an 
individual other than an individual described in paragraph 
(b)(2)(ii)(B)(1) of this section is disregarded if such potential 
obligation is not reasonably expected to arise under the facts and 
circumstances.
    (3) Reinsurance trusts. [Reserved]
    (3) Grandfather rule for certain section 677 trusts in existence on 
September 19, 1995. Subject to the rules of paragraph (d) of this 
section (relating to separate accounting for gratuitous transfers to the 
trust after September 19, 1995), the general rule of Sec. 1.672(f)-1 
does not apply to any portion of a trust that was treated as owned by 
the grantor under section 677 (other than section 677(a)(3)) on 
September 19, 1995, as long as the trust would continue to be so treated 
thereafter. However, the preceding sentence does not apply to any 
portion of the trust attributable to gratuitous transfers to the trust 
after September 19, 1995.
    (4) Examples. The following examples illustrate the rules of this 
paragraph (b):

    Example 1. Amounts distributable only to grantor or grantor's 
spouse. H and his wife, W, are both nonresident aliens. H is 70 years 
old, and W is 65. H and W have a 30-year-old child, C, a resident alien. 
There is no reasonable expectation that H or W will ever have an 
obligation under local law to support C or any other individual. H 
creates and funds an

[[Page 364]]

irrevocable trust, FT, using only his separate property. H is the 
grantor of FT within the meaning of Sec. 1.671-2(e). Under the terms of 
FT, the only amounts distributable (whether income or corpus) from FT as 
long as either H or W is alive are amounts distributable to H or W. Upon 
the death of both H and W, C may receive distributions from FT. During 
H's lifetime, the exception in paragraph (b)(1) of this section is 
applicable.
    Example 2. Effect of grantor's death. Assume the same facts as in 
Example 1. H predeceases W. Assume that W would be treated as owning FT 
under section 678 if the grantor trust rules were applied without regard 
to section 672(f). The exception in paragraph (b)(1) of this section is 
no longer applicable, because W is not a grantor of FT within the 
meaning of Sec. 1.671-2(e).
    Example 3. Amounts temporarily distributable to person other than 
grantor or grantor's spouse. Assume the same facts as in Example 1, 
except that C (age 30) is a law student at the time FT is created and 
the trust instrument provides that, as long as C is in law school, 
amounts may be distributed from FT to pay C's expenses. Thereafter, the 
only amounts distributable from FT as long as either H or W is alive 
will be amounts distributable to H or W. Even assuming there is an 
enforceable obligation under local law for H and W to support C while he 
is in school, distributions from FT in payment of C's expenses cannot 
qualify as distributions in discharge of a legal obligation under 
paragraph (b)(2) of this section, because C is neither permanently and 
totally disabled nor less than 19 years old. The exception in paragraph 
(b)(1) of this section is not applicable. After C graduates from law 
school, the exception in paragraph (b)(1) still will not be applicable, 
because amounts were distributable to C during the lifetime of H.
    Example 4. Fixed investment trust. FC, a foreign corporation, 
invests in a domestic fixed investment trust, DT, that is classified as 
a trust under Sec. 301.7701-4(c)(1) of this chapter. Under the terms of 
DT, the only amounts that are distributable from FC's portion of DT are 
amounts distributable to FC. The exception in paragraph (b)(1) of this 
section is applicable to FC's portion of DT.
    Example 5. Reinsurance trust. A domestic insurance company, DI, 
reinsures a portion of its business with an unrelated foreign insurance 
company, FI. To satisfy state regulatory requirements, FI places the 
premiums in an irrevocable domestic trust, DT. The trust funds are held 
by a United States bank and may be used only to pay claims arising out 
of the reinsurance policies, which are legally enforceable under the 
local law of the jurisdiction in which FI resides. On the termination of 
DT, any assets remaining will revert to FI. Because the only amounts 
that are distributable from DT are distributable either to FI or in 
discharge of FI's legal obligations within the meaning of paragraph 
(b)(2)(i) of this section, the exception in paragraph (b)(1) of this 
section is applicable.
    Example 6. Trust that provides security for loan. FC, a foreign 
corporation, borrows money from B, an unrelated bank, to finance the 
purchase of an airplane. FC creates a foreign trust, FT, to hold the 
airplane as security for the loan from B. The only amounts that are 
distributable from FT while the loan is outstanding are amounts 
distributable to B in the event that FC defaults on its loan from B. 
When FC repays the loan, the trust assets will revert to FC. The loan is 
a legal obligation of FC within the meaning of paragraph (b)(2)(i) of 
this section, because it is enforceable under the local law of the 
country in which FC is incorporated. Paragraph (b)(2)(ii) of this 
section is not applicable, because B is not a related person for 
purposes of Sec. 1.643(h)-1(e). The exception in paragraph (b)(1) of 
this section is applicable.

    (c) Compensatory trusts--(1) In general. The general rule of Sec. 
1.672(f)-1 does not apply to any portion of--
    (i) A nonexempt employees' trust described in section 402(b), 
including a trust created on behalf of a self-employed individual;
    (ii) A trust, including a trust created on behalf of a self-employed 
individual, that would be a nonexempt employees' trust described in 
section 402(b) but for the fact that the trust's assets are not set 
aside from the claims of creditors of the actual or deemed transferor 
within the meaning of Sec. 1.83-3(e); and
    (iii) Any additional category of trust that the Commissioner may 
designate in revenue procedures, notices, or other guidance published in 
the Internal Revenue Bulletin (see Sec. 601.601(d)(2) of this chapter).
    (2) Exceptions. The Commissioner may, in revenue rulings, notices, 
or other guidance published in the Internal Revenue Bulletin (see Sec. 
601.601(d)(2) of this chapter), designate categories of compensatory 
trusts to which the general rule of paragraph (c)(1) of this section 
does not apply.
    (d) Separate accounting for gratuitous transfers to grandfathered 
trusts after September 19, 1995. If a trust that was treated as owned by 
the grantor under section 676 or 677 (other than section 677(a)(3)) on 
September 19, 1995, contains both amounts held in the trust on September 
19, 1995, and amounts that were gratuitously transferred to the

[[Page 365]]

trust after September 19, 1995, paragraphs (a)(3) and (b)(3) of this 
section apply only if the amounts that were gratuitously transferred to 
the trust after September 19, 1995, are treated as a separate portion of 
the trust that is accounted for under the rules of Sec. 1.671-3(a)(2). 
If the amounts that were gratuitously transferred to the trust after 
September 19, 1995 are not so accounted for, the general rule of Sec. 
1.672(f)-1 applies to the entire trust. If such amounts are so accounted 
for, and without regard to whether there is physical separation of the 
assets, the general rule of Sec. 1.672(f)-1 does not apply to the 
portion of the trust that is attributable to amounts that were held in 
the trust on September 19, 1995.
    (e) Effective date. The rules of this section are generally 
applicable to taxable years of a trust beginning after August 10, 1999. 
The initial separate accounting required by paragraph (d) of this 
section must be prepared by the due date (including extensions) for the 
tax return of the trust for the first taxable year of the trust 
beginning after August 10, 1999.

[T.D. 8831, 64 FR 43276, Aug. 10, 1999, as amended by T.D. 8890, 65 FR 
41334, July 5, 2000]



Sec. 1.672(f)-4  Recharacterization of purported gifts.

    (a) In general--(1) Purported gifts from partnerships. Except as 
provided in paragraphs (b), (e), and (f) of this section, and without 
regard to the existence of any trust, if a United States person (United 
States donee) directly or indirectly receives a purported gift or 
bequest (as defined in paragraph (d) of this section) from a 
partnership, the purported gift or bequest must be included in the 
United States donee's gross income as ordinary income.
    (2) Purported gifts from foreign corporations. Except as provided in 
paragraphs (b), (e), and (f) of this section, and without regard to the 
existence of any trust, if a United States donee directly or indirectly 
receives a purported gift or bequest (as defined in paragraph (d) of 
this section) from any foreign corporation, the purported gift or 
bequest must be included in the United States donee's gross income as if 
it were a distribution from the foreign corporation. If the foreign 
corporation is a passive foreign investment company (within the meaning 
of section 1297), the rules of section 1291 apply. For purposes of 
section 1012, the United States donee is not treated as having basis in 
the stock of the foreign corporation. However, for purposes of section 
1223, the United States donee is treated as having a holding period in 
the stock of the foreign corporation on the date of the deemed 
distribution equal to the weighted average of the holding periods of the 
actual interest holders (other than any interest holders who treat the 
portion of the purported gift attributable to their interest in the 
foreign corporation in the manner described in paragraph (b)(1) of this 
section). For purposes of section 902, a United States donee that is a 
domestic corporation is not treated as owning any voting stock of the 
foreign corporation.
    (b) Exceptions--(1) Partner or shareholder treats transfer as 
distribution and gift. Paragraph (a) of this section does not apply to 
the extent the United States donee can demonstrate to the satisfaction 
of the Commissioner that either--
    (i) A United States citizen or resident alien individual who 
directly or indirectly holds an interest in the partnership or foreign 
corporation treated and reported the purported gift or bequest for 
United States tax purposes as a distribution to such individual and a 
subsequent gift or bequest to the United States donee; or
    (ii) A nonresident alien individual who directly or indirectly holds 
an interest in the partnership or foreign corporation treated and 
reported the purported gift or bequest for purposes of the tax laws of 
the nonresident alien individual's country of residence as a 
distribution to such individual and a subsequent gift or bequest to the 
United States donee, and the United States donee timely complied with 
the reporting requirements of section 6039F, if applicable.
    (2) All beneficial owners of domestic partnership are United States 
citizens or residents or domestic corporations. Paragraph (a)(1) of this 
section does not apply to a purported gift or bequest from a domestic 
partnership if the United States donee can demonstrate

[[Page 366]]

to the satisfaction of the Commissioner that all beneficial owners 
(within the meaning of Sec. 1.1441-1(c)(6)) of the partnership are 
United States citizens or residents or domestic corporations.
    (3) Contribution to capital of corporate United States donee. 
Paragraph (a) of this section does not apply to the extent a United 
States donee that is a corporation can establish that the purported gift 
or bequest was treated for United States tax purposes as a contribution 
to the capital of the United States donee to which section 118 applies.
    (4) Charitable transfers. Paragraph (a) of this section does not 
apply if either--
    (i) The United States donee is described in section 170(c); or
    (ii) The transferor has received a ruling or determination letter, 
which has been neither revoked nor modified, from the Internal Revenue 
Service recognizing its exempt status under section 501(c)(3), and the 
transferor made the transfer pursuant to an exempt purpose for which the 
transferor was created or organized. For purposes of the preceding 
sentence, a ruling or determination letter recognizing exemption may not 
be relied upon if there is a material change, inconsistent with 
exemption, in the character, the purpose, or the method of operation of 
the organization.
    (c) Certain transfers from trusts to which a partnership or foreign 
corporation has made a gratuitous transfer--(1) Generally treated as 
distribution from partnership or foreign corporation. Except as provided 
in paragraphs (c)(2) and (3) of this section, if a United States donee 
receives a gratuitous transfer (within the meaning of Sec. 1.671-
2(e)(2)) from a trust (or portion of a trust) to which a partnership or 
foreign corporation has made a gratuitous transfer, the United States 
donee must treat the transfer as a purported gift or bequest from the 
partnership or foreign corporation that is subject to the rules of 
paragraph (a) of this section (including the exceptions in paragraphs 
(b) and (f) of this section). This paragraph (c) applies without regard 
to who is treated as the grantor of the trust (or portion thereof) under 
Sec. 1.671-2(e)(4).
    (2) Alternative rule. Except as provided in paragraph (c)(3) of this 
section, if the United States tax computed under the rules of paragraphs 
(a) and (c)(1) of this section does not exceed the United States tax 
that would be due if the United States donee treated the transfer as a 
distribution from the trust (or portion thereof), paragraph (c)(1) of 
this section does not apply and the United States donee must treat the 
transfer as a distribution from the trust (or portion thereof) that is 
subject to the rules of subparts A through D (section 641 and 
following), part I, subchapter J, chapter 1 of the Internal Revenue 
Code. For purposes of paragraph (f) of this section, the transfer is 
treated as a purported gift or bequest from the partnership or foreign 
corporation that made the gratuitous transfer to the trust (or portion 
thereof).
    (3) Exception. Neither paragraph (c)(1) of this section nor 
paragraph (c)(2) of this section applies to the extent the United States 
donee can demonstrate to the satisfaction of the Commissioner that the 
transfer represents an amount that is, or has been, taken into account 
for United States tax purposes by a United States citizen or resident or 
a domestic corporation. A transfer will be deemed to be made first out 
of amounts that have not been taken into account for United States tax 
purposes by a United States citizen or resident or a domestic 
corporation, unless the United States donee can demonstrate to the 
satisfaction of the Commissioner that another ordering rule is more 
appropriate.
    (d) Definition of purported gift or bequest--(1) In general. Subject 
to the provisions of paragraphs (d)(2) and (3) of this section, a 
purported gift or bequest for purposes of this section is any transfer 
of property by a partnership or foreign corporation other than a 
transfer for fair market value (within the meaning of Sec. 1.671-
2(e)(2)(ii)) to a person who is not a partner in the partnership or a 
shareholder of the foreign corporation (or to a person who is a partner 
in the partnership or a shareholder of a foreign corporation, if the 
amount transferred is inconsistent with the partner's interest in the 
partnership or

[[Page 367]]

the shareholder's interest in the corporation, as the case may be). For 
purposes of this section, the term property includes cash.
    (2) Transfers for less than fair market value--(i) Excess treated as 
purported gift or bequest. Except as provided in paragraph (d)(2)(ii) of 
this section, if a transfer described in paragraph (d)(1) of this 
section is for less than fair market value, the excess of the fair 
market value of the property transferred over the value of the property 
received, services rendered, or the right to use property is treated as 
a purported gift or bequest.
    (ii) Exception for transfers to unrelated parties. No portion of a 
transfer described in paragraph (d)(1) of this section will be treated 
as a purported gift or bequest for purposes of this section if the 
United States donee can demonstrate to the satisfaction of the 
Commissioner that the United States donee is not related to a partner or 
shareholder of the transferor within the meaning of Sec. 1.643(h)-1(e) 
or does not have another relationship with a partner or shareholder of 
the transferor that establishes a reasonable basis for concluding that 
the transferor would make a gratuitous transfer to the United States 
donee.
    (e) Prohibition against affirmative use of recharacterization by 
taxpayers. A taxpayer may not use the rules of this section if a 
principal purpose for using such rules is the avoidance of any tax 
imposed by the Internal Revenue Code. Thus, with respect to such 
taxpayer, the Commissioner may depart from the rules of this section and 
recharacterize (for all purposes of the Internal Revenue Code) the 
transfer in accordance with its form or its economic substance.
    (f) Transfers not in excess of $10,000. This section does not apply 
if, during the taxable year of the United States donee, the aggregate 
amount of purported gifts or bequests that is transferred to such United 
States donee directly or indirectly from all partnerships or foreign 
corporations that are related (within the meaning of section 643(i)) 
does not exceed $10,000. The aggregate amount must include gifts or 
bequests from persons that the United States donee knows or has reason 
to know are related to the partnership or foreign corporation (within 
the meaning of section 643(i)).
    (g) Examples. The following examples illustrate the rules of this 
section. In each example, the amount that is transferred exceeds 
$10,000. The examples are as follows:

    Example 1. Distribution from foreign corporation. FC is a foreign 
corporation that is wholly owned by A, a nonresident alien who is 
resident in Country C. FC makes a gratuitous transfer of property 
directly to A's daughter, B, who is a resident alien. Under paragraph 
(a)(2) of this section, B generally must treat the transfer as a 
dividend from FC to the extent of FC's earnings and profits and as an 
amount received in excess of basis thereafter. If FC is a passive 
foreign investment company, B must treat the amount received as a 
distribution under section 1291. B will be treated as having the same 
holding period as A. However, under paragraph (b)(1)(ii) of this 
section, if B can establish to the satisfaction of the Commissioner 
that, for purposes of the tax laws of Country C, A treated (and 
reported, if applicable) the transfer as a distribution to himself and a 
subsequent gift to B, B may treat the transfer as a gift (provided B 
timely complied with the reporting requirements of section 6039F, if 
applicable).
    Example 2. Distribution of corpus from trust to which foreign 
corporation made gratuitous transfer. FC is a foreign corporation that 
is wholly owned by A, a nonresident alien who is resident in Country C. 
FC makes a gratuitous transfer to a foreign trust, FT, that has no other 
assets. FT immediately makes a gratuitous transfer in the same amount to 
A's daughter, B, who is a resident alien. Under paragraph (c)(1) of this 
section, B must treat the transfer as a transfer from FC that is subject 
to the rules of paragraph (a)(2) of this section. Under paragraph (a)(2) 
of this section, B must treat the transfer as a dividend from FC unless 
she can establish to the satisfaction of the Commissioner that, for 
purposes of the tax laws of Country C, A treated (and reported, if 
applicable) the transfer as a distribution to himself and a subsequent 
gift to B and that B timely complied with the reporting requirements of 
section 6039F, if applicable. The alternative rule in paragraph (c)(2) 
of this section would not apply as long as the United States tax 
computed under the rules of paragraph (a)(2) of this section is equal to 
or greater than the United States tax that would be due if the transfer 
were treated as a distribution from FT.
    Example 3. Accumulation distribution from trust to which foreign 
corporation made gratuitous transfer. FC is a foreign corporation that 
is wholly owned by A, a nonresident

[[Page 368]]

alien. FC is not a passive foreign investment company (as defined in 
section 1297). FC makes a gratuitous transfer of 100X to a foreign 
trust, FT, on January 1, 2001. FT has no other assets on January 1, 
2001. Several years later, FT makes a gratuitous transfer of 1000X to 
A's daughter, B, who is a United States resident. Assume that the 
section 668 interest charge on accumulation distributions will apply if 
the transfer is treated as a distribution from FT. Under the alternative 
rule of paragraph (c)(2) of this section, B must treat the transfer as 
an accumulation distribution from FT, because the resulting United 
States tax liability is greater than the United States tax that would be 
due if the transfer were treated as a transfer from FC that is subject 
to the rules of paragraph (a) of this section.
    Example 4. Transfer from trust that is treated as owned by United 
States citizen. Assume the same facts as in Example 3, except that A is 
a United States citizen. Assume that A treats and reports the transfer 
to FT as a constructive distribution to himself, followed by a 
gratuitous transfer to FT, and that A is properly treated as the grantor 
of FT within the meaning of Sec. 1.671-2(e). A is treated as the owner 
of FT under section 679 and, as required by section 671 and the 
regulations thereunder, A includes all of FT's items of income, 
deductions, and credit in computing his taxable income and credits. 
Neither paragraph (c)(1) nor paragraph (c)(2) of this section is 
applicable, because the exception in paragraph (c)(3) of this section 
applies.
    Example 5. Transfer for less than fair market value. FC is a foreign 
corporation that is wholly owned by A, a nonresident alien. On January 
15, 2001, FC transfers property directly to A's daughter, B, a resident 
alien, in exchange for 90X. The Commissioner later determines that the 
fair market value of the property at the time of the transfer was 100X. 
Under paragraph (d)(2)(i) of this section, 10X will be treated as a 
purported gift to B on January 15, 2001.

    (h) Effective date. The rules of this section are generally 
applicable to any transfer after August 10, 1999, by a partnership or 
foreign corporation, or by a trust to which a partnership or foreign 
corporation makes a gratuitous transfer after August 10, 1999.

[T.D. 8831, 64 FR 43278, Aug. 10, 1999, as amended by T.D. 8890, 65 FR 
41334, July 5, 2000]



Sec. 1.672(f)-5  Special rules.

    (a) Transfers by certain beneficiaries to foreign grantor--(1) In 
general. If, but for section 672(f)(5), a foreign person would be 
treated as the owner of any portion of a trust, any United States 
beneficiary of the trust is treated as the grantor of a portion of the 
trust to the extent the United States beneficiary directly or indirectly 
made transfers of property to such foreign person (without regard to 
whether the United States beneficiary was a United States beneficiary at 
the time of any transfer) in excess of transfers to the United States 
beneficiary from the foreign person. The rule of this paragraph (a) does 
not apply to the extent the United States beneficiary can demonstrate to 
the satisfaction of the Commissioner that the transfer by the United 
States beneficiary to the foreign person was wholly unrelated to any 
transaction involving the trust. For purposes of this paragraph (a), the 
term property includes cash, and a transfer of property does not include 
a transfer that is not a gratuitous transfer (within the meaning of 
Sec. 1.671-2(e)(2)). In addition, a gift is not taken into account to 
the extent such gift would not be characterized as a taxable gift under 
section 2503(b). For a definition of United States beneficiary, see 
section 679.
    (2) Examples. The following examples illustrate the rules of this 
section:

    Example 1. A, a nonresident alien, contributes property to FC, a 
foreign corporation that is wholly owned by A. FC creates a foreign 
trust, FT, for the benefit of A and A's children. FT is revocable by FC 
without the approval or consent of any other person. FC funds FT with 
the property received from A. A and A's family move to the United 
States. Under paragraph (a)(1) of this section, A is treated as a 
grantor of FT. (A may also be treated as an owner of FT under section 
679(a)(4).)
    Example 2. B, a United States citizen, makes a gratuitous transfer 
of $1 million to B's uncle, C, a nonresident alien. C creates a foreign 
trust, FT, for the benefit of B and B's children. FT is revocable by C 
without the approval or consent of any other person. C funds FT with the 
property received from B. Under paragraph (a)(1) of this section, B is 
treated as a grantor of FT. (B also would be treated as an owner of FT 
as a result of section 679.)

    (b) Entity characterization. Entities generally are characterized 
under United States tax principles for purposes of Sec. Sec. 1.672(f)-1 
through 1.672(f)-5. See Sec. Sec. 301.7701-1 through 301.7701-4 of this 
chapter. However, solely for purposes of Sec. 1.672(f)-4, a transferor 
that is

[[Page 369]]

a wholly owned business entity is treated as a corporation, separate 
from its single owner.
    (c) Effective date. The rules in paragraph (a) of this section are 
applicable to transfers to trusts on or after August 10, 1999. The rules 
in paragraph (b) of this section are applicable August 10, 1999.

[T.D. 8831, 64 FR 43280, Aug. 10, 1999, as amended by T.D. 8890, 65 FR 
41334, July 5, 2000]



Sec. 1.673(a)-1  Reversionary interests; income payable to beneficiaries
other than certain charitable organizations; general rule.

    (a) Under section 673(a), a grantor, in general, is treated as the 
owner of any portion of a trust in which he has a reversionary interest 
in either the corpus or income if, as of the inception of that portion 
of the trust, the grantor's interest will or may reasonably be expected 
to take effect in possession or enjoyment within 10 years commencing 
with the date of transfer of that portion of the trust. However, the 
following types of reversionary interests are excepted from the general 
rule of the preceding sentence:
    (1) A reversionary interest after the death of the income 
beneficiary of a trust (see paragraph (b) of this section); and
    (2) Except in the case of transfers in trust made after April 22, 
1969, a reversionary interest in a charitable trust meeting the 
requirements of section 673(b) (see Sec. 1.673(b)-1). Even though the 
duration of the trust may be such that the grantor is not treated as its 
owner under section 673, and therefore is not taxed on the ordinary 
income, he may nevertheless be treated as an owner under section 
677(a)(2) if he has a reversionary interest in the corpus. In the latter 
case, items of income, deduction, and credit allocable to corpus, such 
as capital gains and losses, will be included in the portion he owns. 
See Sec. 1.671-3 and the regulations under section 677. See Sec. 
1.673(d)-1 with respect to a postponement of the date specified for 
reacquisition of a reversionary interest.
    (b) Section 673(c) provides that a grantor is not treated as the 
owner of any portion of a trust by reason of section 673 if his 
reversionary interest in the portion is not to take effect in possession 
or enjoyment until the death of the person or persons to whom the income 
of the portion is regardless of the life expectancies of the income 
beneficiaries. If his reversionary interest is to take effect on or 
after the death of an income beneficiary or upon the expiration of a 
specific term of years, whichever is earlier, the grantor is treated as 
the owner if the specific term of years is less than 10 years (but not 
if the term is 10 years or longer).
    (c) Where the grantor's reversionary interest in a portion of a 
trust is to take effect in possession or enjoyment by reason of some 
event other than the expiration of a specific term of years or the death 
of the income beneficiary, the grantor is treated as the owner of the 
portion if the event may reasonably be expected to occur within 10 years 
from the date of transfer of that portion, but he is not treated as the 
owner under section 673 if the event may not reasonably be expected to 
occur within 10 years from that date. For example, if the reversionary 
interest in any portion of a trust is to take effect on or after the 
death of the grantor (or any person other than the person to whom the 
income is payable) the grantor is treated under section 673 as the owner 
of the portion if the life expectancy of the grantor (or other person) 
is less than 10 years on the date of transfer of the portion, but not if 
the life expectancy is 10 years or longer. If the reversionary interest 
in any portion is to take effect on or after the death of the grantor 
(or any person other than the person to whom the income is payable) or 
upon the expiration of a specific term of years, whichever is earlier, 
the grantor is treated as the owner of the portion if on the date of 
transfer of the portion either the life expectancy of the grantor (or 
other person) or the specific term is less than 10 years; however, if 
both the life expectancy and the specific term are 10 years or longer 
the grantor is not treated as the owner of the portion under section 
673. Similarly, if the grantor has a reversionary interest in any 
portion which will take effect at the death of the income beneficiary or 
the grantor, whichever is earlier, the

[[Page 370]]

grantor is not treated as an owner of the portion unless his life 
expectancy is less than 10 years.
    (d) It is immaterial that a reversionary interest in corpus or 
income is subject to a contingency if the reversionary interest may, 
taking the contingency into consideration, reasonably be expected to 
take effect in possession or enjoyment within 10 years. For example, the 
grantor is taxable where the trust income is to be paid to the grantor's 
son for 3 years, and the corpus is then to be returned to the grantor if 
he survives that period, or to be paid to the grantor's son if he is 
already decreased.
    (e) See section 671 and Sec. Sec. 1.671-2 and 1.671-3 for rules for 
treatment of items of income, deduction, and credit when a person is 
treated as the owner of all or only a portion of a trust.

[T.D. 6500, 25 FR 11814, Nov. 26, 1960, as amended by T.D. 7357, 40 FR 
23742, June 2, 1975]



Sec. 1.673(b)-1  Income payable to charitable beneficiaries before 
amendment by Tax Reform Act of 1969).

    (a) Pursuant to section 673(b) a grantor is not treated as an owner 
of any portion of a trust under section 673, even though he has a 
reversionary interest which will take effect within 10 years, to the 
extent that, under the terms of the trust, the income of the portion is 
irrevocably payable for a period of at least 2 years (commencing with 
the date of the transfer) to a designated beneficiary of the type 
described in section 170(b)(1)(A).
    (b) Income must be irrevocably payable to a designated beneficiary 
for at least 2 years commencing with the date of the transfer before the 
benefit of section 673(b) will apply. Thus, section 673(b) will not 
apply if income of a trust is irrevocably payable to University A for 1 
year and then to University B for the next year; or if income of a trust 
may be allocated among two or more charitable beneficiaries in the 
discretion of the trustee or any other person. On the other hand, 
section 673(b) will apply if half the income of a trust is irrevocably 
payable to University A and the other half is irrevocably payable to 
University B for two years.
    (c) Section 673(b) applies to the period of 2 years or longer during 
which income is paid to a designated beneficiary of the type described 
in section 170(b)(1)(A) (i), (ii), or (iii), even though the trust term 
is to extend beyond that period. However, the other provisions of 
section 673 apply to the part of the trust term, if any, that extends 
beyond that period. This paragraph may be illustrated by the following 
example:

    Example. G transfers property in trust with the ordinary income 
payable to University C (which qualifies under section 170(b)(1)(A)(ii)) 
for 3 years, and then to his son, B, for 5 years. At the expiration of 
the term the trust reverts to G. G is not taxed under section 673 of the 
trust income payable to University C for the first 3 years because of 
the application of section 673(b). However, he is taxed on income for 
the next 5 years because he has a reversionary interest which will take 
effect within 10 years commencing with the date of the transfer. On the 
other hand, if the income were payable to University C for 3 years and 
then to R for 7 years so that the trust corpus would not be returned to 
G within 10 years, G would not be taxable under section 673 on income 
payable to University C and to B during any part of the term.

    (d) This section does not apply to transfers in trust made after 
April 22, 1969.

[T.D. 6500, 25 FR 11814, Nov. 26, 1960, as amended by T.D., 6605, 27 FR 
8097, Aug. 15, 1962; T.D. 7357, 40 FR 23743, June 2, 1975]



Sec. 1.673(c)-1  Reversionary interest after income beneficiary's death.

    The subject matter of section 673(c) is covered in paragraph (b) of 
Sec. 1.673(a)-1.



Sec. 1.673(d)-1  Postponement of date specified for reacquisition.

    Any postponement of the date specified for the reacquisition of 
possession or enjoyment of any reversionary interest is considered a new 
transfer in trust commencing with the date on which the postponement is 
effected and terminating with the date prescribed by the postponement. 
However, the grantor will not be treated as the owner of any portion of 
a trust for any taxable year by reason of the foregoing sentence if he 
would not be so treated in the absence of any postponement. The rules 
contained in this section

[[Page 371]]

may be illustrated by the following example:

    Example. G places property in trust for the benefit of his son B. 
Upon the expiration of 12 years or the earlier death of B the property 
is to be paid over to G or his estate. After the expiration of 9 years G 
extends the term of the trust for an additional 2 years. G is considered 
to have made a new transfer in trust for a term of 5 years (the 
remaining 3 years of the original transfer plus the 2-year extension). 
However, he is not treated as the owner of the trust under section 673 
for the first 3 years of the new term because he would not be so treated 
if the term of the trust had not been extended. G is treated as the 
owner of the trust, however, for the remaining 2 years.



Sec. 1.674(a)-1  Power to control beneficial enjoyment; scope of 
section 674.

    (a) Under section 674, the grantor is treated as the owner of a 
portion of trust if the grantor or a nonadverse party has a power, 
beyond specified limits, to dispose of the beneficial enjoyment of the 
income or corpus, whether the power is a fiduciary power, a power of 
appointment, or any other power. Section 674(a) states in general terms 
that the grantor is treated as the owner in every case in which he or a 
nonadverse party can affect the beneficial enjoyment of a portion of a 
trust, the limitations being set forth as exceptions in subsections (b), 
(c), and (d) of section 674. These exceptions are discussed in detail in 
Sec. Sec. 1.674(b)-1 through 1.674(d)--1. Certain limitations 
applicable to section 674 (b), (c), and (d) are set forth in Sec. 
1.674(d)-2. Section 674(b) describes powers which are excepted 
regardless of who holds them. Section 674(c) describes additional powers 
of trustees which are excepted if at least half the trustees are 
independent, and if the grantor is not a trustee. Section 674(d) 
describes a further power which is excepted if it is held by trustees 
other than the grantor or his spouse (if living with the grantor).
    (b) In general terms the grantor is treated as the owner of a 
portion of a trust if he or a nonadverse party or both has a power to 
dispose of the beneficial enjoyment of the corpus or income unless the 
power is one of the following:
    (1) Miscellaneous powers over either ordinary income or corpus. (i) 
A power that can only affect the beneficial enjoyment of income 
(including capital gains) received after a period of time such that the 
grantor would not be treated as an owner under section 673 if the power 
were a reversionary interest (section 674(b)(2));
    (ii) A testamentary power held by anyone (other than a testamentary 
power held by the grantor over accumulated income) (section 674(b)(3));
    (iii) A power to choose between charitable beneficiaries or to 
affect the manner of their enjoyment of a beneficial interest (section 
674(b)(4));
    (iv) A power to allocate receipts and disbursements between income 
and corpus (section 674(b)(8)).
    (2) Powers of distribution primarily affecting only one beneficiary. 
(i) A power to distribute corpus to or for a current income beneficiary, 
if the distribution must be charged against the share of corpus from 
which the beneficiary may receive income (section 674(b)(5)(B));
    (ii) A power to distribute income to or for a current income 
beneficiary or to accumulate it either (a) if accumulated income must 
either be payable to the beneficiary from whom it was withheld or as 
described in paragraph (b)(6) of Sec. 1.674(b)-1 (section 674(b) (6)); 
(b) if the power is to apply income to the support of a dependent of the 
grantor, and the income is not so applied (section 674(b)(1)); or (c) if 
the beneficiary is under 21 or under a legal disability and accumulated 
income is added to corpus (section 674(b)(7)).
    (3) Powers of distribution affecting more than one beneficiary. A 
power to distribute corpus or income to or among one or more 
beneficiaries or to accumulate income, either (i) if the power is held 
by a trustee or trustees other than the grantor, at least half of whom 
are independent (section 674(c)), or (ii) if the power is limited by a 
reasonably definite standard in the trust instrument, and in the case of 
a power over income, if in addition the power is held by a trustee or 
trustees other than the grantor and the grantor's spouse living with the 
grantor (section 674(b)(5)(A) and (d)). (These powers include both 
powers to ``sprinkle'' income or corpus among current beneficiaries, and 
powers to shift income or corpus between current beneficiaries and

[[Page 372]]

remaindermen; however, certain of the powers described under 
subparagraph (2) of this paragraph can have the latter effect 
incidentally.)
    (c) See section 671 and Sec. Sec. 1.671-2 and 1.671-3 for rules for 
the treatment of income, deductions, and credits when a person is 
treated as the owner of all or only a portion of a trust.



Sec. 1.674(b)-1  Excepted powers exercisable by any person.

    (a) Paragraph (b) (1) through (8) of this section sets forth a 
number of powers which may be exercisable by any person without causing 
the grantor to be treated as an owner of a trust under section 674(a). 
Further, with the exception of powers described in paragraph (b)(1) of 
this section, it is immaterial whether these powers are held in the 
capacity of trustee. It makes no difference under section 674(b) that 
the person holding the power is the grantor, or a related or subordinate 
party (with the qualifications noted in paragraph (b) (1) and (3) of 
this section).
    (b) The exceptions referred to in paragraph (a) of this section are 
as follows (see, however, the limitations set forth in Sec. 1.674(d)-
2):
    (1) Powers to apply income to support of a dependent. Section 
674(b)(1) provides, in effect, that regardless of the general rule of 
section 674(a), the income of a trust will not be considered as taxable 
to the grantor merely because in the discretion of any person (other 
than a grantor who is not acting as a trustee or cotrustee) it may be 
used for the support of a beneficiary whom the grantor is legally 
obligated to support, except to the extent that it is in fact used for 
that purpose. See section 677(b) and the regulations thereunder.
    (2) Powers affecting beneficial enjoyment only after a period. 
Section 674(b)(2) provides an exception to section 674(a) if the 
exercise of a power can only affect the beneficial enjoyment of the 
income of a trust received after a period of time which is such that a 
grantor would not be treated as an owner under section 673 if the power 
were a reversionary interest. See Sec. Sec. 1.673(a)-1 and 1.673(b)-1. 
For example, if a trust created on January 1, 1955, provides for the 
payment of income to the grantor's son, and the grantor reserves the 
power to substitute other beneficiaries of income or corpus in lieu of 
his son on or after January 1, 1965, the grantor is not treated under 
section 674 as the owner of the trust with respect to ordinary income 
received before January 1, 1965. But the grantor will be treated as an 
owner on and after that date unless the power is relinquished. If the 
beginning of the period during which the grantor may substitute 
beneficiaries is postponed, the rules set forth in Sec. 1.673(d)-1 are 
applicable in order to determine whether the grantor should be treated 
as an owner during the period following the postponement.
    (3) Testamentary powers. Under paragraph (3) of section 674(b) a 
power in any person to control beneficial enjoyment exercisable only by 
will does not cause a grantor to be treated as an owner under section 
674(a). However, this exception does not apply to income accumulated for 
testamentary disposition by the grantor or to income which may be 
accumulated for such distribution in the discretion of the grantor or a 
nonadverse party, or both, without the approval or consent of any 
adverse party. For example, if a trust instrument provides that the 
income is to be accumulated during the grantor's life and that the 
grantor may appoint the accumulated income by will, the grantor is 
treated as the owner of the trust. Moreover, if a trust instrument 
provides that the income is payable to another person for his life, but 
the grantor has a testamentary power of appointment over the remainder, 
and under the trust instrument and local law capital gains are added to 
corpus, the grantor is treated as the owner of a portion of the trust 
and capital gains and losses are included in that portion. (See Sec. 
1.671-3.)
    (4) Powers to determine beneficial enjoyment of charitable 
beneficiaries. Under paragraph (4) of section 674(b) a power in any 
person to determine the beneficial enjoyment of corpus or income which 
is irrevocably payable (currently or in the future) for purposes 
specified in section 170(c) (relating to definition of charitable 
contributions) will not cause the grantor to be treated as an

[[Page 373]]

owner under section 674(a). For example, if a grantor creates a trust, 
the income of which is irrevocably payable solely to educational or 
other organizations that qualify under section 170(c), he is not treated 
as an owner under section 674 although he retains the power to allocate 
the income among such organizations.
    (5) Powers to distribute corpus. Paragraph (5) of section 674(b) 
provides an exception to section 674(a) for powers to distribute corpus, 
subject to certain limitations, as follows:
    (i) If the power is limited by a reasonably definite standard which 
is set forth in the trust instrument, it may extend to corpus 
distributions to any beneficiary or beneficiaries or class of 
beneficiaries (whether income beneficiaries or remaindermen) without 
causing the grantor to be treated as an owner under section 674. See 
section 674(b)(5)(A). It is not required that the standard consist of 
the needs and circumstances of the beneficiary. A clearly measurable 
standard under which the holder of a power is legally accountable is 
deemed a reasonably definite standard for this purpose. For instance, a 
power to distribute corpus for the education, support, maintenance, or 
health of the beneficiary; for his reasonable support and comfort; or to 
enable him to maintain his accustomed standard of living; or to meet an 
emergency, would be limited by a reasonably definite standard. However, 
a power to distribute corpus for the pleasure, desire, or happiness of a 
beneficiary is not limited by a reasonably definite standard. The entire 
context of a provision of a trust instrument granting a power must be 
considered in determining whether the power is limited by a reasonably 
definite standard. For example, if a trust instrument provides that the 
determination of the trustee shall be conclusive with respect to the 
exercise or nonexercise of a power, the power is not limited by a 
reasonably definite standard. However, the fact that the governing 
instrument is phrased in discretionary terms is not in itself an 
indication that no reasonably definite standard exists.
    (ii) If the power is not limited by a reasonably definite standard 
set forth in the trust instrument, the exception applies only if 
distributions of corpus may be made solely in favor of current income 
beneficiaries, and any corpus distribution to the current income 
beneficiary must be chargeable against the proportionate part of corpus 
held in trust for payment of income to that beneficiary as if it 
constituted a separate trust (whether or not physically segregated). See 
section 674(b)(5)(B).
    (iii) This subparagraph may be illustrated by the following 
examples:

    Example 1. A trust instrument provides for payment of the income to 
the grantor's two brothers for life, and for payment of the corpus to 
the grantor's nephews in equal shares. The grantor reserves the power to 
distribute corpus to pay medical expenses that may be incurred by his 
brothers or nephews. The grantor is not treated as an owner by reason of 
this power because section 674(b)(5)(A) excepts a power, exercisable by 
any person, to invade corpus for any beneficiary, including a 
remainderman, if the power is limited by a reasonably definite standard 
which is set forth in the trust instrument. However, if the power were 
also exercisable in favor of a person (for example, a sister) who was 
not otherwise a beneficiary of the trust, section 674(b)(5)(A) would not 
be applicable.
    Example 2. The facts are the same as in example 1 except that the 
grantor reserves the power to distribute any part of the corpus to his 
brothers or to his nephews for their happiness. The grantor is treated 
as the owner of the trust. Paragraph (5)(A) of section 674(b) is 
inapplicable because the power is not limited by a reasonably definite 
standard. Paragraph (5)(B) is inapplicable because the power to 
distribute corpus permits a distribution of corpus to persons other than 
current income beneficiaries.
    Example 3. A trust instrument provides for payment of the income to 
the grantor's two adult sons in equal shares for 10 years, after which 
the corpus is to be distributed to his grandchildren in equal shares. 
The grantor reserves the power to pay over to each son up to one-half of 
the corpus during the 10-year period, but any such payment shall 
proportionately reduce subsequent income and corpus payments made to the 
son receiving the corpus. Thus, if one-half of the corpus is paid to one 
son, all the income from the remaining half is thereafter payable to the 
other son. The grantor is not treated as an owner under section 674(a) 
by reason of this power because it qualifies under the exception of 
section 674(b)(5)(B).

    (6) Powers to withhold income temporarily. (i) Section 674(b)(6) 
excepts a power which, in general, enables the holder merely to effect a 
postponement

[[Page 374]]

in the time when the ordinary income is enjoyed by a current income 
beneficiary. Specifically, there is excepted a power to distribute or 
apply ordinary income to or for a current income beneficiary or to 
accumulate the income, if the accumulated income must ultimately be 
payable either:
    (a) To the beneficiary from whom it was withheld, his estate, or his 
appointees (or persons designated by name, as a class, or otherwise as 
alternate takers in default of appointment) under a power of appointment 
held by the beneficiary which does not exclude from the class of 
possible appointees any person other than the beneficiary, his estate, 
his creditors, or the creditors of his estate (section 674(b)(6)(A));
    (b) To the beneficiary from whom it was withheld, or if he does not 
survive a date of distribution which could reasonably be expected to 
occur within his lifetime, to his appointees (or alternate takers in 
default of appointment) under any power of appointment, general or 
special, or if he has no power of appointment to one or more designated 
alternate takers (other than the grantor of the grantor's estate) whose 
shares have been irrevocably specified in the trust instrument (section 
674(b)(6)(A) and the flush material following); or
    (c) On termination of the trust, or in conjunction with a 
distribution of corpus which is augmented by the accumulated income, to 
the current income beneficiaries in shares which have been irrevocably 
specified in the trust instrument, or if any beneficiary does not 
survive a date of distribution which would reasonably be expected to 
occur within his lifetime, to his appointees (or alternate takers in 
default of appointment) under any power of appointment, general or 
special, or if he has no power of appointment to one or more designated 
alternate takers (other than the grantor or the grantor's estate) whose 
shares have been irrevocably specified in the trust instrument (section 
674(b)(6)(B) and the flush material following).

(In the application of (a) of this subdivision, if the accumulated 
income of a trust is ultimately payable to the estate of the current 
income beneficiary or is ultimately payable to his appointees or takers 
in default of appointment, under a power of the type described in (a) of 
this subdivision, it need not be payable to the beneficiary from whom it 
was withheld under any circumstances. Furthermore, if a trust otherwise 
qualifies for the exception in (a) of this subdivision the trust income 
will not be considered to be taxable to the grantor under section 677 by 
reason of the existence of the power of appointment referred to in (a) 
of this subdivision.) In general, the exception in section 674(b)(6) is 
not applicable if the power is in substance one to shift ordinary income 
from one beneficiary to another. Thus, a power will not qualify for this 
exception if ordinary income may be distributed to beneficiary A, or may 
be added to corpus which is ultimately payable to beneficiary B, a 
remainderman who is not a current income beneficiary. However, section 
674(b)(6)(B), and (c) of this subdivision, permit a limited power to 
shift ordinary income among current income beneficiaries, as illustrated 
in example 1 of this subparagraph.
    (ii) The application of section 674(b)(6) may be illustrated by the 
following examples:

    Example 1. A trust instrument provides that the income shall be paid 
in equal shares to the grantor's two adult daughters but the grantor 
reserves the power to withhold from either beneficiary any part of that 
beneficiary's share of income and to add it to the corpus of the trust 
until the younger daughter reaches the age of 30 years. When the younger 
daughter reaches the age of 30, the trust is to terminate and the corpus 
is to be divided equally between the two daughters or their estates. 
Although exercise of this power may permit the shifting of accumulated 
income from one beneficiary to the other (since the corpus with the 
accumulations is to be divided equally) the power is excepted under 
section 674(b)(6)(B) and subdivision (i)(c) of this subparagraph.
    Example 2. The facts are the same as in example 1, except that the 
grantor of the trust reserves the power to distribute accumulated income 
to the beneficiaries in such shares as he chooses. The combined powers 
are not excepted by section 674(b)(6)(B) since income accumulated 
pursuant to the first power is neither required to be payable only in 
conjunction with a corpus distribution nor required to be payable in 
shares specified in the trust instrument. See, however, section 674(c) 
and Sec. 1.674(c)-1 for the effect of such a power if it is exercisable 
only by independent trustees.

[[Page 375]]

    Example 3. A trust provides for payment of income to the grantor's 
adult son with the grantor retaining the power to accumulate the income 
until the grantor's death, when all accumulations are to be paid to the 
son. If the son predeceases the grantor, all accumulations are, at the 
death of the grantor, to be paid to his daughter, or if she is not 
living, to alternate takers (which do not include the grantor's estate) 
in specified shares. The power is excepted under section 674(b)(6)(A) 
since the date of distribution (the date of the grantor's death) may, in 
the usual case, reasonably be expected to occur during the beneficiary's 
(the son's) lifetime. It is not necessary that the accumulations be 
payable to the son's estate or his appointees if he should predecease 
the grantor for this exception to apply.

    (7) Power to withhold income during disability. Section 674(b)(7) 
provides an exception for a power which, in general, will permit 
ordinary income to be withheld during the legal disability of an income 
beneficiary or while he is under 21. Specifically, there is excepted a 
power, exercisable only during the existence of a legal disability of 
any current income beneficiary or the period during which any income 
beneficiary is under the age of 21 years, to distribute or apply 
ordinary income to or for that beneficiary or to accumulate the income 
and add it to corpus. To qualify under this exception it is not 
necessary that the income ultimately be payable to the income 
beneficiary from whom it was withheld, his estate, or his appointees; 
that is, the accumulated income may be added to corpus and ultimately 
distributed to others. For example, the grantor is not treated as an 
owner under section 674 if the income of a trust is payable to his son 
for life, remainder to his grandchildren, although he reserves the power 
to accumulate income and add it to corpus while his son is under 21.
    (8) Powers to allocate between corpus and income. Paragraph (8) of 
section 674(b) provides that a power to allocate receipts and 
disbursements between corpus and income, even though expressed in broad 
language, will not cause the grantor to be treated as an owner under the 
general rule of section 674(a).



Sec. 1.674(c)-1  Excepted powers exercisable only by independent trustees.

    Section 674(c) provides an exception to the general rule of section 
674(a) for certain powers that are exercisable by independent trustees. 
This exception is in addition to those provided for under section 674(b) 
which may be held by any person including an independent trustee. The 
powers to which section 674(c) apply are powers (a) to distribute, 
apportion, or accumulate income to or for a beneficiary or 
beneficiaries, or to, for, or within a class of beneficiaries, or (b) to 
pay out corpus to or for a beneficiary or beneficiaries or to or for a 
class of beneficiaries (whether or not income beneficiaries). In order 
for such a power to fall within the exception of section 674(c) it must 
be exercisable solely (without the approval or consent of any other 
person) by a trustee or trustees none of whom is the grantor and no more 
than half of whom are related or subordinate parties who are subservient 
to the wishes of the grantor. (See section 672(c) for definitions of 
these terms.) An example of the application of section 674(c) is a trust 
whose income is payable to the grantor's three adult sons with power in 
an independent trustee to allocate without restriction the amounts of 
income to be paid to each son each year. Such a power does not cause the 
grantor to be treated as the owner of the trust. See however, the 
limitations set forth in Sec. 1.674(d)-2.



Sec. 1.674(d)-1  Excepted powers exercisable by any trustee other than
grantor or spouse.

    Section 674(d) provides an additional exception to the general rule 
of section 674(a) for a power to distribute, apportion, or accumulate 
income to or for a beneficiary or beneficiaries or to, for, or within a 
class of beneficiaries, whether or not the conditions of section 674(b) 
(6) or (7) are satisfied, if the power is solely exercisable (without 
the approval or consent of any other person) by a trustee or trustees 
none of whom is the grantor or spouse living with the grantor, and if 
the power is limited by a reasonably definite external standard set 
forth in the trust instrument (see paragraph (b)(5) of

[[Page 376]]

Sec. 1.674(b)-1 with respect to what constitutes a reasonably definite 
standard). See, however, the limitations set forth in Sec. 1.674(d)-2.



Sec. 1.674(d)-2  Limitations on exceptions in section 674 (b), (c), 
and (d).

    (a) Power to remove trustee. A power in the grantor to remove, 
substitute, or add trustees (other than a power exercisable only upon 
limited conditions which do not exist during the taxable year, such as 
the death or resignation of, or breach of fiduciary duty by, an existing 
trustee) may prevent a trust from qualifying under section 674 (c) or 
(d). For example, if a grantor has an unrestricted power to remove an 
independent trustee and substitute any person including himself as 
trustee, the trust will not qualify under section 674 (c) or (d). On the 
other hand if the grantor's power to remove, substitute, or add trustees 
is limited so that its exercise could not alter the trust in a manner 
that would disqualify it under section 674 (c) or (d), as the case may 
be, the power itself does not disqualify the trust. Thus, for example, a 
power in the grantor to remove or discharge an independent trustee on 
the condition that he substitute another independent trustee will not 
prevent a trust from qualifying under section 674(c).
    (b) Power to add beneficiaries. The exceptions described in section 
674 (b) (5), (6), and (7), (c), and (d), are not applicable if any 
person has a power to add to the beneficiary or beneficiaries or to a 
class of beneficiaries designated to receive the income or corpus, 
except where the action is to provide for after-born or after-adopted 
children. This limitation does not apply to a power held by a 
beneficiary to substitute other beneficiaries to succeed to his interest 
in the trust (so that he would be an adverse party as to the exercise or 
nonexercise of that power). For example, the limitation does not apply 
to a power in a beneficiary of a nonspendthrift trust to assign his 
interest. Nor does the limitation apply to a power held by any person 
which would qualify as an exception under section 674(b)(3) (relating to 
testamentary powers).



Sec. 1.675-1  Administrative powers.

    (a) General rule. Section 675 provides in effect that the grantor is 
treated as the owner of any portion of a trust if under the terms of the 
trust instrument or circumstances attendant on its operation 
administrative control is exercisable primarily for the benefit of the 
grantor rather than the beneficiaries of the trust. If a grantor retains 
a power to amend the administrative provisions of a trust instrument 
which is broad enough to permit an amendment causing the grantor to be 
treated as the owner of a portion of the trust under section 675, he 
will be treated as the owner of the portion from its inception. See 
section 671 and Sec. Sec. 1.671-2 and 1.671-3 for rules for treatment 
of items of income, deduction, and credit when a person is treated as 
the owner of all or only a portion of a trust.
    (b) Prohibited controls. The circumstances which cause 
administrative controls to be considered exercisable primarily for the 
benefit of the grantor are specifically described in paragraphs (1) 
through (4) of section 675 as follows:
    (1) The existence of a power, exercisable by the grantor or a 
nonadverse party, or both, without the approval or consent of any 
adverse party, which enables the grantor or any other person to 
purchase, exchange, or otherwise deal with or dispose of the corpus or 
the income of the trust for less than adequate consideration in money or 
money's worth. Whether the existence of the power itself will constitute 
the holder an adverse party will depend on the particular circumstances.
    (2) The existence of a power exercisable by the grantor or a 
nonadverse party, or both, which enables the grantor to borrow the 
corpus or income of the trust, directly or indirectly, without adequate 
interest or adequate security. However, this paragraph does not apply 
where a trustee (other than the grantor acting alone) is authorized 
under a general lending power to make loans to any person without regard 
to interest or security. A general lending power in the grantor, acting 
alone as trustee, under which he has power to

[[Page 377]]

determine interest rates and the adequacy of security is not in itself 
an indication that the grantor has power to borrow the corpus or income 
without adequate interest or security.
    (3) The circumstance that the grantor has directly or indirectly 
borrowed the corpus or income of the trust and has not completely repaid 
the loan, including any interest, before the beginning of the taxable 
year. The preceding sentence does not apply to a loan which provides for 
adequate interest and adequate security, if it is made by a trustee 
other than the grantor or a related or subordinate trustee subservient 
to the grantor. See section 672(c) for definition of ``a related or 
subordinate party''.
    (4) The existence of certain powers of administration exercisable in 
a nonfiduciary capacity by any nonadverse party without the approval or 
consent of any person in a fiduciary capacity. The term powers of 
administration means one or more of the following powers:
    (i) A power to vote or direct the voting of stock or other 
securities of a corporation in which the holdings of the grantor and the 
trust are significant from the viewpoint of voting control;
    (ii) A power to control the investment of the trust funds either by 
directing investments or reinvestments, or by vetoing proposed 
investments or reinvestments, to the extent that the trust funds consist 
of stocks or securities of corporations in which the holdings of the 
grantor and the trust are significant from the viewpoint of voting 
control; or
    (iii) A power to reacquire the trust corpus by substituting other 
property of an equivalent value.

If a power is exercisable by a person as trustee, it is presumed that 
the power is exercisable in a fiduciary capacity primarily in the 
interests of the beneficiaries. This presumption may be rebutted only by 
clear and convincing proof that the power is not exercisable primarily 
in the interests of the beneficiaries. If a power is not exercisable by 
a person as trustee, the determination of whether the power is 
exercisable in a fiduciary or a nonfiduciary capacity depends on all the 
terms of the trust and the circumstances surrounding its creation and 
administration.
    (c) Authority of trustee. The mere fact that a power exercisable by 
a trustee is described in broad language does not indicate that the 
trustee is authorized to purchase, exchange, or otherwise deal with or 
dispose of the trust property or income for less than an adequate and 
full consideration in money or money's worth, or is authorized to lend 
the trust property or income to the grantor without adequate interest. 
On the other hand, such authority may be indicated by the actual 
administration of the trust.



Sec. 1.676(a)-1  Power to revest title to portion of trust property in
grantor; general rule.

    If a power to revest in the grantor title to any portion of a trust 
is exercisable by the grantor or a nonadverse party, or both, without 
the approval or consent of an adverse party, the grantor is treated as 
the owner of that portion, except as provided in section 676(b) 
(relating to powers affecting beneficial enjoyment of income only after 
the expiration of certain periods of time). If the title to a portion of 
the trust will revest in the grantor upon the exercise of a power by the 
grantor or a nonadverse party, or both, the grantor is treated as the 
owner of that portion regardless of whether the power is a power to 
revoke, to terminate, to alter or amend, or to appoint. See section 671 
and Sec. Sec. 1.671-2 and 1.671-3 for rules for treatment of items of 
income, deduction, and credit when a person is treated as the owner of 
all or only a portion of a trust.



Sec. 1.676(b)-1  Powers exercisable only after a period of time.

    Section 676(b) provides an exception to the general rule of section 
676(a) when the exercise of a power can only affect the beneficial 
enjoyment of the income of a trust received after the expiration of a 
period of time which is such that a grantor would not be treated as the 
owner of that portion, except as power were a reversionary interest. See 
Sec. Sec. 1.673(a)-1 and 1.673(b)-1. Thus, for example, a grantor is 
excepted from the general rule of section 676(a) with

[[Page 378]]

respect to ordinary income if exercise of a power to revest corpus in 
him cannot affect the beneficial enjoyment of the income received within 
10 years after the date of transfer of that portion of the trust. It is 
immaterial for this purpose that the power is vested at the time of the 
transfer. However, the grantor is subject to the general rule of section 
676(a) after the expiration of the period unless the power is 
relinquished. Thus, in the above example, the grantor may be treated as 
the owner and be taxed on all income in the eleventh and succeeding 
years if exercise of the power can affect beneficial enjoyment of income 
received in those years. If the beginning of the period during which the 
grantor may revest is postponed, the rules set forth in Sec. 1.673(d)-1 
are applicable to determine whether the grantor should be treated as an 
owner during the period following the postponement.



Sec. 1.677(a)-1  Income for benefit of grantor; general rule.

    (a)(1) Scope. Section 677 deals with the treatment of the grantor of 
a trust as the owner of a portion of the trust because he has retained 
an interest in the income from that portion. For convenience, 
``grantor'' and ``spouse'' are generally referred to in the masculine 
and feminine genders, respectively, but if the grantor is a woman the 
reference to ``grantor'' is to her and the reference to ``spouse'' is to 
her husband. Section 677 also deals with the treatment of the grantor of 
a trust as the owner of a portion of the trust because the income from 
property transferred in trust after October 9, 1969, is, or may be, 
distributed to his spouse or applied to the payment of premiums on 
policies of insurance on the life of his spouse. However, section 677 
does not apply when the income of a trust is taxable to a grantor's 
spouse under section 71 (relating to alimony and separate maintenance 
payments) or section 682 (relating to income of an estate or trust in 
case of divorce, etc.). See section 671-1(b).
    (2) Cross references. See section 671 and Sec. Sec. 1.671-2 and 
1.671-3 for rules for treatment of items of income, deduction, and 
credit when a person is treated as the owner of all or a portion of a 
trust.
    (b) Income for benefit of grantor or his spouse; general rule--(1) 
Property transferred in trust prior to October 10, 1969. With respect to 
property transferred in trust prior to October 10, 1969, the grantor is 
treated, under section 677, in any taxable year as the owner (whether or 
not he is treated as an owner under section 674) of a portion of a trust 
of which the income for the taxable year or for a period not within the 
exception described in paragraph (e) of this section is, or in the 
discretion of the grantor or a nonadverse party, or both (without the 
approval or consent of any adverse party) may be:
    (i) Distributed to the grantor;
    (ii) Held or accumulated for future distribution to the grantor; or
    (iii) Applied to the payment of premiums on policies of insurance on 
the life of the grantor, except policies of insurance irrevocably 
payable for a charitable purpose specified in section 170(c).
    (2) Property transferred in trust after October 9, 1969. With 
respect to property transferred in trust after October 9, 1969, the 
grantor is treated, under section 677, in any taxable year as the owner 
(whether or not he is treated as an owner under section 674) of a 
portion of a trust of which the income for the taxable year or for a 
period not within the exception described in paragraph (e) of this 
section is, or in the discretion of the grantor, or his spouse, or a 
nonadverse party, or any combination thereof (without the approval or 
consent of any adverse party other than the grantor's spouse) may be:
    (i) Distributed to the grantor or the grantor's spouse;
    (ii) Held or accumulated for future distribution to the grantor or 
the grantor's spouse; or
    (iii) Applied to the payment of premiums on policies of insurance on 
the life of the grantor or the grantor's spouse, except policies of 
insurance irrevocably payable for a charitable purpose specified in 
section 170(c).

With respect to the treatment of a grantor as the owner of a portion of 
a trust solely because its income is, or

[[Page 379]]

may be, distributed or held or accumulated for future distribution to a 
beneficiary who is his spouse or applied to the payment of premiums for 
insurance on the spouse's life, section 677(a) applies to the income of 
a trust solely during the period of the marriage of the grantor to a 
beneficiary. In the case of divorce or separation, see sections 71 and 
682 and the regulations thereunder.
    (c) Constructive distribution; cessation of interest. Under section 
677 the grantor is treated as the owner of a portion of a trust if he 
has retained any interest which might, without the approval or consent 
of an adverse party, enable him to have the income from that portion 
distributed to him at some time either actually or constructively 
(subject to the exception described in paragraph (e) of this section). 
In the case of a transfer in trust after October 9, 1969, the grantor is 
also treated as the owner of a portion of a trust if he has granted or 
retained any interest which might, without the approval or consent of an 
adverse party (other than the grantor's spouse), enable his spouse to 
have the income from the portion at some time, whether or not within the 
grantor's lifetime, distributed to the spouse either actually or 
constructively. See paragraph (b)(2) of this section for additional 
rules relating to the income of a trust prior to the grantor's marriage 
to a beneficiary. Constructive distribution to the grantor or to his 
spouse includes payment on behalf of the grantor or his spouse to 
another in obedience to his or her direction and payment of premiums 
upon policies of insurance on the grantor's, or his spouse's, life 
(other than policies of insurance irrevocably payable for charitable 
purposes specified in section 170(c)). If the grantor (in the case of 
property transferred prior to Oct. 10, 1969) or the grantor and his 
spouse (in the case of property transferred after Oct. 9, 1969) are 
divested permanently and completely of every interest described in this 
paragraph, the grantor is not treated as an owner under section 677 
after that divesting. The word ``interest'' as used in this paragraph 
does not include the possibility that the grantor or his spouse might 
receive back from a beneficiary an interest in a trust by inheritance. 
Further, with respect to transfers in trust prior to October 10, 1969, 
the word ``interest'' does not include the possibility that the grantor 
might receive back from a beneficiary an interest in a trust as a 
surviving spouse under a statutory right of election or a similar right.
    (d) Discharge of legal obligation of grantor or his spouse. Under 
section 677 a grantor is, in general, treated as the owner of a portion 
of a trust whose income is, or in the discretion of the grantor or a 
nonadverse party, or both, may be applied in discharge of a legal 
obligation of the grantor (or his spouse in the case of property 
transferred in trust by the grantor after October 9, 1969). However, see 
Sec. 1.677(b)-1 for special rules for trusts whose income may not be 
applied for the discharge of any legal obligation of the grantor or the 
grantor's spouse other than the support or maintenance of a beneficiary 
(other than the grantor's spouse) whom the grantor or grantor's spouse 
is legally obligated to support. See Sec. 301.7701-4(e) of this chapter 
for rules on the classification of and application of section 677 to an 
environmental remediation trust.
    (e) Exception for certain discretionary rights affecting income. The 
last sentence of section 677(a) provides that a grantor shall not be 
treated as the owner when a discretionary right can only affect the 
beneficial enjoyment of the income of a trust received after a period of 
time during which a grantor would not be treated as an owner under 
section 673 if the power were a reversionary interest. See Sec. Sec. 
1.673(a)-1 and 1.673(b)-1. For example, if the ordinary income of a 
trust is payable to B for 10 years and then in the grantor's discretion 
income or corpus may be paid to B or to the grantor (or his spouse in 
the case of property transferred in trust by the grantor after October 
9, 1969), the grantor is not treated as an owner with respect to the 
ordinary income under section 677 during the first 10 years. He will be 
treated as an owner under section 677 after the expiration of the 10-
year period unless the power is relinquished. If the beginning of the 
period during which the grantor may substitute beneficiaries is 
postponed, the

[[Page 380]]

rules set forth in Sec. 1.673(d)-1 are applicable in determining 
whether the grantor should be treated as an owner during the period 
following the postponement.
    (f) Accumulation of income. If income is accumulated in any taxable 
year for future distribution to the grantor (or his spouse in the case 
of property transferred in trust by the grantor after Oct. 9, 1969), 
section 677(a)(2) treats the grantor as an owner for that taxable year. 
The exception set forth in the last sentence of section 677(a) does not 
apply merely because the grantor (or his spouse in the case of property 
transferred in trust by the grantor after Oct. 9, 1969) must await the 
expiration of a period of time before he or she can receive or exercise 
discretion over previously accumulated income of the trust, even though 
the period is such that the grantor would not be treated as an owner 
under section 673 if a reversionary interest were involved. Thus, if 
income (including capital gains) of a trust is to be accumulated for 10 
years and then will be, or at the discretion of the grantor, or his 
spouse in the case of property transferred in trust after October 9, 
1969, or a nonadverse party, may be, distributed to the grantor (or his 
spouse in the case of property transferred in trust after Oct. 9, 1969), 
the grantor is treated as the owner of the trust from its inception. If 
income attributable to transfers after October 9, 1969 is accumulated in 
any taxable year during the grantor's lifetime for future distribution 
to his spouse, section 677(a)(2) treats the grantor as an owner for that 
taxable year even though his spouse may not receive or exercise 
discretion over such income prior to the grantor's death.
    (g) Examples. The application of section 677(a) may be illustrated 
by the following examples:

    Example 1. G creates an irrevocable trust which provides that the 
ordinary income is to be payable to him for life and that on his death 
the corpus shall be distributed to B, an unrelated person. Except for 
the right to receive income, G retains no right or power which would 
cause him to be treated as an owner under sections 671 through 677. 
Under the applicable local law capital gains must be applied to corpus. 
During the taxable year 1970 the trust has the following items of gross 
income and deductions:

Dividends.........................................................$5,000
Capital gain.......................................................1,000
Expenses allocable to income.........................................200
Expenses allocable to corpus.........................................100


Since G has a right to receive income he is treated as an owner of a 
portion of the trust under section 677. Accordingly, he should include 
the $5,000 of dividends, $200 income expense, and $100 corpus expense in 
the computation of his taxable income for 1970. He should not include 
the $1,000 capital gain since that is not attributable to the portion of 
the trust that he owns. See Sec. 1.671-3(b). The tax consequences of 
the capital gain are governed by the provisions of subparts A, B, C, and 
D (section 641 and following), part I, subchapter J, chapter 1 of the 
Code. Had the trust sustained a capital loss in any amount the loss 
would likewise not be included in the computation of G's taxable income, 
but would also be governed by the provisions of such subparts.
    Example 2. G creates a trust which provides that the ordinary income 
is payable to his adult son. Ten years and one day from the date of 
transfer or on the death of his son, whichever is earlier, corpus is to 
revert to G. In addition, G retains a discretionary right to receive 
$5,000 of ordinary income each year. (Absent the exercise of this right 
all the ordinary income is to be distributed to his son.) G retained no 
other right or power which would cause him to be treated as an owner 
under subpart E (section 671 and following). Under the terms of the 
trust instrument and applicable local law capital gains must be applied 
to corpus. During the taxable year 1970 the trust had the following 
items of income and deductions:

Dividends........................................................$10,000
Capital gain.......................................................2,000
Expenses allocable to income.........................................400
Expenses allocable to corpus.........................................200


Since the capital gain is held or accumulated for future distributions 
to G, he is treated under section 677(a)(2) as an owner of a portion of 
the trust to which the gain is attributable. See Sec. 1.671-3(b).
    Therefore, he must include the capital gain in the computation of 
his taxable income. (Had the trust sustained a capital loss in any 
amount, G would likewise include that loss in the computation of his 
taxable income.) In addition, because of G's discretionary right 
(whether exercised or not) he is treated as the owner of a portion of 
the trust which will permit a distribution of income to him of $5,000. 
Accordingly, G includes dividends of $5,208.33 and income expenses of 
$208.33 in computing his taxable income, determined in the following 
manner:

Total dividends...........................................    $10,000.00
Less: Expenses allocable to income........................        400.00
                                                           -------------
    Distributable income of the trust.....................      9,600.00
                                                           =============

[[Page 381]]

 
Portion of dividends attributable to G (5,000/                  5,208.33
 9,600x$10,000)...........................................
Portion of income expenses attributable to G (5,000/9,600x        208.33
 $400)....................................................
                                                           -------------
    Amount of income subject to discretionary right.......      5,000.00
 

In accordance with Sec. 1.671-3(c), G also takes into account $104.17 
(5,000/9,600x$200) of corpus expenses in computing his tax liability. 
The portion of the dividends and expenses of the trust not attributable 
to G are governed by the provisions of subparts A through D.

[T.D. 7148, 36 FR 20749, Oct. 29, 1971, as amended by T.D. 8668, 61 FR 
19191, May 1, 1996]



Sec. 1.677(b)-1  Trusts for support.

    (a) Section 677(b) provides that a grantor is not treated as the 
owner of a trust merely because its income may in the discretion of any 
person other than the grantor (except when he is acting as trustee or 
cotrustee) be applied or distributed for the support or maintenance of a 
beneficiary (other than the grantor's spouse in the case of income from 
property transferred in trust after October 9, 1969), such as the child 
of the grantor, whom the grantor or his spouse is legally obligated to 
support. If income of the current year of the trust is actually so 
applied or distributed the grantor may be treated as the owner of any 
portion of the trust under section 677 to that extent, even though it 
might have been applied or distributed for other purposes. In the case 
of property transferred to a trust before October 10, 1969, for the 
benefit of the grantor's spouse, the grantor may be treated as the owner 
to the extent income of the current year is actually applied for the 
support or maintenance of his spouse.
    (b) If any amount applied or distributed for the support of a 
beneficiary, including the grantor's spouse in the case of property 
transferred in trust before October 10, 1969, whom the grantor is 
legally obligated to support is paid out of corpus or out of income 
other than income of the current year, the grantor is treated as a 
beneficiary of the trust, and the amount applied or distributed is 
considered to be an amount paid within the meaning of section 661(a)(2), 
taxable to the grantor under section 662. Thus, he is subject to the 
other relevant portions of subparts A through D (section 641 and 
following), part I, subchapter J, chapter 1 of the Code. Accordingly, 
the grantor may be taxed on an accumulation distribution or a capital 
gain distribution under subpart D (section 665 and following) of such 
part I. Those provisions are applied on the basis that the grantor is 
the beneficiary.
    (c) For the purpose of determining the items of income, deduction, 
and credit of a trust to be included under this section in computing the 
grantor's tax liability, the income of the trust for the taxable year of 
distribution will be deemed to have been first distributed. For example, 
in the case of a trust reporting on the calendar year basis, a 
distribution made on January 1, 1956, will be deemed to have been made 
out of ordinary income of the trust for the calendar year 1956 to the 
extent of the income for that year even though the trust had received no 
income as of January 1, 1956. Thus, if a distribution of $10,000 is made 
on January 1, 1956, for the support of the grantor's dependent, the 
grantor will be treated as the owner of the trust for 1956 to that 
extent. If the trust received dividends of $5,000 and incurred expenses 
of $1,000 during that year but subsequent to January 1, he will take 
into account dividends of $5,000 and expenses of $1,000 in computing his 
tax liability for 1956. In addition, the grantor will be treated as a 
beneficiary of the trust with respect to the $6,000 ($10,000 less 
distributable income of $4,000 (dividends of $5,000 less expenses of 
$1,000)) paid out of corpus or out of other than income of the current 
year. See paragraph (b) of this section.
    (d) The exception provided in section 677(b) relates solely to the 
satisfaction of the grantor's legal obligation to support or maintain a 
beneficiary. Consequently, the general rule of section 677(a) is 
applicable when in the discretion of the grantor or nonadverse parties 
income of a trust may be applied in discharge of a grantor's obligations 
other than his obligation of support or maintenance falling within 
section 677(b). Thus, if the grantor creates a trust the income of which 
may in the discretion of a nonadverse party be applied in the payment of 
the grantor's debts, such as the payment of his rent or other household 
expenses, he is

[[Page 382]]

treated as an owner of the trust regardless of whether the income is 
actually so applied.
    (e) The general rule of section 677(a), and not section 677(b), is 
applicable if discretion to apply or distribute income of a trust rests 
solely in the grantor, or in the grantor in conjunction with other 
persons, unless in either case the grantor has such discretion as 
trustee or cotrustee.
    (f) The general rule of section 677(a), and not section 677(b), is 
applicable to the extent that income is required, without any 
discretionary determination, to be applied to the support of a 
beneficiary whom the grantor is legally obligated to support.

[T.D. 6500, 25 FR 11814, Nov. 26, 1960, as amended by T.D. 7148, 36 FR 
20750, Oct. 29, 1971]



Sec. 1.678(a)-1  Person other than grantor treated as substantial
owner; general rule.

    (a) Where a person other than the grantor of a trust has a power 
exercisable solely by himself to vest the corpus or the income of any 
portion of a testamentary or inter vivos trust in himself, he is treated 
under section 678(a) as the owner of that portion, except as provided in 
section 678(b) (involving taxation of the grantor) and section 678(c) 
(involving and obligation of support). The holder of such a power also 
is treated as an owner of the trust even though he has partially 
released or otherwise modified the power so that he can no longer vest 
the corpus or income in himself, if he has retained such control of the 
trust as would, if retained by a grantor, subject the grantor to 
treatment as the owner under sections 671 to 677, inclusive. See section 
671 and Sec. Sec. 1.671-2 and 1.671-3 for rules for treatment of items 
of income, deduction, and credit where a person is treated as the owner 
of all or only a portion of a trust.
    (b) Section 678(a) treats a person as an owner of a trust if he has 
a power exercisable solely by himself to apply the income or corpus for 
the satisfaction of his legal obligations, other than an obligation to 
support a dependent (see Sec. 1.678(c)-1 subject to the limitation of 
section 678(b). Section 678 does not apply if the power is not 
exercisable solely by himself. However, see Sec. 1.662(a)-4 for 
principles applicable to income of a trust which, pursuant to the terms 
of the trust instrument, is used to satisfy the obligations of a person 
other than the grantor.



Sec. 1.678(b)-1  If grantor is treated as the owner.

    Section 678(a) does not apply with respect to a power over income, 
as originally granted or thereafter modified, if the grantor of the 
trust is treated as the owner under sections 671 to 677, inclusive.



Sec. 1.678(c)-1  Trusts for support.

    (a) Section 678(a) does not apply to a power which enables the 
holder, in the capacity of trustee or cotrustee, to apply the income of 
the trust to the support or maintenance of a person whom the holder is 
obligated to support, except to the extent the income is so applied. See 
paragraphs (a), (b), and (c) of Sec. 1.677(b)-1 for applicable 
principles where any amount is applied for the support or maintenance of 
a person whom the holder is obligated to support.
    (b) The general rule in section 678(a) (and not the exception in 
section 678(c)) is applicable in any case in which the holder of a power 
exercisable solely by himself is able, in any capacity other than that 
of trustee or cotrustee, to apply the income in discharge of his 
obligation of support or maintenance.
    (c) Section 678(c) is concerned with the taxability of income 
subject to a power described in section 678(a). It has no application to 
the taxability of income which is either required to be applied pursuant 
to the terms of the trust instrument or is applied pursuant to a power 
which is not described in section 678(a), the taxability of such income 
being governed by other provisions of the Code. See Sec. 1.662(a)-4.



Sec. 1.678(d)-1  Renunciation of power.

    Section 678(a) does not apply to a power which has been renounced or 
disclaimed within a reasonable time after the holder of the power first 
became aware of its existence.

[[Page 383]]



Sec. 1.679-0  Outline of major topics.

    This section lists the major paragraphs contained in Sec. Sec. 
1.679-1 through 1.679-7 as follows:

    Sec. 1.679-1 U.S. transferor treated as owner of foreign trust.

    (a) In general.
    (b) Interaction with sections 673 through 678.
    (c) Definitions.
    (1) U.S. transferor.
    (2) U.S. person.
    (3) Foreign trust.
    (4) Property.
    (5) Related person.
    (6) Obligation.
    (d) Examples.

       Sec. 1.679-2 Trusts treated as having a U.S. beneficiary.

    (a) Existence of U.S. beneficiary.
    (1) In general.
    (2) Benefit to a U.S. person
    (i) In general.
    (ii) Certain unexpected beneficiaries.
    (iii) Examples.
    (3) Changes in beneficiary's status.
    (i) In general.
    (ii) Examples.
    (4) General rules.
    (i) Records and documents.
    (ii) Additional factors.
    (iii) Examples.
    (b) Indirect U.S. beneficiaries.
    (1) Certain foreign entities.
    (2) Other indirect beneficiaries.
    (3) Examples.
    (c) Treatment of U.S. transferor upon foreign trust's acquisition or 
loss of U.S. beneficiary.
    (1) Trusts acquiring a U.S. beneficiary.
    (2) Trusts ceasing to have a U.S. beneficiary.
    (3) Examples.

                        Sec. 1.679-3 Transfers.

    (a) In general.
    (b) Transfers by certain trusts.
    (1) In general.
    (2) Example.
    (c) Indirect transfers.
    (1) Principal purpose of tax avoidance.
    (2) Principal purpose of tax avoidance deemed to exist.
    (3) Effect of disregarding intermediary.
    (i) In general.
    (ii) Special rule.
    (iii) Effect on intermediary.
    (4) Related parties.
    (5) Examples.
    (d) Constructive transfers.
    (1) In general.
    (2) Examples.
    (e) Guarantee of trust obligations.
    (1) In general.
    (2) Amount transferred.
    (3) Principal repayments.
    (4) Guarantee.
    (5) Examples.
    (f) Transfers to entities owned by a foreign trust.
    (1) General rule.
    (2) Examples.

                Sec. 1.679-4 Exceptions to general rule.

    (a) In general.
    (b) Transfers for fair market value.
    (1) In general.
    (2) Special rule.
    (i) Transfers for partial consideration.
    (ii) Example.
    (c) Certain obligations not taken into account.
    (d) Qualified obligations.
    (1) In general.
    (2) Additional loans.
    (3) Obligations that cease to be qualified.
    (4) Transfers resulting from failed qualified obligations.
    (5) Renegotiated loans.
    (6) Principal repayments.
    (7) Examples.

                  Sec. 1.679-5 Pre-immigration trusts.

    (a) In general.
    (b) Special rules.
    (1) Change in grantor trust status.
    (2) Treatment of undistributed income.
    (c) Examples.

          Sec. 1.679-6 Outbound migrations of domestic trusts.

    (a) In general.
    (b) Amount deemed transferred.
    (c) Example.

                     Sec. 1.679-7 Effective dates.

    (a) In general.
    (b) Special rules.

[T.D. 8955, 66 FR 37889, July 20, 2001]



Sec. 1.679-1  U.S. transferor treated as owner of foreign trust.

    (a) In general. A U.S. transferor who transfers property to a 
foreign trust is treated as the owner of the portion of the trust 
attributable to the property transferred if there is a U.S. beneficiary 
of any portion of the trust, unless an exception in Sec. 1.679-4 
applies to the transfer.
    (b) Interaction with sections 673 through 678. The rules of this 
section apply without regard to whether the

[[Page 384]]

U.S. transferor retains any power or interest described in sections 673 
through 677. If a U.S. transferor would be treated as the owner of a 
portion of a foreign trust pursuant to the rules of this section and 
another person would be treated as the owner of the same portion of the 
trust pursuant to section 678, then the U.S. transferor is treated as 
the owner and the other person is not treated as the owner.
    (c) Definitions. The following definitions apply for purposes of 
this section and Sec. Sec. 1.679-2 through 1.679-7:
    (1) U.S. transferor. The term U.S. transferor means any U.S. person 
who makes a transfer (as defined in Sec. 1.679-3) of property to a 
foreign trust.
    (2) U.S. person. The term U.S. person means a United States person 
as defined in section 7701(a)(30), a nonresident alien individual who 
elects under section 6013(g) to be treated as a resident of the United 
States, and an individual who is a dual resident taxpayer within the 
meaning of Sec. 301.7701(b)-7(a) of this chapter.
    (3) Foreign trust. Section 7701(a)(31)(B) defines the term foreign 
trust. See also Sec. 301.7701-7 of this chapter.
    (4) Property. The term property means any property including cash.
    (5) Related person. A person is a related person if, without regard 
to the transfer at issue, the person is--
    (i) A grantor of any portion of the trust (within the meaning of 
Sec. 1.671-2(e)(1));
    (ii) An owner of any portion of the trust under sections 671 through 
679;
    (iii) A beneficiary of the trust; or
    (iv) A person who is related (within the meaning of section 
643(i)(2)(B)) to any grantor, owner or beneficiary of the trust.
    (6) Obligation. The term obligation means any bond, note, debenture, 
certificate, bill receivable, account receivable, note receivable, open 
account, or other evidence of indebtedness, and, to the extent not 
previously described, any annuity contract.
    (d) Examples. The following examples illustrate the rules of 
paragraph (a) of this section. In these examples, A is a resident alien, 
B is A's son, who is a resident alien, C is A's father, who is a 
resident alien, D is A's uncle, who is a nonresident alien, and FT is a 
foreign trust. The examples are as follows:

    Example 1. Interaction with section 678. A creates and funds FT. FT 
may provide for the education of B by paying for books, tuition, room 
and board. In addition, C has the power to vest the trust corpus or 
income in himself within the meaning of section 678(a)(1). Under 
paragraph (b) of this section, A is treated as the owner of the portion 
of FT attributable to the property transferred to FT by A and C is not 
treated as the owner thereof.
    Example 2. U.S. person treated as owner of a portion of FT. D 
creates and funds FT for the benefit of B. D retains a power described 
in section 676 and Sec. 1.672(f)-3(a)(1). A transfers property to FT. 
Under sections 676 and 672(f), D is treated as the owner of the portion 
of FT attributable to the property transferred by D. Under paragraph (a) 
of this section, A is treated as the owner of the portion of FT 
attributable to the property transferred by A.

[T.D. 8955, 66 FR 37889, July 20, 2001]



Sec. 1.679-2  Trusts treated as having a U.S. beneficiary.

    (a) Existence of U.S. beneficiary--(1) In general. The determination 
of whether a foreign trust has a U.S. beneficiary is made on an annual 
basis. A foreign trust is treated as having a U.S. beneficiary unless 
during the taxable year of the U.S. transferor--
    (i) No part of the income or corpus of the trust may be paid or 
accumulated to or for the benefit of, directly or indirectly, a U.S. 
person; and
    (ii) If the trust is terminated at any time during the taxable year, 
no part of the income or corpus of the trust could be paid to or for the 
benefit of, directly or indirectly, a U.S. person.
    (2) Benefit to a U.S. person--(i) In general. For purposes of 
paragraph (a)(1) of this section, income or corpus may be paid or 
accumulated to or for the benefit of a U.S. person during a taxable year 
of the U.S. transferor if during that year, directly or indirectly, 
income may be distributed to, or accumulated for the benefit of, a U.S. 
person, or corpus may be distributed to, or held for the future benefit 
of, a U.S. person. This determination is made without regard to whether 
income or corpus is actually distributed to a U.S. person during that 
year, and without regard to whether a U.S. person's interest in the 
trust income or corpus is contingent on a future event.

[[Page 385]]

    (ii) Certain unexpected beneficiaries. Notwithstanding paragraph 
(a)(2)(i) of this section, for purposes of paragraph (a)(1) of this 
section, a person who is not named as a beneficiary and is not a member 
of a class of beneficiaries as defined under the trust instrument is not 
taken into consideration if the U.S. transferor demonstrates to the 
satisfaction of the Commissioner that the person's contingent interest 
in the trust is so remote as to be negligible. The preceding sentence 
does not apply with respect to persons to whom distributions could be 
made pursuant to a grant of discretion to the trustee or any other 
person. A class of beneficiaries generally does not include heirs who 
will benefit from the trust under the laws of intestate succession in 
the event that the named beneficiaries (or members of the named class) 
have all deceased (whether or not stated as a named class in the trust 
instrument).
    (iii) Examples. The following examples illustrate the rules of 
paragraphs (a)(1) and (2) of this section. In these examples, A is a 
resident alien, B is A's son, who is a resident alien, C is A's 
daughter, who is a nonresident alien, and FT is a foreign trust. The 
examples are as follows:

    Example 1. Distribution of income to U.S. person. A transfers 
property to FT. The trust instrument provides that all trust income is 
to be distributed currently to B. Under paragraph (a)(1) of this 
section, FT is treated as having a U.S. beneficiary.
    Example 2. Income accumulation for the benefit of a U.S. person. In 
2001, A transfers property to FT. The trust instrument provides that 
from 2001 through 2010, the trustee of FT may distribute trust income to 
C or may accumulate the trust income. The trust instrument further 
provides that in 2011, the trust will terminate and the trustee may 
distribute the trust assets to either or both of B and C, in the 
trustee's discretion. If the trust terminates unexpectedly prior to 
2011, all trust assets must be distributed to C. Because it is possible 
that income may be accumulated in each year, and that the accumulated 
income ultimately may be distributed to B, a U.S. person, under 
paragraph (a)(1) of this section FT is treated as having a U.S. 
beneficiary during each of A's tax years from 2001 through 2011. This 
result applies even though no U.S. person may receive distributions from 
the trust during the tax years 2001 through 2010.
    Example 3. Corpus held for the benefit of a U.S. person. The facts 
are the same as in Example 2, except that from 2001 through 2011, all 
trust income must be distributed to C. In 2011, the trust will terminate 
and the trustee may distribute the trust corpus to either or both of B 
and C, in the trustee's discretion. If the trust terminates unexpectedly 
prior to 2011, all trust corpus must be distributed to C. Because during 
each of A's tax years from 2001 through 2011 trust corpus is held for 
possible future distribution to B, a U.S. person, under paragraph (a)(1) 
of this section FT is treated as having a U.S. beneficiary during each 
of those years. This result applies even though no U.S. person may 
receive distributions from the trust during the tax years 2001 through 
2010.
    Example 4. Distribution upon U.S. transferor's death. A transfers 
property to FT. The trust instrument provides that all trust income must 
be distributed currently to C and, upon A's death, the trust will 
terminate and the trustee may distribute the trust corpus to either or 
both of B and C. Because B may receive a distribution of corpus upon the 
termination of FT, and FT could terminate in any year, FT is treated as 
having a U.S. beneficiary in the year of the transfer and in subsequent 
years.
    Example 5. Distribution after U.S. transferor's death. The facts are 
the same as in Example 4, except the trust instrument provides that the 
trust will not terminate until the year following A's death. Upon 
termination, the trustee may distribute the trust assets to either or 
both of B and C, in the trustee's discretion. All trust assets are 
invested in the stock of X, a foreign corporation, and X makes no 
distributions to FT. Although no U.S. person may receive a distribution 
until the year after A's death, and FT has no realized income during any 
year of its existence, during each year in which A is living corpus may 
be held for future distribution to B, a U.S. person. Thus, under 
paragraph (a)(1) of this section FT is treated as having a U.S. 
beneficiary during each of A's tax years from 2001 through the year of 
A's death.
    Example 6. Constructive benefit to U.S. person. A transfers property 
to FT. The trust instrument provides that no income or corpus may be 
paid directly to a U.S. person. However, the trust instrument provides 
that trust corpus may be used to satisfy B's legal obligations to a 
third party by making a payment directly to the third party. Under 
paragraphs (a)(1) and (2) of this section, FT is treated as having a 
U.S. beneficiary.
    Example 7. U.S. person with negligible contingent interest. A 
transfers property to FT. The trust instrument provides that all income 
is to be distributed currently to C, and upon C's death, all corpus is 
to be distributed to whomever of C's three children is then living. All 
of C's children are nonresident

[[Page 386]]

aliens. Under the laws of intestate succession that would apply to FT, 
if all of C's children are deceased at the time of C's death, the corpus 
would be distributed to A's heirs. A's living relatives at the time of 
the transfer consist solely of two brothers and two nieces, all of whom 
are nonresident aliens, and two first cousins, one of whom, E, is a U.S. 
citizen. Although it is possible under certain circumstances that E 
could receive a corpus distribution under the applicable laws of 
intestate succession, for each year the trust is in existence A is able 
to demonstrate to the satisfaction of the Commissioner under paragraph 
(a)(2)(ii) of this section that E's contingent interest in FT is so 
remote as to be negligible. Provided that paragraph (a)(4) of this 
section does not require a different result, FT is not treated as having 
a U.S. beneficiary.
    Example 8. U.S. person with non-negligible contingent interest. A 
transfers property to FT. The trust instrument provides that all income 
is to be distributed currently to D, A's uncle, who is a nonresident 
alien, and upon A's death, the corpus is to be distributed to D if he is 
then living. Under the laws of intestate succession that would apply to 
FT, B and C would share equally in the trust corpus if D is not living 
at the time of A's death. A is unable to demonstrate to the satisfaction 
of the Commissioner that B's contingent interest in the trust is so 
remote as to be negligible. Under paragraph (a)(2)(ii) of this section, 
FT is treated as having a U.S. beneficiary as of the year of the 
transfer.
    Example 9. U.S. person as member of class of beneficiaries. A 
transfers property to FT. The trust instrument provides that all income 
is to be distributed currently to D, A's uncle, who is a nonresident 
alien, and upon A's death, the corpus is to be distributed to D if he is 
then living. If D is not then living, the corpus is to be distributed to 
D's descendants. D's grandson, E, is a resident alien. Under paragraph 
(a)(2)(ii) of this section, FT is treated as having a U.S. beneficiary 
as of the year of the transfer.
    Example 10. Trustee's discretion in choosing beneficiaries. A 
transfers property to FT. The trust instrument provides that the trustee 
may distribute income and corpus to, or accumulate income for the 
benefit of, any person who is pursuing the academic study of ancient 
Greek, in the trustee's discretion. Because it is possible that a U.S. 
person will receive distributions of income or corpus, or will have 
income accumulated for his benefit, FT is treated as having a U.S. 
beneficiary. This result applies even if, during a tax year, no 
distributions or accumulations are actually made to or for the benefit 
of a U.S. person. A may not invoke paragraph (a)(2)(ii) of this section 
because a U.S. person could benefit pursuant to a grant of discretion in 
the trust instrument.
    Example 11. Appointment of remainder beneficiary. A transfers 
property to FT. The trust instrument provides that the trustee may 
distribute current income to C, or may accumulate income, and, upon 
termination of the trust, trust assets are to be distributed to C. 
However, the trust instrument further provides that D, A's uncle, may 
appoint a different remainder beneficiary. Because it is possible that a 
U.S. person could be named as the remainder beneficiary, and because 
corpus could be held in each year for the future benefit of that U.S. 
person, FT is treated as having a U.S. beneficiary for each year.
    Example 12. Trust not treated as having a U.S. beneficiary. A 
transfers property to FT. The trust instrument provides that the trustee 
may distribute income and corpus to, or accumulate income for the 
benefit of C. Upon termination of the trust, all income and corpus must 
be distributed to C. Assume that paragraph (a)(4) of this section is not 
applicable under the facts and circumstances and that A establishes to 
the satisfaction of the Commissioner under paragraph (a)(2)(ii) of this 
section that no U.S. persons are reasonably expected to benefit from the 
trust. Because no part of the income or corpus of the trust may be paid 
or accumulated to or for the benefit of, either directly or indirectly, 
a U.S. person, and if the trust is terminated no part of the income or 
corpus of the trust could be paid to or for the benefit of, either 
directly or indirectly, a U.S. person, FT is not treated as having a 
U.S. beneficiary.
    Example 13. U.S. beneficiary becomes non-U.S. person. In 2001, A 
transfers property to FT. The trust instrument provides that, as long as 
B remains a U.S. resident, no distributions of income or corpus may be 
made from the trust to B. The trust instrument further provides that if 
B becomes a nonresident alien, distributions of income (including 
previously accumulated income) and corpus may be made to him. If B 
remains a U.S. resident at the time of FT's termination, all accumulated 
income and corpus is to be distributed to C. In 2007, B becomes a 
nonresident alien and remains so thereafter. Because income may be 
accumulated during the years 2001 through 2007 for the benefit of a 
person who is a U.S. person during those years, FT is treated as having 
a U.S. beneficiary under paragraph (a)(1) of this section during each of 
those years. This result applies even though B cannot receive 
distributions from FT during the years he is a resident alien and even 
though B might remain a resident alien who is not entitled to any 
distribution from FT. Provided that paragraph (a)(4) of this section 
does not require a different result and that A establishes to the 
satisfaction of the Commissioner under paragraph (a)(2)(ii) of this 
section that no other

[[Page 387]]

U.S. persons are reasonably expected to benefit from the trust, FT is 
not treated as having a U.S. beneficiary under paragraph (a)(1) of this 
section during tax years after 2007.

    (3) Changes in beneficiary's status--(i) In general. For purposes of 
paragraph (a)(1) of this section, the possibility that a person that is 
not a U.S. person could become a U.S. person will not cause that person 
to be treated as a U.S. person for purposes of paragraph (a)(1) of this 
section until the tax year of the U.S. transferor in which that 
individual actually becomes a U.S. person. However, if a person who is 
not a U.S. person becomes a U.S. person for the first time more than 5 
years after the date of a transfer to the foreign trust by a U.S. 
transferor, that person is not treated as a U.S. person for purposes of 
applying paragraph (a)(1) of this section with respect to that transfer.
    (ii) Examples. The following examples illustrate the rules of 
paragraph (a)(3) of this section. In these examples, A is a resident 
alien, B is A's son, who is a resident alien, C is A's daughter, who is 
a nonresident alien, and FT is a foreign trust. The examples are as 
follows:

    Example 1. Non-U.S. beneficiary becomes U.S. person. In 2001, A 
transfers property to FT. The trust instrument provides that all income 
is to be distributed currently to C and that, upon the termination of 
FT, all corpus is to be distributed to C. Assume that paragraph (a)(4) 
of this section is not applicable under the facts and circumstances and 
that A establishes to the satisfaction of the Commissioner under 
paragraph (a)(2)(ii) of this section that no U.S. persons are reasonably 
expected to benefit from the trust. Under paragraph (a)(3)(i) of this 
section, FT is not treated as having a U.S. beneficiary during the tax 
years of A in which C remains a nonresident alien. If C first becomes a 
resident alien in 2004, FT is treated as having a U.S. beneficiary 
commencing in that year under paragraph (a)(3) of this section. See 
paragraph (c) of this section regarding the treatment of A upon FT's 
acquisition of a U.S. beneficiary.
    Example 2. Non-U.S. beneficiary becomes U.S. person more than 5 
years after transfer. The facts are the same as in Example 1, except C 
first becomes a resident alien in 2007. FT is treated as not having a 
U.S. beneficiary under paragraph (a)(3)(i) of this section with respect 
to the property transfer by A. However, if C had previously been a U.S. 
person during any prior period, the 5-year exception in paragraph 
(a)(3)(i) of this section would not apply in 2007 because it would not 
have been the first time C became a U.S. person.

    (4) General rules--(i) Records and documents. Even if, based on the 
terms of the trust instrument, a foreign trust is not treated as having 
a U.S. beneficiary within the meaning of paragraph (a)(1) of this 
section, the trust may nevertheless be treated as having a U.S. 
beneficiary pursuant to paragraph (a)(1) of this section based on the 
following--
    (A) All written and oral agreements and understandings relating to 
the trust;
    (B) Memoranda or letters of wishes;
    (C) All records that relate to the actual distribution of income and 
corpus; and
    (D) All other documents that relate to the trust, whether or not of 
any purported legal effect.
    (ii) Additional factors. For purposes of determining whether a 
foreign trust is treated as having a U.S. beneficiary within the meaning 
of paragraph (a)(1) of this section, the following additional factors 
are taken into account--
    (A) If the terms of the trust instrument allow the trust to be 
amended to benefit a U.S. person, all potential benefits that could be 
provided to a U.S. person pursuant to an amendment must be taken into 
account;
    (B) If the terms of the trust instrument do not allow the trust to 
be amended to benefit a U.S. person, but the law applicable to a foreign 
trust may require payments or accumulations of income or corpus to or 
for the benefit of a U.S. person (by judicial reformation or otherwise), 
all potential benefits that could be provided to a U.S. person pursuant 
to the law must be taken into account, unless the U.S. transferor 
demonstrates to the satisfaction of the Commissioner that the law is not 
reasonably expected to be applied or invoked under the facts and 
circumstances; and
    (C) If the parties to the trust ignore the terms of the trust 
instrument, or if it is reasonably expected that they will do so, all 
benefits that have been, or are reasonably expected to be, provided to a 
U.S. person must be taken into account.
    (iii) Examples. The following examples illustrate the rules of 
paragraph

[[Page 388]]

(a)(4) of this section. In these examples, A is a resident alien, B is 
A's son, who is a resident alien, C is A's daughter, who is a 
nonresident alien, and FT is a foreign trust. The examples are as 
follows:

    Example 1. Amendment pursuant to local law. A creates and funds FT 
for the benefit of C. The terms of FT (which, according to the trust 
instrument, cannot be amended) provide that no part of the income or 
corpus of FT may be paid or accumulated during the taxable year to or 
for the benefit of any U.S. person, either during the existence of FT or 
at the time of its termination. However, pursuant to the applicable 
foreign law, FT can be amended to provide for additional beneficiaries, 
and there is an oral understanding between A and the trustee that B can 
be added as a beneficiary. Under paragraphs (a)(1) and (a)(4)(ii)(B) of 
this section, FT is treated as having a U.S. beneficiary.
    Example 2. Actions in violation of the terms of the trust. A 
transfers property to FT. The trust instrument provides that no U.S. 
person can receive income or corpus from FT during the term of the trust 
or at the termination of FT. Notwithstanding the terms of the trust 
instrument, a letter of wishes directs the trustee of FT to provide for 
the educational needs of B, who is about to begin college. The letter of 
wishes contains a disclaimer to the effect that its contents are only 
suggestions and recommendations and that the trustee is at all times 
bound by the terms of the trust as set forth in the trust instrument. 
Under paragraphs (a)(1) and (a)(4)(ii)(C) of this section, FT is treated 
as having a U.S. beneficiary.

    (b) Indirect U.S. beneficiaries--(1) Certain foreign entities. For 
purposes of paragraph (a)(1) of this section, an amount is treated as 
paid or accumulated to or for the benefit of a U.S. person if the amount 
is paid to or accumulated for the benefit of--
    (i) A controlled foreign corporation, as defined in section 957(a);
    (ii) A foreign partnership, if a U.S. person is a partner of such 
partnership; or
    (iii) A foreign trust or estate, if such trust or estate has a U.S. 
beneficiary (within the meaning of paragraph (a)(1) of this section).
    (2) Other indirect beneficiaries. For purposes of paragraph (a)(1) 
of this section, an amount is treated as paid or accumulated to or for 
the benefit of a U.S. person if the amount is paid to or accumulated for 
the benefit of a U.S. person through an intermediary, such as an agent 
or nominee, or by any other means where a U.S. person may obtain an 
actual or constructive benefit.
    (3) Examples. The following examples illustrate the rules of this 
paragraph (b). Unless otherwise noted, A is a resident alien. B is A's 
son and is a resident alien. FT is a foreign trust. The examples are as 
follows:

    Example 1. Trust benefitting foreign corporation. A transfers 
property to FT. The beneficiary of FT is FC, a foreign corporation. FC 
has outstanding solely 100 shares of common stock. B owns 49 shares of 
the FC stock and FC2, also a foreign corporation, owns the remaining 51 
shares. FC2 has outstanding solely 100 shares of common stock. B owns 49 
shares of FC2 and nonresident alien individuals own the remaining 51 FC2 
shares. FC is a controlled foreign corporation (as defined in section 
957(a), after the application of section 958(a)(2)). Under paragraphs 
(a)(1) and (b)(1)(i) of this section, FT is treated as having a U.S. 
beneficiary.
    Example 2. Trust benefitting another trust. A transfers property to 
FT. The terms of FT permit current distributions of income to B. A 
transfers property to another foreign trust, FT2. The terms of FT2 
provide that no U.S. person can benefit either as to income or corpus, 
but permit current distributions of income to FT. Under paragraph (a)(1) 
of this section, FT is treated as having a U.S. beneficiary and, under 
paragraphs (a)(1) and (b)(1)(iii) of this section, FT2 is treated as 
having a U.S. beneficiary.
    Example 3. Trust benefitting another trust after transferor's death. 
A transfers property to FT. The terms of FT require that all income from 
FT be accumulated during A's lifetime. In the year following A's death, 
a share of FT is to be distributed to FT2, another foreign trust, for 
the benefit of B. Under paragraphs (a)(1) and (b)(1)(iii) of this 
section, FT is treated as having a U.S. beneficiary beginning with the 
year of A's transfer of property to FT.
    Example 4. Indirect benefit through use of debit card. A transfers 
property to FT. The trust instrument provides that no U.S. person can 
benefit either as to income or corpus. However, FT maintains an account 
with FB, a foreign bank, and FB issues a debit card to B against the 
account maintained by FT and B is allowed to make withdrawals. Under 
paragraphs (a)(1) and (b)(2) of this section, FT is treated as having a 
U.S. beneficiary.
    Example 5. Other indirect benefit. A transfers property to FT. FT is 
administered by FTC, a foreign trust company. FTC forms IBC, an 
international business corporation formed under the laws of a foreign 
jurisdiction. IBC is the beneficiary of FT. IBC maintains an

[[Page 389]]

account with FB, a foreign bank. FB issues a debit card to B against the 
account maintained by IBC and B is allowed to make withdrawals. Under 
paragraphs (a)(1) and (b)(2) of this section, FT is treated as having a 
U.S. beneficiary.

    (c) Treatment of U.S. transferor upon foreign trust's acquisition or 
loss of U.S. beneficiary--(1) Trusts acquiring a U.S. beneficiary. If a 
foreign trust to which a U.S. transferor has transferred property is not 
treated as having a U.S. beneficiary (within the meaning of paragraph 
(a) of this section) for any taxable year of the U.S. transferor, but 
the trust is treated as having a U.S. beneficiary (within the meaning of 
paragraph (a) of this section) in any subsequent taxable year, the U.S. 
transferor is treated as having additional income in the first such 
taxable year of the U.S. transferor in which the trust is treated as 
having a U.S. beneficiary. The amount of the additional income is equal 
to the trust's undistributed net income, as defined in section 665(a), 
at the end of the U.S. transferor's immediately preceding taxable year 
and is subject to the rules of section 668, providing for an interest 
charge on accumulation distributions from foreign trusts.
    (2) Trusts ceasing to have a U.S. beneficiary. If, for any taxable 
year of a U.S. transferor, a foreign trust that has received a transfer 
of property from the U.S. transferor ceases to be treated as having a 
U.S. beneficiary, the U.S. transferor ceases to be treated as the owner 
of the portion of the trust attributable to the transfer beginning in 
the first taxable year following the last taxable year of the U.S. 
transferor during which the trust was treated as having a U.S. 
beneficiary (unless the U.S. transferor is treated as an owner thereof 
pursuant to sections 673 through 677). The U.S. transferor is treated as 
making a transfer of property to the foreign trust on the first day of 
the first taxable year following the last taxable year of the U.S. 
transferor during which the trust was treated as having a U.S. 
beneficiary. The amount of the property deemed to be transferred to the 
trust is the portion of the trust attributable to the prior transfer to 
which paragraph (a)(1) of this section applied. For rules regarding the 
recognition of gain on transfers to foreign trusts, see section 684.
    (3) Examples. The rules of this paragraph (c) are illustrated by the 
following examples. A is a resident alien, B is A's son, and FT is a 
foreign trust. The examples are as follows:

    Example 1. Trust acquiring U.S. beneficiary. (i) In 2001, A 
transfers stock with a fair market value of $100,000 to FT. The stock 
has an adjusted basis of $50,000 at the time of the transfer. The trust 
instrument provides that income may be paid currently to, or accumulated 
for the benefit of, B and that, upon the termination of the trust, all 
income and corpus is to be distributed to B. At the time of the 
transfer, B is a nonresident alien. A is not treated as the owner of any 
portion of FT under sections 673 through 677. FT accumulates a total of 
$30,000 of income during the taxable years 2001 through 2003. In 2004, B 
moves to the United States and becomes a resident alien. Assume 
paragraph (a)(4) of this section is not applicable under the facts and 
circumstances.
    (ii) Under paragraph (c)(1) of this section, A is treated as 
receiving an accumulation distribution in the amount of $30,000 in 2004 
and immediately transferring that amount back to the trust. The 
accumulation distribution is subject to the rules of section 668, 
providing for an interest charge on accumulation distributions.
    (iii) Under paragraphs (a)(1) and (3) of this section, beginning in 
2005, A is treated as the owner of the portion of FT attributable to the 
stock transferred by A to FT in 2001 (which includes the portion 
attributable to the accumulated income deemed to be retransferred in 
2004).
    Example 2. Trust ceasing to have U.S. beneficiary. (i) The facts are 
the same as in Example 1. In 2008, B becomes a nonresident alien. On the 
date B becomes a nonresident alien, the stock transferred by A to FT in 
2001 has a fair market value of $125,000 and an adjusted basis of 
$50,000.
    (ii) Under paragraph (c)(2) of this section, beginning in 2009, FT 
is not treated as having a U.S. beneficiary, and A is not treated as the 
owner of the portion of the trust attributable to the prior transfer of 
stock. For rules regarding the recognition of gain on the termination of 
ownership status, see section 684.

[T.D. 8955, 66 FR 37889, July 20, 2001]



Sec. 1.679-3  Transfers.

    (a) In general. A transfer means a direct, indirect, or constructive 
transfer.
    (b) Transfers by certain trusts--(1) In general. If any portion of a 
trust is treated as owned by a U.S. person, a transfer of property from 
that portion

[[Page 390]]

of the trust to a foreign trust is treated as a transfer from the owner 
of that portion to the foreign trust.
    (2) Example. The following example illustrates this paragraph (b):

    Example. In 2001, A, a U.S. citizen, creates and funds DT, a 
domestic trust. A has the power to revest absolutely in himself the 
title to the property in DT and is treated as the owner of DT pursuant 
to section 676. In 2004, DT transfers property to FT, a foreign trust. A 
is treated as having transferred the property to FT in 2004 for purposes 
of this section.

    (c) Indirect transfers--(1) Principal purpose of tax avoidance. A 
transfer to a foreign trust by any person (intermediary) to whom a U.S. 
person transfers property is treated as an indirect transfer by a U.S. 
person to the foreign trust if such transfer is made pursuant to a plan 
one of the principal purposes of which is the avoidance of United States 
tax.
    (2) Principal purpose of tax avoidance deemed to exist. For purposes 
of paragraph (c)(1) of this section, a transfer is deemed to have been 
made pursuant to a plan one of the principal purposes of which was the 
avoidance of United States tax if--
    (i) The U.S. person is related (within the meaning of paragraph 
(c)(4) of this section) to a beneficiary of the foreign trust, or has 
another relationship with a beneficiary of the foreign trust that 
establishes a reasonable basis for concluding that the U.S. transferor 
would make a transfer to the foreign trust; and
    (ii) The U.S. person cannot demonstrate to the satisfaction of the 
Commissioner that--
    (A) The intermediary has a relationship with a beneficiary of the 
foreign trust that establishes a reasonable basis for concluding that 
the intermediary would make a transfer to the foreign trust;
    (B) The intermediary acted independently of the U.S. person;
    (C) The intermediary is not an agent of the U.S. person under 
generally applicable United States agency principles; and
    (D) The intermediary timely complied with the reporting requirements 
of section 6048, if applicable.
    (3) Effect of disregarding intermediary--(i) In general. Except as 
provided in paragraph (c)(3)(ii) of this section, if a transfer is 
treated as an indirect transfer pursuant to paragraph (c)(1) of this 
section, then the intermediary is treated as an agent of the U.S. 
person, and the property is treated as transferred to the foreign trust 
by the U.S. person in the year the property is transferred, or made 
available, by the intermediary to the foreign trust. The fair market 
value of the property transferred is determined as of the date of the 
transfer by the intermediary to the foreign trust.
    (ii) Special rule. If the Commissioner determines, or if the 
taxpayer can demonstrate to the satisfaction of the Commissioner, that 
the intermediary is an agent of the foreign trust under generally 
applicable United States agency principles, the property will be treated 
as transferred to the foreign trust in the year the U.S. person 
transfers the property to the intermediary. The fair market value of the 
property transferred will be determined as of the date of the transfer 
by the U.S. person to the intermediary.
    (iii) Effect on intermediary. If a transfer of property is treated 
as an indirect transfer under paragraph (c)(1) of this section, the 
intermediary is not treated as having transferred the property to the 
foreign trust.
    (4) Related parties. For purposes of this paragraph (c), a U.S. 
transferor is treated as related to a U.S. beneficiary of a foreign 
trust if the U.S. transferor and the beneficiary are related for 
purposes of section 643(i)(2)(B), with the following modifications--
    (i) For purposes of applying section 267 (other than section 267(f)) 
and section 707(b)(1), ``at least 10 percent'' is used instead of ``more 
than 50 percent'' each place it appears; and
    (ii) The principles of section 267(b)(10), using ``at least 10 
percent'' instead of ``more than 50 percent,'' apply to determine 
whether two corporations are related.
    (5) Examples. The rules of this paragraph (c) are illustrated by the 
following examples:

    Example 1. Principal purpose of tax avoidance. A, a U.S. citizen, 
creates and funds FT,

[[Page 391]]

a foreign trust, for the benefit of A's children, who are U.S. citizens. 
In 2004, A decides to transfer an additional 1000X to the foreign trust. 
Pursuant to a plan with a principal purpose of avoiding the application 
of section 679, A transfers 1000X to I, a foreign person. I subsequently 
transfers 1000X to FT. Under paragraph (c)(1) of this section, A is 
treated as having made a transfer of 1000X to FT.
    Example 2. U.S. person unable to demonstrate that intermediary acted 
independently. A, a U.S. citizen, creates and funds FT, a foreign trust, 
for the benefit of A's children, who are U.S. citizens. On July 1, 2004, 
A transfers XYZ stock to D, A's uncle, who is a nonresident alien. D 
immediately sells the XYZ stock and uses the proceeds to purchase ABC 
stock. On January 1, 2007, D transfers the ABC stock to FT. A is unable 
to demonstrate to the satisfaction of the Commissioner, pursuant to 
paragraph (c)(2) of this section, that D acted independently of A in 
making the transfer to FT. Under paragraph (c)(1) of this section, A is 
treated as having transferred the ABC stock to FT. Under paragraph 
(c)(3) of this section, D is treated as an agent of A, and the transfer 
is deemed to have been made on January 1, 2007.
    Example 3. Indirect loan to foreign trust. A, a U.S. citizen, 
previously created and funded FT, a foreign trust, for the benefit of 
A's children, who are U.S. citizens. On July 1, 2004, A deposits 500X 
with FB, a foreign bank. On January 1, 2005, FB loans 450X to FT. A is 
unable to demonstrate to the satisfaction of the Commissioner, pursuant 
to paragraph (c)(2) of this section, that FB has a relationship with FT 
that establishes a reasonable basis for concluding that FB would make a 
loan to FT or that FB acted independently of A in making the loan. Under 
paragraph (c)(1) of this section, A is deemed to have transferred 450X 
directly to FT on January 1, 2005. Under paragraph (c)(3) of this 
section, FB is treated as an agent of A. For possible exceptions with 
respect to qualified obligations of the trust, and the treatment of 
principal repayments with respect to obligations of the trust that are 
not qualified obligations, see Sec. 1.679-4.
    Example 4. Loan to foreign trust prior to deposit of funds in 
foreign bank. The facts are the same as in Example 3, except that A 
makes the 500X deposit with FB on January 2, 2005, the day after FB 
makes the loan to FT. The result is the same as in Example 3.

    (d) Constructive transfers--(1) In general. For purposes of 
paragraph (a) of this section, a constructive transfer includes any 
assumption or satisfaction of a foreign trust's obligation to a third 
party.
    (2) Examples. The rules of this paragraph (d) are illustrated by the 
following examples. In each example, A is a U.S. citizen and FT is a 
foreign trust. The examples are as follows:

    Example 1. Payment of debt of foreign trust. FT owes 1000X to Y, an 
unrelated foreign corporation, for the performance of services by Y for 
FT. In satisfaction of FT's liability to Y, A transfers to Y property 
with a fair market value of 1000X. Under paragraph (d)(1) of this 
section, A is treated as having made a constructive transfer of the 
property to FT.
    Example 2. Assumption of liability of foreign trust. FT owes 1000X 
to Y, an unrelated foreign corporation, for the performance of services 
by Y for FT. A assumes FT's liability to pay Y. Under paragraph (d)(1) 
of this section, A is treated as having made a constructive transfer of 
property with a fair market value of 1000X to FT.

    (e) Guarantee of trust obligations--(1) In general. If a foreign 
trust borrows money or other property from any person who is not a 
related person (within the meaning of Sec. 1.679-1(c)(5)) with respect 
to the trust (lender) and a U.S. person (U.S. guarantor) that is a 
related person with respect to the trust guarantees (within the meaning 
of paragraph (e)(4) of this section) the foreign trust's obligation, the 
U.S. guarantor is treated for purposes of this section as a U.S. 
transferor that has made a transfer to the trust on the date of the 
guarantee in an amount determined under paragraph (e)(2) of this 
section. To the extent this paragraph causes the U.S. guarantor to be 
treated as having made a transfer to the trust, a lender that is a U.S. 
person shall not be treated as having transferred that amount to the 
foreign trust.
    (2) Amount transferred. The amount deemed transferred by a U.S. 
guarantor described in paragraph (e)(1) of this section is the 
guaranteed portion of the adjusted issue price of the obligation (within 
the meaning of Sec. 1.1275-1(b)) plus any accrued but unpaid qualified 
stated interest (within the meaning of Sec. 1.1273-1(c)).
    (3) Principal repayments. If a U.S. person is treated under this 
paragraph (e) as having made a transfer by reason of the guarantee of an 
obligation, payments of principal to the lender by the foreign trust 
with respect to the obligation are taken into account on and

[[Page 392]]

after the date of the payment in determining the portion of the trust 
attributable to the property deemed transferred by the U.S. guarantor.
    (4) Guarantee. For purposes of this section, the term guarantee--
    (i) Includes any arrangement under which a person, directly or 
indirectly, assures, on a conditional or unconditional basis, the 
payment of another's obligation;
    (ii) Encompasses any form of credit support, and includes a 
commitment to make a capital contribution to the debtor or otherwise 
maintain its financial viability; and
    (iii) Includes an arrangement reflected in a comfort letter, 
regardless of whether the arrangement gives rise to a legally 
enforceable obligation. If an arrangement is contingent upon the 
occurrence of an event, in determining whether the arrangement is a 
guarantee, it is assumed that the event has occurred.
    (5) Examples. The rules of this paragraph (e) are illustrated by the 
following examples. In all of the examples, A is a U.S. resident and FT 
is a foreign trust. The examples are as follows:

    Example 1. Foreign lender. X, a foreign corporation, loans 1000X of 
cash to FT in exchange for FT's obligation to repay the loan. A 
guarantees the repayment of 600X of FT's obligation. Under paragraph 
(e)(2) of this section, A is treated as having transferred 600X to FT.
    Example 2. Unrelated U.S. lender. The facts are the same as in 
Example 1, except X is a U.S. person that is not a related person within 
the meaning of Sec. 1.679-1(c)(5). The result is the same as in Example 
1.

    (f) Transfers to entities owned by a foreign trust--(1) General 
rule. If a U.S. person is a related person (as defined in Sec. 1.679-
1(c)(5)) with respect to a foreign trust, any transfer of property by 
the U.S. person to an entity in which the foreign trust holds an 
ownership interest is treated as a transfer of such property by the U.S. 
person to the foreign trust followed by a transfer of the property from 
the foreign trust to the entity owned by the foreign trust, unless the 
U.S. person demonstrates to the satisfaction of the Commissioner that 
the transfer to the entity is properly attributable to the U.S. person's 
ownership interest in the entity.
    (2) Examples. The rules of this paragraph (f) are illustrated by the 
following examples. In all of the examples, A is a U.S. citizen, FT is a 
foreign trust, and FC is a foreign corporation. The examples are as 
follows:

    Example 1. Transfer treated as transfer to trust. A creates and 
funds FT, which is treated as having a U.S. beneficiary under Sec. 
1.679-2. FT owns all of the outstanding stock of FC. A transfers 
property directly to FC. Because FT is the sole shareholder of FC, A is 
unable to demonstrate to the satisfaction of the Commissioner that the 
transfer is properly attributable to A's ownership interest in FC. 
Accordingly, under this paragraph (f), A is treated as having 
transferred the property to FT, followed by a transfer of such property 
by FT to FC. Under Sec. 1.679-1(a), A is treated as the owner of the 
portion of FT attributable to the property treated as transferred 
directly to FT. Under Sec. 1.367(a)-1T(c)(4)(ii), the transfer of 
property by FT to FC is treated as a transfer of the property by A to 
FC.
    Example 2. Transfer treated as transfer to trust. The facts are the 
same as in Example 1, except that FT is not treated as having a U.S. 
beneficiary under Sec. 1.679-2. Under this paragraph (f), A is treated 
as having transferred the property to FT, followed by a transfer of such 
property by FT to FC. A is not treated as the owner of FT for purposes 
of Sec. 1.679-1(a). For rules regarding the recognition of gain on the 
transfer, see section 684.
    Example 3. Transfer not treated as transfer to trust. A creates and 
funds FT. FC has outstanding solely 100 shares of common stock. FT owns 
50 shares of FC stock, and A owns the remaining 50 shares. On July 1, 
2001, FT and A each transfer 1000X to FC. A is able to demonstrate to 
the satisfaction of the Commissioner that A's transfer to FC is properly 
attributable to A's ownership interest in FC. Accordingly, under this 
paragraph (f), A's transfer to FC is not treated as a transfer to FT.

[T.D. 8955, 66 FR 37889, July 20, 2001]



Sec. 1.679-4  Exceptions to general rule.

    (a) In general. Section 1.679-1 does not apply to--
    (1) Any transfer of property to a foreign trust by reason of the 
death of the transferor;
    (2) Any transfer of property to a foreign trust described in 
sections 402(b), 404(a)(4), or 404A;
    (3) Any transfer of property to a foreign trust described in section 
501(c)(3) (without regard to the requirements of section 508(a)); and

[[Page 393]]

    (4) Any transfer of property to a foreign trust to the extent the 
transfer is for fair market value.
    (b) Transfers for fair market value--(1) In general. For purposes of 
this section, a transfer is for fair market value only to the extent of 
the value of property received from the trust, services rendered by the 
trust, or the right to use property of the trust. For example, rents, 
royalties, interest, and compensation paid to a trust are transfers for 
fair market value only to the extent that the payments reflect an arm's 
length price for the use of the property of, or for the services 
rendered by, the trust. For purposes of this determination, an interest 
in the trust is not property received from the trust. For purposes of 
this section, a distribution to a trust with respect to an interest held 
by such trust in an entity other than a trust or an interest in certain 
investment trusts described in Sec. 301.7701-4(c) of this chapter, 
liquidating trusts described in Sec. 301.7701-4(d) of this chapter, or 
environmental remediation trusts described in Sec. 301.7701-4(e) of 
this chapter is considered to be a transfer for fair market value.
    (2) Special rule--(i) Transfers for partial consideration. For 
purposes of this section, if a person transfers property to a foreign 
trust in exchange for property having a fair market value that is less 
than the fair market value of the property transferred, the exception in 
paragraph (a)(4) of this section applies only to the extent of the fair 
market value of the property received.
    (ii) Example. This paragraph (b) is illustrated by the following 
example:

    Example. A, a U.S. citizen, transfers property that has a fair 
market value of 1000X to FT, a foreign trust, in exchange for 600X of 
cash. Under this paragraph (b), Sec. 1.679-1 applies with respect to 
the transfer of 400X (1000X less 600X) to FT.

    (c) Certain obligations not taken into account. Solely for purposes 
of this section, in determining whether a transfer by a U.S. transferor 
that is a related person (as defined in Sec. 1.679-1(c)(5)) with 
respect to the foreign trust is for fair market value, any obligation 
(as defined in Sec. 1.679-1(c)(6)) of the trust or a related person (as 
defined in Sec. 1.679-1(c)(5)) that is not a qualified obligation 
within the meaning of paragraph (d)(1) of this section shall not be 
taken into account.
    (d) Qualified obligations--(1) In general. For purposes of this 
section, an obligation is treated as a qualified obligation only if--
    (i) The obligation is reduced to writing by an express written 
agreement;
    (ii) The term of the obligation does not exceed five years (for 
purposes of determining the term of an obligation, the obligation's 
maturity date is the last possible date that the obligation can be 
outstanding under the terms of the obligation);
    (iii) All payments on the obligation are denominated in U.S. 
dollars;
    (iv) The yield to maturity is not less than 100 percent of the 
applicable Federal rate and not greater that 130 percent of the 
applicable Federal rate (the applicable Federal rate for an obligation 
is the applicable Federal rate in effect under section 1274(d) for the 
day on which the obligation is issued, as published in the Internal 
Revenue Bulletin (see Sec. 601.601(d)(2) of this chapter));
    (v) The U.S. transferor extends the period for assessment of any 
income or transfer tax attributable to the transfer and any 
consequential income tax changes for each year that the obligation is 
outstanding, to a date not earlier than three years after the maturity 
date of the obligation (this extension is not necessary if the maturity 
date of the obligation does not extend beyond the end of the U.S. 
transferor's taxable year for the year of the transfer and is paid 
within such period); when properly executed and filed, such an agreement 
is deemed to be consented to for purposes of Sec. 301.6501(c)-1(d) of 
this chapter; and
    (vi) The U.S. transferor reports the status of the loan, including 
principal and interest payments, on Form 3520 for every year that the 
loan is outstanding.
    (2) Additional loans. If, while the original obligation is 
outstanding, the U.S. transferor or a person related to the trust 
(within the meaning of Sec. 1.679-1(c)(5)) directly or indirectly 
obtains another obligation issued by the trust, or if the U.S. 
transferor directly or indirectly obtains another obligation issued by a 
person related to the trust,

[[Page 394]]

the original obligation is deemed to have the maturity date of any such 
subsequent obligation in determining whether the term of the original 
obligation exceeds the specified 5-year term. In addition, a series of 
obligations issued and repaid by the trust (or a person related to the 
trust) is treated as a single obligation if the transactions giving rise 
to the obligations are structured with a principal purpose to avoid the 
application of this provision.
    (3) Obligations that cease to be qualified. If an obligation treated 
as a qualified obligation subsequently fails to be a qualified 
obligation (e.g., renegotiation of the terms of the obligation causes 
the term of the obligation to exceed five years), the U.S. transferor is 
treated as making a transfer to the trust in an amount equal to the 
original obligation's adjusted issue price (within the meaning of Sec. 
1.1275-1(b)) plus any accrued but unpaid qualified stated interest 
(within the meaning of Sec. 1.1273-1(c)) as of the date of the 
subsequent event that causes the obligation to no longer be a qualified 
obligation. If the maturity date is extended beyond five years by reason 
of the issuance of a subsequent obligation by the trust (or person 
related to the trust), the amount of the transfer will not exceed the 
issue price of the subsequent obligation. The subsequent obligation is 
separately tested to determine if it is a qualified obligation.
    (4) Transfers resulting from failed qualified obligations. In 
general, a transfer resulting from a failed qualified obligation is 
deemed to occur on the date of the subsequent event that causes the 
obligation to no longer be a qualified obligation. However, based on all 
of the facts and circumstances, the Commissioner may deem a transfer to 
have occurred on any date on or after the issue date of the original 
obligation. For example, if at the time the original obligation was 
issued, the transferor knew or had reason to know that the obligation 
would not be repaid, the Commissioner could deem the transfer to have 
occurred on the issue date of the original obligation.
    (5) Renegotiated loans. Any loan that is renegotiated, extended, or 
revised is treated as a new loan, and any transfer of funds to a foreign 
trust after such renegotiation, extension, or revision under a pre-
existing loan agreement is treated as a transfer subject to this 
section.
    (6) Principal repayments. The payment of principal with respect to 
any obligation that is not treated as a qualified obligation under this 
paragraph is taken into account on and after the date of the payment in 
determining the portion of the trust attributable to the property 
transferred.
    (7) Examples. The rules of this paragraph (d) are illustrated by the 
following examples. In the examples, A and B are U.S. residents and FT 
is a foreign trust. The examples are as follows:

    Example 1. Demand loan. A transfers 500X to FT in exchange for a 
demand note that permits A to require repayment by FT at any time. A is 
a related person (as defined in Sec. 1.679-1(c)(5)) with respect to FT. 
Because FT's obligation to A could remain outstanding for more than five 
years, the obligation is not a qualified obligation within the meaning 
of paragraph (d) of this section and, pursuant to paragraph (c) of this 
section, it is not taken into account for purposes of determining 
whether A's transfer is eligible for the fair market value exception of 
paragraph (a)(4) of this section. Accordingly, Sec. 1.679-1 applies 
with respect to the full 500X transfer to FT.
    Example 2. Private annuity. A transfers 4000X to FT in exchange for 
an annuity from the foreign trust that will pay A 100X per year for the 
rest of A's life. A is a related person (as defined in Sec. 1.679-
1(c)(5)) with respect to FT. Because FT's obligation to A could remain 
outstanding for more than five years, the obligation is not a qualified 
obligation within the meaning of paragraph (d)(1) of this section and, 
pursuant to paragraph (c) of this section, it is not taken into account 
for purposes of determining whether A's transfer is eligible for the 
fair market value exception of paragraph (a)(4) of this section. 
Accordingly, Sec. 1.679-1 applies with respect to the full 4000X 
transfer to FT.
    Example 3. Loan to unrelated foreign trust. B transfers 1000X to FT 
in exchange for an obligation of the trust. The term of the obligation 
is fifteen years. B is not a related person (as defined in Sec. 1.679-
1(c)(5)) with respect to FT. Because B is not a related person, the fair 
market value of the obligation received by B is taken into account for 
purposes of determining whether B's transfer is eligible for the fair 
market value exception of paragraph (a)(4) of this section, even though 
the

[[Page 395]]

obligation is not a qualified obligation within the meaning of paragraph 
(d)(1) of this section.
    Example 4. Transfer for an obligation with term in excess of 5 
years. A transfers property that has a fair market value of 5000X to FT 
in exchange for an obligation of the trust. The term of the obligation 
is ten years. A is a related person (as defined in Sec. 1.679-1(c)(5)) 
with respect to FT. Because the term of the obligation is greater than 
five years, the obligation is not a qualified obligation within the 
meaning of paragraph (d)(1) of this section and, pursuant to paragraph 
(c) of this section, it is not taken into account for purposes of 
determining whether A's transfer is eligible for the fair market value 
exception of paragraph (a)(4) of this section. Accordingly, Sec. 1.679-
1 applies with respect to the full 5000X transfer to FT.
    Example 5. Transfer for a qualified obligation. The facts are the 
same as in Example 4, except that the term of the obligation is 3 years. 
Assuming the other requirements of paragraph (d)(1) of this section are 
satisfied, the obligation is a qualified obligation and its adjusted 
issue price is taken into account for purposes of determining whether 
A's transfer is eligible for the fair market value exception of 
paragraph (a)(4) of this section.
    Example 6. Effect of subsequent obligation on original obligation. A 
transfers property that has a fair market value of 1000X to FT in 
exchange for an obligation that satisfies the requirements of paragraph 
(d)(1) of this section. A is a related person (as defined in Sec. 
1.679-1(c)(5)) with respect to FT. Two years later, A transfers an 
additional 2000X to FT and receives another obligation from FT that has 
a maturity date four years from the date that the second obligation was 
issued. Under paragraph (d)(2) of this section, the original obligation 
is deemed to have the maturity date of the second obligation. Under 
paragraph (a) of this section, A is treated as having made a transfer in 
an amount equal to the original obligation's adjusted issue price 
(within the meaning of Sec. 1.1275-1(b)) plus any accrued but unpaid 
qualified stated interest (within the meaning of Sec. 1.1273-1(c)) as 
of the date of issuance of the second obligation. The second obligation 
is tested separately to determine whether it is a qualified obligation 
for purposes of applying paragraph (a) of this section to the second 
transfer.

[T.D. 8955, 66 FR 37889, July 20, 2001]



Sec. 1.679-5  Pre-immigration trusts.

    (a) In general. If a nonresident alien individual becomes a U.S. 
person and the individual has a residency starting date (as determined 
under section 7701(b)(2)(A)) within 5 years after directly or indirectly 
transferring property to a foreign trust (the original transfer), the 
individual is treated as having transferred to the trust on the 
residency starting date an amount equal to the portion of the trust 
attributable to the property transferred by the individual in the 
original transfer.
    (b) Special rules--(1) Change in grantor trust status. For purposes 
of paragraph (a) of this section, if a nonresident alien individual who 
is treated as owning any portion of a trust under the provisions of 
subpart E of part I of subchapter J, chapter 1 of the Internal Revenue 
Code, subsequently ceases to be so treated, the individual is treated as 
having made the original transfer to the foreign trust immediately 
before the trust ceases to be treated as owned by the individual.
    (2) Treatment of undistributed income. For purposes of paragraph (a) 
of this section, the property deemed transferred to the foreign trust on 
the residency starting date includes undistributed net income, as 
defined in section 665(a), attributable to the property deemed 
transferred. Undistributed net income for periods before the 
individual's residency starting date is taken into account only for 
purposes of determining the amount of the property deemed transferred.
    (c) Examples. The rules of this section are illustrated by the 
following examples:

    Example 1. Nonresident alien becomes resident alien. On January 1, 
2002, A, a nonresident alien individual, transfers property to a foreign 
trust, FT. On January 1, 2006, A becomes a resident of the United States 
within the meaning of section 7701(b)(1)(A) and has a residency starting 
date of January 1, 2006, within the meaning of section 7701(b)(2)(A). 
Under paragraph (a) of this section, A is treated as a U.S. transferor 
and is deemed to transfer the property to FT on January 1, 2006. Under 
paragraph (b)(2) of this section, the property deemed transferred to FT 
on January 1, 2006, includes the undistributed net income of the trust, 
as defined in section 665(a), attributable to the property originally 
transferred.
    Example 2. Nonresident alien loses power to revest property. On 
January 1, 2002, A, a nonresident alien individual, transfers property 
to a foreign trust, FT. A has the power to revest absolutely in himself 
the title to such property transferred and is treated as the owner of 
the trust pursuant to sections 676 and 672(f). On January 1, 2008, the 
terms of FT are amended to remove A's power to

[[Page 396]]

revest in himself title to the property transferred, and A ceases to be 
treated as the owner of FT. On January 1, 2010, A becomes a resident of 
the United States. Under paragraph (b)(1) of this section, for purposes 
of paragraph (a) of this section A is treated as having originally 
transferred the property to FT on January 1, 2008. Because this date is 
within five years of A's residency starting date, A is deemed to have 
made a transfer to the foreign trust on January 1, 2010, his residency 
starting date. Under paragraph (b)(2) of this section, the property 
deemed transferred to the foreign trust on January 1, 2010, includes the 
undistributed net income of the trust, as defined in section 665(a), 
attributable to the property deemed transferred.

[T.D. 8955, 66 FR 37889, July 20, 2001]



Sec. 1.679-6  Outbound migrations of domestic trusts.

    (a) In general. Subject to the provisions of paragraph (b) of this 
section, if an individual who is a U.S. person transfers property to a 
trust that is not a foreign trust, and such trust becomes a foreign 
trust while the U.S. person is alive, the U.S. individual is treated as 
a U.S. transferor and is deemed to transfer the property to a foreign 
trust on the date the domestic trust becomes a foreign trust.
    (b) Amount deemed transferred. For purposes of paragraph (a) of this 
section, the property deemed transferred to the trust when it becomes a 
foreign trust includes undistributed net income, as defined in section 
665(a), attributable to the property previously transferred. 
Undistributed net income for periods prior to the migration is taken 
into account only for purposes of determining the portion of the trust 
that is attributable to the property transferred by the U.S. person.
    (c) Example. The following example illustrates the rules of this 
section. For purposes of the example, A is a resident alien, B is A's 
son, who is a resident alien, and DT is a domestic trust. The example is 
as follows:

    Example. Outbound migration of domestic trust. On January 1, 2002, A 
transfers property to DT, for the benefit of B. On January 1, 2003, DT 
acquires a foreign trustee who has the power to determine whether and 
when distributions will be made to B. Under section 7701(a)(30)(E) and 
Sec. 301.7701-7(d)(ii)(A) of this chapter, DT becomes a foreign trust 
on January 1, 2003. Under paragraph (a) of this section, A is treated as 
transferring property to a foreign trust on January 1, 2003. Under 
paragraph (b) of this section, the property deemed transferred to the 
trust when it becomes a foreign trust includes undistributed net income, 
as defined in section 665(a), attributable to the property deemed 
transferred.

[T.D. 8955, 66 FR 37889, July 20, 2001]



Sec. 1.679-7  Effective dates.

    (a) In general. Except as provided in paragraph (b) of this section, 
the rules of Sec. Sec. 1.679-1, 1.679-2, 1.679-3, and 1.679-4 apply 
with respect to transfers after August 7, 2000.
    (b) Special rules. (1) The rules of Sec. 1.679-4(c) and (d) apply 
to an obligation issued after February 6, 1995, whether or not in 
accordance with a pre-existing arrangement or understanding. For 
purposes of the rules of Sec. 1.679-4(c) and (d), if an obligation 
issued on or before February 6, 1995, is modified after that date, and 
the modification is a significant modification within the meaning of 
Sec. 1.1001-3, the obligation is treated as if it were issued on the 
date of the modification. However, the penalty provided in section 6677 
applies only to a failure to report transfers in exchange for 
obligations issued after August 20, 1996.
    (2) The rules of Sec. 1.679-5 apply to persons whose residency 
starting date is after August 7, 2000.
    (3) The rules of Sec. 1.679-6 apply to trusts that become foreign 
trusts after August 7, 2000.

[T.D. 8955, 66 FR 37889, July 20, 2001]

                              miscellaneous



Sec. 1.681(a)-1  Limitation on charitable contributions deductions of
trusts; scope of section 681.

    Under section 681, the unlimited charitable contributions deduction 
otherwise allowable to a trust under section 642(c) is, in general, 
subject to percentage limitations, corresponding to those applicable to 
contributions by an individual under section 170(b)(1) (A) and (B), 
under the following circumstances;
    (a) To the extent that the deduction is allocable to ``unrelated 
business income'';

[[Page 397]]

    (b) For taxable years beginning before January 1, 1970, if the trust 
has engaged in a prohibited transaction;
    (c) For taxable years beginning before January 1, 1970, if income is 
accumulated for a charitable purpose and the accumulation is (1) 
unreasonable, (2) substantially diverted to a noncharitable purpose, or 
(3) invested against the interests of the charitable beneficiaries.

Further, if the circumstance set forth in paragraph (a) or (c) of this 
section is applicable, the deduction is limited to income actually paid 
out for charitable purposes, and is not allowed for income only set 
aside or to be used for those purposes. If the circumstance set forth in 
paragraph (b) of this section is applicable, deductions for 
contributions to the trust may be disallowed. The provisions of section 
681 are discussed in detail in Sec. Sec. 1.681(a)-2 through 1.681(c)-1. 
For definition of the term ``income'', see section 643(b) and Sec. 
1.643(b)-1.

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



Sec. 1.681(a)-2  Limitation on charitable contributions deduction of 
trusts with trade or business income.

    (a) In general. No charitable contributions deduction is allowable 
to a trust under section 642(c) for any taxable year for amounts 
allocable to the trust's unrelated business income for the taxable year. 
For the purpose of section 681(a) the term unrelated business income of 
a trust means an amount which would be computed as the trust's unrelated 
business taxable income under section 512 and the regulations 
thereunder, if the trust were an organization exempt from tax under 
section 501(a) by reason of section 501(c)(3). For the purpose of the 
computation under section 512, the term unrelated trade or business 
includes a trade or business carried on by a partnership of which a 
trust is a member, as well as one carried on by the trust itself. While 
the charitable contributions deduction under section 642(c) is entirely 
disallowed by section 681(a) for amounts allocable to ``unrelated 
business income'', a partial deduction is nevertheless allowed for such 
amounts by the operation of section 512(b)(11), as illustrated in 
paragraphs (b) and (c) of this section. This partial deduction is 
subject to the percentage limitations applicable to contributions by an 
individual under section 170(b)(1) (A) and (B), and is not allowed for 
amounts set aside or to be used for charitable purposes but not actually 
paid out during the taxable year. Charitable contributions deductions 
otherwise allowable under section 170, 545(b)(2), or 642(c) for 
contributions to a trust are not disallowed solely because the trust has 
unrelated business income.
    (b) Determination of amounts allocable to unrelated business income. 
In determining the amount for which a charitable contributions deduction 
would otherwise be allowable under section 642(c) which are allocable to 
unrelated business income, and therefore not allowable as a deduction, 
the following steps are taken:
    (1) There is first determined the amount which would be computed as 
the trust's unrelated business taxable income under section 512 and the 
regulations thereunder if the trust were an organization exempt from tax 
under section 501(a) by reason of section 501(c)(3), but without taking 
the charitable contributions deduction allowed under section 512(b)(11).
    (2) The amount for which a charitable contributions deduction would 
otherwise be allowable under section 642(c) is then allocated between 
the amount determined in subparagraph (1) of this paragraph and any 
other income of the trust. Unless the facts clearly indicate to the 
contrary, the allocation to the amount determined in subparagraph (1) of 
this paragraph is made on the basis of the ratio (but not in excess of 
100 percent) of the amount determined in subparagraph (1) of this 
paragraph to the taxable income of the trust, determined without the 
deduction for personal exemption under section 642(b), the charitable 
contributions deduction under section 642(c), or the deduction for 
distributions to beneficiaries under section 661(a).
    (3) The amount for which a charitable contributions deduction would 
otherwise be allowable under section 642(c) which is allocable to 
unrelated business income as determined in subparagraph (2) of this 
paragraph, and

[[Page 398]]

therefore not allowable as a deduction, is the amount determined in 
subparagraph (2) of this paragraph reduced by the charitable 
contributions deduction which would be allowed under section 512(b)(11) 
if the trust were an organization exempt from tax under section 501(a) 
by reason of section 501(c)(3).
    (c) Examples. (1) The application of this section may be illustrated 
by the following examples, in which it is assumed that the Y charity is 
not a charitable organization qualifying under section 170(b)(1)(A) (see 
subparagraph (2) of this paragraph):

    Example 1. The X trust has income of $50,000. There is included in 
this amount a net profit of $31,000 from the operation of a trade or 
business. The trustee is required to pay half of the trust income to A, 
an individual, and the balance of the trust income to the Y charity, an 
organization described in section 170(c)(2). The trustee pays each 
beneficiary $25,000. Under these facts, the unrelated business income of 
the trust (computed before the charitable contributions deduction which 
would be allowed under section 512(b)(11)) is $30,000 ($31,000 less the 
deduction of $1,000 allowed by section 512(b)(12)). The deduction 
otherwise allowable under section 642(c) is $25,000, the amount paid to 
the Y charity. The portion allocable to the unrelated business income 
(computed as prescribed in paragraph (b)(2) of this section) is $15,000, 
that is, an amount which bears the same ratio to $25,000 as $30,000 
bears to $50,000. The portion allocable to the unrelated business 
income, and therefore disallowed as a deduction, is $15,000 reduced by 
$6,000 (20 percent of $30,000, the charitable contributions deduction 
which would be allowable under section 512(b)(11)), or $9,000.
    Example 2. Assume the same facts as in example 1, except that the 
trustee has discretion as to the portion of the trust income to be paid 
to each beneficiary, and the trustee pays $40,000 to A and $10,000 to 
the Y charity. The deduction otherwise allowable under section 642(c) is 
$10,000. The portion allocable to the unrelated business income computed 
as prescribed in paragraph (b)(2) of this section is $6,000, that is, an 
amount which bears the same ratio to $10,000 as $30,000 bears to 
$50,000. Since this amount does not exceed the charitable contributions 
deduction which would be allowable under section 512(b)(11) ($6,000, 
determined as in example 1), no portion of it is disallowed as a 
deduction.
    Example 3. Assume the same facts as in example 1, except that the 
terms of the trust instrument require the trustee to pay to the Y 
charity the trust income, if any, derived from the trade or business, 
and to pay to A all the trust income derived from other sources. The 
trustee pays $31,000 to the Y charity and $19,000 to A. The deduction 
otherwise allowable under section 642(c) is $31,000. Since the entire 
income from the trade or business is paid to Y charity, the amount 
allocable to the unrelated business income computed before the 
charitable contributions deduction under section 512(b)(11) is $30,000 
($31,000 less the deduction of $1,000 allowed by section 512(b)(12)). 
The amount allocable to the unrelated business income and therefore 
disallowed as a deduction is $24,000 ($30,000 less $6,000).
    Example 4. (i) Under the terms of the trust, the trustee is required 
to pay half of the trust income to A, an individual, for his life, and 
the balance of the trust income to the Y charity, an organization 
described in section 170(c)(2). Capital gains are allocable to corpus 
and upon A's death the trust is to terminate and the corpus is to be 
distributed to the Y charity. The trust has taxable income of $50,000 
computed without any deduction for personal exemption, charitable 
contributions, or distributions. The amount of $50,000 includes $10,000 
capital gains, $30,000 ($31,000 less the $1,000 deduction allowed under 
section 512(b)(12)) unrelated business income (computed before the 
charitable contributions deduction which would be allowed under section 
512(b)(11)) and other income of $9,000. The trustee pays each 
beneficiary $20,000.
    (ii) The deduction otherwise allowable under section 642(c) is 
$30,000 ($20,000 paid to Y charity and $10,000 capital gains allocated 
to corpus and permanently set aside for charitable purposes). The 
portion allocable to the unrelated business income is $15,000, that is, 
an amount which bears the same ratio to $20,000 (the amount paid to Y 
charity) as $30,000 bears to $40,000 ($50,000 less $10,000 capital gains 
allocable to corpus). The portion allocable to the unrelated business 
income, and therefore disallowed as a deduction, is $15,000 reduced by 
$6,000 (the charitable contributions deduction which would be allowable 
under section 512(b)(11)), or $9,000.

    (2) If, in the examples in subparagraph (1) of this paragraph, the Y 
charity were a charitable organization qualifying under section 
170(b)(1)(A), then the deduction allowable under section 512(b)(11) 
would be computed at a rate of 30 percent.

[T.D. 6500, 25 FR 11814, Nov. 26, 1960, as amended by T.D. 6605, 27 FR 
8097, Aug. 15, 1962]

[[Page 399]]



Sec. 1.681(b)-1  Cross reference.

    For disallowance of certain charitable, etc., deductions otherwise 
allowable under section 642(c), see sections 508(d) and 4948(c)(4). See 
also 26 CFR 1.681(b)-1 and 1.681(c)-1 (rev. as of Apr. 1, 1974) for 
provisions applying before January 1, 1970.

[T.D. 7428, 41 FR 34627, Aug. 16, 1976]



Sec. 1.682(a)-1  Income of trust in case of divorce, etc.

    (a) In general. (1) Section 682(a) provides rules in certain cases 
for determining the taxability of income of trusts as between spouses 
who are divorced, or who are separated under a decree of separate 
maintenance or a written separation agreement. In such cases, the spouse 
actually entitled to receive payments from the trust is considered the 
beneficiary rather than the spouse in discharge of whose obligations the 
payments are made, except to the extent that the payments are specified 
to be for the support of the obligor spouse's minor children in the 
divorce or separate maintenance decree, the separation agreement or the 
governing trust instrument. For convenience, the beneficiary spouse will 
hereafter in this section and in Sec. 1.682(b)-1 be referred to as the 
``wife'' and the obligor spouse from whom she is divorced or legally 
separated as the ``husband''. (See section 7701(a)(17).) Thus, under 
section 682(a) income of a trust:
    (i) Which is paid, credited, or required to be distributed to the 
wife in a taxable year of the wife, and
    (ii) Which, except for the provisions of section 682, would be 
includible in the gross income of her husband,

is includible in her gross income and is not includible in his gross 
income.
    (2) Section 682(a) does not apply in any case to which section 71 
applies. Although section 682(a) and section 71 seemingly cover some of 
the same situations, there are important differences between them. Thus, 
section 682(a) applies, for example, to a trust created before the 
divorce or separation and not in contemplation of it, while section 71 
applies only if the creation of the trust or payments by a previously 
created trust are in discharge of an obligation imposed upon or assumed 
by the husband (or made specific) under the court order or decree 
divorcing or legally separating the husband and wife, or a written 
instrument incident to the divorce status or legal separation status, or 
a written separation agreement. If section 71 applies, it requires 
inclusion in the wife's income of the full amount of periodic payments 
received attributable to property in trust (whether or not out of trust 
income), while, if section 71 does not apply, section 682(a) requires 
amounts paid, credited, or required to be distributed to her to be 
included only to the extent they are includible in the taxable income of 
a trust beneficiary under subparts A through D (section 641 and 
following), part I, subchapter J, chapter 1 of the Code.
    (3) Section 682(a) is designed to produce uniformity as between 
cases in which, without section 682(a), the income of a so-called 
alimony trust would be taxable to the husband because of his continuing 
obligation to support his wife or former wife, and other cases in which 
the income of a so-called alimony trust is taxable to the wife or former 
wife because of the termination of the husband's obligation. 
Furthermore, section 682(a) taxes trust income to the wife in all cases 
in which the husband would otherwise be taxed not only because of the 
discharge of his alimony obligation but also because of his retention of 
control over the trust income or corpus. Section 682(a) applies whether 
the wife is the beneficiary under the terms of the trust instrument or 
is an assignee of a beneficiary.
    (4) The application of section 682(a) may be illustrated by the 
following examples, in which it is assumed that both the husband and 
wife make their income tax returns on a calendar year basis:

    Example 1. Upon the marriage of H and W, H irrevocably transfers 
property in trust to pay the income to W for her life for support, 
maintenance, and all other expenses. Some years later, W obtains a legal 
separation from H under an order of court. W, relying upon the income 
from the trust payable to her, does not ask for any provision for her 
support and the decree recites that since W is adequately provided for 
by the trust, no further provision is being made for her. Under these 
facts, section 682(a), rather than

[[Page 400]]

section 71, is applicable. Under the provisions of section 682(a), the 
income of the trust which becomes payable to W after the order of 
separation is includible in her income and is deductible by the trust. 
No part of the income is includible in H's income or deductible by him.
    Example 2. H transfers property in trust for the benefit of W, 
retaining the power to revoke the trust at any time. H, however, 
promises that if he revokes the trust he will transfer to W property in 
the value of $100,000. The transfer in trust and the agreement were not 
incident to divorce, but some years later W divorces H. The court decree 
is silent as to alimony and the trust. After the divorce, income of the 
trust which becomes payable to W is taxable to her, and is not taxable 
to H or deductible by him. If H later terminates the trust and transfers 
$100,000 of property to W, the $100,000 is not income to W nor 
deductible by H.

    (b) Alimony trust income designated for support of minor children. 
Section 682(a) does not require the inclusion in the wife's income of 
trust income which the terms of the divorce or separate maintenance 
decree, separation agreement, or trust instrument fix in terms of an 
amount of money or a portion of the income as a sum which is payable for 
the support of minor children of the husband. The portion of the income 
which is payable for the support of the minor children is includible in 
the husband's income. If in such a case trust income fixed in terms of 
an amount of money is to be paid but a lesser amount becomes payable, 
the trust income is considered to be payable for the support of the 
husband's minor children to the extent of the sum which would be payable 
for their support out of the originally specified amount of trust 
income. This rule is similar to that provided in the case of periodic 
payments under section 71. See Sec. 1.71-1.



Sec. 1.682(b)-1  Application of trust rules to alimony payments.

    (a) For the purpose of the application of subparts A through D 
(section 641 and following), part I, subchapter J, chapter 1 of the 
Code, the wife described in section 682 or section 71 who is entitled to 
receive payments attributable to property in trust is considered a 
beneficiary of the trust, whether or not the payments are made for the 
benefit of the husband in discharge of his obligations. A wife treated 
as a beneficiary of a trust under this section is also treated as the 
beneficiary of such trust for purposes of the tax imposed by section 56 
(relating to the minimum tax for tax preferences). For rules relating to 
the treatment of items of tax preference with respect to a beneficiary 
of a trust, see Sec. 1.58-3.
    (b) A periodic payment includible in the wife's gross income under 
section 71 attributable to property in trust is included in full in her 
gross income in her taxable year in which any part is required to be 
included under section 652 or 662. Assume, for example, in a case in 
which both the wife and the trust file income tax returns on the 
calendar year basis, that an annuity of $5,000 is to be paid to the wife 
by the trustee every December 31 (out of trust income if possible and, 
if not, out of corpus) pursuant to the terms of a divorce decree. Of the 
$5,000 distributable on December 31, 1954, $4,000 is payable out of 
income and $1,000 out of corpus. The actual distribution is made in 
1955. Although the periodic payment is received by the wife in 1955, 
since under section 662 the $4,000 income distributable on December 31, 
1954, is to be included in the wife's income for 1954, the $1,000 
payment out of corpus is also to be included in her income for 1954.

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



Sec. 1.682(c)-1  Definitions.

    For definitions of the terms ``husband'' and ``wife'' as used in 
section 682, see section 7701(a)(17) and the regulations thereunder.



Sec. 1.683-1  Applicability of provisions; general rule.

    Part I (section 641 and following), subchapter J, chapter 1 of the 
Code, applies to estates and trusts and to beneficiaries only with 
respect to taxable years which begin after December 31, 1953, and end 
after August 16, 1954 the date of enactment of the Internal Revenue Code 
of 1954. In the case of an estate or trust, the date on which a trust is 
created or amended or on which an estate commences, and the taxable 
years of beneficiaries, grantors, or decedents concerned are immaterial. 
This provision applies equally to taxable

[[Page 401]]

years of normal and of abbreviated length.



Sec. 1.683-2  Exceptions.

    (a) In the case of any beneficiary of an estate or trust, sections 
641 through 682 do not apply to any amount paid, credited, or to be 
distributed by an estate or trust in any taxable year of the estate or 
trust which begins before January 1, 1954, or which ends before August 
17, 1954. Whether an amount so paid, credited, or to be distributed is 
to be included in the gross income of a beneficiary is determined with 
reference to the Internal Revenue Code of 1939. Thus, if a trust in its 
fiscal year ending June 30, 1954, distributed its current income to a 
beneficiary on June 30, 1954, the extent to which the distribution is 
includible in the beneficiary's gross income for his taxable year (the 
calendar year 1954) and the character of such income will be determined 
under the Internal Revenue Code of 1939. The Internal Revenue Code of 
1954, however, determines the beneficiary's tax liability for a taxable 
year of the beneficiary to which such Code applies, with respect even to 
gross income of the beneficiary determined under the Internal Revenue 
Code of 1939 in accordance with this paragraph. Accordingly, the 
beneficiary is allowed credits and deductions pursuant to the Internal 
Revenue Code of 1954 for a taxable year governed by the Internal Revenue 
Code of 1954. See subparagraph (ii) of example (1) in paragraph (c) of 
this section.
    (b) For purposes of determining the time of receipt of dividends 
under sections 34 (for purposes of the credit for dividends received on 
or before December 31, 1964) and 116, the dividends paid, credited, or 
to be distributed to a beneficiary are deemed to have been received by 
the beneficiary ratably on the same dates that the dividends were 
received by the estate or trust.
    (c) The application of this section may be illustrated by the 
following examples:

    Example 1. (i) A trust, reporting on the fiscal year basis, receives 
in its taxable year ending November 30, 1954, dividends on December 3, 
1953, and April 3, July 5, and October 4, 1954. It distributes the 
dividends to A, its sole beneficiary (who reports on the calendar year 
basis) on November 30, 1954. Since the trust has received dividends in a 
taxable year ending after July 31, 1954, it will receive a dividend 
credit under section 34 with respect to dividends received which 
otherwise qualify under that section, in this case dividends received on 
October 4, 1954 (i. e., received after July 31, 1954). See section 
7851(a)(1)(C). This credit, however, is reduced to the extent the 
dividends are allocable to the beneficiary as a result of income being 
paid, credited, or required to be distributed to him. The trust will 
also be permitted the dividend exclusion under section 116, since it 
received its dividends in a taxable year ending after July 31, 1954.
    (ii) A is entitled to the section 34 credit with respect to the 
portion of the October 4, 1954, dividends which is distributed to him 
even though the determination of whether the amount distributed to him 
is includible in his gross income is made under the Internal Revenue 
Code of 1939. The credit allowable to the trust is reduced 
proportionately to the extent A is deemed to have received the October 4 
dividends. A is not entitled to a credit with respect to the dividends 
received by the trust on December 3, 1953, and April 3, and July 5, 
1954, because, although he receives after July 31, 1954, the 
distribution resulting from the trust's receipt of dividends, he is 
deemed to have received the dividends ratably with the trust on dates 
prior to July 31, 1954. In determining the exclusion under section 116 
to which he is entitled, all the dividends received by the trust in 1954 
and distributed to him are aggregated with any other dividends received 
by him in 1954, since he is deemed to have received such dividends in 
1954 and therefore within a taxable year ending after July 31, 1954. He 
is not, however, entitled to the exclusion for the dividends received by 
the trust in December 1953.
    Example 2. (i) A simple trust reports on the basis of a fiscal year 
ending July 31. It receives dividends on October 3, 1953, and January 4, 
April 3, and July 5, 1954. It distributes the dividends to A, its sole 
beneficiary, on September 1, 1954. The trust, receiving dividends in a 
taxable year ending prior to August 17, 1954, is entitled neither to the 
dividend received credit under section 34 nor the dividend exclusion 
under section 116.
    (ii) A (reporting on the calendar year basis) is not entitled to the 
section 34 credit, because, although he receives after July 31, 1954, 
the distribution resulting from the trust's receipt of dividends, he is 
deemed to have received the dividends ratably with the trust, that is, 
on October 3, 1953, and January 4, April 3, and July 5, 1954. He is, 
however, entitled to the section 116 exclusion with respect to the 
dividends received by the trust in 1954 (along with other dividends 
received by him in 1954) and distributed to him, since he is deemed to 
have received

[[Page 402]]

such dividends on January 4, April 3, and July 5, 1954, each a date in 
this taxable year ending after July 31, 1954. He is entitled to no 
exclusion for the dividends received by the trust on October 3, 1953, 
since he is deemed to receive the resulting distribution on the same 
date, which falls within a taxable year of his which ends before August 
1, 1954, although he is required to include the October 1953 dividends 
in his 1954 income. See section 164 of the Internal Revenue Code of 
1939.
    Example 3. A simple trust on a fiscal year ending July 31, 1954, 
receives dividends August 5 and November 4, 1953. It distributes the 
dividends to A, its sole beneficiary (who is on a calendar year basis), 
on September 1, 1954. Neither the trust nor A is entitled to a credit 
under section 34 or an exclusion under section 116.

[T.D. 6500, 25 FR 11814, Nov. 26, 1960, as amended by T.D. 6777, 29 FR 
17809, Dec. 16, 1964]



Sec. 1.683-3  Application of the 65-day rule of the Internal Revenue
Code of 1939.

    If an amount is paid, credited, or to be distributed in the first 65 
days of the first taxable year of an estate or trust (heretofore subject 
to the provisions of the Internal Revenue Code of 1939) to which the 
Internal Revenue Code of 1954 applies and the amount would be treated, 
if the Internal Revenue Code of 1939 were applicable, as if paid, 
credited, or to be distributed on the last day of the preceding taxable 
year, sections 641 through 682 do not apply to the amount. The amount so 
paid, credited, or to be distributed is taken into account as provided 
in the Internal Revenue Code of 1939. See 26 CFR (1939) 39.162-2 (c) and 
(d) (Regulations 118).



Sec. 1.684-1  Recognition of gain on transfers to certain foreign
trusts and estates.

    (a) Immediate recognition of gain--(1) In general. Any U.S. person 
who transfers property to a foreign trust or foreign estate shall be 
required to recognize gain at the time of the transfer equal to the 
excess of the fair market value of the property transferred over the 
adjusted basis (for purposes of determining gain) of such property in 
the hands of the U.S. transferor unless an exception applies under the 
provisions of Sec. 1.684-3. The amount of gain recognized is determined 
on an asset-by-asset basis.
    (2) No recognition of loss. Under this section a U.S. person may not 
recognize loss on the transfer of an asset to a foreign trust or foreign 
estate. A U.S. person may not offset gain realized on the transfer of an 
appreciated asset to a foreign trust or foreign estate by a loss 
realized on the transfer of a depreciated asset to the foreign trust or 
foreign estate.
    (b) Definitions. The following definitions apply for purposes of 
this section:
    (1) U.S. person. The term U.S. person means a United States person 
as defined in section 7701(a)(30), and includes a nonresident alien 
individual who elects under section 6013(g) to be treated as a resident 
of the United States.
    (2) U.S. transferor. The term U.S. transferor means any U.S. person 
who makes a transfer (as defined in Sec. 1.684-2) of property to a 
foreign trust or foreign estate.
    (3) Foreign trust. Section 7701(a)(31)(B) defines foreign trust. See 
also Sec. 301.7701-7 of this chapter.
    (4) Foreign estate. Section 7701(a)(31)(A) defines foreign estate.
    (c) Reporting requirements. A U.S. person who transfers property to 
a foreign trust or foreign estate must comply with the reporting 
requirements under section 6048.
    (d) Examples. The following examples illustrate the rules of this 
section. In all examples, A is a U.S. person and FT is a foreign trust. 
The examples are as follows:

    Example 1. Transfer to foreign trust. A transfers property that has 
a fair market value of 1000X to FT. A's adjusted basis in the property 
is 400X. FT has no U.S. beneficiary within the meaning of Sec. 1.679-2, 
and no person is treated as owning any portion of FT. Under paragraph 
(a)(1) of this section, A recognizes gain at the time of the transfer 
equal to 600X.
    Example 2. Transfer of multiple properties. A transfers property Q, 
with a fair market value of 1000X, and property R, with a fair market 
value of 2000X, to FT. At the time of the transfer, A's adjusted basis 
in property Q is 700X, and A's adjusted basis in property R is 2200X. FT 
has no U.S. beneficiary within the meaning of Sec. 1.679-2, and no 
person is treated as owning any portion of FT. Under paragraph (a)(1) of 
this section, A recognizes the 300X of gain attributable to property Q. 
Under paragraph (a)(2) of this section, A does not recognize the 200X of 
loss attributable to

[[Page 403]]

property R, and may not offset that loss against the gain attributable 
to property Q.
    Example 3. Transfer for less than fair market value. A transfers 
property that has a fair market value of 1000X to FT in exchange for 
400X of cash. A's adjusted basis in the property is 200X. FT has no U.S. 
beneficiary within the meaning of Sec. 1.679-2, and no person is 
treated as owning any portion of FT. Under paragraph (a)(1) of this 
section, A recognizes gain at the time of the transfer equal to 800X.
    Example 4. Exchange of property for private annuity. A transfers 
property that has a fair market value of 1000X to FT in exchange for 
FT's obligation to pay A 50X per year for the rest of A's life. A's 
adjusted basis in the property is 100X. FT has no U.S. beneficiary 
within the meaning of Sec. 1.679-2, and no person is treated as owning 
any portion of FT. A is required to recognize gain equal to 900X 
immediately upon transfer of the property to the trust. This result 
applies even though A might otherwise have been allowed to defer 
recognition of gain under another provision of the Internal Revenue 
Code.
    Example 5. Transfer of property to related foreign trust in exchange 
for qualified obligation. A transfers property that has a fair market 
value of 1000X to FT in exchange for FT's obligation to make payments to 
A during the next four years. FT is related to A as defined in Sec. 
1.679-1(c)(5). The obligation is treated as a qualified obligation 
within the meaning of Sec. 1.679-4(d), and no person is treated as 
owning any portion of FT. A's adjusted basis in the property is 100X. A 
is required to recognize gain equal to 900X immediately upon transfer of 
the property to the trust. This result applies even though A might 
otherwise have been allowed to defer recognition of gain under another 
provision of the Internal Revenue Code. Section 1.684-3(d) provides 
rules relating to transfers for fair market value to unrelated foreign 
trusts.

[T.D. 8956, 66 FR 37899, July 20, 2001]



Sec. 1.684-2  Transfers.

    (a) In general. A transfer means a direct, indirect, or constructive 
transfer.
    (b) Indirect transfers--(1) In general. Section 1.679-3(c) shall 
apply to determine if a transfer to a foreign trust or foreign estate, 
by any person, is treated as an indirect transfer by a U.S. person to 
the foreign trust or foreign estate.
    (2) Examples. The following examples illustrate the rules of this 
paragraph (b). In all examples, A is a U.S. citizen, FT is a foreign 
trust, and I is A's uncle, who is a nonresident alien. The examples are 
as follows:

    Example 1. Principal purpose of tax avoidance. A creates and funds 
FT for the benefit of A's cousin, who is a nonresident alien. FT has no 
U.S. beneficiary within the meaning of Sec. 1.679-2, and no person is 
treated as owning any portion of FT. In 2004, A decides to transfer 
additional property with a fair market value of 1000X and an adjusted 
basis of 600X to FT. Pursuant to a plan with a principal purpose of 
avoiding the application of section 684, A transfers the property to I. 
I subsequently transfers the property to FT. Under paragraph (b) of this 
section and Sec. 1.679-3(c), A is treated as having transferred the 
property to FT.
    Example 2. U.S. person unable to demonstrate that intermediary acted 
independently. A creates and funds FT for the benefit of A's cousin, who 
is a nonresident alien. FT has no U.S. beneficiary within the meaning of 
Sec. 1.679-2, and no person is treated as owning any portion of FT. On 
July 1, 2004, A transfers property with a fair market value of 1000X and 
an adjusted basis of 300X to I, a foreign person. On January 1, 2007, at 
a time when the fair market value of the property is 1100X, I transfers 
the property to FT. A is unable to demonstrate to the satisfaction of 
the Commissioner, under Sec. 1.679-3(c)(2)(ii), that I acted 
independently of A in making the transfer to FT. Under paragraph (b) of 
this section and Sec. 1.679-3(c), A is treated as having transferred 
the property to FT. Under paragraph (b) of this section and Sec. 1.679-
3(c)(3), I is treated as an agent of A, and the transfer is deemed to 
have been made on January 1, 2007. Under Sec. 1.684-1(a), A recognizes 
gain equal to 800X on that date.

    (c) Constructive transfers. Section 1.679-3(d) shall apply to 
determine if a transfer to a foreign trust or foreign estate is treated 
as a constructive transfer by a U.S. person to the foreign trust or 
foreign estate.
    (d) Transfers by certain trusts--(1) In general. If any portion of a 
trust is treated as owned by a U.S. person, a transfer of property from 
that portion of the trust to a foreign trust is treated as a transfer 
from the owner of that portion to the foreign trust.
    (2) Examples. The following examples illustrate the rules of this 
paragraph (d). In all examples, A is a U.S. person, DT is a domestic 
trust, and FT is a foreign trust. The examples are as follows:

    Example 1. Transfer by a domestic trust. On January 1, 2001, A 
transfers property which has a fair market value of 1000X and an 
adjusted basis of 200X to DT. A retains the power to revoke DT. On 
January 1, 2003, DT transfers property which has a fair market value of 
500X and an adjusted basis of 100X to

[[Page 404]]

FT. At the time of the transfer, FT has no U.S. beneficiary as defined 
in Sec. 1.679-2 and no person is treated as owning any portion of FT. A 
is treated as having transferred the property to FT and is required to 
recognize gain of 400X, under Sec. 1.684-1, at the time of the transfer 
by DT to FT.
    Example 2. Transfer by a foreign trust. On January 1, 2001, A 
transfers property which has a fair market value of 1000X and an 
adjusted basis of 200X to FT1. At the time of the transfer, FT1 has a 
U.S. beneficiary as defined in Sec. 1.679-2 and A is treated as the 
owner of FT1 under section 679. On January 1, 2003, FT1 transfers 
property which has a fair market value of 500X and an adjusted basis of 
100X to FT2. At the time of the transfer, FT2 has no U.S. beneficiary as 
defined in Sec. 1.679-2 and no person is treated as owning any portion 
of FT2. A is treated as having transferred the property to FT2 and is 
required to recognize gain of 400X, under Sec. 1.684-1, at the time of 
the transfer by FT1 to FT2.

    (e) Deemed transfers when foreign trust no longer treated as owned 
by a U.S. person--(1) In general. If any portion of a foreign trust is 
treated as owned by a U.S. person under subpart E of part I of 
subchapter J, chapter 1 of the Internal Revenue Code, and such portion 
ceases to be treated as owned by that person under such subpart (other 
than by reason of an actual transfer of property from the trust to which 
Sec. 1.684-2(d) applies), the U.S. person shall be treated as having 
transferred, immediately before (but on the same date that) the trust is 
no longer treated as owned by that U.S. person, the assets of such 
portion to a foreign trust.
    (2) Examples. The following examples illustrate the rules of this 
paragraph (e). In all examples, A is a U.S. citizen and FT is a foreign 
trust. The examples are as follows:

    Example 1. Loss of U.S. beneficiary. (i) On January 1, 2001, A 
transfers property, which has a fair market value of 1000X and an 
adjusted basis of 400X, to FT. At the time of the transfer, FT has a 
U.S. beneficiary within the meaning of Sec. 1.679-2, and A is treated 
as owning FT under section 679. Under Sec. 1.684-3(a), Sec. 1.684-1 
does not cause A to recognize gain at the time of the transfer.
    (ii) On July 1, 2003, FT ceases to have a U.S. beneficiary as 
defined in Sec. 1.679-2(c) and as of that date neither A nor any other 
person is treated as owning any portion of FT. Pursuant to Sec. 1.679-
2(c)(2), if FT ceases to be treated as having a U.S. beneficiary, A will 
cease to be treated as owner of FT beginning on the first day of the 
first taxable year following the last taxable year in which there was a 
U.S. beneficiary. Thus, on January 1, 2004, A ceases to be treated as 
owner of FT. On that date, the fair market value of the property is 
1200X and the adjusted basis is 350X. Under paragraph (e)(1) of this 
section, A is treated as having transferred the property to FT on 
January 1, 2004, and must recognize 850X of gain at that time under 
Sec. 1.684-1.
    Example 2. Death of grantor. (i) The initial facts are the same as 
in paragraph (i) of Example 1.
    (ii) On July 1, 2003, A dies, and as of that date no other person is 
treated as the owner of FT. On that date, the fair market value of the 
property is 1200X, and its adjusted basis equals 350X. Under paragraph 
(e)(1) of this section, A is treated as having transferred the property 
to FT immediately before his death, and generally is required to 
recognize 850X of gain at that time under Sec. 1.684-1. However, an 
exception may apply under Sec. 1.684-3(c).
    Example 3. Release of a power. (i) On January 1, 2001, A transfers 
property that has a fair market value of 500X and an adjusted basis of 
200X to FT. At the time of the transfer, FT does not have a U.S. 
beneficiary within the meaning of Sec. 1.679-2. However, A retains the 
power to revoke the trust. A is treated as the owner of the trust under 
section 676 and, therefore, under Sec. 1.684-3(a), A is not required to 
recognize gain under Sec. 1.684-1 at the time of the transfer.
    (ii) On January 1, 2007, A releases the power to revoke the trust 
and, as of that date, neither A nor any other person is treated as 
owning any portion of FT. On that date, the fair market value of the 
property is 900X, and its adjusted basis is 200X. Under paragraph (e)(1) 
of this section, A is treated as having transferred the property to FT 
on January 1, 2007, and must recognize 700X of gain at that time.

    (f) Transfers to entities owned by a foreign trust. Section 1.679-
3(f) provides rules that apply with respect to transfers of property by 
a U.S. person to an entity in which a foreign trust holds an ownership 
interest.

[T.D. 8956, 66 FR 37899, July 20, 2001]



Sec. 1.684-3  Exceptions to general rule of gain recognition.

    (a) Transfers to grantor trusts. The general rule of gain 
recognition under Sec. 1.684-1 shall not apply to any transfer of 
property by a U.S. person to a foreign trust to the extent that any 
person is treated as the owner of the trust under section 671. Section 
1.684-2(e)

[[Page 405]]

provides rules regarding a subsequent change in the status of the trust.
    (b) Transfers to charitable trusts. The general rule of gain 
recognition under Sec. 1.684-1 shall not apply to any transfer of 
property to a foreign trust that is described in section 501(c)(3) 
(without regard to the requirements of section 508(a)).
    (c) Certain transfers at death. The general rule of gain recognition 
under Sec. 1.684-1 shall not apply to any transfer of property by 
reason of death of the U.S. transferor if the basis of the property in 
the hands of the foreign trust is determined under section 1014(a).
    (d) Transfers for fair market value to unrelated trusts. The general 
rule of gain recognition under Sec. 1.684-1 shall not apply to any 
transfer of property for fair market value to a foreign trust that is 
not a related foreign trust as defined in Sec. 1.679-1(c)(5). Section 
1.671-2(e)(2)(ii) defines fair market value.
    (e) Transfers to which section 1032 applies. The general rule of 
gain recognition under Sec. 1.684-1 shall not apply to any transfer of 
stock (including treasury stock) by a domestic corporation to a foreign 
trust if the domestic corporation is not required to recognize gain on 
the transfer under section 1032.
    (f) Certain distributions to trusts. For purposes of this section, a 
transfer does not include a distribution to a trust with respect to an 
interest held by such trust in an entity other than a trust or an 
interest in certain investment trusts described in Sec. 301.7701-4(c) 
of this chapter, liquidating trusts described in Sec. 301.7701-4(d) of 
this chapter, or environmental remediation trusts described in Sec. 
301.7701-4(e) of this chapter.
    (g) Examples. The following examples illustrate the rules of this 
section. In all examples, A is a U.S. citizen and FT is a foreign trust. 
The examples are as follows:

    Example 1. Transfer to owner trust. In 2001, A transfers property 
which has a fair market value of 1000X and an adjusted basis equal to 
400X to FT. At the time of the transfer, FT has a U.S. beneficiary 
within the meaning of Sec. 1.679-2, and A is treated as owning FT under 
section 679. Under paragraph (a) of this section, Sec. 1.684-1 does not 
cause A to recognize gain at the time of the transfer. See Sec. 1.684-
2(e) for rules that may require A to recognize gain if the trust is no 
longer owned by A.
    Example 2. Transfer of property at death: Basis determined under 
section 1014(a). (i) The initial facts are the same as Example 1.
    (ii) A dies on July 1, 2004. The fair market value at A's death of 
all property transferred to FT by A is 1500X. The basis in the property 
is 400X. A retained the power to revoke FT, thus, the value of all 
property owned by FT at A's death is includible in A's gross estate for 
U.S. estate tax purposes. Pursuant to paragraph (c) of this section, A 
is not required to recognize gain under Sec. 1.684-1 because the basis 
of the property in the hands of the foreign trust is determined under 
section 1014(a).
    Example 3. Transfer of property at death: Basis not determined under 
section 1014(a). (i) The initial facts are the same as Example 1.
    (ii) A dies on July 1, 2004. The fair market value at A's death of 
all property transferred to FT by A is 1500X. The basis in the property 
is 400X. A retains no power over FT, and FT's basis in the property 
transferred is not determined under section 1014(a). Under Sec. 1.684-
2(e)(1), A is treated as having transferred the property to FT 
immediately before his death, and must recognize 1100X of gain at that 
time under Sec. 1.684-1.
    Example 4. Transfer of property for fair market value to an 
unrelated foreign trust. A sells a house with a fair market value of 
1000X to FT in exchange for a 30-year note issued by FT. A is not 
related to FT as defined in Sec. 1.679-1(c)(5). FT is not treated as 
owned by any person. Pursuant to paragraph (d) of this section, A is not 
required to recognize gain under Sec. 1.684-1.

[T.D. 8956, 66 FR 37899, July 20, 2001]



Sec. 1.684-4  Outbound migrations of domestic trusts.

    (a) In general. If a U.S. person transfers property to a domestic 
trust, and such trust becomes a foreign trust, and neither trust is 
treated as owned by any person under subpart E of part I of subchapter 
J, chapter 1 of the Internal Revenue Code, the trust shall be treated 
for purposes of this section as having transferred all of its assets to 
a foreign trust and the trust is required to recognize gain on the 
transfer under Sec. 1.684-1(a). The trust must also comply with the 
rules of section 6048.
    (b) Date of transfer. The transfer described in this section shall 
be deemed to occur immediately before, but on the same date that, the 
trust meets the definition of a foreign trust set forth in section 
7701(a)(31)(B).
    (c) Inadvertent migrations. In the event of an inadvertent 
migration, as

[[Page 406]]

defined in Sec. 301.7701-7(d)(2) of this chapter, a trust may avoid the 
application of this section by complying with the procedures set forth 
in Sec. 301.7701-7(d)(2) of this chapter.
    (d) Examples. The following examples illustrate the rules of this 
section. In all examples, A is a U.S. citizen, B is a U.S. citizen, C is 
a nonresident alien, and T is a trust. The examples are as follows:

    Example 1. Migration of domestic trust with U.S. beneficiaries. A 
transfers property which has a fair market value of 1000X and an 
adjusted basis equal to 400X to T, a domestic trust, for the benefit of 
A's children who are also U.S. citizens. B is the trustee of T. On 
January 1, 2001, while A is still alive, B resigns as trustee and C 
becomes successor trustee under the terms of the trust. Pursuant to 
Sec. 301.7701-7(d) of this chapter, T becomes a foreign trust. T has 
U.S. beneficiaries within the meaning of Sec. 1.679-2 and A is, 
therefore, treated as owning FT under section 679. Pursuant to Sec. 
1.684-3(a), neither A nor T is required to recognize gain at the time of 
the migration. Section 1.684-2(e) provides rules that may require A to 
recognize gain upon a subsequent change in the status of the trust.
    Example 2. Migration of domestic trust with no U.S. beneficiaries. A 
transfers property which has a fair market value of 1000X and an 
adjusted basis equal to 400X to T, a domestic trust for the benefit of 
A's mother who is not a citizen or resident of the United States. T is 
not treated as owned by another person. B is the trustee of T. On 
January 1, 2001, while A is still alive, B resigns as trustee and C 
becomes successor trustee under the terms of the trust. Pursuant to 
Sec. 301.7701-7(d) of this chapter, T becomes a foreign trust, FT. FT 
has no U.S. beneficiaries within the meaning of Sec. 1.679-2 and no 
person is treated as owning any portion of FT. T is required to 
recognize gain of 600X on January 1, 2001. Paragraph (c) of this section 
provides rules with respect to an inadvertent migration of a domestic 
trust.

[T.D. 8956, 66 FR 37899, July 20, 2001]



Sec. 1.684-5  Effective date.

    Sections 1.684-1 through 1.684-4 apply to transfers of property to 
foreign trusts and foreign estates after August 7, 2000.

[T.D. 8956, 66 FR 37899, July 20, 2001]

                     income in respect of decedents



Sec. 1.691(a)-1  Income in respect of a decedent.

    (a) Scope of section 691. In general, the regulations under section 
691 cover: (1) The provisions requiring that amounts which are not 
includible in gross income for the decedent's last taxable year or for a 
prior taxable year be included in the gross income of the estate or 
persons receiving such income to the extent that such amounts constitute 
``income in respect of a decedent''; (2) the taxable effect of a 
transfer of the right to such income; (3) the treatment of certain 
deductions and credit in respect of a decedent which are not allowable 
to the decedent for the taxable period ending with his death or for a 
prior taxable year; (4) the allowance to a recipient of income in 
respect of a decedent of a deduction for estate taxes attributable to 
the inclusion of the value of the right to such income in the decedent's 
estate; (5) special provisions with respect to installment obligations 
acquired from a decedent and with respect to the allowance of a 
deduction for estate taxes to a surviving annuitant under a joint and 
survivor annuity contract; and (6) special provisions relating to 
installment obligations transmitted at death when prior law applied to 
the transmission.
    (b) General definition. In general, the term income in respect of a 
decedent refers to those amounts to which a decedent was entitled as 
gross income but which were not properly includible in computing his 
taxable income for the taxable year ending with the date of his death or 
for a previous taxable year under the method of accounting employed by 
the decedent. See the regulations under section 451. Thus, the term 
includes:
    (1) All accrued income of a decedent who reported his income by use 
of the cash receipts and disbursements method;
    (2) Income accrued solely by reason of the decedent's death in case 
of a decedent who reports his income by use of an accrual method of 
accounting; and
    (3) Income to which the decedent had a contingent claim at the time 
of his death.

[[Page 407]]


See sections 736 and 753 and the regulations thereunder for ``income in 
respect of a decedent'' in the case of a deceased partner.
    (c) Prior decedent. The term income in respect of a decedent also 
includes the amount of all items of gross income in respect of a prior 
decedent, if (1) the right to receive such amount was acquired by the 
decedent by reason of the death of the prior decedent or by bequest, 
devise, or inheritance from the prior decedent and if (2) the amount of 
gross income in respect of the prior decedent was not properly 
includible in computing the decedent's taxable income for the taxable 
year ending with the date of his death or for a previous taxable year. 
See example 2 of paragraph (b) of Sec. 1.691(a)-2.
    (d) Items excluded from gross income. Section 691 applies only to 
the amount of items of gross income in respect of a decedent, and items 
which are excluded from gross income under subtitle A of the Code are 
not within the provisions of section 691.
    (e) Cross reference. For items deemed to be income in respect of a 
decedent for purposes of the deduction for estate taxes provided by 
section 691(c), see paragraph (c) of Sec. 1.691(c)-1.

[T.D. 6500, 25 FR 11814, Nov. 26, 1960, as amended by T.D. 6808, 30 FR 
3435, Mar. 16, 1965]



Sec. 1.691(a)-2  Inclusion in gross income by recipients.

    (a) Under section 691(a)(1), income in respect of a decedent shall 
be included in the gross income, for the taxable year when received, of:
    (1) The estate of the decedent, if the right to receive the amount 
is acquired by the decedent's estate from the decedent;
    (2) The person who, by reason of the death of the decedent, acquires 
the right to receive the amount, if the right to receive the amount is 
not acquired by the decedent's estate from the decedent; or
    (3) The person who acquires from the decedent the right to receive 
the amount by bequest, devise, or inheritance, if the amount is received 
after a distribution by the decedent's estate of such right.

These amounts are included in the income of the estate or of such 
persons when received by them whether or not they report income by use 
of the cash receipts and disbursements methods.
    (b) The application of paragraph (a) of this section may be 
illustrated by the following examples, in each of which it is assumed 
that the decedent kept his books by use of the cash receipts and 
disbursements method.

    Example 1. The decedent was entitled at the date of his death to a 
large salary payment to be made in equal annual installments over five 
years. His estate, after collecting two installments, distributed the 
right to the remaining installment payments to the residuary legatee of 
the estate. The estate must include in its gross income the two 
installments received by it, and the legatee must include in his gross 
income each of the three installments received by him.
    Example 2. A widow acquired, by bequest from her husband, the right 
to receive renewal commissions on life insurance sold by him in his 
lifetime, which commissions were payable over a period of years. The 
widow died before having received all of such commissions, and her son 
inherited the right to receive the rest of the commissions. The 
commissions received by the widow were includible in her gross income. 
The commissions received by the son were not includible in the widow's 
gross income but must be included in the gross income of the son.
    Example 3. The decedent owned a Series E United States savings bond, 
with his wife as co-owner or beneficiary, but died before the payment of 
such bond. The entire amount of interest accruing on the bond and not 
includible in income by the decedent, not just the amount accruing after 
the death of the decedent, would be treated as income to his wife when 
the bond is paid.
    Example 4. A, prior to his death, acquired 10,000 shares of the 
capital stock of the X Corporation at a cost of $100 per share. During 
his lifetime, A had entered into an agreement with X Corporation whereby 
X Corporation agreed to purchase and the decedent agreed that his 
executor would sell the 10,000 shares of X Corporation stock owned by 
him at the book value of the stock at the date of A's death. Upon A's 
death, the shares are sold by A's executor for $500 a share pursuant to 
the agreement. Since the sale of stock is consummated after A's death, 
there is no income in respect of a decedent with respect to the 
appreciation in value of A's stock to the date of his death. If, in this 
example, A had in fact sold the stock during his lifetime but payment 
had not been received before his death, any gain on the sale would 
constitute income in respect of a decedent when the proceeds were 
received.

[[Page 408]]

    Example 5. (1) A owned and operated an apple orchard. During his 
lifetime, A sold and delivered 1,000 bushels of apples to X, a canning 
factory, but did not receive payment before his death. A also entered 
into negotiations to sell 3,000 bushels of apples to Y, a canning 
factory, but did not complete the sale before his death. After A's 
death, the executor received payment from X. He also completed the sale 
to Y and transferred to Y 1,200 bushels of apples on hand at A's death 
and harvested and transferred an additional 1,800 bushels. The gain from 
the sale of apples by A to X constitutes income in respect of a decedent 
when received. On the other hand, the gain from the sale of apples by 
the executor to Y does not.
    (2) Assume that, instead of the transaction entered into with Y, A 
had disposed of the 1,200 bushels of harvested apples by delivering them 
to Z, a cooperative association, for processing and sale. Each year the 
association commingles the fruit received from all of its members into a 
pool and assigns to each member a percentage interest in the pool based 
on the fruit delivered by him. After the fruit is processed and the 
products are sold, the association distributes the net proceeds from the 
pool to its members in proportion to their interests in the pool. After 
A's death, the association made distributions to the executor with 
respect to A's share of the proceeds from the pool in which A had in 
interest. Under such circumstances, the proceeds from the disposition of 
the 1,200 bushels of apples constitute income in respect of a decedent.



Sec. 1.691(a)-3  Character of gross income.

    (a) The right to receive an amount of income in respect of a 
decedent shall be treated in the hands of the estate, or by the person 
entitled to receive such amount by bequest, devise, or inheritance from 
the decedent or by reason of his death, as if it had been acquired in 
the transaction by which the decedent (or a prior decedent) acquired 
such right, and shall be considered as having the same character it 
would have had if the decedent (or a prior decedent) had lived and 
received such amount. The provisions of section 1014(a), relating to the 
basis of property acquired from a decedent, do not apply to these 
amounts in the hands of the estate and such persons. See section 
1014(c).
    (b) The application of paragraph (a) of this section may be 
illustrated by the following:
    (1) If the income would have been capital gain to the decedent, if 
he had lived and had received it, from the sale of property, held for 
more than 1 year (6 months for taxable years beginning before 1977; 9 
months for taxable years beginning in 1977), the income, when received, 
shall be treated in the hands of the estate or of such person as capital 
gain from the sale of the property, held for more than 1 year (6 months 
for taxable years beginning before 1977; 9 months for taxable years 
beginning in 1977), in the same manner as if such person had held the 
property for the period the decedent held it, and had made the sale.
    (2) If the income is interest on United States obligations which 
were owned by the decedent, such income shall be treated as interest on 
United States obligations in the hands of the person receiving it, for 
the purpose of determining the credit provided by section 35, as if such 
person had owned the obligations with respect to which such interest is 
paid.
    (3) If the amounts received would be subject to special treatment 
under part I (section 1301 and following), subchapter Q, chapter 1 of 
the Code, relating to income attributable to serveral taxable years, as 
in effect for taxable years beginning before January 1, 1964, if the 
decedent had lived and included such amounts in his gross income, such 
sections apply with respect to the recipient of the income.
    (4) The provisions of sections 632 and 1347, relating to the tax 
attributable to the sale of certain oil or gas property and to certain 
claims against the United States, apply to any amount included in gross 
income, the right to which was obtained by the decedent by a sale or 
claim within the provisions of those sections.

[T.D. 6500, 25 FR 11814, Nov. 26, 1960, as amended by T.D. 6885, 31 FR 
7803, June 2, 1966; T.D. 7728, 45 FR 72650, Nov. 3, 1980]



Sec. 1.691(a)-4  Transfer of right to income in respect of a decedent.

    (a) Section 691(a)(2) provides the rules governing the treatment of 
income in respect of a decedent (or a prior decedent) in the event a 
right to receive such income is transferred by the estate or person 
entitled thereto by bequest, devise, or inheritance, or by reason of the 
death of the decedent. In general, the transferor must include in

[[Page 409]]

his gross income for the taxable period in which the transfer occurs the 
amount of the consideration, if any, received for the right or the fair 
market value of the right at the time of the transfer, whichever is 
greater. Thus, upon a sale of such right by the estate or person 
entitled to receive it, the fair market value of the right or the amount 
received upon the sale, whichever is greater, is included in the gross 
income of the vendor. Similarly, if such right is disposed of by gift, 
the fair market value of the right at the time of the gift must be 
included in the gross income of the donor. In the case of a satisfaction 
of an installment obligation at other than face value, which is likewise 
considered a transfer under section 691(a)(2), see Sec. 1.691(a)-5.
    (b) If the estate of a decedent or any person transmits the right to 
income in respect of a decedent to another who would be required by 
section 691(a)(1) to include such income when received in his gross 
income, only the transferee will include such income when received in 
his gross income. In this situation, a transfer within the meaning of 
section 691(a)(2) has not occurred. This paragraph may be illustrated by 
the following:
    (1) If a person entitled to income in respect of a decedent dies 
before receiving such income, only his estate or other person entitled 
to such income by bequest, devise, or inheritance from the latter 
decedent, or by reason of the death of the latter decedent, must include 
such amount in gross income when received.
    (2) If a right to income in respect of a decedent is transferred by 
an estate to a specific or residuary legatee, only the specific or 
residuary legatee must include such income in gross income when 
received.
    (3) If a trust to which is bequeathed a right of a decedent to 
certain payments of income terminates and transfers the right to a 
beneficiary, only the beneficiary must include such income in gross 
income when received.

If the transferee described in subparagraphs (1), (2), and (3) of this 
paragraph transfers his right to receive the amounts in the manner 
described in paragraph (a) of this section, the principles contained in 
paragraph (a) are applied to such transfer. On the other hand, if the 
transferee transmits his right in the manner described in this 
paragraph, the principles of this paragraph are again applied to such 
transfer.



Sec. 1.691(a)-5  Installment obligations acquired from decedent.

    (a) Section 691(a)(4) has reference to an installment obligation 
which remains uncollected by a decedent (or a prior decedent) and which 
was originally acquired in a transaction the income from which was 
properly reportable by the decedent on the installment method under 
section 453. Under the provisions of section 691(a)(4), an amount equal 
to the excess of the face value of the obligation over its basis in the 
hands of the decedent (determined under section 453(d)(2) and the 
regulations thereunder) shall be considered an amount of income in 
respect of a decedent and shall be treated as such. The decedent's 
estate (or the person entitled to receive such income by bequest or 
inheritance from the decedent or by reason of the decedent's death) 
shall include in its gross income when received the same proportion of 
any payment in satisfaction of such obligations as would be returnable 
as income by the decedent if he had lived and received such payment. No 
gain on account of the transmission of such obligations by the 
decedent's death is required to be reported as income in the return of 
the decedent for the year of his death. See Sec. 1.691(e)-1 for special 
provisions relating to the filing of an election to have the provisions 
of section 691(a)(4) apply in the case of installment obligations in 
respect of which section 44(d) of the Internal Revenue Code of 1939 (or 
corresponding provisions of prior law) would have applied but for the 
filing of a bond referred to therein.
    (b) If an installment obligation described in paragraph (a) of this 
section is transferred within the meaning of section 691(a)(2) and 
paragraph (a) of Sec. 1.691(a)-4, the entire installment obligation 
transferred shall be considered a right to income in respect of a 
decedent but the amount includible in the gross income of the transferor 
shall be reduced by an amount equal to the

[[Page 410]]

basis of the obligation in the hands of the decedent (determined under 
section 453(d)(2) and the regulations thereunder) adjusted, however, to 
take into account the receipt of any installment payments after the 
decedent's death and before such transfer. Thus, the amount includible 
in the gross income of the transferor shall be the fair market value of 
such obligation at the time of the transfer or the consideration 
received for the transfer of the installment obligation, whichever is 
greater, reduced by the basis of the obligation as described in the 
preceding sentence. For purposes of this paragraph, the term 
``transfer'' in section 691(a)(2) and paragraph (a) of Sec. 1.691(a)-4 
includes the satisfaction of an installment obligation at other than 
face value.
    (c) The application of this section may be illustrated by the 
following example:

    Example. An heir of a decedent is entitled to collect an installment 
obligation with a face value of $100, a fair market value of $80, and a 
basis in the hands of the decedent of $60. If the heir collects the 
obligation at face value, the excess of the amount collected over the 
basis is considered income in respect of a decedent and includible in 
the gross income of the heir under section 691(a)(1). In this case, the 
amount includible would be $40 ($100 less $60). If the heir collects the 
obligation at $90, an amount other than face value, the entire 
obligation is considered a right to receive income in respect of a 
decedent but the amount ordinarily required to be included in the heir's 
gross income under section 691(a)(2) (namely, the consideration received 
in satisfaction of the installment obligation or its fair market value, 
whichever is greater) shall be reduced by the amount of the basis of the 
obligation in the hands of the decedent. In this case, the amount 
includible would be $30 ($90 less $60).

[T.D. 6500, 25 FR 11814, Nov. 26, 1960, as amended by T.D. 6808, 30 FR 
3435, Mar. 16, 1965]



Sec. 1.691(b)-1  Allowance of deductions and credit in respect to decedents.

    (a) Under section 691(b) the expenses, interest, and taxes described 
in sections 162, 163, 164, and 212 for which the decedent (or a prior 
decedent) was liable, which were not properly allowable as a deduction 
in his last taxable year or any prior taxable year, are allowed when 
paid:
    (1) As a deduction by the estate; or
    (2) If the estate was not liable to pay such obligation, as a 
deduction by the person who by bequest, devise, or inheritance from the 
decedent or by reason of the death of the decedent acquires, subject to 
such obligation, an interest in property of the decedent (or the prior 
decedent).

Similar treatment is given to the foreign tax credit provided by section 
33. For the purposes of subparagraph (2) of this paragraph, the right to 
receive an amount of gross income in respect of a decedent is considered 
property of the decedent; on the other hand, it is not necessary for a 
person, otherwise within the provisions of subparagraph (2) of this 
paragraph, to receive the right to any income in respect of a decedent. 
Thus, an heir who receives a right to income in respect of a decedent 
(by reason of the death of the decedent) subject to any income tax 
imposed by a foreign country during the decedent's life, which tax must 
be satisfied out of such income, is entitled to the credit provided by 
section 33 when he pays the tax. If a decedent who reported income by 
use of the cash receipts and disbursements method owned real property on 
which accrued taxes had become a lien, and if such property passed 
directly to the heir of the decedent in a jurisdiction in which real 
property does not become a part of a decedent's estate, the heir, upon 
paying such taxes, may take the same deduction under section 164 that 
would be allowed to the decedent if, while alive, he had made such 
payment.
    (b) The deduction for percentage depletion is allowable only to the 
person (described in section 691(a)(1)) who receives the income in 
respect of the decedent to which the deduction relates, whether or not 
such person receives the property from which such income is derived. 
Thus, an heir who (by reason of the decedent's death) receives income 
derived from sales of units of mineral by the decedent (who reported 
income by use of the cash receipts and disbursements method) shall be 
allowed the deduction for percentage depletion, computed on the gross 
income from such number of units as if the

[[Page 411]]

heir had the same economic interest in the property as the decedent. 
Such heir need not also receive any interest in the mineral property 
other than such income. If the decedent did not compute his deduction 
for depletion on the basis of percentage depletion, any deduction for 
depletion to which the decedent was entitled at the date of his death 
would be allowable in computing his taxable income for his last taxable 
year, and there can be no deduction in respect of the decedent by any 
other person for such depletion.



Sec. 1.691(c)-1  Deduction for estate tax attributable to income in
respect of a decedent.

    (a) In general. A person who is required to include in gross income 
for any taxable year an amount of income in respect of a decedent may 
deduct for the same taxable year that portion of the estate tax imposed 
upon the decedent's estate which is attributable to the inclusion in the 
decedent's estate of the right to receive such amount. The deduction is 
determined as follows:
    (1) Ascertain the net value in the decedent's estate of the items 
which are included under section 691 in computing gross income. This is 
the excess of the value included in the gross estate on account of the 
items of gross income in respect of the decedent (see Sec. 1.691(a)-1 
and paragraph (c) of this section) over the deductions from the gross 
estate for claims which represent the deductions and credit in respect 
of the decedent (see Sec. 1.691(b)-1). But see section 691(d) and 
paragraph (b) of Sec. 1.691(d)-1 for computation of the special value 
of a survivor's annuity to be used in computing the net value for estate 
tax purposes in cases involving joint and survivor annuities.
    (2) Ascertain the portion of the estate tax attributable to the 
inclusion in the gross estate of such net value. This is the excess of 
the estate tax over the estate tax computed without including such net 
value in the gross estate. In computing the estate tax without including 
such net value in the gross estate, any estate tax deduction (such as 
the marital deduction) which may be based upon the gross estate shall be 
recomputed so as to take into account the exclusion of such net value 
from the gross estate. See example 2, paragraph (e) of Sec. 1.691(d)-1.

For purposes of this section, the term estate tax means the tax imposed 
under section 2001 or 2101 (or the corresponding provisions of the 
Internal Revenue Code of 1939), reduced by the credits against such tax. 
Each person including in gross income an amount of income in respect of 
a decedent may deduct as his share of the portion of the estate tax 
(computed under subparagraph (2) of this paragraph) an amount which 
bears the same ratio to such portion as the value in the gross estate of 
the right to the income included by such person in gross income (or the 
amount included in gross income if lower) bears to the value in the 
gross estate of all the items of gross income in respect of the 
decedent.
    (b) Prior decedent. If a person is required to include in gross 
income an amount of income in respect of a prior decedent, such person 
may deduct for the same taxable year that portion of the estate tax 
imposed upon the prior decedent's estate which is attributable to the 
inclusion in the prior decedent's estate of the value of the right to 
receive such amount. This deduction is computed in the same manner as 
provided in paragraph (a) of this section and is in addition to the 
deduction for estate tax imposed upon the decedent's estate which is 
attributable to the inclusion in the decedent's estate of the right to 
receive such amount.
    (c) Amounts deemed to be income in respect of a decedent. For 
purposes of allowing the deduction under section 691(c), the following 
items are also considered to be income in respect of a decedent under 
section 691(a):
    (1) The value for estate tax purposes of stock options in respect of 
which amounts are includible in gross income under section 421(b) (prior 
to amendment by section 221(a) of the Revenue Act of 1964), in the case 
of taxable years ending before January 1, 1964, or under section 
422(c)(1), 423(c), or 424(c)(1), whichever is applicable, in the case of 
taxable years ending after December 31, 1963. See section 421(d)(6) 
(prior to amendment by sec. 221(a) of the Revenue Act of 1964), in the 
case of taxable years ending before January 1, 1964, and section 
421(c)(2), in the case of

[[Page 412]]

taxable years ending after December 31, 1963.
    (2) Amounts received by a surviving annuitant during his life 
expectancy period as an annuity under a joint and survivor annuity 
contract to the extent included in gross income under section 72. See 
section 691(d).
    (d) Examples. Paragraphs (a) and (b) of this section may be 
illustrated by the following examples:

    Example 1. X, an attorney who kept his books by use of the cash 
receipts and disbursements method, was entitled at the date of his death 
to a fee for services rendered in a case not completed at the time of 
his death, which fee was valued in his estate at $1,000, and to accrued 
bond interest, which was valued in his estate at $500. In all, $1,500 
was included in his gross estate in respect of income described in 
section 691(a)(1). There were deducted as claims against his estate $150 
for business expenses for which his estate was liable and $50 for taxes 
accrued on certain property which he owned. In all, $200 was deducted 
for claims which represent amounts described in section 691(b) which are 
allowable as deductions to his estate or to the beneficiaries of his 
estate. His gross estate was $185,000 and, considering deductions of 
$15,000 and an exemption of $60,000, his taxable estate amounted to 
$110,000. The estate tax on this amount is $23,700 from which is 
subtracted a $75 credit for State death taxes leaving an estate tax 
liability of $23,625. In the year following the closing of X's estate, 
the fee in the amount of $1,200 was collected by X's son, who was the 
sole beneficiary of the estate. This amount was included under section 
691(a)(1)(C) in the son's gross income. The son may deduct, in computing 
his taxable income for such year, $260 on account of the estate tax 
attributable to such income, computed as follows:

(1) (i) Value of income described in section 691(a)(1)            $1,500
 included in computing gross estate.........................
(ii) Deductions in computing gross estate for claims                 200
 representing deductions described in section 691(b)........
                                                             -----------
(iii) Net value of items described in section 691(a)(1).....       1,300
                                                             ===========
(2) (i) Estate tax..........................................      23,625
(ii) Less: Estate tax computed without including $1,300           23,235
 (item (1)(iii)) in gross estate............................
                                                             -----------
(iii) Portion of estate tax attributable to net value of             390
 items described in section 691(a)(1).......................
                                                             ===========
(3) (i) Value in gross estate of items described in section        1,000
 691(a)(1) received in taxable year (fee)...................
(ii) Value in gross estate of all income items described in        1,500
 section 691(a)(1) (item (1)(i))............................
(iii) Part of estate tax deductible on account of receipt of         260
 $1,200 fee (1,000/1,500 of $390)...........................
 


Although $1,200 was later collected as the fee, only the $1,000 actually 
included in the gross estate is used in the above computations. However, 
to avoid distortion, section 691(c) provides that if the value included 
in the gross estate is greater than the amount finally collected, only 
the amount collected shall be used in the above computations. Thus, if 
the amount collected as the fee were only $500, the estate tax 
deductible on the receipt of such amount would be 500/1,500 of $390, or 
$130. With respect to taxable years ending before January 1, 1964, see 
paragraph (d)(3) of Sec. 1.421-5 for a similar example involving a 
restricted stock option. With respect to taxable years ending after 
December 31, 1963, see paragraph (c)(3) of Sec. 1.421-8 for a similar 
example involving a stock option subject to the provisions of part II of 
subchapter D.
    Example 2. Assume that in example 1 the fee valued at $1,000 had 
been earned by prior decedent Y and had been inherited by X who died 
before collecting it. With regard to the son, the fee would be 
considered income in respect of a prior decedent. Assume further that 
the fee was valued at $1,000 in Y's estate, that the net value in Y's 
estate of items described in section 691 (a)(1) was $5,000 and that the 
estate tax imposed on Y's estate attributable to such net value was 
$550. In such case, the portion of such estate tax attributable to the 
fee would be 1,000/5,000 of $550, or $110. When the son collects the 
$1,200 fee, he will receive for the same taxable year a deduction of 
$110 with respect to the estate tax imposed on the estate of prior 
decedent Y as well as the deduction of $260 (as computed in example 1) 
with respect to the estate tax imposed on the estate of decedent X.

[T.D. 6500, 25 FR 11814, Nov. 26, 1960, as amended by T.D. 6887, 31 FR 
8812, June 24, 1966]



Sec. 1.691(c)-2  Estates and trusts.

    (a) In the case of an estate or trust, the deduction prescribed in 
section 691(c) is determined in the same manner as described in Sec. 
1.691(c)-1, with the following exceptions:
    (1) If any amount properly paid, credited, or required to be 
distributed by an estate or trust to a beneficiary consists of income in 
respect of a decedent received by the estate or trust during the taxable 
year:
    (i) Such income shall be excluded in determining the income in 
respect of the decedent with respect to which the estate or trust is 
entitled to a deduction under section 691(c), and
    (ii) Such income shall be considered income in respect of a decedent 
to such

[[Page 413]]

beneficiary for purposes of allowing the deduction under section 691(c) 
to such beneficiary.
    (2) For determination of the amount of income in respect of a 
decedent received by the beneficiary, see sections 652 and 662, and 
Sec. Sec. 1.652(b)-2 and 1.662(b)-2. However, for this purpose, 
distributable net income as defined in section 643 (a) and the 
regulations thereunder shall be computed without taking into account the 
estate tax deduction provided in section 691(c) and this section. 
Distributable net income as modified under the preceding sentence shall 
be applied for other relevant purposes of subchapter J, chapter 1 of the 
Code, such as the deduction provided by section 651 or 661, or subpart 
D, part I of subchapter J, relating to excess distributions by trusts.
    (3) The rule stated in subparagraph (1) of this paragraph does not 
apply to income in respect of a decedent which is properly allocable to 
corpus by the fiduciary during the taxable year but which is distributed 
to a beneficiary in a subsequent year. The deduction provided by section 
691(c) in such a case is allowable only to the estate or trust. If any 
amount properly paid, credited, or required to be distributed by a trust 
qualifies as a distribution under section 666, the fact that a portion 
thereof constitutes income in respect of a decedent shall be disregarded 
for the purposes of determining the deduction of the trust and of the 
beneficiaries under section 691(c) since the deduction for estate taxes 
was taken into consideration in computing the undistributed net income 
of the trust for the preceding taxable year.
    (b) This section shall apply only to amounts properly paid, 
credited, or required to be distributed in taxable years of an estate or 
trust beginning after December 31, 1953, and ending after August 16, 
1954, except as otherwise provided in paragraph (c) of this section.
    (c) In the case of an estate or trust heretofore taxable under the 
provisions of the Internal Revenue Code of 1939, amounts paid, credited, 
or to be distributed during its first taxable year subject to the 
Internal Revenue Code of 1954 which would have been treated as paid, 
credited, or to be distributed on the last day of the preceding taxable 
year if the Internal Revenue Code of 1939 were still applicable shall 
not be subject to the provisions of section 691(c)(1)(B) or this 
section. See section 683 and the regulations thereunder.
    (d) The provisions of this section may be illustrated by the 
following example, in which it is assumed that the estate and the 
beneficiary make their returns on the calendar year basis:

    Example. (1) The fiduciary of an estate receives taxable interest of 
$5,500 and income in respect of a decedent of $4,500 during the taxable 
year. Neither the will of the decedent nor local law requires the 
allocation to corpus of income in respect of a decedent. The estate tax 
attributable to the income in respect of a decedent is $1,500. In his 
discretion, the fiduciary distributes $2,000 (falling within sections 
661(a) and 662(a)) to a beneficiary during that year. On these facts the 
fiduciary and beneficiary are respectively entitled to estate tax 
deductions of $1,200 and $300, computed as follows:
    (2) Distributable net income computed under section 643(a) without 
regard to the estate tax deduction under section 691(c) is $10,000, 
computed as follows:

Taxable interest.............................................     $5,500
Income in respect of a decedent..............................      4,500
                                                   ------------
    Total....................................................     10,000
 

    (3) Inasmuch as the distributable net income of $10,000 exceeds the 
amount of $2,000 distributed to the beneficiary, the deduction allowable 
to the estate under section 661(a) and the amount taxable to the 
beneficiary under section 662(a) is $2,000.
    (4) The character of the amounts distributed to the beneficiary 
under section 662 (b) is shown in the following table:

------------------------------------------------------------------------
                                                    Income in
                                          Taxable    respect
                                          interest     of a      Total
                                                     decedent
------------------------------------------------------------------------
Distributable net income...............     $5,500     $4,500    $10,000
Amount deemed distributed under section      1,100        900      2,000
 662(b)................................
------------------------------------------------------------------------

    (5) Accordingly, the beneficiary will be entitled to an estate tax 
deduction of $300 (900/4,500x$1,500) and the estate will be entitled to 
an estate tax deduction of $1,200 (3,600/4,500x$1,500).
    (6) The taxable income of the estate is $6,200, computed as follows:

Gross income.................................................    $10,000
Less:
  Distributions to the beneficiary................     $2,000
Estate tax deduction under section 691(c).........      1,200
Personal exemption................................        600

[[Page 414]]

 
                                                                   3,800
                                                   ------------
    Taxable income...........................................      6,200
 



Sec. 1.691(d)-1  Amounts received by surviving annuitant under joint
and survivor annuity contract.

    (a) In general. Under section 691(d), annuity payments received by a 
surviving annuitant under a joint and survivor annuity contract (to the 
extent indicated in paragraph (b) of this section) are treated as income 
in respect of a decedent under section 691(a) for the purpose of 
allowing the deduction for estate tax provided for in section 
691(c)(1)(A). This section applies only if the deceased annuitant died 
after December 31, 1953, and after the annuity starting date as defined 
in section 72(c)(4).
    (b) Special value for surviving annuitant's payments. Section 691(d) 
provides a special value for the surviving annuitant's payments to 
determine the amount of the estate tax deduction provided for in section 
691(c)(1)(A). This special value is determined by multiplying:
    (1) The excess of the value of the annuity at the date of death of 
the deceased annuitant over the total amount excludable from the gross 
income of the surviving annuitant under section 72 during his life 
expectancy period (see paragraph (d)(1)(i) of this section)

by
    (2) A fraction consisting of the value of the annuity for estate tax 
purposes over the value of the annuity at the date of death of the 
deceased annuitant.

This special value is used for the purpose of determining the net value 
for estate tax purposes (see section 691(c)(2)(B) and paragraph (a)(1) 
of Sec. 1.691(c)-1) and for the purpose of determining the portion of 
estate tax attributable to the survivor's annuity (see paragraph (a) of 
Sec. 1.691(c)-1).
    (c) Amount of deduction. The portion of estate tax attributable to 
the survivor's annuity (see paragraph (a) of Sec. 1.691(c)-1) is 
allowable as a deduction to the surviving annuitant over his life 
expectancy period. If the surviving annuitant continues to receive 
annuity payments beyond this period, there is no further deduction under 
section 691(d). If the surviving annuitant dies before expiration of 
such period, there is no compensating adjustment for the unused 
deduction.
    (d) Definitions. (1) For purposes of section 691(d) and this 
section:
    (i) The term life expectancy period means the period beginning with 
the first day of the first period for which an amount is received by the 
surviving annuitant under the contract and ending with the close of the 
taxable year with or in which falls the termination of the life 
expectancy of the surviving annuitant.
    (ii) The life expectancy of the surviving annuitant shall be 
determined as of the date of death of the deceased annuitant, with 
reference to actuarial Table I set forth in Sec. 1.72-9 (but without 
making any adjustment under paragraph (a)(2) of Sec. 1.72-5).
    (iii) The value of the annuity at the date of death of the deceased 
annuitant shall be the entire value of the survivor's annuity determined 
by reference to the principles set forth in section 2031 and the 
regulations thereunder, relating to the valuation of annuities for 
estate tax purposes.
    (iv) The value of the annuity for estate tax purposes shall be that 
portion of the value determined under subdivision (iii) of this 
subparagraph which was includible in the deceased annuitant's gross 
estate.
    (2) The determination of the ``life expectancy period'' of the 
survivor for purposes of section 691(d) may be illustrated by the 
following example:

    Example. H and W file their income tax returns on the calendar year 
basis. H dies on July 15, 1955, on which date W is 70 years of age. On 
August 1, 1955, W receives a monthly payment under a joint and survivor 
annuity contract. W's life expectancy determined as of the date of H's 
death is 15 years as determined from Table I in Sec. 1.72-9; thus her 
life expectancy ends on July 14, 1970. Under the provisions of section 
691(d), her life expectancy period begins as of July 1, 1955, and ends 
as of December 31, 1970, thus giving her a life expectancy period of 
15\1/2\ years.

    (e) Examples. The application of section 691(d) and this section may 
be illustrated by the following examples:

    Example 1. (1) H and W, husband and wife, purchased a joint and 
survivor annuity contract for $203,800 providing for monthly payments of 
$1,000 starting January 28, 1954, and

[[Page 415]]

continuing for their joint lives and for the remaining life of the 
survivor. H contributed $152,850 and W contributed $50,950 to the cost 
of the annuity. As of the annuity starting date, January 1, 1954, H's 
age at his nearest birthday was 70 and W's age at her nearest birthday 
was 67. H dies on January 1, 1957, and beginning on January 28, 1957, W 
receives her monthly payments of $1,000. The value of the annuity at the 
date of H's death is $159,000 (see paragraph (d)(1)(iii) of this 
section), and the value of the annuity for estate tax purposes (see 
paragraph (d)(1)(iv) of this section) is $119,250 (152,850/203,800 of 
$159,000). As of the date of H's death, W's age is 70 and her life 
expectancy period is 15 years (see paragraph (d) of this section for 
method of computation). Both H and W reported income by use of the cash 
receipts and disbursements method and filed income tax returns on the 
calendar year basis.
    (2) The following computations illustrate the application of section 
72 in determining the excludable portions of the annuity payments to W 
during her life expectancy period:

Amount of annuity payments per year (12x$1,000)..............    $12,000
Life expectancy of H and W as of the annuity starting date          19.7
 (see section 72(c)(3)(A) and Table II of Sec. 1.72-9
 (male, age 70; female, age 67)).............................
Expected return as of the annuity starting date, January 1,     $236,400
 1954 ($12,000x19.7 as determined under section 72(c)(3)(A)
 and paragraph (b) of Sec. 1.72-5).........................
Investment in the contract as of the annuity starting date,     $203,800
 Jan. 1, 1954 (see section 72(c)(1) and paragraph (a) of Sec.
   1.72-6)...................................................
Exclusion ratio (203,800/236,400 as determined under section        86.2
 72(b) and Sec. 1.72-4) (percent)..........................
Exclusion per year under section 72 ($12,000x86.2 percent)...    $10,344
Excludable during W's life expectancy period ($10,344x15)....   $155,160
 

    (3) For the purpose of computing the deduction for estate tax under 
section 691(c), the value for estate tax purposes of the amounts 
includible in W's gross income and considered income in respect of a 
decedent by virtue of section 691(d)(1) is $2,880. This amount is 
arrived at in accordance with the formula contained in section 
691(d)(2), as follows:

Value of annuity at the date of H's death....................   $159,000
Total amount excludable from W's gross income under section     $155,160
 72 during W's life expectancy period (see subparagraph (2)
 of this example)............................................
Excess.......................................................     $3,840
Ratio which value of annuity for estate tax purposes bears to         75
 value of annuity at date of H's death (119,250/159,000)
 (percent)...................................................
Value for estate tax purposes (75 percent of $3,840).........     $2,880
 


This amount ($2,880) is included in the items of income under section 
691(a)(1) for the purpose of determining the estate tax attributable to 
each item under section 691(c)(1)(A). The estate tax determined to be 
attributable to the item of $2,880 is then allowed as a deduction to W 
over her 15-year life expectancy period (see example 2 of this 
paragraph).
    Example 2. Assume, in addition to the facts contained in example 1 
of this paragraph, that H was an attorney and was entitled at the date 
of his death to a fee for services rendered in a case not completed at 
the time of his death, which fee was valued at $1,000, and to accrued 
bond interest, which was valued at $500. Taking into consideration the 
annuity payments of example 1, valued at $2,880, a total of $4,380 was 
included in his gross estate in respect of income described in section 
691(a)(1). There were deducted as claims against his estate $280 for 
business expenses for which his estate was liable and $100 for taxes 
accrued on certain property which he owned. In all, $380 was deducted 
for claims which represent amounts described in section 691(b) which are 
allowable as deductions to his estate or to the beneficiaries of his 
estate. His gross estate was $404,250 and considering deductions of 
$15,000, a marital deduction of $119,250 (assuming the annuity to be the 
only qualifying gift) and an exemption of $60,000, his taxable estate 
amounted to $210,000. The estate tax on this amount is $53,700 from 
which is subtracted a $175 credit for State death taxes, leaving an 
estate tax liability of $53,525. W may deduct, in computing her taxable 
income during each year of her 15-year life expectancy period, $14.73 on 
account of the estate tax attributable to the value for estate tax 
purposes of that portion of the annuity payments considered income in 
respect of a decedent, computed as follows:

(1)(i) Value of income described in section 691(a)(1)          $4,380.00
 included in computing gross estate..........................
(ii) Deductions in computing gross estate for claims              380.00
 representing deductions described in section 691(b).........
                                                   ------------
    (iii) Net value of items described in section 691(a) (1).   4,000.00
                                                   ============
(2)(i) Estate tax............................................  53,525.00
(ii) Less: estate tax computed without including $4,000 (item  53,189.00
 (1) (iii)) in gross estate and by reducing marital deduction
 by $2,880 (portion of item (1)(iii) allowed as a marital
 deduction)..................................................
                                                   ------------
    (iii) Portion of estate tax attributable to net value of      336.00
     income items............................................
(3)(i) Value in gross estate of income attributable to          2,880.00
 annuity payments............................................
(ii) Value in gross estate of all income items described in     4,380.00
 section 691(a)(1) (item (1)(i)).............................
(iii) Part of estate tax attributable to annuity income           220.93
 (2,880/4,380 of $336).......................................
(iv) Deduction each year on account of estate tax                  14.73
 attributable to annuity income ($220.93/15 (life expectancy
 period))....................................................
 


[[Page 416]]



Sec. 1.691(e)-1  Installment obligations transmitted at death when
prior law applied.

    (a) In general--(1) Application of prior law. Under section 44(d) of 
the Internal Revenue Code of 1939 and corresponding provisions of prior 
law, gains and losses on account of the transmission of installment 
obligations at the death of a holder of such obligations were required 
to be reported in the return of the decedent for the year of his death. 
However, an exception to this rule was provided if there was filed with 
the Commissioner a bond assuring the return as income of any payment in 
satisfaction of these obligations in the same proportion as would have 
been returnable as income by the decedent had he lived and received such 
payments. Obligations in respect of which such bond was filed are 
referred to in this section as ``obligations assured by bond''.
    (2) Application of present law. Section 691(a)(4) of the Internal 
Revenue Code of 1954 (effective for taxable years beginning after 
December 31, 1953, and ending after August 16, 1954) in effect makes the 
exception which under prior law applied to obligations assured by bond 
the general rule for obligations transmitted at death, but contains no 
requirement for a bond. Section 691(e)(1) provides that if the holder of 
the installment obligation makes a proper election, the provisions of 
section 691(a)(4) shall apply in the case of obligations assured by 
bond. Section 691(e)(1) further provides that the estate tax deduction 
provided by section 691(c)(1) is not allowable for any amount included 
in gross income by reason of filing such an election.
    (b) Manner and scope of election--(1) In general. The election to 
have obligations assured by bond treated as obligations to which section 
691(a)(4) applies shall be made by the filing of a statement with 
respect to each bond to be released, containing the following 
information:
    (i) The name and address of the decedent from whom the obligations 
assured by bond were transmitted, the date of his death, and the 
internal revenue district in which the last income tax return of the 
decedent was filed.
    (ii) A schedule of all obligations assured by the bond on which is 
listed--
    (a) The name and address of the obligors, face amount, date of 
maturity, and manner of payment of each obligation,
    (b) The name, identifying number (provided under section 6109 and 
the regulations thereunder), and address of each person holding the 
obligations, and
    (c) The name, identifying number, and address, of each person who at 
the time of the election possesses an interest in each obligation, and a 
description of such interest.
    (iii) The total amount of income in respect of the obligations which 
would have been reportable as income by the decedent if he had lived and 
received such payment.
    (iv) The amount of income referred to in subdivision (iii) of this 
subparagraph which has previously been included in gross income.
    (v) An unqualified statement, signed by all persons holding the 
obligations, that they elect to have the provisions of section 691(a)(4) 
apply to such obligations and that such election shall be binding upon 
them, all current beneficiaries, and any person to whom the obligations 
may be transmitted by gift, bequest, or inheritance.
    (vi) A declaration that the election is made under the penalties of 
perjury.
    (2) Filing of statement. The statement with respect to each bond to 
be released shall be filed in duplicate with the district director of 
internal revenue for the district in which the bond is maintained. The 
statement shall be filed not later than the time prescribed for filing 
the return for the first taxable year (including any extension of time 
for such filing) to which the election applies.
    (3) Effect of election. The election referred to in subparagraph (1) 
of this paragraph shall be irrevocable. Once an election is made with 
respect to an obligation assured by bond, it shall apply to all payments 
made in satisfaction of such obligation which were received during the 
first taxable year to which the election applies and to all such 
payments received during each taxable year thereafter, whether the 
recipient is the person who made the election, a

[[Page 417]]

current beneficiary, or a person to whom the obligation may be 
transmitted by gift, bequest, or inheritance. Therefore, all payments 
received to which the election applies shall be treated as payments made 
on installment obligations to which section 691(a)(4) applies. However, 
the estate tax deduction provided by section 691(c) is not allowable for 
any such payment. The application of this subparagraph may be 
illustrated by the following example:

    Example. A, the holder of an installment obligation, died in 1952. 
The installment obligation was transmitted at A's death to B who filed a 
bond on Form 1132 pursuant to paragraph (c) of Sec. 39.44-5 of 
Regulations 118 (26 CFR part 39, 1939 ed.) for the necessary amount. On 
January 1, 1965, B, a calendar year taxpayer, filed an election under 
section 691(e) to treat the obligation assured by bond as an obligation 
to which section 691(a)(4) applies, and B's bond was released for 1964 
and subsequent taxable years. B died on June 1, 1965, and the obligation 
was bequeathed to C. On January 1, 1966, C received an installment 
payment on the obligation which had been assured by the bond. Because B 
filed an election with respect to the obligation assured by bond, C is 
required to treat the proper proportion of the January 1, 1966, payment 
and all subsequent payments made in satisfaction of this obligation as 
income in respect of a decedent. However, no estate tax deduction is 
allowable to C under section 691(c)(1) for any estate tax attributable 
to the inclusion of the value of such obligation in the estate of either 
A or B.

    (c) Release of bond. If an election according to the provisions of 
paragraph (b) of this section is filed, the liability under any bond 
filed under section 44(d) of the 1939 Code (or the corresponding 
provisions of prior law) shall be released with respect to each taxable 
year to which such election applies. However, the liability under any 
such bond for an earlier taxable year to which the election does not 
apply shall not be released until the district director of internal 
revenue for the district in which the bond is maintained is assured that 
the proper portion of each installment payment received in such taxable 
year has been reported and the tax thereon paid.

[T.D. 6808, 30 FR 3436, Mar. 16, 1965]



Sec. 1.691(f)-1  Cross reference.

    See section 753 and the regulations thereunder for application of 
section 691 to income in respect of a deceased partner.

[T.D. 6808, 30 FR 3436, Mar. 16, 1965]



Sec. 1.692-1  Abatement of income taxes of certain members of the 
Armed Forces of the United States upon death.

    (a)(1) This section applies if:
    (i) An individual dies while in active service as a member of the 
Armed Forces of the United States, and
    (ii) His death occurs while he is serving in a combat zone (as 
determined under section 112), or at any place as a result of wounds, 
disease, or injury incurred while he was serving in a combat zone.
    (2) If an individuals dies as described in paragraph (a)(1), the 
following liabilities for tax, under subtitle A of the Internal Revenue 
Code of 1954 or under chapter 1 of the Internal Revenue Code of 1939, 
are canceled:
    (i) The libaility of the deceased individual, for the last taxable 
year, ending on the date of his death, and for any prior taxable year 
ending on or after the first day he served in a combat zone in active 
service as a member of the U.S. Armed Forces after June 24, 1950, and
    (ii) The liability of any other person to the extent the liability 
is attributable to an amount received after the individual's death 
(including income in respect of a decedent under section 691) which 
would have been includible in the individual's gross income for his 
taxable year in which the date of his death falls (determined as if he 
had survived).

If the tax (including interest, additions to the tax, and additional 
amounts) is assessed, the assessment will be abated. If the amount of 
the tax is collected (regardless of the date of collection), the amount 
so collected will be credited or refunded as an overpayment.
    (3) If an individual dies as described in paragraph (a)(1), there 
will not be assessed any amount of tax of the indvidual for taxable 
years preceding the years specified in paragraph (a)(2),

[[Page 418]]

under subtitle A of the Internal Revenue Code of 1954, chapter 1 of the 
Internal Revenue Code of 1939, or corresponding provisions of prior 
revenue laws, remaining unpaid as of the date of death. If any such 
unpaid tax (including interest, additions to the tax, and additional 
amounts) has been assessed, the assessments will be abated. If the 
amount of any such unpaid tax is collected after the date of death, the 
amount so collected will be credited or refunded as an overpayment.
    (4) As to what constitutes active service as a member of the Armed 
Forces, service in a combat zone, and wounds, disease, or injury 
incurred while serving in a combat zone, see section 112. As to who are 
members of the Armed Forces, see section 7701(a)(15). As to the period 
of time within which any claim for refund must be filed, see sections 
6511(a) and 7508(a)(1)(E).
    (b) If such an individual and his spouse have for any such year 
filed a joint return, the tax abated, credited, or refunded pursuant to 
the provisions of section 692 for such year shall be an amount equal to 
that portion of the joint tax liability which is the same percentage of 
such joint tax liability as a tax computed upon the separate income of 
such individual is of the sum of the taxes computed upon the separate 
income of such individual and his spouse, but with respect to taxable 
years ending before June 24, 1950, and with respect to taxable years 
ending before the first day such individual served in a combat zone, as 
determined under section 112, the amount so abated, credited, or 
refunded shall not exceed the amount unpaid at the date of death. For 
such purpose, the separate tax of each spouse:
    (1) For taxable years beginning after December 31, 1953, and ending 
after August 16, 1954, shall be the tax computed under subtitle A of the 
Internal Revenue Code of 1954 before the application of sections 31, 32, 
6401(b), and 6402, but after the application of section 33, as if such 
spouse were required to make a separate income tax return; and
    (2) For taxable years beginning before January 1, 1954, and for 
taxable years beginning after December 31, 1953, and ending before 
August 17, 1954, shall be the tax computed under chapter 1 of the 
Internal Revenue Code of 1939 before the application of sections 32, 35, 
and 322(a), but after the application of section 31, as if such spouse 
were required to make a separate income tax return.
    (c) If such an individual and his spouse filed a joint declaration 
of estimated tax for the taxable year ending with the date of his death, 
the estimated tax paid pursuant to such declaration may be treated as 
the estimated tax of either such individual or his spouse, or may be 
divided between them, in such manner as his legal representative and 
such spouse may agree. Should they agree to treat such estimated tax, or 
any portion thereof, as the estimated tax of such individual, the 
estimated tax so paid shall be credited or refunded as an overpayment 
for the taxable year ending with the date of his death.
    (d) For the purpose of determining the tax which is unpaid at the 
date of death, amounts deducted and withheld under chapter 24, subtitle 
C of the Internal Revenue Code of 1954, or under subchapter D, chapter 9 
of the Internal Revenue Code of 1939 (relating to income tax withheld at 
source on wages), constitute payment of tax imposed under subtitle A of 
the Internal Revenue Code of 1954 or under chapter 1 of the Internal 
Revenue Code of 1939, as the case may be.
    (e) This section shall have no application whatsoever with respect 
to the liability of an individual as a transferee of property of a 
taxpayer where such liability relates to the tax imposed upon the 
taxpayer by subtitle A of the Internal Revenue Code of 1954 or by 
chapter 1 of the Internal Revenue Code of 1939.

[T.D. 6500, 25 FR 11814, Nov. 26, 1960, as amended by T.D. 7543, 43 FR 
19392, May 5, 1978]

                        PARTNERS AND PARTNERSHIPS



Determination of Tax Liability--Table of Contents





Sec. 1.701-1  Partners, not partnership, subject to tax.

    Partners are liable for income tax only in their separate 
capacities. Partnerships as such are not subject to the income tax 
imposed by subtitle A but

[[Page 419]]

are required to make returns of income under the provisions of section 
6031 and the regulations thereunder. For definition of the terms 
``partner'' and ``partnership'', see sections 761 and 7701(a)(2), and 
the regulations thereunder. For provisions relating to the election of 
certain partnerships to be taxed as domestic corporations, see section 
1361 and the regulations thereunder.



Sec. 1.701-2  Anti-abuse rule.

    (a) Intent of subchapter K. Subchapter K is intended to permit 
taxpayers to conduct joint business (including investment) activities 
through a flexible economic arrangement without incurring an entity-
level tax. Implicit in the intent of subchapter K are the following 
requirements--
    (1) The partnership must be bona fide and each partnership 
transaction or series of related transactions (individually or 
collectively, the transaction) must be entered into for a substantial 
business purpose.
    (2) The form of each partnership transaction must be respected under 
substance over form principles.
    (3) Except as otherwise provided in this paragraph (a)(3), the tax 
consequences under subchapter K to each partner of partnership 
operations and of transactions between the partner and the partnership 
must accurately reflect the partners' economic agreement and clearly 
reflect the partner's income (collectively, proper reflection of 
income). However, certain provisions of subchapter K and the regulations 
thereunder were adopted to promote administrative convenience and other 
policy objectives, with the recognition that the application of those 
provisions to a transaction could, in some circumstances, produce tax 
results that do not properly reflect income. Thus, the proper reflection 
of income requirement of this paragraph (a)(3) is treated as satisfied 
with respect to a transaction that satisfies paragraphs (a)(1) and (2) 
of this section to the extent that the application of such a provision 
to the transaction and the ultimate tax results, taking into account all 
the relevant facts and circumstances, are clearly contemplated by that 
provision. See, for example, paragraph (d) Example 6 of this section 
(relating to the value-equals-basis rule in Sec. 1.704-
1(b)(2)(iii)(c)), paragraph (d) Example 9 of this section (relating to 
the election under section 754 to adjust basis in partnership property), 
and paragraph (d) Examples 10 and 11 of this section (relating to the 
basis in property distributed by a partnership under section 732). See 
also, for example, Sec. Sec. 1.704-3(e)(1) and 1.752-2(e)(4) (providing 
certain de minimis exceptions).
    (b) Application of subchapter K rules. The provisions of subchapter 
K and the regulations thereunder must be applied in a manner that is 
consistent with the intent of subchapter K as set forth in paragraph (a) 
of this section (intent of subchapter K). Accordingly, if a partnership 
is formed or availed of in connection with a transaction a principal 
purpose of which is to reduce substantially the present value of the 
partners' aggregate federal tax liability in a manner that is 
inconsistent with the intent of subchapter K, the Commissioner can 
recast the transaction for federal tax purposes, as appropriate to 
achieve tax results that are consistent with the intent of subchapter K, 
in light of the applicable statutory and regulatory provisions and the 
pertinent facts and circumstances. Thus, even though the transaction may 
fall within the literal words of a particular statutory or regulatory 
provision, the Commissioner can determine, based on the particular facts 
and circumstances, that to achieve tax results that are consistent with 
the intent of subchapter K--
    (1) The purported partnership should be disregarded in whole or in 
part, and the partnership's assets and activities should be considered, 
in whole or in part, to be owned and conducted, respectively, by one or 
more of its purported partners;
    (2) One or more of the purported partners of the partnership should 
not be treated as a partner;
    (3) The methods of accounting used by the partnership or a partner 
should be adjusted to reflect clearly the partnership's or the partner's 
income;
    (4) The partnership's items of income, gain, loss, deduction, or 
credit should be reallocated; or
    (5) The claimed tax treatment should otherwise be adjusted or 
modified.

[[Page 420]]

    (c) Facts and circumstances analysis; factors. Whether a partnership 
was formed or availed of with a principal purpose to reduce 
substantially the present value of the partners' aggregate federal tax 
liability in a manner inconsistent with the intent of subchapter K is 
determined based on all of the facts and circumstances, including a 
comparison of the purported business purpose for a transaction and the 
claimed tax benefits resulting from the transaction. The factors set 
forth below may be indicative, but do not necessarily establish, that a 
partnership was used in such a manner. These factors are illustrative 
only, and therefore may not be the only factors taken into account in 
making the determination under this section. Moreover, the weight given 
to any factor (whether specified in this paragraph or otherwise) depends 
on all the facts and circumstances. The presence or absence of any 
factor described in this paragraph does not create a presumption that a 
partnership was (or was not) used in such a manner. Factors include:
    (1) The present value of the partners' aggregate federal tax 
liability is substantially less than had the partners owned the 
partnership's assets and conducted the partnership's activities 
directly;
    (2) The present value of the partners' aggregate federal tax 
liability is substantially less than would be the case if purportedly 
separate transactions that are designed to achieve a particular end 
result are integrated and treated as steps in a single transaction. For 
example, this analysis may indicate that it was contemplated that a 
partner who was necessary to achieve the intended tax results and whose 
interest in the partnership was liquidated or disposed of (in whole or 
in part) would be a partner only temporarily in order to provide the 
claimed tax benefits to the remaining partners;
    (3) One or more partners who are necessary to achieve the claimed 
tax results either have a nominal interest in the partnership, are 
substantially protected from any risk of loss from the partnership's 
activities (through distribution preferences, indemnity or loss guaranty 
agreements, or other arrangements), or have little or no participation 
in the profits from the partnership's activities other than a preferred 
return that is in the nature of a payment for the use of capital;
    (4) Substantially all of the partners (measured by number or 
interests in the partnership) are related (directly or indirectly) to 
one another;
    (5) Partnership items are allocated in compliance with the literal 
language of Sec. Sec. 1.704-1 and 1.704-2 but with results that are 
inconsistent with the purpose of section 704(b) and those regulations. 
In this regard, particular scrutiny will be paid to partnerships in 
which income or gain is specially allocated to one or more partners that 
may be legally or effectively exempt from federal taxation (for example, 
a foreign person, an exempt organization, an insolvent taxpayer, or a 
taxpayer with unused federal tax attributes such as net operating 
losses, capital losses, or foreign tax credits);
    (6) The benefits and burdens of ownership of property nominally 
contributed to the partnership are in substantial part retained 
(directly or indirectly) by the contributing partner (or a related 
party); or
    (7) The benefits and burdens of ownership of partnership property 
are in substantial part shifted (directly or indirectly) to the 
distributee partner before or after the property is actually distributed 
to the distributee partner (or a related party).
    (d) Examples. The following examples illustrate the principles of 
paragraphs (a), (b), and (c) of this section. The examples set forth 
below do not delineate the boundaries of either permissible or 
impermissible types of transactions. Further, the addition of any facts 
or circumstances that are not specifically set forth in an example (or 
the deletion of any facts or circumstances) may alter the outcome of the 
transaction described in the example. Unless otherwise indicated, 
parties to the transactions are not related to one another.

    Example 1. Choice of entity; avoidance of entity-level tax; use of 
partnership consistent with the intent of subchapter K. (i) A and B form 
limited partnership PRS to conduct a bona fide business. A, the 
corporate general partner, has a 1% partnership interest. B, the 
individual limited partner, has a 99% interest. PRS is properly 
classified as a partnership under Sec. Sec. 301.7701-2 and 301.7701-3. 
A and B

[[Page 421]]

chose limited partnership form as a means to provide B with limited 
liability without subjecting the income from the business operations to 
an entity-level tax.
    (ii) Subchapter K is intended to permit taxpayers to conduct joint 
business activity through a flexible economic arrangement without 
incurring an entity-level tax. See paragraph (a) of this section. 
Although B has retained, indirectly, substantially all of the benefits 
and burdens of ownership of the money or property B contributed to PRS 
(see paragraph (c)(6) of this section), the decision to organize and 
conduct business through PRS under these circumstances is consistent 
with this intent. In addition, on these facts, the requirements of 
paragraphs (a)(1), (2), and (3) of this section have been satisfied. The 
Commissioner therefore cannot invoke paragraph (b) of this section to 
recast the transaction.
    Example 2. Choice of entity; avoidance of subchapter S shareholder 
requirements; use of partnership consistent with the intent of 
subchapter K. (i) A and B form partnership PRS to conduct a bona fide 
business. A is a corporation that has elected to be treated as an S 
corporation under subchapter S. B is a nonresident alien. PRS is 
properly classified as a partnership under Sec. Sec. 301.7701-2 and 
301.7701-3. Because section 1361(b) prohibits B from being a shareholder 
in A, A and B chose partnership form, rather than admit B as a 
shareholder in A, as a means to retain the benefits of subchapter S 
treatment for A and its shareholders.
    (ii) Subchapter K is intended to permit taxpayers to conduct joint 
business activity through a flexible economic arrangement without 
incurring an entity-level tax. See paragraph (a) of this section. The 
decision to organize and conduct business through PRS is consistent with 
this intent. In addition, on these facts, the requirements of paragraphs 
(a)(1), (2), and (3) of this section have been satisfied. Although it 
may be argued that the form of the partnership transaction should not be 
respected because it does not reflect its substance (inasmuch as 
application of the substance over form doctrine arguably could result in 
B being treated as a shareholder of A, thereby invalidating A's 
subchapter S election), the facts indicate otherwise. The shareholders 
of A are subject to tax on their pro rata shares of A's income (see 
section 1361 et seq.), and B is subject to tax on B's distributive share 
of partnership income (see sections 871 and 875). Thus, the form in 
which this arrangement is cast accurately reflects its substance as a 
separate partnership and S corporation. The Commissioner therefore 
cannot invoke paragraph (b) of this section to recast the transaction.
    Example 3. Choice of entity; avoidance of more restrictive foreign 
tax credit limitation; use of partnership consistent with the intent of 
subchapter K. (i) X, a domestic corporation, and Y, a foreign 
corporation, form partnership PRS under the laws of foreign Country A to 
conduct a bona fide joint business. X and Y each owns a 50% interest in 
PRS. PRS is properly classified as a partnership under Sec. Sec. 
301.7701-2 and 301.7701-3. PRS pays income taxes to Country A. X and Y 
chose partnership form to enable X to qualify for a direct foreign tax 
credit under section 901, with look-through treatment under Sec. 1.904-
5(h)(1). Conversely, if PRS were a foreign corporation for U.S. tax 
purposes, X would be entitled only to indirect foreign tax credits under 
section 902 with respect to dividend distributions from PRS. The look-
through rules, however, would not apply, and pursuant to section 
904(d)(1)(E) and Sec. 1.904-4(g), the dividends and associated taxes 
would be subject to a separate foreign tax credit limitation for 
dividends from PRS, a noncontrolled section 902 corporation.
    (ii) Subchapter K is intended to permit taxpayers to conduct joint 
business activity through a flexible economic arrangement without 
incurring an entity-level tax. See paragraph (a) of this section. The 
decision to organize and conduct business through PRS in order to take 
advantage of the look-through rules for foreign tax credit purposes, 
thereby maximizing X's use of its proper share of foreign taxes paid by 
PRS, is consistent with this intent. In addition, on these facts, the 
requirements of paragraphs (a)(1), (2), and (3) of this section have 
been satisfied. The Commissioner therefore cannot invoke paragraph (b) 
of this section to recast the transaction.
    Example 4. Choice of entity; avoidance of gain recognition under 
sections 351(e) and 357(c); use of partnership consistent with the 
intent of subchapter K. (i) X, ABC, and DEF form limited partnership PRS 
to conduct a bona fide real estate management business. PRS is properly 
classified as a partnership under Sec. Sec. 301.7701-2 and 301.7701-3. 
X, the general partner, is a newly formed corporation that elects to be 
treated as a real estate investment trust as defined in section 856. X 
offers its stock to the public and contributes substantially all of the 
proceeds from the public offering to PRS. ABC and DEF, the limited 
partners, are existing partnerships with substantial real estate 
holdings. ABC and DEF contribute all of their real property assets to 
PRS, subject to liabilities that exceed their respective aggregate bases 
in the real property contributed, and terminate under section 
708(b)(1)(A). In addition, some of the former partners of ABC and DEF 
each have the right, beginning two years after the formation of PRS, to 
require the redemption of their limited partnership interests in PRS in 
exchange for cash or X stock (at X's option) equal to the fair market 
value of their respective interests in PRS at the time of the

[[Page 422]]

redemption. These partners are not compelled, as a legal or practical 
matter, to exercise their exchange rights at any time. X, ABC, and DEF 
chose to form a partnership rather than have ABC and DEF invest directly 
in X to allow ABC and DEF to avoid recognition of gain under sections 
351(e) and 357(c). Because PRS would not be treated as an investment 
company within the meaning of section 351(e) if PRS were incorporated 
(so long as it did not elect under section 856), section 721(a) applies 
to the contribution of the real property to PRS. See section 721(b).
    (ii) Subchapter K is intended to permit taxpayers to conduct joint 
business activity through a flexible economic arrangement without 
incurring an entity-level tax. See paragraph (a) of this section. The 
decision to organize and conduct business through PRS, thereby avoiding 
the tax consequences that would have resulted from contributing the 
existing partnerships' real estate assets to X (by applying the rules of 
sections 721, 731, and 752 in lieu of the rules of sections 351(e) and 
357(c)), is consistent with this intent. In addition, on these facts, 
the requirements of paragraphs (a)(1), (2), and (3) of this section have 
been satisfied. Although it may be argued that the form of the 
transaction should not be respected because it does not reflect its 
substance (inasmuch as the present value of the partners' aggregate 
federal tax liability is substantially less than would be the case if 
the transaction were integrated and treated as a contribution of the 
encumbered assets by ABC and DEF directly to X, see paragraph (c)(2) of 
this section), the facts indicate otherwise. For example, the right of 
some of the former ABC and DEF partners after two years to exchange 
their PRS interests for cash or X stock (at X's option) equal to the 
fair market value of their PRS interest at that time would not require 
that right to be considered as exercised prior to its actual exercise. 
Moreover, X may make other real estate investments and other business 
decisions, including the decision to raise additional capital for those 
purposes. Thus, although it may be likely that some or all of the 
partners with the right to do so will, at some point, exercise their 
exchange rights, and thereby receive either cash or X stock, the form of 
the transaction as a separate partnership and real estate investment 
trust is respected under substance over form principles (see paragraph 
(a)(2) of this section). The Commissioner therefore cannot invoke 
paragraph (b) of this section to recast the transaction.
    Example 5. Special allocations; dividends received deductions; use 
of partnership consistent with the intent of subchapter K. (i) 
Corporations X and Y contribute equal amounts to PRS, a bona fide 
partnership formed to make joint investments. PRS pays $100x for a share 
of common stock of Z, an unrelated corporation, which has historically 
paid an annual dividend of $6x. PRS specially allocates the dividend 
income on the Z stock to X to the extent of the London Inter-Bank 
Offered Rate (LIBOR) on the record date, applied to X's contribution of 
$50x, and allocates the remainder of the dividend income to Y. All other 
items of partnership income and loss are allocated equally between X and 
Y. The allocations under the partnership agreement have substantial 
economic effect within the meaning of Sec. 1.704-1(b)(2). In addition 
to avoiding an entity-level tax, a principal purpose for the formation 
of the partnership was to invest in the Z common stock and to allocate 
the dividend income from the stock to provide X with a floating-rate 
return based on LIBOR, while permitting X and Y to claim the dividends 
received deduction under section 243 on the dividends allocated to each 
of them.
    (ii) Subchapter K is intended to permit taxpayers to conduct joint 
business activity through a flexible economic arrangement without 
incurring an entity-level tax. See paragraph (a) of this section. The 
decision to organize and conduct business through PRS is consistent with 
this intent. In addition, on these facts, the requirements of paragraphs 
(a)(1), (2), and (3) of this section have been satisfied. Section 704(b) 
and Sec. 1.704-1(b)(2) permit income realized by the partnership to be 
allocated validly to the partners separate from the partners' respective 
ownership of the capital to which the allocations relate, provided that 
the allocations satisfy both the literal requirements of the statute and 
regulations and the purpose of those provisions (see paragraph (c)(5) of 
this section). Section 704(e)(2) is not applicable to the facts of this 
example (otherwise, the allocations would be required to be 
proportionate to the partners' ownership of contributed capital). The 
Commissioner therefore cannot invoke paragraph (b) of this section to 
recast the transaction.
    Example 6. Special allocations; nonrecourse financing; low-income 
housing credit; use of partnership consistent with the intent of 
subchapter K. (i) A and B, high-bracket taxpayers, and X, a corporation 
with net operating loss carryforwards, form general partnership PRS to 
own and operate a building that qualifies for the low-income housing 
credit provided by section 42. The project is financed with both cash 
contributions from the partners and nonrecourse indebtedness. The 
partnership agreement provides for special allocations of income and 
deductions, including the allocation of all depreciation deductions 
attributable to the building to A and B equally in a manner that is 
reasonably consistent with allocations that have substantial economic 
effect of some other significant partnership item attributable to the 
building. The section 42 credits are allocated to A and B in accordance 
with the allocation

[[Page 423]]

of depreciation deductions. PRS's allocations comply with all applicable 
regulations, including the requirements of Sec. Sec. 1.704-1(b)(2)(ii) 
(pertaining to economic effect) and 1.704-2(e) (requirements for 
allocations of nonrecourse deductions). The nonrecourse indebtedness is 
validly allocated to the partners under the rules of Sec. 1.752-3, 
thereby increasing the basis of the partners' respective partnership 
interests. The basis increase created by the nonrecourse indebtedness 
enables A and B to deduct their distributive share of losses from the 
partnership (subject to all other applicable limitations under the 
Internal Revenue Code) against their nonpartnership income and to apply 
the credits against their tax liability.
    (ii) At a time when the depreciation deductions attributable to the 
building are not treated as nonrecourse deductions under Sec. 1.704-
2(c) (because there is no net increase in partnership minimum gain 
during the year), the special allocation of depreciation deductions to A 
and B has substantial economic effect because of the value-equals-basis 
safe harbor contained in Sec. 1.704-1(b)(2)(iii)(c) and the fact that A 
and B would bear the economic burden of any decline in the value of the 
building (to the extent of the partnership's investment in the 
building), notwithstanding that A and B believe it is unlikely that the 
building will decline in value (and, accordingly, they anticipate 
significant timing benefits through the special allocation). Moreover, 
in later years, when the depreciation deductions attributable to the 
building are treated as nonrecourse deductions under Sec. 1.704-2(c), 
the special allocation of depreciation deductions to A and B is 
considered to be consistent with the partners' interests in the 
partnership under Sec. 1.704-2(e).
    (iii) Subchapter K is intended to permit taxpayers to conduct joint 
business activity through a flexible economic arrangement without 
incurring an entity-level tax. See paragraph (a) of this section. The 
decision to organize and conduct business through PRS is consistent with 
this intent. In addition, on these facts, the requirements of paragraphs 
(a) (1), (2), and (3) of this section have been satisfied. Section 
704(b), Sec. 1.704-1(b)(2), and Sec. 1.704-2(e) allow partnership 
items of income, gain, loss, deduction, and credit to be allocated 
validly to the partners separate from the partners' respective ownership 
of the capital to which the allocations relate, provided that the 
allocations satisfy both the literal requirements of the statute and 
regulations and the purpose of those provisions (see paragraph (c)(5) of 
this section). Moreover, the application of the value-equals-basis safe 
harbor and the provisions of Sec. 1.704-2(e) with respect to the 
allocations to A and B, and the tax results of the application of those 
provisions, taking into account all the facts and circumstances, are 
clearly contemplated. Accordingly, even if the allocations would not 
otherwise be considered to satisfy the proper reflection of income 
standard in paragraph (a)(3) of this section, that requirement will be 
treated as satisfied under these facts. Thus, even though the partners' 
aggregate federal tax liability may be substantially less than had the 
partners owned the partnership's assets directly (due to X's inability 
to use its allocable share of the partnership's losses and credits) (see 
paragraph (c)(1) of this section), the transaction is not inconsistent 
with the intent of subchapter K. The Commissioner therefore cannot 
invoke paragraph (b) of this section to recast the transaction.
    Example 7. Partner with nominal interest; temporary partner; use of 
partnership not consistent with the intent of subchapter K. (i) Pursuant 
to a plan a principal purpose of which is to generate artificial losses 
and thereby shelter from federal taxation a substantial amount of 
income, X (a foreign corporation), Y (a domestic corporation), and Z (a 
promoter) form partnership PRS by contributing $9,000x, $990x, and $10x, 
respectively, for proportionate interests (90.0%, 9.9%, and 0.1%, 
respectively) in the capital and profits of PRS. PRS purchases offshore 
equipment for $10,000x and validly leases the equipment offshore for a 
term representing most of its projected useful life. Shortly thereafter, 
PRS sells its rights to receive income under the lease to a third party 
for $9,000x, and allocates the resulting $9,000x of income $8,100x to X, 
$891x to Y, and $9x to Z. PRS thereafter makes a distribution of $9,000x 
to X in complete liquidation of its interest. Under Sec. 1.704-
1(b)(2)(iv)(f), PRS restates the partners' capital accounts immediately 
before making the liquidating distribution to X to reflect its assets 
consisting of the offshore equipment worth $1,000x and $9,000x in cash. 
Thus, because the capital accounts immediately before the distribution 
reflect assets of $19,000x (that is, the initial capital contributions 
of $10,000x plus the $9,000x of income realized from the sale of the 
lease), PRS allocates a $9,000x book loss among the partners (for 
capital account purposes only), resulting in restated capital accounts 
for X, Y, and Z of $9,000x, $990x, and $10x, respectively. Thereafter, 
PRS purchases real property by borrowing the $8,000x purchase price on a 
recourse basis, which increases Y's and Z's bases in their respective 
partnership interests from $1,881x and $19x, to $9,801x and $99x, 
respectively (reflecting Y's and Z's adjusted interests in the 
partnership of 99% and 1%, respectively). PRS subsequently sells the 
offshore equipment, subject to the lease, for $1,000x and allocates the 
$9,000x tax loss $8,910x to Y and $90x to Z. Y's and Z's bases in their 
partnership interests are therefore reduced to $891x and $9x, 
respectively.

[[Page 424]]

    (ii) On these facts, any purported business purpose for the 
transaction is insignificant in comparison to the tax benefits that 
would result if the transaction were respected for federal tax purposes 
(see paragraph (c) of this section). Accordingly, the transaction lacks 
a substantial business purpose (see paragraph (a)(1) of this section). 
In addition, factors (1), (2), (3), and (5) of paragraph (c) of this 
section indicate that PRS was used with a principal purpose to reduce 
substantially the partners' tax liability in a manner inconsistent with 
the intent of subchapter K. On these facts, PRS is not bona fide (see 
paragraph (a)(1) of this section), and the transaction is not respected 
under applicable substance over form principles (see paragraph (a)(2) of 
this section) and does not properly reflect the income of Y (see 
paragraph (a)(3) of this section). Thus, PRS has been formed and availed 
of with a principal purpose of reducing substantially the present value 
of the partners' aggregate federal tax liability in a manner 
inconsistent with the intent of subchapter K. Therefore (in addition to 
possibly challenging the transaction under judicial principles or the 
validity of the allocations under Sec. 1.704-1(b)(2) (see paragraph (h) 
of this section)), the Commissioner can recast the transaction as 
appropriate under paragraph (b) of this section.
    Example 8. Plan to duplicate losses through absence of section 754 
election; use of partnership not consistent with the intent of 
subchapter K. (i) A owns land with a basis of $100x and a fair market 
value of $60x. A would like to sell the land to B. A and B devise a plan 
a principal purpose of which is to permit the duplication, for a 
substantial period of time, of the tax benefit of A's built-in loss in 
the land. To effect this plan, A, C (A's brother), and W (C's wife) form 
partnership PRS, to which A contributes the land, and C and W each 
contribute $30x. All partnership items are shared in proportion to the 
partners' respective contributions to PRS. PRS invests the cash in an 
investment asset (that is not a marketable security within the meaning 
of section 731(c)). PRS also leases the land to B under a three-year 
lease pursuant to which B has the option to purchase the land from PRS 
upon the expiration of the lease for an amount equal to its fair market 
value at that time. All lease proceeds received are immediately 
distributed to the partners. In year 3, at a time when the values of the 
partnership's assets have not materially changed, PRS agrees with A to 
liquidate A's interest in exchange for the investment asset held by PRS. 
Under section 732(b), A's basis in the asset distributed equals $100x, 
A's basis in A's partnership interest immediately before the 
distribution. Shortly thereafter, A sells the investment asset to X, an 
unrelated party, recognizing a $40x loss.
    (ii) PRS does not make an election under section 754. Accordingly, 
PRS's basis in the land contributed by A remains $100x. At the end of 
year 3, pursuant to the lease option, PRS sells the land to B for $60x 
(its fair market value). Thus, PRS recognizes a $40x loss on the sale, 
which is allocated equally between C and W. C's and W's bases in their 
partnership interests are reduced to $10x each pursuant to section 705. 
Their respective interests are worth $30x each. Thus, upon liquidation 
of PRS (or their interests therein), each of C and W will recognize $20x 
of gain. However, PRS's continued existence defers recognition of that 
gain indefinitely. Thus, if this arrangement is respected, C and W 
duplicate for their benefit A's built-in loss in the land prior to its 
contribution to PRS.
    (iii) On these facts, any purported business purpose for the 
transaction is insignificant in comparison to the tax benefits that 
would result if the transaction were respected for federal tax purposes 
(see paragraph (c) of this section). Accordingly, the transaction lacks 
a substantial business purpose (see paragraph (a)(1) of this section). 
In addition, factors (1), (2), and (4) of paragraph (c) of this section 
indicate that PRS was used with a principal purpose to reduce 
substantially the partners' tax liability in a manner inconsistent with 
the intent of subchapter K. On these facts, PRS is not bona fide (see 
paragraph (a)(1) of this section), and the transaction is not respected 
under applicable substance over form principles (see paragraph (a)(2) of 
this section). Further, the tax consequences to the partners do not 
properly reflect the partners' income; and Congress did not contemplate 
application of section 754 to partnerships such as PRS, which was formed 
for a principal purpose of producing a double tax benefit from a single 
economic loss (see paragraph (a)(3) of this section). Thus, PRS has been 
formed and availed of with a principal purpose of reducing substantially 
the present value of the partners' aggregate federal tax liability in a 
manner inconsistent with the intent of subchapter K. Therefore (in 
addition to possibly challenging the transaction under judicial 
principles or other statutory authorities, such as the substance over 
form doctrine or the disguised sale rules under section 707 (see 
paragraph (h) of this section)), the Commissioner can recast the 
transaction as appropriate under paragraph (b) of this section.
    Example 9. Absence of section 754 election; use of partnership 
consistent with the intent of subchapter K. (i) PRS is a bona fide 
partnership formed to engage in investment activities with contributions 
of cash from each partner. Several years after joining PRS, A, a partner 
with a capital account balance and basis in its partnership interest of 
$100x,

[[Page 425]]

wishes to withdraw from PRS. The partnership agreement entitles A to 
receive the balance of A's capital account in cash or securities owned 
by PRS at the time of withdrawal, as mutually agreed to by A and the 
managing general partner, P. P and A agree to distribute to A $100x 
worth of non-marketable securities (see section 731(c)) in which PRS has 
an aggregate basis of $20x. Upon distribution, A's aggregate basis in 
the securities is $100x under section 732(b). PRS does not make an 
election to adjust the basis in its remaining assets under section 754. 
Thus, PRS's basis in its remaining assets is unaffected by the 
distribution. In contrast, if a section 754 election had been in effect 
for the year of the distribution, under these facts section 734(b) would 
have required PRS to adjust the basis in its remaining assets downward 
by the amount of the untaxed appreciation in the distributed property, 
thus reflecting that gain in PRS's retained assets. In selecting the 
assets to be distributed, A and P had a principal purpose to take 
advantage of the facts that A's basis in the securities will be 
determined by reference to A's basis in its partnership interest under 
section 732(b), and because PRS will not make an election under section 
754, the remaining partners of PRS will likely enjoy a federal tax 
timing advantage (i.e., from the $80x of additional basis in its assets 
that would have been eliminated if the section 754 election had been 
made) that is inconsistent with proper reflection of income under 
paragraph (a)(3) of this section.
    (ii) Subchapter K is intended to permit taxpayers to conduct joint 
business activity through a flexible economic arrangement without 
incurring an entity-level tax. See paragraph (a) of this section. The 
decision to organize and conduct business through PRS is consistent with 
this intent. In addition, on these facts, the requirements of paragraphs 
(a)(1) and (2) of this section have been satisfied. The validity of the 
tax treatment of this transaction is therefore dependent upon whether 
the transaction satisfies (or is treated as satisfying) the proper 
reflection of income standard under paragraph (a)(3) of this section. 
A's basis in the distributed securities is properly determined under 
section 732(b). The benefit to the remaining partners is a result of PRS 
not having made an election under section 754. Subchapter K is generally 
intended to produce tax consequences that achieve proper reflection of 
income. However, paragraph (a)(3) of this section provides that if the 
application of a provision of subchapter K produces tax results that do 
not properly reflect income, but application of that provision to the 
transaction and the ultimate tax results, taking into account all the 
relevant facts and circumstances, are clearly contemplated by that 
provision (and the transaction satisfies the requirements of paragraphs 
(a)(1) and (2) of this section), then the application of that provision 
to the transaction will be treated as satisfying the proper reflection 
of income standard.
    (iii) In general, the adjustments that would be made if an election 
under section 754 were in effect are necessary to minimize distortions 
between the partners' bases in their partnership interests and the 
partnership's basis in its assets following, for example, a distribution 
to a partner. The electivity of section 754 is intended to provide 
administrative convenience for bona fide partnerships that are engaged 
in transactions for a substantial business purpose, by providing those 
partnerships the option of not adjusting their bases in their remaining 
assets following a distribution to a partner. Congress clearly 
recognized that if the section 754 election were not made, basis 
distortions may result. Taking into account all the facts and 
circumstances of the transaction, the electivity of section 754 in the 
context of the distribution from PRS to A, and the ultimate tax 
consequences that follow from the failure to make the election with 
respect to the transaction, are clearly contemplated by section 754. 
Thus, the tax consequences of this transaction will be treated as 
satisfying the proper reflection of income standard under paragraph 
(a)(3) of this section. The Commissioner therefore cannot invoke 
paragraph (b) of this section to recast the transaction.
    Example 10. Basis adjustments under section 732; use of partnership 
consistent with the intent of subchapter K. (i) A, B, and C are partners 
in partnership PRS, which has for several years been engaged in 
substantial bona fide business activities. For valid business reasons, 
the partners agree that A's interest in PRS, which has a value and basis 
of $100x, will be liquidated with the following assets of PRS: a 
nondepreciable asset with a value of $60x and a basis to PRS of $40x, 
and related equipment with two years of cost recovery remaining and a 
value and basis to PRS of $40x. Neither asset is described in section 
751 and the transaction is not described in section 732(d). Under 
section 732 (b) and (c), A's $100x basis in A's partnership interest 
will be allocated between the nondepreciable asset and the equipment 
received in the liquidating distribution in proportion to PRS's bases in 
those assets, or $50x to the nondepreciable asset and $50x to the 
equipment. Thus, A will have a $10x built-in gain in the nondepreciable 
asset ($60x value less $50x basis) and a $10x built-in loss in the 
equipment ($50x basis less $40x value), which it expects to recover 
rapidly through cost recovery deductions. In selecting the assets to be 
distributed to A, the partners had a principal purpose to take advantage 
of the fact that A's basis in the assets will be determined by reference 
to A's basis in A's partnership interest, thus, in effect, shifting a 
portion of A's basis from the nondepreciable asset to

[[Page 426]]

the equipment, which in turn would allow A to recover that portion of 
its basis more rapidly. This shift provides a federal tax timing 
advantage to A, with no offsetting detriment to B or C.
    (ii) Subchapter K is intended to permit taxpayers to conduct joint 
business activity through a flexible economic arrangement without 
incurring an entity-level tax. See paragraph (a) of this section. The 
decision to organize and conduct business through PRS is consistent with 
this intent. In addition, on these facts, the requirements of paragraphs 
(a)(1) and (2) of this section have been satisfied. The validity of the 
tax treatment of this transaction is therefore dependent upon whether 
the transaction satisfies (or is treated as satisfying) the proper 
reflection of income standard under paragraph (a)(3) of this section. 
Subchapter K is generally intended to produce tax consequences that 
achieve proper reflection of income. However, paragraph (a)(3) of this 
section provides that if the application of a provision of subchapter K 
produces tax results that do not properly reflect income, but the 
application of that provision to the transaction and the ultimate tax 
results, taking into account all the relevant facts and circumstances, 
are clearly contemplated by that provision (and the transaction 
satisfies the requirements of paragraphs (a)(1) and (2) of this 
section), then the application of that provision to the transaction will 
be treated as satisfying the proper reflection of income standard.
    (iii) A's basis in the assets distributed to it was determined under 
section 732 (b) and (c). The transaction does not properly reflect A's 
income due to the basis distortions caused by the distribution and the 
shifting of basis from a nondepreciable to a depreciable asset. However, 
the basis rules under section 732, which in some situations can produce 
tax results that are inconsistent with the proper reflection of income 
standard (see paragraph (a)(3) of this section), are intended to provide 
simplifying administrative rules for bona fide partnerships that are 
engaged in transactions with a substantial business purpose. Taking into 
account all the facts and circumstances of the transaction, the 
application of the basis rules under section 732 to the distribution 
from PRS to A, and the ultimate tax consequences of the application of 
that provision of subchapter K, are clearly contemplated. Thus, the 
application of section 732 to this transaction will be treated as 
satisfying the proper reflection of income standard under paragraph 
(a)(3) of this section. The Commissioner therefore cannot invoke 
paragraph (b) of this section to recast the transaction.
    Example 11. Basis adjustments under section 732; plan or arrangement 
to distort basis allocations artificially; use of partnership not 
consistent with the intent of subchapter K. (i) Partnership PRS has for 
several years been engaged in the development and management of 
commercial real estate projects. X, an unrelated party, desires to 
acquire undeveloped land owned by PRS, which has a value of $95x and a 
basis of $5x. X expects to hold the land indefinitely after its 
acquisition. Pursuant to a plan a principal purpose of which is to 
permit X to acquire and hold the land but nevertheless to recover for 
tax purposes a substantial portion of the purchase price for the land, X 
contributes $100x to PRS for an interest therein. Subsequently (at a 
time when the value of the partnership's assets have not materially 
changed), PRS distributes to X in liquidation of its interest in PRS the 
land and another asset with a value and basis to PRS of $5x. The second 
asset is an insignificant part of the economic transaction but is 
important to achieve the desired tax results. Under section 732 (b) and 
(c), X's $100x basis in its partnership interest is allocated between 
the assets distributed to it in proportion to their bases to PRS, or 
$50x each. Thereafter, X plans to sell the second asset for its value of 
$5x, recognizing a loss of $45x. In this manner, X will, in effect, 
recover a substantial portion of the purchase price of the land almost 
immediately. In selecting the assets to be distributed to X, the 
partners had a principal purpose to take advantage of the fact that X's 
basis in the assets will be determined under section 732 (b) and (c), 
thus, in effect, shifting a portion of X's basis economically allocable 
to the land that X intends to retain to an inconsequential asset that X 
intends to dispose of quickly. This shift provides a federal tax timing 
advantage to X, with no offsetting detriment to any of PRS's other 
partners.
    (ii) Although section 732 recognizes that basis distortions can 
occur in certain situations, which may produce tax results that do not 
satisfy the proper reflection of income standard of paragraph (a)(3) of 
this section, the provision is intended only to provide ancillary, 
simplifying tax results for bona fide partnership transactions that are 
engaged in for substantial business purposes. Section 732 is not 
intended to serve as the basis for plans or arrangements in which 
inconsequential or immaterial assets are included in the distribution 
with a principal purpose of obtaining substantially favorable tax 
results by virtue of the statute's simplifying rules. The transaction 
does not properly reflect X's income due to the basis distortions caused 
by the distribution that result in shifting a significant portion of X's 
basis to this inconsequential asset. Moreover, the proper reflection of 
income standard contained in paragraph (a)(3) of this section is not 
treated as satisfied, because, taking into account all the facts and 
circumstances, the application of section 732 to this arrangement, and 
the ultimate tax consequences that would thereby result, were not 
clearly contemplated by

[[Page 427]]

that provision of subchapter K. In addition, by using a partnership (if 
respected), the partners' aggregate federal tax liability would be 
substantially less than had they owned the partnership's assets directly 
(see paragraph (c)(1) of this section). On these facts, PRS has been 
formed and availed of with a principal purpose to reduce the taxpayers' 
aggregate federal tax liability in a manner that is inconsistent with 
the intent of subchapter K. Therefore (in addition to possibly 
challenging the transaction under applicable judicial principles and 
statutory authorities, such as the disguised sale rules under section 
707, see paragraph (h) of this section), the Commissioner can recast the 
transaction as appropriate under paragraph (b) of this section.

    (e) Abuse of entity treatment--(1) General rule. The Commissioner 
can treat a partnership as an aggregate of its partners in whole or in 
part as appropriate to carry out the purpose of any provision of the 
Internal Revenue Code or the regulations promulgated thereunder.
    (2) Clearly contemplated entity treatment. Paragraph (e)(1) of this 
section does not apply to the extent that--
    (i) A provision of the Internal Revenue Code or the regulations 
promulgated thereunder prescribes the treatment of a partnership as an 
entity, in whole or in part, and
    (ii) That treatment and the ultimate tax results, taking into 
account all the relevant facts and circumstances, are clearly 
contemplated by that provision.
    (f) Examples. The following examples illustrate the principles of 
paragraph (e) of this section. The examples set forth below do not 
delineate the boundaries of either permissible or impermissible types of 
transactions. Further, the addition of any facts or circumstances that 
are not specifically set forth in an example (or the deletion of any 
facts or circumstances) may alter the outcome of the transaction 
described in the example. Unless otherwise indicated, parties to the 
transactions are not related to one another.

    Example 1. Aggregate treatment of partnership appropriate to carry 
out purpose of section 163(e)(5). (i) Corporations X and Y are partners 
in partnership PRS, which for several years has engaged in substantial 
bona fide business activities. As part of these business activities, PRS 
issues certain high yield discount obligations to an unrelated third 
party. Section 163(e)(5) defers (and in certain circumstances disallows) 
the interest deductions on this type of obligation if issued by a 
corporation. PRS, X, and Y take the position that, because PRS is a 
partnership and not a corporation, section 163(e)(5) is not applicable.
    (ii) Section 163(e)(5) does not prescribe the treatment of a 
partnership as an entity for purposes of that section. The purpose of 
section 163(e)(5) is to limit corporate-level interest deductions on 
certain obligations. The treatment of PRS as an entity could result in a 
partnership with corporate partners issuing those obligations and 
thereby circumventing the purpose of section 163(e)(5), because the 
corporate partner would deduct its distributive share of the interest on 
obligations that would have been deferred until paid or disallowed had 
the corporation issued its share of the obligation directly. Thus, under 
paragraph (e)(1) of this section, PRS is properly treated as an 
aggregate of its partners for purposes of applying section 163(e)(5) 
(regardless of whether any party had a tax avoidance purpose in having 
PRS issue the obligation). Each partner of PRS will therefore be treated 
as issuing its share of the obligations for purposes of determining the 
deductibility of its distributive share of any interest on the 
obligations. See also section 163(i)(5)(B).
    Example 2. Aggregate treatment of partnership appropriate to carry 
out purpose of section 1059. (i) Corporations X and Y are partners in 
partnership PRS, which for several years has engaged in substantial bona 
fide business activities. As part of these business activities, PRS 
purchases 50 shares of Corporation Z common stock. Six months later, 
Corporation Z announces an extraordinary dividend (within the meaning of 
section 1059). Section 1059(a) generally provides that if any 
corporation receives an extraordinary dividend with respect to any share 
of stock and the corporation has not held the stock for more than two 
years before the dividend announcement date, the basis in the stock held 
by the corporation is reduced by the nontaxed portion of the dividend. 
PRS, X, and Y take the position that section 1059(a) is not applicable 
because PRS is a partnership and not a corporation.
    (ii) Section 1059(a) does not prescribe the treatment of a 
partnership as an entity for purposes of that section. The purpose of 
section 1059(a) is to limit the benefits of the dividends received 
deduction with respect to extraordinary dividends. The treatment of PRS 
as an entity could result in corporate partners in the partnership 
receiving dividends through partnerships in circumvention of the intent 
of section 1059. Thus, under paragraph (e)(1) of this section, PRS is 
properly treated as an aggregate of its partners

[[Page 428]]

for purposes of applying section 1059 (regardless of whether any party 
had a tax avoidance purpose in acquiring the Z stock through PRS). Each 
partner of PRS will therefore be treated as owning its share of the 
stock. Accordingly, PRS must make appropriate adjustments to the basis 
of the Corporation Z stock, and the partners must also make adjustments 
to the basis in their respective interests in PRS under section 
705(a)(2)(B). See also section 1059(g)(1).
    Example 3. Prescribed entity treatment of partnership; determination 
of CFC status clearly contemplated. (i) X, a domestic corporation, and 
Y, a foreign corporation, intend to conduct a joint venture in foreign 
Country A. They form PRS, a bona fide domestic general partnership in 
which X owns a 40% interest and Y owns a 60% interest. PRS is properly 
classified as a partnership under Sec. Sec. 301.7701-2 and 301.7701-3. 
PRS holds 100% of the voting stock of Z, a Country A entity that is 
classified as an association taxable as a corporation for federal tax 
purposes under Sec. 301.7701-2. Z conducts its business operations in 
Country A. By investing in Z through a domestic partnership, X seeks to 
obtain the benefit of the look-through rules of section 904(d)(3) and, 
as a result, maximize its ability to claim credits for its proper share 
of Country A taxes expected to be incurred by Z.
    (ii) Pursuant to sections 957(c) and 7701(a)(30), PRS is a United 
States person. Therefore, because it owns 10% or more of the voting 
stock of Z, PRS satisfies the definition of a U.S. shareholder under 
section 951(b). Under section 957(a), Z is a controlled foreign 
corporation (CFC) because more than 50% of the voting power or value of 
its stock is owned by PRS. Consequently, under section 904(d)(3), X 
qualifies for look-through treatment in computing its credit for foreign 
taxes paid or accrued by Z. In contrast, if X and Y owned their 
interests in Z directly, Z would not be a CFC because only 40% of its 
stock would be owned by U.S. shareholders. X's credit for foreign taxes 
paid or accrued by Z in that case would be subject to a separate foreign 
tax credit limitation for dividends from Z, a noncontrolled section 902 
corporation. See section 904(d)(1)(E) and Sec. 1.904-4(g).
    (iii) Sections 957(c) and 7701(a)(30) prescribe the treatment of a 
domestic partnership as an entity for purposes of defining a U.S. 
shareholder, and thus, for purposes of determining whether a foreign 
corporation is a CFC. The CFC rules prevent the deferral by U.S. 
shareholders of U.S. taxation of certain earnings of the CFC and reduce 
disparities that otherwise might occur between the amount of income 
subject to a particular foreign tax credit limitation when a taxpayer 
earns income abroad directly rather than indirectly through a CFC. The 
application of the look-through rules for foreign tax credit purposes is 
appropriately tied to CFC status. See sections 904(d)(2)(E) and 
904(d)(3). This analysis confirms that Congress clearly contemplated 
that taxpayers could use a bona fide domestic partnership to subject 
themselves to the CFC regime, and the resulting application of the look-
through rules of section 904(d)(3). Accordingly, under paragraph (e) of 
this section, the Commissioner cannot treat PRS as an aggregate of its 
partners for purposes of determining X's foreign tax credit limitation.

    (g) Effective date. Paragraphs (a), (b), (c), and (d) of this 
section are effective for all transactions involving a partnership that 
occur on or after May 12, 1994. Paragraphs (e) and (f) of this section 
are effective for all transactions involving a partnership that occur on 
or after December 29, 1994.
    (h) Scope and application. This section applies solely with respect 
to taxes under subtitle A of the Internal Revenue Code, and for purposes 
of this section, any reference to a federal tax is limited to any tax 
imposed under subtitle A of the Internal Revenue Code.
    (i) Application of nonstatutory principles and other statutory 
authorities. The Commissioner can continue to assert and to rely upon 
applicable nonstatutory principles and other statutory and regulatory 
authorities to challenge transactions. This section does not limit the 
applicability of those principles and authorities.

[T.D. 8588, 60 FR 27, Jan. 3, 1995; T.D. 8588, 60 FR 9776, 9777, Feb. 
22, 1995, as amended by T.D. 8592, 60 FR 18741, Apr. 13, 1995]



Sec. 1.702-1  Income and credits of partner.

    (a) General rule. Each partner is required to take into account 
separately in his return his distributive share, whether or not 
distributed, of each class or item of partnership income, gain, loss, 
deduction, or credit described in subparagraphs (1) through (9) of this 
paragraph. (For the taxable year in which a partner includes his 
distributive share of partnership taxable income, see section 706(a) and 
Sec. 1.706-1(a). Such distributive share shall be determined as 
provided in section 704 and Sec. 1.704-1.) Accordingly, in determining 
his income tax:
    (1) Each partner shall take into account, as part of his gains and 
losses

[[Page 429]]

from sales or exchanges of capital assets held for not more than 1 year 
(6 months for taxable years beginning before 1977; 9 months for taxable 
years beginning in 1977), his distributive share of the combined net 
amount of such gains and losses of the partnership.
    (2) Each partner shall take into account, as part of his gains and 
losses from sales or exchanges of capital assets held for more than 1 
year (6 months for taxable years beginning before 1977; 9 months for 
taxable years beginning in 1977), his distributive share of the combined 
net amount of such gains and losses of the partnership.
    (3) Each partner shall take into account, as part of his gains and 
losses from sales or exchanges of property described in section 1231 
(relating to property used in the trade or business and involuntary 
conversions), his distributive share of the combined net amount of such 
gains and losses of the partnership. The partnership shall not combine 
such items with items set forth in subparagraph (1) or (2) of this 
paragraph.
    (4) Each partner shall take into account, as part of the charitable 
contributions paid by him, his distributive share of each class of 
charitable contributions paid by the partnership within the 
partnership's taxable year. Section 170 determines the extent to which 
such amount may be allowed as a deduction to the partner. For the 
definition of the term ``charitable contribution'', see section 170(c).
    (5) Each partner shall take into account, as part of the dividends 
received by him from domestic corporations, his distributive share of 
dividends received by the partnership, with respect to which the partner 
is entitled to a credit under section 34 (for dividends received on or 
before December 31, 1964), an exclusion under section 116, or a 
deduction under part VIII, subchapter B, chapter 1 of the Code.
    (6) Each partner shall take into account, as part of his taxes 
described in section 901 which have been paid or accrued to foreign 
countries or to possessions of the United States, his distributive share 
of such taxes which have been paid or accrued by the partnership, 
according to its method of treating such taxes. A partner may elect to 
treat his total amount of such taxes, including his distributive share 
of such taxes of the partnership, as a deduction under section 164 or as 
a credit under section 901, subject to the provisions of sections 901 
through 905.
    (7) Each partner shall take into account, as part of the partially 
tax-exempt interest received by him on obligations of the United States 
or on obligations of instrumentalities of the United States, as 
described in section 35 or section 242, his distributive share of such 
partially tax-exempt interest received by the partnership. However, if 
the partnership elects to amortize premiums on bonds as provided in 
section 171, the amount received on such obligations by the partnership 
shall be reduced by the amortizable bond premium applicable to such 
obligations as provided in section 171(a)(3).
    (8)(i) Each partner shall take into account separately, as part of 
any class of income, gain, loss, deduction, or credit, his distributive 
share of the following items: Recoveries of bad debts, prior taxes, and 
delinquency amounts (section 111); gains and losses from wagering 
transactions (section 165(d)); soil and water conservation expenditures 
(section 175); nonbusiness expenses as described in section 212; 
medical, dental, etc., expenses (section 213); expenses for care of 
certain dependents (section 214); alimony, etc., payments (section 215); 
amounts representing taxes and interest paid to cooperative housing 
corporations (section 216); intangible drilling and developments costs 
(section 263(c)); pre-1970 exploration expenditures (section 615); 
certain mining exploration expenditures (section 617); income, gain, or 
loss to the partnership under section 751(b); and any items of income, 
gain, loss, deduction, or credit subject to a special allocation under 
the partnership agreement which differs from the allocation of 
partnership taxable income or loss generally.
    (ii) Each partner must also take into account separately the 
partner's distributive share of any partnership item which, if 
separately taken into account by any partner, would result in an income 
tax liability for that partner, or

[[Page 430]]

for any other person, different from that which would result if that 
partner did not take the item into account separately. Thus, if any 
partner is a controlled foreign corporation, as defined in section 957, 
items of income that would be gross subpart F income if separately taken 
into account by the controlled foreign corporation must be separately 
stated for all partners. Under section 911(a), if any partner is a bona 
fide resident of a foreign country who may exclude from gross income the 
part of the partner's distributive share which qualifies as earned 
income, as defined in section 911(b), the earned income of the 
partnership for all partners must be separately stated. Similarly, all 
relevant items of income or deduction of the partnership must be 
separately stated for all partners in determining the applicability of 
section 183 (relating to activities not engaged in for profit) and the 
recomputation of tax thereunder for any partner. This paragraph 
(a)(8)(ii) applies to taxable years beginning on or after July 23, 2002.
    (iii) Each partner shall aggregate the amount of his separate 
deductions or exclusions and his distributive share of partnership 
deductions or exclusions separately stated in determining the amount 
allowable to him of any deduction or exclusion under subtitle A of the 
Code as to which a limitation is imposed. For example, partner A has 
individual domestic exploration expenditures of $300,000. He is also a 
member of the AB partnership which in 1971 in its first year of 
operation has foreign exploration expenditures of $400,000. A's 
distributable share of this item is $200,000. However, the total amount 
of his distributable share that A can deduct as exploration expenditures 
under section 617(a) is limited to $100,000 in view of the limitation 
provided in section 617(h). Therefore, the excess of $100,000 ($200,000 
minus $100,000) is not deductible by A.
    (9) Each partner shall also take into account separately his 
distributive share of the taxable income or loss of the partnership, 
exclusive of items requiring separate computations under subparagraphs 
(1) through (8) of this paragraph. For limitation on allowance of a 
partner's distributive share of partnership losses, see section 704(d) 
and paragraph (d) of Sec. 1.704-1.
    (b) Character of items constituting distributive share. The 
character in the hands of a partner of any item of income, gain, loss, 
deduction, or credit described in section 702(a)(1) through (8) shall be 
determined as if such item were realized directly from the source from 
which realized by the partnership or incurred in the same manner as 
incurred by the partnership. For example, a partner's distributive share 
of gain from the sale of depreciable property used in the trade or 
business of the partnership shall be considered as gain from the sale of 
such depreciable property in the hands of the partner. Similarly, a 
partner's distributive share of partnership ``hobby losses'' (section 
270) or his distributive share of partnership charitable contributions 
to organizations qualifying under section 170(b)(1)(A) retains such 
character in the hands of the partner.
    (c) Gross income of a partner. (1) Where it is necessary to 
determine the amount or character of the gross income of a partner, his 
gross income shall include the partner's distributive share of the gross 
income of the partnership, that is, the amount of gross income of the 
partnership from which was derived the partner's distributive share of 
partnership taxable income or loss (including items described in section 
702(a)(1) through (8)). For example, a partner is required to include 
his distributive share of partnership gross income:
    (i) In computing his gross income for the purpose of determining the 
necessity of filing a return (section 6012 (a));
    (ii) In determining the application of the provisions permitting the 
spreading of income for services rendered over a 36-month period 
(section 1301, as in effect for taxable years beginning before January 
1, 1964);
    (iii) In computing the amount of gross income received from sources 
within possessions of the United States (section 937).
    (iv) In determining a partner's ``gross income from farming'' 
(sections 175 and 6073); and
    (v) In determining whether the de minimis or full inclusion rules of 
section 954(b)(3) apply.

[[Page 431]]

    (2) In determining the applicability of the 6-year period of 
limitation on assessment and collection provided in section 6501(e) 
(relating to omission of more than 25 percent of gross income), a 
partner's gross income includes his distributive share of partnership 
gross income (as described in section 6501(e)(1)(A)(i)). In this 
respect, the amount of partnership gross income from which was derived 
the partner's distributive share of any item of partnership income, 
gain, loss, deduction, or credit (as included or disclosed in the 
partner's return) is considered as an amount of gross income stated in 
the partner's return for the purposes of section 6501(e). For example, 
A, who is entitled to one-fourth of the profits of the ABCD partnership, 
which has $10,000 gross income and $2,000 taxable income, reports only 
$300 as his distributive share of partnership profits. A should have 
shown $500 as his distributive share of profits, which amount was 
derived from $2,500 of partnership gross income. However, since A 
included only $300 on his return without explaining in the return the 
difference of $200, he is regarded as having stated in his return only 
$1,500 ($300/$500 of $2,500) as gross income from the partnership.
    (d) Partners in community property States. If separate returns are 
made by a husband and wife domiciled in a community property State, and 
only one spouse is a member of the partnership, the part of his or her 
distributive share of any item or items listed in paragraph (a) (1) 
through (9) of this section which is community property, or which is 
derived from community property, should be reported by the husband and 
wife in equal proportions.
    (e) Special rules on requirement to separately state meal, travel, 
and entertainment expenses. Each partner shall take into account 
separately his or her distributive share of meal, travel, and 
entertainment expenses paid or incurred after December 31, 1986, by 
partnerships that have taxable years beginning before January 1, 1987, 
and ending with or within partner's taxable years beginning on or after 
January 1, 1987. In addition, with respect to skybox rentals under 
section 274 (1) (2), each partner shall take into account separately his 
or her distributive share of rents paid or incurred after December 31, 
1986, by partnerships that have taxable years beginning before January 
1, 1989, and ending with or within partners' taxable years beginning on 
or after January 1, 1987.
    (f) Cross--references. For special rules in accordance with the 
principles of section 702 applicable solely for the purpose of the tax 
imposed by section 56 (relating to the minimum tax for tax preferences) 
see Sec. 1.58-2(a). In the case of a disposition of an oil or gas 
property by the partnership, see the rules contained in section 
613A(c)(7)(D) and Sec. 1.613A-3(e).

[T.D. 6500, 25 FR 11814, Nov. 26, 1960]

    Editorial Note: For Federal Register citations affecting Sec. 
1.702-1, see the List of CFR Sections Affected, which appears in the 
Finding Aids section of the printed volume and at www.fdsys.gov.



Sec. 1.702-2  Net operating loss deduction of partner.

    For the purpose of determining a net operating loss deduction under 
section 172, a partner shall take into account his distributive share of 
items of income, gain, loss, deduction, or credit of the partnership. 
The character of any such item shall be determined as if such item were 
realized directly from the source from which realized by the 
partnership, or incurred in the same manner as incurred by the 
partnership. See section 702(b) and paragraph (b) of Sec. 1.702-1. To 
the extent necessary to determine the allowance under section 172(d)(4) 
of the nonbusiness deductions of a partner (arising from both 
partnership and nonpartnership sources), the partner shall separately 
take into account his distributive share of the deductions of the 
partnership which are not attributable to a trade or business and 
combine such amount with his nonbusiness deductions from nonpartnership 
sources. Such partner shall also separately take into account his 
distributive share of the gross income of the partnership not derived 
from a trade or business and combine such amount with his nonbusiness 
income from nonpartnership sources. See section 172 and the regulations 
thereunder.

[[Page 432]]



Sec. 1.702-3T  4-Year spread (temporary).

    (a) Applicability. This section applies to a partner in a 
partnership if--
    (1) The partnership is required by section 806 of the Tax Reform Act 
of 1986 (the 1986 Act), Pub. L. 99-514, 100 Stat. 2362, to change its 
taxable year for the first taxable year beginning after December 31, 
1986 (partnership's year of change); and
    (2) As a result of such change in taxable year, items from more than 
one taxable year of the partnership would, but for the provisions of 
this section, be included in the taxable year of the partner with or 
within which the partnership's year of change ends.
    (b) Partner's treatment of items from the partnership's year of 
change--(1) In general. Except as provided in paragraph (c) of this 
section, if a partner's share of ``income items'' exceeds the partner's 
share of ``expense items,'' the partner's share of each and every income 
and expense item shall be taken into account ratably (and retain its 
character) over the partner's first 4 taxable years beginning with the 
partner's taxable year with or within which the partnership's year of 
change ends.
    (2) Definitions--(i) Income items. For purposes of this section, the 
term income items means the sum of--
    (A) The partner's distributive share of taxable income (exclusive of 
separately stated items) from the partnership's year of change,
    (B) The partner's distributive share of all separately stated income 
or gain items from the partnership's year of change, and
    (C) Any amount includible in the partner's income under section 
707(c) on account of payments during the partnership's year of change.
    (ii) Expense items. For purposes of this section, the term expense 
items means the sum of--
    (A) The partner's distributive share of taxable loss (exclusive of 
separately stated items) from the partnership's year of change, and
    (B) The partner's distributive share of all separately stated items 
of loss or deduction from the partnership's year of change.
    (c) Electing out of 4-year spread. A partner may elect out of the 
rules of paragraph (b) of this section by meeting the requirements of 
Sec. 301.9100-7T of this chapter (temporary regulations relating to 
elections under the Tax Reform Act of 1986).
    (d) Special rules for a partner that is a partnership or S 
corporation--(1) In general. Except as provided in paragraph (d)(2) of 
this section, a partner that is a partnership or S corporation may, if 
otherwise eligible, use the 4-year spread (with respect to partnership 
interests owned by the partner) described in this section.
    (2) Certain partners prohibited from using 4-year spread--(i) In 
general. Except as provided in paragraph (d)(2)(ii) of this section, a 
partner that is a partnership or S corporation may not use the 4-year 
spread (with respect to partnership interests owned by the partner) if 
such partner is also changing its taxable year pursuant to section 806 
of the 1986 Act.
    (ii) Exception. If a partner's year of change does not include any 
income or expense items with respect to the partnership's year of 
change, such partner may, if otherwise eligible, use the 4-year spread 
(with respect to such partnership interest) described in this section 
even though the partner is a partnership or S corporation. See examples 
13 and 14 in paragraph (h) of this section.
    (e) Basis of partner's interest. The basis of a partner's interest 
in a partnership shall be determined as if the partner elected not to 
spread the partnership items over 4 years, regardless of whether such 
election was in fact made. Thus, for example, if a partner is eligible 
for the 4-year spread and does not elect out of the 4-year spread 
pursuant to paragraph (c) of this section, the partner's basis in the 
partnership interest will be increased in the first year of the 4-year 
spread period by an amount equal to the excess of the income items over 
the expense items. However, the partner's basis will not be increased 
again, with respect to the unamortized income and expense items, as they 
are amortized over the 4-year spread period.
    (f) Effect on other provisions of the Code. Except as provided in 
paragraph (e) of this section, determinations with respect to a partner, 
for purposes of other provisions of the Code, must be

[[Page 433]]

made with regard to the manner in which partnership items are taken into 
account under the rules of this section. Thus, for example, a partner 
who does not elect out of the 4-year spread must take into account, for 
purposes of determining net earnings from self-employment under section 
1402(a) for a taxable year, only the ratable portion of partnership 
items for that taxable year.
    (g) Treatment of dispositions--(1) In general. If a partnership 
interest is disposed of before the last taxable year in the 4-year 
spread period, unamortized income and expense items that are 
attributable to the interest disposed of and that would be taken into 
account by the partner for subsequent taxable years in the 4-year spread 
period shall be taken into account by the partner as determined under 
paragraph (g)(2) of this section. For purposes of this section, the term 
disposed of means any transfer, including (but not limited to) transfers 
by sale, exchange, gift, and by reason of death.
    (2) Year unamortized items taken into account--(i) In general. If, 
at the end of a partner's taxable year, the fraction determined under 
paragraph (g)(2)(ii) of this section is--
    (A) Greater than \2/3\, the partner must continue to take the 
unamortized income and expense items into account ratably over the 4-
year spread period;
    (B) Greater than \1/3\ but less than or equal to \2/3\, the partner 
must, in addition to its ratable amortization, take into account in such 
year 50 percent of the income and expense items that would otherwise be 
unamortized at the end of such year (however, this paragraph 
(g)(2)(i)(B) is only applied once with respect to a partner's interest 
in a particular partnership); or
    (C) Less than or equal to \1/3\, the partner must take into account 
the entire balance of unamortized income and expense items in such year.
    (ii) Determination of fraction. For purposes of paragraph (g)(2)(i) 
of this section, the numerator of the fraction is the partner's 
proportionate interest in the partnership at the end of the partner's 
taxable year and the denominator is the partner's proportionate interest 
in the partnership as of the last day of the partnership's year of 
change.
    (h) Examples. The provisions of this section may be illustrated by 
the following examples.

    Example 1. Assume that P1, a partnership with a taxable year ending 
September 30, is required by the 1986 Act to change its taxable year to 
a calendar year. All of the partners of P1 are individual taxpayers 
reporting on a calendar year. P1 is required to change to a calendar 
year for its taxable year beginning October 1, 1987, and to file a 
return for the short taxable year ending December 31, 1987. Based on the 
above facts, the partners of P1 are required to include the items from 
more than one taxable year of P1 in income for their 1987 taxable year. 
Thus, under paragraph (b) of this section, if a partner's share of 
income items exceeds the partner's share of expense items, the partner's 
share of each and every income and expense item shall be taken into 
account ratably by such partner in each of the partner's first four 
taxable years' beginning with the partner's 1987 taxable year, unless 
such partner elects under paragraph (c) of this section to include all 
such amounts in his 1987 taxable year.
    Example 2. Assume the same facts as in example 1, except P1 is a 
personal service corporation with all of its employee-owners reporting 
on a calendar year. Although P1 is required to change to a calendar year 
for its taxable year beginning October 1, 1987, neither P1 nor its 
employee-owners obtain the benefits of a 4-year spread. Pursuant to 
section 806(e)(2)(C) of the 1986 Act, the 4-year spread provision is 
only applicable to short taxable years of partnerships and S 
corporations required to change their taxable year under the 1986 Act.
    Example 3. Assume the same facts as example 1 and that I is one of 
the individual partners of P1. Further assume that I's distributive 
share of P1's taxable income for the short taxable year ended December 
31, 1987 (i.e., P1's year of change), is $10,000. In addition, I has 
$8,000 of separately stated expense from P1's year of change. Since I's 
income items (i.e., $10,000 of taxable income) exceed I's expense items 
(i.e., $8,000 of separately stated expense) attributable to P1's year of 
change, I is eligible for the 4-year spread provided by this section. If 
I does not elect out of the 4-year spread, I will recognize $2,500 of 
taxable income and $2,000 of separately stated expense in his 1987 
calendar year return. Assuming I does not dispose of his partnership 
interest in P1 by December 31, 1989, the remaining $7,500 of taxable 
income and $6,000 of separately stated expense will be amortized (and 
retain its character) over I's next three taxable years (i.e., 1988, 
1989 and 1990).
    Example 4. Assume the same facts as example 3, except that I 
disposes of his entire interest in P1 during 1988. Pursuant to paragraph 
(g) of this section, I would recognize

[[Page 434]]

$7,500 of taxable income and $6,000 of separately stated expense in his 
1988 calendar year return.
    Example 5. Assume the same facts as in example 3, except that I 
disposes of 50 percent of his interest in P1 during 1989. Pursuant to 
paragraph (g) of this section, I would recognize $3,750 of taxable 
income in his 1989 calendar year return ($2,500 ratable portion for 1989 
plus 50 percent of the $2,500 of income items that would otherwise be 
unamortized at the end of 1989). I would also recognize $3,000 of 
separately stated expense items in 1989 ($2,000 ratable portion for 1989 
plus 50 percent of the $2,000 of separately stated expense items that 
would otherwise be unamortized at the end of 1989).
    Example 6. Assume the same facts as in example 1, except that X, a 
personal service corporation as defined in section 441(i), is a partner 
of P1. X is a calendar year taxpayer, and thus is not required to change 
its taxable year under the 1986 Act. The same result occurs as in 
example 1 (i.e., unless X elects to the contrary, X is required to 
include one fourth of its share of income and expense items from P1's 
year of change in the first four taxable years of X beginning with the 
1987 taxable year).
    Example 7. Assume the same facts as in example 6, except that X is a 
fiscal year personal service corporation with a taxable year ending 
September 30. X is required under the 1986 Act to change to a calendar 
year for its taxable year beginning October 1, 1987, and to file a 
return for its short year ending December 31, 1987. Based on the above 
facts, X is not required to include the items from more than one taxable 
year of P1 in any one taxable year of X. Thus, the provisions of this 
section do not apply to X, and X is required to include the full amount 
of income and expense items from P1's year of change in X's taxable 
income for X's short year ending December 31. Under section 443 of the 
Code, X is required to annualize the taxable income for its short year 
ending December 31, 1987.
    Example 8. Assume that P2 is a partnership with a taxable year 
ending September 30. Under the 1986 Act, P2 would have been required to 
change its taxable year to a calendar year, effective for the taxable 
year beginning October 1, 1987. However, P2 properly changed its taxable 
year to a calendar year for the year beginning October 1, 1986, and 
filed a return for the short period ending December 31, 1986. The 
provisions of the 1986 Act do not apply to P2 because the short year 
ending December 31, 1986, was not required by the amendments made by 
section 806 of the 1986 Act. Thus, the partners of P2 are required to 
take all items of income and expense for the short taxable year ending 
December 31, 1986, into account for the taxable year with or within 
which such short year ends.
    Example 9. Assume that P3 is a partnership with a taxable year 
ending March 31 and I, a calendar year individual, is a partner in P3. 
Under the 1986 Act, P3 would have been required to change its taxable 
year to a calendar year. However, under Rev. Proc. 87-32, P3 establishes 
and changes to a natural business year beginning with the taxable year 
ending June 30, 1987. Thus, P3 is required to change its taxable year 
under section 806 of the 1986 Act, and I is required to include items 
from more than one taxable year of P3 in one of her taxable years. 
Furthermore, I's share of P3's income items exceeds her share of P3's 
expense items for the short period April 1, 1987 through June 30, 1987. 
Accordingly, under this section, unless I elects to the contrary, I is 
required to take one fourth of her share of items of income and expense 
from P3's short taxable year ending June 30, 1987 into account for her 
taxable year ending December 31, 1987.
    Example 10. Assume that P4 is a partnership with a taxable year 
ending March 31. Y, a C corporation, owns a 51 percent interest in the 
profits and capital of P4. Y reports its income on the basis of a 
taxable year ending March 31. P4 establishes and changes to a natural 
business year beginning with the taxable year ending June 30, 1987, 
under Rev. Proc. 87-32. Under the above facts, P4 is not required to 
change its taxable year because its March 31 taxable year was the 
taxable year of Y, the partner owning a majority of the partnership's 
profits and capital. Therefore, the remaining partners of P4 owning 49 
percent of the profits and capital are not permitted the 4-year spread 
of the items of income and expense with respect to the short year, even 
though they may be required to include their distributive share of P4's 
items from more than one taxable year in one of their years.
    Example 11. Assume that X and Y are C corporations with taxable 
years ending June 30. Each owns a 50-percent interest in the profits and 
capital of partnership P5. P5 has a taxable year ending March 31. Assume 
that P5 cannot establish a business purpose in order to retain a taxable 
year ending March 31, and thus P5 must change to a June 30 taxable year, 
the taxable year of its partners. Furthermore, assume that X's share of 
P5's income items exceeds its share of P5's expense items for P5's short 
taxable year ending June 30, 1987. Unless X elects out of the 4-year 
spread, the taxable year ending June 30, 1987, is the first of the four 
taxable years in which X must take into account its share of the items 
of income and expense resulting from P5's short taxable year ending June 
30, 1987.
    Example 12. Assume that I, an individual who reports income on the 
basis of the calendar year, is a partner in two partnerships, P6 and P7. 
Both partnerships have a taxable

[[Page 435]]

year ending September 30. Neither partnership can establish a business 
purpose for retaining its taxable year. Consequently, each partnership 
will change its taxable year to December 31, for the taxable year 
beginning October 1, 1987. The election to avoid a 4-year spread is made 
at the partner level; in addition, a partner may make such elections on 
a partnership-by-partnership basis. Thus, assuming I is eligible to 
obtain the 4-year spread with respect to income and expense items from 
partnerships P6 and P7, I may use the 4-year spread with respect to 
items from P6, while not using the 4-year spread with respect to items 
from P7.
    Example 13. I, an individual taxpayer using a calendar year, owns an 
interest in P8, a partnership using a taxable year ending June 30. 
Furthermore, P8 owns an interest in P9, a partnership with a taxable 
year ending March 31. Under section 806 of the 1986 Act, P8 will be 
required to change to a taxable year ending December 31, while P9 will 
be required to change to a taxable year ending June 30. As a result, 
P8's year of change will be July 1 through December 31, 1987, while P9's 
year of change will be from April 1 through June 30, 1987. Since P9's 
year of change does not end with or within P8's year of change, 
paragraph (d)(2) of this section does not prevent P8 from obtaining a 4-
year spread with respect to its interest in P9.
    Example 14. The facts are the same as in example 13, except that P9 
has a taxable year ending September 30, and under the 1986 Act P9 is 
required to change to a taxable year ending December 31. Therefore, P9's 
year of change will be from October 1, 1987 through December 31, 1987. 
Although P8's year of change from July 1, 1987 through December 31, 1987 
includes two taxable years of P9 (i.e., October 1, 1986 through 
September 30, 1987 and October 1, 1987 through December 31, 1987), 
paragraph (d)(2) of this section prohibits P8 from using the 4-year 
spread with respect to its interest in P9, because P9's year of change 
ends with or within P8's year of change.

[T.D. 8167, 52 FR 48530, Dec. 23, 1987, as amended by T.D. 8435, 57 FR 
43896, Sept. 23, 1992]



Sec. 1.703-1  Partnership computations.

    (a) Income and deductions. (1) The taxable income of a partnership 
shall be computed in the same manner as the taxable income of an 
individual, except as otherwise provided in this section. A partnership 
is required to state separately in its return the items described in 
section 702(a)(1) through (7) and, in addition, to attach to its return 
a statement setting forth separately those items described in section 
702(a)(8) which the partner is required to take into account separately 
in determining his income tax. See paragraph (a)(8) of Sec. 1.702-1. 
The partnership is further required to compute and to state separately 
in its return:
    (i) As taxable income under section 702(a)(9), the total of all 
other items of gross income (not separately stated) over the total of 
all other allowable deductions (not separately stated), or
    (ii) As loss under section 702(a)(9), the total of all other 
allowable deductions (not separately stated) over the total of all other 
items of gross income (not separately stated).

The taxable income or loss so computed shall be accounted for by the 
partners in accordance with their partnership agreement.
    (2) The partnership is not allowed the following deductions:
    (i) The standard deduction provided in section 141.
    (ii) The deduction for personal exemptions provided in section 151.
    (iii) The deduction provided in section 164(a) for taxes, described 
in section 901, paid or accrued to foreign countries or possessions of 
the United States. Each partner's distributive share of such taxes shall 
be accounted for separately by him as provided in section 702(a)(6).
    (iv) The deduction for charitable contributions provided in section 
170. Each partner is considered as having paid within his taxable year 
his distributive share of any contribution or gift, payment of which was 
actually made by the partnership within its taxable year ending within 
or with the partner's taxable year. This item shall be accounted for 
separately by the partners as provided in section 702(a)(4). See also 
paragraph (b) of Sec. 1.702-1.
    (v) The net operating loss deduction provided in section 172. See 
Sec. 1.702-2.
    (vi) The additional itemized deductions for individuals provided in 
part VII, subchapter B, chapter 1 of the Code, as follows: Expenses for 
production of income (section 212); medical, dental, etc., expenses 
(section 213); expenses for care of certain dependents (section 214); 
alimony, etc., payments (section 215); and amounts representing taxes 
and interest paid to cooperative

[[Page 436]]

housing corporation (section 216). However, see paragraph (a)(8) of 
Sec. 1.702-1.
    (vii) The deduction for depletion under section 611 with respect to 
domestic oil or gas which is produced after December 31, 1974, and to 
which gross income from the property is attributable after such year.
    (viii) The deduction for capital gains provided by section 1202 and 
the deduction for capital loss carryover provided by section 1212.
    (b) Elections of the partnership--(1) General rule. Any elections 
(other than those described in subparagraph (2) of this paragraph) 
affecting the computation of income derived from a partnership shall be 
made by the partnership. For example, elections of methods of 
accounting, of computing depreciation, of treating soil and water 
conservation expenditures, and the option to deduct as expenses 
intangible drilling and development costs, shall be made by the 
partnership and not by the partners separately. All partnership 
elections are applicable to all partners equally, but any election made 
by a partnership shall not apply to any partner's nonpartnership 
interests.
    (2) Exceptions. (i) Each partner shall add his distributive share of 
taxes described in section 901 paid or accrued by the partnership to 
foreign countries or possessions of the United States (according to its 
method of treating such taxes) to any such taxes paid or accrued by him 
(according to his method of treating such taxes), and may elect to use 
the total amount either as a credit against tax or as a deduction from 
income.
    (ii) Each partner shall add his distributive share of expenses 
described in section 615 or section 617 paid or accrued by the 
partnership to any such expenses paid or accrued by him and shall treat 
the total amount according to his method of treating such expenses, 
notwithstanding the treatment of the expenses by the partnership.
    (iii) Each partner who is a nonresident alien individual or a 
foreign corporation shall add his distributive share of income derived 
by the partnership from real property located in the United States, as 
described in section 871(d)(1) or 882(d)(1), to any such income derived 
by him and may elect under Sec. 1.871-10 to treat all such income as 
income which is effectively connected for the taxable year with the 
conduct of a trade or business in the United States.

[T.D. 6500, 25 FR 11814, Nov. 26, 1960, as amended by T.D. 7192, 37 FR 
12949, June 30, 1972; T.D. 7332, 39 FR 44232, Dec. 23, 1974; T.D. 8348, 
56 FR 21952, May 13, 1991]



Sec. 1.704-1  Partner's distributive share.

    (a) Effect of partnership agreement. A partner's distributive share 
of any item or class of items of income, gain, loss, deduction, or 
credit of the partnership shall be determined by the partnership 
agreement, unless otherwise provided by section 704 and paragraphs (b) 
through (e) of this section. For definition of partnership agreement see 
section 761(c).
    (b) Determination of partner's distributive share--(0) Cross-
references.

------------------------------------------------------------------------
               Heading                              Section
------------------------------------------------------------------------
Cross-references....................  1.704-1(b)(0)
In general..........................  1.704-1(b)(1)
    Basic principles................  1.704-1(b)(1)(i)
    Effective dates.................  1.704-1(b)(1)(ii)
    Generally.......................  1.704-1(b)(1)(ii)(a)
    Foreign tax expenditures........  1.704-1(b)(1)(ii)(b)
Special rules for certain             1.704-1(b)(1)(ii)(b)(3)
 interbranch payments.
    Effect of other sections........  1.704-1(b)(1)(iii)
    Other possible tax consequences.  1.704-1(b)(1)(iv)
    Purported allocations...........  1.704-1(b)(1)(v)
    Section 704(c) determinations...  1.704-1(b)(1)(vi)
    Bottom line allocations.........  1.704-1(b)(1)(vii)
Substantial economic effect.........  1.704-1(b)(2)
    Two-part analysis...............  1.704-1(b)(2)(i)
    Economic effect.................  1.704-1(b)(2)(ii)
        Fundamental principles......  1.704-1(b)(2)(ii)(a)
        Three requirements..........  1.704-1(b)(2)(ii)(b)
        Obligation to restore         1.704-1(b)(2)(ii)(c)
         deficit.
        Alternate test for economic   1.704-1(b)(2)(ii)(d)
         effect.
        Partial economic effect.....  1.704-1(b)(2)(ii)(e)
        Reduction of obligation to    1.704-1(b)(2)(ii)(f)
         restore.
        Liquidation defined.........  1.704-1(b)(2)(ii)(g)
        Partnership agreement         1.704-1(b)(2)(ii)(h)
         defined.
        Economic effect equivalence.  1.704-1(b)(2)(ii)(i)
    Substantiality..................  1.704-1(b)(2)(iii)
        General rules...............  1.704-1(b)(2)(iii)(a)
        Shifting tax consequences...  1.704-1(b)(2)(iii)(b)
        Transitory allocations......  1.704-1(b)(2)(iii)(c)
Maintenance of capital accounts.....  1.704-1(b)(2)(iv)
    In general......................  1.704-1(b)(2)(iv)(a)
    Basic rules.....................  1.704-1(b)(2)(iv)(b)

[[Page 437]]

 
    Treatment of liabilities........  1.704-1(b)(2)(iv)(c)
    Contributed property............  1.704-1(b)(2)(iv)(d)
        In general..................  1.704-1(b)(2)(iv)(d)(1)
        Contribution of promissory    1.704-1(b)(2)(iv)(d)(2)
         notes.
        Section 704(c)                1.704-1(b)(2)(iv)(d)(3)
         considerations.
        Exercise of noncompensatory   1.704-1(b)(2)(iv)(d)(4).
         options.
    Distributed property............  1.704-1(b)(2)(iv)(e)
        In general..................  1.704-1(b)(2)(iv)(e)(1)
        Distribution of promissory    1.704-1(b)(2)(iv)(e)(2)
         notes.
    Revaluations of property........  1.704-1(b)(2)(iv)(f)
    Adjustments to reflect book       1.704-1(b)(2)(iv)(g)
     value.
        In general..................  1.704-1(b)(2)(iv)(g)(1)
        Payables and receivables....  1.704-1(b)(2)(iv)(g)(2)
        Determining amount of book    1.704-1(b)(2)(iv)(g)(3)
         items.
    Determinations of fair market     1.704-1(b)(2)(iv)(h)
     value.
        In general..................  1.704-1(b)(2)(iv)(h)(1).
        Adjustments for               1.704-1(b)(2)(iv)(h)(2).
         noncompensatory options.
    Section 705(a)(2)(B)              1.704-1(b)(2)(iv)(i)
     expenditures.
        In general..................  1.704-1(b)(2)(iv)(i)(1)
        Expenses described in         1.704-1(b)(2)(iv)(i)(2)
         section 709.
        Disallowed losses...........  1.704-1(b)(2)(iv)(i)(3)
    Basis adjustments to section 38   1.704-1(b)(2)(iv)(j)
     property.
    Depletion of oil and gas          1.704-1(b)(2)(iv)(k)
     properties.
        In general..................  1.704-1(b)(2)(iv)(k)(1)
        Simulated depletion.........  1.704-1(b)(2)(iv)(k)(2)
        Actual depletion............  1.704-1(b)(2)(iv)(k)(3)
        Effect of book values.......  1.704-1(b)(2)(iv)(k)(4)
    Transfers of partnership          1.704-1(b)(2)(iv)(l)
     interests.
    Section 754 elections...........  1.704-1(b)(2)(iv)(m)
        In general..................  1.704-1(b)(2)(iv)(m)(1)
        Section 743 adjustments.....  1.704-1(b)(2)(iv)(m)(2)
        Section 732 adjustments.....  1.704-1(b)(2)(iv)(m)(3)
        Section 734 adjustments.....  1.704-1(b)(2) iv)(m)(4)
        Limitations on adjustments..  1.704-1(b)(2) iv)(m)(5)
    Partnership level                 1.704-1(b)(2)(iv)(n)
     characterization.
    Guaranteed payments.............  1.704-1(b)(2)(iv)(o)
    Minor discrepancies.............  1.704-1(b)(2)(iv)(p)
    Adjustments where guidance is     1.704-1(b)(2)(iv)(q)
     lacking.
    Restatement of capital accounts.  1.704-1(b)(2)(iv)(r)
    Adjustments on the exercise of a  1.704-1(b)(2)(iv)(s).
     noncompensatory option.
    Partner's interest in the         1.704-1(b)(3)
     partnership.
        In general..................  1.704-1(b)(3)(i)
        Factors considered..........  1.704-1(b)(3)(ii)
        Certain determinations......  1.704-1(b)(3)(iii)
    Special rules...................  1.704-1(b)(4)
        Allocations to reflect        1.704-1(b)(4)(i)
         revaluations.
        Credits.....................  1.704-1(b)(4)(ii)
        Excess percentage depletion.  1.704-1(b)(4)(iii)
        Allocations attributable to   1.704-1(b)(4)(iv)
         nonrecourse liabilities.
        Allocations under section     1.704-1(b)(4)(v)
         613A(c(7)(D).
        Amendments to partnership     1.704-1(b)(4)(vi)
         agreement.
        Recapture...................  1.704-1(b)(4)(vii)
Allocation of creditable foreign      1.704-1(b)(4)(viii)
 taxes.
In general..........................  1.704-1(b)(4)(viii)(a)
    Creditable foreign tax            1.704-1(b)(4)(viii)(b)
     expenditures (CFTEs).
    Income to which CFTEs relate....  1.704-1(b)(4)(viii)(c)
        In general..................  1.704-1(b)(4)(viii)(c)(1)
        CFTE category...............  1.704-1(b)(4)(viii)(c)(2)
        Net income in a CFTE          1.704-1(b)(4)(viii)(c)(3)
         category.
    Distributive shares of income...  1.704-1(b)(4)(viii)(c)(4)
    No net income in a CFTE category  1.704-1(b)(4)(viii)(c)(5)
Allocation and apportionment of       1.704-1(b)(4)(viii)(d)
 CFTEs to CFTE categories.
    In general......................  1.704-1(b)(4)(viii)(d)(1)
    Timing and base differences.....  1.704-1(b)(4)(viii)(d)(2)
Special rules for certain             1.704-1(b)(4)(viii)(d)(3)
 interbranch payments.
    Allocations with respect to       1.704-1(b)(4)(ix).
     noncompensatory options.
    Corrective allocations..........  1.704-1(b)(4)(x).
------------------------------------------------------------------------

    (1) In general--(i) Basic principles. Under section 704(b) if a 
partnership agreement does not provide for the allocation of income, 
gain, loss, deduction, or credit (or item thereof) to a partner, or if 
the partnership agreement provides for the allocation of income, gain, 
loss, deduction, or credit (or item thereof) to a partner but such 
allocation does not have substantial economic effect, then the partner's 
distributive share of such income, gain, loss, deduction, or credit (or 
item thereof) shall be determined in accordance with such partner's 
interest in the partnership (taking into account all facts and 
circumstances). If the partnership agreement provides for the allocation 
of income, gain, loss, deduction, or credit (or item thereof) to a 
partner, there are three ways in which such allocation will be respected 
under section 704(b) and this paragraph. First, the allocation can have 
substantial economic effect in accordance with paragraph (b)(2) of this 
section. Second,

[[Page 438]]

taking into account all facts and circumstances, the allocation can be 
in accordance with the partner's interest in the partnership. See 
paragraph (b)(3) of this section. Third, the allocation can be deemed to 
be in accordance with the partner's interest in the partnership pursuant 
to one of the special rules contained in paragraph (b)(4) of this 
section and Sec. 1.704-2. To the extent an allocation under the 
partnership agreement of income, gain, loss, deduction, or credit (or 
item thereof) to a partner does not have substantial economic effect, is 
not in accordance with the partner's interest in the partnership, and is 
not deemed to be in accordance with the partner's interest in the 
partnership, such income, gain, loss, deduction, or credit (or item 
thereof) will be reallocated in accordance with the partner's interest 
in the partnership (determined under paragraph (b)(3) of this section).
    (ii) Effective/applicability date. (a) Generally. Except as 
otherwise provided in this section, the provisions of this paragraph are 
effective for partnership taxable years beginning after December 31, 
1975. However, for partnership taxable years beginning after December 
31, 1975, but before May 1, 1986, (January 1, 1987, in the case of 
allocations of nonrecourse deductions as defined in paragraph 
(b)(4)(iv)(a) of this section) an allocation of income, gain, loss, 
deduction, or credit (or item thereof) to a partner that is not 
respected under this paragraph nevertheless will be respected under 
section 704(b) if such allocation has substantial economic effect or is 
in accordance with the partners' interests in the partnership as those 
terms have been interpreted under the relevant case law, the legislative 
history of section 210(d) of the Tax Reform Act of 1976, and the 
provisions of this paragraph in effect for partnership taxable years 
beginning before May 1, 1986. Paragraphs (b)(2)(iii)(a) (last sentence), 
(b)(2)(iii)(d), (b)(2)(iii)(e), and (b)(5) Example 28, Example 29, and 
Example 30 of this section apply to partnership taxable years beginning 
on or after May 19, 2008. In addition, paragraph (b)(2)(iv)(d)(4), 
paragraph (b)(2)(iv)(f)(1), paragraph (b)(2)(iv)(f)(5)(iv), paragraph 
(b)(2)(iv)(h)(2), paragraph (b)(2)(iv)(s), paragraph (b)(4)(ix), 
paragraph (b)(4)(x), and Examples 31 through 35 in paragraph (b)(5) of 
this section apply to noncompensatory options (as defined in Sec. 
1.721-2(f)) that are issued on or after February 5, 2013.
    (b) Rules relating to foreign tax expenditures--(1) In general. The 
provisions of paragraphs (b)(3)(iv) and (b)(4)(viii) of this section 
(regarding the allocation of creditable foreign taxes) apply for 
partnership taxable years beginning on or after October 19, 2006. The 
rules that apply to allocations of creditable foreign taxes made in 
partnership taxable years beginning before October 19, 2006 are 
contained in Sec. Sec. 1.704-1T(b)(1)(ii)(b)(1) and 1.704-1T(b)(4)(xi) 
as in effect prior to October 19, 2006 (see 26 CFR part 1 revised as of 
April 1, 2005). However, taxpayers may rely on the provisions of 
paragraphs (b)(3)(iv) and (b)(4)(viii) of this section for partnership 
taxable years beginning on or after April 21, 2004.
    (2) Transition rule. Transition relief is provided herein to 
partnerships whose agreements were entered into prior to April 21, 2004. 
In such case, if there has been no material modification to the 
partnership agreement on or after April 21, 2004, then the partnership 
may apply the provisions of paragraph (b) of this section as if the 
amendments made by paragraphs (b)(3)(iv) and (b)(4)(viii) of this 
section had not occurred. If the partnership agreement was materially 
modified on or after April 21, 2004, then the rules provided in 
paragraphs (b)(3)(iv) and (b)(4)(viii) of this section shall apply to 
the later of the taxable year beginning on or after October 19, 2006 or 
the taxable year within which the material modification occurred, and to 
all subsequent taxable years. If the partnership agreement was 
materially modified on or after April 21, 2004, and before a tax year 
beginning on or after October 19, 2006, see Sec. Sec. 1.704-
1T(b)(1)(ii)(b)(1) and 1.704-1T(b)(4)(xi) as in effect prior to October 
19, 2006 (26 CFR part 1 revised as of April 1, 2005). For purposes of 
this paragraph (b)(1)(ii)(b)(2), any change in ownership constitutes a 
material modification to the partnership agreement. This transition rule 
does not apply to any taxable year (and all subsequent taxable

[[Page 439]]

years) in which persons that are related to each other (within the 
meaning of section 267(b) and 707(b)) collectively have the power to 
amend the partnership agreement without the consent of any unrelated 
party.
    (3) Special rules for certain inter-branch payments--(A) In general. 
The provisions of Sec. 1.704-1(b)(4)(viii)(d)(3) apply for partnership 
taxable years ending after February 9, 2015. See 26 CFR 1.704-
1T(b)(4)(viii)(d)(3) (revised as of April 1, 2014) for rules applicable 
to taxable years beginning on or after January 1, 2012, and ending on or 
before February 9, 2015.
    (B) Transition rule. Transition relief is provided herein to 
partnerships whose agreements were entered into prior to February 14, 
2012. In such cases, if there has been no material modification to the 
partnership agreement on or after February 14, 2012, then the 
partnership may apply the provisions of Sec. 1.704-
1(b)(4)(viii)(c)(3)(ii) and Sec. 1.704-1(b)(4)(viii)(d)(3) (revised as 
of April 1, 2011). For purposes of this paragraph (b)(1)(ii)(b)(3), any 
change in ownership constitutes a material modification to the 
partnership agreement. This transition rule does not apply to any 
taxable year in which persons bearing a relationship to each other that 
is specified in section 267(b) or section 707(b) collectively have the 
power to amend the partnership agreement without the consent of any 
unrelated party (and all subsequent taxable years).
    (iii) Effect of other sections. The determination of a partner's 
distributive share of income, gain, loss, deduction, or credit (or item 
thereof) under section 704(b) and this paragraph is not conclusive as to 
the tax treatment of a partner with respect to such distributive share. 
For example, an allocation of loss or deduction to a partner that is 
respected under section 704(b) and this paragraph may not be deductible 
by such partner if the partner lacks the requisite motive for economic 
gain (see, e.g., Goldstein v. Commissioner, 364 F.2d 734 (2d Cir. 
1966)), or may be disallowed for that taxable year (and held in 
suspense) if the limitations of section 465 or section 704(d) are 
applicable. Similarly, an allocation that is respected under section 
704(b) and this paragraph nevertheless may be reallocated under other 
provisions, such as section 482, section 704(e)(2), section 706(d) (and 
related assignment of income principles), and paragraph (b)(2)(ii) of 
Sec. 1.751-1. If a partnership has a section 754 election in effect, a 
partner's distributive share of partnership income, gain, loss, or 
deduction may be affected as provided in Sec. 1.743-1 (see paragraph 
(b)(2)(iv)(m)(2) of this section). A deduction that appears to be a 
nonrecourse deduction deemed to be in accordance with the partners' 
interests in the partnership may not be such because purported 
nonrecourse liabilities of the partnership in fact constitute equity 
rather than debt. The examples in paragraph (b)(5) of this section 
concern the validity of allocations under section 704(b) and this 
paragraph and, except as noted, do not address the effect of other 
sections or limitations on such allocations.
    (iv) Other possible tax consequences. Allocations that are respected 
under section 704(b) and this paragraph may give rise to other tax 
consequences, such as those resulting from the application of section 
61, section 83, section 751, section 2501, paragraph (f) of Sec. 1.46-
3, Sec. 1.47-6, paragraph (b)(1) of Sec. 1.721-1 (and related 
principles), and paragraph (e) of Sec. 1.752-1. The examples in 
paragraph (b)(5) of this section concern the validity of allocations 
under section 704(b) and this paragraph and, except as noted, do not 
address other tax consequences that may result from such allocations.
    (v) Purported allocations. Section 704(b) and this paragraph do not 
apply to a purported allocation if it is made to a person who is not a 
partner of the partnership (see section 7701(a)(2) and paragraph (d) of 
Sec. 301.7701-3) or to a person who is not receiving the purported 
allocation in his capacity as a partner (see section 707(a) and 
paragraph (a) of Sec. 1.707-1).
    (vi) Section 704(c) determinations. Section 704(c) and Sec. 1.704-3 
generally require that if property is contributed by a partner to a 
partnership, the partners' distributive shares of income, gain, loss, 
and deduction, as computed for tax purposes, with respect to the 
property are determined so as to take account of the variation between 
the

[[Page 440]]

adjusted tax basis and fair market value of the property. Although 
section 704(b) does not directly determine the partners' distributive 
shares of tax items governed by section 704(c), the partners' 
distributive shares of tax items may be determined under section 704(c) 
and Sec. 1.704-3 (depending on the allocation method chosen by the 
partnership under Sec. 1.704-3) with reference to the partners' 
distributive shares of the corresponding book items, as determined under 
section 704(b) and this paragraph. (See paragraphs (b)(2)(iv)(d) and 
(b)(4)(i) of this section.) See Sec. 1.704-3 for methods of making 
allocations under section 704(c), and Sec. 1.704-3(d)(2) for a special 
rule in determining the amount of book items if the remedial allocation 
method is chosen by the partnership. See also paragraph (b)(5) Example 
(13) (i) of this section.
    (vii) Bottom line allocations. Section 704(b) and this paragraph are 
applicable to allocations of income, gain, loss, deduction, and credit, 
allocations of specific items of income, gain, loss, deduction, and 
credit, and allocations of partnership net or ``bottom line'' taxable 
income and loss. An allocation to a partner of a share of partnership 
net or ``bottom line'' taxable income or loss shall be treated as an 
allocation to such partner of the same share of each item of income, 
gain, loss, and deduction that is taken into account in computing such 
net or ``bottom line'' taxable income or loss. See example 15(i) of 
paragraph (b)(5) of this section.
    (2) Substantial economic effect--(i) Two-part analysis. The 
determination of whether an allocation of income, gain, loss, or 
deduction (or item thereof) to a partner has substantial economic effect 
involves a two-part analysis that is made as of the end of the 
partnership taxable year to which the allocation relates. First, the 
allocation must have economic effect (within the meaning of paragraph 
(b)(2)(ii) of this section). Second, the economic effect of the 
allocation must be substantial (within the meaning of paragraph 
(b)(2)(iii) of this section).
    (ii) Economic effect--(a) Fundamental principles. In order for an 
allocation to have economic effect, it must be consistent with the 
underlying economic arrangement of the partners. This means that in the 
event there is an economic benefit or economic burden that corresponds 
to an allocation, the partner to whom the allocation is made must 
receive such economic benefit or bear such economic burden.
    (b) Three requirements. Based on the principles contained in 
paragraph (b)(2)(ii)(a) of this section, and except as otherwise 
provided in this paragraph, an allocation of income, gain, loss, or 
deduction (or item thereof) to a partner will have economic effect if, 
and only if, throughout the full term of the partnership, the 
partnership agreement provides--
    (1) For the determination and maintenance of the partners' capital 
accounts in accordance with the rules of paragraph (b)(2)(iv) of this 
section,
    (2) Upon liquidation of the partnership (or any partner's interest 
in the partnership), liquidating distributions are required in all cases 
to be made in accordance with the positive capital account balances of 
the partners, as determined after taking into account all capital 
account adjustments for the partnership taxable year during which such 
liquidation occurs (other than those made pursuant to this requirement 
(2) and requirement (3) of this paragraph (b)(2)(ii)(b)), by the end of 
such taxable year (or, if later, within 90 days after the date of such 
liquidation), and
    (3) If such partner has a deficit balance in his capital account 
following the liquidation of his interest in the partnership, as 
determined after taking into account all capital account adjustments for 
the partnership taxable year during which such liquidation occurs (other 
than those made pursuant to this requirement (3)), he is unconditionally 
obligated to restore the amount of such deficit balance to the 
partnership by the end of such taxable year (or, if later, within 90 
days after the date of such liquidation), which amount shall, upon 
liquidation of the partnership, be paid to creditors of the partnership 
or distributed to other partners in accordance with their positive 
capital account balances (in accordance with requirement (2) of this 
paragraph (b)(2)(ii)(b)).

[[Page 441]]


For purposes of the preceding sentence, a partnership taxable year shall 
be determined without regard to section 706(c)(2)(A). Requirements (2) 
and (3) of this paragraph (b)(2)(ii)(b) are not violated if all or part 
of the partnership interest of one or more partners is purchased (other 
than in connection with the liquidation of the partnership) by the 
partnership or by one or more partners (or one or more persons related, 
within the meaning of section 267(b) (without modification by section 
267(e)(1)) or section 707(b)(1), to a partner) pursuant to an agreement 
negotiated at arm's length by persons who at the time such agreement is 
entered into have materially adverse interests and if a principal 
purpose of such purchase and sale is not to avoid the principles of the 
second sentence of paragraph (b)(2)(ii)(a) of this section. In addition, 
requirement (2) of this paragraph (b)(2)(ii)(b) is not violated if, upon 
the liquidation of the partnership, the capital accounts of the partners 
are increased or decreased pursuant to paragraph (b)(2)(iv)(f) of this 
section as of the date of such liquidation and the partnership makes 
liquidating distributions within the time set out in that requirement 
(2) in the ratios of the partners' positive capital accounts, except 
that it does not distribute reserves reasonably required to provide for 
liabilities (contingent or otherwise) of the partnership and installment 
obligations owed to the partnership, so long as such withheld amounts 
are distributed as soon as practicable and in the ratios of the 
partners' positive capital account balances. See examples 1(i) and (ii), 
(4)(i), (8)(i), and (16)(i) of paragraph (b)(5) of this section.
    (c) Obligation to restore deficit. If a partner is not expressly 
obligated to restore the deficit balance in his capital account, such 
partner nevertheless will be treated as obligated to restore the deficit 
balance in his capital account (in accordance with requirement (3) of 
paragraph (b)(2)(ii)(b) of this section) to the extent of--
    (1) The outstanding principal balance of any promissory note (of 
which such partner is the maker) contributed to the partnership by such 
partner (other than a promissory note that is readily tradable on an 
established securities market), and
    (2) The amount of any unconditional obligation of such partner 
(whether imposed by the partnership agreement or by State or local law) 
to make subsequent contributions to the partnership (other than pursuant 
to a promissory note of which such partner is the maker),

provided that such note or obligation is required to be satisfied at a 
time no later than the end of the partnership taxable year in which such 
partner's interest is liquidated (or, if later, within 90 days after the 
date of such liquidation). If a promissory note referred to in the 
previous sentence is negotiable, a partner will be considered required 
to satisfy such note within the time period specified in such sentence 
if the partnership agreement provides that, in lieu of actual 
satisfaction, the partnership will retain such note and such partner 
will contribute to the partnership the excess, if any, of the 
outstanding principal balance of such note over its fair market value at 
the time of liquidation. See paragraph (b)(2)(iv)(d)(2) of this section. 
See examples (1)(ix) and (x) of paragraph (b)(5) of this section. A 
partner in no event will be considered obligated to restore the deficit 
balance in his capital account to the partnership (in accordance with 
requirement (3) of paragraph (b)(2)(ii)(b) of this section) to the 
extent such partner's obligation is not legally enforceable, or the 
facts and circumstances otherwise indicate a plan to avoid or circumvent 
such obligation. See paragraphs (b)(2)(ii)(f), (b)(2)(ii)(h), and 
(b)(4)(vi) of this section for other rules regarding such obligation. 
For purposes of this paragraph (b)(2), if a partner contributes a 
promissory note to the partnership during a partnership taxable year 
beginning after December 29, 1988 and the maker of such note is a person 
related to such partner (within the meaning of Sec. 1.752-1T(h), but 
without regard to subdivision (4) of that section), then such promissory 
note shall be treated as a promissory note of which such partner is the 
maker.
    (d) Alternate test for economic effect. If--

[[Page 442]]

    (1) Requirements (1) and (2) of paragraph (b)(2)(ii)(b) of this 
section are satisfied, and
    (2) The partner to whom an allocation is made is not obligated to 
restore the deficit balance in his capital account to the partnership 
(in accordance with requirement (3) of paragraph (b)(2)(ii)(b) of this 
section), or is obligated to restore only a limited dollar amount of 
such deficit balance, and
    (3) The partnership agreement contains a ``qualified income 
offset,''

such allocation will be considered to have economic effect under this 
paragraph (b)(2)(ii)(d) to the extent such allocation does not cause or 
increase a deficit balance in such partner's capital account (in excess 
of any limited dollar amount of such deficit balance that such partner 
is obligated to restore) as of the end of the partnership taxable year 
to which such allocation relates. In determining the extent to which the 
previous sentence is satisfied, such partner's capital account also 
shall be reduced for--
    (4) Adjustments that, as of the end of such year, reasonably are 
expected to be made to such partner's capital account under paragraph 
(b)(2)(iv)(k) of this section for depletion allowances with respect to 
oil and gas properties of the partnership, and
    (5) Allocations of loss and deduction that, as of the end of such 
year, reasonably are expected to be made to such partner pursuant to 
section 704(e)(2), section 706(d), and paragraph (b)(2)(ii) of Sec. 
751-1, and
    (6) Distributions that, as of the end of such year, reasonably are 
expected to be made to such partner to the extent they exceed offsetting 
increases to such partner's capital account that reasonably are expected 
to occur during (or prior to) the partnership taxable years in which 
such distributions reasonably are expected to be made (other than 
increases pursuant to a minimum gain chargeback under paragraph 
(b)(4)(iv)(e) of this section or under Sec. 1.704-2(f); however, 
increases to a partner's capital account pursuant to a minimum gain 
chargeback requirement are taken into account as an offset to 
distributions of nonrecourse liability proceeds that are reasonably 
expected to be made and that are allocable to an increase in partnership 
minimum gain).

For purposes of determining the amount of expected distributions and 
expected capital account increases described in (6) above, the rule set 
out in paragraph (b)(2)(iii)(c) of this section concerning the presumed 
value of partnership property shall apply. The partnership agreement 
contains a ``qualified income offset'' if, and only if, it provides that 
a partner who unexpectedly receives an adjustment, allocation, or 
distribution described in (4), (5), or (6) above, will be allocated 
items of income and gain (consisting of a pro rata portion of each item 
of partnership income, including gross income, and gain for such year) 
in an amount and manner sufficient to eliminate such deficit balance as 
quickly as possible. Allocations of items of income and gain made 
pursuant to the immediately preceding sentence shall be deemed to be 
made in accordance with the partners' interests in the partnership if 
requirements (1) and (2) of paragraph (b)(2)(ii)(b) of this section are 
satisfied. See examples (1)(iii), (iv), (v), (vi), (viii), (ix), and 
(x), (15), and (16)(ii) of paragraph (b)(5) of this section.
    (e) Partial economic effect. If only a portion of an allocation made 
to a partner with respect to a partnership taxable year has economic 
effect, both the portion that has economic effect and the portion that 
is reallocated shall consist of a proportionate share of all items that 
made up the allocation to such partner for such year. See examples (15) 
(ii) and (iii) of paragraph (b)(5) of this section.
    (f) Reduction of obligation to restore. If requirements (1) and (2) 
of paragraph (b)(2)(ii)(b) of this section are satisfied, a partner's 
obligation to restore the deficit balance in his capital account (or any 
limited dollar amount thereof) to the partnership may be eliminated or 
reduced as of the end of a partnership taxable year without affecting 
the validity of prior allocations (see paragraph (b)(4)(vi) of this 
section) to the extent the deficit balance (if any) in such partner's 
capital account, after reduction for the items described in (4), (5), 
and (6) of paragraph (b)(2)(ii)(d) of this section, will not exceed the 
partner's remaining obligation (if any) to

[[Page 443]]

restore the deficit balance in his capital account. See example 
(1)(viii) of paragraph (b)(5) of this section.
    (g) Liquidation defined. For purposes of this paragraph, a 
liquidation of a partner's interest in the partnership occurs upon the 
earlier of (1) the date upon which there is a liquidation of the 
partnership, or (2) the date upon which there is a liquidation of the 
partner's interest in the partnership under paragraph (d) of Sec. 
1.761-1. For purposes of this paragraph, the liquidation of a 
partnership occurs upon the earlier of (3) the date upon which the 
partnership is terminated under section 708(b)(1), or (4) the date upon 
which the partnership ceases to be a going concern (even though it may 
continue in existence for the purpose of winding up its affairs, paying 
its debts, and distributing any remaining balance to its partners). 
Requirements (2) and (3) of paragraph (b)(2)(ii)(b) of this section will 
be considered unsatisfied if the liquidation of a partner's interest in 
the partnership is delayed after its primary business activities have 
been terminated (for example, by continuing to engage in a relatively 
minor amount of business activity, if such actions themselves do not 
cause the partnership to terminate pursuant to section 708(b)(1)) for a 
principal purpose of deferring any distribution pursuant to requirement 
(2) of paragraph (b)(2)(ii)(b) of this section or deferring any 
partner's obligations under requirement (3) of paragraph (b)(2)(ii)(b) 
of this section.
    (h) Partnership agreement defined. For purposes of this paragraph, 
the partnership agreement includes all agreements among the partners, or 
between one or more partners and the partnership, concerning affairs of 
the partnership and responsibilities of partners, whether oral or 
written, and whether or not embodied in a document referred to by the 
partners as the partnership agreement. Thus, in determining whether 
distributions are required in all cases to be made in accordance with 
the partners' positive capital account balances (requirement (2) of 
paragraph (b)(2)(ii)(b) of this section), and in determining the extent 
to which a partner is obligated to restore a deficit balance in his 
capital account (requirement (3) of paragraph (b)(2)(ii)(b) of this 
section), all arrangements among partners, or between one or more 
partners and the partnership relating to the partnership, direct and 
indirect, including puts, options, and other buy-sell agreements, and 
any other ``stop-loss'' arrangement, are considered to be part of the 
partnership agreement. (Thus, for example, if one partner who assumes a 
liability of the partnership is indemnified by another partner for a 
portion of such liability, the indemnifying partner (depending upon the 
particular facts) may be viewed as in effect having a partial deficit 
makeup obligation as a result of such indemnity agreement.) In addition, 
the partnership agreement includes provisions of Federal, State, or 
local law that govern the affairs of the partnership or are considered 
under such law to be a part of the partnership agreement (see the last 
sentence of paragraph (c) of Sec. 1.761-1). For purposes of this 
paragraph (b)(2)(ii)(h), an agreement with a partner or a partnership 
shall include an agreement with a person related, within the meaning of 
section 267(b) (without modification by section 267(e)(1)) or section 
707(b)(1), to such partner or partnership. For purposes of the preceding 
sentence, sections 267(b) and 707(b)(1) shall be applied for partnership 
taxable years beginning after December 29, 1988 by (1) substituting ``80 
percent or more'' for ``more than 50 percent'' each place it appears in 
such sections, (2) excluding brothers and sisters from the members of a 
person's family, and (3) disregarding Sec. 267(f)(1)(A).
    (i) Economic effect equivalence. Allocations made to a partner that 
do not otherwise have economic effect under this paragraph (b)(2)(ii) 
shall nevertheless be deemed to have economic effect, provided that as 
of the end of each partnership taxable year a liquidation of the 
partnership at the end of such year or at the end of any future year 
would produce the same economic results to the partners as would occur 
if requirements (1), (2), and (3) of paragraph (b)(2)(ii)(b) of this 
section had been satisfied, regardless of the economic performance of 
the partnership. See examples (4)(ii) and (iii) of paragraph (b)(5) of 
this section.

[[Page 444]]

    (iii) Substantiality--(a) General rules. Except as otherwise 
provided in this paragraph (b)(2)(iii), the economic effect of an 
allocation (or allocations) is substantial if there is a reasonable 
possibility that the allocation (or allocations) will affect 
substantially the dollar amounts to be received by the partners from the 
partnership, independent of tax consequences. Notwithstanding the 
preceding sentence, the economic effect of an allocation (or 
allocations) is not substantial if, at the time the allocation becomes 
part of the partnership agreement, (1) the after-tax economic 
consequences of at least one partner may, in present value terms, be 
enhanced compared to such consequences if the allocation (or 
allocations) were not contained in the partnership agreement, and (2) 
there is a strong likelihood that the after-tax economic consequences of 
no partner will, in present value terms, be substantially diminished 
compared to such consequences if the allocation (or allocations) were 
not contained in the partnership agreement. In determining the after-tax 
economic benefit or detriment to a partner, tax consequences that result 
from the interaction of the allocation with such partner's tax 
attributes that are unrelated to the partnership will be taken into 
account. See examples 5 and 9 of paragraph (b)(5) of this section. The 
economic effect of an allocation is not substantial in the two 
situations described in paragraphs (b)(2)(iii) (b) and (c) of this 
section. However, even if an allocation is not described therein, its 
economic effect may be insubstantial under the general rules stated in 
this paragraph (b)(2)(iii)(a). References in this paragraph (b)(2)(iii) 
to allocations include capital account adjustments made pursuant to 
paragraph (b)(2)(iv)(k) of this section. References in this paragraph 
(b)(2)(iii) to a comparison to consequences arising if an allocation (or 
allocations) were not contained in the partnership agreement mean that 
the allocation (or allocations) is determined in accordance with the 
partners' interests in the partnership (within the meaning of paragraph 
(b)(3) of this section), disregarding the allocation (or allocations) 
being tested under this paragraph (b)(2)(iii).
    (b) Shifting tax consequences. The economic effect of an allocation 
(or allocations) in a partnership taxable year is not substantial if, at 
the time the allocation (or allocations) becomes part of the partnership 
agreement, there is a strong likelihood that--
    (1) The net increases and decreases that will be recorded in the 
partners' respective capital accounts for such taxable year will not 
differ substantially from the net increases and decreases that would be 
recorded in such partners' respective capital accounts for such year if 
the allocations were not contained in the partnership agreement, and
    (2) The total tax liability of the partners (for their respective 
taxable years in which the allocations will be taken into account) will 
be less than if the allocations were not contained in the partnership 
agreement (taking into account tax consequences that result from the 
interaction of the allocation (or allocations) with partner tax 
attributes that are unrelated to the partnership).

If, at the end of a partnership taxable year to which an allocation (or 
allocations) relates, the net increases and decreases that are recorded 
in the partners' respective capital accounts do not differ substantially 
from the net increases and decreases that would have been recorded in 
such partners' respective capital accounts had the allocation (or 
allocations) not been contained in the partnership agreement, and the 
total tax liability of the partners is (as described in (2) above) less 
than it would have been had the allocation (or allocations) not been 
contained in the partnership agreement, it will be presumed that, at the 
time the allocation (or allocations) became part of such partnership 
agreement, there was a strong likelihood that these results would occur. 
This presumption may be overcome by a showing of facts and circumstances 
that prove otherwise. See examples 6, 7(ii) and (iii), and (10)(ii) of 
paragraph (b)(5) of this section.
    (c) Transitory allocations. If a partnership agreement provides for 
the possibility that one or more allocations (the ``original 
allocation(s)'') will be largely offset by one or more other allocations 
(the ``offsetting allocation(s)''), and, at

[[Page 445]]

the time the allocations become part of the partnership agreement, there 
is a strong likelihood that--
    (1) The net increases and decreases that will be recorded in the 
partners' respective capital accounts for the taxable years to which the 
allocations relate will not differ substantially from the net increases 
and decreases that would be recorded in such partners' respective 
capital accounts for such years if the original allocation(s) and 
offsetting allocation(s) were not contained in the partnership 
agreement, and
    (2) The total tax liability of the partners (for their respective 
taxable years in which the allocations will be taken into account) will 
be less than if the allocations were not contained in the partnership 
agreement (taking into account tax consequences that result from the 
interaction of the allocation (or allocations) with partner tax 
attributes that are unrelated to the partnership)

the economic effect of the original allocation(s) and offsetting 
allocation(s) will not be substantial. If, at the end of a partnership 
taxable year to which an offsetting allocation(s) relates, the net 
increases and decreases recorded in the partners' respective capital 
accounts do not differ substantially from the net increases and 
decreases that would have been recorded in such partners' respective 
capital accounts had the original allocation(s) and the offsetting 
allocation(s) not been contained in the partnership agreement, and the 
total tax liability of the partners is (as described in (2) above) less 
than it would have been had such allocations not been contained in the 
partnership agreement, it will be presumed that, at the time the 
allocations became part of the partnership agreement, there was a strong 
likelihood that these results would occur. This presumption may be 
overcome by a showing of facts and circumstances that prove otherwise. 
See examples (1)(xi), (2), (3), (7), (8)(ii), and (17) of paragraph 
(b)(5) of this section. Notwithstanding the foregoing, the original 
allocation(s) and the offsetting allocation(s) will not be insubstantial 
(under this paragraph (b)(2)(iii)(c)) and, for purposes of paragraph 
(b)(2)(iii)(a), it will be presumed that there is a reasonable 
possibility that the allocations will affect substantially the dollar 
amounts to be received by the partners from the partnership if, at the 
time the allocations become part of the partnership agreement, there is 
a strong likelihood that the offsetting allocation(s) will not, in large 
part, be made within five years after the original allocation(s) is made 
(determined on a first-in, first-out basis). See example 2 of paragraph 
(b)(5) of this section. For purposes of applying the provisions of this 
paragraph (b)(2)(iii) (and paragraphs (b)(2)(ii)(d)(6) and (b)(3)(iii) 
of this section), the adjusted tax basis of partnership property (or, if 
partnership property is properly reflected on the books of the 
partnership at a book value that differs from its adjusted tax basis, 
the book value of such property) will be presumed to be the fair market 
value of such property, and adjustments to the adjusted tax basis (or 
book value) of such property will be presumed to be matched by 
corresponding changes in such property's fair market value. Thus, there 
cannot be a strong likelihood that the economic effect of an allocation 
(or allocations) will be largely offset by an allocation (or 
allocations) of gain or loss from the disposition of partnership 
property. See examples 1 (vi) and (xi) of paragraph (b)(5) of this 
section.
    (d) Partners that are look-through entities or members of a 
consolidated group--(1) In general. For purposes of applying paragraphs 
(b)(2)(iii)(a), (b), and (c) of this section to a partner that is a 
look-through entity, the tax consequences that result from the 
interaction of the allocation with the tax attributes of any person that 
is an owner, or in the case of a trust or estate, the beneficiary, of an 
interest in such a partner, whether directly or indirectly through one 
or more look-through entities, must be taken into account. For purposes 
of applying paragraphs (b)(2)(iii)(a), (b), and (c) of this section to a 
partner that is a member of a consolidated group (within the meaning of 
Sec. 1.1502-1(h)), the tax consequences that result from the 
interaction of the allocation with the tax attributes of the 
consolidated group and with the tax attributes of another member with 
respect to a separate return year must be

[[Page 446]]

taken into account. See paragraph (b)(5) Example 29 of this section.
    (2) Look-through entity. For purposes of this paragraph 
(b)(2)(iii)(d), a look-through entity means--
    (i) A partnership;
    (ii) A subchapter S corporation;
    (iii) A trust or an estate;
    (iv) An entity that is disregarded for Federal tax purposes, such as 
a qualified subchapter S subsidiary under section 1361(b)(3), an entity 
that is disregarded as an entity separate from its owner under 
Sec. Sec. 301.7701-1 through 301.7701-3 of this chapter, or a qualified 
REIT subsidiary within the meaning of section 856(i)(2); or
    (v) A controlled foreign corporation if United States shareholders 
of the controlled foreign corporation in the aggregate own, directly or 
indirectly, at least 10 percent of the capital or profits of the 
partnership on any day during the partnership's taxable year. In such 
case, the controlled foreign corporation shall be treated as a look-
through entity, but only with respect to allocations of income, gain, 
loss, or deduction (or items thereof) that enter into the computation of 
a United States shareholder's inclusion under section 951(a) with 
respect to the controlled foreign corporation, enter into any person's 
income attributable to a United States shareholder's inclusion under 
section 951(a) with respect to the controlled foreign corporation, or 
would enter into the computations described in this paragraph if such 
items were allocated to the controlled foreign corporation. See 
paragraph (b)(2)(iii)(d)(6) for the definition of indirect ownership.
    (3) Controlled foreign corporations. For purposes of this section, 
the term controlled foreign corporation means a controlled foreign 
corporation as defined in section 957(a) or section 953(c). In the case 
of a controlled foreign corporation that is a look-through entity, the 
tax attributes to be taken into account are those of any person that is 
a United States shareholder (as defined in paragraph (b)(2)(iii)(d)(5) 
of this section) of the controlled foreign corporation, or, if the 
United States shareholder is a look-through entity, a United States 
person that owns an interest in such shareholder directly or indirectly 
through one or more look-through entities.
    (4) United States person. For purposes of this section, a United 
States person is a person described in section 7701(a)(30).
    (5) United States shareholder. For purposes of this section, a 
United States shareholder is a person described in section 951(b) or 
section 953(c).
    (6) Indirect ownership. For purposes of this section, indirect 
ownership of stock or another equity interest (such as an interest in a 
partnership) shall be determined in accordance with the principles of 
section 318, substituting the phrase ``10 percent'' for the phrase ``50 
percent'' each time it appears.
    (e) De minimis rule--(1) Partnership taxable years beginning after 
May 19, 2008 and beginning before December 28, 2012. Except as provided 
in paragraph (b)(2)(iii)(e)(2) of this section, for purposes of applying 
this paragraph (b)(2)(iii), for partnership taxable years beginning 
after May 19, 2008 and beginning before December 28, 2012, the tax 
attributes of de minimis partners need not be taken into account. For 
purposes of this paragraph (b)(2)(iii)(e)(1), a de minimis partner is 
any partner, including a look-through entity that owns, directly or 
indirectly, less than 10 percent of the capital and profits of a 
partnership, and who is allocated less than 10 percent of each 
partnership item of income, gain, loss, deduction, and credit. See 
paragraph (b)(2)(iii)(d)(6) of this section for the definition of 
indirect ownership.
    (2) Nonapplicability of de minimis rule. (i) Allocations that become 
part of the partnership agreement on or after December 28, 2012. 
Paragraph (b)(2)(iii)(e)(1) of this section does not apply to 
allocations that become part of the partnership agreement on or after 
December 28, 2012.
    (ii) Retest for allocations that become part of the partnership 
agreement prior to December 28, 2012. If the de minimis partner rule of 
paragraph (b)(2)(iii)(e)(1) of this section was relied upon in testing 
the substantiality of allocations that became part of the partnership 
agreement before December 28, 2012, such allocations must be retested on 
the first day of the first partnership taxable year beginning on

[[Page 447]]

or after December 28, 2012, without regard to paragraph 
(b)(2)(iii)(e)(1) of this section.
    (iv) Maintenance of capital accounts--(a) In general. The economic 
effect test described in paragraph (b)(2)(ii) of this section requires 
an examination of the capital accounts of the partners of a partnership, 
as maintained under the partnership agreement. Except as otherwise 
provided in paragraph (b)(2)(ii)(i) of this section, an allocation of 
income, gain, loss, or deduction will not have economic effect under 
paragraph (b)(2)(ii) of this section, and will not be deemed to be in 
accordance with a partner's interest in the partnership under paragraph 
(b)(4) of this section, unless the capital accounts of the partners are 
determined and maintained throughout the full term of the partnership in 
accordance with the capital accounting rules of this paragraph 
(b)(2)(iv).
    (b) Basic rules. Except as otherwise provided in this paragraph 
(b)(2)(iv), the partners' capital accounts will be considered to be 
determined and maintained in accordance with the rules of this paragraph 
(b)(2)(iv) if, and only if, each partner's capital account is increased 
by (1) the amount of money contributed by him to the partnership, (2) 
the fair market value of property contributed by him to the partnership 
(net of liabilities that the partnership is considered to assume or take 
subject to), and (3) allocations to him of partnership income and gain 
(or items thereof), including income and gain exempt from tax and income 
and gain described in paragraph (b)(2)(iv)(g) of this section, but 
excluding income and gain described in paragraph (b)(4)(i) of this 
section; and is decreased by (4) the amount of money distributed to him 
by the partnership, (5) the fair market value of property distributed to 
him by the partnership (net of liabilities that such partner is 
considered to assume or take subject to), (6) allocations to him of 
expenditures of the partnership described in section 705 (a)(2)(B), and 
(7) allocations of partnership loss and deduction (or item thereof), 
including loss and deduction described in paragraph (b)(2)(iv)(g) of 
this section, but excluding items described in (6) above and loss or 
deduction described in paragraphs (b)(4)(i) or (b)(4)(iii) of this 
section; and is otherwise adjusted in accordance with the additional 
rules set forth in this paragraph (b)(2)(iv). For purposes of this 
paragraph, a partner who has more than one interest in a partnership 
shall have a single capital account that reflects all such interests, 
regardless of the class of interests owned by such partner (e.g., 
general or limited) and regardless of the time or manner in which such 
interests were acquired. For liabilities assumed before June 24, 2003, 
references to liabilities in this paragraph (b)(2)(iv)(b) shall include 
only liabilities secured by the contributed or distributed property that 
are taken into account under section 752(a) and (b).
    (c) Treatment of liabilities. For purposes of this paragraph 
(b)(2)(iv), (1) money contributed by a partner to a partnership includes 
the amount of any partnership liabilities that are assumed by such 
partner (other than liabilities described in paragraph (b)(2)(iv)(b)(5) 
of this section that are assumed by a distributee partner) but does not 
include increases in such partner's share of partnership liabilities 
(see section 752(a)), and (2) money distributed to a partner by a 
partnership includes the amount of such partner's individual liabilities 
that are assumed by the partnership (other than liabilities described in 
paragraph (b)(2)(iv)(b)(2) of this section that are assumed by the 
partnership) but does not include decreases in such partner's share of 
partnership liabilities (see section 752(b)). For purposes of this 
paragraph (b)(2)(iv)(c), liabilities are considered assumed only to the 
extent the assuming party is thereby subjected to personal liability 
with respect to such obligation, the obligee is aware of the assumption 
and can directly enforce the assuming party's obligation, and, as 
between the assuming party and the party from whom the liability is 
assumed, the assuming party is ultimately liable.
    (d) Contributed property--(1) In general. The basic capital 
accounting rules contained in paragraph (b)(2)(iv)(b) of this section 
require that a partner's capital account be increased by the fair market 
value of property contributed to the partnership by such partner on

[[Page 448]]

the date of contribution. See Example 13(i) of paragraph (b)(5) of this 
section. Consistent with section 752(c), section 7701(g) does not apply 
in determining such fair market value.
    (2) Contribution of promissory notes. Notwithstanding the general 
rule of paragraph (b)(2)(iv)(b)(2) of this section, except as provided 
in this paragraph (b)(2)(iv)(d)(2), if a promissory note is contributed 
to a partnership by a partner who is the maker of such note, such 
partner's capital account will be increased with respect to such note 
only when there is a taxable disposition of such note by the partnership 
or when the partner makes principal payments on such note. See example 
(1)(ix) of paragraph (b)(5) of this section. The first sentence of this 
paragraph (b)(2)(iv)(d)(2) shall not apply if the note referred to 
therein is readily tradable on an established securities market. See 
also paragraph (b)(2)(ii)(c) of this section. Furthermore, a partner 
whose interest is liquidated will be considered as satisfying his 
obligation to restore the deficit balance in his capital account to the 
extent of (i) the fair market value, at the time of contribution, of any 
negotiable promissory note (of which such partner is the maker) that 
such partner contributes to the partnership on or after the date his 
interest is liquidated and within the time specified in paragraph 
(b)(2)(ii)(b)(3) of this section, and (ii) the fair market value, at the 
time of liquidation, of the unsatisfied portion of any negotiable 
promissory note (of which such partner is the maker) that such partner 
previously contributed to the partnership. For purposes of the preceding 
sentence, the fair market value of a note will be no less than the 
outstanding principal balance of such note, provided that such note 
bears interest at a rate no less than the applicable federal rate at the 
time of valuation.
    (3) Section 704(c) considerations. Section 704(c) and Sec. 1.704-3 
govern the determination of the partners' distributive shares of income, 
gain, loss, and deduction, as computed for tax purposes, with respect to 
property contributed to a partnership (see paragraph (b)(1)(vi) of this 
section). In cases where section 704(c) and Sec. 1.704-3 apply to 
partnership property, the capital accounts of the partners will not be 
considered to be determined and maintained in accordance with the rules 
of this paragraph (b)(2)(iv) unless the partnership agreement requires 
that the partners' capital accounts be adjusted in accordance with 
paragraph (b)(2)(iv)(g) of this section for allocations to them of 
income, gain, loss, and deduction (including depreciation, depletion, 
amortization, or other cost recovery) as computed for book purposes, 
with respect to the property. See, however, Sec. 1.704-3(d)(2) for a 
special rule in determining the amount of book items if the partnership 
chooses the remedial allocation method. See also Example (13) (i) of 
paragraph (b)(5) of this section. Capital accounts are not adjusted to 
reflect allocations under section 704(c) and Sec. 1.704-3 (e.g., tax 
allocations of precontribution gain or loss).
    (4) Exercise of noncompensatory options. Solely for purposes of 
paragraph (b)(2)(iv)(b)(2) of this section, the fair market value of the 
property contributed on the exercise of a noncompensatory option (as 
defined in Sec. 1.721-2(f)) does not include the fair market value of 
the option privilege, but does include the consideration paid to the 
partnership to acquire the option and the fair market value of any 
property (other than the option) contributed to the partnership on the 
exercise of the option. With respect to convertible debt, the fair 
market value of the property contributed on the exercise of the option 
is the adjusted issue price of the debt and the accrued but unpaid 
qualified stated interest (as defined in Sec. 1.1273-1(c)) on the debt 
immediately before the conversion, plus the fair market value of any 
property (other than the convertible debt) contributed to the 
partnership on the exercise of the option. See Examples 31 through 35 of 
paragraph (b)(5) of this section.
    (e) Distributed property--(1) In general. The basic capital 
accounting rules contained in paragraph (b)(2)(iv) (b) of this section 
require that a partner's capital account be decreased by the fair market 
value of property distributed by the partnership (without regard to 
section 7701(g)) to such partner (whether in connection with a 
liquidation or

[[Page 449]]

otherwise). To satisfy this requirement, the capital accounts of the 
partners first must be adjusted to reflect the manner in which the 
unrealized income, gain, loss, and deduction inherent in such property 
(that has not been reflected in the capital accounts previously) would 
be allocated among the partners if there were a taxable disposition of 
such property for the fair market value of such property (taking section 
7701(g) into account) on the date of distribution. See example (14)(v) 
of paragraph (b)(5) of this section.
    (2) Distribution of promissory notes. Notwithstanding the general 
rule of paragraph (b)(2)(iv)(b)(5), except as provided in this paragraph 
(b)(2)(iv)(e)(2), if a promissory note is distributed to a partner by a 
partnership that is the maker of such note, such partner's capital 
account will be decreased with respect to such note only when there is a 
taxable disposition of such note by the partner or when the partnership 
makes principal payments on the note. The previous sentence shall not 
apply if a note distributed to a partner by a partnership who is the 
maker of such note is readily tradable on an established securities 
market. Furthermore, the capital account of a partner whose interest in 
a partnership is liquidated will be reduced to the extent of (i) the 
fair market value, at the time of distribution, of any negotiable 
promissory note (of which such partnership is the maker) that such 
partnership distributes to the partner on or after the date such 
partner's interest is liquidated and within the time specified in 
paragraph (b)(2)(ii)(b)(2) of this section, and (ii) the fair market 
value, at the time of liquidation, of the unsatisfied portion of any 
negotiable promissory note (of which such partnership is the maker) that 
such partnership previously distributed to the partner. For purposes of 
the preceding sentence, the fair market value of a note will be no less 
than the outstanding principal balance of such note, provided that such 
note bears interest at a rate no less than the applicable Federal rate 
at time of valuation.
    (f) Revaluations of property. A partnership agreement may, upon the 
occurrence of certain events, increase or decrease the capital accounts 
of the partners to reflect a revaluation of partnership property 
(including intangible assets such as goodwill) on the partnership's 
books. Capital accounts so adjusted will not be considered to be 
determined and maintained in accordance with the rules of this paragraph 
(b)(2)(iv) unless--
    (1) The adjustments are based on the fair market value of 
partnership property (taking section 7701(g) into account) on the date 
of adjustment, as determined under paragraph (b)(2)(iv)(h) of this 
section. See Example 33 of paragraph (b)(5) of this section.
    (2) The adjustments reflect the manner in which the unrealized 
income, gain, loss, or deduction inherent in such property (that has not 
been reflected in the capital accounts previously) would be allocated 
among the partners if there were a taxable disposition of such property 
for such fair market value on that date, and
    (3) The partnership agreement requires that the partners' capital 
accounts be adjusted in accordance with paragraph (b)(2)(iv)(g) of this 
section for allocations to them of depreciation, depletion, 
amortization, and gain or loss, as computed for book purposes, with 
respect to such property, and
    (4) The partnership agreement requires that the partners' 
distributive shares of depreciation, depletion, amortization, and gain 
or loss, as computed for tax purposes, with respect to such property be 
determined so as to take account of the variation between the adjusted 
tax basis and book value of such property in the same manner as under 
section 704(c) (see paragraph (b)(4)(i) of this section), and
    (5) The adjustments are made principally for a substantial non-tax 
business purpose--
    (i) In connection with a contribution of money or other property 
(other than a de minimis amount) to the partnership by a new or existing 
partner as consideration for an interest in the partnership, or
    (ii) In connection with the liquidation of the partnership or a 
distribution of money or other property (other than a de minimis amount) 
by the partnership to a retiring or continuing

[[Page 450]]

partner as consideration for an interest in the partnership, or
    (iii) In connection with the grant of an interest in the partnership 
(other than a de minimis interest) on or after May 6, 2004, as 
consideration for the provision of services to or for the benefit of the 
partnership by an existing partner acting in a partner capacity, or by a 
new partner acting in a partner capacity or in anticipation of being a 
partner, or
    (iv) In connection with the issuance by the partnership of a 
noncompensatory option (other than an option for a de minimis 
partnership interest), or
    (v) Under generally accepted industry accounting practices, provided 
substantially all of the partnership's property (excluding money) 
consists of stock, securities, commodities, options, warrants, futures, 
or similar instruments that are readily tradable on an established 
securities market.

See examples 14 and 18 of paragraph (b)(5) of this section. If the 
capital accounts of the partners are not adjusted to reflect the fair 
market value of partnership property when an interest in the partnership 
is acquired from or relinquished to the partnership, paragraphs 
(b)(1)(iii) and (b)(1)(iv) of this section should be consulted regarding 
the potential tax consequences that may arise if the principles of 
section 704(c) are not applied to determine the partners' distributive 
shares of depreciation, depletion, amortization, and gain or loss as 
computed for tax purposes, with respect to such property.
    (g) Adjustments to reflect book value--(1) In general. Under 
paragraphs (b)(2)(iv)(d) and (b)(2)(iv)(f) of this section, property may 
be properly reflected on the books of the partnership at a book value 
that differs from the adjusted tax basis of such property. In these 
circumstances, paragraphs (b)(2)(iv)(d)(3) and (b)(2)(iv)(f)(3) of this 
section provide that the capital accounts of the partners will not be 
considered to be determined and maintained in accordance with the rules 
of this paragraph (b)(2)(iv) unless the partnership agreement requires 
the partners' capital accounts to be adjusted in accordance with this 
paragraph (b)(2)(iv)(g) for allocations to them of depreciation, 
depletion, amortization, and gain or loss, as computed for book 
purposes, with respect to such property. In determining whether the 
economic effect of an allocation of book items is substantial, 
consideration will be given to the effect of such allocation on the 
determination of the partners' distributive shares of corresponding tax 
items under section 704(c) and paragraph (b)(4)(i) of this section. See 
example 17 of paragraph (b)(5) of this section. If an allocation of book 
items under the partnership agreement does not have substantial economic 
effect (as determined under paragraphs (b)(2)(ii) and (b)(2)(iii) of 
this section), or is not otherwise respected under this paragraph, such 
items will be reallocated in accordance with the partners' interests in 
the partnership, and such reallocation will be the basis upon which the 
partners' distributive shares of the corresponding tax items are 
determined under section 704(c) and paragraph (b)(4)(i) of this section. 
See examples 13, 14, and 18 of paragraph (b)(5) of this section.
    (2) Payables and receivables. References in this paragraph 
(b)(2)(iv) and paragraph (b)(4)(i) of this section to book and tax 
depreciation, depletion, amortization, and gain or loss with respect to 
property that has an adjusted tax basis that differs from book value 
include, under analogous rules and principles, the unrealized income or 
deduction with respect to accounts receivable, accounts payable, and 
other accrued but unpaid items.
    (3) Determining amount of book items. The partners' capital accounts 
will not be considered adjusted in accordance with this paragraph 
(b)(2)(iv)(g) unless the amount of book depreciation, depletion, or 
amortization for a period with respect to an item of partnership 
property is the amount that bears the same relationship to the book 
value of such property as the depreciation (or cost recovery deduction), 
depletion, or amortization computed for tax purposes with respect to 
such property for such period bears to the adjusted tax basis of such 
property. If such property has a zero adjusted tax basis, the book

[[Page 451]]

depreciation, depletion, or amortization may be determined under any 
reasonable method selected by the partnership.
    (h) Determinations of fair market value--(1) In general. For 
purposes of this paragraph (b)(2)(iv), the fair market value assigned to 
property contributed to a partnership, property distributed by a 
partnership, or property otherwise revalued by a partnership, will be 
regarded as correct, provided that (1) such value is reasonably agreed 
to among the partners in arm's-length negotiations, and (2) the partners 
have sufficiently adverse interests. If, however, these conditions are 
not satisfied and the value assigned to such property is overstated or 
understated (by more than an insignificant amount), the capital accounts 
of the partners will not be considered to be determined and maintained 
in accordance with the rules of this paragraph (b)(2)(iv). Valuation of 
property contributed to the partnership, distributed by the partnership, 
or otherwise revalued by the partnership shall be on a property-by-
property basis, except to the extent the regulations under section 
704(c) permit otherwise.
    (2) Adjustments for noncompensatory options. The value of 
partnership property as reflected on the books of the partnership must 
be adjusted to account for any outstanding noncompensatory options (as 
defined in Sec. 1.721-2(f)) at the time of a revaluation of partnership 
property under paragraph (b)(2)(iv)(f) or (s) of this section. If the 
fair market value of outstanding noncompensatory options (as defined in 
Sec. 1.721-2(f)) as of the date of the adjustment exceeds the 
consideration paid to the partnership to acquire the options, then the 
value of partnership property as reflected on the books of the 
partnership must be reduced by that excess to the extent of the 
unrealized income or gain in partnership property (that has not been 
reflected in the capital accounts previously). This reduction is 
allocated only to properties with unrealized appreciation in proportion 
to their respective amounts of unrealized appreciation. If the 
consideration paid to the partnership to acquire the outstanding 
noncompensatory options (as defined in Sec. 1.721-2(f)) exceeds the 
fair market value of such options as of the date of the adjustment, then 
the value of partnership property as reflected on the books of the 
partnership must be increased by that excess to the extent of the 
unrealized loss in partnership property (that has not been reflected in 
the capital accounts previously). This increase is allocated only to 
properties with unrealized loss in proportion to their respective 
amounts of unrealized loss. However, any reduction or increase shall 
take into account the economic arrangement of the partners with respect 
to the property.
    (i) Section 705(a)(2)(B) expenditures--(1) In general. The basic 
capital accounting rules contained in paragraph (b)(2)(iv)(b) of this 
section require that a partner's capital account be decreased by 
allocations made to such partner of expenditures described in section 
705(a)(2)(B). See example 11 of paragraph (b)(5) of this section. If an 
allocation of these expenditures under the partnership agreement does 
not have substantial economic effect (as determined under paragraphs 
(b)(2)(ii) and (b)(2)(iii) of this section), or is not otherwise 
respected under this paragraph, such expenditures will be reallocated in 
accordance with the partners' interest in the partnership.
    (2) Expenses described in section 709. Except for amounts with 
respect to which an election is properly made under section 709(b), 
amounts paid or incurred to organize a partnership or to promote the 
sale of (or to sell) an interest in such a partnership shall, solely for 
purposes of this paragraph, be treated as section 705(a)(2)(B) 
expenditures, and upon liquidation of the partnership no further capital 
account adjustments will be made in respect thereof.
    (3) Disallowed losses. If a deduction for a loss incurred in 
connection with the sale or exchange of partnership property is 
disallowed to the partnership under section 267(a)(1) or section 707(b), 
that deduction shall, solely for purposes of this paragraph, be treated 
as a section 705(a)(2)(B) expenditure.
    (j) Basis adjustments to section 38 property. The capital accounts 
of the partners will not be considered to be determined and maintained 
in accordance with the rules of this paragraph

[[Page 452]]

(b)(2)(iv) unless such capital accounts are adjusted by the partners' 
shares of any upward or downward basis adjustments allocated to them 
under this paragraph (b)(2)(iv)(j). When there is a reduction in the 
adjusted tax basis of partnership section 38 property under section 
48(q)(1) or section 48(q)(3), section 48(q)(6) provides for an 
equivalent downward adjustment to the aggregate basis of partnership 
interests (and no additional adjustment is made under section 
705(a)(2)(B)). These downward basis adjustments shall be shared among 
the partners in the same proportion as the adjusted tax basis or cost of 
(or the qualified investment in) such section 38 property is allocated 
among the partners under paragraph (f) of Sec. 1.46-3 (or paragraph 
(a)(4)(iv) of Sec. 1.48-8). Conversely, when there is an increase in 
the adjusted tax basis of partnership section 38 property under section 
48(q)(2), section 48(q)(6) provides for an equivalent upward adjustment 
to the aggregate basis of partnership interests. These upward 
adjustments shall be allocated among the partners in the same proportion 
as the investment tax credit from such property is recaptured by the 
partners under Sec. 1.47-6.
    (k) Depletion of oil and gas properties--(1) In general. The capital 
accounts of the partners will not be considered to be determined and 
maintained in accordance with the rules of this paragraph (b)(2)(iv) 
unless such capital accounts are adjusted for depletion and gain or loss 
with respect to the oil or gas properties of the partnership in 
accordance with this paragraph (b)(2)(iv)(k).
    (2) Simulated depletion. Except as provided in paragraph 
(b)(2)(iv)(k) (3) of this section, a partnership shall, solely for 
purposes of maintaining capital accounts under this paragraph, compute 
simulated depletion allowances with respect to its oil and gas 
properties at the partnership level. These allowances shall be computed 
on each depletable oil or gas property of the partnership by using 
either the cost depletion method or the percentage depletion method 
(computed in accordance with section 613 at the rates specified in 
section 613A(c)(5) without regard to the limitations of section 613A, 
which theoretically could apply to any partner) for each partnership 
taxable year that the property is owned by the partnership and subject 
to depletion. The choice between the simulated cost depletion method and 
the simulated percentage depletion method shall be made on a property-
by-property basis in the first partnership taxable year beginning after 
April 30, 1986, for which it is relevent for the property, and shall be 
binding for all partnership taxable years during which the oil or gas 
property is held by the partnership. The partnership shall make downward 
adjustments to the capital accounts of the partners for the simulated 
depletion allowance with respect to each oil or gas property of the 
partnership, in the same proportion as such partners (or their 
precedecessors in interest) were properly allocated the adjusted tax 
basis of each such property. The aggregate capital account adjustments 
for simulated percentage depletion allowances with respect to an oil or 
gas property of the partnership shall not exceed the aggregate adjusted 
tax basis allocated to the partners with respect to such property. Upon 
the taxable disposition of an oil or gas property by a partnership, such 
partnership's simulated gain or loss shall be determined by subtracting 
its simulated adjusted basis in such property from the amount realized 
upon such disposition. (The partnership's simulated adjusted basis in an 
oil or gas property is determined in the same manner as adjusted tax 
basis except that simulated depletion allowances are taken into account 
instead of actual depletion allowances.) The capital accounts of the 
partners shall be adjusted upward by the amount of any simulated gain in 
proportion to such partners' allocable shares of the portion of the 
total amount realized from the disposition of such property that exceeds 
the partnership's simulated adjusted basis in such property. The capital 
accounts of such partners shall be adjusted downward by the amount of 
any simulated loss in proportion to such partners' allocable shares of 
the total amount realized from the disposition of such property that 
represents recovery of the partnership's simulated adjusted basis in 
such property. See section 613A(c)(7)(D)

[[Page 453]]

and the regulations thereunder and paragraph (b)(4)(v) of this section. 
See example (19)(iv) of paragraph (b)(5) of this section.
    (3) Actual depletion. Pursuant to section 613A(c)(7)(D) and the 
regulations thereunder, the depletion allowance under section 611 with 
respect to the oil and gas properties of a partnership is computed 
separately by the partners. Accordingly, in lieu of adjusting the 
partner's capital accounts as provided in paragraph (b)(2)(iv)(k)(2) of 
this section, the partnership may make downward adjustments to the 
capital account of each partner equal to such partner's depletion 
allowance with respect to each oil or gas property of the partnership 
(for the partner's taxable year that ends with or within the 
partnership's taxable year). The aggregate adjustments to the capital 
account of a partner for depletion allowances with respect to an oil or 
gas property of the partnership shall not exceed the adjusted tax basis 
allocated to such partner with respect to such property. Upon the 
taxable disposition of an oil or gas property by a partnership, the 
capital account of each partner shall be adjusted upward by the amount 
of any excess of such partner's allocable share of the total amount 
realized from the disposition of such property over such partner's 
remaining adjusted tax basis in such property. If there is no such 
excess, the capital account of such partner shall be adjusted downward 
by the amount of any excess of such partner's remaining adjusted tax 
basis in such property over such partner's allocable share of the total 
amount realized from the disposition thereof. See section 
613A(c)(7)(4)(D) and the regulations thereunder and paragraph (b)(4)(v) 
of this section.
    (4) Effect of book values. If an oil or gas property of the 
partnership is, under paragraphs (b)(2)(iv(d) or (b)(2)(iv)(f) of this 
section, properly reflected on the books of the partnership at a book 
value that differs from the adjusted tax basis of such property, the 
rules contained in this paragraph (b)(2)(iv)(k) and paragraph (b)(4)(v) 
of this section shall be applied with reference to such book value. A 
revaluation of a partnership oil or gas property under paragraph 
(b)(2)(iv)(f) of this section may give rise to a reallocation of the 
adjusted tax basis of such property, or a change in the partners' 
relative shares of simulated depletion from such property, only to the 
extent permitted by section 613A(c)(7)(D) and the regulations 
thereunder.
    (l) Transfers of partnership interests. The capital accounts of the 
partners will not be considered to be determined and maintained in 
accordance with the rules of this paragraph (b)(2)(iv) unless, upon the 
transfer of all or a part of an interest in the partnership, the capital 
account of the transferor that is attributable to the transferred 
interest carries over to the transferee partner. (See paragraph 
(b)(2)(iv)(m) of this section for rules concerning the effect of a 
section 754 election on the capital accounts of the partners.) If the 
transfer of an interest in a partnership causes a termination of the 
partnership under section 708(b)(1)(B), the capital account of the 
transferee partner and the capital accounts of the other partners of the 
terminated partnership carry over to the new partnership that is formed 
as a result of the termination of the partnership under Sec. 1.708-
1(b)(1)(iv). Moreover, the deemed contribution of assets and liabilities 
by the terminated partnership to a new partnership and the deemed 
liquidation of the terminated partnership that occur under Sec. 1.708-
1(b)(1)(iv) are disregarded for purposes of this paragraph (b)(2)(iv). 
See Example 13 of paragraph (b)(5) of this section and the example in 
Sec. 1.708-1(b)(1)(iv). The previous three sentences apply to 
terminations of partnerships under section 708(b)(1)(B) occurring on or 
after May 9, 1997; however, the sentences may be applied to terminations 
occurring on or after May 9, 1996, provided that the partnership and its 
partners apply the sentences to the termination in a consistent manner.
    (m) Section 754 elections--(1) In general. The capital accounts of 
the partners will not be considered to be determined and maintained in 
accordance with the rules of this paragraph (b)(2)(iv) unless, upon 
adjustment to the adjusted tax basis of partnership property under 
section 732, 734, or 743, the capital accounts of the partners are 
adjusted as provided in this paragraph (b)(2)(iv)(m).

[[Page 454]]

    (2) Section 743 adjustments. In the case of a transfer of all or a 
part of an interest in a partnership that has a section 754 election in 
effect for the partnership taxable year in which such transfer occurs, 
adjustments to the adjusted tax basis of partnership property under 
section 743 shall not be reflected in the capital account of the 
transferee partner or on the books of the partnership, and subsequent 
capital account adjustments for distributions (see paragraph 
(b)(2)(iv)(e)(1) of this section) and for depreciation, depletion, 
amortization, and gain or loss with respect to such property will 
disregard the effect of such basis adjustment. The preceding sentence 
shall not apply to the extent such basis adjustment is allocated to the 
common basis of partnership property under paragraph (b)(1) of Sec. 
1.734-2; in these cases, such basis adjustment shall, except as provided 
in paragraph (b)(2)(iv)(m)(5) of this section, give rise to adjustments 
to the capital accounts of the partners in accordance with their 
interests in the partnership under paragraph (b)(3) of this section. See 
examples 13 (iii) and (iv) of paragraph (b)(5) of this section.
    (3) Section 732 adjustments. In the case of a transfer of all or a 
part of an interest in a partnership that does not have a section 754 
election in effect for the partnership taxable year in which such 
transfer occurs, adjustments to the adjusted tax basis of partnership 
property under section 732(d) will be treated in the capital accounts of 
the partners in the same manner as section 743 basis adjustments are 
treated under paragraph (b)(2)(iv)(m)(2) of this section.
    (4) Section 734 adjustments. Except as provided in paragraph 
(b)(2)(iv)(m)(5) of this section, in the case of a distribution of 
property in liquidation of a partner's interest in the partnership by a 
partnership that has a section 754 election in effect for the 
partnership taxable year in which the distribution occurs, the partner 
who receives the distribution that gives rise to the adjustment to the 
adjusted tax basis of partnership property under section 734 shall have 
a corresponding adjustment made to his capital account. If such 
distribution is made other than in liquidation of a partner's interest 
in the partnership, however, except as provided in paragraph 
(b)(2)(iv)(m)(5) of this section, the capital accounts of the partners 
shall be adjusted by the amount of the adjustment to the adjusted tax 
basis of partnership property under section 734, and such capital 
account adjustment shall be shared among the partners in the manner in 
which the unrealized income and gain that is displaced by such 
adjustment would have been shared if the property whose basis is 
adjusted were sold immediately prior to such adjustment for its 
recomputed adjusted tax basis.
    (5) Limitations on adjustments. Adjustments may be made to the 
capital account of a partner (or his successor in interest) in respect 
of basis adjustments to partnership property under sections 732, 734, 
and 743 only to the extent that such basis adjustments (i) are permitted 
to be made to one or more items of partnership property under section 
755, and (ii) result in an increase or a decrease in the amount at which 
such property is carried on the partnership's balance sheet, as computed 
for book purposes. For example, if the book value of partnership 
property exceeds the adjusted tax basis of such property, a basis 
adjustment to such property may be reflected in a partner's capital 
account only to the extent such adjustment exceeds the difference 
between the book value of such property and the adjusted tax basis of 
such property prior to such adjustment.
    (n) Partnership level characterization. Except as otherwise provided 
in paragraph (b)(2)(iv)(k) of this section, the capital accounts of the 
partners will not be considered to be determined and maintained in 
accordance with the rules of this paragraph (b)(2)(iv) unless 
adjustments to such capital accounts in respect of partnership income, 
gain, loss, deduction, and section 705(a)(2)(B) expenditures (or item 
thereof) are made with reference to the Federal tax treatment of such 
items (and in the case of book items, with reference to the Federal tax 
treatment of the corresponding tax items) at the partnership level, 
without regard to any requisite or elective tax treatment of such items 
at the partner level (for example, under section 58(i)). However, a 
partnership that incurs mining exploration

[[Page 455]]

expenditures will determine the Federal tax treatment of income, gain, 
loss, and deduction with respect to the property to which such 
expenditures relate at the partnership level only after first taking 
into account the elections made by its partners under section 617 and 
section 703(b)(4).
    (o) Guaranteed payments. Guaranteed payments to a partner under 
section 707(c) cause the capital account of the recipient partner to be 
adjusted only to the extent of such partner's distributive share of any 
partnership deduction, loss, or other downward capital account 
adjustment resulting from such payment.
    (p) Minor discrepancies. Discrepancies between the balances in the 
respective capital accounts of the partners and the balances that would 
be in such respective capital accounts if they had been determined and 
maintained in accordance with this paragraph (b)(2)(iv) will not 
adversely affect the validity of an allocation, provided that such 
discrepancies are minor and are attributable to good faith error by the 
partnership.
    (q) Adjustments where guidance is lacking. If the rules of this 
paragraph (b)(2)(iv) fail to provide guidance on how adjustments to the 
capital accounts of the partners should be made to reflect particular 
adjustments to partnership capital on the books of the partnership, such 
capital accounts will not be considered to be determined and maintained 
in accordance with those rules unless such capital account adjustments 
are made in a manner that (1) maintains equality between the aggregate 
governing capital accounts of the partners and the amount of partnership 
capital reflected on the partnership's balance sheet, as computed for 
book purposes, (2) is consistent with the underlying economic 
arrangement of the partners, and (3) is based, wherever practicable, on 
Federal tax accounting principles.
    (r) Restatement of capital accounts. With respect to partnerships 
that began operating in a taxable year beginning before May 1, 1986, the 
capital accounts of the partners of which have not been determined and 
maintained in accordance with the rules of this paragraph (b)(2)(iv) 
since inception, such capital accounts shall not be considered to be 
determined and maintained in accordance with the rules of this paragraph 
(b)(2)(iv) for taxable years beginning after April 30, 1986, unless 
either--
    (1) Such capital accounts are adjusted, effective for the first 
partnership taxable year beginning after April 30, 1986, to reflect the 
fair market value of partnership property as of the first day of such 
taxable year, and in connection with such adjustment, the rules 
contained in paragraph (b)(2)(iv)(f) (2), (3), and (4) of this section 
are satisfied, or
    (2) The differences between the balance in each partner's capital 
account and the balance that would be in such partner's capital account 
if capital accounts had been determined and maintained in accordance 
with this paragraph (b)(2)(iv) throughout the full term of the 
partnership are not significant (for example, such differences are 
solely attributable to a failure to provide for treatment of section 709 
expenses in accordance with the rules of paragraph (b)(2)(iv)(i)(2) of 
this section or to a failure to follow the rules in paragraph 
(b)(2)(iv)(m) of this section), and capital accounts are adjusted to 
bring them into conformity with the rules of this paragraph (b)(2)(iv) 
no later than the end of the first partnership taxable year beginning 
after April 30, 1986.
    (3) With respect to a partnership that began operating in a taxable 
year beginning before May 1, 1986, modifications to the partnership 
agreement adopted on or before November 1, 1988, to make the capital 
account adjustments required to comply with this paragraph, and 
otherwise to satisfy the requirements of this paragraph, will be treated 
as if such modifications were included in the partnership agreement 
before the end of the first partnership taxable year beginning after 
April 30, 1986. However, compliance with the previous sentences will 
have no bearing on the validity of allocations that relate to 
partnership taxable years beginning before May 1, 1986.
    (s) Adjustments on the exercise of a noncompensatory option. A 
partnership agreement may grant a partner, on the exercise of a 
noncompensatory option

[[Page 456]]

(as defined in Sec. 1.721-2(f)), a right to share in partnership 
capital that exceeds (or is less than) the sum of the consideration paid 
to the partnership to acquire and exercise such option. Where such an 
agreement exists, capital accounts will not be considered to be 
determined and maintained in accordance with the rules of this paragraph 
(b)(2)(iv) unless the following requirements are met:
    (1) In lieu of revaluing partnership property under paragraph 
(b)(2)(iv)(f) of this section immediately before the exercise of the 
option, the partnership revalues partnership property in accordance with 
the provisions of paragraphs (b)(2)(iv)(f)(1) through (f)(4) of this 
section immediately after the exercise of the option.
    (2) In determining the capital accounts of the partners (including 
the exercising partner) under paragraph (b)(2)(iv)(s)(1) of this 
section, the partnership first allocates any unrealized income, gain, or 
loss in partnership property (that has not been reflected in the capital 
accounts previously) to the exercising partner to the extent necessary 
to reflect that partner's right to share in partnership capital under 
the partnership agreement, and then allocates any remaining unrealized 
income, gain, or loss (that has not been reflected in the capital 
accounts previously) to the existing partners, to reflect the manner in 
which the unrealized income, gain, or loss in partnership property would 
be allocated among those partners if there were a taxable disposition of 
such property for its fair market value on that date. For purposes of 
the preceding sentence, if the exercising partner's initial capital 
account as determined under Sec. 1.704-1(b)(2)(iv)(b) and (d)(4) of 
this section would be less than the amount that reflects the exercising 
partner's right to share in partnership capital under the partnership 
agreement, then only income or gain may be allocated to the exercising 
partner from partnership properties with unrealized appreciation, in 
proportion to their respective amounts of unrealized appreciation. If 
the exercising partner's initial capital account, as determined under 
Sec. 1.704-1(b)(2)(iv)(b) and (d)(4) of this section, would be greater 
than the amount that reflects the exercising partner's right to share in 
partnership capital under the partnership agreement, then only loss may 
be allocated to the exercising partner from partnership properties with 
unrealized loss, in proportion to their respective amounts of unrealized 
loss. However, any allocation must take into account the economic 
arrangement of the partners with respect to the property.
    (3) If, after making the allocations described in paragraph 
(b)(2)(iv)(s)(2) of this section, the exercising partner's capital 
account does not reflect that partner's right to share in partnership 
capital under the partnership agreement, then the partnership 
reallocates partnership capital between the existing partners and the 
exercising partner so that the exercising partner's capital account 
reflects the exercising partner's right to share in partnership capital 
under the partnership agreement (a capital account reallocation). Any 
increase or decrease in the capital accounts of existing partners that 
occurs as a result of a capital account reallocation under this 
paragraph (b)(2)(iv)(s)(3) must be allocated among the existing partners 
in accordance with the principles of this section. See Example 32 of 
paragraph (b)(5) of this section.
    (4) The partnership agreement requires corrective allocations so as 
to take into account all capital account reallocations made under 
paragraph (b)(2)(iv)(s)(3) of this section (see paragraph (b)(4)(x) of 
this section). See Example 32 of paragraph (b)(5) of this section.
    (3) Partner's interest in the partnership--(i) In general. 
References in section 704(b) and this paragraph to a partner's interest 
in the partnership, or to the partners' interests in the partnership, 
signify the manner in which the partners have agreed to share the 
economic benefit or burden (if any) corresponding to the income, gain, 
loss, deduction, or credit (or item thereof) that is allocated. Except 
with respect to partnership items that cannot have economic effect (such 
as nonrecourse deductions of the partnership), this sharing arrangement 
may or may not correspond to the overall economic arrangement of the 
partners.

[[Page 457]]

Thus, a partner who has a 50 percent overall interest in the partnership 
may have a 90 percent interest in a particular item of income or 
deduction. (For example, in the case of an unexpected downward 
adjustment to the capital account of a partner who does not have a 
deficit make-up obligation that causes such partner to have a negative 
capital account, it may be necessary to allocate a disproportionate 
amount of gross income of the partnership to such partner for such year 
so as to bring that partner's capital account back up to zero.) The 
determination of a partner's interest in a partnership shall be made by 
taking into account all facts and circumstances relating to the economic 
arrangement of the partners.
    (ii) Factors considered. In determining a partner's interest in the 
partnership, the following factors are among those that will be 
considered:
    (a) The partners' relative contributions to the partnership,
    (b) The interests of the partners in economic profits and losses (if 
different than that in taxable income or loss),
    (c) The interests of the partners in cash flow and other non-
liquidating distributions, and
    (d) The rights of the partners to distributions of capital upon 
liquidation.

The provisions of this subparagraph (b)(3) are illustrated by examples 
(1)(i) and (ii), (4)(i), (5)(i) and (ii), (6), (7), (8), (10)(ii), 
(16)(i), and (19)(iii) of paragraph (b)(5) of this section. See 
paragraph (b)(4)(i) of this section concerning rules for determining the 
partners' interests in the partnership with respect to certain tax 
items.
    (iii) Certain determinations. If--
    (a) Requirements (1) and (2) of paragraph (b)(2)(ii)(b) of this 
section are satisfied, and
    (b) All or a portion of an allocation of income, gain, loss, or 
deduction made to a partner for a partnership taxable year does not have 
economic effect under paragraph (b)(2)(ii) of this section.

the partners' interests in the partnership with respect to the portion 
of the allocation that lacks economic effect will be determined by 
comparing the manner in which distributions (and contributions) would be 
made if all partnership property were sold at book value and the 
partnership were liquidated immediately following the end of the taxable 
year to which the allocation relates with the manner in which 
distributions (and contributions) would be made if all partnership 
property were sold at book value and the partnership were liquidated 
immediately following the end of the prior taxable year, and adjusting 
the result for the items described in (4), (5), and (6) of paragraph 
(b)(2)(ii)(d) of this section. A determination made under this paragraph 
(b)(3)(iii) will have no force if the economic effect of valid 
allocations made in the same manner is insubstantial under paragraph 
(b)(2)(iii) of this section. See examples 1 (iv), (v), and (vi), and 15 
(ii) and (iii) of paragraph (b)(5) of this section.
    (iv) Special rule for creditable foreign tax expenditures. In 
determining whether an allocation of a partnership item is in accordance 
with the partners' interests in the partnership, the allocation of the 
creditable foreign tax expenditure (CFTE) (as defined in paragraph 
(b)(4)(viii)(b) of this section) must be disregarded. This paragraph 
(b)(3)(iv) shall not apply to the extent the partners to whom such taxes 
are allocated reasonably expect to claim a deduction for such taxes in 
determining their U.S. tax liabilities.
    (4) Special rules--(i) Allocations to reflect revaluations. If 
partnership property is, under paragraphs (b)(2)(iv)(d) or (b)(2)(iv)(f) 
of this section, properly reflected in the capital accounts of the 
partners and on the books of the partnership at a book value that 
differs from the adjusted tax basis of such property, then depreciation, 
depletion, amortization, and gain or loss, as computed for book 
purposes, with respect to such property will be greater or less than the 
depreciation, depletion, amortization, and gain or loss, as computed for 
tax purposes, with respect to such property. In these cases the capital 
accounts of the partners are required to be adjusted solely for 
allocations of the book items to such partners (see paragraph 
(b)(2)(iv)(g) of this section), and the partners' shares of the 
corresponding tax items are not independently reflected by further 
adjustments to the partners' capital accounts. Thus,

[[Page 458]]

separate allocations of these tax items cannot have economic effect 
under paragraph (b)(2)(ii)(b)(1) of this section, and the partners' 
distributive shares of such tax items must (unless governed by section 
704(c)) be determined in accordance with the partners' interests in the 
partnership. These tax items must be shared among the partners in a 
manner that takes account of the variation between the adjusted tax 
basis of such property and its book value in the same manner as 
variations between the adjusted tax basis and fair market value of 
property contributed to the partnership are taken into account in 
determining the partners' shares of tax items under section 704(c). See 
examples 14 and 18 of paragraph (b)(5) of this section.
    (ii) Credits. Allocations of tax credits and tax credit recapture 
are not reflected by adjustments to the partners' capital accounts 
(except to the extent that adjustments to the adjusted tax basis of 
partnership section 38 property in respect of tax credits and tax credit 
recapture give rise to capital account adjustments under paragraph 
(b)(2)(iv)(j) of this section). Thus, such allocations cannot have 
economic effect under paragraph (b)(2)(ii)(b)(1) of this section, and 
the tax credits and tax credit recapture must be allocated in accordance 
with the partners' interests in the partnership as of the time the tax 
credit or credit recapture arises. With respect to the investment tax 
credit provided by section 38, allocations of cost or qualified 
investment made in accordance with paragraph (f) of Sec. 1.46-3 and 
paragraph (a)(4)(iv) of Sec. 1.48-8 shall be deemed to be made in 
accordance with the partners' interests in the partnership. With respect 
to other tax credits, if a partnership expenditure (whether or not 
deductible) that gives rise to a tax credit in a partnership taxable 
year also gives rise to valid allocations of partnership loss or 
deduction (or other downward capital account adjustments) for such year, 
then the partners' interests in the partnership with respect to such 
credit (or the cost giving rise thereto) shall be in the same proportion 
as such partners' respective distributive shares of such loss or 
deduction (and adjustments). See example 11 of paragraph (b)(5) of this 
section. Identical principles shall apply in determining the partners' 
interests in the partnership with respect to tax credits that arise from 
receipts of the partnership (whether or not taxable).
    (iii) Excess percentage depletion. To the extent the percentage 
depletion in respect of an item of depletable property of the 
partnership exceeds the adjusted tax basis of such property, allocations 
of such excess percentage depletion are not reflected by adjustments to 
the partners' capital accounts. Thus, such allocations cannot have 
economic effect under paragraph (b)(2)(ii)(b)(1) of this section, and 
such excess percentage depletion must be allocated in accordance with 
the partners' interests in the partnership. The partners' interests in 
the partnership for a partnership taxable year with respect to such 
excess percentage depletion shall be in the same proportion as such 
partners' respective distributive shares of gross income from the 
depletable property (as determined under section 613(c)) for such year. 
See example 12 of paragraph (b)(5) of this section. See paragraphs 
(b)(2)(iv)(k) and (b)(4)(v) of this section for special rules concerning 
oil and gas properties of the partnership.
    (iv) Allocations attributable to nonrecourse liabilities. The rules 
for allocations attributable to nonrecourse liabilities are contained in 
Sec. 1.704-2.
    (v) Allocations under section 613A(c)(7)(D). Allocations of the 
adjusted tax basis of a partnership oil or gas property are controlled 
by section 613A(c)(7)(D) and the regulations thereunder. However, if the 
partnership agreement provides for an allocation of the adjusted tax 
basis of an oil or gas property among the partners, and such allocation 
is not otherwise governed under section 704(c) (or related principles 
under paragraph (b)(4)(i) of this section), that allocation will be 
recognized as being in accordance with the partners' interests in 
partnership capital under section 613A(c)(7)(D), provided (a) such 
allocation does not give rise to capital account adjustments under 
paragraph (b)(2)(iv)(k) of this section, the economic effect of which is 
insubstantial (as determined under paragraph (b)(2)(iii) of this 
section),

[[Page 459]]

and (b) all other material allocations and capital account adjustments 
under the partnership agreement are recognized under this paragraph (b). 
Otherwise, such adjusted tax basis must be allocated among the partners 
pursuant to section 613A(c)(7)(D) in accordance with the partners' 
actual interests in partnership capital or income. For purposes of 
section 613A(c)(7)(D) the partners' allocable shares of the amount 
realized upon the partnership's taxable disposition of an oil or gas 
property will, except to the extent governed by section 704(c) (or 
related principles under paragraph (b)(4)(i) of this section), be 
determined under this paragraph (b)(4)(v). If, pursuant to paragraph 
(b)(2)(iv)(k)(2) of this section, the partners' capital accounts are 
adjusted to reflect the simulated depletion of an oil or gas property of 
the partnership, the portion of the total amount realized by the 
partnership upon the taxable disposition of such property that 
represents recovery of its simulated adjusted tax basis therein will be 
allocated to the partners in the same proportion as the aggregate 
adjusted tax basis of such property was allocated to such partners (or 
their predecessors in interest). If, pursuant to paragraph 
(b)(2)(iv)(k)(3) of this section, the partners' capital accounts are 
adjusted to reflect the actual depletion of an oil or gas property of 
the partnership, the portion of the total amount realized by the 
partnership upon the taxable disposition of such property that equals 
the partners' aggregate remaining adjusted basis therein will be 
allocated to the partners in proportion to their respective remaining 
adjusted tax bases in such property. An allocation provided by the 
partnership agreement of the portion of the total amount realized by the 
partnership on its taxable disposition of an oil or gas property that 
exceeds the portion of the total amount realized allocated under either 
of the previous two sentences (whichever is applicable) shall be deemed 
to be made in accordance with the partners' allocable shares of such 
amount realized, provided (c) such allocation does not give rise to 
capital account adjustments under paragraph (b)(2)(iv)(k) of this 
section the economic effect of which is insubstantial (as determined 
under paragraph (b)(2)(ii) of this section), and (d) all other 
allocations and capital account adjustments under the partnership 
agreement are recognized under this paragraph. Otherwise, the partners' 
allocable shares of the total amount realized by the partnership on its 
taxable disposition of an oil or gas property shall be determined in 
accordance with the partners' interests in the partnership under 
paragraph (b)(3) of this section. See example 19 of paragraph (b)(5) of 
this section. (See paragraph (b)(2)(iv)(k) of this section for the 
determination of appropriate adjustments to the partners' capital 
accounts relating to section 613A(c)(7)(D).)
    (vi) Amendments to partnership agreement. If an allocation has 
substantial economic effect under paragraph (b)(2) of this section or is 
deemed to be made in accordance with the partners' interests in the 
partnership under paragraph (b)(4) of this section under the partnership 
agreement that is effective for the taxable year to which such 
allocation relates, and such partnership agreement thereafter is 
modified, both the tax consequences of the modification and the facts 
and circumstances surrounding the modification will be closely 
scrutinized to determine whether the purported modification was part of 
the original agreement. If it is determined that the purported 
modification was part of the original agreement, prior allocations may 
be reallocated in a manner consistent with the modified terms of the 
agreement, and subsequent allocations may be reallocated to take account 
of such modified terms. For example, if a partner is obligated by the 
partnership agreement to restore the deficit balance in his capital 
account (or any limited dollar amount thereof) in accordance with 
requirement (3) of paragraph (b)(2)(ii)(b) of this section and, 
thereafter, such obligation is eliminated or reduced (other than as 
provided in paragraph (b)(2)(ii)(f) of this section), or is not complied 
with in a timely manner, such elimination, reduction, or noncompliance 
may be treated as if it always were part of the partnership agreement 
for purposes of making any reallocations and determining the appropriate 
limitations period.

[[Page 460]]

    (vii) Recapture. For special rules applicable to the allocation of 
recapture income or credit, see paragraph (e) of Sec. 1.1245-1, 
paragraph (f) of Sec. 1.1250-1, paragraph (c) of Sec. 1.1254-1, and 
paragraph (a) of Sec. 1.47-6.
    (viii) Allocation of creditable foreign taxes--(a) In general. 
Allocations of creditable foreign taxes do not have substantial economic 
effect within the meaning of paragraph (b)(2) of this section and, 
accordingly, such expenditures must be allocated in accordance with the 
partners' interests in the partnership. See paragraph (b)(3)(iv) of this 
section. An allocation of a creditable foreign tax expenditure (CFTE) 
will be deemed to be in accordance with the partners' interests in the 
partnership if--
    (1) The CFTE is allocated (whether or not pursuant to an express 
provision in the partnership agreement) and reported on the partnership 
return in proportion to the distributive shares of income to which the 
CFTE relates; and
    (2) Allocations of all other partnership items that, in the 
aggregate, have a material effect on the amount of CFTEs allocated to a 
partner pursuant to paragraph (b)(4)(viii)(a)(1) of this section are 
valid.
    (b) Creditable foreign tax expenditures (CFTEs). For purposes of 
this section, a CFTE is a foreign tax paid or accrued by a partnership 
that is eligible for a credit under section 901(a) or an applicable U.S. 
income tax treaty. A foreign tax is a CFTE for these purposes without 
regard to whether a partner receiving an allocation of such foreign tax 
elects to claim a credit for such tax. Foreign taxes paid or accrued by 
a partner with respect to a distributive share of partnership income, 
and foreign taxes deemed paid under section 902 or 960 by a corporate 
partner with respect to stock owned, directly or indirectly, by or for a 
partnership, are not taxes paid or accrued by a partnership and, 
therefore, are not CFTEs subject to the rules of this section. See 
paragraphs (e) and (f) of Sec. 1.901-2 for rules for determining when 
and by whom a foreign tax is paid or accrued.
    (c) Income to which CFTEs relate--(1) In general. For purposes of 
paragraph (b)(4)(viii)(a) of this section, CFTEs are related to net 
income in the partnership's CFTE category or categories to which the 
CFTE is allocated and apportioned in accordance with the rules of 
paragraph (b)(4)(viii)(d) of this section. Paragraph (b)(4)(viii)(c)(2) 
of this section provides rules for determining a partnership's CFTE 
categories. Paragraph (b)(4)(viii)(c)(3) of this section provides rules 
for determining the net income in each CFTE category. Paragraph 
(b)(4)(viii)(c)(4) of this section provides guidance in determining a 
partner's distributive share of income in a CFTE category. Paragraph 
(b)(4)(viii)(c)(5) of this section provides a special rule for 
allocating CFTEs when a partnership has no net income in a CFTE 
category.
    (2) CFTE category--(i) Income from activities. A CFTE category is a 
category of net income (or loss) attributable to one or more activities 
of the partnership. Net income (or loss) from all the partnership's 
activities shall be included in a single CFTE category unless the 
allocation of net income (or loss) from one or more activities differs 
from the allocation of net income (or loss) from other activities, in 
which case income from each activity or group of activities that is 
subject to a different allocation shall be treated as net income (or 
loss) in a separate CFTE category.
    (ii) Different allocations. Different allocations of net income (or 
loss) generally will result from provisions of the partnership agreement 
providing for different sharing ratios for net income (or loss) from 
separate activities. Different allocations of net income (or loss) from 
separate activities generally will also result if any partnership item 
is shared in a different ratio than any other partnership item. A 
guaranteed payment described in paragraph (b)(4)(viii)(c)(3)(ii) of this 
section, gross income allocation, or other preferential allocation will 
result in different allocations of net income (or loss) from separate 
activities only if the amount of the payment or the allocation is 
determined by reference to income from less than all of the 
partnership's activities. For purposes of this paragraph 
(b)(4)(viii)(c)(2), a partnership item shall not include any item that 
is excluded from income attributable to an activity pursuant to the

[[Page 461]]

second sentence of paragraph (b)(4)(viii)(c)(3)(ii) of this section 
(relating to allocations or payments that result in a deduction under 
foreign law).
    (iii) Activity. Whether a partnership has one or more activities, 
and the scope of each activity, shall be determined in a reasonable 
manner taking into account all the facts and circumstances. In 
evaluating whether aggregating or disaggregating income from particular 
business or investment operations constitutes a reasonable method of 
determining the scope of an activity, the principal consideration is 
whether the proposed determination has the effect of separating CFTEs 
from the related foreign income. Accordingly, relevant considerations 
include whether the partnership conducts business in more than one 
geographic location or through more than one entity or branch, and 
whether certain types of income are exempt from foreign tax or subject 
to preferential foreign tax treatment. In addition, income from a 
divisible part of a single activity shall be treated as income from a 
separate activity if necessary to prevent separating CFTEs from the 
related foreign income. The partnership's activities must be determined 
consistently from year to year absent a material change in facts and 
circumstances.
    (3) Net income in a CFTE category--(i) In general. The net income in 
a CFTE category means the net income for U.S. Federal income tax 
purposes, determined by taking into account all partnership items 
attributable to the relevant activity or group of activities, including 
items of gross income, gain, loss, deduction, and expense and items 
allocated pursuant to section 704(c). The items of gross income 
attributable to an activity shall be determined in a consistent manner 
under any reasonable method taking into account all the facts and 
circumstances. Except as otherwise provided below, expenses, losses or 
other deductions shall be allocated and apportioned to gross income 
attributable to an activity in accordance with the rules of Sec. Sec. 
1.861-8 and 1.861-8T. Under these rules, if an expense, loss or other 
deduction is allocated to gross income from more than one activity, such 
expense, loss or deduction must be apportioned among each such activity 
using a reasonable method that reflects to a reasonably close extent the 
factual relationship between the deduction and the gross income from 
such activities. See Sec. 1.861-8T(c). For purposes of determining net 
income in a CFTE category, the partnership's interest expense and 
research and experimental expenditures described in section 174 may be 
allocated and apportioned under any reasonable method, including but not 
limited to the methods prescribed in Sec. 1.861-9 through Sec. 1.861-
13T (interest expense) and Sec. 1.861-17 (research and experimental 
expenditures). For purposes of determining the net income attributable 
to any activity of a branch, the only items of gross income taken into 
account in applying this paragraph (b)(4)(viii)(c)(3) are those items of 
gross income recognized by the branch for U.S. income tax purposes. See 
paragraph (b)(5) Example 24 of this section (relating to inter-branch 
payments).
    (ii) Special rules. Income attributable to an activity shall include 
the amount included in a partner's income as a guaranteed payment 
(within the meaning of section 707(c)) from the partnership to the 
extent that the guaranteed payment is not deductible by the partnership 
under foreign law. See paragraph (b)(5) Example 25 (iv) of this section. 
Income attributable to an activity shall not include an item of 
partnership income to the extent the allocation of such item of income 
(or payment thereof) results in a deduction under foreign law. See 
paragraph (b)(5) Example 25 (iii) and (iv) of this section. Similarly, 
income attributable to an activity shall not include net income that 
foreign law would exclude from the foreign tax base as a result of the 
status of a partner. See paragraph (b)(5) Example 27 of this section.
    (4) Distributive shares of income. For purposes of paragraph 
(b)(4)(viii)(a)(1) of this section, distributive share of income means 
the net income from each CFTE category, determined in accordance with 
paragraph (b)(4)(viii)(c)(3) of this section, that is allocated to a 
partner. A guaranteed payment shall be treated as a distributive share 
of income for purposes of paragraph (b)(4)(viii)(a)(1) of this section 
to the extent that the guaranteed payment is

[[Page 462]]

treated as income attributable to an activity pursuant to paragraph 
(b)(4)(viii)(c)(3)(ii) of this section. See paragraph (b)(5) Example 25 
(iv) of this section. If more than one partner receives positive income 
allocations (income in excess of expenses) from a CFTE category, which 
in the aggregate exceed the total net income in the CFTE category, then 
for purposes of paragraph (b)(4)(viii)(a)(1) of this section such 
partner's distributive share of income from the CFTE category shall 
equal the partner's positive income allocation from the CFTE category, 
divided by the aggregate positive income allocations from the CFTE 
category, multiplied by the net income in the CFTE category.
    (5) No net income in a CFTE category. If a CFTE is allocated or 
apportioned to a CFTE category that does not have net income for the 
year in which the foreign tax is paid or accrued, the CFTE shall be 
deemed to relate to the aggregate of the net income (disregarding net 
losses) recognized by the partnership in that CFTE category in each of 
the three preceding taxable years. Accordingly, except as provided 
below, such CFTE must be allocated in the current taxable year in the 
same proportion as the allocation of the aggregate net income for the 
prior three-year period in order to satisfy the requirements of 
paragraph (b)(4)(viii)(a)(1) of this section. If the partnership does 
not have net income in the applicable CFTE category in either the 
current year or any of the previous three taxable years, the CFTE must 
be allocated in the same proportion that the partnership reasonably 
expects to allocate the aggregate net income (disregarding net losses) 
in the CFTE category for the succeeding three taxable years. If the 
partnership does not reasonably expect to have net income in the CFTE 
category for the succeeding three years and the partnership has net 
income in one or more other CFTE categories for the year in which the 
foreign tax is paid or accrued, the CFTE shall be deemed to relate to 
such other net income and must be allocated in proportion to the 
allocations of such other net income. If any CFTE is not allocated 
pursuant to the above provisions of this paragraph then the CFTE must be 
allocated in proportion to the partners' outstanding capital 
contributions.
    (d) Allocation and apportionment of CFTEs to CFTE categories--(1) In 
general. CFTEs are allocated and apportioned to CFTE categories in 
accordance with the principles of Sec. 1.904-6. Under these principles, 
a CFTE is related to income in a CFTE category if the income is included 
in the base upon which the foreign tax is imposed. In accordance with 
Sec. 1.904-6(a)(1)(ii) as modified by this paragraph (b)(4)(viii)(d), 
if the foreign tax base includes income in more than one CFTE category, 
the CFTEs are apportioned among the CFTE categories based on the 
relative amounts of taxable income computed under foreign law in each 
CFTE category. For purposes of this paragraph (b)(4)(viii)(d), 
references in Sec. 1.904-6 to a separate category or separate 
categories shall mean ``CFTE category'' or ``CFTE categories'' and the 
rules in Sec. 1.904-6(a)(1)(ii) are modified as follows:
    (i) The related party interest expense rule in Sec. 1.904-
6(a)(1)(ii) shall not apply in determining the amount of taxable income 
computed under foreign law in a CFTE category.
    (ii) If foreign law does not provide for the direct allocation or 
apportionment of expenses, losses or other deductions allowed under 
foreign law to a CFTE category of income, then such expenses, losses or 
other deductions must be allocated and apportioned to gross income as 
determined under foreign law in a manner that is consistent with the 
allocation and apportionment of such items for purposes of determining 
the net income in the CFTE categories for U.S. tax purposes pursuant to 
paragraph (b)(4)(viii)(c)(3) of this section.
    (2) Timing and base differences. A foreign tax imposed on an item 
that would be income under U.S. tax principles in another year (a timing 
difference) is allocated to the CFTE category that would include the 
income if the income were recognized for U.S. tax purposes in the year 
in which the foreign tax is imposed. A foreign tax imposed on an item 
that would not constitute income under U.S. tax principles in any year 
(a base difference) is allocated to the CFTE category that

[[Page 463]]

includes the partnership items attributable to the activity with respect 
to which the foreign tax is imposed. See paragraph (b)(5) Example 23 of 
this section.
    (3) Special rules for inter-branch payments. For rules relating to 
foreign tax paid or accrued in partnership taxable years beginning 
before January 1, 2012, in respect of certain inter-branch payments, see 
26 CFR 1.704-1(b)(4)(viii)(d)(3) (revised as of April 1, 2011).
    (ix) Allocations with respect to noncompensatory options--(a) In 
general. A partnership agreement may grant to a partner that exercises a 
noncompensatory option (as defined in Sec. 1.721-2(f)) a right to share 
in partnership capital that exceeds (or is less than) the sum of the 
amounts paid to the partnership to acquire and exercise the option. In 
such a case, allocations of income, gain, loss, and deduction to the 
partners while the noncompensatory option is outstanding cannot have 
economic effect because, if the noncompensatory option is exercised, the 
exercising partner, rather than the existing partners, may receive the 
economic benefit or bear the economic detriment associated with that 
income, gain, loss, or deduction. However, allocations of partnership 
income, gain, loss, and deduction to the partners while the 
noncompensatory option is outstanding will be deemed to be in accordance 
with the partners' interests in the partnership only if--
    (1) The holder of the noncompensatory option is not treated as a 
partner under Sec. 1.761-3;
    (2) The partnership agreement requires that, while a noncompensatory 
option is outstanding, the partnership comply with the rules of 
paragraph (b)(2)(iv)(f) of this section and that, on the exercise of the 
noncompensatory option, the partnership comply with the rules of 
paragraph (b)(2)(iv)(s) of this section; and
    (3) All material allocations and capital account adjustments under 
the partnership agreement would be respected under section 704(b) if 
there were no outstanding noncompensatory options issued by the 
partnership. See Examples 31 through 35 of paragraph (b)(5) of this 
section.
    (b) Substantial economic effect under sections 168(h) and 
514(c)(9)(E)(i)(ll). An allocation of partnership income, gain, loss, or 
deduction to the partners will be deemed to have substantial economic 
effect for purposes of sections 168(h) and 514(c)(9)(E)(i)(ll) if--
    (1) The allocation would meet the substantial economic effect 
requirements of paragraph (b)(2) of this section if there were no 
outstanding noncompensatory options issued by the partnership; and
    (2) The partnership satisfies the requirements of paragraph 
(b)(4)(ix)(a)(1), (2), and (3) of this section.
    (x) Corrective allocations--(a)--In general. If partnership capital 
is reallocated between existing partners and a partner exercising a 
noncompensatory option under paragraph (b)(2)(iv)(s)(3) of this section 
(a capital account reallocation), then the partnership must, beginning 
with the taxable year of the exercise and in all succeeding taxable 
years until the required allocations are fully taken into account, make 
corrective allocations so as to take into account the capital account 
reallocation. A corrective allocation is an allocation (consisting of a 
pro rata portion of each item) for tax purposes of gross income and 
gain, or gross loss and deduction, that differs from the partnership's 
allocation of the corresponding book item. See Example 32 of paragraph 
(b)(5) of this section.
    (b) Timing. Section 706 and the regulations and principles 
thereunder apply in determining the items of income, gain, loss, and 
deduction that may be subject to corrective allocation.
    (c) Allocation of gross income and gain and gross loss and 
deduction. If the capital account reallocation is from the historic 
partners to the exercising option holder, then the corrective 
allocations must first be made with gross income and gain. If an 
allocation of gross income and gain alone does not completely take into 
account the capital account reallocation in a given year, then the 
partnership must also make corrective allocations using a pro rata 
portion of items of gross loss and deduction as to further take into 
account

[[Page 464]]

the capital account reallocation. Conversely, if the capital account 
reallocation is from the exercising option holder to the historic 
partners, then the corrective allocations must first be made with gross 
loss and deduction. If an allocation of gross loss and deduction alone 
does not completely take into account the capital account reallocation 
in a given year, then the partnership must also make corrective 
allocations using a pro rata portion of items of gross income and gain 
as to further take into account the capital account reallocation.
    (5) Examples. The operation of the rules in this paragraph is 
illustrated by the following examples:

    Example 1. (i) A and B form a general partnership with cash 
contributions of $40,000 each, which cash is used to purchase 
depreciable personal property at a cost of $80,000. The partnership 
elects under section 48(q)(4) to reduce the amount of investment tax 
credit in lieu of adjusting the tax basis of such property. The 
partnership agreement provides that A and B will have equal shares of 
taxable income and loss (computed without regard to cost recovery 
deductions) and cash flow and that all cost recovery deductions on the 
property will be allocated to A. The agreement further provides that the 
partners' capital accounts will be determined and maintained in 
accordance with paragraph (b)(2)(iv) of the section, but that upon 
liquidation of the partnership, distributions will be made equally 
between the partners (regardless of capital account balances) and no 
partner will be required to restore the deficit balance in his capital 
account for distribution to partners with positive capital accounts 
balances. In the partnership's first taxable year, it recognizes 
operating income equal to its operating expenses and has an additional 
$20,000 cost recovery deduction, which is allocated entirely to A. That 
A and B will be entitled to equal distributions on liquidation, even 
through A is allocated the entire $20,000 cost recovery deduction, 
indicates A will not bear the full risk of the economic loss 
corresponding to such deduction if such loss occurs. Under paragraph 
(b)(2)(ii) of this section, the allocation lacks economic effect and 
will be disregarded. The partners made equal contributions to the 
partnership, share equally in other taxable income and loss and in cash 
flow, and will share equally in liquidation proceeds, indicating that 
their actual economic arrangement is to bear the risk imposed by the 
potential decrease in the value of the property equally. Thus, under 
paragraph (b)(3) of this section the partners' interests in the 
partnership are equal, and the cost recovery deduction will be 
reallocated equally between A and B.
    (ii) Assume the same facts as in (i) except that the partnership 
agreement provides that liquidation proceeds will be distributed in 
accordance with capital account balances if the partnership is 
liquidated during the first five years of its existence but that 
liquidation proceeds will be distributed equally if the partnership is 
liquidated thereafter. Since the partnership agreement does not provide 
for the requirement contained in paragraph (b)(2)(ii)(b)(2) of this 
section to be satisfied throughout the term of the partnership, the 
partnership allocations do not have economic effect. Even if the 
partnership agreement provided for the requirement contained in 
paragraph (b)(2)(ii)(b)(2) to be satisfied throughout the term of the 
partnership, such allocations would not have economic effect unless the 
requirement contained in paragraph (b)(2)(ii)(b)(3) of this section or 
the alternate economic effect test contained in paragraph (b)(2)(ii)(d) 
of this section were satisfied.
    (iii) Assume the same facts as in (i) except that distributions in 
liquidation of the partnership (or any partner's interest) are to be 
made in accordance with the partners' positive capital account balances 
throughout the term of the partnership (as set forth in paragraph 
(b)(2)(ii)(b)(2) of this section). Assume further that the partnership 
agreement contains a qualified income offset (as defined in paragraph 
(b)(2)(ii)(d) of this section) and that, as of the end of each 
partnership taxable year, the items described in paragraphs 
(b)(2)(ii)(d)(4), (5), and (6) of this section are not reasonably 
expected to cause or increase a deficit balance in A's capital account.

------------------------------------------------------------------------
                                                        A          B
------------------------------------------------------------------------
Capital account upon formation....................   $40,000     $40,000
Less: year 1 cost recovery deduction..............   (20,000)          0
                                                   ---------------------
      Capital account at end of year 1............   $20,000     $40,000
------------------------------------------------------------------------


Under the alternate economic effect test contained in paragraph 
(b)(2)(ii)(d) of this section, the allocation of the $20,000 cost 
recovery deduction to A has economic effect.
    (iv) Assume the same facts as in (iii) and that in the partnership's 
second taxable year it recognizes operating income equal to its 
operating expenses and has a $25,000 cost recovery deduction which, 
under the partnership agreement, is allocated entirely to A.

------------------------------------------------------------------------
                                                        A          B
------------------------------------------------------------------------
Capital account at beginning of year 2............   $20,000     $40,000
Less: year 2 cost recovery deduction..............   (25,000)          0
                                                   ---------------------
Capital account at end of year 2..................   ($5,000)    $40,000
------------------------------------------------------------------------


[[Page 465]]

    The allocation of the $25,000 cost recovery deduction to A satisfies 
that alternate economic effect test contained in paragraph (b)(2)(ii)(d) 
of this section only to the extent of $20,000. Therefore, only $20,000 
of such allocation has economic effect, and the remaining $5,000 must be 
reallocated in accordance with the partners' interests in the 
partnership. Under the partnership agreement, if the property were sold 
immediately following the end of the partnership's second taxable year 
for $35,000 (its adjusted tax basis), the $35,000 would be distributed 
to B. Thus, B, and not A, bears the economic burden corresponding to 
$5,000 of the $25,000 cost recovery deduction allocated to A. Under 
paragraph (b)(3)(iii) of this section, $5,000 of such cost recovery 
deduction will be reallocated to B.
    (v) Assume the same facts as in (iv) except that the cost recovery 
deduction for the partnership's second taxable year is $20,000 instead 
of $25,000. The allocation of such cost recovery deduction to A has 
economic effect under the alternate economic effect test contained in 
paragraph (b)(2)(ii)(d) of this section. Assume further that the 
property is sold for $35,000 immediately following the end of the 
partnership's second taxable year, resulting in a $5,000 taxable loss 
($40,000 adjusted tax basis less $35,000 sales price), and the 
partnership is liquidated.

------------------------------------------------------------------------
                                                        A          B
------------------------------------------------------------------------
Capital account at beginning of year 2............   $20,000    $40,000
Less: year 2 cost recovery dedustion..............   (20,000)         0
                                                   ---------------------
Capital account at end of year 2..................         0    $40,000
Less: loss on sale................................    (2,500)    (2,500)
                                                   ---------------------
      Capital account before liquidation..........   ($2,500)   $37,500
------------------------------------------------------------------------

Under the partnership agreement the $35,000 sales proceeds are 
distributed to B. Since B bears the entire economic burden corresponding 
to the $5,000 taxable loss from the sale of the property, the allocation 
of $2,500 of such loss to A does not have economic effect and must be 
reallocated in accordance with the partners' interests in the 
partnership. Under paragraph (b)(3)(iii) of this section, such $2,500 
loss will be reallocated to B.
    (vi) Assume the same facts as in (iv) except that the cost recovery 
deduction for the partnership's second taxable year is $20,000 instead 
of $25,000, and that as of the end of the partnership's second taxable 
year it is reasonably expected that during its third taxable year the 
partnership will (1) have operating income equal to its operating 
expenses (but will have no cost recovery deductions), (2) borrow $10,000 
(recourse) and distribute such amount $5,000 to A and $5,000 to B, and 
(3) thereafter sell the partnership property, repay the $10,000 
liability, and liquidate. In determining the extent to which the 
alternate economic effect test contained in paragraph (b)(2)(ii)(d) of 
this section is satisfied as of the end of the partnership's second 
taxable year, the fair market value of partnership property is presumed 
to be equal to its adjusted tax basis (in accordance with paragraph 
(b)(2)(iii)(c) of this section). Thus, it is presumed that the selling 
price of such property during the partnership's third taxable year will 
be its $40,000 adjusted tax basis. Accordingly, there can be no 
reasonable expectation that there will be increases to A's capital 
account in the partnership's third taxable year that will offset the 
expected $5,000 distribution to A. Therefore, the distribution of the 
loan proceeds must be taken into account in determining to what extent 
the alternate economic effect test contained in paragraph (b)(2)(ii)(d) 
is satisfied.

------------------------------------------------------------------------
                                                        A          B
------------------------------------------------------------------------
Capital account at beginning of year 2............   $20,000    $40,000
Less: expected future distribution................    (5,000)    (5,000)
Less: year 2 cost recovery deduction..............   (20,000)        (0)
                                                   ---------------------
      Hypothetical capital account at end of year    ($5,000)   $35,000
       2..........................................
------------------------------------------------------------------------

Upon sale of the partnership property, the $40,000 presumed sales 
proceeds would be used to repay the $10,000 liability, and the remaining 
$30,000 would be distributed to B. Under these circumstances the 
allocation of the $20,000 cost recovery deduction to A in the 
partnership's second taxable year satisfies the alternate economic 
effect test contained in paragraph (b)(2)(ii)(d) of this section only to 
the extent of $15,000. Under paragraph (b)(3)(iii) of this section, the 
remaining $5,000 of such deduction will be reallocated to B. The results 
in this example would be the same even if the partnership agreement also 
provided that any gain (whether ordinary income or capital gain) upon 
the sale of the property would be allocated to A to the extent of the 
prior allocations of cost recovery deductions to him, and, at end of the 
partnership's second taxable year, the partners were confident that the 
gain on the sale of the property in the partnership's third taxable year 
would be sufficient to offset the expected $5,000 distribution to A.
    (vii) Assume the same facts as in (iv) except that the partnership 
agreement also provides that any partner with a deficit balance in his 
capital account following the liquidation of his interest must restore 
that deficit to the partnership (as set forth in paragraph 
(b)(2)(ii)(b)(3) of this section). Thus, if the property were sold for 
$35,000 immediately after the end of the partnership's second taxable 
year, the $35,000 would be distributed to B, A would contribute $5,000 
(the

[[Page 466]]

deficit balance in his capital account) to the partnership, and that 
$5,000 would be distributed to B. The allocation of the entire $25,000 
cost recovery deduction to A in the partnership's second taxable year 
has economic effect.
    (viii) Assume the same facts as in (vii) except that A's obligation 
to restore the deficit balance in his capital account is limited to a 
maximum of $5,000. The allocation of the $25,000 cost recovery deduction 
to A in the partnership's second taxable year has economic effect under 
the alternate economic effect test contained in paragraph (b)(2)(ii)(d) 
of this section. At the end of such year, A makes an additional $5,000 
contribution to the partnership (thereby eliminating the $5,000 deficit 
balance in his capital account). Under paragraph (b)(2)(ii)(f) of this 
section, A's obligation to restore up to $5,000 of the deficit balance 
in his capital account may be eliminated after he contributes the 
additional $5,000 without affecting the validity of prior allocations.
    (ix) Assume the same facts as in (iv) except that upon formation of 
the partnership A also contributes to the partnership his negotiable 
promissory note with a $5,000 principal balance. The note 
unconditionally obligates A to pay an additional $5,000 to the 
partnership at the earlier of (a) the beginning of the partnership's 
fourth taxable year, or (b) the end of the partnership taxable year in 
which A's interest is liquidated. Under paragraph (b)(2)(ii)(c) of this 
section, A is considered obligated to restore up to $5,000 of the 
deficit balance in his capital account to the partnership. Accordingly, 
under the alternate economic effect test contained in paragraph 
(b)(2)(ii)(d) of this section, the allocation of the $25,000 cost 
recovery deduction to A in the partnership's second taxable year has 
economic effect. The results in this example would be the same if (1) 
the note A contributed to the partnership were payable only at the end 
of the partnership's fourth taxable year (so that A would not be 
required to satisfy the note upon liquidation of his interest in the 
partnership), and (2) the partnership agreement provided that upon 
liquidation of A's interest, the partnership would retain A's note, and 
A would contribute to the partnership the excess of the outstanding 
principal balance of the note over its then fair market value.
    (x) Assume the same facts as in (ix) except that A's obligation to 
contribute an additional $5,000 to the partnership is not evidenced by a 
promissory note. Instead, the partnership agreement imposes upon A the 
obligation to make an additional $5,000 contribution to the partnership 
at the earlier of (a) the beginning of the partnership's fourth taxable 
year, or (b) the end of the partnership taxable year in which A's 
interest is liquidated. Under paragraph (b)(2)(ii)(c) of this section, 
as a result of A's deferred contribution requirement, A is considered 
obligated to restore up to $5,000 of the deficit balance in his capital 
account to the partnership. Accordingly, under the alternate economic 
effect test contained in paragraph (b)(2)(ii)(d) of this section, the 
allocation of the $25,000 cost recovery deduction to A in the 
partnership's second taxable year has economic effect.
    (xi) Assume the same facts as in (vii) except that the partnership 
agreement also provides that any gain (whether ordinary income or 
capital gain) upon the sale of the property will be allocated to A to 
the extent of the prior allocations to A of cost recovery deductions 
from such property, and additional gain will be allocated equally 
between A and B. At the time the allocations of cost recovery deductions 
were made to A, the partners believed there would be gain on the sale of 
the property in an amount sufficient to offset the allocations of cost 
recovery deductions to A. Nevertheless, the existence of the gain 
chargeback provision will not cause the economic effect of the 
allocations to be insubstantial under paragraph (b)(2)(iii)(c) of this 
section, since in testing whether the economic effect of such 
allocations is substantial, the recovery property is presumed to 
decrease in value by the amount of such deductions.
    Example 2. C and D form a general partnership solely to acquire and 
lease machinery that is 5-year recovery property under section 168. Each 
contributes $100,000, and the partnership obtains an $800,000 recourse 
loan to purchase the machinery. The partnership elects under section 
48(q)(4) to reduce the amount of investment tax credit in lieu of 
adjusting the tax basis of such machinery. The partnership, C, and D 
have calendar taxable years. The partnership agreement provides that the 
partners' capital accounts will be determined and maintained in 
accordance with paragraph (b)(2)(iv) of this section, distributions in 
liquidation of the partnership (or any partner's interest) will be made 
in accordance with the partners' positive capital account balances, and 
any partner with a deficit balance in his capital account following the 
liquidation of his interest must restore that deficit to the partnership 
(as set forth in paragraphs (b)(2)(ii)(b)(2) and (3) of this section). 
The partnership agreement further provides that (a) partnership net 
taxable loss will be allocated 90 percent to C and 10 percent to D until 
such time as there is partnership net taxable income, and therefore C 
will be allocated 90 percent of such taxable income until he has been 
allocated partnership net taxable income equal to the partnership net 
taxable loss previously allocated to him, (b) all further partnership 
net taxable income or loss will be allocated equally between C and D, 
and (c) distributions of operating cash flow will be made equally 
between C and D. The partnership

[[Page 467]]

enters into a 12-year lease with a financially secure corporation under 
which the partnership expects to have a net taxable loss in each of its 
first 5 partnership taxable years due to cost recovery deductions with 
respect to the machinery and net taxable income in each of its following 
7 partnership taxable years, in part due to the absence of such cost 
recovery deductions. There is a strong likelihood that the partnership's 
net taxable loss in partnership taxable years 1 through 5 will be 
$100,000, $90,000, $80,000, $70,000, and $60,000, respectively, and the 
partnership's net taxable income in partnership taxable years 6 through 
12 will be $40,000, $50,000, $60,000, $70,000, $80,000, $90,000, and 
$100,000, respectively. Even though there is a strong likelihood that 
the allocations of net taxable loss in years 1 through 5 will be largely 
offset by other allocations in partnership taxable years 6 through 12, 
and even if it is assumed that the total tax liability of the partners 
in years 1 through 12 will be less than if the allocations had not been 
provided in the partnership agreement, the economic effect of the 
allocations will not be insubstantial under paragraph (b)(2)(iii)(c) of 
this section. This is because at the time such allocations became part 
of the partnership agreement, there was a strong likelihood that the 
allocations of net taxable loss in years 1 through 5 would not be 
largely offset by allocations of income within 5 years (determined on a 
first-in, first-out basis). The year 1 allocation will not be offset 
until years 6, 7, and 8, the year 2 allocation will not be offset until 
years 8 and 9, the year 3 allocation will not be offset until years 9 
and 10, the year 4 allocation will not be offset until years 10 and 11, 
and the year 5 allocation will not be offset until years 11 and 12.
    Example 3. E and F enter into a partnership agreement to develop and 
market experimental electronic devices. E contributes $2,500 cash and 
agrees to devote his full-time services to the partnership. F 
contributes $100,000 cash and agrees to obtain a loan for the 
partnership for any additional capital needs. The partnership agreement 
provides that all deductions for research and experimental expenditures 
and interest on partnership loans are to be allocated to F. In addition, 
F will be allocated 90 percent, and E 10 percent, of partnership taxable 
income or loss, computed net of the deductions for such research and 
experimental expenditures and interest, until F has received allocations 
of such taxable income equal to the sum of such research and 
experimental expenditures, such interest expense, and his share of such 
taxable loss. Thereafter, E and F will share all taxable income and loss 
equally. Operating cash flow will be distributed equally between E and 
F. The partnership agreement also provides that E's and F's capital 
accounts will be determined and maintained in accordance with paragraph 
(b)(2)(iv) of this section, distributions in liquidation of the 
partnership (or any partner's interest) will be made in accordance with 
the partners' positive capital account balances, and any partner with a 
deficit balance in his capital account following the liquidation of his 
interest must restore that deficit to the partnership (as set forth in 
paragraphs (b)(2)(ii)(b)(2) and (3) of this section). These allocations 
have economic effect. In addition, in view of the nature of the 
partnership's activities, there is not a strong likelihood at the time 
the allocations become part of the partnership agreement that the 
economic effect of the allocations to F of deductions for research and 
experimental expenditures and interest on partnership loans will be 
largely offset by allocations to F of partnership net taxable income. 
The economic effect of the allocations is substantial.
    Example 4. (i) G and H contribute $75,000 and $25,000, respectively, 
in forming a general partnership. The partnership agreement provides 
that all income, gain, loss, and deduction will be allocated equally 
between the partners, that the partners' capital accounts will be 
determined and maintained in accordance with paragraph (b)(2)(iv) of 
this section, but that all partnership distributions will, regardless of 
capital account balances, be made 75 percent to G and 25 percent to H. 
Following the liquidation of the partnership, neither partner is 
required to restore the deficit balance in his capital account to the 
partnership for distribution to partners with positive capital account 
balances. The allocations in the partnership agreement do not have 
economic effect. Since contributions were made in a 75/25 ratio and the 
partnership agreement indicates that all economic profits and losses of 
the partnership are to be shared in a 75/25 ratio, under paragraph 
(b)(3) of this section, partnership income, gain, loss, and deduction 
will be reallocated 75 percent to G and 25 percent to H.
    (ii) Assume the same facts as in (i) except that the partnership 
maintains no capital accounts and the partnership agreement provides 
that all income, gain, loss, deduction, and credit will be allocated 75 
percent to G and 25 percent to H. G and H are ultimately liable (under a 
State law right of contribution) for 75 percent and 25 percent, 
respectively, of any debts of the partnership. Although the allocations 
do not satisfy the requirements of paragraph (b)(2)(ii)(b) of this 
section, the allocations have economic effect under the economic effect 
equivalence test of paragraph (b)(2)(ii)(i) of this section.
    (iii) Assume the same facts as in (i) except that the partnership 
agreement provides that any partner with a deficit balance in his 
capital account must restore that deficit to the partnership (as set 
forth in paragraph (b)(2)(ii)(b)(2) of this section). Although the 
allocations do not satisfy the requirements

[[Page 468]]

of paragraph (b)(2)(ii)(b) of this section, the allocations have 
economic effect under the economic effect equivalence test of paragraph 
(b)(2)(ii)(i) of this section.
    Example 5. (i) Individuals I and J are the only partners of an 
investment partnership. The partnership owns corporate stocks, corporate 
debt instruments, and tax-exempt debt instruments. Over the next several 
years, I expects to be in the 50 percent marginal tax bracket, and J 
expects to be in the 15 percent marginal tax bracket. There is a strong 
likelihood that in each of the next several years the partnership will 
realize between $450 and $550 of tax-exempt interest and between $450 
and $550 of a combination of taxable interest and dividends from its 
investments. I and J made equal capital contributions to the 
partnership, and they have agreed to share equally in gains and losses 
from the sale of the partnership's investment securities. I and J agree, 
however, that rather than share interest and dividends of the 
partnership equally, they will allocate the partnership's tax-exempt 
interest 80 percent to I and 20 percent to J and will distribute cash 
derived from interest received on the tax-exempt bonds in the same 
percentages. In addition, they agree to allocate 100 percent of the 
partnership's taxable interest and dividends to J and to distribute cash 
derived from interest and dividends received on the corporate stocks and 
debt instruments 100 percent to J. The partnership agreement further 
provides that the partners' capital accounts will be determined and 
maintained in accordance with paragraph (b)(2)(iv) of this section, 
distributions in liquidation of the partnership (or any partner's 
interest) will be made in accordance with the partner's positive capital 
account balances, and any partner with a deficit balance in his capital 
account following the liquidation of his interest must restore that 
deficit to the partnership (as set forth in paragraphs (b)(2)(ii)(b) (2) 
and (3) of this section). The allocation of taxable interest and 
dividends and tax-exempt interest has economic effect, but that economic 
effect is not substantial under the general rules set forth in paragraph 
(b)(2)(iii) of this section. Without the allocation I would be allocated 
between $225 and $275 of tax-exempt interest and between $225 and $275 
of a combination of taxable interest and dividends, which (net of 
Federal income taxes he would owe on such income) would give I between 
$337.50 and $412.50 after tax. With the allocation, however, I will be 
allocated between $360 and $440 of tax-exempt interest and no taxable 
interest and dividends, which (net of Federal income taxes) will give I 
between $360 and $440 after tax. Thus, at the time the allocations 
became part of the partnership agreement, I is expected to enhance his 
after-tax economic consequences as a result of the allocations. On the 
other hand, there is a strong likelihood that neither I nor J will 
substantially diminish his after-tax economic consequences as a result 
of the allocations. Under the combination of likely investment outcomes 
least favorable for J, the partnership would realize $550 of tax-exempt 
interest and $450 of taxable interest and dividends, giving J $492.50 
after tax (which is more than the $466.25 after tax J would have 
received if each of such amounts had been allocated equally between the 
partners). Under the combination of likely investment outcomes least 
favorable for I, the partnership would realize $450 of tax-exempt 
interest and $550 of taxable interest and dividends, giving I $360 after 
tax (which is not substantially less than the $362.50 he would have 
received if each of such amounts had been allocated equally between the 
partners). Accordingly, the allocations in the partnership agreement 
must be reallocated in accordance with the partners' interests in the 
partnership under paragraph (b)(3) of this section.
    (ii) Assume the same facts as in (i). In addition, assume that in 
the first partnership taxable year in which the allocation arrangement 
described in (i) applies, the partnership realizes $450 of tax-exempt 
interest and $550 of taxable interest and dividends, so that, pursuant 
to the partnership agreement, I's capital account is credited with $360 
(80 percent of the tax-exempt interest), and J's capital account is 
credited with $640 (20 percent of the tax-exempt interest and 100 
percent of the taxable interest and dividends). The allocations of tax-
exempt interest and taxable interest and dividends (which do not have 
substantial economic effect for the reasons stated in (i) will be 
disregarded and will be reallocated. Since under the partnership 
agreement I will receive 36 percent (360/1,000) and J will receive 64 
percent (640/1,000) of the partnership's total investment income in such 
year, under paragraph (b)(3) of this section the partnership's tax-
exempt interest and taxable interest and dividends each will be 
reallocated 36 percent to I and 64 percent to J.
    Example 6. K and L are equal partners in a general partnership 
formed to acquire and operate property described in section 1231(b). The 
partnership, K, and L have calendar taxable years. The partnership 
agreement provides that the partners' capital accounts will be 
determined and maintained in accordance with paragraph (b)(2)(iv) of 
this section, that distributions in liquidation of the partnership (or 
any partner's interest) will be made in accordance with the partners' 
positive capital account balances, and that any partner with a deficit 
balance in his capital account following the liquidation of his interest 
must restore that deficit to the partnership (as set forth in paragraphs 
(b)(2)(ii)(b) (2) and (3) of this section). For a taxable year in which 
the partnership expects to incur a loss on the sale of a portion of such 
property,

[[Page 469]]

the partnership agreement is amended (at the beginning of the taxable 
year) to allocate such loss to K, who expects to have no gains from the 
sale of depreciable property described in section 1231(b) in that 
taxable year, and to allocate an equivalent amount of partnership loss 
and deduction for that year of a different character to L, who expects 
to have such gains. Any partnership loss and deduction in excess of 
these allocations will be allocated equally between K and L. The 
amendment is effective only for that taxable year. At the time the 
partnership agreement is amended, there is a strong likelihood that the 
partnership will incur deduction or loss in the taxable year other than 
loss from the sale of property described in section 1231(b) in an amount 
that will substantially equal or exceed the expected amount of the 
section 1231(b) loss. The allocations in such taxable year have economic 
effect. However, the economic effect of the allocations is insubstantial 
under the test described in paragraph (b)(2)(iii) (b) of this section 
because there is a strong likelihood, at the time the allocations become 
part of the partnership agreement, that the net increases and decreases 
to K's and L's capital accounts will be the same at the end of the 
taxable year to which they apply with such allocations in effect as they 
would have been in the absence of such allocations, and that the total 
taxes of K and L for such year will be reduced as a result of such 
allocations. If in fact the partnership incurs deduction or loss, other 
than loss from the sale of property described in section 1231(b), in an 
amount at least equal to the section 1231(b) loss, the loss and 
deduction in such taxable year will be reallocated equally between K and 
L under paragraph (b)(3) of this section. If not, the loss from the sale 
of property described in section 1231(b) and the items of deduction and 
other loss realized in such year will be reallocated between K and L in 
proportion to the net decreases in their capital accounts due to the 
allocation of such items under the partnership agreement.
    Example 7. (i) M and N are partners in the MN general partnership, 
which is engaged in an active business. Income, gain, loss, and 
deduction from MN's business is allocated equally between M and N. The 
partnership, M, and N have calendar taxable years. Under the partnership 
agreement the partners' capital accounts will be determined and 
maintained in accordance with paragraph (b)(2)(iv) of this section, 
distributions in liquidation of the partnership (or any partner's 
interest) will be made in accordance with the partner's positive capital 
account balances, and any partner with a deficit balance in his capital 
account following the liquidation of his interest must restore that 
deficit to the partnership (as set forth in paragraphs (b)(2)(ii)(b) (2) 
and (3) of this section). In order to enhance the credit standing of the 
partnership, the partners contribute surplus funds to the partnership, 
which the partners agree to invest in equal dollar amounts of tax-exempt 
bonds and corporate stock for the partnership's first 3 taxable years. M 
is expected to be in a higher marginal tax bracket than N during those 3 
years. At the time the decision to make these investments is made, it is 
agreed that, during the 3-year period of the investment, M will be 
allocated 90 percent and N 10 percent of the interest income from the 
tax-exempt bonds as well as any gain or loss from the sale thereof, and 
that M will be allocated 10 percent and N 90 percent of the dividend 
income from the corporate stock as well as any gain or loss from the 
sale thereof. At the time the allocations concerning the investments 
become part of the partnership agreement, there is not a strong 
likelihood that the gain or loss from the sale of the stock will be 
substantially equal to the gain or loss from the sale of the tax-exempt 
bonds, but there is a strong likelihood that the tax-exempt interest and 
the taxable dividends realized from these investments during the 3-year 
period will not differ substantially. These allocations have economic 
effect, and the economic effect of the allocations of the gain or loss 
on the sale of the tax-exempt bonds and corporate stock is substantial. 
The economic effect of the allocations of the tax-exempt interest and 
the taxable dividends, however, is not substantial under the test 
described in paragraph (b)(2)(iii)(c) of this section because there is a 
strong likelihood, at the time the allocations become part of the 
partnership agreement, that at the end of the 3-year period to which 
such allocations relate, the net increases and decreases to M's and N's 
capital accounts will be the same with such allocations as they would 
have been in the absence of such allocations, and that the total taxes 
of M and N for the taxable years to which such allocations relate will 
be reduced as a result of such allocations. If in fact the amounts of 
the tax-exempt interest and taxable dividends earned by the partnership 
during the 3-year period are equal, the tax-exempt interest and taxable 
dividends will be reallocated to the partners in equal shares under 
paragraph (b)(3) of this section. If not, the tax-exempt interest and 
taxable dividends will be reallocated between M and N in proportion to 
the net increases in their capital accounts during such 3-year period 
due to the allocation of such items under the partnership agreement.
    (ii) Assume the same facts as in (i) except that gain or loss from 
the sale of the tax-exempt bonds and corporate stock will be allocated 
equally between M and N and the partnership agreement provides that the 
90/10 allocation arrangement with respect to the investment income 
applies only to the first $10,000 of interest income from the tax-exempt 
bonds and the first $10,000 of dividend

[[Page 470]]

income from the corporate stock, and only to the first taxable year of 
the partnership. There is a strong likelihood at the time the 90/10 
allocation of the investment income became part of the partnership 
agreement that in the first taxable year of the partnership, the 
partnership will earn more than $10,000 of tax-exempt interest and more 
than $10,000 of taxable dividends. The allocations of tax-exempt 
interest and taxable dividends provided in the partnership agreement 
have economic effect, but under the test contained in paragraph 
(b)(2)(iii)(b) of this section, such economic effect is not substantial 
for the same reasons stated in (i) (but applied to the 1 taxable year, 
rather than to a 3-year period). If in fact the partnership realizes at 
least $10,000 of tax-exempt interest and at least $10,000 of taxable 
dividends in such year, the allocations of such interest income and 
dividend income will be reallocated equally between M and N under 
paragraph (b)(3) of this section. If not, the tax-exempt interest and 
taxable dividends will be reallocated between M and N in proportion to 
the net increases in their capital accounts due to the allocations of 
such items under the partnership agreement.
    (iii) Assume the same facts as in (ii) except that at the time the 
90/10 allocation of investment income becomes part of the partnership 
agreement, there is not a strong likelihood that (1) the partnership 
will earn $10,000 or more of tax-exempt interest and $10,000 or more of 
taxable dividends in the partnership's first taxable year, and (2) the 
amount of tax-exempt interest and taxable dividends earned during such 
year will be substantially the same. Under these facts the economic 
effect of the allocations generally will be substantial. (Additional 
facts may exist in certain cases, however, so that the allocation is 
insubstantial under the second sentence of paragraph (b)(2)(iii). See 
example 5 above.)
    Example 8. (i) O and P are equal partners in the OP general 
partnership. The partnership, O, and P have calendar taxable years. 
Partner O has a net operating loss carryover from another venture that 
is due to expire at the end of the partnership's second taxable year. 
Otherwise, both partners expect to be in the 50 percent marginal tax 
bracket in the next several taxable years. The partnership agreement 
provides that the partners' capital accounts will be determined and 
maintained in accordance with paragraph (b)(2)(iv) of this section, 
distributions in liquidation of the partnership (or any partner's 
interest) will be made in accordance with the partners' positive capital 
account balances, and any partner with a deficit balance in his capital 
account following the liquidation of his interest must restore that 
deficit to the partnership (as set forth in paragraphs (b)(2)(ii)(b) (2) 
and (3) of this section). The partnership agreement is amended (at the 
beginning of the partnership's second taxable year) to allocate all the 
partnership net taxable income for that year to O. Future partnership 
net taxable loss is to be allocated to O, and future partnership net 
taxable income to P, until the allocation of income to O in the 
partnership's second taxable year is offset. It is further agreed orally 
that in the event the partnership is liquidated prior to completion of 
such offset, O's capital account will be adjusted downward to the extent 
of one-half of the allocations of income to O in the partnership's 
second taxable year that have not been offset by other allocations, P's 
capital account will be adjusted upward by a like amount, and 
liquidation proceeds will be distributed in accordance with the 
partners' adjusted capital account balances. As a result of this oral 
amendment, all allocations of partnership net taxable income and net 
taxable loss made pursuant to the amendment executed at the beginning of 
the partnership's second taxable year lack economic effect and will be 
disregarded. Under the partnership agreement other allocations are made 
equally to O and P, and O and P will share equally in liquidation 
proceeds, indicating that the partners' interests in the partnership are 
equal. Thus, the disregarded allocations will be reallocated equally 
between the partners under paragraph (b)(3) of this section.
    (ii) Assume the same facts as in (i) except that there is no 
agreement that O's and P's capital accounts will be adjusted downward 
and upward, respectively, to the extent of one-half of the partnership 
net taxable income allocated to O in the partnership's second taxable 
year that is not offset subsequently by other allocations. The income of 
the partnership is generated primarily by fixed interest payments 
received with respect to highly rated corporate bonds, which are 
expected to produce sufficient net taxable income prior to the end of 
the partnership's seventh taxable year to offset in large part the net 
taxable income to be allocated to O in the partnership's second taxable 
year. Thus, at the time the allocations are made part of the partnership 
agreement, there is a strong likelihood that the allocation of net 
taxable income to be made to O in the second taxable year will be offset 
in large part within 5 taxable years thereafter. These allocations have 
economic effect. However, the economic effect of the allocation of 
partnership net taxable income to O in the partnership's second taxable 
year, as well as the offsetting allocations to P, is not substantial 
under the test contained in paragraph (b)(2)(iii)(c) of this section 
because there is a strong likelihood that the net increases or decreases 
in O's and P's capital accounts will be the same at the end of the 
partnership's seventh taxable year with such allocations as they would 
have been in the absence of such allocations, and the total

[[Page 471]]

taxes of O and P for the taxable years to which such allocations relate 
will be reduced as a result of such allocations. If in fact the 
partnership, in its taxable years 3 through 7, realizes sufficient net 
taxable income to offset the amount allocated to O in the second taxable 
year, the allocations provided in the partnership agreement will be 
reallocated equally between the partners under paragraph (b)(3) of this 
section.
    Example 9. Q and R form a limited partnership with contributions of 
$20,000 and $180,000, respectively. Q, the limited partner, is a 
corporation that has $2,000,000 of net operating loss carryforwards that 
will not expire for 8 years. Q does not expect to have sufficient income 
(apart from the income of the partnership) to absorb any of such net 
operating loss carryforwards. R, the general partner, is a corporation 
that expects to be in the 46 percent marginal tax bracket for several 
years. The partnership agreement provides that the partners' capital 
accounts will be determined and maintained in accordance with paragraph 
(b)(2)(iv) of this section, distributions in liquidation of the 
partnership (or any partner's interest) will be made in accordance with 
the partners' positive capital account balances, and any partner with a 
deficit balance in his capital account following the liquidation of his 
interest must restore that deficit to the partnership (as set forth in 
paragraphs (b)(2)(ii)(b) (2) and (3) of this section). The partnership's 
cash, together with the proceeds of an $800,000 loan, are invested in 
assets that are expected to produce taxable income and cash flow (before 
debt service) of approximately $150,000 a year for the first 8 years of 
the partnership's operations. In addition, it is expected that the 
partnership's total taxable income in its first 8 taxable years will not 
exceed $2,000,000. The partnership's $150,000 of cash flow in each of 
its first 8 years will be used to retire the $800,000 loan. The 
partnership agreement provides that partnership net taxable income will 
be allocated 90 percent to Q and 10 percent to R in the first through 
eighth partnership taxable years, and 90 percent to R and 10 percent to 
Q in all subsequent partnership taxable years. Net taxable loss will be 
allocated 90 percent to R and 10 percent to Q in all partnership taxable 
years. All distributions of cash from the partnership to partners (other 
than the priority distributions to Q described below) will be made 90 
percent to R and 10 percent to Q. At the end of the partnership's eighth 
taxable year, the amount of Q's capital account in excess of one-ninth 
of R's capital account on such date will be designated as Q's ``excess 
capital account.'' Beginning in the ninth taxable year of the 
partnership, the undistributed portion of Q's excess capital account 
will begin to bear interest (which will be paid and deducted under 
section 707(c) at a rate of interest below the rate that the partnership 
can borrow from commercial lenders, and over the next several years 
(following the eight year) the partnership will make priority cash 
distributions to Q in prearranged percentages of Q's excess capital 
account designed to amortize Q's excess capital account and the interest 
thereon over a prearranged period. In addition, the partnership's 
agreement prevents Q from causing his interest in the partnership from 
being liquidated (and thereby receiving the balance in his capital 
account) without R's consent until Q's excess capital account has been 
eliminated. The below market rate of interest and the period over which 
the amortization will take place are prescribed such that, as of the end 
of the partnership's eighth taxable year, the present value of Q's right 
to receive such priority distributions is approximately 46 percent of 
the amount of Q's excess capital account as of such date. However, 
because the partnership's income for its first 8 taxable years will be 
realized approximately ratably over that period, the present value of 
Q's right to receive the priority distributions with respect to its 
excess capital account is, as of the date the partnership agreement is 
entered into, less than the present value of the additional Federal 
income taxes for which R would be liable if, during the partnership's 
first 8 taxable years, all partnership income were to be allocated 90 
percent to R and 10 to Q. The allocations of partnership taxable income 
to Q and R in the first through eighth partnership taxable years have 
economic effect. However, such economic effect is not substantial under 
the general rules set forth in paragraph (b)(2)(iii) of this section. 
This is true because R may enhance his after-tax economic consequences, 
on a present value basis, as a result of the allocations to Q of 90 
percent of partnership's income during taxable years 1 through 8, and 
there is a strong likelihood that neither R nor Q will substantially 
diminish its after-tax economic consequences, on a present value basis, 
as a result of such allocation. Accordingly, partnership taxable income 
for partnership taxable years 1 through 8 will be reallocated in 
accordance with the partners' interests in the partnership under 
paragraph (b)(3) of this section.
    Example 10. (i) S and T form a general partnership to operate a 
travel agency. The partnership agreement provides that the partners' 
capital accounts will be determined and maintained in accordance with 
paragraph (b)(2)(iv) of this section, distributions in liquidation of 
the partnership (or any partner's interest) will be made in accordance 
with the partners' positive capital account balances, and any partner 
with a deficit balance in his capital account following the liquidation 
of his interest must restore that deficit to the partnership (as set 
forth in paragraphs (b)(2)(ii)(b) (2) and (3) of this

[[Page 472]]

section). The partnership agreement provides that T, a resident of a 
foreign country, will be allocated 90 percent, and S 10 percent, of the 
income, gain, loss, and deduction derived from operations conducted by T 
within his country, and all remaining income, gain, loss, and deduction 
will be allocated equally. The amount of such income, gain, loss, or 
deduction cannot be predicted with any reasonable certainty. The 
allocations provided by the partnership agreement have substantial 
economic effect.
    (ii) Assume the same facts as in (i) except that the partnership 
agreement provides that all income, gain, loss, and deduction of the 
partnership will be shared equally, but that T will be allocated all 
income, gain, loss, and deduction derived from operations conducted by 
him within his country as a part of his equal share of partnership 
income, gain, loss, and deduction, upon to the amount of such share. 
Assume the total tax liability of S and T for each year to which these 
allocations relate will be reduced as a result of such allocation. These 
allocations have economic effect. However, such economic effect is not 
substantial under the test stated in paragraph (b)(2)(iii)(b) of this 
section because, at the time the allocations became part of the 
partnership agreement, there is a strong likelihood that the net 
increases and decreases to S's and T's capital accounts will be the same 
at the end of each partnership taxable year with such allocations as 
they would have been in the absence of such allocations, and that the 
total tax liability of S and T for each year to which such allocations 
relate will be reduced as a result of such allocations. Thus, all items 
of partnership income, gain, loss, and income, gain, loss, and deduction 
will be reallocated equally between S and T under paragraph (b)(3) of 
this section.
    Example 11. (i) U and V share equally all income, gain, loss, and 
deduction of the UV general partnership, as well as all non-liquidating 
distributions made by the partnership. The partnership agreement 
provides that the partners' capital accounts will be determined and 
maintained in accordance with paragraph (b)(2)(iv) of this section, 
distributions in liquidation of the partnership (or any partner's 
interest) will be made in accordance with the partners' positive capital 
account balances, and any partner with a deficit balance in his capital 
account following the liquidation of his interest must restore such 
deficit to the partnership (as set forth in paragraphs (b)(2)(ii)(b) (2) 
and (3) of this section). The agreement further provides that the 
partners will be allocated equal shares of any section 705(a)(2)(B) 
expenditures of the partnership. In the partnership's first taxable 
year, it pays qualified first-year wages of $6,000 and is entitled to a 
$3,000 targeted jobs tax credit under sections 44B and 51 of the Code. 
Under section 280C the partnership must reduce its deduction for wages 
paid by the $3,000 credit claimed (which amount constitutes a section 
705(a)(2)(B) expenditure). The partnership agreement allocates the 
credit to U. Although the allocations of wage deductions and section 
705(a)(2)(B) expenditures have substantial economic effect, the 
allocation of tax credit cannot have economic effect since it cannot 
properly be reflected in the partners' capital accounts. Furthermore, 
the allocation is not in accordance with the special partners' interests 
in the partnership rule contained in paragraph (b)(4)(ii) of this 
section. Under that rule, since the expenses that gave rise to the 
credit are shared equally by the partners, the credit will be shared 
equally between U and V.
    (ii) Assume the same facts as in (i) and that at the beginning of 
the partnership's second taxable year, the partnership agreement is 
amended to allocate to U all wage expenses incurred in that year 
(including wage expenses that constitute section 705(a)(2)(B) 
expenditures) whether or not such wages qualify for the credit. The 
partnership agreement contains no offsetting allocations. That taxable 
year the partnership pays $8,000 in total wages to its employees. Assume 
that the partnership has operating income equal to its operating 
expenses (exclusive of expenses for wages). Assume further that $6,000 
of the $8,000 wage expense constitutes qualified first-year wages. U is 
allocated the $3,000 deduction and the $3,000 section 705(a)(2)(B) 
expenditure attributable to the $6,000 of qualified first-year wages, as 
well as the deduction for the other $2,000 in wage expenses. The 
allocations of wage deductions and section 705(a)(2)(B) expenditures 
have substantial economic effect. Furthermore, since the wage credit is 
allocated in the same proportion as the expenses that gave rise to the 
credit, and the allocation of those expenses has substantial economic 
effect, the allocation of such credit to U is in accordance with the 
special partners' interests in the partnership rule contained in 
paragraph (b)(4)(ii) of this section and is recognized thereunder.
    Example 12. (i) W and X form a general partnership for the purpose 
of mining iron ore. W makes an initial contribution of $75,000, and X 
makes an initial contribution of $25,000. The partnership agreement 
provides that non-liquidating distributions will be made 75 percent to W 
and 25 percent to X, and that all items of income, gain, loss, and 
deduction will be allocated 75 percent to W and 25 percent to X, except 
that all percentage depletion deductions will be allocated to W. The 
agreement further provides that the partners' capital accounts will be 
determined and maintained in accordance with paragraphs (b)(2)(iv) of 
this section, distributions in liquidation of the partnership (or

[[Page 473]]

any partner's interest) will be made in accordance with the partners' 
positive capital account balances, and any partner with a deficit 
balance in his capital account following the liquidation of his interest 
must restore such deficit to the partnership (as set forth in paragraphs 
(b)(2)(ii)(b) (2) and (3) of this section). Assume that the adjusted tax 
basis of the partnership's only depletable iron ore property is $1,000 
and that the percentage depletion deduction for the taxable year with 
respect to such property is $1,500. The allocation of partnership 
income, gain, loss, and deduction (excluding the percentage depletion 
deduction) as well as the allocation of $1,000 of the percentage 
depletion deduction have substantial economic effect. The allocation to 
W of the remaining $500 of the percentage depletion deduction, 
representing the excess of percentage depletion over adjusted tax basis 
of the iron ore property, cannot have economic effect since such amount 
cannot properly be reflected in the partners' capital accounts. 
Furthermore, the allocation to W of that $500 excess percentage 
depletion deduction is not in accordance with the special partners' 
interests in the partnership rule contained in paragraph (b)(4)(iii) of 
this section, under which such $500 excess depletion deduction (and all 
further percentage depletion deductions from the mine) will be 
reallocated 75 percent to W and 25 percent to X.
    (ii) Assume the same facts as in (i) except that the partnership 
agreement provides that all percentage depletion deductions of the 
partnership will be allocated 75 percent to W and 25 percent to X. Once 
again, the allocation of partnership income, gain, loss, and deduction 
(excluding the percentage depletion deduction) as well as the allocation 
of $1,000 of the percentage depletion deduction have substantial 
economic effect. Furthermore, since the $500 portion of the percentage 
depletion deduction that exceeds the adjusted basis of such iron ore 
property is allocated in the same manner as valid allocations of the 
gross income from such property during the taxable year (i.e., 75 
percent to W and 25 percent to X), the allocation of the $500 excess 
percentage depletion contained in the partnership agreement is in 
accordance with the special partners' interests in the partnership rule 
contained in paragraph (b)(4)(iii) of this section.
    Example 13. (i) Y and Z form a brokerage general partnership for the 
purpose of investing and trading in marketable securities. Y contributes 
cash of $10,000, and Z contributes securities of P corporation, which 
have an adjusted basis of $3,000 and a fair market value of $10,000. The 
partnership would not be an investment company under section 351(e) if 
it were incorporated. The partnership agreement provides that the 
partners' capital accounts will be determined and maintained in 
accordance with paragraph (b)(2)(iv) of this section, distributions in 
liquidation of the partnership (or any partner's interest) will be made 
in accordance with the partners' positive capital account balances, and 
any partner with a deficit balance in his capital account following the 
liquidation of his interest must restore that deficit to the partnership 
(as set forth in paragraphs (b)(2)(ii)(b) (2) and (3) of this section). 
The partnership uses the interim closing of the books method for 
purposes of section 706. The initial capital accounts of Y and Z are 
fixed at $10,000 each. The agreement further provides that all 
partnership distributions, income, gain, loss, deduction, and credit 
will be shared equally between Y and Z, except that the taxable gain 
attributable to the precontribution appreciation in the value of the 
securities of P corporation will be allocated to Z in accordance with 
section 704(c). During the partnership's first taxable year, it sells 
the securities of P corporation for $12,000, resulting in a $2,000 book 
gain ($12,000 less $10,000 book value) and a $9,000 taxable gain 
($12,000 less $3,000 adjusted tax basis). The partnership has no other 
income, gain, loss, or deductions for the taxable year. The gain from 
the sale of the securities is allocated as follows:

------------------------------------------------------------------------
                                           Y                   Z
                                 ---------------------------------------
                                     Tax      Book       Tax      Book
------------------------------------------------------------------------
Capital account upon formation..   $10,000   $10,000    $3,000   $10,000
Plus: gain......................     1,000     1,000     8,000     1,000
                                 ---------------------------------------
      Capital account at end of    $11,000   $11,000   $11,000   $11,000
       year 1...................
------------------------------------------------------------------------


The allocation of the $2,000 book gain, $1,000 each to Y and Z, has 
substantial economic effect. Furthermore, under section 704(c) the 
partners' distributive shares of the $9,000 taxable gain are $1,000 to Y 
and $8,000 to Z.
    (ii) Assume the same facts as in (i) and that at the beginning of 
the partnership's second taxable year, it invests its $22,000 of cash in 
securities of G Corp. The G Corp. securities increase in value to 
$40,000, at which time Y sells 50 percent of his partnership interest 
(i.e., a 25 percent interest in the partnership) to LK for $10,000. The 
partnership does not have a section 754 election in effect for the 
partnership taxable year during which such sale occurs. In accordance 
with paragraph (b)(2)(iv)(l) of this section, the partnership agreement 
provides that LK inherits 50 percent of Y's $11,000 capital account 
balance. Thus, following the sale, LK and Y each have a capital account 
of $5,500, and Z's capital account remains at $11,000. Prior to the end 
of the partnership's second taxable year, the securities are sold for 
their $40,000 fair market value, resulting in an

[[Page 474]]

$18,000 taxable gain ($40,000 less $22,000 adjusted tax basis). The 
partnership has no other income, gain, loss, or deduction in such 
taxable year. Under the partnership agreement the $18,000 taxable gain 
is allocated as follows:

------------------------------------------------------------------------
                                                Y         Z        LK
------------------------------------------------------------------------
Capital account before sale of securities.    $5,500   $11,000    $5,500
Plus: gain................................     4,500     9,000     4,500
                                           -----------------------------
      Capital account at end of year 2....   $10,000   $20,000   $10,000
------------------------------------------------------------------------

The allocation of the $18,000 taxable gain has substantial economic 
effect.
    (iii) Assume the same facts as in (ii) except that the partnership 
has a section 754 election in effect for the partnership taxable year 
during which Y sells 50 percent of his interest to LK. Accordingly, 
under Sec. 1.743-1 there is a $4,500 basis increase to the G Corp. 
securities with respect to LK. Notwithstanding this basis adjustment, as 
a result of the sale of the G Corp. securities, LK's capital account is, 
as in (ii), increased by $4,500. The fact that LK recognizes no taxable 
gain from such sale (due to his $4,500 section 743 basis adjustment) is 
irrelevant for capital accounting purposes since, in accordance with 
paragraph (b)(2)(iv)(m)(2) of this section, that basis adjustment is 
disregarded in the maintenance and computation of the partners' capital 
accounts.
    (iv) Assume the same facts as in (iii) except that immediately 
following Y's sale of 50 percent of this interest to LK, the G Corp. 
securities decrease in value to $32,000 and are sold. The $10,000 
taxable gain ($32,000 less $22,000 adjusted tax basis) is allocated as 
follows:

------------------------------------------------------------------------
                                                Y         Z        LK
------------------------------------------------------------------------
Capital account before sale of securities.    $5,500   $11,000    $5,500
Plus: gain................................     2,500     5,000     2,500
                                           -----------------------------
      Capital account at end of the year 2    $8,000   $16,000    $8,000
------------------------------------------------------------------------

The fact that LK recognizes a $2,000 taxable loss from the sale of the G 
Corp. securities (due to his $4,500 section 743 basis adjustment) is 
irrelevant for capital accounting purposes since, in accordance with 
paragraph (b)(2)(iv)(m)(2) of this section, that basis adjustment is 
disregarded in the maintenance and computation of the partners' capital 
accounts.
    (v) Assume the same facts as in (ii) except that Y sells 100 percent 
of his partnership interest (i.e., a 50 percent interest in the 
partnership) to LK for $20,000. Under section 708(b)(1)(B) the 
partnership terminates. Under paragraph (b)(1)(iv) of Sec. 1.708-1, 
there is a constructive liquidation of the partnership. Immediately 
preceding the constructive liquidation, the capital accounts of Z and LK 
equal $11,000 each (LK having inherited Y's $11,000 capital account) and 
the book value of the G Corp. securities is $22,000 (original purchase 
price of securities). Under paragraph (b)(2)(iv)(l) of this section, the 
deemed contribution of assets and liabilities by the terminated 
partnership to the new partnership and the deemed liquidation of the 
terminated partnership that occur under Sec. 1.708-1(b)(1)(iv) in 
connection with the constructive liquidation of the terminated 
partnership are disregarded in the maintenance and computation of the 
partners' capital accounts. As a result, the capital accounts of Z and 
LK in the new partnership equal $11,000 each (their capital accounts in 
the terminated partnership immediately prior to the termination), and 
the book value of the G Corp. securities remains $22,000 (its book value 
immediately prior to the termination). This Example 13(v) applies to 
terminations of partnerships under section 708(b)(1)(B) occurring on or 
after May 9, 1997; however, this Example 13(v) may be applied to 
terminations occurring on or after May 9, 1996, provided that the 
partnership and its partners apply this Example 13(v) to the termination 
in a consistent manner.
    Example 14. (i) MC and RW form a general partnership to which each 
contributes $10,000. The $20,000 is invested in securities of Ventureco 
(which are not readily tradable on an established securities market). In 
each of the partnership's taxable years, it recognizes operating income 
equal to its operating deductions (excluding gain or loss from the sale 
of securities). The partnership agreement provides that the partners' 
capital accounts will be determined and maintained in accordance with 
paragraph (b)(2)(iv) of this section, distributions in liquidation of 
the partnership (or any partner's interest) will be made in accordance 
with the partners' positive capital account balances, and any partner 
with a deficit balance in his capital account following the liquidation 
of his interest must restore that deficit to the partnership (as set 
forth in paragraphs (b)(2)(ii)(b)(2) and (3) of this section). The 
partnership uses the interim closing of the books method for purposes of 
section 706. Assume that the Ventureco securities subsequently 
appreciate in value to $50,000. At that time SK makes a $25,000 cash 
contribution to the partnership (thereby acquiring a one-third interest 
in the partnership), and the $25,000 is placed in a bank account. Upon 
SK's admission to the partnership, the capital accounts of MC and RW 
(which were $10,000 each prior to SK's admission) are, in accordance 
with paragraph (b)(2)(iv)(f) of this section, adjusted upward (to 
$25,000 each) to reflect their shares of the unrealized appreciation in 
the Ventureco securities that

[[Page 475]]

occurred before SK was admitted to the partnership. Immediately after 
SK's admission to the partnership, the securities are sold for their 
$50,000 fair market value, resulting in taxable gain of $30,000 ($50,000 
less $20,000 adjusted tax basis) and no book gain or loss. An allocation 
of the $30,000 taxable gain cannot have economic effect since it cannot 
properly be reflected in the partners' book capital accounts. Under 
paragraph (b)(2)(iv)(f) of this section and the special partners' 
interests in the partnership rule contained in paragraph (b)(4)(i) of 
this section, unless the partnership agreement provides that the $30,000 
taxable gain will, in accordance with section 704(c) principles, be 
shared $15,000 to MC and $15,000 to RW, the partners' capital accounts 
will not be considered maintained in accordance with paragraph 
(b)(2)(iv) of this section.

----------------------------------------------------------------------------------------------------------------
                                                         MC                    RW                    SK
                                               -----------------------------------------------------------------
                                                   Tax        Book       Tax        Book       Tax        Book
----------------------------------------------------------------------------------------------------------------
Capital account following SK's admission......    $10,000    $25,000    $10,000    $25,000    $25,000    $25,000
Plus: gain....................................     15,000          0     15,000          0          0          0
                                               -----------------------------------------------------------------
Capital account following sale................    $25,000    $25,000    $25,000    $25,000    $25,000    $25,000
----------------------------------------------------------------------------------------------------------------

    (ii) Assume the same facts as (i), except that after SK's admission 
to the partnership, the Ventureco securities appreciate in value to 
$74,000 and are sold, resulting in taxable gain of $54,000 ($74,000 less 
$20,000 adjusted tax basis) and book gain of $24,000 ($74,000 less 
$50,000 book value). Under the partnership agreement the $24,000 book 
gain (the appreciation in value occurring after SK became a partner) is 
allocated equally among MC, RW, and SK, and such allocations have 
substantial economic effect. An allocation of the $54,000 taxable gain 
cannot have economic effect since it cannot properly be reflected in the 
partners' book capital accounts. Under paragraph (b)(2)(iv)(f) of this 
section and the special partners' interests in the partnership rule 
contained in paragraph (b)(4)(i) of this section, unless the partnership 
agreement provides that the taxable gain will, in accordance with 
section 704(c) principles, be shared $23,000 to MC $23,000 to RW, and 
$8,000 to SK, the partners' capital accounts will not be considered 
maintained in accordance with paragraph (b)(2)(iv) of this section.

----------------------------------------------------------------------------------------------------------------
                                                         MC                    RW                    SK
                                               -----------------------------------------------------------------
                                                   Tax        Book       Tax        Book       Tax        Book
----------------------------------------------------------------------------------------------------------------
Capital account following SK's admission......    $10,000    $25,000    $10,000    $25,000    $25,000    $25,000
Plus: gain....................................     23,000      8,000     23,000      8,000      8,000      8,000
                                               -----------------------------------------------------------------
      Capital account following sale..........    $33,000    $33,000    $33,000    $33,000    $33,000    $33,000
----------------------------------------------------------------------------------------------------------------

    (iii) Assume the same facts as (i) except that after SK's admission 
to the partnership, the Ventureco securities depreciate in value to 
$44,000 and are sold, resulting in taxable gain of $24,000 ($44,000 less 
$20,000 adjusted tax basis) and a book loss of $6,000 ($50,000 book 
value less $44,000). Under the partnership agreement the $6,000 book 
loss is allocated equally among MC, RW, and SK, and such allocations 
have substantial economic effect. An allocation of the $24,000 taxable 
gain cannot have economic effect since it cannot properly be reflected 
in the partners' book capital accounts. Under paragraph (b)(2)(iv)(f) of 
this section and the special partners' interests in the partnership rule 
contained in paragraph (b)(4)(i) of this section, unless the partnership 
agreement provides that the $24,000 taxable gain will, in accordance 
with section 704(c) principles, be shared equally between MC and RW, the 
partners' capital accounts will not be considered maintained in 
accordance with paragraph (b)(2)(iv) of this section.

----------------------------------------------------------------------------------------------------------------
                                                       MC                     RW                     SK
                                            --------------------------------------------------------------------
                                                Tax        Book        Tax        Book        Tax        Book
----------------------------------------------------------------------------------------------------------------
Capital account following SK's admission...    $10,000    $25,000     $10,000    $25,000     $25,000    $25,000
Plus: gain.................................     12,000          0      12,000          0           0          0
Less: loss.................................          0     (2,000)          0     (2,000)          0     (2,000)
                                            --------------------------------------------------------------------
      Capital account following sale.......    $22,000    $23,000     $22,000    $23,000     $25,000    $25,000
----------------------------------------------------------------------------------------------------------------


[[Page 476]]


That SK bears an economic loss of $2,000 without a corresponding taxable 
loss is attributable entirely to the ``ceiling rule.'' See paragraph 
(c)(2) of Sec. 1.704-1.
    (iv) Assume the same facts as in (ii) except that upon the admission 
of SK the capital accounts of MC and RW are not each adjusted upward 
from $10,000 to $25,000 to reflect the appreciation in the partnership's 
securities that occurred before SK was admitted to the partnership. 
Rather, upon SK's admission to the partnership, the partnership 
agreement is amended to provide that the first $30,000 of taxable gain 
upon the sale of such securities will be allocated equally between MC 
and RW, and that all other income, gain, loss, and deduction will be 
allocated equally between MC, RW, and SK. When the securities are sold 
for $74,000, the $54,000 of taxable gain is so allocated. These 
allocations of taxable gain have substantial economic effect. (If the 
agreement instead provides for all taxable gain (including the $30,000 
taxable gain attributable to the appreciation in the securities prior to 
SK's admission to the partnership) to be allocated equally between MC, 
RW, and SK, the partners should consider whether, and to what extent, 
the provisions of paragraphs (b)(1) (iii) and (iv) of this section are 
applicable.)
    (v) Assume the same facts as in (iv) except that instead of selling 
the securities, the partnership makes a distribution of the securities 
(which have a fair market value of $74,000). Assume the distribution 
does not give rise to a transaction described in section 707(a)(2)(B). 
In accordance with paragraph (b)(2)(iv)(e) of this section, the 
partners' capital accounts are adjusted immediately prior to the 
distribution to reflect how taxable gain ($54,000) would have been 
allocated had the securities been sold for their $74,000 fair market 
value, and capital account adjustments in respect of the distribution of 
the securities are made with reference to the $74,000 ``booked-up'' fair 
market value.

------------------------------------------------------------------------
                                             MC         RW         SK
------------------------------------------------------------------------
Capital account before adjustment......   $10,000    $10,000    $25,000
Deemed sale adjustment.................    23,000     23,000      8,000
Less: distribution.....................   (24,667)   (24,667)   (24,667)
                                        --------------------------------
      Capital account after                $8,333     $8,333     $8,333
       distribution....................
------------------------------------------------------------------------

    (vi) Assume the same facts as in (i) except that the partnership 
does not sell the Ventureco securities. During the next 3 years the fair 
market value of the Ventureco securities remains at $50,000, and the 
partnership engages in no other investment activities. Thus, at the end 
of that period the balance sheet of the partnership and the partners' 
capital accounts are the same as they were at the beginning of such 
period. At the end of the 3 years, MC's interest in the partnership is 
liquidated for the $25,000 cash held by the partnership. Assume the 
distribution does not give rise to a transaction described in section 
707(a)(2)(B). Assume further that the partnership has a section 754 
election in effect for the taxable year during which such liquidation 
occurs. Under sections 734(b) and 755 the partnership increases the 
basis of the Ventureco securities by the $15,000 basis adjustment (the 
excess of $25,000 over the $10,000 adjusted tax basis of MC's 
partnership interest).

----------------------------------------------------------------------------------------------------------------
                                                        MC                     RW                    SK
                                             -------------------------------------------------------------------
                                                  Tax        Book        Tax        Book       Tax        Book
----------------------------------------------------------------------------------------------------------------
Capital account before distribution.........    $10,000     $25,000     $10,000    $25,000    $25,000    $25,000
Plus: basis adjustment......................     15,000           0           0          0          0          0
Less: distribution..........................    (25,000)    (25,000)          0          0          0          0
                                             -------------------------------------------------------------------
Capital account account after liquidation...          0           0     $10,000    $25,000    $25,000    $25,000
----------------------------------------------------------------------------------------------------------------

    (vii) Assume the same facts as in (vi) except that the partnership 
has no section 754 election in effect for the taxable year during which 
such liquidation occurs.

----------------------------------------------------------------------------------------------------------------
                                                        MC                     RW                    SK
                                             -------------------------------------------------------------------
                                                  Tax        Book        Tax        Book       Tax        Book
----------------------------------------------------------------------------------------------------------------
Capital account before distribution.........    $10,000     $25,000     $10,000    $25,000    $25,000    $25,000
Less: distribution..........................    (25,000)    (25,000)          0          0          0          0
                                             -------------------------------------------------------------------
Capital account after liquidation...........   ($15,000)          0     $10,000    $25,000    $25,000    $25,000
----------------------------------------------------------------------------------------------------------------

Following the liquidation of MC's interest in the partnership, the 
Ventureco securities are sold for their $50,000 fair market value, 
resulting in no book gain or loss but a $30,000 taxable gain. An 
allocation of this $30,000 taxable gain cannot have economic effect

[[Page 477]]

since it cannot properly be reflected in the partners' book capital 
accounts. Under paragraph (b)(2)(iv)(f) of this section and the special 
partners' interests in the partnership rule contained in paragraph 
(b)(4)(i) of this section, unless the partnership agreement provides 
that $15,000 of such taxable gain will, in accordance with section 
704(c) principles, be included in RW's distributive share, the partners' 
capital accounts will not be considered maintained in accordance with 
paragraph (b)(2)(iv) of this section. The remaining $15,000 of such gain 
will, under paragraph (b)(3) of this section, be shared equally between 
RW and SK.
    Example 15. (i) JB and DK form a limited partnership for the purpose 
of purchasing residential real estate to lease. JB, the limited partner, 
contributes $13,500, and DK, the general partner, contributes $1,500. 
The partnership, which uses the cash receipts and disbursements method 
of accounting, purchases a building for $100,000 (on leased land), 
incurring a recourse mortgage of $85,000 that requires the payment of 
interest only for a period of 3 years. The partnership agreement 
provides that partnership net taxable income and loss will be allocated 
90 percent to JB and 10 percent to DK, the partners' capital accounts 
will be determined and maintained in accordance with paragraph 
(b)(2)(iv) of this section, distributions in liquidation of the 
partnership (or any partner's interest) will be made in accordance with 
the partners' positive capital account balances (as set forth in 
paragraph (b)(2)(ii)(b)(2) of this section), and JB is not required to 
restore any deficit balance in his capital account, but DK is so 
required. The partnership agreement contains a qualified income offset 
(as defined in paragraph (b)(2)(ii)(d) of this section). As of the end 
of each of the partnership's first 3 taxable years, the items described 
in paragraphs (b)(2)(ii)(d)(4), (5), and (6) of this section are not 
reasonably expected to cause or increase a deficit balance in JB's 
capital account. In the partnership's first taxable year, it has rental 
income of $10,000, operating expenses of $2,000, interest expense of 
$8,000, and cost recovery deductions of $12,000. Under the partnership 
agreement JB and DK are allocated $10,800 and $1,200, respectively, of 
the $12,000 net taxable loss incurred in the partnership's first taxable 
year.

------------------------------------------------------------------------
                                                        JB         DK
------------------------------------------------------------------------
Capital account upon formation....................   $13,500     $1,500
Less: year 1 net loss.............................   (10,800)    (1,200)
                                                   ---------------------
Capital account at end of year 1..................    $2,700       $300
------------------------------------------------------------------------


The alternate economic effect test contained in paragraph (b)(2)(ii)(d) 
of this section is satisfied as of the end of the partnership's first 
taxable year. Thus, the allocation made in the partnership's first 
taxable year has economic effect.
    (ii) Assume the same facts as in (i) and that in the partnership's 
second taxable year it again has rental income of $10,000, operating 
expenses of $2,000, interest expense of $8,000, and cost recovery 
deductions of $12,000. Under the partnership agreement JB and DK are 
allocated $10,800 and $1,200, respectively, of the $12,000 net taxable 
loss incurred in the partnership's second taxable year.

------------------------------------------------------------------------
                                                        JB         DK
------------------------------------------------------------------------
Capital account at beginning of year 1............    $2,700       $300
Less: year 2 net loss.............................   (10,800)    (1,200)
                                                   ---------------------
      Capital account at end of year 2............   ($8,100)     ($900)
------------------------------------------------------------------------

Only $2,700 of the $10,800 net taxable loss allocated to JB satisfies 
the alternate economic effect test contained in paragraph (b)(2)(ii)(d) 
of this section as of the end of the partnership's second taxable year. 
The allocation of such $2,700 net taxable loss to JB (consisting of 
$2,250 of rental income, $450 of operating expenses, $1,800 of interest 
expense, and $2,700 of cost recovery deductions) has economic effect. 
The remaining $8,100 of net taxable loss allocated by the partnership 
agreement to JB must be reallocated in accordance with the partners' 
interests in the partnership. Under paragraph (b)(3)(iii) of this 
section, the determination of the partners' interests in the remaining 
$8,100 net taxable loss is made by comparing how distributions (and 
contributions) would be made if the partnership sold its property at its 
adjusted tax basis and liquidated immediately following the end of the 
partnership's first taxable year with the results of such a sale and 
liquidation immediately following the end of the partnership's second 
taxable year. If the partnership's real property were sold for its 
$88,000 adjusted tax basis and the partnership were liquidated 
immediately following the end of the partnership's first taxable year, 
the $88,000 sales proceeds would be used to repay the $85,000 note, and 
there would be $3,000 remaining in the partnership, which would be used 
to make liquidating distributions to DK and JB of $300 and $2,700, 
respectively. If such property were sold for its $76,000 adjusted tax 
basis and the partnership were liquidated immediately following the end 
of the partnership's second taxable year, DK would be required to 
contribute $9,000 to the partnership in order for the partnership to 
repay the $85,000 note, and there would be no assets remaining in the 
partnership to distribute. A comparison of these outcomes indicates that 
JB bore $2,700 and DK $9,300 of the economic burden that corresponds to 
the $12,000 net taxable loss. Thus, in addition to the $1,200 net 
taxable loss allocated to DK

[[Page 478]]

under the partnership agreement, $8,100 of net taxable loss will be 
reallocated to DK under paragraph (b)(3)(iii) of this section. 
Similarly, for subsequent taxable years, absent an increase in JB's 
capital account, all net taxable loss allocated to JB under the 
partnership agreement will be reallocated to DK.
    (iii) Assume the same facts as in (ii) and that in the partnership's 
third taxable year there is rental income of $35,000, operating expenses 
of $2,000, interest expense of $8,000, and cost recovery deductions of 
$10,000. The capital accounts of the partners maintained on the books of 
the partnership do not take into account the reallocation to DK of the 
$8,100 net taxable loss in the partnership's second taxable year. Thus, 
an allocation of the $15,000 net taxable income $13,500 to JB and $1,500 
to DK (as dictated by the partnership agreement and as reflected in the 
capital accounts of the partners) does not have economic effect. The 
partners' interests in the partnership with respect to such $15,000 
taxable gain again is made in the manner described in paragraph (b) (3) 
(iii) of this section. If the partnership's real property were sold for 
its $76,000 adjusted tax basis and the partnership were liquidated 
immediately following the end of the partnership's second taxable year, 
DK would be required to contribute $9,000 to the partnership in order 
for the partnership to repay the $85,000 note, and there would be no 
assets remaining to distribute. If such property were sold for its 
$66,000 adjusted tax basis and the partnership were liquidated 
immediately following the end of the partnership's third taxable year, 
the $91,000 ($66,000 sales proceeds plus $25,000 cash on hand) would be 
used to repay the $85,000 note and there would be $6,000 remaining in 
the partnership, which would be used to make liquidating distributions 
to DK and JB of $600 and $5,400, respectively. Accordingly, under 
paragraph (b) (3) (iii) of this section the $15,000 net taxable income 
in the partnership's third taxable year will be reallocated $9,600 to DK 
(minus $9,000 at end of the second taxable year to positive $600 at end 
of the third taxable year) and $5,400 to JB (zero at end of the second 
taxable year to positive $5,400 at end of the third taxable year).
    Example 16. (i) KG and WN form a limited partnership for the purpose 
of investing in improved real estate. KG, the general partner, 
contributes $10,000 to the partnership, and WN, the limited partner, 
contributes $990,000 to the partnership. The $1,000,000 is used to 
purchase an apartment building on leased land. The partnership agreement 
provides that (1) the partners' capital accounts will be determined and 
maintained in accordance with paragraph (b)(2)(iv) of this section; (2) 
cash will be distributed first to WN until such time as he has received 
the amount of his original capital contribution ($990,000), next to KG 
until such time as he has received the amount of his original capital 
contribution ($10,000), and thereafter equally between WN and KG; (3) 
partnership net taxable income will be allocated 99 percent to WN and 1 
percent to KG until the cumulative net taxable income allocated for all 
taxable years is equal to the cumulative net taxable loss previously 
allocated to the partners, and thereafter equally between WN and KG; (4) 
partnership net taxable loss will be allocated 99 percent to WN and 1 
percent to KG, unless net taxable income has previously been allocated 
equally between WN and KG, in which case such net taxable loss first 
will be allocated equally until the cumulative net taxable loss 
allocated for all taxable years is equal to the cumulative net taxable 
income previously allocated to the partners; and (5) upon liquidation, 
WN is not required to restore any deficit balance in his capital 
account, but KG is so required. Since distributions in liquidation are 
not required to be made in accordance with the partners' positive 
capital account balances, and since WN is not required, upon the 
liquidation of his interest, to restore the deficit balance in his 
capital account to the partnership, the allocations provided by the 
partnership agreement do not have economic effect and will be 
reallocated in accordance with the partners' interests in the 
partnership under paragraph (b) (3) of this section.
    (ii) Assume the same facts as in (i) except that the partnership 
agreement further provides that distributions in liquidation of the 
partnership (or any partner's interest) are to be made in accordance 
with the partners' positive capital account balances (as set forth in 
paragraph (b)(2)(ii)(b)(2) of this section). Assume further that the 
partnership agreement contains a qualified income offset (as defined in 
paragraph (b)(2)(ii)(d) of this section) and that, as of the end of each 
partnership taxable year, the items described in paragraphs 
(b)(2)(iii)(d) (4), (5), and (6) of this section are not reasonably 
expected to cause or increase a deficit balance in WN's capital account. 
The allocations provided by the partnership agreement have economic 
effect.
    Example 17. FG and RP form a partnership with FG contributing cash 
of $100 and RP contributing property, with 2 years of cost recovery 
deductions remaining, that has an adjusted tax basis of $80 and a fair 
market value of $100. The partnership, FG, and RP have calendar taxable 
years. The partnership agreement provides that the partners' capital 
accounts will be determined and maintained in accordance with paragraph 
(b)(2)(iv) of this section, liquidation proceeds will be made in 
accordance with capital account balances, and each partner is liable to 
restore the deficit balance in his capital account to the partnership 
upon liquidation of his interest (as set forth in paragraphs

[[Page 479]]

(b)(2)(ii)(b) (2) and (3) of this section). FG expects to be in a 
substantially higher tax bracket than RP in the partnership's first 
taxable year. In the partnership's second taxable year, and in 
subsequent taxable years, it is expected that both will be in 
approximately equivalent tax brackets. The partnership agreement 
allocates all items equally except that all $50 of book depreciation is 
allocated to FG in the partnership's first taxable year and all $50 of 
book depreciation is allocated to RP in the partnership's second taxable 
year. If the allocation to FG of all book depreciation in the 
partnership's first taxable year is respected, FG would be entitled 
under section 704(c) to the entire cost recovery deduction ($40) for 
such year. Likewise, if the allocation to RP of all the book 
depreciation in the partnership's second taxable year is respected, RP 
would be entitled under section 704(c) to the entire cost recovery 
deduction ($40) for such year. The allocation of book depreciation to FG 
and RP in the partnership's first 2 taxable years has economic effect 
within the meaning of paragraph (b)(2)(ii) of this section. However, the 
economic effect of these allocations is not substantial under the test 
described in paragraph (b)(2)(iii)(c) of this section since there is a 
strong likelihood at the time such allocations became part of the 
partnership agreement that at the end of the 2-year period to which such 
allocations relate, the net increases and decreases to FG's and RP's 
capital accounts will be the same with such allocations as they would 
have been in the absence of such allocation, and the total tax liability 
of FG and RP for the taxable years to which the section 704(c) 
determinations relate would be reduced as a result of the allocations of 
book depreciation. As a result the allocations of book depreciation in 
the partnership agreement will be disregarded. FG and RP will be 
allocated such book depreciation in accordance with the partners' 
interests in the partnership under paragraph (b)(3) of this section. 
Under these facts the book depreciation deductions will be reallocated 
equally between the partners, and section 704(c) will be applied with 
reference to such reallocation of book depreciation.
    Example 18. (i) WM and JL form a general partnership by each 
contributing $300,000 thereto. The partnership uses the $600,000 to 
purchase an item of tangible personal property, which it leases out. The 
partnership elects under section 48 (q)(4) to reduce the amount of 
investment tax credit in lieu of adjusting the tax basis of such 
property. The partnership agreement provides that (1) the partners' 
capital account will be determined and maintained in accordance with 
paragraph (b)(2)(iv) of this section, (2) distributions in liquidation 
of the partnership (or any partner's interest) will be made in 
accordance with the partners' positive capital account balances (as set 
forth in paragraph (b)(2)(ii)(b)(2) of this section), (3) any partner 
with a deficit balance in his capital account following the liquidation 
of his interest must restore that deficit to the partnership (as set 
forth in paragraph (b)(2)(ii)(b)(3) of this section), (4) all income, 
gain, loss, and deduction of the partnership will be allocated equally 
between the partners, and (5) all non-liquidating distributions of the 
partnership will be made equally between the partners. Assume that in 
each of the partnership's taxable years, it recognizes operating income 
equal to its operating deductions (excluding cost recovery and 
depreciation deductions and gain or loss on the sale of its property). 
During its first 2 taxable years, the partnership has an additional 
$200,000 cost recovery deduction in each year. Pursuant to the 
partnership agreement these items are allocated equally between WM and 
JL.

------------------------------------------------------------------------
                                                      WM          JL
------------------------------------------------------------------------
Capital account upon formation..................   $300,000    $300,000
Less: Net loss for years 1 and 2................   (200,000)   (200,000)
                                                 -----------------------
      Capital account at end of year 2..........   $100,000    $100,000
------------------------------------------------------------------------


The allocations made in the partnership's first 2 taxable years have 
substantial economic effect.
    (ii) Assume the same facts as in (i) and that MK is admitted to the 
partnership at the beginning of the partnership's third taxable year. At 
the time of his admission, the fair market value of the partnership 
property is $600,000. MK contributes $300,000 to the partnership in 
exchange for an equal one-third interest in the partnership, and, as 
permitted under paragraph (b)(2)(iv)(g), the capital accounts of WM and 
JL are adjusted upward to $300,000 each to reflect the fair market value 
of partnership property. In addition, the partnership agreement is 
modified to provide that depreciation and gain or loss, as computed for 
tax purposes, with respect to the partnership property that appreciated 
prior to MK's admission will be shared among the partners in a manner 
that takes account of the variation between such property's $200,000 
adjusted tax basis and its $600,000 book value in accordance with 
paragraph (b)(2)(iv)(f) and the special rule contained in paragraph 
(b)(4)(i) of this section. Depreciation and gain or loss, as computed 
for book purposes, with respect to such property will be allocated 
equally among the partners and, in accordance with paragraph 
(b)(2)(iv)(g) of this section, will be reflected in the partner's 
capital accounts, as will all other partnership income, gain, loss, and 
deduction. Since the requirements of (b)(2)(iv)(g) of this section are 
satisfied, the capital accounts of the partners (as adjusted) continue 
to be maintained in accordance with paragraph (B)(2)(iv) of this 
section.

[[Page 480]]

    (iii) Assume the same facts as in (ii) and that immediately after 
MK's admission to the partnership, the partnership property is sold for 
$600,000, resulting in a taxable gain of $400,000 ($600,000 less 
$200,000 adjusted tax basis) and no book gain or loss, and the 
partnership is liquidated. An allocation of the $400,000 taxable gain 
cannot have economic effect because such gain cannot properly be 
reflected in the partners' book capital accounts. Consistent with the 
special partners' interests in the partnership rule contained in 
paragraph (b)(4)(i) of this section, the partnership agreement provides 
that the $400,000 taxable gain will, in accordance with section 704(c) 
principles, be shared equally between WM and JL.

----------------------------------------------------------------------------------------------------------------
                                                         WM                    JL                    MK
                                               -----------------------------------------------------------------
                                                   Tax        Book       Tax        Book       Tax        Book
----------------------------------------------------------------------------------------------------------------
Capital account at beginning of year 3........   $100,000   $300,000   $100,000   $300,000   $300,000   $300,000
Plus: gain....................................    200,000          0    200,000          0          0          0
                                               -----------------------------------------------------------------
      Capital account before liquidation......   $300,000   $300,000   $300,000   $300,000   $300,000   $300,000
----------------------------------------------------------------------------------------------------------------

The $900,000 of partnership cash ($600,000 sales proceeds plus $300,000 
contributed by MK) is distributed equally among WM, JL, and MK in 
accordance with their adjusted positive capital account balances, each 
of which is $300,000.
    (iv) Assume the same facts as in (iii) except that prior to 
liquidation the property appreciates and is sold for $900,000, resulting 
in a taxable gain of $700,000 ($900,000 less $200,000 adjusted tax 
basis) and a book gain of $300,000 ($900,000 less $600,000 book value). 
Under the partnership agreement the $300,000 of book gain is allocated 
equally among the partners, and such allocation has substantial economic 
effect.

----------------------------------------------------------------------------------------------------------------
                                                         WM                    JL                    MK
                                               -----------------------------------------------------------------
                                                   Tax        Book       Tax        Book       Tax        Book
----------------------------------------------------------------------------------------------------------------
Capital account at beginning of year 3........   $100,000   $300,000   $100,000   $300,000   $300,000   $300,000
Plus: gain....................................    300,000    100,000    300,000    100,000    100,000    100,000
                                               -----------------------------------------------------------------
      Capital account before liquidation......   $400,000   $400,000   $400,000   $400,000   $400,000   $400,000
----------------------------------------------------------------------------------------------------------------

Consistent with the special partners' interests in the partnership rule 
contained in paragraph (b)(4)(i) of this section, the partnership 
agreement provides that the $700,000 taxable gain is, in accordance with 
section 704(c) principles, shared $300,000 to JL, $300,000 to WM, and 
$100,000 to MK. This ensures that (1) WM and JL share equally the 
$400,000 taxable gain that is attributable to appreciation in the 
property that occurred prior to MK's admission to the partnership in the 
same manner as it was reflected in their capital accounts upon MK's 
admission, and (2) WM, JL, and MK share equally the additional $300,000 
taxable gain in the same manner as they shared the $300,000 book gain.
    (v) Assume the same facts as in (ii) except that shortly after MK's 
admission the property depreciates and is sold for $450,000, resulting 
in a taxable gain of $250,000 ($450,000 less $200,000 adjusted tax 
basis) and a book loss of $150,000 (450,000 less $600,000 book value). 
Under the partnership agreement these items are allocated as follow:

----------------------------------------------------------------------------------------------------------------
                                                       WM                     JL                     MK
                                            --------------------------------------------------------------------
                                                Tax        Book        Tax        Book        Tax        Book
----------------------------------------------------------------------------------------------------------------
Capital account at beginning of year 3.....   $100,000   $300,000    $100,000   $300,000    $300,000   $300,000
Plus: gain.................................    125,000          0     125,000          0           0          0
Less: loss.................................          0    (50,000)          0    (50,000)          0    (50,000)
                                            --------------------------------------------------------------------
      Capital account before liquidation...   $225,000   $250,000    $225,000   $250,000    $300,000   $250,000
----------------------------------------------------------------------------------------------------------------

The $150,000 book loss is allocated equally among the partners, and such 
allocation has substantial economic effect. Consistent with the special 
partners' interests in the partnership rule contained in paragraph 
(b)(4)(i) of this section, the partnership agreement provides that the 
$250,000 taxable gain is, in accordance with section 704(c) principles, 
shared equally between WM and JL. The fact that MK bears an economic 
loss of $50,000

[[Page 481]]

without a corresponding taxable loss is attributable entirely to the 
``ceiling rule.'' See paragraph (c)(2) of Sec. 1.704-1.
    (vi) Assume the same facts as in (ii) except that the property 
depreciates and is sold for $170,000, resulting in a $30,000 taxable 
loss ($200,000 adjusted tax basis less $170,000) and a book loss of 
$430,000 ($600,000 book value less $170,000). The book loss of $430,000 
is allocated equally among the partners ($143,333 each) and has 
substantial economic effect. Consistent with the special partners' 
interests in the partnership rule contained in paragraph (b)(4)(i) of 
this section, the partnership agreement provides that the entire $30,000 
taxable loss is, in accordance with section 704(c) principles, included 
in MK's distributive share.

----------------------------------------------------------------------------------------------------------------
                                                      WM                     JL                     MK
                                           ---------------------------------------------------------------------
                                               Tax        Book        Tax        Book         Tax        Book
----------------------------------------------------------------------------------------------------------------
Capital account at beginning of year 3....   $100,000   $300,000    $100,000   $300,000    $300,000    $300,000
Less Loss.................................          0   (143,333)          0   (143,333)    (30,000)   (143,333)
                                           ---------------------------------------------------------------------
Capital account before liquidation........   $100,000   $156,667    $100,000   $156,667    $270,000    $156,667
----------------------------------------------------------------------------------------------------------------

    (vii) Assume the same facts as in (ii) and that during the 
partnership's third taxable year, the partnership has an additional 
$100,000 cost recovery deduction and $300,000 book depreciation 
deduction attributable to the property purchased by the partnership in 
its first taxable year. The $300,000 book depreciation deduction is 
allocated equally among the partners, and that allocation has 
substantial economic effect. Consistent with the special partners' 
interests in the partnership rule contained in paragraph (b)(4)(i) of 
this section, the partnership agreement provides that the $100,000 cost 
recovery deduction for the partnership's third taxable year is, in 
accordance with section 704(c) principles, included in MK's distributive 
share. This is because under these facts those principles require MK to 
include the cost recovery deduction for such property in his 
distributive share up to the amount of the book depreciation deduction 
for such property properly allocated to him.

----------------------------------------------------------------------------------------------------------------
                                                      WM                     JL                     MK
                                           ---------------------------------------------------------------------
                                               Tax        Book        Tax        Book         Tax        Book
----------------------------------------------------------------------------------------------------------------
Capital account at beginning of year 3....   $100,000   $300,000    $100,000   $300,000    $300,000    $300,000
Less: recovery/depreciation deduction for           0   (100,000)          0   (100,000)   (100,000)   (100,000)
 year 3...................................
                                           ---------------------------------------------------------------------
Capital account at end of year 3..........   $100,000   $200,000    $100,000   $200,000    $200,000    $200,000
----------------------------------------------------------------------------------------------------------------

    (viii) Assume the same facts as in (vii) except that upon MK's 
admission the partnership property has an adjusted tax basis of $220,000 
(instead of $200,000), and thus the cost recovery deduction for the 
partnership's third taxable year is $110,000. Assume further that upon 
MK's admission WM and JL have adjusted capital account balances of 
$110,000 and $100,000, respectively. Consistent with the special 
partners' interests in the partnership rule contained in paragraph 
(b)(4)(i) of this section, the partnership agreement provides that the 
excess $10,000 cost recovery deduction ($110,000 less $100,000 included 
in MK's distributive share) is, in accordance with section 704 (c) 
principles, shared equally between WM and JL and is so included in their 
respective distributive shares for the partnership's third taxable year.
    (ix) Assume the same facts as in (vii) except that upon MK's 
admission the partnership agreement is amended to allocate the first 
$400,000 of book depreciation and loss on partnership property equally 
between WM and JL and the last $200,000 of such book depreciation and 
loss to MK. Assume such allocations have substantial economic effect. 
Pursuant to this amendment the $300,000 book depreciation deduction in 
the partnership's third taxable year is allocated equally between WM and 
JL. Consistent with the special partners' interests in the partnership 
rule contained in paragraph (b)(4)(i) of this section, the partnership 
agreement provides that the $100,000 cost recovery deduction is, in 
accordance with section 704(c) principles, shared equally between WM and 
JL. In the partnership's fourth taxable year, it has a $60,000 cost 
recovery deduction and a $180,000 book depreciation deduction. Under the 
amendment described above, the $180,000 book depreciation deduction is 
allocated $50,000 to WM, $50,000 to JL, and $80,000 to

[[Page 482]]

MK. Consistent with the special partners' interests in the partnership 
rule contained in paragraph (b)(4)(i) of this section, the partnership 
agreement provides that the $60,000 cost recovery deduction is, in 
accordance with section 704(c) principles, included entirely in MK's 
distributive share.

----------------------------------------------------------------------------------------------------------------
                                                    WM                      JL                      MK
                                         -----------------------------------------------------------------------
                                              Tax        Book         Tax        Book         Tax        Book
----------------------------------------------------------------------------------------------------------------
Capital account at beginning of year 3..   $100,000    $300,000    $100,000    $300,000    $300,000    $300,000
Less:
    (a) recovery/depreciation deduction     (50,000)   (150,000)    (50,000)   (150,000)          0           0
     for year 3.........................
    (b) recovery/depreciation deduction           0     (50,000)          0     (50,000)    (60,000)    (80,000)
     for year 4.........................
                                         -----------------------------------------------------------------------
      Capital account at end of year 4..    $50,000    $100,000     $50,000    $100,000    $240,000    $220,000
----------------------------------------------------------------------------------------------------------------

    (x) Assume the same facts as in (vii) and that at the beginning of 
the partnership's third taxable year, the partnership purchases a second 
item of tangible personal property for $300,000 and elects under section 
48(q) (4) to reduce the amount of investment tax credit in lieu of 
adjusting the tax basis of such property. The partnership agreement is 
amended to allocate the first $150,000 of cost recovery deductions and 
loss from such property to WM and the next $150,000 of cost recovery 
deductions and loss from such property equally between JL and MK. Thus, 
in the partnership's third taxable year it has, in addition to the items 
specified in (vii), a cost recovery and book depreciation deduction of 
$100,000 attributable to the newly acquired property, which is allocated 
entirely to WM.
As in (vii), the allocation of the $300,000 book depreciation 
attributable to the property purchased in the partnership's first 
taxable year equally among the partners has substantial economic effect, 
and consistent with the special partners' interests in the partnership 
rule contained in paragraph (b)(4)(i) of this section, the partnership 
agreement properly provides for the entire $100,000 cost recovery 
deduction attributable to such property to be included in MK's 
distributive share. Furthermore, the allocation to WM of the $100,000 
cost recovery deduction attributable to the property purchased in the 
partnership's third taxable year has substantial economic effect.

----------------------------------------------------------------------------------------------------------------
                                                     WM                      JL                     MK
                                          ----------------------------------------------------------------------
                                               Tax        Book        Tax        Book         Tax        Book
----------------------------------------------------------------------------------------------------------------
Capital account at beginning of year 3...   $100,000    $300,000    $100,000   $300,000    $300,000    $300,000
Less:
    (a) recovery/depreciation deduction            0    (100,000)          0   (100,000)   (100,000)   (100,000)
     for property bought in year 1.......
    (b) recovery/depreciation deduction     (100,000)   (100,000)          0          0           0           0
     for property bought in year 3.......
                                          ----------------------------------------------------------------------
      Capital account at end of year 3...          0    $100,000    $100,000   $200,000    $200,000    $200,000
----------------------------------------------------------------------------------------------------------------

    (xi) Assume the same facts as in (x) and that at the beginning of 
the partnership's fourth taxable year, the properties purchased in the 
partnership's first and third taxable years are disposed of for $90,000 
and $180,000, respectively, and the partnership is liquidated. With 
respect to the property purchased in the first taxable year, there is a 
book loss of $210,000 ($300,000 book value less $90,000) and a taxable 
loss of $10,000 ($100,000 adjusted tax basis less $90,000). The book 
loss is allocated equally among the partners, and such allocation has 
substantial economic effect. Consistent with the special partners' 
interests in the partnership rule contained in paragraph (b)(4)(i) of 
this section, the partnership agreement provides that the taxable loss 
of $10,000 will, in accordance with section 704(c) principles, be 
included entirely in MK's distributive share. With respect to the 
property purchased in the partnership's third taxable year, there is a 
book and taxable loss of $20,000. Pursuant to the partnership agreement 
this loss is allocated entirely to WM, and such allocation has 
substantial economic effect.

[[Page 483]]



----------------------------------------------------------------------------------------------------------------
                                                     WM                      JL                     MK
                                          ----------------------------------------------------------------------
                                               Tax        Book        Tax        Book         Tax        Book
----------------------------------------------------------------------------------------------------------------
Capital account at beginning of year 4...          0    $100,000    $100,000   $200,000    $200,000    $200,000
Less:
    (a) loss on property bought in year 1          0     (70,000)          0    (70,000)    (10,000)    (70,000)
    (b) loss on property bought in year 3    (20,000)    (20,000)          0          0           0           0
                                          ----------------------------------------------------------------------
      Capital account before liquidation.   ($20,000)    $10,000    $100,000   $130,000    $190,000    $130,000
----------------------------------------------------------------------------------------------------------------

Partnership liquidation proceeds ($270,000) are properly distributed in 
accordance with the partners' adjusted positive book capital account 
balances ($10,000 to WM, $130,000 to JL and $130,000 to MK).
    (xii) Assume the same facts as in (x) and that in the partnership's 
fourth taxable year it has a cost recovery deduction of $60,000 and book 
depreciation deduction of $180,000 attributable to the property 
purchased in the partnership's first taxable year, and a cost recovery 
and book depreciation deduction of $100,000 attributable to the property 
purchased in the partnership's third taxable year. The $180,000 book 
depreciation deduction attributable to the property purchased in the 
partnership's first taxable year is allocated equally among the 
partners, and such allocation has substantial economic effect. 
Consistent with the special partners' interests in the partnership rule 
contained in paragraph (b)(4)(i) of this section, the partnership 
agreement provides that the $60,000 cost recovery deduction attributable 
to the property purchased in the first taxable year is, in accordance 
with section 704(c) principles, included entirely in MK's distributive 
share. Furthermore, the $100,000 cost recovery deduction attributable to 
the property purchased in the third taxable year is allocated $50,000 to 
WM, $25,000 to JL, and $25,000 to MK, and such allocation has 
substantial economic effect.

----------------------------------------------------------------------------------------------------------------
                                                    WM                      JL                      MK
                                         -----------------------------------------------------------------------
                                              Tax        Book         Tax        Book         Tax        Book
----------------------------------------------------------------------------------------------------------------
Capital account at beginning of year 4..          0    $100,000    $100,000    $200,000    $200,000    $200,000
Less:
    (a) recovery/depreciation deduction           0     (60,000)          0     (60,000)    (60,000)    (60,000)
     for property bought in year 1......
    (b) recovery/depreciation deduction     (50,000)    (50,000)    (25,000)    (25,000)    (25,000)    (25,000)
     for property bought in year 3......
                                         -----------------------------------------------------------------------
      Capital account at end of year 4..   ($50,000)   ($10,000)    $75,000    $115,000    $115,000    $115,000
----------------------------------------------------------------------------------------------------------------

At the end of the partnership's fourth taxable year the adjusted tax 
bases of the partnership properties acquired in its first and third 
taxable years are $40,000 and $100,000, respectively. If the properties 
are disposed of at the beginning of the partnership's fifth taxable year 
for their adjusted tax bases, there would be no taxable gain or loss, a 
book loss of $80,000 on the property purchased in the partnership's 
first taxable year ($120,000 book value less $40,000), and cash 
available for distribution of $140,000.

----------------------------------------------------------------------------------------------------------------
                                                      WM                      JL                     MK
                                           ---------------------------------------------------------------------
                                                Tax        Book        Tax        Book        Tax        Book
----------------------------------------------------------------------------------------------------------------
Capital account at beginning of year 5....   ($50,000)   ($10,000)    $75,000   $115,000    $115,000   $115,000
Less: loss................................          0     (26,667)          0    (26,667)          0    (26,667)
                                           ---------------------------------------------------------------------
      Capital account before liquidation..   ($50,000)   ($36,667)    $75,000    $88,333    $115,000    $88,333
----------------------------------------------------------------------------------------------------------------

If the partnership is then liquidated, the $140,000 of cash on hand plus 
the $36,667 balance that WM would be required to contribute to the 
partnership (the deficit balance in his book capital account) would be 
distributed equally between JL and MK in accordance with their adjusted 
positive book capital account balances.
    (xiii) Assume the same facts as in (i). Any tax preferences under 
section 57(a)(12) attributable to the partnership's cost recovery 
deductions in the first 2 taxable years will be taken into account 
equally by WM and JL. If the partnership agreement instead provides that 
the partnership's cost recovery deductions in its first 2 taxable years 
are allocated

[[Page 484]]

25 percent to WM and 75 percent to JL (and such allocations have 
substantial economic effect), the tax preferences attributable to such 
cost recovery deductions would be taken into account 25 percent by WM 
and 75 percent by JL. The conclusion in the previous sentence is 
unchanged even if the partnership's operating expenses (exclusive of 
cost recovery and depreciation deductions) exceed its operating income 
in each of the partnership's first 2 taxable years, the resulting net 
loss is allocated entirely to WM, and the cost recovery deductions are 
allocated 25 percent to WM and 75 percent to JL (provided such 
allocations have substantial economic effect). If the partnership 
agreement instead provides that all income, gain, loss, and deduction 
(including cost recovery and depreciations) are allocated equally 
between JL and WM, the tax preferences attributable to the cost recovery 
deductions would be taken into account equally by JL and WM. In this 
case, if the partnership has a $100,000 cost recovery deduction in its 
first taxable year and an additional net loss of $100,000 in its first 
taxable year (i.e., its operating expenses exceed its operating income 
by $100,000) and purports to categorize JL's $100,000 distributive share 
of partnership loss as being attributable to the cost recovery deduction 
and WM's $100,000 distributive share of partnership loss as being 
attributable to the net loss, the economic effect of such allocations is 
not substantial, and each partner will be allocated one-half of all 
partnership income, gain, loss, and deduction and will take into account 
one-half of the tax preferences attributable to the cost recovery 
deductions.
    Example 19. (i) DG and JC form a general partnership for the purpose 
of drilling oil wells. DG contributes an oil lease, which has a fair 
market value and adjusted tax basis of $100,000. JC contributes $100,000 
in cash, which is used to finance the drilling operations. The 
partnership agreement provides that DG is credited with a capital 
account of $100,000, and JC is credited with a capital account of 
$100,000. The agreement further provides that the partners' capital 
accounts will be determined and maintained in accordance with paragraph 
(b)(2)(iv) of this section, distributions in liquidation of the 
partnership (or any partner's interest) will be made in accordance with 
the partners' positive capital account balances, and any partner with a 
deficit balance in his capital account following the liquidation of his 
interest must restore such deficit to the partnership (as set forth in 
paragraphs (b)(2)(ii)(b) (2) and (3) of this section. The partnership 
chooses to adjust capital accounts on a simulated cost depletion basis 
and elects under section 48(q)(4) to reduce the amount of investment tax 
credit in lieu of adjusting the basis of its section 38 property. The 
agreement further provides that (1) all additional cash requirements of 
the partnership will be borne equally by DG and JC, (2) the deductions 
attributable to the property (including money) contributed by each 
partner will be allocated to such partner, (3) all other income, gain, 
loss, and deductions (and item thereof) will be allocated equally 
between DG and JC, and (4) all cash from operations will be distributed 
equally between DG and JC. In the partnership's first taxable year 
$80,000 of partnership intangible drilling cost deductions and $20,000 
of cost recovery deductions on partnership equipment are allocated to 
JC, and the $100,000 basis of the lease is, for purposes of the 
depletion allowance under sections 611 and 613A(c)(7)(D), allocated to 
DG. The allocations of income, gain, loss, and deduction provided in the 
partnership agreement have substantial economic effect. Furthermore, 
since the allocation of the entire basis of the lease to DG will not 
result in capital account adjustments (under paragraph (b)(2)(iv)(k) of 
this section) the economic effect of which is insubstantial, and since 
all other partnership allocations are recognized under this paragraph, 
the allocation of the $100,000 adjusted basis of the lease to DG is, 
under paragraph (b)(4)(v) of this section, recognized as being in 
accordance with the partners' interests in partnership capital for 
purposes of section 613A(c)(7)(D).
    (ii) Assume the same facts as in (i) except that the partnership 
agreement provides that (1) all additional cash requirements of the 
partnership for additional expenses will be funded by additional 
contributions from JC, (2) all cash from operations will first be 
distributed to JC until the excess of such cash distributions over the 
amount of such additional expense equals his initial $100,000 
contributions, (3) all deductions attributable to such additional 
operating expenses will be allocated to JC, and (4) all income will be 
allocated to JC until the aggregate amount of income allocated to him 
equals the amount of partnership operating expenses funded by his 
initial $100,000 contribution plus the amount of additional operating 
expenses paid from contributions made solely by him. The allocations of 
income, gain, loss, and deduction provided in partnership agreement have 
economic effect. In addition, the economic effect of the allocations 
provided in the agreement is substantial. Because the partnership's 
drilling activities are sufficiently speculative, there is not a strong 
likelihood at the time the disproportionate allocations of loss and 
deduction to JC are provided for by the partnership agreement that the 
economic effect of such allocations will be largely offset by 
allocations of income. In addition, since the allocation of the entire 
basis of the lease to DG will not result in capital account adjustments 
(under paragraph (b)(2)(iv)(k) of this section) the economic effect of 
which is insubstantial, and since all other partnership allocations are

[[Page 485]]

recognized under this paragraph, the allocation of the adjusted basis of 
the lease to DG is, under paragraph (b)(4)(v) of this section, 
recognized as being in accordance with the partners' interests in 
partnership capital under section 613A(c)(7)(D).
    (iii) Assume the same facts as in (i) except that all distributions, 
including those made upon liquidation of the partnership, will be made 
equally between DG and JC, and no partner is obligated to restore the 
deficit balance in his capital account to the partnership following the 
liquidation of his interest for distribution to partners with positive 
capital account balances. Since liquidation proceeds will be distributed 
equally between DG and JC irrespective of their capital account 
balances, and since no partner is required to restore the deficit 
balance in his capital account to the partnership upon liquidation (in 
accordance with paragraph (b)(2)(ii)(b)(3) of this section), the 
allocations of income, gain, loss, and deduction provided in the 
partnership agreement do not have economic effect and must be 
reallocated in accordance with the partners' interests in the 
partnership under paragraph (b)(3) of this section. Under these facts 
all partnership income, gain, loss, and deduction (and item thereof) 
will be reallocated equally between JC and DG. Furthermore, the 
allocation of the $100,000 adjusted tax basis of the lease of DG is not, 
under paragraph (b)(4)(v) of this section, deemed to be in accordance 
with the partners' interests in partnership capital under section 
613A(c)(7)(D), and such basis must be reallocated in accordance with the 
partners' interests in partnership capital or income as determined under 
section 613A(c)(7)(D). The results in this example would be the same if 
JC's initial cash contribution were $1,000,000 (instead of $100,000), 
but in such case the partners should consider whether, and to what 
extent, the provisions of paragraph (b)(1) of Sec. 1.721-1, and 
principles related thereto, may be applicable.
    (iv) Assume the same facts as in (i) and that for the partnership's 
first taxable year the simulated depletion deduction with respect to the 
lease is $10,000. Since DG properly was allocated the entire depletable 
basis of the lease (such allocation having been recognized as being in 
accordance with DG's interest in partnership capital with respect to 
such lease), under paragraph (b)(2)(iv)(k)(1) of this section the 
partnership's $10,000 simulated depletion deduction is allocated to DG 
and will reduce his capital account accordingly. If (prior to any 
additional simulated depletion deductions) the lease is sold for 
$100,000, paragraph (b)(4)(v) of this section requires that the first 
$90,000 (i.e., the partnership's simulated adjusted basis in the lease) 
out of the $100,000 amount realized on such sale be allocated to DG (but 
does not directly affect his capital account). The partnership agreement 
allocates the remaining $10,000 amount realized equally between JC and 
DG (but such allocation does not directly affect their capital 
accounts). This allocation of the $10,000 portion of amount realized 
that exceeds the partnership's simulated adjusted basis in the lease 
will be treated as being in accordance with the partners' allocable 
shares of such amount realized under section 613A(c)(7)(D) because such 
allocation will not result in capital account adjustments (under 
paragraph (b)(2)(iv)(k) of this section) the economic effect of which is 
insubstantial, and all other partnership allocations are recognized 
under this paragraph. Under paragraph (b)(2)(iv)(k) of this section, the 
partners' capital accounts are adjusted upward by the partnership's 
simulated gain of $10,000 ($100,000 sales price less $90,000 simulated 
adjusted basis) in proportion to such partners' allocable shares of the 
$10,000 portion of the total amount realized that exceeds the 
partnership's $90,000 simulated adjusted basis ($5,000 to JC and $5,000 
to DG). If the lease is sold for $50,000, under paragraph (b)(4)(v) of 
this section the entire $50,000 amount realized on the sale of the lease 
will be allocated to DG (but will not directly affect his capital 
account). Under paragraph (b)(2)(iv)(k) of this section the partners' 
capital accounts will be adjusted downward by the partnership's $40,000 
simulated loss ($50,000 sales price less $90,000 simulated adjusted 
basis) in proportion to the partners' allocable shares of the total 
amount realized from the property that represents recovery of the 
partnership's simulated adjusted basis therein. Accordingly, DG's 
capital account will be reduced by such $40,000.
    Example 20. (i) A and B form AB, an eligible entity (as defined in 
Sec. 301.7701-3(a) of this chapter), treated as a partnership for U.S. 
tax purposes. AB operates business M in country X and earns income from 
passive investments in country X. Country X imposes a 40 percent tax on 
business M income, which tax is a CFTE, but exempts from tax income from 
passive investments. In 2007, AB earns $100,000 of income from business 
M and $30,000 from passive investments and pays or accrues $40,000 of 
country X taxes. For purposes of section 904(d), the income from 
business M is general limitation income and the income from the passive 
investments is passive income. Pursuant to the partnership agreement, 
all partnership items, including CFTEs, from business M are allocated 60 
percent to A and 40 percent to B, and all partnership items, including 
CFTEs, from passive investments are allocated 80 percent to A and 20 
percent to B. Accordingly, A is allocated 60 percent of the business M 
income ($60,000) and 60 percent of the country X taxes ($24,000), and B 
is allocated 40 percent of the business M income ($40,000) and 40 
percent of the country X taxes ($16,000). The income from the passive 
investments is allocated $24,000 to A and $6,000 to B. Assume

[[Page 486]]

that allocations of all items other than CFTEs are valid.
    (ii) Because the partnership agreement provides for different 
allocations of the net income attributable to business M and the passive 
investments, the net income attributable to each is income in a separate 
CFTE category. See paragraph (b)(4)(viii)(c)(2) of this section. AB must 
determine the net income in each CFTE category and the CFTEs allocable 
to each CFTE category. Under paragraph (b)(4)(viii)(c)(3) of this 
section, the net income in the business M CFTE category is the $100,000 
attributable to business M and the net income in the passive investments 
CFTE category is the $30,000 attributable to the passive investments. 
Under paragraph (b)(4)(viii)(d) of this section, the $40,000 of country 
X taxes is allocated to the business M CFTE category and no portion of 
the country X taxes is allocated to the passive investments CFTE 
category. Therefore, the $40,000 of country X taxes are related to the 
$100,000 of net income in the business M CFTE category. See paragraph 
(b)(4)(viii)(c)(1) of this section. Because AB's partnership agreement 
allocates the net income from the business M CFTE category 60 percent to 
A and 40 percent to B, and the country X taxes 60 percent to A and 40 
percent to B, the allocations of the CFTEs are in proportion to the 
distributive shares of income to which the CFTEs relate. Because AB 
satisfies the requirement of paragraph (b)(4)(viii) of this section, the 
allocations of the country X taxes are deemed to be in accordance with 
the partners' interests in the partnership. Because the business M 
income is general limitation income, all $40,000 of taxes are 
attributable to the general limitation category. See Sec. 1.904-6.
    Example 21. (i) A and B form AB, an eligible entity (as defined in 
Sec. 301.7701-3(a) of this chapter), treated as a partnership for U.S. 
tax purposes. AB operates business M in country X and business N in 
country Y. Country X imposes a 40 percent tax on business M income, 
country Y imposes a 20 percent tax on business N income, and the country 
X and country Y taxes are CFTEs. In 2007, AB has $100,000 of income from 
business M and $50,000 of income from business N. Country X imposes 
$40,000 of tax on the income from business M and country Y imposes 
$10,000 of tax on the income of business N. Pursuant to the partnership 
agreement, all partnership items, including CFTEs, from business M are 
allocated 75 percent to A and 25 percent to B, and all partnership 
items, including CFTEs, from business N are split evenly between A and B 
(50 percent each). Accordingly, A is allocated 75 percent of the income 
from business M ($75,000), 75 percent of the country X taxes ($30,000), 
50 percent of the income from business N ($25,000), and 50 percent of 
the country Y taxes ($5,000). B is allocated 25 percent of the income 
from business M ($25,000), 25 percent of the country X taxes ($10,000), 
50 percent of the income from business N ($25,000), and 50 percent of 
the country Y taxes ($5,000). Assume that allocations of all items other 
than CFTEs are valid. The income from business M and business N is 
general limitation income for purposes of section 904(d).
    (ii) Because the partnership agreement provides for different 
allocations of the net income attributable to businesses M and N, the 
net income attributable to each business is income in a separate CFTE 
category even though all of the income is in the general limitation 
category for section 904(d) purposes. See paragraph (b)(4)(viii)(c)(2) 
of this section. Under paragraph (b)(4)(viii)(c)(3) of this section, the 
net income in the business M CFTE category is the $100,000 attributable 
to business M and the net income in the business N CFTE category is 
$50,000 attributable to business N. Under paragraph (b)(4)(viii)(d) of 
this section, the $40,000 of country X taxes is allocated to the 
business M CFTE category and the $10,000 of country Y taxes is allocated 
to the business N CFTE category. Therefore, the $40,000 of country X 
taxes are related to the $100,000 of net income in the business M CFTE 
category and the $10,000 of country Y taxes are related to the $50,000 
of net income in the business N CFTE category. See paragraph 
(b)(4)(viii)(c)(1) of this section. Because AB's partnership agreement 
allocates the $40,000 of country X taxes in the same proportion as the 
net income in the business M CFTE category, and the $10,000 of country Y 
taxes in the same proportion as the net income in the business N CFTE 
category, the allocations of the country X taxes and the country Y taxes 
are in proportion to the distributive shares of income to which the 
foreign taxes relate. Because AB satisfies the requirements of paragraph 
(b)(4)(viii) of this section, the allocations of the country X and 
country Y taxes are deemed to be in accordance with the partners' 
interests in the partnership.
    Example 22. (i) The facts are the same as in Example 21, except that 
the partnership agreement provides for the following allocations. 
Depreciation attributable to machine X, which is used in business M, is 
allocated 100 percent to A. B is allocated the first $20,000 of gross 
income attributable to business N, which allocation does not result in a 
deduction under foreign law. All remaining items, except CFTEs, are 
allocated 50 percent to A and 50 percent to B. For 2007, assume that 
business M generates $120,000 of income, before taking into account 
depreciation attributable to machine X. The total amount of depreciation 
attributable to machine X is $20,000, which results in $100,000 of net 
income attributable to business M for U.S. and country X tax purposes. 
Business N generates $70,000 of gross income and has $20,000 of 
expenses, resulting in $50,000 of net

[[Page 487]]

income for U.S. and country Y tax purposes. Pursuant to the partnership 
agreement, A is allocated $40,000 of the net income attributable to 
business M ($60,000 of business M income less $20,000 of depreciation 
attributable to machine X), and $15,000 of the net income attributable 
to business N. B is allocated $60,000 of the net income attributable to 
business M and $35,000 of the net income attributable to business N 
($20,000 of gross income, plus $15,000 of net income).
    (ii) As a result of the special allocations, the net income 
attributable to business M ($100,000) is allocated 40 percent to A and 
60 percent to B. The net income attributable to business N ($50,000) is 
allocated 30 percent to A and 70 percent to B. Because the partnership 
agreement provides for different allocations of the net income 
attributable to businesses M and N, the net income from each of 
businesses M and N is income in a separate CFTE category. See paragraph 
(b)(4)(viii)(c)(2) of this section. Under paragraph (b)(4)(viii)(c)(3) 
of this section, the net income in the business M CFTE category is the 
$100,000 of net income attributable to business M and the net income in 
the business N CFTE category is the $50,000 of net income attributable 
to business N. Under paragraph (b)(4)(viii)(d)(1) of this section, the 
$40,000 of country X taxes is allocated to the business M CFTE category 
and the $10,000 of country Y taxes is allocated to the business N CFTE 
category. Therefore, the $40,000 of country X taxes relates to the 
$100,000 of net income in the business M CFTE and the $10,000 of country 
Y taxes relates to the $50,000 of net income in the business N CFTE 
category. See paragraph (b)(4)(viii)(c)(1) of this section. The 
allocations of the country X taxes will be in proportion to the 
distributive shares of income to which they relate and will be deemed to 
be in accordance with the partners' interests in the partnership if such 
taxes are allocated 40 percent to A and 60 percent to B. The allocations 
of the country Y taxes will be in proportion to the distributive shares 
of income to which they relate and will be deemed to be in accordance 
with the partners' interests in the partnership if such taxes are 
allocated 30 percent to A and 70 percent to B.
    (iii) Assume that for 2008, all the facts are the same as in 
paragraph (i) of this Example 22, except that business M generates 
$60,000 of income before taking into account depreciation attributable 
to machine X and country X imposes $16,000 of tax on the $40,000 of net 
income attributable to business M. Pursuant to the partnership 
agreement, A is allocated 25 percent of the income from business M 
($10,000), and B is allocated 75 percent of the income from business M 
($30,000). Allocations of the country X taxes will be in proportion to 
the distributive shares of income to which they relate and will be 
deemed to be in accordance with the partners' interests in the 
partnership if such taxes are allocated 25 percent to A and 75 percent 
to B.
    Example 23. (i) The facts are the same as in Example 21, except that 
AB does not actually receive the $50,000 of income accrued in 2007 with 
respect to business N until 2008 and AB accrues and receives an 
additional $100,000 with respect to business N in 2008. Also assume that 
A, B, and AB each report taxable income on an accrual basis for U.S. tax 
purposes and AB reports taxable income using the cash receipts and 
disbursements method of accounting for country X and country Y purposes. 
In 2007, AB pays or accrues country X taxes of $40,000. In 2008, AB pays 
or accrues country Y taxes of $30,000. Pursuant to the partnership 
agreement, in 2007, A is allocated 75 percent of business M income 
($75,000) and country X taxes ($30,000) and 50 percent of business N 
income ($25,000). B is allocated 25 percent of business M income 
($25,000) and country X taxes ($10,000) and 50 percent of business N 
income ($25,000). In 2008, A and B are each allocated 50 percent of the 
business N income ($50,000) and country Y taxes ($15,000).
    (ii) For 2007, the $40,000 of country X taxes paid or accrued by AB 
relates to the $100,000 of net income in the business M CFTE category. 
No portion of the country X taxes paid or accrued in 2007 relates to the 
$50,000 of net income in the business N CFTE category. For 2008, the net 
income in the business N CFTE category is the $100,000 attributable to 
business N. See paragraph (b)(4)(viii)(c)(3) of this section. Under 
paragraph (b)(4)(viii)(d)(1) of this section, $20,000 of the country Y 
tax paid or accrued in 2008 is allocated to the business N CFTE 
category. The remaining $10,000 of country Y tax is allocated to the 
business N CFTE category under paragraph (b)(4)(viii)(d)(2) of this 
section (relating to timing differences). Therefore, the $30,000 of 
country Y taxes paid or accrued by AB in 2008 is related to the $100,000 
of net income in the business N CFTE category for 2008. See paragraph 
(b)(4)(viii)(c)(1) of this section. Because AB's partnership agreement 
allocates the $40,000 of country X taxes and the $30,000 of country Y 
taxes in proportion to the distributive shares of income to which the 
taxes relate, the allocations of the country X and country Y taxes 
satisfy the requirements of paragraphs (b)(4)(viii)(a)(1) and (2) of 
this section and the allocations of the country X and Y taxes are deemed 
to be in accordance with the partners' interests in the partnership 
under paragraph (b)(4)(viii) of this section.
    Example 24. (i) The facts are the same as in Example 21, except that 
businesses M and N are conducted by entities (DE1 and DE2, respectively) 
that are corporations for country X and Y tax purposes and disregarded 
entities for U.S. Federal income tax purposes. Also, assume that DE1 
makes payments of $75,000 during 2012 to DE2 that are deductible

[[Page 488]]

by DE1 for country X tax purposes and includible in income of DE2 for 
country Y tax purposes. As a result of such payments, DE1 has taxable 
income of $25,000 for country X purposes on which $10,000 of taxes are 
imposed and DE2 has taxable income of $125,000 for country Y purposes on 
which $25,000 of taxes are imposed. For U.S. Federal income tax 
purposes, $100,000 of AB's income is attributable to the activities of 
DE1 and $50,000 of AB's income is attributable to the activities of DE2. 
Pursuant to the partnership agreement, all partnership items from 
business M, excluding CFTEs paid or accrued by business M, are allocated 
75% to A and 25% to B, and all partnership items from business N, 
excluding CFTEs paid or accrued by business N, are split evenly between 
A and B (50% each). Accordingly, A is allocated 75% of the income from 
business M ($75,000), and 50% of the income from business N ($25,000). B 
is allocated 25% of the income from business M ($25,000), and 50% of the 
income from business N ($25,000).
    (ii) Because the partnership agreement provides for different 
allocations of the net income attributable to businesses M and N, the 
net income attributable to each of business M and business N is income 
in separate CFTE categories. See paragraph (b)(4)(viii)(c)(2) of this 
section. Under paragraph (b)(4)(viii)(c)(3) of this section, the 
$100,000 of net income attributable to business M is in the business M 
CFTE category and the $50,000 of net income attributable to business N 
is in the business N CFTE category. Under paragraph (b)(4)(viii)(d)(1) 
of this section, the $10,000 of country X taxes is allocated to the 
business M CFTE category and $10,000 of the country Y taxes is allocated 
to the business N CFTE category. The additional $15,000 of country Y tax 
imposed with respect to the inter-branch payment is assigned to the 
business M CFTE category because for U.S. Federal income tax purposes, 
the related $75,000 of income that country Y is taxing is in the 
business M CFTE category. Therefore, $25,000 of taxes ($10,000 of 
country X taxes and $15,000 of the country Y taxes) is related to the 
$100,000 of net income in the business M CFTE category and the other 
$10,000 of country Y taxes is related to the $50,000 of net income in 
the business N CFTE category. See paragraph (b)(4)(viii)(c)(1) of this 
section. The allocations of country X taxes will be in proportion to the 
distributive shares of income to which they relate and will be deemed to 
be in accordance with the partners' interests in the partnership if such 
taxes are allocated 75% to A and 25% to B. The allocations of country Y 
taxes will be in proportion to the distributive shares of income to 
which they relate and will be deemed to be in accordance with the 
partners' interests in the partnership if $15,000 of such taxes is 
allocated 75% to A and 25% to B and the other $10,000 of such taxes is 
allocated 50% to A and 50% to B. No inference is intended with respect 
to the application of other provisions to arrangements that involve 
disregarded payments.
    (iii) Assume that the facts are the same as in paragraph (i) of this 
Example 24, except that in order to reflect the $75,000 payment from DE1 
to DE2, the partnership agreement allocates $75,000 of the income 
attributable to business M equally between A and B (50% each). In order 
to prevent separating the CFTEs from the related foreign income, the 
$75,000 payment is treated as a divisible part of the business M 
activity and, therefore, a separate activity. See paragraph 
(b)(4)(viii)(c)(2)(iii) of this section. Because items from the 
disregarded payment and business N are both shared equally between A and 
B, the disregarded payment activity and the business N activity are 
treated as a single CFTE category. See paragraph (b)(4)(viii)(c)(2)(i) 
of this section. Accordingly, $25,000 of net income attributable to 
business M is in the business M CFTE category and $75,000 of income of 
business M attributable to the disregarded payment and the $50,000 of 
net income attributable to business N are in the business N CFTE 
category. Under paragraph (b)(4)(viii)(d)(1) of this section, the 
$10,000 of country X taxes is allocated to the business M CFTE category 
and all $25,000 of the country Y taxes is allocated to the business N 
CFTE category. The allocations of country X taxes will be in proportion 
to the distributive shares of income to which they relate and will be 
deemed to be in accordance with the partners' interests in the 
partnership if such taxes are allocated 75% to A and 25% to B. The 
allocations of country Y taxes will be in proportion to the distributive 
shares of income to which they relate and will be deemed to be in 
accordance with the partners' interests in the partnership if such taxes 
are allocated 50% to A and 50% to B.
    Example 25. (i) A contributes $750,000 and B contributes $250,000 to 
form AB, an eligible entity (as defined in Sec. 301.7701-3(a) of this 
chapter), treated as a partnership for U.S. tax purposes. AB operates 
business M in country X. Country X imposes a 20 percent tax on the net 
income from business M, which tax is a CFTE. In 2007, AB earns $300,000 
of gross income, has deductible expenses of $100,000, and pays or 
accrues $40,000 of country X tax. Pursuant to the partnership agreement, 
the first $100,000 of gross income each year is allocated to A as a 
return on excess capital contributed by A. All remaining partnership 
items, including CFTEs, are split evenly between A and B (50 percent 
each). The gross income allocation is not deductible in determining AB's 
taxable income under country X law. Assume that allocations of all items 
other than CFTEs are valid.

[[Page 489]]

    (ii) AB has a single CFTE category because all of AB's net income is 
allocated in the same ratio. See paragraph (b)(4)(viii)(c)(2). Under 
paragraph (b)(4)(viii)(c)(3) of this section, the net income in the 
single CFTE category is $200,000. The $40,000 of taxes is allocated to 
the single CFTE category and, thus, related to the $200,000 of net 
income in the single CFTE category. In 2007, AB's partnership agreement 
allocates $150,000 or 75 percent of the net income to A ($100,000 
attributable to the gross income allocation plus $50,000 of the 
remaining $100,000 of net income) and $50,000 or 25 percent of the net 
income to B. AB's partnership agreement allocates the country X taxes in 
accordance with the partners' shares of partnership items remaining 
after the $100,000 gross income allocation. Therefore, AB allocates the 
country X taxes 50 percent to A ($20,000) and 50 percent to B ($20,000). 
AB's allocations of country X taxes are not deemed to be in accordance 
with the partners' interests in the partnership under paragraph 
(b)(4)(viii) of this section, because they are not in proportion to the 
allocations of the distributive shares of income to which the country X 
taxes relate. Accordingly, the country X taxes will be reallocated 
according to the partners' interests in the partnership. Assuming that 
the partners do not reasonably expect to claim a deduction for the CFTE 
in determining their U.S. tax liabilities, a reallocation of the CFTEs 
under paragraph (b)(3) of this section would be 75 percent to A 
($30,000) and 25 percent to B ($10,000). If the reallocation of the 
CFTEs causes the partners' capital accounts not to reflect their 
contemplated economic arrangement, the partners may need to reallocate 
other partnership items to ensure that the tax consequences of the 
partnership's allocations are consistent with their contemplated 
economic arrangement over the term of the partnership. The Commissioner 
will not reallocate other partnership items after the reallocation of 
the CFTEs.
    (iii) The facts are the same as in paragraph (i) of this Example 25, 
except that the $100,000 allocation of gross income is deductible under 
country X law and that AB pays or accrues $20,000 of foreign tax. Under 
paragraph (b)(4)(viii)(c)(3) of this section, the net income in the 
single CFTE category is the $100,000 of net income, determined by 
disregarding the $100,000 of gross income that is allocated to A and 
deductible in determining AB's taxable income under the law of country 
X. See paragraph (b)(4)(viii)(c)(3)(ii) of this section. The $20,000 of 
country X tax is allocated to the single CFTE category, and, thus, 
related to the $100,000 of net income in the single CFTE category. See 
paragraphs (b)(4)(viii)(c)(1) and (d) of this section. No portion of the 
tax is related to the $100,000 of gross income allocated to A. Pursuant 
to the partnership agreement, AB allocates the country X taxes 50 
percent to A ($10,000) and 50 percent to B ($10,000). AB's allocations 
of country X taxes are deemed to be in accordance with the partners' 
interests in the partnership under paragraph (b)(4)(viii) of this 
section.
    (iv) The results in (ii) and (iii) of this Example 25 would be the 
same assuming all of the facts except that, rather than being a 
preferential gross income allocation, the $100,000 was a guaranteed 
payment to A within the meaning of section 707(c). See paragraph 
(b)(4)(viii)(c)(3) of this section.
    Example 26. (i) A and B form AB, an eligible entity (as defined in 
Sec. 301.7701-3(a) of this chapter), treated as a partnership for U.S. 
tax purposes. AB operates business M in country X and business N in 
country Y. A, a U.S. corporation, contributes a building with a fair 
market value of $200,000 and an adjusted basis of $50,000 for both U.S. 
and country X purposes. The building contributed by A is used in 
business M. B, a country X corporation, contributes $800,000 cash. The 
AB partnership agreement provides that AB will make allocations under 
section 704(c) using the traditional method under Sec. 1.704-3(b) and 
that all other items, excluding creditable foreign taxes, will be 
allocated 20 percent to A and 80 percent to B. The partnership agreement 
provides that creditable foreign taxes will be allocated in proportion 
to the partners' distributive shares of net income in each CFTE 
category, which shall be determined by taking into accounts items 
allocated pursuant to section 704(c). Country X and Country Y impose tax 
at a rate of 20 percent and 40 percent, respectively, and such taxes are 
CFTEs. In 2007, AB sells the building contributed by A for $200,000, 
thereby recognizing taxable income of $150,000 for U.S. and country X 
purposes, and recognizes $250,000 of other income from the operation of 
business M. AB pays or accrues $80,000 of country X tax on such income. 
Also in 2007, business N recognizes $100,000 of taxable income for U.S. 
and country Y purposes and pays or accrues $40,000 of country Y tax. 
Pursuant to the partnership agreement, A is allocated $200,000 of 
business M income ($150,000 of taxable income in accordance with section 
704(c) and $50,000 of other business M income) and $40,000 of country X 
tax, and 20 percent of both business N income ($20,000) and country Y 
tax ($8,000). B is allocated $200,000 of business M income and $40,000 
of country X tax and 80 percent of both the business N income ($80,000) 
and country Y tax ($32,000). Assume that allocations of all items other 
than CFTEs are valid.
    (ii) The net income attributable to business M ($400,000) is 
allocated 50 percent to A and 50 percent to B while the net income 
attributable to business N ($100,000) is allocated 20 percent to A and 
80 percent to B. Because the partnership agreement provides for

[[Page 490]]

different allocations of the net income attributable to businesses M and 
N, the net income attributable to each activity is income in a separate 
CFTE category. See paragraph (b)(4)(viii)(c)(2) of this section. Under 
paragraph (b)(4)(viii)(c)(3) of this section, the net income in the 
business M CFTE category is the $400,000 of net income attributable to 
business M and the net income in the business N CFTE category is the 
$100,000 of net income attributable to business N. Under paragraph 
(b)(4)(viii)(d)(1) of this section, the $80,000 of country X tax is 
allocated to the business M CFTE category and the $40,000 of country Y 
tax is allocated to the business N CFTE category. Therefore, the $80,000 
of country X tax relates to the $400,000 of net income in the business M 
CFTE category and the $40,000 of country Y tax relates to the $100,000 
of net income in the business N CFTE category. See paragraph 
(b)(4)(viii)(c)(1) of this section. Because AB's partnership agreement 
allocates the $80,000 of country X taxes and $40,000 of country Y taxes 
in proportion to the distributive shares of income to which such taxes 
relate, the allocations are deemed to be in accordance with the 
partners' interests in the partnership under paragraph (b)(4)(viii) of 
this section.
    Example 27. (i) A, a U.S. citizen, and B, a country X citizen, form 
AB, a country X eligible entity (as defined in Sec. 301.7701-3(a) of 
this chapter), treated as a partnership for U.S. tax purposes. AB's only 
activity is business M, which it operates in country X. Country X 
imposes a 40 percent tax on the portion of AB's business M income that 
is the allocable share of AB's owners that are not citizens of country 
X, which tax is a CFTE. The partnership agreement provides that all 
partnership items, excluding CFTEs, from business M are allocated 40 
percent to A and 60 percent to B. CFTEs are allocated 100 percent to A. 
In 2007, AB earns $100,000 of net income from business M and pays or 
accrues $16,000 of country X taxes on A's allocable share of AB's income 
($40,000). Pursuant to the partnership agreement, A is allocated 40 
percent of the business M income ($40,000) and 100 percent of the 
country X taxes ($16,000), and B is allocated 60 percent of the business 
M income ($60,000) and no country X taxes. Assume that allocations of 
all items other than CFTEs are valid.
    (ii) AB has a single CFTE category because all of AB's net income is 
allocated in the same ratio. See paragraph (b)(4)(viii)(c)(2). Under 
paragraph (b)(4)(viii)(c)(3) of this section, the $40,000 of business M 
income that is allocated to A is included in the single CFTE category. 
Under paragraph (b)(4)(viii)(c)(3)(ii) of this section, no portion of 
the $60,000 allocated to B is included in the single CFTE category. 
Under paragraph (b)(4)(viii)(d) of this section, the $16,000 of taxes is 
allocated to the single CFTE category.
    Therefore, the $16,000 of country X taxes is related to the $40,000 
of net income in the single CFTE category that is allocated to A. See 
paragraph (b)(4)(viii)(c)(1) of this section. Because AB's partnership 
agreement allocates the country X taxes in proportion to the 
distributive share of income to which the taxes relate, AB satisfies the 
requirement of paragraph (b)(4)(viii) of this section, and the 
allocation of the country X taxes is deemed to be in accordance with the 
partners' interests in the partnership.
    Example 28. (i) B, a domestic corporation, and C, a controlled 
foreign corporation, form BC, a partnership organized under the laws of 
country X. B and C each contribute 50 percent of the capital of BC. B 
and C are wholly-owned subsidiaries of A, a domestic corporation. 
Substantially all of BC's income would not be subpart F income if earned 
directly by C. The BC partnership agreement provides that, for the first 
fifteen years, BC's gross income will be allocated 10 percent to B and 
90 percent to C, and BC's deductions and losses will be allocated 90 
percent to B and 10 percent to C. The partnership agreement also 
provides that, after the initial fifteen year period, BC's gross income 
will be allocated 90 percent to B and 10 percent to C, and BC's 
deductions and losses will be allocated 10 percent to B and 90 percent 
to C.
    (ii) Apart from the application of section 704(b), the Commissioner 
may reallocate or otherwise not respect the allocations under other 
sections. See paragraph (b)(1)(iii) of this section. For example, BC's 
allocations of gross income, deductions, and losses may be evaluated and 
reallocated (or not respected), as appropriate, if it is determined that 
the allocations result in the evasion of tax or do not clearly reflect 
income under section 482.
    Example 29. PRS is a partnership with three equal partners, A, B, 
and C. A is a corporation that is a member of a consolidated group 
within the meaning of Sec. 1.1502-1(h). B is a subchapter S corporation 
that is wholly owned by D, an individual. C is a partnership with two 
partners, E, an individual, and F, a corporation that is a member of a 
consolidated group within the meaning of Sec. 1.1502-1(h). For purposes 
of paragraph (b)(2)(iii) of this section, in determining the after-tax 
economic benefit or detriment of an allocation to A, the tax 
consequences that result from the interaction of the allocation to A 
with the tax attributes of the consolidated group of which A is a member 
must be taken into account. In determining the after-tax economic 
benefit or detriment of an allocation to B, the tax consequences that 
result from the interaction of the allocation with the tax attributes of 
D must be taken into account. In determining the after-tax economic 
benefit or detriment of an allocation to C, the tax consequences that 
result from the interaction of the allocation with the tax attributes of 
E and the consolidated group of

[[Page 491]]

which F is a member must be taken into account.
    Example 30. (i) A, a controlled foreign corporation, and B, a 
foreign corporation that is not a controlled foreign corporation, form 
AB, a partnership organized under the laws of country X. The partnership 
agreement contains the provisions necessary to comply with the economic 
effect safe harbor of paragraph (b)(2)(ii)(b) of this section. A is 
wholly-owned by C, a domestic corporation that is not a member of a 
consolidated group within the meaning of Sec. 1.1502-1(h). B is wholly 
owned by an individual who is a citizen and resident of country X and is 
not related to A. Neither A, B, nor AB, is engaged in a trade or 
business in the United States. A and B each contribute 50 percent of the 
capital of AB. There is a strong likelihood that in each of the next 
several years AB will realize equal amounts of gross income that would 
constitute subpart F income if allocated to A, and gross income that 
would not constitute subpart F income if allocated to A (``non-subpart F 
income''). A and B agree to share bottom-line net income from AB 
equally; however, rather than share all items of gross income equally, A 
and B agree that B will be allocated all of AB's subpart F income to the 
extent of its 50 percent share of bottom-line net income. In year 1, AB 
earns $60x of income, $30x of which is subpart F income and is allocated 
to B, and $30x of which is non-subpart F income and is allocated to A.
    (ii) Although neither A nor B is subject to U.S. tax with respect to 
its distributive share of the income of AB, under paragraph 
(b)(2)(iii)(d) of this section, the tax attributes of C must be taken 
into account with respect to A for purposes of applying the tests 
described in paragraphs (b)(2)(iii)(a), (b), and (c) of this section. 
The allocations in year 1 have economic effect. However, the economic 
effect of the allocations is not substantial under the test described in 
paragraph (b)(2)(iii)(b) of this section because there was a strong 
likelihood, at the time the allocations became part of the AB 
partnership agreement, that the net increases and decreases to A's and 
B's capital accounts in year 1 would not differ substantially when 
compared to the net increases and decreases to A's and B's capital 
accounts for year 1 if the allocations were not contained in the 
partnership agreement, and the total tax liability from the income 
earned by AB in year 1 (taking into account the tax attributes of the 
allocations to C) would be reduced as a result of such allocations. 
Under paragraph (b)(3) of this section, the subpart F income and non-
subpart F income earned by AB in year 1 must each be reallocated 50 
percent to A and 50 percent to B.
    Example 31. (i) In Year 1, A and B each contribute cash of $9,000 to 
LLC, a newly formed limited liability company classified as a 
partnership for Federal tax purposes, in exchange for 100 units in LLC. 
Under the LLC agreement, each unit is entitled to participate equally in 
the profits and losses of LLC. LLC uses the cash contributions to 
purchase a nondepreciable property, Property A, for $18,000. Later in 
Year 1, at a time when Property A is valued at $20,000, LLC issues an 
option to C. The option allows C to buy 100 units in LLC for an exercise 
price of $15,000 in Year 2. C pays $1,000 to LLC to purchase the option. 
Assume that the LLC agreement satisfies the requirements of paragraph 
(b)(2) of this section and requires that, on the exercise of a 
noncompensatory option, LLC comply with the rules of paragraph 
(b)(2)(iv)(s) of this section. Also assume that C's option is a 
noncompensatory option under Sec. 1.721-2(f), and that C is not treated 
as a partner with respect to the option. Under paragraph 
(b)(2)(iv)(f)(5)(iv) of this section, LLC revalues its property in 
connection with the issuance of the option. The $2,000 unrealized gain 
in Property A is allocated equally to A and B under the LLC agreement. 
In Year 2, C exercises the option, contributing the $15,000 exercise 
price to the partnership. At the time the option is exercised, the value 
of Property A is $35,000.

------------------------------------------------------------------------
                                                         Basis    Value
------------------------------------------------------------------------
Year 1 After Issuance of the Option
------------------------------------------------------------------------
Assets:
  Cash Premium........................................   $1,000   $1,000
  Property A..........................................   18,000   20,000
                                                       -----------------
    Total.............................................   19,000   21,000
                                                       =================
Liabilities and Capital:
  Cash Premium........................................    1,000    1,000
  A...................................................    9,000   10,000
  B...................................................    9,000   10,000
                                                       -----------------
    Total.............................................   19,000   21,000
------------------------------------------------------------------------
Year 2 After Exercise of the Option
------------------------------------------------------------------------
 
Assets:
  Property A Cash.....................................   18,000   35,000
  Premium.............................................    1,000    1,000
  Exercise Price......................................   15,000   15,000
                                                       -----------------
    Total.............................................   34,000   51,000
                                                       =================
Liabilities and Capital:
  A...................................................    9,000   17,000
  B...................................................    9,000   17,000
  C...................................................   16,000   17,000
    Total.............................................   34,000   51,000
------------------------------------------------------------------------

    (ii) In lieu of revaluing LLC's property under paragraph 
(b)(2)(iv)(f) of this section immediately before the option is 
exercised, under paragraph (b)(2)(iv)(s)(1) of this section LLC must 
revalue its property under the principles of paragraph (b)(2)(iv)(f) of 
this section immediately after the exercise of the

[[Page 492]]

option. Under paragraphs (b)(2)(iv)(b) and (b)(2)(iv)(d)(4) of this 
section, C's capital account is credited with the amount paid for the 
option ($1,000) and the exercise price of the option ($15,000). Under 
the LLC agreement, however, C is entitled to LLC capital corresponding 
to 100 units of LLC (\1/3\ of LLC's capital). Immediately after the 
exercise of the option, LLC's properties are cash of $16,000 ($1,000 
premium and $15,000 exercise price contributed by C) and Property A, 
which has a value of $35,000. Thus, the total value of LLC's property is 
$51,000. C is entitled to LLC capital equal to \1/3\ of this value, or 
$17,000. As C is entitled to $1,000 more LLC capital than C's capital 
contributions to LLC, the provisions of paragraph (b)(2)(iv)(s) of this 
section apply.
    (iii) Under paragraph (b)(2)(iv)(s)(2) of this section, LLC must 
increase C's capital account from $16,000 to $17,000 by, first, 
revaluing LLC property in accordance with the principles of paragraph 
(b)(2)(iv)(f) of this section. The unrealized gain in LLC's property 
(Property A) which has not been reflected in the capital accounts 
previously is $15,000 ($35,000 value less $20,000 book value). Under 
paragraph (b)(2)(iv)(s)(2) of this section, the first $1,000 of this 
gain must be allocated to C, and the remaining $14,000 of this gain is 
allocated equally to A and B in accordance with the LLC agreement. 
Because the revaluation of LLC property under paragraph (b)(2)(iv)(s)(2) 
of this section increases C's capital account to the amount agreed on by 
the members, LLC is not required to make a capital account reallocation 
under paragraph (b)(2)(iv)(s)(3) of this section. The $17,000 of 
unrealized booked gain in Property A ($35,000 value less $18,000 basis) 
is shared $8,000 to each A and B, and $1,000 to C. Under paragraph 
(b)(2)(iv)(f)(4) of this section, the tax items from the revalued 
property must be allocated in accordance with section 704(c) principles.

----------------------------------------------------------------------------------------------------------------
                                                          A                     B                     C
                                               -----------------------------------------------------------------
                                                   Tax        Book       Tax        Book       Tax        Book
----------------------------------------------------------------------------------------------------------------
Capital account after exercise................     $9,000    $10,000     $9,000    $10,000    $16,000    $16,000
Revaluation amount............................          0      7,000          0      7,000          0      1,000
                                               -----------------------------------------------------------------
    Capital account after revaluation.........      9,000     17,000      9,000     17,000     16,000     17,000
----------------------------------------------------------------------------------------------------------------

    Example 32. (i) Assume the same facts as in Example 31, except that, 
in Year 2, before the exercise of the option, LLC sells Property A for 
$40,000, recognizing gain of $22,000. LLC does not distribute the sale 
proceeds to its partners and it has no other earnings in Year 2. With 
the proceeds ($40,000), LLC purchases Property B, a nondepreciable 
property. Also assume that C exercises the noncompensatory option at the 
beginning of Year 3 and that, at the time C exercises the option, the 
value of Property B is $41,000. In Year 3, LLC has gross income of 
$3,000 and deductions of $1,500.

------------------------------------------------------------------------
                                                         Basis    Value
------------------------------------------------------------------------
                   Year 2 After Purchase of Property B
------------------------------------------------------------------------
Assets:
  Cash Premium........................................   $1,000   $1,000
  Property B..........................................   40,000   40,000
                                                       -----------------
    Total.............................................   41,000   41,000
                                                       =================
Liabilities and Capital:
  Cash Premium........................................    1,000    1,000
  A...................................................   20,000   20,000
  B...................................................   20,000   20,000
                                                       -----------------
    Total.............................................   41,000   41,000
------------------------------------------------------------------------
                   Year 3 After Exercise of the Option
------------------------------------------------------------------------
Assets:
  Property B..........................................   40,000   41,000
  Cash................................................   16,000   16,000
                                                       -----------------
    Total.............................................   56,000   57,000
                                                       =================
Liabilities and Capital:
  A...................................................   20,000   19,000
  B...................................................   20,000   19,000
  C...................................................   16,000   19,000
                                                       -----------------
    Total.............................................   56,000   57,000
------------------------------------------------------------------------

    (ii) Under paragraphs (b)(2)(iv)(b) and (b)(2)(iv)(d)(4) of this 
section, C's capital account is credited with the amount paid for the 
option ($1,000) and the exercise price of the option ($15,000). Under 
the LLC agreement, however, C is entitled to LLC capital corresponding 
to 100 units of LLC (\1/3\ of LLC's capital). Immediately after the 
exercise of the option, LLC's properties are $16,000 cash ($1,000 option 
premium and $15,000 exercise price contributed by C) and Property B, 
which has a value of $41,000. Thus, the total value of LLC's property is 
$57,000. C is entitled to LLC capital equal to \1/3\ of this amount, or 
$19,000. As C is entitled to $3,000 more LLC capital than C's capital 
contributions to LLC, the provisions of paragraph (b)(2)(iv)(s) of this 
section apply.
    (iii) In lieu of revaluing LLC's property under paragraph 
(b)(2)(iv)(f) of this section immediately before the option is 
exercised, under paragraph (b)(2)(iv)(s)(1) of this section

[[Page 493]]

LLC must revalue its property under the principles of paragraph 
(b)(2)(iv)(f) of this section immediately after the exercise of the 
option. Under paragraph (b)(2)(iv)(s) of this section, LLC must increase 
C's capital account from $16,000 to $19,000 by, first, revaluing LLC 
property in accordance with the principles of paragraph (b)(2)(iv)(f) of 
this section, and allocating all $1,000 of unrealized gain from the 
revaluation to C under paragraph (b)(2)(iv)(s)(2). This brings C's 
capital account to $17,000.
    (iv) Next, under paragraph (b)(2)(iv)(s)(3) of this section, LLC 
must reallocate $2,000 of capital from the existing partners (A and B) 
to C to bring C's capital account to $19,000 (the capital account 
reallocation). As A and B shared equally in all items from Property A, 
whose sale gave rise to the need for the capital account reallocation, 
each member's capital account is reduced by \1/2\ of the $2,000 
reduction ($1,000).
    (v) Under paragraph (b)(2)(iv)(s)(4) of this section, beginning in 
the year in which the option is exercised, LLC must make corrective 
allocations so as to take into account the capital account reallocation. 
In Year 3, LLC has gross income of $3,000 and deductions of $1,500. 
Under paragraph (b)(4)(x)(c), LLC must allocate the book gross income of 
$3,000 equally among A, B, and C, but for tax purposes, however, LLC 
must allocate all of its gross income ($3,000) to C. LLC's book and tax 
deductions ($1,500) will then be allocated equally among A, B, and C. 
The $1,000 unrealized booked gain in Property B has been allocated 
entirely to C. Under paragraph (b)(2)(iv)(f)(4) of this section, the tax 
items from Property B must be allocated in accordance with section 
704(c) principles.

----------------------------------------------------------------------------------------------------------------
                                                          A                     B                     C
                                               -----------------------------------------------------------------
                                                   Tax        Book       Tax        Book       Tax        Book
----------------------------------------------------------------------------------------------------------------
Capital account after exercise................    $20,000    $20,000    $20,000    $20,000    $16,000    $16,000
Revaluation...................................          0          0          0          0          0      1,000
                                               -----------------------------------------------------------------
    Capital account after revaluation.........     20,000     20,000     20,000     20,000     16,000     17,000
Capital account reallocation..................          0    (1,000)          0    (1,000)          0      2,000
                                               -----------------------------------------------------------------
    Capital account after capital account          20,000     19,000     20,000     19,000     16,000     19,000
     reallocation.............................
Income allocation (Yr. 3).....................          0      1,000          0      1,000      3,000      1,000
Deduction allocation (Yr. 3)..................      (500)      (500)      (500)      (500)      (500)      (500)
                                               -----------------------------------------------------------------
    Capital account at end of year 3..........     19,500     19,500     19,500     19,500     18,500     19,500
----------------------------------------------------------------------------------------------------------------

    Example 33. (i) In Year 1, D and E each contribute cash of $10,000 
to LLC, a newly formed limited liability company classified as a 
partnership for Federal tax purposes, in exchange for 100 units in LLC. 
Under the LLC agreement, each unit is entitled to participate equally in 
the profits and losses of LLC. LLC uses the cash contributions to 
purchase two nondepreciable properties, Property A and Property B, for 
$10,000 each. Also in Year 1, at a time when Property A and Property B 
are still valued at $10,000 each, LLC issues an option to F. The option 
allows F to buy 100 units in LLC for an exercise price of $15,000 in 
Year 2. F pays $2,000 to LLC to purchase the option. Assume that the LLC 
agreement satisfies the requirements of paragraph (b)(2) of this section 
and requires that, on the exercise of a noncompensatory option, LLC 
comply with the rules of paragraph (b)(2)(iv)(s) of this section. Also 
assume that F's option is a noncompensatory option under Sec. 1.721-
2(f), and that F is not treated as a partner with respect to the option.

------------------------------------------------------------------------
                                                         Basis    Value
------------------------------------------------------------------------
                              End of Year 1
------------------------------------------------------------------------
Assets:
  Cash................................................
  Premium.............................................   $2,000   $2,000
  Property A..........................................   10,000   10,000
  Property B..........................................   10,000   10,000
                                                       -----------------
    Total.............................................   22,000   22,000
                                                       =================
Liabilities and Capital:
  Cash................................................
  Premium.............................................    2,000    2,000
  D...................................................   10,000   10,000
  E...................................................   10,000   10,000
                                                       -----------------
    Total.............................................   22,000   22,000
------------------------------------------------------------------------

    (ii) In year 2, prior to the exercise of F's option, G contributes 
$18,000 to LLC for 100 units in LLC. At the time of G's contribution, 
Property A has a value of $32,000 and a basis of $10,000, Property B has 
a value of $5,000 and a basis of $10,000, and the fair market value of 
F's option is $3,000. In year 2, LLC has no item of income, gain, loss, 
deduction, or credit.
    (iii) Upon G's admission to the partnership, the capital accounts of 
D and E (which were $10,000 each prior to G's admission) are, in

[[Page 494]]

accordance with paragraph (b)(2)(iv)(f) of this section, adjusted upward 
to reflect their shares of the unrealized appreciation in the 
partnership's property. Property A has $22,000 of unrealized gain and 
Property B has $5,000 of unrealized loss. Under paragraph 
(b)(2)(iv)(f)(1) of this section, the adjustments must be based on the 
fair market value of LLC property (taking section 7701(g) into account) 
on the date of the adjustment, as determined under paragraph 
(b)(2)(iv)(h) of this section. The fair market value of partnership 
property must be reduced by the excess of the fair market value of the 
option as of the date of the adjustment over the consideration paid by F 
to acquire the option ($3,000 -$2,000 = $1,000) (under paragraph 
(b)(2)(iv)(h)(2) of this section), but only to the extent of the 
unrealized appreciation in LLC property that has not been reflected in 
the capital accounts previously ($22,000). This $1,000 reduction is 
allocated entirely to Property A, the only asset having unrealized 
appreciation not reflected in the capital accounts previously. 
Therefore, the book value of Property A is $31,000. Accordingly, the 
revaluation adjustments must reflect only $16,000 of the net 
appreciation in LLC's property ($21,000 of unrealized gain in Property A 
and $5,000 of unrealized loss in Property B). Thus, D's and E's capital 
accounts (which were $10,000 each prior to G's admission) must be 
adjusted upward (by $8,000) to $18,000 each. The $21,000 of built-in 
gain in Property A and the $5,000 of built-in loss in Property B must be 
allocated equally between D and E in accordance with section 704(c) 
principles.

----------------------------------------------------------------------------------------------------------------
                                                                                      Option
                                                       Basis           Value        adjustment      704(b) Book
----------------------------------------------------------------------------------------------------------------
Assets:
Property A......................................         $10,000         $32,000        ($1,000)         $31,000
Property B......................................          10,000           5,000               0           5,000
Cash............................................           2,000           2,000               0           2,000
                                                 ---------------------------------------------------------------
    Subtotal....................................          22,000          39,000         (1,000)          38,000
Cash Contributed by G...........................          18,000          18,000               0          18,000
                                                 ---------------------------------------------------------------
        Total...................................          40,000          57,000         (1,000)          56,000
----------------------------------------------------------------------------------------------------------------


 
                                                                        Tax            Value        704(b) Book
----------------------------------------------------------------------------------------------------------------
Liabilities and Capital:
Cash Premium (option value).....................................         $ 2,000         $ 3,000         $ 2,000
D...............................................................          10,000          18,000          18,000
E...............................................................          10,000          18,000          18,000
G...............................................................          18,000          18,000          18,000
                                                                 -----------------------------------------------
    Total.......................................................          40,000          57,000          56,000
----------------------------------------------------------------------------------------------------------------

    (iv) In year 2, after the admission of G, when Property A still has 
a value of $32,000 and a basis of $10,000 and Property B still has a 
value of $5,000 and a basis of $10,000, F exercises the option. On the 
exercise of the option, F's capital account is credited with the amount 
paid for the option ($2,000) and the exercise price of the option 
($15,000). Under the LLC agreement, however, F is entitled to LLC 
capital corresponding to 100 units of LLC (1/4 of LLC's capital). 
Immediately after the exercise of the option, LLC's properties are worth 
$72,000 ($15,000 contributed by F, plus the value of LLC property prior 
to the exercise of the option, $57,000). F is entitled to LLC capital 
equal to 1/4 of this value, or $18,000. As F is entitled to $1,000 more 
LLC capital than F's capital contributions to LLC, the provisions of 
paragraph (b)(2)(iv)(s) of this section apply.
    (v) Under paragraph (b)(2)(iv)(s) of this section, LLC must increase 
F's capital account from $17,000 to $18,000 by, first, revaluing LLC 
property in accordance with the principles of paragraph (b)(2)(iv)(f) of 
this section and allocating the first $1,000 of unrealized gain to F. 
The total unrealized gain which has not been reflected in the capital 
accounts previously is $1,000 (the difference between the actual value 
of Property A, $32,000, and the book value of Property A, $31,000). The 
entire $1,000 of book gain is allocated to F under paragraph 
(b)(2)(iv)(s)(2) of this section. Because the revaluation of LLC 
property under paragraph (b)(2)(iv)(s)(2) of this section increases F's 
capital account to the amount agreed on by the members, LLC is not 
required to make a capital account reallocation under paragraph 
(b)(2)(iv)(s)(3) of this section. The ($5,000) of unrealized booked loss 
in Property B has been allocated ($2,500) to each D and E, and the 
$22,000 of unrealized booked gain in Property A has been allocated 
$10,500 to each D and E, and $1,000 to F. Under paragraph 
(b)(2)(iv)(f)(4) of this section, the tax items from Properties A and B 
must be allocated in accordance with section 704(c) principles.

[[Page 495]]



----------------------------------------------------------------------------------------------------------------
                                             D                   E                   G                  F
                                   -----------------------------------------------------------------------------
                                       Tax      Book       Tax      Book       Tax      Book      Tax      Book
----------------------------------------------------------------------------------------------------------------
Capital account after admission of   $10,000   $18,000   $10,000   $18,000   $18,000   $18,000        0        0
 G................................
Capital account after exercise of     10,000    18,000    10,000    18,000    18,000    18,000   17,000   17,000
 F's option.......................
Revaluation.......................         0         0         0         0         0         0        0    1,000
                                   -----------------------------------------------------------------------------
    Capital account after             10,000    18,000    10,000    18,000    18,000    18,000   17,000   18,000
     revaluation..................
----------------------------------------------------------------------------------------------------------------

    Example 34. (i) On the first day of Year 1, H, I, and J form LLC, a 
limited liability company classified as a partnership for Federal tax 
purposes. H and I each contribute $10,000 cash to LLC for 100 units of 
common interest in LLC. J contributes $10,000 cash for a convertible 
preferred interest in LLC. J's convertible preferred interest entitles J 
to receive an annual allocation and distribution of cumulative LLC net 
profits in an amount equal to 10 percent of J's unreturned capital. J's 
convertible preferred interest also entitles J to convert, in Year 3, 
J's preferred interest into 100 units of common interest. If J converts, 
J has the right to the same share of LLC capital as J would have had if 
J had held the 100 units of common interest since the formation of LLC. 
Under the LLC agreement, each unit of common interest has an equal right 
to share in any LLC net profits that remain after payment of the 
preferred return. Assume that the LLC agreement satisfies the 
requirements of paragraph (b)(2) of this section and requires that, on 
the exercise of a noncompensatory option, LLC comply with the rules of 
paragraph (b)(2)(iv)(s) of this section. Also assume that J's right to 
convert the preferred interest into a common interest qualifies as a 
noncompensatory option under Sec. 1.721-2(f), and that, prior to the 
exercise of the conversion right, the conversion right is not treated as 
a partnership interest.
    (ii) LLC uses the $30,000 to purchase Property Z, a property that is 
depreciable on a straight-line basis over 15 years. In each of Years 1 
and 2, LLC has net income of $2,500, comprised of $4,500 of gross income 
and $2,000 of depreciation. It allocates $1,000 of net income to J and 
distributes $1,000 to J in each year. LLC allocates the remaining $1,500 
of net income equally to H and I in each year but makes no distributions 
to H and I.

----------------------------------------------------------------------------------------------------------------
                                                               H                   I                   J
                                                     -----------------------------------------------------------
                                                         Tax      Book       Tax      Book       Tax      Book
----------------------------------------------------------------------------------------------------------------
Capital account upon formation......................   $10,000   $10,000   $10,000   $10,000   $10,000   $10,000
Allocation of income Years 1 and 2..................     1,500     1,500     1,500     1,500     2,000     2,000
Distributions Years 1 and 2.........................         0         0         0         0   (2,000)   (2,000)
                                                     -----------------------------------------------------------
Capital account at end of Year 2....................    11,500    11,500    11,500    11,500    10,000    10,000
----------------------------------------------------------------------------------------------------------------

    (iii) At the beginning of Year 3, when Property Z has a value of 
$38,000 and a basis of $26,000 ($30,000 original basis less $4,000 of 
depreciation) and LLC has accumulated undistributed cash of $7,000 
($9,000 gross receipts less $2,000 distributions), J converts J's 
preferred interest into a common interest. Under paragraphs 
(b)(2)(iv)(b) and (b)(2)(iv)(d)(4) of this section, J's capital account 
after the conversion equals J's capital account before the conversion, 
$10,000. On the conversion of the preferred interest, however, J is 
entitled to LLC capital corresponding to 100 units of common interest in 
LLC (\1/3\ of LLC's capital). At the time of the conversion, the total 
value of LLC property is $45,000. J is entitled to LLC capital equal to 
\1/3\ of this value, or $15,000. As J is entitled to $5,000 more LLC 
capital than J's capital account immediately after the conversion, the 
provisions of paragraph (b)(2)(iv)(s) of this section apply.

------------------------------------------------------------------------
                                                      Basis      Value
------------------------------------------------------------------------
Assets:
Property Z........................................    $26,000    $38,000
Undistributed Income..............................      7,000      7,000
                                                   ---------------------
    Total.........................................     33,000     45,000
                                                   =====================
Liabilities and Capital:
H.................................................     11,500     15,000
I.................................................     11,500     15,000
J.................................................     10,500     15,000
                                                   ---------------------
    Total.........................................     33,000     45,000
                                                   =====================
------------------------------------------------------------------------

    (iv) Under paragraph (b)(2)(iv)(s) of this section, LLC must 
increase J's capital account from $10,000 to $15,000 by, first, 
revaluing LLC property in accordance with the principles of paragraph 
(b)(2)(iv)(f) of this section, and allocating the first $5,000 of 
unrealized gain from that revaluation to J. The unrealized gain in 
Property Z is $12,000

[[Page 496]]

($38,000 value less $26,000 basis). The first $5,000 of this unrealized 
gain must be allocated to J under paragraph (b)(2)(iv)(s)(2) of this 
section. The remaining $7,000 of the unrealized gain must be allocated 
equally to H and I in accordance with the LLC agreement. Because the 
revaluation of LLC property under paragraph (b)(2)(iv)(s)(2) of this 
section increases J's capital account to the amount agreed on by the 
members, LLC is not required to make a capital account reallocation 
under paragraph (b)(2)(iv)(s)(3) of this section. The $12,000 of 
unrealized booked gain in Property Z has been allocated $3,500 to each H 
and I, and $5,000 to J. Under paragraph (b)(2)(iv)(f)(4) of this 
section, the tax items from the revalued property must be allocated in 
accordance with section 704(c) principles.

----------------------------------------------------------------------------------------------------------------
                                                               H                   I                   J
                                                     -----------------------------------------------------------
                                                         Tax      Book       Tax      Book       Tax      Book
----------------------------------------------------------------------------------------------------------------
Capital account prior to conversion.................   $11,500   $11,500   $11,500   $11,500   $10,000   $10,000
Revaluation on conversion...........................         0     3,500         0     3,500         0     5,000
                                                     -----------------------------------------------------------
    Capital account after conversion................    11,500    15,000    11,500    15,000    10,000    15,000
----------------------------------------------------------------------------------------------------------------

    Example 35. (i) On the first day of Year 1, K and L each contribute 
cash of $10,000 to LLC, a newly formed limited liability company 
classified as a partnership for Federal tax purposes, in exchange for 
100 units in LLC. Immediately after its formation, LLC borrows $10,000 
from M. Under the terms of the debt instrument, interest of $1,000 is 
unconditionally payable at the end of each year and the $10,000 stated 
principal is repayable in five years. Throughout the term of the 
indebtedness, M has the right to convert the debt instrument into 100 
units in LLC. If M converts, M has the right to the same share of LLC 
capital as M would have had if M had held 100 units in LLC since the 
formation of LLC. Under the LLC agreement, each unit participates 
equally in the profits and losses of LLC and has an equal right to share 
in LLC capital. Assume that the LLC agreement satisfies the requirements 
of paragraph (b)(2) of this section and requires that, on the exercise 
of a noncompensatory option, LLC comply with the rules of paragraph 
(b)(2)(iv)(s) of this section. Also assume that M's right to convert the 
debt into an interest in LLC qualifies as a noncompensatory option under 
Sec. 1.721-2(f), and that, prior to the exercise of the conversion 
right, M is not treated as a partner with respect to the convertible 
debt.
    (ii) LLC uses the $30,000 to purchase Property D, property that is 
depreciable on a straight-line basis over 15 years. In each of Years 1, 
2, and 3, LLC has net income of $2,000, comprised of $5,000 of gross 
income, $2,000 of depreciation, and interest expense (representing 
payments of interest on the loan from M) of $1,000. LLC allocates this 
income equally to K and L but makes no distributions to either K or L.

----------------------------------------------------------------------------------------------------------------
                                                K                         L                         M
                                   -----------------------------------------------------------------------------
                                        Tax          Book         Tax          Book         Tax          Book
----------------------------------------------------------------------------------------------------------------
Initial capital account...........      $10,000      $10,000      $10,000      $10,000            0            0
Year 1 net income.................        1,000        1,000        1,000        1,000            0            0
Year 2 net income.................        1,000        1,000        1,000        1,000            0            0
Year 3 net income.................        1,000        1,000        1,000        1,000            0            0
                                   -----------------------------------------------------------------------------
Year 4 initial capital account....       13,000       13,000       13,000       13,000            0            0
----------------------------------------------------------------------------------------------------------------

    (iii) At the beginning of Year 4, at a time when property D, LLC's 
only asset, has a value of $33,000 and basis of $24,000 ($30,000 
original basis less $6,000 depreciation in Years 1 through 3), and LLC 
has accumulated undistributed cash of $12,000 ($15,000 gross income less 
$3,000 of interest payments) in LLC, M converts the debt into a \1/3\ 
interest in LLC. Under paragraphs (b)(2)(iv)(b) and (b)(2)(iv)(d)(4) of 
this section, M's capital account after the conversion is the adjusted 
issue price of the debt immediately before M's conversion of the debt, 
$10,000, plus any accrued but unpaid qualified stated interest on the 
debt, $0. On the conversion of the debt, however, M is entitled to 
receive LLC capital corresponding to 100 units of LLC (\1/3\ of LLC's 
capital). At the time of the conversion, the total value of LLC's 
property is $45,000. M is entitled to LLC capital equal to \1/3\ of this 
value, or $15,000. As M is entitled to $5,000 more LLC capital than M's 
capital contribution to LLC ($10,000), the provisions of paragraph 
(b)(2)(iv)(s) of this section apply.

[[Page 497]]



------------------------------------------------------------------------
                                                      Basis      Value
------------------------------------------------------------------------
Assets:
    Property D....................................    $24,000    $33,000
    Cash..........................................    $12,000    $12,000
                                                   ---------------------
        Total.....................................    $36,000    $45,000
Liabilities and Capital:
    K.............................................    $13,000    $15,000
    L.............................................    $13,000    $15,000
    M.............................................    $10,000    $15,000
                                                   ---------------------
                                                      $36,000    $45,000
------------------------------------------------------------------------

    (iv) Under paragraph (b)(2)(iv)(s) of this section, LLC must 
increase M's capital account from $10,000 to $15,000 by, first, 
revaluing LLC property in accordance with the principles of paragraph 
(b)(2)(iv)(f) of this section, and allocating the first $5,000 of 
unrealized gain from that revaluation to M. The unrealized gain in 
Property D is $9,000 ($33,000 value less $24,000 basis). The first 
$5,000 of this unrealized gain must be allocated to M under paragraph 
(b)(2)(iv)(s)(2) of this section, and the remaining $4,000 of the 
unrealized gain must be allocated equally to K and L in accordance with 
the LLC agreement. Because the revaluation of LLC property under 
paragraph (b)(2)(iv)(s)(2) of this section increases M's capital account 
to the amount agreed upon by the members, LLC is not required to make a 
capital account reallocation under paragraph (b)(2)(iv)(s)(3) of this 
section. The $9,000 unrealized booked gain in property D has been 
allocated $2,000 to each K and L, and $5,000 to M. Under paragraph 
(b)(2)(iv)(f)(4) of this section, the tax items from the revalued 
property must be allocated in accordance with section 704(c) principles.

----------------------------------------------------------------------------------------------------------------
                                                                 K                   L                  M
                                                       ---------------------------------------------------------
                                                           Tax      Book       Tax      Book      Tax      Book
----------------------------------------------------------------------------------------------------------------
Year 4 capital account prior to exercise..............   $13,000   $13,000   $13,000   $13,000        0        0
Capital account after exercise........................    13,000    13,000    13,000    13,000   10,000   10,000
Revaluation...........................................         0     2,000         0     2,000        0    5,000
                                                       ---------------------------------------------------------
    Capital account after revaluation.................    13,000    15,000    13,000    15,000   10,000   15,000
----------------------------------------------------------------------------------------------------------------


    (c) Contributed property; cross-reference. See Sec. 1.704-3 for 
methods of making allocations that take into account precontribution 
appreciation or diminution in value of property contributed by a partner 
to a partnership.
    (d) Limitation on allowance of losses. (1) A partner's distributive 
share of partnership loss will be allowed only to the extent of the 
adjusted basis (before reduction by current year's losses) of such 
partner's interest in the partnership at the end of the partnership 
taxable year in which such loss occurred. A partner's share of loss in 
excess of his adjusted basis at the end of the partnership taxable year 
will not be allowed for that year. However, any loss so disallowed shall 
be allowed as a deduction at the end of the first succeeding partnership 
taxable year, and subsequent partnership taxable years, to the extent 
that the partner's adjusted basis for his partnership interest at the 
end of any such year exceeds zero (before reduction by such loss for 
such year).
    (2) In computing the adjusted basis of a partner's interest for the 
purpose of ascertaining the extent to which a partner's distributive 
share of partnership loss shall be allowed as a deduction for the 
taxable year, the basis shall first be increased under section 705(a)(1) 
and decreased under section 705(a)(2), except for losses of the taxable 
year and losses previously disallowed. If the partner's distributive 
share of the aggregate of items of loss specified in section 702(a) (1), 
(2), (3), (8), and (9) exceeds the basis of the partner's interest 
computed under the preceding sentence, the limitation on losses under 
section 704(d) must be allocated to his distributive share of each such 
loss. This allocation shall be determined by taking the proportion that 
each loss bears to the total of all such losses. For purposes of the 
preceding sentence, the total losses for the taxable year shall be the 
sum of his distributive share of losses for the current year and his 
losses disallowed and carried forward from prior years.
    (3) For the treatment of certain liabilities of the partner or 
partnership, see section 752 and Sec. 1.752-1.
    (4) The provisions of this paragraph may be illustrated by the 
following examples:

    Example 1. At the end of the partnership taxable year 1955, 
partnership AB has a loss

[[Page 498]]

of $20,000. Partner A's distributive share of this loss is $10,000. At 
the end of such year, A's adjusted basis for his interest in the 
partnership (not taking into account his distributive share of the loss) 
is $6,000. Under section 704(d), A's distributive share of partnership 
loss is allowed to him (in his taxable year within or with which the 
partnership taxable year ends) only to the extent of his adjusted basis 
of $6,000. The $6,000 loss allowed for 1955 decreases the adjusted basis 
of A's interest to zero. Assume that, at the end of partnership taxable 
year 1956, A's share of partnership income has increased the adjusted 
basis of A's interest in the partnership to $3,000 (not taking into 
account the $4,000 loss disallowed in 1955). Of the $4,000 loss 
disallowed for the partnership taxable year 1955, $3,000 is allowed A 
for the partnership taxable year 1956, thus again decreasing the 
adjusted basis of his interest to zero. If, at the end of partnership 
taxable year 1957, A has an adjusted basis of his interest of at least 
$1,000 (not taking into account the disallowed loss of $1,000), he will 
be allowed the $1,000 loss previously disallowed.
    Example 2. At the end of partnership taxable year 1955, partnership 
CD has a loss of $20,000. Partner C's distributive share of this loss is 
$10,000. The adjusted basis of his interest in the partnership (not 
taking into account his distributive share of such loss) is $6,000. 
Therefore, $4,000 of the loss is disallowed. At the end of partnership 
taxable year 1956, the partnership has no taxable income or loss, but 
owes $8,000 to a bank for money borrowed. Since C's share of this 
liability is $4,000, the basis of his partnership interest is increased 
from zero to $4,000. (See sections 752 and 722, and Sec. Sec. 1.752-1 
and 1.722-1.) C is allowed the $4,000 loss, disallowed for the preceding 
year under section 704(d), for his taxable year within or with which 
partnership taxable year 1956 ends.
    Example 3. At the end of partnership taxable year 1955, partner C 
has the following distributive share of partnership items described in 
section 702(a): Long-term capital loss, $4,000; short-term capital loss, 
$2,000; income as described in section 702(a)(9), $4,000. Partner C's 
adjusted basis for his partnership interest at the end of 1955, before 
adjustment for any of the above items, is $1,000. As adjusted under 
section 705(a)(1)(A), C's basis is increased from $1,000 to $5,000 at 
the end of the year. C's total distributive share of partnership loss is 
$6,000. Since without regard to losses, C has a basis of only $5,000, C 
is allowed only $5,000/$6,000 of each loss, that is, $3,333 of his long-
term capital loss, and $1,667 of his short-term capital loss. C must 
carry forward to succeeding taxable years $667 as a long-term capital 
loss and $333 as a short-term capital loss.

    (e) Family partnerships--(1) In general--(i) Introduction. The 
production of income by a partnership is attributable to the capital or 
services, or both, contributed by the partners. The provisions of 
subchapter K, chapter 1 of the Code, are to be read in the light of 
their relationship to section 61, which requires, inter alia, that 
income be taxed to the person who earns it through his own labor and 
skill and the utilization of his own capital.
    (ii) Recognition of donee as partner. With respect to partnerships 
in which capital is a material income-producing factor, section 
704(e)(1) provides that a person shall be recognized as a partner for 
income tax purposes if he owns a capital interest in such a partnership 
whether or not such interest is derived by purchase or gift from any 
other person. If a capital interest in a partnership in which capital is 
a material income-producing factor is created by gift, section 704(e)(2) 
provides that the distributive share of the donee under the partnership 
agreement shall be includible in his gross income, except to the extent 
that such distributive share is determined without allowance of 
reasonable compensation for services rendered to the partnership by the 
donor, and except to the extent that the portion of such distributive 
share attributable to donated capital is proportionately greater than 
the share of the donor attributable to the donor's capital. For rules of 
allocation in such cases, see subparagraph (3) of this paragraph.
    (iii) Requirement of complete transfer to donee. A donee or 
purchaser of a capital interest in a partnership is not recognized as a 
partner under the principles of section 704(e)(1) unless such interest 
is acquired in a bona fide transaction, not a mere sham for tax 
avoidance or evasion purposes, and the donee or purchaser is the real 
owner of such interest. To be recognized, a transfer must vest dominion 
and control of the partnership interest in the transferee. The existence 
of such dominion and control in the donee is to be determined from all 
the facts and circumstances. A transfer is not recognized if the 
transferor retains such incidents of ownership that the transferee has 
not acquired full and complete ownership of the partnership interest. 
Transactions between members of a family will be

[[Page 499]]

closely scrutinized, and the circumstances, not only at the time of the 
purported transfer but also during the periods preceding and following 
it, will be taken into consideration in determining the bona fides or 
lack of bona fides of the purported gift or sale. A partnership may be 
recognized for income tax purposes as to some partners but not as to 
others.
    (iv) Capital as a material income-producing factor. For purposes of 
section 704(e)(1), the determination as to whether capital is a material 
income-producing factor must be made by reference to all the facts of 
each case. Capital is a material income-producing factor if a 
substantial portion of the gross income of the business is attributable 
to the employment of capital in the business conducted by the 
partnership. In general, capital is not a material income-producing 
factor where the income of the business consists principally of fees, 
commissions, or other compensation for personal services performed by 
members or employees of the partnership. On the other hand, capital is 
ordinarily a material income-producing factor if the operation of the 
business requires substantial inventories or a substantial investment in 
plant, machinery, or other equipment.
    (v) Capital interest in a partnership. For purposes of section 
704(e), a capital interest in a partnership means an interest in the 
assets of the partnership, which is distributable to the owner of the 
capital interest upon his withdrawal from the partnership or upon 
liquidation of the partnership. The mere right to participate in the 
earnings and profits of a partnership is not a capital interest in the 
partnership.
    (2) Basic tests as to ownership--(i) In general. Whether an alleged 
partner who is a donee of a capital interest in a partnership is the 
real owner of such capital interest, and whether the donee has dominion 
and control over such interest, must be ascertained from all the facts 
and circumstances of the particular case. Isolated facts are not 
determinative; the reality of the donee's ownership is to be determined 
in the light of the transaction as a whole. The execution of legally 
sufficient and irrevocable deeds or other instruments of gift under 
State law is a factor to be taken into account but is not determinative 
of ownership by the donee for the purposes of section 704(e). The 
reality of the transfer and of the donee's ownership of the property 
attributed to him are to be ascertained from the conduct of the parties 
with respect to the alleged gift and not by any mechanical or formal 
test. Some of the more important factors to be considered in determining 
whether the donee has acquired ownership of the capital interest in a 
partnership are indicated in subdivisions (ii) to (x), inclusive, of 
this subparagraph.
    (ii) Retained controls. The donor may have retained such controls of 
the interest which he has purported to transfer to the donee that the 
donor should be treated as remaining the substantial owner of the 
interest. Controls of particular significance include, for example, the 
following:
    (a) Retention of control of the distribution of amounts of income or 
restrictions on the distributions of amounts of income (other than 
amounts retained in the partnership annually with the consent of the 
partners, including the donee partner, for the reasonable needs of the 
business). If there is a partnership agreement providing for a managing 
partner or partners, then amounts of income may be retained in the 
partnership without the acquiescence of all the partners if such amounts 
are retained for the reasonable needs of the business.
    (b) Limitation of the right of the donee to liquidate or sell his 
interest in the partnership at his discretion without financial 
detriment.
    (c) Retention of control of assets essential to the business (for 
example, through retention of assets leased to the alleged partnership).
    (d) Retention of management powers inconsistent with normal 
relationships among partners. Retention by the donor of control of 
business management or of voting control, such as is common in ordinary 
business relationships, is not by itself to be considered as 
inconsistent with normal relationships among partners, provided the 
donee is free to liquidate his interest at

[[Page 500]]

his discretion without financial detriment. The donee shall not be 
considered free to liquidate his interest unless, considering all the 
facts, it is evident that the donee is independent of the donor and has 
such maturity and understanding of his rights as to be capable of 
deciding to exercise, and capable of exercising, his right to withdraw 
his capital interest from the partnership.

The existence of some of the indicated controls, though amounting to 
less than substantial ownership retained by the donor, may be considered 
along with other facts and circumstances as tending to show the lack of 
reality of the partnership interest of the donee.
    (iii) Indirect controls. Controls inconsistent with ownership by the 
donee may be exercised indirectly as well as directly, for example, 
through a separate business organization, estate, trust, individual, or 
other partnership. Where such indirect controls exist, the reality of 
the donee's interest will be determined as if such controls were 
exercisable directly.
    (iv) Participation in management. Substantial participation by the 
donee in the control and management of the business (including 
participation in the major policy decisions affecting the business) is 
strong evidence of a donee partner's exercise of dominion and control 
over his interest. Such participation presupposes sufficient maturity 
and experience on the part of the donee to deal with the business 
problems of the partnership.
    (v) Income distributions. The actual distribution to a donee partner 
of the entire amount or a major portion of his distributive share of the 
business income for the sole benefit and use of the donee is substantial 
evidence of the reality of the donee's interest, provided the donor has 
not retained controls inconsistent with real ownership by the donee. 
Amounts distributed are not considered to be used for the donee's sole 
benefit if, for example, they are deposited, loaned, or invested in such 
manner that the donor controls or can control the use or enjoyment of 
such funds.
    (vi) Conduct of partnership business. In determining the reality of 
the donee's ownership of a capital interest in a partnership, 
consideration shall be given to whether the donee is actually treated as 
a partner in the operation of the business. Whether or not the donee has 
been held out publicly as a partner in the conduct of the business, in 
relations with customers, or with creditors or other sources of 
financing, is of primary significance. Other factors of significance in 
this connection include:
    (a) Compliance with local partnership, fictitious names, and 
business registration statutes.
    (b) Control of business bank accounts.
    (c) Recognition of the donee's rights in distributions of 
partnership property and profits.
    (d) Recognition of the donee's interest in insurance policies, 
leases, and other business contracts and in litigation affecting 
business.
    (e) The existence of written agreements, records, or memoranda, 
contemporaneous with the taxable year or years concerned, establishing 
the nature of the partnership agreement and the rights and liabilities 
of the respective partners.
    (f) Filing of partnership tax returns as required by law.


However, despite formal compliance with the above factors, other 
circumstances may indicate that the donor has retained substantial 
ownership of the interest purportedly transferred to the donee.
    (vii) Trustees as partners. A trustee may be recognized as a partner 
for income tax purposes under the principles relating to family 
partnerships generally as applied to the particular facts of the trust-
partnership arrangement. A trustee who is unrelated to and independent 
of the grantor, and who participates as a partner and receives 
distribution of the income distributable to the trust, will ordinarily 
be recognized as the legal owner of the partnership interest which he 
holds in trust unless the grantor has retained controls inconsistent 
with such ownership. However, if the grantor is the trustee, or if the 
trustee is amenable to the will of the grantor, the provisions of the 
trust instrument (particularly as to whether the trustee is subject to 
the responsibilities of a fiduciary), the provisions of the partnership 
agreement,

[[Page 501]]

and the conduct of the parties must all be taken into account in 
determining whether the trustee in a fiduciary capacity has become the 
real owner of the partnership interest. Where the grantor (or person 
amenable to his will) is the trustee, the trust may be recognized as a 
partner only if the grantor (or such other person) in his participation 
in the affairs of the partnership actively represents and protects the 
interests of the beneficiaries in accordance with the obligations of a 
fiduciary and does not subordinate such interests to the interests of 
the grantor. Furthermore, if the grantor (or person amenable to his 
will) is the trustee, the following factors will be given particular 
consideration:
    (a) Whether the trust is recognized as a partner in business 
dealings with customers and creditors, and
    (b) Whether, if any amount of the partnership income is not properly 
retained for the reasonable needs of the business, the trust's share of 
such amount is distributed to the trust annually and paid to the 
beneficiaries or reinvested with regard solely to the interests of the 
beneficiaries.
    (viii) Interests (not held in trust) of minor children. Except where 
a minor child is shown to be competent to manage his own property and 
participate in the partnership activities in accordance with his 
interest in the property, a minor child generally will not be recognized 
as a member of a partnership unless control of the property is exercised 
by another person as fiduciary for the sole benefit of the child, and 
unless there is such judicial supervision of the conduct of the 
fiduciary as is required by law. The use of the child's property or 
income for support for which a parent is legally responsible will be 
considered a use for the parent's benefit. ``Judicial supervision of the 
conduct of the fiduciary'' includes filing of such accountings and 
reports as are required by law of the fiduciary who participates in the 
affairs of the partnership on behalf of the minor. A minor child will be 
considered as competent to manage his own property if he actually has 
sufficient maturity and experience to be treated by disinterested 
persons as competent to enter business dealings and otherwise to conduct 
his affairs on a basis of equality with adult persons, notwithstanding 
legal disabilities of the minor under State law.
    (ix) Donees as limited partners. The recognition of a donee's 
interest in a limited partnership will depend, as in the case of other 
donated interests, on whether the transfer of property is real and on 
whether the donee has acquired dominion and control over the interest 
purportedly transferred to him. To be recognized for Federal income tax 
purposes, a limited partnership must be organized and conducted in 
accordance with the requirements of the applicable State limited-
partnership law. The absence of services and participation in management 
by a donee in a limited partnership is immaterial if the limited 
partnership meets all the other requirements prescribed in this 
paragraph. If the limited partner's right to transfer or liquidate his 
interest is subject to substantial restrictions (for example, where the 
interest of the limited partner is not assignable in a real sense or 
where such interest may be required to be left in the business for a 
long term of years), or if the general partner retains any other control 
which substantially limits any of the rights which would ordinarily be 
exercisable by unrelated limited partners in normal business 
relationships, such restrictions on the right to transfer or liquidate, 
or retention of other control, will be considered strong evidence as to 
the lack of reality of ownership by the donee.
    (x) Motive. If the reality of the transfer of interest is 
satisfactorily established, the motives for the transaction are 
generally immaterial. However, the presence or absence of a tax-
avoidance motive is one of many factors to be considered in determining 
the reality of the ownership of a capital interest acquired by gift.
    (3) Allocation of family partnership income--(i) In general. (a) 
Where a capital interest in a partnership in which capital is a material 
income-producing factor is created by gift, the donee's distributive 
share shall be includible in his gross income, except to the extent that 
such share is determined without allowance of reasonable compensation 
for services rendered to the partnership by the donor, and except to the 
extent

[[Page 502]]

that the portion of such distributive share attributable to donated 
capital is proportionately greater than the distributive share 
attributable to the donor's capital. For the purpose of section 704, a 
capital interest in a partnership purchased by one member of a family 
from another shall be considered to be created by gift from the seller, 
and the fair market value of the purchased interest shall be considered 
to be donated capital. The ``family'' of any individual, for the purpose 
of the preceding sentence, shall include only his spouse, ancestors, and 
lineal descendants, and any trust for the primary benefit of such 
persons.
    (b) To the extent that the partnership agreement does not allocate 
the partnership income in accordance with (a) of this subdivision, the 
distributive shares of the partnership income of the donor and donee 
shall be reallocated by making a reasonable allowance for the services 
of the donor and by attributing the balance of such income (other than a 
reasonable allowance for the services, if any, rendered by the donee) to 
the partnership capital of the donor and donee. The portion of income, 
if any, thus attributable to partnership capital for the taxable year 
shall be allocated between the donor and donee in accordance with their 
respective interests in partnership capital.
    (c) In determining a reasonable allowance for services rendered by 
the partners, consideration shall be given to all the facts and 
circumstances of the business, including the fact that some of the 
partners may have greater managerial responsibility than others. There 
shall also be considered the amount that would ordinarily be paid in 
order to obtain comparable services from a person not having an interest 
in the partnership.
    (d) The distributive share of partnership income, as determined 
under (b) of this subdivision, of a partner who rendered services to the 
partnership before entering the Armed Forces of the United States shall 
not be diminished because of absence due to military service. Such 
distributive share shall be adjusted to reflect increases or decreases 
in the capital interest of the absent partner. However, the partners may 
by agreement allocate a smaller share to the absent partner due to his 
absence.
    (ii) Special rules. (a) The provisions of subdivision (i) of this 
subparagraph, relating to allocation of family partnership income, are 
applicable where the interest in the partnership is created by gift, 
indirectly or directly. Where the partnership interest is created 
indirectly, the term donor may include persons other than the nominal 
transferor. This rule may be illustrated by the following examples:

    Example 1. A father gives property to his son who shortly thereafter 
conveys the property to a partnership consisting of the father and the 
son. The partnership interest of the son may be considered created by 
gift and the father may be considered the donor of the son's partnership 
interest.
    Example 2. A father, the owner of a business conducted as a sole 
proprietorship, transfers the business to a partnership consisting of 
his wife and himself. The wife subsequently conveys her interest to 
their son. In such case, the father, as well as the mother, may be 
considered the donor of the son's partnership interest.
    Example 3. A father makes a gift to his son of stock in the family 
corporation. The corporation is subsequently liquidated. The son later 
contributes the property received in the liquidation of the corporation 
to a partnership consisting of his father and himself. In such case, for 
purposes of section 704, the son's partnership interest may be 
considered created by gift and the father may be considered the donor of 
his son's partnership interest.

    (b) The allocation rules set forth in section 704(e) and subdivision 
(i) of this subparagraph apply in any case in which the transfer or 
creation of the partnership interest has any of the substantial 
characteristics of a gift. Thus, allocation may be required where 
transfer of a partnership interest is made between members of a family 
(including collaterals) under a purported purchase agreement, if the 
characteristics of a gift are ascertained from the terms of the purchase 
agreement, the terms of any loan or credit arrangements made to finance 
the purchase, or from other relevant data.
    (c) In the case of a limited partnership, for the purpose of the 
allocation provisions of subdivision (i) of this subparagraph, 
consideration shall be given

[[Page 503]]

to the fact that a general partner, unlike a limited partner, risks his 
credit in the partnership business.
    (4) Purchased interest--(i) In general. If a purported purchase of a 
capital interest in a partnership does not meet the requirements of 
subdivision (ii) of this subparagraph, the ownership by the transferee 
of such capital interest will be recognized only if it qualifies under 
the requirements applicable to a transfer of a partnership interest by 
gifts. In a case not qualifying under subdivision (ii) of this 
subparagraph, if payment of any part of the purchase price is made out 
of partnership earnings, the transaction may be regarded in the same 
light as a purported gift subject to deferred enjoyment of income. Such 
a transaction may be lacking in reality either as a gift or as a bona 
fide purchase.
    (ii) Tests as to reality of purchased interests. A purchase of a 
capital interest in a partnership, either directly or by means of a loan 
or credit extended by a member of the family, will be recognized as bona 
fide if:
    (a) It can be shown that the purchase has the usual characteristics 
of an arm's-length transaction, considering all relevant factors, 
including the terms of the purchase agreement (as to price, due date of 
payment, rate of interest, and security, if any) and the terms of any 
loan or credit arrangement collateral to the purchase agreement; the 
credit standing of the purchaser (apart from relationship to the seller) 
and the capacity of the purchaser to incur a legally binding obligation; 
or
    (b) It can be shown, in the absence of characteristics of an arm's-
length transaction, that the purchase was genuinely intended to promote 
the success of the business by securing participation of the purchaser 
in the business or by adding his credit to that of the other 
participants.

However, if the alleged purchase price or loan has not been paid or the 
obligation otherwise discharged, the factors indicated in (a) and (b) of 
this subdivision shall be taken into account only as an aid in 
determining whether a bona fide purchase or loan obligation existed.

[T.D. 6500, 25 FR 11814, Nov. 26, 1960]

    Editorial Note: For Federal Register citations affecting Sec. 
1.704-1, see the List of CFR Sections Affected, which appears in the 
Finding Aids section of the printed volume and at www.fdsys.gov.



Sec. 1.704-2  Allocations attributable to nonrecourse liabilities.

    (a) Table of contents. This paragraph contains a listing of the 
major headings of this Sec. 1.704-2.

   Sec. 1.704-2 Allocations attributable to nonrecourse liabilities.

    (a) Table of contents.
    (b) General principles and definitions.
    (1) Definition of and allocations of nonrecourse deductions.
    (2) Definition of and allocations pursuant to a minimum gain 
chargeback.
    (3) Definition of nonrecourse liability.
    (4) Definition of partner nonrecourse debt.
    (c) Amount of nonrecourse deductions.
    (d) Partnership minimum gain.
    (1) Amount of partnership minimum gain.
    (2) Property subject to more than one liability.
    (i) In general.
    (ii) Allocating liabilities.
    (3) Partnership minimum gain if there is a book/tax disparity.
    (4) Special rule for year of revaluation.
    (e) Requirements to be satisfied.
    (f) Minimum gain chargeback requirement.
    (1) In general.
    (2) Exception for certain conversions and refinancings.
    (3) Exception for certain capital contributions.
    (4) Waiver for certain income allocations that fail to meet minimum 
gain chargeback requirement if minimum gain chargeback distorts economic 
arrangement.
    (5) Additional exceptions.
    (6) Partnership items subject to the minimum gain chargeback 
requirement.
    (7) Examples.
    (g) Shares of partnership minimum gain.
    (1) Partner's share of partnership minimum gain.
    (2) Partner's share of the net decrease in partnership minimum gain.
    (3) Conversions of recourse or partner nonrecourse debt into 
nonrecourse debt.
    (h) Distribution of nonrecourse liability proceeds allocable to an 
increase in partnership minimum gain.
    (1) In general.
    (2) Distribution allocable to nonrecourse liability proceeds.
    (3) Option when there is an obligation to restore.
    (4) Carryover to immediately succeeding taxable year.

[[Page 504]]

    (i) Partnership nonrecourse liabilities where a partner bears the 
economic risk of loss.
    (1) In general.
    (2) Definition of and determination of partner nonrecourse 
deductions.
    (3) Determination of partner nonrecourse debt minimum gain.
    (4) Chargeback of partner nonrecourse debt minimum gain.
    (5) Partner's share of partner nonrecourse debt minimum gain.
    (6) Distribution of partner nonrecourse debt proceeds allocable to 
an increase in partner nonrecourse debt minimum gain.
    (j) Ordering rules.
    (1) Treatment of partnership losses and deductions.
    (i) Partner nonrecourse deductions.
    (ii) Partnership nonrecourse deductions.
    (iii) Carryover to succeeding taxable year.
    (2) Treatment of partnership income and gains.
    (i) Minimum gain chargeback.
    (ii) Chargeback attributable to decrease in partner nonrecourse debt 
minimum gain.
    (iii) Carryover to succeeding taxable year.
    (k) Tiered partnerships.
    (1) Increase in upper-tier partnership's minimum gain.
    (2) Decrease in upper-tier partnership's minimum gain.
    (3) Nonrecourse debt proceeds distributed from the lower-tier 
partnership to the upper-tier partnership.
    (4) Nonrecourse deductions of lower-tier partnership treated as 
depreciation by upper-tier partnership.
    (5) Coordination with partner nonrecourse debt rules.
    (l) Effective dates.
    (1) In general.
    (i) Prospective application.
    (ii) Partnerships subject to temporary regulations.
    (iii) Partnerships subject to former regulations.
    (2) Special rule applicable to pre-January 30, 1989, related party 
nonrecourse debt.
    (3) Transition rule for pre-March 1, 1984, partner nonrecourse debt.
    (4) Election.
    (m) Examples.

    (b) General principles and definitions--(1) Definition of and 
allocations of nonrecourse deductions. Allocations of losses, 
deductions, or section 705(a)(2)(B) expenditures attributable to 
partnership nonrecourse liabilities (``nonrecourse deductions'') cannot 
have economic effect because the creditor alone bears any economic 
burden that corresponds to those allocations. Thus, nonrecourse 
deductions must be allocated in accordance with the partners' interests 
in the partnership. Paragraph (e) of this section provides a test that 
deems allocations of nonrecourse deductions to be in accordance with the 
partners' interests in the partnership. If that test is not satisfied, 
the partners' distributive shares of nonrecourse deductions are 
determined under Sec. 1.704-1(b)(3), according to the partners' overall 
economic interests in the partnership. See also paragraph (i) of this 
section for special rules regarding the allocation of deductions 
attributable to nonrecourse liabilities for which a partner bears the 
economic risk of loss (as described in paragraph (b)(4) of this 
section).
    (2) Definition of and allocations pursuant to a minimum gain 
chargeback. To the extent a nonrecourse liability exceeds the adjusted 
tax basis of the partnership property it encumbers, a disposition of 
that property will generate gain that at least equals that excess 
(``partnership minimum gain''). An increase in partnership minimum gain 
is created by a decrease in the adjusted tax basis of property 
encumbered by a nonrecourse liability below the amount of that liability 
and by a partnership nonrecourse borrowing that exceeds the adjusted tax 
basis of the property encumbered by the borrowing. Partnership minimum 
gain decreases as reductions occur in the amount by which the 
nonrecourse liability exceeds the adjusted tax basis of the property 
encumbered by the liability. Allocations of gain attributable to a 
decrease in partnership minimum gain (a ``minimum gain chargeback,'' as 
required under paragraph (f) of this section) cannot have economic 
effect because the gain merely offsets nonrecourse deductions previously 
claimed by the partnership. Thus, to avoid impairing the economic effect 
of other allocations, allocations pursuant to a minimum gain chargeback 
must be made to the partners that either were allocated nonrecourse 
deductions or received distributions of proceeds attributable to a 
nonrecourse borrowing. Paragraph (e) of this section provides a test 
that, if met, deems allocations of partnership income pursuant to a 
minimum gain chargeback to be in accordance with

[[Page 505]]

the partners' interests in the partnership. If property encumbered by a 
nonrecourse liability is reflected on the partnership's books at a value 
that differs from its adjusted tax basis, paragraph (d)(3) of this 
section provides that minimum gain is determined with reference to the 
property's book basis. See also paragraph (i)(4) of this section for 
special rules regarding the minimum gain chargeback requirement for 
partner nonrecourse debt.
    (3) Definition of nonrecourse liability. Nonrecourse liability means 
a nonrecourse liability as defined in Sec. 1.752-1(a)(2) or a Sec. 
1.752-7 liability (as defined in Sec. 1.752-7(b)(3)(i)) assumed by the 
partnership from a partner on or after June 24, 2003.
    (4) Definition of partner nonrecourse debt. Partner nonrecourse debt 
or partner nonrecourse liability means any partnership liability to the 
extent the liability is nonrecourse for purposes of Sec. 1.1001-2, and 
a partner or related person (within the meaning of Sec. 1.752-4(b)) 
bears the economic risk of loss under Sec. 1.752-2 because, for 
example, the partner or related person is the creditor or a guarantor.
    (c) Amount of nonrecourse deductions. The amount of nonrecourse 
deductions for a partnership taxable year equals the net increase in 
partnership minimum gain during the year (determined under paragraph (d) 
of this section), reduced (but not below zero) by the aggregate 
distributions made during the year of proceeds of a nonrecourse 
liability that are allocable to an increase in partnership minimum gain 
(determined under paragraph (h) of this section). See paragraph (m), 
Examples (1)(i) and (vi), (2), and (3) of this section. However, 
increases in partnership minimum gain resulting from conversions, 
refinancings, or other changes to a debt instrument (as described in 
paragraph (g)(3)) do not generate nonrecourse deductions. Generally, 
nonrecourse deductions consist first of certain depreciation or cost 
recovery deductions and then, if necessary, a pro rata portion of other 
partnership losses, deductions, and section 705(a)(2)(B) expenditures 
for that year; excess nonrecourse deductions are carried over. See 
paragraphs (j)(1) (ii) and (iii) of this section for more specific 
ordering rules. See also paragraph (m), Example (1)(iv) of this section.
    (d) Partnership minimum gain--(1) Amount of partnership minimum 
gain. The amount of partnership minimum gain is determined by first 
computing for each partnership nonrecourse liability any gain the 
partnership would realize if it disposed of the property subject to that 
liability for no consideration other than full satisfaction of the 
liability, and then aggregating the separately computed gains. The 
amount of partnership minimum gain includes minimum gain arising from a 
conversion, refinancing, or other change to a debt instrument, as 
described in paragraph (g)(3) of this section, only to the extent a 
partner is allocated a share of that minimum gain. For any partnership 
taxable year, the net increase or decrease in partnership minimum gain 
is determined by comparing the partnership minimum gain on the last day 
of the immediately preceding taxable year with the partnership minimum 
gain on the last day of the current taxable year. See paragraph (m), 
Examples (1) (i) and (iv), (2), and (3) of this section.
    (2) Property subject to more than one liability. (i) In general. If 
property is subject to more than one liability, only the portion of the 
property's adjusted tax basis that is allocated to a nonrecourse 
liability under paragraph (d)(2)(ii) of this section is used to compute 
minimum gain with respect to that liability.
    (ii) Allocating liabilities. If property is subject to two or more 
liabilities of equal priority, the property's adjusted tax basis is 
allocated among the liabilities in proportion to their outstanding 
balances. If property is subject to two or more liabilities of unequal 
priority, the adjusted tax basis is allocated first to the liability of 
the highest priority to the extent of its outstanding balance and then 
to each liability in descending order of priority to the extent of its 
outstanding balance, until fully allocated. See paragraph (m), Example 
(1) (v) and (vii) of this section.
    (3) Partnership minimum gain if there is a book/tax disparity. If 
partnership property subject to one or more nonrecourse liabilities is, 
under Sec. 1.704-1(b)(2)(iv) (d), (f), or (r), reflected on the

[[Page 506]]

partnership's books at a value that differs from its adjusted tax basis, 
the determinations under this section are made with reference to the 
property's book value. See section 704(c) and Sec. 1.704-1(b)(4)(i) for 
principles that govern the treatment of a partner's share of minimum 
gain that is eliminated by the revaluation. See also paragraph (m), 
Example (3) of this section.
    (4) Special rule for year of revaluation. If the partners' capital 
accounts are increased pursuant to Sec. 1.704-1(b)(2)(iv) (d), (f), or 
(r) to reflect a revaluation of partnership property subject to a 
nonrecourse liability, the net increase or decrease in partnership 
minimum gain for the partnership taxable year of the revaluation is 
determined by:
    (i) First calculating the net decrease or increase in partnership 
minimum gain using the current year's book values and the prior year's 
partnership minimum gain amount; and
    (ii) Then adding back any decrease in minimum gain arising solely 
from the revaluation.


See paragraph (m), Example (3)(iii) of this section. If the partners' 
capital accounts are decreased to reflect a revaluation, the net 
increases or decreases in partnership minimum gain are determined in the 
same manner as in the year before the revaluation, but by using book 
values rather than adjusted tax bases. See section 7701(g) and Sec. 
1.704-1(b)(2)(iv)(f)(1) (property being revalued cannot be booked down 
below the amount of any nonrecourse liability to which the property is 
subject).
    (e) Requirements to be satisfied. Allocations of nonrecourse 
deductions are deemed to be in accordance with the partners' interests 
in the partnership only if--
    (1) Throughout the full term of the partnership requirements (1) and 
(2) of Sec. 1.704-1(b)(2)(ii)(b) are satisfied (i.e., capital accounts 
are maintained in accordance with Sec. 1.704-1(b)(2)(iv) and 
liquidating distributions are required to be made in accordance with 
positive capital account balances), and requirement (3) of either Sec. 
1.704-1(b)(2)(ii)(b) or Sec. 1.704-1(b)(2)(ii)(d) is satisfied (i.e., 
partners with deficit capital accounts have an unconditional deficit 
restoration obligation or agree to a qualified income offset);
    (2) Beginning in the first taxable year of the partnership in which 
there are nonrecourse deductions and thereafter throughout the full term 
of the partnership, the partnership agreement provides for allocations 
of nonrecourse deductions in a manner that is reasonably consistent with 
allocations that have substantial economic effect of some other 
significant partnership item attributable to the property securing the 
nonrecourse liabilities;
    (3) Beginning in the first taxable year of the partnership that it 
has nonrecourse deductions or makes a distribution of proceeds of a 
nonrecourse liability that are allocable to an increase in partnership 
minimum gain, and thereafter throughout the full term of the 
partnership, the partnership agreement contains a provision that 
complies with the minimum gain chargeback requirement of paragraph (f) 
of this section; and
    (4) All other material allocations and capital account adjustments 
under the partnership agreement are recognized under Sec. 1.704-1(b) 
(without regard to whether allocations of adjusted tax basis and amount 
realized under section 613A(c)(7)(D) are recognized under Sec. 1.704-
1(b)(4)(v)).
    (f) Minimum gain chargeback requirement--(1) In general. If there is 
a net decrease in partnership minimum gain for a partnership taxable 
year, the minimum gain chargeback requirement applies and each partner 
must be allocated items of partnership income and gain for that year 
equal to that partner's share of the net decrease in partnership minimum 
gain (within the meaning of paragraph (g)(2)).
    (2) Exception for certain conversions and refinancings. A partner is 
not subject to the minimum gain chargeback requirement to the extent the 
partner's share of the net decrease in partnership minimum gain is 
caused by a recharacterization of nonrecourse partnership debt as 
partially or wholly recourse debt or partner nonrecourse debt, and the 
partner bears the economic risk of loss (within the meaning of Sec. 
1.752-2) for the liability.
    (3) Exception for certain capital contributions. A partner is not 
subject to

[[Page 507]]

the minimum gain chargeback requirement to the extent the partner 
contributes capital to the partnership that is used to repay the 
nonrecourse liability or is used to increase the basis of the property 
subject to the nonrecourse liability, and the partner's share of the net 
decrease in partnership minimum gain results from the repayment or the 
increase to the property's basis. See paragraph (m), Example (1)(iv) of 
this section.
    (4) Waiver for certain income allocations that fail to meet minimum 
gain chargeback requirement if minimum gain chargeback distorts economic 
arrangement. In any taxable year that a partnership has a net decrease 
in partnership minimum gain, if the minimum gain chargeback requirement 
would cause a distortion in the economic arrangement among the partners 
and it is not expected that the partnership will have sufficient other 
income to correct that distortion, the Commissioner has the discretion, 
if requested by the partnership, to waive the minimum gain chargeback 
requirement. The following facts must be demonstrated in order for a 
request for a waiver to be considered:
    (i) The partners have made capital contributions or received net 
income allocations that have restored the previous nonrecourse 
deductions and the distributions attributable to proceeds of a 
nonrecourse liability; and
    (ii) The minimum gain chargeback requirement would distort the 
partners' economic arrangement as reflected in the partnership agreement 
and as evidenced over the term of the partnership by the partnership's 
allocations and distributions and the partners' contributions.
    (5) Additional exceptions. The Commissioner may, by revenue ruling, 
provide additional exceptions to the minimum gain chargeback 
requirement.
    (6) Partnership items subject to the minimum gain chargeback 
requirement. Any minimum gain chargeback required for a partnership 
taxable year consists first of a pro rata portion of certain gains 
recognized from the disposition of partnership property subject to one 
or more partnership nonrecourse liabilities and income from the 
discharge of indebtedness relating to one or more partnership 
nonrecourse liabilities to which partnership property is subject, and 
then, if necessary, consists of a pro rata portion of the partnership's 
other items of income and gain for that year. If the amount of the 
minimum gain chargeback requirement exceeds the partnership's income and 
gains for the taxable year, the excess carries over. See paragraphs 
(j)(2)(i) and (j)(2)(iii) of this section for more specific ordering 
rules.
    (7) Examples. The following examples illustrate the provisions in 
Sec. 1.704-2(f).

    Example 1. Partnership AB consists of two partners, limited partner 
A and general partner B. Partner A contributes $90 and Partner B 
contributes $10 to the partnership. The partnership agreement has a 
minimum gain chargeback provision and provides that, except as otherwise 
required by section 704(c), all losses will be allocated 90 percent to A 
and 10 percent to B; and that all income will be allocated first to 
restore previous losses and thereafter 50 percent to A and 50 percent to 
B. Distributions are made first to return initial capital to the 
partners and then 50 percent to A and 50 percent to B. Final 
distributions are made in accordance with capital account balances. The 
partnership borrows $200 on a nonrecourse basis from an unrelated third 
party and purchases an asset for $300. The partnership's only tax item 
for each of the first three years in $100 of depreciation on the asset. 
A's and B's shares of minimum gain (under paragraph (g) of this section) 
and deficit capital account balances are $180 and $20 respectively at 
the end of the third year. In the fourth year, the partnership earns 
$400 of net operating income and allocates the first $300 to restore the 
previous losses (i.e., $270 to A and $30 to B); the last $100 is 
allocated $50 each. The partnership distributes $200 of the available 
cash that same year; the first $100 is distributed $90 to A and $10 to B 
to return their capital contributions; the last $100 is distributed $50 
each to reflect their ratio for sharing profits.

------------------------------------------------------------------------
                                                           A        B
------------------------------------------------------------------------
Capital account on formation..........................     $90      $10
    Less: Net loss in years 1-3.......................   ($270)    ($30)
                                                       -----------------
Capital account at end of year 3......................   ($180)    ($20)
Allocation of operating income to restore nonrecourse     $180      $20
 deductions...........................................
                                                       =================
Allocation of operating income to restore capital          $90      $10
 contributions........................................
Allocation of operating income to reflect profits.....     $50      $50
                                                       -----------------
Capital accounts after allocation of operating income.    $140      $60
Distribution reflecting capital contribution..........    ($90)    ($10)

[[Page 508]]

 
Distribution in profit-sharing ratio..................    ($50)    ($50)
                                                       -----------------
Capital accounts following distribution...............     ($0)     ($0)
------------------------------------------------------------------------


In the fifth year, the partnership sells the property for $300 and 
realizes $300 of gain. $200 of the proceeds are used to pay the 
nonrecourse lender. The partnership has $300 to distribute, and the 
partners expect to share that equally. Absent a waiver under paragraph 
(f)(4) of this section, the minimum gain chargeback would require the 
partnership to allocate the first $200 of the gain $180 to A and $20 to 
B, which would distort their economic arrangement. This allocation, 
together with the allocation of the $100 profit $50 to each partner, 
would result in A having a positive capital account balance of $230 and 
B having a positive capital account balance of $70. The allocation of 
income in year 4 in effect anticipated the minimum gain chargeback that 
did not occur until year 5. Assuming the partnership would not have 
sufficient other income to correct the distortion that would otherwise 
result, the partnership may request that the Commissioner exercise his 
or her discretion to waive the minimum gain chargeback requirement and 
recognize allocations that would allow A and B to share equally the gain 
on the sale of the property. These allocations would bring the partners' 
capital accounts to $150 each, allowing them to share the last $300 
equally. The Commissioner may, in his or her discretion, permit this 
allocation pursuant to paragraph (f)(4) of this section because the 
minimum gain chargeback would distort the partners' economic arrangement 
over the term of the partnership as reflected in the partnership 
agreement and as evidenced by the partners' contributions and the 
partnership's allocations and distributions.
    Example 2. A and B form a partnership, contribute $25 each to the 
partnership's capital, and agree to share all losses and profits 50 
percent each. Neither partner has an unconditional deficit restoration 
obligation and all the requirements in paragraph (e) of this section are 
met. The partnership obtains a nonrecourse loan from an unrelated third 
party of $100 and purchases two assets, stock for $50 and depreciable 
property for $100. The nonrecourse loan is secured by the partnership's 
depreciable property. The partnership generates $20 of depreciation in 
each of the first five years as its only tax item. These deductions are 
properly treated as nonrecourse deductions and the allocation of these 
deductions 50 percent to A and 50 percent to B is deemed to be in 
accordance with the partners' interests in the partnership. At the end 
of year five, A and B each have a $25 deficit capital account and a $50 
share of partnership minimum gain. In the beginning of year six, (at the 
lender's request), A guarantees the entire nonrecourse liability. 
Pursuant to paragraph (d)(1) of this section, the partnership has a net 
decrease in minimum gain of $100 and under paragraph (g)(2) of this 
section, A's and B's shares of that net decrease are $50 each. Under 
paragraph (f)(1) of this section (the minimum gain chargeback 
requirement), B is subject to a $50 minimum gain chargeback. Because the 
partnership has no gross income in year six, the entire $50 carries over 
as a minimum gain chargeback requirement to succeeding taxable years 
until their is enough income to cover the minimum gain chargeback 
requirement. Under the exception to the minimum gain chargeback in 
paragraph (f)(2) of this section, A is not subject to a minimum gain 
chargeback for A's $50 share of the net decrease because A bears the 
economic risk of loss for the liability. Instead, A's share of partner 
nonrecourse debt minimum gain is $50 pursuant to paragraph (i)(3) of 
this section. In year seven, the partnership earns $100 of net operating 
income and uses the money to repay the entire $100 nonrecourse debt 
(that A has guaranteed). Under paragraph (i)(3) of this section, the 
partnership has a net decrease in partner nonrecourse debt minimum gain 
of $50. B must be allocated $50 of the operating income pursuant to the 
carried over minimum gain chargeback requirement; pursuant to paragraph 
(i)(4) of this section, the other $50 of operating income must be 
allocated to A as a partner nonrecourse debt minimum gain chargeback.

    (g) Shares of partnership minimum gain--(1) Partner's share of 
partnership minimum gain. Except as increased in paragraph (g) (3) of 
this section, a partner's share of partnership minimum gain at the end 
of any partnership taxable year equals:
    (i) The sum of nonrecourse deductions allocated to that partner (and 
to that partner's predecessors in interest) up to that time and the 
distributions made to that partner (and to that partner's predecessors' 
in interest) up to that time of proceeds of a nonrecourse liability 
allocable to an increase in partnership minimum gain (see paragraph 
(h)(1) of this section); minus
    (ii) The sum of that partner's (and that partner's predecessors' in 
interest) aggregate share of the net decreases in partnership minimum 
gain plus their aggregate share of decreases resulting from revaluations 
of partnership property subject to one or more partnership nonrecourse 
liabilities.


[[Page 509]]



For purposes of Sec. 1.704-1(b)(2)(ii)(d), a partner's share of 
partnership minimum gain is added to the limited dollar amount, if any, 
of the deficit balance in the partner's capital account that the partner 
is obligated to restore. See paragraph (m), Examples (1)(i) and (3)(i) 
of this section.
    (2) Partner's share of the net decrease in partnership minimum gain. 
A partner's share of the net decrease in partnership minimum gain is the 
amount of the total net decrease multiplied by the partner's percentage 
share of the partnership's minimum gain at the end of the immediately 
preceding taxable year. A partner's share of any decrease in partnership 
minimum gain resulting from a revaluation of partnership property equals 
the increase in the partner's capital account attributable to the 
revaluation to the extent the reduction in minimum gain is caused by the 
revaluation. See paragraph (m), Example (3)(ii) of this section.
    (3) Conversions of recourse or partner nonrecourse debt into 
nonrecourse debt. A partner's share of partnership minimum gain is 
increased to the extent provided in this paragraph (g)(3) if a recourse 
or partner nonrecourse liability becomes partially or wholly 
nonrecourse. If a recourse liability becomes a nonrecourse liability, a 
partner has a share of the partnership's minimum gain that results from 
the conversion equal to the partner's deficit capital account 
(determined under Sec. 1.704-1(b)(2)(iv)) to the extent the partner no 
longer bears the economic burden for the entire deficit capital account 
as a result of the conversion. For purposes of the preceding sentence, 
the determination of the extent to which a partner bears the economic 
burden for a deficit capital account is made by determining the 
consequences to the partner in the case of a complete liquidation of the 
partnership immediately after the conversion applying the rules 
described in Sec. 1.704-1(b)(2)(iii)(c) that deem the value of 
partnership property to equal its basis, taking into account section 
7701(g) in the case of property that secures nonrecourse indebtedness. 
If a partner nonrecourse debt becomes a nonrecourse liability, the 
partner's share of partnership minimum gain is increased to the extent 
the partner is not subject to the minimum gain chargeback requirement 
under paragraph (i)(4) of this section.
    (h) Distribution of nonrecourse liability proceeds allocable to an 
increase in partnership minimum gain--(1) In general. If during its 
taxable year a partnership makes a distribution to the partners 
allocable to the proceeds of a nonrecourse liability, the distribution 
is allocable to an increase in partnership minimum gain to the extent 
the increase results from encumbering partnership property with 
aggregate nonrecourse liabilities that exceed the property's adjusted 
tax basis. See paragraph (m), Example (1)(vi) of this section. If the 
net increase in partnership minimum gain for a partnership taxable year 
is allocable to more than one nonrecourse liability, the net increase is 
allocated among the liabilities in proportion to the amount each 
liability contributed to the increase in minimum gain.
    (2) Distribution allocable to nonrecourse liability proceeds. A 
partnership may use any reasonable method to determine whether a 
distribution by the partnership to one or more partners is allocable to 
proceeds of a nonrecourse liability. The rules prescribed under Sec. 
1.163-8T for allocating debt proceeds among expenditures (applying those 
rules to the partnership as if it were an individual) constitute a 
reasonable method for determining whether the nonrecourse liability 
proceeds are distributed to the partners and the partners to whom the 
proceeds are distributed.
    (3) Option when there is an obligation to restore. A partnership may 
treat any distribution to a partner of the proceeds of a nonrecourse 
liability (that would otherwise be allocable to an increase in 
partnership minimum gain) as a distribution that is not allocable to an 
increase in partnership minimum gain to the extent the distribution does 
not cause or increase a deficit balance in the partner's capital account 
that exceeds the amount the partner is otherwise obligated to restore 
(within the meaning of Sec. 1.704-1(b)(2)(ii)(c)) as of the end of the 
partnership taxable year in which the distribution occurs.

[[Page 510]]

    (4) Carryover to immediately succeeding taxable year. The carryover 
rule of this paragraph applies if the net increase in partnership 
minimum gain for a partnership taxable year that is allocable to a 
nonrecourse liability under paragraph (h)(2) of this section exceeds the 
distributions allocable to the proceeds of the liability (``excess 
allocable amount''), and all or part of the net increase in partnership 
minimum gain for the year is carried over as an increase in partnership 
minimum gain for the immediately succeeding taxable year (pursuant to 
paragraph (j)(1)(iii) of this section). If the carryover rule of this 
paragraph applies, the excess allocable amount (or the amount carried 
over under paragraph (j)(1)(iii) of this section, if less) is treated in 
the succeeding taxable year as an increase in partnership minimum gain 
that arose in that year as a result of incurring the nonrecourse 
liability to which the excess allocable amount is attributable. See 
paragraph (m), Example (1)(vi) of this section. If for a partnership 
taxable year there is an excess allocable amount with respect to more 
than one partnership nonrecourse liability, the excess allocable amount 
is allocated to each liability in proportion to the amount each 
liability contributed to the increase in minimum gain.
    (i) Partnership nonrecourse liabilities where a partner bears the 
economic risk of loss--(1) In general. Partnership losses, deductions, 
or section 705(a)(2)(B) expenditures that are attributable to a 
particular partner nonrecourse liability (``partner nonrecourse 
deductions,'' as defined in paragraph (i)(2) of this section) must be 
allocated to the partner that bears the economic risk of loss for the 
liability. If more than one partner bears the economic risk of loss for 
a partner nonrecourse liability, any partner nonrecourse deductions 
attributable to that liability must be allocated among the partners 
according to the ratio in which they bear the economic risk of loss. If 
partners bear the economic risk of loss for different portions of a 
liability, each portion is treated as a separate partner nonrecourse 
liability.
    (2) Definition of and determination of partner nonrecourse 
deductions. For any partnership taxable year, the amount of partner 
nonrecourse deductions with respect to a partner nonrecourse debt equals 
the net increase during the year in minimum gain attributable to the 
partner nonrecourse debt (``partner nonrecourse debt minimum gain''), 
reduced (but not below zero) by proceeds of the liability distributed 
during the year to the partner bearing the economic risk of loss for the 
liability that are both attributable to the liability and allocable to 
an increase in the partner nonrecourse debt minimum gain. See paragraph 
(m), Example (1) (viii) and (ix) of this section. The determination of 
which partnership items constitute the partner nonrecourse deductions 
with respect to a partner nonrecourse debt must be made in a manner 
consistent with the provisions of paragraphs (c) and (j)(1) (i) and 
(iii) of this section.
    (3) Determination of partner nonrecourse debt minimum gain. For any 
partnership taxable year, the determination of partner nonrecourse debt 
minimum gain and the net increase or decrease in partner nonrecourse 
debt minimum gain must be made in a manner consistent with the 
provisions of paragraphs (d) and (g)(3) of this section.
    (4) Chargeback of partner nonrecourse debt minimum gain. If during a 
partnership taxable year there is a net decrease in partner nonrecourse 
debt minimum gain, any partner with a share of that partner nonrecourse 
debt minimum gain (determined under paragraph (i)(5) of this section) as 
of the beginning of the year must be allocated items of income and gain 
for the year (and, if necessary, for succeeding years) equal to that 
partner's share of the net decrease in the partner nonrecourse debt 
minimum gain. A partner's share of the net decrease in partner 
nonrecourse debt minimum gain is determined in a manner consistent with 
the provisions of paragraph (g)(2) of this section. A partner is not 
subject to this minimum gain chargeback, however, to the extent the net 
decrease in partner nonrecourse debt minimum gain arises because a 
partner nonrecourse liability becomes partially or wholly a nonrecourse 
liability. The amount that would otherwise be subject to the partner 
nonrecourse debt minimum gain

[[Page 511]]

chargeback is added to the partner's share of partnership minimum gain 
under paragraph (g)(3) of this section. In addition, rules consistent 
with the provisions of paragraphs (f) (2), (3), (4), and (5) of this 
section apply with respect to partner nonrecourse debt in appropriate 
circumstances. The determination of which items of partnership income 
and gain must be allocated pursuant to this paragraph (i)(4) is made in 
a manner that is consistent with the provisions of paragraph (f)(6) of 
this section. See paragraph (j)(2) (ii) and (iii) of this section for 
more specific rules.
    (5) Partner's share of partner nonrecourse debt minimum gain. A 
partner's share of partner nonrecourse debt minimum gain at the end of 
any partnership taxable year is determined in a manner consistent with 
the provisions of paragraphs (g)(1) and (g)(3) of this section with 
respect to each particular partner nonrecourse debt for which the 
partner bears the economic risk of loss. For purposes of Sec. 1.704-
1(b)(2)(ii)(d), a partner's share of partner nonrecourse debt minimum 
gain is added to the limited dollar amount, if any, of the deficit 
balance in the partner's capital account that the partner is obligated 
to restore, and the partner is not otherwise considered to have a 
deficit restoration obligation as a result of bearing the economic risk 
of loss for any partner nonrecourse debt. See paragraph (m), Example 
(1)(viii) of this section.
    (6) Distribution of partner nonrecourse debt proceeds allocable to 
an increase in partner nonrecourse debt minimum gain. Rules consistent 
with the provisions of paragraph (h) of this section apply to 
distributions of the proceeds of partner nonrecourse debt.
    (j) Ordering rules. For purposes of this section, the following 
ordering rules apply to partnership items. Notwithstanding any other 
provision in this section and Sec. 1.704-1, allocations of partner 
nonrecourse deductions, nonrecourse deductions, and minimum gain 
chargebacks are made before any other allocations.
    (1) Treatment of partnership losses and deductions. (i) Partner 
nonrecourse deductions. Partnership losses, deductions, and section 
705(a)(2)(B) expenditures are treated as partner nonrecourse deductions 
in the amount determined under paragraph (i)(2) of this section 
(determining partner nonrecourse deductions) in the following order:
    (A) First, depreciation or cost recovery deductions with respect to 
property that is subject to partner nonrecourse debt;
    (B) Then, if necessary, a pro rata portion of the partnership's 
other deductions, losses, and section 705(a)(2)(B) items.

Depreciation or cost recovery deductions with respect to property that 
is subject to a partnership nonrecourse liability is first treated as a 
partnership nonrecourse deduction and any excess is treated as a partner 
nonrecourse deduction under this paragraph (j)(1)(i).
    (ii) Partnership nonrecourse deductions. Partnership losses, 
deductions, and section 705(a)(2)(B) expenditures are treated as 
partnership nonrecourse deductions in the amount determined under 
paragraph (c) of this section (determining nonrecourse deductions) in 
the following order:
    (A) First, depreciation or cost recovery deductions with respect to 
property that is subject to partnership nonrecourse liabilities;
    (B) Then, if necessary, a pro rata portion of the partnership's 
other deductions, losses, and section 705(a)(2)(B) items.

Depreciation or cost recovery deductions with respect to property that 
is subject to partner nonrecourse debt is first treated as a partner 
nonrecourse deduction and any excess is treated as a partnership 
nonrecourse deduction under this paragraph (j)(1)(ii). Any other item 
that is treated as a partner nonrecourse deduction will in no event be 
treated as a partnership nonrecourse deduction.
    (iii) Carryover to succeeding taxable year. If the amount of partner 
nonrecourse deductions or nonrecourse deductions exceeds the 
partnership's losses, deductions, and section 705(a)(2)(B) expenditures 
for the taxable year (determined under paragraphs (j)(1) (i) and (ii) of 
this section), the excess is treated as an increase in partner 
nonrecourse debt minimum gain or partnership minimum gain in

[[Page 512]]

the immediately succeeding partnership taxable year. See paragraph (m), 
Example (1)(vi) of this section.
    (2) Treatment of partnership income and gains. (i) Minimum gain 
chargeback. Items of partnership income and gain equal to the minimum 
gain chargeback requirement (determined under paragraph (f) of this 
section) are allocated as a minimum gain chargeback in the following 
order:
    (A) First, a pro rata portion of gain from the disposition of 
property subject to partnership nonrecourse liabilities and discharge of 
indebtedness income relating to partnership nonrecourse liabilities to 
which property is subject;
    (B) Then, if necessary, a pro rata portion of the partnership's 
other items of income and gain for that year.

Gain from the disposition of property subject to partner nonrecourse 
debt is allocated to satisfy a minimum gain chargeback requirement for 
partnership nonrecourse debt only to the extent not allocated under 
paragraph (j)(2)(ii) of this section.
    (ii) Chargeback attributable to decrease in partner nonrecourse debt 
minimum gain. Items of partnership income and gain equal to the partner 
nonrecourse debt minimum gain chargeback (determined under paragraph 
(i)(4) of this section) are allocated to satisfy a partner nonrecourse 
debt minimum gain chargeback in the following order:
    (A) First, a pro rata portion of gain from the disposition of 
property subject to partner nonrecourse debt and discharge of 
indebtedness income relating to partner nonrecourse debt to which 
property is subject.
    (B) Then, if necessary, a pro rata portion of the partnership's 
other items of income and gain for that year.

Gain from the disposition of property subject to a partnership 
nonrecourse liability is allocated to satisfy a partner nonrecourse debt 
minimum gain chargeback only to the extent not allocated under paragraph 
(j)(2)(i) of this section. An item of partnership income and gain that 
is allocated to satisfy a minimum gain chargeback under paragraph (f) of 
this section is not allocated to satisfy a minimum gain chargeback under 
paragraph (i)(4).
    (iii) Carryover to succeeding taxable year. If a minimum gain 
chargeback requirement (determined under paragraphs (f) and (i)(4) of 
this section) exceeds the partnership's income and gains for the taxable 
year, the excess is treated as a minimum gain chargeback requirement in 
the immediately succeeding partnership taxable years until fully charged 
back.
    (k) Tiered partnerships. For purposes of this section, the following 
rules determine the effect on partnership minimum gain when a 
partnership (``upper-tier partnership'') is a partner in another 
partnership (``lower-tier partnership'').
    (1) Increase in upper-tier partnership's minimum gain. The sum of 
the nonrecourse deductions that the lower-tier partnership allocates to 
the upper-tier partnership for any taxable year of the upper-tier 
partnership, and the distributions made during that taxable year from 
the lower-tier partnership to the upper-tier partnership of proceeds of 
nonrecourse debt that are allocable to an increase in the lower-tier 
partnership's minimum gain, is treated as an increase in the upper-tier 
partnership's minimum gain.
    (2) Decrease in upper-tier partnership's minimum gain. The upper-
tier partnership's share for its taxable year of the lower-tier 
partnership's net decrease in its minimum gain is treated as a decrease 
in the upper-tier partnership's minimum gain for that taxable year.
    (3) Nonrecourse debt proceeds distributed from the lower-tier 
partnership to the upper-tier partnership. All distributions from the 
lower-tier partnership to the upper-tier partnership during the upper-
tier partnership's taxable year of proceeds of a nonrecourse liability 
allocable to an increase in the lower-tier partnership's minimum gain 
are treated as proceeds of a nonrecourse liability of the upper-tier 
partnership. The increase in the upper-tier partnership's minimum gain 
(under paragraph (k)(1) of this section) attributable to the receipt of 
those distributions is, for purposes of paragraph (h) of this section, 
treated as an increase in the upper-tier partnership's minimum gain 
arising from encumbering property of the

[[Page 513]]

upper-tier partnership with a nonrecourse liability of the upper-tier 
partnership.
    (4) Nonrecourse deductions of lower-tier partnership treated as 
depreciation by upper-tier partnership. For purposes of paragraph (c) of 
this section, all nonrecourse deductions allocated by the lower-tier 
partnership to the upper-tier partnership for the upper-tier 
partnership's taxable year are treated as depreciation or cost recovery 
deductions with respect to property owned by the upper-tier partnership 
and subject to a nonrecourse liability of the upper-tier partnership 
with respect to which minimum gain increased during the year by the 
amount of the nonrecourse deductions.
    (5) Coordination with partner nonrecourse debt rules. The lower-tier 
partnership's liabilities that are treated as the upper-tier 
partnership's liabilities under Sec. 1.752-4(a) are treated as the 
upper-tier partnership's liabilities for purposes of applying paragraph 
(i) of this section. Rules consistent with the provisions of paragraphs 
(k)(1) through (k)(4) of this section apply to determine the allocations 
that the upper-tier partnership must make with respect to any liability 
that constitutes a nonrecourse debt for which one or more partners of 
the upper-tier partnership bear the economic risk of loss.
    (l) Effective/applicability dates--(1) In general--(i) Prospective 
application. Except as otherwise provided in this paragraph (l), this 
section applies for partnership taxable years beginning on or after 
December 28, 1991. For the rules applicable to taxable years beginning 
after December 29, 1988, and before December 28, 1991, see former Sec. 
1.704-1T(b)(4)(iv). For the rules applicable to taxable years beginning 
on or before December 29, 1988, see former Sec. 1.704-1(b)(4)(iv).
    (ii) Partnerships subject to temporary regulations. If a partnership 
agreement entered into after December 29, 1988, and before December 28, 
1991, or a partnership agreement entered into on or before December 29, 
1988, that elected to apply former Sec. 1.704-1T(b)(4)(iv) (as 
contained in the CFR edition revised as of April 1, 1991), complied with 
the provisions of former Sec. 1.704-1T(b)(4)(iv) before December 28, 
1991--
    (A) The provisions of former Sec. 1.704-1T(b)(4)(iv) continue to 
apply to the partnership for any taxable year beginning on or after 
December 28, 1991, (unless the partnership makes an election under 
paragraph (l)(4) of this section) and ending before any subsequent 
material modification to the partnership agreement; and
    (B) The provisions of this section do not apply to the partnership 
for any of those taxable years.
    (iii) Partnerships subject to former regulations. If a partnership 
agreement entered into on or before December 29, 1988, complied with the 
provisions of former Sec. 1.704-1(b)(4)(iv)(d) on or before that date--
    (A) The provisions of former Sec. 1.704-1(b)(4)(iv) (a) through (f) 
continue to apply to the partnership for any taxable year beginning 
after that date (unless the partnership made an election under Sec. 
1.704-1T(b)(4)(iv)(m)(4) in a partnership taxable year ending before 
December 28, 1991, or makes an election under paragraph (l)(4) of this 
section) and ending before any subsequent material modification to the 
partnership agreement; and
    (B) The provisions of this section do not apply to the partnership 
for any of those taxable years.
    (iv) Paragraph (f)(2), the first sentence of paragraph (g)(3), and 
the third sentence of paragraph (i)(4) of this section apply to 
liabilities incurred or assumed by a partnership on or after October 11, 
2006 other than liabilities incurred or assumed by a partnership 
pursuant to a written binding contract in effect prior to October 11, 
2006. The rules applicable to liabilities incurred or assumed (or 
subject to a binding contract in effect) prior to October 11, 2006 are 
contained in this section in effect prior to October 11, 2006. (See 26 
CFR part 1 revised as of April 1, 2006.)
    (v) The first sentence of paragraph (f)(6) of this section and 
paragraphs (j)(2)(i)(A) and (j)(2)(ii)(A) of this section apply on and 
after November 17, 2011.
    (2) Special rule applicable to pre-January 30, 1989, related party 
nonrecourse debt. For purposes of this section and former Sec. 1.704-
1T(b)(4)(iv), if--
    (i) A partnership liability would, but for this paragraph (l)(2) of 
this section,

[[Page 514]]

constitute a partner nonrecourse debt; and
    (ii) Sections 1.752-1 through 1.752-3 or former Sec. Sec. 1.752-1T 
through -3T (whichever is applicable) do not apply to the liability;

the liability is, notwithstanding paragraphs (i) and (b)(4) of this 
section, treated as a nonrecourse liability of the partnership, and not 
as a partner nonrecourse debt, to the extent the liability would be so 
treated under this section (or Sec. 1.704-1T(b)(4)(iv)) if the 
determination of the extent to which one or more partners bears the 
economic risk of loss for the liability under Sec. 1.752-1 or former 
Sec. 1.752-1T were made without regard to the economic risk of loss 
that any partner would otherwise be considered to bear for the liability 
by reason of any obligation undertaken or interest as a creditor 
acquired prior to January 30, 1989, by a person related to the partner 
(within the meaning of Sec. 1.752-4(b) or former Sec. 1.752-1T(h)). 
For purposes of the preceding sentence, if a related person undertakes 
an obligation or acquires an interest as a creditor on or after January 
30, 1989, pursuant to a written binding contract in effect prior to 
January 30, 1989, and at all times thereafter, the obligation or 
interest as a creditor is treated as if it were undertaken or acquired 
prior to January 30, 1989. However, for partnership taxable years 
beginning on or after December 29, 1988, a pre-January 30, 1989, 
liability, other than a liability subject to paragraph (l)(3) of this 
section or former Sec. 1.704-1T(b)(4)(iv)(m)(3) (whichever is 
applicable), that is treated as grandfathered under former Sec. Sec. 
1.752-1T through -3T (whichever is applicable) will be treated as a 
nonrecourse liability for purposes of this section provided that all 
partners in the partnership consistently treat the liability as 
nonrecourse for partnership taxable years beginning on or after December 
29, 1988.
    (3) Transition rule for pre-March 1, 1984, partner nonrecourse debt. 
If a partnership liability would, but for this paragraph (l)(3) or 
former Sec. 1.704-1T(b)(4)(iv), constitute a partner nonrecourse debt 
and the liability constitutes grandfathered partner nonrecourse debt 
that is appropriately treated as a nonrecourse liability of the 
partnership under Sec. 1.752-1 (as in effect prior to December 29, 
1988)--
    (i) The liability is, notwithstanding paragraphs (i) and (b)(4) of 
this section, former Sec. 1.704-1T(b)(4)(iv), and former Sec. 1.704-
1(b)(4)(iv), treated as a nonrecourse liability of the partnership for 
purposes of this section and for purposes of former Sec. 1.704-
1T(b)(4)(iv) and former Sec. 1.704-1(b)(4)(iv) to the extent of the 
amount, if any, by which the smallest outstanding balance of the 
liability during the period beginning at the end of the first 
partnership taxable year ending on or after December 31, 1986, and 
ending at the time of any determination under this paragraph (l)(3)(i) 
or former Sec. 1.704-1T(b)(4)(iv)(m)(3)(i) exceeds the aggregate amount 
of the adjusted basis (or book value) of partnership property allocable 
to the liability (determined in accordance with former Sec. 1.704-
1(b)(4)(iv)(c) (1) and (2) at the end of the first partnership taxable 
year ending on or after December 31, 1986); and
    (ii) In applying this section to the liability, former Sec. 1.704-
1(b)(4)(iv)(c) (1) and (2) is applied as if all of the adjusted basis of 
partnership property allocable to the liability is allocable to the 
portion of the liability that is treated as a partner nonrecourse debt 
and as if none of the adjusted basis of partnership property that is 
allocable to the liability is allocable to the portion of the liability 
that is treated as a nonrecourse liability under this paragraph (l)(3) 
and former Sec. 1.704-1T (b)(4)(iv)(m)(3)(i).

For purposes of the preceding sentence, a grandfathered partner debt is 
any partnership liability that was not subject to former Sec. Sec. 
1.752-1T and -3T but that would have been subject to those sections 
under Sec. 1.752-4T(b) if the liability had arisen (other than pursuant 
to a written binding contract) on or after March 1, 1984. A partnership 
liability is not considered to have been subject to Sec. Sec. 1.752-2T 
and -3T solely because a portion of the liability was treated as a 
liability to which those sections apply under Sec. 1.752-4(e).
    (4) Election. A partnership may elect to apply the provisions of 
this section to the first taxable year of the partnership ending on or 
after December 28, 1991. An election under this paragraph

[[Page 515]]

(l)(4) is made by attaching a written statement to the partnership 
return for the first taxable year of the partnership ending on or after 
December 28, 1991. The written statement must include the name, address, 
and taxpayer identification number of the partnership making the 
statement and must declare that an election is made under this paragraph 
(l)(4).
    (m) Examples. The principles of this section are illustrated by the 
following examples:

    Example 1. Nonrecourse deductions and partnerships minimum gain. For 
Example 1, unless otherwise provided, the following facts are assumed. 
LP, the limited partner, and GP, the general partner, form a limited 
partnership to acquire and operate a commercial office building. LP 
contributes $180,000, and GP contributes $20,000. The partnership 
obtains an $800,000 nonrecourse loan and purchases the building (on 
leased land) for $1,000,000. The nonrecourse loan is secured only by the 
building, and no principal payments are due for 5 years. The partnership 
agreement provides that GP will be required to restore any deficit 
balance in GP's capital account following the liquidation of GP's 
interest (as set forth in Sec. 1.704-1 (b) (2)(ii)(b)(3)), and LP will 
not be required to restore any deficit balance in LP's capital account 
following the liquidation of LP's interest. The partnership agreement 
contains the following provisions required by paragraph (e) of this 
section: a qualified income offset (as defined in Sec. 1.704-
1(b)(2)(ii)(d)); a minimum gain chargeback (in accordance with paragraph 
(f) of this section); a provision that the partners' capital accounts 
will be determined and maintained in accordance with Sec. 1.704-
1(b)(2)(ii)(b)(1); and a provision that distributions will be made in 
accordance with partners' positive capital account balances (as set 
forth in Sec. 1.704-1(b)(2)(ii)(b)(2)). In addition, as of the end of 
each partnership taxable year discussed herein, the items described in 
Sec. 1.704-1(b)(2)(ii)(d) (4), (5), and (6) are not reasonably expected 
to cause or increase a deficit balance in LP's capital account. The 
partnership agreement provides that, except as otherwise required by its 
qualified income offset and minimum gain chargeback provisions, all 
partnership items will be allocated 90 percent to LP and 10 percent to 
GP until the first time when the partnership has recognized items of 
income and gain that exceed the items of loss and deduction it has 
recognized over its life, and all further partnership items will be 
allocated equally between LP and GP. Finally, the partnership agreement 
provides that all distributions, other than distributions in liquidation 
of the partnership or of a partner's interest in the partnership, will 
be made 90 percent to LP and 10 percent to GP until a total of $200,000 
has been distributed, and thereafter all the distributions will be made 
equally to LP and GP. In each of the partnership's first 2 taxable 
years, it generates rental income of $95,000, operating expenses 
(including land lease payments) of $10,000, interest expense of $80,000, 
and a depreciation deduction of $90,000, resulting in a net taxable loss 
of $85,000 in each of those years. The allocations of these losses 90 
per percent to LP and 10 percent to GP have substantial economic effect.

------------------------------------------------------------------------
                                                       LP          GP
------------------------------------------------------------------------
Capital account on formation.....................   $180,000    $20,000
    Less: net loss in years 1 and 2..............   (153,000)   (17,000)
                                                  ----------------------
Capital account at end of year 2.................    $27,000     $3,000
------------------------------------------------------------------------


In the partnership's third taxable year, it again generates rental 
income of $95,000, operating expenses of $10,000, interest expense of 
$80,000, and a depreciation deduction of $90,000, resulting in net 
taxable loss of $85,000. The partnership makes no distributions.
    (i) Calculation of nonrecourse deductions and partnership minimum 
gain. If the partnership were to dispose of the building in full 
satisfaction of the nonrecourse liability at the end of the third year, 
it would realize $70,000 of gain ($800,000 amount realized less $730,000 
adjusted tax basis). Because the amount of partnership minimum gain at 
the end of the third year (and the net increase in partnership minimum 
gain during the year) is $70,000, there are partnership nonrecourse 
deductions for that year of $70,000, consisting of depreciation 
deductions allowable with respect to the building of $70,000. Pursuant 
to the partnership agreement, all partnership items comprising the net 
taxable loss of $85,000, including the $70,000 nonrecourse deduction, 
are allocated 90 percent to LP and 10 percent to GP. The allocation of 
these items, other than the nonrecourse deductions, has substantial 
economic effect.

------------------------------------------------------------------------
                                                       LP          GP
------------------------------------------------------------------------
Capital account at end of year 2.................    $27,000     $3,000
    Less: net loss in year 3 (without nonrecourse    (13,500)    (1,500)
     deductions).................................
    Less: nonrecourse deductions in year 3.......    (63,000)    (7,000)
                                                  ----------------------
Capital account at end of year 3.................   ($49,500)   ($5,500)
------------------------------------------------------------------------

The allocation of the $70,000 nonrecourse deduction satisfies 
requirement (2) of paragraph (e) of this section because it is 
consistent with allocations having substantial

[[Page 516]]

economic effect of other significant partnership items attributable to 
the building. Because the remaining requirements of paragraph (e) of 
this section are satisfied, the allocation of nonrecourse deductions is 
deemed to be in accordance with the partners' interests in the 
partnership. At the end of the partnership's third taxable year, LP's 
and GP's shares of partnership minimum gain are $63,000 and $7,000, 
respectively. Therefore, pursuant to paragraph (g)(1) of this section, 
LP is treated as obligated to restore a deficit capital account balance 
of $63,000, so that in the succeeding year LP could be allocated up to 
an additional $13,500 of partnership deductions, losses, and section 
705(a)(2)(B) items that are not nonrecourse deductions. Even though this 
allocation would increase a deficit capital account balance, it would be 
considered to have economic effect under the alternate economic effect 
test contained in Sec. 1.704-1(b)(2)(ii)(d). If the partnership were to 
dispose of the building in full satisfaction of the nonrecourse 
liability at the beginning of the partnership's fourth taxable year (and 
had no other economic activity in that year), the partnership minimum 
gain would be decreased from $70,000 to zero, and the minimum gain 
chargeback would require that LP and GP be allocated $63,000 and $7,000, 
respectively, of the gain from that disposition.
    (ii) Illustration of reasonable consistency requirement. Assume 
instead that the partnership agreement provides that all nonrecourse 
deductions of the partnership will be allocated equally between LP and 
GP. Furthermore, at the time the partnership agreement is entered into, 
there is a reasonable likelihood that over the partnership's life it 
will realize amounts of income and gain significantly in excess of 
amounts of loss and deduction (other than nonrecourse deductions). The 
equal allocation of excess income and gain has substantial economic 
effect.

------------------------------------------------------------------------
                                                       LP          GP
------------------------------------------------------------------------
Capital account on formation.....................   $180,000    $20,000
    Less: net loss in years 1 and 2..............   (153,000)   (17,000)
    Less: net loss in year (without nonrecourse      (13,500)    (1,500)
     deductions).................................
    Less: nonrecourse deductions in year 3.......    (35,000)   (35,000)
                                                  ----------------------
Capital account at end of year 3.................   ($21,500)  ($33,500)
------------------------------------------------------------------------

The allocation of the $70,000 nonrecourse deduction equally between LP 
and GP satisfies requirement (2) of paragraph (e) of this section 
because the allocation is consistent with allocations, which will have 
substantial economic effect, of other significant partnership items 
attributable to the building. Because the remaining requirements of 
paragraph (e) of this section are satisfied, the allocation of 
nonrecourse deductions is deemed to be in accordance with the partners' 
interests in the partnership. The allocation of the nonrecourse 
deductions 75 percent to LP and 25 percent to GP (or in any other ratio 
between 90 percent to LP/10 percent to GP and 50 percent to LP/50 
percent to GP) also would satisfy requirement (2) of paragraph (e) of 
this section.
    (iii) Allocation of nonrecourse deductions that fails reasonable 
consistency requirement. Assume instead that the partnership agreement 
provides that LP will be allocated 99 percent, and GP 1 percent, of all 
nonrecourse deductions of the partnership. Allocating nonrecourse 
deductions this way does not satisfy requirement (2) of paragraph (e) of 
this section because the allocations are not reasonably consistent with 
allocations, having substantial economic effect, of any other 
significant partnership item attributable to the building. Therefore, 
the allocation of nonrecourse deductions will be disregarded, and the 
nonrecourse deductions of the partnership will be reallocated according 
to the partners' overall economic interests in the partnership, 
determined under Sec. 1.704-1(b)(3)(ii).
    (iv) Capital contribution to pay down nonrecourse debt. At the 
beginning of the partnership's fourth taxable year, LP contributes 
$144,000 and GP contributes $16,000 of addition capital to the 
partnership, which the partnership immediately uses to reduce the amount 
of its nonrecourse liability from $800,000 to $640,000. In addition, in 
the partnership's fourth taxable year, it generates rental income of 
$95,000, operating expenses of $10,000, interest expense of $64,000 
(consistent with the debt reduction), and a depreciation deduction of 
$90,000, resulting in a net taxable loss of $69,000. If the partnership 
were to dispose of the building in full satisfaction of the nonrecourse 
liability at the end of that year, it would realize no gain ($640,000 
amount realized less $640,000 adjusted tax basis). Therefore, the amount 
of partnership minimum gain at the end of the year is zero, which 
represents a net decrease in partnership minimum gain of $70,000 during 
the year. LP's and GP's shares of this net decrease are $63,000 and 
$7,000 respectively, so that at the end of the partnership's fourth 
taxable year, LP's and GP's shares of partnership minimum gain are zero. 
Although there has been a net decrease in partnership minimum gain, 
pursuant to paragraph (f)(3) of this section LP and GP are not subject 
to a minimum gain chargeback.

------------------------------------------------------------------------
                                                       LP          GP
------------------------------------------------------------------------
Capital account at end of year 3.................   ($49,500)   ($5,500)
    Plus: contribution...........................    144,000     16,000
    Less: net loss in year 4.....................    (62,100)    (6,900)
                                                  ----------------------
Capital account at end of year 4.................    $32,400     $3,600
Minimum gain chargeback carryforward.............         $0         $0
------------------------------------------------------------------------


[[Page 517]]

    (v) Loans of unequal priority. Assume instead that the building 
acquired by the partnership is secured by a $700,000 nonrecourse loan 
and a $100,000 recourse loan, subordinate in priority to the nonrecourse 
loan. Under paragraph (d)(2) of this section, $700,000 of the adjusted 
basis of the building at the end of the partnership's third taxable year 
is allocated to the nonrecourse liability (with the remaining $30,000 
allocated to the recourse liability) so that if the partnership disposed 
of the building in full satisfaction of the nonrecourse liability at the 
end of that year, it would realize no gain ($700,000 amount realized 
less $700,000 adjusted tax basis). Therefore, there is no minimum gain 
(or increase in minimum gain) at the end of the partnership's third 
taxable year. If, however, the $700,000 nonrecourse loan were 
subordinate in priority to the $100,000 recourse loan, under paragraph 
(d)(2) of this section, the first $100,000 of adjusted tax basis in the 
building would be allocated to the recourse liability, leaving only 
$630,000 of the adjusted basis of the building to be allocated to the 
$700,000 nonrecourse loan. In that case, the balance of the $700,000 
nonrecourse liability would exceed the adjusted tax basis of the 
building by $70,000, so that there would be $70,000 of minimum gain (and 
a $70,000 increase in partnership minimum gain) in the partnership's 
third taxable year.
    (vi) Nonrecourse borrowing; distribution of proceeds in subsequent 
year. The partnership obtains an additional nonrecourse loan of $200,000 
at the end of its fourth taxable year, secured by a second mortgage on 
the building, and distributes $180,000 of this cash to its partners at 
the beginning of its fifth taxable year. In addition, in its fourth and 
fifth taxable years, the partnership again generates rental income of 
$95,000, operating expenses of $10,000, interest expense of $80,000 
($100,000 in the fifth taxable year reflecting the interest paid on both 
liabilities), and a depreciation deduction of $90,000, resulting in a 
net taxable loss of $85,000 ($105,000 in the fifth taxable year 
reflecting the interest paid on both liabilities). The partnership has 
distributed its $5,000 of operating cash flow in each year ($95,000 of 
rental income less $10,000 of operating expense and $80,000 of interest 
expense) to LP and GP at the end of each year. If the partnership were 
to dispose of the building in full satisfaction of both nonrecourse 
liabilities at the end of its fourth taxable year, the partnership would 
realize $360,000 of gain ($1,000,000 amount realized less $640,000 
adjusted tax basis). Thus, the net increase in partnership minimum gain 
during the partnership's fourth taxable year is $290,000 ($360,000 of 
minimum gain at the end of the fourth year less $70,000 of minimum gain 
at the end of the third year). Because the partnership did not 
distribute any of the proceeds of the loan it obtained in its fourth 
year during that year, the potential amount of partnership nonrecourse 
deductions for that year is $290,000. Under paragraph (c) of this 
section, if the partnership had distributed the proceeds of that loan to 
its partners at the end of its fourth year, the partnership's 
nonrecourse deductions for that year would have been reduced by the 
amount of that distribution because the proceeds of that loan are 
allocable to an increase in partnership minimum gain under paragraph 
(h)(1) of this section. Because the nonrecourse deductions of $290,000 
for the partnership's fourth taxable year exceed its total deductions 
for that year, all $180,000 of the partnership's deductions for that 
year are treated as nonrecourse deductions, and the $110,000 excess 
nonrecourse deductions are treated as an increase in partnership minimum 
gain in the partnership's fifth taxable year under paragraph (c) of this 
section.

------------------------------------------------------------------------
                                                       LP          GP
------------------------------------------------------------------------
Capital account at end of year 3 (including cash    ($63,000)   ($7,000)
 flow distributions).............................
Plus: rental income in year 4....................     85,500      9,500
    Less: nonrecourse deductions in year 4.......   (162,000)   (18,000)
    Less: cash flow distributions in year 4......     (4,500)      (500)
                                                  ----------------------
Capital account at end of year 4.................  ($144,000)  ($16,000)
------------------------------------------------------------------------

At the end of the partnership's fourth taxable year, LP's and GP's 
shares of partnership minimum gain are $225,000 and $25,000, 
respectively (because the $110,000 excess of nonrecourse deductions is 
carried forward to the next year). If the partnership were to dispose of 
the building in full satisfaction of the nonrecourse liabilities at the 
end of its fifth taxable year, the partnership would realize $450,000 of 
gain ($1,000,000 amount realized less $550,000 adjusted tax basis). 
Therefore, the net increase in partnership minimum gain during the 
partnership's fifth taxable year is $200,000 ($110,000 deemed increase 
plus the $90,000 by which minimum gain at the end of the fifth year 
exceeds minimum gain at the end of the fourth year ($450,000 less 
$360,000)). At the beginning of its fifth year, the partnership 
distributes $180,000 of the loan proceeds (retaining $20,000 to pay the 
additional interest expense). Under paragraph (h) of this section, the 
first $110,000 of this distribution (an amount equal to the deemed 
increase in partnership minimum gain for the year) is considered 
allocable to an increase in partnership minimum gain for the year. As a 
result, the amount of nonrecourse deductions for the partnership's fifth 
taxable year is $90,000 ($200,000 net increase in minimum gain less 
$110,000 distribution of nonrecourse liability proceeds allocable to an 
increase in partnership minimum gain), and the nonrecourse deductions

[[Page 518]]

consist solely of the $90,000 depreciation deduction allowable with 
respect to the building. As a result of the distributions during the 
partnership's fifth taxable year, the total distributions to the 
partners over the partnership's life equal $205,000. Therefore, the last 
$5,000 distributed to the partners during the fifth year will be divided 
equally between them under the partnership agreement. Thus, out of the 
$185,000 total distribution during the partnership's fifth taxable year, 
the first $180,000 is distributed 90 percent to LP and 10 percent to GP, 
and the last $5,000 is divided equally between them.

------------------------------------------------------------------------
                                                      LP          GP
------------------------------------------------------------------------
Capital account at end of year 4...............   ($144,000)   ($16,000)
    Less: net loss in year 5 (without               (13,500)     (1,500)
     nonrecourse deductions)...................
    Less: nonrecourse deductions in year 5.....     (81,000)     (9,000)
    Less: distribution of loan proceeds........    (162,000)    (18,000)
    Less: cash flow distribution in year 5.....      (2,500)     (2,500)
                                                ------------------------
Capital account at end of year 5...............   ($403,000)   ($47,000)
------------------------------------------------------------------------

At the end of the partnership's fifth taxable year, LP's share of 
partnership minimum gain is $405,000 ($225,000 share of minimum gain at 
the end of the fourth year plus $81,000 of nonrecourse deductions for 
the fifth year and a $99,000 distribution of nonrecourse liability 
proceeds that are allocable to an increase in minimum gain) and GP's 
share of partnership minimum gain is $45,000 ($25,000 share of minimum 
gain at the end of the fourth year plus $9,000 of nonrecourse deductions 
for the fifth year and an $11,000 distribution of nonrecourse liability 
proceeds that are allocable to an increase in minimum gain).
    (vii) Partner guarantee of nonrecourse debt. LP and GP personally 
guarantee the ``first'' $100,000 of the $800,000 nonrecourse loan (i.e., 
only if the building is worth less than $100,000 will they be called 
upon to make up any deficiency). Under paragraph (d)(2) of this section, 
only $630,000 of the adjusted tax basis of the building is allocated to 
the $700,000 nonrecourse portion of the loan because the collateral will 
be applied first to satisfy the $100,000 guaranteed portion, making it 
superior in priority to the remainder of the loan. On the other hand, if 
LP and GP were to guarantee the ``last'' $100,000 (i.e., if the building 
is worth less than $800,000, they will be called upon to make up the 
deficiency up to $100,000), $700,000 of the adjusted tax basis of the 
building would be allocated to the $700,000 nonrecourse portion of the 
loan because the guaranteed portion would be inferior in priority to it.
    (viii) Partner nonrecourse debt. Assume instead that the $800,000 
loan is made by LP, the limited partner. Under paragraph (b)(4) of this 
section, the $800,000 obligation does not constitute a nonrecourse 
liability of the partnership for purposes of this section because LP, a 
partner, bears the economic risk of loss for that loan within the 
meaning of Sec. 1.752-2. Instead, the $800,000 loan constitutes a 
partner nonrecourse debt under paragraph (b)(4) of this section. In the 
partnership's third taxable year, partnership minimum gain would have 
increased by $70,000 if the debt were a nonrecourse liability of the 
partnership. Thus, under paragraph (i)(3) of this section, there is a 
net increase of $70,000 in the minimum gain attributable to the $800,000 
partner nonrecourse debt for the partnership's third taxable year, and 
$70,000 of the $90,000 depreciation deduction from the building for the 
partnership's third taxable year constitutes a partner nonrecourse 
deduction with respect to the debt. See paragraph (i)(4) of this 
section. Under paragraph (i)(2) of this section, this partner 
nonrecourse deduction must be allocated to LP, the partner that bears 
the economic risk of loss for that liability.
    (ix) Nonrecourse debt and partner nonrecourse debt of differing 
priorities. As in Example 1 (viii) of this paragraph (m), the $800,000 
loan is made to the partnership by LP, the limited partner, but the loan 
is a purchase money loan that ``wraps around'' a $700,000 underlying 
nonrecourse note (also secured by the building) issued by LP to an 
unrelated person in connection with LP's acquisition of the building. 
Under these circumstances, LP bears the economic risk of loss with 
respect to only $100,000 of the liability within the meaning of Sec. 
1.752-2. See Sec. 1.752-2(f) (Example 6). Therefore, for purposes of 
paragraph (d) of this section, the $800,000 liability is treated as a 
$700,000 nonrecourse liability of the partnership and a $100,000 partner 
nonrecourse debt (inferior in priority to the $700,000 liability) of the 
partnership for which LP bears the economic risk of loss. Under 
paragraph (i)(2) of this section, $70,000 of the $90,000 depreciation 
deduction realized in the partnership's third taxable year constitutes a 
partner nonrecourse deduction that must be allocated to LP.
    Example 2. Netting of increases and decreases in partnership minimum 
gain. For Example 2 unless otherwise provided, the following facts are 
assumed. X and Y form a general partnership to acquire and operate 
residential real properties. Each partner contributes $150,000 to the 
partnership. The partnership obtains a $1,500,000 nonrecourse loan and 
purchases 3 apartment buildings (on leased land) for $720,000 
(``Property A''), $540,000 (``Property B''), and $540,000 (``Property 
C''). The nonrecourse loan is secured only by the 3 buildings, and no 
principal payments are due for 5 years. In each of the partnership's 
first 3 taxable years, it generates rental income of $225,000, operating 
expenses (including land lease payments) of $50,000, interest expense

[[Page 519]]

of $175,000, and depreciation deductions on the 3 properties of $150,000 
($60,000 on Property A and $45,000 on each of Property B and Property 
C), resulting in a net taxable loss of $150,000 in each of those years. 
The partnership makes no distributions to X or Y.
    (i) Calculation of net increases and decreases in partnership 
minimum gain. If the partnership were to dispose of the 3 apartment 
buildings in full satisfaction of its nonrecourse liability at the end 
of its third taxable year, it would realize $150,000 of gain ($1,500,000 
amount realized less $1,350,000 adjusted tax basis). Because the amount 
of partnership minimum gain at the end of that year (and the net 
increase in partnership minimum gain during that year) is $150,000, the 
amount of partnership nonrecourse deductions for that year is $150,000, 
consisting of depreciation deductions allowable with respect to the 3 
apartment buildings of $150,000. The result would be the same if the 
partnership obtained 3 separate nonrecourse loans that were ``cross-
collateralized'' (i.e., if each separate loan were secured by all 3 of 
the apartment buildings).
    (ii) Netting of increases and decreases in partnership minimum gain 
when there is a disposition. At the beginning of the partnership's 
fourth taxable year, the partnership (with the permission of the 
nonrecourse lender) disposes of Property A for $835,000 and uses a 
portion of the proceeds to repay $600,000 of the nonrecourse liability 
(the principal amount attributable to Property A), reducing the balance 
to $900,000. As a result of the disposition, the partnership realizes 
gain of $295,000 ($835,000 amount realized less $540,000 adjusted tax 
basis). If the disposition is viewed in isolation, the partnership has 
generated minimum gain of $60,000 on the sale of Property A ($600,000 of 
debt reduction less $540,000 adjusted tax basis). However, during the 
partnership's fourth taxable year it also generates rental income of 
$135,000, operating expenses of $30,000, interest expense of $105,000, 
and depreciation deductions of $90,000 ($45,000 on each remaining 
building). If the partnership were to dispose of the remaining two 
buildings in full satisfaction of its nonrecourse liability at the end 
of the partnership's fourth taxable year, it would realize gain of 
$180,000 ($900,000 amount realized less $720,000 aggregate adjusted tax 
basis), which is the amount of partnership minimum gain at the end of 
the year. Because the partnership minimum gain increased from $150,000 
to $180,000 during the partnership's fourth taxable year, the amount of 
partnership nonrecourse deductions for that year is $30,000, consisting 
of a ratable portion of depreciation deductions allowable with respect 
to the two remaining apartment buildings. No minimum gain chargeback is 
required for the taxable year, even though the partnership disposed of 
one of the properties subject to the nonrecourse liability during the 
year, because there is no net decrease in partnership minimum gain for 
the year. See paragraph (f)(1) of this section.
    Example 3. Nonrecourse deductions and partnership minimum gain 
before third partner is admitted. For purposes of Example 3, unless 
otherwise provided, the following facts are assumed. Additional facts 
are given in each of Examples 3 (ii), (iii), and (iv). A and B form a 
limited partnership to acquire and lease machinery that is 5-year 
recovery property. A, the limited partner, and B, the general partner, 
contribute $100,000 each to the partnership, which obtains an $800,000 
nonrecourse loan and purchases the machinery for $1,000,000. The 
nonrecourse loan is secured only by the machinery. The principal amount 
of the loan is to be repaid $50,000 per year during each of the 
partnership's first 5 taxable years, with the remaining $550,000 of 
unpaid principal due on the first day of the partnership's sixth taxable 
year. The partnership agreement contains all of the provisions required 
by paragraph (e) of this section, and, as of the end of each partnership 
taxable year discussed herein, the items described in Sec. 1.704-
1(b)(2)(ii)(d) (4), (5), and (6) are not reasonably expected to cause or 
increase a deficit balance in A's or B's capital account. The 
partnership agreement provides that, except as otherwise required by its 
qualified income offset and minimum gain chargeback provisions, all 
partnership items will be allocated equally between A and B. Finally, 
the partnership agreement provides that all distributions, other than 
distributions in liquidation of the partnership or of a partner's 
interest in the partnership, will be made equally between A and B. In 
the partnership's first taxable year it generates rental income of 
$130,000, interest expense of $80,000, and a depreciation deduction of 
$150,000, resulting in a net taxable loss of $100,000. In addition, the 
partnership repays $50,000 of the nonrecourse liability, reducing that 
liability to $750,000. Allocations of these losses equally between A and 
B have substantial economic effect.

------------------------------------------------------------------------
                                                       A           B
------------------------------------------------------------------------
Capital account on formation....................   $100,000    $100,000
    Less: net loss in year 1....................    (50,000)    (50,000)
                                                 -----------------------
Capital account at end of year 1................    $50,000     $50,000
------------------------------------------------------------------------


In the partnership's second taxable year, it generates rental income of 
$130,000, interest expense of $75,000, and a depreciation deduction of 
$220,000, resulting in a net taxable loss of $165,000. In addition, the 
partnership repays $50,000 of the nonrecourse liability, reducing that 
liability to $700,000, and distributes $2,500 of cash to each partner. 
If the partnership were to dispose of the machinery

[[Page 520]]

in full satisfaction of the nonrecourse liability at the end of that 
year, it would realize $70,000 of gain ($700,000 amount realized less 
$630,000 adjusted tax basis). Therefore, the amount of partnership 
minimum gain at the end of that year (and the net increase in 
partnership minimum gain during the year) is $70,000, and the amount of 
partnership nonrecourse deductions for the year is $70,000. The 
partnership nonrecourse deductions for its second taxable year consist 
of $70,000 of the depreciation deductions allowable with respect to the 
machinery. Pursuant to the partnership agreement, all partnership items 
comprising the net taxable loss of $165,000, including the $70,000 
nonrecourse deduction, are allocated equally between A and B. The 
allocation of these items, other than the nonrecourse deductions, has 
substantial economic effect.

------------------------------------------------------------------------
                                                        A          B
------------------------------------------------------------------------
Capital account at end of year 1..................   $50,000    $50,000
    Less: net loss in year 2 (without nonrecourse    (47,500)   (47,500)
     deductions)..................................
    Less: nonrecourse deductions in year 2........   (35,000)   (35,000)
    Less: distribution............................    (2,500)    (2,500)
                                                   ---------------------
Capital account at end of year 2..................  ($35,000)  ($35,000)
------------------------------------------------------------------------

    (i) Calculation of nonrecourse deductions and partnership minimum 
gain. Because all of the requirements of paragraph (e) of this section 
are satisfied, the allocation of nonrecourse deductions is deemed to be 
made in accordance with the partners' interests in the partnership. At 
the end of the partnership's second taxable year, A's and B's shares of 
partnership minimum gain are $35,000 each. Therefore, pursuant to 
paragraph (g)(1) of this section, A and B are treated as obligated to 
restore deficit balances in their capital accounts of $35,000 each. If 
the partnership were to dispose of the machinery in full satisfaction of 
the nonrecourse liability at the beginning of the partnership's third 
taxable year (and had no other economic activity in that year), the 
partnership minimum gain would be decreased from $70,000 to zero. A's 
and B's shares of that net decrease would be $35,000 each. Upon that 
disposition, the minimum gain chargeback would require that A and B each 
be allocated $35,000 of that gain before any other allocation is made 
under section 704 (b) with respect to partnership items for the 
partnership's third taxable year.
    (ii) Nonrecourse deductions and restatement of capital accounts. (a) 
Additional facts. C is admitted to the partnership at the beginning of 
the partnership's third taxable year. At the time of C's admission, the 
fair market value of the machinery is $900,000. C contributes $100,000 
to the partnership (the partnership invests $95,000 of this in 
undeveloped land and holds the other $5,000 in cash) in exchange for an 
interest in the partnership. In connection with C's admission to the 
partnership, the partnership's machinery is revalued on the 
partnership's books to reflect its fair market value of $900,000. 
Pursuant to Sec. 1.704-1(b)(2)(iv)(f), the capital accounts of A and B 
are adjusted upwards to $100,000 each to reflect the revaluation of the 
partnership's machinery. This adjustment reflects the manner in which 
the partnership gain of $270,000 ($900,000 fair market value minus 
$630,000 adjusted tax basis) would be shared if the machinery were sold 
for its fair market value immediately prior to C's admission to the 
partnership.

------------------------------------------------------------------------
                                                       A           B
------------------------------------------------------------------------
Capital account before C's admission............   ($35,000)   ($35,000)
    Deemed sale adjustment......................    135,000     135,000
                                                 -----------------------
Capital account adjusted for C's admission......   $100,000    $100,000
------------------------------------------------------------------------

The partnership agreement is modified to provide that, except as 
otherwise required by its qualified income offset and minimum gain 
chargeback provisions, partnership income, gain, loss, and deduction, as 
computed for book purposes, are allocated equally among the partners, 
and those allocations are reflected in the partners' capital accounts. 
The partnership agreement also is modified to provide that depreciation 
and gain or loss, as computed for tax purposes, with respect to the 
machinery will be shared among the partners in a manner that takes 
account of the variation between the property's $630,000 adjusted tax 
basis and its $900,000 book value, in accordance with Sec. 1.704-
1(b)(2)(iv)(f) and the special rule contained in Sec. 1.704-1(b)(4)(i).
    (b) Effect of revaluation. Because the requirements of Sec. 1.704-
1(b)(2)(iv)(g) are satisfied, the capital accounts of the partners (as 
adjusted) continue to be maintained in accordance with Sec. 1.704-
1(b)(2)(iv). If the partnership were to dispose of the machinery in full 
satisfaction of the nonrecourse liability immediately following the 
revaluation of the machinery, it would realize no book gain ($700,000 
amount realized less $900,000 book value). As a result of the 
revaluation of the machinery upward by $270,000, under part (i) of 
paragraph (d)(4) of this section, the partnership minimum gain is 
reduced from $70,000 immediately prior to the revaluation to zero; but 
under part (ii) of paragraph (d)(4) of this section, the partnership 
minimum gain is increased by the $70,000 decrease arising solely from 
the revaluation. Accordingly, there is no net increase or decrease 
solely on account of the revaluation, and so no minimum gain chargeback 
is triggered. All future nonrecourse deductions that occur will be the 
nonrecourse deductions as calculated

[[Page 521]]

for book purposes, and will be charged to all 3 partners in accordance 
with the partnership agreement. For purposes of determining the 
partners' shares of minimum gain under paragraph (g) of this section, 
A's and B's shares of the decrease resulting from the revaluation are 
$35,000 each. However, as illustrated below, under section 704(c) 
principles, the tax capital accounts of A and B will eventually be 
charged $35,000 each, reflecting their 50 percent shares of the decrease 
in partnership minimum gain that resulted from the revaluation.
    (iii) Allocation of nonrecourse deductions following restatement of 
capital accounts. (a) Additional facts. During the partnership's third 
taxable year, the partnership generates rental income of $130,000, 
interest expense of $70,000 a tax depreciation deduction of $210,000, 
and a book depreciation deduction (attributable to the machinery) of 
$300,000. As a result, the partnership has a net taxable loss of 
$150,000 and a net book loss of $240,000. In addition, the partnership 
repays $50,000 of the nonrecourse liability (after the data of C's 
admission), reducing the liability to $650,000 and distributes $5,000 of 
cash to each partner.
    (b) Allocations. If the partnership were to dispose of the machinery 
in full satisfaction of the nonrecourse liability at the end of the 
year, $50,000 of book gain would result ($650,000 amount realized less 
$600,000 book basis). Therefore, the amount of partnership minimum gain 
at the end of the year is $50,000, which represents a net decrease in 
partnership minimum gain of $20,000 during the year. (This is so even 
though there would be an increase in partnership minimum gain in the 
partnership's third taxable year if minimum gain were computed with 
reference to the adjusted tax basis of the machinery.) Nevertheless, 
pursuant to paragraph (d)(4) of this section, the amount of nonrecourse 
deductions of the partnership for its third taxable year is $50,000 (the 
net increase in partnership minimum gain during the year determined by 
adding back the $70,000 decrease in partnership minimum gain 
attributable to the revaluation of the machinery to the $20,000 net 
decrease in partnership minimum gain during the year). The $50,000 of 
partnership nonrecourse deductions for the year consist of book 
depreciation deductions allowable with respect to the machinery of 
$50,000. Pursuant to the partnership agreement, all partnership items 
comprising the net book loss of $240,000, including the $50,000 
nonrecourse deduction, are allocated equally among the partners. The 
allocation of these items, other than the nonrecourse deductions, has 
substantial economic effect. Consistent with the special partners' 
interests in the partnership rule contained in Sec. 1.704-1(b)(4)(i), 
the partnership agreement provides that the depreciation deduction for 
tax purposes of $210,000 for the partnership's third taxable year is, in 
accordance with section 704(c) principles, shared $55,000 to A, $55,000 
to B, and $100,000 to C.

----------------------------------------------------------------------------------------------------------------
                                                A                         B                         C
                                   -----------------------------------------------------------------------------
                                        Tax          Book         Tax          Book         Tax          Book
----------------------------------------------------------------------------------------------------------------
Capital account at beginning of       ($35,000)    $100,000     ($35,000)   $100,0000     $100,000     $100,000
 year 3...........................
Less: nonrecourse deductions......      (9,166)     (16,666)      (9,166)     (16,666)     (16,666)     (16,666)
Less: items other than nonrecourse     (25,834)     (63,334)     (25,834)     (63,334)     (63,334)     (63,334)
 deductions in year 3.............
Less: distribution................      (5,000)      (5,000)      (5,000)      (5,000)      (5,000)      (5,000)
                                   -----------------------------------------------------------------------------
Capital account at end of year 3..    ($75,000)     $15,000     ($75,000)     $15,000      $15,000      $15,000
----------------------------------------------------------------------------------------------------------------

Because the requirements of paragraph (e) of this section are satisfied, 
the allocation of the nonrecourse deduction is deemed to be made in 
accordance with the partners' interests in the partnership. At the end 
of the partnership's third taxable year, A's, B's, and C's shares of 
partnership minimum gain are $16,666 each.
    (iv) Subsequent allocation of nonrecourse deductions following 
restatement of capital accounts. (a) Additional facts. The partners' 
capital accounts at the end of the second and third taxable years of the 
partnership are as stated in Example 3(iii) of this paragraph (m). In 
addition, during the partnership's fourth taxable year the partnership 
generates rental income of $130,000, interest expense of $65,000, a tax 
depreciation deduction of $210,000, and a book depreciation deduction 
(attributable to the machinery) of $300,000. As a result, the 
partnership has a net taxable loss of $145,000 and a net book loss of 
$235,000. In addition, the partnership repays $50,000 of the nonrecourse 
liability, reducing that liability to $600,000, and distributes $5,000 
of cash to each partner.
    (b) Allocations. If the partnership were to dispose of the machinery 
in full satisfaction of the nonrecourse liability at the end of the 
fourth year, $300,000 of book gain would result ($600,000 amount 
realized less $300,000 book value). Therefore, the amount of partnership 
minimum gain as of the end of the year is $300,000, which represents a 
net increase in partnership minimum gain during the year of $250,000. 
Thus, the amount of

[[Page 522]]

partnership nonrecourse deductions for that year equals $250,000, 
consisting of book depreciation deductions of $250,000. Pursuant to the 
partnership agreement, all partnership items comprising the net book 
loss of $235,000, including the $250,000 nonrecourse deduction, are 
allocated equally among the partners. That allocation of all items, 
other than the nonrecourse deductions, has substantial economic effect. 
Consistent with the special partners' interests in the partnership rule 
contained in Sec. 1.704-1(b)(4)(i), the partnership agreement provides 
that the depreciation deduction for tax purposes of $210,000 in the 
partnership's fourth taxable year is, in accordance with section 704(c) 
principles, allocated $55,000 to A, $55,000 to B, and $100,000 to C.

----------------------------------------------------------------------------------------------------------------
                                                A                         B                         C
                                   -----------------------------------------------------------------------------
                                        Tax          Book         Tax          Book         Tax          Book
----------------------------------------------------------------------------------------------------------------
Capital account at end year 3.....    ($75,000)     $15,000     ($75,000)     $15,000      $15,000      $15,000
Less: nonrecourse deductions......     (45,833)     (83,333)     (45,833)     (83,333)     (83,333)     (83,333)
Plus: items other than nonrecourse      12,499        5,000       12,499        5,000        5,000        5,000
 deduction in year 4..............
Less: distribution................      (5,000)      (5,000)      (5,000)      (5,000)      (5,000)      (5,000)
                                   -----------------------------------------------------------------------------
Capital account at end of year 4..   ($113,334)    ($68,333)   ($113,333)    ($68,333)    ($68,333)    ($68,333)
----------------------------------------------------------------------------------------------------------------

The allocation of the $250,000 nonrecourse deduction equally among A, B, 
and C satisfies requirement (2) of paragraph (e) of this section. 
Because all of the requirements of paragraph (e) of this section are 
satisfied, the allocation is deemed to be in accordance with the 
partners' interests in the partnership. At the end of the partnership's 
fourth taxable year, A's, B's, and C's shares of partnership minimum 
gain are $100,000 each.
    (v) Disposition of partnership property following restatement of 
capital accounts. (a) Additional facts. The partners' capital accounts 
at the end of the fourth taxable year of the partnership are as stated 
above in (iv). In addition, at the beginning of the partnership's fifth 
taxable year it sells the machinery for $650,000 (using $600,000 of the 
proceeds to repay the nonrecourse liability), resulting in a taxable 
gain of $440,000 ($650,000 amount realized less $210,000 adjusted tax 
basis) and a book gain of $350,000 ($650,000 amount realized less 
$300,000 book basis). The partnership has no other items of income, 
gain, loss, or deduction for the year.
    (b) Effect of disposition. As a result of the sale, partnership 
minimum gain is reduced from $300,000 to zero, reducing A's, B's, and 
C's shares of partnership minimum gain to zero from $100,000 each. The 
minimum gain chargeback requires that A, B, and C each be allocated 
$100,000 of that gain (an amount equal to each partner's share of the 
net decrease in partnership minimum gain resulting from the sale) before 
any allocation is made to them under section 704(b) with respect to 
partnership items for the partnership's fifth taxable year. Thus, the 
allocation of the first $300,000 of book gain $100,000 to each of the 
partners is deemed to be in accordance with the partners' interests in 
the partnership under paragraph (e) of this section. The allocation of 
the remaining $50,000 of book gain equally among the partners has 
substantial economic effect. Consistent with the special partners' 
interests in the partnership rule contained in Sec. 1.704-1(b)(4)(i), 
the partnership agreement provides that the $440,000 taxable gain is, in 
accordance with section 704(c) principles, allocated $161,667 to A, 
$161,667 to B, and $116,666 to C.

----------------------------------------------------------------------------------------------------------------
                                                A                         B                         C
                                   -----------------------------------------------------------------------------
                                        Tax          Book         Tax          Book         Tax          Book
----------------------------------------------------------------------------------------------------------------
Capital account at end of year 4..   ($113,334)    ($68,333)   ($113,334)    ($68,333)    ($68,333)    ($68,333)
Plus: minimum gain chargeback.....     138,573      100,000      138,573      100,000      100,000      100,000
Plus: additional gain.............      23,094       16,666       23,094       16,666       16,666       16,666
                                   -----------------------------------------------------------------------------
Capital account before liquidation     $48,333      $48,333      $48,333      $48,333      $48,333      $48,333
----------------------------------------------------------------------------------------------------------------

    Example 4. Allocations of increase in partnership minimum gain among 
partnership properties. For Example 4, unless otherwise provided, the 
following facts are assumed. A partnership owns 4 properties, each of 
which is subject to a nonrecourse liability of the partnership. During a 
taxable year of the partnership, the following events take place. First, 
the partnership generates a depreciation deduction (for both book and 
tax purposes) with respect to Property W of $10,000 and repays $5,000 of 
the nonrecourse liability secured only by that property, resulting in an 
increase in minimum gain with respect to

[[Page 523]]

that liability of $5,000. Second, the partnership generates a 
depreciation deduction (for both book and tax purposes) with respect to 
Property X of $10,000 and repays none of the nonrecourse liability 
secured by that property, resulting in an increase in minimum gain with 
respect to that liability of $10,000. Third, the partnership generates a 
depreciation deduction (for both book and tax purposes) of $2,000 with 
respect to Property Y and repays $11,000 of the nonrecourse liability 
secured only by that property, resulting in a decrease in minimum gain 
with respect to that liability of $9,000 (although at the end of that 
year, there remains minimum gain with respect to that liability). 
Finally, the partnership borrows $5,000 on a nonrecourse basis, giving 
as the only security for that liability Property Z, a parcel of 
undeveloped land with an adjusted tax basis (and book value) of $2,000, 
resulting in a net increase in minimum gain with respect to that 
liability of $3,000.
    (i) Allocation of increase in partnership minimum gain. The net 
increase in partnership minimum gain during that partnership taxable 
year is $9,000, so that the amount of nonrecourse deductions of the 
partnership for that taxable year is $9,000. Those nonrecourse 
deductions consist of $3,000 of depreciation deductions with respect to 
Property W and $6,000 of depreciation deductions with respect to 
Property X. See paragraph (c) of this section. The amount of nonrecourse 
deductions consisting of depreciation deductions is determined as 
follows. With respect to the nonrecourse liability secured by Property 
Z, for which there is no depreciation deduction, the amount of 
depreciation deductions that constitutes nonrecourse deductions is zero. 
Similarly, with respect to the nonrecourse liability secured by Property 
Y, for which there is no increase in minimum gain, the amount of 
depreciation deductions that constitutes nonrecourse deductions is zero. 
With respect to each of the nonrecourse liabilities secured by 
Properties W and X, which are secured by property for which there are 
depreciation deductions and for which there is an increase in minimum 
gain, the amount of depreciation deductions that constitutes nonrecourse 
deductions is determined by the following formula:


net increase in the partnership minimum gain for that taxable year X 
total depreciation deductions for that taxable year on the specific 
property securing the nonrecourse liability to the extent minimum gain 
increased on that liability (divided by) total depreciation deductions 
for that taxable year on all properties securing nonrecourse liabilities 
to the extent of the aggregate increase in minimum gain on all those 
liabilities.

Thus, for the liability secured by Property W, the amount is $9,000 
times $5,000/$15,000, or $3,000. For the liability secured by Property 
X, the amount is $9,000 times $10,000/$15,000, or $6,000. (If one 
depreciable property secured two partnership nonrecourse liabilities, 
the amount of depreciation or book depreciation with respect to that 
property would be allocated among those liabilities in accordance with 
the method by which adjusted basis is allocated under paragraph (d)(2) 
of this section).
    (ii) Alternative allocation of increase in partnership minimum gain 
among partnership properties. Assume instead that the loan secured by 
Property Z is $15,000 (rather than $5,000), resulting in a net increase 
in minimum gain with respect to that liability of $13,000. Thus, the net 
increase in partnership minimum gain is $19,000, and the amount of 
nonrecourse deductions of the partnership for that taxable year is 
$19,000. Those nonrecourse deductions consist of $5,000 of depreciation 
deductions with respect to Property W, $10,000 of depreciation 
deductions with respect to Property X, and a pro rata portion of the 
partnership's other items of deduction, loss, and section 705(a)(2)(B) 
expenditure for that year. The method for computing the amounts of 
depreciation deductions that constitute nonrecourse deductions is the 
same as in (i) of this Example 4 for the liabilities secured by 
Properties Y and Z. With respect to each of the nonrecourse liabilities 
secured by Properties W and X, the amount of depreciation deductions 
that constitutes nonrecourse deductions equals the total depreciation 
deductions with respect to the partnership property securing that 
particular liability to the extent of the increase in minimum gain with 
respect to that liability.

[T.D. 8385, 56 FR 66983, Dec. 27, 1991; 57 FR 6073, Feb. 20, 1992; 57 FR 
8961, 8962, Mar. 13, 1992; 57 FR 11430, Apr. 3, 1992; 57 FR 28611, June 
26, 1992; 57 FR 37189, Aug. 18, 1992; T.D. 9207, 70 FR 30342, May 26, 
2005; T.D. 9289, 71 FR 59672, Oct. 11, 2006; T.D. 9557, 76 FR 71258, 
Nov. 17, 2011]



Sec. 1.704-3  Contributed property.

    (a) In general--(1) General principles. The purpose of section 
704(c) is to prevent the shifting of tax consequences among partners 
with respect to precontribution gain or loss. Under section 704(c), a 
partnership must allocate income, gain, loss, and deduction with respect 
to property contributed by a partner to the partnership so as to take 
into account any variation between the adjusted tax basis of the 
property and its fair market value at the time of contribution. 
Notwithstanding any other provision of this section, the allocations 
must be made

[[Page 524]]

using a reasonable method that is consistent with the purpose of section 
704(c). For this purpose, an allocation method includes the application 
of all of the rules of this section (e.g., aggregation rules). An 
allocation method is not necessarily unreasonable merely because another 
allocation method would result in a higher aggregate tax liability. 
Paragraphs (b), (c), and (d) of this section describe allocation methods 
that are generally reasonable. Other methods may be reasonable in 
appropriate circumstances. Nevertheless, in the absence of specific 
published guidance, it is not reasonable to use an allocation method in 
which the basis of property contributed to the partnership is increased 
(or decreased) to reflect built-in gain (or loss), or a method under 
which the partnership creates tax allocations of income, gain, loss, or 
deduction independent of allocations affecting book capital accounts. 
See Sec. 1.704-3(d). Paragraph (e) of this section contains special 
rules and exceptions. The principles of this paragraph (a)(1), together 
with the methods described in paragraphs (b), (c) and (d) of this 
section, apply only to contributions of property that are otherwise 
respected. See for example Sec. 1.701-2. Accordingly, even though a 
partnership's allocation method may be described in the literal language 
of paragraphs (b), (c) or (d) of this section, based on the particular 
facts and circumstances, the Commissioner can recast the contribution as 
appropriate to avoid tax results inconsistent with the intent of 
subchapter K. One factor that may be considered by the Commissioner is 
the use of the remedial allocation method by related partners in which 
allocations of remedial items of income, gain, loss or deduction are 
made to one partner and the allocations of offsetting remedial items are 
made to a related partner.
    (2) Operating rules. Except as provided in paragraphs (e)(2) and 
(e)(3) of this section, section 704(c) and this section apply on a 
property-by-property basis. Therefore, in determining whether there is a 
disparity between adjusted tax basis and fair market value, the built-in 
gains and built-in losses on items of contributed property cannot be 
aggregated. A partnership may use different methods with respect to 
different items of contributed property, provided that the partnership 
and the partners consistently apply a single reasonable method for each 
item of contributed property and that the overall method or combination 
of methods are reasonable based on the facts and circumstances and 
consistent with the purpose of section 704(c). It may be unreasonable to 
use one method for appreciated property and another method for 
depreciated property. Similarly, it may be unreasonable to use the 
traditional method for built-in gain property contributed by a partner 
with a high marginal tax rate while using curative allocations for 
built-in gain property contributed by a partner with a low marginal tax 
rate. A new partnership formed as the result of the termination of a 
partnership under section 708(b)(1)(B) is not required to use the same 
method as the terminated partnership with respect to section 704(c) 
property deemed contributed to the new partnership by the terminated 
partnership under Sec. 1.708-1(b)(1)(iv). The previous sentence applies 
to terminations of partnerships under section 708(b)(1)(B) occurring on 
or after May 9, 1997; however, the sentence may be applied to 
terminations occurring on or after May 9, 1996, provided that the 
partnership and its partners apply the sentence to the termination in a 
consistent manner.
    (3) Definitions--(i) Section 704(c) property. Property contributed 
to a partnership is section 704(c) property if at the time of 
contribution its book value differs from the contributing partner's 
adjusted tax basis. For purposes of this section, book value is 
determined as contemplated by Sec. 1.704-1(b). Therefore, book value is 
equal to fair market value at the time of contribution and is 
subsequently adjusted for cost recovery and other events that affect the 
basis of the property. For a partnership that maintains capital accounts 
in accordance with Sec. 1.704-1(b)(2)(iv), the book value of property 
is initially the value used in determining the contributing partner's 
capital account under Sec. 1.704-1(b)(2)(iv)(d), and is appropriately 
adjusted thereafter (e.g., for book cost recovery under Sec. Sec. 
1.704-1(b)(2)(iv)(g)(3) and

[[Page 525]]

1.704-3(d)(2) and other events that affect the basis of the property). A 
partnership that does not maintain capital accounts under Sec. 1.704-
1(b)(2)(iv) must comply with this section using a book capital account 
based on the same principles (i.e., a book capital account that reflects 
the fair market value of property at the time of contribution and that 
is subsequently adjusted for cost recovery and other events that affect 
the basis of the property). Property deemed contributed to a new 
partnership as the result of the termination of a partnership under 
section 708(b)(1)(B) is treated as section 704(c) property in the hands 
of the new partnership only to the extent that the property was section 
704(c) property in the hands of the terminated partnership immediately 
prior to the termination. See Sec. 1.708-1(b)(1)(iv) for an example of 
the application of this rule. The previous two sentences apply to 
terminations of partnerships under section 708(b)(1)(B) occurring on or 
after May 9, 1997; however, the sentences may be applied to terminations 
occurring on or after May 9, 1996, provided that the partnership and its 
partners apply the sentences to the termination in a consistent manner.
    (ii) Built-in gain and built-in loss. The built-in gain on section 
704(c) property is the excess of the property's book value over the 
contributing partner's adjusted tax basis upon contribution. The built-
in gain is thereafter reduced by decreases in the difference between the 
property's book value and adjusted tax basis. The built-in loss on 
section 704(c) property is the excess of the contributing partner's 
adjusted tax basis over the property's book value upon contribution. The 
built-in loss is thereafter reduced by decreases in the difference 
between the property's adjusted tax basis and book value. See Sec. 
1.460-4(k)(3)(v)(A) for a rule relating to the amount of built-in income 
or built-in loss attributable to a contract accounted for under a long-
term contract method of accounting.
    (4) Accounts payable and other accrued but unpaid items. Accounts 
payable and other accrued but unpaid items contributed by a partner 
using the cash receipts and disbursements method of accounting are 
treated as section 704(c) property for purposes of applying the rules of 
this section.
    (5) Other provisions of the Internal Revenue Code. Section 704(c) 
and this section apply to a contribution of property to the partnership 
only if the contribution is governed by section 721, taking into account 
other provisions of the Internal Revenue Code. For example, to the 
extent that a transfer of property to a partnership is a sale under 
section 707, the transfer is not a contribution of property to which 
section 704(c) applies.
    (6) Other applications of section 704(c) principles--(i) 
Revaluations under section 704(b). The principles of this section apply 
to allocations with respect to property for which differences between 
book value and adjusted tax basis are created when a partnership 
revalues partnership property pursuant to Sec. 1.704-1(b)(2)(iv)(f) or 
1.704-1(b)(2)(iv)(s) (reverse section 704(c) allocations). Partnerships 
are not required to use the same allocation method for reverse section 
704(c) allocations as for contributed property, even if at the time of 
revaluation the property is already subject to section 704(c) and 
paragraph (a) of this section. In addition, partnerships are not 
required to use the same allocation method for reverse section 704(c) 
allocations each time the partnership revalues its property. A 
partnership that makes allocations with respect to revalued property 
must use a reasonable method that is consistent with the purposes of 
section 704(b) and (c).
    (ii) Basis adjustments. A partnership making adjustments under Sec. 
1.743-1(b) or 1.751-1(a)(2) must account for built-in gain or loss under 
section 704(c) in accordance with the principles of this section.
    (7) Transfer of a partnership interest. If a contributing partner 
transfers a partnership interest, built-in gain or loss must be 
allocated to the transferee partner as it would have been allocated to 
the transferor partner. If the contributing partner transfers a portion 
of the partnership interest, the share of built-in gain or loss 
proportionate to the interest transferred must be allocated to the 
transferee partner. This rule does not apply to any person who acquired 
a partnership interest from a

[[Page 526]]

Sec. 1.752-7 liability partner in a transaction to which paragraph 
(e)(1) of Sec. 1.752-7 applies. See Sec. 1.752-7(c)(1).
    (8) Special rules--(i) Disposition in a nonrecognition transaction. 
If a partnership disposes of section 704(c) property in a nonrecognition 
transaction, the substituted basis property (within the meaning of 
section 7701(a)(42)) is treated as section 704(c) property with the same 
amount of built-in gain or loss as the section 704(c) property disposed 
of by the partnership. If gain or loss is recognized in such a 
transaction, appropriate adjustments must be made. The allocation method 
for the substituted basis property must be consistent with the 
allocation method chosen for the original property. If a partnership 
transfers an item of section 704(c) property together with other 
property to a corporation under section 351, in order to preserve that 
item's built-in gain or loss, the basis in the stock received in 
exchange for the section 704(c) property is determined as if each item 
of section 704(c) property had been the only property transferred to the 
corporation by the partnership.
    (ii) Disposition in an installment sale. If a partnership disposes 
of section 704(c) property in an installment sale as defined in section 
453(b), the installment obligation received by the partnership is 
treated as the section 704(c) property with the same amount of built-in 
gain as the section 704(c) property disposed of by the partnership (with 
appropriate adjustments for any gain recognized on the installment 
sale). The allocation method for the installment obligation must be 
consistent with the allocation method chosen for the original property.
    (iii) Contributed contracts. If a partner contributes to a 
partnership a contract that is section 704(c) property, and the 
partnership subsequently acquires property pursuant to the contract in a 
transaction in which less than all of the gain or loss is recognized, 
then the acquired property is treated as the section 704(c) property 
with the same amount of built-in gain or loss as the contract (with 
appropriate adjustments for any gain or loss recognized on the 
acquisition). For this purpose, the term contract includes, but is not 
limited to, options, forward contracts, and futures contracts. The 
allocation method for the acquired property must be consistent with the 
allocation method chosen for the contributed contract.
    (iv) Capitalized amounts. To the extent that a partnership properly 
capitalizes all or a portion of an item as described in paragraph 
(a)(12) of this section, then the item or items to which such cost is 
properly capitalized is treated as section 704(c) property with the same 
amount of built-in loss as corresponds to the amount capitalized.
    (9) Tiered partnerships. If a partnership contributes section 704(c) 
property to a second partnership (the lower-tier partnership), or if a 
partner that has contributed section 704(c) property to a partnership 
contributes that partnership interest to a second partnership (the 
upper-tier partnership), the upper-tier partnership must allocate its 
distributive share of lower-tier partnership items with respect to that 
section 704(c) property in a manner that takes into account the 
contributing partner's remaining built-in gain or loss. Allocations made 
under this paragraph will be considered to be made in a manner that 
meets the requirements of Sec. 1.704-1(b)(2)(iv)(q) (relating to 
capital account adjustments where guidance is lacking).
    (10) Anti-abuse rule--(i) In general. An allocation method (or 
combination of methods) is not reasonable if the contribution of 
property (or event that results in reverse section 704(c) allocations) 
and the corresponding allocation of tax items with respect to the 
property are made with a view to shifting the tax consequences of built-
in gain or loss among the partners in a manner that substantially 
reduces the present value of the partners' aggregate tax liability. For 
purposes of this paragraph (a)(10), all references to the partners shall 
include both direct and indirect partners.
    (ii) Definition of indirect partner. An indirect partner is any 
direct or indirect owner of a partnership, S corporation, or controlled 
foreign corporation (as defined in section 957(a) or 953(c)), or direct 
or indirect beneficiary of a trust or estate, that is a partner in the 
partnership, and any consolidated group of which the partner in the 
partnership is

[[Page 527]]

a member (within the meaning of Sec. 1.1502-1(h)). An owner (whether 
directly or through tiers of entities) of a controlled foreign 
corporation is treated as an indirect partner only with respect to 
allocations of items of income, gain, loss, or deduction that enter into 
the computation of a United States shareholder's inclusion under section 
951(a) with respect to the controlled foreign corporation, enter into 
any person's income attributable to a United States shareholder's 
inclusion under section 951(a) with respect to the controlled foreign 
corporation, or would enter into the computations described in this 
sentence if such items were allocated to the controlled foreign 
corporation.
    (11) Contributing and noncontributing partners' recapture shares. 
For special rules applicable to the allocation of depreciation recapture 
with respect to property contributed by a partner to a partnership, see 
Sec. Sec. 1.1245-1(e)(2) and 1.1250-1(f).
    (12) Sec. 1.752-7 liabilities. Except as otherwise provided in 
Sec. 1.752-7, Sec. 1.752-7 liabilities (within the meaning of Sec. 
1.752-7(b)(2)) are section 704(c) property (built-in loss property that 
at the time of contribution has a book value that differs from the 
contributing partner's adjusted tax basis) for purposes of applying the 
rules of this section. See Sec. 1.752-7(c). To the extent that the 
built-in loss associated with the Sec. 1.752-7 liability exceeds the 
cost of satisfying the Sec. 1.752-7 liability (as defined in Sec. 
1.752-7(b)(3)), the excess creates a ``ceiling rule'' limitation, within 
the meaning of Sec. 1.704-3(b)(1), subject to the methods of allocation 
set forth in Sec. 1.704-3(b), (c) and (d).
    (b) Traditional method--(1) In general. This paragraph (b) describes 
the traditional method of making section 704(c) allocations. In general, 
the traditional method requires that when the partnership has income, 
gain, loss, or deduction attributable to section 704(c) property, it 
must make appropriate allocations to the partners to avoid shifting the 
tax consequences of the built-in gain or loss. Under this rule, if the 
partnership sells section 704(c) property and recognizes gain or loss, 
built-in gain or loss on the property is allocated to the contributing 
partner. If the partnership sells a portion of, or an interest in, 
section 704(c) property, a proportionate part of the built-in gain or 
loss is allocated to the contributing partner. For section 704(c) 
property subject to amortization, depletion, depreciation, or other cost 
recovery, the allocation of deductions attributable to these items takes 
into account built-in gain or loss on the property. For example, tax 
allocations to the noncontributing partners of cost recovery deductions 
with respect to section 704(c) property generally must, to the extent 
possible, equal book allocations to those partners. However, the total 
income, gain, loss, or deduction allocated to the partners for a taxable 
year with respect to a property cannot exceed the total partnership 
income, gain, loss, or deduction with respect to that property for the 
taxable year (the ceiling rule). If a partnership has no property the 
allocations from which are limited by the ceiling rule, the traditional 
method is reasonable when used for all contributed property.
    (2) Examples. The following examples illustrate the principles of 
the traditional method.

    Example 1. Operation of the traditional method. (i) Calculation of 
built-in gain on contribution. A and B form partnership AB and agree 
that each will be allocated a 50 percent share of all partnership items 
and that AB will make allocations under section 704(c) using the 
traditional method under paragraph (b) of this section. A contributes 
depreciable property with an adjusted tax basis of $4,000 and a book 
value of $10,000, and B contributes $10,000 cash. Under paragraph (a)(3) 
of this section, A has built-in gain of $6,000, the excess of the 
partnership's book value for the property ($10,000) over A's adjusted 
tax basis in the property at the time of contribution ($4,000).
    (ii) Allocation of tax depreciation. The property is depreciated 
using the straight-line method over a 10-year recovery period. Because 
the property depreciates at an annual rate of 10 percent, B would have 
been entitled to a depreciation deduction of $500 per year for both book 
and tax purposes if the adjusted tax basis of the property equalled its 
fair market value at the time of contribution. Although each partner is 
allocated $500 of book depreciation per year, the partnership is allowed 
a tax depreciation deduction of only $400 per year (10 percent of 
$4,000). The partnership can allocate only $400 of tax

[[Page 528]]

depreciation under the ceiling rule of paragraph (b)(1) of this section, 
and it must be allocated entirely to B. In AB's first year, the proceeds 
generated by the equipment exactly equal AB's operating expenses. At the 
end of that year, the book value of the property is $9,000 ($10,000 less 
the $1,000 book depreciation deduction), and the adjusted tax basis is 
$3,600 ($4,000 less the $400 tax depreciation deduction). A's built-in 
gain with respect to the property decreases to $5,400 ($9,000 book value 
less $3,600 adjusted tax basis). Also, at the end of AB's first year, A 
has a $9,500 book capital account and a $4,000 tax basis in A's 
partnership interest. B has a $9,500 book capital account and a $9,600 
adjusted tax basis in B's partnership interest.
    (iii) Sale of the property. If AB sells the property at the 
beginning of AB's second year for $9,000, AB realizes tax gain of $5,400 
($9,000, the amount realized, less the adjusted tax basis of $3,600). 
Under paragraph (b)(1) of this section, the entire $5,400 gain must be 
allocated to A because the property A contributed has that much built-in 
gain remaining. If AB sells the property at the beginning of AB's second 
year for $10,000, AB realizes tax gain of $6,400 ($10,000, the amount 
realized, less the adjusted tax basis of $3,600). Under paragraph (b)(1) 
of this section, only $5,400 of gain must be allocated to A to account 
for A's built-in gain. The remaining $1,000 of gain is allocated equally 
between A and B in accordance with the partnership agreement. If AB 
sells the property for less than the $9,000 book value, AB realizes tax 
gain of less than $5,400, and the entire gain must be allocated to A.
    (iv) Termination and liquidation of partnership. If AB sells the 
property at the beginning of AB's second year for $9,000, and AB engages 
in no other transactions that year, A will recognize a gain of $5,400, 
and B will recognize no income or loss. A's adjusted tax basis for A's 
interest in AB will then be $9,400 ($4,000, A's original tax basis, 
increased by the gain of $5,400). B's adjusted tax basis for B's 
interest in AB will be $9,600 ($10,000, B's original tax basis, less the 
$400 depreciation deduction in the first partnership year). If the 
partnership then terminates and distributes its assets ($19,000 in cash) 
to A and B in proportion to their capital account balances, A will 
recognize a capital gain of $100 ($9,500, the amount distributed to A, 
less $9,400, the adjusted tax basis of A's interest). B will recognize a 
capital loss of $100 (the excess of B's adjusted tax basis, $9,600, over 
the amount received, $9,500).
    Example 2. Unreasonable use of the traditional method. (i) Facts. C 
and D form partnership CD and agree that each will be allocated a 50 
percent share of all partnership items and that CD will make allocations 
under section 704(c) using the traditional method under paragraph (b) of 
this section. C contributes equipment with an adjusted tax basis of 
$1,000 and a book value of $10,000, with a view to taking advantage of 
the fact that the equipment has only one year remaining on its cost 
recovery schedule although its remaining economic life is significantly 
longer. At the time of contribution, C has a built-in gain of $9,000 and 
the equipment is section 704(c) property. D contributes $10,000 of cash, 
which CD uses to buy securities. D has substantial net operating loss 
carryforwards that D anticipates will otherwise expire unused. Under 
Sec. 1.704-1(b)(2)(iv)(g)(3), the partnership must allocate the $10,000 
of book depreciation to the partners in the first year of the 
partnership. Thus, there is $10,000 of book depreciation and $1,000 of 
tax depreciation in the partnership's first year. CD sells the equipment 
during the second year for $10,000 and recognizes a $10,000 gain 
($10,000, the amount realized, less the adjusted tax basis of $0).
    (ii) Unreasonable use of method--(A) At the beginning of the second 
year, both the book value and adjusted tax basis of the equipment are 
$0. Therefore, there is no remaining built-in gain. The $10,000 gain on 
the sale of the equipment in the second year is allocated $5,000 each to 
C and D. The interaction of the partnership's one-year write-off of the 
entire book value of the equipment and the use of the traditional method 
results in a shift of $4,000 of the precontribution gain in the 
equipment from C to D (D's $5,000 share of CD's $10,000 gain, less the 
$1,000 tax depreciation deduction previously allocated to D).
    (B) The traditional method is not reasonable under paragraph (a)(10) 
of this section because the contribution of property is made, and the 
traditional method is used, with a view to shifting a significant amount 
of taxable income to a partner with a low marginal tax rate and away 
from a partner with a high marginal tax rate.
    (C) Under these facts, if the partnership agreement in effect for 
the year of contribution had provided that tax gain from the sale of the 
property (if any) would always be allocated first to C to offset the 
effect of the ceiling rule limitation, the allocation method would not 
violate the anti-abuse rule of paragraph (a)(10) of this section. See 
paragraph (c)(3) of this section. Under other facts, (for example, if 
the partnership holds multiple section 704(c) properties and either uses 
multiple allocation methods or uses a single allocation method where one 
or more of the properties are subject to the ceiling rule) the 
allocation to C may not be reasonable.

    (c) Traditional method with curative allocations--(1) In general. To 
correct distortions created by the ceiling rule, a partnership using the 
traditional method under paragraph (b) of this section

[[Page 529]]

may make reasonable curative allocations to reduce or eliminate 
disparities between book and tax items of noncontributing partners. A 
curative allocation is an allocation of income, gain, loss, or deduction 
for tax purposes that differs from the partnership's allocation of the 
corresponding book item. For example, if a noncontributing partner is 
allocated less tax depreciation than book depreciation with respect to 
an item of section 704(c) property, the partnership may make a curative 
allocation to that partner of tax depreciation from another item of 
partnership property to make up the difference, notwithstanding that the 
corresponding book depreciation is allocated to the contributing 
partner. A partnership may limit its curative allocations to allocations 
of one or more particular tax items (e.g., only depreciation from a 
specific property or properties) even if the allocation of those 
available items does not offset fully the effect of the ceiling rule.
    (2) Consistency. A partnership must be consistent in its application 
of curative allocations with respect to each item of section 704(c) 
property from year to year.
    (3) Reasonable curative allocations--(i) Amount. A curative 
allocation is not reasonable to the extent it exceeds the amount 
necessary to offset the effect of the ceiling rule for the current 
taxable year or, in the case of a curative allocation upon disposition 
of the property, for prior taxable years.
    (ii) Timing. The period of time over which the curative allocations 
are made is a factor in determining whether the allocations are 
reasonable. Notwithstanding paragraph (c)(3)(i) of this section, a 
partnership may make curative allocations in a taxable year to offset 
the effect of the ceiling rule for a prior taxable year if those 
allocations are made over a reasonable period of time, such as over the 
property's economic life, and are provided for under the partnership 
agreement in effect for the year of contribution. See paragraph (c)(4) 
Example 3 (ii)(C) of this section.
    (iii) Type--(A) In general. To be reasonable, a curative allocation 
of income, gain, loss, or deduction must be expected to have 
substantially the same effect on each partner's tax liability as the tax 
item limited by the ceiling rule. The expectation must exist at the time 
the section 704(c) property is obligated to be (or is) contributed to 
the partnership and the allocation with respect to that property becomes 
part of the partnership agreement. However, the expectation is tested at 
the time the allocation with respect to that property is actually made 
if the partnership agreement is not sufficiently specific as to the 
precise manner in which allocations are to be made with respect to that 
property. Under this paragraph (c), if the item limited by the ceiling 
rule is loss from the sale of property, a curative allocation of gain 
must be expected to have substantially the same effect as would an 
allocation to that partner of gain with respect to the sale of the 
property. If the item limited by the ceiling rule is depreciation or 
other cost recovery, a curative allocation of income to the contributing 
partner must be expected to have substantially the same effect as would 
an allocation to that partner of partnership income with respect to the 
contributed property. For example, if depreciation deductions with 
respect to leased equipment contributed by a tax-exempt partner are 
limited by the ceiling rule, a curative allocation of dividend or 
interest income to that partner generally is not reasonable, although a 
curative allocation of depreciation deductions from other leased 
equipment to the noncontributing partner is reasonable. Similarly, under 
this rule, if depreciation deductions apportioned to foreign source 
income in a particular statutory grouping under section 904(d) are 
limited by the ceiling rule, a curative allocation of income from 
another statutory grouping to the contributing partner generally is not 
reasonable, although a curative allocation of income from the same 
statutory grouping and of the same character is reasonable.
    (B) Exception for allocation from disposition of contributed 
property. If cost recovery has been limited by the ceiling rule, the 
general limitation on character does not apply to income from the 
disposition of contributed property subject to the ceiling rule, but 
only if properly provided for in the partnership agreement in effect for 
the year of contribution or revaluation.

[[Page 530]]

For example, if allocations of depreciation deductions to a 
noncontributing partner have been limited by the ceiling rule, a 
curative allocation to the contributing partner of gain from the sale of 
that property, if properly provided for in the partnership agreement, is 
reasonable for purposes of paragraph (c)(3)(iii)(A) of this section even 
if not of the same character.
    (4) Examples. The following examples illustrate the principles of 
this paragraph (c).

    Example 1. Reasonable and unreasonable curative allocations. (i) 
Facts. E and F form partnership EF and agree that each will be allocated 
a 50 percent share of all partnership items and that EF will make 
allocations under section 704(c) using the traditional method with 
curative allocations under paragraph (c) of this section. E contributes 
equipment with an adjusted tax basis of $4,000 and a book value of 
$10,000. The equipment has 10 years remaining on its cost recovery 
schedule and is depreciable using the straight-line method. At the time 
of contribution, E has a built-in gain of $6,000, and therefore, the 
equipment is section 704(c) property. F contributes $10,000 of cash, 
which EF uses to buy inventory for resale. In EF's first year, the 
revenue generated by the equipment equals EF's operating expenses. The 
equipment generates $1,000 of book depreciation and $400 of tax 
depreciation for each of 10 years. At the end of the first year EF sells 
all the inventory for $10,700, recognizing $700 of income. The partners 
anticipate that the inventory income will have substantially the same 
effect on their tax liabilities as income from E's contributed 
equipment. Under the traditional method of paragraph (b) of this 
section, E and F would each be allocated $350 of income from the sale of 
inventory for book and tax purposes and $500 of depreciation for book 
purposes. The $400 of tax depreciation would all be allocated to F. 
Thus, at the end of the first year, E and F's book and tax capital 
accounts would be as follows:

----------------------------------------------------------------------------------------------------------------
               E                               F
---------------------------------------------------------------
     Book             Tax            Book             Tax
----------------------------------------------------------------------------------------------------------------
       $10,000          $4,000         $10,000         $10,000  Initial contribution.
<500  <500                              >               >
           350             350             350             350  Sales income.
---------------------------------------------------------------
         9,850           4,350           9,850           9,950
----------------------------------------------------------------------------------------------------------------

    (ii) Reasonable curative allocation. Because the ceiling rule would 
cause a disparity of $100 between F's book and tax capital accounts, EF 
may properly allocate to E under paragraph (c) of this section an 
additional $100 of income from the sale of inventory for tax purposes. 
This allocation results in capital accounts at the end of EF's first 
year as follows:

----------------------------------------------------------------------------------------------------------------
               E                               F
---------------------------------------------------------------
     Book             Tax            Book             Tax
----------------------------------------------------------------------------------------------------------------
       $10,000          $4,000         $10,000         $10,000  Initial contribution.
<500  <500                              >               >
           350             450             350             250  Sales income.
---------------------------------------------------------------
         9,850           4,450           9,850           9,850
----------------------------------------------------------------------------------------------------------------

    (iii) Unreasonable curative allocation. (A) The facts are the same 
as in paragraphs (i) and (ii) of this Example 1, except that E and F 
choose to allocate all the income from the sale of the inventory to E 
for tax purposes, although they share it equally for book purposes. This 
allocation results in capital accounts at the end of EF's first year as 
follows:

----------------------------------------------------------------------------------------------------------------
               E                               F
---------------------------------------------------------------
     Book             Tax            Book             Tax
----------------------------------------------------------------------------------------------------------------
       $10,000          $4,000         $10,000         $10,000  Initial contribution.
<500  <500                              >               >
           350             700             350               0  Sales income.
---------------------------------------------------------------

[[Page 531]]

 
         9,850           4,700           9,850           9,600
----------------------------------------------------------------------------------------------------------------

    (B) This curative allocation is not reasonable under paragraph 
(c)(3)(i) of this section because the allocation exceeds the amount 
necessary to offset the disparity caused by the ceiling rule.
    Example 2. Curative allocations limited to depreciation. (i) Facts. 
G and H form partnership GH and agree that each will be allocated a 50 
percent share of all partnership items and that GH will make allocations 
under section 704(c) using the traditional method with curative 
allocations under paragraph (c) of this section, but only to the extent 
that the partnership has sufficient tax depreciation deductions. G 
contributes property G1, with an adjusted tax basis of $3,000 and a fair 
market value of $10,000, and H contributes property H1, with an adjusted 
tax basis of $6,000 and a fair market value of $10,000. Both properties 
have 5 years remaining on their cost recovery schedules and are 
depreciable using the straight-line method. At the time of contribution, 
G1 has a built-in gain of $7,000 and H1 has a built-in gain of $4,000, 
and therefore, both properties are section 704(c) property. G1 generates 
$600 of tax depreciation and $2,000 of book depreciation for each of 
five years. H1 generates $1,200 of tax depreciation and $2,000 of book 
depreciation for each of 5 years. In addition, the properties each 
generate $500 of operating income annually. G and H are each allocated 
$1,000 of book depreciation for each property. Under the traditional 
method of paragraph (b) of this section, G would be allocated $0 of tax 
depreciation for G1 and $1,000 for H1, and H would be allocated $600 of 
tax depreciation for G1 and $200 for H1. Thus, at the end of the first 
year, G and H's book and tax capital accounts would be as follows:

----------------------------------------------------------------------------------------------------------------
               G                               H
---------------------------------------------------------------
     Book             Tax            Book             Tax
----------------------------------------------------------------------------------------------------------------
       $10,000          $3,000         $10,000          $6,000  Initial contribution.
<1,000  <1,000
<1,000
           500             500             500             500  Operating income.
---------------------------------------------------------------
         8,500           2,500           8,500           5,700
----------------------------------------------------------------------------------------------------------------

    (ii) Curative allocations. Under the traditional method, G is 
allocated more depreciation deductions than H, even though H contributed 
property with a smaller disparity reflected on GH's book and tax capital 
accounts. GH makes curative allocations to H of an additional $400 of 
tax depreciation each year, which reduces the disparities between G and 
H's book and tax capital accounts ratably each year. These allocations 
are reasonable provided the allocations meet the other requirements of 
this section. As a result of their agreement, at the end of the first 
year, G and H's capital accounts are as follows:

----------------------------------------------------------------------------------------------------------------
               G                               H
---------------------------------------------------------------
     Book             Tax            Book             Tax
----------------------------------------------------------------------------------------------------------------
       $10,000          $3,000         $10,000          $6,000  Initial contribution.
<1,000  <1,000
<1,000               e               >
           500             500             500             500  Operating income.
---------------------------------------------------------------
         8,500           2,900           8,500           5,300
----------------------------------------------------------------------------------------------------------------

    Example 3. Unreasonable use of curative allocations. (i) Facts. J 
and K form partnership JK and agree that each will receive a 50 percent 
share of all partnership items and that JK will make allocations under 
section 704(c) using the traditional method with curative allocations 
under paragraph (c) of this section. J contributes equipment with an 
adjusted tax basis of $1,000 and a book value of $10,000, with a view to 
taking advantage of the fact that the equipment has only one year 
remaining on its cost recovery schedule although it has an estimated 
remaining economic life of 10 years. J has substantial net operating 
loss carryforwards that J anticipates will otherwise expire unused. At 
the

[[Page 532]]

time of contribution, J has a built-in gain of $9,000, and therefore, 
the equipment is section 704(c) property. K contributes $10,000 of cash, 
which JK uses to buy inventory for resale. In JK's first year, the 
revenues generated by the equipment exactly equal JK's operating 
expenses. Under Sec. 1.704-1(b)(2)(iv)(g)(3), the partnership must 
allocate the $10,000 of book depreciation to the partners in the first 
year of the partnership. Thus, there is $10,000 of book depreciation and 
$1,000 of tax depreciation in the partnership's first year. In addition, 
at the end of the first year JK sells all of the inventory for $18,000, 
recognizing $8,000 of income. The partners anticipate that the inventory 
income will have substantially the same effect on their tax liabilities 
as income from J's contributed equipment. Under the traditional method 
of paragraph (b) of this section, J and K's book and tax capital 
accounts at the end of the first year would be as follows:

----------------------------------------------------------------------------------------------------------------
               J                               K
---------------------------------------------------------------
     Book             Tax            Book             Tax
----------------------------------------------------------------------------------------------------------------
       $10,000          $1,000         $10,000         $10,000  Initial contribution.
<5,000  <5,000  <5,000  <5,000
Sec. 1.704-4  Distribution of contributed property.

    (a) Determination of gain and loss--(1) In general. A partner that 
contributes section 704(c) property to a partnership must recognize gain 
or loss under section 704(c)(1)(B) and this section on the distribution 
of such property to another partner within five years of its 
contribution to the partnership in an amount equal to the gain or loss 
that would have been allocated to such partner under section 
704(c)(1)(A) and Sec. 1.704-3 if the distributed property had been sold 
by the partnership to the distributee partner for its fair market value 
at the time of the distribution. See Sec. 1.704-3(a)(3)(i) for a 
definition of section 704(c) property.
    (2) Transactions to which section 704(c)(1)(B) applies. Section 
704(c)(1)(B) and this section apply only to the extent that a 
distribution by a partnership is a distribution to a partner acting in 
the capacity of a partner within the meaning of section 731.
    (3) Fair market value of property. The fair market value of the 
distributed section 704(c) property is the price at which the property 
would change hands between a willing buyer and a willing seller at the 
time of the distribution, neither being under any compulsion to buy or 
sell and both having reasonable knowledge of the relevant facts. The 
fair market value that a partnership assigns to distributed section 
704(c) property will be regarded as correct, provided that the value is 
reasonably agreed to among the partners in an

[[Page 541]]

arm's-length negotiation and the partners have sufficiently adverse 
interests.
    (4) Determination of five-year period--(i) General rule. The five-
year period specified in paragraph (a)(1) of this section begins on and 
includes the date of contribution.
    (ii) Section 708(b)(1)(B) terminations. A termination of the 
partnership under section 708(b)(1)(B) does not begin a new five-year 
period for each partner with respect to the built-in gain and built-in 
loss property that the terminated partnership is deemed to contribute to 
the new partnership under Sec. 1.708-1(b)(1)(iv). See Sec. 1.704-
3(a)(3)(ii) for the definitions of built-in gain and built-in loss on 
section 704(c) property. This paragraph (a)(4)(ii) applies to 
terminations of partnerships under section 708(b)(1)(B) occurring on or 
after May 9, 1997; however, this paragraph (a)(4)(ii) may be applied to 
terminations occurring on or after May 9, 1996, provided that the 
partnership and its partners apply this paragraph (a)(4)(ii) to the 
termination in a consistent manner.
    (5) Examples. The following examples illustrate the rules of this 
paragraph (a). Unless otherwise specified, partnership income equals 
partnership expenses (other than depreciation deductions for contributed 
property) for each year of the partnership, the fair market value of 
partnership property does not change, all distributions by the 
partnership are subject to section 704(c)(1)(B), and all partners are 
unrelated.

    Example 1. Recognition of gain. (i) On January 1, 1995, A, B, and C 
form partnership ABC as equal partners. A contributes $10,000 cash and 
Property A, nondepreciable real property with a fair market value of 
$10,000 and an adjusted tax basis of $4,000. Thus, there is a built-in 
gain of $6,000 on Property A at the time of contribution. B contributes 
$10,000 cash and Property B, nondepreciable real property with a fair 
market value and adjusted tax basis of $10,000. C contributes $20,000 
cash.
    (ii) On December 31, 1998, Property A and Property B are distributed 
to C in complete liquidation of C's interest in the partnership.
    (iii) A would have recognized $6,000 of gain under section 
704(c)(1)(A) and Sec. 1.704-3 on the sale of Property A at the time of 
the distribution ($10,000 fair market value less $4,000 adjusted tax 
basis). As a result, A must recognize $6,000 of gain on the distribution 
of Property A to C. B would not have recognized any gain or loss under 
section 704(c)(1)(A) and Sec. 1.704-3 on the sale of Property B at the 
time of distribution because Property B was not section 704(c) property. 
As a result, B does not recognize any gain or loss on the distribution 
of Property B.
    Example 2. Effect of post-contribution depreciation deductions. (i) 
On January 1, 1995, A, B, and C form partnership ABC as equal partners. 
A contributes Property A, depreciable property with a fair market value 
of $30,000 and an adjusted tax basis of $20,000. Therefore, there is a 
built-in gain of $10,000 on Property A. B and C each contribute $30,000 
cash. ABC uses the traditional method of making section 704(c) 
allocations described in Sec. 1.704-3(b) with respect to Property A.
    (ii) Property A is depreciated using the straight-line method over 
its remaining 10-year recovery period. The partnership has book 
depreciation of $3,000 per year (10 percent of the $30,000 book basis), 
and each partner is allocated $1,000 of book depreciation per year (one-
third of the total annual book depreciation of $3,000). The partnership 
has a tax depreciation deduction of $2,000 per year (10 percent of the 
$20,000 tax basis in Property A). This $2,000 tax depreciation deduction 
is allocated equally between B and C, the noncontributing partners with 
respect to Property A.
    (iii) At the end of the third year, the book value of Property A is 
$21,000 ($30,000 initial book value less $9,000 aggregate book 
depreciation) and the adjusted tax basis is $14,000 ($20,000 initial tax 
basis less $6,000 aggregate tax depreciation). A's remaining section 
704(c)(1)(A) built-in gain with respect to Property A is $7,000 ($21,000 
book value less $14,000 adjusted tax basis).
    (iv) On December 31, 1997, Property A is distributed to B in 
complete liquidation of B's interest in the partnership. If Property A 
had been sold for its fair market value at the time of the distribution, 
A would have recognized $7,000 of gain under section 704(c)(1)(A) and 
Sec. 1.704-3(b). Therefore, A recognizes $7,000 of gain on the 
distribution of Property A to B.
    Example 3. Effect of remedial method. (i) On January 1, 1995, A, B, 
and C form partnership ABC as equal partners. A contributes Property A1, 
nondepreciable real property with a fair market value of $10,000 and an 
adjusted tax basis of $5,000, and Property A2, nondepreciable real 
property with a fair market value and adjusted tax basis of $10,000. B 
and C each contribute $20,000 cash. ABC uses the remedial method of 
making section 704(c) allocations described in Sec. 1.704-3(d) with 
respect to Property A1.
    (ii) On December 31, 1998, when the fair market value of Property A1 
has decreased to $7,000, Property A1 is distributed to C in a current 
distribution. If Property A1 had been

[[Page 542]]

sold by the partnership at the time of the distribution, ABC would have 
recognized the $2,000 of remaining built-in gain under section 
704(c)(1)(A) on the sale (fair market value of $7,000 less $5,000 
adjusted tax basis). All of this gain would have been allocated to A. 
ABC would also have recognized a book loss of $3,000 ($10,000 original 
book value less $7,000 current fair market value of the property). Book 
loss in the amount of $2,000 would have been allocated equally between B 
and C. Under the remedial method, $2,000 of tax loss would also have 
been allocated equally to B and C to match their share of the book loss. 
As a result, $2,000 of gain would also have been allocated to A as an 
offsetting remedial allocation. A would have recognized $4,000 of total 
gain under section 704(c)(1)(A) on the sale of Property A1 ($2,000 of 
section 704(c) recognized gain plus $2,000 remedial gain). Therefore, A 
recognizes $4,000 of gain on the distribution of Property A1 to C under 
this section.

    (b) Character of gain or loss--(1) General rule. Gain or loss 
recognized by the contributing partner under section 704(c)(1)(B) and 
this section has the same character as the gain or loss that would have 
resulted if the distributed property had been sold by the partnership to 
the distributee partner at the time of the distribution.
    (2) Example. The following example illustrates the rule of this 
paragraph (b). Unless otherwise specified, partnership income equals 
partnership expenses (other than depreciation deductions for contributed 
property) for each year of the partnership, the fair market value of 
partnership property does not change, all distributions by the 
partnership are subject to section 704(c)(1)(B), and all partners are 
unrelated.

    Example. Character of gain. (i) On January 1, 1995, A and B form 
partnership AB. A contributes $10,000 and Property A, nondepreciable 
real property with a fair market value of $10,000 and an adjusted tax 
basis of $4,000, in exchange for a 25 percent interest in partnership 
capital and profits. B contributes $60,000 cash for a 75 percent 
interest in partnership capital and profits.
    (ii) On December 31, 1998, Property A is distributed to B in a 
current distribution. Property A is used in a trade or business of B.
    (iii) A would have recognized $6,000 of gain under section 
704(c)(1)(A) on a sale of Property A at the time of the distribution 
(the difference between the fair market value ($10,000) and the adjusted 
tax basis ($4,000) of the property at that time). Because Property A is 
not a capital asset in the hands of Partner B and B holds more than 50 
percent of partnership capital and profits, the character of the gain on 
a sale of Property A to B would have been ordinary income under section 
707(b)(2). Therefore, the character of the gain to A on the distribution 
of Property A to B is ordinary income.

    (c) Exceptions--(1) Property contributed on or before October 3, 
1989. Section 704(c)(1)(B) and this section do not apply to property 
contributed to the partnership on or before October 3, 1989.
    (2) Certain liquidations. Section 704(c)(1)(B) and this section do 
not apply to a distribution of an interest in section 704(c) property to 
a partner other than the contributing partner in a liquidation of the 
partnership if--
    (i) The contributing partner receives an interest in the section 
704(c) property contributed by that partner (and no other property); and
    (ii) The built-in gain or loss in the interest distributed to the 
contributing partner, determined immediately after the distribution, is 
equal to or greater than the built-in gain or loss on the property that 
would have been allocated to the contributing partner under section 
704(c)(1)(A) and Sec. 1.704-3 on a sale of the contributed property to 
an unrelated party immediately before the distribution.
    (3) Section 708(b)(1)(B) terminations. Section 704(c)(1)(B) and this 
section do not apply to the deemed distribution of interests in a new 
partnership caused by the termination of a partnership under section 
708(b)(1)(B). A subsequent distribution of section 704(c) property by 
the new partnership to a partner of the new partnership is subject to 
section 704(c)(1)(B) to the same extent that a distribution by the 
terminated partnership would have been subject to section 704(c)(1)(B). 
See also Sec. 1.737-2(a) for a similar rule in the context of section 
737. This paragraph (c)(3) applies to terminations of partnerships under 
section 708(b)(1)(B) occurring on or after May 9, 1997; however, this 
paragraph (c)(3) may be applied to terminations occurring on or after 
May 9, 1996, provided that the partnership and its partners apply this 
paragraph (c)(3) to the termination in a consistent manner.
    (4) Complete transfer to another partnership. Section 704(c)(1)(B) 
and this

[[Page 543]]

section do not apply to a transfer by a partnership (transferor 
partnership) of all of its assets and liabilities to a second 
partnership (transferee partnership) in an exchange described in section 
721, followed by a distribution of the interest in the transferee 
partnership in liquidation of the transferor partnership as part of the 
same plan or arrangement. A subsequent distribution of section 704(c) 
property by the transferee partnership to a partner of the transferee 
partnership is subject to section 704(c)(1)(B) to the same extent that a 
distribution by the transferor partnership would have been subject to 
section 704(c)(1)(B). See Sec. 1.737-2(b) for a similar rule in the 
context of section 737.
    (5) Incorporation of a partnership. Section 704(c)(1)(B) and this 
section do not apply to an incorporation of a partnership by any method 
of incorporation (other than a method involving an actual distribution 
of partnership property to the partners followed by a contribution of 
that property to a corporation), provided that the partnership is 
liquidated as part of the incorporation transaction. See Sec. 1.737-
2(c) for a similar rule in the context of section 737.
    (6) Undivided interests. Section 704(c)(1)(B) and this section do 
not apply to a distribution of an undivided interest in property to the 
extent that the undivided interest does not exceed the undivided 
interest, if any, contributed by the distributee partner in the same 
property. See Sec. 1.737-2(d)(4) for the application of section 737 in 
a similar context. The portion of the undivided interest in property 
retained by the partnership after the distribution, if any, that is 
treated as contributed by the distributee partner, is reduced to the 
extent of the undivided interest distributed to the distributee partner.
    (7) Example. The following example illustrates the rule of paragraph 
(c)(2) of this section. Unless otherwise specified, partnership income 
equals partnership expenses (other than depreciation deductions for 
contributed property) for each year of the partnership, the fair market 
value of partnership property does not change, all distributions by the 
partnership are subject to section 704(c)(1)(B), and all partners are 
unrelated.

    Example. (i) On January 1, 1995, A and B form partnership AB, as 
equal partners. A contributes Property A, nondepreciable real property 
with a fair market value and adjusted tax basis of $20,000. B 
contributes Property B, nondepreciable real property with a fair market 
value of $20,000 and an adjusted tax basis of $10,000. Property B 
therefore has a built-in gain of $10,000 at the time of contribution.
    (ii) On December 31, 1998, the partnership liquidates when the fair 
market value of Property A has not changed, but the fair market value of 
Property B has increased to $40,000.
    (iii) In the liquidation, A receives Property A and a 25 percent 
interest in Property B. This interest in Property B has a fair market 
value of $10,000 to A, reflecting the fact that A was entitled to 50 
percent of the $20,000 post-contribution appreciation in Property B. The 
partnership distributes to B a 75 percent interest in Property B with a 
fair market value of $30,000. B's basis in this portion of Property B is 
$10,000 under section 732(b). As a result, B has a built-in gain of 
$20,000 in this portion of Property B immediately after the distribution 
($30,000 fair market value less $10,000 adjusted tax basis). This built-
in gain is greater than the $10,000 of built-in gain in Property B at 
the time of contribution to the partnership. B therefore does not 
recognize any gain on the distribution of a portion of Property B to A 
under this section.

    (d) Special rules--(1) Nonrecognition transactions, installment 
obligations, contributed contracts, and capitalized costs--
(i)Nonrecognition transactions. Property received by the partnership in 
exchange for section 704(c) property in a nonrecognition transaction is 
treated as the section 704(c) property for purposes of section 
704(c)(1)(B) and this section to the extent that the property received 
is treated as section 704(c) property under Sec. 1.704-3(a)(8). See 
Sec. 1.737-2(d)(3) for a similar rule in the context of section 737.
    (ii)-(iii) [Reserved]
    (iv) Capitalized costs. Property to which the cost of section 704(c) 
property is properly capitalized is treated as section 704(c) property 
for purposes of section 704(c)(1)(B) and this section to the extent that 
such property is treated as section 704(c) property under Sec. 1.704-
3(a)(8)(iv). See Sec. 1.737-2(d)(3) for a similar rule in the context 
of section 737.
    (2) Transfers of a partnership interest. The transferee of all or a 
portion of the partnership interest of a contributing

[[Page 544]]

partner is treated as the contributing partner for purposes of section 
704(c)(1)(B) and this section to the extent of the share of built-in 
gain or loss allocated to the transferee partner. See Sec. 1.704-
3(a)(7).
    (3) Distributions of like-kind property. If section 704(c) property 
is distributed to a partner other than the contributing partner and 
like-kind property (within the meaning of section 1031) is distributed 
to the contributing partner no later than the earlier of (i) 180 days 
following the date of the distribution to the non-contributing partner, 
or (ii) the due date (determined with regard to extensions) of the 
contributing partner's income tax return for the taxable year of the 
distribution to the noncontributing partner, the amount of gain or loss, 
if any, that the contributing partner would otherwise have recognized 
under section 704(c)(1)(B) and this section is reduced by the amount of 
built-in gain or loss in the distributed like-kind property in the hands 
of the contributing partner immediately after the distribution. The 
contributing partner's basis in the distributed like-kind property is 
determined as if the like-kind property were distributed in an unrelated 
distribution prior to the distribution of any other property distributed 
as part of the same distribution and is determined without regard to the 
increase in the contributing partner's adjusted tax basis in the 
partnership interest under section 704(c)(1)(B) and this section. See 
Sec. 1.707-3 for provisions treating the distribution of the like-kind 
property to the contributing partner as a disguised sale in certain 
situations.
    (4) Example. The following example illustrates the rules of this 
paragraph (d). Unless otherwise specified, partnership income equals 
partnership expenses (other than depreciation deductions for contributed 
property) for each year of the partnership, the fair market value of 
partnership property does not change, all distributions by the 
partnership are subject to section 704(c)(1)(B), and all partners are 
unrelated.

    Example. Distribution of like-kind property. (i) On January 1, 1995, 
A, B, and C form partnership ABC as equal partners. A contributes 
Property A, nondepreciable real property with a fair market value of 
$20,000 and an adjusted tax basis of $10,000. B and C each contribute 
$20,000 cash. The partnership subsequently buys Property X, 
nondepreciable real property of a like-kind to Property A with a fair 
market value and adjusted tax basis of $8,000. The fair market value of 
Property X subsequently increases to $10,000.
    (ii) On December 31, 1998, Property A is distributed to B in a 
current distribution. At the same time, Property X is distributed to A 
in a current distribution. The distribution of Property X does not 
result in the contribution of Property A being properly characterized as 
a disguised sale to the partnership under Sec. 1.707-3. A's basis in 
Property X is $8,000 under section 732(a)(1). A therefore has $2,000 of 
built-in gain in Property X ($10,000 fair market value less $8,000 
adjusted tax basis).
    (iii) A would generally recognize $10,000 of gain under section 
704(c)(1)(B) on the distribution of Property A, the difference between 
the fair market value ($20,000) of the property and its adjusted tax 
basis ($10,000). This gain is reduced, however, by the amount of the 
built-in gain of Property X in the hands of A. As a result, A recognizes 
only $8,000 of gain on the distribution of Property A to B under section 
704(c)(1)(B) and this section.

    (e) Basis adjustments--(1) Contributing partner's basis in the 
partnership interest. The basis of the contributing partner's interest 
in the partnership is increased by the amount of the gain, or decreased 
by the amount of the loss, recognized by the partner under section 
704(c)(1)(B) and this section. This increase or decrease is taken into 
account in determining (i) the contributing partner's adjusted tax basis 
under section 732 for any property distributed to the partner in a 
distribution that is part of the same distribution as the distribution 
of the contributed property, other than like-kind property described in 
paragraph (d)(3) of this section (pertaining to the special rule for 
distributions of like-kind property), and (ii) the amount of the gain 
recognized by the contributing partner under section 731 or section 737, 
if any, on a distribution of money or property to the contributing 
partner that is part of the same distribution as the distribution of the 
contributed property. For a determination of basis in a distribution 
subject to section 737, see Sec. 1.737-3(a).
    (2) Partnership's basis in partnership property. The partnership's 
adjusted

[[Page 545]]

tax basis in the distributed section 704(c) property is increased or 
decreased immediately before the distribution by the amount of gain or 
loss recognized by the contributing partner under section 704(c)(1)(B) 
and this section. Any increase or decrease in basis is therefore taken 
into account in determining the distributee partner's adjusted tax basis 
in the distributed property under section 732. For a determination of 
basis in a distribution subject to section 737, see Sec. 1.737-3(b).
    (3) Section 754 adjustments. The basis adjustments to partnership 
property made pursuant to paragraph (e)(2) of this section are not 
elective and must be made regardless of whether the partnership has an 
election in effect under section 754. Any adjustments to the bases of 
partnership property (including the distributed section 704(c) property) 
under section 734(b) pursuant to a section 754 election must be made 
after (and must take into account) the adjustments to basis made under 
paragraph (e)(2) of this section. See Sec. 1.737-3(c)(4) for a similar 
rule in the context of section 737.
    (4) Example. The following example illustrates the rules of this 
paragraph (e). Unless otherwise specified, partnership income equals 
partnership expenses (other than depreciation deductions for contributed 
property) for each year of the partnership, the fair market value of 
partnership property does not change, all distributions by the 
partnership are subject to section 704(c)(1)(B), and all partners are 
unrelated.

    Example. Basis adjustment. On January 1, 1995, A, B, and C form 
partnership ABC as equal partners. A contributes $10,000 cash and 
Property A, nondepreciable real property with a fair market value of 
$10,000 and an adjusted tax basis of $4,000. B and C each contribute 
$20,000 cash.
    (ii) On December 31, 1998, Property A is distributed to B in a 
current distribution.
    (iii) Under paragraph (a) of this section, A recognizes $6,000 of 
gain on the distribution of Property A because that is the amount of 
gain that would have been allocated to A under section 704(c)(1)(A) and 
Sec. 1.704-3 on a sale of Property A for its fair market value at the 
time of the distribution (fair market value of Property A ($10,000) less 
its adjusted tax basis at the time of distribution ($4,000)). The 
adjusted tax basis of A's partnership interest is increased from $14,000 
to $20,000 to reflect this gain. The partnership's adjusted tax basis in 
Property A is increased from $4,000 to $10,000 immediately prior to its 
distribution to B. B's adjusted tax basis in Property A is therefore 
$10,000 under section 732(a)(1).

    (f) Anti-abuse rule--(1) In general. The rules of section 
704(c)(1)(B) and this section must be applied in a manner consistent 
with the purpose of section 704(c)(1)(B). Accordingly, if a principal 
purpose of a transaction is to achieve a tax result that is inconsistent 
with the purpose of section 704(c)(1)(B), the Commissioner can recast 
the transaction for federal tax purposes as appropriate to achieve tax 
results that are consistent with the purpose of section 704(c)(1)(B) and 
this section. Whether a tax result is inconsistent with the purpose of 
section 704(c)(1)(B) and this section must be determined based on all 
the facts and circumstances. See Sec. 1.737-4 for an anti-abuse rule 
and examples in the context of section 737.
    (2) Examples. The following examples illustrate the anti-abuse rule 
of this paragraph (f). The examples set forth below do not delineate the 
boundaries of either permissible or impermissible types of transactions. 
Further, the addition of any facts or circumstances that are not 
specifically set forth in an example (or the deletion of any facts or 
circumstances) may alter the outcome of the transaction described in the 
example. Unless otherwise specified, partnership income equals 
partnership expenses (other than depreciation deductions for contributed 
property) for each year of the partnership, the fair market value of 
partnership property does not change, all distributions by the 
partnership are subject to section 704(c)(1)(B), and all partners are 
unrelated.

    Example 1. Distribution in substance made within five-year period; 
results inconsistent with the purpose of section 704(c)(1)(B). (i) On 
January 1, 1995, A, B, and C form partnership ABC as equal partners. A 
contributes Property A, nondepreciable real property with a fair market 
value of $10,000 and an adjusted tax basis of $1,000. B and C each 
contributes $10,000 cash.
    (ii) On December 31, 1998, the partners desire to distribute 
Property A to B in complete liquidation of B's interest in the 
partnership. If Property A were distributed at

[[Page 546]]

that time, however, A would recognize $9,000 of gain under section 
704(c)(1)(B), the difference between the $10,000 fair market value and 
the $1,000 adjusted tax basis of Property A, because Property A was 
contributed to the partnership less than five years before December 31, 
1998. On becoming aware of this potential gain recognition, and with a 
principal purpose of avoiding such gain, the partners amend the 
partnership agreement on December 31, 1998, and take any other steps 
necessary to provide that substantially all of the economic risks and 
benefits of Property A are borne by B as of December 31, 1998, and that 
substantially all of the economic risks and benefits of all other 
partnership property are borne by A and C. The partnership holds 
Property A until January 5, 2000, at which time it is distributed to B 
in complete liquidation of B's interest in the partnership.
    (iii) The actual distribution of Property A occurred more than five 
years after the contribution of the property to the partnership. The 
steps taken by the partnership on December 31, 1998, however, are the 
functional equivalent of an actual distribution of Property A to B in 
complete liquidation of B's interest in the partnership as of that date. 
Section 704(c)(1)(B) requires recognition of gain when contributed 
section 704(c) property is in substance distributed to another partner 
within five years of its contribution to the partnership. Allowing a 
contributing partner to avoid section 704(c)(1)(B) through arrangements 
such as those in this Example 1 that have the effect of a distribution 
of property within five years of the date of its contribution to the 
partnership would effectively undermine the purpose of section 
704(c)(1)(B) and this section. As a result, the steps taken by the 
partnership on December 31, 1998, are treated as causing a distribution 
of Property A to B for purposes of section 704(c)(1)(B) on that date, 
and A recognizes gain of $9,000 under section 704(c)(1)(B) and this 
section at that time.
    (iv) Alternatively, if on becoming aware of the potential gain 
recognition to A on a distribution of Property A on December 31, 1998, 
the partners had instead agreed that B would continue as a partner with 
no changes to the partnership agreement or to B's economic interest in 
partnership operations, the distribution of Property A to B on January 
5, 2000, would not have been inconsistent with the purpose of section 
704(c)(1)(B) and this section. In that situation, Property A would not 
have been distributed until after the expiration of the five-year period 
specified in section 704(c)(1)(B) and this section. Deferring the 
distribution of Property A until the end of the five-year period for a 
principal purpose of avoiding the recognition of gain under section 
704(c)(1)(B) and this section is not inconsistent with the purpose of 
section 704(c)(1)(B). Therefore, A would not have recognized gain on the 
distribution of Property A in that case.
    Example 2. Suspension of five-year period in manner consistent with 
the purpose of section 704(c)(1)(B). (i) A, B, and C form partnership 
ABC on January 1, 1995, to conduct bona fide business activities. A 
contributes Property A, nondepreciable real property with a fair market 
value of $10,000 and an adjusted tax basis of $1,000, in exchange for a 
49.5 percent interest in partnership capital and profits. B contributes 
$10,000 in cash for a 49.5 percent interest in partnership capital and 
profits. C contributes cash for a 1 percent interest in partnership 
capital and profits. A and B are wholly owned subsidiaries of the same 
affiliated group and continue to control the management of Property A by 
virtue of their controlling interests in the partnership. The 
partnership is formed pursuant to a plan a principal purpose of which is 
to minimize the period of time that A would have to remain a partner 
with a potential acquiror of Property A.
    (ii) On December 31, 1997, D is admitted as a partner to the 
partnership in exchange for $10,000 cash.
    (iii) On January 5, 2000, Property A is distributed to D in complete 
liquidation of D's interest in the partnership.
    (iv) The distribution of Property A to D occurred more than five 
years after the contribution of the property to the partnership. On 
these facts, however, a principal purpose of the transaction was to 
minimize the period of time that A would have to remain partners with a 
potential acquiror of Property A, and treating the five-year period of 
section 704(c)(1)(B) as running during a time when Property A was still 
effectively owned through the partnership by members of the contributing 
affiliated group of which A is a member is inconsistent with the purpose 
of section 704(c)(1)(B). Prior to the admission of D as a partner, the 
pooling of assets between A and B, on the one hand, and C, on the other 
hand, although sufficient to constitute ABC as a valid partnership for 
federal income tax purposes, is not a sufficient pooling of assets for 
purposes of running the five-year period with respect to the 
distribution of Property A to D. Allowing a contributing partner to 
avoid section 704(c)(1)(B) through arrangements such as those in this 
Example 2 would have the effect of substantially nullifying the five-
year requirement of section 704(c)(1)(B) and this section and elevating 
the form of the transaction over its substance. As a result, with 
respect to the distribution of Property A to D, the five-year period of 
section 704(c)(1)(B) is tolled until the admission of D as a partner on 
December 31, 1997. Therefore, the distribution of Property A occurred 
before the end of the five-year period of section 704(c)(1)(B), and A 
recognizes gain of $9,000 under section 704(c)(1)(B) on the 
distribution.


[[Page 547]]


    (g) Effective dates. This section applies to distributions by a 
partnership to a partner on or after January 9, 1995, except that 
paragraph (d)(1)(iv) applies to distributions by a partnership to a 
partner on or after June 24, 2003.

[T.D. 8642, 60 FR 66730, Dec. 26, 1995, as amended by T.D. 8717, 62 FR 
25500, May 9, 1997; T.D. 9193, 70 FR 14395, Mar. 22, 2005; T.D. 9207, 70 
FR 30342, May 26, 2005]



Sec. 1.705-1  Determination of basis of partner's interest.

    (a) General rule. (1) Section 705 and this section provide rules for 
determining the adjusted basis of a partner's interest in a partnership. 
A partner is required to determine the adjusted basis of his interest in 
a partnership only when necessary for the determination of his tax 
liability or that of any other person. The determination of the adjusted 
basis of a partnership interest is ordinarily made as of the end of a 
partnership taxable year. Thus, for example, such year-end determination 
is necessary in ascertaining the extent to which a partner's 
distributive share of partnership losses may be allowed. See section 
704(d). However, where there has been a sale or exchange of all or a 
part of a partnership interest or a liquidation of a partner's entire 
interest in a partnership, the adjusted basis of the partner's interest 
should be determined as of the date of sale or exchange or liquidation. 
The adjusted basis of a partner's interest in a partnership is 
determined without regard to any amount shown in the partnership books 
as the partner's ``capital'', ``equity'', or similar account. For 
example, A contributes property with an adjusted basis to him of $400 
(and a value of $1,000) to a partnership. B contributes $1,000 cash. 
While under their agreement each may have a ``capital account'' in the 
partnership of $1,000, the adjusted basis of A's interest is only $400 
and B's interest $1,000.
    (2) The original basis of a partner's interest in a partnership 
shall be determined under section 722 (relating to contributions to a 
partnership) or section 742 (relating to transfers of partnership 
interests). Such basis shall be increased under section 722 by any 
further contributions to the partnership and by the sum of the partner's 
distributive share for the taxable year and prior taxable years of:
    (i) Taxable income of the partnership as determined under section 
703(a),
    (ii) Tax-exempt receipts of the partnership, and
    (iii) The excess of the deductions for depletion over the basis of 
the depletable property, unless the property is an oil or gas property 
the basis of which has been allocated to partners under section 
613A(c)(7)(D).
    (3) The basis shall be decreased (but not below zero) by 
distributions from the partnership as provided in section 733 and by the 
sum of the partner's distributive share for the taxable year and prior 
taxable years of:
    (i) Partnership losses (including capital losses), and
    (ii) Partnership expenditures which are not deductible in computing 
partnership taxable income or loss and which are not capital 
expenditures.
    (4) The basis shall be decreased (but not below zero) by the amount 
of the partner's deduction for depletion allowable under section 611 for 
any partnership oil and gas property to the extent the deduction does 
not exceed the proportionate share of the adjusted basis of the property 
allocated to the partner under section 613A(c)(7)(D).
    (5) The basis shall be adjusted (but not below zero) to reflect any 
gain or loss to the partner resulting from a disposition by the 
partnership of a domestic oil or gas property after December 31, 1974.
    (6) For the effect of liabilities in determining the amount of 
contributions made by a partner to a partnership or the amount of 
distributions made by a partnership to a partner, see section 752 and 
Sec. 1.752-1, relating to the treatment of certain liabilities. In 
determining the basis of a partnership interest on the effective date of 
subchapter K, chapter 1 of the Code, or any of the sections thereof, the 
partner's share of partnership liabilities on that date shall be 
included.
    (7) For basis adjustments necessary to coordinate sections 705 and 
1032 in certain situations in which a partnership disposes of stock or 
any position in stock to which section 1032 applies of a corporation 
that holds a direct or

[[Page 548]]

indirect interest in the partnership, see Sec. 1.705-2.
    (8) For basis adjustments necessary to coordinate sections 705 and 
358(h), see Sec. 1.358-7(b). For certain basis adjustments with respect 
to a Sec. 1.752-7 liability assumed by a partnership from a partner, 
see Sec. 1.752-7.
    (9) For basis adjustments necessary to coordinate sections 705 and 
362(e)(2), see Sec. 1.362-4(f)(i).
    (b) Alternative rule. In certain cases, the adjusted basis of a 
partner's interest in a partnership may be determined by reference to 
the partner's share of the adjusted basis of partnership property which 
would be distributable upon termination of the partnership. The 
alternative rule may be used to determine the adjusted basis of a 
partner's interest where circumstances are such that the partner cannot 
practicably apply the general rule set forth in section 705(a) and 
paragraph (a) of this section, or where, from a consideration of all the 
facts, it is, in the opinion of the Commissioner, reasonable to conclude 
that the result produced will not vary substantially from the result 
obtainable under the general rule. Where the alternative rule is used, 
adjustments may be necessary in determining the adjusted basis of a 
partner's interest in a partnership. Adjustments would be required, for 
example, in order to reflect in a partner's share of the adjusted basis 
of partnership property any significant discrepancies arising as a 
result of contributed property, transfers of partnership interests, or 
distributions of property to the partners. The operation of the 
alternative rules may be illustrated by the following examples:

    Example 1. The ABC partnership, in which A, B, and C are equal 
partners, owns various properties with a total adjusted basis of $1,500 
and has earned and retained an additional $1,500. The total adjusted 
basis of partnership property is thus $3,000. Each partner's share in 
the adjusted basis of partnership property is one-third of this amount, 
or $1,000. Under the alternative rule, this amount represents each 
partner's adjusted basis for his partnership interest.
    Example 2. Assume that partner A in example 1 of this paragraph 
sells his partnership interest to D for $1,250 at a time when the 
partnership property with an adjusted basis of $1,500 had appreciated in 
value to $3,000, and when the partnership also had $750 in cash. The 
total adjusted basis of all partnership property is $2,250 and the value 
of such property is $3,750. D's basis for his partnership interest is 
his cost, $1,250. However, his one-third share of the adjusted basis of 
partnership property is only $750. Therefore, for the purposes of the 
alternative rule, D has an adjustment of $500 in determining the basis 
of his interest. This amount represents the difference between the cost 
of his partnership interest and his share of partnership basis at the 
time of his purchase. If the partnership subsequently earns and retains 
an additional $1,500, its property will have an adjusted basis of 
$3,750. D's adjusted basis for his interest under the alternative rule 
is $1,750, determined by adding $500, his basis adjustment to $1,250 
(his one-third share of the $3,750 adjusted basis of partnership 
property). If the partnership distributes $250 to each partner in a 
current distribution, D's adjusted basis for his interest will be $1,500 
($1,000, his one-third share of the remaining basis of partnership 
property, $3,000, plus his basis adjustment of $500).
    Example 3. Assume that BCD partnership in example 2 of this 
paragraph continues to operate. In 1960, D proposes to sell his 
partnership interest and wishes to evaluate the tax consequences of such 
sale. It is necessary, therefore, to determine the adjusted basis of his 
interest in the partnership. Assume further that D cannot determine the 
adjusted basis of his interest under the general rule. The balance sheet 
of the BCD partnership is as follows:

------------------------------------------------------------------------
                                                   Adjusted
                     Assets                        basis per    Market
                                                     books       value
------------------------------------------------------------------------
Cash............................................      $3,000      $3,000
Receivables.....................................       4,000       4,000
Depreciable property............................       5,000       5,000
Land held for investment........................      18,000      30,000
                                                 -----------------------
    Total.......................................      30,000      42,000
------------------------------------------------------------------------


------------------------------------------------------------------------
                   Liabilities and capital                     Per books
------------------------------------------------------------------------
Liabilities.................................................      $6,000
Capital accounts:
  B.........................................................       4,500
  C.........................................................       4,500
  D.........................................................      15,000
                                                             -----------
    Total...................................................      30,000
------------------------------------------------------------------------

    The $15,000 representing the amount of D's capital account does not 
reflect the $500 basis adjustment arising from D's purchase of his 
interest. See example 2 of this paragraph. The adjusted basis of D's 
partnership interest determined under the alternative rule is as 
follows:

D's share of the adjusted basis of partnership property          $15,000
 (reduced by the amount of liabilities) at time of proposed
 sale.......................................................

[[Page 549]]

 
D's share of partnership liabilities (under the partnership        2,000
 agreement liabilities are shared equally)..................
D's basis adjustment from example 2.........................         500
                                                             -----------
    Adjusted basis of D's interest at the time of proposed        17,500
     sale, as determined under alternative rule.............
 


[T.D. 6500, 25 FR 11814, Nov. 26, 1960, 25 FR 14021, Dec. 31, 1960, as 
amended by T.D. 8437, 57 FR 43903, Sept. 23, 1992; T.D. 8986, 67 FR 
15114, Mar. 29, 2002; T.D. 9049, 68 FR 12816, Mar. 18, 2003; T.D. 9207, 
70 FR 30342, May 26, 2005; T.D. 9633, 78 FR 54168, Sept. 3, 2013]



Sec. 1.705-2  Basis adjustments coordinating sections 705 and 1032.

    (a) Purpose. This section coordinates the application of sections 
705 and 1032 and is intended to prevent inappropriate increases or 
decreases in the adjusted basis of a corporate partner's interest in a 
partnership resulting from the partnership's disposition of the 
corporate partner's stock. The rules under section 705 generally are 
intended to preserve equality between the adjusted basis of a partner's 
interest in a partnership (outside basis) and such partner's share of 
the adjusted basis in partnership assets (inside basis). However, in 
situations where a section 754 election was not in effect for the year 
in which a partner acquired its interest, the partner's inside basis and 
outside basis may not be equal. Similarly, in situations where a section 
754 election was not in effect for the year in which a partnership 
distributes money or other property to another partner and that partner 
recognizes gain or loss on the distribution or the basis of the property 
distributed to that partner is adjusted, the remaining partners' inside 
basis and outside basis may not be equal. In these situations, gain or 
loss allocated to the partner upon disposition of the partnership assets 
that is attributable to the difference between the adjusted basis of the 
partnership assets absent the section 754 election and the adjusted 
basis of the partnership assets had a section 754 election been in 
effect generally will result in an adjustment to the basis of the 
partner's interest in the partnership under section 705(a). Such gain 
(or loss) therefore generally will be offset by a corresponding decrease 
in the gain or increase in the loss (or increase in the gain or decrease 
in the loss) upon the subsequent disposition by the partner of its 
interest in the partnership. Where such a difference exists with respect 
to stock of a corporate partner that is held by the partnership, gain or 
loss from the disposition of corporate partner stock attributable to the 
difference is not recognized by the corporate partner under section 
1032. To adjust the basis of the corporate partner's interest in the 
partnership for this unrecognized gain or loss would not be appropriate 
because it would create an opportunity for the recognition of taxable 
gain or loss on a subsequent disposition of the partnership interest 
where no economic gain or loss has been incurred by the corporate 
partner and no corresponding taxable gain or loss had previously been 
allocated to the corporate partner by the partnership.
    (b) Single partnership--(1) Required adjustments relating to 
acquisitions of partnership interest. (i) This paragraph (b)(1) applies 
in situations where a corporation acquires an interest in a partnership 
that holds stock in that corporation (or the partnership subsequently 
acquires stock in that corporation in an exchanged basis transaction), 
the partnership does not have an election under section 754 in effect 
for the year in which the corporation acquires the interest, and the 
partnership later sells or exchanges the stock. In these situations, the 
increase (or decrease) in the corporation's adjusted basis in its 
partnership interest resulting from the sale or exchange of the stock 
equals the amount of gain (or loss) that the corporate partner would 
have recognized (absent the application of section 1032) if, for the 
year in which the corporation acquired the interest, a section 754 
election had been in effect.
    (ii) The provisions of this paragraph (b)(1) are illustrated by the 
following example:

    Example. (i) A, B, and C form equal partnership PRS. Each partner 
contributes $30,000 in exchange for its partnership interest. PRS has no 
liabilities. PRS purchases stock in corporation X for $30,000, which 
appreciates in value to $120,000. PRS also purchases inventory for 
$60,000, which appreciates in value to $150,000. A sells its interest in 
PRS to corporation X for $90,000 in a year for which an election under 
section 754 is not in effect. PRS later sells the X stock for

[[Page 550]]

$150,000. PRS realizes a gain of $120,000 on the sale of the X stock. 
X's share of the gain is $40,000. Under section 1032, X does not 
recognize its share of the gain.
    (ii) Normally, X would be entitled to a $40,000 increase in the 
basis of its PRS interest for its allocable share of PRS's gain from the 
sale of the X stock, but a special rule applies in this situation. If a 
section 754 election had been in effect for the year in which X acquired 
its interest in PRS, X would have been entitled to a basis adjustment 
under section 743(b) of $60,000 (the excess of X's basis for the 
transferred partnership interest over X's share of the adjusted basis to 
PRS of PRS's property). See Sec. 1.743-1(b). Under Sec. 1.755-1(b), 
the basis adjustment under section 743(b) would have been allocated 
$30,000 to the X stock (the amount of the gain that would have been 
allocated to X from the hypothetical sale of the stock), and $30,000 to 
the inventory (the amount of the gain that would have been allocated to 
X from the hypothetical sale of the inventory).
    (iii) If a section 754 election had been in effect for the year in 
which X acquired its interest in PRS, the amount of gain that X would 
have recognized upon PRS's disposition of X stock (absent the 
application of section 1032) would be $10,000 (X's share of PRS's gain 
from the stock sale, $40,000, minus the amount of X's basis adjustment 
under section 743(b), $30,000). See Sec. 1.743-1(j). Accordingly, the 
increase in the basis of X's interest in PRS is $10,000.

    (2) Required adjustments relating to distributions. (i) This 
paragraph (b)(2) applies in situations where a corporation owns a direct 
or indirect interest in a partnership that owns stock in that 
corporation, the partnership distributes money or other property to 
another partner and that partner recognizes gain or loss on the 
distribution or the basis of the property distributed to that partner is 
adjusted during a year in which the partnership does not have an 
election under section 754 in effect, and the partnership subsequently 
sells or exchanges the stock. In these situations, the increase (or 
decrease) in the corporation's adjusted basis in its partnership 
interest resulting from the sale or exchange of the stock equals the 
amount of gain (or loss) that the corporate partner would have 
recognized (absent the application of section 1032) if, for the year in 
which the partnership made the distribution, a section 754 election had 
been in effect.
    (ii) The provisions of this paragraph (b)(2) are illustrated by the 
following example:

    Example. (i) A, B, and corporation C form partnership PRS. A and B 
each contribute $10,000 and C contributes $20,000 in exchange for a 
partnership interest. PRS has no liabilities. PRS purchases stock in 
corporation C for $10,000, which appreciates in value to $70,000. PRS 
distributes $25,000 to A in complete liquidation of A's interest in PRS 
in a year for which an election under section 754 is not in effect. PRS 
later sells the C stock for $70,000. PRS realizes a gain of $60,000 on 
the sale of the C stock. C's share of the gain is $40,000. Under section 
1032, C does not recognize its share of the gain.
    (ii) Normally, C would be entitled to a $40,000 increase in the 
basis of its PRS interest for its allocable share of PRS's gain from the 
sale of the C stock, but a special rule applies in this situation. If a 
section 754 election had been in effect for the year in which PRS made 
the distribution to A, PRS would have been entitled to adjust the basis 
of partnership property under section 734(b)(1)(A) by $15,000 (the 
amount of gain recognized by A with respect to the distribution to A 
under section 731(a)(1)). See Sec. 1.734-1(b). Under Sec. 1.755-
1(c)(1)(ii), the basis adjustment under section 734(b) would have been 
allocated to the C stock, increasing its basis to $25,000 (where there 
is a distribution resulting in an adjustment under section 734(b)(1)(A) 
to the basis of undistributed partnership property, the adjustment is 
allocated only to capital gain property).
    (iii) If a section 754 election had been in effect for the year in 
which PRS made the distribution to A, the amount of gain that PRS would 
have recognized upon PRS's disposition of C stock would be $45,000 
($70,000 minus $25,000 basis in the C stock), and the amount of gain C 
would have recognized upon PRS's disposition of the C stock (absent the 
application of section 1032) would be $30,000 (C's share of PRS's gain 
of $45,000 from the stock sale). Accordingly, upon PRS's sale of the C 
stock, the increase in the basis of C's interest in PRS is $30,000.

    (c) Tiered partnerships and other arrangements--(1) Required 
adjustments. The purpose of these regulations as set forth in paragraph 
(a) of this section cannot be avoided through the use of tiered 
partnerships or other arrangements. For example, if a corporation 
acquires an indirect interest in its own stock through a chain of two or 
more partnerships (either where the corporation acquires a direct 
interest in a partnership or where one of the partnerships in the chain 
acquires an interest in another partnership), and gain or loss from the 
sale or exchange of the stock is subsequently allocated to the

[[Page 551]]

corporation, then the bases of the interests in the partnerships 
included in the chain shall be adjusted in a manner that is consistent 
with the purpose of this section. Similarly, if a corporation owns an 
indirect interest in its own stock through a chain of two or more 
partnerships, and a partnership in the chain distributes money or other 
property to another partner and that partner recognizes gain or loss on 
the distribution or the basis of the property distributed to that 
partner is adjusted during a year in which the partnership does not have 
an election under section 754 in effect, then upon any subsequent sale 
or exchange of the stock, the bases of the interests in the partnerships 
included in the chain shall be adjusted in a manner that is consistent 
with the purpose of this section.
    (2) Examples. The provisions of this paragraph (c) are illustrated 
by the following examples:

    Example 1. Acquisition of upper-tier partnership interest by 
corporation. (i) A, B, and C form a partnership (UTP), with each partner 
contributing $25,000. UTP and D form a partnership (LTP). UTP 
contributes $75,000 in exchange for its interest in LTP, and D 
contributes $25,000 in exchange for D's interest in LTP. Neither UTP nor 
LTP has any liabilities. LTP purchases stock in corporation E for 
$100,000, which appreciates in value to $1,000,000. C sells its interest 
in UTP to corporation E for $250,000 in a year for which an election 
under section 754 is not in effect for UTP or LTP. LTP later sells the E 
stock for $2,000,000. LTP realizes a $1,900,000 gain on the sale of the 
E stock. UTP's share of the gain is $1,425,000, and E's share of the 
gain is $475,000. Under section 1032, E does not recognize its share of 
the gain.
    (ii) With respect to the basis of UTP's interest in LTP, if all of 
the gain from the sale of the E stock (including E's share) were to 
increase the basis of UTP's interest in LTP, UTP's basis in such 
interest would be $1,500,000 ($75,000 + $1,425,000). The fair market 
value of UTP's interest in LTP is $1,500,000. Because UTP did not have a 
section 754 election in effect for the taxable year in which E acquired 
its interest in UTP, UTP's basis in the LTP interest does not reflect 
the purchase price paid by E for its interest. Increasing the basis of 
UTP's interest in LTP by the full amount of the gain that would be 
recognized (in the absence of section 1032) on the sale of the E stock 
preserves the conformity between UTP's inside basis and outside basis 
with respect to LTP (i.e., UTP's share of LTP's cash is equal to 
$1,500,000, and UTP's basis in the LTP interest is $1,500,000) and 
appropriately would cause UTP to recognize no gain or loss on the sale 
of UTP's interest in LTP immediately after the sale of the E stock. 
Accordingly, increasing the basis of UTP's interest in LTP by the entire 
amount of gain allocated to UTP (including E's share) from LTP's sale of 
the E stock is consistent with the purpose of this section. The 
$1,425,000 of gain allocated by LTP to UTP will increase the adjusted 
basis of UTP's interest in LTP under section 705(a)(1). The basis of 
UTP's interest in LTP immediately after the sale of the E stock is 
$1,500,000.
    (iii) With respect to the basis of E's interest in UTP, if E's share 
of the gain allocated to UTP and then to E were to increase the basis of 
E's interest in UTP, E's basis in such interest would be $725,000 
($250,000 + $475,000) and the fair market value of such interest would 
be $500,000, so that E would recognize a loss of $225,000 if E sold its 
interest in UTP immediately after LTP's disposition of the E stock. It 
would be inappropriate for E to recognize a taxable loss of $225,000 
upon a disposition of its interest in UTP because E would not incur an 
economic loss in the transaction, and E did not recognize a taxable gain 
upon LTP's disposition of the E stock that appropriately would be offset 
by a taxable loss on the disposition of its interest in UTP. 
Accordingly, increasing E's basis in its UTP interest by the entire 
amount of gain allocated to E from the sale of the E stock is not 
consistent with the purpose of this section. (Conversely, because A and 
B were allocated taxable gain on the disposition of the E stock, it 
would be appropriate to increase A's and B's bases in their respective 
interests in UTP by the full amount of the gain allocated to them.)
    (iv) The appropriate basis adjustment for E's interest in UTP upon 
the disposition of the E stock by LTP can be determined as the amount of 
gain that E would have recognized (in the absence of section 1032) upon 
the sale by LTP of the E stock if both UTP and LTP had made section 754 
elections for the taxable year in which E acquired the interest in UTP. 
If section 754 elections had been in effect for UTP and LTP for the year 
in which E acquired E's interest in UTP, the following would occur. E 
would be entitled to a $225,000 positive basis adjustment under section 
743(b) with respect to the property of UTP. The entire basis adjustment 
would be allocated to UTP's only asset, its interest in LTP. In 
addition, the sale of C's interest in UTP would be treated as a deemed 
sale of E's share of UTP's interest in LTP for purposes of sections 754 
and 743. The deemed selling price of E's share of UTP's interest in LTP 
would be $250,000 (E's share of UTP's adjusted basis in LTP, $25,000, 
plus E's basis adjustment under section 743(b) with respect to the 
assets of UTP, $225,000). The deemed sale of E's share of UTP's interest 
in LTP would

[[Page 552]]

trigger a basis adjustment under section 743(b) of $225,000 with respect 
to the assets of LTP (the excess of E's share of UTP's adjusted basis in 
LTP, including E's basis adjustment ($225,000), $250,000, over E's share 
of the adjusted basis of LTP's property, $25,000). This $225,000 
adjustment by LTP would be allocated to LTP's only asset, the E stock, 
and would be segregated and allocated solely to E. The amount of LTP's 
gain from the sale of the E stock (before considering section 743(b)) 
would be $1,900,000. E's share of this gain, $475,000, would be offset 
in part by the $225,000 basis adjustment under section 743(b), so that E 
would recognize gain equal to $250,000 in the absence of section 1032.
    (v) If the basis of E's interest in UTP were increased by $250,000, 
the total basis of E's interest would equal $500,000. This would conform 
to E's share of UTP's basis in the LTP interest ($1,500,000x1/
3=$500,000) as well as E's indirect share of the cash held by LTP ((1/
3x3/4)x$2,000,000=$500,000). Such a basis adjustment does not create the 
opportunity for the recognition of an inappropriate loss by E on a 
subsequent disposition of E's interest in UTP and is consistent with the 
purpose of this section. Accordingly, under this paragraph (c), of the 
$475,000 gain allocated to E, only $250,000 will apply to increase the 
adjusted basis of E in UTP under section 705(a)(1). E's adjusted basis 
in its UTP interest following the sale of the E stock is $500,000.
    Example 2. Acquisition of lower-tier partnership interest by upper-
tier partnership. (i) A, corporation B, and C form an equal partnership 
(UTP), with each partner contributing $100,000. D, E, and F also form an 
equal partnership (LTP), with each partner contributing $30,000. LTP 
purchases stock in corporation B for $90,000, which appreciates in value 
to $900,000. LTP has no liabilities. UTP purchases D's interest in LTP 
for $300,000. LTP does not have an election under section 754 in effect 
for the taxable year of UTP's purchase. LTP later sells the B stock for 
$900,000. UTP's share of the gain is $270,000, and B's share of that 
gain is $90,000. Under section 1032, B does not recognize its share of 
the gain.
    (ii) With respect to the basis of UTP's interest in LTP, if all of 
the gain from the sale of the B stock (including B's share) were to 
increase the basis of UTP's interest in LTP, UTP's basis in the LTP 
interest would be $570,000 ($300,000 + $270,000), and the fair market 
value of such interest would be $300,000, so that B would be allocated a 
loss of $90,000 (($570,000-$300,000)x1/3) if UTP sold its interest in 
LTP immediately after LTP's disposition of the B stock. It would be 
inappropriate for B to recognize a taxable loss of $90,000 upon a 
disposition of UTP's interest in LTP. B would not incur an economic loss 
in the transaction, and B was not allocated a taxable gain upon LTP's 
disposition of the B stock that appropriately would be offset by a 
taxable loss on the disposition of UTP's interest in LTP. Accordingly, 
increasing UTP's basis in its LTP interest by the gain allocated to B 
from the sale of the B stock is not consistent with the purpose of this 
section. (Conversely, because E and F were allocated taxable gain on the 
disposition of the B stock, it would be appropriate to increase E's and 
F's bases in their respective interests in LTP by the full amount of 
such gain.)
    (iii) The appropriate basis adjustment for UTP's interest in LTP 
upon the disposition of the B stock by LTP can be determined as the 
amount of gain that UTP would have recognized (in the absence of section 
1032) upon the sale by LTP of the B stock if the portion of the gain 
allocated to UTP that subsequently is allocated to B were determined as 
if LTP had made an election under section 754 for the taxable year in 
which UTP acquired its interest in LTP. If a section 754 election had 
been in effect for LTP for the year in which UTP acquired its interest 
in LTP, then with respect to B, the following would occur. UTP would be 
entitled to a $90,000 positive basis adjustment under section 743(b), 
allocable to B, in the property of LTP. The entire basis adjustment 
would be allocated to LTP's only asset, its B stock. The amount of LTP's 
gain from the sale of the B stock (before considering section 743(b)) 
would be $810,000. UTP's share of this gain, $270,000, would be offset, 
in part, by the basis adjustment under section 743(b), so that UTP would 
recognize gain equal to $180,000.
    (iv) If the basis of UTP's interest in LTP were increased by 
$180,000, the total basis of UTP's partnership interest would equal 
$480,000. This would conform to the sum of UTP's share of the cash held 
by LTP ((1/3x$900,000=$300,000) and the taxable gain recognized by A and 
C on the disposition of the B stock that appropriately may be offset on 
the disposition of their interests in UTP ($90,000+$90,000=$180,000). 
Such a basis adjustment does not inappropriately create the opportunity 
for the allocation of a loss to B on a subsequent disposition of UTP's 
interest in LTP and is consistent with the purpose of this section. 
Accordingly, of the $270,000 gain allocated to UTP, only $180,000 will 
apply to increase the adjusted basis of UTP in LTP under section 
705(a)(1). Such $180,000 basis increase must be segregated and allocated 
$90,000 each to solely A and C. UTP's adjusted basis in its LTP interest 
following the sale of the B stock is $480,000.
    (v) With respect to B's interest in UTP, if B's share of the gain 
allocated to UTP and then to B were to increase the basis of B's 
interest in UTP, B would have a UTP partnership interest with an 
adjusted basis of $190,000 ($100,000 + $90,000) and a value of $100,000, 
so that B would recognize a loss of

[[Page 553]]

$90,000 if B sold its interest in UTP immediately after LTP's 
disposition of the B stock. It would be inappropriate for B to recognize 
a taxable loss of $90,000 upon a disposition of its interest in UTP 
because B would not incur an economic loss in the transaction, and B did 
not recognize a taxable gain upon LTP's disposition of the B stock that 
appropriately would be offset by a taxable loss on the disposition of 
its interest in UTP. Accordingly, increasing B's basis in its UTP 
interest by the gain allocated to B from the sale of the B stock is not 
consistent with the purpose of this section. (Conversely, because A and 
C were allocated taxable gain on the disposition of the B stock that is 
a result of LTP not having a section 754 election in effect, it would be 
appropriate for A and C to recognize an offsetting taxable loss on the 
disposition of A's and C's interests in UTP. Accordingly, it would be 
appropriate to increase A's and C's bases in their respective interests 
in UTP by the amount of gain recognized by A and C.)
    (vi) The appropriate basis adjustment for B's interest in UTP upon 
the disposition of the B stock by LTP can be determined as the amount of 
gain that B would have recognized (in the absence of section 1032) upon 
the sale by LTP of the B stock if the portion of the gain allocated to 
UTP that is subsequently allocated to B were determined as if LTP had 
made an election under section 754 for the taxable year in which UTP 
acquired its interest in LTP. If a section 754 election had been in 
effect for LTP for the year in which UTP acquired its interest in LTP, 
then with respect to B, the following would occur. UTP would be entitled 
to a basis adjustment under section 743(b) in the property of LTP of 
$90,000 with respect to B. The entire basis adjustment would be 
allocated to LTP's only asset, its B stock. The amount of LTP's gain 
from the sale of the B stock (before considering section 743(b)) would 
be $810,000. UTP's share of this gain, $270,000, would be offset, in 
part, by the $90,000 basis adjustment under section 743(b), so that UTP 
would recognize gain equal to $180,000. The $90,000 basis adjustment 
would completely offset the gain that otherwise would be allocated to B.
    (vii) If no gain were allocated to B so that the basis of B's 
interest in UTP was not increased, the total basis of B's interest would 
equal $100,000. This would conform to B's share of UTP's basis in the 
LTP interest (($480,000-$180,000 (i.e., A's and C's share of the basis 
that should offset taxable gain recognized as a result of LTP's failure 
to have a section 754 election))x1/3=$100,000) as well as B's indirect 
share of the cash held by LTP ((1/3x1/3)x$900,000=$100,000). Such a 
basis adjustment does not create the opportunity for the recognition of 
an inappropriate loss by B on a subsequent disposition of B's interest 
in UTP and is consistent with the purpose of this section. Accordingly, 
under this paragraph (c), of the $90,000 gain allocated to B, none will 
apply to increase the adjusted basis of B in UTP under section 
705(a)(1). B's adjusted basis in its UTP interest following the sale of 
the B stock is $100,000.
    (viii) Immediately after LTP's disposition of the B stock, UTP sells 
its interest in LTP for $300,000. UTP's adjusted basis in its LTP 
interest is $480,000, $180,000 of which must be allocated $90,000 each 
to A and C. Accordingly, upon UTP's sale of its interest in LTP, UTP 
realizes $180,000 of loss, and A and C in turn each realize $90,000 of 
loss.

    (d) Positions in Stock. For purposes of this section, stock includes 
any position in stock to which section 1032 applies.
    (e) Effective date. This section applies to gain or loss allocated 
with respect to sales or exchanges of stock occurring after December 6, 
1999, except that paragraph (d) of this section is applicable with 
respect to sales or exchanges of stock occurring on or after March 29, 
2002, and the fourth sentence of paragraph (a), paragraph (b)(2), and 
the third sentence of paragraph (c)(1) of this section are applicable 
with respect to sales or exchanges of stock occurring on or after March 
18, 2003.

[T.D. 8986, 67 FR 15114, Mar. 29, 2002, as amended by T.D. 9049, 68 FR 
12816, Mar. 18, 2003]



Sec. 1.706-1  Taxable years of partner and partnership.

    (a) Year in which partnership income is includible. (1) In computing 
taxable income for a taxable year, a partner is required to include the 
partner's distributive share of partnership items set forth in section 
702 and the regulations thereunder for any partnership taxable year 
ending within or with the partner's taxable year. A partner must also 
include in taxable income for a taxable year guaranteed payments under 
section 707(c) that are deductible by the partnership under its method 
of accounting in the partnership taxable year ending within or with the 
partner's taxable year.
    (2) The rules of this paragraph (a)(1) may be illustrated by the 
following example:

    Example. Partner A reports income using a calendar year, while the 
partnership of which A is a member reports its income using a fiscal 
year ending May 31. The partnership reports its income and deductions

[[Page 554]]

under the cash method of accounting. During the partnership taxable year 
ending May 31, 2002, the partnership makes guaranteed payments of 
$120,000 to A for services and for the use of capital. Of this amount, 
$70,000 was paid to A between June 1 and December 31, 2001, and the 
remaining $50,000 was paid to A between January 1 and May 31, 2002. The 
entire $120,000 paid to A is includible in A's taxable income for the 
calendar year 2002 (together with A's distributive share of partnership 
items set forth in section 702 for the partnership taxable year ending 
May 31, 2002).

    (3) If a partner receives distributions under section 731 or sells 
or exchanges all or part of a partnership interest, any gain or loss 
arising therefrom does not constitute partnership income.
    (b) Taxable year--(1) Partnership treated as a taxpayer. The taxable 
year of a partnership must be determined as though the partnership were 
a taxpayer.
    (2) Partnership's taxable year--(i) Required taxable year. Except as 
provided in paragraph (b)(2)(ii) of this section, the taxable year of a 
partnership must be--
    (A) The majority interest taxable year, as defined in section 
706(b)(4);
    (B) If there is no majority interest taxable year, the taxable year 
of all of the principal partners of the partnership, as defined in 
706(b)(3) (the principal partners' taxable year); or
    (C) If there is no majority interest taxable year or principal 
partners' taxable year, the taxable year that produces the least 
aggregate deferral of income as determined under paragraph (b)(3) of 
this section.
    (ii) Exceptions. A partnership may have a taxable year other than 
its required taxable year if it makes an election under section 444, 
elects to use a 52-53-week taxable year that ends with reference to its 
required taxable year or a taxable year elected under section 444, or 
establishes a business purpose for such taxable year and obtains 
approval of the Commissioner under section 442.
    (3) Least aggregate deferral--(i) Taxable year that results in the 
least aggregate deferral of income. The taxable year that results in the 
least aggregate deferral of income will be the taxable year of one or 
more of the partners in the partnership which will result in the least 
aggregate deferral of income to the partners. The aggregate deferral for 
a particular year is equal to the sum of the products determined by 
multiplying the month(s) of deferral for each partner that would be 
generated by that year and each partner's interest in partnership 
profits for that year. The partner's taxable year that produces the 
lowest sum when compared to the other partner's taxable years is the 
taxable year that results in the least aggregate deferral of income to 
the partners. If the calculation results in more than one taxable year 
qualifying as the taxable year with the least aggregate deferral, the 
partnership may select any one of those taxable years as its taxable 
year. However, if one of the qualifying taxable years is also the 
partnership's existing taxable year, the partnership must maintain its 
existing taxable year. The determination of the taxable year that 
results in the least aggregate deferral of income generally must be made 
as of the beginning of the partnership's current taxable year. The 
director, however, may determine that the first day of the current 
taxable year is not the appropriate testing day and require the use of 
some other day or period that will more accurately reflect the ownership 
of the partnership and thereby the actual aggregate deferral to the 
partners where the partners engage in a transaction that has as its 
principal purpose the avoidance of the principles of this section. Thus, 
for example the preceding sentence would apply where there is a transfer 
of an interest in the partnership that results in a temporary transfer 
of that interest principally for purposes of qualifying for a specific 
taxable year under the principles of this section. For purposes of this 
section, deferral to each partner is measured in terms of months from 
the end of the partnership's taxable year forward to the end of the 
partner's taxable year.
    (ii) Determination of the taxable year of a partner or partnership 
that uses a 52-53-week taxable year. For purposes of the calculation 
described in paragraph (b)(3)(i) of this section, the taxable year of a 
partner or partnership that uses a 52-53-week taxable year must be the 
same year determined under the

[[Page 555]]

rules of section 441(f) and the regulations thereunder with respect to 
the inclusion of income by the partner or partnership.
    (iii) Special de minimis rule. If the taxable year that results in 
the least aggregate deferral produces an aggregate deferral that is less 
than .5 when compared to the aggregate deferral of the current taxable 
year, the partnership's current taxable year will be treated as the 
taxable year with the least aggregate deferral. Thus, the partnership 
will not be permitted to change its taxable year.
    (iv) Examples. The principles of this section may be illustrated by 
the following examples:

    Example 1. Partnership P is on a fiscal year ending June 30. Partner 
A reports income on the fiscal year ending June 30 and Partner B reports 
income on the fiscal year ending July 31. A and B each have a 50 percent 
interest in partnership profits. For its taxable year beginning July 1, 
1987, the partnership will be required to retain its taxable year since 
the fiscal year ending June 30 results in the least aggregate deferral 
of income to the partners. This determination is made as follows:

----------------------------------------------------------------------------------------------------------------
                                                                    Interest in      Months of
                    Test 6/30                        Year end       partnership   deferral for 6/    Interestx
                                                                      profits       30 year end      deferral
----------------------------------------------------------------------------------------------------------------
Partner A.......................................            6/30             .5                0            0
Partner B.......................................            7/31             .5                1             .5
                                                                                                 ---------------
    Aggregate deferral..........................  ..............  ..............  ..............             .5
----------------------------------------------------------------------------------------------------------------


----------------------------------------------------------------------------------------------------------------
                                                                    Interest in      Months of
                    Test 7/31                        Year end       partnership   deferral for 7/    Interestx
                                                                      profits       31 year end      deferral
----------------------------------------------------------------------------------------------------------------
Partner A.......................................            6/30             .5               11            5.5
Partner B.......................................            7/31             .5                0            0
                                                                                                 ---------------
    Aggregate deferral..........................  ..............  ..............  ..............            5.5
----------------------------------------------------------------------------------------------------------------

    Example 2. The facts are the same as in Example 1 except that A 
reports income on the calendar year and B reports on the fiscal year 
ending November 30. For the partnership's taxable year beginning July 1, 
1987, the partnership is required to change its taxable year to a fiscal 
year ending November 30 because such year results in the least aggregate 
deferral of income to the partners. This determination is made as 
follows:

----------------------------------------------------------------------------------------------------------------
                                                                    Interest in      Months of
                   Test 12/31                        Year end       partnership    deferral for      Interestx
                                                                      profits     12/31 year end     deferral
----------------------------------------------------------------------------------------------------------------
Partner A.......................................           12/31             .5                0            0
Partner B.......................................           11/30             .5               11            5.5
                                                                                                 ---------------
    Aggregate deferral..........................  ..............  ..............  ..............            5.5
----------------------------------------------------------------------------------------------------------------


----------------------------------------------------------------------------------------------------------------
                                                                    Interest in      Months of
                   Test 11/30                        Year end       partnership    deferral for      Interestx
                                                                      profits     11/30 year end     deferral
----------------------------------------------------------------------------------------------------------------
Partner A.......................................           12/31             .5                1             .5
Partner B.......................................           11/30             .5                0            0
                                                                                                 ---------------
    Aggregate deferral..........................  ..............  ..............  ..............             .5
----------------------------------------------------------------------------------------------------------------

    Example 3. The facts are the same as in Example 2 except that B 
reports income on the fiscal year ending June 30. For the partnership's 
taxable year beginning July 1, 1987, each partner's taxable year will 
result in identical aggregate deferral of income. If the partnership's 
current taxable year was neither a fiscal year ending June 30 nor the 
calendar year, the partnership would select either the fiscal year 
ending June 30 or the calendar year as its taxable year. However, since 
the partnership's current taxable year ends June 30, it must retain its 
current taxable year. The determination is made as follows:

[[Page 556]]



----------------------------------------------------------------------------------------------------------------
                                                                    Interest in      Months of
                   Test 12/31                        Year end       partnership    deferral for      Interestx
                                                                      profits     12/31 year end     deferral
----------------------------------------------------------------------------------------------------------------
Partner A.......................................           12/31             .5                0            0
Partner B.......................................            6/30             .5                6            3.0
                                                                                                 ---------------
    Aggregate deferral..........................  ..............  ..............  ..............            3.0
----------------------------------------------------------------------------------------------------------------


----------------------------------------------------------------------------------------------------------------
                                                                    Interest in      Months of
                    Test 6/30                        Year end       partnership   deferral for 6/    Interestx
                                                                      profits       30 year end      deferral
----------------------------------------------------------------------------------------------------------------
Partner A.......................................           12/31             .5                6            3.0
Partner B.......................................            6/30             .5                0            0
                                                                                                 ---------------
    Aggregate deferral..........................  ..............  ..............  ..............            3.0
----------------------------------------------------------------------------------------------------------------

    Example 4. The facts are the same as in Example 1 except that on 
December 31, 1987, partner A sells a 4 percent interest in the 
partnership to Partner C, who reports income on the fiscal year ending 
June 30, and a 40 percent interest in the partnership to Partner D, who 
also reports income on the fiscal year ending June 30. The taxable year 
beginning July 1, 1987, is unaffected by the sale. However, for the 
taxable year beginning July 31, 1988, the partnership must determine the 
taxable year resulting in the least aggregate deferral as of July 1, 
1988. In this case, the partnership will be required to retain its 
taxable year since the fiscal year ending June 30 continues to be the 
taxable year that results in the least aggregate deferral of income to 
the partners.
    Example 5. The facts are the same as in Example 4 except that 
Partner D reports income on the fiscal year ending April 30. As in 
Example 4, the taxable year during which the sale took place is 
unaffected by the shifts in interests. However, for its taxable year 
beginning July 1, 1988, the partnership will be required to change its 
taxable year to the fiscal year ending April 30. This determination is 
made as follows:

----------------------------------------------------------------------------------------------------------------
                                                                    Interest in      Months of
                    Test 7/31                        Year end       partnership   deferral for 7/    Interestx
                                                                      profits       31 year end      deferral
----------------------------------------------------------------------------------------------------------------
Partner A.......................................            6/30             .06              11             .66
Partner B.......................................            7/31             .5                0            0
Partner C.......................................            6/30             .04              11             .44
Partner D.......................................            4/30             .4                9            3.60
                                                                                                 ---------------
    Aggregate deferral..........................  ..............  ..............  ..............            4.70
----------------------------------------------------------------------------------------------------------------


----------------------------------------------------------------------------------------------------------------
                                                                    Interest in      Months of
                    Test 6/30                        Year end       partnership   deferral for 6/    Interestx
                                                                      profits       30 year end      deferral
----------------------------------------------------------------------------------------------------------------
Partner A.......................................            6/30             .06               0            0
Partner B.......................................            7/31             .5                1             .5
Partner C.......................................            6/30             .04               0            0
Partner D.......................................            4/30             .4               10            4.0
                                                                                                 ---------------
    Aggregate deferral..........................  ..............  ..............  ..............            4.5
----------------------------------------------------------------------------------------------------------------


----------------------------------------------------------------------------------------------------------------
                                                                    Interest in      Months of
                    Test 4/30                        Year end       partnership   deferral for 4/    Interestx
                                                                      profits       30 year end      deferral
----------------------------------------------------------------------------------------------------------------
Partner A.......................................            6/30             .06               2             .12
Partner B.......................................            7/31             .5                3            1.50
Partner C.......................................            6/30             .04               2             .08
Partner D.......................................            4/30             .4                0            0
                                                                                                 ---------------
    Aggregate deferral..........................  ..............  ..............  ..............            1.70
----------------------------------------------------------------------------------------------------------------
                                            Sec. 1.706-1(b)(3) Test
----------------------------------------------------------------------------------------------------------------
Current taxable year (June 30)..................................................................            4.5
Less: Taxable year producing the least aggregate deferral (April 30)............................            1.7
                                                 ---------------------------------------------------------------

[[Page 557]]

 
Additional aggregate deferral (greater than .5).................................................            2.8
----------------------------------------------------------------------------------------------------------------

    Example 6. (i) Partnership P has two partners, A who reports income 
on the fiscal year ending March 31, and B who reports income on the 
fiscal year ending July 31. A and B share profits equally. P has 
determined its taxable year under paragraph (b)(3) of this section to be 
the fiscal year ending March 31 as follows:

----------------------------------------------------------------------------------------------------------------
                                                                    Interest in
                    Test 3/31                        Year end       partnership   Deferral for 3/    Interestx
                                                                      profits       31 year end      deferral
----------------------------------------------------------------------------------------------------------------
Partner A.......................................            3/31             .5                0            0
Partner B.......................................            7/31             .5                4            2
                                                                                                 ---------------
    Aggregate deferral..........................  ..............  ..............  ..............            2
----------------------------------------------------------------------------------------------------------------


----------------------------------------------------------------------------------------------------------------
                                                                    Interest in
                    Test 7/31                        Year end       partnership   Deferral for 7/    Interestx
                                                                      profits       31 year end      deferral
----------------------------------------------------------------------------------------------------------------
Partner A.......................................            3/31             .5                8            4
Partner B.......................................            7/31             .5                0            0
                                                                                                 ---------------
    Aggregate deferral..........................  ..............  ..............  ..............            4
----------------------------------------------------------------------------------------------------------------

    (ii) In May 1988, Partner A sells a 45 percent interest in the 
partnership to C, who reports income on the fiscal year ending April 30. 
For the taxable period beginning April 1, 1989, the fiscal year ending 
April 30 is the taxable year that produces the least aggregate deferral 
of income to the partners. However, under paragraph (b)(3)(iii) of this 
section the partnership is required to retain its fiscal year ending 
March 31. This determination is made as follows:

----------------------------------------------------------------------------------------------------------------
                                                                    Interest in
                    Test 3/31                        Year end       partnership   Deferral for 3/    Interestx
                                                                      profits       31 year end      deferral
----------------------------------------------------------------------------------------------------------------
Partner A.......................................            3/31             .05               0            0
Partner B.......................................            7/31             .5                4            2.0
Partner C.......................................            4/30             .45               1             .45
                                                                                                 ---------------
    Aggregate deferral..........................  ..............  ..............  ..............            2.45
----------------------------------------------------------------------------------------------------------------


----------------------------------------------------------------------------------------------------------------
                                                                    Interest in
                    Test 7/31                        Year end       partnership   Deferral for 7/    Interestx
                                                                      profits       31 year end      deferral
----------------------------------------------------------------------------------------------------------------
Partner A.......................................            3/31             .05               8             .40
Partner B.......................................            7/31             .5                0            0
Partner C.......................................            4/30             .45               9            4.05
                                                                                                 ---------------
    Aggregate deferral..........................  ..............  ..............  ..............            4.45
----------------------------------------------------------------------------------------------------------------


----------------------------------------------------------------------------------------------------------------
                                                                    Interest in
                    Test 4/30                        Year end       partnership   Deferral for 4/    Interestx
                                                                      profits       30 year end      deferral
----------------------------------------------------------------------------------------------------------------
Partner A.......................................            3/31             .05              11             .55
Partner B.......................................            7/31             .5                3            1.50
Partner C.......................................            4/30             .45               0            0
                                                                                                 ---------------
    Aggregate deferral..........................  ..............  ..............  ..............            2.05
----------------------------------------------------------------------------------------------------------------
                                            Sec. 1.706-1(b)(3) Test
----------------------------------------------------------------------------------------------------------------
Current taxable year (3/31).....................................................................            2.45
Less: Taxable year producing the least aggregate deferral (4/30)................................            2.05
                                                 ---------------------------------------------------------------

[[Page 558]]

 
Additional aggregate deferral (less than .5)....................................................             .40
----------------------------------------------------------------------------------------------------------------


    (4) Measurement of partner's profits and capital interest--
    (i) In general. The rules of this paragraph (b)(4) apply in 
determining the majority interest taxable year, the principal partners' 
taxable year, and the least aggregate deferral taxable year.
    (ii) Profits interest--(A) In general. For purposes of section 
706(b), a partner's interest in partnership profits is generally the 
partner's percentage share of partnership profits for the current 
partnership taxable year. If the partnership does not expect to have net 
income for the current partnership taxable year, then a partner's 
interest in partnership profits instead must be the partner's percentage 
share of partnership net income for the first taxable year in which the 
partnership expects to have net income.
    (B) Percentage share of partnership net income. The partner's 
percentage share of partnership net income for a partnership taxable 
year is the ratio of: the partner's distributive share of partnership 
net income for the taxable year, to the partnership's net income for the 
year. If a partner's percentage share of partnership net income for the 
taxable year depends on the amount or nature of partnership income for 
that year (due to, for example, preferred returns or special allocations 
of specific partnership items), then the partnership must make a 
reasonable estimate of the amount and nature of its income for the 
taxable year. This estimate must be based on all facts and circumstances 
known to the partnership as of the first day of the current partnership 
taxable year. The partnership must then use this estimate in determining 
the partners' interests in partnership profits for the taxable year.
    (C) Distributive share. For purposes of this paragraph (b)(4)(ii), a 
partner's distributive share of partnership net income is determined by 
taking into account all rules and regulations affecting that 
determination, including, without limitation, sections 704(b), (c), and 
(e), 736, and 743.
    (iii) Capital interest. Generally, a partner's interest in 
partnership capital is determined by reference to the assets of the 
partnership that the partner would be entitled to upon withdrawal from 
the partnership or upon liquidation of the partnership. If the 
partnership maintains capital accounts in accordance with Sec. 1.704-
1(b)(2)(iv), then for purposes of section 706(b), the partnership may 
assume that a partner's interest in partnership capital is the ratio of 
the partner's capital account to all partners' capital accounts as of 
the first day of the partnership taxable year.
    (5) Taxable year of a partnership with tax-exempt partners--(i) 
Certain tax-exempt partners disregarded. In determining the taxable year 
(the current year) of a partnership under section 706(b) and the 
regulations thereunder, a partner that is tax-exempt under section 
501(a) shall be disregarded if such partner was not subject to tax, 
under chapter 1 of the Internal Revenue Code, on any income attributable 
to its investment in the partnership during the partnership's taxable 
year immediately preceding the current year. However, if a partner that 
is tax-exempt under section 501(a) was not a partner during the 
partnership's immediately preceding taxable year, such partner will be 
disregarded for the current year if the partnership reasonably believes 
that the partner will not be subject to tax, under chapter 1 of the 
Internal Revenue Code, on any income attributable to such partner's 
investment in the partnership during the current year.
    (ii) Example. The provisions of paragraph (b)(5)(i) of this section 
may be illustrated by the following example:

    Example. Assume that partnership A has historically used the 
calendar year as its taxable year. In addition, assume that A is owned 
by 5 partners, 4 calendar year individuals (each owning 10 percent of 
A's profits and capital) and a tax-exempt organization (owning 60 
percent of A's profits and capital).

[[Page 559]]

The tax-exempt organization has never had unrelated business taxable 
income with respect to A and has historically used a June 30 fiscal 
year. Finally, assume that A desires to retain the calendar year for its 
taxable year beginning January 1, 2003. Under these facts and but for 
the special rule in paragraph (b)(5)(i) of this section, A would be 
required under section 706(b)(1)(B)(i) to change to a year ending June 
30, for its taxable year beginning January 1, 2003. However, under the 
special rule provided in paragraph (b)(5)(i) of this section the partner 
that is tax-exempt is disregarded, and A must retain the calendar year, 
under section 706(b)(1)(B)(i), for its taxable year beginning January 1.

    (iii) Effective date. The provisions of this paragraph (b)(5) are 
applicable for taxable years beginning on or after July 23, 2002. For 
taxable years beginning before July 23, 2002, see Sec. 1.706-3T as 
contained in 26 CFR part 1 revised April 1, 2002.
    (6) Certain foreign partners disregarded--(i) Interests of 
disregarded foreign partners not taken into account. In determining the 
taxable year (the current taxable year) of a partnership under section 
706(b) and the regulations thereunder, any interest held by a 
disregarded foreign partner is not taken into account. A foreign partner 
is a disregarded foreign partner unless such partner is allocated any 
gross income of the partnership that was effectively connected (or 
treated as effectively connected) with the conduct of a trade or 
business within the United States during the partnership's taxable year 
immediately preceding the current taxable year (or, if such partner was 
not a partner during the partnership's immediately preceding taxable 
year, the partnership reasonably believes that the partner will be 
allocated any such income during the current taxable year) and taxation 
of that income is not otherwise precluded under any U.S. income tax 
treaty.
    (ii) Definition of foreign partner. For purposes of this paragraph 
(b)(6), a foreign partner is any partner that is not a U.S. person (as 
defined in section 7701(a)(30)), except that a partner that is a 
controlled foreign corporation (as defined in section 957(a)) or a 
foreign personal holding company (as defined in section 552) shall not 
be treated as a foreign partner.
    (iii) Minority interest rule. If each partner that is not a 
disregarded foreign partner under paragraph (b)(6)(i) of this section 
(regarded partner) holds less than a 10-percent interest, and the 
regarded partners, in the aggregate, hold less than a 20-percent 
interest in the capital or profits of the partnership, then paragraph 
(b)(6)(i) of this section does not apply. In determining ownership in a 
partnership for purposes of this paragraph (b)(6)(iii), each regarded 
partner is treated as owning any interest in the partnership owned by a 
related partner. For this purpose, partners are treated as related if 
they are related within the meaning of sections 267(b) or 707(b) (using 
the language ``10 percent'' instead of ``50 percent'' each place it 
appears). However, for purposes of determining if partners hold less 
than a 20-percent interest in the aggregate, the same interests will not 
be considered as being owned by more than one regarded partner.
    (iv) Example. The provisions of paragraph (b)(6) of this section may 
be illustrated by the following example:

    Example. Partnership B is owned by two partners, F, a foreign 
corporation that owns a 95-percent interest in the capital and profits 
of partnership B, and D, a domestic corporation that owns the remaining 
5-percent interest in the capital and profits of partnership B. 
Partnership B is not engaged in the conduct of a trade or business 
within the United States, and, accordingly, partnership B does not earn 
any income that is effectively connected with a U.S. trade or business. 
F uses a March 31 fiscal year, and causes partnership B to maintain its 
books and records on a March 31 fiscal year as well. D is a calendar 
year taxpayer. Under paragraph (b)(6)(i) of this section, F would be 
disregarded and partnership B's taxable year would be determined by 
reference to D. However, because D owns less than a 10-percent interest 
in the capital and profits of partnership B, the minority interest rule 
of paragraph (b)(6)(iii) of this section applies, and partnership B must 
adopt the March 31 fiscal year for Federal tax purposes.

    (v) Effective date--(A) Generally. The provisions of this paragraph 
(b)(6) are applicable for the first taxable year of a partnership other 
than an existing partnership that begins on or after July 23, 2002. For 
this purpose, an existing partnership is a partnership that was formed 
prior to September 23, 2002.

[[Page 560]]

    (B) Voluntary change in taxable year. An existing partnership may 
change its taxable year to a year determined in accordance with this 
section. An existing partnership that makes such a change will cease to 
be exempted from the requirements of paragraph (b)(6) of this section.
    (C) Subsequent sale or exchange of interests. If an existing 
partnership terminates under section 708(b)(1)(B), the resulting 
partnership is not an existing partnership for purposes of paragraph 
(b)(6)(v)(A) of this section.
    (D) Transition rule. If, in the first taxable year beginning on or 
after July 23, 2002, an existing partnership voluntarily changes its 
taxable year to a year determined in accordance with this paragraph 
(b)(6), then the partners of that partnership may apply the provisions 
of Sec. 1.702-3T to take into account all items of income, gain, loss, 
deduction, and credit attributable to the partnership year of change 
ratably over a four-year period.
    (7) Adoption of taxable year. A newly-formed partnership may adopt, 
in accordance with Sec. 1.441-1(c), its required taxable year, a 
taxable year elected under section 444, or a 52-53-week taxable year 
ending with reference to its required taxable year or a taxable year 
elected under section 444 without securing the approval of the 
Commissioner. If a newly-formed partnership wants to adopt any other 
taxable year, it must establish a business purpose and secure the 
approval of the Commissioner under section 442.
    (8) Change in taxable year--(i) Partnerships-(A) Approval required. 
An existing partnership may change its taxable year only by securing the 
approval of the Commissioner under section 442 or making an election 
under section 444. However, a partnership may obtain automatic approval 
for certain changes, including a change to its required taxable year, 
pursuant to administrative procedures published by the Commissioner.
    (B) Short period tax return. A partnership that changes its taxable 
year must make its return for a short period in accordance with section 
443, but must not annualize the partnership taxable income.
    (C) Change in required taxable year. If a partnership is required to 
change to its majority interest taxable year, then no further change in 
the partnership's required taxable year is required for either of the 
two years following the year of the change. This limitation against a 
second change within a three-year period applies only if the first 
change was to the majority interest taxable year and does not apply 
following a change in the partnership's taxable year to the principal 
partners' taxable year or the least aggregate deferral taxable year.
    (ii) Partners. Except as otherwise provided in the Internal Revenue 
Code or the regulations thereunder (e.g., section 859 regarding real 
estate investment trusts or Sec. 1.442-2(c) regarding a subsidiary 
changing to its consolidated parent's taxable year), a partner may not 
change its taxable year without securing the approval of the 
Commissioner under section 442. However, certain partners may be 
eligible to obtain automatic approval to change their taxable years 
pursuant to the regulations or administrative procedures published by 
the Commissioner. A partner that changes its taxable year must make its 
return for a short period in accordance with section 443.
    (9) Retention of taxable year. In certain cases, a partnership will 
be required to change its taxable year unless it obtains the approval of 
the Commissioner under section 442, or makes an election under section 
444, to retain its current taxable year. For example, a partnership 
using a taxable year that corresponds to its required taxable year must 
obtain the approval of the Commissioner to retain such taxable year if 
its required taxable year changes as a result of a change in ownership, 
unless the partnership previously obtained approval for its current 
taxable year or, if appropriate, makes an election under section 444.
    (10) Procedures for obtaining approval or making a section 444 
election. See Sec. 1.442-1(b) for procedures to obtain the approval of 
the Commissioner (automatically or otherwise) to adopt, change, or 
retain a taxable year. See Sec. Sec. 1.444-1T and 1.444-2T for 
qualifications, and Sec. 1.444-3T for procedures, for making an 
election under section 444.

[[Page 561]]

    (11) Effect of partner elections under section 444--(i) Election 
taken into account. For purposes of section 706(b)(1)(B), any section 
444 election by a partner in a partnership shall be taken into account 
in determining the taxable year of the partnership. See Sec. 1.7519-
1T(d), Example (4).
    (ii) Effective date. The provisions of this paragraph (b)(11) are 
applicable for taxable years beginning on or after July 23, 2002. For 
taxable years beginning before July 23, 2002, see Sec. 1.706-3T as 
contained in 26 CFR part 1 revised April 1, 2002.
    (c) Closing of partnership year--(1) General rule. Section 706(c) 
and this paragraph provide rules governing the closing of partnership 
years. The closing of a partnership taxable year or a termination of a 
partnership for Federal income tax purposes is not necessarily governed 
by the ``dissolution'', ``liquidation'', etc., of a partnership under 
State or local law. The taxable year of a partnership shall not close as 
the result of the death of a partner, the entry of a new partner, the 
liquidation of a partner's entire interest in the partnership (as 
defined in section 761(d)), or the sale or exchange of a partner's 
interest in the partnership, except in the case of a termination of a 
partnership and except as provided in subparagraph (2) of this 
paragraph. In the case of termination, the partnership taxable year 
closes for all partners as of the date of termination. See section 
708(b) and paragraph (b) of Sec. 1.708-1.
    (2) Partner who retires or sells interest in partnership--(i) 
Disposition of entire interest. A partnership taxable year shall close 
with respect to a partner who sells or exchanges his entire interest in 
a partnership, and with respect to a partner whose entire interest is 
liquidated. However, a partnership taxable year with respect to a 
partner who dies shall not close prior to the end of such partnership 
taxable year, or the time when such partner's interest (held by his 
estate or other successor) is liquidated or sold or exchanged, whichever 
is earlier. See subparagraph (3) of this paragraph.
    (ii) Inclusions in taxable income. In the case of a sale, exchange, 
or liquidation of a partner's entire interest in a partnership, the 
partner shall include in his taxable income for his taxable year within 
or with which his membership in the partnership ends, his distributive 
share of items described in section 702(a), and any guaranteed payments 
under section 707(c), for his partnership taxable year ending with the 
date of such sale, exchange, or liquidation. In order to avoid an 
interim closing of the partnership books, such partner's distributive 
share of items described in section 702(a) may, by agreement among the 
partners, be estimated by taking his pro rata part of the amount of such 
items he would have included in his taxable income had he remained a 
partner until the end of the partnership taxable year. The proration may 
be based on the portion of the taxable year that has elapsed prior to 
the sale, exchange, or liquidation, or may be determined under any other 
method that is reasonable. Any partner who is the transferee of such 
partner's interest shall include in his taxable income, as his 
distributive share of items described in section 702(a) with respect to 
the acquired interest, the pro rata part (determined by the method used 
by the transferor partner) of the amount of such items he would have 
included had he been a partner from the beginning of the taxable year of 
the partnership. The application of this subdivision may be illustrated 
by the following example:

    Example. Assume that a partner selling his partnership interest on 
June 30, 1955, has an adjusted basis for his interest of $5,000 on that 
date; that his pro rata share of partnership income up to June 30 is 
$15,000; and that he sells his interest for $20,000. Under the 
provisions of section 706(c)(2), the partnership year with respect to 
him closes at the time of the sale. The $15,000 is includible in his 
income as his distributive share and, under section 705, it increases 
the basis of his partnership interest to $20,000, which is also the 
selling price of his interest. Therefore, no gain is realized on the 
sale of his partnership interest. The purchaser of this partnership 
interest shall include in his income as his distributive share his pro 
rata part of partnership income for the remainder of the partnership 
taxable year.

    (3) Partner who dies. (i) When a partner dies, the partnership 
taxable year shall not close with respect to such

[[Page 562]]

partner prior to the end of the partnership taxable year. The 
partnership taxable year shall continue both for the remaining partners 
and the decedent partner. Where the death of a partner results in the 
termination of the partnership, the partnership taxable year shall close 
for all partners on the date of such termination under section 
708(b)(1)(A). See also paragraph (b)(1)(i)(b) of Sec. 1.708-1 for the 
continuation of a 2-member partnership under certain circumstances after 
the death of a partner. However, if the decedent partner's estate or 
other successor sells or exchanges its entire interest in the 
partnership, or if its entire interest is liquidated, the partnership 
taxable year with respect to the estate or other successor in interest 
shall close on the date of such sale or exchange, or the date of 
completion of the liquidation.
    (ii) The last return of a decedent partner shall include only his 
share of partnership taxable income for any partnership taxable year or 
years ending within or with the last taxable year for such decedent 
partner (i. e., the year ending with the date of his death). The 
distributive share of partnership taxable income for a partnership 
taxable year ending after the decedent's last taxable year is includible 
in the return of his estate or other successor in interest. If the 
estate or other successor in interest of a partner continues to share in 
the profits or losses of the partnership business, the distributives 
share thereof is includible in the taxable year of the estate or other 
successor in interest within or with which the taxable year of the 
partnership ends. See also paragraph (a)(1)(ii) of Sec. 1.736-1. Where 
the estate or other successor in interest receives distributions, any 
gain or loss on such distributions is includible in its gross income for 
its taxable year in which the distribution is made.
    (iii) If a partner (or a retiring partner), in accordance with the 
terms of the partnership agreement, designates a person to succeed to 
his interest in the partnership after his death, such designated person 
shall be regarded as a successor in interest of the deceased for 
purposes of this chapter. Thus, where a partner designates his widow as 
the successor in interest, her distributive share of income for the 
taxable year of the partnership ending within or with her taxable year 
may be included in a joint return in accordance with the provisions of 
sections 2 and 6013(a) (2) and (3).
    (iv) If, under the terms of an agreement existing at the date of 
death of a partner, a sale or exchange of the decedent partner's 
interest in the partnership occurs upon that date, then the taxable year 
of the partnership with respect to such decedent partner shall close 
upon the date of death. See section 706(c)(2)(A)(i). The sale or 
exchange of a partnership interest does not, for the purpose of this 
rule, include any transfer of a partnership interest which occurs at 
death as a result of inheritance or any testamentary disposition.
    (v) To the extent that any part of a distributive share of 
partnership income of the estate or other successor in interest of a 
deceased partner is attributable to the decedent for the period ending 
with the date of his death, such part of the distributive share is 
income in respect of the decedent under section 691. See section 691 and 
the regulations thereunder.
    (vi) The provisions of this subparagraph may be illustrated by the 
following examples:

    Example 1. B has a taxable year ending December 31 and is a member 
of partnership ABC, the taxable year of which ends on June 30. B dies on 
October 31, 1955. His estate (which as a new taxpayer may, under section 
441 and the regulations thereunder, adopt any taxable year) adopts a 
taxable year ending October 31. The return of the decedent for the 
period January 1 to October 31, 1955, will include only his distributive 
share of taxable income of the partnership for its taxable year ending 
June 30, 1955. The distributive share of taxable income of the 
partnership for its taxable year ending June 30, 1956, arising from the 
interest of the decedent, will be includible in the return of the estate 
for its taxable year ending October 31, 1956. That part of the 
distributive share attributable to the decedent for the period ending 
with the date of his death (July 1 through October 31, 1955) is income 
in respect of a decedent under section 691.
    Example 2. Assume the same facts as in example 1 of this 
subdivision, except that, prior to B's death, B and D had agreed that, 
upon B's death, D would purchase B's interest for $10,000. When B dies 
on October 31, 1955, the partnership taxable year beginning

[[Page 563]]

July 1, 1955, closes with respect to him. Therefore, the return for B's 
last taxable year (January 1 to October 31, 1955) will include his 
distributive share of taxable income of the partnership for its taxable 
year ending June 30, 1955, plus his distributive share of partnership 
taxable income for the period July 1 to October 31, 1955. See 
subdivision (iv) of this subparagraph.
    Example 3. H is a member of a partnership having a taxable year 
ending December 31. Both H and his wife W are on a calendar year and 
file joint returns. H dies on March 31, 1955. Administration of the 
estate is completed and the estate, including the partnership interest, 
is distributed to W as legatee on November 30, 1955. Such distribution 
by the estate is not a sale or exchange of H's partnership interest. No 
part of the taxable income of the partnership for the taxable year 
ending December 31, 1955, which is allocable to H, will be included in 
H's taxable income for his last taxable year (January 1 through March 
31, 1955) or in the taxable income of H's estate for the taxable year 
April 1 through November 30, 1955. The distributive share of partnership 
taxable income for the full calendar year that is allocable to H will be 
includible in the taxable income of W for her taxable year ending 
December 31, 1955, and she may file a joint return under sections 2 and 
6013(a)(3). That part of the distributive share attributable to the 
decedent for the period ending with the date of his death (January 1 
through March 31, 1955) is income in respect of a decedent under section 
691.
    Example 4. M is a member of partnership JKM which operates on a 
calendar year. M and his wife S file joint returns for calendar years. 
In accordance with the partnership agreement, M designated S to succeed 
to his interest in the partnership upon his death. M, who had withdrawn 
$10,000 from the partnership before his death, dies on October 20, 1955. 
S's distributive share of income for the taxable year 1955 is $15,000 
($10,000 of which represents the amount withdrawn by M). S shall include 
$15,000 in her income, even though M received $10,000 of this amount 
before his death. S may file a joint return with M for the year 1955 
under sections 2 and 6013(a). That part of the $15,000 distributive 
share attributable to the decedent for the period ending with the date 
of his death (January 1 through October 20, 1955) is income in respect 
of a decedent under section 691.

    (4) Disposition of less than entire interest. If a partner sells or 
exchanges a part of his interest in a partnership, or if the interest of 
a partner is reduced, the partnership taxable year shall continue to its 
normal end. In such case, the partner's distributive share of items 
which he is required to include in his taxable income under the 
provisions of section 702(a) shall be determined by taking into account 
his varying interests in the partnership during the partnership taxable 
year in which such sale, exchange, or reduction of interest occurred.
    (5) Transfer of interest by gift. The transfer of a partnership 
interest by gift does not close the partnership taxable year with 
respect to the donor. However, the income up to the date of gift 
attributable to the donor's interest shall be allocated to him under 
section 704(e)(2).
    (6) Foreign taxes. For rules relating to the treatment of foreign 
taxes paid or accrued by a partnership, see Sec. 1.901-2(f)(4)(i) and 
(f)(4)(ii).
    (d) Effective date. The rules of this section are applicable for 
taxable years ending on or after May 17, 2002, except for paragraph (c), 
which applies for taxable years beginning after December 31, 1953.

[T.D. 6500, 25 FR 11814, Nov. 26, 1960; 25 FR 14021, Dec. 31, 1960, as 
amended by T.D. 7286, 38 FR 26912, Sept. 27, 1973; T.D. 8123, 52 FR 
3623, Feb. 5, 1987; T.D. 8996, 67 FR 35020, May 17, 2002; T.D. 9009, 67 
FR 48019, July 23, 2002; T.D. 9576, 77 FR 8124, Feb. 14, 2012]



Sec. 1.706-2T  Temporary regulations; question and answer under the
Tax Reform Act of 1984.

    Question 1: For purposes of section 706(d), how is an otherwise 
deductible amount that is deferred under section 267(a)(2) treated?
    Answer 1: In the year the deduction is allowed, the deduction will 
constitute an allocable cash basis item under section 706(d)(2)(B)(iv).

(Secs. 267(f)(2)(B), 706(d)(2)(B)(iv), 1502, and 7805, Internal Revenue 
Code of 1954 (98 Stat. 704, 26 U.S.C. 267; 98 Stat. 589, 26 U.S.C. 706; 
68A Stat. 367, 26 U.S.C. 1502; 68A Stat. 917, 26 U.S.C. 7805))

[T.D. 7991, 49 FR 47001, Nov. 30, 1984]



Sec. 1.707-0  Table of contents.

    This section lists the captions that appear in Sec. Sec. 1.707-1 
through 1.707-9.

       Sec. 1.707-1 Transactions Between Partner and Partnership

    (a) Partner not acting in capacity as partner.
    (b) Certain sales or exchanges of property with respect to 
controlled partnerships.

[[Page 564]]

    (1) Losses disallowed.
    (2) Gains treated as ordinary income.
    (3) Ownership of a capital or profits interest.
    (c) Guaranteed payments.

        Sec. 1.707-2 Disguised Payments for Services. [Reserved]

 Sec. 1.707-3 Disguised Sales of Property to Partnership; General Rule.

    (a) Treatment of transfers as a sale.
    (1) In general.
    (2) Definition and timing of sale.
    (3) Application of disguised sale rules.
    (4) Deemed terminations under section 708.
    (b) Transfers treated as a sale.
    (1) In general.
    (2) Facts and circumstances.
    (c) Transfers made within two years presumed to be a sale.
    (1) In general.
    (2) Disclosure of transfers made within two years.
    (d) Transfers made more than two years apart presumed not to be a 
sale.
    (e) Scope.
    (f) Examples.

Sec. 1.707-4 Disguised Sales of Property to Partnership; Special Rules 
  Applicable to Guaranteed Payments, Preferred Returns, Operating Cash 
   Flow Distributions, and Reimbursements of Preformation Expenditures

    (a) Guaranteed payments and preferred returns.
    (1) Guaranteed payment not treated as part of a sale.
    (i) In general.
    (ii) Reasonable guaranteed payments.
    (iii) Unreasonable guaranteed payments.
    (2) Presumption regarding reasonable preferred returns.
    (3) Definition of reasonable preferred returns and guaranteed 
payments.
    (i) In general.
    (ii) Reasonable amount.
    (4) Examples.
    (b) Presumption regarding operating cash flow distributions.
    (1) In general.
    (2) Operating cash flow distributions.
    (i) In general.
    (ii) Operating cash flow safe harbor.
    (iii) Tiered partnerships.
    (c) Accumulation of guaranteed payments, preferred returns, and 
operating cash flow distributions.
    (d) Exception for reimbursements of preformation expenditures.
    (e) Other exceptions.

Sec. 1.707-5 Disguised Sales of Property to Partnership; Special Rules 
                         Relating to Liabilities

    (a) Liability assumed or taken subject to by partnership.
    (1) In general.
    (2) Partner's share of liability.
    (i) Recourse liability.
    (ii) Nonrecourse liability.
    (3) Reduction of partner's share of liability.
    (4) Special rule applicable to transfers of encumbered property to a 
partnership by more than one partner pursuant to a plan.
    (5) Special rule applicable to qualified liabilities.
    (6) Qualified liability of a partner defined.
    (7) Liability incurred within two years of transfer presumed to be 
in anticipation of the transfer.
    (i) In general.
    (ii) Disclosure of transfers of property subject to liabilities 
incurred within two years of the transfer.
    (b) Treatment of debt-financed transfers of consideration by 
partnerships.
    (1) In general.
    (2) Partner's allocable share of liability.
    (i) In general.
    (ii) Debt-financed transfers made pursuant to a plan.
    (A) In general.
    (B) Special rule.
    (iii) Reduction of partner's share of liability.
    (c) Refinancings.
    (d) Share of liability where assumption accompanied by transfer of 
money.
    (e) Tiered partnerships and other related persons.
    (f) Examples.

  Sec. 1.707-6 Disguised Sales of Property by Partnership to Partner; 
                              General Rules

    (a) In general.
    (b) Special rules relating to liabilities.
    (1) In general.
    (2) Qualified liabilities.
    (c) Disclosure rules.
    (d) Examples.

   Sec. 1.707-7 Disguised Sales of Partnership Interests. [Reserved]

             Sec. 1.707-8 Disclosure of Certain Information

    (a) In general.
    (b) Method of providing disclosure.
    (c) Disclosure by certain partnerships.

          Sec. 1.707-9 Effective Dates and Transitional Rules

    (a) Sections 1.707-3 through 1.707-6.
    (1) In general.
    (2) Transfers occurring on or before April 24, 1991.
    (3) Effective date of section 73 of the Tax Reform Act of 1984.
    (b) Section 1.707-8 disclosure of certain information.

[T.D. 8439, 57 FR 44978, Sept. 30, 1992]

[[Page 565]]



Sec. 1.707-1  Transactions between partner and partnership.

    (a) Partner not acting in capacity as partner. A partner who engages 
in a transaction with a partnership other than in his capacity as a 
partner shall be treated as if he were not a member of the partnership 
with respect to such transaction. Such transactions include, for 
example, loans of money or property by the partnership to the partner or 
by the partner to the partnership, the sale of property by the partner 
to the partnership, the purchase of property by the partner from the 
partnership, and the rendering of services by the partnership to the 
partner or by the partner to the partnership. Where a partner retains 
the ownership of property but allows the partnership to use such 
separately owned property for partnership purposes (for example, to 
obtain credit or to secure firm creditors by guaranty, pledge, or other 
agreement) the transaction is treated as one between a partnership and a 
partner not acting in his capacity as a partner. However, transfers of 
money or property by a partner to a partnership as contributions, or 
transfers of money or property by a partnership to a partner as 
distributions, are not transactions included within the provisions of 
this section. In all cases, the substance of the transaction will govern 
rather than its form. See paragraph (c)(3) of Sec. 1.731-1.
    (b) Certain sales or exchanges of property with respect to 
controlled partnerships--(1) Losses disallowed. (i) No deduction shall 
be allowed for a loss on a sale or exchange of property (other than an 
interest in the partnership, directly or indirectly, between a 
partnership and a partner who owns, directly or indirectly, more than 50 
percent of the capital interest or profits interest in such partnership. 
A loss on a sale or exchange of property, directly or indirectly, 
between two partnerships in which the same persons own, directly or 
indirectly, more than 50 percent of the capital interest or profits 
interest in each partnership shall not be allowed.
    (ii) If a gain is realized upon the subsequent sale or exchange by a 
transferee of property with respect to which a loss was disallowed under 
the provisions of subdivision (i) of this subparagraph, section 267(d) 
(relating to amount of gain where loss previously disallowed) shall 
apply as though the loss were disallowed under section 267(a)(1).
    (2) Gains treated as ordinary income. Any gain recognized upon the 
sale or exchange, directly or indirectly, of property which, in the 
hands of the transferee immediately after the transfer, is property 
other than a capital asset, as defined in section 1221, shall be 
ordinary income if the transaction is between a partnership and a 
partner who owns, directly or indirectly, more than 80 percent of the 
capital interest or profits interest in the partnership. This rule also 
applies where such a transaction is between partnerships in which the 
same persons own, directly or indirectly, more than 80 percent of the 
capital interest or profits interest in each partnership. The term 
property other than a capital asset includes (but is not limited to) 
trade accounts receivable, inventory, stock in trade, and depreciable or 
real property used in the trade or business.
    (3) Ownership of a capital or profits interest. In determining the 
extent of the ownership by a partner, as defined in section 761(b), of 
his capital interest or profits interest in a partnership, the rules for 
constructive ownership of stock provided in section 267(c) (1), (2), 
(4), and (5) shall be applied for the purpose of section 707(b) and this 
paragraph. Under these rules, ownership of a capital or profits interest 
in a partnership may be attributed to a person who is not a partner as 
defined in section 761(b) in order that another partner may be 
considered the constructive owner of such interest under section 267(c). 
However, section 707(b)(1)(A) does not apply to a constructive owner of 
a partnership interest since he is not a partner as defined in section 
761(b). For example, where trust T is a partner in the partnership ABT, 
and AW, A's wife, is the sole beneficiary of the trust, the ownership of 
a capital and profits interest in the partnership by T will be 
attributed to AW only for the purpose of further attributing the 
ownership of such interest to A. See section 267(c) (1) and (5). If A, 
B, and T are

[[Page 566]]

equal partners, then A will be considered as owning more than 50 percent 
of the capital and profits interest in the partnership, and losses on 
transactions between him and the partnership will be disallowed by 
section 707(b)(1)(A). However, a loss sustained by AW on a sale or 
exchange of property with the partnership would not be disallowed by 
section 707, but will be disallowed to the extent provided in paragraph 
(b) of Sec. 1.267(b)-1. See section 267 (a) and (b), and the 
regulations thereunder.
    (c) Guaranteed payments. Payments made by a partnership to a partner 
for services or for the use of capital are considered as made to a 
person who is not a partner, to the extent such payments are determined 
without regard to the income of the partnership. However, a partner must 
include such payments as ordinary income for his taxable year within or 
with which ends the partnership taxable year in which the partnership 
deducted such payments as paid or accrued under its method of 
accounting. See section 706(a) and paragraph (a) of Sec. 1.706-1. 
Guaranteed payments are considered as made to one who is not a member of 
the partnership only for the purposes of section 61(a) (relating to 
gross income) and section 162(a) (relating to trade or business 
expenses). For a guaranteed payment to be a partnership deduction, it 
must meet the same tests under section 162(a) as it would if the payment 
had been made to a person who is not a member of the partnership, and 
the rules of section 263 (relating to capital expenditures) must be 
taken into account. This rule does not affect the deductibility to the 
partnership of a payment described in section 736(a)(2) to a retiring 
partner or to a deceased partner's successor in interest. Guaranteed 
payments do not constitute an interest in partnership profits for 
purposes of sections 706(b)(3), 707(b), and 708(b). For the purposes of 
other provisions of the internal revenue laws, guaranteed payments are 
regarded as a partner's distributive share of ordinary income. Thus, a 
partner who receives guaranteed payments for a period during which he is 
absent from work because of personal injuries or sickness is not 
entitled to exclude such payments from his gross income under section 
105(d). Similarly, a partner who receives guaranteed payments is not 
regarded as an employee of the partnership for the purposes of 
withholding of tax at source, deferred compensation plans, etc. The 
provisions of this paragraph may be illustrated by the following 
examples:

    Example 1. Under the ABC partnership agreement, partner A is 
entitled to a fixed annual payment of $10,000 for services, without 
regard to the income of the partnership. His distributive share is 10 
percent. After deducting the guaranteed payment, the partnership has 
$50,000 ordinary income. A must include $15,000 as ordinary income for 
his taxable year within or with which the partnership taxable year ends 
($10,000 guaranteed payment plus $5,000 distributive share).
    Example 2. Partner C in the CD partnership is to receive 30 percent 
of partnership income as determined before taking into account any 
guaranteed payments, but not less than $10,000. The income of the 
partnership is $60,000, and C is entitled to $18,000 (30 percent of 
$60,000) as his distributive share. No part of this amount is a 
guaranteed payment. However, if the partnership had income of $20,000 
instead of $60,000, $6,000 (30 percent of $20,000) would be partner C's 
distributive share, and the remaining $4,000 payable to C would be a 
guaranteed payment.
    Example 3. Partner X in the XY partnership is to receive a payment 
of $10,000 for services, plus 30 percent of the taxable income or loss 
of the partnership. After deducting the payment of $10,000 to partner X, 
the XY partnership has a loss of $9,000. Of this amount, $2,700 (30 
percent of the loss) is X's distributive share of partnership loss and, 
subject to section 704(d), is to be taken into account by him in his 
return. In addition, he must report as ordinary income the guaranteed 
payment of $10,000 made to him by the partnership.
    Example 4. Assume the same facts as in example 3 of this paragraph, 
except that, instead of a $9,000 loss, the partnership has $30,000 in 
capital gains and no other items of income or deduction except the 
$10,000 paid X as a guaranteed payment. Since the items of partnership 
income or loss must be segregated under section 702(a), the partnership 
has a $10,000 ordinary loss and $30,000 in capital gains. X's 30 percent 
distributive shares of these amounts are $3,000 ordinary loss and $9,000 
capital gain. In addition, X has received a $10,000 guaranteed payment 
which is ordinary income to him.

[T.D. 6500, 25 FR 11814, Nov. 26, 1960, as amended by T.D. 7891, 48 FR 
20049, May 4, 1983]

[[Page 567]]



Sec. 1.707-2  Disguised payments for services. [Reserved]



Sec. 1.707-3  Disguised sales of property to partnership; general
rules.

    (a) Treatment of transfers as a sale--(1) In general. Except as 
otherwise provided in this section, if a transfer of property by a 
partner to a partnership and one or more transfers of money or other 
consideration by the partnership to that partner are described in 
paragraph (b)(1) of this section, the transfers are treated as a sale of 
property, in whole or in part, to the partnership.
    (2) Definition and timing of sale. For purposes of Sec. Sec. 1.707-
3 through 1.707-5, the use of the term sale (or any variation of that 
word) to refer to a transfer of property by a partner to a partnership 
and a transfer of consideration by a partnership to a partner means a 
sale or exchange of that property, in whole or in part, to the 
partnership by the partner acting in a capacity other than as a member 
of the partnership, rather than a contribution and distribution to which 
sections 721 and 731, respectively, apply. A transfer that is treated as 
a sale under paragraph (a)(1) this section is treated as a sale for all 
purposes of the Internal Revenue Code (e.g., sections 453, 483, 1001, 
1012, 1031 and 1274). The sale is considered to take place on the date 
that, under general principles of Federal tax law, the partnership is 
considered the owner of the property. If the transfer of money or other 
consideration from the partnership to the partner occurs after the 
transfer of property to the partnership; the partner and the partnership 
are treated as if, on the date of the sale, the partnership transferred 
to the partner an obligation to transfer to the partner money or other 
consideration.
    (3) Application of disguised sale rules. If a person purports to 
transfer property to a partnership in a capacity as a partner, the rules 
of this section apply for purposes of determining whether the property 
was transferred in a disguised sale, even if it is determined after the 
application of the rules of this section that such person is not a 
partner. If after the application of the rules of this section to a 
purported transfer of property to a partnership, it is determined that 
no partnership exists because the property was actually sold, or it is 
otherwise determined that the contributed property is not owned by the 
partnership for tax purposes, the transferor of the property is treated 
as having sold the property to the person (or persons) that acquired 
ownership of the property for tax purposes.
    (4) Deemed terminations under section 708. In applying the rules of 
this section, transfers resulting from a termination of a partnership 
under section 708(b)(1)(B) are disregarded.
    (b) Transfers treated as a sale--(1) In general. A transfer of 
property (excluding money or an obligation to contribute money) by a 
partner to a partnership and a transfer of money or other consideration 
(including the assumption of or the taking subject to a liability) by 
the partnership to the partner constitute a sale of property, in whole 
or in part, by the partner to the partnership only if based on all the 
facts and circumstances--
    (i) The transfer of money or other consideration would not have been 
made but for the transfer of property; and
    (ii) In cases in which the transfers are not made simultaneously, 
the subsequent transfer is not dependent on the entrepreneurial risks of 
partnership operations.
    (2) Facts and circumstances. The determination of whether a transfer 
of property by a partner to the partnership and a transfer of money or 
other consideration by the partnership to the partner constitute a sale, 
in whole or in part, under paragraph (b)(1) of this section is made 
based on all the facts and circumstances in each case. The weight to be 
given each of the facts and circumstances will depend on the particular 
case. Generally, the facts and circumstances existing on the date of the 
earliest of such transfers are the ones considered in determining 
whether a sale exists under paragraph (b)(1) of this section. Among the 
facts and circumstances that may tend to prove the existence of a sale 
under paragraph (b)(1) of this section are the following:
    (i) That the timing and amount of a subsequent transfer are 
determinable with reasonable certainty at the time of an earlier 
transfer;

[[Page 568]]

    (ii) That the transferor has a legally enforceable right to the 
subsequent transfer;
    (iii) That the partner's right to receive the transfer of money or 
other consideration is secured in any manner, taking into account the 
period during which it is secured;
    (iv) That any person has made or is legally obligated to make 
contributions to the partnership in order to permit the partnership to 
make the transfer of money or other consideration;
    (v) That any person has loaned or has agreed to loan the partnership 
the money or other consideration required to enable the partnership to 
make the transfer, taking into account whether any such lending 
obligation is subject to contingencies related to the results of 
partnership operations;
    (vi) That a partnership has incurred or is obligated to incur debt 
to acquire the money or other consideration necessary to permit it to 
make the transfer, taking into account the likelihood that the 
partnership will be able to incur that debt (considering such factors as 
whether any person has agreed to guarantee or otherwise assume personal 
liability for that debt);
    (vii) That the partnership holds money or other liquid assets, 
beyond the reasonable needs of the business, that are expected to be 
available to make the transfer (taking into account the income that will 
be earned from those assets);
    (viii) That partnership distributions, allocation or control of 
partnership operations is designed to effect an exchange of the burdens 
and benefits of ownership of property;
    (ix) That the transfer of money or other consideration by the 
partnership to the partner is disproportionately large in relationship 
to the partner's general and continuing interest in partnership profits; 
and
    (x) That the partner has no obligation to return or repay the money 
or other consideration to the partnership, or has such an obligation but 
it is likely to become due at such a distant point in the future that 
the present value of that obligation is small in relation to the amount 
of money or other consideration transferred by the partnership to the 
partner.
    (c) Transfers made within two years presumed to be a sale--(1) In 
general. For purposes of this section, if within a two-year period a 
partner transfers property to a partnership and the partnership 
transfers money or other consideration to the partner (without regard to 
the order of the transfers), the transfers are presumed to be a sale of 
the property to the partnership unless the facts and circumstances 
clearly establish that the transfers do not constitute a sale.
    (2) Disclosure of transfers made within two years. Disclosure to the 
Internal Revenue Service in accordance with Sec. 1.707-8 is required 
if--
    (i) A partner transfers property to a partnership and the 
partnership transfers money or other consideration to the partner with a 
two-year period (without regard to the order of the transfers);
    (ii) The partner treats the transfers other than as a sale for tax 
purposes; and
    (iii) The transfer of money or other consideration to the partner is 
not presumed to be a guaranteed payment for capital under Sec. 1.707-
4(a)(1)(ii), is not a reasonable preferred return within the meaning of 
Sec. 1.707-4(a)(3), and is not an operating cash flow distribution 
within the meaning of Sec. 1.707-4(b)(2).
    (d) Transfers made more than two years apart presumed not to be a 
sale. For purposes of this section, if a transfer of money or other 
consideration to a partner by a partnership and the transfer of property 
to the partnership by that partner are more than two years apart, the 
transfers are presumed not to be a sale of the property to the 
partnership unless the facts and circumstances clearly establish that 
the transfers constitute a sale.
    (e) Scope. This section and Sec. Sec. 1.707-4 through 1.707-9 apply 
to contributions and distributions of property described in section 
707(a)(2)(A) and transfers described in section 707(a)(2)(B) of the 
Internal Revenue Code.
    (f) Examples. The following examples illustrate the application of 
this section.


[[Page 569]]


    Example 1. Treatment of simultaneous transfers as a sale. A 
transfers property X to partnership AB on April 9, 1992, in exchange for 
an interest in the partnership. At the time of the transfer, property X 
has a fair market value of $4,000,000 and an adjusted tax basis of 
$1,200,000. Immediately after the transfer, the partnership transfers 
$3,000,000 in cash to A. Assume that, under this section, the 
partnership's transfer of cash to A is treated as part of a sale of 
property X to the partnership. Because the amount of cash A receives on 
April 9, 1992, does not equal the fair market value of the property, A 
is considered to have sold a portion of property X with a value of 
$3,000,000 to the partnership in exchange for the cash. Accordingly, A 
must recognize $2,100,000 of gain ($3,000,000 amount realized less 
$900,000 adjusted tax basis ($1,200,000 multiplied by $3,000,000/
$4,000,000)). Assuming A receives no other transfers that are treated as 
consideration for the sale of the property under this section, A is 
considered to have contributed to the partnership, in A's capacity as a 
partner, $1,000,000 of the fair market value of the property with an 
adjusted tax basis of $300,000.
    Example 2. Treatment of transfers at different times as a sale. (i) 
The facts are the same as in Example 1, except that the $3,000,000 is 
transferred to A one year after A's transfer of property X to the 
partnership. Assume that under this section the partnership's transfer 
of cash to A is treated as part of a sale of property X to the 
partnership. Assume also that the applicable Federal short-term rate for 
April, 1992, is 10 percent, compounded semiannually.
    (ii) Under paragraph (a)(2) of this section, A and the partnership 
are treated as if, on April 9, 1992, A sold a portion of property X to 
the partnership in exchange for an obligation to transfer $3,000,000 to 
A one year later. Section 1274 applies to this obligation because it 
does not bear interest and is payable more than six months after the 
date of the sale. As a result, A's amount realized from the receipt of 
the partnership's obligation will be the imputed principal amount of the 
partnership's obligation to transfer $3,000,000 to A, which equals 
$2,721,088 (the present value on April 9, 1992, of a $3,000,000 payment 
due one year later, determined using a discount rate of 10 percent, 
compounded semiannually). Therefore, A's amount realized from the 
receipt of the partnership's obligation is $2,721,088 (without regard to 
whether the sale is reported under the installment method). A is 
therefore considered to have sold only $2,721,088 of the fair market 
value of property X. The remainder of the $3,000,000 payment ($278,912) 
is characterized in accordance with the provisions of section 1272. 
Accordingly, A must recognize $1,904,761 of gain ($2,721,088 amount 
realized less $816,327 adjusted tax basis ($1,200,000 multiplied by 
$2,721,088/$4,000,000)) on the sale of property X to the partnership. 
The gain is reportable under the installment method of section 453 if 
the sale is otherwise eligible. Assuming A receives no other transfers 
that are treated as consideration for the sale of property under this 
section, A is considered to have contributed to the partnership, in A's 
capacity as a partner, $1,278,912 of the fair market value of property X 
with an adjusted tax basis of $383,673.
    Example 3. Operation of presumption for transfers within two years. 
(i) C transfers undeveloped land to the CD partnership in exchange for 
an interest in the partnership. The partnership intends to construct a 
building on the land. At the time the land is transferred to the 
partnership, it is unencumbered and has an adjusted tax basis of 
$500,000 and a fair market value of $1,000,000. The partnership 
agreement provides that upon completing construction of the building the 
partnership will distribute $900,000 to C.
    (ii) If, within two years of C's transfer of land to the 
partnership, a transfer is made to C pursuant to the provision requiring 
a distribution upon completion of the building, the transfer is presumed 
to be, under paragraph (c) of this section, part of a sale of the land 
to the partnership. C may rebut the presumption that the transfer is 
part of a sale if the facts and circumstances clearly establish that--
    (A) The transfer to C would have been made without regard to C's 
transfer of land to the partnership; or
    (B) The partnership's obligation or ability to make this transfer to 
C depends, at the time of the transfer to the partnership, on the 
entrepreneurial risks of partnership operations.
    (iii) For example, if the partnership will be able to fund the 
transfer of cash to C only to the extent that permanent loan proceeds 
exceed the cost of constructing the building, the fact that excess 
permanent loan proceeds will be available only if the cost to complete 
the building is significantly less than the amount projected by a 
reasonable budget would be evidence that the transfer to C is not part 
of a sale. Similarly, a condition that limits the amount of the 
permanent loan to the cost of constructing the building (and thereby 
limits the partnership's ability to make a transfer to C) unless all or 
a substantial portion of the building is leased would be evidence that 
the transfer to C is not part of a sale, if a significant risk exists 
that the partnership may not be able to lease the building to that 
extent. Another factor that may prove that the transfer of cash to C is 
not part of a sale would be that, at the time the land is transferred to 
the partnership, no lender has committed to make a permanent loan to 
fund the transfer of cash to C.

[[Page 570]]

    (iv) Facts indicating that the transfer of cash to C is not part of 
a sale, however, may be offset by other factors. An offsetting factor to 
restrictions on the permanent loan proceeds may be that the permanent 
loan is to be a recourse loan and certain conditions to the loan are 
likely to be waived by the lender because of the creditworthiness of the 
partners or the value of the partnership's other assets. Similarly, the 
factor that no lender has committed to fund the transfer of cash to C 
may be offset by facts establishing that the partnership is obligated to 
attempt to obtain such a loan and that its ability to obtain such a loan 
is not significantly dependent on the value that will be added by 
successful completion of the building, or that the partnership 
reasonably anticipates that it will have (and will utilize) an 
alternative source to fund the transfer of cash to C if the permanent 
loan proceeds are inadequate.
    Example 4. Operation of presumption for transfers within two years. 
E is a partner in the equal EF partnership. The partnership owns two 
parcels of unimproved real property (parcels 1 and 2). Parcels 1 and 2 
are unencumbered. Parcel 1 has a fair market value of $500,000, and 
parcel 2 has a fair market value of $1,500,000. E transfers additional 
unencumbered, unimproved real property (parcel 3) with a fair market 
value of $1,000,000 to the partnership in exchange for an increased 
interest in partnership profits of 66\2/3\ percent. Immediately after 
this transfer, the partnership sells parcel 1 for $500,000 in a 
transaction not in the ordinary course of business. The partnership 
transfers the proceeds of the sale $333,333 to E and $166,667 to F in 
accordance with their respective partnership interests. The transfer of 
$333,333 to E is presumed to be, in accordance with paragraph (c) of 
this section, a sale, in part, of parcel 3 to the partnership. However, 
the facts of this example clearly establish that $250,000 of the 
transfer to E is not part of a sale of parcel 3 to the partnership 
because E would have been distributed $250,000 from the sale of parcel 1 
whether or not E had transferred parcel 3 to the partnership. The 
transfer to E exceeds by $83,333 ($333,333 minus $250,000) the amount of 
the distribution that would have been made to E if E had not transferred 
parcel 3 to the partnership. Therefore, $83,333 of the transfer is 
presumed to be part of a sale of a portion of parcel 3 to the 
partnership by E.
    Example 5. Operation of presumption for transfers more than two 
years apart. (i) G transfers undeveloped land to the GH partnership in 
exchange for an interest in the partnership. At the time the land is 
transferred to the partnership, it is unencumbered and has an adjusted 
tax basis of $500,000 and a fair market value of $1,000,000. H 
contributes $1,000,000 in cash in exchange for an interest in the 
partnership. Under the partnership agreement, the partnership is 
obligated to construct a building on the land. The projected 
construction cost is $5,000,000, which the partnership plans to fund 
with its $1,000,000 in cash and the proceeds of a construction loan 
secured by the land and improvements.
    (ii) Shortly before G's transfer of the land to the partnership, the 
partnership secures commitments from lending institutions for 
construction and permanent financing. To obtain the construction loan, H 
guarantees completion of the building for a cost of $5,000,000. The 
partnership is not obligated to reimburse or indemnify H if H must make 
payment on the completion guarantee. The permanent loan will be funded 
upon completion of the building, which is expected to occur two years 
after G's transfer of the land. The amount of the permanent loan is to 
equal the lesser of $5,000,000 or 80 percent of the appraised value of 
the improved property at the time the permanent loan is closed. Under 
the partnership agreement, the partnership is obligated to apply the 
proceeds of the permanent loan to retire the construction loan and to 
hold any excess proceeds for transfer to G 25 months after G's transfer 
of the land to the partnership. The appraised value of the improved 
property at the time the permanent loan is closed is expected to exceed 
$5,000,000 only if the partnership is able to lease a substantial 
portion of the improvements by that time, and there is a significant 
risk that the partnership will not be able to achieve a satisfactory 
occupancy level. The partnership completes construction of the building 
for the projected cost of $5,000,000 approximately two years after G's 
transfer of the land. Shortly thereafter, the permanent loan is funded 
in the amount of $5,000,000. At the time of funding the land and 
building have an appraised value of $7,000,000. The partnership 
transfers the $1,000,000 excess permanent loan proceeds to G 25 months 
after G's transfer of the land to the partnership.
    (iii) G's transfer of the land to the partnership and the 
partnership's transfer of $1,000,000 to G occurred more than two years 
apart. In accordance with paragraph (d) of this section, those transfers 
are presumed not to be a sale unless the facts and circumstances clearly 
establish that the transfers constitute a sale of the property, in whole 
or part, to the partnership. The transfer of $1,000,000 to G would not 
have been made but for G's transfer of the land to the partnership. In 
addition, at the time G transferred the land to the partnership, G had a 
legally enforceable right to receive a transfer from the partnership at 
a specified time an amount that equals the excess of the permanent loan 
proceeds over $4,000,000. In this case, however, there was a significant 
risk that the appraised value of the property would be insufficient to 
support a permanent

[[Page 571]]

loan in excess of $4,000,000 because of the risk that the partnership 
would not be able to achieve a sufficient occupancy level. Therefore, 
the facts of this example indicate that at the time G transferred the 
land to the partnership the subsequent transfer of $1,000,000 to G 
depended on the entrepreneurial risks of partnership operations. 
Accordingly, G's transfer of the land to the partnership is not treated 
as part of a sale.
    Example 6. Rebuttal of presumption for transfers more than two years 
apart. The facts are the same as in Example 5, except that the 
partnership is able to secure a commitment for a permanent loan in the 
amount of $5,000,000 without regard to the appraised value of the 
improved property at the time the permanent loan is funded. Under these 
facts, at the time that G transferred the land to the partnership the 
subsequent transfer of $1,000,000 to G was not dependent on the 
entrepreneurial risks of partnership operations, because during the 
period before the permanent loan is funded, the permanent lender's 
obligation to make a loan in the amount necessary to fund the transfer 
is not subject to the contingencies related to the risks of partnership 
operations, and after the permanent loan is funded, the partnership 
holds liquid assets sufficient to make the transfer. Therefore, the 
facts and circumstances clearly establish that G's transfer of the land 
to the partnership is part of a sale.
    Example 7. Operation of presumption for transfers more than two 
years apart. The facts are the same as in Example 6, except that H does 
not guarantee either that the improvements will be completed or that the 
cost to the partnership of completing the improvements will not exceed 
$5,000,000. Under these facts, if there is a significant risk that the 
improvements will not be completed, G's transfer of the land to the 
partnership will not be treated as part of a sale because the lender is 
required to make the permanent loan if the improvements are not 
completed. Similarly, the transfers will not be treated as a sale to the 
extent that there is a significant risk that the cost of constructing 
the improvements will exceed $5,000,000, because, in the absence of a 
guarantee of the cost of the improvements by H, the $5,000,000 proceeds 
of the permanent loan might not be sufficient to retire the construction 
loan and fund the transfer to G. In either case, the transfer of cash to 
G would be dependent on the entrepreneurial risks of partnership 
operations.
    Example 8. Rebuttal of presumption for transfers more than two years 
apart. (i) On February 1, 1992, I, J, and K form partnership IJK. On 
formation of the partnership, I transfers an unencumbered office 
building with a fair market value of $50,000,000 and an adjusted tax 
basis of $20,000,000 to the partnership, and J and K each transfer 
United States government securities with a fair market value and an 
adjusted tax basis of $25,000,000 to the partnership. Substantially all 
of the rentable space in the office building is leased on a long-term 
basis. The partnership agreement provides that all items of income, 
gain, loss, and deduction from the office building are to be allocated 
45 percent to J, 45 percent to K, and 10 percent to I. The partnership 
agreement also provides that all items of income, gain, loss, and 
deduction from the government securities are to be allocated 90 percent 
to I, 5 percent to J, and 5 percent to K. The partnership agreement 
requires that cash flow from the office building and government 
securities be allocated between partners in the same manner as the items 
of income, gain, loss, and deduction from those properties are allocated 
between them. The partnership agreement complies with the requirements 
of Sec. 1.704-1(b)(2)(ii)(b). It is not expected that the partnership 
will need to resort to the government securities or the cash flow 
therefrom to operate the office building. At the time the partnership is 
formed, I, J, and K contemplated that I's interest in the partnership 
would be liquidated sometime after January 31, 1994, in exchange for a 
transfer of the government securities and cash (if necessary). On March 
1, 1995, the partnership transfers cash and the government securities to 
I in liquidation of I's interest in the partnership. The cash 
transferred to I represents the excess of I's share of the appreciation 
in the office building since the formation of the partnership over J's 
and K's share of the appreciation in the government securities since 
they are acquired by the partnership.
    (ii) I's transfer of the office building to the partnership and the 
partnership's transfer of the government securities and cash to I 
occurred more than two years apart. Therefore, those transfers are 
presumed not to be a sale unless the facts and circumstances clearly 
establish that the transfers constitute a sale. Absent I's transfer of 
the office building to the partnership, I would not have received the 
government securities from the partnership. The facts including the 
amount and nature of partnership assets) indicate that, at the time that 
I transferred the office building to the partnership, the timing of the 
transfer of the government securities to I was anticipated and was not 
dependent on the entrepreneurial risks of partnership operations. 
Moreover, the facts indicate that the partnership allocations were 
designed to effect an exchange of the burdens and benefits of ownership 
of the government securities in anticipation of the transfer of those 
securities to I and those burdens and benefits were effectively shifted 
to I on formation of the partnership. Accordingly, the facts and 
circumstances clearly establish that I sold

[[Page 572]]

the office building to the partnership on February 1, 1992, in exchange 
for the partnership's obligation to transfer the government securities 
to I and to make certain other cash transfers to I.

[T.D. 8439, 57 FR 44978, Sept. 30, 1992]



Sec. 1.707-4  Disguised sales of property to partnership; special
rules applicable to guaranteed payments, preferred returns, 
operating cash flow distributions, and reimbursements of preformation 
expenditures.

    (a) Guaranteed payments and preferred returns--(1) Guaranteed 
payment not treated as part of a sale--(i) In general. A guaranteed 
payment for capital made to a partner is not treated as part of a sale 
of property under Sec. 1.707-3(a) (relating to treatment of transfers 
as a sale). A party's characterization of a payment as a guaranteed 
payment for capital will not control in determining whether a payment 
is, in fact, a guaranteed payment for capital. The term guaranteed 
payment for capital means any payment to a partner by a partnership that 
is determined without regard to partnership income and is for the use of 
that partner's capital. See section 707(c). For this purpose, one or 
more payments are not made for the use of a partner's capital if the 
payments are designed to liquidate all or part of the partner's interest 
in property contributed to the partnership rather than to provide the 
partner with a return on an investment in the partnership.
    (ii) Reasonable guaranteed payments. Notwithstanding the presumption 
set forth in Sec. 1.707-3(c) (relating to transfers made within two 
years of each other), for purposes of section 707(a)(2) and the 
regulations thereunder a transfer of money to a partner that is 
characterized by the parties as a guaranteed payment for capital, is 
determined without regard to the income of the partnership and is 
reasonable (within the meaning of paragraph (a)(3) of this section) is 
presumed to be a guaranteed payment for capital unless the facts and 
circumstances clearly establish that the transfer is not a guaranteed 
payment for capital and is part of a sale.
    (iii) Unreasonable guaranteed payments. A transfer of money to a 
partner that is characterized by the parties as a guaranteed payment for 
capital but that is not reasonable (within the meaning of paragraph 
(a)(3) of this section) is presumed not to be a guaranteed payment for 
capital unless the facts and circumstances clearly establish that the 
transfer is a guaranteed payment for capital. A transfer that is not a 
guaranteed payment for capital is subject to the rules of Sec. 1.707-3.
    (2) Presumption regarding reasonable preferred returns. 
Notwithstanding the presumption set forth in Sec. 1.707-3(c) (relating 
to transfers made within two years of each other), a transfer of money 
to a partner that is characterized by the parties as a preferred return 
and that is reasonable (within the meaning of paragraph (a)(3) of this 
section) is presumed not to be part of a sale of property to the 
partnership unless the facts and circumstances (including the likelihood 
and expected timing of the subsequent allocation of income or gain to 
support the preferred return) clearly establish that the transfer is 
part of a sale. The term preferred return means a preferential 
distribution of partnership cash flow to a partner with respect to 
capital contributed to the partnership by the partner that will be 
matched, to the extent available, by an allocation of income or gain.
    (3) Definition of reasonable preferred returns and guaranteed 
payments--(i) In general. A transfer of money to a partner that is 
characterized as a preferred return or guaranteed payment for capital is 
reasonable only to the extent that the transfer is made to the partner 
pursuant to a written provision of a partnership agreement that provides 
for payment for the use of capital in a reasonable amount, and only to 
the extent that the payment is made for the use of capital after the 
date on which that provision is added to the partnership agreement.
    (ii) Reasonable amount. A transfer of money that is made to a 
partner during any partnership taxable year and is characterized as a 
preferred return or guaranteed payment for capital is reasonable in 
amount if the sum of any preferred return and any guaranteed payment for 
capital that is payable for that year does not exceed the amount 
determined by multiplying either the

[[Page 573]]

partner's unreturned capital at the beginning of the year or, at the 
partner's option, the partner's weighted average capital balance for the 
year (with either amount appropriately adjusted, taking into account the 
relevant compounding periods, to reflect any unpaid preferred return or 
guaranteed payment for capital that is payable to the partner) by the 
safe harbor interest rate for that year. The safe harbor interest rate 
for a partnership's taxable year equals 150 percent of the highest 
applicable Federal rate, at the appropriate compounding period or 
periods, in effect at any time from the time that the right to the 
preferred return or guaranteed payment for capital is first established 
pursuant to a binding, written agreement among the partners through the 
end of the taxable year. A partner's unreturned capital equals the 
excess of the aggregate amount of money and the fair market value of 
other consideration (net of liabilities) contributed by the partner to 
the partnership over the aggregate amount of money and the fair market 
value of other consideration (net of liabilities) distributed by the 
partnership to the partner other than transfers of money that are 
presumed to be guaranteed payments for capital under paragraph 
(a)(1)(ii) of this section, transfers of money that are reasonable 
preferred returns within the meaning of this paragraph (a)(3), and 
operating cash flow distributions within the meaning of paragraph (b)(2) 
of this section.
    (4) Examples. The following examples illustrate the application of 
paragraph (a) of this section:

    Example 1. Transfer presumed to be a guaranteed payment. (i) A 
transfers property with a fair market value of $100,000 to partnership 
AB. At the time of A's transfer, the partnership agreement is amended to 
provide that A is to receive a guaranteed payment for the use of A's 
capital of 10 percent (compounded annually) of the fair market value of 
the transferred property in each of the three years following the 
transfer. The partnership agreement provides that partnership net 
taxable income and loss will be allocated equally between partners A and 
B, and that partnership cash flow will be distributed in accordance with 
the allocation of partnership net taxable income and loss. The 
partnership would be allowed a deduction in the year paid if the 
transfers made to A are treated as guaranteed payments under section 
707(c). Under the partnership agreement, that deduction would be 
allocated in the same manner as any other item of partnership deduction. 
The partnership agreement complies with the requirements of Sec. 1.704-
1(b)(2)(ii)(b). The partnership agreement does not provide for the 
payment of a preferred return and, other than the guaranteed payment to 
be paid to A, no transfer is expected to be made during the three year 
period following A's transfer that is not an operating cash flow 
distribution (within the meaning of paragraph (b)(2) of this section). 
Assume that the highest applicable Federal rate in effect at the time of 
A's transfer is eight percent compounded annually.
    (ii) The transfer of money to be made to A under the partnership 
agreement is characterized by the parties as a guaranteed payment for 
capital and is determined without regard to the income of the 
partnership. The transfer is also reasonable within the meaning of Sec. 
1.707-4(a)(3). The transfer, therefore, is presumed to be a guaranteed 
payment for capital. The presumption set forth in Sec. 1.707-3(c) 
(relating to transfers made within two years of each other) thus does 
not apply to this transfer. The transfer will not be treated as part of 
a sale of property to the partnership unless the facts and circumstances 
clearly establish that the transfer is not a guaranteed payment for 
capital but is part of a sale.
    (iii) The presumption that the transfer is a guaranteed payment for 
capital is not rebutted, because there are no facts indicating that the 
transfer is not a guaranteed payment for the use of capital.
    Example 2. Transfers characterized as guaranteed payments treated as 
part of a sale. (i) C and D form partnership CD. C transfers property 
with a fair market value of $100,000 and an adjusted tax basis of 
$20,000 in exchange for a partnership interest. D is responsible for 
managing the day-to-day operations of the partnership and makes no 
capital contribution to the partnership upon its formation. The 
partnership agreement provides that C is to receive payments 
characterized as guaranteed payments and determined without regard to 
partnership income of $8,333 per year for the first four years of 
partnership operations for the use of C's capital. In addition, the 
partnership agreement provides that--
    (A) Partnership net taxable income and loss will be allocated 75 
percent to C and 25 percent to D; and
    (B) All partnership cash flow (determined prior to consideration of 
the guaranteed payment) will be distributed 75 percent to C and 25 
percent to D except that guaranteed payments that the partnership is 
obligated to make to C are payable solely out of D's share of the 
partnership's cash flow.
    (ii) If D's share of the partnership's cash flow is not sufficient 
to make the guaranteed

[[Page 574]]

payment to C, then D is obligated to contribute any shortfall to the 
partnership, even in the event the partnership is liquidated. Thus, the 
effect of the guaranteed payment arrangement is that the guaranteed 
payment to C is funded entirely by D. The partnership agreement complies 
with the requirements of Sec. 1.704-1(b)(2)(ii)(b). Assume that, at the 
time the partnership is formed, the partnership or D could borrow 
$25,000 pursuant to a loan requiring equal payments of principal and 
interest over a four-year term at the current market interest rate of 
approximately 12 percent (compounded annually). Assume that the highest 
applicable Federal rate in effect at the time the partnership is formed 
is 10 percent compounded annually.
    (iii) The transfer of money to be made to C under the partnership 
agreement is characterized by the parties as a guaranteed payment for 
capital and is determined without regard to the income of the 
partnership. The transfer is also reasonable within the meaning of Sec. 
1.707-4(a)(3). The transfer, therefore, is presumed to be a guaranteed 
payment for capital. The presumption set forth in Sec. 1.707-3(c) 
(relating to transfers made within two years of each other) thus does 
not apply to this transfer. The transfer will not be treated as part of 
a sale of property to the partnership unless the facts and circumstances 
clearly establish that the transfer is not a guaranteed payment for 
capital and is part of a sale.
    (iv) For the first four years of partnership operations, the total 
guaranteed payments made to C under the partnership agreement will equal 
$33,332. If the characterization of those payments as guaranteed 
payments for capital within the meaning of section 707(c) were 
respected, C would be allocated $24,999 of the deductions that would be 
claimed by the partnership for those payments, thereby leaving the 
balance in C's capital account approximately $25,000 less than it would 
have been if the guaranteed payments had not been made. The guaranteed 
payments thus have the effect of offsetting approximately $25,000 of the 
credit made to C's capital account for the property transferred to the 
partnership by C. C's resulting capital account is approximately 
equivalent to the capital account C would have had if C had only 
contributed 75 percent of the property to the partnership. Furthermore, 
the effect of D's funding the guaranteed payment to C (either through 
reduced distributions of cash flow to D or additional contributions) is 
that D's capital account is approximately equivalent to the capital 
account D would have had if D had contributed 25 percent of the property 
(or contributed cash so that the partnership could purchase the 25 
percent). Moreover, a $25,000 loan requiring equal payments of principal 
and interest over a four-year term at the current market interest rate 
of 12 percent (compounded annually), would have resulted in annual 
payments of principal and interest of $8,230.86. Consequently, the 
guaranteed payments effectively place the partners in the same economic 
position that they would have been in had D purchased a one-quarter 
interest in the property from C financed at the current market rate of 
interest, and then C and D each contributed their share of the property 
to the partnership. In view of the burden the guaranteed payments place 
on D's right to transfers of partnership cash flow and D's legal 
obligation to make contributions to the partnership to the extent 
necessary to fund the guaranteed payments, D has effectively purchased 
through the partnership a one-quarter interest in the property from C.
    (v) Under these facts, the presumption that the transfers to C are 
guaranteed payments for capital is rebutted, because the facts and 
circumstances clearly establish that the transfers are part of a sale 
and not guaranteed payments for capital. Under Sec. 1.707-3(a), C and 
the partnership are treated as if C sold a one-quarter interest in the 
property to the partnership in exchange for a promissory note evidencing 
the partnership's obligation to make the guaranteed payments.

    (b) Presumption regarding operating cash flow distributions--(1) In 
general. Notwithstanding the presumption set forth in Sec. 1.707-3(c) 
(relating to transfers made within two years of each other), an 
operating cash flow distribution is presumed not to be part of a sale of 
property to the partnership unless the facts and circumstances clearly 
establish that the transfer is part of a sale.
    (2) Operating cash flow distributions--(i) In general. One or more 
transfers of money by the partnership to a partner during a taxable year 
of the partnership are operating cash flow distributions for purposes of 
paragraph (b)(1) of this section to the extent that those transfers are 
not presumed to be guaranteed payments for capital under paragraph 
(a)(1)(ii) of this section, are not reasonable preferred returns within 
the meaning of paragraph (a)(3) of this section, are not characterized 
by the parties as distributions to the partner acting in a capacity 
other than as a partner, and to the extent they do not exceed the 
product of the net cash flow of the partnership from operations for the 
year multiplied by the lesser of the partner's percentage interest in 
overall partnership profits for that year or the partner's percentage 
interest in overall partnership profits for the life of the

[[Page 575]]

partnership. For purposes of the preceding sentence, the net cash flow 
of the partnership from operations for a taxable year is an amount equal 
to the taxable income or loss of the partnership arising in the ordinary 
course of the partnership's business and investment activities, 
increased by tax exempt interest, depreciation, amortization, cost 
recovery allowances and other noncash charges deducted in determining 
such taxable income and decreased by--
    (A) Principal payments made on any partnership indebtedness;
    (B) Property replacement or contingency reserves actually 
established by the partnership;
    (C) Capital expenditures when made other than from reserves or from 
borrowings the proceeds of which are not included in operating cash 
flow; and
    (D) Any other cash expenditures (including preferred returns) not 
deducted in determining such taxable income or loss.
    (ii) Operating cash flow safe harbor. For any taxable year, in 
determining a partner's operating cash flow distributions for the year, 
the partner may use the partner's smallest percentage interest under the 
terms of the partnership agreement in any material item of partnership 
income or gain that may be realized by the partnership in the three-year 
period beginning with such taxable year. This provision is merely 
intended to provide taxpayers with a safe harbor and is not intended to 
preclude a taxpayer from using a different percentage under the rules of 
paragraph (b)(2)(i) of this section.
    (iii) Tiered partnerships. In the case of tiered partnerships, the 
upper-tier partnership must take into account its share of the net cash 
flow from operations of the lower-tier partnership applying principles 
similar to those described in paragraph (b)(2)(i) of this section, so 
that the amount of the upper-tier partnership's operating cash flow 
distributions is neither overstated nor understated.
    (c) Accumulation of guaranteed payments, preferred returns, and 
operating cash flow distributions. Guaranteed payments for capital, 
preferred returns, and operating cash flow distributions presumed not to 
be part of a sale under the rules of paragraphs (a) and (b) of this 
section do not lose the benefit of the presumption by reason of being 
retained for distribution in a later year.
    (d) Exception for reimbursements of preformation expenditures. A 
transfer of money or other consideration by the partnership to a partner 
is not treated as part of a sale of property by the partner to the 
partnership under Sec. 1.707-3(a) (relating to treatment of transfers 
as a sale) to the extent that the transfer to the partner by the 
partnership is made to reimburse the partner for, and does not exceed 
the amount of, capital expenditures that--
    (1) Are incurred during the two-year period preceding the transfer 
by the partner to the partnership; and
    (2) Are incurred by the partner with respect to--
    (i) Partnership organization and syndication costs described in 
section 709; or
    (ii) Property contributed to the partnership by the partner, but 
only to the extent the reimbursed capital expenditures do not exceed 20 
percent of the fair market value of such property at the time of the 
contribution. However, the 20 percent of fair market value limitation of 
this paragraph (d)(2)(ii) does not apply if the fair market value of the 
contributed property does not exceed 120 percent of the partner's 
adjusted basis in the contributed property at the time of contribution.
    (e) Other exceptions. The Commissioner may provide by guidance 
published in the Internal Revenue Bulletin that other payments or 
transfers to a partner are not treated as part of a sale for purposes of 
section 707(a)(2) and the regulations thereunder.

[T.D. 8439, 57 FR 44981, Sept. 30, 1992; 57 FR 56444, Nov. 30, 1992]



Sec. 1.707-5  Disguised sales of property to partnership; special
rules relating to liabilities.

    (a) Liability assumed or taken subject to by partnership--(1) In 
general. For purposes of this section and Sec. Sec. 1.707-3 and 1.707-
4, if a partnership assumes or takes property subject to a qualified 
liability (as defined in paragraph (a)(6) of this section) of a partner, 
the partnership is treated as transferring consideration to the partner 
only to the

[[Page 576]]

extent provided in paragraph (a)(5) of this section. By contrast, if the 
partnership assumes or takes property subject to a liability of the 
partner other than a qualified liability, the partnership is treated as 
transferring consideration to the partner to the extent that the amount 
of the liability exceeds the partner's share of that liability 
immediately after the partnership assumes or takes subject to the 
liability as provided in paragraphs (a) (2), (3) and (4) of this 
section.
    (2) Partner's share of liability. A partner's share of any liability 
of the partnership is determined under the following rules:
    (i) Recourse liability. A partner's share of a recourse liability of 
the partnership equals the partner's share of the liability under the 
rules of section 752 and the regulations thereunder. A partnership 
liability is a recourse liability to the extent that the obligation is a 
recourse liability under Sec. 1.752-1(a)(1) or would be treated as a 
recourse liability under that section if it were treated as a 
partnership liability for purposes of that section.
    (ii) Nonrecourse liability. A partner's share of a nonrecourse 
liability of the partnership is determined by applying the same 
percentage used to determine the partner's share of the excess 
nonrecourse liability under Sec. 1.752-3(a)(3). A partnership liability 
is a nonrecourse liability of the partnership to the extent that the 
obligation is a nonrecourse liability under Sec. 1.752-1(a)(2) or would 
be a nonrecourse liability of the partnership under Sec. 1.752-1(a)(2) 
if it were treated as a partnership liability for purposes of that 
section.
    (3) Reduction of partner's share of liability. For purposes of this 
section, a partner's share of a liability, immediately after a 
partnership assumes or takes subject to the liability, is determined by 
taking into account a subsequent reduction in the partner's share if--
    (i) At the time that the partnership assumes or takes subject to a 
liability, it is anticipated that the transferring partner's share of 
the liability will be subsequently reduced; and
    (ii) The reduction of the partner's share of the liability is part 
of a plan that has as one of its principal purposes minimizing the 
extent to which the assumption of or taking subject to the liability is 
treated as part of a sale under Sec. 1.707-3.
    (4) Special rule applicable to transfers of encumbered property to a 
partnership by more than one partner pursuant to a plan. For purposes of 
paragraph (a)(1) of this section, if the partnership assumes or takes 
property or properties subject to the liabilities of more than one 
partner pursuant to a plan, a partner's share of the liabilities assumed 
or taken subject to by the partnership pursuant to that plan immediately 
after the transfers equals the sum of that partner's shares of the 
liabilities (other than that partner's qualified liabilities, as defined 
in paragraph (a)(6) of this section) assumed or taken subject to by the 
partnership pursuant to the plan. This paragraph (a)(4) does not apply 
to any liability assumed or taken subject to by the partnership with a 
principal purpose of reducing the extent to which any other liability 
assumed or taken subject to by the partnership is treated as a transfer 
of consideration under paragraph (a)(1) of this section.
    (5) Special rule applicable to qualified liabilities. (i) If a 
transfer of property by a partner to a partnership is not otherwise 
treated as part of a sale, the partnership's assumption of or taking 
subject to a qualified liability in connection with a transfer of 
property is not treated as part of a sale. If a transfer of property by 
a partner to the partnership is treated as part of a sale without regard 
to the partnership's assumption of or taking subject to a qualified 
liability (as defined in paragraph (a)(6) of this section) in connection 
with the transfer of property, the partnership's assumption of or taking 
subject to that liability is treated as a transfer of consideration made 
pursuant to a sale of such property to the partnership only to the 
extent of the lesser of--
    (A) The amount of consideration that the partnership would be 
treated as transferring to the partner under paragraph (a)(1) of this 
section if the liability were not a qualified liability; or
    (B) The amount obtained by multiplying the amount of the qualified 
liability by the partner's net equity percentage with respect to that 
property.

[[Page 577]]

    (ii) A partner's net equity percentage with respect to an item of 
property equals the percentage determined by dividing--
    (A) The aggregate transfers of money or other consideration to the 
partner by the partnership (other than any transfer described in this 
paragraph (a)(5)) that are treated as proceeds realized from the sale of 
the transferred property; by
    (B) The excess of the fair market value of the property at the time 
it is transferred to the partnership over any qualified liability 
encumbering the property or, in the case of any qualified liability 
described in paragraph (a)(6)(i) (C) or (D) of this section, that is 
properly allocable to the property.
    (6) Qualified liability of a partner defined. A liability assumed or 
taken subject to by a partnership in connection with a transfer of 
property to the partnership by a partner is qualified liability of the 
partner only to the extend--
    (i) The liability is--
    (A) A liability that was incurred by the partner more than two years 
prior to the earlier of the date the partner agrees in writing to 
transfers the property or the date the partner transfers the property to 
the partnership and that has encumbered the transferred property 
throughout that two-year period;
    (B) A liability that was not incurred in anticipation of the 
transfer of the property to a partnership, buy that was incurred by the 
partner within the two-year period prior to the earlier of the date the 
partner agrees in writing to transfer the property or the date the 
partner transfers the property to the partnership and that has 
encumbered the transferred property since it was incurred (see paragraph 
(a)(7) of this section for further rules regarding a liability incurred 
within two years of a property transfer or of a written agreement to 
transfer);
    (C) A liability that is allocable under the rules of Sec. 1.163-8T 
to capital expenditures with respect to the property; or
    (D) A liability that was incurred in the ordinary course of the 
trade or business in which property transferred to the partnership was 
used or held but only if all the assets related to that trade or 
business are transferred other than assets that are not material to a 
continuation of the trade or business; and
    (ii) If the liability is a recourse liability, the amount of the 
liability does not exceed the fair market value of the transferred 
property (less the amount of any other liabilities that are senior in 
priority and that either encumber such property or are liabilities 
described in paragraph (a)(6)(i) (C) or (D) of this section) at the time 
of the transfer.
    (7) Liability incurred within two years of transfer presumed to be 
in anticipation of the transfer--(i) In general. For purposes of this 
section, if within a two-year period a partner incurs a liability (other 
than a liability described in paragraph (a)(6)(i) (C) or (D) of this 
section) and transfers property to a partnership or agrees in writing to 
transfer the property, and in connection with the transfer the 
partnership assumes or takes the property subject to the liability, the 
liability is presumed to be incurred in anticipation of the transfer 
unless the facts and circumstances clearly establish that the liability 
was not incurred in anticipation of the transfer.
    (ii) Disclosure of transfers of property subject to liabilities 
incurred within two years of the transfer. If a partner treats a 
liability assumed or taken subject to by a partnership as a qualified 
liability under paragraph (a)(6)(i)(B) of this section, such treatment 
is to be disclosed to the Internal Revenue Service in accordance with 
Sec. 1.707-8.
    (b) Treatment of debt-financed transfers of consideration by 
partnerships--(1) In general. For purposes of Sec. 1.707-3, if a 
partner transfers property to a partnership, and the partnership incurs 
a liability and all or a portion of the proceeds of that liability are 
allocable under Sec. 1.163-8T to a transfer of money or other 
consideration to the partner made within 90 days of incurring the 
liability, the transfer of money or other consideration to the partner 
is taken into account only to the extent that the amount of money or the 
fair market value of the other consideration transferred exceeds that 
partner's allocable share of the partnership liability.
    (2) Partner's allocable share of liability--(i) In general. A 
partner's allocable

[[Page 578]]

share of a partnership liability for purposes of paragraph (b)(1) of 
this section equals the amount obtained by multiplying the partner's 
share of the liability as described in paragraph (a)(2) of this section 
by the fraction determined by dividing--
    (A) The portion of the liability that is allocable under Sec. 
1.163-8T to the money or other property transferred to the partner; by
    (B) The total amount of the liability.
    (ii) Debt-financed transfers made pursuant to a plan--(A) In 
general. Except as provided in paragraph (b)(2)(iii) of this section, if 
a partnership transfers to more than one partner pursuant to a plan all 
or a portion of the proceeds of one or more partnership liabilities, 
paragraph (b)(1) of this section is applied by treating all of the 
liabilities incurred pursuant to the plan as one liability, and each 
partner's allocable share of those liabilities equals the amount 
obtained by multiplying the sum of the partner's shares of each of the 
respective liabilities (as defined in paragraph (a)(2) of this section) 
by the fraction obtained by dividing--
    (1) The portion of those liabilities that is allocable under Sec. 
1.163-8T to the money or other consideration transferred to the partners 
pursuant to the plan; by
    (2) The total amount of those liabilities.
    (B) Special rule. Paragraph (b)(2)(ii)(A) of this section does not 
apply to any transfer of money or other property to a partner that is 
made with a principal purpose of reducing the extent to which any 
transfer is taken into account under paragraph (b)(1) of this section.
    (iii) Reduction of partner's share of liability. For purposes of 
paragraph (b)(2) of this section, a partner's share of a liability, 
immediately after the partnership assumes or takes subject to the 
liability, is determined by taking into account a subsequent reduction 
in the partner's share if--
    (A) It is anticipated that the partner's share of the liability that 
is allocable to a transfer of money or other consideration to the 
partner will be reduced subsequent to the transfer; and
    (B) The reduction of the partner's share of the liability is part of 
a plan that has as one of its principal purposes minimizing the extent 
to which the partnership's distribution of the proceeds of the borrowing 
is treated as part of a sale.
    (c) Refinancings. To the extent that the proceeds of a partner or 
partnership liability (the refinancing debt) are allocable under the 
rules of Sec. 1.163-8T to payments discharging all or part of any other 
liability of that partner or of the partnership, as the case may be, the 
refinancing debt is treated as the other liability for purposes of 
applying the rules of this section.
    (d) Share of liability where assumption accompanied by transfer of 
money. For purposes of Sec. Sec. 1.707-3 through 1.707-5, if pursuant 
to a plan a partner pays or contributes money to the partnership and the 
partnership assumes or takes subject to one or more liabilities (other 
than qualified liabilities) of the partner, the amount of those 
liabilities that the partnership is treated as assuming or taking 
subject to is reduced (but not below zero) by the money transferred.
    (e) Tiered partnerships and other related persons. If a lower-tier 
partnership succeeds to a liability of an upper-tier partnership, the 
liability in the lower-tier partnership retains the characterization as 
qualified or nonqualified that it had under these rules in the upper-
tier partnership. A similar rule applies to other related party 
transactions involving liabilities to the extent provided by guidance 
published in the Internal Revenue Bulletin.
    (f) Examples. The following examples illustrate the application of 
this section.

    Example 1. Partnership's assumption of nonrecourse liability 
encumbering transferred property. (i) A and B form partnership AB, which 
will engage in renting office space. A transfers $500,000 in cash to the 
partnership, and B transfers an office building to the partnership. At 
the time it is transferred to the partnership, the office building has a 
fair market value of $1,000,000, an adjusted basis of $400,000, and is 
encumbered by a $500,000 liability, which B incurred 12 months earlier 
to finance the acquisition of other property. No facts rebut the 
presumption that the liability was incurred in anticipation of the 
transfer of the property to the partnership. Assume that this liability 
is a nonrecourse

[[Page 579]]

liability of the partnership within the meaning of section 752 and the 
regulations thereunder. The partnership agreement provides that 
partnership items will be allocated equally between A and B, including 
excess nonrecourse deductions under Sec. 1.752-3(a)(3). The partnership 
agreement complies with the requirements of Sec. 1.704-1(b)(2)(ii)(b).
    (ii) The nonrecourse liability secured by the office building is not 
a qualified liability within the meaning of paragraph (a)(6) of this 
section. B would be allocated 50 percent of the excess nonrecourse 
liability under the partnership agreement. Accordingly, immediately 
after the partnership's assumption of that liability, B's share of the 
liability equals $250,000, which is equal to B's 50 percent share of the 
excess nonrecourse liability of the partnership as determined in 
accordance with B's share of partnership profits under Sec. 1.752-
3(a)(3).
    (iii) The partnership's taking subject to the liability encumbering 
the office building is treated as a transfer of $250,000 of 
consideration to B (the amount by which the liability ($500,000) exceeds 
B's share of that liability immediately after taking subject to 
$250,000)). B is treated as having sold $250,000 of the fair market 
value of the office building to the partnership in exchange for the 
partnership's taking subject to a $250,000 liability. This results in a 
gain of $150,000 ($250,000 minus ($250,000/$1,000,000 multiplied by 
$400,000)).
    Example 2. Partnership's assumption of recourse liability 
encumbering transferred property. (i) C transfers property Y to a 
partnership. At the time of its transfer to the partnership, property Y 
has a fair market value of $10,000,000 and is subject to an $8,000,000 
liability that C incurred, immediately before transferring property Y to 
the partnership, in order to finance other expenditures. Upon the 
transfer of property Y to the partnership, the partnership assumed the 
liability encumbering that property. The partnership assumed this 
liability solely to acquire property Y. Under section 752 and the 
regulations thereunder, immediately after the partnership's assumption 
of the liability encumbering property Y, the liability is a recourse 
liability of the partnership and C's share of that liability is 
$7,000,000.
    (ii) Under the facts of this example, the liability encumbering 
property Y is not a qualified liability. Accordingly, the partnership's 
assumption of the liability results in a transfer of consideration to C 
in connection with C's transfer of property Y to the partnership in the 
amount of $1,000,000 (the excess of the liability assumed by the 
partnership ($8,000,000) over C's share of the liability immediately 
after the assumption ($7,000,000)). See paragraphs (a) (1) and (2) of 
this section.
    Example 3. Subsequent reduction of transferring partner's share of 
liability. (i) The facts are the same as in Example 2. In addition, 
property Y is a fully leased office building, the rental income from 
property Y is sufficient to meet debt service, and the remaining term of 
the liability is ten years. It is anticipated that, three years after 
the partnership's assumption of the liability, C's share of the 
liability under section 752 will be reduced to zero because of a shift 
in the allocation of partnership losses pursuant to the terms of the 
partnership agreement. Under the partnership agreement, this shift in 
the allocation of partnership losses is dependent solely on the passage 
of time.
    (ii) Under paragraph (a)(3) of this section, if the reduction in C's 
share of the liability was anticipated at the time of C's transfer, and 
the reduction was part of a plan that has as one of its principal 
purposes minimizing the extent of sale treatment under Sec. 1.707-3 
(i.e., a principal purpose of allocating a large percentage of losses to 
C in the first three years when losses were not likely to be realized 
was to minimize the extent to which C's transfer would be treated as 
part of a sale), C's share of the liability immediately after the 
assumption is treated as equal to C's reduced share.
    Example 4. Trade payables as qualified liabilities. (i) D and E form 
partnership DE which will engage in a consulting business that requires 
no overhead and minimal cash on hand for daily operating expenses. 
Previously, D and E, as individual sole proprietors, operated separate 
consulting businesses. D and E each transfer to the partnership 
sufficient cash to cover daily operating expenses together with the 
goodwill and trade payables related to each sole proprietorship. Due to 
uncertainty over the collection rate on the trade receivables related to 
their sole proprietorships, D and E agree that none of the trade 
receivables will be transferred to the partnership.
    (ii) Under the facts of this example, all the assets related to the 
consulting business (other than the trade receivables) together with the 
trade payables were transferred to partnership DE. The trade receivables 
retained by D and E are not material to a continuation of the trade or 
business by the partnership because D and E contributed sufficient cash 
to cover daily operating expenses. Accordingly, the trade payables 
transferred to the partnership constitute qualified liability under 
paragraph (a)(6) of this section.
    Example 5. Partnership's assumption of a qualified liability as sole 
consideration. (i) F transfers property Z to a partnership. At the time 
of its transfer to the partnership, property Z has a fair market value 
of $165,000 and an adjusted tax basis of $75,000. Also, at the time of 
the transfer, property Z is subject to a $75,000 liability that F 
incurred more than two years before transferring property Z to

[[Page 580]]

the partnership. The liability has been secured by property Z since it 
was incurred by F. Upon the transfer of property Z to the partnership, 
the partnership assumed the liability encumbering that property. The 
partnership made no other transfers to F in consideration for the 
transfer of property Z to the partnership. Assume that, under section 
752 and the regulations thereunder, immediately after the partnership's 
assumption of the liability encumbering property Z, the liability is a 
recourse liability of the partnership and F's share of that liability is 
$25,000.
    (ii) The $75,000 liability secured by property Z is a qualified 
liability of F because F incurred the liability more than two years 
prior to the assumption of the liability by the partnership and the 
liability has encumbered property Z for more than two years prior to 
that assumption. See paragraph (a)(6) of this section. Therefore, since 
no other transfer to F was made as consideration for the transfer of 
property Z, under paragraph (a)(5) of this section, the partnership's 
assumption of the qualified liability of F encumbering property Z is not 
treated as part of a sale.
    Example 6. Partnership's assumption of a qualified liability in 
addition to other consideration. (i) The facts are the same as in 
Example 5, except that the partnership makes a transfer to D of $30,000 
in money that is consideration for F's transfer of property Z to the 
partnership under Sec. 1.707-3.
    (ii) As in Example 5, the $75,000 liability secured by property Z is 
a qualified liability of F. Since the partnership transferred $30,000 to 
F in addition to assuming the qualified liability under paragraph (a)(5) 
of this section, the partnership's assumption of this qualified 
liability is treated as a transfer of additional consideration to F to 
the extent of the lesser of--
    (A) The amount that the partnership would be treated as transferring 
to F if the liability were not a qualified liability ($50,000 (i.e., the 
excess of the $75,000 qualified liability over F's $25,000 share of that 
liability)); or
    (B) The amount obtained by multiplying the qualified liability 
($75,000) by F's net equity percentage with respect to property Z (one-
third).
    (iii) F's net equity percentage with respect to property Z equals 
the fraction determined by dividing--
    (A) The aggregate amount of money or other consideration (other than 
the qualified liability) transferred to F and treated as part of a sale 
of property Z under Sec. 1.707-3(a) ($30,000 transfer of money); by
    (B) F's net equity in property Z ($90,000 (i.e., the excess of the 
$165,000 fair market value over the $75,000 qualified liability)).
    (iv) Accordingly, the partnership's assumption of the qualified 
liability of F encumbering property Z is treated as a transfer of 
$25,000 (one-third of $75,000) of consideration to F pursuant to a sale. 
Therefore, F is treated as having sold $55,000 of the fair market value 
of property Z to the partnership in exchange for $30,000 in money and 
the partnership's assumption of $25,000 of the qualified liability. 
Accordingly, F must recognize $30,000 of gain on the sale (the excess of 
the $55,000 amount realized over $25,000 of F's adjusted basis for 
property, Z (i.e., one-third of F's adjusted basis for the property, 
because F is treated as having sold one-third of the property to the 
partnership)).
    Example 7. Partnership's assumptions of liabilities encumbering 
properties transferred pursuant to a plan. (i) Pursuant to a plan, G and 
H transfer property 1 and property 2, respectively, to an existing 
partnership in exchange for interests in the partnership. At the time 
the properties are transferred to the partnership, property 1 has a fair 
market value of $10,000 and an adjusted tax basis of $6,000, and 
property 2 has a fair market value of $10,000 and an adjusted tax basis 
of $4,000. At the time properties 1 and 2 are transferred to the 
partnership, a $6,000 nonrecourse liability (liability 1) is secured by 
property 1 and a $7,000 recourse liability of F (liability 2) is secured 
by property 2. Properties 1 and 2 are transferred to the partnership, 
and the partnership takes subject to liability 1 and assumes liability 
2. G and H incurred liabilities 1 and 2 immediately prior to 
transferring properties 1 and 2 to the partnership and used the proceeds 
for personal expenditures. The liabilities are not qualified 
liabilities. Assume that G and H are each allocated $2,000 of liability 
1 in accordance with Sec. 1.707-5(a)(2)(ii) (which determines a 
partner's share of a nonrecourse liability). Assume further that G's 
share of liability 2 is $3,500 and H's share is $0 in accordance with 
Sec. 1.707-5(a)(2)(i) (which determines a partner's share of a recourse 
liability).
    (ii) G and H transferred properties 1 and 2 to the partnership 
pursuant to a plan. Accordingly, the partnership's taking subject to 
liability 1 is treated as a transfer of only $500 of consideration to G, 
(the amount by which liability 1 ($6,000) exceeds G's share of 
liabilities 1 and 2 ($5,500)), and the partnership's assumption of 
liability 2 is treated as a transfer of only $5,000 of consideration to 
H (the amount by which liability 2 ($7,000) exceeds H's share of 
liabilities 1 and 2 ($2,000)). G is treated under the rule in Sec. 
1.707-3 as having sold $500 of the fair market value of property 1 in 
exchange for the partnership's taking subject to liability 1 and H is 
treated as having sold $5,000 of the fair market value of property 2 in 
exchange for the assumption of liability 2.
    Example 8. Partnership's assumption of liability pursuant to a plan 
to avoid sale treatment of partnership assumption of another liability. 
(i) The facts are the same as in Example 7, except that--

[[Page 581]]

    (A) H transferred the proceeds of liability 2 to the partnership; 
and
    (B) H incurred liability 2 in an attempt to reduce the extent to 
which the partnership's taking subject to liability 1 would be treated 
as a transfer of consideration to G (and thereby reduce the portion of 
G's transfer of property 1 to the partnership that would be treated as 
part of a sale).
    (ii) Because the partnership assumed liability 2 with a principal 
purpose of reducing the extent to which the partnership's taking subject 
to liability 1 would be treated as a transfer of consideration to G, 
liability 2 is ignored in applying paragraph (a)(3) of this section. 
Accordingly, the partnership's taking subject to liability 1 is treated 
as a transfer of $4,000 of consideration to G (the amount by which 
liability 1 ($6,000) exceeds G's share of liability 1 ($2,000)). On the 
other hand, the partnership's assumption of liability 2 is not treated 
as a transfer of any consideration to H because H's share of that 
liability equals $7,000 as a result of H's transfer of $7,000 in money 
to the partnership.
    Example 9. Partnership's assumptions of qualified liabilities 
encumbering properties transferred pursuant to a plan in addition to 
other consideration. (i) Pursuant to a plan, I transfers property 1 and 
J transfers property 2 plus $10,000 in cash to partnership IJ in 
exchange for equal interests in the partnership. At the time the 
properties are transferred to the partnership, property 1 has a fair 
market value of $100,000, an adjusted tax basis of $5,000, and is 
encumbered by a qualified liability of $50,000 (liability 1). Property 2 
has a fair market value of $100,000, an adjusted tax basis of $5,000, 
and is encumbered by a qualified liability of $70,000 (liability 2). 
Pursuant to the plan, the partnership transferred to I $10,000 in cash. 
That amount is consideration for I's transfer of property 1 to the 
partnership under Sec. 1.707-3. In accordance with Sec. 1.707-5(a)(2), 
I and J are each allocated $25,000 of liability 1 and $35,000 of 
liability 2.
    (ii) Because the partnership transferred $10,000 to I as 
consideration for the transfer of property, under Sec. 1.707-5(a)(5), 
the partnership's assumption of liability 1 is treated as a transfer of 
additional consideration to I, even though liability 1 is a qualified 
liability, to the extent of the lesser of--
    (A) The amount that the partnership would be treated as transferring 
to I if the liability were not a qualified liability; or
    (B) The amount obtained by multiplying the qualified liability by 
I's net equity percentage with respect to property 1.
    (iii) Because I and J transferred properties 1 and 2 to the 
partnership pursuant to a plan, treating I's qualified liability as a 
nonqualified liability under Sec. 1.707-5(a)(5)(i)(A) enables I to 
apply the special rule applicable to transfers of encumbered property to 
a partnership by more than one partner pursuant to a plan under Sec. 
1.707-5(a)(4). Under this alternative test, the partnership's assumption 
of liability 1 encumbering property 1 is treated as a transfer of zero 
($0) additional consideration to I pursuant to a sale. This is because 
the amount of liability 1 ($50,000) does not exceed the sum of I's share 
of liability 1 treated as a nonqualified liability ($25,000) and I's 
share of liability 2 ($35,000)).
    (iv) The alternative under Sec. 1.707-5(a)(5)(i)(B) is the amount 
obtained by multiplying the qualified liability ($50,000) by I's net 
equity percentage with respect to property 1. I's net equity percentage 
with respect to property 1 equals one-fifth, the fraction determined by 
dividing--
    (A) The aggregate amount of money or other consideration (other than 
the qualified liability) transferred to I and treated as part of a sale 
of property 1 under Sec. 1.707-3(a) (the $10,000 transfer of money; by
    (B) I's net equity in property 1 ($50,000 i.e., the excess of the 
$100,000 fair market value over the $50,000 qualified liability).
    (v) Under this alternative test, the partnership's assumption of the 
qualified liability encumbering property 1 is treated as a transfer of 
$10,000 (one-fifth of the $50,000 qualified liability) of additional 
consideration to I pursuant to a sale.
    (vi) Applying Sec. 1.707-5(a)(5) to these facts, the partnership's 
assumption of liability 1 is treated as a transfer of additional 
consideration to I to the extent of the lesser of--
    (A) zero; or
    (B) $10,000.
    (vii) Therefore, the partnership's assumption of I's qualified 
liability encumbering property 1 is not treated as a transfer of any 
additional consideration to I pursuant to a sale, and I is treated as 
having only received $10,000 of the fair market value of property 1 to 
the partnership in exchange for $10,000 in cash. Accordingly, I must 
recognize $9,500 of gain on the sale, that is, the excess of the $10,000 
amount realized over $500 of I's adjusted tax basis for property 1 (one-
tenth of I's adjusted tax basis for the property, because I is treated 
as having sold one-tenth of the property to the partnership). Since no 
other transfer to J was made as consideration for the transfer of 
property 2, the partnership's assumption of the qualified liability of J 
encumbering property 2 is not treated as part of a sale.
    Example 10. Treatment of debt-financed transfers of consideration by 
partnership. (i) K transfers property Z to partnership KL in exchange 
for an interest therein on April 9, 1992. On September 13, 1992, the 
partnership incurs a liability of $20,000. On November 17, 1992, the 
partnership transfers $20,000 to K, and $10,000 of this transfer is 
allocable under the rules of Sec. 1.163-8T to proceeds of the 
partnership liability incurred on September 13, 1992. The remaining 
$10,000 is paid from other partnership funds. Assume that, under section 
752 and the corresponding regulations,

[[Page 582]]

the $20,000 liability incurred on September 13, 1992, is a recourse 
liability of the partnership and K's share of that liability is $10,000 
on November 17, 1992.
    (ii) Because a portion of the transfer made to K on November 17, 
1992, is allocable under Sec. 1.163-8T to proceeds of a partnership 
liability that was incurred by the partnership within 90 days of that 
transfer, K is required to take the transfer into account in applying 
the rules of this section and Sec. 1.707-3 only to the extent that the 
amount of the transfer exceeds K's allocable share of the liability used 
to fund the transfer. K's allocable share of the $20,000 liability used 
to fund $10,000 of the transfer to K is $5,000 (K's share of the 
liability ($10,000) multiplied by the fraction obtained by dividing--
    (A) The amount of the liability that is allocable to the 
distribution to K ($10,000); by
    (B) The total amount of such liability ($20,000)).
    (iii) Therefore, K is required to take into account only $15,000 of 
the $20,000 partnership transfer to K for purposes of this section and 
Sec. 1.707-3. Under these facts, assuming the within-two-year 
presumption is not rebutted, this $15,000 transfer will be treated under 
the rule in Sec. 1.707-3 as part of a sale by K of property Z to the 
partnership.
    Example 11. Borrowing against pool of receivables. (i) M generates 
receivables which have an adjusted basis of zero in the ordinary course 
of its business. For M to use receivables as security for a loan, a 
commercial lender requires M to transfer the receivables to a 
partnership in which M has a 90 percent interest. In January, 1992, M 
transfers to the partnership receivables with a face value of $100,000. 
N (who is not related to M) transfers $10,000 cash to the partnership in 
exchange for a 10 percent interest. The partnership borrows $80,000, 
secured by the receivables, and makes a distribution of $72,000 of the 
proceeds to M and $8,000 of the proceeds to N within 90 days of 
incurring the liability. M's share of the liability under Sec. 1.707-
5(a)(2) is $72,000 (90 percentx$80,000).
    (ii) Because the transfer of the loan proceeds to M is allocable 
under Sec. 1.163-8T to proceeds of a partnership loan that was incurred 
by the partnership within 90 days of that transfer, M is required to 
take the transfer into account in applying the rules of this section and 
Sec. 1.707-3 only to the extent that the amount of the transfer 
($72,000) exceeds M's allocable share of the liability used to fund the 
transfer. Because the distribution was a debt-financed transfer pursuant 
to a plan, M's allocable share of the liability is $72,000 
($72,000x$80,000/80,000) under Sec. 1.707-5(b)(2)(ii). Therefore, M is 
not required to take into account any of the loan proceeds for purposes 
of this section and Sec. 1.707-3.
    (iii) When the receivables are collected, M must be allocated the 
gain on the contributed receivables under section 704(c). However, the 
lender permits the partnership to distribute cash to the partners only 
to the extent of the value of new receivables contributed to the 
partnership. In 1993, M contributes additional receivables and receives 
a distribution of cash. The taxable income recognized by the partnership 
on the receivables is taxable income of the partnership arising in the 
ordinary course of the partnership's activities. To the extent the 
distribution does not exceed 90 percent (M's percentage interest in 
overall partnership profits) of the partnership's operating cash flow 
under Sec. 1.707-4(b), the distribution to M is presumed not to be a 
part of a sale of receivables by M to the partnership, and the 
presumption is not rebutted under these facts.

[T.D. 8439, 57 FR 44983, Sept. 30, 1992]



Sec. 1.707-6  Disguised sales of property by partnership to partner;
general rules.

    (a) In general. Rules similar to those provided in Sec. 1.707-3 
apply in determining whether a transfer of property by a partnership to 
a partner and one or more transfers of money or other consideration by 
that partner to the partnership are treated as a sale of property, in 
whole or in part, to the partner.
    (b) Special rules relating to liabilities--(1) In general. Rules 
similar to those provided in Sec. 1.707-5 apply to determine the extent 
to which an assumption of or taking subject to a liability by a partner, 
in connection with a transfer of property by a partnership, is 
considered part of a sale. Accordingly, if a partner assumes or takes 
property subject to a qualified liability (as defined in paragraph 
(b)(2) of this section) of a partnership, the partner is treated as 
transferring consideration to the partnership only to the extent 
provided in paragraph (b). If the partner assumes or takes subject to a 
liability that is not a qualified liability, the amount treated as 
consideration transferred to the partnership is the amount that the 
liability assumed or taken subject to by the partner exceeds the 
partner's share of that liability (determined under the rules of Sec. 
1.707-5(a)(2)) immediately before the transfer. Similar to the rules 
provided in Sec. 1.707-5(a)(4), if more than one partner assumes or 
takes subject to a liability pursuant to a plan, the amount that is 
treated as a

[[Page 583]]

transfer of consideration by each partner is the amount by which all of 
the liabilities (other than qualified liabilities) assumed or taken 
subject to by the partner pursuant to the plan exceed the partner's 
share of all of those liabilities immediately before the assumption or 
taking subject to. This paragraph (b)(1) does not apply to any liability 
assumed or taken subject to by a partner with a principal purpose of 
reducing the extent to which any other liability assumed or taken 
subject to by a partner is treated as a transfer of consideration under 
this paragraph (b).
    (2) Qualified liabilities. (i) If a transfer of property by a 
partnership to a partner is not otherwise treated as part of a sale, the 
partner's assumption of or taking subject to a qualified liability is 
not treated as part of a sale. If a transfer of property by a 
partnership to the partner is treated as part of a sale without regard 
to the partner's assumption of or taking subject to a qualified 
liability, the partner's assumption of or taking subject to that 
liability is treated as a transfer of consideration made pursuant to a 
sale of such property to the partner only to the extent of the lesser 
of--
    (A) The amount of consideration that the partner would be treated as 
transferring to the partnership under paragraph (b) of this section if 
the liability were not a qualified liability; or
    (B) The amount obtained by multiplying the amount of the liability 
at the time of its assumption or taking subject to by the partnership's 
net equity percentage with respect to that property.
    (ii) A partnership's net equity percentage with respect to an item 
of property encumbered by a qualified liability equals the percentage 
determined by dividing--
    (A) The aggregate transfers to the partnership from the partner 
(other than any transfer described in this paragraph (b)(2)) that are 
treated as the proceeds realized from the sale of the transferred 
property to the partner; by
    (B) The excess of the fair market value of the property at the time 
it is transferred to the partner over any qualified liabilities of the 
partnership that are assumed or taken subject to by the partner at that 
time.
    (iii) For purposes of this section, the definition of a qualified 
liability is that provided in Sec. 1.707-5(a)(6) with the following 
exceptions--
    (A) In applying the definition, the qualified liability is one that 
is originally an obligation of the partnership and is assumed or taken 
subject to by the partner in connection with a transfer of property to 
the partner; and
    (B) If the liability was incurred by the partnership more than two 
years prior to the earlier of the date the partnership agrees in writing 
to transfer the property or the date the partnership transfers the 
property to the partner, that liability is a qualified liability whether 
or not it has encumbered the transferred property throughout the two-
year period.
    (c) Disclosure rules. Similar to the rules provided in Sec. Sec. 
1.707-3(c)(2) and 1.707-5(a)(7)(ii), a partnership is to disclose to the 
Internal Revenue Service, in accordance with Sec. 1.707-8, the facts in 
the following circumstances:
    (1) When a partnership transfers property to a partner and the 
partner transfers money or other consideration to the partnership within 
a two-year period (without regard to the order of the transfers) and the 
partnership treats the transfers as other than a sale for tax purposes; 
and
    (2) When a partner assumes or takes subject to a liability of a 
partnership in connection with a transfer of property by the partnership 
to the partner, and the partnership incurred the liability within the 
two-year period prior to the earlier of the date the partnership agrees 
in writing to the transfer of property or the date the partnership 
transfers the property, and the partnership treats the liability as a 
qualified liability under rules similar to Sec. 1.707-5(a)(6)(i)(B).
    (d) Examples. The following examples illustrate the rules of this 
section.

    Example 1. Sale of property by partnership to partner. (i) A is a 
member of a partnership. The partnership transfers property X to A. At 
the time of the transfer, property X has a fair market value of 
$1,000,000. One year after the transfer, A transfers $1,100,000 to the 
partnership. Assume that under the rules of section 1274 the imputed 
principal amount of an obligation to transfer $1,100,000 one year

[[Page 584]]

after the transfer of property X is $1,000,000 on the date of the 
transfer.
    (ii) Since the transfer of $1,100,000 to the partnership by A is 
made within two years of the transfer of property X to A, under rules 
similar to those provided in Sec. 1.707-3(c), the transfers are 
presumed to be a sale unless the facts and circumstances clearly 
establish otherwise. If no facts exist that would rebut this 
presumption, on the date that the partnership transfers property X to A, 
the partnership is treated as having sold property X to A in exchange 
for A's obligation to transfer $1,100,000 to the partnership one year 
later.
    Example 2. Assumption of liability by partner. (i) B is a member of 
an existing partnership. The partnership transfers property Y to B. On 
the date of the transfer, property Y has a fair market value of 
$1,000,000 and is encumbered by a nonrecourse liability of $600,000. B 
takes the property subject to the liability. The partnership incurred 
the nonrecourse liability six months prior to the transfer of property Y 
to B and used the proceeds to purchase an unrelated asset. Assume that, 
under rule of Sec. 1.707-5(a)(2)(ii) (which determines a partner's 
share of a nonrecourse liability), B's share of the nonrecourse 
liability immediately before the transfer of property Y was $100,000.
    (ii) The liability is not allocable under the rules of Sec. 1.163-
8T to capital expenditures with respect to the property transferred to B 
and was not incurred in the ordinary course of the trade or business in 
which the property transferred to the partner was used or held. Since 
the partnership incurred the nonrecourse liability within two years of 
the transfer to B, under rules similar to those provided in Sec. 1.707-
5(a)(5), the liability is presumed to be incurred in anticipation of the 
transfer unless the facts and circumstances clearly establish the 
contrary. Assuming no facts exist to rebut this presumption, the 
liability taken subject to by B is not a qualified liability. The 
partnership is treated as having received, on the date of the transfer 
of property Y to B, $500,000 ($600,000 liability assumed by B less B's 
share of the $100,000 liability immediately prior to the transfer) as 
consideration for the sale of one-half ($500,000/$1,000,000) of property 
Y to B. The partnership is also treated as having distributed to B, in 
B's capacity as a partner, the other one-half of property Y.

[T.D. 8439, 57 FR 44987, Sept. 30, 1992]



Sec. 1.707-7  Disguised sales of partnership interests. [Reserved]



Sec. 1.707-8  Disclosure of certain information.

    (a) In general. The disclosure referred to in Sec. 1.707-3(c)(2) 
(regarding certain transfers made within two years of each other), Sec. 
1.707-5(a)(7)(ii) (regarding a liability incurred within two years prior 
to a transfer of property), and Sec. 1.707-6(c) (relating to transfers 
of property from a partnership to a partner in situations analogous to 
those listed above) is to be made in accordance with paragraph (b) of 
this section.
    (b) Method of providing disclosure. Disclosure is to be made on a 
completed Form 8275 or on a statement attached to the return of the 
transferor of property for the taxable year of the transfer that 
includes the following:
    (1) A caption identifying the statement as disclosure under section 
707;
    (2) An identification of the item (or group of items) with respect 
to which disclosure is made;
    (3) The amount of each item; and
    (4) The facts affecting the potential tax treatment of the item (or 
items) under section 707.
    (c) Disclosure by certain partnerships. If more than one partner 
transfers property to a partnership pursuant to a plan, the disclosure 
required by this section may be made by the partnership on behalf of all 
the transferors rather than by each transferor separately.

[T.D. 8439, 57 FR 44988, Sept. 30, 1992]



Sec. 1.707-9  Effective dates and transitional rules.

    (a) Sections 1.707-3 through 1.707-6--(1) In general. Except as 
provided in paragraph (a)(3) of this section, Sec. Sec. 1.707-3 through 
1.707-6 apply to any transaction with respect to which all transfers 
that are part of a sale of an item of property occur after April 24, 
1991.
    (2) Transfers occurring on or before April 24, 1991. Except as 
otherwise provided in paragraph (a)(3) of this section, in the case of 
any transaction with respect to which one or more of the transfers 
occurs on or before April 24, 1991, the determination of whether the 
transaction is a disguised sale of property (including a partnership 
interest) under section 707(a)(2) is to be made on the basis of the 
statute and the guidance provided regarding that provision in the 
legislative history of section 73 of the Tax Reform Act of 1984 (Pub. L. 
98-369, 98 Stat. 494). See H.R. Rep. No. 861, 98th Cong., 2d Sess. 859-
62 (1984); S. Prt. No. 169 (Vol. I),

[[Page 585]]

98th Cong., 2d Sess. 223-32 (1984); H.R. Rep. No. 432 (Pt. 2), 98th 
Cong., 2d Sess. 1216-21 (1984).
    (3) Effective date of section 73 of the Tax Reform Act of 1984. 
Sections 1.707-3 through 1.707-6 do not apply to any transfer of money 
or other consideration to which section 73(a) of the Tax Reform Act of 
1984 (Pub. L. 98-369, 98 Stat. 494) does not apply pursuant to section 
73(b) of that Act.
    (b) Section 1.707-8 disclosure of certain information. The 
disclosure provisions described in Sec. 1.707-8 apply to transactions 
with respect to which all transfers that are part of a sale of property 
occur after September 30, 1992.

[T.D. 8439, 57 FR 44989, Sept. 30, 1992]



Sec. 1.708-1  Continuation of partnership.

    (a) General rule. For purposes of subchapter K, chapter 1 of the 
Code, an existing partnership shall be considered as continuing if it is 
not terminated.
    (b) Termination--(1) General rule. A partnership shall terminate 
when the operations of the partnership are discontinued and no part of 
any business, financial operation, or venture of the partnership 
continues to be carried on by any of its partners in a partnership. For 
example, on November 20, 1956, A and B, each of whom is a 20-percent 
partner in partnership ABC, sell their interests to C, who is a 60-
percent partner. Since the business is no longer carried on by any of 
its partners in a partnership, the ABC partnership is terminated as of 
November 20, 1956. However, where partners DEF agree on April 30, 1957, 
to dissolve their partnership, but carry on the business through a 
winding up period ending September 30, 1957, when all remaining assets, 
consisting only of cash, are distributed to the partners, the 
partnership does not terminate because of cessation of business until 
September 30, 1957.
    (i) Upon the death of one partner in a 2-member partnership, the 
partnership shall not be considered as terminated if the estate or other 
successor in interest of the deceased partner continues to share in the 
profits or losses of the partnership business.
    (ii) For the continuation of a partnership where payments are being 
made under section 736 (relating to payments to a retiring partner or a 
deceased partner's successor in interest), see paragraph (a)(6) of Sec. 
1.736-1.
    (2) A partnership shall terminate when 50 percent or more of the 
total interest in partnership capital and profits is sold or exchanged 
within a period of 12 consecutive months. Such sale or exchange includes 
a sale or exchange to another member of the partnership. However, a 
disposition of a partnership interest by gift (including assignment to a 
successor in interest), bequest, or inheritance, or the liquidation of a 
partnership interest, is not a sale or exchange for purposes of this 
subparagraph. Moreover, if the sale or exchange of an interest in a 
partnership (upper-tier partnership) that holds an interest in another 
partnership (lower-tier partnership) results in a termination of the 
upper-tier partnership, the upper-tier partnership is treated as 
exchanging its entire interest in the capital and profits of the lower-
tier partnership. If the sale or exchange of an interest in an upper-
tier partnership does not terminate the upper-tier partnership, the sale 
or exchange of an interest in the upper-tier partnership is not treated 
as a sale or exchange of a proportionate share of the upper-tier 
partnership's interest in the capital and profits of the lower-tier 
partnership. The previous two sentences apply to terminations of 
partnerships under section 708(b)(1)(B) occurring on or after May 9, 
1997; however, the sentences may be applied to terminations occurring on 
or after May 9, 1996, provided that the partnership and its partners 
apply the sentences to the termination in a consistent manner. 
Furthermore, the contribution of property to a partnership does not 
constitute such a sale or exchange. See, however, paragraph (c)(3) of 
Sec. 1.731-1. Fifty percent or more of the total interest in 
partnership capital and profits means 50 percent or more of the total 
interest in partnership capital plus 50 percent or more of the total 
interest in partnership profits. Thus, the sale of a 30-percent interest 
in partnership capital and a 60-percent interest in partnership profits 
is not the sale or exchange of 50 percent or more of the total interest 
in partnership capital and profits. If one or more partners sell or 
exchange interests aggregating 50 percent or more

[[Page 586]]

of the total interest in partnership capital and 50 percent or more of 
the total interest in partnership profits within a period of 12 
consecutive months, such sale or exchange is considered as being within 
the provisions of this subparagraph. When interests are sold or 
exchanged on different dates, the percentages to be added are determined 
as of the date of each sale. For example, with respect to the ABC 
partnership, the sale by A on May 12, 1956, of a 30-percent interest in 
capital and profits to D, and the sale by B on March 27, 1957, of a 30-
percent interest in capital and profits to E, is a sale of a 50-percent 
or more interest. Accordingly, the partnership is terminated as of March 
27, 1957. However, if, on March 27, 1957, D instead of B, sold his 30-
percent interest in capital and profits to E, there would be no 
termination since only one 30-percent interest would have been sold or 
exchanged within a 12-month period.
    (3) For purposes of subchapter K, chapter 1 of the Code, a 
partnership taxable year closes with respect to all partners on the date 
on which the partnership terminates. See section 706(c)(1) and paragraph 
(c)(1) of Sec. 1.706-1. The date of termination is:
    (i) For purposes of section 708(b)(1)(A), the date on which the 
winding up of the partnership affairs is completed.
    (ii) For purposes of section 708(b)(1)(B), the date of the sale or 
exchange of a partnership interest which, of itself or together with 
sales or exchanges in the preceding 12 months, transfers an interest of 
50 percent or more in both partnership capital and profits.
    (4) If a partnership is terminated by a sale or exchange of an 
interest, the following is deemed to occur: The partnership contributes 
all of its assets and liabilities to a new partnership in exchange for 
an interest in the new partnership; and, immediately thereafter, the 
terminated partnership distributes interests in the new partnership to 
the purchasing partner and the other remaining partners in proportion to 
their respective interests in the terminated partnership in liquidation 
of the terminated partnership, either for the continuation of the 
business by the new partnership or for its dissolution and winding up. 
In the latter case, the new partnership terminates in accordance with 
(b)(1) of this section. This paragraph (b)(4) applies to terminations of 
partnerships under section 708(b)(1)(B) occurring on or after May 9, 
1997; however, this paragraph (b)(4) may be applied to terminations 
occurring on or after May 9, 1996, provided that the partnership and its 
partners apply this paragraph (b)(4) to the termination in a consistent 
manner. The provisions of this paragraph (b)(4) are illustrated by the 
following example:

    Example. (i) A and B each contribute $10,000 cash to form AB, a 
general partnership, as equal partners. AB purchases depreciable 
Property X for $20,000. Property X increases in value to $30,000, at 
which time A sells its entire 50 percent interest to C for $15,000 in a 
transfer that terminates the partnership under section 708(b)(1)(B). At 
the time of the sale, Property X had an adjusted tax basis of $16,000 
and a book value of $16,000 (original $20,000 tax basis and book value 
reduced by $4,000 of depreciation). In addition, A and B each had a 
capital account balance of $8,000 (original $10,000 capital account 
reduced by $2,000 of depreciation allocations with respect to Property 
X).
    (ii) Following the deemed contribution of assets and liabilities by 
the terminated AB partnership to a new partnership (new AB) and the 
liquidation of the terminated AB partnership, the adjusted tax basis of 
Property X in the hands of new AB is $16,000. See Section 723. The book 
value of Property X in the hands of new partnership AB is also $16,000 
(the book value of Property X immediately before the termination) and B 
and C each have a capital account of $8,000 in new AB (the balance of 
their capital accounts in AB prior to the termination). See Sec. 1.704-
1(b)(2)(iv)(l) (providing that the deemed contribution and liquidation 
with regard to the terminated partnership are disregarded in determining 
the capital accounts of the partners and the books of the new 
partnership). Additionally, under Sec. 301.6109-1(d)(2)(iii) of this 
chapter, new AB retains the taxpayer identification number of the 
terminated AB partnership.
    (iii) Property X was not section 704(c) property in the hands of 
terminated AB and is therefore not treated as section 704(c) property in 
the hands of new AB, even though Property X is deemed contributed to new 
AB at a time when the fair market value of Property X ($30,000) was 
different from its adjusted tax basis ($16,000). See Sec. 1.704-
3(a)(3)(i) (providing that property contributed to a new partnership 
under Sec. 1.708-1(b)(4) is treated as section 704(c) property only to

[[Page 587]]

the extent that the property was section 704(c) property in the hands of 
the terminated partnership immediately prior to the termination).

    (5) If a partnership is terminated by a sale or exchange of an 
interest in the partnership, a section 754 election (including a section 
754 election made by the terminated partnership on its final return) 
that is in effect for the taxable year of the terminated partnership in 
which the sale occurs, applies with respect to the incoming partner. 
Therefore, the bases of partnership assets are adjusted pursuant to 
sections 743 and 755 prior to their deemed contribution to the new 
partnership. This paragraph (b)(5) applies to terminations of 
partnerships under section 708(b)(1)(B) occurring on or after May 9, 
1997; however, this paragraph (b)(5) may be applied to terminations 
occurring on or after May 9, 1996, provided that the partnership and its 
partners apply this paragraph (b)(5) to the termination in a consistent 
manner.
    (6) Treatment of certain start-up or organizational expenses 
following a technical termination--(i) In general. If a partnership that 
has elected to amortize start-up expenditures under section 195(b) or 
organizational expenses under section 709(b)(1) terminates in a 
transaction (or a series of transactions) described in section 
708(b)(1)(B) or paragraph (b)(2) of this section, the new partnership 
must continue to amortize those expenditures over the remaining portion 
of the amortization period adopted by the terminating partnership. See 
section 195 and Sec. 1.195-1 for rules concerning the amortization of 
start-up expenditures and section 709 and Sec. 1.709-1 for rules 
concerning the amortization of organizational expenses.
    (ii) Effective/applicability date. This paragraph (b)(6) applies to 
a technical termination of a partnership under section 708(b)(1)(B) that 
occurs on or after December 9, 2013.
    (c) Merger or consolidation--(1) General rule. If two or more 
partnerships merge or consolidate into one partnership, the resulting 
partnership shall be considered a continuation of the merging or 
consolidating partnership the members of which own an interest of more 
than 50 percent in the capital and profits of the resulting partnership. 
If the resulting partnership can, under the preceding sentence, be 
considered a continuation of more than one of the merging or 
consolidating partnerships, it shall, unless the Commissioner permits 
otherwise, be considered the continuation solely of that partnership 
which is credited with the contribution of assets having the greatest 
fair market value (net of liabilities) to the resulting partnership. Any 
other merging or consolidating partnerships shall be considered as 
terminated. If the members of none of the merging or consolidating 
partnerships have an interest of more than 50 percent in the capital and 
profits of the resulting partnership, all of the merged or consolidated 
partnerships are terminated, and a new partnership results.
    (2) Tax returns. The taxable years of any merging or consolidating 
partnerships which are considered terminated shall be closed in 
accordance with the provisions of section 706(c) and the regulations 
thereunder, and such partnerships shall file their returns for a taxable 
year ending upon the date of termination, i.e., the date of merger or 
consolidation. The resulting partnership shall file a return for the 
taxable year of the merging or consolidating partnership that is 
considered as continuing. The return shall state that the resulting 
partnership is a continuation of such merging or consolidating 
partnership, shall retain the employer identification number (EIN) of 
the partnership that is continuing, and shall include the names, 
addresses, and EINs of the other merged or consolidated partnerships. 
The respective distributive shares of the partners for the periods prior 
to and including the date of the merger or consolidation and subsequent 
to the date of merger or consolidation shall be shown as a part of the 
return.
    (3) Form of a merger or consolidation--(i) Assets-over form. When 
two or more partnerships merge or consolidate into one partnership under 
the applicable jurisdictional law without undertaking a form for the 
merger or consolidation, or undertake a form for the merger or 
consolidation that is not described in paragraph (c)(3)(ii) of this 
section, any merged or consolidated partnership

[[Page 588]]

that is considered terminated under paragraph (c)(1) of this section is 
treated as undertaking the assets-over form for Federal income tax 
purposes. Under the assets-over form, the merged or consolidated 
partnership that is considered terminated under paragraph (c)(1) of this 
section contributes all of its assets and liabilities to the resulting 
partnership in exchange for an interest in the resulting partnership, 
and immediately thereafter, the terminated partnership distributes 
interests in the resulting partnership to its partners in liquidation of 
the terminated partnership.
    (ii) Assets-up form. Despite the partners' transitory ownership of 
the terminated partnership's assets, the form of a partnership merger or 
consolidation will be respected for Federal income tax purposes if the 
merged or consolidated partnership that is considered terminated under 
paragraph (c)(1) of this section distributes all of its assets to its 
partners (in a manner that causes the partners to be treated, under the 
laws of the applicable jurisdiction, as the owners of such assets) in 
liquidation of the partners' interests in the terminated partnership, 
and immediately thereafter, the partners in the terminated partnership 
contribute the distributed assets to the resulting partnership in 
exchange for interests in the resulting partnership.
    (4) Sale of an interest in the merging or consolidating partnership. 
In a transaction characterized under the assets-over form, a sale of all 
or part of a partner's interest in the terminated partnership to the 
resulting partnership that occurs as part of a merger or consolidation 
under section 708(b)(2)(A), as described in paragraph (c)(3)(i) of this 
section, will be respected as a sale of a partnership interest if the 
merger agreement (or another document) specifies that the resulting 
partnership is purchasing interests from a particular partner in the 
merging or consolidating partnership and the consideration that is 
transferred for each interest sold, and if the selling partner in the 
terminated partnership, either prior to or contemporaneous with the 
transaction, consents to treat the transaction as a sale of the 
partnership interest. See section 741 and Sec. 1.741-1 for determining 
the selling partner's gain or loss on the sale or exchange of the 
partnership interest.
    (5) Examples. The following examples illustrate the rules in 
paragraphs (c)(1) through (4) of this section:

    Example 1. Partnership AB, in whose capital and profits A and B each 
own a 50-percent interest, and partnership CD, in whose capital and 
profits C and D each own a 50-percent interest, merge on September 30, 
1999, and form partnership ABCD. Partners A, B, C, and D are on a 
calendar year, and partnership AB and partnership CD also are on a 
calendar year. After the merger, the partners have capital and profits 
interests as follows: A, 30 percent; B, 30 percent; C, 20 percent; and 
D, 20 percent. Since A and B together own an interest of more than 50 
percent in the capital and profits of partnership ABCD, such partnership 
shall be considered a continuation of partnership AB and shall continue 
to file returns on a calendar year basis. Since C and D own an interest 
of less than 50 percent in the capital and profits of partnership ABCD, 
the taxable year of partnership CD closes as of September 30, 1999, the 
date of the merger, and partnership CD is terminated as of that date. 
Partnership ABCD is required to file a return for the taxable year 
January 1 to December 31, 1999, indicating thereon that, until September 
30, 1999, it was partnership AB. Partnership CD is required to file a 
return for its final taxable year, January 1 through September 30, 1999.
    Example 2. (i) Partnership X, in whose capital and profits A owns a 
40-percent interest and B owns a 60-percent interest, and partnership Y, 
in whose capital and profits B owns a 60-percent interest and C owns a 
40-percent interest, merge on September 30, 1999. The fair market value 
of the partnership X assets (net of liabilities) is $100X, and the fair 
market value of the partnership Y assets (net of liabilities) is $200X. 
The merger is accomplished under state law by partnership Y contributing 
its assets and liabilities to partnership X in exchange for interests in 
partnership X, with partnership Y then liquidating, distributing 
interests in partnership X to B and C.
    (ii) B, a partner in both partnerships prior to the merger, owns a 
greater than 50-percent interest in the resulting partnership following 
the merger. Accordingly, because the fair market value of partnership 
Y's assets (net of liabilities) was greater than that of partnership 
X's, under paragraph (c)(1) of this section, partnership X will be 
considered to terminate in the merger. As a result, even though, for 
state law purposes, the transaction was undertaken with partnership Y 
contributing its assets and liabilities to partnership X and 
distributing interests in

[[Page 589]]

partnership X to its partners, pursuant to paragraph (c)(3)(i) of this 
section, for Federal income tax purposes, the transaction will be 
treated as if partnership X contributed its assets to partnership Y in 
exchange for interests in partnership Y and then liquidated, 
distributing interests in partnership Y to A and B.
    Example 3. (i) The facts are the same as in Example 2, except that 
partnership X is engaged in a trade or business and has, as one of its 
assets, goodwill. In addition, the merger is accomplished under state 
law by having partnership X convey an undivided 40-percent interest in 
each of its assets to A and an undivided 60-percent interest in each of 
its assets to B, with A and B then contributing their interests in such 
assets to partnership Y. Partnership Y also assumes all of the 
liabilities of partnership X.
    (ii) Under paragraph (c)(3)(ii) of this section, the form of the 
partnership merger will be respected so that partnership X will be 
treated as following the assets-up form for Federal income tax purposes.
    Example 4. (i) Partnership X and partnership Y merge when the 
partners of partnership X transfer their partnership X interests to 
partnership Y in exchange for partnership Y interests. Immediately 
thereafter, partnership X liquidates into partnership Y. The resulting 
partnership is considered a continuation of partnership Y, and 
partnership X is considered terminated.
    (ii) The partnerships are treated as undertaking the assets-over 
form described in paragraph (c)(3)(i) of this section because the 
partnerships undertook a form that is not the assets-up form described 
in paragraph (c)(3)(ii) of this section. Accordingly, for Federal income 
tax purposes, partnership X is deemed to contribute its assets and 
liabilities to partnership Y in exchange for interests in partnership Y, 
and, immediately thereafter, partnership X is deemed to have distributed 
the interests in partnership Y to its partners in liquidation of their 
interests in partnership X.
    Example 5. (i) A, B, and C are partners in partnership X. D, E, and 
F are partners in Partnership Y. Partnership X and partnership Y merge, 
and the resulting partnership is considered a continuation of 
partnership Y. Partnership X is considered terminated. Under state law, 
partnerships X and Y undertake the assets-over form of paragraph 
(c)(3)(i) of this section to accomplish the partnership merger. C does 
not want to become a partner in partnership Y, and partnership X does 
not have the resources to buy C's interest before the merger. C, 
partnership X, and partnership Y enter into an agreement specifying that 
partnership Y will purchase C's interest in partnership X for $150 
before the merger, and as part of the agreement, C consents to treat the 
transaction in a manner that is consistent with the agreement. As part 
of the merger, partnership X receives from partnership Y $150 that will 
be distributed to C immediately before the merger, and interests in 
partnership Y in exchange for partnership X's assets and liabilities.
    (ii) Because the merger agreement satisfies the requirements of 
paragraph (c)(4) of this section and C provides the necessary consent, C 
will be treated as selling its interest in partnership X to partnership 
Y for $150 before the merger. See section 741 and Sec. 1.741-1 to 
determine the amount and character of C's gain or loss on the sale or 
exchange of its interest in partnership X.
    (iii) Because the merger agreement satisfies the requirements of 
paragraph (c)(4) of this section, partnership Y is considered to have 
purchased C's interest in partnership X for $150 immediately before the 
merger. See Sec. 1.704-1(b)(2)(iv)(l) for determining partnership Y's 
capital account in partnership X. Partnership Y's adjusted basis of its 
interest in partnership X is determined under section 742 and Sec. 
1.742-1. To the extent any built-in gain or loss on section 704(c) 
property in partnership X would have been allocated to C (including any 
allocations with respect to property revaluations under section 704(b) 
(reverse section 704(c) allocations)), see section 704 and Sec. 1.704-
3(a)(7) for determining the built-in gain or loss or reverse section 
704(c) allocations apportionable to partnership Y. Similarly, after the 
merger is completed, the built-in gain or loss and reverse section 
704(c) allocations attributable to C's interest are apportioned to D, E, 
and F under section 704(c) and Sec. 1.704-3(a)(7).
    (iv) Under paragraph (c)(3)(i) of this section, partnership X 
contributes its assets and liabilities attributable to the interests of 
A and B to partnership Y in exchange for interests in partnership Y; 
and, immediately thereafter, partnership X distributes the interests in 
partnership Y to A and B in liquidation of their interests in 
partnership X. At the same time, partnership X distributes assets to 
partnership Y in liquidation of partnership Y's interest in partnership 
X. Partnership Y's bases in the distributed assets are determined under 
section 732(b).

    (6) Prescribed form not followed in certain circumstances. (i) If 
any transactions described in paragraph (c)(3) or (4) of this section 
are part of a larger series of transactions, and the substance of the 
larger series of transactions is inconsistent with following the form 
prescribed in such paragraph, the Commissioner may disregard such form, 
and may recast the larger series of transactions in accordance with 
their substance.

[[Page 590]]

    (ii) Example. The following example illustrates the rules in 
paragraph (c)(6) of this section:

    Example. A, B, and C are equal partners in partnership ABC. ABC 
holds no section 704(c) property. D and E are equal partners in 
partnership DE. B and C want to exchange their interests in ABC for all 
of the interests in DE. However, rather than exchanging partnership 
interests, DE merges with ABC by undertaking the assets-up form 
described in paragraph (c)(3)(ii) of this section, with D and E 
receiving title to the DE assets and then contributing the assets to ABC 
in exchange for interests in ABC. As part of a prearranged transaction, 
the assets acquired from DE are contributed to a new partnership, and 
the interests in the new partnership are distributed to B and C in 
complete liquidation of their interests in ABC. The merger and division 
in this example represent a series of transactions that in substance are 
an exchange of interests in ABC for interests in DE. Even though 
paragraph (c)(3)(ii) of this section provides that the form of a merger 
will be respected for Federal income tax purposes if the steps 
prescribed under the assets-up form are followed, and paragraph 
(d)(3)(i) of this section provides a form that will be followed for 
Federal income tax purposes in the case of partnership divisions, these 
forms will not be respected for Federal income tax purposes under these 
facts, and the transactions will be recast in accordance with their 
substance as a taxable exchange of interests in ABC for interests in DE.

    (7) Effective date. This paragraph (c) is applicable to partnership 
mergers occurring on or after January 4, 2001. However, a partnership 
may apply paragraph (c) of this section to partnership mergers occurring 
on or after January 11, 2000.
    (d) Division of a partnership--(1) General rule. Upon the division 
of a partnership into two or more partnerships, any resulting 
partnership (as defined in paragraph (d)(4)(iv) of this section) or 
resulting partnerships shall be considered a continuation of the prior 
partnership (as defined in paragraph (d)(4)(ii) of this section) if the 
members of the resulting partnership or partnerships had an interest of 
more than 50 percent in the capital and profits of the prior 
partnership. Any other resulting partnership will not be considered a 
continuation of the prior partnership but will be considered a new 
partnership. If the members of none of the resulting partnerships owned 
an interest of more than 50 percent in the capital and profits of the 
prior partnership, none of the resulting partnerships will be considered 
a continuation of the prior partnership, and the prior partnership will 
be considered to have terminated. Where members of a partnership which 
has been divided into two or more partnerships do not become members of 
a resulting partnership which is considered a continuation of the prior 
partnership, such members' interests shall be considered liquidated as 
of the date of the division.
    (2) Tax consequences--(i) Tax returns. The resulting partnership 
that is treated as the divided partnership (as defined in paragraph 
(d)(4)(i) of this section) shall file a return for the taxable year of 
the partnership that has been divided and retain the employer 
identification number (EIN) of the prior partnership. The return shall 
include the names, addresses, and EINs of all resulting partnerships 
that are regarded as continuing. The return shall also state that the 
partnership is a continuation of the prior partnership and shall set 
forth separately the respective distributive shares of the partners for 
the periods prior to and including the date of the division and 
subsequent to the date of division. All other resulting partnerships 
that are regarded as continuing and new partnerships shall file separate 
returns for the taxable year beginning on the day after the date of the 
division with new EINs for each partnership. The return for a resulting 
partnership that is regarded as continuing and that is not the divided 
partnership shall include the name, address, and EIN of the prior 
partnership.
    (ii) Elections. All resulting partnerships that are regarded as 
continuing are subject to preexisting elections that were made by the 
prior partnership. A subsequent election that is made by a resulting 
partnership does not affect the other resulting partnerships.
    (3) Form of a division--(i) Assets-over form. When a partnership 
divides into two or more partnerships under applicable jurisdictional 
law without undertaking a form for the division, or undertakes a form 
that is not described in paragraph (d)(3)(ii) of this section, the 
transaction will be characterized under

[[Page 591]]

the assets-over form for Federal income tax purposes.
    (A) Assets-over form where at least one resulting partnership is a 
continuation of the prior partnership. In a division under the assets-
over form where at least one resulting partnership is a continuation of 
the prior partnership, the divided partnership (as defined in paragraph 
(d)(4)(i) of this section) contributes certain assets and liabilities to 
a recipient partnership (as defined in paragraph (d)(4)(iii) of this 
section) or recipient partnerships in exchange for interests in such 
recipient partnership or partnerships; and, immediately thereafter, the 
divided partnership distributes the interests in such recipient 
partnership or partnerships to some or all of its partners in partial or 
complete liquidation of the partners' interests in the divided 
partnership.
    (B) Assets-over form where none of the resulting partnerships is a 
continuation of the prior partnership. In a division under the assets-
over form where none of the resulting partnerships is a continuation of 
the prior partnership, the prior partnership will be treated as 
contributing all of its assets and liabilities to new resulting 
partnerships in exchange for interests in the resulting partnerships; 
and, immediately thereafter, the prior partnership will be treated as 
liquidating by distributing the interests in the new resulting 
partnerships to the prior partnership's partners.
    (ii) Assets-up form--(A) Assets-up form where the partnership 
distributing assets is a continuation of the prior partnership. Despite 
the partners' transitory ownership of some of the prior partnership's 
assets, the form of a partnership division will be respected for Federal 
income tax purposes if the divided partnership (which, pursuant to Sec. 
1.708-1(d)(4)(i), must be a continuing partnership) distributes certain 
assets (in a manner that causes the partners to be treated, under the 
laws of the applicable jurisdiction, as the owners of such assets) to 
some or all of its partners in partial or complete liquidation of the 
partners' interests in the divided partnership, and immediately 
thereafter, such partners contribute the distributed assets to a 
recipient partnership or partnerships in exchange for interests in such 
recipient partnership or partnerships. In order for such form to be 
respected for transfers to a particular recipient partnership, all 
assets held by the prior partnership that are transferred to the 
recipient partnership must be distributed to, and then contributed by, 
the partners of the recipient partnership.
    (B) Assets-up form where none of the resulting partnerships are a 
continuation of the prior partnership. If none of the resulting 
partnerships are a continuation of the prior partnership, then despite 
the partners' transitory ownership of some or all of the prior 
partnership's assets, the form of a partnership division will be 
respected for Federal income tax purposes if the prior partnership 
distributes certain assets (in a manner that causes the partners to be 
treated, under the laws of the applicable jurisdiction, as the owners of 
such assets) to some or all of its partners in partial or complete 
liquidation of the partners' interests in the prior partnership, and 
immediately thereafter, such partners contribute the distributed assets 
to a resulting partnership or partnerships in exchange for interests in 
such resulting partnership or partnerships. In order for such form to be 
respected for transfers to a particular resulting partnership, all 
assets held by the prior partnership that are transferred to the 
resulting partnership must be distributed to, and then contributed by, 
the partners of the resulting partnership. If the prior partnership does 
not liquidate under the applicable jurisdictional law, then with respect 
to the assets and liabilities that, in form, are not transferred to a 
new resulting partnership, the prior partnership will be treated as 
transferring these assets and liabilities to a new resulting partnership 
under the assets-over form described in paragraph (d)(3)(i)(B) of this 
section.
    (4) Definitions--(i) Divided partnership. For purposes of paragraph 
(d) of this section, the divided partnership is the continuing 
partnership which is treated, for Federal income tax purposes, as 
transferring the assets and liabilities to the recipient partnership or 
partnerships, either directly (under the assets-

[[Page 592]]

over form) or indirectly (under the assets-up form). If the resulting 
partnership that, in form, transferred the assets and liabilities in 
connection with the division is a continuation of the prior partnership, 
then such resulting partnership will be treated as the divided 
partnership. If a partnership divides into two or more partnerships and 
only one of the resulting partnerships is a continuation of the prior 
partnership, then the resulting partnership that is a continuation of 
the prior partnership will be treated as the divided partnership. If a 
partnership divides into two or more partnerships without undertaking a 
form for the division that is recognized under paragraph (d)(3) of this 
section, or if the resulting partnership that had, in form, transferred 
assets and liabilities is not considered a continuation of the prior 
partnership, and more than one resulting partnership is considered a 
continuation of the prior partnership, the continuing resulting 
partnership with the assets having the greatest fair market value (net 
of liabilities) will be treated as the divided partnership.
    (ii) Prior partnership. For purposes of paragraph (d) of this 
section, the prior partnership is the partnership subject to division 
that exists under applicable jurisdictional law before the division.
    (iii) Recipient partnership. For purposes of paragraph (d) of this 
section, a recipient partnership is a partnership that is treated as 
receiving, for Federal income tax purposes, assets and liabilities from 
a divided partnership, either directly (under the assets-over form) or 
indirectly (under the assets-up form).
    (iv) Resulting partnership. For purposes of paragraph (d) of this 
section, a resulting partnership is a partnership resulting from the 
division that exists under applicable jurisdictional law after the 
division and that has at least two partners who were partners in the 
prior partnership. For example, where a prior partnership divides into 
two partnerships, both partnerships existing after the division are 
resulting partnerships.
    (5) Examples. The following examples illustrate the rules in 
paragraphs (d)(1), (2), (3), and (4) of this section:

    Example 1. Partnership ABCD is in the real estate and insurance 
businesses. A owns a 40-percent interest, and B, C, and D each owns a 
20-percent interest, in the capital and profits of the partnership. The 
partnership and the partners report their income on a calendar year. On 
November 1, 1999, they separate the real estate and insurance businesses 
and form two partnerships. Partnership AB takes over the real estate 
business, and partnership CD takes over the insurance business. Because 
members of resulting partnership AB owned more than a 50-percent 
interest in the capital and profits of partnership ABCD (A, 40 percent, 
and B, 20 percent), partnership AB shall be considered a continuation of 
partnership ABCD. Partnership AB is required to file a return for the 
taxable year January 1 to December 31, 1999, indicating thereon that 
until November 1, 1999, it was partnership ABCD. Partnership CD is 
considered a new partnership formed at the beginning of the day on 
November 2, 1999, and is required to file a return for the taxable year 
it adopts pursuant to section 706(b) and the applicable regulations.
    Example 2. (i) Partnership ABCD owns properties W, X, Y, and Z, and 
divides into partnership AB and partnership CD. Under paragraph (d)(1) 
of this section, partnership AB is considered a continuation of 
partnership ABCD and partnership CD is considered a new partnership. 
Partnership ABCD distributes property Y to C and titles property Y in 
C's name. Partnership ABCD distributes property Z to D and titles 
property Z in D's name. C and D then contribute properties Y and Z, 
respectively, to partnership CD in exchange for interests in partnership 
CD. Properties W and X remain in partnership AB.
    (ii) Under paragraph (d)(3)(ii) of this section, partnership ABCD 
will be treated as following the assets-up form for Federal income tax 
purposes.
    Example 3. (i) The facts are the same as in Example 2, except 
partnership ABCD distributes property Y to C and titles property Y in 
C's name. C then contributes property Y to partnership CD. 
Simultaneously, partnership ABCD contributes property Z to partnership 
CD in exchange for an interest in partnership CD. Immediately 
thereafter, partnership ABCD distributes the interest in partnership CD 
to D in liquidation of D's interest in partnership ABCD.
    (ii) Under paragraph (d)(3)(i) of this section, because partnership 
ABCD did not undertake the assets-up form with respect to all of the 
assets transferred to partnership CD, partnership ABCD will be treated 
as undertaking the assets-over form in transferring the assets to 
partnership CD. Accordingly, for Federal income tax purposes, 
partnership ABCD is deemed to contribute property Y and property Z to 
partnership CD in exchange for interests in partnership CD, and 
immediately thereafter, partnership ABCD is deemed to distribute the 
interests in partnership CD to partner C and partner D

[[Page 593]]

in liquidation of their interests in partnership ABCD.
    Example 4. (i) Partnership ABCD owns three parcels of property: 
property X, with a value of $500; property Y, with a value of $300; and 
property Z, with a value of $200. A and B each own a 40-percent interest 
in the capital and profits of partnership ABCD, and C and D each own a 
10 percent interest in the capital and profits of partnership ABCD. On 
November 1, 1999, partnership ABCD divides into three partnerships (AB1, 
AB2, and CD) by contributing property X to a newly formed partnership 
(AB1) and distributing all interests in such partnership to A and B as 
equal partners, and by contributing property Z to a newly formed 
partnership (CD) and distributing all interests in such partnership to C 
and D as equal partners in exchange for all of their interests in 
partnership ABCD. While partnership ABCD does not transfer property Y, C 
and D cease to be partners in the partnership. Accordingly, after the 
division, the partnership holding property Y is referred to as 
partnership AB2.
    (ii) Partnerships AB1 and AB2 both are considered a continuation of 
partnership ABCD, while partnership CD is considered a new partnership 
formed at the beginning of the day on November 2, 1999. Under paragraph 
(d)(3)(i)(A) of this section, partnership ABCD will be treated as 
following the assets-over form, with partnership ABCD contributing 
property X to partnership AB1 and property Z to partnership CD, and 
distributing the interests in such partnerships to the designated 
partners.
    Example 5. (i) The facts are the same as in Example 4, except that 
partnership ABCD divides into three partnerships by operation of state 
law, without undertaking a form.
    (ii) Under the last sentence of paragraph (d)(4)(i) of this section, 
partnership AB1 will be treated as the resulting partnership that is the 
divided partnership. Under paragraph (d)(3)(i)(A) of this section, 
partnership ABCD will be treated as following the assets-over form, with 
partnership ABCD contributing property Y to partnership AB2 and property 
Z to partnership CD, and distributing the interests in such partnerships 
to the designated partners.
    Example 6. (i) The facts are the same as in Example 4, except that 
partnership ABCD divides into three partnerships by contributing 
property X to newly-formed partnership AB1 and property Y to newly-
formed partnership AB2 and distributing all interests in each 
partnership to A and B in exchange for all of their interests in 
partnership ABCD.
    (ii) Because resulting partnership CD is not a continuation of the 
prior partnership (partnership ABCD), partnership CD cannot be treated, 
for Federal income tax purposes, as the partnership that transferred 
assets (i.e., the divided partnership), but instead must be treated as a 
recipient partnership. Under the last sentence of paragraph (d)(4)(i) of 
this section, partnership AB1 will be treated as the resulting 
partnership that is the divided partnership. Under paragraph 
(d)(3)(i)(A) of this section, partnership ABCD will be treated as 
following the assets-over form, with partnership ABCD contributing 
property Y to partnership AB2 and property Z to partnership CD, and 
distributing the interests in such partnerships to the designated 
partners.
    Example 7. (i) Partnership ABCDE owns Blackacre, Whiteacre, and 
Redacre, and divides into partnership AB, partnership CD, and 
partnership DE. Under paragraph (d)(1) of this section, partnership 
ABCDE is considered terminated (and, hence, none of the resulting 
partnerships are a continuation of the prior partnership) because none 
of the members of the new partnerships (partnership AB, partnership CD, 
and partnership DE) owned an interest of more than 50 percent in the 
capital and profits of partnership ABCDE.
    (ii) Partnership ABCDE distributes Blackacre to A and B and titles 
Blackacre in the names of A and B. A and B then contribute Blackacre to 
partnership AB in exchange for interests in partnership AB. Partnership 
ABCDE will be treated as following the assets-up form described in 
paragraph (d)(3)(ii)(B) of this section for Federal income tax purposes.
    (iii) Partnership ABCDE distributes Whiteacre to C and D and titles 
Whiteacre in the names of C and D. C and D then contribute Whiteacre to 
partnership CD in exchange for interests in partnership CD. Partnership 
ABCDE will be treated as following the assets-up form described in 
paragraph (d)(3)(ii)(B) of this section for Federal income tax purposes.
    (iv) Partnership ABCDE does not liquidate under state law so that, 
in form, the assets in new partnership DE are not considered to have 
been transferred under state law. Partnership ABCDE will be treated as 
undertaking the assets-over form described in paragraph (d)(3)(i)(B) of 
this section for Federal income tax purposes with respect to the assets 
of partnership DE. Thus, partnership ABCDE will be treated as 
contributing Redacre to partnership DE in exchange for interests in 
partnership DE; and, immediately thereafter, partnership ABCDE will be 
treated as distributing interests in partnership DE to D and E in 
liquidation of their interests in partnership ABCDE. Partnership ABCDE 
then terminates.

    (6) Prescribed form not followed in certain circumstances. If any 
transactions described in paragraph (d)(3) of this section are part of a 
larger series of transactions, and the substance of the

[[Page 594]]

larger series of transactions is inconsistent with following the form 
prescribed in such paragraph, the Commissioner may disregard such form, 
and may recast the larger series of transactions in accordance with 
their substance.
    (7) Effective date. This paragraph (d) is applicable to partnership 
divisions occurring on or after January 4, 2001. However, a partnership 
may apply paragraph (d) of this section to partnership divisions 
occurring on or after January 11, 2000.

[T.D. 6500, 25 FR 11814, Nov. 26, 1960; 25 FR 14021, Dec. 31, 1960, as 
amended by T.D. 8717, 62 FR 25500, May 9, 1997; T.D. 8925, 65 FR 719, 
Jan. 4, 2001; 67 FR 57330, Sept. 10, 2002; T.D. 9681, 79 FR 42679, July 
23, 2014]



Sec. 1.709-1  Treatment of organization and syndication costs.

    (a) General rule. Except as provided in paragraph (b) of this 
section, no deduction shall be allowed under chapter 1 of the Code to a 
partnership or to any partner for any amounts paid or incurred, directly 
or indirectly, in partnership taxable years beginning after December 31, 
1975, to organize a partnership, or to promote the sale of, or to sell, 
an interest in the partnership.
    (b) Election to amortize organizational expenses--(1) In general. 
Under section 709(b), a partnership may elect to amortize organizational 
expenses as defined in section 709(b)(3) and Sec. 1.709-2(a). In the 
taxable year in which a partnership begins business, an electing 
partnership may deduct an amount equal to the lesser of the amount of 
the organizational expenses of the partnership, or $5,000 (reduced (but 
not below zero) by the amount by which the organizational expenses 
exceed $50,000). The remainder of the organizational expenses is 
deductible ratably over the 180-month period beginning with the month in 
which the partnership begins business. All organizational expenses of 
the partnership are considered in determining whether the organizational 
expenses exceed $50,000, including expenses incurred on or before 
October 22, 2004.
    (2) Time and manner of making election. A partnership is deemed to 
have made an election under section 709(b) to amortize organizational 
expenses as defined in section 709(b)(3) and Sec. 1.709-2(a) for the 
taxable year in which the partnership begins business. A partnership may 
choose to forgo the deemed election by affirmatively electing to 
capitalize its organizational expenses on a timely filed Federal income 
tax return (including extensions) for the taxable year in which the 
partnership begins business. The election either to amortize 
organizational expenses under section 709(b) or to capitalize 
organizational expenses is irrevocable and applies to all organizational 
expenses of the partnership. A change in the characterization of an item 
as an organizational expense is a change in method of accounting to 
which sections 446 and 481(a) apply if the partnership treated the item 
consistently for two or more taxable years. A change in the 
determination of the taxable year in which the partnership begins 
business also is treated as a change in method of accounting if the 
partnership amortized organizational expenses for two or more taxable 
years.
    (3) Liquidation of partnership--(i)In general. If there is a winding 
up and complete liquidation of the partnership prior to the end of the 
amortization period, the unamortized amount of organizational expenses 
is a partnership deduction in its final taxable year to the extent 
provided under section 165 (relating to losses). However, there is no 
partnership deduction with respect to its capitalized syndication 
expenses.
    (ii) Technical termination of a partnership. If a partnership that 
has elected to amortize organizational costs under section 709(b) 
terminates in a transaction (or a series of transactions) described in 
section 708(b)(1)(B) or Sec. 1.708-1(b)(2), the termination shall not 
be treated as resulting in a liquidation of the partnership for purposes 
of section 709(b)(2). See Sec. 1.708-1(b)(6) for rules concerning the 
treatment of these organizational costs by the new partnership.
    (4) Examples. The following examples illustrate the application of 
this section:

    Example 1. Expenditures of $5,000 or less. Partnership X, a calendar 
year taxpayer, incurs $3,000 of organizational expenses after October 
22, 2004, and begins business on July 1, 2011. Under paragraph (b)(2) of 
this section,

[[Page 595]]

Partnership X is deemed to have elected to amortize organizational 
expenses under section 709(b) in 2011. Therefore, Partnership X may 
deduct the entire amount of the organizational expenses in 2011, the 
taxable year in which Partnership X begins business.
    Example 2. Expenditures of more than $5,000 but less than or equal 
to $50,000. The facts are the same as in Example 1 except that 
Partnership X incurs organizational expenses of $41,000. Under paragraph 
(b)(2) of this section, Partnership X is deemed to have elected to 
amortize organizational expenses under section 709(b) in 2011. 
Therefore, Partnership X may deduct $5,000 and the portion of the 
remaining $36,000 that is allocable to July through December of 2011 
($36,000/180 x 6 = $1,200) in 2011, the taxable year in which 
Partnership X begins business. Partnership X may amortize the remaining 
$34,800 ($36,000 - $1,200 = $34,800) ratably over the remaining 174 
months.
    Example 3. Subsequent change in the characterization of an item. The 
facts are the same as in Example 2 except that Partnership X realizes in 
2013 that Partnership X incurred $10,000 for an additional 
organizational expense erroneously deducted in 2011 under section 162 as 
a business expense. Under paragraph (b)(2) of this section, Partnership 
X is deemed to have elected to amortize organizational expenses under 
section 709(b) in 2011, including the additional $10,000 of 
organizational expenses. Partnership X is using an impermissible method 
of accounting for the additional $10,000 of organizational expenses and 
must change its method under Sec. 1.446-1(e) and the applicable general 
administrative procedures in effect in 2013.
    Example 4. Subsequent redetermination of year in which business 
begins. The facts are the same as in Example 2 except that, in 2012, 
Partnership X deducted the organizational expenses allocable to January 
through December of 2012 ($36,000/180 x 12 = $2,400). In addition, in 
2013 it is determined that Partnership X actually began business in 
2012. Under paragraph (b)(2) of this section, Partnership X is deemed to 
have elected to amortize organizational expenses under section 709(b) in 
2012. Partnership X impermissibly deducted organizational expenses in 
2011, and incorrectly determined the amount of organizational expenses 
deducted in 2012. Therefore, Partnership X is using an impermissible 
method of accounting for the organizational expenses and must change its 
method under Sec. 1.446-1(e) and the applicable general administrative 
procedures in effect in 2013.
    Example 5. Expenditures of more than $50,000 but less than or equal 
to $55,000. The facts are the same as in Example 1 except that 
Partnership X incurs organizational expenses of $54,500. Under paragraph 
(b)(2) of this section, Partnership X is deemed to have elected to 
amortize organizational expenses under section 709(b) in 2011. 
Therefore, Partnership X may deduct $500 ($5,000-$4,500) and the portion 
of the remaining $54,000 that is allocable to July through December of 
2011 ($54,000/180 x 6 = $1,800) in 2011, the taxable year in which 
Partnership X begins business. Partnership X may amortize the remaining 
$52,200 ($54,000 - $1,800 = $ 52,200) ratably over the remaining 174 
months.
    Example 6. Expenditures of more than $55,000. The facts are the same 
as in Example 1 except that Partnership X incurs organizational expenses 
of $450,000. Under paragraph (b)(2) of this section, Partnership X is 
deemed to have elected to amortize organizational expenses under section 
709(b) in 2011. Therefore, Partnership X may deduct the amounts 
allocable to July through December of 2011 ($450,000/180 x 6 = $15,000) 
in 2011, the taxable year in which Partnership X begins business. 
Partnership X may amortize the remaining $435,000 ($450,000 - $15,000 = 
$435,000) ratably over the remaining 174 months.

    (5) Effective/applicability date. This section applies to 
organizational expenses paid or incurred after August 16, 2011. However, 
taxpayers may apply all the provisions of this section to organizational 
expenses paid or incurred after October 22, 2004, provided that the 
period of limitations on assessment of tax for the year the election 
under paragraph (b)(2) of this section is deemed made has not expired. 
For organizational expenses paid or incurred on or before September 8, 
2008, taxpayers may instead apply Sec. 1.709-1, as in effect prior to 
that date (Sec. 1.709-1 as contained in 26 CFR part 1 edition revised 
as of April 1, 2008). Paragraph (b)(3)(ii) of this section applies to a 
technical termination of a partnership under section 708(b)(1)(B) that 
occurs on or after December 9, 2013.

[T.D. 7891, 48 FR 20048, May 4, 1983, as amended by T.D. 9411, 73 FR 
38914, July 8, 2008; T.D. 9542, 76 FR 50890, Aug. 17, 2011; 76 FR 56973, 
Sept. 15, 2011; T.D. 9681, 79 FR 42679, July 23, 2014]



Sec. 1.709-2  Definitions.

    (a) Organizational expenses. Section 709(b)(2) of the Internal 
Revenue Code defines organizational expenses as expenses which:
    (1) Are incident to the creation of the partnership;
    (2) Are chargeable to capital account; and
    (3) Are of a character which, if expended incident to the creation 
of a partnership having an ascertainable

[[Page 596]]

life, would (but for section 709(a)) be amortized over such life.

An expenditure which fails to meet one or more of these three tests does 
not qualify as an organizational expense for purposes of section 709(b) 
and this section. To satisfy the statutory requirement described in 
paragraph (a)(1) of this section, the expense must be incurred during 
the period beginning at a point which is a reasonable time before the 
partnership begins business and ending with the date prescribed by law 
for filing the partnership return (determined without regard to any 
extensions of time) for the taxable year the partnership begins 
business. In addition, the expenses must be for creation of the 
partnership and not for operation or starting operation of the 
partnership trade or business. To satisfy the statutory requirement 
described in paragraph (a)(3) of this section, the expense must be for 
an item of a nature normally expected to benefit the partnership 
throughout the entire life of the partnership. The following are 
examples of organizational expenses within the meaning of section 709 
and this section: Legal fees for services incident to the organization 
of the partnership, such as negotiation and preparation of a partnership 
agreement; accounting fees for services incident to the organization of 
the partnership; and filing fees. The following are examples of expenses 
that are not organizational expenses within the meaning of section 709 
and this section (regardless of how the partnership characterizes them): 
Expenses connected with acquiring assets for the partnership or 
transferring assets to the partnership; expenses connected with the 
admission or removal of partners other than at the time the partnership 
is first organized; expenses connected with a contract relating to the 
operation of the partnership trade or business (even where the contract 
is between the partnership and one of its members); and syndication 
expenses.
    (b) Syndication expenses. Syndication expenses are expenses 
connected with the issuing and marketing of interests in the 
partnership. Examples of syndication expenses are brokerage fees; 
registration fees; legal fees of the underwriter or placement agent and 
the issuer (the general partner or the partnership) for securities 
advice and for advice pertaining to the adequacy of tax disclosures in 
the prospectus or placement memorandum for securities law purposes; 
accounting fees for preparation of representations to be included in the 
offering materials; and printing costs of the prospectus, placement 
memorandum, and other selling and promotional material. These expenses 
are not subject to the election under section 709(b) and must be 
capitalized.
    (c) Beginning business. The determination of the date a partnership 
begins business for purposes of section 709 presents a question of fact 
that must be determined in each case in light of all the circumstances 
of the particular case. Ordinarily, a partnership begins business when 
it starts the business operations for which it was organized. The mere 
signing of a partnership agreement is not alone sufficient to show the 
beginning of business.

If the activities of the partnership have advanced to the extent 
necessary to establish the nature of its business operations, it will be 
deemed to have begun business. Accordingly, the acquisition of operating 
assets which are necessary to the type of business contemplated may 
constitute beginning business for these purposes. The term operating 
assets, as used herein, means assets that are in a state of readiness to 
be placed in service within a reasonable period following their 
acquisition.

[T.D. 7891, 48 FR 20049, May 4, 1983]

               Contributions, Distributions, and Transfers

                     contributions to a partnership



Sec. 1.721-1  Nonrecognition of gain or loss on contribution.

    (a) No gain or loss shall be recognized either to the partnership or 
to any of its partners upon a contribution of property, including 
installment obligations, to the partnership in exchange for a 
partnership interest. This rule applies whether the contribution is made 
to a partnership in the process of formation or to a partnership which 
is already formed and operating. Section

[[Page 597]]

721 shall not apply to a transaction between a partnership and a partner 
not acting in his capacity as a partner since such a transaction is 
governed by section 707. Rather than contributing property to a 
partnership, a partner may sell property to the partnership or may 
retain the ownership of property and allow the partnership to use it. In 
all cases, the substance of the transaction will govern, rather than its 
form. See paragraph (c)(3) of Sec. 1.731-1. Thus, if the transfer of 
property by the partner to the partnership results in the receipt by the 
partner of money or other consideration, including a promissory 
obligation fixed in amount and time for payment, the transaction will be 
treated as a sale or exchange under section 707 rather than as a 
contribution under section 721. For the rules governing the treatment of 
liabilities to which contributed property is subject, see section 752 
and Sec. 1.752-1.
    (b)(1) Normally, under local law, each partner is entitled to be 
repaid his contributions of money or other property to the partnership 
(at the value placed upon such property by the partnership at the time 
of the contribution) whether made at the formation of the partnership or 
subsequent thereto. To the extent that any of the partners gives up any 
part of his right to be repaid his contributions (as distinguished from 
a share in partnership profits) in favor of another partner as 
compensation for services (or in satisfaction of an obligation), section 
721 does not apply. The value of an interest in such partnership capital 
so transferred to a partner as compensation for services constitutes 
income to the partner under section 61. The amount of such income is the 
fair market value of the interest in capital so transferred, either at 
the time the transfer is made for past services, or at the time the 
services have been rendered where the transfer is conditioned on the 
completion of the transferee's future services. The time when such 
income is realized depends on all the facts and circumstances, including 
any substantial restrictions or conditions on the compensated partner's 
right to withdraw or otherwise dispose of such interest. To the extent 
that an interest in capital representing compensation for services 
rendered by the decedent prior to his death is transferred after his 
death to the decedent's successor in interest, the fair market value of 
such interest is income in respect of a decedent under section 691.
    (2) To the extent that the value of such interest is: (i) 
Compensation for services rendered to the partnership, it is a 
guaranteed payment for services under section 707(c); (ii) compensation 
for services rendered to a partner, it is not deductible by the 
partnership, but is deductible only by such partner to the extent 
allowable under this chapter.
    (c) Underwritings of partnership interests--(1) In general. For the 
purpose of section 721, if a person acquires a partnership interest from 
an underwriter in exchange for cash in a qualified underwriting 
transaction, the person who acquires the partnership interest is treated 
as transferring cash directly to the partnership in exchange for the 
partnership interest and the underwriter is disregarded. A qualified 
underwriting transaction is a transaction in which a partnership issues 
partnership interests for cash in an underwriting in which either the 
underwriter is an agent of the partnership or the underwriter's 
ownership of the partnership interests is transitory.
    (2) Effective date. This paragraph (c) is effective for qualified 
underwriting transactions occurring on or after May 1, 1996.
    (d) Debt-for-equity exchange--(1) In general. Except as otherwise 
provided in section 721 and the regulations under section 721, section 
721 applies to a contribution of a partnership's indebtedness by a 
creditor to the debtor partnership in exchange for a capital or profits 
interest in the partnership (debt-for-equity exchange). See Sec. 1.108-
8(a) for rules in determining the debtor partnership's discharge of 
indebtedness income.
    (2) Exception. Section 721 does not apply to a debt-for-equity 
exchange to the extent the transfer of the partnership interest to the 
creditor is in exchange for the partnership's indebtedness for unpaid 
rent, royalties, or interest (including accrued original issue discount) 
that accrued on or after the beginning of the creditor's holding period 
for the indebtedness. The debtor

[[Page 598]]

partnership will not recognize gain or loss upon the transfer of a 
partnership interest to a creditor in a debt-for-equity exchange for 
unpaid rent, royalties, or interest (including accrued original issue 
discount).
    (3) Cross reference. For rules in determining whether a partnership 
interest transferred to a creditor in a debt-for-equity exchange is 
treated as payment of interest or accrued original issue discount, see 
Sec. Sec. 1.446-2 and 1.1275-2, respectively.
    (4) Effective/applicability date. This paragraph (d) applies to 
debt-for-equity exchanges occurring on or after November 17, 2011.

[T.D. 6500, 25 FR 11814, Nov. 26, 1960; 25 FR 14021, Dec. 31, 1960, as 
amended by T.D. 8665, 61 FR 19189, May 1, 1996; T.D. 9557, 76 FR 71259, 
Nov. 17, 2011]



Sec. 1.721-2  Noncompensatory options.

    (a) Exercise of a noncompensatory option--(1) In general. 
Notwithstanding Sec. 1.721-1(b)(1), section 721 applies to the exercise 
(as defined in paragraph (g)(4) of this section) of a noncompensatory 
option (as defined in paragraph (f) of this section). Except as provided 
in paragraph (a)(2) of this section, section 721 applies to the exercise 
of a noncompensatory option when the holder pays the exercise price with 
either property or cash, regardless of whether the terms of the option 
require or permit cash payment. However, if the exercise price (as 
defined in paragraph (g)(5) of this section) of a noncompensatory option 
exceeds the capital account received by the option holder on the 
exercise of the option, then general tax principles will apply to 
determine the tax consequences of the transaction.
    (2) Exception. Section 721 does not apply to the exercise of a 
noncompensatory option to the extent that the exercise price is 
satisfied with the partnership's obligation to the option holder for 
unpaid rent, royalties, or interest (including accrued original issue 
discount) that accrued on or after the beginning of the option holder's 
holding period for the obligation. The issuing partnership will not 
recognize gain or loss upon the transfer of a partnership interest to an 
exercising option holder in satisfaction of such unpaid rent, royalties, 
or interest (including accrued original issue discount).
    (b) Transfer of property or satisfaction of an obligation in 
exchange for a noncompensatory option--(1) In general. Except as 
provided in paragraph (b)(2) of this section, section 721 does not apply 
to a transfer of property to a partnership in exchange for a 
noncompensatory option, or to the satisfaction of a partnership 
obligation with a noncompensatory option.
    (2) Exception. Section 721 does apply to a transfer of property to a 
partnership in exchange for convertible equity (as defined in paragraph 
(g)(3) of this section).
    (c) Lapse of a noncompensatory option. Section 721 does not apply to 
the lapse of a noncompensatory option.
    (d) Cash settlement of a noncompensatory option. Section 721 does 
not apply to the settlement of a noncompensatory option in cash or 
property other than a partnership interest in the issuing partnership.
    (e) Issuance of a partnership interest in satisfaction of 
indebtedness for interest on convertible debt. Section 721 does not 
apply to the transfer of a partnership interest to a noncompensatory 
option holder upon conversion of convertible debt in the partnership to 
the extent that the transfer is in satisfaction of the partnership's 
indebtedness for unpaid interest (including accrued original issue 
discount) on the convertible debt that accrued on or after the beginning 
of the convertible debt holder's holding period for the indebtedness. 
The debtor partnership will not, however, recognize gain or loss upon 
such conversion. For rules in determining whether a partnership interest 
transferred to a creditor is treated as payment of interest or accrued 
original issue discount, see Sec. Sec. 1.446-2 and 1.1275-2, 
respectively.
    (f) Scope. The provisions of this section apply only to 
noncompensatory options. For purposes of this section, the term 
noncompensatory option means an option (as defined in paragraph (g)(1) 
of this section) issued by a partnership (the issuing partnership), 
other than an option issued in connection with the performance of 
services.

[[Page 599]]

    (g) Definitions. The following definitions apply for the purposes of 
this section:
    (1) Option means a contractual right to acquire an interest in the 
issuing partnership, including a call option, warrant, or other similar 
arrangement, the conversion feature of convertible debt (as defined in 
paragraph (g)(2) of this section), or the conversion feature of 
convertible equity (as defined in paragraph (g)(3) of this section). To 
achieve the purposes of this section, the Commissioner can treat other 
contractual agreements, including a futures contract, a forward 
contract, or a notional principal contract, as an option. A contract 
that otherwise constitutes an option will not fail to be treated as an 
option for purposes of this section merely because it may or must be 
settled in cash or property other than a partnership interest.
    (2) Convertible debt is any indebtedness of a partnership that is 
convertible into an interest in the partnership that issued the debt.
    (3) Convertible equity is equity in a partnership that is 
convertible into a different equity interest in the partnership that 
issued the convertible equity.
    (4) Exercise means the exercise of an option in exchange for an 
interest in the issuing partnership or the conversion of convertible 
debt or convertible equity into an interest in the issuing partnership.
    (5) Exercise price means, in the case of a call option, the exercise 
price of the call option; in the case of convertible equity, the 
converting partner's capital account with respect to that convertible 
equity, increased by the fair market value of cash or other property 
contributed to the partnership in connection with the conversion; and, 
in the case of convertible debt, the adjusted issue price (within the 
meaning of Sec. 1.1275-1(b)) of the debt converted, increased by 
accrued but unpaid qualified stated interest on the debt and by the fair 
market value of cash or other property contributed to the partnership in 
connection with the conversion.
    (h) Example. The following example illustrates the provisions of 
this section:

    Example. In Year 1, L and M form general partnership LM with cash 
contributions of $5,000 each, which are used to purchase land, Property 
D, for $10,000. In that same year, LM issues an option to N to buy a 
one-third interest in LM at any time before the end of Year 3. The 
exercise price of the option is $5,000, payable in either cash or 
property. N transfers Property E with a basis of $600 and a value of 
$1,000 to the partnership in exchange for the option. N provides no 
other consideration for the option. Assume that N's option is a 
noncompensatory option under paragraph (f) of this section and that N is 
not treated as a partner with respect to the option. Under paragraph (b) 
of this section, section 721(a) does not apply to N's transfer of 
Property E to LM in exchange for the option. In accordance with Sec. 
1.1001-1, upon N's transfer of Property E to the partnership in exchange 
for the option, N recognizes $400 of gain. Under open transaction 
principles applicable to noncompensatory options, the partnership does 
not recognize any income for the premium (the property received in 
exchange for the option). The partnership has a basis of $1,000 in 
Property E. In Year 3, when the partnership property is valued at 
$16,000, N exercises the option, contributing Property F with a basis of 
$3,000 and a fair market value of $5,000 to the partnership. Under 
paragraph (a) of this section, neither the partnership nor N recognizes 
gain upon N's contribution of property to the partnership upon the 
exercise of the option. Under section 723, the partnership has a basis 
of $3,000 in Property F. The partnership does not recognize income for 
the premium (Property E) upon exercise of the option. See Sec. 1.704-
1(b)(2)(iv)(d)(4) and (s) for special rules applicable to capital 
account adjustments on the exercise of a noncompensatory option.

    (i) Effective/applicability date. This section applies to 
noncompensatory options that are issued on or after February 5, 2013.

[T.D. 9612, 78 FR 8012, Feb. 5, 2013]



Sec. 1.722-1  Basis of contributing partner's interest.

    The basis to a partner of a partnership interest acquired by a 
contribution of property, including money, to the partnership shall be 
the amount of money contributed plus the adjusted basis at the time of 
contribution of any property contributed. If the acquisition of an 
interest in partnership capital results in taxable income to a partner, 
such income shall constitute an addition to the basis of the partner's 
interest. See paragraph (b) of Sec. 1.721-1. If the contributed 
property is subject to indebtedness or if liabilities of the partner are 
assumed by the partnership,

[[Page 600]]

the basis of the contributing partner's interest shall be reduced by the 
portion of the indebtedness assumed by the other partners, since the 
partnership's assumption of his indebtedness is treated as a 
distribution of money to the partner. Conversely, the assumption by the 
other partners of a portion of the contributor's indebtedness is treated 
as a contribution of money by them. See section 752 and Sec. 1.752-1. 
See Sec. 1.460-4(k)(3)(iv)(A) for rules relating to basis adjustments 
required where a contract accounted for under a long-term contract 
method of accounting is transferred in a contribution to which section 
721(a) applies. The provisions of this section may be illustrated by the 
following examples:

    Example 1. A acquired a 20-percent interest in a partnership by 
contributing property. At the time of A's contribution, the property had 
a fair market value of $10,000, an adjusted basis to A of $4,000, and 
was subject to a mortgage of $2,000. Payment of the mortgage was assumed 
by the partnership. The basis of A's interest in the partnership is 
$2,400, computed as follows:

Adjusted basis to A of property contributed.................      $4,000
Less portion of mortgage assumed by other partners which           1,600
 must be treated as a distribution (80 percent of $2,000)...
                                                             -----------
    Basis of A's interest...................................       2,400
 

    Example 2. If, in example 1 of this section, the property 
contributed by A was subject to a mortgage of $6,000, the basis of A's 
interest would be zero, computed as follows:

Adjusted basis to A of property contributed.................      $4,000
Less portion of mortgage assumed by other partners which           4,800
 must be treated as a distribution (80 percent of $6,000)...
                                                             -----------
                                                                   (800)
 


Since A's basis cannot be less than zero, the $800 in excess of basis, 
which is considered as a distribution of money under section 752(b), is 
treated as capital gain from the sale or exchange or a partnership 
interest. See section 731(a).

[T.D. 6500, 25 FR 11814, Nov. 26, 1960; 25 FR 14021, Dec. 31, 1960, as 
amended by T.D. 9137, 69 FR 42558, July 16, 2004]



Sec. 1.723-1  Basis of property contributed to partnership.

    The basis to the partnership of property contributed to it by a 
partner is the adjusted basis of such property to the contributing 
partner at the time of the contribution. Since such property has the 
same basis in the hands of the partnership as it had in the hands of the 
contributing partner, the holding period of such property for the 
partnership includes the period during which it was held by the partner. 
See section 1223(2). For elective adjustments to the basis of 
partnership property arising from distributions or transfers of 
partnership interests, see sections 732(d), 734(b), and 743(b). See 
Sec. 1.460-4(k)(3)(iv)(B)(2) for rules relating to adjustments to the 
basis of contracts accounted for using a long-term contract method of 
accounting that are acquired in certain contributions to which section 
721(a) applies.

[T.D. 6500, 25 FR 11814, Nov. 26, 1960; 25 FR 14021, Dec. 31, 1960, as 
amended by T.D. 9137, 69 FR 42558, July 16, 2004]

                     distributions by a partnership



Sec. 1.731-1  Extent of recognition of gain or loss on distribution.

    (a) Recognition of gain or loss to partner--(1) Recognition of gain. 
(i) Where money is distributed by a partnership to a partner, no gain 
shall be recognized to the partner except to the extent that the amount 
of money distributed exceeds the adjusted basis of the partner's 
interest in the partnership immediately before the distribution. This 
rule is applicable both to current distributions (i.e., distributions 
other than in liquidation of an entire interest) and to distributions in 
liquidation of a partner's entire interest in a partnership. Thus, if a 
partner with a basis for his interest of $10,000 receives a distribution 
of cash of $8,000 and property with a fair market value of $3,000, no 
gain is recognized to him. If $11,000 cash were distributed, gain would 
be recognized to the extent of $1,000. No gain shall be recognized to a 
distributee partner with respect to a distribution of property (other 
than money) until he sells or otherwise disposes of such property, 
except to the extent otherwise provided by section 736 (relating to 
payments to a retiring partner or a deceased partner's successor in 
interest) and section 751 (relating to unrealized receivables and 
inventory items). See section 731(c) and paragraph (c) of this section.
    (ii) For the purposes of sections 731 and 705, advances or drawings 
of money

[[Page 601]]

or property against a partner's distributive share of income shall be 
treated as current distributions made on the last day of the partnership 
taxable year with respect to such partner.
    (2) Recognition of loss. Loss is recognized to a partner only upon 
liquidation of his entire interest in the partnership, and only if the 
property distributed to him consists solely of money, unrealized 
receivables (as defined in section 751(c)), and inventory items (as 
defined in section 751(d)(2)). The term liquidation of a partner's 
interest, as defined in section 761(d), is the termination of the 
partner's entire interest in the partnership by means of a distribution 
or a series of distributions. Loss is recognized to the distributee 
partner in such cases to the extent of the excess of the adjusted basis 
of such partner's interest in the partnership at the time of the 
distribution over the sum of:
    (i) Any money distributed to him, and
    (ii) The basis to the distributee, as determined under section 732, 
of any unrealized receivables and inventory items that are distributed 
to him.

If the partner whose interest is liquidated receives any property other 
than money, unrealized receivables, or inventory items, then no loss 
will be recognized. Application of the provisions of this subparagraph 
may be illustrated by the following examples:

    Example 1. Partner A has a partnership interest in partnership ABC 
with an adjusted basis to him of $10,000. He retires from the 
partnership and receives, as a distribution in liquidation of his entire 
interest, his share of partnership property. This share is $5,000 cash 
and inventory with a basis to him (under section 732) of $3,000. Partner 
A realizes a capital loss of $2,000, which is recognized under section 
731(a)(2).
    Example 2. Partner B has a partnership interest in partnership BCD 
with an adjusted basis to him of $10,000. He retires from the 
partnership and receives, as a distribution in liquidation of his entire 
interest, his share of partnership property. This share is $4,000 cash, 
real property (used in the trade or business) with an adjusted basis to 
the partnership of $2,000, and unrealized receivables having a basis to 
him (under section 732) of $3,000. No loss will be recognized to B on 
the transaction because he received property other than money, 
unrealized receivables, and inventory items. As determined under section 
732, the basis to B for the real property received is $3,000.

    (3) Character of gain or loss. Gain or loss recognized under section 
731(a) on a distribution is considered gain or loss from the sale or 
exchange of the partnership interest of the distributee partner, that 
is, capital gain or loss.
    (b) Gain or loss recognized by partnership. A distribution of 
property (including money) by a partnership to a partner does not result 
in recognized gain or loss to the partnership under section 731. 
However, recognized gain or loss may result to the partnership from 
certain distributions which, under section 751(b), must be treated as a 
sale or exchange of property between the distributee partner and the 
partnership.
    (c) Exceptions. (1) Section 731 does not apply to the extent 
otherwise provided by:
    (i) Section 736 (relating to payments to a retiring partner or to a 
deceased partner's successor in interest) and
    (ii) Section 751 (relating to unrealized receivables and inventory 
items).

For example, payments under section 736(a), which are considered as a 
distributive share or guaranteed payment, are taxable as such under that 
section.
    (2) The receipt by a partner from the partnership of money or 
property under an obligation to repay the amount of such money or to 
return such property does not constitute a distribution subject to 
section 731 but is a loan governed by section 707(a). To the extent that 
such an obligation is canceled, the obligor partner will be considered 
to have received a distribution of money or property at the time of 
cancellation.
    (3) If there is a contribution of property to a partnership and 
within a short period:
    (i) Before or after such contribution other property is distributed 
to the contributing partner and the contributed property is retained by 
the partnership, or
    (ii) After such contribution the contributed property is distributed 
to another partner,

such distribution may not fall within the scope of section 731. Section 
731 does not apply to a distribution of property, if, in fact, the 
distribution

[[Page 602]]

was made in order to effect an exchange of property between two or more 
of the partners or between the partnership and a partner. Such a 
transaction shall be treated as an exchange of property.



Sec. 1.731-2  Partnership distributions of marketable securities.

    (a) Marketable securities treated as money. Except as otherwise 
provided in section 731(c) and this section, for purposes of sections 
731(a)(1) and 737, the term money includes marketable securities and 
such securities are taken into account at their fair market value as of 
the date of the distribution.
    (b) Reduction of amount treated as money--(1) Aggregation of 
securities. For purposes of section 731(c)(3)(B) and this paragraph (b), 
all marketable securities held by a partnership are treated as 
marketable securities of the same class and issuer as the distributed 
security.
    (2) Amount of reduction. The amount of the distribution of 
marketable securities that is treated as a distribution of money under 
section 731(c) and paragraph (a) of this section is reduced (but not 
below zero) by the excess, if any, of--
    (i) The distributee partner's distributive share of the net gain, if 
any, which would be recognized if all the marketable securities held by 
the partnership were sold (immediately before the transaction to which 
the distribution relates) by the partnership for fair market value; over
    (ii) The distributee partner's distributive share of the net gain, 
if any, which is attributable to the marketable securities held by the 
partnership immediately after the transaction, determined by using the 
same fair market value as used under paragraph (b)(2)(i) of this 
section.
    (3) Distributee partner's share of net gain. For purposes of section 
731(c)(3)(B) and paragraph (b)(2) of this section, a partner's 
distributive share of net gain is determined--
    (i) By taking into account any basis adjustments under section 
743(b) with respect to that partner;
    (ii) Without taking into account any special allocations adopted 
with a principal purpose of avoiding the effect of section 731(c) and 
this section; and
    (iii) Without taking into account any gain or loss attributable to a 
distributed security to which paragraph (d)(1) of this section applies.
    (c) Marketable securities--(1) In general. For purposes of section 
731(c) and this section, the term marketable securities is defined in 
section 731(c)(2).
    (2) Actively traded. For purposes of section 731(c) and this 
section, a financial instrument is actively traded (and thus is a 
marketable security) if it is of a type that is, as of the date of 
distribution, actively traded within the meaning of section 1092(d)(1). 
Thus, for example, if XYZ common stock is listed on a national 
securities exchange, particular shares of XYZ common stock that are 
distributed by a partnership are marketable securities even if those 
particular shares cannot be resold by the distributee partner for a 
designated period of time.
    (3) Interests in an entity--(i) Substantially all. For purposes of 
section 731(c)(2)(B)(v) and this section, substantially all of the 
assets of an entity consist (directly or indirectly) of marketable 
securities, money, or both only if 90 percent or more of the assets of 
the entity (by value) at the time of the distribution of an interest in 
the entity consist (directly or indirectly) of marketable securities, 
money, or both.
    (ii) Less than substantially all. For purposes of section 
731(c)(2)(B)(vi) and this section, an interest in an entity is a 
marketable security to the extent that the value of the interest is 
attributable (directly or indirectly) to marketable securities, money, 
or both, if less than 90 percent but 20 percent or more of the assets of 
the entity (by value) at the time of the distribution of an interest in 
the entity consist (directly or indirectly) of marketable securities, 
money, or both.
    (4) Value of assets. For purposes of section 731(c) and this 
section, the value of the assets of an entity is determined without 
regard to any debt that may encumber or otherwise be allocable to those 
assets, other than debt that is incurred to acquire an asset with a 
principal purpose of avoiding or reducing the effect of section 731(c) 
and this section.

[[Page 603]]

    (d) Exceptions--(1) In general. Except as otherwise provided in 
paragraph (d)(2) of this section, section 731(c) and this section do not 
apply to the distribution of a marketable security if--
    (i) The security was contributed to the partnership by the 
distributee partner;
    (ii) The security was acquired by the partnership in a 
nonrecognition transaction, and the following conditions are satisfied--
    (A) The value of any marketable securities and money exchanged by 
the partnership in the nonrecognition transaction is less than 20 
percent of the value of all the assets exchanged by the partnership in 
the nonrecognition transaction; and
    (B) The partnership distributed the security within five years of 
either the date the security was acquired by the partnership or, if 
later, the date the security became marketable; or
    (iii) The security was not a marketable security on the date 
acquired by the partnership, and the following conditions are 
satisfied--
    (A) The entity that issued the security had no outstanding 
marketable securities at the time the security was acquired by the 
partnership;
    (B) The security was held by the partnership for at least six months 
before the date the security became marketable; and
    (C) The partnership distributed the security within five years of 
the date the security became marketable.
    (2) Anti-stuffing rule. Paragraph (d)(1) of this section does not 
apply to the extent that 20 percent or more of the value of the 
distributed security is attributable to marketable securities or money 
contributed (directly or indirectly) by the partnership to the entity to 
which the distributed security relates after the security was acquired 
by the partnership (other than marketable securities contributed by the 
partnership that were originally contributed to the partnership by the 
distributee partner). For purposes of this paragraph (d)(2), money 
contributed by the distributing partnership does not include any money 
deemed contributed by the partnership as a result of section 752.
    (3) Successor security. Section 731(c) and this section apply to the 
distribution of a marketable security acquired by the partnership in a 
nonrecognition transaction in exchange for a security the distribution 
of which immediately prior to the exchange would have been excepted 
under this paragraph (d) only to the extent that section 731(c) and this 
section otherwise would have applied to the exchanged security.
    (e) Investment partnerships--(1) In general. Section 731(c) and this 
section do not apply to the distribution of marketable securities by an 
investment partnership (as defined in section 731(c)(3)(C)(i)) to an 
eligible partner (as defined in section 731(c)(3)(C)(iii)).
    (2) Eligible partner--(i) Contributed services. For purposes of 
section 731(c)(3)(C)(iii) and this section, a partner is not treated as 
a partner other than an eligible partner solely because the partner 
contributed services to the partnership.
    (ii) Contributed partnership interests. For purposes of determining 
whether a partner is an eligible partner under section 731(c)(3)(C), if 
the partner has contributed to the investment partnership an interest in 
another partnership that meets the requirements of paragraph (e)(4)(i) 
of this section after the contribution, the contributed interest is 
treated as property specified in section 731(c)(3)(C)(i).
    (3) Trade or business activities. For purposes of section 
731(c)(3)(C) and this section, a partnership is not treated as engaged 
in a trade or business by reason of--
    (i) Any activity undertaken as an investor, trader, or dealer in any 
asset described in section 731(c)(3)(C)(i), including the receipt of 
commitment fees, break-up fees, guarantee fees, director's fees, or 
similar fees that are customary in and incidental to any activities of 
the partnership as an investor, trader, or dealer in such assets;
    (ii) Reasonable and customary management services (including the 
receipt of reasonable and customary fees in exchange for such management 
services) provided to an investment partnership (within the meaning of 
section 731(c)(3)(C)(i)) in which the partnership holds a partnership 
interest; or

[[Page 604]]

    (iii) Reasonable and customary services provided by the partnership 
in assisting the formation, capitalization, expansion, or offering of 
interests in a corporation (or other entity) in which the partnership 
holds or acquires a significant equity interest (including the provision 
of advice or consulting services, bridge loans, guarantees of 
obligations, or service on a company's board of directors), provided 
that the anticipated receipt of compensation for the services, if any, 
does not represent a significant purpose for the partnership's 
investment in the entity and is incidental to the investment in the 
entity.
    (4) Partnership tiers. For purposes of section 731(c)(3)(C)(iv) and 
this section, a partnership (upper-tier partnership) is not treated as 
engaged in a trade or business engaged in by, or as holding (instead of 
a partnership interest) a proportionate share of the assets of, a 
partnership (lower-tier partnership) in which the partnership holds a 
partnership interest if--
    (i) The upper-tier partnership does not actively and substantially 
participate in the management of the lower-tier partnership; and
    (ii) The interest held by the upper-tier partnership is less than 20 
percent of the total profits and capital interests in the lower-tier 
partnership.
    (f) Basis rules--(1) Partner's basis--(i) Partner's basis in 
distributed securities. The distributee partner's basis in distributed 
marketable securities with respect to which gain is recognized by reason 
of section 731(c) and this section is the basis of the security 
determined under section 732, increased by the amount of such gain. Any 
increase in the basis of the marketable securities attributable to gain 
recognized by reason of section 731(c) and this section is allocated to 
marketable securities in proportion to their respective amounts of 
unrealized appreciation in the hands of the partner before such 
increase.
    (ii) Partner's basis in partnership interest. The basis of the 
distributee partner's interest in the partnership is determined under 
section 733 as if no gain were recognized by the partner on the 
distribution by reason of section 731(c) and this section.
    (2) Basis of partnership property. No adjustment is made to the 
basis of partnership property under section 734 as a result of any gain 
recognized by a partner, or any step-up in the basis in the distributed 
marketable securities in the hands of the distributee partner, by reason 
of section 731(c) and this section.
    (g) Coordination with other sections--(1) Sections 704(c)(1)(B) and 
737--(i) In general. If a distribution results in the application of 
sections 731(c) and one or both of sections 704(c)(1)(B) and 737, the 
effect of the distribution is determined by applying section 
704(c)(1)(B) first, section 731(c) second, and finally section 737.
    (ii) Section 704(c)(1)(B). The basis of the distributee partner's 
interest in the partnership for purposes of determining the amount of 
gain, if any, recognized by reason of section 731(c) (and for 
determining the basis of the marketable securities in the hands of the 
distributee partner) includes the increase or decrease, if any, in the 
partner's basis that occurs under section 704(c)(1)(B)(iii) as a result 
of a distribution to another partner of property contributed by the 
distributee partner in a distribution that is part of the same 
distribution as the marketable securities.
    (iii) Section 737--(A) Marketable securities as other property. A 
distribution of marketable securities is treated as a distribution of 
property other than money for purposes of section 737 to the extent that 
the marketable securities are not treated as money under section 731(c). 
In addition, marketable securities contributed to the partnership are 
treated as property other than money in determining the contributing 
partner's net precontribution gain under section 737(b).
    (B) Basis increase under section 737. The basis of the distributee 
partner's interest in the partnership for purposes of determining the 
amount of gain, if any, recognized by reason of section 731(c) (and for 
determining the basis of the marketable securities in the hands of the 
distributee partner) does not include the increase, if any, in the 
partner's basis that occurs under section 737(c)(1) as a result of a 
distribution of property to the distributee partner in a

[[Page 605]]

distribution that is part of the same distribution as the marketable 
securities.
    (2) Section 708(b)(1)(B). If a partnership termination occurs under 
section 708(b)(1)(B), the successor partnership will be treated as if 
there had been no termination for purposes of section 731(c) and this 
section. Accordingly, a section 708(b)(1)(B) termination will not affect 
whether a partnership qualifies for any of the exceptions in paragraphs 
(d) and (e) of this section. In addition, a deemed distribution that may 
occur as a result of a section 708(b)(1)(B) termination will not be 
subject to section 731(c) and this section.
    (h) Anti-abuse rule. The provisions of section 731(c) and this 
section must be applied in a manner consistent with the purpose of 
section 731(c) and the substance of the transaction. Accordingly, if a 
principal purpose of a transaction is to achieve a tax result that is 
inconsistent with the purpose of section 731(c) and this section, the 
Commissioner can recast the transaction for Federal tax purposes as 
appropriate to achieve tax results that are consistent with the purpose 
of section 731(c) and this section. Whether a tax result is inconsistent 
with the purpose of section 731(c) and this section must be determined 
based on all the facts and circumstances. For example, under the 
provisions of this paragraph (h)--
    (1) A change in partnership allocations or distribution rights with 
respect to marketable securities may be treated as a distribution of the 
marketable securities subject to section 731(c) if the change in 
allocations or distribution rights is, in substance, a distribution of 
the securities;
    (2) A distribution of substantially all of the assets of the 
partnership other than marketable securities and money to some partners 
may also be treated as a distribution of marketable securities to the 
remaining partners if the distribution of the other property and the 
withdrawal of the other partners is, in substance, equivalent to a 
distribution of the securities to the remaining partners; and
    (3) The distribution of multiple properties to one or more partners 
at different times may also be treated as part of a single distribution 
if the distributions are part of a single plan of distribution.
    (i) [Reserved]
    (j) Examples. The following examples illustrate the rules of this 
section. Unless otherwise specified, all securities held by a 
partnership are marketable securities within the meaning of section 
731(c); the partnership holds no marketable securities other than the 
securities described in the example; all distributions by the 
partnership are subject to section 731(a) and are not subject to 
sections 704(c)(1)(B), 707(a)(2)(B), 751(b), or 737; and no securities 
are eligible for an exception to section 731(c). The examples are as 
follows:

    Example 1. Recognition of gain. (i) A and B form partnership AB as 
equal partners. A contributes property with a fair market value of 
$1,000 and an adjusted tax basis of $250. B contributes $1,000 cash. AB 
subsequently purchases Security X for $500 and immediately distributes 
the security to A in a current distribution. The basis in A's interest 
in the partnership at the time of distribution is $250.
    (ii) The distribution of Security X is treated as a distribution of 
money in an amount equal to the fair market value of Security X on the 
date of distribution ($500). (The amount of the distribution that is 
treated as money is not reduced under section 731(c)(3)(B) and paragraph 
(b) of this section because, if Security X had been sold immediately 
before the distribution, there would have been no gain recognized by AB 
and A's distributive share of the gain would therefore have been zero.) 
As a result, A recognizes $250 of gain under section 731(a)(1) on the 
distribution ($500 distribution of money less $250 adjusted tax basis in 
A's partnership interest).
    Example 2. Reduction in amount treated as money--in general. (i) A 
and B form partnership AB as equal partners. AB subsequently distributes 
Security X to A in a current distribution. Immediately before the 
distribution, AB held securities with the following fair market values, 
adjusted tax bases, and unrecognized gain or loss:

------------------------------------------------------------------------
                                                                   Gain
                                                Value    Basis    (Loss)
------------------------------------------------------------------------
Security X...................................      100       70       30
Security Y...................................      100       80       20
Security Z...................................      100      110     (10)
------------------------------------------------------------------------

    (ii) If AB had sold the securities for fair market value immediately 
before the distribution to A, the partnership would have

[[Page 606]]

recognized $40 of net gain ($30 gain on Security X plus $20 gain on 
Security Y minus $10 loss on Security Z). A's distributive share of this 
gain would have been $20 (one-half of $40 net gain). If AB had sold the 
remaining securities immediately after the distribution of Security X to 
A, the partnership would have $10 of net gain ($20 of gain on Security Y 
minus $10 loss on Security Z). A's distributive share of this gain would 
have been $5 (one-half of $10 net gain). As a result, the distribution 
resulted in a decrease of $15 in A's distributive share of the net gain 
in AB's securities ($20 net gain before distribution minus $5 net gain 
after distribution).
    (iii) Under paragraph (b) of this section, the amount of the 
distribution of Security X that is treated as a distribution of money is 
reduced by $15. The distribution of Security X is therefore treated as a 
distribution of $85 of money to A ($100 fair market value of Security X 
minus $15 reduction).
    Example 3. Reduction in amount treated as money--carried interest. 
(i) A and B form partnership AB. A contributes $1,000 and provides 
substantial services to the partnership in exchange for a 60 percent 
interest in partnership profits. B contributes $1,000 in exchange for a 
40 percent interest in partnership profits. AB subsequently distributes 
Security X to A in a current distribution. Immediately before the 
distribution, AB held securities with the following fair market values, 
adjusted tax bases, and unrecognized gain:

------------------------------------------------------------------------
                                                Value    Basis     Gain
------------------------------------------------------------------------
Security X...................................      100       80       20
Security Y...................................      100       90       10
------------------------------------------------------------------------

    (ii) If AB had sold the securities for fair market value immediately 
before the distribution to A, the partnership would have recognized $30 
of net gain ($20 gain on Security X plus $10 gain on Security Y). A's 
distributive share of this gain would have been $18 (60 percent of $30 
net gain). If AB had sold the remaining securities immediately after the 
distribution of Security X to A, the partnership would have $10 of net 
gain ($10 gain on Security Y). A's distributive share of this gain would 
have been $6 (60 percent of $10 net gain). As a result, the distribution 
resulted in a decrease of $12 in A's distributive share of the net gain 
in AB's securities ($18 net gain before distribution minus $6 net gain 
after distribution).
    (iii) Under paragraph (b) of this section, the amount of the 
distribution of Security X that is treated as a distribution of money is 
reduced by $12. The distribution of Security X is therefore treated as a 
distribution of $88 of money to A ($100 fair market value of Security X 
minus $12 reduction).
    Example 4. Reduction in amount treated as money--change in 
partnership allocations. (i) A is admitted to partnership ABC as a 
partner with a 1 percent interest in partnership profits. At the time of 
A's admission, ABC held no securities. ABC subsequently acquires 
Security X. A's interest in partnership profits is subsequently 
increased to 2 percent for securities acquired after the increase. A 
retains a 1 percent interest in all securities acquired before the 
increase. ABC then acquires Securities Y and Z and later distributes 
Security X to A in a current distribution. Immediately before the 
distribution, the securities held by ABC had the following fair market 
values, adjusted tax bases, and unrecognized gain or loss:

------------------------------------------------------------------------
                                                                   Gain
                                                Value    Basis    (Loss)
------------------------------------------------------------------------
Security X...................................    1,000      500      500
Security Y...................................    1,000      800      200
Security Z...................................    1,000    1,100    (100)
------------------------------------------------------------------------

    (ii) If ABC had sold the securities for fair market value 
immediately before the distribution to A, the partnership would have 
recognized $600 of net gain ($500 gain on Security X plus $200 gain on 
Security Y minus $100 loss on Security Z). A's distributive share of 
this gain would have been $7 (1 percent of $500 gain on Security X plus 
2 percent of $200 gain on Security Y minus 2 percent of $100 loss on 
Security Z).
    (iii) If ABC had sold the remaining securities immediately after the 
distribution of Security X to A, the partnership would have $100 of net 
gain ($200 gain on Security Y minus $100 loss on Security Z). A's 
distributive share of this gain would have been $2 (2 percent of $200 
gain on Security Y minus 2 percent of $100 loss on Security Z). As a 
result, the distribution resulted in a decrease of $5 in A's 
distributive share of the net gain in ABC's securities ($7 net gain 
before distribution minus $2 net gain after distribution).
    (iv) Under paragraph (b) of this section, the amount of the 
distribution of Security X that is treated as a distribution of money is 
reduced by $5. The distribution of Security X is therefore treated as a 
distribution of $995 of money to A ($1000 fair market value of Security 
X minus $5 reduction).
    Example 5. Basis consequences--distribution of marketable security. 
(i) A and B form partnership AB as equal partners. A contributes 
nondepreciable real property with a fair market value and adjusted tax 
basis of $100.
    (ii) AB subsequently distributes Security X with a fair market value 
of $120 and an adjusted tax basis of $90 to A in a current distribution. 
At the time of distribution, the basis in A's interest in the 
partnership is $100. The amount of the distribution that is treated as 
money is reduced under section 731(c)(3)(B) and paragraph (b)(2) of this 
section by $15 (one-half of $30 net gain in Security X). As a result, A 
recognizes $5 of gain

[[Page 607]]

under section 731(a) on the distribution (excess of $105 distribution of 
money over $100 adjusted tax basis in A's partnership interest).
    (iii) A's adjusted tax basis in Security X is $95 ($90 adjusted 
basis of Security X determined under section 732(a)(1) plus $5 of gain 
recognized by A by reason of section 731(c)). The basis in A's interest 
in the partnership is $10 as determined under section 733 ($100 pre-
distribution basis minus $90 basis allocated to Security X under section 
732).
    Example 6. Basis consequences--distribution of marketable security 
and other property. (i) A and B form partnership AB as equal partners. A 
contributes nondepreciable real property, with a fair market value of 
$100 and an adjusted tax basis of $10.
    (ii) AB subsequently distributes Security X with a fair market value 
and adjusted tax basis of $40 to A in a current distribution and, as 
part of the same distribution, AB distributes Property Z to A with an 
adjusted tax basis and fair market value of $40. At the time of 
distribution, the basis in A's interest in the partnership is $10. A 
recognizes $30 of gain under section 731(a) on the distribution (excess 
of $40 distribution of money over $10 adjusted tax basis in A's 
partnership interest).
    (iii) A's adjusted tax basis in Security X is $35 ($5 adjusted basis 
determined under section 732(a)(2) plus $30 of gain recognized by A by 
reason of section 731(c)). A's basis in Property Z is $5, as determined 
under section 732(a)(2). The basis in A's interest in the partnership is 
$0 as determined under section 733 ($10 pre-distribution basis minus $10 
basis allocated between Security X and Property Z under section 732).
    (iv) AB's adjusted tax basis in the remaining partnership assets is 
unchanged unless the partnership has a section 754 election in effect. 
If AB made such an election, the aggregate basis of AB's assets would be 
increased by $70 (the difference between the $80 combined basis of 
Security X and Property Z in the hands of the partnership before the 
distribution and the $10 combined basis of the distributed property in 
the hands of A under section 732 after the distribution). Under section 
731(c)(5), no adjustment is made to partnership property under section 
734 as a result of any gain recognized by A by reason of section 731(c) 
or as a result of any step-up in basis in the distributed marketable 
securities in the hands of A by reason of section 731(c).
    Example 7. Coordination with section 737. (i) A and B form 
partnership AB. A contributes Property A, nondepreciable real property 
with a fair market value of $200 and an adjusted basis of $100 in 
exchange for a 25 percent interest in partnership capital and profits. 
AB owns marketable Security X.
    (ii) Within five years of the contribution of Property A, AB 
subsequently distributes Security X, with a fair market value of $120 
and an adjusted tax basis of $100, to A in a current distribution that 
is subject to section 737. As part of the same distribution, AB 
distributes Property Y to A with a fair market value of $20 and an 
adjusted tax basis of $0. At the time of distribution, there has been no 
change in the fair market value of Property A or the adjusted tax basis 
in A's interest in the partnership.
    (iii) If AB had sold Security X for fair market value immediately 
before the distribution to A, the partnership would have recognized $20 
of gain. A's distributive share of this gain would have been $5 (25 
percent of $20 gain). Because AB has no other marketable securities, A's 
distributive share of gain in partnership securities after the 
distribution would have been $0. As a result, the distribution resulted 
in a decrease of $5 in A's share of the net gain in AB's securities ($5 
net gain before distribution minus $0 net gain after distribution). 
Under paragraph (b)(2) of this section, the amount of the distribution 
of Security X that is treated as a distribution of money is reduced by 
$5. The distribution of Security X is therefore treated as a 
distribution of $115 of money to A ($120 fair market value of Security X 
minus $5 reduction). The portion of the distribution of the marketable 
security that is not treated as a distribution of money ($5) is treated 
as other property for purposes of section 737.
    (iv) A recognizes total gain of $40 on the distribution. A 
recognizes $15 of gain under section 731(a)(1) on the distribution of 
the portion of Security X treated as money ($115 distribution of money 
less $100 adjusted tax basis in A's partnership interest). A recognizes 
$25 of gain under section 737 on the distribution of Property Y and the 
portion of Security X that is not treated as money. A's section 737 gain 
is equal to the lesser of (i) A's precontribution gain ($100) or (ii) 
the excess of the fair market value of property received ($20 fair 
market value of Property Y plus $5 portion of Security X not treated as 
money) over the adjusted basis in A's interest in the partnership 
immediately before the distribution ($100) reduced (but not below zero) 
by the amount of money received in the distribution ($115).
    (v) A's adjusted tax basis in Security X is $115 ($100 basis of 
Security X determined under section 732(a) plus $15 of gain recognized 
by reason of section 731(c)). A's adjusted tax basis in Property Y is $0 
under section 732(a). The basis in A's interest in the partnership is 
$25 ($100 basis before distribution minus $100 basis allocated to 
Security X under section 732(a) plus $25 gain recognized under section 
737).

    (k) Effective date. This section applies to distributions made on or 
after December 26, 1996. However, taxpayers may apply the rules of this 
section to

[[Page 608]]

distributions made after December 8, 1994, and before December 26, 1996.

[T.D. 8707, 61 FR 67938, Dec. 26, 1996; 62 FR 8086, Feb. 21, 1997]



Sec. 1.732-1  Basis of distributed property other than money.

    (a) Distributions other than in liquidation of a partner's interest. 
The basis of property (other than money) received by a partner in a 
distribution from a partnership, other than in liquidation of his entire 
interest, shall be its adjusted basis to the partnership immediately 
before such distribution. However, the basis of the property to the 
partner shall not exceed the adjusted basis of the partner's interest in 
the partnership, reduced by the amount of any money distributed to him 
in the same transaction. The provisions of this paragraph may be 
illustrated by the following examples:

    Example 1. Partner A, with an adjusted basis of $15,000 for his 
partnership interest, receives in a current distribution property having 
an adjusted basis of $10,000 to the partnership immediately before 
distribution, and $2,000 cash. The basis of the property in A's hands 
will be $10,000. Under sections 733 and 705, the basis of A's 
partnership interest will be reduced by the distribution to $3,000 
($15,000 less $2,000 cash, less $10,000, the basis of the distributed 
property to A).
    Example 2. Partner R has an adjusted basis of $10,000 for his 
partnership interest. He receives a current distribution of $4,000 cash 
and property with an adjusted basis to the partnership of $8,000. The 
basis of the distributed property to partner R is limited to $6,000 
($10,000, the adjusted basis of his interest, reduced by $4,000, the 
cash distributed).

    (b) Distribution in liquidation. Where a partnership distributes 
property (other than money) in liquidation of a partner's entire 
interest in the partnership, the basis of such property to the partner 
shall be an amount equal to the adjusted basis of his interest in the 
partnership reduced by the amount of any money distributed to him in the 
same transaction. Application of this rule may be illustrated by the 
following example:

    Example. Partner B, with a partnership interest having an adjusted 
basis to him of $12,000, retires from the partnership and receives cash 
of $2,000, and real property with an adjusted basis to the partnership 
of $6,000 and a fair market value of $14,000. The basis of the real 
property to B is $10,000 (B's basis for his partnership interest, 
$12,000, reduced by $2,000, the cash distributed).

    (c) Allocation of basis among properties distributed to a partner--
(1) General rule--(i) Unrealized receivables and inventory items. The 
basis to be allocated to properties distributed to a partner under 
section 732(a)(2) or (b) is allocated first to any unrealized 
receivables (as defined in section 751(c)) and inventory items (as 
defined in section 751(d)(2)) in an amount equal to the adjusted basis 
of each such property to the partnership immediately before the 
distribution. If the basis to be allocated is less than the sum of the 
adjusted bases to the partnership of the distributed unrealized 
receivables and inventory items, the adjusted basis of the distributed 
property must be decreased in the manner provided in paragraph (c)(2)(i) 
of this section. See Sec. 1.460-4(k)(2)(iv)(D) for a rule determining 
the partnership's basis in a long-term contract accounted for under a 
long-term contract method of accounting.
    (ii) Other distributed property. Any basis not allocated to 
unrealized receivables or inventory items under paragraph (c)(1)(i) of 
this section is allocated to any other property distributed to the 
partner in the same transaction by assigning to each distributed 
property an amount equal to the adjusted basis of the property to the 
partnership immediately before the distribution. However, if the sum of 
the adjusted bases to the partnership of such other distributed property 
does not equal the basis to be allocated among the distributed property, 
any increase or decrease required to make the amounts equal is allocated 
among the distributed property as provided in paragraph (c)(2) of this 
section.
    (2) Adjustment to basis allocation--(i) Decrease in basis. Any 
decrease to the basis of distributed property required under paragraph 
(c)(1) of this section is allocated first to distributed property with 
unrealized depreciation in proportion to each property's respective

[[Page 609]]

amount of unrealized depreciation before any decrease (but only to the 
extent of each property's unrealized depreciation). If the required 
decrease exceeds the amount of unrealized depreciation in the 
distributed property, the excess is allocated to the distributed 
property in proportion to the adjusted bases of the distributed 
property, as adjusted pursuant to the immediately preceding sentence.
    (ii) Increase in basis. Any increase to the basis of distributed 
property required under paragraph (c)(1)(ii) of this section is 
allocated first to distributed property (other than unrealized 
receivables and inventory items) with unrealized appreciation in 
proportion to each property's respective amount of unrealized 
appreciation before any increase (but only to the extent of each 
property's unrealized appreciation). If the required increase exceeds 
the amount of unrealized appreciation in the distributed property, the 
excess is allocated to the distributed property (other than unrealized 
receivables or inventory items) in proportion to the fair market value 
of the distributed property.
    (3) Unrealized receivables and inventory items. If the basis to be 
allocated upon a distribution in liquidation of the partner's entire 
interest in the partnership is greater than the adjusted basis to the 
partnership of the unrealized receivables and inventory items 
distributed to the partner, and if there is no other property 
distributed to which the excess can be allocated, the distributee 
partner sustains a capital loss under section 731(a)(2) to the extent of 
the unallocated basis of the partnership interest.
    (4) Examples. The provisions of this paragraph (c) are illustrated 
by the following examples:

    Example 1. A is a one-fourth partner in partnership PRS and has an 
adjusted basis in its partnership interest of $650. PRS distributes 
inventory items and Assets X and Y to A in liquidation of A's entire 
partnership interest. The distributed inventory items have a basis to 
the partnership of $100 and a fair market value of $200. Asset X has an 
adjusted basis to the partnership of $50 and a fair market value of 
$400. Asset Y has an adjusted basis to the partnership and a fair market 
value of $100. Neither Asset X nor Asset Y consists of inventory items 
or unrealized receivables. Under this paragraph (c), A's basis in its 
partnership interest is allocated first to the inventory items in an 
amount equal to their adjusted basis to the partnership. A, therefore, 
has an adjusted basis in the inventory items of $100. The remaining 
basis, $550, is allocated to the distributed property first in an amount 
equal to the property's adjusted basis to the partnership. Thus, Asset X 
is allocated $50 and Asset Y is allocated $100. Asset X is then 
allocated $350, the amount of unrealized appreciation in Asset X. 
Finally, the remaining basis, $50, is allocated to Assets X and Y in 
proportion to their fair market values: $40 to Asset X (400/500x$50), 
and $10 to Asset Y (100/500x$50). Therefore, after the distribution, A 
has an adjusted basis of $440 in Asset X and $110 in Asset Y.
    Example 2. B is a one-fourth partner in partnership PRS and has an 
adjusted basis in its partnership interest of $200. PRS distributes 
Asset X and Asset Y to B in liquidation of its entire partnership 
interest. Asset X has an adjusted basis to the partnership and fair 
market value of $150. Asset Y has an adjusted basis to the partnership 
of $150 and a fair market value of $50. Neither of the assets consists 
of inventory items or unrealized receivables. Under this paragraph (c), 
B's basis is first assigned to the distributed property to the extent of 
the partnership's basis in each distributed property. Thus, Asset X and 
Asset Y are each assigned $150. Because the aggregate adjusted basis of 
the distributed property, $300, exceeds the basis to be allocated, $200, 
a decrease of $100 in the basis of the distributed property is required. 
Assets X and Y have unrealized depreciation of zero and $100, 
respectively. Thus, the entire decrease is allocated to Asset Y. After 
the distribution, B has an adjusted basis of $150 in Asset X and $50 in 
Asset Y.
    Example 3. C, a partner in partnership PRS, receives a distribution 
in liquidation of its entire partnership interest of $6,000 cash, 
inventory items having an adjusted basis to the partnership of $6,000, 
and real property having an adjusted basis to the partnership of $4,000. 
C's basis in its partnership interest is $9,000. The cash distribution 
reduces C's basis to $3,000, which is allocated entirely to the 
inventory items. The real property has a zero basis in C's hands. The 
partnership bases not carried over to C for the distributed properties 
are lost unless an election under section 754 is in effect requiring the 
partnership to adjust the bases of remaining partnership properties 
under section 734(b).
    Example 4. Assume the same facts as in Example 3 of this paragraph 
except C receives a distribution in liquidation of its entire 
partnership interest of $1,000 cash and inventory items having a basis 
to the partnership of $6,000. The cash distribution reduces C's basis to 
$8,000, which can be allocated only to the extent of $6,000 to the 
inventory

[[Page 610]]

items. The remaining $2,000 basis, not allocable to the distributed 
property, constitutes a capital loss to partner C under section 
731(a)(2). If the election under section 754 is in effect, see section 
734(b) for adjustment of the basis of undistributed partnership 
property.

    (5) Effective date. This paragraph (c) applies to distributions of 
property from a partnership that occur on or after December 15, 1999.
    (d) Special partnership basis to transferee under section 732(d). 
(1)(i) A transfer of a partnership interest occurs upon a sale or 
exchange of an interest or upon the death of a partner. Section 732(d) 
provides a special rule for the determination of the basis of property 
distributed to a transferee partner who acquired any part of his 
partnership interest in a transfer with respect to which the election 
under section 754 (relating to the optional adjustment to basis of 
partnership property) was not in effect.
    (ii) Where an election under section 754 is in effect, see section 
743(b) and Sec. Sec. 1.743-1 and 1.732-2.
    (iii) If a transferee partner receives a distribution of property 
(other than money) from the partnership within 2 years after he acquired 
his interest or part thereof in the partnership by a transfer with 
respect to which the election under section 754 was not in effect, he 
may elect to treat as the adjusted partnership basis of such property 
the adjusted basis such property would have if the adjustment provided 
in section 743(b) were in effect.
    (iv) If an election under section 732(d) is made upon a distribution 
of property to a transferee partner, the amount of the adjustment with 
respect to the transferee partner is not diminished by any depletion or 
depreciation of that portion of the basis of partnership property which 
arises from the special basis adjustment under section 732(d), since 
depletion or depreciation on such portion for the period prior to 
distribution is allowed or allowable only if the optional adjustment 
under section 743(b) is in effect.
    (v) If property is distributed to a transferee partner who elects 
under section 732(d), and if such property is not the same property 
which would have had a special basis adjustment, then such special basis 
adjustment shall apply to any like property received in the 
distribution, provided that the transferee, in exchange for the property 
distributed, has relinquished his interest in the property with respect 
to which he would have had a special basis adjustment. This rule applies 
whether the property in which the transferee has relinquished his 
interest is retained or disposed or by the partnership. (For a shift of 
transferee's basis adjustment under section 743(b) to like property, see 
Sec. 1.743-1(g).)
    (vi) The provisions of this paragraph (d)(1) may be illustrated by 
the following example:

    Example. (i) Transferee partner, T, purchased a one-fourth interest 
in partnership PRS for $17,000. At the time T purchased the partnership 
interest, the election under section 754 was not in effect and the 
partnership inventory had a basis to the partnership of $14,000 and a 
fair market value of $16,000. T's purchase price reflected $500 of this 
difference. Thus, $4,000 of the $17,000 paid by T for the partnership 
interest was attributable to T's share of partnership inventory with a 
basis of $3,500. Within 2 years after T acquired the partnership 
interest, T retired from the partnership and received in liquidation of 
its entire partnership interest the following property:

------------------------------------------------------------------------
                                                     Assets
                                       ---------------------------------
                                         Adjusted basis     Fair market
                                             to PRS            value
------------------------------------------------------------------------
Cash..................................            $1,500          $1,500
Inventory.............................             3,500           4,000
Asset X...............................             2,000           4,000
Asset Y...............................             4,000           5,000
------------------------------------------------------------------------

    (ii) The fair market value of the inventory received by T was one-
fourth of the fair market value of all partnership inventory and was T's 
share of such property. It is immaterial whether the inventory T 
received was on hand when T acquired the interest. In accordance with 
T's election under section 732(d), the amount of T's share of 
partnership basis that is attributable to partnership inventory is 
increased by $500 (one-fourth of the $2,000 difference between the fair 
market value of the property, $16,000, and its $14,000 basis to the 
partnership at the time T purchased its interest). This adjustment under 
section 732(d) applies only for purposes of distributions to T, and not 
for purposes of partnership depreciation, depletion, or gain or loss on 
disposition. Thus, the amount to be allocated among the properties 
received by T in the liquidating distribution is $15,500 ($17,000, T's 
basis for the partnership interest, reduced by the amount of cash 
received, $1,500). This amount is allocated as follows:

[[Page 611]]

the basis of the inventory items received is $4,000, consisting of the 
$3,500 common partnership basis, plus the basis adjustment of $500 which 
T would have had under section 743(b). The remaining basis of $11,500 
($15,500 minus $4,000) is allocated among the remaining property 
distributed to T by assigning to each property the adjusted basis to the 
partnership of such property and adjusting that basis by any required 
increase or decrease. Thus, the adjusted basis to T of Asset X is $5,111 
($2,000, the adjusted basis of Asset X to the partnership, plus $2,000, 
the amount of unrealized appreciation in Asset X, plus $1,111 ($4,000/
$9,000 multiplied by $2,500)). Similarly, the adjusted basis of Asset Y 
to T is $6,389 ($4,000, the adjusted basis of Asset Y to the 
partnership, plus $1,000, the amount of unrealized appreciation in Asset 
Y, plus, $1,389 ($5,000/$9,000 multiplied by $2,500)).

    (2) A transferee partner who wishes to elect under section 732(d) 
shall make the election with his tax return:
    (i) For the year of the distribution, if the distribution includes 
any property subject to the allowance for depreciation, depletion, or 
amortization, or
    (ii) For any taxable year no later than the first taxable year in 
which the basis of any of the distributed property is pertinent in 
determining his income tax, if the distribution does not include any 
such property subject to the allowance for depreciation, depletion or 
amortization.
    (3) A taxpayer making an election under section 732(d) shall submit 
with the return in which the election is made a schedule setting forth 
the following:
    (i) That under section 732(d) he elects to adjust the basis of 
property received in a distribution; and
    (ii) The computation of the special basis adjustment for the 
property distributed and the properties to which the adjustment has been 
allocated. For rules of allocation, see section 755.
    (4) A partner who acquired any part of his partnership interest in a 
transfer to which the election provided in section 754 was not in 
effect, is required to apply the special basis rule contained in section 
732(d) to a distribution to him, whether or not made within 2 years 
after the transfer, if at the time of his acquisition of the transferred 
interest:
    (i) The fair market value of all partnership property (other than 
money) exceeded 110 percent of its adjusted basis to the partnership.
    (ii) An allocation of basis under section 732(c) upon a liquidation 
of his interest immediately after the transfer of the interest would 
have resulted in a shift of basis from property not subject to an 
allowance for depreciation, depletion, or amortization, to property 
subject to such an allowance, and
    (iii) A basis adjustment under section 743(b) would change the basis 
to the transferee partner of the property actually distributed.
    (5) Required statements. If a transferee partner notifies a 
partnership that it plans to make the election under section 732(d) 
under paragraph (d)(3) of this section, or if a partnership makes a 
distribution to which paragraph (d)(4) of this section applies, the 
partnership must provide the transferee with such information as is 
necessary for the transferee properly to compute the transferee's basis 
adjustments under section 732(d).
    (e) Exception. When a partnership distributes unrealized receivables 
(as defined in section 751(c)) or substantially appreciated inventory 
items (as defined in section 751(d)) in exchange for any part of a 
partner's interest in other partnership property (including money), or, 
conversely, partnership property (including money) other than unrealized 
receivables or substantially appreciated inventory items in exchange for 
any part of a partner's interest in the partnership's unrealized 
receivables or substantially appreciated inventory items, the 
distribution will be treated as a sale or exchange of property under the 
provisions of section 751(b). In such case, section 732 (including 
subsection(d) thereof) applies in determining the partner's basis of the 
property which he is treated as having sold to or exchanged with the 
partnership (as constituted after the distribution). The partner is 
considered as having received such property in a current distribution 
and, immediately thereafter, as having sold or exchanged it. See section 
751(b) and paragraph (b) of Sec. 1.751-1. However, section 732 does not 
apply in determining the basis of that part of property actually 
distributed to a partner which is treated as received by him

[[Page 612]]

in a sale or exchange under section 751(b). Consequently, the basis of 
such property shall be its cost to the partner.

[T.D. 6500, 25 FR 11814, Nov. 26, 1960; 25 FR 14021, Dec. 31, 1960, as 
amended by T.D. 8847, 64 FR 69907, Dec. 15, 1999; T.D. 9137, 69 FR 
42558, July 16, 2004]



Sec. 1.732-2  Special partnership basis of distributed property.

    (a) Adjustments under section 734(b). In the case of a distribution 
of property to a partner, the partnership bases of the distributed 
properties shall reflect any increases or decreases to the basis of 
partnership property which have been made previously under section 
734(b) (relating to the optional adjustment to basis of undistributed 
partnership property) in connection with previous distributions.
    (b) Adjustments under section 743(b). In the case of a distribution 
of property to a partner who acquired any part of his interest in a 
transfer as to which an election under section 754 was in effect, then, 
for the purposes of section 732 (other than subsection (d) thereof), the 
adjusted partnership bases of the distributed property shall take into 
account, in addition to any adjustments under section 734(b), the 
transferee's special basis adjustment for the distributed property under 
section 743(b). The application of this paragraph may be illustrated by 
the following example:

    Example. Partner D acquired his interest in partnership ABD from a 
previous partner. Since the partnership had made an election under 
section 754, a special basis adjustment with respect to D is applicable 
to the basis of partnership property in accordance with section 743(b). 
One of the assets of the partnership at the time D acquired his interest 
was property X, which is later distributed to D in a current 
distribution. Property X has an adjusted basis to the partnership of 
$1,000 and with respect to D it has a special basis adjustment of $500. 
Therefore, for purposes of section 732(a)(1), the adjusted basis of such 
property to the partnership with respect to D immediately before its 
distribution is $1,500. However, if property X is distributed to partner 
A, a nontransferee partner, its adjusted basis to the partnership for 
purposes of section 732(a)(1) is only $1,000. In such case, D's $500 
special basis adjustment may shift over to other property. See Sec. 
1.743-1(g).

    (c) Adjustments to basis of distributed inventory and unrealized 
receivables. Under section 732, the basis to be allocated to distributed 
properties shall be allocated first to any unrealized receivables and 
inventory items. If the distributee partner is a transferee of a 
partnership interest and has a special basis adjustment for unrealized 
receivables or inventory items under either section 743(b) or section 
732(d), then the partnership adjusted basis immediately prior to 
distribution of any unrealized receivables or inventory items 
distributed to such partner shall be determined as follows: If the 
distributee partner receives his entire share of the fair market value 
of the inventory items or unrealized receivables of the partnership, the 
adjusted basis of such distributed property to the partnership, for the 
purposes of section 732, shall take into account the entire amount of 
any special basis adjustment which the distributee partner may have for 
such assets. If the distributee partner receives less than his entire 
share of the fair market value of partnership inventory items or 
unrealized receivables, then, for purposes of section 732, the adjusted 
basis of such distributed property to the partnership shall take into 
account the same proportion of the distributee's special basis 
adjustment for unrealized receivables or inventory items as the value of 
such items distributed to him bears to his entire share of the total 
value of all such items of the partnership. The provisions of this 
paragraph may be illustrated by the following example:

    Example. Partner C acquired his 40-percent interest in partnership 
AC from a previous partner. Since the partnership had made an election 
under section 754, C has a special basis adjustment to partnership 
property under section 743(b). C retires from the partnership when the 
adjusted basis of his partnership interest is $3,000. He receives from 
the partnership in liquidation of his entire interest, $1,000 cash, 
certain capital assets, depreciable property, and certain inventory 
items and unrealized receivables. C has a special basis adjustment of 
$800 with respect to partnership inventory items and of $200 with 
respect to unrealized receivables. The common partnership basis for the 
inventory items distributed to him is $500 and for the unrealized 
receivables is zero. If the value of inventory items and the unrealized 
receivables distributed to C in his 40 percent share

[[Page 613]]

of the total value of all partnership inventory items and unrealized 
receivables, then, for purposes of section 732, the adjusted basis of 
such property in C's hands will be $1,300 for the inventory items ($500 
plus $800) and $200 for the unrealized receivables (zero plus $200). The 
remaining basis of $500, which constitutes the basis of the capital 
assets and depreciable property distributed to C, is determined as 
follows: $3,000 (total basis) less $1,000 cash, or $2,000 (the amount to 
be allocated to the basis of all distributed property), less $1,500 
($800 and $200 special basis adjustments, plus $500 common partnership 
basis, the amount allocated to inventory items and unrealized 
receivables). However, if the value of the inventory items and 
unrealized receivables distributed to C consisted of only 20 percent of 
the total fair market value of such property (i. e., only one-half of 
C's 40-percent share), then only one-half of C's special basis 
adjustment of $800 for partnership inventory items and $200 for 
unrealized receivables would be taken into account. In that case, the 
basis of the inventory items in C's hands would be $650 ($250, the 
common partnership basis for inventory items distributed to him, plus 
$400, one-half of C's special basis adjustment for inventory items). The 
basis of the unrealized receivables in C's hands would be $100 (zero 
plus $100, one-half of C's special basis adjustment for unrealized 
receivables).

[T.D. 6500, 25 FR 11814, Nov. 26, 1960; 25 FR 14021, Dec. 31, 1960, as 
amended by T.D. 8847, 64 FR 69908, Dec. 15, 1999]



Sec. 1.732-3  Corresponding adjustment to basis of assets of a
distributed corporation controlled by a corporate partner.

    The determination of whether a corporate partner has control of a 
distributed corporation for purposes of section 732(f) shall be made by 
applying the special aggregate stock ownership rules of Sec. 1.1502-34.

[T.D. 8949, 66 FR 32902, June 19, 2001]



Sec. 1.733-1  Basis of distributee partner's interest.

    In the case of a distribution by a partnership to a partner other 
than in liquidation of a partner's entire interest, the adjusted basis 
to such partner of his interest in the partnership shall be reduced (but 
not below zero) by the amount of any money distributed to such partner 
and by the amount of the basis to him of distributed property other than 
money as determined under section 732 and Sec. Sec. 1.732-1 and 1.732-
2.



Sec. 1.734-1  Optional adjustment to basis of undistributed partnership
property.

    (a) General rule. A partnership shall not adjust the basis of 
partnership property as the result of a distribution of property to a 
partner, unless the election provided in section 754 (relating to 
optional adjustment to basis of partnership property) is in effect.
    (b) Method of adjustment--(1) Increase in basis. Where an election 
under section 754 is in effect and a distribution of partnership 
property is made, whether or not in liquidation of the partner's entire 
interest in the partnership, the adjusted basis of the remaining 
partnership assets shall be increased by:
    (i) The amount of any gain recognized under section 731(a)(1) to the 
distributee partner, or
    (ii) The excess of the adjusted basis to the partnership immediately 
before the distribution of any property distributed (including 
adjustments under section 743(b) or section 732(d) when applied) over 
the basis under section 732 (including such special basis adjustments) 
of such property to the distributee partner.
    See Sec. 1.460-4(k)(2)(iv)(D) for a rule determining the 
partnership's basis in a long-term contract accounted for under a long-
term contract method of accounting. The provisions of this paragraph 
(b)(1) are illustrated by the following examples:

    Example 1. Partner A has a basis of $10,000 for his one-third 
interest in partnership ABC. The partnership has no liabilities and has 
assets consisting of cash of $11,000 and property with a partnership 
basis of $19,000 and a value of $22,000. A receives $11,000 in cash in 
liquidation of his entire interest in the partnership. He has a gain of 
$1,000 under section 731(a)(1). If the election under section 754 is in 
effect, the partnership basis for the property becomes $20,000 ($19,000 
plus $1,000).
    Example 2. Partner D has a basis of $10,000 for his one-third 
interest in partnership DEF. The partnership balance sheet before the 
distribution shows the following:

                                 Assets
------------------------------------------------------------------------
                                          Adjusted basis       Value
------------------------------------------------------------------------
Cash..................................      $4,000           $4,000
Property X............................      11,000           11,000
Property Y............................      15,000           18,000
                                       ---------------------------------

[[Page 614]]

 
    Total.............................      30,000           33,000
------------------------------------------------------------------------


                         Liabilities and Capital
------------------------------------------------------------------------
                                          Adjusted basis       Value
------------------------------------------------------------------------
Liabilities...........................          $0               $0
Capital:
  D...................................      10,000           11,000
  E...................................      10,000           11,000
  F...................................      10,000           11,000
                                       ---------------------------------
    Total.............................      30,000           33,000
------------------------------------------------------------------------


In liquidation of his entire interest in the partnership, D received 
property X with a partnership basis of $11,000. D's basis for property X 
is $10,000 under section 732(b). Where the election under section 754 is 
in effect, the excess of $1,000 (the partnership basis before the 
distribution less D's basis for property X after distribution) is added 
to the basis of property Y. The basis of property Y becomes $16,000 
($15,000 plus $1,000). If the distribution is made to a transferee 
partner who elects under section 732(d), see Sec. 1.734-2.

    (2) Decrease in basis. Where the election provided in section 754 is 
in effect and a distribution is made in liquidation of a partner's 
entire interest, the partnership shall decrease the adjusted basis of 
the remaining partnership property by:
    (i) The amount of loss, if any, recognized under section 731(a)(2) 
to the distributee partner, or
    (ii) The excess of the basis of the distributed property to the 
distributee, as determined under section 732 (including adjustments 
under section 743(b) or section 732(d) when applied) over the adjusted 
basis of such property to the partnership (including such special basis 
adjustments) immediately before such distribution.

The provisions of this subparagraph may be illustrated by the following 
examples:

    Example 1. Partner G has a basis of $11,000 for his one-third 
interest in partnership GHI. Partnership assets consist of cash of 
$10,000 and property with a basis of $23,000 and a value of $20,000. 
There are no partnership liabilities. In liquidation of his entire 
interest in the partnership, G receives $10,000 in cash. He has a loss 
of $1,000 under section 731(a)(2). If the election under section 754 is 
in effect, the partnership basis for the property becomes $22,000 
($23,000 less $1,000).
    Example 2. Partner J has a basis of $11,000 for his one-third 
interest in partnership JKL. The partnership balance sheet before the 
distribution shows the following:

                                 Assets
------------------------------------------------------------------------
                                          Adjusted basis       Value
------------------------------------------------------------------------
Cash..................................      $5,000           $5,000
Property X............................      10,000           10,000
Property Y............................      18,000           15,000
                                       ---------------------------------
    Total.............................      33,000           30,000
------------------------------------------------------------------------


                         Liabilities and Capital
------------------------------------------------------------------------
                                          Adjusted basis       Value
------------------------------------------------------------------------
Liabilities...........................          $0               $0
Capital:
  J...................................      11,000           10,000
  K...................................      11,000           10,000
  L...................................      11,000           10,000
                                       ---------------------------------
    Total.............................      33,000           30,000
------------------------------------------------------------------------


In liquidation of his entire interest in the partnership, J receives 
property X with a partnership basis of $10,000. J's basis for property X 
under section 732(b) is $11,000. Where the election under section 754 is 
in effect, the excess of $1,000 ($11,000 basis of property X to J, the 
distributee, less its $10,000 adjusted basis to the partnership 
immediately before the distribution) decreases the basis of property Y 
in the partnership. Thus, the basis of property Y becomes $17,000 
($18,000 less $1,000). If the distribution is made to a transferee 
partner who elects under section 732(d), see Sec. 1.734-2.

    (c) Allocation of basis. For allocation among the partnership 
properties of basis adjustments under section 734(b) and paragraph (b) 
of this section, see section 755 and Sec. 1.755-1.
    (d) Returns. A partnership which must adjust the bases of 
partnership properties under section 734 shall attach a statement to the 
partnership return for the year of the distribution setting forth the 
computation of the adjustment and the partnership properties to which 
the adjustment has been allocated.
    (e) Recovery of adjustments to basis of partnership property--(1) 
Increases in basis. For purposes of section 168, if the basis of a 
partnership's recovery property is increased as a result of the 
distribution of property to a partner, then the increased portion of the 
basis must be taken into account as if it were newly-purchased recovery 
property placed in service when the distribution

[[Page 615]]

occurs. Consequently, any applicable recovery period and method may be 
used to determine the recovery allowance with respect to the increased 
portion of the basis. However, no change is made for purposes of 
determining the recovery allowance under section 168 for the portion of 
the basis for which there is no increase.
    (2) Decreases in basis. For purposes of section 168, if the basis of 
a partnership's recovery property is decreased as a result of the 
distribution of property to a partner, then the decrease in basis must 
be accounted for over the remaining recovery period of the property 
beginning with the recovery period in which the basis is decreased.
    (3) Effective date. This paragraph (e) applies to distributions of 
property from a partnership that occur on or after December 15, 1999.

[T.D. 6500, 25 FR 11814, Nov. 26, 1960; 25 FR 14021, Dec. 31, 1960, as 
amended by T.D. 8847, 64 FR 69908, Dec. 15, 1999; T.D. 9137, 69 FR 
42559, July 16, 2004]



Sec. 1.734-2  Adjustment after distribution to transferee partner.

    (a) In the case of a distribution of property by the partnership to 
a partner who has obtained all or part of his partnership interest by 
transfer, the adjustments to basis provided in section 743(b) and 
section 732(d) shall be taken into account in applying the rules under 
section 734(b). For determining the adjusted basis of distributed 
property to the partnership immediately before the distribution where 
there has been a prior transfer of a partnership interest with respect 
to which the election provided in section 754 or section 732(d) is in 
effect, see Sec. Sec. 1.732-1 and 1.732-2.
    (b)(1) If a transferee partner, in liquidation of his entire 
partnership interest, receives a distribution of property (including 
money) with respect to which he has no special basis adjustment, in 
exchange for his interest in property with respect to which he has a 
special basis adjustment, and does not utilize his entire special basis 
adjustment in determining the basis of the distributed property to him 
under section 732, the unused special basis adjustment of the 
distributee shall be applied as an adjustment to the partnership basis 
of the property retained by the partnership and as to which the 
distributee did not use his special basis adjustment. The provisions of 
this subparagraph may be illustrated by the following example:

    Example. Upon the death of his father, partner S acquires by 
inheritance a half-interest in partnership ACS. Partners A and C each 
have a one-quarter interest. The assets of the partnership consist of 
$10,000 cash and land used in farming worth $10,000 with a basis of 
$1,000 to the partnership. Since the partnership had made the election 
under section 754 at the time of transfer, partner S had a special basis 
adjustment of $4,500 under section 743(b) with respect to his undivided 
half-interest in the real estate. The basis of S's partnership interest, 
in accordance with section 742, is $10,000. S retires from the 
partnership and receives $10,000 in cash in exchange for his entire 
interest. Since S has received no part of the real estate, his special 
basis adjustment of $4,500 will be allocated to the real estate, the 
remaining partnership property, and will increase its basis to the 
partnership to $5,500.

    (2) The provisions of this paragraph do not apply to the extent that 
certain distributions are treated as sales or exchanges under section 
751(b) (relating to unrealized receivables and substantially appreciated 
inventory items). See section 751(b) and paragraph (b) of Sec. 1.751-1.



Sec. 1.735-1  Character of gain or loss on disposition of distributed
property.

    (a) Sale or exchange of distributed property--(1) Unrealized 
receivables. Any gain realized or loss sustained by a partner on a sale 
or exchange or other disposition of unrealized receivables (as defined 
in paragraph (c)(1) of Sec. 1.751-1) received by him in a distribution 
from a partnership shall be considered gain or loss from the sale or 
exchange of property other than a capital asset.
    (2) Inventory items. Any gain realized or loss sustained by a 
partner on a sale or exchange of inventory items (as defined in section 
751(d)(2)) received in a distribution from a partnership shall be 
considered gain or loss from the sale or exchange of property other than 
a capital asset if such inventory items are sold or exchanged within 5 
years from the date of the distribution by the partnership. The 
character of any gain or loss from a sale or exchange by the distributee 
partner of such inventory

[[Page 616]]

items after 5 years from the date of distribution shall be determined as 
of the date of such sale or exchange by reference to the character of 
the assets in his hands at that date (inventory items, capital assets, 
property used in a trade or business, etc.).
    (b) Holding period for distributed property. A partner's holding 
period for property distributed to him by a partnership shall include 
the period such property was held by the partnership. The provisions of 
this paragraph do not apply for the purpose of determining the 5-year 
period described in section 735(a)(2) and paragraph (a)(2) of this 
section. If the property has been contributed to the partnership by a 
partner, then the period that the property was held by such partner 
shall also be included. See section 1223(2). For a partnership's holding 
period for contributed property, see Sec. 1.723-1.
    (c) Effective date. Section 735(a) applies to any property 
distributed by a partnership to a partner after March 9, 1954. See 
section 771(b)(2) and paragraph (b)(2) of Sec. 1.771-1. However, see 
section 771(c).

[T.D. 6500, 25 FR 11814, Nov. 26, 1960, as amended by T.D. 6832, 30 FR 
8574, July 7, 1965]



Sec. 1.736-1  Payments to a retiring partner or a deceased partner's 
successor in interest.

    (a) Payments considered as distributive share or guaranteed payment. 
(1)(i) Section 736 and this section apply only to payments made to a 
retiring partner or to a deceased partner's successor in interest in 
liquidation of such partner's entire interest in the partnership. See 
section 761(d). Section 736 and this section do not apply if the estate 
or other successor in interest of a deceased partner continues as a 
partner in its own right under local law. Section 736 and this section 
apply only to payments made by the partnership and not to transactions 
between the partners. Thus, a sale by partner A to partner B of his 
entire one-fourth interest in partnership ABCD would not come within the 
scope of section 736.
    (ii) A partner retires when he ceases to be a partner under local 
law. However, for the purposes of subchapter K, chapter 1 of the Code, a 
retired partner or a deceased partner's successor will be treated as a 
partner until his interest in the partnership has been completely 
liquidated.
    (2) When payments (including assumption of liabilities treated as a 
distribution of money under section 752) are made to a withdrawing 
partner, that is, a retiring partner or the estate or other successor in 
interest of a deceased partner, the amounts paid may represent several 
items. In part, they may represent the fair market value at the time of 
his death or retirement of the withdrawing partner's interest in all the 
assets of the partnership (including inventory) unreduced by partnership 
liabilities. Also, part of such payments may be attributable to his 
interest in unrealized receivables and part to an arrangement among the 
partners in the nature of mutual insurance. When a partnership makes 
such payments, whether or not related to partnership income, to retire 
the withdrawing partner's entire interest in the partnership, the 
payments must be allocated between (i) payments for the value of his 
interest in assets, except unrealized receivables and, under some 
circumstances, good will (section 736(b)), and (ii) other payments 
(section 736(a)). The amounts paid for his interest in assets are 
treated in the same manner as a distribution in complete liquidation 
under sections 731, 732, and, where applicable, 751. See paragraph 
(b)(4)(ii) of Sec. 1.751-1. The remaining partners are allowed no 
deduction for these payments since they represent either a distribution 
or a purchase of the withdrawing partner's capital interest by the 
partnership (composed of the remaining partners).
    (3) Under section 736(a), the portion of the payments made to a 
withdrawing partner for his share of unrealized receivables, good will 
(in the absence of an agreement to the contrary), or otherwise not in 
exchange for his interest in assets under the rules contained in 
paragraph (b) of this section will be considered either:
    (i) A distributive share of partnership income, if the amount of 
payment is determined with regard to income of the partnership; or

[[Page 617]]

    (ii) A guaranteed payment under section 707(c), if the amount of the 
payment is determined without regard to income of the partnership.
    (4) Payments, to the extent considered as a distributive share of 
partnership income under section 736(a)(1), are taken into account under 
section 702 in the income of the withdrawing partner and thus reduce the 
amount of the distributive shares of the remaining partners. Payments, 
to the extent considered as guaranteed payments under section 736(a)(2), 
are deductible by the partnership under section 162(a) and are taxable 
as ordinary income to the recipient under section 61(a). See section 
707(c).
    (5) The amount of any payments under section 736(a) shall be 
included in the income of the recipient for his taxable year with or 
within which ends the partnership taxable year for which the payment is 
a distributive share, or in which the partnership is entitled to deduct 
such amount as a guaranteed payment. On the other hand, payments under 
section 736(b) shall be taken into account by the recipient for his 
taxable year in which such payments are made. See paragraph (b)(4) of 
this section.
    (6) A retiring partner or a deceased partner's successor in interest 
receiving payments under section 736 is regarded as a partner until the 
entire interest of the retiring or deceased partner is liquidated. 
Therefore, if one of the members of a 2-man partnership retires under a 
plan whereby he is to receive payments under section 736, the 
partnership will not be considered terminated, nor will the partnership 
year close with respect to either partner, until the retiring partner's 
entire interest is liquidated, since the retiring partner continues to 
hold a partnership interest in the partnership until that time. 
Similarly, if a partner in a 2-man partnership dies, and his estate or 
other successor in interest receives payments under section 736, the 
partnership shall not be considered to have terminated upon the death of 
the partner but shall terminate as to both partners only when the entire 
interest of the decedent is liquidated. See section 708(b).
    (b) Payments for interest in partnership. (1) Payments made in 
liquidation of the entire interest of a retiring partner or deceased 
partner shall, to the extent made in exchange for such partner's 
interest in partnership property (except for unrealized receivables and 
good will as provided in subparagraphs (2) and (3) of this paragraph), 
be considered as a distribution by the partnership (and not as a 
distributive share or guaranteed payment under section 736(a)). 
Generally, the valuation placed by the partners upon a partner's 
interest in partnership property in an arm's length agreement will be 
regarded as correct. If such valuation reflects only the partner's net 
interest in the property (i.e., total assets less liabilities), it must 
be adjusted so that both the value of the partner's interest in property 
and the basis for his interest take into account the partner's share of 
partnership liabilities. Gain or loss with respect to distributions 
under section 736(b) and this paragraph will be recognized to the 
distributee to the extent provided in section 731 and, where applicable, 
section 751.
    (2) Payments made to a retiring partner or to the successor in 
interest of a deceased partner for his interest in unrealized 
receivables of the partnership in excess of their partnership basis, 
including any special basis adjustment for them to which such partner is 
entitled, shall not be considered as made in exchange for such partner's 
interest in partnership property. Such payments shall be treated as 
payments under section 736(a) and paragraph (a) of this section. For 
definition of unrealized receivables, see section 751(c).
    (3) For the purposes of section 736(b) and this paragraph, payments 
made to a retiring partner or to a successor in interest of a deceased 
partner in exchange for the interest of such partner in partnership 
property shall not include any amount paid for the partner's share of 
good will of the partnership in excess of its partnership basis, 
including any special basis adjustments for it to which such partner is 
entitled, except to the extent that the partnership agreement provides 
for a reasonable payment with respect to such good will. Such payments 
shall be considered as payments under section

[[Page 618]]

736(a). To the extent that the partnership agreement provides for a 
reasonable payment with respect to good will, such payments shall be 
treated under section 736(b) and this paragraph. Generally, the 
valuation placed upon good will by an arm's length agreement of the 
partners, whether specific in amount or determined by a formula, shall 
be regarded as correct.
    (4) Payments made to a retiring partner or to a successor in 
interest of a deceased partner for his interest in inventory shall be 
considered as made in exchange for such partner's interest in 
partnership property for the purposes of section 736(b) and this 
paragraph. However, payments for an interest in substantially 
appreciated inventory items, as defined in section 751(d), are subject 
to the rules provided in section 751(b) and paragraph (b) of Sec. 
1.751-1. The partnership basis in inventory items as to a deceased 
partner's successor in interest does not change because of the death of 
the partner unless the partnership has elected the optional basis 
adjustment under section 754. But see paragraph (b)(3)(iii) of Sec. 
1.751-1.
    (5) Where payments made under section 736 are received during the 
taxable year, the recipient must segregate that portion of each such 
payment which is determined to be in exchange for the partner's interest 
in partnership property and treated as a distribution under section 
736(b) from that portion treated as a distributive share or guaranteed 
payment under section 736(a). Such allocation shall be made as follows:
    (i) If a fixed amount (whether or not supplemented by any additional 
amounts) is to be received over a fixed number of years, the portion of 
each payment to be treated as a distribution under section 736(b) for 
the taxable year shall bear the same ratio to the total fixed agreed 
payments for such year (as distinguished from the amount actually 
received) as the total fixed agreed payments under section 736(b) bear 
to the total fixed agreed payments under section 736 (a) and (b). The 
balance, if any, of such amount received in the same taxable year shall 
be treated as a distributive share or a guaranteed payment under section 
736(a) (1) or (2). However, if the total amount received in any one year 
is less than the amount considered as a distribution under section 
736(b) for that year, then any unapplied portion shall be added to the 
portion of the payments for the following year or years which are to be 
treated as a distribution under section 736(b). For example, retiring 
partner W who is entitled to an annual payment of $6,000 for 10 years 
for his interest in partnership property, receives only $3,500 in 1955. 
In 1956, he receives $10,000. Of this amount, $8,500 ($6,000 plus $2,500 
from 1955) is treated as a distribution under section 736 (b) for 1956; 
$1,500, as a payment under section 736(a).
    (ii) If the retiring partner or deceased partner's successor in 
interest receives payments which are not fixed in amount, such payments 
shall first be treated as payments in exchange for his interest in 
partnership property under section 736(b) to the extent of the value of 
that interest and, thereafter, as payments under section 736(a).
    (iii) In lieu of the rules provided in subdivisions (i) and (ii) of 
this subparagraph, the allocation of each annual payment between section 
736 (a) and (b) may be made in any manner to which all the remaining 
partners and the withdrawing partner or his successor in interest agree, 
provided that the total amount allocated to property under section 
736(b) does not exceed the fair market value of such property at the 
date of death or retirement.
    (6) Except to the extent section 751(b) applies, the amount of any 
gain or loss with respect to payments under section 736(b) for a 
retiring or deceased partner's interest in property for each year of 
payment shall be determined under section 731. However, where the total 
of section 736(b) payments is a fixed sum, a retiring partner or a 
deceased partner's successor in interest may elect (in his tax return 
for the first taxable year for which he receives such payments), to 
report and to measure the amount of any gain or loss by the difference 
between:
    (i) The amount treated as a distribution under section 736(b) in 
that year, and
    (ii) The portion of the adjusted basis of the partner for his 
partnership interest attributable to such distribution

[[Page 619]]

(i.e., the amount which bears the same proportion to the partner's total 
adjusted basis for his partnership interest as the amount distributed 
under section 736(b) in that year bears to the total amount to be 
distributed under section 736(b)).

A recipient who elects under this subparagraph shall attach a statement 
to his tax return for the first taxable year for which he receives such 
payments, indicating his election and showing the computation of the 
gain included in gross income.
    (7) The provisions of this paragraph may be illustrated by the 
following examples:

    Example 1. Partnership ABC is a personal service partnership and its 
balance sheet is as follows:

                                 Assets
------------------------------------------------------------------------
                                                     Adjusted
                                                    basis per    Market
                                                      books      value
------------------------------------------------------------------------
Cash..............................................    $13,000    $13,000
Unrealized receivables............................          0     30,000
Capital and section 1231 assets...................     20,000     23,000
                                                   ---------------------
    Total.........................................     33,000     66,000
------------------------------------------------------------------------


                         Liabilities and Capital
------------------------------------------------------------------------
                                                    Per books    Value
------------------------------------------------------------------------
Liabilities.......................................     $3,000     $3,000
Capital:
  A...............................................     10,000     21,000
  B...............................................     10,000     21,000
  C...............................................     10,000     21,000
                                                   ---------------------
    Total.........................................     33,000     66,000
------------------------------------------------------------------------


Partner A retires from the partnership in accordance with an agreement 
whereby his share of liabilities ($1,000) is assumed. In addition he is 
to receive $9,000 in the year of retirement plus $10,000 in each of the 
two succeeding years. Thus, the total that A receives for his 
partnership interest is $30,000 ($29,000 in cash and $1,000 in 
liabilities assumed). Under the agreement terminating A's interest, the 
value of A's interest in section 736(b) partnership property is $12,000 
(one-third of $36,000, the sum of $13,000 cash and $23,000, the fair 
market value of capital and section 1231 assets). A's share in 
unrealized receivables is not included in his interest in partnership 
property described in section 736(b). Since the basis of A's interest is 
$11,000 ($10,000 plus $1,000, his share of partnership liabilities), he 
will realize a capital gain of $1,000 ($12,000 minus $11,000) from the 
disposition of his interest in partnership property. The remaining 
$18,000 ($30,000 minus $12,000) will constitute payments under section 
736(a)(2) which are taxable to A as guaranteed payments under section 
707(c). The payment for the first year is $10,000, consisting of $9,000 
in cash, plus $1,000 in liability assumed (section 752(b)). Thus, unless 
the partners agree otherwise under subparagraph (5)(iii) of this 
paragraph, each annual payment of $10,000 will be allocated as follows: 
$6,000 (18,000/30,000 of $10,000) is a section 736(a)(2) payment and 
$4,000 (12,000/30,000 of $10,000) is a payment for an interest in 
section 736(b) partnership property. (The partnership may deduct the 
$6,000 guaranteed payment made to A in each of the 3 years.) The gain on 
the payments for partnership property will be determined under section 
731, as provided in subparagraph (6) of this paragraph. A will treat 
only $4,000 of each payment as a distribution in a series in liquidation 
of his entire interest and, under section 731, will have a capital gain 
of $1,000 when the last payment is made. However, if A so elects, as 
provided in subparagraph (6) of this paragraph, he may treat such gain 
as follows: Of each $4,000 payment attributable to A's interest in 
partnership property, $333 is capital gain (one-third of the total 
capital gain of $1,000), and $3,667 is a return of capital.
    Example 2. Assume the same facts as in example 1 of this 
subparagraph except that the agreement between the partners provides for 
payments to A for 3 years of a percentage of annual income instead of a 
fixed amount. Unless the partners agree otherwise under subparagraph 
(5)(iii) of this paragraph, all payments received by A up to $12,000 
shall be treated under section 736(b) as payments for A's interest in 
partnership property. His gain of $1,000 will be taxed only after he has 
received his full basis under section 731. Since the payments are not 
fixed in amount, the election provided in subparagraph (6) of this 
paragraph is not available. Any payments in excess of $12,000 shall be 
treated as a distributive share of partnership income to A under section 
736(a)(1).
    Example 3. Assume the same facts as in example 1 of this 
subparagraph except that the partnership agreement provides that the 
payment for A's interest in partnership property shall include payment 
for his interest in the good will of the partnership. At the time of A's 
retirement, the partners determine the value of partnership good will to 
be $9,000. The value of A's interest in partnership property described 
in section 736(b) is thus $15,000 (one-third of $45,000, the sum of 
$13,000 cash, plus $23,000, the value of capital and section 1231 
assets, plus $9,000 good will). From the disposition of his interest in 
partnership property, A will realize a capital gain of $4,000 ($15,000, 
minus $11,000) the basis of his interest. The remaining $15,000 ($30,000

[[Page 620]]

minus $15,000) will constitute payments under section 736(a)(2) which 
are taxable to A as guaranteed payments under section 707(c).
    Example 4. Assume the same facts as in example 1 of this 
subparagraph except that the capital and section 1231 assets consist of 
an item of section 1245 property (as defined in section 1245(a)(3)). 
Assume further that under paragraph (c)(4) of Sec. 1.751-1 the section 
1245 property is an unrealized receivable to the extent of $2,000. 
Therefore, the value of A's interest in section 736(b) partnership 
property is only $11,333 (one-third of $34,000, the sum of $13,000 cash 
and $21,000, the fair market value of section 1245 property to the 
extent not an unrealized receivable). From the disposition of his 
interest in partnership property, A will realize a capital gain of $333 
($11,333 minus $11,000, the basis of his interest). The remaining 
$18,667 ($30,000 minus $11,333) will constitute payments under section 
736(a)(2) which are taxable to A as guaranteed payments under section 
707(c).

    (c) Cross reference. See section 753 for treatment of payments under 
section 736(a) as income in respect of a decedent under section 691.

[T.D. 6500, 25 FR 11814, Nov. 26, 1960, as amended by T.D. 6832, 30 FR 
8574, July 7, 1965]



Sec. 1.737-1  Recognition of precontribution gain.

    (a) Determination of gain--(1) In general. A partner that receives a 
distribution of property (other than money) must recognize gain under 
section 737 and this section in an amount equal to the lesser of the 
excess distribution (as defined in paragraph (b) of this section) or the 
partner's net precontribution gain (as defined in paragraph (c) of this 
section). Gain recognized under section 737 and this section is in 
addition to any gain recognized under section 731.
    (2) Transactions to which section 737 applies. Section 737 and this 
section apply only to the extent that a distribution by a partnership is 
a distribution to a partner acting in the capacity of a partner within 
the meaning of section 731, except that section 737 and this section do 
not apply to the extent that section 751(b) applies to the distribution.
    (b) Excess distribution--(1) Definition. The excess distribution is 
the amount (if any) by which the fair market value of the distributed 
property (other than money) exceeds the distributee partner's adjusted 
tax basis in the partner's partnership interest.
    (2) Fair market value of property. The fair market value of the 
distributed property is the price at which the property would change 
hands between a willing buyer and a willing seller at the time of the 
distribution, neither being under any compulsion to buy or sell and both 
having reasonable knowledge of the relevant facts. The fair market value 
that a partnership assigns to distributed property will be regarded as 
correct, provided that the value is reasonably agreed to among the 
partners in an arm's-length negotiation and the partners have 
sufficiently adverse interests.
    (3) Distributee partner's adjusted tax basis--(i) General rule. In 
determining the amount of the excess distribution, the distributee 
partner's adjusted tax basis in the partnership interest includes any 
basis adjustment resulting from the distribution that is subject to 
section 737 (for example, adjustments required under section 752) and 
from any other distribution or transaction that is part of the same 
distribution, except for--
    (A) The increase required under section 737(c)(1) for the gain 
recognized by the partner under section 737; and
    (B) The decrease required under section 733(2) for any property 
distributed to the partner other than property previously contributed to 
the partnership by the distributee partner. See Sec. 1.704-4(e)(1) for 
a rule in the context of section 704(c)(1)(B). See also Sec. 1.737-
3(b)(2) for a special rule for determining a partner's adjusted tax 
basis in distributed property previously contributed by the partner to 
the partnership.
    (ii) Advances or drawings. The distributee partner's adjusted tax 
basis in the partnership interest is determined as of the last day of 
the partnership's taxable year if the distribution to which section 737 
applies is properly characterized as an advance or drawing against the 
partner's distributive share of income. See Sec. 1.731-1(a)(1)(ii).
    (c) Net precontribution gain--(1) General rule. The distributee 
partner's net precontribution gain is the net gain (if any) that would 
have been recognized

[[Page 621]]

by the distributee partner under section 704(c)(1)(B) and Sec. 1.704-4 
if all property that had been contributed to the partnership by the 
distributee partner within five years of the distribution and is held by 
the partnership immediately before the distribution had been distributed 
by the partnership to another partner other than a partner who owns, 
directly or indirectly, more than 50 percent of the capital or profits 
interest in the partnership. See Sec. 1.704-4 for provisions 
determining a contributing partner's gain or loss under section 
704(c)(1)(B) on an actual distribution of contributed section 704(c) 
property to another partner.
    (2) Special rules--(i) Property contributed on or before October 3, 
1989. Property contributed to the partnership on or before October 3, 
1989, is not taken into account in determining a partner's net 
precontribution gain. See Sec. 1.704-4(c)(1) for a similar rule in the 
context of section 704(c)(1)(B).
    (ii) Section 734(b)(1)(A) adjustments. For distributions to a 
distributee partner of money by a partnership with a section 754 
election in effect that are part of the same distribution as the 
distribution of property subject to section 737, for purposes of 
paragraph (a) and (c)(1) of this section the distributee partner's net 
precontribution gain is reduced by the basis adjustments (if any) made 
to section 704(c) property contributed by the distributee partner under 
section 734(b)(1)(A). See Sec. 1.737-3(c)(4) for rules regarding basis 
adjustments for partnerships with a section 754 election in effect.
    (iii) Transfers of a partnership interest. The transferee of all or 
a portion of a contributing partner's partnership interest succeeds to 
the transferor's net precontribution gain, if any, in an amount 
proportionate to the interest transferred. See Sec. 1.704-3(a)(7) and 
Sec. 1.704-4(d)(2) for similar provisions in the context of section 
704(c)(1)(A) and section 704(c)(1)(B).
    (iv) Section 704(c)(1)(B) gain recognized in related distribution. A 
distributee partner's net precontribution gain is determined after 
taking into account any gain or loss recognized by the partner under 
section 704(c)(1)(B) and Sec. 1.704-4 (or that would have been 
recognized by the partner except for the like-kind exception in section 
704(c)(2) and Sec. 1.704-4(d)(3)) on an actual distribution to another 
partner of section 704(c) property contributed by the distributee 
partner that is part of the same distribution as the distribution to the 
distributee partner.
    (v) Section 704(c)(2) disregarded. A distributee partner's net 
precontribution gain is determined without regard to the provisions of 
section 704(c)(2) and Sec. 1.704-4(d)(3) in situations in which the 
property contributed by the distributee partner is not actually 
distributed to another partner in a distribution related to the section 
737 distribution.
    (d) Character of gain. The character of the gain recognized by the 
distributee partner under section 737 and this section is determined by, 
and is proportionate to, the character of the partner's net 
precontribution gain. For this purpose, all gains and losses on section 
704(c) property taken into account in determining the partner's net 
precontribution gain are netted according to their character. Character 
is determined at the partnership level for this purpose, and any 
character with a net negative amount is disregarded. The character of 
the partner's gain under section 737 is the same as, and in proportion 
to, any character with a net positive amount. Character for this purpose 
is determined as if the section 704(c) property had been sold by the 
partnership to an unrelated third party at the time of the distribution 
and includes any item that would have been taken into account separately 
by the contributing partner under section 702(a) and Sec. 1.702-1(a).
    (e) Examples. The following examples illustrate the provisions of 
this section. Unless otherwise specified, partnership income equals 
partnership expenses (other than depreciation deductions for contributed 
property) for each year of the partnership, the fair market value of 
partnership property does not change, all distributions by the 
partnership are subject to section 737, and all partners are unrelated.

    Example 1. Calculation of excess distribution and net 
precontribution gain. (i) On January 1, 1995, A, B, and C form 
partnership ABC as equal partners. A contributes Property A, depreciable 
real property with a fair market value of $30,000 and an adjusted tax 
basis of

[[Page 622]]

$20,000. B contributes Property B, nondepreciable real property with a 
fair market value and adjusted tax basis of $30,000. C contributes 
$30,000 cash.
    (ii) Property A has 10 years remaining on its cost recovery schedule 
and is depreciated using the straight-line method. The partnership uses 
the traditional method for allocating items under section 704(c) 
described in Sec. 1.704-3(b)(1) for Property A. The partnership has 
book depreciation of $3,000 per year (10 percent of the $30,000 book 
basis in Property A) and each partner is allocated $1,000 of book 
depreciation per year (one-third of the total annual book depreciation 
of $3,000). The partnership also has tax depreciation of $2,000 per year 
(10 percent of the $20,000 adjusted tax basis in Property A). This 
$2,000 tax depreciation is allocated equally between B and C, the 
noncontributing partners with respect to Property A.
    (iii) At the end of 1997, the book value of Property A is $21,000 
($30,000 initial book value less $9,000 aggregate book depreciation) and 
its adjusted tax basis is $14,000 ($20,000 initial tax basis less $6,000 
aggregate tax depreciation).
    (iv) On December 31, 1997, Property B is distributed to A in 
complete liquidation of A's partnership interest. The adjusted tax basis 
of A's partnership interest at that time is $20,000. The amount of the 
excess distribution is $10,000, the difference between the fair market 
value of the distributed Property B ($30,000) and A's adjusted tax basis 
in A's partnership interest ($20,000). A's net precontribution gain is 
$7,000, the difference between the book value of Property A ($21,000) 
and its adjusted tax basis at the time of the distribution ($14,000). A 
recognizes gain of $7,000 on the distribution, the lesser of the excess 
distribution and the net precontribution gain.
    Example 2. Determination of distributee partner's basis. (i) On 
January 1, 1995, A, B, and C form general partnership ABC as equal 
partners. A contributes Property A, nondepreciable real property with a 
fair market value of $10,000 and an adjusted tax basis of $4,000. B and 
C each contributes $10,000 cash.
    (ii) The partnership purchases Property B, nondepreciable real 
property with a fair market value of $9,000, subject to a $9,000 
nonrecourse liability. This nonrecourse liability is allocated equally 
among the partners under section 752, increasing A's adjusted tax basis 
in A's partnership interest from $4,000 to $7,000.
    (iii) On December 31, 1998, A receives $2,000 cash and Property B, 
subject to the $9,000 liability, in a current distribution.
    (iv) In determining the amount of the excess distribution, the 
adjusted tax basis of A's partnership interest is adjusted to take into 
account the distribution of money and the shift in liabilities. A's 
adjusted tax basis is therefore increased to $11,000 for this purpose 
($7,000 initial adjusted tax basis, less $2,000 distribution of money, 
less $3,000 (decrease in A's share of the $9,000 partnership liability), 
plus $9,000 (increase in A's individual liabilities)). As a result of 
this basis adjustment, the adjusted tax basis of A's partnership 
interest ($11,000) is greater than the fair market value of the 
distributed property ($9,000) and therefore, there is no excess 
distribution. A recognizes no gain under section 737.
    Example 3. Net precontribution gain reduced for gain recognized 
under section 704(c)(1)(B). (i) On January 1, 1995, A, B, and C form 
partnership ABC as equal partners. A contributes Properties A1 and A2, 
nondepreciable real properties located in the United States each with a 
fair market value of $10,000 and an adjusted tax basis of $6,000. B 
contributes Property B, nondepreciable real property located outside the 
United States, with a fair market value and adjusted tax basis of 
$20,000. C contributes $20,000 cash.
    (ii) On December 31, 1998, Property B is distributed to A in 
complete liquidation of A's interest and, as part of the same 
distribution, Property A1 is distributed to B in a current distribution.
    (iii) A's net precontribution gain before the distribution is $8,000 
($20,000 fair market value of Properties A1 and A2 less $12,000 adjusted 
tax basis of such properties). A recognizes $4,000 of gain under section 
704(c)(1)(B) and Sec. 1.704-4 on the distribution of Property A1 to B 
($10,000 fair market value of Property A1 less $6,000 adjusted tax basis 
of Property A1). This gain is taken into account in determining A's 
excess distribution and net precontribution gain. As a result, A's net 
precontribution gain is reduced from $8,000 to $4,000, and the adjusted 
tax basis in A's partnership interest is increased by $4,000 to $16,000.
    (iv) A recognizes gain of $4,000 on the receipt of Property B under 
section 737, an amount equal to the lesser of the excess distribution of 
$4,000 ($20,000 fair market value of Property B less $16,000 adjusted 
tax basis of A's interest in the partnership) and A's remaining net 
precontribution gain of $4,000.
    Example 4. Character of gain. (i) On January 1, 1995, A, B, and C 
form partnership ABC as equal partners. A contributes the following 
nondepreciable property to the partnership:

------------------------------------------------------------------------
                                                       Fair
                                                      market    Adjusted
                                                      value    tax basis
------------------------------------------------------------------------
Property A1.......................................    $30,000    $20,000
Property A2.......................................     30,000     38,000
Property A3.......................................     10,000      9,000
------------------------------------------------------------------------

    (ii) The character of gain or loss on Property A1 and Property A2 is 
long-term, U.S.-source capital gain or loss. The character of gain on 
Property A3 is long-term, foreign-source capital gain. B contributes 
Property B, nondepreciable real property with a fair

[[Page 623]]

market value and adjusted tax basis of $70,000. C contributes $70,000 
cash.
    (iii) On December 31, 1998, Property B is distributed to A in 
complete liquidation of A's interest in the partnership. A recognizes 
$3,000 of gain under section 737, an amount equal to the excess 
distribution of $3,000 ($70,000 fair market value of Property B less 
$67,000 adjusted tax basis in A's partnership interest) and A's net 
precontribution gain of $3,000 ($70,000 aggregate fair market value of 
properties contributed by A less $67,000 aggregate adjusted tax basis of 
such properties).
    (iv) In determining the character of A's gain, all gains and losses 
on property taken into account in determining A's net precontribution 
gain are netted according to their character and allocated to A's 
recognized gain under section 737 based on the relative proportions of 
the net positive amounts. U.S.-source and foreign-source gains must be 
netted separately because A would have been required to take such gains 
into account separately under section 702. As a result, A's net 
precontribution gain of $3,000 consists of $2,000 of net long-term, 
U.S.-source capital gain ($10,000 gain on Property A1 and $8,000 loss on 
Property A2) and $1,000 of net long-term, foreign-source capital gain 
($1,000 gain on Property A3).
    (v) The character of A's gain under paragraph (d) of this section is 
therefore $2,000 long-term, U.S.-source capital gain ($3,000 gain 
recognized under section 737x$2,000 net long-term, U.S.-source capital 
gain/$3,000 total net precontribution gain) and $1,000 long-term, 
foreign-source capital gain ($3,000 gain recognized under section 737 x 
$1,000 net long-term, foreign-source capital gain/$3,000 total net 
precontribution gain).

[T.D. 8642, 60 FR 66733, Dec. 26, 1995]



Sec. 1.737-2  Exceptions and special rules.

    (a) Section 708(b)(1)(B) terminations. Section 737 and this section 
do not apply to the deemed distribution of interests in a new 
partnership caused by the termination of a partnership under section 
708(b)(1)(B). A subsequent distribution of property by the new 
partnership to a partner of the new partnership that was formerly a 
partner of the terminated partnership is subject to section 737 to the 
same extent that a distribution from the terminated partnership would 
have been subject to section 737. See also Sec. 1.704-4(c)(3) for a 
similar rule in the context of section 704(c)(1)(B). This paragraph (a) 
applies to terminations of partnerships under section 708(b)(1)(B) 
occurring on or after May 9, 1997; however, this paragraph (a) may be 
applied to terminations occurring on or after May 9, 1996, provided that 
the partnership and its partners apply this paragraph (a) to the 
termination in a consistent manner.
    (b) Transfers to another partnership--(1) Complete transfer. Section 
737 and this section do not apply to a transfer by a partnership 
(transferor partnership) of all of its assets and liabilities to a 
second partnership (transferee partnership) in an exchange described in 
section 721, followed by a distribution of the interest in the 
transferee partnership in liquidation of the transferor partnership as 
part of the same plan or arrangement. See Sec. 1.704-4(c)(4) for a 
similar rule in the context of section 704(c)(1)(B).
    (2) Certain divisive transactions. Section 737 and this section do 
not apply to a transfer by a partnership (transferor partnership) of all 
of the section 704(c) property contributed by a partner to a second 
partnership (transferee partnership) in an exchange described in section 
721, followed by a distribution as part of the same plan or arrangement 
of an interest in the transferee partnership (and no other property) in 
complete liquidation of the interest of the partner that originally 
contributed the section 704(c) property to the transferor partnership.
    (3) Subsequent distributions. A subsequent distribution of property 
by the transferee partnership to a partner of the transferee partnership 
that was formerly a partner of the transferor partnership is subject to 
section 737 to the same extent that a distribution from the transferor 
partnership would have been subject to section 737.
    (c) Incorporation of a partnership. Section 737 and this section do 
not apply to an incorporation of a partnership by any method of 
incorporation (other than a method involving an actual distribution of 
partnership property to the partners followed by a contribution of that 
property to a corporation), provided that the partnership is liquidated 
as part of the incorporation transaction. See Sec. 1.704-4(c)(5) for a 
similar rule in the context of section 704(c)(1)(B).

[[Page 624]]

    (d) Distribution of previously contributed property--(1) General 
rule. Any portion of the distributed property that consists of property 
previously contributed by the distributee partner (previously 
contributed property) is not taken into account in determining the 
amount of the excess distribution or the partner's net precontribution 
gain. The previous sentence applies on or after May 9, 1997. See Sec. 
1.737-3(b)(2) for a special rule for determining the basis of previously 
contributed property in the hands of a distributee partner who 
contributed the property to the partnership.
    (2) Limitation for distribution of previously contributed interest 
in an entity. An interest in an entity previously contributed to the 
partnership is not treated as previously contributed property to the 
extent that the value of the interest is attributable to property 
contributed to the entity after the interest was contributed to the 
partnership. The preceding sentence does not apply to the extent that 
the property contributed to the entity was contributed to the 
partnership by the partner that also contributed the interest in the 
entity to the partnership.
    (3) Nonrecognition transactions, installment sales, contributed 
contracts, and capitalized costs--(i) Nonrecognition transactions. 
Property received by the partnership in exchange for contributed section 
704(c) property in a nonrecognition transaction is treated as the 
contributed property with regard to the contributing partner for 
purposes of section 737 to the extent that the property received is 
treated as section 704(c) property under Sec. 1.704-3(a)(8). See Sec. 
1.704-4(d)(1) for a similar rule in the context of section 704(c)(1)(B).
    (ii) Installment sales. An installment obligation received by the 
partnership in an installment sale (as defined in section 453(b)) of 
section 704(c) property is treated as the contributed property with 
regard to the contributing partner for purposes of section 737 to the 
extent that the installment obligation received is treated as section 
704(c) property under Sec. 1.704-3(a)(8). See Sec. 1.704-4(d)(1) for a 
similar rule in the context of section 704(c)(1)(B).
    (iii) Contributed contracts. Property acquired by a partnership 
pursuant to a contract that is section 704(c) property is treated as the 
contributed property with regard to the contributing partner for 
purposes of section 737 to the extent that the acquired property is 
treated as section 704(c) property under Sec. 1.704-3(a)(8). See Sec. 
1.704-4(d)(1) for a similar rule in the context of section 704(c)(1)(B).
    (iv) Capitalized costs. Property to which the cost of section 704(c) 
property is properly capitalized is treated as section 704(c) property 
for purposes of section 737 to the extent that such property is treated 
as section 704(c) property under Sec. 1.704-3(a)(8)(iv). See Sec. 
1.704-4(d)(1) for a similar rule in the context of section 704(c)(1)(B).
    (4) Undivided interests. The distribution of an undivided interest 
in property is treated as the distribution of previously contributed 
property to the extent that the undivided interest does not exceed the 
undivided interest, if any, contributed by the distributee partner in 
the same property. See Sec. 1.704-4(c)(6) for the application of 
section 704(c)(1)(B) in a similar context. The portion of the undivided 
interest in property retained by the partnership after the distribution, 
if any, that is treated as contributed by the distributee partner, is 
reduced to the extent of the undivided interest distributed to the 
distributee partner.
    (e) Examples. The following examples illustrate the rules of this 
section. Unless otherwise specified, partnership income equals 
partnership expenses (other than depreciation deductions for contributed 
property) for each year of the partnership, the fair market value of 
partnership property does not change, all distributions by the 
partnership are subject to section 737, and all partners are unrelated.

    Example 1. Distribution of previously contributed property. (i) On 
January 1, 1995, A, B, and C form partnership ABC as equal partners. A 
contributes the following nondepreciable real property to the 
partnership:

------------------------------------------------------------------------
                                                       Fair
                                                      market    Adjusted
                                                      value    tax basis
------------------------------------------------------------------------
Property A1.......................................    $20,000    $10,000
Property A2.......................................     10,000      6,000
------------------------------------------------------------------------

    (ii) A's total net precontribution gain on the contributed property 
is $14,000 ($10,000 on Property A1 plus $4,000 on Property A2). B

[[Page 625]]

contributes $10,000 cash and Property B, nondepreciable real property 
with a fair market value and adjusted tax basis of $20,000. C 
contributes $30,000 cash.
    (iii) On December 31, 1998, Property A2 and Property B are 
distributed to A in complete liquidation of A's interest in the 
partnership. Property A2 was previously contributed by A and is 
therefore not taken into account in determining the amount of the excess 
distribution or A's net precontribution gain. The adjusted tax basis of 
Property A2 in the hands of A is also determined under section 732 as if 
that property were the only property distributed to A.
    (iv) As a result of excluding Property A2 from these determinations, 
the amount of the excess distribution is $10,000 ($20,000 fair market 
value of distributed Property B less $10,000 adjusted tax basis in A's 
partnership interest). A's net precontribution gain is also $10,000 
($14,000 total net precontribution gain less $4,000 gain with respect to 
previously contributed Property A2). A therefore recognizes $10,000 of 
gain on the distribution, the lesser of the excess distribution and the 
net precontribution gain.
    Example 2. Distribution of a previously contributed interest in an 
entity. (i) On January 1, 1995, A, B, and C form partnership ABC as 
equal partners. A contributes Property A, nondepreciable real property 
with a fair market value of $10,000 and an adjusted tax basis of $5,000, 
and all of the stock of Corporation X with a fair market value and 
adjusted tax basis of $500. B contributes $500 cash and Property B, 
nondepreciable real property with a fair market value and adjusted tax 
basis of $10,000. Partner C contributes $10,500 cash. On December 31, 
1996, ABC contributes Property B to Corporation X in a nonrecognition 
transaction under section 351.
    (ii) On December 31, 1998, all of the stock of Corporation X is 
distributed to A in complete liquidation of A's interest in the 
partnership. The stock is treated as previously contributed property 
with respect to A only to the extent of the $500 fair market value of 
the Corporation X stock contributed by A. The fair market value of the 
distributed stock for purposes of determining the amount of the excess 
distribution is therefore $10,000 ($10,500 total fair market value of 
Corporation X stock less $500 portion treated as previously contributed 
property). The $500 fair market value and adjusted tax basis of the 
Corporation X stock is also not taken into account in determining the 
amount of the excess distribution and the net precontribution gain.
    (iii) A recognizes $5,000 of gain under section 737, the amount of 
the excess distribution ($10,000 fair market value of distributed 
property less $5,000 adjusted tax basis in A's partnership interest) and 
A's net precontribution gain ($10,000 fair market value of Property A 
less $5,000 adjusted tax basis in Property A).
    Example 3. Distribution of undivided interest in property. (i) On 
January 1, 1995, A and B form partnership AB as equal partners. A 
contributes $500 cash and an undivided one-half interest in Property X. 
B contributes $500 cash and an undivided one-half interest in Property 
X.
    (ii) On December 31, 1998, an undivided one-half interest in 
Property X is distributed to A in a current distribution. The 
distribution of the undivided one-half interest in Property X is treated 
as a distribution of previously contributed property because A 
contributed an undivided one-half interest in Property X. As a result, A 
does not recognize any gain under section 737 on the distribution.

[T.D. 8642, 60 FR 66735, Dec. 26, 1995, as amended by T.D. 8717, 62 FR 
25501, May 9, 1997; T.D. 9193, 70 FR 14395, Mar. 22, 2005; T.D. 9207, 70 
FR 30342, May 26, 2005; T.D. 9193, 70 FR 45531, Aug. 8, 2005]



Sec. 1.737-3  Basis adjustments; Recovery rules.

    (a) Distributee partner's adjusted tax basis in the partnership 
interest. The distributee partner's adjusted tax basis in the 
partnership interest is increased by the amount of gain recognized by 
the distributee partner under section 737 and this section. This 
increase is not taken into account in determining the amount of gain 
recognized by the partner under section 737(a)(1) and this section or in 
determining the amount of gain recognized by the partner under section 
731(a) on the distribution of money in the same distribution or any 
related distribution. See Sec. 1.704-4(e)(1) for a determination of the 
distributee partner's adjusted tax basis in a distribution subject to 
section 704(c)(1)(B).
    (b) Distributee partner's adjusted tax basis in distributed 
property--(1) In general. The distributee partner's adjusted tax basis 
in the distributed property is determined under section 732 (a) or (b) 
as applicable. The increase in the distributee partner's adjusted tax 
basis in the partnership interest under paragraph (a) of this section is 
taken into account in determining the distributee partner's adjusted tax 
basis in the distributed property other than property previously 
contributed by the partner. See Sec. 1.704-4(e)(2) for a determination 
of basis in a distribution subject to section 704(c)(1)(B).

[[Page 626]]

    (2) Previously contributed property. The distributee partner's 
adjusted tax basis in distributed property that the partner previously 
contributed to the partnership is determined as if it were distributed 
in a separate and independent distribution prior to the distribution 
that is subject to section 737 and Sec. 1.737-1.
    (c) Partnership's adjusted tax basis in partnership property--(1) 
Increase in basis. The partnership's adjusted tax basis in eligible 
property is increased by the amount of gain recognized by the 
distributee partner under section 737.
    (2) Eligible property. Eligible property is property that--
    (i) Entered into the calculation of the distributee partner's net 
precontribution gain;
    (ii) Has an adjusted tax basis to the partnership less than the 
property's fair market value at the time of the distribution;
    (iii) Would have the same character of gain on a sale by the 
partnership to an unrelated party as the character of any of the gain 
recognized by the distributee partner under section 737; and
    (iv) Was not distributed to another partner in a distribution 
subject to section 704(c)(1)(B) and Sec. 1.704-4 that was part of the 
same distribution as the distribution subject to section 737.
    (3) Method of adjustment. For the purpose of allocating the basis 
increase under paragraph (c)(2) of this section among the eligible 
property, all eligible property of the same character is treated as a 
single group. Character for this purpose is determined in the same 
manner as the character of the recognized gain is determined under Sec. 
1.737-1(d). The basis increase is allocated among the separate groups of 
eligible property in proportion to the character of the gain recognized 
under section 737. The basis increase is then allocated among property 
within each group in the order in which the property was contributed to 
the partnership by the partner, starting with the property contributed 
first, in an amount equal to the difference between the property's fair 
market value and its adjusted tax basis to the partnership at the time 
of the distribution. For property that has the same character and was 
contributed in the same (or a related) transaction, the basis increase 
is allocated based on the respective amounts of unrealized appreciation 
in such properties at the time of the distribution.
    (4) Section 754 adjustments. The basis adjustments to partnership 
property made pursuant to paragraph (c)(1) of this section are not 
elective and must be made regardless of whether the partnership has an 
election in effect under section 754. Any adjustments to the bases of 
partnership property (including eligible property as defined in 
paragraph (c)(2) of this section) under section 734(b) pursuant to a 
section 754 election (other than basis adjustments under section 
734(b)(1)(A) described in the following sentence) must be made after 
(and must take into account) the adjustments to basis made under 
paragraph (a) and paragraph (c)(1) of this section. Basis adjustments 
under section 734(b)(1)(A) that are attributable to distributions of 
money to the distributee partner that are part of the same distribution 
as the distribution of property subject to section 737 are made before 
the adjustments to basis under paragraph (a) and paragraph (c)(1) of 
this section. See Sec. 1.737-1(c)(2)(ii) for the effect, if any, of 
basis adjustments under section 734(b)(1)(A) on a partner's net 
precontribution gain. See also Sec. 1.704-4(e)(3) for a similar rule 
regarding basis adjustments pursuant to a section 754 election in the 
context of section 704(c)(1)(B).
    (d) Recovery of increase to adjusted tax basis. Any increase to the 
adjusted tax basis of partnership property under paragraph (c)(1) of 
this section is recovered using any applicable recovery period and 
depreciation (or other cost recovery) method (including first-year 
conventions) available to the partnership for newly purchased property 
(of the type adjusted) placed in service at the time of the 
distribution.
    (e) Examples. The following examples illustrate the rules of this 
section. Unless otherwise specified, partnership income equals 
partnership expenses (other than depreciation deductions for contributed 
property) for each year of the partnership, the fair market value of 
partnership property does not

[[Page 627]]

change, all distributions by the partnership are subject to section 737, 
and all partners are unrelated.

    Example 1. Partner's basis in distributed property. (i) On January 
1, 1995, A, B, and C form partnership ABC as equal partners. A 
contributes Property A, nondepreciable real property with a fair market 
value of $10,000 and an adjusted tax basis of $5,000. B contributes 
Property B, nondepreciable real property with a fair market value and 
adjusted tax basis of $10,000. C contributes $10,000 cash.
    (ii) On December 31, 1998, Property B is distributed to A in 
complete liquidation of A's interest in the partnership. A recognizes 
$5,000 of gain under section 737, an amount equal to the excess 
distribution of $5,000 ($10,000 fair market value of Property B less 
$5,000 adjusted tax basis in A's partnership interest) and A's net 
precontribution gain of $5,000 ($10,000 fair market value of Property A 
less $5,000 adjusted tax basis of such property).
    (iii) A's adjusted tax basis in A's partnership interest is 
increased by the $5,000 of gain recognized under section 737. This 
increase is taken into account in determining A's basis in the 
distributed property. Therefore, A's adjusted tax basis in distributed 
Property B is $10,000 under section 732(b).
    Example 2. Partner's basis in distributed property in connection 
with gain recognized under section 704(c)(1)(B). (i) On January 1, 1995, 
A, B, and C form partnership ABC as equal partners. A contributes the 
following nondepreciable real property located in the United States to 
the partnership:

------------------------------------------------------------------------
                                                       Fair
                                                      market    Adjusted
                                                      value    tax basis
------------------------------------------------------------------------
Property A1.......................................    $10,000      5,000
Property A2.......................................     10,000      2,000
------------------------------------------------------------------------

    (ii) B contributes $10,000 cash and Property B, nondepreciable real 
property located outside the United States, with a fair market value and 
adjusted tax basis of $10,000. C contributes $20,000 cash.
    (iii) On December 31, 1998, Property B is distributed to A in a 
current distribution and Property A1 is distributed to B in a current 
distribution. A recognizes $5,000 of gain under section 704(c)(1)(B) and 
Sec. 1.704-4 on the distribution of Property A1 to B, the difference 
between the fair market value of such property ($10,000) and the 
adjusted tax basis in distributed Property A1 ($5,000). The adjusted tax 
basis of A's partnership interest is increased by this $5,000 of gain 
under section 704(c)(1)(B) and Sec. 1.704-4(e)(1).
    (iv) The increase in the adjusted tax basis of A's partnership 
interest is taken into account in determining the amount of the excess 
distribution. As a result, there is no excess distribution because the 
fair market value of Property B ($10,000) is less than the adjusted tax 
basis of A's interest in the partnership at the time of distribution 
($12,000). A therefore recognizes no gain under section 737 on the 
receipt of Property B. A's adjusted tax basis in Property B is $10,000 
under section 732(a)(1). The adjusted tax basis of A's partnership 
interest is reduced from $12,000 to $2,000 under section 733. See 
Example 3 of Sec. 1.737-1(e).
    Example 3. Partnership's basis in partnership property after a 
distribution with section 737 gain. (i) On January 31, 1995, A, B, and C 
form partnership ABC as equal partners. A contributes the following 
nondepreciable property to the partnership:

------------------------------------------------------------------------
                                                       Fair
                                                      market    Adjusted
                                                      value    tax basis
------------------------------------------------------------------------
Property A1.......................................     $1,000       $500
Property A2.......................................      4,000      1,500
Property A3.......................................      4,000      6,000
Property A4.......................................      6,000      4,000
------------------------------------------------------------------------

    (ii) The character of gain or loss on Properties A1, A2, and A3 is 
long-term, U.S.-source capital gain or loss. The character of gain on 
Property A4 is long-term, foreign-source capital gain. B contributes 
Property B, nondepreciable real property with a fair market value and 
adjusted tax basis of $15,000. C contributes $15,000 cash.
    (iii) On December 31, 1998, Property B is distributed to A in 
complete liquidation of A's interest in the partnership. A recognizes 
gain of $3,000 under section 737, an amount equal to the excess 
distribution of $3,000 ($15,000 fair market value of Property B less 
$12,000 adjusted tax basis in A's partnership interest) and A's net 
precontribution gain of $3,000 ($15,000 aggregate fair market value of 
the property contributed by A less $12,000 aggregate adjusted tax basis 
of such property).
    (iv) $2,000 of A's gain is long-term, foreign-source capital gain 
($3,000 total gain under section 737 x $2,000 net long-term, foreign-
source capital gain/$3,000 total net precontribution gain). $1,000 of 
A's gain is long-term, U.S.-source capital gain ($3,000 total gain under 
section 737 x $1,000 net long-term, U.S.-source capital gain/$3,000 
total net precontribution gain).
    (v) The partnership must increase the adjusted tax basis of the 
property contributed by A by $3,000. All property contributed by A is 
eligible property. Properties A1, A2, and A3 have the same character and 
are grouped into a single group for purposes of allocating this basis 
increase. Property A4 is in a separate character group.
    (vi) $2,000 of the basis increase must be allocated to long-term, 
foreign-source capital assets because $2,000 of the gain recognized by A 
was long-term, foreign-source capital gain. The adjusted tax basis of 
Property A4 is therefore increased from $4,000 to $6,000. $1,000 of the 
increase must be allocated to

[[Page 628]]

Properties A1 and A2 because $1,000 of the gain recognized by A is long-
term, U.S.-source capital gain. No basis increase is allocated to 
Property A3 because its fair market value is less than its adjusted tax 
basis. The $1,000 basis increase is allocated between Properties A1 and 
A2 based on the unrealized appreciation in each asset before such basis 
adjustment. As a result, the adjusted tax basis of Property A1 is 
increased by $167 ($1,000x$500/$3,000) and the adjusted tax basis of 
Property A2 is increased by $833 ($1,000x$2,500/3,000).

[T.D. 8642, 60 FR 66736, Dec. 26, 1995; 61 FR 7214, Feb. 27, 1996]



Sec. 1.737-4  Anti-abuse rule.

    (a) In general. The rules of section 737 and Sec. Sec. 1.737-1, 
1.737-2, and 1.737-3 must be applied in a manner consistent with the 
purpose of section 737. Accordingly, if a principal purpose of a 
transaction is to achieve a tax result that is inconsistent with the 
purpose of section 737, the Commissioner can recast the transaction for 
federal tax purposes as appropriate to achieve tax results that are 
consistent with the purpose of section 737. Whether a tax result is 
inconsistent with the purpose of section 737 must be determined based on 
all the facts and circumstances. See Sec. 1.704-4(f) for an anti-abuse 
rule and examples in the context of section 704(c)(1)(B). The anti-abuse 
rule and examples under section 704(c)(1)(B) and Sec. 1.704-4(f) are 
relevant to section 737 and Sec. Sec. 1.737-1, 1.737-2, and 1.737-3 to 
the extent that the net precontribution gain for purposes of section 737 
is determined by reference to section 704(c)(1)(B).
    (b) Examples. The following examples illustrate the rules of this 
section. The examples set forth below do not delineate the boundaries of 
either permissible or impermissible types of transactions. Further, the 
addition of any facts or circumstances that are not specifically set 
forth in an example (or the deletion of any facts or circumstances) may 
alter the outcome of the transaction described in the example. Unless 
otherwise specified, partnership income equals partnership expenses 
(other than depreciation deductions for contributed property) for each 
year of the partnership, the fair market value of partnership property 
does not change, all distributions by the partnership are subject to 
section 737, and all partners are unrelated.

    Example 1. Increase in distributee partner's basis by temporary 
contribution; results inconsistent with the purpose of section 737. (i) 
On January 1, 1995, A, B, and C form partnership ABC as equal partners. 
A contributes Property A1, nondepreciable real property with a fair 
market value of $10,000 and an adjusted tax basis of $1,000. B 
contributes Property B, nondepreciable real property with a fair market 
value of $10,000 and an adjusted tax basis of $10,000. C contributes 
$10,000 cash.
    (ii) On January 1, 1999, pursuant to a plan a principal purpose of 
which is to avoid gain under section 737, A transfers to the partnership 
Property A2, nondepreciable real property with a fair market value and 
adjusted tax basis of $9,000. A treats the transfer as a contribution to 
the partnership pursuant to section 721 and increases the adjusted tax 
basis of A's partnership interest from $1,000 to $10,000. On January 1, 
1999, the partnership agreement is amended and all other necessary steps 
are taken so that substantially all of the economic risks and benefits 
of Property A2 are retained by A. On February 1, 1999, Property B is 
distributed to A in a current distribution. If the contribution of 
Property A2 is treated as a contribution to the partnership for purposes 
of section 737, there is no excess distribution because the fair market 
value of distributed Property B ($10,000) does not exceed the adjusted 
tax basis of A's interest in the partnership ($10,000), and therefore 
section 737 does not apply. A's adjusted tax basis in distributed 
Property B is $10,000 under section 732(a)(1) and the adjusted tax basis 
of A's partnership interest is reduced to zero under section 733.
    (iii) On March 1, 2000, A receives Property A2 from the partnership 
in complete liquidation of A's interest in the partnership. A recognizes 
no gain on the distribution of Property A2 because the property was 
previously contributed property. See Sec. 1.737-2(d).
    (iv) Although A has treated the transfer of Property A2 as a 
contribution to the partnership that increased the adjusted tax basis of 
A's interest in the partnership, it would be inconsistent with the 
purpose of section 737 to recognize the transfer as a contribution to 
the partnership. Section 737 requires recognition of gain when the value 
of distributed property exceeds the distributee partner's adjusted tax 
basis in the partnership interest. Section 737 assumes that any 
contribution or other transaction that affects a partner's adjusted tax 
basis in the partnership interest is a contribution or transaction in 
substance and is not engaged in with a principal purpose of avoiding 
recognition of gain under section 737. Because the transfer of Property 
A2 to the partnership was not a contribution in substance and was made 
with a principal purpose of avoiding recognition

[[Page 629]]

of gain under section 737, the Commissioner can disregard the 
contribution of Property A2 for this purpose. As a result, A recognizes 
gain of $9,000 under section 737 on the receipt of Property B, an amount 
equal to the lesser of the excess distribution of $9,000 ($10,000 fair 
market value of distributed Property B less the $1,000 adjusted tax 
basis of A's partnership interest, determined without regard to the 
transitory contribution of Property A2) or A's net precontribution gain 
of $9,000 on Property A1.
    Example 2. Increase in distributee partner's basis; section 752 
liability shift; results consistent with the purpose of section 737. (i) 
On January 1, 1995, A and B form general partnership AB as equal 
partners. A contributes Property A, nondepreciable real property with a 
fair market value of $10,000 and an adjusted tax basis of $1,000. B 
contributes Property B, nondepreciable real property with a fair market 
value and adjusted tax basis of $10,000. The partnership also borrows 
$10,000 on a recourse basis and purchases Property C. The $10,000 
liability is allocated equally between A and B under section 752, 
thereby increasing the adjusted tax basis in A's partnership interest to 
$6,000.
    (ii) On December 31, 1998, the partners agree that A is to receive 
Property B in a current distribution. If A were to receive Property B at 
that time, A would recognize $4,000 of gain under section 737, an amount 
equal to the lesser of the excess distribution of $4,000 ($10,000 fair 
market value of Property B less $6,000 adjusted tax basis in A's 
partnership interest) or A's net precontribution gain of $9,000 ($10,000 
fair market value of Property A less $1,000 adjusted tax basis of 
Property A).
    (iii) With a principal purpose of avoiding such gain, A and B agree 
that A will be solely liable for the repayment of the $10,000 
partnership liability and take the steps necessary so that the entire 
amount of the liability is allocated to A under section 752. The 
adjusted tax basis in A's partnership interest is thereby increased from 
$6,000 to $11,000 to reflect A's share of the $5,000 of liability 
previously allocated to B. As a result of this increase in A's adjusted 
tax basis, there is no excess distribution because the fair market value 
of distributed Property B ($10,000) is less than the adjusted tax basis 
of A's partnership interest. Recognizing A's increased adjusted tax 
basis as a result of the shift in liabilities is consistent with the 
purpose of section 737 and this section. Section 737 requires 
recognition of gain only when the value of the distributed property 
exceeds the distributee partner's adjusted tax basis in the partnership 
interest. The $10,000 recourse liability is a bona fide liability of the 
partnership that was undertaken for a substantial business purpose and 
A's and B's agreement that A will assume responsibility for repayment of 
that debt has substance. Therefore, the increase in A's adjusted tax 
basis in A's interest in the partnership due to the shift in partnership 
liabilities under section 752 is respected, and A recognizes no gain 
under section 737.

[T.D. 8642, 60 FR 66738, Dec. 26, 1995]



Sec. 1.737-5  Effective dates.

    Sections 1.737-1, 1.737-2, 1.737-3, and 1.737-4 apply to 
distributions by a partnership to a partner on or after January 9, 1995, 
except that Sec. 1.737-2(d)(3)(iv) applies to distributions by a 
partnership to a partner on or after June 24, 2003.

[T.D. 9207, 70 FR 30342, May 26, 2005]

                 transfers of interests in a partnership



Sec. 1.741-1  Recognition and character of gain or loss on sale or
exchange.

    (a) The sale or exchange of an interest in a partnership shall, 
except to the extent section 751(a) applies, be treated as the sale or 
exchange of a capital asset, resulting in capital gain or loss measured 
by the difference between the amount realized and the adjusted basis of 
the partnership interest, as determined under section 705. For treatment 
of selling partner's distributive share up to date of sale, see section 
706(c)(2). Where the provisions of section 751 require the recognition 
of ordinary income or loss with respect to a portion of the amount 
realized from such sale or exchange, the amount realized shall be 
reduced by the amount attributable under section 751 to unrealized 
receivables and substantially appreciated inventory items, and the 
adjusted basis of the transferor partner's interest in the partnership 
shall be reduced by the portion of such basis attributable to such 
unrealized receivables and substantially appreciated inventory items. 
See section 751 and Sec. 1.751-1.
    (b) Section 741 shall apply whether the partnership interest is sold 
to one or more members of the partnership or to one or more persons who 
are not members of the partnership. Section 741 shall also apply even 
though the sale of the partnership interest results in a termination of 
the partnership under section 708(b). Thus, the provisions of section 
741 shall be applicable (1) to the transferor partner in a 2-man

[[Page 630]]

partnership when he sells his interest to the other partner, and (2) to 
all the members of a partnership when they sell their interests to one 
or more persons outside the partnership.
    (c) See section 351 for nonrecognition of gain or loss upon transfer 
of a partnership interest to a corporation controlled by the transferor.
    (d) For rules relating to the treatment of liabilities on the sale 
or exchange of interests in a partnership see Sec. Sec. 1.752-1 and 
1.1001-2.
    (e) For rules relating to the capital gain or loss recognized when a 
partner sells or exchanges an interest in a partnership that holds 
appreciated collectibles or section 1250 property with section 1250 
capital gain, see Sec. 1.1(h)-1. This paragraph (e) applies to 
transfers of interests in partnerships that occur on or after September 
21, 2000.
    (f) For rules relating to dividing the holding period of an interest 
in a partnership, see Sec. 1.1223-3. This paragraph (f) applies to 
transfers of partnership interests and distributions of property from a 
partnership that occur on or after September 21, 2000.

[T.D. 6500, 25 FR 11814, Nov. 26, 1960; 25 FR 14021, Dec. 31, 1960, as 
amended by T.D. 7741, 45 FR 81745, Dec. 12, 1980; T.D. 8902, 65 FR 
57099, Sept. 21, 2000]



Sec. 1.742-1  Basis of transferee partner's interest.

    The basis to a transferee partner of an interest in a partnership 
shall be determined under the general basis rules for property provided 
by part II (section 1011 and following), subchapter O, chapter 1 of the 
Code. Thus, the basis of a purchased interest will be its cost. The 
basis of a partnership interest acquired from a decedent is the fair 
market value of the interest at the date of his death or at the 
alternate valuation date, increased by his estate's or other successor's 
share of partnership liabilities, if any, on that date, and reduced to 
the extent that such value is attributable to items constituting income 
in respect of a decedent (see section 753 and paragraph (c)(3)(v) of 
Sec. 1.706-1 and paragraph (b) of Sec. 1.753-1) under section 691. See 
section 1014(c). For basis of contributing partner's interest, see 
section 722. The basis so determined is then subject to the adjustments 
provided in section 705.



Sec. 1.743-1  Optional adjustment to basis of partnership property.

    (a) Generally. The basis of partnership property is adjusted as a 
result of the transfer of an interest in a partnership by sale or 
exchange or on the death of a partner only if the election provided by 
section 754 (relating to optional adjustments to the basis of 
partnership property) is in effect with respect to the partnership. 
Whether or not the election provided in section 754 is in effect, the 
basis of partnership property is not adjusted as the result of a 
contribution of property, including money, to the partnership.
    (b) Determination of adjustment. In the case of the transfer of an 
interest in a partnership, either by sale or exchange or as a result of 
the death of a partner, a partnership that has an election under section 
754 in effect--
    (1) Increases the adjusted basis of partnership property by the 
excess of the transferee's basis for the transferred partnership 
interest over the transferee's share of the adjusted basis to the 
partnership of the partnership's property; or
    (2) Decreases the adjusted basis of partnership property by the 
excess of the transferee's share of the adjusted basis to the 
partnership of the partnership's property over the transferee's basis 
for the transferred partnership interest.
    (c) Determination of transferee's basis in the transferred 
partnership interest. In the case of the transfer of a partnership 
interest by sale or exchange or as a result of the death of a partner, 
the transferee's basis in the transferred partnership interest is 
determined under section 742 and Sec. 1.742-1. See also section 752 and 
Sec. Sec. 1.752-1 through 1.752-5.
    (d) Determination of transferee's share of the adjusted basis to the 
partnership of the partnership's property--(1) Generally. A transferee's 
share of the adjusted basis to the partnership of partnership property 
is equal to the sum of the transferee's interest as a partner in the 
partnership's previously taxed capital,

[[Page 631]]

plus the transferee's share of partnership liabilities. Generally, a 
transferee's interest as a partner in the partnership's previously taxed 
capital is equal to--
    (i) The amount of cash that the transferee would receive on a 
liquidation of the partnership following the hypothetical transaction, 
as defined in paragraph (d)(2) of this section (to the extent 
attributable to the acquired partnership interest); increased by
    (ii) The amount of tax loss (including any remedial allocations 
under Sec. 1.704-3(d)), that would be allocated to the transferee from 
the hypothetical transaction (to the extent attributable to the acquired 
partnership interest); and decreased by
    (iii) The amount of tax gain (including any remedial allocations 
under Sec. 1.704-3(d)), that would be allocated to the transferee from 
the hypothetical transaction (to the extent attributable to the acquired 
partnership interest).
    (2) Hypothetical transaction defined. For purposes of paragraph 
(d)(1) of this section, the hypothetical transaction means the 
disposition by the partnership of all of the partnership's assets, 
immediately after the transfer of the partnership interest, in a fully 
taxable transaction for cash equal to the fair market value of the 
assets. See Sec. 1.460-4(k)(3)(v)(B) for a rule relating to the 
computation of income or loss that would be allocated to the transferee 
from a contract accounted for under a long-term contract method of 
accounting as a result of the hypothetical transaction.
    (3) Examples. The provisions of this paragraph (d) are illustrated 
by the following examples:

    Example 1. (i) A is a member of partnership PRS in which the 
partners have equal interests in capital and profits. The partnership 
has made an election under section 754, relating to the optional 
adjustment to the basis of partnership property. A sells its interest to 
T for $22,000. The balance sheet of the partnership at the date of sale 
shows the following:

------------------------------------------------------------------------
                                                         Assets
                                               -------------------------
                                                  Adjusted   Fair market
                                                   basis        value
------------------------------------------------------------------------
Cash..........................................       $5,000       $5,000
Accounts receivable...........................       10,000       10,000
Inventory.....................................       20,000       21,000
Depreciable assets............................       20,000       40,000
                                               -------------------------
    Total.....................................       55,000       76,000
------------------------------------------------------------------------


------------------------------------------------------------------------
                                                 Liabilities and Capital
                                               -------------------------
                                                  Adjusted   Fair market
                                                 per books      value
------------------------------------------------------------------------
Liabilities...................................      $10,000      $10,000
Capital:
    A.........................................       15,000       22,000
    B.........................................       15,000       22,000
    C.........................................       15,000       22,000
                                               -------------------------
        Total.................................       55,000       76,000
------------------------------------------------------------------------

    (ii) The amount of the basis adjustment under section 743(b) is the 
difference between the basis of T's interest in the partnership and T's 
share of the adjusted basis to the partnership of the partnership's 
property. Under section 742, the basis of T's interest is $25,333 (the 
cash paid for A's interest, $22,000, plus $3,333, T's share of 
partnership liabilities). T's interest in the partnership's previously 
taxed capital is $15,000 ($22,000, the amount of cash T would receive if 
PRS liquidated immediately after the hypothetical transaction, decreased 
by $7,000, the amount of tax gain allocated to T from the hypothetical 
transaction). T's share of the adjusted basis to the partnership of the 
partnership's property is $18,333 ($15,000 share of previously taxed 
capital, plus $3,333 share of the partnership's liabilities). The amount 
of the basis adjustment under section 743(b) to partnership property 
therefore, is $7,000, the difference between $25,333 and $18,333.
    Example 2. A, B, and C form partnership PRS, to which A contributes 
land (Asset 1) with a fair market value of $1,000 and an adjusted basis 
to A of $400, and B and C each contribute $1,000 cash. Each partner has 
$1,000 credited to it on the books of the partnership as its capital 
contribution. The partners share in profits equally. During the 
partnership's first taxable year, Asset 1 appreciates in value to 
$1,300. A sells its one-third interest in the partnership to T for 
$1,100, when an election under section 754 is in effect. The amount of 
tax gain that would be allocated to T from the hypothetical transaction 
is $700 ($600 section 704(c) built-in gain, plus one-third of the 
additional gain). Thus, T's interest in the partnership's previously 
taxed capital is $400 ($1,100, the amount of cash T would receive if PRS 
liquidated immediately after the hypothetical transaction, decreased by 
$700, T's share of gain from the hypothetical transaction). The amount 
of T's basis adjustment under section 743(b) to partnership property is 
$700

[[Page 632]]

(the excess of $1,100, T's cost basis for its interest, over $400, T's 
share of the adjusted basis to the partnership of partnership property).

    (e) Allocation of basis adjustment. For the allocation of the basis 
adjustment under this section among the individual items of partnership 
property, see section 755 and the regulations thereunder.
    (f) Subsequent transfers. Where there has been more than one 
transfer of a partnership interest, a transferee's basis adjustment is 
determined without regard to any prior transferee's basis adjustment. In 
the case of a gift of an interest in a partnership, the donor is treated 
as transferring, and the donee as receiving, that portion of the basis 
adjustment attributable to the gifted partnership interest. The 
provisions of this paragraph (f) are illustrated by the following 
example:

    Example. (i) A, B, and C form partnership PRS. A and B each 
contribute $1,000 cash, and C contributes land with a basis and fair 
market value of $1,000. When the land has appreciated in value to 
$1,300, A sells its interest to T1 for $1,100 (one-third of $3,300, the 
fair market value of the partnership property). An election under 
section 754 is in effect; therefore, T1 has a basis adjustment under 
section 743(b) of $100.
    (ii) After the land has further appreciated in value to $1,600, T1 
sells its interest to T2 for $1,200 (one-third of $3,600, the fair 
market value of the partnership property). T2 has a basis adjustment 
under section 743(b) of $200. This amount is determined without regard 
to any basis adjustment under section 743(b) that T1 may have had in the 
partnership assets.
    (iii) During the following year, T2 makes a gift to T3 of fifty 
percent of T2's interest in PRS. At the time of the transfer, T2 has a 
$200 basis adjustment under section 743(b). T2 is treated as 
transferring $100 of the basis adjustment to T3 with the gift of the 
partnership interest.

    (g) Distributions--(1) Distribution of adjusted property to the 
transferee--(i) Coordination with section 732. If a partnership 
distributes property to a transferee and the transferee has a basis 
adjustment for the property, the basis adjustment is taken into account 
under section 732. See Sec. 1.732-2(b).
    (ii) Coordination with section 734. For certain adjustments to the 
common basis of remaining partnership property after the distribution of 
adjusted property to a transferee, see Sec. 1.734-2(b).
    (2) Distribution of adjusted property to another partner--(i) 
Coordination with section 732. If a partner receives a distribution of 
property with respect to which another partner has a basis adjustment, 
the distributee does not take the basis adjustment into account under 
section 732.
    (ii) Reallocation of basis. A transferee with a basis adjustment in 
property that is distributed to another partner reallocates the basis 
adjustment among the remaining items of partnership property under Sec. 
1.755-1(c).
    (3) Distributions in complete liquidation of a partner's interest. 
If a transferee receives a distribution of property (whether or not the 
transferee has a basis adjustment in such property) in liquidation of 
its interest in the partnership, the adjusted basis to the partnership 
of the distributed property immediately before the distribution includes 
the transferee's basis adjustment for the property in which the 
transferee relinquished an interest (either because it remained in the 
partnership or was distributed to another partner). Any basis adjustment 
for property in which the transferee is deemed to relinquish its 
interest is reallocated among the properties distributed to the 
transferee under Sec. 1.755-1(c).
    (4) Coordination with other provisions. The rules of sections 
704(c)(1)(B), 731, 737, and 751 apply before the rules of this paragraph 
(g).
    (5) Example. The provisions of this paragraph (g) are illustrated by 
the following example:

    Example. (i) A, B, and C are equal partners in partnership PRS. Each 
partner originally contributed $10,000 in cash, and PRS used the 
contributions to purchase five nondepreciable capital assets. PRS has no 
liabilities. After five years, PRS's balance sheet appears as follows:

------------------------------------------------------------------------
                                                         Assets
                                               -------------------------
                                                  Adjusted   Fair market
                                                   basis        value
------------------------------------------------------------------------
Asset 1.......................................      $10,000      $10,000
Asset 2.......................................        4,000        6,000
Asset 3.......................................        6,000        6,000
Asset 4.......................................        7,000        4,000
Asset 5.......................................        3,000       13,000
                                               -------------------------
    Total.....................................       30,000       39,000
------------------------------------------------------------------------


[[Page 633]]


------------------------------------------------------------------------
                                                         Capital
                                               -------------------------
                                                  Adjusted   Fair market
                                                 per books      value
------------------------------------------------------------------------
Partner A.....................................      $10,000      $13,000
Partner B.....................................       10,000       13,000
Partner C.....................................       10,000       13,000
                                               -------------------------
    Total.....................................       30,000       39,000
------------------------------------------------------------------------

    (ii) A sells its interest to T for $13,000 when PRS has an election 
in effect under section 754. T receives a basis adjustment under section 
743(b) in the partnership property that is equal to $3,000 (the excess 
of T's basis in the partnership interest, $13,000, over T's share of the 
adjusted basis to the partnership of partnership property, $10,000). The 
basis adjustment is allocated under section 755, and the partnership's 
balance sheet appears as follows:

------------------------------------------------------------------------
                                                 Assets
                               -----------------------------------------
                                  Adjusted   Fair market       Basis
                                   basis        value       adjustment
------------------------------------------------------------------------
Asset 1.......................      $10,000      $10,000          $0.00
Asset 2.......................        4,000        6,000         666.67
Asset 3.......................        6,000        6,000           0.00
Asset 4.......................        7,000        4,000      (1,000.00)
Asset 5.......................        3,000       13,000       3,333.33
                               -----------------------------------------
    Total.....................       30,000       39,000       3,000.00
------------------------------------------------------------------------


------------------------------------------------------------------------
                                                  Capital
                                  --------------------------------------
                                     Adjusted   Fair market    Special
                                    per books      value        basis
------------------------------------------------------------------------
Partner T........................      $10,000      $13,000       $3,000
Partner B........................       10,000       13,000            0
Partner C........................       10,000       13,000            0
                                  --------------------------------------
    Total........................       30,000       39,000        3,000
------------------------------------------------------------------------

    (iii) Assume that PRS distributes Asset 2 to T in partial 
liquidation of T's interest in the partnership. T has a basis adjustment 
under section 743(b) of $666.67 in Asset 2. Under paragraph (g)(1)(i) of 
this section, T takes the basis adjustment into account under section 
732. Therefore, T will have a basis in Asset 2 of $4,666.67 following 
the distribution.
    (iv) Assume instead that PRS distributes Asset 5 to C in complete 
liquidation of C's interest in PRS. T has a basis adjustment under 
section 743(b) of $3,333.33 in Asset 5. Under paragraph (g)(2)(i) of 
this section, C does not take T's basis adjustment into account under 
section 732. Therefore, the partnership's basis for purposes of sections 
732 and 734 is $3,000. Under paragraph (g)(2)(ii) of this section, T's 
$3,333.33 basis adjustment is reallocated among the remaining 
partnership assets under Sec. 1.755-1(c).
    (v) Assume instead that PRS distributes Asset 5 to T in complete 
liquidation of its interest in PRS. Under paragraph (g)(3) of this 
section, immediately prior to the distribution of Asset 5 to T, PRS must 
adjust the basis of Asset 5. Therefore, immediately prior to the 
distribution, PRS's basis in Asset 5 is equal to $6,000, which is the 
sum of (A) $3,000, PRS's common basis in Asset 5, plus (B) $3,333.33, 
T's basis adjustment to Asset 5, plus (C) ($333.33), the sum of T's 
basis adjustments in Assets 2 and 4. For purposes of sections 732 and 
734, therefore, PRS will be treated as having a basis in Asset 5 equal 
to $6,000.

    (h) Contributions of adjusted property--(1) Section 721(a) 
transactions. If, in a transaction described in section 721(a), a 
partnership (the upper tier) contributes to another partnership (the 
lower tier) property with respect to which a basis adjustment has been 
made, the basis adjustment is treated as contributed to the lower-tier 
partnership, regardless of whether the lower-tier partnership makes a 
section 754 election. The lower tier's basis in the contributed assets 
and the upper tier's basis in the partnership interest received in the 
transaction are determined with reference to the basis adjustment. 
However, that portion of the basis of the upper tier's interest in the 
lower tier attributable to the basis adjustment must be segregated and 
allocated solely to the transferee partner for whom the basis adjustment 
was made. Similarly, that portion of the lower tier's basis in its 
assets attributable to the basis adjustment must be segregated and 
allocated solely to the upper tier and the transferee. A partner with a 
basis adjustment in property held by a partnership that terminates under 
section 708(b)(1)(B) will continue to have the same basis adjustment 
with respect to property deemed contributed by the terminated 
partnership to the new partnership under Sec. 1.708-1(b)(1)(iv), 
regardless of whether the new partnership makes a section 754 election.
    (2) Section 351 transactions--(i) Basis in transferred property. A 
corporation's adjusted tax basis in property transferred to the 
corporation by a partnership in a transaction described in section 351 
is determined with reference to any basis adjustments to the property 
under section 743(b) (other than any basis adjustment that reduces a 
partner's gain under paragraph (h)(2)(ii) of this section).

[[Page 634]]

    (ii) Partnership gain. The amount of gain, if any, recognized by the 
partnership on a transfer of property by the partnership to a 
corporation in a transfer described in section 351 is determined without 
reference to any basis adjustment to the transferred property under 
section 743(b). The amount of gain, if any, recognized by the 
partnership on the transfer that is allocated to a partner with a basis 
adjustment in the transferred property is adjusted to reflect the 
partner's basis adjustment in the transferred property.
    (iii) Basis in stock. The partnership's adjusted tax basis in stock 
received from a corporation in a transfer described in section 351 is 
determined without reference to the basis adjustment in property 
transferred to the corporation in the section 351 exchange. A partner 
with a basis adjustment in property transferred to the corporation, 
however, has a basis adjustment in the stock received by the partnership 
in the section 351 exchange in an amount equal to the partner's basis 
adjustment in the transferred property, reduced by any basis adjustment 
that reduced the partner's gain under paragraph (h)(2)(ii) of this 
section.
    (iv) Example. The following example illustrates the principles of 
this paragraph (h)(2):

    Example. (i) A, B, and C are equal partners in partnership PRS. The 
partnership's only asset, Asset 1, has an adjusted tax basis of $60 and 
a fair market value of $120. Asset 1 is a nondepreciable capital asset 
and is not section 704(c) property. A has a basis in its partnership 
interest of $40, and a positive section 743(b) adjustment of $20 in 
Asset 1. In a transaction to which section 351 applies, PRS contributes 
Asset 1 to X, a corporation, in exchange for $15 in cash and X stock 
with a fair market value of $105.
    (ii) Under paragraph (h)(2)(ii) of this section, PRS realizes $60 of 
gain on the transfer of Asset 1 to X ($120, its amount realized, minus 
$60, its adjusted basis), but recognizes only $15 of that gain under 
section 351(b)(1). Of this amount, $5 is allocated to each partner. A 
must use $5 of its basis adjustment in Asset 1 to offset A's share of 
PRS's gain. Under paragraph (h)(2)(iii) of this section, PRS's basis in 
the stock received from X is $60. However, A has a basis adjustment in 
the stock received by PRS equal to $15 (its basis adjustment in Asset 1, 
$20, reduced by the portion of the adjustment which reduced A's gain, 
$5). Under paragraph (h)(2)(i) of this section, X's basis in Asset 1 
equals $90 (PRS's common basis in the asset, $60, plus the gain 
recognized by PRS under section 351(b)(1), $15, plus A's basis 
adjustment under section 743(b), $20, less the portion of the adjustment 
which reduced A's gain, $5).

    (i) [Reserved]
    (j) Effect of basis adjustment--(1) In general. The basis adjustment 
constitutes an adjustment to the basis of partnership property with 
respect to the transferee only. No adjustment is made to the common 
basis of partnership property. Thus, for purposes of calculating income, 
deduction, gain, and loss, the transferee will have a special basis for 
those partnership properties the bases of which are adjusted under 
section 743(b) and this section. The adjustment to the basis of 
partnership property under section 743(b) has no effect on the 
partnership's computation of any item under section 703.
    (2) Computation of partner's distributive share of partnership 
items. The partnership first computes its items of income, deduction, 
gain, or loss at the partnership level under section 703. The 
partnership then allocates the partnership items among the partners, 
including the transferee, in accordance with section 704, and adjusts 
the partners' capital accounts accordingly. The partnership then adjusts 
the transferee's distributive share of the items of partnership income, 
deduction, gain, or loss, in accordance with paragraphs (j)(3) and (4) 
of this section, to reflect the effects of the transferee's basis 
adjustment under section 743(b). These adjustments to the transferee's 
distributive shares must be reflected on Schedules K and K-1 of the 
partnership's return (Form 1065). These adjustments to the transferee's 
distributive shares do not affect the transferee's capital account. See 
Sec. 1.460-4(k)(3)(v)(B) for rules relating to the effect of a basis 
adjustment under section 743(b) that is allocated to a contract 
accounted for under a long-term contract method of accounting in 
determining the transferee's distributive share of income or loss from 
the contract.
    (3) Effect of basis adjustment in determining items of income, gain, 
or loss--(i) In general. The amount of a transferee's income, gain, or 
loss from the sale or exchange of a partnership asset in

[[Page 635]]

which the transferee has a basis adjustment is equal to the transferee's 
share of the partnership's gain or loss from the sale of the asset 
(including any remedial allocations under Sec. 1.704-3(d)), minus the 
amount of the transferee's positive basis adjustment for the partnership 
asset (determined by taking into account the recovery of the basis 
adjustment under paragraph (j)(4)(i)(B) of this section) or plus the 
amount of the transferee's negative basis adjustment for the partnership 
asset (determined by taking into the account the recovery of the basis 
adjustment under paragraph (j)(4)(ii)(B) of this section).
    (ii) Examples. The following examples illustrate the principles of 
this paragraph (j)(3):

    Example 1. A and B form equal partnership PRS. A contributes 
nondepreciable property with a fair market value of $50 and an adjusted 
tax basis of $100. PRS will use the traditional allocation method under 
Sec. 1.704-3(b). B contributes $50 cash. A sells its interest to T for 
$50. PRS has an election in effect to adjust the basis of partnership 
property under section 754. T receives a negative $50 basis adjustment 
under section 743(b) that, under section 755, is allocated to the 
nondepreciable property. PRS then sells the property for $60. PRS 
recognizes a book gain of $10 (allocated equally between T and B) and a 
tax loss of $40. T will receive an allocation of $40 of tax loss under 
the principles of section 704(c). However, because T has a negative $50 
basis adjustment in the nondepreciable property, T recognizes a $10 gain 
from the partnership's sale of the property.
    Example 2. A and B form equal partnership PRS. A contributes 
nondepreciable property with a fair market value of $100 and an adjusted 
tax basis of $50. B contributes $100 cash. PRS will use the traditional 
allocation method under Sec. 1.704-3(b). A sells its interest to T for 
$100. PRS has an election in effect to adjust the basis of partnership 
property under section 754. Therefore, T receives a $50 basis adjustment 
under section 743(b) that, under section 755, is allocated to the 
nondepreciable property. PRS then sells the nondepreciable property for 
$90. PRS recognizes a book loss of $10 (allocated equally between T and 
B) and a tax gain of $40. T will receive an allocation of the entire $40 
of tax gain under the principles of section 704(c). However, because T 
has a $50 basis adjustment in the property, T recognizes a $10 loss from 
the partnership's sale of the property.
    Example 3. A and B form equal partnership PRS. PRS will make 
allocations under section 704(c) using the remedial allocation method 
described in Sec. 1.704-3(d). A contributes nondepreciable property 
with a fair market value of $100 and an adjusted tax basis of $150. B 
contributes $100 cash. A sells its partnership interest to T for $100. 
PRS has an election in effect to adjust the basis of partnership 
property under section 754. T receives a negative $50 basis adjustment 
under section 743(b) that, under section 755, is allocated to the 
property. The partnership then sells the property for $120. The 
partnership recognizes a $20 book gain and a $30 tax loss. The book gain 
will be allocated equally between the partners. The entire $30 tax loss 
will be allocated to T under the principles of section 704(c). To match 
its $10 share of book gain, B will be allocated $10 of remedial gain, 
and T will be allocated an offsetting $10 of remedial loss. T was 
allocated a total of $40 of tax loss with respect to the property. 
However, because T has a negative $50 basis adjustment to the property, 
T recognizes a $10 gain from the partnership's sale of the property.

    (4) Effect of basis adjustment in determining items of deduction--
(i) Increases--(A) Additional deduction. The amount of any positive 
basis adjustment that is recovered by the transferee in any year is 
added to the transferee's distributive share of the partnership's 
depreciation or amortization deductions for the year. The basis 
adjustment is adjusted under section 1016(a)(2) to reflect the recovery 
of the basis adjustment.
    (B) Recovery period--(1) In general. Except as provided in paragraph 
(j)(4)(i)(B)(2) of this section, for purposes of section 168, if the 
basis of a partnership's recovery property is increased as a result of 
the transfer of a partnership interest, then the increased portion of 
the basis is taken into account as if it were newly-purchased recovery 
property placed in service when the transfer occurs. Consequently, any 
applicable recovery period and method may be used to determine the 
recovery allowance with respect to the increased portion of the basis. 
However, no change is made for purposes of determining the recovery 
allowance under section 168 for the portion of the basis for which there 
is no increase.
    (2) Remedial allocation method. If a partnership elects to use the 
remedial allocation method described in Sec. 1.704-3(d) with respect to 
an item of the partnership's recovery property, then the portion of any 
increase in the basis of the item of the partnership's recovery

[[Page 636]]

property under section 743(b) that is attributable to section 704(c) 
built-in gain is recovered over the remaining recovery period for the 
partnership's excess book basis in the property as determined in the 
final sentence of Sec. 1.704-3(d)(2). Any remaining portion of the 
basis increase is recovered under paragraph (j)(4)(i)(B)(1) of this 
section.
    (C) Examples. The provisions of this paragraph (j)(4)(i) are 
illustrated by the following examples:

    Example 1. (i) A, B, and C are equal partners in partnership PRS, 
which owns Asset 1, an item of depreciable property that has a fair 
market value in excess of its adjusted tax basis. C sells its interest 
in PRS to T while PRS has an election in effect under section 754. PRS, 
therefore, increases the basis of Asset 1 with respect to T.
    (ii) Assume that in the year following the transfer of the 
partnership interest to T, T's distributive share of the partnership's 
common basis depreciation deductions from Asset 1 is $1,000. Also assume 
that, under paragraph (j)(4)(i)(B) of this section, the amount of the 
basis adjustment under section 743(b) that T recovers during the year is 
$500. The total amount of depreciation deductions from Asset 1 reported 
by T is equal to $1,500.
    Example 2. (i) A and B form equal partnership PRS. A contributes 
property with an adjusted basis of $100,000 and a fair market value of 
$500,000. B contributes $500,000 cash. When PRS is formed, the property 
has five years remaining in its recovery period. The partnership's 
adjusted basis of $100,000 will, therefore, be recovered over the five 
years remaining in the property's recovery period. PRS elects to use the 
remedial allocation method under Sec. 1.704-3(d) with respect to the 
property. If PRS had purchased the property at the time of the 
partnership's formation, the basis of the property would have been 
recovered over a 10-year period. The $400,000 of section 704(c) built-in 
gain will, therefore, be amortized under Sec. 1.704-3(d) over a 10-year 
period beginning at the time of the partnership's formation.
    (ii)(A) Except for the depreciation deductions, PRS's expenses equal 
its income in each year of the first two years commencing with the year 
the partnership is formed. After two years, A's share of the adjusted 
basis of partnership property is $120,000, while B's is $440,000:

------------------------------------------------------------------------
                                           Capital accounts
                             -------------------------------------------
                                  A                     B
                             -------------------------------------------
                                 Book       Tax        Book       Tax
------------------------------------------------------------------------
Initial Contribution........   $500,000   $100,000   $500,000   $500,000
Depreciation Year 1.........   (30,000)  .........   (30,000)   (20,000)
Remedial....................  .........     10,000  .........   (10,000)
                             -------------------------------------------
                                470,000    110,000    470,000    470,000
Depreciation Year 2.........   (30,000)  .........   (30,000)   (20,000)
Remedial....................  .........     10,000  .........   (10,000)
                             -------------------------------------------
                                440,000    120,000    440,000    440,000
------------------------------------------------------------------------

    (B) A sells its interest in PRS to T for its fair market value of 
$440,000. A valid election under section 754 is in effect with respect 
to the sale of the partnership interest. Accordingly, PRS makes an 
adjustment, pursuant to section 743(b), to increase the basis of 
partnership property. Under section 743(b), the amount of the basis 
adjustment is equal to $320,000. Under section 755, the entire basis 
adjustment is allocated to the property.
    (iii) At the time of the transfer, $320,000 of section 704(c) built-
in gain from the property was still reflected on the partnership's 
books, and all of the basis adjustment is attributable to section 704(c) 
built-in gain. Therefore, the basis adjustment will be recovered over 
the remaining recovery period for the section 704(c) built-in gain under 
Sec. 1.704-3(d).

    (ii) Decreases--(A) Reduced deduction. The amount of any negative 
basis adjustment allocated to an item of depreciable or amortizable 
property that is recovered in any year first decreases the transferee's 
distributive share of the partnership's depreciation or amortization 
deductions from that item of property for the year. If the amount of the 
basis adjustment recovered in any year exceeds the transferee's 
distributive share of the partnership's depreciation or amortization 
deductions from the item of property, then the transferee's distributive 
share of the partnership's depreciation or amortization deductions from 
other items of partnership property is decreased. The transferee then 
recognizes ordinary income to the extent of the excess, if any, of the 
amount of the basis adjustment recovered in any year over the 
transferee's distributive share of the partnership's depreciation or 
amortization deductions from all items of property.
    (B) Recovery period. For purposes of section 168, if the basis of an 
item of a

[[Page 637]]

partnership's recovery property is decreased as the result of the 
transfer of an interest in the partnership, then the decrease is 
recovered over the remaining useful life of the item of the 
partnership's recovery property. The portion of the decrease that is 
recovered in any year during the recovery period is equal to the product 
of--
    (1) The amount of the decrease to the item's adjusted basis 
(determined as of the date of the transfer); multiplied by
    (2) A fraction, the numerator of which is the portion of the 
adjusted basis of the item recovered by the partnership in that year, 
and the denominator of which is the adjusted basis of the item on the 
date of the transfer (determined prior to any basis adjustments).
    (C) Examples. The provisions of this paragraph (j)(4)(ii) are 
illustrated by the following examples:

    Example 1. (i) A, B, and C are equal partners in partnership PRS, 
which owns Asset 2, an item of depreciable property that has a fair 
market value that is less than its adjusted tax basis. C sells its 
interest in PRS to T while PRS has an election in effect under section 
754. PRS, therefore, decreases the basis of Asset 2 with respect to T.
    (ii) Assume that in the year following the transfer of the 
partnership interest to T, T's distributive share of the partnership's 
common basis depreciation deductions from Asset 2 is $1,000. Also assume 
that, under paragraph (j)(4)(ii)(B) of this section, the amount of the 
basis adjustment under section 743(b) that T recovers during the year is 
$500. The total amount of depreciation deductions from Asset 2 reported 
by T is equal to $500.
    Example 2. (i) A and B form equal partnership PRS. A contributes 
property with an adjusted basis of $100,000 and a fair market value of 
$50,000. B contributes $50,000 cash. When PRS is formed, the property 
has five years remaining in its recovery period. The partnership's 
adjusted basis of $100,000 will, therefore, be recovered over the five 
years remaining in the property's recovery period. PRS uses the 
traditional allocation method under Sec. 1.704-3(b) with respect to the 
property. As a result, B will receive $5,000 of depreciation deductions 
from the property in each of years 1-5, and A, as the contributing 
partner, will receive $15,000 of depreciation deductions in each of 
these years.
    (ii) Except for the depreciation deductions, PRS's expenses equal 
its income in each of the first two years commencing with the year the 
partnership is formed. After two years, A's share of the adjusted basis 
of partnership property is $70,000, while B's is $40,000. A sells its 
interest in PRS to T for its fair market value of $40,000. A valid 
election under section 754 is in effect with respect to the sale of the 
partnership interest. Accordingly, PRS makes an adjustment, pursuant to 
section 743(b), to decrease the basis of partnership property. Under 
section 743(b), the amount of the adjustment is equal to ($30,000). 
Under section 755, the entire adjustment is allocated to the property.
    (iii) The basis of the property at the time of the transfer of the 
partnership interest was $60,000. In each of years 3 through 5, the 
partnership will realize depreciation deductions of $20,000 from the 
property. Thus, one third of the negative basis adjustment ($10,000) 
will be recovered in each of years 3 through 5. Consequently, T will be 
allocated, for tax purposes, depreciation of $15,000 each year from the 
partnership and will recover $10,000 of its negative basis adjustment. 
Thus, T's net depreciation deduction from the partnership in each year 
is $5,000.
    Example 3. (i) A, B, and C are equal partners in partnership PRS, 
which owns Asset 2, an item of depreciable property that has a fair 
market value that is less than its adjusted tax basis. C sells its 
interest in PRS to T while PRS has an election in effect under section 
754. PRS, therefore, decreases the basis of Asset 2 with respect to T.
    (ii) Assume that in the year following the transfer of the 
partnership interest to T, T's distributive share of the partnership's 
common basis depreciation deductions from Asset 2 is $500. PRS allocates 
no other depreciation to T. Also assume that, under paragraph 
(j)(4)(ii)(B) of this section, the amount of the negative basis 
adjustment that T recovers during the year is $1,000. T will report $500 
of ordinary income because the amount of the negative basis adjustment 
recovered during the year exceeds T's distributive share of the 
partnership's common basis depreciation deductions from Asset 2.

    (5) Depletion. Where an adjustment is made under section 743(b) to 
the basis of partnership property subject to depletion, any depletion 
allowance is determined separately for each partner, including the 
transferee partner, based on the partner's interest in such property. 
See Sec. 1.702-1(a)(8). For partnerships that hold oil and gas 
properties that are depleted at the partner level under section 
613A(c)(7)(D), the transferee partner (and not the partnership) must 
make the basis adjustments, if any, required under section 743(b) with 
respect to such properties. See Sec. 1.613A-3(e)(6)(iv).

[[Page 638]]

    (6) Example. The provisions of paragraph (j)(5) of this section are 
illustrated by the following example:

    Example. A, B, and C each contributes $5,000 cash to form 
partnership PRS, which purchases a coal property for $15,000. A, B, and 
C have equal interests in capital and profits. C subsequently sells its 
partnership interest to T for $100,000 when the election under section 
754 is in effect. T has a basis adjustment under section 743(b) for the 
coal property of $95,000 (the difference between T's basis, $100,000, 
and its share of the basis of partnership property, $5,000). Assume that 
the depletion allowance computed under the percentage method would be 
$21,000 for the taxable year so that each partner would be entitled to 
$7,000 as its share of the deduction for depletion. However, under the 
cost depletion method, at an assumed rate of 10 percent, the allowance 
with respect to T's one-third interest which has a basis to him of 
$100,000 ($5,000, plus its basis adjustment of $95,000) is $10,000, 
although the cost depletion allowance with respect to the one-third 
interest of A and B in the coal property, each of which has a basis of 
$5,000, is only $500. For partners A and B, the percentage depletion is 
greater than cost depletion and each will deduct $7,000 based on the 
percentage depletion method. However, as to T, the transferee partner, 
the cost depletion method results in a greater allowance and T will, 
therefore, deduct $10,000 based on cost depletion. See section 613(a).

    (k) Returns--(1) Statement of adjustments--(i) In general. A 
partnership that must adjust the bases of partnership properties under 
section 743(b) must attach a statement to the partnership return for the 
year of the transfer setting forth the name and taxpayer identification 
number of the transferee as well as the computation of the adjustment 
and the partnership properties to which the adjustment has been 
allocated.
    (ii) Special rule. Where an interest is transferred in a partnership 
which holds oil and gas properties that are depleted at the partner 
level under section 613A(c)(7)(D), the transferee must attach a 
statement to the transferee's return for the year of the transfer, 
setting forth the computation of the basis adjustment under section 
743(b) which is allocable to such properties and the specific properties 
to which the adjustment has been allocated.
    (iii) Example. The provisions of paragraph (k)(1)(ii) of this 
section are illustrated by the following example:

    Example. (i) Partnership XYZ owns a single section 613A(c)(7)(D) 
domestic oil and gas property (Property) and other non-depletable 
assets. A, a partner in XYZ with an adjusted tax basis in Property of 
$100 (excluding any prior adjustments under section 743(b)), sells its 
partnership interest to B for $800 cash. Under Sec. 1.613A-3(e)(6)(iv), 
A's adjusted basis of $100 in Property carries over to B.
    (ii) Under section 755, XYZ determines that Property accounts for 
50% of the fair market value of all partnership assets. The remaining 
50% of B's purchase price ($400) is attributable to non-depletable 
property. XYZ must provide a statement to B containing the portion of 
B's adjusted basis attributable to non-depletable property ($400). Under 
this paragraph (k)(1), XYZ must report basis adjustments under section 
743(b) to non-depletable property. B must report basis adjustments under 
section 743(b) to Property.

    (2) Requirement that transferee notify partnership--(i) Sale or 
exchange. A transferee that acquires, by sale or exchange, an interest 
in a partnership with an election under section 754 in effect for the 
taxable year of the transfer, must notify the partnership, in writing, 
within 30 days of the sale or exchange. The written notice to the 
partnership must be signed under penalties of perjury and must include 
the names and addresses of the transferee and (if ascertainable) of the 
transferor, the taxpayer identification numbers of the transferee and 
(if ascertainable) of the transferor, the relationship (if any) between 
the transferee and the transferor, the date of the transfer, the amount 
of any liabilities assumed or taken subject to by the transferee, and 
the amount of any money, the fair market value of any other property 
delivered or to be delivered for the transferred interest in the 
partnership, and any other information necessary for the partnership to 
compute the transferee's basis.
    (ii) Transfer on death. A transferee that acquires, on the death of 
a partner, an interest in a partnership with an election under section 
754 in effect for the taxable year of the transfer, must notify the 
partnership, in writing, within one year of the death of the deceased 
partner. The written notice to the partnership must be signed under 
penalties of perjury and must include the names and addresses of the 
deceased partner and the transferee, the taxpayer identification numbers 
of the

[[Page 639]]

deceased partner and the transferee, the relationship (if any) between 
the transferee and the transferor, the deceased partner's date of death, 
the date on which the transferee became the owner of the partnership 
interest, the fair market value of the partnership interest on the 
applicable date of valuation set forth in section 1014, and the manner 
in which the fair market value of the partnership interest was 
determined.
    (iii) Nominee reporting. If a partnership interest is transferred to 
a nominee which is required to furnish the statement under section 
6031(c)(1) to the partnership, the nominee may satisfy the notice 
requirement contained in this paragraph (k)(2) by providing the 
statement required under Sec. 1.6031(c)-1T, provided that the statement 
satisfies all requirements of Sec. 1.6031(c)-1T and this paragraph 
(k)(2).
    (3) Reliance. In making the adjustments under section 743(b) and any 
statement or return relating to such adjustments under this section, a 
partnership may rely on the written notice provided by a transferee 
pursuant to paragraph (k)(2) of this section to determine the 
transferee's basis in a partnership interest. The previous sentence 
shall not apply if any partner who has responsibility for federal income 
tax reporting by the partnership has knowledge of facts indicating that 
the statement is clearly erroneous.
    (4) Partnership not required to make or report adjustments under 
section 743(b) until it has notice of the transfer. A partnership is not 
required to make the adjustments under section 743(b) (or any statement 
or return relating to those adjustments) with respect to any transfer 
until it has been notified of the transfer. For purposes of this 
section, a partnership is notified of a transfer when either--
    (i) The partnership receives the written notice from the transferee 
required under paragraph (k)(2) of this section; or
    (ii) Any partner who has responsibility for federal income tax 
reporting by the partnership has knowledge that there has been a 
transfer of a partnership interest.
    (5) Effect on partnership of the failure of the transferee to 
comply. If the transferee fails to provide the partnership with the 
written notice required by paragraph (k)(2) of this section, the 
partnership must attach a statement to its return in the year that the 
partnership is otherwise notified of the transfer. This statement must 
set forth the name and taxpayer identification number (if ascertainable) 
of the transferee. In addition, the following statement must be 
prominently displayed in capital letters on the first page of the 
partnership's return for such year, and on the first page of any 
schedule or information statement relating to such transferee's share of 
income, credits, deductions, etc.: ``RETURN FILED PURSUANT TO Sec. 
1.743-1(k)(5).'' The partnership will then be entitled to report the 
transferee's share of partnership items without adjustment to reflect 
the transferee's basis adjustment in partnership property. If, following 
the filing of a return pursuant to this paragraph (k)(5), the transferee 
provides the applicable written notice to the partnership, the 
partnership must make such adjustments as are necessary to adjust the 
basis of partnership property (as of the date of the transfer) in any 
amended return otherwise to be filed by the partnership or in the next 
annual partnership return of income to be regularly filed by the 
partnership. At such time, the partnership must also provide the 
transferee with such information as is necessary for the transferee to 
amend its prior returns to properly reflect the adjustment under section 
743(b).
    (l) Effective date. This section applies to transfers of partnership 
interests that occur on or after December 15, 1999.

[T.D. 8847, 64 FR 69909, Dec. 15, 1999; 65 FR 9220, Feb. 24, 2000, as 
amended by T.D. 9137, 69 FR 42559, July 16, 2004]

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



Sec. 1.751-1  Unrealized receivables and inventory items.

    (a) Sale or exchange of interest in a partnership--(1) Character of 
amount realized. To the extent that money or property received by a 
partner in exchange for all or part of his partnership interest is 
attributable to his share of

[[Page 640]]

the value of partnership unrealized receivables or substantially 
appreciated inventory items, the money or fair market value of the 
property received shall be considered as an amount realized from the 
sale or exchange of property other than a capital asset. The remainder 
of the total amount realized on the sale or exchange of the partnership 
interest is realized from the sale or exchange of a capital asset under 
section 741. For definition of ``unrealized receivables'' and 
``inventory items which have appreciated substantially in value'', see 
section 751 (c) and (d). Unrealized receivables and substantially 
appreciated inventory items are hereafter in this section referred to as 
``section 751 property''. See paragraph (e) of this section.
    (2) Determination of gain or loss. The income or loss realized by a 
partner upon the sale or exchange of its interest in section 751 
property is the amount of income or loss from section 751 property 
(including any remedial allocations under Sec. 1.704-3(d)) that would 
have been allocated to the partner (to the extent attributable to the 
partnership interest sold or exchanged) if the partnership had sold all 
of its property in a fully taxable transaction for cash in an amount 
equal to the fair market value of such property (taking into account 
section 7701(g)) immediately prior to the partner's transfer of the 
interest in the partnership. Any gain or loss recognized that is 
attributable to section 751 property will be ordinary gain or loss. The 
difference between the amount of capital gain or loss that the partner 
would realize in the absence of section 751 and the amount of ordinary 
income or loss determined under this paragraph (a)(2) is the 
transferor's capital gain or loss on the sale of its partnership 
interest. See Sec. 1.460-4(k)(2)(iv)(E) for rules relating to the 
amount of ordinary income or loss attributable to a contract accounted 
for under a long-term contract method of accounting.
    (3) Statement required. A partner selling or exchanging any part of 
an interest in a partnership that has any section 751 property at the 
time of sale or exchange must submit with its income tax return for the 
taxable year in which the sale or exchange occurs a statement setting 
forth separately the following information--
    (i) The date of the sale or exchange;
    (ii) The amount of any gain or loss attributable to the section 751 
property; and
    (iii) The amount of any gain or loss attributable to capital gain or 
loss on the sale of the partnership interest.
    (b) Certain distributions treated as sales or exchanges--(1) In 
general. (i) Certain distributions to which section 751(b) applies are 
treated in part as sales or exchanges of property between the 
partnership and the distributee partner, and not as distributions to 
which sections 731 through 736 apply. A distribution treated as a sale 
or exchange under section 751(b) is not subject to the provisions of 
section 707(b). Section 751(b) applies whether or not the distribution 
is in liquidation of the distributee partner's entire interest in the 
partnership. However, section 751(b) applies only to the extent that a 
partner either receives section 751 property in exchange for his 
relinquishing any part of his interest in other property, or receives 
other property in exchange for his relinquishing any part of his 
interest in section 751 property.
    (ii) Section 751(b) does not apply to a distribution to a partner 
which is not in exchange for his interest in other partnership property. 
Thus, section 751(b) does not apply to the extent that a distribution 
consists of the distributee partner's share of section 751 property or 
his share of other property. Similarly, section 751(b) does not apply to 
current drawings or to advances against the partner's distributive 
share, or to a distribution which is, in fact, a gift or payment for 
services or for the use of capital. In determining whether a partner has 
received only his share of either section 751 property or of other 
property, his interest in such property remaining in the partnership 
immediately after a distribution must be taken into account. For 
example, the section 751 property in partnership ABC has a fair market 
value of $100,000 in which partner A has an interest of 30 percent, or 
$30,000. If A receives $20,000 of section 751 property in a 
distribution, and continues to have a 30-percent interest in the $80,000 
of section

[[Page 641]]

751 property remaining in the partnership after the distribution, only 
$6,000 ($30,000 minus $24,000 (30 percent of $80,000)) of the section 
751 property received by him will be considered to be his share of such 
property. The remaining $14,000 ($20,000 minus $6,000) received is in 
excess of his share.
    (iii) If a distribution is, in part, a distribution of the 
distributee partner's share of section 751 property, or of other 
property (including money) and, in part, a distribution in exchange of 
such properties, the distribution shall be divided for the purpose of 
applying section 751(b). The rules of section 751(b) shall first apply 
to the part of the distribution treated as a sale or exchange of such 
properties, and then the rules of sections 731 through 736 shall apply 
to the part of the distribution not treated as a sale or exchange. See 
paragraph (b)(4)(ii) of this section for treatment of payments under 
section 736(a).
    (2) Distribution of section 751 property (unrealized receivables or 
substantially appreciated inventory items). (i) To the extent that a 
partner receives section 751 property in a distribution in exchange for 
any part of his interest in partnership property (including money) other 
than section 751 property, the transaction shall be treated as a sale or 
exchange of such properties between the distributee partner and the 
partnership (as constituted after the distribution).
    (ii) At the time of the distribution, the partnership (as 
constituted after the distribution) realizes ordinary income or loss on 
the sale or exchange of the section 751 property. The amount of the 
income or loss to the partnership will be measured by the difference 
between the adjusted basis to the partnership of the section 751 
property considered as sold to or exchanged with the partner, and the 
fair market value of the distributee partner's interest in other 
partnership property which he relinquished in the exchange. In computing 
the partners' distributive shares of such ordinary income or loss, the 
income or loss shall be allocated only to partners other than the 
distributee and separately taken into account under section 702(a)(8).
    (iii) At the time of the distribution, the distributee partner 
realizes gain or loss measured by the difference between his adjusted 
basis for the property relinquished in the exchange (including any 
special basis adjustment which he may have) and the fair market value of 
the section 751 property received by him in exchange for his interest in 
other property which he has relinquished. The distributee's adjusted 
basis for the property relinquished is the basis such property would 
have had under section 732 (including subsection (d) thereof) if the 
distributee partner had received such property in a current distribution 
immediately before the actual distribution which is treated wholly or 
partly as a sale or exchange under section 751(b). The character of the 
gain or loss to the distributee partner shall be determined by the 
character of the property in which he relinquished his interest.
    (3) Distribution of partnership property other than section 751 
property. (i) To the extent that a partner receives a distribution of 
partnership property (including money) other than section 751 property 
in exchange for any part of his interest in section 751 property of the 
partnership, the distribution shall be treated as a sale or exchange of 
such properties between the distributee partner and the partnership (as 
constituted after the distribution).
    (ii) At the time of the distribution, the partnership (as 
constituted after the distribution) realizes gain or loss on the sale or 
exchange of the property other than section 751 property. The amount of 
the gain to the partnership will be measured by the difference between 
the adjusted basis to the partnership of the distributed property 
considered as sold to or exchanged with the partner, and the fair market 
value of the distributee partner's interest in section 751 property 
which he relinquished in the exchange. The character of the gain or loss 
to the partnership is determined by the character of the distributed 
property treated as sold or exchanged by the partnership. In computing 
the partners' distributive shares of such gain or loss, the gain or loss 
shall be allocated only to partners

[[Page 642]]

other than the distributee and separately taken into account under 
section 702(a)(8).
    (iii) At the time of the distribution, the distributee partner 
realizes ordinary income or loss on the sale or exchange of the section 
751 property. The amount of the distributee partner's income or loss 
shall be measured by the difference between his adjusted basis for the 
section 751 property relinquished in the exchange (including any special 
basis adjustment which he may have), and the fair market value of other 
property (including money) received by him in exchange for his interest 
in the section 751 property which he has relinquished. The distributee 
partner's adjusted basis for the section 751 property relinquished is 
the basis such property would have had under section 732 (including 
subsection (d) thereof) if the distributee partner had received such 
property in a current distribution immediately before the actual 
distribution which is treated wholly or partly as a sale or exchange 
under section 751(b).
    (4) Exceptions. (i) Section 751(b) does not apply to the 
distribution to a partner of property which the distributee partner 
contributed to the partnership. The distribution of such property is 
governed by the rules set forth in sections 731 through 736, relating to 
distributions by a partnership.
    (ii) Section 751(b) does not apply to payments made to a retiring 
partner or to a deceased partner's successor in interest to the extent 
that, under section 736(a), such payments constitute a distributive 
share of partnership income or guaranteed payments. Payments to a 
retiring partner or to a deceased partner's successor in interest for 
his interest in unrealized receivables of the partnership in excess of 
their partnership basis, including any special basis adjustment for them 
to which such partner is entitled, constitute payments under section 
736(a) and, therefore, are not subject to section 751(b). However, 
payments under section 736(b) which are considered as made in exchange 
for an interest in partnership property are subject to section 751(b) to 
the extent that they involve an exchange of substantially appreciated 
inventory items for other property. Thus, payments to a retiring partner 
or to a deceased partner's successor in interest under section 736 must 
first be divided between payments under section 736(a) and section 
736(b). The section 736(b) payments must then be divided, if there is an 
exchange of substantially appreciated inventory items for other 
property, between the payments treated as a sale or exchange under 
section 751(b) and payments treated as a distribution under sections 731 
through 736. See subparagraph (1)(iii) of this paragraph, and section 
736 and Sec. 1.736-1.
    (5) Statement required. A partnership which distributes section 751 
property to a partner in exchange for his interest in other partnership 
property, or which distributes other property in exchange for any part 
of the partner's interest in section 751 property, shall submit with its 
return for the year of the distribution a statement showing the 
computation of any income, gain, or loss to the partnership under the 
provisions of section 751(b) and this paragraph. The distributee partner 
shall submit with his return a statement showing the computation of any 
income, gain, or loss to him. Such statement shall contain information 
similar to that required under paragraph (a)(3) of this section.
    (c) Unrealized receivables. (1) The term unrealized receivables, as 
used in subchapter K, chapter 1 of the Code, means any rights 
(contractual or otherwise) to payment for:
    (i) Goods delivered or to be delivered (to the extent that such 
payment would be treated as received for property other than a capital 
asset), or
    (ii) Services rendered or to be rendered,

to the extent that income arising from such rights to payment was not 
previously includible in income under the method of accounting employed 
by the partnership. Such rights must have arisen under contracts or 
agreements in existence at the time of sale or distribution, although 
the partnership may not be able to enforce payment until a later time. 
For example, the term includes trade accounts receivable of a cash 
method taxpayer, and rights to payment for work or goods

[[Page 643]]

begun but incomplete at the time of the sale or distribution.
    (2) The basis for such unrealized receivables shall include all 
costs or expenses attributable thereto paid or accrued but not 
previously taken into account under the partnership method of 
accounting.
    (3) In determining the amount of the sale price attributable to such 
unrealized receivables, or their value in a distribution treated as a 
sale or exchange, full account shall be taken not only of the estimated 
cost of completing performance of the contract or agreement, but also of 
the time between the sale or distribution and the time of payment.
    (4)(i) With respect to any taxable year of a partnership ending 
after September 12, 1966 (but only in respect of expenditures paid or 
incurred after that date), the term unrealized receivables, for purposes 
of this section and sections 731, 736, 741, and 751, also includes 
potential gain from mining property defined in section 617(f)(2). With 
respect to each item of partnership mining property so defined, the 
potential gain is the amount that would be treated as gain to which 
section 617(d)(1) would apply if (at the time of the transaction 
described in section 731, 736, 741, or 751, as the case may be) the item 
were sold by the partnership at its fair market value.
    (ii) With respect to sales, exchanges, or other dispositions after 
December 31, 1975, in any taxable year of a partnership ending after 
that date, the term unrealized receivables, for purposes of this section 
and sections 731, 736, 741, and 751, also includes potential gain from 
stock in a DISC as described in section 992(a). With respect to stock in 
such a DISC, the potential gain is the amount that would be treated as 
gain to which section 995(c) would apply if (at the time of the 
transaction described in section 731, 736, 741, or 751, as the case may 
be) the stock were sold by the partnership at its fair market value.
    (iii) With respect to any taxable year of a partnership beginning 
after December 31, 1962, the term unrealized receivables, for purposes 
of this section and sections 731, 736, 741, and 751, also includes 
potential gain from section 1245 property. With respect to each item of 
partnership section 1245 property (as defined in section 1245(a)(3)), 
potential gain from section 1245 property is the amount that would be 
treated as gain to which section 1245(a)(1) would apply if (at the time 
of the transaction described in section 731, 736, 741, or 751, as the 
case may be) the item of section 1245 property were sold by the 
partnership at its fair market value. See Sec. 1.1245-1(e)(1). For 
example, if a partnership would recognize under section 1245(a)(1) gain 
of $600 upon a sale of one item of section 1245 property and gain of 
$300 upon a sale of its only other item of such property, the potential 
section 1245 income of the partnership would be $900.
    (iv) With respect to transfers after October 9, 1975, and to sales, 
exchanges, and distributions taking place after that date, the term 
unrealized receivables, for purposes of this section and sections 731, 
736, 741, and 751, also includes potential gain from stock in certain 
foreign corporations as described in section 1248. With respect to stock 
in such a foreign corporation, the potential gain is the amount that 
would be treated as gain to which section 1248(a) would apply if (at the 
time of the transaction described in section 731, 736, 741, or 751, as 
the case may be) the stock were sold by the partnership at its fair 
market value.
    (v) With respect to any taxable year of a partnership ending after 
December 31, 1963, the term unrealized receivables, for purposes of this 
section and sections 731, 736, 741, and 751, also includes potential 
gain from section 1250 property. With respect to each item of 
partnership section 1250 property (as defined in section 1250(c)), 
potential gain from section 1250 property is the amount that would be 
treated as gain to which section 1250(a) would apply if (at the time of 
the transaction described in section 731, 736, 741, or 751, as the case 
may be) the item of section 1250 property were sold by the partnership 
at its fair market value. See Sec. 1.1250-1(f)(1).
    (vi) With respect to any taxable year of a partnership beginning 
after December 31, 1969, the term unrealized receivables, for purposes 
of this section and sections 731, 736, 741, and 751, also

[[Page 644]]

includes potential gain from farm recapture property as defined in 
section 1251(e)(1) (as in effect before enactment of the Tax Reform Act 
of 1984). With respect to each item of partnership farm recapture 
property so defined, the potential gain is the amount which would be 
treated as gain to which section 1251(c) (as in effect before enactment 
of the Tax Reform Act of 1984) would apply if (at the time of the 
transaction described in section 731, 736, 741, or 751, as the case may 
be) the item were sold by the partnership at its fair market value.
    (vii) With respect to any taxable year of a partnership beginning 
after December 31, 1969, the term unrealized receivables, for purposes 
of this section and sections 731, 736, 741, and 751, also includes 
potential gain from farm land as defined in section 1252(a)(2). With 
respect to each item of partnership farm land so defined, the potential 
gain is the amount that would be treated as gain to which section 
1252(a)(1) would apply if (at the time of the transaction described in 
section 731, 736, 741, or 751, as the case may be) the item were sold by 
the partnership at its fair market value.
    (viii) With respect to transactions which occur after December 31, 
1976, in any taxable year of a partnership ending after that date, the 
term unrealized receivables, for purposes of this section and sections 
731, 736, 741, and 751, also includes potential gain from franchises, 
trademarks, or trade names referred to in section 1253(a). With respect 
to each such item so referred to in section 1253(a), the potential gain 
is the amount that would be treated as gain to which section 1253(a) 
would apply if (at the time of the transaction described in section 731, 
736, 741, or 751, as the case may be) the items were sold by the 
partnership at its fair market value.
    (ix) With respect to any taxable year of a partnership ending after 
December 31, 1975, the term unrealized receivables, for purposes of this 
section and sections 731, 736, 741, and 751, also includes potential 
gain under section 1254(a) from natural resource recapture property as 
defined in Sec. 1.1254-1(b)(2). With respect to each separate 
partnership natural resource recapture property so described, the 
potential gain is the amount that would be treated as gain to which 
section 1254(a) would apply if (at the time of the transaction described 
in section 731, 736, 741, or 751, as the case may be) the property were 
sold by the partnership at its fair market value.
    (5) For purposes of subtitle A of the Internal Revenue Code, the 
basis of any potential gain described in paragraph (c)(4) of this 
section is zero.
    (6)(i) If (at the time of any transaction referred to in paragraph 
(c)(4) of this section) a partnership holds property described in 
paragraph (c)(4) of this section and if--
    (A) A partner had a special basis adjustment under section 743(b) in 
respect of the property;
    (B) The basis under section 732 of the property if distributed to 
the partner would reflect a special basis adjustment under section 
732(d); or
    (C) On the date a partner acquired a partnership interest by way of 
a sale or exchange (or upon the death of another partner) the 
partnership owned the property and an election under section 754 was in 
effect with respect to the partnership, the partner's share of any 
potential gain described in paragraph (c)(4) of this section is 
determined under paragraph (c)(6)(ii) of this section.
    (ii) The partner's share of the potential gain described in 
paragraph (c)(4) of this section in respect of the property to which 
this paragraph (c)(6)(ii) applies is that amount of gain that the 
partner would recognize under section 617(d)(1), 995(c), 1245(a), 
1248(a), 1250(a), 1251(c) (as in effect before the Tax Reform Act of 
1984), 1252(a), 1253(a), or 1254(a) (as the case may be) upon a sale of 
the property by the partnership, except that, for purposes of this 
paragraph (c)(6) the partner's share of such gain is determined in a 
manner that is consistent with the manner in which the partner's share 
of partnership property is determined; and the amount of a potential 
special basis adjustment under section 732(d) is treated as if it were 
the amount of a special basis adjustment under section 743(b). For 
example, in determining, for purposes of this paragraph (c)(6), the 
amount of gain that a partner would recognize

[[Page 645]]

under section 1245 upon a sale of partnership property, the items 
allocated under Sec. 1.1245-1(e)(3)(ii) are allocated to the partner in 
the same manner as the partner's share of partnership property is 
determined. See Sec. 1.1250-1(f) for rules similar to those contained 
in Sec. 1.1245-1(e)(3)(ii).
    (d) Inventory items which have substantially appreciated in value--
(1) Substantial appreciation. Partnership inventory items shall be 
considered to have appreciated substantially in value if, at the time of 
the sale or distribution, the total fair market value of all the 
inventory items of the partnership exceeds 120 percent of the aggregate 
adjusted basis for such property in the hands of the partnership 
(without regard to any special basis adjustment of any partner) and, in 
addition, exceeds 10 percent of the fair market value of all partnership 
property other than money. The terms ``inventory items which have 
appreciated substantially in value'' or ``substantially appreciated 
inventory items'' refer to the aggregate of all partnership inventory 
items. These terms do not refer to specific partnership inventory items 
or to specific groups of such items. For example, any distribution of 
inventory items by a partnership the inventory items of which as a whole 
are substantially appreciated in value shall be a distribution of 
substantially appreciated inventory items for the purposes of section 
751(b), even though the specific inventory items distributed may not be 
appreciated in value. Similarly, if the aggregate of partnership 
inventory items are not substantially appreciated in value, a 
distribution of specific inventory items, the value of which is more 
than 120 percent of their adjusted basis, will not constitute a 
distribution of substantially appreciated inventory items. For the 
purpose of this paragraph, the ``fair market value'' of inventory items 
has the same meaning as ``market'' value in the regulations under 
section 471, relating to general rule for inventories.
    (2) Inventory items. The term inventory items as used in subchapter 
K, chapter 1 of the Code, includes the following types of property:
    (i) Stock in trade of the partnership, or other property of a kind 
which would properly be included in the inventory of the partnership if 
on hand at the close of the taxable year, or property held by the 
partnership primarily for sale to customers in the ordinary course of 
its trade or business. See section 1221(1).
    (ii) Any other property of the partnership which, on sale or 
exchange by the partnership, would be considered property other than a 
capital asset and other than property described in section 1231. Thus, 
accounts receivable acquired in the ordinary course of business for 
services or from the sale of stock in trade constitute inventory items 
(see section 1221(4)), as do any unrealized receivables.
    (iii) Any other property retained by the partnership which, if held 
by the partner selling his partnership interest or receiving a 
distribution described in section 751(b), would be considered property 
described in subdivision (i) or (ii) of this subparagraph. Property 
actually distributed to the partner does not come within the provisions 
of section 751(d)(2)(C) and this subdivision.
    (e) Section 751 property and other property. For the purposes of 
this section, section 751 property means unrealized receivables or 
substantially appreciated inventory items, and other property means all 
property (including money) except section 751 property.
    (f) Effective date. Section 751 applies to gain or loss to a seller, 
distributee, or partnership in the case of a sale, exchange, or 
distribution occurring after March 9, 1954. For the purpose of applying 
this paragraph in the case of a taxable year beginning before January 1, 
1955, a partnership or a partner may elect to treat as applicable any 
other section of subchapter K, chapter 1 of the Code. Any such election 
shall be made by a statement submitted not later than the time 
prescribed by law for the filing of the return for such taxable year, or 
August 21, 1956, whichever date is later (but not later than 6 months 
after the time prescribed by law for the filing of the return for such 
year). See section 771(b)(3) and paragraph (b)(3) of Sec. 1.771-1. See 
also section 771(c) and paragraph (c) of Sec. 1.771-1. The rules 
contained in paragraphs (a)(2) and (a)(3) of this section apply to 
transfers

[[Page 646]]

of partnership interests that occur on or after December 15, 1999.
    (g) Examples. Application of the provisions of section 751 may be 
illustrated by the following examples:

    Example 1. (i)(A) A and B are equal partners in personal service 
partnership PRS. B transfers its interest in PRS to T for $15,000 when 
PRS's balance sheet (reflecting a cash receipts and disbursements method 
of accounting) is as follows:

------------------------------------------------------------------------
                                                         Assets
                                               -------------------------
                                                  Adjusted   Fair market
                                                   basis        value
------------------------------------------------------------------------
Cash..........................................       $3,000       $3,000
Loans Receivable..............................       10,000       10,000
Capital Assets................................        7,000        5,000
Unrealized Receivables........................            0       14,000
                                               -------------------------
  Total.......................................       20,000       32,000
------------------------------------------------------------------------


------------------------------------------------------------------------
                                                 Liabilities and Capital
                                               -------------------------
                                                  Adjusted   Fair market
                                                 per books      value
------------------------------------------------------------------------
Liabilities...................................       $2,000       $2,000
Capital:
  A...........................................        9,000       15,000
  B...........................................        9,000       15,000
                                               -------------------------
    Total.....................................       20,000       32,000
------------------------------------------------------------------------

    (B) None of the assets owned by PRS is section 704(c) property, and 
the capital assets are nondepreciable. The total amount realized by B is 
$16,000, consisting of the cash received, $15,000, plus $1,000, B's 
share of the partnership liabilities assumed by T. See section 752. B's 
undivided half-interest in the partnership property includes a half-
interest in the partnership's unrealized receivables items. B's basis 
for its partnership interest is $10,000 ($9,000, plus $1,000, B's share 
of partnership liabilities). If section 751(a) did not apply to the 
sale, B would recognize $6,000 of capital gain from the sale of the 
interest in PRS. However, section 751(a) does apply to the sale.
    (ii) If PRS sold all of its section 751 property in a fully taxable 
transaction immediately prior to the transfer of B's partnership 
interest to T, B would have been allocated $7,000 of ordinary income 
from the sale of PRS's unrealized receivables. Therefore, B will 
recognize $7,000 of ordinary income with respect to the unrealized 
receivables. The difference between the amount of capital gain or loss 
that the partner would realize in the absence of section 751 ($6,000) 
and the amount of ordinary income or loss determined under paragraph 
(a)(2) of this section ($7,000) is the transferor's capital gain or loss 
on the sale of its partnership interest. In this case, B will recognize 
a $1,000 capital loss.
    Example 2. (a) Facts. Partnership ABC makes a distribution to 
partner C in liquidation of his entire one-third interest in the 
partnership. At the time of the distribution, the balance sheet of the 
partnership, which uses the accrual method of accounting, is as follows:

                                 Assets
------------------------------------------------------------------------
                                                   Adjusted
                                                   basis per    Market
                                                     books       value
------------------------------------------------------------------------
Cash............................................     $15,000     $15,000
Accounts receivable.............................       9,000       9,000
Inventory.......................................      21,000      30,000
Depreciable property............................      42,000      48,000
Land............................................       9,000       9,000
                                                 -----------------------
    Total.......................................      96,000      11,000
------------------------------------------------------------------------


                         Liabilities and Capital
------------------------------------------------------------------------
                                                   Per books     Value
------------------------------------------------------------------------
Current liabilities.............................     $15,000     $15,000
Mortgage payable................................      21,000      21,000
Capital:
  A.............................................      20,000      25,000
  B.............................................      20,000      25,000
  C.............................................      20,000      25,000
                                                 -----------------------
    Total.......................................      96,000     111,000
------------------------------------------------------------------------


The distribution received by C consists of $10,000 cash and depreciable 
property with a fair market value of $15,000 and an adjusted basis to 
the partnership of $15,000.
    (b) Presence of section 751 property. The partnership has no 
unrealized receivables, but the dual test provided in section 751(d)(1) 
must be applied to determine whether the inventory items of the 
partnership, in the aggregate, have appreciated substantially in value. 
The fair market value of all partnership inventory items, $39,000 
(inventory $30,000, and accounts receivable $9,000), exceeds 120 percent 
of the $30,000 adjusted basis of such items to the partnership. The fair 
market value of the inventory items, $39,000, also exceeds 10 percent of 
the fair market value of all partnership property other than money (10 
percent of $96,000 or $9,600). Therefore, the partnership inventory 
items have substantially appreciated in value.
    (c) The properties exchanged. Since C's entire partnership interest 
is to be liquidated, the provisions of section 736 are applicable. No 
part of the payment, however, is considered as a distributive share or 
as a guaranteed payment under section 736(a) because the entire payment 
is made for C's interest in partnership property. Therefore, the entire 
payment is for an interest in partnership property under section 736(b), 
and, to the extent applicable, subject to the rules of section 751. In 
the distribution, C received his

[[Page 647]]

share of cash ($5,000) and $15,000 in depreciable property ($1,000 less 
than his $16,000 share). In addition, he received other partnership 
property ($5,000 cash and $12,000 liabilities assumed, treated as money 
distributed under section 752(b)) in exchange for his interest in 
accounts receivable ($3,000), inventory ($10,000), land ($3,000), and 
the balance of his interest in depreciable property ($1,000). Section 
751(b) applies only to the extent of the exchange of other property for 
section 751 property (i.e., inventory items, which include trade 
accounts receivable). The section 751 property exchanged has a fair 
market value of $13,000 ($3,000 in accounts receivable and $10,000 in 
inventory). Thus, $13,000 of the total amount C received is considered 
as received for the sale of section 751 property.
    (d) Distributee partner's tax consequences. C's tax consequences on 
the distribution are as follows:
    (1) The section 751(b) sale or exchange. C's share of the inventory 
items is treated as if he received them in a current distribution, and 
his basis for such items is $10,000 ($7,000 for inventory and $3,000 for 
accounts receivable) as determined under paragraph (b)(3)(iii) of this 
section. Then C is considered as having sold his share of inventory 
items to the partnership for $13,000. Thus, on the sale of his share of 
inventory items, C realizes $3,000 of ordinary income.
    (2) The part of the distribution not under section 751(b). Section 
751(b) does not apply to the balance of the distribution. Before the 
distribution, C's basis for his partnership interest was $32,000 
($20,000 plus $12,000, his share of partnership liabilities). See 
section 752(a). This basis is reduced by $10,000, the basis attributed 
to the section 751 property treated as distributed to C and sold by him 
to the partnership. Thus, C has a basis of $22,000 for the remainder of 
his partnership interest. The total distribution to C was $37,000 
($22,000 in cash and liabilities assumed, and $15,000 in depreciable 
property). Since C received no more than his share of the depreciable 
property, none of the depreciable property constitutes proceeds of the 
sale under section 751(b). C did receive more than his share of money. 
Therefore, the sale proceeds, treated separately in subparagraph (1) of 
this paragraph of this example, must consist of money and therefore must 
be deducted from the money distribution. Consequently, in liquidation of 
the balance of C's interest, he receives depreciable property and $9,000 
in money ($22,000 less $13,000). Therefore, no gain or loss is 
recognized to C on the distribution. Under section 732(b), C's basis for 
the depreciable property is $13,000 (the remaining basis of his 
partnership interest, $22,000, reduced by $9,000, the money received in 
the distribution).
    (e) Partnership's tax consequences. The tax consequences to the 
partnership on the distribution are as follows:
    (1) The section 751(b) sale or exchange. The partnership consisting 
of the remaining members has no ordinary income on the distribution 
since it did not give up any section 751 property in the exchange. Of 
the $22,000 money distributed (in cash and the assumption of C's share 
of liabilities), $13,000 was paid to acquire C's interest in inventory 
($10,000 fair market value) and in accounts receivable ($3,000). Since 
under section 751(b) the partnership is treated as buying these 
properties, it has a new cost basis for the inventory and accounts 
receivable acquired from C. Its basis for C's share of inventory and 
accounts receivable is $13,000, the amount which the partnership is 
considered as having paid C in the exchange. Since the partnership is 
treated as having distributed C's share of inventory and accounts 
receivable to him, the partnership must decrease its basis for inventory 
and accounts receivable ($30,000) by $10,000, the basis of C's share 
treated as distributed to him, and then increase the basis for inventory 
and accounts receivable by $13,000 to reflect the purchase prices of the 
items acquired. Thus, the basis of the partnership inventory is 
increased from $21,000 to $24,000 in the transaction. (Note that the 
basis of property acquired in a section 751(b) exchange is determined 
under section 1012 without regard to any elections of the partnership. 
See paragraph (e) of Sec. 1.732-1.) Further, the partnership realizes 
no capital gain or loss on the portion of the distribution treated as a 
sale under section 751(b) since, to acquire C's interest in the 
inventory and accounts receivable, it gave up money and assumed C's 
share of liabilities.
    (2) The part of the distribution not under section 751(b). In the 
remainder of the distribution to C which was not in exchange for C's 
interest in section 751 property, C received only other property as 
follows: $15,000 in depreciable property (with a basis to the 
partnership of $15,000) and $9,000 in money ($22,000 less $13,000 
treated under subparagraph (1) of this paragraph of this example). Since 
this part of the distribution is not an exchange of section 751 property 
for other property, section 751(b) does not apply. Instead, the 
provisions which apply are sections 731 through 736, relating to 
distributions by a partnership. No gain or loss is recognized to the 
partnership on the distribution. (See section 731(b).) Further, the 
partnership makes no adjustment to the basis of remaining depreciable 
property unless an election under section 754 is in effect. (See section 
734(a).) Thus, the basis of the depreciable property before the 
distribution, $42,000, is reduced by the basis of the depreciable 
property distributed, $15,000, leaving a basis for the depreciable 
property in the partnership of $27,000.

[[Page 648]]

However, if an election under section 754 is in effect, the partnership 
must make the adjustment required under section 734(b) as follows: Since 
the adjusted basis of the distributed property to the partnership had 
been $15,000, and is only $13,000 in C's hands (see paragraph (d)(2) of 
this example), the partnership will increase the basis of the 
depreciable property remaining in the partnership by $2,000 (the excess 
of the adjusted basis to the partnership of the distributed depreciable 
property immediately before the distribution over its basis to the 
distributee). Whether or not an election under section 754 is in effect, 
the basis for each of the remaining partner's partnership interests will 
be $38,000 ($20,000 original contribution, plus $12,000, each partner's 
original share of the liabilities, plus $6,000, the share of C's 
liabilities each assumed).
    (f) Partnership trial balance. A trial balance of the AB partnership 
after the distribution in liquidation of C's entire interest would 
reflect the results set forth in the schedule below. Column I shows the 
amounts to be reflected in the records if an election is in effect under 
section 754 with respect to an optional adjustment under section 734(b) 
to the basis of undistributed partnership property. Column II shows the 
amounts to be reflected in the records where an election under section 
754 is not in effect. Note that in column II, the total bases for the 
partnership assets do not equal the total of the bases for the 
partnership interests.
    Example 3. (a) Facts. Assume that the distribution to partner C in 
example 2 of this paragraph in liquidation of his entire interest in 
partnership ABC consists of $5,000 in cash and $20,000 worth of 
partnership inventory with a basis of $14,000.

------------------------------------------------------------------------
                                           I                  II
                                 ---------------------------------------
                                   Sec.754, Election   Sec.754, Election
                                       in effect         not in effect
                                 ---------------------------------------
                                              Fair                Fair
                                    Basis    market     Basis    market
                                              value               value
------------------------------------------------------------------------
Cash............................    $5,000    $5,000    $5,000    $5,000
Accounts receivable.............     9,000     9,000     9,000     9,000
Inventory.......................    24,000    30,000    24,000    30,000
Depreciable property............    29,000    33,000    27,000    33,000
Land............................     9,000     9,000     9,000     9,000
                                 ---------------------------------------
                                    76,000    86,000    74,000    86,000
                                 =======================================
Current liabilities.............    15,000    15,000    15,000    15,000
Mortgage........................    21,000    21,000    21,000    21,000
Capital:
                                    20,000    25,000    20,000    25,000
                                    20,000    25,000    20,000    25,000
                                 ---------------------------------------
                                    76,000    86,000    76,000    86,000
------------------------------------------------------------------------

    (b) Presence of section 751 property. For the same reason as stated 
in paragraph (b) of example 2, the partnership inventory items have 
substantially appreciated in value.
    (c) The properties exchanged. In the distribution, C received his 
share of cash ($5,000) and his share of appreciated inventory items 
($13,000). In addition, he received appreciated inventory with a fair 
market value of $7,000 (and with an adjusted basis to the partnership of 
$4,900) and $12,000 in money (liabilities assumed). C has relinquished 
his interest in $16,000 of depreciable property and $3,000 of land. 
Although C relinquished his interest in $3,000 of accounts receivable, 
such accounts receivable are inventory items and, therefore, that 
exchange was not an exchange of section 751 property for other property. 
Section 751(b) applies only to the extent of the exchange of other 
property for section 751 property (i.e., depreciable property or land 
for inventory items). Assume that the partners agree that the $7,000 of 
inventory in excess of C's share was received by him in exchange for 
$7,000 of depreciable property.
    (d) Distributee partner's tax consequences. C's tax consequence on 
the distributions are as follows:
    (1) The section 751(b) sale or exchange. C is treated as if he had 
received his 7/16ths share of the depreciable property in a current 
distribution. His basis for that share is $6,125 (42,000/48,000 of 
$7,000), as determined under paragraph (b)(2)(iii) of this section. Then 
C is considered as having sold his 7/16ths share of depreciable property 
to the partnership for $7,000, realizing a gain of $875.
    (2) The part of the distribution not under section 751(b). Section 
751(b) does not apply to the balance of the distribution. Before the 
distribution, C's basis for his partnership interest was $32,000 
($20,000, plus $12,000, his share of partnership liabilities). See 
section 752(a). This basis is reduced by $6,125, the basis of property 
treated as distributed to C and sold by him to the partnership. Thus, C 
will have a basis of $25,875 for the remainder of his partnership 
interest. Of the $37,000 total distribution to C, $30,000 ($17,000 in 
money, including liabilities assumed, and $13,000 in inventory) is not 
within section 751(b). Under section 732(b), C's basis for the inventory 
with a fair market value of $13,000 (which had an adjusted basis to the 
partnership of $9,100) is limited to $8,875, the amount of the remaining 
basis for his partnership interest, $25,875, reduced by $17,000, the 
money received. Thus, C's total aggregate basis for the inventory 
received is $15,875 ($7,000 plus $8,875), and not its $14,000 basis in 
the hands of the partnership.
    (e) Partnership's tax consequences. The tax consequences to the 
partnership on the distribution are as follows:
    (1) The section 751(b) sale or exchange. The partnership consisting 
of the remaining members has $2,100 of ordinary income on the sale of 
the $7,000 of inventory which had

[[Page 649]]

a basis to the partnership of $4,900 (21,000/30,000 of $7,000). This 
$7,000 of inventory was paid to acquire 7/16ths of C's interest in the 
depreciable property. Since, under section 751(b), the partnership is 
treated as buying this property from C, it has a new cost basis for such 
property. Its basis for the depreciable property is $42,875 ($42,000 
less $6,125, the basis of the 7/16ths share considered as distributed to 
C, plus $7,000, the partnership purchase price for this share).
    (2) The part of the distribution not under section 751 (b). In the 
remainder of the distribution to C which was not a sale or exchange of 
section 751 property for other property, the partnership realizes no 
gain or loss. See section 731(b). Further, under section 734(a), the 
partnership makes no adjustment to the basis of the accounts receivable 
or the 9/16ths interest in depreciable property which C relinquished. 
However, if an election under section 754 is in effect, the partnership 
must make the adjustment required under section 734(b) since the 
adjusted basis to the partnership of the inventory distributed had been 
$9,100, and C's basis for such inventory after distribution is only 
$8,875. The basis of the inventory remaining in the partnership must be 
increased by $225. Whether or not an election under section 754 is in 
effect, the basis for each of the remaining partnership interests will 
be $39,050 ($20,000 original contribution, plus $12,000, each partner's 
original share of the liabilities, plus $6,000, the share of C's 
liabilities now assumed, plus $1,050, each partner's share of ordinary 
income realized by the partnership upon that part of the distribution 
treated as a sale or exchange).
    Example 4. (a) Facts. Assume the same facts as in example 3 of this 
paragraph, except that the partners did not identify the property which 
C relinquished in exchange for the $7,000 of inventory which he received 
in excess of his share.
    (b) Presence of section 751 property. For the same reasons stated in 
paragraph (b) of example 2 of this paragraph, the partnership inventory 
items have substantially appreciated in value.
    (c) The properties exchanged. The analysis stated in paragraph (c) 
of example 3 of this paragraph is the same in this example, except that, 
in the absence of a specific agreement among the partners as to the 
properties exchanged, C will be presumed to have sold to the partnership 
a proportionate amount of each property in which he relinquished an 
interest. Thus, in the absence of an agreement, C has received $7,000 of 
inventory in exchange for his release of 7/19ths of the depreciable 
property and 7/19ths of the land. ($7,000, fair market value of property 
released, over $19,000, the sum of the fair market values of C's 
interest in the land and C's interest in the depreciable property.)
    (d) Distributee partner's tax consequences. C's tax consequences on 
the distribution are as follows:
    (1) The section 751(b) sale or exchange. C is treated as if he had 
received his 7/19ths shares of the depreciable property and land in a 
current distribution. His basis for those shares is $6,263 (51,000/
57,000 of $7,000, their fair market value), as determined under 
paragraph (b)(2)(iii) of this section. Then C is considered as having 
sold his 7/19ths shares of depreciable property and land to the 
partnership for $7,000, realizing a gain of $737.
    (2) The part of the distribution not under section 751(b). Section 
751(b) does not apply to the balance of the distribution. Before the 
distribution C's basis for his partnership interest was $32,000 ($20,000 
plus $12,000, his share of partnership liabilities). See section 752(a). 
This basis is reduced by $6,263, the bases of C's shares of depreciable 
property and land treated as distributed to him and sold by him to the 
partnership. Thus, C will have a basis of $25,737 for the remainder of 
his partnership interest. Of the total $37,000 distributed to C, $30,000 
($17,000 in money, including liabilities assumed, and $13,000 in 
inventory) is not within section 751(b). Under section 732(b), C's basis 
for the inventory (with a fair market value of $13,000 and an adjusted 
basis to the partnership of $9,100) is limited to $8,737, the amount of 
the remaining basis for his partnership interest ($25,737 less $17,000, 
money received. Thus, C's total aggregate basis for the inventory he 
received is $15,737 ($7,000 plus $8,737), and not the $14,000 basis it 
had in the hands of the partnership.
    (e) Partnership's tax consequences. The tax consequences to the 
partnership on the distribution are as follows:
    (1) The section 751(b) sale or exchange. The partnership consisting 
of the remaining members has $2,100 of ordinary income on the sale of 
$7,000 of inventory which had a basis to the partnership of $4,900 
(21,000/30,000 of $7,000). This $7,000 of inventory was paid to acquire 
7/19ths of C's interest in the depreciable property and land. Since, 
under section 751(b), the partnership is treated as buying this property 
from C, it has a new cost basis for such property. The bases of the 
depreciable property and land would be $42,737 and $9,000, respectively. 
The basis for the depreciable property is computed as follows: The 
common partnership basis of $42,000 is reduced by the $5,158 basis 
(42,000/48,000 of $5,895) for C's 7/19ths interest constructively 
distributed and increased by $5,895 (16,000/19,000 of $7,000), the part 
of the purchase price allocated to the depreciable property. The basis 
of the land would be computed in the same way. The $9,000 original 
partnership basis is reduced by $1,105 basis ($9,000/9,000 of $1,105) of 
land constructively distributed to C, and increased by $1,105 (3,000/
19,000

[[Page 650]]

of $7,000), the portion of the purchase price allocated to the land.
    (2) The part of the distribution not under section 751(b). In the 
remainder of the distribution to C which was not a sale or exchange of 
section 751 property for other property, the partnership realizes no 
gain or loss. See section 731(b). Further, under section 734(a), the 
partnership makes no adjustment to the basis of the accounts receivable 
or the 12/19ths interests in depreciable property and land which C 
relinquished. However, if an election under section 754 is in effect, 
the partnership must make the adjustment required under section 734(b) 
since the adjusted basis to the partnership of the inventory distributed 
had been $9,100 and C's basis for such inventory after the distribution 
is only $8,737. The basis of the inventory remaining in the partnership 
must be increased by the difference of $363. Whether or not an election 
under section 754 is in effect, the basis for each of the remaining 
partnership interests will be $39,050 ($20,000 original contribution 
plus $12,000, each partner's original share of the liabilities, plus 
$6,000, the share of C's liabilities assumed, plus $1,050, each 
partner's share of ordinary income realized by the partnership upon the 
part of the distribution treated as a sale or exchange).
    Example 5. (a) Facts. Assume that partner C in example 2 of this 
paragraph agrees to reduce his interest in capital and profits from one-
third to one-fifth for a current distribution consisting of $5,000 in 
cash, and $7,500 of accounts receivable with a basis to the partnership 
of $7,500. At the same time, the total liabilities of the partnership 
are not reduced. Therefore, after the distribution, C's share of the 
partnership liabilities has been reduced by $4,800 from $12,000 (1/3 of 
$36,000) to $7,200 (1/5 of $36,000).
    (b) Presence of section 751 property. For the same reasons as stated 
in paragraph (b) of example 2 of this paragraph, the partnership 
inventory items have substantially appreciated in value.
    (c) The properties exchanged. C's interest in the fair market value 
of the partnership properties before and after the distribution can be 
illustrated by the following table:

----------------------------------------------------------------------------------------------------------------
                                  C's interest Fair Market Value            C received
                                 ----------------------------------------------------------------
              Item                   One-third       One-fifth     Distribution    In excess of   C relinquished
                                      before           after         of share          share
----------------------------------------------------------------------------------------------------------------
Cash............................          $5,000          $2,000          $3,000          $2,000  ..............
Liabilities assumed.............        (12,000)         (7,200)  ..............           4,800  ..............
Inventory items:
  Accounts receivable...........           3,000             300           2,700           4,800  ..............
  Inventory.....................          10,000           6,000  ..............  ..............          $4,000
Depreciable property............          16,000           9,600  ..............  ..............           6,400
Land............................           3,000           1,800  ..............  ..............           1,200
                                 -------------------------------------------------------------------------------
    Total.......................          25,000          12,500           5,700          11,600          11,600
----------------------------------------------------------------------------------------------------------------


Although C relinquished his interest in $4,000 of inventory and received 
$4,800 of accounts receivable, both items constitute section 751 
property and C has received only $800 of accounts receivable for $800 
worth of depreciable property or for an $800 undivided interest in land. 
In the absence of an agreement identifying the properties exchanged, it 
is presumed C received $800 for proportionate shares of his interests in 
both depreciable property and land. To the extent that inventory was 
exchanged for accounts receivable, or to the extent cash was distributed 
for the release of C's interest in the balance of the depreciable 
property and land, the transaction does not fall within section 751(b) 
and is a current distribution under section 732(a). Thus, the remaining 
$6,700 of accounts receivable are received in a current distribution.
    (d) Distributee partner's tax consequences. C's tax consequences on 
the distribution are as follows:
    (1) The section 751(b) sale or exchange. Assuming that the partners 
paid $800 worth of accounts receivable for $800 worth of depreciable 
property, C is treated as if he received the depreciable property in a 
current distribution, and his basis for the $800 worth of depreciable 
property is $700 (42,000/48,000 of $800, its fair market value), as 
determined under paragraph (b)(2)(iii) of this section. Then C is 
considered as having sold his $800 share of depreciable property to the 
partnership for $800. On the sale of the depreciable property, C 
realizes a gain of $100. If, on the other hand, the partners had agreed 
that C exchanged an $800 interest in the land for $800 worth of accounts 
receivable, C would realize no gain or loss, because under paragraph 
(b)(2)(iii) of this section his basis for the land sold would be $800. 
In the absence of an agreement, the basis for the depreciable property 
and land (which C is considered as having received in a current 
distribution and then sold back to the partnership) would be $716 
(51,000/57,000 of $800). In that case, on the sale of the balance of the 
$800 share of depreciable property and land, C would realize $84 of gain 
($800 less $716).

[[Page 651]]

    (2) The part of the distribution not under section 751(b). Section 
751(b) does not apply to the balance of the distribution. Under section 
731, C does not realize either gain or loss on the balance of the 
distribution. The adjustments to the basis of C's interest are 
illustrated in the following table:

------------------------------------------------------------------------
                                      If accounts
                                       receivable      If
                                        received    accounts    If there
                                          for      receivable    is no
                                      depreciable   received   agreement
                                        property    for land
------------------------------------------------------------------------
Original basis for C's interest.....    $32,000     $32,000    $32,000
Less basis of property distributed         -700        -800       -716
 prior to sec. 751 (b) sale or
 exchange...........................
                                     -----------------------------------
                                         31,300      31,200     31,284
Less money received in distribution.     -9,800      -9,800     -9,800
                                     -----------------------------------
                                         21,500      21,400     21,484
Less basis of property received in a     -6,700      -6,700     -6,700
 current distribution under sec. 732
                                     -----------------------------------
Resulting basis for C's interest....     14,800      14,700     14,784
------------------------------------------------------------------------

C's basis for the $1,500 worth of accounts receivable which he received 
in the distribution will be $7,500, composed of $800 for the portion 
purchased in the section 751(b) exchange, plus $6,700, the basis carried 
over under section 732(a) for the portion received in the current 
distribution.
    (e) Partnership's tax consequences. The tax consequences to the 
partnership on the distribution are as follows:
    (1) The section 751(b) sale or exchange. The partnership realizes no 
gain or loss in the section 751 sale or exchange because it had a basis 
of $800 for the accounts receivable for which it received $800 worth of 
other property. If the partnership agreed to purchase $800 worth of 
depreciable property, the partnership basis of depreciable property 
becomes $42,100 ($42,000 less $700 basis of property constructively 
distributed to C, plus $800, price of property purchased). If the 
partnership purchased land with the accounts receivable, there would be 
no change in the basis of the land to the partnership because the basis 
of land distributed was equal to its purchase price. If there were no 
agreement, the basis of the depreciable property and land would be 
$51,084 (depreciable property, $42,084 and land $9,000). The basis for 
the depreciable property is computed as follows: The common partnership 
basis of $42,000 is reduced by the $590 basis (42,000/48,000 of $674) 
for C's $674 interest constructively distributed, and increased by $674 
(6,400/7,600 of $800), the part of the purchase price allocated to the 
depreciable property. The basis of the land would be computed in the 
same way. The $9,000 original partnership basis is reduced by $126 basis 
(9,000/9,000 of $126) of the land constructively distributed to C, and 
increased by $126 (1,200/7,600 of $800), the portion of the purchase 
price allocated to the land.
    (2) The part of the distribution not under section 751(b). The 
partnership will realize no gain or loss in the balance of the 
distribution under section 731. Since the property in C's hands after 
the distribution will have the same basis it had in the partnership, the 
basis of partnership property remaining in the partnership after the 
distribution will not be adjusted (whether or not an election under 754 
is in effect).
    Example 6. (a) Facts. Partnership ABC distributes to partner C, in 
liquidation of his entire one-third interest in the partnership, a 
machine which is section 1245 property with a recomputed basis (as 
defined in section 1245(a)(2)) of $18,000. At the time of the 
distribution, the balance sheet of the partnership is as follows:

                                 Assets
------------------------------------------------------------------------
                                                   Adjusted
                                                   basis per    Market
                                                     books       value
------------------------------------------------------------------------
Cash............................................      $3,000      $3,000
Machine (section 1245 property).................       9,000      15,000
Land............................................      18,000      27,000
                                                 -----------------------
    Total.......................................      30,000      45,000
------------------------------------------------------------------------


                         Liabilities and Capital
------------------------------------------------------------------------
                                                   Per books     Value
------------------------------------------------------------------------
Liabilities.....................................          $0          $0
Capital:
  A.............................................      10,000      15,000
  B.............................................      10,000      15,000
  C.............................................      10,000      15,000
                                                 -----------------------
    Total.......................................      30,000      45,000
------------------------------------------------------------------------

    (b) Presence of section 751 property. The section 1245 property is 
an unrealized receivable of the partnership to the extent of the 
potential section 1245 income in respect of the property. Since the fair 
market value of the property ($15,000) is lower than its recomputed 
basis ($18,000), the excess of the fair market value over its adjusted 
basis ($9,000), or $6,000, is the potential section 1245 income of the 
partnership in respect of the property. The partnership has no other 
section 751 property.
    (c) The properties exchanged. In the distribution C received his 
share of section 751 property (potential section 1245 income of $2,000, 
i.e., \1/3\ of $6,000) and his share of section 1245 property (other 
than potential section 1245 income) with a fair market value of

[[Page 652]]

$3,000, i.e., \1/3\ of ($15,000 minus $6,000), and an adjusted basis of 
$3,000, i.e., \1/3\ of $9,000. In addition he received $4,000 of section 
751 property (consisting of $4,000 ($6,000 minus $2,000) of potential 
section 1245 income) and section 1245 property (other than potential 
section 1245 income) with a fair market value of $6,000 ($9,000 minus 
$3,000) and an adjusted basis of $6,000 ($9,000 minus $3,000). C 
relinquished his interest in $1,000 of cash and $9,000 of land. Assume 
that the partners agree that the $4,000 of section 751 property in 
excess of C's share was received by him in exchange for $4,000 of land.
    (d) Distributee partner's tax consequences. C's tax consequences on 
the distributions are as follows:
    (1) The section 751(b) sale or exchange. C is treated as if he 
received in a current distribution 4/9ths of his share of the land with 
a basis of $2,667 (18,000/27,000x$4,000). Then C is considered as having 
sold his 4/9ths share of the land to the partnership for $4,000, 
realizing a gain of $1,333. C's basis for the remainder of his 
partnership interest after the current distribution is $7,333, i.e., the 
basis of his partnership interest before the current distribution 
($10,000) minus the basis of the land treated as distributed to him 
($2,667).
    (2) The part of the distribution not under section 751(b). Of the 
$15,000 total distribution to C, $11,000 ($2,000 of potential section 
1245 income and $9,000 section 1245 property other than potential 
section 1245 income) is not within section 751(b). Under section 732(b) 
and (c), C's basis for his share of potential section 1245 income is 
zero (see paragraph (c)(5) of this section) and his basis for $9,000 of 
section 1245 property (other than potential section 1245 income) is 
$7,333, i.e., the amount of the remaining basis for his partnership 
interest ($7,333) reduced by the basis for his share of potential 
section 1245 income (zero). Thus C's total aggregate basis for the 
section 1245 property (fair market value of $15,000) distributed to him 
is $11,333 ($4,000 plus $7,333). For an illustration of the computation 
of his recomputed basis for the section 1245 property immediately after 
the distribution, see example 2 of paragraph (f)(3) of Sec. 1.1245-4.
    (e) Partnership's tax consequences. The tax consequences to the 
partnership on the distribution are as follows:
    (1) The section 751(b) sale or exchange. Upon the sale of $4,000 
potential section 1245 income, with a basis of zero, for 4/9ths of C's 
interest in the land, the partnership consisting of the remaining 
members has $4,000 ordinary income under sections 751(b) and 1245(a)(1). 
See section 1245(b)(3) and (6)(A). The partnership's new basis for the 
land is $19,333, i.e., $18,000, less the basis of the 4/9ths share 
considered as distributed to C ($2,667), plus the partnership purchase 
price for this share ($4,000).
    (2) The part of the distribution not under section 751(b). The 
analysis under this subparagraph should be made in accordance with the 
principles illustrated in paragraph (e)(2) of examples 3, 4, and 5 of 
this paragraph.

[T.D. 6500, 25 FR 11814, Nov. 26, 1960, as amended by T.D. 6832, 30 FR 
8575, July 7, 1965; T.D. 7084, 36 FR 268, Jan. 8, 1971; T.D. 8586, 60 FR 
2500, Jan. 10, 1995; T.D. 8847, 64 FR 69915, Dec. 15, 1999; T.D. 9137, 
69 FR 42559, July 16, 2004]



Sec. 1.752-0  Table of contents.

    This section lists the major paragraphs that appear in Sec. Sec. 
1.752-1 through 1.752-7.

           Sec. 1.752-1 Treatment of partnership liabilities.

    (a) Definitions.
    (1) Recourse liability defined.
    (2) Nonrecourse liability defined.
    (3) Related person.
    (4) Liability defined.
    (i) In general.
    (ii) Obligation.
    (iii) Other liabilities.
    (iv) Effective date.
    (b) Increase in partner's share of liabilities.
    (c) Decrease in partner's share of liabilities.
    (d) Assumption of liability.
    (e) Property subject to a liability.
    (f) Netting of increases and decreases in liabilities resulting from 
same transaction.
    (g) Example.
    (h) Sale or exchange of partnership interest.
    (i) Bifurcation of partnership liabilities.

         Sec. 1.752-2 Partner's share of recourse liabilities.

    (a) In general.
    (b) Obligation to make a payment.
    (1) In general.
    (2) Treatment upon deemed disposition.
    (3) Obligations recognized.
    (4) Contingent obligations.
    (5) Reimbursement rights.
    (6) Deemed satisfaction or obligation.
    (c) Partner or related person as lender.
    (1) In general.
    (2) Wrapped debt.
    (d) De minimis exceptions.
    (1) Partner as lender.
    (2) Partner as guarantor.
    (e) Special rule for nonrecourse liability with interest guaranteed 
by a partner.
    (1) In general.
    (2) Computation of present value.
    (3) Safe harbor.
    (4) De minimis exception.
    (f) Examples.
    (g) Time-value-of-money considerations.
    (1) In general.
    (2) Valuation of an obligation.

[[Page 653]]

    (3) Satisfaction of obligation with partner's promissory note.
    (4) Example.
    (h) Partner providing property as security for partnership 
liability.
    (1) Direct pledge.
    (2) Indirect pledge.
    (3) Valuation.
    (4) Partner's promissory note.
    (i) Treatment of recourse liabilities in tiered partnerships.
    (j) Anti-abuse rules.
    (1) In general.
    (2) Arrangements tantamount to a guarantee.
    (3) Plan to circumvent or avoid the regulations.
    (4) Examples.

        Sec. 1.752-3 Partner's share of nonrecourse liabilities.

    (a) In general.
    (b) Examples.

                      Sec. 1.752-4 Special rules.

    (a) Tiered partnerships.
    (b) Related person definition.
    (1) In general.
    (2) Person related to more than one partner.
    (i) In general.
    (ii) Natural persons.
    (iii) Related partner exception.
    (iv) Special rule where entity structured to avoid related person 
status.
    (A) In general.
    (B) Ownership interest.
    (C) Example.
    (c) Limitation.
    (d) Time of determination.

           Sec. 1.752-5 Effective dates and transition rules.

    (a) In general.
    (b) Election.
    (1) In general.
    (2) Time and manner of election.
    (c) Effect of section 708(b)(1)(B) termination on determining date 
liabilities are incurred or assumed.

  Sec. 1.752-6 Partnership assumption of partner's section 358(h)(3) 
       liability after October 18, 1999, and before June 24, 2003.

    (a) In general.
    (b) Exceptions.
    (1) In general.
    (2) Transactions described in Notice 2000-44.
    (c) Example.
    (d) Effective date.
    (1) In general.
    (2) Election to apply Sec. 1.752-7.

    Sec. 1.752-7 Partnership assumption of partner's Sec. 1.752-7 
                  liability on or after June 24, 2003.

    (a) Purpose and structure.
    (b) Definitions.
    (1) Assumption.
    (2) Adjusted value.
    (3) Sec. 1.752-7 liability.
    (i) In general.
    (ii) Amount and share of Sec. 1.752-7 liability.
    (iii) Example.
    (4) Sec. 1.752-7 liability transfer.
    (i) In general.
    (ii) Terminations under section 708(b)(1)(B).
    (5) Sec. 1.752-7 liability partner.
    (i) In general.
    (ii) Tiered partnerships.
    (A) Assumption by a lower-tier partnership.
    (B) Distribution of partnership interest.
    (6) Remaining built-in loss associated with a Sec. 1.752-7 
liability.
    (i) In general.
    (ii) Partial dispositions and assumptions.
    (7) Sec. 1.752-7 liability reduction.
    (i) In general.
    (ii) Partial dispositions and assumptions.
    (8) Satisfaction of Sec. 1.752-7 liability.
    (9) Testing date.
    (10) Trade or business.
    (i) In general.
    (ii) Examples.
    (c) Application of section 704(b) and (c) to assumed Sec. 1.752-7 
liabilities.
    (1) In general.
    (i) Section 704(c).
    (ii) Section 704(b).
    (2) Example.
    (d) Special rules for transfers of partnership interests, 
distributions of partnership assets, and assumptions of the Sec. 1.752-
7 liability after a Sec. 1.752-7 liability transfer.
    (1) In general.
    (2) Exceptions.
    (i) In general.
    (ii) Examples.
    (e) Transfer of Sec. 1.752-7 liability partner's partnership 
interest.
    (1) In general.
    (2) Examples.
    (3) Exception for nonrecognition transactions.
    (i) In general.
    (ii) Examples.
    (f) Distribution in liquidation of Sec. 1.752-7 liability partner's 
partnership interest.
    (1) In general.
    (2) Example.
    (g) Assumption of Sec. 1.752-7 liability by a partner other than 
Sec. 1.752-7 liability partner.
    (1) In general.
    (2) Consequences to Sec. 1.752-7 liability partner.
    (3) Consequences to partnership.
    (4) Consequences to assuming partner.
    (5) Example.
    (h) Notification by the partnership (or successor) of the 
satisfaction of the Sec. 1.752-7 liability.

[[Page 654]]

    (i) Special rule for amounts that are capitalized prior to the 
occurrence of an event described in paragraphs (e), (f), or (g).
    (1) In general.
    (2) Example.
    (j) Tiered partnerships.
    (1) Look-through treatment.
    (2) Trade or business exception.
    (3) Partnership as a Sec. 1.752-7 liability partner.
    (4) Transfer of Sec. 1.752-7 liability by partnership to another 
partnership or corporation after a transaction described in paragraphs 
(e),(f), or (g).
    (i) In general.
    (ii) Subsequent transfers.
    (5) Example.
    (k) Effective dates.
    (1) In general.
    (2) Election to apply this section to assumptions of liabilities 
occurring after October 18, 1999 and before June 24, 2003.
    (i) In general.
    (ii) Manner of making election.
    (iii) Filing of amended returns.
    (iv) Time for making election.

[T.D. 8380, 56 FR 66350, Dec. 23, 1991, as amended by T.D. 9207, 70 FR 
30342, May 26, 2005]



Sec. 1.752-1  Treatment of partnership liabilities.

    (a) Definitions. For purposes of section 752, the following 
definitions apply:
    (1) Recourse liability defined. A partnership liability is a 
recourse liability to the extent that any partner or related person 
bears the economic risk of loss for that liability under Sec. 1.752-2.
    (2) Nonrecourse liability defined. A partnership liability is a 
nonrecourse liability to the extent that no partner or related person 
bears the economic risk of loss for that liability under Sec. 1.752-2.
    (3) Related person. Related person means a person having a 
relationship to a partner that is described in Sec. 1.752-4(b).
    (4) Liability defined--(i) In general. An obligation is a liability 
for purposes of section 752 and the regulations thereunder (Sec. 1.752-
1 liability), only if, when, and to the extent that incurring the 
obligation--
    (A) Creates or increases the basis of any of the obligor's assets 
(including cash);
    (B) Gives rise to an immediate deduction to the obligor; or
    (C) Gives rise to an expense that is not deductible in computing the 
obligor's taxable income and is not properly chargeable to capital.
    (ii) Obligation. For purposes of this paragraph and Sec. 1.752-7, 
an obligation is any fixed or contingent obligation to make payment 
without regard to whether the obligation is otherwise taken into account 
for purposes of the Internal Revenue Code. Obligations include, but are 
not limited to, debt obligations, environmental obligations, tort 
obligations, contract obligations, pension obligations, obligations 
under a short sale, and obligations under derivative financial 
instruments such as options, forward contracts, futures contracts, and 
swaps.
    (iii) Other liabilities. For obligations that are not Sec. 1.752-1 
liabilities, see Sec. Sec. 1.752-6 and 1.752-7.
    (iv) Effective date. Except as otherwise provided in Sec. 1.752-
7(k), this paragraph (a)(4) applies to liabilities that are incurred or 
assumed by a partnership on or after June 24, 2003.
    (b) Increase in partner's share of liabilities. Any increase in a 
partner's share of partnership liabilities, or any increase in a 
partner's individual liabilities by reason of the partner's assumption 
of partnership liabilities, is treated as a contribution of money by 
that partner to the partnership.
    (c) Decrease in partner's share of liabilities. Any decrease in a 
partner's share of partnership liabilities, or any decrease in a 
partner's individual liabilities by reason of the partnership's 
assumption of the individual liabilities of the partner, is treated as a 
distribution of money by the partnership to that partner.
    (d) Assumption of liability. Except as otherwise provided in 
paragraph (e) of this section, a person is considered to assume a 
liability only to the extent that:
    (1) The assuming person is personally obligated to pay the 
liability; and
    (2) If a partner or related person assumes a partnership liability, 
the person to whom the liability is owed knows of the assumption and can 
directly enforce the partner's or related person's obligation for the 
liability, and no other partner or person that is a related person to 
another partner

[[Page 655]]

would bear the economic risk of loss for the liability immediately after 
the assumption.
    (e) Property subject to a liability. If property is contributed by a 
partner to the partnership or distributed by the partnership to a 
partner and the property is subject to a liability of the transferor, 
the transferee is treated as having assumed the liability, to the extent 
that the amount of the liability does not exceed the fair market value 
of the property at the time of the contribution or distribution.
    (f) Netting of increases and decreases in liabilities resulting from 
same transaction. If, as a result of a single transaction, a partner 
incurs both an increase in the partner's share of the partnership 
liabilities (or the partner's individual liabilities) and a decrease in 
the partner's share of the partnership liabilities (or the partner's 
individual liabilities), only the net decrease is treated as a 
distribution from the partnership and only the net increase is treated 
as a contribution of money to the partnership. Generally, the 
contribution to or distribution from a partnership of property subject 
to a liability or the termination of the partnership under section 
708(b) will require that increases and decreases in liabilities 
associated with the transaction be netted to determine if a partner will 
be deemed to have made a contribution or received a distribution as a 
result of the transaction. When two or more partnerships merge or 
consolidate under section 708(b)(2)(A), as described in Sec. 1.708-
1(c)(3)(i), increases and decreases in partnership liabilities 
associated with the merger or consolidation are netted by the partners 
in the terminating partnership and the resulting partnership to 
determine the effect of the merger under section 752.
    (g) Example. The following example illustrates the principles of 
paragraphs (b), (c), (e), and (f) of this section.

    Example 1. Property contributed subject to a liability; netting of 
increase and decrease in partner's share of liability. B contributes 
property with an adjusted basis of $1,000 to a general partnership in 
exchange for a one-third interest in the partnership. At the time of the 
contribution, the partnership does not have any liabilities outstanding 
and the property is subject to a recourse debt of $150 and has a fair 
market value in excess of $150. After the contribution, B remains 
personally liable to the creditor and none of the other partners bears 
any of the economic risk of loss for the liability under state law or 
otherwise. Under paragraph (e) of this section, the partnership is 
treated as having assumed the $150 liability. As a result, B's 
individual liabilities decrease by $150. At the same time, however, B's 
share of liabilities of the partnership increases by $150. Only the net 
increase or decrease in B's share of the liabilities of the partnership 
and B's individual liabilities is taken into account in applying section 
752. Because there is no net change, B is not treated as having 
contributed money to the partnership or as having received a 
distribution of money from the partnership under paragraph (b) or (c) of 
this section. Therefore B's basis for B's partnership interest is $1,000 
(B's basis for the contributed property).
    Example 2. Merger or consolidation of partnerships holding property 
encumbered by liabilities. (i) B owns a 70 percent interest in 
partnership T. Partnership T's sole asset is property X, which is 
encumbered by a $900 liability. Partnership T's adjusted basis in 
property X is $600, and the value of property X is $1,000. B's adjusted 
basis in its partnership T interest is $420. B also owns a 20 percent 
interest in partnership S. Partnership S's sole asset is property Y, 
which is encumbered by a $100 liability. Partnership S's adjusted basis 
in property Y is $200, the value of property Y is $1,000, and B's 
adjusted basis in its partnership S interest is $40.
    (ii) Partnership T and partnership S merge under section 
708(b)(2)(A). Under section 708(b)(2)(A) and Sec. 1.708-1(c)(1), 
partnership T is considered terminated and the resulting partnership is 
considered a continuation of partnership S. Partnerships T and S 
undertake the form described in Sec. 1.708-1(c)(3)(i) for the 
partnership merger. Under Sec. 1.708-1(c)(3)(i), partnership T 
contributes property X and its $900 liability to partnership S in 
exchange for an interest in partnership S. Immediately thereafter, 
partnership T distributes the interests in partnership S to its partners 
in liquidation of their interests in partnership T. B owns a 25 percent 
interest in partnership S after partnership T distributes the interests 
in partnership S to B.
    (iii) Under paragraph (f) of this section, B nets the increases and 
decreases in its share of partnership liabilities associated with the 
merger of partnership T and partnership S. Before the merger, B's share 
of partnership liabilities was $650 (B had a $630 share of partnership 
liabilities in partnership T and a $20 share of partnership liabilities 
in partnership S immediately before the merger). B's share of S's 
partnership liabilities after the merger is $250 (25 percent of S's 
total partnership liabilities of $1,000). Accordingly, B has a $400 net 
decrease in its share of S's partnership liabilities. Thus, B is treated 
as

[[Page 656]]

receiving a $400 distribution from partnership S under section 752(b). 
Because B's adjusted basis in its partnership S interest before the 
deemed distribution under section 752(b) is $460 ($420 + $40), B will 
not recognize gain under section 731. After the merger, B's adjusted 
basis in its partnership S interest is $60.

    (h) Sale or exchange of a partnership interest. If a partnership 
interest is sold or exchanged, the reduction in the transferor partner's 
share of partnership liabilities is treated as an amount realized under 
section 1001 and the regulations thereunder. For example, if a partner 
sells an interest in a partnership for $750 cash and transfers to the 
purchaser the partner's share of partnership liabilities in the amount 
of $250, the seller realizes $1,000 on the transaction.
    (i) Bifurcation of partnership liabilities. If one or more partners 
bears the economic risk of loss as to part, but not all, of a 
partnership liability represented by a single contractual obligation, 
that liability is treated as two or more separate liabilities for 
purposes of section 752. The portion of the liability as to which one or 
more partners bear the economic risk of loss is a recourse liability and 
the remainder of the liability, if any, is a nonrecourse liability.

[T.D. 8380, 56 FR 66351, Dec. 23, 1991, as amended by T.D. 8925, 66 FR 
723, Jan. 4, 2001; T.D. 9207, 70 FR 30343, May 26, 2005]



Sec. 1.752-2  Partner's share of recourse liabilities.

    (a) In general. A partner's share of a recourse partnership 
liability equals the portion of that liability, if any, for which the 
partner or related person bears the economic risk of loss. The 
determination of the extent to which a partner bears the economic risk 
of loss for a partnership liability is made under the rules in 
paragraphs (b) through (k) of this section.
    (b) Obligation to make a payment--(1) In general. Except as 
otherwise provided in this section, a partner bears the economic risk of 
loss for a partnership liability to the extent that, if the partnership 
constructively liquidated, the partner or related person would be 
obligated to make a payment to any person (or a contribution to the 
partnership) because that liability becomes due and payable and the 
partner or related person would not be entitled to reimbursement from 
another partner or person that is a related person to another partner. 
Upon a constructive liquidation, all of the following events are deemed 
to occur simultaneously:
    (i) All of the partnership's liabilities become payable in full;
    (ii) With the exception of property contributed to secure a 
partnership liability (see Sec. 1.752-2(h)(2)), all of the 
partnership's assets, including cash, have a value of zero;
    (iii) The partnership disposes of all of its property in a fully 
taxable transaction for no consideration (except relief from liabilities 
for which the creditors's right to repayment is limited solely to one or 
more assets of the partnership);
    (iv) All items of income, gain, loss, or deduction are allocated 
among the partners; and
    (v) The partnership liquidates.
    (2) Treatment upon deemed disposition. For purposes of paragraph 
(b)(1) of this section, gain or loss on the deemed disposition of the 
partnership's assets is computed in accordance with the following:
    (i) If the creditor's right to repayment of a partnership liability 
is limited solely to one or more assets of the partnership, gain or loss 
is recognized in an amount equal to the difference between the amount of 
the liability that is extinguished by the deemed disposition and the tax 
basis (or book value to the extent section 704(c) or Sec. 1.704-
1(b)(4)(i) applies) in those assets.
    (ii) A loss is recognized equal to the remaining tax basis (or book 
value to the extent section 704(c) or Sec. 1.704-1(b)(4)(i) applies) of 
all the partnership's assets not taken into account in paragraph 
(b)(2)(i) of this section.
    (3) Obligations recognized. The determination of the extent to which 
a partner or related person has an obligation to make a payment under 
paragraph (b)(1) of this section is based on the facts and circumstances 
at the time of the determination. All statutory and contractual 
obligations relating to the partnership liability are taken into account 
for purposes of applying this section, including:

[[Page 657]]

    (i) Contractual obligations outside the partnership agreement such 
as guarantees, indemnifications, reimbursement agreements, and other 
obligations running directly to creditors or to other partners, or to 
the partnership;
    (ii) Obligations to the partnership that are imposed by the 
partnership agreement, including the obligation to make a capital 
contribution and to restore a deficit capital account upon liquidation 
of the partnership; and
    (iii) Payment obligations (whether in the form of direct remittances 
to another partner or a contribution to the partnership) imposed by 
state law, including the governing state partnership statute.

To the extent that the obligation of a partner to make a payment with 
respect to a partnership liability is not recognized under this 
paragraph (b)(3), paragraph (b) of this section is applied as if the 
obligation did not exist.
    (4) Contingent obligations. A payment obligation is disregarded if, 
taking into account all the facts and circumstances, the obligation is 
subject to contingencies that make it unlikely that the obligation will 
ever be discharged. If a payment obligation would arise at a future time 
after the occurrence of an event that is not determinable with 
reasonable certainty, the obligation is ignored until the event occurs.
    (5) Reimbursement rights. A partner's or related person's obligation 
to make a payment with respect to a partnership liability is reduced to 
the extent that the partner or related person is entitled to 
reimbursement from another partner or a person who is a related person 
to another partner.
    (6) Deemed satisfaction of obligation. For purposes of determining 
the extent to which a partner or related person has a payment obligation 
and the economic risk of loss, it is assumed that all partners and 
related persons who have obligations to make payments actually perform 
those obligations, irrespective of their actual net worth, unless the 
facts and circumstances indicate a plan to circumvent or avoid the 
obligation. See paragraphs (j) and (k) of this section.
    (c) Partner or related person as lender--(1) In general. A partner 
bears the economic risk of loss for a partnership liability to the 
extent that the partner or a related person makes (or acquires an 
interest in) a nonrecourse loan to the partnership and the economic risk 
of loss for the liability is not borne by another partner.
    (2) Wrapped debt. If a partnership liability is owed to a partner or 
related person and that liability includes (i.e., is ``wrapped'' around) 
a nonrecourse obligation encumbering partnership property that is owed 
to another person, the partnership liability will be treated as two 
separate liabilities. The portion of the partnership liability 
corresponding to the wrapped debt is treated as a liability owed to 
another person.
    (d) De minimis exceptions--(1) Partner as lender. The general rule 
contained in paragraph (c)(1) of this section does not apply if a 
partner or related person whose interest (directly or indirectly through 
one or more partnerships including the interest of any related person) 
in each item of partnership income, gain, loss, deduction, or credit for 
every taxable year that the partner is a partner in the partnership is 
10 percent or less, makes a loan to the partnership which constitutes 
qualified nonrecourse financing within the meaning of section 465(b)(6) 
(determined without regard to the type of activity financed).
    (2) Partner as guarantor. The general rule contained in paragraph 
(b)(1) of this section does not apply if a partner or related person 
whose interest (directly or indirectly through one or more partnerships 
including the interest of any related person) in each item of 
partnership income, gain, loss, deduction, or credit for every taxable 
year that the partner is a partner in the partnership is 10 percent or 
less, guarantees a loan that would otherwise be a nonrecourse loan of 
the partnership and which would constitute qualified nonrecourse 
financing within the meaning of section 465(b)(6) (without regard to the 
type of activity financed) if the guarantor had made the loan to the 
partnership.
    (e) Special rule for nonrecourse liability with interest guaranteed 
by a partner--(1)

[[Page 658]]

In general. For purposes of this section, if one or more partners or 
related persons have guaranteed the payment of more than 25 percent of 
the total interest that will accrue on a partnership nonrecourse 
liability over its remaining term, and it is reasonable to expect that 
the guarantor will be required to pay substantially all of the 
guaranteed future interest if the partnership fails to do so, then the 
liability is treated as two separate partnership liabilities. If this 
rule applies, the partner or related person that has guaranteed the 
payment of interest is treated as bearing the economic risk of loss for 
the partnership liability to the extent of the present value of the 
guaranteed future interest payments. The remainder of the stated 
principal amount of the partnership liability constitutes a nonrecourse 
liability. Generally, in applying this rule, it is reasonable to expect 
that the guarantor will be required to pay substantially all of the 
guaranteed future interest if, upon a default in payment by the 
partnership, the lender can enforce the interest guaranty without 
foreclosing on the property and thereby extinguishing the underlying 
debt. The guarantee of interest rule continues to apply even after the 
point at which the amount of guaranteed interest that will accrue is 
less than 25 percent of the total interest that will accrue on the 
liability.
    (2) Computation of present value. The present value of the 
guaranteed future interest payments is computed using a discount rate 
equal to either the interest rate stated in the loan documents, or if 
interest is imputed under either section 483 or section 1274, the 
applicable federal rate, compounded semi-annually. The computation takes 
into account any payment of interest that the partner or related person 
may be required to make only to the extent that the interest will accrue 
economically (determined in accordance with section 446 and the 
regulations thereunder) after the date of the interest guarantee. If the 
loan document contains a variable rate of interest that is an interest 
rate based on current values of an objective interest index, the present 
value is computed on the assumption that the interest determined under 
the objective interest index on the date of the computation will remain 
constant over the term of the loan. The term ``objective interest 
index'' has the meaning given to it in section 1275 and the regulations 
thereunder (relating to variable rate debt instruments). Examples of an 
objective interest index include the prime rate of a designated 
financial institution, LIBOR (London Interbank Offered Rate), and the 
applicable federal rate under section 1274(d).
    (3) Safe harbor. The general rule contained in paragraph (e)(1) of 
this section does not apply to a partnership nonrecourse liability if 
the guarantee of interest by the partner or related person is for a 
period not in excess of the lesser of five years or one-third of the 
term of the liability.
    (4) De minimis exception. The general rule contained in paragraph 
(e)(1) of this section does not apply if a partner or related person 
whose interest (directly or indirectly through one or more partnerships 
including the interest of any related person) in each item of 
partnership income, gain, loss, deduction, or credit for every taxable 
year that the partner is a partner in the partnership is 10 percent of 
less, guarantees the interest on a loan to that partnership which 
constitutes qualified nonrecourse financing within the meaning of 
section 465(b)(6) (determined without regard to the type of activity 
financed). An allocation of interest to the extent paid by the guarantor 
is not treated as a partnership item of deduction or loss subject to the 
10 percent or less rule.
    (f) Examples. The following examples illustrate the principles of 
paragraphs (a) through (e) of this section.

    Example 1. Determining when a partner bears the economic risk of 
loss. A and B form a general partnership with each contributing $100 in 
cash. The partnership purchases an office building on leased land for 
$1,000 from an unrelated seller, paying $200 in cash and executing a 
note to the seller for the balance of $800. The note is a general 
obligation of the partnership, i.e., no partner has been relieved from 
personal liability. The partnership agreement provides that all items 
are allocated equally except that tax losses are specially allocated 90% 
to A and 10% to B and that capital accounts will be maintained in 
accordance with the regulations under section 704(b), including a 
deficit capital account restoration obligation on liquidation.

[[Page 659]]

In a constructive liquidation, the $800 liability becomes due and 
payable. All of the partnership's assets, including the building, are 
deemed to be worthless. The building is deemed sold for a value of zero. 
Capital accounts are adjusted to reflect the loss on the hypothetical 
disposition, as follows:

------------------------------------------------------------------------
                                                     A            B
------------------------------------------------------------------------
Initial contribution..........................       $100         $100
Loss on hypothetical sale.....................       (900)        (100)
                                               -------------------------
                                                    ($800)          $0
------------------------------------------------------------------------


Other than the partners' obligation to fund negative capital accounts on 
liquidation, there are no other contractual or statutory payment 
obligations existing between the partners, the partnership and the 
lender. Therefore, $800 of the partnership liability is classified as a 
recourse liability because one or more partners bears the economic risk 
of loss for non-payment. B has no share of the $800 liability since the 
constructive liquidation produces no payment obligation for B. A's share 
of the partnership liability is $800 because A would have an obligation 
in that amount to make a contribution to the partnership.
    Example 2. Recourse liability; deficit restoration obligation. C and 
D each contribute $500 in cash to the capital of a new general 
partnership, CD. CD purchases property from an unrelated seller for 
$1,000 in cash and a $9,000 mortgage note. The note is a general 
obligation of the partnership, i.e., no partner has been relieved from 
personal liability. The partnership agreement provides that profits and 
losses are to be divided 40% to C and 60% to D. C and D are required to 
make up any deficit in their capital accounts. In a constructive 
liquidation, all partnership assets are deemed to become worthless and 
all partnership liabilities become due and payable in full. The 
partnership is deemed to dispose of all its assets in a fully taxable 
transaction for no consideration. Capital accounts are adjusted to 
reflect the loss on the hypothetical disposition, as follows:

------------------------------------------------------------------------
                                                     C            D
------------------------------------------------------------------------
Initial contribution..........................       $500         $500
                                               -------------------------
Loss on hypothetical sale.....................     (4,000)      (6,000)
                                                  ($3,500)     ($5,500)
------------------------------------------------------------------------


C's capital account reflects a deficit that C would have to make up to 
$3,500 and D's capital account reflects a deficit that D would have to 
make up of $5,500. Therefore, the $9,000 mortgage note is a recourse 
liability because one or more partners bear the economic risk of loss 
for the liability. C's share of the recourse liability is $3,500 and D's 
share is $5,500.
    Example 3. Guarantee by limited partner; partner deemed to satisfy 
obligation. E and F form a limited partnership. E, the general partner, 
contributes $2,000 and F, the limited partner, contributes $8,000 in 
cash to the partnership. The partnership agreement allocates losses 20% 
to E and 80% to F until F's capital account is reduced to zero, after 
which all losses are allocated to E. The partnership purchases 
depreciable property for $25,000 using its $10,000 cash and a $15,000 
recourse loan from a bank. F guarantees payment of the $15,000 loan to 
the extent the loan remains unpaid after the bank has exhausted its 
remedies against the partnership. In a constructive liquidation, the 
$15,000 liability becomes due and payable. All of the partnership's 
assets, including the depreciable property, are deemed to be worthless. 
The depreciable property is deemed sold for a value of zero. Capital 
accounts are adjusted to reflect the loss on the hypothetical 
disposition, as follows:

------------------------------------------------------------------------
                                                     E            F
------------------------------------------------------------------------
Initial contribution..........................     $2,000       $8,000
Loss on hypothetical sale.....................    (17,000)      (8,000)
                                               -------------------------
                                                 ($15,000)          $0
------------------------------------------------------------------------


E, as a general partner, would be obligated by operation of law to make 
a net contribution to the partnership of $15,000. Because E is assumed 
to satisfy that obligation, it is also assumed that F would not have to 
satisfy F's guarantee. The $15,000 mortgage is treated as a recourse 
liability because one or more partners bear the economic risk of loss. 
E's share of the liability is $15,000, and F's share is zero. This would 
be so even if E's net worth at the time of the determination is less 
than $15,000, unless the facts and circumstances indicate a plan to 
circumvent or avoid E's obligation to contribute to the partnership.
    Example 4. Partner guarantee with right of subrogation. G, a limited 
partner in the GH partnership, guarantees a portion of a partnership 
liability. The liability is a general obligation of the partnership, 
i.e., no partner has been relieved from personal liability. If under 
state law G is subrogated to the rights of the lender, G would have the 
right to recover the amount G paid to the recourse lender from the 
general partner. Therefore, G does not bear the economic risk of loss 
for the partnership liability.
    Example 5. Bifurcation of partnership liability; guarantee of part 
of nonrecourse liability. A partnership borrows $10,000, secured by a 
mortgage on real property. The mortgage note contains an exoneration 
clause which provides that in the event of default, the holder's only 
remedy is to foreclose on the property. The holder may not look to any 
other partnership asset or to any partner to

[[Page 660]]

pay the liability. However, to induce the lender to make the loan, a 
partner guarantees payment of $200 of the loan principal. The 
exoneration clause does not apply to the partner's guarantee. If the 
partner paid pursuant to the guarantee, the partner would be subrogated 
to the rights of the lender with respect to $200 of the mortgage debt, 
but the partner is not otherwise entitled to reimbursement from the 
partnership or any partner. For purposes of section 752, $200 of the 
$10,000 mortgage liability is treated as a recourse liability of the 
partnership and $9,800 is treated as a nonrecourse liability of the 
partnership. The partner's share of the recourse liability of the 
partnership is $200.
    Example 6. Wrapped debt. I, an individual, purchases real estate 
from an unrelated seller for $10,000, paying $1,000 in cash and giving a 
$9,000 purchase mortgage note on which I has no personal liability and 
as to which the seller can look only to the property for satisfaction. 
At a time when the property is worth $15,000, I sells the property to a 
partnership in which I is a general partner. The partnership pays for 
the property with a partnership purchase money mortgage note of $15,000 
on which neither the partnership nor any partner (or person related to a 
partner) has personal liability. The $15,000 mortgage note is a wrapped 
debt that includes the $9,000 obligation to the original seller. The 
liability is a recourse liability to the extent of $6,000 because I is 
the creditor with respect to the loan and I bears the economic risk of 
loss for $6,000. I's share of the recourse liability is $6,000. The 
remaining $9,000 is treated as a partnership nonrecourse liability that 
is owed to the unrelated seller.
    Example 7. Guarantee of interest by partner treated as part recourse 
and part nonrecourse. On January 1, 1992, a partnership obtains a 
$4,000,000 loan secured by a shopping center owned by the partnership. 
Neither the partnership nor any partner has any personal liability under 
the loan documents for repayment of the stated principal amount. 
Interest accrues at a 15 percent annual rate and is payable on December 
31 of each year. The principal is payable in a lump sum on December 31, 
2006. A partner guarantees payment of 50 percent of each interest 
payment required by the loan. The guarantee can be enforced without 
first foreclosing on the property. When the partnership obtains the 
loan, the present value (discounted at 15 percent, compounded annually) 
of the future interest payments is $3,508,422, and of the future 
principal payment is $491,578. If tested on that date, the loan would be 
treated as a partnership liability of $1,754,211 ($3,508,422x.5) for 
which the guaranteeing partner bears the economic risk of loss and a 
partnership nonrecourse liability of $2,245,789 ($1,754,211 + $491,578).
    Example 8. Contingent obligation not recognized. J and K form a 
general partnership with cash contributions of $2,500 each. J and K 
share partnership profits and losses equally. The partnership purchases 
an apartment building for its $5,000 of cash and a $20,000 nonrecourse 
loan from a commercial bank. The nonrecourse loan is secured by a 
mortgage on the building. The loan documents provide that the 
partnership will be liable for the outstanding balance of the loan on a 
recourse basis to the extent of any decrease in the value of the 
apartment building resulting from the partnership's failure properly to 
maintain the property. There are no facts that establish with reasonable 
certainty the existence of any liability on the part of the partnership 
(and its partners) for damages resulting from the partnership's failure 
properly to maintain the building. Therefore, no partner bears the 
economic risk of loss, and the liability constitutes a nonrecourse 
liability. Under Sec. 1.752-3, J and K share this nonrecourse liability 
equally because they share all profits and losses equally.

    (g) Time-value-of-money considerations--(1) In general. The extent 
to which a partner or related person bears the economic risk of loss is 
determined by taking into account any delay in the time when a payment 
or contribution obligation with respect to a partnership liability is to 
be satisfied. If a payment obligation with respect to a partnership 
liability is not required to be satisfied within a reasonable time after 
the liability becomes due and payable, or if the obligation to make a 
contribution to the partnership is not required to be satisfied before 
the later of--
    (i) The end of the year in which the partner's interest is 
liquidated, or
    (ii) 90 days after the liquidation,

the obligation is recognized only to the extent of the value of the 
obligation.
    (2) Valuation of an obligation. The value of a payment or 
contribution obligation that is not required to be satisfied within the 
time period specified in paragraph (g)(1) of this section equals the 
entire principal balance of the obligation only if the obligation bears 
interest equal to or greater than the applicable federal rate under 
section 1274(d) at the time of valuation, commencing on--
    (i) In the case of a payment obligation, the date that the 
partnership liability to a creditor or other person to whom the 
obligation relates becomes due and payable, or

[[Page 661]]

    (ii) In the case of a contribution obligation, the date of the 
liquidation of the partner's interest in the partnership. If the 
obligation does not bear interest at a rate at least equal to the 
applicable federal rate at the time of valuation, the value of the 
obligation is discounted to the present value of all payments due from 
the partner or related person (i.e., the imputed principal amount 
computed under section 1274(b)). For purposes of making this present 
value determination, the partnership is deemed to have constructively 
liquidated as of the date on which the payment obligation is valued and 
the payment obligation is assumed to be a debt instrument subject to the 
rules of section 1274 (i.e., the debt instrument is treated as if it 
were issued for property at the time of the valuation).
    (3) Satisfaction of obligation with partner's promissory note. An 
obligation is not satisfied by the transfer to the obligee of a 
promissory note by a partner or related person unless the note is 
readily tradeable on an established securities market.
    (4) Example. The following example illustrates the principle of 
paragraph (g) of this section.

    Example. Value of obligation not required to be satisfied within 
specified time period. A, the general partner, and B, the limited 
partner, each contributes $10,000 to partnership AB. AB purchases 
property from an unrelated seller for $20,000 in cash and a $70,000 
recourse purchase money note. The partnership agreement provides that 
profits and losses are to be divided equally. A and B are required to 
make up any deficit in their capital accounts. While A is required to 
restore any deficit balance in A's capital account within 90 days after 
the date of liquidation of the partnership, B is not required to restore 
any deficit for two years following the date of liquidation. The deficit 
in B's capital account will not bear interest during that two-year 
period. In a constructive liquidation, all partnership assets are deemed 
to become worthless and all partnership liabilities become due and 
payable in full. The partnership is deemed to dispose of all its assets 
in a fully taxable transaction for no consideration. Capital accounts 
are adjusted to reflect the loss on the hypothetical disposition, as 
follows:

------------------------------------------------------------------------
                                                     A            B
------------------------------------------------------------------------
Initial contribution..........................    $10,000      $10,000
Loss on hypothetical sale.....................    (45,000)     (45,000)
                                               -------------------------
                                                  (35,000)     (35,000)
------------------------------------------------------------------------


A's and B's capital accounts each reflect deficits of $35,000. B's 
obligation to make a contribution pursuant to B's deficit restoration 
obligation is recognized only to the extent of the fair market value of 
that obligation at the time of the constructive liquidation because B is 
not required to satisfy that obligation by the later of the end of the 
partnership taxable year in which B's interest is liquidated or within 
90 days after the date of the liquidation. Because B's obligation does 
not bear interest, the fair market value is deemed to equal the imputed 
principal amount under section 1274(b). Under section 1274(b), the 
imputed principal amount of a debt instrument equals the present value 
of all payments due under the debt instrument. Assume the applicable 
federal rate with respect to B's obligation is 10 percent compounded 
semiannually. Using this discount rate, the present value of the $35,000 
payment that B would be required to make two years after the 
constructive liquidation to restore the deficit balance in B's capital 
account equals $28,795. To the extent that B's deficit restoration 
obligation is not recognized, it is assumed that B's obligation does not 
exist. Therefore, A, as the sole general partner, would be obligated by 
operation of law to contribute an additional $6,205 of capital to the 
partnership. Accordingly, under paragraph (g) of this section, B bears 
the economic risk of loss for $28,795 and A bears the economic risk of 
loss for $41,205 ($35,000 + $6,205).

    (h) Partner providing property as security for partnership 
liability--(1) Direct pledge. A partner is considered to bear the 
economic risk of loss for a partnership liability to the extent of the 
value of any the partner's or related person's separate property (other 
than a direct or indirect interest in the partnership) that is pledged 
as security for the partnership liability.
    (2) Indirect pledge. A partner is considered to bear the economic 
risk of loss for a partnership liability to the extent of the value of 
any property that the partner contributes to the partnership solely for 
the purpose of securing a partnership liability. Contributed property is 
not treated as contributed solely for the purpose of securing a 
partnership liability unless substantially all of the items of income, 
gain, loss, and deduction attributable

[[Page 662]]

to the contributed property are allocated to the contributing partner, 
and this allocation is generally greater than the partner's share of 
other significant items of partnership income, gain, loss, or deduction.
    (3) Valuation. The extent to which a partner bears the economic risk 
of loss for a partnership liability as a result of a direct pledge 
described in paragraph (h)(1) of this section or an indirect pledge 
described in paragraph (h)(2) of this section is limited to the net fair 
market value of the property (pledged property) at the time of the 
pledge or contribution. If a partner provides additional pledged 
property, the addition is treated as a new pledge and the net fair 
market value of the pledged property (including but not limited to the 
additional property) must be determined at that time. For purposes of 
this paragraph (h), if pledged property is subject to one or more other 
obligations, those obligations must be taken into account in determining 
the net fair market value of pledged property at the time of the pledge 
or contribution.
    (4) Partner's promissory note. For purposes of paragraph (h)(2) of 
this section, a promissory note of the partner or related person that is 
contributed to the partnership shall not be taken into account unless 
the note is readily tradeable on an established securities market.
    (i) Treatment of recourse liabilities in tiered partnerships. If a 
partnership (the ``upper-tier partnership'') owns (directly or 
indirectly through one or more partnerships) an interest in another 
partnership (the ``lower-tier partnership''), the liabilities of the 
lower-tier partnership are allocated to the upper-tier partnership in an 
amount equal to the sum of the following--
    (1) The amount of the economic risk of loss that the upper-tier 
partnership bears with respect to the liabilities; and
    (2) Any other amount of the liabilities with respect to which 
partners of the upper-tier partnership bear the economic risk of loss.
    (j) Anti-abuse rules--(1) In general. An obligation of a partner or 
related person to make a payment may be disregarded or treated as an 
obligation of another person for purposes of this section if facts and 
circumstances indicate that a principal purpose of the arrangement 
between the parties is to eliminate the partner's economic risk of loss 
with respect to that obligation or create the appearance of the partner 
or related person bearing the economic risk of loss when, in fact, the 
substance of the arrangement is otherwise. Circumstances with respect to 
which a payment obligation may be disregarded include, but are not 
limited to, the situations described in paragraphs (j)(2) and (j)(3) of 
this section.
    (2) Arrangements tantamount to a guarantee. Irrespective of the form 
of a contractual obligation, a partner is considered to bear the 
economic risk of loss with respect to a partnership liability, or a 
portion thereof, to the extent that:
    (i) The partner or related person undertakes one or more contractual 
obligations so that the partnership may obtain a loan;
    (ii) The contractual obligations of the partner or related person 
eliminate substantially all the risk to the lender that the partnership 
will not satisfy its obligations under the loan; and
    (iii) One of the principal purposes of using the contractual 
obligations is to attempt to permit partners (other than those who are 
directly or indirectly liable for the obligation) to include a portion 
of the loan in the basis of their partnership interests.

The partners are considered to bear the economic risk of loss for the 
liability in accordance with their relative economic burdens for the 
liability pursuant to the contractual obligations. For example, a lease 
between a partner and a partnership which is not on commercially 
reasonable terms may be tantamount to a guarantee by the partner of a 
partnership liability.
    (3) Plan to circumvent or avoid the obligation. An obligation of a 
partner to make a payment is not recognized if the facts and 
circumstances evidence a plan to circumvent or avoid the obligation.
    (4) Example. The following example illustrates the principle of 
paragraph (j)(3) of this section.

    Example. Plan to circumvent or avoid obligation. A and B form a 
general partnership. A, a corporation, contributes $20,000 and B

[[Page 663]]

contributes $80,000 to the partnership. A is obligated to restore any 
deficit in its partnership capital account. The partnership agreement 
allocates losses 20% to A and 80% to B until B's capital account is 
reduced to zero, after which all losses are allocated to A. The 
partnership purchases depreciable property for $250,000 using its 
$100,000 cash and a $150,000 recourse loan from a bank. B guarantees 
payment of the $150,000 loan to the extent the loan remains unpaid after 
the bank has exhausted its remedies against the partnership. A is a 
subsidiary, formed by a parent of a consolidated group, with capital 
limited to $20,000 to allow the consolidated group to enjoy the tax 
losses generated by the property while at the same time limiting its 
monetary exposure for such losses. These facts, when considered together 
with B's guarantee, indicate a plan to circumvent or avoid A's 
obligation to contribute to the partnership. The rules of section 752 
must be applied as if A's obligation to contribute did not exist. 
Accordingly, the $150,000 liability is a recourse liability that is 
allocated entirely to B.
    (k) Effect of a disregarded entity--(1) In general. In determining 
the extent to which a partner bears the economic risk of loss for a 
partnership liability, an obligation under paragraph (b)(1) of this 
section (Sec. 1.752-2(b)(1) payment obligation) of a business entity 
that is disregarded as an entity separate from its owner under sections 
856(i) or 1361(b)(3) or Sec. Sec. 301.7701-1 through 301.7701-3 of this 
chapter (disregarded entity) is taken into account only to the extent of 
the net value of the disregarded entity as of the allocation date (as 
defined in paragraph (k)(2)(iv) of this section) that is allocated to 
the partnership liability as determined under the rules of this 
paragraph (k). The rules of this paragraph (k) do not apply to a Sec. 
1.752-2(b)(1) payment obligation of a disregarded entity to the extent 
that the owner of the disregarded entity is otherwise required to make a 
payment (that satisfies the requirements of paragraph (b)(1) of this 
section) with respect to the obligation of the disregarded entity.
    (2) Net value of a disregarded entity--(i) Definition. For purposes 
of this paragraph (k), the net value of a disregarded entity equals the 
following--
    (A) The fair market value of all assets owned by the disregarded 
entity that may be subject to creditors' claims under local law 
(including the disregarded entity's enforceable rights to contributions 
from its owner and the fair market value of an interest in any 
partnership other than the partnership for which net value is being 
determined, but excluding the disregarded entity's interest in the 
partnership for which the net value is being determined and the net fair 
market value of property pledged to secure a liability of the 
partnership under paragraph (h)(1) of this section); less
    (B) All obligations of the disregarded entity that do not constitute 
Sec. 1.752-2(b)(1) payment obligations of the disregarded entity.
    (ii) Timing of the net value determination--(A) Initial 
determination. If a partnership interest is held by a disregarded 
entity, and the partnership has or incurs a liability, all or a portion 
of which may be allocable to the owner of the disregarded entity under 
this paragraph (k), the disregarded entity's net value must be initially 
determined on the allocation date described in paragraph (k)(2)(iv) of 
this section.
    (B) Other events. If a partnership interest is held by a disregarded 
entity, and the partnership has or incurs a liability, all or a portion 
of which may be allocable to the owner of the disregarded entity under 
this paragraph (k), then, if one or more valuation events (as defined in 
paragraph (k)(2)(iii) of this section) occur during the partnership 
taxable year, except as provided in paragraph (k)(2)(iii)(E) of this 
section, the net value of the disregarded entity is determined on the 
allocation date described in paragraph (k)(2)(iv) of this section.
    (iii) Valuation events. The following are valuation events for 
purposes of this paragraph (k):
    (A) A more than de minimis contribution to a disregarded entity of 
property other than property pledged to secure a partnership liability 
under paragraph (h)(1) of this section, unless the contribution is 
followed immediately by a contribution of equal net value by the 
disregarded entity to the partnership for which the net value of the 
disregarded entity otherwise would be determined, taking into account 
any obligations assumed or taken subject to in connection with such 
contributions.

[[Page 664]]

    (B) A more than de minimis distribution from a disregarded entity of 
property other than property pledged to secure a partnership liability 
under paragraph (h)(1) of this section, unless the distribution 
immediately follows a distribution of equal net value to the disregarded 
entity by the partnership for which the net value of the disregarded 
entity otherwise would be determined, taking into account any 
obligations assumed or taken subject to in connection with such 
distributions.
    (C) A change in the legally enforceable obligation of the owner of 
the disregarded entity to make contributions to the disregarded entity.
    (D) The incurrence, refinancing, or assumption of an obligation of 
the disregarded entity that does not constitute a Sec. 1.752-2(b)(1) 
payment obligation of the disregarded entity.
    (E) The sale or exchange of a non-de minimis asset of the 
disregarded entity (in a transaction that is not in the ordinary course 
of business). In this case, the net value of the disregarded entity may 
be adjusted only to reflect the difference, if any, between the fair 
market value of the asset at the time of the sale or exchange and the 
fair market value of the asset when the net value of the disregarded 
entity was last determined. The adjusted net value is taken into account 
for purposes of Sec. 1.752-2(k)(1) as of the allocation date.
    (iv) Allocation Date. For purposes of this paragraph (k), the 
allocation date is the earlier of--
    (A) The first date occurring on or after the date on which the 
requirement to determine the net value of a disregarded entity arises 
under paragraph (k)(2)(ii)(A) or (B) of this section on which the 
partnership otherwise determines a partner's share of partnership 
liabilities under Sec. Sec. 1.705-1(a) and 1.752-4(d); or
    (B) The end of the partnership's taxable year in which the 
requirement to determine the net value of a disregarded entity arises 
under paragraph (k)(2)(ii)(A) or (B) of this section.
    (3) Multiple liabilities. If one or more disregarded entities have 
Sec. 1.752-2(b)(1) payment obligations with respect to one or more 
liabilities of a partnership, the partnership must allocate the net 
value of each disregarded entity among partnership liabilities in a 
reasonable and consistent manner, taking into account the relative 
priorities of those liabilities.
    (4) Reduction in net value of a disregarded entity. For purposes of 
this paragraph (k), the net value of a disregarded entity is determined 
by taking into account a subsequent reduction in the net value of the 
disregarded entity if, at the time the net value of the disregarded 
entity is determined, it is anticipated that the net value of the 
disregarded entity will subsequently be reduced and the reduction is 
part of a plan that has as one of its principal purposes creating the 
appearance that a partner bears the economic risk of loss for a 
partnership liability.
    (5) Information to be provided by the owner of a disregarded entity. 
A partner that may be treated as bearing the economic risk of loss for a 
partnership liability based upon a Sec. 1.752-2(b)(1) payment 
obligation of a disregarded entity must provide information to the 
partnership as to the entity's tax classification and the net value of 
the disregarded entity that is appropriately allocable to the 
partnership's liabilities on a timely basis.
    (6) Examples. The following examples illustrate the rules of this 
paragraph (k):

    Example 1. Disregarded entity with net value of zero. (i) In 2007, A 
forms a wholly owned domestic limited liability company, LLC, with a 
contribution of $100,000. A has no liability for LLC's debts, and LLC 
has no enforceable right to contribution from A. Under Sec. 301.7701-
3(b)(1)(ii) of this chapter, LLC is a disregarded entity. Also in 2007, 
LLC contributes $100,000 to LP, a limited partnership with a calendar 
year taxable year, in exchange for a general partnership interest in LP, 
and B and C each contributes $100,000 to LP in exchange for a limited 
partnership interest in LP. The partnership agreement provides that only 
LLC is required to make up any deficit in its capital account. On 
January 1, 2008, LP borrows $300,000 from a bank and uses $600,000 to 
purchase nondepreciable property. The $300,000 debt is secured by the 
property and is also a general obligation of LP. LP makes payments of 
only interest on its $300,000 debt during 2008. LP has a net taxable 
loss in 2008, and under Sec. Sec. 1.705-1(a) and 1.752-4(d), LP 
determines its partners' shares of the $300,000 debt at the end of its 
taxable year, December 31, 2008. As of that date, LLC holds no assets 
other than its interest in LP.

[[Page 665]]

    (ii) Because LLC is a disregarded entity, A is treated as the 
partner in LP for Federal tax purposes. Only LLC has an obligation to 
make a payment on account of the $300,000 debt if LP were to 
constructively liquidate as described in paragraph (b)(1) of this 
section. Therefore, under this paragraph (k), A is treated as bearing 
the economic risk of loss for LP's $300,000 debt only to the extent of 
LLC's net value. Because that net value is $0 on December 31, 2008, when 
LP determines its partners' shares of its $300,000 debt, A is not 
treated as bearing the economic risk of loss for any portion of LP's 
$300,000 debt. As a result, LP's $300,000 debt is characterized as 
nonrecourse under Sec. 1.752-1(a) and is allocated as required by Sec. 
1.752-3.
    Example 2. Disregarded entity with positive net value. (i) The facts 
are the same as in Example 1 except that on January 1, 2009, A 
contributes $250,000 to LLC. On January 5, 2009, LLC borrows $100,000 
and LLC shortly thereafter uses the $350,000 to purchase unimproved 
land. LP makes payments of only interest on its $300,000 debt during 
2009. As of December 31, 2009, LLC holds its interest in LP and the 
land, the value of which has declined to $275,000. LP has a net taxable 
loss in 2009, and under Sec. Sec. 1.705-1(a) and 1.752-4(d), LP 
determines its partners' shares of the $300,000 debt at the end of its 
taxable year, December 31, 2009.
    (ii) A's contribution of $250,000 to LLC on January 1, 2009, 
constitutes a more than de minimis contribution of property to LLC under 
paragraph (k)(2)(iii)(A) of this section and the debt incurred by LLC on 
January 5, 2009, is a valuation event under paragraph (k)(2)(iii)(D) of 
this section. Accordingly, under paragraph (k)(2)(ii) of this section, 
LLC's value must be redetermined as of the end of the partnership's 
taxable year. At that time LLC's net value is $175,000 ($275,000 land--
$100,000 debt). Accordingly, $175,000 of LP's $300,000 debt will be 
recharacterized as recourse under Sec. 1.752-1(a) and allocated to A 
under this section, and the remaining $125,000 of LP's $300,000 debt 
will remain characterized as nonrecourse under Sec. 1.752-1(a) and is 
allocated as required by Sec. 1.752-3.
    Example 3. Multiple partnership liabilities. (i) The facts are the 
same as in Example 2 except that on January 1, 2010, A forms another 
wholly owned domestic limited liability company, LLC2, with a 
contribution of $120,000. Shortly thereafter, LLC2 uses the $120,000 to 
purchase stock in X corporation. A has no liability for LLC2's debts, 
and LLC2 has no enforceable right to contribution from A. Under Sec. 
301.7701-3(b)(1)(ii) of this chapter, LLC2 is a disregarded entity. On 
July 1, 2010, LP borrows $100,000 from a bank and uses the $100,000 to 
purchase nondepreciable property. The $100,000 debt is secured by the 
property and is also a general obligation of LP. The $100,000 debt is 
senior in priority to LP's existing $300,000 debt. Also, on July 1, 
2010, LLC2 agrees to guarantee both LP's $100,000 and $300,000 debts. LP 
makes payments of only interest on both its $100,000 and $300,000 debts 
during 2010. LP has a net taxable loss in 2010 and, under Sec. Sec. 
1.705-1(a) and 1.752-4(d), must determine its partners' shares of its 
$100,000 and $300,000 debts at the end of its taxable year, December 31, 
2010. As of that date, LLC holds its interest in LP and the land, and 
LLC2 holds the X corporation stock which has appreciated in value to 
$140,000.
    (ii) Both LLC and LLC2 have obligations to make a payment on account 
of LP's debts if LP were to constructively liquidate as described in 
paragraph (b)(1) of this section. Therefore, under paragraph (k)(1) of 
this section, A is treated as bearing the economic risk of loss for LP's 
$100,000 and $300,000 debts only to the extent of the net values of LLC 
and LLC2, as allocated among those debts in a reasonable and consistent 
manner pursuant to paragraph (k)(3) of this section.
    (iii) No events have occurred that would allow a valuation of LLC 
under paragraph (k)(2)(iii) of this section. Therefore, LLC's net value 
remains $175,000. LLC2's net value as of December 31, 2010, when LP 
determines its partners' shares of its liabilities, is $140,000. Under 
paragraph (k)(3) of this section, LP must allocate the net values of LLC 
and LLC2 between its $100,000 and $300,000 debts in a reasonable and 
consistent manner. Because the $100,000 debt is senior in priority to 
the $300,000 debt, LP first allocates the net values of LLC and LLC2, 
pro rata, to its $100,000 debt. Thus, LP allocates $56,000 of LLC's net 
value and $44,000 of LLC2's net value to its $100,000 debt, and A is 
treated as bearing the economic risk of loss for all of LP's $100,000 
debt. As a result, all of LP's $100,000 debt is characterized as 
recourse under Sec. 1.752-1(a) and is allocated to A under this 
section. LP then allocates the remaining $119,000 of LLC's net value and 
LLC2's $96,000 net value to its $300,000 debt, and A is treated as 
bearing the economic risk of loss for a total of $215,000 of the 
$300,000 debt. As a result, $215,000 of LP's $300,000 debt is 
characterized as recourse under Sec. 1.752-1(a) and is allocated to A 
under this section, and the remaining $85,000 of LP's $300,000 debt is 
characterized as nonrecourse under Sec. 1.752-1(a) and is allocated as 
required by Sec. 1.752-3. This example illustrates one reasonable 
method of allocating net values of disregarded entities among multiple 
partnership liabilities.
    Example 4. Disregarded entity with interests in two partnerships. 
(i) In 2007, B forms a wholly owned domestic limited liability company, 
LLC, with a contribution of $175,000. B has no liability for LLC's debts 
and LLC has no enforceable right to contribution from B. Under Sec. 
301.7701-3(b)(1)(ii) of this chapter, LLC is a disregarded entity. LLC 
contributes $50,000 to LP1 in exchange for a general partnership 
interest in LP1,

[[Page 666]]

and $25,000 to LP2 in exchange for a general partnership interest in 
LP2. LLC retains the $100,000 in cash. Both LP1 and LP2 have taxable 
years than end on December 31 and, under both LP1's and LP2's 
partnership agreements, only LLC is required to make up any deficit in 
its capital account. During 2007, LP1 and LP2 incur partnership 
liabilities that are general obligations of the partnership. LP1 borrows 
$300,000 (Debt 1), and LP2 borrows $60,000 (Debt 2) and $40,000 (Debt 
3). Debt 2 is senior in priority to Debt 3. LP1 and LP2 make payments of 
only interest on Debts 1, 2, and 3 during 2007. As of the end of taxable 
year 2007, LP1 and LP2 each have a net taxable loss and must determine 
its partners' shares of partnership liabilities under Sec. Sec. 1.705-
1(a) and 1.752-4(d) as of December 31, 2007. As of that date, LLC's 
interest in LP1 has a fair market value of $45,000, and LLC's interest 
in LP2 has a fair market value of $15,000.
    (ii) Because LLC is a disregarded entity, B is treated as the 
partner in LP1 and LP2 for federal tax purposes. Only LLC has an 
obligation to make a payment on account of Debts 1, 2, and 3 if LP1 and 
LP2 were to constructively liquidate as described in paragraph (b)(1) of 
this section. Therefore, under this paragraph (k), B is treated as 
bearing the economic risk of loss for LP1's and LP2's liabilities only 
to the extent of LLC's net value as of the allocation date, December 31, 
2007.
    (iii) LLC's net value with respect to LP1 is $115,000 ($100,000 cash 
+ $15,000 interest in LP2). Therefore, under paragraph (k)(1) of this 
section, B is treated as bearing the economic risk of loss for $115,000 
of Debt 1. Accordingly, $115,000 of LP1's $300,000 debt is characterized 
as recourse under Sec. 1.752-1(a) and is allocated to B under this 
section. The balance of Debt 1 ($185,000) is characterized as 
nonrecourse under Sec. 1.752-1(a) and is allocated as required by Sec. 
1.752-3.
    (iv) LLC's net value with respect to LP2 is $145,000 ($100,000 cash 
+ $45,000 interest in LP1). Therefore, under paragraph (k)(1) of this 
section, B is treated as bearing the economic risk of loss with respect 
to Debts 2 and 3 only to the extent of $145,000. Because Debt 2 is 
senior in priority to Debt 3, LP2 first allocates $60,000 of LLC's net 
value to Debt 2. LP2 then allocates $40,000 of LLC's net value to Debt 
3. As a result, both Debts 2 and 3 are characterized as recourse under 
Sec. 1.752-1(a) and allocated to B. This example illustrates one 
reasonable method of allocating the net value of a disregarded entity 
among multiple partnership liabilities.
    (l) Effective dates. Paragraph (a), the last sentence of paragraph 
(b)(6), and paragraphs (h)(3) and (k) of this section apply to 
liabilities incurred or assumed by a partnership on or after October 11, 
2006, other than liabilities incurred or assumed by a partnership 
pursuant to a written binding contract in effect prior to that date. The 
rules applicable to liabilities incurred or assumed (or subject to a 
binding contract in effect) prior to October 11, 2006 are contained in 
Sec. 1.752-2 in effect prior to October 11, 2006, (see 26 CFR part 1 
revised as of April 1, 2006).

[T.D. 8380, 56 FR 66351, Dec. 23, 1991; 57 FR 4913, Feb. 10, 1992; 57 FR 
5054, Feb. 12, 1992; 57 FR 5511, Feb. 14, 1992; T.D. 9289, 71 FR 59672, 
Oct. 11, 2006]



Sec. 1.752-3  Partner's share of nonrecourse liabilities.

    (a) In general. A partner's share of the nonrecourse liabilities of 
a partnership equals the sum of paragraphs (a)(1) through (a)(3) of this 
section as follows--
    (1) The partner's share of partnership minimum gain determined in 
accordance with the rules of section 704(b) and the regulations 
thereunder;
    (2) The amount of any taxable gain that would be allocated to the 
partner under section 704(c) (or in the same manner as section 704(c) in 
connection with a revaluation of partnership property) if the 
partnership disposed of (in a taxable transaction) all partnership 
property subject to one or more nonrecourse liabilities of the 
partnership in full satisfaction of the liabilities and for no other 
consideration; and
    (3) The partner's share of the excess nonrecourse liabilities (those 
not allocated under paragraphs (a)(1) and (a)(2) of this section) of the 
partnership as determined in accordance with the partner's share of 
partnership profits. The partner's interest in partnership profits is 
determined by taking into account all facts and circumstances relating 
to the economic arrangement of the partners. The partnership agreement 
may specify the partners' interests in partnership profits for purposes 
of allocating excess nonrecourse liabilities provided the interests so 
specified are reasonably consistent with allocations (that have 
substantial economic effect under the section 704(b) regulations) of 
some other significant item of partnership income or gain. 
Alternatively, excess nonrecourse liabilities may be allocated among the 
partners in accordance with the manner in

[[Page 667]]

which it is reasonably expected that the deductions attributable to 
those nonrecourse liabilities will be allocated. Additionally, the 
partnership may first allocate an excess nonrecourse liability to a 
partner up to the amount of built-in gain that is allocable to the 
partner on section 704(c) property (as defined under Sec. 1.704-
3(a)(3)(ii)) or property for which reverse section 704(c) allocations 
are applicable (as described in Sec. 1.704-3(a)(6)(i)) where such 
property is subject to the nonrecourse liability to the extent that such 
built-in gain exceeds the gain described in paragraph (a)(2) of this 
section with respect to such property. This additional method does not 
apply for purposes of Sec. 1.707-5(a)(2)(ii). To the extent that a 
partnership uses this additional method and the entire amount of the 
excess nonrecourse liability is not allocated to the contributing 
partner, the partnership must allocate the remaining amount of the 
excess nonrecourse liability under one of the other methods in this 
paragraph (a)(3). Excess nonrecourse liabilities are not required to be 
allocated under the same method each year.
    (b) Allocation of a single nonrecourse liability among multiple 
properties--(1) In general. For purposes of determining the amount of 
taxable gain under paragraph (a)(2) of this section, if a partnership 
holds multiple properties subject to a single nonrecourse liability, the 
partnership may allocate the liability among the multiple properties 
under any reasonable method. A method is not reasonable if it allocates 
to any item of property an amount of the liability that, when combined 
with any other liabilities allocated to the property, is in excess of 
the fair market value of the property at the time the liability is 
incurred. The portion of the nonrecourse liability allocated to each 
item of partnership property is then treated as a separate loan under 
paragraph (a)(2) of this section. In general, a partnership may not 
change the method of allocating a single nonrecourse liability under 
this paragraph (b) while any portion of the liability is outstanding. 
However, if one or more of the multiple properties subject to the 
liability is no longer subject to the liability, the portion of the 
liability allocated to that property must be reallocated among the 
properties still subject to the liability so that the amount of the 
liability allocated to any property does not exceed the fair market 
value of such property at the time of reallocation.
    (2) Reductions in principal. For purposes of this paragraph (b), 
when the outstanding principal of a partnership liability is reduced, 
the reduction of outstanding principal is allocated among the multiple 
properties in the same proportion that the partnership liability 
originally was allocated to the properties under paragraph (b)(1) of 
this section.
    (c) Examples. The following examples illustrate the principles of 
this section:

    Example 1. Partner's share of nonrecourse liabilities. The AB 
partnership purchases depreciable property for a $1,000 purchase money 
note that is nonrecourse liability under the rules of this section. 
Assume that this is the only nonrecourse liability of the partnership, 
and that no principal payments are due on the purchase money note for a 
year. The partnership agreement provides that all items of income, gain, 
loss, and deduction are allocated equally. Immediately after purchasing 
the depreciable property, the partners share the nonrecourse liability 
equally because they have equal interests in partnership profits. A and 
B are each treated as if they contributed $500 to the partnership to 
reflect each partner's increase in his or her share of partnership 
liabilities (from $0 to $500). The minimum gain with respect to an item 
of partnership property subject to a nonrecourse liability equals the 
amount of gain that would be recognized if the partnership disposed of 
the property in full satisfaction of the nonrecourse liability and for 
no other consideration. Therefore, if the partnership claims a 
depreciation deduction of $200 for the depreciable property for the year 
it acquires that property, partnership minimum gain for the year will 
increase by $200 (the excess of the $1,000 nonrecourse liability over 
the $800 adjusted tax basis of the property). See section 704(b) and the 
regulations thereunder. A and B each have a $100 share of partnership 
minimum gain at the end of that year because the depreciation deduction 
is treated as a nonrecourse deduction. See section 704(b) and the 
regulation thereunder. Accordingly, at the end of that year, A and B are 
allocated $100 each of the nonrecourse liability to match their shares 
of partnership minimum gain. The remaining $800 of the nonrecourse 
liability will be allocated equally between A and B ($400 each).

[[Page 668]]

    Example 2. Excess nonrecourse liabilities allocated consistently 
with reasonably expected deductions. The facts are the same as in 
Example 1 except that the partnership agreement provides that 
depreciation deductions will be allocated to A. The partners agree to 
allocate excess nonrecourse liabilities in accordance with the manner in 
which it is reasonably expected that the deductions attributable to 
those nonrecourse liabilities will be allocated. Assuming that the 
allocation of all of the depreciation deductions to A is valid under 
section 704(b), immediately after purchasing the depreciable property, 
A's share of the nonrecourse liability is $1,000. Accordingly, A is 
treated as if A contributed $1,000 to the partnership.
    Example 3. Allocation of liability among multiple properties. (i) A 
and B are equal partners in a partnership (PRS). A contributes $70 of 
cash in exchange for a 50-percent interest in PRS. B contributes two 
items of property, X and Y, in exchange for a 50-percent interest in 
PRS. Property X has a fair market value (and book value) of $70 and an 
adjusted basis of $40, and is subject to a nonrecourse liability of $50. 
Property Y has a fair market value (and book value) of $120, an adjusted 
basis of $40, and is subject to a nonrecourse liability of $70. 
Immediately after the initial contributions, PRS refinances the two 
separate liabilities with a single $120 nonrecourse liability. All of 
the built-in gain attributable to Property X ($30) and Property Y ($80) 
is section 704(c) gain allocable to B.
    (ii) The amount of the nonrecourse liability ($120) is less than the 
total book value of all of the properties that are subject to such 
liability ($70 + $120 = $190), so there is no partnership minimum gain. 
Sec. 1.704-2(d). Accordingly, no portion of the liability is allocated 
pursuant to paragraph (a)(1) of this section.
    (iii) Pursuant to paragraph (b)(1) of this section, PRS decides to 
allocate the nonrecourse liability evenly between the Properties X and 
Y. Accordingly, each of Properties X and Y are treated as being subject 
to a separate $60 nonrecourse liability for purposes of applying 
paragraph (a)(2) of this section. Under paragraph (a)(2) of this 
section, B will be allocated $20 of the liability for each of Properties 
X and Y (in each case, $60 liability minus $40 adjusted basis). As a 
result, a portion of the liability is allocated pursuant to paragraph 
(a)(2) of this section as follows:

------------------------------------------------------------------------
             Partner                     Property        Tier 1   Tier 2
------------------------------------------------------------------------
A................................  X..................       $0       $0
                                   Y..................        0        0
B................................  X..................        0       20
                                   Y..................        0       20
------------------------------------------------------------------------

    (iv) PRS has $80 of excess nonrecourse liability that it may 
allocate in any manner consistent with paragraph (a)(3) of this section. 
PRS determines to allocate the $80 of excess nonrecourse liabilities to 
the partners up to their share of the remaining section 704(c) gain on 
the properties, with any remaining amount of liabilities being allocated 
equally to A and B consistent with their equal interests in partnership 
profits. B has $70 of remaining section 704(c) gain ($10 on Property X 
and $60 on Property Y), and thus will be allocated $70 of the liability 
in accordance with this gain.
    The remaining $10 is divided equally between A and B. Accordingly, 
the overall allocation of the $120 nonrecourse liability is as follows:

------------------------------------------------------------------------
               Partner                 Tier 1   Tier 2   Tier 3   Total
------------------------------------------------------------------------
A...................................       $0       $0       $5       $5
B...................................        0       40       75      115
------------------------------------------------------------------------


[T.D. 8380, 56 FR 66355, Dec. 23, 1991, as amended by T.D. 8906, 65 FR 
64890, Oct. 31, 2000]



Sec. 1.752-4  Special rules.

    (a) Tiered partnerships. An upper-tier partnership's share of the 
liabilities of a lower-tier partnership (other than any liability of the 
lower-tier partnership that is owed to the upper-tier partnership) is 
treated as a liability of the upper-tier partnership for purposes of 
applying section 752 and the regulations thereunder to the partners of 
the upper-tier partnership.
    (b) Related person definition--(1) In general. A person is related 
to a partner if the person and the partner bear a relationship to each 
other that is specified in section 267(b) or 707(b)(1), subject to the 
following modifications:
    (i) Substitute ``80 percent or more'' for ``more than 50 percent'' 
each place it appears in those sections;
    (ii) A person's family is determined by excluding brothers and 
sisters; and
    (iii) Disregard sections 267(e)(1) and 267(f)(1)(A).
    (2) Person related to more than one partner--(i) In general. If, in 
applying the related person rules in paragraph (b)(1) of this section, a 
person is related to more than one partner, paragraph (b)(1) of this 
section is applied by treating the person as related only to the partner 
with whom there is the highest percentage of related ownership. If two 
or more partners have the same percentage of related ownership and no 
other partner has a greater percentage, the liability is allocated 
equally among

[[Page 669]]

the partners having the equal percentages of related ownership.
    (ii) Natural persons. For purposes of determining the percentage of 
related ownership between a person and a partner, natural persons who 
are related by virtue of being members of the same family are treated as 
having a percentage relationship of 100 percent with respect to each 
other.
    (iii) Related partner exception. Notwithstanding paragraph (b)(1) of 
this section (which defines related person), persons owning interests 
directly or indirectly in the same partnership are not treated as 
related persons for purposes of determining the economic risk of loss 
borne by each of them for the liabilities of the partnership. This 
paragraph (iii) does not apply when determining a partner's interest 
under the de minimis rules in Sec. Sec. 1.752-2 (d) and (e).
    (iv) Special rule where entity structured to avoid related person 
status--(A) In general. If--
    (1) A partnership liability is owed to or guaranteed by another 
entity that is a partnership, an S corporation, a C corporation, or a 
trust;
    (2) A partner or related person owns (directly or indirectly) a 20 
percent or more ownership interest in the other entity; and
    (3) A principal purpose of having the other entity act as a lender 
or guarantor of the liability was to avoid the determination that the 
partner that owns the interest bears the economic risk of loss for 
federal income tax purposes for all or part of the liability;

then the partner is treated as holding the other entity's interest as a 
creditor or guarantor to the extent of the partner's or related person's 
ownership interest in the entity.
    (B) Ownership interest. For purposes of paragraph (b)(2)(iv)(A) of 
this section, a person's ownership interest in:
    (1) A partnership equals the partner's highest percentage interest 
in any item of partnership loss or deduction for any taxable year;
    (2) An S corporation equals the percentage of the outstanding stock 
in the S corporation owned by the shareholder;
    (3) A C corporation equals the percentage of the fair market value 
of the issued and outstanding stock owned by the shareholder; and
    (4) A trust equals the percentage of the actuarial interests owned 
by the beneficial owner of the trust.
    (C) Example. Entity structured to avoid related person status. A, B, 
and C form a general partnership, ABC. A, B, and C are equal partners, 
each contributing $1,000 to the partnership. A and B want to loan money 
to ABC and have the loan treated as nonrecourse for purposes of section 
752. A and B form partnership AB to which each contributes $50,000. A 
and B share losses equally in partnership AB. Partnership AB loans 
partnership ABC $100,000 on a nonrecourse basis secured by the property 
ABC buys with the loan. Under these facts and circumstances, A and B 
bear the economic risk of loss with respect to the partnership liability 
equally based on their percentage interest in losses of partnership AB.
    (c) Limitation. The amount of an indebtedness is taken into account 
only once, even though a partner (in addition to the partner's liability 
for the indebtedness as a partner) may be separately liable therefor in 
a capacity other than as a partner.
    (d) Time of determination. A partner's share of partnership 
liabilities must be determined whenever the determination is necessary 
in order to determine the tax liability of the partner or any other 
person. See Sec. 1.705-1(a) for rules regarding when the adjusted basis 
of a partner's interest in the partnership must be determined.

[T.D. 8380, 56 FR 66356, Dec. 23, 1991]



Sec. 1.752-5  Effective dates and transition rules.

    (a) In general. Except as otherwise provided in Sec. Sec. 1.752-1 
through 1.752-4, unless a partnership makes an election under paragraph 
(b)(1) of this section to apply the provisions of Sec. Sec. 1.752-1 
through 1.752-4 earlier, Sec. Sec. 1.752-1 through 1.752-4 apply to any 
liability incurred or assumed by a partnership on or after December 28, 
1991, other than a liability incurred or assumed by the partnership 
pursuant to a written binding contract in effect prior to December 28, 
1991 and at all times thereafter. However, Sec. 1.752-3(a)(3) fifth, 
sixth, and seventh sentences, (b), and

[[Page 670]]

(c) Example 3, do not apply to any liability incurred or assumed by a 
partnership prior to October 31, 2000. Nevertheless, Sec. 1.752-3(a)(3) 
fifth, sixth, and seventh sentences, (b), and (c) Example 3, may be 
relied upon for any liability incurred or assumed by a partnership prior 
to October 31, 2000 for taxable years ending on or after October 31, 
2000. In addition, Sec. 1.752-1(f) last sentence and (g) Example 2, do 
not apply to any liability incurred or assumed by a partnership prior to 
January 4, 2001. Nevertheless, Sec. 1.752-1(f) last sentence and (g) 
Example 2, may be relied on for any liability incurred or assumed by a 
partnership prior to January 4, 2001 and, unless the partnership makes 
an election under paragraph (b)(1) of this section, on or after December 
28, 1991, other than a liability incurred or assumed by the partnership 
pursuant to a written binding contract in effect prior to December 28, 
1991 and at all times thereafter. For liabilities incurred or assumed by 
a partnership prior to December 28, 1991 (or pursuant to a written 
binding contract in effect prior to December 28, 1991 and at all times 
thereafter), unless an election to apply these regulations has been 
made, see Sec. Sec. 1.752-0T to 1.752-4T, set forth in 26 CFR 1.752-0T 
through 1.752-4T as contained in 26 CFR edition revised April 1, 1991, 
(TD 8237, TD 8274, and TD 8355) and Sec. 1.752-1, set forth in 26 CFR 
1.752-1 as contained in 26 CFR edition revised April 1, 1988 (TD 6175 
and TD 6500).
    (b) Election--(1) In general. A partnership may elect to apply the 
provisions of Sec. Sec. 1.752-1 through 1.752-4 to all of its 
liabilities to which the provisions of those sections do not otherwise 
apply as of the beginning of the first taxable year of the partnership 
ending on or after December 28, 1991.
    (2) Time and manner of election. An election under this paragraph 
(b) is made by attaching a written statement to the partnership return 
for the first taxable year of the partnership ending on or after 
December 28, 1991. The written statement must include the name, address, 
and taxpayer identification number of the partnership making the 
statement and contain a declaration that an election is being made under 
this paragraph (b).
    (c) Effect of section 708(b)(1)(B) termination on determining date 
liabilities are incurred or assumed. For purposes of applying this 
section, a termination of the partnership under section 708(b)(1)(B) 
will not cause partnership liabilities incurred or assumed prior to the 
termination to be treated as incurred or assumed on the date of the 
termination.

[T.D. 8380, 56 FR 66356, Dec. 23, 1991, as amended by T.D. 8906, 65 FR 
64890, Oct. 31, 2000; T.D. 8925, 66 FR 723, Jan. 4, 2001; T.D. 9207, 70 
FR 30343, May 26, 2005]



Sec. 1.752-6  Partnership assumption of partner's section 358(h)(3)
liability after October 18, 1999, and before June 24, 2003.

    (a) In general. If, in a transaction described in section 721(a), a 
partnership assumes a liability (defined in section 358(h)(3)) of a 
partner (other than a liability to which section 752(a) and (b) apply), 
then, after application of section 752(a) and (b), the partner's basis 
in the partnership is reduced (but not below the adjusted value of such 
interest) by the amount (determined as of the date of the exchange) of 
the liability. For purposes of this section, the adjusted value of a 
partner's interest in a partnership is the fair market value of that 
interest increased by the partner's share of partnership liabilities 
under Sec. Sec. 1.752-1 through 1.752-5.
    (b) Exceptions--(1) In general. Except as provided in paragraph 
(b)(2) of this section, the exceptions contained in section 358(h)(2)(A) 
and (B) apply to this section.
    (2) Transactions described in Notice 2000-44. The exception 
contained in section 358(h)(2)(B) does not apply to an assumption of a 
liability (defined in section 358(h)(3)) by a partnership as part of a 
transaction described in, or a transaction that is substantially similar 
to the transactions described in, Notice 2000-44 (2000-2 C.B. 255). See 
Sec. 601.601(d)(2) of this chapter.
    (c) Example. The following example illustrates the principles of 
paragraph (a) of this section:

    Example. In 1999, A and B form partnership PRS. A contributes 
property with a value and basis of $200, subject to a nonrecourse debt 
obligation of $50 and a fixed or contingent obligation of $100 that is 
not a liability

[[Page 671]]

to which section 752(a) and (b) applies, in exchange for a 50% interest 
in PRS. Assume that, after the contribution, A's share of partnership 
liabilities under Sec. Sec. 1.752-1 through 1.752-5 is $25. Also assume 
that the $100 liability is not associated with a trade or business 
contributed by A to PRS or with assets contributed by A to PRS. After 
the contribution, A's basis in PRS is $175 (A's basis in the contributed 
land ($200) reduced by the nonrecourse debt assumed by PRS ($50), 
increased by A's share of partnership liabilities under Sec. Sec. 
1.752-1 through 1.752-5 ($25)). Because A's basis in the PRS interest is 
greater than the adjusted value of A's interest, $75 (the fair market 
value of A's interest ($50) increased by A's share of partnership 
liabilities ($25)), paragraph (a) of this section operates to reduce A's 
basis in the PRS interest (but not below the adjusted value of that 
interest) by the amount of liabilities described in section 358(h)(3) 
(other than liabilities to which section 752(a) and (b) apply) assumed 
by PRS. Therefore, A's basis in PRS is reduced to $75.

    (d) Effective date--(1) In general. This section applies to 
assumptions of liabilities occurring after October 18, 1999, and before 
June 24, 2003.
    (2) Election to apply Sec. 1.752-7. The partnership may elect, 
under Sec. 1.752-7(k)(2), to apply the provisions referenced in Sec. 
1.752-7(k)(2)(ii) to all assumptions of liabilities by the partnership 
occurring after October 18, 1999, and before June 24, 2003. Section 
1.752-7(k)(2) describes the manner in which the election is made.

[T.D. 9207, 70 FR 30343, May 26, 2005]



Sec. 1.752-7  Partnership assumption of partner's Sec. 1.752-7
liability on or after June 24, 2003.

    (a) Purpose and structure. The purpose of this section is to prevent 
the acceleration or duplication of loss through the assumption of 
obligations not described in Sec. 1.752-1(a)(4)(i) in transactions 
involving partnerships. Under paragraph (c) of this section, any such 
obligation that is assumed by a partnership from a partner in a 
transaction governed by section 721(a) is treated as section 704(c) 
property. Paragraphs (e), (f), and (g) of this section provide rules for 
situations where a partnership assumes such an obligation from a partner 
and, subsequently, that partner transfers all or part of the partnership 
interest, that partner receives a distribution in liquidation of the 
partnership interest, or another partner assumes part or all of that 
obligation from the partnership. These rules prevent the duplication of 
loss by prohibiting the partnership and any person other than the 
partner from whom the obligation was assumed from claiming a deduction, 
loss, or capital expense to the extent of the built-in loss associated 
with the obligation. These rules also prevent the acceleration of loss 
by deferring the partner's deduction or loss attributable to the 
obligation (if any) until the satisfaction of the Sec. 1.752-7 
liability (within the meaning of paragraph (b)(8) of this section). 
Paragraph (d) of this section provides a number of exceptions to 
paragraphs (e), (f), and (g) of this section, including a de minimis 
exception. Paragraph (i) provides a special rule for situations in which 
an amount paid to satisfy a Sec. 1.752-7 liability is capitalized into 
other partnership property. Paragraph (j) of this section provides 
special rules for tiered partnership transactions.
    (b) Definitions. For purposes of this section, the following 
definitions apply:
    (1) Assumption. The principles of Sec. 1.752-1(d) and (e) apply in 
determining if a Sec. 1.752-7 liability has been assumed.
    (2) Adjusted value. The adjusted value of a partner's interest in a 
partnership is the fair market value of that interest increased by the 
partner's share of partnership liabilities under Sec. Sec. 1.752-1 
through 1.752-5.
    (3) Sec. 1.752-7 liability--(i) In general. A Sec. 1.752-7 
liability is an obligation described in Sec. 1.752-1(a)(4)(ii) to the 
extent that either--
    (A) The obligation is not described in Sec. 1.752-1(a)(4)(i); or
    (B) The amount of the obligation (under paragraph (b)(3)(ii) of this 
section) exceeds the amount taken into account under Sec. 1.752-
1(a)(4)(i).
    (ii) Amount and share of Sec. 1.752-7 liability. The amount of a 
Sec. 1.752-7 liability (or, for purposes of paragraph (b)(3)(i) of this 
section, the amount of an obligation) is the amount of cash that a 
willing assignor would pay to a willing assignee to assume the Sec. 
1.752-7 liability in an arm's-length transaction. If the obligation 
arose under a contract in exchange for rights granted to the obligor 
under that contract, and those

[[Page 672]]

contractual rights are contributed to the partnership in connection with 
the partnership's assumption of the contractual obligation, then the 
amount of the Sec. 1.752-7 liability or obligation is the amount of 
cash, if any, that a willing assignor would pay to a willing assignee to 
assume the entire contract. A partner's share of a partnership's Sec. 
1.752-7 liability is the amount of deduction that would be allocated to 
the partner with respect to the Sec. 1.752-7 liability if the 
partnership disposed of all of its assets, satisfied all of its 
liabilities (other than Sec. 1.752-7 liabilities), and paid an 
unrelated person to assume all of its Sec. 1.752-7 liabilities in a 
fully taxable arm's-length transaction (assuming such payment would give 
rise to an immediate deduction to the partnership).
    (iii) Example. In 2005, A, B, and C form partnership PRS. A 
contributes $10,000,000 in exchange for a 25% interest in PRS and PRS's 
assumption of a debt obligation. The debt obligation was issued for cash 
and the issue price was equal to the stated redemption price at maturity 
($5,000,000). The debt obligation bears interest, payable quarterly, at 
a fixed rate of interest, which was a market rate of interest when the 
debt obligation was issued. At the time of the assumption, all accrued 
interest has been paid. Prior to the partnership assuming the 
obligation, interest rates decrease, resulting in the debt obligation 
bearing an above-market interest rate. Assume that, as a result of the 
decline in interest rates, A would have had to pay a willing assignee 
$6,000,000 to assume the debt obligation. The assumption of the debt 
obligation by PRS from A is treated as an assumption of a Sec. 1.752-
1(a)(4)(i) liability in the amount of $5,000,000 (the portion of the 
total amount of the debt obligation that has created basis in A's 
assets, that is, the $5,000,000 that was issued in exchange for the debt 
obligation) and an assumption of a Sec. 1.752-7 liability in the amount 
of $1,000,000 (the difference between the total obligation, $6,000,000, 
and the Sec. 1.752-1(a)(4)(i)liability, $5,000,000).
    (4) Sec. 1.752-7 liability transfer--(i) In general. Except as 
provided in paragraph (b)(4)(ii) of this section, a Sec. 1.752-7 
liability transfer is any assumption of a Sec. 1.752-7 liability by a 
partnership from a partner in a transaction governed by section 721(a).
    (ii) Terminations under section 708(b)(1)(B). In determining if a 
deemed contribution of assets and assumption of liability as a result of 
a technical termination is treated as a Sec. 1.752-7 liability 
transfer, only Sec. 1.752-7 liabilities that were assumed by the 
terminating partnership as part of an earlier Sec. 1.752-7 liability 
transfer are taken into account and, then, only to the extent of the 
remaining built-in loss associated with that Sec. 1.752-7 liability.
    (5) Sec. 1.752-7 liability partner--(i) In general. A Sec. 1.752-7 
liability partner is a partner from whom a partnership assumes a Sec. 
1.752-7 liability as part of a Sec. 1.752-7 liability transfer or any 
person who acquires a partnership interest from the Sec. 1.752-7 
liability partner in a transaction to which paragraph (e)(3) of this 
section applies.
    (ii) Tiered partnerships--(A) Assumption by a lower-tier 
partnership. If, in a Sec. 1.752-7 liability transfer, a partnership 
(lower-tier partnership) assumes a Sec. 1.752-7 liability from another 
partnership (upper-tier partnership), then both the upper-tier 
partnership and the partners of the upper-tier partnership are Sec. 
1.752-7 liability partners. Therefore, paragraphs (e) and (f) of this 
section apply on a sale or liquidation of any partner's interest in the 
upper-tier partnership and on a sale or liquidation of the upper-tier 
partnership's interest in the lower-tier partnership. See paragraph 
(j)(3) of this section. If, in a Sec. 1.752-7 liability transfer, the 
upper-tier partnership assumes a Sec. 1.752-7 liability from a partner, 
and, subsequently, in another Sec. 1.752-7 liability transfer, a lower-
tier partnership assumes that Sec. 1.752-7 liability from the upper-
tier partnership, then the partner from whom the upper-tier partnership 
assumed the Sec. 1.752-7 liability continues to be the Sec. 1.752-7 
liability partner of the lower-tier partnership with respect to the 
remaining built-in loss associated with that Sec. 1.752-7 liability. 
Any new built-in loss associated with the Sec. 1.752-7 liability that 
is created on the assumption of the Sec. 1.752-7 liability from the 
upper-tier partnership by the lower-tier partnership is shared by all

[[Page 673]]

the partners of the upper-tier partnership in accordance with their 
interests in the upper-tier partnership, and each partner of the upper-
tier partnership is treated as a Sec. 1.752-7 liability partner with 
respect to that new built-in loss. See paragraph (e)(3)(ii), Example 3 
of this section.
    (B) Distribution of partnership interest. If, in a transaction 
described in Sec. 1.752-7(e)(3), an interest in a partnership (lower-
tier partnership) that has assumed a Sec. 1.752-7 liability is 
distributed by a partnership (upper-tier partnership) that is the Sec. 
1.752-7 liability partner with respect to that liability, then the 
persons receiving interests in the lower-tier partnership are Sec. 
1.752-7 liability partners with respect to the lower-tier partnership to 
the same extent that they were prior to the distribution.
    (6) Remaining built-in loss associated with a Sec. 1.752-7 
liability. (i) In general. The remaining built-in loss associated with a 
Sec. 1.752-7 liability equals the amount of the Sec. 1.752-7 liability 
as of the time of the assumption of the Sec. 1.752-7 liability by the 
partnership, reduced by the portion of the Sec. 1.752-7 liability 
previously taken into account by the Sec. 1.752-7 liability partner 
under paragraph (j)(3) of this section and adjusted as provided in 
paragraph (c) of this section and Sec. 1.704-3 for--
    (A) Any portion of that built-in loss associated with the Sec. 
1.752-7 liability that is satisfied by the partnership on or prior to 
the testing date (whether capitalized or deducted); and
    (B) Any assumption of all or part of the Sec. 1.752-7 liability by 
the Sec. 1.752-7 liability partner (including any assumption that 
occurs on the testing date).
    (ii) Partial dispositions and assumptions. In the case of a partial 
disposition of the Sec. 1.752-7 liability partner's partnership 
interest or a partial assumption of the Sec. 1.752-7 liability by 
another partner, the remaining built-in loss associated with Sec. 
1.752-7 liability is pro rated based on the portion of the interest sold 
or the portion of the Sec. 1.752-7 liability assumed.
    (7) Sec. 1.752-7 liability reduction--(i) In general. The Sec. 
1.752-7 liability reduction is the amount by which the Sec. 1.752-7 
liability partner is required to reduce the basis in the partner's 
partnership interest by operation of paragraphs (e), (f), and (g) of 
this section. The Sec. 1.752-7 liability reduction is the lesser of--
    (A) The excess of the Sec. 1.752-7 liability partner's basis in the 
partnership interest over the adjusted value of that interest (as 
defined in paragraph (b)(2) of this section); or
    (B) The remaining built-in loss associated with the Sec. 1.752-7 
liability (as defined in paragraph (b)(6) of this section without regard 
to paragraph (b)(6)(ii) of this section).
    (ii) Partial dispositions and assumptions. In the case of a partial 
disposition of the Sec. 1.752-7 liability partner's partnership 
interest or a partial assumption of the Sec. 1.752-7 liability by 
another partner, the Sec. 1.752-7 liability reduction is pro rated 
based on the portion of the interest sold or the portion of the Sec. 
1.752-7 liability assumed.
    (8) Satisfaction of Sec. 1.752-7 liability--In general. A Sec. 
1.752-7 liability is treated as satisfied (in whole or in part) on the 
date on which the partnership (or the assuming partner) would have been 
allowed to take the Sec. 1.752-7 liability into account for federal tax 
purposes but for this section. For example, a Sec. 1.752-7 liability is 
treated as satisfied when, but for this section, the Sec. 1.752-7 
liability would give rise to--
    (i) An increase in the basis of the partnership's or the assuming 
partner's assets (including cash);
    (ii) An immediate deduction to the partnership or to the assuming 
partner;
    (iii) An expense that is not deductible in computing the 
partnership's or the assuming partner's taxable income and not properly 
chargeable to capital account; or
    (iv) An amount realized on the sale or other disposition of property 
subject to that liability if the property was disposed of by the 
partnership or the assuming partner at that time.
    (9) Testing date. The testing date is--
    (i) For purposes of paragraph (e) of this section, the date of the 
sale, exchange, or other disposition of part or all of the Sec. 1.752-7 
liability partner's partnership interest;
    (ii) For purposes of paragraph (f) of this section, the date of the 
partnership's distribution in liquidation of the

[[Page 674]]

Sec. 1.752-7 liability partner's partnership interest; and
    (iii) For purposes of paragraph (g) of this section, the date of the 
assumption (or partial assumption) of the Sec. 1.752-7 liability by a 
partner other than the Sec. 1.752-7 liability partner.
    (10) Trade or business--(i) In general. A trade or business is a 
specific group of activities carried on by a person for the purpose of 
earning income or profit, other than a group of activities consisting of 
acquiring, holding, dealing in, or disposing of financial instruments, 
if the activities included in that group include every operation that 
forms a part of, or a step in, the process of earning income or profit. 
Such group of activities ordinarily includes the collection of income 
and the payment of expenses. The group of activities must constitute the 
carrying on of a trade or business under section 162(a) (determined as 
though the activities were conducted by an individual).
    (ii) Examples. The following examples illustrate the provisions of 
this paragraph (b)(10):

    Example 1. Corporation Y owns, manages, and derives rental income 
from an office building and also owns vacant land that may be subject to 
environmental liabilities. Corporation Y contributes the land subject to 
the environmental liabilities to PRS in a transaction governed by 
section 721(a). PRS plans to develop the land as a landfill. The 
contribution of the vacant land does not constitute the contribution of 
a trade or business because Corporation Y did not conduct any 
significant business or development activities with respect to the land 
prior to the contribution.
    Example 2. For the past 5 years, Corporation X has owned and 
operated gas stations in City A, City B, and City C. Corporation X 
transfers all of the assets associated with the operation of the gas 
station in City A to PRS for interests in PRS and the assumption by PRS 
of the Sec. 1.752-7 liabilities associated with that gas station. PRS 
continues to operate the gas station in City A after the contribution. 
The contribution of the gas station to PRS constitutes the contribution 
of a trade or business.
    Example 3. For the past 7 years, Corporation Z has engaged in the 
manufacture and sale of household products. Throughout this period, 
Corporation Z has maintained a research department for use in connection 
with its manufacturing activities. The research department has 10 
employees actively engaged in the development of new products. 
Corporation Z contributes the research department to PRS in exchange for 
a PRS interest and the assumption by PRS of pension liabilities with 
respect to the employees of the research department. PRS continues the 
research operations on a contractual basis with several businesses, 
including Corporation Z. The contribution of the research operations to 
PRS constitutes a contribution of a trade or business.

    (c) Application of section 704(b) and (c) to assumed Sec. 1.752-7 
liabilities--(1) In general--(i) Section 704(c). Except as otherwise 
provided in this section, sections 704(c)(1)(A) and (B), section 737, 
and the regulations thereunder, apply to Sec. 1.752-7 liabilities. See 
Sec. 1.704-3(a)(12). However, Sec. 1.704-3(a)(7) does not apply to any 
person who acquired a partnership interest from a Sec. 1.752-7 
liability partner in a transaction to which paragraph (e)(1) of this 
section applies.
    (ii) Section 704(b). Section 704(b) and Sec. 1.704-1(b) apply to a 
post-contribution change in the value of a Sec. 1.752-7 liability. If 
there is a decrease in the value of a Sec. 1.752-7 liability that is 
reflected in the capital accounts of the partners under Sec. 1.704-
1(b)(2)(iv)(f), the amount of the decrease constitutes an item of income 
for purposes of section 704(b) and Sec. 1.704-1(b). Conversely, if 
there is an increase in the value of a Sec. 1.752-7 liability that is 
reflected in the capital accounts of the partners under Sec. 1.704-
1(b)(2)(iv)(f), the amount of the increase constitutes an item of loss 
for purposes of section 704(b) and Sec. 1.704-1(b).
    (2) Example. The following example illustrates the provisions of 
this paragraph (c):

    Example. (i) Facts. In 2004, A, B, and C form partnership PRS. A 
contributes Property 1 with a fair market value and basis of $400X, 
subject to a Sec. 1.752-7 liability of $100X, for a 25% interest in 
PRS. B contributes $300X cash for a 25% interest in PRS, and C 
contributes $600X cash for a 50% interest in PRS. Assume that the 
partnership complies with the substantial economic effect safe harbor of 
Sec. 1.704-1(b)(2). Under Sec. 1.704-1(b)(2)(iv)(b), A's capital 
account is credited with $300X (the fair market value of Property 1, 
$400X, less the Sec. 1.752-7 liability assumed by PRS, $100X). In 
accordance with Sec. Sec. 1.752-7(c)(1)(i) and 1.704-3, the partnership 
can use any reasonable method for section 704(c) purposes. In this case, 
the partnership elects the traditional method under Sec. 1.704-3(b) and 
also elects to treat the deductions or losses attributable to the Sec. 
1.752-7 liability as coming first from the built-in loss. In 2005,

[[Page 675]]

PRS earns $200X of income and uses it to satisfy the Sec. 1.752-7 
liability which has increased in value to $200X. Assume that the cost to 
PRS of satisfying the Sec. 1.752-7 liability is deductible by PRS. The 
$200X of partnership income is allocated according to the partnership 
agreement, $50X to A, $50X to B, and $100X to C.
[GRAPHIC] [TIFF OMITTED] TR26MY05.000

    (ii) Analysis. Pursuant to paragraph (c) of this section, $100X of 
the deduction attributable to the satisfaction of the Sec. 1.752-7 
liability is specially allocated to A, the Sec. 1.752-7 liability 
partner, under section 704(c)(1)(A) and Sec. 1.704-3. No book item 
corresponds to this tax allocation. The remaining $100X of deduction 
attributable to the satisfaction of the Sec. 1.752-7 liability is 
allocated, for both book and tax purposes, according to the partnership 
agreement, $25X to A, $25X to B, and $50X to C. If the partnership, 
instead, satisfied the Sec. 1.752-7 liability over a number of years, 
the first $100X of deduction with respect to the Sec. 1.752-7 liability 
would be allocated to A, the Sec. 1.752-7 liability partner, before any 
deduction with respect to the Sec. 1.752-7 liability would be allocated 
to the other partners. For example, if PRS were to satisfy $50X of the 
Sec. 1.752-7 liability, the $50X deduction with respect to the Sec. 
1.752-7 liability would be allocated to A for tax purposes only. No 
deduction would arise for book purposes. If PRS later paid a further 
$100X in satisfaction of the Sec. 1.752-7 liability, $50X of the 
deduction with respect to the Sec. 1.752-7 liability would be 
allocated, solely for tax purposes, to A and the remaining $50X would be 
allocated, for both book and tax purposes, according to the partnership 
agreement. Under these circumstances, the partnership's method of 
allocating the built-in loss associated with the Sec. 1.752-7 liability 
is reasonable.

    (d) Special rules for transfers of partnership interests, 
distributions of partnership assets, and assumptions of the Sec. 1.752-
7 liability after a Sec. 1.752-7 liability transfer--(1) In general. 
Except as provided in paragraphs (d)(2) and (i) of this section, 
paragraphs (e), (f), and (g) of this section apply to certain 
partnership transactions occurring after a Sec. 1.752-7 liability 
transfer.
    (2) Exceptions--(i) In general. Paragraphs (e), (f), and (g) of this 
section do not apply--
    (A) If the partnership assumes the Sec. 1.752-7 liability as part 
of a contribution to the partnership of the trade or business with which 
the liability is associated, and the partnership continues to carry on 
that trade or business after the contribution (for the definition of a 
trade or business, see paragraph (b)(10) of this section); or
    (B) If, immediately before the testing date, the amount of the 
remaining built-in loss with respect to all Sec. 1.752-7 liabilities 
assumed by the partnership (other than Sec. 1.752-7 liabilities assumed 
by the partnership with an associated trade or business) in one or more 
Sec. 1.752-7 liability transfers is less than the lesser of 10% of the 
gross value of partnership assets or $1,000,000.
    (ii) Examples. The following examples illustrate the principles of 
this paragraph (d)(2):

    Example 1. For the past 5 years, Corporation X, a C corporation, has 
been engaged in Business A and Business B. In 2004, Corporation X 
contributes Business A, in a transaction governed by section 721(a), to 
PRS in exchange for a PRS interest and the assumption by PRS of pension 
liabilities with respect to the employees engaged in Business A. PRS 
plans to carry on Business A after the contribution. Because PRS has 
assumed the pension liabilities as part of a contribution to PRS of the 
trade or business with which the liabilities are associated, the 
treatment of the pension liabilities is not affected by paragraphs (e), 
(f), and (g) of this section with respect to any transaction occurring 
after the Sec. 1.752-7 liability transfer of the pension liabilities.
    Example 2. (i) Facts. The facts are the same as in Example 1, except 
that PRS also assumes from Corporation X certain pension liabilities 
with respect to the employees of Business B. At the time of the 
assumption,

[[Page 676]]

the amount of the pension liabilities with respect to the employees of 
Business A is $3,000,000 (the A liabilities) and the amount of the 
pension liabilities associated with the employees of Business B (the B 
liabilities) is $2,000,000. Two years later, Corporation X sells its 
interest in PRS to Y for $9,000,000. At the time of the sale, the 
remaining built-in loss associated with the A liabilities is $2,100,000, 
the remaining built-in loss associated with the B liabilities is 
$900,000, and the gross value of PRS's assets (excluding Sec. 1.752-7 
liabilities) is $20,000,000. Assume that PRS has no Sec. 1.752-7 
liabilities other than those assumed from Corporation X.
[GRAPHIC] [TIFF OMITTED] TR26MY05.001

    (ii) Analysis. The only liabilities assumed by PRS from Corporation 
X that were not assumed as part of Corporation X's contribution of 
Business A were the B liabilities. Immediately before the testing date, 
the remaining built-in loss associated with the B liabilities ($900,000) 
was less than the lesser of 10% of the gross value of PRS's assets 
($2,000,000) or $1,000,000. Therefore, paragraph (d)(2)(i)(B) of this 
section applies to exclude Corporation X's sale of the PRS interest to Y 
from the application of paragraph (e) of this section.

    (e) Transfer of Sec. 1.752-7 liability partner's partnership 
interest--(1) In general. Except as provided in paragraphs (d)(2), 
(e)(3), and (i) of this section, immediately before the sale, exchange, 
or other disposition of all or a part of a Sec. 1.752-7 liability 
partner's partnership interest, the Sec. 1.752-7 liability partner's 
basis in the partnership interest is reduced by the Sec. 1.752-7 
liability reduction (as defined in paragraph (b)(7) of this section). No 
deduction, loss, or capital expense is allowed to the partnership on the 
satisfaction of the Sec. 1.752-7 liability (within the meaning of 
paragraph (b)(8) of this section) to the extent of the remaining built-
in loss associated with the Sec. 1.752-7 liability (as defined in 
paragraph (b)(6) of this section). For purposes of section 705(a)(2)(B) 
and Sec. 1.704-1(b)(2)(ii)(b) only, the remaining built-in loss 
associated with the Sec. 1.752-7 liability is not treated as a 
nondeductible, noncapital expenditure of the partnership. Therefore, the 
remaining partners' capital accounts and bases in their partnership 
interests are not reduced by the remaining built-in loss associated with 
the Sec. 1.752-7 liability. If the partnership (or any successor) 
notifies the Sec. 1.752-7 liability partner of the satisfaction of the 
Sec. 1.752-7 liability, then the Sec. 1.752-7 liability partner is 
entitled to a loss or deduction. The amount of that deduction or loss 
is, in the case of a partial satisfaction of the Sec. 1.752-7 
liability, the amount that the partnership would, but for this section, 
take into account on the partial satisfaction of the Sec. 1.752-7 
liability (but not, in total, more than the Sec. 1.752-7 liability 
reduction) or, in the case of a complete satisfaction of the Sec. 
1.752-7 liability, the remaining Sec. 1.752-7 liability reduction. To 
the extent of the amount that the partnership would, but for this 
section, take into account on the satisfaction of the Sec. 1.752-7 
liability, the character of that deduction or loss is determined as if 
the Sec. 1.752-7 liability partner had satisfied the liability. To the 
extent that the Sec. 1.752-7 liability reduction exceeds the amount 
that the partnership would, but for this section, take into account on 
the satisfaction of the Sec. 1.752-7 liability, the character of the 
Sec. 1.752-7 liability partner's loss is capital.
    (2) Examples. The following examples illustrate the principles of 
paragraph (e)(1) of this section:


[[Page 677]]


    Example 1. (i) Facts. In 2004, A, B, and C form partnership PRS. A 
contributes Property 1 with a fair market value of $5,000,000 and basis 
of $4,000,000 subject to a Sec. 1.752-7 liability of $2,000,000 in 
exchange for a 25% interest in PRS. B contributes $3,000,000 cash in 
exchange for a 25% interest in PRS, and C contributes $6,000,000 cash in 
exchange for a 50% interest in PRS. In 2006, when PRS has a section 754 
election in effect, A sells A's interest in PRS to D for $3,000,000. At 
the time of the sale, the basis of A's PRS interest is $4,000,000, the 
remaining built-in loss associated with the Sec. 1.752-7 liability is 
$2,000,000, and PRS has no liabilities (as defined in Sec. 1.752-
1(a)(4)). Assume that none of the exceptions of paragraph (d)(2) of this 
section apply and that the satisfaction of the Sec. 1.752-7 liability 
would have given rise to a deductible expense to A. In 2007, PRS pays 
$3,000,000 to satisfy the liability.
[GRAPHIC] [TIFF OMITTED] TR26MY05.002

    (ii) Sale of A's PRS interest. Immediately before the sale of the 
PRS interest to D, A's basis in the PRS interest is reduced (to 
$3,000,000) by the Sec. 1.752-7 liability reduction, i.e., the lesser 
of the excess of A's basis in the PRS interest ($4,000,000) over the 
adjusted value of that interest ($3,000,000), $1,000,000, or the 
remaining built-in loss associated with the Sec. 1.752-7 liability, 
$2,000,000. Therefore, A neither realizes nor recognizes any gain or 
loss on the sale of the PRS interest to D. D's basis in the PRS interest 
is $3,000,000. D's share of the adjusted basis of partnership property, 
as determined under Sec. 1.743-1(d), equals D's interest in the 
partnership's previously taxed capital of $2,000,000 (the amount of cash 
that D would receive on a liquidation of the partnership, $3,000,000, 
increased by the amount of tax loss that would be allocated to D in the 
hypothetical transaction, $0, and reduced by the amount of tax gain that 
would be allocated to D in the hypothetical transaction, $1,000,000). 
Therefore, the positive basis adjustment under section 743(b) is 
$1,000,000.

[[Page 678]]

[GRAPHIC] [TIFF OMITTED] TR26MY05.003

    (iii) Satisfaction of Sec. 1.752-7 liability. Neither PRS nor any 
of its partners is entitled to a deduction, loss, or capital expense 
upon the satisfaction of the Sec. 1.752-7 liability to the extent of 
the remaining built-in loss associated with the Sec. 1.752-7 liability 
($2,000,000). PRS is entitled to a deduction, however, for the amount by 
which the cost of satisfying the Sec. 1.752-7 liability exceeds the 
remaining built-in loss associated with the Sec. 1.752-7 liability. 
Therefore, in 2007, PRS may deduct $1,000,000 (cost to satisfy the Sec. 
1.752-7 liability, $3,000,000, less the remaining built-in loss 
associated with the Sec. 1.752-7 liability, $2,000,000). If PRS 
notifies A of the satisfaction of the Sec. 1.752-7 liability, then A is 
entitled to an ordinary deduction in 2007 of $1,000,000 (the Sec. 
1.752-7 liability reduction).
[GRAPHIC] [TIFF OMITTED] TR26MY05.004

    Example 2. The facts are the same as in Example 1 except that, at 
the time of A's sale of the PRS interest to D, PRS has a nonrecourse 
liability of $4,000,000, of which A's share is $1,000,000. A's basis in 
PRS is $5,000,000. At the time of the sale of the PRS interest to D, the 
adjusted value of A's interest is $4,000,000 (the fair market value of 
the interest ($3,000,000), increased by A's share of partnership 
liabilities ($1,000,000)). The difference between the basis of A's 
interest ($5,000,000) and the adjusted value of that interest 
($4,000,000) is $1,000,000. Therefore, the Sec. 1.752-7 liability 
reduction is $1,000,000 (the lesser of this difference or the remaining 
built-in loss associated with the Sec. 1.752-7 liability, $2,000,000). 
Immediately before the sale of the PRS interest to D, A's basis is 
reduced from $5,000,000 to $4,0000,000. A's amount realized on the sale 
of the PRS interest to D is $4,000,000 ($3,000,000 paid by D, increased 
under section 752(d) by A's share of partnership liabilities, or 
$1,000,000). Therefore, A neither realizes nor recognizes any gain or 
loss on the sale. D's basis in the PRS interest is $4,000,000. Because 
D's share of the adjusted basis of partnership property is $3,000,000 
(D's share of the partnership's previously taxed capital, $2,000,000, 
plus D's share of partnership liabilities, $1,000,000), the basis 
adjustment under section 743(b) is $1,000,000.

[[Page 679]]

[GRAPHIC] [TIFF OMITTED] TR26MY05.005

[GRAPHIC] [TIFF OMITTED] TR26MY05.006

    Example 3. The facts are the same as in Example 1, except that the 
satisfaction of the Sec. 1.752-7 liability would have given rise to a 
capital expense to A or PRS. Neither PRS nor any of its partners are 
entitled to a capital expense upon the satisfaction of the Sec. 1.752-7 
liability to the extent of the remaining built-in loss associated with 
the Sec. 1.752-7 liability ($2,000,000). PRS may, however, increase the 
basis of appropriate partnership assets by the amount by which the cost 
of satisfying the Sec. 1.752-7 liability exceeds the remaining built-in 
loss associated with the Sec. 1.752-7 liability. Therefore, in 2007, 
PRS may capitalize $1,000,000 (cost to satisfy the Sec. 1.752-7 
liability, $3,000,000, less the remaining built-in loss associated with 
the Sec. 1.752-7 liability, $2,000,000) to the appropriate partnership 
assets. If A is notified by PRS that the Sec. 1.752-7 liability has 
been satisfied, then A is entitled to a capital loss in 2007 as provided 
in paragraph (e)(1) of this section, the year of the satisfaction of the 
Sec. 1.752-7 liability.

    (3) Exception for nonrecognition transactions--(i) In general. 
Paragraph (e)(1) of this section does not apply where a Sec. 1.752-7 
liability partner transfers all or part of the partner's partnership 
interest in a transaction in which the

[[Page 680]]

transferee's basis in the partnership interest is determined in whole or 
in part by reference to the transferor's basis in the partnership 
interest. In addition, paragraph (e)(1) of this section does not apply 
to a distribution of an interest in the partnership (lower-tier 
partnership) that has assumed the Sec. 1.752-7 liability by a 
partnership that is the Sec. 1.752-7 liability partner (upper-tier 
partnership) if the partners of the upper-tier partnership that were 
Sec. 1.752-7 liability partners with respect to the lower-tier 
partnership prior to the distribution continue to be Sec. 1.752-7 
liability partners with respect to the lower-tier partnership after the 
distribution. See paragraphs (b)(4)(ii) and (j)(3) of this section for 
rules on the application of this section to partners of the Sec. 1.752-
7 liability partner.
    (ii) Examples. The following examples illustrate the provisions of 
this paragraph (e)(3):

    Example 1. Transfer of partnership interest to lower-tier 
partnership. (i) Facts. In 2004, X contributes undeveloped land with a 
value and basis of $2,000,000 and subject to environmental liabilities 
of $1,500,000 to partnership LTP in exchange for a 50% interest in LTP. 
LTP develops the land as a landfill. In 2005, in a transaction governed 
by section 721(a), X contributes the LTP interest to UTP in exchange for 
a 50% interest in UTP. In 2008, X sells the UTP interest to A for 
$500,000. At the time of the sale, X's basis in UTP is $2,000,000, the 
remaining built-in loss associated with the environmental liability is 
$1,500,000, and the gross value of UTP's assets is $2,500,000. The 
environmental liabilities were not assumed by LTP as part of a 
contribution by X to LTP of a trade or business with which the 
liabilities were associated. (See paragraph (b)(10)(ii), Example 1 of 
this section.)
    (ii) Analysis. Because UTP's basis in the LTP interest is determined 
by reference to X's basis in the LTP interest, X's contribution of the 
LTP interest to UTP is exempted from the rules of paragraph (e)(1) of 
this section. Under paragraph (j)(1) of this section, X's contribution 
of the LTP interest to UTP is treated as a contribution of X's share of 
the assets of LTP and UTP's assumption of X's share of the LTP 
liabilities (including Sec. 1.752-7 liabilities). Therefore, X's 
transfer of the LTP interest to UTP is a Sec. 1.752-7 liability 
transfer. The Sec. 1.752-7 liabilities deemed transferred by X to UTP 
are not associated with a trade or business transferred to UTP for 
purposes of paragraph (d)(2)(i)(A) of this section, because they were 
not associated with a trade or business transferred by X to LTP as part 
of the original Sec. 1.752-7 liability transfer. See paragraph (j)(2) 
of this section. Because none of the exceptions described in paragraph 
(d)(2) of this section apply to X's taxable sale of the UTP interest to 
A in 2008, paragraph (e)(1) of this section applies to that sale.
    Example 2. Transfer of partnership interest to corporation. The 
facts are the same as in Example 1, except that, rather than 
transferring the LTP interest to UTP in 2005, X contributes the LTP 
interest to Corporation Y in an exchange to which section 351 applies. 
Because Corporation Y's basis in the LTP interest is determined by 
reference to X's basis in that interest, X's contribution of the LTP 
interest is exempted from the rules of paragraph (e)(1) of this section. 
But see section 358(h) and Sec. 1.358-7 for appropriate basis 
adjustments.
    Example 3. Partnership merger. (i) Facts. In 2004, A, B, C, and D 
form equal partnership PRS1. A contributes Blackacre with a value and 
basis of $2,000,000 to PRS1 and PRS1 assumes from A $1,500,000 of 
pension liabilities unrelated to Blackacre. B, C, and D each contribute 
$500,000 cash to PRS1. PRS1 uses the cash contributed by B, C, and D 
($1,500,000) to purchase Whiteacre. In 2006, PRS1 merges into PRS2 in an 
assets-over merger under Sec. 1.708-1(c)(3). Assume that, under Sec. 
1.708-1(c), PRS2 is the surviving partnership and PRS1 is the 
terminating partnership. At the time of the merger, the value of 
Blackacre is still $2,000,000, the remaining built-in loss with respect 
to the pension liabilities is still $1,500,000, but the value of 
Whiteacre has declined to $500,000.
    (ii) Deemed assumption by PRS2 of PRS1 liabilities. Under Sec. 
1.708-1(c)(3), the merger is treated as a contribution of the assets and 
liabilities of PRS1 to PRS2, followed by a distribution of the PRS2 
interests by PRS1 in liquidation of PRS1. Because PRS2 assumes a Sec. 
1.752-7 liability (the pension liabilities) of PRS1, PRS1 is a Sec. 
1.752-7 liability partner of PRS2. Under paragraph (b)(5)(ii)(A) of this 
section, A is also Sec. 1.752-7 liability partner of PRS2 to the extent 
of the remaining $1,500,000 built-in loss associated with the pension 
liabilities. B, C, and D are not Sec. 1.752-7 liability partners with 
respect to PRS1. If the amount of the pension liabilities had increased 
between the date of PRS1's assumption of those liabilities from A and 
the date of the merger of PRS1 into PRS2, then B, C, and D would be 
Sec. 1.752-7 liability partners with respect to PRS2 to the extent of 
their respective shares of that increase. See paragraph (b)(5)(ii) of 
this section.
    (iii) Deemed distribution of PRS2 interests. Paragraph (e)(1) does 
not apply to PRS1's deemed distribution of the PRS2 interests, because, 
under paragraph (b)(5)(ii)(B) of this section, all of the partners that 
were Sec. 1.752-7 liability partners with respect to PRS2 before the 
distribution, i.e., A, continue to be

[[Page 681]]

Sec. 1.752-7 liability partners after the distribution. After the 
distribution, A's share of the pension liabilities now held by PRS2 will 
continue to be $1,500,000.
    Example 4. Partnership division; no shifting of Sec. 1.752-7 
liability. The facts are the same as in Example 3, except that PRS1 does 
not merge with PRS2, but instead contributes Blackacre to PRS2 in 
exchange for PRS2 interests and the assumption by PRS2 of the pension 
liabilities. Immediately thereafter, PRS1 distributes the PRS2 interests 
to A and B in liquidation of their interests in PRS1. The analysis is 
the same as in Example 3. After the assumption of the pension 
liabilities by PRS2, A is a Sec. 1.752-7 liability partner with respect 
to PRS2. After the distribution of a PRS2 interest to A, A continues to 
be a Sec. 1.752-7 liability partner with respect to PRS2, and the 
amount of A's built-in loss with respect to the Sec. 1.752-7 
liabilities continues to be $1,500,000. Therefore, paragraph (e)(1) of 
this section does not apply to the distribution of the PRS2 interests to 
A and B.
    Example 5. Partnership division; shifting of Sec. 1.752-7 
liability. The facts are the same as in Example 4, except that PRS1 
distributes the PRS2 interests not to A and B, but to C and D, in 
liquidation of their interests in PRS1. After this distribution, A does 
not continue to be a Sec. 1.752-7 liability partner of PRS2, because A 
no longer has an interest in PRS2. Therefore, paragraph (e)(1) of this 
section applies to the distribution of the PRS2 interests to C and D.

    (f) Distribution in liquidation of Sec. 1.752-7 liability partner's 
partnership interest--(1) In general. Except as provided in paragraphs 
(d)(2) and (i) of this section, immediately before a distribution in 
liquidation of a Sec. 1.752-7 liability partner's partnership interest, 
the Sec. 1.752-7 liability partner's basis in the partnership interest 
is reduced by the Sec. 1.752-7 liability reduction (as defined in 
paragraph (b)(7) of this section). This rule applies before section 737. 
No deduction, loss, or capital expense is allowed to the partnership on 
the satisfaction of the Sec. 1.752-7 liability (within the meaning of 
paragraph (b)(8) of this section) to the extent of the remaining built-
in loss associated with the Sec. 1.752-7 liability (as defined in 
paragraph (b)(6) of this section). For purposes of section 705(a)(2)(B) 
and Sec. 1.704-1(b)(2)(ii)(b) only, the remaining built-in loss 
associated with the Sec. 1.752-7 liability is not treated as a 
nondeductible, noncapital expenditure of the partnership. Therefore, the 
remaining partners' capital accounts and bases in their partnership 
interests are not reduced by the remaining built-in loss associated with 
the Sec. 1.752-7 liability. If the partnership (or any successor) 
notifies the Sec. 1.752-7 liability partner of the satisfaction of the 
Sec. 1.752-7 liability, then the Sec. 1.752-7 liability partner is 
entitled to a loss or deduction. The amount of that deduction or loss 
is, in the case of a partial satisfaction of the Sec. 1.752-7 
liability, the amount that the partnership would, but for this section, 
take into account on the partial satisfaction of the Sec. 1.752-7 
liability (but not, in total, more than the Sec. 1.752-7 liability 
reduction) or, in the case of a complete satisfaction of the Sec. 
1.752-7 liability, the remaining Sec. 1.752-7 liability reduction. To 
the extent of the amount that the partnership would, but for this 
section, take into account on satisfaction of the Sec. 1.752-7 
liability, the character of that deduction or loss is determined as if 
the Sec. 1.752-7 liability partner had satisfied the liability. To the 
extent that the Sec. 1.752-7 liability reduction exceeds the amount 
that the partnership would, but for this section, take into account on 
satisfaction of the Sec. 1.752-7 liability, the character of the Sec. 
1.752-7 liability partner's loss is capital.
    (2) Example. The following example illustrates the provision of this 
paragraph (f):

    Example. (i) Facts. In 2004, A, B, and C form partnership PRS. A 
contributes Property 1 with a fair market value and basis of $5,000,000 
subject to a Sec. 1.752-7 liability of $2,000,000 for a 25% interest in 
PRS. B contributes $3,000,000 cash for a 25% interest in PRS, and C 
contributes $6,000,000 cash for a 50% interest in PRS. In 2012, when PRS 
has a section 754 election in effect, PRS distributes Property 2, which 
has a basis and fair market value of $3,000,000, to A in liquidation of 
A's PRS interest. At the time of the distribution, the fair market value 
of A's PRS interest is still $3,000,000, the basis of that interest is 
still $5,000,000, and the remaining built-in loss associated with the 
Sec. 1.752-7 liability is still $2,000,000. Assume that none of the 
exceptions of paragraph (d)(2) of this section apply to the distribution 
and that the satisfaction of the Sec. 1.752-7 liability would have 
given rise to a deductible expense to A. In 2013, PRS pays $1,000,000 to 
satisfy the entire Sec. 1.752-7 liability.

[[Page 682]]

[GRAPHIC] [TIFF OMITTED] TR26MY05.007

    (ii) Liquidation of A's PRS interest. Immediately before the 
distribution of Property 2 to A, A's basis in the PRS interest is 
reduced (to $3,000,000) by the Sec. 1.752-7 liability reduction, i.e., 
the lesser of the excess of A's basis in the PRS interest ($5,000,000) 
over the adjusted value ($3,000,000) of that interest ($2,000,000) or 
the remaining built-in loss associated with the Sec. 1.752-7 liability 
($2,000,000). Therefore, A's basis in Property 2 under section 732(b) is 
$3,000,000. Because this is the same as the partnership's basis in 
Property 2 immediately before the distribution, the partnership's basis 
adjustment under section 734(b) is $0.
[GRAPHIC] [TIFF OMITTED] TR26MY05.008

    (iii) Satisfaction of Sec. 1.752-7 liability. PRS is not entitled 
to a deduction, loss, or capital expense on the satisfaction of the 
Sec. 1.752-7 liability to the extent of the remaining built-in loss 
associated with the Sec. 1.752-7 liability ($2,000,000). Because this 
amount exceeds the amount paid by PRS to satisfy the Sec. 1.752-7 
liability ($1,000,000), PRS is not entitled to any deduction for the 
Sec. 1.752-7 liability in 2013. If, however, PRS notifies A of the 
satisfaction of the Sec. 1.752-7 liability, A is entitled to an 
ordinary deduction in 2013 of $1,000,000 (the amount paid in 
satisfaction of the Sec. 1.752-7 liability) and a capital loss of 
$1,000,000 (the remaining Sec. 1.752-7 liability reduction).
[GRAPHIC] [TIFF OMITTED] TR26MY05.009

    (g) Assumption of Sec. 1.752-7 liability by a partner other than 
Sec. 1.752-7 liability partner--(1) In general. If this paragraph (g) 
applies, section 704(c)(1)(B) does not apply to an assumption of a Sec. 
1.752-7 liability from a partnership by a partner other than the Sec. 
1.752-7 liability partner. The rules of paragraph (g)(2) of

[[Page 683]]

this section apply only if the Sec. 1.752-7 liability partner is a 
partner in the partnership at the time of the assumption of the Sec. 
1.752-7 liability from the partnership. The rules of paragraphs (g)(3) 
and (4) of this section apply to any assumption of the Sec. 1.752-7 
liability by a partner other than the Sec. 1.752-7 liability partner, 
whether or not the Sec. 1.752-7 liability partner is a partner in the 
partnership at the time of the assumption from the partnership.
    (2) Consequences to Sec. 1.752-7 liability partner. If, at the time 
of an assumption of a Sec. 1.752-7 liability from a partnership by a 
partner other than the Sec. 1.752-7 liability partner, the Sec. 1.752-
7 liability partner remains a partner in the partnership, then the Sec. 
1.752-7 liability partner's basis in the partnership interest is reduced 
by the Sec. 1.752-7 liability reduction (as defined in paragraph (b)(7) 
of this section). If the assuming partner (or any successor) notifies 
the Sec. 1.752-7 liability partner of the satisfaction of the Sec. 
1.752-7 liability (within the meaning of paragraph (b)(8) of this 
section), then the Sec. 1.752-7 liability partner is entitled to a 
deduction or loss. The amount of that deduction or loss is, in the case 
of a partial satisfaction of the Sec. 1.752-7 liability, the amount 
that the assuming partner would, but for this section, take into account 
on the satisfaction of the Sec. 1.752-7 liability (but not, in total, 
more than the Sec. 1.752-7 liability reduction) or, in the case of a 
complete satisfaction of the Sec. 1.752-7 liability, the remaining 
Sec. 1.752-7 liability reduction. To the extent of the amount that the 
assuming partner would, but for this section, take into account on the 
satisfaction of the Sec. 1.752-7 liability, the character of that 
deduction or loss is determined as if the Sec. 1.752-7 liability 
partner had satisfied the liability. To the extent that the Sec. 1.752-
7 liability reduction exceeds the amount that the assuming partner 
would, but for this section, take into account on the satisfaction of 
the Sec. 1.752-7 liability, the character of the Sec. 1.752-7 
liability partner's loss is capital.
    (3) Consequences to partnership. Immediately after the assumption of 
the Sec. 1.752-7 liability from the partnership by a partner other than 
the Sec. 1.752-7 liability partner, the partnership must reduce the 
basis of partnership assets by the remaining built-in loss associated 
with the Sec. 1.752-7 liability (as defined in paragraph (b)(6) of this 
section). The reduction in the basis of partnership assets must be 
allocated among partnership assets as if that adjustment were a basis 
adjustment under section 734(b).
    (4) Consequences to assuming partner. No deduction, loss, or capital 
expense is allowed to an assuming partner (other than the Sec. 1.752-7 
liability partner) on the satisfaction of the Sec. 1.752-7 liability 
assumed from a partnership to the extent of the remaining built-in loss 
associated with the Sec. 1.752-7 liability. Instead, upon the 
satisfaction of the Sec. 1.752-7 liability, the assuming partner must 
adjust the basis of the partnership interest, any assets (other than 
cash, accounts receivable, or inventory) distributed by the partnership 
to the partner, or gain or loss on the disposition of the partnership 
interest, as the case may be. These adjustments are determined as if the 
assuming partner's basis in the partnership interest at the time of the 
assumption were increased by the lesser of the amount paid (or to be 
paid) to satisfy the Sec. 1.752-7 liability or the remaining built-in 
loss associated with the Sec. 1.752-7 liability. However, the assuming 
partner cannot take into account any adjustments to depreciable basis, 
reduction in gain, or increase in loss until the satisfaction of the 
Sec. 1.752-7 liability.
    (5) Example. The following example illustrates the provisions of 
this paragraph (g):

    Example. (i) Facts. In 2004, A, B, and C form partnership PRS. A 
contributes Property 1, a nondepreciable capital asset with a fair 
market value and basis of $5,000,000, in exchange for a 25% interest in 
PRS and assumption by PRS of a Sec. 1.752-7 liability of $2,000,000. B 
contributes $3,000,000 cash for a 25% interest in PRS, and C contributes 
$6,000,000 cash for a 50% interest in PRS. PRS uses the cash contributed 
to purchase Property 2. In 2007, PRS distributes Property 1, subject to 
the Sec. 1.752-7 liability to B in liquidation of B's interest in PRS. 
At the time of the distribution, A's interest in PRS still has a value 
of $3,000,000 and a basis of $5,000,000, and B's interest in PRS still 
has a value and basis of $3,000,000. Also at that time, Property 1 still 
has a value and basis of $5,000,000, Property 2 still

[[Page 684]]

has a value and basis of $9,000,000, and the remaining built-in loss 
associated with the Sec. 1.752-7 liability still is $2,000,000. Assume 
that none of the exceptions of paragraph (d)(2)(i) of this section apply 
to the assumption of the Sec. 1.752-7 liability by B and that the 
satisfaction of the Sec. 1.752-7 liability by A would have given rise 
to a deductible expense to A. In 2010, B pays $1,000,000 to satisfy the 
entire Sec. 1.752-7 liability. At that time, B still owns Property 1, 
which has a basis of $3,000,000.
[GRAPHIC] [TIFF OMITTED] TR26MY05.010

    (ii) Assumption of Sec. 1.752-7 liability by B. Section 
704(c)(1)(B) does not apply to the assumption of the Sec. 1.752-7 
liability by B. Instead, A's basis in the PRS interest is reduced (to 
$3,000,000) by the Sec. 1.752-7 liability reduction, i.e., the lesser 
of the excess of A's basis in the PRS interest ($5,000,000) over the 
adjusted value ($3,000,000) of that interest ($2,000,000), or the 
remaining built-in loss associated with the Sec. 1.752-7 liability as 
of the time of the assumption ($2,000,000). PRS's basis in Property 2 is 
reduced (to $7,000,000) by the $2,000,000 remaining built-in loss 
associated with the Sec. 1.752-7 liability. B's basis in Property 1 
under section 732(b) is $3,000,000 (B's basis in the PRS interest). This 
is $2,000,000 less than PRS's basis in Property 1 before the 
distribution of Property 1 to B. If PRS has a section 754 election in 
effect for 2007, PRS may increase the basis of Property 2 under section 
734(b) by $2,000,000.

[[Page 685]]

[GRAPHIC] [TIFF OMITTED] TR26MY05.011

    (iii) Satisfaction of Sec. 1.752-7 liability. B is not entitled to 
a deduction on the satisfaction of the Sec. 1.752-7 liability in 2010 
to the extent of the remaining built-in loss associated with the Sec. 
1.752-7 liability ($2,000,000). As this amount exceeds the amount paid 
by B to satisfy the Sec. 1.752-7 liability, B is not entitled to any 
deduction on the satisfaction of the Sec. 1.752-7 liability in 2010. B 
may, however, increase the basis of Property 1 by the lesser of the 
remaining built-in loss associated with the Sec. 1.752-7 liability 
($2,000,000) or the amount paid to satisfy the Sec. 1.752-7 liability 
($1,000,000). Therefore, B's basis in Property 1 is increased to 
$4,000,000. If B notifies A of the satisfaction of the Sec. 1.752-7 
liability, then A is entitled to an ordinary deduction in 2010 of 
$1,000,000 (the amount paid in satisfaction of the Sec. 1.752-7 
liability) and a capital loss of $1,000,000 (the remaining Sec. 1.752-7 
liability reduction).

         B's Basis in Property 1 After Satisfaction of Liability
                              [In millions]
1. Basis in Property 1 after distribution.......................      $3
2. Plus lesser of remaining built-in loss.......................
    ($2) or amount paid to satisfy liability ($1)...............       1
                                                                 -------
3. Basis in Property 1 after satisfaction of liability..........      $4
------------------------------------------------------------------------

    (h) Notification by the partnership (or successor) of the 
satisfaction of the Sec. 1.752-7 liability. For purposes of paragraphs 
(e), (f), and (g) of this section, notification by the partnership (or 
successor) of the satisfaction of the Sec. 1.752-7 liability must be 
attached to the Sec. 1.752-7 liability partner's return (whether an 
original or an amended return) for the year in which the loss is being 
claimed and must include--
    (1) The amount paid in satisfaction of the Sec. 1.752-7 liability, 
and whether the amounts paid were in partial or complete satisfaction of 
the Sec. 1.752-7 liability;
    (2) The name and address of the person satisfying the Sec. 1.752-7 
liability;
    (3) The date of the payment on the Sec. 1.752-7 liability; and
    (4) The character of the loss to the Sec. 1.752-7 liability partner 
with respect to the Sec. 1.752-7 liability.
    (i) Special rule for amounts that are capitalized prior to the 
occurrence of an event described in paragraphs (e), (f), or (g)--(1) In 
general. If all or a portion of a Sec. 1.752-7 liability is properly 
capitalized (capitalized basis) prior to an event described in paragraph 
(e), (f), or (g) of this section, then, before an event described in 
paragraph (e), (f), or

[[Page 686]]

(g) of this section, the partnership may take the capitalized basis into 
account for purposes of computing cost recovery and gain or loss on the 
sale of the asset to which the basis has been capitalized (and for any 
other purpose for which the basis of the asset is relevant), but after 
an event described in paragraph (e), (f), or (g) of this section, the 
partnership may not take any remaining capitalized basis into account 
for tax purposes.
    (2) Example. The following example illustrates the provisions of 
this paragraph (i):

    Example. (i) Facts. In 2004, A and B form partnership PRS. A 
contributes Property 1, a nondepreciable capital asset, with a fair 
market value and basis of $5,000,000, in exchange for a 25% interest in 
PRS and an assumption by PRS of a Sec. 1.752-7 liability of $2,000,000. 
B contributes $9,000,000 in cash in exchange for a 75% interest in PRS. 
PRS uses $7,000,000 of the cash to purchase Property 2, also a 
nondepreciable capital asset. In 2007, when PRS's assets have not 
changed, PRS satisfies the Sec. 1.752-7 liability by paying $2,000,000. 
Assume that PRS is required to capitalize the cost of satisfying the 
Sec. 1.752-7 liability. In 2008, A sells his interest in PRS to C for 
$3,000,000. At the time of the sale, the basis of A's interest is still 
$5,000,000.
    (ii) Analysis. On the sale of A's interest to C, A realizes a loss 
of $2,000,000 on the sale of the PRS interest (the excess of $5,000,000, 
the basis of the partnership interest, over $3,000,000, the amount 
realized on sale). The remaining built-in loss associated with the Sec. 
1.752-7 liability at that time is zero because all of the Sec. 1.752-7 
liability as of the time of the assumption of the Sec. 1.752-7 
liability by the partnership was capitalized by the partnership. The 
partnership may not take any remaining capitalized basis into account 
for tax purposes.
[GRAPHIC] [TIFF OMITTED] TR26MY05.013

    (iii) Partial Satisfaction. Assume that, prior to the sale of A's 
interest in PRS to C, PRS had paid $1,500,000 to satisfy a portion of 
the Sec. 1.752-7 liability. Therefore, immediately before the sale of 
the PRS interest to C, A's basis in the PRS interest would be reduced 
(to $4,500,000) by the $500,000 remaining built-in loss associated with 
the Sec. 1.752-7 liability ($2,000,000 less the $1,500,000 portion 
capitalized by the partnership as that time). On the sale of the PRS 
interest, A realizes a loss of $1,500,000 (the excess of $4,500,000, the 
basis of the PRS interest, over $3,000,000, the amount realized on the 
sale). Neither PRS nor any of its partners is entitled to a deduction, 
loss, or capital expense upon the satisfaction of the Sec. 1.752-7 
liability to the extent of the remaining built-in loss associated with 
the Sec. 1.752-7 liability ($500,000). If PRS notifies A of the 
satisfaction of the remaining portion of the Sec. 1.752-7 liability, 
then A is entitled to a deduction or loss of $500,000 (the remaining 
Sec. 1.752-7 liability reduction). The partnership may not take any 
remaining capitalized basis into account for tax purposes.

[[Page 687]]

[GRAPHIC] [TIFF OMITTED] TR26MY05.014

    (j) Tiered partnerships--(1) Look-through treatment. For purposes of 
this section, a contribution by a partner of an interest in a 
partnership (lower-tier partnership) to another partnership (upper-tier 
partnership) is treated as a contribution by the partner of the 
partner's share of each of the lower-tier partnership's assets and an 
assumption by the upper-tier partnership of the partner's share of the 
lower-tier partnership's liabilities (including Sec. 1.752-7 
liabilities). See paragraph (e)(3)(ii) Example 1 of this section. In 
addition, a partnership is treated as having its share of any Sec. 
1.752-7 liabilities of the partnerships in which it has an interest.
    (2) Trade or business exception. If a partnership (upper-tier 
partnership) assumes a Sec. 1.752-7 liability of a partner, and, 
subsequently, another partnership (lower-tier partnership) assumes that 
Sec. 1.752-7 liability from the upper-tier partnership, then the Sec. 
1.752-7 liability is treated as associated only with any trade or 
business contributed to the upper-tier partnership by the Sec. 1.752-7 
liability partner. The same rule applies where a partnership assumes a 
Sec. 1.752-7 liability of a partner, and, subsequently, the Sec. 
1.752-7 liability partner transfers that partnership interest to another 
partnership. See paragraph (e)(3)(ii) Example 1 of this section.
    (3) Partnership as a Sec. 1.752-7 liability partner. If a 
transaction described in paragraph (e), (f), or (g) of this section 
occurs with respect to a partnership (upper-tier partnership) that is a 
Sec. 1.752-7 liability partner of another partnership (lower-tier 
partnership), then such transaction will also be treated as a 
transaction described in paragraph (e), (f), or (g) of this section, as 
appropriate, with respect to the partners of the upper-tier partnership, 
regardless of whether the upper-tier partnership assumed the Sec. 
1.752-7 liability from those partners. (See paragraph (b)(5) of this 
section for rules relating to the treatment of transactions by the 
partners of the upper-tier partnership). In such a case, each partner's 
share of the Sec. 1.752-7 liability reduction in the upper-tier 
partnership is equal to that partner's share of the Sec. 1.752-7 
liability. The partners of the upper-tier partnership at the time of the 
transaction described in paragraph (e), (f), or (g) of this section, and 
not the upper-tier partnership, are entitled to the deduction or loss on 
the satisfaction of the Sec. 1.752-7 liability. Similar principles 
apply where the upper-tier partnership is itself owned by one or a 
series of partnerships. This paragraph does not apply to the extent that 
Sec. 1.752-7(j)(4) applied to the assumption of the Sec. 1.752-7 
liability by the lower-tier partnership.
    (4) Transfer of Sec. 1.752-7 liability by partnership to another 
partnership or corporation after a transaction described in paragraph 
(e), (f), or (g)--(i) In general. If, after a transaction described in 
paragraph (e), (f), or (g) of this section with respect to a Sec. 
1.752-7 liability assumed by a partnership (the upper-tier partnership), 
another partnership or a corporation assumes the Sec. 1.752-7 liability 
from the upper-tier partnership (or the assuming partner) in a 
transaction in which the basis of property is determined, in whole or in 
part, by reference to the basis of the property in the hands of the 
upper-tier partnership (or assuming partner), then--
    (A) The upper-tier partnership (or assuming partner) must reduce its 
basis in any corporate stock or partnership interest received by the 
remaining built-in loss associated with the Sec. 1.752-

[[Page 688]]

7 liability, at the time of the transaction described in paragraph (e), 
(f), or (g) of this section (but the partners of the upper-tier 
partnership do not reduce their bases or capital accounts in the upper-
tier partnership); and
    (B) No deduction, loss, or capital expense is allowed to the 
assuming partnership or corporation on the satisfaction of the Sec. 
1.752-7 liability to the extent of the remaining built-in loss 
associated with the Sec. 1.752-7 liability.
    (ii) Subsequent transfers. Similar rules apply to subsequent 
assumptions of the Sec. 1.752-7 liability in transactions in which the 
basis of property is determined, in whole or in part, by reference to 
the basis of the property in the hands of the transferor. If, subsequent 
to an assumption of the Sec. 1.752-7 liability by a partnership in a 
transaction to which paragraph (j)(4)(i) of this section applies, the 
Sec. 1.752-7 liability is assumed from the partnership by a partner 
other than the partner from whom the partnership assumed the Sec. 
1.752-7 liability, then the rules of paragraph (g) of this section 
apply.
    (5) Example. The following example illustrates the provisions of 
paragraphs (j)(3) and (4) of this section:
    Example. (i) Assumption of Sec. 1.752-7 liability by UTP and 
transfer of Sec. 1.752-7 liability partner's interest in UTP. In 2004, 
A, B, and C form partnership UTP. A contributes Property 1 with a fair 
market value and basis of $5,000,000 subject to a Sec. 1.752-7 
liability of $2,000,000 in exchange for a 25% interest in UTP. B 
contributes $3,000,000 cash in exchange for a 25% interest in UTP, and C 
contributes $6,000,000 cash in exchange for a 50% interest in UTP. UTP 
invests the $9,000,000 cash in Property 2. In 2006, A sells A's interest 
in UTP to D for $3,000,000. At the time of the sale, the basis of A's 
UTP interest is $5,000,000, the remaining built-in loss associated with 
the Sec. 1.752-7 liability is $2,000,000, and UTP has no liabilities 
other than the Sec. 1.752-7 liabilities assumed from A. Assume that 
none of the exceptions of paragraph (d)(2) of this section apply and 
that the satisfaction of the Sec. 1.752-7 liability would give rise to 
a deductible expense to A and to UTP. Under paragraph (e) of this 
section, immediately before the sale of the UTP interest to D, A's basis 
in UTP is reduced to $3,000,000 by the $2,000,000 Sec. 1.752-7 
liability reduction. Therefore, A neither realizes nor recognizes any 
gain or loss on the sale of the UTP interest to D. D's basis in the UTP 
interest is $3,000,000.
[GRAPHIC] [TIFF OMITTED] TR26MY05.015


[[Page 689]]


    (ii) Assumption of Sec. 1.752-7 liability by LTP from UTP. In 2008, 
at a time when the estimated amount of the Sec. 1.752-7 liability has 
increased to $3,500,000, UTP contributes Property 1 and Property 2, 
subject to the Sec. 1.752-7 liability, to LTP in exchange for a 50% 
interest in LTP. At the time of the contribution, Property 1 still has a 
value and basis of $5,000,000 and Property 2 still has a value and basis 
of $9,000,000. UTP's basis in LTP under section 722 is $14,000,000. 
Under paragraph (j)(4)(i) of this section, UTP must reduce its basis in 
LTP by the $2,000,000 remaining built-in loss associated with the Sec. 
1.752-7 liability (as of the time of the sale of the UTP interest by A). 
The partners in UTP are not required to reduce their bases in UTP by 
this amount. UTP is a Sec. 1.752-7 liability partner of LTP with 
respect to the entire $3,500,000 Sec. 1.752-7 liability assumed by LTP. 
However, as A is no longer a partner of UTP, none of the partners of UTP 
(as of the time of the assumption of the Sec. 1.752-7 liability by LTP) 
are Sec. 1.752-7 liability partners of LTP with respect to the 
$2,000,000 remaining built-in loss associated with the Sec. 1.752-7 
liability (as of the time of the sale of the UTP interest by A). The UTP 
partners (as of the time of the assumption of the Sec. 1.752-7 
liability by LTP) are Sec. 1.752-7 liability partners of LTP with 
respect to the $1,500,000 increase in the amount of the Sec. 1.752-7 
liability of UTP since the assumption of that Sec. 1.752-7 liability by 
UTP from A.
[GRAPHIC] [TIFF OMITTED] TR26MY05.016

    (iii) Sale by UTP of LTP interest. In 2010, UTP sells its interest 
in LTP to E for $10,500,000. At the time of the sale, the LTP interest 
still has a value of $10,500,000 and a basis of $12,000,000, and the 
remaining built-in loss associated with the Sec. 1.752-7 liability is 
$3,500,000. Under paragraph (e) of this section, immediately before the 
sale, UTP must reduce its basis in the LTP interest by the Sec. 1.752-7 
liability reduction. Under paragraph (a)(4) of this section, the 
remaining built-in loss associated with the Sec. 1.752-7 liability is 
$1,500,000 (remaining built-in loss associated with the Sec. 1.752-7 
liability, $3,500,000, reduced by the amount of the Sec. 1.752-7 
liability taken into account under paragraph (j)(4) of this section, 
$2,000,000). The difference between the basis of the LTP interest held 
by UTP ($12,000,000) and the adjusted value of that interest 
($10,500,000) is also $1,500,000. Therefore, the Sec. 1.752-7 liability 
reduction is $1,500,000 and UTP's basis in the LTP interest must be 
reduced to $10,500,000. In addition, UTP's partners must reduce their 
bases in their UTP interests by their proportionate shares of the Sec. 
1.752-7 liability reduction. Thus, the basis of each of B's and D's 
interest in UTP must be reduced by $375,000 and

[[Page 690]]

the basis of C's interest in UTP must be reduced by $750,000. In 2011, D 
sells the UTP interest to F.
[GRAPHIC] [TIFF OMITTED] TR26MY05.017

    (iv) Deduction, expense, or loss associated with the Sec. 1.752-7 
liability by LTP. In 2012, LTP pays $3,500,000 to satisfy the Sec. 
1.752-7 liability. Under paragraphs (e) and (j)(4) of this section, LTP 
is not entitled to any deduction with respect to the Sec. 1.752-7 
liability. Under paragraph (j)(3) of this section, UTP also is not 
entitled to any deduction with respect to the Sec. 1.752-7 liability. 
If LTP notifies A, B, C and D of the satisfaction of the Sec. 1.752-7 
liability, then A is entitled to a deduction in 2012 of $2,000,000, B 
and D are each entitled to deductions in 2012 of $375,000, and C is 
entitled to a deduction in 2012 of $750,000.

    (k) Effective dates--(1) In general. This section applies to Sec. 
1.752-7 liability transfers occurring on or after June 24, 2003. For 
assumptions occurring after October 18, 1999, and before June 24, 2003, 
see Sec. 1.752-6. For Sec. 1.752-7 liability transfers occurring on or 
after June 24, 2003 and before May 26, 2005, taxpayers may rely on the 
exception for trading and investment partnerships in paragraph 
(b)(8)(ii) of Sec. 1.752.7 (2003-28 I.R.B. 46; 68 FR 37434).
    (2) Election to apply this section to assumptions of liabilities 
occurring after October 18, 1999 and before June 24, 2003--(i) In 
general. A partnership may elect to apply this section to all 
assumptions of liabilities (including Sec. 1.752-7 liabilities) 
occurring after October 18, 1999, and before June 24, 2003. Such an 
election is binding on the partnership and all of its partners. A 
partnership making such an election must apply all of the provisions of 
Sec. 1.752-1 and Sec. 1.752-7, including Sec. 1.358-5T, Sec. 1.358-
7, Sec. 1.704-1(b)(1)(ii) and (b)(2)(iv)(b), Sec. 1.704-2(b)(3), Sec. 
1.704-3(a)(7), (a)(8)(iv), and (a)(12), Sec. 1.704-4(d)(1)(iv), Sec. 
1.705-1(a)(8), Sec. 1.732-2(d)(3)(iv), and Sec. 1.737-5.
    (ii) Manner of making election. A partnership makes an election 
under this paragraph (k)(2) by attaching the following statement to its 
timely filed return: [Insert name and employer identification number of 
electing partnership] elects under Sec. 1.752-7 of the Income Tax 
Regulations to be subject to

[[Page 691]]

the rules of Sec. 1.358-5T, Sec. 1.358-7, Sec. 1.704-1(b)(1)(ii) and 
(b)(2)(iv)(b), Sec. 1.704-2(b)(3), Sec. 1.704-3(a)(7), (a)(8)(iv), and 
(a)(12), Sec. 1.704-4(d)(1)(iv), Sec. 1.705-1(a)(8), Sec. 1.732-
2(d)(3)(iv), and Sec. 1.737-5 with respect to all liabilities 
(including Sec. 1.752-7 liabilities) assumed by the partnership after 
October 18, 1999 and before June 24, 2003. In the statement, the 
partnership must list, with respect to each liability (including each 
Sec. 1.752-7 liability) assumed by the partnership after October 18, 
1999 and before June 24, 2003--
    (A) The name, address, and taxpayer identification number of the 
partner from whom the liability was assumed;
    (B) The date on which the liability was assumed by the partnership;
    (C) The amount of the liability as of the time of its assumption; 
and
    (D) A description of the liability.
    (iii) Filing of amended returns. An election under this paragraph 
(k)(2) will be valid only if the partnership and its partners promptly 
amend any returns for open taxable years that would be affected by the 
election.
    (iv) Time for making election. An election under this paragraph 
(k)(2) must be filed with any timely filed Federal income tax return 
filed by the partnership on or after September 24, 2003 and on or before 
December 31, 2005.

[T.D. 9207, 70 FR 30344, May 26, 2005; 70 FR 39654, July 11, 2005]



Sec. 1.753-1  Partner receiving income in respect of decedent.

    (a) Income in respect of a decedent under section 736(a). All 
payments coming within the provisions of section 736(a) made by a 
partnership to the estate or other successor in interest of a deceased 
partner are considered income in respect of the decedent under section 
691. The estate or other successor in interest of a deceased partner 
shall be considered to have received income in respect of a decedent to 
the extent that amounts are paid by a third person in exchange for 
rights to future payments from the partnership under section 736(a). 
When a partner who is receiving payments under section 736(a) dies, 
section 753 applies to any remaining payments under section 736(a) made 
to his estate or other successor in interest.
    (b) Other income in respect of a decedent. When a partner dies, the 
entire portion of the distributive share which is attributable to the 
period ending with the date of his death and which is taxable to his 
estate or other successor constitutes income in respect of a decedent 
under section 691. This rule applies even though that part of the 
distributive share for the period before death which the decedent 
withdrew is not included in the value of the decedent's partnership 
interest for estate tax purposes. See paragraph (c) (3) of Sec. 1.706-
1.
    (c) Example. The provisions of this section may be illustrated by 
the following example:

    Example. A and the decedent B were equal partners in a business 
having assets (other than money) worth $40,000 with an adjusted basis of 
$10,000. Certain partnership business was well advanced towards 
completion before B's death and, after B's death but before the end of 
the partnership year, payment of $10,000 was made to the partnership for 
such work. The partnership agreement provided that, upon the death of 
one of the partners, all partnership property, including unfinished 
work, would pass to the surviving partner, and that the surviving 
partner would pay the estate of the decedent the undrawn balance of his 
share of partnership earnings to the date of death, plus $10,000 in each 
of the three years after death. B's share of earnings to the date of his 
death was $4,000, of which he had withdrawn $3,000. B's distributive 
share of partnership income of $4,000 to the date of his death is income 
in respect of a decedent (although only the $1,000 undrawn at B's death 
will be reflected in the value of B's partnership interest on B's estate 
tax return). Assume that the value of B's interest in partnership 
property at the date of his death was $22,000, composed of the following 
items: B's one-half share of the assets of $40,000, plus $2,000, B's 
interest in partnership cash. It should be noted that B's $1,000 undrawn 
share of earnings to the date of his death is not a separate item but 
will be paid from partnership assets. Under the partnership agreement, A 
is to pay B's estate a total of $31,000. The difference of $9,000 
between the amount to be paid by A ($31,000) and the value of B's 
interest in partnership property ($22,000) comes within section 736(a) 
and, thus, also constitutes income in respect of a decedent. (However, 
the $17,000 difference between the $5,000 basis for B's share of the 
partnership property and its $22,000 value at the date of his death does 
not constitute income in respect of a decedent.) If, before the close of 
the partnership taxable year, A pays B's estate $11,000, of which they

[[Page 692]]

agree to allocate $3,000 as the payment under section 736(a), B's estate 
will include $7,000 in its gross income (B's $4,000 distributive share 
plus $3,000 payment under section 736(a)). In computing the deduction 
under section 691(c), this $7,000 will be considered as the value for 
estate tax purposes of such income in respect of a decedent, even though 
only $4,000 ($1,000 of distributive share not withdrawn, plus $3,000, 
payment under section 736(a)) of this amount can be identified on the 
estate tax return as part of the partnership interest.

    (d) Effective date. The provisions of section 753 apply only in the 
case of payments made with respect to decedents whose death occurred 
after December 31, 1954. See section 771(b)(4) and paragraph (b)(4) of 
Sec. 1.771-1.



Sec. 1.754-1  Time and manner of making election to adjust basis of
partnership property.

    (a) In general. A partnership may adjust the basis of partnership 
property under sections 734(b) and 743(b) if it files an election in 
accordance with the rules set forth in paragraph (b) of this section. An 
election may not be filed to make the adjustments provided in either 
section 734(b) or section 743(b) alone, but such an election must apply 
to both sections. An election made under the provisions of this section 
shall apply to all property distributions and transfers of partnership 
interests taking place in the partnership taxable year for which the 
election is made and in all subsequent partnership taxable years unless 
the election is revoked pursuant to paragraph (c) of this section.
    (b) Time and method of making election. (1) An election under 
section 754 and this section to adjust the basis of partnership property 
under sections 734(b) and 743(b), with respect to a distribution of 
property to a partner or a transfer of an interest in a partnership, 
shall be made in a written statement filed with the partnership return 
for the taxable year during which the distribution or transfer occurs. 
For the election to be valid, the return must be filed not later than 
the time prescribed by paragraph (e) of Sec. 1.6031-1 (including 
extensions thereof) for filing the return for such taxable year (or 
before August 23, 1956, whichever is later). Notwithstanding the 
preceding two sentences, if a valid election has been made under section 
754 and this section for a preceding taxable year and not revoked 
pursuant to paragraph (c) of this section, a new election is not 
required to be made. The statement required by this subparagraph shall 
(i) set forth the name and address of the partnership making the 
election, (ii) be signed by any one of the partners, and (iii) contain a 
declaration that the partnership elects under section 754 to apply the 
provisions of section 734(b) and section 743(b). For rules regarding 
extensions of time for filing elections, see Sec. 1.9100-1.
    (2) The principles of this paragraph may be illustrated by the 
following example:

    Example. A, a U.S. citizen, is a member of partnership ABC, which 
has not previously made an election under section 754 to adjust the 
basis of partnership property. The partnership and the partners use the 
calendar year as the taxable year. A sells his interest in the 
partnership to D on January 1, 1971. The partnership may elect under 
section 754 and this section to adjust the basis of partnership property 
under sections 734(b) and 743(b). Unless an extension of time to make 
the election is obtained under the provisions of Sec. 1.9100-1, the 
election must be made in a written statement filed with the partnership 
return for 1971 and must contain the information specified in 
subparagraph (1) of this paragraph. Such return must be filed by April 
17, 1972 (unless an extension of time for filing the return is 
obtained). The election will apply to all distributions of property to a 
partner and transfers of an interest in the partnership occurring in 
1971 and subsequent years, unless revoked pursuant to paragraph (c) of 
this section.

    (c) Revocation of election--(1) In general. A partnership having an 
election in effect under this section may revoke such election with the 
approval of the district director for the internal revenue district in 
which the partnership return is required to be filed. A partnership 
which wishes to revoke such an election shall file with the district 
director for the internal revenue district in which the partnership 
return is required to be filed an application setting forth the grounds 
on which the revocation is desired. The application shall be filed not 
later than 30 days after the close of the partnership taxable year with 
respect to which revocation is intended to take effect and shall

[[Page 693]]

be signed by any one of the partners. Examples of situations which may 
be considered sufficient reason for approving an application for 
revocation include a change in the nature of the partnership business, a 
substantial increase in the assets of the partnership, a change in the 
character of partnership assets, or an increased frequency of 
retirements or shifts of partnership interests, so that an increased 
administrative burden would result to the partnership from the election. 
However, no application for revocation of an election shall be approved 
when the purpose of the revocation is primarily to avoid stepping down 
the basis of partnership assets upon a transfer or distribution.
    (2) Revocations effective on December 15, 1999. Notwithstanding 
paragraph (c)(1) of this section, any partnership having an election in 
effect under this section for its taxable year that includes December 
15, 1999, may revoke such election effective for transfers or 
distributions occurring on or after December 15, 1999, by attaching a 
statement to the partnership's return for such year. For the revocation 
to be valid, the statement must be filed not later than the time 
prescribed by Sec. 1.6031(a)-1(e) (including extensions thereof) for 
filing the return for such taxable year, and must set forth the name and 
address of the partnership revoking the election, be signed by any one 
of the partners who is authorized to sign the partnership's federal 
income tax return, and contain a declaration that the partnership 
revokes its election under section 754 to apply the provisions of 
section 734(b) and 743(b). In addition, the following statement must be 
prominently displayed in capital letters on the first page of the 
partnership's return for such year: ``RETURN FILED PURSUANT TO Sec. 
1.754-1(c)(2).''

[T.D. 6500, 25 FR 11814, Nov. 26, 1960, as amended by T.D. 7208, 37 FR 
20686, Oct. 3, 1972; T.D. 8847, 64 FR 69916, Dec. 15, 1999; 65 FR 9220, 
Feb. 24, 2000]



Sec. 1.755-1  Rules for allocation of basis.

    (a) In general--(1) Scope. This section provides rules for 
allocating basis adjustments under sections 743(b) and 734(b) among 
partnership property. If there is a basis adjustment to which this 
section applies, the basis adjustment is allocated among the 
partnership's assets as follows. First, the partnership must determine 
the value of each of its assets under paragraphs (a)(2) through (5) of 
this section. Second, the basis adjustment is allocated between the two 
classes of property described in section 755(b). These classes of 
property consist of capital assets and section 1231(b) property (capital 
gain property), and any other property of the partnership (ordinary 
income property). For purposes of this section, properties and potential 
gain treated as unrealized receivables under section 751(c) and the 
regulations thereunder shall be treated as separate assets that are 
ordinary income property. Third, the portion of the basis adjustment 
allocated to each class is allocated among the items within the class. 
Basis adjustments under section 743(b) are allocated among partnership 
assets under paragraph (b) of this section. Basis adjustments under 
section 734(b) are allocated among partnership assets under paragraph 
(c) of this section.
    (2) Coordination of sections 755 and 1060. If there is a basis 
adjustment to which this section applies, and the assets of the 
partnership constitute a trade or business (as described in Sec. 
1.1060-1(b)(2)), then the partnership is required to use the residual 
method to assign values to the partnership's section 197 intangibles. To 
do so, the partnership must, first, determine the value of partnership 
assets other than section 197 intangibles under paragraph (a)(3) of this 
section. The partnership then must determine partnership gross value 
under paragraph (a)(4) of this section. Last, the partnership must 
assign values to the partnership's section 197 intangibles under 
paragraph (a)(5) of this section. For purposes of this section, the term 
section 197 intangibles includes all section 197 intangibles (as defined 
in section 197), as well as any goodwill or going concern value that 
would not qualify as a section 197 intangible under section 197.
    (3) Values of properties other than section 197 intangibles. For 
purposes of this section, the fair market value of each item of 
partnership property other

[[Page 694]]

than section 197 intangibles shall be determined on the basis of all the 
facts and circumstances, taking into account section 7701(g).
    (4) Partnership gross value--(i) Basis adjustments under section 
743(b)--(A) In general. Except as provided in paragraph (a)(4)(ii) of 
this section, in the case of a basis adjustment under section 743(b), 
partnership gross value generally is equal to the amount that, if 
assigned to all partnership property, would result in a liquidating 
distribution to the partner equal to the transferee's basis in the 
transferred partnership interest immediately following the relevant 
transfer (reduced by the amount, if any, of such basis that is 
attributable to partnership liabilities).
    (B) Special situations. In certain circumstances, such as where 
income or loss with respect to particular section 197 intangibles are 
allocated differently among partners, partnership gross value may vary 
depending on the values of particular section 197 intangibles held by 
the partnership. In these special situations, the partnership must 
assign value, first, among section 197 intangibles (other than goodwill 
and going concern value) in a reasonable manner that is consistent with 
the ordering rule in paragraph (a)(5) of this section and would cause 
the appropriate liquidating distribution under paragraph (a)(4)(i)(A) of 
this section. If the actual fair market values, determined on the basis 
of all the facts and circumstances, of all section 197 intangibles 
(other than goodwill and going concern value) is not sufficient to cause 
the appropriate liquidating distribution, then the fair market value of 
goodwill and going concern value shall be presumed to equal an amount 
that if assigned to goodwill and going concern value would cause the 
appropriate liquidating distribution.
    (C) Income in respect of a decedent. Solely for the purpose of 
determining partnership gross value under this paragraph (a)(4)(i), 
where a partnership interest is transferred as a result of the death of 
a partner, the transferee's basis in its partnership interest is 
determined without regard to section 1014(c), and is deemed to be 
adjusted for that portion of the interest, if any, that is attributable 
to items representing income in respect of a decedent under section 691.
    (ii) Basis adjustments under section 743(b) resulting from 
substituted basis transactions. This paragraph (a)(4)(ii) applies to 
basis adjustments under section 743(b) that result from exchanges in 
which the transferee's basis in the partnership interest is determined 
in whole or in part by reference to the transferor's basis in the 
interest or to the basis of other property held at any time by the 
transferee (substituted basis transactions). In the case of a 
substituted basis transaction, partnership gross value equals the value 
of the entire partnership as a going concern, increased by the amount of 
partnership liabilities at the time of the exchange giving rise to the 
basis adjustment.
    (iii) Basis adjustments under section 734(b). In the case of a basis 
adjustment under section 734(b), partnership gross value equals the 
value of the entire partnership as a going concern immediately following 
the distribution causing the adjustment, increased by the amount of 
partnership liabilities immediately following the distribution.
    (5) Determining the values of section 197 intangibles--(i) Two 
classes. If the aggregate value of partnership property other than 
section 197 intangibles (as determined in paragraph (a)(3) of this 
section) is equal to or greater than partnership gross value (as 
determined in paragraph (a)(4) of this section), then all section 197 
intangibles are deemed to have a value of zero for purposes of this 
section. In all other cases, the aggregate value of the partnership's 
section 197 intangibles (the residual section 197 intangibles value) is 
deemed to equal the excess of partnership gross value over the aggregate 
value of partnership property other than section 197 intangibles. The 
residual section 197 intangibles value must be allocated between two 
asset classes in the following order--
    (A) Among section 197 intangibles other than goodwill and going 
concern value; and
    (B) To goodwill and going concern value.
    (ii) Values assigned to section 197 intangibles other than goodwill 
and going concern value. The fair market value assigned to a section 197 
intangible

[[Page 695]]

(other than goodwill and going concern value) shall not exceed the 
actual fair market value (determined on the basis of all the facts and 
circumstances) of that asset on the date of the relevant transfer. If 
the residual section 197 intangibles value is less than the sum of the 
actual fair market values (determined on the basis of all the facts and 
circumstances) of all section 197 intangibles (other than goodwill and 
going concern value) held by the partnership, then the residual section 
197 intangibles value must be allocated among the individual section 197 
intangibles (other than goodwill and going concern value) as follows. 
The residual section 197 intangibles value is assigned first to any 
section 197 intangibles (other than goodwill and going concern value) 
having potential gain that would be treated as unrealized receivables 
under the flush language of section 751(c) (flush language receivables) 
to the extent of the basis of those section 197 intangibles and the 
amount of income arising from the flush language receivables that the 
partnership would recognize if the section 197 intangibles were sold for 
their actual fair market values (determined based on all the facts and 
circumstances) (collectively, the flush language receivables value). If 
the value assigned to section 197 intangibles (other than goodwill and 
going concern value) is less than the flush language receivables value, 
then the assigned value is allocated among the properties giving rise to 
the flush language receivables in proportion to the flush language 
receivables value in those properties. Any remaining residual section 
197 intangibles value is allocated among the remaining portions of the 
section 197 intangibles (other than goodwill and going concern value) in 
proportion to the actual fair market values of such portions (determined 
based on all the facts and circumstances).
    (iii) Value assigned to goodwill and going concern value. The fair 
market value of goodwill and going concern value is the amount, if any, 
by which the residual section 197 intangibles value exceeds the 
aggregate value of the partnership's section 197 intangibles (other than 
goodwill and going concern value).
    (6) Examples. The provisions of paragraphs (a)(2) through (5) are 
illustrated by the following examples, which assume that the 
partnerships have an election in effect under section 754 at the time of 
the transfer and that the assets of each partnership constitute a trade 
or business (as described in Sec. 1.1060-1(b)(2)). Except as provided, 
no partnership asset (other than inventory) is property described in 
section 751(a), and partnership liabilities are secured by all 
partnership assets. The examples are as follows:

    Example 1. (i) A is the sole general partner in PRS, a limited 
partnership having three equal partners. PRS has goodwill and going 
concern value, two section 197 intangibles other than goodwill and going 
concern value (Intangible 1 and Intangible 2), and two other assets with 
fair market values (determined using all the facts and circumstances) as 
follows: inventory worth $1,000,000 and a building (a capital asset) 
worth $2,000,000. The fair market value of each of Intangible 1 and 
Intangible 2 is $50,000. PRS has one liability of $1,000,000, for which 
A bears the entire risk of loss under section 752 and the regulations 
thereunder. D purchases A's partnership interest for $650,000, resulting 
in a basis adjustment under section 743(b). After the purchase, D bears 
the entire risk of loss for PRS's liability under section 752 and the 
regulations thereunder. Therefore, D's basis in its interest in PRS is 
$1,650,000.
    (ii) D's basis in the transferred partnership interest (reduced by 
the amount of such basis that is attributable to partnership 
liabilities) is $650,000 ($1,650,000--$1,000,000). Under paragraph 
(a)(4)(i) of this section, partnership gross value is $2,950,000 (the 
amount that, if assigned to all partnership property, would result in a 
liquidating distribution to D equal to $650,000).
    (iii) Under paragraph (a)(3) of this section, the inventory has a 
fair market value of $1,000,000, and the building has a fair market 
value of $2,000,000. Thus, the aggregate value of partnership property 
other than section 197 intangibles, $3,000,000, is equal to or greater 
than partnership gross value, $2,950,000. Accordingly, under paragraphs 
(a)(3) and (5) of this section, the value assigned to each of the 
partnership's assets is as follows: inventory, $1,000,000; building, 
$2,000,000; Intangibles 1 and 2, $0; and goodwill and going concern 
value, $0. D's section 743(b) adjustment must be allocated under 
paragraph (b) of this section using these assigned fair market values.
    Example 2. (i) Assume the same facts as in Example 1, except that 
the fair market values of Intangible 1 and Intangible 2 are each 
$300,000, and that D purchases A's interest in

[[Page 696]]

PRS for $1,000,000. After the purchase, D's basis in its interest in PRS 
is $2,000,000.
    (ii) D's basis in the transferred partnership interest (reduced by 
the amount of such basis that is attributable to partnership 
liabilities) is $1,000,000 ($2,000,000--$1,000,000). Under paragraph 
(a)(4)(i) of this section, partnership gross value is $4,000,000 (the 
amount that, if assigned to all partnership property, would result in a 
liquidating distribution to D equal to $1,000,000).
    (iii) Under paragraph (a)(5) of this section, the residual section 
197 intangibles value is $1,000,000 (the excess of partnership gross 
value, $4,000,000, over the aggregate value of assets other than section 
197 intangibles, $3,000,000 (the sum of the value of the inventory, 
$1,000,000, and the value of the building, $2,000,000)). The partnership 
must determine the values of section 197 assets by allocating the 
residual section 197 intangibles value among the partnership's assets. 
The residual section 197 intangibles value is assigned first to section 
197 intangibles other than goodwill and going concern value, and then to 
goodwill and going concern value. Thus, $300,000 is assigned to each of 
Intangible 1 and Intangible 2, and $400,000 is assigned to goodwill and 
going concern value (the amount by which the residual section 197 
intangibles value, $1,000,000, exceeds the fair market value of section 
197 intangibles other than goodwill and going concern value, $600,000). 
D's section 743(b) adjustment must be allocated under paragraph (b) of 
this section using these assigned fair market values.
    Example 3. (i) Assume the same facts as in Example 1, except that 
the fair market values of Intangible 1 and Intangible 2 are each 
$300,000, and that D purchases A's interest in PRS for $750,000. After 
the purchase, D's basis in its interest in PRS is $1,750,000. Also 
assume that Intangible 1 was originally purchased for $300,000, and that 
its adjusted basis has been decreased to $50,000 as a result of 
amortization. Assume that, if PRS were to sell Intangible 1 for 
$300,000, it would recognize $250,000 of gain that would be treated as 
an unrealized receivable under the flush language in section 751(c).
    (ii) D's basis in the transferred partnership interest (reduced by 
the amount of such basis that is attributable to partnership 
liabilities) is $750,000 ($1,750,000--$1,000,000). Under paragraph 
(a)(4)(i) of this section, partnership gross value is $3,250,000 (the 
amount that, if assigned to all partnership property, would result in a 
liquidating distribution to D equal to $750,000).
    (iii) Under paragraph (a)(5) of this section, the residual section 
197 intangibles value is $250,000 (the amount by which partnership gross 
value, $3,250,000, exceeds the aggregate value of partnership property 
other than section 197 intangibles, $3,000,000). Intangible 1 has 
potential gain that would be treated as unrealized receivables under the 
flush language of section 751(c). The flush language receivables value 
in Intangible 1 is $300,000 (the sum of PRS's basis in Intangible 1, 
$50,000, and the amount of ordinary income, $250,000, that the 
partnership would recognize if Intangible 1 were sold for its actual 
fair market value). Because the residual section 197 intangibles value, 
$250,000, is less than the flush language receivables value of 
Intangible 1, Intangible 1 is assigned a value of $250,000, and 
Intangible 2 and goodwill and going concern value are assigned a value 
of zero. D's section 743(b) adjustment must be allocated under paragraph 
(b) of this section using these assigned fair market values.
    Example 4. Assume the same facts as in Example 1, except that the 
fair market values of Intangible 1 and Intangible 2 are each $300,000, 
and that A does not sell its interest in PRS. Instead, A contributes its 
interest in PRS to E, a newly formed corporation wholly-owned by A, in a 
transaction described in section 351. Assume that the contribution 
results in a basis adjustment under section 743(b) (other than zero). 
PRS determines that its value as a going concern immediately following 
the contribution is $3,000,000. Under paragraph (a)(4)(ii) of this 
section, partnership gross value is $4,000,000 (the value of PRS as a 
going concern, $3,000,000, increased by the partnership's liability, 
$1,000,000, immediately after the contribution). Under paragraph (a)(5) 
of this section, the residual section 197 intangibles value is 
$1,000,000 (the amount by which partnership gross value, $4,000,000, 
exceeds the aggregate value of partnership property other than section 
197 intangibles, $3,000,000). Of the residual section 197 intangibles 
value, $300,000 is assigned to each of Intangible 1 and Intangible 2, 
and $400,000 is assigned to goodwill and going concern value (the amount 
by which the residual section 197 intangibles value, $1,000,000, exceeds 
the fair market value of section 197 intangibles other than goodwill and 
going concern value, $600,000). E's section 743(b) adjustment must be 
allocated under paragraph (b)(5) of this section using these assigned 
fair market values.
    Example 5. G is the sole general partner in PRS, a limited 
partnership having three equal partners (G, H, and I). PRS has goodwill 
and going concern value, two section 197 intangibles other than goodwill 
and going concern value (Intangible 1 and Intangible 2), and two capital 
assets with fair market values (determined using all the facts and 
circumstances) as follows: Vacant land worth $1,000,000, and a building 
worth $2,000,000. The fair market value of each of Intangible 1 and 
Intangible 2 is $300,000. PRS has one liability of $1,000,000, for which 
G bears the entire risk of loss under section 752 and the regulations 
thereunder. PRS distributes the land to H in liquidation of H's interest 
in PRS. Immediately prior to the distribution, PRS's basis

[[Page 697]]

in the land is $800,000, and H's basis in its interest in PRS is 
$750,000. The distribution causes the partnership to increase the basis 
of its remaining property by $50,000 under section 734(b)(1)(B). PRS 
determines that its value as a going concern immediately following the 
distribution is $2,000,000. Under paragraph (a)(4)(iii) of this section, 
partnership gross value is $3,000,000 (the value of PRS as a going 
concern, $2,000,000, increased by the partnership's liability, 
$1,000,000, immediately after the distribution). Under paragraph (a)(5) 
of this section, the residual section 197 intangibles value of PRS's 
section 197 intangibles is $1,000,000 (the amount by which partnership 
gross value, $3,000,000, exceeds the aggregate value of partnership 
property other than section 197 intangibles, $2,000,000). Of the 
residual section 197 intangibles value, $300,000 is assigned to each of 
Intangible 1 and Intangible 2, and $400,000 is assigned to goodwill and 
going concern value (the amount by which the residual section 197 
intangibles value, $1,000,000, exceeds the fair market value of section 
197 intangibles other than goodwill and going concern value, $600,000). 
PRS's section 734(b) adjustment must be allocated under paragraph (c) of 
this section using these assigned fair market values.

    (b) Adjustments under section 743(b)--(1) Generally. (i) 
Application. For basis adjustments under section 743(b) resulting from 
substituted basis transactions, paragraph (b)(5) of this section shall 
apply. For basis adjustments under section 743(b) resulting from all 
other transfers, paragraphs (b)(2) through (4) of this section shall 
apply. Except as provided in paragraph (b)(5) of this section, the 
portion of the basis adjustment allocated to one class of property may 
be an increase while the portion allocated to the other class is a 
decrease. This would be the case even though the total amount of the 
basis adjustment is zero. Except as provided in paragraph (b)(5) of this 
section, the portion of the basis adjustment allocated to one item of 
property within a class may be an increase while the portion allocated 
to another is a decrease. This would be the case even though the basis 
adjustment allocated to the class is zero.
    (ii) Hypothetical transaction. For purposes of paragraphs (b)(2) 
through (b)(4) of this section, the allocation of the basis adjustment 
under section 743(b) between the classes of property and among the items 
of property within each class are made based on the allocations of 
income, gain, or loss (including remedial allocations under Sec. 1.704-
3(d)) that the transferee partner would receive (to the extent 
attributable to the acquired partnership interest) if, immediately after 
the transfer of the partnership interest, all of the partnership's 
property were disposed of in a fully taxable transaction for cash in an 
amount equal to the fair market value of such property (the hypothetical 
transaction). See Sec. 1.460-4(k)(3)(v)(B) for a rule relating to the 
computation of income or loss that would be allocated to the transferee 
from a contract accounted for under a long-term contract method of 
accounting as a result of the hypothetical transaction.
    (2) Allocations between classes of property--(i) In general. The 
amount of the basis adjustment allocated to the class of ordinary income 
property is equal to the total amount of income, gain, or loss 
(including any remedial allocations under Sec. 1.704-3(d)) that would 
be allocated to the transferee (to the extent attributable to the 
acquired partnership interest) from the sale of all ordinary income 
property in the hypothetical transaction. The amount of the basis 
adjustment to capital gain property is equal to--
    (A) The total amount of the basis adjustment under section 743(b); 
less
    (B) The amount of the basis adjustment allocated to ordinary income 
property under the preceding sentence; provided, however, that in no 
event may the amount of any decrease in basis allocated to capital gain 
property exceed the partnership's basis (or in the case of property 
subject to the remedial allocation method, the transferee's share of any 
remedial loss under Sec. 1.704-3(d) from the hypothetical transaction) 
in capital gain property. In the event that a decrease in basis 
allocated to capital gain property would otherwise exceed the 
partnership's basis in capital gain property, the excess must be applied 
to reduce the basis of ordinary income property.
    (ii) Examples. The provisions of this paragraph (b)(2) are 
illustrated by the following examples:

    Example 1. (i) A and B form equal partnership PRS. A contributes 
$50,000 and Asset 1, a nondepreciable capital asset with a fair market 
value of $50,000 and an adjusted tax

[[Page 698]]

basis of $25,000. B contributes $100,000. PRS uses the cash to purchase 
Assets 2, 3, and 4. After a year, A sells its interest in PRS to T for 
$120,000. At the time of the transfer, A's share of the partnership's 
basis in partnership assets is $75,000. Therefore, T receives a $45,000 
basis adjustment.
    (ii) Immediately after the transfer of the partnership interest to 
T, the adjusted basis and fair market value of PRS's assets are as 
follows:

------------------------------------------------------------------------
                                                          Assets
                                                 -----------------------
                                                   Adjusted  Fair market
                                                    basis       value
------------------------------------------------------------------------
Capital Gain Property:
    Asset 1.....................................    $25,000      $75,000
    Asset 2.....................................    100,000      117,500
Ordinary Income Property:
    Asset 3.....................................     40,000       45,000
    Asset 4.....................................     10,000        2,500
                                                 -----------------------
      Total.....................................    175,000      240,000
------------------------------------------------------------------------

    (iii) If PRS sold all of its assets in a fully taxable transaction 
at fair market value immediately after the transfer of the partnership 
interest to T, the total amount of capital gain that would be allocated 
to T is equal to $46,250 ($25,000 section 704(c) built-in gain from 
Asset 1, plus fifty percent of the $42,500 appreciation in capital gain 
property). T would also be allocated a $1,250 ordinary loss from the 
sale of the ordinary income property.
    (iv) The amount of the basis adjustment that is allocated to 
ordinary income property is equal to ($1,250) (the amount of the loss 
allocated to T from the hypothetical sale of the ordinary income 
property).
    (v) The amount of the basis adjustment that is allocated to capital 
gain property is equal to $46,250 (the amount of the basis adjustment, 
$45,000, less ($1,250), the amount of loss allocated to T from the 
hypothetical sale of the ordinary income property).
    Example 2. (i) A and B form equal partnership PRS. A and B each 
contribute $1,000 cash which the partnership uses to purchase Assets 1, 
2, 3, and 4. After a year, A sells its partnership interest to T for 
$1,000. T's basis adjustment under section 743(b) is zero.
    (ii) Immediately after the transfer of the partnership interest to 
T, the adjusted basis and fair market value of PRS's assets are as 
follows:

------------------------------------------------------------------------
                                                          Assets
                                                 -----------------------
                                                   Adjusted  Fair market
                                                    basis       value
------------------------------------------------------------------------
Capital Gain Property:
    Asset 1.....................................       $500         $750
    Asset 2.....................................        500          500
Ordinary Income Property:
    Asset 3.....................................        500          250
    Asset 4.....................................        500          500
                                                 -----------------------
      Total.....................................      2,000        2,000
------------------------------------------------------------------------

    (iii) If, immediately after the transfer of the partnership interest 
to T, PRS sold all of its assets in a fully taxable transaction at fair 
market value, T would be allocated a loss of $125 from the sale of the 
ordinary income property. Thus, the amount of the basis adjustment to 
ordinary income property is ($125). The amount of the basis adjustment 
to capital gain property is $125 (zero, the amount of the basis 
adjustment under section 743(b), less ($125), the amount of the basis 
adjustment allocated to ordinary income property).

    (3) Allocation within the class--(i) Ordinary income property. The 
amount of the basis adjustment to each item of property within the class 
of ordinary income property is equal to--
    (A) The amount of income, gain, or loss (including any remedial 
allocations under Sec. 1.704-3(d)) that would be allocated to the 
transferee (to the extent attributable to the acquired partnership 
interest) from the hypothetical sale of the item; reduced by
    (B) The product of--
    (1) Any decrease to the amount of the basis adjustment to ordinary 
income property required pursuant to the last sentence of paragraph 
(b)(2)(i) of this section; multiplied by
    (2) A fraction, the numerator of which is the fair market value of 
the item of property to the partnership and the denominator of which is 
the total fair market value of all of the partnership's items of 
ordinary income property.
    (ii) Capital gain property. The amount of the basis adjustment to 
each item of property within the class of capital gain property is equal 
to--
    (A) The amount of income, gain, or loss (including any remedial 
allocations under Sec. 1.704-3(d)) that would be allocated to the 
transferee (to the extent attributable to the acquired partnership 
interest) from the hypothetical sale of the item; minus
    (B) The product of--
    (1) The total amount of gain or loss (including any remedial 
allocations under Sec. 1.704-3(d)) that would be allocated to the 
transferee (to the extent

[[Page 699]]

attributable to the acquired partnership interest) from the hypothetical 
sale of all items of capital gain property, minus the amount of the 
positive basis adjustment to all items of capital gain property or plus 
the amount of the negative basis adjustment to capital gain property; 
multiplied by
    (2) A fraction, the numerator of which is the fair market value of 
the item of property to the partnership, and the denominator of which is 
the fair market value of all of the partnership's items of capital gain 
property.
    (iii) Special rules--(A) Assets in which partner has no interest. An 
asset with respect to which the transferee partner has no interest in 
income, gain, losses, or deductions shall not be taken into account in 
applying paragraph (b)(3)(ii)(B) of this section.
    (B) Limitation in decrease of basis. In no event may the amount of 
any decrease in basis allocated to an item of capital gain property 
under paragraph (b)(3)(ii)(B) of this section exceed the partnership's 
adjusted basis in that item (or in the case of property subject to the 
remedial allocation method, the transferee's share of any remedial loss 
under Sec. 1.704-3(d) from the hypothetical transaction). In the event 
that a decrease in basis allocated under paragraph (b)(3)(ii)(B) of this 
section to an item of capital gain property would otherwise exceed the 
partnership's adjusted basis in that item, the excess must be applied to 
reduce the remaining basis, if any, of other capital gain assets pro 
rata in proportion to the bases of such assets (as adjusted under this 
paragraph (b)(3)).
    (iv) Examples. The provisions of this paragraph (b)(3) are 
illustrated by the following examples:

    Example 1. (i) Assume the same facts as Example 1 in paragraph 
(b)(2)(ii) of this section. Of the $45,000 basis adjustment, $46,250 was 
allocated to capital gain property. The amount allocated to ordinary 
income property was ($1,250).
    (ii) Asset 1 is a capital gain asset, and T would be allocated 
$37,500 from the sale of Asset 1 in the hypothetical transaction. 
Therefore, the amount of the adjustment to Asset 1 is $37,500.
    (iii) Asset 2 is a capital gain asset, and T would be allocated 
$8,750 from the sale of Asset 2 in the hypothetical transaction. 
Therefore, the amount of the adjustment to Asset 2 is $8,750.
    (iv) Asset 3 is ordinary income property, and T would be allocated 
$2,500 from the sale of Asset 3 in the hypothetical transaction. 
Therefore, the amount of the adjustment to Asset 3 is $2,500.
    (v) Asset 4 is ordinary income property, and T would be allocated 
($3,750) from the sale of Asset 4 in the hypothetical transaction. 
Therefore, the amount of the adjustment to Asset 4 is ($3,750).
    Example 2. (i) Assume the same facts as Example 1 in paragraph 
(b)(2)(ii) of this section, except that A sold its interest in PRS to T 
for $110,000 rather than $120,000. T, therefore, receives a basis 
adjustment under section 743(b) of $35,000. Of the $35,000 basis 
adjustment, ($1,250) is allocated to ordinary income property, and 
$36,250 is allocated to capital gain property.
    (ii) Asset 3 is ordinary income property, and T would be allocated 
$2,500 from the sale of Asset 3 in the hypothetical transaction. 
Therefore, the amount of the adjustment to Asset 3 is $2,500.
    (iii) Asset 4 is ordinary income property, and T would be allocated 
($3,750) from the sale of Asset 4 in the hypothetical transaction. 
Therefore, the amount of the adjustment to Asset 4 is ($3,750).
    (iv) Asset 1 is a capital gain asset, and T would be allocated 
$37,500 from the sale of Asset 1 in the hypothetical transaction. Asset 
2 is a capital gain asset, and T would be allocated $8,750 from the sale 
of Asset 2 in the hypothetical transaction. The total amount of gain 
that would be allocated to T from the sale of the capital gain assets in 
the hypothetical transaction is $46,250, which exceeds the amount of the 
basis adjustment allocated to capital gain property by $10,000. The 
amount of the adjustment to Asset 1 is $33,604 ($37,500 minus $3,896 
($10,000x$75,000/$192,500)). The amount of the basis adjustment to Asset 
2 is $2,646 ($8,750 minus $6,104 ($10,000x$117,500/$192,500)).

    (4) Income in respect of a decedent--(i) In general. Where a 
partnership interest is transferred as a result of the death of a 
partner, under section 1014(c) the transferee's basis in its partnership 
interest is not adjusted for that portion of the interest, if any, which 
is attributable to items representing income in respect of a decedent 
under section 691. See Sec. 1.742-1. Accordingly, if a partnership 
interest is transferred as a result of the death of a partner, and the 
partnership holds assets representing income in respect of a decedent, 
no part of the basis adjustment under section 743(b) is allocated to 
these assets. See Sec. 1.743-1(b).

[[Page 700]]

    (ii) The provisions of this paragraph (b)(4) are illustrated by the 
following example:

    Example. (i) A and B are equal partners in personal service 
partnership PRS. In 2004, as a result of B's death, B's partnership 
interest is transferred to T when PRS's balance sheet (reflecting a cash 
receipts and disbursements method of accounting) is as follows (based on 
all the facts and circumstances):

                                 Assets
------------------------------------------------------------------------
                                                                  Fair
                                                     Adjusted    market
                                                      basis      value
------------------------------------------------------------------------
Section 197 Intangible............................     $2,000     $5,000
Unrealized Receivables............................          0     15,000
                                                   ---------------------
        Total.....................................     $2,000    $20,000
------------------------------------------------------------------------
                         Liabilities and Capital
------------------------------------------------------------------------
                                                     Adjusted     Fair
                                                    per books    market
                                                                 value
------------------------------------------------------------------------
Capital:
    A.............................................      1,000     10,000
    B.............................................      1,000     10,000
                                                   ---------------------
        Total.....................................     $2,000    $20,000
------------------------------------------------------------------------

    (ii) None of the assets owned by PRS is section 704(c) property, and 
the section 197 intangible is not amortizable. The fair market value of 
T's partnership interest on the applicable date of valuation set forth 
in section 1014 is $10,000. Of this amount, $2,500 is attributable to 
T's 50% share of the partnership's section 197 intangible, and $7,500 is 
attributable to T's 50% share of the partnership's unrealized 
receivables. The partnership's unrealized receivables represent income 
in respect of a decedent. Accordingly, under section 1014(c), T's basis 
in its partnership interest is not adjusted for that portion of the 
interest which is attributable to the unrealized receivables. Therefore, 
T's basis in its partnership interest is $2,500.
    (iii) Under paragraph (a)(4)(i)(C) of this section, solely for 
purposes of determining partnership gross value, T's basis in its 
partnership interest is deemed to be $10,000. Under paragraph (a)(4)(i) 
of this section, partnership gross value is $20,000 (the amount that, if 
assigned to all partnership property, would result in a liquidating 
distribution to T equal to $10,000).
    (iv) Under paragraph (a)(5) of this section, the residual section 
197 intangibles value is $5,000 (the excess of partnership gross value, 
$20,000, over the aggregate value of assets other than section 197 
intangibles, $15,000). The residual section 197 intangibles value is 
assigned first to section 197 intangibles other than goodwill and going 
concern value, and then to goodwill and going concern value. Thus, 
$5,000 is assigned to the section 197 intangible, and $0 is assigned to 
goodwill and going concern value. T's section 743(b) adjustment must be 
allocated using these assigned fair market values.
    (v) At the time of the transfer, B's share of the partnership's 
basis in partnership assets is $1,000. Accordingly, T receives a $1,500 
basis adjustment under section 743(b). Under this paragraph (b)(4), the 
entire basis adjustment is allocated to the partnership's section 197 
intangible.

    (5) Substituted basis transactions--(i) In general. This paragraph 
(b)(5) applies to basis adjustments under section 743(b) that result 
from exchanges in which the transferee's basis in the partnership 
interest is determined in whole or in part by reference to the 
transferor's basis in that interest. For exchanges on or after June 9, 
2003, this paragraph (b)(5) also applies to basis adjustments under 
section 743(b) that result from exchanges in which the transferee's 
basis in the partnership interest is determined by reference to other 
property held at any time by the transferee. For example, this paragraph 
(b)(5) applies if a partnership interest is contributed to a corporation 
in a transaction to which section 351 applies, if a partnership interest 
is contributed to a partnership in a transaction to which section 721(a) 
applies, or if a partnership interest is distributed by a partnership in 
a transaction to which section 731(a) applies.
    (ii) Allocations between classes of property. If the total amount of 
the basis adjustment under section 743(b) is zero, then no adjustment to 
the basis of partnership property will be made under this paragraph 
(b)(5). If there is an increase in basis to be allocated to partnership 
assets, such increase must be allocated to capital gain property or 
ordinary income property, respectively, only if the total amount of gain 
or loss (including any remedial allocations under Sec. 1.704-3(d)) that 
would be allocated to the transferee (to the extent attributable to the 
acquired partnership interest) from the hypothetical sale of all such 
property would result in a net gain or net income, as the case may be, 
to the transferee. Where, under the preceding sentence, an increase in 
basis may be allocated to both capital gain assets and ordinary income 
assets, the increase shall be allocated to each

[[Page 701]]

class in proportion to the net gain or net income, respectively, which 
would be allocated to the transferee from the sale of all assets in each 
class. If there is a decrease in basis to be allocated to partnership 
assets, such decrease must be allocated to capital gain property or 
ordinary income property, respectively, only if the total amount of gain 
or loss (including any remedial allocations under Sec. 1.704-3(d)) that 
would be allocated to the transferee (to the extent attributable to the 
acquired partnership interest) from the hypothetical sale of all such 
property would result in a net loss to the transferee. Where, under the 
preceding sentence, a decrease in basis may be allocated to both capital 
gain assets and ordinary income assets, the decrease shall be allocated 
to each class in proportion to the net loss which would be allocated to 
the transferee from the sale of all assets in each class.
    (iii) Allocations within the classes--(A) Increases. If there is an 
increase in basis to be allocated within a class, the increase must be 
allocated first to properties with unrealized appreciation in proportion 
to the transferee's share of the respective amounts of unrealized 
appreciation before such increase (but only to the extent of the 
transferee's share of each property's unrealized appreciation). Any 
remaining increase must be allocated among the properties within the 
class in proportion to the transferee's share of the amount that would 
be realized by the partnership upon the hypothetical sale of each asset 
in the class.
    (B) Decreases. If there is a decrease in basis to be allocated 
within a class, the decrease must be allocated first to properties with 
unrealized depreciation in proportion to the transferee's shares of the 
respective amounts of unrealized depreciation before such decrease (but 
only to the extent of the transferee's share of each property's 
unrealized depreciation). Any remaining decrease must be allocated among 
the properties within the class in proportion to the transferee's shares 
of their adjusted bases (as adjusted under the preceding sentence).
    (C) Limitation in decrease of basis. Where, as the result of a 
transaction to which this paragraph (b)(5) applies, a decrease in basis 
must be allocated to capital gain assets, ordinary income assets, or 
both, and the amount of the decrease otherwise allocable to a particular 
class exceeds the transferee's share of the adjusted basis to the 
partnership of all depreciated assets in that class, the transferee's 
negative basis adjustment is limited to the transferee's share of the 
partnership's adjusted basis in all depreciated assets in that class.
    (D) Carryover adjustment. Where a transferee's negative basis 
adjustment under section 743(b) cannot be allocated to any asset, 
because the adjustment exceeds the transferee's share of the adjusted 
basis to the partnership of all depreciated assets in a particular 
class, the adjustment is made when the partnership subsequently acquires 
property of a like character to which an adjustment can be made.
    (iv) Examples. The provisions of this paragraph (b)(5) are 
illustrated by the following examples:

    Example 1. A is a member of partnership LTP, which has made an 
election under section 754. The three partners in LTP have equal 
interests in capital and profits. Solely in exchange for a partnership 
interest in UTP, A contributes its interest in LTP to UTP in a 
transaction described in section 721. At the time of the transfer, A's 
basis in its partnership interest ($5,000) equals its share of inside 
basis (also $5,000). Under section 723, UTP's basis in its interest in 
LTP is $5,000. LTP's only two assets on the date of contribution are 
inventory with a basis of $5,000 and a fair market value of $7,500, and 
a nondepreciable capital asset with a basis of $10,000 and a fair market 
value of $7,500. The amount of the basis adjustment under section 743(b) 
to partnership property is $0 ($5,000, UTP's basis in its interest in 
LTP, minus $5,000, UTP's share of LTP's basis in partnership assets). 
Because UTP acquired its interest in LTP in a substituted basis 
transaction, and the total amount of the basis adjustment under section 
743(b) is zero, UTP receives no special basis adjustments under section 
743(b) with respect to the partnership property of LTP.
    Example 2. (i) A purchases a partnership interest in LTP at a time 
when an election under section 754 is not in effect. The three partners 
in LTP have equal interests in capital and profits. During a later year 
for which LTP has an election under section 754 in effect, and in a 
transaction that is unrelated to A's purchase of the LTP interest, A 
contributes its interest in LTP to UTP in a transaction described in 
section 721 (solely in

[[Page 702]]

exchange for a partnership interest in UTP). At the time of the 
transfer, A's adjusted basis in its interest in LTP is $20,433. Under 
section 721, A recognizes no gain or loss as a result of the 
contribution of its partnership interest to UTP. Under section 723, 
UTP's basis in its partnership interest in LTP is $20,433. The balance 
sheet of LTP on the date of the contribution shows the following:

------------------------------------------------------------------------
                                                         Assets
                                               -------------------------
                                                  Adjusted   Fair market
                                                   basis        value
------------------------------------------------------------------------
Cash..........................................       $5,000       $5,000
Accounts receivable...........................       10,000       10,000
Inventory.....................................       20,000       21,000
Nondepreciable capital asset..................       20,000       40,000
                                               -------------------------
  Total.......................................       55,000       76,000
------------------------------------------------------------------------


------------------------------------------------------------------------
                                                 Liabilities and Capital
                                               -------------------------
                                                  Adjusted   Fair market
                                                 per books      value
------------------------------------------------------------------------
Liabilities...................................      $10,000      $10,000
Capital:
  A...........................................       15,000       22,000
  B...........................................       15,000       22,000
  C...........................................       15,000       22,000
                                               -------------------------
    Total.....................................       55,000       76,000
------------------------------------------------------------------------

    (ii) The amount of the basis adjustment under section 743(b) is the 
difference between the basis of UTP's interest in LTP and UTP's share of 
the adjusted basis to LTP of partnership property. UTP's interest in the 
previously taxed capital of LTP is $15,000 ($22,000, the amount of cash 
UTP would receive if LTP liquidated immediately after the hypothetical 
transaction, decreased by $7,000, the amount of tax gain allocated to 
UTP from the hypothetical transaction). UTP's share of the adjusted 
basis to LTP of partnership property is $18,333 ($15,000 share of 
previously taxed capital, plus $3,333 share of LTP's liabilities). The 
amount of the basis adjustment under section 743(b) to partnership 
property therefore, is $2,100 ($20,433 minus $18,333).
    (iii) The total amount of gain that would be allocated to UTP from 
the hypothetical sale of capital gain property is $6,666.67 (one-third 
of the excess of the fair market value of LTP's nondepreciable capital 
asset, $40,000, over its basis, $20,000). The total amount of gain that 
would be allocated to UTP from the hypothetical sale of ordinary income 
property is $333.33 (one-third of the excess of the fair market value of 
LTP's inventory, $21,000, over its basis, $20,000). Under this paragraph 
(b)(5), LTP must allocate $2,000 ($6,666.67 divided by $7,000 times 
$2,100) of UTP's basis adjustment to the nondepreciable capital asset. 
LTP must allocate $100 ($333.33 divided by $7,000 times $2,100) of UTP's 
basis adjustment to the inventory.

    (c) Adjustments under section 734(b)--(1) Allocations between 
classes of property--(i) General rule. Where there is a distribution of 
partnership property resulting in an adjustment to the basis of 
undistributed partnership property under section 734(b)(1)(B) or 
(b)(2)(B), the adjustment must be allocated to remaining partnership 
property of a character similar to that of the distributed property with 
respect to which the adjustment arose. Thus, when the partnership's 
adjusted basis of distributed capital gain property immediately prior to 
distribution exceeds the basis of the property to the distributee 
partner (as determined under section 732), the basis of the 
undistributed capital gain property remaining in the partnership is 
increased by an amount equal to the excess. Conversely, when the basis 
to the distributee partner (as determined under section 732) of 
distributed capital gain property exceeds the partnership's adjusted 
basis of such property immediately prior to the distribution, the basis 
of the undistributed capital gain property remaining in the partnership 
is decreased by an amount equal to such excess. Similarly, where there 
is a distribution of ordinary income property, and the basis of the 
property to the distributee partner (as determined under section 732) is 
not the same as the partnership's adjusted basis of the property 
immediately prior to distribution, the adjustment is made only to 
undistributed property of the same class remaining in the partnership.
    (ii) Special rule. Where there is a distribution resulting in an 
adjustment under section 734(b)(1)(A) or (b)(2)(A) to the basis of 
undistributed partnership property, the adjustment is allocated only to 
capital gain property.
    (2) Allocations within the classes--(i) Increases. If there is an 
increase in basis to be allocated within a class, the increase must be 
allocated first to properties with unrealized appreciation in proportion 
to their respective amounts of unrealized appreciation before such 
increase (but only to the extent of each property's unrealized 
appreciation). Any remaining increase must be allocated among the 
properties within the class in proportion to their fair market values.

[[Page 703]]

    (ii) Decreases. If there is a decrease in basis to be allocated 
within a class, the decrease must be allocated first to properties with 
unrealized depreciation in proportion to their respective amounts of 
unrealized depreciation before such decrease (but only to the extent of 
each property's unrealized depreciation). Any remaining decrease must be 
allocated among the properties within the class in proportion to their 
adjusted bases (as adjusted under the preceding sentence).
    (3) Limitation in decrease of basis. Where a decrease in the basis 
of partnership assets is required under section 734(b)(2) and the amount 
of the decrease exceeds the adjusted basis to the partnership of 
property of the required character, the basis of such property is 
reduced to zero (but not below zero).
    (4) Carryover adjustment. Where, in the case of a distribution, an 
increase or a decrease in the basis of undistributed property cannot be 
made because the partnership owns no property of the character required 
to be adjusted, or because the basis of all the property of a like 
character has been reduced to zero, the adjustment is made when the 
partnership subsequently acquires property of a like character to which 
an adjustment can be made.
    (5) Cross reference. See Sec. 1.460-4(k)(3)(v)(B) for a rule 
relating to the computation of unrealized appreciation or depreciation 
in a contract accounted for under a long-term contract method of 
accounting.
    (6) Example. The following example illustrates this paragraph (c):

    Example. (i) A, B, and C form equal partnership PRS. A contributes 
$50,000 and Asset 1, nondepreciable capital gain property with a fair 
market value of $50,000 and an adjusted tax basis of $25,000. B and C 
each contributes $100,000. PRS uses the cash to purchase Assets 2, 3, 4, 
5, and 6. Assets 2 and 3 are nondepreciable capital assets, and Assets 
4, 5, and 6 are inventory that has not appreciated substantially in 
value within the meaning of section 751(b)(3). Assets 4, 5, and 6 are 
the only assets held by the partnership that are subject to section 751. 
The partnership has an election in effect under section 754. After seven 
years, the adjusted basis and fair market value of PRS's assets are as 
follows:

------------------------------------------------------------------------
                                                         Assets
                                               -------------------------
                                                  Adjusted   Fair market
                                                   basis        value
------------------------------------------------------------------------
Capital Gain Property:
  Asset 1.....................................     $ 25,000     $ 75,000
  Asset 2.....................................      100,000      117,500
  Asset 3.....................................       50,000       60,000
Ordinary Income Property:
  Asset 4.....................................       40,000       45,000
  Asset 5.....................................       50,000       60,000
    Asset 6...................................       10,000        2,500
                                               -------------------------
    Total.....................................      275,000      360,000
------------------------------------------------------------------------

    (ii) Allocation between classes. Assume that PRS distributes Assets 
3 and 5 to A in complete liquidation of A's interest in the partnership. 
A's basis in the partnership interest was $75,000. The partnership's 
basis in Assets 3 and 5 was $50,000 each. A's $75,000 basis in its 
partnership interest is allocated between Assets 3 and 5 under sections 
732(b) and (c). A will, therefore, have a basis of $25,000 in Asset 3 
(capital gain property), and a basis of $50,000 in Asset 5 (section 751 
property). The distribution results in a $25,000 increase in the basis 
of capital gain property. There is no change in the basis of ordinary 
income property.
    (iii) Allocation within class. The amount of the basis increase to 
capital gain property is $25,000 and must be allocated among the 
remaining capital gain assets in proportion to the difference between 
the fair market value and basis of each. The fair market value of Asset 
1 exceeds its basis by $50,000. The fair market value of Asset 2 exceeds 
its basis by $17,500. Therefore, the basis of Asset 1 will be increased 
by $18,519 ($25,000, multiplied by $50,000, divided by $67,500), and the 
basis of Asset 2 will be increased by $6,481 ($25,000 multiplied by 
$17,500, divided by $67,500).

    (d) Required statements. See Sec. 1.743-1(k)(2) for provisions 
requiring the transferee of a partnership interest to provide 
information to the partnership relating to the transfer of an interest 
in the partnership. See Sec. 1.743-1(k)(1) for a provision requiring 
the partnership to attach a statement to the partnership return showing 
the computation of a basis adjustment under section 743(b) and the 
partnership properties to which the adjustment is allocated under 
section 755. See Sec. 1.732-1(d)(3) for a provision requiring a 
transferee partner to attach a statement to its return showing the 
computation of a basis adjustment under section 732(d) and the 
partnership properties to which the adjustment is allocated under 
section 755.

[[Page 704]]

See Sec. 1.732-1(d)(5) for a provision requiring the partnership to 
provide information to a transferee partner reporting a basis adjustment 
under section 732(d).
    (e) Effective Date--(1) Generally. Except as provided in paragraphs 
(b)(5) and (e)(2) of this section, this section applies to transfers of 
partnership interests and distributions of property from a partnership 
that occur on or after December 15, 1999.
    (2) Special rules. Paragraphs (a) and (b)(3)(iii) of this section 
apply to transfers of partnership interests and distributions of 
property from a partnership that occur on or after June 9, 2003.

[T.D. 8847, 64 FR 69916, Dec. 15, 1999; 65 FR 9220, Feb. 24, 2000, as 
amended by T.D. 9059, 68 FR 34295, June 9, 2003; T.D. 9137, 69 FR 42559, 
July 16, 2004]

                               definitions



Sec. 1.761-1  Terms defined.

    (a) Partnership. The term partnership means a partnership as 
determined under Sec. Sec. 301.7701-1, 301.7701-2, and 301.7701-3 of 
this chapter.
    (b) Partner. The term partner means a member of a partnership.
    (c) Partnership agreement. For the purposes of subchapter K, a 
partnership agreement includes the original agreement and any 
modifications thereof agreed to by all the partners or adopted in any 
other manner provided by the partnership agreement. Such agreement or 
modifications can be oral or written. A partnership agreement may be 
modified with respect to a particular taxable year subsequent to the 
close of such taxable year, but not later than the date (not including 
any extension of time) prescribed by law for the filing of the 
partnership return. As to any matter on which the partnership agreement, 
or any modification thereof, is silent, the provisions of local law 
shall be considered to constitute a part of the agreement.
    (d) Liquidation of partner's interest. The term liquidation of a 
partner's interest means the termination of a partner's entire interest 
in a partnership by means of a distribution, or a series of 
distributions, to the partner by the partnership. A series of 
distributions will come within the meaning of this term whether they are 
made in one year or in more than one year. Where a partner's interest is 
to be liquidated by a series of distributions, the interest will not be 
considered as liquidated until the final distribution has been made. For 
the basis of property distributed in one liquidating distribution, or in 
a series of distributions in liquidation, see section 732(b). A 
distribution which is not in liquidation of a partner's entire interest, 
as defined in this paragraph, is a current distribution. Current 
distributions, therefore, include distributions in partial liquidation 
of a partner's interest, and distributions of the partner's distributive 
share. See paragraph (a)(1)(ii) of Sec. 1.731-1.
    (e) Distribution of partnership interest. For purposes of section 
708(b)(1)(B) and Sec. 1.708-1(b)(1)(iv), the deemed distribution of an 
interest in a new partnership by a partnership that terminates under 
section 708(b)(1)(B) is not a sale or exchange of an interest in the new 
partnership. However, the deemed distribution of an interest in a new 
partnership by a partnership that terminates under section 708(b)(1)(B) 
is treated as an exchange of the interest in the new partnership for 
purposes of section 743. This paragraph (e) applies to terminations of 
partnerships under section 708(b)(1)(B) occurring on or after May 9, 
1997; however, this paragraph (e) may be applied to terminations 
occurring on or after May 9, 1996, provided that the partnership and its 
partners apply this paragraph (e) to the termination in a consistent 
manner.

[T.D. 6500, 25 FR 11814, Nov. 26, 1960, as amended by T.D. 7208, 37 FR 
20686, Oct. 3, 1972; T.D. 8697, 61 FR 66588, Dec. 18, 1996; T.D. 8717, 
62 FR 25501, May 9, 1997]



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

    (a) Exclusion of eligible unincorporated organizations--(1) In 
general. Under conditions set forth in this section, an unincorporated 
organization described in subparagraph (2) or (3) of this paragraph may 
be excluded from the application of all or a part of the provisions of 
subchapter K of chapter 1 of the Code. Such organization must be

[[Page 705]]

availed of (i) for investment purposes only and not for the active 
conduct of a business, or (ii) for the joint production, extraction, or 
use of property, but not for the purpose of selling services or property 
produced or extracted. The members of such organization must be able to 
compute their income without the necessity of computing partnership 
taxable income. Any syndicate, group, pool, or joint venture which is 
classifiable as an association, or any group operating under an 
agreement which creates an organization classifiable as an association, 
does not fall within these provisions.
    (2) Investing partnership. Where the participants in the joint 
purchase, retention, sale, or exchange of investment property:
    (i) Own the property as coowners,
    (ii) Reserve the right separately to take or dispose of their shares 
of any property acquired or retained, and
    (iii) Do not actively conduct business or irrevocably authorize some 
person or persons acting in a representative capacity to purchase, sell, 
or exchange such investment property, although each separate participant 
may delegate authority to purchase, sell, or exchange his share of any 
such investment property for the time being for his account, but not for 
a period of more than a year, then

such group may be excluded from the application of the provisions of 
subchapter K under the rules set forth in paragraph (b) of this section.
    (3) Operating agreements. Where the participants in the joint 
production, extraction, or use of property:
    (i) Own the property as coowners, either in fee or under lease or 
other form of contract granting exclusive operating rights, and
    (ii) Reserve the right separately to take in kind or dispose of 
their shares of any property produced, extracted, or used, and
    (iii) Do not jointly sell services or the property produced or 
extracted, although each separate participant may delegate authority to 
sell his share of the property produced or extracted for the time being 
for his account, but not for a period of time in excess of the minimum 
needs of the industry, and in no event for more than 1 year, then

such group may be excluded from the application of the provisions of 
subchapter K under the rules set forth in paragraph (b) of this section. 
However, the preceding sentence does not apply to any unincorporated 
organization one of whose principal purposes is cycling, manufacturing, 
or processing for persons who are not members of the organization. In 
addition, except as provided in paragraph (d)(2)(i) of this section, 
this paragraph (a)(3) does not apply to any unincorporated organization 
that produces natural gas under a joint operating agreement, unless all 
members of the unincorporated organization comply with paragraph (d) of 
this section.
    (b) Complete exclusion from subchapter K--(1) Time for making 
election for exclusion. Any unincorporated organization described in 
subparagraph (1) and either (2) or (3) of paragraph (a) of this section 
which wishes to be excluded from all of subchapter K must make the 
election provided in section 761(a) not later than the time prescribed 
by paragraph (e) of Sec. 1.6031-1 (including extensions thereof) for 
filing the partnership return for the first taxable year for which 
exclusion from subchapter K is desired. Notwithstanding the prior 
sentence such organization may be deemed to have made the election in 
the manner prescribed in subparagraph (2)(ii) of this paragraph.
    (2) Method of making election. (i) Except as provided in subdivision 
(ii) of this subparagraph, any unincorporated organization described in 
subparagraphs (1) and either (2) or (3) of paragraph (a) of this section 
which wishes to be excluded from all of subchapter K must make the 
election provided in section 761(a) in a statement attached to, or 
incorporated in, a properly executed partnership return, Form 1065, 
which shall contain the information required in this subdivision. Such 
return shall be filed with the internal revenue officer with whom a 
partnership return, Form 1065, would be required to be filed if no 
election were made. Where, for the purpose of determining such officer, 
it is necessary to determine the internal revenue district (or service 
center serving such district) in which the electing organization has its 
principal office or place of business,

[[Page 706]]

the principal office or place of business of the person filing the 
return shall be considered the principal office or place of business of 
the organization. The partnership return must be filed not later than 
the time prescribed by paragraph (e) of Sec. 1.6031-1 (including 
extensions thereof) for filing the partnership return with respect to 
the first taxable year for which exclusion from subchapter K is desired. 
Such partnership return shall contain, in lieu of the information 
required by Form 1065 and by the instructions relating thereto, only the 
name or other identification and the address of the organization 
together with information on the return, or in the statement attached to 
the return, showing the names, addresses, and identification numbers of 
all the members of the organization; a statement that the organization 
qualifies under subparagraphs (1) and either (2) or (3) of paragraph (a) 
of this section; a statement that all of the members of the organization 
elect that it be excluded from all of subchapter K; and a statement 
indicating where a copy of the agreement under which the organization 
operates is available (or if the agreement is oral, from whom the 
provisions of the agreement may be obtained).
    (ii) If an unincorporated organization described in subparagraphs 
(1) and either (2) or (3) of paragraph (a) of this section does not make 
the election provided in section 761(a) in the manner prescribed by 
subdivision (i) of this subparagraph, it shall nevertheless be deemed to 
have made the election if it can be shown from all the surrounding facts 
and circumstances that it was the intention of the members of such 
organization at the time of its formation to secure exclusion from all 
of subchapter K beginning with the first taxable year of the 
organization. Although the following facts are not exclusive, either one 
of such facts may indicate the requisite intent:
    (a) At the time of the formation of the organization there is an 
agreement among the members that the organization be excluded from 
subchapter K beginning with the first taxable year of the organization, 
or
    (b) The members of the organization owning substantially all of the 
capital interests report their respective shares of the items of income, 
deductions, and credits of the organization on their respective returns 
(making such elections as to individual items as may be appropriate) in 
a manner consistent with the exclusion of the organization from 
subchapter K beginning with the first taxable year of the organization.
    (3) Effect of election--(i) In general. An election under this 
section to be excluded will be effective unless within 90 days after the 
formation of the organization (or by October 15, 1956, whichever is 
later) any member of the organization notifies the Commissioner that the 
member desires subchapter K to apply to such organization, and also 
advises the Commissioner that he has so notified all other members of 
the organization by registered or certified mail. Such election is 
irrevocable as long as the organization remains qualified under 
subparagraphs (1) and either (2) or (3) of paragraph (a) of this 
section, or unless approval of revocation of the election is secured 
from the Commissioner. Application for permission to revoke the election 
must be submitted to the Commissioner of Internal Revenue, Attention: 
T:I, Washington, DC 20224, no later than 30 days after the beginning of 
the first taxable year to which the revocation is to apply.
    (ii) Special rule. Notwithstanding subdivision (i) of this 
subparagraph, an election deemed made pursuant to subparagraph (2)(ii) 
of this paragraph will not be effective in the case of an organization 
which had a taxable year ending on or before November 30, 1972, if any 
member of the organization notifies the Commissioner that the member 
desires subchapter K to apply to such organization, and also advises the 
Commissioner that he has so notified all other members of the 
organization by registered or certified mail. Such notification to the 
Commissioner must be made on or before January 2, 1973 and must include 
the names and addresses of all of the members of the organization.
    (c) Partial exclusion from subchapter K. An unincorporated 
organization which wishes to be excluded from only certain sections of 
subchapter K must submit to the Commissioner, no later than 90

[[Page 707]]

days after the beginning of the first taxable year for which partial 
exclusion is desired, a request for permission to be excluded from 
certain provisions of subchapter K. The request shall set forth the 
sections of subchapter K from which exclusion is sought and shall state 
that such organization qualifies under subparagraphs (1) and either (2) 
or (3) of paragraph (a) of this section, and that the members of the 
organization elect to be excluded to the extent indicated. Such 
exclusion shall be effective only upon approval of the election by the 
Commissioner and subject to the conditions he may impose.
    (d) Rules for gas producers that produce natural gas under joint 
operating agreements--(1) Joint operating agreements and gas balancing. 
Co-owners of a property producing natural gas enter into a joint 
operating agreement (JOA) to define the rights and obligations of each 
co- producer of the gas in place. The JOA determines, among other 
things, each co-producer's proportionate share of the natural gas as it 
is produced from the reservoir, together with the associated production 
expenses. A gas imbalance arises when a co-producer does not take its 
proportionate share of current gas production under the JOA 
(underproducer) and another co-producer takes more than its 
proportionate share of current production (overproducer). The co-
producers often enter into a gas balancing agreement (GBA) as an 
addendum to their JOA to establish their rights and obligations when a 
gas imbalance arises. A GBA typically allows the overproducer to take 
the amount of the gas imbalance (overproduced gas) and entitles the 
underproducer to recoup the overproduced gas either from the volume of 
the gas remaining in the reservoir or by a cash balancing payment.
    (2) Permissible gas balancing methods--(i) General requirement. All 
co-producers of natural gas operating under the same JOA must use the 
cumulative gas balancing method, as described in paragraph (d)(3) of 
this section, unless they use the annual gas balancing method described 
in paragraph (d)(4) of this section. A co-producer's failure to comply 
with the provisions of this paragraph (d)(2)(i) generally constitutes 
the use of an impermissible method of accounting, requiring a change to 
a permissible method under Sec. 1.446-1(e)(3) with any terms and 
conditions as may be imposed by the Commissioner. The co-producers' 
election to be excluded from all or part of subchapter K will not be 
revoked, unless the Commissioner determines that there was willful 
failure to comply with the requirements of this paragraph (d)(2)(i).
    (ii) Change in method of accounting; adoption of method of 
accounting--(A) In general. The annual gas balancing method and the 
cumulative gas balancing method are methods of accounting. Accordingly, 
a change to or from either of these methods is a change in method of 
accounting that requires the consent of the Commissioner. See section 
446(e) and Sec. 1.446-1(e). For purposes of this section, each JOA is 
treated as a separate trade or business. Paragraph (d)(2)(ii)(B) of this 
section provides rules for adopting either permissible method of 
accounting. Paragraph (d)(2)(ii)(C) of this section provides rules on 
the timing of required changes to either permissible method during the 
transitional period, and paragraph (d)(5) of this section contains the 
procedural provisions for making a change in method of accounting 
required in paragraph (d)(2)(ii)(C) of this section.
    (B) Adoption of method of accounting. A co-producer must adopt a 
permissible method for each JOA entered into on or after the start of 
the co-producer's first taxable year beginning after December 31, 1994 
(or, in the case of the use of the annual gas balancing method by co-
producers not having the same taxable year, the start of the first 
taxable year beginning after December 31, 1994, of the co-producer whose 
taxable year begins latest in the calendar year). If a co-producer is 
adopting the cumulative method, the co-producer may adopt the method by 
using the method on its timely filed return for the taxable year of 
adoption. A co-producer may adopt the annual gas balancing method with 
the permission of the Commissioner under guidelines set forth in 
paragraph (d)(4)(ii) of this section.
    (C) Required change in method of accounting for certain joint 
operating agreements. This paragraph (d)(2)(ii)(C) applies to certain 
JOAs entered into prior

[[Page 708]]

to 1996. Except in the case of a part-year change in method of 
accounting or in the case of the cessation of a JOA (both of which are 
described in this paragraph (d)(2)(ii)(C)), for each JOA entered into 
prior to a co-producer's first taxable year beginning after December 31, 
1994, and in effect as of the beginning of that year, the co-producer 
must change its method of accounting for sales of gas and its treatment 
of certain related deductions and credits to a permissible method as of 
the start of its first taxable year beginning after December 31, 1994. 
In the case of a JOA of co-producers that do not all have the same 
taxable year and that choose the annual gas balancing method, if the JOA 
is entered into prior to the first taxable year beginning after December 
31, 1994 of the co-producer whose taxable year begins latest in the 
calendar year and the JOA is in effect as of January 1, 1996, a change 
to the annual gas balancing method by each co-producer under that JOA is 
made as of January 1, 1996 (part-year change in method of accounting). 
If the co-producers would have made a part-year change to the annual gas 
balancing method but for the fact that their JOA ceased to be in effect 
before January 1, 1996 (cessation of a JOA), the co-producers do not 
change their method of accounting with respect to the JOA. Rather, for 
their taxable years in which the JOA ceases to be in effect, the co-
producers use their current method of accounting with respect to that 
JOA.
    (3) Cumulative gas balancing method--(i) In general. The cumulative 
gas balancing method (cumulative method), solely for purposes of 
reporting income from gas sales and certain related deductions and 
credits, treats each co-producer under the same JOA as the sole owner of 
its percentage share of the total gas in the reservoir and disregards 
the ownership arrangement described in the JOA for gas as it is produced 
from the reservoir. Each co-producer is considered to be taking only its 
share of the total gas in the reservoir as long as the gas remaining in 
the reservoir is sufficient to satisfy the ownership rights of the co-
producers in their percentage shares of the total gas in the reservoir. 
After a co-producer has taken its entire share of the total gas in the 
reservoir, any additional gas taken by that co-producer (taking co-
producer) is treated as having been taken from its other co-producers' 
shares of the total gas in the reservoir. The effect of being treated as 
a taking co-producer under the cumulative method is that the taking co-
producer generally may not claim an allowance for depletion and a 
production credit on its sales of its other co-producers' percentage 
shares of the total gas in the reservoir.
    (ii) Requirements--(A) Reporting of income from sales of gas. Under 
the cumulative method, each co-producer must include in gross income 
under its overall method of accounting the amount of its sales from all 
gas produced from the reservoir, including sales of gas taken from 
another co-producer's share of the gas in the reservoir.
    (B) Reporting of deduction of taking co-producer. A taking co-
producer deducts the amount of a payment (in cash or property, other 
than gas produced under the JOA) made to another co-producer for sales 
of that co-producer's gas, but only for the taxable year in which the 
payment is made. Thus, an accrual method taking co-producer is not 
permitted a deduction for any obligation it has to pay another co-
producer for sales of that co-producer's gas until a payment is made. 
See paragraph (d)(3)(iii)(B) of this section for a rule requiring a 
reduction of the amount of the deduction described in this paragraph 
(d)(3)(ii)(B) if the taking co-producer had mistakenly claimed a 
depletion deduction relating to those sales.
    (C) Reporting of income by other co-producers. Any co-producer that 
is entitled to receive a payment from a taking co-producer must include 
the amount of the payment in gross income as proceeds from the sale of 
its gas only for the taxable year that the payment is actually received, 
regardless of its overall method of accounting.
    (D) Reporting of production expenses. Each co-producer deducts its 
proportionate share of production expenses, as provided in the JOA, 
under its regular method of accounting for the expenses.

[[Page 709]]

    (iii) Special rules for production credits and depletion deductions 
under the cumulative method--(A) In general. Under the cumulative 
method, a co-producer's depletion allowance and production credit for a 
taxable year are based on its income from gas sales and production of 
gas from its percentage share of the total gas in the reservoir, and are 
not based on its current proportionate share of income and production as 
determined under the JOA. Thus, in general, a taking co-producer is not 
allowed a production credit or an allowance for depletion on its sales 
of gas in excess of its percentage share of the total gas in the 
reservoir. However, the Service will not disallow depletion deductions 
or production credits claimed by a taking co-producer on the gas of 
other co-producers if the taking co-producer had a reasonable but 
mistaken belief that the deductions or credits were claimed with respect 
to the taking co-producer's percentage share of total gas in the 
reservoir and the taking co-producer makes the appropriate reductions 
and additions to tax required in paragraphs (d)(3)(iii)(B) and 
(d)(3)(iii)(C) of this section. The reasonableness of the mistaken 
belief is determined at the time of filing the return claiming the 
deductions or credits. A co-producer receiving a payment for sales of 
its gas from a taking co-producer claims a production credit and an 
allowance for depletion relating to those sales only for the taxable 
year in which the amount of the payment is included in its gross income.
    (B) Reduction of taking co-producer's payment deduction for 
depletion claimed on another co-producer's gas. If a taking co-producer 
claims an allowance for depletion on another co-producer's gas, the 
taking co-producer must reduce its deduction claimed in a later year for 
making a payment to the other co-producer for sales of that co-
producer's gas by the amount of any percentage depletion deduction 
allowed on the gas sales to which the payment relates. If the percentage 
limitation of section 613A(d)(1) applied to disallow a depletion 
deduction for a previous year, the taking co-producer must reduce the 
amount of any carried over depletion deduction allowable in the year of 
the payment or in a future year by the portion of the carried over 
depletion deduction, if any, that relates to another co-producer's gas.
    (C) Addition to tax of taking co-producer for production credit 
claimed on another co-producer's gas. If a taking co-producer claims a 
production credit on another co-producer's gas, the taking co-producer 
must add to its tax for the taxable year that it makes a payment to the 
other co-producer for sales of that co-producer's gas any production 
credit allowed in an earlier taxable year on the gas sales to which the 
payment relates, but only to the extent the credit allowed actually 
reduced the taking co- producer's tax in any earlier year. The taking 
co-producer also must reduce the amount of its minimum tax credit 
allowable by reason of section 53(d)(1)(B)(iii) in the year of the 
payment or in a future year by the portion of the credit, if any, that 
relates to another co-producer's gas.
    (iv) Anti-abuse rule. If the Commissioner determines that co-
producers using the cumulative method have arranged or altered their 
taking of production for a taxable year with a principal purpose of 
shifting the income, deductions, or credits relating to that production 
to avoid tax, the co- producers' election to be excluded from all or 
part of subchapter K will be revoked for that year and for subsequent 
years. In determining that a principal purpose was to avoid tax, the 
Commissioner will examine all the facts and circumstances surrounding 
the use of the cumulative method by the co-producers. See Examples 3 and 
4 of paragraph (d)(6) of this section.
    (4) Annual gas balancing method--(i) In general. The annual gas 
balancing method (annual method) takes into account each co-producer's 
ownership rights and obligations, as described in the JOA, with respect 
to the co-producer's current proportionate share of gas as it is 
produced from the reservoir. Under the annual method, gas imbalances 
relating to a JOA must be eliminated annually through a balancing 
payment, which may be in the form of cash, gas produced under the same 
JOA, or other property. If all the co-producers under a JOA have the 
same taxable year, any gas imbalance remaining at the end of a taxable 
year

[[Page 710]]

must be eliminated by a balancing payment from the overproducer to the 
underproducer by the due date of the overproducer's tax return for that 
taxable year (including extensions). If all the co-producers under a JOA 
do not have the same taxable year, any gas imbalance remaining at the 
end of a calendar year must be eliminated by a balancing payment from 
the overproducer to the underproducer by September 15 of the following 
calendar year. The annual method may be used only if the Commissioner's 
permission is obtained. Paragraph (d)(4)(ii) of this section provides 
guidelines for applying for this permission. The annual method is not 
available for a JOA with respect to which any co-producer made an 
election under paragraph (d)(5)(i)(B)(3) of this section (to take an 
aggregate section 481(a) adjustment for all JOAs of a co-producer into 
account in the year of change).
    (ii) Obtaining the Commissioner's permission to use the annual 
method. A request for the Commissioner's permission to adopt the annual 
method for a new JOA must be in writing and must set forth the names of 
all the co-producers under the JOA and the respective taxable year of 
adoption. See paragraphs (d)(2)(ii) and (d)(5)(ii) of this section for 
the rules for a change in method of accounting to the annual method. In 
addition, the request must contain an explanation of how the co-
producers will report income from gas sales, the making or receiving of 
a balancing payment, production expenses, depletion deductions, and 
production credits. Permission will be granted under appropriate 
conditions, including, but not limited to, an agreement in writing by 
all co-producers to use the annual method and to eliminate any gas 
imbalances annually in accordance with paragraph (d)(4)(i) of this 
section.
    (5) Transitional rules for making a change in method of accounting 
required in paragraph (d)(2)(ii)(C) of this section--(i) Change in 
method of accounting to the cumulative method--(A) Automatic consent to 
change in method of accounting to the cumulative method. A co-producer 
changing to the cumulative method for any JOA entered into prior to its 
first taxable year beginning after December 31, 1994, and in effect as 
of the beginning of that year is granted the consent of the Commissioner 
to change its method of accounting with respect to each JOA to the 
cumulative method, provided the co-producer--
    (1) Makes the change on its timely filed return for its first 
taxable year beginning after December 31, 1994;
    (2) Attaches a completed and signed Form 3115 to the co-producer's 
tax return for the year of change, stating that, pursuant to Sec. 
1.761-2(d)(2)(ii) of the regulations, the co-producer is changing its 
method of accounting for sales of gas and its treatment of certain 
related deductions and credits under each JOA to the cumulative method;
    (3) In the case of a co-producer making an election under paragraph 
(d)(5)(i)(B)(3) of this section to take the aggregate section 481(a) 
adjustment into account in the year of change, attaches the statement 
described in paragraph (d)(5)(i)(B)(3)(ii) of this section; and
    (4) In the case of a co-producer not making an election under 
paragraph (d)(5)(i)(B)(3) of this section, attaches a list of each JOA 
with respect to which there is a section 481(a) adjustment computed in 
accordance with paragraph (d)(5)(i)(B)(2)(i) of this section.
    (B) Section 481(a) adjustment--(1) Application of section 481(a). A 
change in method of accounting to the cumulative method under the 
automatic consent procedure in paragraph (d)(5)(i)(A) of this section is 
a change in method of accounting to which the provisions of section 
481(a) apply. Thus, a section 481(a) adjustment must be taken into 
account in the manner provided by this paragraph (d)(5)(i)(B) to prevent 
the omission or duplication of income. Paragraph (d)(5)(i)(B)(2) of this 
section provides the general rules for computing the amount of the 
section 481(a) adjustment of a co-producer relating to a particular JOA 
and for taking the section 481(a) adjustment into account. Paragraph 
(d)(5)(i)(B)(3) of this section provides rules for electing to take a 
co-producer's section 481(a) adjustment computed on an aggregate basis 
for all JOAs into account in the year of change. Paragraph (d)(5)(i)(C) 
of

[[Page 711]]

this section provides rules to coordinate the taking of a depletion 
deduction or a production credit with the inclusion of a section 481(a) 
adjustment arising from a change in method of accounting to the 
cumulative method under this paragraph (d)(5)(i).
    (2) Computation of the section 481(a) adjustment relating to a joint 
operating agreement--(i) In general. The section 481(a) adjustment of a 
co-producer relating to a JOA is computed as of the first day of the co-
producer's year of change and is equal to the difference between the 
amount of income reported under the co-producer's former method of 
accounting for all taxable years prior to the year of change and the 
amount of income that would have been reported if the co-producer's new 
method had been used in all those taxable years.
    (ii) Section 481(a) adjustment period. Except to the extent that 
paragraph (d)(5)(i)(B)(3) of this section applies, a co-producer's 
section 481(a) adjustment relating to a JOA, whether positive or 
negative, is taken into account in computing taxable income ratably over 
the 6-taxable-year period beginning with the year of change (the section 
481(a) adjustment period). If the co-producer has been in existence less 
than 6 taxable years, the adjustment is taken into account over the 
number of years the co-producer has been in existence. If the co-
producer ceases to engage in the trade or business that gave rise to the 
section 481(a) adjustment at any time during the section 481(a) 
adjustment period, the entire remaining balance of the section 481(a) 
adjustment relating to that trade or business must be taken into account 
in the year of the cessation. For purposes of this paragraph 
(d)(5)(i)(B)(2)(ii), production under each JOA is treated as a separate 
trade or business. The determination as to whether the co-producer 
ceases to engage in its trade or business is to be made under the 
principles of Sec. 1.446-1(e)(3)(ii) and its underlying administrative 
procedures. For example, the permanent cessation of production under a 
co-producer's JOA constitutes the cessation of a trade or business of 
the co-producer. Accordingly, for the year that production under a JOA 
permanently ceases, the remaining balance of the section 481(a) 
adjustment relating to the JOA must be taken into account.
    (3) Election to take aggregate section 481(a) adjustment for all 
joint operating agreements into account in the year of change--(i) In 
general. A co-producer may elect to take into account its section 481(a) 
adjustment, computed on an aggregate basis for all of its JOAs, whether 
negative or positive, in the year of change, provided the co-producer 
uses the cumulative method for all of its JOAs entered into prior to its 
first taxable year beginning after December 31, 1994, and in effect as 
of the beginning of that year. The aggregate section 481(a) adjustment 
of a co-producer is equal to the difference between the amount of income 
reported under the co-producer's former method of accounting for all 
taxable years prior to the year of change and the amount of income that 
would have been reported if the co-producer's new method had been used 
in all of those taxable years for all JOAs for which the co-producer 
changes its method of accounting. An election made under this paragraph 
(d)(5)(i)(B)(3) is irrevocable. If any person who, together with another 
person, would be treated as a single taxpayer under section 41(f)(1) (A) 
or (B) makes an election under this paragraph (d)(5)(i)(B)(3), all 
persons within that single taxpayer group will be treated as if they had 
made an election under this paragraph (d)(5)(i)(B)(3) and, as such, will 
be irrevocably bound by that election. If a co-producer does not make an 
election under this paragraph, each JOA entered into prior to the start 
of its first taxable year beginning after December 31, 1994, and in 
effect as of the beginning of that year must be accounted for separately 
in computing the section 481(a) adjustment and taxable income of the co-
producer for any year to which this paragraph (d) applies.
    (ii) Time and manner for making the election. An election under this 
paragraph (d)(5)(i)(B)(3) is made by attaching a statement to the co-
producer's timely filed return for its year of change indicating that 
the co- producer is electing under Sec. 1.761-2(d)(5)(i)(B)(3)

[[Page 712]]

to take its aggregate section 481(a) adjustment into account in the year 
of change.
    (C) Treatment of section 481(a) adjustment as a sale for purposes of 
computing a production credit and as gross income from the property for 
purposes of depletion deductions. Any positive section 481(a) adjustment 
arising as a result of a change in method of accounting for gas 
imbalances under this paragraph (d)(5)(i) and taken into account in 
computing taxable income under paragraph (d)(5)(i)(B) of this section is 
considered a sale by the taxpayer for purposes of computing any 
production credit in the year that the adjustment is taken into account. 
Similarly, the positive section 481(a) adjustment is considered gross 
income from the property and taxable income from the property for 
purposes of computing depletion deductions in the year the adjustment is 
taken into account. Sales amounts used in computing any production 
credit in any year in which a negative section 481(a) adjustment is 
taken into account in computing taxable income under paragraph 
(d)(5)(i)(B) of this section must be reduced by the amount of the 
negative section 481(a) adjustment taken into account in that year. 
Similarly, gross income from the property and taxable income from the 
property used in computing any depletion deduction in any year in which 
the negative section 481(a) adjustment is taken into account must be 
reduced by the amount of the negative adjustment. For these purposes, 
any taxpayer that makes an aggregate section 481(a) adjustment election 
under paragraph (d)(5)(i)(B)(3) of this section must allocate the 
adjustment among its properties in any reasonable manner that prevents a 
duplication or omission of depletion deductions.
    (ii) Change in method of accounting to the annual method--(A) In 
general. A co-producer changing to the annual method in accordance with 
paragraph (d)(2)(ii) of this section must request a change under Sec. 
1.446-1(e)(3) and will be subject to any terms and conditions as may be 
imposed by the Commissioner.
    (B) Section 481(a) adjustment. A change in method of accounting to 
the annual method is a change in method of accounting to which the 
provisions of section 481(a) apply. Thus, a section 481(a) adjustment 
must be taken into account to prevent the omission or duplication of 
income. If all the co-producers under a JOA have the same taxable year, 
the section 481(a) adjustment involved in a change to the annual method 
by a co-producer relating to the JOA is computed as of the first day of 
the co-producer's year of change. If the co-producers under a JOA do not 
all have the same taxable year (that is, in the case of a part-year 
change described in paragraph (d)(2)(ii)(C) of this section), the change 
in method of accounting occurs on January 1, 1996, and the section 
481(a) adjustment is computed on that date.
    (iii) Untimely change in method of accounting to comply with this 
section. Unless a co-producer required by this section to change its 
method of accounting complies with the provisions of this paragraph 
(d)(5) for its first applicable taxable year within the time prescribed 
by this paragraph (d)(5), the co-producer must take the section 481(a) 
adjustment into account under the provisions of any applicable 
administrative procedure that is prescribed by the Commissioner 
specifically for purposes of complying with this section. Absent such an 
administrative procedure, a co-producer must request a change under 
Sec. 1.446-1(e)(3) and will be subject to any terms and conditions as 
may be imposed by the Commissioner.
    (6) Examples. The following examples illustrate the application of 
the cumulative method described in paragraph (d)(3) of this section.

    Example 1. Operation of the cumulative method. (i) L, a corporation 
using the cash receipts and disbursements method of accounting, and M, a 
corporation using an accrual method, file returns on a calendar year 
basis. On January 1, 1995, L and M enter into a JOA to produce natural 
gas as an unincorporated organization from a reservoir located in State 
Y. The JOA allocates reservoir production 60 percent to L and 40 percent 
to M. L and M enter into a GBA as an addendum to the JOA. L and M agree 
to use the cumulative method to account for gas sales from the reservoir 
and elect under section 761(a) and this section to exclude the 
organization from the application of subchapter K. Production from the 
reservoir is eligible for the section 29 credit for producing fuel from 
a nonconventional source. L and M produce and sell the following

[[Page 713]]

amounts of natural gas (in mmcf) until 2000 during which year production 
from the reservoir ceases:

------------------------------------------------------------------------
                                 1995   1996   1997   1998   1999   2000
------------------------------------------------------------------------
L.............................    720    480    600    -0-    -0-    -0-
M.............................    240     60    120    160     80     40
------------------------------------------------------------------------

    (ii) By the end of 1996, neither L nor M has fully produced its 
percentage share of the total gas in the reservoir. In 1997, L produces 
a total of 600 mmcf of gas at the rate of 50 mmcf per month. Prior to 
filing its return for 1997, L determines that it fully produced its 
percentage share of gas in the reservoir as of June 30, 1997. Pursuant 
to the GBA executed by L and M, L pays M at the end of 2000 for the 300 
mmcf of M's gas (as determined under the cumulative method) that L sold 
in the last half of 1997.
    (iii) For 1995, L and M must include in their gross income the 
amounts relating to gas sales of 720 mmcf and 240 mmcf, respectively. 
For 1996, L and M must include the amounts relating to gas sales of 480 
mmcf and 60 mmcf, respectively. For both 1995 and 1996, L and M compute 
an allowance for depletion and a section 29 credit based upon gas taken 
and sold by each from the reservoir for each taxable year.
    (iv) For 1997, L and M must include in gross income the amounts 
relating to their gas sales of 600 mmcf and 120 mmcf, respectively. 
Under paragraph (d)(3)(iii)(A) of this section, L computes an allowance 
for depletion and the section 29 credit based only on production from 
L's proportionate share of gas in the reservoir (that is, based on L's 
production through June 30, 1997). Accordingly, for 1997, L claims 
depletion and the section 29 credit only with respect to 300 mmcf of gas 
(50 mmcf per month x 6 months). For 1997, because M has not fully 
produced from its percentage share of the total gas in the reservoir as 
of the end of 1997, M claims depletion and the section 29 credit on the 
120 mmcf that M produced in 1997.
    (v) In 1998 and 1999, M must include in gross income the amounts 
relating to M's sales of gas, that is, 160 mmcf for 1998 and 80 mmcf for 
1999. For 2000, M must include in gross income the amount relating to 
sales of 340 mmcf of gas, which consists of its own sales of 40 mmcf 
plus the payment for 300 mmcf of gas that L made to M for having sold 
from M's share of the total gas in the reservoir during the last half of 
1997. Because M produced from its percentage share of the total gas in 
the reservoir during 1998, 1999, and 2000, M claims a depletion 
deduction and a section 29 credit on its income and production for those 
years, that is, 160 mmcf for 1998, 80 mmcf for 1999, and 40 mmcf for 
2000. Additionally, for 2000, M claims depletion and the section 29 
credit relating to the payment that M received from L for the 300 mmcf 
of M's gas that L sold in the last half of 1997. Under paragraph 
(d)(3)(ii)(B) of this section, L's deduction for its payment to M for 
the 300 mmcf of M's gas that L sold in 1997 is allowable only for 2000.
    Example 2. Adjustments under the cumulative method for depletion 
deductions and production credits that were claimed for sales in excess 
of a co-producer's percentage share of total gas in the reservoir. (i) 
L, a corporation using the cash receipts and disbursements method of 
accounting, and M, a corporation using an accrual method, file returns 
on a calendar year basis. On January 1, 1995, L and M enter into a JOA 
to produce natural gas as an unincorporated organization from a 
reservoir located in State Y. The JOA allocates reservoir production 60 
percent to L and 40 percent to M. L and M enter into a GBA as an 
addendum to the JOA. L and M agree to use the cumulative method to 
account for gas sales from the reservoir and elect under section 761(a) 
and this section to exclude the organization from the application of 
subchapter K. Production from the reservoir is eligible for the section 
29 credit for producing fuel from a nonconventional source. L and M 
produce and sell the following amounts of natural gas (in mmcf) until 
2000 during which year production from the reservoir ceases:

------------------------------------------------------------------------
                                 1995   1996   1997   1998   1999   2000
------------------------------------------------------------------------
L.............................    720    480    600     60     60    -0-
M.............................    240     60    120     60     60     40
------------------------------------------------------------------------

    (ii) In addition, L does not realize until December 31, 1999, that L 
fully produced its percentage share of the total gas in the reservoir as 
of June 30, 1997. At the time of filing its returns for 1997 and 1998, L 
reasonably believes that during 1997 and 1998, respectively, it did not 
fully produce its percentage share of the total gas in the reservoir. 
Thus, L claims depletion and the section 29 credit for its total sales 
of 600 mmcf in 1997 and 60 mmcf in 1998. Pursuant to the GBA executed by 
L and M, L pays M at the end of 2000 for the 420 mmcf of M's gas (as 
determined under the cumulative method) that L sold (300 mmcf in the 
last half of 1997 (assuming that production was at a rate of 50 mmcf per 
month), 60 mmcf in 1998, and 60 mmcf in 1999).
    (iii) In 1997 and 1998, L and M include in gross income the amounts 
relating to their respective sales of gas, that is, for L 600 mmcf for 
1997 and 60 mmcf for 1998, and for M 120 mmcf for 1997 and 60 mmcf for 
1998.
    (iv) For 1999, L must include in gross income the amount of its 
sales of 60 mmcf, but may not claim depletion or the section 29 credit 
on those sales. For 1999, M must include in gross income the amount of 
its sales of 60 mmcf and claims depletion and the section 29 credit with 
respect to those 60 mmcf.

[[Page 714]]

    (v) For 2000, M must include in gross income the amount relating to 
gas sales of 460 mmcf, that is, the amount of M's own gas sales of 40 
mmcf and the amount of the payment received from L for the 420 mmcf of 
M's gas that L sold (consisting of 300 mmcf in 1997, 60 mmcf in 1998, 
and 60 mmcf in 1999). Under paragraph (d)(3)(iii)(A) of this section, M 
computes a depletion deduction and a production credit relating to the 
amount of M's actual gas sales for 2000 and the payment received from L, 
that is, relating to a total of 460 mmcf of gas (M's sales of 40 mmcf 
for 2000, plus L's payment for 420 mmcf of gas). Under paragraph 
(d)(3)(ii)(B) of this section, L's deduction for making its payment to M 
for 420 mmcf of gas is allowable only for 2000. Under paragraph 
(d)(3)(iii)(B) of this section, L must reduce its deduction by the 
amount of any percentage depletion deductions allowed on its sales of 
M's gas, that is, relating to 360 mmcf of gas (300 mmcf for 1997 and 60 
mmcf for 1998). In addition, under paragraph (d)(3)(iii)(C) of this 
section, L must increase its tax for 2000 by the amount of any section 
29 credit L claimed on its sales of M's gas, but only to the extent that 
the credit claimed actually reduced L's tax in any earlier year.
    Example 3. Non-abusive altering of the taking of production for a 
taxable year. (i) C and D enter into a JOA and a GBA on December 1, 
1994, for gas production from a reservoir. The JOA allocates production 
at 50 percent to C and 50 percent to D. C and D agree in writing to use 
the cumulative method to account for gas sales. Additionally, C and D 
elect under section 761(a) and this section to exclude their 
organization from the application of subchapter K. C and D arrange to 
sell all their production under annually renewable contracts. In 1995, C 
and D each sell 480 mmcf of gas from the reservoir.
    (ii) In November 1995, D is notified that its contract with its 
purchaser will not be renewed for 1996. D is unable to find a new 
purchaser for its gas for 1996. In December 1995, D notifies C that it 
will not be taking production from the reservoir in 1996. Pursuant to 
the GBA, C then contracts with its current gas purchaser to sell an 
additional 20 mmcf per month in 1996. Accordingly, C sells 720 mmcf in 
1996 (60 mmcf per month x 12 months). Under the facts described in this 
example, a principal purpose of altering the taking of production is not 
to avoid tax. Accordingly, the co-producers' election under section 
761(a) will not be revoked by reason of altering the taking of 
production.
    Example 4. Abusive altering of the taking of production for a 
taxable year. The facts are the same as in Example 3(i). For 1996, C 
anticipates that C's regular tax (reduced by the credits allowable under 
sections 27 and 28) will not exceed C's tentative minimum tax. 
Accordingly, under section 29(b)(6), C's credit allowed under section 
29(a) for sales of its gas will be zero. For 1997, C anticipates that 
its credit allowed under section 29(a) will not be limited by section 
29(b)(6). On the other hand, D anticipates that any credit it may claim 
under section 29(a) for 1996, even including a credit based on sales of 
C's share of current production under the JOA, will not be limited by 
section 29(b)(6). However, for 1997, D anticipates that its credit under 
section 29(a) will be limited by section 29(b)(6). On January 1, 1996, C 
and D agree that D will contract with its purchaser to sell the entire 
960 mmcf produced from the reservoir in 1996 and that C will contract 
with its purchaser to sell the entire 960 mmcf produced from the 
reservoir in 1997. Under these facts, a principal purpose of altering 
the taking of production is to avoid tax. Accordingly, the co-producers' 
election under section 761(a) will be revoked for 1996 and for 
subsequent years.

    (7) Effective date. Except in the case of a part-year change to the 
annual method or the cessation of a JOA, both of which are described in 
paragraph (d)(2)(ii)(C) of this section, the provisions of this 
paragraph (d) apply to all taxable years beginning after December 31, 
1994, of any producer that is a member of an unincorporated organization 
that produces natural gas under a JOA in effect on or after the start of 
the producer's first taxable year beginning after December 31, 1994. In 
the case of a part-year change, the provisions of this paragraph (d) 
apply on and after January 1, 1996. In the case of the cessation of a 
JOA, the co-producers use their current method of accounting with 
respect to that JOA until the JOA ceases to be in effect.
    (e) Cross reference. For requirements with respect to the filing of 
a return on Form 1065 by a partnership, see Sec. 1.6031-1.

[T.D. 7208, 37 FR 20687, Oct. 3, 1972; 37 FR 23161, Oct. 31, 1972, as 
amended by T.D. 8578, 59 FR 66183, Dec. 23, 1994; 60 FR 11028, Mar. 1, 
1995]



Sec. 1.761-3  Certain option holders treated as partners.

    (a) Noncompensatory option treated as a partnership interest--(1) 
General rule. A noncompensatory option (as defined in paragraph (b)(2) 
of this section) is treated as a partnership interest for all Federal 
tax purposes if, on the date of a measurement event (as defined in 
paragraph (c) of this section) with respect to the option--

[[Page 715]]

    (i) The noncompensatory option (and any agreements associated with 
it) provides the option holder with rights that are substantially 
similar to the rights afforded a partner (as determined under paragraph 
(d) of this section); and
    (ii) There is a strong likelihood that the failure to treat the 
holder of the noncompensatory option as a partner would result in a 
substantial reduction in the present value of the partners' and 
noncompensatory option holder's aggregate Federal tax liabilities (as 
determined under paragraph (e) of this section).
    (2) Continuing applicability of general principles of law. The fact 
that an option is not treated as a partnership interest under this 
section does not prevent the option from being treated as a partnership 
interest under general principles of Federal tax law.
    (3) Timing of characterization. If a noncompensatory option is 
treated under this section as a partnership interest, that treatment 
applies, as the case may be, upon the issuance of the option, or 
immediately before any other measurement event that gave rise to the 
characterization under paragraph (a)(1) of this section.
    (4) Effect of characterization. If a noncompensatory option is 
treated as a partnership interest under this section or under general 
principles of law, the option holder will be treated as a partner with 
respect to the partnership interest and will receive a distributive 
share of the partnership's income, gain, loss, deduction, or credit (or 
items thereof), as determined in accordance with that partner's interest 
in the partnership (taking into account all facts and circumstances) in 
accordance with Sec. 1.704-1(b)(3). Once a noncompensatory option is 
treated as a partnership interest, in no event may it be characterized 
as an option thereafter.
    (b) Definitions. For purposes of this section:
    (1) Look-through entity. Look-through entity means an entity 
described in Sec. 1.704-1(b)(2)(iii)(d)(2).
    (2) Noncompensatory option. Noncompensatory option means an option 
(as defined in paragraph (b)(3) of this section) issued by a 
partnership, other than an option issued in connection with the 
performance of services. For purposes of applying this section, an 
option that would be a noncompensatory option under this paragraph if it 
had been issued by a partnership is a noncompensatory option if the 
option was issued by an eligible entity (as defined in Sec. 301.7701-
3(a)) that would become a partnership under Sec. 301.7701-3(f)(2) if 
the noncompensatory option holder were treated as a partner. Also for 
purposes of applying this section, if a noncompensatory option is issued 
by such an eligible entity, then the eligible entity is treated as a 
partnership.
    (3) Option. An option is a contractual right to acquire an interest 
in the issuing partnership, including a call option, warrant, or other 
similar arrangement. In addition, an option includes convertible debt 
(as defined in Sec. 1.721-2(g)(2)) and convertible equity (as defined 
in Sec. 1.721-2(g)(3)). To achieve the purposes of this section, the 
Commissioner can treat other contractual agreements, including a forward 
contract, a futures contract, or a notional principal contract, as an 
option. A contract that otherwise constitutes an option will not fail to 
be treated as an option for purposes of this section merely because it 
may or must be settled in cash or property other than a partnership 
interest.
    (4) Underlying partnership interest. Underlying partnership interest 
means the interest in the issuing partnership that would be acquired by 
the noncompensatory option holder upon exercise of the noncompensatory 
option.
    (c) Measurement event--(1) General rule. Except as provided in 
paragraph (c)(2) of this section, a measurement event with respect to a 
noncompensatory option is any of the following events:
    (i) Issuance of the noncompensatory option;
    (ii) An adjustment of the terms (modification) of the 
noncompensatory option or of the underlying partnership interest (as 
defined in paragraph (b)(4) of this section) (including an adjustment 
pursuant to the terms of the noncompensatory option or the underlying 
partnership interest);
    (iii) Transfer of the noncompensatory option if either:

[[Page 716]]

    (A) The option may be exercised (or settled) more than 12 months 
after its issuance, or
    (B) The transfer is pursuant to a plan in existence at the time of 
the issuance or modification of the noncompensatory option that has as a 
principal purpose the substantial reduction of the present value of the 
aggregate Federal tax liabilities of the partners and the 
noncompensatory option holder (under paragraph (a)(1)(ii) of this 
section);
    (2) Events not treated as measurement events. A measurement event 
does not include the following events:
    (i) A transfer of the noncompensatory option at death, between 
spouses or former spouses under section 1041, or in a transaction that 
is disregarded for Federal tax purposes;
    (ii) A modification that neither materially increases the likelihood 
that the noncompensatory option will be exercised (as described in 
paragraph (d)(2) of this section) nor provides the noncompensatory 
option holder with partner attributes (as described in paragraph (d)(3) 
of this section);
    (iii) A change in the strike price of a noncompensatory option or in 
the interests in the issuing partnership that may be issued or 
transferred pursuant to the noncompensatory option, made pursuant to a 
bona fide, reasonable adjustment formula that has the intended effect of 
preventing dilution of the interests of the noncompensatory option 
holder;
    (iv) Any other event as provided in guidance published in the 
Internal Revenue Bulletin.
    (d) Rights substantially similar to partner rights--(1) In general. 
A noncompensatory option provides the holder with rights that are 
substantially similar to the rights afforded to a partner if either the 
option is reasonably certain to be exercised or the option holder 
possesses partner attributes.
    (2) Reasonable certainty of exercise--(i) General rule. The 
determination of whether a noncompensatory option is reasonably certain 
to be exercised at the time of a measurement event is based on all the 
facts and circumstances, including--
    (A) The fair market value of the partnership interest that is the 
subject of the noncompensatory option;
    (B) The strike price of the noncompensatory option;
    (C) The term of the noncompensatory option;
    (D) The volatility of the value or income of the issuing partnership 
or the underlying partnership interest;
    (E) Anticipated distributions by the partnership during the term of 
the noncompensatory option;
    (F) Any other special option features, such as a strike price that 
fluctuates;
    (G) The existence of related options, including reciprocal options; 
and
    (H) Any other arrangements affecting or undertaken with a principal 
purpose of affecting the likelihood that the noncompensatory option will 
be exercised.
    (ii) Safe harbors--(A) General rule. Except as provided in paragraph 
(d)(2)(ii)(C) of this section, a noncompensatory option is not 
considered reasonably certain to be exercised if, as of the date of a 
measurement event with respect to the noncompensatory option--
    (1) The option may be exercised no more than 24 months after the 
date of the measurement event and the strike price is equal to or 
greater than 110 percent of the fair market value of the underlying 
partnership interest on the date of the measurement event; or
    (2) The terms of the option provide that the strike price of the 
option is equal to or greater than the fair market value of the 
underlying partnership interest on the exercise date.
    (B) Options exercisable at fair market value. For purposes of 
paragraph (d)(2)(ii)(A) of this section, an option whose strike price is 
determined by a formula is considered to have a strike price equal to or 
greater than the fair market value of the underlying partnership 
interest on the exercise date if the formula is agreed upon by the 
parties when the option is issued in a bona fide attempt to arrive at 
the fair market value on the exercise date and is to be applied based on 
the facts and circumstances in existence on the exercise date.
    (C) Exception. The safe harbors of paragraph (d)(2)(ii)(A) of this 
section

[[Page 717]]

do not apply if the parties to the noncompensatory option had a 
principal purpose described in paragraph (c)(1)(iii)(B) of this section 
with respect to a measurement event for that option (or, if multiple 
options were issued pursuant to a plan, a measurement event with respect 
to any option issued pursuant to that plan).
    (D) Failure to satisfy safe harbor. Failure of an option to satisfy 
one of the safe harbors of paragraph (d)(2)(ii)(A) does not affect the 
determination of whether an option is treated as reasonably certain to 
be exercised.
    (3) Partner attributes--(i) General rule. The determination of 
whether a holder of a noncompensatory option possesses partner 
attributes is based on all the facts and circumstances, including 
whether the option holder, directly or indirectly, through the option 
agreement or a related agreement, is provided with voting rights or 
managerial rights in the partnership.
    (ii) Certain factors that conclusively establish partner attributes. 
For purposes of this section, a noncompensatory option holder has 
partner attributes if, based on all the facts and circumstances--
    (A) The option holder is provided with rights (through the option 
agreement or a related agreement) that are similar to rights ordinarily 
afforded to a partner to participate in partnership profits through 
present possessory rights to share in current operating or liquidating 
distributions with respect to the underlying partnership interests; or
    (B) The option holder, directly or indirectly, undertakes 
obligations (through the option agreement or a related agreement) that 
are similar to obligations undertaken by a partner to bear partnership 
losses.
    (iii) Special rules. The following rules apply for purposes of 
paragraphs (d)(3)(i) and (d)(3)(ii) of this section:
    (A) Rights in the issuing partnership possessed by a noncompensatory 
option holder solely by virtue of owning an interest in the issuing 
partnership are not taken into account, provided that those rights are 
no greater than the rights granted to other partners owning 
substantially similar interests in the partnership and who do not hold 
noncompensatory options in the partnership.
    (B) If all of the partners owning substantially similar interests in 
the issuing partnership also hold noncompensatory options in the 
partnership, or if none of the other partners owns substantially similar 
interests in the partnership, then all facts and circumstances will be 
considered in determining whether the rights in the partnership 
possessed by the option holder are possessed solely by virtue of owning 
a partnership interest. If those rights are possessed solely by virtue 
of owning a partnership interest, they are not taken into account.
    (C) A noncompensatory option holder will not ordinarily be 
considered to possess partner attributes solely because the 
noncompensatory option agreement significantly controls or restricts, or 
the noncompensatory option holder has the ability to significantly 
control or restrict, a partnership decision that could substantially 
affect the value of the underlying partnership interest. In particular, 
the following abilities of the option holder will not be treated as 
partner attributes:
    (1) The ability to impose reasonable restrictions on partnership 
distributions or dilutive issuances of partnership equity or options 
while the noncompensatory option is outstanding.
    (2) The ability to choose the partnership's section 704(c) method 
for partnership properties.
    (D) When the applicable measurement event is a transfer described in 
paragraph (c)(1) of this section, the partner attributes of the 
transferee, not the transferor, are taken into account.
    (E) The option holder will be treated as owning all partnership 
interests and noncompensatory options issued by the partnership that are 
owned by any person related to the option holder. For purposes of the 
preceding sentence, a person related to the option holder is defined as 
any person bearing a relationship to the option holder described in 
section 267(b) or 707(b).

[[Page 718]]

    (e) Substantial tax reduction requirement--(1) General rule. The 
determination of whether there is a strong likelihood that the failure 
to treat a noncompensatory option holder as a partner would result in a 
substantial reduction in the present value of the partners' and the 
noncompensatory option holder's aggregate Federal tax liabilities is 
based on all the facts and circumstances, including--
    (i) The interaction of the allocations of the issuing partnership 
and the partners' and noncompensatory option holder's Federal tax 
attributes (taking into account tax consequences that result from the 
interaction of the allocations with the partners' and noncompensatory 
option holder's Federal tax attributes that are unrelated to the 
partnership);
    (ii) The absolute amount of the Federal tax reduction;
    (iii) The amount of the reduction relative to overall Federal tax 
liability; and
    (iv) The timing of items of income and deductions.
    (2) Special rules. For purposes of applying paragraph (e)(1) of this 
section to a partner or noncompensatory option holder that is--
    (i) A look-through entity (as defined in paragraph (b)(1) of this 
section), the Federal tax consequences that result from the interaction 
of allocations of the partnership and the Federal tax attributes of any 
person that is an owner, or in the case of a trust or estate, the 
beneficiary, of an interest in such a partner or noncompensatory option 
holder, whether directly, or indirectly through one or more look-through 
entities, must be taken into account; or
    (ii) A member of a consolidated group (within the meaning of Sec. 
1.1502-1(h)), the tax consequences that result from the interaction of 
the issuing partnership's allocations and the tax attributes of the 
consolidated group and the tax attributes of another member with respect 
to a separate return year must be taken into account.
    (f) Example. The following example illustrates the provisions of 
this section. For purposes of the example, assume that PRS is a 
partnership for Federal tax purposes, none of the noncompensatory option 
holders or partners are related persons, and that general principles of 
law do not apply to treat the noncompensatory option as a partnership 
interest. The example reads as follows:

    Example. Active trade or business. PRS is engaged in an active real 
estate business, the amount of income, gain, loss, and deductions from 
which cannot be predicted with any reasonable certainty. In exchange for 
a premium of $10x, PRS issues a noncompensatory option to A to acquire a 
10 percent interest in PRS for $110x at any time during a 3-year period 
commencing on the date on which the option is issued. At the time of the 
issuance of the noncompensatory option, a 10 percent interest in PRS has 
a fair market value of $100x. Due to the nature of PRS's business, the 
value of a 10 percent PRS interest in 3 years is not reasonably 
predictable as of the time the noncompensatory option is issued. 
Assuming there are no other facts affecting the certainty of the 
option's exercise, it is not reasonably certain that A's option will be 
exercised. Therefore, assuming that A does not possess partner 
attributes as described in paragraph (d)(3) of this section, A's 
noncompensatory option is not treated as a partnership interest under 
paragraph (a)(1) of this section.

    (g) Effective/applicability date. This section applies to 
noncompensatory options issued on or after February 5, 2013.

[T.D. 9612, 78 FR 8013, Feb. 5, 2013, as amended at 78 FR 17869, Mar. 
25, 2013]

         effective date for subchapter k, chapter 1 of the code



Sec. 1.771-1  Effective date.

    (a) General rule. Except as provided in paragraph (b) or (c) of this 
section, the provisions of subchapter K, chapter 1 of the Code, shall 
apply to any taxable year of a partnership beginning after December 31, 
1954, and to any part of a partner's taxable year falling within such 
partnership taxable year. The provisions of the Internal Revenue Code of 
1939 relating to partnerships shall apply to any taxable year of a 
partnership beginning before January 1, 1955, and to any part of a 
partner's taxable year falling within such partnership taxable year. If 
a partnership and the partners are on different taxable years, 
subchapter K shall become effective at the same time both for the 
partnership and for the partners.

[[Page 719]]

    (b) Special rules. Certain provisions of section 771 apply after 
specific dates in 1954, as follows:
    (1) Adoption of taxable year. Section 706(b) (relating to the 
adoption of taxable years by partners and partnerships), shall apply to 
any partnership which adopts or changes to, and any partner who changes 
to, a taxable year beginning on or after April 2, 1954. For the purpose 
of applying this subparagraph, the rules of section 708 (relating to the 
continuation of partnerships) shall apply. For example, if two or more 
partnerships merge after April 1, 1954, and the new partnership uses the 
taxable year of the partnership of which it is deemed to be the 
successor under section 708(b)(2)(A), it will not need prior approval to 
continue to use such taxable year even though such year may be different 
from the taxable years of the partners. Such a partnership is not 
``adopting'' or ``changing'' its taxable year.
    (2) Property distributed by a partnership. Section 735(a), relating 
to the character of gain or loss on disposition of property distributed 
by a partnership to a partner, shall apply only to property distributed 
after March 9, 1954. Although a partnership whose taxable year begins 
before January 1, 1955, generally will be subject to the provisions of 
the Internal Revenue Code of 1939, any unrealized receivables or 
inventory items distributed by any such partnership after March 9, 1954, 
will be subject to the provisions of section 735(a), and the gain or 
loss on the subsequent disposition of such property will be ordinary 
gain or loss rather than capital gain or loss. In the case of property 
distributed before March 10, 1954, section 735(a) will not apply, even 
though the property is disposed of by the distributee partner after that 
date, unless the partnership elects under paragraph (c) of this section 
to apply section 735.
    (3) Unrealized receivables and inventory items. Section 751 
(providing for the realization of ordinary income on certain transfers 
or distributions of unrealized receivables or substantially appreciated 
inventory items) shall be applicable to any such transfer or 
distribution occurring after March 9, 1954. For the purpose of applying 
section 751 in the case of a taxable year beginning before January 1, 
1955, a partnership or partner may elect to treat as applicable any 
other section of subchapter K. See paragraph (f) of Sec. 1.751-1.
    (4) Partner receiving income in respect of a decedent. Section 753, 
which provides that the amount includible in the gross income of a 
successor in interest of a deceased partner under section 736(a) shall 
be considered income in respect of a decedent under section 691, shall 
apply only in the case of payments made with respect to decedents whose 
death occurred after December 31, 1954.
    (c) Optional treatment of certain distributions. (1) For a 
partnership taxable year beginning after December 31, 1953, and before 
January 1, 1955, a partnership may elect to apply the rules of certain 
sections of subchapter K with respect to current distributions made by 
the partnership in such year. These sections are 731, 732 (a), (c), and 
(e), 733, 735, and 751 (b), (c), and (d). If an election is made, it 
shall apply to the partnership and all its members for all current 
distributions made by the partnership during the taxable year. Such 
distributions shall also be subject to the rules of section 705 
(relating to determination of basis of a partner's interest), 752 
(relating to treatment of certain liabilities), and 761(d) (relating to 
the definition of liquidation of a partner's interest), to the extent 
that such sections apply to current distributions.
    (2) An election under this paragraph shall be made by a statement 
filed with the partnership return for the taxable year to which such 
election applies, or before August 23, 1956, whichever date is later. 
The statement shall be signed by all members of the partnership and the 
election once made shall be binding on the partnership and on all of its 
members.

                           INSURANCE COMPANIES

                        Life Insurance Companies

                         definition; tax imposed



Sec. 1.801-1  Definitions.

    (a) Life insurance company. The term life insurance company as used 
in subtitle A of the Code is defined in section 801. For the purpose of 
determining

[[Page 720]]

whether a company is a ``life insurance company'' within the meaning of 
that term as used in section 801, it must first be determined whether 
the company is taxable as an insurance company under the Code. For the 
definition of an ``insurance company'', see paragraph (b) of this 
section. In determining whether an insurance company is a life insurance 
company, the life insurance reserves (as defined in section 803(b)) plus 
any unearned premiums and unpaid losses on noncancellable life, health, 
or accident policies, not included in ``life insurance reserves'' must 
comprise more than 50 percent of its total reserves (as defined in 
section 801). An insurance company writing only noncancellable life, 
health, or accident policies and having no ``life insurance reserves'' 
may qualify as a life insurance company if its unearned premiums and 
unpaid losses on such policies comprise more than 50 percent of its 
total reserves. A noncancellable insurance policy means a contract which 
the insurance company is under an obligation to renew or continue at a 
specified premium and with respect to which a reserve in addition to the 
unearned premium must be carried to cover that obligation. For the 
purpose of the preceding sentence, the term ``unearned premium'' means 
the amount which will cover the cost of carrying the insurance risk for 
the period for which the premium has been paid in advance. A burial or 
funeral benefit insurance company qualifying as a life insurance company 
engaged directly in the manufacture of funeral supplies or the 
performance of funeral services will be taxable under section 821 or 
section 831 as an insurance company other than life.
    (b) Insurance companies. (1) Insurance companies include both stock 
and mutual companies, as well as mutual benefit insurance companies. A 
voluntary unincorporated association of employees formed for the purpose 
of relieving sick and aged members and the dependents of deceased 
members is an insurance company, whether the fund for such purpose is 
created wholly by membership dues or partly by contributions from the 
employer. A corporation which merely sets aside a fund for the insurance 
of its employees is not required to file a separate return for such 
fund, but the income therefrom shall be included in the return of the 
corporation.
    (2) Though its name, charter powers, and subjection to State 
insurance laws are significant in determining the business which a 
corporation is authorized and intends to carry on, the character of the 
business actually done in the taxable year determines whether it is 
taxable as an insurance company under the Code. For example, during the 
year 1954 the M Corporation, incorporated under the insurance laws of 
the State of R, carried on the business of lending money in addition to 
guaranteeing the payment of principal and interest of mortgage loans. Of 
its total income for the year, one-third was derived from its insurance 
business of guaranteeing the payment of principal and interest of 
mortgage loans and two-thirds was derived from its noninsurance business 
of lending money. The M Corporation is not an insurance company for the 
year 1954 within the meaning of the Code and the regulations thereunder.



Sec. 1.801-2  Taxable years affected.

    Section 1.801-1 is applicable only to taxable years beginning after 
December 31, 1953, and before January 1, 1955, and all references to 
sections of part I, subchapter L, chapter 1 of the Code are to the 
Internal Revenue Code of 1954, before amendments. Sections 1.801-3 
through 1.801-7 are applicable only to taxable years beginning after 
December 31, 1957, and all references to sections of part I, subchapter 
L, chapter 1 of the Code are to the Internal Revenue Code of 1954, as 
amended by the Life Insurance Company Income Tax Act of 1959 (73 Stat. 
112). Section 1.801-8 is applicable only to taxable years beginning 
after December 31, 1961, and all references to sections of part I, 
subchapter L, chapter 1 of the Code are to the Internal Revenue Code of 
1954, as amended by the Life Insurance Company Income Tax Act of 1959 
(73 Stat. 112) and section 3 of the Act of October 23, 1962 (76 Stat. 
1134).

[T.D. 6886, 31 FR 8681, June 23, 1966]

[[Page 721]]



Sec. 1.801-3  Definitions.

    For purposes of part I, subchapter L, chapter 1 of the Code, this 
section defines the following terms, which are to be used in determining 
if a taxpayer is a life insurance company (as defined in section 801(a) 
and paragraph (b) of this section):
    (a) Insurance company. (1) The term insurance company means a 
company whose primary and predominant business activity during the 
taxable year is the issuing of insurance or annuity contracts or the 
reinsuring of risks underwritten by insurance companies. Thus, though 
its name, charter powers, and subjection to State insurance laws are 
significant in determining the business which a company is authorized 
and intends to carry on, it is the character of the business actually 
done in the taxable year which determines whether a company is taxable 
as an insurance company under the Internal Revenue Code.
    (2) Insurance companies include both stock and mutual companies, as 
well as mutual benefit insurance companies. For taxable years beginning 
before January 1, 1970, a voluntary unincorporated association of 
employees, including an association fulfilling the requirements of 
section 801(b)(2)(B) (as in effect for such years), formed for the 
purpose of relieving sick and aged members and the dependents of 
deceased members, is an insurance company, whether the fund for such 
purpose is created wholly by membership dues or partly by contributions 
from the employer. A corporation which merely sets aside a fund for the 
insurance of its employees is not an insurance company, and the income 
from such fund shall be included in the return of the corporation.
    (b) Life insurance company. (1) The term life insurance company, as 
used in subtitle A of the Code, is defined in section 801(a). For the 
purpose of determining whether a company is a ``life insurance company'' 
within the meaning of that term as used in section 801(a), it must first 
be determined whether the company is taxable as an insurance company (as 
defined in paragraph (a) of this section). An insurance company shall be 
taxed as a life insurance company if it is engaged in the business of 
issuing life insurance and annuity contracts (either separately or 
combined with health and accident insurance), or noncancellable 
contracts of health and accident insurance, and its life insurance 
reserves (as defined in section 801(b) and Sec. 1.801-4), plus unearned 
premiums, and unpaid losses (whether or not ascertained), on 
noncancellable life, health, or accident policies not included in life 
insurance reserves, comprise more than 50 percent of its total reserves 
(as defined in section 801(c) and Sec. 1.801-5). For purposes of 
determining whether it satisfies the percentage requirements of the 
preceding sentence, a company shall first make any adjustments to life 
insurance reserves and total reserves required by section 806(a) 
(relating to adjustments for certain changes in reserves and assets) and 
then as required by section 801(d) (relating to adjustments in reserves 
for policy loans). For examples of the adjustments required under 
section 806(a), see paragraph (b)(4) of Sec. 1.806-3. For an example of 
the adjustments required under section 801(d), see paragraph (c) of 
Sec. 1.801-6. Furthermore, if an insurance company which computes its 
life insurance reserves on a preliminary term basis elects to revalue 
such reserves on a net level premium basis under section 818(c), such 
revalued basis shall be disregarded for purposes of section 801.
    (2) An insurance company writing only noncancellable life, health, 
or accident policies and having no ``life insurance reserves'' may 
qualify as a life insurance company if its unearned premiums, and unpaid 
losses (whether or not ascertained), on such policies comprise more than 
50 percent of its total reserves.
    (3) Section 801(f) provides that a burial or funeral benefit 
insurance company engaged directly in the manufacture of funeral 
supplies or the performance of funeral services shall not be taxable 
under section 802 but shall be taxable under section 821 or section 831 
as an insurance company other than life.
    (c) Noncancellable life, health, or accident insurance policy. The 
term noncancellable life, health, or accident insurance policy means a 
health and accident contract, or a health and accident

[[Page 722]]

contract combined with a life insurance or annuity contract, which the 
insurance company is under an obligation to renew or continue at a 
specified premium and with respect to which a reserve in addition to the 
unearned premiums (as defined in paragraph (e) of this section) must be 
carried to cover that obligation. Such a health and accident contract 
shall be considered noncancellable even though it states a termination 
date at a stipulated age, if, with respect to the health and accident 
contract, such age termination date is 60 or over. Such a contract, 
however, shall not be considered to be noncancellable after the age 
termination date stipulated in the contract has passed. However, if the 
age termination date stipulated in the contract occurs during the period 
covered by a premium received by the life insurance company prior to 
such date, and the company cannot cancel or modify the contract during 
such period, the age termination date shall be deemed to occur at the 
expiration of the period for which the premium has been received.
    (d) Guaranteed renewable life, health, and accident insurance 
policy. The term guaranteed renewable life, health, and accident 
insurance policy means a health and accident contract, or a health and 
accident contract combined with a life insurance or annuity contract, 
which is not cancellable by the company but under which the company 
reserves the right to adjust premium rates by classes in accordance with 
its experience under the type of policy involved, and with respect to 
which a reserve in addition to the unearned premiums (as defined in 
paragraph (e) of this section) must be carried to cover that obligation. 
Section 801(e) provides that such policies shall be treated in the same 
manner as noncancellable life, health, and accident insurance policies. 
For example, the age termination date requirements applicable to 
noncancellable health and accident insurance policies shall also apply 
to guaranteed renewable life, health, and accident insurance policies. 
See paragraph (c) of this section.
    (e) Unearned premiums. The term unearned premiums means those 
amounts which shall cover the cost of carrying the insurance risk for 
the period for which the premiums have been paid in advance. Such term 
includes all unearned premiums, whether or not required by law.
    (f) Life insurance reserves. For the definition of the term ``life 
insurance reserves'', see section 801(b) and Sec. 1.801-4.
    (g) Unpaid losses (whether or not ascertained). The term unpaid 
losses (whether or not ascertained) means a reasonable estimate of the 
amount of the losses (based upon the facts in each case and the 
company's experience with similar cases):
    (1) Reported and ascertained by the end of the taxable year but 
where the amount of the loss has not been paid by the end of the taxable 
year,
    (2) Reported by the end of the taxable year but where the amount 
thereof has not been either ascertained or paid by the end of the 
taxable year, or
    (3) Which have occurred by the end of the taxable year but which 
have not been reported or paid by the end of the taxable year.
    (h) Total reserves. For the definition of the term total reserves, 
see section 801(c) and Sec. 1.801-5.
    (i) Amount of reserves. For purposes of subsections (a), (b), and 
(c) of section 801 and this section, section 801(b)(5) provides that the 
amount of any reserve (or portion thereof) for any taxable year shall be 
the mean of such reserve (or portion thereof) at the beginning and end 
of the taxable year.

[T.D. 6513, 25 FR 12655, Dec. 10, 1960, as amended by T.D. 7172, 37 FR 
5619, Mar. 17, 1972]



Sec. 1.801-4  Life insurance reserves.

    (a) Life insurance reserves defined. For purposes of part I, 
subchapter L, chapter 1 of the Code, the term life insurance reserves 
(as defined in section 801(b)) means those amounts:
    (1) Which are computed or estimated on the basis of recognized 
mortality or morbidity tables and assumed rates of interest;
    (2) Which are set aside to mature or liquidate, either by payment or 
reinsurance, future unaccrued claims arising from life insurance, 
annuity, and noncancellable health and accident insurance contracts 
(including life insurance or annuity contracts combined

[[Page 723]]

with noncancellable health and accident insurance) involving, at the 
time with respect to which the reserve is computed, life, health, or 
accident contingencies; and
    (3) Which, except as otherwise provided by section 801(b)(2) and 
paragraphs (b) and (c) of this section, are required by law. For the 
meaning of the term ``reserves required by law'', see paragraph (b) of 
Sec. 1.801-5.

For purposes of determining life insurance reserves, only those amounts 
shall be taken into account which must be reserved either by express 
statutory provisions or by rules and regulations of the insurance 
department of a State, Territory, or the District of Columbia when 
promulgated in the exercise of a power conferred by statute. Moreover, 
such amounts must actually be held by the company during the taxable 
year for which the reserve is claimed. However, reserves held by the 
company with respect to the net value of risks reinsured in other 
solvent companies (whether or not authorized) shall be deducted from the 
company's life insurance reserves. For example, if an ordinary life 
policy with a reserve of $100 is reinsured in another solvent company on 
a yearly renewable term basis, and the reserve on such yearly renewable 
term policy is $10, the reinsured company shall include $90 ($100 minus 
$10) in determining its life insurance reserves. Generally, life 
insurance reserves, as in the case of level premium life insurance, are 
held to supplement the future premium receipts when the latter, alone, 
are insufficient to cover the increased risk in the later years. For 
examples of reserves which qualify as life insurance reserves, see 
paragraph (d) of this section. For examples of reserves which do not 
qualify as life insurance reserves, see paragraph (e) of this section.
    (b) Certain reserves which need not be required by law. Section 
801(b)(2) sets forth certain reserves which, though not required by law, 
may still qualify as life insurance reserves, provided, however, that 
they first satisfy the requirements of section 801(b)(1) (A) and (B) and 
paragraph (a) (1) and (2) of this section. Thus, reserves need not be 
required by law:
    (1) In the case of policies covering life, health, and accident 
insurance combined in one policy issued on the weekly premium payment 
plan, continuing for life and not subject to cancellation, and
    (2) For taxable years beginning before January 1, 1970, in the case 
of policies issued by an organization which met the requirements of 
section 501(c)(9) (as it existed prior to amendment by the Tax Reform 
Act of 1969) other than the requirement of subparagraph (B) thereof.
    (c) Assessment companies. Section 801(b)(3) provides that in the 
case of an assessment life insurance company or association, the term 
life insurance reserves includes:
    (1) Sums actually deposited by such company or association with 
officers of a State or Territory pursuant to law as guaranty or reserve 
funds, and
    (2) Any funds maintained, under the charter or articles of 
incorporation or association of such company or association (or bylaws 
approved by the State insurance commissioner) of such company or 
association, exclusively for the payment of claims arising under 
certificates of membership or policies issued upon the assessment plan 
and not subject to any other use.

For purposes of part I, subchapter L, chapter 1 of the Code, the 
reserves described in this paragraph shall be included as life insurance 
reserves even though such reserves do not meet the requirements of 
section 801(b) and paragraph (a) of this section. However, for such 
reserves to be included as life insurance reserves, they must be 
deposited or maintained to liquidate future unaccrued claims arising 
from life insurance, annuity, or noncancellable health and accident 
insurance contracts (including life insurance or annuity contracts 
combined with noncancellable health and accident insurance) involving, 
at the time with respect to which the reserve is deposited or 
maintained, life, health, or accident contingencies. The rate of 
interest assumed in calculating the reserves described in this paragraph 
shall be 3 percent, regardless of the rate of interest (if any) 
specified in the contract in respect of such reserves.

[[Page 724]]

    (d) Reserves which qualify as life insurance reserves. The following 
reserves, provided they meet the requirements of section 801(b) and 
paragraph (a) of this section, are illustrative of reserves which shall 
be included as life insurance reserves:
    (1) Reserves held under life insurance contracts.
    (2) Reserves held under annuity contracts (including reserves held 
under variable annuity contracts as described in section 801(g)(1)).
    (3) Reserves held under noncancellable health and accident insurance 
contracts (as defined in paragraph (c) of Sec. 1.801-3) and reserves 
held under guaranteed renewable health and accident insurance contracts 
(as defined in paragraph (d) of Sec. 1.801-3).
    (4) Reserves held either separately or combined under contracts 
described in subparagraphs (1), (2), or (3) of this paragraph.
    (5) Reserves held under deposit administration contracts. Generally, 
the reserves held by a life insurance company on both the active and 
retired lives under deposit administration contracts will meet the 
requirements of section 801(b) and paragraph (a) of this section.

However, reserves held by the company with respect to the net value of 
risks reinsured in other solvent companies (whether or not authorized) 
shall be deducted from the company's life insurance reserves. See 
paragraph (a) of this section.
    (e) Reserves and liabilities which do not qualify as life insurance 
reserves. The following are illustrative of reserves and liabilities 
which do not meet the requirements of section 801(b) and paragraph (a) 
of this section and, accordingly, shall not be included as life 
insurance reserves:
    (1) Liability for supplementary contracts not involving at the time 
with respect to which the liability is computed, life, health, or 
accident contingencies.
    (2) In the case of cancellable health and accident policies and 
similar cancellable contracts, the unearned premiums and unpaid losses 
(whether or not ascertained).
    (3) The unearned premiums, and unpaid losses (whether or not 
ascertained), on noncancellable life, health, or accident policies (and 
guaranteed renewable life, health, and accident policies) not included 
in life insurance reserves. (However, such amounts shall be taken into 
account under section 801(a)(2) for purposes of determining whether an 
insurance company is a life insurance company.)
    (4) The deficiency reserve (as defined in section 801(b)(4)) for 
each individual contract, that is, that portion of the reserve for such 
contract equal to the amount (if any) by which:
    (i) The present value of the future net premiums required for such 
contract, exceeds
    (ii) The present value of the future actual premiums and 
consideration charged for such contract.
    (5) Reserves required to be maintained to provide for the ordinary 
operating expenses of a business which must be currently paid by every 
company from its income if its business is to continue, such as taxes, 
salaries, and unpaid brokerage.
    (6) Liability for premiums received in advance.
    (7) Liability for premium deposit funds.
    (8) Liability for annual and deferred dividends declared or 
apportioned.
    (9) Liability for dividends left on deposit at interest.
    (10) Liability for accrued but unsettled policy claims whether known 
or unreported.
    (11) A mandatory securities valuation reserve.
    (f) Adjustments to life insurance reserves. In the event it is 
determined on the basis of the facts of a particular case that premiums 
deferred and uncollected and premiums due and unpaid are not properly 
accruable for the taxable year under section 809 and, accordingly, are 
not properly includible under assets (as defined in section 805(b)(4)) 
for the taxable year, appropriate reduction shall be made in the life 
insurance reserves. This reduction shall be made when the insurance 
company has calculated life insurance reserves on the assumption that 
the premiums on all policies are paid annually or that all

[[Page 725]]

premiums due on or prior to the date of the annual statement have been 
paid.

[T.D. 6513, 25 FR 12656, Dec. 10, 1960, as amended by T.D. 7172, 37 FR 
5619, Mar. 17, 1972]



Sec. 1.801-5  Total reserves.

    (a) Total reserves defined. For purposes of section 801(a) and Sec. 
1.801-3, the term ``total reserves'' is defined in section 801(c) as the 
sum of:
    (1) Life insurance reserves (as defined in section 801(b) and Sec. 
1.801-4),
    (2) Unearned premiums (as defined in paragraph (e) of Sec. 1.801-
3), and unpaid losses (whether or not ascertained) (as defined in 
paragraph (g) of Sec. 1.801-3), not included in life insurance 
reserves, and
    (3) All other insurance reserves required by law.

The term ``total reserves'' does not, however, include deficiency 
reserves (within the meaning of section 801(b)(4), and paragraph (e)(4) 
of Sec. 1.801-4), even though such deficiency reserves are required by 
State law. In determining total reserves, a company is permitted to make 
use of the highest aggregate reserve required by any State or Territory 
or the District of Columbia in which it transacts business, but the 
reserve must have been actually held during the taxable year for which 
the reserve is claimed. For example, during the taxable year 1958 a life 
insurance company sells life insurance and annuity contracts in States A 
and B. State A requires reserves of 10 against the life and 5 against 
the annuity business. State B requires reserves of 9 against the life 
and 7 against the annuity business. Assuming the company actually holds 
these reserves during the taxable year 1958, its highest aggregate 
reserve for such taxable year is the 16 required by State B. Thus, the 
company is not permitted to compute its highest aggregate reserve by 
taking State A's requirement of 10 against its life insurance business 
and adding it to State B's requirement of 7 against its annuity 
business.
    (b) Reserves required by law defined. For purposes of part I, 
subchapter L, chapter 1 of the Code, the term reserves required by law 
means reserves which are required either by express statutory provisions 
or by rules and regulations of the insurance department of a State, 
Territory, or the District of Columbia when promulgated in the exercise 
of a power conferred by statute, and which are reported in the annual 
statement of the company and accepted by state regulatory authorities as 
held for the fulfillment of the claims of policyholders or 
beneficiaries.
    (c) Information to be filed. In any case where reserves are claimed, 
sufficient information must be filed with the return to enable the 
district director to determine the validity of the claim. See section 
6012 and paragraph (c) of Sec. 1.6012-2. If the basis (for Federal 
income tax purposes) for determining the amount of any of the life 
insurance reserves as of the close of the taxable year differs from the 
basis for such determination as of the beginning of the taxable year 
then the following information must be filed with respect to all such 
changes in basis:
    (1) The nature of the life insurance reserve (i.e., life, annuity, 
etc.);
    (2) The mortality or morbidity table, assumed rate of interest, 
method used in computing or estimating such reserve on the old basis, 
and the amount of such reserve at the beginning and close of the taxable 
year computed on the old basis;
    (3) The mortality or morbidity table, assumed rate of interest, 
method used in computing or estimating such reserve on the new basis, 
and the amount of such reserve at the close of the taxable year computed 
on the new basis;
    (4) The deviation, if any, from recognized mortality or morbidity 
tables, or recognized methods of computation;
    (5) The reasons for the change in basis of such reserve; and
    (6) Whether such change in the reserve has been approved or accepted 
by the regulatory authorities of the State of domicile, and if so, a 
copy of the letter, certificate, or other evidence of such approval or 
acceptance.
    (d) Illustration of principles. The provisions of section 801 
relating to the percentage requirements for qualification as a life 
insurance company may be illustrated by the following example:

    Example. The books of Y, an insurance company, selling life 
insurance,

[[Page 726]]

noncancellable health and accident insurance, and cancellable accident 
and health insurance, reflect (after adjustment under sections 806(a) 
and 801(d)) the following facts for the taxable year 1958:

------------------------------------------------------------------------
                                                                 Mean of
                                                Jan. 1  Dec. 31    year
------------------------------------------------------------------------
1. Life insurance reserves...................   $3,000   $5,000   $4,000
2. Unearned premiums, and unpaid losses            400      600      500
 (whether or not ascertained), on
 noncancellable accident and health insurance
 not included in life insurance reserves.....
3. Unearned premiums, and unpaid losses          1,800    2,200    2,000
 (whether or not ascertained), on cancellable
 accident and health insurance...............
4. All other insurance reserves required by        900    1,100    1,000
 law.........................................
                                              --------------------------
5. Total reserves............................  .......  .......    7,500
------------------------------------------------------------------------


The rules provided by section 801 require that the sum of the mean of 
the year figures in items 1 and 2 comprise more than 50 percent of the 
mean of the year figure in item 5 for an insurance company to qualify as 
a life insurance company. Thus, Y would qualify as a life insurance 
company for the taxable year 1958 as the sum of the mean of the year 
figures in items 1 and 2 ($4,500) comprise 60 percent of the mean of the 
year figure in item 5 ($7,500).

[T.D. 6513, 25 FR 12657, Dec. 10, 1960]



Sec. 1.801-6  Adjustments in reserves for policy loans.

    (a) In general. Section 801(d) provides that for purposes only of 
determining whether or not an insurance company is a life insurance 
company (as defined in section 801(a) and paragraph (b) of Sec. 1.801-
3), the life insurance reserves (as defined in section 801(b) and Sec. 
1.801-4), and the total reserves (as defined in section 801(c) and 
paragraph (a) of Sec. 1.801-5), shall each be reduced by an amount 
equal to the mean of the aggregates, at the beginning and end of the 
taxable year, of the policy loans outstanding with respect to contracts 
for which life insurance reserves are maintained. Such reduction shall 
be made after any adjustments required under section 806(a) and Sec. 
1.806-3 have been made.
    (b) Policy loans defined. The term policy loans includes loans made 
by the insurance company, by whatever name called, for which the reserve 
on a contract is the collateral.
    (c) Illustration of principles. The provisions of section 801(d) and 
this section may be illustrated by the following example:

    Example. The books of T, an insurance company, selling only life 
insurance and cancellable accident and health insurance, reflect (after 
adjustment under section 806 (a)) the following facts for the taxable 
year 1958:

------------------------------------------------------------------------
                                                                 Mean of
                                                Jan. 1  Dec. 31    year
------------------------------------------------------------------------
1. Life insurance reserves...................   $1,000   $2,000   $1,500
2. Policy loans..............................       50      850      450
                                              --------------------------
3. Life insurance reserves less policy loans.  .......  .......    1,050
4. Unearned premiums, and unpaid losses            900    1,600    1,250
 (whether or not ascertained), on cancellable
 accident and health insurance...............
                                              --------------------------
5. Total reserves adjusted for policy loans    .......  .......    2,300
 (item 3 plus item 4)........................
------------------------------------------------------------------------


As the rules provided by section 801 (a) and (d) require that the figure 
in item 3 ($1,050) be more than 50 percent of the mean of the year 
figure in item 5 ($2,300) for an insurance company to qualify as a life 
insurance company, T would not qualify as a life insurance company for 
the taxable year 1958.

[T.D. 6513, 25 FR 12657, Dec. 10, 1960]



Sec. 1.801-7  Variable annuities.

    (a) In general. (1) Section 801(g)(1) provides that for purposes of 
part I, subchapter L, chapter 1 of the Code, an annuity contract 
includes a contract which provides for the payment of a variable annuity 
computed on the basis of recognized mortality tables and the investment 
experience of the company issuing such a contract. A variable annuity 
differs from the ordinary or fixed dollar annuity in that the annuity 
benefits payable under a variable annuity contract vary with the 
insurance company's investment experience with respect to such contracts 
while the annuity benefits paid under a fixed dollar annuity contract 
are guaranteed irrespective of the company's actual investment earnings.
    (2) The reserves held with respect to the annuity contracts 
described in section 801(g)(1) and subparagraph (1) of this paragraph 
shall qualify as life insurance reserves within the meaning of section 
801(b)(1) and paragraph (a) of

[[Page 727]]

Sec. 1.801-4 provided such reserves are required by law (as defined in 
paragraph (b) of Sec. 1.801-5) and are set aside to mature or 
liquidate, either by payment or reinsurance, future unaccrued claims 
arising from such contracts involving, at the time with respect to which 
the reserve is computed, life, health, or accident contingencies. 
Accordingly, a company issuing variable annuity contracts shall qualify 
as a life insurance company for Federal income tax purposes if it 
satisfies the requirements of section 801(a) (relating to the definition 
of a life insurance company) and paragraph (b) of Sec. 1.801-3.
    (b) Special rules for variable annuities--(1) Adjusted reserves 
rate; assumed rate. The adjusted reserves rate for any taxable year with 
respect to the annuity contracts described in section 801(g)(1) and 
paragraph (a)(1) of this section, and the rate of interest assumed by 
the taxpayer for any taxable year in calculating the reserve on any such 
contract, shall be a rate equal to the current earnings rate determined 
under section 801(g)(3) and subparagraph (2) of this paragraph. However, 
any change in the rate of interest assumed by the taxpayer in 
calculating the reserve on a variable annuity contract for any taxable 
year which is attributable to an increase or decrease in the current 
earnings rate, shall not be treated as a change of basis in computing 
reserves for purposes of section 806(b) (relating to certain changes in 
reserves) or section 810 (d)(1) (relating to adjustment for change in 
computing reserves).
    (2) Current earnings rate. (i) The current earnings rate for any 
taxable year with respect to the annuity contracts described in section 
801(g)(1) and paragraph (a)(1) of this section shall be the current 
earnings rate determined under section 805(b)(2) and paragraph (a)(2) of 
Sec. 1.805-5 with respect to such contracts, reduced by the percentage 
obtained by dividing (a) the amount of the actuarial margin charge on 
all such variable annuity contracts issued by the taxpayer, by (b) the 
mean of the reserves for such contracts.
    (ii) For purposes of section 801(g)(3) and subdivision (i) of this 
subparagraph, the term actuarial margin charge means any amount retained 
by the company from gross investment income pursuant to the terms of the 
variable annuity contract in excess of any portion of the investment 
expenses which is attributable to such contract and which is deductible 
under section 804(c) and paragraph (b) of Sec. 1.804-4.
    (3) Increases and decreases in reserves. (i) Section 801(g)(4) 
provides that for purposes of section 810 (a) and (b) (relating to 
adjustments for increases or decreases in certain reserves), the sum of 
the items described in section 810(c) and paragraph (b) of Sec. 1.810-2 
taken into account as of the close of the taxable year shall be 
adjusted:
    (a) By subtracting therefrom the sum of any amounts added from time 
to time (for the taxable year) to the reserves for variable annuity 
contracts described in section 801(g)(1) and paragraph (a)(1) of this 
section by reason of realized or unrealized appreciation in the value of 
the assets held in relation thereto, and
    (b) By adding thereto the sum of any amounts subtracted from time to 
time (for the taxable year) from such reserves by reason of realized or 
unrealized depreciation in the value of such assets.
    (ii) The application of section 801(g)(4) and subdivision (i) of 
this subparagraph may be illustrated by the following example:

    Example. Company M, a life insurance company issuing only variable 
annuity contracts of the type described in section 801(g)(1) and 
paragraph (a)(1) of this section, increased its life insurance reserves 
held with respect to such contracts during the taxable year 1959 by 
$275,000. Of the total increase in the reserves, $100,000 was 
attributable to premium receipts, $50,000 to dividends and interest, 
$100,000 to unrealized appreciation in the value of the assets held in 
relation to such reserves, and $25,000 to realized capital gains on the 
sale of such assets. As of the close of the taxable year 1959, the 
reserves held by company M with respect to all variable annuity 
contracts amounted to $1,275,000. However, under section 801(g)(4) and 
subdivision (i) of this subparagraph, this amount must be reduced by the 
$100,000 unrealized asset value appreciation and the $25,000 of realized 
capital gains. Accordingly, for purposes of section 810 (a) and (b), the 
amount of these reserves which is to be taken into account as of the 
close of the taxable year 1959 under section 810(c) is $1,150,000 
($1,275,000 less $125,000).


[[Page 728]]


    (c) Companies issuing variable annuities and other contracts. (1) In 
the case of a life insurance company which issues both annuity contracts 
described in section 801(g)(1) and paragraph (a)(1) of this section and 
other contracts, the policy and other contract liability requirements 
(as defined in section 805(a) and paragraph (b) of Sec. 1.805-4) of 
such a company for any taxable year shall be considered to be the sum 
of:
    (i) The policy and other contract liability requirements computed 
with respect to the items which relate to such variable annuity 
contracts, and
    (ii) The policy and other contract liability requirements computed 
by excluding the items taken into account under subdivision (i) of this 
subparagraph.
    (2) [Reserved for regulations to be issued under section 
801(g)(5)(B).]
    (d) Termination. Paragraphs (1), (2), (3), (4), and (5) of section 
801(g) and paragraphs (a), (b), (c), and (d) of this section shall not 
apply with respect to any taxable year beginning after December 31, 
1962.

[T.D. 6610, 27 FR 8717, Aug. 31, 1962]



Sec. 1.801-8  Contracts with reserves based on segregated asset 
accounts.

    (a) Definitions--(1) Annuity contracts include variable annuity 
contracts. Section 801(g)(1)(A) provides that for purposes of part I, 
subchapter L, chapter 1 of the Code, an annuity contract includes a 
contract which provides for the payment of a variable annuity computed 
on the basis of recognized mortality tables and the investment 
experience of the company issuing such a contract. A variable annuity 
differs from the ordinary or fixed dollar annuity in that the annuity 
benefits payable under a variable annuity contract vary with the 
insurance company's investment experience with respect to such contracts 
while the annuity benefits paid under a fixed dollar annuity contract 
are guaranteed irrespective of the company's actual investment earnings.
    (2) Contracts with reserves based on a segregated asset account. (i) 
For purposes of part I, section 801(g)(1)(B) defines the term contract 
with reserves based on a segregated asset account as a contract 
(individual or group):
    (a) Which provides for the allocation of all or part of the amounts 
received under the contract to an account which, pursuant to State law 
or regulation, is segregated from the general asset accounts of the 
company,
    (b) Which provides for the payment of annuities, and
    (c) Under which the amounts paid in, or the amount paid as 
annuities, reflect the investment return and the market value of the 
segregated asset account.
    (ii) The term contract with reserves based on a segregated asset 
account includes a contract such as a variable annuity contract, which 
reflects the investment return and the market value of the segregated 
asset account, even though such contract provides for the payment of an 
annuity computed on the basis of recognized mortality tables, but the 
term includes such contract only for the period during which it 
satisfies the requirements of section 801(g)(1)(B) and subdivision (i) 
of this subparagraph. However, such term does not include a pension 
contract written on the basis of the so-called new-money concept. Thus, 
for example, such term does not include a pension contract whereby 
reserves are credited on the basis of the company's new high yield 
investments. Furthermore, such term does not include a contract which 
during the taxable year contains a right to participate in the divisible 
surplus of the company where such right merely reflects the company's 
investment return. Nevertheless, the term does include a contract which 
meets the requirements of section 801(g)(1)(B) and of this subparagraph 
even if part of the amounts received are, for example, allocated to 
reserves under provisions of the contract which are written on the basis 
of the new-money concept. However, such reserves do not qualify as a 
segregated asset account referred to in section 801(g) and this section.
    (iii) If at any time during the taxable year a contract otherwise 
satisfying the requirements of section 801(g)(1)(B) and subdivision (i) 
of this subparagraph ceases to reflect current investment return and 
current market value, such contract shall not be considered as meeting 
the requirements of section 801(g)(1)(B)(iii) and subdivision (i)(c) of

[[Page 729]]

this subparagraph after such cessation. Thus, a contract with reserves 
based on a segregated asset account includes a contract under which the 
reflection of investment return and market value terminates at the 
beginning of the annuity payments, but only for the period prior to such 
termination. For example, if the purchaser of a variable annuity 
contract which meets such requirements elects an option which provides 
for the payment of a fixed dollar annuity, then such contract shall be 
considered as satisfying such requirements only for the period prior to 
the time such contract ceases to reflect current investment return and 
current market value. Furthermore, a group annuity contract which 
satisfies the requirements of section 801(g)(1)(B) and subdivision (i) 
of this subparagraph shall be considered as continuing to meet such 
requirements even though a certificate holder under the group contract 
elects an option which provides for the payment of a fixed dollar 
annuity. However, the annuity attributable to such certificate holder 
shall not be considered as satisfying such requirements as of the time 
such annuity ceases to reflect current investment return and current 
market value. On the other hand, a group annuity contract which does not 
reflect current market value shall not be considered as satisfying such 
requirements even though a certificate holder under the group contract 
elects an option which provides for the payment of a variable annuity. 
However, the variable annuity attributable to such certificate holder 
shall be considered as satisfying such requirements as of the time such 
variable annuity commences to reflect current investment return and 
current market value.
    (b) Life insurance reserves. Section 801(g)(2) provides that for 
purposes of section 801(b)(1)(A), the reflection of the investment 
return and the market value of the segregated asset account shall be 
considered an assumed rate of interest. Thus, the reserves held with 
respect to contracts described in section 801(g)(1) and paragraph (a) of 
this section shall qualify as life insurance reserves within the meaning 
of section 801(b)(1) and paragraph (a) of Sec. 1.801-4 provided such 
reserves are required by law (as defined in paragraph (b) of Sec. 
1.801-5) and are set aside to mature or liquidate, either by payment or 
reinsurance, future unaccrued claims arising from such contracts with 
reserves based on segregated asset accounts involving, at the time with 
respect to which the reserve is computed, life, health, or accident 
contingencies. Accordingly, a company issuing contracts with reserves 
based on segregated asset accounts shall qualify as a life insurance 
company for Federal income tax purposes if it satisfies the requirements 
of section 801(a) (relating to the definition of a life insurance 
company) and paragraph (b) of Sec. 1.801-3.
    (c) Separate accounting. (1) For purposes of part I, section 
801(g)(3) provides that a life insurance company (as defined in section 
801(a) and paragraph (b) of Sec. 1.801-3) which issues contracts with 
reserves based on segregated asset accounts (as defined in section 801 
(g)(1)(B) and paragraph (a)(2) of this section) shall separately account 
for each and every income, exclusion, deduction, asset, reserve, and 
other liability item which is properly attributable to such segregated 
asset accounts. In those cases where such items are not directly 
accounted for, separate accounting shall be made:
    (i) According to the method regularly employed by the company, if 
such method is reasonable, and
    (ii) In all other cases in a manner which, in the opinion of the 
district director, is reasonable.

A method of separate accounting for such items as are not accounted for 
directly will be deemed ``regularly employed'' by a life insurance 
company if the method was consistently followed in prior taxable years, 
or if, in the case of a company which has never before issued contracts 
with reserves based on segregated asset accounts, the company initiates 
in the first taxable year for which it issues such contracts a 
reasonable method of separate accounting for such items and consistently 
follows such method thereafter. Ordinarily, a company regularly employs 
a method of accounting in accordance with the statute of the State, 
Territory, or the District of Columbia, in which it operates.

[[Page 730]]

    (2) Every life insurance company issuing contracts with reserves 
based on segregated asset accounts shall keep such permanent records and 
other data relating to such contracts as is necessary to enable the 
district director to determine the correctness of the application of the 
rules prescribed in section 301(g) and this section and to ascertain the 
accuracy of the computations involved.
    (d) Investment yield. (1) For purposes of part I, section 
801(g)(4)(A) provides that the policy and other contract liability 
requirements (as determined under section 805), and the life insurance 
company's share of investment yield (as determined under sections 804(a) 
or 809(b)), shall be separately computed:
    (i) With respect to the items separately accounted for in accordance 
with section 801(g)(3) and paragraph (c) of this section, and
    (ii) Excluding the items taken into account under subdivision (i) of 
this subparagraph.

Thus, for purposes of determining both taxable investment income and 
gain or loss from operations, a life insurance company shall separately 
compute the life insurance company's share of the investment yield on 
the assets in its segregated asset account without regard to the policy 
and other contract liability requirements of, and the investment income 
attributable to, contracts with reserves that are not based on the 
segregated asset account. Such separate computations shall be made after 
any allocation required under section 801(g)(4)(B) and subparagraph (2) 
of this paragraph.
    (2)(i) Section 801(g)(4)(B) provides that if the net short-term 
capital gain (as defined in section 1222(5)) exceeds the net long-term 
capital loss (as defined in section 1222(8)), determined without regard 
to any separate computations under section 801(g)(4)(A) and subparagraph 
(1) of this paragraph, then such excess shall be allocated between 
section 801(g)(4)(A) (i) and (ii) and subparagraph (1) (i) and (ii) of 
this paragraph. Such allocation shall be in proportion to the respective 
contributions to such excess of the items taken into account under each 
such section and subparagraph. The allocation under this subparagraph 
shall be made before the separate computations prescribed by section 
801(g)(4)(A) and subparagraph (1) of this paragraph.
    (ii) The operation of the allocation required under section 
801(g)(4)(B) and subdivision (i) of this subparagraph may be illustrated 
by the following examples:

    Example 1. For the taxable year 1962, T, a life insurance company 
which issues regular life insurance and annuity contracts and contracts 
with reserves based on segregated asset accounts, had (without regard to 
section 801(g)(4)(A)) realized short-term capital gains of $10,000 and 
short-term capital losses of $10,000 attributable to its general asset 
accounts and realized short-term capital gains of $12,000 attributable 
to its segregated asset accounts. For the taxable year 1962, the excess 
of the net short-term capital gain ($10,000+$12,000-$10,000, or $12,000) 
over the net long-term capital loss (0) was $12,000. Of the excess of 
$12,000, 100 percent was contributed by the segregated asset accounts. 
Applying the provisions of section 801(g)(4)(B), T would allocate the 
entire $12,000 to its segregated asset accounts for such taxable year.
    Example 2. The facts are the same as in example 1 except that for 
the taxable year 1962, T had (without regard to section 801(g)(4)(A)) 
realized short-term capital losses of $8,000 attributable to its general 
asset accounts and realized long-term capital gains of $1,000 and long-
term capital losses of $5,000 attributable to its segregated asset 
accounts. For the taxable year 1962, the excess of the net short-term 
capital gain ($10,000+$12,000-$8,000, or $14,000) over the net long-term 
capital loss ($5,000-$1,000, or $4,000) was $10,000. Of the excess of 
$10,000, the general asset accounts contributed 20 percent ($2,000 
($10,000-$8,000)/$10,000) and the segregated asset accounts contributed 
80 percent ($8,000 ($12,000-$4,000)/$10,000). Applying the provisions of 
section 801(g)(4)(B), T would allocate $2,000 ($10,000x20 percent) to 
its general asset accounts and $8,000 ($10,000x80 percent) to its 
segregated asset accounts for such taxable year.
    Example 3. W is a life insurance company which issues regular life 
insurance and annuity contracts and contracts with reserves based on 
either of two segregated asset accounts, Separate Account C or Separate 
Account D. For the taxable year 1962, W had (without regard to section 
801(g)(4)(A)) realized short-term capital gains of $16,000 and long-term 
capital losses of $15,000 attributable to its general asset accounts, 
long-term capital gains of $12,000 and short-term capital losses of 
$6,000 attributable to Separate Account C and long-term capital gains of 
$7,000 and short-term capital losses of $5,000 attributable to Separate 
Account D.

[[Page 731]]

For the taxable year 1962, the excess of the net short-term capital gain 
($16,000-$6,000-$5,000) over the net long-term capital loss (0) was 
$5,000. Of the $5,000 excess, 20 percent ($16,000-$15,000/$5,000) was 
contributed by the general asset accounts, leaving 80 percent as the 
amount contributed by the segregated asset accounts. Applying the 
provisions of section 801(g)(4)(B) W would allocate $1,000 (20 percent 
of $5,000) to the general asset accounts, leaving $4,000 (80 percent of 
$5,000) to be allocated among the segregated asset accounts, Separate 
Account C and Separate Account D. W would allocate $3,000 of the $4,000 
to Separate Account C computed as follows:
[GRAPHIC] [TIFF OMITTED] TC14NO91.135


W would allocate $1,000 of the $4,000 to Separate Account D computed as 
follows:
[GRAPHIC] [TIFF OMITTED] TC14NO91.136

    (e) Policy and other contract liability requirements. (1) For 
purposes of part I, section 801(g)(5)(A) provides that with respect to 
life insurance reserves based on segregated asset accounts (as defined 
in section 801(g)(1)(B) and paragraph (a)(2) of this section), the 
adjusted reserves rate and the current earnings rate for purposes of 
section 805(b), and the rate of interest assumed by the taxpayer for 
purposes of sections 805(c) and 809(a)(2), shall be a rate equal to the 
current earnings rate determined under section 805(b)(2) and paragraph 
(a)(2) of Sec. 1.805-5 with respect to the items separately accounted 
for in accordance with section 801(g)(3), reduced by the percentage 
obtained by dividing:
    (i) Any amount retained with respect to all of the reserves based on 
a segregated asset account by the life insurance company from gross 
investment income (as defined in section 804(b) and paragraph (a) of 
Sec. 1.804-3) on segregated assets, to the extent such retained amount 
exceeds the deductions allowable under section 804(c) which are 
attributable to such reserves, by
    (ii) The means of such reserves.
    (2) For purposes of part I, section 801 (g)(5)(B) provides that with 
respect to reserves based on segregated asset accounts other than life 
insurance reserves, there shall be included as interest paid within the 
meaning of section 805(e)(1) and paragraph (b)(1) of Sec. 1.805-8, an 
amount equal to the product of the means of such reserves multiplied by 
the rate of interest assumed as defined in section 801(g)(5)(A) and 
subparagraph (1) of this paragraph.
    (3) For purposes of this paragraph, any change in the rate of 
interest assumed by the taxpayer in calculating the reserve on a 
contract with reserves based on a segregated asset account for any 
taxable year beginning after December 31, 1961, which is attributable to 
an increase or decrease in the current earnings rate, shall not be 
treated as a change of basis in computing reserves for purposes of 
section 806(b) (relating to certain changes in reserves) or section 810 
(d)(1) (relating to adjustment for change in computing reserves).
    (4) The provisions of section 801(g) (3) through (5) may be 
illustrated by the following example. For purposes of this example, it 
is assumed that all computations have been carried out to a sufficient 
number of decimal places to insure substantial accuracy and to eliminate 
any significant error in the resulting tax liability.

    Example. The books of R, a life insurance company, discloses the 
following facts with respect to items of investment yield, deductions, 
assets, and reserves for the taxable year 1962:
    (a) Excerpts from Company Financial Statements.

------------------------------------------------------------------------
                                       Company
        (1) Investment yield           regular     Separate    Separate
                                       account     account A   account B
------------------------------------------------------------------------
Interest wholly tax-exempt.........     $100,000      $3,000      $1,000
Interest--other....................   10,000,000       8,000      15,000
Dividends received.................      200,000      25,000      27,000
Other items of investment yield....      100,000       2,000       1,000
                                    ------------------------------------
Gross investment income............   10,400,000      38,000      44,000
Less deductions (sec. 804(c))......    1,000,000       4,000       4,400
                                    ------------------------------------
Investment yield...................    9,400,000      34,000      39,600
                                    ------------------------------------
(2) Assets and reserves:
  (i) Assets:
    Jan. 1, 1962...................  190,000,000  ..........  ..........
    Dec. 31, 1962..................  210,000,000   1,600,000   1,800,000
    Mean...........................  200,000,000     800,000     900,000
                                    ------------------------------------
  (ii) Life insurance reserves:
    Jan. 1, 1962...................  152,000,000  ..........  ..........
    Dec. 31, 1962..................  168,000,000   1,600,000   1,640,000

[[Page 732]]

 
    Mean...........................  160,000,000     800,000     820,000
                                    ------------------------------------
  (iii) Reserves based on
   segregated asset accounts other
   than life insurance reserves:
    Jan. 1, 1962...................  ...........  ..........  ..........
    Dec. 31, 1962..................  ...........  ..........     120,000
    Mean...........................  ...........  ..........      60,000
------------------------------------------------------------------------

    (b) Additional facts. In addition to the facts assumed in (a) above, 
assume the following: The company retained with respect to reserves 
based upon segregated asset accounts a total of $4,720 from gross 
investment income on Separate Account A and $5,720 from gross investment 
income on Separate Account B. With respect to the Company Regular 
Account computed without regard to the items in either of the separate 
accounts, the policy and other contract liability requirement is 
$6,580,000 and the required interest is $5,640,000. There are no items 
of interest paid with respect to the separate accounts other than those 
computed under section 801(g)(5)(B). Based on these facts, the current 
earnings rate (sec. 805(b)); adjusted reserves rate (sec. 805 (b)); and 
rate of interest assumed (secs. 805(c) and 809(a)(2)); and the policy 
and other contract liability requirements are determined for each of the 
Separate Accounts A and B (and the policy and other contract liability 
requirements for the Company Regular Account) as set forth in items (c) 
through (1) below.
    (c) Separate Account A. The current earnings rate determined under 
section 805 (b)(2) with respect to the items separately accounted for 
under Separate Account A, prior to the reduction provided for under 
section 801(g)(5)(A), is 4.25 percent (the investment yield, $34,000, 
divided by the mean of the assets, $800,000). The company retained with 
respect to such reserves from gross investment income on Separate 
Account A a total of $4,720. The company had deductions allowable under 
section 804(c) with respect to such account of $4,000. Accordingly, for 
purposes of section 801(g)(5)(A)(i), the amount retained by the company 
was $720 (the total amount retained of $4,720 less the deductions 
allowable under section 804(c) of $4,000). The reduction percentage for 
purposes of section 801(g)(5)(A) is 0.09 percent (the amount retained of 
$720 divided by the mean of the life insurance reserves of $800,000). 
Therefore, the adjusted reserves rate and the current earnings rate for 
purposes of section 805(b), and the rate of interest assumed for 
purposes of sections 805(c) and 809(a)(2) is equal to 4.16 percent (the 
current earnings rate of 4.25 percent less the reduction percentage of 
0.09 percent).
    The policy and other contract liability requirements with respect to 
Separate Account A is determined as follows: For purposes of section 
805(a) (1) and (2), the amount is $33,280 (the mean of the life 
insurance reserves, $800,000, multiplied by the current earnings rate, 
as determined under section 801(g)(5)(A), 4.16 percent). Thus, the 
policy and other contract liability requirement for Separate Account A 
is $33,280.
    (d) Separate Account B. The current earnings rate determined under 
section 805 (b)(2) with respect to the items separately accounted for 
under Separate Account B, prior to the reduction provided for under 
section 801(g)(5)(A), is 4.40 percent (the investment yield, $39,600 
divided by the mean of the assets, $900,000). The company retained with 
respect to such reserves from gross investment income on Separate 
Account B a total of $5,720. The company had deductions allowable under 
section 804(c) with respect to such account of $4,400. Accordingly, for 
purposes of section 801(g)(5)(A)(i) the amount retained by the company 
was $1,320 (the total amount retained of $5,720 less the deductions 
allowable under section 804(c) of $4,400). The reduction percentage for 
purposes of section 801(g)(5)(A) is 0.15 percent (the amount retained of 
$1,320 divided by the mean of the reserves based on Separate Account B 
of $880,000 ($820,000 plus $60,000)). Therefore, the adjusted reserves 
rate and the current earnings rate for purposes of section 805(b), and 
the rate of interest assumed for purposes of section 805(c) and 
809(a)(2) is equal to 4.25 percent (the current earnings rate of 4.40 
percent less the reduction percentage of 0.15 percent).
    With respect to reserves based on segregated asset accounts other 
than life insurance reserves, Separate Account B had such reserves at 
December 31, 1962, of $120,000. The mean of such reserves was $60,000. 
The rate of interest assumed with respect to such reserves is 4.25 
percent, as computed above. Accordingly, there shall be included as 
interest paid within the meaning of section 805(e)(1) the amount of 
$2,550 (the mean of such reserves, $60,000 multiplied by the rate of 
interest assumed of 4.25 percent).
    The policy and other contract liability requirements with respect to 
Separate Account B is determined as follows:
    (1) For purposes of section 805(a)(1) and (2), the amount is $34,850 
(the mean of the life insurance reserves, $820,000, multiplied by the 
current earnings rate, as determined under section 801(g)(5)(A), 4.25 
percent).
    (2) For purposes of section 805(a)(3), the amount is $2,550 (the 
mean of the reserves based on Separate Account B other than life 
insurance reserves, $60,000, multiplied by the rate of interest assumed, 
as determined under section 801(g)(5)(A), 4.25 percent). It has been 
assumed that there was no other interest paid on Separate Account B 
within

[[Page 733]]

the meaning of section 805(e). If there was other interest paid with 
respect to Separate Account B that met the requirements of section 
805(e), however, then such interest would be included under section 
805(a)(3). Thus, the policy and other contract liability requirement for 
Separate Account B is $37,400 ($34,850+$2,550).
    (e) Company Regular Account. The policy and other contract liability 
requirements with respect to the Company Regular Account is $6,580,000 
(this amount is determined by the company in the manner provided by 
section 805 (and the regulations thereunder) without regard to either 
Separate Account A or Separate Account B).
    (f) Policyholders' share and company's share of investment yield--
section 804. The policyholders' and company's share of investment yield 
and taxable investment income are computed as follows:

                       (1) Company Regular Account
 
Policyholders' share of investment       70% ($6,580,000/$9,400,000).
 yield.
 
Company's share of investment yield      30%.
 (100% less 70%).
 
                         (2) Separate Account A
 
Policyholders' share of investment       97.8824% ($33,280 /$34,000).
 yield.
 
Company's share of investment yield      2.1176%.
 (100% less 97.8824%).
 
                         (3) Separate Account B
 
Policyholders' share of investment       94.444% ($37,400 /$39,600).
 yield.
 
Company's share of investment yield      5.556%.
 (100% less 94.444%).
 

    (g) The company's share of investment yield under section 804 is 
determined as follows:

----------------------------------------------------------------------------------------------------------------
                                                    Company regular      Separate account A   Separate account B
                                                  account (30 percent     (2.1176 percent       (5.556 percent
      Investment yield (from item (a)(1))         times each amount in   times each amount    times each amount
                                                      item (a)(1))        in item (a)(1))      in item (a)(1))
----------------------------------------------------------------------------------------------------------------
Interest wholly tax-exempt.....................          $30,000                   $63.53               $55.56
Interest--other................................        3,000,000                   169.41               833.40
Dividends received.............................           60,000                   529.40             1,500.12
Other items of gross investment income.........           30,000                    42.35                55.56
                                                ----------------------------------------------------------------
                                                       3,120,000                   804.69             2,444.64
    Less deductions............................          300,000                    84.70               244.46
                                                ----------------------------------------------------------------
Investment yield...............................        2,820,000                   719.99             2,200.18
----------------------------------------------------------------------------------------------------------------

    (h) Taxable investment income. The company's taxable investment 
income (without regard to any excess of net long-term capital gain over 
net short-term capital loss) is determined as follows:

Life insurance company's share of investment yield   ...   $2,822,920.17
 ($2,820,000+$719.99+ $2,200.18)...................
Less:
  Company's share of interest wholly tax-exempt
   ($30,000+ $63.53+$55.56)=$30,119.09
  85 percent of company's share of dividends
   received (but not to exceed 85% of taxable
   investment income computed without regard to
   this deduction) (85%x$62,029.52) ($60,000+
   $529.40+$1,500.12)=$52,725.09
  Small business deduction (10% of investment        ...      107,844.18
   yield, $9,473,600, not to exceed $25,000)
   =$25,000.00.....................................
                                                         ---------------
    Taxable investment income......................  ...    2,715,075.99
------------------------------------------------------------------------

    (i) Required interest--section 809(a)(2)--(1) Separate Account A. 
The rate of interest assumed by the company, with respect to Separate 
Account A is 4.16 percent (see (c) above). The required interest for 
purposes of section 809(a)(2) is determined as follows:

Life insurance reserves: 4.16% (rate assumed) times           $33,280.00
 $800,000 (mean of life insurance reserves).............
 

    (2) Separate Account B. The rate of interest assumed by the company 
with respect to Separate Account B is 4.25 percent (see (d) above). The 
required interest for purposes of section 809(a)(2) is determined as 
follows:

(i) Life insurance reserves: 4.25% (rate assumed) times       $34,850.00
 $820,000 (mean of life insurance reserves).............
(ii) Other section 810(c) reserves: 4.25% (rate assumed)       $2,550.00
 times $60,000 (mean of reserves other than life
 insurance reserves)....................................
                                                         ---------------
                                                              $37,400.00
 

    (3) Company Regular Account. The required interest with respect to 
the Company Regular Account is $5,640,000 (this amount is assumed for 
purposes of this example, but it would be determined by the company in 
the

[[Page 734]]

manner provided by section 809 without regard to either Separate Account 
A or Separate Account B).
    (j) Policyholders' share and company's share of investment yield--
section 809. The policyholders' share and the company's share of 
investment yield for purposes of section 809 is determined as follows:

(1) Company Regular Account:
    Policyholders' share of investment yield.  60% ($5,640,000/
                                                $9,400,000).
    Company's share of investment yield (100   40%.
     percent--60%)..
(2) Separate Account A:
    Policyholders' share of investment yield.  97.8824% ($33,280/
                                                $34,000).
    Company's share of investment yield        2.1176%.
     (100%--97.8824 percent)..
(3) Separate Account B:
    Policyholders' share of investment yield.  94.444% ($37,400/
                                                $39,600).
    Company's share of investment yield        5.556%.
     (100%--94.444%)..
------------------------------------------------------------------------

    (k) The company's share of investment yield under section 809 is 
determined as follows:

----------------------------------------------------------------------------------------------------------------
                                                                Separate account A
  Investment yield (from item     Company regular account     (2.1176 percent times    Separate account B (5.556
            (a)(1))                (40 percent times each      each amount in item     percent times each amount
                                   amount in item (a)(1))            (a)(1))                in item (a)(1))
----------------------------------------------------------------------------------------------------------------
Interest wholly tax-exempt.....                    $40,000                     $63.53                     $55.56
Interest--other................                  4,000,000                     169.41                     833.40
Dividends received.............                     80,000                     529.40                   1,500.12
Other items of gross investment                     40,000                      42.35                      55.56
 income........................
                                --------------------------------------------------------------------------------
                                                 4,160,000                     804.69                   2,444.64
    Less deductions............                    400,000                      84.70                     244.46
                                --------------------------------------------------------------------------------
Investment yield...............                  3,760,000                     719.99                   2,200.18
----------------------------------------------------------------------------------------------------------------

    (1) Deductions under section 809(d)(8). For purposes of section 
809(d)(8), the life insurance company's share of each of such items is 
determined as follows:

(1) Wholly tax-exempt interest ($40,000+$63.53+$55.56)....    $40,119.09
(2) Dividends received 85%x $82,029.52                         69,725.09
 ($80,000+$529.40+$1,500.12) (it is assumed for purposes
 of this example that this amount does not exceed 85% of
 the gain from operations as computed under sec.
 809(d)(8)(B))............................................
 


    (f) Increases and decreases in reserves. (1) Section 801(g)(6) 
provides that for purposes of section 810 (a) and (b) (relating to 
adjustments for increases or decreases in certain reserves), the sum of 
the items described in section 810(c) and paragraph (b) of Sec. 1.810-2 
taken into account as of the close of the taxable year shall be 
adjusted:
    (i) By subtracting therefrom the sum of any amounts added from time 
to time (for the taxable year) to the reserves separately accounted for 
in accordance with section 801(g)(3) and paragraph (c) of this section 
by reason of realized or unrealized appreciation in value of the assets 
held in relation thereto, and
    (ii) By adding thereto the sum of any amounts subtracted from time 
to time (for the taxable year) from such reserves by reason of realized 
or unrealized depreciation in the value of such assets.
    (2) The provisions of subparagraph (1) of this paragraph may be 
illustrated by the following example:

    Example. Company M, a life insurance company issuing only contracts 
with reserves based on segregated asset accounts as defined in section 
801(g)(1)(B) and paragraph (a)(2) of this section (other than contracts 
described in section 805(d)(1) (A), (B), (C), or (D)), increased its 
life insurance reserves held with respect to such contracts during the 
taxable year 1962 by $275,000. Of the total increase in the reserves, 
$100,000 was attributable to premium receipts, $50,000 to dividends and 
interest, $100,000 to unrealized appreciation in the value of the assets 
held in relation to such reserves, and $25,000 to realized capital gains 
on the sale of such assets. As of the close of the taxable year 1962, 
the reserves held by company M with respect to all such contracts 
amounted to $1,275,000. However, under section 801(g)(6) and this 
subparagraph, this amount must be reduced by the $100,000 unrealized 
asset value appreciation and the $25,000 of realized capital gains.

[[Page 735]]

Accordingly, for purposes of section 810(a) and (b), the amount of these 
reserves which is to be taken into account as of the close of the 
taxable year 1962 under section 810(c) is $1,150,000 ($1,275,000 less 
$125,000). However, for purposes of section 810 (a) and (b), the amount 
of these reserves which is to be taken into account as of the beginning 
of the taxable year 1963 under section 810(c) is $1,275,000 (the amount 
as of the close of the taxable year 1962 before reduction of $125,000 
for unrealized appreciation and realized capital gains).

    (3)(i) Under section 801(g)(6), the deduction allowable for items 
described in section 809(d) (1) and (7) (relating to death benefits and 
assumption reinsurance, respectively) with respect to segregated asset 
accounts shall be reduced to the extent that the amount of such items is 
increased for the taxable year by appreciation (or shall be increased to 
the extent that the amount of such items is decreased for the taxable 
year by depreciation) not reflected in adjustments required to be made 
under subparagraph (1) of this paragraph.
    (ii) The provisions of this subparagraph may be illustrated by the 
following example:

    Example. On June 30, 1962, X, a life insurance company, reinsured a 
portion of its insurance contracts with reserves based on segregated 
asset accounts with Y, a life insurance company, under an agreement 
whereby Y agreed to assume and become solely liable under the contracts 
reinsured. The reserves on the contracts reinsured by X were $90,000, of 
which $10,000 was attributable to unrealized appreciation in the value 
of the assets held in relation to such reserves. However, no amounts had 
been added to the reserves by reason of the unrealized appreciation of 
$10,000 and consequently, the $10,000 was not reflected in adjustments 
to reserves under section 809(g)(6) or subparagraph (1) of this 
paragraph. Under the reinsurance agreement, X made a payment of $90,000 
in cash to Y for assuming such contracts. Applying the provisions of 
section 809(d)(7), and assuming no other such reinsurance transactions 
by X during the taxable year, X would have an allowable deduction of 
$90,000 as a result of this payment on June 30, 1962. However, applying 
the provisions of section 801(g)(6) and this subparagraph, the actual 
deduction allowed would be $80,000 ($90,000 less $10,000). See section 
806 (a) and Sec. 1.806-3 for the adjustments in reserves and assets to 
be made by X and Y as a result of this transaction. For the treatment by 
Y of this $90,000 payment, see section 809(c)(1) and paragraph (a)(1)(i) 
of Sec. 1.809-4.

    (g) Basis of assets held for certain pension plan contracts. Section 
801(g)(7) provides that in the case of contracts described in section 
805(d)(1) (A), (B), (C), (D), or (E) (relating to the definition of 
pension plan reserves), the basis of each asset in a segregated asset 
account shall (in addition to all other adjustments to basis) be (i) 
increased by the amount of any appreciation in value, and (ii) decreased 
by the amount of any depreciation in value; but only to the extent that 
such appreciation and depreciation are reflected in the increases and 
decreases in reserves, or other items described in section 801(g)(6), 
with respect to such contracts. Thus, there shall be no capital gains 
tax payable by a life insurance company on appreciation realized on 
assets in a segregated asset account to the extent such appreciation has 
been reflected in reserves, or other items described in section 
801(g)(6), for contracts described in section 805(d)(1) (A), (B), (C), 
(D), or (E) based on segregated asset accounts.
    (h) Additional separate computation--(1) Assets and total insurance 
liabilities. A life insurance company which issues contracts with 
reserves based on segregated asset accounts (as defined in section 
801(g)(1)(B) and paragraph (a)(2) of this section) shall separately 
compute and report with its return the assets and total insurance 
liabilities which are properly attributable to all of such segregated 
asset accounts. Each foreign corporation carrying on a life insurance 
business which issues such contracts shall separately compute and report 
with its return assets held in the United States and total insurance 
liabilities on United States business which are properly attributable to 
all of such segregated asset accounts.
    (2) Foreign life insurance companies. For adjustment under section 
819 in the case of a foreign life insurance company which issues 
contracts based on segregated asset accounts under section 801(g), see 
Sec. 1.819-2(b)(4).

[T.D. 6886, 31 FR 8681, June 23, 1966, as amended by T.D. 6970, 33 FR 
12044, Aug. 24, 1968; T.D. 7501, 42 FR 42341, Aug. 23, 1977]

[[Page 736]]



Sec. 1.802(b)-1  Tax on life insurance companies.

    (a) For taxable years beginning after December 31, 1953, but before 
January 1, 1955, and ending after August 16, 1954, section 802(b) 
imposes a tax on the 1954 life insurance company taxable income of all 
life insurance companies (including a foreign life insurance company 
carrying on a life insurance business within the United States if with 
respect to its United States business it would qualify as a life 
insurance company under section 801). The tax so imposed is equal to 
3\3/4\ percent of the amount of such income not in excess of $200,000, 
plus 6\1/2\ percent of the amount of such income in excess of $200,000. 
For the definition of the term ``1954 life insurance company taxable 
income'', see Sec. 1.805-1.
    (b) The taxable income of life insurance companies differs from the 
taxable income of other corporations. See section 803. Life insurance 
companies are entitled, in computing life insurance company taxable 
income, to the special deductions provided in part VIII (section 241 and 
following), except section 248, subchapter B, chapter 1 of the Code. The 
gross income, the deduction under section 803 (g)(1) for wholly tax-
exempt interest, and the deduction under section 242 for partially tax-
exempt interest, are decreased by the appropriate amortization of 
premium and increased by the appropriate accrual of discount 
attributable to the taxable year on bonds, notes, debentures, or other 
evidences of indebtedness held by a life insurance company. See section 
803 (i) and Sec. 1.803-6. Such companies are not subject to the 
provisions of subchapter P (section 1201 and following), chapter 1 of 
the Code, relating to capital gains and losses, nor to the provisions of 
section 171 (amortizable bond premium).
    (c) All provisions of the Code and of the regulations in this part 
not inconsistent with the specific provision of sections 801 to 807, 
inclusive, are applicable to the assessment and collection of the tax 
imposed by section 802, and life insurance companies are subject to the 
same penalties as are provided in the case of returns and payment of 
income tax by other corporations. The return shall be on Form 1120L.
    (d) Foreign life insurance companies not carrying on an insurance 
business within the United States are not taxable under section 802, but 
are taxable as other foreign corporations. See section 881.



Sec. 1.802-2  Taxable years affected.

    Section 1.802(b)-1 is applicable only to taxable years beginning 
after December 31, 1953, and before January 1, 1955, and all references 
to sections of part I, subchapter L, chapter 1 of the Code are to the 
Internal Revenue Code of 1954, before amendments. Sections 1.802-3 
through 1.802-5 (other than paragraph (f)(2) of Sec. 1.802-3), except 
as otherwise provided therein, are applicable only to taxable years 
beginning after December 31, 1957, and all references to sections of 
part I, subchapter L, chapter 1 of the Code are to the Internal Revenue 
Code of 1954, as amended by the Life Insurance Company Income Tax Act of 
1959 (73 Stat. 112) and section 235(c)(1) of the Revenue Act of 1964 (78 
Stat. 126). Paragraph (f)(2) of Sec. 1.802-3 is applicable only to 
taxable years beginning after December 31, 1961, and all reference to 
sections of part I, subchapter L, chapter 1 of the Code are to the 
Internal Revenue Code of 1954, as amended by the Life Insurance Company 
Income Tax Act of 1959 (73 Stat. 112), section 3 of the Act of October 
23, 1962 (76 Stat. 1134) and section 235(c)(1) of the Revenue Act of 
1964 (78 Stat. 126).

[T.D. 6886, 31 FR 8685, June 23, 1966]



Sec. 1.802-3  Tax imposed on life insurance companies.

    (a) In general. For taxable years beginning after December 31, 1957, 
section 802(a)(1) imposes a tax on the life insurance company taxable 
income (as defined in section 802(b) and paragraph (a) of Sec. 1.802-4) 
of every life insurance company (including a foreign life insurance 
company carrying on a life insurance business within the United States 
if with respect to its United States business it would qualify as a life 
insurance company under section 801(a)). The tax imposed by section 
802(a)(1) is payable upon the basis of returns rendered by the life 
insurance

[[Page 737]]

companies liable thereto. See subchapter A, chapter 61 (section 6001 and 
following) of the Code.
    (b) Tax imposed. The tax imposed by section 802(a)(1) consists of a 
normal tax and a surtax computed as provided in section 11 as though the 
life insurance company taxable income (as defined in section 802(b)) 
were the taxable income referred to in section 11.
    (c) Normal tax. The normal tax is computed by applying to the life 
insurance company taxable income the regular corporate normal tax rate 
(as in effect for the taxable year) provided by section 11(b).
    (d) Surtax. The surtax is computed by applying the regular corporate 
surtax rate (as in effect for the taxable year) provided by section 
11(c) to the amount by which the life insurance company taxable income 
exceeds the surtax exemption for the taxable year as determined under 
section 11(d). See sections 269 and 1551 and the regulations thereunder, 
for certain circumstances in which the surtax exemption may be 
disallowed in whole or in part.
    (e) Special rule for 1959 and 1960. See section 802(a)(3) and 
paragraph (a) of Sec. 1.802-5 for a transitional rule applicable in 
certain cases in determining tax liability for the taxable years 1959 
and 1960 by reason of the operation of section 802(b)(3).
    (f) Tax imposed in case of certain capital gains--(1) Taxable years 
beginning after December 31, 1958, and before January 1, 1962. For 
taxable years beginning after December 31, 1958, and before January 1, 
1962, if the net long-term capital gain (as defined in section 1222(7)) 
of any life insurance company exceeds its net short-term capital loss 
(as defined in section 1222(6)), section 802(a)(2) imposes a separate 
tax equal to 25 percent of such excess. This separate 25 percent tax 
rate applies whether or not there is life insurance company taxable 
income, taxable investment income, or a gain or loss from operations for 
the taxable year. For taxable years beginning after December 31, 1958, 
and before January 1, 1962, only the excess (if any) of net short-term 
capital gain (as defined in section 1222(5)) over net long-term capital 
loss (as defined in section 1222(8)) shall be taken into account in 
computing taxable investment income and gain or loss from operations. 
See sections 804(b) and 809(b). Except as modified by section 817 (rules 
relating to certain gains and losses), the general rules of the Code 
relating to gains and losses (such as the rules for determining the 
amount, characterization, and treatment thereof) shall apply with 
respect to life insurance companies.
    (2) Alternative tax in case of capital gains for taxable years 
beginning after December 31, 1961. For taxable years beginning after 
December 31, 1961, if the net long-term capital gain (as defined in 
section 1222(7)) of any life insurance company exceeds its net short-
term capital loss (as defined in section 1222(6)), section 802(a)(2) 
imposes an alternative tax in lieu of the tax imposed by section 
802(a)(1), if and only if such alternative tax is less than the tax 
imposed by section 802(a)(1). The alternative tax is the sum of:
    (i) A partial tax, computed as provided by section 802(a)(1), on the 
life insurance company taxable income determined by reducing the taxable 
investment income, and the gain from operations, by the amount of the 
excess of its net long-term capital gain over its net short-term capital 
loss, and
    (ii)(a) In the case of a taxable year beginning before January 1, 
1970, an amount equal to 25 percent of such excess, or
    (b) In the case of a taxable year beginning after December 31, 1969, 
an amount determined as provided in section 1201(a) and paragraph (a)(3) 
of Sec. 1.1201-1 on such excess.


In the computation of the partial tax, the deductions provided by 
sections 170 (as modified by section 809(a)(3)), 243, 244, 245 (as 
modified by sections 804 (a)(5) and 809(d)(8)(B)), and the limitation 
provided by section 809(f), shall not be recomputed as a result of the 
reduction of taxable investment income, and gain from operations, by the 
amount of such excess. Except as modified by section 817 (rules relating 
to certain gains and losses), the general rules of the Code relating to 
gains and losses (such as the rules for determining the amount, 
characterization and treatment thereof) shall apply

[[Page 738]]

with respect to life insurance companies.
    (g) Foreign life insurance companies. Foreign life insurance 
companies not carrying on an insurance business within the United States 
are not taxable under section 802, but are taxable as other foreign 
corporations. See section 881.
    (h) Assessment and collection of tax imposed. All provisions of the 
Internal Revenue Code and of the regulations in this part not 
inconsistent with the specific provisions of sections 801 to 820, 
inclusive, are applicable to the assessment and collection of the tax 
imposed by section 802(a), and life insurance companies are subject to 
the same penalties as are provided in the case of returns and payment of 
income tax by other corporations. The return shall be on Form 1120L.
    (i) Illustration of principles. The provisions of section 802(a), 
other than paragraph (3) thereof, and this section may be illustrated by 
the following example:

    Example. For the taxable year 1959, T, a life insurance company, has 
life insurance company taxable income of $300,000 (including $25,000 of 
net short-term capital gain) and $80,000 of net long-term capital gain. 
The tax of T under section 802(a) for 1959 is $170,500 ($90,000 normal 
tax, $60,500 surtax, and $20,000 capital gains tax) computed as follows:

                        Computation of Normal Tax
Life insurance company taxable income........................   $300,000
Normal tax (30% of $300,000).................................     90,000
                          Computation of Surtax
Life insurance company taxable income........................   $300,000
Less: Exemption from surtax..................................     25,000
                                                              ----------
    Excess of life insurance company taxable income subject      275,000
     to surtax...............................................
Surtax (22% of $275,000).....................................     60,500
                    Computation of Capital Gains Tax
Excess of net long-term capital gain over net short-term         $80,000
 capital loss................................................
Capital gains tax (25% of $80,000)...........................     20,000
 

    (j) Cross reference. In the case of a taxable year of a life 
insurance company ending after December 31, 1963, for which an election 
under section 1562(a)(1) by a controlled group of corporations is 
effective, the additional tax imposed by section 1562 may apply. See 
section 1562 and the regulations thereunder.

[T.D. 6513, 25 FR 12658, Dec. 10, 1960, as amended by T.D. 6845, 30 FR 
9740, Aug. 5, 1965; T.D. 6886, 31 FR 8685, June 23, 1966; T.D. 7337, 39 
FR 44972, Dec. 30, 1974]



Sec. 1.802-4  Life insurance company taxable income.

    (a) Life insurance company taxable income defined. Section 802(b) 
defines the term life insurance company taxable income, for purposes of 
part I, subchapter L, chapter 1 of the Code, as the sum of:
    (1) The taxable investment income (as defined in section 804), or, 
if smaller, the gain from operations (as defined in section 809),
    (2) If the gain from operations exceeds the taxable investment 
income, an amount equal to 50 percent of such excess, plus
    (3) The amount subtracted from the policyholders surplus account for 
the taxable year, as determined under section 815.

If for any taxable year there is a loss from operations (as defined in 
section 809(b)(2)), the amount taken into account under paragraphs (1) 
and (2) of section 802(b) and subparagraphs (1) and (2) of this 
paragraph shall be zero. However, even in such a case, there may still 
be an amount includible in life insurance company taxable income (and 
hence an amount subject to tax) by reason of an amount includible under 
section 802(b)(3) and subparagraph (3) of this paragraph.
    (b) Illustration of principles. The provisions of section 802(b) and 
this section may be illustrated by the following examples:

    Example 1. For the taxable year 1959, Y, a life insurance company, 
has taxable investment income of $250,000, and a gain from operations of 
$175,000. Y made no subtractions from the policyholders surplus account 
during such taxable year. For the taxable year 1959, Y has life 
insurance company taxable income of $175,000.
    Example 2. The facts are the same as in example 1 except that for 
the taxable year 1959, Y has a gain from operations of $400,000. For the 
taxable year 1959, Y has life insurance company taxable income of 
$325,000, computed by adding taxable investment income ($250,000) and 50 
percent ($75,000) of the amount ($150,000) by which the gain from 
operations ($400,000) exceeds the taxable investment income ($250,000).
    Example 3. For the taxable year 1959, W, a life insurance company, 
has taxable investment income of zero (0) and a gain from operations of 
$90,000. W made no subtractions from the policyholders surplus account 
during such taxable year. For the taxable year 1959, W has life 
insurance company taxable

[[Page 739]]

income of $45,000, computed by adding taxable investment income (0) and 
50 percent ($45,000) of the amount ($90,000) by which the gain from 
operations ($90,000) exceeds the taxable investment income (0).
    Example 4. For the taxable year 1961, Z, a life insurance company, 
has taxable investment income of $100,000, a policyholders surplus 
account of $50,000 as of the beginning of such taxable year, a loss from 
operations (as defined in section 809(b)(2)) of $25,000, and 
subtractions from the policyholders surplus account in the amount of 
$20,000. For the taxable year 1961, Z has life insurance company taxable 
income of $20,000, as only the amount ($20,000) subtracted from the 
policyholders surplus account is taken into account.

[T.D. 6513, 25 FR 12658, Dec. 10, 1960]



Sec. 1.802-5  Special rule for 1959 and 1960.

    (a) Transitional rule. Section 802(a)(3) provides a transitional 
rule for the determination of the tax liability of a life insurance 
company for the taxable years 1959 and 1960 by reason of the operation 
of section 802(b)(3). Except as limited by section 802(a)(3) and 
paragraph (b) of this section, any increase in a life insurance 
company's tax that is attributable to the operation of section 802(b)(3) 
is taken into account only to the extent of one-third and two-thirds for 
the taxable years 1959 and 1960, respectively. To the extent there is an 
increase in a life insurance company's tax that is attributable to the 
operation of section 802(b)(3) which is not taken into account for the 
taxable years 1959 and 1960 because of the transitional rule provided by 
section 802(a)(3) and this paragraph, such amounts shall be included in 
``other accounts'' under section 815(a)(3). For taxable years commencing 
after December 31, 1960, the full amount of any increase in tax due to 
the operation of section 802(b)(3) shall be imposed without any further 
transitional reduction.
    (b) Limitations. The transitional rule provided by section 802(a)(3) 
is limited solely to an increase in tax under section 802(b)(3) that is 
occasioned by the operation of section 815(c)(3) (relating to 
subtractions from the policyholders surplus account by reason of 
distributions to shareholders). This rule is further limited to actual 
distributions that are made by life insurance companies in 1959 or 1960 
and does not extend to other distributions that are treated under 
section 815(d)(2)(B) as made by life insurance companies in 1959 or 
1960. Furthermore, section 802(a)(3) shall not apply to any increase in 
tax under section 802(b)(3) that is attributable to other subtractions 
from the policyholders surplus account by reason of the operation of the 
special rules contained in section 815(d). However, the transitional 
rule provided by section 802(a)(3) does apply in the case of a 
distribution to which section 815(e)(1)(B) (ii) applies.
    (c) Illustration of principles. The provisions of section 802(a)(3) 
and this section may be illustrated by the following example:

    Example. For the taxable year 1960, X, a life insurance company, had 
taxable investment income of $9,000, gain from operations of $27,000, 
and subtractions from the policyholders surplus account of $22,000. 
Based upon these figures, X had life insurance company taxable income of 
$40,000 for 1960, of which $18,000 was includible under section 802(b) 
(1) and (2) and $22,000 under section 802(b)(3). Applying the tax 
imposed by section 802(a)(1) (at rates as in effect for 1960), without 
regard to the transitional rule of section 802(a)(3), X would have a tax 
liability of $15,300 ($40,000 multiplied by 52 percent, less $5,500). 
However, applying the transitional rule of section 802(a)(3), the actual 
tax liability of X, for 1960, would be $12,000, computed as follows:

(1) Total tax liability (without regard to sec. 802(a)(3))...    $15,300
(2) Life insurance company taxable income.........    $40,000
(3) Amount subtracted from policyholders surplus       22,000
 account..........................................
(4) Item (2) less item (3)........................     18,000
(5) Tax on amount includible under sec. 802(b) (1) and (2)         5,400
 (30% of $18,000)............................................
                                                   ------------
(6) Tax attributable to sec. 802(b)(3) (item (1) less item         9,900
 (5))........................................................
(7) Less: 33\1/3\ percent of tax attributable to sec.              3,300
 802(b)(3) (1/3 of $9,900)...................................
(8) Tax liability for 1960 after application of sec.              12,000
 802(a)(3) (item (1) less item (7))..........................
 


[T.D. 6513, 25 FR 12659, Dec. 10, 1960]



Sec. 1.803-1  Life insurance reserves.

    (a) The term ``life insurance reserves'' is defined in section 
803(b). Generally, such reserves, as in the case of level premium life 
insurance, are held to supplement the future premium receipts when the 
latter, alone, are insufficient to cover the increased risk in the later 
years. In the case of

[[Page 740]]

cancellable health and accident policies and similar cancellable 
contracts, the unearned premiums held to cover the risk for the 
unexpired period covered by the premiums are not included in life 
insurance reserves. Unpaid loss reserves for noncancellable health and 
accident policies are included in life insurance reserves if they are 
computed or estimated on the basis of recognized mortality or morbidity 
tables and assumed rates of interest.
    (b) In the case of an assessment life insurance company or 
association, life insurance reserves include sums actually deposited by 
such company or association with State or Territorial officers pursuant 
to law as guaranty or reserve funds, and any funds maintained under the 
charter or articles of incorporation or association of such company or 
association, or bylaws (approved by the State insurance commissioner) of 
such company or association, exclusively for the payment of claims 
arising under certificates of membership or policies issued upon the 
assessment plan and not subject to any other use.
    (c) Life insurance reserves, except as otherwise provided in section 
803(b), must be required by law either by express statutory provisions 
or by rules and regulations of the insurance department of a State, 
Territory, or the District of Columbia when promulgated in the exercise 
of a power conferred by statute but such requirement, without more, is 
not conclusive; for example, life insurance reserves do not include 
reserves required to be maintained to provide for the ordinary running 
expenses of a business which must be currently paid by every company 
from its income if its business is to continue, such as taxes, salaries, 
and unpaid brokerage; nor do they include the net value of risks 
reinsured in other solvent companies; liability for premiums paid in 
advance; liability for annual and deferred dividends declared or 
apportioned; liability for dividends left on deposit at interest; 
liability for accrued but unsettled policy claims whether known or 
unreported; liability for supplementary contracts not involving, at the 
time with respect to which the liability is computed, life, health, or 
accident contingencies.
    (d) In any case where reserves are claimed, sufficient information 
must be filed with the return to enable the district director to 
determine the validity of the claim. Only reserves which are required by 
law or insurance department ruling, which are peculiar to insurance 
companies, and which are dependent upon interest earnings for their 
maintenance will, except as otherwise specifically provided in section 
803(b), be considered as life insurance reserves. A company is permitted 
to make use of the highest aggregate reserve required by any State or 
Territory or the District of Columbia in which it transacts business, 
but the reserve must have been actually held.
    (e) In the case of life insurance companies issuing policies 
covering life, health, and accident insurance combined in one policy 
issued on the weekly premium payment plan, continuing for life and not 
subject to cancellation, it is required that reserve funds thereon be 
based upon recognized mortality or morbidity tables covering disability 
benefits of the kind contained in policies issued by this particular 
class of companies but they need not be required by law.



Sec. 1.803-2  Adjusted reserves.

    For the purpose of determining ``required interest'' for taxable 
years beginning after December 31, 1953, but before January 1, 1955, and 
ending after August 16, 1954, certain reserves computed on a preliminary 
term method are to be adjusted by increasing such reserves by 7 percent. 
The reserves to be thus adjusted are reserves computed on preliminary 
term methods, such as the Illinois Standard, or the Select and Ultimate 
methods. Only reserves on policies in the modification period are to be 
so adjusted. Where reserves under a preliminary term method are the same 
as on the level premium method, and in the case of reserves for extended 
or paid-up insurance, no adjustment is to be made. The reserves are thus 
adjusted, and the rate of interest on which they are computed, should be 
reported in Schedule A, Form 1120L.



Sec. 1.803-3  Interest paid or accrued.

    Interest paid or accrued is one of the elements to be used in 
computing the

[[Page 741]]

amount of ``required interest'' for purposes of determining the reserve 
interest credit provided in section 805. See Sec. 1.805-1. Interest 
paid or accrued consists of (a) interest paid or accrued on indebtedness 
(except indebtedness incurred or continued to purchase or carry tax-
exempt securities as set forth in section 803(f)(1)) and (b) amounts in 
the nature of interest paid or accrued on certain contracts, as provided 
in section 803(f)(2). Interest on indebtedness includes interest on 
dividends held on deposit and surrendered during the taxable year but 
does not include interest paid or accrued on deferred dividends. Life 
insurance reserves as defined in Sec. 1.803-1 are not indebtedness. 
Dividends left with the company to accumulate at interest are a debt and 
not a reserve liability. Amounts in the nature of interest include so-
called excess-interest dividends as well as guaranteed interest paid or 
accrued within the taxable year on insurance or annuity contracts (or 
contracts arising out of insurance or annuity contracts) which, at the 
time of payment, do not involve life, health, or accident contingencies. 
It is immaterial whether the optional mode of settlement specified in 
the insurance or annuity contract arises from an option exercised by the 
insured during his or her lifetime or from an option exercised by a 
beneficiary after the policy has matured, frequently referred to as a 
supplementary contract not involving life contingencies; for example, a 
contract to pay the insurance benefit in 10 annual installments. No 
distinction is made based on the person choosing the method of payment, 
and the full amount of the interest paid or accrued and not merely the 
guaranteed interest is considered as interest paid or accrued.



Sec. 1.803-4  Taxable income and deductions.

    (a) In general. The taxable income of a life insurance company is 
its gross amount of income received or accrued during the taxable year 
from interest, dividends, and rents, less the deductions provided in 
section 803(g) for wholly tax-exempt interest, investment expenses, real 
estate expenses, depreciation, and the special deductions provided in 
part VIII (section 241 and following, except section 248), subchapter B, 
chapter 1 of the Code. In addition to the limitations on deductions 
relating to real estate owned and occupied by a life insurance company 
provided in section 803(h), the limitations on the adjustment for 
amortization of premium and accrual of discount provided in section 
803(i), and the limitation on the deduction for investment expenses 
where general expenses are allocated to investment income provided in 
section 803(g)(2), life insurance companies are subject to the 
limitations on deductions relating to wholly tax-exempt income provided 
in section 265. Life insurance companies are not entitled to the net 
operating loss deduction provided in section 172.
    (b) Wholly tax-exempt interest. Interest which in the case of other 
taxpayers is excluded from gross income by section 103 but included in 
the gross income of a life insurance company by section 803(a)(2) is 
allowed as a deduction from gross income by section 803(g)(1).
    (c) Investment expenses. (1) As used in the Code, the term general 
expenses means any expense paid or incurred for the benefit of more than 
one department of the company rather than for the benefit of a 
particular department thereof. Any assignment of such expense to the 
investment department of the company for which a deduction is claimed 
under section 803(g)(2) subjects the entire deduction for investment 
expenses to the limitation provided in that section. The accounting 
procedure employed is not conclusive as to whether any assignment has in 
fact been made. Investment expenses do not include Federal income and 
excess profits taxes.
    (2) If no general expenses are assigned to or included in investment 
expenses the deduction may consist of investment expenses paid or 
incurred during the taxable year in which case an itemized schedule of 
such expenses must be appended to the return.
    (3) Invested assets for the purpose of section 803(g)(2) and this 
section are those which are owned and used, and to the extent used, for 
the purpose of producing the income specified in section

[[Page 742]]

803(a)(2). They do not include real estate owned and occupied, and to 
the extent owned and occupied, by the company. If general expenses are 
assigned to or included in investment expenses, the maximum allowance 
will not be granted unless it is shown to the satisfaction of the 
district director that such allowance is justified by a reasonable 
assignment of actual expenses.
    (d) Taxes and expenses with respect to real estate. The deduction 
for taxes and expenses under section 803(g)(3) includes taxes and 
expenses paid or accrued during the taxable year exclusively upon or 
with respect to real estate owned by the company and any sum 
representing taxes imposed upon a shareholder of the company upon his 
interest as shareholder which is paid or accrued by the company without 
reimbursement from the shareholder. No deduction shall be allowed, 
however, for taxes, expenses, and depreciation upon or with respect to 
any real estate owned by the company except to the extent used for the 
purpose of producing investment income. See paragraph (c) of this 
section. As to real estate owned and occupied by the company, see Sec. 
1.803-5.
    (e) Depreciation. The deduction allowed for depreciation is, except 
as provided in section 803(h), identical with that allowed other 
corporations by section 167. The amount allowed by section 167 in the 
case of life insurance companies is limited to depreciation sustained on 
the property used, and to the extent used, for the purpose of producing 
the income specified in section 803(a)(2).



Sec. 1.803-5  Real estate owned and occupied.

    The amount allowable as a deduction for taxes, expenses, and 
depreciation upon or with respect to any real estate owned and occupied 
in whole or in part by a life insurance company is limited to an amount 
which bears the same ratio to such deduction (computed without regard to 
this limitation) as the rental value of the space not so occupied bears 
to the rental value of the entire property. For example, if the rental 
value of the space not occupied by the company is equal to one-half of 
the rental value of the entire property, the deduction for taxes, 
expenses, and depreciation is one-half of the taxes, expenses, and 
depreciation on account of the entire property. Where a deduction is 
claimed as provided in this section, the parts of the property occupied 
and the parts not occupied by the company, together with the respective 
rental values thereof, must be shown in a statement accompanying the 
return.



Sec. 1.803-6  Amortization of premium and accrual of discount.

    (a) Section 803(i) provides for certain adjustments on account of 
amortization of premium and accrual of discount on bonds, notes, 
debentures, or other evidences of indebtedness held by a life insurance 
company. Such adjustments are limited to the amount of appropriate 
amortization or accrual attributable to the taxable year with respect to 
such securities which are not in default as to principal or interest and 
which are amply secured. The question of ample security will be resolved 
according to the rules laid down from time to time by the National 
Association of Insurance Commissioners. The adjustment for amortization 
of premium decreases, and for accrual of discount increases, (1) the 
gross income, (2) the deduction for wholly tax-exempt interest, and (3) 
the deduction for partially tax-exempt interest.
    (b) The premium for any such security is the excess of its 
acquisition value over its maturity value and the discount is the excess 
of its maturity value over its acquisition value. The acquisition value 
of any such security is its cost (including buying commissions or 
brokerage but excluding any amounts paid for accrued interest) if 
purchased for cash, or if not purchased for cash, then its fair market 
value. The maturity value of any such security is the amount payable 
thereunder either at the maturity date or an earlier call date. The 
earlier call date of any such security may be the earliest call date 
specified therein as a day certain, the earliest interest payment date 
if it is callable or payable at such date, the earliest date at which it 
is callable at par, or such other call or payment date, prior to 
maturity, specified in the security as may be selected by the life 
insurance company. A life

[[Page 743]]

insurance company which adjusts amortization of premium or accrual of 
discount with reference to a particular call or payment date must make 
the adjustments with reference to the value on such date and may not, 
after selecting such date, use a different call or payment date, or 
value, in the calculation of such amortization or discount with respect 
to such security unless the security was not in fact called or paid on 
such selected date.
    (c) The adjustments for amortization of premium and accrual of 
discount will be determined:
    (1) According to the method regularly employed by the company, if 
such method is reasonable, or
    (2) According to the method prescribed by this section.

A method of amortization of premium or accrual of discount will be 
deemed ``regularly employed'' by a life insurance company if the method 
was consistently followed in prior taxable years, or if, in the case of 
a company which has never before made such adjustments, the company 
initiates in the first taxable year for which the adjustments are made a 
reasonable method of amortization of premium or accrual of discount and 
consistently follows such method thereafter. Ordinarily, a company 
regularly employs a method in accordance with the statute of some State, 
Territory, or the District of Columbia, in which it operates.
    (d) The method of amortization and accrual prescribed by this 
section is as follows:
    (1) The premium (or discount) shall be determined in accordance with 
this section; and
    (2) The appropriate amortization of premium (or accrual of discount) 
attributable to the taxable year shall be an amount which bears the same 
ratio to the premium (or discount) as the number of months in the 
taxable year during which the security was owned by the life insurance 
company bears to the number of months between the date of acquisition of 
the security and its maturity or earlier call date, determined in 
accordance with this section. For the purpose of this section, a 
fractional part of a month shall be disregarded unless it amounts to 
more than half a month, in which case it shall be considered as a month.



Sec. 1.803-7  Taxable years affected.

    Sections 1.803-1 through 1.803-6 are applicable only to taxable 
years beginning after December 31, 1953, and before January 1, 1955, and 
all references to sections of part I, subchapter L, chapter 1 of the 
Code are to the Internal Revenue Code of 1954, before amendments.

[T.D. 6513, 25 FR 12660, Dec. 10, 1960]

                            investment income



Sec. 1.804-3  Gross investment income of a life insurance company.

    (a) Gross investment income defined. For purposes of part I, 
subchapter L, chapter 1 of the Code, section 804(b) defines the term 
gross investment income of a life insurance company as the sum of the 
following:
    (1) The gross amount of income from:
    (i) Interest (including tax-exempt interest and partially tax-exempt 
interest), as described in Sec. 1.61-7. Interest shall be adjusted for 
amortization of premium and accrual of discount in accordance with the 
rules prescribed in section 818(b) and the regulations thereunder.
    (ii) Dividends, as described in Sec. 1.61-9.
    (iii) Rents and royalties, as described in Sec. 1.61-8.
    (iv) The entering into of any lease, mortgage, or other instrument 
or agreement from which the life insurance company may derive interest, 
rents, or royalties.
    (v) The alteration or termination of any instrument or agreement 
described in subdivision (iv) of this subparagraph.

For example, gross investment income includes amounts received as 
commitment fees, as a bonus for the entering into of a lease, or as a 
penalty for the early payment of a mortgage.
    (2) In the case of a taxable year beginning after December 31, 1958, 
the amount (if any) by which the net short-term capital gain (as defined 
in section 1222(5)) exceeds the net long-term capital loss (as defined 
in section 1222(8)), and
    (3) The gross income from any trade or business (other than an 
insurance

[[Page 744]]

business) carried on by the life insurance company, or by a partnership 
of which the life insurance company is a partner.
    (b) No double inclusion of income. In computing the gross income 
from any trade or business (other than an insurance business) carried on 
by the life insurance company, or by a partnership of which the life 
insurance company is a partner, any item described in section 804(b)(1) 
and paragraph (a)(1) of this section shall not be considered as gross 
income arising from the conduct of such trade or business or 
partnership, but shall be taken into account under section 804(b)(1) and 
paragraph (a)(1) of this section.
    (c) Exclusion of net long-term capital gains. Any net long-term 
capital gains from the sale or exchange of a capital asset (or any gain 
considered to be from the sale or exchange of a capital asset under 
applicable law) shall be excluded from the gross investment income of a 
life insurance company. However, section 804(b)(2) and paragraph (a)(2) 
of this section provide that the amount (if any) by which the net short-
term capital gain exceeds the net long-term capital loss shall be 
included in the gross investment income of a life insurance company.

[T.D. 6513, 25 FR 12661, Dec. 10, 1960]



Sec. 1.804-4  Investment yield of a life insurance company.

    (a) Investment yield defined. Section 804(c) defines the term 
``investment yield'' of a life insurance company for purposes of part I, 
subchapter L, chapter 1 of the Code. Investment yield means gross 
investment income (as defined in section 804(b) and paragraph (a) of 
Sec. 1.804-3), less the deductions provided in section 804(c) and 
paragraph (b) of this section for investment expenses, real estate 
expenses, depreciation, depletion, and trade or business (other than an 
insurance business) expenses. However, such expenses are deductible only 
to the extent that they relate to investment income and the deduction of 
such expenses is not disallowed by any other provision of subtitle A of 
the Code. For example, investment expenses are not allowable unless they 
are ordinary and necessary expenses within the meaning of section 162, 
and under section 265, no deduction is allowable for interest on 
indebtedness incurred or continued to purchase or carry obligations the 
interest on which is wholly exempt from taxation under chapter 1 of the 
Code. A deduction shall not be permitted with respect to the same item 
more than once.
    (b) Deductions from gross investment income--(1) Investment 
expenses. (i) Section 804(c)(1) provides for the deduction of investment 
expenses by a life insurance company in determining investment yield. 
``Investment expenses'' are those expenses of the taxable year which are 
fairly chargeable against gross investment income. For example, 
investment expenses include salaries and expenses paid exclusively for 
work in looking after investments, and amounts expended for printing, 
stationery, postage, and stenographic work incident to the collection of 
interest. An itemized schedule of such expenses shall be attached to the 
return.
    (ii) Any assignment of general expenses to the investment department 
of a life insurance company for which a deduction is claimed under 
section 804(c)(1) subjects the entire deduction for investment expenses 
to the limitation provided in that section and subdivision (iii) of this 
subparagraph. As used in section 804(c)(1), the term general expenses 
means any expense paid or incurred for the benefit of more than one 
department of the company rather than for the benefit of a particular 
department thereof. For example, if real estate taxes, depreciation, or 
other expenses attributable to office space owned by the company and 
utilized by it in connection with its investment function are assigned 
to investment expenses, such items shall be deductible as general 
expenses assigned to or included in investment expenses and as such 
shall be subject to the limitation of section 804(c)(1) and subdivision 
(iii) of this subparagraph. Similarly, if an expense, such as a salary, 
is attributable to more than one department, including the investment 
department, such expense may be properly allocated among these 
departments. If such expenses are allocated, the amount properly 
allocable to the investment department shall be deductible as general

[[Page 745]]

expenses assigned to or included in investment expenses and as such 
shall be subject to the limitation of section 804(c)(1) and subdivision 
(iii) of this subparagraph. If general expenses are in part assigned to 
or included in investment expenses, the maximum allowance (as determined 
under section 804(c)(1)) shall not be granted unless it is shown to the 
satisfaction of the district director that such allowance is justified 
by a reasonable assignment of actual expenses. The accounting procedure 
employed is not conclusive as to whether any assignment has in fact been 
made. Investment expenses do not include Federal income and excess 
profits taxes, if any. In cases where the investment expenses allowable 
as deductions under section 804(c)(1) exceed the limitation contained 
therein, see section 809(d)(9).
    (iii) If any general expenses are in part assigned to or included in 
investment expenses, the total deduction under section 804(c)(1) shall 
not exceed the sum of:
    (a) One-fourth of one percent of the mean of the assets (as defined 
in section 805(b)(4) and paragraph (a)(4) of Sec. 1.805-5) held at the 
beginning and end of the taxable year,
    (b) The amount of the mortgage service fees for the taxable year, 
plus
    (c) Whichever of the following is the greater:
    (1) One-fourth of the amount by which the investment yield (computed 
without any deduction for investment expenses allowed by section 
804(c)(1)) exceeds 3\3/4\ percent of the mean of the assets (as defined 
in section 805(b)(4)) held at the beginning and end of the taxable year, 
reduced by the amount of the mortgage service fees for the taxable year, 
or
    (2) One-fourth of one percent of the mean of the value of mortgages 
held at the beginning and end of the taxable year for which there are no 
mortgage service fees for the taxable year. For purposes of the 
preceding sentence, the term mortgages held refers to mortgages, and 
other similar liens, on real property which are held by the company as 
security for ``mortgage loans''.

For purposes of section 804(c)(1)(B) and (C)(i) and (b) and (c)(1) of 
this subdivision, the term mortgage service fees includes mortgage 
origination fees. Such mortgage origination fees shall be amortized in 
accordance with the rules prescribed in section 818(b) and the 
regulations thereunder.
    (iv) The operation of the limitation contained in section 804(c)(1) 
and subdivision (iii) of this subparagraph may be illustrated by the 
following example:

    Example. The books of S, a life insurance company, reflect the 
following items for the taxable year 1958:

Investment expenses (including general expenses assigned        $125,000
 to or included in investment expenses)...................
Mean of the assets held at the beginning and end of the       20,000,000
 taxable year.............................................
Mortgage service fees.....................................        25,000
Investment yield computed without regard to investment         1,200,000
 expenses.................................................
Mean of the value of mortgages held at the beginning and       6,000,000
 end of the taxable year for which there are no mortgage
 service fees.............................................
 

    In order to determine the limitation on investment expenses, S would 
make up the following schedule:

1. Mean of the assets held at the beginning    $20,000,000
 and end of the taxable year................
                                             ---------------
2. One-fourth of 1 percent of item 1 (1/4 of        50,000
 1% of $20,000,000).........................
3. Mortgage service fees....................        25,000
4. The greater of (a) or (b):
(a)(i) Investment yield computed without        $1,200,000
 regard to investment expenses..............
(ii) Three and three-fourths percent of item       750,000
 1 (3\3/4\% x $20,000,000)..................
(iii) Excess of (i) over (ii) ($1,200,000          450,000
 minus $750,000)............................
(iv) One-fourth of (iii) (1/4 x $450,000)...       112,500
(v) Less: Mortgage service fees (item 3)....         25,00
------------------------------------------------------------------------
(vi) Excess of (iv) over (v) ($112,500 minus        87,500
 $25,000)...................................
------------------------------------------------------------------------
(b) One-fourth of 1 percent of the mean of the value of
 mortgages held at the beginning and end of the taxable
 year for which there are no mortgage service fees (1/4 of
  1% x $6,000,000)..........................        15,000
5. The greater of item 4 (a) or (b).......................        87,500
                                             ---------------
6. Limitation on investment expenses (items 2, 3, and            162,500
 4(a))....................................................
 


As the investment expenses (including general expenses assigned to or 
included in investment expenses) of S for the taxable year 1958 
($125,000) do not exceed the limitation on such expenses ($162,500), S 
would be entitled to deduct the entire $125,000 under section 804(c)(1).


[[Page 746]]


    (2) Real estate expenses and taxes. The deduction for expenses and 
taxes under section 804(c)(2) includes taxes (as defined in section 164) 
and other expenses for the taxable year exclusively on or with respect 
to real estate owned by the company. For example, no deduction shall be 
allowed under section 804(c)(2) for amounts allowed as a deduction under 
section 164(e) (relating to taxes of shareholders paid by a 
corporation). No deduction shall be allowed under section 804(c)(2) for 
any amount paid out for new buildings, or for permanent improvements or 
betterments made to increase the value of any property. An itemized 
schedule of such taxes and expenses shall be attached to the return. See 
subparagraph (4) of this paragraph for limitation of such deduction.
    (3) Depreciation. The deduction allowed for depreciation is, except 
as provided in section 804(c)(3) and subparagraph (4) of this paragraph, 
identical to that allowed other corporations by section 167. Such amount 
allowed as a deduction from gross investment income in determining 
investment yield is limited to depreciation sustained on the property 
used, and to the extent used, for the purpose of producing the income 
specified in section 804(b). An election with respect to any of the 
methods of depreciation provided in section 167 shall not be affected in 
any way by the enactment of the Life Insurance Company Income Tax Act of 
1959 (73 Stat. 112). However, in appropriate cases, the method of 
depreciation may be changed with the consent of the Commissioner. See 
section 167(e) and Sec. 1.167(e)-1. See subparagraph (4) of this 
paragraph for limitation of such deduction. See section 809(d)(12) and 
the regulations thereunder for the treatment of depreciable property 
used in the operation of a life insurance business.
    (4) Limitation on deductions allowable under section 804 (c)(2) and 
(c)(3). Section 804(c)(3) provides that the amount allowable as a 
deduction for taxes, expenses, and depreciation on or with respect to 
any real estate owned and occupied for insurance purposes in whole or in 
part by a life insurance company shall be limited to an amount which 
bears the same ratio to such deduction (computed without regard to this 
limitation) as the rental value of the space not so occupied bears to 
the rental value of the entire property. For example, T, a life 
insurance company, owns a twenty-story downtown home office building. 
The rental value of each floor of the building is identical. T rents 
nine floors to various tenants, one floor is utilized by it in operating 
its investment department, and the remaining ten floors are occupied by 
it in carrying on its insurance business. Since floor space equivalent 
to eleven-twentieths, or 55 percent, of the rental value of the entire 
property is owned and occupied for insurance purposes by the company, 
the deductions allowable under section 804(c)(2) and (3) for taxes, 
depreciation, and other real estate expenses shall be limited to nine-
twentieths, or 45 percent, of the taxes, depreciation, and other real 
estate expenses on account of the entire property. However, the portion 
of such allowable deductions attributable to the operation of the 
investment department (one-twentieth, or 5 percent) may be deductible as 
general expenses assigned to or included in investment expenses and as 
such shall be subject to the limitations of section 804(c)(1). Where a 
deduction is claimed as provided in this section, the parts of the 
property occupied and the parts not occupied by the company in carrying 
on its insurance business, together with the respective rental values 
thereof, must be shown in a schedule accompanying the return.
    (5) Depletion. The deduction for depletion (and depreciation) 
provided in section 804(c)(4) is identical to that allowed other 
corporations by section 611. The amount allowed by section 611 in the 
case of a life insurance company is limited to depletion (and 
depreciation) sustained on the property used, and to the extent used, 
for the purpose of producing the income specified in section 804(b). See 
section 611 and Sec. 1.611-5 for special rules relating to the 
depreciation of improvements in the case of mines, oil and gas wells, 
other natural deposits, and timber.
    (6) Trade or business deductions. (i) Under section 804(c)(5), the 
deductions allowed by subtitle A of the Code (without regard to this 
part) which are

[[Page 747]]

attributable to any trade or business (other than an insurance business) 
carried on by the life insurance company, or by a partnership of which 
the life insurance company is a partner are, subject to the limitations 
in subdivisions (ii), (iii), and (iv) of this subparagraph, allowable as 
deductions from the gross investment income of a life insurance company 
in determining its investment yield. Such deductions are allowable, 
however, only to the extent that they are attributable to the production 
of income which is included in the life insurance company's gross 
investment income by reason of section 804(b)(3). However, since any 
interest, dividends, rents, and royalties received by any trade or 
business (other than an insurance business) carried on by the life 
insurance company, or by a partnership of which the life insurance 
company is a partner, is included in the life insurance company's gross 
investment income by reason of section 804(b)(1) and paragraph (b) of 
Sec. 1.804-3, any expenses fairly chargeable against the production of 
such income may be deductible under section 804(c) (1), (2), (3), or 
(4). The allowable deductions may exceed the gross income from such 
business.
    (ii) In computing the deductions under section 804(c)(5), there 
shall be excluded losses:
    (a) From (or considered as from) sales or exchanges of capital 
assets,
    (b) From sales or exchanges of property used in the trade or 
business (as defined in section 1231(b)), and
    (c) From the compulsory or involuntary conversion (as a result of 
destruction, in whole or in part, theft or seizure, or an exercise of 
the power of requisition or condemnation or the threat or imminence 
thereof) of property used in the trade or business (as so defined).
    (iii) Any item, to the extent attributable to the carrying on of the 
insurance business, shall not be taken into account. For example, if a 
life insurance company operates a radio station primarily to advertise 
its own insurance services, a portion of the expenses of the radio 
station shall not be allowed as a deduction. The portion disallowed 
shall be an amount which bears the same ratio to the total expenses of 
the station as the value of advertising furnished to the insurance 
company bears to the total value of services rendered by the station.
    (iv) The deduction for net operating losses provided in section 172, 
and the special deductions for corporations provided in part VIII, 
subchapter B, chapter 1 of the Code, shall not be allowed.

[T.D. 6513, 25 FR 12662, Dec. 10, 1960]



Sec. 1.806-1  Adjustment for certain reserves.

    (a) For taxable years beginning after December 31, 1953, but before 
January 1, 1955, and ending after August 16, 1954, a life insurance 
company writing contracts other than life insurance or annuity contracts 
(either separately or combined with noncancellable health and accident 
insurance contracts) must add to its life insurance company taxable 
income (as a factor in determining 1954 adjusted taxable income) an 
amount equal to eight times the amount of the adjustment for certain 
reserves provided in paragraph (b) of this section.
    (b) The adjustment for certain reserves referred to in paragraph (a) 
of this section shall be an amount equal to 3\1/4\ percent of the mean 
of the unearned premiums and unpaid losses at the beginning and end of 
the taxable year on such other contracts as are not included in life 
insurance reserves. If such unearned premiums, however, are less than 25 
percent of the net premiums written during the taxable year on such 
other contracts, then the adjustment shall be 3\1/4\ percent of 25 
percent of the net premiums written during the taxable year on such 
other contracts plus 3\1/4\ percent of the mean of the unpaid losses at 
the beginning and end of the taxable year on such other contracts. As 
used in this section, the term ``unearned premiums'' has the same 
meaning as in section 832(b)(4) and Sec. 1.832-1.



Sec. 1.806-2  Taxable years affected.

    Section 1.806-1 is applicable only to taxable years beginning after 
December 31, 1953, and before January 1, 1955, and all references to 
sections of part I, subchapter L, chapter 1 of the Code are to the 
Internal Revenue Code of 1954, before amendments. Sections 1.806-3

[[Page 748]]

and 1.806-4 are applicable only to taxable years beginning after 
December 31, 1957, and all references to sections of part I, subchapter 
L, chapter 1 of the Code are to the Internal Revenue Code of 1954, as 
amended by the Life Insurance Company Income Tax Act of 1959 (73 Stat. 
112).

[T.D. 6513, 25 FR 12668, Dec. 10, 1960]



Sec. 1.806-3  Certain changes in reserves and assets.

    (a) In general. For purposes of part I, subchapter L, chapter 1 of 
the Code, section 806(a) provides that if there is a change in life 
insurance reserves (as defined in section 801(b)), during the taxable 
year, which is attributable to the transfer between the taxpayer and 
another person of liabilities under contracts taken into account in 
computing such life insurance reserves, then the means of such reserves, 
and the mean of the assets, shall be appropriately adjusted to reflect 
the amounts involved in such transfer. For example, the adjustments 
required under section 806(a) are applicable to transfers in which one 
life insurance company purchases or acquires a part or all of the 
business of another life insurance company under an arrangement whereby 
the purchaser or transferee becomes solely liable on the contracts 
transferred. This provision shall apply in the case of assumption 
reinsurance but not in the case of indemnity reinsurance or reinsurance 
ceded. Thus, no adjustments shall be required under section 806(a) when, 
in the ordinary course of business, an indemnity reinsurance contract is 
entered into with another company (on a yearly renewable term basis, on 
a coinsurance basis, or otherwise) whereby there is a sharing of risks 
under one or more individual contracts. It will be necessary for each 
life insurance company participating in a transfer described in section 
806(a) to make the adjustments required by such section. Such 
adjustments shall be made without regard to whether or not the 
transferor of the liabilities was the original insurer.
    (b) Manner in which adjustments shall be made--(1) Daily basis. The 
means of the life insurance reserves, and the mean of the assets, shall 
be appropriately adjusted, on a daily basis, to reflect the amounts 
involved in a transfer described in section 806(a) and paragraph (a) of 
this section. The transferor and the transferee shall be treated as 
having held such life insurance reserves and assets for a fraction of 
the year in which the transfer occurs.
    (2) Determination of period held. In determining the fraction which 
represents the fractional year that such reserves and assets were held, 
the numerator shall be the number of days during the taxable year which 
such reserves and assets were actually held, and the denominator shall 
be the number of days in the calendar year of the transfer. In computing 
the period held for purposes of the numerator, the day on which such 
reserves and assets are transferred is included by the transferor and 
excluded by the transferee.
    (3) Adjustments to the means of life insurance reserves and assets 
not transferred. All life insurance reserves and assets transferred 
during the taxable year, within the meaning of section 806(a), shall be 
excluded from the beginning and end of the taxable year balances of the 
transferor and transferee, respectively. The amount of assets to be 
excluded from the beginning of the taxable year balance of the 
transferor shall be an amount equal to the value of such reserves at the 
beginning of the taxable year. The amount of assets to be excluded from 
the end of the taxable year balance of the transferee shall be an amount 
equal to the value of such reserves at the end of the taxable year. The 
means of the life insurance reserves and assets not so transferred shall 
be determined in the ordinary manner, that is, the arithmetic means. 
There shall be added to these means an amount to appropriately adjust 
them, on a daily basis, for the life insurance reserves and assets that 
were transferred during the taxable year. This adjustment shall be 
determined by multiplying (i) the mean of the transferred life insurance 
reserves (or assets, as the case may be) at the beginning of the taxable 
year (or, if acquired later, at the beginning of the period held as 
defined in subparagraph (2) of this paragraph) and the end of the period 
held as defined in subparagraph (2) of this paragraph (or

[[Page 749]]

at the end of the taxable year, if held at such time) by (ii) the 
fraction determined under subparagraph (2) of this paragraph.
    (4) Examples. The application of this paragraph may be illustrated 
by the following examples:

    Example 1. On March 14, 1958, the M Company, a life insurance 
company, transferred to the N Company, a life insurance company, 
pursuant to an assumption reinsurance agreement, all of its life 
insurance reserves, and related assets, on one block of policies. The 
reserves (and assets) for this block were held by the M Company on 
January 1, 1958, and totaled $60,000; on March 14, the reserves (and 
assets) totaled $64,000. The M Company had life insurance reserves of 
$1,000,000 at the beginning of 1958 (including those subsequently 
transferred) and $1,040,000 at the end of 1958. The M Company had assets 
of $1,300,000 at the beginning of 1958 (including those subsequently 
transferred) and $1,380,000 at the end of 1958. The mean of M's life 
insurance reserves for the taxable year 1958 is computed as follows:

Reserves at 1-1-58............................   $1,000,000
  Exclude reserves (at beginning of year) on         60,000
   contracts transferred to N.................
                                               -------------
  Recomputed amount at 1-1-58..............................     $940,000
Reserves at 12-31-58.......................................    1,040,000
                                               --------------
      Sum..................................................    1,980,000
                                               --------------
      Mean.................................................      990,000
Adjustment for reserves transferred on 8-14-
 58:
  Reserves at 1-1-58 on contracts transferred       $60,000
   to N.......................................
  Reserves at 3-14-58 on such contracts.......       64,000
                                               -------------
      Sum.....................................      124,000
                                               -------------
      Mean....................................       62,000
Fraction taken into account...................       73/365
      Adjustment (73/365x$62,000)..........................      $12,400
                                               --------------
Mean of M's life insurance reserves after section 806(a)       1,002,400
 adjustment................................................
 

    Example 2. Assuming the facts to be the same as in example 1, the 
mean of M's assets for the taxable year 1958 is computed as follows:

Assets at 1-1-58..............................   $1,300,000
  Exclude assets (at beginning of year) on           60,000
   contracts transferred to N.................
                                               -------------
      Recomputed amount at 1-1-58..........................   $1,240,000
Assets at 12-31-58.........................................    1,380,000
                                               --------------
      Sum..................................................    2,620,000
                                               --------------
      Mean.................................................    1,310,000
Adjustments for assets transferred on 3-14-58:
  Assets at 1-1-58 on contracts transferred to      $60,000
   N..........................................
  Assets at 3-14-58 on such contracts.........       64,000
                                               -------------
      Sum.....................................      124,000
                                               -------------
      Mean....................................       62,000
                                               -------------
Fraction taken into account...................       73/365
      Adjustment (73/365x$62,000)-.........................      $12,400
                                               --------------
Mean of M's assets after section 806(a) adjustment.........    1,322,400
 

    Example 3. Assume the facts are the same as in example 1. At the end 
of 1958, N Company had life insurance reserves (and assets) of $80,000 
on the contracts transferred on March 14, 1958. The N Company had life 
insurance reserves of $6,000,000 at the beginning of 1958 and $6,400,000 
at the end of 1958 (including those transferred). The N Company had 
assets of $6,800,000 at the beginning of 1958 and $7,300,000 at the end 
of 1958 (including those on the contracts transferred). The mean of N's 
life insurance reserves for the taxable year 1958 is computed as 
follows:

Reserves at 1-1-58.........................................   $6,000,000
Reserves at 12-31-58..........................   $6,400,000
  Exclude reserves (at end of year) on               80,000
   contracts transferred from M...............
                                               -------------
      Recomputed amount at 12-31-58........................    6,320,000
                                               --------------
      Sum..................................................   12,320,000
                                               --------------
      Mean.................................................    6,160,000
Adjustment for reserves transferred on 3-14-
 58:
  Reserves at 3-14-58 on contracts transferred      $64,000
   from M.....................................
  Reserves at 12-31-58 on such contracts......       80,000
                                               -------------
      Sum.....................................      144,000
                                               -------------
      Mean....................................       72,000
Fraction taken into account...................      292/365
      Adjustment (292/365x$72,000).........................       57,600
                                               --------------
Mean of N's life insurance reserves after section 806(a)       6,217,600
 adjustment................................................
 

    Example 4. Assuming the facts to be the same as in example 3, the 
mean of N's assets for the taxable year 1958 is computed as follows:

Assets at 1-1-58...........................................   $6,800,000
Assets at 12-31-58............................   $7,300,000
  Exclude assets (at end of year) on contracts       80,000
   transferred from M.........................
                                               -------------
      Recomputed amount at 12-31-58........................    7,220,000
                                               --------------
      Sum..................................................   14,020,000
                                               --------------
      Mean.................................................    7,010,000

[[Page 750]]

 
Adjustments for assets transferred on 3-14-58:
Assets at 3-14-58 on contracts transferred          $64,000
 from M.......................................
Assets at 12-31-58 on such contracts..........       80,000
                                               -------------
      Sum.....................................      144,000
                                               -------------
      Mean....................................       72,000
                                               -------------
Fraction taken into account...................      292/365
  Adjustment (292/365x$72,000).............................      $57,600
                                               --------------
Mean of N's assets after section 806(a) adjustment.........    7,067,600
 

    Example 5. The facts are the same as in example 1, except that on 
October 19, 1958, company N transfers to company P, a life insurance 
company, all of the life insurance reserves, and related assets, on the 
block of policies it had received from company M on March 14, 1958. The 
reserves (and assets) for this block totaled $76,000 on October 19, 
1958. The means of company M's life insurance reserves and assets, as 
computed in examples 1 and (2), respectively, would be unchanged by the 
transfer of October 19, 1958. Since company N did not own this block of 
policies at either the beginning or end of the taxable year, it would 
not have to recompute its beginning or end of the taxable year reserves 
or assets. Company N will, however, have to adjust (or increase) the 
mean of its life insurance reserves and assets on account of the 
policies it received from company M. This adjustment will be $42,000, 
which is determined by multiplying the means of the life insurance 
reserves (or assets) on these policies as of March 15, 1958, and October 
19, 1958, $70,000 ($64,000+$76,000=$140,000/2) by the fraction 219/365 
(the numerator of 219 is determined by excluding the day of the transfer 
to N, March 14, 1958, and including the day of the transfer from N to P, 
October 19, 1958). Company P will have to recompute its end of the year 
life insurance reserves and assets (in the same manner as illustrated in 
examples 3 and 4). Assuming the end of the year reserves (and assets) on 
this block of policies is $80,000, company P will have an adjustment 
under section 806 (a) of $15,600, which is determined by multiplying the 
means of the reserves on these policies as of October 20, 1958, and 
December 31, 1958, $78,000 ($76,000+$80,000= $156,000/2) by the fraction 
73/365.

[T.D. 6513, 25 FR 12663, Dec. 10, 1960]



Sec. 1.806-4  Change of basis in computing reserves.

    (a) In general. For purposes of subpart B, part I, subchapter L, 
chapter 1 of the Code, section 806(b) provides that if the basis for 
determining the amount of any item referred to in section 810(c) 
(relating to items taken into account) as of the close of the taxable 
year differs from the basis for such determination as of the beginning 
of the taxable year, then in determining taxable investment income the 
amount of the item as of the close of the taxable year shall be the 
amount computed on the old basis, and the amount of the item as of the 
beginning of the next taxable year shall be the amount computed on the 
new basis. For purposes of the preceding sentence, an election under 
section 818(c) shall not be treated as a change in basis for determining 
the amount of an item referred to in section 810(c). A change of basis 
in computing any of the items referred to in section 810(c) is not a 
change of accounting method requiring the consent of the Secretary or 
his delegate under section 446(e).
    (b) Illustration of change of basis in computing reserves. The 
application of section 806(b) and paragraph (a) of this section may be 
illustrated by the following examples:

    Example 1. Assume that the life insurance reserves of Y, a life 
insurance company, at the beginning of the taxable year 1959 are $100 
and that during such taxable year a portion of the reserves is 
strengthened (by reason of a change in mortality or interest 
assumptions, or otherwise), so that at the end of the taxable year 1959 
the reserves (computed on the new basis) are $130 but computed on the 
old basis would be $120. Assume further that at the close of the next 
taxable year, 1960, the reserves (computed on the new basis) are $142. 
Under the provisions of section 806(b) and paragraph (a) of this 
section, the mean of such reserves for the taxable year of the reserve 
strengthening, namely 1959, is $110 (the mean of $100, the balance at 
the beginning of the taxable year 1959, and $120, the balance at the end 
of the taxable year 1959 computed on the old basis). The mean of such 
reserves for the next taxable year, 1960, is $136 (the mean of $130, the 
balance at the beginning of the taxable year 1960 computed on the new 
basis, and $142, the balance at the end of the taxable year 1960 
computed on the new basis).
    Example 2. The life insurance reserves of S, a life insurance 
company, computed with respect to contracts for which such reserves are 
determined on a recognized preliminary term basis amount to $50 on 
January 1, 1959, and $80 on December 31, 1959. For the taxable year 
1959, S elects to revalue such reserves on a net level premium basis 
under section 818(c). Such reserves computed under section 818(c) amount 
to $60 on January 1, 1959, and

[[Page 751]]

$96 on December 31, 1959. Under the provisions of paragraph (a) of this 
section, the mean of such reserves for the taxable year 1959 is $78 (the 
mean of $60, the balance at the beginning of the taxable year 1959 
computed under section 818(c), and $96, the balance at the end of the 
taxable year 1959 computed under section 818(c).

[T.D. 6513, 25 FR 12669, Dec. 10, 1960]



Sec. 1.807-1  Mortality and morbidity tables.

    (a) Tables to be used. If there are no commissioners' standard 
tables applicable to an insurance contract when the contract is issued, 
then the mortality and morbidity tables set forth in this subsection are 
used to compute reserves under section 807(d)(2) for the contract.

------------------------------------------------------------------------
             Type of Contract                           Table
------------------------------------------------------------------------
1. Group term life insurance (active life   1960 Commissioners' Standard
 reserves).                                  Group Mortality Table.
2. Group life insurance (active life        1959 Accidental Death
 reserves); accidental death benefits.       Benefits Table.
3. Permanent and paid-up group life         Same table as are applicable
 insurance (active life reserves).           to males for ordinary life
                                             insurance.
4a. Group life insurance disability income  The tables of period 2
 benefits (active life reserves).            disablement rates and the
                                             1930 to 1950 termination
                                             rates of the 1952
                                             Disability Study of the
                                             Society of Actuaries.
4b. Group life insurance disability income  The 1930 to 1950 termination
 benefits (disabled life reserves).          rates of the 1952
                                             Disability study of the
                                             Society of Actuaries.
5. Group life insurance; survivor income    Same tables as are
 benefits insurance.                         applicable to group
                                             annuities.
6. Group life insurance; extended death     1970 Intercompany Group life
 benefits for disabled lives.                Disability Valuation Table.
7. Credit life insurance..................  1958 Commissions' Extended
                                             Term Table.
8. Supplementary contracts involving life   Same tables as are
 contingencies.                              applicable to individual
                                             immediate annuities.
9. Noncancellable accident and health       Tables used for NAIC annual
 insurance (active life reserves);           statement reserves as of
 benefits issued before 1984.                December 31, 1983.
10a. Noncancellable accident and health     1964 Commissioners'
 insurance (active life reserves); group     Disability Tables.
 disability benefits issued after 1983 and
 individual disability benefits issued
 after 1983 and before 1989.
10b. Noncancellable accident and health     1985 Commissioners'
 insurance (active life reserves);           Individual Disability Table
 individual disability benefits issued       A or Commissioners'
 after 1988.                                 Individual Disability Table
                                             B.
11. Noncancellable accident and health      1959 Accidental Death
 insurance (active life reserves);           Benefits Tables.
 accidental death benefits issued after
 1983.
12. Noncancellable accident and health      Tables used for NAIC annual
 insurance (active life reserves); all       statement reserves.
 benefits issued after 1983 other than
 disability and accidental death.
13a. Noncancellable accident and health     1964 Commissioners'
 insurance (claim reserves); group           Disability Tables.
 disability benefits for all years of
 issue and individual disability benefits
 for years before 1989.
13b. Noncancellable accident and health     1985 Commissioners'
 insurance (claim reserves); individual      Individual Disability Table
 disability benefits for years after 1988.   A or Commissioners'
                                             Individual Disability Table
                                             B.
14. Noncancellable accident and health      Tables used for annual
 insurance (claim reserves); all benefits    statement reserves.
 other than disability for all years of
 issue.
------------------------------------------------------------------------

    (b) Adjustments. An appropriate adjustment may be made to the tables 
in paragraph (a) of this section to reflect risks (such as substandard 
risks) incurred under the contract which are not otherwise taken into 
account.
    (c) Special rule where more than 1 table or option applicable. If, 
with respect to any category of risks, there are 2 or more tables (or 
options under 1 or more tables) in paragraph (a) of this section, the 
table (and option thereunder) which generally yields the lowest reserves 
shall be used to compute reserves under section 807(d)(2) for the 
contract.
    (d) Effective date. This section is effective for taxable years 
beginning after December 31, 1983, except that the 1985 Commissioners' 
Individual Disability Tables A and B shall be treated (for purposes of 
section 807(d)(5)(B) and for purposes of determining the issue dates of 
contracts for which they shall be used) as if the tables were new 
prevailing commissioners' standard tables adopted by the twenty-sixth 
State on December 26, 1989.

[T.D. 8278, 54 FR 52934, Dec. 26, 1989; 55 FR 1768, Jan. 18, 1990]



Sec. 1.807-2  Cross-reference.

    For special rules regarding the treatment of modified guaranteed 
contracts

[[Page 752]]

(as defined in section 817A and Sec. 1.817A-1(a)(1)), see Sec. 1.817A-
1.

[T.D. 9058, 68 FR 24350, May 7, 2003]

                      gain and loss from operations



Sec. 1.809-1  Taxable years affected.

    Sections 1.809 through 1.809-8, except as otherwise provided 
therein, are applicable only to taxable years beginning after December 
31, 1957, and all reference to sections of part I, subchapter L, chapter 
1 of the Code are to the Internal Revenue Code of 1954, as amended by 
the Life Insurance Company Income Tax Act of 1959 (73 Stat. 112), the 
Act of June 27, 1961 (75 Stat. 120), the Act of October 10, 1962 (76 
Stat. 808); the Act of October 23, 1962 (76 Stat. 1134), and section 
214(b)(4) of the Revenue Act of 1964 (78 Stat. 55).

[T.D. 6992, 34 FR 827, Jan. 18, 1969]



Sec. 1.809-2  Exclusion of share of investment yield set aside for
policyholders.

    (a) In general. Section 809 provides the rules for determining the 
gain or loss from operations of a life insurance company, which amount 
is necessary to determine life insurance company taxable income. In 
order to determine gain or loss from operations, a life insurance 
company must first determine the share of each and every item of its 
investment yield (as defined in section 804(c) and paragraph (a) of 
Sec. 1.804-4) set aside for policyholders (as computed under section 
809(a)(1) and paragraph (b) of this section), as this share is excluded 
from gain or loss from operations (as defined in section 809(b) (1) and 
(2) and paragraphs (a) and (b) of Sec. 1.809-3, respectively). The life 
insurance company shall then add its share of each and every item of its 
investment yield to the sum of the items comprising gross amount (as 
described in section 809(c) and paragraph (a) of Sec. 1.809-4). In 
addition, the life insurance company shall, for taxable years beginning 
after December 31, 1961, add the amount (if any) by which its net long-
term capital gain exceeds its net short-term loss. From the sum so 
computed (which includes the capital gains item only for taxable years 
beginning after December 31, 1961) there shall then be subtracted the 
deductions provided in section 809(d) and paragraph (a) of Sec. 1.809-
5. The amount thus obtained is the gain or loss from operations for the 
taxable year.
    (b) Computation of share of investment yield set aside for 
policyholders. Section 809(a)(1) provides that the share of each and 
every item of investment yield (including tax-exempt interest, partially 
tax-exempt interest, and dividends received) of any life insurance 
company set aside for policyholders shall not be included in gain or 
loss from operations. For this purpose, the percentage used in 
determining the share of each of these items comprising the investment 
yield set aside for policyholders shall be determined by dividing the 
required interest (as defined in section 809(a)(2) and paragraph (d) of 
this section) by the investment yield (as defined in section 804(c) and 
paragraph (a) of Sec. 1.804-4). The percentage thus obtained is then 
applied to each and every item of the investment yield so that the share 
of each and every item of investment yield set aside for policyholders 
shall be excluded from gain or loss from operations. However, if in any 
case the required interest exceeds the investment yield, then the share 
of any item set aside for policyholders shall be 100 percent.
    (c) Computation of life insurance company's share of investment 
yield. For purposes of subpart C, part I, subchapter L, chapter 1 of the 
Code, section 809(b)(3) provides that the percentage used in determining 
the life insurance company's share of each and every item of investment 
yield (including tax-exempt interest, partially tax-exempt interest, and 
dividends received) shall be obtained by subtracting the percentage 
obtained under paragraph (b) of this section from 100 percent. For 
example, if the policyholders' percentage (as determined under section 
809(a)(1) and paragraph (b) of this section) is 72.38 percent, then the 
life insurance company's share is 27.62 percent (100 percent minus 72.38 
percent). In such a case, if the amount of a particular item is $200, 
then the life insurance company's share of such item included in 
determining gain or loss from operations is $55.24 ($200 multiplied by 
27.62 percent) and the share of such item set aside for policyholders

[[Page 753]]

(which is excluded from gain or loss from operations) is $144.76 ($200 
multiplied by 72.38 percent). For purposes of determining gain or loss 
from operations, the life insurance company's share of each and every 
item of investment yield (including tax-exempt interest, partially tax-
exempt interest, and dividends received) shall be added to the sum of 
the items comprising gross amount (as described in section 809(c) and 
paragraph (a) of Sec. 1.809-4).
    (d) Required interest defined. (1) For purposes of part I, section 
809(a)(2) defines the term required interest for any taxable year as the 
sum of the products obtained by multiplying (i) each rate of interest 
required, or assumed by the taxpayer, in calculating the reserves 
described in section 810(c), by (ii) the means of the amount of such 
reserves computed at that rate at the beginning and end of the taxable 
year. In the case of the reserves described in section 810(c)(1), such 
rate of interest shall be the same as that used by the taxpayer for 
purposes of paragraph (b) of Sec. 1.801-5 (relating to the definition 
of reserves required by law) with respect to such reserves. In the case 
of the reserves described in section 810(c)(2) through (5), such rate of 
interest shall be the same as that actually paid, credited, or accrued 
by the taxpayer with respect to such reserves. Thus, the required 
interest for any taxable year includes the elements of interest paid (as 
defined in section 805(e)) with respect to the reserves described in 
section 810(c).
    (2) For purposes of computing required interest under section 
809(a)(2) and subparagraph (1) of this paragraph, the amount of life 
insurance reserves taken into account shall be adjusted first as 
required by section 818(c) (relating to an election with respect to life 
insurance reserves computed on a preliminary term basis) and then as 
required by section 806(a) (relating to adjustments for certain changes 
in reserves and assets) before applying the rate of interest required, 
or assumed by the taxpayer, thereto. However, in the case of the 
adjustments required by section 810(d) as a result of a change in the 
basis of computing reserves, the adjustments to any of the reserves 
described in section 810(c) shall be taken into account in accordance 
with the rules prescribed in section 810(d) and Sec. 1.810-3.

[T.D. 6535, 26 FR 525, Jan. 20, 1961, as amended by T.D. 6886, 31 FR 
8687, June 23, 1966]



Sec. 1.809-3  Gain and loss from operations defined.

    (a) Gain from operations. For purposes of part I, subchapter L, 
chapter 1 of the Code, section 809(b)(1) defines the term gain from 
operations as the excess of the sum of (1) the life insurance company's 
share of each and every item of investment yield (including tax-exempt 
interest, partially tax-exempt interest, and dividends received), (2) 
the items of gross amount taken into account under section 809(c) and 
paragraph (a) of Sec. 1.809-4, and (3) for taxable years beginning 
after December 31, 1961, the amount (if any) by which the net long-term 
capital gain exceeds the net short-term capital loss, over the sum of 
the deductions provided by section 809(d) and Sec. 1.809-5.
    (b) Loss from operations. For purposes of part I, section 809(b)(2) 
defines the term loss from operations as the excess of the sum of the 
deductions provided by section 809(d) and Sec. 1.809-5 over the sum of 
(1) the life insurance company's share of each and every item of 
investment yield (including tax-exempt interest, partially tax-exempt 
interest, and dividends received), (2) the items of gross amount taken 
into account under section 809(c) and paragraph (a) of Sec. 1.809-4, 
and (3) for taxable years beginning after December 31, 1961, the amount 
(if any) by which the net long-term capital gain exceeds the net short-
term capital loss.
    (c) Illustration of principles. The provisions of section 809(b) (1) 
through (3) and paragraphs (a) and (b) of this section may be 
illustrated by the following example:

    Example. For the taxable year 1958, T, a life insurance company, had 
investment yield of $900,000, including $150,000 of dividends received 
from domestic corporations subject to taxation under chapter 1 of the 
Code, $10,000 of wholly tax-exempt interest, and $78,000 of partially 
tax-exempt interest. T also had items of gross amount under section 
809(c) in the amount of $12,000,000 and deductions under section 809(d) 
of $6,963,500 (exclusive of any deductions for wholly tax-exempt 
interest, partially tax-exempt interest, and dividends received). For 
such taxable year, the

[[Page 754]]

share of each and every item of investment yield set aside for 
policyholders was 80 percent and the company's share of each and every 
item of investment yield was 20 percent. Based upon these figures, T had 
a gain from operations of $5,180,000 for the taxable year 1958, computed 
as follows:

------------------------------------------------------------------------
                                                Col. 2 (80% x    Col. 3
                                                   Col. 1)       (20% x
                                      Col. 1    exclusion of    Col. 1)
                                               policyholder's  company's
                                                    share        share
------------------------------------------------------------------------
Interest wholly tax-exempt........    $10,000        $8,000       $2,000
Interest partially tax-exempt.....     78,000        62,400       15,600
Dividends received................     50,000       120,000       30,000
Other items of investment yield...    662,000       529,600      132,400
    Investment yield..............    900,000       720,000      180,000
------------------------------------------------------------------------


Gross amount (sum of items under sec.        ...........     $12,000,000
 809(c))...................................
                                                         ---------------
    Total..................................  ...........      12,180,000
Less:
  Deductions under sec. 809(d)(8):
    Company's share of interest wholly tax-       $2,000
     exempt................................
    30/52 of company's share of interest           9,000
     partially tax-exempt (30/52 x$15,600).
    85% of company's share of dividends           25,500
     received (but not to exceed 85% of
     gain from operations as computed under
     sec. 809(d)(8)(B)) (85%x$30,000)......
All other deductions under sec. 809(d)         6,963,500
                                            -------------
                                             ...........       7,000,000
                                                         ---------------
      Gain from operations..............................       5,180,000
 

    (d) Exception. (1) In accordance with section 809(b)(4), if it is 
established in any case to the satisfaction of the Commissioner, or by a 
determination of The Tax Court of the United States, or of any other 
court of competent jurisdiction, which has become final, that the 
application of the definition of gain from operations contained in 
section 809(b)(1) results in the imposition of tax on:
    (i) Any interest which under section 103 is excluded from gross 
income,
    (ii) Any amount of interest which under section 242 (as modified by 
section 804(a)(3)) is allowable as a deduction, or
    (iii) Any amount of dividends received which under sections 243, 
244, and 245 (as modified by section 809(d)(8)(B)) is allowable as a 
deduction,

adjustment shall be made to the extent necessary to prevent such 
imposition.
    (2) For the date upon which a decision by the Tax Court becomes 
final, see section 7481. For the date upon which a judgment of any other 
court becomes final, see paragraph (c) of Sec. 1.1313(a)-1.

[T.D. 6535, 26 FR 526, Jan. 20, 1961, as amended by T.D. 6886, 31 FR 
8687, June 28, 1966]



Sec. 1.809-4  Gross amount.

    (a) Items taken into account. For purposes of determining gain or 
loss from operations under section 809(b) (1) and (2), respectively, 
section 809(c) specifies three categories of items which shall be taken 
into account. Such items are in addition to the life insurance company's 
share of the investment yield (as determined under section 809(a)(1) and 
paragraph (c) of Sec. 1.809-2), and the amount (if any) by which the 
net long-term capital gain exceeds the net short-term capital loss (such 
capital gains item is included in determining gain or loss from 
operations only for taxable years beginning after December 31, 1961). 
The additional three categories of items taken into account are:
    (1) Premiums. (i) The gross amount of all premiums and other 
consideration on insurance and annuity contracts (including contracts 
supplementary thereto); less return premiums and premiums and other 
consideration arising out of reinsurance ceded. The term gross amount of 
all premiums means the premiums and other consideration provided in the 
insurance or annuity contract. Thus, the amount to be taken into account 
shall be the total of the premiums and other consideration provided in 
the insurance or annuity contract without any deduction for commissions, 
return premiums, reinsurance, dividends to policyholders, dividends left 
on deposit with the company, discounts on premiums paid in advance, 
interest applied in reduction of premiums (whether or not required

[[Page 755]]

to be credited in reduction of premiums under the terms of the 
contract), or any other item of similar nature. Such term includes 
advance premiums, premiums deferred and uncollected and premiums due and 
unpaid, deposits, fees, assessments, and consideration in respect of 
assuming liabilities under contracts not issued by the taxpayer (such as 
a payment or transfer of property in an assumption reinsurance 
transaction as defined in paragraph (a)(7)(ii) of Sec. 1.809-5). The 
term also includes amounts a life insurance company charges itself 
representing premiums with respect to liability for insurance and 
annuity benefits for its employees (including full-time life insurance 
salesmen within the meaning of section 7701(a)(20)).
    (ii) The term return premiums means amounts returned or credited 
which are fixed by contract and do not depend on the experience of the 
company or the discretion of the management. Thus, such term includes 
amounts refunded due to policy cancellations or erroneously computed 
premiums. Furthermore, amounts of premiums or other consideration 
returned to another life insurance company in respect of reinsurance 
ceded shall be included in return premiums. For the treatment of amounts 
which do not meet the requirements of return premiums, see section 811 
(relating to dividends to policyholders).
    (iii) For purposes of section 809(c)(1) and this subparagraph, the 
term reinsurance ceded means an arrangement whereby the taxpayer (the 
reinsured) remains solely liable to the policyholder, whether all or 
only a portion of the risk has been transferred to the reinsurer. Such 
term includes indemnity reinsurance transactions but does not include 
assumption reinsurance transactions. See paragraph (a)(7)(ii) of Sec. 
1.809-5 for the definition of assumption reinsurance.
    (2) Decreases in certain reserves. Each net decrease in reserves 
which is required by section 810 (a) and (d)(1) or 811(b)(2) to be taken 
into account for the taxable year as a net decrease for purposes of 
section 809(c)(2).
    (3) Other amounts. All amounts, not included in computing investment 
yield and not otherwise taken into account under section 809(c) (1) or 
(2), shall be taken into account under section 809(c)(3) to the extent 
that such amounts are includible in gross income under subtitle A of the 
Code. See section 61 (relating to gross income defined) and the 
regulations thereunder.
    (b) Treatment of net long-term capital gains. For taxable years 
beginning before January 1, 1962, any net long-term capital gains (as 
defined in section 1222(7)) from the sale or exchange of a capital asset 
(or any gain considered to be from the sale or exchange of a capital 
asset under applicable law) shall be excluded from the determination of 
gain or loss from operations of a life insurance company. On the other 
hand, with respect to taxable years beginning after December 31, 1961, 
the amount (if any) by which the net long-term capital gain exceeds the 
net short-term capital loss (as defined in section 1222(6)) shall be 
taken into account in determining gain or loss from operations under 
section 809. However, for any taxable year beginning after December 31, 
1958, the excess of net short-term capital gain (as defined in section 
1222(5)) over net long-term capital loss (as defined in section 1222(8)) 
is included in computing investment yield (as defined in section 804(c)) 
and, to that extent, is taken into account in determining gain or loss 
from operations under section 809.

[T.D. 6535, 26 FR 527, Jan. 20, 1961, as amended by T.D. 6610, 27 FR 
8718, Aug. 31, 1962, T.D. 6886, 31 FR 8687, June 23, 1966]



Sec. 1.809-5  Deductions.

    (a) Deductions allowed. Section 809(d) provides the following 
deductions for purposes of determining gain or loss from operations 
under section 809(b) (1) and (2), respectively:
    (1) Death benefits, etc. All claims and benefits accrued (less 
reinsurance recoverable), and all losses incurred (whether or not 
ascertained), during the taxable year on insurance and annuity contracts 
(including contracts supplementary thereto). The term all claims and 
benefits accrued includes, for example, matured endowments and amounts 
allowed on surrender. The term losses incurred (whether or not 
ascertained) includes a reasonable estimate of the amount of the losses 
(based

[[Page 756]]

upon the facts in each case and the company's experience with similar 
cases) incurred but not reported by the end of the taxable year as well 
as losses reported but where the amount thereof cannot be ascertained by 
the end of the taxable year.
    (2) Increases in certain reserves. The net increase in reserves 
which is required by section 810 (b) and (d)(1) to be taken into account 
for the taxable year as a net increase for purposes of section 
809(d)(2).
    (3) Dividends to policyholders. The deduction for dividends to 
policyholders as determined under section 811(b) and Sec. 1.811-2. 
Except as provided in section 809(d)(3) and this subparagraph, no amount 
shall be allowed as a deduction in respect of dividends to policyholders 
under section 809(d). See section 809(f) and Sec. 1.809-7 for 
limitation of such deduction.
    (4) Operations loss deduction. The operations loss deduction as 
determined under section 812.
    (5) Certain nonparticipating contracts. (i) An amount equal to the 
greater of:
    (a) 10 percent of the increase for the taxable year in certain life 
insurance reserves for nonparticipating contracts (other than group 
contracts); or
    (b) 3 percent of the premiums for the taxable year attributable to 
nonparticipating contracts (other than group contracts) which are issued 
or renewed for periods of 5 years or more.
    (ii) For purposes of section 809(d)(5) and this subparagraph, the 
term nonparticipating contracts means those contracts which during the 
taxable year contain no right to participate in the divisible surplus of 
the company. For example, if at any time during the taxable year for 
which the deduction allowed under section 809(d)(5) and this 
subparagraph is claimed such contracts have rights to dividends or 
similar distributions (as defined in section 811(a) and paragraph (a) of 
Sec. 1.811-2), such contracts shall no longer be deemed 
nonparticipating contracts and, therefore, no deduction shall be 
allowed. Thus, if a class of contracts having no right to participate in 
the divisible surplus of the company is in force for nine years and on 
March 10, 1958, it is announced that such contracts shall be accorded 
dividend rights as of August 1, 1958, no deduction shall be allowed 
under section 809(d)(5) and this subparagraph for the taxable year 1958 
or any succeeding taxable year, whether or not dividends are actually 
paid on such contracts. However, if the announcement of March 10, 1958, 
states that such contracts shall be accorded dividend rights as of 
January 1, 1959, a deduction under section 809(d)(5) and this 
subparagraph shall be allowed for the taxable year 1958 but not for any 
succeeding taxable year.
    (iii) For purposes of section 809(d)(5) and this subparagraph, the 
term reserves for nonparticipating contracts means such part of the life 
insurance reserves (as defined in section 801(b) and Sec. 1.801-4), 
other than that portion of such reserves which is allocable to annuity 
features, as relates to nonparticipating contracts (as defined in 
subdivision (ii) of this subparagraph). The amount of life insurance 
reserves taken into account shall be adjusted first as required by 
section 818(c) (relating to an election with respect to life insurance 
reserves computed on a preliminary term basis) and then as required by 
section 806(a) (relating to adjustments for certain changes in reserves 
and assets). In the case of the adjustments required by section 810(d) 
(relating to adjustment for change in computing reserves), the increase 
in life insurance reserves attributable to reserve strengthening shall 
be taken into account in accordance with the rules prescribed in section 
810(d) and Sec. 1.810-3.
    (iv) For purposes of section 809(d)(5) and this subparagraph, the 
term premiums means the net amount of the premiums and other 
consideration attributable to nonparticipating contracts (as defined in 
subdivision (ii) of this subparagraph) which are taken into account 
under section 809(c)(1). For this purpose, premiums include only such 
amounts attributable to such contracts which are issued or renewed for 
periods of 5 years or more, but does not include that portion of the 
premiums which is allocable to annuity features. No portion of a premium 
shall be deemed allocable to annuity features solely because a contract, 
such as an endowment contract, provides that at maturity the insured 
shall have an

[[Page 757]]

option to take an annuity. The determination of whether a contract meets 
the 5-year requirement shall be made as of the date the contract is 
issued, or as of the date it is renewed, whichever is applicable. Thus, 
a 20-year nonparticipating endowment policy shall qualify for the 
deduction under section 809(d)(5), even though the insured subsequently 
dies at the end of the second year, since the policy is issued for a 
period of 5 years or more. However, a 1-year renewable term contract 
shall not qualify, since as of the date it is issued (or of any renewal 
date) it is not issued (or renewed) for a period of 5 years or more. In 
like manner, a policy originally issued for a 3-year period and 
subsequently renewed for an additional 3-year period shall not qualify. 
However, if this policy is renewed for a period of 5 years or more, the 
policy shall qualify for the deduction under section 809(d)(5) from the 
date it is renewed.
    (v) The provisions of section 809(d)(5) and this subparagraph may be 
illustrated by the following example:

    Example. Assume the following facts with respect to X, a life 
insurance company, for the taxable year 1958:

Life insurance reserves on nonparticipating contracts           $150,000
 without annuity features (other than group contracts) at 1-
 1-58.......................................................
Life insurance reserves on nonparticipating contracts            225,000
 without annuity features (other than group contracts) at 12-
 31-58......................................................
Annuity reserves on nonparticipating contracts (other than        48,000
 group contracts) at 1-1-58.................................
Annuity reserves on nonparticipating contracts (other than        57,000
 group contracts) at 12-31-58...............................
Premiums on nonparticipating contracts without annuity            85,000
 features (other than group contracts) issued or renewed for
 5 years or more............................................
Premiums on nonparticipating contracts allocable to annuity       14,000
 features (other than group contracts) issued or renewed for
 5 years or more............................................
Return premiums on nonparticipating contracts without              5,000
 annuity features (other than group contracts)..............
 


In order to determine the deduction under section 809(d)(5) (without 
regard to the limitation of section 809(f)), X would make up the 
following schedule:

(1) Life insurance reserves on nonparticipating     $225,000
 contracts without annuity features (other than
 group contracts) at 12-31-58...................
(2) Life insurance reserves on nonparticipating      150,000
 contracts without annuity features (other than
 group contracts) at 1-1-58.....................
                                                 ------------
(3) Excess of item (1) over item (2) ($225,000        75,000
 minus $150,000)................................
(4) 10 percent of item (3) (10%x$75,000)........  ..........       7,500
                                                             -----------
(5) Net premiums on nonparticipating contracts        80,000
 without annuity features issued or renewed for
 5 years or more (other than group contracts)
 (gross premiums on such contracts ($85,000)
 minus return premiums ($5,000) on such
 contracts).....................................
(6) 3 percent of item (5) (3%x$80,000)..........  ..........       2,400
(7) The greater of item (4) or item (6).........  ..........       7,500
(8) Tentative deduction under sec. 809(d)(5)      ..........       7,500
 (computed without regard to the limitation of
 sec. 809(f))...................................
                                                             -----------
 

    (vi) See section 809(f) and Sec. 1.809-7 for limitation of the 
deduction provided by this subparagraph.
    (6) Certain accident and health insurance and group life insurance. 
(i) For taxable years beginning before January 1, 1963, an amount equal 
to two percent of the premiums for the taxable year attributable to 
group life insurance contracts, group accident and health insurance 
contracts, or group accident and health insurance contracts with a life 
feature. For taxable years beginning after December 31, 1962, the 
deduction shall be an amount equal to two percent of the premiums for 
the taxable year attributable to group life insurance contracts, 
accident and health insurance contracts (other than those to which 
section 809(d)(5) applies), or accident and health insurance contracts 
with a life feature (other than those to which section 809(d)(5) 
applies). For purposes of section 809(d)(6) and this subparagraph, the 
term ``premiums'' means the net amount of the premiums and other 
consideration attributable to such contracts taken into account under 
section 809(c)(1). The deduction allowed by section 809(d)(6) and this 
subparagraph for the taxable year and all preceding taxable years shall 
not exceed 50 percent of the net amount of the premiums attributable to 
such contracts for the taxable year. For example, assume that premiums 
attributable to group life insurance and group accident and health 
insurance contracts are $103,000 for the taxable year 1962. Assume 
further that there are $3,000 of return premiums attributable to such 
contracts for the taxable year. Under the provisions of

[[Page 758]]

section 809(d)(6) and this subparagraph, a deduction (determined without 
regard to section 809(f) of $2,000 (2 percent of $100,000 ($103,000-
$3,000)) is allowed. Assuming that the company continues to receive net 
premiums of $100,000 attributable to such contracts for 15 years, the 
cumulative amount of these deductions is $30,000 ($2,000 for 15 years). 
If, in the sixteenth year, net premiums attributable to such contracts 
amount to $60,000, no deduction shall be allowed under section 809(d)(6) 
and this subparagraph since the cumulative amount of these deductions 
($30,000) equals 50 percent of the current year's premiums ($60,000) 
from such contracts.
    (ii) In computing the deduction under section 809(d)(6), the 
determination as to when the 50 percent limitation on such deduction has 
been reached shall be based upon the amount allowed as a deduction for 
the taxable year and all preceding taxable years after the application 
of the limitation provided in section 809(f) and Sec. 1.809-7. Thus, if 
in the example set forth in paragraph (c) of Sec. 1.809-7 the 
application of the limitation provided by section 809(f) limited the 
deduction allowed for the taxable year under section 809(d)(6) to 
$3,250,000, then for purposes of determining the 50 percent limitation 
on such deduction, only $3,250,000 (the amount allowed) shall be taken 
into account.
    (iii) For purposes of determining whether the 50 percent limitation 
applies to any taxable year, the deduction provided by section 809(d)(6) 
for all preceding taxable years shall be taken into account, 
irrespective of whether or not the life insurance company claimed a 
deduction for these amounts for such preceding taxable years.
    (iv) See section 809(f) and Sec. 1.809-7 for limitation of the 
deduction provided by this subparagraph.
    (7) Assumption by another person of liabilities under insurance, 
etc., contracts. (i) The consideration (other than consideration arising 
out of reinsurance ceded as defined in paragraph (a)(1)(iii) of Sec. 
1.809-4) in respect of the assumption by another person of liabilities 
under insurance and annuity contracts (including contracts supplementary 
thereto) of the taxpayer.
    (ii) For purposes of section 809(d)(7) and this subparagraph, the 
term assumption reinsurance means an arrangement whereby another person 
(the reinsurer) becomes solely liable to the policyholders on the 
contracts transferred by the taxpayer. Such term does not include 
indemnity reinsurance or reinsurance ceded (as defined in paragraph 
(a)(1)(iii) of Sec. 1.809-4).
    (iii) The provisions of section 809(d)(7) and this subparagraph may 
be illustrated by the following example:

    Example. During the taxable year 1958, T, a life insurance company, 
transferred a block of insurance policies and made a payment of $50,000 
to R, a life insurance company, under an arrangement whereby R became 
solely liable to the policyholders on the policies transferred by T. 
Under the provisions of section 809(d)(7) and this subparagraph, T is 
allowed a deduction of $50,000 for the taxable year 1958. For the 
treatment by R of this $50,000 payment, see section 809(c)(1) and 
paragraph (a)(1)(i) of Sec. 1.809-4. See section 806(a) and Sec. 
1.806-3 for the adjustments in reserves and assets to be made by T and R 
as a result of this transaction.

    (8) Tax-exempt interest, dividends, etc. (i) Each of the following 
items:
    (a) The life insurance company's share of interest which under 
section 103 is excluded from gross income;
    (b) The deduction for partially tax-exempt interest provided by 
section 242 (as modified by section 804(a)(3) and paragraph (d)(2)(i) of 
Sec. 1.804-2) computed with respect to the life insurance company's 
share of such interest; and
    (c) The deductions for dividends received provided by sections 243, 
244, and 245 (as modified by section 809(d)(8)(B) and subdivision (ii) 
of this subparagraph) computed with respect to the life insurance 
company's share of the dividends received.
    (ii) The modification contained in section 809(d)(8)(B) provides the 
method for applying section 246(b) (relating to limitation on aggregate 
amount of deductions for dividends received) for purposes of section 
809(d)(8)(A)(iii) and subdivision (i)(c) of this subparagraph. Under 
this method, the sum of the deductions allowed by sections 243(a)(1) 
(relating to dividends received by corporations), 244(a) (relating to 
dividends received on certain preferred stock), and 245 (relating to 
dividends received from certain foreign corporations)

[[Page 759]]

shall be limited to 85 percent of the gain from operations computed 
without regard to:
    (a) The deductions provided by section 809(d) (3), (5), and (6);
    (b) The operations loss deductions provided by section 812; and
    (c) The deductions allowed by sections 243(a)(1), 244(a), and 245.

If a life insurance company has a loss from operations (as determined 
under sec. 812) for the taxable year, the limitation provided in section 
809(d)(8)(B) and this subdivision shall not be applicable for such 
taxable year. In that event, the deductions provided by sections 
243(a)(1), 244(a), and 245 shall be allowable for all tax purposes to 
the life insurance company for such taxable year without regard to such 
limitation. If the life insurance company does not have a loss from 
operations for the taxable year, however, the limitation shall be 
applicable for all tax purposes for such taxable year. In determining 
whether a life insurance company has a loss from operations for the 
taxable year under section 812, the deductions allowed by sections 
243(a)(1), 244(a), and 245 shall be computed without regard to the 
limitation provided in section 809(d)(8)(B) and this subdivision.
    (9) Investment expenses, etc. (i) The amount of investment expenses 
to the extent not allowed as a deduction under section 804(c)(1) in 
computing investment yield. For example, if a deduction in the amount of 
$100,000 is claimed for investment expenses, which amount includes 
general expenses assigned to or included in investment expenses, and due 
to the operation of the limitation provided by section 804(c)(1) only 
$85,000 is allowed, then the excess ($15,000) shall be allowed as a 
deduction under section 809(d)(9) and this subparagraph.
    (ii) The amount (if any) by which the sum of the deductions 
allowable under section 804(c) exceeds the gross investment income. For 
example, if gross investment income under section 804(b) equals 
$400,000, and the sum of the deductions allowable under section 804(c) 
equals $425,000, then the excess ($25,000) shall be allowed as a 
deduction under section 809(d)(9) and this subparagraph.
    (iii) In determining the amount of the deductions allowed under 
subdivisions (i) and (ii) of this subparagraph, a life insurance company 
shall first take such deductions to the full extent allowable under 
section 804(c)(1), and any amount which is allowed as a deduction under 
section 804(c) shall not again be allowed as a deduction under section 
809(d)(9).
    (10) Small business deduction. The small business deduction as 
determined under section 804(a)(4).
    (11) Certain mutualization distributions. The amount of 
distributions to shareholders actually made by the life insurance 
company in 1958, 1959, 1960, and 1961 in acquisition of stock pursuant 
to a plan of mutualization adopted by the company before January 1, 
1958. If such deduction is claimed, there must be attached to the return 
of the company claiming such deduction a certified copy of the plan of 
mutualization and proof that such plan was adopted prior to January 1, 
1958. See section 809(g) and Sec. 1.809-8 for limitation of such 
deduction.
    (12) Other deductions. Except as modified by section 809(e) and 
Sec. 1.809-6, all other deductions allowed under subtitle A of the Code 
for purposes of computing taxable income to the extent not allowed as a 
deduction in computing investment yield. For example, a life insurance 
company shall be allowed a deduction under section 809(d)(12) and this 
subparagraph for amounts representing premiums charged itself with 
respect to liability for insurance and annuity benefits for its 
employees (including full-time life insurance salesmen within the 
meaning of section 7701(a)(20)) in accordance with the rules prescribed 
in sections 162 and 404 and the regulations thereunder, to the extent 
that a deduction for such amounts is not allowed under section 804(c)(1) 
and paragraph (b)(1) of Sec. 1.804-4 or section 809(d)(9) and 
subparagraph (9) of this paragraph.
    (b) Denial of double deduction. Nothing in section 809(d) shall 
permit the same item to be deducted more than once in determining gain 
or loss from operations. For example, if an item is allowed as a 
deduction for the taxable year by reason of its being a loss incurred 
within such taxable year

[[Page 760]]

(whether or not ascertained) under section 809(d)(1), such item, or any 
portion thereof, shall not also be allowed as a deduction for such 
taxable year under section 809(d)(2).

[T.D. 6535, 26 FR 527, Jan. 20, 1961, as amended by T.D. 6610, 27 FR 
8718, Aug. 31, 1962; T.D. 6886, 31 FR 8687, June 23, 1966; T.D. 6992, 34 
FR 827, Jan. 18, 1969]



Sec. 1.809-6  Modifications.

    Under section 809(e), the deductions allowed under section 
809(d)(12) and paragraph (a)(12) of Sec. 1.809-5 (relating to other 
deductions) are subject to the following modifications:
    (a) Interest. No deduction shall be allowed under section 163 for 
interest in respect of items described in section 810(c) since such 
interest is taken into account in the determination of required interest 
under section 809.
    (b) Bad debts. No deduction shall be allowed for an addition to 
reserves for bad debts under section 166(c). However, a deduction for 
specific bad debts shall be allowed to the extent that such deduction is 
allowed under section 166 and the regulations thereunder. In the case of 
a loss incurred on the sale of mortgaged or pledged property, see Sec. 
1.166-6 of this chapter.
    (c) Charitable, etc., contributions and gifts. (1) The deduction by 
a life insurance company in any taxable year for a charitable 
contribution (as defined in section 170(c)) shall be limited to 5 
percent of the gain from operations (as determined under section 
809(b)(1)), computed without regard to any deductions for:
    (i) Charitable contributions under section 170;
    (ii) Dividends to policyholders under section 811(b);
    (iii) Certain nonparticipating contracts under section 809(d)(5);
    (iv) Group life insurance contracts and group accident and health 
insurance contracts under section 809(d)(6);
    (v) Tax-exempt interest, dividends, etc., under section 809(d)(8); 
and
    (vi) Any operations loss carryback to the taxable year under section 
812.
    (2) In applying the first sentence of section 170(b)(2) as contained 
in section 170 or, in the case of taxable years beginning after December 
31, 1969, section 170(d)(2)(B) as contained in section 170A, any excess 
of the charitable contributions made by a life insurance company in a 
taxable year over the amount deductible in such year under the 
limitation contained in subparagraph (1) of this paragraph, shall be 
reduced to the extent that such excess:
    (i) Reduces life insurance company taxable income (computed without 
regard to section 802(b)(3)) for the purpose of determining the offsets 
referred to in section 812(b)(2); and
    (ii) Increases an operations loss carryover under section 812 for a 
succeeding taxable year.
    (3) The application of the rules provided in section 809(e)(3) and 
this paragraph may be illustrated by the following example:

    Example. Assume that life insurance company P is organized on 
January 1, 1958, and has a loss from operations for that year in the 
amount of $100,000 which is an operations loss carryover to 1959. In 
1959, company P has a gain from operations and tax base (computed 
without regard to section 802(b)(3)) of $100,000 before the allowance of 
a deduction for a $5,000 charitable contribution made in 1959 and before 
the application of the operations loss carryover from 1958. Under 
section 170(b)(2), the operations loss carryover from 1958 is first 
applied to eliminate the $100,000 gain from operations and tax base in 
1959 and the $5,000 charitable contribution carryover would (except for 
the limitation contained in this paragraph) become a charitable 
contribution carryover to 1960. However, for the purpose of computing 
the offsets referred to in section 812(b)(2), the $5,000 charitable 
contribution is applied to reduce the gain from operations and tax base 
for 1959 to $95,000 before the application of the operations carryover 
from 1958. Since only $95,000 of the $100,000 loss from operations in 
1958 is an offset for 1959, the remaining $5,000 becomes an operations 
loss carryover to 1960. Accordingly, under the limitation contained in 
this paragraph, the charitable contributions carryover provided under 
the second sentence of section 170(b)(2) is eliminated.

    (d) Amortizable bond premium. No deduction shall be allowed under 
section 171 for the amortization of bond premiums since a special 
deduction for such premiums is specifically taken into account under 
section 818(b).
    (e) Net operating loss deduction. No deduction shall be allowed 
under section 172 since section 812 allows an ``operations loss 
deduction''.
    (f) Partially tax-exempt interest. No deduction shall be allowed 
under section

[[Page 761]]

242 for partially tax-exempt interest since section 809(d)(8) allows a 
deduction for such interest.
    (g) Dividends received. No deduction shall be allowed under sections 
243, 244, and 245 for dividends received since section 809(d)(8) allows 
a deduction for such dividends.

[T.D. 6535, 26 FR 529, Jan. 20, 1961, as amended by T.D. 7207, 37 FR 
20797, Oct. 5, 1972]



Sec. 1.809-7  Limitation on certain deductions.

    (a) In general. Section 809(f)(1) limits the deductions under 
section 809(d) (3), (5), and (6), relating to deductions for dividends 
to policyholders, certain nonparticipating contracts, and group life, 
accident, and health insurance contracts, respectively. This limitation 
provides that the amount of such deductions shall not exceed the sum of 
(1) the amount (if any) by which the gain from operations for the 
taxable year (determined without regard to such deductions) exceeds the 
taxpayer's taxable investment income for such year, plus (2) $250,000.
    (b) Application of limitation. Section 809(f)(2) provides a priority 
system for applying the limitation contained in section 809(f)(1) and 
paragraph (a) of this section. Under this priortity system, the 
limitation shall be applied in the following order:
    (1) For taxable years beginning before January 1, 1962:
    (i) First to the amount of the deduction under section 809(d)(6) 
(relating to group life, accident, and health insurance);
    (ii) Then to the amount of the deduction under section 809(d)(5) 
(relating to certain nonparticipating contracts); and
    (iii) Finally to the amount of the deduction under section 809(d)(3) 
(relating to dividends to policyholders).
    (2) For taxable years beginning after December 31, 1961, the 
limitation shall be applied in the following order:
    (i) First to the amount of the deduction under section 809(d)(3);
    (ii) Then to the amount of the deduction under section 809(d)(6); 
and
    (iii) Finally to the amount of the deduction under section 
809(d)(5).

Thus, for taxable years beginning after December 31, 1961, the 
limitation and priority system would operate first to disallow a 
deduction under section 809(d)(5), then a deduction under section 
809(d)(6), and finally a deduction under section 809(d)(3). For purposes 
of applying the 50 percent limitation contained in section 809(d)(6) 
with respect to a taxable year beginning after December 31, 1961, the 
amount of the deductions for taxable years beginning before January 1, 
1962, shall be determined by applying the priortity system contained in 
subparagraph (1) of this paragraph.
    (c) Illustration of principles. The operation of the limitation and 
priority system provided by section 809(f) and this section may be 
illustrated by the following examples:

    Example 1. Assume the following facts with respect to M, a life 
insurance company, for the taxable year 1958:

Gain from operations computed without regard to the         $100,000,000
 deductions under sec. 809(d) (3), (5), and (6).........
Taxable investment income...............................      83,000,000
Tentative deduction for group life, accident, and health       4,000,000
 insurance under sec. 809(d)(6).........................
Tentative deduction for certain nonparticipating               6,000,000
 contracts under sec. 809(d)(5).........................
Tentative deduction for dividends to policyholders under      10,000,000
 sec. 809(d)(3).........................................
 


In order to determine the limitation on the deductions under section 
809(d) (3), (5), and (6), M would make up the following schedule:

(1) Statutory amount provided under sec. 809(f)(1)........      $250,000
(2) Gain from operations computed without     $100,000,000
 regard to the deductions under sec.
 809(d) (3), (5), and (6).................
(3) Taxable investment income.............      83,000,000
                                           ----------------
(4) Excess of item (2) over item (3)......................    17,000,000
                                           -----------------
(5) Limitation on deductions under sec. 809(d) (3), (5),     17,250,000
 and (6) (item (1) plus item (4)).........................
Since the total tentative deductions under section 809(d) (3), (5), and
 (6) ($20,000,000) exceeds the limitation on such deductions
 ($17,250,000), M would make up the following schedule to determine the
 application of the priority system:
 
(6) Maximum possible deduction under sec. 809(d) (3), (5),   $17,250,000
 and (6) (item (5)).......................................
(7) Deduction for group life, accident, and health             4,000,000
 insurance under sec. 809(d)(6) (not in excess of item
 (6)).....................................................
                                           -----------------

[[Page 762]]

 
(8) Maximum possible deduction under sec. 809(d)(5) (item     13,250,000
 (6) less item (7)).......................................
(9) Deduction for certain nonparticipating contracts under     6,000,000
 sec. 809(d)(5) (not in excess of item (8))...............
                                           -----------------
(10) Maximum possible deduction under sec. 809(d)(3) (item     7,250,000
 (8) less item (9)).......................................
(11) Deduction for dividends to policyholders under sec.       7,250,000
 809(d)(3) (not in excess of item (10))...................
------------------------------------------------------------------------

Thus, as a result of the application of the limitation and priority 
system for the taxable year 1958, M shall be allowed a deduction of 
$4,000,000 under section 809(d)(6), $6,000,000 under section 809(d)(5), 
and only $7,250,000 of the $10,000,000 tentative deduction under section 
809(d)(3).
    Example 2. The facts are the same as in example 1, except that the 
taxable year is 1962. Since the total tentative deductions under section 
809(d) (3), (5), and (6) ($20,000,000) exceeds the limitation on such 
deductions ($17,250,000), M would make up the following schedule to 
determine the application of the priority system:

(1) Maximum possible deductions under sec. 809(d) (3),       $17,250,000
 (5), and (6) (item (5) in example 1).....................
(2) Deduction for dividends to policyholders under sec.       10,000,000
 809(d)(3) (not in excess of item (1))....................
                                                           -------------
(3) Maximum possible deduction under sec. 809(d)(6) (item      7,250,000
 (1) less item (2)).......................................
(4) Deduction for certain accident, health, and group life     4,000,000
 insurance under sec. 809(d)(6) (not in excess of item
 (3)).....................................................
                                                           -------------
(5) Maximum possible deduction under sec. 809(d)(5) (item      3,250,000
 (4) less item (5)).......................................
(6) Deduction for certain nonparticipating contracts under     3,250,000
 sec. 809(d)(5) (not in excess of item (5))...............
 


Thus, as a result of the application of the limitation and priority 
system for the taxable year 1962, M shall be allowed a deduction of 
$10,000,000 under section 809(d)(3), $4,000,000 under section 809(d)(6), 
and only $3,250,000 of the $6,000,000 tentative deduction under section 
809(d)(5).

[T.D. 6535, 26 FR 530, Jan. 20, 1961, as amended by T.D. 6886, 31 FR 
8688, June 23, 1966]



Sec. 1.809-8  Limitation on deductions for certain mutualization
distributions.

    (a) Deduction not to reduce taxable investment income. Section 
809(g)(1) limits the deduction under section 809(d)(11) for certain 
mutualization distributions. This limitation provides that such 
deduction shall not exceed the amount (if any) by which the gain from 
operations for the taxable year, computed without regard to such 
deduction (but after the application of the limitation contained in 
section 809(f) and Sec. 1.809-7), exceeds the taxpayer's taxable 
investment income for such year.
    (b) Deduction not to reduce tax below that imposed by 1957 law. 
Section 809(g)(2) further limits the deduction under section 809(d)(11). 
Under section 809(g)(2), such deduction shall be allowed only to the 
extent that it (after the application of all other deductions) does not 
reduce the tax imposed by section 802(a)(1) for the taxable year below 
the amount of tax which would have been imposed for such taxable year if 
the law in effect for 1957 applied for such taxable year. If such 
deduction is claimed for 1958 (or 1959), the company shall attach to its 
return a schedule showing what its tax for 1958 (or 1959) would have 
been had such tax been computed under the law in effect for 1957.
    (c) Application of section 815. Section 809(g)(3) provides that any 
portion of a distribution which is allowed as a deduction under section 
809(d)(11) shall not be treated as a distribution to shareholders for 
purposes of section 815; except that in the case of any distributions 
made in 1959, such portion shall be treated as a distribution with 
respect to which a reduction is required under section 815(e)(2)(B) 
(relating to adjustment in allocation ratio for certain distributions 
after December 31, 1958).

[T.D. 6535, 26 FR 530, Jan. 20, 1961]



Sec. 1.809-9  Computation of the differential earnings rate and the 
recomputed differential earnings rate.

    (a) In general. Neither the differential earnings rate under section 
809(c) nor the recomputed differential earnings rate that is used in 
computing the recomputed differential earnings amount under section 
809(f)(3) may be less than zero.
    (b) Definitions--(1) Recomputed differential earnings amount. The 
recomputed differential earnings amount, with respect to any taxable 
year, is the amount equal to the product of--

[[Page 763]]

    (i) The life insurance company's average equity base for the taxable 
year; multiplied by
    (ii) The recomputed differential earnings rate for that taxable 
year.
    (2) Recomputed differential earnings rate. The recomputed 
differential earnings rate for any taxable year equals the excess of--
    (i) The imputed earnings rate for the taxable year; over
    (ii) The average mutual earning rate for the calendar year in which 
the taxable year begins.
    (c) Effective date. The regulations are effective for all taxable 
years beginning after December 31, 1986.

[T.D. 8499, 58 FR 64899, Dec. 10, 1993]



Sec. 1.809-10  Computation of equity base.

    (a) In general. For purposes of section 809, the equity base of a 
life insurance company includes the amount of any asset valuation 
reserve and the amount of any interest maintenance reserve.
    (b) Effective date. This section is effective for taxable years 
ending after December 31, 1991.

[T.D. 8484, 58 FR 47061, Sept. 7, 1993, as amended by T.D. 8564, 59 FR 
49579, Sept. 29, 1994]



Sec. 1.810-1  Taxable years affected.

    Sections 1.810-2 through 1.810-4 are applicable only to taxable 
years beginning after December 31, 1957, and all references to sections 
of part I, subchapter L, chapter 1 of the Code are to the Internal 
Revenue Code of 1954, as amended by the Life Insurance Company Income 
Tax Act of 1959 (73 Stat. 112).

[T.D. 6535, 26 FR 531, Jan. 20, 1961]



Sec. 1.810-2  Rules for certain reserves.

    (a) Adjustment for decrease or increase in certain reserve items--
(1) Adjustment for decrease. Section 810(a) provides that if the sum of 
the items described in section 810(c) and paragraph (b) of this section 
at the beginning of the taxable year exceeds the sum of such items at 
the end of the taxable year (reduced by the amount of investment yield 
not included in gain or loss from operations for the taxable year by 
reason of section 809(a)(1)), the amount of such excess shall be taken 
into account as a net decrease referred to in section 809(c)(2) and 
paragraph (a)(2) of Sec. 1.809-4 in determining gain or loss from 
operations.
    (2) Adjustment for increase. Section 810(b) provides that if the sum 
of the items described in section 810(c) and paragraph (b) of this 
section at the end of the taxable year (reduced by the amount of 
investment yield not included in gain or loss from operations for the 
taxable year by reason of section 809(a)(1)) exceeds the sum of such 
items at the beginning of the taxable year, the amount of such excess 
shall be taken into account as a net increase referred to in section 
809(d)(2) and paragraph (a)(2) of Sec. 1.809-5 in determining gain or 
loss from operations.
    (b) Items taken into account. The items described in section 810(c) 
and referred to in section 810 (a) and (b) and paragraph (a) of this 
section are:
    (1) The life insurance reserves (as defined in section 801(b) and 
Sec. 1.801-4);
    (2) The unearned premiums and unpaid losses included in total 
reserves under section 801(c)(2) and Sec. 1.801-5;
    (3) The amounts (discounted at the rates of interest assumed by the 
company) necessary to satisfy the obligations under insurance or annuity 
contracts (including contracts supplementary thereto), but only if such 
obligations do not involve (at the time with respect to which the 
computation is made under this subparagraph) life, health, or accident 
contingencies;
    (4) Dividend accumulations, and other amounts, held at interest in 
connection with insurance or annuity contracts (including contracts 
supplementary thereto); and
    (5) Premiums received in advance, and liabilities for premium 
deposit funds.
    (6) Special contingency reserves under contracts of group term life 
insurance or group health and accident insurance which are established 
and maintained for the provision of insurance on retired lives, for 
premium stabilization, or for a combination thereof.

For purposes of this paragraph, the same item shall be counted only once 
and deficiency reserves (as defined in section 801(b)(4) and paragraph 
(e)(4) of

[[Page 764]]

Sec. 1.801-4) shall not be taken into account.
    (c) Special rules. For purposes of section 810 (a) and (b) and 
paragraph (a) of this section, in determining whether there is a net 
increase or decrease in the sum of the items described in section 810(c) 
and paragraph (b) of this section for the taxable year, the following 
rules shall apply:
    (1) Computation of net increase or decrease in reserves. The sum of 
the items described in section 810(c) and paragraph (b) of this section 
at the beginning of the taxable year shall be the aggregate of the sums 
of each of such items at the beginning of the taxable year. The sum of 
the items described in section 810(c) and paragraph (b) of this section 
at the end of the taxable year shall be the aggregate of the sums of 
each of such items at the end of the taxable year. However, in order to 
determine whether there is a net increase or decrease in such items for 
the taxable year, the aggregate of the sums of the items at the end of 
the taxable year must first be reduced by the amount of investment yield 
not included in gain or loss from operations for the taxable year by 
reason of section 809(a)(1).
    (2) Effect of change in basis in computing reserves. Any increase or 
decrease in the sum of the items described in section 810(c) and 
paragraph (b) of this section for the taxable year which is attributable 
to a change in the basis used in computing such items during the taxable 
year shall not be taken into account under section 810 (a) or (b) and 
paragraph (a) of this section but shall be taken into account in the 
manner prescribed in section 810(d) and paragraph (a) of Sec. 1.810-3.
    (3) Effect of section 818(c) election. If a company which computes 
its life insurance reserves on a preliminary term basis elects to 
revalue such reserves on a net level premium basis under section 818(c), 
the sum of such reserves at the beginning and end of all taxable years 
(including the first taxable year) for which the election applies shall 
be the sum of such reserves computed on such net level premium basis.
    (4) Cross references. For taxable years beginning before January 1, 
1970, see section 810(e) (as in effect for such years) and Sec. 1.810-4 
for special rules for determining the net increase or decrease in the 
sum of the items described in section 810(c) and paragraph (b) of this 
section in the case of certain voluntary employees' beneficiary 
associations. For similar special rules in the case of life insurance 
companies issuing variable annuity contracts, see section 801(g)(4) and 
the regulations thereunder.
    (d) Illustration of principles. The provisions of section 810 (a) 
and (b) and this section may be illustrated by the following examples:

    Example 1. Assume the following facts with respect to R, a life 
insurance company:

Sum of items described in section 810(c) (1) through (6) at         $940
 beginning of taxable year..................................
Sum of items described in section 810(c) (1) through (6) at        1,060
 end of taxable year........................................
Required interest (as defined in section 809(a)(2)).........          70
Investment yield (as defined in section 804(c)).............         100
Amount of investment yield not included in gain or loss from          70
 operations for the taxable year by reason of section
 809(a)(1)..................................................
 


In order to determine the adjustment for decrease or increase in the sum 
of the items described in section 810(c) for the taxable year, R must 
first reduce the sum of such items at the end of the taxable year 
($1,060) by the amount of investment yield ($70) not included in gain or 
loss from operations for the taxable year by reason of section 
809(a)(1). Since the adjusted sum of such items at the end of the 
taxable year, $990 ($1,060 minus $70), exceeds the sum of such items at 
the beginning of the taxable year, $940, the excess of $50 ($990 minus 
$940) shall be taken into account as a net increase under section 
809(d)(2) and paragraph (a)(2) of Sec. 1.809-5 in determining gain or 
loss from operations.
    Example 2. Assume the facts are the same as in example 1, except 
that the sum of the items described in section 810(c) at the beginning 
of the taxable year is $1000. Since the sum of the items described in 
section 810(c) at the beginning of taxable year, $1000, exceeds the sum 
of such items at the end of the taxable year after adjustment for the 
amount of investment yield not included in gain or loss from operations 
for the taxable year by reason of section 809(a)(1), $990 ($1060 minus 
$70), the excess of $10 ($1000 minus $990) shall be taken into account 
as a net decrease under section 809 (c)(2) and paragraph (a)(2) of Sec. 
1.809-4 in determining gain or loss from operations.
    Example 3. Assume the following facts with respect to S, a life 
insurance company:

Sum of items described in section 810(c) (1) through (6) at       $1,970
 beginning of taxable year..................................
Sum of items described in section 810(c) (1) through (6) at        2,040
 the end of taxable year....................................

[[Page 765]]

 
Required interest (as defined in section 809(a)(2)).........          60
Investment yield (as defined in section 804(c)).............          40
Amount of investment yield not included in gain or loss from          40
 operations by reason of section 809(a)(1)..................
 


Under the provisions of section 809(a)(1), since the required interest 
($60) exceeds the investment yield ($40), the share of each and every 
item of investment yield set aside for policyholders and not included in 
gain or loss from operations for the taxable year shall be 100 percent. 
Thus, applying the provisions of section 810 (a) and (b), the sum of the 
items described in section 810(c) at the end of the taxable year 
($2,040) must first be reduced by the entire amount of the investment 
yield ($40) in order to determine the net increase or decrease in the 
sum of such items for the taxable year. Since the adjusted sum of such 
items at the end of the taxable year, $2,000 ($2,040 minus $40), is 
greater than the sum of such items at the beginning of the taxable year, 
$1,970, the excess of $30 ($2,000 minus $1,970) shall be taken into 
account as a net increase under section 809(d)(2) and paragraph (a)(2) 
of Sec. 1.809-5 in determining gain or loss from operations. No 
additional deduction is allowed under section 809(d) for the amount 
($20) by which the required interest exceeds the investment yield for 
the taxable year.
    Example 4. Assume the facts are the same as in example 1, except 
that as a result of a change in the basis used in computing an item 
described in section 810(c) during the taxable year, the sum of such 
items at the end of the taxable year is $1,200. Under the provisions of 
paragraph (c)(2) of this section, any increase or decrease in the sum of 
the section 810(c) items for the taxable year which is attributable to a 
change in the basis used in computing such items during the taxable year 
shall not be taken into account under section 810 (a) and (b). Thus, for 
purposes of section 810 (a) and (b), the sum of the items described in 
section 810(c) at the end of the taxable year shall be $1,060 (the 
amount computed without regard to the change in basis) and S shall treat 
the $50 computed in the manner described in example 1 as a net increase 
under section 809(d)(2) and paragraph (a)(2) of Sec. 1.809-5 in 
determining its gain or loss from operations for the taxable year. The 
amount of the increase in the section 810(c) items which is attributable 
to the change in basis during the taxable year, $140 ($1,200 minus 
$1,060), shall be taken into account in the manner prescribed in section 
810(d) and paragraph (a) of Sec. 1.810-3.
    Example 5. The life insurance reserves of M, a life insurance 
company, computed with respect to contracts for which such reserves are 
determined on a recognized preliminary term basis amount to $100 on 
January 1, 1960, and $110 on December 31, 1960. For the taxable year 
1960, M elects to revalue such reserves on a net level premium basis 
under section 818(c). Such reserves computed under section 818(c) amount 
to $115 on January 1, 1960, and $127 on December 31, 1960. Under the 
provisions of paragraph (c)(3) of this section, a company which makes 
the section 818(c) election must use the net level premium basis in 
computing the sum of its life insurance reserves at the beginning and 
end of all taxable years for which the election applies. Thus, for 
purposes of section 810 (a) and (b), in determining whether there is a 
net increase or decrease in the sum of the section 810(c) items for the 
taxable year 1960, M shall include $115 as its reserves with respect to 
such contracts under section 810(c)(1) at the beginning of the taxable 
year and $127 as its reserves with respect to such contracts under 
section 810(c)(1) at the end of the taxable year.

[T.D. 6535, 26 FR 531, Jan. 20, 1961, as amended by T.D. 7163, 37 FR 
4189, Feb. 29, 1972; T.D. 7172, 37 FR 5619, Mar. 17, 1972]



Sec. 1.810-3  Adjustment for change in computing reserves.

    (a) Reserve strengthening or weakening. Section 810(d)(1) provides 
that if the basis for determining any item referred to in section 810(c) 
and paragraph (b) of Sec. 1.810-2 at the end of any taxable year 
differs from the basis for such determination at the end of the 
preceding taxable year, then so much of the difference between:
    (1) The amount of the item at the end of the taxable year, computed 
on the new basis, and
    (2) The amount of the item at the end of the taxable year, computed 
on the old basis,

as is attributable to contracts issued before the taxable year shall be 
taken into account as follows:
    (i) If the amount of the item at the end of the taxable year 
computed on the new basis exceeds the amount of the item at the end of 
the taxable year computed on the old basis, \1/10\ of such excess shall 
be taken into account, for each of the succeeding 10 taxable years as a 
net increase to which section 809(d)(2) and paragraph (a)(2) of Sec. 
1.809-5 applies; or
    (ii) If the amount of the item at the end of the taxable year 
computed on the old basis exceeds the amount of the item at the end of 
the taxable year computed on the new basis, \1/10\ of such excess shall 
be taken into account, for

[[Page 766]]

each of the 10 succeeding taxable years, as a net decrease to which 
section 809 (c)(2) and paragraph (a)(2) of Sec. 1.809-4 applies.
    (b) Illustration of principles. The provisions of section 810(d)(1) 
and paragraph (a) of this section may be illustrated by the following 
examples:

    Example 1. Assume that the amount of an item described in section 
810(c) of L, a life insurance company, at the beginning of the taxable 
year 1959 is $100. Assume that at the end of the taxable year 1959, as a 
result of a change in the basis used in computing such item during the 
taxable year, the amount of the item (computed on the new basis) is $200 
but computed on the old basis would have been $150. Since the amount of 
the item at the end of the taxable year computed on the new basis, $200, 
exceeds the amount of the item at the end of the taxable year computed 
on the old basis, $150, by $50, \1/10\ of the amount of such excess, or 
$5, shall be taken into account as a net increase referred to in section 
809(d)(2) and paragraph (a)(2) of Sec. 1.809-5 in determining gain or 
loss from operations for each of the 10 taxable years immediately 
following the taxable year 1959. Any increase (or decrease) in the sum 
of the section 810(c) items computed on the old basis at the end of the 
taxable year 1959 ($150) after adjustment for investment yield not 
included in gain or loss from operations for the taxable year by reason 
of section 809(a)(1), over the sum of such items computed on the old 
basis at the beginning of the taxable year 1959 ($100), shall be taken 
into account in the manner prescribed in section 810 (a) or (b) and 
Sec. 1.810-2 for purposes of determining L's gain or loss from 
operations for 1959.
    Example 2. Assume the facts are the same as in example 1, and that 
the sum of the items described in section 810(c) (computed on the new 
basis) is $200 on January 1, 1960, and $260 on December 31, 1960. Under 
the provisions of section 810(d)(1), as a result of the reserve 
strengthening attributable to the change in basis which occurred in 
1959, L would include $5 (computed in the manner described in example 1) 
as a net increase under section 809(d)(2) and paragraph (a)(2) of Sec. 
1.809-5 in determining its gain or loss from operations for 1960. In 
addition to this amount, any increase (or decrease) in the sum of the 
items described in section 810(c) at the end of the taxable year 1960 
($260) after adjustment for investment yield not included in gain or 
loss from operations for the taxable year by reason of section 
809(a)(1), over the sum of such items at the beginning of the taxable 
year 1960 ($200), shall be taken into account in the manner prescribed 
in section 810 (a) or (b) and Sec. 1.810-2 for purposes of determining 
L's gain or loss from operations for 1960.

    (c) Termination as life insurance company. Section 810(d)(2) 
provides, subject to the provisions of section 381(c)(22) and the 
regulations thereunder (relating to carryovers in certain corporate 
readjustments), that if for any taxable year a company which previously 
was a life insurance company no longer meets the requirements of section 
801(a) and paragraph (b) of Sec. 1.801-3 (relating to the definition of 
a life insurance company), the balance of any adjustments remaining to 
be made under section 810(d)(1) and paragraph (a) of this section shall 
be taken into account for the preceding taxable year.
    (d) Illustration of principles. The provisions of section 810(d)(2) 
and paragraph (c) of this section may be illustrated by the following 
example:

    Example. Assume the facts are the same as in example 1 of paragraph 
(b) of this section, except that for the taxable year 1962, L no longer 
meets the requirements of section 801(a) (relating to the definition of 
a life insurance company) and that the provisions of section 381(c)(22) 
are not applicable. Under the provisions of section 810 (d)(2), the 
entire balance of the adjustment remaining to be made with respect to 
the change in basis which occurred in 1959, \8/10\ of $50, or $40, shall 
be taken into account for the taxable year 1961, the last year L was a 
life insurance company. Thus, for the taxable year 1961, the total 
amount to be taken into account by L as a net increase referred to in 
section 809(d)(2) and paragraph (a)(2) of Sec. 1.809-5 in determining 
its gain or loss from operations shall be $45. Of this amount, $5 (1/10 
of $50) represents the amount determined under the provisions of section 
810(d)(1), and $40 represents the amount determined under the provisions 
of section 810(d)(2).

    (e) Effect of preliminary term election. (1) Section 810(d)(3) 
provides that if a company which computes its life insurance reserves on 
a preliminary term basis elects to revalue such reserves on a net level 
premium basis under section 818(c), such election shall not be treated 
as a change in basis within the meaning of section 810(d)(1) and 
paragraph (a) of this section. Thus, any increase or decrease in 
reserves attributable to such election shall not be taken into account 
under section 810(d)(1) and paragraph (a) of this section but shall be 
taken into account in the manner prescribed in section 810 (a)

[[Page 767]]

and (b) and paragraph (a) of Sec. 1.810-2. See paragraph (c)(3) of 
Sec. 1.810-2.
    (2) Section 810(d)(3) further provides that where an election under 
section 818(c) would apply to an item referred to in section 810(c) but 
for the fact that the basis used in computing such item has actually 
been changed, any increase or decrease in such item attributable to such 
actual change in basis shall be subject to the adjustment required under 
section 810(d)(1) and paragraph (a) of this section. In such a case, 
however, for purposes of section 810(d)(1)(B) and paragraph (a)(2) of 
this section, the amount of such item at the end of the taxable year 
computed on the old basis shall be the amount of such item at the end of 
the taxable year computed as if the election under section 818(c) 
applied in respect of such item for the taxable year.
    (f) Illustration of principles. The provisions of section 810(d)(3) 
and par- agraph (e) of this section may be illustrated by the following 
examples:

    Example 1. Assume that S, a life insurance company which computes 
its life insurance reserves on a 3-percent assumed rate and the 
Commissioner's reserve valuation method (one of the recognized 
preliminary term reserve methods), elects to revalue such reserves on a 
net level premium method under section 818(c) and that the significant 
facts are as follows:

------------------------------------------------------------------------
                                                                   Dec.
                                                        Jan. 1,    31,
                                                          1958     1958
------------------------------------------------------------------------
Book reserves at 3-percent assumed rate,                    100      118
 Commissioner's reserve valuation method..............
Reserves at 3-percent assumed rate, after restatement       110      131
 under section 818(c).................................
------------------------------------------------------------------------


Under the provisions of section 810(d)(3), an election under section 
818(c) is not treated as a change in basis for purposes of section 
810(d)(1). Accordingly, the increase of $21 ($131 minus $110) 
attributable to such election shall not be subject to the adjustment 
provided by section 810(d)(1) but shall be taken into account in the 
manner prescribed in section 810(b). For purposes of determining the 
amount to be taken into account under section 810(b), the reserves with 
respect to the contracts subject to the section 818(c) election shall be 
$110 at the beginning of the taxable year 1958 and $131 at the end of 
the taxable year 1958. However, as a result of making the election under 
section 818(c), the difference ($10) between the reserves computed on 
the preliminary term basis on January 1, 1958 ($100) and the reserves 
restated on the net level premium basis on January 1, 1958 ($110) shall 
not be taken into account under section 809(d) for the year 1958, or for 
any subsequent taxable year.
    Example 2. Assume the facts are the same as in example 1, except 
that during the taxable year 1959, S actually changed from the 
preliminary term basis to a net level premium basis which was identical 
with the net level premium basis used under the section 818(c) election 
and that the significant facts are as follows:

------------------------------------------------------------------------
                                                                   Dec.
                                                        Jan. 1,    31,
                                                          1959     1959
------------------------------------------------------------------------
Book reserves at 3-percent assumed rate,                    118      127
 Commissioner's reserve valuation method..............
Reserves at 3-percent assumed rate, after restatement       131      142
 under section 818(c).................................
Strengthened reserves at 3-percent assumed rate and     .......      142
 net level premium method.............................
------------------------------------------------------------------------


Under the provisions of section 810(d)(3), if a company which has made 
an election under section 818(c) which has not been revoked actually 
changes the basis used by it in computing the reserves subject to such 
election, any increase or decrease in reserves attributable to such 
change in basis shall be taken into account in the manner prescribed in 
section 810(d)(1). Since S actually changed to the same basis which it 
used in computing its reserves under section 818(c), the reserves at the 
end of the taxable year computed on the new basis ($142) are the same as 
the reserves at the end of the taxable year computed on the old basis 
($142), i.e., the basis which would have applied under section 818(c) if 
the election applied for 1959. Accordingly, no adjustment under section 
810(d)(1) is required.
    Example 3. Assume the facts are the same as in example 1, except 
that during the taxable year 1960, S actually changed the basis used by 
it in computing its reserves on a certain block of contracts subject to 
the election under section 818(c) and that the significant facts with 
respect to this block of contracts are as follows:

------------------------------------------------------------------------
                                                                   Dec.
                                                        Jan. 1,    31,
                                                          1960     1960
------------------------------------------------------------------------
Book reserves at 3-percent assumed rate,                     50       63
 Commissioner's reserve valuation method..............
Reserves at 3-percent assumed rate, after restatement        60       75
 under section 818(c).................................
Strengthened reserves at 2-percent assumed rate and     .......       95
 net level premium method.............................
------------------------------------------------------------------------


Under the provisions of section 810(d)(3), the amount of the reserves 
subject to the section

[[Page 768]]

818(c) election at the end of the taxable year computed on the old basis 
shall be the amount of such reserves at the end of the taxable year 
determined under section 818(c) ($75). Since the reserves at the end of 
the taxable year computed on the new basis, $95, exceed the reserves at 
the end of the taxable year computed on the old basis, $75, by $20, \1/
10\ of the excess of $20, or $2, shall be taken into account as a net 
increase referred to in section 809(d)(2) and paragraph (a)(2) of Sec. 
1.809-5 in determining gain or loss from operations for each of the 10 
taxable years immediately following the taxable year 1960. For purposes 
of determining whether there is a net increase or decrease in the sum of 
the items described in section 810(c) for the taxable year 1960 under 
section 810 (a) or (b), the sum of the reserves with respect to such 
block of contracts shall be $60 at the beginning of the taxable year and 
$75 at the end of the taxable year (the amount of such reserves computed 
under section 818(c) at the beginning and end of the taxable year). The 
difference ($10) between the reserves computed on the preliminary term 
basis on January 1, 1960 ($50) and the reserves restated on the net 
level premium basis on January 1, 1960 ($60) shall not be taken into 
account under section 809(d) for the year 1960, or for any subsequent 
taxable year.

[T.D. 6535, 26 FR 532, Jan. 20, 1961]



Sec. 1.810-4  Certain decreases in reserves of voluntary employees'
beneficiary associations.

    (a) Decreases due to voluntary lapses of policies issued before 
January 1, 1958. (1) Section 810(e) provides that if for any taxable 
year a life insurance company which meets the requirements of section 
501(c)(9), other than the requirement of subparagraph (B) thereof, makes 
an election in the manner provided in section 810(e)(3) and paragraph 
(b) of this section, only 11\1/2\ percent of any decrease in life 
insurance reserves (as defined in section 801(b) and Sec. 1.801-4) 
attributable to the voluntary lapse on or after January 1, 1958, of any 
policy issued prior to that date shall be taken into account under 
section 810 (a) or (b) and paragraph (a) of Sec. 1.810-2 in determining 
the net increase or decrease in the sum of the items described in 
section 810(c) during the taxable year. In applying the preceding 
sentence, the decrease in the reserve for any policy shall be determined 
by reference to the amount of such reserve at the beginning of the 
taxable year, reduced by any amount allowable as a deduction under 
section 809(d)(1) and paragraph (a)(1) of Sec. 1.809-5 in respect of 
such policy by reason of such lapse. The election under section 810(e) 
shall be adhered to in computing the company's gain or loss from 
operation for the taxable year for which the election is made and for 
all subsequent taxable years, unless consent to revoke such election is 
obtained from the Commissioner.
    (2) The application of the election provided under section 810(e) 
and subparagraph (1) of this paragraph may be illustrated by the 
following example:

    Example. For the taxable year 1960, M, a life insurance company 
which meets the requirements of section 501(c)(9), other than the 
requirement of subparagraph (B) thereof, makes the election under 
section 810(e). Assume the following facts with respect to a policy 
issued in 1955 which voluntarily lapsed during the taxable year:

(1) Life insurance reserve on January 1, 1960................       $600
(2) Amount allowable as a deduction under sec. 809(d)(1).....        200
(3) Decrease in life insurance reserves for sec. 810(e)              400
 purposes (item (1) minus item (2))..........................
(4) Amount taken into account under sec. 810 (a) and (b) by           46
 reason of sec. 810(e) election (11 1/2%x$400)...............
 


Under the provisions of section 810(e) and subparagraph (1) of this 
paragraph, M would include $46 as its life insurance reserve with 
respect to such policy under section 810(c)(1) at the beginning of the 
taxable year 1960 for purposes of determining the net increase or 
decrease in the sum of the items described in section 810(c) for the 
taxable year under section 810 (a) or (b).

    (b) Time and manner of making election. The election provided by 
section 810(e)(3) shall be made in a statement attached to the life 
insurance company's income tax return for the first taxable year for 
which the company desires the election to apply. The return and 
statement must be filed not later than the date prescribed by law 
(including extensions thereof) for filing the return for such taxable 
year. However, if the last day prescribed by law (including extensions 
thereof) for filing a return for the first taxable year for which the 
company desires the election to apply falls before January 20, 1961, the 
election provided by section 810(e)(3) may be made for such year by 
filing the statement and an amended return for such taxable year (and 
all

[[Page 769]]

subsequent taxable years for which returns have been filed) before April 
21, 1961. The statement shall indicate that the company meets the 
requirements of section 501(c)(9), other than the requirement of 
subparagraph (B) thereof, and has made the election provided under 
section 810(e) and paragraph (a) of this section. The statement shall 
set forth the following information with respect to each policy 
described in paragraph (a) of this section which has voluntarily lapsed 
during such year:
    (1) Type of policy.
    (2) Date issued.
    (3) Date lapsed.
    (4) Reason for lapse.
    (5) Policy reserve as of beginning of taxable year.
    (6) Deduction allowable under section 809(d)(1) and paragraph (a)(1) 
of Sec. 1.809-5 during taxable year by reason of lapse.
    (7) Decrease in policy reserve for section 810(e) purposes (excess 
of (5) over (6)).

In addition, the statement shall set forth the total of the amounts 
referred to in subparagraph (7) of this paragraph with respect to all 
policies described in paragraph (a) of this section which have 
voluntarily lapsed during the taxable year.
    (c) Scope of election. An election made under section 810(e)(3) and 
paragraph (a) of this section shall be effective for the taxable year 
for which made and for all succeeding taxable years, unless consent to 
revoke the election is obtained from the Commissioner. However, for 
taxable years beginning prior to January 20, 1961, a company may revoke 
the election provided by section 810(e)(3) without obtaining consent 
from the Commissioner by filing, before April 21, 1961, a statement that 
the company desires to revoke such election. An amended return 
reflecting such revocation must accompany the statement for all taxable 
years for which returns have been filed with respect to such election.
    (d) Disallowance of carryovers from pre-1958 losses from operations. 
For any taxable year for which the election provided under section 
810(e)(3) and paragraph (b) of this section is effective, the provisions 
of section 812(b)(1) and Sec. 1.812-4 shall not apply with respect to 
any loss from operations for any taxable year beginning before January 
1, 1958.
    (e) Effective date; cross reference. The provisions of section 
810(e) (as in effect for such years) and this section apply only with 
respect to taxable years beginning before January 1, 1970. For 
provisions relating to certain funded pension trusts applicable to 
taxable years beginning after December 31, 1969, see section 501(c)(18) 
and the regulations thereunder.

[T.D. 6535, 26 FR 533, Jan. 20, 1961, as amended by T.D. 7172, 37 FR 
5619, Mar. 17, 1972]



Sec. 1.811-1  Taxable years affected.

    Section 1.811-2, except as otherwise provided therein, is applicable 
only to taxable years beginning after December 31, 1957, and all 
references to sections of part I, subchapter L, chapter 1 of the Code 
are to the Internal Revenue Code of 1954, as amended by the Life 
Insurance Company Income Tax Act of 1959 (73 Stat. 112).

[T.D. 6535, 26 FR 534, Jan. 20, 1961]



Sec. 1.811-2  Dividends to policyholders.

    (a) Dividends to policyholders defined. Section 811(a) defines the 
term dividends to policyholders, for purposes of part I, subchapter L, 
chapter 1 of the Code, to mean dividends and similar distributions to 
policyholders in their capacity as such. The term includes amounts 
returned to policyholders where the amount is not fixed in the contract 
but depends on the experience of the company or the discretion of the 
management. In general, any payment not fixed in the contract which is 
made with respect to a participating contract (that is, a contract which 
during the taxable year contains a right to participate in the divisible 
surplus of the company) shall be treated as a dividend to policyholders. 
Similarly, any amount refunded or allowed as a rate credit with respect 
to either a participating or a nonparticipating contract shall be 
treated as a dividend to policyholders if such amount depends on the 
experience of the company. However, the term does not include interest 
paid (as defined in section 805(e) and paragraph (b) of Sec. 1.805-8) 
or return premiums (as defined in section 809(c) and

[[Page 770]]

paragraph (a)(1)(ii) of Sec. 1.809-4). Thus, so-called excess-interest 
dividends and amounts returned by one life insurance company to another 
in respect of reinsurance ceded shall not be treated as dividends to 
policyholders even though such amounts are not fixed in the contract but 
depend upon the experience of the company or the discretion of the 
management.
    (b) Amount of deduction--(1) In general. Section 811(b)(1) provides, 
subject to the limitation of section 809(f), that the deduction for 
dividends to policyholders for any taxable year shall be an amount equal 
to the dividends to policyholders paid during the taxable year:
    (i) Increased by the excess of the amounts held as reserves for 
dividends to policyholders at the end of the taxable year for payment 
during the year following the taxable year, over the amounts held as 
reserves for dividends to policyholders at the end of the preceding 
taxable year for payment during the taxable year, or
    (ii) Decreased by the excess of the amounts held as reserves for 
dividends to policyholders at the end of the preceding taxable year for 
payment during the taxable year, over the amounts held as reserves for 
dividends to policyholders at the end of the taxable year for payment 
during the year following the taxable year.

For the rule as to when dividends are considered paid, see section 561 
and the regulations thereunder. For the determination of the amounts 
held as reserves for dividends to policyholders, see paragraph (c) of 
this section. For special provisions relating to the treatment of 
dividends to policyholders paid with respect to policies reinsured under 
modified coinsurance contracts, see section 820(c)(5) and the 
regulations thereunder.
    (2) Certain amounts to be treated as net decreases. Section 
811(b)(2) provides that if the amount determined under subparagraph 
(1)(ii) of this paragraph exceeds the dividends to policyholders paid 
during the taxable year, the amount of such excess shall be a net 
decrease referred to in section 809(c)(2).
    (c) Reserves for dividends to policyholders defined--(1) In general. 
The term reserves for dividends to policyholders, as used in section 
811(b)(1) (A) and (B) and paragraph (b)(1) of this section, means only 
those amounts:
    (i) Actually held, or set aside as provided in subparagraph (2) of 
this paragraph and thus treated as actually held, by the company at the 
end of the taxable year, and
    (ii) With respect to which, at the end of the taxable year or, if 
set aside, within the period prescribed in subparagraph (2) of this 
paragraph, the company is under an obligation, which is either fixed or 
determined according to a formula which is fixed and not subject to 
change by the company, to pay such amounts as dividends to policyholders 
(as defined in section 811(a) and paragraph (a) of this section) during 
the year following the taxable year.
    (2) Amounts set aside. (i) In the case of a life insurance company 
(as defined in section 801(a) and paragraph (b) of Sec. 1.801-3), all 
amounts set aside before the 16th day of the 3d month of the year 
following the taxable year for payment as dividends to policyholders (as 
defined in section 811(a) and paragraph (a) of this section) during the 
year following such taxable year shall be treated as amounts actually 
held at the end of the taxable year.
    (ii) In the case of a mutual savings bank subject to the tax imposed 
by section 594, all amounts set aside before the 16th day of the 4th 
month of the year following the taxable year for payment as dividends to 
policyholders (as defined in section 811(a) and paragraph (a) of this 
section) during the year following such taxable year shall be treated as 
amounts actually held at the end of the taxable year.
    (3) 1958 reserve for dividends to policyholders. For purposes of 
section 811(b) and paragraph (b) of this section, the amounts held at 
the end of 1957 as reserves for dividends to policyholders payable 
during 1958 shall be determined as if part I, subchapter L, chapter 1 of 
the Code (as in effect for 1958) applied for 1957. Any adjustment in the 
reserves for dividends to policyholders at the beginning of 1957 
required as a result of an understatement or overstatement of such 
reserves by the company shall be made to the balance of such reserves as 
of the beginning of 1957. For example, if at the beginning of 1957 the

[[Page 771]]

reserves for dividends to policyholders are stated to be $100 and it is 
subsequently determined that such reserves should have been $90, the 
reserves at the beginning of 1957 shall be reduced by $10. Under no 
circumstances shall an adjustment required with regard to the beginning 
1957 reserves be made to the reserves at the end of 1957.
    (4) Information to be filed. Every company claiming a deduction for 
dividends to policyholders shall keep such permanent records as are 
necessary to establish the amount of dividends actually paid during the 
taxable year. Such company shall also keep a copy of the dividend 
resolution and any necessary supporting data relating to the amounts of 
dividends declared and to the amounts held or set aside as reserves for 
dividends to policyholders during the taxable year. The company shall 
file with its return a concise statement of the pertinent facts relating 
to its dividend policy for the year, the amount of dividends actually 
paid during the taxable year, and the amounts held or set aside as 
reserves for dividends to policyholders during the taxable year.
    (d) Illustration of principles. The provisions of section 811(b) and 
this section may be illustrated by the following examples:

    Example 1. On December 31, 1959, M, a life insurance company, held 
$200 as reserves for dividends to policyholders due and payable in 1960. 
On March 10, 1960, M set aside an additional $50 as reserves for 
dividends to policyholders due and payable in 1960. During the taxable 
year 1960, M paid $240 as dividends to its policyholders and at the end 
of the taxable year 1960, held $175 as reserves for dividends to 
policyholders due and payable in 1961. No additional amount was set 
aside before March 16, 1961, as reserves for dividends to policyholders 
due and payable in 1961. For the taxable year 1960, subject to the 
limitation of section 809(f), M's deduction for dividends to 
policyholders is $165, computed as follows:

(1) Dividends paid to policyholders during the taxable    ......    $240
 year 1960..............................................
(2) Decreased by the excess of item (a) over item (b):
(a) Reserves for dividends to policyholders as of 12-31-    $250
 59 (including amounts set aside as provided in
 paragraph (c)(2) of this section)......................
(b) Reserves for dividends to policyholders as of 12-31-     175
 60-....................................................
                                                           -----      75
                                                                 -------
(3) Deduction for dividends to policyholders under sec.   ......    $165
 811(b) (computed without regard to the limitation of
 sec. 809(f))...........................................
 

    Example 2. On December 31, 1960, S, a life insurance company, held 
$100 as reserves for dividends to policyholders due and payable in 1961. 
During the taxable year 1961, S paid $125 as dividends to its 
policyholders and at the end of the taxable year 1961, held $110 as 
reserves for dividends to policyholders due and payable in 1962. No 
additional amount was set aside for dividends to policyholders as 
provided in paragraph (c)(2) of this section before March 16, 1961, or 
March 16, 1962. For the taxable year 1961, subject to the limitation of 
section 809(f), S's deduction for dividends to policyholders is $135, 
computed as follows:

(1) Dividends paid to policyholders during the taxable    ......    $125
 year 1961..............................................
(2) Increased by the excess of item (a) over item (b):
(a) Reserves for dividends to policyholders as of 12-31-    $110
 61.....................................................
(b) Reserves for dividends to policyholders as of 12-31-     100
 60.....................................................
                                                           -----      10
                                                                 -------
(3) Deduction for dividends to policyholders under sec.   ......    $135
 811(b) (computed without regard to the limitation of
 sec. 809(f))...........................................
 

    Example 3. Assume the facts are the same as in example 2, except 
that on December 31, 1960, the amount held as reserves for dividends to 
policyholders due and payable in 1961 is $250. For the taxable year 
1961, S's deduction for dividends to policyholders is zero, computed as 
follows:

(1) Dividends paid to policyholders during the taxable    ......    $125
 year 1961..............................................
(2) Decreased by the excess of item (a) over item (b):
(a) Reserves for dividends to policyholders as of 12-31-    $250
 60.....................................................
(b) Reserves for dividends to policyholders as of 12-31-     110
 61.....................................................
                                                           -----     140
                                                                 -------
(3) Deduction for dividends to policyholders under sec.   ......      $0
 811(b) (computed without regard to the limitation of
 sec. 809(f))...........................................
 


Under the provisions of section 811(b)(2) and paragraph (b)(2) of this 
section, since the decrease in the reserves for dividends to 
policyholders during the taxable year, $140 ($250 minus $110), exceeds 
the dividends to policyholders paid during the taxable year 1961, $125, 
S shall include $15 (the amount of such excess) as a net decrease under 
section 809(c)(2) and paragraph (a)(2) of Sec. 1.809-4 in determining 
its gain or loss from operations for 1961.

[T.D. 6535, 26 FR 534, Jan. 20, 1961]

[[Page 772]]



Sec. 1.811-3  Cross-reference.

    For special rules regarding the treatment of modified guaranteed 
contracts (as defined in section 817A and Sec. 1.817A-1(a)(1)), see 
Sec. 1.817A-1.

[T.D. 9058, 68 FR 24350, May 7, 2003]



Sec. 1.812-1  Taxable years affected.

    Sections 1.812-2 through 1.812-8, except as otherwise provided 
therein, are applicable only to taxable years beginning after December 
31, 1957, and all references to sections of part I, subchapter L, 
chapter 1 of the Code are to the Internal Revenue Code of 1954, as 
amended by the Life Insurance Company Income Tax Act of 1959 (73 Stat. 
112) and the Act of October 23, 1962 (76 Stat. 1134).

[T.D. 6886, 31 FR 8689, June 23, 1966]



Sec. 1.812-2  Operations loss deduction.

    (a) Allowance of deduction. Section 812 provides that a life 
insurance company shall be allowed a deduction in computing gain or loss 
from operations for any taxable year beginning after December 31, 1957, 
in an amount equal to the aggregate of the operations loss carryovers 
and operations loss carrybacks to such taxable year. This deduction is 
referred to as the operations loss deduction. The loss from operations 
(computed under section 809), is the basis for the computation of the 
operations loss carryovers and operations loss carrybacks and ultimately 
for the operations loss deduction itself. Section 809(e)(5) provides 
that the net operating loss deduction provided in section 172 shall not 
be allowed a life insurance company since the operations loss deduction 
provided in section 812 and this paragraph shall be allowed in lieu 
thereof.
    (b) Steps in computation of operations loss deduction. The three 
steps to be taken in the ascertainment of the operations loss deduction 
for any taxable year beginning after December 31, 1957, are as follows:
    (1) Compute the loss from operations for any preceding or succeeding 
taxable year from which a loss from operations may be carried over or 
carried back to such taxable year.
    (2) Compute the operations loss carryovers to such taxable year from 
such preceding taxable years and the operations loss carrybacks to such 
taxable year from such succeeding taxable years.
    (3) Add such operations loss carryovers and carrybacks in order to 
determine the operations loss deduction for such taxable year.
    (c) Statement with tax return. Every life insurance company claiming 
an operations loss deduction for any taxable year shall file with its 
return for such year a concise statement setting forth the amount of the 
operations loss deduction claimed and all material and pertinent facts 
relative thereto, including a detailed schedule showing the computation 
of the operations loss deduction.
    (d) Ascertainment of deduction dependent upon operations loss 
carryback. If a life insurance company is entitled in computing its 
operations loss deduction to a carryback which it is not able to 
ascertain at the time its return is due, it shall compute the operations 
loss deduction on its return without regard to such operations loss 
carryback. When the life insurance company ascertains the operations 
loss carryback, it may within the applicable period of limitations file 
a claim for credit or refund of the overpayment, if any, resulting from 
the failure to compute the operations loss deduction for the taxable 
year with the inclusion of such carryback; or it may file an application 
under the provisions of section 6411 for a tentative carryback 
adjustment.
    (e) Law applicable to computations. The following rules shall apply 
to all taxable years beginning after December 31, 1957:
    (1) In determining the amount of any operations loss carryback or 
carryover to any taxable year, the necessary computations involving any 
other taxable year shall be made under the law applicable to such other 
taxable year.
    (2) The loss from operations for any taxable year shall be 
determined under the law applicable to that year without regard to the 
year to which it is to be carried and in which, in effect, it is to be 
deducted as part of the operations loss deduction.
    (3) The amount of the operations loss deduction which shall be 
allowed for

[[Page 773]]

any taxable year shall be determined under the law applicable for that 
year.
    (f) Special rules. For purposes of taxable years beginning after 
December 31, 1954, and before January 1, 1958:
    (1) The amount of any:
    (i) Loss from operations;
    (ii) Operations loss carryback; and
    (iii) Operations loss carryover

shall be computed as if part I, subchapter L, chapter 1 of the Code (as 
in effect for 1958) and section 381(c)(22) applied to such taxable 
years.
    (2) A loss from operations (determined in accordance with the 
provisions of section 812(b)(1)(C) and this paragraph) for such taxable 
years shall in no way affect the tax liability of any life insurance 
company for such taxable years. However, such loss may, to the extent 
allowed as an operations loss carryover under section 812, affect the 
tax liability of a life insurance company for a taxable year beginning 
after December 31, 1957. For example, for the taxable year 1956, X, a 
life insurance company, has a loss from operations (determined in 
accordance with the provisions of section 812(b)(1)(C) and this 
paragraph). Such loss shall in no way affect X's tax liability for the 
taxable years 1956 (the year of the loss), 1955 (a year to which such 
loss shall be carried back), or 1957 (a year to which such loss shall be 
carried forward). However, to the extent allowed under section 812, any 
amount of the loss for 1956 remaining after such carryback and 
carryforward shall be taken into account in determining X's tax 
liability for taxable years beginning after December 31, 1957.

[T.D. 6535, 26 FR 536, Jan. 20, 1961]



Sec. 1.812-3  Computation of loss from operations.

    (a) Modification of deductions. A loss from operations is sustained 
by a life insurance company in any taxable year, if and to the extent 
that, for such year, there is an excess of the sum of the deductions 
provided by section 809(d) over the sum of (1) the life insurance 
company's share of each and every item of investment yield (including 
tax-exempt interest, partially tax-exempt interest, and dividends 
received) as determined under section 809(b)(3), and (2) the sum of the 
items of gross amount taken into account under section 809(c). In 
determining the loss from operations for purposes of section 812:
    (i) No deduction shall be allowed under section 812 for the 
operations loss deduction.
    (ii) The 85 percent limitation on dividends received provided by 
section 246 (b) as modified by section 809(d)(8)(B) shall not apply to 
the deductions otherwise allowed under:
    (a) Section 243(a) in respect to dividends received by corporations,
    (b) Section 244 in respect of dividends received on certain 
preferred stock of public utilities, and
    (c) Section 245 in respect of dividends received from certain 
foreign corporations.
    (b) Illustration of principles. The application of paragraph (a) of 
this section may be illustrated by the following example:

    Example. For the taxable year 1960, X, a life insurance company, has 
items taken into account under section 809(c) amounting to $150,000, its 
share of the investment yield amounts to $250,000, and total deductions 
allowed by section 809(d) of $375,000, exclusive of any operations loss 
deduction and exclusive of any deduction for dividends received. In 
1960, X received as its share of dividends entitled to the benefits of 
section 243(a) the amount of $100,000. These dividends are included in 
X's share of the investment yield. X has no other deductions to which 
section 812(c) applies. On the basis of these facts, X has a loss from 
operations for the taxable year 1960 of $60,000, computed as follows:

Deductions for 1960.........................................    $375,000
Plus: Deduction for dividends received computed without           85,000
 regard to the limitation provided by sec. 246(b), as
 modified by sec. 809(d)(8)(B) (85% of $100,000)............
                                                             -----------
    Total deductions as modified by sec. 812(c).............     460,000
Less: Sum of sec. 809(c) items and X's share of investment       400,000
 yield (including $100,000 of dividends)....................
                                                             -----------
    Loss from operations for 1960...........................    (60,000)
 


[T.D. 6535, 26 FR 536, Jan. 20, 1961]



Sec. 1.812-4  Operations loss carrybacks and operations loss carryovers.

    (a) In general--(1) Years to which loss may be carried. In order to 
compute the operations loss deduction of a life insurance company the 
company must first determine the part of any losses

[[Page 774]]

from operations for any preceding or succeeding taxable years which are 
carryovers or carrybacks to the taxable year in issue. Except as 
otherwise provided by this paragraph, a loss from operations for taxable 
years beginning after December 31, 1954, shall be carried back to each 
of the 3 taxable years preceding the loss year and shall be carried 
forward to each of the 5 taxable years succeeding the loss year. Except 
as limited by section 812(e)(2) and paragraph (b) of Sec. 1.812-6, if 
the life insurance company is a new company (as defined in section 
812(e)(1)) for the loss year, the loss from operations shall be carried 
back to each of the 3 taxable years preceding the loss year and shall be 
carried forward to each of the 8 taxable years succeeding the loss year. 
In determining the span of years for which a loss from operations may be 
carried, taxable years in which a company does not qualify as a life 
insurance company (as defined in section 801(a)), or is not treated as a 
new company, shall be taken into account.
    (2) Special transitional rules. (i) A loss from operations for any 
taxable year beginning before January 1, 1958, shall not be carried back 
to any taxable year beginning before January 1, 1955. Furthermore, a 
loss from operations for any taxable year beginning after December 31, 
1957, shall not be carried back to any taxable year beginning before 
January 1, 1958.
    (ii) If for any taxable year a life insurance company has made an 
election under section 810(e) (relating to certain decreases in reserves 
for voluntary employees' beneficiary associations) which is effective 
for such taxable year, the provisions of section 812(b)(1) and 
subparagraph (1) of this paragraph shall not apply with respect to any 
loss from operations for any taxable year beginning before January 1, 
1958.
    (3) Illustration of principles. The provisions of section 812(b)(1) 
and of this paragraph may be illustrated by the following examples:

    Example 1. P, a life insurance company, organized in 1940, has a 
loss from operations of $1,000 in 1958. This loss cannot be carried 
back, but shall be carried forward to each of the 5 taxable years 
following 1958.
    Example 2. Q, a life insurance company, organized in 1940, has a 
loss from operations of $1,200 in 1959. This loss shall be carried back 
to the taxable year 1958 and then shall be carried forward to each of 
the 5 taxable years following 1959.
    Example 3. R, a life insurance company, organized in 1940, has a 
loss from operations of $1,300 for the taxable year 1956. This loss 
shall first be carried back to the taxable year 1955 and then shall be 
carried forward to each of the 5 taxable years following 1956. The loss 
for 1956, carryback to 1955, and carryover to 1957 shall each be 
computed as if part I, subchapter L, chapter 1 of the Code (as in effect 
for 1958) applied to such taxable years.
    Example 4. S, a life insurance company, organized in 1958 and 
meeting the provisions of section 812(e) (rules relating to new 
companies), has a loss from operations of $1,400 for the taxable year 
1958. This loss cannot be carried back, but shall be carried forward to 
each of the 8 taxable years following 1958, provided, however, S is not 
a nonqualified corporation at any time during the loss year (1958) or 
any taxable year thereafter.
    Example 5. T, a life insurance company, organized in 1954 and 
meeting the provisions of section 812(e) (rules relating to new 
companies), has a loss from operations of $1,500 for the taxable year 
1956. This loss shall first be carried back to the taxable year 1955 and 
then carried forward to each of the 8 taxable years following 1956, 
provided, however, T is not a nonqualified corporation at any time 
during the loss year (1956) or any taxable year thereafter. The loss for 
1956, carryback to 1955, and carryover to 1957 shall each be computed as 
if part I of subchapter L (as in effect for 1958) applied to such 
taxable years.

    (4) Periods of less than 12 months. A fractional part of a year 
which is a taxable year under sections 441(b) and 7701(a)(23) is a 
preceding or a succeeding taxable year for the purpose of determining 
under section 812 the first, second, etc., preceding or succeeding 
taxable year. For the determination of the loss from operations for 
periods of less than 12 months, see section 818(d) and the regulations 
thereunder.
    (5) Amount of loss to be carried. The amount which is carried back 
or carried over to any taxable year is the loss from operations to the 
extent it was not absorbed in the computation of gain from operations 
for other taxable years, preceding such taxable year, to which it may be 
carried back or carried over. For the purpose of determining the gain 
from operations for any such preceding taxable year, the various 
operations loss carryovers and carrybacks to such taxable year are 
considered to be applied in reduction of

[[Page 775]]

the gain from operations in the order of the taxable years from which 
such losses are carried over or carried back, beginning with the loss 
for the earliest taxable year.
    (6) Corporate acquisitions. For the computation of the operations 
loss carryovers in the case of certain acquisitions of the assets of a 
life insurance company by another life insurance company, see section 
381(c)(22) and the regulations thereunder.
    (b) Portion of loss from operations which is a carryback or a 
carryover to the taxable year in issue--(1) Manner of computation. (i) A 
loss from operations shall first be carried back to the earliest taxable 
year permissible under section 812(b) and paragraph (a) of this section 
for which such loss is allowable as a carryback or a carryover. The 
entire amount of the loss from operation shall be carried back to such 
earliest year.
    (ii) Section 812(b)(2) provides that the portion of the loss from 
operations which shall be carried to each of the taxable years 
subsequent to the earliest taxable year shall be the excess (if any) of 
the amount of the loss from operations over the sum of the offsets (as 
defined in section 812(d) and paragraph (a) of Sec. 1.812-5) for all 
prior taxable years to which the loss from operations may be carried.
    (2) Illustration of principles. The application of this paragraph 
may be illustrated by the following example:

    Example. T, a life insurance company (which is not a new company as 
defined in section 812(e)(1)), has a loss from operations for 1960. The 
entire amount of the loss from operations for 1960 shall first be 
carried back to 1958. The amount of the carryback to 1959 is the excess 
(if any) of the 1960 loss over the offset for 1958. The amount of the 
carryover to 1961 is the excess (if any) of the 1960 loss over the sum 
of the offsets for 1958 and 1959. The amount of the 1960 loss remaining 
(if any) to be carried over to 1962, 1963, or 1964 shall be computed in 
a like manner.

[T.D. 6535, 26 FR 537, Jan. 20, 1961]



Sec. 1.812-5  Offset.

    (a) Offset defined. Section 812(d) defines the term ``offset'' for 
purposes of section 812(b)(2) and paragraph (b)(1)(ii) of Sec. 1.812-4. 
For any taxable year the offset is only that portion of the increase in 
the operations loss deduction for the taxable year which is necessary to 
reduce the life insurance company taxable income (computed without 
regard to section 802(b)(3)) for such year to zero. For purposes of the 
preceding sentence, the offset shall be determined with the 
modifications prescribed in paragraph (b) of this section. Such 
modifications shall be made independently of, and without reference to, 
the modifications required by paragraph (a) of Sec. 1.812-3 for 
purposes of computing the loss from operations itself.
    (b) Modifications--(1) Operations loss deduction--(i) In general. 
Section 812(d)(2) provides that for purposes of section 812(d)(1) 
(relating to the definition of offset), the operations loss deduction 
for any taxable year shall be computed by taking into account only such 
losses from operations otherwise allowable as carryovers or as 
carrybacks to such taxable year as were sustained in taxable years 
preceding the taxable year in which the life insurance company sustained 
the loss from operations from which the offset is to be deducted. Thus, 
for such purposes the loss from operations for the loss year or for any 
taxable year thereafter shall not be taken into account.
    (ii) Illustration of principles. The provisions of this subparagraph 
may be illustrated by the following example:

    Example. In computing the operations loss deduction for 1960, Y, a 
life insurance company, has a carryover from 1958 of $9,000, a carryover 
from 1959 of $6,000, a carryback from 1961 of $18,000, and a carryback 
from 1962 of $10,000, or an aggregate of $43,000 in carryovers and 
carrybacks. Thus, the operations loss deduction for 1960, for purposes 
of determining the tax liability for 1960, is $43,000. However, in 
computing the offset for 1960 which is subtracted from the loss from 
operations for 1961 for the purpose of determining the portion of such 
loss which may be carried over to subsequent taxable years, the 
operations loss deduction for 1960 is $15,000, that is, the aggregate of 
the $9,000 carryover from 1958 and the $6,000 carryover from 1959. In 
computing the operations loss deduction for such purpose, the $18,000 
carryback from 1961 and the $10,000 carryback from 1962 are disregarded. 
In computing the offset for 1960, however, which is subtracted from the 
loss from operations for 1962 for the purpose of determining the portion 
of such 1962 loss which may be carried

[[Page 776]]

over for subsequent taxable years, the operations loss deduction for 
1960 is $33,000, that is, the aggregate of the $9,000 carryover from 
1958, the $6,000 carryover from 1959, and the $18,000 carryback from 
1961. In computing the operations loss deduction for such purpose, the 
$10,000 carryback from 1962 is disregarded.

    (2) Recomputation of deductions limited by section 809(f)--(i) In 
general. If in any taxable year a life insurance company has deductions 
under section 809(d) (3), (5), and (6), as limited by section 809(f), 
and sustains a loss from operations in a succeeding taxable year which 
may be carried back as an operations loss deduction, such limitation and 
deductions shall be recomputed. This recomputation is required since the 
carryback must be taken into account for purposes of determining such 
limitation and deductions.
    (ii) Illustration of principles. The provisions of this subparagraph 
may be illustrated by the following example:

    (a) Facts. The books of P, a life insurance company, reveal the 
following facts:

----------------------------------------------------------------------------------------------------------------
                                                                      Taxable
                          Taxable year                              investment       Gain from       Loss from
                                                                      income        operations      operations
----------------------------------------------------------------------------------------------------------------
1959............................................................      $9,000,000     $10,000,000  ..............
1960............................................................  ..............  ..............    ($9,800,000)
----------------------------------------------------------------------------------------------------------------


The gain from operations thus shown is computed without regard to any 
operations loss deduction or deductions under section 809(d) (3), (5), 
and (6), as limited by section 809(f). Assume that for the taxable year 
1959, P has (without regard to the limitation of section 809(f) or the 
operations loss deduction for 1959) a deduction under section 809(d)(3) 
of $2,500,000 for dividends to policyholders and no deductions under 
section 809(d) (5) or (6).
    (b) Determination of section 809(f) limitation and deduction for 
dividends to policyholders without regard to the operations loss 
deduction for 1959. In order to determine gain or loss from operations 
for 1959, P must determine the deduction for dividends to policyholders 
for such year. Under the provisions of section 809(f), the amount of 
such deduction shall not exceed the sum of (1) the amount (if any) by 
which the gain from operations for such year (determined without regard 
to such deduction) exceeds P's taxable investment income for such year, 
plus (2) $250,000. Since the gain from operations as thus determined 
($10,000,000) exceeds the taxable investment income ($9,000,000) by 
$1,000,000, the limitation on such deduction is $1,250,000 ($1,000,000 
plus $250,000). Accordingly, only $1,250,000 of the $2,500,000 deduction 
for dividends to policyholders shall be allowed. The gain from 
operations for such year is $8,750,000 ($10,000,000 minus $1,250,000).
    (c) Recomputation of section 809(f) limitation and deduction for 
dividends to policyholders after application of the operations loss 
deduction for 1959. Since P has sustained a loss from operations for 
1960 which shall be carried back to 1959 as an operations loss 
deduction, it must recompute the section 809(f) limitation and deduction 
for dividends to policyholders. Taking into account the $9,800,000 
operations loss deduction for 1959 reduces gain from operations for such 
year to $200,000 ($10,000,000 minus $9,800,000). Since the gain from 
operations as thus determined ($200,000) is less than the taxable 
investment income ($9,000,000), the limitation on the deduction for 
dividends to policyholders is $250,000. Thus, only $250,000 of the 
$2,500,000 deduction for dividends to policyholders shall be allowed. 
The gain from operations for such year as thus determined is $9,750,000 
($10,000,000 minus $250,000) since for purposes of this determination 
the operations loss deduction for 1959 is not taken into account (see 
section 812(c)(1)). Accordingly, the offset for 1959 is $9,750,000 (the 
increase in the operations loss deduction for 1959, computed without 
regard to the carryback for 1960, which reduces life insurance company 
taxable income for 1959 to zero); thus, the portion of the 1960 loss 
from operations which shall be carried forward to 1961 is $50,000 (the 
excess of the 1960 loss ($9,800,000) over the offset for 1959 
($9,750,000)).

    (3) Minimum limitation. The life insurance company taxable income, 
as modified under this paragraph, shall in no case be considered less 
than zero.

[T.D. 6535, 26 FR 537, Jan. 20, 1961]



Sec. 1.812-6  New company defined.

    Section 812(e) provides that for purposes of part I, subchapter L, 
chapter 1 of the Code, a life insurance company is a ``new company'' for 
any taxable year only if such taxable year begins not more than 5 years 
after the first day on which it (or any predecessor if section 
381(c)(22) applies or would have applied if in effect) was authorized to 
do business as an insurance company.

[T.D. 7326, 39 FR 35354, Oct. 1, 1974]



Sec. 1.812-7  Application of subtitle A and subtitle F.

    Section 812(f) provides that except as modified by section 809(e) 
(relating to modifications of deduction items otherwise allowable under 
subtitle A of the Code) subtitles A and F of the Code

[[Page 777]]

shall apply to operations loss carrybacks and carryovers, and to the 
operations loss deduction, in the same manner and to the same extent 
that such subtitles apply in respect of net operation loss carrybacks, 
net operating loss carryovers, and the net operating loss deduction of 
corporations generally. For the computation of the operations loss 
carrybacks and carryovers, and of the operations loss deduction in the 
case of certain acquisitions of the assets of a life insurance company 
by another life insurance company, see section 381(c)(22) and the 
regulations thereunder.

[T.D. 6535, 26 FR 539, Jan. 20, 1961]



Sec. 1.812-8  Illustration of operations loss carrybacks and carryovers.

    The application of Sec. 1.812-4 may be illustrated by the following 
example:

    (a) Facts. The books of M, a life insurance company, organized in 
1940, reveal the following facts:

------------------------------------------------------------------------
                                        Taxable
            Taxable year              investment   Gain from   Loss from
                                        income    operations  operations
------------------------------------------------------------------------
1958................................     $11,000     $15,000  ..........
1959................................      23,000      30,000  ..........
1960................................  ..........  ..........   ($75,000)
1961................................      25,000      20,000  ..........
1962................................  ..........  ..........   (150,000)
1963................................      22,000      30,000  ..........
1964................................      40,000      35,000  ..........
1965................................      62,000      75,000  ..........
1966................................      25,000      17,000  ..........
1967................................      39,000      53,000  ..........
------------------------------------------------------------------------


The gain from operations thus shown is computed without regard to any 
operations loss deduction. The assumption is also made that none of the 
other modifications prescribed in paragraph (b) of Sec. 1.812-5 apply. 
There are no losses from operations for 1955, 1956, 1957, 1968, 1969, 
1970.
    (b) Loss sustained in 1960. The portions of the $75,000 loss from 
operations for 1960 which shall be used as carrybacks to 1958 and 1959 
and as carryovers to 1961, 1962, 1963, 1964, and 1965 are computed as 
follows:
    (1) Carryback to 1958. The carryback to this year is $75,000, that 
is, the amount of the loss from operations.
    (2) Carryback to 1959. The carryback to this year is $60,000 (the 
excess of the loss for 1960 over the offset for 1958), computed as 
follows:

Loss from operations........................................     $75,000
Less:
  Offset for 1958 (the $15,000 gain from operations for such      15,000
   year computed without the deduction of the carryback from
   1960)....................................................
                                                 -------------
    Carryback...............................................      60,000
 

    (3) Carryover to 1961. The carryover to this year is $30,000 (the 
excess, if any, of the loss for 1960 over the sum of the offsets for 
1958 and 1959), computed as follows:

Loss from operations........................................     $75,000
Less:
  Offset for 1958 (the $15,000 gain from             $15,000
   operations for such year computed without the
   deduction of the carryback from 1960)........
  Offset for 1959 (the $30,000 gain from              30,000
   operations for such year computed without the
   deduction of the carryback from 1960 or the
   carryback from 1962).........................
                                                 ------------
    Sum of offsets..........................................      45,000
                                                 -------------
    Carryover...............................................      30,000
 

    (4) Carryover to 1962. The carryover to this year is $10,000 (the 
excess, if any, of the loss for 1960 over the sum of the offsets for 
1958, 1959, and 1961), computed as follows:

Loss from operations........................................     $75,000
Less:
  Offset for 1958 (the $15,000 gain from             $15,000
   operations for such year computed without the
   deduction of the carryback from 1960)........
  Offset for 1959 (the $30,000 gain from              80,000
   operations for such year computed without the
   deduction of the carryback from 1960 or the
   carryback from 1962).........................
  Offset for 1961 (the $20,000 gain from              20,000
   operations for such year computed without the
   deduction of the carryover from 1960 or the
   carryback from 1962).........................
                                                 ------------
    Sum of offsets..........................................      65,000
                                                 -------------
    Carryover...............................................      10,000
 

    (5) Carryover to 1963. The carryover to this year is $10,000 (the 
excess, if any, of the loss for 1960 over the sum of the offsets for 
1958, 1959, 1961, and 1962), computed as follows:

Loss from operations........................................     $75,000
Less:
  Offset for 1958 (the $15,000 gain from             $15,000
   operations for such year computed without the
   deduction of the carryback from 1960)........
  Offset for 1959 (the $30,000 gain from              30,000
   operations for such year computed without the
   deduction of the carryback from 1960 or the
   carryback from 1962).........................
  Offset for 1961 (the $20,000 gain from              20,000
   operations for such year computed without the
   deduction of the carryover from 1960 or the
   carryback from 1962).........................

[[Page 778]]

 
  Offset for 1962 (a year in which a loss from             0
   operations was sustained)....................
                                                 ------------
    Sum of offsets..........................................      65,000
                                                 -------------
    Carryover...............................................      10,000
 

    (6) Carryover to 1964. The carryover to this year is $0 (the excess, 
if any, of the loss from 1960 over the sum of the offsets for 1958, 
1959, 1961, 1962, and 1963), computed as follows:

Loss from operations........................................     $75,000
Less:
  Offset for 1958 (the $15,000 gain from             $15,000
   operations for such year computed without the
   deduction of the carryback from 1960)........
  Offset for 1959 (the $30,000 gain from              30,000
   operations for such year computed without the
   deduction of the carryback from 1960 or the
   carryback from 1962).........................
  Offset for 1961 (the $20,000 gain from              20,000
   operations for such year computed without the
   deduction of the carryover from 1960 or the
   carryback from 1962).........................
  Offset for 1962 (a year in which a loss from             0
   operations was sustained)....................
  Offset for 1963 (the $30,000 gain from              30,000
   operations for such year computed without the
   deduction of the carryover from 1960 or the
   carryover from 1962).........................
                                                 ------------
    Sum of offsets..........................................      95,000
                                                 -------------
    Carryover...............................................           0
 

    (7) Carryover to 1965. The carryover to this year is $0 (the excess, 
if any, of the loss from 1960 over the sum of the offsets for 1958, 
1959, 1961, 1962, 1963, and 1964), computed as follows:

Loss from operations........................................     $75,000
Less:
  Offset for 1958 (the $15,000 gain from             $15,000
   operations for such year computed without the
   deduction of the carryback from 1960)........
  Offset for 1959 (the $30,000 gain from              30,000
   operations for such year computed without the
   deduction for the carryback from 1960 or the
   carryback from 1962).........................
  Offset for 1961 (the $20,000 gain from              20,000
   operations for such year computed without the
   deduction for the carryover from 1960 or the
   carryback from 1962).........................
  Offset for 1962 (a year in which a loss from             0
   operations was sustained)....................
  Offset for 1963 (the $30,000 gain from              30,000
   operations for such year computed without the
   deduction for the carryover from 1960 or the
   carryover from 1962).........................
  Offset for 1964 (the $35,000 gain from              35,000
   operations for such year computed without the
   deduction of the carryover from 1960 or the
   carryover from 1962).........................
                                                 ------------
    Sum of offsets..........................................     130,000
                                                 -------------
    Carryover...............................................           0
 

    (c) Loss sustained in 1962. The portions of the $150,000 loss from 
operations for 1962 which shall be used as carrybacks to 1959, 1960, and 
1961 and as carryovers to 1963, 1964, 1965, 1966, and 1967 are computed 
as follows:
    (1) Carryback to 1959. The carryback to this year is $150,000, that 
is, the amount of the loss from operations.
    (2) Carryback to 1960. The carryback to this year is $150,000 (the 
excess, if any, of the loss from 1962 over the offset for 1959), 
computed as follows:

Loss from operations........................................    $150,000
Less:
  Offset for 1959 (the $30,000 gain from operations for such           0
   year reduced by the carryback to such year of $60,000
   from 1960, the carryback from 1962 to 1959 not being
   taken into account)......................................
                                                 -------------
    Carryback...............................................     150,000
 

    (3) Carryback to 1961. The carryback to this year is $150,000 (the 
excess, if any, of the loss from 1962 over the sum of the offsets for 
1959 and 1960), computed as follows:

Loss from operations........................................    $150,000
Less:
  Offset for 1959 (the $30,000 gain from operations for such           0
   year reduced by the carryback to such year of $60,000
   from 1960, the carryback from 1962 to 1959 not being
   taken into account)......................................
  Offset for 1960 (a year in which a loss from operations              0
   was sustained)...........................................
                                                 -------------
    Sum of offsets..........................................           0
                                                 -------------
    Carryback...............................................     150,000
 

    (4) Carryover to 1963. The carryover to this year is $150,000 (the 
excess, if any, of the loss from 1962 over the sum of the offsets for 
1959, 1960, and 1961), computed as follows:

Loss from operations........................................    $150,000
Less:
  Offset for 1959 (the $30,000 gain from                   0
   operations for such year reduced by the
   carryback to such year of $60,000 from 1960,
   the carryback from 1962 to 1959 not being
   taken into account)..........................
  Offset for 1960 (a year in which a loss from             0
   operations was sustained)....................

[[Page 779]]

 
  Offset for 1961 (the $20,000 gain from                   0
   operations for such year reduced by the
   carryover to such year of $30,000 from 1960,
   the carryback from 1962 to 1961 not being
   taken into account)..........................
                                                 ------------
    Sum of offsets..........................................           0
                                                 -------------
    Carryover...............................................     150,000
 

    (5) Carryover to 1964. The carryover to this year is $130,000 (the 
excess, if any, of the loss from 1962 over the sum of the offsets for 
1959, 1960, 1961, and 1963), computed as follows:

Loss from operations........................................    $150,000
Less:
  Offset for 1959 (the $30,000 gain from                   0
   operations for such year reduced by the
   carryback to such year of $60,000 from 1960,
   the carryback from 1962 to 1959 not being
   taken into account)..........................
  Offset for 1960 (a year in which a loss from             0
   operations was sustained)....................
  Offset for 1961 (the $20,000 gain from                   0
   operations for such year reduced by the
   carryover to such year of $30,000 from 1960,
   the carryback from 1962 to 1961 not being
   taken into account)..........................
  Offset for 1963 (the $30,000 gain from              20,000
   operations for such year reduced by the
   carryover to such year of $10,000 from 1960,
   the carryover from 1962 to 1963 not being
   taken into account)..........................
                                                 ------------
  Sum of offsets............................................      20,000
                                                 -------------
    Carryover...............................................     130,000
 

    (6) Carryover to 1965. The carryover to this year is $95,000 (the 
excess, if any, of the loss from 1962 over the sum of the offsets for 
1959, 1960, 1961, 1963, and 1964), computed as follows:

Loss from operations........................................    $150,000
Less:
  Offset for 1959 (the $30,000 gain from                   0
   operations for such year reduced by the
   carryback to such year of $60,000 from 1960,
   the carryback from 1962 to 1959 not being
   taken into account)..........................
  Offset for 1960 (a year in which a loss from             0
   operations was sustained)....................
  Offset for 1961 (the $20,000 gain from                   0
   operations for such year reduced by the
   carryover to such year of $30,000 from 1960
   the carryback from 1962 to 1961 not being
   taken into account)..........................
  Offset for 1963 (the $30,000 gain from              20,000
   operations for such year reduced by the
   carryover to such year of $10,000 from 1960,
   the carryover from 1962 to 1963 not being
   taken into account)..........................
  Offset for 1964 (the $35,000 gain from              35,000
   operations for such year reduced by the
   carryover to such year of $0 from 1960, the
   carryover from 1962 to 1964 not being taken
   into account)................................
                                                 ------------
    Sum of offsets..........................................      55,000
                                                 -------------
    Carryover...............................................      95,000
 

    (7) Carryover to 1966. The carryover to this year is $20,000 (the 
excess, if any, of the loss from 1962 over the sum of the offsets for 
1959, 1960, 1961, 1963, 1964, and 1965), computed as follows:

Loss from operations........................................    $150,000
Less:
  Offset for 1959 (the $30,000 gain from                   0
   operations for such year reduced by the
   carryback to such year of $60,000 from 1960,
   the carryback from 1962 to 1959 not being
   taken into account)..........................
  Offset for 1960 (a year in which a loss from             0
   operations was sustained)....................
  Offset for 1961 (the $20,000 gain from                   0
   operations for such year reduced by the
   carryover to such year of $30,000 from 1960,
   the carryback from 1962 to 1961 not being
   taken into account)..........................
  Offset for 1963 (the $30,000 gain from              20,000
   operations for such year reduced by the
   carryover for such year of $10,000 from 1960,
   the carryover from 1962 to 1963 not being
   taken into account)..........................
  Offset for 1964 (the $35,000 gain from              35,000
   operations for such year reduced by the
   carryover to such year of $0 from 1960, the
   carryover from 1962 to 1964 not being taken
   into account)................................

[[Page 780]]

 
  Offset for 1965 (the $75,000 gain from             $75,000
   operations for such year reduced by the
   carryover to such year of $0 to 1960, the
   carryover from 1962 to 1965 not being taken
   into account)................................
                                                 ------------
    Sum of offsets..........................................    $130,000
                                                 -------------
    Carryover...............................................      20,000
 

    (8) Carryover to 1967. The carryover to this year is $3,000 (the 
excess, if any, of the loss from 1962 over the sum of the offsets for 
1959, 1960, 1961, 1963, 1964, 1965, and 1966), computed as follows:

Loss from operations........................................    $150,000
Less:
  Offset for 1959 (the $30,000 gain from                   0
   operations for such year reduced by the
   carryback to such year of $60,000 from 1960,
   the carryback from 1962 to 1959 not being
   taken into account)..........................
  Offset for 1960 (a year in which a loss from             0
   operations was sustained)....................
  Offset for 1961 (the $20,000 gain from                   0
   operations for such year reduced by the
   carryover to such year of $30,000 from 1960,
   the carryback from 1962 to 1961 not being
   taken into account)..........................
  Offset for 1963 (the $30,000 gain from              20,000
   operations for such year reduced by the
   carryover to such year of $10,000 from 1960,
   the carryover from 1962 to 1963 not being
   taken into account)..........................
  Offset for 1964 (the $35,000 gain from              35,000
   operations for such year reduced by the
   carryover to such year of $0 from 1960, the
   carryover from 1962 to 1964 not being taken
   into account)................................
  Offset for 1965 (the $75,000 gain from              75,000
   operations for such year reduced by the
   carryover to such year of $0 from 1960, the
   carryover from 1962 to 1965 not being taken
   into account)................................
  Offset for 1966 (the $17,000 gain from              17,000
   operations for such year computed without the
   deduction of the carryover from 1962)........
                                                 ------------
    Sum of offsets..........................................     147,000
                                                 -------------
    Carryover...............................................       3,000
 

    (d) Determination of operations loss deduction for each year. The 
carryovers and carrybacks computed under paragraphs (b) and (c) of this 
section are used as a basis for the computation of the operations loss 
deduction in the following manner:

----------------------------------------------------------------------------------------------------------------
                                                                Carryover             Carryback       Operations
                      Taxable year                       --------------------------------------------  loss de-
                                                          From 1960  From 1962  From 1960  From 1962   ductions
----------------------------------------------------------------------------------------------------------------
1958....................................................  .........  .........    $75,000  .........     $75,000
1959....................................................  .........  .........     60,000   $150,000     210,000
1961....................................................    $30,000  .........  .........    150,000     180,000
1963....................................................     10,000   $150,000  .........  .........     160,000
1964....................................................  .........    130,000  .........  .........     130,000
1965....................................................  .........     95,000  .........  .........      95,000
1966....................................................  .........     20,000  .........  .........      20,000
1967....................................................  .........      3,000  .........  .........       3,000
----------------------------------------------------------------------------------------------------------------


[T.D. 6535, 26 FR 539, Jan. 20, 1961]



Sec. 1.812-9  Cross-reference.

    For special rules regarding the treatment of modified guaranteed 
contracts (as defined in section 817A and Sec. 1.817A-1(a)(1)), see 
Sec. 1.817A-1.

[T.D. 9058, 68 FR 24350, May 7, 2003]

                      distributions to shareholders



Sec. 1.815-1  Taxable years affected.

    Sections 1.815-2 through 1.815-6, except as otherwise provided 
therein, are applicable only to taxable years beginning after December 
31, 1957, and all references to sections of part I, subchapter L, 
chapter 1 of the Code are to the Internal Revenue Code of 1954, as 
amended by the Life Insurance Company Income Tax Act of 1959 (73 Stat. 
112), the Act of October 10, 1962 (76 Stat. 808), and the Act of October 
23, 1962 (76 Stat. 1134).

[T.D. 6886, 31 FR 8689, June 23, 1966]

[[Page 781]]



Sec. 1.815-2  Distributions to shareholders.

    (a) In general. Section 815 provides that every stock life insurance 
company subject to the tax imposed by section 802 shall establish and 
maintain two special surplus accounts for Federal income tax purposes. 
These special accounts are the shareholders surplus account (as defined 
in section 815(b) and Sec. 1.815-3) and the policyholders surplus 
account (as defined in section 815(c) and Sec. 1.815-4). To the extent 
that a distribution to shareholders (as defined in paragraph (c) of this 
section) is treated as being made out of the shareholders surplus 
account, no tax is imposed on the company with respect to such 
distribution. However, to the extent that a distribution to shareholders 
is treated as being made out of the policyholders surplus account, the 
amount subtracted from the policyholders surplus account by reason of 
such distribution shall be taken into account in determining life 
insurance company taxable income under section 802(b).
    (b) Priority system for distributions to shareholders. (1) For 
purposes of section 815 (other than subsection (e) thereof relating to 
certain mutualizations) and section 802(b)(3) (relating to the 
determination of life insurance company taxable income), any 
distribution made to shareholders after December 31, 1958, shall be 
treated in the following manner:
    (i) Distributions shall be treated as first being made out of the 
shareholders surplus account (as defined in section 815(b) and Sec. 
1.815-3);
    (ii) Once the shareholders surplus account has been reduced to zero, 
distributions shall then be treated as being made out of the 
policyholders surplus account (as defined in section 815(c) and Sec. 
1.815-4) until that account has been reduced to zero; and
    (iii) Finally, any distributions in excess of the amounts in the 
shareholders surplus account and the policyholders surplus account shall 
be treated as being made out of other accounts (as defined in Sec. 
1.815-5).
    (2) For purposes of subparagraph (1) of this paragraph, in order to 
determine whether a distribution (or any portion thereof) shall be 
treated as being made out of the shareholders surplus account, 
policyholders surplus account, or other accounts, the amount in such 
accounts at the end of any taxable year shall be the cumulative balance 
in such accounts at the end of the taxable year, computed without 
diminution by reason of a distribution (or any portion thereof) during 
the taxable year which is treated as being made out of such accounts. 
For example, on January 1, 1960, S, a stock life insurance company, had 
$1,000 in its shareholders surplus account and $3,000 in its 
policyholders surplus account. On November 1, 1960, S distributed $4,000 
to its shareholders. Under the provisions of section 815(b)(2) and 
paragraph (b) of Sec. 1.815-3, S added $5,000 to its shareholders 
surplus account for the taxable year 1960. Since the distributions to 
shareholders during the taxable year 1960, $4,000, does not exceed the 
cumulative balance in the shareholders surplus account at the end of the 
taxable year, computed without diminution by reason of distributions 
treated as made out of such account during the taxable year, $6,000 
($1,000 plus $5,000), the entire distribution is treated as being made 
out of the shareholders surplus account.
    (3) Except in the case of a distribution in cash and as otherwise 
provided herein, the amount to be charged to the special surplus 
accounts referred to in subparagraph (1) of this paragraph with respect 
to any distributions to shareholders (as defined in section 815(a) and 
paragraph (c) of this section) shall be the fair market value of the 
property distributed, determined as of the date of distribution. 
However, for the amount of the adjustment to earnings and profits 
reflecting such distributions, see section 312 and the regulations 
thereunder. For a special rule relating to the determination of the 
amount to be charged to such special surplus accounts in the case of a 
distribution by a foreign life insurance company carrying on a life 
insurance business within the United States, see section 819(c)(1) and 
the regulations thereunder.
    (c) Distributions to shareholders defined. (1) Except as otherwise 
provided in section 815(f) and subparagraph (2) of this paragraph, the 
term distribution, as used in section 815(a) and paragraph (b)

[[Page 782]]

of this section, means any distribution of property made by a life 
insurance company to its shareholders. For purposes of the preceding 
sentence, the term property means any property (including money, 
securities, and indebtedness to the company) other than stock, or rights 
to acquire stock, in the company making the distribution. Thus, for 
example, the term includes a distribution which is considered a dividend 
under section 316, but is not limited to the extent that such 
distribution must be made out of the accumulated or current earnings and 
profits of the company making the distribution. For example, except as 
otherwise provided in section 815(f) and subparagraph (2) of this 
paragraph, there is a distribution within the meaning of this paragraph 
in any case in which a corporation acquires the stock of a shareholder 
in exchange for property in a redemption treated as a distribution in 
exchange for stock under section 302(a) or treated as a distribution of 
property under section 302(d). For special rules relating to 
distributions to shareholders in acquisition of stock pursuant to a plan 
of mutualization, see section 815(e) and paragraph (e) of Sec. 1.815-6.
    (2) The term distribution, as used in section 815(a) and paragraph 
(b) of this section, does not (except for purposes of section 815(a)(3) 
and (e)(2)(B)) include any distribution in redemption of stock issued 
prior to January 1, 1958, where such stock was at all times on and after 
the date of its issuance and on and before the date of its redemption 
limited as to the amount of dividends payable and was callable, at the 
option of the issuer, at a price not in excess of 105 percent of the sum 
of its issue price plus the amount of contribution to surplus (if any) 
made by the original purchaser at the time of his purchase.

[T.D. 6535, 26 FR 542, Jan. 20, 1961, as amended by T.D. 7189, 37 FR 
12793, June 29, 1972]



Sec. 1.815-3  Shareholders surplus account.

    (a) In general. Every stock life insurance company subject to the 
tax imposed by section 802 shall establish and maintain a shareholders 
surplus account. This account shall be established as of January 1, 
1958, and the beginning or opening balance of the shareholders surplus 
account on that date shall be zero.
    (b) Additions to shareholders surplus account. (1) The amount added 
to the shareholders surplus account for any taxable year beginning after 
December 31, 1957, shall be the amount by which the sum of:
    (i) The life insurance company taxable income (computed without 
regard to section 802(b)(3)),
    (ii) In the case of a taxable year beginning after December 31, 
1958, the amount (if any) by which the net long-term capital gain 
exceeds the net short-term capital loss, reduced (in the case of a 
taxable year beginning after December 31, 1961) by the amount referred 
to in subdivision (i) of this subparagraph,
    (iii) The deduction for partially tax-exempt interest provided by 
section 242 (as modified by section 804(a)(3)), the deductions for 
dividends received provided by sections 243, 244, and 245 (as modified 
by section 809(d)(8)(B)), and the amount of interest excluded from gross 
income under section 103, and
    (iv) The small business deduction provided by section 809(d)(10). 
Exceeds the taxes imposed for the taxable year by section 802(a), 
computed without regard to section 802(b)(3).
    (c) Subtractions from shareholders surplus account--(1) In general. 
There shall be subtracted from the cumulative balance in the 
shareholders surplus account at the end of any taxable year, computed 
without diminution by reason of distributions made during the taxable 
year, the amount which is treated as being distributed out of such 
account under section 815(a) and paragraph (b) of Sec. 1.815-2.
    (2) Special rule; distributions in 1958. There shall be subtracted 
from the shareholders surplus account (to the extent thereof) for any 
taxable year beginning in 1958 the amount of the distributions to 
shareholders made by the company during 1958. For example, assume S, a 
stock life insurance company, had additions to its shareholders surplus 
account (as determined under section 815(b)(2) and paragraph (b) of this 
section) for the taxable year 1958 of $10,000, and actually distributed 
as

[[Page 783]]

dividends to its shareholders $8,000 during the year 1958. The balance 
in S's shareholders surplus account as of January 1, 1959, shall be 
$2,000. If S had distributed $12,000 as dividends in 1958, the balance 
in its shareholders surplus account as of January 1, 1959, would be zero 
and the other accounts referred to in section 815(a)(3) and paragraph 
(b)(1)(iii) of Sec. 1.815-2 would be reduced by $2,000.
    (d) Illustration of principles. The application of section 815(b) 
and this section may be illustrated by the following example:

    Example. The books of S, a stock life insurance company, reflect the 
following items for the taxable year 1960.

Balance in shareholders surplus account as of 1-1-60........      $5,000
Life insurance company taxable income computed without             4,000
 regard to sec. 802(b)(3)...................................
Excess of net long-term capital gain over net short-term           1,700
 capital loss...............................................
Tax-exempt interest included in gross investment income              100
 under sec. 804(b)..........................................
Small business deduction (determined under sec. 809(d)(10)).         200
Tax liability under sec. 802(a) (1) and (2) computed without       1,625
 regard to sec. 802(b)(3)...................................
Amount distributed to shareholders..........................       9,000
 


For purposes of determining the amount to be subtracted from its 
shareholders surplus account for the taxable year, S would first make up 
the following schedule in order to determine the cumulative balance in 
the shareholders surplus account at the end of the taxable year, 
computed without diminution by reason of distributions made during the 
taxable year:

(1) Balance in shareholders surplus account as of 1-1-60....      $5,000
(2) Additions to account:
  (a) Life insurance company taxable income           $4,000
   computed without regard to sec. 802(b)(3)....
  (b) Excess of net long-term capital gain over        1,700
   net short-term capital loss..................
  (c) Tax-exempt interest included in gross              100
   investment income under sec. 804(b)..........
  (d) Small business deduction (determined under         200
   sec. 809(d)(10)).............................
                                                 ------------
    Total.......................................       6,000
Less:
  Tax liability under sec. 802(a) (1) and (2)          1,625
   computed without regard to sec. 802(b)(3)....
                                                   ---------       4,375
                                                 -------------
(3) Cumulative balance in shareholders surplus account as of       9,375
 12-31-60 (item (1) plus item (2))..........................
 

Since the amount distributed to shareholders during the taxable year, 
$9,000, does not exceed the cumulative balance in the shareholders 
surplus account at the end of the taxable year, computed without 
diminution by reason of distributions made during the taxable year, 
$9,375, under the provisions of section 815(a), the entire distribution 
shall be treated as being made out of the shareholders surplus account. 
Thus, $9,000 shall be subtracted from the shareholders surplus account 
(leaving a balance of $375 in such account at the end of the taxable 
year) and S shall incur no additional tax liability by reason of the 
distribution to its shareholders during the taxable year 1960.

[T.D. 6535, 26 FR 542, Jan. 20, 1961, as amended by T.D. 7189, 37 FR 
12793, June 29, 1972]



Sec. 1.815-4  Policyholders surplus account.

    (a) In general. Every stock life insurance company subject to the 
tax imposed by section 802 shall establish and maintain a policyholders 
surplus account. This account shall be established as of January 1, 
1959, and the beginning or opening balance of the policyholders surplus 
account on that date shall be zero.
    (b) Additions to policyholders surplus account. The amount added to 
the policyholders surplus account for any taxable year beginning after 
December 31, 1958, shall be the sum of:
    (1) An amount equal to 50 percent of the amount by which the gain 
from operations for the taxable year exceeds the taxable investment 
income,
    (2) The deduction allowed or allowable under section 809(d)(5) (as 
limited by section 809(f)) for certain nonparticipating contracts, and
    (3) The deduction allowed or allowable under section 809(d)(6) (as 
limited by section 809(f)) for taxable years beginning before January 1, 
1963, for group life and group accident and health insurance contracts, 
and for taxable years beginning after December 31, 1962, for accident 
and health insurance and group life insurance contracts.
    (c) Subtractions from policyholders surplus account--(1) In general. 
There shall be subtracted from the cumulative balance in the 
policyholders surplus account at the end of any taxable year, computed 
without diminution by reason of distributions made during the

[[Page 784]]

taxable year, an amount equal to the sum of:
    (i) The amount which (without regard to subdivision (ii) of this 
subparagraph) is treated under section 815(a) as distributed out of the 
policyholders surplus account for the taxable year, plus
    (ii) The amount (determined without regard to section 802(a)(3)) by 
which the tax imposed for taxable years beginning before January 1, 
1962, by section 802(a)(1), and for taxable years beginning after 
December 31, 1961, by section 802(a), is increased by reason of section 
802(b)(3).

In addition, there shall be subtracted from the policyholders surplus 
account for the taxable year those amounts which, at the close of the 
taxable year, are subtracted or treated as subtracted from the 
policyholders surplus account under section 815(d) (1) and (4) and 
paragraphs (a) and (d) of Sec. 1.815-6. For purposes of this paragraph, 
the subtractions from the policyholders surplus account shall be treated 
as made in the following order:
    (a) First the amount determined under section 815(c)(3) by reason of 
distributions to shareholders during the taxable year which are treated 
as being made out of the policyholders surplus account;
    (b) Next the amount elected to be subtracted from the policyholders 
surplus account for the taxable year under section 815(d)(1);
    (c) Then the amount which is treated as a subtraction from the 
policyholders surplus account for the taxable year by reason of the 
limitation provided in section 815(d)(4); and
    (d) Finally the amount taken into account upon termination as a life 
insurance company as provided in section 815(d)(2).
    (2) Method of computing amount subtracted from policyholders surplus 
account--(i) Where life insurance company taxable income, computed 
without regard to section 802(b)(3), exceeds $25,000. If the life 
insurance company taxable income for any taxable year computed under 
section 802(b), computed without regard to section 802(b)(3), exceeds 
$25,000, the amount subtracted from the policyholders surplus account 
shall be determined by multiplying the amount treated as distributed out 
of such account by a ratio, the numerator of which is 100 percent and 
the denominator of which is 100 percent minus the sum of the normal tax 
rate and the surtax rate for the taxable year.
    (ii) Where life insurance company taxable income does not exceed 
$25,000. If the life insurance company taxable income for any taxable 
year, computed under section 802(b), does not exceed $25,000, the amount 
subtracted from the policyholders surplus account shall be determined by 
multiplying the amount treated as distributed out of such account by a 
ratio, the numerator of which is 100 percent and the denominator of 
which is 100 percent minus the normal tax rate for the taxable year.
    (iii) Where life insurance company taxable income, computed without 
regard to section 802(b)(3) does not exceed $25,000, but computed with 
regard to section 802(b)(3) does exceed $25,000. If the life insurance 
company taxable income for any taxable year, computed without regard to 
section 802(b)(3) does not exceed $25,000, but computed with regard to 
section 802(b)(3) does exceed $25,000, the amount subtracted from the 
policyholders surplus account shall be determined in the following 
manner:
    (a) First, determine the amount by which $25,000 exceeds the amount 
determined under section 802(b) (1) and (2);
    (b) Then, multiply the amount determined under (a) by a ratio, the 
numerator of which is 100 percent minus the normal tax rate and the 
denominator of which is 100 percent;
    (c) Next, determine the amount by which the amount treated as 
distributed out of the policyholders surplus account exceeds the amount 
determined under (b) and multiply such excess by a ratio, the numerator 
of which is 100 percent and the denominator of which is 100 percent 
minus the sum of the normal tax rate and the surtax rate; and
    (d) Finally, add the amounts determined under (a) and (c).
    (3) Illustration of principles. The application of section 815(c)(3) 
and subparagraph (2) of this paragraph may be illustrated by the 
following examples:


[[Page 785]]


    Example 1. The life insurance company taxable income of S, a stock 
life insurance company, computed without regard to section 802(b)(3), 
exceeds $25,000 for the taxable year 1959. Assume that of the amount 
distributed by S to its shareholders during the taxable year, $9,600 (as 
determined under section 815(a) and without regard to section 
815(c)(3)(B)) is treated as distributed out of the policyholders surplus 
account. Since the sum of the normal tax rate (30%) and the surtax rate 
(22%) in effect for 1959 is 52 percent. S shall subtract $20,000 from 
its policyholders surplus account for the taxable year 1959, computed as 
follows:

$9,600x100/(100-52)=$9,600x100/48=$20,000


Of this amount, $9,600 is due to the application of section 815(c)(3)(A) 
and $10,400 to the application of section 815(c)(3)(B).
    Example 2. Assume that for the taxable year 1960, S, a stock life 
insurance company, has taxable investment income of $1,000 and a gain 
from operations of $2,000. Assume further that of the amount distributed 
by S to its shareholders during the taxable year, $3,500 (as determined 
under section 815(a) and without regard to section 815(c)(3)(B)) is 
treated as distributed out of the policyholders surplus account. Since 
S's life insurance company taxable income does not exceed $25,000 for 
the taxable year and the normal tax rate in effect for 1960 is 30 
percent, S shall subtract $5,000 from its policyholders surplus account 
for the taxable year 1960, computed as follows:

$3,500x100/(100-30)=$3,500x100/70=$5,000


Of this amount, $3,500 is due to the application of section 
815(c)(3)(A), and $1,500 to the application of section 815(c)(3)(B).
    Example 3. For the taxable year 1960, the life insurance company 
taxable income of S, a stock life insurance company, computed without 
regard to section 802(b)(3), is $10,000. Assume that of the amount 
distributed by S to its shareholders during the taxable year, $12,000 
(as determined under section 815(a) and without regard to section 
815(c)(3)(B)) is treated as distributed out of the policyholders surplus 
account. Since the life insurance company taxable income of S, computed 
with regard to section 802(b)(3), exceeds $25,000, in order to determine 
the amount to be subtracted from its policyholders surplus account, S 
would make up the following schedule:

(1) $25,000 minus life insurance company taxable income,         $15,000
 computed without regard to sec. 802(b)(3) ($25,000 minus
 $10,000.....................................................
(2) Item (1) multiplied by 100 percent minus the normal tax
 rate as in effect for 1960, over 100 percent
    ($15,000x(100-30)/100)...................................     10,500
(3) Amount by which the amount treated as distributed out of
 policyholders surplus account ($12,000) exceeds item (2)
 ($10,500), multiplied by 100 percent over 100 percent minus
 the sum of the normal tax rate and the surtax rate as in
 effect for 1960
    ($1,500x100/(100-52))....................................      3,125
(4) Item (1) plus item (3) ($15,000 plus $3,125).............     18,125
 


For the taxable year 1960, S shall subtract $18,125 from its 
policyholders surplus account. Of this amount, $10,500 represents the 
distribution from the policyholders surplus account which is taxed at a 
30 percent tax rate and $1,500 the distribution from the policyholders 
surplus account which is taxed at a 52 percent tax rate. Thus, of the 
amount subtracted from the policyholders surplus account for the taxable 
year 1960, $12,000 is due to the application of section 815(c)(3) (A), 
and $6,125 to the application of section 815(c)(3)(B).

    (d) Illustration of principles. The application of section 815(c) 
and this section may be illustrated by the following example:

    Example. The books of S, a stock life insurance company, reflect the 
following items for the taxable year 1960:

Taxable investment income....................................    $25,000
Gain from operations.........................................     30,000
Tax base (sec. 802(b)(1) and (2))............................     27,500
Deduction for certain nonparticipating policies provided by          600
 sec. 809(d)(5) (as limited by sec. 809(f))..................
Deduction for group policies provided by sec. 809(d)(6) (as          400
 limited by sec. 809(f)).....................................
Amount distributed to shareholders...........................     60,000
Cumulative balance in shareholders surplus account as of 12-      36,000
 31-60.......................................................
Balance in policyholders surplus account as of 1-1-60........     48,000
 


For purposes of determining the amount to be subtracted from its 
policyholders surplus account for the taxable year, S would first make 
up the following schedule in order to determine the cumulative balance 
in the policyholders surplus account at the end of the taxable year, 
computed without diminution by reason of distributions made during the 
taxable year:

(1) Balance in policyholders surplus account as of 1-1-60....    $48,000
(2) Additions to account:
  (a) 50 percent of the amount by which the gain       $2,500
   from operations ($30,000) exceeds the taxable
   investment income ($25,000) (1/2 x$5,000)......
  (b) The deduction for certain nonparticipating          600
   contracts provided by sec. 809(d)(5) (as
   limited by sec. 809(f))........................
  (c) The deduction for group contracts provided          400
   by sec. 809(d)(6) (as limited by sec. 809(f))..

[[Page 786]]

 
                                                     --------      3,500
                                                              ----------
(3) Cumulative balance in policyholders account as of 12-31-      51,500
 60 (item (1) plus item (2)).................................
 

Under the provisions of section 815(a), since the amount distributed to 
shareholders during the taxable year, $60,000, exceeds the cumulative 
balance in the shareholders surplus at the end of the taxable year, 
computed without diminution by reason of distributions during the 
taxable year, $36,000, the shareholders surplus account shall first be 
reduced to zero. The remaining $24,000 ($60,000 minus $36,000) of the 
distribution shall then be treated as made out of the policyholders 
surplus account. Thus, since the tax base under section 802(b)(1) and 
(2) is in excess of $25,000, the total amount to be subtracted from the 
policyholders surplus account at the end of the taxable year would be 
$50,000 ($24,000x100/(100-52)). Of this amount $26,000 ($50,000 minus 
$24,000) represents the tax on the portion of the distribution to 
shareholders which is treated as being out of the policyholders surplus 
account.

    (e) Special rule for 1959 and 1960. For a special transitional rule 
applicable to any increase in tax liability under section 802(b)(3) for 
the taxable years 1959 and 1960 which is due solely to the operation of 
section 815(c)(3) and this section, see section 802(a)(3) and Sec. 
1.802-5.

[T.D. 6535, 26 FR 543, Jan. 20, 1961, as amended by T.D. 6886, 31 FR 
8689, June 23, 1966]



Sec. 1.815-5  Other accounts defined.

    The term other accounts, as used in section 815(a)(3) and paragraph 
(b) of Sec. 1.815-2, means all amounts which are not specifically 
included in the shareholders surplus account under section 815(b) and 
paragraph (b) of Sec. 1.815-3, or in the policyholders surplus account 
under section 815(c) and paragraph (b) of Sec. 1.815-4. Thus, for 
example, other accounts includes amounts representing the increase in 
tax due to the operation of section 802(b)(3) which is not taken into 
account for the taxable years 1959 and 1960 because of the special 
transitional rule provided in section 802(a)(3) and Sec. 1.802-5, 
earnings and profits accumulated prior to January 1, 1958, paid-in 
surplus, capital, etc. To the extent that a distribution (or any portion 
thereof) is treated as being made out of other accounts, no tax is 
imposed on the company with respect to such distribution.

[T.D. 6535, 26 FR 544, Jan. 20, 1961]



Sec. 1.815-6  Special rules.

    (a) Election to transfer amounts from policyholders surplus account 
to shareholders surplus account--(1) In general. Section 815(d)(1) 
permits a life insurance company to elect, after the close of any 
taxable year for which it is a life insurance company, to subtract any 
amount (or any portion thereof) in its policyholders surplus account as 
of the close of the taxable year. The effect of such election is to 
subject the company to tax on the amounts elected to be subtracted for 
the taxable year for which the election applies. The amount so 
subtracted, less the amount of tax imposed with respect to such amount 
by reason of section 802(b)(3), shall be added to the shareholders 
surplus account as of the beginning of the taxable year following the 
taxable year for which the election applies and no further tax shall be 
imposed upon the company if the amount elected to be transferred to the 
shareholders surplus account is subsequently distributed to 
shareholders.
    (2) Manner and effect of election. (i) The election provided by 
section 815(d)(1) and this section shall be made in a statement attached 
to the life insurance company's income tax return for any taxable year 
for which the company desires the election to apply. The statement shall 
include the name and address of the taxpayer, shall be signed by the 
taxpayer (or his duly authorized representative), and shall be filed not 
later than the date prescribed by law (including extensions thereof) for 
filing the return for such taxable year. In addition, the statement 
shall indicate that the company has made the election provided under 
section 815(d)(1) for the taxable year and the amount elected to be 
subtracted from the policyholders surplus account.
    (ii) An election made under section 815(d)(1)(B) and subdivision (i) 
of this subparagraph shall be effective only with respect to the taxable 
year for which the election is made. Thus, the company must make a new 
election for each taxable year for which it desires the election to 
apply. Once such an election has been made for any taxable year it may 
not be revoked.

[[Page 787]]

    (3) The application of subparagraph (1) of this paragraph may be 
illustrated by the following example:

    Example. For the taxable year 1960, the life insurance company 
taxable income of S, a stock life insurance company, computed without 
regard to section 802(b)(3), exceeds $25,000. Assume that S elects to 
subtract $20,000 from its policyholders surplus account under section 
815(d)(1) for the taxable year. Since S is subject to a 52 percent tax 
rate, the tax on the amount elected to be subtracted from the 
policyholders surplus account (as of the close of the taxable year 1960) 
is $10,400 ($20,000x52 percent). Thus, the amount to be added to the 
shareholders surplus account as of January 1, 1961, is $9,600 (the 
amount subtracted from the policyholders surplus account by virtue of 
the section 815(d)(1) election, less the tax imposed upon such amount by 
reason of section 802(b)(3), or $20,000 minus $10,400).

    (b) Termination as life insurance company--(1) Effect of 
termination. Except as provided in section 381(c)(22) (relating to 
carryovers in certain corporate readjustments), section 815(d)(2)(A) 
provides that if for any taxable year the taxpayer is not an insurance 
company (as defined in paragraph (a) of Sec. 1.801-3), or if for any 
two successive taxable years the taxpayer is not a life insurance 
company (as defined in section 801(a) and paragraph (b) of Sec. 1.801-
3), the amount taken into account under section 802(b)(3) for the last 
preceding year for which the company was a life insurance company shall 
be increased (after the application of section 815(d)(2)(B)) by the 
entire balance in the policyholders surplus account at the close of such 
last preceding taxable year.
    (2) Effect of certain distributions. If for any taxable year the 
taxpayer is an insurance company (as defined in paragraph (a) of Sec. 
1.801-3) but is not a life insurance company (as defined in section 
801(a) and paragraph (b) of Sec. 1.801-3), section 815(d)(2)(B) 
provides that any distribution to shareholders during such taxable year 
shall be treated as having been made on the last day of the last 
preceding taxable year for which the company was a life insurance 
company.
    (3) Examples. The application of section 815(d)(2) and this 
paragraph may be illustrated by the following examples:

    Example 1. At the end of the taxable year 1959, the balance in the 
policyholders surplus account of S, a life insurance company within the 
meaning of section 801(a) and paragraph (b) of Sec. 1.801-3, is 
$12,000. If S fails to qualify as an insurance company (as defined in 
paragraph (a) of Sec. 1.801-3) for the taxable year 1960, and section 
381(c)(22) does not apply, under the provisions of section 815(d)(2)(A), 
the entire balance of $12,000 in the policyholders surplus account at 
the end of 1959, the last year S was a life insurance company, shall be 
taken into account under section 802(b)(3) for purposes of determining 
S's tax liability for the taxable year 1959.
    Example 2. Assume the facts are the same as in example 1, except 
that for the taxable years 1960 and 1961, S qualifies as an insurance 
company (as defined in paragraph (a) of Sec. 1.801-3) but does not 
qualify as a life insurance company within the meaning of section 801(a) 
and paragraph (b) of Sec. 1.801-3. Assume further that as a result of a 
distribution by S to its shareholders in 1960, $4,800 (as determined 
under section 815(a) and without regard to section 815(c)(3)(B)) is 
treated as distributed out of the policyholders surplus account. Under 
the provisions of section 815(d)(2)(B), if section 381(c)(22) does not 
apply, any distribution to shareholders during the taxable years 1960 
and 1961 shall be treated as having been made on December 31, 1959 (the 
last day of the last preceding taxable year for which S was a life 
insurance company). Thus, assuming S is subject to a 52 percent tax rate 
on additions to life insurance company taxable income, $10,000 ($4,800 
plus $5,200, the tax on the portion of the distribution treated as made 
out of the policyholders surplus account) shall be treated as being 
subtracted from the policyholders surplus account at the end of 1959 and 
shall be taken into account under section 802(b)(3) for purposes of 
determining S's tax liability for the taxable year 1959. Under the 
provisions of section 815(d)(2)(A), the entire balance of $2,000 
($12,000 minus $10,000) in the policyholders surplus account at the end 
of 1959 (after the application of section 815(d)(2)(B)), shall also be 
taken into account under section 802(b)(3) for purposes of determining 
S's tax liability for the taxable year 1959.

    (c) Treatment of certain indebtedness. Section 815(d)(3) provides 
that if a taxpayer makes any payment in discharge of its indebtedness 
and such indebtedness is attributable to a distribution by the taxpayer 
to its shareholders after February 9, 1959, the amount of such payment 
shall be treated as a distribution in cash to shareholders both for 
purposes of section 802(b)(3) and section 815. However, this paragraph 
shall only

[[Page 788]]

apply to the extent that the distribution of such indebtedness to 
shareholders was treated as being out of accounts other than the 
shareholders and policyholders surplus accounts at the time of 
distribution.
    (d) Limitation on amount in policyholders surplus account--(1) In 
general. Section 815(d)(4) provides a limitation on the amount that any 
life insurance company may accumulate in its policyholders surplus 
account. If the policyholders surplus account at the end of any taxable 
year (computed without regard to this paragraph) exceeds whichever of 
the following is the greatest:
    (i) 15 percent of life insurance reserves (as defined in section 
801(b) and paragraph (a) of Sec. 1.801-4) at the end of the taxable 
year.
    (ii) 25 percent of the amount by which the life insurance reserves 
at the end of the taxable year exceed the life insurance reserves at the 
end of 1958, or
    (iii) 50 percent of the net amount of the premiums and other 
consideration taken into account for the taxable year under section 
809(c)(1),

then such excess shall be treated as a subtraction from the 
policyholders surplus account as of the end of such taxable year. The 
amount so treated as subtracted, less the amount of tax imposed with 
respect to such amount by reason of section 802(b)(3), shall be added to 
the shareholders surplus account at the beginning of the succeeding 
taxable year.
    (2) Example. The application of the limitation contained in 
subparagraph (1) of this paragraph may be illustrated by the following 
example:

    Example. The books of S, a stock life insurance company, reflect the 
following items for the taxable year 1960:

Balance in policyholders surplus account, computed without          $175
 regard to sec. 815(d)(4), as of 12-31-60....................
Life insurance reserves (as defined in sec. 801(b)) as of 12-      4,500
 31-60.......................................................
Life insurance reserves (as defined in sec. 801(b)) as of 12-      3,900
 31-58.......................................................
Premiums and other consideration taken into account for the          310
 taxable year under sec. 809(c)(1)...........................
 


In order to determine the limitations on the amount that it may 
accumulate in its policyholders surplus account at the end of the 
taxable year under section 815(d)(4), S would make up the following 
schedule:

(1) 15 percent of life insurance reserves at the end of the         $675
 taxable year (15%x$4,500)...................................
(2) 25 percent of amount by which life insurance reserves at         150
 the end of the taxable year ($4,500) exceed life insurance
 reserves as of 12-31-58 ($3,900) (25%x$600).................
(3) 50 percent of premiums and other consideration taken into        155
 account under sec. 809(c)(1) for the taxable year (50%x$310)
(4) Limitation on policyholders surplus account (the greatest        675
 of items (1), (2), or (3))..................................
 

Since the balance in the policyholders surplus account at the end of the 
taxable year 1960, $175, does not exceed the limitation provided by 
section 815(d)(4), $675, S is not required to make any further 
adjustment to its policyholders surplus account at the end of the 
taxable year.

    (e) Special rule for certain mutualizations--(1) In general. Section 
815(e) provides a rule for determining priorities which shall operate in 
place of section 815(a) and paragraph (b) of Sec. 1.815-2 where a life 
insurance company makes any distribution to its shareholders after 
December 31, 1958, in acquisition of stock pursuant to a plan of 
mutualization. Section 815(e)(1) provides that such a distribution shall 
first be treated as being made out of paid-in capital and paid-in 
surplus, and, to the extent thereof, no tax shall be imposed on the 
company with respect to such distribution. Thereafter, distributions 
made pursuant to such plan of mutualization shall be treated as made in 
two allocable parts. One part shall be treated as being made out of 
other accounts (as defined in Sec. 1.815-5) and the company shall incur 
no tax with respect to such portion of the distribution. The other part 
shall be treated as a distribution to which section 815(a) and paragraph 
(b) of Sec. 1.815-2 applies. Thus, such portion of the distribution 
shall be treated as first being made out of the shareholders surplus 
account (as defined in section 815(b) and Sec. 1.815-3), to the extent 
thereof, and then out of the policyholders surplus account (as defined 
in section 815(c) and Sec. 1.815-4), to the extent thereof. See 
paragraph (a) of Sec. 1.815-2. For purposes of this paragraph, a 
distribution shall be considered as being made pursuant to a plan of 
mutualization only if the requirements of applicable State law for the 
adoption of such plan (as, for

[[Page 789]]

example, approval by the requisite majority of the board of directors, 
shareholders, and policyholders) have been fulfilled.
    (2) Allocation ratio. Section 815(e)(2)(A) provides an allocation 
ratio which when applied to the amount distributed under a plan of 
mutualization in excess of the balance in the paid-in capital and paid-
in surplus accounts determines the portion of such excess to be treated 
as distributed out of the shareholders surplus account, policyholders 
surplus account, or other accounts. The numerator of this ratio is the 
excess of the assets of the company (as defined in section 805(b)(4) and 
paragraph (a)(4) of Sec. 1.805-5) over the total liabilities (including 
reserves), both determined as of December 31, 1958, and adjusted in the 
manner provided in subparagraph (3) of this paragraph. The denominator 
of this ratio is the amount included in the numerator plus the amounts 
in the shareholders surplus account and policyholders surplus account, 
all determined as of the beginning of the year of the distribution.
    (3) Adjustment for certain distributions. Section 815(e)(2)(B) 
provides that if between 1958 and the year of distribution the taxpayer 
has been treated as having made a distribution (under a plan of 
mutualization or otherwise) which is treated as a return of paid-in 
capital and paid-in surplus or as out of other accounts (as defined in 
Sec. 1.815-5), the aggregate amount of any such prior distributions 
must be subtracted from the numerator and denominator in all cases where 
the allocation ratio provided by subparagraph (2) of this paragraph 
applies.
    (f) Recomputation required as a result of a subsequent loss from 
operations under section 812--(1) In general. Any amounts added to or 
subtracted from the special surplus accounts referred to in section 
815(a) and paragraph (b) of Sec. 1.815-2 for any taxable year shall be 
adjusted to the extent necessary to properly reflect a subsequent loss 
from operations which under section 812 is carried back to the taxable 
year for which such additions or subtractions were made.
    (2) Example. The application of subparagraph (1) of this paragraph 
may be illustrated by the following example:
    Example. Assume that for the taxable years 1959 through 1961, the 
books of S, a stock life insurance company subject to a 30 percent tax 
rate for all taxable years involved, reflect the following items:

------------------------------------------------------------------------
                                            1959       1960       1961
------------------------------------------------------------------------
Taxable investment income..............     $40.00     $40.00     $40.00
Gain from operations...................      60.00      60.00      60.00
Tax base (sec. 802(b)(1) and (2))......      50.00      50.00      50.00
Tax (sec. 802(b)(1) and (2) base)......      15.00      15.00      15.00
Shareholders surplus account--
  At beginning of year.................          0      35.00      37.00
  Added at beginning of year by reason           0       7.00          0
   of election under sec. 815(d)(1)....
  Added for year (without regard to          35.00      35.00      35.00
   election under sec. 815(d)(1))......
  Subtracted (distributions)...........          0      40.00      40.00
Policyholders surplus account--
  At beginning of year.................          0          0      10.00
  Added for year.......................      10.00      10.00      10.00
  Subtracted (distributions)...........          0          0          0
  Subtracted (by reason of election          10.00          0          0
   under sec. 815(d)(1))...............
  Tax base (sec. 802(b)(3))............      10.00          0          0
  Tax (sec. 802(b)(3) base)............       3.00          0          0
------------------------------------------------------------------------


Assume further that S has a loss from operations for the taxable year 
1962 of $25. Under the provisions of section 812, the $25 loss from 
operations would be carried back to the taxable year 1959 and would 
reduce the 1959 tax base under section 802(b)(1) and (2) to $35 ($60 
minus $25). After adjustments reflecting the 1962 loss from operations, 
the results for the taxable years 1959 through the beginning of 1962 
would be as follows:

------------------------------------------------------------------------
                                        1959     1960     1961     1962
------------------------------------------------------------------------
Taxable investment income...........   $40.00   $40.00   $40.00  .......
Gain from operations................    35.00    60.00    60.00  .......
Tax base (sec. 802(b)(1) and (2))...    35.00    50.00    50.00  .......
Tax (sec. 802(b)(1) and (2) base)...    10.50    15.00    15.00  .......
Shareholders surplus account--
  At beginning of year..............        0    24.50    19.50   $14.50
  Added for year (without regard to     24.50    35.00    35.00  .......
   election under sec. 815(d)(1))...

[[Page 790]]

 
  Added by reason of election under         0        0        0  .......
   sec. 815(d)(1)...................
  Subtracted (distributions)........        0    40.00    40.00  .......
Policyholders surplus account--
  At beginning of year..............        0        0    10.00    20.00
  Added for year....................        0    10.00    10.00  .......
  Subtracted (distributions)........        0        0        0  .......
  Subtracted (by reason of election         0        0        0  .......
   under sec. 815(d)(1))............
Tax base (sec. 802(b)(3))...........        0        0        0  .......
Tax (sec. 802(b)(3) base)...........        0        0        0  .......
------------------------------------------------------------------------

As a result of the loss from operations for 1962, the election under 
section 815(d)(1) for the taxable year 1959 has become inapplicable in 
its entirety since the balance in the policyholders surplus account at 
the end of 1959, as recomputed, is zero. Thus, S would be entitled to a 
total refund of $7.50 for the taxable year 1959. Of this amount, $4.50 
is due to the recomputation of the section 802(b)(1) and (2) tax base 
and $3 to the amount of tax paid by reason of the election under section 
815(d)(1).

[T.D. 6535, 26 FR 545, Jan. 20, 1961]

                        miscellaneous provisions



Sec. 1.817-1  Taxable years affected.

    Except as otherwise provided therein, Sec. Sec. 1.817-2 through 
1.817-4 are applicable only to taxable years beginning after December 
31, 1957, and all references to sections of part I, subchapter L, 
chapter 1 of the Code are to the Internal Revenue Code of 1954, as 
amended by the Life Insurance Company Income Tax Act of 1959 (73 Stat. 
112) and section 3 of the Act of October 23, 1962 (76 Stat. 1134).

[T.D. 6886, 31 FR 8689, June 23, 1966]



Sec. 1.817-2  Treatment of capital gains and losses.

    (a) In general. For taxable years beginning after December 31, 1958, 
and before January 1, 1962, if the net long-term capital gain (as 
defined in section 1222(7)) of any life insurance company exceeds its 
net short-term capital loss (as defined in section 1222(6)), section 
802(a)(2) prior to its amendment by section 3 of the Act of October 23, 
1962 (76 Stat. 1134), imposes a separate tax equal to 25 percent of such 
excess. For taxable years beginning after December 31, 1961, if the net 
long-term capital gain of any life insurance company exceeds its net 
short-term capital loss, section 802(a)(2) imposes an alternative tax in 
lieu of the tax imposed by section 802(a)(1), if and only if such 
alternative tax is less than the tax imposed by section 802(a)(1). 
Except as modified by section 817 (rules relating to certain gains and 
losses), the general rules of the Code relating to gains and losses, 
such as subchapter O (relating to gain or loss on disposition of 
property), subchapter P (relating to capital gains and losses), etc., 
shall apply with respect to life insurance companies.
    (b) Modification of section 1221 and 1231. (1) In the case of a life 
insurance company, section 817(a)(1) provides that for purposes of 
applying section 1231(a) (relating to property used in the trade or 
business and involuntary conversions), the term property used in the 
trade or business shall be treated as including only:
    (i) Property used in carrying on an insurance business, of a 
character subject to the allowance for depreciation under section 167 
(even though fully depreciated), held for more than 1 year (6 months for 
taxable years beginning before 1977; 9 months taxable years beginning in 
1977), and real property used in carrying on an insurance business, held 
for more than 1 year (6 months for taxable years beginning before 1977; 
9 months taxable years beginning in 1977), and which is not:
    (a) Property of a kind which would properly be includible in the 
inventory of the taxpayer if on hand at the close of the taxable year;
    (b) Property held by the taxpayer primarily for sale to customers in 
the ordinary course of business; or
    (c) A copyright, a literary, musical, or artistic composition, a 
letter or memorandum, or similar property held by a taxpayer described 
in section 1221(3). In the case of a letter, memorandum, or property 
similar to a letter or memorandum, this subdivision (c) applies only to 
sales and other dispositions occurring after July 25, 1969.
    (ii) The cutting or disposal of timber, or the disposal of coal or 
iron ore, to the extent considered arising from a

[[Page 791]]

sale or exchange by reason of the provisions of section 631 and the 
regulations thereunder.
    (2) In the case of a life insurance company, section 817(a)(2) 
provides that for purposes of applying section 1221(2) (relating to the 
exclusion of certain property from the term capital asset), the 
reference to property used in trade or business shall be treated as 
including only property used in carrying on an insurance business.
    (3) Section 1231(a), as modified by section 817(a)(1) and 
subparagraph (1) of this paragraph, shall apply to recognized gains and 
losses from the following:
    (i) The sale, exchange, or involuntary conversion of the following 
property, if held for more than 1 year (6 months for taxable years 
beginning before 1977; 9 months taxable years beginning in 1977):
    (a) The home office and branch office buildings (including land) 
owned and occupied by the life insurance company;
    (b) Furniture and equipment owned by the life insurance company and 
used in the home office and branch office buildings occupied by the life 
insurance company; and
    (c) Automobiles and other depreciable personal property used in 
connection with the operations conducted in the home office and branch 
office buildings occupied by the life insurance company.
    (ii) The involuntary conversion of capital assets held for more than 
1 year (6 months for taxable years beginning before 1977; 9 months 
taxable years beginning in 1977).
    (iii) The cutting or disposal of timber, or the disposal of coal or 
iron ore, to the extent considered arising from a sale or exchange by 
reason of the provisions of section 631 and the regulations thereunder.
    (4) Section 1221(2), as modified by section 817(a)(2) and 
subparagraph (2) of this paragraph, shall include only the following 
property;
    (i) The home office and branch office buildings (including land) 
owned and occupied by the life insurance company;
    (ii) Furniture and equipment owned by the life insurance company and 
used in the home office and branch office buildings occupied by the life 
insurance company; and
    (iii) Automobiles and other depreciable personal property used in 
connection with the operations conducted in the home office and branch 
office buildings occupied by the life insurance company.
    (5) If an asset described in subparagraph (3) (i)(a), (b), or (c) or 
subparagraph (4) of this paragraph, or any portion thereof, is also an 
``investment asset'' (an asset from which gross investment income, as 
defined in section 804(b), is derived), such asset, or portion thereof, 
shall not be treated as an asset used in carrying on an insurance 
business. Accordingly, the gains or losses from the sale or exchange (or 
considered as from the sale or exchange) of depreciable assets 
attributable to any trade or business, other than the insurance trade or 
business, carried on by the life insurance company, such as operating a 
radio station, housing development, or a farm, or renting various pieces 
of real estate shall be treated as gains or losses from the sale or 
exchange of a capital asset unless such asset is involuntarily converted 
(within the meaning of paragraph (e) of Sec. 1.123-1).
    (c) Illustration of principles. The provisions of section 817(a) and 
this section may be illustrated by the following examples:

    Example 1. L, a life insurance company, has recognized gains and 
losses for the taxable year 1959 from the sale or involuntary conversion 
of the following items:

------------------------------------------------------------------------
                                                     Gains      Losses
------------------------------------------------------------------------
Stocks, held for more than 6 months.............    $100,000  ..........
Bonds, held for more than 6 months..............  ..........      $5,000
Housing development, held for more than 6 months  ..........     400,000
Branch office building owned and occupied by L,   ..........     115,000
 held for more than 6 months....................
Furniture and equipment used in the investment        30,000  ..........
 department, held for more than 6 months........
Radio station, held for more than 6 months......     200,000  ..........
Involuntary conversion of apartment building,          7,000  ..........
 held for more than 6 months....................
------------------------------------------------------------------------


The recognized gains and losses from the sale of the stocks, bonds, 
housing development,

[[Page 792]]

and radio station shall be treated as gains and losses from the sale of 
capital assets since such items are capital assets within the meaning of 
section 1221 (as modified by section 817(a)(2)). Accordingly, the 
provisions of section 1231 shall not apply to the sale of such capital 
assets. However, the provisions of section 1231 (as modified by section 
817(a)(1)) shall apply to the sale of the branch office building and the 
furniture and equipment, and the apartment building involuntarily 
converted. Since the aggregate of the recognized losses ($115,000) 
exceeds the aggregate of the recognized gains ($37,000), the gains and 
losses are treated as ordinary gains and losses.
    Example 2. Y, a life insurance company, owns a twenty-story home 
office building, having an adjusted basis of $15,000,000, ten floors of 
which it rents to various tenants, one floor of which is utilized by it 
in operating its investment department, and the remaining nine floors of 
which are occupied by it in carrying on its insurance business. If in 
1960, Y sells the building for $10,000,000, Y must first apportion its 
basis between that portion of the building (one-half) used in carrying 
on an insurance business, and that portion of the building (one-half) 
classified as an ``investment asset'', before it can determine the 
character of the loss attributable to each portion of the building. For 
such purpose, the one floor utilized by Y in operating its investment 
department is treated as used in carrying on an insurance business. 
Assuming that each portion of the building bears an equal (one-half) 
relation to the basis of the entire building, Y (without regard to 
section 817(b)) would have a $2,500,000 ordinary loss on that portion 
used in carrying on an insurance business (assuming that Y had no gains 
subject to section 1231), and a $2,500,000 capital loss on that portion 
of the building classified as an investment asset.

[T.D. 6558, 26 FR 2782, Apr. 4, 1961, as amended by T.D. 6841, 30 FR 
9308, July 27, 1965; T.D. 6886, 31 FR 8689, June 23, 1966; T.D. 7369, 40 
FR 29840, July 16, 1975; T.D. 7728, 45 FR 72650, Nov. 3, 1980]



Sec. 1.817-3  Gain on property held on December 31, 1958, and certain
substituted property acquired after 1958.

    (a) Limitation on gain recognized on property held on December 31, 
1958. (1) Section 817(b)(1) limits the amount of gain that shall be 
recognized on the sale or other disposition of property other than 
insurance and annuity contracts (and contracts supplementary thereto) 
and property described in section 1221(1) (relating to stock in trade or 
inventory-type property) if:
    (i) The property was held (or treated as held within the meaning of 
paragraph (c)(1) of this section) by a life insurance company on 
December 31, 1958;
    (ii) The taxpayer has been a life insurance company at all times on 
and after December 31, 1958, including the date of the sale or other 
disposition of the property; and
    (iii) The fair market value of the property on December 31, 1958, 
exceeds the adjusted basis for determining gain as of such date.

The gain on the sale or other disposition of such property shall be 
limited to an amount (but not less than zero) equal to the amount by 
which the gain (determined without regard to section 817(b)(1)) exceeds 
the difference between fair market value of such property on December 
31, 1958, and the adjusted basis for determining gain as of such date. 
Accordingly, the tax imposed under section 802(a) shall apply with 
respect to the amount of gain so limited. In addition, in the case of a 
stock life insurance company, the amount of such gain shall be taken 
into account under section 815(b)(2)(A)(ii) for purposes of determining 
the amount to be added to the shareholders surplus account (as defined 
in section 815(b) and Sec. 1.815-3) for the taxable year. Furthermore, 
the amount of the gain (determined without regard to section 817(b)(1) 
and this paragraph) which is not taken into account under section 802(a) 
and under paragraph (f) of Sec. 1.802-3 by reason of the application of 
section 817(b)(1) shall be included in other accounts (as defined in 
Sec. 1.815-5) by such a company for the taxable year.
    (2) Section 817(b)(1) and subparagraph (1) of this paragraph shall 
not apply for purposes of determining loss with respect to property held 
on December 31, 1958.
    (b) Illustration of principles. The application of section 817(b)(1) 
and paragraph (a) of this section may be illustrated by the following 
examples:

    Example 1. On December 31, 1958, J, a stock life insurance company, 
owned stock of Z Corporation and on such date the stock had an adjusted 
basis for determining gain of $5,000 and a fair market value of $6,000. 
On August 1, 1959, the company sells such stock

[[Page 793]]

for $8,000. Assuming J qualifies as a life insurance company for the 
taxable year 1959, and applying the provisions of section 817(b)(1) and 
paragraph (a) of this section, the gain recognized (assuming no 
adjustment to basis for the period since December 31, 1958) on the sale 
shall be limited to $2,000 (the amount by which the gain realized, 
$3,000, exceeds the difference, $1,000, between the fair market value, 
$6,000, and the adjusted basis, $5,000, for determining gain on December 
31, 1958). Thus, J shall take into account $2,000 under section 
815(b)(2)(A)(ii) for purposes of determining the amount to be added to 
its shareholders surplus account for the taxable year and shall include 
$1,000 in other accounts for the taxable year.
    Example 2. The facts are the same as in example 1, except that the 
selling price is $5,800. In such case, no gain shall be recognized even 
though there is a realized gain of $800 since such realized gain does 
not exceed the difference ($1,000) between the fair market value 
($6,000) and the adjusted basis ($5,000) for determining gain on 
December 31, 1958. Furthermore, no loss shall be realized or recognized 
as a result of this transaction. Thus, J shall include $800 in other 
accounts for the taxable year and shall not take into account any amount 
under section 815(b)(2)(A)(ii).
    Example 3. The facts are the same as in example 1, except that the 
adjusted basis for determining loss is $5,000 and the selling price is 
$4,500. In such case, since J has sustained a loss, section 817(b)(1) 
does not apply.

    (c) Certain substituted property acquired after December 31, 1958. 
Section 817(b)(2) provides that if a life insurance company acquires 
property after December 31, 1958, in exchange for property actually held 
by the company on December 31, 1958, and the property acquired has a 
substituted basis within the meaning of section 1016(b) and Sec. 
1.1016-10, the following rules shall apply:
    (1) For purposes of section 817(b)(1), such acquired property shall 
be deemed as having been held continuously by the taxpayer since the 
beginning of the holding period thereof as determined under section 
1223;
    (2) The fair market value and adjusted basis referred to in section 
817(b)(1) shall be that of that property for which the holding period 
taken into account includes December 31, 1958;
    (3) Section 817(b)(1) shall apply only if the property or 
properties, the holding periods of which are taken into account, were 
held only by life insurance companies after December 31, 1958, during 
the holding periods so taken into account;
    (4) The difference between the fair market value and adjusted basis 
referred to in section 817(b)(1) shall be reduced (but not below zero) 
by the excess of (i) the gain that would have been recognized but for 
section 817(b) on all prior sales or other dispositions after December 
31, 1958, of properties referred to in section 817(b)(2)(C) over (ii) 
the gain that was recognized on such sales or other dispositions; and
    (5) The basis of such acquired property shall be determined as if 
the gain which would have been recognized but for section 817(b) were 
recognized gain.

For purposes of section 817(b)(2) and this paragraph, the term property 
does not include insurance and annuity contracts (and contracts 
supplementary thereto) and property described in section 1221(1) 
(relating to stock in trade or inventory-type property). Furthermore, 
the provisions of section 817(b)(1) and paragraph (a)(1) of this section 
shall not apply for purposes of determining loss with respect to 
property described in section 817(b)(2) and this paragraph.
    (d) Illustration of principles. The application of section 817(b)(2) 
and paragraph (c) of this section may be illustrated by the following 
example:

    Example. Assume that W, a life insurance company, owns property B on 
December 31, 1958, at which time its adjusted basis was $1,000 and its 
fair market value was $1,800. On January 31, 1960, in a transaction to 
which section 1031 (relating to exchange of property held for productive 
use or investment) applies, W receives property H having a fair market 
value of $1,700 plus $300 in cash in exchange for property B. The gain 
realized on the transaction, without regard to section 817(b) is $1,000 
(assuming no adjustments to basis for the period since December 31, 
1958). Under the provisions of section 817(b)(1) the gain is limited to 
$200. The entire $200 shall be recognized since such amount is less than 
the amount of gain ($300) which would be recognized under section 1031. 
Applying the provisions of section 817(b)(2) and paragraph (c) of this 
section, the basis of property H shall be determined as if the entire 
$300 of cash received is recognized gain. Thus, the basis of property H 
under section 1031 is $1,000 ($1,000 (the basis of property B) minus 
$300 (the amount of money received) plus $300 (the recognized gain of 
$200 plus $100 which would have been recognized but for section 817(b)). 
If W later sells property H for $2,200 cash,

[[Page 794]]

and assuming no further adjustments to its basis of $1,000, the gain 
realized is $1,200, but due to the application of section 817(b)(2) the 
amount of gain recognized is $500, computed as follows:

Selling price...............................................      $2,200
Less: Adjusted basis as of date of sale.....................       1,000
                                                 -------------
    Gain realized...........................................       1,200
Fair market value as of 12-31-58................      $1,800
Adjusted basis as of 12-31-58...................       1,000
                                                 ------------
  Excess of fair market value over adjusted              800
   basis........................................
Less: Excess of gain which would have been               100
 recognized on all prior dispositions but for
 sec. 817(b) over gain recognized on all prior
 dispositions ($300 minus $200).................
                                                   ---------        $700
    Gain recognized.............................         500
 


[T.D. 6558, 26 FR 2783, Apr. 4, 1961, as amended by T.D. 6886, 31 FR 
8689, June 23, 1966]



Sec. 1.817-4  Special rules.

    (a) Limitation on capital loss carryovers. Section 817(c) provides 
that a net capital loss (as defined in section 1222(10)) for any taxable 
year beginning before January 1, 1959, shall not be taken into account. 
For any taxable year beginning after December 31, 1958, the provisions 
of part II, subchapter P, chapter 1 of the Code (relating to the 
treatment of capital losses) shall be applicable to life insurance 
companies for purposes of determining the tax imposed by section 802(a) 
and Sec. 1.802-3 (relating to the imposition of tax in case of capital 
gains).
    (b) Gain on transactions occurring prior to January 1, 1959. For 
purposes of part I, subchapter L, chapter 1 of the Code, section 817(d) 
provides that:
    (1) There shall be excluded from tax any gain from the sale or 
exchange of a capital asset, and any gain considered as gain from sale 
or exchange of a capital asset, which results from sales or other 
dispositions of property prior to January 1, 1959; and
    (2) Any gain after December 31, 1958, resulting from the sale or 
other disposition of property prior to January 1, 1959, which, but for 
this subparagraph would be taken into account under section 1231, shall 
not be taken into account under section 1231.

For example, if a life insurance company makes an installment sale of a 
capital asset prior to January 1, 1959, and payments are received after 
such date, any capital gain attributable to such sale shall not be taken 
into account for purposes of section 802(a). Furthermore, any gain 
referred to in subparagraphs (1) and (2) and the preceding sentence 
shall not be taken into account in determining the excess of the net 
short-term capital gain over the net long-term capital loss (and for 
taxable years beginning after December 31, 1961, the excess of the net 
long-term capital gain over the net short-term capital loss) for 
purposes of computing taxable investment income under section 804(a)(2) 
or gain or loss from operations under section 809(b).
    (c) Certain reinsurance transactions in 1958. For purposes of part 
I, section 817(e) provides that where a life insurance company reinsures 
(or sells) all of its insurance contracts of a particular type, such as 
an entire industrial department, in either a single transaction, or in a 
series of related transactions, all of which occurred during 1958, and 
the reinsuring (or purchasing) company or companies assume all 
liabilities under such contracts, such reinsurance (or sale) shall be 
treated as the sale of a capital asset. However, such transaction shall 
be subject to the provisions of section 806(a) and Sec. 1.806-3 
(relating to adjustments for certain changes in reserves and assets).
    (d) Certain other reinsurance transactions. (1) For any taxable year 
beginning after December 31, 1958, the reinsurance of all or a part of 
the insurance contracts of a particular type by a life insurance 
company, in either a single transaction, or in a series of related 
transactions, occurring in any such taxable year, whereby the reinsuring 
company or companies assume all liabilities under such contracts, shall 
not be treated as the sale or exchange of a capital asset but shall be 
subject to the provisions of section 806(a) and 809 and the regulations 
thereunder. However, if in connection with a transaction described in 
the preceding sentence the reinsured or reinsurer transfers an asset 
which is a capital asset within the meaning of section 1221 (as modified 
by section 817(a)(2)), such transfer shall be treated as the sale or 
exchange of a capital asset by the transferor.

[[Page 795]]

    (2)(i) The consideration paid by the reinsured to the reinsurer in 
connection with a transaction described in subparagraph (1) of this 
paragraph shall be treated as an item of deduction under section 
809(d)(7). However any amount received by the reinsured from the 
reinsurer shall be applied against and reduce (but not below zero) the 
amount of such consideration, and to the extent that it exceeds such 
consideration, shall be treated as an item of gross amount under section 
809(c)(3).
    (ii) In connection with an assumption reinsurance (as defined in 
paragraph (a)(7)(ii) of Sec. 1.809-5) transaction, a reinsurer shall in 
any taxable year beginning after December 31, 1957:
    (A) Treat the consideration received from the reinsured in any such 
taxable year as an item of gross amount under section 809(c)(1), and
    (B) Treat any amount paid to the reinsured for the purchase of such 
contracts, to the extent such amount meets the requirements of section 
162, as a deferred expense that may be amortized over the reasonably 
estimated life (as defined in paragraph (d)(2)(iv) of this section) of 
the contracts reinsured and treat the portion of the expense so 
amortized in each taxable year as a deduction under section 809(d)(12) 
irrespective of the taxable year in which such amount was paid to the 
reinsured.
    (iii) For purposes of paragraph (d)(2)(ii) of this section where the 
reinsured transfers to the reinsurer in connection with the assumption 
reinsurance transaction a net amount which is less than the increase in 
the reinsurer's reserves resulting from the transaction, the reinsurer 
shall be treated as:
    (A) Having received from the reinsured consideration in an amount 
equal to the net amount of the increase in the reinsurer's reserves 
resulting from the transaction, and
    (B) Having paid the reinsured an amount for the purchase of the 
contracts equal to the excess of the amount of such increase in the 
reinsurer's reserves over the net amount received from the reinsured.
    (iv) For purposes of this subparagraph, the term reasonably 
estimated life means the period during which the contract reinsured 
remains in force. Such period shall be based on the facts in each case 
(such as age, health, and sex of the insured, type of contract 
reinsured, etc.) and the assuming company's experience (such as 
mortality, lapse rate, etc.) with similar risks.
    (3) The provisions of this paragraph may be illustrated by the 
following examples:

    Example 1. On June 30, 1959, X, a life insurance company, reinsured 
a portion of its insurance contracts with Y, a life insurance company, 
under an agreement whereby Y agreed to assume and to become solely 
liable under the contracts reinsured. The reserves on the contracts 
reinsured by X were $100,000. Under the reinsurance agreement X agreed 
to pay Y $100,000 for assuming such contracts and Y agreed to pay X 
$17,000 for the right to receive future premium payments under this 
block of contracts. Rather than exchange payments of money, X agreed to 
pay Y a net amount of $83,000 in cash. Assuming that the reasonably 
estimated life of the contracts reinsured is 17 years, that there are no 
other insurance transactions by X or Y during the taxable year, and 
assuming that X and Y compute the reserves on the contracts reinsured on 
the same basis, X has income of $100,000 under section 809(c)(2) as a 
result of the net decrease in its reserves. X has a net deduction of 
$83,000 ($100,000-$17,000) under section 809(d)(7). For the taxable year 
1959, Y has income of $100,000 under section 809(c)(1) as a result of 
the consideration received from X and a deduction of $100,000 under 
section 809(d)(2) for the net increase in reserves and $1,000 ($17,000 
divided by 17, the reasonably estimated life of the contracts 
reinsured), under section 809(d)(12). The remaining $16,000 shall be 
amortized over the next 16 succeeding taxable years (16x$1,000=$16,000) 
under section 809(d)(12) at the rate of $1,000 for each such taxable 
year.
    Example 2. The facts are the same as in example 1, except X agreed 
to pay Y a consideration of $100,000 in cash for assuming these 
contracts and Y paid X a bonus of $17,000 in cash and that this bonus 
meets the requirements of section 162. Assuming that the reasonably 
estimated life of the contracts reinsured is 17 years, X has income of 
$100,000 under section 809(c)(2) as a result of this net decrease in its 
reserves and a deduction of $83,000 under section 809(d)(7) for the 
amount of the consideration ($100,000) paid to Y for assuming these 
contracts, reduced by the bonus ($17,000) received from Y. For the 
taxable year 1959, Y has income of $100,000 under section 809(c)(1) as a 
result of the consideration received from X and deductions of $100,000 
under section 809(d)(2) for the net increase in reserves and $1,000 (the 
bonus of

[[Page 796]]

$17,000 divided by 17, the reasonably estimated life of the contracts 
reinsured), under section 809(d)(12). The remaining amount of the bonus 
($16,000) shall be amortized over the next 16 succeeding taxable years 
(16x$1,000=$16,000) under section 809(d)(12) at the rate of $1,000 for 
each such taxable year.
    Example 3. The facts are the same as in Example 1, except that the 
reinsurance agreement does not specifically provide that X agreed to pay 
Y $100,000 for assuming the contracts reinsured and Y agreed to pay X 
$17,000 for the right to receive future premium payments under such 
contracts. Instead, X agreed to pay Y a net amount of $83,000 in cash 
for assuming such contracts. Nevertheless, Y is treated as having 
received from X consideration equal to $100,000, the amount of the 
increase in Y's reserves, and as having paid $17,000 ($100,000 less 
$83,000) for the purchase of such contracts. Therefore, for the taxable 
year 1959, Y has income of $100,000 under section 809(c)(1). Y also has 
a deduction of $100,000 under section 809(d)(2) for the net increase in 
its reserves and an amortization deduction under section 809(d)(12) of 
$1,000 ($17,000 divided by 17, the reasonably estimated life of the 
contracts reinsured). The remaining $16,000 shall be amortized by Y over 
the next 16 succeeding years at the rate of $1,000 for each such year. 
For 1959, X has income of $100,000 under section 809(c)(2) as a result 
of the net decrease in its reserves and a deduction of $83,000 under 
section 809(d)(7) for the net amount of consideration paid to Y for 
assuming the contracts reinsured.
    Example 4. The facts are the same as in example 1, except that X 
agreed to pay Y a consideration of $130,000 in cash for assuming such 
contracts. Based upon these facts, X has income of $100,000 under 
section 809(c)(2) as a result of this net decrease in its reserves and a 
deduction of $130,000 under section 809(d)(7) for the amount of the 
consideration paid to Y for assuming these contracts. Y has income of 
$130,000 under section 809(c)(1) as a result of the consideration 
received from X and a deduction of $100,000 under section 809(d)(2) for 
the net increase in its reserves.
    Example 5. On August 1, 1960, R, a life insurance company, reinsured 
all of its insurance policies with S, a life insurance company, under an 
agreement whereby S agreed to assume and become solely liable under the 
contracts reinsured. The reserves on the contracts reinsured by R were 
$3,000,000. Under the reinsurance agreement, R agreed to pay S a 
consideration of $3,000,000 in stocks and bonds for assuming such 
contracts. Assuming no other insurance transactions by R or S during the 
taxable year, that R and S compute the reserves on the contracts 
reinsured on the same basis, and that R has a recognized gain (after the 
application of the limitation of section 817(b)(1)) of $20,000 due to 
appreciation in value of the assets transferred, the results to each 
company are as follows:

                          Company R (reinsured)
Net decrease in reserves (sec. 809(c) (2)).................   $3,000,000
Capital gain (as limited by sec. 817(b) (1)) to be taxed          20,000
 separately under sec. 802(a)(2)...........................
Consideration paid by R to S in respect of S's assuming       $3,000,000
 liabilities under contracts issued by R (sec. 809(d)(7))..
                                 Income
                          Company S (reinsurer)
Consideration received by S in respect of assuming            $3,000,000
 liabilities under contracts issued by R (sec. 809(c)(1))..
                               Deductions
Net increase in reserves (sec.809(d)(2))...................   $3,000,000
 


[T.D. 6558, 26 FR 2783, Apr. 4, 1961, as amended by T.D. 6625, 27 FR 
12543, Dec. 19, 1962; T.D. 6886, 31 FR 8689, June 23, 1966; T.D. 41 FR 
5100, Feb. 4, 1976]



Sec. 1.817-5  Diversification requirements for variable annuity,
endowment, and life insurance contracts.

    (a) Consequences of nondiversification--(1) In general. Except as 
provided in paragraph (a)(2) of this section, for purposes of subchapter 
L, section 72, and section 7702(a), a variable contract (as defined in 
section 817(d)), other than a pension plan contract (as defined in 
section 818(a)), which is based on one or more segregated asset accounts 
shall not be treated as an annuity, endowment, or life insurance 
contract for any calendar quarter period for which the investments of 
any such account are not adequately diversified. For this purpose, a 
variable contract shall be treated as based on a segregated asset 
account for a calendar quarter period if amounts received under the 
contract (or earnings thereon) are allocated to the segregated asset 
account at any time during the period. In addition, a variable contract 
that is not treated as an annuity, endowment, or life insurance contract 
for any period by reason of this paragraph (a)(1) shall not be treated 
as an annuity, endowment, or life insurance contract for any subsequent 
period even if the investments are adequately diversified for such 
subsequent period. If a variable contract which is a life insurance or 
endowment contract under other applicable (e.g., State or foreign) law 
is not treated as a life insurance or endowment contract under section 
7702(a), the income on the contract for any taxable year of the 
policyholder is treated as ordinary income received or

[[Page 797]]

accrued by the policyholder during such year in accordance with section 
7702 (g) and (h). Likewise, if a variable contract is not treated as an 
annuity contract under section 72, the income on the contract for any 
taxable year of the policyholder shall be treated as ordinary income 
received or accrued by the policyholder during such year in the same 
manner as a life insurance or endowment contract under section 7702 (g) 
and (h).
    (2) Inadvertent failure to diversify. The investments of a 
segregated asset account shall be treated as satisfying the requirements 
of paragraph (b) of this section for one or more periods, provided the 
following conditions are satisfied--
    (i) The issuer or holder must show the Commissioner that the failure 
of the investments to satisfy the requirements of paragraph (b) of this 
section for such period or periods was inadvertent,
    (ii) The investments of the account must satisfy the requirements of 
paragraph (b) of this section within a reasonable time after the 
discovery of such failure, and
    (iii) The issuer or holder of the variable contract must agree to 
make such adjustments or pay such amounts as may be required by the 
Commissioner with respect to the period or periods during which the 
investments of the account did not satisfy the requirements of paragraph 
(b) of this section.
    (b) Diversification of investments--(1) In general. (i) Except as 
otherwise provided in this paragraph and paragraph (c) of this section, 
the investments of a segregated asset account shall be considered 
adequately diversified for purposes of this section and section 817(h) 
only if--
    (A) No more than 55% of the value of the total assets of the account 
is represented by any one investment;
    (B) No more than 70% of the value of the total assets of the account 
is represented by any two investments;
    (C) No more than 80% of the value of the total assets of the account 
is represented by any three investments; and
    (D) No more than 90% of the value of the total assets of the account 
is represented by any four investments.
    (ii) For purposes of this section--
    (A) All securities of the same issuer, all interests in the same 
real property project, and all interests in the same commodity are each 
treated as a single investment; and
    (B) In the case of government securities, each government agency or 
instrumentality shall be treated as a separate issuer.
    (iii) See paragraph (f) of this section for circumstances in which a 
segregated asset account is treated as the owner of assets held 
indirectly through certain pass-through entities and corporations taxed 
under subchapter M, chapter 1 of the Code.
    (2) Safe harbor. A segregated asset account will be considered 
adequately diversified for purposes of this section and section 817(h) 
if--
    (i) The account meets the requirements of section 851 (b)(4) and the 
regulations thereunder; and
    (ii) No more than 55% of the value of the total assets of the 
account is attributable to cash, cash items (including receivables), 
government securities, and securities of other regulated investment 
companies.
    (3) Alternative diversification requirements for variable life 
insurance contracts. (i) A segregated asset account with respect to 
variable life insurance contracts will be considered adequately 
diversified for purposes of this section and section 817(h) if the 
requirements of paragraph (b)(1) or (b)(2) of this section are satisfied 
or if the assets of such account, other than Treasury securities, 
satisfy the percentage limitations prescribed in paragraph (b)(1) of 
this section increased by the product of (A) .5 and (B) the percentage 
of the value of the total assets of the account that is represented by 
Treasury securities. In determining whether the assets of an account, 
other than Treasury securities, satisfy the increased percentage 
limitations, such limitations are applied as if the Treasury securities 
were not included in the account (i.e., the increased percentage 
limitations are not applied to Treasury securities and the value of the 
total assets of the account is reduced by the value of the Treasury 
securities).
    (ii) The provisions of this paragraph (b)(3) may be illustrated by 
the following examples:


[[Page 798]]


    Example 1. On the last day of a quarter of a calendar year, a 
segregated asset account with respect to variable life insurance 
contracts holds assets having a total value of $100,000. The assets of 
the account are represented by Treasury securities having a total value 
of $90,000 and securities of Corporation A having a total value of 
$10,000. The 55% limit described in paragraph (b)(1)(i) of this section 
would be increased by 45% (0.5x90%) to 100%, and would then be applied 
to the assets of the account other than Treasury securities. Because no 
more than 100% of the value of the assets other than Treasury securities 
is represented by securities of Corporation A, the investments of the 
account will be considered adequately diversified.
    Example 2. On the last day of a quarter of a calendar year, a 
segregated asset account with respect to variable life insurance 
contracts holds assets having a total value of $100,000. The assets of 
the account are represented by Treasury securities having a total value 
of $60,000, securities of Corporation A having a total value of $30,000, 
and securities of Corporation B having a total value of $10,000. The 55% 
and 70% limits described in paragraph (b)(1)(i) of this section would be 
increased by 30% (0.5x60%) to 85% and 100%, respectively, and would then 
be applied to the assets of the account other than Treasury securities. 
Securities of Corporation A represent 75%, and securities of Corporation 
B represent 25%, of the value of the assets of the account other than 
Treasury securities. Because no more than 85% of the value of the assets 
other than Treasury securities is represented by securities of 
Corporation A or B and no more than 100% of the value of the assets 
other than Treasury securities is represented by securities of 
Corporations A and B, the investments of the account will be considered 
adequately diversified.

    (c) Periods for which an account is adequately diversified--(1) In 
general. A segregated asset account that satisfies the requirements of 
paragraph (b) of this section on the last day of a quarter of a calendar 
year (i.e., March 31, June 30, September 30, and December 31) or within 
30 days after such last day shall be considered adequately diversified 
for such quarter.
    (2) Start-up period. (i) Except as provided in paragraph (c)(2)(iv) 
of this section, a segregated asset account that is not a real property 
account on its first anniversary shall be considered adequately 
diversified until such first anniversary.
    (ii) Except as provided in paragraph (c)(2)(iv) of this section, a 
segregated asset account that is a real property account on its first 
anniversary shall be considered adequately diversified until the earlier 
of its fifth anniversary or the anniversary on which the account ceases 
to be a real property account.
    (iii) For purposes of paragraph (c)(2) (i) and (ii) of this section, 
the anniversary of a segregated asset account is the anniversary of the 
date on which any amount received under a life insurance or annuity 
contract, other than a pension plan contract (as defined in section 818 
(a)), is first allocated to the account.
    (iv) If more than 30 percent of the amount allocated to a segregated 
asset account as of the last day of a calendar quarter is attributable 
to contracts entered into more than one year before such date, paragraph 
(c)(2)(i) of this section shall not apply to the segregated asset 
account for any period after such date. Similarly, if more than 30 
percent of the amount allocated to a segregated asset account as of the 
last day of a calendar quarter is attributable to contracts entered into 
more than 5 years before such date, paragraph (c)(2)(ii) of this section 
shall not apply to the segregated asset account for any period after 
such date. For purposes of this paragraph (c)(2), amounts transferred to 
the account from a diversified account (determined without regard to 
this paragraph (c)(2)) or as a result of an exchange pursuant to section 
1035 in which the issuer of the contract received in the exchange is not 
related in a manner specified in section 267(b) to the issuer of the 
contract transferred in the exchange are not treated as--
    (A) Amounts attributable to contracts entered into more than one 
year before such date, in the case of accounts subject to paragraph 
(c)(2)(i) of this section, or
    (B) Amounts attributable to contracts entered into more than five 
years before such date, in the case of accounts subject to paragraph 
(c)(2)(ii) of this section.
    (3) Liquidation period. A segregated asset account that satisfies 
the requirements of paragraph (b) of this section on the date a plan of 
liquidation is

[[Page 799]]

adopted shall be considered adequately diversified for--
    (i) The one-year period beginning on the date the plan of 
liquidation is adopted if the account is not a real property account on 
such date; or
    (ii) The two-year period beginning on the date the plan of 
liquidation is adopted if the account is a real property account on such 
date.
    (d) Market fluctuations. A segregated asset account that satisfies 
the requirements of paragraph (b) of this section at the end of any 
calendar quarter (or within 30 days after the end of such calendar 
quarter) shall not be considered nondiversified in a subsequent quarter 
because of a discrepancy between the value of its assets and the 
diversification requirements unless such discrepancy exists immediately 
after the acquisition of any asset and such discrepancy is wholly or 
partly the result of such acquisition.
    (e) Segregated asset account. For purposes of section 817(h) and 
this section, a segregated asset account shall consist of all assets the 
investment return and market value of each of which must be allocated in 
an identical manner to any variable contract invested in any of such 
assets. See paragraph (g) for examples illustrating the application of 
this paragraph (e).
    (f) Look-through rule for assets held through certain investment 
companies, partnerships, or trusts--(1) In general. If this paragraph 
(f) applies, a beneficial interest in a regulated investment company, a 
real estate investment trust, a partnership, or a trust that is treated 
under sections 671 through 679 as owned by the grantor or another person 
(``investment company, partnership, or trust'') shall not be treated as 
a single investment of a segregated asset account. Instead, a pro rata 
portion of each asset of the investment company, partnership, or trust 
shall be treated, for purposes of this section, as an asset of the 
segregated asset account. For purposes of this section, the ratable 
interest of a partner in a partnership's assets shall be determined in 
accordance with the partner's capital interest in the partnership.
    (2) Applicability--(i) Certain investment companies, partnerships, 
and trusts. This paragraph (f) shall apply to an investment company, 
partnership, or trust if--
    (A) All the beneficial interests in the investment company, 
partnership, or trust (other than those described in paragraph (f)(3) of 
this section) are held by one or more segregated asset accounts of one 
or more insurance companies; and
    (B) Public access to such investment company, partnership, or trust 
is available exclusively (except as otherwise permitted in paragraph 
(f)(3) of this section) through the purchase of a variable contract. 
Solely for this purpose, the status of a contract as a variable contract 
will be determined without regard to section 817(h) and this section.
    (ii) Trusts holding Treasury securities. This paragraph (f) shall 
also apply to a trust that is treated under section 671 through 679 as 
owned by the grantor or another person if substantially all of the 
assets of the trust are represented by Treasury securities.
    (3) Interests not held by segregated asset accounts. Satisfaction of 
the requirements of paragraph (f)(2)(i) of this section shall not be 
prevented by reason of beneficial interests in the investment company, 
partnership, or trust that are--
    (i) Held by the general account of a life insurance company or a 
corporation related in a manner specified in section 267(b) to a life 
insurance company, but only if the return on such interests is computed 
in the same manner as the return on an interest held by a segregated 
asset account is computed (determined without regard to expenses 
attributable to variable contracts), there is no intent to sell such 
interests to the public, and a segregated asset account of such life 
insurance company also holds or will hold a beneficial interest in the 
investment company, partnership, or trust;
    (ii) Held by the manager, or a corporation related in a manner 
specified in section 267(b) to the manager, of the investment company, 
partnership, or trust, but only if the holding of the interests is in 
connection with the creation or management of the investment company, 
partnership, or trust,

[[Page 800]]

the return on such interest is computed in the same manner as the return 
on an interest held by a segregated asset account is computed 
(determined without regard to expenses attributable to variable 
contracts), and there is no intent to sell such interests to the public;
    (iii) Held by the trustee of a qualified pension or retirement plan;
    (iv) Held by a qualified tuition program as defined in section 529;
    (v) Held by the trustee of a pension plan established and maintained 
outside of the United States, as defined in section 7701(a)(9), 
primarily for the benefit of individuals substantially all of whom are 
nonresident aliens, as defined in section 7701(b)(1)(B);
    (vi) Held by an account which, pursuant to Puerto Rican law or 
regulation, is segregated from the general asset accounts of the life 
insurance company that owns the account, provided the requirements of 
section 817(d) and (h) are satisfied. Solely for purposes of this 
paragraph (f)(3)(vi), the requirement under section 817(d)(1) that the 
account be segregated pursuant to State law or regulation shall be 
disregarded and Sec. 1.817-5(f)(1) shall be applied without regard to 
the Puerto Rican segregated asset account; or
    (vii) Held by the public, or treated as owned by policyholders 
pursuant to Rev. Rul. 81-225, 1981-2 C.B. 12, but only if (A) the 
investment company, partnership, or trust was closed to the public in 
accordance with Rev. Rul. 82-55, 1982-1 C.B. 12, or (B) all the assets 
of the segregated asset account are attributable to premium payments 
made by policyholders prior to September 26, 1981, to premium payments 
made in connection with a qualified pension or retirement plan, or to 
any combination of such premium payments.
    (g) Examples. The provisions of paragraphs (e) and (f) of this 
section may be illustrated by the following examples.

    Example 1. (i) The assets underlying variable contracts issued by a 
life insurance company consist of two groups of assets: (a) a 
diversified portfolio of debt securities and (b) interests in P, a 
partnership. All of the beneficial interests in P are held by one or 
more segregated asset accounts of one or more insurance companies and 
public access to P is available exclusively through the purchase of a 
variable contract. The variable contracts provide that policyholders may 
specify which portion of each premium is to be invested in the debt 
securities and which portion is to be invested in P interests. The 
portfolio of debt securities and the assets of P, considered separately, 
each satisfy the diversification requirements of paragraph (b) of this 
section.
    (ii) As a result of the ability of policyholders to allocate 
premiums among the two groups of assets, the investment return and 
market value of the interests in P and the debt securities may be 
allocated to different variable contracts in a non-identical manner. 
Accordingly, under paragraph (e) of this section, the interests in P are 
treated as part of a single segregated asset account (``Account 1'') and 
the debt securities are treated as part of a different segregated asset 
account (``Account 2'').
    (iii) Since P is described in paragraph (f)(2)(i) of this section, 
interests in P will not be treated as a single investment of Account 1. 
Rather, Account 1 is treated as owning a pro rata portion of the assets 
of P.
    (iv) Since Account 1 and Account 2 each satisfy the requirements of 
paragraph (b) of this section, variable contracts that are based on 
either or both accounts are treated as annuity, endowment, or life 
insurance contracts.
    Example 2. The facts are the same as in example 1 except that some 
of the beneficial interests in P are held by persons not described in 
paragraph (f)(3) of this section. Since P is not described in paragraph 
(f)(2) of this section, interests in P will be treated as a single 
investment of Account 1. As a result, Account 1 does not satisfy the 
requirements of paragraph (b) of this section. Variable contracts based 
in whole or in part on Account 1 are not treated as annuity, endowment, 
or life insurance contracts. Variable contracts that are not based on 
Account 1 at any time during the period in which such account fails to 
satisfy the requirements of paragraph (b) of this section (i.e., 
contracts based entirely on Account 2), are treated as annuity, 
endowment, or life insurance contracts. See paragraph (a)(1).
    Example 3. The facts are the same as in example 2 except that the 
variable contracts do not permit policyholders to allocate premiums 
between or among the debt securities and interests in P. Thus, the 
investment return and market value of the interests in P and the debt 
securities must be allocated to the same variable contracts and in an 
identical manner. Under paragraph (e) of this section, the interests in 
P and the debt securities are treated as part of a single segregated 
asset account. If the interests in P and the debt securities, considered 
together, satisfy the requirements of paragraph (b) of

[[Page 801]]

this section, contracts based on this segregated asset account will be 
treated as annuity, endowment, or life insurance contracts.

    (h) Definitions. The terms defined below shall, for purposes of this 
section, have the meanings set forth in such definitions:
    (1) Government security--(i) General rule. The term government 
security shall mean any security issued or guaranteed or insured by the 
United States or an instrumentality of the United States; or any 
certificate of deposit for any of the foregoing. Any security or 
certificate or deposit insured or guaranteed only in part by the United 
States or an instrumentality thereof is treated as issued by the United 
States or its instrumentality only to the extent so insured or 
guaranteed, and as issued by the direct obligor to the extent not so 
insured or guaranteed. For purposes of this paragraph (h)(1), an 
instrumentality of the United States shall mean any person that is 
treated for purposes of 15 U.S.C. 80a-2 (16), as amended, as a person 
controlled or supervised by and acting as an instrumentality of the 
Government of the United States pursuant to authority granted by the 
Congress of the United States.
    (ii) Example. A segregated asset account purchases a certificate of 
deposit in the amount of $150,000 from bank A. Deposits in bank A are 
insured by the Federal Deposit Insurance Corporation, an instrumentality 
of the United States, to the extent of $100,000 per depositor. The 
certificate of deposit is treated as a government security to the extent 
of the $100,000 insured amount and is treated as a security issued by 
bank A to the extent of the $50,000 excess of the value of the 
certificate of deposit over the insured amount.
    (2) Treasury security--(i) General rule. For purposes of paragraph 
(b)(3) of this section and section 817(h)(3), the term Treasury security 
shall mean a security the direct obligor of which is the United States 
Treasury.
    (ii) Example. A segregated asset account purchases put and call 
options on U.S. Treasury securities issued by the Options Clearing 
Corporation. The options are not Treasury securities for purposes of 
paragraph (b)(3) and section 817(h)(3) because the direct obligor of the 
options is not the United States Treasury.
    (3) Real property. The term real property shall mean any property 
that is treated as real property under 1.856-3 (d) except that it shall 
not include interests in real property.
    (4) Real property account. A segregated asset account is a real 
property account on an anniversary of the account (within the meaning of 
paragraph (c)(2)(iii) of this section) or on the date a plan of 
liquidation is adopted if not less than the applicable percentage of the 
total assets of the account is represented by real property or interests 
in real property on such anniversary or date. For this purpose, the 
applicable percentage is 40% for the period ending on the first 
anniversary of the date on which premium income is first received, 50% 
for the year ending on the second anniversary, 60% for the year ending 
on the third anniversary, 70% for the year ending on the fourth 
anniversary, and 80% thereafter. A segregated asset account will also be 
treated as a real property account on its first anniversary if on or 
before such first anniversary the issuer has stated in the contract or 
prospectus or in a submission to a regulatory agency, an intention that 
the assets of the account will be primarily invested in real property or 
interests in real property, provided that at least 40% of the total 
assets of the account are so invested within six months after such first 
anniversary.
    (5) Commodity. The term commodity shall mean any type of personal 
property other than a security.
    (6) Security. The term security shall include a cash item and any 
partnership interest, whether or not registered under a Federal or State 
law regulating the offering or sale of securities. The term shall not 
include any interest in real property, or any interest in a commodity.
    (7) Interest in real property. The term interest in real property 
shall include the ownership and co-ownership of land or improvements 
thereon and leaseholds of land or improvements thereon. Such term shall 
not, however, include mineral, oil, or gas royalty interests, such

[[Page 802]]

as a retained economic interest in coal or iron ore with respect to 
which the special provisions of section 631(c) apply. The term 
``interest in real property'' also shall include options to acquire land 
or improvements thereon, and options to acquire leaseholds of land or 
improvements thereon.
    (8) Interest in a commodity. The term interest in a commodity shall 
include the ownership and co-ownership of any type of personal property 
other than a security, and any leaseholds thereof. Such term shall 
include mineral, oil, and gas royalty interests, including any 
fractional undivided interest therein. Such term also shall include any 
put, call, straddle, option, or privilege on any type of personal 
property other than a security.
    (9) Value. The term value shall mean, with respect to investments 
for which market quotations are readily available, the market value of 
such investments; and with respect to other investments, fair value as 
determined in good faith by the managers of the segregated asset 
account.
    (10) Terms used in section 851. To the extent not inconsistent with 
this paragraph (h) all terms used in this section shall have the same 
meaning as when used in section 851.
    (i) Effective date--(1) In general. This section is effective for 
taxable years beginning after December 31, 1983.
    (2) Exceptions. (i) If, at all times after December 31, 1983, an 
insurance company would be considered the owner of the assets of a 
segregated asset account under the principles of Rev. Rul. 81-225, 1981-
2 C.B. 12, this section will not apply to such account until December 
15, 1986.
    (ii) This section will not apply to any variable contract to which 
Rev. Rul. 77-85, 1977-1 C.B. 12, or Rev. Rul. 81-225, 1981-2 C.B. 12, 
did not apply by reason of the limited retroactive effect of such 
rulings.
    (iii) In determining whether a segregated asset account is 
adequately diversified for any calendar quarter ending before July 1, 
1988, debt instruments that are issued, guaranteed, or insured by the 
United States or an instrumentality of the United States shall not be 
treated as government securities if such debt instruments are secured by 
a mortgage on real property (other than real property owned by the 
United States or an instrumentality of the United States) or represent 
an interest in a pool of debt instruments secured by such mortgages.
    (iv) This section shall not apply until January 1, 1989, with 
respect to a variable contract (as defined in section 817(d)) that (1) 
provides for the payment of an immediate annuity (as defined in section 
72(u)(4)); (2) was outstanding on September 12, 1986; and (3) the 
segregated asset account on which it was based was, on September 12, 
1986, wholly invested in deposits insured by the Federal Deposit 
Insurance Corporation or the Federal Savings and Loan Insurance 
Corporation.
    (v) A segregated asset account in existence before March 1, 2005, 
will be considered to be adequately diversified if--
    (A) As of March 1, 2005, the account was adequately diversified 
within the meaning of section 817(h) and this regulation as in effect 
prior to that date; and
    (B) By December 31, 2005, the account is adequately diversified 
within the meaning of section 817(h) and this regulation.

[T.D. 8242, 54 FR 8730, Mar. 2, 1989; T.D. 8242, 54 FR 11866, Mar. 22, 
1989; T.D. 9185, 70 FR 9872, Mar. 1, 2005; T.D. 9385, 73 FR 12265, Mar. 
7, 2008]



Sec. 1.817A-0  Table of contents.

    This section lists the captions that appear in section Sec. 1.817A-
1:

          Sec. 1.817A-1 Certain modified guaranteed contracts.

    (a) Definitions.
    (1) Modified guaranteed contract.
    (2) Temporary guarantee period.
    (3) Equity-indexed modified guaranteed contract.
    (4) Non-equity-indexed modified guaranteed contract.
    (5) Current market rate for non-equity-indexed modified guaranteed 
contract.
    (6) Current market rate for equity-indexed modified guaranteed 
contract. [Reserved]
    (b) Applicable interest rates for non-equity-indexed modified 
guaranteed contracts.
    (1) Tax reserves during temporary guarantee period.
    (2) Required interest during temporary guarantee period.
    (3) Application of section 811(d).

[[Page 803]]

    (4) Periods after the end of the temporary guarantee period.
    (5) Examples.
    (c) Applicable interest rates for equity-indexed modified guaranteed 
contracts. [Reserved]
    (d) Effective date.

[T.D. 9058, 68 FR 24350, May 7, 2003]



Sec. 1.817A-1  Certain modified guaranteed contracts.

    (a) Definitions--(1) Modified guaranteed contract. The term modified 
guaranteed contract (MGC) is defined in section 817A(d) as an annuity, 
life insurance, or pension plan contract (other than a variable contract 
described in section 817) under which all or parts of the amounts 
received under the contract are allocated to a segregated account. 
Assets and reserves in this segregated account must be valued from time 
to time with reference to market values for annual statement purposes. 
Further, an MGC must provide either for a net surrender value or for a 
policyholder's fund (as defined in section 807(e)(1)). If only a portion 
of a contract is not described in section 817, such portion is treated 
as a separate contract for purposes of applying section 817A.
    (2) Temporary guarantee period. An MGC may temporarily guarantee a 
return other than the permanently guaranteed crediting rate for a period 
specified in the contract (the temporary guarantee period). During the 
temporary guarantee period, the amount paid to the policyholder upon 
surrender is usually increased or decreased by a market value 
adjustment, which is determined by a formula set forth under the terms 
of the MGC.
    (3) Equity-indexed modified guaranteed contract. An equity-indexed 
MGC is an MGC, as defined in paragraph (a)(1) of this section, that 
provides a return during or at the end of the temporary guarantee period 
based on the performance of stocks, other equity instruments, or equity-
based derivatives.
    (4) Non-equity-indexed modified guaranteed contract. A non-equity-
indexed MGC is an MGC, as defined in paragraph (a)(1) of this section, 
that provides a return during or at the end of the temporary guarantee 
period not based on the performance of stocks, other equity instruments, 
or equity-based derivatives.
    (5) Current market rate for non-equity-indexed modified guaranteed 
contracts. The current market rate for a non-equity-indexed MGC issued 
by an insurer (whether issued in that tax year or a previous one) is the 
appropriate Treasury constant maturity interest rate published by the 
Board of Governors of the Federal Reserve System for the month 
containing the last day of the insurer's taxable year. The appropriate 
rate is that rate published for Treasury securities with the shortest 
published maturity that is greater than (or equal to) the remaining 
duration of the current temporary guarantee period under the MGC.
    (6) Current market rate for equity-indexed modified guaranteed 
contracts. [Reserved]
    (b) Applicable interest rates for non-equity-indexed modified 
guaranteed contracts--(1) Tax reserves during temporary guarantee 
period. An insurance company is required to determine the tax reserves 
for an MGC under sections 807(c)(3) or (d)(2). During a non-equity-
indexed MGC's temporary guarantee period, the applicable interest rate 
to be used under sections 807(c)(3) and (d)(2)(B) is the current market 
rate, as defined in paragraph (a)(5) of this section.
    (2) Required interest during temporary guarantee period. During the 
temporary guarantee period of a non-equity-indexed MGC, the applicable 
interest rate to be used to determine required interest under section 
812(b)(2)(A) is the same current market rate, defined in paragraph 
(a)(5) of this section, that applies for that period for purposes of 
sections 807(c)(3) or (d)(2)(B).
    (3) Application of section 811(d). An additional reserve computation 
rule applies under section 811(d) for contracts that guarantee certain 
interest payments beyond the end of the taxable year. Section 811(d) is 
waived for non-equity-indexed MGCs.
    (4) Periods after the end of the temporary guarantee period. For 
periods after the end of the temporary guarantee period, sections 
807(c)(3), 807(d)(2)(B), 811(d) and 812(b)(2)(A) are

[[Page 804]]

not modified when applied to non-equity-indexed MGCs. None of these 
sections are affected by the definition of current market rate contained 
in paragraph (a)(5) of this section once the temporary guarantee period 
has expired.
    (5) Examples. The following examples illustrate this paragraph (b):

    Example 1. (i) IC, a life insurance company as defined in section 
816, issues a MGC (the Contract) on August 1 of 1996. The Contract is an 
annuity contract that gives rise to life insurance reserves, as defined 
in section 816(b). IC is a calendar year taxpayer. The Contract 
guarantees that interest will be credited at 8 percent per year for the 
first 8 contract years and 4 percent per year thereafter. During the 8-
year temporary guarantee period, the Contract provides for a market 
value adjustment based on changes in a published bond index and not on 
the performance of stocks, other equity instruments or equity based 
derivatives. IC has chosen to avail itself of the provisions of these 
regulations for 1996 and taxable years thereafter. The 10-year Treasury 
constant maturity interest rate published for December of 1996 was 6.30 
percent. The next shortest maturity published for Treasury constant 
maturity interest rates is 7 years. As of the end of 1996, the remaining 
duration of the temporary guarantee period for the Contract was 7 years 
and 7 months.
    (ii) To determine under section 807(d)(2) the end of 1996 reserves 
for the Contract, IC must use a discount interest rate of 6.30 percent 
for the temporary guarantee period. The interest rate to be used in 
computing required interest under section 812(b)(2)(A) for 1996 reserves 
is also 6.30 percent.
    (iii) The discount rate applicable to periods outside the 8-year 
temporary guarantee period is determined under sections 807(c)(3), 
807(d)(2)(B), 811(d) and 812(b)(2)(A) without regard to the current 
market rate.
    Example 2. Assume the same facts as in Example 1 except that it is 
now the last day of 1998. The remaining duration of the temporary 
guarantee period under the Contract is now 5 years and 7 months. The 7-
year Treasury constant maturity interest rate published for December of 
1998 was 4.65 percent. The next shortest duration published for Treasury 
constant maturity interest rates is 5 years. A discount rate of 4.65 
percent is used for the remaining duration of the temporary guarantee 
period for the purpose of determining a reserve under section 807(d) and 
for the purpose of determining required interest under section 
812(b)(2)(A).
    Example 3. Assume the same facts as in Example 1 except that it is 
now the last day of 2001. The remaining duration of the temporary 
guarantee period under the Contract is now 2 years and 7 months. The 3-
year Treasury constant maturity interest rate published for December of 
2001 was 3.62 percent. The next shortest duration published for Treasury 
constant maturity interest rates is 2 years. A discount rate of 3.62 
percent is used for the remaining duration of the temporary guarantee 
period for the purpose of determining a reserve under section 807(d) and 
for the purpose of determining required interest under section 
812(b)(2)(A).

    (c) Applicable interest rates for equity-indexed modified guaranteed 
contracts. [Reserved]
    (d) Effective date. Paragraphs (a), (b) and (d) of this section are 
effective on May 7, 2003. However, pursuant to section 7805(b)(7), 
taxpayers may elect to apply those paragraphs retroactively for all 
taxable years beginning after December 31, 1995, the effective date of 
section 817A.

[T.D. 9058, 68 FR 24350, May 7, 2003]



Sec. 1.818-1  Taxable years affected.

    Sections 1.818-2 through 1.818-8, except as otherwise provided 
therein, are applicable only to taxable years beginning after December 
31, 1957, and all references to sections of part I, subchapter L, 
chapter 1 of the Code are to the Internal Revenue Code of 1954, as 
amended by the Life Insurance Company Income Tax Act of 1959 (73 Stat. 
112).

[T.D. 6558, 26 FR 2785, Apr. 4, 1961 as amended by T.D. 7469, 42 FR 
12181, Mar. 3, 1977]



Sec. 1.818-2  Accounting provisions.

    (a) Method of accounting. (1) Section 818(a)(1) provides the general 
rule that all computations entering into the determination of taxes 
imposed by part I, subchapter L, chapter 1 of the Code, shall be made 
under an accrual method of accounting. Thus, the over-all method of 
accounting for life insurance companies shall be the accrual method. 
Except as otherwise provided in part I, the term ``accrual method'' 
shall have the same meaning and application in section 818 as it does 
under section 446 (relating to general rule for methods of accounting) 
and the regulations thereunder. For general rules relating to the 
taxable year for inclusion of income

[[Page 805]]

and deduction of expenses under an accrual method of accounting, see 
sections 451 and 461 and the regulations thereunder.
    (2) Section 818(a)(2) provides that, to the extent permitted under 
this section, a life insurance company's method of accounting may be a 
combination of the accrual method with any other method of accounting 
permitted by chapter 1 of the Internal Revenue Code of 1954, other than 
the cash receipts and disbursements method. Thus, section 818(a)(2) 
specifically prohibits the use by a life insurance company of the cash 
receipts and disbursements method either separately or in combination 
with a permissible method of accounting. The term ``method of 
accounting'' includes not only the over-all method of accounting of the 
taxpayer but also the accounting treatment of any item. For purposes of 
section 818(a)(2), a life insurance company may elect to compute its 
taxable income under an over-all method of accounting consisting of the 
accrual method combined with the special methods of accounting for 
particular items of income and expense provided under other sections of 
chapter 1 of the Internal Revenue Code of 1954, other than the cash 
receipts and disbursements method. These methods of accounting for 
special items include the accounting treatment provided for depreciation 
(section 167), research and experimental expenditures (section 174), 
soil and water conservation expenditures (section 175), organizational 
expenditures (section 248), etc. In addition, a life insurance company 
may, where applicable, use the crop method of accounting (as provided in 
the regulations under sections 61 and 162), and the installment method 
of accounting for sales of realty and casual sales of personalty (as 
provided in section 453(b)). To the extent not inconsistent with the 
provisions of the Internal Revenue Code of 1954 or the regulations 
thereunder and the method of accounting adopted by the taxpayer pursuant 
to this section, all computations entering into the determination of 
taxes imposed by part I shall be made in a manner consistent with the 
manner required for purposes of the annual statement approved by the 
National Association of Insurance Commissioners.
    (3)(i) An election to use any of the special methods of accounting 
referred to in subparagraph (2) of this paragraph which was made 
pursuant to any provisions of the Internal Revenue Code of 1954 or prior 
revenue laws for purposes of determining a company's tax liabilities for 
prior years, shall have the same force and effect in determining the 
items of gross investment income under section 804(b) and the items of 
deduction under section 804(c) of the Life Insurance Company Income Tax 
Act of 1959 (73 Stat. 112) as if such Act had not been enacted.
    (ii) For purposes of determining gain or loss from operations under 
section 809(b), in computing the life insurance company's share of 
investment yield under section 809(b) (1)(A) and (2)(A), an election 
with respect to any of the special methods of accounting referred to in 
subparagraph (2) of this paragraph which was made pursuant to any 
provision of the Internal Revenue Code of 1954 or prior revenue laws, 
shall not be affected in any way by the enactment of the Life Insurance 
Company Income Tax Act of 1959 (73 Stat. 112).
    (iii) For purposes of determining gain or loss from operations under 
section 809(b), in computing the items of gross amount under section 
809(c) and the deduction items under section 809(d), an election to use 
any of the special methods of accounting referred to in subparagraph (2) 
of this paragraph must be made in accordance with the specific statutory 
provisions of the sections containing such elections and the regulations 
thereunder. However, where a particular election may be made only with 
the consent of the Commissioner (either because the time for making the 
election without the consent of the Commissioner has expired or because 
the particular section contained no provision for making an election 
without consent), and the time prescribed by the applicable regulations 
for submitting a request for permission to make such an election for the 
taxable year 1958 has expired, a life insurance company may make such an 
election for the year 1958 at the time of filing its return for that 
year (including extensions thereof). For example, a life insurance 
company may elect any of the methods of depreciation prescribed

[[Page 806]]

in section 167 (to the extent permitted under that section and the 
regulations thereunder) with respect to those assets, or any portion 
thereof, for which no depreciation was allowable under prior revenue 
laws, for example, furniture and fixtures used in the underwriting 
department. Similarly, a life insurance company shall be permitted to 
make an election under section 461(c) (relating to the accrual of real 
property taxes) with respect to real property for which no deduction was 
allowable under prior revenue laws. Any such election shall be made in 
the manner and form prescribed in the applicable regulations.
    (iv) For purposes of subdivision (ii) of this subparagraph, the 
method used under section 1016(a)(3)(C) (relating to adjustments to 
basis) in determining the amount of exhaustion, wear and tear, 
obsolescence, and amortization actually sustained shall not preclude a 
taxpayer from electing any of the methods prescribed in section 167 in 
accordance with the provisions of that section and the regulations 
thereunder for determining the amount of such exhaustion, wear and tear, 
obsolescence, and amortization for the year 1958. For example, if the 
amount of depreciation actually sustained, under section 1016(a)(3)(C), 
on a life insurance company's home office building (other than that 
portion for which depreciation was allowable under prior revenue laws) 
is determined on the straight line method, the life insurance company 
may elect for the year 1958 to use any of the methods prescribed in 
section 167 for determining its depreciation allowance for 1958. 
However, such election shall be binding for 1958, and for all subsequent 
taxable years, unless consent to change such election, if required, is 
obtained from the Commissioner in accordance with the provisions of 
section 167 and the regulations thereunder.
    (4)(i) For purposes of section 805(b)(3)(B)(i) (relating to the 
determination of the current earnings rate for any taxable year 
beginning before January 1, 1958), the determination for any year of the 
investment yield and the assets shall be made as though the taxpayer had 
been on the accrual method prescribed in subparagraph (1) of this 
paragraph for such year, or the accrual method in combination with the 
other methods of accounting prescribed in subparagraph (2) of this 
paragraph, if these other methods of accounting are used by the taxpayer 
in determining the investment yield and assets for the taxable year 
1958. However, where the method used for determining the deduction under 
section 167 for the year 1958 differs from the method used in prior 
years, the amount of the deduction actually allowed or allowable for 
such prior years for purposes of section 1016(a)(2) (relating to 
adjustments to basis) shall be the amount to be taken into account in 
determining the current earnings rate under section 805(b)(3)(B)(i).
    (ii) For purposes of section 812(b)(1)(C) (relating to operations 
loss carrybacks and carryovers for years prior to 1958), the 
determination for those years of the gain or loss from operations shall 
be made as though the taxpayer had been on the accrual method of 
accounting prescribed in subparagraph (1) of this paragraph for such 
year, or the accrual method in combination with the other methods of 
accounting prescribed in subparagraph (2) of this paragraph, if these 
other methods of accounting are used by the taxpayer in the 
determination of gain or loss from operations for the taxable year 1958. 
However, where any adjustment to basis is required under section 
1016(a)(3)(C) on account of exhaustion, wear and tear, obsolescence, 
amortization, and depletion sustained, the amount actually sustained as 
determined under section 1016(a)(3)(C) for each of the years involved 
shall be the amount allowed in the determination of gain or loss from 
operations for purposes of section 812(b)(1)(C).
    (b) Adjustments required if accrual method of accounting was not 
used in 1957. The items of gross amount taken into account under section 
809(c) and the items of deductions allowed under section 809(d) for the 
taxable year 1958 shall be determined as though the taxpayer had been on 
the accrual method of accounting prescribed in paragraph (a) of this 
section for all prior years. Thus, life insurance companies not on the 
accrual method for the year 1957 shall accrue, as of December 31, 1957,

[[Page 807]]

those items of gross amount which would have been properly taken into 
account for the year 1957 if the company had been on the accrual method 
described in section 818(a). Likewise, life insurance companies not on 
the accrual method for the year 1957 shall accrue, as of December 31, 
1957, those items of deductions which would have been properly allowed 
for the year 1957 if the company had been on the accrual method 
described in section 818(a). For example, if certain premium amounts 
were received during the year 1958 but such amounts would have been 
properly taken into account for the year 1957 if the taxpayer had been 
on the accrual method for the year 1957, then the taxpayer will not be 
required to take such premium amounts into account for the year 1958. 
If, for example, certain claims, benefits, and losses were paid during 
the year 1958 but such items would have been properly taken into account 
for the year 1957 if the taxpayer had been on the accrual method for the 
year 1957, then the taxpayer will not be permitted to deduct such 
expense items for the year 1958. For a special transitional rule 
applicable with respect to changes in method of accounting required by 
section 818(a) and paragraph (a) of this section, see section 818(e) and 
Sec. 1.818-6.
    (c) Change of basis in computing reserves. (1) Section 806(b) 
provides that if the basis for determining the amount of any item 
referred to in section 810(c) as of the close of the taxable year 
differs from the basis for such determination as of the beginning of the 
taxable year, then for purposes of subpart B, part I, subchapter L, 
chapter 1 of the Code (relating to the determination of taxable 
investment income), the amount of such item shall be the amount computed 
on the old basis as of the close of the taxable year and the amount 
computed on the new basis as of the beginning of the next taxable year. 
Similarly, section 810(d)(1) provides rules for determining the amount 
of the adjustment to be made for purposes of subpart C, part I, 
subchapter L, chapter 1 of the Code (relating to the determination of 
gain or loss from operations), if the basis for determining any item 
referred to in section 810(c) as of the close of any taxable year 
differs from the basis for such determination as of the close of the 
preceding taxable year. Under an accrual method of accounting, a change 
in the basis or method of computing the amount of liability of any item 
referred to in section 810(c) occurs in the taxable year in which all 
the events have occurred which determine the change in the basis or 
method of computing the amount of such liability and, in which, the 
amount thereof (whether increased or decreased) can be determined with 
reasonable accuracy.
    (2) The application of subparagraph (1) of this paragraph may be 
illustrated by the following examples:

    Example 1. Assume that during the taxable year 1960, M, a life 
insurance company, determines that the amount of its life insurance 
reserves held with respect to a particular block of contracts is 
understated on the present basis being used in valuing such liability 
and that such liability can be more accurately reflected by changing 
from the present basis to a particular new basis. Assume that M uses 
such new basis in computing its reserves under such contracts at the end 
of the taxable year 1960. Under the provisions of section 818(a) and 
subparagraph (1) of this paragraph, the change in basis for purposes of 
sections 806(b) and 810(d) occurs during the taxable year 1960, the year 
in which all the events have occurred which determine the change in 
basis and the amount of any increase (or decrease) attributable to such 
change can be determined with reasonable accuracy. Such change shall be 
treated as having occurred during the taxable year 1960 whether M 
determines that its liability under such contracts was understated for 
the first time during 1960, or that its liability under such contracts 
has, in fact, been understated for a number of prior years.
    Example 2. Assume the facts are the same as in example 1, except 
that during the taxable year 1960 the insurance department of State X 
issues a ruling, pursuant to authority conferred by statute, requiring M 
to use the particular new basis which more accurately reflects its 
liability with respect to such contracts and that as a result of such 
ruling, M uses the new basis in computing its reserves under such 
contracts for the taxable years 1958, 1959, and 1960. Under the 
provisions of section 818(a) and subparagraph (1) of this paragraph, the 
change in basis for purposes of sections 806(b) and 810(d) occurs during 
the taxable year 1960, the year in which all the events have occurred 
which determine that a change in basis should be

[[Page 808]]

made and the amount of any increase (or decrease) attributable to such 
change can be determined with reasonable accuracy.

[T.D. 6558, 26 FR 2785, Apr. 4, 1961]



Sec. 1.818-3  Amortization of premium and accrual of discount.

    (a) In general. Section 818(b) provides that the appropriate items 
of income, deductions, and adjustments under part I, subchapter L, 
chapter 1 of the Code, shall be adjusted to reflect the appropriate 
amortization of premium and the appropriate accrual of discount on 
bonds, notes, debentures, or other evidences of indebtedness held by a 
life insurance company. Such adjustments are limited to the amount of 
appropriate amortization or accrual attributable to the taxable year 
with respect to such securities which are not in default as to principal 
or interest and which are amply secured. The question of ample security 
will be resolved according to the rules laid down from time to time by 
the National Association of Insurance Commissioners. The adjustment for 
amortization of premium decreases the gross investment income, the 
exclusion and reduction for wholly tax-exempt interest, the exclusion 
and deduction for partially tax-exempt interest, and the basis or 
adjusted basis of such securities. The adjustment for accrual of 
discount increases the gross investment income, the exclusion and 
reduction for wholly tax-exempt interest, the exclusion and deduction 
for partially tax-exempt interest, and the basis or adjusted basis of 
such securities. However, for taxable years beginning after May 31, 
1960, only the accrual of discount relating to issue discount will 
increase the exclusion and reduction for wholly tax-exempt interest. See 
section 103.
    (b) Acquisitions before January 1, 1958. (1) In the case of any such 
security acquired before January 1, 1958, the premium is the excess of 
its acquisition value over its maturity value and the discount is the 
excess of its maturity value over its acquisition value. The acquisition 
value of any such security is its cost (including buying commissions or 
brokerage but excluding any amounts paid for accrued interest) if 
purchased for cash, or if not purchased for cash, its then fair market 
value. The maturity value of any such security is the amount payable 
thereunder either at the maturity date or an earlier call date. The 
earlier call date of any such security may be the earliest interest 
payment date if it is callable or payable at such date, the earliest 
date at which it is callable at par, or such other call or payment date, 
prior to maturity, specified in the security as may be selected by the 
life insurance company. A life insurance company which adjusts 
amortization of premium or accrual of discount with reference to a 
particular call or payment date must make the adjustments with reference 
to the value on such date and may not, after selecting such date, use a 
different call or payment date, or value, in the calculation of such 
amortization or discount with respect to such security unless the 
security was not in fact called or paid on such selected date.
    (2) The adjustments for amortization of premium and accrual of 
discount will be determined:
    (i) According to the method regularly employed by the company, if 
such method is reasonable, or
    (ii) According to the method prescribed by this section.

A method of amortization of premium or accrual of discount will be 
deemed ``regularly employed'' by a life insurance company if the method 
was consistently followed in prior taxable years, or if, in the case of 
a company which has never before made such adjustments, the company 
initiates in the first taxable year for which the adjustments are made a 
reasonable method of amortization of premium or accrual of discount and 
consistently follows such method thereafter. Ordinarily, a company 
regularly employs a method in accordance with the statute of some State, 
Territory, or the District of Columbia, in which it operates.
    (3) The method of amortization and accrual prescribed by this 
section is as follows:
    (i) The premium (or discount) shall be determined in accordance with 
this section; and
    (ii) The appropriate amortization of premium (or accrual of 
discount) attributable to the taxable year shall be an amount which 
bears the same ratio

[[Page 809]]

to the premium (or discount) as the number of months in the taxable year 
during which the security was owned by the life insurance company bears 
to the number of months between the date of acquisition of the security 
and its maturity or earlier call date, determined in accordance with 
this section. For purposes of this section, a fractional part of a month 
shall be disregarded unless it amounts to more than half a month, in 
which case it shall be considered a month.
    (c) Acquisitions after December 31, 1957. (1) In the case of:
    (i) Any bond, as defined in section 171(d), acquired after December 
31, 1957, the amount of the premium and the amortizable premium for the 
taxable year, shall be determined under section 171(b) and the 
regulations thereunder, as if the election set forth in section 171(c) 
had been made, and
    (ii) Any bond, note, debenture, or other evidence of indebtedness 
not described in subdivision (i) of this subparagraph and acquired after 
December 31, 1957, the amount of the premium and the amortizable premium 
for the taxable year, shall be determined under paragraph (b) of this 
section.
    (2) In the case of any bond, note, debenture, or other evidence of 
indebtedness acquired after December 31, 1957, the amount of the 
discount and the accrual of discount attributable to the taxable year 
shall be determined under paragraph (b) of this section.
    (d) Convertible evidences of indebtedness. Section 818(b)(2)(B) 
provides that in no case shall the amount of premium on a convertible 
evidence of indebtedness (including any bond, note, or debenture) 
include any amount attributable to the conversion features of the 
evidence of indebtedness. This provision is the same as the one 
contained in section 171(b), and the rules prescribed in paragraph (c) 
of Sec. 1.171-2 shall be applicable for purposes of section 
818(b)(2)(B). This provision is to be applied without regard to the date 
upon which the evidence of indebtedness was acquired. Thus, where a 
convertible evidence of indebtedness was acquired before January 1, 
1958, and a portion or all of the premium attributable to the conversion 
features of the evidence of indebtedness has been amortized for taxable 
years beginning before January 1, 1958, no adjustment for such 
amortization will be required by reason of section 818(b)(2)(B). Such 
amortization will, however, require an adjustment to the basis of the 
evidence of indebtedness under section 1016(a)(17). For taxable years 
beginning after December 31, 1957, no further amortization of the 
premium attributable to the conversion features of such an evidence of 
indebtedness will be taken into account.
    (e) Adjustments to basis. Section 1016(a)(17) (relating to 
adjustments to basis) provides that in the case of any evidence of 
indebtedness referred to in section 818(b) and this section, the basis 
shall be adjusted to the extent of the adjustments required under 
section 818(b) (or the corresponding provisions of prior income tax 
laws) for the taxable year and all prior taxable years. The basis of any 
evidence of indebtedness shall be reduced by the amount of the 
adjustment required under section 818(b) (or the corresponding provision 
of prior income tax laws) on account of amortizable premium and shall be 
increased by the amount of the adjustment required under section 818(b) 
on account of accruable discounts.
    (f) Denial of double inclusion. Any amount which is includible in 
gross investment income by reason of section 818(b) and paragraph (a) of 
this section shall not be includible in gross income under section 
1232(a) (relating to the taxation of bonds and other evidences of 
indebtedness). See section 1232(a)(2)(C) and the regulations thereunder.

[T.D. 6558, 26 FR 2786, Apr. 4, 1961]



Sec. 1.818-4  Election with respect to life insurance reserves
computed on preliminary term basis.

    (a) In general. Section 818(c) permits a life insurance company 
issuing contracts with respect to which the life insurance reserves are 
computed on one of the recognized preliminary term bases to elect to 
revalue such reserves on a net level premium basis for the purpose of 
determining the amount which may be taken into account as life insurance 
reserves for purposes of part I, subchapter L, chapter 1 of the Code, 
other than section 801 (relating

[[Page 810]]

to the definition of a life insurance company). If such an election is 
made, the method to be used in making this revaluation of reserves shall 
be either the exact revaluation method (as described in section 
818(c)(1) and paragraph (b)(1) of this section) or the approximate 
revaluation method (as described in section 818(c)(2) and paragraph 
(b)(2) of this section).
    (b) Revaluation of reserves computed on preliminary term basis. If a 
life insurance company makes an election under section 818(c) in the 
manner provided in paragraph (e) of this section, the amount to be taken 
into account as life insurance reserves with respect to contracts for 
which such reserves are computed on a preliminary term basis may be 
determined on either of the following bases:
    (1) Exact revaluation method. As if the reserves for all such 
contracts had been computed on a net level premium basis (using the same 
mortality or morbidity assumptions and interest rates for both the 
preliminary term basis and the net level premium basis).
    (2) Approximate revaluation method. The amount computed without 
regard to section 818(c):
    (i) Increased by $21 per $1,000 of insurance in force (other than 
term insurance) under such contracts, less 2.1 percent of reserves under 
such contracts, and
    (ii) Increased by $5 per $1,000 of term insurance in force under 
such contracts which at the time of issuance cover a period of more than 
15 years, less 0.5 percent of reserves under such contracts.
    (c) Exception. If a life insurance company which makes an election 
under section 818(c)(2) and paragraph (b)(2) of this section has life 
insurance reserves with respect to both life insurance and 
noncancellable accident and health contracts for which such reserves are 
computed on a preliminary term basis, it shall use the approximate 
revaluation method for all its life insurance reserves other than that 
portion of such reserves held with respect to its noncancellable 
accident and health contracts, and shall use the exact revaluation 
method for all its life insurance reserves held with respect to such 
noncancellable accident and health contracts.
    (d) Reserves subject to recomputation. (1) For the first taxable 
year for which the election under section 818(c) and paragraph (b) of 
this section applies, a company making such election must revalue all 
its life insurance reserves held with respect to contracts for which 
such reserves are computed on a preliminary term basis at the end of 
such taxable year on the basis elected under section 818(c) and 
paragraph (b) of this section. However, for purposes of the preceding 
sentence, an election under section 818(c) shall not apply with respect 
to such reserves which would not be treated as being computed on the 
preliminary term basis at the end of such taxable year except for the 
provisions of section 810 (a) or (b). See paragraph (c)(2) of Sec. 
1.810-2. For example, if S, a life insurance company which computes its 
life insurance reserves on a recognized preliminary term basis at the 
beginning of the taxable year 1958, strengthens a portion of such 
reserves during the taxable year by actually changing to a net level 
premium basis in computing such reserves, and then makes the election 
under section 818(c) and paragraph (b) of this section for 1958, such 
election shall not apply with respect to the strengthened contracts.
    (2) For any taxable year other than the first taxable year for which 
the election under section 818(c) and paragraph (b) of this section 
applies, a company making such election must revalue all its life 
insurance reserves held with respect to contracts for which such 
reserves are computed on a preliminary term basis at the beginning or 
end of the taxable year on the basis elected under section 818(c) and 
paragraph (b) of this section. For example, if M, a life insurance 
company which made a valid outstanding election under section 818(c) in 
the manner provided in paragraph (e) of this section for the taxable 
year 1959, sells a block of contracts subject to such election on 
September 1, 1960, M would value such contracts on the basis elected 
under section 818(c) and paragraph (b) of this section on January 1, 
1960, for purposes of determining the net decrease or increase in the 
sum of the

[[Page 811]]

items described in section 810(c) for the taxable year under section 810 
(a) or (b).
    (3) For the effect of an election under section 818(c) and paragraph 
(b) of this section in determining gain or loss from operations for the 
taxable year, see paragraph (c)(3) of Sec. 1.810-2 and paragraph (e) of 
Sec. 1.810-3.
    (e) Time and manner of making election. The election provided by 
section 818(c) shall be made in a statement attached to the life 
insurance company's income tax return for the first taxable year for 
which the company desires the election to apply. The return and 
statement must be filed not later than the date prescribed by law 
(including extensions thereof) for filing the return for such taxable 
year. However, if the last day prescribed by law (including extensions 
thereof) for filing a return for the first taxable year for which the 
company desires the election to apply falls before April 4, 1961, the 
election provided by section 818(c) may be made for such year by filing 
the statement and an amended return for such taxable year (and all 
subsequent taxable years for which returns have been filed) before July 
4, 1961. The statement shall indicate whether the exact or the 
approximate method of revaluation has been adopted. The statement shall 
also set forth sufficient information as to mortality and morbidity 
asumptions; interest rates; the valuation method used; the amount of the 
reserves and the amount and type of insurance in force under all 
contracts for which reserves are computed on a preliminary term basis; 
and such other pertinent data as will enable the Commissioner to 
determine the correctness of the application of the revaluation method 
adopted and the accuracy of the computations involved in revaluing the 
reserves. The election to use either the exact revaluation method or the 
approximate revaluation method shall, except for the purposes of section 
801, be adhered to in making the computations under part I for the 
taxable year for which such election is made and for all subsequent 
taxable years.
    (f) Scope of election. An election made under section 818(c) and 
paragraph (b) of this section to use either the exact or the approximate 
method of revaluing the company's life insurance reserves shall be 
binding for the taxable year for which made, and, except as provided in 
paragraph (g) of this section, shall be binding for all succeeding 
taxable years, unless consent to revoke the election is obtained from 
the Commissioner. However, for taxable years beginning prior to April 4, 
1961, a company may revoke the election provided by section 818(c) 
without obtaining consent from the Commissioner by filing, before July 
4, 1961, a statement that the company desires to revoke such election. 
An amended return reflecting such revocation must accompany the 
statement for all taxable years for which returns have been filed with 
respect to such election.
    (g) Special rule for 1958. If an election is made for a taxable year 
beginning in 1958 to use the approximate revaluation method described in 
section 818(c)(2) and paragraph (b)(2) of this section the company may, 
for its first taxable year beginning after 1958, elect to change to the 
exact revaluation method described in section 818(c)(1) and paragraph 
(b)(1) of this section without obtaining the consent of the 
Commissioner. In such case, the election to change shall be made in a 
statement attached to the company's income tax return for such taxable 
year and filed not later than the date prescribed by law (including 
extensions thereof) for filing the return for such year. The statement 
shall indicate that the company has elected to change from the 
approximate to the exact revaluation method for such taxable year and 
shall include such information and data referred to in paragraph (e) of 
this section as will enable the Commissioner to determine the 
correctness and accuracy of the computations involved.

[T.D. 6558, 26 FR 2787, Apr. 4, 1961; 26 FR 3276, Apr. 18, 1961]



Sec. 1.818-5  Short taxable years.

    (a) In general. Section 818(d) provides that if any return of a 
corporation made under part I, subchapter L, chapter 1 of the Code, is 
for a period of less than the entire calendar year, then section 443 
(relating to returns for a period of less than 12 months) shall not 
apply. This section further provides

[[Page 812]]

certain rules to be used in determining the life insurance company 
taxable income for a period of less than the entire calendar year.
    (b) Returns for periods of less than the entire calendar year. A 
return for a short period, that is, for a taxable year consisting of a 
period of less than the entire calendar year, shall be made only under 
the following circumstances:
    (1) If a company which qualifies as a life insurance company is not 
in existence for the entire taxable year, a return is required for the 
short period during which the taxpayer was in existence. For example, a 
life insurance company organized on August 1, is required to file a 
return for the short period from August 1 to December 31, and returns 
for each calendar year thereafter. Similarly, if a company which 
qualifies as a life insurance company completely dissolves during the 
taxable year it is required to file a return for the short period from 
January 1 to the date it goes out of existence. All items entering into 
the computation of taxable investment income and gain or loss from 
operations for the short period shall be determined on a consistent 
basis and in the manner provided in paragraph (c) of this section.
    (2) A return must be filed for a short period resulting from the 
termination by the district director of a taxpayer's taxable year for 
jeopardy. See section 6851 and the regulations thereunder.

A company which was an insurance company for the preceding taxable year 
(but not a life insurance company as defined in section 801(a) and 
paragraph (b) of Sec. 1.801-3) and which for the current taxable year 
qualifies as a life insurance company shall not file a return for the 
short period from the time during the taxable year that it first 
qualifies as a life insurance company to the end of the taxable year. 
Similarly, an insurance company which was a life insurance company for 
the preceding taxable year but which for the current taxable year does 
not qualify as a life insurance company shall not file a return for the 
short period from the beginning of the taxable year to the time during 
the taxable year that it no longer qualifies as a life insurance 
company.
    (c) Computation of life insurance company taxable income for short 
period. (1) If a return is made for a short period, section 818(d)(1) 
provides that the taxable investment income and the gain or loss from 
operations shall be determined on an annual basis by a ratable daily 
projection of the appropriate figures for the short period. The 
appropriate figures for the short period shall be determined on an 
annual basis by multiplying such figures by a fraction, the numerator of 
which is the number of days in the calendar year in which the short 
period occurs and the denominator of which is the number of days in the 
short period.
    (2)(i) In computing taxable investment income for a short period, 
the investment yield, the policy and other contract liability 
requirements, the policyholders' share of each and every item of 
investment yield, and the company's share of any item of investment 
yield shall be determined on an annual basis.
    (ii) For purposes of determining the investment yield on an annual 
basis, each item of gross investment income under section 804(b) and 
each item of deduction under section 804(c) shall be annualized in the 
manner provided in subparagraph (1) of this paragraph. In any case in 
which a limitation is placed on the amount of a deduction provided under 
section 804(c), the limitation shall apply to the item of deduction 
computed on an annual basis.
    (iii) The policy and other contract liability requirements shall be 
determined on an annual basis in the following manner:
    (a) The interest paid (as defined in section 805(e) and Sec. 1.805-
8) for the short period shall be annualized in the manner prescribed in 
subparagraph (1) of this paragraph.
    (b) The current earnings rate for the taxable year in which the 
short period occurs shall be determined by dividing the taxpayer's 
investment yield, as determined on an annual basis under subdivision 
(ii) of this subparagraph, by the mean of the taxpayer's assets at the 
beginning and end of the short period. For purposes of section 805, any 
reference to the current earnings rate for the taxable year in which the 
short

[[Page 813]]

period occurs means the current earnings rate as determined under this 
subdivision.
    (c) The adjusted life insurance reserves shall be determined as 
provided in section 805(c), and the pension plan reserves shall be 
determined as provided in section 805(d).
    (iv) The policyholders' share of each and every item of investment 
yield (as defined in section 804(a)) shall be that percentage obtained 
by dividing the policy and other contract liability requirements, 
determined under subdivision (iii) of this subparagraph, by the 
investment yield, determined under subdivision (ii) of this 
subparagraph.
    (v) The taxable investment income for the short period shall be an 
amount (not less than zero) equal to the life insurance company's share 
of each and every item of investment yield, as determined under 
subdivision (ii) of this subparagraph, reduced by the items described in 
section 804(a)(2) (A) and (B). In determining these reductions under 
section 804(a)(2)(A) the amount of the respective items shall be the 
amount that is determined on an annual basis under subdivision (ii) of 
this subparagraph. The small business deduction, under section 
804(a)(2)(B) shall be an amount (not to exceed $25,000) equal to 10 
percent of the investment yield, determined under subdivision (ii) of 
this subparagraph, for the short period.
    (vi) Except as provided in this paragraph, the determination of 
taxable investment income under subpart B, part I, subchapter L, chapter 
1 of the Code, shall be made in accordance with all the provisions of 
that subpart.
    (3)(i) In computing gain or loss from operations for a short period, 
the share of each and every item of investment yield set aside for 
policyholders, the life insurance company's share of each and every item 
of investment yield, the items of gross amount, and the items of 
deduction shall, except as modified by this subparagraph, be determined 
on an annual basis in the manner provided in subparagraph (1) of this 
paragraph. In any case in which a limitation is placed on the amount of 
a deduction provided under section 809, the limitation shall apply to 
the item of deduction computed on an annualized basis.
    (ii) For purposes of sections 809 and 810, the investment yield 
shall be determined in the manner provided in subparagraph (2)(ii) of 
this paragraph. The share of any item of investment yield set aside for 
policyholders shall be that percentage obtained by dividing the required 
interest as determined under section 809(a)(2), by the investment yield, 
as determined in this subparagraph, except that if the required interest 
exceeds the investment yield then the share of any item of investment 
yield set aside for policyholders shall be 100 percent.
    (iii) The items of gross amount and the items of deduction, other 
than the operations loss deduction under section 809(d)(4), shall be 
determined on an annual basis. See subdivision (iv) of this subparagraph 
for the manner in which the net decrease or net increase in reserves 
under section 810 shall be annualized.
    (iv) For purposes of determining either a net decrease in reserves 
under section 810(a) or a net increase in reserves under section 810(b), 
the sum of the items described in section 810(c) as of the end of the 
short period shall be reduced by the amount of the investment yield not 
included in gain or loss from operations for the short period by reason 
of section 809(a)(1). The amount of investment yield excluded under 
section 809(a)(1) has been determined upon an annualized basis while the 
sum of the items described in section 180(c) at the end of the short 
period has been determined on an actual basis. In order to place these 
on the same basis, the amount of investment yield not included in gain 
or loss from operations by reason of section 809(a)(1), determined under 
subdivision (ii) shall, for purposes of section 810(a) and section 
810(b), be reduced to an amount which bears the same ratio to the full 
amount as the number of days in the short period bears to the number of 
days in the entire calendar year. The net decrease or the net increase 
of the items referred to in section 810(c) for the short period shall 
then be determined, as provided in section 810(a) and section 810(b), 
respectively, and the result annualized.
    (4) The portion of the life insurance company taxable income 
described in

[[Page 814]]

section 802(b) (1) and (2) (relating to taxable investment income and 
gain or loss from operations) shall be determined on an annual basis by 
treating the amounts ascertained under subparagraph (2) of this 
paragraph as the taxable investment income, and the amount ascertained 
under subparagraph (3) of this paragraph as the gain or loss from 
operations, for the taxable year.
    (5) The portion of the life insurance company taxable income 
described in section 802(b) (1) and (2) for the short period shall be 
the amount which bears the same ratio to the amount ascertained under 
section 818(d) (2) and subparagraph (4) of this paragraph as the number 
of days in the short period bears to the number of days in the entire 
year.
    (d) Special rules. (1) For purposes of determining the average 
earnings rate (as defined in section 805(b)(3)) for subsequent taxable 
years, the current earnings rate for the taxable year in which the short 
period occurs shall be the rate determined under paragraph (c)(2) of 
this section.
    (2) For purposes of determining an operations loss deduction under 
section 812, the loss from operations for the short period shall be the 
loss from operations determined under paragraph (c)(5) of this section.

[T.D. 6558, 26 FR 2788, Apr. 4, 1961]



Sec. 1.818-6  Transitional rule for change in method of accounting.

    (a) In general. Section 818(e) prescribes the rules to be followed 
in recomputing the taxes of a life insurance company for the taxable 
year 1957 in cases where the method of accounting required to be used in 
computing the company's taxes for 1958 under section 818(a) and 
paragraph (a) of Sec. 1.818-2 is different from the method used in 
1957.
    (b) Recomputation of 1957 taxes. (1) For purposes of recomputing its 
taxes for 1957, a life insurance company must ascertain the net amount 
of those adjustments which are determined (as of the close of 1957) to 
be necessary solely by reason of the change to the method of accounting 
required by section 818(a) and paragraph (a) of Sec. 1.818-2 in order 
to prevent amounts from being duplicated or omitted. Thus, for example, 
life insurance companies not on the accrual method of accounting for the 
year 1957 shall accrue, as of December 31, 1957, those items of gross 
investment income under section 803(b) and those items of deduction 
under section 803(c), as in effect for 1957, which would have been 
properly accruable for the year 1957 if the company had been on the 
accrual method of accounting.
    (2) In the case of a change in the over-all method of accounting, 
the term ``net amount of those adjustments'' means the consolidation of 
adjustments (whether the amounts thereof represent increases or 
decreases in items of income or deductions) arising with respect to 
balances in the various accounts on December 31, 1957. In the case of a 
change in the treatment of a single material item, the amount of the 
adjustment shall be determined with reference only to the net dollar 
balances in that particular account.
    (3)(i) The amount of the taxpayer's tax for 1957 shall be recomputed 
(under the law applicable to 1957, modified as provided in section 
818(e) (4) and paragraph (e) of this section) by taking into account an 
amount equal to one-tenth of the net amount of the adjustments 
determined under subparagraph (1) of this paragraph. The increase or 
decrease in tax attributable to the adjustments for such year is the 
difference between the tax for such year computed with the allocation of 
one-tenth of the net amount of the adjustments to such taxable year over 
the tax computed without the allocation of any part of the adjustments 
to such year.
    (ii) The amount of increase or decrease (as the case may be) 
referred to in section 818(e) (2) or (3) and paragraphs (c) or (d) of 
this section, shall be the amount of the increase or decrease in tax 
ascertained in the manner described in subdivision (i) of this 
subparagraph, multiplied by 10.
    (c) Treatment of decrease. Section 818(e) (2) provides that for 
purposes of subtitle F of the Code, if the recomputation under paragraph 
(b) (3) (ii) of this section results in a decrease, the amount of such 
decrease shall be treated as a decrease in the tax imposed for 1957; 
except that for purposes of computing the period of limitation on the

[[Page 815]]

making of refunds or the allowance of credits with respect to such 
overpayments, the amount of such decrease shall be treated as an 
overpayment of tax for 1959. No interest shall be paid, for any period 
before March 16, 1960, on any overpayment of the tax imposed for 1957 
which is attributable to such decrease.
    (d) Treatment of increase--(1) In general. Section 818(e) (3) (A) 
provides that for purposes of subtitle F of the Code, other than section 
6016 (relating to declarations of estimated income tax by corporations) 
and section 6655 (relating to failure by corporations to pay estimated 
income tax), if the recomputation under paragraph (b) (3) (ii) of this 
section results in an increase, the amount of such increase shall be 
treated as a tax imposed for 1959. Such tax shall be payable in 10 equal 
annual installments, beginning with March 15, 1960.
    (2) Special rules. Section 818(e) (3) (B) provides that for purposes 
of section 818(e) (3) (A) and subparagraph (1) of this paragraph:
    (i) No interest shall be paid on any installment described in 
section 818(e) (3) (A) and subparagraph (1) of this paragraph before the 
time prescribed therein for the payment of such installment.
    (ii) Section 6152(c) (relating to proration of deficiencies to 
installments) and the regulations thereunder shall apply. However, 
section 6152(a) (relating to the election to make installment payments) 
and the regulations thereunder shall not apply.
    (iii) In applying section 6502(a) (1) (relating to collection after 
assessment) and the regulations thereunder, the assessment of any 
installment described in section 818(e) (3) (A) and subparagraph (1) of 
this paragraph shall be treated as made at the time prescribed therein 
for the payment of such installment.
    (iv) If for any taxable year the taxpayer is not a life insurance 
company, the amount of the increase in tax (as determined under 
paragraph (b) (3) (ii) of this section), to the extent not taken into 
account for prior taxable years, shall be payable on the date the return 
for such taxable year is due (determined without regard to any 
extensions of time for filing such return), unless such amount is 
required to be taken into account by the acquiring corporation under 
section 381(c) (22) and the regulations thereunder.
    (e) Modifications of 1957 tax computation. Section 818(e) (4) 
provides that in recomputing the taxpayer's tax for 1957 for purposes of 
section 818(e) (1) and paragraph (b) of this section:
    (1) Section 804(b), as in effect for 1957 (relating to the maximum 
reserve and other policy liability deduction), shall not apply with 
respect to any amount required to be taken into account by reason of 
section 818(e) (1) and paragraph (b) of this section; and
    (2) The amount of the deduction allowed by section 805, as in effect 
for 1957 (relating to the special interest deduction), shall not be 
reduced by reason of any amount required to be taken into account under 
section 818(e) (1) and paragraph (b) of this section.
    (f) Illustration of principles. The application of section 818(e) 
and this section may be illustrated by the following examples:

    Example 1. For the taxable year 1957, the life insurance taxable 
income of M, a life insurance company, is $200,000 computed on the cash 
receipts and disbursements method of accounting. The net amount of the 
adjustments required under section 818(e)(1) by reason of the change to 
the accrual method of accounting for 1958, increases M's life insurance 
taxable income for 1957 by $50,000. The increase in tax attributable to 
the change in method of accounting required by section 818(a) is 
$26,000, computed as follows:

(1) Life insurance taxable income before adjustments........    $200,000
(2) Adjustments required by sec. 818(e) (1) (1/10x$50,000)..       5,000
(3) Life insurance taxable income after adjustments (item        205,000
 (1) plus item (2)).........................................
(4) Tax liability after adjustments (52%x$205,000, minus         101,100
 $5,500)....................................................
(5) Tax liability before adjustments (52%x$200,000, minus         98,500
 $5,500)....................................................
(6) Excess of item (4) over item (5)........................       2,600
(7) Increase in tax for purposes of sec. 818(e) (3) (item         26,000
 (6) multiplied by 10)......................................
 


Under the provisions of section 818(e)(3), one-tenth of the increase in 
tax for 1957 attributable to the change in method of accounting required 
by section 818(a), $2,600 (1/10x$26,000), was due and payable on March 
15, 1960, and the balance, $23,400 (9/10x$26,000), is due and payable in 
equal installments on March 15th of the nine succeeding taxable years. 
However, if for the taxable year 1965, M is no longer a life insurance 
company, and

[[Page 816]]

section 381(c)(22) does not apply, the balance of the installments not 
paid in prior taxable years, $10,400 (4/10x$26,000), shall be due and 
payable on March 15, 1966.
    Example 2. Assume the facts are the same as in example 1, except 
that the net amount of the adjustments required by section 818(e)(1) 
decreases M's life insurance taxable income for 1957 by $25,000. The 
decrease in tax attributable to the change in method of accounting 
required by section 818(a) is $13,000, computed as follows:

(1) Life insurance taxable income before adjustments........    $200,000
(2) Adjustments required by sec. 818(e) (1) (1/10x$25,000)..       2,500
(3) Life insurance taxable income after adjustments (item        197,500
 (1) minus item (2))........................................
(4) Tax liability after adjustments (52%x$197,500, minus          97,200
 $5,500)....................................................
(5) Tax liability before adjustments (52%x$200,000, minus         98,500
 $5,500)....................................................
(6) Excess of item (5) over item (4)........................       1,300
(7) Decrease in tax for purposes of sec. 818(e)(2) (item (6)      13,000
 multiplied by 10)..........................................
 


Under the provisions of section 818(e)(2), the entire $13,000 decrease 
in tax for 1957 attributable to the change in method of accounting 
required by section 818(a) shall be treated as an overpayment of tax for 
the taxable year 1959.

[T.D. 6558, 26 FR 2789, Apr. 4, 1961]



Sec. 1.818-7  Denial of double deductions.

    Section 818(f) provides that the same item may not be deducted more 
than once under subpart B, part I, subchapter L, chapter 1 of the Code 
(relating to the determination of taxable investment income), and more 
than once under subpart C, part I, subchapter L, chapter 1 of the Code 
(relating to the determination of gain or loss from operations).

[T.D. 6558, 26 FR 2790, Apr. 4, 1961]



Sec. 1.818-8  Special rules relating to consolidated returns and 
certain capital losses.

    Section 818(g) provides that, in the case of a life insurance 
company filing or required to file a consolidated return under section 
1501 for a taxable year, the computations of the policyholders' share of 
investment yield under subparts B and C, part I, subchapter L, chapter 1 
of the Code (including all determinations and computations incident 
thereto) shall be made as if such company were not filing a consolidated 
return. Thus, for example, if X and Y are life insurance companies which 
are entitled to file a consolidated return for 1975 and X has paid 
dividends to Y during such taxable year, Y must include such dividends 
in the computation of gross investment income under section 804(b). For 
other rules relating to the filing of consolidated returns, see sections 
1501 through 1504 and the regulations thereunder.

[T.D. 7469, 42 FR 12181, Mar. 3, 1977]



Sec. 1.819-1  Taxable years affected.

    Section 1.819-2 is applicable only to taxable years beginning after 
December 31, 1957, and all references to sections of part I, subchapter 
L, chapter 1 of the Code, are to the Internal Revenue Code of 1954, as 
amended by the Life Insurance Company Income Tax Act of 1959 (73 Stat. 
112).

[T.D. 6558, 26 FR 2791, Apr. 4, 1961]



Sec. 1.819-2  Foreign life insurance companies.

    (a) Carrying on United States insurance business. Section 819(a) 
provides that a foreign life insurance company carrying on a life 
insurance business within the United States, if with respect to its 
United States business it would qualify as a life insurance company 
under section 801, shall be taxable on its United States business under 
section 802 in the same manner as a domestic life insurance company. 
Thus, the life insurance company taxable income of such a foreign life 
insurance company shall not be determined in the manner provided by part 
I, subchapter N, chapter 1 of the Code (relating to determination of 
sources of income), but shall be determined in the manner provided by 
part I, subchapter L, chapter 1 of the Code (relating to life insurance 
companies). See section 842. Accordingly, in determining its life 
insurance company taxable income from its United States business, such a 
foreign life insurance company shall take into account the appropriate 
items of income irrespective of whether such items of income are from 
sources within or without the United States. A foreign life insurance 
company shall take into account the appropriate items of expenses, 
losses, and other deductions properly allocable to such items of income 
from its United

[[Page 817]]

States business. To the extent not inconsistent with the provisions of 
this paragraph, section 818(a), and section 819(b), all computations 
entering into the determination of taxes imposed by part I shall be made 
in a manner consistent with the manner required for purposes of the 
annual statement approved by the National Association of Insurance 
Commissioners.
    (b) Adjustment where surplus held in the United States is less than 
specified minimum--(1) In general. Section 819(b)(1) provides that if 
the minimum figure for the taxable year determined under section 
819(b)(2) and subparagraph (2)(i) of this paragraph exceeds the surplus 
held in the United States as of the end of the taxable year (as defined 
in section 819(b)(2)(B) and subparagraph (2)(ii) of this paragraph) by a 
foreign life insurance company carrying on a life insurance business 
within the United States and taxable under section 802, then:
    (i) The amount of the policy and other contract liability 
requirements (determined under section 805 and Sec. 1.805-4 without 
regard to this subparagraph), and
    (ii) The amount of the required interest (determined under section 
809(a)(2) and paragraph (d) of Sec. 1.809-2 without regard to this 
subparagraph),

shall each be reduced by an amount determined by multiplying such excess 
by the current earnings rate (as defined in section 805(b)(2) and 
paragraph (a)(2) of Sec. 1.805-5) of such company. Such current 
earnings rate shall be determined by reference to the assets held by the 
company in the United States.
    (2) Definitions. For purposes of section 819(b)(1) and subparagraph 
(1) of this paragraph:
    (i) The term minimum figure, in the case of a taxable year beginning 
after December 31, 1957, but before January 1, 1959, means the amount 
obtained by multiplying the company's total insurance liabilities on 
United States business by 9 percent. In the case of any taxable year 
beginning after December 31, 1958, such term means the amount obtained 
by multiplying the company's total insurance liabilities on United 
States business by the percentage determined and proclaimed by the 
Secretary as being applicable for such year.
    (ii) The term surplus held in the United States means the excess of 
the assets held in the United States (as of the end of the taxable year) 
over the total insurance liabilities on United States business (as of 
the end of the taxable year).
    (iii) The term total insurance liabilities means the sum of the 
total reserves (as defined in section 801(c) and paragraph (a) of Sec. 
1.801-5) as of the end of the taxable year plus (to the extent not 
included in total reserves) the items referred to in section 810(c) (3), 
(4), and (5) of paragraph (b) (3), (4), and (5) of Sec. 1.810-2 as of 
the end of the taxable year; and
    (iv) The term assets shall have the same meaning as that contained 
in section 805(b)(4) and paragraph (a)(4) of Sec. 1.805-5.
    (3) Illustration of principles. The provisions of section 819(b) and 
this paragraph may be illustrated by the following example:

    Example. For the taxable year 1958, P, a foreign life insurance 
company carrying on a life insurance business within the United States 
and taxable under section 802, has total insurance liabilities on United 
States business (as of the end of the taxable year) of $940,000, assets 
held in the United States of $1,000,000 (as of the end of the taxable 
year), policy and other contract liability requirements in the amount of 
$30,000 required interest in the amount of $20,000, and a current 
earnings rate of 4 percent. In order to determine whether section 819(b) 
applies for the taxable year 1958, P must first compute its minimum 
figure, for if the minimum figure is less than the surplus held in the 
United States (as of the end of the taxable year), no section 819(b) 
adjustments need be made. Since the minimum figure, $84,600 ($940,000, 
the total insurance liabilities on United States business multiplied by 
9 percent, the percentage applicable for 1958), exceeds the surplus held 
in the United States, $60,000 (the excess of the assets held in the 
United States, $1,000,000, over the total insurance liabilities on 
United States business, $940,000), by $24,600, section 819(b) applies 
for the taxable year 1958. Thus, the amount of the policy and other 
contract liability requirements, $30,000, and the amount of the required 
interest, $20,000, shall each be reduced by $984 ($24,600, the amount of 
such excess, multiplied by 4 percent, the current earnings rate).


[[Page 818]]


    (4) Segregated asset accounts. For taxable years beginning after 
December 31, 1967, pursuant to the provisions of section 801(g):
    (i) A foreign corporation carrying on a life insurance business 
which issues contracts based on segregated asset accounts shall 
separately compute in a manner consistent with this subparagraph the 
adjustment (if any) under section 819 to the amount of policy and other 
contract liability requirements and the amount of required interest 
properly attributable to each of such segregated asset accounts. The 
``minimum figure'' used in section 819 in making the adjustment with 
respect to each of the segregated asset accounts shall be computed as 
provided in subdivision (ii) of this subparagraph in lieu of the manner 
provided in subparagraphs (1), (2), and (3) of this paragraph.
    (ii) The minimum figure applicable to a segregated asset account 
referred to in subdivision (i) of this subparagraph is the amount 
determined by multiplying the total insurance liabilities on U.S. 
business attributable to such a segregated asset account, by 1 percent.
    (iii) The minimum figure as computed under subdivision (ii) of this 
subparagraph shall be compared only with the surplus held in the United 
States attributable to each segregated asset account referred to in 
subdivision (i) of this subparagraph. Such surplus is the excess of 
assets held in the United States properly attributable to such 
segregated asset account over the total insurance liabilities on U.S. 
business properly attributable to such account.
    (iv) If the minimum figure applicable to accounts other than 
segregated asset accounts exceeds the surplus held in the United States 
attributable to such other accounts, for purposes of section 819 and 
this paragraph, the amount of such excess shall not exceed the company's 
overall excess, as defined in this subdivision. No adjustment under 
section 819 or this paragraph shall be made with respect to any account 
if there is no such overall excess. For purposes of this subdivision and 
of subdivision (v) of this subparagraph, the term ``overall excess'' 
means the amount, if any, by which the aggregate minimum figures 
applicable to segregated asset accounts plus the minimum figure 
applicable to accounts other than segregated asset accounts exceeds the 
surplus held in the United States with respect to the company's entire 
U.S. life insurance business, including segregated asset accounts as 
well as other accounts.
    (v) In the case of a company which issues contracts based on one or 
more than one segregated asset account, if the minimum figure applicable 
to a segregated asset account exceeds the surplus held in the United 
States attributable to such account, then for purposes of section 819 
and this paragraph, the amount of such excess shall not exceed the 
account limitation figure, as defined in this subdivision. Therefore, no 
adjustment under section 819 or under this subparagraph shall be made 
with respect to any segregated asset account if the aggregate of the 
account limitation figures is zero, but nothing in this subdivision 
shall preclude an adjustment under section 819 with respect to accounts 
other than segregated asset accounts. For purposes of this subdivision, 
the term ``account limitation figure'' is a segregated assets account's 
proportionate share of the aggregate of the account limitation figures. 
Such aggregate of the account limitation figures is equal to the lesser 
of either the company's overall excess as defined in subdivision (iv) of 
this subparagraph, or the amount, if any, by which the aggregate of the 
minimum figures applicable to segregated asset accounts exceeds the 
surplus held in the United States with respect to all such segregated 
asset accounts. For purposes of this subdivision, a segregated asset 
account's proportionate share of the aggregate of the account limitation 
figures is determined by multiplying the amount of such aggregate of 
account limitation figures by a percentage, the numerator of which is 
the amount by which the minimum figure applicable to such account 
exceeds the surplus held in the United States attributable to such 
account, and the denominator of which is the aggregate of the amounts by 
which the minimum figure applicable to each segregated asset account 
exceeds the

[[Page 819]]

surplus held in the United States attributable to such account.
    (vi) Subdivisions (i), (ii), (iii), (iv), and (v) of this 
subparagraph may be illustrated by the following examples:

    Example 1. (a) For the taxable year 1968, T, a foreign life 
insurance company carrying on a life insurance business within the 
United States and taxable under section 802, has the following assets 
and total insurance liabilities with respect to such U.S. business:

------------------------------------------------------------------------
                                     Regular      Separate     Separate
                                     account     account A    account B
------------------------------------------------------------------------
Assets...........................   $9,300,000   $1,810,000     $515,000
Total insurance liabilities......    8,000,000    1,800,000      500,000
------------------------------------------------------------------------


It is further assumed that the percentage determined and proclaimed by 
the Secretary under section 819(a)(2)(A) for the taxable year 1968 is 15 
percent.
    (b) In order to determine whether any adjustment under section 819 
must be made, T must compute the minimum figure applicable to its 
Regular Account as well as each of its Separate Accounts. The minimum 
figure for the Regular Account is $1,200,000 (15 percent of $8,000,000). 
The minimum figure applicable to Separate Account A is $18,000 (1 
percent of $1,800,000). The minimum figure applicable to Separate 
Account B is $5,000 (1 percent of $500,000). The aggregate of the 
minimum figures is $1,223,000 ($1,200,000+$18,000+$5,000). The surplus 
held in the United States with respect to the Regular Account is 
$1,300,000 ($9,300,000-$8,000,000), with respect to Separate Account A 
is $10,000 ($1,810,000-$1,800,000) and with respect to Separate Account 
B is $15,000 ($515,000-$500,000). The surplus held in the United States 
with respect to T's entire U.S. life insurance business is $1,325,000 
($1,300,000+$10,000+$15,000).
    (c) Since the aggregate of the minimum figures ($1,223,000) does not 
exceed the surplus held in the United States attributable to T's entire 
U.S. life insurance business ($1,325,000), under subdivision (iv) of 
this subparagraph no adjustment under section 819 shall be made with 
respect to the Regular Account or either of the Separate Accounts.
    Example 2. (a) The facts are the same as in example 1 except that 
the assets held in the United States with respect to the Regular Account 
is $8,300,000 instead of $9,300,000. Thus, the surplus held in the 
United States with respect to the Regular Account is $300,000 
($8,300,000-$8,000,000), and the surplus held in the United States with 
respect to T's entire U.S. life insurance business is $325,000 
($300,000+$10,000 +$15,000).
    (b) Since the aggregate of the minimum figures with respect to the 
Separate Accounts, $23,000 ($18,000+$5,000), does not exceed the surplus 
held in the United States with respect to both of such Separate 
Accounts, $25,000 ($10,000+$15,000), under subdivision (v) of this 
subparagraph, no adjustment under section 819 must be made with respect 
to either of the Separate Accounts.
    (c) The excess of the minimum figure for the Regular Account 
($1,200,000) over the surplus held in the United States with respect to 
the Regular Account ($300,000) is equal to $900,000 ($1,200,000-
$300,000). However, the company's overall excess as defined in 
subdivision (iv) of this subparagraph, is $898,000 ($1,223,000-
$325,000). Under subdivision (iv) of this subparagraph the excess with 
respect to the Regular Account ($900,000) is limited to the amount of 
overall excess ($898,000). Thus, the amount of policy and other contract 
liability requirements with respect to T's Regular Account and the 
amount of required interest with respect to T's Regular Account (both 
computed without regard to section 819) shall each be reduced by an 
amount equal to the product of $898,000 and the current earnings rate 
computed only with respect to T's Regular Account.

    (c) Distributions to shareholders--(1) In general. In the case of a 
foreign life insurance company carrying on a life insurance business 
within the United States and taxable under section 802, section 
819(c)(1) provides alternative methods for determining the amount of 
distributions to shareholders for purposes of section 815 (relating to 
distributions to shareholders) and section 802(b)(3) (relating to life 
insurance company taxable income). Such a foreign life insurance company 
may elect (in the manner provided by subparagraph (4) of this paragraph) 
for each taxable year whichever of the alternative methods provided by 
section 819(c)(1) and this subparagraph it desires, and the method 
elected for any one taxable year shall be effective only with respect to 
the taxable year for which the election is made. Such alternative 
methods are:
    (i) The amount of the distributions to shareholders shall be the 
amount determined by multiplying the total amount of distributions to 
shareholders by the percentage which the minimum figure for the taxable 
year is of the excess of the assets of the company over the total 
insurance liabilities; or
    (ii) The amount of the distributions for shareholders shall be the 
amount determined by multiplying the total

[[Page 820]]

amount of distributions for shareholders by the percentage which the 
total insurance liabilities on United States business for the taxable 
year is of the total insurance liabilities of the company.
    (2) Definitions. For purposes of section 819(c)(1) and subparagraph 
(1) of this paragraph:
    (i) The term total amount of the distributions to shareholders means 
all distributions (within the meaning of section 815 and Sec. 1.815-2) 
by a foreign life insurance company to all of its shareholders whether 
or not in the United States;
    (ii) The term minimum figure for the taxable year means the amount 
determined under section 819(b)(2)(A) and paragraph (b)(2) of this 
section;
    (iii) The term assets of the company means all of the assets (as 
defined in section 805(b) (4) and paragraph (a) (4) of Sec. 1.805-5) of 
the foreign life insurance company whether or not in the United States 
(as of the end of the taxable year); and
    (iv) The term total insurance liabilities of the company means the 
total insurance liabilities (as defined in section 819(b)(2) and 
paragraph (b)(2) of this section) on all of its business whether or not 
in the United States (as of the end of the taxable year).
    (3) Illustration of principles. The provisions of section 819(c)(1) 
and subparagraphs (1) and (2) of this paragraph may be illustrated by 
the following examples:

    Example 1. For the taxable year 1958, T, a foreign life insurance 
company carrying on a life insurance business within the United States 
and taxable under section 802, has a minimum figure of $40,000, total 
amount of distributions to all shareholders (within the meaning of 
section 815) of $5,000, assets (as of the end of the year) of $500,000, 
total insurance liabilities (as of the end of the year) of $450,000, and 
total insurance liabilities on United States business (as of the end of 
the year) of $180,000. Based upon these facts, if T elects the method 
provided in section 819(c)(1)(A) and subparagraph (1)(i) of this 
paragraph, the amount of T's distributions to shareholders for the 
taxable year 1958 is $4,000, that is, $5,000 (the total amount of 
distributions to shareholders) multiplied by 80 percent (the percentage 
which the minimum figure for the taxable year, $40,000, is of $50,000, 
the excess of the assets of the company ($500,000) over the total 
insurance liabilities ($450,000)).
    Example 2. The facts are the same as in example 1, except that for 
the taxable year 1958, T elects the method provided in section 
819(c)(1)(B) and subparagraph (1)(ii) of this paragraph. Based upon 
these facts, the amount of T's distributions to shareholders for the 
taxable year 1958 is $2,000, that is, $5,000 (the total amount of 
distributions to shareholders) multiplied by 40 percent (the percentage 
which the total insurance liabilities on United States business 
($180,000) is of the total insurance liabilities of the company 
($450,000)).

    (4) Manner and effect of election. (i) The election provided by 
section 819(c)(1) shall be made in a statement attached to the foreign 
life insurance company's income tax return for any taxable year for 
which the company desires the election to apply. The return and 
statement must be filed not later than the date prescribed by law 
(including extensions thereof) for filing the return for such taxable 
year. The statement shall indicate the method elected, the name and 
address of the taxpayer, and shall be signed by the taxpayer (or his 
duly authorized representative).
    (ii) An election made under section 819(c)(1) and this paragraph 
shall be effective only with respect to the taxable year for which the 
election is made. Thus, the company must make a new election for each 
taxable year for which it desires the election to apply. Once such 
election has been made for any taxable year it may not be revoked. 
However, for taxable years beginning prior to April 4, 1961, a company 
may revoke the election provided by section 819(c)(1) without obtaining 
consent from the Commissioner by filing, before July 4, 1961, a 
statement that the company desires to revoke such election. An amended 
return reflecting such revocation and the selection of the other 
percentage must accompany the statement for all taxable years for which 
returns have been filed with respect to such election.
    (5) Application of section 815. Once the amount of distributions to 
shareholders is determined under the provisions of section 819(c)(1) and 
this paragraph, the rules of section 815 (relating to distributions to 
shareholders) shall

[[Page 821]]

apply to the shareholders surplus account and the policyholders surplus 
account of a foreign stock life insurance company in the same manner as 
they would apply to a domestic stock life insurance company.
    (d) Distributions pursuant to certain mutualizations. Section 
819(c)(2) provides that for purposes of applying section 815(e) and 
paragraph (e) of Sec. 1.815-6 (relating to a special rule for certain 
mutualizations) in the case of a foreign life insurance company subject 
to tax under section 802:
    (1) The paid-in capital and paid-in surplus referred to in section 
815(e)(1)(A) of a foreign life insurance company is the portion of such 
capital and surplus determined by multiplying such amounts by the 
percentage selected for the taxable year under section 819(c)(1) and 
paragraph (c)(1) of this section; and
    (2) The excess referred to in section 815(e)(2)(A)(i) (without the 
adjustment provided by section 815(e)(2)(B)), is whichever of the 
following is the greater:
    (i) The minimum figure for 1958 determined under section 
819(b)(2)(A); or
    (ii) The surplus held in the United States (as defined in section 
819(b)(2)(B)) determined as of December 31, 1958.
    (e) No United States insurance business. Foreign life insurance 
companies not carrying on an insurance business within the United States 
shall not be taxable under part I, subchapter L, chapter 1 of the Code, 
but shall be taxable as other foreign corporations. See section 881 and 
the regulations thereunder.

[T.D. 6558, 26 FR 2791, Apr. 4, 1961; 26 FR 3276, Apr. 18, 1961, as 
amended by T.D. 6970, 33 FR 12044, Aug. 24, 1968]

    Editorial Note: For a determination with respect to the percentage 
to be used by foreign life insurance companies in computing income tax 
for the taxable year 1984 and the estimated tax for taxable year 1985, 
see 51 FR 883, Jan. 9, 1986.

Mutual Insurance Companies (Other Than Life and Certain Marine Insurance 
Companies and Other Than Fire or Flood Insurance Companies Which Operate 
           on Basis of Perpetual Policies or Premium Deposits)



Sec. 1.821-1  Tax on mutual insurance companies other than life or
marine or fire insurance companies subject to the tax imposed by
section 831.

    (a) In general. (1) For taxable years beginning after December 31, 
1953, but before January 1, 1955, and ending after August 16, 1954, all 
mutual insurance companies, including foreign insurance companies 
carrying on an insurance business within the United States, not taxable 
under section 801 or 831 and not specifically exempt under the 
provisions of section 501(c)(15), are subject to the tax imposed by 
section 821 on their investment income or on their gross income, 
whichever tax is the greater, except interinsurers and reciprocal 
underwriters which are taxed only on their investment income. For the 
alternative tax, in lieu of the tax imposed by section 821 (a) or (b), 
where the net long-term capital gain for any taxable year exceeds the 
net short-term capital loss, see section 1201(a) and the regulations 
thereunder.
    (2) The taxable income of mutual insurance companies subject to the 
tax imposed by section 821 differs from the taxable income of other 
corporations. See section 821(a)(2) and section 822. Such companies are 
entitled, in computing mutual insurance company taxable income, to the 
deductions provided in part VIII (section 241 and following, except 
section 248), subchapter B, chapter 1 of the Code. The gross amount of 
income during the taxable year from interest, the deduction under 
section 822(c)(1) for wholly tax-exempt interest, and the deduction 
under section 242 for partially tax-exempt interest, are decreased by 
the appropriate amortization of premium and increased by the appropriate 
accrual of discount attributable to the taxable year on bonds, notes, 
debentures or other evidences of indebtedness held by a mutual insurance 
company subject to the tax imposed by section 821. See section 822(d)(2) 
and Sec. 1.822-3.

[[Page 822]]

    (3) All provisions of the Code and of the regulations in this part 
not inconsistent with the specific provisions of section 821 are 
applicable to the assessment and collection of the tax imposed by 
section 821 (a) or (b) and mutual insurance companies subject to the tax 
imposed by section 821 are subject to the same penalties as are provided 
in the case of returns and payment of income tax by other corporations. 
The return shall be on Form 1120M.
    (4) Foreign mutual insurance companies not carrying on an insurance 
business within the United States are not taxable under section 821 (a) 
or (b), but are taxable as other foreign corporations. See section 881.
    (5) Mutual insurance companies subject to the tax imposed by section 
821, except interinsurers or reciprocal underwriters, with mutual 
insurance company taxable income (computed without regard to the 
deduction provided in section 242 for partially tax-exempt interest) of 
over $3,000 or with gross amounts of income from interest, dividends, 
rents, and net premiums (minus dividends to policyholders and wholly 
tax-exempt interest) in excess of $75,000, are subject to a tax computed 
under section 821(a)(1) or section 821(a)(2) whichever is the greater. 
Interinsurers and reciprocal underwriters with mutual insurance company 
taxable income (computed without regard to the deduction provided in 
section 242 for partially tax-exempt interest) of over $50,000 are 
subject to a tax computed under section 821(b).
    (b) Rates of tax. (1) The normal tax under section 821(a)(1)(A) and 
821(b)(1), except as hereinafter indicated, is computed upon mutual 
insurance company taxable income for purposes of the normal tax at the 
rate of 30 percent.
    (2) The surtax under section 821(a)(1)(B) and 821(b)(2), except as 
hereinafter indicated, is computed on that portion of the mutual 
insurance company taxable income for purposes of the surtax in excess of 
$25,000 at the rate of 22 percent. The tax under section 821(a)(2), 
except as hereinafter indicated, is 1 percent of the gross amount of 
income from interest, dividends, rents, and net premiums, minus 
dividends to policyholders and minus wholly tax-exempt interest.
    (3) Under section 821(a)(1)(A) companies with mutual insurance 
company taxable income for purposes of the normal tax of over $3,000 and 
not over $6,000 pay a normal tax, at a specified rate, on that portion 
of such income in excess of $3,000. The rate applicable in computing the 
normal tax of such companies is 60 percent. Under section 821(a)(2) 
companies with gross amounts of income from interest dividends, rents, 
and net premiums, minus dividends to policyholders and minus wholly tax-
exempt interest, of over $75,000 and not over $150,000 pay a tax equal 
to 2 percent of that portion in excess of $75,000.
    (4) Under section 821(b)(1) interinsurers and reciprocal 
underwriters with mutual insurance company taxable income for purposes 
of the normal tax of over $50,000 and not over $100,000 pay a normal tax 
computed on that portion of such income in excess of $50,000 at the rate 
of 60 percent. Under section 821(b)(2) interinsurers and reciprocal 
underwriters with mutual insurance company taxable income for purposes 
of the surtax of over $50,000 and not over $100,000 pay a surtax, at the 
rate of 33 percent, on that portion of such income in excess of $50,000.
    (5) Section 821(c) provides for an adjustment of the amount computed 
under section 821(a)(1), section 821(a)(2), and section 821(b) where the 
gross amount received during the taxable year from interest, dividends, 
rents, and premiums (including deposits and assessments) is over $75,000 
and less than $125,000. The adjustment reduces the tax otherwise 
computed under those sections to an amount which bears the same 
proportion to such tax as the excess over $75,000 bears to $50,000.
    (c) Application. The application of section 821 (a) to (c) 
inclusive, may be illustrated by the following examples:

    Example 1. The W Company, a mutual casualty insurance company, for 
the calendar year 1954, has mutual insurance company taxable income for 
purposes of the surtax of $5,500 and, due to partially tax-exempt 
interest of $800, has income for purposes of the normal tax of $4,700. 
The gross amount of income of the W Company from interest, dividends, 
rents and net premiums, minus dividends to policyholders and wholly tax-
exempt interest, is $150,000. Its normal tax

[[Page 823]]

under section 821(a)(1) for the calendar year 1954 is 60 percent of 
$1,700 ($4,700 minus $3,000) or $1,020, since its income subject to 
normal tax is not over $6,000. It is not liable for surtax for the 
calendar year 1954 as its mutual insurance company taxable income for 
purposes of the surtax does not exceed $25,000. It has no surtax and, 
therefore, its total tax under section 821(a)(1)(A) is the normal tax of 
$1,020. The tax under section 821(a)(2) is 2 percent of $75,000 
($150,000-$75,000), or $1,500. Since the tax under section 821(a)(2) 
exceeds the tax under section 821(a)(1), the tax under section 821 is 
$1,500, namely, that imposed by section 821(a)(2).
    Example 2. If in example 1 the income for purposes of the normal tax 
were not over $3,000, the income for purposes of the surtax were not 
over $25,000, the gross amount received from interest, dividends, rents, 
and premiums (including deposits and assessments) were $90,000, and the 
gross amount of income from interest, dividends, rents, and net 
premiums, minus dividends to policyholders and wholly tax-exempt 
interest, were $70,000, the W Company would be required to file an 
income tax return but due to section 821(a) no income tax would be 
imposed.
    Example 3. The X Company, a mutual casualty insurance company, for 
the calendar year 1954 has mutual insurance company taxable income for 
surtax purposes of $28,000 and, due to partially tax-exempt interest of 
$5,000, has income for normal tax purposes of $23,000. The gross amount 
of income of the X Company from interest, dividends, rents, and net 
premiums, minus dividends to policyholders and wholly tax-exempt 
interest, is $1,200,000. Under section 821(a)(1) its normal tax for the 
calendar year 1954 is 30 percent of $23,000, or $6,900, and the surtax 
is 22 percent of $3,000 ($28,000-$25,000), or $660. The combined tax 
under section 821(a)(1) is $7,560 ($6,900 plus $660). The tax under 
section 821(a)(2) is 1 percent of $1,200,000, or $12,000. Since the tax 
under section 821(a)(2) exceeds the tax under section 821(a)(1), the tax 
under section 821(a) is $12,000, namely, that imposed by section 
821(a)(2).
    Example 4. The Y Company, a mutual fire insurance company subject to 
the tax imposed by section 821 for the calendar year 1954, has mutual 
insurance company taxable income for purposes of the surtax of $35,000 
and, due to partially tax-exempt interest of $5,000, has income for 
purposes of the normal tax of $30,000. The gross amount received from 
interest, dividends, rents and premiums (including deposits and 
assessments) is $120,000, and the gross amount of income from interest, 
dividends, rents, and net premiums, minus dividends to policyholders and 
wholly tax-exempt interest, is $100,000. Under section 821(a)(1), 
without application of section 821(c), the normal tax would be 30 
percent of $30,000, or $9,000, since this is less than $16,200, 60 
percent of $27,000 (excess of $30,000 over $3,000); and the surtax would 
be 22 percent of $10,000 (excess of $35,000 over $25,000), or $2,200. 
The combined tax of $11,200 ($9,000 plus $2,200) would then be reduced 
by applying section 821(c), since the gross receipts are between $75,000 
and $125,000. The tax under section 821(a)(1), as thus adjusted, would 
be 90 percent of $11,200, or $10,080, since $45,000 (excess of $120,000 
over $75,000) is 90 percent of $50,000. Under section 821(a)(2), without 
reference to section 821(c), the tax is 2 percent of $25,000 (excess of 
$100,000 over $75,000), or $500, since this is less than $1,000, 1 
percent of $100,000. Applying section 821(c) reduces this to $450, or 90 
percent of $500. Since $10,080, the tax under section 821(a)(1), as 
adjusted, exceeds $450, the tax under section 821(a)(2), as adjusted, 
the tax under section 821(a)(1), as adjusted, is applicable. The Y 
Company would accordingly pay a combined normal taxing and surtax of 
$10,080.
    Example 5. The Z Exchange, an interinsurer, for the calendar year 
1954 has mutual insurance company taxable income for purposes of the 
surtax of $60,000 and, due to partially tax-exempt interest of $12,000, 
has income for purposes of the normal tax of $48,000. The gross amount 
received from interest, dividends, rents, and premiums (including 
deposits and assessments) is $2,700,000. The Z Exchange is not liable 
for normal tax under section 821(b)(1) for the calendar year 1954 as its 
mutual insurance company taxable income for purposes of the normal tax 
does not exceed $50,000. Its surtax is 33 percent of $10,000 ($60,000 
minus $50,000), or $3,300, since that amount is less than $7,700, 22 
percent of $35,000 (excess of $60,000 over $25,000). Since the Z 
Exchange has no normal tax, is not subject to the tax imposed by section 
821(a)(2), and is not entitled to the adjustment provided in section 
821(c), its total tax under section 821(a) is $3,300.



Sec. 1.821-2  Taxable years affected.

    Section 1.821-1 is applicable only to taxable years beginning after 
December 31, 1953, but before January 1, 1955, and ending after August 
16, 1954, and all references to sections of part II, subchapter L, 
chapter 1 of the Code are to the Internal Revenue Code of 1954, before 
amendments. Section 1.821-3 is applicable only to taxable years 
beginning after December 31, 1954, but before January 1, 1963, and all 
references to sections of part II, subchapter L, chapter 1 of the Code 
are to the Internal Revenue Code of 1954, as amended by the Life 
Insurance Company Tax Act for 1955 (70 Stat. 36). Sections 1.821-4 and 
1.821-5 are applicable only to taxable years beginning after December 
31,

[[Page 824]]

1962, and all references to sections of parts II and III, subchapter L, 
chapter 1 of the Code are to sections of the Internal Revenue Code of 
1954 as amended by section 8 of the Revenue Act of 1962 (76 Stat. 989).

[T.D. 6681, 28 FR 11110, Oct. 17, 1963]



Sec. 1.821-3  Tax on mutual insurance companies other than life or
marine or fire insurance companies subject to the tax imposed by
section 831.

    (a) In general. (1) For taxable years beginning after December 31, 
1954, all mutual insurance companies, including foreign insurance 
companies carrying on an insurance business within the United States, 
not taxable under section 802 or 831 and not specifically exempt under 
the provisions of section 501(c)(15), are subject to the tax imposed by 
section 821 on their investment income or on their gross income, 
whichever tax is the greater, except interinsurers and reciprocal 
underwriters which are taxed only on their investment income. For the 
alternative tax, in lieu of the tax imposed by section 821 (a) or (b), 
where the net long-term capital gain for any taxable year exceeds the 
net short-term capital loss, see section 1201(a) and the regulations 
thereunder.
    (2) The taxable income of mutual insurance companies subject to the 
tax imposed by section 821 differs from the taxable income of other 
corporations. See section 821(a)(2) and section 822. Such companies are 
entitled, in computing mutual insurance company taxable income, to the 
deductions provided in part VIII (section 241 and following, except 
section 248), subchapter B, chapter 1 of the Code. The gross amount of 
income during the taxable year from interest, the deduction under 
section 822(c)(1) for wholly tax-exempt interest, and the deduction 
under section 242 for partially tax-exempt interest, are decreased by 
the appropriate amortization of premium and increased by the appropriate 
accrual of discount attributable to the taxable year on bonds, notes, 
debentures or other evidences of indebtedness held by a mutual insurance 
company subject to the tax imposed by section 821. See section 822(d)(2) 
and Sec. 1.822-7. However, for taxable years beginning after May 31, 
1960, only the accrual of discount relating to issue discount will 
increase the deduction for wholly tax-exempt interest. See section 103. 
In the case of any such evidence of indebtedness, adjustment shall be 
made to basis in the same manner as that made by life insurance 
companies under section 1016(a)(17) and the regulations thereunder.
    (3) All provisions of the Internal Revenue Code and of the 
regulations in this part not inconsistent with the specific provisions 
of section 821 are applicable to the assessment and collection of the 
tax imposed by section 821 (a) or (b) and mutual insurance companies 
subject to the tax imposed by section 821 are subject to the same 
penalties as are provided in the case of returns and payment of income 
tax by other corporations. The return shall be on Form 1120M.
    (4) Foreign mutual insurance companies not carrying on an insurance 
business within the United States are not taxable under section 821 (a) 
or (b), but are taxable as other foreign corporations. See section 881.
    (5) Mutual insurance companies subject to the tax imposed by section 
821, except interinsurers or reciprocal underwriters, with mutual 
insurance company taxable income (computed without regard to the 
deduction provided in section 242 for partially tax-exempt interest) of 
over $3,000 or with gross amounts of income during the taxable year from 
the items described in section 822(b) (other than paragraph (1)(D) 
thereof) and net premiums (minus dividends to policyholders and wholly 
tax-exempt interest) in excess of $75,000, are subject to a tax computed 
under section 821(a)(1) or section 821(a)(2) whichever is the greater. 
Interinsurers and reciprocal underwriters with mutual insurance company 
taxable income (computed without regard to the deduction provided in 
section 242 for partially tax-exempt interest) of over $50,000 are 
subject to a tax computed under section 821(b).
    (b) Rates of tax. (1) For taxable years beginning before July 1, 
1963, the normal tax under section 821(a)(1)(A) and

[[Page 825]]

821(b)(1), except as hereinafter indicated, is computed upon mutual 
insurance company taxable income for purposes of the normal tax at the 
rate of 30 percent.
    (2) The surtax under section 821(a)(1)(B) and 821(b)(2), except as 
hereinafter indicated, is computed on that portion of the mutual 
insurance company taxable income for the purposes of the surtax in 
excess of $25,000 at the rate of 22 percent. The tax under section 
821(a)(2), except as hereinafter indicated, is 1 percent of the gross 
amount of income during the taxable year from the items described in 
section 822(b) (other than paragraph (1)(D) thereof) and net premiums, 
minus dividends to policyholders and minus wholly tax-exempt interest.
    (3) For taxable years beginning before July 1, 1963, under section 
821(a)(1)(A) companies with mutual insurance company taxable income for 
purposes of the normal tax of over $3,000 and not over $6,000 pay a 
normal tax, at a specified rate, on that portion of such income in 
excess of $3,000. The rate applicable in computing the normal tax of 
such companies is 60 percent. Under section 821(a)(2) companies with 
gross amounts of income during the taxable year from the items described 
in section 822(b) (other than paragraph (1)(D) thereof) and net 
premiums, minus dividends to policyholders and minus wholly tax-exempt 
interest, of over $75,000 and not over $150,000 pay a tax equal to 2 
percent of that portion in excess of $75,000.
    (4) For taxable years beginning before July 1, 1963, under section 
821(b)(1) interinsurers and reciprocal underwriters with mutual 
insurance company taxable income for purposes of the normal tax of over 
$50,000 and not over $100,000 pay a normal tax computed on that portion 
of such income in excess of $50,000 at the rate of 60 percent. Under 
section 821(b)(2) interinsurers and reciprocal underwriters with mutual 
insurance company taxable income for purposes of the surtax of over 
$50,000 and not over $100,000 pay a surtax, at the rate of 33 percent, 
on that portion of such income in excess of $50,000.
    (5) Section 821(c) provides for an adjustment of the amount computed 
under section 821(a)(1), section 821(a)(2), and section 821(b) where the 
gross amount received during the taxable year from the items described 
in section 822(b) (other than paragraph (1)(D) thereof) and premiums 
(including deposits and assessments) is over $75,000 and less than 
$125,000. The adjustment reduces the tax otherwise computed under those 
sections to an amount which bears the same proportion to such tax as the 
excess over $75,000 bears to $50,000.
    (c) Application. The application of section 821 (a) to (c) 
inclusive, may be illustrated by the following examples:

    Example 1. The W Company, a mutual casualty insurance company, for 
the calendar year 1958, has mutual insurance company taxable income for 
purposes of the surtax of $5,500 and, due to partially tax-exempt 
interest of $800, has income for purposes of the normal tax of $4,700. 
The gross amount of income of the W Company from the items described in 
section 822(b) (other than paragraph (1)(D) thereof) and net premiums, 
minus dividends to policyholders and wholly tax-exempt interest, is 
$150,000. Its normal tax under section 821(a)(1) for the calendar year 
1958 is 60 percent of $1,700 ($4,700 minus $3,000) or $1,020, since its 
income subject to normal tax is not over $6,000. It is not liable for 
surtax for the calendar year 1958 as its mutual insurance company 
taxable income for purposes of the surtax does not exceed $25,000. It 
has no surtax and, therefore, its total tax under section 821(a)(1)(A) 
is the normal tax of $1,020. The tax under section 821(a)(2) is 2 
percent of $75,000 ($150,000- $75,000), or $1,500. Since the tax under 
section 821(a)(2) exceeds the tax under section 821(a)(1), the tax under 
section 821 is $1,500, namely, that imposed by section 821(a)(2).
    Example 2. If in the above example the income for purposes of the 
normal tax were not over $3,000, the income for purposes of the surtax 
were not over $25,000, the gross amount received from interest, 
dividends, rents, and premiums (including deposits and assessments) were 
$90,000, and the gross amount of income from the items described in 
section 822(b) (other than paragraph (1)(D) thereof) and net premiums, 
minus dividends to policyholders and wholly tax-exempt interest were 
$70,000, the W Company would be required to file an income tax return 
but due to section 821(a) no income tax would be imposed.
    Example 3. The X Company, a mutual casualty insurance company, for 
the calendar year 1958, has mutual insurance company taxable income for 
surtax purposes of $28,000 and, due to partially tax-exempt interest of 
$5,000, has income for normal tax purposes of

[[Page 826]]

$23,000. The gross amount of income of the X Company received during the 
taxable year from the items described in section 822(b) (other than 
paragraph (1)(D) thereof) and net premiums, minus dividends to 
policyholders and wholly tax-exempt interest, is $1,200,000. Under 
section 821(a)(1) its normal tax for the calendar year 1958 is 30 
percent of $23,000, or $6,900, and the surtax is 22 percent of $3,000 
($28,000-$25,000), or $660. The combined tax under section 821(a)(1) is 
$7,560 ($6,900 plus $660). The tax under section 821(a)(2) is 1 percent 
of $1,200,000, or $12,000. Since the tax under section 821(a)(2) exceeds 
the tax under section 821(a)(1), the tax under section 821(a) is 
$12,000, namely, that imposed by section 821(a)(2).
    Example 4. The Y Company, a mutual fire insurance company subject to 
the tax imposed by section 821 for the calendar year 1958, has mutual 
insurance company taxable income for purposes of the surtax of $35,000 
and, due to partially tax-exempt interest of $5,000, has income for 
purposes of the normal tax of $30,000. The gross amount received during 
the taxable year from the items described in section 822(b) (other than 
paragraph (1)(D) thereof) and premiums (including deposits and 
assessments) is $120,000, and the gross amount of income from interest, 
dividends, rents, and net premiums, minus dividends to policyholders and 
wholly tax-exempt interest, is $100,000. Under section 821(a)(1), 
without application of section 821(c), the normal tax would be 30 
percent of $30,000, or $9,000, since this is less than $16,200, 60 
percent of $27,000 (excess of $30,000 over $3,000); and the surtax would 
be 22 percent of $10,000 (excess of $35,000 over $25,000), or $2,200. 
The combined tax of $11,200 ($9,000 plus $2,200) would then be reduced 
by applying section 821(c), since the gross receipts are between $75,000 
and $125,000. The tax under section 821(a)(1), as thus adjusted, would 
be 90 percent of $11,200, or $10,080, since $45,000 (excess of $120,000 
over $75,000) is 90 percent of $50,000. Under section 821(a)(2), without 
reference to section 821(c), the tax is 2 percent of $25,000 (excess of 
$100,000 over $75,000), or $500, since this is less than $1,000, 1 
percent of $100,000. Applying section 821(c) reduces this to $450, or 90 
percent of $500. Since $10,080, the tax under section 821(a)(1), as 
adjusted, exceeds $450, the tax under section 821(a)(2), as adjusted, 
the tax under section 821(a)(1), as adjusted, is applicable. The Y 
Company would accordingly pay a combined normal tax and surtax of 
$10,080.
    Example 5. The Z Exchange, an interinsurer, for the calendar year 
1958 has mutual insurance company taxable income for purposes of the 
surtax of $60,000 and, due to partially tax-exempt interest of $12,000, 
has income for purposes of the normal tax of $48,000. The gross amount 
received during the taxable year from the items described in section 
822(b) (other than paragraph (1)(D) thereof) and premiums (including 
deposits and assessments) is $2,700,000. The Z Exchange is not liable 
for normal tax under section 821(b)(1) for the calendar year 1958 as its 
mutual insurance company taxable income for purposes of the normal tax 
does not exceed $50,000. Its surtax is 33 percent of $10,000 ($60,000 
minus $50,000), or $3,300, since that amount is less than $7,700, 22 
percent of $35,000 (excess of $60,000 over $25,000). Since the Z 
Exchange has no normal tax, is not subject to the tax imposed by section 
821(a)(2), and is not entitled to the adjustment provided in section 
821(c), its total tax under section 821(b) is $3,300.

[T.D. 6610, 27 FR 8718, Aug. 31, 1962]



Sec. 1.821-4  Tax on mutual insurance companies other than life 
insurance companies and other than fire, flood, or marine insurance
companies, subject to tax imposed by section 831.

    (a) In general--(1) Tax imposed. (i) For taxable years beginning 
after December 31, 1962, all mutual insurance companies, including 
foreign insurance companies carrying on an insurance business within the 
United States, not taxable under section 802 or 831, and not 
specifically exempt under the provisions of section 501(c)(15), are 
subject either to the tax imposed by section 821(a) on mutual insurance 
company taxable income or, in the case of certain small companies, to 
the tax imposed by section 821(c) on taxable investment income. The 
determination of whether a mutual insurance company is taxable under 
section 821 (a) or (c) for the taxable year is dependent upon the gross 
amount received by the company during such taxable year from the items 
described in section 822(b) (other than paragraph (1)(D) thereof) and 
premiums (including deposits and assessments). If such gross amount 
received exceeds $150,000, but does not exceed $500,000 for the taxable 
year, the company is subject to the tax imposed by section 821(c) on 
taxable investment income, unless (a) the company elects under section 
821(d) in the manner provided in paragraph (f) of this section to be 
subject to the tax imposed by section 821(a), or (b) there is a balance 
in its protection against loss account at the beginning of the taxable 
year. A company having a gross amount received in excess of $500,000 is 
subject to the tax imposed by section

[[Page 827]]

821(a). For exemption from income tax of companies having a gross amount 
received not in excess of $150,000, see section 501(c)(15). For the 
alternative tax, in lieu of the tax imposed by section 821 (a) or (c), 
where the net long-term capital gain for any taxable year exceeds the 
net short-term capital loss, see section 1201(a) and the regulations 
thereunder. For the definition of an insurance company, see paragraph 
(a) of Sec. 1.801-3.;
    (ii) The term ``premiums'' as used in section 821 and this section 
has the same meaning as in section 501(c)(15) and Sec. 1.501(c)(15)-1, 
and means the total amount of the premiums and other consideration 
provided in the insurance contract without any deduction for 
commissions, return premiums, reinsurance, dividends to policyholders, 
dividends left on deposit with the company, discounts on premiums paid 
in advance, interest applied in reduction of premiums (whether or not 
required to be credited in reduction of premiums under the terms of the 
contract), or any other item of similar nature. Such term includes 
advance premiums, premiums deferred and uncollected and premiums due and 
unpaid, deposits, fees, assessments, and consideration in respect of 
assuming liabilities under contracts not issued by the taxpayer (such as 
a payment or transfer of property in an assumption reinsurance 
transaction), but does not include amounts received from other insurance 
companies for losses paid under reinsurance contracts.
    (2) Tax base. The taxable income of mutual insurance companies 
taxable under section 821 differs from the taxable income of other 
corporations. See sections 821(b) and 822. Mutual insurance companies 
have special items of income and special deductions not provided for 
other corporations. See, for example, sections 821(b)(1)(C), 822(d), 
823(b), 824(a), and 825(a). Thus, the computation of mutual insurance 
company taxable income for a company taxable under section 821(a), and 
the computation of taxable investment income for a company taxable under 
section 821(c), must be made in strict accordance with the provisions of 
part II of subchapter L of the Code.
    (3) Applicability of other provisions. All provisions of the Code 
and of the regulations in this part not inconsistent with the specific 
provisions of part II of subchapter L of the Code are applicable to the 
assessment and collection of the tax imposed by section 821 (a) or (c), 
and mutual insurance companies subject to the tax imposed by section 821 
are subject to the same penalties as are provided in the case of returns 
and payment of income tax by other corporations. The return shall be on 
Form 1120M.
    (4) Certain foreign companies. Foreign mutual insurance companies 
(other than a life insurance company and other than a fire, flood, or 
marine insurance company subject to the tax imposed by section 831) not 
carrying on an insurance business within the United States are not 
taxable under section 821 (a) or (c), but are taxable as other foreign 
corporations. See section 881.
    (b) Rates of tax imposed by section 821(a)--(1) Normal tax. For 
taxable years beginning before January 1, 1964, the normal tax imposed 
under section 821(a) is the lesser of 30 percent of mutual insurance 
company taxable income, or 60 percent of the amount by which mutual 
insurance company taxable income exceeds $6,000. In the case of taxable 
years beginning after December 31, 1963, the normal tax is imposed at 
the rate of 22 percent of mutual insurance company taxable income, or 44 
percent of the amount by which mutual insurance company taxable income 
exceeds $6,000, whichever is the lesser. For example, a company subject 
to tax under section 821(a) will file a return but will pay no normal 
tax if mutual insurance company taxable income does not exceed $6,000. 
When mutual insurance company taxable income exceeds $6,000 but does not 
exceed $12,000, the company will pay a normal tax equal to 44 percent 
(60 percent in the case of taxable years beginning before Jan. 1, 1964), 
of the amount by which mutual insurance company taxable income exceeds 
$6,000. When mutual insurance company taxable income exceeds $12,000, 
the company will pay normal tax at the rate of 22 percent (30 percent in 
the case of taxable

[[Page 828]]

years beginning before Jan. 1, 1964), of such income.
    (2) Surtax--(i) Taxable years beginning before January 1, 1964. For 
taxable years beginning before January 1, 1964, companies taxable under 
section 821(a) are subject to a surtax equal to 22 percent of so much of 
their mutual insurance company taxable income (computed without regard 
to the deduction provided in section 242 for partially tax-exempt 
interest) as exceeds $25,000. In the case of an interinsurer or 
reciprocal underwriter electing to be subject to the limitation provided 
in section 826(b), the surtax applies to any increase in mutual 
insurance company taxable income attributable to such election, without 
regard to the $25,000 surtax exemption otherwise provided by this 
subparagraph, and without regard to whether the company is liable for 
any normal tax under subparagraph (1) of this paragraph. See section 
826(f) and Sec. 1.826-2.
    (ii) Taxable years beginning after December 31, 1963. For taxable 
years beginning after December 31, 1963, companies taxable under section 
821(a) are subject to a surtax at the rates and with the exemptions 
provided in section 11(c) on their mutual insurance company taxable 
income. In the case of an interinsurer or reciprocal underwriter 
electing to be subject to the limitation provided in section 826(b), the 
surtax applies to any increase in mutual insurance company taxable 
income attributable to such election, without regard to the surtax 
exemption otherwise provided by section 11(d), and without regard to 
whether the company is liable for any normal tax under section 821(a)(1) 
and subparagraph (1) of this paragraph. See section 826(f) and Sec. 
1.826-2.
    (c) Mutual insurance company taxable income defined. The tax imposed 
by section 821(a) with respect to any taxable year is computed upon 
mutual insurance company taxable income for the taxable year. Section 
821(b) provides that in the case of a mutual insurance company subject 
to the tax imposed by section 821(a), mutual insurance company taxable 
income means the amount by which:
    (1) The sum of:
    (i) The taxable investment income (as defined in section 822(a)(1) 
and paragraph (a)(1) of Sec. 1.822-8).
    (ii) The statutory underwriting income (as defined in section 
823(a)(1) and paragraph (b)(1) of Sec. 1.823-6), and
    (iii) The amounts required by section 824(d) and paragraph (b)(3) of 
Sec. 1.824-1 to be subtracted from the protection against loss account, 
exceeds.
    (2) The sum of:
    (i) The investment loss (as defined in section 822(a)(2) and 
paragraph (a)(2) of Sec. 1.822-8),
    (ii) The statutory underwriting loss (as defined in section 
823(a)(2) and paragraph (b)(2) of Sec. 1.823-6), and
    (iii) The unused loss deduction provided by section 825(a) and 
paragraph (a) of Sec. 1.825-1.

If for any taxable year the amount determined under subparagraph (2) of 
this paragraph equals or exceeds the amount determined under 
subparagraph (1) of this paragraph, the mutual insurance company taxable 
income for such year shall be zero.
    (d) Examples. The application of the tax imposed by section 821(a) 
may be illustrated by the following examples:

    Example 1. (a) M, a mutual casualty insurance company, for the 
calendar year 1963 has gross receipts from the items described in 
section 822(b) (other than paragraph (1)(D) thereof) and premiums 
(including deposits and assessments) in excess of $500,000, and 
therefore is subject to the tax imposed by section 821(a). M's taxable 
investment income, computed under section 822, is $30,000 and its 
statutory underwriting income, computed under section 823, is $15,000. M 
subtracts $3,000 from its protection against loss account in accordance 
with the computation made under section 824(d). M has no unused loss 
deduction. M received no partially tax exempt interest. If M is not 
subject to section 826, its mutual insurance company taxable income for 
the taxable year 1963 is $48,000, computed as follows:

(1) Taxable investment income.................................   $30,000
(2) Statutory underwriting income.............................    15,000
(3) Subtractions from protection against loss account.........     3,000
                                                               ---------
(4) Total income items........................................    48,000
                                                               ---------
(5) Investment loss...........................................         0
                                                               ---------
(6) Statutory underwriting loss...............................         0
                                                               ---------
(7) Unused loss deduction.....................................         0
                                                               ---------
(8) Total loss items..........................................         0
                                                               =========

[[Page 829]]

 
(9) Mutual insurance company taxable income (item (4) minus       48,000
 item (8))....................................................
 

    (b) Since M's mutual insurance company taxable income is in excess 
of $12,000, M will pay normal tax on its mutual insurance company 
taxable income at a rate of 30 percent. In addition, since M's mutual 
insurance company taxable income exceeds $25,000, M will pay surtax on 
such excess at a rate of 22 percent. M's total tax liability for the 
taxable year 1963 is $19,460, computed as follows:

(1) Mutual insurance company taxable income as computed in       $48,000
 item (a)(9)..................................................
(2) Normal tax; 30 percent of mutual insurance company taxable    14,400
 income.......................................................
(3) Surtax exemption..........................................    25,000
(4) Mutual insurance company taxable income subject to the        23,000
 surtax (item (1) minus item (3)).............................
(5) Surtax: 22 percent of mutual insurance company taxable         5,060
 income subject to the surtax.................................
(6) Total tax (item (2) plus item (5))........................    19,460
 

    Example 2. If in example 1, M's mutual insurance company taxable 
income for 1963 had been in excess of $6,000 but not in excess of 
$12,000, M would pay normal tax in an amount equal to 60 percent of the 
amount by which such income exceeded $6,000. Thus, if M had mutual 
insurance company taxable income of $11,000, M's total tax liability for 
the taxable year 1963 would be $3,000, computed as follows:

(1) Mutual insurance company taxable income...................   $11,000
(2) Mutual insurance company taxable income in excess of           5,000
 $6,000 ($11,000 minus $6,000)................................
(3) 30 percent of item (1)....................................     3,800
(4) 60 percent of item (2)....................................     3,000
(5) Normal tax (lesser of items (3) or (4))...................     3,000
(6) Surtax exemption..........................................    25,000
 


Since the surtax exemption exceeds the mutual insurance company taxable 
income for purposes of the surtax, there is no surtax liability. Since 
the normal tax under section 821(a) is the lesser of 30 percent of 
mutual insurance company taxable income or 60 percent of the amount by 
which such income exceeds $6,000, M's normal tax (and total income tax 
liability) is $3,000. If M's mutual insurance company taxable income was 
not in excess of $6,000, M would be required to file a return, but would 
not be liable for any normal tax, since, in such a case, 60 percent of 
M's mutual insurance company taxable income in excess of $6,000 would be 
zero.
    Example 3. Assume the same income as in example 1 in the 1965 
calendar year and that M is not a corporation to which section 1561 
(with respect to certain controlled corporations) applies. Since M's 
mutual insurance company taxable income is in excess of $12,000, M will 
pay normal tax on its mutual insurance company taxable income at a rate 
of 22 percent. In addition, since M's mutual insurance company taxable 
income exceeds the surtax exemption provided in section 11(d) of 
$25,000, M will pay a surtax on such excess at the rate provided in 
section 11(c), 26 percent. M's total liability for the taxable year 1964 
is $16,540, computed as follows:

(1) Mutual insurance company taxable income as computed in       $48,000
 example (1)..................................................
(2) Normal tax: 22 percent of mutual insurance company taxable    10,560
 income for normal tax purposes...............................
(3) Surtax exemption provided by section 11(d)................    25,000
(4) Mutual insurance company taxable income subject to the        23,000
 surtax (item (1) minus item (3)).............................
(5) Surtax: at rates provided in section 11(c): 26 percent of      5,980
 mutual insurance company taxable income subject to the surtax
(6) Total tax (item (2) plus item (5))........................    16,540
 

    (e) Alternative tax for certain small mutual insurance companies--
(1) In general. (i) Section 821(c) provides an alternative tax for 
certain small mutual insurance companies. This alternative tax, which is 
in lieu of the tax imposed by section 821(a), is imposed on taxable 
investment income (as defined in section 822(a)(1) and paragraph (a)(1) 
of Sec. 1.822-8) and consists of a normal tax and a surtax. The tax 
provided by section 821(c) is imposed on every mutual insurance company 
(other than a life insurance company and other than a fire, flood, or 
marine insurance company subject to the tax imposed by section 831) 
which received during the taxable year from the items described in 
section 822(b) (other than paragraph (1)(D) thereof) and premiums 
(including deposits and assessments) a gross amount in excess of 
$150,000 but not in excess of $500,000, except a company which has 
properly elected under section 821(d) and paragraph (f) of this section 
to be subject to the tax imposed by section 821(a), or a company which 
has a balance in its protection against loss account at the beginning of 
the taxable year.
    (ii) Any company which would be taxable under section 821(c) but for 
the presence of an amount in its protection against loss account at the 
beginning of the taxable year may elect to subtract the balance from 
such account. See section 824(d)(5) and Sec. 1.824-3. If such an 
election is made in such a case, the company shall not be subject to the 
tax imposed by section 821(a), but shall be subject to the tax imposed 
by section 821(c).
    (2) Rates of tax imposed by section 821(c)--(i) Normal tax. The 
normal tax for taxable years beginning before January 1, 1964, is the 
lesser of 30 percent

[[Page 830]]

of taxable investment income or 60 percent of the amount by which 
taxable investment income exceeds $3,000. For taxable years beginning 
after December 31, 1963, the normal tax is imposed at the rate of 22 
percent of taxable investment income, or 44 percent of the amount by 
which taxable investment income exceeds $3,000, whichever is the lesser. 
Thus, a company subject to tax under section 821(c) will file a return 
but will pay no tax if for the taxable year its taxable investment 
income does not exceed $3,000; or will pay a normal tax equal to 44 
percent (60 percent in the case of taxable years beginning before Jan. 
1, 1964), of taxable investment income in excess of $3,000 when such 
income exceeds $3,000 but does not exceed $6,000. When taxable 
investment income exceeds $6,000, the normal tax is imposed at the rate 
of 22 percent (30 percent in the case of taxable years beginning before 
Jan. 1, 1964) of such income.
    (ii) Surtax. For taxable years beginning before January 1, 1964, a 
surtax is imposed at the rate of 22 percent of taxable investment income 
(computed without regard to the deduction provided in section 242 for 
partially tax-exempt interest) in excess of $25,000. For taxable years 
beginning after December 31, 1963, a surtax is imposed at the rate 
provided in section 11(c) on taxable investment income in excess of the 
surtax exemption provided in section 11(d).
    (f) Election to be taxed under section 821(a)--(1) In general. 
Section 821(d) provides that any mutual insurance company taxable under 
section 821(c) may elect, in the manner provided by subparagraph (3) of 
this paragraph, to be taxed under section 821(a).
    (2) Scope of election. Except as otherwise provided herein, an 
election made under section 821(d) and this paragraph to be taxable 
under section 821(a) shall be binding for the taxable year for which 
made and for all succeeding taxable years unless the Commissioner 
consents to a revocation of such election. If for any taxable year the 
gross amount received from the items described in section 822(b) (other 
than paragraph (1)(D) thereof) and premiums (including deposits and 
assessments) does not exceed $150,000, a company's prior election made 
under section 821(d) to be taxable under section 821(a) will 
automatically terminate and any balance in the protection against loss 
account will be taken into account for the preceding taxable year. (See 
section 824(d)(4) and Sec. 1.824-2 for automatic termination of 
protection against loss account if company is not subject to the tax 
imposed by section 821(a).) If for any taxable year thereafter the gross 
amount received exceeds $150,000 but does not exceed $500,000, the 
company shall be taxable under section 821(c) unless it makes a new 
election to be taxable under section 821(a). If a company subject to tax 
under section 821(c) for a taxable year elects under section 821(d) and 
this section to be taxed under section 821(a) and, in a subsequent 
taxable year, the gross receipts of such company exceed $500,000, the 
election made for such earlier taxable year shall be considered as 
continuing in effect. Thus, such a company will continue to be taxable 
under section 821(a) notwithstanding that its gross receipts 
subsequently fall below $500,000 (so long as they do not fall below 
$150,000) unless the Commissioner consents to a revocation of the prior 
election. Whether revocation is permissible in any case will depend on 
the facts and circumstances of the particular case, but in no case will 
revocation be granted in the absence of a showing that the election 
creates an undue burden or material hardship on the company due to a 
substantial change in the character of its operations.
    (3) Time and manner of making election. The election provided by 
section 821(d) shall be made in a statement attached to the company's 
income tax return for the first taxable year for which the election is 
to apply. The statement shall include the name and address of the 
taxpayer, shall be signed by the taxpayer (or its duly authorized 
representative), and shall be filed not later than the date prescribed 
by law (including extensions thereof) for filing the return for such 
taxable year.
    (g) Examples. The application of the tax imposed by section 821(c) 
may be illustrated by the following examples:

    Example 1. M, a mutual casualty insurance company, for the calendar 
year 1963 has a

[[Page 831]]

gross amount received from the items described in section 822(b) (other 
than paragraph (1)(D) thereof) and premiums (including deposits and 
assessments) of $400,000. Since M's gross amount received exceeds 
$150,000, but does not exceed $500,000, M is subject to the tax imposed 
by section 821(c) on taxable investment income unless it elects to be 
subject to the tax imposed on mutual insurance company taxable income by 
section 821(a). M computes its taxable investment income under section 
822 to be $35,000. In computing taxable investment income, M deducted 
$2,000 of partially tax-exempt interest under section 242. If M does not 
make an election to be taxed under section 821(a), its total tax 
liability for the taxable year 1963 is $13,140 computed as follows:

(1) Taxable investment income as computed under section 822.     $35,000
(2) 30 percent of taxable investment income.................      10,500
(3) 60 percent of taxable investment income in excess of          19,200
 $3,000.....................................................
(4) Normal tax (lesser of items (2) or (3)).................      10,500
(5) Partially tax-exempt interest deducted in computing            2,000
 taxable investment income..................................
(6) Taxable investment income for purposes of the surtax          37,000
 (item (1) plus item (5))...................................
(7) Surtax exemption........................................      25,000
(8) Taxable investment income subject to surtax (item (6)         12,000
 minus item (7))............................................
(9) Surtax (22 percent of item (8)).........................       2,640
(10) Total tax liability (item (4) plus item (9))...........      13,140
 

    Example 2. N, a mutual casualty insurance company, for the taxable 
year 1963 has a gross amount received from the items described in 
section 822(b) (other than paragraph (1)(D) thereof) and premiums 
(including deposits and assessments) of $210,000. Since N's gross amount 
received exceeds $150,000 but does not exceed $500,000, N is subject to 
the tax imposed by section 821(c) on taxable investment income unless it 
elects to be subject to the tax imposed by section 821(a). Furthermore, 
since the gross amount received by N does not exceed $250,000, N is 
entitled to the special tax reduction provided by section 821(c)(2). N 
computes its taxable investment income under section 822 to be $24,000. 
In computing taxable investment income, N deducted $2,000 of partially 
tax-exempt interest under section 242. If N does not make an election to 
be taxed under section 821(a), its total tax liability for the taxable 
year 1963 is $4,452 computed as follows:

(1) Taxable investment income as computed under section 822.     $24,000
(2) 30 percent of taxable investment income.................       7,200
(3) 60 percent of taxable investment income in excess of          12,600
 $3,000.....................................................
(4) Normal tax (lesser of items (2) or (3)).................       7,200
(5) Partially tax-exempt interest deducted in computing            2,000
 taxable investment income..................................
(6) Taxable investment income for purposes of the surtax          26,000
 (item (1) plus item (5))...................................
(7) Surtax exemption........................................      25,000
(8) Taxable investment income subject to surtax (item (6)          1,000
 minus item (7))............................................
(9) Surtax 22 percent of item (8)...........................         220
(10) Tax liability computed without regard to special              7,420
 reduction (item (4) plus item (9)).........................
(11) Amount by which gross receipts exceed $150,000               60,000
 ($210,000 gross receipts minus $150,000)...................
(12) Percentage which item (1) bears to $100,000 ($60,000           0.60
 over $100,000).............................................
(13) Tax as adjusted (percentage determined in item (12)           4,452
 applied to item (10))......................................
 


If N's taxable investment income for purposes of the surtax did not 
exceed $3,000, N would file a return but would pay no tax. Had N elected 
(under section 821(d)) to be subject to tax under section 821(a), N 
would not be entitled to the special reduction afforded by section 
821(c)(2), since that provision applies only to companies taxable under 
section 821(c).

[T.D. 6681, 28 FR 11110, Oct. 17, 1963, as amended by T.D. 7100, 36 FR 
5333, Mar. 20, 1971; 36 FR 5846, Mar. 30, 1971]



Sec. 1.821-5  Special transitional underwriting loss.

    (a) In general. Section 821(f) provides a special reduction in the 
statutory underwriting income (as defined by section 823(a)(1) and 
paragraph (b)(1) of Sec. 1.823-6) of any company taxable under section 
821(a) which was taxable under section 821 for the five taxable years 
immediately preceding January 1, 1962, and which incurred an 
underwriting loss (as defined in section 821(f)(3) and paragraph (c) of 
this section) for each of such five taxable years.
    (b) Amount of reduction. In the case of a company described in 
section 821(f)(1) and paragraph (a) of this section the statutory 
underwriting income for the taxable year (determined without regard to 
this paragraph) shall be reduced by an amount equal to the amount by 
which:
    (1) The sum of the underwriting losses of such company for the five 
taxable years immediately preceding January 1, 1962, exceeds
    (2) The total amount by which the company's statutory underwriting 
income was reduced by reason of section 821(f) and this section for 
prior taxable years.
    (c) Underwriting loss defined. For purposes of computing the amount 
of the reduction available under section 821(f) and paragraph (a) of 
this section, the term underwriting loss means statutory underwriting 
loss (as defined by section 823(a)(2) and paragraph (b)(2) of

[[Page 832]]

Sec. 1.823-6) computed without any deduction under section 824(a) and 
paragraph (a) of Sec. 1.824-1 (relating to deduction to provide 
protection against losses) and without any deduction under section 
832(c)(11) (relating to dividends and similar distributions paid or 
declared to policyholders). For rules relating to the definition of 
dividends and similar distributions paid or declared to policyholders, 
see paragraph (a) of Sec. 1.832-5.
    (d) Years of applicability. Section 821(f)(4) provides that the 
special reduction of statutory underwriting income allowed by section 
821(f)(2) and paragraph (b) of this section shall apply to any taxable 
year beginning after December 31, 1962, and before January 1, 1968, for 
which the taxpayer is subject to the tax imposed by section 821(a).

[T.D. 6681, 28 FR 11112, Oct. 17, 1963]



Sec. 1.822-1  Taxable income and deductions.

    (a) In general. For taxable years beginning after December 31, 1953, 
but before January 1, 1955, and ending after August 16, 1954, the 
taxable income of a mutual insurance company subject to the tax imposed 
by section 821 is its gross investment income, namely, the gross amount 
of income during the taxable year from interest, dividends, rents, and 
gains from sales or exchanges of capital assets, less the deductions 
provided in section 822(c) for wholly tax-exempt interest, investment 
expenses, real estate expenses, depreciation, interest paid or accrued, 
capital losses to the extent provided in subchapter P (sec. 1201 and 
following), chapter 1 of the Code, and the special deductions provided 
in part VIII (section 241 and following), except section 248, subchapter 
B, chapter 1 of the Code. In addition to the limitations on deductions 
relating to real estate owned and occupied by a mutual insurance company 
subject to the tax imposed by section 821 provided in section 822(d)(1), 
the adjustment for amortization of premium and accrual of discount 
provided in section 822(d)(2), and the limitation on the deduction for 
investment expenses where general expenses are allocated to investment 
income provided in section 822(c)(2), mutual insurance companies subject 
to the tax imposed by section 821 are subject to the limitation on 
deductions relating to wholly tax-exempt income provided in section 265. 
Such companies are not entitled to the net operating loss deduction 
provided in section 172.
    (b) Wholly tax-exempt interest. Interest which in the case of other 
taxpayers is excluded from gross income by section 103 but included in 
the gross investment income by section 822(b) is allowed as a deduction 
from gross investment income by section 822(c)(1).
    (c) Investment expenses. The deduction allowed by section 822(c)(2) 
for investment expenses is the same as that allowed life insurance 
companies by section 803(g)(2). See paragraph (c) of Sec. 1.803-4.
    (d) Taxes and expenses with respect to real estate. The deduction 
allowed by section 822(c)(3) for taxes and expenses with respect to real 
estate owned by the company is the same as that allowed life insurance 
companies by section 803(g)(3). See paragraph (d) of Sec. 1.803-4.
    (e) Depreciation. The deduction allowed by section 822(c)(4) for 
depreciation is the same as that allowed life insurance companies by 
section 803(g)(4). See paragraph (e) of Sec. 1.803-4.
    (f) Interest paid or accrued. The deduction allowed by section 
822(c)(5) for interest on indebtedness is the same as that allowed other 
corporations by section 163. See Sec. 1.163-1.
    (g) Capital losses. (1) The deduction for capital losses under 
section 822(c)(6) includes not only capital losses to the extent 
provided in subchapter P but in addition thereto losses from capital 
assets sold or exchanged to provide funds to meet abnormal insurance 
losses and to provide for the payment of dividends and similar 
distributions to policyholders. Losses in the latter case may be 
deducted from ordinary income while the deduction for losses under 
subchapter P is limited to the gains. See section 1211.
    (2) Capital assets are considered as sold or exchanged to provide 
for the funds or payments specified in section 822(c)(6), to the extent 
that the gross receipts from the sale or exchange of

[[Page 833]]

such assets are not greater than the excess, if any, for the taxable 
year of the sum of dividends and similar distributions paid to 
policyholders, and losses and expenses paid over the sum of interest, 
dividends, rents, and net premiums received. If, by reason of a 
particular sale or exchange of a capital asset, gross receipts are 
greater than such excess, the gross receipts and the resulting loss 
should be apportioned and the excess included in capital losses subject 
to the provisions of subchapter P. Capital losses actually used to 
reduce net income in any taxable year may not again be used in a 
succeeding taxable year as an offset against capital gains in that year 
and for that purpose a special rule is set forth for the application of 
section 1212.
    (3) The application of section 822(c)(6) may be illustrated by the 
following examples:

    Example 1. The X Company, a mutual fire insurance company subject to 
the tax imposed by section 821, in the taxable year 1954 sells capital 
assets in order to obtain funds to meet abnormal insurance losses and to 
provide for the payment of dividends and similar distributions to 
policyholders. The gross receipts from the sale are $60,000, resulting 
in losses of $20,000. It pays dividends to policyholders of $150,000. It 
sustains losses of $25,000, and pays expenses of $25,000. It receives 
interest of $50,000, dividends of $5,000, rents of $4,000, and net 
premiums of $66,000. The excess of the sum of dividends, losses, and 
expenses paid ($200,000) over the sum of interest, dividends, rents, and 
net premiums received ($125,000) is $75,000. As the gross receipts from 
the sale of capital assets ($60,000) do not exceed such excess 
($75,000), the losses of $20,000 are allowable as a deduction from gross 
investment income.
    Example 2. If in example 1 the gross receipts were $76,000 and the 
last capital asset sold, for the purpose therein specified, resulted in 
gross receipts of $2,000 and a loss of $500, the losses allowable as a 
deduction from gross investment income would be $19,750. The last sale 
made the gross receipts of $76,000 exceed by $1,000 the excess ($75,000) 
of the sum of dividends, losses, and expenses paid ($200,000) over the 
sum of interest, dividends, rents, and net premiums received ($125,000). 
The gross receipts and the resulting loss from the last sale are 
apportioned on the basis of the ratio of the excess of $1,000 to the 
gross receipts of $2,000, or 50 percent. Fifty percent of the loss of 
$500 is deducted from the total loss of $20,000. The remaining gross 
receipts of $1,000 and the proportionate loss of $250 should be reported 
as capital losses under subchapter P.
    Example 3. If in example 1 the X Company had mutual insurance 
company taxable income for purposes of the surtax of $9,750 and, under 
the provisions of subchapter P, had capital losses of $18,000 and 
capital gains of $10,000, the net capital loss for the taxable year 
1954, in applying section 1212 for the purposes of section 822(c)(6), 
would be $8,000. This is determined by subtracting from total losses of 
$38,000 ($18,000 capital losses under subchapter P plus $20,000 other 
capital losses under section 822(c)(6)) the sum of capital gains of 
$10,000 and losses from the sale or exchange of capital assets sold or 
exchanged to obtain funds to meet abnormal insurance losses and to 
provide for the payment of dividends and similar distributions to 
policyholders of $20,000. Such losses of $20,000 are added to capital 
gains of $10,000, since they are less than taxable income for purposes 
of the surtax, computed without regard to gains or losses from sales or 
exchanges of capital assets, of $29,750 ($9,750 taxable income for 
purposes of the surtax plus $20,000 other capital losses under section 
822(c)(6) plus the portion of capital losses allowable under subchapter 
P of $10,000 minus capital gains under subchapter P of $10,000).

    (h) Special deductions. Section 822(c)(7) allows a mutual insurance 
company the special deductions provided by part VIII (section 241 and 
following), except section 248, subchapter B, chapter 1 of the Code, 
relating to partially tax-exempt interest and to dividends received.



Sec. 1.822-2  Real estate owned and occupied.

    The limitation in section 822(d)(1) on the amount allowable as a 
deduction for taxes, expenses, and depreciation upon or with respect to 
any real estate owned and occupied in whole or in part by a mutual 
insurance company subject to the tax imposed by section 821 is the same 
as that provided in the case of life insurance companies by section 
803(h). See Sec. 1.803-5.



Sec. 1.822-3  Amortization of premium and accrual of discount.

    Section 822(d)(2) makes provision for the appropriate amortization 
of premium and the appropriate accrual of discount, attributable to the 
taxable year, on bonds, notes, debentures or other evidences of 
indebtedness held by a mutual insurance company subject to the tax 
imposed by section 821. Such

[[Page 834]]

amortization and accrual is the same as that provided for life insurance 
companies by section 803(i) and shall be determined in accordance with 
Sec. 1.803-6, except that in determining the premium and discount of a 
mutual insurance company subject to the tax imposed by section 821 the 
basis provided in section 1012 shall be used in lieu of the acquisition 
value.



Sec. 1.822-4  Taxable years affected.

    Sections 1.822-1 through 1.822-3 are applicable only to taxable 
years beginning after December 31, 1953, but before January 1, 1955, and 
ending after August 16, 1954, and all references to sections of part II, 
subchapter L, chapter 1 of the Code are to the Internal Revenue Code of 
1954, before amendments. Sections 1.822-5 through 1.822-7 are applicable 
only to taxable years beginning after December 31, 1954, but before 
January 1, 1963, and all references to sections of part II, subchapter 
L, chapter 1 of the Code are to the Internal Revenue Code of 1954, as 
amended by the Life Insurance Company Tax Act for 1955 (70 Stat. 36). 
Sections 1.822-8 through 1.822-12 are applicable only to taxable years 
beginning after December 31, 1962, and all references to sections of 
parts II and III, subchapter L, chapter 1 of the Code are to the 
Internal Revenue Code of 1954 as amended by section 8 of the Revenue Act 
of 1962 (76 Stat. 989).

[T.D. 6681, 28 FR 11113, Oct. 17, 1963]



Sec. 1.822-5  Mutual insurance company taxable income.

    (a) Mutual insurance company taxable income defined. Section 822(a) 
defines the term ``mutual insurance company taxable income'' for 
purposes of part II, subchapter L, chapter 1 of the Code. Mutual 
insurance company taxable income means gross investment income (as 
defined in section 822(b) and paragraph (b) of this section), less the 
deductions provided in section 822(c) and paragraph (c) of this section 
for wholly tax-exempt interest, investment expenses, real estate 
expenses, depreciation, interest paid or accrued, capital losses, 
special deductions, trade or business (other than in insurance business) 
expenses, and depletion. However, such expenses are deductible only to 
the extent that they relate to investment income and the deduction of 
such expenses is not disallowed by any other provision of subtitle A of 
the Code. For example, investment expenses are not allowable unless they 
are ordinary and necessary expenses within the meaning of section 162. 
In addition to the limitations on deductions relating to real estate 
owned and occupied by a mutual insurance company subject to the tax 
imposed by section 821 provided in section 822(d)(1), the adjustment for 
amortization of premium and accrual of discount provided in section 
822(d)(2), and the limitation on the deduction for investment expenses 
where general expenses are allocated to investment income provided in 
section 822(c)(2), mutual insurance companies subject to the tax imposed 
by section 821 are subject to the limitation on deductions relating to 
wholly tax-exempt income provided in section 265. Such companies are not 
entitled to the net operating loss deduction provided in section 172, 
and a deduction shall not be permitted with respect to the same item 
more than once.
    (b) Gross investment income defined. For purposes of part II, 
subchapter L, chapter 1 of the Code, section 822(b) defines the term 
``gross investment income'' of a mutual insurance company subject to the 
tax imposed by section 821 as the sum of the following:
    (1) The gross amount of income during the taxable year from:
    (i) Interest (including tax-exempt interest and partially tax-exempt 
interest), as described in Sec. 1.61-7. Interest shall be adjusted for 
amortization of premium and accrual of discount in accordance with the 
rules prescribed in section 822(d)(2) and Sec. 1.822-7;
    (ii) Dividends, as described in Sec. 1.61-9;
    (iii) Rents and royalties, as described in Sec. 1.61-8;
    (iv) The entering into of any lease, mortgage or other instrument or 
agreement from which the company may derive interest, rents, or 
royalties;
    (v) The alteration or termination of any instrument or agreement 
described in subdivision (iv) of this subparagraph;
    (vi) Gains from sales or exchanges of capital assets to the extent 
provided in

[[Page 835]]

subchapter P (section 1201 and following, relating to capital gains and 
losses), chapter 1 of the Code.
    (2) The gross income from any trade or business (other than an 
insurance business) carried on by a mutual insurance company subject to 
the tax imposed by section 821, or by a partnership of which the 
insurance company is a partner.

For example, gross investment income includes amounts received as 
commitment fees, or as a bonus for the entering into of a lease, or as a 
penalty for the early payment of a mortgage. In computing the gross 
income from any trade or business (other than an insurance business) 
carried on by the insurance company, or by a partnership of which the 
insurance company is a partner, any item described in section 822(b)(1) 
and paragraph (b)(1) of this section shall not be considered as gross 
income arising from the conduct of such trade or business, but shall be 
taken into account under section 822(b)(1) and paragraph (b)(1) of this 
section.
    (c) Deductions from gross investment income--(1) Wholly tax-exempt 
interest. Interest which in the case of other taxpayers is excluded from 
gross income by section 103 but included in the gross investment income 
by section 822(b) is allowed as a deduction from gross investment income 
by section 822(c)(1).
    (2) Investment expenses. (i) The deduction for investment expenses 
under section 822(c)(2) includes only those expenses of the taxable year 
which are fairly chargeable against gross investment income. For 
example, investment expenses include salaries and expenses paid 
exclusively for work in looking after investments, and amounts expended 
for printing, stationery, postage, and stenographic work incident to the 
collection of interest. An itemized schedule of such expenses shall be 
attached to the return.
    (ii) Any assignment of general expenses to the investment department 
of a mutual insurance company subject to the tax imposed by section 821 
subjects the entire deduction for investment expenses to the limitation 
provided in section 822(c)(2) and subdivision (iii) of this 
subparagraph. As used in section 822(c)(2), the term ``general 
expenses'' means any expense paid or incurred for the benefit of more 
than one department of the company rather than for the benefit of a 
particular department thereof. For example, if an expense, such as a 
salary, is attributable to more than one department, including the 
investment department, such expense may be properly allocated among 
these departments. If such expense is allocated, the amount properly 
allocable to the investment department shall be deductible as general 
expenses assigned to or included in investment expenses and as such 
shall be subject to the limitation of section 822(c)(2) and subdivision 
(iii) of this subparagraph. However, a company subject to the tax 
imposed by section 821 shall not deduct under section 822(c)(2) its real 
estate taxes, depreciation, or other expenses with respect to any 
portion of the real estate which it owns, irrespective of whether such 
items are properly allocable to its investment department. For the rules 
relating to the deductibility of these items, see section 822(c) (3) and 
(4) and subparagraphs (3) and (4) of this paragraph. If general expenses 
are in part assigned to or included in investment expenses, the maximum 
allowance (as determined under section 822(c)(2) shall not be granted 
unless it is shown to the satisfaction of the district director that 
such allowance is justified by a reasonable assignment of actual 
expenses. The accounting procedure employed is not conclusive as to 
whether any assignment has in fact been made. Investment expenses do not 
include Federal income and excess profits taxes, if any.
    (iii) If any general expenses are in part assigned to or included in 
investment expenses, the total deduction under section 822(c)(2) shall 
not exceed the sum of:
    (a) One-fourth of 1 percent of the mean of the book value of the 
invested assets held at the beginning and end of the taxable year, plus.
    (b) One-fourth of the amount by which mutual insurance company 
taxable income (computed without any deduction for investment expenses, 
tax-free interest, partially tax-exempt interest, or dividends received) 
exceeds 33/4 percent of the book value of the

[[Page 836]]

mean of the invested assets held at the beginning and end of the taxable 
year.


For purposes of section 822(c)(2) and this paragraph, the term 
``invested assets'' means only those assets which are owned and used, 
and to the extent used, for the purpose of producing the income 
specified in section 822(b). See paragraph (b) of this section. The term 
does not include real estate owned and occupied, and to the extent owned 
and occupied, by the company.
    (3) Real estate expenses and taxes. The deduction for real estate 
expenses and taxes under section 822(c)(3) includes taxes (as defined in 
section 164) and other expenses for the taxable year exclusively on or 
with respect to real estate owned by the company. For example, no 
deduction shall be allowed under section 822(c)(3) for amounts allowed 
as a deduction under section 164(e) (relating to taxes of shareholders 
paid by a corporation). No deduction shall be allowed under section 
822(c)(3) for any amount paid out for new buildings, or for permanent 
improvements or betterments made to increase the value of any property. 
An itemized schedule of such taxes and expenses shall be attached to the 
return. See Sec. 1.822-6 for limitation of such deduction.
    (4) Depreciation. The deduction allowed by section 822(c)(4) for 
depreciation is, except as provided in section 822(d)(1) and Sec. 
1.822-6, identical to that allowed other corporations by section 167. 
Such amount allowed as a deduction from gross investment income in 
determining mutual insurance company taxable income is limited to 
depreciation sustained on the property used, and to the extent used, for 
the purpose of producing the income specified in section 822(b).
    (5) Interest paid or accrued. The deduction allowed by section 
822(c)(5) for interest on indebtedness is the same as that allowed other 
corporations by section 163. See Sec. 1.163-1.
    (6) Capital losses. (i) The deduction for capital losses under 
section 822(c)(6) includes not only capital losses to the extent 
provided in subchapter P, chapter 1 of the Code but in addition thereto 
losses from capital assets sold or exchanged to provide funds to meet 
abnormal insurance losses and to provide for the payment of dividends 
and similar distributions to policyholders. Losses in the latter case 
may be deducted from ordinary income while the deduction for losses 
under subchapter P is limited to the gains. See section 1211.
    (ii) Capital assets are considered as sold or exchanged to provide 
for the funds or payments specified in section 822(c)(6), to the extent 
that the gross receipts from the sale or exchange of such assets are not 
greater than the excess, if any, for the taxable year of the sum of 
dividends and similar distributions paid to policyholders, and losses 
and expenses paid over the sum of the items described in section 822(b) 
(other than paragraph (1)(D) thereof) and net premiums received. If, by 
reason of a particular sale or exchange of a capital asset, gross 
receipts are greater than such excess, the gross receipts and the 
resulting loss should be apportioned and the excess included in capital 
losses subject to the provisions of subchapter P. Capital losses 
actually used to reduce net income in any taxable year may not again be 
used in a succeeding taxable year as an offset against capital gains in 
that year and for that purpose a special rule is set forth for the 
application of section 1212.
    (iii) The application of section 822(c)(6) may be illustrated by the 
following examples:

    Example 1. The X Company, a mutual fire insurance company subject to 
the tax imposed by section 821, in the taxable year 1958 sells capital 
assets in order to obtain funds to meet abnormal insurance losses and to 
provide for the payment of dividends and similar distributions to 
policyholders. The gross receipts from the sale are $60,000, resulting 
in losses of $20,000. It pays dividends to policyholders of $150,000. It 
sustains losses of $25,000, and pays expenses of $25,000. It receives 
interest of $50,000, dividends of $5,000, royalties of $4,000, and net 
premiums of $66,000. The excess of the sum of dividends, losses, and 
expenses paid ($200,000) over the sum of the items described in section 
822(b) (other than paragraph (1)(D) thereof) and net premiums received 
($125,000) is $75,000. As the gross receipts from the sale of capital 
assets ($60,000) do not exceed such excess ($75,000), the losses of 
$20,000 are allowable as a deduction from gross investment income.
    Example 2. If in example 1 the gross receipts were $76,000 and the 
last capital asset

[[Page 837]]

sold, for the purpose therein specified, resulted in gross receipts of 
$2,000 and a loss of $500, the losses allowable as a deduction from 
gross investment income would be $19,750. The last sale made the gross 
receipts of $76,000 exceed by $1,000 the excess ($75,000) of the sum of 
dividends, losses, and expenses paid ($200,000) over the sum of the 
items described in section 822(b) (other than paragraph (1)(D) thereof) 
and net premiums received ($125,000). The gross receipts and the 
resulting loss from the last sale are apportioned on the basis of the 
ratio of the excess of $1,000 to the gross receipts of $2,000, or 50 
percent. Fifty percent of the loss of $500 is deducted from the total 
loss of $20,000. The remaining gross receipts of $1,000 and the 
proportionate loss of $250 should be reported as capital losses under 
subchapter P.
    Example 3. If in example 1 the X Company had mutual insurance 
company taxable income for purposes of the surtax of $9,750 and, under 
the provisions of subchapter P, chapter 1 of the Code, had capital 
losses of $18,000 and capital gains of $10,000, the net capital loss for 
the taxable year 1958, in applying section 1212 for the purposes of 
section 822(c)(6), would be $8,000. This is determined by subtracting 
from total losses of $38,000 ($18,000 capital losses under subchapter P 
plus $20,000 other capital losses under section 822(c)(6)) the sum of 
capital gains of $10,000 and losses from the sale or exchange of capital 
assets sold or exchanged to obtain funds to meet abnormal insurance 
losses and to provide for the payment of dividends and similar 
distributions to policyholders of $20,000. Such losses of $20,000 are 
added to capital gains of $10,000, since they are less than taxable 
income for purposes of the surtax, computed without regard to gains or 
losses from sales or exchanges of capital assets, of $29,750 ($9,750 
taxable income for purposes of the surtax plus $20,000 other capital 
losses under section 822(c)(6) plus the portion of capital losses 
allowable under subchapter P of $10,000 minus capital gains under 
subchapter P of $10,000).

    (7) Special deductions. Section 822(c)(7) allows a mutual insurance 
company the special deductions provided by part VIII (section 241 and 
following), except section 248, subchapter B, chapter 1 of the Code, 
relating to partially tax-exempt interest and to dividends received.
    (8) Trade or business deductions. (i) Under section 822(c)(8), the 
deductions allowed by subtitle A of the Code (without regard to this 
part) which are attributable to any trade or business (other than an 
insurance business) carried on by the insurance company, or by a 
partnership of which the company is a partner are, subject to the 
limitations in subdivision (ii) of this subparagraph, allowable as 
deductions from gross investment income in computing mutual insurance 
company taxable income. Such deductions are allowable, however, only to 
the extent that they relate to income which is included in the company's 
gross investment income by reason of section 822(b) (2). Thus, a 
deduction shall not be allowed under section 822(c)(8) with respect to 
any item described in section 822(b)(1). The allowable deductions may 
exceed the gross income from such business.
    (ii) In computing the deductions under section 822(c)(8):
    (a) Any item, to the extent attributable to the carrying on of the 
insurance business, shall not be taken into account. For example, if the 
company operates a radio station primarily to advertise its own 
insurance services, a portion of the expenses of the radio station shall 
not be allowed as a deduction. The portion disallowed shall be an amount 
which bears the same ratio to the total expenses of the station as the 
value of advertising furnished to the insurance company bears to the 
total value of services rendered by the station.
    (b) The deduction for net operating losses provided in section 172 
shall not be allowed.
    (9) Depletion. The deduction allowed by section 822(c)(9) for 
depletion is the same as that allowed life insurance companies under 
section 804(c)(4). See paragraph (b)(5) of Sec. 1.804-4.

[T.D. 6610, 27 FR 8720, Aug. 31, 1962, as amended by T.D. 6631, 28 FR 
219, Jan. 9, 1963]



Sec. 1.822-6  Real estate owned and occupied.

    Section 822(d)(1) provides that the amount allowable as a deduction 
for taxes, expenses, and depreciation on or with respect to any real 
estate owned and occupied in whole or in part by a mutual insurance 
company subject to the tax imposed by section 821 shall be limited to an 
amount which bears the same ratio to such deduction (computed without 
regard to this limitation) as the rental value of the space not so 
occupied bears to the rental value of the entire property. For example, 
if the rental value of the space not

[[Page 838]]

occupied by the company is equal to one-half of the rental value of the 
entire property, the deduction for taxes, expenses, and depreciation is 
one-half of the taxes, expenses, and depreciation on account of the 
entire property. Where a deduction is claimed as provided in this 
section, the parts of the property occupied and the parts not occupied 
by the company, together with the respective rental values thereof, must 
be shown in a statement accompanying the return.

[T.D. 6610, 27 FR 8722, Aug. 31, 1962]



Sec. 1.822-7  Amortization of premium and accrual of discount.

    Section 822(d)(2) makes provision for the appropriate amortization 
of premium and the appropriate accrual of discount, attributable to the 
taxable year, on bonds, notes, debentures, or other evidences of 
indebtedness held by a mutual insurance company subject to the tax 
imposed by section 821. Such amortization and accrual is the same as 
that provided for life insurance companies by section 818(b)(1), as 
amended by the Life Insurance Company Income Tax Act of 1959 (73 Stat. 
133), and shall be determined in accordance with paragraphs (a) and (b) 
of Sec. 1.818-3, except in the case of a mutual insurance company 
subject to the tax imposed by section 821, paragraph (b) of Sec. 1.818-
3 shall apply without regard to the date of acquisition and the basis 
provided in section 1012 shall be used in lieu of the acquisition value.

[T.D. 6610, 27 FR 8722, Aug. 31, 1962]



Sec. 1.822-8  Determination of taxable investment income.

    (a) In general--(1) Taxable investment income defined. Section 
822(a)(1) defines the term ``taxable investment income'' for purposes of 
part II, subchapter L, chapter 1 of the Code as the gross investment 
income (as defined in section 822(b) and paragraph (b) of this section), 
less the deductions provided in section 822(c) and paragraph (c) of this 
section for wholly tax-exempt interest, investment expenses, real estate 
expenses, depreciation, interest paid or accrued, capital losses, 
special deductions, trade or business (other than an insurance business) 
expenses, and depletion. However, such expenses are deductible only to 
the extent that they relate to investment income and the deduction of 
such expenses is not disallowed by any other provision of subtitle A of 
the Code.

For example, investment expenses are not allowable unless they are 
ordinary and necessary expenses within the meaning of section 162. In 
addition to the limitations on deductions relating to real estate owned 
and occupied by a mutual insurance company subject to the tax imposed by 
section 821 provided in section 822(d)(1), the adjustment for 
amortization of premium and accrual of discount provided in section 
822(d)(2), and the limitation on the deduction for investment expenses 
where general expenses are allocated to investment income provided in 
section 822(c)(2), mutual insurance companies subject to the tax imposed 
by section 821 (a) or (c) are subject to the limitation on deductions 
relating to wholly tax-exempt income provided in section 265. Such 
companies are not entitled to the net operating loss deduction provided 
in section 172. See, however, section 825 and paragraph (a) of Sec. 
1.825-1 for unused loss deduction allowed companies taxable under 
section 821(a). A deduction shall not be permitted with respect to the 
same item more than once.
    (2) Investment loss defined. The term ``investment loss'' is defined 
by section 822(a)(2) as the amount by which the deductions allowable 
under section 822(c) and paragraph (c) of this section exceed the gross 
investment income (as defined in section 822(b) and paragraph (b) of 
this section).
    (b) Gross investment income defined. For purposes of part II, 
subchapter L, chapter 1 of the Code, section 822(b) defines the term 
``gross investment income'' of a mutual insurance company subject to the 
tax imposed by section 821 (a) or (c) as the sum of the following:
    (1) The gross amount of income during the taxable year from:
    (i) Interest (including tax-exempt interest and partially tax-exempt 
interest), as described in Sec. 1.61-7. Interest shall be adjusted for 
amortization of

[[Page 839]]

premium and accrual of discount in accordance with the rules prescribed 
in section 822(d)(2) and Sec. 1.822-10;
    (ii) Dividends, as described in Sec. 1.61-9;
    (iii) Rents and royalties, as described in Sec. 1.61-8;
    (iv) The entering into of any lease, mortgage or other instrument or 
agreement from which the company may derive interest, rents, or 
royalties;
    (v) The alteration or termination of any instrument or agreement 
described in subdivision (iv) of this subparagraph;
    (vi) Gains from sales or exchanges of capital assets to the extent 
provided in subchapter P (section 1201 and following, relating to 
capital gains and losses) chapter 1 of the Code.
    (2) The gross income from any trade or business (other than an 
insurance business) carried on by a mutual insurance company subject to 
the tax imposed by section 821 (a) or (c), or by a partnership of which 
the insurance company is a partner.

For example, gross investment income includes amounts received as 
commitment fees, or as a bonus for the entering into of a lease, or as a 
penalty for the early payment of a mortgage. In computing the gross 
income from any trade or business (other than an insurance business) 
carried on by the insurance company, or by a partnership of which the 
insurance company is a partner, any item described in section 822(b)(1) 
and paragraph (b)(1) of this section shall not be considered as gross 
income arising from the conduct of such trade or business, but shall be 
taken into account under section 822(b)(1) and paragraph (b)(1) of this 
section.
    (c) Deductions from gross investment income--(1) Wholly tax-exempt 
interest. Interest which in the case of other taxpayers is excluded from 
gross income by section 103 but included in the gross investment income 
by section 822(b) is allowed as a deduction from gross investment income 
by section 822(c)(1).
    (2) Investment expenses. (i) The deduction for investment expenses 
under section 822(c)(2) includes only those expenses of the taxable year 
which are fairly chargeable against gross investment income. For 
example, investment expenses include salaries and expenses paid 
exclusively for work in looking after investments, and amounts expended 
for printing, stationery, postage, and stenographic work incident to the 
collection of interest. An itemized schedule of such expenses shall be 
attached to the return.
    (ii) Any assignment of general expenses to the investment department 
of a mutual insurance company subject to the tax imposed by section 821 
(a) or (c) subjects the entire deduction for investment expenses to the 
limitation provided in section 822(c)(2) and subdivision (iii) of this 
subparagraph. As used in section 822(c)(2), the term ``general 
expenses'' means any expense paid or incurred for the benefit of more 
than one department of the company rather than for the benefit of a 
particular department thereof. For example, if an expense, such as a 
salary, is attributable to more than one department, including the 
investment department, such expense may be properly allocated among 
these departments. If such expense is allocated, the amount properly 
allocable to the investment department shall be deductible as general 
expenses assigned to or included in investment expenses and as such 
shall be subject to the limitation of section 822(c)(2) and subdivision 
(iii) of this subparagraph. However, a company subject to the tax 
imposed by section 821 (a) or (c) shall not deduct under section 
822(c)(2) its real estate taxes, depreciation, or other expenses with 
respect to any portion of the real estate which it owns, irrespective of 
whether such items are properly allocable to its investment department. 
For the rules relating to the deductibility of these items, see section 
822(c) (3) and (4) and subparagraphs (3) and (4) of this paragraph. If 
general expenses are in part assigned to or included in investment 
expenses, the maximum allowance (as determined under section 822(c)(2)) 
shall not be granted unless it is shown to the satisfaction of the 
district director that such allowance is justified by a reasonable 
assignment of actual expenses. The accounting procedure employed is not 
conclusive as to whether any assignment has in fact been made. 
Investment expenses do not include Federal income and excess profits 
taxes, if any.

[[Page 840]]

    (iii) If any general expenses are in part assigned to or included in 
investment expenses, the total deduction under section 822(c)(2) shall 
not exceed the sum of:
    (a) One-fourth of 1 percent of the mean of the book value of the 
invested assets held at the beginning and end of the taxable year, plus
    (b) One-fourth of the amount by which taxable investment income 
(computed without any deduction for investment expenses, tax-free 
interest, partially tax-exempt interest, or dividends received) exceeds 
33/4 percent of the book value of the mean of the invested assets held 
at the beginning and end of the taxable year.


For purposes of section 822(c)(2) and this paragraph, the term 
``invested assets'' means only those assets which are owned and used, 
and to the extent used, for the purpose of producing the income 
specified in section 822(b). See paragraph (b) of this section. The term 
does not include real estate owned and occupied, and to the extent owned 
and occupied, by the company.
    (3) Real estate expenses and taxes. The deduction for real estate 
expenses and taxes under section 822(c)(3) includes taxes (as defined in 
section 164) and other expenses for the taxable year exclusively on or 
with respect to real estate owned by the company. For example, no 
deduction shall be allowed under section 822(c)(3) for amounts allowed 
as a deduction under section 164(e) (relating to taxes of shareholders 
paid by a corporation). No deduction shall be allowed under section 
822(c)(3) for any amount paid out for new buildings, or for permanent 
improvements or betterments made to increase the value of any property. 
An itemized schedule of such taxes and expenses shall be attached to the 
return. See Sec. 1.822-9 for limitation of such deduction.
    (4) Depreciation. The deduction allowed by section 822(c)(4) for 
depreciation is, except as provided in section 822(d)(1) and Sec. 
1.822-9, identical to that allowed other corporations by section 167. 
Such amount allowed as a deduction from gross investment income in 
determining taxable investment income is limited to depreciation 
sustained on the property used, and to the extent used, for the purpose 
of producing the income specified in section 822(b).
    (5) Interest paid or accrued. The deduction allowed by section 
822(c)(5) for interest on indebtedness is the same as that allowed other 
corporations by section 163. See Sec. 1.163-1.
    (6) Capital losses. (i) The deduction for capital losses under 
section 822(c)(6) includes not only capital losses to the extent 
provided in subchapter P, chapter 1 of the Code but in addition thereto 
losses from capital assets sold or exchanged to provide funds to meet 
abnormal insurance losses and to provide for the payment of dividends 
and similar distributions to policyholders. Losses in the latter case 
may be deducted from ordinary income while the deduction for losses 
under subchapter P is limited to the gains. See section 1211.
    (ii) Capital assets are considered as sold or exchanged to provide 
for the funds or payments specified in section 822(c)(6), to the extent 
that the gross receipts from the sale or exchange of such assets are not 
greater than the excess, if any, for the taxable year of the sum of 
dividends and similar distributions paid to policyholders, and losses 
and expenses paid over the sum of the items described in section 822(b) 
(other than paragraph (1)(D) thereof) and net premiums received. If, by 
reason of a particular sale or exchange of a capital asset, gross 
receipts are greater than such excess, the gross receipts and the 
resulting loss should be apportioned and the excess included in capital 
losses subject to the provisions of subchapter P. Capital losses 
actually used to reduce net income in any taxable year may not again be 
used in a succeeding taxable year as an offset against capital gains in 
that year and for that purpose a special rule is set forth for the 
application of section 1212.
    (iii) The application of section 822(c)(6) may be illustrated by the 
following examples:

    Example 1. The X Company, a mutual fire insurance company subject to 
tax under section 821, in the taxable year 1963 sells capital assets in 
order to obtain funds to meet abnormal insurance losses and to provide 
for

[[Page 841]]

the payment of dividends and similar distributions to policyholders. The 
gross receipts from the sale are $60,000, resulting in losses of 
$20,000. It pays dividends to policyholders of $150,000. It sustains 
losses of $25,000, and pays expenses of $25,000. It receives interest of 
$50,000, dividends of $5,000, royalties of $4,000, and net premiums of 
$66,000. The excess of the sum of dividends, losses, and expenses paid 
($200,000) over the sum of the items described in section 822(b) (other 
than paragraph (1)(D) thereof) and net premiums received ($125,000) is 
$75,000. Since the gross receipts from the sale of capital assets 
($60,000) do not exceed such excess ($75,000), the losses of $20,000 are 
allowable as a deduction from gross investment income in computing 
taxable investment income under section 822.
    Example 2. If in example 1 the gross receipts were $76,000 and the 
last capital asset sold, for the purpose therein specified, resulted in 
gross receipts of $2,000 and a loss of $500, the losses allowable as a 
deduction from gross investment income would be $19,750. The last sale 
made the gross receipts of $76,000 exceed by $1,000 the excess ($75,000) 
of the sum of dividends, losses, and expenses paid ($200,000) over the 
sum of the items described in section 822(b) (other than paragraph 
(1)(D) thereof) and net premiums received ($125,000). The gross receipts 
and the resulting loss from the last sale are apportioned on the basis 
of the ratio of the excess of $1,000 to the gross receipts of $2,000, or 
50 percent. Fifty percent of the loss of $500 is deducted from the total 
loss of $20,000. The remaining gross receipts of $1,000 and the 
proportionate loss of $250 should be reported as capital losses under 
subchapter P.
    Example 3. If in example 1 the X Company had taxable investment 
income for purposes of the surtax of $9,750 and, under the provisions of 
subchapter P, chapter 1 of the Code, had capital losses of $18,000 and 
capital gains of $10,000, the net capital loss for the taxable year 
1963, in applying section 1212 for the purposes of section 822(c)(6), 
would be $8,000. This is determined by subtracting from total losses of 
$38,000 ($18,000 capital losses under subchapter P plus $20,000 other 
capital losses under section 822(c)(6)) the sum of capital gains of 
$10,000 and losses from the sale or exchange of capital assets sold or 
exchanged to obtain funds to meet abnormal insurance losses and to 
provide for the payment of dividends and similar distributions to 
policyholders of $20,000. Such losses of $20,000 are added to capital 
gains of $10,000, since they are less than taxable investment income for 
purposes of the surtax, computed without regard to gains or losses from 
sales or exchanges of capital assets, of $29,750 ($9,750 taxable 
investment income for purposes of the surtax plus $20,000 other capital 
losses under section 822(c)(6) plus the portion of capital losses 
allowable under subchapter P of $10,000 minus capital gains under 
subchapter P of $10,000).

    (7) Special deductions. Section 822(c)(7) allows a mutual insurance 
company the special deductions provided by part VIII (section 241 and 
following), except section 248, subchapter B, chapter 1 of the Code, 
relating to partially tax-exempt interest and to dividends received. In 
applying section 246(b) (relating to limitation on aggregate amount of 
deductions for dividends received) for purposes of this subparagraph, 
the reference in such section to ``taxable income'' shall be treated as 
a reference to ``taxable investment income''.
    (8) Trade or business deductions. (i) Under section 822(c)(8), the 
deductions allowed by subtitle A of the Code (without regard to this 
part) which are attributable to any trade or business (other than an 
insurance business) carried on by the insurance company, or by a 
partnership of which the company is a partner are, subject to the 
limitations in subdivision (ii) of this subparagraph, allowable as 
deductions from gross investment income in computing taxable investment 
income. Such deductions are allowable, however, only to the extent that 
they relate to income which is included in the company's gross 
investment income by reason of section 822(b)(2). Thus, a deduction 
shall not be allowed under section 822(c)(8) with respect to any item 
described in section 822(b)(1). The allowable deductions may exceed the 
gross income from such business.
    (ii) In computing the deductions under section 822(c)(8):
    (a) Any item, to the extent attributable to the carrying on of the 
insurance business, shall not be taken into account. For example, if the 
company operates a radio station primarily to advertise its own 
insurance services, a portion of the expenses of the radio station shall 
not be allowed as a deduction. The portion disallowed shall be an amount 
which bears the same ratio to the total expenses of the station as the 
value of advertising furnished to the insurance company bears to the 
total value of services rendered by the station.

[[Page 842]]

    (b) The deduction for net operating losses provided in section 172 
shall not be allowed.
    (9) Depletion. The deduction allowed by section 822(c)(9) for 
depletion is the same as that allowed life insurance companies under 
section 804(c)(4). See paragraph (b)(5) of Sec. 1.804-4.

[T.D. 6681, 28 FR 11113, Oct. 17, 1963]



Sec. 1.822-9  Real estate owned and occupied.

    Section 822(d)(1) provides that the amount allowable as a deduction 
for taxes, expenses, and depreciation on or with respect to any real 
estate owned and occupied in whole or in part by a mutual insurance 
company subject to the tax imposed by section 821 (a) or (c) shall be 
limited to an amount which bears the same ratio to such deduction 
(computed without regard to this limitation) as the rental value of the 
space not so occupied bears to the rental value of the entire property. 
For example, if the rental value of the space not occupied by the 
company is equal to one-half of the rental value of the entire property, 
the deduction for taxes, expenses, and depreciation is one-half of the 
taxes, expenses, and depreciation on account of the entire property. 
Where a deduction is claimed as provided in this section, the parts of 
the property occupied and the parts not occupied by the company, 
together with the respective rental values thereof, must be shown in a 
statement accompanying the return.

[T.D. 6681, 28 FR 11115, Oct. 17, 1963]



Sec. 1.822-10  Amortization of premium and accrual of discount.

    (a) In general. In computing taxable investment income for the 
taxable year, the gross amount of income from interest, the deduction 
under section 822(c)(1) for wholly tax-exempt interest, and the 
deduction under section 242 for partially tax-exempt interest, are, 
under the provisions of section 822(d)(2), each to be decreased by the 
appropriate amortization of premium and increased by the appropriate 
accrual of discount attributable to the taxable year on bonds, notes, 
debentures, or other evidences of indebtedness held by a mutual 
insurance company subject to the tax imposed by section 821 (a) or (c). 
However, only the accrual of discount relating to issue discount will 
increase the deduction for wholly tax-exempt interest. See section 103. 
Such amortization and accrual is the same as that provided for life 
insurance companies by section 818(b)(1), as amended by the Life 
Insurance Company Income Tax Act of 1959 (73 Stat. 133), and shall be 
determined in accordance with paragraphs (a) and (b) of Sec. 1.818-3, 
except as provided by paragraph (b) of this section.
    (b) Modifications. (1) Paragraph (b) of Sec. 1.818-3 shall apply to 
mutual casualty insurance companies subject to the tax imposed by 
section 821 (a) or (c) without regard to the date of acquisition of the 
particular securities to which the amortization of premium or accrual of 
discount is attributable.
    (2) In computing the amount of premium or discount for purposes of 
section 822(d)(2) with respect to securities held by a company taxable 
under section 821, the basis provided by section 1012 shall be used in 
lieu of the acquisition value provided by paragraph (b) of Sec. 1.818-
3. In the case of a company subject to the tax imposed by section 
821(c), adjustments to basis to reflect the accrual of discount and the 
amortization of premium shall be made in the manner provided by 
paragraphs (a) and (b) of Sec. 1.818-3. However, for purposes of 
determining statutory underwriting income or loss for the taxable year 
under section 823, a company subject to the tax imposed by section 
821(a) is not required to accrue discount or to amortize premium in 
computing its income under section 832 as if it were subject to the tax 
imposed by section 831. Thus, the accrual of discount and amortization 
of premium required in the computation of taxable investment income by a 
company subject to the tax imposed by section 821(a) neither increases 
nor decreases the mutual insurance company taxable income of such a 
company and, except to the extent such a company actually accrues 
discount or amortizes premium for purposes of making the section 832 
computation, no adjustment shall be made to the basis of obligations 
held by it to

[[Page 843]]

reflect accrual of discount or amortization of premium.

[T.D. 6681, 28 FR 11115, Oct. 17, 1963]



Sec. 1.822-11  Net premiums.

    The term ``net premiums'', defined in section 822(f)(1), includes 
deposits and assessments, but excludes amounts returned to policyholders 
which are treated as dividends under section 822(f)(2). Net premiums are 
used in sections 822(c)(6) and 832(c)(5) in determining the limitation 
on certain capital losses and in the application of section 1212.

[T.D. 6681, 28 FR 11115, Oct. 17, 1963]



Sec. 1.822-12  Dividends to policyholders.

    (a) Dividends to policyholders are used in determining the 
``underwriting loss'' for purposes of the special transitional 
underwriting loss deduction provided by section 821(f), and the 
limitation on capital losses under section 822(c)(6); in computing 
statutory underwriting income or loss under section 823, and the 
subtractions from the protection against loss account under section 
824(d). The term ``dividends to policyholders'' is defined in section 
822(f)(2) as dividends and similar distributions paid or declared to 
policyholders. It includes amounts returned to policyholders where the 
amount is not fixed in the insurance contract but depends upon the 
experience of the company or the discretion of the management. Such 
amounts are not to be treated as return premiums under section 
822(f)(1). Savings credited to the individual accounts of the 
subscribers of a reciprocal underwriter or interinsurer under section 
823(b)(2) are not dividends paid or declared within the meaning of this 
paragraph. However, distributions in respect of such credits shall be 
considered as dividends paid. See section 823(b)(2) and paragraph (c)(2) 
of Sec. 1.823-6. The term ``paid or declared'' is to be construed 
according to the method of accounting regularly employed in keeping the 
books of the insurance company, and such method shall be consistently 
followed with respect to all deductions (including dividends and similar 
distributions to policyholders) and all items of income.
    (b) If the method of accounting so employed is the cash receipts and 
disbursements method, the deduction is limited to the dividends and 
similar distributions actually paid to policyholders in the taxable 
year. If, on the other hand, the method of accounting so employed is the 
accrual method, the deduction, or a reasonably accurate estimate 
thereof, for dividends and similar distributions declared to 
policyholders for any taxable year will, in general, be computed by 
adding the amount of dividends and similar distributions declared but 
unpaid at the end of the taxable year to dividends and similar 
distributions paid during the taxable year and deducting dividends and 
similar distributions declared but unpaid at the beginning of the 
taxable year. If an insurance company using the accrual method does not 
compute the deduction for dividends and similar distributions declared 
to policyholders in the manner stated, it must submit with its return a 
full and complete explanation of the manner in which the deduction is 
computed. For the rule as to when dividends are considered paid, see the 
regulations under section 561.

[T.D. 6681, 28 FR 11115, Oct. 17, 1963]



Sec. 1.823-1  Net premiums.

    Net premiums are one of the items used, together with interest, 
dividends, and rents, less dividends to policyholders and wholly tax-
exempt interest, in determining tax liability under section 821(a)(2). 
They are also used in section 822(c)(6) in determining the limitation on 
certain capital losses and in the application of section 1212. The term 
``net premiums'' is defined in section 823(1) and includes deposits and 
assessments, but excludes amounts returned to policyholders which are 
treated as dividends under section 823(2).



Sec. 1.823-2  Dividends to policyholders.

    (a) Dividends to policyholders is one of the deductions used, 
together with wholly tax-exempt interest, in determining tax liability 
under section 821(a)(2). They are also used in section 822(c)(6) in 
determining the limitation on certain capital losses and in the 
application of section 1212. The term

[[Page 844]]

``dividends to policyholders'' is defined in section 823(2) as dividends 
and similar distributions paid or declared to policyholders. It includes 
amounts returned to policyholders where the amount is not fixed in the 
insurance contract but depends upon the experience of the company or the 
discretion of the management. Such amounts are not to be treated as 
return premiums under section 823(1). Similar distributions include such 
payments as the so-called unabsorbed premium deposits returned to 
policyholders by factory mutual fire insurance companies. The term 
``paid or declared'' is to be construed according to the method of 
accounting regularly employed in keeping the books of the insurance 
company, and such method shall be consistently followed with respect to 
all deductions (including dividends and similar distributions to 
policyholders) and all items of income.
    (b) If the method of accounting so employed is the cash receipts and 
disbursements method, the deduction is limited to the dividends and 
similar distributions actually paid to policyholders in the taxable 
year. If, on the other hand, the method of accounting so employed is the 
accrual method, the deduction, or a reasonably accurate estimate 
thereof, for dividends and similar distributions declared to 
policyholders for any taxable year will, in general, be computed as 
follows:

    To dividends and similar distributions paid during the taxable year 
add the amount of dividends and similar distributions declared but 
unpaid at the end of the taxable year and deduct dividends and similar 
distributions declared but unpaid at the beginning of the taxable year.


If an insurance company using the accrual method does not compute the 
deduction for dividends and similar distributions declared to 
policyholders in the manner stated, it must submit with its return a 
full and complete explanation of the manner in which the deduction is 
computed. For the rule as to when dividends are considered paid, see the 
regulations under section 561.



Sec. 1.823-3  Taxable years affected.

    Sections 1.823-1 and 1.823-2 are applicable only to taxable years 
beginning after December 31, 1953, but before January 1, 1955, and 
ending after August 16, 1954, and all references to sections of part II, 
subchapter L, chapter 1 of the Code are to the Internal Revenue Code of 
1954, before amendments. Sections 1.823-4 and 1.823-5 are applicable 
only to taxable years beginning after December 31, 1954, but before 
January 1, 1963, and all references to sections of part II, subchapter 
L, chapter 1 of the Code are to the Internal Revenue Code of 1954, as 
amended by the Life Insurance Company Tax Act for 1955 (70 Stat. 36). 
Sections 1.823-6 through 1.823-8 are applicable only to taxable years 
beginning after December 31, 1962, and all references to sections of 
parts II and III, subchapter L, chapter 1 of the Code are to the 
Internal Revenue Code of 1954 as amended by section 8 of the Revenue Act 
of 1962 (76 Stat. 989).

[T.D. 6681, 28 FR 11116, Oct. 17, 1963]



Sec. 1.823-4  Net premiums.

    Net premiums are one of the items used, together with the gross 
amount of income during the taxable year from the items described in 
section 822(b) (other than paragraph (1)(D) thereof), less dividends to 
policyholders and wholly tax-exempt interest, in determining tax 
liability under section 821(a)(2). They are also used in section 
822(c)(6) in determining the limitation on certain capital losses and in 
the application of section 1212. The term ``net premiums'' is defined in 
section 823(1) and includes deposits and assessments, but excludes 
amounts returned to policyholders which are treated as dividends under 
section 823(2).

[T.D. 6610, 27 FR 8722, Aug. 31, 1962]



Sec. 1.823-5  Dividends to policyholders.

    (a) Dividends to policyholders is one of the deductions used, 
together with wholly tax-exempt interest, in determining tax liability 
under section 821(a)(2). They are also used in section 822(c)(6) in 
determining the limitation on certain capital losses and in the 
application of section 1212. The term ``dividends to policyholders'' is 
defined in section 823(2) as dividends and similar distributions paid or 
declared to policyholders. It includes amounts returned to policyholders 
where the amount is not fixed in the insurance

[[Page 845]]

contract but depends upon the experience of the company or the 
discretion of the management. Such amounts are not to be treated as 
return premiums under section 823(1). Similar distributions include such 
payments as the so-called unabsorbed premium deposits returned to 
policyholders by factory mutual fire insurance companies. The term 
``paid or declared'' is to be construed according to the method of 
accounting regularly employed in keeping the books of the insurance 
company, and such method shall be consistently followed with respect to 
all deductions (including dividends and similar distributions to 
policyholders) and all items of income.
    (b) If the method of accounting so employed is the cash receipts and 
disbursements method, the deduction is limited to the dividends and 
similar distributions actually paid to policyholders in the taxable 
year. If, on the other hand, the method of accounting so employed is the 
accrual method, the deduction, or a reasonably accurate estimate 
thereof, for dividends and similar distributions declared to 
policyholders for any taxable year will, in general, be computed as 
follows: To dividends and similar distributions paid during the taxable 
year add the amount of dividends and similar distributions declared but 
unpaid at the end of the taxable year and deduct dividends and similar 
distributions declared but unpaid at the beginning of the taxable year. 
If an insurance company using the accrual method does not compute the 
deduction for dividends and similar distributions declared to 
policyholders in the manner stated, it must submit with its return a 
full and complete explanation of the manner in which the deduction is 
computed. For the rule as to when dividends are considered paid, see the 
regulations under section 561.

[T.D. 6610, 27 FR 8722, Aug. 31, 1962]



Sec. 1.823-6  Determination of statutory underwriting income or loss.

    (a) In general. Section 823(a) and this section provide that for 
purposes of determining statutory underwriting income or loss for the 
taxable year, a mutual insurance company subject to the tax imposed by 
section 821(a) must first take into account the same gross income and 
deduction items (except as modified by section 823(b) and paragraph (c) 
of this section) as a taxpayer subject to tax under section 831 would 
take into account for purposes of determining its taxable income under 
section 832. These items are then reduced to the extent that they 
include amounts which are included in determining taxable investment 
income or loss under section 822(a) and Sec. 1.822-8. In addition, in 
computing its statutory underwriting income or loss for the taxable 
year, a company taxable under section 821(a) is allowed to deduct the 
amount determined under section 824(a) (relating to deduction to provide 
protection against losses) and, if its gross amount received is less 
than $1,100,000, is allowed to deduct the amount determined under 
section 823(c) and paragraph (d) of this section (relating to special 
deduction for certain small companies), subject to the limitations 
provided therein.
    (b) Definitions--(1) Statutory underwriting income defined. Section 
823(a) (1) defines the term ``statutory underwriting income'' for 
purposes of part II of subchapter L of the Code. Subject to the 
modifications provided by section 823(b) and paragraph (c) of this 
section, statutory underwriting income is defined as the amount by 
which:
    (i) The gross income which would be taken into account in computing 
taxable income under section 832 if the taxpayer were subject to the tax 
imposed by section 831, reduced by the gross investment income (as 
determined under section 822(b)), exceeds
    (ii) The sum of:
    (a) The deductions which would be taken into account in computing 
taxable income if the taxpayer were subject to the tax imposed by 
section 831, reduced by the deductions provided in section 822(c) 
(relating to deductions allowed in computing taxable investment income), 
plus
    (b) The deductions provided in section 823(c) (relating to special 
deduction for small company having gross amount of less than $1,100,000) 
and section 824(a) (relating to deduction to provide protection against 
losses).

For purposes of subdivision (ii)(a) of this subparagraph, the 
limitations on

[[Page 846]]

the amounts deductible under paragraphs (9) (relating to charitable, 
etc., contributions) and (12) (relating to partially tax-exempt interest 
and to dividends received) of section 832(c) shall be computed by 
reference to taxable income as defined by section 832(a), and as 
modified by section 823(b) and paragraph (c) of this section.
    (2) Statutory underwriting loss defined. ``Statutory underwriting 
loss'' is defined in section 823(a)(2) as the amount by which the amount 
determined under section 823(a)(1)(B) and subparagraph (1)(ii) of this 
paragraph exceeds the amount determined under section 823(a)(1)(A) and 
subparagraph (1)(i) of this paragraph.
    (c) Modifications--(1) Net operating losses. In applying section 832 
for purposes of determining statutory underwriting income or loss under 
section 823(a) and paragraph (b) of this section, the deduction for net 
operating losses provided by section 172 is not allowed. However, see 
section 825(a) and Sec. 1.825-1 for unused loss deduction allowed 
companies taxable under section 821(a) in computing mutual insurance 
company taxable income under section 821(b).
    (2) Interinsurers and reciprocal underwriters--(i) In general. 
Section 823(b)(2) provides that in computing the statutory underwriting 
income or loss of a mutual insurance company which is an interinsurer or 
reciprocal underwriter, there shall be allowed as a deduction the 
increase for the taxable year in savings credited to subscriber 
accounts, or there shall be included as an item of gross income the 
decrease for the taxable year in savings credited to subscriber 
accounts. For purposes of this subparagraph, the term ``savings credited 
to subscriber accounts'' means such portion of the surplus for the 
taxable year as is credited to the individual accounts of subscribers 
before the 16th day of the third month following the close of the 
taxable year, but only if the company would be obligated to pay such 
amount promptly to such subscriber if he terminated his contract at the 
close of the company's taxable year, and only if the company mails 
notification to such subscriber of the amount credited to his individual 
account in the manner provided by subdivision (v) of this subparagraph.
    (ii) Limitations. Amounts representing return premiums (as defined 
in paragraph (a)(1)(ii) of Sec. 1.809-4) which the company would be 
obligated to pay to any subscriber terminating his contract at the close 
of the company's taxable year are not savings credited to subscriber 
accounts within the meaning of section 823(b)(2) and subdivision (i) of 
this subparagraph. The deduction for savings credited to individual 
subscriber accounts is allowed only in the case of reciprocal 
underwriters or interinsurers where the subscriber or policyholder has 
not only a legally enforceable right to receive the amount so credited 
if he withdraws from the exchange, but where the amounts credited, as a 
matter of actual practice, are paid to subscribers or policyholders who 
terminate their contracts. Thus, no deduction shall be allowed for 
savings credited to subscriber accounts if such savings are not in fact 
promptly returned to subscribers when they terminate their contracts.
    (iii) Computation of increase or decrease in savings credited to 
subscriber accounts. For purposes of determining the increase or 
decrease for the taxable year in savings credited to subscriber 
accounts, every reciprocal underwriter or interinsurer claiming a 
deduction under section 823(b)(2) and this section shall establish and 
maintain an account for savings credited to subscriber accounts. The 
opening balance in such account for the first taxable year for which a 
deduction is claimed under section 823(b)(2) and this section shall be 
zero. In each taxable year there shall be added to such account the 
total amount of savings credited to subscriber accounts for the taxable 
year, and there shall be subtracted from such account the total amount 
of savings subtracted from subscriber accounts for the taxable year. 
However, in no case may the amount added to the account exceed the total 
amount of savings to subscribers for the taxable year, irrespective of 
the amount of savings credited to subscriber accounts for the taxable 
year. Credits made to subscriber accounts after the close of the taxable 
year and before the 16th day of the third month following the close of

[[Page 847]]

the taxable year will be taken into account as if such amounts had been 
credited on the last day of the taxable year to the extent such amounts 
would have become fixed and determinable legal obligations due 
subscribers if such subscribers had terminated their contracts on the 
last day of the company's taxable year unless, at the time the amounts 
are credited, the company specifically designates such amounts as being 
from surplus for the taxable year in which the amounts were actually 
credited. Such a designation, once made, shall be irrevocable. However, 
if a company credited savings to subscriber accounts after December 31, 
1962, and before March 16, 1963, and failed to designate such credits as 
being from surplus for the taxable year 1963, such company may designate 
such credits as being from surplus for the taxable year 1963 for 
purposes of determining the total amount of credits to subscriber 
accounts for such year. In determining the total amount of savings 
subtracted from subscriber accounts for the taxable year, only amounts 
subtracted from savings credited for taxable years beginning with the 
first taxable year for which a deduction was claimed under section 
823(b)(2) and this subparagraph will be taken into account. The method 
of accounting regularly employed by the taxpayer in keeping its books of 
account will be used for purposes of determining whether the amounts 
subtracted from the subscriber accounts are from savings for taxable 
years beginning before the first taxable year for which a deduction is 
claimed under section 823(b)(2) and this subparagraph, or from savings 
for taxable years beginning with such first taxable year. Where the 
method of accounting regularly employed by the taxpayer in keeping its 
books of account does not clearly indicate whether an amount was 
subtracted from savings credited to subscriber accounts for taxable 
years beginning before the first taxable year for which a deduction is 
claimed under section 823(b)(2) and this subparagraph, or from savings 
credited for such first taxable year and subsequent taxable years, the 
amount subtracted will be deemed to have come from savings credited to 
subscriber accounts for all taxable years, on a pro rata basis. Where an 
amount is subtracted from a subscriber's account for record purposes, 
but such subtraction does not reflect the discharge of the company's 
legal obligation to pay the amount subtracted promptly to the subscriber 
if he terminates his contract, then such subtraction shall not be taken 
into account for purposes of section 823(b)(2) and this subparagraph. On 
the other hand, where the company ceases to be under a legal obligation 
to pay promptly to any subscriber the amount credited to his individual 
account, then such amount shall be considered as having been subtracted 
from such subscriber's account at the time such obligation ceased to 
exist. For purposes of section 823(b)(2) and this subparagraph, the 
increase (if any) for the taxable year in savings credited to subscriber 
accounts shall be the amount by which the balance in the account for 
savings credited to subscriber accounts as of the close of the taxable 
year exceeds the balance in such account as of the close of the 
preceding taxable year; and the decrease (if any) for the taxable year 
in savings credited to subscriber accounts shall be the amount by which 
the balance in the account for savings credited to subscriber accounts 
as of the close of the preceding taxable year exceeds the balance in 
such account as of the close of the taxable year.
    (iv) Legal obligation. For purposes of this subparagraph, the 
existence of a legal obligation on the part of the company to pay to the 
subscriber the savings credited to him will be determined under the 
insurance contract pursuant to which the credits are made. Where it 
appears that the company is otherwise legally obligated to pay amounts 
credited to its subscribers, the requisite legal obligation will not be 
considered absent merely because a subscriber's credits remain subject 
to absorption by future losses incurred if left on deposit with the 
company.
    (v) Notification to subscribers. Every reciprocal underwriter or 
interinsurer claiming a deduction under section 823(b)(2) and this 
subparagraph for amounts credited to the individual accounts of its 
subscribers must mail to

[[Page 848]]

each such subscriber written notification of the amount credited to the 
subscriber's account for the taxable year, the date on which such amount 
was credited, and the date on which the subscriber's right to such 
amount first would have become fixed if such subscriber had terminated 
his contract at the close of the company's taxable year. As an 
alternative to providing each subscriber with specific information 
relating to the amount of savings credited to his individual account, 
the notification required by this subdivision may be provided in the 
form of a table or formula mailed to the subscribers. However, a table 
or formula may not be used in lieu of the specific notification required 
by this subdivision unless such table or formula has been approved by 
the Commissioner. Generally, a table or formula will be approved if it 
enables the subscriber to simply and readily ascertain the amount of 
savings credited to his individual account for the taxable year, the 
date on which such amount was credited, and the date on which his right 
to such amount first would have become fixed if he had terminated his 
contract at the close of the company's taxable year. A reciprocal 
underwriter or interinsurer which desires to use such a table or formula 
should direct a written request for approval of such table or formula to 
the Commissioner of Internal Revenue, Attention: T:R, Washington, DC, 
20224. Such request must set forth a copy of the table or formula 
proposed to be used, together with sufficient information to permit the 
Commissioner to determine the basis upon which such table or formula was 
prepared and the manner in which the subscribers will use such table or 
formula in determining the amounts credited to their individual 
accounts. Once a table or formula has been approved, the use of such 
table or formula with respect to savings credited for subsequent taxable 
years will not require further approval unless the basis upon which such 
table or formula was prepared, or the manner in which such table or 
formula is to be applied, is substantially changed. The table or formula 
method of notification may be used with respect to all or less than all 
of the company's subscribers. For example, the company might provide the 
notification required by this subdivision to one class of subscribers in 
the form of a table or formula mailed to the individual subscribers, 
while providing another class of subscribers with specific statements of 
the amounts credited to their individual accounts. The notification 
required by this subdivision must be mailed before the 16th day of the 
third month following the close of the reciprocal's taxable year for 
which the account was credited. Where for any taxable year a reciprocal 
underwriter or interinsurer claims a deduction under section 823(b) and 
this subparagraph and fails to give notice as required by this 
subdivision, such deduction shall not be allowed unless the reciprocal 
establishes to the satisfaction of the district director that the 
failure to mail such notice within the prescribed period was due to 
reasonable cause.
    (d) Special deduction for small company having gross amount of less 
than $1,100,000--(1) In general. In the case of a taxpayer subject to 
the tax imposed by section 821(a), section 823(c) provides that if the 
gross amount received during the taxable year from the items described 
in section 822(b) (other than paragraph (1)(D) thereof) and premiums 
(including deposits and assessments) is less than $1,100,000, then, 
subject to the limitation provided in section 823(c)(2) and subparagraph 
(2) of this paragraph, there shall be allowed an additional deduction 
for purposes of determining statutory underwriting income or loss under 
section 823(a) for the taxable year. The amount of the additional 
deduction is $6,000; except that if the gross amount received for the 
taxable year exceeds $500,000, the additional deduction is limited to an 
amount equal to 1 percent of the amount by which $1,100,000 exceeds such 
gross amount.
    (2) Limitation. The amount of the deduction provided by section 
823(c)(1) may not exceed the statutory underwriting income for the 
taxable year, computed without regard to the deduction allowed under 
section 823(c)(1) and subparagraph (1) of this paragraph, and the 
deduction allowed under section 824(a) (relating to deduction for 
protection against losses).

[[Page 849]]

    (3) Example. The application of section 823(c) and this paragraph 
may be illustrated by the following example:

    Example. M, a mutual insurance company subject to the tax imposed by 
section 821(a), has the following items for the taxable year 1963:

Gross amount for purposes of section 823(c)(1)..............    $800,000
Gross investment income (including capital gains)...........     150,000
Capital gains...............................................     100,000
Gross income under section 832..............................     900,000
Deductions under section 822(c).............................      22,000
Deductions under section 832 (as modified by section             746,000
 823(b)(2)).................................................
 

    Under the provisions of section 823(c), M's special small company 
deduction for the taxable year 1963 would be $3,000, computed as 
follows:

(1) Gross amount for purposes of section 823(c)(1)..........    $800,000
(2) Amount by which $1,100,000 exceeds item (1) ($1,100,000      300,000
 minus $800,000)............................................
(3) 1 percent of item (2) (not to exceed $6,000)............       3,000
(4) Gross income under section 832, reduced by gross             750,000
 investment income ($900,000 minus $150,000)................
(5) Deductions under section 832 (as modified by section         724,000
 823(b)), reduced by deductions under section 822(c)
 ($746,000 minus $22,000)...................................
(6) Limitation on deduction under section 823(c) (1)              26,000
 (excess, if any, of item (4) over item (5))................
(7) Deduction under section 823(c)(1) (item (3) or item (6),       3,000
 whichever is the lesser)...................................
 


[T.D. 6681, 28 FR 11116, Oct. 17, 1963]



Sec. 1.823-7  Subscribers of reciprocal underwriters and interinsurers.

    A subscriber or policyholder of a reciprocal underwriter or 
interinsurer entitled to the deduction allowed by section 823(b)(2) and 
paragraph (c)(2) of Sec. 1.823-6 shall treat amounts representing 
savings credit to his individual account for the taxable year as a 
dividend paid or declared for purposes of computing his taxable income. 
If a reciprocal credits savings to subscriber accounts after the close 
of its taxable year, but before the 16th day of the third month 
following the close of the taxable year, and the reciprocal takes such 
credits into account as if they had been made on the last day of its 
taxable year, the subscribers of such reciprocal must take such savings 
into account as if they had in fact been credited on the last day of the 
company's taxable year. The subscriber shall take savings credited to 
his account into account without regard to whether the amounts credited 
are actually distributed to him in cash. To the extent the insurance 
premium constituted a deductible expense when paid or accrued, the 
subscriber's taxable income for the taxable year will be increased and 
any loss for the taxable year will be decreased, by the amount credited 
to his account. Amounts credited to a subscriber's account which are 
taken into income by him and which subsequently are used to absorb 
losses of the reciprocal shall be treated by the subscriber as an 
additional insurance expense for the taxable year in which the amounts 
are absorbed. Such amounts may be deducted in computing taxable income 
to the extent insurance constitutes an otherwise properly deductible 
expense for such taxable year.

[T.D. 6681, 28 FR 11118, Oct. 17, 1963]



Sec. 1.823-8  Special transitional underwriting loss; cross reference.

    With respect to taxable years beginning after December 31, 1962, and 
before January 1, 1968, section 821(f) provides, for any company subject 
to the tax imposed by section 821(a), a special reduction in the 
statutory underwriting income if such company was subject to tax under 
section 821 for the five taxable years immediately preceding January 1, 
1962, and incurred an underwriting loss in each of such five taxable 
years. For rules relating to the determination of the amount of such 
reduction, see section 821(f) and Sec. 1.821-5.

[T.D. 6681, 28 FR 11118, Oct. 17, 1963]



Sec. 1.825-1  Unused loss deduction; in general.

    (a) Amount of deduction. Section 825(a) provides that the unused 
loss deduction of a mutual insurance company subject to the tax imposed 
by section 821(a) shall be an amount equal to the sum of the unused loss 
carryovers and carrybacks to the taxable year. The amount so determined 
is used in the computation of mutual insurance company taxable income 
for the taxable year. See section 821(b) and Sec. 1.821-4.
    (b) Unused loss defined. Section 825(b) defines the term ``unused 
loss'' as the amount (if any) by which:
    (1) The sum of the statutory underwriting loss (as defined in 
section

[[Page 850]]

823(a)(2)) and the investment loss (as defined in section 822(a)(2)) 
exceeds
    (2) The sum of:
    (i) The taxable investment income (as defined in section 822(a)(1)),
    (ii) The statutory underwriting income (as defined in section 
823(a)(1)), and
    (iii) The amounts required to be subtracted from the protection 
against loss account under section 824(d).
    (c) Steps in computation of unused loss deduction. The three steps 
to be taken in the ascertainment of the unused loss deduction for any 
taxable year are as follows:
    (1) Compute the unused loss for any preceding or succeeding taxable 
year from which an unused loss may be carried over or carried back to 
the taxable year.
    (2) Compute the unused loss carryovers to the taxable year from such 
preceding taxable years and the unused loss carrybacks to the taxable 
year from such succeeding taxable years.
    (3) Add such unused loss carryovers and carrybacks in order to 
determine the unused loss deduction for the taxable year.
    (d) Statement with tax return. Every mutual insurance company 
taxable under section 821(a) claiming an unused loss deduction for any 
taxable year shall file with its return for such year a concise 
statement setting forth the amount of the unused loss deduction claimed 
and all material and pertinent facts relative thereto, including a 
detailed schedule showing the computation of the unused loss deduction.
    (e) Ascertainment of deduction dependent upon unused loss carryback. 
If a mutual insurance company taxable under section 821(a) is entitled 
in computing its unused loss deduction to a carryback which it is not 
able to ascertain at the time its return is due, it shall compute the 
unused loss deduction on its return without regard to such unused loss 
carryback. When the company ascertains the unused loss carryback, it may 
within the applicable period of limitations file a claim for credit or 
refund of the overpayment, if any, resulting from the failure to compute 
the unused loss deduction for the taxable year with the inclusion of 
such carryback; or it may file an application under the provisions of 
section 6411 for a tentative carryback adjustment.
    (f) Law applicable to computations. The following rules shall apply 
to taxable years for which the taxpayer is subject to the tax imposed by 
section 821(a):
    (1) In determining the amount of any unused loss carryback or 
carryover to any taxable year, the necessary computations involving any 
other taxable year shall be made under the law applicable to such other 
taxable year.
    (2) The unused loss for any taxable year shall be determined under 
the law applicable to that year without regard to the year to which it 
is to be carried and in which, in effect, it is to be deducted as part 
of the unused loss deduction.
    (3) The amount of the unused loss deduction which shall be allowed 
for any taxable year shall be determined under the law applicable for 
that year.

[T.D. 6681, 28 FR 11122, Oct. 17, 1963]



Sec. 1.825-2  Unused loss carryovers and carrybacks.

    (a) Years to which loss may be carried--(1) In general. In order to 
determine its unused loss deduction for any taxable year, a mutual 
insurance company taxable under section 821(a) must first determine the 
part of any unused losses for any preceding or succeeding taxable years 
which are carryovers or carrybacks to the taxable year in issue. An 
unused loss is to be an unused loss carryback to each of the 3 taxable 
years preceding the loss year, and an unused loss carryover to each of 
the 5 taxable years following the loss year, subject to the limitations 
provided in section 825(g) and subparagraph (2) of this paragraph.
    (2) Limitations. An unused loss may not be carried:
    (i) To or from any taxable year beginning before January 1, 1963,
    (ii) To or from any taxable year for which the taxpayer is not 
subject to the tax imposed by section 821(a), nor
    (iii) To any taxable year if, between the loss year and such taxable 
year, there is an intervening taxable year for which the taxpayer was 
not subject to the tax imposed by section 821(a).

[[Page 851]]

    (3) Periods of less than 12 months. A fractional part of a year 
which is a taxable year under sections 441(b) and 7701(a)(23) is a 
preceding or a succeeding taxable year for the purpose of determining 
under section 825 the first, second, etc., preceding or succeeding 
taxable year.
    (b) Loss year defined. The term ``loss year'' as used in this 
section means any taxable year for which a company subject to the tax 
imposed by section 821(a) has an unused loss in excess of zero.
    (c) Amount of carrybacks and carryovers. Section 825(e) provides 
that in the case of a loss year for a company taxable under section 
821(a), the entire amount of the unused loss shall be carried to the 
earliest taxable year to which such loss may be carried under section 
825(d) (subject to the limitations of section 825(g)). The amount of the 
unused loss carried to each of the other taxable years to which such 
loss may be carried under section 825(d) following such earliest taxable 
year shall be the excess (if any) of such loss over the sum of the 
offsets for each taxable year preceding the taxable year to which the 
unused loss is carried.
    (d) Offset defined--(1) In general. Section 825(f) defines the term 
``offset'' and provides that the taxable year to which an unused loss is 
carried shall be referred to as the ``offset year''. The definition of 
the term offset in the case of an unused loss carryback to an offset 
year, differs from the definition of such term in the case of an unused 
loss carryover to an offset year.
    (2) Offset in case of carryback. In the case of an unused loss 
carryback from the loss year to the offset year, the offset is the 
mutual insurance company taxable income for the offset year, computed 
without regard to any unused loss carryback from the loss year or any 
taxable year thereafter.
    (3) Offset in case of carryover. In the case of an unused loss 
carryover from the loss year to the offset year, the offset is equal to 
the sum of:
    (i) The amount required to be subtracted from the protection against 
loss account under section 824(d)(1)(C) (relating to amounts equal to 
the unused loss carryovers to the offset year), plus
    (ii) The mutual insurance company taxable income for the taxable 
year, computed without regard to any unused loss carryback or carryover 
from the loss year or any taxable year thereafter.

[T.D. 6681, 28 FR 11123, Oct. 17, 1963]



Sec. 1.825-3  Examples.

    The application of section 825 may be illustrated by the following 
examples:

    Example 1. For the taxable year 1967, F, a mutual insurance company 
subject to the tax imposed by section 821(a), has the following items:

Taxable investment income....................................          1
Underwriting loss............................................         59
Addition to protection against loss account..................          8
Statutory underwriting loss..................................         67
 

    The subtractions from the protection against loss account are as 
follows:

Amount subtracted from amounts in account with respect to             18
 taxable years 1963 through 1966.............................
Amount subtracted from amounts in account with respect to              8
 taxable year 1967...........................................
                                                              ----------
Total subtractions from protection against loss account under         26
 section 824(d)..............................................
 

    The application of section 825 in this case may be illustrated by 
the facts and results shown in the following table and explained below:

                                                  Taxable Year
----------------------------------------------------------------------------------------------------------------
                                                        1963      1964      1965      1966      1967      1968
----------------------------------------------------------------------------------------------------------------
Protection against loss account:
  Addition to account during taxable year...........         6         2         3         7         8         7
  Subtraction from account during taxable year......         0         0         0         0         8         7
      Protection against loss account (at end of             6         2         3         7         0         0
       year)........................................
      Protection against loss account (at end of             0         0         0         0         0         0
       taxable year 1968)...........................
Unused loss.........................................         0         0         0         0        40         0
Unused loss carryback...............................         0        40        35        25         0         0
Unused loss carryover...............................         0         0         0         0         0        18
Unused loss deduction...............................         0        40        35        25         0        18
Mutual insurance company taxable income (computed           13         5        10         7         0         2
 without regard to unused loss).....................

[[Page 852]]

 
Mutual insurance company taxable income (computed           13         0         0         0         0         0
 with regard to unused loss)........................
Offset for year.....................................         0         5        10         7         0         9
Offset total........................................         0         5        15        22        22        31
----------------------------------------------------------------------------------------------------------------

    1967: Under the provisions of section 825(b), F's unused loss for 
1967 is 40, the amount by which the sum of the statutory underwriting 
loss and the investment loss, 67 (67 plus 0), exceeds the sum of the 
taxable investment income, the statutory underwriting income, and the 
amounts required to be subtracted from the protection against loss 
account under section 824(d) for the taxable year, 27 (the sum of 1, 0, 
and 26, respectively).
    1967 carryback to 1964: Under the provisions of section 825(e), the 
entire unused loss for 1967 of 40 is carried back to 1964, the earliest 
year to which the loss may be carried under section 825(d). Since there 
are no other amounts carried to 1964, the unused loss deduction for 1964 
is 40. Thus, after taking the unused loss deduction into account, the 
mutual insurance company taxable income for 1964 is zero, and the offset 
for 1964 is 5 (the mutual insurance company taxable income for 1964 
determined without regard to the unused loss carryback from 1967 or any 
year thereafter).
    1967 carryback to 1965: The portion of the unused loss for 1967 
which is carried back to 1965 is 35 (40 minus 5, the offset for 1964). 
After taking the unused loss deduction into account, the mutual 
insurance company taxable income for 1965 is zero. The offset for 1965 
is 10, the mutual insurance company taxable income for 1965 determined 
without regard to any unused loss carryback from 1967 or any year 
thereafter.
    1967 carryback to 1966: The portion of the unused loss for 1967 
which is carried back to 1966 is 25. This amount is the excess of the 
unused loss for 1967 of 40 over the sum of the offset for 1964 (5) and 
the offset for 1965 (10). As a result of the unused loss deduction the 
mutual insurance company taxable income for 1966 is reduced to zero. The 
offset for 1966 is 7.
    1967 carryover to 1968: Under the provisions of section 825(d), the 
portion of the unused loss for 1967 which is carried forward to 1968 is 
18 (40 minus the sum of 5, 10, and 7, the offsets for 1964, 1965, and 
1966, respectively). Under section 825(f)(2), this amount is first 
applied against any amounts in the protection against loss account at 
the end of 1968, and is then applied against the mutual insurance 
company taxable income for 1968 (computed without regard to any unused 
loss carryovers or carrybacks from 1967 or any taxable year thereafter). 
Thus, assuming that there are no other subtractions from its protection 
against loss account under section 824(d) for 1968, F's protection 
against loss account of 7 is reduced to zero by reason of the 
subtraction under section 824(d)(1)(C). The remaining portion of the 
unused loss for 1967 which is carried to 1968, 11 (18 minus 7, the 
amount of the unused loss carryover to 1968 which is subtracted from the 
protection against loss account under section 824(d)(1)(C)), is then 
applied against the mutual insurance company taxable income for 1968 
computed without regard to any unused carryback or carryover from the 
loss year (1967) or any taxable year thereafter. After the application 
of the unused loss deduction for 1968, the mutual insurance company 
taxable income for 1968 is zero. The offset for 1968 is 9, the sum of 
the amount required to be subtracted from the protection against loss 
account under section 824(d)(1)(C) for 1968 (7), plus the mutual 
insurance company taxable income for 1968, determined without regard to 
any unused loss carryover or carryback from 1967 or any year thereafter 
(2). The remaining 9 of the unused loss for 1967 (40 minus the sum of 5, 
10, 7, and 9, the offsets for 1964, 1965, 1966, and 1968, respectively), 
is carried forward to 1969, and to the extent not used in that year or 
any year thereafter, may be carried forward to 1970, 1971, and 1972, in 
that order.
    Example 2. If in example 1 F had an unused loss in 1966 of 22, then, 
with respect to F's 1967 unused loss of 40, the offset for 1964 would be 
zero; the offset for 1965 would be 6--the 1965 mutual insurance company 
taxable income of 10 less an unused loss carryback of 4 from 1966 (the 
1966 unused loss of 22 minus the 1963 offset of 13 and the 1964 offset 
of 5); the offset for the loss year 1966 would be zero, and 34 (the 1967 
unused loss of 40 minus the offset for 1965 of 6) would remain as an 
unused loss carryover to 1968, 1969, 1970, 1971, 1972, in that order. 
Thus, the unused loss carrybacks or carryovers to an offset year are 
applied against the mutual insurance company taxable income for such 
year in the order in which the losses occurred, with the earliest loss 
being offset first.
    Example 3. For the taxable year 1963, M, a mutual insurance company 
subject to tax imposed by section 821(a), has an unused loss (as defined 
in section 825(b)) of $65,000. Under section 825(g), the loss may not be 
carried back to any taxable year beginning before 1963. However, the 
loss may be carried forward to each of the 5 taxable years following

[[Page 853]]

1963 provided that for each of such succeeding taxable years M is 
subject to the tax imposed by section 821(a).
    Example 4. Assume the facts are the same as in example 3, except 
that for the taxable year 1964, the gross amount received by M from the 
items described in section 822(b) (other than paragraph (1)(D) thereof) 
and premiums (including deposits and assessments) exceeds $150,000 but 
does not exceed $500,000. If M does not make the election under section 
821(d) (relating to election to be taxed under section 821(a)) for 1964, 
M's 1963 unused loss of $65,000 will not be allowed as an unused loss 
carryover or carryback since, by reason of section 825(g)(3), the unused 
loss may not be carried to any taxable year if, between the loss year 
and such taxable year, there is an intervening taxable year for which 
the insurance company was not subject to the tax imposed by section 
821(a), and by reason of section 825(g)(1), the unused loss may not be 
carried to any taxable year beginning before 1963.

[T.D. 6681, 28 FR 11123, Oct. 17, 1963]



Sec. 1.826-1  Election by reciprocal underwriters and interinsurers.

    (a) In general. Except as otherwise provided in section 826(c), any 
mutual insurance company which is an interinsurer or reciprocal 
underwriter taxable under section 821(a) may elect under section 826(a) 
to limit its deductions for amounts paid or incurred to its attorney-in-
fact to the deductions of its attorney-in-fact which are allocable to 
income received by the attorney-in-fact from the reciprocal during the 
taxable year. See Sec. 1.826-4 for rules relating to allocation of 
expenses. In no case may such an election increase the amount deductible 
by the reciprocal for amounts paid or due its attorney-in-fact for the 
taxable year. The election allowed by section 826(a) and this section in 
effect increases the income of the reciprocal by the net income of the 
attorney-in-fact attributable to its business with the reciprocal. A 
reciprocal making the election is allowed a credit for the amount of tax 
paid by the attorney-in-fact for the taxable year which is attributable 
to income received by the attorney-in-fact from the reciprocal. See 
section 826(e) and Sec. 1.826-5.
    (b) Companies eligible to elect under section 826(a). Any mutual 
insurance company which is a reciprocal underwriter or interinsurer 
subject to the tax imposed by section 821(a) may elect (in the manner 
prescribed by paragraph (c) of this section) to be subject to the 
limitation provided by section 826(b) and paragraph (a) of this section 
provided the attorney-in-fact of the electing reciprocal:
    (1) Is subject to the taxes imposed by section 11 (b) and (c) and 
the regulations thereunder;
    (2) Consents (in the manner provided by paragraph (a) of Sec. 
1.826-3) to provide the information required under paragraph (b) of 
Sec. 1.826-3 during the period in which the election made under section 
826(a) and this section is in effect;
    (3) Reports the income received from the reciprocal and the 
deductions allocable thereto under the same method of accounting used by 
the reciprocal in reporting its deductions for amounts paid or due its 
attorney-in-fact; and
    (4) Files its income tax return on a calendar year basis.
    (c) Manner of making election. The election provided by section 
826(a) and this section shall be made in a statement attached to the 
taxpayer's income tax return for the first taxable year for which such 
election is to apply. The statement shall include the name and address 
of the taxpayer, shall be signed by the taxpayer (or its duly authorized 
representative), and shall be filed not later than the time prescribed 
by law for filing the income tax return (including extensions thereof) 
for the first taxable year for which such election is to apply. For 
information required of an electing reciprocal, see paragraph (e) of 
this section.
    (d) Scope of election. The election allowed by section 826(a) is 
binding for the taxable year for which made and all succeeding taxable 
years unless the Commissioner consents to a revocation of such election. 
Whether revocation will be permitted will depend upon the facts and 
circumstances of each particular case.
    (e) Information required of an electing company. Every reciprocal 
underwriter or interinsurer making the election provided by section 
826(a) and this section shall, in the manner provided by paragraph (f) 
of this section, furnish the following information for each taxable year 
during which such election is in effect:

[[Page 854]]

    (1) The name and address of the attorney-in-fact with respect to 
which the election allowed by section 826(a) and this section is in 
effect; the district in which such attorney-in-fact filed its return for 
the taxable year; and a copy of the consent required by section 826 and 
Sec. 1.826-3 and the date and district in which such consent was filed;
    (2) The deductible amount paid or due to such attorney-in-fact from 
the reciprocal computed without regard to the limitation provided by 
section 826(b);
    (3) The total amount claimed as a deduction by the reciprocal for 
amounts paid to its attorney-in-fact after giving effect to the 
limitation provided by section 826(b);
    (4) The amount of the increase (if any) in underwriting gain (as 
defined in section 824(a)) attributable to the election allowed by 
section 826(a);
    (5) The amount of the increase (if any) in the deduction allowed by 
section 824(a) (relating to deduction to provide protection against 
losses) attributable to the election allowed by section 826(a);
    (6) The amount of any increase or decrease in the statutory 
underwriting income or loss for the taxable year (as computed under 
section 823) attributable to the election allowed by section 826(a);
    (7) The amount of any increase or decrease in the mutual insurance 
company taxable income or unused loss for the taxable year attributable 
to the election allowed by section 826(a);
    (8) The amount of the increase (if any) in the tax liability of the 
reciprocal for the taxable year attributable to the election allowed by 
section 826(a) before taking into account the credit provided by section 
826(e);
    (9) The amount of tax attributable to income received by the 
attorney-in-fact from the reciprocal during the taxable year (as 
determined under Sec. 1.826-5) claimed (under section 826(e) and 
paragraph (a) of this section) by the reciprocal as a credit for the 
taxable year; and
    (10) The information which the attorney-in-fact is required to 
submit to the reciprocal under paragraphs (b) and (c) of Sec. 1.826-3.
    (f) Manner in which information is to be provided. The information 
required by paragraph (e) of this section shall be set forth in a 
statement attached to the taxpayer's income tax return for each taxable 
year for which such information is required. Such statement shall 
include the name and address of the taxpayer; and shall be filed not 
later than the date prescribed by law (including extensions thereof) for 
filing the income tax return for the taxable year with respect to which 
such information is being provided.

[T.D. 6681, 28 FR 11124, Oct. 17, 1963]



Sec. 1.826-2  Special rules applicable to electing reciprocals.

    (a) Protection against loss account. Section 826(d) provides that 
for purposes of determining the amount to be subtracted from the 
protection against loss account under section 824(d)(1)(D) and the 
regulations thereunder (relating to amounts added to the account for the 
fifth preceding taxable year) for any taxable year, any amount which was 
added to such account by reason of the election under section 826(a) and 
paragraph (a) of Sec. 1.826-1 shall be treated as having been added by 
reason of section 824(a)(1)(A) and the regulations thereunder (relating 
to amounts equal to 1 percent of losses incurred during the taxable 
year). Thus, no amount added to the protection against loss account by 
reason of an election made under section 826(a) may remain in such 
account beyond the end of the fifth taxable year following the taxable 
year with respect to which such amount was added. See section 
824(d)(1)(D) and paragraph (b)(3) of Sec. 1.824-1. The amount added to 
the protection against loss account by reason of an election under 
section 826(a) is that amount which is equal to 25 percent (plus, in the 
case of a reciprocal which qualifies as a concentrated risk company 
under section 824(a), so much of the concentrated wind-storm, etc., 
premium percentage as exceeds 40 percent) of the amount by which:
    (1) The underwriting gain (as defined by section 824(a)(1)) computed 
after taking into account the limitation provided by section 826(b) and 
Sec. 1.826-1, exceeds

[[Page 855]]

    (2) The underwriting gain computed without regard to the limitation 
provided by section 826(b) and Sec. 1.826-1.
    (b) Denial of surtax exemption. Section 826(f) provides that the tax 
imposed upon any increase in the mutual insurance company taxable income 
of a reciprocal which is attributable to the limitation provided by 
section 826(b) shall be computed without regard to the surtax exemption 
provided by section 821(a)(2) and the regulations thereunder. Thus, a 
company making the election provided under section 826(a) will be 
subject to surtax, as well as normal tax, on the increase in its mutual 
insurance company taxable income for the taxable year which is 
attributable to such election. Similarly, any amount which was added to 
the protection against loss account by reason of an election under 
section 826(a) and Sec. 1.826-1, and which is subtracted from such 
account in accordance with section 826(d) and paragraph (a) of this 
section, will be subject to surtax, as well as normal tax, to the extent 
such amount increases mutual insurance company taxable income in the 
year in which the subtraction is made. Furthermore, the company will be 
subject to surtax on such increases notwithstanding the fact that it may 
have no normal tax liability for the taxable year, because its mutual 
insurance company taxable income (after giving effect to the election 
provided by section 826(a)) does not exceed $6,000.
    (c) Adjustment for refunds. Section 826(g) provides that if for any 
taxable year an attorney-in-fact is allowed a credit or refund for taxes 
paid with respect to which credit or refund to the reciprocal resulted 
under section 826(e), the taxes of such reciprocal for such taxable year 
shall be properly adjusted. The reciprocal shall make the adjustment 
required by section 826(g) by increasing its income tax liability for 
its taxable year in which the credit or refund is allowed to the 
attorney-in-fact by the amount of such credit or refund which is 
attributable to taxes paid by the attorney-in-fact on income received 
from the reciprocal, as determined under Sec. 1.826-6, but only to the 
extent that the payment of such amount by the attorney-in-fact resulted 
in a credit or refund to the reciprocal. However, if the refund or 
credit to the attorney-in-fact is the result of an error in determining 
its items of income or deduction for the taxable year with respect to 
which the refund or credit is allowed, and such error affects the amount 
of deductions allocable to its reciprocal for such taxable year, then, 
if the reciprocal's period for filing an amended return has not 
otherwise expired, the preceding sentence shall not apply and the 
reciprocal shall make the adjustment required by section 826(g) by 
filing an amended return for such taxable year and all subsequent 
taxable years for which an adjustment is required. The reciprocal's 
amended return or returns shall give effect to the change in the 
deductions of the attorney-in-fact allocable to income received from the 
reciprocal and the tax paid by the attorney-in-fact attributable to such 
income. The amount of any adjustment required by section 826(g) and this 
section and the computation thereof shall be set forth in a statement 
attached to and filed with the taxpayer's income tax return for the 
taxable year for which the adjustment is made. Such statement shall 
include the name and address of the taxpayer, and a copy of the 
notification received by the attorney-in-fact indicating that it has 
been allowed the credit or refund requiring adjustment of the 
reciprocal's taxes.

[T.D. 6681, 28 FR 11125, Oct. 17, 1963, as amended by T.D. 7100, 36 FR 
5334, Mar. 20, 1971]



Sec. 1.826-3  Attorney-in-fact of electing reciprocals.

    (a) Manner of making consent. Section 826(c)(2) provides that a 
reciprocal may not elect to be subject to the limitation provided by 
section 826(b) unless its attorney-in-fact consents to make certain 
information available. See paragraph (b) of this section. The attorney-
in-fact of a reciprocal making the election provided by section 826(a) 
shall signify the consent required by section 826(c) in a statement 
attached to its income tax return for the first taxable year for which 
the reciprocal's election is to apply. Such statement shall include the 
name and address of the consenting taxpayer; the name and address of the 
reciprocal with respect

[[Page 856]]

to which such consent is to apply; shall be signed by the taxpayer (or 
its duly authorized representative); and shall be filed not later than 
the date prescribed by law (including extensions thereof) for filing the 
income tax return for the first taxable year for which such consent is 
to apply. In addition, such statement shall specify that the taxpayer is 
subject to the taxes imposed by section 11 (b) and (c); the method of 
accounting used in reporting income received from its reciprocal and the 
deductions allocable thereto; and that its return is filed on the 
calendar year basis. Consent, once given, shall be irrevocable for the 
period during which the election provided for the reciprocal by section 
826(a) is in effect. See paragraph (e) of Sec. 1.826-1.
    (b) Information required of consenting attorney-in-fact. Every 
attorney-in-fact making the consent provided by section 826(c)(2) and 
paragraph (a) of this section shall, in the manner prescribed by 
paragraph (c) of this section, furnish the following information for 
each taxable year during which the consent provided by section 826(c)(2) 
and paragraph (a) of this section is in effect:
    (1) The name and address of the reciprocal with respect to which the 
consent required by section 826(c)(2) and paragraph (a) of this section 
is to apply;
    (2) Gross income in total and by sources, adjusted for returns and 
allowances;
    (3) Deductions (itemized to the same extent as on taxpayer's income 
tax return and accompanying schedules) allocable to each source of gross 
income and in total (see Sec. 1.826-4);
    (4) Method of allocation used in subparagraph (3) of this paragraph;
    (5) Taxable income (if any) in total and by sources, as in 
subparagraph (2) of this paragraph (income by sources from subparagraph 
(2) of this paragraph minus expenses allocable thereto under 
subparagraph (3) of this paragraph);
    (6) Total income tax liability (if any) for the taxable year;
    (7) Taxes paid attributable (under Sec. 1.826-5) to income earned 
by the taxpayer in dealing with the reciprocal;
    (8) Such other information as may be required by the district 
director.
    (c) Manner in which information is to be provided. (1) The 
information required by paragraph (b) of this section shall be set forth 
in a statement attached to the taxpayer's income tax return for each 
taxable year for which the consent provided by section 826(c)(2) and 
paragraph (a) of this section is in effect. Such statement shall include 
the name and address of the taxpayer, and shall be filed not later than 
the date prescribed by law (including extensions thereof) for filing the 
income tax return for each taxable year for which such information is 
required.
    (2) A copy of the statement containing the information required by 
paragraph (b) of this section shall be submitted to the board of 
advisors (or other comparable body) of the reciprocal on whose behalf 
the consent provided under section 826(c)(2) is given. The copy shall be 
executed in the same manner as the original and shall be delivered to 
such board not later than 10 days before the last date prescribed by law 
(including extensions thereof) for filing the reciprocal's income tax 
return for the taxable year for which the information is required unless 
the attorney-in-fact establishes to the satisfaction of the district 
director that the failure to furnish such copy or the failure to furnish 
such copy within the prescribed 10 day period was due to circumstances 
beyond its control. In addition, there shall be attached to and made a 
part of such copy, a copy of the income tax return of the attorney-in-
fact (including accompanying schedules) for each taxable year for which 
such statement is required.

[T.D. 6681, 28 FR 11125, Oct. 17, 1963]



Sec. 1.826-4  Allocation of expenses.

    An attorney-in-fact allocating expenses as required by section 
826(b) and paragraph (b) of Sec. 1.826-3 shall allocate each expense 
itemized in its income tax return (and accompanying schedules) for the 
taxable year to each source of gross income (as set forth pursuant to 
paragraph (b)(2) of Sec. 1.826-3). However, no portion of the net 
operating loss deduction allowed by section 172 shall be allocated to 
income received or due from the reciprocal, and no expenses, other than 
those directly

[[Page 857]]

related thereto, shall be allocated to capital gains. Where the method 
of allocation used by the taxpayer does not reasonably reflect the 
expenses of the taxpayer allocable to income received or due from the 
reciprocal, the district director may require the taxpayer to use such 
other method of allocation as is reasonable under the circumstances.

[T.D. 6681, 28 FR 11126, Oct. 17, 1963]



Sec. 1.826-5  Attribution of tax.

    (a) In general. Section 826(e) provides that a reciprocal making the 
election allowed by section 826(a) shall be credited with so much of the 
tax paid by the attorney-in-fact as is attributable to the income 
received by the attorney-in-fact from the reciprocal in such taxable 
year.
    (b) Computation. For purposes of section 826(e) and paragraph (a) of 
this section, the amount of tax attributable to income received by the 
attorney-in-fact from the reciprocal in the taxable year shall be 
computed in the following manner:
    (1) First, compute the taxable income (if any) from each source of 
gross income set forth in paragraph (b)(2) of Sec. 1.826-3 by deducting 
from each such amount the expenses allocable thereto under Sec. 1.826-
4;
    (2) Second, compute the normal tax on each amount of taxable income 
computed in subparagraph (1) of this paragraph at the rate provided by 
section 11(b) of the Code;
    (3) Third, deduct from each amount determined in subparagraph (1) of 
this paragraph an amount which bears the same proportion to the surtax 
exemption provided by section 11(c) of the Code as each amount computed 
under subparagraph (1) of this paragraph bears to the total of the 
amounts computed under subparagraph (1) of this paragraph;
    (4) Fourth, compute the surtax on each remainder computed in 
subparagraph (3) of this paragraph at the rate provided by section 11(c) 
of the Code;
    (5) Fifth, add the normal tax computed under subparagraph (2) of 
this paragraph to the surtax computed under subparagraph (4) of this 
paragraph for each amount computed under subparagraph (1) of this 
paragraph;
    (6) Sixth, deduct from each amount of tax computed under 
subparagraph (5) of this paragraph any tax credits (other than those 
arising from payments made with respect to the tax liability for the 
taxable year or other taxable years) allocable (in the same manner as 
provided for expenses under Sec. 1.826-4) to such amount;
    (7) Seventh, compute that amount which bears the same proportion to 
the tax actually paid with respect to the taxable year as each 
individual amount computed under subparagraph (6) of this paragraph 
bears to the total of the amounts computed under subparagraph (6) of 
this paragraph. The amount so determined with respect to each amount 
computed under subparagraph (6) of this paragraph is the tax paid which 
is attributable to the amount computed under subparagraph (1) of this 
paragraph.

To the extent the amounts determined under subparagraph (1) of this 
paragraph are attributable to amounts received from the reciprocal for 
the taxable year, the tax attributable to such amounts (as determined 
under subparagraph (7) of this paragraph) shall be the amount of tax 
attributable to income received by the attorney-in-fact from the 
reciprocal during the taxable year.
    (c) Taxes of attorney-in-fact unaffected. Nothing in section 826 or 
the regulations thereunder shall increase or decrease the taxes imposed 
on the income of the attorney-in-fact.

[T.D. 6681, 28 FR 11126, Oct. 17, 1963]



Sec. 1.826-6  Credit or refund.

    (a) Notification required. In any case where a taxpayer applies for 
a credit or refund of taxes paid by it in respect of a taxable year for 
which the taxpayer was the consenting attorney-in-fact of a reciprocal 
making the election provided by section 826(a), such taxpayer shall give 
notice to its reciprocal for such taxable year, first, upon applying for 
the credit or refund; and again, within 10 days from the date on which a 
final determination is made that such credit or refund has been allowed 
or denied.
    (b) Notice form. The notices required by this section shall include 
the name and address of the taxpayer and shall

[[Page 858]]

be signed by the taxpayer or its duly authorized representative. In 
addition, there shall be attached to and made a part of each first 
notice a concise statement of the claim upon which the application for 
refund or credit is based; and there shall be attached to and made a 
part of each second notice:
    (1) A copy of the notification (if any) received by the taxpayer 
indicating that the credit or refund has been allowed; and
    (2) A statement setting forth the amount of such credit or refund 
attributable to taxes paid by the taxpayer on income received from the 
reciprocal, and the computation by which such amount was determined.
    (c) Manner of apportioning refund or credit. The taxpayer shall 
determine the amount of the refund or credit attributable to taxes paid 
on income received from its reciprocal by reallocating its income and 
expense items for the taxable year, with respect to which the refund or 
credit is allowed, in the manner provided by Sec. Sec. 1.826-3 and 
1.826-4 so as to reflect the adjustments (if any) in such items which 
resulted in the credit or refund of tax for the taxable year. The 
taxpayer shall then recompute the tax attributable to income received 
from its reciprocal for such taxable year in the manner provided by 
Sec. 1.826-5. The district director may require such additional 
information as may be necessary in the circumstances to verify the 
computations required by this paragraph.

[T.D. 6681, 28 FR 11126, Oct. 17, 1963]



Sec. 1.826-7  Examples.

    The application of section 826 may be illustrated by the following 
examples:

    Example 1. For the taxable year 1963, R, a reciprocal underwriter 
subject to the taxes imposed by section 821(a), has the following items 
(determined before applying any election under section 826):

Gross income under sec. 832..................................       $578
Gross investment income......................................         50
                                                   ============
Deductions under sec. 832 (as modified by sec.
 823(b)):
    Deduction for amounts paid by R to attorney-in-      $100
     fact A.......................................
    All other deductions..........................        500
                                                   ===========
      Total deductions under sec. 832.............        600
Deductions under sec. 822(c).................................         40
Incurred losses..............................................        400
Protection against loss deduction............................          4
Underwriting gain............................................          0
Mutual insurance company taxable income......................          0
Unused loss..................................................         22
Credit or refund for taxes paid..............................          0
 


Assume that the deductions of attorney-in-fact A allocable to the income 
received by A from R are 60 and the tax paid by A allocable to the 
income received from R is 16. If R elects to be subject to the 
limitation provided in section 826(b), the results for 1963 would be as 
follows:

Gross income under sec. 832..................................       $578
Gross investment income......................................         50
                                                   ============
Deductions under sec. 832 (as modified by sec.
 823(b)):
    Deduction for amounts paid by R to attorney-in-       $60
     fact A.......................................
    All other deductions..........................        500
                                                   ===========
      Total deduction under sec. 832..............        560
Deductions under sec. 822(c).................................         40
Incurred losses..............................................        400
Underwriting gain............................................          8
Protection against loss deduction............................          6
Mutual insurance company taxable income......................         12
Unused loss..................................................          0
Credit or refund for taxes paid..............................         16
 

    Under the provisions of section 826(b), R's deduction for amounts 
paid or incurred to the attorney-in-fact in the taxable year 1963 would 
be limited to the deductions of A allocable to the income received by A 
from R. Thus, R's deductions under section 832 (as modified by section 
823(b)) for 1963 would be 60 (the deductions of A which are allocable to 
the income received by A from R). As a result of making the election 
under section 826(a) for the taxable year 1963, R's underwriting gain 
would be 8, and its statutory underwriting income would be 2 (the 
underwriting gain of 8 minus the protection against loss deduction of 
6--of which 4 represents the amount determined under section 
824(a)(1)(A)--and 2 represents the amount determined under section 
824(a)(1)(B)--or 8 minus 6). R's mutual insurance company taxable income 
for 1963 would be 12, consisting of taxable investment income of 10 
(gross investment income minus deductions under section 822(c), or 50 
minus 40) plus statutory underwriting income of 2. Since all of R's 
mutual insurance company taxable income of 12 is attributable to the 
limitation under section 826(b), the entire amount is subject to the 
surtax under section 821(a)(2) without regard to the $25,000 surtax 
exemption. The credit of 16, representing that part of the tax paid by A 
which is allocable to the income received by A from R, may be applied by 
R against its taxes with respect to its mutual insurance company taxable 
income of 12 for 1963, and R would be entitled to a refund of any excess 
of the amount of such credit over its tax liability for 1963.

[[Page 859]]

    Under the provisions of section 826(d), no portion of the amount 
added to the protection against loss account in 1963 by reason of the 
election under section 826(a), 2 (25 percent of the amount by which the 
consolidated underwriting gain exceeds 25 percent of the underwriting 
gain determined without regard to the election under section 826(a), or 
the amount by which 25 percent of 8 exceeds 25 percent of 0), may remain 
in such account beyond the taxable year 1968.
    Example 2. For the taxable year 1963, F is a corporate attorney-in-
fact subject to the taxes imposed by section 11(b) and (c) of the Code. 
F files its return on the calendar year basis and reports income 
received from its reciprocal and the deductions allocable thereto under 
the same method of accounting used by its reciprocal in reporting its 
deductions for amounts paid to R. F properly consents to provide the 
information required by paragraph (b) of Sec. 1.826-3. In addition to 
its attorney-in-fact business, F owns real estate for investment 
purposes, and operates a real estate management service. For the taxable 
year 1963, F has gross income from these various sources as follows:

Attorney-in-fact fees............................................$85,000
Real estate management fees.......................................18,000
Rental income.....................................................25,000


F allocates its expenses for the taxable year on the basis of their 
direct relation to each source of income. During 1963, F acquired 
property for use in its attorney-in-fact operations which entitled F to 
an investment credit of $800 under section 38. For 1963, F determines 
that the tax paid by it which is attributable to its reciprocal is 
$21,863, computed as follows:

------------------------------------------------------------------------
                              Attorney-     Real
                               in-fact     estate     Rental     Total
                                 fees    management   income
------------------------------------------------------------------------
Gross income................    $85,000     $18,000   $25,000   $128,000
Allocable expenses..........     25,000       3,000    35,000     63,000
Taxable income (loss).......     60,000      15,000  (10,000)     65,000
Normal tax (30 percent).....     18,000       4,500         0     19,500
Surtax exemption............     20,000       5,000         0     25,000
Income subject to surtax....     40,000      10,000         0     40,000
Surtax (22 percent).........      8,800       2,200         0      8,800
Total tax...................     26,800       6,700         0     28,300
Investment credit...........        800           0         0        800
1963 tax liability..........     26,000       6,700         0     27,500
1963 tax paid...............  .........  ..........  ........     27,500
Allocation of tax paid......     21,863       5,637         0     27,500
------------------------------------------------------------------------

Under paragraph (b)(1) of Sec. 1.826-5, F computes its taxable income 
from its attorney-in-fact fees to be $60,000 ($85,000 minus $25,000), 
and its taxable income from its real estate management to be $15,000 
($18,000 minus $3,000). Since F's rental operations resulted in a 
$10,000 loss for the taxable year ($25,000 minus $35,000), F's taxable 
income from its rental operations is zero. Using the 30 percent rate 
provided by section 11(b), F computes its normal tax to be $18,000 on 
its attorney-in-fact fees and $4,500 on its real estate management 
operations. F's normal tax on total income is $19,500. The $3,000 
difference between the normal tax on F's total income and the normal 
taxes on F's profitable operations results from the loss on F's rental 
operations. Under paragraph (b)(3) of Sec. 1.826-5, F allocates its 
surtax exemption as follows: $20,000 $60,000/$75,000x$25,000) to its 
attorney-in-fact fees; and $5,000 $15,000/$75,000x$25,000) to its real 
estate management operations. F computes its surtax on its profitable 
operations at the 22 percent rate provided by section 11(c) as follows: 
$8,800 (22 percent of $40,000) on attorney-in-fact fees; and $2,200 (22 
percent of $10,000) on real estate management income. F adds its normal 
tax and surtax on its profitable operations and determines its total tax 
to be $26,800 on its attorney-in-fact operations; $6,700 on its real 
estate management operations; and $28,300 on its total income. F must 
allocate its investment credit on the same basis as it used to allocate 
its expenses. Thus, F's entire investment credit must be allocated to 
its attorney-in-fact operations. Accordingly, F's 1963 tax liability is 
$26,000 on its attorney-in-fact fees; $6,700 on its real estate 
management operations; $0 on its rental operations; and $27,500 on its 
total income. Under paragraph (b)(7) of Sec. 1.826-5, F allocates 
$21,863 ($26,000/$32,700x$27,500) of its 1963 tax paid to its attorney-
in-fact fees; and $5,637 ($6,700/$32,700x$27,500) of its 1963 tax paid 
to its real estate management business. F's reciprocal will be allowed a 
credit or refund of $21,863 for taxes paid by F which are attributable 
to F's income received from its reciprocal.
    Example 3. Assume the same facts as in example 2, and assume further 
that in 1966 F sustains a net operating loss on its overall operations 
of $5,000. In carrying the loss back to 1963 as a net operating loss 
deduction under section 172, F must allocate the deduction under the 
same method it used in allocating its 1963 deductions. Thus, if the loss 
was entirely attributable to F's rental operations for the taxable year 
1966, F would reduce its taxable income attributable to those operations 
by the entire amount of the loss and would recompute the tax 
attributable to those operations under paragraph (b) of Sec. 1.826-5. 
As recomputed in the table below, F's 1963 tax liability from attorney-
in-fact fees would be $19,800 and F's total tax liability would be 
$24,900.

[[Page 860]]



----------------------------------------------------------------------------------------------------------------
                                                                     Attorney-     Real
                                                                      in-fact     estate      Rental     Total
                                                                        fees    management    income
----------------------------------------------------------------------------------------------------------------
Gross income.......................................................    $85,000     $18,000    $25,000   $128,000
Allocable expenses.................................................     25,000       3,000     35,000     63,000
Net operating loss deduction.......................................          0           0      5,000      5,000
Taxable income (loss)..............................................     60,000      15,000   (15,000)     60,000
Normal tax (30 percent)............................................     18,000       4,500          0     18,000
Surtax exemption...................................................     20,000       5,000          0     25,000
Income subject to surtax...........................................     40,000      10,000          0     35,000
Surtax (22 percent)................................................      8,800       2,200          0      7,700
Total tax..........................................................     26,800       6,700          0     25,700
Investment credit..................................................        800           0          0        800
1963 tax liability.................................................     26,000       6,700          0     24,900
1963 tax paid......................................................  .........  ..........  .........     24,900
Allocation of tax paid.............................................     19,800       5,100          0     24,900
----------------------------------------------------------------------------------------------------------------


As a result of its 1966 net operating loss, F would be entitled to a 
refund of $2,600 (1963 taxes paid of $27,500 minus recomputed 1963 taxes 
of $24,900). Under paragraph (a) of Sec. 1.826-6, F would be required 
to notify its reciprocal of its claim for refund and of the amount of 
the refund or credit attributable to taxes paid on income received from 
the reciprocal. Since the 1963 tax paid by F attributable to its 
reciprocal (as recomputed) is less than the amount claimed in 1963 by 
F's reciprocal as a credit, F's reciprocal would be required, under 
section 826(g), to add the difference--$2,063 ($21,863 minus $19,800), 
to its tax liability for 1966. Thus, F's reciprocal would first compute 
its tax liability for 1966 without regard to section 826(g) and then 
would increase such liability by $2,063.

[T.D. 6681, 28 FR 11126, Oct. 17, 1963]

                        Other Insurance Companies



Sec. 1.831-1  Tax on insurance companies (other than life or mutual),
mutual marine insurance companies, and mutual fire insurance companies
issuing perpetual policies.

    (a) All insurance companies, other than life or mutual or foreign 
insurance companies not carrying on an insurance business within the 
United States, and all mutual marine insurance companies and mutual fire 
insurance companies exclusively issuing either perpetual policies, or 
policies for which the sole premium charged is a single deposit which, 
except for such deduction of underwriting costs as may be provided, is 
refundable upon cancellation or expiration of the policy, are subject to 
the tax imposed by section 831. As used in this section and Sec. Sec. 
1.832-1 and 1.832-2, the term ``insurance companies'' means only those 
companies which qualify as insurance companies under the definition 
provided by paragraph (b) of Sec. 1.801-1 and which are subject to the 
tax imposed by section 831.
    (b) All provisions of the Code and of the regulations in this part 
not inconsistent with the specific provisions of section 831 are 
applicable to the assessment and collection of the tax imposed by 
section 831(a), and insurance companies are subject to the same 
penalties as are provided in the case of returns and payment of income 
tax by other corporations.
    (c) Since section 832 provides that the underwriting and investment 
exhibit of the annual statement approved by the National Convention of 
Insurance Commissioners shall be the basis for computing gross income 
and since the annual statement is rendered on the calendar year basis, 
the returns under section 831 shall be made on the basis of the calendar 
year and shall be on Form 1120. Insurance companies are entitled, in 
computing insurance company taxable income, to the deductions provided 
in part VIII (section 241 and following), subchapter B, chapter 1 of the 
Code.
    (d) Foreign insurance companies not carrying on an insurance 
business within the United States are not taxable under section 831 but 
are taxable as other foreign corporations. See section 881.
    (e) Insurance companies are subject to both normal tax and surtax. 
The normal tax shall be computed as provided in section 11(b) and the 
surtax shall be computed as provided in section 11(c). For the 
circumstances under which the $25,000 exemption from surtax for certain 
taxable years may be disallowed in whole or in part, see section 1551. 
For alternative tax where the net long-term capital gain for any taxable 
year exceeds the net short-term

[[Page 861]]

capital loss, see section 1201(a) and the regulations thereunder.



Sec. 1.831-2  Taxable years affected.

    Section 1.831-1 is applicable only to taxable years beginning after 
December 31, 1953, but before January 1, 1963, and ending after August 
16, 1954, and all references therein to sections of the Code and 
regulations are to sections of the Internal Revenue Code of 1954 and the 
regulations thereunder before amendments. Section 1.831-3 is applicable 
only to taxable years beginning after December 31, 1962, and all 
references therein to sections of the Code and regulations are to 
sections of the Internal Revenue Code of 1954 as amended. Section 1.831-
4 is applicable only with respect to the companies described therein, 
and only with respect to taxable years beginning after December 31, 
1961.

[T.D. 6681, 28 FR 11128, Oct. 17, 1963]



Sec. 1.831-3  Tax on insurance companies (other than life or mutual),
mutual marine insurance companies, mutual fire insurance companies 
issuing perpetual policies, and mutual fire or flood insurance 
companies operating on the basis of premium deposits; taxable years 
beginning after December 31, 1962.

    (a) All insurance companies, other than life or mutual or foreign 
insurance companies not carrying on an insurance business within the 
United States, and all mutual marine insurance companies and mutual fire 
or flood insurance companies exclusively issuing perpetual policies or 
whose principal business is the issuance of policies for which the 
premium deposits are the same regardless of the length of the term for 
which the policies are written, are subject to the tax imposed by 
section 831 if the unabsorbed portion of such premium deposits not 
required for losses, expenses or reserves is returned or credited to the 
policyholder on cancellation or expiration of the policy. For purposes 
of section 831 and this section, in the case of a mutual flood insurance 
company, the premium deposits will be considered to be the same if the 
payment of a premium increases the total insurance under the policy in 
an amount equal to the amount of such premium and the omission of any 
annual premium does not result in the reduction or suspension of 
coverage under the policy. As used in this section and section 832 and 
the regulations thereunder, the term ``insurance companies'' means only 
those companies which qualify as insurance companies under the 
definition provided by paragraph (b) of Sec. 1.801-1 and which are 
subject to the tax imposed by section 831.
    (b) All provisions of the Code and of the regulations in this part 
not inconsistent with the specific provisions of section 831 are 
applicable to the assessment and collection of the tax imposed by 
section 831(a), and insurance companies are subject to the same 
penalties as are provided in the case of returns and payment of income 
tax by other corporations.
    (c) Since section 832 provides that the underwriting and investment 
exhibit of the annual statement approved by the National Convention of 
Insurance Commissioners shall be the basis for computing gross income 
and since the annual statement is rendered on the calendar year basis, 
the returns under section 831 shall be made on the basis of the calendar 
year and shall be on Form 1120. Insurance companies are entitled, in 
computing insurance company taxable income, to the deductions provided 
in part VIII (section 241 and following), subchapter B, chapter 1 of the 
Code.
    (d) Foreign insurance companies not carrying on an insurance 
business within the United States are not taxable under section 831 but 
are taxable as other foreign corporations. See section 881.
    (e) Insurance companies are subject to both normal tax and surtax. 
The normal tax shall be computed as provided in section 11(b) and the 
surtax shall be computed as provided in section 11(c). For the 
circumstances under which the $25,000 exemption from surtax for certain 
taxable years may be disallowed in whole or in part, see section 1551. 
For alternative tax where the net long-term capital gain for any taxable 
year exceeds the net short-term

[[Page 862]]

capital loss, see section 1201(a) and the regulations thereunder.

[T.D. 6681, 28 FR 11128, Oct. 17, 1963]



Sec. 1.831-4  Election of multiple line companies to be taxed on
total income.

    (a) In general. Section 831(c) provides that any mutual insurance 
company engaged in writing marine, fire, and casualty insurance which, 
for any 5-year period beginning after December 31, 1941, and ending 
before January 1, 1962, was subject to the tax imposed by section 831 
(or the tax imposed by corresponding provisions of prior law) may elect, 
in the manner provided by paragraph (b) of this section, to be subject 
to the tax imposed by section 831, whether or not marine insurance is 
its predominant source of premium income. A company making an election 
under section 831(c) and this section will be subject to the tax imposed 
by section 831 for taxable years beginning after December 31, 1961, 
rather than subject to the tax imposed by section 821.
    (b) Time and manner of making election. The election provided by 
section 831(c) and paragraph (a) of this section shall be made in a 
statement attached to the taxpayer's return for the taxable year 1962. 
The statement shall indicate that the taxpayer has made the election 
provided by section 831(c) and this section; shall include the name and 
address of the taxpayer, and shall be signed by the taxpayer or his duly 
authorized representative. In addition, the statement shall list the 5 
consecutive taxable years prior to 1962 for which the taxpayer was 
subject to tax under section 831 (or the corresponding provisions of 
prior law); the types of insurance written by the company; and the 
percentage of marine insurance to total insurance written. The return 
and statement must be filed not later than the date prescribed by law 
(including extensions thereof) for filing the return for the taxable 
year 1962. However, if the last date prescribed by law (including 
extensions thereof) for filing the income tax return for the taxable 
year 1962 falls before October 17, 1963, the election provided by 
section 831(c) and this section may be made for such year by filing the 
statement and an amended return for such taxable year (and all 
subsequent taxable years for which returns have been filed) before 
January 16, 1964.
    (c) Scope of election. An election made under section 831(c) and 
paragraph (b) of this section shall be binding for all taxable years 
beginning after December 31, 1961, unless consent to revoke the election 
is obtained from the Commissioner. However, if a taxpayer made the 
election provided by section 831(c) and this section for taxable years 
beginning prior to October 17, 1963, the taxpayer may revoke such 
election without obtaining consent from the Commissioner by filing, 
before January 16, 1964, a statement that the taxpayer desires to revoke 
such election. Such statement shall be signed by the taxpayer or its 
duly authorized representative. An amended return reflecting such 
revocation must accompany the statement for all taxable years for which 
returns have been filed with respect to such election.
    (d) Limitation on certain net operating loss carryovers and 
carrybacks. In the case of a taxpayer making the election allowed under 
section 831(c) and this section, a net operating loss shall not be 
carried:
    (1) To or from any taxable year for which the insurance company is 
not subject to the tax imposed by section 831(a) (or predecessor 
sections); or
    (2) To any taxable year if, between the loss year and such taxable 
year, there is an intervening taxable year for which the insurance 
company was not subject to the tax imposed by section 831(a) (or 
predecessor sections).

[T.D. 6681, 28 FR 11128, Oct. 17, 1963]



Sec. 1.832-1  Gross income.

    (a) Gross income as defined in section 832(b)(1) means the gross 
amount of income earned during the taxable year from interest, 
dividends, rents, and premium income, computed on the basis of the 
underwriting and investment exhibit of the annual statement approved by 
the National Convention of Insurance Commissioners, as well as the gain 
derived from the sale or other disposition of property, and all other 
items constituting gross income under section 61, except that in the 
case of a mutual fire insurance company described in Sec. 1.831-1 the 
amount of single

[[Page 863]]

deposit premiums received, but not assessments, shall be excluded from 
gross income. Gross income does not include increase in liabilities 
during the year on account of reinsurance treaties, remittances from the 
home office of a foreign insurance company to the United States branch, 
borrowed money, or gross increase due to adjustments in book value of 
capital assets. The underwriting and investment exhibit is presumed to 
reflect the true net income of the company, and insofar as it is not 
inconsistent with the provisions of the Code will be recognized and used 
as a basis for that purpose. All items of the exhibit, however, do not 
reflect an insurance company's income as defined in the Code. By reason 
of the definition of investment income, miscellaneous items which are 
intended to reflect surplus but do not properly enter into the 
computation of income, such as dividends declared to shareholders in 
their capacity as such, home office remittances and receipts, and 
special deposits, are ignored. Gain or loss from agency balances and 
bills receivable not admitted as assets on the underwriting and 
investment exhibit will be ignored, excepting only such agency balances 
and bills receivable as have been allowed as deductions for worthless 
debts or, having been previously so allowed, are recovered during the 
taxable year. In computing ``premiums earned on insurance contracts 
during the taxable year'' the amount of the unearned premiums shall 
include (1) life insurance reserves as defined in section 803(b) and 
Sec. 1.803-1 pertaining to the life, burial, or funeral insurance, or 
annuity business of an insurance company subject to the tax imposed by 
section 831 and not qualifying as a life insurance company under section 
801, and (2) liability for return premiums under a rate credit or 
retrospective rating plan based on experience, such as the ``War 
Department Insurance Rating Plan,'' and which return premiums are 
therefore not earned premiums. In computing ``losses incurred'' the 
determination of unpaid losses at the close of each year must represent 
actual unpaid losses as nearly as it is possible to ascertain them.
    (b) Every insurance company to which this section applies must be 
prepared to establish to the satisfaction of the district director that 
the part of the deduction for ``losses incurred'' which represents 
unpaid losses at the close of the taxable year comprises only actual 
unpaid losses stated in amounts which, based upon the facts in each case 
and the company's experience with similar cases, can be said to 
represent a fair and reasonable estimate of the amount the company will 
be required to pay. Amounts included in, or added to, the estimates of 
such losses which, in the opinion of the district director are in excess 
of the actual liability determined as provided in the preceding sentence 
will be disallowed as a deduction. The district director may require any 
such insurance company to submit such detailed information with respect 
to its actual experience as is deemed necessary to establish the 
reasonableness of the deduction for ``losses incurred.''
    (c) That part of the deduction for ``losses incurred'' which 
represents an adjustment to losses paid for salvage and reinsurance 
recoverable shall, except as hereinafter provided, include all salvage 
in course of liquidation, and all reinsurance in process of collection 
not otherwise taken into account as a reduction of losses paid, 
outstanding at the end of the taxable year. Salvage in course of 
liquidation includes all property (other than cash), real or personal, 
tangible or intangible, except that which may not be included by reason 
of express statutory provisions (or rules and regulations of an 
insurance department) of any State or Territory or the District of 
Columbia in which the company transacts business. Such salvage in course 
of liquidation shall be taken into account to the extent of the value 
thereof at the end of the taxable year as determined from a fair and 
reasonable estimate based upon either the facts in each case or the 
company's experience with similar cases. Cash received during the 
taxable year with respect to items of salvage or reinsurance shall be 
taken into account in computing losses paid during such taxable year.



Sec. 1.832-2  Deductions.

    (a) The deductions allowable are specified in section 832(c) and by 
reason

[[Page 864]]

of the provisions of section 832(c)(10) and (12) include in addition 
certain deductions provided in sections 161, and 241 and following. The 
deductions, however, are subject to the limitation provided in section 
265, relating to expenses and interest in respect of tax-exempt income. 
The net operating loss deduction is computed under section 172 and the 
regulations thereunder. For the purposes of section 172, relating to net 
operating loss deduction, ``gross income'' shall mean gross income as 
defined in section 832(b)(1) and the allowable deductions shall be those 
allowed by section 832(c) with the exceptions and limitations set forth 
in section 172(d). In addition to the deduction for capital losses 
provided in subchapter P (section 1201 and following), chapter 1 of the 
Code, insurance companies are allowed a deduction for losses from 
capital assets sold or exchanged in order to obtain funds to meet 
abnormal insurance losses and to provide for the payment of dividends 
and similar distributions to policyholders. A special rule is provided 
for the application of the capital loss carryover provisions of section 
1212. The deduction is the same as that allowed mutual insurance 
companies subject to the tax imposed by section 821; see section 
822(c)(6) and the regulations thereunder. Insurance companies, other 
than mutual fire insurance companies described in Sec. 1.831-1, are 
also allowed a deduction for dividends and similar distributions paid or 
declared to policyholders in their capacity as such. The deduction is 
otherwise the same as that allowed mutual insurance companies subject to 
the tax imposed by section 821; see section 823(2) and the regulations 
thereunder.
    (b) Among the items which may not be deducted are income and profits 
taxes imposed by the United States, income and profits taxes imposed by 
any foreign country or possession of the United States (in cases where 
the company chooses to claim to any extent a credit for such taxes), 
taxes assessed against local benefits, decrease during the year due to 
adjustments in the book value of capital assets, decrease in liabilities 
during the year on account of reinsurance treaties, dividends paid to 
shareholders in their capacity as such, remittances to the home office 
of a foreign insurance company by the United States branch, and borrowed 
money repaid.
    (c) In computing taxable income of insurance companies, losses 
sustained during the taxable year from the sale or other disposition of 
property are deductible subject to the limitation contained in section 
1211. Insurance companies are entitled to the alternative taxes provided 
in section 1201.

[T.D. 6500, 25 FR 11814, Nov. 26, 1960, as amended by T.D. 6867, 30 FR 
15094, Dec. 12, 1965]



Sec. 1.832-3  Taxable years affected.

    Sections 1.832-1 and 1.832-2 are applicable only to taxable years 
beginning after December 31, 1953, and before January 1, 1963, and 
ending after August 16, 1954, and all references therein to sections of 
the Code and regulations are to sections of the Internal Revenue Code of 
1954 and the regulations thereunder before amendments. Sections 1.832-4, 
1.832-5, and 1.832-6 are applicable only to taxable years beginning 
after December 31, 1962, and all references therein to sections of the 
Code and regulations are to sections of the Internal Revenue Code of 
1954 as amended.

[T.D. 6681, 28 FR 11129, Oct. 17, 1963]



Sec. 1.832-4  Gross income.

    (a)(1) Gross income as defined in section 832(b)(1) means the gross 
amount of income earned during the taxable year from interest, 
dividends, rents, and premium income, computed on the basis of the 
underwriting and investment exhibit of the annual statement approved by 
the National Convention of Insurance Commissioners, as well as the gain 
derived from the sale or other disposition of property, and all other 
items constituting gross income under section 61, except that in the 
case of a mutual fire insurance company described in section 
831(a)(3)(A) the amount of single deposit premiums received, but not 
assessments, shall be excluded from gross income. Section 832(b)(1)(D) 
provides that in the case of a mutual fire or flood insurance company 
described in section 831(a)(3)(B), there shall be included in gross 
income an amount equal to 2 percent of the

[[Page 865]]

premiums earned during the taxable year on contracts described in 
section 831(a)(3)(B) after deduction of premium deposits returned or 
credited during such taxable year with respect to such contracts. Gross 
income does not include increase in liabilities during the year on 
account of reinsurance treaties, remittances from the home office of a 
foreign insurance company to the United States branch, borrowed money, 
or gross increase due to adjustments in book value of capital assets.
    (2) The underwriting and investment exhibit is presumed to reflect 
the true net income of the company, and insofar as it is not 
inconsistent with the provisions of the Code will be recognized and used 
as a basis for that purpose. All items of the exhibit, however, do not 
reflect an insurance company's income as defined in the Code. By reason 
of the definition of investment income, miscellaneous items which are 
intended to reflect surplus but do not properly enter into the 
computation of income, such as dividends declared to shareholders in 
their capacity as such, home office remittances and receipts, and 
special deposits, are ignored. Gain or loss from agency balances and 
bills receivable not admitted as assets on the underwriting and 
investment exhibit will be ignored, excepting only such agency balances 
and bills receivable as have been allowed as deductions for worthless 
debts or, having been previously so allowed, are recovered during the 
taxable year.
    (3) Premiums earned. The determination of premiums earned on 
insurance contracts during the taxable year begins with the insurance 
company's gross premiums written on insurance contracts during the 
taxable year, reduced by return premiums and premiums paid for 
reinsurance. Subject to the exceptions in sections 832(b)(7), 832(b)(8), 
and 833(a)(3), this amount is increased by 80 percent of the unearned 
premiums on insurance contracts at the end of the preceding taxable 
year, and is decreased by 80 percent of the unearned premiums on 
insurance contracts at the end of the current taxable year.
    (4) Gross premiums written--(i) In general. Gross premiums written 
are amounts payable for insurance coverage. The label placed on a 
payment in a contract does not determine whether an amount is a gross 
premium written. Gross premiums written do not include other items of 
income described in section 832(b)(1)(C) (for example, charges for 
providing loss adjustment or claims processing services under 
administrative services or cost-plus arrangements). Gross premiums 
written on an insurance contract include all amounts payable for the 
effective period of the insurance contract. To the extent that amounts 
paid or payable with respect to an arrangement are not gross premiums 
written, the insurance company may not treat amounts payable to 
customers under the applicable portion of such arrangements as losses 
incurred described in section 832(b)(5).
    (ii) Items included. Gross premiums written include--
    (A) Any additional premiums resulting from increases in risk 
exposure during the effective period of an insurance contract;
    (B) Amounts subtracted from a premium stabilization reserve to pay 
for insurance coverage; and
    (C) Consideration in respect of assuming insurance liabilities under 
insurance contracts not issued by the taxpayer (such as a payment or 
transfer of property in an assumption reinsurance transaction).
    (5) Method of reporting gross premiums written--(i) In general. 
Except as otherwise provided under this paragraph (a)(5), an insurance 
company reports gross premiums written for the earlier of the taxable 
year that includes the effective date of the insurance contract or the 
year in which the company receives all or a portion of the gross premium 
for the insurance contract. The effective date of the insurance contract 
is the date on which the insurance coverage provided by the contract 
commences. The effective period of an insurance contract is the period 
over which one or more rates for insurance coverage are guaranteed in 
the contract. If a new rate for insurance coverage is guaranteed after 
the effective date of an insurance contract, the making of such a 
guarantee generally

[[Page 866]]

is treated as the issuance of a new insurance contract with an effective 
period equal to the duration of the new guaranteed rate for insurance 
coverage.
    (ii) Special rule for additional premiums resulting from an increase 
in risk exposure. An insurance company reports additional premiums that 
result from an increase in risk exposure during the effective period of 
an insurance contract in gross premiums written for the taxable year in 
which the change in risk exposure occurs. Unless the increase in risk 
exposure is of temporary duration (for example, an increase in risk 
exposure under a workers' compensation policy due to seasonal variations 
in the policyholder's payroll), the company reports additional premiums 
resulting from an increase in risk exposure based on the remainder of 
the effective period of the insurance contract.
    (iii) Exception for certain advance premiums. If an insurance 
company receives a portion of the gross premium for an insurance 
contract prior to the first day of the taxable year that includes the 
effective date of the contract, the company may report the advance 
premium (rather than the full amount of the gross premium for the 
contract) in gross premiums written for the taxable year in which the 
advance premium is received. An insurance company may adopt this method 
of reporting advance premiums only if the company's deduction for 
premium acquisition expenses for the taxable year in which the company 
receives the advance premium does not exceed the limitation of paragraph 
(a)(5)(vii) of this section. A company that reports an advance premium 
in gross premiums written under this paragraph (a)(5)(iii) takes into 
account the remainder of the gross premium written and premium 
acquisition expenses for the contract in the taxable year that includes 
the effective date of the contract. A company that adopts this method of 
reporting advance premiums must use the method for all contracts with 
advance premiums.
    (iv) Exception for certain cancellable accident and health insurance 
contracts with installment premiums. If an insurance company issues or 
proportionally reinsures a cancellable accident and health insurance 
contract (other than a contract with an effective period that exceeds 12 
months) for which the gross premium is payable in installments over the 
effective period of the contract, the company may report the installment 
premiums (rather than the total gross premium for the contract) in gross 
premiums written for the earlier of the taxable year in which the 
installment premiums are due under the terms of the contract or the year 
in which the installment premiums are received. An insurance company may 
adopt this method of reporting installment premiums for a cancellable 
accident and health insurance contract only if the company's deduction 
for premium acquisition expenses for the first taxable year in which an 
installment premium is due or received under the contract does not 
exceed the limitation of paragraph (a)(5)(vii) of this section. A 
company that adopts this method of reporting installment premiums for a 
cancellable accident and health contract must use the method for all of 
its cancellable accident and health insurance contracts with installment 
premiums.
    (v) Exception for certain multi-year insurance contracts. If an 
insurance company issues or proportionally reinsures an insurance 
contract, other than a contract described in paragraph (a)(5)(vi) of 
this section, with an effective period that exceeds 12 months, for which 
the gross premium is payable in installments over the effective period 
of the contract, the company may treat the insurance coverage provided 
under the multi-year contract as a series of separate insurance 
contracts. The first contract in the series is treated as having been 
written for an effective period of twelve months. Each subsequent 
contract in the series is treated as having been written for an 
effective period equal to the lesser of 12 months or the remainder of 
the period for which the rates for insurance coverage are guaranteed in 
the multi-year insurance contract. An insurance company may adopt this 
method of reporting premiums on a multi-year contract only if the 
company's deduction for premium acquisition expenses for each year of 
the multi-year contract does not exceed the limitation of paragraph

[[Page 867]]

(a)(5)(vii) of this section. A company that adopts this method of 
reporting premiums for a multi-year contract must use the method for all 
multi-year contracts with installment premiums.
    (vi) Exception for insurance contracts described in section 
832(b)(7). If an insurance company issues or reinsures the risks related 
to a contract described in section 832(b)(7), the company may report 
gross premiums written for the contract in the manner required by 
sections 803 and 811(a) for life insurance companies. An insurance 
company may adopt this method of reporting premiums on contracts 
described in section 832(b)(7) only if the company also determines the 
deduction for premium acquisition costs for the contract in accordance 
with section 811(a), as adjusted by the amount required to be taken into 
account under section 848 in connection with the net premiums of the 
contract. A company that adopts this method of reporting premiums for a 
contract described in section 832(b)(7) must use the method for all of 
its contracts described in that section.
    (vii) Limitation on deduction of premium acquisition expenses. An 
insurance company's deduction for premium acquisition expenses (for 
example, commissions, state premium taxes, overhead reimbursements to 
agents or brokers, and other similar amounts) related to an insurance 
contract is within the limitation of this paragraph (a)(5)(vii) if--
    (A) The ratio obtained by dividing the sum of the company's 
deduction for premium acquisition expenses related to the insurance 
contract for the taxable year and previous taxable years by the total 
premium acquisition expenses attributable to the insurance contract; 
does not exceed
    (B) The ratio obtained by dividing the sum of the amounts included 
in gross premiums written with regard to the insurance contract for the 
taxable year and previous taxable years by the total gross premium 
written for the insurance contract.
    (viii) Change in method of reporting gross premiums. An insurance 
company that adopts a method of accounting for gross premiums written 
and premium acquisition expenses described in paragraph (a)(5)(iii), 
(iv), (v), or (vi) of this section must continue to use the method to 
report gross premiums written and premium acquisition expenses unless 
the company obtains the consent of the Commissioner to change to a 
different method under section 446(e) and Sec. 1.446-1(e).
    (6) Return premiums--(i) In general. An insurance company's 
liability for return premiums includes amounts previously included in an 
insurance company's gross premiums written, which are refundable to a 
policyholder or ceding company, provided that the amounts are fixed by 
the insurance contract and do not depend on the experience of the 
insurance company or the discretion of its management.
    (ii) Items included. Return premiums include amounts--
    (A) Which were previously paid and become refundable due to policy 
cancellations or decreases in risk exposure during the effective period 
of an insurance contract;
    (B) Which reflect the unearned portion of unpaid premiums for an 
insurance contract that is canceled or for which there is a decrease in 
risk exposure during its effective period; or
    (C) Which are either previously paid and refundable or which reflect 
the unearned portion of unpaid premiums for an insurance contract, 
arising from the redetermination of a premium due to correction of 
posting or other similar errors.
    (7) Method of reporting return premiums. An insurance company 
reports the liability for a return premium resulting from the 
cancellation of an insurance contract for the taxable year in which the 
contract is canceled. An insurance company reports the liability for a 
return premium attributable to a reduction in risk exposure under an 
insurance contract for the taxable year in which the reduction in risk 
exposure occurs.
    (8) Unearned premiums--(i) In general. The unearned premium for a 
contract, other than a contract described in section 816(b)(1)(B), 
generally is the portion of the gross premium written that is 
attributable to future insurance coverage during the effective period of 
the insurance contract. However, unearned premiums held by an insurance 
company with regard to the net value of

[[Page 868]]

risks reinsured with other solvent companies (whether or not authorized 
to conduct business under state law) are subtracted from the company's 
unearned premiums. Unearned premiums also do not include any additional 
liability established by the insurance company on its annual statement 
to cover premium deficiencies. Unearned premiums do not include an 
insurance company's estimate of its liability for amounts to be paid or 
credited to a customer with regard to the expired portion of a 
retrospectively rated contract (retro credits). An insurance company's 
estimate of additional amounts payable by its customers with regard to 
the expired portion of a retrospectively rated contract (retro debits) 
cannot be subtracted from unearned premiums.
    (ii) Special rules for unearned premiums. For purposes of computing 
``premiums earned on insurance contracts during the taxable year'' under 
section 832(b)(4), the amount of unearned premiums includes--
    (A) Life insurance reserves (as defined in section 816(b), but 
computed in accordance with section 807(d) and sections 811(c) and (d));
    (B) In the case of a mutual flood or fire insurance company 
described in section 832(b)(1)(D) (with respect to contracts described 
in that section), the amount of unabsorbed premium deposits that the 
company would be obligated to return to its policyholders at the close 
of the taxable year if all its insurance contracts were terminated at 
that time;
    (C) In the case of an interinsurer or reciprocal underwriter that 
reports unearned premiums on its annual statement net of premium 
acquisition expenses, the unearned premiums on the company's annual 
statement increased by the portion of premium acquisition expenses 
allocable to those unearned premiums; and
    (D) In the case of a title insurance company, its discounted 
unearned premiums (computed in accordance with section 832(b)(8)).
    (9) Method of determining unearned premiums. If the risk of loss 
under an insurance contract does not vary significantly over the 
effective period of the contract, the unearned premium attributable to 
the unexpired portion of the effective period of the contract is 
determined on a pro rata basis. If the risk of loss varies significantly 
over the effective period of the contract, the insurance company may 
consider the pattern and incidence of the risk in determining the 
portion of the gross premium that is attributable to the unexpired 
portion of the effective period of the contract. An insurance company 
that uses a method of computing unearned premiums other than the pro 
rata method must maintain sufficient information to demonstrate that its 
method of computing unearned premiums accurately reflects the pattern 
and incidence of the risk for the insurance contract.
    (10) Examples. The provisions of paragraphs (a)(4) through (a)(9) of 
this section are illustrated by the following examples:

    Example 1. (i) IC is a non-life insurance company which, pursuant to 
section 843, files its returns on a calendar year basis. IC writes a 
casualty insurance contract that provides insurance coverage for a one-
year period beginning on July 1, 2000 and ending on June 30, 2001. IC 
charges a $500 premium for the insurance contract, which may be paid 
either in full by the effective date of the contract or in quarterly 
installments over the contract's one year term. The policyholder selects 
the installment payment option. As of December 31, 2000, IC collected 
$250 of installment premiums for the contract.
    (ii) The effective period of the insurance contract begins on July 
1, 2000 and ends on June 30, 2001. For the taxable year ending December 
31, 2000, IC includes the $500 gross premium, based on the effective 
period of the contract, in gross premiums written under section 
832(b)(4)(A). IC's unearned premium with respect to the contract was 
$250 as of December 31, 2000. Pursuant to section 832(b)(4)(B), to 
determine its premiums earned, IC deducts $200 ($250x.8) for the 
insurance contract at the end of the taxable year.
    Example 2. (i) The facts are the same as Example 1, except that the 
insurance contract has a stated term of 5 years. On each contract 
anniversary date, IC may adjust the rate charged for the insurance 
coverage for the succeeding 12 month period. The amount of the 
adjustment in the charge for insurance coverage is not substantially 
limited under the insurance contract.
    (ii) Under paragraph (a)(5)(i) of this section, IC is required to 
report gross premiums written for the insurance contract based on

[[Page 869]]

the effective period for the contract. The effective period of the 
insurance contract is the period for which a rate for insurance coverage 
is guaranteed in the contract. Although the insurance contract issued by 
IC has a stated term of 5 years, a rate for insurance coverage is 
guaranteed only for a period of 12 months beginning with the contract's 
effective date and each anniversary date thereafter. Thus, for the 
taxable year ending December 31, 2000, IC includes the $500 gross 
premium for the 12 month period beginning with the contract's effective 
date in gross premiums written. IC's unearned premium with respect to 
the contract was $250 as of December 31, 2000. Pursuant to section 
832(b)(4)(B), to determine its premiums earned, IC deducts $200 ($250 
x.8) for the insurance contract at the end of the taxable year.
    Example 3. (i) The facts are the same as Example 1, except that 
coverage under the insurance contract begins on January 1, 2001 and ends 
on December 31, 2001. On December 15, 2000, IC collects the first $125 
premium installment on the insurance contract. For the taxable year 
ended December 31, 2000, IC deducts $20 of premium acquisition expenses 
related to the insurance contract. IC's total premium acquisition 
expenses, based on the insurance contract's $500 gross premium, are $80.
    (ii) Under paragraph (a)(5)(iii) of this section, IC may elect to 
report only the $125 advance premium (rather than the contract's $500 
gross premium) in gross premiums written for the taxable year ended 
December 31, 2000, provided that IC's deduction for the premium 
acquisition expenses related to the insurance contract does not exceed 
the limitation in paragraph (a)(5)(vii). IC's deduction for premium 
acquisition expenses is within this limitation only if the ratio of the 
insurance contract's premium acquisition expenses deducted for the 
taxable year and any previous taxable year to the insurance contract's 
total premium acquisition expenses does not exceed the ratio of the 
amounts included in gross premiums written for the taxable year and any 
previous taxable year for the contract to the total gross premium 
written for the contract.
    (iii) For the taxable year ended December 31, 2000, IC deducts $20 
of premium acquisition expenses related to the insurance contract. This 
deduction represents 25% of the total premium acquisition expenses for 
the insurance contract ($20 / $80 = 25%). This ratio does not exceed the 
ratio of the $125 advance premium to the insurance contract's $500 gross 
premium ($125 / $500 = 25%). Therefore, under paragraph (a)(5)(iii) of 
this section, IC may elect to report only the $125 advance premium 
(rather than the $500 gross premium) in gross premiums written for the 
taxable year ending December 31, 2000. IC reports the balance of the 
gross premium for the insurance contract ($375) and deducts the 
remaining premium acquisition expenses ($60) for the insurance contract 
in the taxable year ending December 31, 2001.
    Example 4. (i) The facts are the same as Example 3, except that for 
the taxable year ending December 31, 2000, IC deducts $60 of premium 
acquisition expenses related to the insurance contract.
    (ii) For the taxable year ended December 31, 2000, IC deducted 75% 
of total premium acquisition expenses for the insurance contract ($60 / 
$80 = 75%). This ratio exceeds the ratio of the $125 advance premium to 
the $500 gross premium ($125 / $500 = 25%). Because IC's deduction for 
premium acquisition expenses allocable to the contract exceeds the 
limitation in paragraph (a)(5)(vii) of this section, paragraph (a)(5)(i) 
of this section requires IC to report the $500 gross premium in gross 
premiums written for the taxable year ending December 31, 2000. IC's 
unearned premium with respect to the contract was $500 as of December 
31, 2000. Pursuant to section 832(b)(4)(B), to determine its premiums 
earned, IC deducts $400 ($500 x .8) for the insurance contract at the 
end of the taxable year.
    Example 5. (i) IC is a non-life insurance company which, pursuant to 
section 843, files its returns on a calendar year basis. On August 1, 
2000, IC issues a one-year cancellable accident and health insurance 
policy to X, a corporation with 80 covered employees. The gross premium 
written for the insurance contract is $320,000. Premiums are payable in 
monthly installments. As of December 31, 2000, IC has collected $150,000 
of installment premiums from X. For the taxable year ended December 31, 
2000, IC has paid or incurred $21,000 of premium acquisition expenses 
related to the insurance contract. IC's total premium acquisition 
expenses for the insurance contract, based on the $320,000 gross 
premium, are $48,000.
    (ii) Under paragraph (a)(5)(iv) of this section, IC may elect to 
report only the $150,000 of installment premiums (rather than the 
$320,000 estimated gross premium) in gross premiums written for the 
taxable year ended December 31, 2000, provided that its deduction for 
premium acquisition expenses allocable to the insurance contract does 
not exceed the limitation in paragraph (a)(5)(vii). For the taxable year 
ended December 31, 2000, IC deducts $21,000 of premium acquisition 
expenses related to the insurance contract, or 43.75% of total premium 
acquisition expenses for the insurance contract ($21,000 / $48,000 = 
43.75%). This ratio does not exceed the ratio of installment premiums to 
the gross premium for the contract ($150,000 / $320,000 = 46.9%). 
Therefore, under paragraph (a)(5)(iv) of this section, IC may elect to 
report only $150,000 of installment premiums for the insurance contract 
(rather than $320,000 of gross premium) in gross premiums

[[Page 870]]

written for the taxable year ending December 31, 2000.
    Example 6. (i) IC is a non-life insurance company which, pursuant to 
section 843, files its returns on a calendar year basis. On July 1, 
2000, IC issues a one-year workers' compensation policy to X, an 
employer. The gross premium for the policy is determined by applying a 
monthly rate of $25 to each of X's employees. This rate is guaranteed 
for a period of 12 months, beginning with the effective date of the 
contract. On July 1, 2000, X has 1,050 employees. Based on the 
assumption that X's payroll would remain constant during the effective 
period of the contract, IC determines an estimated gross premium for the 
contract of $315,000 (1,050 x $25 x 12 = $315,000). The estimated gross 
premium is payable by X in equal monthly installments. At the end of 
each calendar quarter, the premiums payable under the contract are 
adjusted based on an audit of X's actual payroll during the preceding 
three months of coverage.
    (ii) Due to an expansion of X's business in 2000, the actual number 
of employees covered under the contract during each month of the period 
between July 1, 2000 and December 31, 2000 is 1,050 (July), 1,050 
(August), 1,050 (September), 1,200 (October), 1,200 (November), and 
1,200 (December). The increase in the number of employees during the 
year is not attributable to a temporary or seasonal variation in X's 
business activities and is expected to continue for the remainder of the 
effective period of the contract.
    (iii) Under paragraph (a)(5)(i) of this section, IC is required to 
report gross premiums written for the insurance contract based on the 
effective period of the contract. The effective period of X's contract 
is based on the 12 month period for which IC has guaranteed rates for 
insurance coverage. Under paragraph (a)(5)(ii), IC must also report the 
additional premiums resulting from the change in risk exposure under the 
contract for the taxable year in which the change in such exposure 
occurs. Unless the change in risk exposure is of temporary duration, the 
additional gross premiums are included in gross premiums written for the 
remainder of the effective period of the contract. Thus, for the taxable 
year ending December 31, 2000, IC reports gross premiums written of 
$348,750 with respect to the workers' compensation contract issued to X, 
consisting of the sum of the initial gross premium for the contract 
($315,000) plus the additional gross premium attributable to the 150 
employees added to X's payroll who will be covered during the last nine 
months of the contract's effective period (150 x $25 (monthly premium) x 
9 = $33,750). IC's unearned premium with respect to the contract was 
$180,000 as of December 31, 2000, which consists of the sum of the 
remaining portion of the original gross premium ($315,000 x 6 / 12 = 
$157,500), plus the additional premiums resulting from the change in 
risk exposure ($33,750 x 6 / 9 = $22,500) that are allocable to the 
remaining six months of the contract's effective period. Pursuant to 
section 832(b)(4)(B), to determine its premiums earned, IC deducts 
$144,000 ($180,000 x .8) for the insurance contract at the end of the 
taxable year.
    Example 7. (i) The facts are the same as Example 6, except that the 
increase in the number of X's employees for the period ending December 
31, 2000 is attributable to a seasonal variation in X's business 
activity.
    (ii) Under paragraph (a)(5)(ii) of this section, for the taxable 
year ending December 31, 2000, IC reports gross premiums written of 
$326,500, consisting of the sum of the initial gross premium for the 
contract ($315,000) plus the additional premium attributable to the 
temporary increase in risk exposure during the taxable year (150 x $25 x 
3 = $11,250). The unearned premium that is allocable to the remaining 
six months of the effective period of the contract is $157,500. Pursuant 
to section 832(b)(4)(B), to determine its premiums earned, IC deducts 
$126,000 ($157,500 x .8) for the insurance contract at the end of the 
taxable year.
    Example 8. (i) IC, a non-life insurance company, issues a 
noncancellable accident and health insurance contract (other than a 
qualified long-term care insurance contract, as defined in section 
7702B(b)) to A, an individual, on July 1, 2000. The contract has an 
entry-age annual premium of $2,400, which is payable by A in equal 
monthly installments of $200 on the first day of each month of coverage. 
IC incurs agents' commissions, premium taxes, and other premium 
acquisition expenses equal to 10% of the gross premiums received for the 
contract. As of December 31, 2000, IC has collected $1,200 of 
installment premiums for the contract.
    (ii) A noncancellable accident and health insurance contract is a 
contract described in section 832(b)(7). Thus, under paragraph 
(a)(5)(vi) of this section, IC may report gross premiums written in the 
manner required for life insurance companies under sections 803 and 811. 
Accordingly, for the taxable year ending December 31, 2000, IC may 
report gross premiums written of $1,200, based on the premiums actually 
received on the contract. Pursuant to section (a)(5)(vi) of this 
section, IC deducts a total of $28 of premium acquisition costs for the 
contract, based on the difference between the acquisition costs actually 
paid or incurred under section 811(a) ($1,200 x .10 = $120) and the 
amount required to be taken into account under section 848 in connection 
with the net premiums for the contract ($1,200 x .077 = $92).
    (iii) Under paragraph (a)(8)(ii)(A) of this section, IC includes the 
amount of life insurance reserves (as defined in section 816(b), but 
computed in accordance with section 807(d) and sections 811(c) and (d)) 
in unearned

[[Page 871]]

premiums under section 832(b)(4)(B). Section 807(d)(3)(A)(iii) requires 
IC to use a two-year preliminary term method to compute the amount of 
life insurance reserves for a noncancellable accident and health 
insurance contract (other than a qualified long-term care contract). 
Under this tax reserve method, no portion of the $1,200 gross premium 
received by IC for A's contract is allocable to future insurance 
coverage. Accordingly, for the taxable year ending December 31, 2000, no 
life insurance reserves are included in IC's unearned premiums under 
section 832(b)(4)(B) with respect to the contract.
    Example 9. (i) IC, a non-life insurance company, issues an insurance 
contract with a twelve month effective period for $1,200 on December 1, 
2000. Immediately thereafter, IC reinsures 90% of its liability under 
the insurance contract for $900 with IC-2, an unrelated and solvent 
insurance company. On December 31, 2000, IC-2 has an $825 unearned 
premium with respect to the reinsurance contract it issued to IC. In 
computing its earned premiums, pursuant to section 832(b)(4)(B), IC-2 
deducts $660 of unearned premiums ($825 x .8) with respect to the 
reinsurance contract.
    (ii) Under paragraph (a)(8)(i) of this section, unearned premiums 
held by an insurance company with regard to the net value of the risks 
reinsured in other solvent companies are deducted from the ceding 
company's unearned premiums taken into account for purposes of section 
832(b)(4)(B). If IC had not reinsured 90% of its risks, IC's unearned 
premium for the insurance contract would have been $1,100 ($1,200 x 11 / 
12) and IC would have deducted $880 ($1,100 x .8) of unearned premiums 
with respect to such contract. However, because IC reinsured 90% of its 
risks under the contract with IC-2, as of December 31, 2000, the net 
value of the risks retained by IC for the remaining 11 months of the 
effective period of the contract is $110 ($1,100 - $990). For the 
taxable year ending December 31, 2000, IC includes the $1,200 gross 
premium in its gross premiums written and deducts the $900 reinsurance 
premium paid to IC-2 under section 832(b)(4)(A). Pursuant to section 
832(b)(4)(B), to determine its premiums earned, IC deducts $88 ($110 x 
.8) for the insurance contract at the end of the taxable year.

    (11) Change in method of accounting--(i) In general. A change in the 
method of determining premiums earned to comply with the provisions of 
paragraphs (a)(3) through (a)(10) of this section is a change in method 
of accounting for which the consent of the Commissioner is required 
under section 446(e) and Sec. 1.446-1(e).
    (ii) Application. For the first taxable year beginning after 
December 31, 1999, a taxpayer is granted consent of the Commissioner to 
change its method of accounting for determining premiums earned to 
comply with the provisions of paragraphs (a)(3) through (a)(10) of this 
section. A taxpayer changing its method of accounting in accordance with 
this section must follow the automatic change in accounting provisions 
of Rev. Proc. 99-49, 1999-52 I.R.B. 725 (see Sec. 601.601(d)(2) of this 
chapter), except that--
    (A) The scope limitations in section 4.02 of Rev. Proc. 99-49 shall 
not apply;
    (B) The timely duplicate filing requirement in section 6.02(2) of 
Rev. Proc. 99-49 shall not apply; and
    (C) If the method of accounting for determining premiums earned is 
an issue under consideration within the meaning of section 3.09 of Rev. 
Proc. 99-49 as of January 5, 2000, then section 7.01 of Rev. Proc. 99-49 
shall not apply.
    (12) Effective date. Paragraphs (a)(3) through (a)(11) of this 
section are applicable with respect to the determination of premiums 
earned for taxable years beginning after December 31, 1999.
    (13) In computing the amount of unabsorbed premium deposits which a 
mutual fire or flood insurance company described in section 831(a)(3)(B) 
would be obligated to return to its policyholders at the close of its 
taxable year, the company must use its own schedule of unabsorbed 
premium deposit returns then in effect. A copy of the applicable 
schedule must be filed with the company's income tax return for each 
taxable year for which a computation based upon such schedule is made. 
In addition, a taxpayer making such a computation must provide the 
following information for each taxable year for which the computation is 
made:
    (i) The amount of gross premiums received during the taxable year, 
and the amount of premiums paid for reinsurance during the taxable year, 
on the policies described in section 831(a)(3)(B) and on other policies;
    (ii) The amount of insurance written during the taxable year under 
the policies described in section 831(a)(3)(B) and under other policies, 
and the amount of such insurance written which was reinsured during the 
taxable

[[Page 872]]

year. The information required under this subdivision shall only be 
submitted upon the specific request of the district director for a 
statement setting forth such information, and, if required, such 
statement shall be filed in the manner provided by this subparagraph or 
in such other manner as is satisfactory to the district director;
    (iii) The amount of premiums earned during the taxable year on the 
policies described in section 831(a)(3)(B) and on other policies and the 
computations by which such amounts were determined, including sufficient 
information to support the taxpayer's determination of the amount of 
unearned premiums on premium deposit plan and other policies at the 
beginning and end of the taxable year, and the amount of unabsorbed 
premium deposits at the beginning and end of the taxable year on 
policies described in section 831(a)(3)(B).

The information required by this subparagraph shall be set forth in a 
statement attached to the taxpayer's income tax return for the taxable 
year for which such information is being provided. Such statement shall 
include the name and address of the taxpayer, and shall be filed not 
later than the date prescribed by law (including extensions thereof) for 
filing the income tax return for the taxable year.
    (14) In computing ``losses incurred'' the determination of unpaid 
losses at the close of each year must represent actual unpaid losses as 
nearly as it is possible to ascertain them.
    (b) Losses incurred. Every insurance company to which this section 
applies must be prepared to establish to the satisfaction of the 
district director that the part of the deduction for ``losses incurred'' 
which represents unpaid losses at the close of the taxable year 
comprises only actual unpaid losses. See section 846 for rules relating 
to the determination of discounted unpaid losses. These losses must be 
stated in amounts which, based upon the facts in each case and the 
company's experience with similar cases, represent a fair and reasonable 
estimate of the amount the company will be required to pay. Amounts 
included in, or added to, the estimates of unpaid losses which, in the 
opinion of the district director, are in excess of a fair and reasonable 
estimate will be disallowed as a deduction. The district director may 
require any insurance company to submit such detailed information with 
respect to its actual experience as is deemed necessary to establish the 
reasonableness of the deduction for ``losses incurred.''
    (c) Losses incurred are reduced by salvage. Under section 
832(b)(5)(A), losses incurred are computed by taking into account losses 
paid reduced by salvage and reinsurance recovered, the change in 
discounted unpaid losses, and the change in estimated salvage and 
reinsurance recoverable. For purposes of section 832(b)(5)(A)(iii), 
estimated salvage recoverable includes all anticipated recoveries on 
account of salvage, whether or not the salvage is treated, or may be 
treated, as an asset for state statutory accounting purposes. Estimates 
of salvage recoverable must be based on the facts of each case and the 
company's experience with similar cases. Except as otherwise provided in 
guidance published by the Commissioner in the Internal Revenue Bulletin, 
estimated salvage recoverable must be discounted either--
    (1) By using the applicable discount factors published by the 
Commissioner for estimated salvage recoverable; or
    (2) By using the loss payment pattern for a line of business as the 
salvage recovery pattern for that line of business and by using the 
applicable interest rate for calculating unpaid losses under section 
846(c). For purposes of section 832(b)(5)(A) and the regulations 
thereunder, the term ``salvage recoverable'' includes anticipated 
recoveries on account of subrogation claims arising with respect to paid 
or unpaid losses.
    (d) Increase in unpaid losses shown on annual statement in certain 
circumstances--(1) In general. An insurance company that takes estimated 
salvage recoverable into account in determining the amount of its unpaid 
losses shown on its annual statement is allowed to increase its unpaid 
losses by the amount of estimated salvage recoverable taken into account 
if the company complies with the disclosure requirement of paragraph 
(d)(2) of this section. This adjustment shall not be used in determining 
under section

[[Page 873]]

846(d) the loss payment pattern for a line of business.
    (2) Disclosure requirement. (i) In general. A company described in 
paragraph (d)(1) of this section is allowed to increase the unpaid 
losses shown on its annual statement only if the company either--
    (A) Discloses on its annual statement, by line of business and 
accident year, the extent to which estimated salvage recoverable is 
taken into account in computing the unpaid losses shown on the annual 
statement filed by the company for the calendar year ending with or 
within the taxable year of the company; or
    (B) Files a statement on or before the due date of its Federal 
income tax return (determined without regard to extensions) with the 
appropriate state regulatory authority of each state to which the 
company is required to submit an annual statement. The statement must be 
contained in a separate document captioned ``DISCLOSURE CONCERNING LOSS 
RESERVES'' and must disclose, by line of business and accident year, the 
extent to which estimated salvage recoverable is taken into account in 
computing the unpaid losses shown on the annual statement filed by the 
company for the calendar year ending with or within the taxable year of 
the company.
    (ii) Transitional rule. For a taxable year ending before December 
31, 1991, a taxpayer is deemed to satisfy the disclosure requirement of 
paragraph (d)(2)(i)(B) of this section if the taxpayer files the 
statement described in paragraph (d)(2)(i)(B) of this section before 
March 17, 1992.
    (3) Failure to disclose in a subsequent year. If a company that 
claims the increase permitted by paragraph (d)(1) of this section fails 
in a subsequent taxable year to make the disclosure described in 
paragraph (d)(2) of this section, the company cannot claim an increase 
under paragraph (d)(1) of this section in any subsequent taxable year 
without the consent of the Commissioner.
    (e) Treatment of estimated salvage recoverable--(1) In general. An 
insurance company is required to take estimated salvage recoverable 
(including that which cannot be treated as an asset for state statutory 
accounting purposes) into account in computing the deduction for losses 
incurred. Except as provided in paragraph (e)(2)(iii) of this section, 
an insurance company must apply this method of accounting to estimated 
salvage recoverable for all lines of business and for all accident 
years.
    (2) Change in method of accounting--(i) If an insurance company did 
not take estimated salvage recoverable into account as required by 
paragraph (c) of this section for its last taxable year beginning before 
January 1, 1990, taking estimated salvage recoverable into account as 
required by paragraph (c) of this section is a change in method of 
accounting.
    (ii) If a company does not claim the deduction under section 
11305(c)(3) of the 1990 Act, the company must take into account 13 
percent of the adjustment that would otherwise be required under section 
481 for pre-1990 accident years as a result of the change in accounting 
method. This paragraph (e)(2)(ii) applies only to an insurance company 
subject to tax under section 831.
    (iii) If a company claims the deduction under section 11305(c)(3) of 
the 1990 Act and paragraph (f) of this section, the company must 
implement the change in method of accounting for estimated salvage 
recoverable for post-1989 taxable years pursuant to a ``cut-off'' 
method.
    (3) Rule for overestimates. An insurance company is required under 
section 11305(c)(4) of the 1990 Act to include in gross income 87 
percent of any amount (adjusted for discounting) by which the section 
481 adjustment is overestimated. The rule is applied by comparing the 
amount of the section 481 adjustment (determined without regard to 
paragraph (e)(2)(ii) of this section and any discounting) to the sum of 
the actual salvage recoveries and remaining undiscounted estimated 
salvage recoverable that are attributable to losses incurred in accident 
years beginning before 1990. For any taxable year beginning after 
December 31, 1989, any excess of the section 481 adjustment over this 
sum (reduced by amounts treated as overestimates in prior taxable years 
pursuant to this paragraph (e)(3)) is an overestimate. To determine

[[Page 874]]

the amount to be included in income, it is necessary to discount this 
excess and multiply the resulting amount by 87 percent.
    (f) Special deduction--(1) In general. Under section 11305(c)(3) of 
the 1990 Act, an insurance company may deduct an amount equal to 87 
percent of the discounted amount of estimated salvage recoverable that 
the company took into account in determining the deduction for losses 
incurred under section 832(b)(5) in the last taxable year beginning 
before January 1, 1990. A company that claims the special deduction must 
establish to the satisfaction of the district director that the 
deduction represents only the discounted amount of estimated salvage 
recoverable that was actually taken into account by the company in 
computing losses incurred for that taxable year.
    (2) Safe harbor. The requirements of paragraph (f)(1) of this 
section are deemed satisfied and the amount that the company reports as 
bona fide estimated salvage recoverable is not subject to adjustment by 
the district director, if--
    (i) The company files with the insurance regulatory authority of the 
company's state of domicile, on or before September 16, 1991, a 
statement disclosing the extent to which losses incurred for each line 
of business reported on its 1989 annual statement were reduced by 
estimated salvage recoverable,
    (ii) The company attaches a statement to its Federal income tax 
return filed for the first taxable year beginning after December 31, 
1989, agreeing to apply the special rule for overestimates under section 
11305(c)(4) of the 1990 Act to the amount of estimated salvage 
recoverable for which it has taken the special deduction, and
    (iii) In the case of a company that is a member of a consolidated 
group, each insurance company subject to tax under section 831 that is 
included in the consolidated group complies with paragraph (f)(2)(ii) of 
this section with respect to its special deduction, if any.
    (3) Limitations on special deduction--(i) The special deduction 
under section 11305(c)(3) of the 1990 Act is available only to an 
insurance company subject to tax under section 831.
    (ii) An insurance company that claimed the benefit of the ``fresh 
start'' with respect to estimated salvage recoverable under section 
1023(e) of the Tax Reform Act of 1986 may not claim the special 
deduction allowed by section 11305(c)(3) of the 1990 Act to the extent 
of the estimated salvage recoverable for which a fresh start benefit was 
previously claimed.
    (iii) A company that claims the special deduction is precluded from 
also claiming the section 481 adjustment provided in paragraph 
(e)(2)(ii) of this section for pre-1990 accident years.
    (g) Effective date. Paragraphs (b) through (f) of this section are 
effective for taxable years beginning after December 31, 1989.

[T.D. 6681, 28 FR 11129, Oct. 17, 1963, as amended by T.D. 8171, 53 FR 
118, Jan. 5, 1988; T.D. 8293, 55 FR 9425, Mar. 14, 1990. Redesignated 
and amended by T.D. 8390, 57 FR 3132, Jan. 28, 1992; 57 FR 6353, Feb. 
24, 1992; T.D. 8857, 65 FR 706, Jan. 6, 2000]



Sec. 1.832-5  Deductions.

    (a) The deductions allowable are specified in section 832(c) and by 
reason of the provisions of section 832(c)(10) and (12) include in 
addition certain deductions provided in sections 161, and 241 and 
following. The deductions, however, are subject to the limitation 
provided in section 265, relating to expenses and interest in respect of 
tax-exempt income. The net operating loss deduction is computed under 
section 172 and the regulations thereunder. For the purposes of section 
172, relating to net operating loss deduction, ``gross income'' shall 
mean gross income as defined in section 832(b)(1) and the allowable 
deductions shall be those allowed by section 832(c) with the exceptions 
and limitations set forth in section 172(d). In addition to the 
deduction for capital losses provided in subchapter P (section 1201 and 
following), chapter 1 of the Code, insurance companies are allowed a 
deduction for losses from capital assets sold or exchanged in order to 
obtain funds to meet abnormal insurance losses and to provide for the 
payment of dividends and similar distributions to policyholders. A 
special rule is provided for the application of the capital loss 
carryover provisions of section 1212. The deduction is the same

[[Page 875]]

as that allowed mutual insurance companies subject to the tax imposed by 
section 821; see section 822(c)(6) and the regulation thereunder. 
Insurance companies, other than mutual fire insurance companies 
described in section 831(a)(3)(A) and the regulations thereunder, are 
also allowed a deduction for dividends and similar distributions paid or 
declared to policyholders in their capacity as such. Similar 
distributions include such payments as the so-called unabsorbed premium 
deposits returned to policyholders by factory mutual insurance 
companies. The deduction is otherwise the same as that allowed mutual 
insurance companies subject to the tax imposed by section 821; see 
section 822(f)(2) and the regulations thereunder.
    (b) Among the items which may not be deducted are income and profits 
taxes imposed by the United States, income and profits taxes imposed by 
any foreign country or possession of the United States (in cases where 
the company chooses to claim to any extent a credit for such taxes), 
taxes assessed against local benefits, decrease during the year due to 
adjustments in the book value of capital assets, decrease in liabilities 
during the year on account of reinsurance treaties, dividends paid to 
shareholders in their capacity as such, remittances to the home office 
of a foreign insurance company by the United States branch, and borrowed 
money repaid.
    (c) In computing taxable income of insurance companies, losses 
sustained during the taxable year from the sale or other disposition of 
property are deductible subject to the limitation contained in section 
1211. Insurance companies are entitled to the alternative taxes provided 
in section 1201.

[T.D. 6681, 28 FR 11130, Oct. 17, 1963, as amended by T.D. 6867, 30 FR 
15094, Dec. 7, 1965]



Sec. 1.832-6  Policyholders of mutual fire or flood insurance companies
operating on the basis of premium deposits.

    For purposes of determining his taxable income for any taxable year, 
a taxpayer insured by a mutual fire or flood insurance company under a 
policy for which the premium deposit is the same regardless of the 
length of the term for which the policy is written, and who is entitled 
to have returned or credited to his on the cancellation or expiration of 
such policy the unabsorbed portion of the premium deposit not required 
for losses, expenses, or establishment of reserves, may, if such amount 
is otherwise deductible under this chapter, deduct so much of his 
premium deposit as was absorbed by the company during the taxpayer's 
taxable year. The amount of the premium deposit absorbed during the 
taxpayer's taxable year shall be determined in accordance with the 
schedule of unabsorbed premium deposit returns in effect for the company 
during such taxable year. If the taxpayer is unable to determine the 
applicable rate of absorption in effect during his taxable year, he 
shall compute his deduction on the basis of the rate of absorption in 
effect at the end of the company's taxable year which next preceded the 
end of the taxpayer's taxable year. In such a case, an appropriate 
adjustment will be made upon the final determination of the rate of 
absorption applicable to the taxable year.

[T.D. 6681, 28 FR 11130, Oct. 17, 1963]



Sec. 1.832-7T  Treatment of salvage and reinsurance in computing 
``losses incurred'' deduction, taxable years beginning before 
January 1, 1990 (temporary).

    (a) In computing ``losses incurred'' the determination of unpaid 
losses at the close of each year must represent actual unpaid losses as 
nearly as it is possible to ascertain them.
    (b) Every insurance company to which this section applies must be 
prepared to establish to the satisfaction of the district director that 
the part of the deduction for ``losses incurred'' which represents 
unpaid losses at the close of the taxable year comprises only actual 
unpaid losses stated in amounts which, based upon the facts in each case 
and the company's experience with similar cases, can be said to 
represent a fair and reasonable estimate of the amount the company will 
be required to pay. Amounts included in, or added to, the estimates of 
such

[[Page 876]]

losses which in the opinion of the district director are in excess of 
the actual liability determined as provided in the preceding sentence 
will be disallowed as a deduction. The district director may require any 
such insurance company to submit such detailed information with respect 
to its actual experience as is deemed necessary to establish the 
reasonableness of the deduction for ``losses incurred''.
    (c) That part of the deduction for ``losses incurred'' which 
represents an adjustment to losses paid for salvage and reinsurance 
recoverable shall, except as hereinafter provided, include all salvage 
in course of liquidation, and all reinsurance in process of collection 
not otherwise taken into account as a reduction of losses paid, 
outstanding at the end of the taxable year. Salvage in course of 
liquidation includes all property (other than cash), real or personal, 
tangible or intangible, except that which may not be included by reason 
of express statutory provisions (or rules and regulations of an 
insurance department) of any State or Territory or the District of 
Columbia in which the company transacts business. Such salvage in course 
of liquidation shall be taken into account to the extent of the value 
thereof at the end of the taxable year as determined from a fair and 
reasonable estimate based upon either the facts in each case or the 
company's experience with similar cases. Cash received during the 
taxable year with respect to items of salvage or reinsurance shall be 
taken into account in computing losses paid during such taxable year.
    (d) This section is effective for taxable years beginning before 
January 1, 1990.

[T.D. 8266, 54 FR 38970, Sept. 22, 1989; T.D. 8293, 55 FR 9425, Mar. 14, 
1990]



Sec. 1.833-1  Medical Loss Ratio under section 833(c)(5).

    (a) In general. Section 833 does not apply to an organization unless 
the organization's medical loss ratio (MLR) for a taxable year is at 
least 85 percent. Paragraph (b) of this section provides definitions 
that apply for purposes of section 833(c)(5) and this section. Paragraph 
(c) of this section provides rules for computing an organization's MLR 
under section 833(c)(5). Paragraph (d) of this section addresses the 
treatment under section 833 of an organization that has an MLR of less 
than 85 percent. Paragraph (e) of this section provides the effective/
applicability date.
    (b) Definitions. The following definitions apply for purposes of 
section 833(c)(5) and this section.
    (1) Reimbursement for clinical services provided to enrollees. The 
term reimbursement for clinical services provided to enrollees has the 
same meaning as that term has in section 300gg-18 of title 42, United 
States Code and the regulations issued under that section (see 45 CFR 
158.140).
    (2) Total premium revenue. The term total premium revenue means the 
total amount of premium revenue (excluding Federal and State taxes and 
licensing or regulatory fees and after accounting for payments or 
receipts for risk adjustment, risk corridors, and reinsurance under 
sections 1341, 1342, and 1343 of the Patient Protection and Affordable 
Care Act, Public Law 111-148 (124 Stat. 119 (2010)) (42 U.S.C. sections 
18061, 18062, and 18063)) as those terms are used for purposes of 
section 300gg-18(b) of title 42, United States Code and the regulations 
issued under that section (see 45 CFR Part 158).
    (c) Computation of MLR under section 833(c)(5)--(1) In general. 
Starting with the first taxable year beginning after December 31, 2015, 
and for all succeeding taxable years, an organization's MLR with respect 
to a taxable year is the ratio, expressed as a percentage, of the MLR 
numerator, as described in paragraph (c)(1)(i) of this section, to the 
MLR denominator, as described in paragraph (c)(1)(ii) of this section.
    (i) MLR numerator. The numerator of an organization's MLR is the 
total premium revenue expended on reimbursement for clinical services 
provided to enrollees under its policies for the taxable year, computed 
using a three-year period in the same manner as those expenses are 
computed for the plan year for purposes of section 300gg-18(b) of title 
42, United States Code and regulations issued under that section (see 45 
CFR Part 158).
    (ii) MLR denominator. The denominator of an organization's MLR is 
the

[[Page 877]]

organization's total premium revenue for the taxable year, computed 
using a three-year period in the same manner as the total premium 
revenue is computed for the plan year for purposes of section 300gg-
18(b) of title 42, United States Code and regulations issued under that 
section (see 45 CFR Part 158).
    (2) Transition rules. The transition rules in paragraphs (c)(2)(i) 
and (c)(2)(ii) of this section apply solely for the first taxable year 
beginning after December 31, 2013, and the first taxable year beginning 
after December 31, 2014.
    (i) First taxable year beginning after December 31, 2013. For the 
first taxable year beginning after December 31, 2013, the numerator of 
an organization's MLR is the total premium revenue expended on 
reimbursement for clinical services provided to enrollees under its 
policies for the first taxable year beginning after December 31, 2013, 
and the denominator of an organization's MLR is the organization's total 
premium revenue for the first taxable year beginning after December 31, 
2013.
    (ii) First taxable year beginning after December 31, 2014. For the 
first taxable year beginning after December 31, 2014, the numerator of 
an organization's MLR is the sum of the total premium revenue expended 
on reimbursement for clinical services provided to enrollees under its 
policies for the first taxable year beginning after December 31, 2013, 
and for the first taxable year beginning after December 31, 2014, and 
the denominator of an organization's MLR is the sum of the 
organization's total premium revenue for the first taxable year 
beginning after December 31, 2013, and for the first taxable year 
beginning after December 31, 2014.
    (d) Failure to qualify under section 833(c)(5)--(1) In general. If, 
for any taxable year, an organization's MLR is less than 85 percent, 
then beginning in that taxable year and for each subsequent taxable year 
for which the organization's MLR remains less than 85 percent, 
paragraphs (d)(1)(i) through (d)(1)(iii) of this section apply.
    (i) Automatic stock insurance company status. The organization is 
not taxable as a stock insurance company by reason of section 833(a)(1), 
but may be taxable as an insurance company if it otherwise meets the 
requirements of section 831(c);
    (ii) Special deduction. The organization is not allowed the special 
deduction set forth in section 833(b); and
    (iii) Premiums earned. The organization must take into account 80 
percent, rather than 100 percent, of its unearned premiums under section 
832(b)(4) as it applies to other non-life insurance companies, provided 
the organization qualifies as an insurance company by meeting the 
requirements of section 831(c).
    (2) No material change. An organization's loss of eligibility for 
treatment under section 833 solely by reason of section 833(c)(5) will 
not be treated as a material change in the operations of such 
organization or in its structure for purposes of section 833(c)(2)(C).
    (e) Effective/applicability date. This section applies to taxable 
years beginning after December 31, 2013.

[T.D. 9651, 79 FR 757, Jan. 7, 2014]



Sec. 1.846-0  Outline of provisions.

    The following is a list of the headings in Sec. Sec. 1.846-1 
through 1.846-4.

             Sec. 1.846-1 Application of discount factors.

    (a) In general.
    (1) Rules.
    (2) Examples.
    (3) Increase in discounted unpaid losses shown on the annual 
statement.
    (4) Increase in unpaid losses which take into account estimated 
salvage recoverable.
    (b) Applicable discount factors.
    (1) In general.
    (i) Discount factors published by the Service.
    (ii) Composite discount factors.
    (iii) Annual statement changes.
    (2) Title insurance company reserves.
    (3) Reinsurance business.
    (i) Proportional reinsurance for accident years after 1987.
    (ii) Non-proportional reinsurance.
    (A) Accident years after 1991.
    (B) Accident years 1988 through 1991.
    (iii) Reinsurance for accident years before 1988.
    (iv) 90 percent exception.
    (4) International business.
    (5) Composite discount factors.

   Sec. 1.846-2 Election by taxpayer to use its own historical loss 
                            payment pattern.

    (a) In general.
    (b) Eligible line of business.
    (1) In general.

[[Page 878]]

    (2) Other published guidance.
    (3) Special rule for 1987 determination year.
    (c) Anti-abuse rule.
    (d) Effect of section 338 election on section 846(e) election.

          Sec. 1.846-3 Fresh start and reserve strengthening.

    (a) In general.
    (b) Applicable discount factors.
    (1) Calculation of beginning balance.
    (2) Example.
    (c) Rules for determining the amount of reserve strengthening.
    (1) In general.
    (2) Accident years after 1985.
    (i) In general.
    (ii) Hypothetical unpaid loss reserve.
    (3) Accident years before 1986.
    (i) In general.
    (ii) Exceptions.
    (iii) Certain transactions deemed to be reinsurance assumed (ceded) 
in 1986.
    (d) Section 845.
    (e) Treatment of reserve strengthening.
    (f) Examples.

                     Sec. 1.846-4 Effective dates.

    (a) In general.
    (b) Section 338 election.

[T.D. 8433, 57 FR 40843, Sept. 8, 1992; 57 FR 48563, Oct. 27, 1992; T.D. 
9257, 71 FR 18005, Apr. 10, 2006; T.D. 9377, 73 FR 3873, Jan. 23, 2008]



Sec. 1.846-1  Application of discount factors.

    (a) In general--(1) Rules. A separate series of discount factors are 
computed for, and applied, to undiscounted unpaid losses attributable to 
each accident year of each line of business shown on the annual 
statement (as defined by section 846(f)(3)) filed by that taxpayer for 
the calendar year ending with or within the taxable year of the 
taxpayer. See Sec. 1.832-4(b) relating to the determination of unpaid 
losses. Paragraph (b) of this section provides rules relating to 
applicable discount factors and Sec. 1.846-3(b) contains guidance 
relating to discount factors applicable to accident years prior to the 
1987 accident year. Once a taxpayer applies a series of discount factors 
to unpaid losses attributable to an accident year of a line of business, 
that series of discount factors must be applied to discount the unpaid 
losses for that accident year for that line of business for all future 
taxable years. The discount factors cannot be changed to reflect a 
change in the taxpayer's loss payment pattern during a subsequent year 
or to reflect a different interest rate assumption. However, discount 
factors may be changed for taxpayers who elect to use their own 
historical loss payment pattern, if information upon which the pattern 
is based is adjusted upon examination by the district director.
    (2) Examples. The following examples illustrate the principles of 
paragraph (a)(1) of this section:

    Example 1. A taxpayer discounts unpaid losses attributable to all 
accident years prior to 1992 using discount factors published by the 
Service. In 1992, the taxpayer elects, under Sec. 1.846-2, to compute 
discount factors using its own historical loss payment pattern. The 
taxpayer must continue to discount unpaid losses attributable to pre-
1992 accident years using the discount factors published for those 
accident years by the Service.
    Example 2. On its annual statements through 1987, a taxpayer did not 
allocate unpaid losses attributable to proportional reinsurance to the 
line of business associated with the risks being reinsured. Beginning 
with the 1988 annual statement, the taxpayer allocated those losses for 
all accident years to the line of business being reinsured. The taxpayer 
must continue to discount the unpaid losses attributable to proportional 
reinsurance from pre-1988 accident years using the discount factors that 
were used in determining tax reserves for the 1987 tax year. (See 
paragraph (b)(3) of this section for rules relating to the application 
of discount factors to reinsurance unpaid losses.)

    (3) Increase in discounted unpaid losses shown on the annual 
statement. If the amount of unpaid losses shown on the annual statement 
is determined on a discounted basis, and the extent to which the unpaid 
losses were discounted can be determined on the basis of information 
disclosed on or with the annual statement, the amount of the unpaid 
losses to which the discount factors are applied shall be determined 
without regard to any reduction attributable to the discounting 
reflected on the annual statement.
    (4) Increase in unpaid losses which take into account estimated 
salvage recoverable. If the amount of unpaid losses shown on the annual 
statement reflects a reduction for estimated salvage recoverable and the 
extent to which the unpaid losses were reduced by estimated salvage 
recoverable is appropriately disclosed as required by Sec. 1.832-

[[Page 879]]

4(d)(2), the amount of unpaid losses shall be determined without regard 
to the reduction for salvage recoverable.
    (b) Applicable discount factors--(1) In general. Except as otherwise 
provided in section 846(f)(6) (relating to certain accident and health 
lines of business), in Sec. 1.846-2 (relating to a taxpayer's election 
to use its own historical loss payment pattern), in this paragraph (b), 
or in other guidance published in the Internal Revenue Bulletin, the 
following factors must be used--
    (i) Discount factors published by the Service. If the Service has 
published discount factors for a line of business, a taxpayer must 
discount unpaid losses attributable to that line by applying those 
discount factors; and
    (ii) Composite discount factors. If the Service has not published 
discount factors for a line of business, a taxpayer must discount unpaid 
losses attributable to that line by applying composite discount factors.
    (iii) Annual statement changes. If the groupings of individual lines 
of business on the annual statement changes, taxpayers must discount the 
unpaid losses on the resulting lines of business with the discounting 
patterns that would have applied to those unpaid losses based on their 
annual statement classification prior to the change.
    (2) Title insurance company reserves. A title insurance company may 
only take into account case reserves (relating to claims which have been 
reported to the insurance company). Unless the Service publishes other 
guidance, the reserves must be discounted using the ``Miscellaneous 
Casualty'' discount factors published by the Service. Section 832(b)(8) 
provides rules for determining the discounted unearned premiums of a 
title insurance company.
    (3) Reinsurance business--(i) Proportional reinsurance for accident 
years after 1987. For the 1988 accident year and subsequent accident 
years, unpaid losses for proportional reinsurance must be discounted 
using discount factors applicable to the line of business to which those 
unpaid losses are allocated as required on the annual statement.
    (ii) Non-proportional reinsurance--(A) Accident years after 1991. 
For the 1992 accident year and subsequent accident years, unpaid losses 
for non-proportional reinsurance must be discounted using the applicable 
discount factors published by the Service for the appropriate 
reinsurance line of business.
    (B) Accident years 1988 through 1991. For the 1988, 1989, 1990, and 
1991 accident years unpaid losses for non-proportional reinsurance must 
be discounted using composite discount factors.
    (iii) Reinsurance for accident years before 1988. If on its annual 
statement a taxpayer does not allocate unpaid losses to the applicable 
line of business for proportional or nonproportional reinsurance 
attributable to the 1987 accident year or a prior accident year, those 
losses must be discounted using composite discount factors. If on its 
annual statement a taxpayer allocates to the underlying line of business 
reinsurance unpaid losses that are attributable to the 1987 accident 
year or a prior accident year, those losses must be discounted using 
discount factors applicable to the underlying line of business.
    (iv) 90 percent exception. For purposes of Sec. 1.846-1(b)(3) (ii) 
and (iii), if more than 90 percent of all the unallocated losses of a 
taxpayer for an accident year relate to one underlying line of business, 
the taxpayer must discount all unallocable reinsurance unpaid losses 
attributable to that accident year using the discount factors published 
by the Service for the underlying line of business.
    (4) International business. For any accident year, unpaid losses 
which are attributable to international business must be discounted 
using composite discount factors unless more than 90 percent of all 
losses for that accident year relate to one underlying line of business. 
If more than 90 percent of all losses for an accident year relate to one 
underlying line of business, the taxpayer must discount the losses 
attributable to that accident year using discount factors published by 
the Service for the underlying line of business.
    (5) Composite discount factors. For purposes of the regulations 
under section 846, ``composite discount factors'' means the series of 
discount factors

[[Page 880]]

published annually by the Service determined on the basis of the 
appropriate composite loss payment pattern.

[T.D. 8433, 57 FR 40844, Sept. 8, 1992]



Sec. 1.846-2  Election by taxpayer to use its own historical loss 
payment pattern.

    (a) In general. If a taxpayer has one or more eligible lines of 
business in a determination year, the taxpayer may elect on the 
taxpayer's timely filed Federal income tax return for the determination 
year to discount unpaid losses using its own historical loss payment 
pattern instead of the industry-wide pattern determined by the 
Secretary. A taxpayer making the election must use its own historical 
loss payment pattern in discounting unpaid losses for each line of 
business that is an eligible line of business in that determination 
year. The election applies to accident years ending with the 
determination year and to each of the four succeeding accident years. If 
a taxpayer makes the election for the 1987 determination year, the 
taxpayer must use its 1987 loss payment pattern (determined by reference 
to its 1985 annual statement) to discount unpaid losses attributable to 
all accident years prior to 1988.
    (b) Eligible line of business--(1) In general. A line of business is 
an eligible line of business in a determination year if, on the most 
recent annual statement filed by the taxpayer before the beginning of 
that determination year, the taxpayer reports losses and loss expenses 
incurred (in Schedule P, part 1, column 24 of the 1990 annual statement 
or comparable location in an earlier or subsequently revised blank) for 
at least the number of accident years for which losses and loss expenses 
incurred for that line of business are required to be separately 
reported on that annual statement. For example, for the 1987 
determination year, the 1985 annual statement is used. The annual 
statement to be used to determine eligibility in subsequent 
determination years is the annual statement for each fifth year after 
1985 (e.g., 1990, 1995, etc.).
    (2) Other published guidance. A line of business is also an eligible 
line of business for purposes of the election if the line is an eligible 
line under requirements published for this purpose in the Internal 
Revenue Bulletin.
    (3) Special rule for 1987 determination year. A line of business is 
an eligible line of business in the 1987 determination year if it is 
eligible under paragraph (b) (1) or (2) of this section, or if on the 
most recent annual statement filed by the taxpayer before the beginning 
of the 1987 determination year, the taxpayer reports written premiums 
for the line of business for at least the number of accident years that 
unpaid losses for that line of business are required to be separately 
reported on that annual statement.
    (c) Anti-abuse rule. To prevent avoidance of the requirement that 
the election to use historical loss payment patterns apply to all 
eligible lines of business of a taxpayer, the district director may--
    (1) Nullify a taxpayer's election to compute discounted unpaid 
losses based on its historical loss payment pattern;
    (2) Adjust a taxpayer's historical loss payment pattern; or
    (3) Make other proper adjustments.
    (d) Effect of section 338 election on section 846(e) election. For 
rules regarding qualified stock purchase occurring on or after April 10, 
2006, see Sec. Sec. 1.338-1(b)(2)(vii) and 1.338-11(e).

[T.D. 8433, 57 FR 40845, Sept. 8, 1992, as amended by T.D. 9257, 71 FR 
18005, Apr. 10, 2006; T.D. 9377, 73 FR 3873, Jan. 23, 2008]



Sec. 1.846-2T  Election by taxpayer to use its own historical loss
payment pattern (temporary).

    (a) through (c) [Reserved]. For further guidance, see Sec. 1.846-
2(a) through (c).
    (d) Effect of section 338 election on section 846(e) election. For 
rules regarding qualified stock purchases occurring on or after April 
10, 2006, see Sec. Sec. 1.338-1(b)(2)(vii) and 1.338-11T(e).

[T.D. 9257, 71 FR 18005, Apr. 10, 2006]



Sec. 1.846-3  Fresh start and reserve strengthening.

    (a) In general. Section 1023(e) of the Tax Reform Act of 1986 (``the 
1986 Act'') provides rules relating to fresh start and reserve 
strengthening. For purposes of section 1023(e) of the 1986 Act,

[[Page 881]]

a taxpayer must discount its unpaid losses as of the end of the last 
taxable year beginning before January 1, 1987. The excess of 
undiscounted unpaid losses over discounted unpaid losses as of that time 
is not required to be included in income, except (as provided in 
paragraph (e) of this section) to the extent of any ``reserve 
strengthening'' in a taxable year beginning in 1986. The exclusion from 
income of this excess is known as ``fresh start.'' The amount of fresh 
start is, however, included in earnings and profits for the first 
taxable year beginning after December 31, 1986.
    (b) Applicable discount factors--(1) Calculation of beginning 
balance. For purposes of section 1023(e) of the 1986 Act, a taxpayer 
discounts unpaid losses as of the end of the last taxable year beginning 
before January 1, 1987--
    (i) By using the same discount factors that are used in the 
succeeding taxable year to discount unpaid losses attributable to the 
1987 accident year and prior accident years (see section 1023(e)(2) of 
the 1986 Act); and
    (ii) By applying those discount factors as if the 1986 accident year 
were the 1987 accident year.
    (2) Example. The following example illustrates the principles of 
this paragraph (b):

    Example. X, a calendar year taxpayer, does not make an election in 
1987 to use its own historical loss payment pattern. When X computes 
discounted unpaid losses for its last taxable year beginning before 
January 1, 1987, the discount factor for AY+0 published in Rev. Rul. 87-
34, 1987-1 C.B. 168, must be applied to unpaid losses attributable to 
the 1986 accident year; the discount factor for AY+1 is applied to 
unpaid losses attributable to the 1985 accident year; etc.

    (c) Rules for determining the amount of reserve strengthening 
(weakening)--(1) In general. The amount of reserve strengthening 
(weakening) is the amount that is determined under paragraph (c)(2) or 
(3) to have been added to (subtracted from) an unpaid loss reserve in a 
taxable year beginning in 1986. For purposes of section 1023(e)(3)(B) of 
the 1986 Act, the amount of reserve strengthening (weakening) must be 
determined separately for each unpaid loss reserve by applying the rules 
of this paragraph (c). This determination is made without regard to the 
reasonableness of the amount of the unpaid loss reserve and without 
regard to the taxpayer's discretion, or lack thereof, in establishing 
the amount of the unpaid loss reserve. The amount of reserve 
strengthening for an unpaid loss reserve may not exceed the amount of 
the reserve, including any undiscounted strengthening amount, as of the 
end of the last taxable year beginning before January 1, 1987. For 
purposes of this section, an ``unpaid loss reserve'' is the aggregate of 
the unpaid loss estimate for losses (whether or not reported) incurred 
in an accident year of a line of business.
    (2) Accident years after 1985--(i) In general. The amount of reserve 
strengthening (weakening) for an unpaid loss reserve for an accident 
year after 1985 is the amount by which that reserve at the end of the 
last taxable year beginning in 1986 exceeds (is less than) a 
hypothetical unpaid loss reserve.
    (ii) Hypothetical unpaid loss reserve. For purposes of this 
paragraph (c)(2), the term ``hypothetical unpaid loss reserve'' means a 
reserve computed for losses the estimates of which were included, at the 
end of the last taxable year beginning in 1986, in the unpaid loss 
reserve for which reserve strengthening (weakening) is being determined. 
The hypothetical unpaid loss reserve must be computed using the same 
assumptions, other than the assumed interest rates in the case of 
reserves determined on a discounted basis for annual statement reporting 
purposes, that were used to determine the 1985 accident year reserve, if 
any, for the line of business for which the hypothetical reserve is 
being computed. If there was no 1985 accident year reserve for that line 
of business, the hypothetical unpaid loss reserve is the reserve, at the 
end of the last taxable year beginning in 1986, for which reserve 
strengthening (weakening) is being determined (and thus there is no 
reserve strengthening or weakening).
    (3) Accident years before 1986--(i) In general. For each taxable 
year beginning in 1986, the amount of reserve strengthening (weakening) 
for an unpaid loss reserve for an accident year before 1986 is the 
amount by which the

[[Page 882]]

reserve at the end of that taxable year exceeds (is less than)--
    (A) The reserve at the end of the immediately preceding taxable 
year; reduced by
    (B) Claims paid and loss adjustment expenses paid (``loss 
payments'') in the taxable year beginning in 1986 with respect to losses 
that are attributable to the reserve. The amount by which a reserve is 
reduced as a result of reinsurance ceded during a taxable year beginning 
in 1986 is treated as a loss payment made in that taxable year.
    (ii) Exceptions. Notwithstanding paragraph (c)(3)(i) of this 
section, the amount of reserve strengthening (weakening) for an unpaid 
loss reserve for an accident year before 1986 does not include--
    (A) An amount added to the reserve in a taxable year beginning in 
1986 as a result of a loss reported to the taxpayer from a mandatory 
state or federal assigned risk pool if the amount of the loss reported 
is not discretionary with the taxpayer; or
    (B) Payments made with respect to reinsurance assumed during a 
taxable year beginning in 1986 or amounts added to the reserve to take 
into account reinsurance assumed for a line of business during a taxable 
year beginning in 1986, but only to the extent that the amount does not 
exceed the amount of a hypothetical reserve for the reinsurance assumed. 
The amount of the hypothetical reserve is determined using the same 
assumptions (other than the assumed interest rates) that were used to 
determine a reserve for reinsurance assumed for the line of business in 
a taxable year beginning in 1985.
    (iii) Certain transactions deemed to be reinsurance assumed (ceded) 
in 1986. For purposes of this paragraph (c)(3), reinsurance assumed 
(ceded) in a taxable year beginning in 1985 is treated as assumed 
(ceded) during the succeeding taxable year if the appropriate unpaid 
loss reserve is not adjusted to take into account the reinsurance 
transaction until that succeeding taxable year.
    (d) Section 845. Any reinsurance transaction that has as one of its 
purposes the avoidance of the reserve strengthening limitation is 
subject to section 845.
    (e) Treatment of reserve strengthening. The fresh start provision of 
section 1023(e)(3)(A) of the 1986 Act does not apply to the portion of 
the taxpayer's unpaid losses attributable to reserve strengthening. 
Thus, the difference between the undiscounted unpaid losses attributable 
to reserve strengthening and the discounted unpaid losses attributable 
to reserve strengthening must be included in income and, therefore, 
included in earnings and profits for the first taxable year beginning 
after December 31, 1986. The amount that a taxpayer must include in 
income for its first taxable year beginning after December 31, 1986, as 
a result of reserve strengthening is equal to the excess (if any) of--
    (1) The sum of each amount of reserve strengthening multiplied by 
the difference between 100 percent and the discount factor that, under 
paragraph (b) of this section, is applicable to the unpaid loss reserve 
which was strengthened; over
    (2) The sum of each reserve weakening multiplied by the difference 
between 100 percent and the discount factor that, under paragraph (b) of 
this section, is applicable to the unpaid loss reserve which was 
weakened.
    (f) Examples. The following examples illustrate the principles of 
this section. For purposes of these examples, it is assumed that the 
taxpayers are property and casualty insurance companies that in 1987 did 
not elect to use their own historical loss payment patterns.

    Example 1. (i) As of the end of 1985, X, a calendar year taxpayer, 
had undiscounted unpaid losses of $1,000,000 in the workers' 
compensation line of business for the 1984 accident year. The same 
reserve had undiscounted unpaid losses of $900,000 at the end of 1986. 
During 1986, X's loss payments for this reserve were $300,000. 
Accordingly, under paragraph (c)(3)(i) of this section, X has a reserve 
strengthening of $200,000 ($900,000-($1,000,000-$300,000)).
    (ii) This was X's only reserve strengthening or weakening. Thus, 
under paragraph (e) of this section, for 1987 X must include in income 
$54,361.40 ($200,000x(100%-72.8193%)). The factor of 72.8193% is the 
AY+2 factor from the workers' compensation series of discount factors 
published in Rev. Rul. 87-34, 1987-1 C.B. 168.
    Example 2. The facts are the same as in Example 1, except that X's 
1986 loss payments

[[Page 883]]

for the reserve were $1,100,000. If only paragraph (c)(3)(i) of this 
section were applied, X would have a $1,000,000 reserve strengthening 
($900,000-($1,000,000-$1,100,000)). Under paragraph (c)(1) of this 
section, however, the amount of reserve strengthening for the reserve is 
limited to the amount of the reserve at the end of 1986. Accordingly, X 
has a reserve strengthening of $900,000 and for 1987 must include in 
income $244,626.30 ($900,000x(100%-72.1893%)).
    Example 3. (i) As of the end of 1985, Y, a calendar year taxpayer, 
had undiscounted unpaid losses of $1,000,000 in the auto physical damage 
line of business for the 1985 accident year. The same reserve included 
undiscounted unpaid losses of $600,000 at the end of 1986. During 1986, 
Y had loss payments of $300,000 for this line of business. Under 
paragraph (c)(3)(i) of this section Y has a $100,000 reserve weakening 
$600,000-($1,000,000-$300,000)).
    (ii) Under paragraph (e) of this section, the only effect of the 
reserve weakening is to reduce the amount that Y is required to include 
in income as a result of any strengthening of another reserve.
    Example 4. The facts are the same as in Example 1 except that X also 
has a $100,000 reserve weakening for the 1985 accident year in its auto 
physical damage line of business. Under paragraph (b) of this section, 
the reserve discount factor for the reserve is 93.3400, the AY+1 factor 
from the auto physical damage series of discount factors published in 
Rev. Rul. 87-34. Thus, under paragraph (e) of this section, the amount 
that X is required to include in income in 1987 is reduced by $6,660 
($100,000x(100%-93.3400%)), resulting in an amount of $47,761.40 
($54,361.40-$6,660).
    Example 5. (i) At the end of 1985, Z, a calendar year taxpayer, had 
undiscounted unpaid losses of $1,000,000 in the workers' compensation 
line of business for the 1984 accident year. On May 1, 1986, Z ceded 
$130,000 of the reserve to an unrelated reinsurer. Z added $250,000 to 
the 1985 year end reserve to take into account workers' compensation 
risks for the 1984 accident year that Z assumed in a reinsurance 
transaction on September 1, 1986. Z had $230,000 of 1986 loss payments 
related to the 1984 accident year of its workers' compensation line, 
$60,000 of which was attributable to the reinsurance assumed by Z. At 
the end of 1986, Z's reserve for the workers' compensation line for the 
1984 accident year was $1,100,000.
    (ii) If only paragraph (c)(3)(i) of this section were applied, Z 
would have a $460,000 reserve strengthening ($1,100,000-($1,000,000-
$230,000-$130,000)). Under paragraph (c)(3)(ii)(B) of this section, 
however, reserve strengthening does not include the $250,000 that Z 
added to the reserve to take into account the reinsurance assumed. Also, 
none of the $60,000 of loss payments attributable to the reinsurance 
assumed in 1986 are taken into account. Accordingly, Z has $150,000 of 
reserve strengthening ($460,000-$250,000-$60,000). If this is Z's only 
reserve strengthening or weakening, then the amount that Z must include 
in income for 1987 under paragraph (e) of this section is $40,771.05 
($150,000x(100%-72.8193%)). The factor of 72.8193% is the AY+2 factor 
from the workers' compensation series of discount factors published in 
Rev. Rul. 87-34.
    Example 6. (i) X was a calendar year taxpayer before July 1, 1986, 
the date on which X became a member of an affiliated group of 
corporations that files a consolidated return with a June 30 year end. 
Thus, X had two taxable years beginning in 1986: a short taxable year 
ending June 30, 1986, and a fiscal taxable year ending June 30, 1987.
    (ii) As of the end of 1985, X had undiscounted unpaid losses of 
$800,000 in the automobile liability line of business for the 1983 
accident year. At the end of the short taxable year, X had reserves of 
$700,000 of undiscounted unpaid losses, and on June 30, 1987, had 
reserves of $600,000 of undiscounted unpaid losses. During the short 
taxable year, ending June 30, 1986, X's loss payments for this reserve 
were $120,000. During the taxable year ending June 30, 1987, X's loss 
payments for this reserve were $180,000. Under paragraph (c)(3)(i) of 
this section, X has a $100,000 reserve strengthening: of which $20,000 
($700,000-($800,000-$120,000)) is attributable to the short taxable year 
ending June 30, 1986 and $80,000 ($600,000-($700,000-$180,000)) is 
attributable to the taxable year ending June 30, 1987.
    (iii) The amount of reserve strengthening for this line of business 
is determined pursuant to the principles of paragraph (c)(2) of this 
section.

[T.D. 8433, 57 FR 40845, Sept. 8, 1992; 57 FR 48563, Oct. 27, 1992; 57 
FR 57531, Dec. 4, 1992]



Sec. 1.846-4  Effective/applicability date.

    (a) In general. Sections 1.846-1 through 1.846-3 apply to taxable 
years beginning after December 31, 1986.
    (b) Section 338 election. Section 1.846-2(d) applies to section 
846(e) elections made with regard to a qualified stock purchase made on 
or after April 10, 2006.

[T.D. 9257, 71 FR 18006, Apr. 10, 2006, as amended by T.D. 9377, 73 FR 
3873, Jan. 23, 2008]



Sec. 1.846-4T  Effective dates (temporary).

    (a) [Reserved]. For further guidance, see Sec. 1.846-2(a).
    (b) Section 338 election. Section 1.846-2(d) applies to section 
846(e) elections

[[Page 884]]

made with regard to a qualified stock purchase made on or after April 
10, 2006.

[T.D. 9257, 71 FR 18006, Apr. 10, 2006]



Sec. 1.848-0  Outline of regulations under section 848.

    This section lists the paragraphs in Sec. Sec. 1.848-1 through 
1.848-3.

            Sec. 1.848-1 Definitions and special provisions.

    (a) Scope and effective date.
    (b) Specified insurance contract.
    (1) In general.
    (2) Exceptions.
    (i) In general.
    (ii) Reinsurance of qualified foreign contracts.
    (c) Life insurance contract.
    (d) Annuity contract.
    (e) Noncancellable accident and health insurance contract.
    (f) Guaranteed renewable accident and health insurance contract.
    (g) Combination contract.
    (1) Definition.
    (2) Treatment of premiums on a combination contract.
    (i) In general.
    (ii) De minimis premiums.
    (3) Example.
    (h) Group life insurance contract.
    (1) In general.
    (2) Group affiliation requirement.
    (i) In general.
    (ii) Employee group.
    (iii) Debtor group.
    (iv) Labor union group.
    (v) Association group.
    (vi) Credit union group.
    (vii) Multiple group.
    (viii) Certain discretionary groups.
    (ix) Employees treated as members.
    (x) Class or classes of a group determined without regard to 
individual health characteristics.
    (A) In general.
    (B) Limitation of coverage based on certain work and age 
requirements permissible.
    (3) Premiums determined on a group basis.
    (i) In general.
    (ii) Exception for substandard premium rates for certain high risk 
insureds.
    (iii) Flexible premium contracts.
    (iv) Determination of actual age.
    (4) Underwriting practices used by company. [Reserved]
    (5) Disqualification of group.
    (i) In general.
    (ii) Exception for de minimis failures.
    (6) Supplemental life insurance coverage.
    (7) Special rules relating to the payment of proceeds.
    (i) Contracts issued to a welfare benefit fund.
    (ii) Credit life insurance contracts.
    (iii) ``Organization or association'' limited to the sponsor of the 
contract or the group policyholder.
    (i) General deductions.

              Sec. 1.848-2 Determination of net premiums.

    (a) Net premiums.
    (1) In general.
    (2) Separate determination of net premiums for certain reinsurance 
agreements.
    (b) Gross amount of premiums and other consideration.
    (1) General rule.
    (2) Items included.
    (3) Treatment of premium deposits.
    (i) In general.
    (ii) Amounts irrevocably committed to the payment of premiums.
    (iii) Retired lives reserves.
    (4) Deferred and uncollected premiums.
    (c) Policy exchanges.
    (1) General rule.
    (2) External exchanges.
    (3) Internal exchanges resulting in fundamentally different 
contracts.
    (i) In general.
    (ii) Certain modifications treated as not changing the mortality, 
morbidity, interest, or expense guarantees.
    (iii) Exception for contracts restructured by a court supervised 
rehabilitation or similar proceeding.
    (4) Value of the contract.
    (i) In general.
    (ii) Special rule for group term life insurance contracts.
    (iii) Special rule for certain policy enhancement and update 
programs.
    (A) In general.
    (B) Policy enhancement or update program defined.
    (5) Example.
    (d) Amounts excluded from the gross amount of premiums and other 
consideration.
    (1) In general.
    (2) Amounts received or accrued from a guaranty association.
    (3) Exclusion not to apply to dividend accumulations.
    (e) Return premiums.
    (f) Net consideration for a reinsurance agreement.
    (1) In general.
    (2) Net consideration determined by a ceding company.
    (i) In general.
    (ii) Net negative and net positive consideration.
    (3) Net consideration determined by the reinsurer.
    (i) In general.
    (ii) Net negative and net positive consideration.
    (4) Timing consistency required.

[[Page 885]]

    (5) Modified coinsurance and funds-withheld reinsurance agreements.
    (i) In general.
    (ii) Special rule for certain funds-withheld reinsurance agreements.
    (6) Treatment of retrocessions.
    (7) Mixed reinsurance agreements.
    (8) Treatment of policyholder loans.
    (9) Examples.
    (g) Reduction in the amount of net negative consideration to ensure 
consistency of capitalization for reinsurance agreements.
    (1) In general.
    (2) Application to reinsurance agreements subject to the interim 
rules.
    (3) Amount of reduction.
    (4) Capitalization shortfall.
    (5) Required capitalization amount.
    (i) In general.
    (ii) Special rule with respect to net negative consideration.
    (6) General deductions allocable to reinsurance agreements.
    (7) Allocation of capitalization shortfall among reinsurance 
agreements.
    (8) Election to determine specified policy acquisition expenses for 
an agreement without regard to general deductions limitation.
    (i) In general.
    (ii) Manner of making election.
    (iii) Election statement.
    (iv) Effect of election.
    (9) Examples.
    (h) Treatment of reinsurance agreements with parties not subject to 
U.S. taxation.
    (1) In general.
    (2) Agreements to which this paragraph (h) applies.
    (i) In general.
    (ii) Parties subject to U.S. taxation.
    (A) In general.
    (B) Effect of a closing agreement.
    (3) Election to separately determine the amounts required to be 
capitalized for reinsurance agreements with parties not subject to U.S. 
taxation.
    (i) In general.
    (ii) Manner of making the election.
    (4) Amount taken into account for purposes of determining specified 
policy acquisition expenses.
    (5) Net foreign capitalization amount.
    (i) In general.
    (ii) Foreign capitalization amounts by category.
    (6) Treatment of net negative foreign capitalization amount.
    (i) Applies as a reduction to previously capitalized amounts.
    (ii) Carryover of remaining net negative foreign capitalization 
amount.
    (7) Reduction of net positive foreign capitalization amount by 
carryover amounts allowed.
    (8) Examples.
    (i) Carryover of excess negative capitalization amount.
    (1) In general.
    (2) Excess negative capitalization amount.
    (3) Treatment of excess negative capitalization amount.
    (4) Special rule for the treatment of an excess negative 
capitalization amount of an insolvent company.
    (i) When applicable.
    (ii) Election to forego carryover of excess negative capitalization 
amount.
    (iii) Amount of reduction to the excess negative capitalization 
amount and specified policy acquisition expenses.
    (iv) Manner of making election.
    (v) Presumptions relating to the insolvency of an insurance company 
undergoing a court supervised rehabilitation or similar state 
proceeding.
    (vi) Example.
    (j) Ceding commissions with respect to reinsurance of contracts 
other than specified insurance contracts.
    (k) Effective dates.
    (1) In general.
    (2) Reduction in the amount of net negative consideration to ensure 
consistency of capitalization for reinsurance agreements.
    (3) Net consideration rules.
    (4) Determination of the date on which a reinsurance agreement is 
entered into.
    (5) Special rule for certain reinsurance agreements with parties not 
subject to U.S. taxation.
    (6) Carryover of excess negative capitalization amount.

     Sec. 1.848-3 Interim rules for certain reinsurance agreements.

    (a) Scope and effective dates.
    (b) Interim rules.
    (c) Adjustments and special rules.
    (1) Assumption reinsurance.
    (2) Reimbursable dividends.
    (3) Ceding commissions.
    (i) In general.
    (ii) Amount of ceding commission.
    (4) Termination payments.
    (5) Modified coinsurance agreements.
    (d) Examples.

[T.D. 8456, 57 FR 61818, Dec. 29, 1992]



Sec. 1.848-1  Definitions and special provisions.

    (a) Scope and effective date. The definitions and special provisions 
in this section apply solely for purposes of determining specified 
policy acquisition expenses under section 848 of the Internal Revenue 
Code, this section, and Sec. Sec. 1.848-2 and 1.848-3. Unless otherwise 
specified, the rules of this section are effective for the taxable years 
of an insurance company beginning after November 14, 1991.

[[Page 886]]

    (b) Specified insurance contract--(1) In general. A ``specified 
insurance contract'' is any life insurance contract, annuity contract, 
noncancellable or guaranteed renewable accident and health insurance 
contract, or combination contract. A reinsurance agreement that 
reinsures the risks under a specified insurance contract is treated in 
the same manner as the reinsured contract.
    (2) Exceptions--(i) In general. A ``specified insurance contract'' 
does not include any pension plan contract (as defined in section 
818(a)), flight insurance or similar contract, or qualified foreign 
contract (as defined in section 807(e)(4)).
    (ii) Reinsurance of qualified foreign contracts. The exception for 
qualified foreign contracts does not apply to reinsurance agreements 
that reinsure qualified foreign contracts.
    (c) Life insurance contract. A ``life insurance contract'' is any 
contract--
    (1) Issued after December 31, 1984, that qualifies as a life 
insurance contract under section 7702(a) (including an endowment 
contract as defined in 7702(h)); or
    (2) Issued prior to January 1, 1985, if the premiums on the contract 
are reported as life insurance premiums on the insurance company's 
annual statement (or could be reported as life insurance premiums if the 
company were required to file the annual statement for life and accident 
and health companies).
    (d) Annuity contract. An ``annuity contract'' is any contract (other 
than a life insurance contract as defined in paragraph (c) of this 
section) if amounts received under the contract are subject to the rules 
in section 72(b) or section 72(e) (determined without regard to section 
72(u)). The term ``annuity contract'' also includes a contract that is a 
qualified funding asset under section 130(d).
    (e) Noncancellable accident and health insurance contract. The term 
``noncancellable accident and health insurance contract'' has the same 
meaning for purposes of section 848 as the term has for purposes of 
section 816(b).
    (f) Guaranteed renewable accident and health insurance contract. The 
term ``guaranteed renewable accident and health insurance contract'' has 
the same meaning for purposes of section 848 as the term has for 
purposes of section 816(e).
    (g) Combination contract--(1) Definition. A ``combination contract'' 
is a contract (other than a contract described in section 848(e)(3)) 
that provides two or more types of insurance coverage, at least one of 
which if offered separately would be a life insurance contract, an 
annuity contract, or a noncancellable or guaranteed renewable accident 
and health insurance contract.
    (2) Treatment of premiums on a combination contract--(i) In general. 
If the premium allocable to each type of insurance coverage is 
separately stated on the insurance company's annual statement (or could 
be separately stated if the insurance company were required to file the 
annual statement for life and accident and health companies), the 
premium allocable to each type of insurance coverage in a combination 
contract is subject to the capitalization rate, if any, that would apply 
if that coverage was provided in a separate contract. If the premium 
allocable to each type of insurance coverage in a combination contract 
is not separately stated, the entire premium is subject to the highest 
capitalization percentage applicable to any of the coverages provided.
    (ii) De minimis premiums. For purposes of this paragraph (g)(2)--
    (A) A de minimis premium is not required to be separately stated;
    (B) In determining the highest capitalization percentage applicable 
to a combination contract, the coverage to which a de minimis premium is 
allocable is disregarded;
    (C) If the separate statement requirement of this paragraph (g)(2) 
is satisfied, a de minimis premium is treated in accordance with its 
characterization on the insurance company's annual statement; and
    (D) Whether a premium for an insurance coverage is de minimis is 
determined by comparing that premium with the aggregate of the premiums 
for the combination contract. A premium that is not more than 2 percent 
of the

[[Page 887]]

premium for the entire contract is considered de minimis. Whether a 
premium that is more than 2 percent is de minimis is determined based on 
all the facts and circumstances.
    (3) Example. The principles of this paragraph (g) are illustrated by 
the following example.

    Example. A life insurance company (L1) issues a contract to an 
employer (X) which provides cancellable accident and health insurance 
coverage and group term life insurance coverage to X's employees. L1 
charges a premium of $1,000 for the contract, $950 of which is 
attributable to the cancellable accident and health insurance coverage 
and $50 of which is attributable to the group term life insurance 
coverage. On its annual statement, L1 reports the premiums attributable 
to the accident and health insurance coverage separately from the 
premiums attributable to the group term life insurance coverage. The 
contract issued by L1 is a combination contract as defined in paragraph 
(g)(1) of this section. Pursuant to paragraph (g)(2)(i) of this section, 
only the premiums attributable to the group term life insurance coverage 
($50) are subject to the provisions of section 848. The premiums 
attributable to the cancellable accident and health insurance coverage 
($950) are not subject to the provisions of section 848.

    (h) Group life insurance contract--(1) In general. A life insurance 
contract (as defined in paragraph (c) of this section) is group life 
insurance contract if--
    (i) The contract is a group life insurance contract under the 
applicable law;
    (ii) The coverage is provided under a master contract issued to the 
group policyholder, which may be a trust, trustee, or agent;
    (iii) The premiums on the contract are reported either as group life 
insurance premiums or credit life insurance premiums on the insurance 
company's annual statement (or could be reported as group life insurance 
premiums or credit life insurance premiums if the company were required 
to file the annual statement for life and accident and health 
companies);
    (iv) The group affiliation requirement of paragraph (h)(2) of this 
section is satisfied;
    (v) The premiums on the contract are determined on a group basis 
within the meaning of paragraph (h)(3) of this section; and
    (vi) The proceeds of the contract are not payable to or for the 
benefit of the insured's employer, an organization or association to 
which the insured belongs, or other similar person. (See paragraph 
(h)(7) of this section for special rules that apply in determining if 
this requirement is satisfied.)
    (2) Group affiliation requirement--(i) In general. The group 
affiliation requirement of section 848(e)(2)(A) and this paragraph 
(h)(2) is satisfied only if all of the individuals eligible for coverage 
under the contract constitute a group described in paragraphs (h)(2) 
(ii) through (viii) of this section.
    (ii) Employee group. An employee group consists of all of the 
employees (including statutory employees within the meaning of section 
3121(d)(3) and individuals who are treated as employed by a single 
employer under section 414 (b), (c), or (m)), or any class or classes 
thereof within the meaning of paragraph (h)(2)(x) of this section, of an 
employer. For this purpose, the term ``employee'' includes--
    (A) A retired or former employee;
    (B) The sole proprietor, if the employer is a sole proprietorship;
    (C) A partner of the partnership, if the employer is a partnership;
    (D) A director of the corporation, if the employer is a corporation; 
and
    (E) An elected or appointed official of the public body, if the 
employer is a public body.
    (iii) Debtor group. A debtor group consists of all of the debtors, 
or any class or classes thereof within the meaning of paragraph 
(h)(2)(x) of this section, of a creditor. For this purpose, the term 
``debtor'' includes a borrower of money or purchaser or lessee of goods, 
services, or property for which payment is arranged through a credit 
transaction.
    (iv) Labor union group. A labor union group consists of all of the 
members, or any class or classes thereof within the meaning of paragraph 
(h)(2)(x) of this section, of a labor union or similar employee 
organization.
    (v) Association group. An association group consists of all of the 
members, or any class or classes thereof within the meaning of paragraph 
(h)(2)(x) of this section, of an association that, at the time the 
master contract is issued--
    (A) Is organized and maintained for purposes other than obtaining 
insurance;

[[Page 888]]

    (B) Has been in active existence for at least two years (including, 
in the case of a merged or successor association, the years of active 
existence of any predecessor association); and
    (C) Has at least 100 members.
    (vi) Credit union group. A credit union group consists of all of the 
members or borrowers, or any class or classes thereof within the meaning 
of paragraph (h)(2)(x) of this section, of a credit union.
    (vii) Multiple group. A multiple group consists of two or more 
groups from any single category described in paragraphs (h)(2) (ii) 
through (vi) of this section. A multiple group may not include two or 
more groups from different categories described in paragraph (h)(2) (ii) 
through (vi) of this section.
    (viii) Certain discretionary groups. Provided that the contract 
otherwise satisfies the requirements of paragraph (h)(1) of this 
section, a contract issued to one of the following discretionary groups 
is treated as satisfying the group affiliation requirement of this 
paragraph (h)(2)--
    (A) A contract issued to a group consisting of students of one or 
more universities or other educational institutions;
    (B) A contract issued to a group consisting of members or former 
members of the U.S. Armed Forces;
    (C) A contract issued to a group of individuals for the payment of 
future funeral expenses; and
    (D) A contract issued to any other discretionary group as specified 
by the Commissioner in subsequent guidance published in the Internal 
Revenue Bulletin. (See Sec. 601.601(d)(2)(ii)(b) of this chapter.)
    (ix) Employees treated as members. In determining whether the group 
affiliation requirement of paragraph (h)(2) of this section is 
satisfied, the employees of a labor union, credit union, or association 
may be treated as members of a labor union group, a credit union group, 
or an association group, respectively.
    (x) Class or classes of a group determined without regard to 
individual health characteristics--(A) In general. A class or classes of 
a group described in paragraphs (h)(2) (ii) through (viii) of this 
section may be determined using any reasonable characteristics (for 
example, amount of insurance, location, or occupation) other than 
individual health characteristics. The employees of a single employer 
covered under a policy issued to a multi-employer trust are considered a 
class of a group described in paragraph (h)(2)(ii) of this section.
    (B) Limitation of coverage based on certain work and age 
requirements permissible. A limitation of coverage under a group 
contract to persons who are actively at work or of a pre-retirement age 
(for example, age 65 or younger) is not treated as based on individual 
health characteristics.
    (3) Premiums determined on a group basis--(i) In general. Premiums 
for a contract are determined on a group basis for purposes of section 
848(e)(2)(B) and this paragraph (h) only if the premium charged by the 
insurance company for each member of the group (or any class thereof) is 
determined on the basis of the same rates for the corresponding amount 
of coverage (for example, per $1,000 of insurance) or on the basis of 
rates which differ only because of the gender, smoking habits, or age of 
the member.
    (ii) Exception for substandard premium rates for certain high risk 
insureds. Any difference in premium rates is disregarded for purposes of 
this paragraph (h)(3) if the difference is charged for an individual who 
was accepted for coverage at a substandard rate prior to January 1, 
1993.
    (iii) Flexible premium contracts. In the case of a group universal 
life insurance contract, the identical premium requirement is satisfied 
if the premium rates used by the insurance company in determining the 
periodic mortality charges applied to the policy account value of any 
member insured by the contract differ from those of other members 
(within the same class) only because of the gender, smoking habits, or 
age of the member.
    (iv) Determination of actual age. For purposes of this paragraph 
(h)(3), determinations of actual age may be made using any reasonable 
method, provided that this method is applied consistently for all 
members of the group.

[[Page 889]]

    (4) Underwriting practices used by company. [Reserved]
    (5) Disqualification of group--(i) In general. Except as otherwise 
provided in this paragraph (h)(5), if the requirements of paragraphs 
(h)(1), (2), and (3) of this section are not satisfied with respect to 
one or more members of the group, or of a class within a group (within 
the meaning of paragraph (h)(2)(x) of this section), the premiums for 
the entire group (or class) are treated as individual life insurance 
premiums.
    (ii) Exception for de minimis failures. If the requirements of 
paragraphs (h) (1), (2), or (3) of this section are not satisfied with 
respect to one or more members of the group (or class), but the sum of 
the premiums charged by the insurance company for those individuals is 
no more than 5 percent of the aggregate premiums for the group (or 
class), only the premiums charged for those individuals are treated as 
premiums for an individual life insurance contract.
    (6) Supplemental life insurance coverage. For purposes of 
determining whether the requirement in paragraph (h)(3)(i) of this 
section is satisfied, any supplemental life insurance coverage 
(including optional coverage for members of the group, their spouses, or 
their dependent children) is (or is treated as) a separate contract. In 
determining whether the group affiliation requirement of paragraph 
(h)(2) of this section is satisfied for the supplemental coverage, a 
member's spouse and dependent children are treated as members of the 
group if they are eligible for coverage.
    (7) Special rules relating to the payment of proceeds. The following 
rules apply for purposes of section 848(e)(2) and paragraph (h)(1)(vi) 
of this section.
    (i) Contracts issued to a welfare benefit fund. If a contract issued 
to a welfare benefit fund (as defined in section 419) provides for 
payment of proceeds to the welfare benefit fund, the proceeds of the 
contract are not considered payable to or for the benefit of the 
insured's employer, an organization or association to which the insured 
belongs, or other similar person, provided the proceeds are paid as 
benefits to the employee or the employee's beneficiary.
    (ii) Credit life insurance contracts. If a credit life insurance 
contract provides for payment of proceeds to the insured's creditor, the 
proceeds of the contract are not treated as payable to or for the 
benefit of the insured's employer, an organization or association to 
which the insured belongs, or other similar person, provided the 
proceeds are applied against an outstanding indebtedness of the insured.
    (iii) ``Organization or association'' limited to the sponsor of the 
contract or the group policyholder. The term ``organization or 
association'' means the organization or association that is either the 
sponsor of the contract or the group policyholder.
    (i) General deductions. The term ``general deductions'' is defined 
in section 848(c)(2). An insurance company determines its general 
deductions for the taxable year without regard to amounts capitalized or 
amortized under section 848(a). The amount of a company's general 
deductions is also determined without regard to the rules of Sec. 
1.848-2(f), which apply only for purposes of determining net 
consideration for reinsurance agreements.

[T.D. 8456, 57 FR 61819, Dec. 29, 1992; 58 FR 9245, Feb. 19, 1993]



Sec. 1.848-2  Determination of net premiums.

    (a) Net premiums--(1) In general. An insurance company must use the 
accrual method of accounting (as prescribed by section 811(a)(1)) to 
determine the net premiums with respect to each category of specified 
insurance contracts. With respect to any category of contracts, net 
premiums means--
    (i) The gross amount of premiums and other consideration (see 
paragraph (b) of this section); reduced by
    (ii) The sum of--
    (A) The return premiums (see paragraph (e) of this section); and
    (B) The net negative consideration for a reinsurance agreement 
(other than an agreement described in paragraph (h)(2) of this section). 
See paragraphs (f) and (g) of this section for rules relating to the 
determination of net negative consideration.

[[Page 890]]

    (2) Separate determination of net premiums for certain reinsurance 
agreements. Net premiums with respect to reinsurance agreements for 
which an election under paragraph (h)(3) of this section has been made 
(certain reinsurance agreements with parties not subject to United 
States taxation) are treated separately and are subject to the rules of 
paragraph (h) of this section.
    (b) Gross amount of premiums and other consideration--(1) General 
rule. The term ``gross amount of premiums and other consideration'' 
means the sum of--
    (i) All premiums and other consideration (other than amounts on 
reinsurance agreements); and
    (ii) The net positive consideration for any reinsurance agreement 
(other than an agreement for which an election under paragraph (h)(3) of 
this section has been made).
    (2) Items included. The gross amount of premiums and other 
consideration includes--
    (i) Advance premiums;
    (ii) Amounts in a premium deposit fund or similar account, to the 
extent provided in paragraph (b)(3) of this section;
    (iii) Fees;
    (iv) Assessments;
    (v) Amounts that the insurance company charges itself representing 
premiums with respect to benefits for its employees (including full-time 
life insurance salesmen treated as employees under section 7701(a)(20)); 
and
    (vi) The value of a new contract issued in an exchange described in 
paragraph (c)(2) or (c)(3) of this section.
    (3) Treatment of premium deposits--(i) In general. An amount in a 
premium deposit fund or similar account is taken into account in 
determining the gross amount of premiums and other consideration at the 
earlier of the time that the amount is applied to, or irrevocably 
committed to, the payment of a premium on a specified insurance 
contract. If an amount is irrevocably committed to the payment of a 
premium on a specified insurance contract, then neither that amount nor 
any earnings allocable to that amount are included in the gross amount 
of premiums and other consideration when applied to the payment of a 
premium on the same contract.
    (ii) Amounts irrevocably committed to the payment of premiums. 
Except as provided in paragraph (b)(3)(iii) of this section, an amount 
in a premium deposit fund or similar account is irrevocably committed to 
the payment of premiums on a contract only if neither the amount nor any 
earnings allocable to that amount may be--
    (A) Returned to the policyholder or any other person (other than on 
surrender of the contract); or
    (B) Used by the policyholder to fund another contract.
    (iii) Retired lives reserves. Premiums received by an insurance 
company under a retired lives reserve arrangement are treated as 
irrevocably committed to the payment of premiums on a specified 
insurance contract.
    (4) Deferred and uncollected premiums. The gross amount of premiums 
and other consideration does not include deferred and uncollected 
premiums.
    (c) Policy exchanges--(1) General rule. Except as otherwise provided 
in this paragraph (c), an exchange of insurance contracts (including a 
change in the terms of a specified insurance contract) does not result 
in any amount being included in the gross amount of premiums and other 
consideration.
    (2) External exchanges. If a contract is exchanged for a specified 
insurance contract issued by another insurance company, the company that 
issues the new contract must include the value of the new contract in 
the gross amount of premiums and other consideration.
    (3) Internal exchanges resulting in fundamentally different 
contracts--(i) In general. If a contract is exchanged for a specified 
insurance contract issued by the same insurance company that issued the 
original contract, the company must include the value of the new 
contract in the gross amount of premiums and other consideration if the 
new contract--
    (A) Relates to a different category of specified insurance contract 
than the original contract;
    (B) Does not cover the same insured as the original contract; or
    (C) Changes the interest, mortality, morbidity, or expense 
guarantees with respect to the nonforfeiture benefits provided in the 
original contract.

[[Page 891]]

    (ii) Certain modifications treated as not changing the mortality, 
morbidity, interest, or expense guarantees. For purposes of paragraph 
(c)(3)(i)(C) of this section, the following items are not treated as 
changing the interest, mortality, morbidity, or expense guarantees with 
respect to the nonforfeiture benefits provided in the contract--
    (A) A change in a temporary guarantee with respect to the amounts to 
be credited as interest to the policyholder's account, or charged as 
mortality, morbidity, or expense charges, if the new guarantee applies 
for a period of ten years or less;
    (B) The determination of benefits on annuitization using rates which 
are more favorable to the policyholder than the permanently guaranteed 
rates; and
    (C) Other items as specified by the Commissioner in subsequent 
guidance published in the Internal Revenue Bulletin.
    (iii) Exception for contracts restructured by a court supervised 
rehabilitation or similar proceeding. No amount is included in the gross 
amount of premiums and other consideration with respect to any change 
made to the interest, mortality, morbidity, or expense guarantees with 
respect to the nonforfeiture benefits of contracts of an insurance 
company that is the subject of a rehabilitation, conservatorship, 
insolvency, or similar state proceeding. This treatment applies only if 
the change--
    (A) Occurs as part of the rehabilitation, conservatorship, 
insolvency, or similar state proceeding; and
    (B) Is approved by the state court, the state insurance department, 
or other state official with authority to act in the rehabilitation, 
conservatorship, insolvency, or similar state proceeding.
    (4) Value of the contract--(i) In general. For purposes of paragraph 
(c)(2) or (c)(3) of this section, the value of the new contract is 
established through the most recent sale by the company of a comparable 
contract. If the value of the new contract is not readily ascertainable, 
the value may be approximated by using the interpolated terminal reserve 
of the original contract as of the date of the exchange.
    (ii) Special rule for group term life insurance contracts. In the 
case of any exchange involving a group term life insurance contract 
without cash value, the value of the new contract is deemed to be zero.
    (iii) Special rule for certain policy enhancement and update 
programs--(A) In general. If the interest, mortality, morbidity, or 
expense guarantees with respect to the nonforfeiture benefits of a 
specified insurance contract are changed pursuant to a policy 
enhancement or update program, the value of the contract included in the 
gross amount of premiums and other consideration equals 30 percent of 
the value determined under paragraph (c)(4) of this section.
    (B) Policy enhancement or update program defined. For purposes of 
paragraph (c)(4)(iii)(A) of this section, a policy enhancement or update 
program means any offer or commitment by the insurance company to all of 
the policyholders holding a particular policy form to change the 
interest, mortality, morbidity, or expense guarantees used to determine 
the contract's nonforfeiture benefits.
    (5) Example. The principles of this paragraph (c) are illustrated by 
the following example.

    Example. (i) An individual (A) owns a life insurance policy issued 
by a life insurance company (L1). On January 1, 1993, A purchases 
additional term insurance for $250, which is added as a rider to A's 
life insurance policy. The purchase of the additional term insurance 
does not change the interest mortality, morbidity, or expense guarantees 
with respect to the nonforfeiture benefits provided by A's life 
insurance policy.
    (ii) A's purchase of the term insurance rider is not considered to 
result in a fundamentally different contract under paragraph (c)(3) of 
this section because the addition of the rider did not change the 
interest, mortality, morbidity, or expense guarantees with respect to 
the nonforfeiture values of A's original life insurance policy. 
Therefore, L1 includes only the $250 received from A in the gross amount 
of premiums and other consideration.

    (d) Amounts excluded from the gross amount of premiums and other 
consideration--(1) In general. The following items are not included in 
the gross amount of premiums and other consideration--

[[Page 892]]

    (i) Items treated by section 808(e) as policyholder dividends that 
are paid to the policyholder and immediately returned to the insurance 
company as a premium on the same contract that generated the dividends, 
including--
    (A) A policyholder dividend applied to pay a premium under the 
contract that generated the dividend;
    (B) Excess interest accumulated within the contract;
    (C) A policyholder dividend applied for additional coverage (for 
example, a paid-up addition, extension of the period for which insurance 
protection is provided, or reduction of the period for which premiums 
are paid) on the contract that generated the dividend;
    (D) A policyholder dividend applied to reduce premiums otherwise 
payable on the contract that generated the dividend;
    (E) An experience-rated refund applied to pay a premium on the group 
contract that generated the refund; and
    (F) An experience-rated refund applied to a premium stabilization 
reserve held with respect to the group contract that generated the 
refund;
    (ii) Premiums waived as a result of the disability of an insured or 
the disability or death of a premium payor;
    (iii) Premiums considered to be paid on a contract as the result of 
a partial surrender or withdrawal from the contract, or as a result of 
the surrender or withdrawal of a paid-up addition previously issued with 
respect to the same contract; and
    (iv) Amounts treated as premiums upon the selection by a 
policyholder or by a beneficiary of a settlement option provided in a 
life insurance contract.
    (2) Amounts received or accrued from a guaranty association. Amounts 
received or accrued from a guaranty association relating to an insurance 
company that is subject to an insolvency, delinquency, conservatorship, 
rehabilitation, or similar proceeding are not included in the gross 
amount of premiums and other consideration.
    (3) Exclusion not to apply to dividend accumulations. For purposes 
of section 848(d)(3) and paragraph (d)(1) of this section, amounts 
applied from a dividend accumulation account to pay premiums on a 
specified insurance contract are not amounts treated as paid to, and 
immediately returned by, the policyholder.
    (e) Return premiums. For purposes of section 848(d)(1)(B) and this 
section, return premiums do not include policyholder dividends (as 
defined in section 808), claims or benefits payments, or amounts 
returned to another insurance company under a reinsurance agreement. For 
the treatment of amounts returned to another insurance company under a 
reinsurance agreement, see paragraph (f) of this section.
    (f) Net consideration for a reinsurance agreement--(1) In general. 
For purposes of section 848, the ceding company and the reinsurer must 
treat amounts arising from the reinsurance of a specified insurance 
contract consistently in determining their net premiums. See paragraph 
(g) of this section for restrictions on the amount of the net negative 
consideration for any reinsurance agreement that may be taken into 
account. See paragraph (h) of this section for special rules applicable 
to reinsurance agreements with parties not subject to United States 
taxation.
    (2) Net consideration determined by a ceding company--(i) In 
general. The net consideration determined by a ceding company for a 
reinsurance agreement equals--
    (A) The gross amount incurred by the reinsurer with respect to the 
reinsurance agreement, including any ceding commissions, annual 
allowances, reimbursements of claims and benefits, modified coinsurance 
reserve adjustments under paragraph (f)(5) of this section, experience-
rated adjustments, and termination payments; less
    (B) The gross amount of premiums and other consideration incurred by 
the ceding company with respect to the reinsurance agreement.
    (ii) Net negative and net positive consideration. If the net 
consideration is less than zero, the ceding company has net negative 
consideration for the reinsurance agreement. If the net consideration is 
greater than zero, the ceding company has net positive consideration for 
the reinsurance agreement.
    (3) Net consideration determined by the reinsurer--(i) In general. 
The net consideration determined by a reinsurer for a reinsurance 
agreement equals--

[[Page 893]]

    (A) The amount described in paragraph (f)(2)(i)(B) of this section; 
less
    (B) The amount described in paragraph (f)(2)(i)(A) of this section.
    (ii) Net negative and net positive consideration. If the net 
consideration is less than zero, the reinsurer has net negative 
consideration for the reinsurance agreement. If the net consideration is 
greater than zero, the reinsurer has net positive consideration for the 
reinsurance agreement.
    (4) Timing consistency required. For purposes of determining the net 
consideration of a party for a reinsurance agreement, an income or 
expense item is taken into account for the first taxable year for which 
the item is required to be taken into account by either party. Thus, the 
ceding company and the reinsurer must take the item into account for the 
same taxable year (or for the same period if the parties have different 
taxable years).
    (5) Modified coinsurance and funds-withheld reinsurance agreements--
(i) In general. In the case of a modified coinsurance or funds-withheld 
reinsurance agreement, the net consideration for the agreement includes 
the amount of any payments or reserve adjustments, as well as any 
related loan transactions between the ceding company and the reinsurer. 
The amount of any investment income transferred between the parties as 
the result of a reserve adjustment or loan transaction is treated as an 
item of consideration under the reinsurance agreement.
    (ii) Special rule for certain funds-withheld reinsurance agreements. 
In the case of a funds-withheld reinsurance agreement that is entered 
into after November 14, 1991, but before the first day of the first 
taxable year beginning after December 31, 1991, and is terminated before 
January 1, 1995, the parties' net consideration in the year of 
termination must include the amount of the original reserve for any 
reinsured specified insurance contract that, in applying the provisions 
of subchapter L, was treated as premiums and other consideration 
incurred for reinsurance for the taxable year in which the agreement 
became effective.
    (6) Treatment of retrocessions. For purposes of this paragraph (f), 
a retrocession agreement is treated as a separate reinsurance agreement. 
The party that is relieved of liability under a retrocession agreement 
is treated as the ceding company.
    (7) Mixed reinsurance agreement. If a reinsurance agreement includes 
more than one category of specified insurance contracts (or specified 
insurance contracts and contracts that are not specified insurance 
contracts), the portion of the agreement relating to each category of 
reinsured specified insurance contracts is treated as a separate 
agreement. The portion of the agreement relating to reinsured contracts 
that are not specified insurance contracts is similarly treated as a 
separate agreement.
    (8) Treatment of policyholder loans. For purposes of determining the 
net consideration under a reinsurance agreement, the transfer of a 
policyholder loan receivable is treated as an item of consideration 
under the agreement. The interest credited with respect to a 
policyholder loan receivable is treated as investment income earned 
directly by the party holding the receivable. The amounts taken into 
account as claims and benefit reimbursements under the agreement must be 
determined without reduction for the policyholder loan.
    (9) Examples. The principles of this paragraph (f) are illustrated 
by the following examples.

    Example 1. On July 1, 1992, a life insurance company (L1) transfers 
a block of individual life insurance contracts to an unrelated life 
insurance company (L2) under an agreement whereby L2 becomes solely 
liable to the policyholders under the contracts reinsured. L1 and L2 are 
calendar year taxpayers. Under the assumption reinsurance agreement, L1 
agrees to pay L2 $100,000 for assuming the life insurance contracts, and 
L2 agrees to pay L1 a $17,000 ceding commission. Under paragraph (f)(2) 
of this section, L1 has net negative consideration of ($83,000) ($17,000 
ceding commission incurred by L2--$100,000 incurred by L1 for 
reinsurance). Under paragraph (f)(3) of this section, L2 has net 
positive consideration of $83,000. Under paragraph (b)(1)(ii) of this 
section, L2 includes the net positive consideration in its gross amount 
of premiums and other consideration.
    Example 2. (i) On July 1, 1992, a life insurance company (L1) 
transfers a block of individual life insurance contracts to an unrelated 
life insurance company (L2) under an agreement whereby L1 remains liable 
to the policyholders under the reinsured contracts.

[[Page 894]]

L1 and L2 are calendar year taxpayers. Under the indemnity reinsurance 
agreement, L1 agrees to pay L2 $100,000 for reinsuring the life 
insurance contracts, and L2 agrees to pay L1 a $17,000 ceding 
commission. L1 agrees to pay L2 an amount equal to the future premiums 
on the reinsured contracts. L2 agrees to indemnify L1 for claims and 
benefits and administrative expenses incurred by L1 while the 
reinsurance agreement is in effect.
    (ii) For the period beginning July 1, 1992, and ending December 31, 
1992, the following income and expense items are determined with respect 
to the reinsured contracts:

------------------------------------------------------------------------
                       Item                           Income    Expense
------------------------------------------------------------------------
Premiums..........................................    $25,000  .........
Death benefits....................................  .........    $10,000
Surrender benefits................................  .........      8,000
Premium taxes and other expenses..................  .........      2,000
                                                              ----------
      Total.......................................  .........     20,000
------------------------------------------------------------------------

    (iii) Under paragraph (f)(2) of this section, L1's net negative 
consideration equals ($88,000), which is determined by subtracting the 
$125,000 ($100,000 + $25,000) incurred by L1 from the $37,000 incurred 
by L2 under the reinsurance agreement ($17,000 + $10,000 + $8,000 + 
$2,000). L2's net positive consideration is $88,000. Under paragraph 
(b)(1)(ii) of this section, L2 includes the $88,000 net positive 
consideration in its gross amount of premiums and other consideration.
    Example 3. (i) Assume that the reinsurance agreement referred to in 
Example 2 is terminated on December 31, 1993. During the period from 
January 1, 1993 through December 31, 1993, the following income and 
expense items are determined with respect to the reinsured contracts:

------------------------------------------------------------------------
                       Item                           Income    Expense
------------------------------------------------------------------------
Premiums..........................................    $45,000  .........
Death benefits....................................  .........    $18,000
Surrender benefits................................  .........      6,000
Premium taxes and other expenses..................  .........      8,000
                                                              ----------
      Total.......................................  .........     32,000
------------------------------------------------------------------------

    (ii) On the termination of the reinsurance agreement, L1 receives a 
payment of $70,000 from L2 as consideration for releasing L2 from 
liability with respect to the reinsured contracts.
    (iii) L1's net positive consideration equals $57,000, which is the 
excess of the $102,000 incurred by L2 for the year ($18,000 + $6,000 + 
$8,000 + $70,000) over the $45,000 incurred by L1. L2's net negative 
consideration is ($57,000). L1 includes the net positive consideration 
in its gross amount of premiums and other consideration.
    Example 4. (i) On January 1, 1993, an insurance company (L1) enters 
into a modified coinsurance agreement with another insurance company 
(L2), covering a block of individual life insurance contracts. Both L1 
and L2 are calendar year taxpayers. Under the agreement, L2 is credited 
with an initial reinsurance premium equal to L1's reserves on the 
reinsured contracts at the inception of the agreement, any new premiums 
received with respect to the reinsured contracts, any decrease in L1's 
reserves on the reinsured contracts, and an amount of investment income 
determined by reference to L1's reserves on the reinsured contracts. L2 
is charged for all claims and expenses incurred with respect to the 
reinsured contracts plus an amount reflecting any increase in L1's 
reserves. The agreement further provides that cash settlements between 
the parties are made at the inception and termination of the agreement, 
as well as at the end of each calendar year while the agreement is in 
effect. The cash settlement is determined by netting the sum of the 
amounts credited to L2 against the sum of the amounts charged to L2 with 
respect to the reinsured policies. L1's reserves on the reinsured 
policies at the inception of the reinsurance agreement are $375,000.
    (ii) Under the cash settlement formula, L2 is credited with an 
initial reinsurance premium equal to L1's reserves on the reinsured 
policies ($375,000), but is charged an amount reflecting L1's policy 
reserve requirements ($375,000).
    (iii) For the period ending December 31, 1993, L2 is also credited 
and charged the following amounts with respect to the reinsured 
contracts.

------------------------------------------------------------------------
                       Item                           Income    Expense
------------------------------------------------------------------------
Premiums..........................................   $100,000  .........
Investment income.................................     39,000  .........
Death benefits....................................  .........    $65,000
Increase in reserves..............................  .........     75,000
------------------------------------------------------------------------

    (iv) Under paragraph (f)(5) of this section, L2's net negative 
consideration for the 1993 taxable year equals ($1,000) which is 
determined by subtracting the sum of the amounts charged to L2 ($375,000 
+ $65,000 + $75,000 = $515,000) from the sum of the amounts credited to 
L2 ($375,000 + $100,000 + $39,000 = $514,000). L1's net positive 
consideration for calendar year 1993 equals $1,000. Under paragraph 
(b)(1)(ii) of this section, L1 includes the $1,000 net positive 
consideration in its gross amount of premiums and other consideration.
    Example 5. (i) On January 1, 1993, an insurance company (L1) enters 
into a coinsurance agreement with another insurance company (L2) 
covering a block of individual life insurance contracts. Both L1 and L2 
are calendar year taxpayers. Under the agreement, L2 is credited with an 
initial reinsurance premium equal to L1's reserves on the effective date 
of the agreement, any new premiums received on the reinsured contracts, 
but must indemnify L1 of all claims and expenses incurred

[[Page 895]]

with respect to the contracts. As part of the agreement, L2 makes a loan 
to L1 equal to the amount of the reserves on the reinsured contracts. 
L1's reserves on the reinsured contracts on the effective date of the 
agreement are $375,000. Thus, on the inception date of the reinsurance 
agreement, L1 transfers to L2 its note for $375,000 as consideration for 
reinsurance.
    (ii) The reinsurance agreement between L1 and L2 is a funds-withheld 
reinsurance agreement. Under paragraph (f)(5) of this section, the 
amount of any loan transaction is taken into account in determining the 
parties' net consideration. At the inception of the reinsurance 
agreement, L2 is credited with a reinsurance premium equal to L1's 
reserves on the reinsured contracts ($375,000). L2's $375,000 loan to L1 
is treated as an amount returned to L1 under the agreement.
    (iii) For the period ending December 31, 1993, L2 is credited and 
charged the following amounts with respect to the reinsured contracts 
and the loan transaction with L1.

------------------------------------------------------------------------
                       Item                           Income    Expense
------------------------------------------------------------------------
Premiums..........................................   $100,000  .........
Accrued interest..................................     39,000  .........
Death benefits....................................  .........    $65,000
Increase in loan to L1............................  .........     75,000
------------------------------------------------------------------------

    (iv) Under paragraph (f)(5) of this section, L2's net negative 
consideration for the 1993 taxable year equals ($1,000), which is 
determined by subtracting the sum of amounts incurred by L2 with respect 
to death benefits and the loan transaction ($375,000 + $65,000 + $75,000 
= $515,000) from the sum of the amounts credited to L2 as reinsurance 
premiums and interest on the loan transaction ($375,000 + $100,000 + 
39,000 = $514,000). L1's net positive consideration for calendar year 
1993 equals $1,000. Under paragraph (b)(1)(ii) of this section, L1 
includes the $1,000 net positive consideration in its gross amount of 
premiums and other consideration.
    Example 6. (i) On December 31, 1993, an insurance company (L1) 
enters into a reinsurance agreement with another insurance company (L2) 
covering a block of individual life insurance contracts. Both L1 and L2 
are calendar year taxpayers. Under the agreement, L2 is credited with 
L1's reserves on the reinsured contracts on the effective date of the 
agreement, plus any new premiums received on the reinsured contracts, 
but must indemnify L1 for all claims and expenses incurred with respect 
to the contracts. Under the agreement, L1 transfers cash of $325,000 to 
L2 plus rights to its policyholder loan receivables on the reinsured 
contracts ($50,000). L2 reports the reinsurance agreement by including 
the transferred policyholder loan receivables as an asset on its books.
    (ii) For the period beginning January 1, 1994 and ending December 
31, 1994, the following income and expense items are incurred with 
respect to the reinsured contracts.

------------------------------------------------------------------------
                       Item                           Income    Expense
------------------------------------------------------------------------
Premiums..........................................   $100,000  .........
Death benefits....................................  .........    $25,000
Surrender benefits................................  .........      5,000
Premium taxes and other expenses..................  .........      8,000
                                                              ----------
      Total.......................................  .........     38,000
------------------------------------------------------------------------

    (iii) These amounts are net of the outstanding policyholder loans 
held by L2 of $20,000 with respect to death benefits and $15,000 with 
respect to surrender benefits.
    (iv) Under paragraph (f)(8) of this section, the transferred 
policyholder loan receivables are treated as an item of consideration 
under the reinsurance agreement. In determining the parties' net 
consideration for the agreement, the transferred policyholder loan 
receivables ($50,000) are treated as an item of consideration incurred 
by L1 under paragraph (f)(2)(i)(B) of this section. Therefore, for the 
1993 taxable year, L1 has net negative consideration of ($375,000). L2 
has net positive consideration of $375,000. Under paragraph (b)(1)(ii) 
of this section, L2 includes the $375,000 net positive consideration in 
its gross amount of premiums and other consideration.
    (v) For the 1994 taxable year, L2 has net positive consideration for 
the reinsurance agreement of $62,000 before adjustment for the 
transferred policyholder loans. Under paragraph (f)(8) of this section, 
the amounts taken into account as claim and benefit payments must be 
adjusted by the amount of any transferred policyholder loan receivables 
which are netted against the reinsurer's claim and benefit 
reimbursements. Therefore, L2 takes into account $45,000 
($25,000+$20,000=$45,000) as reimbursements for death benefits, and 
$20,000 ($5,000+$15,000=$20,000) as reimbursements for surrender 
benefits. After adjustment for these items, L2 has net positive 
consideration of $27,000, which is determined by subtracting the sum of 
the amounts charged to L2 ($45,000+$20,000+$8,000=$73,000) from the sum 
of the amounts credited to L2 ($100,000). L1 has net negative 
consideration of ($27,000) under the agreement. Under paragraph 
(b)(1)(ii) of this section, L2 includes the $27,000 net positive 
consideration in its gross amount of premiums and other consideration. 
The amount of any interest earned on the policyholder loan receivables 
after their transfer to L2 is treated as investment income earned 
directly by L2, and is not taken into account as an item of 
consideration under the agreement.

    (g) Reduction in the amount of net negative consideration to ensure 
consistency of capitalization for reinsurance agreements--(1) In 
general. Paragraph (g)(3)

[[Page 896]]

of this section provides for a reduction in the amount of net negative 
consideration that a party to a reinsurance agreement (other than a 
reinsurance agreement described in paragraph (h)(2) of this section) may 
take into account in determining net premiums under paragraph (a)(2)(ii) 
of this section if the party with net positive consideration has a 
capitalization shortfall (as defined in paragraph (g)(4) of this 
section). Unless the party with net negative consideration demonstrates 
that the party with net positive consideration does not have a 
capitalization shortfall or demonstrates the amount of the other party's 
capitalization shortfall which is allocable to the reinsurance 
agreement, the net negative consideration that may be taken into account 
under paragraph (a)(2)(ii) of this section is zero. However, the 
reduction of paragraph (g)(3) of this section does not apply to a 
reinsurance agreement if the parties make a joint election under 
paragraph (g)(8) of this section. Under the election, the party with net 
positive consideration capitalizes specified policy acquisition expenses 
with respect to the agreement without regard to the general deductions 
limitation of section 848(c)(1).
    (2) Application to reinsurance agreements subject to the interim 
rules. In applying this paragraph (g) to a reinsurance agreement that is 
subject to the interim rules of Sec. 1.848-3, the term ``premiums and 
other consideration incurred for reinsurance under section 
848(d)(1)(B)'' is substituted for ``net negative consideration,'' and 
the term ``gross amount of premiums and other consideration under 
section 848(d)(1)(A)'' is substituted for ``net positive 
consideration.'' If an insurance company has ``premiums and other 
consideration incurred for reinsurance under section 848(d)(1)(B)'' and 
a ``gross amount of premiums and other consideration under section 
848(d)(1)(A)'' for the same agreement, the net of these amounts is taken 
into account for purposes of this paragraph (g).
    (3) Amount of reduction. The reduction required by this paragraph 
(g)(3) equals the amount obtained by dividing--
    (i) The portion of the capitalization shortfall (as defined in 
paragraph (g)(4) of this section) allocated to the reinsurance agreement 
under paragraph (g)(7) of this section; by
    (ii) The applicable percentage set forth in section 848(c)(1) for 
the category of specified insurance contracts reinsured by the 
agreement.
    (4) Capitalization shortfall. A ``capitalization shortfall'' equals 
the excess of--
    (i) The sum of the required capitalization amounts (as defined in 
paragraph (g)(5) of this section) for all reinsurance agreements (other 
than reinsurance agreements for which an election has been made under 
paragraph (h)(3) of this section); over
    (ii) The general deductions allocated to those reinsurance 
agreements, as determined under paragraph (g)(6) of this section.
    (5) Required capitalization amount--(i) In general. The ``required 
capitalization amount'' for a reinsurance agreement (other than a 
reinsurance agreement for which an election has been made under 
paragraph (h)(3) of this section) equals the amount (either positive or 
negative) obtained by multiplying--
    (A) The net positive or negative consideration for an agreement not 
described in paragraph (h)(2) of this section, and the net positive 
consideration for an agreement described in paragraph (h)(2) of this 
section, but for which an election under paragraph (h)(3) of this 
section has not been made; by
    (B) The applicable percentage set forth in section 848(c)(1) for 
that category of specified insurance contracts.
    (ii) Special rule with respect to net negative consideration. Solely 
for purposes of computing a party's required capitalization amount under 
this paragraph (g)(5)--
    (A) If either party to the reinsurance agreement is the direct 
issuer of the reinsured contracts, the party computing its required 
capitalization amount takes into account the full amount of any net 
negative consideration without regard to any potential reduction under 
paragraph (g)(3) of this section; and
    (B) If neither party to the reinsurance agreement is the direct 
issuer of the reinsured contracts, any net negative consideration is 
deemed to equal zero in computing a party's required

[[Page 897]]

capitalization amount except to the extent that the party with the net 
negative consideration establishes that the other party to that 
reinsurance agreement capitalizes the appropriate amount.
    (6) General deductions allocable to reinsurance agreements. An 
insurance company's general deductions allocable to its reinsurance 
agreements equals the excess, if any, of--
    (i) The company's general deductions (excluding additional amounts 
treated as general deductions under paragraph (g)(8) of this section); 
over
    (ii) The amount determined under section 848(c)(1) on specified 
insurance contracts that the insurance company has issued directly 
(determined without regard to any reinsurance agreements).
    (7) Allocation of capitalization shortfall among reinsurance 
agreements. The capitalization shortfall is allocated to each 
reinsurance agreement for which the required capitalization amount (as 
determined in paragraph (g)(5) of this section) is a positive amount. 
The portion of the capitalization shortfall allocable to each agreement 
equals the amount which bears the same ratio to the capitalization 
shortfall as the required capitalization amount for the reinsurance 
agreement bears to the sum of the positive required capitalization 
amounts.
    (8) Election to determine specified policy acquisition expenses for 
an agreement without regard to general deductions limitation--(i) In 
general. The reduction specified by paragraph (g)(3) of this section 
does not apply if the parties to a reinsurance agreement make an 
election under this paragraph (g)(8). The election requires the party 
with net positive consideration to capitalize specified policy 
acquisition expenses with respect to the reinsurance agreement without 
regard to the general deductions limitation of section 848(c)(1). That 
party must reduce its deductions under section 805 or section 832(c) by 
the amount, if any, of the party's capitalization shortfall allocable to 
the reinsurance agreement. The additional capitalized amounts are 
treated as specified policy acquisition expenses attributable to 
premiums and other consideration on the reinsurance agreement, and are 
deductible in accordance with section 848(a)(2).
    (ii) Manner of making election. To make an election under paragraph 
(g)(8) of this section, the ceding company and the reinsurer must 
include an election statement in the reinsurance agreement, either as 
part of the original terms of the agreement or by an addendum to the 
agreement. The parties must each attach a schedule to their federal 
income tax returns which identifies the reinsurance agreement for which 
the joint election under this paragraph (g)(8) has been made. The 
schedule must be attached to each of the parties' federal income tax 
returns filed for the later of--
    (A) The first taxable year ending after the election becomes 
effective; or
    (B) The first taxable year ending on or after December 29, 1992.
    (iii) Election statement. The election statement in the reinsurance 
agreement must--
    (A) Provide that the party with net positive consideration for the 
reinsurance agreement for each taxable year will capitalize specified 
policy acquisition expenses with respect to the reinsurance agreement 
without regard to the general deductions limitation of section 
848(a)(1);
    (B) Set forth the agreement of the parties to exchange information 
pertaining to the amount of net consideration under the reinsurance 
agreement each year to ensure consistency;
    (C) Specify the first taxable year for which the election is 
effective; and
    (D) Be signed by both parties.
    (iv) Effect of election. An election under this paragraph (g)(8) is 
effective for the first taxable year specified in the election statement 
and for all subsequent taxable years for which the reinsurance agreement 
remains in effect. The election may not be revoked without the consent 
of the Commissioner.
    (9) Example. The principles of this paragraph (g) are illustrated by 
the following examples.

    Example 1. (i) On December 31, 1992, a life insurance company (L1) 
transfers a block of individual life insurance contracts to an unrelated 
life insurance company (L2) under an agreement in which L2 becomes 
solely liable to the policyholders on the reinsured contracts. L1 
transfers $105,000 to L2 as consideration for the reinsurance of the 
contracts.

[[Page 898]]

    (ii) L1 and L2 do not make an election under paragraph (g)(8) of 
this section to capitalize specified policy acquisition expenses with 
respect to the reinsurance agreement without regard to the general 
deductions limitation. L2 has no other insurance business, and its 
general deductions for the taxable year are $3,500.
    (iii) Under paragraph (f)(2) of this section, L1's net negative 
consideration is ($105,000). Under paragraph (f)(3) of this section, 
L2's net positive consideration is $105,000. Pursuant to paragraph 
(b)(1)(ii) of this section, L2 includes the net positive consideration 
in its gross amount of premiums and other consideration.
    (iv) The required capitalization amount under paragraph (g)(5) of 
this section for the reinsurance agreement is $8,085 ($105,000x.077). 
L2's general deductions, all of which are allocable to the reinsurance 
agreement with L1, are $3,500. The $4,585 difference between the 
required capitalization amount ($8,085) and the general deductions 
allocable to the reinsurance agreement ($3,500) represents L2's 
capitalization shortfall under paragraph (g)(4) of this section.
    (v) Since L2 has a capitalization shortfall allocable to the 
agreement, the rules of paragraph (g)(1) of this section apply for 
purposes of determining the amount by which L1 may reduce its net 
premiums. Under paragraph (g)(3) of this section, L1 must reduce the 
amount of net negative consideration that it takes into account under 
paragraph (a)(2)(ii) of this section by $59,545 ($4,585/.077). Thus, of 
the $105,000 net negative consideration under the reinsurance agreement, 
L1 may take into account only $45,455 as a reduction of its net 
premiums.
    Example 2. The facts are the same as Example 1, except that L1 and 
L2 make the election under paragraph (g)(8) of this section to 
capitalize specified policy acquisition expenses with respect to the 
reinsurance agreement without regard to the general deductions 
limitation. Pursuant to this election, L2 must capitalize as specified 
policy acquisition expenses an amount equal to $8,085 ($105,000x.077). 
L1 may reduce its net premiums by the $105,000 of net negative 
consideration.
    Example 3. (i) A life insurance company (L1) is both a direct issuer 
and a reinsurer of life insurance and annuity contracts. For 1993, L1's 
net premiums under section 848 (d)(1) for directly issued individual 
life insurance and annuity contracts are as follows:

------------------------------------------------------------------------
                        Category                           Net premiums
------------------------------------------------------------------------
Life insurance contracts................................     $17,000,000
Annuity contracts.......................................       8,000,000
------------------------------------------------------------------------

    (ii) L1's general deductions for 1993 are $1,500,000.
    (iii) For 1993, L1 is a reinsurer under four separate indemnity 
reinsurance agreements with unrelated insurance companies (L2, L3, L4, 
and L5). The agreements with L2, L3, and L4 cover life insurance 
contracts issued by those companies. The agreement with L5 covers 
annuity contracts issued by L5, The parties to the reinsurance 
agreements have not made the election under paragraph (g)(8) of this 
section to capitalize specified policy acquisition expenses with respect 
to these agreements without regard to the general deductions limitation.
    (iv) L1's net consideration for 1993 with respect to its reinsurance 
agreements is as follows:

------------------------------------------------------------------------
                                                                Net
                        Agreement                          consideration
------------------------------------------------------------------------
L2.......................................................    $1,200,000
L3.......................................................      (350,000)
L4.......................................................       300,000
L5.......................................................       600,000
------------------------------------------------------------------------

    (v) To determine whether a reduction under paragraph (g)(3) of this 
section applies with respect to these reinsurance agreements, L1 must 
determine the required capitalization amounts for its reinsurance 
agreements and the amount of its general deductions allocable to these 
agreements.
    (vi) Pursuant to paragraph (g)(5) of this section, the required 
capitalization amount for each reinsurance agreement is determined as 
follows:

L2...............................................$1,200,000x.077=$92,400
L3.............................................($350,000)x.077=($26,950)
L4.................................................$300,000x.077=$23,100
L5................................................$600,000x.0175=$10,500

    (vii) Thus, the sum of L1's required capitalization amounts on its 
reinsurance agreements equals $99,050.
    (viii) Pursuant to paragraph (g)(6) of this section, L1 determines 
its general deductions allocable to its reinsurance agreements. The 
amount determined under section 848(c)(1) on its directly issued 
contracts is:

                     Required capitalization amount
Category:
  Annuity contracts...................    $8,000,000x.0175 =    $140,000
  Life insurance contracts............    $17,000,000x.077 =   1,309,000
                                                             -----------
                                                              $1,449,000
 

    (ix) L1's general deductions allocable to its reinsurance agreements 
are $51,000 ($1,500,000-$1,449,000).
    (x) Pursuant to paragraph (g)(4) of this section, L1's 
capitalization shortfall equals $48,050, reflecting the excess of L1's 
required capitalization amounts for its reinsurance agreements ($99,050) 
over the general deductions allocable to its reinsurance agreements 
($51,000).
    (xi) Pursuant to paragraph (g)(7) of this section, the 
capitalization shortfall of $48,050

[[Page 899]]

must be allocated between each of L1's reinsurance agreements with net 
positive consideration in proportion to their respective required 
capitalization amounts. The allocation of the shortfall between L1's 
reinsurance agreements is determined as follows:

L2=$35,237 ($48,050x92,400/126,000)
L4=$8,809 ($48,050x23,100/126,000)
L5=$4,004 ($48,050x10,500/126,000)

    (xii) Accordingly, the reduction under paragraph (g)(3) of this 
section that applies to the amount of net negative consideration that 
may be taken into account by L2, L4, and L5 under paragraph 
(a)(1)(ii)(B) of this section is determined as follows:

L2=$457,623 ($35,237/.077)
L4=$114,403 ($8,809/.077)
L5=$228,800 ($4,004/.0175)
    Example 4. The facts are the same as Example 3, except that L1 and 
L4 make a joint election under paragraph (g)(8) of this section to 
capitalize specified policy acquisition expenses with respect to the 
reinsurance agreement without regard to the general deductions 
limitation. Pursuant to this election, L1 must reduce its deductions 
under section 805 by an amount equal to the capitalization shortfall 
allocable to the reinsurance agreement with L4 ($8,809). L1 treats the 
additional capitalized amounts as specified policy acquisition expenses 
allocable to premiums and other consideration under the agreement. L4 
may reduce its net premiums by the $300,000 net negative consideration. 
The election by L1 and L4 does not change the amount of the 
capitalization shortfall allocable under paragraph (g)(7) of this 
section to the reinsurance agreements with L2 and L5. Thus, the 
reduction required by paragraph (g)(3) of this section with respect to 
the amount of the net negative consideration that L2 and L5 may 
recognize under paragraph (a)(2)(ii) of this section is $457,623 and 
$228,800, respectively.

    (h) Treatment of reinsurance agreements with parties not subject to 
U.S. taxation--(1) In general. Unless an election under paragraph (h)(3) 
of this section is made, an insurance company may not reduce its net 
premiums by the net negative consideration for the taxable year (or, 
with respect to a reinsurance agreement that is subject to the interim 
rules of Sec. 1.848-3, by the premiums and other consideration incurred 
for reinsurance) under a reinsurance agreement to which this paragraph 
(h) applies.
    (2) Agreements to which this paragraph (h) applies--(i) In general. 
This paragraph (h) applies to a reinsurance agreement if, with respect 
to the premiums and other consideration under the agreement, one party 
to that agreement is subject to United States taxation and the other 
party is not.
    (ii) Parties subject to U.S. taxation--(A) In general. A party is 
subject to United States taxation for this purpose if the party is 
subject to United States taxation either directly under the provisions 
of subchapter L of chapter 1 of the Internal Revenue Code (subchapter 
L), or indirectly under the provisions of subpart F of part III of 
subchapter N of chapter 1 of the Internal Revenue Code (subpart F).
    (B) Effect of a closing agreement. If a reinsurer agrees in a 
closing agreement with the Internal Revenue Service to be subject to tax 
under rules equivalent to the provisions of subchapter L on its premiums 
and other consideration from reinsurance agreements with parties subject 
to United States taxation, the reinsurer is treated as an insurance 
company subject to tax under subchapter L.
    (3) Election to separately determine the amounts required to be 
capitalized for reinsurance agreements with parties not subject to U.S. 
taxation--(i) In general. This paragraph (h)(3) authorizes an insurance 
company to make an election to separately determine the amounts required 
to be capitalized for the taxable year with respect to reinsurance 
agreements with parties that are not subject to United States taxation. 
If this election is made, an insurance company separately determines a 
net foreign capitalization amount for the taxable year for all 
reinsurance agreements to which this paragraph (h) applies.
    (ii) Manner of making the election. An insurance company makes the 
election authorized by this paragraph (h)(3) by attaching an election 
statement to the federal income tax return (including an amended return) 
for the taxable year for which the election becomes effective. The 
election applies to that taxable year and all subsequent taxable years 
unless permission to revoke the election is obtained from the 
Commissioner.
    (4) Amount taken into account for purposes of determining specified 
policy acquisition expenses. If for a taxable year an insurance company 
has a net positive foreign capitalization amount (as

[[Page 900]]

defined in paragraph (h)(5)(i) of this section), any portion of that 
amount remaining after the reduction described in paragraph (h)(7) of 
this section is treated as additional specified policy acquisition 
expenses for the taxable year (determined without regard to amounts 
taken into account under this paragraph (h)). A net positive 
capitalization amount is treated as an amount otherwise required to be 
capitalized for the taxable year for purposes of the reduction under 
section 848(f)(1)(A).
    (5) Net foreign capitalization amount--(i) In general. An insurance 
company's net foreign capitalization amount equals the sum of the 
foreign capitalization amounts (netting positive and negative amounts) 
determined under paragraph (h)(5)(ii) of this section for each category 
of specified insurance contracts reinsured by agreements described in 
paragraph (h)(2) of this section. If the amount is less than zero, the 
company has a net negative foreign capitalization amount. If the amount 
is greater than zero, the company has a net positive foreign 
capitalization amount.
    (ii) Foreign capitalization amounts by category. The foreign 
capitalization amount for a category of specified insurance contracts is 
determined by--
    (A) Combining the net positive consideration and the net negative 
consideration for the taxable year (or, with respect to a reinsurance 
agreement that is subject to the interim rules of Sec. 1.848-3, by 
combining the gross amount of premiums and other consideration and the 
premiums and other consideration incurred for reinsurance) for all 
agreements described in paragraph (h)(2) of this section which reinsure 
specified insurance contracts in that category; and
    (B) Multiplying the result (either positive or negative) by the 
percentage for that category specified in section 848(c)(1).
    (6) Treatment of net negative foreign capitalization amount--(i) 
Applied as a reduction to previously capitalized amounts. If for a 
taxable year an insurance company has a net negative foreign 
capitalization amount, the negative amount reduces (but not below zero) 
the unamortized balances of the amounts previously capitalized 
(beginning with the amount capitalized for the most recent taxable year) 
to the extent attributable to prior years' net positive foreign 
capitalization amounts. The amount by which previously capitalized 
amounts is reduced is allowed as a deduction for the taxable year.
    (ii) Carryover of remaining net negative foreign capitalization 
amount. The net negative foreign capitalization amount, if any, 
remaining after the reduction described in paragraph (h)(6)(i) of this 
section is carried over to reduce a future net positive capitalization 
amount. The remaining net negative foreign capitalization amount may 
only offset a net positive foreign capitalization amount in a future 
year, and may not be used to reduce the amounts otherwise required to be 
capitalized under section 848(a) for the taxable year, or to reduce the 
unamortized balances of specified policy acquisition expenses from 
preceding taxable years, with respect to directly written business or 
reinsurance agreements other than agreements for which the election 
under paragraph (h)(3) of this section has been made.
    (7) Reduction of net positive foreign capitalization amount by 
carryover amounts allowed. If for a taxable year an insurance company 
has a net positive foreign capitalization amount, that amount is reduced 
(but not below zero) by any carryover of net negative foreign 
capitalization amounts from preceding taxable years. Any remaining net 
positive foreign capitalization amount is taken into account as provided 
in paragraph (h)(4) of this section.
    (8) Examples. The principles of this paragraph (h) are illustrated 
by the following examples.

    Example 1. (i) On January 1, 1993, a life insurance company (L1) 
enters into a reinsurance agreement with a foreign corporation (X) 
covering a block of annuity contracts issued to residents of the United 
States. X is not subject to taxation either directly under subchapter L 
or indirectly under subpart F on the premiums for the reinsurance 
agreement with L1. L1 makes the election under paragraph (h)(3) of this 
section to separately determine the amounts required to be capitalized 
for the taxable year with respect to

[[Page 901]]

parties not subject to United States taxation.
    (ii) For the taxable year ended December 31, 1993, L1 has net 
negative consideration of ($25,000) under its reinsurance agreement with 
X. L1 has no other reinsurance agreements with parties not subject to 
United States taxation.
    (iii) Under paragraph (h)(5) of this section, L1's net negative 
foreign capitalization amount for the 1993 taxable year equals 
($437.50), which is determined by multiplying L1's net negative 
consideration on the agreement with X ($25,000) by the percentage in 
section 848(c)(1) for the reinsured specified insurance contracts 
(1.75%). Under paragraph (h)(6)(ii) of this section, L1 carries over the 
net negative foreign capitalization amount of $437.50) to future taxable 
years. The net negative foreign capitalization amount may not be used to 
reduce the amounts which L1 is required to capitalize on directly 
written business or reinsurance agreements other than those agreements 
described in paragraph (h)(2) of this section.
    Example 2. (i) The facts are the same as Example 1 except that L1 
terminates its reinsurance agreement with X and receives $35,000 on 
December 31, 1994. For the 1994 taxable year, L1 has net positive 
consideration of $35,000 under its agreement with X. L1 has no other 
reinsurance agreements with parties not subject to United States 
taxation.
    (ii) Under paragraph (h)(5) of this section, L1's net positive net 
foreign capitalization amount for the 1984 taxable year equals $612.50, 
which is determined by multiplying the net positive consideration on the 
agreement with X ($35,000) by the percentage in section 848(c)(1) for 
the reinsured specified insurance contracts (1.75%). Under paragraph 
(h)(4) of this section, L1 reduces the net positive foreign 
capitalization amount for the taxable year by the net negative foreign 
capitalization amount carried over from preceding taxable years 
($437.50). After this reduction, L1 includes $175 ($612.50-$437.50) as 
specified policy acquisition expenses for the 1994 taxable year.

    (i) Carryover of excess negative capitalization amount--(1) In 
general. This paragraph (i) authorizes a carryover of an excess negative 
capitalization amount (as defined in paragraph (i)(2) of this section) 
to reduce amounts otherwise required to be capitalized under section 
848. Paragraph (i)(4) provides special rules for the treatment of excess 
negative capitalization amounts of insolvent insurance companies.
    (2) Excess negative capitalization amount. The excess negative 
capitalization amount with respect to a category of specified insurance 
contracts for a taxable year is equal to the excess of--
    (A) The negative capitalization amount with respect to that 
category; over
    (B) The amount that can be utilized under section 848(f)(1).
    (3) Treatment of excess negative capitalization amount. The excess 
negative capitalization amount for a taxable year reduces the amounts 
that are otherwise required to be capitalized by an insurance company 
under section 848(c)(1) for future years.
    (4) Special rule for the treatment of an excess negative 
capitalization amount of an insolvent company--(i) When applicable. This 
paragraph (i)(4) applies only for the taxable year in which an insolvent 
insurance company has an excess negative capitalization amount and has 
net negative consideration under a reinsurance agreement. See paragraph 
(i)(4)(v) of this section for the definition of ``insolvent.''
    (ii) Election to forego carryover of excess negative capitalization 
amount. At the joint election of the insolvent insurance company and the 
other party to the reinsurance agreement--
    (A) The insolvent insurance company reduces the excess negative 
capitalization amount which would otherwise be carried over under 
paragraph (i)(1) of this section by the amount determined under 
paragraph (i)(4)(iii) of this section; and
    (B) The other party reduces the amount of its specified policy 
acquisition expenses for the taxable year by the amount determined under 
paragraph (i)(4)(iii) of this section.
    (iii) Amount of reduction to the excess negative capitalization 
amount and specified policy acquisition expenses. To determine the 
reduction to the carryover of an insolvent insurance company's excess 
negative capitalization amount and the specified policy acquisition 
expenses of the other party with respect to a reinsurance agreement--
    (A) Multiply the net negative consideration for each reinsurance 
agreement of the insolvent insurer for which there is net negative 
consideration for the taxable year by the appropriate percentage 
specified in section 848(c)(1) for the category of specified insurance 
contracts reinsured by the agreement;

[[Page 902]]

    (B) Sum the results for each agreement;
    (C) Calculate the ratio between the results in paragraphs 
(i)(4)(iii) (A) and (B) of this section for each agreement; and
    (D) Multiply that result by the increase in the excess negative 
capitalization amount of the insolvent insurer for the taxable year.
    (iv) Manner of making election. To make an election under paragraph 
(i)(4) of this section, each party to the reinsurance agreement must 
attach an election statement to its federal income tax return (including 
an amended return) for the taxable year for which the election is 
effective. The election statement must identify the reinsurance 
agreement for which the joint election under this paragraph (i)(4) has 
been made, state the amount of the reduction to the insolvent insurance 
company's excess negative capitalization amount that is attributable to 
the agreement, and be signed by both parties. An election under this 
paragraph (i)(4) is effective for the taxable year specified in the 
election statement, and may not be revoked without the consent of the 
Commissioner.
    (v) Presumptions relating to the insolvency of an insurance company 
undergoing a court supervised rehabilitation or similar state 
proceeding. For purposes of this paragraph (i)(4), an insurance company 
which is undergoing a rehabilitation, conservatorship, or similar state 
proceeding shall be presumed to be insolvent if the state proceeding 
results in--
    (A) An order of the state court finding that the fair market value 
of the insurance company's assets is less than its liabilities;
    (B) The use of funds, guarantees, or reinsurance from a guaranty 
association;
    (C) A reduction of the policyholders' available account balances; or
    (D) A substantial limitation on access to funds (for example, a 
partial or total moratorium on policyholder withdrawals or surrenders 
that applies for a period of 5 years).
    (vi) Example. The principles of this paragraph (i)(4) are 
illustrated by the following example.

    Example. (i) An insurance company (L1) is the subject of a 
rehabilitation proceeding under the supervision of a state court. The 
state court has made a finding that the fair market value of L1's assets 
is less than its liabilities. On December 31, 1993, L1 transfers a block 
of individual life insurance contracts to an unrelated insurance company 
(L2) under an assumption reinsurance agreement whereby L2 becomes solely 
liable to the policyholders under the contracts reinsured. Under the 
agreement, L1 agrees to pay L2 $2,000,000 for assuming the life 
insurance contracts. This negative net consideration causes L1 to incur 
an excess negative capitalization amount of $138,600 for the 1993 
taxable year. L1 has no other reinsurance agreements for the taxable 
year.
    (ii) As part of the reinsurance agreement, L1 and L2 agree to make 
an election under paragraph (i)(4) of this section. Under the election, 
L1 agrees to forgo the carryover of the $138,600 excess negative 
capitalization amount for future taxable years. L2 must include the 
$2,000,000 net positive consideration for the reinsurance agreement in 
its gross amount of premiums and other consideration. L2 reduces its 
specified policy acquisition expenses for the 1993 taxable year by 
$138,600.

    (j) Ceding commissions with respect to reinsurance of contracts 
other than specified insurance contracts. A ceding commission incurred 
with respect to the reinsurance of an insurance contract that is not a 
specified insurance contract is not subject to the provisions of section 
848(g).
    (k) Effective dates--(1) In general. Unless otherwise specified in 
this paragraph, the rules of this section are effective for the taxable 
years of an insurance company beginning after November 14, 1991.
    (2) Reduction in the amount of net negative consideration to ensure 
consistency of capitalization for reinsurance agreements. Section 1.848-
2(g) (which provides for an adjustment to ensure consistency) is 
effective for--
    (i) All amounts arising under any reinsurance agreement entered into 
after November 14, 1991; and
    (ii) All amounts arising under any reinsurance agreement for taxable 
years beginning after December 31, 1991, without regard to the date on 
which the reinsurance agreement was entered into.

[[Page 903]]

    (3) Net consideration rules. Section 1.848-2(f) (which provides 
rules for determining the net consideration for a reinsurance agreement) 
applies to--
    (i) Amounts arising in taxable years beginning after December 31, 
1991, under a reinsurance agreement entered into after November 14, 
1991; and
    (ii) Amounts arising in taxable years beginning after December 31, 
1994, under a reinsurance agreement entered into before November 15, 
1991.
    (4) Determination of the date on which a reinsurance agreement is 
entered into. A reinsurance agreement is considered entered into at the 
earlier of--
    (i) The date of the reinsurance agreement; or
    (ii) The date of a binding written agreement to enter into a 
reinsurance transaction if the written agreement evidences the parties' 
agreement on substantially all material items relating to the 
reinsurance transaction.
    (5) Special rule for certain reinsurance agreements with parties not 
subject to U.S. taxation. The election and special rules in paragraph 
(h) of this section relating to the determination of amounts required to 
be capitalized on reinsurance agreements with parties not subject to 
United States taxation apply to taxable years ending on or after 
September 30, 1990.
    (6) Carryover of excess negative capitalization amount. The 
provisions of paragraph (i) of this section, including the special rule 
for the treatment of excess negative capitalization amounts of insolvent 
insurance companies, are affected with respect to amounts arising in 
taxable years ending on or after September 30, 1990.

[T.D. 8456, 57 FR 61821, Dec. 29, 1992; 58 FR 7987, Feb. 11, 1993; 59 FR 
947, Jan. 7, 1994]



Sec. 1.848-3  Interim rules for certain reinsurance agreements.

    (a) Scope and effective dates. The rules of this section apply in 
determining net premiums for a reinsurance agreement with respect to--
    (1) Amounts arising in taxable years beginning before January 1, 
1992, under a reinsurance agreement entered into after November 14, 
1991; and
    (2) Amounts arising in taxable years beginning before January 1, 
1995, under a reinsurance agreement entered into before November 15, 
1991.
    (b) Interim rules. In determining a company's gross amount of 
premiums and other consideration under section 848(d)(1)(A) and premiums 
and other consideration incurred for reinsurance under section 
848(d)(1)(B), the general rules of subchapter L of the Internal Revenue 
Code apply with the adjustments and special rules set forth in paragraph 
(c) of this section. Except as provided in paragraph (c)(5) of this 
section (which applies to modified coinsurance transactions), the gross 
amount of premiums and other consideration is determined without any 
reduction for ceding commissions, annual allowances, reimbursements of 
claims and benefits, or other amounts incurred by a reinsurer with 
respect to reinsured contracts.
    (c) Adjustment and special rules. This paragraph sets forth certain 
adjustments and special rules that apply for reinsurance agreements in 
determining the gross amount of premiums and other consideration under 
section 848(d)(1)(A) and premiums and other considerations incurred for 
reinsurance under section 848(d)(1)(B).
    (1) Assumption reinsurance. The ceding company must treat the gross 
amount of consideration incurred with respect to an assumption 
reinsurance agreement as premiums and other consideration incurred for 
reinsurance under section 848(d)(1)(B). The reinsurance must include the 
same amount in the gross amount of premiums and other consideration 
under section 848(d)(1)(A). For rules relating to the determination and 
treatment of ceding commissions, see paragraph (c)(3) of this section.
    (2) Reimbursable dividends. The reinsurer must treat the amount of 
policyholder dividends reimbursable to the ceding company (other than 
under a modified coinsurance agreement covered by paragraph (c)(5) of 
this section) as a return premium under section 848(d)(1)(B). The ceding 
company must include the same amount in the gross amount of premiums and 
other consideration under section 848(d)(1)(A). The amount of any 
experience-related refund due the ceding company is treated

[[Page 904]]

as a policyholder dividend reimbursable to the ceding company.
    (3) Ceding commissions--(i) In general. The reinsurer must treat 
ceding commissions as a general deduction. The ceding company must treat 
ceding commissions as non-premium related income under section 
803(a)(3). The ceding company may not reduce its general deductions by 
the amount of the ceding commission.
    (ii) Amount of ceding commission. For purposes of this section, the 
amount of a ceding commission equals the excess, if any, of--
    (A) The increase in the reinsurer's tax reserves resulting from the 
reinsurance agreement (computed in accordance with section 807(d)); over
    (B) The gross consideration incurred by the ceding company for the 
reinsurance agreement, less any amount incurred by the reinsurer as part 
of the reinsurance agreement.
    (4) Termination payments. The reinsurer must treat the gross amount 
of premiums and other consideration payable as a termination payment to 
the ceding company (including the tax reserves on the reinsured 
contracts) as premiums and other consideration incurred for reinsurance 
under section 848(d)(1)(B). The ceding company must include the same 
amount in the gross amount of premiums and other consideration under 
section 848(d)(1)(A). This paragraph does not apply to modified 
coinsurance agreements.
    (5) Modified coinsurance agreements. In the case of a modified 
coinsurance agreement, the parties must determine their net premiums on 
a net consideration basis as described in Sec. 1.848-2(f)(5).
    (D) Examples. The principles of this section are illustrated by the 
following examples.

    Example 1. On July 1, 1991, an insurance company (L1) transfers a 
block of individual life insurance contracts to an unrelated insurance 
company (L2) under an arrangement whereby L2 becomes solely liable to 
the policy holder under the contracts reinsured. The tax reserves on the 
reinsured contracts are $100,000. Under the assumption reinsurance 
agreement, L1 pays L2 $83,000 for assuming the life insurance contracts. 
Under paragraph (c)(3) of this section, since the increase in L2's tax 
reserves ($100,000) exceeds the net consideration transferred by L1 
($83,000), the reinsurance agreement provides for a ceding commission. 
The ceding commission equals $17,000 ($100,000-$83,000). Under paragraph 
(c)(3) of this section, L1 reduces its gross amount of premiums and 
other consideration for the 1991 taxable year under section 848(d)(1)(B) 
by the $100,000 premium incurred for reinsurance, and L2 includes the 
$100,000 premium for reinsurance in its gross amount of premiums and 
other consideration under section 848(d)(1)(A). L1 treats the $17,000 
ceding commission as non-premium related income and section 803 (a)(3).
    Example 2. On July 1, 1991, a life insurance company (L1) transfers 
a block of individual life insurance contracts to an unrelated insurance 
company (L2) under an arrangement whereby L2 becomes solely liable to 
the policyholder under the contracts reinsured. The tax reserves on the 
reinsured contracts are $100,000. Under the assumption reinsurance 
agreement, L1 pays L2 $100,000 for assuming the contracts, and L2 pays 
L1 a $17,000 ceding commission. Under paragraph (c)(1) of this section, 
L1 reduces its gross amount of premiums and other consideration under 
section 848(d)(1)(B) by $100,000. L2 includes $100,000 in its gross 
amount of premiums and other consideration under section 848(d)(1)(A). 
Under paragraph (c)(3) of this section, since the increase in L2's tax 
reserves ($100,000) exceeds the net consideration transferred by L1, the 
reinsurance agreement provides for a ceding commission. The ceding 
commission equals $17,000 ($100,000 increase in L2's tax reserves less 
$83,000 net consideration transferred by L1). L1 treats the $17,000 
ceding commission as non-premium related income under section 803(a)(3).
    Example 3. On July 1, 1991, a life insurance company (L1) transfers 
a block of individual life insurance contracts to an unrelated insurance 
company (L2) under an arrangement whereby L2 becomes solely liable to 
the policyholder under the contracts reinsured. Under the assumption 
reinsurance agreement, L1 transfers assets of $105,000 to L2. The tax 
reserves on the reinsured contracts are $100,000. Under paragraph (c)(1) 
of this section, L1 reduces its gross amount of premiums and other 
consideration under section 848(d)(1)(B) by $105,000, and L2 increases 
its gross amount of premiums and other consideration under section 
848(d)(1)(A) by $105,000. Since the net consideration transferred by L1 
exceeds the increase in L2's tax reserves, there is no ceding commission 
under paragraph (c)(3) of this section.
    Example 4. (i) On June 30, 1991, a life insurance company (L1) 
reinsures 40% of certain individual life insurance contracts to be 
issued after that date with an unrelated insurance company (L2) under an 
agreement whereby L1 remains directly liable to the policyholders with 
respect to the contracts reinsured. The agreement provides that L2 is 
credited with 40% of any premiums received with respect to the reinsured 
contracts, but

[[Page 905]]

must indemnify L1 for 40% of any claims, expenses, and policyholder 
dividends. During the period from July 1 through December 31, 1991, L1 
has the following income and expense items with respect to the reinsured 
policies:

------------------------------------------------------------------------
                         Item                           Income   Expense
------------------------------------------------------------------------
Premiums.............................................   $8,000  ........
Benefits paid........................................  .......    $1,000
Commissions..........................................  .......     6,000
Policyholder dividends...............................  .......       500
                                                      ----------
      Total..........................................  .......     7,500
------------------------------------------------------------------------

    (ii) Under paragraphs (b) and (c)(2) of this section, L1 includes 
$8,200 in its gross amount of premiums and other consideration under 
section 848(d)(1)(A) ($8,000 gross premiums on the reinsured contracts 
plus $200 of policyholder dividends reimbursed by L2 ($500x40%). L1 
reduces its gross amount of premiums and other consideration by $3,200 
(40%x$8,000) as premiums and other consideration incurred for 
reinsurance under section 848(d)(1)(B). The benefits and commissions 
incurred by L1 with respect to the reinsured contracts do not reduce 
L1's gross amount of premiums and other consideration under section 
848(d)(1)(B). L2 includes $3,200 in its gross amount of premiums and 
other consideration (40%x$8,000) and is treated as having paid return 
premiums of $200 (the amount of reimbursable dividends paid to L1). L2 
is also treated as having incurred the following expenses with respect 
to the reinsured contracts: $400 as benefits paid (40%x$1,000) and 
$2,400 as commissions expense (40%x$6,000). Under paragraph (b) of this 
section, these expenses do not reduce L2's gross amount of premiums and 
other consideration under section 848(d)(1)(A).
    Example 5. On December 31, 1991, an insurance company (L1) 
terminates a reinsurance agreement with an unrelated insurance company 
(L2). The termination applies to a reinsurance agreement under which L1 
had ceded 40% of its liability on a block of individual life insurance 
contracts to L2. Upon termination of the reinsurance agreement, L2 makes 
a final payment of $116,000 to L1 for assuming full liability under the 
contracts. The tax reserves attributable to L2's portion of the 
reinsured contracts are $120,000. Under paragraph (c)(4) of this 
section, L2 reduces its gross amount of premiums and other consideration 
under section 848(d)(1)(B) by $120,000. L1 includes $120,000 in its 
gross amount of premiums and other consideration under section 
848(d)(1)(A).
    Example 6. (i) On June 30, 1991, an insurance company (L1) reinsures 
40% of its existing life insurance contracts with an unrelated life 
insurance company (L2) under a modified coinsurance agreement. For the 
period July 1, 1991 through December 31, 1991, L1 reports the following 
income and expense items with respect to L2's 40% share of the reinsured 
contracts:

------------------------------------------------------------------------
                        Item                           Income    Expense
------------------------------------------------------------------------
Premiums............................................   $10,000
Benefits paid.......................................  ........    $4,000
Policyholder dividends..............................  ........       500
Reserve adjustment..................................  ........     1,500
                                                               ---------
      Total.........................................  ........     6,000
------------------------------------------------------------------------

    (ii) Pursuant to paragraph (c)(5) of this section, L1 reduces its 
gross amount of premiums and other consideration under section 
848(d)(1)(B) by the $4,000 net consideration for the modified 
coinsurance agreement ($10,000-$6,000). L2 includes the $4,000 net 
consideration in its gross amount of premiums and other consideration 
under section 848(d)(1)(A).

[T.D. 8456, 57 FR 61829, Dec. 29, 1992]



Sec. Sec. 1.849-1.850  [Reserved]

[[Page 907]]



                              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 909]]



                    Table of CFR Titles and Chapters




                      (Revised as of April 1, 2015)

                      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 Guidance (Parts 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)
         X  Department of the Treasury (Parts 1000--1099)
        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)

[[Page 910]]

    XXVIII  Department of Justice (Parts 2800--2899)
      XXIX  Department of Labor (Parts 2900--2999)
       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)
     XXXVI  Office of National Drug Control Policy, Executive 
                Office of the President (Parts 3600--3699)
    XXXVII  Peace Corps (Parts 3700--3799)
     LVIII  Election Assistance Commission (Parts 5800--5899)
       LIX  Gulf COast Ecosystem Restoration Council (Parts 5900--
                5999)

                        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)
       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)

[[Page 911]]

      XXIX  Federal Communications Commission (Parts 3900--3999)
       XXX  Farm Credit System Insurance Corporation (Parts 4000--
                4099)
      XXXI  Farm Credit Administration (Parts 4100--4199)
    XXXIII  Overseas Private Investment Corporation (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)

[[Page 912]]

    LXXVII  Office of Management and Budget (Parts 8700--8799)
      LXXX  Federal Housing Finance Agency (Parts 9000--9099)
   LXXXIII  Special Inspector General for Afghanistan 
                Reconstruction (Parts 9300--9399)
    LXXXIV  Bureau of Consumer Financial Protection (Parts 9400--
                9499)
    LXXXVI  National Credit Union Administration (Parts 9600--
                9699)
     XCVII  Department of Homeland Security Human Resources 
                Management System (Department of Homeland 
                Security--Office of Personnel Management) (Parts 
                9700--9799)
     XCVII  Council of the Inspectors General on Integrity and 
                Efficiency (Parts 9800--9899)
      XCIV  Military Compensation and Retirement Modernization 
                Commission (Parts 9900--9999)

                      Title 6--Domestic Security

         I  Department of Homeland Security, Office of the 
                Secretary (Parts 1--199)
         X  Privacy and Civil Liberties Oversight Board (Parts 
                1000--1099)

                         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)

[[Page 913]]

       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)
       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)

[[Page 914]]

                 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)

                           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)

[[Page 915]]

     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)

                    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

[[Page 916]]

        XX  Office of the United States Trade Representative 
                (Parts 2000--2099)
            Subtitle D--Regulations Relating to Telecommunications 
                and Information
     XXIII  National Telecommunications and Information 
                Administration, Department of Commerce (Parts 
                2300--2399)

                    Title 16--Commercial Practices

         I  Federal Trade Commission (Parts 0--999)
        II  Consumer Product Safety Commission (Parts 1000--1799)

             Title 17--Commodity and Securities Exchanges

         I  Commodity Futures Trading Commission (Parts 1--199)
        II  Securities and Exchange Commission (Parts 200--399)
        IV  Department of the Treasury (Parts 400--499)

          Title 18--Conservation of Power and Water Resources

         I  Federal Energy Regulatory Commission, Department of 
                Energy (Parts 1--399)
       III  Delaware River Basin Commission (Parts 400--499)
        VI  Water Resources Council (Parts 700--799)
      VIII  Susquehanna River Basin Commission (Parts 800--899)
      XIII  Tennessee Valley Authority (Parts 1300--1399)

                       Title 19--Customs Duties

         I  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)

[[Page 917]]

        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)

                      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)

[[Page 918]]

                Title 24--Housing and Urban Development

            Subtitle A--Office of the Secretary, Department of 
                Housing and Urban Development (Parts 0--99)
            Subtitle B--Regulations Relating to Housing and Urban 
                Development
         I  Office of Assistant Secretary for Equal Opportunity, 
                Department of Housing and Urban Development (Parts 
                100--199)
        II  Office of Assistant Secretary for Housing-Federal 
                Housing Commissioner, Department of Housing and 
                Urban Development (Parts 200--299)
       III  Government National Mortgage Association, Department 
                of Housing and Urban Development (Parts 300--399)
        IV  Office of Housing and Office of Multifamily Housing 
                Assistance Restructuring, Department of Housing 
                and Urban Development (Parts 400--499)
         V  Office of Assistant Secretary for Community Planning 
                and Development, Department of Housing and Urban 
                Development (Parts 500--599)
        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) [Reserved]
        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) [Reserved]
       XXV  Neighborhood Reinvestment Corporation (Parts 4100--
                4199)

                           Title 25--Indians

         I  Bureau of Indian Affairs, Department of the Interior 
                (Parts 1--299)

[[Page 919]]

        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)

                      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)

[[Page 920]]

        IV  Office of Labor-Management Standards, Department of 
                Labor (Parts 400--499)
         V  Wage and Hour Division, Department of Labor (Parts 
                500--899)
        IX  Construction Industry Collective Bargaining Commission 
                (Parts 900--999)
         X  National Mediation Board (Parts 1200--1299)
       XII  Federal Mediation and Conciliation Service (Parts 
                1400--1499)
       XIV  Equal Employment Opportunity Commission (Parts 1600--
                1699)
      XVII  Occupational Safety and Health Administration, 
                Department of Labor (Parts 1900--1999)
        XX  Occupational Safety and Health Review Commission 
                (Parts 2200--2499)
       XXV  Employee Benefits Security Administration, Department 
                of Labor (Parts 2500--2599)
     XXVII  Federal Mine Safety and Health Review Commission 
                (Parts 2700--2799)
        XL  Pension Benefit Guaranty Corporation (Parts 4000--
                4999)

                      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)

[[Page 921]]

        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
       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 Career, Technical and Adult Education, 
                Department of Education (Parts 400--499)

[[Page 922]]

         V  Office of Bilingual Education and Minority Languages 
                Affairs, Department of Education (Parts 500--599) 
                [Reserved]
        VI  Office of Postsecondary Education, Department of 
                Education (Parts 600--699)
       VII  Office of Educational Research and Improvement, 
                Department of Education (Parts 700--799) 
                [Reserved]
            Subtitle C--Regulations Relating to Education
        XI  [Reserved]
       XII  National Council on Disability (Parts 1200--1299)

                          Title 35 [Reserved]

             Title 36--Parks, Forests, and Public Property

         I  National Park Service, Department of the Interior 
                (Parts 1--199)
        II  Forest Service, Department of Agriculture (Parts 200--
                299)
       III  Corps of Engineers, Department of the Army (Parts 
                300--399)
        IV  American Battle Monuments Commission (Parts 400--499)
         V  Smithsonian Institution (Parts 500--599)
        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  U.S. 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--599)

           Title 38--Pensions, Bonuses, and Veterans' Relief

         I  Department of Veterans Affairs (Parts 0--199)
        II  Armed Forces Retirement Home (Parts 200--299)

[[Page 923]]

                       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)
      VIII  Gulf Coast Ecosystem Restoration Council (Parts 1800--
                1899)

          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)

[[Page 924]]

       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)

                   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)

[[Page 925]]

        VI  National Science Foundation (Parts 600--699)
       VII  Commission on Civil Rights (Parts 700--799)
      VIII  Office of Personnel Management (Parts 800--899)
         X  Office of Community Services, Administration for 
                Children and Families, Department of Health and 
                Human Services (Parts 1000--1099)
        XI  National Foundation on the Arts and the Humanities 
                (Parts 1100--1199)
       XII  Corporation for National and Community Service (Parts 
                1200--1299)
      XIII  Office of Human Development Services, Department of 
                Health and Human Services (Parts 1300--1399)
       XVI  Legal Services Corporation (Parts 1600--1699)
      XVII  National Commission on Libraries and Information 
                Science (Parts 1700--1799)
     XVIII  Harry S. Truman Scholarship Foundation (Parts 1800--
                1899)
       XXI  Commission on Fine Arts (Parts 2100--2199)
     XXIII  Arctic Research Commission (Part 2301)
      XXIV  James Madison Memorial Fellowship Foundation (Parts 
                2400--2499)
       XXV  Corporation for National and Community Service (Parts 
                2500--2599)

                          Title 46--Shipping

         I  Coast Guard, Department of Homeland Security (Parts 
                1--199)
        II  Maritime Administration, Department of Transportation 
                (Parts 200--399)
       III  Coast Guard (Great Lakes Pilotage), Department of 
                Homeland Security (Parts 400--499)
        IV  Federal Maritime Commission (Parts 500--599)

                      Title 47--Telecommunication

         I  Federal Communications Commission (Parts 0--199)
        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)

[[Page 926]]

         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)
        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 (Parts 5300--5399) 
                [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)

[[Page 927]]

                       Title 49--Transportation

            Subtitle A--Office of the Secretary of Transportation 
                (Parts 1--99)
            Subtitle B--Other Regulations Relating to 
                Transportation
         I  Pipeline and Hazardous Materials Safety 
                Administration, Department of Transportation 
                (Parts 100--199)
        II  Federal Railroad Administration, Department of 
                Transportation (Parts 200--299)
       III  Federal Motor Carrier Safety Administration, 
                Department of Transportation (Parts 300--399)
        IV  Coast Guard, Department of Homeland Security (Parts 
                400--499)
         V  National Highway Traffic Safety Administration, 
                Department of Transportation (Parts 500--599)
        VI  Federal Transit Administration, Department of 
                Transportation (Parts 600--699)
       VII  National Railroad Passenger Corporation (AMTRAK) 
                (Parts 700--799)
      VIII  National Transportation Safety Board (Parts 800--999)
         X  Surface Transportation Board, Department of 
                Transportation (Parts 1000--1399)
        XI  Research and Innovative Technology Administration, 
                Department of Transportation (Parts 1400--1499) 
                [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)

[[Page 929]]





           Alphabetical List of Agencies Appearing in the CFR




                      (Revised as of April 1, 2015)

                                                  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
Afghanistan Reconstruction, Special Inspector     22, LXXXIII
     General for
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

[[Page 930]]

Animal and Plant Health Inspection Service        7, III; 9, I
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
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
Council of the Inspectors General on Integrity    5, XCVIII
     and Efficiency
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 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 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              5, LXXXIV; 12, X
Consumer Product Safety Commission                5, LXXI; 16, 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
Customs and Border Protection                     19, I
Defense Contract Audit Agency                     32, I
Defense Department                                2, XI; 5, XXVI; 32, 
                                                  Subtitle A; 40, VII

[[Page 931]]

  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 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
  Career, Technical, and Adult Education, Office  34, IV
       of
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
  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         2, XXXVI; 21, III
  National Security Council                       32, XXI; 47, 2
  Presidential Documents                          3

[[Page 932]]

  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
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

[[Page 933]]

  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
Gulf Coast Ecosystem Restoration Council          2, LIX; 40, VIII
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
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

[[Page 934]]

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
  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
  Safety and Enforcement Bureau, Bureau of        30, II
  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
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                                  2, XXIX; 5, XLII
  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

[[Page 935]]

  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 Royalty Board                         37, III
  U.S. Copyright Office                           37, II
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
Military Compensation and Retirement              5, XCIV
     Modernization Commission
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     22, 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              5, LXXXVI; 12, VII
National Crime Prevention and Privacy Compact     28, IX
     Council
National Drug Control Policy, Office of           2, XXXVI; 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 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
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

[[Page 936]]

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
Privacy and Civil Liberties Oversight Board       6, X
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
Rural Telephone Bank                              7, XVI
Rural Utilities Service                           7, XVII, XVIII, XLII, L
Safety and Environmental Enforcement, Bureau of   30, II
Saint Lawrence Seaway Development Corporation     33, IV
Science and Technology Policy, Office of          32, XXIV

[[Page 937]]

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
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                               2, X;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
United States and Canada, International Joint     22, IV
     Commission
United States and Mexico, International Boundary  22, XI
     and Water Commission, United States Section
U.S. Copyright Office                             37, II
Utah Reclamation Mitigation and Conservation      43, III
   Commission
[[Page 938]]

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
Career, Technical 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 939]]







                      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.



PART 602_OMB CONTROL NUMBERS UNDER THE PAPERWORK REDUCTION ACT--Table of Contents





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
1.36B-5....................................................    1545-2232
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
1.42-18....................................................    1545-2088
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

[[Page 940]]

 
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
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)-1.................................................    1545-2147
1.108(i)-2.................................................    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

[[Page 941]]

 
                                                               1545-0177
                                                               1545-0786
1.165-12...................................................    1545-0786
1.166-1....................................................    1545-0123
1.166-2....................................................    1545-1254
1.166-4....................................................    1545-0123
1.166-10...................................................    1545-0123
1.167(a)-5T................................................    1545-1021
1.167(a)-7.................................................    1545-0172
1.167(a)-11................................................    1545-0152
                                                               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)-1.................................................    1545-2248
1.263(a)-3.................................................    1545-2248
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
1.336-2....................................................    1545-2125
1.336-4....................................................    1545-2125
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

[[Page 942]]

 
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
1.362-4....................................................    1545-2247
1.367(a)-1T................................................    1545-0026
1.367(a)-2T................................................    1545-0026
1.367(a)-3.................................................    1545-0026
                                                               1545-1478
1.367(a)-3T................................................    1545-2183
1.367(a)-6T................................................    1545-0026
1.367(a)-7.................................................    1545-2183
1.367(a)-7T................................................    1545-2183
1.367(a)-8.................................................    1545-1271
                                                               1545-2056
                                                               1545-2183
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)(9)-1..............................................    1545-1573
1.401(a)(9)-3..............................................    1545-1466
1.401(a)(9)-4..............................................    1545-1573
1.401(a)(9)-6..............................................    1545-2234
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
1.401-12(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

[[Page 943]]

 
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
                                                               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
1.501(r)-3.................................................    1545-0047
1.501(r)-4.................................................    1545-0047
1.501(r)-6.................................................    1545-0047
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)-4.................................................    1545-2157
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

[[Page 944]]

 
1.585-8....................................................    1545-1290
1.586-2....................................................    1545-0123
1.593-1....................................................    1545-0123
1.593-6....................................................    1545-0123
1.593-6A...................................................    1545-0123
1.593-7....................................................    1545-0123
1.595-1....................................................    1545-0123
1.597-2....................................................    1545-1300
1.597-4....................................................    1545-1300
1.597-6....................................................    1545-1300
1.597-7....................................................    1545-1300
1.611-2....................................................    1545-0099
1.611-3....................................................    1545-0007
                                                               1545-0099
                                                               1545-1784
1.612-4....................................................    1545-0074
1.612-5....................................................    1545-0099
1.613-3....................................................    1545-0099
1.613-4....................................................    1545-0099
1.613-6....................................................    1545-0099
1.613-7....................................................    1545-0099
1.613A-3...................................................    1545-0919
1.613A-3(e)................................................    1545-1251
1.613A-3(l)................................................    1545-0919
1.613A-5...................................................    1545-0099
1.613A-6...................................................    1545-0099
1.614-2....................................................    1545-0099
1.614-3....................................................    1545-0099
1.614-5....................................................    1545-0099
1.614-6....................................................    1545-0099
1.614-8....................................................    1545-0099
1.617-1....................................................    1545-0099
1.617-3....................................................    1545-0099
1.617-4....................................................    1545-0099
1.631-1....................................................    1545-0007
1.631-2....................................................    1545-0007
1.641(b)-2.................................................    1545-0092
1.642(c)-1.................................................    1545-0092
1.642(c)-2.................................................    1545-0092
1.642(c)-5.................................................    1545-0074
1.642(c)-6.................................................    1545-0020
                                                               1545-0074
                                                               1545-0092
1.642(g)-1.................................................    1545-0092
1.642(i)-1.................................................    1545-0092
1.645-1....................................................    1545-1578
1.663(b)-2.................................................    1545-0092
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

[[Page 945]]

 
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
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
1.874-1....................................................    1545-0089
1.881-4....................................................    1545-1440
1.882-4....................................................    1545-0126
1.883-0....................................................    1545-1677
1.883-1....................................................    1545-1677
1.883-2....................................................    1545-1677
1.883-3....................................................    1545-1677
1.883-4....................................................    1545-1677
1.883-5....................................................    1545-1677
1.884-0....................................................    1545-1070
1.884-1....................................................    1545-1070
1.884-2....................................................    1545-1070
1.884-2T...................................................    1545-0126
                                                               1545-1070
1.884-4....................................................    1545-1070
1.884-5....................................................    1545-1070
1.892-1T...................................................    1545-1053
1.892-2T...................................................    1545-1053
1.892-3T...................................................    1545-1053
1.892-4T...................................................    1545-1053
1.892-5T...................................................    1545-1053
1.892-6T...................................................    1545-1053
1.892-7T...................................................    1545-1053
1.897-2....................................................    1545-0123
                                                               1545-0902
1.897-3....................................................    1545-0123
1.897-5T...................................................    1545-0902
1.897-6T...................................................    1545-0902
1.901-2....................................................    1545-0746
1.901-2A...................................................    1545-0746
1.901-3....................................................    1545-0122
1.902-1....................................................    1545-0122
                                                               1545-1458
1.904-1....................................................    1545-0121
                                                               1545-0122
1.904-2....................................................    1545-0121
                                                               1545-0122
1.904-3....................................................    1545-0121
1.904-4....................................................    1545-0121
1.904-5....................................................    1545-0121
1.904-7....................................................    1545-2104
1.904-7T...................................................    1545-2104
1.904(f)-1.................................................    1545-0121
                                                               1545-0122
1.904(f)-2.................................................    1545-0121
1.904(f)-3.................................................    1545-0121
1.904(f)-4.................................................    1545-0121
1.904(f)-5.................................................    1545-0121
1.904(f)-6.................................................    1545-0121
1.904(f)-7.................................................    1545-1127
1.905-2....................................................    1545-0122
1.905-3T...................................................    1545-1056
1.905-4T...................................................    1545-1056
1.905-5T...................................................    1545-1056
1.911-1....................................................    1545-0067
                                                               1545-0070
1.911-2....................................................    1545-0067
                                                               1545-0070
1.911-3....................................................    1545-0067
                                                               1545-0070
1.911-4....................................................    1545-0067
                                                               1545-0070
1.911-5....................................................    1545-0067
                                                               1545-0070
1.911-6....................................................    1545-0067
                                                               1545-0070
1.911-7....................................................    1545-0067
                                                               1545-0070
1.913-13...................................................    1545-0067
1.921-1T...................................................    1545-0190
                                                               1545-0884
                                                               1545-0935
                                                               1545-0939
1.921-2....................................................    1545-0884
1.921-3T...................................................    1545-0935
1.923-1T...................................................    1545-0935
1.924(a)-1T................................................    1545-0935
1.925(a)-1T................................................    1545-0935
1.925(b)-1T................................................    1545-0935
1.926(a)-1T................................................    1545-0935
1.927(a)-1T................................................    1545-0935
1.927(b)-1T................................................    1545-0935
1.927(d)-1.................................................    1545-0884
1.927(d)-2T................................................    1545-0935
1.927(e)-1T................................................    1545-0935
1.927(e)-2T................................................    1545-0935
1.927(f)-1.................................................    1545-0884
1.931-1....................................................    1545-0074
                                                               1545-0123
1.934-1....................................................    1545-0782
1.935-1....................................................    1545-0074
                                                               1545-0087
                                                               1545-0803
1.936-1....................................................    1545-0215
                                                               1545-0217
1.936-4....................................................    1545-0215
1.936-5....................................................    1545-0704
1.936-6....................................................    1545-0215
1.936-7....................................................    1545-0215
1.936-10(c)................................................    1545-1138
1.937-1....................................................    1545-1930
1.952-2....................................................    1545-0126
1.953-2....................................................    1545-0126
1.954-1....................................................    1545-1068
1.954-2....................................................    1545-1068
1.955-2....................................................    1545-0123
1.955-3....................................................    1545-0123
1.955A-2...................................................    1545-0755
1.955A-3...................................................    1545-0755

[[Page 946]]

 
1.956-1....................................................    1545-0704
1.956-2....................................................    1545-0704
1.959-1....................................................    1545-0704
1.959-2....................................................    1545-0704
1.960-1....................................................    1545-0122
1.962-2....................................................    1545-0704
1.962-3....................................................    1545-0704
1.962-4....................................................    1545-0704
1.964-1....................................................    1545-0126
                                                               1545-0704
                                                               1545-1072
                                                               1545-2104
1.964-3....................................................    1545-0126
1.970-2....................................................    1545-0126
1.985-2....................................................    1545-1051
                                                               1545-1131
1.985-3....................................................    1545-1051
1.988-0....................................................    1545-1131
1.988-1....................................................    1545-1131
1.988-2....................................................    1545-1131
1.988-3....................................................    1545-1131
1.988-4....................................................    1545-1131
1.988-5....................................................    1545-1131
1.988-6....................................................    1545-1831
1.992-1....................................................    1545-0190
                                                               1545-0938
1.992-2....................................................    1545-0190
                                                               1545-0884
                                                               1545-0938
1.992-3....................................................    1545-0190
                                                               1545-0938
1.992-4....................................................    1545-0190
                                                               1545-0938
1.993-3....................................................    1545-0938
1.993-4....................................................    1545-0938
1.994-1....................................................    1545-0938
1.995-5....................................................    1545-0938
1.1001-1...................................................    1545-1902
1.1012-1...................................................    1545-0074
                                                               1545-1139
1.1014-4...................................................    1545-0184
1.1015-1...................................................    1545-0020
1.1017-1...................................................    1545-1539
1.1031(d)-1T...............................................    1545-1021
1.1033(a)-2................................................    1545-0184
1.1033(g)-1................................................    1545-0184
1.1034-1...................................................    1545-0072
1.1039-1...................................................    1545-0184
1.1041-1T..................................................    1545-0074
1.1041-2...................................................    1545-1751
1.1042-1T..................................................    1545-0916
1.1044(a)-1................................................    1545-1421
1.1045-1...................................................    1545-1893
1.1060-1...................................................    1545-1658
                                                               1545-1990
1.1071-1...................................................    1545-0184
1.1071-4...................................................    1545-0184
1.1081-4...................................................    1545-0028
                                                               1545-0046
                                                               1545-0123
1.1081-11..................................................    1545-2019
1.1082-1...................................................    1545-0046
1.1082-2...................................................    1545-0046
1.1082-3...................................................    1545-0046
                                                               1545-0184
1.1082-4...................................................    1545-0046
1.1082-5...................................................    1545-0046
1.1082-6...................................................    1545-0046
1.1083-1...................................................    1545-0123
1.1092(b)-1T...............................................    1545-0644
1.1092(b)-2T...............................................    1545-0644
1.1092(b)-3T...............................................    1545-0644
1.1092(b)-4T...............................................    1545-0644
1.1092(b)-5T...............................................    1545-0644
1.1211-1...................................................    1545-0074
1.1212-1...................................................    1545-0074
1.1221-2...................................................    1545-1480
1.1231-1...................................................    1545-0177
                                                               1545-0184
1.1231-2...................................................    1545-0177
                                                               1545-0184
1.1231-2...................................................    1545-0074
1.1232-3...................................................    1545-0074
1.1237-1...................................................    1545-0184
1.1239-1...................................................    1545-0091
1.1242-1...................................................    1545-0184
1.1243-1...................................................    1545-0123
1.1244(e)-1................................................    1545-0123
                                                               1545-1447
1.1245-1...................................................    1545-0184
1.1245-2...................................................    1545-0184
1.1245-3...................................................    1545-0184
1.1245-4...................................................    1545-0184
1.1245-5...................................................    1545-0184
1.1245-6...................................................    1545-0184
1.1247-1...................................................    1545-0122
1.1247-2...................................................    1545-0122
1.1247-4...................................................    1545-0122
1.1247-5...................................................    1545-0122
1.1248-7...................................................    1545-0074
1.1248(f)-2................................................    1545-2183
1.1248(f)-3T...............................................    1545-2183
1.1250-1...................................................    1545-0184
1.1250-2...................................................    1545-0184
1.1250-3...................................................    1545-0184
1.1250-4...................................................    1545-0184
1.1250-5...................................................    1545-0184
1.1251-1...................................................    1545-0184
1.1251-2...................................................    1545-0074
                                                               1545-0184
1.1251-3...................................................    1545-0184
1.1251-4...................................................    1545-0184
1.1252-1...................................................    1545-0184
1.1252-2...................................................    1545-0184
1.1254-1(c)(3).............................................    1545-1352
1.1254-4...................................................    1545-1493
1.1254-5(d)(2).............................................    1545-1352
1.1258-1...................................................    1545-1452
1.1272-3...................................................    1545-1353
1.1273-2(f)(9).............................................    1545-1353
1.1273-2(h)(2).............................................    1545-1353
1.1274-3(d)................................................    1545-1353
1.1274-5(b)................................................    1545-1353
1.1274A-1(c)...............................................    1545-1353
1.1275-2...................................................    1545-1450
1.1275-3...................................................    1545-0887
                                                               1545-1353
                                                               1545-1450
1.1275-4...................................................    1545-1450
1.1275-6...................................................    1545-1450
1.1287-1...................................................    1545-0786
1.1291-9...................................................    1545-1507
1.1291-10..................................................    1545-1304
                                                               1545-1507
1.1294-1T..................................................    1545-1002
                                                               1545-1028
1.1295-1...................................................    1545-1555
1.1295-3...................................................    1545-1555
1.1298-3...................................................    1545-1507
1.1301-1...................................................    1545-1662
1.1311(a)-1................................................    1545-0074
1.1361-1...................................................    1545-0731
                                                               1545-1591
                                                               1545-2114

[[Page 947]]

 
1.1361-3...................................................    1545-1590
1.1361-5...................................................    1545-1590
1.1362-1...................................................    1545-1308
1.1362-2...................................................    1545-1308
1.1362-3...................................................    1545-1308
1.1362-4...................................................    1545-1308
1.1362-5...................................................    1545-1308
1.1362-6...................................................    1545-1308
1.1362-7...................................................    1545-1308
1.1362-8...................................................    1545-1590
1.1363-2...................................................    1545-1906
1.1366-1...................................................    1545-1613
1.1367-1(f)................................................    1545-1139
1.1368-1(f)(2).............................................    1545-1139
1.1368-1(f)(3).............................................    1545-1139
1.1368-1(f)(4).............................................    1545-1139
1.1368-1(g)(2).............................................    1545-1139
1.1374-1A..................................................    1545-0130
1.1377-1...................................................    1545-1462
1.1378-1...................................................    1545-1748
1.1383-1...................................................    1545-0074
1.1385-1...................................................    1545-0074
                                                               1545-0098
1.1388-1...................................................    1545-0118
                                                               1545-0123
1.1397E-1..................................................    1545-1908
1.1398-1...................................................    1545-1375
1.1398-2...................................................    1545-1375
1.1402(a)-2................................................    1545-0074
1.1402(a)-5................................................    1545-0074
1.1402(a)-11...............................................    1545-0074
1.1402(a)-15...............................................    1545-0074
1.1402(a)-16...............................................    1545-0074
1.1402(b)-1................................................    1545-0171
1.1402(c)-2................................................    1545-0074
1.1402(e)(1)-1.............................................    1545-0074
1.1402(e)(2)-1.............................................    1545-0074
1.1402(e)-1A...............................................    1545-0168
1.1402(e)-2A...............................................    1545-0168
1.1402(e)-3A...............................................    1545-0168
1.1402(e)-4A...............................................    1545-0168
1.1402(e)-5A...............................................    1545-0168
1.1402(f)-1................................................    1545-0074
1.1402(h)-1................................................    1545-0064
1.1411-10(g)...............................................    1545-2227
1.1441-1...................................................    1545-1484
1.1441-2...................................................    1545-0795
1.1441-3...................................................    1545-0165
                                                               1545-0795
1.1441-4...................................................    1545-1484
1.1441-5...................................................    1545-0096
                                                               1545-0795
                                                               1545-1484
1.1441-6...................................................    1545-0055
                                                               1545-0795
                                                               1545-1484
1.1441-7...................................................    1545-0795
1.1441-8...................................................    1545-1053
                                                               1545-1484
1.1441-9...................................................    1545-1484
1.1443-1...................................................    1545-0096
1.1445-1...................................................    1545-0902
1.1445-2...................................................    1545-0902
                                                               1545-1060
                                                               1545-1797
1.1445-3...................................................    1545-0902
                                                               1545-1060
                                                               1545-1797
1.1445-4...................................................    1545-0902
1.1445-5...................................................    1545-0902
1.1445-6...................................................    1545-0902
                                                               1545-1060
1.1445-7...................................................    1545-0902
1.1445-8...................................................    1545-0096
1.1445-9T..................................................    1545-0902
1.1445-10T.................................................    1545-0902
1.1446-1...................................................    1545-1934
1.1446-3...................................................    1545-1934
1.1446-4...................................................    1545-1934
1.1446-5...................................................    1545-1934
1.1446-6...................................................    1545-1934
1.1451-1...................................................    1545-0054
1.1451-2...................................................    1545-0054
1.1461-1...................................................    1545-0054
                                                               1545-0055
                                                               1545-0795
                                                               1545-1484
1.1461-2...................................................    1545-0054
                                                               1545-0055
                                                               1545-0096
                                                               1545-0795
1.1462-1...................................................    1545-0795
1.1492-1...................................................    1545-0026
1.1494-1...................................................    1545-0026
1.1502-5...................................................    1545-0257
1.1502-9...................................................    1545-1634
1.1502-9A..................................................    1545-0121
1.1502-13..................................................    1545-0123
                                                               1545-0885
                                                               1545-1161
                                                               1545-1433
1.1502-16..................................................    1545-0123
1.1502-18..................................................    1545-0123
1.1502-19..................................................    1545-0123
                                                               1545-1774
1.1502-20..................................................    1545-1774
1.1502-21..................................................    1545-1237
1.1502-21T.................................................    1545-2171
1.1502-31..................................................    1545-1344
1.1502-32..................................................    1545-1344
                                                               1545-1774
1.1502-33..................................................    1545-1344
1.1502-35..................................................    1545-1828
1.1502-36..................................................    1545-2096
1.1502-47..................................................    1545-0123
1.1502-75..................................................    1545-0025
                                                               1545-0123
                                                               1545-0133
                                                               1545-0152
1.1502-76..................................................    1545-1344
1.1502-76T.................................................    1545-2019
1.1502-77..................................................    1545-1699
1.1502-77A.................................................    1545-0123
                                                               1545-1046
1.1502-77B.................................................    1545-1699
1.1502-78..................................................    1545-0582
1.1502-95..................................................    1545-1218
1.1502-95A.................................................    1545-1218
1.1502-96..................................................    1545-1218
1.1503-2...................................................    1545-1583
1.1503-2A..................................................    1545-1083
1.1503(d)-1................................................    1545-1946
1.1503(d)-3................................................    1545-1946
1.1503(d)-4................................................    1545-1946
1.1503(d)-5................................................    1545-1946
1.1503(d)-6................................................    1545-1946
1.1552-1...................................................    1545-0123
1.1561-3...................................................    1545-0123
1.1563-1...................................................    1545-0123
                                                               1545-0797
                                                               1545-2019
1.1563-3...................................................    1545-0123
1.5000A-3..................................................    1545-0074
1.5000A-4..................................................    1545-0074

[[Page 948]]

 
1.6001-1...................................................    1545-0058
                                                               1545-0074
                                                               1545-0099
                                                               1545-0123
                                                               1545-0865
1.6011-1...................................................    1545-0055
                                                               1545-0074
                                                               1545-0085
                                                               1545-0089
                                                               1545-0090
                                                               1545-0091
                                                               1545-0096
                                                               1545-0121
                                                               1545-0458
                                                               1545-0666
                                                               1545-0675
                                                               1545-0908
1.6011-2...................................................    1545-0055
                                                               1545-0938
1.6011-3...................................................    1545-0238
                                                               1545-0239
1.6011-4...................................................    1545-1685
1.6012-1...................................................    1545-0067
                                                               1545-0074
                                                               1545-0085
                                                               1545-0089
                                                               1545-0675
1.6012-2...................................................    1545-0047
                                                               1545-0051
                                                               1545-0067
                                                               1545-0123
                                                               1545-0126
                                                               1545-0128
                                                               1545-0130
                                                               1545-0175
                                                               1545-0687
                                                               1545-0890
                                                               1545-1023
                                                               1545-1027
1.6012-3...................................................    1545-0047
                                                               1545-0067
                                                               1545-0092
                                                               1545-0196
                                                               1545-0687
1.6012-4...................................................    1545-0067
1.6012-5...................................................    1545-0067
                                                               1545-0936
                                                               1545-0967
                                                               1545-0970
                                                               1545-0991
                                                               1545-1023
                                                               1545-1033
                                                               1545-1079
1.6012-6...................................................    1545-0067
                                                               1545-0089
                                                               1545-0129
1.6013-1...................................................    1545-0074
1.6013-2...................................................    1545-0091
1.6013-6...................................................    1545-0074
1.6013-7...................................................    1545-0074
1.6015-5...................................................    1545-1719
1.6015(a)-1................................................    1545-0087
1.6015(b)-1................................................    1545-0087
1.6015(d)-1................................................    1545-0087
1.6015(e)-1................................................    1545-0087
1.6015(f)-1................................................    1545-0087
1.6015(g)-1................................................    1545-0087
1.6015(h)-1................................................    1545-0087
1.6015(i)-1................................................    1545-0087
1.6017-1...................................................    1545-0074
                                                               1545-0087
                                                               1545-0090
1.6031(a)-1................................................    1545-1583
1.6031(b)-1T...............................................    1545-0099
1.6031(c)-1T...............................................    1545-0099
1.6032-1...................................................    1545-0099
1.6033-2...................................................    1545-0047
                                                               1545-0049
                                                               1545-0052
                                                               1545-0092
                                                               1545-0687
                                                               1545-1150
                                                               1545-2117
1.6033-3...................................................    1545-0052
1.6034-1...................................................    1545-0092
                                                               1545-0094
1.6035-1...................................................    1545-0704
1.6035-2...................................................    1545-0704
1.6035-3...................................................    1545-0704
1.6037-1...................................................    1545-0130
                                                               1545-1023
1.6038-2...................................................    1545-1617
                                                               1545-2020
1.6038-3...................................................    1545-1617
1.6038A-2..................................................    1545-1191
1.6038A-3..................................................    1545-1191
                                                               1545-1440
1.6038B-1..................................................    1545-1617
                                                               1545-2183
1.6038B-1T.................................................    1545-0026
                                                               1545-2183
1.6038B-2..................................................    1545-1617
1.6039-2...................................................    1545-0820
1.6041-1...................................................    1545-0008
                                                               1545-0108
                                                               1545-0112
                                                               1545-0115
                                                               1545-0120
                                                               1545-0295
                                                               1545-0350
                                                               1545-0367
                                                               1545-0387
                                                               1545-0441
                                                               1545-0957
                                                               1545-1705
1.6041-2...................................................    1545-0008
                                                               1545-0119
                                                               1545-0350
                                                               1545-0441
                                                               1545-1729
1.6041-3...................................................    1545-1148
1.6041-4...................................................    1545-0115
                                                               1545-0295
                                                               1545-0367
                                                               1545-0387
                                                               1545-0957
1.6041-5...................................................    1545-0295
                                                               1545-0367
                                                               1545-0387
                                                               1545-0957
1.6041-6...................................................    1545-0008
                                                               1545-0115
1.6041-7...................................................    1545-0112
                                                               1545-0295
                                                               1545-0350
                                                               1545-0367
                                                               1545-0387
                                                               1545-0441
                                                               1545-0957
1.6042-1...................................................    1545-0110
1.6042-2...................................................    1545-0110
                                                               1545-0295
                                                               1545-0367
                                                               1545-0387

[[Page 949]]

 
                                                               1545-0957
1.6042-3...................................................    1545-0295
                                                               1545-0367
                                                               1545-0387
                                                               1545-0957
1.6042-4...................................................    1545-0110
1.6043-1...................................................    1545-0041
1.6043-2...................................................    1545-0041
                                                               1545-0110
                                                               1545-0295
                                                               1545-0387
1.6043-3...................................................    1545-0047
1.6044-1...................................................    1545-0118
1.6044-2...................................................    1545-0118
1.6044-3...................................................    1545-0118
1.6044-4...................................................    1545-0118
1.6044-5...................................................    1545-0118
1.6045-1...................................................    1545-0715
                                                               1545-1705
1.6045-1(c)(3)(xi)(C)......................................    1545-2186
1.6045-1(n)(5).............................................    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
                                                               1545-0295
                                                               1545-0387
1.6047-2...................................................    1545-2234
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
1.6055-1...................................................    1545-2252
1.6055-2...................................................    1545-2252
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

[[Page 950]]

 
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
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
20.2010-2T.................................................    1545-0015
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

[[Page 951]]

 
                                                               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
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

[[Page 952]]

 
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
                                                               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
                                                               1545-2097
31.6413(a)-1...............................................    1545-0029
                                                               1545-2097
31.6413(a)-2...............................................    1545-0029
                                                               1545-0256
                                                               1545-2097
31.6413(c)-1...............................................    1545-0029
                                                               1545-0171
31.6414-1..................................................    1545-0029
                                                               1545-2097
32.1.......................................................    1545-0029
                                                               1545-0415
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
41.4481-2..................................................    1545-0143
41.4483-3..................................................    1545-0143
41.6001-1..................................................    1545-0143
41.6001-2..................................................    1545-0143
41.6001-3..................................................    1545-0143
41.6060-1(a)(1)............................................    1545-1231
41.6071(a)-1...............................................    1545-0143
41.6081(a)-1...............................................    1545-0143
41.6091-1..................................................    1545-0143
41.6107-1..................................................    1545-1231
41.6109-1..................................................    1545-0143
41.6151(a)-1...............................................    1545-0143
41.6156-1..................................................    1545-0143
41.6161(a)(1)-1............................................    1545-0143
44.4401-1..................................................    1545-0235
44.4403-1..................................................    1545-0235
44.4412-1..................................................    1545-0236

[[Page 953]]

 
44.4901-1..................................................    1545-0236
44.4905-1..................................................    1545-0236
44.4905-2..................................................    1545-0236
44.6001-1..................................................    1545-0235
44.6011(a)-1...............................................    1545-0235
                                                               1545-0236
44.6060-1(a)(1)............................................    1545-1231
44.6071-1..................................................    1545-0235
44.6091-1..................................................    1545-0235
44.6107-1..................................................    1545-1231
44.6151-1..................................................    1545-0235
44.6419-1..................................................    1545-0235
44.6419-2..................................................    1545-0235
46.4371-4..................................................    1545-0023
46.4374-1..................................................    1545-0023
46.4375-1..................................................    1545-2238
46.4376-1..................................................    1545-2238
46.4701-1..................................................    1545-0023
                                                               1545-0257
48.4041-4..................................................    1545-0023
48.4041-5..................................................    1545-0023
48.4041-6..................................................    1545-0023
48.4041-7..................................................    1545-0023
48.4041-9..................................................    1545-0023
48.4041-10.................................................    1545-0023
48.4041-11.................................................    1545-0023
48.4041-12.................................................    1545-0023
48.4041-13.................................................    1545-0023
48.4041-18.................................................    1545-0023
48.4041-19.................................................    1545-0023
48.4041-20.................................................    1545-0023
48.4041-21.................................................    1545-1270
48.4042-2..................................................    1545-0023
48.4052-1..................................................    1545-1418
48.4061(a)-1...............................................    1545-0023
48.4061(a)-2...............................................    1545-0023
48.4061(b)-3...............................................    1545-0023
48.4064-1..................................................    1545-0014
                                                               1545-0242
48.4071-1..................................................    1545-0023
48.4073-1..................................................    1545-0023
48.4073-3..................................................    1545-0023
                                                               1545-1074
                                                               1545-1087
48.4081-2..................................................    1545-1270
                                                               1545-1418
48.4081-3..................................................    1545-1270
                                                               1545-1418
                                                               1545-1897
48.4081-4(b)(2)(ii)........................................    1545-1270
48.4081-4(b)(3)(i).........................................    1545-1270
48.4081-4(c)...............................................    1545-1270
48.4081-6(c)(1)(ii)........................................    1545-1270
48.4081-7..................................................    1545-1270
                                                               1545-1418
48.4082-1T.................................................    1545-1418
48.4082-2..................................................    1545-1418
48.4082-6..................................................    1545-1418
48.4082-7..................................................    1545-1418
48.4091-3..................................................    1545-1418
48.4101-1..................................................    1545-1418
48.4101-1T.................................................    1545-1418
48.4101-2..................................................    1545-1418
48.4161(a)-1...............................................    1545-0723
48.4161(a)-2...............................................    1545-0723
48.4161(a)-3...............................................    1545-0723
48.4161(b)-1...............................................    1545-0723
48.4216(a)-2...............................................    1545-0023
48.4216(a)-3...............................................    1545-0023
48.4216(c)-1...............................................    1545-0023
48.4221-1..................................................    1545-0023
48.4221-2..................................................    1545-0023
48.4221-3..................................................    1545-0023
48.4221-4..................................................    1545-0023
48.4221-5..................................................    1545-0023
48.4221-6..................................................    1545-0023
48.4221-7..................................................    1545-0023
48.4222(a)-1...............................................    1545-0014
                                                               1545-0023
48.4223-1..................................................    1545-0023
                                                               1545-0257
                                                               1545-0723
48.6302(c)-1...............................................    1545-0023
                                                               1545-0257
48.6412-1..................................................    1545-0723
48.6416(a)-1...............................................    1545-0023
                                                               1545-0723
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
                                                               1545-1087
48.6416(b)(2)-4............................................    1545-0723
48.6416(b)(3)-1............................................    1545-0723
48.6416(b)(3)-2............................................    1545-0723
48.6416(b)(3)-3............................................    1545-0723
48.6416(b)(4)-1............................................    1545-0723
48.6416(b)(5)-1............................................    1545-0723
48.6416(c)-1...............................................    1545-0723
48.6416(e)-1...............................................    1545-0023
                                                               1545-0723
48.6416(f)-1...............................................    1545-0023
                                                               1545-0723
48.6416(g)-1...............................................    1545-0723
48.6416(h)-1...............................................    1545-0723
48.6420(c)-2...............................................    1545-0023
48.6420(f)-1...............................................    1545-0023
48.6420-1..................................................    1545-0162
                                                               1545-0723
48.6420-2..................................................    1545-0162
                                                               1545-0723
48.6420-3..................................................    1545-0162
                                                               1545-0723
48.6420-4..................................................    1545-0162
                                                               1545-0723
48.6420-5..................................................    1545-0162
                                                               1545-0723
48.6420-6..................................................    1545-0162
                                                               1545-0723
48.6421-0..................................................    1545-0162
                                                               1545-0723
48.6421-1..................................................    1545-0162
                                                               1545-0723
48.6421-2..................................................    1545-0162
                                                               1545-0723
48.6421-3..................................................    1545-0162
                                                               1545-0723
48.6421-4..................................................    1545-0162
                                                               1545-0723
48.6421-5..................................................    1545-0162
                                                               1545-0723
48.6421-6..................................................    1545-0162
                                                               1545-0723
48.6421-7..................................................    1545-0162
                                                               1545-0723
48.6424-0..................................................    1545-0723
48.6424-1..................................................    1545-0723
48.6424-2..................................................    1545-0723
48.6424-3..................................................    1545-0723

[[Page 954]]

 
48.6424-4..................................................    1545-0723
48.6424-5..................................................    1545-0723
48.6424-6..................................................    1545-0723
48.6427-0..................................................    1545-0723
48.6427-1..................................................    1545-0023
                                                               1545-0162
                                                               1545-0723
48.6427-2..................................................    1545-0162
                                                               1545-0723
48.6427-3..................................................    1545-0723
48.6427-4..................................................    1545-0723
48.6427-5..................................................    1545-0723
48.6427-8..................................................    1545-1418
48.6427-9..................................................    1545-1418
48.6427-10.................................................    1545-1418
48.6427-11.................................................    1545-1418
49.4251-1..................................................    1545-1075
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
                                                               1545-0224
                                                               1545-0225
                                                               1545-0226
                                                               1545-0230
                                                               1545-0257
                                                               1545-0912
49.4271-1(d)...............................................    1545-0685
49.5000B-1.................................................    1545-2177
51.2(f)(2)(ii).............................................    1545-2209
51.7.......................................................    1545-2209
52.4682-1(b)(2)(iii).......................................    1545-1153
52.4682-2(b)...............................................    1545-1153
                                                               1545-1361
52.4682-2(d)...............................................    1545-1153
                                                               1545-1361
52.4682-3(c)(2)............................................    1545-1153
52.4682-3(g)...............................................    1545-1153
52.4682-4(f)...............................................    1545-0257
                                                               1545-1153
52.4682-5(d)...............................................    1545-1361
52.4682-5(f)...............................................    1545-1361
53.4940-1..................................................    1545-0052
                                                               1545-0196
53.4942(a)-1...............................................    1545-0052
53.4942(a)-2...............................................    1545-0052
53.4942(a)-3...............................................    1545-0052
53.4942(b)-3...............................................    1545-0052
53.4945-1..................................................    1545-0052
53.4945-4..................................................    1545-0052
53.4945-5..................................................    1545-0052
53.4945-6..................................................    1545-0052
53.4947-1..................................................    1545-0196
53.4947-2..................................................    1545-0196
53.4948-1..................................................    1545-0052
53.4958-6..................................................    1545-1623
53.4961-2..................................................    1545-0024
53.4963-1..................................................    1545-0024
53.6001-1..................................................    1545-0052
53.6011-1..................................................    1545-0049
                                                               1545-0052
                                                               1545-0092
                                                               1545-0196
53.6060-1(a)(1)............................................    1545-1231
53.6065-1..................................................    1545-0052
53.6071-1..................................................    1545-0049
53.6081-1..................................................    1545-0066
                                                               1545-0148
53.6107-1..................................................    1545-1231
53.6161-1..................................................    1545-0575
54.4972-1..................................................    1545-0197
54.4975-7..................................................    1545-0575
54.4977-1T.................................................    1545-0771
54.4980B-6.................................................    1545-1581
54.4980B-7.................................................    1545-1581
54.4980B-8.................................................    1545-1581
54.4980F-1.................................................    1545-1780
54.4981A-1T................................................    1545-0203
54.6011-1..................................................    1545-0575
54.6011-1T.................................................    1545-0575
54.6060-1(a)(1)............................................    1545-1231
54.6107-1..................................................    1545-1231
54.9801-3..................................................    1545-1537
54.9801-4..................................................    1545-1537
54.9801-5..................................................    1545-1537
54.9801-6..................................................    1545-1537
54.9812-1T.................................................    1545-2165
54.9815-1251T..............................................    1545-2178
54.9815-2711T..............................................    1545-2179
54.9815-2712T..............................................    1545-2180
54.9815-2714T..............................................    1545-2172
54.9815-2715...............................................    1545-2229
54.9815-2719AT.............................................    1545-2181
54.9815-2719T..............................................    1545-2182
55.6001-1..................................................    1545-0123
55.6011-1..................................................    1545-0123
                                                               1545-0999
                                                               1545-1016
55.6060-1(a)(1)............................................    1545-1231
55.6061-1..................................................    1545-0999
55.6071-1..................................................    1545-0999
55.6107-1..................................................    1545-1231
56.4911-6..................................................    1545-0052
56.4911-7..................................................    1545-0052
56.4911-9..................................................    1545-0052
56.4911-10.................................................    1545-0052
56.6001-1..................................................    1545-1049
56.6011-1..................................................    1545-1049
56.6060-1(a)(1)............................................    1545-1231
56.6081-1..................................................    1545-1049
56.6107-1..................................................    1545-1231
56.6161-1..................................................    1545-0257
                                                               1545-1049
57.2(e)(2)(i)..............................................    1545-2249
145.4051-1.................................................    1545-0745
145.4052-1.................................................    1545-0120
                                                               1545-0745
                                                               1545-1076
145.4061-1.................................................    1545-0224
                                                               1545-0230
                                                               1545-0257
                                                               1545-0745
156.6001-1.................................................    1545-1049
156.6011-1.................................................    1545-1049
156.6060-1(a)(1)...........................................    1545-1231
156.6081-1.................................................    1545-1049
156.6107-1.................................................    1545-1231
156.6161-1.................................................    1545-1049
157.6001-1.................................................    1545-1824
157.6011-1.................................................    1545-1824
157.6060-1(a)(1)...........................................    1545-1231
157.6081-1.................................................    1545-1824
157.6107-1.................................................    1545-1231
157.6161-1.................................................    1545-1824
301.6011-2.................................................    1545-0225
                                                               1545-0350
                                                               1545-0387
                                                               1545-0441
                                                               1545-0957
301.6011(g)-1..............................................    1545-2079
301.6017-1.................................................    1545-0090
301.6034-1.................................................    1545-0092
301.6035-1.................................................    1545-0123

[[Page 955]]

 
301.6036-1.................................................    1545-0013
                                                               1545-0773
301.6047-1.................................................    1545-0367
                                                               1545-0957
301.6056-1.................................................    1545-2251
301.6056-2.................................................    1545-2251
301.6057-1.................................................    1545-0710
301.6057-2.................................................    1545-0710
301.6058-1.................................................    1545-0710
301.6059-1.................................................    1545-0710
301.6103(c)-1..............................................    1545-1816
301.6103(n)-1..............................................    1545-1841
301.6103(p)(2)(B)-1........................................    1545-1757
301.6104(a)-1..............................................    1545-0495
301.6104(a)-5..............................................    1545-0056
301.6104(a)-6..............................................    1545-0056
301.6104(b)-1..............................................    1545-0094
                                                               1545-0742
301.6104(d)-1..............................................    1545-1655
301.6104(d)-2..............................................    1545-1655
301.6104(d)-3..............................................    1545-1655
301.6109-1.................................................    1545-0003
                                                               1545-0295
                                                               1545-0367
                                                               1545-0387
                                                               1545-0957
                                                               1545-1461
                                                               1545-2242
301.6109-3.................................................    1545-1564
301.6110-3.................................................    1545-0074
301.6110-5.................................................    1545-0074
301.6111-1T................................................    1545-0865
                                                               1545-0881
301.6111-2.................................................    1545-0865
                                                               1545-1687
301.6112-1.................................................    1545-0865
                                                               1545-1686
301.6112-1T................................................    1545-0865
                                                               1545-1686
301.6114-1.................................................    1545-1126
                                                               1545-1484
301.6222(a)-2..............................................    1545-0790
301.6222(b)-1..............................................    1545-0790
301.6222(b)-2..............................................    1545-0790
301.6222(b)-3..............................................    1545-0790
301.6223(b)-1..............................................    1545-0790
301.6223(c)-1..............................................    1545-0790
301.6223(e)-2..............................................    1545-0790
301.6223(g)-1..............................................    1545-0790
301.6223(h)-1..............................................    1545-0790
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
301.6231(c)-1..............................................    1545-0790
301.6231(c)-2..............................................    1545-0790
301.6241-1T................................................    1545-0130
301.6316-4.................................................    1545-0074
301.6316-5.................................................    1545-0074
301.6316-6.................................................    1545-0074
301.6316-7.................................................    1545-0029
301.6324A-1................................................    1545-0015
301.6361-1.................................................    1545-0024
                                                               1545-0074
301.6361-2.................................................    1545-0024
301.6361-3.................................................    1545-0074
301.6402-2.................................................    1545-0024
                                                               1545-0073
                                                               1545-0091
301.6402-3.................................................    1545-0055
                                                               1545-0073
                                                               1545-0091
                                                               1545-0132
                                                               1545-1484
301.6402-5.................................................    1545-0928
301.6404-1.................................................    1545-0024
301.6404-2T................................................    1545-0024
301.6404-3.................................................    1545-0024
301.6405-1.................................................    1545-0024
301.6501(c)-1..............................................    1545-1241
                                                               1545-1637
301.6501(d)-1..............................................    1545-0074
                                                               1545-0430
301.6501(o)-2..............................................    1545-0728
301.6511(d)-1..............................................    1545-0024
                                                               1545-0582
301.6511(d)-2..............................................    1545-0024
                                                               1545-0582
301.6511(d)-3..............................................    1545-0024
                                                               1545-0582
301.6652-2.................................................    1545-0092
301.6685-1.................................................    1545-0092
301.6689-1T................................................    1545-1056
301.6707-1T................................................    1545-0865
                                                               1545-0881
301.6708-1T................................................    1545-0865
301.6712-1.................................................    1545-1126
301.6723-1A(d).............................................    1545-0909
301.6903-1.................................................    1545-0013
                                                               1545-1783
301.6905-1.................................................    1545-0074
301.7001-1.................................................    1545-0123
301.7101-1.................................................    1545-1029
301.7207-1.................................................    1545-0092
301.7216-2.................................................    1545-0074
301.7216-2(o)..............................................    1545-1209
301.7425-3.................................................    1545-0854
301.7430-2(c)..............................................    1545-1356
301.7502-1.................................................    1545-1899
301.7507-8.................................................    1545-0123
301.7507-9.................................................    1545-0123
301.7513-1.................................................    1545-0429
301.7517-1.................................................    1545-0015
301.7605-1.................................................    1545-0795
301.7623-1.................................................    1545-0409
                                                               1545-1534
301.7654-1.................................................    1545-0803
301.7701-3.................................................    1545-1486
301.7701-4.................................................    1545-1465
301.7701-7.................................................    1545-1600
301.7701-16................................................    1545-0795
301.7701(b)-1..............................................    1545-0089
301.7701(b)-2..............................................    1545-0089
301.7701(b)-3..............................................    1545-0089
301.7701(b)-4..............................................    1545-0089
301.7701(b)-5..............................................    1545-0089
301.7701(b)-6..............................................    1545-0089
301.7701(b)-7..............................................    1545-0089
                                                               1545-1126
301.7701(b)-9..............................................    1545-0089
301.7805-1.................................................    1545-0805
301.9000-5.................................................    1545-1850
301.9001-1.................................................    1545-0220
301.9100-2.................................................    1545-1488
301.9100-3.................................................    1545-1488
301.9100-4T................................................    1545-0016
                                                               1545-0042
                                                               1545-0074

[[Page 956]]

 
                                                               1545-0129
                                                               1545-0172
                                                               1545-0619
301.9100-6T................................................    1545-0872
301.9100-7T................................................    1545-0982
301.9100-8.................................................    1545-1112
301.9100-11T...............................................    1545-0123
301.9100-12T...............................................    1545-0026
                                                               1545-0074
                                                               1545-0172
                                                               1545-1027
301.9100-14T...............................................    1545-0046
301.9100-15T...............................................    1545-0046
301.9100-16T...............................................    1545-0152
302.1-7....................................................    1545-0024
305.7701-1.................................................    1545-0823
305.7871-1.................................................    1545-0823
404.6048-1.................................................    1545-0160
420.0-1....................................................    1545-0710
Part 509...................................................    1545-0846
Part 513...................................................    1545-0834
Part 514...................................................    1545-0845
Part 521...................................................    1545-0848
601.104....................................................    1545-0233
601.105....................................................    1545-0091
601.201....................................................    1545-0019
                                                               1545-0819
601.204....................................................    1545-0152
601.401....................................................    1545-0257
601.504....................................................    1545-0150
601.601....................................................    1545-0800
601.602....................................................    1545-0295
                                                               1545-0387
                                                               1545-0957
601.702....................................................    1545-0429
------------------------------------------------------------------------


(26 U.S.C. 7805)

[T.D. 8011, 50 FR 10222, Mar. 14, 1985]

    Editorial Note: For Federal Register citations affecting Sec.  
602.101, see the List of CFR Sections Affected, which appears in the 
Finding Aids section of the printed volume and at www.fdsys.gov.

[[Page 957]]



List of CFR Sections Affected



All changes in this volume of the Code of Federal Regulations (CFR) that 
were made by documents published in the Federal Register since January 
1, 2010 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, parts and 
subparts as well as sections for revisions.
For changes to this volume of the CFR prior to this listing, consult the 
annual edition of the monthly List of CFR Sections Affected (LSA). The 
LSA is available at www.fdsys.gov. For changes to this volume of the CFR 
prior to 2001, see the ``List of CFR Sections Affected, 1949-1963, 1964-
1972, 1973-1985, and 1986-2000'' published in 11 separate volumes. The 
``List of CFR Sections Affected 1986-2000'' is available at 
www.fdsys.gov.

                                  2010

26 CFR
                                                                   75 FR
                                                                    Page
Chapter I
1.704-3 (a)(1) and (f) amended; (a)(10) revised....................32660

                                  2011

26 CFR
                                                                   76 FR
                                                                    Page
Chapter I
1.642(c)-6 (d), (e) and (f) revised................................49572
1.642(c)-6T Removed................................................49595
1.642(c)-6A (f)(3)(ii), (4) and (5) amended........................49612
1.664-1 (a)(6) introductory text amended...........................49612
1.664-2 (c) and (e) revised........................................49595
1.664-4 (a)(1), (d), (e) heading, (1), (2), (5), (7) and (f) 
        revised....................................................49595
1.664-4T Removed...................................................49611
1.664-4A (f)(5) amended............................................49612
1.704-2 (f)(6) amended; (j)(2)(i)(A), (ii)(A) and (l) heading 
        revised; (l)(1)(v) added...................................71258
1.709-1 (b) revised................................................50890
    (b)(4) Example 2, Example 5 and Example 6 correctly amended....56973
1.709-1T Removed...................................................50891
1.721-1 (d) added..................................................71259

                                  2012

26 CFR
                                                                   77 FR
                                                                    Page
Chapter I
1.642(c)-3 (b) heading and (2) revised; (b)(1) heading and (3) 
        heading added; (b)(4) removed..............................22484
1.643(a)-5 (b) revised.............................................22485
1.704-1 (b)(0) table amended; (b)(1)(ii)(b)(3) added; 
        (b)(4)(viii)(c)(3)(ii), (d)(3) and (5) Example 24 revised 
                                                                    8134
    (b)(2)(iii)(e) revised.........................................76382
1.704-1T Added......................................................8134
1.706-1 (c)(6) added................................................8124

                                  2013

26 CFR
                                                                   78 FR
                                                                    Page
Chapter I
1.704-1 (b)(0) table, (1)(ii) and (2)(iv)(f)(5)(iii) amended; 
        (b)(1)(ii) heading and (2)(iv)(f)(1) revised; 
        (b)(2)(iv)(f)(5)(iv) and (h) redesignated as 
        (b)(2)(iv)(f)(5)(v) and (h)(1); undesignated text 
        following (b)(2)(iv)(r)(2) designated as (b)(2)(iv)(r)(3); 
        (b)(2)(iv)(d)(4), new (b)(2)(iv)(f)(5)(iv), (h)(1) 
        heading, (2), (s), (4)(ix), (x) and (5) Examples 31 
        through 35 added............................................8006

[[Page 958]]

    (b)(5) Example 35 table and section correctly amended..........17868
    Table corrected................................................19100
    (b)(5) Example 32 (v) correctly amended........................35559
1.704-3 (a)(6)(i) amended...........................................8012
    (a)(9) added...................................................54168
1.721-2 Added.......................................................8012
1.761-3 Added.......................................................8013
    (b)(3) and (f) correctly amended; (f) introductory text 
correctly revised..................................................17869

                                  2014

26 CFR
                                                                   79 FR
                                                                    Page
Chapter I
1.708-1 (b)(6) added...............................................42679
1.709-1 (b)(3) amended.............................................42679
1.833-1 Added........................................................757

                                  2015

   (Regulations published from January 1, 2015, through April 1, 2015)

26 CFR
                                                                   80 FR
                                                                    Page
Chapter I
1.704-1 (b)(0) amended; (b)(1)(ii)(b)(3), (4)(viii)(d)(3) and (5) 
        Example 24 revised..........................................7326
1.704-1T Removed....................................................7327


                                  [all]