[Title 26 CFR ]
[Code of Federal Regulations (annual edition) - April 1, 2021 Edition]
[From the U.S. Government Publishing Office]



[[Page i]]

          

          Title 26

Internal Revenue


________________________

Part 1 (Sec. Sec.  1.501 to 1.640)

                         Revised as of April 1, 2021

          Containing a codification of documents of general 
          applicability and future effect

          As of April 1, 2021
                    Published by the Office of the Federal Register 
                    National Archives and Records Administration as a 
                    Special Edition of the Federal Register

[[Page ii]]

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[[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........................     585
      Alphabetical List of Agencies Appearing in the CFR......     605
      Table of OMB Control Numbers............................     615
      List of CFR Sections Affected...........................     633

[[Page iv]]





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

                     Cite this Code: CFR
                     To cite the regulations in 
                       this volume use title, 
                       part and section number. 
                       Thus, 26 CFR 1.501(a)-1 
                       refers to title 26, part 
                       1, section 501(a)-1.

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

[[Page v]]



                               EXPLANATION

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

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

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

LEGAL STATUS

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

HOW TO USE THE CODE OF FEDERAL REGULATIONS

    The Code of Federal Regulations is kept up to date by the individual 
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    To determine whether a Code volume has been amended since its 
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Sections Affected (LSA),'' which is issued monthly, and the ``Cumulative 
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EFFECTIVE AND EXPIRATION DATES

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OMB CONTROL NUMBERS

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

[[Page vi]]

Many agencies have begun publishing numerous OMB control numbers as 
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PAST PROVISIONS OF THE CODE

    Provisions of the Code that are no longer in force and effect as of 
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``[RESERVED]'' TERMINOLOGY

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Federal Regulations. An agency may add regulatory information at a 
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INCORPORATION BY REFERENCE

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This material, like any other properly issued regulation, has the force 
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Federal Register will approve an incorporation by reference only when 
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alphabetical list of agencies publishing in the CFR are also included in 
this volume.

[[Page vii]]

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INQUIRIES

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    Oliver A. Potts,
    Director,
    Office of the Federal Register.
    April 1, 2021.







[[Page ix]]



                               THIS TITLE

    Title 26--Internal Revenue is composed of twenty-two volumes. The 
contents of these volumes represent all current regulations codified 
under this title by the Internal Revenue Service, Department of the 
Treasury, as of April 1, 2021. 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, Ann Worley 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.  1.501 to 1.640)

  --------------------------------------------------------------------
                                                                    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)

                          Exempt Organizations

                              General Rule

Sec.
1.501(a)-1 Exemption from taxation.
1.501(c)(2)-1 Corporations organized to hold title to property for 
          exempt organizations.
1.501(c)(3)-1 Organizations organized and operated for religious, 
          charitable, scientific, testing for public safety, literary, 
          or educational purposes, or for the prevention of cruelty to 
          children or animals.
1.501(c)(4)-1 Civic organizations and local associations of employees.
1.501(c)(5)-1 Labor, agricultural, and horticultural organizations.
1.501(c)(6)-1 Business leagues, chambers of commerce, real estate 
          boards, and boards of trade.
1.501(c)(7)-1 Social clubs.
1.501(c)(8)-1 Fraternal beneficiary societies.
1.501(c)(9)-1 Voluntary employees' beneficiary associations, in general.
1.501(c)(9)-2 Membership in a voluntary employees' beneficiary 
          association; employees; voluntary association of employees.
1.501(c)(9)-3 Voluntary employees' beneficiary associations; life, sick, 
          accident, or other benefits.
1.501(c)(9)-4 Voluntary employees' beneficiary associations; inurement.
1.501(c)(9)-5 Voluntary employees' beneficiary associations; 
          recordkeeping requirements.
1.501(c)(9)-6 Voluntary employees' beneficiary associations; benefits 
          includible in gross income.
1.501(c)(9)-7 Voluntary employees' beneficiary associations; section 
          3(4) of ERISA.
1.501(c)(9)-8 Voluntary employees' beneficiary associations; effective 
          date.
1.501(c)(10)-1 Certain fraternal beneficiary societies.
1.501(c)(12)-1 Local benevolent life insurance associations, mutual 
          irrigation and telephone companies, and like organizations.
1.501(c)(13)-1 Cemetery companies and crematoria.
1.501(c)(14)-1 Credit unions and mutual insurance funds.
1.501(c)(15)-1 Mutual insurance companies or associations.
1.501(c)(16)-1 Corporations organized to finance crop operations.
1.501(c)(17)-1 Supplemental unemployment benefit trusts.
1.501(c)(17)-2 General rules.
1.501(c)(17)-3 Relation to other sections of the Code.
1.501(c)(18)-1 Certain funded pension trusts.
1.501(c)(19)-1 War veterans organizations.
1.501(c)(21)-1 Black lung trusts--certain terms.
1.501(c)(21)-2 Same--trust instrument.
1.501(c)(29)-1 CO-OP Health Insurance Issuers.
1.501(d)-1 Religious and apostolic associations or corporations.
1.501(e)-1 Cooperative hospital service organizations.
1.501(h)-1 Application of the expenditure test to expenditures to 
          influence legislation; introduction.
1.501(h)-2 Electing the expenditure test.
1.501(h)-3 Lobbying or grass roots expenditures normally in excess of 
          ceiling amount.
1.501(r)-0 Outline of regulations.
1.501(r)-1 Definitions.
1.501(r)-2 Failures to satisfy section 501(r).
1.501(r)-3 Community health needs assessments.
1.501(r)-4 Financial assistance policy and emergency medical care 
          policy.
1.501(r)-5 Limitation on charges.
1.501(r)-6 Billing and collection.
1.501(r)-7 Effective/applicability dates.
1.502-1 Feeder organizations.
1.503(a)-1 Denial of exemption to certain organizations engaged in 
          prohibited transactions.
1.503(b)-1 Prohibited transactions.
1.503(c)-1 Future status of organizations denied exemption.
1.503(d)-1 Cross references.
1.503(e)-1 Special rules.
1.503(e)-2 Requirements.
1.503(e)-3 Effective dates.
1.503(f)-1 Loans by employers who are prohibited from pledging assets.
1.504-1 Attempts to influence legislation; certain organizations 
          formerly described in section 501(c)(3) denied exemption.
1.504-2 Certain transfers made to avoid section 504(a).
1.505(c)-1T Questions and answers relating to the notification 
          requirement for recognition of exemption under paragraphs (9), 
          (17) and (20) of Section 501(c) (temporary).
1.506-1 Organizations required to notify Commissioner of intent to 
          operate under section 501(c)(4).

                           Private Foundations

1.507-1 General rule.

[[Page 6]]

1.507-2 Special rules; transfer to, or operation as, public charity.
1.507-3 Special rules; transferee foundations.
1.507-4 Imposition of tax.
1.507-5 Aggregate tax benefit; in general.
1.507-6 Substantial contributor defined.
1.507-7 Value of assets.
1.507-8 Liability in case of transfers.
1.507-9 Abatement of taxes.
1.508-1 Notices.
1.508-2 Disallowance of certain charitable, etc., deductions.
1.508-3 Governing instruments.
1.508-4 Effective date.
1.509(a)-1 Definition of private foundation.
1.509(a)-2 Exclusion for certain organizations described in section 
          170(b)(1)(A).
1.509(a)-3 Broadly, publicly supported organizations.
1.509(a)-4 Supporting organizations.
1.509(a)-5 Special rules of attribution.
1.509(a)-6 Classification under section 509(a).
1.509(a)-7 Reliance by grantors and contributors to section 509(a) (1), 
          (2), and (3) organizations.
1.509(b)-1 Continuation of private foundation status.
1.509(c)-1 Status of organization after termination of private 
          foundation status.
1.509(d)-1 Definition of support.
1.509(e)-1 Definition of gross investment income.

       Taxation of Business Income of Certain Exempt Organizations

1.511-1 Imposition and rates of tax.
1.511-2 Organizations subject to tax.
1.511-3 Provisions generally applicable to the tax on unrelated business 
          income.
1.511-4 Minimum tax for tax preferences.
1.512(a)-1 Definition.
1.512(a)-2 Definition applicable to taxable years beginning before 
          December 13, 1967.
1.512(a)-3 [Reserved]
1.512(a)-4 Special rules applicable to war veterans organizations.
1.512(a)-5 Questions and answers relating to the unrelated business 
          taxable income of organizations described in paragraphs (9) or 
          (17) of section 501(c).
1.512(a)-6 Special rule for organizations with more than one unrelated 
          trade or business.
1.512(b)-1 Modifications.
1.512(c)-1 Special rules applicable to partnerships; in general.
1.513-1 Definition of unrelated trade or business.
1.513-2 Definition of unrelated trade or business applicable to taxable 
          years beginning before December 13, 1967.
1.513-3 Qualified convention and trade show activity.
1.513-4 Certain sponsorship not unrelated trade or business.
1.513-5 Certain bingo games not unrelated trade or business.
1.513-6 Certain hospital services not unrelated trade or business.
1.513-7 Travel and tour activities of tax exempt organizations.
1.514(a)-1 Unrelated debt-financed income and deductions.
1.514(a)-2 Business lease rents and deductions for taxable years 
          beginning before January 1, 1970.
1.514(b)-1 Definition of debt-financed property.
1.514(c)-1 Acquisition indebtedness.
1.514(c)-2 Permitted allocations under section 514(c)(9)(E).
1.514(d)-1 Basis of debt-financed property acquired in corporate 
          liquidation.
1.514(e)-1 Allocation rules.
1.514(f)-1 Definition of business lease.
1.514(g)-1 Business lease indebtedness.

                          Farmers' Cooperatives

1.521-1 Farmers' cooperative marketing and purchasing associations; 
          requirements for exemption under section 521.
1.522-1 Tax treatment of farmers' cooperative marketing and purchasing 
          associations exempt under section 521.
1.522-2 Manner of taxation of cooperative associations subject to 
          section 522.
1.522-3 Patronage dividends, rebates, or refunds; treatment as to 
          cooperative associations entitled to tax treatment under 
          section 522.
1.522-4 Taxable years affected.
1.527-1 Political organizations; generally.
1.527-2 Definitions.
1.527-3 Exempt function income.
1.527-4 Special rules for computation of political organization taxable 
          income.
1.527-5 Activities resulting in gross income to an individual or 
          political organization.
1.527-6 Inclusion of certain amounts in the gross income of an exempt 
          organization which is not a political organization.
1.527-7 Newsletter funds.
1.527-8 Effective date; filing requirements; and miscellaneous 
          provisions.
1.527-9 Special rule for principal campaign committees.

                         Homeowners Associations

1.528-1 Homeowners associations.
1.528-2 Organized and operated to provide for the acquisition, 
          construction, management, maintenance and care of association 
          property.
1.528-3 Association property.
1.528-4 Substantiality test.
1.528-5 Source of income test.
1.528-6 Expenditure test.
1.528-7 Inurement.
1.528-8 Election to be treated as a homeowners association.

[[Page 7]]

1.528-9 Exempt function income.
1.528-10 Special rules for computation of homeowners association taxable 
          income and tax.

                         Qualified ABLE Programs

1.529A-0 Table of contents.
1.529A-1 Exempt status of qualified ABLE program and definitions.
1.529A-2 Qualified ABLE program.
1.529A-3 Tax treatment.
1.529A-4 Gift, estate, and generation-skipping transfer taxes.
1.529A-5 Reporting of the establishment of and contributions to an ABLE 
          account.
1.529A-6 Reporting of distributions from and termination of an ABLE 
          account.
1.529A-7 Electronic furnishing of statements to designated beneficiaries 
          and contributors.
1.529A-8 Applicability dates and transition relief.

          Corporations Used To Avoid Income Tax on Shareholders

              Corporations Improperly Accumulating Surplus

1.531-1 Imposition of tax.
1.532-1 Corporations subject to accumulated earnings tax.
1.533-1 Evidence of purpose to avoid income tax.
1.533-2 Statement required.
1.534-1 Burden of proof as to unreasonable accumulations generally.
1.534-2 Burden of proof as to unreasonable accumulations in cases before 
          the Tax Court.
1.534-3 Jeopardy assessments in Tax Court cases.
1.535-1 Definition.
1.535-2 Adjustments to taxable income.
1.535-3 Accumulated earnings credit.
1.536-1 Short taxable years.
1.537-1 Reasonable needs of the business.
1.537-2 Grounds for accumulation of earnings and profits.
1.537-3 Business of the corporation.

                       Personal Holding Companies

1.541-1 Imposition of tax.
1.542-1 General rule.
1.542-2 Gross income requirement.
1.542-3 Stock ownership requirement.
1.542-4 Corporations filing consolidated returns.
1.543-1 Personal holding company income.
1.543-2 Limitation on gross income and personal holding company income 
          in transactions involving stocks, securities, and commodities.
1.544-1 Constructive ownership.
1.544-2 Constructive ownership by reason of indirect ownership.
1.544-3 Constructive ownership by reason of family and partnership 
          ownership.
1.544-4 Options.
1.544-5 Convertible securities.
1.544-6 Constructive ownership as actual ownership.
1.544-7 Option rule in lieu of family and partnership rule.
1.545-1 Definition.
1.545-2 Adjustments to taxable income.
1.545-3 Special adjustment to taxable income.
1.547-1 General rule.
1.547-2 Requirements for deficiency dividends.
1.547-3 Claim for credit or refund.
1.547-4 Effect on dividends paid deduction.
1.547-5 Deduction denied in case of fraud or wilful failure to file 
          timely return.
1.547-6 Suspension of statute of limitations and stay of collection.
1.547-7 Effective date.

                   Foreign Personal Holding Companies

1.551-1 General rule.
1.551-2 Amount included in gross income.

                      Deduction for Dividends Paid

1.561-1 Deduction for dividends paid.
1.561-2 When dividends are considered paid.
1.562-1 Dividends for which the dividends paid deduction is allowable.
1.562-2 Preferential dividends.
1.562-3 Distributions by a member of an affiliated group.
1.563-1 Accumulated earnings tax.
1.563-2 Personal holding company tax.
1.563-3 Dividends considered as paid on last day of taxable year.
1.564-1 Dividend carryover.
1.565-1 General rule.
1.565-2 Limitations.
1.565-3 Effect of consent.
1.565-4 Consent dividends and other distributions.
1.565-5 Nonresident aliens and foreign corporations.
1.565-6 Definitions.

                          Banking Institutions

          Rules of General Application to Banking Institutions

1.581-1 Banks.
1.581-2 Mutual savings banks, building and loan associations, and 
          cooperative banks.
1.581-3 Definition of bank prior to September 28, 1962.
1.582-1 Bad debts, losses, and gains with respect to securities held by 
          financial institutions.
1.584-1 Common trust funds.
1.584-2 Income of participants in common trust fund.
1.584-3 Computation of common trust fund income.
1.584-4 Admission and withdrawal of participants in the common trust 
          fund.

[[Page 8]]

1.584-5 Returns of banks with respect to common trust funds.
1.584-6 Net operating loss deduction.
1.585-1 Reserve for losses on loans of banks.
1.585-2 Addition to reserve.
1.585-3 Special rules.
1.585-4 Reorganizations and asset acquisitions.
1.585-5 Denial of bad debt reserves for large banks.
1.585-6 Recapture method of changing from the reserve method of section 
          585.
1.585-7 Elective cut-off method of changing from the reserve method of 
          section 585.
1.585-8 Rules for making and revoking elections under Sec. Sec.  1.585-6 
          and 1.585-7.

                       Mutual Savings Banks, Etc.

1.591-1 Deduction for dividends paid on deposits.
1.592-1 Repayment of certain loans by mutual savings banks, building and 
          loan associations, and cooperative banks.
1.594-1 Mutual savings banks conducting life insurance business.
1.596-1 Limitation on dividends received deduction.
1.597-1 Definitions.
1.597-2 Taxation of FFA.
1.597-3 Other rules.
1.597-4 Bridge Banks and Agency Control.
1.597-5 Taxable Transfers.
1.597-6 Limitation on collection of federal income tax.
1.597-7 Effective/applicability dates.
1.597-8 Transitional rules for Federal financial assistance.

                             Bank Affiliates

1.601-1 Special deduction for bank affiliates.

                            Natural Resources

                               Deductions

1.611-0 Regulatory authority.
1.611-1 Allowance of deduction for depletion.
1.611-2 Rules applicable to mines, oil and gas wells, and other natural 
          deposits.
1.611-3 Rules applicable to timber.
1.611-4 Depletion as a factor in computing earnings and profits for 
          dividend purposes.
1.611-5 Depreciation of improvements.
1.612-1 Basis for allowance of cost depletion.
1.612-2 Allowable capital additions in case of mines.
1.612-3 Depletion; treatment of bonus and advanced royalty.
1.612-4 Charges to capital and to expense in case of oil and gas wells.
1.612-5 Charges to capital and to expense in case of geothermal wells.
1.613-1 Percentage depletion; general rule.
1.613-2 Percentage depletion rates.
1.613-3 Gross income from the property.
1.613-4 Gross income from the property in the case of minerals other 
          than oil and gas.
1.613-5 Taxable income from the property.
1.613-6 Statement to be attached to return when depletion is claimed on 
          percentage basis.
1.613-7 Application of percentage depletion rates provided in section 
          613(b) to certain taxable years ending in 1954.
1.613A-0 Limitations on percentage depletion in the case of oil and gas 
          wells; table of contents.
1.613A-1 Post-1974 limitations on percentage depletion in case of oil 
          and gas wells; general rule.
1.613A-2 Exemption for certain domestic gas wells.
1.613A-3 Exemption for independent producers and royalty owners.
1.613A-4 Limitations on application of Sec.  1.613A-3 exemption.
1.613A-5 Election under section 613A(c)(4).
1.613A-6 Recordkeeping requirements.
1.613A-7 Definitions.
1.614-0 Introduction.
1.614-1 Definition of property.
1.614-2 Election to aggregate separate operating mineral interests under 
          section 614(b) prior to its amendment by Revenue Act of 1964.
1.614-3 Rules relating to separate operating mineral interests in the 
          case of mines.
1.614-4 Treatment under the Internal Revenue Code of 1939 with respect 
          to separate operating mineral interests for taxable years 
          beginning before January 1, 1964, in the case of oil and gas 
          wells.
1.614-5 Special rules as to aggregating nonoperating mineral interests.
1.614-6 Rules applicable to basis, holding period, and abandonment 
          losses where mineral interests have been aggregated or 
          combined.
1.614-7 Extension of time for performing certain acts.
1.614-8 Elections with respect to separate operating mineral interests 
          for taxable years beginning after December 31, 1963, in the 
          case of oil and gas wells.
1.615-1 Pre-1970 exploration expenditures.
1.615-2 Deduction of pre-1970 exploration expenditures in the year paid 
          or incurred.
1.615-3 Election to defer pre-1970 exploration expenditures.
1.615-4 Limitation of amount deductible.
1.615-5 Time for making election with respect to returns due on or 
          before May 2, 1960.
1.615-6 Election to deduct under section 615.
1.615-7 Effect of transfer of mineral property.
1.615-8 Termination of section 615.
1.615-9 Notification under Tax Reform Act of 1969.
1.616-1 Development expenditures.
1.616-2 Election to defer.

[[Page 9]]

1.616-3 Time for making election with respect to returns due on or 
          before May 2, 1960.
1.617-1 Exploration expenditures.
1.617-2 Limitation on amount deductible.
1.617-3 Recapture of exploration expenditures.
1.617-4 Treatment of gain from disposition of certain mining property.
1.617-5 Effective/applicability date.

                           Sales and Exchanges

1.631-1 Election to consider cutting as sale or exchange.
1.631-2 Gain or loss upon the disposal of timber under cutting contract.
1.631-3 Gain or loss upon the disposal of coal or domestic iron ore with 
          a retained economic interest.
1.632-1 Tax on sale of oil or gas properties.

                       Mineral Production Payments

1.636-1 Treatment of production payments as loans.
1.636-2 Production payments retained in leasing transactions.
1.636-3 Definitions.
1.636-4 Effective dates of section 636.

                         Continental Shelf Areas

1.638-1 Continental Shelf areas.
1.638-2 Effective date.
1.639-1.640 [Reserved]

    Authority: 26 U.S.C. 7805, unless otherwise noted.
    Section 1.501(c)(29)-1 also issued under 26 U.S.C. 501(c)(29)(B)(i).
    Section 1.501(c)(29)-1T also issued under 26 U.S.C. 
501(c)(29)(B)(i).
    Sections 1.504-1 and 1.504-2 also issued under 26 U.S.C. 504(b).
    Section 1.514(c)-2 also issued under 26 U.S.C. 514(c)(9)(E)(iii).
    Section 1.527-9 also issued under 26 U.S.C. 527(h)(2)(B)(i).
    Sections 1.529A-0 through 1.529A-8 also issued under 26 U.S.C. 
529A(g).
    Section1.585-5 through 1.585-8 also issued under 26 U.S.C. 
585(b)(3).
    Section1.597-1 through 1.597-7 also issued under 26 U.S.C. 597 and 
1502.
    Section1.597-8 also issued under 26 U.S.C. 597.

    Source: T.D. 6500, 25 FR 11737, Nov. 26, 1960; 25 FR 14021, Dec. 31, 
1960, unless otherwise noted.

                          Exempt Organizations



General Rule--Table of Contents





Sec.  1.501(a)-1  Exemption from taxation.

    (a) In general; proof of exemption. (1) Section 501(a) provides an 
exemption from income taxes for organizations which are described in 
section 501 (c) or (d) and section 401(a), unless such organization is a 
feeder organization (see section 502), or unless it engages in a 
transaction described in section 503. However, the exemption does not 
extend to unrelated business taxable income of such an organization (see 
part III (Section 511 and following), subchapter F, chapter 1 of the 
Code).
    (2) An organization, other than an employees' trust described in 
section 401(a), is not exempt from tax merely because it is not 
organized and operated for profit. In order to establish its exemption, 
it is necessary that every such organization claiming exemption file an 
application form as set forth below with the appropriate office as 
designated by the Commissioner in guidance published in the Internal 
Revenue Bulletin, forms, or instructions to the applicable forms. 
Subject only to the Commissioner's inherent power to revoke rulings, 
including with retroactive effect as permitted under section 7805(b), 
because of a change in the law or regulations or for other good cause, 
an organization that has been determined by the Commissioner (or 
previously by a district director) to be exempt under section 501(a) or 
the corresponding provision of prior law may rely upon such 
determination so long as there are no substantial changes in the 
organization's character, purposes, or methods of operation. An 
organization that has been determined to be exempt under the provisions 
of the Internal Revenue Code of 1939 or prior law is not required to 
secure a new determination of exemption merely because of the enactment 
of the Internal Revenue Code of 1954 unless affected by substantive 
changes in law made by such Code.
    (3) An organization claiming exemption under section 501(a) and 
described in any paragraph of section 501(c) (other than section 
501(c)(1) shall file the form of application prescribed by the 
Commissioner and shall include thereon such information as required by 
such form and the instructions issued with respect thereto. For rules 
relating to the obtaining of a determination of exempt status by an 
employees' trust described in section

[[Page 10]]

401(a), see the regulations under section 401.
    (b) Additional proof by particular classes of organizations. (1) 
Unless otherwise prescribed by applicable regulations or other guidance 
published in the Internal Revenue Bulletin, organizations mentioned 
below shall submit with and as a part of their applications the 
following information:
    (i) Mutual insurance companies shall submit copies of the policies 
or certificates of membership issued by them.
    (ii) In the case of title holding companies described in section 
501(c)(2), if the organization for which title is held has not been 
specifically notified in writing by the Internal Revenue Service that it 
is held to be exempt under section 501(a), the title holding company 
shall submit the information indicated herein as necessary for a 
determination of the status of the organization for which title is held.
    (iii) An organization described in section 501(c)(3) shall submit 
with, and as a part of, an application filed after July 26, 1959, a 
detailed statement of its proposed activities.
    (2) In addition to the information specifically called for by this 
section, the Commissioner may require any additional information deemed 
necessary for a proper determination of whether a particular 
organization is exempt under section 501(a), and when deemed advisable 
in the interest of an efficient administration of the internal revenue 
laws, he may in the cases of particular types of organizations prescribe 
the form in which the proof of exemption shall be furnished.
    (3) An organization claiming to be specifically exempted by section 
6033(a) from filing annual returns shall submit with and as a part of 
its application (or in such other manner as is prescribed in guidance 
published in the Internal Revenue Bulletin) a statement of all the facts 
on which it bases its claim.
    (c) Private shareholder or individual defined. The words private 
shareholder or individual in section 501 refer to persons having a 
personal and private interest in the activities of the organization.
    (d) Requirement of annual returns. For the annual return 
requirements of organizations exempt under section 501(a), see section 
6033 and Sec.  1.6033-1.
    (e) Certain Puerto Rican pension, etc., trusts. Effective for 
taxable years beginning after December 31, 1973, section 1022(i)(1) of 
the Employee Retirement Income Security Act of 1974 (ERISA) (88 Stat. 
942) provides that trusts under certain Puerto Rican pension, etc., 
plans (as defined under P.R. Laws Ann. tit. 13, section 3165, and the 
articles thereunder), all of the participants of which are residents of 
the Commonwealth of Puerto Rico, are to be treated only for purposes of 
section 501(a) as trusts described in section 401(a). The practical 
effect of section 1022(i)(1) is to exempt these trusts from U.S. income 
tax on income from their U.S. investments. For purposes of section 
1022(i)(1), the term residents of the Commonwealth of Puerto Rico means 
bona fide residents of Puerto Rico, and persons who perform labor or 
services primarily within the Commonwealth of Puerto Rico, regardless of 
residence for other purposes, and the term participants is restricted to 
current employees who are not excluded under the eligibility provisions 
of the plan.
    (f) Effective/applicability date. Paragraphs (a)(2), (b)(1), and 
(b)(3) of this section apply on and after July 1, 2014.

[T.D. 6500, 25 FR 11737, Nov. 26, 1960, as amended by T.D. 7428, 41 FR 
34619, Aug. 16, 1976; T.D. 7859, 47 FR 54298, Dec. 2, 1982; T.D. 9674, 
79 FR 37631, July 2, 2014; T.D. 9819, 82 FR 29732, June 30, 2017]



Sec.  1.501(c)(2)-1  Corporations organized to hold title to
property for exempt organizations.

    (a) A corporation described in section 501(c)(2) and otherwise 
exempt from tax under section 501(a) is taxable upon its unrelated 
business taxable income. For taxable years beginning before January 1, 
1970, see Sec.  1.511-2(c)(4). Since a corporation described in section 
501(c)(2) cannot be exempt under section 501(a) if it engages in any 
business other than that of holding title to property and collecting 
income therefrom, it cannot have unrelated business taxable income as 
defined in section 512 other than income which is treated as unrelated 
business taxable income solely because of the applicability of section 
512(a)(3)(C); or debt financed income

[[Page 11]]

which is treated as unrelated business taxable income solely because of 
section 514; or certain interest, annuities, royalties, or rents which 
are treated as unrelated business taxable income solely because of 
section 512(b) (3)(B)(ii) or (13). Similarly, exempt status under 
section 501(c)(2) shall not be affected where certain rents from 
personal property leased with real property are treated as unrelated 
business taxable income under section 512(b)(3)(A)(ii) solely because 
such rents attributable to such personal property are more than 
incidental when compared to the total rents received or accrued under 
the lease, or under section 512(b)(3)(B)(i) solely because such rents 
attributable to such personal property exceed 50 percent of the total 
rents received or accrued under the lease.
    (b) A corporation described in section 501(c)(2) cannot accumulate 
income and retain its exemption, but it must turn over the entire amount 
of such income, less expenses, to an organization which is itself exempt 
from tax under section 501(a).

[T.D. 6500, 25 FR 11737, Nov. 26, 1960, as amended by T.D. 7658, 45 FR 
33972, May 21, 1980]



Sec.  1.501(c)(3)-1  Organizations organized and operated for religious,
charitable, scientific, testing for public safety, literary, or 
educational purposes, or for the prevention of cruelty to children or
animals.

    (a) Organizational and operational tests. (1) In order to be exempt 
as an organization described in section 501(c)(3), an organization must 
be both organized and operated exclusively for one or more of the 
purposes specified in such section. If an organization fails to meet 
either the organizational test or the operational test, it is not 
exempt.
    (2) The term exempt purpose or purposes, as used in this section, 
means any purpose or purposes specified in section 501(c)(3), as defined 
and elaborated in paragraph (d) of this section.
    (b) Organizational test--(1) In general. (i) An organization is 
organized exclusively for one or more exempt purposes only if its 
articles of organization (referred to in this section as its articles) 
as defined in subparagraph (2) of this paragraph:
    (a) Limit the purposes of such organization to one or more exempt 
purposes; and
    (b) Do not expressly empower the organization to engage, otherwise 
than as an insubstantial part of its activities, in activities which in 
themselves are not in furtherance of one or more exempt purposes.
    (ii) In meeting the organizational test, the organization's 
purposes, as stated in its articles, may be as broad as, or more 
specific than, the purposes stated in section 501(c)(3). Therefore, an 
organization which, by the terms of its articles, is formed for literary 
and scientific purposes within the meaning of section 501(c)(3) of the 
Code shall, if it otherwise meets the requirements in this paragraph, be 
considered to have met the organizational test. Similarly, articles 
stating that the organization is created solely to receive contributions 
and pay them over to organizations which are described in section 
501(c)(3) and exempt from taxation under section 501(a)) are sufficient 
for purposes of the organizational test. Moreover, it is sufficient if 
the articles set for the purpose of the organization to be the operation 
of a school for adult education and describe in detail the manner of the 
operation of such school. In addition, if the articles state that the 
organization is formed for charitable purposes, such articles ordinarily 
shall be sufficient for purposes of the organizational test (see 
subparagraph (5) of this paragraph for rules relating to construction of 
terms).
    (iii) An organization is not organized exclusively for one or more 
exempt purposes if its articles expressly empower it to carry on, 
otherwise than as an insubstantial part of its activities, activities 
which are not in furtherance of one or more exempt purposes, even though 
such organization is, by the terms of such articles, created for a 
purpose that is no broader than the purposes specified in section 
501(c)(3). Thus, an organization that is empowered by its articles to 
engage in a manufacturing business, or to engage in the operation of a 
social club does not meet the organizational test regardless of the fact 
that its articles may state

[[Page 12]]

that such organization is created for charitable purposes within the 
meaning of section 501(c)(3) of the Code.
    (iv) In no case shall an organization be considered to be organized 
exclusively for one or more exempt purposes, if, by the terms of its 
articles, the purposes for which such organization is created are 
broader than the purposes specified in section 501(c)(3). The fact that 
the actual operations of such an organization have been exclusively in 
furtherance of one or more exempt purposes shall not be sufficient to 
permit the organization to meet the organizational test. Similarly, such 
an organization will not meet the organizational test as a result of 
statements or other evidence that the members thereof intend to operate 
only in furtherance of one or more exempt purposes.
    (v) Unless otherwise prescribed by applicable regulations or other 
guidance published in the Internal Revenue Bulletin, an organization 
must, in order to establish its exemption, submit a detailed statement 
of its proposed activities with and as a part of its application for 
exemption (see Sec.  1.501(a)-1(b)).
    (2) Articles of organization. For purposes of this section, the term 
articles of organization or articles includes the trust instrument, the 
corporate charter, the articles of association, or any other written 
instrument by which an organization is created.
    (3) Authorization of legislative or political activities. An 
organization is not organized exclusively for one or more exempt 
purposes if its articles expressly empower it:
    (i) To devote more than an insubstantial part of its activities to 
attempting to influence legislation by propaganda or otherwise; or
    (ii) Directly or indirectly to participate in, or intervene in 
(including the publishing or distributing of statements), any political 
campaign on behalf of or in opposition to any candidate for public 
office; or
    (iii) To have objectives and to engage in activities which 
characterize it as an action organization as defined in paragraph (c)(3) 
of this section.


The terms used in subdivisions (i), (ii), and (iii) of this subparagraph 
shall have the meanings provided in paragraph (c)(3) of this section. An 
organization's articles will not violate the provisions of paragraph 
(b)(3)(i) of this section even though the organization's articles 
expressly empower it to make the election provided for in section 501(h) 
with respect to influencing legislation and, only if it so elects, to 
make lobbying or grass roots expenditures that do not normally exceed 
the ceiling amounts prescribed by section 501(h)(2) (B) and (D).
    (4) Distribution of assets on dissolution. An organization is not 
organized exclusively for one or more exempt purposes unless its assets 
are dedicated to an exempt purpose. An organization's assets will be 
considered dedicated to an exempt purpose, for example, if, upon 
dissolution, such assets would, by reason of a provision in the 
organization's articles or by operation of law, be distributed for one 
or more exempt purposes, or to the Federal Government, or to a State or 
local government, for a public purpose, or would be distributed by a 
court to another organization to be used in such manner as in the 
judgment of the court will best accomplish the general purposes for 
which the dissolved organization was organized. However, an organization 
does not meet the organizational test if its articles or the law of the 
State in which it was created provide that its assets would, upon 
dissolution, be distributed to its members or shareholders.
    (5) Construction of terms. The law of the State in which an 
organization is created shall be controlling in construing the terms of 
its articles. However, any organization which contends that such terms 
have under State law a different meaning from their generally accepted 
meaning must establish such special meaning by clear and convincing 
reference to relevant court decisions, opinions of the State attorney-
general, or other evidence of applicable State law.
    (6) Applicability of the organizational test. A determination by the 
Commissioner that an organization is described in section 501(c)(3) and 
exempt under section 501(a) will not be granted after July 26, 1959, 
regardless of when the application is filed, unless such organization 
meets the organizational test prescribed by this paragraph (b). If, 
before

[[Page 13]]

July 27, 1959, an organization has been determined by the Commissioner 
or district director to be exempt as an organization described in 
section 501(c)(3) or in a corresponding provision of prior law and such 
determination has not been revoked before such date, the fact that such 
organization does not meet the organizational test prescribed by this 
paragraph (b) shall not be a basis for revoking such determination. 
Accordingly, an organization that has been determined to be exempt 
before July 27, 1959, and which does not seek a new determination of 
exemption is not required to amend its articles of organization to 
conform to the rules of this paragraph (b), but any organization that 
seeks a determination of exemption after July 26, 1959, must have 
articles of organization that meet the rules of this paragraph (b). For 
the rules relating to whether an organization determined to be exempt 
before July 27, 1959, is organized exclusively for one or more exempt 
purposes, see 26 CFR (1939) 39.101(6)-1 (Regulations 118) as made 
applicable to the Code by Treasury Decision 6091, approved August 16, 
1954 (19 FR 5167; 1954-2 CB 47).
    (c) Operational test--(1) Primary activities. An organization will 
be regarded as operated exclusively for one or more exempt purposes only 
if it engages primarily in activities which accomplish one or more of 
such exempt purposes specified in section 501(c)(3). An organization 
will not be so regarded if more than an insubstantial part of its 
activities is not in furtherance of an exempt purpose.
    (2) Distribution of earnings. An organization is not operated 
exclusively for one or more exempt purposes if its net earnings inure in 
whole or in part to the benefit of private shareholders or individuals. 
For the definition of the words private shareholder or individual, see 
paragraph (c) of Sec.  1.501(a)-1.
    (3) Action organizations. (i) An organization is not operated 
exclusively for one or more exempt purposes if it is an action 
organization as defined in subdivisions (ii), (iii), or (iv) of this 
subparagraph.
    (ii) An organization is an action organization if a substantial part 
of its activities is attempting to influence legislation by propaganda 
or otherwise. For this purpose, an organization will be regarded as 
attempting to influence legislation if the organization:
    (a) Contacts, or urges the public to contact, members of a 
legislative body for the purpose of proposing, supporting, or opposing 
legislation; or
    (b) Advocates the adoption or rejection of legislation.


The term legislation, as used in this subdivision, includes action by 
the Congress, by any State legislature, by any local council or similar 
governing body, or by the public in a referendum, initiative, 
constitutional amendment, or similar procedure. An organization will not 
fail to meet the operational test merely because it advocates, as an 
insubstantial part of its activities, the adoption or rejection of 
legislation. An organization for which the expenditure test election of 
section 501(h) is in effect for a taxable year will not be considered an 
action organization by reason of this paragraph (c)(3)(ii) for that year 
if it is not denied exemption from taxation under section 501(a) by 
reason of section 501(h).
    (iii) An organization is an action organization if it participates 
or intervenes, directly or indirectly, in any political campaign on 
behalf of or in opposition to any candidate for public office.


The term candidate for public office means an individual who offers 
himself, or is proposed by others, as a contestant for an elective 
public office, whether such office be national, State, or local. 
Activities which constitute participation or intervention in a political 
campaign on behalf of or in opposition to a candidate include, but are 
not limited to, the publication or distribution of written or printed 
statements or the making of oral statements on behalf of or in 
opposition to such a candidate.
    (iv) An organization is an action organization if it has the 
following two characteristics: (a) Its main or primary objective or 
objectives (as distinguished from its incidental or secondary 
objectives) may be attained only by legislation or a defeat of proposed 
legislation; and (b) it advocates, or campaigns for, the attainment of

[[Page 14]]

such main or primary objective or objectives as distinguished from 
engaging in nonpartisan analysis, study, or research and making the 
results thereof available to the public. In determining whether an 
organization has such characteristics, all the surrounding facts and 
circumstances, including the articles and all activities of the 
organization, are to be considered.
    (v) An action organization, described in subdivisions (ii) or (iv) 
of this subparagraph, though it cannot qualify under section 501(c)(3), 
may nevertheless qualify as a social welfare organization under section 
501(c)(4) if it meets the requirements set out in paragraph (a) of Sec.  
1.501(c)(4)-1.
    (d) Exempt purposes--(1) In general. (i) An organization may be 
exempt as an organization described in section 501(c)(3) if it is 
organized and operated exclusively for one or more of the following 
purposes:
    (a) Religious,
    (b) Charitable,
    (c) Scientific,
    (d) Testing for public safety,
    (e) Literary,
    (f) Educational, or
    (g) Prevention of cruelty to children or animals.
    (ii) An organization is not organized or operated exclusively for 
one or more of the purposes specified in subdivision (i) of this 
subparagraph unless it serves a public rather than a private interest. 
Thus, to meet the requirement of this subdivision, it is necessary for 
an organization to establish that it is not organized or operated for 
the benefit of private interests such as designated individuals, the 
creator or his family, shareholders of the organization, or persons 
controlled, directly or indirectly, by such private interests.
    (iii) Examples. The following examples illustrate the requirement of 
paragraph (d)(1)(ii) of this section that an organization serve a public 
rather than a private interest:

    Example 1. (i) O is an educational organization the purpose of which 
is to study history and immigration. O's educational activities include 
sponsoring lectures and publishing a journal. The focus of O's 
historical studies is the genealogy of one family, tracing the descent 
of its present members. O actively solicits for membership only 
individuals who are members of that one family. O's research is directed 
toward publishing a history of that family that will document the 
pedigrees of family members. A major objective of O's research is to 
identify and locate living descendants of that family to enable those 
descendants to become acquainted with each other.
    (ii) O's educational activities primarily serve the private 
interests of members of a single family rather than a public interest. 
Therefore, O is operated for the benefit of private interests in 
violation of the restriction on private benefit in paragraph (d)(1)(ii) 
of this section. Based on these facts and circumstances, O is not 
operated exclusively for exempt purposes and, therefore, is not 
described in section 501(c)(3).
    Example 2. (i) O is an art museum. O's principal activity is 
exhibiting art created by a group of unknown but promising local 
artists. O's activity, including organized tours of its art collection, 
promotes the arts. O is governed by a board of trustees unrelated to the 
artists whose work O exhibits. All of the art exhibited is offered for 
sale at prices set by the artist. Each artist whose work is exhibited 
has a consignment arrangement with O. Under this arrangement, when art 
is sold, the museum retains 10 percent of the selling price to cover the 
costs of operating the museum and gives the artist 90 percent.
    (ii) The artists in this situation directly benefit from the 
exhibition and sale of their art. As a result, the principal activity of 
O serves the private interests of these artists. Because O gives 90 
percent of the proceeds from its sole activity to the individual 
artists, the direct benefits to the artists are substantial and O's 
provision of these benefits to the artists is more than incidental to 
its other purposes and activities. This arrangement causes O to be 
operated for the benefit of private interests in violation of the 
restriction on private benefit in paragraph (d)(1)(ii) of this section. 
Based on these facts and circumstances, O is not operated exclusively 
for exempt purposes and, therefore, is not described in section 
501(c)(3).
    Example 3. (i) O is an educational organization the purpose of which 
is to train individuals in a program developed by P, O's president. The 
program is of interest to academics and professionals, representatives 
of whom serve on an advisory panel to O. All of the rights to the 
program are owned by Company K, a for-profit corporation owned by P. 
Prior to the existence of O, the teaching of the program was conducted 
by Company K. O licenses, from Company K, the right to conduct seminars 
and lectures on the program and to use the name of the program as part 
of O's name, in exchange for specified royalty payments. Under the 
license agreement, Company K provides O with the services of trainers 
and with course materials on the program. O may develop and copyright 
new course materials on the program but all such

[[Page 15]]

materials must be assigned to Company K without consideration if and 
when the license agreement is terminated. Company K sets the tuition for 
the seminars and lectures on the program conducted by O. O has agreed 
not to become involved in any activity resembling the program or its 
implementation for 2 years after the termination of O's license 
agreement.
    (ii) O's sole activity is conducting seminars and lectures on the 
program. This arrangement causes O to be operated for the benefit of P 
and Company K in violation of the restriction on private benefit in 
paragraph (d)(1)(ii) of this section, regardless of whether the royalty 
payments from O to Company K for the right to teach the program are 
reasonable. Based on these facts and circumstances, O is not operated 
exclusively for exempt purposes and, therefore, is not described in 
section 501(c)(3).
    (iv) Since each of the purposes specified in subdivision (i) of this 
subparagraph is an exempt purpose in itself, an organization may be 
exempt if it is organized and operated exclusively for any one or more 
of such purposes. If, in fact, an organization is organized and operated 
exclusively for an exempt purpose or purposes, exemption will be granted 
to such an organization regardless of the purpose or purposes specified 
in its application for exemption. For example, if an organization claims 
exemption on the ground that it is educational, exemption will not be 
denied if, in fact, it is charitable.
    (2) Charitable defined. The term charitable is used in section 
501(c)(3) in its generally accepted legal sense and is, therefore, not 
to be construed as limited by the separate enumeration in section 
501(c)(3) of other tax-exempt purposes which may fall within the broad 
outlines of charity as developed by judicial decisions. Such term 
includes: Relief of the poor and distressed or of the underprivileged; 
advancement of religion; advancement of education or science; erection 
or maintenance of public buildings, monuments, or works; lessening of 
the burdens of Government; and promotion of social welfare by 
organizations designed to accomplish any of the above purposes, or (i) 
to lessen neighborhood tensions; (ii) to eliminate prejudice and 
discrimination; (iii) to defend human and civil rights secured by law; 
or (iv) to combat community deterioration and juvenile delinquency. The 
fact that an organization which is organized and operated for the relief 
of indigent persons may receive voluntary contributions from the persons 
intended to be relieved will not necessarily prevent such organization 
from being exempt as an organization organized and operated exclusively 
for charitable purposes. The fact that an organization, in carrying out 
its primary purpose, advocates social or civic changes or presents 
opinion on controversial issues with the intention of molding public 
opinion or creating public sentiment to an acceptance of its views does 
not preclude such organization from qualifying under section 501(c)(3) 
so long as it is not an action organization of any one of the types 
described in paragraph (c)(3) of this section.
    (3) Educational defined--(i) In general. The term educational, as 
used in section 501(c)(3), relates to:
    (a) The instruction or training of the individual for the purpose of 
improving or developing his capabilities; or
    (b) The instruction of the public on subjects useful to the 
individual and beneficial to the community.


An organization may be educational even though it advocates a particular 
position or viewpoint so long as it presents a sufficiently full and 
fair exposition of the pertinent facts as to permit an individual or the 
public to form an independent opinion or conclusion. On the other hand, 
an organization is not educational if its principal function is the mere 
presentation of unsupported opinion.
    (ii) Examples of educational organizations. The following are 
examples of organizations which, if they otherwise meet the requirements 
of this section, are educational:

    Example 1. An organization, such as a primary or secondary school, a 
college, or a professional or trade school, which has a regularly 
scheduled curriculum, a regular faculty, and a regularly enrolled body 
of students in attendance at a place where the educational activities 
are regularly carried on.
    Example 2. An organization whose activities consist of presenting 
public discussion groups, forums, panels, lectures, or other similar 
programs. Such programs may be on radio or television.
    Example 3. An organization which presents a course of instruction by 
means of correspondence or through the utilization of television or 
radio.

[[Page 16]]

    Example 4. Museums, zoos, planetariums, symphony orchestras, and 
other similar organizations.

    (4) Testing for public safety defined. The term testing for public 
safety, as used in section 501(c)(3), includes the testing of consumer 
products, such as electrical products, to determine whether they are 
safe for use by the general public.
    (5) Scientific defined. (i) Since an organization may meet the 
requirements of section 501(c)(3) only if it serves a public rather than 
a private interest, a scientific organization must be organized and 
operated in the public interest (see subparagraph (1)(ii) of this 
paragraph). Therefore, the term scientific, as used in section 
501(c)(3), includes the carrying on of scientific research in the public 
interest. Research when taken alone is a word with various meanings; it 
is not synonymous with scientific; and the nature of particular research 
depends upon the purpose which it serves. For research to be scientific, 
within the meaning of section 501(c)(3), it must be carried on in 
furtherance of a scientific purpose. The determination as to whether 
research is scientific does not depend on whether such research is 
classified as fundamental or basic as contrasted with applied or 
practical. On the other hand, for purposes of the exclusion from 
unrelated business taxable income provided by section 512(b)(9), it is 
necessary to determine whether the organization is operated primarily 
for purposes of carrying on fundamental, as contrasted with applied, 
research.
    (ii) Scientific research does not include activities of a type 
ordinarily carried on as an incident to commercial or industrial 
operations, as, for example, the ordinary testing or inspection of 
materials or products or the designing or construction of equipment, 
buildings, etc.
    (iii) Scientific research will be regarded as carried on in the 
public interest:
    (a) If the results of such research (including any patents, 
copyrights, processes, or formulae resulting from such research) are 
made available to the public on a nondiscriminatory basis;
    (b) If such research is performed for the United States, or any of 
its agencies or instrumentalities, or for a State or political 
subdivision thereof; or
    (c) If such research is directed toward benefiting the public. The 
following are examples of scientific research which will be considered 
as directed toward benefiting the public, and, therefore, which will be 
regarded as carried on in the public interest: (1) Scientific research 
carried on for the purpose of aiding in the scientific education of 
college or university students; (2) scientific research carried on for 
the purpose of obtaining scientific information, which is published in a 
treatise, thesis, trade publication, or in any other form that is 
available to the interested public; (3) scientific research carried on 
for the purpose of discovering a cure for a disease; or (4) scientific 
research carried on for the purpose of aiding a community or 
geographical area by attracting new industry to the community or area or 
by encouraging the development of, or retention of, an industry in the 
community or area. Scientific research described in this subdivision 
will be regarded as carried on in the public interest even though such 
research is performed pursuant to a contract or agreement under which 
the sponsor or sponsors of the research have the right to obtain 
ownership or control of any patents, copyrights, processes, or formulae 
resulting from such research.
    (iv) An organization will not be regarded as organized and operated 
for the purpose of carrying on scientific research in the public 
interest and, consequently, will not qualify under section 501(c)(3) as 
a scientific organization, if:
    (a) Such organization will perform research only for persons which 
are (directly or indirectly) its creators and which are not described in 
section 501(c)(3), or
    (b) Such organization retains (directly or indirectly) the ownership 
or control of more than an insubstantial portion of the patents, 
copyrights, processes, or formulae resulting from its research and does 
not make such patents, copyrights, processes, or formulae available to 
the public. For purposes of this subdivision, a patent, copyright, 
process, or formula shall be considered as made available to the

[[Page 17]]

public if such patent, copyright, process, or formula is made available 
to the public on a nondiscriminatory basis. In addition, although one 
person is granted the exclusive right to the use of a patent, copyright, 
process, or formula, such patent, copyright, process, or formula shall 
be considered as made available to the public if the granting of such 
exclusive right is the only practicable manner in which the patent, 
copyright, process, or formula can be utilized to benefit the public. In 
such a case, however, the research from which the patent, copyright, 
process, or formula resulted will be regarded as carried on in the 
public interest (within the meaning of subdivision (iii) of this 
subparagraph) only if it is carried on for a person described in 
subdivision (iii)(b) of this subparagraph or if it is scientific 
research described in subdivision (iii)(c) of this subparagraph.
    (v) The fact that any organization (including a college, university, 
or hospital) carries on research which is not in furtherance of an 
exempt purpose described in section 501(c)(3) will not preclude such 
organization from meeting the requirements of section 501(c)(3) so long 
as the organization meets the organizational test and is not operated 
for the primary purpose of carrying on such research (see paragraph (e) 
of this section, relating to organizations carrying on a trade or 
business). See paragraph (a)(5) of Sec.  1.513-2, with respect to 
research which constitutes an unrelated trade or business, and section 
512(b) (7), (8), and (9), with respect to income derived from research 
which is excludable from the tax on unrelated business income.
    (vi) The regulations in this subparagraph are applicable with 
respect to taxable years beginning after December 31, 1960.
    (e) Organizations carrying on trade or business--(1) In general. An 
organization may meet the requirements of section 501(c)(3) although it 
operates a trade or business as a substantial part of its activities, if 
the operation of such trade or business is in furtherance of the 
organization's exempt purpose or purposes and if the organization is not 
organized or operated for the primary purpose of carrying on an 
unrelated trade or business, as defined in section 513. In determining 
the existence or nonexistence of such primary purpose, all the 
circumstances must be considered, including the size and extent of the 
trade or business and the size and extent of the activities which are in 
furtherance of one or more exempt purposes. An organization which is 
organized and operated for the primary purpose of carrying on an 
unrelated trade or business is not exempt under section 501(c)(3) even 
though it has certain religious purposes, its property is held in 
common, and its profits do not inure to the benefit of individual 
members of the organization. See, however, section 501(d) and Sec.  
1.501(d)-1, relating to religious and apostolic organizations.
    (2) Taxation of unrelated business income. For provisions relating 
to the taxation of unrelated business income of certain organizations 
described in section 501(c)(3), see sections 511 to 515, inclusive, and 
the regulations thereunder.
    (f) Interaction with section 4958--(1) Application process. An 
organization that applies for recognition of exemption under section 
501(a) as an organization described in section 501(c)(3) must establish 
its eligibility under this section. The Commissioner may deny an 
application for exemption for failure to establish any of section 
501(c)(3)'s requirements for exemption. Section 4958 does not apply to 
transactions with an organization that has failed to establish that it 
satisfies all of the requirements for exemption under section 501(c)(3). 
See Sec.  53.4958-2.
    (2) Substantive requirements for exemption still apply to applicable 
tax-exempt organizations described in section 501(c)(3)--(i) In general. 
Regardless of whether a particular transaction is subject to excise 
taxes under section 4958, the substantive requirements for tax exemption 
under section 501(c)(3) still apply to an applicable tax-exempt 
organization (as defined in section 4958(e) and Sec.  53.4958-2) 
described in section 501(c)(3) whose disqualified persons or 
organization managers are subject to excise taxes under section 4958. 
Accordingly, an organization will no longer meet the requirements for 
tax-exempt status under section 501(c)(3) if

[[Page 18]]

the organization fails to satisfy the requirements of paragraph (b), (c) 
or (d) of this section. See Sec.  53.4958-8(a).
    (ii) Determination of whether revocation of tax-exempt status is 
appropriate when section 4958 excise taxes also apply. In determining 
whether to continue to recognize the tax-exempt status of an applicable 
tax-exempt organization (as defined in section 4958(e) and Sec.  
53.4958-2) described in section 501(c)(3) that engages in one or more 
excess benefit transactions (as defined in section 4958(c) and Sec.  
53.4958-4) that violate the prohibition on inurement under section 
501(c)(3), the Commissioner will consider all relevant facts and 
circumstances, including, but not limited to, the following--
    (A) The size and scope of the organization's regular and ongoing 
activities that further exempt purposes before and after the excess 
benefit transaction or transactions occurred;
    (B) The size and scope of the excess benefit transaction or 
transactions (collectively, if more than one) in relation to the size 
and scope of the organization's regular and ongoing activities that 
further exempt purposes;
    (C) Whether the organization has been involved in multiple excess 
benefit transactions with one or more persons;
    (D) Whether the organization has implemented safeguards that are 
reasonably calculated to prevent excess benefit transactions; and
    (E) Whether the excess benefit transaction has been corrected 
(within the meaning of section 4958(f)(6) and Sec.  53.4958-7), or the 
organization has made good faith efforts to seek correction from the 
disqualified person(s) who benefited from the excess benefit 
transaction.
    (iii) All factors will be considered in combination with each other. 
Depending on the particular situation, the Commissioner may assign 
greater or lesser weight to some factors than to others. The factors 
listed in paragraphs (f)(2)(ii)(D) and (E) of this section will weigh 
more heavily in favor of continuing to recognize exemption where the 
organization discovers the excess benefit transaction or transactions 
and takes action before the Commissioner discovers the excess benefit 
transaction or transactions. Further, with respect to the factor listed 
in paragraph (f)(2)(ii)(E) of this section, correction after the excess 
benefit transaction or transactions are discovered by the Commissioner, 
by itself, is never a sufficient basis for continuing to recognize 
exemption.
    (iv) Examples. The following examples illustrate the principles of 
paragraph (f)(2)(ii) of this section. For purposes of each example, 
assume that O is an applicable tax-exempt organization (as defined in 
section 4958(e) and Sec.  53.4958-2) described in section 501(c)(3). The 
examples read as follows:

    Example 1. (i) O was created as a museum for the purpose of 
exhibiting art to the general public. In Years 1 and 2, O engages in 
fundraising and in selecting, leasing, and preparing an appropriate 
facility for a museum. In Year 3, a new board of trustees is elected. 
All of the new trustees are local art dealers. Beginning in Year 3 and 
continuing to the present, O uses a substantial portion of its revenues 
to purchase art solely from its trustees at prices that exceed fair 
market value. O exhibits and offers for sale all of the art it 
purchases. O's Form 1023, ``Application for Recognition of Exemption,'' 
did not disclose the possibility that O would purchase art from its 
trustees.
    (ii) O's purchases of art from its trustees at more than fair market 
value constitute excess benefit transactions between an applicable tax-
exempt organization and disqualified persons under section 4958. 
Therefore, these transactions are subject to the applicable excise taxes 
provided in that section. In addition, O's purchases of art from its 
trustees at more than fair market value violate the proscription against 
inurement under section 501(c)(3) and paragraph (c)(2) of this section.
    (iii) The application of the factors in paragraph (f)(2)(ii) of this 
section to these facts is as follows. Beginning in Year 3, O does not 
engage primarily in regular and ongoing activities that further exempt 
purposes because a substantial portion of O's activities consists of 
purchasing art from its trustees and dealing in such art in a manner 
similar to a commercial art gallery. The size and scope of the excess 
benefit transactions collectively are significant in relation to the 
size and scope of any of O's ongoing activities that further exempt 
purposes. O has been involved in multiple excess benefit transactions, 
namely, purchases of art from its trustees at more than fair market 
value. O has not implemented safeguards that are reasonably calculated 
to prevent such improper purchases in the future. The excess benefit 
transactions have not been corrected, nor has O made good faith efforts 
to seek

[[Page 19]]

correction from the disqualified persons who benefited from the excess 
benefit transactions (the trustees). The trustees continue to control 
O's Board. Based on the application of the factors to these facts, O is 
no longer described in section 501(c)(3) effective in Year 3.
    Example 2. (i) The facts are the same as in Example 1, except that 
in Year 4, O's entire board of trustees resigns, and O no longer offers 
all exhibited art for sale. The former board is replaced with members of 
the community who are not in the business of buying or selling art and 
who have skills and experience running charitable and educational 
programs and institutions. O promptly discontinues the practice of 
purchasing art from current or former trustees, adopts a written 
conflicts of interest policy, adopts written art valuation guidelines, 
hires legal counsel to recover the excess amounts O had paid its former 
trustees, and implements a new program of activities to further the 
public's appreciation of the arts.
    (ii) O's purchases of art from its former trustees at more than fair 
market value constitute excess benefit transactions between an 
applicable tax-exempt organization and disqualified persons under 
section 4958. Therefore, these transactions are subject to the 
applicable excise taxes provided in that section. In addition, O's 
purchases of art from its trustees at more than fair market value 
violate the proscription against inurement under section 501(c)(3) and 
paragraph (c)(2) of this section.
    (iii) The application of the factors in paragraph (f)(2)(ii) of this 
section to these facts is as follows. In Year 3, O does not engage 
primarily in regular and ongoing activities that further exempt 
purposes. However, in Year 4, O elects a new board of trustees comprised 
of individuals who have skills and experience running charitable and 
educational programs and implements a new program of activities to 
further the public's appreciation of the arts. As a result of these 
actions, beginning in Year 4, O engages in regular and ongoing 
activities that further exempt purposes. The size and scope of the 
excess benefit transactions that occurred in Year 3, taken collectively, 
are significant in relation to the size and scope of O's regular and 
ongoing exempt function activities that were conducted in Year 3. 
Beginning in Year 4, however, as O's exempt function activities grow, 
the size and scope of the excess benefit transactions that occurred in 
Year 3 become less and less significant as compared to the size and 
scope of O's regular and ongoing exempt function activities. O was 
involved in multiple excess benefit transactions in Year 3. However, by 
discontinuing its practice of purchasing art from its current and former 
trustees, by replacing its former board with independent members of the 
community, and by adopting a conflicts of interest policy and art 
valuation guidelines, O has implemented safeguards that are reasonably 
calculated to prevent future violations. In addition, O has made a good 
faith effort to seek correction from the disqualified persons who 
benefited from the excess benefit transactions (its former trustees). 
Based on the application of the factors to these facts, O continues to 
meet the requirements for tax exemption under section 501(c)(3).
    Example 3. (i) O conducts educational programs for the benefit of 
the general public. Since its formation, O has employed its founder, C, 
as its Chief Executive Officer. Beginning in Year 5 of O's operations 
and continuing to the present, C caused O to divert significant portions 
of O's funds to pay C's personal expenses. The diversions by C 
significantly reduced the funds available to conduct O's ongoing 
educational programs. The board of trustees never authorized C to cause 
O to pay C's personal expenses from O's funds. Certain members of the 
board were aware that O was paying C's personal expenses. However, the 
board did not terminate C's employment and did not take any action to 
seek repayment from C or to prevent C from continuing to divert O's 
funds to pay C's personal expenses. C claimed that O's payments of C's 
personal expenses represented loans from O to C. However, no 
contemporaneous loan documentation exists, and C never made any payments 
of principal or interest.
    (ii) The diversions of O's funds to pay C's personal expenses 
constitute excess benefit transactions between an applicable tax-exempt 
organization and a disqualified person under section 4958. Therefore, 
these transactions are subject to the applicable excise taxes provided 
in that section. In addition, these transactions violate the 
proscription against inurement under section 501(c)(3) and paragraph 
(c)(2) of this section.
    (iii) The application of the factors in paragraph (f)(2)(ii) of this 
section to these facts is as follows. O has engaged in regular and 
ongoing activities that further exempt purposes both before and after 
the excess benefit transactions occurred. However, the size and scope of 
the excess benefit transactions engaged in by O beginning in Year 5, 
collectively, are significant in relation to the size and scope of O's 
activities that further exempt purposes. Moreover, O has been involved 
in multiple excess benefit transactions. O has not implemented any 
safeguards that are reasonably calculated to prevent future diversions. 
The excess benefit transactions have not been corrected, nor has O made 
good faith efforts to seek correction from C, the disqualified person 
who benefited from the excess benefit transactions. Based on the 
application of the factors to these facts, O is no longer described in 
section 501(c)(3) effective in Year 5.

[[Page 20]]

    Example 4. (i) O conducts activities that further exempt purposes. O 
uses several buildings in the conduct of its exempt activities. In Year 
1, O sold one of the buildings to Company K for an amount that was 
substantially below fair market value. The sale was a significant event 
in relation to O's other activities. C, O's Chief Executive Officer, 
owns all of the voting stock of Company K. When O's board of trustees 
approved the transaction with Company K, the board did not perform due 
diligence that could have made it aware that the price paid by Company K 
to acquire the building was below fair market value. Subsequently, but 
before the IRS commences an examination of O, O's board of trustees 
determines that Company K paid less than the fair market value for the 
building. Thus, O concludes that an excess benefit transaction occurred. 
After the board makes this determination, it promptly removes C as Chief 
Executive Officer, terminates C's employment with O, and hires legal 
counsel to recover the excess benefit from Company K. In addition, O 
promptly adopts a conflicts of interest policy and new contract review 
procedures designed to prevent future recurrences of this problem.
    (ii) The sale of the building by O to Company K at less than fair 
market value constitutes an excess benefit transaction between an 
applicable tax-exempt organization and a disqualified person under 
section 4958 in Year 1. Therefore, this transaction is subject to the 
applicable excise taxes provided in that section. In addition, this 
transaction violates the proscription against inurement under section 
501(c)(3) and paragraph (c)(2) of this section.
    (iii) The application of the factors in paragraph (f)(2)(ii) of this 
section to these facts is as follows. O has engaged in regular and 
ongoing activities that further exempt purposes both before and after 
the excess benefit transaction occurred. Although the size and scope of 
the excess benefit transaction were significant in relation to the size 
and scope of O's activities that further exempt purposes, the 
transaction with Company K was a one-time occurrence. By adopting a 
conflicts of interest policy and new contract review procedures and by 
terminating C, O has implemented safeguards that are reasonably 
calculated to prevent future violations. Moreover, O took corrective 
actions before the IRS commenced an examination of O. In addition, O has 
made a good faith effort to seek correction from Company K, the 
disqualified person who benefited from the excess benefit transaction. 
Based on the application of the factors to these facts, O continues to 
be described in section 501(c)(3).
    Example 5. (i) O is a large organization with substantial assets and 
revenues. O conducts activities that further its exempt purposes. O 
employs C as its Chief Financial Officer. During Year 1, O pays $2,500 
of C's personal expenses. O does not make these payments pursuant to an 
accountable plan, as described in Sec.  53.4958-4(a)(4)(ii). In 
addition, O does not report any of these payments on C's Form W-2, 
``Wage and Tax Statement,'' or on a Form 1099-MISC, ``Miscellaneous 
Income,'' for C for Year 1, and O does not report these payments as 
compensation on its Form 990, ``Return of Organization Exempt From 
Income Tax,'' for Year 1. Moreover, none of these payments can be 
disregarded as nontaxable fringe benefits under Sec.  53.4958-4(c)(2) 
and none consisted of fixed payments under an initial contract under 
Sec.  53.4958-4(a)(3). C does not report the $2,500 of payments as 
income on his individual Federal income tax return for Year 1. O does 
not repeat this reporting omission in subsequent years and, instead, 
reports all payments of C's personal expenses not made under an 
accountable plan as income to C.
    (ii) O's payment in Year 1 of $2,500 of C's personal expenses 
constitutes an excess benefit transaction between an applicable tax-
exempt organization and a disqualified person under section 4958. 
Therefore, this transaction is subject to the applicable excise taxes 
provided in that section. In addition, this transaction violates the 
proscription against inurement in section 501(c)(3) and paragraph (c)(2) 
of this section.
    (iii) The application of the factors in paragraph (f)(2)(ii) of this 
section to these facts is as follows. O engages in regular and ongoing 
activities that further exempt purposes. The payment of $2,500 of C's 
personal expenses represented only a de minimis portion of O's assets 
and revenues; thus, the size and scope of the excess benefit transaction 
were not significant in relation to the size and scope of O's activities 
that further exempt purposes. The reporting omission that resulted in 
the excess benefit transaction in Year 1 occurred only once and is not 
repeated in subsequent years. Based on the application of the factors to 
these facts, O continues to be described in section 501(c)(3).
    Example 6. (i) O is a large organization with substantial assets and 
revenues. O furthers its exempt purposes by providing social services to 
the population of a specific geographic area. O has a sizeable workforce 
of employees and volunteers to conduct its work. In Year 1, O's board of 
directors adopted written procedures for setting executive compensation 
at O. O's executive compensation procedures were modeled on the 
procedures for establishing a rebuttable presumption of reasonableness 
under Sec.  53.4958-6. In accordance with these procedures, the board 
appointed a compensation committee to gather data on compensation levels 
paid by similarly situated organizations for functionally comparable 
positions. The members of the compensation committee were disinterested 
within the meaning of Sec.  53.4958-

[[Page 21]]

6(c)(1)(iii). Based on its research, the compensation committee 
recommended a range of reasonable compensation for several of O's 
existing top executives (the Top Executives). On the basis of the 
committee's recommendations, the board approved new compensation 
packages for the Top Executives and timely documented the basis for its 
decision in board minutes. The board members were all disinterested 
within the meaning of Sec.  53.4958-6(c)(1)(iii). The Top Executives 
were not involved in setting their own compensation. In Year 1, even 
though payroll expenses represented a significant portion of O's total 
operating expenses, the total compensation paid to O's Top Executives 
represented only an insubstantial portion of O's total payroll expenses. 
During a subsequent examination, the IRS found that the compensation 
committee relied exclusively on compensation data from organizations 
that perform similar social services to O. The IRS concluded, however, 
that the organizations were not similarly situated because they served 
substantially larger geographic regions with more diverse populations 
and were larger than O in terms of annual revenues, total operating 
budget, number of employees, and number of beneficiaries served. 
Accordingly, the IRS concluded that the compensation committee did not 
rely on ``appropriate data as to comparability'' within the meaning of 
Sec.  53.4958-6(c)(2) and, thus, failed to establish the rebuttable 
presumption of reasonableness under Sec.  53.4958-6. Taking O's size and 
the nature of the geographic area and population it serves into account, 
the IRS concluded that the Top Executives' compensation packages for 
Year 1 were excessive. As a result of the examination, O's board added 
new members to the compensation committee who have expertise in 
compensation matters and also amended its written procedures to require 
the compensation committee to evaluate a number of specific factors, 
including size, geographic area, and population covered by the 
organization, in assessing the comparability of compensation data. O's 
board renegotiated the Top Executives' contracts in accordance with the 
recommendations of the newly constituted compensation committee on a 
going forward basis. To avoid potential liability for damages under 
state contract law, O did not seek to void the Top Executives' 
employment contracts retroactively to Year 1 and did not seek correction 
of the excess benefit amounts from the Top Executives. O did not 
terminate any of the Top Executives.
    (ii) O's payments of excessive compensation to the Top Executives in 
Year 1 constituted excess benefit transactions between an applicable 
tax-exempt organization and disqualified persons under section 4958. 
Therefore, these payments are subject to the applicable excise taxes 
provided under that section, including second-tier taxes if there is no 
correction by the disqualified persons. In addition, these payments 
violate the proscription against inurement under section 501(c)(3) and 
paragraph (c)(2) of this section.
    (iii) The application of the factors in paragraph (f)(2)(ii) of this 
section to these facts is as follows. O has engaged in regular and 
ongoing activities that further exempt purposes both before and after 
the excess benefit transactions occurred. The size and scope of the 
excess benefit transactions, in the aggregate, were not significant in 
relation to the size and scope of O's activities that further exempt 
purposes. O engaged in multiple excess benefit transactions. 
Nevertheless, prior to entering into these excess benefit transactions, 
O had implemented written procedures for setting the compensation of its 
top management that were reasonably calculated to prevent the occurrence 
of excess benefit transactions. O followed these written procedures in 
setting the compensation of the Top Executives for Year 1. Despite the 
board's failure to rely on appropriate comparability data, the fact that 
O implemented and followed these written procedures in setting the 
compensation of the Top Executives for Year 1 is a factor favoring 
continued exemption. The fact that O amended its written procedures to 
ensure the use of appropriate comparability data and renegotiated the 
Top Executives' compensation packages on a going-forward basis are also 
factors favoring continued exemption, even though O did not void the Top 
Executives' existing contracts and did not seek correction from the Top 
Executives. Based on the application of the factors to these facts, O 
continues to be described in section 501(c)(3).

    (3) Applicability. The rules in paragraph (f) of this section will 
apply with respect to excess benefit transactions occurring after March 
28, 2008.
    (g) Applicability of regulations in this section. The regulations in 
this section are, except as otherwise expressly provided, applicable 
with respect to taxable years beginning after July 26, 1959. For the 
rules applicable with respect to taxable years beginning before July 27, 
1959, see 26 CFR (1939) 39.101(6)-1 (Regulations 118) as made applicable 
to the Code by Treasury Decision 6091, approved August 16, 1954 (19 FR 
5167; C.B. 1954-2, 47).

[[Page 22]]

    (h) Effective/applicability date. Paragraphs (b)(1)(v) and (b)(6) of 
this section apply on and after July 1, 2014.

[T.D. 6500, 25 FR 11737, Nov. 26, 1960, as amended by T.D. 6525, 26 FR 
189, Jan. 11, 1961; T.D. 6939, 32 FR 17661, Dec. 12, 1967; T.D. 7428, 41 
FR 34620, Aug. 16, 1976; T.D. 8308, 55 FR 35587, Aug. 31, 1990; T.D. 
9390, 73 FR 16521, Mar. 28, 2008; T.D. 9390, 73 FR 23069, Apr. 29, 2008; 
T.D. 9674, 79 FR 37631, July 2, 2014; T.D. 9819, 82 FR 29732, June 30, 
2017]



Sec.  1.501(c)(4)-1  Civic organizations and local associations of 
employees.

    (a) Civic organizations--(1) In general. A civic league or 
organization may be exempt as an organization described in section 
501(c)(4) if--
    (i) It is not organized or operated for profit; and
    (ii) It is operated exclusively for the promotion of social welfare.
    (2) Promotion of social welfare--(i) In general. An organization is 
operated exclusively for the promotion of social welfare if it is 
primarily engaged in promoting in some way the common good and general 
welfare of the people of the community. An organization embraced within 
this section is one which is operated primarily for the purpose of 
bringing about civic betterments and social improvements. A social 
welfare organization will qualify for exemption as a charitable 
organization if it falls within the definition of charitable set forth 
in paragraph (d)(2) of Sec.  1.501(c)(3)-1 and is not an action 
organization as set forth in paragraph (c)(3) of Sec.  1.501(c)(3)-1.
    (ii) Political or social activities. The promotion of social welfare 
does not include direct or indirect participation or intervention in 
political campaigns on behalf of or in opposition to any candidate for 
public office. Nor is an organization operated primarily for the 
promotion of social welfare if its primary activity is operating a 
social club for the benefit, pleasure, or recreation of its members, or 
is carrying on a business with the general public in a manner similar to 
organizations which are operated for profit. See, however, section 
501(c)(6) and Sec.  1.501(c)(6)-1, relating to business leagues and 
similar organizations. A social welfare organization that is not, at any 
time after October 4, 1976, exempt from taxation as an organization 
described in section 501(c)(3) may qualify under section 501(c)(4) even 
though it is an action organization described in Sec.  1.501(c)(3)-
1(c)(3)(ii) or (iv), if it otherwise qualifies under this section. For 
rules relating to an organization that is, after October 4, 1976, exempt 
from taxation as an organization described in section 501(c)(3), see 
section 504 and Sec.  1.504-1.
    (b) Local associations of employees. Local associations of employees 
described in section 501(c)(4) are expressly entitled to exemption under 
section 501(a). As conditions to exemption, it is required (1) that the 
membership of such an association be limited to the employees of a 
designated person or persons in a particular municipality, and (2) that 
the net earnings of the association be devoted exclusively to 
charitable, educational, or recreational purposes. The word local is 
defined in paragraph (b) of Sec.  1.501(c)(12)-1. See paragraph (d) (2) 
and (3) of Sec.  1.501(c)(3)-1 with reference to the meaning of 
charitable and educational as used in this section.

[T.D. 6500, 25 FR 11737, Nov. 26, 1960; 25 FR 14021, Dec. 31, 1960, as 
amended by T.D. 8308, 55 FR 35588, Aug. 31, 1990]



Sec.  1.501(c)(5)-1  Labor, agricultural, and horticultural organizations.

    (a) The organizations contemplated by section 501(c)(5) as entitled 
to exemption from income taxation are those which:
    (1) Have no net earnings inuring to the benefit of any member, and
    (2) Have as their objects the betterment of the conditions of those 
engaged in such pursuits, the improvement of the grade of their 
products, and the development of a higher degree of efficiency in their 
respective occupations.
    (b)(1) General rule. An organization is not an organization 
described in section 501(c)(5) if the principal activity of the 
organization is to receive, hold, invest, disburse or otherwise manage 
funds associated with savings or investment plans or programs, including 
pension or other retirement savings plans or programs.
    (2) Exception. Paragraph (b)(1) of this section shall not apply to 
an organization which--

[[Page 23]]

    (i) Is established and maintained by another labor organization 
described in section 501(c)(5) (determined without regard to this 
paragraph (b)(2));
    (ii) Is not directly or indirectly established or maintained in 
whole or in part by one or more--
    (A) Employers;
    (B) Governments or agencies or instrumentalities thereof; or
    (C) Government controlled entities;
    (iii) Is funded by membership dues from members of the labor 
organization described in this paragraph (b)(2) and earnings thereon; 
and
    (iv) Has not at any time after September 2, 1974 (the date of 
enactment of the Employee Retirement Income Security Act of 1974, Pub. 
L. 93-406, 88 Stat. 829) provided for, permitted or accepted employer 
contributions.
    (3) Example. The principles of this paragraph (b) are illustrated by 
the following example:

    Example. Trust A is organized in accordance with a collective 
bargaining agreement between labor union K and multiple employers. Trust 
A forms part of a plan that is established and maintained pursuant to 
the agreement and which covers employees of the signatory employers who 
are members of K. Representatives of both the employers and K serve as 
trustees. A receives contributions from the employers who are subject to 
the agreement. Retirement benefits paid to K's members as specified in 
the agreement are funded exclusively by the employers' contributions and 
accumulated earnings. A also provides information to union members about 
their retirement benefits and assists them with administrative tasks 
associated with the benefits. Most of A's activities are devoted to 
these functions. From time to time, A also participates in the 
renegotiation of the collective bargaining agreement. A's principal 
activity is to receive, hold, invest, disburse, or otherwise manage 
funds associated with a retirement savings plan. In addition, A does not 
satisfy all the requirements of the exception described in paragraph 
(b)(2) of this section. (For example, A accepts contributions from 
employers.) Therefore, A is not a labor organization described in 
section 501(c)(5).

    (c) Organizations described in section 501(c)(5) and otherwise 
exempt from tax under section 501(a) are taxable upon their unrelated 
business taxable income. See part II (section 511 and following), 
subchapter F, chapter 1 of the Code, and the regulations thereunder.

[T.D. 6500, 25 FR 11737, Nov. 26, 1960; 25 FR 14021, Dec. 31, 1960, as 
amended by T.D. 8726, 62 FR 40449, July 29, 1997]



Sec.  1.501(c)(6)-1  Business leagues, chambers of commerce, real
estate boards, and boards of trade.

    A business league is an association of persons having some common 
business interest, the purpose of which is to promote such common 
interest and not to engage in a regular business of a kind ordinarily 
carried on for profit. It is an organization of the same general class 
as a chamber of commerce or board of trade. Thus, its activities should 
be directed to the improvement of business conditions of one or more 
lines of business as distinguished from the performance of particular 
services for individual persons. An organization whose purpose is to 
engage in a regular business of a kind ordinarily carried on for profit, 
even though the business is conducted on a cooperative basis or produces 
only sufficient income to be self-sustaining, is not a business league. 
An association engaged in furnishing information to prospective 
investors, to enable them to make sound investments, is not a business 
league, since its activities do not further any common business 
interest, even though all of its income is devoted to the purpose 
stated. A stock or commodity exchange is not a business league, a 
chamber of commerce, or a board of trade within the meaning of section 
501(c)(6) and is not exempt from tax. Organizations otherwise exempt 
from tax under this section are taxable upon their unrelated business 
taxable income. See part II (section 511 and following), subchapter F, 
chapter 1 of the Code, and the regulations thereunder.



Sec.  1.501(c)(7)-1  Social clubs.

    (a) The exemption provided by section 501(a) for organizations 
described in section 501(c)(7) applies only to clubs which are organized 
and operated exclusively for pleasure, recreation, and other 
nonprofitable purposes, but does not apply to any club if any part of 
its net earnings inures to the benefit of any private shareholder. In 
general, this exemption extends to social and

[[Page 24]]

recreation clubs which are supported solely by membership fees, dues, 
and assessments. However, a club otherwise entitled to exemption will 
not be disqualified because it raises revenue from members through the 
use of club facilities or in connection with club activities.
    (b) A club which engages in business, such as making its social and 
recreational facilities available to the general public or by selling 
real estate, timber, or other products, is not organized and operated 
exclusively for pleasure, recreation, and other nonprofitable purposes, 
and is not exempt under section 501(a). Solicitation by advertisement or 
otherwise for public patronage of its facilities is prima facie evidence 
that the club is engaging in business and is not being operated 
exclusively for pleasure, recreation, or social purposes. However, an 
incidental sale of property will not deprive a club of its exemption.



Sec.  1.501(c)(8)-1  Fraternal beneficiary societies.

    (a) A fraternal beneficiary society is exempt from tax only if 
operated under the lodge system or for the exclusive benefit of the 
members so operating. Operating under the lodge system means carrying on 
its activities under a form of organization that comprises local 
branches, chartered by a parent organization and largely self-governing, 
called lodges, chapters, or the like. In order to be exempt it is also 
necessary that the society have an established system for the payment to 
its members or their dependents of life, sick, accident, or other 
benefits.

[T.D. 6500, 25 FR 11737, Nov. 26, 1960, as amended by T.D. 7061, 35 FR 
14770, Sept. 23, 1970]



Sec.  1.501(c)(9)-1  Voluntary employees' beneficiary associations,
in general.

    To be described in section 501(c)(9) an organization must meet all 
of the following requirements:
    (a) The organization is an employees' association,
    (b) Membership in the association is voluntary,
    (c) The organization provides for the payment of life, sick, 
accident, or other benefits to its members or their dependents or 
designated beneficiaries, and substantially all of its operations are in 
furtherance of providing such benefits, and
    (d) No part of the net earnings of the organization inures, other 
than by payment of the benefits referred to in paragraph (c) of this 
section, to the benefit of any private shareholder or individual.

[T.D. 7750, 45 FR 1721, Jan. 7, 1981]



Sec.  1.501(c)(9)-2  Membership in a voluntary employees' beneficiary
association; employees; voluntary association of employees.

    (a) Membership--(1) In general. The membership of an organization 
described in section 501(c)(9) must consist of individuals who become 
entitled to participate by reason of their being employees and whose 
eligibility for membership is defined by reference to objective 
standards that constitute an employment-related common bond among such 
individuals. Typically, those eligible for membership in an organization 
described in section 501(c)(9) are defined by reference to a common 
employer (or affiliated employers), to coverage under one or more 
collective bargaining agreements (with respect to benefits provided by 
reason of such agreement(s)), to membership in a labor union, or to 
membership in one or more locals of a national or international labor 
union. For example, membership in an association might be open to all 
employees of a particular employer, or to employees in specified job 
classifications working for certain employers at specified locations and 
who are entitled to benefits by reason of one or more collective 
bargaining agreements. In addition, employees of one or more employers 
engaged in the same line of business in the same geographic locale will 
be considered to share an employment-related bond for purposes of an 
organization through which their employers provide benefits. Employees 
of a labor union also will be considered to share an employment-related 
common bond with members of the union, and employees of an association 
will be considered to share an employment-related common bond with 
members of the association. Whether a

[[Page 25]]

group of individuals is defined by reference to a permissible standard 
or standards is a question to be determined with regard to all the facts 
and circumstances, taking into account the guidelines set forth in this 
paragraph. Exemption will not be denied merely because the membership of 
an association includes some individuals who are not employees (within 
the meaning of paragraph (b) of this section), provided that such 
individuals share an employment-related bond with the employee-members. 
Such individuals may include, for example, the proprietor of a business 
whose employees are members of the association. For purposes of the 
preceding two sentences, an association will be considered to be 
composed of employees if 90 percent of the total membership of the 
association on one day of each quarter of the association's taxable year 
consists of employees (within the meaning of paragraph (b) of this 
section).
    (2) Restrictions--(i) In general. Eligibility for membership may be 
restricted by geographic proximity, or by objective conditions or 
limitations reasonably related to employment, such as a limitation to a 
reasonable classification of workers, a limitation based on a reasonable 
minimum period of service, a limitation based on maximum compensation, 
or a requirement that a member be employed on a full-time basis. 
Similarly, eligibility for benefits may be restricted by objective 
conditions relating to the type or amount of benefits offered. Any 
objective criteria used to restrict eligibility for membership or 
benefits may not, however, be selected or administered in a manner that 
limits membership or benefits to officers, shareholders, or highly 
compensated employees of an employer contributing to or otherwise 
funding the employees' association. Similarly, eligibility for benefits 
may not be subject to conditions or limitations that have the effect of 
entitling officers, shareholders, or highly compensated employees of an 
employer contributing to or otherwise funding the employees' association 
to benefits that are disproportionate in relation to benefits to which 
other members of the association are entitled. See Sec.  1.501(c)(9)-
4(b). Whether the selection or administration of objective conditions 
has the effect of providing disproportionate benefits to officers, 
shareholders, or highly compensated employees generally is to be 
determined on the basis of all the facts and circumstances.
    (ii) Generally permissible restrictions or conditions. In general 
the following restrictions will not be considered to be inconsistent 
with Sec.  1.501(c)(9)-2(a)(2)(i) or Sec.  1.501(c)(9)-4(b):
    (A) In the case of an employer-funded organization, a provision that 
excludes or has the effect of excluding from membership in the 
organization or participation in a particular benefit plan employees who 
are members of another organization or covered by a different plan, 
funded or contributed to by the employer, to the extent that such other 
organization or plan offers similar benefits on comparable terms to the 
excluded employees.
    (B) In the case of an employer funded-organization, a provision that 
excludes from membership, or limits the type or amount of benefits 
provided to, individuals who are included in a unit of employees covered 
by an agreement which the Secretary of Labor finds to be a collective 
bargaining agreement between employee representatives and one or more 
employers, if there is evidence that the benefit or benefits provided by 
the organization were the subject of good faith bargaining between such 
employee representatives and such employer or employers.
    (C) Restrictions or conditions on eligibility for membership or 
benefits that are determined through collective bargaining, by trustees 
designated pursuant to a collective bargaining agreement, or by the 
collective bargaining agents of the members of an association or 
trustees named by such agent or agents.
    (D) The allowance of benefits only on condition that a member or 
recipient contribute to the cost of such benefits, or the allowance of 
different benefits based solely on differences in contributions, 
provided that those making equal contributions are entitled to 
comparable benefits.

[[Page 26]]

    (E) A requirement that a member (or a member's dependents) meet a 
reasonable health standard related to eligibility for a particular 
benefit.
    (F) The provision of life benefits in amounts that are a uniform 
percentage of the compensation received by the individual whose life is 
covered.
    (G) The provision of benefits in the nature of wage replacement in 
the event of disability in amounts that are a uniform percentage of the 
compensation of the covered individuals (either before or after taking 
into account any disability benefits provided through social security or 
any similar plan providing for wage replacement in the event of 
disability).
    (3) Examples. The provisions of this section may be illustrated by 
the following examples:

    Example 1. Pursuant to a collective bargaining agreement entered 
into by X Corporation and W, a labor union which represents all of X 
Corporation's hourly-paid employees, the X Corporation Union Benefit 
Plan is established to provide life insurance benefits to employees of X 
represented by W. The Plan is funded by contributions from X, and is 
jointly administered by X and W. In order to provide its non-unionized 
employees with comparable life insurance benefits, X also establishes 
and funds the X Corporation Life Insurance Trust. The Trust will not be 
ineligible for exemption as an organization described in section 
501(c)(9) solely because membership is restricted to those employees of 
X who are not members of W.
    Example 2. The facts are the same as in Example 1 except that the 
life insurance benefit provided to the non-unionized employees of X 
differs from the life insurance benefit provided to the unionized 
employees of X pursuant to the collective bargaining agreement. The 
trust will not be ineligible for exemption as an organization described 
in section 501(c)(9) solely because the life insurance benefit provided 
to X's nonunionized employees is not same as the life insurance benefit 
provided to X's unionized employees.
    Example 3. S corporation established a plan to provide health 
benefits to all its employees. In accordance with the provisions of the 
plan each employee may secure insurance coverage by making an election 
under which the employee agrees to contribute periodically to the plan 
an amount which is determined solely by whether the employee elects a 
high option coverage or a low option coverage and on whether the 
employee is unmarried or has a family. As an alternative, the employee 
may elect high or low options, self only or self and family, coverage 
through a local prepaid group medical plan. The contributions required 
of those electing the prepaid group medical plan also vary with the type 
of coverage selected, and differ from those required of employees 
electing insurance. The difference between the amount contributed by 
employees electing the various coverages and the actual cost of 
purchasing the coverage is made up through contributions by S to the 
plan, and under the plan, S provides approximately the same proportion 
of the cost for each coverage. To fund the plan, S established an 
arrangement in the nature of a trust under applicable local law and 
contributes all employee contributions, and all amounts which by the 
terms of the plan it is required to contribute, to the trust. The terms 
of the plan do not provide for disproportionate benefits to the 
employees of S and will not be considered inconsistent with Sec.  
1.501(c)(9)-2(a)(2)(i).
    Example 4. The facts are the same as in Example 3 except that, for 
those employees or former employees covered by Medicare, the plan 
provides a distinct coverage which supplements Medicare benefits. 
Eligibility for Medicare is an objective condition relating to a type of 
benefit offered, and the provision of separate coverage for those 
eligible for Medicare will not be considered inconsistent with Sec.  
1.501(c)(9)-2(a)(2)(i).

    (b) Meaning of employee. Whether an individual is an employee is 
determined by reference to the legal and bona fide relationship of 
employer and employee. The term employee includes the following:
    (1) An individual who is considered an employee:
    (i) For employment tax purposes under subtitle C of the Internal 
Revenue Code and the regulations thereunder, or
    (ii) For purposes of a collective bargaining agreement,


whether or not the individual could qualify as an employee under 
applicable common law rules. This would include any person who is 
considered an employee for purposes of the Labor Management Relations 
Act of 1947, 61 Stat. 136, as amended, 29 U.S.C. 141 (1979).
    (2) An individual who became entitled to membership in the 
association by reason of being or having been an employee. Thus, an 
individual who would otherwise qualify under this paragraph will 
continue to qualify as an employee even though such individual is on 
leave of absence, works temporarily for another employer or as

[[Page 27]]

an independent contractor, or has been terminated by reason of 
retirement, disability or layoff. For example, an individual who in the 
normal course of employment is employed intermittently by more than one 
employer in an industry characterized by short-term employment by 
several different employers will not, by reason of temporary 
unemployment, cease to be an employee within the meaning of this 
paragraph.
    (3) The surviving spouse and dependents of an employee (if, for 
purposes of the 90-percent test of Sec.  1.501(c)(9)-2(a)(1) they are 
considered to be members of the association).
    (c) Description of voluntary association of employees--(1) 
Association. To be described in section 501(c)(9) and this section there 
must be an entity, such as a corporation or trust established under 
applicable local law, having an existence independent of the member-
employees or their employer.
    (2) Voluntary. Generally, membership in an association is voluntary 
if an affirmative act is required on the part of an employee to become a 
member rather than the designation as a member due to employee status. 
However, an association shall be considered voluntary although 
membership is required of all employees, provided that the employees do 
not incur a detriment (for example, in the form of deductions from pay) 
as the result of membership in the association. An employer is not 
deemed to have imposed involuntary membership on the employee if 
membership is required as the result of a collective bargaining 
agreement or as an incident of membership in a labor organization.
    (3) Of employees. To be described in this section, an organization 
must be controlled--
    (i) By its membership,
    (ii) By independent trustee(s) (such as a bank), or
    (iii) By trustees or other fiduciaries at least some of whom are 
designated by, or on behalf of, the membership. Whether control by or on 
behalf of the membership exists is a question to be determined with 
regard to all of the facts and circumstances, but generally such control 
will be deemed to be present when the membership (either directly or 
through its representative) elects, appoints or otherwise designates a 
person or persons to serve as chief operating officer(s), 
administrator(s), or trustee(s) of the organization. For purposes of 
this paragraph an organization will be considered to be controlled by 
independent trustees if it is an employee welfare benefit plan, as 
defined in section 3(1) of the Employee Retirement Income Security Act 
of 1974 (ERISA), and, as such, is subject to the requirements of parts 1 
and 4 of subtitle B, title I of ERISA. Similarly, a plan will be 
considered to be controlled by its membership if it is controlled by one 
or more trustees designated pursuant to a collective bargaining 
agreement (whether or not the bargaining agent of the represented 
employees bargained for and obtained the right to participate in 
selecting the trustees).
    (4) Examples. The provisions of this section may be illustrated by 
the following examples:

    Example 1. X, a labor union, represents all the hourly-paid 
employees of Y Corporation. A health insurance benefit plan was 
established by X and Y as the result of a collective bargaining 
agreement entered into by them. The plan established the terms and 
conditions of membership in, and the benefits to be provided by, the 
plan. In accordance with the terms of the agreement, Y Corporation is 
obligated to establish a trust fund and make contributions thereto at 
specified rates. The trustees, some of whom are designated by X and some 
by Y, are authorized to hold and invest the assets of the trust and to 
make payments on instructions issued by Y Corporation in accordance with 
the conditions contained in the plan. The interdependent benefit plan 
agreement and trust indenture together create a voluntary employees' 
beneficiary association over which the employees posses the requisite 
control through the trustees designated by their representative, X.
    Example 2. Z Corporation unilaterally established an educational 
benefit plan for its employees. The purpose of the plan is to provide 
payments for job-related educational or training courses, such as 
apprenticeship training programs, for Z Corporation employees, according 
to objective criteria set forth in the plan. Z establishes a separate 
bank account which it uses to fund payments to the plan. Contributions 
to the account are to be made at the discretion of and solely by Z 
Corporation, which also administers the plan and retains control over 
the assets in the fund. Z Corporation's educational benefit

[[Page 28]]

plan and the related account do not constitute an association having an 
existence independent of Z Corporation and therefore do not constitute a 
voluntary employees' beneficiary association.
    Example 3. A, an individual, is the incorporator and chief operating 
officer of Lawyers' Beneficiary Association (LBA). LBA is engaged in the 
business of providing medical benefits to members of the Association and 
their families. Membership is open only to practicing lawyers located in 
a particular metropolitan area who are neither self-employed nor 
partners in a law firm. Membership in LBA is solicited by insurance 
agents under the control of X Corporation (owned by A) which, by 
contract with LBA, is the exclusive sales agent. Medical benefits are 
paid from a trust account containing periodic contributions paid by the 
members, together with proceeds from the investment of those 
contributions. Contribution and benefit levels are set by LBA. The 
members of LBA do not hold meetings, have no right to elect officers or 
directors of the Association, and no right to replace trustees. 
Collectively, the subscribers for medical benefits from LBA cannot be 
said to control the association and membership is neither more than nor 
different from the purchase of an insurance policy from a stock 
insurance company. LBA is not a voluntary employees' beneficiary 
association.
    Example 4. U corporation unilaterally established a plan to provide 
benefits to its employees. In accordance with the provisions of the 
plan, each employee may secure insurance or benefit coverage by making 
an election under which the employee agrees to contribute to the plan an 
amount which is determined solely by whether the employee elects a high 
option coverage or a low option coverage and on whether the employee 
elects self only or self and family coverage. The difference between the 
amount contributed by employees electing the various coverages and the 
actual cost of the coverage is made up through contributions by U to the 
plan. To fund the plan, U established an arrangement in the nature of a 
trust under applicable local law and contributed all employee 
contributions, and all amounts which by the term of the plan it was 
required to provide to the plan, to the trust. The trust constitutes an 
employee welfare benefit plan within the meaning of, and subject to 
relevant requirements of, ERISA. It will be considered to meet the 
requirements of Sec.  1.501(c)(9)-2(c)(3).

[T.D. 7750, 46 FR 1723, Jan. 7, 1981]



Sec.  1.501(c)(9)-3  Voluntary employees' beneficiary associations;
life, sick, accident, or other benefits.

    (a) In general. The life, sick, accident, or other benefits provided 
by a voluntary employees' beneficiary association must be payable to its 
members, their dependents, or their designated beneficiaries. For 
purposes of section 501(c)(9), dependent means the member's spouse; any 
child of the member or the member's spouse who is a minor or a student 
(within the meaning of section 151(e)(4)); any other minor child 
residing with the member; and any other individual who an association, 
relying on information furnished to it by a member, in good faith 
believes is a person described in section 152(a). Life, sick, accident, 
or other benefits may take the form of cash or noncash benefits. A 
voluntary employees' beneficiary association is not operated for the 
purpose of providing life, sick, accident, or other benefits unless 
substantially all of its operations are in furtherance of the provision 
of such benefits. Further, an organization is not described in this 
section if it systematically and knowingly provides benefits (of more 
than a de minimis amount) that are not permitted by paragraphs (b), (c), 
(d), or (e) of this section.
    (b) Life benefits. The term life benefits means a benefit (including 
a burial benefit or a wreath) payable by reason of the death of a member 
or dependent. A life benefit may be provided directly or through 
insurance. It generally must consist of current protection, but also may 
include a right to convert to individual coverage on termination of 
eligibility for coverage through the association, or a permanent benefit 
as defined in, and subject to the conditions in, the regulations under 
section 79. A life benefit also includes the benefit provided under any 
life insurance contract purchased directly from an employee-funded 
association by a member or provided by such an association to a member. 
The term life benefit does not include a pension, annuity or similar 
benefit, except that a benefit payable by reason of the death of an 
insured may be settled in the form of an annuity to the beneficiary in 
lieu of a lump-sum death benefit (whether or not the contract provides 
for settlement in a lump sum).
    (c) Sick and accident benefits. The term sick and accident benefits 
means amounts furnished to or on behalf of a member or a member's 
dependents in

[[Page 29]]

the event of illness or personal injury to a member or dependent. Such 
benefits may be provided through reimbursement to a member or a member's 
dependents for amounts expended because of illness or personal injury, 
or through the payment of premiums to a medical benefit or health 
insurance program. Similarly, a sick and accident benefit includes an 
amount paid to a member in lieu of income during a period in which the 
member is unable to work due to sickness or injury. Sick benefits also 
include benefits designed to safeguard or improve the health of members 
and their dependents. Sick and accident benefits may be provided 
directly by an association to or on behalf of members and their 
dependents, or may be provided indirectly by an association through the 
payment of premiums or fees to an insurance company, medical clinic, or 
other program under which members and their dependents are entitled to 
medical services or to other sick and accident benefits. Sick and 
accident benefits may also be furnished in noncash form, such as, for 
example, benefits in the nature of clinical care services by visiting 
nurses, and transportation furnished for medical care.
    (d) Other benefits. The term other benefits includes only benefits 
that are similar to life, sick, or accident benefits. A benefit is 
similar to a life, sick, or accident benefit if:
    (1) It is intended to safeguard or improve the health of a member or 
a member's dependents, or
    (2) It protects against a contingency that interrupts or impairs a 
member's earning power.
    (e) Examples of other benefits. Paying vacation benefits, providing 
vacation facilities, reimbursing vacation expenses, and subsidizing 
recreational activities such as athletic leagues are considered other 
benefits. The provision of child-care facilities for preschool and 
school-age dependents are also considered other benefits. The provision 
of job readjustment allowances, income maintenance payments in the event 
of economic dislocation, temporary living expense loans and grants at 
times of disaster (such as fire or flood), supplemental unemployment 
compensation benefits (as defined in section 501(c)(17)(D)(i) of the 
Code), severance benefits (under a severance pay plan within the meaning 
of 29 CFR 2510.3-2(b)) and education or training benefits or courses 
(such as apprentice training programs) for members, are considered other 
benefits because they protect against a contingency that interrupts 
earning power. Personal legal service benefits which consist of payments 
or credits to one or more organizations or trusts described in section 
501(c)(20) are considered other benefits. Except to the extent otherwise 
provided in these regulations, as amended from time to time, other 
benefits also include any benefit provided in the manner permitted by 
paragraphs (5) et seq. of section 302(c) of the Labor Management 
Relations Act of 1947, 61 Stat. 136, as amended, 29 U.S.C. 186(c) 
(1979).
    (f) Examples of nonqualifying benefits. Benefits that are not 
described in paragraphs (d) or (e) of this section are not other 
benefits. Thus, other benefits do not include the payment of commuting 
expenses, such as bridge tolls or train fares, the provision of accident 
or homeowner's insurance benefits for damage to property, the provision 
of malpractice insurance, or the provision of loans to members except in 
times of distress (as permitted by Sec.  1.501(c)(9)-3(e)). Other 
benefits also do not include the provision of savings facilities for 
members. The term other benefits does not include any benefit that is 
similar to a pension or annuity payable at the time of mandatory or 
voluntary retirement, or a benefit that is similar to the benefit 
provided under a stock bonus or profit-sharing plan. For purposes of 
section 501(c)(9) and these regulations, a benefit will be considered 
similar to that provided under a pension, annuity, stock bonus or 
profit-sharing plan if it provides for deferred compensation that 
becomes payable by reason of the passage of time, rather than as the 
result of an unanticipated event. Thus, for example, supplemental 
unemployment benefits, which generally become payable by reason of 
unanticipated layoff, are not, for purposes of these regulations, 
considered similar to the benefit provided under a pension, annuity, 
stock bonus or profit-sharing plan.

[[Page 30]]

    (g) Examples. The provisions of this section may be further 
illustrated by the following examples:

    Example 1. V was organized in connection with a vacation plan 
created pursuant to a collective bargaining agreement between M, a labor 
union, which represents certain hourly paid employees of T corporation, 
and T. The agreement calls for the payment by T to V of a specified sum 
per hour worked by T employees who are covered by the collective 
bargaining agreement. T includes the amounts in the covered employees' 
wages and withholds income and FICA taxes. The amounts are paid by T to 
V to provide vacation benefits provided under the collective bargaining 
agreement. Generally, each covered employee receives a check in payment 
of his or her vacation benefit during the year following the year in 
which contributions were made by T to V. The amount of the vacation 
benefit is determined by reference to the contributions during the prior 
year to V by T on behalf of each employee, and is distributed in cash to 
each such employee. If the earnings on investments by V during the year 
preceding distribution are sufficient after deducting the expenses of 
administering the plan, each recipient of a vacation benefit is paid an 
amount, in addition to the contributions on his or her behalf, equal to 
his/her ratable share of the net earnings of V during such year. The 
plan provides a vacation benefit that constitutes an eligible other 
benefit described in section 501(c)(9) and Sec.  1.501(c)(9)-3(e).
    Example 2. The facts are the same as in Example 1, except that each 
covered employee of T is entitled, at his or her discretion, to 
contribute up to an additional $1,000 each year to V, which agrees in 
respect of such sum to pay interest at a stated rate from the time of 
contribution until the time at which the contributing employee's 
vacation benefit is distributed. In addition, each employee may elect to 
leave all or a portion of his/her distributable benefit on deposit past 
the time of distribution, in which case interest will continue to 
accrue. Because the plan more closely resembles a savings arrangement 
than a vacation plan, the benefit payable to the covered employees of T 
is not a vacation benefit and is not an eligible other benefit described 
in section 501(c)(9) and Sec.  1.501(c)(9)-3 (d) or (e).

[T.D. 7750, 46 FR 1724, Jan. 7, 1981]



Sec.  1.501(c)(9)-4  Voluntary employees' beneficiary associations;
inurement.

    (a) General rule. No part of the net earnings of an employees' 
association may inure to the benefit of any private shareholder or 
individual other than through the payment of benefits permitted by Sec.  
1.501(c)(9)-3. The disposition of property to, or the performance of 
services for, a person for less than the greater of fair market value or 
cost (including indirect costs) to the association, other than as a 
life, sick, accident or other permissible benefit, constitutes 
prohibited inurement. Generally, the payment of unreasonable 
compensation to the trustees or employees of the association, or the 
purchase of insurance or services for amounts in excess of their fair 
market value from a company in which one or more of the association's 
trustees, officers or fiduciaries has an interest, will constitute 
prohibited inurement. Whether prohibited inurement has occurred is a 
question to be determined with regard to all of the facts and 
circumstances, taking into account the guidelines set forth in this 
section. The guidelines and examples contained in this section are not 
an exhaustive list of the activities that may constitute prohibited 
inurement, or the persons to whom the association's earnings could 
impermissibly inure. See Sec.  1.501(a)-1(c).
    (b) Disproportionate benefits. For purposes of subsection (a), the 
payment to any member of disproportionate benefits, where such payment 
is not pursuant to objective and nondiscriminatory standards, will not 
be considered a benefit within the meaning of Sec.  1.501(c)(9)-3 even 
though the benefit otherwise is one of the type permitted by that 
section. For example, the payment to highly compensated personnel of 
benefits that are disproportionate in relation to benefits received by 
other members of the association will constitute prohibited inurement. 
Also, the payment to similarly situated employees of benefits that 
differ in kind or amount will constitute prohibited inurement unless the 
difference can be justified on the basis of objective and reasonable 
standards adopted by the association or on the basis of standards 
adopted pursuant to the terms of a collective bargaining agreement. In 
general, benefits paid pursuant to standards or subject to conditions 
that do not provide for disproportionate benefits to officers, 
shareholders, or highly compensated employees will not be considered 
disproportionate. See Sec.  1.501(c)(9)-2(a) (2) and (3).

[[Page 31]]

    (c) Rebates. The rebate of excess insurance premiums, based on the 
mortality or morbidity experience of the insurer to which the premiums 
were paid, to the person or persons whose contributions were applied to 
such premiums, does not constitute prohibited inurement. A voluntary 
employees' beneficiary association may also make administrative 
adjustments strictly incidental to the provision of benefits to its 
members.
    (d) Termination of plan or dissolution of association. It will not 
constitute prohibited inurement if, on termination of a plan established 
by an employer and funded through an association described in section 
501(c)(9), any assets remaining in the association, after satisfaction 
of all liabilities to existing beneficiaries of the plan, are applied to 
provide, either directly or through the purchase of insurance, life, 
sick, accident or other benefits within the meaning of Sec.  
1.501(c)(9)-3 pursuant to criteria that do not provide for 
disproportionate benefits to officers, shareholders, or highly 
compensated employees of the employer. See Sec.  1.501(c)(9)-2(a)(2). 
Similarly, a distribution to members upon the dissolution of the 
association will not constitute prohibited inurement if the amount 
distributed to members are determined pursuant to the terms of a 
collective bargaining agreement or on the basis of objective and 
reasonable standards which do not result in either unequal payments to 
similarly situated members or in disproportionate payments to officers, 
shareholders, or highly compensated employees of an employer 
contributing to or otherwise funding the employees' association. Except 
as otherwise provided in the first sentence of this paragraph, if the 
association's corporate charter, articles of association, trust 
instrument, or other written instrument by which the association was 
created, as amended from time to time, provides that on dissolution its 
assets will be distributed to its members' contributing employers, or if 
in the absence of such provision the law of the state in which the 
association was created provides for such distribution to the 
contributing employers, the association is not described in section 
501(c)(9).
    (e) Example. The provisions of this section may be illustrated by 
the following example:

    Example. Employees A, B and C, members of the X voluntary employees' 
beneficiary association, are unemployed. They receive unemployment 
benefits from X. Those to A include an amount in addition to those 
provided to B and C, to provide for A's retraining. B has been found 
pursuant to objective and reasonable standards not to qualify for the 
retraining program. C, although eligible for retraining benefits has 
declined. X's additional payment to A for retraining does not constitute 
prohibited inurement.

[T.D. 7750, 46 FR 1725, Jan. 7, 1981]



Sec.  1.501(c)(9)-5  Voluntary employees' beneficiary associations;
recordkeeping requirements.

    (a) Records. In addition to such other records which may be required 
(for example, by section 512(a)(3) and the regulations thereunder), 
every organization described in section 501(c)(9) must maintain records 
indicating the amount contributed by each member and contributing 
employer, and the amount and type of benefits paid by the organization 
to or on behalf of each member.
    (b) Cross reference. For provisions relating to annual information 
returns with respect to payments, see section 6041 and the regulations 
thereunder.

[T.D. 7750, 46 FR 1725, Jan. 7, 1981]



Sec.  1.501(c)(9)-6  Voluntary employees' beneficiary associations;
benefits includible in gross income.

    (a) In general. Cash and noncash benefits realized by a person on 
account of the activities of an organization described in section 
501(c)(9) shall be included in gross income to the extent provided in 
the Internal Revenue Code of 1954, including, but not limited to, 
sections 61, 72, 101, 104 and 105 of the Code and regulations 
thereunder.
    (b) Availability of statutory exclusions from gross income. The 
availability of any statutory exclusion from gross income with respect 
to contributions to, or the payment of benefits from, an organization 
described in section 501(c)(9) is determined by the statutory provision 
conferring the exclusion, and the regulations and rulings thereunder, 
not by whether an individual is eligible for

[[Page 32]]

membership in the organization or by the permissibility of the benefit 
paid. Thus, for example, if a benefit is paid by an employer-funded 
organization described in section 501(c)(9) to a member who is not an 
employee, a statutory exclusion from gross income that is available only 
for employees would be unavailable in the case of a benefit paid to such 
individual. Similarly, the fact that, for example, under some 
circumstances educational benefits constitute other benefits does not of 
itself mean that such benefits are eligible for the exclusion of either 
section 117 or section 127 of the Code.

[T.D. 7750, 46 FR 1725, Jan. 7, 1981]



Sec.  1.501(c)(9)-7  Voluntary employees' beneficiary associations;
section 3(4) of ERISA.

    The term voluntary employees' beneficiary association in section 
501(c)(9) of the Internal Revenue Code is not necessarily coextensive 
with the term employees' beneficiary association as used in section 3(4) 
of the Employee Retirement Income Security Act of 1974 (ERISA), 29 
U.S.C. 1002(4), and the requirements which an organization must meet to 
be an employees' beneficiary association within the meaning of section 
3(4) of ERISA are not necessarily identical to the requirements that an 
organization must meet in order to be a voluntary employees' beneficiary 
association within the meaning of section 501(c)(9) of the Code.

[T.D. 7750, 46 FR 1725, Jan. 7, 1981]



Sec.  1.501(c)(9)-8  Voluntary employees' beneficiary associations;
effective date.

    (a) General rule. Except as otherwise provided in this section, the 
provisions of Sec. Sec.  1.501(c)(9)-1 through 1.501(c)(9)-7 shall apply 
with respect to taxable years beginning after December 31, 1954.
    (b) Pre-1970 taxable years. For taxable years beginning before 
January 1, 1970, section 501(c)(9)(B) (relating to the requirement that 
85 percent or more of the association's income consist of amounts 
collected from members and contributed by employers), as in effect for 
such years, shall apply.
    (c) Existing associations. Except as otherwise provided in paragraph 
(d), the provisions of Sec.  1.501(c)(9)-2(a)(1) and (c)(3) shall apply 
with respect to taxable years beginning after December 31, 1980.
    (d) Collectively-bargained plans. In the case of a voluntary 
employees' beneficiary association which receives contributions from one 
or more employers pursuant to one or more collective bargaining 
agreements in effect on December 31, 1980, the provisions of Sec. Sec.  
1.501(c)(9)-1 through 1.501(c)(9)-5 shall apply with respect to taxable 
years beginning after the date on which the agreement terminates 
(determined without regard to any extension thereof agreed to after 
December 31, 1980).
    (e) Election. Notwithstanding paragraphs (c) and (d) of this 
section, an organization may choose to be subject to all or a portion of 
one or more of the provisions of these regulations for any taxable year 
beginning after December 31, 1954.

[T.D. 7750, 46 FR 1725, Jan. 7, 1981; 46 FR 11971, Feb. 12, 1981]



Sec.  1.501(c)(10)-1  Certain fraternal beneficiary societies.

    (a) For taxable years beginning after December 31, 1969, an 
organization will qualify for exemption under section 501(c)(10) if it:
    (1) Is a domestic fraternal beneficiary society order, or 
association, described in section 501(c)(8) and the regulations 
thereunder except that it does not provide for the payment of life, 
sick, accident, or other benefits to its members, and
    (2) Devotes its net earnings exclusively to religious, charitable, 
scientific, literary, educational, and fraternal purposes


Any organization described in section 501(c)(7), such as, for example, a 
national college fraternity, is not described in section 501(c)(10) and 
this section.

[T.D. 7172, 37 FR 5618, Mar. 17, 1972]



Sec.  1.501(c)(12)-1  Local benevolent life insurance associations,
mutual irrigation and telephone companies, and like organizations.

    (a) An organization described in section 501(c)(12) must receive at 
least 85 percent of its income from amounts

[[Page 33]]

collected from members for the sole purpose of meeting losses and 
expenses. If an organization issues policies for stipulated cash 
premiums, or if it requires advance deposits to cover the cost of the 
insurance and maintains investments from which more than 15 percent of 
its income is derived, it is not entitled to exemption. On the other 
hand, an organization may be entitled to exemption, although it makes 
advance assessments for the sole purpose of meeting future losses and 
expenses, provided that the balance of such assessments remaining on 
hand at the end of the year is retained to meet losses and expenses or 
is returned to members.
    (b) The phrase of a purely local character applies to benevolent 
life insurance associations, and not to the other organizations 
specified in section 501(c)(12). It also applies to any organization 
seeking exemption on the ground that it is an organization similar to a 
benevolent life insurance association. An organization of a purely local 
character is one whose business activities are confined to a particular 
community, place, or district, irrespective, however, of political 
subdivisions. If the activities of an organization are limited only by 
the borders of a State it cannot be considered to be purely local in 
character.
    (c) For taxable years of a mutual or cooperative telephone company 
beginning after December 31, 1974, the 85 percent member-income test 
described in paragraph (a) of this section is applied without taking 
into account income received or accrued from another telephone company 
for the performance of communication services involving the completion 
of long distance calls to, from, or between members of the mutual or 
cooperative telephone company. For example, if, in one year, a 
cooperative telephone company receives $85x from its members for 
telephone calls, $15x as interest income, and $20x as credits under long 
distance interconnection agreements with other telephone companies for 
the performance of communication services involving the completion of 
long distance calls to, from, or between the cooperative's members 
(whether or not the credits may be offset, in whole or in part, by 
amounts due the other companies under the interconnection agreements), 
the member-income fraction is calculated without taking into account, 
either in the numerator or denominator, the $20x credits received from 
the other telephone companies. In this example, the 85 percent member-
income test is satisfied because at least 85 percent
[GRAPHIC] [TIFF OMITTED] TC14NO91.158


of the cooperative's total income is derived from member income.

[T.D. 6500, 25 FR 11737, Nov. 26, 1960; 25 FR 14021, Dec. 31, 1960, as 
amended at 44 FR 59523, Oct. 16, 1979]



Sec.  1.501(c)(13)-1  Cemetery companies and crematoria.

    (a) Nonprofit mutual cemetery companies. A nonprofit cemetery 
company may be entitled to exemption if it is owned by and operated 
exclusively for the benefit of its lot owners who hold such lots for 
bona fide burial purposes and not for the purpose of fesale. A mutual 
cemetery company which also engages in charitable activities, such as 
burial of paupers, will be regarded as operating in conformity with this 
standard. Further, the fact that a mutual cemetery company limits its 
membership to a particular class of individuals, such as members of a 
family, will not affect its status as mutual so long as all the other 
requirements of section 501(c)(13) are met.
    (b) Nonprofit cemetery companies and crematoria. Any nonprofit 
corporation, chartered solely for the purpose of the burial, or (for 
taxable years beginning after December 31, 1970) the cremation of 
bodies, and not permitted by its charter to engage in any business not 
necessarily incident to that purpose, is exempt from income tax, 
provided that no part of its net earnings inures to the benefit of any 
private shareholder or individual.
    (c) Preferred stock--(1) In general. Except as provided in 
subparagraph (3) of this paragraph, a cemetery company or crematorium is 
not described in section 501(c)(13) if it issues preferred stock on or 
after November 28, 1978.

[[Page 34]]

    (2) Transitional rule for preferred stock issued prior to November 
28, 1978. In the case of preferred stock issued prior to November 28, 
1978, a cemetery company or crematorium which issued such stock shall 
not fail to be exempt from income tax solely because it issued preferred 
stock which entitled the holders to dividends at a fixed rate, not 
exceeding the legal rage of interest in the State of incorporation or 8 
percent per annum, whichever is greater, on the value of the 
consideration for which the stock was issued, if its articles of 
incorporation require:
    (i) That the preferred stock be retired at par as rapidly as funds 
therefor become available from operations, and
    (ii) That all funds not required for the payment of dividends upon 
or for the retirement of preferred stock be used by the company for the 
care and inprovement of the cemetery property. The term legal rate of 
interest shall mean the rate of interest prescribed by law in the State 
of incorporation which prevails in the absence of an agreement between 
contracting parties fixing a rate.
    (3) Transitional rule for preferred stock issued on or after 
November 28, 1978. In the case of preferred stok issued on or after 
November 28, 1978, a cemetery company or crematorium shall not fail to 
be exempt from income tax if its articles of incorporation and the 
preferred stock meet the requirements of paragraph (c)(2) and if such 
stock is issued pursuant to a plan which has been reduced to writing and 
adopted prior to November 28, 1978. The adoption of the plan must be 
shown by the acts of the duly constituted responsible officers and 
appear upon the official records of the cemetery company or crematorium.
    (d) Sales to exempt cemetery companies and crematoria. Except as 
provided in paragraph (c)(2) or (c)(3) of this section (relating to 
transitional rules for preferred stock), no person may have any interest 
in the net earnings of a tax-exempt cemetery company or crematorium. 
Thus, a cemetery company or crematorium is not exempt from tax if 
property is transferred to such organization in exchange for an interest 
in the net earnings of the organization so long as such interest remains 
outstanding. An interest in a cemetery company or crematorium that 
constitutes an equity interest within the meaning of section 385 will be 
considered an interest in the net earnings of the cemetery. However, an 
interest in a cemetery company or crematorium that does not constitute 
an equity interest within the meaning of section 385 may nevertheless 
constitute an interest in the net earning of the organization. Thus, for 
example, a bond or other evidence of indebtedness issued by a cemetery 
company or crematorium which provides for a fixed rate of interest but 
which, in addition, provides for additional interest payments contingent 
upon the revenues or income of the organization is considered an 
interest in the net earnings of the organization. Similarly, a 
convertible debt obligation issued by a cemetery company or crematorium 
after July 7, 1975, is considered an interest in the net earnings of the 
organization.

[T.D. 7698, 45 FR 33972, May 21, 1980]



Sec.  1.501(c)(14)-1  Credit unions and mutual insurance funds.

    Credit unions (other than Federal credit unions described in section 
501(c)(1)) without capital stock, organized and operated for mutual 
purposes and without profit, are exempt from tax under section 501(a). 
Corporations or associations without capital stock organized before 
September 1, 1951 and operated for mutual purposes and without profit 
for the purpose of providing reserve funds for, and insurance of, shares 
or deposits in:
    (a) Domestic building and loan associations as defined in section 
7701(a)(19),
    (b) Cooperative banks without capital stock organized and operated 
for mutual purposes and without profit, or
    (c) Mutual savings banks not having capital stock represented by 
shares


are also exempt from tax under section 501(a). In addition, corporations 
or associations of the type described in the preceding sentence which 
were organized on or after September 1, 1951, but before September 1, 
1957, are exempt

[[Page 35]]

from tax under section 501(a) for taxable years beginning after December 
31, 1959.

[T.D. 6493, 25 FR 9219, Sept. 27, 1960]



Sec.  1.501(c)(15)-1  Mutual insurance companies or associations.

    (a) Taxable years beginning after December 31, 1962. An insurance 
company or association described in section 501(c)(15) is exempt under 
section 501(a) if it is a mutual company or association (other than life 
or marine) or if it is a mutual interinsurer or reciprocal underwriter 
(other than life or marine) and if the gross amount received during the 
taxable year from the sum of the following items does not exceed 
$150,000:
    (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 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 company may derive interest, rents, or 
royalties.
    (v) The alteration or termination of any instrument or agreement 
described in subdivision (iv) of this subparagraph.
    (2) The gross income from any trade or business (other than an 
insurance business) carried on by the company or association, or by a 
partnership of which the company or association is a partner.
    (3) Premiums (including deposits and assessments).
    (b) Taxable years beginning after December 31, 1954, and before 
January 1, 1963. An insurance company or association described in 
section 501(c)(15) and paragraph (a) of this section is exempt under 
section 501(a) if the gross amount received during the taxable year from 
the sum of the items described in paragraph (a) (1), (2), and (3) of 
this section does not exceed $75,000.
    (c) No double inclusion of income. In computing the gross income 
from any trade or business (other than an insurance business) carried on 
by the company or association, or by a partnership of which the company 
or association is a partner, any item described in section 822(b)(1) 
(A), (B), or (C) and paragraph (a)(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) (A), 
(B), or (C) and paragraph (a)(1) of this section.
    (d) Taxable years beginning after December 31, 1953, and before 
January 1, 1955. An insurance company or association described in 
section 501(c)(15) is exempt under section 501(a) if it is a mutual 
company or association (other than life or marine) or if it is a mutual 
interinsurer or reciprocal underwriter (other than life or marine) and 
if the gross amount received during the taxable year from the sum of the 
following items does not exceed $75,000:
    (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.  1.822-3.
    (ii) Dividends, as described in Sec.  1.61-9.
    (iii) Rents (but excluding royalties), as described in Sec.  1.61-8.
    (2) Premiums (including deposits and assessments).
    (e) Exclusion of capital gains. 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, 
shall be excluded from the amounts described in this section.

[T.D. 6662, 28 FR 6972, July 29, 1963]



Sec.  1.501(c)(16)-1  Corporations organized to finance crop operations.

    A corporation organized by a farmers' cooperative marketing or 
purchasing association, or the members thereof, for the purpose of 
financing the ordinary crop operations of such members or other 
producers is exempt, provided the marketing or purchasing

[[Page 36]]

association is exempt under section 521 and the financing corporation is 
operated in conjunction with the marketing or purchasing association. 
The provisions of Sec.  1.521-1 relating to a reserve or surplus and to 
capital stock shall also apply to corporations coming under this 
section.



Sec.  1.501(c)(17)-1  Supplemental unemployment benefit trusts.

    (a) Requirements for qualification. (1) A supplemental unemployment 
benefit trust may be exempt as an organization described in section 
501(c)(17) if the requirements of subparagraphs (2) through (6) of this 
paragraph are satisfied.
    (2) The trust is a valid, existing trust under local law and is 
evidenced by an executed written document.
    (3) The trust is part of a written plan established and maintained 
by an employer, his employees, or both the employer and his employees, 
solely for the purpose of providing supplemental unemployment 
compensation benefits (as defined in section 501(c)(17)(D) and paragraph 
(b)(1) of Sec.  1.501(c)(17)-1).
    (4) The trust is part of a plan which provides that the corpus and 
income of the trust cannot (in the taxable year, and at any time 
thereafter, before the satisfaction of all liabilities to employees 
covered by the plan) be used for, or diverted to, any purpose other than 
the providing of supplemental unemployment compensation benefits. Thus, 
if the plan provides for the payment of any benefits other than 
supplemental unemployment compensation benefits as defined in paragraph 
(b) of this section, the trust will not be entitled to exemption as an 
organization described in section 501(c)(17). However, the payment of 
any necessary or appropriate expenses in connection with the 
administration of a plan providing supplemental unemployment 
compensation benefits shall be considered a payment to provide such 
benefits and shall not affect the qualification of the trust.
    (5) The trust is part of a plan whose eligibility conditions and 
benefits do not discriminate in favor of employees who are officers, 
shareholders, persons whose principal duties consist of supervising the 
work of other employees, or highly compensated employees. See sections 
401(a)(3)(B) and 401(a)(4) and Sec. Sec.  1.401-3 and 1.401(a)(4)-0 
through 1.401(a)(4)-13. However, a plan is not discriminatory within the 
meaning of section 501(c)(17)(A)(iii), relating to the requirement that 
the benefits paid under the plan be nondiscriminatory, merely because 
the benefits received under the plan bear a uniform relationship to the 
total compensation, or the basic or regular rate of compensation, of the 
employees covered by the plan. Accordingly, the benefits provided for 
highly paid employees may be greater than the benefits provided for 
lower paid employees if the benefits are determined by reference to 
their compensation; but, in such a case, the plan will not qualify if 
the benefits paid to the higher paid employees bear a larger ratio to 
their compensation than the benefits paid to the lower paid employees 
bear to their compensation. In addition, section 501(c)(17)(B) sets 
forth certain other instances in which a plan will not be considered 
discriminatory (see paragraph (c) of Sec.  1.501(c)(17)-2).
    (6) The trust is part of a plan which requires that benefits are to 
be determined according to objective standards. Thus, a plan may provide 
similarly situated employees with benefits which differ in kind and 
amount, but may not permit such benefits to be determined solely in the 
discretion of the trustees.
    (b) Meaning of terms. The following terms are defined for purposes 
of section 501(c)(17):
    (1) Supplemental unemployment compensation benefits. The term 
supplemental unemployment compensation benefits means only:
    (i) Benefits paid to an employee because of his involuntary 
separation from the employment of the employer, whether or not such 
separation is temporary, but only when such separation is one resulting 
directly from a reduction in force, the discontinuance of a plant or 
operation, or other similar conditions; and
    (ii) Sick and accident benefits subordinate to the benefits 
described in subdivision (i) of this subparagraph.
    (2) Employee. The term employee means an individual whose status is 
that of an employee under the usual

[[Page 37]]

common-law rules applicable in determining the employer-employee 
relationship. The term employee also includes an individual who 
qualifies as an employee under the State or Federal unemployment 
compensation law covering his employment, whether or not such an 
individual could qualify as an employee under such common-law rules.
    (3) Involuntary separation from the employment of the employer. 
Whether a separation from the employment of the employer occurs is a 
question to be decided with regard to all the facts and circumstances. 
However, for purposes of section 501(c)(17), the term separation 
includes both a temporary separation and a permanent severance of the 
employment relationship. Thus, for example, an employee may be separated 
from the employment of his employer even though at the time of 
separation it is believed that he will be reemployed by the same 
employer. Whether or not an employee is involuntarily separated from the 
employment of the employer is a question of fact. However, normally, an 
employee will not be deemed to have separated himself voluntarily from 
the employment of his employer merely because his collective bargaining 
agreement provides for the termination of his services upon the 
happening of a condition subsequent and that condition does in fact 
occur. For example, if the collective bargaining agreement provides that 
the employer may automate a given department and thereby dislocate 
several employees, the fact that the employees' collective bargaining 
agent has consented to such a condition will not render any employee's 
subsequent unemployment for such cause voluntary.
    (4) Other similar conditions. Involuntary separation directly 
resulting from other similar conditions includes, for example, 
involuntary separation from the employment of the employer resulting 
from cyclical, seasonal, or technological causes. Some causes of 
involuntary separation from the employment of the employer which are not 
similar to those enumerated in section 501(c)(17)(D)(i) are separation 
for disciplinary reasons or separation because of age.
    (5) Subordinate sick and accident benefits. In general, a sick and 
accident benefit payment is an amount paid to an employee in the event 
of his illness or personal injury (whether or not such illness or injury 
results in the employee's separation from the service of his employer). 
In addition, the phrase sick and accident benefits includes amounts 
provided under the plan to reimburse an employee for amounts he expends 
because of the illness or injury of his spouse or a dependent (as 
defined in section 152). Sick and accident benefits may be paid by a 
trust described in section 501(c)(17) only if such benefits are 
subordinate to the separation payments provided under the plan of which 
the trust forms a part. Whether the sick and accident benefits provided 
under a supplemental unemployment compensation benefit plan are 
subordinate to the separation benefits provided under such plan is a 
question to be decided with regard to all the facts and circumstances.

[T.D. 6972, 33 FR 12900, Sept. 12, 1968, as amended by T.D. 9849, 84 FR 
9235, Mar. 14, 2019]



Sec.  1.501(c)(17)-2  General rules.

    (a) Supplemental unemployment compensation benefits. Supplemental 
unemployment compensation benefits as defined in section 501(c)(17)(D) 
and paragraph (b)(1) of Sec.  1.501(c)(17)-1 may be paid in a lump sum 
or installments. Such benefits may be paid to an employee who has, 
subsequent to his separation from the employment of the employer, 
obtained other part-time, temporary, or permanent employment. 
Furthermore, such payments may be made in cash, services, or property. 
Thus, supplemental unemployment compensation benefits provided to 
involuntarily separated employees may include, for example, the 
following: Furnishing of medical care at an established clinic, 
furnishing of food, job training and schooling, and job counseling. If 
such benefits are furnished in services or property, the fair market 
value of the benefits must satisfy the requirements of section 
501(c)(17)(A)(iii), relating to nondiscrimination as to benefits. 
However, supplemental unemployment compensation benefits may be provided

[[Page 38]]

only to an employee and only under circumstances described in paragraph 
(b)(1) of Sec.  1.501(c)(17)-1. Thus, a trust described in section 
501(c)(17) may not provide, for example, for the payment of a death, 
vacation, or retirement benefit.
    (b) Sick and accident benefits. If a trust described in section 
501(c)(17) provides for the payment of sick and accident benefits, such 
benefits may only be provided for employees who are eligible for receipt 
of separation benefits under the plan of which the trust is a part. 
However, the sick and accident benefits need not be provided for all the 
employees who are eligible for receipt of separation benefits, so long 
as the plan does not discriminate in favor of persons with respect to 
whom discrimination is proscribed in section 501(c)(17)(A) (ii) and 
(iii). Furthermore, the portion of the plan which provides for the 
payment of sick and accident benefits must satisfy the nondiscrimination 
requirements of section 501(c)(17)(A) (ii) and (iii) without regard to 
the portion of the plan which provides for the payment of benefits 
because of involuntary separation.
    (c) Correlation with other plans. (1) In determining whether a plan 
meets the requirements of section 501(c)(17)(A) (ii) and (iii), any 
benefits provided under any other plan shall not be taken into 
consideration except in the particular instances enumerated in section 
501(c)(17)(B) (i), (ii), and (iii). In general, these three exceptions 
permit a plan providing for the payment of supplemental unemployment 
compensation benefits to satisfy the nondiscrimination requirements in 
section 501(c)(17)(A) (ii) and (iii) if the plan is able to satisfy such 
requirements when it is correlated with one or more of the plans 
described in section 501(c)(17)(B).
    (2) Under section 501(c)(17)(B)(i), a plan will not be considered 
discriminatory merely because the benefits under the plan which are 
first determined in a nondiscriminatory manner (within the meaning of 
section 501(c)(17)(A)) are then reduced by any sick, accident, or 
unemployment compensation benefits received under State or Federal law, 
or are reduced by a portion of these benefits if determined in a 
nondiscriminatory manner. Under this exception, a plan may, for example, 
satisfy the requirements of section 501(c)(17)(A)(iii) if it provides 
for the payment of an unemployment benefit and the amount of such 
benefit is determined as a percentage of the employee's compensation 
which is then reduced by any unemployment benefit which the employee 
receives under a State plan. In addition, a plan could provide for the 
reduction of such a plan benefit by a percentage of the State benefit. 
Furthermore, a plan may also satisfy the requirements of section 
501(c)(17)(A) if it provides for the payment to an employee of an amount 
which when added to any State unemployment benefit equals a percentage 
of the employee's compensation.
    (3) Under section 501(c)(17)(B)(ii), a plan will not be considered 
discriminatory merely because the plan provides benefits only for 
employees who are not eligible to receive sick, accident, or 
unemployment compensation benefits under State or Federal law. In such a 
case, however, the benefits provided under the plan seeking to satisfy 
the requirements of section 501(c)(17) must be the same benefits, or a 
portion of the same benefits if determined in a nondiscriminatory 
manner, which such ineligible employees would receive under State or 
Federal law if they were eligible for such benefits. Under this 
exception, for example, an employer may establish a plan only for 
employees who have exhausted their benefits under the State law, and, if 
the plan provides for such employees the same benefits which they would 
receive under the State plan, the State plan and the plan of the 
employer will be considered as one plan in determining whether the 
requirements relating to nondiscrimination in section 501(c)(17)(A) are 
satisfied. Furthermore, such a plan could also qualify even though it 
does not provide all of the benefits provided under the State plan. 
Thus, a plan could provide for the payment of a reduced amount of the 
benefits, or for the payment of only certain of the types of benefits, 
provided by the State plan. For example, if the State plan provides for 
the payment of sick, accident, and separation benefits, the plan of the 
employer may provide for

[[Page 39]]

the payment of only separation benefits, or for the payment of an amount 
equal to only one-half of the State provided benefit. However, if a plan 
provides benefits for employees who are not eligible to receive the 
benefits provided under a State plan and such benefits are greater or of 
a different type than those under the State plan, the plan of the 
employer must satisfy the requirements of section 501(c)(17)(A) without 
regard to the benefits and coverage provided by the State plan.
    (4) Under section 501(c)(17)(B)(iii), a plan is not considered 
discriminatory merely because the plan provides benefits only for 
employees who are not eligible to receive benefits under another plan 
which satisfies the requirements of section 501(c)(17)(A) and which is 
funded solely by contributions of the employer. In such a case, the plan 
seeking to qualify under section 501(c)(17) must provide the same 
benefits, or a portion of such benefits if determined in a 
nondiscriminatory manner, as are provided for the employees under the 
plan funded solely by employer contributions. Furthermore, this 
exception only applies if the employees eligible to receive benefits 
under both plans would satisfy the requirements in section 
501(c)(17)(A)(ii), relating to nondiscrimination as to coverage. The 
plan of the employer which is being correlated with the plan seeking to 
satisfy the requirements of section 501(c)(17) may be a plan which forms 
part of a voluntary employees' beneficiary association described in 
section 501(c)(9), if such plan satisfies all the requirements of 
section 501(c)(17)(A). Under this exception, for example, if an employer 
has established a plan providing for the payment of supplemental 
unemployment compensation benefits for his hourly wage employees and 
such plan satisfies the requirements of section 501(c)(17)(A) (even 
though the plan forms part of a voluntary employees' beneficiary 
association described in section 501(c)(9)), the salaried employees of 
such employee may establish a plan for themselves, and, if such plan 
provides for the same benefits as the plan covering hourly-wage 
employees, both plans may be considered as one plan in determining 
whether the plan covering the salaried employees satisfies the 
requirement that is be nondiscriminatory as to coverage. The foregoing 
example would also be applicable if the benefits provided for the 
salaried employees were funded solely or in part by employer 
contributions.
    (d) Permanency of the plan. A plan providing for the payment of 
supplemental unemployment compensation benefits contemplates a permanent 
as distinguished from a temporary program. Thus, although there may be 
reserved the right to change or terminate the plan, and to discontinue 
contributions thereunder, the abandonment of the plan for any reason 
other than business necessity within a few years after it has taken 
effect will be evidence that the plan from its inception was not a bona 
fide program for the purpose of providing supplemental unemployment 
compensation benefits to employees. Whether or not a particular plan 
constitutes a permanent arrangement will be determined by all of the 
surrounding facts and circumstances. However, merely because a 
collective bargaining agreement provides that a plan may be modified at 
the termination of such agreement, or that particular provisions of the 
plan are subject to renegotiation during the duration of such agreement, 
does not necessarily imply that the plan is not a permanent arrangement. 
Moreover, the fact that the plan provides that the assets remaining in 
the trust after the satisfaction of all liabilities (including 
contingent liabilities) under the plan may be returned to the employer 
does not imply that the plan is not a permanent arrangement nor preclude 
the trust from qualifying under section 501(c)(17).
    (e) Portions of years. A plan must satisfy the requirements of 
section 501(c)(17) throughout the entire taxable year of the trust in 
order for the trust to be exempt for such year. However, section 
501(c)(17)(C) provides that a plan will satisfy the nondiscrimination as 
to classification requirements of section 501(c)(17)(A) if on at least 
one day in each quarter of the taxable year of the trust it satisfies 
such requirements.
    (f) Several trusts constituting one plan. Several trusts may be 
designated as

[[Page 40]]

constituting part of one plan which is intended to satisfy the 
requirements of section 501(c)(17), in which case all of such trusts 
taken as a whole must meet the requirements of such section. The fact 
that a combination of trusts fails to satisfy the requirements of 
section 501(c)(17) as one plan does not prevent such of the trusts as 
satisfy the requirements of section 501(c)(17) from qualifying for 
exemption under that section.
    (g) Plan of several employers. A trust forming part of a plan of 
several employers, or the employees of several employers, will be a 
supplemental unemployment benefit trust described in section 501(c)(17) 
if all the requirements of that section are otherwise satisfied.
    (h) Investment of trust funds. No specific limitations are provided 
in section 501(c)(17) with respect to investments which may be made by 
the trustees of a trust qualifying under that section. Generally, the 
contributions may be used by the trustees to purchase any investments 
permitted by the trust agreement to the extent allowed by local law. 
However, the tax-exempt status of the trust will be forfeited if the 
investments made by the trustees constitute prohibited transactions 
within the meaning of section 503. See section 503 and the regulations 
thereunder. In addition, such a trust will be subject to tax under 
section 511 with respect to any unrelated business taxable income (as 
defined in section 512) realized by it from its investments. See 
sections 511 to 515, inclusive, and the regulations thereunder.
    (i) Allocations. If a plan which provides sick and accident benefits 
is financed solely by employer contributions to the trust, and such sick 
and accident benefits are funded by payment of premiums on an accident 
or health insurance policy (whether on a group or individual basis) or 
by contributions to a separate fund which pays such sick and accident 
benefits, the plan must specify that portion of the contributions to be 
used to fund such benefits. If a plan which is financed in whole or in 
part by employee contributions provides sick and accident benefits, the 
plan must specify the portion, if any, of employee contributions 
allocated to the cost of funding such benefits, and must allocate the 
cost of funding such benefits between employer contributions and 
employee contributions.
    (j) Required records and returns. Every trust described in section 
501(c)(17) must maintain records indicating the amount of separation 
benefits and sick and accident benefits which have been provided to each 
employee. If a plan is financed, in whole or in part, by employee 
contributions to the trust, the trust must maintain records indicating 
the amount of each employee's total contributions allocable to 
separation benefits. In addition, every trust described in section 
501(c)(17) which makes one or more payments totaling $600 or more in 1 
year to an individual must file an annual information return in the 
manner described in paragraph (b)(1) of Sec.  1.6041-2. However, if the 
payments from such trust are subject to income tax withholding under 
section 3402(o) and the regulations thereunder, the trust must file, in 
lieu of such annual information return, the returns of income tax 
withheld from wages required by section 6011 and the regulations 
thereunder. In such circumstances, the trust must also furnish the 
statements to the recipients of trust distributions required by section 
6051 and the regulations thereunder.

[T.D. 6972, 33 FR 12901, Sept. 12, 1968, as amended by T.D. 7068, 35 FR 
17328, Nov. 11, 1970]



Sec.  1.501(c)(17)-3  Relation to other sections of the Code.

    (a) Taxability of benefit distributions--(1) Separation benefits. If 
the separation benefits described in section 501(c)(17)(D)(i) are funded 
entirely by employer contributions, then the full amount of any 
separation benefit payment received by an employee is includible in his 
gross income under section 61(a). If any such separation benefit is 
funded by both employer and employee contributions, or solely by 
employee contributions, the amount of any separation benefit payment 
which is includible in the gross income of the employee is the amount by 
which such

[[Page 41]]

distribution and any prior distributions of such separation payments 
exceeds the employee's total contributions to fund such separation 
benefits.
    (2) Sick and accident benefits. Any benefit payment received from 
the trust under the part of the plan, if any, which provides for the 
payment of sick and accident benefits must be included in gross income 
under section 61(a), unless specifically excluded under section 104 or 
105 and the regulations thereunder. See section 105(b) and Sec.  1.105-2 
for benefit payments expended for medical care, benefit payments in 
excess of actual medical expenses, and benefit payments which an 
employee is entitled to receive irrespective of whether or not he incurs 
expenses for medical care. See section 213 and Sec.  1.213-1(g) for 
benefit payments representing reimbursement for medical expenses paid in 
prior years. See Sec.  1.501(c)(17)-2(i) for the requirement that a 
trust described in section 501(c)(17) which receives employee 
contributions must be part of a written plan which provides for the 
allocation of the cost of funding sick and accident benefits.
    (b) Exemption as a voluntary employees' beneficiary association. 
Section 501(c)(17)(E) contemplates that a trust forming part of a plan 
providing for the payment of supplemental unemployment compensation 
benefits may, if it qualifies, apply for exemption from income tax under 
section 501(a) either as a voluntary employees' beneficiary association 
described in section 501(c)(9) or as a trust described in section 
501(c)(17).
    (c) Returns. A trust which is described in section 501(c)(17) and 
which is exempt from tax under section 501(a) must file a return in 
accordance with section 6033 and the regulations thereunder. If such a 
trust realizes any unrelated business taxable income, as defined in 
section 512, the trust is also required to file a return with respect to 
such income.
    (d) Effective date. Section 501(c)(17) shall apply to taxable years 
beginning after December 31, 1959, and shall apply to supplemental 
unemployment benefit trusts regardless of when created or organized.

[T.D. 6972, 33 FR 12902, Sept. 12, 1968]



Sec.  1.501(c)(18)-1  Certain funded pension trusts.

    (a) In general. Organizations described in section 501(c)(18) are 
trusts created before June 25, 1959, forming part of a plan for the 
payment of benefits under a pension plan funded only by contributions of 
employees. In order to be exempt, such trusts must also meet the 
requirements set forth in section 501(c)(18) (A), (B), and (C), and in 
paragraph (b) of this section.
    (b) Requirements for qualification. A trust described in section 
501(c)(18) must meet the following requirements:
    (1) Local law. The trust must be a valid, existing trust under local 
law, and must be evidenced by an executed written document.
    (2) Funding. The trust must be funded solely from contributions of 
employees who are members of the plan. For purposes of this section, the 
term contributions of employees shall include earnings on, and gains 
derived from, the assets of the trust which were contributed by 
employees.
    (3) Creation before June 25, 1959--(i) In general. The trust must 
have been created before June 25, 1959. A trust created before June 25, 
1959 is described in section 501(c)(18) and this section even though 
changes in the makeup of the trust have occurred since that time so long 
as these are not fundamental changes in the character of the trust or in 
the character of the beneficiaries of the trust. Increases in the 
beneficiaries of the trust by the addition of employees in the same or 
related industries, whether such additions are of individuals or of 
units (such as local units of a union) will generally not be considered 
a fundamental change in the character of the trust. A merger of a trust 
created after June 25, 1959 into a trust created before such date is not 
in itself a fundamental change in the character of the latter trust if 
the two trusts are for the benefit of employees of the same or related 
industries.
    (ii) Examples. The provisions of this subparagraph may be 
illustrated by the following examples:

    Example 1. Assume that trust C, for the benefit of members of 
participating locals of National Union X, was established in 1950 and 
adopted by 29 locals before June 25, 1959.

[[Page 42]]

The subsequent adoption of trust C by additional locals of National 
Union X in 1962 will not constitute a fundamental change in the 
character of trust C, since such subsequent adoption is by employees in 
a related industry.
    Example 2. Assume the facts as stated in example 1, except that in 
1965 National Union X merged with National Union Y, whose members are 
engaged in trades related to those engaged in by X's members. Assume 
further that trust D, the employee funded pension plan and fund for 
employees of Y, was subsequently merged into trust C. The merger of 
trust D into trust C would not in itself constitute a fundamental change 
in the character of trust C, since both C and D are for the benefit of 
employees of related industries.

    (4) Payment of benefits. The trust must provide solely for the 
payment of pension or retirement benefits to its beneficiaries. For 
purposes of this section, the term retirement benefits is intended to 
include customary and incidental benefits, such as death benefits within 
the limits permissible under section 401.
    (5) Diversion. The trust must be part of a plan which provides that, 
before the satisfaction of all liabilities to employees covered by the 
plan, the corpus and income of the trust cannot (within the taxable year 
and at any time thereafter) be used for, or diverted to, any purpose 
other than the providing of pension or retirement benefits. Payment of 
expenses in connection with the administration of a plan providing 
pension or retirement benefits shall be considered a payment to provide 
such benefits and shall not affect the qualification of the trust.
    (6) Discrimination. The trust must be part of a plan whose 
eligibility conditions and benefits do not discriminate in favor of 
employees who are officers, shareholders, persons whose principal duties 
consist of supervising the work of other employees, or highly 
compensated employees. See sections 401(a)(3)(B) and 401(a)(4) and 
Sec. Sec.  1.401-3 and 1.401(a)(4)-0 through 1.401(a)(4)-13. However, a 
plan is not discriminatory within the meaning of section 501(c)(18) 
merely because the benefits received under the plan bear a uniform 
relationship to the total compensation, or the basic or regular rate of 
compensation, of the employees covered by the plan. Accordingly, the 
benefits provided for highly paid employees may be greater than the 
benefits provided for lower paid employees if the benefits are 
determined by reference to their compensation; but, in such a case, the 
plan will not qualify if the benefits paid to the higher paid employees 
are a larger portion of compensation than the benefits paid to lower 
paid employees.
    (7) Objective standards. The trust must be part of a plan which 
requires that benefits be determined according to objective standards. 
Thus, while a plan may provide similarly situated employees with 
benefits which differ in kind and amount, these benefits may not be 
determined solely in the discretion of the trustees.
    (c) Effective date. The provisions of section 501(c)(18) and this 
section shall apply with respect to taxable years beginning after 
December 31, 1969.

[T.D. 7172, 37 FR 5618, Mar. 17, 1972, as amended by T.D. 9849, 84 FR 
9235, Mar. 14, 2019]



Sec.  1.501(c)(19)-1  War veterans organizations.

    (a) In general. (1) For taxable years beginning after December 31, 
1969, a veterans post or organization which is organized in the United 
States or any of its possessions may be exempt as an organization 
described in section 501(c)(19) if the requirements of paragraphs (b) 
and (c) of this section are met and if no part of its net earnings 
inures to the benefit of any private shareholder or individual. 
Paragraph (b) of this section contains the membership requirements such 
a post or organization must meet in order to qualify under section 
501(c)(19). Paragraph (c) of this section outlines the purposes, at 
least one of which such a post or organization must have in order to so 
qualify.
    (2) In addition, an auxiliary unit or society described in paragraph 
(d) of this section of such a veterans post or organization and a trust 
or foundation described in paragraph (e) of this section for such post 
or organization may be exempt as an organization described in section 
501(c)(19).
    (b) Membership requirements. (1) In order to be described in section 
501(c)(19) under paragraph (a)(1) of this section, an organization must 
meet the membership requirements of section

[[Page 43]]

501(c)(19)(B) and this paragraph. There are two requirements that must 
be met under this paragraph. The first requirement is that at least 75 
percent of the members of the organization must be war veterans. For 
purposes of this section the term war veterans means persons, whether or 
not present members of the United States Armed Forces, who have served 
in the Armed Forces of the United States during a period of war 
(including the Korean and Vietnam conflicts).
    (2) The second requirement of this paragraph is that at least 97.5 
percent of all members of the organization must be described in one or 
more of the following categories:
    (i) War veterans,
    (ii) Present or former members of the United States Armed Forces,
    (iii) Cadets (including only students in college or university ROTC 
programs or at Armed Services academies), or
    (iv) Spouses, widows, or widowers of individuals referred to in 
paragraph (b)(2) (i), (ii) or (iii) of this section.
    (c) Exempt purposes. In addition to the requirements of paragraphs 
(a)(1) and (b) of this section, in order to be described in section 
501(c)(19) under paragraph (a)(1) of this section an organization must 
be operated exclusively for one or more of the following purposes:
    (1) To promote the social welfare of the community as defined in 
Sec.  1.501(c)(4)-1(a)(2).
    (2) To assist disabled and needy war veterans and members of the 
United States Armed Forces and their dependents, and the widows and 
orphans of deceased veterans,
    (3) To provide entertainment, care, and assistance to hospitalized 
veterans or members of the Armed Forces of the United States,
    (4) To carry on programs to perpetuate the memory of deceased 
veterans and members of the Armed Forces and to comfort their survivors,
    (5) To conduct programs for religious, charitable, scientific, 
literary, or educational purposes,
    (6) To sponsor or participate in activities of a patriotic nature,
    (7) To provide insurance benefits for their members or dependents of 
their members or both, or
    (8) To provide social and recreational activities for their members.
    (d) Auxiliary units or societies for war veterans organizations. A 
unit or society may be exempt as an organization described in section 
501(c)(19) and paragraph (a)(2) of this section if it is an auxiliary 
unit or society of a post or organization of war veterans described in 
paragraph (a)(1) of this section. A unit or society is an auxiliary unit 
or society or such a post or organization if it meets the following 
requirements:
    (1) It is affiliated with, and organized in accordance with, the 
bylaws and regulations formulated by an organization described in 
paragraph (a)(1) of this section,
    (2) At least 75 percent of its members are either war veterans, or 
spouses of war veterans, or are related to a war veteran within two 
degrees of consanguinity (i.e., grandparent, brother, sister, 
grandchild, represent the most distant allowable relationships),
    (3) All of its members are either members of an organization 
described in paragraph (a)(1) of this section, or spouses of a member of 
such an organization or are related to a member of such an organization, 
within two degrees of consanguinity, and
    (4) No part of its net earnings inures to the benefit of any private 
shareholder or individual.
    (e) Trusts or foundations. A trust or foundation may be exempt as an 
organization described in section 501(c)(19) and paragraph (a)(2) of 
this section if it is a trust or foundation for a post or organization 
of war veterans described in paragraph (a)(1) of this section. A trust 
or foundation is a trust or foundation for such a post or organization 
if it meets the following requirements:
    (1) The trust or foundation is in existence under local law and, if 
organized for charitable purposes, has a dissolution provision described 
in Sec.  1.501(c)(3)-1(b)(4).
    (2) The corpus or income cannot be diverted or used other than for 
the funding of a post or organization of war veterans described in 
paragraph (a)(1) of this section, for section 170(c)(4) purposes, or as 
an insurance set aside (as defined in Sec.  1.512(a)-4(b)).
    (3) The trust income is not unreasonably accumulated and, if the 
trust or

[[Page 44]]

foundation is not an insurance set aside, a substantial portion of the 
income is in fact distributed to such post or organization or for 
section 170(c)(4) charitable purposes, and
    (4) It is organized exclusively for one or more of those purposes 
enumerated in paragraph (c) of this section.

[T.D. 7438, 41 FR 44392, Oct. 8, 1976]



Sec.  1.501(c)(21)-1  Black lung trusts--certain terms.

    (a) Created or organized in the United States. A trust is not 
created or organized in the United States unless it is maintained at all 
times as a domestic trust in the United States. For this purpose, 
section 7701(a)(9) limits the term United States to the District of 
Columbia and States of the United States.
    (b) Insurance company. The term insurance company means an 
insurance, surety, bonding or other company whose liability for the 
kinds of claims to which section 501(c)(21)(A)(i) applies is as an 
insurer or guarantor of the liabilities of another.
    (c) Black Lung Acts. The term Black Lung Acts includes any State law 
providing compensation for disability or death due to pneumoconiosis 
even though the State law compensates for other kinds of injuries. In 
such a case, section 501(c)(21) applies only to the extent that the 
liability is attributable to disability or death due to pneumoconiosis. 
For this purpose, the term pneumoconiosis has the same meaning as it has 
under federal law. See 30 U.S.C. 902.
    (d) Insurance exclusively covering such liability. The term 
insurance exclusively covering such liability includes insurance that 
covers risk for liabilities in addition to the liabilities to which 
section 501(c)(21)(A)(i) applies. In such a case, payment for premiums 
may be made from the trust only to the extent of that portion of the 
premiums that has been separately allocated and stated by the insurer as 
attributable solely to coverage of the liabilities to which section 
501(c)(21)(A)(i) applies.
    (e) Administrative and other incidental expenses. The term 
administrative and other incidental expenses means expenditures that are 
appropriate and helpful to the trust making them in carrying out the 
purposes for which its assets may be used under section 501(c)(21)(B). 
The term includes any exicse tax imposed on the trust under section 4952 
(relating to taxes on taxable expenditures) and reasonable expenses, 
such as legal expenses, incurred by the trust in connection with an 
assertion against the trust of liability for a taxable expenditure. The 
term does not include an excise tax imposed on the trustee or on other 
disqualified persons under section 4951 (relating to taxes on self-
dealing) or under section 4953 (relating to tax on excess contributions 
to black lung benefit trusts) or any expenses incurred in connection 
with the assertion of these taxes other than expenses that are treated 
as part of reasonable compensation under section 4951(d)(2)(C). See 
Sec. Sec.  53.4941 (d)-2(f)(3) and (d)-3(c) for interpretations of 
similar provisions under section 4941(d)(2)(E), relating to reasonable 
compensation for private foundation disqualified persons.
    (f) Public debt securities of the United States. The term public 
debt securities of the United States means obligations that are taken 
into consideration for purposes of the public debt limit. See, for 
example 31 U.S.C. 757b.
    (g) Obligations of a State or local government. The term obligations 
of a State or local government means the obligations of a State or local 
governmental unit the interest on which is exempt from tax under section 
103(a). See Sec.  1.103-1(a).
    (h) Time or demand deposits. The term time or demand deposits 
includes checking accounts, savings accounts, certificates of deposit or 
other time or demand deposits. The term does not include common or 
collective trust funds such as a common trust fund as defined in section 
584.

[44 FR 52197, Sept. 7, 1979]



Sec.  1.501(c)(21)-2  Same--trust instrument.

    As trust does not meet the requirements of section 501(c)(21) if it 
is not established and maintained pursuant to a written instrument. The 
trust instrument must definitely and affirmatively prohibit a diversion 
or use of trust assets that is not permitted under section 501(c)(21)(B) 
or section

[[Page 45]]

4953(c), whether by operation or natural termination of the trust, by 
power of revocation or amendment by the happening of a contingency by 
collateral arrangement, or by any other means. No particular form for 
the trust instrument is required. A trust may meet the requirements of 
section 501(c)921) although the trust instrument fails to contain 
provisions the effects of which are to prohibit acts that are subject to 
section 4951 (relating to taxes on self-dealing), section 4952 (relating 
to taxes on taxable expenditures) or the retention of contributions 
subject to section 4953 (relating to tax on excess contributions to 
black lung benefit trusts).

[44 FR 52197, Sept. 7, 1979]



Sec.  1.501(c)(29)-1  CO-OP Health Insurance Issuers.

    (a) Organizations must notify the Commissioner that they are 
applying for recognition of section 501(c)(29) status. An organization 
will not be treated as described in section 501(c)(29) unless the 
organization has given notice to the Commissioner that it is applying 
for recognition as an organization described in section 501(c)(29) in 
the manner prescribed by the Commissioner in published guidance.
    (b) Effective date of recognition of section 501(c)(29) status. An 
organization may be recognized as an organization described in section 
501(c)(29) as of a date prior to the date of the notice required by 
paragraph (a) of this section if the notice is given in the manner and 
within the time prescribed by the Commissioner and the organization's 
purposes and activities prior to giving such notice were consistent with 
the requirements for exempt status under section 501(c)(29). However, an 
organization may not be recognized as an organization described in 
section 501(c)(29) before the later of its formation or March 23, 2010.
    (c) Effective/applicability date. Paragraphs (a) and (b) of this 
section are applicable beginning February 7, 2012.

[T.D. 9709, 80 FR 4793, Jan. 29, 2015]



Sec.  1.501(d)-1  Religious and apostolic associations or corporations.

    (a) Religious or apostolic associations or corporations are 
described in section 501(d) and are exempt from taxation under section 
501(a) if they have a common treasury or community treasury, even though 
they engage in business for the common benefit of the members, provided 
each of the members includes (at the time of filing his return) in his 
gross income his entire pro rata share, whether distributed or not, of 
the net income of the association or corporation for the taxable year of 
the association or corporation ending with or during his taxable year. 
Any amount so included in the gross income of a member shall be treated 
as a dividend received.
    (b) For annual return requirements of organizations described in 
section 501(d), see section 6033 and paragraph (a)(5) of Sec.  1.6033-1.



Sec.  1.501(e)-1  Cooperative hospital service organizations.

    (a) General rule. Section 501(e) is the exclusive and controlling 
section under which a cooperative hospital service organization can 
qualify as a charitable organization. A cooperative hospital service 
organization which meets the requirements of section 501(e) and this 
section shall be treated as an organization described in section 
501(c)(3), exempt from taxation under section 501(a), and referred to in 
section 170(b)(1)(A) (iii) (relating to percentage limitations on 
charitable contributions). In order to qualify for tax exempt status, a 
cooperative hospital service organization must--
    (1) Be organized and operated on a cooperative basis,
    (2) Perform, on a centralized basis, only one or more specifically 
enumerated services which, if performed directly by a tax exempt 
hospital, would constitute activities in the exercise or performance of 
the purpose or function constituting the basis for its exemption, and
    (3) Perform such service or services solely for two or more patron-
hospitals as described in paragraph (d) of this section.
    (b) Organized and operated on a cooperative basis--(1) In general. 
In order to

[[Page 46]]

meet the requirements of section 501(e), the organization must be 
organized and operated on a cooperative basis (whether or not under a 
specific statute on cooperatives) and must allocate or pay all of its 
net earnings within 8\1/2\ months after the close of the taxable year to 
its patron-hospitals on the basis of the percentage of its services 
performed for each patron. To allocate its net earnings to its patron-
hospitals, the organization must make appropriate bookkeeping entries 
and provide timely written notice to each patron-hospital disclosing to 
the patron-hospital the amount allocated to it on the books of the 
organization. For the recordkeeping requirements of a section 501(e) 
organization, see Sec.  1.521-1(a)(1).
    (2) Percentage of services defined. The percentage of services 
performed for each patron-hospital may be determined on the basis of 
either the value or the quantity of the services provided by the 
organization to the patron-hospital, provided such basis is realistic in 
terms of the actual cost of the services to the organization.
    (3) Retention of net earnings. Exemption will not be denied a 
cooperative hospital service organization solely because the 
organization, instead of paying all net earnings to its patron-
hospitals, retains an amount for such purposes as retiring indebtedness, 
expanding the services of the organization, or for any other necessary 
purpose and allocates such amounts to its patrons. However, such funds 
may not be accumulated beyond the reasonably anticipated needs of the 
organization. See, Sec.  1.537-1(b). Whether there is an improper 
accumulation of funds depends upon the particular circumstances of each 
case. Moreover, where an organization retains net earnings for necessary 
purposes, the organization's records must show each patron's rights and 
interests in the funds retained. For purposes of this paragraph, the 
term net earnings does not include capital contributions to the 
organization and such contributions need not satisfy the allocation or 
payment requirements.
    (4) Nonpatronage and other income. An organization described in 
section 501(e) may, in addition to net earnings, receive membership dues 
and related membership assessment fees, gifts, grants and income from 
nonpatronage sources such as investment of retained earnings. However, 
such an organization cannot be exempt if it engages in any business 
other than that of providing the specified services, described in 
paragraph (c), for the specified patron-hospitals, described in 
paragraph (d). Thus, an organization described in section 501(e) 
generally cannot have unrelated business taxable income as defined in 
section 512, although it may earn certain interest, annuities, 
royalties, and rents which are excluded from unrelated business taxable 
income because of the modifications contained in sections 512(b) (1), 
(2) or (3). An organization described in section 501(e) may, however, 
have debt-financed income which is treated as unrelated business taxable 
income solely because of the applicability of section 514. In addition, 
exempt status under section 501(e) will not be affected where rent from 
personal property leased with real property is treated as unrelated 
business taxable income under section 512(b)(3)(A)(ii) solely because 
the rent attributable to the personal property is more than incidental 
or under section 512(b)(3)(B)(i) solely because the rent attributable to 
the personal property exceeds 50 percent of the total rent received or 
accrued under the lease. Exemption will not be affected solely because 
the determination of the amount of rent depends in whole or in part on 
the income or profits derived from the property leased. See, section 
512(b)(3)(B)(ii). An organization described in section 501(e) may also 
derive nonpatronage income from sources that are incidental to the 
conduct of its exempt purposes or functions. For example, income derived 
from the operation of a cafeteria or vending machines primarily for the 
convenience of its employees or the disposition of by-products in 
substantially the same state they were in on completion of the exempt 
function (e.g., the sale of silver waste produced in the processing of 
x-ray film) will not be considered unrelated business taxable income. 
See, section 513(a)(2) and Sec.  1.513-1(d)(4)(ii). The nonpatronage and 
other income permitted under this subparagraph (4) must be allocated or 
paid as provided

[[Page 47]]

in subparagraph (1) or retained as provided in subparagraph (3).
    (5) Stock ownership--(i) Capital stock of organization. An 
organization does not meet the requirements of section 501(e) unless all 
of the organization's outstanding capital stock, if there is such stock, 
is held solely by its patron-hospitals. However, no amount may be paid 
as dividends on the capital stock of the organization. For purposes of 
the preceding sentence, the term capital stock includes common stock 
(whether voting or nonvoting), preferred stock, or any other form 
evidencing a proprietary interest in the organization.
    (ii) Stock ownership as a condition for obtaining credit. If by 
statutory requirement a cooperative hospital service organization must 
be a shareholder in a United States or state chartered corporation as a 
condition for obtaining credit from that corporate-lender, the ownership 
of shares and the payment of dividends thereon will not for such reason 
be a basis for the denial of exemption to the organization. See, e.g., 
National Consumer Cooperative Bank, 12 U.S.C. 3001 et seq.
    (c) Scope of services--(1) Permissible services. An organization 
meets the requirements of section 501(e) only if the organization 
performs, on a centralized basis, one or more of the following services 
and only such services: data processing, purchasing (including the 
purchasing and dispensing of drugs and pharmaceuticals to patron-
hospitals), warehousing, billing and collection, food, clinical 
(including radiology), industrial engineering (including the 
installation, maintenance and repair of biomedical and similar 
equipment), laboratory, printing, communications, record center, and 
personnel (including recruitment, selection, testing, training, 
education and placement of personnel) services. An organization is not 
described in section 501(e) if, in addition to or instead of one or more 
of these specified services, the organization performs any other service 
(other than services referred to under paragraph (b)(4) that are 
incidental to the conduct of exempt purposes or functions).
    (2) Illustration. The provisions of this subparagraph may be 
illustrated by the following example.

    Example. An organization performs industrial engineering services on 
a cooperative basis solely for patron-hospitals each of which is an 
organization described in section 501(c)(3) and exempt from taxation 
under section 501(a). However, in addition to this service, the 
organization operates laundry services for its patron-hospitals. This 
cooperative organization does not meet the requirements of this 
paragraph because it performs laundry services not specified in this 
paragraph.

    (d) Patron-hospitals--(1) Defined. Section 501(e) only applies if 
the organization performs its services solely for two or more patron-
hospitals each of which is--
    (i) An organization described in section 501(c)(3) which is exempt 
from taxation under section 501(a),
    (ii) A constituent part of an organization described in section 
501(c)(3) which is exempt from taxation under section 501(a) and which, 
if organized and operated as a separate entity, would constitute an 
organization described in section 501(c)(3), or
    (iii) Owned and operated by the United States, a State, the District 
of Columbia, or a possession of the United States, or a political 
subdivision or an agency or instrumentality of any of the foregoing.
    (2) Business with nonvoting patron-hospitals. Exemption will not be 
denied a cooperative hospital service organization solely because the 
organization (whether organized on a stock or membership basis) 
transacts business with patron-hospitals which do not have voting rights 
in the organization and therefore do not participate in the decisions 
affecting the operation of the organization. Where the organization has 
both patron-hospitals with voting rights and patron-hospitals without 
such rights, the organization must provide at least 50 percent of its 
services to patron-hospitals with voting rights in the organization. 
Thus, the percentage of services provided to nonvoting patrons may not 
exceed the percentage of such services provided to voting patrons. A 
patron-hospital will be deemed to have voting rights in the cooperative 
hospital service organization if the patron-hospital may vote directly 
on matters affecting the operation of the organization or if the patron-
hospital may vote in the election of cooperative

[[Page 48]]

board members. Notwithstanding that an organization may have both voting 
and nonvoting patron-hospitals, patronage refunds must nevertheless be 
allocated or paid to all patron-hospitals solely on the basis specified 
in paragraph (b) of this section.
    (3) Services to other organizations. An organization does not meet 
the requirements of section 501(e) if, in addition to performing 
services for patron-hospitals (entities described in subdivisions (i), 
(ii) or (iii) of subparagraph (1)), the organization performs any 
service for any other organization. For example, a cooperative hospital 
service organization is not exempt if it performs services for 
convalescent homes for children or the aged, vocational training 
facilities for the handicapped, educational institutions which do not 
provide hospital care in their facilities, and proprietary hospitals. 
However, the provision of the specified services between or among 
cooperative hospital service organizations meeting the requirements of 
section 501(e) and this section is permissible. Also permissible is the 
provision of the specified services to entities which are not patron-
hospitals, but only if such services are de minimis and are mandated by 
a governmental unit as, for example, a condition for licensing.
    (e) Effective dates. An organization, other than an organization 
performing clinical services, may meet the requirements of section 
501(e) and be a tax exempt organization for taxable years ending after 
June 28, 1968. An organization performing clinical services may meet the 
requirements of section 501(e) and be a tax exempt organization for 
taxable years ending after December 31, 1976. However, pursuant to the 
authority contained in section 7805(b) of the Internal Revenue Code, 
these regulations shall not become effective with respect to an 
organization which has received a ruling or determination letter from 
the Internal Revenue Service recognizing its exemption under section 
501(e) until January 2, 1987.

[T.D. 8100, 51 FR 31615, Sept. 4, 1986; 51 FR 33593, Sept. 22, 1986]



Sec.  1.501(h)-1  Application of the expenditure test to expenditures
to influence legislation; introduction.

    (a) Scope. (1) There are certain requirements an organization must 
meet in order to be a charity described in section 501(c)(3). Among 
other things, section 501(c)(3) states that ``no substantial part of the 
activities of [a charity may consist of] carrying on propaganda, or 
otherwise attempting to influence legislation, (except as otherwise 
provided in subsection (h)).'' This requirement is called the 
substantial part test.
    (2) Under section 501(h), many public charities may elect the 
expenditure test as a substitute for the substantial part test. The 
expenditure test is described in section 501(h) and this Sec.  1.501(h). 
A public charity is any charity that is not a private foundation under 
section 509(a). (Unlike a public charity, a private foundation may not 
make any lobbying expenditures: If a private foundation does make a 
lobbying expenditure, it is subject to an excise tax under section 
4945). Section 1.501(h)-2 lists which public charities are eligible to 
make the expenditure test election. Section 1.501(h)-2 also provides 
information about how a public charity makes and revokes the election to 
be covered by the expenditure test.
    (3) A public charity that makes the election may make lobbying 
expenditures within specified dollar limits. If an electing public 
charity's lobbying expenditures are within the dollar limits determined 
under section 4911(c), the electing public charity will not owe tax 
under section 4911 nor will it lose its tax exempt status as a charity 
by virtue of section 501(h). If, however, that electing public charity's 
lobbying expenditures exceed its section 4911 lobbying limit, the 
organization is subject to an excise tax on the excess lobbying 
expenditures. Further, under section 501(h), if an electing public 
charity's lobbying expenditures normally are more than 150 percent of 
its section 4911 lobbying limit, the organization will cease to be a 
charity described in section 501(c)(3).
    (4) A public charity that elects the expenditure test may 
nevertheless lose its tax exempt status if it is an action organization 
under Sec.  1.501(c)(3)-

[[Page 49]]

1(c)(3)(iii) or (iv). A public charity that does not elect the 
expenditure test remains subject to the substantial part test. The 
substantial part test is applied without regard to the provisions of 
section 501(h) and 4911 and the related regulations.
    (b) Effective date. The provisions of Sec.  1.501(h)-1 through Sec.  
1.501(h)-3, are effective for taxable years beginning after August 31, 
1990. An election made before August 31, 1990, under the provisions of 
Sec.  7.0(c)(4) or the instructions to Form 5768, will be effective 
under these regulations without again filing Form 5768.

[T.D. 8308, 55 FR 35588, Aug. 31, 1990]



Sec.  1.501(h)-2  Electing the expenditure test.

    (a) In general. The election to be governed by section 501(h) may be 
made by an eligible organization (as described in paragraph (b) of this 
section) for any taxable year of the organization beginning after 
December 31, 1976, other than the first taxable year for which a 
voluntary revocation of the election is effective (see paragraph (d) of 
this section). The election is made by filing a completed Form 5768, 
Election/Revocation of Election by an Eligible Section 501(c)(3) 
Organization to Make Expenditures to Influence Legislation, with the 
appropriate Internal Revenue Service Center listed on that form. Under 
section 501(h)(6), the election is effective with the beginning of the 
taxable year in which the form is filed. For example, if an eligible 
organization whose taxable year is the calendar year files Form 5768 on 
December 31, 1979, the organization is governed by section 501(h) for 
its taxable year beginning January 1, 1979. Once made, the expenditure 
test election is effective (without again filing Form 5768) for each 
succeeding taxable year for which the organization is an eligible 
organization and which begins before a notice of revocation is filed 
under paragraph (d) of this section.
    (b) Organizations eligible to elect the expenditure test--(1) In 
general. For purposes of section 501(h) and the regulations thereunder, 
an organization is an eligible organization for a taxable year if, for 
that taxable year, it is--
    (i) Described in section 501(c)(3) (determined, in any year for 
which an election is in effect, without regard to the substantial part 
test of section 501(c)(3)),
    (ii) Described in section 501(h)(4) and paragraph (b)(2) of this 
section, and
    (iii) Not a disqualified organization described in section 501(h)(5) 
and paragraph (b)(3) of this section.
    (2) Certain organizations listed. An organization is described in 
section 501(h)(4) and this paragraph (b)(2) if it is an organization 
described in--
    (i) Section 170(b)(1)(A)(ii) (relating to educational institutions),
    (ii) Section 170(b)(1)(A)(iii) (relating to hospitals and medical 
research organizations),
    (iii) Section 170(b)(1)(A)(iv) (relating to organizations supporting 
government schools),
    (iv) Section 170(b)(1)(A)(vi) (relating to organizations publicly 
supported by charitable contributions),
    (v) Section 509(a)(2) (relating to organizations publicly supported 
by admissions, sales, etc.), or
    (vi) Section 509(a)(3) (relating to organizations supporting public 
charities), except that for purposes of this paragraph (b)(2), section 
509(a)(3) shall be applied without regard to the last sentence of 
section 509(a).
    (3) Disqualified organizations. An organization is a disqualified 
organization described in section 501(h)(5) and this paragraph (b)(3) if 
the organization is--
    (i) Described in section 170(b)(1)(A)(i) (relating to churches),
    (ii) An integrated auxiliary of a church or of a convention or 
association of churches see (Sec.  1.6033-2(g)(5)), or
    (iii) Described in section 501(c)(3) and affiliated (within the 
meaning of Sec.  56.4911-7) with one or more organizations described in 
paragraph (b)(3) (i) or (ii) of this section.
    (4) Other organizations ineligible to elect. Under section 
501(h)(4), certain organizations, although not disqualified 
organizations, are not eligible to elect the expenditure test. For 
example, organizations described in section 509(a)(4) are not listed in 
section 501(h)(4) and therefore are not eligible to elect. Similarly, 
private foundations (within the meaning of section 509(a))

[[Page 50]]

are not eligible to elect. For the treatment of expenditures by a 
private foundation for the purpose of carrying on propaganda, or 
otherwise attempting, to influence legislation, see Sec.  53.4945-2.
    (c) New organizations. A newly created organization may submit Form 
5768 to elect the expenditure test under section 501(h) before it is 
determined to be an eligible organization and may submit Form 5768 at 
the time it submits its application for recognition of exemption (Form 
1023). If the newly created organization is determined to be an eligible 
organization, the election will be effective under the provisions of 
paragraph (a) of this section, that is, with the beginning of the 
taxable year in which the Form 5768 is filed by the eligible 
organization. However, if a newly created organization is determined by 
the Service not to be an eligible organization, the organization's 
election will not be effective and the substantial part test will apply 
from the effective date of its section 501(c)(3) classification.
    (d) Voluntary revocation of expenditure test election--(1) 
Revocation effective. An organization may voluntarily revoke an 
expenditure test election by filing a notice of voluntary revocation 
with the appropriate Internal Revenue Service Center listed on Form 
5768. Under section 501(h)(6)(B), a voluntary revocation is effective 
with the beginning of the first taxable year after the taxable year in 
which the notice is filed. If an organization voluntarily revokes its 
election, the substantial part test of section 501(c)(3) will apply with 
respect to the organization's activities in attempting to influence 
legislation beginning with the taxable year for which the voluntary 
revocation is effective.
    (2) Re-election of expenditure test. If an organization's 
expenditure test election is voluntarily revoked, the organization may 
again make the expenditure test election, effective no earlier than for 
the taxable year following the first taxable year for which the 
revocation is effective.
    (3) Example. X, an organization whose taxable year is the calendar 
year, plans to voluntarily revoke its expenditure test election 
effective beginning with its taxable year 1985. X must file its notice 
of voluntary revocation on Form 5768 after December 31, 1983, and before 
January 1, 1985. If X files a notice of voluntary revocation on December 
31, 1984, the revocation is effective beginning with its taxable year 
1985. The organization may again elect the expenditure test by filing 
Form 5768. Under paragraph (d)(2) of this section, the election may not 
be made for taxable year 1985. Under paragraph (a) of this section, a 
new expenditure test election will be effective for taxable years 
beginning with taxable year 1986, if the Form 5768 is filed after 
December 31, 1985, and before January 1, 1987.
    (e) Involuntary revocation of expenditure test election. If, while 
an election by an eligible organization is in effect, the organization 
ceases to be an eligible organization, its election is automatically 
revoked. The revocation is effective with the beginning of the first 
full taxable year for which it is determined that the organization is 
not an eligible organization. If an organization's expenditure test 
election is involuntarily revoked under this paragraph (e) but the 
organization continues to be described in section 501(c)(3), the 
substantial part test of section 501(c)(3) will apply with respect to 
the organization's activities in attempting to influence legislation 
beginning with the first taxable year for which the involuntary 
revocation is effective.
    (f) Supersession. This section supersedes Sec.  7.0(c)(4) of the 
Temporary Income Tax Regulations under the Tax Reform Act of 1976, 
effective August 31, 1990.

[T.D. 8308, 55 FR 35588, Aug. 31, 1990]



Sec.  1.501(h)-3  Lobbying or grass roots expenditures normally in
excess of ceiling amount.

    (a) Scope. This section provides rules under section 501(h) for 
determining whether an organization that has elected the expenditure 
test and that is not a member of an affiliated group of organizations 
(as defined in Sec.  56.4911-7(e)) either normally makes lobbying 
expenditures in excess of its lobbying ceiling amount or normally makes 
grass roots expenditures in excess of its

[[Page 51]]

grass roots ceiling amount. Under section 501(h) and this section, an 
organization that has elected the expenditure test and that normally 
makes expenditures in excess of the corresponding ceiling amount will 
cease to be exempt from tax under section 501(a) as an organization 
described in section 501(c)(3). For similar rules relating to members of 
an affiliated group of organizations, see Sec.  56.4911-9.
    (b) Loss of exemption--(1) In general. Under section 501(h)(1), an 
organization that has elected the expenditure test shall be denied 
exemption from taxation under section 501(a) as an organization 
described in section 501(c)(3) for the taxable year following a 
determination year if--
    (i) The sum of the organization's lobbying expenditures for the base 
years exceeds 150 percent of the sum of its lobbying nontaxable amounts 
for the base years, or (ii) The sum of the organization's grass roots 
expenditures for its base years exceeds 150 percent of the sum of its 
grass roots nontaxable amounts for the base years.

The organization thereafter shall not be exempt from tax under section 
501(a) as an organization described in section 501(c)(3) unless, 
pursuant to paragraph (d) of this section, the organization reapplies 
for recognition of exemption and is recognized as exempt.
    (2) Special exception for organization's first election. For the 
first, second, or third consecutive determination year for which an 
organization's first expenditure test election is in effect, no 
determination is required under paragraph (b)(1) of this section, and 
the organization will not be denied exemption from tax by reason of 
section 501(h) and this section if, taking into account as base years 
only those years for which the expenditure test election is in effect--
    (i) The sum of the organization's lobbying expenditures for such 
base years does not exceed 150 percent of the sum of its lobbying 
nontaxable amounts for the same base years, and
    (ii) The sum of the organization's grass roots expenditure for those 
base years does not exceed 150 percent of the sum of its grass roots 
nontaxable amounts for such base years. If an organization does not 
satisfy the requirements of this paragraph (b)(2), paragraph (b)(1) of 
this section will apply.
    (c) Definitions. For purposes of this section--
    (1) The term lobbying expenditures means lobbying expenditures as 
defined in section 4911(c)(1) or section 4911(f)(4)(A) and Sec.  
56.4911-2(a).
    (2) The term lobbying nontaxable amount is defined in Sec.  56.4911-
1(c)(1).
    (3) An organization's lobbying ceiling amount is 150 percent of the 
organization's lobbying nontaxable amount for a taxable year.
    (4) The term grass roots expenditures means expenditures for grass 
roots lobbying communications as defined in section 4911(c)(3) or 
section 4911(f)(4)(A) and Sec. Sec.  56.4911-2 and 56.4911-3.
    (5) The term grass roots nontaxable amount is defined in Sec.  
56.4911-1(c)(2).
    (6) An organization's grass roots ceiling amount is 150 percent of 
the organization's grass roots nontaxable amount for a taxable year.
    (7) In general, the term base years means the determination year and 
the three taxable years immediately preceding the determination year. 
The base years, however, do not include any taxable year preceding the 
taxable year for which the organization is first treated as described in 
section 501(c)(3).
    (8) A taxable year is a determination year if it is a year for which 
the expenditure test election is in effect, other than the taxable year 
for which the organization is first treated as described in section 
501(c)(3).
    (d) Reapplication for recognition of exemption--(1) Time of 
application. An organization that is denied exemption from taxation 
under section 501(a) by reason of section 501(h) and this section may 
apply on Form 1023 for recognition of exemption as an organization 
described in section 501(c)(3) for any taxable year following the first 
taxable year for which exemption is so denied. See paragraphs (d)(2) and 
(d)(3) of this section for material to be included with an application 
described in the preceding sentence.
    (2) Section 501(h) calculation. An application described in 
paragraph (d)(1) of this section must demonstrate that the organization 
would not be denied exemption from taxation under section 501(a) by 
reason of section 501(h) if the

[[Page 52]]

expenditure test election has been in effect for all of its last taxable 
year ending before the application is made by providing the 
calculations, described either in paragraphs (b)(1) (i) and (ii) of this 
section or in Sec.  56.4911-9(b), that would have applied to the 
organization for that year.
    (3) Operations not disqualifying. An application described in 
paragraph (d)(1) of this section must include information that 
demonstrates to the satisfaction of the Commissioner that the 
organization will not knowingly operate in a manner that would 
disqualify the organization for tax exemption under section 501(c)(3) by 
reason of attempting to influence legislation.
    (4) Reelection of expenditure test. If an organization is denied 
exemption from tax for a taxable year by reason of section 501(h) and 
this section, and thereafter is again recognized as an organization 
described in section 501(c)(3) pursuant to this paragraph (d), it may 
again elect the expenditure test under section 501(h) in accordance with 
Sec.  1.501(h)-2(a).
    (e) Examples. The provisions of this section are illustrated by the 
following examples, which also illustrate the operation of the tax 
imposed by section 4911.

    Example 1. (1) The following table contains information used in this 
example concerning organization X.

----------------------------------------------------------------------------------------------------------------
                                                                                             Lobbying
                                Exempt purpose                                   -------------------------------
             Year                expenditures              Calculation                               Lobbying
                                     (EPE)                                          Nontaxable     expenditures
                                                                                   amount (LNTA)       (LE)
----------------------------------------------------------------------------------------------------------------
1979..........................        $400,000  (20% of $400,000=)..............         $80,000        $100,000
1980..........................         300,000  (20% of $300,000=)..............          60,000         100,000
1981..........................         600,000  (20% of $500,000 + 15% of                115,000         120,000
                                                 $100,000=).
1982..........................         500,000  (20% of $500,000=)..............         100,000         100,000
-----------------------------------------------                                  -------------------------------
  Totals......................       1,800,000  ................................         355,000         420,000
----------------------------------------------------------------------------------------------------------------

    (2) Organization X, whose taxable year is the calendar year, was 
organized in 1971. X first made the expenditure test election under 
section 501(h) effective for taxable years beginning with 1979 and has 
not revoked the election. None of X's lobbying expenditures for its 
taxable years 1979 through 1982 are grass roots expenditures. Under 
section 4911(a) and Sec.  56.4911-1(a), X must determine for each year 
for which the expenditure test election is effective whether it is 
liable for the 25 percent excise tax imposed by section 4911(a) on 
excess lobbying expenditures. X is liable for this tax for each of its 
taxable years 1979, 1980, and 1981, because in each year its lobbying 
expenditures exceeded its lobbying nontaxable amount for the year. For 
1979, the tax imposed by section 4911(a) is $5,000 {25% x ($100,000-
$80,000) = $5,000{time} . For 1980, the tax is $10,000. For 1981, the 
tax is $1,250.
    (3) The taxable years 1979 through 1981 are all determination years 
under paragraph (c)(8) of this section. On its annual return for 
determination year 1979, the first year of its first election, X can 
demonstrate, under paragraph (b)(2) of this section, that its lobbying 
expenditures during 1979 ($100,000) do not exceed 150 percent of its 
lobbying nontaxable amount for 1979 ($120,000). For determination year 
1980, under paragraph (b)(2), X can demonstrate that the sum of its 
lobbying expenditures for 1979 and 1980 ($200,000) does not exceed 150 
percent of the sum of its lobbying nontaxable amounts for 1979 and 1980 
($210,000). For 1981, under paragraph (b)(2), X can demonstrate that the 
sum of its lobbying expenditures for 1979, 1980, and 1981 ($320,000) 
does not exceed 150 percent of the sum of its lobbying nontaxable 
amounts for 1979, 1980, and 1981 ($382,500). For each of the 
determination years 1979, 1980, and 1981, the first three years of its 
first election, X satisfies the requirements of paragraph (b)(2). 
Accordingly, no determination under paragraph (b)(1) of this section is 
required for those years, and X is not denied tax exemption by reason of 
section 501(h).
    (4) Under paragraph (b)(1) of this section, X must determine for its 
determination year 1982 whether it has normally made lobbying 
expenditures in excess of the lobbying ceiling amount. This 
determination takes into account expenditures in base years 1979 through 
1982. The sum of X's lobbying expenditures for the base years ($420,000) 
does not exceed 150 percent of the sum of the lobbying nontaxable 
amounts for the base years (150% x $355,000 = $532,500). Accordingly, X 
is not denied tax exemption by reason of section 501(h).
    Example 2. (1) The following table contains information used in this 
example concerning W.

[[Page 53]]



--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                                            Grass roots
                                      Exempt purpose                                         Lobbying                       nontaxable
                                       expenditures                                         nontaxable       Lobbying       amount (25      Grass roots
                Year                       (EPE)                  Calculation              amount (LNTA)   expenditures     percent of     expenditures
                                         (dollars)                                           (dollars)    (LE) (dollars)       LNTA)         (dollars)
                                                                                                                             (dollars)
--------------------------------------------------------------------------------------------------------------------------------------------------------
1979................................         700,000  (20% of $500,000 + 15% of                  130,000         120,000          32,500          30,000
                                                       $200,000=).
1980................................         800,000  (20% of $500,000 + 15% of                  145,000         100,000          36,250          60,000
                                                       $300,000=).
1981................................         800,000  (20% of $500,000 + 15% of                  145,000         100,000          36,250          65,000
                                                       $300,000=).
1982................................         900,000  (20% of $500,000 + 15% of                  160,000         150,000          40,000          65,000
                                                       $400,000=).
                                     ----------------                                    ---------------------------------------------------------------
  Total.............................       3,200,000  ..................................         580,000         470,000         145,000         220,000
--------------------------------------------------------------------------------------------------------------------------------------------------------

    (2) Organization W, whose taxable year is the calendar year, made 
the expenditure test election under section 501(h) effective for taxable 
years beginning with 1979 and has not revoked the election. W has been 
treated as an organization described in section 501(c)(3) for each of 
its taxable years beginning within its taxable year 1974.
    (3) Under section 4911(a) and Sec.  56.4911-1(a), W must determine 
for each year for which the expenditure test election is effective 
whether it is liable for the 25 percent excise tax imposed by section 
4911(a) on excess lobbying expenditures. In 1980, 1981, and 1982, W has 
excess lobbying expenditures because its grass roots expenditures in 
each of those years exceeded its grass roots nontaxable amount for the 
year. Therefore, W is liable for the excise tax under section 4911(a) 
for those years. The tax imposed by section 4911(a) for 1980 is 
$5,937.50 {25% x ($60,000-$36,250)= $5,937.50{time} . For 1981, the tax 
is $7,187.50. For 1982, the tax is $6,250.
    (4) On its annual return for its determination years 1979, 1980, and 
1981, the first three years of its first election, W demonstrates that 
it satisfies the requirements of paragraph (b)(2) of this section. 
Accordingly, no determination under paragraph (b)(1) of this section is 
required for those years, and W is not denied tax exemption by reason of 
section 501(h).
    (5) On its annual return for its determination year 1982, W must 
determine under paragraph (b)(1) whether it has normally made lobbying 
expenditures or grass roots expenditures in excess of the corresponding 
ceiling amount. This determination takes into account expenditures in 
base years 1979 through 1982. The sum of W's lobbying expenditures for 
the base years ($470,000) does not exceed 150% of the sum of W's 
lobbying nontaxable amounts for those years (150% x $580,000 = 
$870,000). However, the sum of W's grass roots expenditures for the base 
years ($220,000) does exceed 150% of the sum of W's grass roots 
nontaxable amonts for those years (150% x $145,000 = $217,500). Under 
section 501(h), W is denied tax exemption under section 501(a) as an 
organization described in section 501(c)(3) for its taxable year 1983. 
For its taxable year 1984 and any taxable year thereafter, W is exempt 
from tax as an organization described in section 501(c)(3) only if W 
applies for recognition of its exempt status under paragraph (d) of this 
section and is recognized as exempt from tax.
    Example 3. (1) The following table contains information used in this 
example concerning organization Y.

--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                                            Grass roots
                                      Exempt purpose                                         Lobbying        Lobbying       nontaxable      Grass roots
            Taxable Year               expenditures               Calculation               nontaxable     expenditures     amount (25     expenditures
                                           (EPE)                                           amount (LNTA)   (LE)(dollars)    percent of       (dollars)
                                         (dollars)                                           (dollars)                    LNTA)(dollars)
--------------------------------------------------------------------------------------------------------------------------------------------------------
1977................................         700,000  (20% of $500,000 + 15% of                  130,000         182,000          32,500          30,000
                                                       $200,000=).
1978................................         800,000  (20% of $500,000 + 15% of                  145,000         224,750          36,250          35,000
                                                       $300,000=).
                                     ----------------                                    ---------------------------------------------------------------
  Subtotal..........................       1,500,000  ..................................         275,000         406,750          68,750          65,000
1979................................         900,000  (20% of $500,000 + 15% of                  160,000         264,000          40,000          50,000
                                                       $400,000=).
                                     ----------------                                    ---------------------------------------------------------------
  Totals:...........................       2,400,000  ..................................         435,000         670,750         108,750         115,000
--------------------------------------------------------------------------------------------------------------------------------------------------------

    (2) Organization Y, whose taxable year is the calendar year, was 
first treated as an organization described in section 501(c)(3) on 
February 1, 1977. Y made the expenditure

[[Page 54]]

test election under section 501(h) effective for taxable years beginning 
with 1977 and has not revoked the election.
    (3) For 1977, Y has excess lobbying expenditures of $52,000 because 
its lobbying expenditures ($182,000) exceed its lobbying nontaxable 
amount ($130,000) for the taxable year. Accordingly, Y is liable for the 
25 percent excise tax imposed by section 4911(a). The amount of the tax 
is $13,000 [25% x ($182,000-$130,000) = $13,000].
    (4) For 1978, Y again has excess lobbying expenditures and is again 
liable for the 25 percent excise tax imposed by section 4911(a). The 
amount of the tax is $19,937.50 [25% x ($224,750-$145,000) = 
$19,937.50].
    (5) For 1979, Y's lobbying expenditures ($264,000) exceed its 
lobbying nontaxable amount ($160,000) by $104,000, and its grass roots 
expenditures ($50,000) exceed its grass roots nontaxable amount 
($40,000) by $10,000. Under Sec.  56.4911-1(b), Y's excess lobbying 
expenditures are the greater of $104,000 or $10,000. The amount of the 
tax, therefore, is $26,000 [25% x $104,000 = $26,000].
    (6) Under paragraph (c)(8) of this section, 1977 is not a 
determination year because it is the first year for which the 
organization is treated as described in section 501(c)(3). For 1977, Y 
need not determine whether it has normally made lobbying expenditures or 
grass roots expenditures in excess of the corresponding ceiling amount 
for purposes of determining whether it is denied exemption under section 
501(h) for its taxable year 1978.
    (7) For determination year 1978, Y must determine whether it has 
normally made lobbying or grass roots expenditures in excess of the 
corresponding ceiling amount, taking into account expenditures for the 
base years 1977 and 1978. For Y, the determination under paragraph 
(b)(2) of this section considers the same base years as the 
determination under paragraph (b)(1) of this section and is, therefore, 
redundant. Accordingly, Y proceeds to determine, under (b)(1), whether 
it is denied exemption. Y's grass roots expenditures for 1977 and 1978 
($65,000) did not exceed 150 percent of the sum of its grass roots 
nontaxable amounts for those years ($103,125). Y's lobbying expenditures 
for 1977 and 1978 ($406,750) did not exceed 150% of its lobbying 
nontaxable amount for those years (150% x $275,000 = $412,500). 
Therefore, Y is not denied tax exemption under section 501(h) for its 
taxable year 1979.
    (8) For determination year 1979, the sum of Y's grass roots 
expenditures in base years 1977, 1978, and 1979 does not exceed 150 
percent of its grass roots nontaxable amount (calculation omitted). 
However, the sum of Y's lobbying expenditures for the base years 
($670,750) does exceed 150% of the sum of the lobbying nontaxable 
amounts for those years (150% x $435,000 = $652,500). Since Y was not 
described in section 501(c)(3) prior to 1977, only the years 1977, 1978, 
and 1979 may be considered in determining whether Y has normally made 
lobbying expenditures in excess of its lobbying ceiling. Therefore, Y 
determines that it has normally made lobbying expenditures in excess of 
its lobbying ceiling. Under section 501(h), Y is denied tax exemption 
under section 501(a) as an organization described in section 501(c)(3) 
for its taxable year 1980. For its taxable year 1981, and any taxable 
year thereafter, Y is exempt from tax as an organization described in 
section 501(c)(3) only if Y applies for recognition of its exempt status 
under paragraph (d) of this section and is recognized as exempt from 
tax.
    Example 4. Organization M made the expenditure test election under 
section 501(h) effective for taxable years beginning with 1977 and has 
not revoked the election. M has $500,000 of exempt purpose expenditures 
during each of the years 1981 through 1984. In addition, during each of 
those years, M spends $75,000 for direct lobbying and $25,000 for grass 
roots lobbying. Since the amount expended for M's lobbying (both total 
lobbying and grass roots lobbying) is within the respective nontaxable 
expenditure limitations, M is not liable for the 25 percent excise tax 
imposed under section 4911(a) upon excess lobbying expenditures, nor is 
M denied tax-exempt status by reason of section 501 (h).
    Example 5. Assume the same facts as in Example 4, except that, on 
behalf of M, numerous unpaid volunteers conduct substantial lobbying 
activities with no reimbursement. Since the substantial lobbying 
activities of the unpaid volunteers are not counted towards the 
expenditure limitations and the amount expended for M's lobbying is 
within the respective nontaxable expenditure limitations, M is not 
liable for the 25 percent excise tax under section 4911, nor is M denied 
tax-exempt status by reason of section 501(h).

[T.D. 8308, 55 FR 35589, Aug. 31, 1990]



Sec.  1.501(r)-0  Outline of regulations.

    This section lists the table of contents for Sec. Sec.  1.501(r)-1 
through 1.501(r)-7.

                      Sec.  1.501(r)-1 Definitions.

    (a) Application.
    (b) Definitions.
    (1) Amounts generally billed (AGB).
    (2) AGB percentage.
    (3) Application period.
    (4) Authorized body of a hospital facility.
    (5) Billing and collections policy.
    (6) Date provided.
    (7) Discharge.
    (8) Disregarded entity.
    (9) Emergency medical care.
    (10) Emergency medical conditions.
    (11) Extraordinary collection action (ECA).
    (12) Financial assistance policy (FAP).

[[Page 55]]

    (13) FAP application.
    (14) FAP application form.
    (15) FAP-eligible.
    (16) Gross charges.
    (17) Hospital facility.
    (18) Hospital organization.
    (19) Medicaid.
    (20) Medicare fee-for-service.
    (21) Noncompliant facility income.
    (22) Operating a hospital facility.
    (23) Partnership agreement.
    (24) Plain language summary of the FAP.
    (25) Presumptive FAP-eligibility determination.
    (26) Private health insurer.
    (27) Referring.
    (28) Substantially-related entity.
    (29) Widely available on a Web site.

          Sec.  1.501(r)-2 Failures to satisfy section 501(r).

    (a) Revocation of section 501(c)(3) status.
    (b) Minor omissions and errors.
    (1) In general.
    (2) Minor.
    (3) Inadvertent.
    (4) Reasonable cause.
    (c) Excusing certain failures if hospital facility corrects and 
discloses.
    (d) Taxation of noncompliant hospital facilities.
    (1) In general.
    (2) Noncompliant facility income.
    (3) No aggregation.
    (4) Interaction with other Code provisions.
    (e) Instances in which a hospital organization is not required to 
meet section 501(r).

          Sec.  1.501(r)-3 Community health needs assessments.

    (a) In general.
    (b) Conducting a CHNA.
    (1) In general.
    (2) Date a CHNA is conducted.
    (3) Community served by a hospital facility.
    (4) Assessing community health needs.
    (5) Persons representing the broad interests of the community.
    (6) Documentation of a CHNA.
    (7) Making the CHNA report widely available to the public.
    (c) Implementation strategy.
    (1) In general.
    (2) Description of how the hospital facility plans to address a 
significant health need.
    (3) Description of why a hospital facility is not addressing a 
significant health need.
    (4) Joint implementation strategies.
    (5) When the implementation strategy must be adopted.
    (d) Exception for acquired, new, and terminated hospital facilities.
    (1) Acquired hospital facilities.
    (2) New hospital organizations.
    (3) New hospital facilities.
    (4) Transferred or terminated hospital facilities.
    (e) Transition rule for CHNAs conducted in taxable years beginning 
before March 23, 2012.

Sec.  1.501(r)-4 Financial assistance policy and emergency medical care 
                                 policy.

    (a) In general.
    (b) Financial assistance policy.
    (1) In general.
    (2) Eligibility criteria and basis for calculating amounts charged 
to patients.
    (3) Method for applying for financial assistance.
    (4) Actions that may be taken in the event of nonpayment.
    (5) Widely publicizing the FAP.
    (6) Readily obtainable information.
    (7) Providing documents electronically.
    (8) Medically necessary care.
    (c) Emergency medical care policy.
    (1) In general.
    (2) Interference with provision of emergency medical care.
    (3) Relation to federal law governing emergency medical care.
    (4) Examples.
    (d) Establishing the FAP and other policies.
    (1) In general.
    (2) Implementing a policy.
    (3) Establishing a policy for more than one hospital facility.

                 Sec.  1.501(r)-5 Limitation on charges.

    (a) In general.
    (b) Amounts generally billed.
    (1) In general.
    (2) Meaning of charged.
    (3) Look-back method.
    (4) Prospective Medicare or Medicaid method.
    (5) Examples.
    (c) Gross charges.
    (d) Safe harbor for certain charges in excess of AGB.
    (e) Medically necessary care.

                Sec.  1.501(r)-6 Billing and collection.

    (a) In general.
    (b) Extraordinary collection actions.
    (1) In general.
    (2) Certain debt sales that are not ECAs.
    (3) Liens on certain judgments, settlements, or compromises.
    (4) Bankruptcy claims.
    (c) Reasonable efforts.
    (1) In general.
    (2) Presumptive FAP-eligibility determinations based on third-party 
information or prior FAP-eligibility determinations.
    (3) Reasonable efforts based on notification and processing of 
applications.
    (4) Notification.
    (5) Incomplete FAP applications.
    (6) Complete FAP applications.
    (7) When no FAP application is submitted.

[[Page 56]]

    (8) Suspending ECAs while a FAP application is pending.
    (9) Waiver does not constitute reasonable efforts.
    (10) Agreements with other parties.
    (11) Clear and conspicuous placement.
    (12) Providing documents electronically.

             Sec.  1.501(r)-7 Effective/applicability date.

    (a) Effective/applicability date.
    (b) Reasonable interpretation for taxable years beginning on or 
before December 29, 2015.

[T.D. 9708, 79 FR 78997, Dec. 31, 2014; 80 FR 12762, Mar. 11, 2015]



Sec.  1.501(r)-1  Definitions.

    (a) Application. The definitions set forth in this section apply to 
Sec. Sec.  1.501(r)-2 through 1.501(r)-7.
    (b) Definitions--(1) Amounts generally billed (AGB) means the 
amounts generally billed for emergency or other medically necessary care 
to individuals who have insurance covering such care, determined in 
accordance with Sec.  1.501(r)-5(b).
    (2) AGB percentage means a percentage of gross charges that a 
hospital facility uses under Sec.  1.501(r)-5(b)(3) to determine the AGB 
for any emergency or other medically necessary care it provides to an 
individual who is eligible for assistance under its financial assistance 
policy (FAP).
    (3) Application period means the period during which a hospital 
facility must accept and process an application for financial assistance 
under its FAP submitted by an individual in order to have made 
reasonable efforts to determine whether the individual is FAP-eligible 
under Sec.  1.501(r)-6(c). A hospital facility may accept and process an 
individual's FAP application submitted outside of the application 
period. With respect to any care provided by a hospital facility to an 
individual, the application period begins on the date the care is 
provided and ends on the later of the 240th day after the date that the 
first post-discharge billing statement for the care is provided or 
either--
    (i) In the case of an individual who the hospital facility is 
notifying as described in Sec.  1.501(r)-6(c)(4), the deadline specified 
by a written notice described in Sec.  1.501(r)-6(c)(4); or
    (ii) In the case of an individual who the hospital facility has 
presumptively determined to be eligible for less than the most generous 
assistance available under the FAP as described in Sec.  1.501(r)-
6(c)(2), the end of the reasonable period of time described in Sec.  
1.501(r)-6(c)(2)(i)(B).
    (4) Authorized body of a hospital facility means--
    (i) The governing body (that is, the board of directors, board of 
trustees, or equivalent controlling body) of the hospital organization 
that operates the hospital facility or a committee of, or other party 
authorized by, that governing body to the extent such committee or other 
party is permitted under state law to act on behalf of the governing 
body; or
    (ii) The governing body of an entity that is disregarded or treated 
as a partnership for federal tax purposes that operates the hospital 
facility or a committee of, or other party authorized by, that governing 
body to the extent such committee or other party is permitted under 
state law to act on behalf of the governing body.
    (5) Billing and collections policy means a written policy that 
includes all of the elements described in Sec.  1.501(r)-4(b)(4)(i).
    (6) Date provided means, in the case of any billing statement, 
written notice, or other written communication that is mailed, the date 
of mailing. The date that a billing statement, written notice, or other 
written communication is provided can also be the date such 
communication is sent electronically or delivered by hand.
    (7) Discharge means to release from a hospital facility after the 
care at issue has been provided, regardless of whether that care has 
been provided on an inpatient or outpatient basis. Thus, a billing 
statement for care is considered ``post-discharge'' if it is provided to 
an individual after the care has been provided and the individual has 
left the hospital facility.
    (8) Disregarded entity means an entity that is generally disregarded 
as separate from its owner for federal tax purposes under Sec.  
301.7701-3 of this chapter. One example of a disregarded entity is a 
domestic single member limited liability company that does not elect to 
be classified as an association taxable

[[Page 57]]

as a corporation for federal tax purposes.
    (9) Emergency medical care means care provided by a hospital 
facility for emergency medical conditions.
    (10) Emergency medical conditions means emergency medical conditions 
as defined in section 1867 of the Social Security Act (42 U.S.C. 
1395dd).
    (11) Extraordinary collection action (ECA) means an action described 
in Sec.  1.501(r)-6(b)(1).
    (12) Financial assistance policy (FAP) means a written policy that 
meets the requirements described in Sec.  1.501(r)-4(b).
    (13) FAP application means the information and accompanying 
documentation that an individual submits to apply for financial 
assistance under a hospital facility's FAP. An individual is considered 
to have submitted a complete FAP application if he or she provides 
information and documentation sufficient for the hospital facility to 
determine whether the individual is FAP-eligible and an incomplete FAP 
application if he or she provides some, but not sufficient, information 
and documentation to determine FAP-eligibility. The term ``FAP 
application'' does not refer only to written submissions, and a hospital 
facility may obtain information from an individual in writing or orally 
(or a combination of both).
    (14) FAP application form means the application form (and any 
accompanying instructions) that a hospital facility makes available for 
individuals to submit as part of a FAP application.
    (15) FAP-eligible means eligible for financial assistance under a 
hospital facility's FAP for care covered by the FAP, without regard to 
whether an individual has applied for assistance under the FAP.
    (16) Gross charges, or the chargemaster rate, means a hospital 
facility's full, established price for medical care that the hospital 
facility consistently and uniformly charges patients before applying any 
contractual allowances, discounts, or deductions.
    (17) Hospital facility means a facility that is required by a state 
to be licensed, registered, or similarly recognized as a hospital. 
Multiple buildings operated under a single state license are considered 
to be a single hospital facility. For purposes of this paragraph 
(b)(17), the term ``state'' includes only the 50 states and the District 
of Columbia and not any U.S. territory or foreign country. References to 
a hospital facility taking actions include instances in which the 
hospital organization operating the hospital facility takes actions 
through or on behalf of the hospital facility.
    (18) Hospital organization means an organization recognized (or 
seeking to be recognized) as described in section 501(c)(3) that 
operates one or more hospital facilities. If the section 501(c)(3) 
status of such an organization is revoked, the organization will, for 
purposes of section 4959, continue to be treated as a hospital 
organization during the taxable year in which such revocation becomes 
effective.
    (19) Medicaid means any medical assistance program administered by 
the state in which a hospital facility is licensed in accordance with 
Title XIX of the Social Security Act (42 U.S.C. 1396 through 1396w-5), 
including programs in which such medical assistance is provided through 
a contract between the state and a Medicaid managed care organization or 
a prepaid inpatient health plan.
    (20) Medicare fee-for-service means health insurance available under 
Medicare Part A and Part B of Title XVIII of the Social Security Act (42 
U.S.C. 1395c through 1395w-5).
    (21) Noncompliant facility income means income that a hospital 
organization operating more than one hospital facility derives from a 
hospital facility that fails to meet one or more of the requirements of 
section 501(r) during a taxable year as determined in accordance with 
Sec.  1.501(r)-2(d).
    (22) Operating a hospital facility--(i) In general. Operating a 
hospital facility includes operating the facility through the 
organization's own employees or contracting out to another organization 
to operate the facility. For example, if an organization hires a 
management company to operate the facility, the hiring organization is 
considered to operate the facility. An organization also operates a 
hospital facility if it is

[[Page 58]]

the sole member or owner of a disregarded entity that operates the 
hospital facility. In addition, an organization operates a hospital 
facility if it owns a capital or profits interest in an entity treated 
as a partnership for federal tax purposes that operates the hospital 
facility, unless paragraph (b)(22)(ii) of this section applies. For 
purposes of this paragraph (b)(22), an organization is considered to own 
a capital or profits interest in an entity treated as a partnership for 
federal tax purposes if it owns such an interest directly or indirectly 
through one or more lower-tier entities treated as partnerships for 
federal tax purposes.
    (ii) Exception for certain partnerships. An organization does not 
operate a hospital facility despite owning a capital or profits interest 
in an entity treated as a partnership for federal tax purposes that 
operates the hospital facility if--
    (A) The organization does not have control over the operation of the 
hospital facility operated by the partnership sufficient to ensure that 
the operation of the hospital facility furthers an exempt purpose 
described in section 501(c)(3) and thus treats the operation of the 
hospital facility, including the facility's provision of medical care, 
as an unrelated trade or business described in section 513 with respect 
to the hospital organization; or
    (B) At all times since March 23, 2010, the organization has been 
organized and operated primarily for educational or scientific purposes 
and has not engaged primarily in the operation of one or more hospital 
facilities and, pursuant to a partnership agreement entered into before 
March 23, 2010--
    (1) Does not own more than 35 percent of the capital or profits 
interest in the partnership (determined in accordance with section 
707(b)(3));
    (2) Does not own a general partner interest, managing-member 
interest, or similar interest in the partnership; and
    (3) Does not have control over the operation of the hospital 
facility sufficient to ensure that the hospital facility complies with 
the requirements of section 501(r).
    (23) Partnership agreement means, for purposes of paragraph 
(b)(22)(ii)(B) of this section, all written agreements among the 
partners, or between one or more partners and the partnership, and 
concerning affairs of the partnership and responsibilities of the 
partners, whether or not embodied in a document referred to by the 
partners as the partnership agreement. A partnership agreement also 
includes any modifications to the agreement agreed to by all partners, 
or adopted in any other manner provided by the partnership agreement, 
except for modifications adopted on or after March 23, 2010, that affect 
whether or not the agreement is described in paragraph (b)(22)(ii)(B) of 
this section. In addition, a partnership agreement includes provisions 
of federal, state, or local law that were in effect before March 23, 
2010, and continue to be in effect that govern the affairs of the 
partnership or are considered under such law to be part of the 
partnership agreement.
    (24) Plain language summary of the FAP means a written statement 
that notifies an individual that the hospital facility offers financial 
assistance under a FAP and provides the following additional information 
in language that is clear, concise, and easy to understand:
    (i) A brief description of the eligibility requirements and 
assistance offered under the FAP.
    (ii) A brief summary of how to apply for assistance under the FAP.
    (iii) The direct Web site address (or URL) and physical locations 
where the individual can obtain copies of the FAP and FAP application 
form.
    (iv) Instructions on how the individual can obtain a free copy of 
the FAP and FAP application form by mail.
    (v) The contact information, including telephone number and physical 
location, of the hospital facility office or department that can provide 
information about the FAP and of either--
    (A) The hospital facility office or department that can provide 
assistance with the FAP application process; or
    (B) If the hospital facility does not provide assistance with the 
FAP application process, at least one nonprofit organization or 
government agency that the hospital facility has identified as an 
available source of assistance with FAP applications.

[[Page 59]]

    (vi) A statement of the availability of translations of the FAP, FAP 
application form, and plain language summary of the FAP in other 
languages, if applicable.
    (vii) A statement that a FAP-eligible individual may not be charged 
more than AGB for emergency or other medically necessary care.
    (25) Presumptive FAP-eligibility determination means a determination 
that an individual is FAP-eligible based on information other than that 
provided by the individual or based on a prior FAP-eligibility 
determination, as described in Sec.  1.501(r)-6(c)(2).
    (26) Private health insurer means any organization that is not a 
governmental unit that offers health insurance, including 
nongovernmental organizations administering a health insurance plan 
under Medicare Advantage (Part C of Title XVIII of the Social Security 
Act, 42 U.S.C. 1395w-21 through 1395w-29). For purposes of Sec.  
1.501(r)-5(b), medical assistance provided through a contract between 
the state and a Medicaid managed care organization or a prepaid 
inpatient health plan is not considered to be a reimbursement from or a 
claim allowed by a private health insurer.
    (27) Referring an individual's debt to a debt collection agency or 
other party means contracting with, delegating to, or otherwise using 
the debt collection agency or other party to collect amounts owed by the 
individual to the hospital facility while still maintaining ownership of 
the debt.
    (28) Substantially-related entity means, with respect to a hospital 
facility operated by a hospital organization, an entity treated as a 
partnership for federal tax purposes in which the hospital organization 
owns a capital or profits interest, or a disregarded entity of which the 
hospital organization is the sole member or owner, that provides 
emergency or other medically necessary care in the hospital facility, 
unless the provision of such care is an unrelated trade or business 
described in section 513 with respect to the hospital organization. 
Notwithstanding the preceding sentence, a partnership that qualifies for 
the exception described in paragraph (b)(22)(ii)(B) of this section is 
not considered a substantially-related entity within the meaning of this 
paragraph (b)(28).
    (29) Widely available on a Web site means--
    (i) The hospital facility conspicuously posts a complete and current 
version of the document on--
    (A) The hospital facility's Web site;
    (B) If the hospital facility does not have its own Web site separate 
from the hospital organization that operates it, the hospital 
organization's Web site; or
    (C) A Web site established and maintained by another entity, but 
only if the Web site of the hospital facility or hospital organization 
(if the facility or organization has a Web site) provides a 
conspicuously-displayed link to the Web page where the document is 
posted, along with clear instructions for accessing the document on that 
Web site;
    (ii) Individuals with access to the Internet can access, download, 
view, and print a hard copy of the document from the Web site--
    (A) Without requiring special computer hardware or software (other 
than software that is readily available to members of the public without 
payment of any fee);
    (B) Without paying a fee to the hospitality facility, hospital 
organization, or other entity maintaining the Web site; and
    (C) Without creating an account or being otherwise required to 
provide personally identifiable information; and
    (iii) The hospital facility provides individuals who ask how to 
access a copy of the document online with the direct Web site address, 
or URL, of the Web page where the document is posted.

[T.D. 9708, 79 FR 78998, Dec. 31, 2014; 80 FR 12762, Mar. 11, 2015]



Sec.  1.501(r)-2  Failures to satisfy section 501(r).

    (a) Revocation of section 501(c)(3) status. Except as otherwise 
provided in paragraphs (b) and (c) of this section, a hospital 
organization failing to meet one or more of the requirements of section 
501(r) separately with respect to one or more hospital facilities it 
operates may have its section 501(c)(3) status revoked as of the first 
day of the

[[Page 60]]

taxable year in which the failure occurs. In determining whether to 
continue to recognize the section 501(c)(3) status of a hospital 
organization that fails to meet one or more of the requirements of 
section 501(r) with respect to one or more hospital facilities, the 
Commissioner will consider all relevant facts and circumstances 
including, but not limited to, the following:
    (1) Whether the organization has previously failed to meet the 
requirements of section 501(r), and, if so, whether the same type of 
failure previously occurred.
    (2) The size, scope, nature, and significance of the organization's 
failure(s).
    (3) In the case of an organization that operates more than one 
hospital facility, the number, size, and significance of the facilities 
that have failed to meet the section 501(r) requirements relative to 
those that have complied with these requirements.
    (4) The reason for the failure(s).
    (5) Whether the organization had, prior to the failure(s), 
established practices or procedures (formal or informal) reasonably 
designed to promote and facilitate overall compliance with the section 
501(r) requirements.
    (6) Whether the practices or procedures had been routinely followed 
and the failure(s) occurred through an oversight or mistake in applying 
them.
    (7) Whether the organization has implemented safeguards that are 
reasonably calculated to prevent similar failures from occurring in the 
future.
    (8) Whether the organization corrected the failure(s) as promptly 
after discovery as is reasonable given the nature of the failure(s).
    (9) Whether the organization took the measures described in 
paragraphs (a)(7) and (a)(8) of this section before the Commissioner 
discovered the failure(s).
    (b) Minor omissions and errors--(1) In general. A hospital 
facility's omission of required information from a policy or report 
described in Sec.  1.501(r)-3 or Sec.  1.501(r)-4, or error with respect 
to the implementation or operational requirements described in 
Sec. Sec.  1.501(r)-3 through 1.501(r)-6, will not be considered a 
failure to meet a requirement of section 501(r) if the following 
conditions are satisfied:
    (i) Such omission or error was minor and either inadvertent or due 
to reasonable cause.
    (ii) The hospital facility corrects such omission or error as 
promptly after discovery as is reasonable given the nature of the 
omission or error. Such correction must include establishment (or review 
and, if necessary, revision) of practices or procedures (formal or 
informal) that are reasonably designed to promote and facilitate overall 
compliance with the requirements of section 501(r).
    (2) Minor. In the case of multiple omissions or errors, the 
omissions or errors are considered minor for purposes of this paragraph 
(b) only if they are minor in the aggregate.
    (3) Inadvertent. For purposes of this paragraph (b), the fact that 
the same omission or error has been made and corrected previously is a 
factor tending to show that an omission or error is not inadvertent.
    (4) Reasonable cause. For purposes of this paragraph (b), the fact 
that a hospital facility has established practices or procedures (formal 
or informal) reasonably designed to promote and facilitate overall 
compliance with the section 501(r) requirements prior to the occurrence 
of an omission or error is a factor tending to show that the omission or 
error is due to reasonable cause.
    (c) Excusing certain failures if hospital facility corrects and 
discloses. A hospital facility's failure to meet one or more of the 
requirements described in Sec. Sec.  1.501(r)-3 through 1.501(r)-6 that 
is neither willful nor egregious shall be excused for purposes of this 
section if the hospital facility corrects and makes disclosure in 
accordance with rules set forth by revenue procedure, notice, or other 
guidance published in the Internal Revenue Bulletin. For purposes of 
this paragraph (c), a ``willful'' failure includes a failure due to 
gross negligence, reckless disregard, or willful neglect, and an 
``egregious'' failure includes only a very serious failure, taking into 
account the severity of the impact and the number of affected persons. 
Whether a failure is willful or egregious will be determined based on

[[Page 61]]

all of the facts and circumstances. A hospital facility's correction and 
disclosure of a failure in accordance with the relevant guidance is a 
factor tending to show that the failure was not willful.
    (d) Taxation of noncompliant hospital facilities--(1) In general. 
Except as otherwise provided in paragraphs (b) and (c) of this section, 
if a hospital organization that operates more than one hospital facility 
fails to meet one or more of the requirements of section 501(r) 
separately with respect to a hospital facility during a taxable year, 
the income derived from the noncompliant hospital facility 
(``noncompliant facility income'') during that taxable year will be 
subject to tax computed as provided in section 11 (or as provided in 
section 1(e) if the hospital organization is a trust described in 
section 511(b)(2)), but substituting the term ``noncompliant facility 
income'' for ``taxable income,'' if--
    (i) The hospital organization continues to be recognized as 
described in section 501(c)(3) during the taxable year; but
    (ii) The hospital organization would not continue to be recognized 
as described in section 501(c)(3) during the taxable year based on the 
facts and circumstances described in paragraph (a) of this section (but 
disregarding paragraph (a)(3) of this section) if the noncompliant 
hospital facility were the only hospital facility operated by the 
organization.
    (2) Noncompliant facility income--(i) In general. For purposes of 
this paragraph (d), the noncompliant facility income derived from a 
hospital facility during a taxable year will be the gross income derived 
from that hospital facility during the taxable year, less the deductions 
allowed by chapter 1 that are directly connected to the operation of 
that hospital facility during the taxable year, excluding any gross 
income and deductions taken into account in computing any unrelated 
business taxable income described in section 512 that is derived from 
the facility during the taxable year.
    (ii) Directly connected deductions. For purposes of this paragraph 
(d), to be directly connected with the operation of a hospital facility 
that has failed to meet the requirements of section 501(r), an item of 
deduction must have proximate and primary relationship to the operation 
of the hospital facility. Expenses, depreciation, and similar items 
attributable solely to the operation of a hospital facility are 
proximately and primarily related to such operation, and therefore 
qualify for deduction to the extent that they meet the requirements of 
section 162, section 167, or other relevant provisions of the Internal 
Revenue Code (Code). Where expenses, depreciation, and similar items are 
attributable to a noncompliant hospital facility and other hospital 
facilities operated by the hospital organization (and/or to other 
activities of the hospital organization unrelated to the operation of 
hospital facilities), such items shall be allocated among the hospital 
facilities (and/or other activities) on a reasonable basis. The portion 
of any such item so allocated to a noncompliant hospital facility is 
proximately and primarily related to the operation of that facility and 
shall be allowable as a deduction in computing the facility's 
noncompliant facility income in the manner and to the extent it would 
meet the requirements of section 162, section 167, or other relevant 
provisions of the Code.
    (3) No aggregation. In computing the noncompliant facility income of 
a hospital facility, the gross income from (and the deductions allowed 
with respect to) the hospital facility may not be aggregated with the 
gross income from (and the deductions allowed with respect to) the 
hospital organization's other noncompliant hospital facilities subject 
to tax under this paragraph (d) or its unrelated trade or business 
activities described in section 513.
    (4) Interaction with other Code provisions--(i) Hospital 
organization operating a noncompliant hospital facility continues to be 
treated as tax-exempt. A hospital organization operating a noncompliant 
hospital facility subject to tax under this paragraph (d) shall continue 
to be treated as an organization that is exempt from tax under section 
501(a) because it is described in section 501(c)(3) for all purposes of 
the Code. In addition, the application of this paragraph (d) shall not, 
by itself, result in the operation of the noncompliant hospital

[[Page 62]]

facility being considered an unrelated trade or business described in 
section 513 with respect to the hospital organization. Thus, for 
example, the application of this paragraph (d) shall not, by itself, 
affect the tax-exempt status of bonds issued to finance the noncompliant 
hospital facility.
    (ii) Noncompliant hospital facility operated by a tax-exempt 
hospital organization is subject to tax. A noncompliant hospital 
facility described in paragraph (d)(1) of this section is subject to tax 
under this paragraph (d), notwithstanding the fact that the hospital 
organization operating the hospital facility is otherwise exempt from 
tax under section 501(a) and subject to tax under section 511(a) and 
that Sec.  1.11-1(a) of this chapter states such organizations are not 
liable for the tax imposed under section 11.
    (iii) Noncompliant hospital facility not a business entity. A 
noncompliant hospital facility subject to tax under this paragraph (d) 
is not considered a business entity for purposes of Sec.  301.7701-
2(b)(7) of this chapter.
    (e) Instances in which a hospital organization is not required to 
meet section 501(r). A hospital organization is not required to meet the 
requirements of section 501(r) (and, therefore, is not subject to any 
consequence described in this section for failing to meet the 
requirements of section 501(r)) with respect to--
    (1) Any hospital facility it is not ``operating'' within the meaning 
of Sec.  1.501(r)-1(b)(22);
    (2) The operation of a facility that is not required by a state to 
be licensed, registered, or similarly recognized as a hospital; or
    (3) Any activities that constitute an unrelated trade or business 
described in section 513 with respect to the hospital organization.

[T.D. 9708, 79 FR 78998, Dec. 31, 2014; 80 FR 12762, Mar. 11, 2015]



Sec.  1.501(r)-3  Community health needs assessments.

    (a) In general. With respect to any taxable year, a hospital 
organization meets the requirements of section 501(r)(3) with respect to 
a hospital facility it operates only if--
    (1) The hospital facility has conducted a community health needs 
assessment (CHNA) that meets the requirements of paragraph (b) of this 
section in such taxable year or in either of the two taxable years 
immediately preceding such taxable year (except as provided in paragraph 
(d) of this section); and
    (2) An authorized body of the hospital facility (as defined in Sec.  
1.501(r)-1(b)(4)) has adopted an implementation strategy to meet the 
community health needs identified through the CHNA, as described in 
paragraph (c) of this section, on or before the 15th day of the fifth 
month after the end of such taxable year.
    (b) Conducting a CHNA--(1) In general. To conduct a CHNA for 
purposes of paragraph (a) of this section, a hospital facility must 
complete all of the following steps:
    (i) Define the community it serves.
    (ii) Assess the health needs of that community.
    (iii) In assessing the health needs of the community, solicit and 
take into account input received from persons who represent the broad 
interests of that community, including those with special knowledge of 
or expertise in public health.
    (iv) Document the CHNA in a written report (CHNA report) that is 
adopted for the hospital facility by an authorized body of the hospital 
facility.
    (v) Make the CHNA report widely available to the public.
    (2) Date a CHNA is conducted. For purposes of this section, a 
hospital facility will be considered to have conducted a CHNA on the 
date it has completed all of the steps described in paragraph (b)(1) of 
this section. Solely for purposes of determining the taxable year in 
which a CHNA has been conducted under this paragraph (b)(2), a hospital 
facility will be considered to have completed the step of making a CHNA 
report widely available to the public on the date it first makes the 
CHNA report widely available to the public as described in paragraph 
(b)(7)(i) of this section.
    (3) Community served by a hospital facility. In defining the 
community it serves for purposes of paragraph

[[Page 63]]

(b)(1)(i) of this section, a hospital facility may take into account all 
of the relevant facts and circumstances, including the geographic area 
served by the hospital facility, target population(s) served (for 
example, children, women, or the aged), and principal functions (for 
example, focus on a particular specialty area or targeted disease). 
However, a hospital facility may not define its community to exclude 
medically underserved, low-income, or minority populations who live in 
the geographic areas from which the hospital facility draws its patients 
(unless such populations are not part of the hospital facility's target 
patient population(s) or affected by its principal functions) or 
otherwise should be included based on the method the hospital facility 
uses to define its community. In addition, in determining its patient 
populations for purposes of defining its community, a hospital facility 
must take into account all patients without regard to whether (or how 
much) they or their insurers pay for the care received or whether they 
are eligible for assistance under the hospital facility's financial 
assistance policy. In the case of a hospital facility consisting of 
multiple buildings that operate under a single state license and serve 
different geographic areas or populations, the community served by the 
hospital facility is the aggregate of such areas or populations.
    (4) Assessing community health needs. To assess the health needs of 
the community it serves for purposes of paragraph (b)(1)(ii) of this 
section, a hospital facility must identify significant health needs of 
the community, prioritize those health needs, and identify resources 
(such as organizations, facilities, and programs in the community, 
including those of the hospital facility) potentially available to 
address those health needs. For these purposes, the health needs of a 
community include requisites for the improvement or maintenance of 
health status both in the community at large and in particular parts of 
the community (such as particular neighborhoods or populations 
experiencing health disparities). These needs may include, for example, 
the need to address financial and other barriers to accessing care, to 
prevent illness, to ensure adequate nutrition, or to address social, 
behavioral, and environmental factors that influence health in the 
community. A hospital facility may determine whether a health need is 
significant based on all of the facts and circumstances present in the 
community it serves. In addition, a hospital facility may use any 
criteria to prioritize the significant health needs it identifies, 
including, but not limited to, the burden, scope, severity, or urgency 
of the health need; the estimated feasibility and effectiveness of 
possible interventions; the health disparities associated with the need; 
or the importance the community places on addressing the need.
    (5) Persons representing the broad interests of the community--(i) 
In general. For purposes of paragraph (b)(1)(iii) of this section, a 
hospital facility must solicit and take into account input received from 
all of the following sources in identifying and prioritizing significant 
health needs and in identifying resources potentially available to 
address those health needs:
    (A) At least one state, local, tribal, or regional governmental 
public health department (or equivalent department or agency), or a 
State Office of Rural Health described in section 338J of the Public 
Health Service Act (42 U.S.C. 254r), with knowledge, information, or 
expertise relevant to the health needs of that community.
    (B) Members of medically underserved, low-income, and minority 
populations in the community served by the hospital facility, or 
individuals or organizations serving or representing the interests of 
such populations. For purposes of this paragraph (b), medically 
underserved populations include populations experiencing health 
disparities or at risk of not receiving adequate medical care as a 
result of being uninsured or underinsured or due to geographic, 
language, financial, or other barriers.
    (C) Written comments received on the hospital facility's most 
recently conducted CHNA and most recently adopted implementation 
strategy.
    (ii) Additional sources of input. In addition to the sources 
described in paragraph (b)(5)(i) of this section, a hospital

[[Page 64]]

facility may solicit and take into account input received from a broad 
range of persons located in or serving its community, including, but not 
limited to, health care consumers and consumer advocates, nonprofit and 
community-based organizations, academic experts, local government 
officials, local school districts, health care providers and community 
health centers, health insurance and managed care organizations, private 
businesses, and labor and workforce representatives.
    (6) Documentation of a CHNA--(i) In general. For purposes of 
paragraph (b)(1)(iv) of this section, the CHNA report adopted for the 
hospital facility by an authorized body of the hospital facility must 
include--
    (A) A definition of the community served by the hospital facility 
and a description of how the community was determined;
    (B) A description of the process and methods used to conduct the 
CHNA;
    (C) A description of how the hospital facility solicited and took 
into account input received from persons who represent the broad 
interests of the community it serves;
    (D) A prioritized description of the significant health needs of the 
community identified through the CHNA, along with a description of the 
process and criteria used in identifying certain health needs as 
significant and prioritizing those significant health needs;
    (E) A description of the resources potentially available to address 
the significant health needs identified through the CHNA; and
    (F) An evaluation of the impact of any actions that were taken, 
since the hospital facility finished conducting its immediately 
preceding CHNA, to address the significant health needs identified in 
the hospital facility's prior CHNA(s).
    (ii) Process and methods used to conduct the CHNA. A hospital 
facility's CHNA report will be considered to describe the process and 
methods used to conduct the CHNA for purposes of paragraph (b)(6)(i)(B) 
of this section if the CHNA report describes the data and other 
information used in the assessment, as well as the methods of collecting 
and analyzing this data and information, and identifies any parties with 
whom the hospital facility collaborated, or with whom it contracted for 
assistance, in conducting the CHNA. In the case of data obtained from 
external source material, the CHNA report may cite the source material 
rather than describe the method of collecting the data.
    (iii) Input from persons who represent the broad interests of the 
community served by the hospital facility. A hospital facility's CHNA 
report will be considered to describe how the hospital facility took 
into account input received from persons who represent the broad 
interests of the community it serves for purposes of paragraph 
(b)(6)(i)(C) of this section if the CHNA report summarizes, in general 
terms, any input provided by such persons and how and over what time 
period such input was provided (for example, whether through meetings, 
focus groups, interviews, surveys, or written comments and between what 
approximate dates); provides the names of any organizations providing 
input and summarizes the nature and extent of the organization's input; 
and describes the medically underserved, low-income, or minority 
populations being represented by organizations or individuals that 
provided input. A CHNA report does not need to name or otherwise 
identify any specific individual providing input on the CHNA. In the 
event a hospital facility solicits, but cannot obtain, input from a 
source described in paragraph (b)(5)(i) of this section, the hospital 
facility's CHNA report also must describe the hospital facility's 
efforts to solicit input from such source.
    (iv) Separate CHNA reports. While a hospital facility may conduct 
its CHNA in collaboration with other organizations and facilities 
(including, but not limited to, related and unrelated hospital 
organizations and facilities, for-profit and government hospitals, 
governmental departments, and nonprofit organizations), every hospital 
facility must document the information described in this paragraph 
(b)(6) in a separate CHNA report to satisfy paragraph (b)(1)(iv) of this 
section unless it adopts a joint CHNA report as described in paragraph 
(b)(6)(v) of this section. However, if a hospital facility

[[Page 65]]

is collaborating with other facilities and organizations in conducting 
its CHNA or if another organization (such as a state or local public 
health department) has conducted a CHNA for all or part of the hospital 
facility's community, portions of the hospital facility's CHNA report 
may be substantively identical to portions of a CHNA report of a 
collaborating hospital facility or other organization conducting a CHNA, 
if appropriate under the facts and circumstances. For example, if two 
hospital facilities with overlapping, but not identical, communities are 
collaborating in conducting a CHNA, the portions of each hospital 
facility's CHNA report relevant to the shared areas of their communities 
might be identical. Similarly, if the state or local public health 
department with jurisdiction over the community served by a hospital 
facility conducts a CHNA for an area that includes the hospital 
facility's community, the hospital facility's CHNA report might include 
portions of the state or local public health department's CHNA report 
that are relevant to its community.
    (v) Joint CHNA reports--(A) In general. A hospital facility that 
collaborates with other hospital facilities or other organizations (such 
as state or local public health departments) in conducting its CHNA will 
satisfy paragraph (b)(1)(iv) of this section if an authorized body of 
the hospital facility adopts for the hospital facility a joint CHNA 
report produced for the hospital facility and one or more of the 
collaborating facilities and organizations, provided that the following 
conditions are met:
    (1) The joint CHNA report meets the requirements of paragraph 
(b)(6)(i) of this section.
    (2) The joint CHNA report is clearly identified as applying to the 
hospital facility.
    (3) All of the collaborating hospital facilities and organizations 
included in the joint CHNA report define their community to be the same.
    (B) Example. The following example illustrates this paragraph 
(b)(6)(v):

    Example. P is one of 10 hospital facilities located in and serving 
the populations of a particular Metropolitan Statistical Area (MSA). P 
and seven other facilities in the MSA, some of which are unrelated to P, 
decide to collaborate in conducting a CHNA for the MSA and to each 
define their community as constituting the entire MSA. The eight 
hospital facilities work together with the state and local health 
departments of jurisdictions in the MSA to assess the health needs of 
the MSA and collaborate in conducting surveys and holding public forums 
to solicit and receive input from the MSA's residents, including its 
medically underserved, low-income, and minority populations. The 
hospital facilities also consider the written comments received on their 
most recently conducted CHNAs and most recently adopted implementation 
strategies. The hospital facilities then work together to prepare a 
joint CHNA report documenting this joint CHNA process that contains all 
of the elements described in paragraph (b)(6)(i) of this section. The 
joint CHNA report identifies all of the collaborating hospital 
facilities included in the report, including P, by name, both within the 
report itself and on the cover page. The board of directors of the 
hospital organization operating P adopts the joint CHNA report for P. P 
has complied with the requirements of this paragraph (b)(6)(v) and, 
accordingly, has satisfied paragraph (b)(1)(iv) of this section.

    (7) Making the CHNA report widely available to the public--(i) In 
general. For purposes of paragraph (b)(1)(v) of this section, a hospital 
facility's CHNA report is made widely available to the public only if 
the hospital facility--
    (A) Makes the CHNA report widely available on a Web site, as defined 
in Sec.  1.501(r)-1(b)(29), at least until the date the hospital 
facility has made widely available on a Web site its two subsequent CHNA 
reports; and
    (B) Makes a paper copy of the CHNA report available for public 
inspection upon request and without charge at the hospital facility at 
least until the date the hospital facility has made available for public 
inspection a paper copy of its two subsequent CHNA reports.
    (ii) Making draft CHNA reports widely available. Notwithstanding 
paragraph (b)(7)(i) of this section, if a hospital facility makes widely 
available on a Web site (and/or for public inspection) a version of the 
CHNA report that is expressly marked as a draft on which the public may 
comment, the hospital facility will not be considered to have made the 
CHNA report widely available to the public for purposes of determining 
the date on which the hospital

[[Page 66]]

facility has conducted a CHNA under paragraph (b)(2) of this section.
    (c) Implementation strategy--(1) In general. For purposes of 
paragraph (a)(2) of this section, a hospital facility's implementation 
strategy to meet the community health needs identified through the 
hospital facility's CHNA is a written plan that, with respect to each 
significant health need identified through the CHNA, either--
    (i) Describes how the hospital facility plans to address the health 
need; or
    (ii) Identifies the health need as one the hospital facility does 
not intend to address and explains why the hospital facility does not 
intend to address the health need.
    (2) Description of how the hospital facility plans to address a 
significant health need. A hospital facility's implementation strategy 
will have described a plan to address a significant health need 
identified through a CHNA for purposes of paragraph (c)(1)(i) of this 
section if the implementation strategy--
    (i) Describes the actions the hospital facility intends to take to 
address the health need and the anticipated impact of these actions;
    (ii) Identifies the resources the hospital facility plans to commit 
to address the health need; and
    (iii) Describes any planned collaboration between the hospital 
facility and other facilities or organizations in addressing the health 
need.
    (3) Description of why a hospital facility is not addressing a 
significant health need. In explaining why it does not intend to address 
a significant health need for purposes of paragraph (c)(1)(ii) of this 
section, a brief explanation of the hospital facility's reason for not 
addressing the health need is sufficient. Such reasons may include, for 
example, resource constraints, other facilities or organizations in the 
community addressing the need, a relative lack of expertise or 
competency to effectively address the need, the need being a relatively 
low priority, and/or a lack of identified effective interventions to 
address the need.
    (4) Joint implementation strategies. A hospital facility may develop 
an implementation strategy in collaboration with other hospital 
facilities or other organizations, including, but not limited to, 
related and unrelated hospital organizations and facilities, for-profit 
and government hospitals, governmental departments, and nonprofit 
organizations. In general, a hospital facility that collaborates with 
other facilities or organizations in developing its implementation 
strategy must still document its implementation strategy in a separate 
written plan that is tailored to the particular hospital facility, 
taking into account its specific resources. However, a hospital facility 
that adopts a joint CHNA report described in paragraph (b)(6)(v) of this 
section may also adopt a joint implementation strategy that, with 
respect to each significant health need identified through the joint 
CHNA, either describes how one or more of the collaborating facilities 
or organizations plan to address the health need or identifies the 
health need as one the collaborating facilities or organizations do not 
intend to address and explains why they do not intend to address the 
health need. For a collaborating hospital facility to meet the 
requirements of paragraph (a)(2) of this section, such a joint 
implementation strategy adopted for the hospital facility must--
    (i) Be clearly identified as applying to the hospital facility;
    (ii) Clearly identify the hospital facility's particular role and 
responsibilities in taking the actions described in the implementation 
strategy and the resources the hospital facility plans to commit to such 
actions; and
    (iii) Include a summary or other tool that helps the reader easily 
locate those portions of the joint implementation strategy that relate 
to the hospital facility.
    (5) When the implementation strategy must be adopted--(i) In 
general. For purposes of paragraph (a)(2) of this section, an authorized 
body of the hospital facility must adopt the implementation strategy on 
or before the 15th day of the fifth month after the end of the taxable 
year in which the hospital facility completes the final step for the 
CHNA described in paragraph (b)(1) of this section, regardless of 
whether the hospital facility began working on the CHNA in a prior 
taxable year.
    (ii) Example. The following example illustrates this paragraph 
(c)(5):


[[Page 67]]


    Example. M is a hospital facility that last conducted a CHNA and 
adopted an implementation strategy in Year 1. In Year 3, M defines the 
community it serves, assesses the significant health needs of that 
community, and solicits and takes into account input received from 
persons who represent the broad interests of that community. In Year 4, 
M documents its CHNA in a CHNA report that is adopted by an authorized 
body of M, makes the CHNA report widely available on a Web site, and 
makes paper copies of the CHNA report available for public inspection. 
To meet the requirements of paragraph (a)(2) of this section, an 
authorized body of M must adopt an implementation strategy to meet the 
health needs identified through the CHNA completed in Year 4 by the 15th 
day of the fifth month of Year 5.

    (d) Exception for acquired, new, and terminated hospital 
facilities--(1) Acquired hospital facilities. A hospital organization 
that acquires a hospital facility (whether through merger or 
acquisition) must meet the requirements of section 501(r)(3) with 
respect to the acquired hospital facility by the last day of the 
organization's second taxable year beginning after the date on which the 
hospital facility was acquired. In the case of a merger between two 
organizations that results in the liquidation of one organization and 
the survival of the other organization, the hospital facility or 
facilities formerly operated by the liquidated organization will be 
considered ``acquired'' for purposes of this paragraph (d)(1).
    (2) New hospital organizations. An organization that becomes newly 
subject to the requirements of section 501(r) because it is recognized 
as described in section 501(c)(3) and is operating a hospital facility 
must meet the requirements of section 501(r)(3) with respect to any 
hospital facility by the last day of the second taxable year beginning 
after the later of the effective date of the determination letter or 
ruling recognizing the organization as described in section 501(c)(3) or 
the first date that a facility operated by the organization was 
licensed, registered, or similarly recognized by a state as a hospital.
    (3) New hospital facilities. A hospital organization must meet the 
requirements of section 501(r)(3) with respect to a new hospital 
facility it operates by the last day of the second taxable year 
beginning after the date the facility was licensed, registered, or 
similarly recognized by its state as a hospital.
    (4) Transferred or terminated hospital facilities. A hospital 
organization is not required to meet the requirements of section 
501(r)(3) with respect to a hospital facility in a taxable year if, 
before the end of that taxable year, the hospital organization transfers 
all ownership of the hospital facility to another organization or 
otherwise ceases its operation of the hospital facility or the facility 
ceases to be licensed, registered, or similarly recognized as a hospital 
by a state.
    (e) Transition rule for CHNAs conducted in taxable years beginning 
before March 23, 2012. A hospital facility that conducted a CHNA 
described in section 501(r)(3) in either its first taxable year 
beginning after March 23, 2010, or its first taxable year beginning 
after March 23, 2011, does not need to meet the requirements of section 
501(r)(3) again until the third taxable year following the taxable year 
in which the hospital facility conducted that CHNA, provided that the 
hospital facility adopted an implementation strategy to meet the 
community health needs identified through that CHNA on or before the 
15th day of the fifth calendar month following the close of its first 
taxable year beginning after March 23, 2012.

[T.D. 9708, 79 FR 78998, Dec. 31, 2014; 80 FR 12762, Mar. 11, 2015]



Sec.  1.501(r)-4  Financial assistance policy and emergency medical
care policy.

    (a) In general. A hospital organization meets the requirements of 
section 501(r)(4) with respect to a hospital facility it operates only 
if the hospital organization establishes for that hospital facility--
    (1) A written financial assistance policy (FAP) that meets the 
requirements of paragraph (b) of this section; and
    (2) A written emergency medical care policy that meets the 
requirements of paragraph (c) of this section.
    (b) Financial assistance policy--(1) In general. To satisfy 
paragraph (a)(1) of this section, a hospital facility's FAP must--
    (i) Apply to all emergency and other medically necessary care 
provided by the hospital facility, including all such

[[Page 68]]

care provided in the hospital facility by a substantially-related entity 
(as defined in Sec.  1.501(r)-1(b)(28));
    (ii) Be widely publicized as described in paragraph (b)(5) of this 
section; and
    (iii) Include--
    (A) The eligibility criteria for financial assistance and whether 
such assistance includes free or discounted care;
    (B) The basis for calculating amounts charged to patients;
    (C) The method for applying for financial assistance;
    (D) In the case of a hospital facility that does not have a separate 
billing and collections policy, the actions that may be taken in the 
event of nonpayment;
    (E) If applicable, any information obtained from sources other than 
an individual seeking financial assistance that the hospital facility 
uses, and whether and under what circumstances it uses prior FAP-
eligibility determinations, to presumptively determine that the 
individual is FAP-eligible, as described in Sec.  1.501(r)-6(c)(2); and
    (F) A list of any providers, other than the hospital facility 
itself, delivering emergency or other medically necessary care in the 
hospital facility that specifies which providers are covered by the 
hospital facility's FAP and which are not.
    (2) Eligibility criteria and basis for calculating amounts charged 
to patients--(i) In general. To satisfy paragraphs (b)(1)(iii)(A) and 
(b)(1)(iii)(B) of this section, the FAP must specify the following:
    (A) All financial assistance available under the FAP, including all 
discounts and free care available under the FAP and, if applicable, the 
amount(s) (for example, gross charges) to which any discount percentages 
available under the FAP will be applied.
    (B) The eligibility criteria that an individual must satisfy to 
receive each discount, free care, or other level of assistance available 
under the FAP.
    (C) The method under Sec.  1.501(r)-5(b) the hospital facility uses 
to determine the amounts generally billed to individuals who have 
insurance covering emergency or other medically necessary care (AGB). If 
the hospital facility uses the look-back method described in Sec.  
1.501(r)-5(b)(3), the FAP also must state the AGB percentage(s) that the 
hospital facility uses to determine AGB and describe how the hospital 
facility calculated such percentage(s) or, alternatively, explain how 
members of the public may readily obtain such percentage(s) and 
accompanying description of the calculation in writing and free of 
charge. In addition, the FAP must indicate that, following a 
determination of FAP-eligibility, a FAP-eligible individual may not be 
charged more than AGB for emergency or other medically necessary care.
    (ii) Examples. The following examples illustrate this paragraph 
(b)(2):

    Example 1. (i) Q is a hospital facility that establishes a FAP that 
provides assistance to all uninsured and underinsured individuals whose 
family income is less than or equal to x% of the Federal Poverty Level 
(FPL), with the level of discount for which an individual is eligible 
under Q's FAP determined based upon the individual's family income as a 
percentage of FPL. Q's FAP defines the meaning of ``uninsured,'' 
``underinsured,'' ``family income,'' and ``Federal Poverty Level.'' Q's 
FAP also states that Q determines AGB by multiplying the gross charges 
for any emergency or other medically necessary care it provides to a 
FAP-eligible individual by an AGB percentage of 56%. The FAP states, 
further, that Q calculated the AGB percentage of 56% based on all claims 
allowed by Medicare and private health insurers over a specified 12-
month period, divided by the associated gross charges for those claims. 
Q's FAP contains the following chart, specifying each discount available 
under the FAP, the amounts (gross charges) to which these discounts will 
be applied, and the specific eligibility criteria for each such 
discount:

------------------------------------------------------------------------
                                                Discount off of gross
         Family income as % of FPL                     charges
------------------------------------------------------------------------
y% - x%........................  50%.
z% - y%........................  75%.
<=z%......................................  Free.
------------------------------------------------------------------------

    (ii) Q's FAP also contains a statement that no FAP-eligible 
individual will be charged more for emergency or other medically 
necessary care than AGB because Q's AGB percentage is 56% of gross 
charges and the most a FAP-eligible individual will be charged is 50% of 
gross charges. Q's FAP satisfies the requirements of this paragraph 
(b)(2).
    Example 2. (i) R is a hospital facility that establishes a FAP that 
provides assistance based on household income. R's FAP defines the 
meaning of ``household income.'' R's FAP contains the following chart 
specifying the assistance available under the FAP and

[[Page 69]]

the specific eligibility criteria for each level of assistance offered, 
which R updates occasionally to account for inflation:

------------------------------------------------------------------------
                                          Maximum amount individual will
            Household income                be responsible for paying
------------------------------------------------------------------------
$b - $a.....................  40% of gross charges, up to the
                                          lesser of AGB or x% of
                                          household income.
$c - $b.....................  20% of gross charges, up to the
                                          lesser of AGB or y% of
                                          household income.
<=$c...................................  $0 (free).
------------------------------------------------------------------------

    (ii) R's FAP contains a statement that no FAP-eligible individual 
will be charged more for emergency or other medically necessary care 
than AGB. R's FAP also states that R determines AGB by multiplying the 
gross charges for any emergency or other medically necessary care it 
provides by AGB percentages, which are based on claims allowed under 
Medicare. In addition, the FAP provides a Web site address individuals 
can visit, and a telephone number they can call, if they would like to 
obtain an information sheet stating R's AGB percentages and explaining 
how these AGB percentages were calculated. This information sheet, which 
R makes available on its Web site and provides to any individual who 
requests it, states that R's AGB percentages are 35% of gross charges 
for inpatient care and 61% of gross charges for outpatient care. It also 
states that these percentages were based on all claims allowed for R's 
emergency or other medically necessary inpatient and outpatient care by 
Medicare over a specified 12-month period, divided by the associated 
gross charges for those claims. R's FAP satisfies the requirements of 
this paragraph (b)(2).

    (3) Method for applying for financial assistance--(i) In general. To 
satisfy paragraph (b)(1)(iii)(C) of this section, a hospital facility's 
FAP must describe how an individual applies for financial assistance 
under the FAP. In addition, either the hospital facility's FAP or FAP 
application form (including accompanying instructions) must describe the 
information and documentation the hospital facility may require an 
individual to provide as part of his or her FAP application and provide 
the contact information described in Sec.  1.501(r)-1(b)(24)(v). A 
hospital facility may not deny financial assistance under its FAP based 
on an applicant's failure to provide information or documentation unless 
that information or documentation is described in the FAP or FAP 
application form. However, a hospital facility may grant financial 
assistance under its FAP notwithstanding an applicant's failure to 
provide information or documentation described in the FAP or FAP 
application form and may, for example, rely on other evidence of 
eligibility or an attestation by the applicant to determine that the 
applicant is FAP-eligible.
    (ii) Example. The following example illustrates this paragraph 
(b)(3):

    Example. S is a hospital facility with a FAP that bases eligibility 
solely on an individual's household income. S's FAP provides that an 
individual may apply for financial assistance by completing and 
submitting S's FAP application form. S's FAP also describes how 
individuals can obtain copies of the FAP application form. S's FAP 
application form contains lines on which the applicant lists all items 
of household income received by the applicant's household over the last 
month and the names of the applicant's household members. The 
instructions to S's FAP application form tell applicants where to submit 
the application and provide that an applicant must attach to his or her 
FAP application form proof of household income in the form of payroll 
check stubs from the last month or, if last month's wages are not 
representative of the applicant's annual income, a copy of the 
applicant's most recent federal tax return. Alternatively, the 
instructions state that an applicant may provide documentation of his or 
her qualification for certain specified state means-tested programs. The 
instructions also state that if an applicant does not have any of the 
listed documents proving household income, he or she may call S's 
financial assistance office and discuss other evidence that may be 
provided to demonstrate eligibility. S does not deny financial 
assistance to FAP applicants based on a failure to submit any 
information or documentation not mentioned in the FAP application form 
or instructions. S's FAP application form instructions also provide the 
contact information of the hospital facility office that can provide an 
applicant with information about the FAP and assistance with the FAP 
application process. S's FAP satisfies the requirements of this 
paragraph (b)(3).

    (4) Actions that may be taken in the event of nonpayment--(i) In 
general. To satisfy paragraph (b)(1)(iii)(D) of this section, either a 
hospital facility's FAP or a separate written billing and collections 
policy established for the hospital facility must describe--
    (A) Any actions that the hospital facility (or other authorized 
party) may take related to obtaining payment of a bill for medical care, 
including, but not

[[Page 70]]

limited to, any extraordinary collection actions (ECAs) described in 
Sec.  1.501(r)-6(b);
    (B) The process and time frames the hospital facility (or other 
authorized party) uses in taking the actions described in paragraph 
(b)(4)(i)(A) of this section, including, but not limited to, the 
reasonable efforts it will make to determine whether an individual is 
FAP-eligible before engaging in any ECAs, as described in Sec.  
1.501(r)-6(c); and
    (C) The office, department, committee, or other body with the final 
authority or responsibility for determining that the hospital facility 
has made reasonable efforts to determine whether an individual is FAP-
eligible and may therefore engage in ECAs against the individual.
    (ii) Separate billing and collections policy. In the case of a 
hospital facility that satisfies paragraph (b)(1)(iii)(D) of this 
section by establishing a separate written billing and collections 
policy, the hospital facility's FAP must state that the actions the 
hospital facility may take in the event of nonpayment are described in a 
separate billing and collections policy and explain how members of the 
public may readily obtain a free copy of this separate policy.
    (5) Widely publicizing the FAP--(i) In general. To satisfy the 
requirement in paragraph (b)(1)(ii) of this section to widely publicize 
its FAP, a hospital facility must--
    (A) Make the FAP, FAP application form, and plain language summary 
of the FAP (as defined in Sec.  1.501(r)-1(b)(24)) widely available on a 
Web site (as defined in Sec.  1.501(r)-1(b)(29));
    (B) Make paper copies of the FAP, FAP application form, and plain 
language summary of the FAP available upon request and without charge, 
both by mail and in public locations in the hospital facility, 
including, at a minimum, in the emergency room (if any) and admissions 
areas;
    (C) Notify and inform members of the community served by the 
hospital facility about the FAP in a manner reasonably calculated to 
reach those members who are most likely to require financial assistance 
from the hospital facility; and
    (D) Notify and inform individuals who receive care from the hospital 
facility about the FAP by--
    (1) Offering a paper copy of the plain language summary of the FAP 
to patients as part of the intake or discharge process;
    (2) Including a conspicuous written notice on billing statements 
that notifies and informs recipients about the availability of financial 
assistance under the hospital facility's FAP and includes the telephone 
number of the hospital facility office or department that can provide 
information about the FAP and FAP application process and the direct Web 
site address (or URL) where copies of the FAP, FAP application form, and 
plain language summary of the FAP may be obtained; and
    (3) Setting up conspicuous public displays (or other measures 
reasonably calculated to attract patients' attention) that notify and 
inform patients about the FAP in public locations in the hospital 
facility, including, at a minimum, the emergency room (if any) and 
admissions areas.
    (ii) Accessibility to limited English proficient individuals. To 
widely publicize its FAP, a hospital facility must accommodate all 
significant populations that have limited English proficiency (LEP) by 
translating its FAP, FAP application form, and plain language summary of 
the FAP into the primary language(s) spoken by such populations. A 
hospital facility will satisfy this translation requirement in a taxable 
year if it makes available translations of its FAP, FAP application 
form, and plain language summary of the FAP in the language spoken by 
each LEP language group that constitutes the lesser of 1,000 individuals 
or 5 percent of the community served by the hospital facility or the 
population likely to be affected or encountered by the hospital 
facility. For purposes of this paragraph (b)(5)(ii), a hospital facility 
may determine the percentage or number of LEP individuals in the 
hospital facility's community or likely to be affected or encountered by 
the hospital facility using any reasonable method.
    (iii) Meaning of notify and inform. For purposes of paragraphs 
(b)(5)(i)(C) and (b)(5)(i)(D)(3) of this section, a measure

[[Page 71]]

will notify and inform members of a community or patients about the 
hospital facility's FAP if the measure, at a minimum, notifies the 
reader or listener that the hospital facility offers financial 
assistance under a FAP and informs him or her about how or where to 
obtain more information about the FAP and FAP application process and to 
obtain copies of the FAP, FAP application form, and plain language 
summary of the FAP.
    (iv) Meaning of reasonably calculated. Whether one or more measures 
to widely publicize a hospital facility's FAP are reasonably calculated 
to notify and inform members of a community or patients about the 
hospital facility's FAP in the manner described in paragraphs 
(b)(5)(i)(C) and (b)(5)(i)(D)(3) of this section will depend on all of 
the facts and circumstances, including the primary language(s) spoken by 
the members of the community served by the hospital facility and other 
attributes of the community and the hospital facility.
    (v) Examples. The following examples illustrate this paragraph 
(b)(5):

    Example 1. (i) Z is a hospital facility. The home page and main 
billing page of Z's Web site conspicuously display the following 
message: ``Need help paying your bill? You may be eligible for financial 
assistance. Click here for more information.'' When readers click on the 
link, they are taken to a Web page that explains the various discounts 
available under Z's FAP and the specific eligibility criteria for each 
such discount. This Web page also provides all of the other information 
required to be included in a plain language summary of the FAP (as 
defined in Sec.  1.501(r)-1(b)(24)), including a telephone number of Z 
that individuals can call and a room number of Z that individuals can 
visit for more information about the FAP and assistance with FAP 
applications. In addition, the Web page contains prominently-displayed 
links that allow readers to download PDF files of the FAP and the FAP 
application form, free of charge and without being required to create an 
account or provide personally identifiable information. Z provides any 
individual who asks how to access a copy of the FAP, FAP application 
form, or plain language summary of the FAP online with the URL of this 
Web page. By implementing these measures, Z has made its FAP widely 
available on a Web site within the meaning of paragraph (b)(5)(i)(A) of 
this section.
    (ii) Z distributes copies of the plain language summary of its FAP 
and its FAP application form to all of its referring staff physicians 
and to the community health centers serving its community. Z also 
distributes copies of these documents to the local health department and 
to numerous public agencies and nonprofit organizations in its community 
that address the health issues and other needs of low-income 
populations, in quantities sufficient to meet demand. In addition, every 
issue of the quarterly newsletter that Z mails to the individuals in its 
customer database contains a prominently-displayed advertisement 
informing readers that Z offers financial assistance and that people 
having trouble paying their hospital bills may be eligible for financial 
assistance. The advertisement provides readers with the URL of the Web 
page where Z's FAP and FAP application form can be accessed and a 
telephone number of Z that individuals can call and a room number of Z 
that individuals can visit with questions about the FAP or assistance 
with the FAP application process. By implementing these measures, Z 
notifies and informs members of its community about the FAP within the 
meaning of paragraph (b)(5)(i)(C) of this section.
    (iii) Z makes paper copies of the FAP, FAP application form, and 
plain language summary of the FAP available upon request and without 
charge, both by mail and in its admissions areas and emergency room. Z 
also conspicuously displays a sign in large font regarding the FAP in 
its admissions areas and emergency room. The sign says: ``Uninsured? 
Having trouble paying your hospital bill? You may be eligible for 
financial assistance.'' The sign also provides the URL of the Web page 
where Z's FAP and FAP application form can be accessed. In addition, the 
sign provides a telephone number of Z that individuals can call and a 
room number of Z that individuals can visit with questions about the FAP 
or assistance with the FAP application process. Underneath each sign, Z 
conspicuously displays copies of a brochure that contains all of the 
information required to be included in a plain language summary of the 
FAP (as defined in Sec.  1.501(r)-1(b)(24)). Z makes these brochures 
available in quantities sufficient to meet visitor demand. Z also offers 
a plain language summary of the FAP as part of its intake process. Z's 
billing statements include a conspicuously-placed statement in large 
font containing the same information that Z includes on its signs. By 
implementing these measures, Z makes a paper copy of the FAP, FAP 
application form, and plain language summary of the FAP available upon 
request within the meaning of paragraph (b)(5)(i)(B) of this section and 
notifies and informs individuals who receive care from the hospital 
facility about the FAP within the meaning of paragraph (b)(5)(i)(D) of 
this section.
    (iv) Because Z takes measures to widely publicize the FAP described 
in paragraphs (b)(5)(i)(A), (b)(5)(i)(B), (b)(5)(i)(C), and

[[Page 72]]

(b)(5)(i)(D) of this section, Z meets the requirement to widely 
publicize its FAP under paragraph (b)(1)(ii) of this section.

    Example 2. Assume the same facts as Example 1, except that Z serves 
a community in which 6% of the members speak Spanish and have limited 
proficiency in English. Z translates its FAP, FAP application form, and 
FAP brochure (which constitutes a plain language summary of the FAP) 
into Spanish, and displays and distributes both Spanish and English 
versions of these documents in its hospital facility using all of the 
measures described in Example 1. Z also distributes Spanish versions of 
its FAP application form and FAP brochure to organizations serving 
Spanish-speaking members of its community. Moreover, the home page and 
main billing page of Z's Web site conspicuously display an 
``[iquest]Habla Espa[ntilde]ol?'' link that takes readers to a Web page 
that summarizes the FAP in Spanish and contains links that allow readers 
to download PDF files of the Spanish versions of the FAP and FAP 
application form, free of charge and without being required to create an 
account or provide personally identifiable information. Z meets the 
requirement to widely publicize its FAP under paragraph (b)(1)(ii) of 
this section.

    (6) Readily obtainable information. For purposes of paragraphs 
(b)(2)(i)(C) and (b)(4)(ii) of this section, information is readily 
obtainable by members of the public if a hospital facility--
    (i) Makes the information available free of charge on a Web site and 
via a paper copy upon request in a manner similar to that described in 
paragraphs (b)(5)(i)(A) and (b)(5)(i)(B) of this section; and
    (ii) Provides translations of the information as described in 
paragraph (b)(5)(ii) of this section.
    (7) Providing documents electronically. A hospital facility may 
provide electronically (for example, on an electronic screen, by email, 
or by providing the direct Web site address, or URL, of the Web page 
where the document or information is posted) any document or information 
that is required by this paragraph (b) to be provided in the form of a 
paper copy to any individual who indicates he or she prefers to receive 
or access the document or information electronically.
    (8) Medically necessary care. For purposes of meeting the 
requirements of this section, a hospital facility may (but is not 
required to) use a definition of medically necessary care applicable 
under the laws of the state in which it is licensed, including the 
Medicaid definition, or a definition that refers to the generally 
accepted standards of medicine in the community or to an examining 
physician's determination.
    (c) Emergency medical care policy--(1) In general. To satisfy 
paragraph (a)(2) of this section, a hospital organization must establish 
a written policy for a hospital facility that requires the hospital 
facility to provide, without discrimination, care for emergency medical 
conditions to individuals regardless of whether they are FAP-eligible.
    (2) Interference with provision of emergency medical care. A 
hospital facility's emergency medical care policy will not be described 
in paragraph (c)(1) of this section unless it prohibits the hospital 
facility from engaging in actions that discourage individuals from 
seeking emergency medical care, such as by demanding that emergency 
department patients pay before receiving treatment for emergency medical 
conditions or by permitting debt collection activities that interfere 
with the provision, without discrimination, of emergency medical care.
    (3) Relation to federal law governing emergency medical care. 
Subject to paragraph (c)(2) of this section, a hospital facility's 
emergency medical care policy will be described in paragraph (c)(1) of 
this section if it requires the hospital facility to provide the care 
for emergency medical conditions that the hospital facility is required 
to provide under Subchapter G of Chapter IV of Title 42 of the Code of 
Federal Regulations (or any successor regulations).
    (4) Examples. The following examples illustrate this paragraph (c):

    Example 1. F is a hospital facility with a dedicated emergency 
department that is subject to the Emergency Medical Treatment and Labor 
Act (EMTALA) and is not a critical access hospital. F establishes a 
written emergency medical care policy requiring F to comply with EMTALA 
by providing medical screening examinations and stabilizing treatment 
and referring or transferring an individual to another facility, when 
appropriate, and providing emergency services in accordance with 42 CFR 
482.55 (or any successor regulation). F's emergency medical care policy 
also states that F prohibits any actions that would discourage 
individuals from seeking emergency medical care, such as by demanding 
that emergency department patients pay before receiving treatment for

[[Page 73]]

emergency medical conditions or permitting debt collection activities 
that interfere with the provision, without discrimination, of emergency 
medical care. F's emergency medical care policy is described in 
paragraph (c)(1) of this section.

    Example 2. G is a rehabilitation hospital facility. G does not have 
a dedicated emergency department, nor does it have specialized 
capabilities that would make it appropriate to accept transfers of 
individuals who need stabilizing treatment for an emergency medical 
condition. G establishes a written emergency medical care policy that 
addresses how it appraises emergencies, provides initial treatment, and 
refers or transfers an individual to another facility, when appropriate, 
in a manner that complies with 42 CFR 482.12(f)(2) (or any successor 
regulation). G's emergency medical care policy also prohibits G from 
engaging in actions that discourage individuals from seeking emergency 
medical care, such as by demanding that patients pay before receiving 
initial treatment for emergency medical conditions or permitting debt 
collection activities that interfere with the facility's appraisal and 
provision, without discrimination, of such initial treatment. G's 
emergency medical care policy is described in paragraph (c)(1) of this 
section.

    (d) Establishing the FAP and other policies--(1) In general. A 
hospital organization has established a FAP, a billing and collections 
policy, or an emergency medical care policy for a hospital facility only 
if an authorized body of the hospital facility (as defined in Sec.  
1.501(r)-1(b)(4)) has adopted the policy for the hospital facility and 
the hospital facility has implemented the policy.
    (2) Implementing a policy. For purposes of this paragraph (d), a 
hospital facility will be considered to have implemented a policy if the 
hospital facility has consistently carried out the policy.
    (3) Establishing a policy for more than one hospital facility. A 
hospital organization may establish a FAP, billing and collections 
policy, and/or emergency medical care policy for a hospital facility 
that is identical to that of other hospital facilities or a joint policy 
that is shared with multiple hospital facilities provided that any joint 
policy clearly identifies each facility to which it applies. However, 
hospital facilities that have different AGB percentages or use different 
methods to determine AGB must include in their FAPs (or, in the case of 
information related to AGB percentages, otherwise make readily 
obtainable) different information regarding AGB to meet the requirements 
of paragraph (b)(2)(i)(C) of this section.

[T.D. 9708, 79 FR 78998, Dec. 31, 2014]



Sec.  1.501(r)-5  Limitation on charges.

    (a) In general. A hospital organization meets the requirements of 
section 501(r)(5) with respect to a hospital facility it operates only 
if the hospital facility (and any substantially-related entity, as 
defined in Sec.  1.501(r)-1(b)(28)) limits the amount charged for care 
it provides to any individual who is eligible for assistance under its 
financial assistance policy (FAP) to--
    (1) In the case of emergency or other medically necessary care, not 
more than the amounts generally billed to individuals who have insurance 
covering such care (AGB), as determined under paragraph (b) of this 
section; and
    (2) In the case of all other medical care covered under the FAP, 
less than the gross charges for such care, as described in paragraph (c) 
of this section.
    (b) Amounts generally billed--(1) In general. For purposes of 
meeting the requirements of paragraph (a)(1) of this section, a hospital 
facility must determine AGB for emergency or other medically necessary 
care using a method described in paragraph (b)(3) or (b)(4) of this 
section or any other method specified in regulations or other guidance 
published in the Internal Revenue Bulletin. A hospital facility may use 
only one of these methods to determine AGB at any one time, but 
different hospital facilities operated by the same hospital organization 
may use different methods. A hospital facility may change the method it 
uses to determine AGB at any time.
    (2) Meaning of charged. For purposes of paragraph (a)(1) of this 
section, a FAP-eligible individual is considered to be ``charged'' only 
the amount he or she is personally responsible for paying, after all 
deductions, discounts (including discounts available under the FAP), and 
insurance reimbursements have been applied. Thus, in the case of a FAP-
eligible individual who has health insurance coverage, a hospital 
facility will meet the requirements of paragraph (a)(1) of this section 
if the

[[Page 74]]

FAP-eligible individual is not personally responsible for paying (for 
example, in the form of co-payments, co-insurance, and deductibles) more 
than AGB for the care after all reimbursements by the health insurer 
have been applied, even if the total amount paid by the FAP-eligible 
individual and his or her health insurer together exceeds AGB.
    (3) Look-back method--(i) In general. A hospital facility may 
determine AGB for any emergency or other medically necessary care it 
provides to a FAP-eligible individual by multiplying the hospital 
facility's gross charges for the care by one or more percentages of 
gross charges (AGB percentage(s)). A hospital facility using this method 
must calculate its AGB percentage(s) at least annually by dividing the 
sum of the amounts of all of its claims for emergency and other 
medically necessary care that have been allowed by health insurers 
described in paragraph (b)(3)(ii) of this section during a prior 12-
month period by the sum of the associated gross charges for those 
claims. Whether a claim is used in calculating a hospital facility's AGB 
percentage(s) depends on whether the claim was allowed by a health 
insurer during the 12-month period used in the calculation, not on 
whether the care resulting in the claim was provided during that 12-
month period. If the amount a health insurer will allow for a claim has 
not been finally determined as of the last day of the 12-month period 
used to calculate the AGB percentage(s), a hospital facility should 
exclude the amount of the claim from that calculation and include it in 
the subsequent 12-month period during which the amount allowed is 
finally determined. When including allowed claims in calculating its AGB 
percentage(s), the hospital facility should include the full amount that 
has been allowed by the health insurer, including both the amount the 
insurer will pay or reimburse and the amount (if any) the individual is 
personally responsible for paying in the form of co-payments, co-
insurance, and deductibles, regardless of whether or when the full 
amount allowed is actually paid and disregarding any discounts applied 
to the individual's portion.
    (ii) Health insurers used in calculating AGB percentage(s). In 
calculating its AGB percentage(s), a hospital facility must include the 
claims allowed during a prior 12-month period by--
    (A) Medicare fee-for-service;
    (B) Medicare fee-for-service and all private health insurers that 
pay claims to the hospital facility; or
    (C) Medicaid, either alone or in combination with the insurer(s) 
described in paragraph (b)(3)(ii)(A) or (b)(3)(ii)(B) of this section.
    (iii) One or multiple AGB percentages. A hospital facility's AGB 
percentage that is calculated using the method described in this 
paragraph (b)(3) may be one average percentage of gross charges for all 
emergency and other medically necessary care provided by the hospital 
facility. Alternatively, a hospital facility may calculate multiple AGB 
percentages for separate categories of care (such as inpatient and 
outpatient care or care provided by different departments) or for 
separate items or services, as long as the hospital facility calculates 
AGB percentages for all emergency and other medically necessary care 
provided by the hospital facility.
    (iv) Start date for applying AGB percentages. For purposes of 
determining AGB under this paragraph (b)(3), with respect to any AGB 
percentage that a hospital facility has calculated, the hospital 
facility must begin applying the AGB percentage by the 120th day after 
the end of the 12-month period the hospital facility used in calculating 
the AGB percentage.
    (v) Use of all claims for medical care. A hospital facility 
determining AGB under this paragraph (b)(3) may use claims allowed for 
all medical care during a prior 12-month period rather than just those 
allowed for emergency and other medically necessary care.
    (vi) Determining AGB percentages for more than one hospital 
facility. Although generally a hospital organization must calculate AGB 
percentage(s) separately for each hospital facility it operates, 
hospital facilities that are covered under the same Medicare provider 
agreement (as defined in 42 CFR 489.3

[[Page 75]]

or any successor regulations) may calculate one AGB percentage (or 
multiple AGB percentages for separate categories of care or for separate 
items or services) using the method described in this paragraph (b)(3) 
based on the claims and gross charges for all such hospital facilities 
and implement the AGB percentage(s) across all such hospital facilities.
    (4) Prospective Medicare or Medicaid method. A hospital facility may 
determine AGB for any emergency or other medically necessary care 
provided to a FAP-eligible individual by using the billing and coding 
process the hospital facility would use if the FAP-eligible individual 
were a Medicare fee-for-service or Medicaid beneficiary and setting AGB 
for the care at the amount the hospital facility determines would be the 
total amount Medicare or Medicaid would allow for the care (including 
both the amount that would be reimbursed by Medicare or Medicaid and the 
amount the beneficiary would be personally responsible for paying in the 
form of co-payments, co-insurance, and deductibles). A hospital facility 
using the method described in this paragraph (b)(4) may base AGB on 
Medicare fee-for-service or Medicaid or both, provided that, if it uses 
both, its FAP describes the circumstance under which it will use 
Medicare fee-for-service or Medicaid in determining AGB.
    (5) Examples. The following examples illustrate this paragraph (b):

    Example 1. On March 15 of Year 1, Y, a hospital facility, generates 
data on the amount of all of Y's claims for emergency and other 
medically necessary care that were allowed by all private health 
insurers and Medicare fee-for-service over the immediately preceding 
calendar year. Y determines that the private health insurers allowed a 
total amount of $250 million and Medicare fee-for-service allowed a 
total amount of $150 million, with the total allowed amounts including 
both the portion the insurers agreed to reimburse and the portion that 
the insured patients were personally responsible for paying. Y's gross 
charges for these claims totaled $800 million. Y calculates that its AGB 
percentage is 50% of gross charges ($400 million/$800 million). Y 
updates its FAP to reflect the new AGB percentage of 50% and makes the 
updated FAP widely available (both on its Web site and via paper copies 
upon request) on April 1 of Year 1. Between April 1 of Year 1 (less than 
120 days after the end of the preceding calendar year) and March 31 of 
Year 2, Y determines AGB for any emergency or other medically necessary 
care it provides to a FAP-eligible individual by multiplying the gross 
charges for the care provided to the individual by 50%. Y has determined 
AGB between April 1 of Year 1 and March 31 of Year 2 in accordance with 
this paragraph (b) by using the look-back method described in paragraph 
(b)(3) of this section.
    Example 2. On August 20 of Year 1, X, a hospital facility, generates 
data on the amount of all of X's claims for emergency and other 
medically necessary care that were allowed by Medicare fee-for-service 
over the 12 months ending on July 31 of Year 1. X determines that, of 
these claims for inpatient services, Medicare allowed a total amount of 
$100 million (including both the portion Medicare agreed to reimburse 
and the portion Medicare beneficiaries were personally responsible for 
paying). X's gross charges for these inpatient claims totaled $250 
million. Of the claims for outpatient services, Medicare allowed a total 
amount of $125 million. X's gross charges for these outpatient claims 
totaled $200 million. X calculates that its AGB percentage for inpatient 
services is 40% of gross charges ($100 million/$250 million) and its AGB 
percentage for outpatient services is 62.5% of gross charges ($125 
million/$200 million). Y discloses its AGB percentages and describes how 
they were calculated on the Web page where its FAP can be accessed, and 
it updates this Web page to reflect the new AGB percentages on November 
1. Y also starts making an updated information sheet with the new AGB 
percentages available upon request on and after November 1. Between 
November 1 of Year 1 (less than 120 days after the end of the 12-month 
claim period) and October 31 of Year 2, X determines AGB for any 
emergency or other medically necessary inpatient care it provides to a 
FAP-eligible individual by multiplying the gross charges for the 
inpatient care it provides to the individual by 40% and AGB for any 
emergency or other medically necessary outpatient care it provides to a 
FAP-eligible individual by multiplying the gross charges for the 
outpatient care it provides to the individual by 62.5%. X has determined 
AGB between November 1 of Year 1 and October 31 of Year 2 in accordance 
with this paragraph (b) by using the look-back method described in 
paragraph (b)(3) of this section.
    Example 3. Whenever Z, a hospital facility, provides emergency or 
other medically necessary care to a FAP-eligible individual, Z 
determines the AGB for the care by using the billing and coding process 
it would use if the individual were a Medicare fee-for-service 
beneficiary and setting AGB for the care at the amount it determines 
Medicare and the Medicare beneficiary together would be

[[Page 76]]

expected to pay for the care. Z has determined AGB in accordance with 
this paragraph (b) by using the prospective Medicare method described in 
paragraph (b)(4) of this section.
    Example 4. Using the look-back method described in paragraph (b)(3) 
of this section, W, a hospital facility, calculates that its AGB 
percentage for Year 1 is 60% of gross charges. Under W's FAP, which 
applies to all emergency and other medically necessary care provided by 
W and which has been updated to reflect the AGB percentage for Year 1, 
the most that W charges a FAP-eligible individual is 50% of gross 
charges. W properly implements its FAP and charges no FAP-eligible 
individual more for emergency or other medically necessary care than 50% 
of gross charges in Year 1. W has met the requirements of paragraphs 
(a)(1) and (b) of this section in Year 1.
    Example 5. A, an individual, receives medically necessary care from 
hospital facility V for which the AGB is $3y. A is insured by U, a 
health insurer. Under U's contracts with V and A, the amount allowed for 
the care V provided to A is $5y. Of that amount allowed, A is personally 
responsible for paying $1y (in co-payments and deductibles) while U is 
responsible for paying $4y. Based on the eligibility criteria specified 
in its FAP, V determines that A is FAP-eligible. Pursuant to paragraph 
(b)(2) of this section, V may charge U and A collectively $5y while 
still meeting the requirements of paragraph (a)(1) of this section 
because the amount A is personally responsible for paying in co-payments 
and deductibles ($1y) is less than the AGB for the care ($3y).
    Example 6. Assume the same facts as Example 5, except that under U's 
contracts with V and A, A is personally responsible for paying $4y (in 
co-payments and deductibles) for the care while U is responsible for 
paying V $1y. Because A is FAP-eligible under V's FAP, paragraph (a)(1) 
of this section requires that A not be personally responsible for paying 
V more than $3y (the AGB for the care provided).

    (c) Gross charges. A hospital facility must charge a FAP-eligible 
individual less than the gross charges for any medical care covered 
under the hospital facility's FAP. A billing statement issued by a 
hospital facility to a FAP-eligible individual for medical care covered 
under the FAP may state the gross charges for such care and apply 
contractual allowances, discounts, or deductions to the gross charges, 
provided that the actual amount the individual is personally responsible 
for paying is less than the gross charges for such care.
    (d) Safe harbor for certain charges in excess of AGB. A hospital 
facility will be deemed to meet the requirements of paragraph (a) of 
this section, even if it charges more than AGB for emergency or other 
medically necessary care (or gross charges for any medical care covered 
under the FAP) provided to a FAP-eligible individual, if--
    (1) The charge in excess of AGB was not made or requested as a pre-
condition of providing medically necessary care to the FAP-eligible 
individual (for example, an upfront payment that a hospital facility 
requires before providing medically necessary care);
    (2) As of the time of the charge, the FAP-eligible individual has 
not submitted a complete FAP application to the hospital facility to 
obtain financial assistance for the care or has not otherwise been 
determined by the hospital facility to be FAP-eligible for the care; and
    (3) If the individual subsequently submits a complete FAP 
application and is determined to be FAP-eligible for the care, the 
hospital facility refunds any amount the individual has paid for the 
care (whether to the hospital facility or any other party to whom the 
hospital facility has referred or sold the individual's debt for the 
care) that exceeds the amount he or she is determined to be personally 
responsible for paying as a FAP-eligible individual, unless such excess 
amount is less than $5 (or such other amount set by notice or other 
guidance published in the Internal Revenue Bulletin).
    (e) Medically necessary care. For purposes of meeting the 
requirements of this section, a hospital facility may (but is not 
required to) use a definition of medically necessary care applicable 
under the laws of the state in which it is licensed, including the 
Medicaid definition, or a definition that refers to the generally 
accepted standards of medicine in the community or to an examining 
physician's determination.

[T.D. 9708, 79 FR 78998, Dec. 31, 2014]



Sec.  1.501(r)-6  Billing and collection.

    (a) In general. A hospital organization meets the requirements of 
section 501(r)(6) with respect to a hospital facility it operates only 
if the hospital

[[Page 77]]

facility does not engage in extraordinary collection actions (ECAs), as 
defined in paragraph (b) of this section, against an individual to 
obtain payment for care before the hospital facility has made reasonable 
efforts to determine whether the individual is eligible for assistance 
for the care under its financial assistance policy (FAP), as described 
in paragraph (c) of this section. For purposes of this section, with 
respect to any debt owed by an individual for care provided by a 
hospital facility--
    (1) ECAs against the individual include ECAs to obtain payment for 
the care against any other individual who has accepted or is required to 
accept responsibility for the individual's hospital bill for the care; 
and
    (2) The hospital facility will be deemed to have engaged in an ECA 
against the individual to obtain payment for the care, or to have taken 
one or more of the steps necessary to have made reasonable efforts to 
determine whether the individual is FAP-eligible for the care, if any 
purchaser of the individual's debt, any debt collection agency or other 
party to which the hospital facility has referred the individual's debt, 
or any substantially-related entity (as defined in Sec.  1.501(r)-
1(b)(28)) has engaged in such an ECA or taken such steps (whichever is 
applicable).
    (b) Extraordinary collection actions--(1) In general. Except as 
otherwise provided in this paragraph (b), the following actions taken by 
a hospital facility against an individual related to obtaining payment 
of a bill for care covered under the hospital facility's FAP are ECAs:
    (i) Selling an individual's debt to another party (other than debt 
sales described in paragraph (b)(2) of this section).
    (ii) Reporting adverse information about the individual to consumer 
credit reporting agencies or credit bureaus.
    (iii) Deferring or denying, or requiring a payment before providing, 
medically necessary care because of an individual's nonpayment of one or 
more bills for previously provided care covered under the hospital 
facility's FAP (which is considered an ECA to obtain payment for the 
previously provided care, not the care being potentially deferred or 
denied). If a hospital facility requires a payment before providing 
medically necessary care to an individual with one or more outstanding 
bills for previously provided care, such a requirement for payment will 
be presumed to be because of the individual's nonpayment of such bill(s) 
unless the hospital facility can demonstrate that it required the 
payment from the individual based on factors other than, and without 
regard to, the individual's nonpayment of past bills.
    (iv) Actions that require a legal or judicial process, including but 
not limited to--
    (A) Placing a lien on an individual's property (other than a lien 
described in paragraph (b)(3) of this section);
    (B) Foreclosing on an individual's real property;
    (C) Attaching or seizing an individual's bank account or any other 
personal property;
    (D) Commencing a civil action against an individual;
    (E) Causing an individual's arrest;
    (F) Causing an individual to be subject to a writ of body 
attachment; and
    (G) Garnishing an individual's wages.
    (2) Certain debt sales that are not ECAs. A hospital facility's sale 
of an individual's debt for care provided by the hospital facility will 
not be considered an ECA if, prior to the sale, the hospital facility 
has entered into a legally binding written agreement with the purchaser 
of the debt pursuant to which--
    (i) The purchaser is prohibited from engaging in any ECAs to obtain 
payment for the care;
    (ii) The purchaser is prohibited from charging interest on the debt 
in excess of the rate in effect under section 6621(a)(2) at the time the 
debt is sold (or such other interest rate set by notice or other 
guidance published in the Internal Revenue Bulletin);
    (iii) The debt is returnable to or recallable by the hospital 
facility upon a determination by the hospital facility or the purchaser 
that the individual is FAP-eligible; and
    (iv) If the individual is determined to be FAP-eligible and the debt 
is not returned to or recalled by the hospital facility, the purchaser 
is required to adhere to procedures specified in the

[[Page 78]]

agreement that ensure that the individual does not pay, and has no 
obligation to pay, the purchaser and the hospital facility together more 
than he or she is personally responsible for paying as a FAP-eligible 
individual.
    (3) Liens on certain judgments, settlements, or compromises. Any 
lien that a hospital facility is entitled to assert under state law on 
the proceeds of a judgment, settlement, or compromise owed to an 
individual (or his or her representative) as a result of personal 
injuries for which the hospital facility provided care is not an ECA.
    (4) Bankruptcy claims. The filing of a claim in any bankruptcy 
proceeding is not an ECA.
    (c) Reasonable efforts--(1) In general. A hospital facility will 
have made reasonable efforts to determine whether an individual is FAP-
eligible for care only if the hospital facility meets the requirements 
described in paragraph (c)(2) or (c)(3) of this section.
    (2) Presumptive FAP-eligibility determinations based on third-party 
information or prior FAP-eligibility determinations--(i) In general. 
With respect to any care provided by a hospital facility to an 
individual, the hospital facility will have made reasonable efforts to 
determine whether the individual is FAP-eligible for the care if it 
determines that the individual is FAP-eligible for the care based on 
information other than that provided by the individual or based on a 
prior FAP-eligibility determination and, if the individual is 
presumptively determined to be eligible for less than the most generous 
assistance available under the FAP, the hospital facility--
    (A) Notifies the individual regarding the basis for the presumptive 
FAP-eligibility determination and the way to apply for more generous 
assistance available under the FAP;
    (B) Gives the individual a reasonable period of time to apply for 
more generous assistance before initiating ECAs to obtain the discounted 
amount owed for the care; and
    (C) If the individual submits a complete FAP application seeking 
more generous assistance during the application period (as defined in 
Sec.  1.501(r)-1(b)(3)), determines whether the individual is eligible 
for a more generous discount and otherwise meets the requirements 
described in paragraph (c)(6) of this section with respect to that 
complete FAP application.
    (ii) Examples. The following examples illustrate this paragraph 
(c)(2):

    Example 1. V is a hospital facility with a FAP under which the 
specific assistance for which an individual is eligible depends 
exclusively upon that individual's household income. The most generous 
assistance offered for care under V's FAP is free care. V's FAP states 
that V uses enrollment in certain specified means-tested public programs 
to presumptively determine that individuals are FAP-eligible. D, an 
individual, receives care from V. Although D does not submit a FAP 
application to V, V learns that D is eligible for certain benefits under 
a state program that bases eligibility on household income. Based on 
this knowledge, V presumptively determines that D is eligible to receive 
free care under its FAP. V notifies D that it has determined he is 
eligible for free care based on his eligibility for the benefits under 
the state program and therefore does not owe V anything for the care he 
received. V has made reasonable efforts to determine whether D is FAP-
eligible under this paragraph (c)(2).
    Example 2. X is a hospital facility with a FAP that describes the 
data, including both hospital and publicly-available data, X uses to 
make presumptive FAP-eligibility determinations. On January 16, F, an 
individual, receives care from X. Using the hospital and publicly-
available data described in its FAP, X presumptively determines that F 
is eligible for a 50% discount under its FAP, a discount that is not the 
most generous discount available under the FAP. The first billing 
statement that X sends to F indicates that F has been given a 50% 
discount under X's FAP, explains the basis for this presumptive FAP-
eligibility determination, and informs F that she may apply for 
financial assistance if she believes she is eligible for a more generous 
discount. The billing statement indicates that F may call 1-800-888-xxxx 
or visit X's Web site at www.hospitalX.org/FAP to learn more about the 
FAP or the FAP application process. X sends F three more billing 
statements, each of which contains the standard written notice about the 
FAP that X includes on all of its billing statements in accordance with 
Sec.  1.501(r)-4(b)(5), but F neither pays the amount she is personally 
responsible for paying nor applies for more generous financial 
assistance. The time between the first and fourth billing statement 
constitutes a reasonable period of time for F to apply for more generous 
assistance. V has made reasonable efforts to determine whether D is FAP-
eligible under this paragraph (c)(2).


[[Page 79]]


    (3) Reasonable efforts based on notification and processing of 
applications. With respect to any care provided by a hospital facility 
to an individual, the hospital facility will have made reasonable 
efforts to determine whether the individual is FAP-eligible for the care 
if it--
    (i) Notifies the individual about the FAP as described in paragraph 
(c)(4) of this section before initiating any ECAs to obtain payment for 
the care and refrains from initiating such ECAs (with the exception of 
an ECA described in paragraph (b)(1)(iii) of this section) for at least 
120 days from the date the hospital facility provides the first post-
discharge billing statement for the care;
    (ii) In the case of an individual who submits an incomplete FAP 
application during the application period, notifies the individual about 
how to complete the FAP application and gives the individual a 
reasonable opportunity to do so as described in paragraph (c)(5) of this 
section; and
    (iii) In the case of an individual who submits a complete FAP 
application during the application period, determines whether the 
individual is FAP-eligible for the care and otherwise meets the 
requirements described in paragraph (c)(6) of this section.
    (4) Notification--(i) In general. With respect to any care provided 
by a hospital facility to an individual and except as provided in 
paragraph (c)(4)(iii) of this section, a hospital facility will have 
notified an individual about its FAP for purposes of paragraph (c)(3)(i) 
of this section only if the hospital facility does the following at 
least 30 days before first initiating one or more ECA(s) to obtain 
payment for the care:
    (A) Provides the individual with a written notice that indicates 
financial assistance is available for eligible individuals, that 
identifies the ECA(s) that the hospitality facility (or other authorized 
party) intends to initiate to obtain payment for the care, and that 
states a deadline after which such ECA(s) may be initiated that is no 
earlier than 30 days after the date that the written notice is provided.
    (B) Provides the individual with a plain language summary of the FAP 
(as defined in Sec.  1.501(r)-1(b)(24)) with the written notice 
described in paragraph (c)(4)(i)(A) of this section (or, if applicable, 
paragraph (c)(4)(iii) of this section).
    (C) Makes a reasonable effort to orally notify the individual about 
the hospital facility's FAP and about how the individual may obtain 
assistance with the FAP application process.
    (ii) Notification in the event of multiple episodes of care. A 
hospital facility may satisfy the notification requirements described in 
paragraph (c)(4)(i) of this section simultaneously for multiple episodes 
of care and notify the individual about the ECA(s) the hospital facility 
intends to initiate to obtain payment for multiple outstanding bills for 
care. However, if a hospital facility aggregates an individual's 
outstanding bills for multiple episodes of care before initiating one or 
more ECAs to obtain payment for those bills, it will have not have made 
reasonable efforts to determine whether the individual is FAP-eligible 
under paragraph (c)(3) of this section unless it refrains from 
initiating the ECA(s) until 120 days after it provided the first post-
discharge billing statement for the most recent episode of care included 
in the aggregation.
    (iii) Notification before deferring or denying care due to 
nonpayment for prior care. In the case of an ECA described in paragraph 
(b)(1)(iii) of this section, a hospital facility may notify the 
individual about its FAP less than 30 days before initiating the ECA, 
provided that the hospital facility does the following:
    (A) Otherwise meets the requirements of paragraph (c)(4)(i) of this 
section but, instead of the notice described in paragraph (c)(4)(i)(A) 
of this section, provides the individual with a FAP application form and 
a written notice indicating that financial assistance is available for 
eligible individuals and stating the deadline, if any, after which the 
hospital facility will no longer accept and process a FAP application 
submitted (or, if applicable, completed) by the individual for the 
previously provided care at issue. This deadline must be no earlier than 
the later of 30 days after the date that the written notice is provided 
or 240 days

[[Page 80]]

after the date that the first post-discharge billing statement for the 
previously provided care was provided.
    (B) If the individual submits a FAP application for the previously 
provided care on or before the deadline described in paragraph 
(c)(4)(iii)(A) of this section (or at any time, if the hospital facility 
didn't provide any such deadline to the individual), processes the FAP 
application on an expedited basis.
    (iv) Examples. The following example illustrates this paragraph 
(c)(4):

    Example 1. A, an individual, receives care from T, a hospital 
facility, in February. T provides A with the first post-discharge 
billing statement for that care on March 3. This and subsequent billing 
statements that T sends to A contain the standard written notice about 
the FAP that X includes on all of its billing statements in accordance 
with Sec.  1.501(r)-4(b)(5). A has not paid her bill or submitted a FAP 
application when T provides her with the third billing statement for the 
care, postmarked June 1. With this third billing statement, T includes a 
plain language summary of the FAP and a letter informing A that if she 
does not pay the amount owed or submit a FAP application by July 1, T 
intends to report A's delinquency to credit reporting agencies. T also 
calls A and informs her about the financial assistance available to 
eligible patients under T's FAP and about how to obtain assistance with 
the FAP application process. A does not pay her bill or submit a FAP 
application by July 1. T has made reasonable efforts to determine 
whether A is FAP-eligible, and thus may report A's delinquency to credit 
reporting agencies, as of July 2.
    Example 2. G, an individual, receives care from Y, a hospital 
facility, on May 25 of Year 1. Y also makes numerous attempts to 
encourage G to apply for financial assistance, including by calling G to 
inform her about the financial assistance available to eligible patients 
under Y's FAP and to offer assistance with the FAP application process. 
By June 24 of Year 2, Y, which had not previously initiated any ECAs 
against G to obtain payment for the care, notifies G in writing that if 
G does not pay or complete a FAP application by July 24 of Year 2, Y 
intends to file a lawsuit seeking a judgment for the amount G owes for 
the care and to seek court permission to enforce the judgment by either 
seizing G's bank account or garnishing G's wages. The written notice 
also includes a plain language summary of the FAP. G fails to pay or 
submit a FAP application by July 24 of Year 2. Y has made reasonable 
efforts to determine whether G is FAP-eligible, and may seek a judgment 
for the amount G owes and court permission to enforce the judgment by 
seizing G's bank account or garnishing G's wages, as of July 25 of Year 
2.

    (5) Incomplete FAP applications--(i) In general. With respect to any 
care provided by a hospital facility to an individual, if an individual 
submits an incomplete FAP application during the application period, the 
hospital facility will have notified the individual about how to 
complete the FAP application and given the individual a reasonable 
opportunity to do so for purposes of paragraph (c)(3)(ii) of this 
section only if the hospital facility--
    (A) Suspends any ECAs to obtain payment for the care as described in 
paragraph (c)(8) of this section; and
    (B) Provides the individual with a written notice that describes the 
additional information and/or documentation required under the FAP or 
FAP application form that must be submitted to complete the FAP 
application and that includes the contact information described in Sec.  
1.501(r)-1(b)(24)(v).
    (ii) FAP application completed. If an individual who has submitted 
an incomplete FAP application during the application period subsequently 
completes the FAP application during the application period (or, if 
later, within a reasonable timeframe given to respond to requests for 
additional information and/or documentation), the individual will be 
considered to have submitted a complete FAP application during the 
application period, and the hospital facility will have made reasonable 
efforts to determine whether the individual is FAP-eligible only if it 
meets the requirements for complete FAP applications described in 
paragraph (c)(6) of this section.
    (iii) Examples. The following examples illustrate this paragraph 
(c)(5):

    Example 1. (i) Assume the same facts as Example 1 in paragraph 
(c)(4)(iv) of this section and the following additional facts: A submits 
an incomplete FAP application to T on July 15, which is before the last 
day of the application period on October 29 but after T has already 
initiated ECAs. Eligibility for assistance under T's FAP is based solely 
on an individual's family income and the instructions to T's FAP 
application form require applicants to attach to their application forms 
certain documentation verifying family income. The FAP application form 
that A

[[Page 81]]

submits to T on July 15 includes all of the required income information, 
but A fails to attach the required documentation verifying her family 
income. On July 22, a member of T's staff calls A to inform her that she 
failed to attach any of the required documentation of her family income 
and explains what kind of documentation A needs to submit and how she 
can submit it. T indicates that the documentation should be provided by 
September 22. T also sends A a letter that describes the missing 
documentation that A must submit by September 22 (and how to submit it) 
and provides a telephone number A can call and room number she can visit 
to get assistance with the FAP application process. T does not initiate 
any new ECAs against A and does not take any further action on the ECAs 
T previously initiated against A between July 15 and September 22. A 
does not respond to T's letter and does not submit any missing 
documentation by September 22. T has made reasonable efforts to 
determine whether A is FAP-eligible, and may initiate or resume ECAs 
against A, as of September 23.
    (ii) On October 10, before the last day of the application period on 
October 29, A provides T with the missing documentation. Because A has 
submitted a complete FAP application during the application period, to 
meet the requirements of paragraph (a) of this section, T must process 
the FAP application documentation to determine whether A is FAP-eligible 
and otherwise meet the requirements for complete FAP applications 
described in paragraph (c)(6) of this section.
    Example 2. (i) B, an individual, receives care from U, a hospital 
facility, on January 10. U has established a FAP that provides 
assistance to all individuals whose household income is less than $y, 
and the instructions to U's FAP application form specify the 
documentation that applicants must provide to verify their household 
income. Shortly after receiving care, B submits a FAP application form 
to U indicating that he has household income of less than $y. B's FAP 
application form includes all of the required income information, but B 
fails to attach the required documentation verifying household income.
    (ii) On February 9, U sends B the first post-discharge billing 
statement for the care that contains the standard written notice about 
the FAP that U includes on all of its billing statements in accordance 
with Sec.  1.501(r)-4(b)(5). With this first post-discharge billing 
statement, U includes a letter informing B that the income information 
he provided on his FAP application form indicates that he may be 
eligible to pay only x% of the amount stated on the billing statement if 
he can provide documentation that verifies his household income. In 
addition, this letter describes the type of documentation (which is also 
described in the instructions to U's FAP application form) that B needs 
to provide to complete his FAP application and provides a telephone 
number that B may call and room number he may visit if he has questions 
or needs assistance with the FAP application process. By the time U is 
getting ready to send B a third billing statement for the care, B has 
not provided any response to U's request for the missing documentation. 
Accordingly, with the third billing statement postmarked May 10, U 
includes a plain language summary of the FAP plus a written notice 
informing B that U intends to report B's delinquency to credit reporting 
agencies if B does not submit the missing documentation or pay the 
amount due by June 9. U also calls B to inform B about the impending ECA 
and to see if he has questions about the missing documentation that U 
has requested. B does not provide any response to U's request for the 
missing documentation by June 9. U has made reasonable efforts to 
determine whether B is FAP-eligible, and thus may report B's delinquency 
to credit reporting agencies, as of June 10.

    (6) Complete FAP applications--(i) In general. With respect to any 
care provided by a hospital facility to an individual, if an individual 
submits a complete FAP application during the application period, the 
hospital facility will have made reasonable efforts to determine whether 
the individual is FAP-eligible for the care only if the hospital 
facility does the following in a timely manner:
    (A) Suspends any ECAs to obtain payment for the care as described in 
paragraph (c)(8) of this section.
    (B) Makes a determination as to whether the individual is FAP-
eligible for the care and notifies the individual in writing of this 
eligibility determination (including, if applicable, the assistance for 
which the individual is eligible) and the basis for this determination.
    (C) If the hospital facility determines the individual is FAP-
eligible for the care, does the following:
    (1) If the individual is determined to be eligible for assistance 
other than free care, provides the individual with a billing statement 
that indicates the amount the individual owes for the care as a FAP-
eligible individual and how that amount was determined and that states, 
or describes how the individual can get information regarding, the AGB 
for the care.
    (2) Refunds to the individual any amount he or she has paid for the 
care (whether to the hospital facility or any

[[Page 82]]

other party to whom the hospital facility has referred or sold the 
individual's debt for the care) that exceeds the amount he or she is 
determined to be personally responsible for paying as a FAP-eligible 
individual, unless such excess amount is less than $5 (or such other 
amount set by notice or other guidance published in the Internal Revenue 
Bulletin).
    (3) Takes all reasonably available measures to reverse any ECA (with 
the exception of a sale of debt and an ECA described in paragraph 
(b)(1)(iii) of this section) taken against the individual to obtain 
payment for the care. Such reasonably available measures generally 
include, but are not limited to, measures to vacate any judgment against 
the individual, lift any levy or lien (other than a lien described in 
paragraph (b)(3) of this section) on the individual's property, and 
remove from the individual's credit report any adverse information that 
was reported to a consumer reporting agency or credit bureau.
    (ii) Anti-abuse rule for complete FAP applications. A hospital 
facility will not have made reasonable efforts to determine whether an 
individual is FAP-eligible if the hospital facility bases its 
determination that the individual is not FAP-eligible on information 
that the hospital facility has reason to believe is unreliable or 
incorrect or on information obtained from the individual under duress or 
through the use of coercive practices. For purposes of this paragraph 
(c)(6)(ii), a coercive practice includes delaying or denying emergency 
medical care to an individual until the individual has provided 
information requested to determine whether the individual is FAP-
eligible for the care being delayed or denied.
    (iii) Determination based on complete FAP applications sufficient 
for reasonable efforts. A hospital facility will have made reasonable 
efforts to determine whether an individual is FAP-eligible with respect 
to any ECAs it initiates to obtain payment for care if, before 
initiating any such ECAs, it determines whether the individual is FAP-
eligible for the care based on a complete FAP application and otherwise 
meets the requirements described in this paragraph (c)(6). If these 
conditions are satisfied, the hospital facility will have made 
reasonable efforts to determine whether the individual is FAP-eligible 
for the care regardless of whether it has notified the individual as 
described in paragraph (c)(4) of this section or, if applicable, in 
paragraph (c)(5)(i)(B) of this section.
    (iv) Determining Medicaid eligibility. A hospital facility will not 
fail to have made reasonable efforts to determine whether an individual 
is FAP-eligible for care if, upon receiving a complete FAP application 
from an individual who the hospital facility believes may qualify for 
Medicaid, the hospital facility postpones determining whether the 
individual is FAP-eligible for the care until after the individual's 
Medicaid application has been completed and submitted and a 
determination as to the individual's Medicaid eligibility has been made.
    (v) Examples. The following examples illustrate this paragraph 
(c)(6):

    Example 1. C, an individual, receives care from W, a hospital 
facility, on September 1. W has established a FAP that provides 
assistance only to individuals whose family income is less than or equal 
to x% of the Federal Poverty Level (FPL), which, in the case of C's 
family size, is $y. Upon discharge, W's staff gives C a plain language 
summary of the FAP and informs C that if she needs assistance filling 
out a FAP application form, W has a social worker on staff who can 
assist her. C expresses interest in getting assistance with a FAP 
application while she is still on site and is directed to K, one of W's 
social workers. K explains the eligibility criteria in W's FAP to C, and 
C realizes that to determine her family income as a percentage of FPL 
she needs to look at her prior year's tax returns. On September 20, 
after returning home and obtaining the necessary information, C submits 
a FAP application to W that contains all of the information and 
documentation required in the FAP application form instructions. W's 
staff promptly examines C's FAP application and, based on the 
information and documentation therein, determines that C's family income 
is well in excess of $y. On October 1, W sends C her first post-
discharge billing statement for the care she received on September 1. 
With the billing statement, W includes a letter informing C that she is 
not eligible for financial assistance because her FAP application 
indicates that she has family income in excess of x% of FPL ($y for a 
family the size of C's family) and W only provides financial assistance 
to individuals with family income

[[Page 83]]

that is less than x% of FPL. W has made reasonable efforts to determine 
whether C is FAP-eligible as of October 1.
    Example 2. E, an individual, receives care from P, a hospital 
facility, from February 24 to 28. E pays a co-payment of $30 at 
discharge and is determined by her insurer to be personally responsible 
for paying another $550 in deductibles. P sends E several billing 
statements starting on March 20 indicating that E owes $550. By July 30, 
E has not paid the $550 or submitted a FAP application. On July 30, P 
notifies E in writing that if E does not pay or complete a FAP 
application by August 30, P intends to report B's delinquency to credit 
reporting agencies. The written notice also includes a plain language 
summary of the FAP. In addition, P calls E and informs her about the 
financial assistance available to eligible patients under P's FAP and 
about how to obtain assistance with the FAP application process. E fails 
to pay or submit a FAP application by August 30. P subsequently reports 
E's delinquency to credit reporting agencies. E then provides a complete 
FAP application to P on November 10, before the last day of the 
application period on November 15. P promptly examines the application 
and determines that E is eligible for free care under P's FAP. P 
contacts the credit reporting agencies to which it had reported E's 
delinquency and asks them to remove the adverse information from E's 
credit report. P also sends E a letter that informs her that she is 
eligible for free care under P's FAP and explains the basis for this 
eligibility determination and includes with this letter a check for $30 
(the co-payment E had paid). P has made reasonable efforts to determine 
whether E is FAP-eligible.
    Example 3. R, a hospital facility, has established a FAP that 
provides financial assistance only to individuals whose family income is 
less than or equal to x% of the Federal Poverty Level (FPL), based on 
their prior year's federal tax return. L, an individual, receives care 
from R. While L is being discharged from R, she is approached by M, an 
employee of a debt collection company that has a contract with R to 
handle all of R's patient billing. M asks L for her family income 
information, telling L that this information is needed to determine 
whether L is eligible for financial assistance. L tells M that she does 
not know what her family income is and would need to consult her tax 
returns to determine it. M tells L that she can just provide a ``rough 
estimate'' of her family income. L states that her family income may be 
around $y, an amount slightly above the amount that would allow her to 
qualify for financial assistance. M enters $y on the income line of a 
FAP application form with L's name on it and marks L as not FAP-
eligible. Based on M's information collection, R determines that L is 
not FAP-eligible and notifies L of this determination with her first 
billing statement. Because M had reason to believe that the income 
estimate provided by L was unreliable, R has violated the anti-abuse 
rule described in paragraph (c)(6)(ii) of this section. Thus, R has not 
made reasonable efforts to determine whether L is FAP-eligible.

    (7) When no FAP application is submitted. Unless and until an 
individual submits a FAP application during the application period, any 
paragraphs of this section that are conditioned on an individual's 
submitting a FAP application (namely, paragraphs (c)(2)(i)(C), 
(c)(3)(ii), and (c)(3)(iii) of this section) do not apply, and the 
hospital facility will have made reasonable efforts to determine whether 
the individual is FAP-eligible for care, and may initiate one or more 
ECAs to obtain payment for the care, once it has met the requirements of 
this section that are not contingent on an individual's submission of a 
FAP application. For example, unless and until a hospital facility 
receives a FAP application from an individual during the application 
period, the hospital facility has made reasonable efforts to determine 
whether the individual is FAP-eligible for care (and thus may initiate 
ECAs to obtain payment for the care) once it has notified the individual 
about the FAP as described in paragraph (c)(3)(i) of this section.
    (8) Suspending ECAs while a FAP application is pending. With respect 
to any care provided by a hospital facility to an individual, if an 
individual submits a FAP application during the application period, the 
hospital facility (or other authorized party) will have suspended ECAs 
for purposes of this paragraph (c) only if, after receiving the 
application, the hospital facility (or other authorized party) does not 
initiate, or take further action on any previously-initiated, ECAs (with 
the exception of an ECA described in paragraph (b)(1)(iii) of this 
section) to obtain payment for the care until either--
    (i) The hospital facility has determined whether the individual is 
FAP-eligible based on a complete FAP application and otherwise met the 
requirements of paragraph (c)(6) of this section; or
    (ii) In the case of an incomplete FAP application, the individual 
has failed to

[[Page 84]]

respond to requests for additional information and/or documentation 
within a reasonable period of time given to respond to such requests.
    (9) Waiver does not constitute reasonable efforts. For purposes of 
this paragraph (c), obtaining a signed waiver from an individual, such 
as a signed statement that the individual does not wish to apply for 
assistance under the FAP or receive the information described in 
paragraphs (c)(4) or (c)(5) of this section, will not itself constitute 
a determination that the individual is not FAP-eligible and will not 
satisfy the requirement to make reasonable efforts to determine whether 
the individual is FAP-eligible before engaging in ECAs against the 
individual.
    (10) Agreements with other parties. With the exception of sales 
described in paragraph (b)(2) of this section, if a hospital facility 
sells or refers an individual's debt related to care to another party, 
the hospital facility will have made reasonable efforts to determine 
whether the individual is FAP-eligible for the care only if it first 
enters into (and, to the extent applicable, enforces) a legally binding 
written agreement with the party that is reasonably designed to ensure 
that no ECAs are taken to obtain payment for the care until reasonable 
efforts have been made to determine whether the individual is FAP-
eligible for the care. At a minimum, such an agreement must provide the 
following:
    (i) If the individual submits a FAP application after the referral 
or sale of the debt but before the end of the application period, the 
party will suspend ECAs to obtain payment for the care as described in 
paragraph (c)(8) of this section.
    (ii) If the individual submits a FAP application after the referral 
or sale of the debt but before the end of the application period and is 
determined to be FAP-eligible for the care, the party will do the 
following in a timely manner:
    (A) Adhere to procedures specified in the agreement that ensure that 
the individual does not pay, and has no obligation to pay, the party and 
the hospital facility together more than he or she is required to pay 
for the care as a FAP-eligible individual.
    (B) If applicable and if the party (rather than the hospital 
facility) has the authority to do so, take all reasonably available 
measures to reverse any ECA (other than the sale of a debt or an ECA 
described in paragraph (b)(1)(iii) of this section) taken against the 
individual as described in paragraph (c)(6)(i)(C)(3) of this section.
    (iii) If the party refers or sells the debt to yet another party 
during the application period, the party will obtain a written agreement 
from that other party including all of the elements described in this 
paragraph (c)(10).
    (11) Clear and conspicuous placement. A hospital facility may print 
any written notice or communication described in this paragraph (c), 
including any plain language summary of the FAP, on a billing statement 
or along with other descriptive or explanatory matter, provided that the 
required information is conspicuously placed and of sufficient size to 
be clearly readable.
    (12) Providing documents electronically. A hospital facility may 
provide any written notice or communication described in this paragraph 
(c) electronically (for example, by email) to any individual who 
indicates he or she prefers to receive the written notice or 
communication electronically.

[T.D. 9708, 79 FR 78998, Dec. 31, 2014; 80 FR 12762, Mar. 11, 2015]



Sec.  1.501(r)-7  Effective/applicability dates.

    (a) Effective/applicability date. The rules of Sec. Sec.  1.501(r)-1 
through 1.501(r)-6 apply to taxable years beginning after December 29, 
2015.
    (b) Reasonable interpretation for taxable years beginning on or 
before December 29, 2015. For taxable years beginning on or before 
December 29, 2015, a hospital facility may rely on a reasonable, good 
faith interpretation of section 501(r). A hospital facility will be 
deemed to have operated in accordance with a reasonable, good faith 
interpretation of section 501(r) if it has complied with the provisions 
of the proposed or final regulations under section 501(r) (REG-130266-11 
and/or REG-106499-12). Accordingly, a hospital facility may rely on 
Sec.  1.501(r)-3 of the proposed or final regulations, or another

[[Page 85]]

reasonable interpretation of section 501(r)(3), for any CHNA conducted 
or implementation strategy adopted before the first day of the hospital 
organization's first taxable year beginning after December 29, 2015.

[T.D. 9708, 79 FR 78998, Dec. 31, 2014]



Sec.  1.502-1  Feeder organizations.

    (a) In the case of an organization operated for the primary purpose 
of carrying on a trade or business for profit, exemption is not allowed 
under section 501 on the ground that all the profits of such 
organization are payable to one or more organizations exempt from 
taxation under section 501. In determining the primary purpose of an 
organization, all the circumstances must be considered, including the 
size and extent of the trade or business and the size and extent of 
those activities of such organization which are specified in the 
applicable paragraph of section 501.
    (b) If a subsidiary organization of a tax-exempt organization would 
itself be exempt on the ground that its activities are an integral part 
of the exempt activities of the parent organization, its exemption will 
not be lost because, as a matter of accounting between the two 
organizations, the subsidiary derives a profit from its dealings with 
its parent organization, for example, a subsidiary organization which is 
operated for the sole purpose of furnishing electric power used by its 
parent organization, a tax-exempt educational organization, in carrying 
on its educational activities. However, the subsidiary organization is 
not exempt from tax if it is operated for the primary purpose of 
carrying on a trade or business which would be an unrelated trade or 
business (that is, unrelated to exempt activities) if regularly carried 
on by the parent organization. For example, if a subsidiary organization 
is operated primarily for the purpose of furnishing electric power to 
consumers other than its parent organization (and the parent's tax-
exempt subsidiary organizations), it is not exempt since such business 
would be an unrelated trade or business if regularly carried on by the 
parent organization. Similarly, if the organization is owned by several 
unrelated exempt organizations, and is operated for the purpose of 
furnishing electric power to each of them, it is not exempt since such 
business would be an unrelated trade or business if regularly carried on 
by any one of the tax-exempt organizations. For purposes of this 
paragraph, organizations are related only if they consist of:
    (1) A parent organization and one or more of its subsidiary 
organizations; or
    (2) Subsidiary organizations having a common parent organization


An exempt organization is not related to another exempt organization 
merely because they both engage in the same type of exempt activities.
    (c) In certain cases an organization which carries on a trade or 
business for profit but is not operated for the primary purpose of 
carrying on such trade or business is subject to the tax imposed under 
section 511 on its unrelated business taxable income.
    (d) Exception--(1) Taxable years beginning before January 1, 1970. 
For purposes of section 502 and this section, for taxable years 
beginning before January 1, 1970, the term trade or business does not 
include the rental by an organization of its real property (including 
personal property leased with the real property).
    (2) Taxable years beginning after December 31, 1969. For purposes of 
section 502 and this section, for taxable years beginning after December 
31, 1969, the term trade or business does not include:
    (i) The deriving of rents described in section 512(b)(3)(A),
    (ii) Any trade or business in which substantially all the work in 
carrying on such trade or business is performed for the organization 
without compensation, or
    (iii) Any trade or business (such as a thrift shop) which consists 
of the selling of merchandise, substantially all of which has been 
received by the organization as gifts or contributions


For purposes of the exception described in subdivision (i) of this 
subparagraph, if the rents derived by an organization would not be 
excluded from unrelated business income pursuant to section 512(b)(3) 
and the regulations thereunder, the deriving of such rents shall be 
considered a trade or business.

[[Page 86]]

    (3) Cross references and special rules. (i) For determination of 
when rents are excluded from the tax on unrelated business income see 
section 512(b)(3) and the regulations thereunder.
    (ii) The rules contained in Sec.  1.513-1(e)(1) shall apply in 
determining whether a trade or business is described in section 
502(b)(2) and subparagraph (2)(ii) of this paragraph.
    (iii) The rules contained in Sec.  1.513-1(e)(3) shall apply in 
determining whether a trade or business is described in section 
502(b)(3) and subparagraph (2)(iii) of this paragraph.

[T.D. 6500, 25 FR 11737, No. 26, 1960, as amended by T.D. 6662, 28 FR 
6973, July 29, 1963; T.D. 7033, 35 FR 19997, Dec. 31, 1970]



Sec.  1.503(a)-1  Denial of exemption to certain organizations engaged
in prohibited transactions.

    (a)(1) Prior to January 1, 1970, section 503 applies to those 
organizations described in sections 501(c)(3), 501(c)(17), and section 
401(a) except:
    (i) A religious organization (other than a trust);
    (ii) An educational organization which normally maintains a regular 
faculty and curriculum and normally has a regularly enrolled body of 
pupils or students in attendance at the place where its educational 
activities are regularly carried on;
    (iii) An organization which normally receives a substantial part of 
its support (exclusive or income received in the exercise or performance 
by such organization of its charitable, educational, or other purpose or 
function constituting the basis for its exemption under section 501(a)) 
from the United States or any State or political subdivision thereof or 
from direct of indirect contributions from the general public,
    (iv) An organization which is operated, supervised, controlled or 
principally supported by a religious organization (other than a trust) 
which is itself not subject to the provisions of this section; and
    (v) An organization the principal purposes or functions of which are 
the providing of medical or hospital care or medical education or 
medical research or agricultural research.
    (2) Effective January 1, 1907, and prior to January 1, 1975, section 
503 shall apply only to organizations described in section 501(c) (17) 
or (18) or section 401(a).
    (3) Effective January 1, 1975, section 503 shall apply only to 
organization described in section 501(c) (17) or (18) or described in 
section 401(a) and referred to in section 4975(g) (2) or (3).
    (b) The prohibited transactions enumerated in section 503(b) are in 
addition to and not in limitation of the restrictions contained in 
section 501(c) (3), (17), or (18) or section 401(a). Even though an 
organization has not engaged in any of the prohibited transactions 
referred to in section 503(b), it still may not qualify for tax 
exemptions in view of the general provisions of section 501(c) (3), 
(17), or (18) or section 401(a). Thus, if a trustee or other fiduciary 
of the organization (whether or not he is also a creater or such 
organization) enters into a transaction with the organization, such 
transaction will be closely scrutinized in the light of the fiduciary 
principle requiring undivided loyalty to ascertain whether the 
organization is in fact being operated for the stated exempt purpose.
    (c) An organization--
    (1) Described in section 501(c)(3) which after July 1, 1950, but 
before January 1, 1970, has engaged in any prohibited transaction as 
defined in section 503(b), unless it is excepted by the provisions of 
paragraph (a)(1) of this section;
    (2) Described in section 401(a) and referred to in section 4975(g) 
(2) or (3) which after March 1, 1954, has engaged in any prohibited 
transaction as defined in section 503(b);
    (3) Described in section 401(a) and not referred to in section 
4975(g) (2) or (3) which after March 1, 1954, but before January 1, 
1975, has engaged in any prohibited transaction as defined in section 
503(b) or which after December 31, 1962, but before January 1, 1975, has 
engaged in any prohibited transaction as defined in section 503(g) prior 
to its repeal by section 2003(b)(5) of the Employee Retirement Income 
Security Act of 1974 (88 Stat. 978);

[[Page 87]]

    (4) Described in section 501(c)(17) which after December 31, 1959, 
has engaged in any prohibited transaction as defined in section 503(b); 
or
    (5) Described in section 501(c)(18) which after December 31, 1969, 
has engaged in any prohibited transaction described in section 503(b)


Shall not be exempt from taxation under section 501(a) for any taxable 
year subsequent to the taxable year in which there is mailed to it a 
notice in writing by the Commissioner that it has engaged in such 
prohibited transactions. Such notification by the Commissioner shall be 
by registered or certified mail to the last known name and address of 
the organization. However, notwithstanding the requirement of 
notification by the Commissioner, the exemption shall be denied with 
respect to any taxable year if such organization during or prior to such 
taxable year commenced the prohibited transaction with the purpose of 
diverting income or corpus from its exempt purposes and such transaction 
involved a substantial party of the income or corpus of such 
organization. For the purpose of this section, the term taxable year 
means the established annual accounting period of the organization; or, 
if the organization has no such established annual accounting period, 
the taxable year of the organizations means a calendar year. See 26 CFR 
Sec.  1.503(j)-1 (rev. as of Apr. 1, 1974) for provisions relating to 
the definition of prohibited transactions in the case of trusts 
benefitting certain owner-employees after December 31, 1962, but prior 
to January 1, 1975. See also section 2003 (c)(1)(B) of the Employee 
Retirement Income Security Act of 1974 (88 Stat. 978) in the case of an 
organization described in section 401(a) with respect to which a 
disqualified person elects to pay a tax in the amount and manner 
provided with respect to the tax imposed by section 4975 of the Code so 
that the organization may avoid denial of exemption under section 503. 
For further guidance regarding the definition of last known address, see 
Sec.  301.6212-2 of this chapter.
    (d) The application of section 503(b) may be illustrated by the 
following examples:

    Example 1. A creates a foundation in 1954 ostensibly for educational 
purposes. B, a trustee, accumulates the foundation's income from 1957 
until 1959 and then uses a substantial part of this accumulated income 
to send A's children to college. The foundation would lose its exemption 
for the taxable years 1957 through 1959 and for subsequent taxable years 
until it regains its exempt status.
    Example 2. If under the facts in Example 1 such private benefit was 
the purpose of the foundation from its inception, such foundation is not 
exempt by reason of the general provisions of section 501(c)(3), without 
regard to the provisions of section 503, for all years since its 
inception, that is, for the taxable years 1954 through 1959 and 
subsequent taxable years, since under section 501(c)(3) the organization 
must be organized and operated exclusively for exempt purposes. See 
Sec.  1.501(c)(3)-1.

[T.D. 7428, 41 FR 34621, Aug. 16, 1976, as amended by T.D. 8939, 66 FR 
2819, Jan. 12, 2001]



Sec.  1.503(b)-1  Prohibited transactions.

    (a) In general. The term prohibited transaction means any 
transaction set forth in section 503(b) engaged in by any organization 
described in paragraph (a) of Sec.  1.503(a)-1. Whether a transaction is 
a prohibited transaction depends on the facts and circumstances of the 
particular case. This section is intended to deny tax-exempt status to 
such organizations which engage in certain transactions which inure to 
the private advantage of (1) the creator of such organization (if it is 
a trust); (2) any substantial contributor to such organization; (3) a 
member of the family (as defined in section 267(c)(4) of an individual 
who is such creator of or such substantial contributor to such 
organization; or (4) a corporation controlled, as set forth in section 
503(b), by such creator or substantial contributor.
    (b) Loans as prohibited transactions under section 503(b)(1)--(1) 
Adequate security. For the purposes of section 503(b)(1), which treats 
as prohibited transactions certain loans by an organization without 
receipt of adequate security and a reasonable rate of interest, the term 
adequate security means something in addition to and supporting a 
promise to pay, which is so pledged to the organization that it may be 
sold, foreclosed upon, or otherwise disposed of in default of repayment 
of

[[Page 88]]

the loan, the value and liquidity of which security is such that it may 
reasonably be anticipated that loss of principal or interest will not 
result from the loan. Mortgages or liens on property, accommodation 
endorsements of those financially capable of meeting the indebtedness, 
and stock or securities issued by corporations other than the borrower 
may constitute security for a loan to the persons or organizations 
described in section 503(b). Stock of a borrowing corporation does not 
constitute adequate security. A borrower's evidence of indebtedness, 
irrespective of its name, is not security for a loan, whether or not it 
was issued directly to the exempt organization. However, if any such 
evidence of indebtedness provides for security that may be sold, 
foreclosed upon, or otherwise disposed of in default of repayment of the 
loan, there may be adequate security for such loan. If an organization 
subject to section 503(b) purchases debentures issued by a person 
specified in section 503(b), the purchase is considered, for purposes of 
section 503(b)(1), as a loan made by the purchaser to the issuer on the 
date of such purchase. For example, if an exempt organization subject to 
section 503(b) makes a purchase through a registered security exchange 
of debentures issued by a person described in section 503(b), and owned 
by an unknown third party, the purchase will be considered as a loan to 
the issuer by the purchaser. For rules relating to loan of funds to, or 
investment of funds in stock or securities of, persons described in 
section 503(b) by an organization described in section 401(a), see 
paragraph (b)(5) of Sec.  1.401-1.
    (2) Effective dates. The effective dates for the application of the 
definition of adequate security in paragraph (b)(1) of this paragraph 
are:
    (i) March 15, 1956, for loans (other than debentures) made after 
March 15, 1956;
    (ii) January 31, 1957, for loans (other than debentures) made before 
March 16, 1956, and continued after January 31, 1957;
    (iii) November 8, 1956, for debentures which were purchased after 
November 8, 1956;
    (iv) December 1, 1958, for debentures which were purchased before 
November 9, 1956, and held after December 1, 1958;
    (v) If an employees' pension, stock bonus, or profit-sharing trust 
described in section 401(a) made a loan before March 1, 1954, repayable 
by its terms after December 31, 1955, and which would constitute a 
prohibited transaction if made on or after March 1, 1954, the loan shall 
not constitute a prohibited transaction if held until maturity 
(determined without regard to any extension or renewal thereof);
    (vi) January 1, 1960, for loans (including the purchase of 
debentures) made by supplemental unemployment benefit trusts, described 
in section 501 (c)(17);
    (vii) January 1, 1970, for loans (including the purchase of 
debentures) made by employees' contribution pension plan trusts 
described in section 501(c)(18).
    (3) Certain exceptions to section 503(b)(1). See section 503(e) and 
Sec.  1.503(e)-1, 1.503(e)-2, and 1.503(e)-3 for special rules providing 
that certain obligations acquired by trusts described in section 401(a) 
or section 501(c) (17) or (18) shall not be treated as loans made 
without the receipt of adequate security for purposes of section 
503(b)(1). See section 503(f) and Sec.  1.503(f)-1 for an exception to 
the application of sections 503(b)(1) for certain loans made by 
employees' trusts described in section 401(a).
    (c) Examples. The principles of this section are illustrated by the 
following examples: (Assume that section 503 (e) and (f) are not 
applicable.)

    Example 1. A, creator of an exempt trust subject to section 503, 
borrows $100,000 from such trust in 1960, giving his unsecured 
promissory note. The net worth of A is $1,000,000. The net worth of A is 
not security for such loan and the transaction is a prohibited 
transaction. If, however, the note is secured by a mortgage on property 
of sufficient value, or is accompanied by acceptable collateral of 
sufficient value, or carries with it the secondary promise of repayment 
by an accommodation endorser financially capable of meeting the 
indebtedness, it may be adequately secured. However, subordinated 
debentures bonds of a partnership which are guaranteed by the general 
partners are not adequately secured since the general partners are 
liable for the firm's debt and their guaranty adds no additional 
security.

[[Page 89]]

    Example 2. Assume the same facts as in example 1 except that A's 
promissory note in the amount of $100,000 to the trust is secured by 
property which has a fair market value of $75,000. A's promissory note 
secured to the extent of $75,000 is not adequately secured within the 
meaning of section 503(b)(1) since the security at the time of the 
transaction must be sufficient to repay the indebtedness, interest, and 
charges which may pertain thereto.
    Example 3. Corporation M, a substantial contributor to an exempt 
organization subject to section 503, borrows $150,000 from such 
organization in 1960, giving its promissory note accompanied by stock of 
the borrowing corporation with a fair market value of $200,000. Since 
promissory notes and debentures have priority over stock in the event of 
liquidation of the corporation, stock of a borrowing corporation is not 
adequate security. Likewise, debenture bonds which are convertible on 
default into voting stock of the issuing corporation do not constitute 
adequate security under section 503(b)(1).
    Example 4. B, creator of an exempt trust subject to section 503, 
borrows $100,000 from such trust in 1960, giving his secured promissory 
note at the rate of 3 percent interest. The prevailing rate of interest 
charged by financial institutions in the community where the transaction 
takes place is 5 percent for a loan of the same duration and similarly 
secured. The loan by the trust to the grantor is a prohibited 
transaction since section 503(b)(1) requires both adequate security and 
a reasonable rate of interest. Further, a promise to repay the loan plus 
a percentage of future profits which may be greater than the prevailing 
rate of interest does not meet the reasonable rate of interest 
requirement.
    Example 5. N Corporation, a substantial contributor to an exempt 
organization subject to section 503 borrows $50,000 on or after March 
16, 1956, from the organization. If the loan is not adequately secured, 
the organization has committed a prohibited transaction at the time the 
loan was made. If the loan had been made on or before March 15, 1956, 
and is continued after January 31, 1957, it must be adequately secured 
on February 1, 1957, or it will be considered a prohibited transaction 
on that date. However, if the exempt organization were an employees' 
trust, described in section 401(a), and the loan were made before March 
1, 1954, repayable by its terms after December 31, 1955, it would not 
have to be adequately secured on February 1, 1957. Moreover, if the 
exempt organization were a supplemental unemployment benefit trust, 
described in section 501(c)(17), and the loan were made before January 
1, 1960, repayable by its terms after December 31, 1959, it would not 
have to be adequately secured on January 1, 1960.
    Example 6. An exempt organization subject to section 503 purchases a 
debenture issued by O Corporation, which is a substantial contributor to 
the organization. The organization purchases the debenture in an arm's 
length transaction from a third person on or after November 9, 1956. The 
purchase is considered as a loan by the organization to O Corporation. 
The loan must be adequately secured when it is made, or it is considered 
as a prohibited transaction at that time. If the organization purchased 
the debenture before November 9, 1956, and holds it after December 1, 
1958, the debenture must be adequately secured on December 2, 1958, or 
it will then be considered as a prohibited transaction. However, if the 
organization were an employees' trust described in section 401(a), and 
if the debenture were purchased before March 1, 1954, and its maturity 
date is after December 31, 1955, the debenture does not have to be 
adequately secured. Moreover, if the organization were an employees' 
contribution pension plan trust described in section 501(c)(18), and if 
the debenture were purchased before January 1, 1970, and its maturity 
date is after December 31, 1969, the debenture does not have to be 
adequately secured.

[T.D. 7428, 41 FR 34621, Aug. 16, 1976]



Sec.  1.503(c)-1  Future status of organizations denied exemption.

    (a) Any organization described in section 501(c) (3), (17), or (18), 
or an employees' trust described in section 401(a), which is denied 
exemption under section 501(a) by reason of the provisions of section 
503(a), may file, in any taxable year following the taxable year in 
which notice of denial was issued, a claim for exemption. In the case of 
organizations described in section 501(c) (3), (17), or (18), the 
appropriate exemption application shall be used for this purpose, and 
shall be filed with the district director. In the case of an enmployees' 
trust described in section 401(a), the information described in Sec.  
1.404(a)-2 shall be submitted with a letter claiming exemption. All 
employees' trust described in section 401(a) shall submit this 
information to the district director with whom a request for a 
determination as to its qualification under section 401 and exemption 
under section 501 may be submitted under paragraph (s) of Sec.  601.201 
of this chapter (Statement of Procedural Rules). A claim for exemption 
must

[[Page 90]]

contain or have attached to it, in addition to the information generally 
required of such an organization claiming exemption as an organization 
described in section 501(c) (17), or (18), or section 401(a) (or section 
501(c)(3) prior to January 1, 1970), a written declaration made under 
the penalities of perjury by principal officer of such organization 
authorized to make such declaration that the organization will not 
knowingly again engage in a prohibited transaction, (as defined in 
section 503(b) (or 4975(c) if such section applies to such 
organization)). In the case of section 501(c)(3) organizations which 
have lost their exemption after December 31, 1969, pursuant to section 
503, a claim for exemption must contain or have attached to it a written 
agreement made under penalities of perjury by a principal officer of 
such organization authorized to make such agreement that the 
organization will not violate the provisions of chapter 42. In addition, 
such organization must comply with the rules for governing instruments 
as prescribed in Sec.  1.508-3. See Sec.  1.501(a)-1 for proof of 
exemption requirements in general.
    (b) If the Commissioner is satisfied that such organization will not 
knowingly again engage in a prohibited transaction (as defined under 
section 503(b) or 4975(c), as applicable to such organization) or in the 
case of a section 501(c)(3) organization, will not violate the 
provisions of chapter 42, and the organization also satisfied all the 
other requirements under section 501(c) (3), (17), or (18), or section 
401(a), the organization will be so notified in writing. In such case 
the organization will be exempt (subject to the provisions of section 
501(c)(3), or sections 501(c) (17), (18) or 401(a), and 503, and 504 
when applicable) with respect to the taxable years subsequent to the 
taxable year in which the claim described in section 503(c) is filed. 
Section 503 contemplates that an organization denied exemption because 
of the terms of such section will be subject to taxation for at least 
one full taxable year. For the purpose of this section, the term taxable 
year means the established annual accounting period of the organization; 
or, if the organization has no such established annual accounting 
period, the taxable year of the organization means the calendar year.
    (c) For taxable years beginning after December 31, 1969, the denial 
of an exemption pursuant to this section, for a taxable year prior to 
January 1, 1970, of an organization described in section 501(c)(3) shall 
not cause such organization to cease to be described in section 
501(c)(3) for purposes of part II of subchapter F, chapter 1 and for 
purposes of the application of chapter 42 taxes.
    (d) In the case of an organization described in section 501(c)(3), 
which has lost its exemption pursuant to section 503, and which has not 
notified the Commissioner that it is applying for recognition of its 
exempt status under section 508(a) and this section, no gift or 
contribution made after December 31, 1969, which would otherwise be 
deductible under section 170, 642(c), or 545(b)(2) shall be allowed as a 
deduction.

[T.D. 7428, 41 FR 34622, Aug. 16, 1976, as amended by T.D. 7896, 48 FR 
23817, May 27, 1983; T.D. 9849, 84 FR 9235, Mar. 14, 2019]



Sec.  1.503(d)-1  Cross references.

    For provisions relating to loans described in section 503(b)(1) by a 
trust described in section 401(a), see Sec.  1.503(b)-1 and section 503 
(e) and (f) and the regulations thereunder.

[T.D. 7428, 41 FR 34623, Aug. 16, 1976]



Sec.  1.503(e)-1  Special rules.

    (a) In general. (1) Section 503(e) provides that for purposes of 
section 503(b)(1) (relating to loans made without the receipt of 
adequate security and a reasonable rate of interest) the acquisition of 
a bond, debenture, note, or certificate or other evidence of 
indebtedness shall not be treated as a loan made without the receipt of 
adequate security if certain requirements are met. Those requirements 
are described in Sec.  1.503(e)-2.
    (2) Section 503(e) does not affect the requirement in section 
503(b)(1) of a reasonable rate of interest. Thus, although the 
acquistion of a certificate of indebtedness which meets all of the 
requirements of section 503(e) and of Sec.  1.503(e)-2 will not be 
considered as a loan made without the receipt of adequate security, the 
acquisition of such

[[Page 91]]

an indebtedness does consitute a prohibited transaction if the 
indebtedness does not bear a reasonable rate of interest.
    (3) The provisions of section 503(e) do not limit the effect of 
section 401(a) and Sec.  1.401-2, section 501(c)(17)(A)(i), or section 
501(c)(18)(A), all relating to the use of diversion of corpus or incopme 
of the respective employee trusts. Furthermore, the provisions of 
section 503(e) do not limit the effect of any of the provisions of 
section 503 other than section 503(b)(1). Thus, for example, although a 
loan made by employees' trust described in section 503(a)(1)(B) meets 
all the requirements of section 503(e) and therefore is not treated as a 
loan made without the receipt of adequate security, such an employees' 
trust making such a loan will lose its exempt status if the loan is not 
considered as made for the exclusive benefit of the employees or their 
beneficiaries. Similarly, a loan which meets the requirements of section 
503(e) will constitute a prohibited transaction within the meaning of 
section 503(b)(6) if it results in a substantial diversion of the 
trust's income or corpus to a person described in section 503(b).
    (b) Definitions. For purposes of section 503(e):
    (1) The term obligation means bond, debenture, note, or certificate 
or other evidence of indebtedness.
    (2) The term issuer includes any person described in section 503(b) 
who issues an obligation.
    (3)(i) The term person independent of the issuer means a person who 
is not related to the issuer by blood, by marriage, or by reason of any 
substantial business interests. Persons who will be considered not to be 
independent of the issuer include but are not limited to:
    (a) The spouse, ancestor, lineal descendant, or brother or sister 
(whether by whole or half blood) of an individual who is the issuer of 
an obligation;
    (b) A corporation controlled directly or indirectly by an individual 
who is the issuer, or directly or indirectly by the spouse, ancestor, 
lineal descendant, or brother or sister (whether by whole or half blood) 
of an individual who is the issuer;
    (c) A corporation which directly or indirectly controls, or is 
controlled by, a corporate issuer;
    (d) A controlling shareholder of a corporation which is the issuer, 
or which controls the issuer;
    (e) An officer, director, or other employee of the issuer, of a 
corporation controlled by the issuer, or of a corporation which controls 
the issuer;
    (f) A fiduciary of any trust created by the issuer, by a corporation 
which controls the issuer, or by a corporation which is controlled by 
the issuer; or
    (g) A corporation controlled by a person who controls a corporate 
issuer.
    (ii) For purposes of paragraph (b)(3)(i) of this section, the term 
control means, with respect to a corporation, direct or indirect 
ownership of 50 percent or more of the total combined voting power of 
all voting stock or 50 percent or more of the total value of shares of 
all classes of stock. If the aggregate amount of stock in a corporation 
owned by an individual and by the spouse, ancestors, lineal descendants, 
brothers and sisters (whether by whole of half blood) of the individual 
is 50 percent or more of the total combined voting power of all voting 
stock or is 50 percent or more of the total value of all classes of 
stock, then each of these persons shall be considered as the controlling 
shareholder of the corporation.
    (iii) In determining family relationships for purposes of paragraph 
(b)(3)(i) of this section, a legally adopted child of an individual 
shall be treated as a child of such individual by blood.
    (4) The term issue means all the obligations of an issuer which are 
offered for sale on substantially the same terms. Obligations shall be 
considered offered for sale on substantially the same terms if such 
obligation would, at the same time and under the same circumstances, be 
traded on the market at the same price. On the other hand, if the terms 
on which obligations are offered for sale differ in such manner as would 
cause such obligations to be traded on the market at different prices, 
then such obligations are not part of the same issue. The following are 
examples of terms which, if different, would cause obligations to be 
traded on the market at different prices: (i) Interest rate; (ii) 
Maturity

[[Page 92]]

date; (iii) Collateral; and (iv) Conversion provisions


The fact that obligations are offered for sale on different dates will 
not preclude such obligations from being part of the same issue if they 
all mature on the same date and if the terms on which they are offered 
for sale are otherwise the same, since such obligations would, at the 
same time and under the same conditions, be traded on the market at the 
same price. Obligations shall not be considered part of the same issue 
merely because they are part of the same authorization or because they 
are registered as part of the same issue with the Securities and 
Exchange Commission.

[T.D. 7428, 41 FR 34623, Aug. 16, 1976]



Sec.  1.503(e)-2  Requirements.

    (a) In general. The requirements which must be met under section 
503(e) for an obligation not to be treated as a loan made without the 
receipt of adequate security for purposes of section 503(b)(1) are 
described in paragraphs (b), (c), and (d) of this section. For purposes 
of this section, the term employee trust shall mean any of the three 
kinds of organizations described in section 503(a)(1).
    (b) Methods of acquisition--(1) In general. The employee trust must 
acquire the obligation of the market, by purchase from an underwriter, 
or by purchase from the issuer, in the manner described in subparagraph 
(2), (3), or (4) of this paragraph.
    (2) On the market. (i) An obligation is acquired on the market when 
it is purchased through a national securities exchange which is 
registered with the Securities and Exchange Commission, or when it is 
purchased in an over-the-counter transaction. For purposes of the 
preceding sentence, securities purchased through an exchange which is 
not a national securities exchange registered with the Securities and 
Exchange Commission shall be treated as securities purchased in an over-
the-counter transaction.
    (ii)(a) If the obligation is listed on a national securities 
exchange registered with the Securities and Exchange Commission, it must 
be purchased through such an exchange or in an over-the-counter 
transaction at a price not greater than the price of the obligation 
prevailing on such an exchange at the time of the purchase by the 
employee trust.
    (b) For purposes of section 503(e), the price of the obligation 
prevailing at the time of the purchase means the price which accurately 
reflects the market value of the obligation. In the case of an 
obligation purchased through a national securities exchange which is 
registered with the Securities and Exchange Commission, the price paid 
for the obligation will be considered the prevailing price of the 
obligation. In the case of an obligation purchased in an over-the-
counter transaction, the prevailing price may be the price at which the 
last sale of the obligation was affected on such national securities 
exchange immediately before the employee trust's purchase of such 
obligation on the same day or may be the mean between the highest and 
lowest prices at which sales were effected on such exchange on the same 
day or on the immediately preceding day or on the last day during which 
there were sales of such obligation or may be a price determined by any 
other method which accurately reflects the market value of the 
obligation.
    (iii)(a) If the obligation is not listed on a national securities 
exchange which is registered with the Securities and Exchange 
Commission, it must be purchased in an over-the-counter transaction at a 
price not greater than the offering price for the obligation as 
established by current bid and asked prices quoted by persons 
independent of the issuer.
    (b) For purposes of section 503(e) the offering price for the 
obligation at the time of the purchase means the price which accurately 
reflects the market value of the obligation. The offering price may be 
the price at which the last sale of the obligation to a person 
independent of the issuer was effected immediately before the employee 
trust's purchase of such obligation on the same day or may be the mean 
between the highest and lowest prices at which sales to persons 
independent of the issuer were effected on the same day or on the last 
day during which they were sales of such obligation or

[[Page 93]]

may be a price determinated by any other method which accurately 
reflects the market value of the obligation. The offering price for an 
obligation must be a valid price for the amount of the obligations which 
the trust is purchasing. For example, if an employees' trust described 
in section 503(a)(1)(B) purchases 1,000 bonds of the employer 
corporation at the offering price established by current prices for a 
lot of 10 such bonds, such offering price may not be a valid price for 
1,000 bonds and the purchase may therefore not meet the requirements of 
this subdivision. For a purchase of an obligation to qualify under this 
subdivision, there must be sufficient current prices quoted by persons 
independent of the issuer to establish accurately the current value of 
the obligation. Thus, if there are no current prices quoted by persons 
independent of the issuer, an over-the-counter transaction will not 
qualify under this subparagraph even though the obligation was purchased 
in an arms's length transaction from a person independent of the issuer.
    (iv) For purposes of this section, an over-the-counter transaction 
is one not executed on a national securities exchange which is 
registered with the Securities and Exchange Commission. An over-the-
counter transaction may be made through a dealer or an exchange which is 
not such a national securities exchange or may be made directly from the 
seller to the purchaser.
    (3) From an underwriter. An obligation may be purchased from an 
underwriter if it is purchased at a price not greater than:
    (i) The public offering price for the obligation as set forth in a 
prospectus or offering circular filed with the Securities and Exchange 
Commission, or
    (ii) The price at which a substantial portion of the issue including 
such obligation is acquired by persons independent of the issuer


whichever is the lesser price. For purposes of this subparagraph, a 
portion of the issue will be considered substantial if the purchasers of 
such portion by persons independent of the issuer are sufficient to 
establish that fair market value of the obligations included in such 
issue. In determining whether the purchases are sufficient to establish 
the fair market value, all the surrounding facts and circumstances will 
be considered, including the number of independent purchasers, the 
aggregate amount purchased by each such independent purchaser, and the 
number of transactions. In the case of a large issue, purchases of a 
small percentage of the outstanding obligations may be considered 
purchases of a substantial portion of the issue; whereas, in the case of 
a small issue, purchases of a larger percentage of the outstanding 
obligations will ordinarily be required. The requirement in paragraph 
(b)(3)(ii) of this section contemplates purchase of the obligations by 
persons independent of the issuer contemporaneously with the purchase by 
the employee trust. If a substantial portion has been purchased at 
different prices, the price of the portion may be based on the average 
of such prices, and if several substantial portions have been sold to 
persons independent of the issuer, the price of any of the substantial 
portions may be used for pusposes of this subparagraph.
    (4) From the issuer. An obligation may be purchased directly from 
the issuer at a price not greater than the price paid currently for a 
substantial portion of the same issue by persons independent of the 
issuer. This requirement contemplates purchase of a substantial portion 
of the same issue by persons independent of the issuer contemporaneously 
with the purchase by the employee trust. For purposes of this 
subparagraph, a portion of the issue will be considered substantial if 
the purchases of such portion by persons independent of the issuer are 
sufficient to establish the fair market value of the obligations 
included in such issue. In determining whether the purchases are 
sufficient to establish the fair market value, all the surrounding facts 
and circumstances will be considered, including the number of 
independent purchasers, the aggregage amount purchased by each such 
independent purchaser, and the number of transactions. In the case of a 
large issue, purchases of a small percentage of the outstanding 
obligations may be considered purchases of a substantial portion of the 
issue; whereas, in the case of a

[[Page 94]]

small issue, purchases of a larger percentage of the outstanding 
obligations will ordinarily be required. The price paid for a 
substantial portion of the issue may be determined in the manner 
privided in paragraph (b)(3) of this section.
    (c) Limitations on holdings of obligations. (1) Immediately 
following acquisition of the obligation by the employee trust:
    (i) Not more than 25 percent of the aggregate amount of the 
obligations issued in such issue and outstanding immediately after 
acquisition by the trust may be held by the trust, and
    (ii) At least 50 percent of such aggregate amount must be held by 
persons independent of the issuer.
    (2)(i) For purposes of paragraph (c)(1) of this section, an 
obligation is not considered as outstanding if it is held by the issuer. 
For example, if an obligation which has been issued and outstanding is 
repurchased and held by the issuer, without cancellation or retirement, 
such an obligation is not considered outstanding.
    (ii) For purposes of paragraph (c)(1) of this section, the amounts 
of the obligations held by the trust and by persons independent of the 
issuer shall be computed on the basis of the face amount of the 
obligations.
    (d) Limitation on amount invested in obligations. (1)(i) Immediately 
following acquisition of the obligation, not more 25 percent of the 
assets of the employee trust may be invested in all obligations of all 
persons described in section 503(b). For purposes of determining the 
amount of the trust's assets which are invested in obligations of 
persons described in section 503(b) immediately following acquisition of 
the obligation, those obligations shall be valued as follows:
    (a) Those obligations included in the acquisition in respect of 
which the percentage test in the first sentence of this subdivision is 
being applied shall be valued at their adjusted basis, as provided in 
section 1011, relating to adjusted basis for determining gain or loss; 
and
    (b) All other obligations of persons described in section 503(b) 
which were part of the trust's assets immediately before the acquisition 
of the obligations described in (d)(1)(i)(a) of this section shall be 
valued at their fair market value on the day that the obligations 
described in (d)(1)(i)(a) of this section were acquired. For purposes of 
determining the total amount of the assets of the trust (including 
obligations of persons described in section 503(b)), there shall be used 
the fair market value of those assets on the day the obligation is 
acquired.
    (ii) The application of the rules in paragraph (d)(1)(i) of this 
section may be illustrated by the following example:

    Example. On February 1, 1960, an exempt employees' trust described 
in section 401(a) purchases unsecured debentures issued by the employer 
corporation for $1,000. At the time of this purchase, such debentures 
have a fair market value of $1,200. Immediately after the purchase of 
such unsecured debentures, the assets of the trust consist of the 
following:

------------------------------------------------------------------------
                                                                 Fair
                                                                market
                                                     Cost      value on
                                                                Feb. 1,
                                                                 1960
------------------------------------------------------------------------
(a) Assets other than obligations of persons          $5,000      $7,800
 described in sec. 503(b).......................
(b) Obligations of persons described in sec.             500       1,000
 503(b) acquired before Feb. 1, 1960............
(c) Unsecured debentures of employer purchased         1,000       1,200
 on Feb. 1, 1960................................
------------------------------------------------------------------------

    Immediately following acquisition of the unsecured debentures by the 
trust, the percent of the assets of the trust that are invested in all 
obligations of all persons described in section 503(b) is computed as 
follows:

(1) Obligations of persons described in section 503(b)            $1,000
 acquired before Feb. 1, 1960 (valued at fair market value).
(2) Unsecured debentures of employer purchased on Feb. 1,          1,000
 1960 (valued at cost)......................................
                                                             -----------
(3) Total amount of trust's assets invested in obligations         2,000
 of persons described in section 503(b) ((1) plus (2))......
                                                             ===========
(4) Assets of the trust other than obligations of persons          7,800
 described in section 503(b) (valued at fair market value on
 Feb. 1, 1960)..............................................
(5) Obligations of persons described in section 503(b)             1,000
 acquired before Feb. 1, 1960 (valued at fair market value
 on Feb. 1, 1960)...........................................
(6) Unsecured debentures of employer purchased on Feb. 1,         $1,200
 1960 (valued at fair market value on Feb. 1, 1960).........
                                                             -----------
(7) Total assets of the trust valued at fair market value on      10,000
 Feb. 1, 1960 (sum of (4), (5), and (6))....................

[[Page 95]]

 
(8) Percent of assets of the trust invested in all                   20%
 obligations of all persons described in section 503(b)
 immediately following purchase of unsecured debentures on
 Feb. 1, 1960 ((3) / (7), that is, $2,000 / $10,000)........
 

    (2) In determining for purposes of subparagraph (1) of this 
paragraph the amount invested in obligations of persons described in 
section 503(b), there shall be included amounts invested in any 
obligations issued by any such person, irrespective of whether the 
obligation is secured, and irrespective of whether the obligation meets 
the conditions of section 503(e) or section 503(f). Obligations of 
persons described in section 503(b) other than the issuer of the 
obligation to which section 503(e) applies are also included within the 
25 percent limitation. For example, if on February 19, 1959, an exempt 
employees' trust described in section 401(a) purchases unsecured 
debentures issued by the employer corporation in a transaction effected 
on the New York Stock Exchange, and if immediately after the purchase 10 
percent of the trust's assets is invested in such debentures and 20 
percent of its assets is invested in a loan made with adequate security 
on January 12, 1959, to the wholly-owned subsidiary of the employer 
corporation, then the purchase of the employer's debentures will not 
qualify under section 503(e), since 30 percent of the trust's assets are 
then invested in obligations of persons described in section 503(b).
    (e) Change of terms of an obligation. A change in terms of an 
obligation is considered as the acquisition of a new obligation. If such 
new obligation is not adequately secured, the requirements of section 
503(e) must be met at the time the terms of the obligation are changed 
for such section to be applicable to such new loan.

[T.D. 7428, 41 FR 34624, Aug. 16, 1976]



Sec.  1.503(e)-3  Effective dates.

    (a) Section 503(e) and Sec. Sec.  1.503(e)-1 and 1.503(e)-3 are 
effective in the case of an employees' trust described in section 401(a) 
for taxable years ending after March 15, 1956. Thus, if during a taxable 
year ending before March 16, 1956, an employees' trust made a loan which 
meets the requirements of section 503(e), such loan will not be treated 
as made without the receipt of adequate security and will not cause the 
loss of exemption for taxable years ending after March 15, 1956, 
although such loan was not considered adequately secured when made. 
(However, section 503 does not apply to organizations described in 
section 401(a) not referred to in section 4975(g) (2) or (3) for 
transactions occurring after December 31, 1974.)
    (b)(1) In the case of obligations acquired by an employees' trust 
described in section 401(a) before September 2, 1958, which were held on 
that date, the requirements described in paragraphs (c) and (d) of Sec.  
1.503(e)-2 which were not satisfied immediately following the 
acquisition shall be treated as satisfied at that time if those 
requirements would have been satisfied had the obligations been acquired 
on September 2, 1958. For example, on January 3, 1955, an employees' 
trust described in section 401(a) purchased through the New York Stock 
Exchange unsecured debentures issued by the employer corporation. Under 
section 503(e) the acquisition of such debentures by the trust will not 
be treated for taxable years ending after March 15, 1956, as a loan made 
without the receipt of adequate security if the debentures were held by 
the employees' trust on September 2, 1958, and if the requirements of 
paragraphs (c) and (d) of Sec.  1.503(e)-2 which were not met on January 
3, 1955, were met on September 2, 1958, as if that date were the date of 
acquisition.
    (2) In the case of obligations acquired before September 2, 1958, 
which were not held by the employees' trust described in section 401(a) 
on that date, only the requirements described in paragraph (b) of Sec.  
1.503(e)-2 must be satisfied for section 503(e) to be applicable to such 
acquisition. For example, if on December 5, 1956, an employees' trust 
lent money to the employer corporation by purchasing a debenture issued 
by the employer and if the trust sold the debenture on August 1, 1958, 
such loan would not be treated as made without the receipt of adequate 
security if the requirement described in paragraph (b) of Sec.  
1.503(e)-2 was met on December 5, 1956.
    (c) Section 503(e) and Sec. Sec.  1.503(e)-1 and 1.503(e)-2 are 
effective in the case of trusts described in section 501(c)(17)

[[Page 96]]

with respect to loans made, renewed, or, in the case of demand loans, 
continued after December 31, 1959, and in the case of trusts described 
in section 501(c)(18) with respect to loans made, renewed or, in the 
case of demand loans, continued after December 31, 1969.
    (d) See paragraph (b)(2) of Sec.  1.503(b)-1 for the effective dates 
for the application of the definition of adequate security.

[T.D. 7428, 41 FR 34626, Aug. 16, 1976]



Sec.  1.503(f)-1  Loans by employers who are prohibited from pledging
assets.

    (a) In general. (1) Section 503(f) provides that section 503(b)(1) 
shall not apply to a loan made to the employer by an employees' trust 
described in section 401(a) if the loan bears a reasonable rate of 
interest and certain conditions are met. Section 503(f) also applies to 
the renewal of loans to the employer and, in the case of demand loans, 
to the continuation of such loans.
    (2) The provisions of section 503(f) do not limit the effect of 
section 401(a) and Sec.  1.401-2, relating to use or diversion of corpus 
or income of an employees' trust, or the effect of any of the provisions 
of section 503 other than section 503(b)(1). Consequently, although a 
loan made by an employees' trust described in section 503(a)(1)(B) meets 
all the requirements of section 503(f) and therefore is not treated as a 
loan made without the receipt of adequate security, an employees' trust 
making such a loan will lose its exempt status if the loan is not 
considered as made for the exclusive benefit of the employees or their 
beneficiaries. Similarly, a loan which meets the requirements of section 
503(f) will constitute a prohibited transaction within the meaning of 
section 503(b)(6) if it results in a substantial diversion of the 
trust's income or corpus to a person described in section 503(b).
    (b) Conditions. (1) Section 503(f) applies to a loan only if, with 
respect to the making or renewal of the loan, the conditions described 
in paragraphs (b) (2), (3), and (4) of this section are met. For purpose 
of this paragraph, the mere continuance of a demand loan is not 
considered as the making or renewal of such a loan.
    (2) The employer must be prohibited (at the time of the making or 
renewal of the loan) by any law of the United States or regulations 
thereunder from directly or indirectly pledging, as security for such a 
loan, a particular class or classes of his assets the value of which (at 
such time) represents more than one-half of the value of all his assets. 
If a loan is made or renewed when the employer is prohibited by a law of 
the United States (or the regulations thereunder) from pledging a class 
of his assets, the qualification of such a loan under section 503(f) 
will not be affected by a subsequent change in such law or regulations 
permitting the employer to pledge such assets, unless such loan is 
renewed after such change. See section 8(a) of the Securities Exchange 
Act of 1934, as amended (15 U.S.C. 78h(a)), which prohibits certain 
persons from pledging a class of assets as security for loans, and 12 
CFR 220.5(a) (credit by brokers, dealers, and members of national 
securities exchanges).
    (3) The making or renewal, as the case may be, must be approved in 
writing as an investment which is consistent with the exempt purposes of 
the trust by a trustee who is independent of the employer, and such 
written approval must not have been previously refused by any other such 
trustee. A trustee is independent of the employer, for purposes of this 
subparagraph, if he is entirely free of influence or controlled by the 
employer. For example, if the employer is a partnership, then a partner 
in such partnership, or a member of a partner's family would not be 
considered independent of the employer. Similarly, an employee of the 
employer would not be considered independent of the employer. For 
purposes of this subparagraph, the term trustee means, with respect to 
any trust for which there are two trustees who are independent of the 
employer, both of such trustees and, with respect to any trust for which 
there are more than two such independent trustees, a majority of the 
trustees independent of the employer.
    (4)(i) Immediately following the making or renewal, as the case may 
be, the aggregate amount lent by the trust to

[[Page 97]]

the employer, without the receipt of adequate security must not exceed 
25 percent of the value of all the assets of the trust.
    (ii) For purposes of paragraph (b)(4)(i) of this section, the 
determination as to whether any amount lent by the trust to the employer 
is a loan made without the receipt of adequate security shall be made 
without regard to section 503(e). Thus, if an employees' trust makes a 
loan on January 2, 1959, to the employer without adequate security (but 
which loan is not considered as made without adequate security under 
section 503(e)), and if immediately after making such loan 10 percent of 
the value of all its assets is invested in such loan, then the trust may 
on that day invest not more than an additional 15 percent of its assets 
in a loan which would be considered made without adequate security if it 
were not for the provisions of section 503(f).
    (iii) For purposes of paragraph (b)(4)(i) of this section, in 
determining the value of all the assets of the trust, there shall be 
used the fair market value of those assets on the day of the making or 
renewal.
    (c) Reasonable rate of interest. Section 503(f) only applies if, in 
addition to meeting the conditions described in paragraph (b) of this 
section, the loan bears a reasonable rate of interest when it is made, 
renewed, or, in the case of demand loans, during the period of its 
existence.
    (d) Change of terms of loan. A change in the terms of a loan 
(including a reduction in the security for a loan) is considered as the 
making of a new loan. If such a new loan is not adequately secured, the 
requirements of section 503(f) must be met at the time the terms of the 
loan are changed for such section to be applicable to such new loan.
    (e) Effective date. (1) This section and section 503(f) are 
effective for taxable years ending after September 2, 1958, but only 
with respect to periods after such date. Thus, if a loan was made on or 
before September 2, 1958, without the receipt of adequate security and 
if, when such loan was made, it met all of the requirements of section 
503(f) and this section, then the loan is not subject to section 
503(b)(1) after September 2, 1958, and would not consitite a prohibited 
transaction after that date because of a lack of adequate security.
    (2) See paragraph (b)(2) of Sec.  1.503(b)-1 for the effective dates 
for application of the definition of adequate security.

[T.D. 7428, 41 FR 34626, Aug. 16, 1976]



Sec.  1.504-1  Attempts to influence legislation; certain organizations
formerly described in section 501(c)(3) denied exemption.

    Section 504(a) and this section apply to an organization that is 
exempt from taxation at any time after October 4, 1976, as an 
organization described in section 501(c)(3), and that ceases to be 
described in that section because it--
    (a) Is an action organization within the meaning of Sec.  
1.501(c)(3)-1(c)(3)(ii) or (iv), on account of activities occurring 
after October 4, 1976, or
    (b) Is denied exemption under the provisions of section 501(h) (see 
Sec.  1.501(h)-3 or Sec.  56.4911-9).

This section does not apply, however, to an organization that was 
described in section 501(h)(5) and Sec.  1.501(h)-2(b)(3) (relating 
generally to churches) for its taxable year immediately preceding the 
first taxable year for which it is no longer an organization described 
in section 501(c)(3). An organization to which section 504(a) and this 
section apply shall not be treated as described in section 501(c)(4) at 
any time after the organization ceases to be described in section 
501(c)(3). Further, an organization denied treatment as an organization 
described in section 501(c)(4) under this section may not be treated as 
an organization described in section 501(c) other than as an 
organization described in section 501(c)(3). For rules relating to 
recognition of exemption after exemption is denied under section 501(h), 
Sec.  1.501(h)-3(d).

[T.D. 8308, 55 FR 35592, Aug. 31, 1990]



Sec.  1.504-2  Certain transfers made to avoid section 504(a).

    (a) Scope. Under section 504(b), a transfer described in paragraph 
(b) or (c) of this section to an organization exempt from tax under 
section 501(a) may result in loss of exemption by the

[[Page 98]]

transferee unless the Commissioner determines, under paragraph (e) of 
this section, that the original transfer did not effect an avoidance of 
section 504(a). For purposes of this section, the term transfer includes 
any use by, or for the benefit of, the recipient of the transfer, but 
does not include any transfer made for adequate and full consideration.
    (b) Transferor and transferee commonly controlled--(1) Loss of 
exemption. A transfer is described in this paragraph (b) if it is 
described in paragraphs (b)(2) through (b)(6). The transferee of a 
transfer described in this paragraph will cease to be exempt from tax 
under section 501(a), unless the provisions of paragraph (e) of this 
section apply.
    (2) Transferor organization. A transfer is described in this 
paragraph (b)(2) only if it is from an organization that--
    (i) Is or was described in section 501(c)(3), but not in section 
501(h)(5), and
    (ii) Is determined to be an ``action'' organization (as defined in 
Sec.  1.501(c)(3)-1(c)(3)(ii) or (iv)), or is denied exemption from tax 
by reason of section 501(h) and either Sec.  1.501(h)-3 or Sec.  
56.4911-9.
    (3) Transferor and transferee commonly controlled. A transfer is 
described in this paragraph (b)(3) only if, at the time of the transfer 
or at any time during the transferee's ten taxable years following the 
year in which the transfer was made, the transferee is controlled 
(directly or indirectly), as defined in paragraph (f) of this section, 
by the same person or persons who control the transferor.
    (4) Time of transfer. A transfer is described in this paragraph 
(b)(4) only if the transfer is made--
    (i) After the date that is 24 months before the earliest of the 
effective date of the determination under section 501(h) that the 
transferor is not exempt, the effective date of the Commissioner's 
determination that the transferor is an ``action'' organization (as 
defined in Sec.  1.501(c)(3)(ii) or (iv)), or the date on which the 
Commissioner proposes to treat it as no longer described in section 
501(c)(3), and
    (ii) Before the transferor again is recognized as an organization 
described in section 501(c)(3).
    (5) Transferee. A transfer is described in this paragraph (b)(5) 
only if the transferee is exempt from tax under section 501(a) but the 
transferee is neither--
    (i) An organization described in section 501(c)(3), nor
    (ii) An organization described in section 401(a) to which the 
transferor contributes as an employer.
    (6) Amount of transfer. A transfer is described in this paragraph 
(b)(6) only if the amount of the transfer exceeds the lesser of 30 
percent of the net fair market value of the transferor's assets or 50 
percent of the net fair market value of the transferee's assets, 
computed immediately before the transfer. For purposes of this paragraph 
(b)(6)--
    (i) The amount of a transfer by a transferor is the sum of the 
amounts transferred to any number of transferees in any number of 
transfers, all of which are described in paragraphs (b)(2) through 
(b)(5) of this section, and the time of the transfer is the time of the 
first transfer so taken into account; and
    (ii) The amount of a transfer to a transferee is the sum of the 
amounts transferred by a transferor to the transferee in any number of 
transfers, all of which are described in paragraphs (b)(2) through 
(b)(5) of this section, and the time of the transfer is the time of the 
first transfer so taken into account.
    (c) Other transfers--(1) Transfers included. A transfer is described 
in this paragraph (c) if it would be described in paragraph (b) of this 
section except that either--
    (i) The amount of the transfer is less than the amount determined in 
paragraph (b)(6) of this section, or
    (ii) The transferor and transferee are not commonly controlled as 
described in paragraph (b)(3) of this section, or
    (iii) The transferee is an organization described in sections 
501(c)(3) and 501(h)(4).
    (2) Loss of exemption. The transferee of a transfer described in 
this paragraph (c) will cease to be exempt under

[[Page 99]]

section 501(a) if the Commissioner determines on all the facts and 
circumstances that the transfer effected an avoidance of section 504(a). 
In determining whether a transfer effected an avoidance of section 
504(a), the Commissioner may consider whether the transferee engages, or 
has engaged, in attempts to influence legislation and may also consider 
any factors enumerated in paragraph (e) of this section.
    (d) Date of loss of exempt status. A transferee of a transfer 
described in paragraph (b), (c)(1)(ii), or (c)(1)(iii) of this section 
will cease to be exempt from tax under section 501(a) on the date that 
all requirements of paragraph (b), (c)(1)(ii), or (c)(1)(iii) (other 
than the determination by the Commissioner) are satisfied. A transferee 
of a transfer described in paragraph (c)(1)(i) of this section will 
cease to be exempt from tax under section 501(a) on the date of the last 
transfer preceding notification of the transferee that the Commissioner 
proposes to treat the transferee as other than an exempt organization.
    (e) Transfers not in avoidance of section 504(a). Notwithstanding 
paragraph (b) of this section, if, based on all the facts and 
circumstances, the Commissioner determines that a transfer described in 
paragraph (b) did not effect an avoidance of section 504(a), the 
transferee will not be denied exemption from tax by reason of section 
504(b) and this section. In making the determination called for in the 
preceding sentence, the Commissioner may consider all relevant factors 
including:
    (1) Whether enforceable and effective conditions on the transfer 
preclude use of any of the transferred assets for any purpose that, if 
it were a substantial part of an organization's activities, would be 
inconsistent with exemption as an organization described in section 
501(c)(3);
    (2) In the absence of conditions described in paragraph (e)(1) of 
this section, whether the transferred assets are used exclusively for 
purposes that are consistent with the transferor's exemption as an 
organization described in section 501(c)(3);
    (3) Whether the assets transferred would be describe in Sec.  
53.4942(a)(-2(c)(3) before, as well as after, the transfer if both the 
transferor and transferee were private foundations;
    (4) Whether and to what extent the transfer would satisfy the 
provisions of Sec.  1.507-2(a) (7) and (8) if the transferor were a 
private foundation;
    (5) Whether all of the transferred assets have been expended during 
a period when the transferee was not controlled (directly or indirectly) 
by the same person or persons who controlled the transferor; and
    (6) Whether the entire amount of the transferred assets were in turn 
transferred, before the close of the transferee's taxable year following 
the taxable year in which the transferred assets were received, to one 
or more organizations described in section 507(b)(1)(A) none of which 
are controlled (directly or indirectly) by the same persons who control 
either the original transferor or transferee.
    (f) Control. For purposes of section 504 and the regulations 
thereunder--
    (1) The transferor will be presumed to control any organization with 
which it is affiliated within the meaning of Sec.  56.4911-7(a), or 
would be if both organizations were described in section 501(c)(3), and
    (2) The transferee will be treated as controlled (directly of 
indirectly) by the same person or persons who control the transferor if 
the transferee would be treated as controlled under Sec.  53.4942(a)-
3(a)(3), for which purpose the transferor shall be treated as a private 
foundation.

[T.D. 8308, 55 FR 35592, Aug. 31, 1990]



Sec.  1.505(c)-1T  Questions and answers relating to the notification 
requirement for recognition of exemption under paragraphs (9), (17) and
(20) of Section 501(c) (temporary).

    Q-1: What does section 505(c) of the Internal Revenue Code provide?
    A-1: Section 505(c) provides that an organization will not be 
recognized as exempt under section 501(c)(9) as a voluntary employees' 
beneficiary association, under section 501(c)(17) as a trust forming 
part of a plan providing for the payment of supplemental unemployment 
compensation benefits, or under section 501(c)(20) as a trust forming 
part of a qualified group legal services plan unless notification is 
given to the Internal Revenue Service. The notification

[[Page 100]]

required of a trust created pursuant to section 501(c)(20) and forming 
part of a qualified group legal services plan is set forth in Q&A-2. The 
notification required of an organization organized after July 18, 1984, 
and applying for exempt status as an organization described in section 
501(c) (9) or (17) is set forth in Q&A-3 through Q&A-8. The notification 
required of an organization organized on or before July 18, 1984, and 
claiming exemption as an organization described in section 501(c) (9) or 
(17) is set forth in Q&A-9 through Q&A-11. However, an organization that 
has previously notified the Internal Revenue Service of its claim to 
exemption under section 501(c) (9), (17), or (20) or its claim to 
exemption under those sections pursuant to another provision of the 
Code, is not required, under section 505(c), to submit a renotification 
(See Q&A-2 and Q&A-12).

                        Section 501(c)(20) Trusts

    Q-2: What is the notice required of a trust created pursuant to 
section 501(c)(20) and forming part of a qualified group legal services 
plan under section 120?
    A-2: (a) A trust claiming exemption as an organization described in 
section 501(c)(20) will be recognized as exempt if the exclusive 
function of the trust is to form part of a qualified group legal 
services plan or plans. Exemption of the trust under section 501(c)(20) 
will generally be dependent upon and coextensive with recognition of the 
plan as a qualified group legal services plan. Therefore, a trust 
organized pursuant to section 501(c)(20) after July 18, 1984, need not 
file a separate notice with the Internal Revenue Service of its claim to 
exemption because the notice required by section 120(c)(4) will suffice 
for purposes of section 505(c), provided a copy of the trust instrument 
is filed with the Form 1024 submitted by the group legal services plan. 
If the trust instrument has not been filed with the Form 1024 submitted 
by the group legal services plan, the trust must comply with (and 
exemption will be dependent upon) the filing applicable to a trust 
organized on or before July 18, 1984. For the notice required and 
effective dates of exemption of a qualified group legal services plan 
under section 120, see Sec.  1.120-3.
    (b) A trust organized on or before July 18, 1984, that claims exempt 
status as a trust described in section 501(c)(20) and that forms part of 
a qualified group legal services plan which has been recognized as 
exempt under section 120, must file a copy of its trust instrument with 
the Internal Revenue Service before February 4, 1987. If a copy of the 
trust instrument is filed within the time provided, the trust's 
exemption will be recognized retroactively to the date the qualified 
group legal services plan was recognized as exempt under section 120. 
However, if a copy of the trust instrument is filed after the time 
provided, exemption will be recognized only for the period after the 
copy of the trust instrument is filed with the Internal Revenue Service. 
See Q&A-7 for a further discussion of date of filing. A trust that has 
previously filed a copy of its trust instrument with the Service need 
not refile that document.

 Section 501(c)(9) and (17) Organizations Organized After July 18, 1984

    Q-3: What is the notice required of an organization or trust, 
organized after July 18, 1984, that is applying for recognition of tax 
exempt status under section 501(c) (9) or (17)?
    A-3: An organization or trust that is organized after July 18, 1984, 
will not be treated as described in paragraphs (9) or (17) of section 
501(c), unless the organization notifies the Internal Revenue Service 
that it is applying for recognition of exemption. In addition, unless 
the required notice is given in the manner and within the time 
prescribed by these regulations, an organization will not be treated as 
exempt for any period before the giving of the required notice. The 
notice is filed by submitting a properly completed and executed Form 
1024, ``Application for Recognition of Exemption Under Section 501(a) or 
for Determination Under Section 120'' together with the additional 
information required under Q&A-4 and Q&A-5. The notice is filed with the 
district director for the key district in which the organization's 
principal place of business or principal office is located.
    The notice may be filed by either the plan administrator (as defined 
in section 414(g)) or the trustee. The Internal Revenue Service will not 
accept a Form 1024 for any organization or trust before such entity has 
been organized.
    Q-4: What information, in addition to the information required by 
Form 1024, must be submitted by an organization or trust seeking 
recognition of exemption under section 501(c) (9) or (17)?
    A-4: A notice will not be considered complete unless, in addition to 
a properly completed and executed Form 1024, the organization or trust 
submits a full description of the benefits available to participants 
under section 501(c) (9) or (17). Moreover, both the terms and 
conditions of eligibility for membership and the terms and conditions of 
eligibility for benefits must be set forth. This information may be 
contained in a separate document, such as a plan document, or it may be 
contained in the creating document of the entity (e.g., the articles of 
incorporation or association, or a trust indenture). For benefits 
provided through a policy or policies of insurance, all such policies 
must be included with the notice. Where individual policies of insurance 
are provided to the participants, single exemplar copies, typical of 
policies generally issued to participants, are acceptable, provided they 
adequately describe all

[[Page 101]]

forms of insurance available to participants. In providing a full 
description of the benefits available, the benefits provided must be 
sufficiently described so that each benefit is definitely determinable. 
A benefit is definitely determinable if the amount of the benefit, its 
duration, and the persons eligible to receive it are ascertainable from 
the plan document or other instrument. Thus, a benefit is not definitely 
determinable if the rules governing either its amount, its duration, or 
its recipients are not ascertainable from the plan document or other 
instrument but are instead subject to the discretion of a person or 
committee. Likewise, a benefit is not definitely determinable if the 
amount for any individual is based upon a percentage share of any item 
that is within the discretion of the employer. However, a disability 
benefit will not fail to be considered definitely determinable merely 
because the determination of whether an individual is disabled is made 
under established guidelines by an authorized person or committee.
    Q-5: What is the notice required of collectively bargained plans?
    A-5: If an organization or trust claiming exemption under section 
501(c) (9) or (17) is organized and maintained pursuant to a collective 
bargaining agreement between employee representatives and one or more 
employer, only one Form 1024 is required to be filed for the 
organization or trust, regardless of the number of employers originally 
participating in the agreement. Moreover, once a Form 1024 is filed 
pursuant to a collective bargaining areement, an additional Form 1024 is 
not required to be filed by an employer who thereafter participates in 
that agreement. When benefits are provided pursuant to a collective 
bargaining agreement, the notice will not be considered complete unless, 
in addition to a properly completed and executed Form 1024, a copy of 
the collective bargaining agreement is also submitted together with the 
additional information delineated in Q&A-4.
    Q-6: When must the required notice be filed by an organization or 
trust, organized after July 18, 1984, that seeks recognition of 
exemption under section 501(c) (9) or (17)?
    A-6: An organization or trust applying for exemption must file the 
required notice by the later of February 4, 1987 or 15 months from the 
end of the month in which the organization or trust was organized. An 
extension of time for filing the required notice may be granted by the 
district director if the request is submitted before the end of the 
applicable period and it is demonstrated that additional time is needed.
    Q-7: What is the effective date of exemption for a new organization 
or trust, organized after July 18, 1984, that has submitted the required 
notice?
    A-7: If the required notice is filed within the time provided by 
these regulations, the organization's exemption will be recognized 
retroactively to the date the organization was organized, provided its 
purpose, organization and operation (including compliance with the 
applicable nondiscrimination requirements) during the period prior to 
the date of the determination letter are in accordance with the 
applicable law. However, if the required notice is filed after the time 
provided by these regulations, exemption will be recognized only for the 
period after the application is filed with the Internal Revenue Service. 
The date of filing is the date of the United States postmark on the 
cover in which an exemption application is mailed or, if no postmark 
appears on the cover, the date the application is stamped as received by 
the Service. If an extension for filing the required notice has been 
granted to the organization, a notice filed on or before the last day 
specified in the extension will be considered timely and not the 
otherwise applicable date under Q&A-6.
    Q-8: What is the effect on exemption of the filing of an incomplete 
notice?
    A-8: Although a properly completed and executed Form 1024 together 
with the required additional information (See Q&A-4 and Q&A-5) must be 
submitted to satisfy the notice required by section 505(c), the failure 
to file, within the time specified, all of the information necessary to 
complete such notice will not alone be sufficient to deny recognition of 
exemption from the date of organization to the date the completed 
information is submitted to the Service. If the notice which is filed 
with the Service within the required time is substantially complete, and 
the organization supplies the necessary additional information requested 
by the Service within the additional time allowed, the original notice 
will be considered timely. However, if the notice is not substantially 
complete or the additional information is not provided within the 
additional time allowed, exemption will be recognized only from the date 
of filing of the additional information.

Section 501(c)(9) and (17) Organizations Organized on or Before July 18, 
                                  1984

    Q-9: What is the notice required of an organization or trust 
organized on or before July 18, 1984, that claims exempt status as an 
organization described in section 501(c) (9) or (17)?
    A-9: Section 505(c) provides a special rule for existing 
organizations and trusts organized on or before July 18, 1984. Such an 
organization or trust will not be treated as described in paragraphs (9) 
or (17) of section 501(c) unless the organization or trust notifies the 
Internal Revenue Service in the manner and within the time prescribed in 
these regulations that it is claiming exemption under the particular 
section. The type of notice, the manner for filing that notice,

[[Page 102]]

and the additional information required is the same as that set forth in 
Q&A-3 through Q&A-5 for new organizations.
    Q-10: When must the required notice be filed by an organization or 
trust organized on or before July 18, 1984?
    A-10: An organization or trust organized on or before July 18, 1984, 
that claims exempt status as an organization described in section 501(c) 
(9) or (17), must file the required notice before February 4, 1987. An 
extension of time for filing the required notice may be granted by the 
district director if the request is submitted before the due date of the 
notice and it is demonstrated that additional time is needed.
    Q-11: What is the effective date of exemption for an organization or 
trust organized on or before July 18, 1984, that has submitted the 
required notice?
    A-11: If the required notice is filed within the time provided by 
these regulations, the organization's exemption will be recognized 
retroactively to the date the organization was organized, provided its 
purpose, organization and operation (including compliance with the 
applicable nondiscrimination requirements) during the period prior to 
the date of the determination letter are in accordance with the 
applicable law. If, on the other hand, the required notice is filed 
after the time provided by these regulations, exemption will be 
recognized only for the period after the notice is received by the 
Internal Revenue Service. See Q&A-7 for a further discussion of date of 
filing. See also Q&A-8 for the effect on exemption of a notice that has 
been timely filed but is incomplete.

                    Exceptions to Notice Requirement

    Q-12: Are any organizations or trusts claiming recognition of 
exemption as an organization described in section 501(c) (9) or (17) 
excepted from the notice requirement of section 505(c)?
    A-12: An organization or trust that has previously notified the 
Internal Revenue Service of its claim to exemption by filing Form 1024 
is not required, under section 505(c), to renotify the Service. Thus, an 
organization that has filed a Form 1024 that is pending with the Service 
need not refile that form. Also, an organization that has received a 
ruling or determination letter from the Service recognizing its 
exemption from taxation need not submit the notification required by 
section 505(c).

[T.D. 8073, 51 FR 4330, Feb. 4, 1986]



Sec.  1.506-1  Organizations required to notify Commissioner of intent
to operate under section 501(c)(4).

    (a) Notification requirement--(1) In general. Except as provided in 
paragraph (b) of this section, an organization (whether domestic or 
foreign) described in section 501(c)(4) must, no later than 60 days 
after the date the organization is organized, notify the Commissioner 
that it is operating as an organization described in section 501(c)(4) 
by submitting a completed Form 8976, ``Notice of Intent to Operate Under 
Section 501(c)(4),'' or its successor (the notification). The 
notification must be submitted in accordance with the form and its 
instructions. The notification must include the information specified in 
paragraph (a)(2) of this section and be accompanied by payment of the 
user fee described in paragraph (a)(3) of this section. Additional 
guidance on the procedure for submitting the notification may be 
provided in published guidance in the Internal Revenue Bulletin (see 
Sec.  601.601(d)(2) of this chapter) or in other guidance, such as forms 
or instructions, issued with respect to the notification.
    (2) Contents of the notification. The notification must include the 
following information:
    (i) The name, address, and taxpayer identification number of the 
organization.
    (ii) The date on which, and the state or other jurisdiction under 
the laws of which, the organization was organized (that is, formed as a 
legal entity). For an organization formed outside the United States, the 
jurisdiction is the foreign country under the laws of which it is 
organized.
    (iii) A statement of the purpose of the organization.
    (iv) Such additional information as may be specified in published 
guidance in the Internal Revenue Bulletin (see Sec.  601.601(d)(2) of 
this chapter) or in other guidance, such as forms or instructions, 
issued with respect to the notification.
    (3) User fee. The notification must be accompanied by payment of the 
user fee set forth by published guidance in the Internal Revenue 
Bulletin (see Sec.  601.601(d)(2) of this chapter) or in other guidance, 
such as forms or instructions, issued with respect to the notification.
    (4) Extension for reasonable cause. The Commissioner may, for 
reasonable cause, extend the 60-day period for submitting the 
notification.

[[Page 103]]

    (b) Special rules for organizations that were organized on or before 
July 8, 2016--(1) Notification requirement does not apply to 
organizations that filed with the IRS on or before December 18, 2015. 
The requirement to submit the notification does not apply to any 
organization described in section 501(c)(4) that, on or before December 
18, 2015, either--
    (i) Applied for a written determination of recognition as an 
organization described in section 501(c)(4) in accordance with Sec.  
1.501(a)-1 and all applicable guidance published in the Internal Revenue 
Bulletin (see Sec.  601.601(d)(2) of this chapter), forms, and 
instructions; or
    (ii) Filed at least one annual information return or annual 
electronic notification required under section 6033(a)(1) or (i).
    (2) Transition relief available for organizations that filed with 
the IRS on or before July 8, 2016. An organization described in section 
501(c)(4) is not required to submit the notification if, on or before 
July 8, 2016, the organization either--
    (i) Applied for a written determination of recognition as an 
organization described in section 501(c)(4) in accordance with Sec.  
1.501(a)-1 and all applicable guidance published in the Internal Revenue 
Bulletin (see Sec.  601.601(d)(2) of this chapter), forms, and 
instructions; or
    (ii) Filed at least one annual information return or annual 
electronic notification required under section 6033(a)(1) or (i).
    (3) Extended due date. An organization that was organized on or 
before July 8, 2016, and is not described in paragraph (b)(1) or (2) of 
this section, satisfies the requirement to submit the notification if 
the notification was submitted on or before September 6, 2016.
    (c) Failure to submit the notification. For information on the 
penalties for failure to submit the notification, the applicable 
reasonable cause exception, and applicable special rules, see section 
6652(c)(4) through (6).
    (d) Acknowledgment of receipt. Within 60 days after receipt of the 
notification, the Commissioner will send the organization an 
acknowledgment of such receipt. This acknowledgment is not a 
determination by the Commissioner that the organization qualifies for 
exemption under section 501(a) as an organization described in section 
501(c)(4). See paragraph (e) of this section.
    (e) Separate procedure by which an organization may request an IRS 
determination that it qualifies for section 501(c)(4) tax-exempt status. 
Submission of the notification does not constitute a request by an 
organization for a determination by the Commissioner that the 
organization qualifies for exemption under section 501(a) as an 
organization described in section 501(c)(4). An organization seeking IRS 
recognition of its tax-exempt status must separately request such a 
determination in accordance with Sec.  1.501(a)-1 and all applicable 
guidance published in the Internal Revenue Bulletin (see Sec.  
601.601(d)(2) of this chapter), forms, and instructions.
    (f) Applicability date. This section applies on and after July 8, 
2016.

[T.D. 9873, 84 FR 35306, July 23, 2019]

                           Private Foundations



Sec.  1.507-1  General rule.

    (a) In general. Except as provided in Sec.  1.507-2, the status of 
any organization as a private foundation shall be terminated only if:
    (1) Such organization notifies the district director of its intent 
to accomplish such termination, or
    (2)(i) With respect to such organization, there have been either 
willful repeated acts (or failures to act), or a willful and flagrant 
act (or failure to act), giving rise to liability for tax under chapter 
42, and
    (ii) The Commissioner notifies such organization that, by reason of 
subdivision (i) of this subparagraph, such organization is liable for 
the tax imposed by section 507(c)


and either such organization pays the tax imposed by section 507(c) (or 
any portion not abated under section 507(g)) or the entire amount of 
such tax is abated under section 507(g).
    (b) Termination under section 507(a)(1). (1) In order to terminate 
its private foundation status under paragraph (a)(1) of this section, an 
organization must submit a statement to the district director of its 
intent to terminate its private foundation status under section 
507(a)(1). Such statement must set

[[Page 104]]

forth in detail the computation and amount of tax imposed under section 
507(c). Unless the organization requests abatement of such tax pursuant 
to section 507(g), full payment of such tax must be made at the time the 
statement is filed under section 507(a)(1). An organization may request 
the abatement of all of the tax imposed under section 507(c), or may pay 
any part thereof and request abatement of the unpaid portion of the 
amount of tax assessed. If the organization requests abatement of the 
tax imposed under section 507(c) and such request is denied, the 
organization must pay such tax in full upon notification by the Internal 
Revenue Service that such tax will not be abated. For purposes of 
subtitle F of the Code, the statement described in this subparagraph, 
once filed, shall be treated as a return.
    (2) Termination of private foundation status under section 507(a)(1) 
does not relieve a private foundation, or any disqualified person with 
respect thereto, of liability for tax under chapter 42 with respect to 
acts or failures to act prior to termination or for any additional taxes 
imposed for failure to correct such acts or failures to act. See 
subparagraph (8) of this paragraph as to the possible imposition of 
transferee liability in cases not involving termination of private 
foundation status.
    (3) In the case of an organization which has terminated its private 
foundation status under section 507(a) and continues in operation 
thereafter, if such organization wishes to be treated as described in 
section 501(c)(3), then pursuant to section 509(c) and Sec.  1.509(c)-1 
such organization must apply for recognition of exemption as an 
organization described in section 501(c)(3) in accordance with the 
provisions of section 508(a).
    (4) See Sec.  53.4947-1(c)(7) of this chapter as to the application 
of section 507(a) to certain split-interest trusts.
    (5) For purposes of section 508(d)(1), the Internal Revenue Service 
shall make notice to the public (such as by publication in the Internal 
Revenue Bulletin) of any notice received from a private foundation 
pursuant to section 507(a)(1) or of any notice given to a private 
foundation pursuant to section 507(a)(2).
    (6) If a private foundation transfers all or part of its assets to 
one or more other private foundations (or one or more private 
foundations and one or more section 509(a) (1), (2), (3), or (4) 
organizations) pursuant to a transfer described in section 507(b)(2) and 
Sec.  1.507-3(c), such transferor foundation will not have terminated 
its private foundation status under section 507(a)(1). See Sec.  1.507-
3, however, for the special rules applicable to private foundations 
participating in section 507(b)(2) transfers.
    (7) Neither a transfer of all of the assets of a private foundation 
nor a significant disposition of assets (as defined in Sec.  1.507-
3(c)(2)) by a private foundation (whether or not any portion of such 
significant disposition of assets is made to another private foundation) 
shall be deemed to result in a termination of the transferor private 
foundation under section 507(a) unless the transferor private foundation 
elects to terminate pursuant to section 507(a)(1) or section 507(a)(2) 
is applicable. Thus, if a private foundation transfers all of its assets 
to one or more persons, but less than all of its net assets to one or 
more organizations described in section 509(a)(1) which have been in 
existence and so described for a continuous period of 60 calendar 
months, for purposes of this paragraph such transferor foundation will 
not be deemed by reason of such transfer to have terminated its private 
foundation status under section 507 (a) or (b) unless section 507(a)(2) 
is applicable. Such foundation will continue to be treated as a private 
foundation for all purposes. For example, if a private foundation 
transfers all of its net assets to a section 509(a)(2) organization in 
1971 and receives a bequest in 1973, the bequest will be regarded as 
having been made to a private foundation and the foundation will be 
subject to the provisions of chapter 42 with respect to such funds. If a 
private foundation makes a transfer of all of its net assets to a 
section 509(a) (2) or (3) organization, for example, it must retain 
sufficient income or assets to pay the tax imposed under section 4940 
for that portion of its taxable year prior to such transfer. For 
additional rules applicable to a transfer by a private foundation of all 
of its

[[Page 105]]

net assets to a section 509(a)(1) organization which has not been in 
existence and so described for a continuous period of 60 calendar 
months, see Sec.  1.507-3(e).
    (8) If a private foundation makes a transfer described in 
subparagraph (7) of this paragraph and prior to, or in connection with, 
such transfer, liability for any tax under chapter 42 is incurred by the 
transferor foundation, transferee liability may be applied against the 
transferee organization for payment of such taxes. For purposes of this 
subparagraph, liability for any tax imposed under chapter 42 for failure 
to correct any act or failure to act shall be deemed incurred on the 
date on which the act or failure to act giving rise to the initial tax 
liability occurred.
    (9) A private foundation which transfers all of its net assets is 
required to file the annual information return required by section 6033, 
and the foundation managers are required to file the annual report of a 
private foundation required by section 6056, for the taxable year in 
which such transfer occurs. However, neither such foundation nor its 
foundation managers will be required to file such returns for any 
taxable year following the taxable year in which the last of any such 
transfers occurred, if at no time during the subsequent taxable years in 
question the foundation has either legal or equitable title to any 
assets or engages in any activity.
    (c) Involuntary termination under section 507(a)(2). (1) For 
purposes of section 507(a)(2)(A), the term willful repeated acts (or 
failures to act) means at least two acts or failures to act both of 
which are voluntary, conscious, and intentional.
    (2) For purposes of section 507(a)(2)(A), a willful and flagrant act 
(or failure to act) is one which is voluntarily, consciously, and 
knowingly committed in violation of any provision of chapter 42 (other 
than section 4940 or 4948(a)) and which appears to a reasonable man to 
be a gross violation of any such provision.
    (3) An act (or failure to act) may be treated as an act (or failure 
to act) by the private foundation for purposes of section 507(a)(2) even 
though tax is imposed upon one or more foundation managers rather than 
upon the foundation itself.
    (4) For purposes of section 507(a)(2), the failure to correct the 
act or acts (or failure or failures to act) which gave rise to liability 
for tax under any section of chapter 42 by the close of the correction 
period for such section may be a willful and flagrant act (or failure to 
act).
    (5) No motive to avoid the restrictions of the law or the incurrence 
of any tax is necessary to make an act (or failure to act) willful. 
However, a foundation's act (or failure to act) is not willful if the 
foundation (or a foundation manager, if applicable) does not know that 
it is an act of self-dealing, a taxable expenditure, or other act (or 
failure to act) to which chapter 42 applies. Rules similar to the 
regulations under chapter 42 (see, for example, Sec.  53.4945-
1(a)(2)(iii) of this chapter) shall apply in determining whether a 
foundation or a foundation manager knows that an act (or failure to act) 
is an act of self-dealing a taxable expenditure or other such act (or 
failure to act).

[T.D. 7233, 37 FR 28157, Dec. 21, 1972, as amended by T.D. 7290, 38 FR 
31833, Nov. 19, 1973]



Sec.  1.507-2  Special rules; transfer to, or operation as, public
charity.

    (a) Transfer to public charities--(1) General rule. Under section 
507(b)(1)(A) a private foundation, with respect to which there have not 
been either willful repeated acts (or failures to act) or a willful and 
flagrant act (or failure to act) giving rise to liability for tax under 
Chapter 42, may terminate its private foundation status by distributing 
all of its net assets to one or more organizations described in section 
170(b)(1)(A) (other than in clauses (vii) and (viii)) each of which has 
been in existence and so described for a continuous period of at least 
60 calendar months immediately preceding such distribution. Because 
section 507(a) does not apply to such a termination, a private 
foundation which makes such a termination is not required to give the 
notification described in section 507(a)(1). A private foundation that 
terminates its private foundation status

[[Page 106]]

under section 507(b)(1)(A) does not incur tax under section 507(c) and, 
therefore, no abatement of such tax under section 507(g) is required.
    (2) Effect of current ruling. A private foundation seeking to 
terminate its private foundation status pursuant to section 507(b)(1)(A) 
may rely on a ruling or determination letter issued to a potential 
distributee organization that such distributee organization is an 
organization described in section 170(b)(1)(A)(i), 170(b)(1)(A)(ii), 
170(b)(1)(A)(iii), 170(b)(1)(A)(iv), 170(b)(1)(A)(v), or 
170(b)(1)(A)(vi) in accordance with the provisions of Sec.  1.509(a)-7.
    (3) Organizations described in more than one clause of section 
170(b)(1)(A). For purposes of this paragraph and section 507(b)(1)(A), 
the parenthetical term ``other than in clauses (vii) and (viii)'' shall 
refer only to an organization that is described only in section 
170(b)(1)(A)(vii) or section 170(b)(1)(A) (viii). Thus, an organization 
described in section 170(b)(1)(A)(i), 170(b)(1)(A)(ii), 
170(b)(1)(A)(iii), 170(b)(1)(A)(iv), 170(b)(1)(A)(v), or 
170(b)(1)(A)(vi) will not be precluded from being a distributee 
described in section 507(b)(1)(A) merely because it also appears to meet 
the description of an organization described in section 
170(b)(1)(A)(vii) or section 170(b)(1)(A)(viii).
    (4) Applicability of Chapter 42 to foundations terminating under 
section 507(b)(1)(A). An organization that terminates its private 
foundation status pursuant to section 507(b)(1)(A) will remain subject 
to the provisions of Chapter 42 until the distribution of all of its net 
assets to distributee organizations described in section 507(b)(1)(A) 
has been completed.
    (5) Return required from organizations terminating private 
foundation status under section 507(b)(1)(A)--(i) An organization that 
terminates its private foundation status under section 507(b)(1)(A) is 
required to file a return under the provisions of section 6043(b).
    (ii) An organization that terminates its private foundation status 
under section 507(b)(1)(A) is not required to comply with section 
6104(d) for the taxable year in which such termination occurs.
    (6) Distribution of net assets. A private foundation will meet the 
requirement to ``distribute all of its net assets'' within the meaning 
of section 507(b)(1)(A) only if it transfers all of its right, title, 
and interest in and to all of its net assets to one or more 
organizations referred to in section 507(b)(1)(A).
    (7) Effect of restrictions and conditions upon distributions of net 
assets--(i) In general. In order to effectuate a transfer of ``all of 
its right, title, and interest in and to all of its net assets'' within 
the meaning of paragraph (a)(6) of this section, a transferor private 
foundation may not impose any material restriction or condition that 
prevents the transferee organization referred to in section 507(b)(1)(A) 
(herein sometimes referred to as the ``public charity'') from freely and 
effectively employing the transferred assets, or the income derived 
therefrom, in furtherance of its exempt purposes. Whether or not a 
particular condition or restriction imposed upon a transfer of assets is 
material (within the meaning of this paragraph (a)(7)) must be 
determined from all of the facts and circumstances of the transfer. Some 
of the more significant facts and circumstances to be considered in 
making such a determination are--
    (A) Whether the public charity (including a participating trustee, 
custodian, or agent in the case of a community trust) is the owner in 
fee of the assets it receives from the private foundation;
    (B) Whether such assets are to be held and administered by the 
public charity in a manner consistent with one or more of its exempt 
purposes;
    (C) Whether the governing body of the public charity has the 
ultimate authority and control over such assets, and the income derived 
therefrom; and
    (D) Whether, and to what extent, the governing body of the public 
charity is organized and operated so as to be independent from the 
transferor.
    (ii) Independent governing body. As provided in paragraph 
(a)(7)(i)(D) of this section, one of the more significant facts and 
circumstances to be considered in making the determination whether a 
particular condition or restriction imposed upon a transfer of assets is 
material within the meaning of

[[Page 107]]

this paragraph (a)(7) is whether, and the extent to which, the governing 
body is organized and operated so as to be independent from the 
transferor. In turn, the determination as to such factor must be 
determined from all of the facts and circumstances. Some of the more 
significant facts and circumstances to be considered in making such a 
determination are--
    (A) Whether, and to what extent, members of the governing body are 
comprised of persons selected by the transferor private foundation or 
disqualified persons with respect thereto or are themselves such 
disqualified persons;
    (B) Whether, and to what extent, members of the governing body are 
selected by public officials acting in their capacities as such; and
    (C) How long a period of time each member of the governing body may 
serve in such capacity. In the case of a transfer that is to a community 
trust, the community trust shall meet this paragraph (a)(7)(ii)(C) if--
    (1) Its governing body is comprised of members who may serve a 
period of not more than ten consecutive years; and
    (2) Upon completion of a period of service (beginning before or 
after the date of transfer), no member may serve again within a period 
consisting of the lesser of five years or the number of consecutive 
years the member has immediately completed serving.
    (iii) Factors not adversely affecting determination. The presence of 
some or all of the following factors will not be considered as 
preventing the transferee ``from freely and effectively employing the 
transferred assets, or the income derived therefrom, in furtherance of 
its exempt purposes'' (within the meaning of paragraph (a)(7)(i) of this 
section):
    (A) Name. The fund is given a name or other designation which is the 
same as or similar to that of the transferor private foundation or 
otherwise memorializes the creator of the foundation or his family.
    (B) Purpose. The income and assets of the fund are to be used for a 
designated purpose or for one or more particular section 509(a)(1), 
section 509(a)(2), or section 509(a)(3) organization, and such use is 
consistent with the charitable, educational, or other basis for the 
exempt status of the public charity under section 501(c)(3).
    (C) Administration. The transferred assets are administered in an 
identifiable or separate fund, some or all of the principal of which is 
not to be distributed for a specified period, if the public charity 
(including a participating trustee, custodian, or agent in the case of a 
community trust) is the legal and equitable owner of the fund and the 
governing body exercises ultimate and direct authority and control over 
such fund, as, for example, a fund to endow a chair at a university or a 
medical research fund at a hospital. In the case of a community trust, 
the transferred assets must be administered in or as a component part of 
the community trust within the meaning of Sec.  1.170A-9(f)(11).
    (D) Restrictions on disposition. The transferor private foundation 
transfers property the continued retention of which by the transferee is 
required by the transferor if such retention is important to the 
achievement of charitable or other similar purposes in the community 
because of the peculiar features of such property, as, for example, 
where a private foundation transfers a woodland preserve which is to be 
maintained by the public charity as an arboretum for the benefit of the 
community. Such a restriction does not include a restriction on the 
disposition of an investment asset or the distribution of income.
    (iv) Adverse factors. The presence of any of the following factors 
will be considered as preventing the transferee ``from freely and 
effectively employing the transferred assets, or the income derived 
therefrom, in furtherance of its exempt purposes'' (within the meaning 
of paragraph (a)(7)(i) of this section):
    (A) Distributions. (1) With respect to distributions made after 
April 19, 1977, the transferor private foundation, a disqualified person 
with respect thereto, or any person or committee designated by, or 
pursuant to the terms of an agreement with, such a person (hereinafter 
referred to as donor), reserves the right, directly or indirectly, to 
name (other than by designation in the instrument of transfer of 
particular section 509(a)(1), section 509(a)(2), or

[[Page 108]]

section 509(a)(3) organizations) the persons to which the transferee 
public charity must distribute, or to direct the timing of such 
distributions (other than by direction in the instrument of transfer 
that some or all of the principal, as opposed to specific assets, not be 
distributed for a specified period) as, for example, by a power of 
appointment. The IRS will examine carefully whether the seeking of 
advice by the transferee from, or the giving of advice by, any donor 
after the assets have been transferred to the transferee constitutes an 
indirect reservation of a right to direct such distributions. In any 
such case, the reservation of such a right will be considered to exist 
where the only criterion considered by the public charity in making a 
distribution of income or principal from a donor's fund is advice 
offered by the donor. Whether there is a reservation of such a right 
will be determined from all of the facts and circumstances, including, 
but not limited to, the factors contained in paragraphs (a)(7)(iv)(A)(2) 
and (a)(7)(iv)(A)(3) of this section.
    (2) The presence of some or all of the following factors will 
indicate that the reservation of a right to direct distributions does 
not exist:
    (i) There has been an independent investigation by the staff of the 
public charity evaluating whether the donor's advice is consistent with 
specific charitable needs most deserving of support by the public 
charity (as determined by the public charity).
    (ii) The public charity has promulgated guidelines enumerating 
specific charitable needs consistent with the charitable purposes of the 
public charity and the donor's advice is consistent with such 
guidelines.
    (iii) The public charity has instituted an educational program 
publicizing to donors and other persons the guidelines enumerating 
specific charitable needs consistent with the charitable purposes of the 
public charity.
    (iv) The public charity distributes funds in excess of amounts 
distributed from the donor's fund to the same or similar types of 
organizations or charitable needs as those recommended by the donor.
    (v) The public charity's solicitations (written or oral) for funds 
specifically state that such public charity will not be bound by advice 
offered by the donor.
    (3) The presence of some or all of the following factors will 
indicate the reservation of a right to direct distributions does exist:
    (i) The solicitations (written or oral) of funds by the public 
charity state or imply, or a pattern of conduct on the part of the 
public charity creates an expectation, that the donor's advice will be 
followed.
    (ii) The advice of a donor (whether or not restricted to a 
distribution of income or principal from the donor's trust or fund) is 
limited to distributions of amounts from the donor's fund, and the 
factors described in paragraph (a)(7)(iv)(A)(2)(i) or paragraph 
(a)(7)(iv)(A)(2)(ii) of this section are not present.
    (iii) Only the advice of the donor as to distributions of such 
donor's fund is solicited by the public charity and no procedure is 
provided for considering advice from persons other than the donor with 
respect to such fund.
    (iv) For the taxable year and all prior taxable years the public 
charity follows the advice of all donors with respect to their funds 
substantially all of the time.
    (B) Other action or withholding of action. The terms of the transfer 
agreement, or any expressed or implied understanding, required the 
public charity to take or withhold action with respect to the 
transferred assets which is not designed to further one or more of the 
exempt purposes of the public charity, and such action or withholding of 
action would, if performed by the transferor private foundation with 
respect to such assets, have subjected the transferor to tax under 
Chapter 42 (other than with respect to the minimum investment return 
requirement of section 4942(e)).
    (C) Assumption of leases, contractual obligations, or liabilities. 
The public charity assumes leases, contractual obligations, or 
liabilities of the transferor private foundation, or takes the assets 
thereof subject to such liabilities (including obligations under 
commitments or pledges to donees of the transferor private foundation), 
for purposes inconsistent with the purposes or

[[Page 109]]

best interests of the public charity, other than the payment of the 
transferor's Chapter 42 taxes incurred prior to the transfer to the 
public charity to the extent of the value of the assets transferred.
    (D) Retention of investment assets. The transferee public charity is 
required by any restriction or agreement (other than a restriction or 
agreement imposed or required by law or regulatory authority), express 
or implied, to retain any securities or other investment assets 
transferred to it by the private foundation. In a case where such 
transferred assets consistently produce a low annual return of income, 
the IRS will examine carefully whether the transferee is required by any 
such restriction or agreement to retain such assets.
    (E) Right of first refusal. An agreement is entered into in 
connection with the transfer of securities or other property which 
grants directly or indirectly to the transferor private foundation or 
any disqualified person with respect thereto a right of first refusal 
with respect to the transferred securities or other property when and if 
disposed of by the public charity, unless such securities or other 
property was acquired by the transferor private foundation subject to 
such right of first refusal prior to October 9, 1969.
    (F) Relationships. An agreement is entered into between the 
transferor private foundation and the transferee public charity which 
establishes irrevocable relationships with respect to the maintenance or 
management of assets transferred to the public charity, such as 
continuing relationships with banks, brokerage firms, investment 
counselors, or other advisors with regard to the investments or other 
property transferred to the public charity (other than a relationship 
with a trustee, custodian, or agent for a community trust acting as 
such). The transfer of property to a public charity subject to 
contractual obligations which were established prior to November 11, 
1976, between the transferor private foundation and persons other than 
disqualified persons with respect to such foundation will not be treated 
as prohibited under the preceding sentence, but only if such contractual 
obligations were not entered into pursuant to a plan to terminate the 
private foundation status of the transferor under section 507(b)(1)(A) 
and if the continuation of such contractual obligations is in the best 
interests of the public charity.
    (G) Other conditions. Any other condition is imposed on action by 
the public charity which prevents it from exercising ultimate control 
over the assets received from the transferor private foundation for 
purposes consistent with its exempt purposes.
    (v) Examples. The provisions of this paragraph (a)(7) may be 
illustrated by the following examples:

    Example 1. The M Private Foundation transferred all of its net 
assets to the V Cancer Institute, a public charity described in section 
170(b)(1)(A)(iii). Prior to the transfer, M's activities consisted of 
making grants to hospitals and universities to further research into the 
causes of cancer. Under the terms of the transfer, V is required to keep 
M's assets in a separate fund and use the income and principal to 
further cancer research. Although the assets may be used only for a 
limited purpose, this purpose is consistent with and in furtherance of 
V's exempt purposes, and does not prevent the transfer from being a 
distribution for purposes of section 507(b)(1)(A).
    Example 2. The N Private Foundation transferred all of its net 
assets to W University, a public charity described in section 
170(b)(1)(A)(ii). Under the terms of the transfer, W is required to use 
the income and principal to endow a chair at the university to be known 
as the ``John J. Doe Memorial Professorship,'' named after N's creator. 
Although the transferred assets are to be used for a specified purpose 
by W, this purpose is in furtherance of W's exempt educational purposes, 
and there are no conditions on investment or reinvestment of the 
principal or income. The use of the name of the foundation's creator for 
the chair is not a restriction which would prevent the transfer from 
being a distribution for purposes of section 507(b)(1)(A).
    Example 3. The O Private Foundation transferred all of its net 
assets to X Bank as trustee for the Q Community Trust, a community trust 
that is a public charity described in section 170(b)(1)(A)(vi). Under 
the terms of the transfer, X is to hold the assets in trust for Q and is 
directed to distribute the income annually to the Y Church, a public 
charity described in section 170(b)(1)(A)(i). The distribution of income 
to Y Church is consistent with Q's exempt purposes. If the trust created 
by this transfer otherwise meets the requirements of Sec.  1.170A-

[[Page 110]]

9(f)(11) as a component part of the Q Community Trust, the assets 
transferred by O to X will be treated as distributed to one or more 
public charities within the meaning of section 507(b)(1)(A). The 
direction to distribute the income to Y Church meets the conditions of 
paragraph (a)(7)(iii)(B) of this section and will therefore not 
disqualify the transfer under section 507(b)(1)(A).
    Example 4. (i) The P Private Foundation transferred all of its net 
assets to Z Bank as trustee for the R Community Trust, a community trust 
that is a public charity described in section 170(b)(1)(A)(vi). Under 
the terms of the transfer, Z is to hold the assets in trust for R and 
distribute the income to those public charities described in section 
170(b)(1)(A)(i) through (b)(1)(A)(vi) that are designated by B, the 
creator of P. R's governing body has no authority during B's lifetime to 
vary B's direction. Under the terms of the transfer, it is intended that 
Z retain the transferred assets in their present form for a period of 20 
years, or until the date of B's death if it occurs before the expiration 
of such period. Upon the death of B, R will have the power to distribute 
the income to such public charities as it selects and may dispose of the 
corpus as it sees fit.
    (ii) Under paragraph (a)(7)(iv)(A) or paragraph (a)(7)(iv)(D) of 
this section, as a result of the restrictions imposed with respect to 
the transferred assets, there has been no distribution of all P's net 
assets within the meaning of section 507(b)(1)(A) at the time of the 
transfer. In addition, P has not transferred its net assets to a 
component part of R Community Trust, but rather to a separate trust 
described in Sec.  1.170A-9(f)(12).

    (b) Operation as a public charity--(1) In general. Under section 
507(b)(1)(B), an organization can terminate its private foundation 
status if the organization--
    (i) Meets the requirements of section 509(a)(1), section 509(a)(2) 
or section 509(a)(3) for a continuous period of 60 calendar months 
beginning with the first day of any taxable year that begins after 
December 31, 1969;
    (ii) In compliance with section 507(b)(1)(B)(ii) and paragraph 
(b)(3) of this section, properly notifies the IRS, in such manner as may 
be provided by published guidance, publication, form or instructions, 
before the commencement of such 60-month period, that it is terminating 
its private foundation status; and
    (iii) Properly establishes immediately after the expiration of such 
60-month period that such organization has complied with the 
requirements of section 509(a)(1), section 509(a)(2) or section 
509(a)(3) during the 60-month period, in the manner described in 
paragraph (b)(4) of this section.
    (2) Relationship of section 507(b)(1)(B) to sections 507(a), 507(c), 
and 507(g). Because section 507(a) does not apply to a termination 
described in section 507(b)(1)(B), a private foundation's notification 
that it is commencing a termination pursuant to section 507(b)(1)(B) 
will not be treated as a notification described in section 507(a) even 
if the private foundation does not successfully terminate its private 
foundation status pursuant to section 507(b)(1)(B). A private foundation 
that terminates its private foundation status under section 507(b)(1)(B) 
does not incur tax under section 507(c) and, therefore, no abatement of 
such tax under section 507(g) is required.
    (3) Notification of termination. In order to comply with the 
requirements under section 507(b)(1)(B)(ii), an organization shall 
before the commencement of the 60-month period under section 
507(b)(1)(B)(i) notify the IRS, in such manner as may be provided by 
published guidance, publication, form or instructions, of its intention 
to terminate its private foundation status. Such notification shall 
contain the following information--
    (i) The name and address of the private foundation;
    (ii) Its intention to terminate its private foundation status;
    (iii) The Code section under which it seeks classification (section 
509(a)(1), section 509(a)(2) or section 509(a)(3));
    (iv) If section 509(a)(1) is applicable, the clause of section 
170(b)(1)(A) involved;
    (v) The date its regular taxable year begins; and
    (vi) The date of commencement of the 60-month period.
    (4) Establishment of termination. In order to comply with the 
requirements under section 507(b)(1)(B)(iii), an organization shall 
within 90 days after the expiration of the 60-month period file such 
information with the IRS, in such manner as may be provided by published 
guidance, publication, form or instructions, as is necessary to make a 
determination as to the organization's status as an organization 
described

[[Page 111]]

under section 509(a)(1), section 509(a)(2) or section 509(a)(3) and the 
related regulations. See paragraph (c) of this section as to the 
information required to be submitted under this paragraph (b)(4).
    (5) Incomplete information. The failure to supply, within the 
required time, all of the information required by paragraph (b)(3) or 
paragraph (b)(4) of this section is not alone sufficient to constitute a 
failure to satisfy the requirements of section 507(b)(1)(B). If the 
information that is submitted within the required time is incomplete and 
the organization supplies the necessary additional information at the 
request of the Commissioner within the additional time period allowed by 
him, the original submission will be considered timely.
    (6) Application of special rules and filing requirements. An 
organization that has terminated its private foundation status under 
section 507(b)(1)(B) is not required to comply with the special rules 
set forth in sections 508(a) and 508(b). Such organization is also not 
required to file a return under the provisions of section 6043(b) by 
reason of termination of its private foundation status under the 
provisions of section 507(b)(1)(B).
    (7) Extension of time to assess deficiencies. If a private 
foundation files a notification (described in paragraph (b)(3) of this 
section) that it intends to begin a 60-month termination pursuant to 
section 507(b)(1)(B) and does not file a request for an advance ruling 
pursuant to paragraph (d) of this section, such private foundation may 
file with the notification described in paragraph (b)(3) of this section 
a consent under section 6501(c)(4) to the effect that the period of 
limitation upon assessment under section 4940 for any taxable year 
within the 60-month termination period shall not expire prior to one 
year after the date of expiration of the time prescribed by law for the 
assessment of a deficiency for the last taxable year within the 60-month 
period. Such consents, if filed, will ordinarily be accepted by the 
Commissioner. See paragraph (e)(3) of this section for an illustration 
of the procedure required to obtain a refund of the tax imposed by 
section 4940 in a case where such a consent is not in effect.
    (c) Sixty-month terminations--(1) Method of determining normal 
sources of support. (i) In order to meet the requirements of section 
507(b)(1)(B) for the 60-month termination period as a section 509(a)(1) 
or section 509(a)(2) organization, an organization must meet the 
requirements of section 509(a)(1) or section 509(a)(2), as the case may 
be, for a continuous period of at least 60 calendar months. In 
determining whether an organization seeking status under section 
509(a)(1) as an organization described in section 170(b)(1)(A)(iv) or 
section 170(b)(1)(A)(vi) or under section 509(a)(2) normally meets the 
requirements set forth under such sections, support received in taxable 
years prior to the commencement of the 60-month period shall not be 
taken into consideration, except as otherwise provided in this section.
    (ii) For purposes of section 507(b)(1)(B), an organization will be 
considered to be a section 509(a)(1) organization described in section 
170(b)(1)(A)(vi) for a continuous period of 60 calendar months only if 
the organization satisfies the provisions of Sec.  1.170A-9(f), other 
than Sec.  1.170A-9(f)(4)(v), based upon aggregate data for such entire 
period. The calculation of public support shall be made over the period 
beginning with the date of the commencement of the 60-month period, and 
ending with the last day of the 60-month period.
    (iii) For purposes of section 507(b)(1)(B), an organization will be 
considered to be a section 509(a)(2) organization only if such 
organization meets the support requirements set forth in sections 
509(a)(2)(A) and 509(a)(2)(B) and the related regulations, other than 
Sec.  1.509(a)-3(d), for the continuous period of 60 calendar months 
prescribed under section 507(b)(1)(B). The calculation of public support 
shall be made over the period beginning with the date of the 
commencement of the 60-month period, and ending with the last day of the 
60-month period.
    (2) Organizational and operational tests. In order to meet the 
requirements of section 507(b)(1)(B) for the 60-month termination period 
as an organization described in section 170(b)(1)(A)(i),

[[Page 112]]

170(b)(1)(A)(ii), 170(b)(1)(A)(iii), 170(b)(1)(A)(iv), or 
170(b)(1)(A)(v) or section 509(a)(3), as the case may be, an 
organization must meet the requirements of the applicable provisions for 
a continuous period of at least 60 calendar months. For purposes of 
section 507(b)(1)(B), an organization will be considered to be such an 
organization only if it satisfies the requirements of the applicable 
provision (including with respect to section 509(a)(3), the 
organizational and operational test set forth in section 509(a)(3)(A)) 
at the commencement of such 60-month period and continuously thereafter 
during such period.
    (d) Advance rulings for 60-month terminations--(1) In general. An 
organization that files the notification required by section 
507(b)(1)(B)(ii) that it is commencing a 60-month termination may obtain 
an advance ruling from the Commissioner that it can be expected to 
satisfy the requirements of section 507(b)(1)(B)(i) during the 60-month 
period. Such an advance ruling may be issued if the organization can 
reasonably be expected to meet the requirements of section 
507(b)(1)(B)(i) during the 60-month period. The issuance of a ruling 
will be discretionary with the Commissioner.
    (2) Basic consideration. In determining whether an organization can 
reasonably be expected (within the meaning of paragraph (d)(1) of this 
section) to meet the requirements of section 507(b)(1)(B)(i) for the 60-
month period, the basic consideration is whether its organizational 
structure (taking into account any revisions made prior to the beginning 
of the 60-month period), current or proposed programs or activities, 
actual or intended method of operation, and current or projected sources 
of support are such as to indicate that the organization is likely to 
satisfy the requirements of section 509(a)(1), section 509(a)(2), or 
section 509(a)(3) and paragraph (c) of this section during the 60-month 
period. In making such a determination, all pertinent facts and 
circumstances shall be considered.
    (3) Reliance by grantors and contributors. For purposes of sections 
170, 545(b)(2), 642(c), 4942, 4945, 4966, 2055, 2106(a)(2), and 2522, 
grants or contributions to an organization which has obtained a ruling 
referred to in this paragraph will be treated as made to an organization 
described in section 509(a)(1), section 509(a)(2), or section 509(a)(3), 
as the case may be, until the IRS publishes notice that such advance 
ruling is being revoked (such as by publication in the Internal Revenue 
Bulletin). However, a grantor or contributor may not rely on such an 
advance ruling if the grantor or contributor was responsible for, or 
aware of, the act or failure to act that resulted in the organization's 
failure to meet the requirements of section 509(a)(1), section 
509(a)(2), or section 509(a)(3), or acquired knowledge that the IRS had 
given notice to such organization that its advance ruling would be 
revoked. Prior to the making of any grant or contribution which 
allegedly will not result in the grantee's failure to meet the 
requirements of section 509(a)(1), section 509(a)(2), or section 
509(a)(3), a potential grantee organization may request a ruling whether 
such grant or contribution may be made without such failure. A request 
for such ruling may be filed by the grantee organization with the IRS. 
The issuance of such ruling will be at the sole discretion of the 
Commissioner. The organization must submit all information necessary to 
make a determination on the factors referred to in paragraph (d)(2) of 
this section. If a favorable ruling is issued, such ruling may be relied 
upon by the grantor or contributor of the particular contribution in 
question for purposes of sections 170, 507, 545(b)(2), 642(c), 4942, 
4945, 4966, 2055, 2106(a)(2), and 2522.
    (4) Reliance by organization. An organization obtaining an advance 
ruling pursuant to this paragraph cannot rely on such a ruling. 
Consequently, if the organization does not pay the tax imposed by 
section 4940 for any taxable year or years during the 60-month period, 
and it is subsequently determined that such tax is due for such year or 
years (because the organization did not in fact complete a successful 
termination pursuant to section 507(b)(1)(B) and was not treated as an 
organization described in section 509(a)(1), section 509(a)(2), or 
section 509(a)(3) for such

[[Page 113]]

year or years), the organization is liable for interest in accordance 
with section 6601 if any amount of tax under section 4940 has not been 
paid on or before the last date prescribed for payment. However, because 
any failure to pay such tax during the 60-month period (or prior to the 
revocation of such ruling) is due to reasonable cause, the penalty under 
section 6651 with respect to the tax imposed by section 4940 shall not 
apply.
    (5) Extension of time to assess deficiencies. The advance ruling 
described in paragraph (d)(1) of this section shall be issued only if 
such organization's request for an advance ruling is filed with a 
consent under section 6501(c)(4) to the effect that the period of 
limitations upon assessment under section 4940 for any taxable year 
within the advance ruling period shall not expire prior to one year 
after the date of the expiration of the time prescribed by law for the 
assessment of a deficiency for the last taxable year within the 60-month 
period.
    (e) Effect on grantors or contributors and on the organization 
itself--(1) Effect of satisfaction of requirements for termination; 
treatment during the termination period. In the event that an 
organization satisfies the requirements of section 507(b)(1)(B) for 
termination of its private foundation status during the continuous 60-
month period, such organization shall be treated for such entire 60-
month period in the same manner as an organization described in section 
509(a)(1), section 509(a)(2), or section 509(a)(3), as the case may be.
    (2) Failure to meet termination requirements--(i) In general. Except 
as otherwise provided in paragraphs (d) and (e)(2)(ii) of this section, 
any organization that fails to satisfy the requirements of section 
507(b)(1)(B) for termination of its private foundation status during the 
continuous 60-month period shall be treated as a private foundation for 
the entire 60-month period, for purposes of sections 507 through 509 and 
Chapter 42, and grants or contributions to such an organization shall be 
treated as made to a private foundation for purposes of sections 170, 
507(b)(1)(A), 4942, and 4945.
    (ii) Certain 60-month terminations. Notwithstanding paragraph 
(e)(2)(i) of this section, if an organization fails to satisfy the 
requirements of section 509(a)(1), section 509(a)(2), or section 
509(a)(3) for the continuous 60-month period but does satisfy the 
requirements of section 509(a)(1), section 509(a)(2), or section 
509(a)(3), as the case may be, for any taxable year or years during such 
60-month period, the organization shall be treated as a section 
509(a)(1), section 509(a)(2), or section 509(a)(3) organization for such 
taxable year or years, and grants or contributions made during such 
taxable year or years shall be treated as made to an organization 
described in section 509(a)(1), section 509(a)(2), or section 509(a)(3). 
In addition, sections 507 through 509 and Chapter 42 shall not apply to 
such organization for any taxable year within such 60-month period for 
which it does meet such requirements. For purposes of determining 
whether an organization satisfies the requirements of section 509(a)(1), 
section 509(a)(2), or section 509(a)(3) for any taxable year in the 60-
month period, the calculation of public support shall be made over the 
period beginning with the date of the commencement of the 60-month 
period, and ending with the last day of the taxable year being tested. 
The organization shall not be treated as a section 509(a)(1) or section 
509(a)(2) organization for any taxable year during the 60-month period 
solely by reason of having met a public support test for the preceding 
year. In addition, the transition rules in Sec. Sec.  1.170-
9(f)(14)(iii) and 1.509(a)-3(n)(iii) shall not apply.
    (iii) Aggregate tax benefit. For purposes of section 507(d), the 
organization's aggregate tax benefit resulting from the organization's 
section 501(c)(3) status shall continue to be computed from the date 
from which such computation would have been made, but for the notice 
filed under section 507(b)(1)(B)(ii), except that any taxable year 
within such 60-month period for which such organization meets the 
requirements of section 509(a)(1), section 509(a)(2), or section 
509(a)(3) shall be excluded from such computations.
    (iv) Excess business holdings. See section 4943 and the related 
regulations

[[Page 114]]

for rules relating to decreases in a private foundation's holdings in a 
business enterprise which are caused by the foundation's failure to 
terminate its private foundation status after giving the notification 
for termination under section 507(b)(1)(B)(ii).
    (3) Example. The provisions of this paragraph (e) may be illustrated 
by the following example:
    Example 1. Y, a calendar year private foundation, notifies the IRS 
that it intends to terminate its private foundation status by converting 
into a publicly supported organization described in section 
170(b)(1)(A)(vi) and that its 60-month termination period will commence 
on January 1, 2010. Y does not obtain a ruling described in paragraph 
(d) of this section. Based upon its support for 2010, Y does not qualify 
as a publicly supported organization within the meaning of Sec.  1.170A-
9(f) and this paragraph for 2010. Consequently, in order to avoid the 
risks of penalties and interest if Y fails to terminate within the 60-
month period, Y files its 2010 return as a private foundation and pays 
the tax imposed by section 4940. Because a consent (described in 
paragraph (b)(7) of this section), which would prevent the period of 
limitations for all years in the 60-month period from expiring, is not 
in effect, in order to be able to file a claim for refund, Y and the IRS 
must agree to extend the period of limitation for all taxes imposed 
under Chapter 42 for 2010. Based on the aggregate data for the entire 
60-month period (2010 through 2014), Y does qualify as a publicly-
supported organization for the entire 60-month period. Consequently, Y 
is treated as a publicly-supported organization for the entire 60-month 
period. Y files a claim for refund for the taxes paid under section 4940 
for 2010, and such taxes are refunded.

    (f) Effective/applicability date--(1) Effective date. These 
regulations are effective on September 8, 2011.
    (2) Applicability date. The regulations in this section shall apply 
to tax years beginning on or after January 1, 2008. For taxable years 
beginning after December 31, 1969, and beginning before January 1, 2008, 
see Sec.  1.507-2 (as contained in 26 CFR part 1 revised April 1, 2008).

[T.D. 9549, 76 FR 55760, Sept. 8, 2011]



Sec.  1.507-3  Special rules; transferee foundations.

    (a) General rule. (1) For purposes of part II, subchapter F, chapter 
1 of the Code, in the case of a transfer of assets of any private 
foundation to another private foundation pursuant to any liquidation, 
merger, redemption, recapitalization, or other adjustment, organization, 
or reorganization, the transferee organization shall not be treated as a 
newly created organization. Thus, in the case of a significant 
disposition of assets to one or more private foundations within the 
meaning of paragraph (c) of this section, the transferee organization 
shall not be treated as a newly created organization. A transferee 
organization to which this paragraph applies shall be treated as 
possessing those attributes and characteristics of the transferor 
organization which are described in subparagraphs (2), (3), and (4) of 
this paragraph.
    (2)(i) A transferee organization to which this paragraph applies 
shall succeed to the aggregate tax benefit of the transferor 
organization in an amount determined as follows: Such amount shall be an 
amount equal to the amount of such aggregate tax benefit multiplied by a 
fraction the numerator of which is the fair market value of the assets 
(less encumbrances) transferred to such transferee and the denominator 
of which is the fair market value of the assets of the transferor (less 
encumbrances) immediately before the transfer. Fair market value shall 
be determined as of the time of the transfer.
    (ii) Notwithstanding subdivision (i) of this subparagraph, a 
transferee organization which is not effectively controlled (within the 
meaning of Sec.  1.482-1(a)(3)), directly or indirectly, by the same 
person or persons who effectively control the transferor organization 
shall not succeed to an aggregate tax benefit in excess of the fair 
market value of the assets transferred at the time of the transfer.
    (iii) This subparagraph may be illustrated by the following 
examples:

    Example 1. Pursuant to a transfer described in section 507(b)(2), F, 
a private foundation, transfers to G, a private foundation, all of its 
assets, which have a fair market value of $400,000. Immediately before 
the transfer F's aggregate tax benefit was $200,000, and G's aggregate 
tax benefit was $300,000. After the transfer G's aggregate tax benefit 
is $500,000 ($200,000 + $300,000).
    Example 2. Pursuant to a transfer described in section 507(b)(2), M, 
a private foundation, transfers all of its assets, which immediately 
prior to the transfer have a fair market

[[Page 115]]

value of $100,000. The assets were transferred to the following 
organizations at the following fair market values (determined at the 
time of transfer) $40,000 to N, a private foundation, $30,000 to O, a 
private foundation, and $30,000 to P, an organization described in 
section 170(b)(1)(A)(vi). Immediately before the transfer M's aggregate 
tax benefit was $50,000. Therefore, N succeeds to M's aggregate tax 
benefit to the extent of $20,000 ($50,000 x $40,000/$100,000) and O 
succeeds to M's aggregate tax benefit to the extent of $15,000 ($50,000 
x $30,000/$100,000). The remaining $15,000 of M's aggregate tax benefit 
is retained by M as M has not terminated under section 507.
    Example 3. Assume the same facts as in Example 2 except that the 
transfers were made as follows: M transferred $30,000 to N on January 1, 
1972, $40,000 to P on July 1, 1972, and $30,000 to O on December 31, 
1972. Further, assume that the fair market value of the assets and the 
aggregate tax benefit do not change during 1972 and that O is not 
effectively controlled (directly or indirectly) by the same person or 
persons who effectively control M. N succeeds to M's aggregate tax 
benefit to the extent of $15,000 ($50,000 x $30,000/$100,000). However, 
since $40,000 of the remaining $70,000 ($100,000-$30,000) of assets of M 
was transferred to P on July 1, 1972, immediately before the transfer to 
O, the fair market value of the assets held by M is $30,000 ($70,000-
$40,000). On the other hand, because P is not a private foundation, M's 
aggregate tax benefit immediately before the transfer to O remains 
$35,000 ($50,000-$15,000). Therefore, before applying subdivision (ii) 
of this subparagraph, O would succeed to $35,000 ($35,000 x $30,000/
$30,000) of M's aggregate tax benefit. However, applying subdivision 
(ii) of this subparagraph since M transferred only $30,000 to O, O shall 
succeed to only $30,000 of M's aggregate tax benefit. The remaining 
$5,000 ($35,000-$30,000) of M's aggregate tax benefit is retained by M 
as M has not terminated under section 507.

    (3) For purposes of section 507(d)(2), in the event of a transfer of 
assets described in section 507(b)(2), any person who is a substantial 
contributor (within the meaning of section 507(d)(2)) with respect to 
the transferor foundation shall be treated as a substantial contributor 
with respect to the transferee foundation, regardless of whether such 
person meets the $5,000-two percent test with respect to the transferee 
organization at any time. If a private foundation makes a transfer 
described in section 507(b)(2) to two or more transferee private 
foundations, any person who is a substantial contributor with respect to 
the transferor foundation prior to such transfer shall be considered a 
substantial contributor with respect to each transferee private 
foundation.
    (4) If a private foundation incurs liability for one or more of the 
taxes imposed under chapter 42 (or any penalty resulting therefrom) 
prior to, or as a result of, making a transfer of assets described in 
section 507(b)(2) to one or more private foundations, in any case where 
transferee liability applies each transferee foundation shall be treated 
as receiving the transferred assets subject to such liability to the 
extent that the transferor foundation does not satisfy such liability.
    (5) Except as provided in subparagraph (9) of this paragraph, a 
private foundation is required to meet the distribution requirements of 
section 4942 for any taxable year in which it makes a section 507(b)(2) 
transfer of all or part of its net assets to another private foundation. 
Such transfer shall itself be counted toward satisfaction of such 
requirements to the extent the amount transferred meets the requirements 
of section 4942(g). However, where the transferor has disposed of all of 
its assets, the recordkeeping requirements of section 4942(g)(3)(B) 
shall not apply during any period in which it has no assets. Such 
requirements are applicable for any taxable year other than a taxable 
year during which the transferor has no assets.
    (6) For purposes of section 4943(c) (4), (5), and (6), whenever a 
private foundation makes a section 507(b)(2) transfer of all or part of 
its net assets to another private foundation, the applicable period of 
time described in section 4943(c) (4), (5), or (6) shall include both 
the period during which the transferor foundation held such assets and 
the period during which the transferee foundation holds such assets.
    (7) Except as provided in subparagraph (9) of this paragraph, where 
the transferor has disposed of all of its assets, during any period in 
which the transferor has no assets, section 4945 (d)(4) and (h) shall 
not apply to the transferee or the transferor with respect to any 
expenditure responsibility grants made by the transferor. However, the 
exception contained in this

[[Page 116]]

subparagraph shall not apply with respect to any information reporting 
requirements imposed by section 4945 and the regulations thereunder for 
any year in which any such transfer is made.
    (8)(i) Except as provided in subdivision (ii) of this subparagraph 
or subparagraph (6) or (9) of this paragraph or whenever a private 
foundation makes a transfer of assets described in section 507(b)(2) to 
one or more private foundations, the transferee foundation:
    (a) Will not be treated as being in existence prior to January 1, 
1970, with respect to any transferred assets;
    (b) Will not be treated as holding the transferred assets prior to 
January 1, 1970; and
    (c) Will not be treated as having engaged in, or become subject to, 
any transaction, lease, contract, or other obligation with respect to 
the transferred assets prior to January 1, 1970.
    (ii) Notwithstanding subdivision (i) of this subparagraph, the 
provisions enumerated in (a) through (g) of this subdivision shall apply 
to the transferee foundation with respect to the assets transferred to 
the same extent and in the same manner that they would have applied to 
the transferor foundation had the transfer described in section 
507(b)(2) not been effected:
    (a) Section 4940(c)(4)(B) and the regulations thereunder with 
respect to basis of property,
    (b) Section 4942(f)(4) and the regulations thereunder with respect 
to distributions of income,
    (c) Section 101(l)(2) of the Tax Reform Act of 1969 (83 Stat. 533), 
as amended by sections 1301 and 1309 of the Tax Reform Act of 1976 (90 
Stat. 1713, 1729), with respect to the provisions of section 4941,
    (d) Section 101(l)(3)(A) of the Tax Reform Act of 1969 (83 Stat. 
534) with respect to the provisions of section 4942, but only if the 
transferor qualified for the application of such section immediately 
before the transfer, and at least 85 percent of the fair market value of 
the net assets of the transferee immediately after the transfer was 
received pursuant to the transfer,
    (e) Section 101(l)(3) (B) through (E) of the Tax Reform Act of 1969 
(83 Stat. 534) with respect to the provisions of section 4942,
    (f) Section 101(l)(5) of the Tax Reform Act of 1969 (83 Stat. 535) 
with respect to the provisions of section 4945, and
    (g) Section 101(l)(6) of the Tax Reform Act of 1969 (83 Stat. 535) 
with respect to the provisions of section 508(e).
    (9) (i) If a private foundation transfers all of its net assets to 
one or more private foundations which are effectively controlled (within 
the meaning of Sec.  1.482-1(a)(3)), directly or indirectly, by the same 
person or persons which effectively controlled the transferor private 
foundation, for purposes of chapter 42 (section 4940 et seq.) and part 
II of subchapter F of chapter 1 of the Code (sections 507 through 509) 
such a transferee private foundation shall be treated as if it were the 
transferor. However, where proportionality is appropriate, such a 
transferee private foundation shall be treated as if it were the 
transferor in the proportion which the fair market value of the assets 
(less encumbrances) transferred to such transferee bears to the fair 
market value of the assets (less encumbrances) of the transferor 
immediately before the transfer.
    (ii) Subdivision (i) of this subparagraph shall not apply to the 
requirements under sections 6033, 6056, and 6104 which must be complied 
with by the transferor private foundation, nor to the requirement under 
section 6043 that the transferor file a return with respect to its 
liquidation, dissolution, or termination.
    (iii) This subparagraph may be illustrated by the following 
examples:

    Example 1. The trustees of X charitable trust, a private foundation, 
form the Y charitable corporation, also a private foundation, in order 
to facilitate the conduct of their activities. The trustees of X are 
also the directors of Y. Y has the same charitable purposes as X. All of 
the assets of X are transferred to Y, and Y continues to carry on X's 
charitable activities. Under such circumstances, Y shall be treated as 
if it were X for the purposes of subdivision (i) of this subparagraph. 
Thus, for example, Y will be permitted to take advantage of any special 
rules or savings provisions with respect to chapter 42 to the same 
extent as X could have if X had continued in existence.
    Example 2. A and B are the trustees of the P charitable trust, a 
private foundation, and are the only substantial contributors to P.

[[Page 117]]

On July 1, 1973, in order to facilitate accomplishment of diverse 
charitable purposes, A and B create and control the R Foundation, the S 
Foundation and the T Foundation and transfer the net assets of P to R, 
S, and T. As of the end of 1973, P has an outstanding grant to 
Foundation W and has been required to exercise expenditure 
responsibility with respect to this grant under sections 4945 (d)(4) and 
(h). Under these circumstances, R, S, and T shall each be treated as if 
they are P in the proportion the fair market value of the assets 
transferred to each bears to the fair market value of the assets of P 
immediately before the transfer. Since R, S, and T are treated as P, 
absent a specific provision for exercising expenditure responsibility 
with respect to the grant to W, each of them is required to exercise 
expenditure responsibility with respect to such grant. If, as a part of 
the transfer to R, P assigned, and R assumed, P's duties with respect to 
the expenditure responsibility grant to W, only R would be required to 
exercise expenditure responsibility with respect to the grant to W. 
Since R, S, and T are treated as P rather than as recipients of 
expenditure responsibility grants, there are no expenditure 
responsibility requirements which must be exercised under sections 4945 
(d)(4) and (h) with respect to the transfers of assets to R, S, and T.

    (10) For certain rules relating to filing requirements where a 
private foundation has transferred all its net assets, see Sec.  1.507-
1(b)(9).
    (b) Status of transferee organization under section 507(b)(2). Since 
a transfer of assets pursuant to any liquidation, merger, redemption, 
recapitalization, or other adjustment, organization or reorganization to 
an organization not described in section 501(c)(3) (other than an 
organization described in section 509(a)(4)) or 4947 is a taxable 
expenditure under section 4945(d)(5), in order for such a transfer of 
assets not to be a taxable expenditure, it must be to an organization 
described in section 501(c)(3) (other than an organization described in 
section 509(a)(4)) or treated as described in section 501(c)(3) under 
section 4947. See Sec.  53.4945-6(c)(3) of this chapter. Consequently, 
unless such a transferee is an organization described in section 509(a) 
(1), (2), or (3), the transferee is a private foundation and the rules 
of section 507(b)(2) and paragraph (a) of this section apply. On the 
other hand, if such a transfer of assets is made to a transferee 
organization which is not described in either section 501(c)(3) (other 
than an organization described in section 509(a)(4)) or 4947, and in 
order to correct the making of a taxable expenditure, such assets are 
transferred to a private foundation, section 507(b)(2) and paragraph (a) 
of this section shall apply as if the transfer of assets had been made 
directly to such private foundation.
    (c) Section 507(b)(2) transfers. (1) A transfer of assets is 
described in section 507(b)(2) if it is made by a private foundation to 
another private foundation pursuant to any liquidation, merger, 
redemption, recapitalization, or other adjustment, organization, or 
reorganization. This shall include any organization or reorganization 
described in subchapter C of chapter 1. For purposes of section 
507(b)(2), the terms other adjustment, organization, or reorganization 
shall include any partial liquidation or any other significant 
disposition of assets to one or more private foundations, other than 
transfers for full and adequate consideration or distributions out of 
current income. For purposes of this paragraph, a distribution out of 
current income shall include any distribution described in section 
4942(h)(1) (A) and (B).
    (2) The term significant disposition of assets to one or more 
private foundations shall include any disposition for a taxable year 
where the aggregate of:
    (i) The dispositions to one or more private foundations for the 
taxable year, and
    (ii) Where any disposition to one or more private foundations for 
the taxable year is part of a series of related dispositions made during 
prior taxable years, the total of the related dispositions made during 
such prior taxable years, is 25 percent or more of the fair market value 
of the net assets of the foundation at the beginning of the taxable year 
(in the case of subdivision (i) of this subparagraph) or at the 
beginning of the first taxable year in which any of the series of 
related dispositions was made (in the case of subdivision (ii) of this 
subparagraph). A significant disposition of assets may occur in a single 
taxable year (as in subdivision (i) of this subparagraph) or over the 
course of two or more taxable years (as in subdivision (ii) of this 
subparagraph). The determination whether a significant

[[Page 118]]

disposition has occurred through a series of related distributions 
(within the meaning of subdivision (ii) of this subparagraph) will be 
made on the basis of all the facts and circumstances of the particular 
case. However, if one or more persons who are disqualified persons 
(within the meaning of section 4946) with respect to the transferor 
private foundation are also disqualified persons with respect to any of 
the transferee private foundations, such fact shall be evidence that the 
transfer is part of a series of related dispositions (within the meaning 
of subdivision (ii) of this subparagraph). In the case of a series of 
related dispositions described in subdivision (ii) of this subparagraph, 
each transferee private foundation shall (on any date) be subject to the 
provisions of section 507(b)(2) (with respect to all such dispositions 
made to it on or before such date) to the extent described in paragraphs 
(a) and (b) of this section.
    (3) A private foundation which fails to meet the requirements of 
section 507(b)(1)(A) for a taxable year may be required to file a return 
under section 6043(b) by reason of a transfer of assets to one or more 
sections 509(a) (1), (2), or (3) organizations. Hence, such filing does 
not necessarily mean that a section 507(b)(2) transfer has occurred. See 
Sec.  1.6043-3(f)(1).
    (4) This paragraph applies to any section 507(b)(2) transfer made by 
a private foundation referred to in section 170(b)(1)(E) (i), (ii), or 
(iii).
    (5) The provisions of this paragraph may be illustrated by the 
following examples:

    Example 1. M is a private foundation on the calendar year basis. It 
has net assets worth $100,000 as of January 1, 1971. In 1971, in 
addition to distributions out of current income, M transfers $10,000 to 
N, $10,000 to O, and $10,000 to P. N, O, and P are all private 
foundations. Under subparagraph (2)(i) of this paragraph, M has made a 
significant disposition of its assets in 1971 since M has disposed of 
more than 25 percent of its net assets (with respect to the fair market 
value of such assets as of January 1, 1971). M has therefore made 
section 507(b)(2) transfers within the meaning of this paragraph, and 
section 507(b)(2) applies to the transfers made to N, O, and P.
    Example 2. U, a tax-exempt private foundation on the calendar year 
basis, has net assets worth $100,000 as of January 1, 1971. As part of a 
series of related dispositions in 1971 and 1972, U transfers in 1971, in 
addition to distributions out of current income, $10,000 to private 
foundation X and $10,000 to private foundation Y, and in 1972, in 
addition to distributions out of current income, U transfers $10,000 to 
private foundation Z. Under subparagraph (2)(ii) of this paragraph, U is 
treated as having made a series of related dispositions in 1971 and 
1972. The aggregate of the 1972 disposition (under subparagraph (2)(i) 
of this paragraph) and the series of related dispositions (under 
subparagraph (2)(ii) of this paragraph) is $30,000, which is more than 
25 percent of the fair market value of U's net assets as of the 
beginning of 1971 ($100,000), the first year in which any such 
disposition was made. Thus, U has made a significant disposition of its 
assets and has made transfers described in section 507(b)(2). The 
provisions of paragraphs (a) and (b) of this section apply to each of 
the transferees as of the date on which it received assets from U.

    (d) Inapplicability of section 507(a) to section 507(b)(2) 
transfers. Unless a private foundation voluntarily gives notice pursuant 
to section 507(a)(1), a transfer of assets described in section 
507(b)(2) will not constitute a termination of the transferor's private 
foundation status under section 507(a)(1). Such transfer must, 
nevertheless, satisfy the requirements of any pertinent provisions of 
chapter 42. See subparagraphs (5) through (7) of paragraph (a) of this 
section. However, if such transfer constitutes an act or failure to act 
which is described in section 507(a)(2)(A), then such transfer will be 
subject to the provisions of section 507(a)(2) rather than section 
507(b)(2). For example, X, a private nonoperating foundation, transfers 
all of its net assets to Y, a private operating foundation, in 1971. X 
does not file the notice referred to in section 507(a)(1) and the 
transfer does not constitute either a willful and flagrant act (or 
failure to act), or one of a series of willful repeated acts (or 
failures to act), giving rise to liability for tax under chapter 42. 
Under these circumstances, the transfer is described in section 
507(b)(2) and the provisions of paragraph (a) of this section apply with 
respect to Y. The private foundation status of X has not been terminated 
under section 507(a).
    (e) Transfers to certain section 509(a) (1), (2), or (3) 
organizations. If a private

[[Page 119]]

foundation transfers all or part of its assets to one or more 
organizations described in section 509(a) (1), (2), or (3) and, within a 
period of 3 years from the date of such transfers, one or more of the 
transferee organizations lose their section 509(a) (1), (2), or (3) 
status and become private foundations, then for purposes of this 
section, a transfer of assets within the meaning of paragraph (c) of 
this section to such an organization which becomes a private foundation 
will be treated as a transfer described in section 507(b)(2), and the 
provisions of paragraph (a) of this section shall be treated as applying 
to such a transferee organization from the date on which any such 
transfer was made to it.
    (f) Certain transfers made during section 507(b)(1)(B) terminations. 
If:
    (1) During the course of the 12-month or 60-month period described 
in section 507(b)(1)(B), a private foundation makes one or more 
transfers to one or more private foundations;
    (2) Such transfers are described in Sec.  1.507-3(c)(1); and
    (3) Even though the transferor foundation thereafter meets the 
requirements of section 507(b)(1)(B)


then for purposes of this section, the provisions of Sec.  1.507-2(e) 
shall not apply with respect to such transfers, and such transfers will 
be treated as transfers described in section 507(b)(2) and Sec.  1.507-3 
rather than as transfers from an organization described in section 
509(a) (1), (2), or (3).

[T.D. 7233, 37 FR 28158, Dec. 21, 1972; 38 FR 3189, Feb. 2, 1973, as 
amended by T.D. 7678, 45 FR 12415, Feb. 26, 1980]



Sec.  1.507-4  Imposition of tax.

    (a) General rule. Section 507(c) imposes on each organization the 
private foundation status of which is terminated under section 507(a) a 
tax equal to the lower of:
    (1) The amount which such organization substantiates by adequate 
records (or other corroborating evidence which may be required by the 
Commissioner) as the aggregate tax benefit (as defined in section 
507(d)) resulting from the section 501(c)(3) status of such 
organization, or
    (2) The value of the net assets of such organization.
    (b) Transfers not subject to section 507(c). Private foundations 
which make transfers described in section 507(b)(1)(A) or (2) are not 
subject to the tax imposed under section 507(c) with respect to such 
transfers unless the provisions of section 507(a) become applicable. See 
Sec. Sec.  1.507-1(b), 1.507-2(a)(6) and 1.507-3(d).

[T.D. 7233, 37 FR 28161, Dec. 21, 1972]



Sec.  1.507-5  Aggregate tax benefit; in general.

    (a) General rule. For purposes of section 507(c)(1), the aggregate 
tax benefit resulting from the section 501(c)(3) status of any private 
foundation is the sum of:
    (1) The aggregate increases in tax under chapters 1, 11, and 12 (or 
the corresponding provisions of prior law) which would have been imposed 
with respect to all substantial contributors to the foundation if 
deductions for all contributions made by such contributors to the 
foundation after February 28, 1913, had been disallowed,
    (2) The aggregate increases in tax under chapter 1 (or the 
corresponding provisions of prior law) which would have been imposed 
with respect to the income of the private foundation for taxable years 
beginning after December 31, 1912, if (i) it had not been exempt from 
tax under section 501(a) (or the corresponding provisions of prior law), 
and (ii) in the case of a trust, deductions under section 642(c) (or the 
corresponding provisions of prior law) had been limited to 20 percent of 
the taxable income of the trust (computed without the benefit of section 
642(c) but with the benefit of section 170(b)(1)(A)),
    (3) The amount succeeded to from transferors under Sec.  1.507-3(a) 
and section 507(b)(2), and
    (4) Interest on the increases in tax determined under subparagraphs 
(1), (2), and (3) of this paragraph from the first date on which each 
such increase would have been due and payable to the date on which the 
organization ceases to be a private foundation.
    (b) Contributions. In computing the amount of the aggregate 
increases in tax under subparagraph (1) of this paragraph, all 
deductions attributable to a

[[Page 120]]

particular contribution shall be included. For example, if a substantial 
contributor has taken deductions under sections 170 and 2522 (or the 
corresponding provisions of prior law) with respect to the same 
contribution, the amount of each deduction shall be included in the 
computations under section 507(d)(1)(A). Accordingly, the aggregate tax 
benefit may exceed the fair market value of the property transferred.

[T.D. 7233, 37 FR 28161, Dec. 21, 1972]



Sec.  1.507-6  Substantial contributor defined.

    (a) Definition--(1) In general. Except as provided in subparagraph 
(2) of this paragraph, the term substantial contributor means, with 
respect to a private foundation, any person (within the meaning of 
section 7701(a)(1)), whether or not exempt from taxation under section 
501(a), who contributed or bequeathed an aggregate amount of more than 
$5,000 to the private foundation, if such amount is more than 2 percent 
of the total contributions and bequests received by the private 
foundation before the close of the taxable year of the private 
foundation in which a contribution or bequest is received by the 
foundation from such person. In the case of a trust, the term 
substantial contributor also means the creator of the trust. Such term 
does not include a governmental unit described in section 170(c)(1).
    (2) Special rules. For purposes of sections 170(b)(1)(E)(iii), 
507(d)(1), 508(d), 509(a) (1) and (3), and chapter 42, the term 
substantial contributor shall not include an organization which is 
described in section 509(a) (1), (2), or (3) or any other organization 
which is wholly owned by such section 509(a) (1), (2), or (3) 
organization. Furthermore, taking section 4941 (relating to taxes on 
self-dealing) in context, it would unduly restrict the activities of 
private foundations if the term substantial contributor were to include 
any section 501(c)(3) organizations. It was not intended, for example, 
that a large grant for charitable purposes from one private foundation 
to another world forever preclude the latter from making any grants to, 
or otherwise dealing with, the former. Accordingly, for purposes of 
section 4941 only, the term substantial contributor shall not only 
include any organization which is described in section 501(c)(3) (other 
than an organization described in section 509(a)(4)).
    (b) Determination of substantial contributor--(1) In general. In 
determining under paragraph (a) of this section whether the aggregate of 
contributions and bequests from a person exceeds 2 percent of the total 
contributions and bequests received by a private foundation, both the 
total of such amounts received by the private foundation, and the 
aggregate of such amounts contributed and bequeathed by such person, 
shall be determined as of the last day of each taxable year commencing 
with the first taxable year ending after October 9, 1969. Generally, 
under section 507(d)(2) and this section, except for purposes of 
valuation under section 507(d)(2)(B)(i), all contributions and bequests 
made before October 9, 1969, are deemed to have been made on October 9, 
1969. For purposes of section 509(a)(2) and the support test described 
in Sec.  1.509(a)-3(c), contributions and bequests before October 9, 
1969, will be taken into account in the year when actually made. For 
example, in the case of a contribution or bequest of $6,000 in 1967, 
such contribution or bequest shall be treated as made by a substantial 
contributor in 1967 for purposes of section 509(a)(2) and Sec.  
1.509(a)-3(c) if such person met the $5,000--2 percent test as of 
December 31, 1967, and December 31, 1969 (in the case of a calendar year 
accounting period). Although the determination of the percentage of 
total contributions and bequests represented by a given donor's 
contributions and bequests is not made until the end of the foundation's 
taxable year, a donor is a substantial contributor as of the first date 
when the foundation received from him an amount sufficient to make him a 
substantial contributor. Except as otherwise provided in this 
subparagraph, such amount is treated for all purposes as made by a 
substantial contributor. Thus, the total contributions and bequests 
received by the private foundation from all persons, and the aggregate 
contributions and bequests made by a particular person, are to be 
determined as of December 31, 1969 (in the

[[Page 121]]

case of a calendar year organization which was in existence on that 
date), and the amounts included in each respective total would be all 
contributions and bequests received by the organization on or before 
that date, and all contributions and bequests made by the person on or 
before that date. Thereafter, a similar determination is to be made with 
respect to such private foundation as of the end of each of its 
succeeding taxable years. Status as a substantial contributor, however, 
will date from the time when the donor first met the $5,000 and 2 
percent test. Once a person is a substantial contributor with respect to 
a private foundation, he remains a substantial contributor even though 
he might not be so classified if a determination were first made at some 
later date. For instance, even though the aggregate contributions and 
bequests of a person become less than 2 percent of the total received by 
a private foundation (for example, because of subsequent contributions 
and bequests by other persons), such person remains a substantial 
contributor with respect to the foundation.
    (2) Examples. The provisions of paragraph (a) of this section and 
this paragraph (b) may be illustrated by the following examples:

    Example 1. On January 1, 1968, A, an individual, gave $4,500 to M, a 
private foundation on a calendar year basis. On June 1, 1969, A gave M 
the further sum of $1,500. Throughout its existence, through December 
31, 1969, M has received $250,000 in contributions and bequests from all 
sources. As of June 1, 1969, A is a substantial contributor to M for 
purposes of section 509(a)(2).
    Example 2. On September 9, 1966, B, an individual, gave $3,500 to N, 
a private foundation on a calendar year basis. On March 15, 1970, B gave 
N the further sum of $3,500. Throughout its existence, through December 
31, 1970, N has received $200,000 in contributions and bequests from all 
sources. B is a substantial contributor to N as of March 15, 1970, since 
that is the first date on which his contributions met the 2 percent-
$5,000 test.
    Example 3. On July 21, 1964, X, a corporation, gave $2,000 to O, a 
private foundation on a calendar year basis. As of December 31, 1969, O 
had received $150,000 from all sources. On September 17, 1970, X gave O 
the further sum of $3,100. Through September 17, 1970, O had received 
$245,000 from all sources as total contributions and bequests. Between 
September 17, 1970, and December 31, 1970, however, O received $50,000 
in contributions and bequests from others. X is not a substantial 
contributor to O, since X's contributions to O were not more than 2 
percent of the total contributions and bequests received by O by 
December 31, 1970, the end of O's taxable year, even though X's 
contributions met that test at one point during the year.
    Example 4. On September 16, 1970, C, an individual, gave $10,000 to 
P, a private foundation on a calendar year basis. Throughout its 
existence, and through December 31, 1970, the close of its taxable year, 
P had received a total of $100,000 in contributions and bequests. On 
January 3, 1971, P received a bequest of $1 million. C is a substantial 
contributor to P since he was a substantial contributor as of September 
16, 1970, and therefore remains one even though he no longer meets the 
2-percent test on a later date after the end of the taxable year of the 
foundation in which he first became a substantial contributor.

    (c) Special rules--(1) Contributions defined. The term contribution 
shall, for purposes of section 507(d)(2), have the same meaning as such 
term has under section 170(c) and also include bequests, legacies, 
devises, and transfers within the meaning of section 2055 or 2106(a)(2). 
Thus, for purposes of section 507(d)(2), any payment of money or 
transfer of property without adequate consideration shall be considered 
a contribution. Where payment is made or property transferred as 
consideration for admissions, sales of merchandise, performance of 
services, or furnishing of facilities to the donor, the qualification of 
all or any part of such payment or transfer as a contribution under 
section 170(c) shall determine whether and to what extent such payment 
or transfer constitutes a contribution under section 507(d)(2).
    (2) Valuation of contributions and bequests. Each contribution or 
bequest to a private foundation shall be valued at fair market value 
when actually received by the private foundation.
    (3) Contributions and bequests by a spouse. An individual shall be 
considered, for purposes of this section, to have made all contributions 
and bequests made by his spouse during the period of their marriage. 
Thus, for example, where W contributed $500,000 to P, a private 
foundation, in 1941 and that amount exceeded 2 percent of the total 
contributions received by P as of the end of P's first taxable year 
ending after October 9, 1969, H (W's spouse at

[[Page 122]]

the time of the 1941 gift) is considered to have made such contribution 
(even if W died prior to October 9, 1969, or their marriage was 
otherwise terminated prior to such date). Similarly, any bequest or 
devise shall be treated as having been made by the decedent's surviving 
spouse.

[T.D. 7241, 37 FR 28743, Dec. 29, 1972; 38 FR 24206, Sept. 6, 1973]



Sec.  1.507-7  Value of assets.

    (a) In general. For purposes of section 507(c), the value of the net 
assets shall be determined at whichever time such value is higher:
    (1) The first day on which action is taken by the organization which 
culminates in its ceasing to be a private foundation, or
    (2) The date on which it ceases to be a private foundation.
    (b) Valuation dates. (1) In the case of a termination under section 
507(a)(1), the date referred to in paragraph (a)(1) of this section 
shall be the date on which the terminating foundation gives the 
notification described in section 507(a)(1).
    (2) In the case of a termination under section 507(a)(2), the date 
referred to in paragraph (a)(1) of this section shall be the date of 
occurrence of the willful and flagrant act (or failure to act) or the 
first of the series of willful repeated acts (or failures to act) giving 
rise to liability for tax under chapter 42 and the imposition of tax 
under section 507(a)(2).
    (c) Fair market value. For purposes of this section, fair market 
value shall be determined pursuant to the provisions of Sec.  
53.4942(a)-2(c)(4) of this chapter.
    (d) Net assets. For purposes of section 507 and the regulations 
thereunder, the term net assets shall mean the gross assets of a private 
foundation reduced by all liabilities of the foundation, including 
appropriate estimated and contingent liabilities. Thus, a determination 
of net assets may reflect reductions for any liability or contingent 
liability for tax imposed upon the private foundation under chapter 42 
with respect to acts or failures to act prior to termination, for any 
liability or contingent liability for failures to correct such acts or 
failures to act, or for any liability or estimated or contingent 
liability with respect to expenses associated with winding up the 
organization. If a private foundation's determination of net assets 
reflects any reduction for any estimated or contingent liability, such 
private foundation must establish, to the satisfaction of the 
Commissioner, the reasonableness of such reduction. If the amount of net 
assets reflects a reduction for any estimated or contingent liability, 
at the earlier of the final determination of the contingency or the 
termination of a reasonable time, any excess of the amount by which the 
gross assets was reduced over the amount of the liability shall be 
treated in the same manner as if such excess had been considered part of 
the net assets.

[T.D. 7233, 37 FR 28161, Dec. 21, 1972]



Sec.  1.507-8  Liability in case of transfers.

    For purposes of determining liability for the tax imposed under 
section 507(c) in the case of assets transferred by the private 
foundation, such tax shall be deemed to have been imposed on the first 
day on which action is taken by the organization which culminates in its 
ceasing to be a private foundation. If an organization's private 
foundation status is terminated under section 507(a)(2), the first day 
on which action is taken which culminates in its ceasing to be a private 
foundation (within the meaning of section 507(f)) shall be the date 
described in Sec.  1.507-7(b)(2). If an organization terminates its 
private foundation status under section 507(a)(1), the first day on 
which action is taken which culminates in its ceasing to be a private 
foundation (within the meaning of section 507(f)) shall be the date 
described in Sec.  1.507-7(b)(1).

[T.D. 7233, 37 FR 28161, Dec. 21, 1972]



Sec.  1.507-9  Abatement of taxes.

    (a) General rule. The Commissioner may at his discretion abate the 
unpaid portion of the assessment of any tax imposed by section 507(c), 
or any liability in respect thereof, if:
    (1) The private foundation distributes all of its net assets to one 
or more organizations described in section 170(b)(1)(A) (other than in 
clauses (vii)

[[Page 123]]

or (viii)) each of which has been in existence and so described for a 
continuous period of at least 60 calendar months, or
    (2) Effective assurance is given to the Commissioner in accordance 
with paragraphs (b) and (c) of this section that the assets of the 
organization which are dedicated to charitable purposes will, in fact, 
be used for charitable purposes


The provisions of Sec.  1.507-2(a) (2), (3), and (7) shall apply to 
distributions under subparagraph (1) of this paragraph. Since section 
507(g) provides only for the abatement of tax imposed under section 
507(c), no tax imposed under any provision of chapter 42 shall be abated 
under section 507(g). Where the taxpayer files a petition with the Tax 
Court with respect to a notice of deficiency regarding any tax under 
section 507(c), such tax shall be treated as having been assessed for 
the purposes of abatement of such tax under section 507(g) and the 
regulations thereunder.
    (b) State proceedings. (1) The Commissioner may at his discretion 
abate the unpaid portion of the assessment of any tax imposed by section 
507(c), or any liability in respect thereof, under the procedures 
outlined in subparagraphs (2) and (3) of this paragraph. Such tax may 
not be abated by the Commissioner unless he determines that corrective 
action as defined in paragraph (c) of this section has been taken. The 
Commissioner may not abate by reason of section 507(g) any amount of 
such tax which has already been collected since only the unpaid portion 
thereof can be abated.
    (2) The appropriate State officer shall have 1 year from the date of 
notification prescribed in section 6104(c) that a notice of deficiency 
of tax imposed under section 507(c) has been issued with respect to a 
foundation, to advise the Commissioner that corrective action has been 
initiated pursuant to State law as may be ordered or approved by a court 
of competent jurisdiction. Corrective action may be initiated either by 
the appropriate State officer or by an organization described in section 
509(a) (1), (2), or (3) which is a beneficiary of the private foundation 
and has enforceable rights against such foundation under State law. 
Copies of all pleadings and other documents filed with the court at the 
initial stages of the proceedings shall be attached to the notification 
made by the State officer to the Commissioner. Prior to notification by 
the appropriate State officer that corrective action has been initiated, 
the Commissioner shall follow those procedures which would apply with 
respect to the assessment and collection of the tax imposed under 
section 507(c) without regard to section 507(g)(2). Subsequent to 
notification by the appropriate State officer that corrective action has 
been initiated, the Commissioner shall suspend action with respect to 
the assessment or collection of tax imposed under section 507(c) until 
notified of the final determination of such corrective action, as long 
as any such resulting delay does not jeopardize the collection of such 
tax and does not cause collection to be barred by operation of law or 
any rule of law. In any case where collection of such tax is about to be 
barred by operation of section 6502 and the Commissioner has not been 
advised of the final determination of corrective action, the 
Commissioner should make every effort to obtain appropriate agreements 
with the foundation subject to such tax to extend the period of 
limitations under section 6502(a)(2). Where such agreements are 
obtained, action with respect to the assessment and collection of such 
tax may be suspended to the extent not inconsistent with this 
subparagraph.
    (3) Upon receipt of certification from the appropriate State officer 
that action has been ordered or approved by a court of competent 
jurisdiction, the Commissioner may abate the unpaid portion of the 
assessment of tax imposed by section 507(c), or any liability in respect 
thereof, if in his judgment such action is corrective action within the 
meaning of paragraph (c) of this section. In the event that such action 
is not corrective action, the Commissioner may in his discretion again 
suspend action on the assessment and collection of such tax until 
corrective action is obtained, or if in his judgment corrective action 
cannot be obtained, he may resume the assessment and collection of such 
tax.

[[Page 124]]

    (c) Corrective action. The term corrective action referred to in 
paragraph (b) of this section means vigorous enforcement of State laws 
sufficient to assure implementation of the provisions of chapter 42 and 
insure that the assets of such private foundation are preserved for such 
charitable or other purposes specified in section 501(c)(3). Except 
where assets of the terminated private foundation are transferred to an 
organization described in section 509(a) (1) through (4) the State is 
required to take such action to assure that the provisions of section 
508(e)(1) (A) and (B) are applicable to the terminated foundation (or 
any transferee) with respect to such assets as if such organization were 
a private foundation. Thus, the governing instrument of such 
organization must include provisions with respect to such assets:
    (1) Requiring its income therefrom for each taxable year to be 
distributed at such time and in such manner as not to subject such 
organization to tax under section 4942 (as if the organization were a 
private foundation),
    (2) Prohibiting such organization from engaging in any act of self-
dealing (as defined in section 4941(d) as if the organization were a 
private foundation),
    (3) Prohibiting such organization from retaining any excess business 
holdings (as defined in section 4943(c) as if the organization were a 
private foundation),
    (4) Prohibiting such organization from making any investments in 
such manner as to subject such organization to tax under section 4944 
(as if the organization were a private foundation), and
    (5) Prohibiting such organization from making any taxable 
expenditures (as defined in section 4945(d) as if the organization were 
a private foundation). Consequently, in cases where the preceding 
sentence applies, although the private foundation status of an 
organization is terminated for tax purposes, it is contemplated that its 
status under State law would remain unchanged, because the tax under 
section 507(c) has been abated solely because the Commissioner has been 
given effective assurance that there is vigorous enforcement of State 
laws sufficient to assure implementation of the provisions of chapter 
42. Therefore, in such a case while chapter 42 will not apply to acts 
occurring subsequent to termination which previously would have resulted 
in the imposition of tax under chapter 42, it is contemplated that there 
will be vigorous enforcement of State laws (including laws made 
applicable by the provisions in the governing instrument) with respect 
to such acts. Notwithstanding the preceding three sentences, no 
amendment to the organization's governing instrument is necessary where 
there are provisions of State law which have the effect of requiring a 
terminated private foundation to which the rules of subparagraphs (1) 
through (5) of this paragraph apply to be subject to such rules whether 
or not there are such provisions in such terminated private foundation's 
governing instrument.

[T.D. 7233, 37 FR 28161, Dec. 21, 1972]



Sec.  1.508-1  Notices.

    (a) New organizations must notify the Commissioner that they are 
applying for recognition of section 501(c)(3) status--(1) In general. 
Except as provided in subparagraph (3) of this paragraph, an 
organization that is organized after October 9, 1969, will not be 
treated as described in section 501(c)(3):
    (i) Unless such organization has given the Commissioner notice in 
the manner prescribed in subparagraph (2) of this paragraph; or
    (ii) For any period before the giving of such notice, unless such 
notice is given in the manner and within the time prescribed in 
subparagraph (2) of this paragraph


No organization shall be exempt from taxation under section 501(a) by 
reason of being described in section 501(c)(3) whenever such 
organization is not treated as described in section 501(c)(3) by reason 
of section 508(a) and this paragraph. See section 508(d)(2)(B) and Sec.  
1.508-2(b) regarding the deductibility of charitable contributions to an 
organization during the period such organization is not exempt under 
section 501(a) as an organization described in section 501(c)(3) by 
reason of failing to file a notice under section 508(a) and this 
subparagraph. See also Sec.  1.508-

[[Page 125]]

2(b)(1)(viii) regarding the deductibility of charitable contributions to 
trusts described in section 4947(a)(1).
    (2) Filing of notice. (i) For purposes of paragraph (a)(1) of this 
section, except as provided in paragraph (a)(3) of this section, an 
organization seeking exemption under section 501(c)(3) must file the 
notice described in section 508(a) within 15 months from the end of the 
month in which the organization was organized. Such notice is filed by 
submitting a properly completed and executed Form 1023 (or, if 
applicable, Form 1023-EZ) exemption application. Notice should be filed 
with the appropriate office as designated by the Commissioner in 
guidance published in the Internal Revenue Bulletin, forms, or 
instructions to the applicable forms. A request for extension of time 
for the filing of such notice should be submitted to such appropriate 
office. Such request may be granted if it demonstrates that additional 
time is required.
    (ii) Although the information required by either Form 1023 or Form 
1023-EZ must be submitted to satisfy the notice required by this 
section, the failure to supply, within the required time, all of the 
information required to complete such form is not alone sufficient to 
deny exemption from the date of organization to the date such complete 
information for such form is submitted by the organization. If the 
information that is submitted within the required time is incomplete, 
and the organization supplies the necessary additional information 
requested by the Commissioner within the additional time period allowed, 
the original notice will be considered timely.
    (iii) For purposes of subdivision (i) of this subparagraph and 
paragraph (b)(2)(i) of this section, an organization shall be considered 
organized on the date it becomes an organization described in section 
501(c)(3) (determined without regard to section 508(a)).
    (iv) Since a trust described in section 4947(a)(2) is not an 
organization described in section 501(c)(3), it is not required to file 
a notice described in section 508(a).
    (v) For the treatment of community trusts, and the trusts or funds 
comprising them, under section 508, see the special rules under Sec.  
1.170A-9(e).
    (vi) A foreign organization shall, for purposes of section 508, be 
treated in the same manner as a domestic organization, except that 
section 508 shall not apply to a foreign organization which is described 
in section 4948(b).
    (3) Exceptions from notice. (i) Paragraphs (a) (1) and (2) of this 
section are inapplicable to the following organizations:
    (a) Churches, interchurch organizations of local units of a church, 
conventions or associations of churches, or integrated auxiliaries of a 
church. See Sec.  1.6033-2(h) regarding the definition of integrated 
auxiliary of a church;
    (b) Any organization which is not a private foundation (as defined 
in section 509(a)) and the gross receipts of which in each taxable year 
are normally not more than $5,000 (as described in subdivision (ii) of 
this subparagraph);
    (c) Subordinate organizations (other than private foundations) 
covered by a group exemption letter;
    (d) Solely for purposes of sections 507, 508(d)(1), 508(d)(2)(A) and 
508(d)(3), 508(e), 509 and chapter 42, a trust described in section 
4947(a)(1). (However, a trust described in section 501(c)(3) which was 
organized after October 9, 1969, shall be exempt under section 501(a) by 
reason of being described in section 501(c)(3) only if it files such 
notice); and
    (e) Any other class of organization that the Commissioner from time 
to time excludes from the requirement of filing notice under section 
508(a).
    (ii) For purposes of subdivision (i) (b) of this subparagraph and 
paragraph (b)(7)(ii) of this section, the gross receipts (as defined in 
subdivision (iii) of this subparagraph) of an organization are normally 
not more than $5,000 if:
    (a) During the first taxable year of the organization the 
organization has received gross receipts of $7,500 or less;
    (b) During its first 2 taxable years the aggregate gross receipts 
received by the organization are $12,000 or less; and
    (c) In the case of an organization which has been in existence for 
at least 3 taxable years, the aggregate gross receipts received by the 
organization

[[Page 126]]

during the immediately preceding 2 taxable years, plus the current year 
are $15,000 or less


If an organization fails to meet the requirements of (a), (b), or (c) of 
this subdivision, then with respect to the organization, such 
organization shall be required to file the notices described in section 
508 (a) and (b) within 90 days after the end of the period described in 
(a), (b), or (c) of this subdivision or before March 22, 1973, whichever 
is later, in lieu of the period prescribed in subparagraph (2)(i) of 
this paragraph. Thus, for example, if an organization meets the $7,500 
requirement of (a) of this subdivision for its first taxable year, but 
fails to meet the $12,000 requirement of (b) of this subdivision for the 
period ending with its second taxable year, then such organization shall 
meet the notification requirements of section 508(a)(1) and 508(b) and 
subparagraph (2)(i) of this paragraph if it files such notification 
within 90 days after the close of its second taxable year. If an 
organization which has been in existence at least 3 taxable years meets 
the requirements of (a), (b), and (c) with respect to all prior taxable 
years, but fails to meet the requirements of (c) of this subdivision 
with respect to the current taxable year, then even if the organization 
fails to make such notification within 90 days after the close of the 
current taxable year, section 508(a)(1) and 508(b) shall not apply with 
respect to its prior years. In such a case, the organization shall not 
be treated as described in section 501(c)(3) for a period beginning with 
such current taxable year and ending when such notice is given under 
section 508(a)(2).
    (iii) For a definition of gross receipts for purposes of subdivision 
(i)(b) of this subparagraph and paragraph (b)(7)(ii) of this section, 
see Sec.  1.6033-2(g)(4).
    (4) Voluntary filings by new organizations excepted from filing 
notice. Any organization excepted from the requirement of filing notice 
under section 508(a) will be exempt from taxation under section 
501(c)(3) if it meets the requirements of that section, whether or not 
it files such notice. However, in order to establish its exemption with 
the Internal Revenue Service and receive a ruling or determination 
letter recognizing its exempt status, an organization excepted from the 
notice requirement by reason of subparagraph (3) of this paragraph 
should file proof of its exemption in the manner prescribed in Sec.  
1.501(a)-1.
    (b) Presumption that old and new organizations are private 
foundations--(1) In general. Except as provided in subparagraph (7) of 
this paragraph, any organization (including an organization in existence 
on October 9, 1969) which is described in section 501(c)(3), and which 
does not notify the Commissioner within the time and in the manner 
prescribed in subparagraph (2) that it is not a private foundation, will 
be presumed to be a private foundation.
    (2) Filing of notice. (i) Except as provided in subparagraph (7) of 
this paragraph, an organization must file the notice described in 
section 508(b) and subparagraph (1) of this paragraph within 15 months 
from the end of the month in which such organization was organized, or 
before March 22, 1973, whichever comes later. See paragraph (a)(2)(iii) 
of this section, for rules pertaining to when an organization is 
organized.
    (ii) Any organization filing notice under this paragraph that has 
received a ruling or determination letter from the Internal Revenue 
Service dated on or before July 13, 1970, recognizing its exemption from 
taxation under section 501(c)(3) (or the corresponding provisions of 
prior law), shall file the notice described in section 508(b) by 
submitting a properly completed and executed Form 4653, Notification 
Concerning Foundation Status.
    (iii) The financial schedule on Form 4653 need be completed only if 
the organization is, or thinks it might be, described in section 
170(b)(1)(A) (iv) or (vi) or section 509(a)(2).
    (iv) Any organization filing notice under this paragraph (b)(2)(iv) 
shall file its notice by submitting a properly completed and executed 
Form 1023 (or, if applicable, Form 1023-EZ) and providing information 
that it is not a private foundation. The organization shall also submit 
all information required by the regulations under section 170 or 509 
(whichever is applicable) necessary to establish recognition of its 
classification as an organization described in

[[Page 127]]

section 509(a)(1), (2), (3), or (4). The notice required by this 
paragraph (b)(2)(iv) should be filed with the appropriate office as 
designated by the Commissioner in guidance published in the Internal 
Revenue Bulletin, forms, or instructions to the applicable forms.
    (v) An extension of time for the filing of a notice under this 
paragraph (b)(2) may be granted by the office with which the notice is 
filed upon timely request by the organization, if the organization 
demonstrates that additional time is required.
    (3) Effect of notice upon the filing organization. (i) The notice 
filed under this paragraph may not be relied upon by the organization so 
filing unless and until the Internal Revenue Service notifies the 
organization that it is an organization described in paragraph (1), (2), 
(3), or (4), of section 509(a). For purposes of the preceding sentence, 
an organization that has filed notice under section 508(b), and has 
previously received a ruling that it is an organization described in 
section 170(b)(1)(A) (other than clauses (vii) and (viii) thereof), will 
be considered to have been notified by the Internal Revenue Service that 
it is an organization described in paragraph (1) of section 509(a) if 
(a) the facts and circumstances forming the basis for the issuance of 
such ruling have not substantially changed, and (b) the ruling issued 
under that section has not been revoked expressly or by a subsequent 
change of the law or regulations under which the ruling was issued.
    (ii) If an organization has filed a notice under section 508(b) 
stating that it is not a private foundation and designating only one 
paragraph of section 509(a) under which it claims recognition of its 
classification (such as an organization described in section 509(a)(2)), 
and if it has received a ruling or determination letter which recognizes 
that it is not a private foundation but which fails to designate the 
paragraph under section 509(a) in which it is described, then such 
organization will be treated as described under the paragraph designated 
by it, until such ruling or determination letter is modified or revoked. 
The rule in the preceding sentence shall not apply to an organization 
which indicated that it does not know its status under section 509(a) or 
which claimed recognition of its status under more than one paragraph of 
section 509(a).
    (4) Effect of notice upon grantors or contributors to the filing 
organization. In the case of grants, contributions, or distributions 
made prior to:
    (i) In the case of community trusts, 6 months after the date on 
which corrective and clarifying regulations designated as Sec.  1.170A-
9(e)(10) become final;
    (ii) In the case of medical research organizations, 6 months after 
the date on which corrective and clarifying regulations designated as 
Sec.  1.170A-9(b)(2), become final, and
    (iii) In all other cases, January 1, 1976, any organization which 
has properly filed the notice described in section 508(b) prior to March 
22, 1973 will not be treated as a private foundation for purposes of 
making any determination under the internal revenue laws with respect to 
a grantor, contributor or distributor (as for example, a private 
foundation distributing all of its net assets pursuant to a section 
507(b)(1)(A) termination) thereto, unless the organization is controlled 
directly or indirectly by such grantor, contributor or distributor, if 
by the 30th day after the day on which such notice is filed, the 
organization has not been notified by the Commissioner that the notice 
filed by such organization has failed to establish that such 
organization is not a private foundation. See subparagraph (6) of this 
paragraph for the effect of an adverse notice by the Internal Revenue 
Service. For purposes of this subparagraph, an organization which has 
properly filed notice described in section 508(b) prior to March 22, 
1973, and which has claimed recognition of its status under only one 
paragraph of section 509(a) in such notice, will be treated only for 
purposes of grantors, contributors or distributors as having the 
classification claimed in the notice if the provisions of this 
subparagraph are otherwise satisfied.
    (5) Statement that old and new organizations are operating 
foundations. (i) Any organization (including an organization in 
existence on October 9, 1969) which is described in section 501(c)(3)

[[Page 128]]

may submit a statement, in the form and manner provided for notice in 
subparagraph (2) of this paragraph, that it is an operating foundation 
(as defined in section 4942(j)(3)) and include in such statement:
    (a) Necessary supporting information as required by the regulations 
under section 4942(j)(3) to confirm such determination (including a 
statement identifying the clause of section 4942(j)(3)(B) that is 
applicable); and
    (b) A written declaration by the principal officer, manager, or 
authorized trustee that there is a reasonable basis in law and in fact 
that the organization so filing is an operating foundation, and that to 
the best of the knowledge and belief of such officer, manager or 
trustee, the information submitted is complete and correct.
    (ii) The statement filed under this subparagraph may not be relied 
upon by the organization so filing unless and until the Internal Revenue 
Service notifies the organization that it is an operating foundation 
described in section 4942(j)(3).
    (iii) In the case of grants, contributions, or distributions made 
prior to March 22, 1973, any organization which has properly filed the 
statement described in this subparagraph prior to such date will be 
treated as an operating foundation for purposes of making any 
determination under the internal revenue laws with respect to a grantor, 
contributor, or distributor thereto, unless the organization is 
controlled directly or indirectly by such grantor, contributor, or 
distributor, if by the 30th day after the day on which such statement is 
filed, the organization has not been notified by the Commissioner or his 
delegate that its statement has failed to establish that such 
organization is an operating foundation. See subparagraph (6) of this 
paragraph for the effect of an adverse notice by the Internal Revenue 
Service.
    (6) Effect of notice by Internal Revenue Service concerning 
organization's notice or statement. Subparagraph (4) and subdivision 
(iii) of subparagrph (5) of this paragraph shall have no effect:
    (i) With respect to a grantor, contributor, or distributor to any 
organization for any period after the date on which the Internal Revenue 
Service makes notice to the public (such as by publication in the 
Internal Revenue Bulletin) that a grantor, contributor, or distributor 
to such organization can no longer rely upon the notice or statement 
submitted by such organization; and
    (ii) Upon any grant, contribution, or distribution made to an 
organization on or after the date on which a grantor, contributor, or 
distributor acquired knowledge that the Internal Revenue Service has 
given notice to such organization that its notice or statement has 
failed to establish that such organization either is not a private 
foundation, or is an operating foundation, as the case may be.
    (7) Exceptions from notice. Subparagraphs (1) and (2) of this 
paragraph are inapplicable to the following organizations:
    (i) Churches, interchurch organizations of local units of a church, 
conventions or associations of churches, or integrated auxiliaries of a 
church, such as a men's or women's organization, religious school, 
mission society, or youth group;
    (ii) Any organization which is not a private foundation (as defined 
in section 509(a)) and the gross receipts of which in each taxable year 
are normally not more than $5,000 (as determined under paragraph 
(a)(3)(ii) of this section);
    (iii) Subordinate organizations (other than private foundations) 
covered by a group exemption letter but only if the parent or 
supervisory organization submits a notice covering the subordinates;
    (iv) Trusts described in section 4947(a)(1); and
    (v) Any other class of organization that the Commissioner from time 
to time excludes from the notification requirements of section 508(b).
    (8) Voluntary filings by organizations excepted from filing notice. 
Any organization excepted from the requirement of filing notice under 
section 508(b) by reason of subdivisions (i), (ii), and (v) of 
subparagraph (7) of this paragraph may receive the benefits of 
subparagraph (4) of this paragraph by filing such notice.
    (c) Effective/applicability date. Paragraphs (a)(2)(i), (a)(2)(ii), 
(b)(2)(iv), and

[[Page 129]]

(b)(2)(v) of this section apply on and after July 1, 2014.

(Secs. 508 and 7805 of the Internal Revenue Code of 1954 (68A Stat. 917; 
26 U.S.C. 7805))

[T.D. 7232, 37 FR 28289, Dec. 22, 1972, as amended by T.D. 7342, 40 FR 
1237, Jan. 7, 1975; T.D. 7395, 41 FR 1063, Jan. 6, 1976; T.D. 8640, 60 
FR 65552, Dec. 20, 1995; T.D. 9674, 79 FR 37632, July 2, 2014; T.D. 
9819, 82 FR 29733, June 30, 2017]



Sec.  1.508-2  Disallowance of certain charitable, etc., deductions.

    (a) Gift or bequest to organizations subject to section 507(c) tax--
(1) General rule. No gift or bequest made to an organization upon which 
the tax provided by section 507(c) has been imposed shall be allowed as 
a deduction under section 170, 545(b)(2), 556(b)(2), 642(c), 2055, 
2106(a)(2), or 2522, if such gift or bequest is made:
    (i) By any person after notification has been made by the 
organization under section 507(a)(1) or after notification has been made 
by the Commissioner under section 507(a)(2)(B), or
    (ii) By a substantial contributor (as defined in section 507(d)(2)) 
in his taxable year which includes the first day on which action is 
taken by such organization which culminates in the imposition of tax 
under section 507(c) and any subsequent taxable year


For purposes of subdivision (ii) of this subparagraph, the first day on 
which action is taken by an organization which culminates in the 
imposition of tax under section 507(c) shall be determined under the 
rules set forth in Sec.  1.507-7(b) (1) and (2).
    (2) Exception. Subparagraph (1) of this paragraph shall not apply if 
the entire amount of the unpaid portion of the tax imposed by section 
507(c) is abated by the Commissioner under section 507(g).
    (b) Gift or bequest to taxable private foundation, section 4947 
trust, etc.--(1) General rule. (i) Except as provided in subparagraph 
(2) of this paragraph, no gift or bequest made to an organization shall 
be allowed as a deduction under section 170, 545(b)(2), 556(b)(2), 
642(c), 2055, 2106(a)(2), or 2522, if such gift or bequest is made:
    (a) To a private foundation or a trust described in section 
4947(a)(2) in a taxable year for which it fails to meet the requirements 
of section 508(e) (determined without regard to section 508(e)(2) (B) 
and (C), or
    (b) To any organization in a period for which it is not treated as 
an organization described in section 501(c)(3) by reason of section 
508(a).
    (ii) For purposes of subdivision (i)(a) of this subparagraph the 
term taxable year refers to the taxable year of the donee or beneficiary 
organization. In the event a bequest is made to a private foundation or 
trust described in section 4947(a)(2) which is not in existence at the 
date of the testator's death (but which is created under the terms of 
the testator's will), the term taxable year shall mean the first taxable 
year of the private foundation or trust.
    (iii) For purposes of subdivision (i)(a) of this subparagraph, an 
organization does not fail to meet the requirements of section 508(e) 
for a taxable year, unless it fails to meet such requirements for the 
entire year. Therefore, even if a donee organization fails to meet the 
requirements of section 508(e) on the date it receives a grant from a 
donor, the donor's grant will not be disallowed by operation of section 
508(d)(2)(A) and subdivision (i)(a) of this subparagraph, if the 
organization meets the requirements of section 508(e) (determined 
without regard to section 508(e)(2) (B) or (C)) by the end of its 
taxable year.
    (iv) No deduction will be disallowed under section 508(d)(2)(A) with 
respect to a deduction under section 170, 545(b)(2), 556(b)(2), 642(c), 
2055, 2106(a)(2), or 2522 if during the taxable year in question, the 
private foundation or trust described in section 4947(a)(2) has 
instituted a judicial proceeding which is necessary to reform its 
governing instrument or other instrument in order to meet the 
requirements of section 508(e)(1). This subdivision shall not apply 
unless within a reasonable time such judicial proceedings succeed in so 
reforming such instrument.
    (v) No deduction will be disallowed under section 508(d)(2)(A) and 
subdivision (i)(a) of this subparagraph for any taxable year beginning 
before January 1, 1972, with respect to a private foundation or trust 
described in section 4947 organized before January 1, 1970. See also 
Sec.  1.508-3(g) regarding transitional

[[Page 130]]

rules for extending compliance with section 508(e)(1).
    (vi)(a) In the case of a contribution or bequest to a trust 
described in section 4947(a)(2) other than to a trust to which 
subdivision (vii) of this subparagraph applies, no deduction shall be 
disallowed by reason of section 508(d)(2)(A) on the grounds that such 
trust's governing instrument contains no provisions with respect to 
section 4942. Similarly, if for a taxable year such trust is also a 
trust described in section 4947(b)(3), no deduction for such year shall 
be so disallowed on the grounds that the governing instrument contains 
no provision with respect to section 4943 or 4944.
    (b) This subdivision may be illustrated by the following example:

    Example. H executes a will on January 1, 1977, establishing a 
charitable remainder trust (as described in section 664) with income 
payable to W, his wife, for life, remainder to X university, an 
organization described in section 170(b)(1)(A)(ii). The will provides 
that the trust is prohibited from engaging in activities which would 
subject itself, its foundation manager or a disqualified person to taxes 
under section 4941 or 4945 of the Code. The will is silent as to 
sections 4942, 4943, and 4944. H dies February 12, 1978. Section 
508(d)(2)(A) will not operate to disallow any deduction to H's estate 
under section 2055 with respect to such trust.

    (vii)(a) In the case of a trust described in section 4947(a)(2) 
which by its terms will become a trust described in section 4947(a)(1) 
and the governing instrument of which is executed after March 22, 1973, 
the governing instrument shall not meet the requirements of section 
508(e)(1) if it does not contain provisions to the effect that the trust 
must comply with the provisions of section 4942, or sections 4942, 4943, 
and 4944 (as the case may be) to the extent such section or sections 
shall become applicable to such trust.
    (b) This subdivision may be illustrated by the following example:

    Example. H executes a will on January 1, 1977, establishing a 
charitable remainder trust (as described in section 664) with income 
payable to W, his wife, for life, remainder in trust in perpetuity for 
the benefit of an organization described in section 170(c). By its terms 
the trust will become a trust described in section 4947(a)(1), and will 
become a private foundation. The will provides that the trust is 
prohibited from engaging in activities which would subject itself, its 
foundation manager or a disqualified person to taxes under sections 4941 
or 4945 of the Code. The will is silent as to sections 4942, 4943, and 
4944. H dies February 12, 1978. Unless the trust's governing instrument 
is amended prior to the end of the trust's first taxable year, or 
judicial proceedings have been instituted under subdivision (iv) of this 
subparagraph, section 508(d)(2)(A) will operate to disallow any 
deduction to H's estate under section 2055 with respect to such trust.

    (viii) Since a charitable trust described in section 4947(a)(1) is 
not required to file a notice under section 508(a), section 508(d)(2)(B) 
and subdivision (i)(b) of this subparagraph are not applicable to such a 
trust.
    (2) Transitional rules. Any deduction which would otherwise be 
allowable under section 642(c)(2), 2106(a)(2), or 2055 shall not be 
disallowed under section 508(d)(2)(A) if such deduction is attributable 
to:
    (i) Property passing under the terms of a will executed on or before 
October 9, 1969,
    (a) If the decedent dies 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,
    (b) If the decedent dies after October 9, 1969, and at no time after 
that date had the right to change the portions of the will which 
pertains to the passing of property to, or for the use of, an 
organization described in section 170(c)(2)(B) or 2055(a), or
    (c) If no dispositive provision of the will is amended by the 
decedent, by codicil or otherwise, before October 9, 1972, and the 
decedent is on October 9, 1972, and at all times thereafter under a 
mental disability (as defined in Sec.  1.642(c)-2(b)(3)(ii)) to amend 
the will by codicil or otherwise, or
    (ii) Property transferred in trust on or before October 9, 1969,
    (a) If the grantor dies after October 9, 1969, but before October 9, 
1972, without having amended, after October 9, 1969, any dispositive 
provision of the instrument governing the disposition of the property,
    (b) If the property transferred was an irrevocable interest to, or 
for the use of, an organization described in section 170(c)(2)(B) or 
2055(a),

[[Page 131]]

    (c) In the case of a deduction under section 2106(a)(2) or 2055; if 
no dispositive provision of the instrument governing the disposition of 
the property is amended by the grantor before October 9, 1972, and the 
grantor is on October 9, 1972, and at all times thereafter under a 
mental disability (as defined in Sec.  1.642(c)-2(b)(3)(ii)) to change 
the disposition of the property, or
    (d) In the case of a deduction under section 642(c)(2)(A), if the 
grantor is at all times after October 9, 1969, and up to, and including, 
the last day of the taxable year for which the deduction under such 
section is claimed, under a mental disability (as defined in Sec.  
1.642(c)-2(b)(3)(ii)) to change the terms of the trust


See also Sec.  1.508-3(g) regarding the extension of time for compliance 
with section 508(e), Sec.  1.664-1(f)(3) (ii) and (g) regarding the 
special transitional rules for charitable remainder annuity and 
unitrusts described in section 664 which were created prior to December 
31, 1972, and Sec.  20.2055-2(e)(4) of this chapter regarding the rules 
for determining if the dispositive provisions have been amended.

[T.D. 7232, 37 FR 28291, Dec. 22, 1972]



Sec.  1.508-3  Governing instruments.

    (a) General rule. A private foundation shall not be exempt from 
taxation under section 501(a) for a taxable year unless by the end of 
such taxable year its governing instrument includes provisions the 
effects of which are:
    (1) To require distributions at such times and in such manner as not 
to subject the foundation to tax under section 4942, and
    (2) To prohibit the foundation from engaging in any act of self-
dealing (as defined in section 4941(d)), from retaining any excess 
business holdings (as defined in section 4943(c)), from making any 
investments in such manner as to subject the foundation to tax under 
section 4944, and from making any taxable expenditures (as defined in 
section 4945(d)).
    (b) Effect and nature of governing instrument--(1) In general. 
Except as provided in paragraph (d) of this section, the provisions of a 
foundation's governing instrument must require or prohibit, as the case 
may be, the foundation to act or refrain from acting so that the 
foundation, and any foundation managers or other disqualified persons 
with respect thereto, shall not be liable for any of the taxes imposed 
by sections 4941, 4942, 4943, 4944, and 4945 of the Code or, in the case 
of a split-interest trust described in section 4947(a)(2), any of the 
taxes imposed by those sections of chapter 42 made applicable under 
section 4947. Specific reference to these sections of the Code will 
generally be required to be included in the governing instrument, unless 
equivalent language is used which is deemed by the Commissioner to have 
the same full force and effect. However, a governing instrument which 
contains only language sufficient to satisfy the requirements of the 
organizational test under Sec.  1.501(c)(3)-1(b) will not be considered 
as meeting the requirements of this subparagraph, regardless of the 
interpretation placed on such language as a matter of law by a State 
court in a particular jurisdiction, unless the requirements of paragraph 
(d) of this section are satisfied.
    (2) Corpus. A governing instrument does not meet the requirements of 
paragraph (a)(1) of this section if it expressly prohibits the 
distribution of capital or corpus.
    (3) Savings provisions. For purposes of sections 508(d)(2) (A) and 
(e), a governing instrument need not include any provision which is 
inconsistent with section 101(l) (2), (3), (4), or (5) of the Tax Reform 
Act of 1969 (83 Stat. 533), as amended by sections 1301 and 1309 of the 
Tax Reform Act of 1976 (90 Stat. 1713, 1729), with respect to the 
organization. Accordingly, a governing instrument complying with the 
requirements of subparagraph (1) of this paragraph may incorporate any 
savings provision contained in section 101(l) (2), (3), (4), or (5) of 
the Tax Reform Act of 1969, as amended by sections 1301 and 1309 of the 
Tax Reform Act of 1976, as a specific exception to the general 
provisions of paragraph (a) of this section. In addition, in the absence 
of any express provisions to the contrary, the exceptions contained in 
such savings provisions will generally be regarded as contained in a 
governing instrument

[[Page 132]]

meeting the requirements of subparagraph (1) of this paragraph.
    (4) Excess holdings. For purposes of paragraph (a)(2) of this 
section, the prohibition against retaining any excess business holdings 
(as defined in section 4943(c)) shall be deemed only to prohibit the 
foundation from retaining any excess business holdings when such 
holdings would subject the foundation to tax under section 4943(a).
    (5) Revoked ruling on status. In the case of an organization which:
    (i) Has been classified as an organization described in section 
509(a) (1), (2), (3), or (4), and
    (ii) Subsequently receives a ruling or determination letter stating 
that it is no longer described in section 509(a) (1), (2), (3), or (4), 
but is a private foundation within the meaning of section 509,

such organization shall have 1 year from the date of receipt of such 
ruling or determination letter, or the final ruling or determination 
letter if a protest is filed to an earlier one, to meet the requirements 
of section 508(e). Section 508(d)(2)(A) shall not be applicable with 
respect to gifts and bequests made during this 1-year period if such 
requirements are met within the 1-year period.
    (6) Judicial proceeding. For purposes of paragraphs (a), (b)(5), 
(d)(2), and (e)(3) of this section, an organization shall be deemed to 
have met the requirements of section 508(e) within a year, if a judicial 
proceeding which is necessary to reform its governing instrument or 
other instrument is instituted within the year and within a reasonable 
time the organization, in fact, meets the requirements of section 
508(e). For purposes only of paragraphs (b)(5), (d)(2), and (e)(3) of 
this section, if an organization organized before January 1, 1970, 
institutes such a judicial proceeding within such 1-year period, section 
508 (e)(2)(C) shall be applied as if such proceeding had been instituted 
prior to January 1, 1972.
    (c) Meaning of governing instrument. For purposes of section 508(e), 
the term governing instrument shall have the same meaning as the term 
articles of organization under Sec.  1.501(c)(3)-1(b)(2). The bylaws of 
an organization shall not constitute its governing instrument for 
purposes of section 508(e).
    (d) Effect of State law--(1) In general. A private foundation's 
governing instrument shall be deemed to conform with the requirements of 
paragraph (a) of this section if valid provisions of State law have been 
enacted which:
    (i) Require it to act or refrain from acting so as not to subject 
the foundation to the taxes imposed by section 4941 (relating to taxes 
on self-dealing), 4942 (relating to taxes on failure to distribute 
income), 4943 (relating to taxes on excess business holdings), 4944 
(relating to taxes on investments which jeopardize charitable purpose), 
and 4945 (relating to taxable expenditures); or
    (ii) Treat the required provisions as contained in the foundation's 
governing instrument.
    (2) Validity. (i) Any provision of State law described in 
subparagraph (1) of this paragraph shall be presumed valid as enacted, 
and in the absence of State provisions to the contrary, to apply with 
respect to any foundation that does not specifically disclaim coverage 
under State law (either by notification to the appropriate State 
official or by commencement of judicial proceedings) except as provided 
in subdivisions (ii) and (iii) of this subparagraph.
    (ii) If such provision is declared invalid or inapplicable with 
respect to a class of foundations by the highest appellate court of the 
State or by the Supreme Court of the United States, the foundations 
covered by the determination must meet the requirements of section 
508(e) within 1 year from the date on which the time for perfecting an 
application for review by the Supreme Court expires. If such application 
is filed, the requirements of section 508(e) must be met within a year 
from the date on which the Supreme Court disposes of the case, whether 
by denial of the application for review or decision on the merits.
    (iii) In addition, if such provision of State law is declared 
invalid or inapplicable with respect to a class of foundations by any 
court of competent jurisdiction which decision is not reviewed by a 
court referred to in subdivision (ii)

[[Page 133]]

of this subparagraph, and the Commissioner makes notice to the general 
public (such as by publication in the Internal Revenue Bulletin) that 
such provision has been so declared invalid or inapplicable, then all 
foundations in such State must meet the requirements of section 508(e), 
without reliance upon such statute to the extent declared invalid or 
inapplicable by such decision, within 1 year from the date such notice 
is made public.
    (iv) This subparagraph shall not apply to any foundation that is 
subject to a final judgment entered by a court of competent 
jurisdiction, holding the law invalid or inapplicable with respect to 
such foundation. See paragraph (b)(6) of this section for the effect of 
certain judicial proceedings that are brought within 1 year.
    (3) Conflicting instrument. For taxable years beginning after March 
22, 1973 in order for a private foundation or trust described in section 
4947(a)(2) to receive the benefit of coverage under any State statute 
which makes applicable the requirements of section 508(e)(1) (A) and 
(B), where the statute by its terms does not apply to a governing 
instrument which contains a mandatory direction conflicting with any of 
such requirements, such organization must indicate on its annual return 
required to be filed under section 6033 (or section 6012 in the case of 
a trust described in section 4947(a)) that its governing instrument 
contains no mandatory directions which conflict with the requirements of 
section 508(e)(1) (A) or (B), as incorporated by the State statute. 
General language in a governing instrument empowering the trustee to 
make investments without being limited to those investments authorized 
by law will not be regarded as a mandatory conflicting direction.
    (4) Exclusion from statute. (i) For any taxable year beginning after 
March 22, 1973 in the case of a private foundation or trust described in 
section 4947(a)(2) subject to a State statute which makes applicable the 
requirements of section 508(e)(1) (A) and (B) to the governing 
instruments of such organizations, other than those which take action to 
be excluded therefrom (such as by filing a notice of exclusion or by 
instituting appropriate judicial proceedings), an organization will 
receive the benefit of such State statute only if it indicates on its 
annual return required to be filed under section 6033 (or section 6012 
in the case of a trust described in section 4947(a)) that it has not so 
taken action to be excluded.
    (ii) This paragraph permits certain organizations that are subject 
to the provisions of such a State law, to avoid changing their governing 
instruments in order to meet the requirements of section 508(e)(1). 
Since an organization which avoids the application of a provision or 
provisions of State law, such as by filing a notice of exclusion, is not 
entitled to the benefits of this paragraph, such an organization must 
meet the requirements of section 508(e)(1) without regard to this 
paragraph and except as provided in section 508(e)(2)(C) or paragraph 
(g)(1)(iii) of this section must change its governing instrument to the 
extent inconsistent with section 508(e)(1).
    (5) Treatment of prevailing conflicting clause. If provisions of 
State law are inapplicable to a clause in a governing instrument which 
is contrary to the provisions of section 508(e)(1), the requirements of 
section 508(e)(2)(C) and paragraph (g)(1)(iii) of this section are not 
satisfied by a provision of State law which purports to eliminate the 
need for litigation under such circumstances. Therefore, except as 
otherwise provided in this section unless the governing instrument is 
changed or litigation is commenced pursuant to section 508(e)(2)(B) by 
an organization organized before January 1, 1970, or pursuant to 
paragraph (g)(1)(ii) of this section, to amend the nonconforming 
provision to meet the requirements of section 508(e)(1) (A) and (B), 
then pursuant to section 508(e), such organization will not be exempt 
from taxation.
    (6) Retroactive application to grants or bequests. If valid 
provisions of such a State law apply retroactively to a taxable year 
within which an organization has received a grant or request, section 
508(d)(2)(A) shall not apply so as to disallow such grant or bequest, 
but only if such valid provisions of State law are enacted within 2 
years of such grant or bequest.
    (e) Effect of section 508(e) upon section 4947 trusts--(1) Section 
4947(a)(1) trusts. A

[[Page 134]]

charitable trust described in section 4947(a)(1) (unless also described 
in a paragraph of section 509(a)) is subject to all the provisions of 
paragraph (a) of this section.
    (2) Section 4947(a)(2) trusts. A split-interest trust described in 
section 4947(a)(2), as long as it is so described, is subject to the 
provisions of paragraph (a)(2) of this section, except to the extent 
that section 4947 makes any such provisions inapplicable to certain 
trusts and certain amounts in trust. The governing instrument of a trust 
described in section 4947(a)(2) may except amounts described in section 
4947(a)(2) (A), (B), and (C) from the requirements of paragraph (a)(2) 
of this section. In the case of a trust having amounts transferred to it 
both before May 27, 1969, and after May 26, 1969, its governing 
instrument may except from the provisions of paragraph (a)(2) of this 
section only those segregated amounts excluded from the application of 
section 4947(a)(2) by reason of section 4947(a)(2)(C) and the 
regulations thereunder. Also, the governing instrument of such a trust 
may exclude the application of sections 4943 and 4944 for any period 
during which such trust is described in section 4947(b)(3) (A) or (B). 
See Sec.  53.4947-1(c) of this chapter for rules relating to the 
applicability of section 4947 to split-interest trusts and Sec.  1.508-
2(b)(1) (vi) and (vii) for rules relating to the deductibility of grants 
or bequests to such trusts.
    (3) A section 4947(a)(2) trust becoming a section 4947(a)(1) trust. 
If the governing instrument of a trust described in section 4947(a)(2) 
meets the applicable requirements of paragraph (a)(2) of this section 
and such trust ceases to be so described and becomes instead a trust 
described in section 4947(a)(1), then such governing instrument must 
meet, prior to the end of 12 months from the date such trust first 
becomes described in section 4947(a)(1) (except as otherwise provided in 
this section) all the requirements of paragraph (a) of this section in 
order to comply with section 508(e).
    (f) Special rules for existing private foundations. (1) Pursuant to 
section 508(e)(2), section 508(e)(1) and paragraph (a) of this section 
shall not apply in the case of any organization whose governing 
instrument was executed before January 1, 1970:
    (i) To any taxable year beginning before January 1, 1972;
    (ii) To any period after December 31, 1971, during the pendency of 
any judicial proceeding begun before January 1, 1972, by the private 
foundation which is necessary to reform, or to excuse such foundation 
from compliance with, its governing instrument or any other instrument 
in order to meet the requirements of section 508(e)(1); and
    (iii) To any period after the termination of any judicial proceeding 
described in subdivision (ii) of this subparagraph during which its 
governing instrument or any other instrument does not permit it to meet 
the requirements of section 508(e)(1).
    (2) For purposes of subparagraph (1) of this paragraph, and Sec.  
1.508-2(b)(1)(vi)(a), a governing instrument will not be treated as 
executed before the applicable date, if, after such date the dispositive 
provisions of the instrument are amended (determined under rules similar 
to the rules set forth in Sec.  20.2055-2(e)(4) of this chapter).
    (3) For purposes of subparagraph (1) (ii) and (iii) of this 
paragraph, a private foundation will be treated as meeting the 
requirements of section 508(e)(2) (B) and (C) if it has commenced a 
necessary and timely proceeding in an appropriate court of original 
jurisdiction and such court has ruled that the foundation's governing 
instrument or any other instrument does not permit it to meet the 
requirements of section 508(e)(1). Such foundation is not required to 
commence proceedings in any court of appellate jurisdiction in order to 
comply with section 508(e)(2)(C). See also Sec.  1.508-2(b)(2).
    (g) Extension of time for compliance with section 508(e). (1) Except 
as provided in subparagraph (2) of this paragraph, section 508(e)(1) 
shall not apply to any private foundation (regardless of when organized) 
with respect:
    (i) To any taxable year beginning before the transitional date,
    (ii) To any period on or after the transitional date during the 
pendency of any judicial proceeding begun before the transitional date 
by the private foundation which is necessary to reform, or to excuse 
such foundation

[[Page 135]]

from compliance with, its governing instrument or any other instrument 
in order to meet the requirements of section 508(e)(1), and
    (iii) To any period after the termination of any judicial proceeding 
described in subdivision (ii) of this subparagraph during which its 
governing instrument or any other instrument does not permit it to meet 
the requirements of section 508(e)(1).
    (2) Subparagraph (1) of this paragraph shall apply only to gifts or 
bequests referred to in section 508(d)(2)(A) that are made before the 
transitional date.
    (3) For purposes of this paragraph the term transitional dates means 
the earlier of the following dates:
    (i) In the case of a medical research organization, May 21, 1976 or 
in the case of a community trust February 10, 1977, or
    (ii) The 91st day after the date an organization receives a final 
ruling or determination letter that it is a private foundation under 
section 509(a).

[T.D. 7232, 37 FR 28292, Dec. 22, 1972, as amended by T.D. 7440, 41 FR 
50656, Nov. 17, 1976; T.D. 7678, 45 FR 12415, Feb. 26, 1980]



Sec.  1.508-4  Effective date.

    Except as otherwise provided, Sec. Sec.  1.508-1 through 1.508-3 
shall take effect on January 1, 1970.

(Sec. 7805 of the Internal Revenue Code of 1954, 68A Stat. 917; 26 
U.S.C. 7805)

[T.D. 7232, 37 FR 28294, Dec. 22, 1972]



Sec.  1.509(a)-1  Definition of private foundation.

    In general. Section 509(a) defines the term private foundation to 
mean any domestic or foreign organization described in section 501(c)(3) 
other than an organization described in section 509(a) (1), (2), (3), or 
(4). Organizations which fall into the categories excluded from the 
definition of private foundation are generally those which either have 
broad public support or actively function in a supporting relationship 
to such organizations. Organizations which test for public safety are 
also excluded.

[T.D. 7212, 37 FR 21907, Oct. 17, 1972]



Sec.  1.509(a)-2  Exclusion for certain organizations described in 
section 170(b)(1)(A).

    (a) General rule. Organizations described in section 170(b)(1)(A) 
(other than in clauses (vii) and (viii)) are excluded from the 
definition of private foundation by section 509(a)(1). For the 
requirements to be met by organizations described in section 
170(b)(1)(A) (i) through (vi), see Sec.  1.170A-9 (a) through (e) and 
paragraph (b) of this section. For purposes of this section, the 
parenthetical language other than in clauses (vii) and (viii) used in 
section 509(a)(1) means other than an organization which is described 
only in clause (vii) or (viii). For purposes of this section, an 
organization may qualify as a section 509(a)(1) organization regardless 
of the fact that it does not satisfy section 170(c)(2) because:
    (1) Its funds are not used within the United States or its 
possessions, or
    (2) It was created or organized other than in, or under the law of, 
the United States, any State or territory, the District of Columbia, or 
any possession of the United States.
    (b) Medical research organizations. In order to qualify under 
section 509(a)(1) as a medical research organization described in 
section 170(b)(1)(A)(iii), an organization must meet the requirements of 
section 170(b)(1)(A)(iii) and Sec.  1.170A-9(c)(2), except that, solely 
for purposes of classification as a section 509(a)(1) organization, such 
organization need not be committed to spend every contribution for 
medical research before January 1 of the fifth calendar year which 
begins after the date such contribution is made.

[T.D. 7212, 37 FR 21907, Oct. 17, 1972]



Sec.  1.509(a)-3  Broadly, publicly supported organizations.

    (a) In general--(1) General rule. Section 509(a)(2) excludes certain 
types of broadly, publicly supported organizations from private 
foundation status. An organization will be excluded under section 
509(a)(2) if it meets the one-third support test under section 
509(a)(2)(A) and the not-more-than-one-third support test under section 
509(a)(2)(B).
    (2) One-third support test. An organization will meet the one-third 
support

[[Page 136]]

test if it normally (within the meaning of paragraph (c) or paragraph 
(d) of this section) receives from permitted sources more than one-third 
of its support in each taxable year from any combination of--
    (i) Gifts, grants, contributions, or membership fees; and
    (ii) Gross receipts from admissions, sales of merchandise, 
performance of services, or furnishing of facilities, in an activity 
that is not an unrelated trade or business (within the meaning of 
section 513), subject to certain limitations described in paragraph (b) 
of this section. For purposes of this section, governmental units, 
organizations described in section 509(a)(1), and persons other than 
disqualified persons with respect to the organization shall be referred 
to as permitted sources. For purposes of this section, the amount of 
support received from the sources described in paragraph (a)(2)(i) of 
this section and this paragraph (a)(2)(ii) (subject to the limitations 
referred to in this paragraph (a)(2)) will be referred to as the 
numerator of the one-third support fraction, and the total amount of 
support received (as defined in section 509(d)) will be referred to as 
the denominator of the one-third support fraction. Section 1.509(a)-3(f) 
distinguishes gifts and contributions from gross receipts; Sec.  
1.509(a)-3(g) distinguishes grants from gross receipts; Sec.  1.509(a)-
3(h) defines membership fees; Sec.  1.509(a)-3(i) defines ``any bureau 
or similar agency of a governmental unit''; Sec.  1.509(a)-3(j) 
describes the treatment of certain indirect forms of support; paragraph 
(k) of this section describes the method of accounting for support; 
Sec.  1.509(a)-3(l) describes the treatment of gross receipts from 
section 513(a)(1), section 513(a)(2), or section 513(a)(3) activities; 
Sec.  1.509(a)-3(m) distinguishes gross receipts from gross investment 
income; and Sec.  1.509(a)-3(n) describes transition rules for 
organizations that received advance rulings that expire on or after June 
9, 2008.
    (3) Not-more-than-one-third support test--(i) In general. An 
organization will meet the not-more-than-one-third support test under 
section 509(a)(2)(B) if it normally (within the meaning of paragraph (c) 
or (d) of this section) receives not more than one-third of its support 
in each taxable year from the sum of its gross investment income (as 
defined in section 509(e)) and the excess (if any) of the amount of its 
unrelated business taxable income (as defined in section 512, without 
regard to section 512(a)(6), or with regard to section 512(a)(6), if the 
organization so chooses) derived from trades or businesses that were 
acquired by the organization after June 30, 1975, over the amount of tax 
imposed on such income by section 511.For purposes of this section the 
amount of support received from items described in section 509(a)(2)(B) 
will be referred to as the numerator of the not-more-than-one-third 
support fraction, and the total amount of support (as defined in section 
509(d)) will be referred to as the denominator of the not-more-than-one-
third support fraction. For purposes of section 509(a)(2), paragraph (m) 
of this section distinguishes gross receipts from gross investment 
income. For purposes of section 509(e), gross investment income includes 
the items of investment income described in Sec.  1.512(b)-1(a).
    (ii) Trade or business. For purposes of section 509(a)(2)(B)(ii), a 
trade or business acquired after June 30, 1975, by an organization shall 
include, in addition to other trades or businesses:
    (A) A trade or business acquired after such date from, or as a 
result of the liquidation of, an organization's subsidiary which is 
described in section 502 whether or not the subsidiary was held on June 
30, 1975.
    (B) A new trade or business commenced by an organization after such 
date.
    (iii) Allocation of deductions between businesses acquired before, 
and businesses acquired after, June 30, 1975. Deductions which are 
allowable under section 512 but are not directly connected to a 
particular trade or business, such as deductions referred to in 
paragraphs (10) and (12) of section 512(b), shall be allocated in the 
proportion that the unrelated trade or business taxable income derived 
from trades or businesses acquired after June 30, 1975, bears to the 
organization's total unrelated business taxable income, both amounts 
being determined without regard to such deductions.

[[Page 137]]

    (iv) Allocation of tax. The tax imposed by section 511 shall be 
allocated in the same proportion as in paragraph (a)(3)(iii) of this 
section.
    (4) Unrelated business activities. The denominator of the one-third 
support fraction and the denominator of the not-more-than-one-third 
support fraction both include net income from unrelated business 
activities, whether or not such activities are carried on regularly as a 
trade or business. The term net income from unrelated business 
activities includes (but is not limited to) an organization's unrelated 
business taxable income (UBTI) within the meaning of section 512. 
However, when calculating UBTI for purposes of determining the 
denominator of both support fractions, section 512(a)(6) does not apply. 
Accordingly, in the case of an organization that derives gross income 
from the regular conduct of two or more unrelated business activities, 
support includes the aggregate of gross income from all such unrelated 
business activities less the aggregate of the deductions allowed with 
respect to all such unrelated business activities. Nonetheless, when 
determining support, such organization can use either its UBTI 
calculated under section 512(a)(6) or its UBTI calculated in the 
aggregate.
    (5) Purposes. The one-third support test and the not-more-than-one-
third support test are designed to insure that an organization which is 
excluded from private foundation status under section 509(a)(2) is 
responsive to the general public, rather than to the private interests 
of a limited number of donors or other persons.
    (b) Limitation on gross receipts--(1) General rule. In computing the 
amount of support received from gross receipts under section 
509(a)(2)(A)(ii) for purposes of the one-third support test of section 
509(a)(2)(A), gross receipts from related activities received from any 
person, or from any bureau or similar agency of a governmental unit, are 
includible in any taxable year only to the extent that such receipts do 
not exceed the greater of $5,000 or 1 percent of the organization's 
support in such taxable year.
    (2) Examples. The application of this paragraph may be illustrated 
by the examples set forth below. For purposes of these examples, the 
term general public is defined as persons other than disqualified 
persons and other than persons from whom the foundation receives gross 
receipts in excess of the greater of $5,000 or 1 percent of its support 
in any taxable year, and the term gross receipts is limited to receipts 
from activities which are not unrelated trade or business (within the 
meaning of section 513).

    Example 1. For the taxable year 1970, X, an organization described 
in section 501(c)(3), received support of $10,000 from the following 
sources:

Bureau M (a governmental bureau from which X received gross      $25,000
 receipts for services rendered)............................
Bureau N (a governmental bureau from which X received gross       25,000
 receipts for services rendered)............................
General public (gross receipts for services rendered).......      20,000
Gross investment income.....................................      15,000
Contributions from individual substantial contributors            15,000
 (defined as disqualified persons under section 4946(a)(2)).
                                                             -----------
    Total support...........................................     100,000
 


Since the $25,000 received from each bureau amounts to more than the 
greater of $5,000 or 1 percent of X's support for 1970 (1% of $100,000 = 
$1,000) under section 509(a)(2)(A)(ii), each amount is includible in the 
numerator of the one-third support fraction only to the extent of 
$5,000. Thus, for the taxable year 1970, X received support from sources 
which are taken into account in meeting the one-third support test of 
section 509(a)(2)(A) computed as follows:

Bureau M....................................................      $5,000
Bureau N....................................................       5,000
General public..............................................      20,000
                                                             -----------
    Total...................................................      30,000
 

Therefore, in making the computations required under paragraph (c), (d), 
or (e) of this section, only $30,000 is includible in the aggregate 
numerator and $100,000 is includible in the aggregate denominator of the 
support fraction.
    Example 2. For the taxable year 1970, Y, an organization described 
in section 501(c)(3), received support of $600,000 from the following 
sources:

Bureau O (gross receipts for services rendered).............     $10,000
Bureau P (gross receipts for services rendered).............      10,000
General public (gross receipts for services rendered).......     150,000
General public (contributions)..............................      40,000
Gross investment income.....................................     150,000
Contributions from substantial contributors.................     240,000
                                                             -----------
    Total support...........................................     600,000
 


Since the $10,000 received from each bureau amounts to more than the 
greater of $5,000 or

[[Page 138]]

1 percent of Y's support for 1970 (1% of $600,000 = $6,000), each amount 
is includible in the numerator of the one-third support fraction only to 
the extent of $6,000. Thus, for the taxable year 1970, Y received 
support from sources required to meet the one-third support test of 
section 509(a)(2)(A) computed as follows:

Bureau O....................................................      $6,000
Bureau P....................................................       6,000
General public (gross receipts).............................     150,000
General public (contributions)..............................      40,000
                                                             -----------
    Total...................................................     202,000
 

Therefore, in making the computations required under paragraph (c), (d), 
or (e) of this section, $202,000 is includible in the aggregate 
numerator and $600,000 is includible in the aggregate denominator of the 
support fraction.

    (c) Normally--(1) In general--(i) Definition. The support tests set 
forth in section 509(a)(2) are to be computed on the basis of the nature 
of the organization's normal sources of support. An organization will be 
considered as ``normally'' receiving one third of its support from any 
combination of gifts, grants, contributions, membership fees, and gross 
receipts from permitted sources (subject to the limitations described in 
Sec.  1.509(a)-3(b)) and not more than one third of its support from 
items described in section 509(a)(2)(B) for a taxable year and the 
taxable year immediately succeeding such year, if, for such taxable year 
and the four taxable years immediately preceding such taxable year, the 
aggregate amount of the support received during the applicable period 
from gifts, grants, contributions, membership fees, and gross receipts 
from permitted sources (subject to the limitations described in Sec.  
1.509(a)-3(b)) is more than one third, and the aggregate amount of the 
support received from items described in section 509(a)(2)(B) is not 
more than one third, of the total support of the organization for such 
five-year period. A publicly supported organization described under 
section 509(a)(2) that has failed to meet either the one-third support 
test of paragraph (a)(2) of this section or the not-more-than-one-third 
support test of paragraph (a)(3) of this section for two consecutive 
years will be treated as a private foundation as of the first day of the 
second consecutive taxable year only for purposes of sections 507, 4940, 
and 6033. Such an organization must file a Form 990-PF, ``Return of 
Private Foundation or Section 4947(a)(1) Nonexempt Charitable Trust 
Treated as a Private Foundation,'' and will be liable for the net 
investment tax imposed by section 4940 and, if applicable, the private 
foundation termination tax imposed by section 507(c), for that second 
consecutive failed year. For the succeeding years, the organization will 
be treated as a private foundation for all purposes.
    (ii) First five years of an organization's existence. See paragraph 
(d)(1) of this section for the definition of ``normally'' for 
organizations in the first five years of their existence.
    (2) Terminations under section 507(b)(1)(B). For the special rules 
applicable to the term normally as applied to private foundations that 
elect to terminate their private foundation status pursuant to the 60-
month procedure provided in section 507(b)(1)(B), see the regulations 
under such section.
    (3) Exclusion of unusual grants. For purposes of applying the tests 
for support set forth in paragraphs (a)(2) and (a)(3) of this section, 
one or more contributions may be excluded from the numerator of the one-
third support fraction and from the denominator of both the one-third 
support and not-more-than-one-third support fractions only if such a 
contribution meets the requirements of this paragraph (c)(3). The 
exclusion provided by this paragraph (c)(3) is generally intended to 
apply to substantial contributions and bequests from disinterested 
parties, which contributions or bequests--
    (i) Are attracted by reason of the publicly supported nature of the 
organization;
    (ii) Are unusual or unexpected with respect to the amount thereof; 
and
    (iii) Would by reason of their size, adversely affect the status of 
the organization as normally meeting the one-third support test for any 
of the applicable periods described in this paragraph (c) or paragraph 
(d) of this section. In the case of a grant (as defined in Sec.  
1.509(a)-3(g)) that meets the requirements of this paragraph (c)(3), if 
the terms of the granting instrument require that the funds be paid to 
the recipient organization over a period of

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years, the grant amounts may be excluded for such year or years in which 
they would otherwise be includible in computing support under the method 
of accounting on the basis of which the organization regularly computes 
its income in keeping its books under section 446. However, no item 
described in section 509(a)(2)(B) may be excluded under this paragraph 
(c)(3). The provisions of this paragraph (c)(3) shall apply to exclude 
unusual grants made during any of the applicable periods described in 
this paragraph (c) or paragraph (d) of this section. See paragraph 
(c)(5) of this section as to reliance by a grantee organization upon an 
unusual grant ruling under this paragraph (c)(3).
    (4) Determining factors. In determining whether a particular 
contribution may be excluded under paragraph (c)(3) of this section, all 
pertinent facts and circumstances will be taken into consideration. No 
single factor will necessarily be determinative. Among the factors to be 
considered are--
    (i) Whether the contribution was made by any person (or persons 
standing in a relationship to such person which is described in section 
4946(a)(1)(C) through 4946(a)(1)(G)) who created the organization, 
previously contributed a substantial part of its support or endowment, 
or stood in a position of authority, such as a foundation manager 
(within the meaning of section 4946(b)), with respect to the 
organization. A contribution made by a person other than those persons 
described in this paragraph (c)(4)(i) will ordinarily be given more 
favorable consideration than a contribution made by a person described 
in this paragraph (c)(4)(i);
    (ii) Whether the contribution was a bequest or an inter vivos 
transfer. A bequest will ordinarily be given more favorable 
consideration than an inter vivos transfer;
    (iii) Whether the contribution was in the form of cash, readily 
marketable securities, or assets which further the exempt purposes of 
the organization, such as a gift of a painting to a museum;
    (iv) Except in the case of a new organization, whether, prior to the 
receipt of the particular contribution, the organization has carried on 
an actual program of public solicitation and exempt activities and has 
been able to attract a significant amount of public support;
    (v) Whether the organization may reasonably be expected to attract a 
significant amount of public support subsequent to the particular 
contribution. In this connection, continued reliance on unusual grants 
to fund an organization's current operating expenses (as opposed to 
providing new endowment funds) may be evidence that the organization 
cannot reasonably be expected to attract future support from the general 
public;
    (vi) Whether, prior to the year in which the particular contribution 
was received, the organization met the one-third support test described 
in paragraph (a)(2) of this section without the benefit of any 
exclusions of unusual grants pursuant to paragraph (c)(3) of this 
section;
    (vii) Whether neither the contributor nor any person standing in a 
relationship to such contributor which is described in section 
4946(a)(1)(C) through 4946(a)(1)(G) continues directly or indirectly to 
exercise control over the organization;
    (viii) Whether the organization has a representative governing body 
as described in Sec.  1.509(a)-3(d)(3)(i); and
    (ix) Whether material restrictions or conditions (within the meaning 
of Sec.  1.507-2(a)(7)) have been imposed by the transferor upon the 
transferee in connection with such transfer.
    (5) Grantors and contributors. Prior to the making of any grant or 
contribution expected to meet the requirements for exclusion under 
paragraph (c)(3) of this section, a potential grantee organization may 
request a determination whether such grant or contribution may be so 
excluded. Requests for such determination may be filed by the grantee 
organization in the time and manner specified by revenue procedure or 
other guidance published in the Internal Revenue Bulletin. The issuance 
of such determination will be at the sole discretion of the 
Commissioner. The organization must submit all information necessary to 
make a determination of the applicability of paragraph (c)(3) of this 
section, including

[[Page 140]]

all information relating to the factors described in paragraph (c)(4) of 
this section. If a favorable determination is issued, such determination 
may be relied upon by the grantor or contributor of the particular 
contribution in question for purposes of sections 170, 507, 545(b)(2), 
642(c), 4942, 4945, 4966, 2055, 2106(a)(2), and 2522 and by the grantee 
organization for purposes of paragraph (c)(3) of this section.
    (6) Examples. The application of the principles set forth in this 
paragraph is illustrated by the examples as follows. For purposes of 
these examples, the term general public is defined as persons other than 
disqualified persons and other than persons from whom the foundation 
received gross receipts in excess of the greater of $5,000 or 1 percent 
of its support in any taxable year, the term gross investment income is 
as defined in section 509(e), and the term gross receipts is limited to 
receipts from activities which are not unrelated trades or businesses 
(within the meaning of section 513).

    Example 1. (i) For the years 2008 through 2012, X, an organization 
exempt under section 501(c)(3) that makes scholarship grants to needy 
students of a particular city, received support from the following 
sources:

2008:
    Gross receipts (general public)..........................    $35,000
    Contributions (substantial contributors).................     36,000
    Gross investment income..................................     29,000
                                                              ----------
        Total support........................................    100,000
2009:
    Gross receipts (general public)..........................     34,000
    Contributions (substantial contributors).................     35,000
    Gross investment income..................................     31,000
                                                              ----------
        Total support........................................    100,000
2010:
    Gross receipts (general public)..........................     35,000
    Contributions (substantial contributors).................     30,000
    Gross investment income..................................     35,000
                                                              ----------
        Total support........................................    100,000
2011:
    Gross receipts (general public)..........................     33,000
    Contributions (substantial contributors).................     32,000
    Gross investment income..................................     35,000
                                                              ----------
        Total support........................................    100,000
2012:
    Gross receipts (general public)..........................     31,000
    Contributions (substantial contributors).................     39,000
    Gross investment income..................................     30,000
                                                              ----------
        Total support........................................    100,000
 

    (ii) In applying section 509(a)(2) to the taxable year 2012, on the 
basis of paragraph (c)(1)(i) of this section, the total amount of 
support from gross receipts from the general public ($168,000) for the 
period 2008 through 2012, was more than one third, and the total amount 
of support from gross investment income ($160,000) was less than one 
third, of X's total support for the same period ($500,000). For the 
taxable years 2012 and 2013, X is therefore considered normally to 
receive more than one third of its support from the public sources 
described in section 509(a)(2)(A) and less than one third of its support 
from items described in section 509(a)(2)(B). The fact that X received 
less than one third of its support from section 509(a)(2)(A) sources in 
2012 and more than one third of its support from items described in 
section 509(a)(2)(B) in 2011 does not affect its status because it 
normally met the applicable tests over a five-year period.

[[Page 141]]

    Example 2. Assume the same facts as in Example 1 except that in 
2012, X also received an unexpected bequest of $50,000 from A, an 
elderly widow who was interested in encouraging the work of X, but had 
no other relationship to it. Solely by reason of the bequest, A became a 
disqualified person. X used the bequest to create five new scholarships. 
Its operations otherwise remained the same. Under these circumstances, 
if A's bequest is included in X's support calculation, X could not meet 
the five-year support test because the total amount received from gross 
receipts from the general public ($168,000) would not be more than one-
third of its total support for the five-year period ($550,000). Because 
A is a disqualified person, her bequest cannot be included in the 
numerator of the one-third support test under section 509(a)(2)(A). 
However, based on the factors set forth in paragraph (c)(4) of this 
section, A's bequest may be excluded as an unusual grant under paragraph 
(c)(3) of this section. Therefore, X will be considered to have met the 
support test for the taxable years 2012 and 2013.
    Example 3. Y, an organization described in section 501(c)(3), was 
created by A, the holder of all the common stock in M corporation; B, 
A's wife; and C, A's business associate. The purpose of Y was to sponsor 
and equip athletic teams for underprivileged children in the community. 
Each of the three creators makes small cash contributions to Y. A, B, 
and C have been active participants in the affairs of Y since its 
creation. Y regularly raises small amounts of contributions through 
fundraising drives and selling admission to some of the sponsored 
sporting events. The operations of Y are carried out on a small scale, 
usually being restricted to the sponsorship of two to four baseball 
teams of underprivileged children. In 2009, M recapitalizes and creates 
a first and second class of 6 percent nonvoting preferred stock, most of 
which is held by A and B. In 2010, A contributes 49 percent of his 
common stock in M to Y. A's contribution of M's common stock was 
substantial and constitutes 90 percent of Y's total support for 2010. A 
combination of the facts and circumstances described in paragraph (c)(4) 
of this section preclude A's contribution of M's common stock in 2010 
from being excluded as an unusual grant under paragraph (c)(3) of this 
section for purposes of determining whether Y meets the one-third 
support test under section 509(a)(2).
    Example 4. (i) M is organized in 2009 to promote the appreciation of 
ballet in a particular region of the United States. Its principal 
activities consist of erecting a theater for the performance of ballet 
and the organization and operation of a ballet company. M receives a 
determination letter that it is an organization described in section 
501(c)(3) and that it is a public charity described in section 
509(a)(2). The governing body of M consists of nine prominent unrelated 
citizens residing in the region who have either an expertise in ballet 
or a strong interest in encouraging appreciation of the art form.
    (ii) In 2010, Z, a private foundation, proposes to makes a grant of 
$500,000 in cash to M to provide sufficient capital for M to commence 
its activities. Although A, the creator of Z, is one of the nine members 
of M's governing body, was one of M's original founders, and continues 
to lend his prestige to M's activities and fund raising efforts, A does 
not, directly or indirectly, exercise any control over M. M also 
receives a significant amount of support from a number of smaller 
contributions and pledges from other members of the general public. M 
charges admission to the ballet performances to the general public.
    (iii) Although the support received in 2010 will not impact M's 
status as a public charity for its first five taxable years, it will be 
relevant to the determination of whether M meets the one-third support 
test under section 509(a)(2) for the 2014 taxable year, using the 
computation period 2010 through 2014. Within the appropriate timeframe, 
M may submit a request for a private letter ruling that the $500,000 
contribution from Z qualifies as an unusual grant.
    (iv) Under the above circumstances, even though A was a founder and 
member of the governing body of M, M may exclude Z's contribution of 
$500,000 in 2010 as an unusual grant under paragraph (c)(3) of this 
section for purposes of determining whether M meets the one-third 
support test under section 509(a)(2) for 2014.
    Example 5. (i) Assume the same facts as Example 4(i) except that, in 
addition, in 2013, B, a widow, passes away and bequeaths $4 million to 
M. During 2009 through 2013, B made small contributions to M, none 
exceeding $10,000 in any year. During 2009 through 2013, M received 
approximately $450,000 from receipts for admissions and contributions 
from the general public. At the time of B's death, no person standing in 
a relationship to B described in section 4946(a)(1)(C) through 
4946(a)(1)(G) was a member of M's governing body. B's bequest was in the 
form of cash and readily marketable securities. The only condition 
placed upon the bequest was that it be used by M to advance the art of 
ballet.
    (ii) Although the support received in 2013 will not impact M's 
status as a public charity for its first five taxable years, it will be 
relevant to the determination of whether M meets the one-third support 
test under section 509(a)(2) for future years. Within the appropriate 
timeframe, M may submit a request for a private letter ruling that the 
$4 million bequest from B qualifies as an unusual grant.
    (iii) Under the above circumstances, M may exclude B's bequest of $4 
million in 2013 as an unusual grant under paragraph (c)(3) of

[[Page 142]]

this section for purposes of determining whether M meets the one-third 
support test under section 509(a)(2) for 2014 and subsequent years.
    Example 6. (i) N is a research organization that was created by A in 
2009 for the purpose of carrying on economic studies primarily through 
persons receiving grants from N and engaging in the sale of economic 
publications. N received a determination letter that it is described in 
section 501(c)(3) and that it is a public charity described in 
509(a)(2). N's five-member governing body consists of A; A's sons, B and 
C; and two unrelated economists. In 2009, A made a contribution to N of 
$100,000 to help establish the organization. During 2009 through 2013, A 
made annual contributions to N averaging $20,000 a year. During the same 
period, N received annual contributions from members of the general 
public averaging $15,000 per year and receipts from the sale of its 
publications averaging $50,000 per year. In 2013, B made an inter vivos 
contribution to N of $600,000 in cash and readily marketable securities.
    (ii) Although the support received in 2013 will not impact N's 
status as a public charity for its first five taxable years, it will be 
relevant to the determination of whether N meets the one-third support 
test under section 509(a)(2) for future years. In determining whether 
B's contribution of $600,000 in 2013 may be excluded as an unusual 
grant, the support N received in 2009 through 2013 is relevant in 
considering the factor described in paragraph (c)(4)(vi) of this 
section, notwithstanding that N received a determination letter that it 
is described in section 509(a)(2).
    (iii) Under the above circumstances, in particular the facts that B 
is a disqualified person described in section 4946(a)(1)(D) and N does 
not have a representative governing body as described in paragraphs 
(c)(4)(viii) and (d)(3)(i) of this section, N cannot exclude B's 
contribution of $600,000 in 2013 as an unusual grant under paragraph 
(c)(3) of this section for purposes of determining whether N meets the 
one-third support test under section 509(a)(2) for 2014 and future 
years.
    Example 7. (i) O is an educational organization created in 2009. O 
received a determination letter that it is described in section 
501(c)(3) and that it is a public charity described in section 
509(a)(2). The governing body of O has 9 members, consisting of A, a 
prominent civic leader, and 8 other unrelated civic leaders and 
educators in the community, all of whom participated in the creation of 
O. During 2009 through 2013, the principal source of income for O has 
been receipts from the sale of its educational periodicals. These sales 
have amounted to $200,000 for this period. Small contributions amounting 
to $50,000 have also been received during the same period from members 
of the governing body, including A, as well as other members of the 
general public.
    (ii) In 2013, A contributed $750,000 of the nonvoting stock of S, a 
closely held corporation, to O. A retained a substantial portion of the 
voting stock of S. By a majority vote, the governing body of O decided 
to retain the S stock for a period of at least five years.
    (iii) Although the support received in 2013 will not impact O's 
status as a public charity for its first five taxable years, it will be 
relevant to the determination of whether O meets the one-third support 
test under section 509(a)(2) for future years. In determining whether 
A's contribution of the S stock in 2013 may be excluded as an unusual 
grant, the support O received in 2009 through 2013 is relevant in 
considering the factor described in paragraph (c)(4)(vi) of this 
section, notwithstanding that O received a determination letter that it 
is described in section 509(a)(2).
    (iv) Under the above circumstances, in particular the facts that A 
is a foundation manager within the meaning of section 4946(b) and A's 
contribution is in the form of closely held stock, O cannot exclude A's 
contribution of the S stock in 2013 as an unusual grant under paragraph 
(c)(3) of this section for purposes of determining whether O meets the 
one-third support test under section 509(a)(2) for 2014 and future 
years.

    (d) Definition of normally; first five years of an organization's 
existence--(1) In general. An organization will ``normally'' meet the 
one-third support test and the not-more-than-one-third support test 
during its first five taxable years as a section 501(c)(3) organization 
if the organization can reasonably be expected to meet the requirements 
of the one-third support test and the not-more-than-one-third support 
test during that period. With respect to an organization's sixth taxable 
year, the general definition of normally in paragraph (c)(1) of this 
section applies. Alternatively, the organization shall be treated as 
normally meeting the one-third support test and the not-more-than-one-
third support test for its sixth taxable year (but not its seventh 
taxable year) if it meets the one-third support test and the not-more-
than-one-third support test under the definition of normally set forth 
in paragraph (c)(1)(i) of this section for its fifth taxable year (based 
on support received in its first through fifth taxable years). If a new 
publicly supported organization described under section 509(a)(2) cannot 
meet the requirements of the one-third support test or the not-more-
than-one-third support test for its sixth taxable

[[Page 143]]

year using either the general definition of normally in paragraph (c)(1) 
of this section or the alternate rule above (effectively failing to meet 
a public support test for both its fifth and sixth years), it will be 
reclassified as a private foundation as of the first day of its sixth 
taxable year only for purposes of sections 507, 4940, and 6033. Such an 
organization must file a Form 990-PF, ``Return of Private Foundation or 
Section 4947(a)(1) Nonexempt Charitable Trust Treated as a Private 
Foundation,'' and is liable for the net investment tax imposed by 
section 4940 and, if applicable, the private foundation termination tax 
imposed by section 507(c), for its sixth taxable year. Beginning the 
first day of its seventh taxable year, the organization will be treated 
as a private foundation for all purposes.
    (2) Basic consideration. In determining whether an organization can 
reasonably be expected (within the meaning of paragraph (c)(1)(i) of 
this section) to meet the one-third support test under section 
509(a)(2)(A) and the not-more-than-one-third support test under section 
509(a)(2)(B) described in paragraph (a) of this section during its first 
five taxable years, the basic consideration is whether its 
organizational structure, current or proposed programs or activities, 
and actual or intended method of operation are such as to attract the 
type of broadly based support from the general public, public charities, 
and governmental units that is necessary to meet such tests. The factors 
that are relevant to this determination, and the weight accorded to each 
of them, may differ from case to case, depending on the nature and 
functions of the organization. An organization cannot reasonably be 
expected to meet the one-third support test and the not-more-than-one-
third support test where the facts indicate that an organization is 
likely during its first five taxable years to receive less than one-
third of its support from permitted sources (subject to the limitations 
of paragraph (b) of this section) or to receive more than one-third of 
its support from items described in section 509(a)(2)(B).
    (3) Factors taken into account. All pertinent facts and 
circumstances shall be taken into account under paragraph (d)(2) of this 
section in determining whether the organizational structure, programs or 
activities, and method of operation of an organization are such as to 
enable it to meet the tests under section 509(a)(2) during its first 
five taxable years. Some of the pertinent factors are:
    (i) Whether the organization has or will have a representative 
governing body which is comprised of public officials, or individuals 
chosen by public officials acting in their capacity as such; of persons 
having special knowledge in the particular field or discipline in which 
the organization is operating; of community leaders, such as elected 
officials, clergymen, and educators; or, in the case of a membership 
organization, of individuals elected pursuant to the organization's 
governing instrument or bylaws by a broadly based membership. This 
characteristic does not exist if the membership of the organization's 
governing body is such as to indicate that it represents the personal or 
private interests of disqualified persons, rather than the interests of 
the community or the general public.
    (ii) Whether a substantial portion of the organization's initial 
funding is to be provided by the general public, by public charities, or 
by government grants, rather than by a limited number of grantors or 
contributors who are disqualified persons with respect to the 
organization. The fact that the organization plans to limit its 
activities to a particular community or region or to a special field 
which can be expected to appeal to a limited number of persons will be 
taken into consideration in determining whether those persons providing 
the initial support for the organization are representative of the 
general public. On the other hand, the subsequent sources of funding 
which the organization can reasonably expect to receive after it has 
become established and fully operational will also be taken into 
account.
    (iii) Whether a substantial proportion of the organization's initial 
funds are placed, or will remain, in an endowment, and whether the 
investment of such funds is unlikely to result in more than one third of 
its total support

[[Page 144]]

being received from items described in section 509(a)(2)(B).
    (iv) In the case of an organization that carries on fundraising 
activities, whether the organization has developed a concrete plan for 
solicitation of funds from the general public on a community or area-
wide basis; whether any steps have been taken to implement such plan; 
whether any firm commitments of financial or other support have been 
made to the organization by civic, religious, charitable, or similar 
groups within the community; and whether the organization has made any 
commitments to, or established any working relationships with, those 
organizations or classes of persons intended as the future recipients of 
its funds.
    (v) In the case of an organization that carries on community 
services, such as combating community deterioration in an economically 
depressed area that has suffered a major loss of population and jobs, 
whether the organization has a concrete program to carry out its work in 
the community; whether any steps have been taken to implement that 
program; whether it will receive any part of its funds from a public 
charity or governmental agency to which it is in some way held 
accountable as a condition of the grant or contribution; and whether it 
has enlisted the sponsorship or support of other civic or community 
leaders involved in community service programs similar to those of the 
organization.
    (vi) In the case of an organization that carries on educational or 
other exempt activities for, or on behalf of, members, whether the 
solicitation for dues-paying members is designed to enroll a substantial 
number of persons in the community, area, profession, or field of 
special interest (depending on the size of the area and the nature of 
the organization's activities); whether membership dues for individual 
(rather than institutional) members have been fixed at rates designed to 
make membership available to a broad cross-section of the public rather 
than to restrict membership to a limited number of persons; and whether 
the activities of the organization will be likely to appeal to persons 
having some broad common interest or purpose, such as educational 
activities in the case of alumni associations, musical activities in the 
case of symphony societies, or civic affairs in the case of parent-
teacher associations.
    (vii) In the case of an organization that provides goods, services, 
or facilities, whether the organization is or will be required to make 
its services, facilities, performances, or products available 
(regardless of whether a fee is charged) to the general public, public 
charities, or governmental units, rather than to a limited number of 
persons or organizations; whether the organization will avoid executing 
contracts to perform services for a limited number of firms or 
governmental agencies or bureaus; and whether the service to be provided 
is one which can be expected to meet a special or general need among a 
substantial portion of the general public.
    (4) Example. The application of this paragraph (d) may be 
illustrated by the following example:

    Example. (i) Organization X was formed in January 2008 and uses a 
taxable year ending December 31. After September 9, 2008, and before 
December 31, 2008, Organization X filed Form 1023 requesting recognition 
of exemption as an organization described in section 501(c)(3) and in 
section 509(a)(2). In its application, Organization X established that 
it can reasonably be expected to operate as a publicly supported 
organization under paragraph (d) of this section. Subsequently, 
Organization X received a ruling or determination letter that it is an 
organization described in sections 501(c)(3) and 509(a)(2) effective as 
of the date of its formation.
    (ii) Organization X is described in section 509(a)(2) for its first 
five taxable years (for the taxable years ending December 31, 2008, 
through December 31, 2012).
    (iii) Organization X can qualify as a publicly supported 
organization beginning with the taxable year ending December 31, 2013, 
if Organization X can meet the requirements of either Sec.  1.170A-
9(f)(2) or Sec.  1.170A-9(f)(3) or paragraphs (a) and (b) of this 
section for the taxable years ending December 31, 2009, through December 
31, 2013, or for the taxable years ending December 31, 2008, through 
December 31, 2012.

    (e) Determinations on foundation classification and reliance. (1) A 
ruling or determination letter that an organization is described in 
section 509(a)(2) may be issued to an organization. Such

[[Page 145]]

determination may be made in conjunction with the recognition of the 
organization's tax-exempt status or at such other time as the 
organization believes it is described in section 509(a)(2). The ruling 
or determination letter that the organization is described in section 
509(a)(2) may be revoked if, upon examination, the organization has not 
met the requirements of this section. The ruling or determination letter 
that the organization is described in section 509(a)(2) also may be 
revoked if the organization's application for a ruling or determination 
contained one or more material misstatements or omissions of fact or 
such application was part of a scheme or plan to avoid or evade any 
provision of the Code. The revocation of the determination that an 
organization is described in section 509(a)(2) does not preclude 
revocation of the determination that the organization is described in 
section 501(c)(3).
    (2) Status of grantors or contributors. (i) For purposes of sections 
170, 507, 545(b)(2), 642(c), 4942, 4945, 4966, 2055, 2106(a)(2), and 
2522, grantors and contributors may rely upon a determination letter or 
ruling that an organization is described in section 509(a)(2) until the 
IRS publishes notice of a change of status (for example, in the Internal 
Revenue Bulletin or Publication 78, ``Cumulative List of Organizations 
described in Section 170(c) of the Internal Revenue Code of 1986,'' 
which can be searched at http://www.irs.gov). For this purpose, grantors 
or contributors may also rely on an advance ruling that expires on or 
after June 9, 2008. However, a grantor or contributor may not rely on 
such an advance ruling or any determination letter or ruling if the 
grantor or contributor was responsible for, or aware of, the act or 
failure to act that resulted in the organization's loss of 
classification under section 509(a)(2) or acquired knowledge that the 
IRS had given notice to such organization that it would be deleted from 
such classification.
    (ii) A grantor or contributor (other than one of the organization's 
founders, creators, or foundation managers (within the meaning of 
section 4946(b))) will not be considered to be responsible for, or aware 
of, the act or failure to act that resulted in the loss of the 
organization's publicly supported classification under section 509(a)(2) 
if such grantor or contributor has made such grant or contribution in 
reliance upon a written statement by the grantee organization that such 
grant or contribution will not result in the loss of such organization's 
classification as not a private foundation under section 509(a). Such 
statement must be signed by a responsible officer of the grantee 
organization and must set forth sufficient information, including a 
summary of the pertinent financial data for the five taxable years 
immediately preceding the current taxable year, to assure a reasonably 
prudent person that his grant or contribution will not result in the 
loss of the grantee organization's classification as a publicly 
supported organization under section 509(a). If a reasonable doubt 
exists as to the effect of such grant or contribution, or if the grantor 
or contributor is one of the organization's founders, creators, or 
foundation managers, the procedure for requesting a determination letter 
set forth in paragraph (c)(5) of this section may be followed by the 
grantee organization for the protection of the grantor or contributor.
    (3) Examples. The provisions of this paragraph (e) may be 
illustrated by the following examples:
    Example 1. Y, a calendar year organization described in section 
501(c)(3), is created in February 2008 for the purpose of displaying 
African art. On its exemption application Y shows, under penalties of 
perjury, that it can reasonably, in accordance with the requirements of 
paragraph (d) of this section, expect to receive support from the public 
in 2008 through 2012 that will satisfy the one-third support and not-
more-than-one-third support tests described in section 509(a)(2) for its 
first five taxable years, 2008 through 2012. Y may therefore receive a 
determination that it meets the requirements of paragraph (a) of this 
section for its first five taxable years (2008, 2009, 2010, 2011, and 
2012), regardless of the public support Y in fact receives during this 
period.
    Example 2. Z, a calendar year organization described in section 
501(c)(3), is created in July 2008. On its exemption application Z 
shows, under penalties of perjury, that it can reasonably, in accordance 
with the requirements of paragraph (d) of this section, expect to 
receive support from the public in 2008 through 2012 that will satisfy 
the one-third support and not-more-than-one-third support

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tests described in section 509(a)(2) for its first five taxable years, 
2008 through 2012. Z receives a determination that it is described in 
section 509(a)(2). However, the support actually received from the 
public over Z's first five taxable years (2008 through 2012) does not 
satisfy the one-third support and not-more-than-one-third support tests 
described in section 509(a)(2). Moreover, the support Z receives from 
2009 through 2013, also does not meet the one-third support and not-
more-than-one-third support tests described in section 509(a)(2). Z is 
described in section 509(a)(2) during its first five years for all 
purposes. However, because Z has not met the requirements of paragraph 
(a) of this section for either 2008 through 2012 or 2009 through 2013, Z 
is not described in section 509(a)(2) for its taxable year 2013. If Z is 
not described in section 509(a)(1), section 509(a)(3), or section 
509(a)(4), then Z will be reclassified as a private foundation as of the 
first day of 2013. However, for 2013, Z will be treated as a private 
foundation only for purposes of sections 507, 4940 and 6033. Z must file 
Form 990-PF and will be liable for the net investment tax imposed by 
section 4940 and, if applicable, the private foundation termination tax 
imposed by section 507(c) for 2013. For 2014 and succeeding years, Z 
will be treated as a private foundation for all purposes (except as 
provided in paragraph (e)(2) of this section with respect to grantors 
and contributors).

    (f) Gifts and contributions distinguished from gross receipts--(1) 
In general. In determining whether an organization normally receives 
more than one-third of its support from permitted sources, all gifts and 
contributions (within the meaning of section 509(a)(2)(A)(i)) received 
from permitted sources, are includible in the numerator of the support 
fraction in each taxable year. However, gross receipts (within the 
meaning of section 509(a)(2)(A)(ii)) from admissions, sales of 
merchandise, performance of services, or furnishing of facilities, in an 
activity which is not an unrelated trade or business, are includible in 
the numerator of the support fraction in any taxable year only to the 
extent that such gross receipts do not exceed the limitation with 
respect to the greater of $5,000 or 1 percent of support which is 
describing paragraph (b) of this section. The terms gifts and 
contributions shall, for purposes of section 509(a)(2), have the same 
meaning as such terms have under section 170(c) and also include 
bequests, legacies, devises, and transfers within the meaning of section 
2055 or 2106(a)(2). Thus, for purposes of section 509(a)(2)(A), any 
payment of money or transfer of property without adequate consideration 
shall be considered a gift or contribution. Where payment is made or 
property transferred as consideration for admissions, sales of 
merchandise, performance of services, or furnishing of facilities to the 
donor, the status of the payment or transfer under section 170(c) shall 
determine whether and to what extent such payment or transfer 
constitutes a gift or contribution under section 509(a)(2)(A)(i) as 
distinguished from gross receipts from related activities under section 
509(a)(2)(A)(ii). For purposes of section 509(a)(2), the term 
contributions includes qualified sponsorship payments (as defined in 
Sec.  1.513-4) in the form of money or property (but not services).
    (2) Valuation of property. For purposes of section 509(a)(2), the 
amount includible in computing support with respect to gifts, grants or 
contributions of property or use of such property shall be the fair 
market or rental value of such property at the date of such gift or 
contribution.
    (3) Examples. The provisions of this paragraph (f) may be 
illustrated by the following examples:

    Example 1. P is a local agricultural club described in section 
501(c)(3). In order to encourage interest and proficiency by young 
people in farming and raising livestock, it makes awards at its annual 
fair for outstanding specimens of produce and livestock. Most of these 
awards are cash or other property donated by local businessmen. When the 
awards are made, the donors are given recognition for their donations by 
being identified as the donor of the award. The recognition given to 
donors is merely incidental to the making of the award to worthy 
youngsters. For these reasons, the donations will constitute 
contributions for purposes of section 509(a)(2)(A)(i). The amount 
includible in computing support with respect to such contributions is 
equal to the cash contributed or the fair market value of other property 
on the dates contributed.
    Example 2. Q, a performing arts center, enters into a contract with 
a large company to be the exclusive sponsor of the center's theatrical 
events. The company makes a payment of cash and products in the amount 
of $100,000 to Q, and in return, Q agrees to make a broadcast 
announcement thanking the company before each show and to provide $2,000 
of advertising in the show's program

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(2% of $100,000 is $2,000). The announcement constitutes use or 
acknowledgment pursuant to section 513(i)(2). Because the value of the 
advertising does not exceed 2% of the total payment, the entire $100,000 
is a qualified sponsorship payment under section 513(i), and $100,000 is 
treated as a contribution for purposes of section 509(a)(2)(A)(i).
    Example 3. R, a charity, enters into a contract with a law firm to 
be the exclusive sponsor of the charity's outreach program. Instead of 
making a cash payment, the law firm agrees to perform $100,000 of legal 
services for the charity. In return, R agrees to acknowledge the law 
firm in all its informational materials. The total fair market value of 
the legal services, or $100,000, is a qualified sponsorship payment 
under section 513(i), but no amount is treated as a contribution under 
section 509(a)(2)(A)(i) because the contribution is of services.

    (g) Grants distinguished from gross receipts--(1) In general. In 
determining whether an organization normally receives more than one-
third of its support from public sources, all grants (within the meaning 
of section 509(a)(2)(A)(i)) received from permitted sources are 
includible in full in the numerator of the support fraction in each 
taxable year. However, gross receipts (within the meaning of section 
509(a)(2)(A)(ii)) from admissions, sales of merchandise, performance of 
services, or furnishing of facilities, in an activity which is not an 
unrelated trade or business, are includible in the numerator of the 
support fraction in any taxable year only to the extent that such gross 
receipts do not exceed the limitation with respect to the greater of 
$5,000 or 1 percent of support which is described in paragraph (b) of 
this section. A grant is normally made to encourage the grantee 
organization to carry on certain programs or activities in furtherance 
of its exempt purposes. It may contain certain terms and conditions 
imposed by the grantor to insure that the grantee's programs or 
activities are conducted in a manner compatible with the grantor's own 
programs and policies and beneficial to the public. The grantee may also 
perform a service or produce a work product which incidentally benefits 
the grantor. Because of the imposition of terms and conditions, the 
frequent similarlity of public purposes of grantor and grantee, and the 
possibility of benefit resulting to the grantor, amounts received as 
grants for the carrying on of exempt activities are sometimes difficult 
to distinguish from amounts received as gross receipts from the carrying 
on of exempt activities. The fact that the agreement, pursuant to which 
payment is made, is designated a contract or a grant is not controlling 
for purposes of classifying the payment under section 509(a)(2).
    (2) Distinguishing factors. For purposes of section 
509(a)(2)(A)(ii), in distinguishing the term gross receipts from the 
term grants, the term gross receipts means amounts received from an 
activity which is not an unrelated trade or business, if a specific 
service, facility, or product is provided to serve the direct and 
immediate needs of the payor, rather than primarily to confer a direct 
benefit upon the general public. In general, payments made primarily to 
enable the payor to realize or receive some economic or physical benefit 
as a result of the service, facility, or product obtained will be 
treated as gross receipts with respect to the payee. The fact that a 
profitmaking organization would, primarily for its own economic or 
physical betterment, contract with a nonprofit organization for the 
rendition of a comparable service, facility or product from such 
organization constitutes evidence that any payments received by the 
nonprofit payee organization (whether from a governmental unit, a 
nonprofit or a profitmaking organization) for such services, facilities 
or products are primarily for the economic or physical benefit of the 
payor and would therefore be considered gross receipts, rather than 
grants with respect to the payee organization. For example, if a 
nonprofit hospital described in section 170(b)(1)(A)(iii) engages an 
exempt research and development organization to develop a more 
economical system of preparing food for its own patients and personnel, 
and it can be established that a hospital operated for profit might 
engage the services of such an organization to perform a similar benefit 
for its economic betterment, such fact would constitute evidence that 
the payments received by the research and development organization 
constitute gross receipts, rather than grants. Research leading to the 
development of tangible products for the

[[Page 148]]

use or benefit of the payor will generally be treated as a service 
provided to serve the direct and immediate needs of the payor, while 
basic research or studies carried on in the physical or social sciences 
will generally be treated as primarily to confer a direct benefit upon 
the general public.
    (3) Examples. The application of this paragraph may be illustrated 
by the following examples:

    Example 1. M, a nonprofit research organization described in section 
501(c)(3), engages in some contract research. It receives funds from the 
government to develop a specific electronic device needed to perfect 
articles of space equipment. The initiative for the project came solely 
from the government. Furthermore, the government could have contracted 
with profitmaking research organizations which carry on similar 
activities. The funds received from the government for this project are 
gross receipts and do not constitute grants within the meaning of 
section 509(a)(2)(A)(i). M provided a specific product at the 
government's request and thus was serving the direct and immediate needs 
of the payor within the meaning of subparagraph (2) of this paragraph.
    Example 2. N is a nonprofit educational organization described in 
section 501(c)(3). Its principal activity is to operate institutes to 
train employees of various industries in the principles of management 
and administration. The government pays N to set up a special institute 
for certain government employees and to train them over a 2-year period. 
Management training is also provided by profitmaking organizations. The 
funds received are included as gross receipts. The particular services 
rendered were to serve the direct and immediate needs of the government 
in the training of its employees within the meaning of subparagraph (2) 
of this paragraph.
    Example 3. The Office of Economic Opportunity makes a community 
action program grant to O, an organization described in section 
509(a)(1). O serves as a delegate agency of OEO for purposes of 
financing a local community action program. As part of this program, O 
signs an agreement with X, an educational and charitable organization 
described in section 501(c)(3), to carry out a housing program for the 
benefit of poor families. Pursuant to this agreement, O pays X out of 
the funds provided by OEO to build or rehabilitate low income housing 
and to provide advisory services to other nonprofit organizations in 
order for them to meet similar housing objectives, all on a nonprofit 
basis. Payments made from O to X constitute grants for purposes of 
section 509(a)(2)(A) because such program is carried on primarily for 
the direct benefit of the community.
    Example 4. P is an educational institute described in section 
501(c)(3). It carries on studies and seminars to assist institutions of 
higher learning. It receives funds from the government to research and 
develop a program of black studies for institutions of higher learning. 
The performance of such a service confers a direct benefit upon the 
public. Because such program is carried on primarily for the direct 
benefit of the public, the funds are considered a grant.
    Example 5. Q is an organization described in section 501(c)(3) which 
carries on medical research. Its efforts have primarily been directed 
toward cancer research. Q sought funds from the government for a 
particular project being contemplated in connection with its work. In 
order to encourage its activities, the government gives Q the sum of 
$25,000. The research project sponsored by government funds is primarily 
to provide direct benefit to the general public, rather than to serve 
the direct and immediate needs of the government. The funds are 
therefore considered a grant.
    Example 6. R is a public service organization described in section 
501(c)(3) and composed of State and local officials involved in public 
works activities. The Bureau of Solid Waste, Management of the 
Department of Health, Education, and Welfare paid R to study the 
feasibility of a particular system for disposal of solid waste. Upon 
completion of the study, R was required to prepare a final report 
setting forth its findings and conclusions. Although R is providing the 
Bureau of Solid Waste Management with a final report, such report is the 
result of basic research and study in the physical sciences and is 
primarily to provide direct benefit to the general public by serving to 
further the general functions of government, rather than a direct and 
immediate governmental needs. The funds paid to R are therefore a grant 
within the meaning of section 509(a)(2).
    Example 7. R is the public service organization referred to in 
example 6. W, a municipality described in section 170(c)(1), decides to 
construct a sewage disposal plant. W pays R to study a number of 
possible locations for such plant and to make recommendations to W, 
based upon a number of factors, as to the best location. W instructed R 
that in making its recommendation, primary consideration should be given 
to minimizing the costs of the project to W. Since the study 
commissioned by W was primarily directed toward producing an economic 
benefit to W in the form of minimizing the costs of its project, the 
services rendered are treated as serving W's direct and immediate needs 
and are includible as gross receipts by R.
    Example 8. S in an organization described in section 501(c)(3). It 
was organized and is operated to further African development and

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strengthen understanding between the United States and Africa. To 
further these purposes, S receives funds from the Agency for 
International Development and the Department of State under which S is 
required to carry out the following programs: Selection, transportation, 
orientation, counseling, and language training of African students 
admitted to American institutions of higher learning; payment of 
tuition, other fees, and maintenance of such students; and operation of 
schools and vocational training programs in underdeveloped countries for 
residents of those countries. Since the programs carried on by S are 
primarily to provide direct benefit to the general public, all of the 
funds received by S from the Federal agencies are considered grants 
within the meaning of section 509(a)(2).

    (h) Definition of membership fees--(1) General rule. For purposes of 
section 509(a)(2), the fact that a membership organization provides 
services, admissions, facilities, or merchandise to its members as part 
of its overall activities will not, in itself, result in the 
classification of fees received from members as gross receipts rather 
than membership fees. If an organization uses membership fees as a means 
of selling admissions, merchandise, services, or the use of facilities 
to members of the general public who have no common goal or interest 
(other than the desire to purchase such admissions, merchandise, 
services, or use of facilities), then the income received from such fees 
shall not constitute membership fees under section 509(a)(2)(A)(i), but 
shall, if from a related activity, constitute gross receipts under 
section 509(a)(2)(A)(ii). On the other hand, to the extent the basic 
purpose for making the payment is to provide support for the 
organization rather than to purchase admissions, merchandise, services, 
or the use of facilities, the income received from such payment shall 
constitute membership fees.
    (2) Examples. The provisions of this paragraph may be illustrated by 
the following examples:

    Example 1. M is a symphony society described in section 501(c)(3). 
Its primary purpose is to support the local symphony orchestra. The 
organization has three classes of membership. Contributing members pay 
annual dues of $10, sustaining members pay $25, and honorary members pay 
$100. The dues are placed in a maintenance fund which is used to provide 
financial assistance in underwriting the orchestra's annual deficit. 
Members have the privilege of purchasing subscriptions to the concerts 
before they go on sale to the general public, but must pay the same 
price as any other member of the public. They also are entitled to 
attend a number of rehearsals each season without charge. Under these 
circumstances, M's receipts from the members constitute membership fees 
for purposes of section 509(a)(2)(A)(i).
    Example 2. N is a theater association described in section 
501(c)(3). Its purpose is to support a repertory company in the 
community in order to make live theatrical performances available to the 
public. The organization sponsors six plays each year. Members of the 
organization are entitled to a season subscription to the plays. The fee 
paid as dues approximates the retail price of the six plays, less a 10-
percent discount. Tickets to each performance are also sold directly to 
the general public. The organization also holds a series of lectures on 
the theater which members may attend. Under these circumstances, the 
fees paid by members as dues will be considered gross receipts from a 
related activity. Although the fees are designated as membership fees, 
they are actually admissions to a series of plays.

    (i) Bureau defined--(1) In general. The term any bureau or similar 
agency of a governmental unit (within the meaning of section 
509(a)(2)(A)(ii)), refers to a specialized operating unit of the 
executive, judicial, or legislative branch of government where business 
is conducted under certain rules and regulations. Since the term bureau 
refers to a unit functioning at the operating, as distinct from the 
policymaking, level of government, it is normally descriptive of a 
subdivision of a department of government. The term bureau, for purposes 
of section 509(a)(2)(A)(ii), would therefore not usually include those 
levels of government which are basically policymaking or administrative, 
such as the office of the Secretary or Assistant Secretary of a 
department, but would consist of the highest operational level under 
such policymaking or administrative levels. Each subdivision of a larger 
unit within the Federal Government, which is headed by a Presidential 
appointee holding a position at or above Level V of the Executive 
Schedule under 5 U.S.C. 5316, will normally be considered an 
administrative or policymaking, rather than an operating, unit. Amounts 
received from a unit functioning at the policymaking

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or administrative level of government will be treated as received from 
one bureau or similar agency of such unit. Units of a governmental 
agency above the operating level shall be aggregated and considered a 
separate bureau for this purpose. Thus, an organization receiving gross 
receipts from both a policymaking or administrative unit and an 
operational unit of a department will be treated as receiving gross 
receipts from two bureaus within the meaning of section 
509(a)(2)(A)(ii). For purposes of this subparagraph, the Departments of 
Air Force, Army, and Navy are separate departments and each is 
considered as having its own policymaking, administrative, and operating 
units.
    (2) Examples. The provisions of this paragraph may be illustrated by 
the following examples:

    Example 1. The Bureau of Health Insurance is considered a bureau 
within the meaning of section 509(a)(2)(A)(ii). It is a part of the 
Department of Health, Education, and Welfare, whose Secretary performs a 
policymaking function, and is under the Social Security Administration, 
which is basically an administrative unit. The Bureau of Health 
Insurance is in the first operating level within the Social Security 
Administration. Similarly, the National Cancer Institute would be 
considered a bureau, as it is an operating part of the National 
Institutes of Health within the Department of Health, Education, and 
Welfare.
    Example 2. The Bureau for Africa and the Bureau for Latin America 
are considered bureaus within the meaning of section 509(a)(2)(A)(ii). 
Both are separate operating units under the administrator of the Agency 
for International development, a policymaking official. If an 
organization received gross receipts from both of these bureaus, the 
amount of gross receipts received from each would be subject to the 
greater of $5,000 or 1 percent limitation under section 
509(a)(2)(A)(ii).
    Example 3. The Bureau of International Affairs of the Civil 
Aeronautics Board is considered a bureau within the meaning of section 
509(a)(2)(A)(ii). It is an operating unit under the administrative 
office of the Executive Director. The subdivisions of the Bureau of 
International Affairs are Geographic Areas and Project Development 
Staff. If an organization received gross receipts from these 
subdivisions, the total gross receipts from these subdivisions would be 
considered gross receipts from the same bureau, the Bureau of 
International Affairs, and would be subject to the greater of $5,000 or 
1 percent limitation under section 509(a)(2)(A)(ii).
    Example 4. The Department of Mental Health, a State agency which is 
an operational part of State X's Department of Public Health, is 
considered a bureau. The Department of Public Health is basically an 
administrative agency and the Department of Mental Health is at the 
first operational level within it.
    Example 5. The Aeronautical Systems Division of the Air Force 
Systems Command, and other units on the same level, are considered 
separate bureaus with the meaning of section 509(a)(2)(A)(ii). They are 
part of the Department of the Air Force which is a separate department 
for this purpose, as are the Army and Navy. The Secretary and the Under 
Secretary of the Air Force perform the policymaking function, the Chief 
of Staff and the Air Force Systems Command are basically administrative, 
having a comprehensive complement of staff functions to provide 
administration for the various divisions. The Aeronautical Systems 
Division and other units on the same level are thus the first operating 
level, as evidenced by the fact that they are the units that let 
contracts and perform the various operating functions.
    Example 6. The Division of Space Nuclear Systems, the Division of 
Biology and Medicine, and other units on the same level within the 
Atomic Energy Commission are each separate bureaus within the meaning of 
section 509(a)(2)(A)(ii). The Commissioners (which make up the 
Commission) are the policymakers. The general manager and the various 
assistant general managers perform the administrative function. The 
various divisions perform the operating function as evidenced by the 
fact that each has separate programs to pursue and contracts 
specifically for these various programs.

    (j) Grants from public charities--(1) General rule. For purposes of 
the one-third support test in section 509(a)(2)(A), grants (as defined 
in paragraph (g) of this section) received from an organization 
described in section 509(a)(1) (hereinafter referred to in this 
subparagraph as a public charity) are generally includible in full in 
computing the numerator of the recipient's support fraction of the 
taxable year in question. It is sometimes necessary to determine whether 
the recipient of a grant from a public charity has received such support 
from the public charity as a grant, or whether the recipient has in fact 
received such support as an indirect contribution from a donor to the 
public charity. If the amount received is considered a grant

[[Page 151]]

from the public charity, it is fully includible in the numerator of the 
support fraction under section 509(a)(2)(A). However, if the amount 
received is considered to be an indirect contribution from one of the 
public charity's donors which has passed through the public chairty to 
the recipient organization, such amount will retain its character as a 
contribution from such donor and, if, for example, the donor is a 
substantial contributor (as defined in section 507(d)(2)) with respect 
to the ultimate recipient, such amount shall be excluded from the 
numerator of the support fraction under section 509(a)(2). If a public 
charity makes both an indirect contribution from its donor and an 
additional grant to the ultimate recipient, the indirect contribution 
shall be treated as made first.
    (2) Indirect contributions. For purposes of subparagraph (1) of this 
paragraph, an indirect contribution is one which is expressly or 
impliedly ear-marked by the donor as being for, or for the benefit of, a 
particular recipient (rather than for a particular purpose).
    (3) Examples. The provisions of this paragraph may be illustrated by 
the following examples:

    Example 1. M, a national foundation for the encouragement of the 
musical arts, is an organization described in section 170(b)(1)(A)(vi). 
A gives M a donation of $5,000 without imposing any restrictions or 
conditions upon the gift. M subsequently makes a $5,000 grant to X, an 
organization devoted to giving public performances of chamber music. 
Since the grant to X is treated as being received from M, it is fully 
includible in the numerator of X's support fraction for the taxable year 
of receipt.
    Example 2. Assume M is the same organization described in example 1. 
B gives M a donation of $10,000, but requires that M spend the money for 
the purpose of supporting organizations devoted to the advancement of 
contemporary American music. M has complete discretion as to the 
organizations of the type described to which it will make a grant. M 
decides to make grants of $5,000 each to Y and Z, both being 
organizations described in section 501(c)(3) and devoted to furthering 
contemporary American music. Since the grants to Y and Z are treated as 
being received from M, Y and Z may each include one of the $5,000 grants 
in the numerator of its support fraction for purposes of section 
509(a)(2)(A). Although the donation to M was conditioned upon the use of 
the funds for a particular purpose, M was free to select the ultimate 
recipient.
    Example 3. N is a national foundation for the encouragement of art 
and is an organization described in section 170(b)(1)(A)(vi). Grants to 
N are permitted to be earmarked for particular purposes. O, which is an 
art workshop devoted to training young artists and claiming status under 
section 509(a)(2), persuades C, a private foundation, to make a grant of 
$25,000 to N. C is a disqualified person with respect to O. C made the 
grant to N with the understanding that N would be bound to make a grant 
to O in the sum of $25,000, in addition to a matching grant of N's funds 
to O in the sum of $25,000. Only the $25,000 received directly from N is 
considered a grant from N. The other $25,000 is deemed an indirect 
contribution from C to O and is to be excluded from the numerator of O's 
support fraction.

    (k) Method of accounting. For purposes of section 509(a)(2), an 
organization's support will be determined under the method of accounting 
on the basis of which the organization regularly computes its income in 
keeping its books under section 446. For example, if a grantor makes a 
grant to an organization payable over a term of years, such grant will 
be includible in the support fraction of the grantee organization under 
the method of accounting on the basis of which it regularly computes its 
income in keeping its books under section 446.
    (l) Gross receipts from section 513(a) (1), (2), or (3) activities. 
For purposes of section 509(a)(2)(A)(ii), gross receipts from activities 
described in section 513(a) (1), (2), or (3) will be considered gross 
receipts from activities which are not unrelated trade or business.
    (m) Gross receipts distinguished from gross investment income. (1) 
For purposes of section 509(a)(2), where the charitable purpose of an 
organization described in section 501(c)(3) is accomplished through the 
furnishing of facilities for a rental fee or loans to a particular class 
of persons, such as aged, sick, or needy persons, the support received 
from such persons will be considered gross receipts (within the meaning 
of section 509(d)(2)) from an activity which is not an unrelated trade 
or business, rather than gross investment income. However, if such 
organization also furnishes facilities or loans to persons who are not 
members of such class

[[Page 152]]

and such furnishing does not contribute importantly to the 
accomplishment of such organization's exempt purposes (aside from the 
need of such organization for income or funds or the use it makes of the 
profits derived), the support received from such furnishing will be 
considered rents or interest and therefore will be treated as gross 
investment income within the meaning of section 509(d)(4), unless such 
income is included in computing the tax imposed by section 511.
    (2) The provisions of this paragraph may be illustrated by the 
following example:

    Example. X, an organization described in section 501(c)(3), is 
organized and operated to provide living facilities for needy widows of 
deceased servicemen. X charges such widows a small rental fee for the 
use of such facilities. Since X is accomplishing its exempt purpose 
through the rental of such facilities, the support received from the 
widows is considered gross receipts within the meaning of section 
509(d)(2). However, if X rents part of its facilities to persons having 
no relationship to X's exempt purpose, the support received from such 
rental will be considered gross investment income within the meaning of 
section 509(d)(4), unless such income is included in computing the tax 
imposed by section 511.
    (n) Transition rules. (1) An organization that received an advance 
ruling, that expires on or after June 9, 2008, that it will be treated 
as an organization described in section 509(a)(2) will be treated as 
meeting the requirements of paragraph (d)(1) of this section for the 
first five taxable years of its existence as a section 501(c)(3) 
organization unless the IRS issued to the organization a proposed 
determination prior to September 9, 2008, that the organization is not 
described in sections 170(b)(1)(A)(vi) and 509(a)(1) or in section 
509(a)(2).
    (2) Paragraph (d)(1) of this section shall not apply to an 
organization that received an advance ruling that expired prior to June 
9, 2008, and that did not timely file with the IRS the required 
information to establish that it is an organization described in 
sections 170(b)(1)(A)(vi) and 509(a)(1) or in section 509(a)(2).
    (3) An organization that fails to meet a public support test for its 
first taxable year beginning on or after January 1, 2008, under the 
regulations in this section may use the prior test set forth in 
Sec. Sec.  1.509(a)-3(a)(2) and 1.509(a)-3(a)(3) or Sec.  1.170A-9(e)(2) 
or Sec.  1.170A-9(e)(3) as in effect before September 9, 2008, (as 
contained in 26 CFR part 1 revised April 1, 2008) to determine whether 
the organization may be publicly supported for its 2008 taxable year 
based on its satisfaction of a public support test for taxable year 
2007, computed over the period 2003 through 2006.

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

    Example 1. (i) Organization M was formed in January 2004, and uses a 
taxable year ending June 30. Organization M received an advance ruling 
letter that it is recognized as an organization described in section 
501(c)(3) effective as of the date of its formation and that it is 
treated as a publicly supported organization under section 509(a)(2) 
during the five-year advance ruling period that will end on June 30, 
2008. This date is on or after June 9, 2008.
    (ii) Under the transition rule, Organization M is a publicly 
supported organization described in section 509(a)(2) for the taxable 
years ending June 30, 2004, through June 30, 2008. Organization M does 
not need to establish within 90 days after June 30, 2008, that it met a 
public support test under Sec.  1.170A-9(e) or Sec.  1.509(a)-3, as in 
effect prior to September 9, 2008, (as contained in 26 CFR part 1 
revised April 1, 2008) for its advance ruling period.
    (iii) Organization M can qualify as a public charity beginning with 
the taxable year ending June 30, 2009, if Organization M can meet the 
requirements of Sec.  1.170A-9(f)(2) or Sec.  1.170A-9(f)(3) or 
paragraphs (a)(2) and (a)(3) of this section for the taxable years 
ending June 30, 2005, through June 30, 2009, or for the taxable years 
ending June 30, 2004, through June 30, 2008. In addition, for its 
taxable year ending June 30, 2009, Organization M may qualify as a 
publicly supported organization by availing itself of the transition 
rule contained in paragraph (n)(iii) of this section, which looks to 
support received by M in the taxable years ending June 30, 2004, through 
June 30, 2007.
    Example 2. (i) Organization N was formed in January 2000 and uses a 
December 31 taxable year. Organization N received a final determination 
that it was recognized as tax-exempt under section 501(c)(3) and as a 
public charity prior to September 9, 2008.
    (ii) For taxable year 2008, Organization N will qualify as publicly 
supported if it meets the requirements under either Sec.  1.170A-9(f)(2) 
or Sec.  1.170A-9(f)(3) or paragraphs (a)(2) and (a)(3) of this section 
for the five-year period January 1, 2004, through December 31, 2008. 
Organization N will also qualify as publicly

[[Page 153]]

supported for taxable year 2008 if it meets the requirements under 
either Sec.  1.170A-9(e)(2) or Sec.  1.170A-9(e)(3) or Sec. Sec.  
1.509(a)-3(a)(2) and 1.509(a)-3(a)(3) as in effect prior to September 9, 
2008, (as contained in 26 CFR part 1 revised April 1, 2008) for taxable 
year 2007, using the four-year period from January 1, 2003, through 
December 31, 2006.

    (o) Applicability date. This section generally applies to taxable 
years beginning after December 31, 1969, except paragraphs (a)(3)(i) and 
(a)(4) of this section apply to taxable years beginning on or after 
December 2, 2020. Taxpayers may choose to apply this section to taxable 
years beginning on or after January 1, 2018, and before December 2, 
2020. Otherwise, for taxable years beginning before December 2, 2020, 
see these paragraphs as in effect and contained in 26 CFR part 1 revised 
as of April 1, 2020.

[T.D. 7212, 37 FR 21907, Oct. 17, 1972, as amended by T.D. 7784, 46 FR 
37889, July 23, 1981; T.D. 8423, 57 FR 33443, July 29, 1992; T.D. 8991, 
67 FR 20437, Apr. 25, 2002; T.D. 9423, 73 FR 52549, Sept. 9, 2008; T.D. 
9549, 76 FR 55764, Sept. 8, 2011; T.D. 9549, 76 FR 61946, Oct. 6, 2011; 
T.D. 9933, 85 FR 77979, Dec. 2, 2020]



Sec.  1.509(a)-4  Supporting organizations.

    (a) In general. (1) Section 509(a)(3) excludes from the definition 
of private foundation those organizations which meet the requirements of 
subparagraphs (A), (B), and (C) thereof.
    (2) Section 509(a)(3)(A) provides that a section 509(a)(3) 
organization must be organized, and at all times thereafter operated, 
exclusively for the benefit of, to perform the functions of, or to carry 
out the purposes of one or more specified organizations described in 
section 509(a) (1) or (2). Section 509(a)(3)(A) describes the nature of 
the support or benefit which a section 509(a)(3) organization must 
provide to one or more section 509(a) (1) or (2) organizations. For 
purposes of section 509(a)(3)(A), paragraph (b) of this section 
generally describes the organizational and operational tests; paragraph 
(c) of this section describes permissible purposes under the 
organizational test; paragraph (d) of this section describes the 
requirement of supporting or benefiting one or more specified publicly 
supported organizations; and paragraph (e) of this section describes 
permissible beneficiaries and activities under the operational test.
    (3) Section 509(a)(3)(B) provides that a section 509(a)(3) 
organization must be operated, supervised, or controlled by or in 
connection with one or more organizations described in section 509(a) 
(1) or (2). Section 509(a)(3)(B) and paragraph (f) of this section 
describe the nature of the relationship which must exist between the 
section 509(a)(3) and section 509(a) (1) or (2) organizations. For 
purposes of section 509(a)(3)(B), paragraph (g) of this section defines 
operated, supervised, or controlled by; paragraph (h) of this section 
defines supervised or controlled in connection with; and paragraph (i) 
of this section defines operated in connection with.
    (4) Section 509(a)(3)(C) provides that a section 509(a)(3) 
organization must not be controlled directly or indirectly by 
disqualified persons (other than foundation managers or organizations 
described in section 509(a) (1) or (2)). Section 509(a)(3)(C) and 
paragraph (j) of this section prescribe a limitation on the control over 
the section 509(a)(3) organization.
    (5) For purposes of this section, the term supporting organization 
means either an organization described in section 509(a)(3) or an 
organization seeking section 509(a)(3) status, depending upon its 
context. For purposes of this section, the term publicly supported 
organization means an organization described in section 509(a) (1) or 
(2).
    (6) For purposes of paragraph (i) of this section, the term 
``supported organization'' means a specified publicly supported 
organization described in paragraphs (d)(2)(iv) or (d)(4) of this 
section.
    (b) Organizational and operational tests. (1) Under subparagraph (A) 
of section 509(a)(3), in order to qualify as a supporting organization, 
an organization must be both organized and operated exclusively for the 
benefit of, to perform the functions of, or to carry out the purposes of 
(hereinafter referred to in this section as being organized and operated 
to support or benefit) one or more specified publicly supported 
organizations. If an organization fails to meet either the 
organizational or the operational test, it cannot qualify as a 
supporting organization.

[[Page 154]]

    (2) In the case of supporting organizations created prior to January 
1, 1970, the organizational and operational tests shall apply as of 
January 1, 1970. Therefore, even though the original articles of 
organization did not limit its purposes to those required under section 
509(a)(3)(A) and even though it operated before January 1, 1970, for 
some purpose other than those required under section 509(a)(3)(A), an 
organization will satisfy the organizational and operational tests if, 
on January 1, 1970, and at all times thereafter, it is so constituted as 
to comply with these tests. For the special rules pertaining to the 
application of the organizational and operational tests to organizations 
terminating their private foundation status under the 12-month or 60-
month termination period provided under section 507(b)(1)(B) by becoming 
public under section 509(a)(3), see the regulations under section 
507(b).
    (c) Organizational test--(1) In general. An organization is 
organized exclusively for one or more of the purposes specified in 
section 509(a)(3)(A) only if its articles of organization (as defined in 
Sec.  1.501(c)(3)-1(b)(2)):
    (i) Limit the purposes of such organization to one or more of the 
purposes set forth in section 509(a)(3)(A);
    (ii) Do not expressly empower the organization to engage in 
activities which are not in furtherance of the purposes referred to in 
subdivision (i) of this subparagraph;
    (iii) State the specified publicly supported organizations on whose 
behalf such organization is to be operated (within the meaning of 
paragraph (d) of this section); and
    (iv) Do not expressly empower the organization to operate to support 
or benefit any organization other than the specified publicly supported 
organizations referred to in subdivision (iii) of this subparagraph.
    (2) Purposes. In meeting the organizational test, the organization's 
purposes, as stated in its articles, may be as broad as, or more 
specific than, the purposes set forth in section 509(a)(3)(A). 
Therefore, an organization which, by the terms of its articles, is 
formed for the benefit of one or more specified publicly supported 
organizations shall, if it otherwise meets the other requirements of 
this paragraph, be considered to have met the organizational test. 
Similarly, articles which state that an organization is formed to 
perform the publishing functions of a specified university are 
sufficient to comply with the organizational test. An organization which 
is operated, supervised, or controlled by (within the meaning of 
paragraph (g) of this section) or supervised or controlled in connection 
with (within the meaning of paragraph (h) of this section) one or more 
sections 509(a) (1) or (2) organizations to carry out the purposes of 
such organizations, will be considered as meeting the requirements of 
this paragraph if the purposes set forth in its articles are similar to, 
but no broader than, the purposes set forth in the articles of its 
controlling section 509(a) (1) or (2) organizations. If, however, the 
organization by which it is operated, supervised, or controlled is a 
publicly supported section 501(c) (4), (5), or (6) organization (deemed 
to be a section 509(a)(2) organization for purposes of section 509(a)(3) 
under the provisions of section 509(a)), the supporting organization 
will be considered as meeting the requirements of this paragraph if its 
articles require it to carry on charitable, etc., activities within the 
meaning of section 170(c)(2).
    (3) Limitations. An organization is not organized exclusively for 
the purposes set forth in section 509(a)(3)(A) if its articles expressly 
permit it to operate to support or benefit any organization other than 
those specified publicly supported organizations referred to in 
subparagraph (1)(iii) of this paragraph. Thus, for example, an 
organization will not meet the organizational test under section 
509(a)(3)(A) if its articles expressly empower it to pay over any part 
of its income to, or perform any service for, any organization other 
than those publicly supported organizations specified in its articles 
(within the meaning of paragraph (d) of this section). The fact that the 
actual operations of such organization have been exclusively for the 
benefit of the specified publicly supported organizations shall not be 
sufficient to permit it to meet the organizational test.
    (d) Specified organizations--(1) In general. In order to meet the 
requirements

[[Page 155]]

of section 509(a)(3)(A), an organization must be organized and operated 
exclusively to support or benefit one or more specified publicly 
supported organizations. The manner in which the publicly supported 
organizations must be specified in the articles for purposes of section 
509(a)(3)(A) will depend upon whether the supporting organization is 
operated, supervised, or controlled by or supervised or controlled in 
connection with (within the meaning of paragraphs (g) and (h) of this 
section) such organizations or whether it is operated in connection with 
(within the meaning of paragraph (i) of this section) such 
organizations.
    (2) Nondesignated publicly supported organizations; requirements. 
(i) Except as provided in subdivision (iv) of this subparagraph, in 
order to meet the requirements of subparagraph (1) of this paragraph, 
the articles of the supporting organization must designate each of the 
specified organizations by name unless:
    (a) The supporting organization is operated, supervised, or 
controlled by (within the meaning of paragraph (g) of this section), or 
is supervised or controlled in connection with (within the meaning of 
paragraph (h) of this section) one or more publicly supported 
organizations; and
    (b) The articles of organization of the supporting organization 
require that it be operated to support or benefit one or more 
beneficiary organizations which are designated by class or purpose and 
which include:
    (1) The publicly supported organizations referred to in (a) of this 
subdivision (without designating such organizations by name); or
    (2) Publicly supported organizations which are closely related in 
purpose or function to those publicly supported organizations referred 
to in subdivision (i)(a) or this subparagraph (without designating such 
organization by name).
    (ii) If a supporting organization is described in subdivision (i)(a) 
of this subparagraph, it will not be considered as failing to meet the 
requirements of subparagraph (1) of this paragraph that the publicly 
supported organizations be specified merely because its articles of 
organization permit the conditions described in subparagraphs (3) (i), 
(ii), and (iii) and (4)(i) (a) and (b) of this paragraph.
    (iii) This subparagraph may be illustrated by the following 
examples:

    Example 1. X is an organization described in section 501(c)(3) which 
operates for the benefit of institutions of higher learning in the State 
of Y. X is controlled by these institutions (within the meaning of 
paragraph (g) of this section) and such institutions are all section 
509(a)(1) organizations. X's articles will meet the organizational test 
if they require X to operate for the benefit of institutions of higher 
learning or educational organizations in the State of Y (without naming 
each institution). X's articles would also meet the organizational test 
if they provided for the giving of scholarships to enable students to 
attend institutions of higher learning but only in the State of Y.
    Example 2. M is an organization described in section 501(c)(3) which 
was organized and operated by representatives of N church to run a home 
for the aged. M is controlled (within the meaning of paragraph (g) of 
this section) by N church, a section 509(a)(1) organization. The care of 
the sick and the aged are longstanding temporal functions and purposes 
of organized religion. By operating a home for the aged, M is operating 
to support or benefit N church in carrying out one of its temporal 
purposes. Thus M's articles will meet the organizational test if they 
require M to care for the aged since M is operating to support one of N 
church's purposes (without designating N church by name).

    (iv) A supporting organization will meet the requirements of 
subparagraph (1) of this paragraph even though its articles do not 
designate each of the specified organizations by name if:
    (a) There has been an historic and continuing relationship between 
the supporting organization and the section 509(a) (1) or (2) 
organizations, and
    (b) By reason of such relationship, there has developed a 
substantial identity of interests between such organizations.
    (3) Nondesignated publicly supported organizations; scope of rule. 
If the requirements of subparagraph (2)(i) (a) of this paragraph are 
met, a supporting organization will not be considered as failing the 
test of being organized for the benefit of specified organizations 
solely because its articles:
    (i) Permit the substitution of one publicly supported organization 
within a designated class for another publicly supported organization 
either in the

[[Page 156]]

same or a different class designated in the articles;
    (ii) Permit the supporting organization to operate for the benefit 
of new or additional publicly supported organizations of the same or a 
different class designated in the articles; or
    (iii) Permit the supporting organization to vary the amount of its 
support among different publicly supported organizations within the 
class or classes of organizations designated by the articles


For example, X is an organization which operates for the benefit of 
private colleges in the State of Y. If X is controlled by these colleges 
(within the meaning of paragraph (g) of this section) and such colleges 
are all section 509(a)(1) organizations, X's articles will meet the 
organization test even if they permit X to operate for the benefit of 
any new colleges created in State Y in addition to the existing colleges 
or in lieu of one which has ceased to operate, or if they permit X to 
vary its support by paying more to one college than to another in a 
particular year.
    (4) Designated publicly supported organizations. (i) If an 
organization is organized and operated to support one or more publicly 
supported organizations and it is operated in connection with such 
organization or organizations, then, except as provided in subparagraph 
(2)(iv) of this paragraph, its articles of organization must, for 
purposes of satisfying the organizational test under section 
509(a)(3)(A), designate the specified organizations by name. Under the 
circumstances described in this subparagraph, a supporting organization 
which has one or more specified organizations designated by name in its 
articles, will not be considered as failing the test of being organized 
for the benefit of specified organizations solely because its articles:
    (a) Permit a publicly supported organization which is designated by 
class or purpose, rather than by name, to be substituted for the 
publicly supported organization or organizations designated by name in 
the articles, but only if such substitution is conditioned upon the 
occurrence of an event which is beyond the control of the supporting 
organization, such as loss of exemption, substantial failure or 
abandonment of operations, or dissolution of the publicly supported 
organization or organizations designated in the articles;
    (b) Permit the supporting organization to operate for the benefit of 
a beneficiary organization which is not a publicly supported 
organization, but only if such supporting organization is currently 
operating for the benefit of a publicly supported organization and the 
possibility of its operating for the benefit of other than a publicly 
supported organization is a remote contingency; or
    (c) Permit the supporting organization to vary the amount of its 
support between different designated organizations, so long as it meets 
the requirements of the integral part test set forth in paragraph (i)(3) 
of this section with respect to at least one beneficiary organization.
    (ii) If the beneficiary organization referred to in subdivision 
(i)(b) of this subparagraph is not a publicly supported organization, 
the supporting organization will not then meet the operational test of 
paragraph (e)(1) of this section. Therefore, if a supporting 
organization substituted in accordance with such subdivision (i)(b) a 
beneficiary other than a publicly supported organization and operated in 
support of such beneficiary organization, the supporting organization 
would not be described in section 509(a)(3).
    (iii) This subparagraph may be illustrated by the following example:

    Example. X is a charitable trust described in section 4947(a)(1) 
organized in 1968. Under the terms of its trust instrument, X's trustees 
are required to pay over all of X's annual income to M University 
Medical School for urological research. If M University Medical School 
is unable or unwilling to devote these funds to urological research, the 
trustees are required to pay all of such income to N University Medical 
School. However if N University Medical School is also unable or 
unwilling to devote these funds to urological research, X's trustees are 
directed to choose a similar organization willing to apply X's funds for 
urological research. From 1968 to 1973, X pays all of its net income to 
M University Medical School pursuant to the terms of the trust. M and N 
are publicly supported organizations. Although the contingent 
remainderman may not be a publicly supported organization, the 
possibility that X may operate for the benefit of other than

[[Page 157]]

a publicly supported organization is, in 1973, a remote possibility, and 
X will be considered as operating for the benefit of a specified 
publicly supported organization under subdivision (i)(b) of this 
subparagraph. However, if, at some future date, X actually substituted a 
nonpublicly supported organization as beneficiary, X would fail the 
requirements of the operational test set forth in paragraph (e)(1) of 
this section.

    (e) Operational test--(1) Permissible beneficiaries. A supporting 
organization will be regarded as operated exclusively to support one or 
more specified publicly supported organizations (hereinafter referred to 
as the operational test) only if it engages solely in activities which 
support or benefit the specified publicly supported organizations. Such 
activities may include making payments to or for the use of, or 
providing services or facilities for, individual members of the 
charitable class benefited by the specified publicly supported 
organization. A supporting organization may also, for example, make a 
payment indirectly through another unrelated organization to a member of 
a charitable class benefited by the specified publicly supported 
organization, but only if such a payment constitutes a grant to an 
individual rather than a grant to an organization. In determining 
whether a grant is indirectly to an individual rather than to an 
organization the same standard shall be applied as in Sec.  53.4945-
4(a)(4) of this chapter. Similarly, an organization will be regarded as 
operated exclusively to support or benefit one or more specified 
publicly supported organizations even if it supports or benefits an 
organization, other than a private foundation, which is described in 
section 501(c)(3) and is operated, supervised, or controlled directly by 
or in connection with such publicly supported organizations, or which is 
described in section 511(a)(2)(B). However, an organization will not be 
regarded as operated exclusively if any part of its activities is in 
furtherance of a purpose other than supporting or benefiting one or more 
specified publicly supported organizations.
    (2) Permissible activities. A supporting organization is not 
required to pay over its income to the publicly supported organizations 
in order to meet the operational test. It may satisfy the test by using 
its income to carry on an independent activity or program which supports 
or benefits the specified publicly supported organizations. All such 
support must, however, be limited to permissible beneficiaries in 
accordance with subparagraph (1) of this paragraph. The supporting 
organization may also engage in fund raising activities, such as 
solicitations, fund raising dinners, and unrelated trade or business to 
raise funds for the publicly supported organizations, or for the 
permissible beneficiaries.
    (3) Examples. The provisions of this paragraph may be illustrated by 
the following examples:

    Example 1. M is a separately incorporated alumni association of X 
University and is an organization described in section 501(c)(3). X 
University is designated in M's articles as the sole beneficiary of its 
support. M uses all of its dues and income to support its own program of 
educational activities for alumni, faculty, and students of X University 
and to encourage alumni to maintain a close relationship with the 
university and to make contributions to it. M does not distribute any of 
its income directly to X for the latter's general purposes. M pays no 
part of its funds to, or for the benefit of, any organization other than 
X. Under these circumstances, M is considered as operated exclusively to 
perform the functions and carry out the purpose of X. Although it does 
not pay over any of its funds to X, it carries on a program which both 
supports and benefits X.
    Example 2. N is a separately incorporated religious and educational 
organization described in section 501(c)(3). It was formed and is 
operated by Y Church to provide religious training for the members of 
the church. While it does not maintain a regular faculty, N conducts a 
Sunday school, weekly adult education lectures on religious subjects, 
and other similar activities for the benefit of the church members. All 
of its funds are disbursed in furtherance of such activities and no part 
of its funds is paid to, or for the benefit of, any organization other 
than Y Church. N is considered as operated exclusively to perform the 
educational functions of Y Church and to carry out its religious 
purposes by providing various forms of religious instruction.
    Example 3. P is an organization described in section 501(c)(3). Its 
primary activity is providing financial assistance to S, a publicly 
supported organization which aids underdeveloped nations in Central 
America. P's articles of organization designate S as the principal 
recipient of P's assistance. However, P also makes a small annual 
general

[[Page 158]]

purpose grant to T, a private foundation engaged in work similar to that 
carried on by S. T performs a particular function that assists in the 
overall aid program carried on by S. Even though P is operating 
primarily for the benefit of S, a specified publicly supported 
organization, it is not considered as operated exclusively for the 
purposes set forth in section 509(a)(3)(A). The grant to T, a private 
foundation, prevents it from complying with the operational test under 
section 509(a)(3)(A).
    Example 4. Assume the same facts as example 3, except that T is a 
section 501(c)(3) organization other than a private foundation and is 
operated in connection with S. Under these circumstances, P will be 
considered as operated exclusively to support S within the meaning of 
section 509(a)(3)(A).
    Example 5. Assume the same facts as example 3 except that instead of 
the annual general purpose grant made to T, each grant made by P to T is 
specifically earmarked for the training of social workers and teachers, 
designated by name, from Central America. Under these circumstances, P's 
grants to T would be treated as grants to the individual social workers 
and teachers under section 4945(d)(3) and Sec.  53.4945-4(a)(4), rather 
than as grants to T under section 4945(d)(4). These social workers and 
teachers are part of the charitable class benefitted by S. P would thus 
be considered as operating exclusively to support S within the meaning 
of section 509(a)(3)(A).

    (f) Nature of relationship required between organizations--(1) In 
general. Section 509(a)(3)(B) describes the nature of the relationship 
required between a section 501(c)(3) organization and one or more 
publicly supported organizations in order for such section 501(c)(3) 
organization to qualify under the provisions of section 509(a)(3). To 
meet the requirements of section 509(a)(3), an organization must be 
operated, supervised, or controlled by or in connection with one or more 
publicly supported organizations. If an organization does not stand in 
one of such relationships (as provided in this paragraph) to one or more 
publicly supported organizations, it is not an organization described in 
section 509(a)(3).
    (2) Types of relationships. Section 509(a)(3)(B) sets forth three 
different types of relationships, one of which must be met in order to 
meet the requirements of subparagraph (1) of this paragraph. Thus, a 
supporting organization may be:
    (i) Operated, supervised, or controlled by,
    (ii) Supervised or controlled in connection with, or
    (iii) Operated in connection with, one or more publicly supported 
organizations.
    (3) Requirements of relationships. Although more than one type of 
relationship may exist in any one case, any relationship described in 
section 509(a)(3)(B) must insure that:
    (i) The supporting organization will be responsive to the needs of 
demands of one or more publicly supported organizations; and
    (ii) The supporting organization will constitute an integral part 
of, or maintain a significant involvement in, the operations of one or 
more publicly supported organizations.
    (4) General description of relationships. In the case of supporting 
organizations which are operated, supervised, or controlled by one or 
more publicly supported organizations, the distinguishing feature of 
this type of relationship is the presence of a substantial degree of 
direction by the publicly supported organizations over the conduct of 
the supporting organization, as described in paragraph (g) of this 
section. In the case of supporting organizations which are supervised or 
controlled in connection with one or more publicly supported 
organizations, the distinguishing feature is the presence of common 
supervision or control among the governing bodies of all organizations 
involved, such as the presence of common directors, as described in 
paragraph (h) of this section. In the case of a supporting organization 
which is operated in connection with one or more publicly supported 
organizations, the distinguishing feature is that the supporting 
organization is responsive to, and significantly involved in the 
operations of, the publicly supported organization, as described in 
paragraph (i) of this section.
    (5) Contributions from controlling donors--(i) In general. For any 
taxable year, a supporting organization shall not be considered to be 
operated, supervised, or controlled by, or operated in connection with, 
one or more publicly supported organizations, if the supporting 
organization accepts any gift or contribution from any person who is--

[[Page 159]]

    (A) A person (other than an organization described in section 
509(a)(1), (2), or (4)) who directly or indirectly controls, either 
alone or together with persons described in paragraphs (f)(5)(i)(B) or 
(f)(5)(i)(C) of this section, the governing body of a specified publicly 
supported organization supported by such supporting organization;
    (B) A member of the family (determined under section 4958(f)(4)) of 
an individual described in paragraph (f)(5)(i)(A) of this section; or
    (C) A 35-percent controlled entity (as defined in section 4958(f)(3) 
by substituting ``clause (i) or (ii) of section 509(f)(2)(B)'' for 
``subparagraph (A) or (B) of paragraph (1)'' in paragraph (f)(3)(A)(i) 
thereof).
    (ii) Meaning of control. [Reserved]
    (g) Meaning of operated, supervised, or controlled by. (1)(i) Each 
of the items operated by, supervised by, and controlled by, as used in 
section 509(a)(3)(B), presupposes a substantial degree of direction over 
the policies, programs, and activities of a supporting organization by 
one or more publicly supported organizations. The relationship required 
under any one of these terms is comparable to that of a parent and 
subsidiary, where the subsidiary is under the direction of, and 
accountable or responsible to, the parent organization. This 
relationship is established by the fact that a majority of the officers, 
directors, or trustees of the supporting organization are appointed or 
elected by the governing body, members of the governing body, officers 
acting in their official capacity, or the membership of one or more 
publicly supported organizations.
    (ii) A supporting organization may be operated, supervised, or 
controlled by one or more publicly supported organizations within the 
meaning of section 509(a)(3)(B) even though its governing body is not 
comprised of representatives of the specified publicly supported 
organizations for whose benefit it is operated within the meaning of 
section 509(a)(3)(A). A supporting organization may be operated, 
supervised, or controlled by one or more publicly supported 
organizations (within the meaning of section 509(a)(3)(B)) and be 
operated for the benefit of one or more different publicly supported 
organizations (within the meaning of section 509(a)(3)(A)) only if it 
can be demonstrated that the purposes of the former organizations are 
carried out by benefitting the latter organizations.
    (2) The provisions of this paragraph may be illustrated by the 
following examples:

    Example 1. X is a university press which is organized and operated 
as a nonstock educational corporation to perform the publishing and 
printing for M University, a publicly supported organization. Control of 
X is vested in a Board of Governors appointed by the Board of Trustees 
of M University upon the recommendation of the president of the 
university. X is considered to be operated, supervised, or controlled by 
M University within the meaning of section 509(a)(3)(B).
    Example 2. Y Council was organized under the joint sponsorship of 
seven independent publicly supported organizations, each of which is 
dedicated to the advancement of knowledge in a particular field of 
social science. The sponsoring organizations organized Y Council as a 
means of pooling their ideas and resources for the attainment of common 
objectives, including the conducting of scholarly studies and formal 
discussions in various fields of social science. Under Y Council's by-
laws, each of the seven sponsoring organizations elects three members to 
Y's board of trustees for 3-year terms. Y's board also includes the 
president of Y Council and eight other individuals elected at large by 
the board. Pursuant to policies established or approved by the board, Y 
Council engages in research, planning, and evaluation in the social 
sciences and sponsors or arranges conferences, seminars, and similar 
programs for scholars and social scientists. It carries out these 
activities through its own full-time professional staff, through a part-
time committee of scholars, and through grant recipients. Under the 
above circumstances, Y Council is subject to a substantial degree of 
direction by the sponsoring publicly supported organizations. It is 
therefore considered to be operated, supervised, or controlled by such 
sponsoring organizations within the meaning of section 509(a)(3)(B).
    Example 3. Z is a charitable trust created by A in 1972. It has 
three trustees, all of whom are appointed by M University, a publicly 
supported organization. The trust was organized and is operated to pay 
over all of its net income for medical research to N, O, and P, each of 
which is specified in the trust, is a hospital described in section 
509(a)(1), and is located in the same city as M. Members of M's biology 
department are permitted to use the research facilities of N, O, and P. 
Under subparagraph (1)(ii) of this paragraph, Z is considered to be 
operated, supervised, or

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controlled by M within the meaning of section 509(a)(3)(B), even though 
it is operated for the benefit of N, O, and P within the meaning of 
section 509(a)(3)(A).

    (h) Meaning of supervised or controlled in connection with. (1) In 
order for a supporting organization to be supervised or controlled in 
connection with one or more publicly supported organizations, there must 
be common supervision or control by the persons supervising or 
controlling both the supporting organization and the publicly supported 
organizations to insure that the supporting organization will be 
responsive to the needs and requirements of the publicly supported 
organizations. Therefore, in order to meet such requirement, the control 
or management of the supporting organization must be vested in the same 
persons that control or manage the publicly supported organizations.
    (2) A supporting organization will not be considered to be 
supervised or controlled in connection with one or more publicly 
supported organizations if such organization merely makes payments 
(mandatory or discretionary) to one or more named publicly supported 
organizations, even if the obligation to make payments to the named 
beneficiaries is enforceable under State law by such beneficiaries and 
the supporting organization's governing instrument contains provisions 
whose effect is described in section 508(e)(1) (A) and (B). Such 
arrangements do not provide a sufficient connection between the payor 
organization and the needs and requirements of the publicly supported 
organizations to constitute supervision or control in connection with 
such organizations.
    (3) The provisions of this paragraph may be illustrated by the 
following examples:

    Example 1. A, a philanthropist, founded X school for orphan boys (a 
publicly supported organization). At the same time A founded X school, 
he also established Y trust into which he transferred all of the 
operating assets of the school, together with a substantial endowment 
for it. Under the provisions of the trust instrument, the same persons 
who control and manage the school also control and manage the trust. The 
sole function of Y trust is to hold legal title to X school's operating 
and endowment assets, to invest the endowment assets and to apply the 
income from the endowment to the benefit of the school in accordance 
with direction from the school's governing body. Under these 
circumstances, Y trust is organized and operated for the benefit of X 
school and is supervised or controlled in connection with such 
organization within the meaning of section 509(a)(3). The fact that the 
same persons control both X and Y insures Y's responsiveness to X's 
needs.
    Example 2. In 1972, B, a philanthropist, created P, a charitable 
trust for the benefit of Z, a symphony orchestra described in section 
509(a)(2). B transferred 100 shares of common stock to P. Under the 
terms of the trust instrument, the trustees (none of whom is under the 
control of B) were required to pay over all of the income produced by 
the trust assets to Z. The governing instrument of P contains certain 
provisions whose effect is described in section 508(e)(1) (A) and (B). 
Under applicable State law, Z can enforce the provisions of the trust 
instrument and compel payment to Z in a court of equity. There is no 
relationship between the trustees of P and the governing body of Z. 
Under these circumstances P is not supervised or controlled in 
connection with a publicly supported organization. Because of the lack 
of any common supervision or control by the trustees of P and the 
governing body of Z, P is not supervised or controlled in connection 
with Z within the meaning of section 509(a)(3)(B).
    Example 3. T is a charitable trust described in section 501(c)(3) 
and created under the will of D. Prior to his death, D was a leader and 
very active in C church, a publicly supported organization. D created T 
to perpetuate his interest in, and assistance to, C. The sole purpose of 
T was to provide financial support for C and its related institutions. 
All of the original named trustees of T are members of C, are leaders in 
C, and hold important offices in one or more of C's related 
institutions. Successor trustees of T are by the terms of the charitable 
trust instrument to be chosen by the remaining trustees and are also to 
be members of C. All of the original trustees have represented that any 
successor trustee will be a leader in C and will hold an important 
office in one or more of C's related institutions. By reason of the 
foregoing relationship T and its trustees are responsive to the needs 
and requirements of C and its related institutions. Under these 
circumstances, T trust is organized and operated for the benefit of C 
and is supervised or controlled in connection with C and its related 
institutions within the meaning of section 509(a)(3)(B).

    (i) Meaning of operated in connection with--(1) General rule. For 
each taxable year, a supporting organization is operated in connection 
with one or more supported organizations (that is, is a

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``Type III supporting organization'') only if it is not disqualified by 
reason of paragraph (f)(5) (relating to acceptance of contributions from 
controlling donors) or paragraph (i)(10) (relating to foreign supported 
organizations) of this section, and it satisfies--
    (i) The notification requirement, which is set forth in paragraph 
(i)(2) of this section;
    (ii) The responsiveness test, which is set forth in paragraph (i)(3) 
of this section; and
    (iii) The integral part test, which is satisfied by maintaining 
significant involvement in the operations of one or more supported 
organizations and providing support on which the supported 
organization(s) are dependent; in order to satisfy this test, the 
supporting organization must meet the requirements either for--
    (A) Functionally integrated Type III supporting organizations set 
forth in paragraph (i)(4) of this section; or
    (B) Non-functionally integrated Type III supporting organizations 
set forth in paragraph (i)(5) of this section.
    (2) Notification requirement--(i) Annual notification. For each 
taxable year, a Type III supporting organization must provide the 
following documents to each of its supported organizations:
    (A) A written notice addressed to a principal officer of the 
supported organization describing the type and amount of all of the 
support the supporting organization provided to the supported 
organization during the supporting organization's taxable year 
immediately preceding the taxable year in which the written notice is 
provided (and during any other taxable year of the supporting 
organization ending after December 28, 2012, for which such support 
information has not previously been provided);
    (B) A copy of the supporting organization's Form 990, ``Return of 
Organization Exempt from Income Tax,'' or other annual information 
return required to be filed under section 6033 (although the supporting 
organization may redact from the return the name and address of any 
contributor to the organization) that was most recently filed as of the 
date the notification is provided (and any such return for any other 
taxable year of the supporting organization ending after December 28, 
2012, that has not previously been provided to the supported 
organization); and
    (C) A copy of the supporting organization's governing documents as 
in effect on the date the notification is provided, including its 
articles of organization and bylaws (if any) and any amendments to such 
documents, unless such documents have been previously provided and not 
subsequently amended.
    (ii) Electronic media. The notification documents required by this 
paragraph (i)(2) may be provided by electronic media.
    (iii) Due date. The notification documents required by this 
paragraph (i)(2) for any taxable year shall be postmarked or 
electronically transmitted by the last day of the fifth calendar month 
following the close of that taxable year.
    (iv) Principal officer. For purposes of paragraph (i)(2)(i)(A) of 
this section, a principal officer includes, but is not limited to, a 
person who, regardless of title, has ultimate responsibility for--
    (A) Implementing the decisions of the governing body of a supported 
organization;
    (B) Supervising the management, administration, or operation of the 
supported organization; or
    (C) Managing the finances of the supported organization.
    (3) Responsiveness test--(i) General rule. A supporting organization 
meets the responsiveness test if it is responsive to the needs or 
demands of a supported organization. Except as provided in paragraph 
(i)(3)(v) of this section, in order to meet this test, a supporting 
organization must satisfy the requirements of paragraphs (i)(3)(ii) and 
(i)(3)(iii) of this section.
    (ii) Relationship of officers, directors, or trustees. A supporting 
organization satisfies the requirements of this paragraph (i)(3)(ii) 
with respect to a supported organization only if--
    (A) One or more officers, directors, or trustees of the supporting 
organization are elected or appointed by the officers, directors, 
trustees, or membership of the supported organization;

[[Page 162]]

    (B) One or more members of the governing body of the supported 
organization are also officers, directors, or trustees of, or hold other 
important offices in, the supporting organization; or
    (C) The officers, directors, or trustees of the supporting 
organization maintain a close and continuous working relationship with 
the officers, directors, or trustees of the supported organization.
    (iii) Significant voice. A supporting organization satisfies the 
requirements of this paragraph (i)(3)(iii) only if, by reason of 
paragraphs (i)(3)(ii)(A), (i)(3)(ii)(B), or (i)(3)(ii)(C) of this 
section, the officers, directors, or trustees of the supported 
organization have a significant voice in the investment policies of the 
supporting organization, the timing of grants, the manner of making 
grants, and the selection of grant recipients by such supporting 
organization, and in otherwise directing the use of the income or assets 
of the supporting organization.
    (iv) Examples. The provisions of this paragraph (i)(3) may be 
illustrated by the following examples:

    Example 1. X, an organization described in section 501(c)(3), is a 
trust created under the last will and testament of Decedent. The trustee 
of X (Trustee) is a bank. Under the trust instrument, X supports M, a 
private university described in section 509(a)(1). The trust instrument 
provides that Trustee has discretion regarding the timing and amount of 
distributions consistent with the Trustee's fiduciary duties. 
Representatives of Trustee and an officer of M have quarterly face-to-
face or telephonic meetings during which they discuss M's projected 
needs and ways in which M would like X to use its income and invest its 
assets. Additionally, Trustee communicates regularly with that officer 
of M regarding X's investments and plans for distributions from X. 
Trustee provides the officer of M with quarterly investment statements, 
the information required under paragraph (i)(2) of this section, and an 
annual accounting statement. Based on these facts, X meets the 
responsiveness test of this paragraph (i)(3) with respect to M.
    Example 2. Y is an organization described in section 501(c)(3) and 
is a trust under State law. The trustee of Y (Trustee) is a bank. Y 
supports charities P, Q, and R, each an organization described in 
section 509(a)(1). Y makes annual cash payments to P, Q, and R. Once a 
year, Trustee sends to P, Q, and R the cash payment, the information 
required under paragraph (i)(2) of this section, and an accounting 
statement. Trustee has no other communication with P, Q, or R. Y does 
not meet the responsiveness test of this paragraph (i)(3).

    (v) Exception for pre-November 20, 1970 organizations. In the case 
of a supporting organization that was supporting or benefiting a 
supported organization before November 20, 1970, additional facts and 
circumstances, such as a historic and continuing relationship between 
the organizations, may be taken into account, in addition to the factors 
described in paragraphs (i)(3)(ii) and (i)(3)(iii) of this section, to 
establish compliance with the responsiveness test.
    (4) Integral part test--functionally integrated Type III supporting 
organization--(i) General rule. A supporting organization meets the 
integral part test and will be considered functionally integrated within 
the meaning of section 4943(f)(5)(B), if it--
    (A) Engages in activities substantially all of which directly 
further the exempt purposes of one or more supported organizations and 
otherwise meets the requirements described in paragraph (i)(4)(ii) of 
this section;
    (B) Is the parent of each of its supported organizations, as 
described in paragraph (i)(4)(iii) of this section; or
    (C) Supports a governmental supported organization and otherwise 
meets the requirements of paragraph (i)(4)(iv) of this section.
    (ii) Substantially all activities directly further exempt purposes--
(A) In general. A supporting organization meets the requirements of this 
paragraph (i)(4)(ii) if it engages in activities substantially all of 
which--
    (1) Directly further the exempt purposes of one or more supported 
organizations to which the supporting organization is responsive by 
performing the functions of, or carrying out the purposes of, such 
supported organization(s); and
    (2) But for the involvement of the supporting organization, would 
normally be engaged in by such supported organization(s).
    (B) Meaning of substantially all. For purposes of paragraph 
(i)(4)(ii)(A) of this section, in determining whether

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substantially all of a supporting organization's activities directly 
further the exempt purposes of one or more supported organization(s) to 
which the supporting organization is responsive, all pertinent facts and 
circumstances will be taken into consideration.
    (C) Meaning of directly further. Activities ``directly further'' the 
exempt purposes of one or more supported organizations for purposes of 
this paragraph (i)(4) only if they are conducted by the supporting 
organization itself, rather than by a supported organization. Holding 
title to and managing exempt-use assets described in paragraph 
(i)(8)(ii) of this section are activities that directly further the 
exempt purposes of the supported organization within the meaning of this 
paragraph (i)(4). Conversely, except as provided in paragraph 
(i)(4)(ii)(D) of this section, fundraising, making grants (whether to 
the supported organization or to third parties), and investing and 
managing non-exempt-use assets are not activities that directly further 
the exempt purposes of the supported organization within the meaning of 
this paragraph (i)(4).
    (D) Payments to individual beneficiaries. The making or awarding of 
grants, scholarships, or other payments to individual beneficiaries who 
are members of the charitable class benefited by a supported 
organization will be treated as an activity that directly furthers the 
exempt purposes of that supported organization for purposes of this 
paragraph (i)(4) only if--
    (1) The individual beneficiaries are selected on an objective and 
nondiscriminatory basis (as described in Sec.  53.4945-4(b));
    (2) The officers, directors, or trustees of the supported 
organization have a significant voice in the timing of the payments, the 
manner of making them, and the selection of recipients; and
    (3) The making or awarding of such payments is part of an active 
program of the supporting organization that directly furthers the exempt 
purposes of the supported organization and in which the supporting 
organization maintains significant involvement, as defined in Sec.  
53.4942(b)-1(b)(2)(ii) (except that ``supporting organization'' shall be 
substituted for ``foundation'').
    (iii) Parent of supported organization(s). For purposes of paragraph 
(i)(4)(i)(B) of this section, a supporting organization is the parent of 
a supported organization if the supporting organization exercises a 
substantial degree of direction over the policies, programs, and 
activities of the supported organization and a majority of the officers, 
directors, or trustees of the supported organization is appointed or 
elected, directly or indirectly, by the governing body, members of the 
governing body, or officers (acting in their official capacity) of the 
supporting organization.
    (iv) Supporting a governmental entity. [Reserved]
    (v) Examples. The provisions of this paragraph (i)(4) may be 
illustrated by the following examples:

    Example 1. N, an organization described in section 501(c)(3), is the 
parent organization of a healthcare system consisting of two hospitals 
(Q and R) and an outpatient clinic (S), each of which is described in 
section 509(a)(1), and a taxable subsidiary (T). N is the sole member of 
each of Q, R, and S. Under the charter and bylaws of each of Q, R, and 
S, N appoints all members of the board of directors of each corporation. 
N engages in the overall coordination and supervision of the healthcare 
system's exempt subsidiary corporations Q, R, and S in approval of their 
budgets, strategic planning, marketing, resource allocation, securing 
tax-exempt bond financing, and community education. N also manages and 
invests assets that serve as endowments of Q, R, and S. Based on these 
facts, N qualifies as a functionally integrated Type III supporting 
organization under paragraph (i)(4)(i)(B) of this section.
    Example 2. V, an organization described in section 501(c)(3), is 
organized and operated as a supporting organization to L, a church 
described in section 509(a)(1). V meets the responsiveness test 
described in paragraph (i)(3) of this section with respect to L. L 
transferred to V title to the buildings in which L conducts religious 
services, Bible study, and community enrichment programs. Substantially 
all of V's activities consist of holding and maintaining these 
buildings, which L continues to use, free of charge, to further its 
exempt purposes. But for the activities of V, L would hold and maintain 
the buildings. Based on these facts, V satisfies the requirements of 
paragraph (i)(4)(ii) of this section.
    Example 3. O is a local nonprofit food pantry described in section 
501(c)(3). O collects donated food from local growers, grocery stores, 
and individuals and distributes this

[[Page 164]]

food free of charge to poor and needy people in O's community. O is 
organized and operated as a supporting organization to eight churches of 
a particular denomination located in O's community, each of which is 
described in section 509(a)(1). Control of O is vested in a five-member 
Board of Directors, which includes an official from one of the churches 
as well as four lay members of the churches' congregations. The officers 
of O maintain a close and continuing working relationship with each of 
the eight churches and as a result of such relationship, each of the 
eight churches has a significant voice in directing the use of the 
income and assets of O. As a result, O is responsive to its supported 
organizations. All of O's activities directly further the exempt 
purposes of the eight supported organizations to which it is responsive. 
Additionally, but for the activities of O, the churches would normally 
operate food pantries themselves. Based on these facts, O satisfies the 
requirements of paragraph (i)(4)(ii) of this section.
    Example 4. M, an organization described in section 501(c)(3), was 
created by B, an individual, to provide scholarships for students of U, 
a private secondary school and an organization described in section 
509(a)(1). U establishes the scholarship criteria, publicizes the 
scholarship program, solicits and reviews applications, and selects the 
scholarship recipients. M invests its assets and disburses the funds for 
scholarships to the recipients selected by U. M does not provide the 
scholarships as part of an active program in which it maintains 
significant involvement, as defined in Sec.  53.4942(b)-1(b)(2)(ii). 
Based on these facts, M does not satisfy the requirements of paragraph 
(i)(4)(ii) of this section.
    Example 5. J, an organization described in section 501(c)(3), is 
organized as a supporting organization to community foundation G, an 
organization described in section 509(a)(1). J meets the responsiveness 
test described in paragraph (i)(3) of this section with respect to G. In 
addition to maintaining field-of-interest funds, sponsoring donor 
advised funds, and conducting general grantmaking activities, G also 
engages in activities to beautify and maintain local parks. 
Substantially all of J's activities consist of maintaining all of the 
local parks in the area of community foundation G by performing 
activities such as establishing and maintaining trails, planting trees, 
and removing trash. But for the activities of J, G would normally engage 
in these efforts to beautify and maintain the local parks. Based on 
these facts, J satisfies the requirements of paragraph (i)(4)(ii) of 
this section.

    (5) Integral part test--non-functionally integrated Type III 
supporting organization--(i) General rule. A supporting organization 
meets the integral part test and will be considered non-functionally 
integrated if it satisfies either--
    (A) The distribution requirement of paragraph (i)(5)(ii) of this 
section and the attentiveness requirement of paragraph (i)(5)(iii) of 
this section; or
    (B) The pre-November 20, 1970 trust requirements of paragraph (i)(9) 
of this section.
    (ii) Distribution requirement--(A) Annual distribution. With respect 
to each taxable year, a supporting organization must distribute to or 
for the use of one or more supported organizations an amount equaling or 
exceeding the supporting organization's distributable amount for the 
taxable year, as defined in paragraph (i)(5)(ii)(B) of this section, on 
or before the last day of the taxable year.
    (B) Distributable amount. Except as provided in paragraphs 
(i)(5)(ii)(D) and (E) of this section, the distributable amount for a 
taxable year is an amount equal to the greater of 85 percent of the 
supporting organization's adjusted net income (as determined by applying 
the principles of section 4942(f) and Sec.  53.4942(a)-2(d) of this 
chapter) for the taxable year immediately preceding the taxable year of 
the required distribution (immediately preceding taxable year) or its 
minimum asset amount (as defined in paragraph (i)(5)(ii)(C) of this 
section) for the immediately preceding taxable year, reduced by the 
amount of taxes imposed on the supporting organization under subtitle A 
of the Internal Revenue Code during the immediately preceding taxable 
year.
    (C) Minimum asset amount. For purposes of this paragraph (i)(5), a 
supporting organization's minimum asset amount for the immediately 
preceding taxable year is 3.5 percent of the excess of the aggregate 
fair market value of all of the supporting organization's non-exempt-use 
assets (determined under paragraph (i)(8) of this section) in that 
immediately preceding taxable year over the acquisition indebtedness 
with respect to such non-exempt-use assets (determined under section 
514(c)(1) without regard to the taxable year in which the indebtedness 
was incurred), increased by--
    (1) Amounts received or accrued during the immediately preceding 
taxable

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year as repayments of amounts which were taken into account by the 
organization to meet the distribution requirement imposed in this 
paragraph (i)(5)(ii) for any taxable year;
    (2) Amounts received or accrued during the immediately preceding 
taxable year from the sale or other disposition of property to the 
extent that the acquisition of such property was taken into account by 
the organization to meet the distribution requirement imposed in this 
paragraph (i)(5)(ii) for any taxable year; and
    (3) Any amount set aside under paragraph (i)(6)(v) of this section 
to the extent it is determined during the immediately preceding taxable 
year that such amount is not necessary for the purposes for which it was 
set aside and such amount was taken into account by the organization to 
meet the distribution requirement imposed in this paragraph (i)(5)(ii) 
for any taxable year.
    (D) First taxable year. The distributable amount for the first 
taxable year an organization is treated as a non-functionally integrated 
Type III supporting organization is zero. Notwithstanding the foregoing, 
for purposes of determining whether an excess amount is created under 
paragraph (i)(7)(ii) of this section, the distributable amount for the 
first taxable year an organization is treated as a non-functionally 
integrated Type III supporting organization is the distributable amount 
that would apply under paragraph (i)(5)(ii)(B) of this section in the 
absence of this paragraph (i)(5)(ii)(D).
    (E) Emergency temporary reduction. The Secretary may provide by 
publication in the Internal Revenue Bulletin (see Sec.  
601.601(d)(2)(ii)(b) of this chapter) for a temporary reduction in the 
distributable amount in the case of a disaster or emergency.
    (F) Reasonable cause exception. A non-functionally integrated Type 
III supporting organization that fails to meet the distribution 
requirement of this paragraph (i)(5)(ii) will not be classified as a 
private foundation for the taxable year in which it fails to meet the 
distribution requirement if the organization establishes to the 
satisfaction of the Secretary that--
    (1) The failure was due solely to unforeseen events or circumstances 
that are beyond the organization's control, a clerical error, or an 
incorrect valuation of assets;
    (2) The failure was due to reasonable cause and not to willful 
neglect; and
    (3) The distribution requirement is met within 180 days after the 
organization is first able to distribute its distributable amount 
notwithstanding the unforeseen events or circumstances, or 180 days 
after the date the incorrect valuation or clerical error was or should 
have been discovered; however, no amounts paid to meet a distribution 
requirement for a prior taxable year under this paragraph 
(i)(5)(ii)(F)(3) may be counted toward the distribution requirement for 
the taxable year in which such amounts are paid.
    (iii) Attentiveness requirement--(A) General rule. With respect to 
each taxable year, a non-functionally integrated Type III supporting 
organization must distribute one-third or more of its distributable 
amount to one or more supported organizations that are attentive to the 
operations of the supporting organization (within the meaning of 
paragraph (i)(5)(iii)(B) of this section) and to which the supporting 
organization is responsive (within the meaning of paragraph (i)(3) of 
this section).
    (B) Attentiveness. A supported organization is attentive to the 
operations of the supporting organization during a taxable year if, in 
the taxable year, at least one of the following requirements is 
satisfied:
    (1) The supporting organization distributes to the supported 
organization amounts equaling or exceeding 10 percent of the supported 
organization's total support (or, in the case of a particular department 
or school of a university, hospital, or church, the total support of the 
department or school) received during the supported organization's last 
taxable year ending before the beginning of the supporting 
organization's taxable year.
    (2) The amount of support received from the supporting organization 
is necessary to avoid the interruption of the carrying on of a 
particular function or activity of the supported organization. The 
support is necessary if the

[[Page 166]]

supporting organization or the supported organization earmarks the 
support for a particular program or activity of the supported 
organization, even if such program or activity is not the supported 
organization's primary program or activity, as long as such program or 
activity is a substantial one.
    (3) Based on the consideration of all pertinent factors, including 
the number of supported organizations, the length and nature of the 
relationship between the supported organization and supporting 
organization, and the purpose to which the funds are put, the amount of 
support received from the supporting organization is a sufficient part 
of a supported organization's total support (or, in the case of a 
particular department or school of a university, hospital, or church, 
the total support of the department or school) to ensure attentiveness. 
Normally the attentiveness of a supported organization is influenced by 
the amounts received from the supporting organization. Thus, the more 
substantial the amount involved in terms of a percentage of the 
supported organization's total support, the greater the likelihood that 
the required degree of attentiveness will be present. However, in 
determining whether the amount received from the supporting organization 
is sufficient to ensure the attentiveness of the supported organization 
to the operations of the supporting organization (including 
attentiveness to the nature and yield of the supporting organization's 
investments), evidence of actual attentiveness by the supported 
organization is of almost equal importance. A supported organization is 
not considered to be attentive solely because it has enforceable rights 
against the supporting organization under state law.
    (C) Distribution to donor advised fund disregarded. Notwithstanding 
paragraph (i)(5)(iii)(B) of this section, in determining whether a 
supported organization will be considered attentive to the operations of 
a supporting organization, any amount received from the supporting 
organization that is held by the supported organization in a donor 
advised fund described in section 4966(d)(2) will be disregarded.
    (D) Examples. This paragraph (i)(5)(iii) is illustrated by the 
following examples:

    Example 1. K, an organization described in section 501(c)(3), 
annually pays an aggregate amount equaling or exceeding its 
distributable amount described in paragraph (i)(5)(ii)(B) of this 
section to L, a museum described in section 509(a)(2). K meets the 
responsiveness test described in paragraph (i)(3) of this section with 
respect to L. In recent years, L has earmarked the income received from 
K to underwrite the cost of carrying on a chamber music series 
consisting of 12 performances a year that are performed for the general 
public free of charge at its premises. The chamber music series is not 
L's primary activity but it is a substantial activity. L could not 
continue the performances without K's support. Based on these facts, K 
meets the requirements of paragraph (i)(5)(iii)(B)(2) of this section.
    Example 2. M, an organization described in section 501(c)(3), 
annually pays an aggregate amount equaling or exceeding its 
distributable amount described in paragraph (i)(5)(ii)(B) of this 
section to the Law School of N University, an organization described in 
section 509(a)(1). M meets the responsiveness test described in 
paragraph (i)(3) of this section with respect to N. M has earmarked the 
income paid over to N's Law School to endow a chair in International 
Law. Without M's continued support, N could not continue to maintain 
this chair. The chair is not N's primary activity but it is a 
substantial activity. Based on these facts, M meets the requirements of 
paragraph (i)(5)(iii)(B)(2) of this section.
    Example 3. R is a charitable trust created under the will of B, who 
died in 1969. R's purpose is to hold assets as an endowment for S (a 
hospital), T (a university), and U (a national medical research 
organization), all organizations described in section 509(a)(1) and 
specifically named in the trust instrument, and to distribute all of the 
income each year in equal shares among the three named beneficiaries. 
Each year, R pays to S, T, and U an aggregate amount equaling or 
exceeding its distributable amount described in paragraph (i)(5)(ii)(B) 
of this section. Such payments equal less than one percent of the total 
support that each supported organization received in its most recently 
completed taxable year. Based on these facts, R does not meet the 
requirements of paragraph (i)(5)(iii)(B)(1) of this section. However, 
because B died prior to November 20, 1970, R could meet the requirements 
of paragraph (i)(5)(i)(B) of this section upon meeting all of the 
requirements of paragraph (i)(9) of this section.
    Example 4. O is an organization described in section 501(c)(3). O is 
organized to support five private universities, V, W, X, Y, and Z,

[[Page 167]]

each of which is described in section 509(a)(1). O meets the 
responsiveness test under paragraph (i)(3) of this section only as to V. 
Each year, O distributes an aggregate amount that equals its 
distributable amount described in paragraph (i)(5)(ii)(B) of this 
section and distributes an equal amount to each of the five 
universities. Accordingly, O distributes only one-fifth of its 
distributable amount to a supported organization to which O is also 
responsive (V). Because O does not distribute at least one-third of its 
distributable amount to supported organizations that are both attentive 
to the operations of O and to which the O is responsive, O does not meet 
the attentiveness requirements of this paragraph (i)(5)(iii).

    (6) Distributions that count toward distribution requirement. For 
purposes of this paragraph (i)(6), the amount of a distribution made to 
a supported organization is the amount of cash distributed or the fair-
market value of the property distributed as of the date the distribution 
is made. The amount of a distribution will be determined solely on the 
cash receipts and disbursements method of accounting described in 
section 446(c)(1). Distributions by the supporting organization that 
count toward the distribution requirement imposed in paragraph 
(i)(5)(ii) of this section shall include, but not be limited to--
    (i) Any amount paid to a supported organization to accomplish the 
supported organization's exempt purposes;
    (ii) Any amount paid by the supporting organization to perform an 
activity that satisfies the requirements of paragraph (i)(4)(ii) of this 
section, but only to the extent such amount exceeds any income derived 
by the supporting organization from the activity;
    (iii) Any reasonable and necessary administrative expenses paid to 
accomplish the exempt purposes of the supported organization(s), which 
do not include expenses incurred in the production of investment income;
    (iv) Any amount paid to acquire an exempt-use asset described in 
paragraph (i)(8)(ii) of this section; and
    (v) Any amount set aside for a specific project that accomplishes 
the exempt purposes of a supported organization to which the supporting 
organization is responsive, with such set aside counting toward the 
distribution requirement for the taxable year in which the amount is set 
aside but not in the year in which it is actually paid, if at the time 
of the set-aside, the supporting organization--
    (A) Obtains a written statement from each supported organization 
whose exempt purposes the specific project accomplishes, signed under 
penalty of perjury by one of the supported organization's principal 
officers, as defined in paragraph (i)(2)(iv) of this section, stating 
that the supported organization approves the project as one that 
accomplishes one or more of the supported organization's exempt purposes 
and also approves the supporting organization's determination that the 
project is one that can be better accomplished by such a set-aside than 
by the immediate payment of funds;
    (B) Establishes to the satisfaction of the Commissioner, by meeting 
the approval and information requirements described in Sec.  53.4942(a)-
3(b)(7)(i) of this chapter and by providing the written statement 
described in paragraph (i)(6)(v)(A) of this section, that the amount set 
aside will be paid for the specific project within 60 months after it is 
set aside and that the project is one that can better be accomplished by 
the set-aside than by the immediate payment of funds; and
    (C) Evidences the set-aside by the entry of a dollar amount on the 
books and records of the supporting organization as a pledge or 
obligation to be paid at a future date or dates within 60 months of the 
set aside.
    (7) Carryover of excess amounts--(i) In general. If with respect to 
any taxable year, an excess amount, as defined in paragraph (i)(7)(ii) 
of this section, is created, such excess amount may be used to reduce 
the distributable amount in any of the five taxable years immediately 
following the taxable year in which the excess amount is created. An 
excess amount created in a taxable year can only be carried over for 
five taxable years.
    (ii) Excess amount. An excess amount is created for any taxable year 
beginning after December 28, 2012, if the total distributions made in 
that taxable year that count toward the distribution requirement exceed 
the supporting organization's distributable amount for the taxable year, 
as determined under paragraph (i)(5)(ii)(B) of

[[Page 168]]

this section. With respect to any taxable year to which an excess amount 
is carried over, in determining whether an excess amount is created in 
that taxable year, the distributable amount is first reduced by any 
excess amounts carried over (with the oldest excess amounts applied 
first) and then by any distributions made in that taxable year.
    (8) Valuation of non-exempt-use assets. For purposes of determining 
its distributable amount for a taxable year, a supporting organization 
determines its minimum asset amount, as defined in paragraph 
(i)(5)(ii)(C) of this section, by determining the aggregate fair market 
value of all of its non-exempt-use assets in the immediately preceding 
taxable year. For these purposes, the determination of the aggregate 
fair market value of all non-exempt-use assets shall be made using the 
valuation methods described in Sec.  53.4942(a)-2(c) of this chapter. 
The aggregate fair market value of the supporting organization's non-
exempt-use assets shall not be reduced by any amount that is set aside 
under paragraph (i)(6)(v) of this section. For these purposes, the non-
exempt use assets of the supporting organization are all assets of the 
supporting organization other than--
    (i) Assets described in Sec.  53.4942(a)-2(c)(2)(i) through (iv) of 
this chapter (with the term ``supporting organization'' being 
substituted for ``foundation'' or ``private foundation'' and the date 
``August 17, 2006'' being substituted for ``December 31, 1969''); and
    (ii) Exempt-use assets, which are assets that are used (or held for 
use) directly in carrying out the exempt purposes of the supporting 
organization's supported organization(s) (determined by applying the 
principles described in Sec.  53.4942(a)-2(c)(3) of this chapter) by 
either--
    (A) The supporting organization; or
    (B) One or more supported organizations, but only if the supporting 
organization makes the asset available to the supported organization(s) 
at no cost (or nominal rent) to the supported organization(s).
    (9) Alternate integral part test for certain trusts. A trust 
(whether or not exempt from taxation under section 501(a)) that on 
November 20, 1970, met and continues to meet the requirements of 
paragraphs (i)(9)(i) through (i)(9)(v) of this section, shall be treated 
as meeting the requirements of paragraph (i)(5) of this section if for 
taxable years beginning after October 16, 1972, the trustee of such 
trust makes annual written reports to all of the trust's supported 
organizations, setting forth a description of the trust's assets, 
including a detailed list of the assets and the income produced by such 
assets. A trust that meets the requirements of this paragraph (i)(9) may 
request a ruling that it is described in section 509(a)(3) in such 
manner as the Commissioner may prescribe. The requirements of this 
paragraph (i)(9) are as follows:
    (i) All the unexpired interests in the trust are devoted to one or 
more purposes described in section 170(c)(1) or (c)(2)(B) and a 
deduction was allowed with respect to such interests under sections 170, 
545(b)(2), 556(b)(2), 642(c), 2055, 2106(a)(2), 2522, or corresponding 
provisions of prior law (or would have been allowed such a deduction if 
the trust had not been created before 1913).
    (ii) The trust was created prior to November 20, 1970, and did not 
receive any grant, contribution, bequest or other transfer on or after 
such date. For purposes of this paragraph (i)(9)(ii), a split-interest 
trust described in section 4947(a)(2) that was created prior to November 
20, 1970, was irrevocable on such date, and that becomes a charitable 
trust described in section 4947(a)(1) after such date shall be treated 
as having been created prior to such date.
    (iii) The trust is required by its governing instrument to 
distribute all of its net income currently to a designated beneficiary 
supported organization. If more than one beneficiary supported 
organization is designated in the governing instrument of a trust, all 
of the net income must be distributable and must be distributed 
currently to each of such supported organizations in fixed shares 
pursuant to such governing instrument. For purposes of this paragraph 
(i)(9)(iii), the governing instrument of a charitable trust shall be 
treated as requiring distribution to a designated supported organization 
when the trust instrument describes

[[Page 169]]

the charitable purpose of the trust so completely that such description 
can apply to only one existing supported organization and is of 
sufficient particularity as to vest in such organization rights against 
the trust enforceable in a court possessing equitable powers.
    (iv) The trustee of the trust does not have discretion to vary 
either the beneficiary supported organizations or the amounts payable to 
the supported organizations. For purposes of this paragraph (i)(9)(iv), 
a trustee shall not be treated as having such discretion if the trustee 
has discretion to make payments of principal to the single supported 
organization that is currently entitled to receive all of the trust's 
income or if the trust instrument provides that the trustee may cease 
making income payments to a particular supported organization in the 
event of certain specific occurrences, such as the loss of exemption 
under section 501(c)(3) or classification under section 509(a)(1) or 
(a)(2) by the supported organization or the failure of the supported 
organization to carry out its charitable purpose properly.
    (v) None of the trustees would be disqualified persons within the 
meaning of section 4946(a) (other than foundation managers under section 
4946(a)(1)(B)) with respect to the trust if such trust were treated as a 
private foundation.
    (10) Foreign supported organizations. A supporting organization is 
not operated in connection with one or more supported organizations if 
it supports any supported organization organized outside of the United 
States.
    (11) Transition rules--(i) Notification requirement. A Type III 
supporting organization will be treated as having satisfied the 
notification requirement described in paragraph (i)(2) of this section 
for its taxable year that includes December 28, 2012, if the required 
notification is postmarked or electronically transmitted by the later of 
the last day of the fifth calendar month following the close of that 
taxable year or the due date (including extensions) of the supporting 
organization's annual information return described in section 6033 for 
that taxable year.
    (ii) Integral part test--(A) Qualification as a functionally 
integrated Type III supporting organization. A Type III supporting 
organization in existence on December 28, 2012, that met and continues 
to meet the requirements of Treas. Reg. Sec.  1.509(a)-4(i)(3)(ii), as 
in effect prior to December 28, 2012, will be treated as meeting the 
requirements of paragraph (i)(4) of this section until the first day of 
the organization's second taxable year beginning after December 28, 
2012.
    (B) Qualification as a non-functionally integrated Type III 
supporting organization. A Type III supporting organization in existence 
on December 28, 2012, that met and continues to meet the requirements of 
Treas. Reg. Sec.  1.509(a)-4(i)(3)(iii), as in effect prior to December 
28, 2012, will be treated as meeting the requirements of paragraph 
(i)(5)(i)(A) of this section until the first day of its second taxable 
year beginning after December 28, 2012. Notwithstanding the foregoing, 
in determining whether an excess amount is created under paragraph 
(i)(7)(ii) of this section in the first taxable year beginning after 
December 28, 2012, the distributable amount for that taxable year of a 
Type III supporting organization treated as meeting the requirements of 
paragraph (i)(5)(i)(A) of this section under this paragraph 
(i)(11)(ii)(B) is the amount described in Sec.  1.509(a)-
4T(i)(5)(ii)(B).
    (C) Transitioning to a non-functionally integrated Type III 
supporting organization in the first taxable year after effective date. 
A Type III supporting organization in existence on December 28, 2012, 
that meets the requirements of Treas. Reg. Sec.  1.509(a)-4(i)(3)(ii), 
as in effect prior to December 28, 2012, in its taxable year including 
December 28, 2012, but not in its first taxable year beginning after 
December 28, 2012, is a non-functionally integrated Type III supporting 
organization and will be treated as having a distributable amount of 
zero for purposes of meeting the requirements of paragraph (i)(5)(i)(A) 
of this section during the organization's first taxable year beginning 
after December 28, 2012. Notwithstanding the foregoing, in determining 
whether an excess amount is created under paragraph (i)(7)(ii) of this 
section in the first taxable year beginning

[[Page 170]]

after December 28, 2012, the distributable amount for that taxable year 
of a Type III supporting organization described in this paragraph 
(i)(11)(ii)(C) is the amount described in Sec.  1.509(a)-
4T(i)(5)(ii)(B), determined without regard to paragraph (i)(5)(ii)(D) of 
this section.
    (D) Second taxable year after effective date. Beginning in the 
second taxable year beginning after December 28, 2012, and in all 
succeeding taxable years, all Type III supporting organizations 
described in this paragraph (i)(11)(ii) must meet either the 
requirements of paragraph (i)(4) or (i)(5) of this section. If a Type 
III supporting organization described in paragraph (i)(11)(ii)(A) of 
this section does not meet the requirements of paragraph (i)(4) of this 
section during its second taxable year beginning after December 28, 
2012, its distributable amount for that second taxable year will be 
determined under Sec.  1.509(a)-4T(i)(5)(ii)(B), without regard to 
paragraph (i)(5)(ii)(D) of this section. Any Type III supporting 
organization intending to meet the requirements of paragraph (i)(5) of 
this section in its second taxable year beginning after December 28, 
2012, must value its assets in accordance with Sec.  1.509(a)-4T(i)(8) 
beginning in its first taxable year beginning after December 28, 2012.
    (E) Judicial proceedings to reform instruments. During any taxable 
years in which there is pending a judicial proceeding that meets the 
requirements of this paragraph (i)(11)(ii)(E), a non-functionally 
integrated Type III supporting organization organized before September 
24, 2009, will not have to comply with the distribution requirement 
under paragraph (i)(5)(ii) of this section to the extent such compliance 
would be inconsistent with mandatory provisions of a governing 
instrument or other instrument executed before September 24, 2009, that 
prohibits distributing capital or corpus. Beginning with the first 
taxable year following the taxable year in which such judicial 
proceeding is terminated, such a non-functionally integrated Type III 
supporting organization must satisfy the distribution requirement under 
paragraph (i)(5)(ii) of this section, regardless of the outcome of the 
judicial proceeding. Thus, if, during a taxable year after such a 
judicial proceeding, an organization fails to comply with paragraph 
(i)(5)(ii) of this section, the organization will not qualify as a non-
functionally integrated Type III supporting organization, regardless of 
whether such failure to comply was a result of the organization 
operating in accordance with its governing instrument or other 
instrument. To meet the requirements of this paragraph (i)(11)(ii)(E), a 
judicial proceeding must be--
    (1) Necessary to reform, or to excuse the supporting organization 
from compliance with, a governing instrument or other instrument (as in 
effect on September 24, 2009, and all times thereafter) in order to 
permit the organization to satisfy paragraph (i)(5)(ii) of this section;
    (2) Commenced before June 26, 2013; and
    (3) Not subject to any unreasonable delay for which the supporting 
organization is responsible.

    (j) Control by disqualified persons--(1) In general. Under the 
provisions of section 509(a)(3)(C) a supporting organization may not be 
controlled directly or indirectly by one or more disqualified persons 
(as defined in section 4946) other than foundation managers and other 
than one or more publicly supported organizations. If a person who is a 
disqualified person with respect to a supporting organization, such as a 
substantial contributor to the supporting organization, is appointed or 
designated as a foundation manager of the supporting organization by a 
publicly supported beneficiary organization to serve as the 
representative of such publicly supported organization, then for 
purposes of this paragraph such person will be regarded as a 
disqualified person, rather than as a representative of the publicly 
supported organization. An organization will be considered controlled, 
for purposes of section 509(a)(3)(C), if the disqualified persons, by 
aggregating their votes or positions of authority, may require such 
organization to perform any act which significantly affects its 
operation or may prevent such organization from performing such act. 
This includes, but is not limited to, the right of any substantial 
contributor or his spouse to designate annually the recipients, from

[[Page 171]]

among the publicly supported organizations of the income attributable to 
his contribution to the supporting organization. Except as provided in 
subparagraph (2) of this paragraph, a supporting organization will be 
considered to be controlled directly or indirectly by one or more 
disqualified persons if the voting power of such persons is 50 percent 
or more of the total voting power of the organization's governing body 
or if one or more of such persons have the right to exercise veto power 
over the actions of the organization. Thus, if the governing body of a 
foundation is composed of five trustees, none of whom has a veto power 
over the actions of the foundation, and no more than two trustees are at 
any time disqualified persons, such foundation will not be considered to 
be controlled directly or indirectly by one or more disqualified persons 
by reason of this fact alone. However, all pertinent facts and 
circumstances including the nature, diversity, and income yield of an 
organization's holdings, the length of time particular stocks, 
securities, or other assets are retained, and its manner of exercising 
its voting rights with respect to stocks in which members of its 
governing body also have some interest, will be taken into consideration 
in determining whether a disqualified person does in fact indirectly 
control an organization.
    (2) Proof of independent control. Notwithstanding subparagraph (1) 
of this paragraph, an organization shall be permitted to establish to 
the satisfaction of the Commissioner that disqualified persons do not 
directly or indirectly control it. For example, in the case of a 
religious organization operated in connection with a church, the fact 
that the majority of the organization's governing body is composed of 
lay persons who are substantial contributors to the organization will 
not disqualify the organization under section 509(a)(3)(C) if a 
representative of the church, such as a bishop or other official, has 
control over the policies and decisions of the organization.
    (k) Organizations operated in conjunction with certain section 
501(c) (4), (5), or (6) organizations. (1) For purposes of section 
509(a)(3), an organization which is operated in conjunction with an 
organization described in section 501(c) (4), (5), or (6) (such as a 
social welfare organization, labor or agricultural organization, 
business league, or real estate board) shall, if it otherwise meets the 
requirements of section 509(a)(3), be considered an organization 
described in section 509(a)(3) if such section 501(c) (4), (5), or (6) 
organization would be described in section 509(a)(2) if it were an 
organization described in section 501(c)(3). The section 501(c) (4), 
(5), or (6) organization, which the supporting organization is operating 
in conjunction with, must therefore meet the one-third tests of a 
publicly supported organization set forth in section 509(a)(2).
    (2) This paragraph may be illustrated by the following example:

    Example. X medical association, described in section 501(c)(6), is 
supported by membership dues and funds resulting from the performance of 
its exempt activities. This support, which is entirely from permitted 
sources, constitutes more than one-third of X's support. X does not 
normally receive more than one-third of its support from items described 
in section 509(a)(2)(B). X organized and operated an endowment fund for 
the sole purpose of furthering medical education. The fund is an 
organization described in section 501(c)(3). Since more than one-third 
of X's support is derived from membership dues and from funds resulting 
from the performance of exempt purposes (all of which are from permitted 
sources) and not more than one-third of its support is from items 
described in section 509(a)(2)(B), it would be a publicly supported 
organization described in section 509(a)(2) if it were described in 
section 501(c)(3) rather than section 501(c)(6). Accordingly, if the 
fund otherwise meets the requirements of section 509(a)(3) with respect 
to X, it will be considered an organization described in section 
509(a)(3).

    (l) Effective/applicability dates. Paragraphs (a)(6), (f)(5), (i)(1) 
through (i)(4)(ii)(B), (i)(4)(ii)(D) through (i)(5)(i), (i)(5)(ii)(E) 
through (i)(5)(iii)(C), (i)(6)(i) through (iii), (i)(6)(v) through 
(i)(7)(i), and (i)(9) through (11) of this section are applicable on 
December 28, 2012. Paragraphs (i)(4)(ii)(C), (i)(5)(ii)(A) through 
(i)(5)(ii)(D), (i)(5)(iii)(D), (i)(6)(iv), (i)(7)(ii) and (i)(8) of this 
section are applicable on December 21, 2015. See paragraphs 
(i)(5)(ii)(B), (i)(5)(ii)(C), and (i)(8) of Sec.  1.509(a)-4T contained 
in 26 CFR part 1, revised as

[[Page 172]]

of April 1, 2015, for certain rules regarding non-functionally 
integrated Type III supporting organizations effective before December 
21, 2015.

[T.D. 7212, 37 FR 21916, Oct. 17, 1972, as amended by T.D. 7784, 46 FR 
37890, July 23, 1981; 77 FR 76394, Dec. 28, 2012; T.D. 9746, 80 FR 
79686, Dec. 23, 2015]



Sec.  1.509(a)-5  Special rules of attribution.

    (a) Retained character of gross investment income. (1) For purposes 
of determining whether an organization meets the not-more-than-one-third 
support test set forth in section 509(a)(2)(B), amounts received by such 
organization from:
    (i) An organization which seeks to be described in section 509(a)(3) 
by reason of its support of such organization; or
    (ii) A charitable trust, corporation, fund, or association described 
in section 501(c)(3) (including a charitable trust described in section 
4947(a)(1)) or a split interest trust described in section 4947(a)(2), 
which is required by its governing instrument or otherwise to 
distribute, or which normally does distribute, at least 25 percent of 
its adjusted net income (within the meaning of section 4942(f)) to such 
organization, and such distribution normally comprises at least 5 
percent of such distributee organization's adjusted net income


will retain their character as gross investment income (rather than 
gifts or contributions) to the extent that such amounts are 
characterized as gross investment income in the possession of the 
distributing organization described in subdivision (i) or (ii) of this 
subparagraph or, if the distributing organization is a split interest 
trust described in section 4947(a)(2), to the extent that such amounts 
would be characterized as gross investment income attributable to 
transfers in trust after May 26, 1969, if such trust were a private 
foundation. For purposes of this section, all income which is 
characterized as gross investment income in the possession of the 
distributing organization shall be deemed to be distributed first by 
such organization and shall retain its character as such in the 
possession of the recipient of amounts described in this paragraph. If 
an organization described in subdivision (i) or (ii) of this 
subparagraph makes distributions to more than one organization, the 
amount of gross investment income deemed distributed shall be prorated 
among the distributees.
    (2) For purposes of subparagraph (1) of this paragraph, amounts paid 
by an organization to provide goods, services, or facilities for the 
direct benefit of an organization seeking section 509(a)(2) status 
(rather than for the direct benefit of the general public) shall be 
treated in the same manner as amounts received by the latter 
organization. Such amounts will be treated as gross investment income to 
the extent that such amounts are characterized as gross investment 
income in the possession of the organization spending such amounts. For 
example, X is an organization described in subparagraph (1)(i) of this 
paragraph. It uses part of its funds to provide Y, an organization 
seeking section 509(a)(2) status, with certain services which Y would 
otherwise be required to purchase on its own. To the extent that the 
funds used by X to provide such services for Y are characterized as 
gross investment income in the possession of X, such funds will be 
treated as gross investment income received by Y.
    (3) An organization seeking section 509(a)(2) status shall file a 
separate statement with its return required by section 6033, setting 
forth all amounts received from organizations described in paragraph 
(a)(1) (i) or (ii) of this section.
    (b) Relationships created for avoidance purposes. (1) If a 
relationship between an organization seeking section 509(a)(3) status 
and an organization seeking section 509(a)(2) status:
    (i) Is established or availed of after October 9, 1969, and
    (ii) One of the purposes of establishing or utilizing such 
relationship is to avoid classification as a private foundation with 
respect to either organization, the character and amount of support 
received by the section 509(a)(3) organization will be attributed to the 
section 509(a)(2) organization for purposes of determining whether the 
latter meets the one-third support test

[[Page 173]]

and the not-more-than-one-third support test under section 509(a)(2). If 
a relationship described in this subparagraph is established or utilized 
by an organization seeking section 509(a)(3) status and two or more 
organizations seeking section 509(a)(2) status, the amount of support 
received by the former organization will be prorated among the latter 
organizations and the character of each class of support (as defined in 
section 509(d)) will be attributed pro rata to each such organization. 
The provisions of this paragraph and of paragraph (a) of this section 
are not mutually exclusive.
    (2) In determining whether a relationship between one or more 
organizations seeking section 509(a)(2) status (hereinafter referred to 
as beneficiary organizations) and an organization seeking section 
509(a)(3) status (hereinafter referred to as the supporting 
organization) has been established or availed of to avoid classification 
as a private foundation (within the meaning of subparagraph (1) of this 
paragraph), all pertinent facts and circumstances, including the 
following, shall be taken into account as evidence that a relationship 
was not established or availed of to avoid classification as a private 
foundation:
    (i) The supporting organization is operated to support or benefit 
several specified beneficiary organizations.
    (ii) The beneficiary organization has a substantial number of dues-
paying members (in relation to the public it serves and the nature of 
its activities) and such members have an effective voice in the 
management of both the supporting and beneficiary organizations.
    (iii) The beneficiary organization is composed of several membership 
organizations, each of which has a substantial number of members (in 
relation to the public it serves and the nature of its activities), and 
such membership organizations have an effective voice in the management 
of the supporting and beneficiary organizations.
    (iv) The beneficiary organization receives a substantial amount of 
support from the general public, public charities, or governmental 
grants.
    (v) The supporting organization uses its funds to carry on a 
meaningful program of activities to support or benefit the beneficiary 
organization and such use would, if such supporting organization were a 
private foundation, be sufficient to avoid the imposition of any tax 
upon such organization under section 4942.
    (vi) The supporting organization is not able to exercise substantial 
control or influence over the beneficiary organization by reason of the 
former's receiving support or holding assets which are 
disproportionately large in comparison with the support received or the 
assets held by the latter.
    (vii) Different persons manage the operations of the beneficiary and 
supporting organizations and each organization performs a different 
function.
    (3) The provisions of this paragraph may be illustrated by the 
following examples:

    Example 1. M, an organization described in section 509(a)(2), is a 
council composed of 10 learned societies. Each member society has a 
large membership of scholars interested in a particular academic area. 
In 1970 M established N, an organization seeking section 509(a)(3) 
status, for the purpose of carrying on research and study projects of 
interest to the member societies. The principal source of funds for N's 
activities is from foundation and government grants and contracts. The 
principal source of funds for M's activities after the creation of N is 
membership dues. M continued to maintain a wide variety of activities 
for its members, such as publishing periodicals and carrying on seminars 
and conferences. N is subject to complete control by the governing body 
of M. Under these circumstances, the relationship between these 
organizations is not one which is described in subparagraph (1) of this 
paragraph.
    Example 2. Q is a local medical research organization described in 
section 509(a)(2). Its fixed assets are negligible and it carries on 
research activities on a limited scale. It also makes a limited number 
of grants to scientists and doctors who are engaged in medical research 
of interest to Q. It receives support through small government grants 
and a few research contracts from private foundations. R is an 
organization described in section 501(c)(3). As of January 1, 1970, R 
was classified as a private foundation under section 509. It has a 
substantial endowment which it uses to make grants to various charitable 
and scientific organizations described in section 501(c)(3). During 
1970, R agrees to subsidize the research activities of Q. R amends its 
governing instrument to provide specifically that all of R's support

[[Page 174]]

will be used for research activities which are approved and supervised 
by Q. R also amends its bylaws to permit a minority of Q's board of 
directors to be members of R's governing body. R then gives timely 
notification under section 507(b)(1)(B)(ii) that R is terminating its 
private foundation status by meeting the requirements of section 
509(a)(3) by the end of the 12-month period described in section 
507(b)(1)(B)(i). For purposes of determining whether R has met the 
requirements of section 509(a)(3) by the end of the 12-month period, as 
well as determining Q's status under section 509(a)(2), the character 
and amount of support received by R will be attributed to Q.

    (c) Effect on organizations claiming section 509(a)(3) status. If an 
organization claiming section 509(a)(2) status fails to meet either the 
one-third support test or the not-more-than-one-third support test under 
section 509(a)(2) by reason of the application of the provisions of 
paragraph (a) or (b) of this section, and such organization is one of 
the specified organizations (within the meaning of section 509(a)(3)(A)) 
for whose support or benefit an organization claiming section 509(a)(3) 
status is operated, the organization claiming section 509(a)(3) status 
will not be considered to be operated exclusively to support or benefit 
one or more section 509(a) (1) or (2) organizations.

[T.D. 7212, 37 FR 21922, Oct. 17, 1972, as amended by T.D. 7290, 38 FR 
31834, Nov. 19, 1973; T.D. 7784, 46 FR 37890, July 23, 1981]



Sec.  1.509(a)-6  Classification under section 509(a).

    If an organization is described in section 509(a)(1) and also in 
another paragraph of section 509(a), it will be treated as described in 
section 509(a)(1). For purposes of this section, the parenthetical 
language other than in clauses (vii) and (viii) used in section 
509(a)(1) shall be construed to mean other than an organization which is 
described only in clause (vii) or (viii). For example, X is an 
organization which is described in section 170(b)(1)(A)(vi), but could 
also meet the description of section 170(b)(1)(A)(viii) as an 
organization described in section 509(a)(2). For purposes of the one-
third support test in section 509(a)(2)(A), contributions from X to 
other organizations will be treated as support from an organization 
described in section 170(b)(1)(A)(vi) rather than from an organization 
described in section 170(b)(1)(A)(viii).

[T.D. 7212, 37 FR 21923, Oct. 17, 1972]



Sec.  1.509(a)-7  Reliance by grantors and contributors to 
section 509(a) (1), (2), and (3) organizations.

    (a) General rule. Once an organization has received a final ruling 
or determination letter classifying it as an organization described in 
section 509(a) (1), (2), or (3), the treatment of grants and 
contributions and the status of grantors and contributors to such 
organization under sections 170, 507, 545(b)(2), 556(b)(2), 642(c), 
4942, 4945, 2055, 2106(a)(2), and 2522 will not be affected by reason of 
a subsequent revocation by the service of the organization's 
classification as described in section 509(a) (1), (2), or (3) until the 
date on which notice of change of status is made to the public (such as 
by publication in the Internal Revenue Bulletin) or another applicable 
date, if any, specified in such public notice. In appropriate cases, 
however, the treatment of grants and contributions and the status of 
grantors and contributors to an organization described in section 509(a) 
(1), (2), or (3) may be affected pending verification of the continued 
classification of such organization under section 509(a) (1), (2), or 
(3). Notice to this affect will be made in a public announcement by the 
service. In such cases the effect of grants and contributions made after 
the date of the announcement will depend upon the statutory 
qualification of the organization as an organization described in 
section 509(a) (1), (2), or (3).
    (b) Exceptions. (1) Paragraph (a) of this section shall not apply if 
the grantor or contributor:
    (i) Had knowledge of the revocation of the ruling or determination 
letter classifying the organization as an organization described in 
section 509(a) (1), (2), or (3), or
    (ii) Was in part responsible for, or was aware of, the act, the 
failure to act, or the substantial and material change on the part of 
the organization which gave rise to the revocation of the ruling or 
determination letter classifying the organization as an organization 
described in section 509(a) (1), (2), or (3).

[[Page 175]]

    (2) Paragraph (a) of this section shall not apply where a different 
rule is otherwise expressly provided in the regulations under sections 
170(b)(1)(A), 507(b)(1)(B), or 509.

[T.D. 7212, 37 FR 21923, Oct. 17, 1972]



Sec.  1.509(b)-1  Continuation of private foundation status.

    (a) In general. If an organization is a private foundation (within 
the meaning of section 509(a)) on October 9, 1969, or becomes a private 
foundation on any subsequent date, such organization shall be treated as 
a private foundation for all periods after October 9, 1969, or after 
such subsequent date, unless its status as such is terminated under 
section 507. Therefore, if an organization was described in section 
501(c)(3) and was a private foundation within the meaning of section 
509(a) on October 9, 1969, it shall be treated as a private foundation 
for all periods thereafter, even though it may also satisfy the 
requirements of an organization described in some other paragraph of 
section 501(c). For example, if on October 9, 1969, an organization was 
described in section 501(c)(3), but because of its activities, it could 
also have qualified as an organization described in section 501(c)(4), 
such organization will continue to be treated as a private foundation, 
if it was a private foundation within the meaning of section 509(a) on 
October 9, 1969.
    (b) Taxable private foundations. If an organization is a private 
foundation on October 9, 1969, and it is determined that it is not 
exempt under section 501(a) as an organization described in section 
501(c)(3) as of any date after October 9, 1969, such organization, even 
though it may operate thereafter as a taxable entity, will continue to 
be treated as a private foundation unless its status as such is 
terminated under section 507. For example, X organization is a private 
foundation on October 9, 1969. It is subsequently determined that, as of 
July 1, 1972, X is no longer exempt under section 501(a) as an 
organization described in section 501(c)(3) because, for example, it has 
not conformed its governing instrument pursuant to section 508(e). X 
will continue to be treated as a private foundation after July 1, 1972, 
unless its status as such is terminated under section 507. However, if 
an organization is not exempt under section 501(a) as an organization 
described in section 501(c)(3) on October 9, 1969, then it will not be 
treated as a private foundation within the meaning of section 509(a) by 
reason of section 509(b), unless it becomes a private foundation on a 
subsequent date.

[T.D. 7212, 37 FR 21924, Oct. 17, 1972]



Sec.  1.509(c)-1  Status of organization after termination of private
foundation status.

    (a) In general. For purposes of part II of subchapter F of this 
chapter, an organization whose status as a private foundation is 
terminated under section 507 shall be treated as an organization created 
on the day after the date of such termination. An organization whose 
private foundation status has been terminated under the provisions of 
section 507(a) will, if it continues to operate, be treated as a new 
organization and must, if it desires to be classified under section 
501(c)(3), give notification that it is applying for recognition of 
section 501(c)(3) status pursuant to the provisions of section 508(a).
    (b) Effect upon section 507(d)(1). If the private foundation status 
of an organization has been terminated under section 507(b)(1)(B) and 
the regulations thereunder, and:
    (1) Such organization does not continue at all times thereafter to 
meet the requirements of section 509(a) (1), (2), or (3) (and is 
therefore no longer excluded from the definition of a private 
foundation); and
    (2) The status of such organization as a private foundation is 
thereafter terminated under section 507(a)


then the tax imposed under section 507(c)(1) upon the aggregate tax 
benefit (described in section 507(d)(1)) resulting from section 
501(c)(3) status shall be computed only upon the aggregate tax benefit 
resulting after the date on which the organization again becomes a 
private foundation under subparagraph (1) of this paragraph.

[T.D. 7212, 37 FR 21924, Oct. 17, 1972]



Sec.  1.509(d)-1  Definition of support

    For purposes of section 509(a)(2), the term support does not include 
amounts

[[Page 176]]

received in repayment of the principal of a loan or other indebtedness. 
See, however, section 509(e) as to amounts received as interest on a 
loan or other indebtedness.

[T.D. 7212, 37 FR 21924, Oct. 17, 1972]



Sec.  1.509(e)-1  Definition of gross investment income.

    For the distinction between gross receipts and gross investment 
income, see Sec.  1.509(a)-3(m).

(Sec. 7805, Internal Revenue Code of 1954, 68A Stat. 917; 26 U.S.C. 
7805)

[T.D. 7212, 37 FR 21925, Oct. 17, 1972]

       Taxation of Business Income of Certain Exempt Organizations



Sec.  1.511-1  Imposition and rates of tax.

    Section 511(a) imposes a tax upon the unrelated business taxable 
income of certain organizations otherwise exempt from Federal income 
tax. Under section 511(a)(1), organizations described in section 
511(a)(2)(A) and in paragraph (a) of Sec.  1.511-2 and organizations 
described in section 511(a)(2)(B) are subject to normal tax and surtax 
at the corporate rates provided by section 11. Under section 511(b)(1), 
trusts described in section 511(b)(2) are subject to tax at the 
individual rates prescribed in section 1(d) of the Code as amended by 
the Tax Reform Act of 1969 (section 1 for taxable years ending before 
Jan. 1, 1971). The deduction for personal exemption provided in section 
642(b) in the case of a trust taxable under subchapter J, chapter 1 of 
the Code, is not allowed in computing unrelated business taxable income.

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



Sec.  1.511-2  Organizations subject to tax.

    (a) Organizations other than trusts and title holding companies. 
(1)(i) The taxes imposed by section 511(a)(1) apply in the case of any 
organization (other than a trust described in section 511(b)(2) or an 
organization described in section 501(c)(1)) which is exempt from 
taxation under section 501(a) (except as provided in sections 507 
through 515). For special rules concerning corporations described in 
section 501(c)(2), see paragraph (c) of this section.
    (ii) In the case of an organization described in section 501(c)(4), 
(7), (8), (9), (10), (11), (12), (13), (14)(A), (15), (16), or (18), the 
taxes imposed by section 511(a)(1) apply only for taxable years 
beginning after December 31, 1969. In the case of an organization 
described in section 501(c)(14) (B) or (C), the taxes imposed by section 
511(a)(1) apply only for taxable years beginning after February 2, 1966.
    (2) The taxes imposed by section 511(a) apply in the case of any 
college or university which is an agency or instrumentality of any 
government or any political subdivision thereof, or which is owned or 
operated by a government or any political subdivision thereof or by any 
agency or instrumentality of any one or more governments or political 
subdivisions. Such taxes also apply in the case of any corporation 
wholly owned by one or more such colleges or universities. As here used, 
the word government includes any foreign government (to the extent not 
contrary to any treaty obligation of the United States) and all domestic 
governments (the United States and any of its Territories or 
possessions, any State, and the District of Columbia). Elementary and 
secondary schools operated by such governments are not subject to the 
tax on unrelated business income.
    (3)(i) For taxable years beginning before January 1, 1970, churches 
and associations or conventions of churches are exempt from the taxes 
imposed by section 511. The exemption is applicable only to an 
organization which itself is a church or an association or convention of 
churches. Subject to the provisions of subdivision (ii) of this 
subparagraph, religious organizations, including religious orders, if 
not themselves churches or associations or conventions of churches, and 
all other organizations which are organized or operated under church 
auspices, are subject to the tax imposed by section 511, whether or not 
they engage in religious, educational, or charitable activities approved 
by a church.
    (ii) The term church includes a religious order or a religious 
organization if such order or organization (a) is an integral part of a 
church, and (b) is engaged in carrying out the functions of

[[Page 177]]

a church, whether as a civil law corporation or otherwise. In 
determining whether a religious order or organization is an integral 
part of a church, consideration will be given to the degree to which it 
is connected with, and controlled by, such church. A religious order or 
organization shall be considered to be engaged in carrying out the 
functions of a church if its duties include the ministration of 
sacerdotal functions and the conduct of religious worship. If a 
religious order or organization is not an integral part of a church, or 
if such an order or organization is not authorized to carry out the 
functions of a church (ministration of sacerdotal functions and conduct 
of religious worship) then it is subject to the tax imposed by section 
511 whether or not it engages in religious, educational, or charitable 
activities approved by a church. What constitutes the conduct of 
religious worship or the ministration of sacerdotal functions depends on 
the tenets and practices of a particular religious body constituting a 
church. If a religious order or organization can fully meet the 
requirements stated in this subdivision, exemption from the tax imposed 
by section 511 will apply to all its activities, including those which 
it conducts through a separate corporation (other than a corporation 
described in section 501(c)(2)) or other separate entity which it wholly 
owns and which is not operated for the primary purpose of carrying on a 
trade or business for profit. Such exemption from tax will also apply to 
activities conducted through a separate corporation (other than a 
corporation described in section 501(c)(2)) or other separate entity 
which is wholly owned by more than one religious order or organization, 
if all such orders or organizations fully meet the requirements stated 
in this subdivision and if such corporation or other entity is not 
operated for the primary purpose of carrying on a trade or business for 
profit.
    (iii) For taxable years beginning after December 31, 1969, churches 
and conventions or associations of churches are subject to the taxes 
imposed by section 511, unless otherwise entitled to the benefit of the 
transitional rules of section 512(b)(14) and Sec.  1.512(b)-1(i).
    (b) Trusts--(1) In general. The taxes imposed by section 511(b) 
apply in the case of any trust which is exempt from taxation under 
section 501(a) (except as provided in sections 507 through 515), and 
which, if it were not for such exemption, would be subject to the 
provisions of subchapter J, chapter 1, of the Code. An organization 
which is considered as trustee of a stock bonus, pension, or profit-
sharing plan described in section 401(a), a supplemental unemployment 
benefit trust described in section 501(c)(17), or a pension plan 
described in section 501(c)(18) (regardless of the form of such 
organization) is subject to the taxes imposed by section 511(b)(1) on 
its unrelated business income. However, if such an organization conducts 
a business which is a separate taxable entity on the basis of all the 
facts and circumstances, for example, an association taxable as a 
corporation, the business will be taxable as a feeder organization 
described in section 502.
    (2) Effective dates. In the case of a trust described in section 
501(c)(3), the taxes imposed by section 511(b) apply for taxable years 
beginning after December 31, 1953. In the case of a trust described in 
section 401(a), the taxes imposed by section 511(b) apply for taxable 
years beginning after June 30, 1954. In the case of a trust described in 
section 501(c)(17), the taxes imposed by section 511(b) apply for 
taxable years beginning after December 31, 1959. In the case of any 
other trust described in subparagraph (1) of this paragraph, the taxes 
imposed by section 511(b) apply for taxable years beginning after 
December 31, 1969.
    (c) Title Holding Companies--(1) In general. If a corporation 
described in section 501(c)(2) pays any amount of its net income for a 
taxable year to an organization exempt from taxation under section 
501(a) (or would pay such an amount but for the fact that the expenses 
of collecting its income exceed its income), and if such corporation and 
such organization file a consolidated income tax return for such taxable 
year, then such corporation shall be treated, for purposes of the tax 
imposed by section 511(a), as being organized and operated for the same 
purposes as such organization, as well as

[[Page 178]]

for its title-holding purpose. Therefore, if an item of income of the 
section 501(c)(2) corporation is derived from a source which is related 
to the exempt function of the exempt organization to which such income 
is payable and with which such corporation files a consolidated return, 
such item is, together with all deductions directly connected therewith, 
excluded from the determination of unrelated business taxable income 
under section 512 and shall not be subject to the tax imposed by section 
511(a). If, however, such item of income is derived from a source which 
is not so related, then such item, less all deductions directly 
connected therewith, is, subject to the modifications provided in 
section 512(b), unrelated business taxable income subject to the tax 
imposed by section 511(a).
    (2) The provisions of subparagraph (1) of this paragraph may be 
illustrated by the following example:

    Example. The income of X, a section 501(c)(2) corporation, is 
required to be distributed to exempt organization A. During the taxable 
year X realizes net income of $900,000 from source M and $100,000 from 
source N. Source M is related to A's exempt function, while source N is 
not so related. X and A file a consolidated return for such taxable 
year. X has net unrelated business income of $100,000, subject to the 
modifications in section 512(b).

    (3) Cross reference. For rules relating generally to the filing of 
consolidated returns by certain organizations exempt from taxation under 
section 501(a), see section 1504(e) of the Code and Sec.  1.1502-100.
    (4) Effective dates. Subparagraphs (1) through (3) of this paragraph 
apply with respect to taxable years beginning after December 31, 1969. 
For taxable years beginning before January 1, 1970, a corporation 
described in section 501(c)(2) and otherwise exempt from taxation under 
section 501(a) is taxable upon its unrelated business taxable income 
only if such income is payable either:
    (i) To a church or convention or association of churches, or
    (ii) To any organization subject, for taxable years beginning before 
January 1, 1970, to the tax imposed by section 511(a)(1).
    (d) The fact that any class of organizations exempt from taxation 
under section 501(a) is subject to the unrelated business income tax 
under section 511 and this section does not in any way enlarge the 
permissible scope of business activities of such class for purposes of 
the continued qualification of such class under section 501(a).
    (e) ABLE programs--(1) Unrelated business taxable income. A 
qualified ABLE program described in section 529A and Sec.  1.529A-
1(b)(14) generally is exempt from Federal income taxation, but is 
subject to taxes imposed by section 511 relating to the imposition of 
tax on unrelated business income. A qualified ABLE program is required 
to file Form 990-T, ``Exempt Organization Business Income Tax Return,'' 
if such filing would be required under the rules of Sec. Sec.  1.6012-
2(e) and 1.6012-3(a)(5) if the ABLE program were an organization 
described in those sections.
    (2) Applicability date. This paragraph (e) applies to taxable years 
beginning after December 31, 2020.

[T.D. 6500, 25 FR 11737, Nov. 26, 1960, as amended by T.D. 7183, 37 FR 
7884, Apr. 21, 1972; T.D. 7632, 44 FR 42681, July 20, 1979; T.D. 9923, 
85 FR 74034, Nov. 19, 2020]



Sec.  1.511-3  Provisions generally applicable to the tax on unrelated
business income.

    (a) Assessment and collections. Since the taxes imposed by section 
511 are taxes imposed by subtitle A of the Code, all provisions of law 
and of the regulations applicable to the taxes imposed by subtitle A are 
applicable to the assessment and collection of the taxes imposed by 
section 511. Organizations subject to the tax imposed by section 
511(a)(1) are subject to the same provisions, including penalties, as 
are provided in the case of the income tax of other corporations. In the 
case of a trust subject to the tax imposed by section 511(b)(1), the 
fiduciaries for such trust are subject to the same provisions, including 
penalties, as are applicable to fiduciaries in the case of the income 
tax of other trusts. See section 6151, et seq., and the regulations 
prescribed thereunder, for provisions relating to payment of tax.

[[Page 179]]

    (b) Returns. For requirements of filing annual returns with respect 
to unrelated business taxable income by organizations subject to the tax 
on such income, see section 6012, paragraph (e) of Sec.  1.6012-2, and 
paragraph (a)(5) of Sec.  1.6012-3.
    (c) Taxable years, method of accounting, etc. The taxable year 
(fiscal year or calendar year, as the case may be) of an organization 
shall be determined without regard to the fact that such organization 
may have been exempt from tax during any prior period. See sections 441 
and 446, and the regulations thereunder in this part, and section 7701 
and the regulations in part 301 of this chapter (Regulations on 
Procedure and Administration). Similarly, in computing unrelated 
business taxable income, the determination of the taxable year for which 
an item of income or expense is taken into account shall be made under 
the provisions of sections 441, 446, 451, and 461, and the regulations 
thereunder, whether or not the item arose during a taxable year 
beginning before, on, or after the effective date of the provisions 
imposing a tax upon unrelated business taxable income. If a method for 
treating bad debts was selected in a return of income (other than an 
information return) for a previous taxable year, the taxpayer must 
follow such method in its returns under section 511, unless such method 
is changed in accordance with the provisions of Sec.  1.166-1. A 
taxpayer which has not previously selected a method for treating bad 
debts may, in its first return under section 511, exercise the option 
granted in Sec.  1.166-1.
    (d) Foreign tax credit. See section 515 for provisions applicable to 
the credit for foreign taxes provided in section 901.



Sec.  1.511-4  Minimum tax for tax preferences.

    The tax imposed by section 56 applies to an organization subject to 
tax under section 511 with respect to items of tax preference which 
enter into the computation of unrelated business taxable income. For 
this purpose, only those items of income and those deductions entering 
into the determination of the tax imposed by this section are considered 
in the determination of the items of tax preference under section 57. 
For rules relating to the minimum tax for tax preferences, see sections 
56 through 58 and the regulations thereunder.

[T.D. 7564, 43 FR 40494, Sept. 12, 1978]



Sec.  1.512(a)-1  Definition.

    (a) In general. Except as otherwise provided in Sec.  1.512(a)-3, 
Sec.  1.512(a)-4, or paragraph (f) of this section, section 512(a)(1) 
defines unrelated business taxable income as the gross income derived 
from any unrelated trade or business regularly carried on, less those 
deductions allowed by chapter 1 of the Internal Revenue Code (Code) 
which are directly connected with the carrying on of such trade or 
business, subject to certain modifications referred to in Sec.  
1.512(b)-1. To be deductible in computing unrelated business taxable 
income, therefore, expenses, depreciation, and similar items not only 
must qualify as deductions allowed by chapter 1 of the Code, but also 
must be directly connected with the carrying on of unrelated trade or 
business. Except as provided in paragraph (d)(2) of this section, to be 
directly connected with the conduct of unrelated business for purposes 
of section 512, an item of deduction must have proximate and primary 
relationship to the carrying on of that business. In the case of an 
organization with more than one unrelated trade or business, unrelated 
business taxable income is calculated separately with respect to each 
such trade or business. See Sec.  1.512(a)-6. For the treatment of 
amounts of income or loss of common trust funds, see Sec.  1.584-
2(c)(3).
    (b) Expenses attributable solely to unrelated business activities. 
Expenses, depreciation, and similar items attributable solely to the 
conduct of unrelated business activities are proximately and primarily 
related to that business activity, and therefore qualify for deduction 
to the extent that they meet the requirements of section 162, section 
167, or other relevant provisions of the Code. Thus, for example, 
salaries of personnel employed full-time in carrying on unrelated 
business activities are directly connected with the conduct of that 
activity and are deductible in computing unrelated business taxable 
income if they otherwise qualify

[[Page 180]]

for deduction under the requirements of section 162.
    (c) Dual use of facilities or personnel. Where facilities are used 
both to carry on exempt activities and to conduct unrelated trade or 
business activities, expenses, depreciation and similar items 
attributable to such facilities (as, for example, items of overhead), 
shall be allocated between the two uses on a reasonable basis. 
Similarly, where personnel are used both to carry on exempt activities 
and to conduct unrelated trade or business activities, expenses and 
similar items attributable to such personnel (as, for example, items of 
salary) shall be allocated between the two uses on a reasonable basis. 
The portion of any such item so allocated to the unrelated trade or 
business activity is proximately and primarily related to that business 
activity, and shall be allowable as a deduction in computing unrelated 
business taxable income in the manner and to the extent permitted by 
section 162, section 167, or other relevant provisions of the Code. 
Thus, for example, assume that X, an exempt organization subject to the 
provisions of section 511, pays its president a salary of $20,000 a 
year. X derives gross income from the conduct of unrelated trade or 
business activities. The president devotes approximately 10 percent of 
his time during the year to the unrelated business activity. For 
purposes of computing X's unrelated business taxable income, a deduction 
of $2,000 (10 percent of $20,000), would be allowable for the salary 
paid to its president. However, allocation of expenses, depreciation, 
and similar items is not reasonable if the cost of providing a good or 
service in a related and an unrelated activity is substantially the 
same, but the price charged for that good or service in the unrelated 
activity is greater than the price charged in the related activity and 
no adjustment is made to equalize the price difference for purposes of 
allocating expenses, depreciation, and similar items based on revenue 
between related and unrelated activities. For example, if a social club 
described in section 501(c)(7) charges nonmembers a higher price than it 
charges members for the same good or service but does not adjust the 
price of the good or service provided to members for purposes of 
allocating expenses, depreciation, and similar items attributable to the 
provision of that good or service, the allocation method is not 
reasonable.
    (d) Exploitation of exempt activities--(1) In general. In certain 
cases, gross income is derived from an unrelated trade or business 
activity which exploits an exempt activity. One example of such 
exploitation is the sale of advertising in a periodical of an exempt 
organization which contains editorial material related to the 
accomplishment of the organization's exempt purpose. Except as specified 
in subparagraph (2) of this paragraph and paragraph (f) of this section, 
in such cases, expenses, depreciation and similar items attributable to 
the conduct of the exempt activities are not deductible in computing 
unrelated business taxable income. Since such items are incident to an 
activity which is carried on in furtherance of the exempt purpose of the 
organization, they do not possess the necessary proximate and primary 
relationship to the unrelated trade or business activity and are 
therefore not directly connected with that business activity.
    (2) Allowable deductions. Where an unrelated trade or business 
activity is of a kind carried on for profit by taxable organizations and 
where the exempt activity exploited by the business is a type of 
activity normally conducted by taxable organizations in pursuance of 
such business, expenses, depreciation, and similar items which are 
attributable to the exempt activity qualify as directly connected with 
the carrying on of the unrelated trade or business activity to the 
extent that:
    (i) The aggregate of such items exceeds the income (if any) derived 
from or attributable to the exempt activity; and
    (ii) The allocation of such excess to the unrelated trade or 
business activity does not result in a loss from such unrelated trade or 
business activity


Under the rule of the preceding sentence, expenses, depreciation and 
similar items paid or incurred in the performance of an exempt activity 
must be allocated first to the exempt activity to the extent of the 
income derived

[[Page 181]]

from or attributable to the performance of that activity. Furthermore, 
such items are in no event allocable to the unrelated trade or business 
activity exploiting such exempt activity to the extent that their 
deduction would result in a loss carryover or carryback with respect to 
that trade or business activity. Similarly, they may not be taken into 
account in computing unrelated business taxable income attributable to 
any unrelated trade or business activity not exploiting the same exempt 
activity. See paragraph (f) of this section for the application of these 
rules to periodicals published by exempt organizations.
    (e) Examples. This section is illustrated by the following examples:

    Example 1. W is an exempt business league with a large membership. 
Under an arrangement with an advertising agency W regularly mails 
brochures, pamphlets and other advertising materials to its members, 
charging the agency an agreed amount per enclosure. The distribution of 
the advertising materials does not contribute importantly to the 
accomplishment of the purpose for which W is granted exemption. 
Accordingly, the payments made to W by the advertising agency constitute 
gross income from an unrelated trade or business activity. In computing 
W's unrelated business taxable income, the expenses attributable solely 
to the conduct of the business, or allocable to such business under the 
rule of paragraph (c) of this section, are allowable as deductions in 
accordance with the provisions of section 162. Such deductions include 
the costs of handling and mailing, the salaries of personnel used full-
time in the unrelated business activity and an allocable portion of the 
salaries of personnel used both to carry on exempt activities and to 
conduct the unrelated business activity. However, costs of developing 
W's membership and carrying on its exempt activities are not deductible. 
Those costs are necessary to the maintenance of the intangible asset 
exploited in the unrelated business activity--W's membership--but are 
incurred primarily in connection with W's fundamental purpose as an 
exempt organization. As a consequence, they do not have proximate and 
primary relationship to the conduct of the unrelated business activity 
and do not qualify as directly connected with it.
    Example 2. (i) P, a manufacturer of photographic equipment, 
underwrites a photography exhibition organized by M, an art museum 
described in section 501(c)(3). In return for a payment of $100,000, M 
agrees that the exhibition catalog sold by M in connection with the 
exhibit will advertise P's product. The exhibition catalog will also 
include educational material, such as copies of photographs included in 
the exhibition, interviews with photographers, and an essay by the 
curator of M's department of photography. For purposes of this example, 
assume that none of the $100,000 is a qualified sponsorship payment 
within the meaning of section 513(i) and Sec.  1.513-4, that M's 
advertising activity is regularly carried on, and that the entire amount 
of the payment is unrelated business taxable income to M. Expenses 
directly connected with generating the unrelated business taxable income 
(i.e., direct advertising costs) total $25,000. Expenses directly 
connected with the preparation and publication of the exhibition catalog 
(other than direct advertising costs) total $110,000. M receives $60,000 
of gross revenue from sales of the exhibition catalog. Expenses directly 
connected with the conduct of the exhibition total $500,000.
    (ii) The computation of unrelated business taxable income is as 
follows:

(A) Unrelated trade or business (sale of
 advertising):
    Income.......................................   $100,000   .........
    Directly-connected expenses..................    (25,000)  .........
                                                  ----------------------
      Subtotal...................................     75,000    $75,000
                                                  ======================
(B) Exempt function (publication of exhibition
 catalog):
    Income (from catalog sales)..................     60,000   .........
    Directly-connected expenses..................   (110,000)  .........
                                                  ----------------------
      Net exempt function income (loss)..........    (50,000)   (50,000)
                                                  ======================
      Unrelated business taxable income..........  ..........    25,000
 

    (iii) Expenses related to publication of the exhibition catalog 
exceed revenues by $50,000. Because the unrelated business activity (the 
sale of advertising) exploits an exempt activity (the publication of the 
exhibition catalog), and because the publication of editorial material 
is an activity normally conducted by taxable entities that sell 
advertising, the net loss from the exempt publication activity is 
allowed as a deduction from unrelated business income under paragraph 
(d)(2) of this section. In contrast, the presentation of an exhibition 
is not an activity normally conducted by taxable entities engaged in 
advertising and publication activity for purposes of paragraph (d)(2) of 
this section. Consequently, the $500,000 cost of presenting the 
exhibition is not directly connected with the conduct of the unrelated 
advertising activity and does not have a proximate and primary 
relationship to that activity. Accordingly, M has unrelated business 
taxable income of $25,000.


[[Page 182]]


    (f) Determination of unrelated business taxable income derived from 
sale of advertising in exempt organization periodicals--(1) In general. 
Under section 513 (relating to the definition of unrelated trade or 
business) and Sec.  1.513-1, amounts realized by an exempt organization 
from the sale of advertising in a periodical constitute gross income 
from an unrelated trade or business activity involving the exploitation 
of an exempt activity; namely, the circulation and readership of the 
periodical developed through the production and distribution of the 
readership content of the periodical. Paragraph (d) of this section 
provides for the allowance of deductions attributable to the production 
and distribution of the readership content of the periodical. Thus, 
subject to the limitations of paragraph (d)(2) of this section, where 
the circulation and readership of an exempt organization periodical are 
utilized in connection with the sale of advertising in the periodical, 
expenses, depreciation, and similar items of deductions attributable to 
the production and distribution of the editorial or readership content 
of the periodical shall qualify as items of deductions directly 
connected with the unrelated advertising activity. Subparagraphs (2) 
through (6) of this paragraph provide rules for determining the amount 
of unrelated business taxable income attributable to the sale of 
advertising in exempt organization periodicals. Subparagraph (7) of this 
paragraph provides rules for determining when the unrelated business 
taxable income of two or more exempt organization periodicals may be 
determined on a consolidated basis.
    (2) Computation of unrelated business taxable income attributable to 
sale of advertising--(i) Excess advertising costs. If the direct 
advertising costs of an exempt organization periodical (determined under 
subparagraph (6)(ii) of this paragraph) exceed gross advertising income 
(determined under subparagraph (3)(ii) of this paragraph), such excess 
shall be allowable as a deduction in determining unrelated business 
taxable income from any unrelated trade or business activity carried on 
by the organization.
    (ii) Excess advertising income. If the gross advertising income of 
an exempt organization periodical exceeds direct advertising costs, 
paragraph (d)(2) of this section provides that items of deduction 
attributable to the production and distribution of the readership 
content of an exempt organization periodical shall qualify as items of 
deduction directly connected with unrelated advertising activity in 
computing the amount of unrelated business taxable income derived from 
the advertising activity to the extent that such items exceed the income 
derived from or attributable to such production and distribution, but 
only to the extent that such items do not result in a loss from such 
advertising activity. Furthermore, such items of deduction shall not 
qualify as directly connected with such advertising activity to the 
extent that their deduction would result in a loss carryback or 
carryover with respect to such advertising activity. Similarly, such 
items of deduction shall not be taken into account in computing 
unrelated business taxable income attributable to any unrelated trade or 
business activity other than such advertising activity. Thus:
    (a) If the circulation income of the periodical (determined under 
subparagraph (3)(iii) of this paragraph) equals or exceeds the 
readership costs of such periodical (determined under subparagraph 
(6)(iii) of this paragraph), the unrelated business taxable income 
attributable to the periodical is the excess of the gross advertising 
income of the periodical over direct advertising costs; but
    (b) If the readership costs of an exempt organization periodical 
exceed the circulation income of the periodical, the unrelated business 
taxable income is the excess, if any, of the total income attributable 
to the periodical (determined under subparagraph (3) of this paragraph) 
over the total periodical costs (as defined in subparagraph (6)(i) of 
this paragraph)


See subparagraph (7) of this paragraph for rules relating to the 
consolidation of two or more periodicals.
    (iii) Examples. The application of this paragraph may be illustrated 
by the following examples. For purposes of these examples it is assumed 
that the production and distribution of the readership content of the 
periodical is

[[Page 183]]

related to the organization's exempt purpose.

    Example 1. X, an exempt trade association, publishes a single 
periodical which carries advertising. During 1971, X realizes a total of 
$40,000 from the sale of advertising in the periodical (gross 
advertising income) and $60,000 from the sales of the periodical to 
members and nonmembers (circulation income). The total periodical costs 
are $90,000 of which $50,000 is directly connected with the sale and 
publication of advertising (direct advertising costs) and $40,000 is 
attributable to the production and distribution of the readership 
content (readership costs). Since the direct advertising costs of the 
periodical ($50,000) exceed gross advertising income ($40,000), pursuant 
to subdivision (i) of this subparagraph, the unrelated business taxable 
income attributable to advertising is determined solely on the basis of 
the income and deductions directly connected with the production and 
sale of the advertising:

Gross advertising revenue..................................      $40,000
Direct advertising costs...................................     (50,000)
                                                            ------------
Loss attributable to advertising...........................     (10,000)
                                                            ============
 


X has realized a loss of $10,000 from its advertising activity. This 
loss is an allowable deduction in computing X's unrelated business 
taxable income derived from any other unrelated trade or business 
activity.
    Example 2. Assume the facts as stated in example 1, except that the 
circulation income of X periodical is $100,000 instead of $60,000, and 
that of the total periodical costs, $25,000 are direct advertising 
costs, and $65,000 are readership costs. Since the circulation income 
($100,000) exceeds the total readership costs ($65,000), pursuant to 
subdivision (ii)(a) of this subparagraph the unrelated business taxable 
income attributable to the advertising activity is $15,000, the excess 
of gross advertising income ($40,000) over direct advertising costs 
($25,000).
    Example 3. Assume the facts as stated in example 1, except that of 
the total periodical costs, $20,000 are direct advertising costs and 
$70,000 are readership costs. Since the readership costs of the 
periodical ($70,000), exceed the circulation income ($60,000), pursuant 
to subdivision (ii) (b) of this subparagraph the unrelated business 
taxable income attributable to advertising is the excess of the total 
income attributable to the periodical over the total periodical costs. 
Thus, X has unrelated business taxable income attributable to the 
advertising activity of $10,000 ($100,000 total income attributable to 
the periodical less $90,000 total periodical costs).
    Example 4. Assume the facts as stated in example 1, except that the 
total periodical costs are $120,000 of which $30,000 are direct 
advertising costs and $90,000 are readership costs. Since the readership 
costs of the periodical ($90,000), exceed the circulation income 
($60,000), pursuant to subdivision (ii) (b) of this subparagraph the 
unrelated business taxable income attributable to advertising is the 
excess, if any, of the total income attributable to the periodical over 
the total periodical costs. Since the total income of the periodical 
($100,000) does not exceed the total periodical costs ($120,000), X has 
not derived any unrelated business taxable income from the advertising 
activity. Further, only $70,000 of the $90,000 of readership costs may 
be deducted in computing unrelated business taxable income since as 
provided in subdivision (ii) of this subparagraph, such costs may be 
deducted, to the extent they exceed circulation income, only to the 
extent they do not result in a loss from the advertising activity. Thus, 
there is no loss from such activity, and no amount may be deducted on 
this account in computing X's unrelated trade or business income derived 
from any other unrelated trade or business activity.

    (3) Income attributable to exempt organization periodicals--(i) In 
general. For purposes of this paragraph the total income attributable to 
an exempt organization periodical is the sum of its gross advertising 
income and its circulation income.
    (ii) Gross advertising income. The term gross advertising income 
means all amounts derived from the unrelated advertising activities of 
an exempt organization periodical (or for purposes of this paragraph in 
the case of a taxable organization, all amounts derived from the 
advertising activities of the taxable organization).
    (iii) Circulation income. The term circulation income means the 
income attributable to the production, distribution or circulation of a 
periodical (other than gross advertising income) including all amounts 
realized from or attributable to the sale or distribution of the 
readership content of the periodical, such as amounts realized from 
charges made for reprinting or republishing articles and special items 
in the periodical and amounts realized from sales of back issues. Where 
the right to receive an exempt organization periodical is associated 
with membership or similar status in such organization for which dues, 
fees or other charges are received (hereinafter referred to as 
membership receipts), circulation income includes the portion of such 
membership receipts allocable to the periodical (hereinafter referred to 
as allocable

[[Page 184]]

membership receipts). Allocable membership receipts is the amount which 
would have been charged and paid if:
    (a) The periodical was that of a taxable organization.
    (b) The periodical was published for profit, and
    (c) The member was an unrelated party dealing with the taxable 
organization at arm's length


See subparagraph (4) of this paragraph for a discussion of the factors 
to be considered in determining allocable membership receipts of an 
exempt organization periodical under the standard described in the 
preceding sentence.
    (4) Allocable membership receipts. The allocable membership receipts 
of an exempt organization periodical shall be determined in accordance 
with the following rules:
    (i) Subscription price charged to nonmembers. If 20 percent or more 
of the total circulation of a periodical consist of sales to nonmembers, 
the subscription price charged to such nonmembers shall determine the 
price of the periodical for purposes of allocating membership receipts 
to the periodical.
    (ii) Subscription price to nonmembers. If paragraph (f)(4)(i) of 
this section does not apply and if the membership dues from 20 percent 
or more of the members of an exempt organization are less than those 
received from the other members because the former members do not 
receive the periodical, the amount of the reduction in membership dues 
for a member not receiving the periodical shall determine the price of 
the periodical for purposes of allocating membership receipts to the 
periodical.
    (iii) Pro rata allocation of membership receipts. Since it may 
generally be assumed that membership receipts and gross advertising 
income are equally available for all the exempt activities (including 
the periodical) of the organization, the share of membership receipts 
allocated to the periodical, where paragraphs (f)(4) (i) and (ii) of 
this section do not apply, shall be an amount equal to the 
organization's membership receipts multiplied by a fraction the 
numerator of which is the total periodical costs and the denominator of 
which is such costs plus the cost of other exempt activities of the 
organization. For example, assume that an exempt organization has total 
periodical costs of $30,000 and other exempt costs of $70,000. Further 
assume that the membership receipts of the organization are $60,000 and 
that paragraphs (f)(4) (i) and (ii) of this section do not apply. Under 
these circumstances $18,000 ($60,000 times $30,000/$100,000) is 
allocated to the periodical's circulation income.
    (5) Examples. The rules set forth in paragraph (f)(4) of this 
section may be illustrated by the following examples. For purposes of 
these examples it is assumed that the exempt organization periodical 
contains advertising, and that the production and distribution of the 
readership content of the periodical is related to the organization's 
exempt purpose.

    Example 1. U is an exempt scientific organization with 10,000 
members who pay annual dues of $15 per year. One of U's activities is 
the publication of a monthly periodical which is distributed to all of 
its members. U also distributes 5,000 additional copies of its 
periodical to nonmember subscribers at a cost of $10 per year. Pursuant 
to paragraph (f)(4)(i) of this section, since the nonmember circulation 
of U's periodical represents 33\1/3\ percent of its total circulation 
the subscription price charged to nonmembers will be used to determine 
the portion of U's membership receipts allocable to the periodical. 
Thus, U's allocable membership receipts will be $100,000 ($10 times 
10,000 members), and U's total circulation income for the periodical 
will be $150,000 ($100,000 from members plus $50,000 from sales to 
nonmembers).
    Example 2. Assume the facts as stated in example 1, except that U 
sells only 500 copies of its periodical to nonmembers, at a price of $10 
per year. Assume further that U's members may elect not to receive the 
periodical, in which case their annual dues are reduced from $15 per 
year to $6 per year, and that only 3,000 members elect to receive the 
periodical and pay the full dues of $15 per year. U's stated 
subscription price to members of $9 consistently results in an excess of 
total income (including gross advertising income) attributable to the 
periodical over total costs of the periodical. Since the 500 copies of 
the periodical distributed to nonmembers represents only 14 percent of 
the 3,500 copies distributed, pursuant to paragraph (f)(4)(i) of this 
section, the $10 subscription price charged to nonmembers will not be 
used in determining the portion of membership receipts allocable to the 
periodical. On the other hand, since 70 percent of the members

[[Page 185]]

elect not to receive the periodical and pay $9 less per year in dues, 
pursuant to paragraph (f)(4)(ii) of this section, such $9 price will be 
used in determining the subscription price charged to members. Thus, the 
allocable membership receipts will be $9 per member, or $27,000 ($9 
times 3,000 copies) and U's total circulation income will be $32,000 
($27,000 plus $5,000).
    Example 3. (a) W, an exempt trade association, has 800 members who 
pay annual dues of $50 per year. W publishes a monthly journal the 
editorial content and advertising of which are directed to the business 
interests of its own members. The journal is distributed to all of W's 
members and no receipts are derived from nonmembers.
    (b) W has total receipts of $100,000 of which $40,000 ($50 x 800) 
are membership receipts and $60,000 are gross advertising income. W's 
total costs for the journal and other exempt activities is $100,000. W 
has total periodical costs of $76,000 of which $41,000 are direct 
advertising costs and $35,000 are readership costs.
    (c) Paragraph (f)(4)(i) of this section will not apply since no 
copies are available to nonmembers. Therefore, the allocation of 
membership receipts shall be made in accordance with paragraph 
(f)(4)(iii) of this section. Based upon pro rata allocation of 
membership receipts (40,000) by a fraction the numerator of which is 
total periodical costs ($76,000) and the denominator of which is the 
total costs of the journal and the other exempt activities ($100,000), 
$30,400 ($76,000/$100,000 times $40,000) of membership receipts is 
circulation income.

    (6) Deductions attributable to exempt organization periodicals--(i) 
In general. For purposes of this paragraph the term total periodical 
costs means the total deductions attributable to the periodical. For 
purposes of this paragraph the total periodical costs of an exempt 
organization periodical are the sum of the direct advertising costs of 
the periodical (determined under subdivision (ii) of this subparagraph) 
and the readership costs of the periodical (determined under subdivision 
(iii) of this subparagraph). Items of deduction properly attributable to 
exempt activities other than the publication of an exempt organization 
periodical may not be allocated to such periodical. Where items are 
attributable both to an exempt organization periodical and to other 
activities of an exempt organization, the allocation of such items must 
be made on a reasonable basis which fairly reflects the portion of such 
item properly attributable to each such activity. The method of 
allocation will vary with the nature of the item, but once adopted, a 
reasonable method of allocation with respect to an item must be used 
consistently. Thus, for example, salaries may generally be allocated 
among various activities on the basis of the time devoted to each 
activity; occupancy costs such as rent, heat and electricity may be 
allocated on the basis of the portion of space devoted to each activity; 
and depreciation may be allocated on the basis of space occupied and the 
portion of the particular asset utilized in each activity. Allocations 
based on dollar receipts from various exempt activities will generally 
not be reasonable since such receipts are usually not an accurate 
reflection of the costs associated with activities carried on by exempt 
organizations.
    (ii) Direct advertising costs. (a) The direct advertising costs of 
an exempt organization periodical include all expenses, depreciation, 
and similar items of deduction which are directly connected with the 
sale and publication of advertising as determined in accordance with 
paragraphs (a), (b), and (c) of this section. These items are allowable 
as deductions in the computation of unrelated business income of the 
organization for the taxable year to the extent they meet the 
requirements of section 162, section 167, or other relevant provisions 
of the Code. The items allowable as deductions under this subdivision do 
not include any items of deduction attributable to the production or 
distribution of the readership content of the periodical.
    (b) The items allowable as deductions under this subdivision would 
include agency commissions and other direct selling costs, such as 
transportation and travel expenses, office salaries, promotion and 
research expenses, and direct office overhead directly connected with 
the sale of advertising lineage in the periodical. Also included would 
be other items of deduction commonly classified as advertising costs 
under standard account classification, such as art work and copy 
preparation, telephone, telegraph, postage, and similar costs directly 
connected with advertising.

[[Page 186]]

    (c) In addition to the items of deduction normally included in 
standard account classifications relating to advertising costs, it is 
also necessary to ascertain the portion of mechanical and distribution 
costs attributable to advertising lineage. For this purpose, the general 
account classifications of items includible in mechanical and 
distribution costs ordinarily employed in business-paper and consumer 
publication accounting provide a guide for the computation. Thus, the 
mechanical and distribution costs in such cases would include the 
portion of the costs and other expenses of composition, presswork, 
binding, mailing (including paper and wrappers used for mailing), and 
the bulk postage attributable to the advertising lineage of the 
publication. The portion of mechanical and distribution costs 
attributable to advertising lineage of the periodical will be determined 
on the basis of the ratio of advertising lineage to total lineage of the 
periodical, and the application of that ratio to the total mechanical 
and distribution costs of the periodical, where records are not kept in 
such a manner as to reflect more accurately the allocation of mechanical 
and distributions costs to advertising lineage of the periodical, and 
where there is no factor in the character of the periodical to indicate 
that such an allocation would be unreasonable.
    (iii) Readership costs. The readership costs of an exempt 
organization periodical include expenses, depreciation or similar items 
which are directly connected with the production and distribution of the 
readership content of the periodical and which would otherwise be 
allowable as deductions in determining unrelated business taxable income 
under section 512 and the regulations thereunder if such production and 
distribution constituted an unrelated trade or business activity. Thus, 
readership costs include all the items of deduction attributable to an 
exempt organization periodical which are not allocated to direct 
advertising costs under subdivision (ii) of this subparagraph, including 
the portion of such items attributable to the readership content of the 
periodical, as opposed to the advertising content, and the portion of 
mechanical and distribution costs which is not attributable to 
advertising lineage in the periodical.
    (7) Consolidation--(i) In general. Where an exempt organization 
subject to unrelated business income tax under section 511 publishes two 
or more periodicals for the production of income, it may treat the gross 
income from all (but not less than all) of such periodicals and the 
items of deduction directly connected with such periodicals (including 
readership costs of such periodicals), on a consolidated basis as if 
such periodicals were one periodical in determining the amount of 
unrelated business taxable income derived from the sale of advertising 
in such periodical. Such treatment must, however, be followed 
consistently and once adopted shall be binding unless the consent of the 
Commissioner is obtained as provided in sections 446(e) and Sec.  1.446-
1(e).
    (ii) Production of income. For purposes of this subparagraph, an 
exempt organization periodical is published for the production of income 
if:
    (a) The organization generally receives gross advertising income 
from the periodical equal to at least 25 percent of the readership costs 
of such periodical, and
    (b) The publication of such periodical is an activity engaged in for 
profit


For purposes of the preceding sentence, the determination whether the 
publication of a periodical is an activity engaged in for profit is to 
be made by reference to objective standards taking into account all the 
facts and circumstances involved in each case. The facts and 
circumstances must indicate that the organization carries on the 
activity with the objective that the publication of the periodical will 
result in economic profit (without regard to tax consequences), although 
not necessarily in a particular year. Thus, an exempt organization 
periodical may be treated as having been published with such an 
objective even though in a particular year its total periodical costs 
exceed its total income. Similarly, if an exempt organization begins 
publishing a new periodical, the fact that the total periodical costs 
exceed the total income for the startup years because of a lack of 
advertising sales does

[[Page 187]]

not mean that the periodical was published without an objective of 
economic profit. The organization may establish that the activity was 
carried on with such an objective. This might be established by showing, 
for example, that there is a reasonable expectation that the total 
income, by reason of an increase in advertising sales, will exceed costs 
within a reasonable time. See Sec.  1.183-2 for additional factors 
bearing on this determination.
    (iii) Example. This subparagraph may be illustrated by the following 
example:

    Example. Y, an exempt trade association, publishes three periodicals 
which it distributes to its members: a weekly newsletter, a monthly 
magazine, and quarterly journal. Both the monthly magazine and the 
quarterly journal contain advertising which accounts for gross 
advertising income equal to more than 25 percent of their respective 
readership costs. Similarly, the total income attributable to each such 
periodical has exceeded the total deductions attributable to each such 
periodical for substantially all the years they have been published. The 
newsletter carries no advertising and its annual subscription price is 
not intended to cover the cost of publication. The newsletter is a 
service of Y distributed to all of its members in an effort to keep them 
informed of changes occurring in the business world and is not engaged 
in for profit. Under these circumstances, Y may consolidate the income 
and deductions from the monthly and quarterly journals in computing its 
unrelated business taxable income, but may not consolidate the income 
and deductions attributable to the publication of the newsletter with 
the income and deductions of its other periodicals since the newsletter 
is not published for the production of income.

    (g) Foreign organizations--(1) In general. The unrelated business 
taxable income of a foreign organization exempt from taxation under 
section 501(a) consists of:
    (i) The organization's unrelated business taxable income which is 
derived from sources within the United States but which is not 
effectively connected with the conduct of a trade or business within the 
United States, plus
    (ii) The organization's unrelated business taxable income 
effectively connected with the conduct of a trade or business within the 
United States (whether or not such income is derived from sources within 
the United States)


To determine whether income realized by a foreign organization is 
derived from sources within the United States or is effectively 
connected with the conduct of a trade or business within the United 
States, see part 1, subchapter N, chapter 1 of the Code (section 861 and 
following) and the regulations thereunder.
    (2) Effective dates. Subparagraph (1) of this paragraph applies to 
taxable years beginning after December 31, 1969. For taxable years 
beginning on or before December 31, 1969, the unrelated business taxable 
income of a foreign organization exempt from taxation under section 
501(a) consists of the organization's unrelated business taxable income 
which:
    (i) For taxable years beginning after December 31, 1966, is 
effectively connected with the conduct of a trade or business within the 
United States, whether or not such income is derived from sources within 
the United States;
    (ii) For taxable years beginning on or before December 31, 1966, is 
derived from sources within the United States.
    (h) Applicability date. This section generally applies to taxable 
years beginning after December 12, 1967, except as provided in paragraph 
(g)(2) of this section, and except that paragraphs (a) through (c) of 
this section apply to taxable years beginning on or after December 2, 
2020. For taxable years beginning before December 2, 2020, see these 
paragraphs as in effect and contained in 26 CFR part 1 revised as of 
April 1, 2020.

[T.D. 7392, 40 FR 58638, Dec. 18, 1975, as amended by T.D. 7438, 41 FR 
44392, Oct. 8, 1976; T.D. 7935, 49 FR 1694, Jan. 13, 1984; T.D. 8991, 67 
FR 20437, Apr. 25, 2002; T.D. 9933, 85 FR 77979, Dec. 2, 2020]



Sec.  1.512(a)-2  Definition applicable to taxable years beginning
before December 13, 1967.

    (a) In general. The unrelated business taxable income which is 
subject to the tax imposed by section 511 is the gross income, derived 
by any organization to which section 511 applies, from any unrelated 
trade or business regularly carried on by it, less the deductions 
allowed by chapter 1 of the Code which

[[Page 188]]

are directly connected with the carrying on of such trade or business, 
subject to certain exceptions, additions, and limitations referred to 
below. In the case of an organization which regularly carries on two or 
more unrelated businesses, its unrelated business taxable income is the 
aggregate of its gross income from all such unrelated businesses, less 
the aggregate of the deductions allowed with respect to all such 
unrelated businesses. For provisions generally applicable to the 
unrelated business tax, see Sec.  1.511-3, and for rules applicable to 
the determination of the adjusted basis of property, see paragraph 
(a)(2) of Sec.  1.514(a)-1.
    (b) Effective date. Except as provided in paragraph (f) of Sec.  
1.512(a)-1, this section is applicable with respect to taxable years 
beginning before December 13, 1967.

[T.D. 6500, 25 FR 11737, Nov. 26, 1960, as amended by T.D. 6939, 32 FR 
17660, Dec. 12, 1967]



Sec.  1.512(a)-3  [Reserved]



Sec.  1.512(a)-4  Special rules applicable to war veterans organizations.

    (a) In general. For taxable years beginning after December 31, 1969, 
this section provides special rules for the determination of the 
unrelated business taxable income of an organization described in 
section 501(c)(19). In general, the rules contained in sections 511 
through 514 which are applicable to any organization listed in section 
501(c) apply in determining the unrelated business taxable income of an 
organization described in section 501(c)(19). However, that amount which 
is paid by members to the organization for the purpose described in 
paragraph (b)(1) of this section, if set aside from other organizational 
monies and accounts in an insurance set aside, may be excluded from the 
unrelated business taxable income of the organization. The insurance set 
aside shall be used exclusively for providing insurance benefits, for 
the purposes specified in section 170(c)(4) of the Code, for the 
reasonable costs of administering the insurance program that are 
directly related to such set aside, or for the reasonable costs of 
distributing funds for section 170(c)(4) purposes. If an amount so set 
aside is used for any purposes other than those described in the 
preceding sentence, it shall be included in unrelated business taxable 
income without regard to any modifications provided by section 512(b), 
in the taxable year in which it is withdrawn from such set aside. 
Amounts will be considered to have been withdrawn from an insurance set 
aside if they are used in any manner inconsistent with providing 
insurance benefits, paying the reasonable costs of administering the 
insurance program for section 170(c)(4) purposes and for costs of 
distributing funds for section 170(c)(4) purposes. An example of a use 
of funds which would be considered a withdrawal would be the use of such 
funds as security for a loan.
    (b) Insurance set aside--(1) Purpose of payments by members. 
Payments by members (including commissions on such payments earned by 
the set aside as agent for an insurance company) into an insurance set 
aside must be for the sole purpose of obtaining life, sick, accident or 
health insurance benefits from the organization or for the reasonable 
costs of administration of the insurance program, except that such 
purpose is not violated when excess funds from an experience gain are 
utilized for those purposes specified in section 170(c)(4) or the 
reasonable costs of distributing funds for such purposes. Funds for any 
other purpose may not be set aside in the insurance set aside.
    (2) Income from set aside. In addition to the payments by members 
described in paragraph (b)(1) of this section, only income from amounts 
in the insurance set aside (including commissions earned as agent for an 
insurance company) may be so set aside. Moreover unless such income is 
used for providing insurance benefits, for those purposes specified in 
section 170(c)(4), or for reasonable costs of administration, such 
income must be set aside within the period described in paragraph (b)(3) 
of this section in order to avoid being included as an item of unrelated 
business taxable income under section 512(a)(4).
    (3) Time within which income must be set aside. Income from amounts 
in the insurance set aside generally must be set aside in the taxable 
year in which it would be includible in gross income

[[Page 189]]

but for this section. However, income set aside on or before the date 
prescribed for filing the organization's return of unrelated business 
taxable income (whether or not it had such income) for the taxable year 
(including any extension of time) may, at the election of the 
organization, be treated as having been set aside in such taxable year.
    (4) Computation of income from set aside. Income from amounts in the 
insurance set aside shall consist solely of items of investment income 
from, and other gains derived from dealings in, property in the set 
aside. The deductions allowed against such items of income or other 
gains are those amounts which are related to the production of such 
income or other gains. Only the amounts of income or other gain which 
are in excess of such deductions may be set aside in the insurance set 
aside.
    (5) Requirements for set aside. An amount is not properly set aside 
if the organization commingles it with any amount which is not to be set 
aside. However, adequate records describing the amount set aside and 
indicating that it is to be used for the designated purpose are 
sufficient. Amounts that are set aside need not be permanently committed 
to such use either under state law or by contract. Thus, for example, it 
is not necessary that the organization place these funds in an 
irrevocable trust. Although set aside income may be accumulated, any 
accumulation which is unreasonable in amount or duration is evidence 
that the income was not accumulated for the purposes set forth. For 
purposes of the preceding sentence, accumulations which are reasonably 
necessary for the purpose of providing life, sick, health, or accident 
insurance benefits on the basis of recognized mortality or morbidity 
tables and assumed rates of interest under an actuarially acceptable 
method would not be unreasonable even though such accumulations are 
quite large and the time between the receipt by the organization of such 
amounts and the date of payment of the benefits is quite long. For 
example, an accumulation of income for 20 years or longer which is 
determined to be reasonable necessary to pay life insurance benefits to 
members, their dependents or designated beneficiaries, generally would 
not be an unreasonable accumulation. Income which has been set aside may 
be invested, pending the action contemplated by the set aside, without 
being regarded as having been used for other purposes.

[T.D. 7438, 41 FR 44393, Oct. 8, 1976]



Sec.  1.512(a)-5  Questions and answers relating to the unrelated
business taxable income of organizations described in 
paragraphs (9) or (17) of section 501(c).

    (a)(1) Q-1. What does section 512(a)(3) provide with respect to 
organizations described in paragraphs (9) or (17) of section 501(c)?
    (2) A-1. (i) In general, section 512(a)(3) provides rules for 
determining the unrelated business income tax of voluntary employees' 
beneficiary associations (VEBAs) and supplemental unemployment benefit 
trusts (SUBs). Under section 512(a)(3)(A), a Covered Entity's 
``unrelated business taxable income'' (UBTI) means all income except 
exempt function income. Under section 512(a)(3)(B), exempt function 
income includes income that is set aside for exempt purposes, as 
described in paragraph (b) of this section, subject to certain limits, 
as described in paragraph (c) of this section.
    (ii) For purposes of this section, a ``Covered Entity'' means a VEBA 
or a SUB, and, to the extent provided in section 512(a)(3)(C), a 
corporation described in section 501(c)(2).
    (b)(1) Q-2. What is exempt function income?
    (2) A-2. (i) Under section 512(a)(3)(B), the exempt function income 
of a Covered Entity for a taxable year means the sum of--
    (A) Amounts referred to in the first sentence of section 
512(a)(3)(B) that are paid by members of the Covered Entity and employer 
contributions to the Covered Entity (collectively ``member 
contributions'');
    (B) Other income of the Covered Entity (including earnings on member 
contributions) that is set aside for a purpose specified in section 
170(c)(4) and reasonable costs of administration directly connected with 
such purpose; and

[[Page 190]]

    (C) Other income of the Covered Entity (including earnings on member 
contributions) that, subject to the limitation of section 512(a)(3)(E) 
(as described in paragraph (c) of this section), is set aside for the 
payment of life, sick, accident, or other benefits and reasonable costs 
of administration directly connected with such purpose.
    (ii) The other income described in paragraphs (b)(2)(i)(B) and (C) 
of this section does not include the gross income derived from any 
unrelated trade or business (as defined in section 513) regularly 
carried on by the Covered Entity, computed as if the organization were 
subject to section 512(a)(1).
    (c)(1) Q-3. What are the limits on the amount that may be set aside?
    (2) A-3. (i) Pursuant to section 512(a)(3)(E)(i), and except as 
provided in paragraph (c)(2)(ii) of this section, the amount of 
investment income (as defined in paragraph (c)(2)(iii) of this section) 
set aside by a Covered Entity as of the close of a taxable year of such 
Covered Entity to provide for the payment of life, sick, accident, or 
other benefits (and administrative costs associated with the provision 
of such benefits) is not taken into account for purposes of determining 
the amount of that income that constitutes ``exempt function income'' to 
the extent that the total amount of the assets of the Covered Entity at 
the end of the taxable year set aside to provide for the payment of 
life, sick, accident, or other benefits (and related administrative 
costs) exceeds the applicable account limit for such taxable year of the 
Covered Entity (as described in paragraph (c)(2)(iv) of this section). 
Accordingly, any investment income a Covered Entity earns during the 
taxable year is subject to unrelated business income tax to the extent 
the Covered Entity's year-end assets exceed the applicable account 
limit. The rule in this paragraph (c)(2) applies regardless of whether 
the Covered Entity spends or retains (or is deemed to spend or deemed to 
retain) that investment income during the course of the year. Thus, in 
addition to the unrelated business taxable income derived by a Covered 
Entity from any unrelated trade or business (as defined in section 513) 
regularly carried on by it, computed as if the organization were subject 
to section 512(a)(1), the unrelated business taxable income of a Covered 
Entity for a taxable year of such an organization includes the lesser 
of--
    (A) The investment income of the Covered Entity for the taxable 
year; and
    (B) The excess (if any) of--
    (1) The total amount of the assets of the Covered Entity (excluding 
amounts set aside for a purpose described in section 170(c)(4)) as of 
the close of the taxable year; over
    (2) The applicable account limit for the taxable year.
    (ii) In accordance with section 512(a)(3)(E)(iii), a Covered Entity 
is not subject to the limits described in this paragraph (c) if 
substantially all of the contributions to the Covered Entity are made by 
employers who were tax exempt throughout the five year taxable period 
ending with the taxable year in which the contributions are made.
    (iii) For purposes of this section, a Covered Entity's ``investment 
income''--
    (A) Means all income except--
    (1) Member contributions described in paragraph (b)(2)(i)(A) of this 
section;
    (2) Income set aside as described in paragraph (b)(2)(i)(B) of this 
section; or
    (3) Income from any unrelated trade or business described in 
paragraph (b)(2)(ii) of this section; and
    (B) Includes gain realized by the Covered Entity on the sale or 
disposition of any asset during such year (other than gain on the sale 
or disposition of assets of an unrelated trade or business described in 
paragraph (b)(2)(ii) of this section), except to the extent provided in 
section 512(a)(3)(D).
    (C) For purposes of paragraph (c)(2)(iii)(B) of this section, the 
gain realized by a Covered Entity on the sale or disposition of an asset 
is equal to the amount realized by the organization over the basis of 
such asset in the hands of the organization reduced by any qualified 
direct costs attributable to such asset (under paragraphs (b), (c), and 
(d) of Q&A-6 of Sec.  1.419A-1T).
    (iv) In calculating the total amount of the assets of a Covered 
Entity as of the close of the taxable year, certain

[[Page 191]]

assets with useful lives extending substantially beyond the end of the 
taxable year (for example, buildings and licenses) are not to be taken 
into account to the extent they are used in the provision of life, sick, 
accident, or other benefits. By contrast, cash and securities (and other 
similar investments) held by a Covered Entity are taken into account in 
calculating the total amount of the assets of a Covered Entity as of the 
close of the taxable year because they may be used to pay welfare 
benefits, rather than merely used in the provision of such benefits.
    (v) The determination of the applicable account limit for purposes 
of this paragraph (c) is made under the rules of sections 419A(c) and 
419A(f)(7), except that a reserve for post-retirement medical benefits 
under section 419A(c)(2)(A) is not to be taken into account. See Sec.  
1.419A-2T for special rules relating to collectively bargained welfare 
benefit funds.
    (vi) The limits of this paragraph (c) apply to a Covered Entity that 
is part of a 10 or more employer plan, as defined in section 419A(f)(6). 
For purposes of this paragraph (c), the account limit is determined as 
if the plan is not subject to the exception under section 419A(f)(6).
    (vii) The following examples illustrate the calculation of a VEBA's 
UBTI.
    (A) Example 1. (1) Employer X establishes a VEBA as of January 1, 
2015, through which it provides health benefits to active employees. The 
plan year is the calendar year. The VEBA has no employee contributions 
or member dues, receives no income from an unrelated trade or business 
regularly carried on by the VEBA, and has no income set aside for a 
purpose specified in section 170(c)(4). The VEBA's investment income in 
2020 is $1,000. As of December 31, 2020, the applicable account limit 
under section 512(a)(3)(E)(i) is $5,000 and the total amount of assets 
of the VEBA is $7,000.
    (2) The VEBA's UBTI for 2020 is $1,000. This is because the UBTI is 
the lesser of the investment income for the year ($1,000) and the excess 
of the VEBA assets over the account limit at the end of the year ($7,000 
over $5,000, or $2,000).
    (B) Example 2. (1) The facts are the same as in the example in 
paragraph (c)(2)(vii)(A) of this section (Example 1), except that the 
VEBA's applicable account limit under section 512(a)(3)(E)(i) as of 
December 31, 2020, is $6,500.
    (2) The VEBA's UBTI for 2020 is $500. This is because the UBTI for 
2020 is the lesser of the investment income for the year ($1,000) and 
the excess of the VEBA assets over the account limit at the end of the 
year ($7,000 over $6,500, or $500).
    (C) Example 3. (1) Employer Y contributes to a VEBA through which Y 
provides health benefits to active and retired employees. The plan year 
is the calendar year. At the end of 2020, there was no carryover of 
excess contributions within the meaning of section 419(d), the balance 
in the VEBA was $25,000, the Incurred but Unpaid (IBU) claims reserve 
was $6,000, the reserve for post-retirement medical benefits (PRMB) 
(computed in accordance with section 419A(c)(2)) was $19,000, and there 
were no existing reserves within the meaning of section 
512(a)(3)(E)(ii). During 2021, the VEBA receives $70,000 in employer 
contributions and $5,000 in investment income, pays $72,000 in benefit 
payments and $7,000 in administrative expenses, and receives no income 
from an unrelated trade or business regularly carried on by the VEBA. 
All the 2021 benefit payments are with respect to active employees and 
the IBU claims reserve (that is, the account limit under section 
419A(c)(1)) at the end of 2021 was $7,200. The reserve for PRMB at the 
end of 2021 is $20,000. All amounts designated as ``administrative 
expenses'' are expenses incurred in connection with the administration 
of the employee health benefits. ``Investment income'' is net of 
administrative costs incurred in the production of the investment income 
(for example, investment management and/or brokerage fees). Only 
employers contributed to the VEBA (that is, there were no employee 
contributions or member dues/fees). The VEBA does not set aside any 
income for the purpose specified in section 170(c)(4).
    (2) The total amount of assets of the VEBA at the end of 2021 is 
$21,000 (that is, $25,000 beginning of year balance +

[[Page 192]]

$70,000 contributions + $5,000 investment income-($72,000 in benefit 
payments + $7,000 in administrative expenses)).
    (3) The applicable account limit under section 512(a)(3)(E)(i) (that 
is, the account limit under section 419A(c), excluding the reserve for 
post-retirement medical benefits) is the IBU claims reserve ($7,200).
    (4) The total amount of assets of the VEBA as of the close of the 
year ($21,000) exceeds the applicable account limit ($7,200) by $13,800.
    (5) The unrelated business taxable income of the VEBA is $5,000 
(that is, the lesser of investment income ($5,000) and the excess of the 
amount of assets of the VEBA as of the close of the taxable year over 
the applicable account limit ($13,800)).
    (D) Example 4. (1) The facts are the same as in the example in 
paragraph (c)(2)(vii)(C) of this section (Example 3) except that the 
2020 year-end balance was $15,000.
    (2) The total amount of assets in the VEBA at the end of 2021 is 
$11,000 (that is, $15,000 beginning of year balance + $70,000 
contributions + $5,000 investment income-($72,000 in benefit payments + 
$7,000 in administrative expenses)).
    (3) The applicable account limit under section 512(a)(3)(E)(i) 
remains $7,200.
    (4) The total amount of assets of the VEBA as of the close of the 
year ($11,000) exceeds the applicable account limit ($7,200) by $3,800.
    (5) The VEBA's unrelated business taxable income is $3,800 (that is, 
the lesser of investment income ($5,000) and the excess of the total 
amount of assets of the VEBA at the close of the taxable year over the 
applicable account limit ($3,800)).
    (d)(1) Q-4. What is the effective date of the amendments to section 
512(a)(3) and what transition rules apply to ``existing reserves for 
post-retirement medical or life insurance benefits''?
    (2) A-4. (i) The amendments to section 512(a)(3), made by the Tax 
Reform Act of 1984, apply to income earned by a Covered Entity after 
December 31, 1985, in the taxable years of such an organization ending 
after such date.
    (ii) Section 512(a)(3)(E)(ii)(I) provides that income that is 
attributable to ``existing reserves for post-retirement medical or life 
insurance benefits'' will not be treated as unrelated business taxable 
income. This includes income that is either directly or indirectly 
attributable to existing reserves. An ``existing reserve for post-
retirement medical or life insurance benefits'' (as defined in section 
512(a)(3)(E)(ii)(II)) is the total amount of assets actually set aside 
by a Covered Entity on July 18, 1984 (calculated in the manner set forth 
in paragraph (c) of this section, and adjusted under paragraph (c) of 
Q&A-11 of Sec.  1.419-1T), reduced by employer contributions to the fund 
on or before such date to the extent such contributions are not 
deductible for the taxable year of the employer including July 18, 1984, 
and for any prior taxable year of the employer, for purposes of 
providing such post-retirement benefits. For purposes of the preceding 
sentence only, an amount that was not actually set aside on July 18, 
1984, will be treated as having been actually set aside on such date if 
the amount was--
    (A) Incurred by the employer (without regard to section 461(h)) as 
of the close of the last taxable year of the Covered Entity ending 
before July 18, 1984; and
    (B) Actually contributed to the Covered Entity within 8 \1/2\ months 
following the close of such taxable year.
    (iii) In addition, section 512(a)(3)(E)(ii)(I) applies to existing 
reserves for such post-retirement benefits only to the extent that such 
``existing reserves'' do not exceed the amount that could be accumulated 
under the principles set forth in Revenue Rulings 69-382, 1969-2 CB 28; 
69-478, 1969-2 CB 29; and 73-599, 1973-2 CB 40. Thus, amounts 
attributable to any such excess ``existing reserves'' are not within the 
transition rule of section 512(a)(3)(E)(ii)(I) even though they were 
actually set aside on July 18, 1984. See Sec.  601.601(d)(2)(ii)(b) of 
this chapter.
    (iv) All post-retirement medical or life insurance benefits (or 
other benefits to the extent paid with amounts set aside to provide 
post-retirement medical or life insurance benefits) provided after July 
18, 1984 (whether or not the employer has maintained a reserve

[[Page 193]]

or fund for such benefits) are to be charged, first, against the 
``existing reserves'' within the transition rule of section 
512(a)(3)(E)(ii)(I) (including amounts attributable to ``existing 
reserves'' within the transition rule of section 512(a)(3)(E)(ii)(I) for 
post-retirement medical benefits or for post-retirement life insurance 
benefits (as the case may be)) and, second, against all other amounts. 
For purposes of this paragraph (d)(2)(iv), the qualified direct cost of 
an asset with a useful life extending substantially beyond the end of 
the taxable year (as determined under Q&A-6 of Sec.  1.419-1T) will be 
treated as a benefit provided and thus charged against the ``existing 
reserve'' based on the extent to which such asset is used in the 
provision of post-retirement medical benefits or post-retirement life 
insurance benefits (as the case may be). All plans of an employer 
providing post-retirement medical benefits are to be treated as one plan 
for purposes of section 512(a)(3)(E)(ii)(III), and all plans of an 
employer providing post-retirement life insurance benefits are to be 
treated as one plan for purposes of section 512(a)(3)(E)(ii)(III).
    (v) In calculating the unrelated business taxable income of a 
Covered Entity for a taxable year of such organization, the total income 
of the Covered Entity for the taxable year is reduced by the income 
attributable to ``existing reserves'' within the transition rule of 
section 512(a)(3)(E)(ii)(I) before such income is compared to the excess 
of the total amount of the assets of the Covered Entity as of the close 
of the taxable year over the applicable account limit for the taxable 
year.
    (vi) The following example illustrates the calculation of UBTI for a 
VEBA that has existing reserves.
    (A) Example. Assume that the total income of a VEBA for a taxable 
year is $1,000, and that the excess of the total amount of the assets of 
the VEBA as of the close of the taxable year over the applicable account 
limit is $600. Assume also that of the $1,000 of total income, $540 is 
attributable to ``existing reserves'' within the transition rule of 
section 512(a)(3)(E)(ii)(I). The unrelated business taxable income of 
this VEBA for the taxable year is $460, determined as the lesser of the 
following two amounts:
    (1) The total income of the VEBA for the taxable year, reduced by 
the extent to which such income is attributable to ``existing reserves'' 
within the meaning of the transition rule of section 512(a)(3)(E)(ii)(I) 
($1,000-$540 = $460); and
    (2) The excess of the total amount of the assets of the VEBA as of 
the close of the taxable year over the applicable account limit ($600).
    (B) [Reserved]
    (e)(1) Q-5. What is the applicability date of this section?
    (2) A-5. Except as otherwise provided in this paragraph (e)(2), this 
section is applicable to taxable years beginning on or after December 
10, 2019. For rules that apply to earlier periods, see Sec.  1.512(a)-
5T, as contained in 26 CFR part 1, revised April 1, 2019.

[T.D. 9886, 84 FR 67373, Dec. 10, 2019]



Sec.  1.512(a)-6  Special rule for organizations with more than one
unrelated trade or business.

    (a) More than one unrelated trade or business--(1) In general. An 
organization with more than one unrelated trade or business must compute 
unrelated business taxable income (UBTI) separately with respect to each 
such trade or business, without regard to the specific deduction in 
section 512(b)(12), including for purposes of determining any net 
operating loss (NOL) deduction. An organization with more than one 
unrelated trade or business computes its total UBTI under paragraph (g) 
of this section.
    (2) Separate trades or businesses. An organization determines 
whether it regularly carries on unrelated trades or businesses by 
applying sections 511 through 514. For purposes of section 512(a)(6)(A) 
and paragraph (a)(1) of this section, an organization identifies its 
separate unrelated trades or businesses using the methods described in 
paragraphs (b) through (e) of this section.
    (3) Reporting changes in identification. An organization that 
changes the identification of a separate unrelated trade or business 
under paragraph (a)(2) of this section must report the change in the 
taxable year of that change in accordance with forms and instructions.

[[Page 194]]

For this purpose, a change in identification of a separate unrelated 
trade or business includes the changed identification of the separate 
unrelated trade or business with respect to a partnership interest that 
was incorrectly designated as a qualifying partnership interest (QPI). 
In the case of an incorrect designation of a QPI, paragraph (c)(2)(iii) 
of this section (regarding designation of qualifying partnership 
interests) does not apply. In all cases, to report the change in 
identification, an organization must provide the following information 
with respect to each separate change in identification--
    (i) The identification of the separate unrelated trade or business 
in the previous taxable year;
    (ii) The identification of the separate unrelated trade or business 
in the current taxable year; and
    (iii) The reason for the change.
    (b) North American Industry Classification System--(1) In general. 
Except as provided in paragraphs (c) through (e) of this section, an 
organization identifies each of its separate unrelated trades or 
businesses using the first two digits of the North American Industry 
Classification System code (NAICS 2-digit code) that most accurately 
describes the unrelated trade or business based on the more specific 
NAICS code, such as at the 6-digit level, that describes the activity it 
conducts and subject to the requirements of paragraph (b)(2) and (3) of 
this section. The descriptions in the current NAICS manual (available at 
www.census.gov) of trades or businesses using more than two digits of 
the NAICS codes are relevant in this determination. In the case of the 
sale of goods, both online and in stores, the separate unrelated trade 
or business is identified by the goods sold in stores if the same goods 
generally are sold both online and in stores.
    (2) Codes must identify the unrelated trade or business. The NAICS 
2-digit code must identify the unrelated trade or business in which the 
organization engages (directly or indirectly) and not activities the 
conduct of which are substantially related to the exercise or 
performance by such organization of its charitable, educational, or 
other purpose or function constituting the basis for its exemption under 
section 501 (or, in the case of an organization described in section 
511(a)(2)(B), to the exercise or performance of any purpose or function 
described in section 501(c)(3)). For example, a college or university 
described in section 501(c)(3) cannot use the NAICS 2-digit code for 
educational services to identify all its separate unrelated trades or 
businesses, and a qualified retirement plan described in section 401(a) 
cannot use the NAICS 2-digit code for finance and insurance to identify 
all of its unrelated trades or businesses.
    (3) Codes only reported once. An organization will report each NAICS 
2-digit code only once. For example, a hospital organization that 
operates several hospital facilities in a geographic area (or multiple 
geographic areas), all of which include pharmacies that sell goods to 
the general public, would include all the pharmacies under the NAICS 2-
digit code for retail trade, regardless of whether the hospital 
organization keeps separate books and records for each pharmacy.
    (c) Activities in the nature of investments--(1) In general. An 
organization's activities in the nature of investments (investment 
activities) are treated collectively as a separate unrelated trade or 
business for purposes of section 512(a)(6) and paragraph (a) of this 
section. Except as provided in paragraphs (c)(7) and (c)(8) of this 
section, an organization's investment activities are limited to its--
    (i) Qualifying partnership interests (described in paragraph (c)(2) 
of this section);
    (ii) Qualifying S corporation interests (described in paragraph 
(e)(2)(i) of this section); and
    (iii) Debt-financed property or properties (within the meaning of 
section 514).
    (2) Qualifying partnership interests--(i) Directly-held partnership 
interests. An interest in a partnership is a qualifying partnership 
interest (QPI) if the exempt organization holds a direct interest in the 
partnership (directly-held partnership interest) that meets the 
requirements of either the de minimis test (described in paragraph 
(c)(3) of this section) or the participation test

[[Page 195]]

(described in paragraph (c)(4) of this section).
    (ii) Indirectly-held partnership interests--(A) Look through rule. 
If an organization holds a direct interest in a partnership but that 
directly-held partnership interest is not a QPI because it does not meet 
the requirements of the de minimis test (described in paragraph (c)(3) 
of this section) or the participation test (described in paragraph 
(c)(4) of this section), any partnership in which the organization holds 
an indirect interest through the directly-held partnership interest 
(indirectly-held partnership interest) may be a QPI if the indirectly-
held partnership interest meets the requirements of paragraph 
(c)(2)(ii)(B) or (c)(2)(ii)(C) of this section.
    (B) Indirectly-held partnership interests that meet the requirements 
of the de minimis test. An indirectly-held partnership interest meets 
the requirements of this paragraph (c)(2)(ii)(B) if the indirectly-held 
partnership interest meets the requirements of the de minimis test 
described in paragraph (c)(3) of this section with regard to the 
organization. For example, if an organization directly holds 50 percent 
of the capital interests of a partnership and the directly-held 
partnership holds 4 percent of the capital and profits interest of 
lower-tier partnership A, the organization may aggregate its interest in 
lower-tier partnership A with its other QPIs because the organization 
indirectly holds 2 percent of the capital and profits interests of 
lower-tier partnership A (4 percent x 50 percent).
    (C) Indirectly-held partnership interests that meet the requirements 
of the participation test. An indirectly-held partnership interest meets 
the requirements of this paragraph (c)(2)(ii)(C) if the indirectly-held 
partnership interest meets the requirements of the participation test 
(described in paragraph (c)(4) of this section) with respect to the 
partnership that directly owns the interest in the indirectly-held 
partnership. For purposes of applying the participation test to a 
partnership, the term organization in paragraph (c)(4) of this section 
refers to the partnership that directly holds the indirectly-held 
partnership interest being tested for QPI status. Additionally, the list 
of officers, directors, trustees, or employees of an organization found 
in paragraphs (c)(4)(iii)(B) and (C) includes a general partner that 
directly owns an interest in the lower-tier partnership.
    (D) Example. (1) Organization D is described in section 501(c) and 
is exempt from Federal income tax under section 501(a). Organization D 
owns 50 percent of the capital interest in Partnership A. Partnership A 
owns 30 percent of the capital interest in Partnership B, but 
Partnership A does not significantly participate in Partnership B within 
the meaning of paragraph (c)(4)(iii) of this section. Further, 
Partnership B owns 15 percent of the capital interest in Partnership C, 
in which Partnership B does not significantly participate within the 
meaning of paragraph (c)(4)(iii) of this section. No other organizations 
related (within the meaning of paragraph (c)(4)(ii) of this section) to 
either Organization D or the partnerships owns an interest in any of the 
lower-tier partnerships.
    (2) Neither the interest in Partnership A nor B is a QPI. 
Organization D's interest in Partnership A does not meet the 
requirements of either the de minimis test or the participation test 
because it owns 50 percent of the interest in the partnership. 
Organization D's indirect interest in Partnership B (50 percent of 30 
percent, or 15 percent) does not meet the de minimis test. Additionally, 
because Partnership A owns greater than 20 percent interest in 
Partnership B, Partnership A's interest in Partnership B does not meet 
the participation test. However, Organization D's interest in 
Partnership C is a QPI because Partnership C meets the participation 
test. That is, Partnership B holds a 15 percent interest in Partnership 
C and does not significantly participate in Partnership C.
    (iii) Designation. An organization that has a partnership interest 
meeting the requirements of paragraph (c)(2)(i) or (ii) of this section 
in a taxable year may designate that partnership interest as a QPI by 
including its share of partnership gross income (and directly connected 
deductions) with the gross

[[Page 196]]

income (and directly connected deductions) from its other investment 
activities (see paragraph (c)(1) of this section) in accordance with 
forms and instructions. Any partnership interest that is designated as a 
QPI remains a QPI unless and until it no longer meets the requirements 
of paragraph (c)(2)(i) or (ii) of this section. For example, if an 
organization designates a directly-held partnership interest that meets 
the requirements of the de minimis rule as a QPI in one taxable year, 
the organization cannot, in the next taxable year, use NAICS 2-digit 
codes to describe the partnership trades or businesses that are 
unrelated trades or businesses with respect to the organization unless 
the directly-held partnership interest fails to meet the requirements of 
both the de minimis test and the participation test (after application 
of the grace period described in paragraph (c)(6) of this section, if 
appropriate).
    (3) De minimis test. A partnership interest is a QPI that meets the 
requirements of the de minimis test if the organization holds directly 
(within the meaning of paragraph (c)(2)(i) of this section) or 
indirectly (within the meaning of paragraph (c)(2)(ii) of this section) 
no more than 2 percent of the profits interest and no more than 2 
percent of the capital interest during the organization's taxable year 
with which or in which the partnership's taxable year ends.
    (4) Participation test--(i) In general. A partnership interest is a 
QPI that meets the requirements of the participation test if the 
organization holds directly (within the meaning of paragraph (c)(2)(i) 
of this section) or indirectly (within the meaning of paragraph 
(c)(2)(ii) of this section) no more than 20 percent of the capital 
interest during the organization's taxable year with which or in which 
the partnership's taxable year ends and the organization does not 
significantly participate in the partnership within the meaning of 
paragraph (c)(4)(iii) of this section.
    (ii) Combining related interests. When determining an organization's 
percentage interest in a partnership for purposes of paragraph (c)(4)(i) 
of this section, the interests of a supporting organization (as defined 
in section 509(a)(3) and Sec.  1.509(a)-4), other than a Type III 
supporting organization (as defined in Sec.  1.509(a)-4(i)) that is not 
a parent of its supported organization, or of a controlled entity (as 
defined in section 512(b)(13)(D) and Sec.  1.512(b)-1(l)) in the same 
partnership will be taken into account. For example, if an organization 
owns 10 percent of the capital interests in a partnership, and its Type 
I supporting organization owns an additional 15 percent capital interest 
in that partnership, the organization would not meet the requirements of 
the participation test because its aggregate percentage interest exceeds 
20 percent (10 percent + 15 percent = 25 percent).
    (iii) Significant Participation. An organization significantly 
participates in a partnership if--
    (A) The organization, by itself, may require the partnership to 
perform, or may prevent the partnership from performing (other than 
through a unanimous voting requirement or through minority consent 
rights), any act that significantly affects the operations of the 
partnership;
    (B) Any of the organization's officers, directors, trustees, or 
employees have rights to participate in the management of the 
partnership at any time;
    (C) Any of the organization's officers, directors, trustees, or 
employees have rights to conduct the partnership's business at any time; 
or
    (D) The organization, by itself, has the power to appoint or remove 
any of the partnership's officers or employees or a majority of 
directors.
    (5) Determining percentage interest--(i) Profits interest. For 
purposes of the de minimis test described in paragraph (c)(3) of this 
section, an organization's profits interest in a partnership is 
determined in the same manner as its distributive share of partnership 
taxable income. See section 704(b) (relating to the determination of the 
distributive share by the income or loss ratio) and Sec. Sec.  1.704-1 
through 1.704-4.
    (ii) Capital interest. For purposes of the de minimis test 
(described in paragraph (c)(3) of this section) and the participation 
test (described in paragraph (c)(4)(i) of this section), in the absence

[[Page 197]]

of a provision in the partnership agreement, an organization's capital 
interest in a partnership is determined on the basis of its interest in 
the assets of the partnership which would be distributable to such 
organization upon its withdrawal from the partnership, or upon 
liquidation of the partnership, whichever is the greater.
    (iii) Average percentage interest. For purposes of the de minimis 
test (described in paragraph (c)(3) of this section) and the 
participation test (described in paragraph (c)(4)(i) of this section), 
an organization determines its percentage interest by taking the average 
of the organization's percentage interest at the beginning and the end 
of the partnership's taxable year, or, in the case of a partnership 
interest held for less than a year, the percentage interest held at the 
beginning and end of the period of ownership within the partnership's 
taxable year. For example, if an organization acquires an interest in a 
partnership that files on a calendar year basis in May and the 
partnership reports on Schedule K-1 (Form 1065) that the partner held a 
3 percent profits interest at the date of acquisition but held a 1 
percent profits interest at the end of the calendar year, the 
organization will be considered to have held 2 percent of the profits 
interest in that partnership for that year ((3 percent + 1 percent)/2).
    (iv) Reliance on Schedule K-1 (Form 1065). When determining the 
organization's average percentage interest (described in paragraph 
(c)(5)(iii) of this section) in a partnership for purposes of the de 
minimis test (described in paragraph (c)(3) of this section) and the 
participation test (described in paragraph (c)(4) of this section), an 
organization may rely on the Schedule K-1 (Form 1065) (or its successor) 
it receives from the partnership if the form lists the organization's 
percentage profits interest or its percentage capital interest, or both, 
at the beginning and end of the year. However, the organization may not 
rely on the form to the extent that any information about the 
organization's percentage interest is not specifically provided. For 
example, if the Schedule K-1 (Form 1065) an organization receives from a 
partnership lists the organization's profits interest as ``variable'' 
but lists its percentage capital interest at the beginning and end of 
the year, the organization may rely on the form only with respect to its 
percentage capital interest.
    (6) Changes in percentage interest. A partnership interest that 
fails to meet the requirements of the de minimis test (described in 
paragraph (c)(3) of this section) or the participation test (described 
in paragraph (c)(4) of this section) because of an increase in 
percentage interest in the organization's current taxable year may be 
treated for the taxable year of the change as meeting the requirements 
of the test it met in the prior taxable year if--
    (i) The partnership interest met the requirements of the de minimis 
test or participation test, respectively, in the organization's prior 
taxable year without application of this paragraph (c)(6);
    (ii) The increase in percentage interest is solely due to the 
actions of one or more partners other than the organization; and
    (iii) In the case of a partnership interest that met the 
requirements of the participation test in the prior taxable year, the 
interest of the partner or partners that caused the increase in 
paragraph (c)(6)(ii) of this section was not combined for the prior 
taxable year and is not combined for the taxable year of the change with 
the organization's partnership interest for purposes of paragraph 
(c)(4)(ii) of this section.
    (7) UBTI from the investment activities of organizations subject to 
section 512(a)(3). For purposes of paragraph (c)(1) of this section, 
UBTI from the investment activities of an organization subject to 
section 512(a)(3) includes any amount that--
    (i) Would be excluded from the calculation of UBTI under section 
512(b)(1), (2), (3), or (5) if the organization were subject to section 
512(a)(1);
    (ii) Is attributable to income set aside (and not in excess of the 
set aside limit described in section 512(a)(3)(E)), but not used, for a 
purpose described in section 512(a)(3)(B)(i) or (ii); or
    (iii) Is in excess of the set aside limit described in section 
512(a)(3)(E).
    (8) Limitations--(i) Social clubs. Paragraphs (c)(2) (regarding 
QPIs) and (c)(9) (transition rule for certain partnership interests) of 
this section do not apply

[[Page 198]]

to social clubs described in section 501(c)(7).
    (ii) General partnership interests. Any partnership in which an 
organization, or an organization whose interest is combined with that 
organization's interest for purposes of paragraph (c)(4)(ii) of this 
section, is a general partner under applicable state law is not a QPI 
within the meaning of paragraph (c)(2) of this section, regardless of 
the organization's percentage interest. Such partnership interest cannot 
be a QPI for any organization or for any of the organizations whose 
interest is combined with that organization's interest for purposes of 
paragraph (c)(4)(ii) of this section.
    (iii) Application of other sections. This paragraph (c) does not 
otherwise impact application of section 512(c) and the fragmentation 
rule under section 513(c).
    (9) Transition rule for certain partnership interests--(i) In 
general. If a directly-held partnership interest acquired prior to 
August 21, 2018, is not a QPI, an organization may treat such 
partnership interest as a separate unrelated trade or business for 
purposes of section 512(a)(6) regardless of the number of unrelated 
trades or businesses directly or indirectly conducted by the 
partnership. For example, if an organization has a 35 percent capital 
interest in a partnership acquired prior to August 21, 2018, it can 
treat the partnership as a single trade or business even if the 
partnership's investments generated UBTI from lower-tier partnerships 
that were engaged in multiple trades or businesses. A partnership 
interest acquired prior to August 21, 2018, will continue to meet the 
requirement of this rule even if the organization's percentage interest 
in such partnership changes before the end of the transition period (see 
paragraph (c)(9)(iii) of this section).
    (ii) Exclusivity. An organization may apply either the transition 
rule in paragraph (c)(9)(i) of this section or the look-through rule in 
paragraph (c)(2)(ii) of this section, but not both, to a partnership 
interest described in paragraph (c)(9)(i) of this section that also 
qualifies for application of the look-through rule described in 
paragraph (c)(2)(ii).
    (iii) Transition period. An organization may rely on this transition 
rule until the first day of the organization's first taxable year 
beginning after December 2, 2020.
    (d) Income from certain controlled entities--(1) Specified payments 
from controlled entities. If an organization (controlling organization) 
controls another entity (within the meaning of section 512(b)(13)(D)) 
(controlled entity), all specified payments (as defined in section 
512(b)(13)(C)) received by a controlling organization from that 
controlled entity are treated as gross income from a separate unrelated 
trade or business for purposes of paragraph (a) of this section. If a 
controlling organization receives specified payments from two different 
controlled entities, the payments from each controlled entity are 
treated as a separate unrelated trade or business. For example, a 
controlling organization that receives rental payments from two 
controlled entities has two separate unrelated trades or businesses, one 
for each controlled entity. The specified payments from a controlled 
entity are treated as gross income from one trade or business regardless 
of whether the controlled entity engages in more than one unrelated 
trade or business or whether the controlling organization receives more 
than one type of specified payment from that controlled entity.
    (2) Certain amounts derived from controlled foreign corporations. 
All amounts included in UBTI under section 512(b)(17) are treated as 
income derived from a separate unrelated trade or business for purposes 
of paragraph (a) of this section.
    (e) S corporation interests--(1) In general. Except as provided in 
paragraph (e)(2) of this section, if an organization owns stock in an S 
corporation (S corporation interest), such S corporation interest is 
treated as an interest in a separate unrelated trade or business for 
purposes of paragraph (a) of this section. Thus, if an organization owns 
two S corporation interests, neither of which is described in paragraph 
(e)(2) of this section, the exempt organization reports two separate 
unrelated trades or businesses, one for each S corporation interest. The 
UBTI from an S corporation interest is the

[[Page 199]]

amount described in section 512(e)(1)(B).
    (2) Exception for a qualifying S corporation interest. 
Notwithstanding paragraph (e)(1) of this section, an organization may 
aggregate its UBTI from an S corporation interest with its UBTI from 
other investment activities (described in paragraph (c)(1) of this 
section) if the organization's ownership interest in the S corporation 
meets the criteria for a QPI as described in paragraph (c)(2)(i) of this 
section (substituting ``S corporation'' for ``partnership'' and 
``shareholder'' or ``shareholders'' for ``partner'' or ``partners,'' as 
applicable, throughout paragraphs (c)(2)(i), (c)(3), (c)(4), 
(c)(5)(iii), (c)(5)(iv), and (c)(6) of this section; ``no more than 2 
percent of stock ownership'' for ``no more than 2 percent of the profits 
interest and no more than 2 percent of the capital interest'' in 
paragraph (c)(3) of this section; ``no more than 20 percent of stock 
ownership'' in place of ``no more than 20 percent of the capital 
interest'' in paragraph (c)(4)(i) of this section; and ``Schedule K-1 
(Form 1120-S)'' for ``Schedule K-1 (Form 1065)'' for purposes of 
paragraph (c)(5)(iv) of this section). Paragraphs (c)(5)(i) and 
(c)(5)(ii) do not apply for purposes of determining an organization's 
ownership interest in an S corporation; rather, the average percentage 
stock ownership determined under paragraph (c)(5)(iii) of this section 
applies for purposes of this paragraph (e)(2). For purposes of paragraph 
(c)(5)(iv) of this section, an organization can rely on the Schedule K-1 
(Form 1120-S) (or its successor) it receives from the S corporation only 
if the form lists information sufficient to determine the organization's 
percentage of stock ownership for the year. A Schedule K-1 (Form 1120-S) 
that reports ``zero'' as the organization's number of shares of stock in 
either the beginning or end of the S corporation's taxable year does not 
list information sufficient to determine the organization's percentage 
of stock ownership for the year. The grace period described in paragraph 
(c)(6) of this section applies to changes in an exempt organization's 
percentage of stock ownership in an S corporation.
    (f) Allocation of deductions. An organization must allocate 
deductions between separate unrelated trades or businesses using the 
method described in Sec.  1.512(a)-1(c).
    (g) Total UBTI--(1) In general. The total UBTI of an organization 
with more than one unrelated trade or business is the sum of the UBTI 
computed with respect to each separate unrelated trade or business (as 
identified under paragraph (a)(2) of this section and subject to the 
limitation described in paragraph (g)(2) of this section), less a 
charitable contribution deduction, an NOL deduction for losses arising 
in taxable years beginning before January 1, 2018 (pre-2018 NOLs), and a 
specific deduction under section 512(b)(12), as applicable.
    (2) UBTI not less than zero. For purposes of paragraph (g)(1) of 
this section, the UBTI with respect to any separate unrelated trade or 
business identified under paragraph (a)(2) of this section cannot be 
less than zero.
    (h) Net operating losses--(1) In general. For taxable years 
beginning after December 31, 2017, an exempt organization with more than 
one unrelated trade or business determines the NOL deduction allowed by 
sections 172(a) and 512(b)(6) separately with respect to each of its 
unrelated trades or businesses. Accordingly, if an exempt organization 
has more than one unrelated trade or business, Sec.  1.512(b)-1(e) 
applies separately with respect to each such unrelated trade or 
business.
    (2) Coordination of pre-2018 and post-2017 NOLs. An organization 
with pre-2018 NOLs, and with losses arising in a taxable year beginning 
after December 31, 2017 (post-2017 NOLs), deducts its pre-2018 NOLs from 
total UBTI before deducting any post-2017 NOLs with regard to a separate 
unrelated trade or business against the UBTI from such trade or 
business. Pre-2018 NOLs are taken against the total UBTI as determined 
under paragraph (g) of this section in a manner that allows for maximum 
utilization of post-2017 NOLs in a taxable year. For example, an 
organization could choose to allocate all of its pre-2018 NOLs to one of 
its separate unrelated trades or businesses or it could allocate its 
pre-2018 NOLs ratably among its separate unrelated

[[Page 200]]

trades or businesses, whichever results in the greatest utilization of 
the post-2017 NOLs in that taxable year.
    (3) Treatment of NOLs upon the termination, sale, exchange, or other 
disposition of a separate unrelated trade or business. After offsetting 
any gain resulting from the termination, sale, exchange, or disposition 
of a separate unrelated trade or business, any NOL remaining is 
suspended. However, the suspended NOLs may be used if that previous 
separate unrelated trade or business is later resumed or if a new 
unrelated trade or business that is accurately identified using the same 
NAICS 2-digit code as the previous separate unrelated trade or business 
is commenced or acquired in a future taxable year.
    (4) Treatment of NOLs when the identification of a separate 
unrelated trade or business changes--(i) In general. For purposes of 
section 512(a)(6) and this section, a separate unrelated trade or 
business for which the appropriate identification (within the meaning of 
paragraph (a) of this section) changes is treated as if the originally 
identified separate unrelated trade or business is terminated and a new 
separate unrelated trade or business is commenced. None of the NOLs from 
the previously identified separate unrelated trade or business will be 
carried over to the newly identified separate unrelated trade or 
business. For example, if the nature of a separate unrelated trade or 
business changes such that it is more accurately described by another 
NAICS 2-digit code, the separate unrelated trade or business is treated 
as a new separate unrelated trade or business with no NOLs. The change 
in identification may apply to all or a part of the originally 
identified separate unrelated trade or business. If the change in 
identification applies to the originally identified separate trade or 
business in its entirety, any NOLs attributable to that separate 
unrelated trade or business are suspended in accordance with paragraph 
(h)(3) of this section. If the change in identification applies to the 
originally identified separate unrelated trade or business in part, the 
originally identified separate unrelated trade or business that is not 
changing retains the full NOLs attributable to the originally identified 
separate unrelated trade or business, without allocation to the portion 
that became a newly identified separate unrelated trade or business. 
This paragraph (h)(4) also applies to each QPI that becomes a non-QPI. 
In this case, any NOLs attributable to the QPI that became a non-QPI are 
retained with the organization's investment activities described in 
paragraph (c) of this section.
    (ii) Exception for non-material changes. In the case of a separate 
unrelated trade or business that is accidentally identified using the 
wrong NAICS 2-digit code or if an organization has determined that a 
separate unrelated trade or business that has not materially changed is 
more accurately identified by another NAICS 2-digit code, any NOL 
attributable to the originally identified separate unrelated trade or 
business becomes an NOL of the newly identified separate unrelated trade 
or business.
    (iii) Effective date of change in identification. A change in 
identification described in this paragraph (h)(4) is effective on the 
first day of the taxable year in which the change in identification is 
made. Accordingly, the newly identified separate unrelated trade or 
business is treated as commencing on this date.
    (iv) Examples--(A) In general. The following examples illustrate the 
rules described in this paragraph (h)(4).
    (B) Example 1. Erroneous code. (1) Organization G is described in 
section 501(c) and is exempt from Federal income tax under section 
501(a). In addition to its investment activities, Organization G has two 
separate unrelated trades or businesses--Q and R--that are identified 
with different NAICS 2-digit codes. Both Q and R have NOLs carried over 
from post-2017 taxable years.
    (2) In Year 2 (a post-2017 taxable year), Organization G realizes 
that it accidentally used the wrong NAICS 2-digit code to identify R. 
The NOLs attributable to R under the old NAICS 2-digit code become the 
NOLs of R under the new NAICS 2-digit code as of the first day of Year 
2.
    (C) Example 2. Material change. (1) Same facts as Example 1, except 
assume

[[Page 201]]

that, in addition to its investment activities, Organization G has three 
separate unrelated trades or businesses--Q, R, and S--that are 
identified with different NAICS 2-digit codes. Q, R, and S all have NOLs 
carried over from post-2017 taxable years.
    (2) Organization G changes the NAICS 2-digit code identifying R to 
the same NAICS 2-digit code identifying S because the nature of the 
unrelated trade or business materially changed. Any post-2017 NOLs 
attributable to R are suspended (see paragraph (h)(4)(i) of this 
section). Organization G now has two separate unrelated trades or 
businesses--Q and S--as of the first day of Year 2.
    (D) Example 3. Partial material change. Same facts as Example 1, 
except assume that Organization G determines that a part of R has 
materially changed such that R should be identified as two separate 
unrelated trades or businesses--R1 and R2. R1 retains the NAICS 2-digit 
code originally identifying R, and R2 is identified with a new NAICS 2-
digit code that is not the same NAICS 2-digit code identifying Q. R2 is 
treated as a new separate unrelated trade or business with no NOLs as of 
the first day of Year 2. Any post-2017 NOLs attributable to R remain 
with R1.
    (E) Example 4. QPI to non-QPI. (1) Same facts as Example 1, but 
assume that Organization G has a partnership interest in T that was, for 
prior taxable years, a QPI included with Organization G's investment 
activities. In Year 3 (a post-2017 taxable year), Organization G 
acquires more than 20 percent of the capital interests in T. The grace 
period described in paragraph (c)(6) of this section does not apply 
because the increase in percentage interest was not due to the actions 
of other partners.
    (2) T conducts two trade or business activities that are unrelated 
trade or business activities with respect to Organization G--T1 and T2. 
Both T1 and T2 will be treated as new separate unrelated trades or 
business as of the first day of Year 2. Organization G identifies T1 
with the same NAICS 2-digit code used to identify Q and T2 with a NAICS 
2-digit code that is different than the NAICS 2-digit codes used to 
identify Q and R. In addition to its investment activities, Organization 
G has three separate unrelated trades or businesses--Q, R, and T2. Any 
post-2017 NOLs attributable to the QPI remain with Organization G's 
other investment activities separate unrelated trade or business.
    (i) Applicability dates. This section is applicable to taxable years 
beginning on or after December 2, 2020. Taxpayers may choose to apply 
this section to taxable years beginning on or after January 1, 2018, and 
before December 2, 2020.

[T.D. 9933, 85 FR 77979, Dec. 2, 2020; 86 FR 9286, Feb. 12, 2021]



Sec.  1.512(b)-1  Modifications.

    Whether a particular item of income falls within any of the 
modifications provided in section 512(b) shall be determined by all the 
facts and circumstances of each case. For example, if a payment termed 
rent by the parties is in fact a return of profits by a person operating 
the property for the benefit of the tax-exempt organization or is a 
share of the profits retained by such organization as a partner or joint 
venturer, such payment is not within the modification for rents. The 
modifications provided in section 512(b) are as follows:
    (a) Certain Investment Income. (1) Dividends (including an inclusion 
of subpart F income under section 951(a)(1)(A) or an inclusion of global 
intangible low-taxed income (GILTI) under section 951A(a), both of which 
are treated in the same manner as a dividend for purposes of section 
512(b)(1)), interest, payments with respect to securities loans (as 
defined in section 512(a)(5)), annuities, income from notional principal 
contracts (as defined in Sec.  1.837-7 or regulations issued under 
section 446), other substantially similar income from ordinary and 
routine investments to the extent determined by the Commissioner, and 
all deductions directly connected with any of the foregoing items of 
income must be excluded in computing unrelated business taxable income.
    (2) Limitations. The exclusions under paragraph (a)(1) of this 
section do not apply to income derived from and deductions in connection 
with debt-financed property (as defined in section 514(b)). Moreover, 
the exclusions under

[[Page 202]]

paragraph (a)(1) of this section do not apply to gains or losses from 
the sale, exchange, or other disposition of any property, or to gains or 
losses from the lapse or termination of options to buy or sell 
securities. For rules regarding the treatment of these gains and losses, 
see section 512(b)(5) and Sec.  1.512(b)-1(d). Furthermore, the 
exclusions under paragraph (a)(1) of this section do not apply to 
interest and annuities derived from and deductions in connection with 
controlled organizations. For rules regarding the treatment of such 
amounts, see section 512(b)(13) and Sec.  1.512(b)-1(l). Finally, the 
exclusions under paragraph (a)(1) of this section of income from 
notional principal contracts and income that the Commissioner determines 
to be substantially similar income from ordinary and routine investments 
do not apply to income earned by brokers or dealers (including 
organizations that make a market in derivative financial products, as 
described in Treasury Regulations 26 CFR 1.954-2T(a)(4)(iii)(B)).
    (3) Effective dates. The effective dates of the rules of paragraphs 
(a)(1) and (a)(2) of this section that were in effect prior to August 
30, 1991, remain the same. The exclusion under paragraph (a)(1) of this 
section of income from notional principal contracts is effective for 
amounts received after August 30, 1991. However, an organization may 
apply the exclusion under paragraph (a)(1) of this section of income 
from notional principal contracts prior to that date, provided that such 
amounts are treated consistently for all open taxable years. Unless 
otherwise provided by the Commissioner, the exclusion under paragraph 
(a)(1) of this section of income that the Commissioner determines to be 
substantially similar income from ordinary and routine investments is 
effective for amounts received after the date of the Commissioner's 
determination. The exclusion under paragraph (a)(1) of this section of 
an inclusion of subpart F income under section 951(a)(1)(A) or an 
inclusion of GILTI under section 951A(a) from income (both inclusions 
being treated in the same manner as dividends) is applicable to taxable 
years beginning on or after December 2, 2020. However, an organization 
may choose to apply this exclusion to taxable years beginning before 
December 2, 2020.
    (b) Royalties. Royalties, including overriding royalties, and all 
deductions directly connected with such income shall be excluded in 
computing unrelated business taxable income. However, for taxable years 
beginning after December 31, 1969, certain royalties from and certain 
deductions in connection with either, debt-financed property (as defined 
in section 514(b)) or controlled organizations (as defined in paragraph 
(l) of this section) shall be included in computing unrelated business 
taxable income. Mineral royalties shall be excluded whether measured by 
production or by gross or taxable income from the mineral property. 
However, where an organization owns a working interest in a mineral 
property, and is not relieved of its share of the development costs by 
the terms of any agreement with an operator, income received from such 
an interest shall not be excluded. To the extent not treated as a loan 
under section 636, payments in discharge of mineral production payments 
shall be treated in the same manner as royalty payments for the purpose 
of computing unrelated business taxable income. To the extent treated as 
a loan under section 636, the amount of any payment in discharge of a 
production payment which is the equivalent of interest shall be treated 
as interest for purposes of section 512(b)(1) and paragraph (a) of this 
section.
    (c) Rents--(1) Taxable years beginning before January 1, 1970. For 
taxable years beginning before January 1, 1970, rents from real property 
(including personal property leased with the real property) and the 
deductions directly connected therewith shall be excluded in computing 
unrelated business taxable income, except that certain rents from, and 
certain deductions in connection with, a business lease (as defined in 
section 514(f)) shall be included in computing unrelated business 
taxable income. See subparagraph (5) of this paragraph for rules 
governing amounts received for the rendering of services.
    (2) Taxable years beginning after December 31, 1969--(i) In general. 
For taxable years beginning after December 31, 1969, except as provided 
in subdivision

[[Page 203]]

(iii) of this subparagraph, rents from property described in subdivision 
(ii) of this subparagraph, and the deductions directly connected 
therewith, shall be excluded in computing unrelated business taxable 
income. However, notwithstanding subdivision (ii) of this subparagraph, 
certain rents from and certain deductions in connection with either 
debt-financed property (as defined in section 514(b)) or property rented 
to controlled organizations (as defined in paragraph (l) of this 
section) shall be included in computing unrelated business taxable 
income.
    (ii) Excluded rents. The rents which are excluded from unrelated 
business income under section 512(b)(3)(A) and this paragraph are:
    (a) Real property. All rents from real property; and
    (b) Personal property. All rents from personal property leased with 
real property if the rents attributable to such personal property are an 
incidental amount of the total rents received or accrued under the 
lease, determined at the time sonal property are an incidental amount 
service by the lessee


For purposes of the preceding sentence, rents attributable to personal 
property generally are not an incidental amount of the total rents if 
such rents exceed 10 percent of the total rents from all the property 
leased. For example, if the rents attributable to the personal property 
leased are determined to be $3,000 per year, and the total rents from 
all property leased are $10,000 per year, then such $3,000 amount is not 
to be excluded from the computation of unrelated business taxable income 
by operation of section 512(b)(3)(A)(ii) and this paragraph, since such 
amount is not an incidental portion of the total rents.
    (iii) Exception. Subdivision (ii) of this subparagraph shall not 
apply, if either:
    (a) Excess personal property rents. More than 50 percent of the 
total rents are attributable to personal property, determined at the 
time such personal property is first placed in service by the lessee; or
    (b) Net profits. The determination of the amount of such rents 
depends in whole or in part on the income or profits derived by any 
person from the property leased, other than an amount based on a fixed 
percentage or percentages of the gross receipts or sales. For purposes 
of the preceding sentence, the rules contained in paragraph (b) (3) and 
(6) (other than paragraph (b)(6)(ii)) of Sec.  1.856-4 shall apply.
    (iv) Illustration. This subparagraph may be illustrated by the 
following example:

    Example. A, an exempt organization, owns a printing factory which 
consists of a building housing two printing presses and other equipment 
necessary for printing. On January 1, 1971, A rents the building and the 
printing equipment to B for $10,000 a year. The lease states that $9,000 
of such rent is for the building and $1,000 for the printing equipment. 
However, it is determined that notwithstanding the terms of the lease 
$4,000, or 40 percent ($4,000/$10,000), of the rent is actually 
attributable to the printing equipment. During 1971, A has $3,000 of 
deductions, all of which are properly allocable to the land and 
building. Under these circumstances, A shall not take into account in 
computing its unrelated business taxable income the $6,000 of rent 
attributable to the building and the $3,000 of deductions directly 
connected with such rent. However, the $4,000 of rent attributable to 
the printing equipment is not excluded from the computation of A's 
unrelated business taxable income by operation of section 
512(b)(3)(A)(ii) or this paragraph since such rent represents more than 
an incidental portion of the total rents.

    (3) Definitions and special rules. For purposes of subparagraph (2) 
of this paragraph:
    (i) Real property defined. The term real property means all real 
property, including any property described in sections 1245(a)(3)(C) and 
1250(c) and the regulations thereunder.
    (ii) Personal property defined. The term personal property means all 
personal property, including any property described in section 
1245(a)(3)(B) and the regulations thereunder.
    (iii) Multiple leases. If separate leases are entered into with 
respect to real and personal property, and such properties have an 
integrated use (e.g., one or more leases for real property and another 
lease or leases for personal property to be used upon such real 
property), all such leases shall be considered as one lease.
    (iv) Placed in service. Property is placed in service by the lessee 
when it is first subject to his use in accordance

[[Page 204]]

with the terms of the lease. For example, property subject to a lease 
entered into on November 1, 1971, for a term commencing on January 1, 
1972, shall be considered as placed in service on January 1, 1972, 
regardless of when the property is first actually used by the lessee.
    (v) Changes in rent charged or personal property rented. If:
    (a) By reason of the placing of additional or substitute personal 
property in service, there is an increase of 100 percent or more in the 
rent attributable to all the personal property leased, or
    (b) There is a modification of the lease by which there is a change 
in the rent charged (whether or not there is a change in the amount of 
personal property rented), the rent attributable to personal property 
shall be recomputed to determine whether the exclusion under 
subparagraph (2)(ii)(b) of this paragraph or the exception under 
subparagraph (2)(iii)(a) of this paragraph applies. Any change in the 
treatment of rents, attributable to a recomputation under this 
subdivision, shall be effective only with respect to rents for the 
period beginning with the event which occasioned the recomputation.
    (4) Examples. Subparagraphs (2) and (3) of this paragraph may be 
illustrated by the following examples:

    Example 1. On January 1, 1971, A, an exempt organization, executes 
two leases with B. One is for the rental of a computer, with a stated 
annual rent of $750. The other is for the rental of office space in 
which to use the computer, at a stated annual rent of $7,250. The total 
annual rent under both leases for 1971 is $8,000. At the time the 
computer is first placed in service, however, taking both leases into 
consideration, it is determined that notwithstanding the terms of the 
leases $3,000, or 37.5 percent ($3,000/$8,000), of the rent is actually 
attributable to the computer. Therefore, for 1971, only the $5,000 
($8,000-$3,000) attributable to the rental of the office space is 
excluded from the computation of A's unrelated business taxable income 
by operation of section 512(b)(3).
    Example 2. Assume the facts as stated in example 1. Assume further 
that the leases to which the computer and office space are subject in 
example 1 provide that the rent may be increased or decreased, depending 
upon the prevailing rental value for similar computers and office space. 
On January 1, 1972, the total annual rent is increased in the computer 
lease to $2,000, and in the office space lease to $9,000. For 1972, it 
is determined that notwithstanding the terms of the leases $6,000, or 
54.5 percent ($6,000/$11,000), of the total rent is actually 
attributable to the computer as of that time. Even though the rent 
attributable to personal property now exceeds 50 percent of the total 
rent, the rent attributable to real property will continue to be 
excluded, since there was no modification of the terms of the leases and 
since the increase in the rent was not attributable to the placing of 
new personal property in service. See subparagraph (3)(v) of this 
paragraph. Thus, for 1972 the $5,000 of rent attributable to the office 
space continues to be excluded from the computation of A's unrelated 
business taxable income by operation of section 512(b)(3).
    Example 3. Assume the facts as stated in example 1, except that on 
January 1, 1973, B rents a second computer from A, which is placed in 
service on that date. The total rent is increased to $2,000 for the 
computer lease and to $10,000 for the office space lease. It is 
determined at the time the second computer is first placed in service 
that notwithstanding the terms of the leases $7,000 of the rent is 
actually attributable to the computers. Since the rent attributable to 
personal property has increased by more than 100 percent ($4,000 / 
$3,000 = 133 percent), a redetermination must be made pursuant to 
subparagraph (3)(v) (a) of this paragraph. As a result, 58.3 percent 
($7,000/$12,000) of the total rent is determined to be attributable to 
personal property. Accordingly, since more than 50 percent of the total 
rent A receives is attributable to the personal property leased, none of 
the rents are excluded from the computation of A's unrelated business 
taxable income by operation of section 512(b)(3).
    Example 4. Assume the facts as stated in example 3, except that on 
June 30, 1975, the lease between B and A is modified. The total rent for 
the computer lease is reduced to $1,500 and the total rent for the 
office space lease is reduced to $7,500. Pursuant to subdivision 
(3)(v)(b) of this paragraph, a redetermination is made as of June 30, 
1975. As of the modification date, it is determined that notwithstanding 
the terms of the leases, the rent actually attributable to the computers 
is $4,000, or 44.4 percent ($4,000/$9,000), of the total rent. Since 
less than 50 percent of the total rent is now attributable to personal 
property, the rent attributable to real property ($5,000), for periods 
after June 30, 1975, is excluded from the computation of A's unrelated 
business taxable income by operation of section 512(b)(3). However, the 
rent attributable to personal property ($4,000) is not excluded from 
unrelated business taxable income for such periods by operation of 
section 512(b)(3), since it represents more than an incidental portion 
of the total rent.


[[Page 205]]


    (5) Rendering of services. For purposes of this paragraph, payments 
for the use or occupancy of rooms and other space where services are 
also rendered to the occupant, such as for the use or occupancy of rooms 
or other quarters in hotels, boarding houses, or apartment houses 
furnishing hotel services, or in tourist camps or tourist homes, motor 
courts, or motels, or for the use of occupancy of space in parking lots, 
warehouses, or storage garages, does not constitute rent from real 
property. Generally, services are considered rendered to the occupant if 
they are primarily for his convenience and are other than those usually 
or customarily rendered in connection with the rental of rooms or other 
space for occupancy only. The supplying of maid service, for example, 
constitutes such service; whereas the furnishing of heat and light, the 
cleaning of public entrances, exists, stairways, and lobbies, the 
collection of trash, etc., are not considered as services rendered to 
the occupant. Payments for the use or occupancy of entire private 
residences or living quarters in duplex or multiple housing units, of 
offices in any office building, etc., are generally treated as rent from 
real property.
    (d)(1) Gains and losses from the sale, etc. of property. There shall 
also be excluded from the computation of unrelated business taxable 
income gains or losses from the sale, exchange, or other disposition of 
property other than (i) stock in trade or other property of a kind which 
would properly be included in the inventory of the organization if on 
hand at the close of the taxable year, or (ii) property held primarily 
for sale to customers in the ordinary course of the trade or business. 
This exclusion does not apply with respect to the cutting of timber 
which is considered, upon the application of section 631(a), as a sale 
or exchange of such timber. In addition, for taxable years beginning 
after December 31, 1969, this exclusion does not apply to the gain 
derived from the sale or other disposition of debt-financed property (as 
defined in section 514(b)). Otherwise, the exclusion under section 
512(b)(5) applies with respect to gains and losses from involuntary 
conversions, casualties, etc.
    (2) There shall be excluded from the computation of unrelated 
business taxable income any gain from the lapse or termination after 
December 31, 1975, of options to buy or sell securities (as that term is 
defined in section 1236(c)). An option is considered terminated when the 
organization's obligation under the option ceases by any means other 
than by reason of the exercise or lapse of such option. If the exclusion 
is otherwise available it will apply whether or not the organization 
owns the securities upon which the option is written, that is, whether 
or not the option is covered. However, income from the lapse or 
termination of an option is excludable only if the option is written in 
connection with the organization's investment activities. Thus, for 
example, if the securities upon which the options are written are held 
by the organization as inventory or for sale to customers in the 
ordinary course of a trade or business, the income from the lapse or 
termination will not be excludable under the provisions of this 
paragraph. Similarly, if an organization is engaged in the trade or 
business of writing options (whether or not such options are covered) 
the exclusion will not be available.
    (e) Net operating losses. (1) The net operating loss deduction 
provided in section 172 shall be allowed in computing unrelated business 
taxable income. However, the net operating loss carryback or carryover 
(from a taxable year for which the taxpayer is subject to the provisions 
of section 511) shall be determined under section 172 without taking 
into account any amount of income or deduction which is not included 
under section 511 in computing unrelated business taxable income. For 
example, a loss attributable to an unrelated trade or business shall not 
be diminished by reason of the receipt of dividend income.
    (2) For the purpose of computing the net operating loss deduction 
provided by section 172, any prior taxable year for which an 
organization was not subject to the provisions of section 511, or a 
corresponding provision of prior law, shall not be taken into account. 
Thus, if the organization was not subject to the provisions of section 
511 or supplement U of the Internal Revenue Code of

[[Page 206]]

1939 for a preceding taxable year, the net operating loss is not a 
carryback to such preceding taxable year, and the net operating loss 
carryover to succeeding taxable years is not reduced by the taxable 
income for such preceding taxable year.
    (3) A net operating loss carryback or carryover shall be allowed 
only from a taxable year for which the taxpayer is subject to the 
provisions of section 511, or a corresponding provision of prior law.
    (4) In determining the span of years for which a net operating loss 
may be carried for purposes of section 172, taxable years in which an 
organization was not subject to the provisions of section 511 or a 
corresponding provision of prior law shall be taken into account. Thus, 
for example, if an organization is subject to the provisions of section 
511 for the taxable year 1955 and has a net operating loss for that 
year, the last taxable year to which any part thereof may be carried 
over is the year 1960 regardless of whether the organization is subject 
to the provisions of section 511 in any of the intervening taxable 
years.
    (5) See Sec.  1.512(a)-6(h) regarding the computation of the net 
operating loss deduction when an organization has more than one 
unrelated trade or business.
    (f) Research. (1) Income derived from research for the United States 
or any of its agencies or instrumentalities or a State or political 
subdivision thereof, and all deductions directly connected with such 
income, shall be excluded in computing unrelated business taxable 
income.
    (2) In the case of a college, university, or hospital, all income 
derived from research performed for any person and all deductions 
directly connected with such income, shall be excluded in computing 
unrelated business taxable income.
    (3) In the case of an organization operated primarily for the 
purpose of carrying on fundamental research (as distinguished from 
applied research) the results of which are freely available to the 
general public, all income derived from research performed for any 
person and all deductions directly connected with such income shall be 
excluded in computing unrelated business taxable income.
    (4) For the purpose of Sec. Sec.  1.512(a)-1, 1.512(a)-2, and this 
section, the term research does not include activities of a type 
ordinarily carried on as an incident to commercial or industrial 
operations, for example, the ordinary testing or inspection of materials 
or products or the designing or construction of equipment, buildings, 
etc. The term fundamental research does not include research carried on 
for the primary purpose of commercial or industrial application.
    (g) Charitable, etc., contributions. (1) In computing the unrelated 
business taxable income of an organization described in section 
511(a)(2) the deduction from gross income allowed by section 170 
(relating to charitable contributions and gifts) shall be allowed, 
whether or not the contribution is directly connected with the carrying 
on of the trade or business. Section 512(b)(10) provides that this 
deduction shall not exceed 5 percent of the organization's unrelated 
business taxable income computed without regard to that deduction. The 
provisions of section 170(b)(2) are not applicable to contributions by 
the organizations described in section 511(a)(2).
    (2) In computing the unrelated business taxable income of a trust 
described in section 511(b)(2), the deduction allowed by section 170 
(relating to charitable contributions and gifts) shall be allowed 
whether or not the contribution is directly connected with the carrying 
on of the trade or business. The deduction is limited as provided in 
section 170(b)(1) (A) and (B), except that the amounts so allowed are 
determined on the basis of unrelated business taxable income computed 
without regard to this deduction (rather than on the basis of adjusted 
gross income). For purposes of this deduction, a distribution by a trust 
described in section 511(b)(2) made pursuant to the trust instrument to 
a beneficiary described in section 170 shall be treated in the same 
manner as gifts or contributions.
    (3) The contribution, whether made by a trust or other exempt 
organization, must be paid to another organization to be allowable. For 
example, a

[[Page 207]]

university described in section 501(c)(3) which is exempt from tax and 
which operates an unrelated business, shall be allowed a deduction, not 
in excess of 5 percent of its unrelated business taxable income, for 
gifts or contributions to another university described in section 
501(c)(3) for educational work but shall not be allowed any deduction 
for amounts expended in administering its own educational program.
    (4) The term unrelated business taxable income as used in section 
512(b)(10) and (11) refers to unrelated business taxable income after 
application of section 512(a)(6).
    (5) Paragraph (g)(4) of this section is applicable to taxable years 
beginning on or after December 2, 2020. Taxpayers may choose to apply 
this section to taxable years beginning on or after January 1, 2018, and 
before December 2, 2020.
    (h) Specific deduction--(1) In general. In computing unrelated 
business taxable income a specific deduction from gross income of $1,000 
is allowed. However, for taxable years beginning after December 31, 
1969, such specific deduction is not allowed in computing the net 
operating loss under section 172 and paragraph (6) of section 512(b).
    (2) Special rule for a diocese, province of a religious order, or a 
convention or association of churches. (i) In the case of a diocese, 
province of a religious order, or a convention or association of 
churches, there shall be allowed with respect to each parish, individual 
church, district, or other local unit a specific deduction equal to the 
lower of $1,000 or the gross income derived from an unrelated trade or 
business regularly conducted by such local unit. However, a diocese, 
province of a religious order, or a convention or association of 
churches shall not be entitled to a specific deduction for a local unit 
which, for a taxable year, files a separate return. In the case of a 
local unit which, for a taxable year, files a separate return, such 
local unit may claim a specific deduction equal to the lower of $1,000 
or the gross income derived from any unrelated trade or business which 
it regularly conducts.
    (ii) The provisions of this subparagraph may be illustrated by the 
following example:

    Example. X is an association of churches on the calendar year basis. 
X is divided into local units A, B, C, and D. During 1973, A, B, C, and 
D derive gross income of, respectively, $1,200, $800, $1,500, and $700 
from unrelated businesses which they regularly conduct. Furthermore, for 
such taxable year, D files a separate return. X may claim a specific 
deduction of $1,000 with respect to A, $800 with respect to B, and 
$1,000 with respect to C. X may not claim a specific deduction with 
respect to D. D, however, may claim a specific deduction of $700 on its 
return.

    (i) Transitional period for churches. (1)(i) In the case of an 
unrelated trade or business (as defined in section 513) carried on 
before May 27, 1969, by a church or convention or association of 
churches (as defined in Sec.  1.511-2(a)(3)(ii)), or by the predecessor 
of a church or convention or association of churches which predecessor 
was itself a church or convention or association of churches, all gross 
income derived from such unrelated trade or business and all deductions 
directly connected with the carrying on of such unrelated trade or 
business shall be excluded from the determination of unrelated business 
taxable income under section 512(a) for all taxable years beginning 
before January 1, 1976. Notwithstanding the preceding sentence, in the 
case of income from debt-financed property (and the deductions 
attributable thereto), as defined in section 514, of a church or 
convention or association of churches or by the predecessor of a church 
or convention or association of churches, the provisions of paragraphs 
(a) through (e) of section 514 and paragraph (4) of section 512(b) shall 
apply for taxable years beginning after December 31, 1969.
    (ii) The provisions of subdivision (i) may be illustrated by the 
following example:

    Example. X, a church as defined in Sec.  1.511-2(a)(3)(ii), realizes 
gross income from an unrelated business (as defined in section 513) of 
$100,000 for calendar year 1972. X's predecessor church, Y, began 
conducting such unrelated business in January 1, 1968. Of the $100,000 
realized for calendar year 1972, $40,000 is attributable to debt-
financed property (as defined in section 514). Since the unrelated 
business was conducted by Y prior to May 27, 1969, and since X's taxable 
year begins before January 1, 1976, that amount of the income realized 
from such business (and all deductions directly connected therewith) 
which is

[[Page 208]]

not attributable to debt-financed property shall be excluded from the 
determination of unrelated business taxable income under section 512(a). 
Therefore, of the $100,000 realized, $60,000 ($100,000 less $40,000 
attributable to debt-financed property), and all deductions directly 
connected therewith shall be excluded from the determination of such 
unrelated business taxable income for purposes of imposition of the tax 
under section 511(a). The remaining $40,000 and the deductions 
attributable thereto shall be subject to the provisions of paragraphs 
(a) through (e) of section 514 and paragraph (4) of section 512(b).

    (2) This paragraph shall not apply in the case of income from 
property, or deductions directly connected with such income, if title to 
the property is held by a corporation described in section 501(c)(2) for 
a church or convention or association of churches. Thus, if such income 
is derived from an unrelated trade or business, the corporation shall be 
liable for tax imposed by section 511(a) on such income.
    (j) Special rule for certain unrelated trades or businesses carried 
on by a religious order or by an educational institution maintained by 
such order. (1) Except as provided in subparagraph (2) of this 
paragraph, gross income realized by a religious order (or an educational 
organization described in section 170(b)(1)(A)(ii) maintained by such 
order) from an unrelated trade or business, together with all deductions 
directly connected therewith, shall be excluded from the determination 
of unrelated business taxable income under section 512(a), if:
    (i) The trade or business has been operated by such order or by such 
institution since before May 27, 1959,
    (ii) The trade or business consists of providing services under a 
license issued by a Federal regulatory agency,
    (iii) More than 90 percent of the net income from the business is, 
for each taxable year for which gross income from such business is so 
excluded by reason of section 512(b)(15) and this paragraph, devoted to 
religious, charitable, or educational purposes, and
    (iv) It is established to the satisfaction of an officer no lower 
than the Regional Commissioner that the rates or other charges for such 
services are fully competitive with rates or other charges charged for 
such services by persons not exempt from taxation. Rates or other 
charges for such services shall be considered as fully competitive with 
rates or other charges charged for such services by persons not exempt 
from taxation if the rates charged by such unrelated trade or business 
are neither materially higher nor materially lower than the rates 
charged by similar businesses operating in the same general area.
    (2) The provisions of this paragraph shall not apply with respect to 
income from debt-financed property (as defined in section 514) and the 
deductions attributable thereto. For taxable years beginning after 
December 31, 1969, such income and deductions are subject to the 
provisions of paragraphs (a) through (e) of section 514 and paragraph 
(4) of section 512(b).
    (k) Income and deductions from debt-financed property. For taxable 
years beginning after December 31, 1969, in the case of debt-financed 
property (as defined in section 514(b)), there shall be included in the 
unrelated business taxable income of an exempt organization, as an item 
of gross income derived from an unrelated trade or business, the amount 
of unrelated debt-financed income determined under section 514(a)(1) and 
Sec.  1.514(a)-1(a), and there shall be allowed, as a deduction with 
respect to such income, the amount determined under section 514(a)(2) 
and Sec.  1.514(a)-1(b).
    (l) Interest, annuities, royalties, and rents from controlled 
organizations--(1) In general. For taxable years beginning after 
December 31, 1969, if an exempt organization (hereinafter referred to as 
the controlling organization) has control (as defined in subparagraph 
(4) of this paragraph) of another organization (hereinafter referred to 
as the controlled organization), the controlling organization shall 
include as an item of gross income in computing its unrelated business 
taxable income, the amount of interest, annuities, royalties, and rents 
derived from the controlled organization determined under subparagraph 
(2) or (3) of this paragraph. The preceding sentence shall apply whether 
or not the activity conducted by the controlling organization to derive 
such amounts represents a trade or business or is regularly carried

[[Page 209]]

on. Thus, amounts received by a controlling organization from the rental 
of its real property to a controlled organization may be included in the 
unrelated business taxable income of the controlling organization, even 
though the rental of such property is not an activity regularly carried 
on by the controlling organization.
    (2) Exempt controlled organization--(i) In general. If the 
controlled organization is exempt from taxation under section 501(a), 
the amount referred to in subparagraph (1) of this paragraph is an 
amount which bears the same ratio to the interest, annuities, royalties, 
and rents received by the controlling organization from the controlled 
organization as the unrelated business taxable income of the controlled 
organization bears to whichever of the following amounts is the greater:
    (a) The taxable income of the controlled organization, computed as 
though the controlled organization were not exempt from taxation under 
section 501(a), or
    (b) The unrelated business taxable income of the controlled 
organization


both determined without regard to any amounts paid directly or 
indirectly to the controlling organization. The controlling organization 
shall be allowed all deductions directly connected with amounts included 
in gross income under the preceding sentence.
    (ii) Examples. This subparagraph may be illustrated by the following 
examples:

    Example 1. A, an exempt scientific organization described in section 
501(c)(3), owns all the stock of B, another exempt scientific 
organization described in section 501(c)(3). During 1971, A rents space 
for a laboratory to B for $15,000 a year. A's total deductions for 1971 
with respect to the leased property are $3,000: $1,000 for maintenance 
and $2,000 for depreciation. If B were not an exempt organization, its 
total taxable income would be $300,000, disregarding rent paid to A. B's 
unrelated business taxable income, disregarding rent paid to A, is 
$100,000. Under these circumstances, $4,000 of the rent paid by B will 
be included by A as net rental income in determining its unrelated 
business taxable income, computed as follows:

B's unrelated business taxable income (disregarding rent        $100,000
 paid to A)................................................
B's taxable income (computed as though B were not exempt         300,000
 and disregarding rent paid to A)..........................
Ratio ($100,000/$300,000)..................................        \1/3\
Total rent.................................................       15,000
Total deductions...........................................        3,000
Rental income treated as gross income from an unrelated            5,000
 trade or business (\1/3\ of $15,000)......................
Less deductions directly connected with such income (\1/3\         1,000
 of $3,000)................................................
                                                            ------------
Net rental income included by A in computing its unrelated        $4,000
 business taxable income...................................
 

    Example 2. Assume the facts as stated in example 1, except that B's 
taxable income is $90,000 (computed as though B were not an exempt 
organization, and disregarding rents paid to A). B's unrelated business 
taxable income ($100,000) is therefore greater than its taxable income 
($90,000). Thus, the ratio used to determine the portion of rent 
received by A which is to be taken into account is one since both the 
numerator and denominator of such ratio is B's unrelated business 
taxable income. Consequently, all the rent received by A from B 
($15,000), and all the deductions directly connected therewith ($3,000), 
are included by A in computing its unrelated business taxable income.

    (3) Nonexempt controlled organization--(i) In general. If the 
controlled organization is not exempt from taxation under section 
501(a), the amount referred to in subparagraph (1) of this paragraph is 
an amount which bears the same ratio to the interest, annuities, 
royalties, and rents received by the controlling organization from the 
controlled organization as the excess taxable income (as defined in 
subdivision (ii) of this subparagraph) of the controlled organization 
bears to whichever of the following amounts is the greater:
    (a) The taxable income of the controlled organization, or
    (b) The excess taxable income of the controlled organization


both determined without regard to any amount paid directly or indirectly 
to the controlling organization. The controlling organization shall be 
allowed all deductions which are directly connected with amounts 
included in gross income under the preceding sentence.
    (ii) Excess taxable income. For purposes of this paragraph, the term 
excess taxable income means the excess of the controlled organization's 
taxable income over the amount of such taxable income which, if derived 
directly by the controlling organization, would not be unrelated 
business taxable income.

[[Page 210]]

    (iii) Examples. This subparagraph may be illustrated by the 
following examples:

    Example 1. A, an exempt university described in section 501(c)(3), 
owns all the stock of M, a nonexempt organization. During 1971, M leases 
a factory and a dormitory from A for a total annual rent of $100,000. 
During the taxable year, M has $500,000 of taxable income, disregarding 
the rent paid to A: $150,000 from a dormitory for students of A 
university, and $350,000 from the operation of a factory which is a 
business unrelated to A's exempt purpose. A's deductions for 1971 with 
respect to the leased property are $4,000 for the dormitory and $16,000 
for the factory. Under these circumstances, $56,000 of the rent paid by 
M will be included by A as net rental income in determining its 
unrelated business taxable income, computed as follows:

M's taxable income (disregarding rent paid to A)...........     $500,000
Less taxable income from dormitory.........................      150,000
                                                            ------------
Excess taxable income......................................     $350,000
                                                            ============
Ratio ($350,000/$500,000)..................................       \7/10\
Total rent paid to A.......................................     $100,000
Total deductions ($4,000 + $16,000)........................       20,000
Rental income treated as gross income from an unrelated           70,000
 trade or business (\7/10\ of $100,000)....................
Less deductions directly connected with such income (\7/10\       14,000
 of $20,000)...............................................
                                                            ------------
Net rental income included by A in computing its unrelated       $56,000
 business taxable income...................................
 

    Example 2. Assume the facts as stated in example 1, except that M's 
taxable income (disregarding rent paid to A) is $300,000, consisting of 
$350,000 from the operation of the factory and a $50,000 loss from the 
operation of the dormitory. Thus, M's excess taxable income is also 
$300,000, since none of M's taxable income would be excluded from the 
computation of A's unrelated business taxable income if received 
directly by A. The ratio of M's excess taxable income to its taxable 
income is therefore one ($300,000/$300,000). Thus, all the rent received 
by A from M ($100,000), and all the deductions directly connected 
therewith ($20,000), are included in the computation of A's unrelated 
business taxable income.

    (4) Control--(i) In general. For purposes of this paragraph--
    (a) Stock corporation. In the case of an organization which is a 
stock corporation, the term control means ownership by an exempt 
organization of stock possessing at least 80 percent of the total 
combined voting power of all classes of stock entitled to vote and at 
least 80 percent of the total number of shares of all other classes of 
stock of such corporation.
    (b) Nonstock organization. In the case of a nonstock organization, 
the term control means that at least 80 percent of the directors or 
trustees of such organization are either representatives of or directly 
or indirectly controlled by an exempt organization. A trustee or 
director is a representative of an exempt organization if he is a 
trustee, director, agent, or employee of such exempt organization. A 
trustee or director is controlled by an exempt organization if such 
organization has the power to remove such trustee or director and 
designate a new trustee or director.
    (ii) Gain or loss of control. If control of an organization (as 
defined in subdivision (i) of this subparagraph) is acquired or 
relinquished during the taxable year, only the interest, annuities, 
royalties, and rents paid or accrued to the controlling organization in 
accordance with its method of accounting for that portion of the taxable 
year it has control shall be subject to the tax on unrelated business 
income.
    (5) Amounts taxable under other provisions of the Code--(i) In 
general. Except as provided in subdivision (ii) of this subparagraph, 
section 512(b)(13) and this paragraph do not apply to amounts which are 
included in the computation of unrelated business taxable income by 
operation of any other provision of the Code. However, amounts which are 
not included in unrelated business taxable income by operation of 
section 512(a)(1), or which are excluded by operation of section 512(b) 
(1), (2), or (3), may be included in unrelated business taxable income 
by operation of section 512(b)(13) and this paragraph.
    (ii) Debt-financed property. Rents deprived from the lease of debt-
financed property by a controlling organization to a controlled 
organization are subject to the rules contained in section 512(b)(13) 
and this paragraph. Thus, if a controlling organization leases debt-
financed property to a controlled organization, the amount of rents 
includible in the controlling organization's unrelated business taxable 
income shall first be determined under section 512(b)(13) and this 
paragraph, and only

[[Page 211]]

the portion of such rents not taken into account by operation of section 
512(b)(13) are taken into account by operation of section 514. See 
example 3 of Sec.  1.514(b)-1(b)(3).

[T.D. 6500, 25 FR 11737, Nov. 26, 1960, as amended by T.D. 6939, 32 FR 
17661, Dec. 12, 1967; T.D. 7177, 37 FR 7089, Apr. 8, 1972; T.D. 7183, 37 
FR 7885, Apr. 21, 1972; T.D. 7261, 38 FR 5466, Mar. 1, 1973; 38 FR 6387, 
Mar. 9, 1973; T.D. 7632, 44 FR 42681, July 20, 1979; T.D. 7767, 46 FR 
11265, Feb. 6, 1981; T.D. 8423, 57 FR 33443, July 29, 1992; 57 FR 42490, 
Sept. 15, 1992; T.D. 9933, 85 FR 77984, Dec. 2, 2020]



Sec.  1.512(c)-1  Special rules applicable to partnerships; in general.

    In the event an organization to which section 511 applies is a 
member of a partnership regularly engaged in a trade or business which 
is an unrelated trade or business with respect to such organization, the 
organization shall include in computing its unrelated business taxable 
income so much of its share (whether or not distributed) of the 
partnership gross income as is derived from that unrelated business and 
its share of the deductions attributable thereto. For this purpose, both 
the gross income and the deductions shall be computed with the necessary 
adjustments for the exceptions, additions, and limitations referred to 
in section 512(b) and in Sec.  1.512(b)-1. For example, if an exempt 
educational institution is a partner in a partnership which operates a 
factory and if such partnership also holds stock in a corporation, the 
exempt organization shall include in computing its unrelated business 
taxable income its share of the gross income from the operation of the 
factory, but not its share of any dividends received by the partnership 
from the corporation. If the taxable year of the organization differs 
from that of the partnership, the amounts included or deducted in 
computing unrelated business taxable income shall be based upon the 
income and deductions of the partnership for each taxable year of the 
partnership ending within or with the taxable year of the organization.



Sec.  1.513-1  Definition of unrelated trade or business.

    (a) In general. As used in section 512 the term unrelated business 
taxable income means the gross income derived by an organization from 
any unrelated trade or business regularly carried on by it, less the 
deductions and subject to the modifications provided in section 512. 
Section 513 specifies with certain exceptions that the phrase unrelated 
trade or business means, in the case of an organization subject to the 
tax imposed by section 511, any trade or business the conduct of which 
is not substantially related (aside from the need of such organization 
for income or funds or the use it makes of the profits derived) to the 
exercise or performance by such organization of its charitable, 
educational, or other purpose or function constituting the basis for its 
exemption under section 501 (or, in the case of an organization 
described in section 511(a)(2)(B), to the exercise or performance of any 
purpose or function described in section 501(c)(3)). For certain 
exceptions from this definition, see paragraph (e) of this section. For 
a special definition of unrelated trade or business applicable to 
certain trusts, see paragraph (f) of this section. Therefore, unless one 
of the specific exceptions of section 512 or 513 is applicable, gross 
income of an exempt organization subject to the tax imposed by section 
511 is includible in the computation of unrelated business taxable 
income if: (1) It is income from trade or business; (2) such trade or 
business is regularly carried on by the organization; and (3) the 
conduct of such trade or business is not substantially related (other 
than through the production of funds) to the organization's performance 
of its exempt functions.
    (b) Trade or business. The primary objective of adoption of the 
unrelated business income tax was to eliminate a source of unfair 
competition by placing the unrelated business activities of certain 
exempt organizations upon the same tax basis as the nonexempt business 
endeavors with which they compete. On the other hand, where an activity 
does not possess the characteristics of a trade or business within the 
meaning of section 162, such as when an organization sends out low-cost 
articles incidental to the solicitation of charitable contributions, the 
unrelated business income tax does not apply since the organization is 
not in competition with taxable organizations.

[[Page 212]]

However, in general, any activity of a section 511 organization which is 
carried on for the production of income and which otherwise possesses 
the characteristics required to constitute trade or business within the 
meaning of section 162--and which, in addition, is notsubstantially 
related to the performance of exempt functions--presents sufficient 
likelihood of unfair competition to be within the policy of the tax. 
Accordingly, for purposes of section 513 the term trade or business has 
the same meaning it has in section 162, and generally includes any 
activity carried on for the production of income from the sale of goods 
or performance of services. Thus, the term trade or business in section 
513 is not limited to integrated aggregates of assets, activities and 
good will which comprise businesses for the purposes of certain other 
provisions of the Internal Revenue Code. Activities of producing or 
distributing goods or performing services from which a particular amount 
of gross income is derived do not lose identity as trade or business 
merely because they are carried on within a larger aggregate of similar 
activities or within a larger complex of other endeavors which may, or 
may not, be related to the exempt purposes of the organization. Thus, 
for example, the regular sale of pharmaceutical supplies to the general 
public by a hospital pharmacydoes not lose identity as trade or business 
merely because the pharmacy also furnishes supplies to the hospital and 
patients of the hospital in accordance with its exempt purposes or in 
compliance with the terms of section 513(a)(2). Similarly, activities of 
soliciting, selling, and publishing commercial advertising do not lose 
identity as a trade or business even though the advertising is published 
in an exempt organization periodical which contains editorial matter 
related to the exempt purposes of the organization. However, where an 
activity carried on for the production of income constitutes an 
unrelated trade or business, no part of such trade or business shall be 
excluded from such classification merely because it does not result in 
profit.
    (c) Regularly carried on--(1) General principles. In determining 
whether trade or business from which a particular amount of gross income 
derives is regularly carried on, within the meaning of section 512, 
regard must be had to the frequency and continuity with which the 
activities productive of the income are conducted and the manner in 
which they are pursued. This requirement must be applied in light of the 
purpose of the unrelated business income tax to place exempt 
organization business activities upon the same tax basis as the 
nonexempt business endeavors with which they compete. Hence, for 
example, specific business activities of an exempt organization will 
ordinarily be deemed to be regularly carried on if they manifest a 
frequency and continuity, and are pursued in a manner, generally similar 
to comparable commercial activities of nonexempt organizations.
    (2) Application of principles in certain cases--(i) Normal time span 
of activities. Where income producing activities are of a kind normally 
conducted by nonexempt commercial organizations on a year-round basis, 
the conduct of such activities by an exempt organization over a period 
of only a few weeks does not constitute the regular carrying on of trade 
or business. For example, the operation of a sandwich stand by a 
hospital auxiliary for only 2 weeks at a state fair would not be the 
regular conduct of trade or business. However, the conduct of year-round 
business activities for one day each week would constitute the regular 
carrying on of trade or business. Thus, the operation of a commercial 
parking lot on Saturday of each week would be the regular conduct of 
trade or business. Where income producing activities are of a kind 
normally undertaken by nonexempt commercial organizations only on a 
seasonal basis, the conduct of such activities by an exempt organization 
during a significant portion of the season ordinarilyconstitutes the 
regular conduct of trade or business. For example, the operation of a 
track for horse racing for several weeks of a year would be considered 
the regular conduct of trade or business because it is usual to carry on 
such trade or business only during a particular season.

[[Page 213]]

    (ii) Intermittent activities; in general. In determining whether or 
not intermittently conducted activities are regularly carried on, the 
manner of conduct of the activities must be compared with the manner in 
which commercial activities are normally pursued by nonexempt 
organizations. In general, exempt organization business activities which 
are engaged in only discontinuously or periodically will not be 
considered regularly carried on if they are conducted without the 
competitive and promotional efforts typical of commercial endeavors. For 
example, the publication of advertising in programs for sports events or 
music or drama performances will not ordinarily be deemed to be the 
regular carrying on of business. Similarly, where an organization sells 
certain types of goods or services to a particular class of persons in 
pursuance of its exempt functions or primarily for the convenience of 
such persons within the meaning of section 513(a)(2) (as, for example, 
the sale of books by a college bookstore to students or the sale of 
pharmaceutical supplies by a hospital pharmacy to patients of the 
hospital), casual sales in the course of such activity which do not 
qualify as related to the exempt function involved or as described in 
section 513(a)(2) will not be treated as regular. On the other hand, 
where the nonqualifyingsales are not merely casual, but are 
systematically and consistently promoted and carried on by the 
organization, they meet the section 512 requirement of regularity.
    (iii) Intermittent activities; special rule in certain cases of 
infrequent conduct. Certain intermittent income producing activities 
occur so infrequently that neither their recurrence nor the manner of 
their conduct will cause them to be regarded as trade or business 
regularly carried on. For example, income producing or fund raising 
activities lasting only a short period of time will not ordinarily be 
treated as regularly carried on if they recur only occasionally or 
sporadically. Furthermore, such activities will not be regarded as 
regularly carried on merely because they are conducted on an annually 
recurrent basis. Accordingly, income derived from the conduct of an 
annual dance or similar fund raising event for charity would not be 
income from trade or business regularly carried on.
    (d) Substantially related--(1) In general. Gross income derives from 
unrelated trade or business, within the meaning of section 513(a), if 
the conduct of the trade or business which produces the income is not 
substantially related (other than through the production of funds) to 
the purposes for which exemption is granted. The presence of this 
requirement necessitates an examination of the relationship between the 
business activities which generate the particular income in question--
the activities, that is, of producing or distributing the goods or 
performing the services involved--and the accomplishment of the 
organization's exempt purposes.
    (2) Type of relationship required. Trade or business is related to 
exempt purposes, in the relevant sense, only where the conduct of the 
business activities has causal relationship to the achievement of exempt 
purposes (other than through the production of income); and it is 
substantially related, for purposes of section 513, only if the causal 
relationship is a substantial one. Thus, for the conduct of trade or 
business from which a particular amount of gross income is derived to be 
substantially related to purposes for which exemption is granted, the 
production or distribution of the goods or the performance of the 
services from which the gross income is derived must contribute 
importantly to the accomplishment of those purposes. Where the 
production or distribution of the goods or the performance of the 
services does not contribute importantly to the accomplishment of the 
exempt purposes of an organization, the income from the sale of the 
goods or the performance of the services does not derive from the 
conduct of related trade or business. Whether activities productive of 
gross income contribute importantly to the accomplishment of any purpose 
for which an organization is granted exemption depends in each case upon 
the facts and circumstances involved.
    (3) Size and extent of activities. In determining whether activities 
contribute importantly to the accomplishment of an exempt purpose, the 
size and extent of the activities involved must be considered in 
relation to the

[[Page 214]]

nature and extent of the exempt function which they purport to serve. 
Thus, where income is realized by an exempt organization from activities 
which are in part related to the performance of its exempt functions, 
but which are conducted on a larger scale than is reasonably necessary 
for performance of such functions, the gross income attributable to that 
portion of the activities in excess of the needs of exempt functions 
constitutes gross income from the conduct of unrelated trade or 
business. Such income is not derived from the production or distribution 
of goods or the performance of services which contribute importantly to 
the accomplishment of any exempt purpose of the organization.
    (4) Application of principles--(i) Income from performance of exempt 
functions--(A) In general. Gross income derived from charges for the 
performance of exempt functions does not constitute gross income from 
the conduct of unrelated trade or business.
    (B) Examples. The following examples illustrate the application of 
this paragraph (d)(4)(i):
    (1) Example 1. M, an organization described in section 501(c)(3), 
operates a school for training children in the performing arts, such as 
acting, singing, and dancing. It presents performances by its students 
and derives gross income from admission charges for the performances. 
The students' participation in performances before audiences is an 
essential part of their training. Since the income realized from the 
performances derives from activities which contribute importantly to the 
accomplishment of M's exempt purposes, it does not constitute gross 
income from unrelated trade or business. (For specific exclusion 
applicable in certain cases of contributed services, see section 
513(a)(1) and paragraph (e)(1) of this section.)
    (2) Example 2. N is a trade union qualified for exemption under 
section 501(c)(5). To improve the trade skills of its members, N 
conducts refresher training courses and supplies handbooks and technical 
manuals. N receives payments from its members for these services and 
materials. However, the development and improvement of the skills of its 
members is one of the purposes for which exemption is granted N; and the 
activities described contribute importantly to that purpose. Therefore, 
the income derived from these activities does not constitute gross 
income from unrelated trade or business.
    (3) Example 3. O is an industry trade association qualified for 
exemption under section 501(c)(6). It presents a trade show in which 
members of its industry join in an exhibition of industry products. O 
derives income from charges made to exhibitors for exhibit space and 
admission fees charged patrons or viewers of the show. The show is not a 
sales facility for individual exhibitors; its purpose is the promotion 
and stimulation of interest in, and demand for, the industry's products 
in general, and it is conducted in a manner reasonably calculated to 
achieve that purpose. The stimulation of demand for the industry's 
products in general is one of the purposes for which exemption is 
granted O. Consequently, the activities productive of O's gross income 
from the show--that is, the promotion, organization and conduct of the 
exhibition--contribute importantly to the achievement of an exempt 
purpose, and the income does not constitute gross income from unrelated 
trade or business. See also section 513(d) and regulations thereunder 
regarding sales activity.
    (4) Example 4. P is a qualified ABLE program described in section 
529A and Sec.  1.529A-1(b)(14). P receives amounts in order to establish 
or maintain ABLE accounts, as administrative or maintenance fees and 
other similar fees including service charges. Because the payment of 
these amounts is essential to the operation of a qualified ABLE program, 
the income generated from the activity does not constitute gross income 
from an unrelated trade or business.
    (ii) Disposition of product of exempt functions. Ordinarily, gross 
income from the sale of products which result from the performance of 
exempt functions does not constitute gross income from the conduct of 
unrelated trade or business if the product is sold in substantially the 
same state it is in on completion of the exempt functions.

[[Page 215]]

Thus, in the case of an organization described in section 501(c)(3) and 
engaged in a program of rehabilitation of handicapped persons, income 
from sale of articles made by such persons as a part of their 
rehabilitation training would not be gross income from conduct of 
unrelated trade or business. The income in such case would be from sale 
of products, the production of which contributed importantly to the 
accomplishment of purposes for which exemption is granted the 
organization--namely, rehabilitation of the handicapped. On the other 
hand, if a product resulting from an exempt function is utilized or 
exploitedin further business endeavor beyond that reasonably appropriate 
or necessary for disposition in the state it is in upon completion of 
exempt functions, the gross income derived therefrom would be from 
conduct of unrelated trade or business. Thus, in the case of an 
experimental dairy herd maintained for scientific purposes by a research 
organization described in section 501(c)(3), income from sale of milk 
and cream produced in the ordinary course of operation of the project 
would not be gross income from conduct of unrelated trade or business. 
On the other hand, if the organization were to utilize the milk and 
cream in the further manufacture of food items such as ice cream, 
pastries, etc., the gross income from the sale of such products would be 
from the conduct of unrelated trade or business unless the manufacturing 
activities themselves contribute importantly to the accomplishment of an 
exempt purpose of the organization.
    (iii) Dual use of assets or facilities. In certain cases, an asset 
or facility necessary to the conduct of exempt functions may also be 
employed in a commercial endeavor. In such cases, the mere fact of the 
use of the asset or facility in exempt functions does not, by itself, 
make the income from the commercial endeavor gross income from related 
trade or business. The test, instead, is whether the activities 
productive of the income in question contribute importantly to the 
accomplishment of exempt purposes. Assume, for example, that a museum 
exempt under section 501(c)(3) has a theater auditorium which is 
specially designed and equipped for showing of educational films in 
connection with its program of public education in the arts and 
sciences. The theater is a principal feature of the museum and is in 
continuous operation during the hours the museum is open to the public. 
If the organization were to operate the theater as an ordinary motion 
picture theater for public entertainment during the evening hours when 
the museum was closed, gross income from such operation would be gross 
income from conduct of unrelated trade or business.
    (iv) Exploitation of exempt functions. In certain cases, activities 
carried on by an organization in the performance of exempt functions may 
generate good will or other intangibles which are capable of being 
exploited in commercial endeavors. Where an organization exploits such 
an intangible in commercial activities, the mere fact that the resultant 
income depends in part upon an exempt function of the organization does 
not make it gross income from related trade or business. In such cases, 
unless the commercial activities themselves contribute importantly to 
the accomplishment of an exempt purpose, the income which they produce 
is gross income from the conduct of unrelated trade or business. The 
application of this subdivision is illustrated in the following 
examples:

    Example 1. U, an exempt scientific organization, enjoys an excellent 
reputation in the field of biological research. It exploits this 
reputation regularly by selling endorsements of various items of 
laboratory equipment to manufacturers. The endorsing of laboratory 
equipment does not contribute importantly to the accomplishment of any 
purpose for which exemption is granted U. Accordingly, the income 
derived from the sale of endorsements is gross income from unrelated 
trade or business.
    Example 2. V, an exempt university, has a regular faculty and a 
regularly enrolled student body. During the school year, V sponsors the 
appearance of professional theater companies and symphony orchestras 
which present drama and musical performances for the students and 
faculty members. Members of the general public are also admitted. V 
advertises these performances and supervises advance ticket sales at 
various places, including such university facilities as the cafeteria 
and the university bookstore. V derives gross income from the conduct of 
the performances. However, while the presentation

[[Page 216]]

of the performances makes use of an intangible generated by V's exempt 
educational functions--the presence of the student body and faculty--the 
presentation of such drama and music events contributes importantly to 
the overall educational and cultural function of the university. 
Therefore, the income which V receives does not constitute gross income 
from the conduct of unrelated trade or business.
    Example 3. W is an exempt business league with a large membership. 
Under an arrangement with an advertising agency, W regularly mails 
brochures, pamphlets and other commercial advertising materials to its 
members, for which service W charges the agency an agreed amount per 
enclosure. The distribution of the advertising materials does not 
contribute importantly to the accomplishment of any purpose for which W 
is granted exemption. Accordingly, the payments made to W by the 
advertising agency constitute gross income from unrelated trade or 
business.
    Example 4. X, an exempt organization for the advancement of public 
interest in classical music, owns a radio station and operates it in a 
manner which contributes importantly to the accomplishment of the 
purposes for which the organization is granted exemption. However, in 
the course of the operation of the station the organization derives 
gross income from the regular sale of advertising time and services to 
commercial advertisers in the manner of an ordinary commercial station. 
Neither the sale of such time nor the performance of such services 
contributes importantly to the accomplishment of any purpose for which 
the organization is granted exemption. Notwithstanding the fact that the 
production of the advertising income depends upon the existence of the 
listening audience resulting from performance of exempt functions, such 
income is gross income from unrelated trade or business.
    Example 5. Y, an exempt university, provides facilities, instruction 
and faculty supervision for a campus newspaper operated by its students. 
In addition to news items and editorial commentary, the newspaper 
publishes paid advertising. The solicitation, sale, and publication of 
the advertising are conducted by students, under the supervision and 
instruction of the university. Although the services rendered to 
advertisers are of a commercial character, the advertising business 
contributes importantly to the university's educational program through 
the training of the students involved. Hence, none of the income derived 
from publication of the newspaper constitutes gross income from 
unrelated trade or business. The same result would follow even though 
the newspaper is published by a separately incorporated section 
501(c)(3) organization, qualified under the university rules for 
recognition of student activities, and even though such organization 
utilizes its own facilities and is independent of faculty supervision, 
but carries out its educational purposes by means of student instruction 
of other students in the editorial and advertising activities and 
student participation in those activities.
    Example 6. Z is an association exempt under section 501(c)(6), 
formed to advance the interests of a particular profession and drawing 
its membership from the members of that profession. Z publishes a 
monthly journal containing articles and other editorial material which 
contribute importantly to the accomplishment of purposes for which 
exemption is granted the organization. Income from the sale of 
subscriptions to members and others in accordance with the 
organization's exempt purposes, therefore, does not constitute gross 
income from unrelated trade or business. In connection with the 
publication of the journal, Z also derives income from the regular sale 
of space and services for general consumer advertising,including 
advertising of such products as soft drinks, automobiles, articles of 
apparel, and home appliances. Neither the publication of such 
advertisements nor the performance of services for such commercial 
advertisers contributes importantly to the accomplishment of any purpose 
for which exemption is granted. Therefore, notwithstanding the fact that 
the production of income from advertising utilizes the circulation 
developed and maintained in performance of exempt functions, such income 
is gross income from unrelated trade or business.
    Example 7. The facts are as described in the preceding example, 
except that the advertising in Z's journal promotes only products which 
are within the general area of professional interest of its members. 
Following a practice common among taxable magazines which publish 
advertising, Z requires its advertising to comply with certain general 
standards of taste, fairness, and accuracy; but within those limits the 
form, content, and manner of presentation of the advertising messages 
are governed by the basic objective of the advertisers to promote the 
sale of the advertised products. While the advertisements contain 
certain information, the informational function of the advertising is 
incidental to the controlling aim of stimulating demand for the 
advertised products and differs in no essential respect from the 
informational function of any commercial advertising. Like taxable 
publishers of advertising, Z accepts advertising only from those who are 
willing to pay its prescribed rates. Although continuing education of 
itsmembers in matters pertaining to their profession is one of the 
purposes for which Z

[[Page 217]]

is granted exemption, the publication of advertising designed and 
selected in the manner of ordinary commercial advertising is not an 
educational activity of the kind contemplated by the exemption statute; 
it differs fundamentally from such an activity both in its governing 
objective and in its method. Accordingly, Z's publication of advertising 
does not contribute importantly to the accomplishment of its exempt 
purposes; and the income which it derives from advertising constitutes 
gross income from unrelated trade or business.

    (e) Exceptions. Section 513(a) specifically states that the term 
unrelated trade or business does not include:
    (1) Any trade or business in which substantially all the work in 
carrying on such trade or business is performed for the organization 
without compensation; or
    (2) Any trade or business carried on by an organization described in 
section 501(c)(3) or by a governmental college or university described 
in section 511(a)(2)(B), primarily for the convenience of its members, 
students, patients, officers, or employees; or, any trade or business 
carried on by a local association of employees described in section 
501(c)(4) organized before May 27, 1969, which consists of the selling 
by the organization of items of work-related clothes and equipment and 
items normally sold through vending machines, through food dispensing 
facilities, or by snack bars, for the convenience of its members at 
their usual places of employment; or
    (3) Any trade or business which consists of selling merchandise, 
substantially all of which has been received by the organization as 
gifts or contributions


An example of the operation of the first of the exceptions mentioned 
above would be an exempt orphanage operating a retail store and selling 
to the general public, where substantially all the work in carrying on 
such business is performed for the organization by volunteers without 
compensation. An example of the first part of the second exception, 
relating to an organization described in section 501(c)(3) or a 
governmental college or university described in section 511(a)(2)(B), 
would be a laundry operated by a college for the purpose of laundering 
dormitory linens and the clothing of students. The latter part of the 
second exception, dealing with certain sales by local employee 
associations, will not apply to sales of these items at locations other 
than the usual place of employment of the employees; therefore sales at 
such other locations will continue to be treated as unrelated trade or 
business. The third exception applies to so-called thrift shops operated 
by a tax-exempt organization where those desiring to benefit such 
organization contribute old clothes, books, furniture, et cetera, to be 
sold to the general public with the proceeds going to the exempt 
organization.
    (f) Special definition of ``unrelated trade or business'' for 
trusts. In the case of a trust computing its unrelated business taxable 
income under section 512 for purposes of section 681, or a trust 
described in section 401(a) or section 501(c)(17), which is exempt from 
tax under section 501(a), section 513(b) provides that the term 
unrelated trade or business means any trade or business regularly 
carried on by such trust or by a partnership of which it is a member. 
This definition also applies to an individual retirement account 
described in section 408 that, under section 408(e), is subject to the 
tax imposed by section 511.
    (g) Special rule respecting publishing businesses prior to 1970. For 
a special rule for taxable years beginning before January 1, 1970, with 
respect to publishing businesses carried on by an organization, see 
section 513(c) of the Code prior to its amendment by section 121(c) of 
the Tax Reform Act of 1969 (83 Stat. 542).
    (h) Effective date. This section is applicable with respect to 
taxable years beginning after December 12, 1967. However, if a taxpayer 
wishes to rely on the rules stated in this section for taxable years 
beginning before December 13, 1967, it may do so. Paragraph (f) of this 
section applies to taxable years beginning on or after December 2, 2020.

[T.D. 6939, 32 FR 17657, Dec. 12, 1967; 32 FR 17890, Dec. 14, 1967; 32 
FR 17938, Dec. 15, 1967; T.D. 7107, 36 FR 6421, Apr. 3, 1971; T.D. 7392, 
40 FR 58642, Dec. 18, 1975; T.D. 7896, 48 FR 23817, May 27, 1983; T.D. 
9923, 85 FR 74034, Nov. 19, 2020; T.D. 9933, 85 FR 77984, Dec. 2, 2020]

[[Page 218]]



Sec.  1.513-2  Definition of unrelated trade or business applicable to 
taxable years beginning before December 13, 1967.

    (a) In general. (1) As used in section 512(a), the term unrelated 
business taxable income includes only income from an unrelated trade or 
business regularly carried on, and the term trade or business has the 
same meaning as it has in section 162.
    (2) The income of an exempt organization is subject to the tax on 
unrelated business income only if two conditions are present with 
respect to such income. The first condition is that the income must be 
from a trade or business which is regularly carried on by the 
organization. The second condition is that the trade or business must 
not be substantially related (aside from the need of the organization 
for income or funds or the use it makes of the profits derived) to the 
exercise or performance by such organization of its charitable, 
educational, or other purpose or function constituting the basis for its 
exemption under section 501, or in the case ofan organization described 
in section 511(a)(2)(B) (governmental colleges, etc.) to the exercise or 
performance of any purpose or function described in section 501(c)(3). 
Whether or not an organization is subject to the tax imposed by section 
511 shall be determined by the application of these tests to the 
particular circumstances involved in each individual case. For certain 
exceptions from the term unrelated trade or business, see paragraph (b) 
of this section.
    (3) A trade or business is regularly carried on when the activity is 
conducted with sufficient consistency to indicate a continuing purpose 
of the organization to derive some of its income from such activity. An 
activity may be regularly carried on even though its performance is 
infrequent or seasonal.
    (4) Ordinarily, a trade or business is substantially related to the 
activities for which an organization is granted exemption if the 
principal purpose of such trade or business is to further (other than 
through the production of income) the purpose for which the organization 
is granted exemption. In the usual case the nature and size of the trade 
or business must be compared with the nature and extent of the 
activities for which the organization is granted exemption in order to 
determine whether the principal purpose of such trade or business is to 
further (other than through the production of income) the purpose for 
which the organization is granted exemption. For example, the operation 
of a wheat farm is substantially related to the exempt activity of an 
agricultural college if the wheat farm isoperated as a part of the 
educational program of the college, and is not operated on a scale 
disproportionately large when compared with the educational program of 
the college. Similarly, a university radio station or press is 
considered a related trade or business if operated primarily as an 
integral part of the educational program of the university, but is 
considered an unrelated trade or business if operated in substantially 
the same manner as a commercial radio station or publishing house. A 
trade or business not otherwise related does not become substantially 
related to an organization's exempt purpose merely because incidental 
use is made of the trade or business in order to further the exempt 
purpose. For example, the manufacture and sale of a product by an exempt 
college would not become substantially related merely because students 
as part of their educational program perform clerical or bookkeeping 
functions in the business. In some cases, the business may be 
substantially related because it is a necessary part of the exempt 
activity. For example, in the case of an organization described in 
section 501(c)(3) and engaged in the rehabilitation of handicapped 
persons, the business of selling articles made by such persons as a part 
of their rehabilitation training would not be considered an unrelated 
business since such business is a necessary part of the rehabilitation 
program.
    (5) If an organization receives a payment pursuant to a contract or 
agreement under which such organization is to perform research which 
constitutes an unrelated trade or business, the entire amount of such 
payment is income from an unrelated trade or business. See, however, 
section 512(b), (7), (8), and (9), relating to the exclusion from 
unrelated business taxable income of

[[Page 219]]

income derived from research for the United States, or any State, and of 
income derived from research performed for any person by a college, 
university, hospital, or organization operated primarily for the purpose 
of carrying on fundamental research the results of which are freely 
available to the general public.
    (b) Exceptions. Section 513(a) specifically states that the term 
unrelated trade or business does not include:
    (1) Any trade or business in which substantially all the work in 
carrying on such trade or business is performed for the organization 
without compensation; or
    (2) Any trade or business carried on by an organization described in 
section 501(c)(3) or by a governmental college or university described 
in section 511(a)(2)(B), primarily for the convenience of its members, 
students, patients, officers, or employees; or
    (3) Any trade or business which consists of selling merchandise, 
substantially all of which has been received by the organization as 
gifts or contributions


An example of the operation of the first of the exceptions mentioned 
above would be an exempt orphanage operating a retail store and selling 
to the general public, where substantially all the work in carrying on 
such business is performed for the organization by volunteers without 
compensation. An example of the second exception would be a laundry 
operated by a college for the purpose of laundering dormitory linens and 
the clothing of students. The third exception applies to so-called 
thrift shops operated by a tax-exempt organization where those desiring 
to benefit such organization contribute old clothes, books, furniture, 
etc., to be sold to the general public with the proceeds going to the 
exempt organization.
    (c) Special rules respecting publishing businesses. For a special 
rule with respect to publishing businesses carried on by an 
organization, see section 513(c) of the Code prior to its amendment by 
section 121(c) of the Tax Reform Act of 1969 (83 Stat. 542).
    (d) Effective date. Except as provided in paragraph (g) of Sec.  
1.513-1, this section is applicable with respect to taxable years 
beginning before December 13, 1967.

(Sec. 513 as amended by sec. 4, Act of July 14, 1960 (P.L. 86-667, 74 
Stat. 536); secs. 121 (b)(4) and (c), Tax Reform Act of 1969 (83 Stat. 
536, 542))

[T.D. 6500, 25 FR 11737, Nov. 26, 1960, as amended by T.D. 6525, 26 FR 
190, Jan. 11, 1961; T.D. 6939, 32 FR 17657, Dec. 12, 1967; T.D. 7392, 40 
FR 58643, Dec. 18, 1975; 40 FR 60053, Dec. 31, 1975]



Sec.  1.513-3  Qualified convention and trade show activity.

    (a) Introduction--(1) In general. Section 513(d) and Sec.  1.513-
3(b) provide that convention and trade show activities carried on by a 
qualifying organization in connection with a qualified convention or 
trade show will not be treated as unrelated trade or business. 
Consequently, income from qualified convention and trade show 
activities, derived by a qualifying organization that sponsors the 
qualified convention or trade show, will not be subject to the tax 
imposed by section 511. Section 1.513-3(c) defines qualifying 
organizations and qualified conventions or trade shows. Section 1.513-
3(d) concerns the treatment of income derived from certain activities, 
including rental of exhibition space at a qualified convention or trade 
show where sales activity is permitted, and the treatment of supplier 
exhibits at qualified conventions and trade shows.
    (2) Effective date. This section is effective for taxable years 
beginning after October 4, 1976.
    (b) Qualified activities not unrelated. A convention or trade show 
activity, as defined in section 513(d)(3)(A) and Sec.  1.513-3(c)(4), 
will not be considered unrelated trade or business if it is conducted by 
a qualifying organization described in section 513(d)(3)(C) and Sec.  
1.513-3(c)(1), in conjunction with a qualified convention or trade show, 
as defined in section 513(d)(3)(B) and Sec.  1.513-3(c)(2), sponsored by 
the qualifying organization. Such an activity is a qualified convention 
or trade show activity. A convention or trade show activity which is 
conducted by an organization described in section 501(c) (5) or (6), but 
which otherwise is not so qualified under this section, will be 
considered unrelated trade or business.

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    (c) Definitions--(1) Qualifying organization. Under section 
513(d)(3)(C), a qualifying organization is one which:
    (i) Is described in either section 501(c) (5) or (6), and
    (ii) Regularly conducts as one of its substantial exempt purposes a 
qualified convention or trade show.
    (2) Qualified convention or trade show. For purposes of this 
section, the term qualified convention or trade show means a show that 
meets the following requirements:
    (i) It is conducted by a qualifying organization described in 
section 513(d)(3)(C);
    (ii) At least one purpose of the sponsoring organization in 
conducting the show is the education of its members, or the promotion 
and stimulation of interest in, and demand for, the products or services 
of the industry (or segment thereof) of the members of the qualifying 
organization; and
    (iii) The show is designed to achieve that purpose through the 
character of a significant portion of the exhibits or the character of 
conferences and seminars held at a convention or meeting.
    (3) Show. For purposes of this section, the term show includes an 
international, national, state, regional, or local convention, annual 
meeting or show.
    (4) Convention and trade show activity. For purposes of this 
section, convention and trade show activity means any activity of a kind 
traditionally carried on at shows. It includes, but is not limited to--
    (i) Activities designed to attract to the show members of the 
sponsoring organization, members of an industry in general, and members 
of the public, to view industry products or services and to stimulate 
interest in, and demand for such products or services;
    (ii) Activities designed to educate persons in the industry about 
new products or services or about new rules and regulations affecting 
the industry; and
    (iii) Incidental activities, such as furnishing refreshments, of a 
kind traditionally carried on at such shows.
    (d) Certain activities--(1) Rental of exhibition space. The rental 
of display space to exhibitors (including exhibitors who are suppliers) 
at a qualified trade show or at a qualified convention and trade show 
will not be considered unrelated trade or business even though the 
exhibitors who rent the space are permitted to sell or solicit orders.
    (2) Suppliers defined. For purposes of subparagraph (1), a 
supplier's exhibit is one in which the exhibitor displays goods or 
services that are supplied to, rather than by, the members of the 
qualifying organization in the conduct of such members' own trades or 
businesses.
    (e) Example. The provisions of this section may be illustrated by 
the following examples:

    Example 1. X, an organization described in section 501(c)(6), was 
formed to promote the construction industry. Its membership is made up 
of manufacturers of heavy construction machinery many of whom own, rent, 
or lease one or more digital computers produced by various computer 
manufacturers. X is a qualifying organization under section 513(d)(3)(C) 
that regularly holds an annual meeting. At this meeting a national 
industry sales campaign and methods of consumer financing for heavy 
construction machinery are discussed. In addition, new construction 
machinery developed for use in the industry is on display with 
representatives of the various manufacturers present to promote their 
machinery. Both members and nonmembers attend this portion of the 
conference. In addition, manufacturers of computers are present to 
educate X's members. While this aspect of the conference is a supplier 
exhibit (as defined in paragraph (d) of this section), income earned 
from such activity by X will not constitute unrelated business taxable 
income to X because the activity is conducted as part of a qualified 
trade show described in Sec.  1.513-3(c).
    Example 2. Assume the same facts as in Example 1, but the only goods 
or services displayed are those of suppliers, the computer 
manufacturers. Selling and order taking are permitted. No member 
exhibits are maintained. Standing alone, this supplier exhibit (as 
defined in paragraph (d)(2) of this section) would constitute a supplier 
show and not a qualified convention or trade show. In this situation, 
however, the rental of exhibition space to suppliers is not unrelated 
trade or business. It is conducted by a qualifying organization in 
conjunction with a qualified convention or trade show. The show (the 
annual meeting) is a qualified convention or trade show because one of 
its purposes is the promotion and stimulation of interest in, and demand 
for, the products or services of the industry through the character of 
the annual meeting.

[[Page 221]]

    Example 3. Y is an organization described in section 501(c)(6). The 
organization conducts an annual show at which its members exhibit their 
products and services in order to promote public interest in the line of 
business. Potential customers are invited to the show, and sales and 
order taking are permitted. The organization secures the exhibition 
facility, undertakes the planning and direction of the show, and 
maintains exhibits designed to promote the line of business in general. 
The show is a qualified convention or trade show described in paragraph 
(c)(2) of this section. The provision of exhibition space to individual 
members is a qualified trade show activity, and is not unrelated trade 
or business.
    Example 4. Z is an organization described in section 501(c)(6) that 
sponsors an annual show. As the sole activity at the show, suppliers to 
the members of Z exhibit their products and services for the purpose of 
stimulating the sale of their products. Selling and order taking are 
permitted. The show is a supplier show and does not meet the definition 
of a qualified convention show as it does not satisfy any of the three 
alternative bases for qualification. First, the show does not stimulate 
interest in the members' products through the character of product 
exhibits as the only products exhibited are those of suppliers rather 
than members. Second, the show does not stimulate interest in members' 
products through conferences or seminars as no such conferences are held 
at the show. Third, the show does not meet the definition of a qualified 
show on the basis of educational activities as the exhibition of 
suppliers' products is designed primarily to stimulate interest in, and 
sale of, suppliers' products. Thus, the organization's provision of 
exhibition space is not a qualified convention or trade show activity. 
Income derived from rentals of exhibition space to suppliers will be 
unrelated business taxable income under section 512.

[T.D. 7896, 48 FR 23817, May 27, 1983]



Sec.  1.513-4  Certain sponsorship not unrelated trade or business.

    (a) In general. Under section 513(i), the receipt of qualified 
sponsorship payments by an exempt organization which is subject to the 
tax imposed by section 511 does not constitute receipt of income from an 
unrelated trade or business.
    (b) Exception. The provisions of this section do not apply with 
respect to payments made in connection with qualified convention and 
trade show activities. For rules governing qualified convention and 
trade show activity, see Sec.  1.513-3. The provisions of this section 
also do not apply to income derived from the sale of advertising or 
acknowledgments in exempt organization periodicals. For this purpose, 
the term periodical means regularly scheduled and printed material 
published by or on behalf of the exempt organization that is not related 
to and primarily distributed in connection with a specific event 
conducted by the exempt organization. For this purpose, printed material 
includes material that is published electronically. For rules governing 
the sale of advertising in exempt organization periodicals, see Sec.  
1.512(a)-1(f).
    (c) Qualified sponsorship payment--(1) Definition. The term 
qualified sponsorship payment means any payment by any person engaged in 
a trade or business with respect to which there is no arrangement or 
expectation that the person will receive any substantial return benefit. 
In determining whether a payment is a qualified sponsorship payment, it 
is irrelevant whether the sponsored activity is related or unrelated to 
the recipient organization's exempt purpose. It is also irrelevant 
whether the sponsored activity is temporary or permanent. For purposes 
of this section, payment means the payment of money, transfer of 
property, or performance of services.
    (2) Substantial return benefit--(i) In general. For purposes of this 
section, a substantial return benefit means any benefit other than a use 
or acknowledgment described in paragraph (c)(2)(iv) of this section, or 
disregarded benefits described in paragraph (c)(2)(ii) of this section.
    (ii) Certain benefits disregarded. For purposes of paragraph 
(c)(2)(i) of this section, benefits are disregarded if the aggregate 
fair market value of all the benefits provided to the payor or persons 
designated by the payor in connection with the payment during the 
organization's taxable year is not more than 2% of the amount of the 
payment. If the aggregate fair market value of the benefits exceeds 2% 
of the amount of the payment, then (except as provided in paragraph 
(c)(2)(iv) of this section) the entire fair market value of such 
benefits, not merely the excess amount, is a substantial return benefit. 
Fair market value is determined as

[[Page 222]]

provided in paragraph (d)(1) of this section.
    (iii) Benefits defined. For purposes of this section, benefits 
provided to the payor or persons designated by the payor may include:
    (A) Advertising as defined in paragraph (c)(2)(v) of this section.
    (B) Exclusive provider arrangements as defined in paragraph 
(c)(2)(vi)(B) of this section.
    (C) Goods, facilities, services or other privileges.
    (D) Exclusive or nonexclusive rights to use an intangible asset 
(e.g., trademark, patent, logo, or designation) of the exempt 
organization.
    (iv) Use or acknowledgment. For purposes of this section, a 
substantial return benefit does not include the use or acknowledgment of 
the name or logo (or product lines) of the payor's trade or business in 
connection with the activities of the exempt organization. Use or 
acknowledgment does not include advertising as described in paragraph 
(c)(2)(v) of this section, but may include the following: exclusive 
sponsorship arrangements; logos and slogans that do not contain 
qualitative or comparative descriptions of the payor's products, 
services, facilities or company; a list of the payor's locations, 
telephone numbers, or Internet address; value-neutral descriptions, 
including displays or visual depictions, of the payor's product-line or 
services; and the payor's brand or trade names and product or service 
listings. Logos or slogans that are an established part of a payor's 
identity are not considered to contain qualitative or comparative 
descriptions. Mere display or distribution, whether for free or 
remuneration, of a payor's product by the payor or the exempt 
organization to the general public at the sponsored activity is not 
considered an inducement to purchase, sell or use the payor's product 
for purposes of this section and, thus, will not affect the 
determination of whether a payment is a qualified sponsorship payment.
    (v) Advertising. For purposes of this section, the term advertising 
means any message or other programming material which is broadcast or 
otherwise transmitted, published, displayed or distributed, and which 
promotes or markets any trade or business, or any service, facility or 
product. Advertising includes messages containing qualitative or 
comparative language, price information or other indications of savings 
or value, an endorsement, or an inducement to purchase, sell, or use any 
company, service, facility or product. A single message that contains 
both advertising and an acknowledgment is advertising. This section does 
not apply to activities conducted by a payor on its own. For example, if 
a payor purchases broadcast time from a television station to advertise 
its product during commercial breaks in a sponsored program, the exempt 
organization's activities are not thereby converted to advertising.
    (vi) Exclusivity arrangements--(A) Exclusive sponsor. An arrangement 
that acknowledges the payor as the exclusive sponsor of an exempt 
organization's activity, or the exclusive sponsor representing a 
particular trade, business or industry, generally does not, by itself, 
result in a substantial return benefit. For example, if in exchange for 
a payment, an organization announces that its event is sponsored 
exclusively by the payor (and does not provide any advertising or other 
substantial return benefit to the payor), the payor has not received a 
substantial return benefit.
    (B) Exclusive provider. An arrangement that limits the sale, 
distribution, availability, or use of competing products, services, or 
facilities in connection with an exempt organization's activity 
generally results in a substantial return benefit. For example, if in 
exchange for a payment, the exempt organization agrees to allow only the 
payor's products to be sold in connection with an activity, the payor 
has received a substantial return benefit.
    (d) Allocation of payment--(1) In general. If there is an 
arrangement or expectation that the payor will receive a substantial 
return benefit with respect to any payment, then only the portion, if 
any, of the payment that exceeds the fair market value of the 
substantial return benefit is a qualified sponsorship payment. However, 
if the exempt organization does not establish that the payment exceeds 
the fair market value of any substantial return benefit, then

[[Page 223]]

no portion of the payment constitutes a qualified sponsorship payment.
    (i) Treatment of payments other than qualified sponsorship payments. 
The unrelated business income tax (UBIT) treatment of any payment (or 
portion thereof) that is not a qualified sponsorship payment is 
determined by application of sections 512, 513 and 514. For example, 
payments related to an exempt organization's providing facilities, 
services, or other privileges to the payor or persons designated by the 
payor, advertising, exclusive provider arrangements described in 
paragraph (c)(2)(vi)(B) of this section, a license to use intangible 
assets of the exempt organization, or other substantial return benefits, 
are evaluated separately in determining whether the exempt organization 
realizes unrelated business taxable income.
    (ii) Fair market value. The fair market value of any substantial 
return benefit provided as part of a sponsorship arrangement is the 
price at which the benefit would be provided between a willing recipient 
and a willing provider of the benefit, neither being under any 
compulsion to enter into the arrangement and both having reasonable 
knowledge of relevant facts, and without regard to any other aspect of 
the sponsorship arrangement.
    (iii) Valuation date. In general, the fair market value of the 
substantial return benefit is determined when the benefit is provided. 
However, if the parties enter into a binding, written sponsorship 
contract, the fair market value of any substantial return benefit 
provided pursuant to that contract is determined on the date the parties 
enter into the sponsorship contract. If the parties make a material 
change to a sponsorship contract, it is treated as a new sponsorship 
contract as of the date the material change is effective. A material 
change includes an extension or renewal of the contract, or a more than 
incidental change to any amount payable (or other consideration) 
pursuant to the contract.
    (iv) Examples. The following examples illustrate the provisions of 
this section:

    Example 1. On June 30, 2001, a national corporation and Z, a 
charitable organization, enter into a five-year binding, written 
contract effective for years 2002 through 2007. The contract provides 
that the corporation will make an annual payment of $5,000 to Z, and in 
return the corporation will receive no benefit other than advertising. 
On June 30, 2001, the fair market value of the advertising to be 
provided to the corporation in each year of the agreement is $75, which 
is less than the disregarded benefit amount provided for in paragraph 
(c)(2)(ii) of this section (2% of $5,000 is $100). In 2002, pursuant to 
the sponsorship contract, the corporation makes a payment to Z of 
$5,000, and receives the specified benefit (advertising). As of January 
1, 2002, the fair market value of the advertising to be provided by Z 
each year has increased to $110. However, for purposes of this section, 
the fair market value of the advertising benefit is determined on June 
30, 2001, the date the parties entered into the sponsorship contract. 
Therefore, the entire $5,000 payment received in 2002 is a qualified 
sponsorship payment.
    Example 2. The facts are the same as Example 1, except that the 
contract provides for an initial payment by the corporation to Z of 
$5,000 in 2002, followed by annual payments of $1,000 during each of 
years 2003-2007. In 2003, pursuant to the sponsorship contract, the 
corporation makes a payment to Z of $1,000, and receives the specified 
advertising benefit. In 2003, the fair market value of the benefit 
provided ($75, as determined on June 30, 2001) exceeds 2% of the total 
payment received (2% of $1,000 is $20). Therefore, only $925 of the 
$1,000 payment received in 2003 is a qualified sponsorship payment.

    (2) Anti-abuse provision. To the extent necessary to prevent 
avoidance of the rule stated in paragraphs (d)(1) and (c)(2) of this 
section, where the exempt organization fails to make a reasonable and 
good faith valuation of any substantial return benefit, the Commissioner 
(or the Commissioner's delegate) may determine the portion of a payment 
allocable to such substantial return benefit and may treat two or more 
related payments as a single payment.
    (e) Special rules--(1) Written agreements. The existence of a 
written sponsorship agreement does not, in itself, cause a payment to 
fail to be a qualified sponsorship payment. The terms of the agreement, 
not its existence or degree of detail, are relevant to the determination 
of whether a payment is a qualified sponsorship payment. Similarly, the 
terms of the agreement and not the title or responsibilities of the 
individuals negotiating the agreement determine whether a payment (or 
any portion thereof) made pursuant to the

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agreement is a qualified sponsorship payment.
    (2) Contingent payments. The term qualified sponsorship payment does 
not include any payment the amount of which is contingent, by contract 
or otherwise, upon the level of attendance at one or more events, 
broadcast ratings, or other factors indicating the degree of public 
exposure to the sponsored activity. The fact that a payment is 
contingent upon sponsored events or activities actually being conducted 
does not, by itself, cause the payment to fail to be a qualified 
sponsorship payment.
    (3) Determining public support. Qualified sponsorship payments in 
the form of money or property (but not services) are treated as 
contributions received by the exempt organization for purposes of 
determining public support to the organization under section 
170(b)(1)(A)(vi) or 509(a)(2). See Sec. Sec.  1.509(a)-3(f)(1) and 
1.170A-9(e)(6)(i). The fact that a payment is a qualified sponsorship 
payment that is treated as a contribution to the payee organization does 
not determine whether the payment is deductible by the payor under 
section 162 or 170.
    (f) Examples. The provisions of this section are illustrated by the 
following examples. The tax treatment of any payment (or portion of a 
payment) that does not constitute a qualified sponsorship payment is 
governed by general UBIT principles. In these examples, the recipients 
of the payments at issue are section 501(c) organizations. The 
expectations or arrangements of the parties are those specifically 
indicated in the example. The examples are as follows:

    Example 1. M, a local charity, organizes a marathon and walkathon at 
which it serves to participants drinks and other refreshments provided 
free of charge by a national corporation. The corporation also gives M 
prizes to be awarded to winners of the event. M recognizes the 
assistance of the corporation by listing the corporation's name in 
promotional fliers, in newspaper advertisements of the event and on T-
shirts worn by participants. M changes the name of its event to include 
the name of the corporation. M's activities constitute acknowledgment of 
the sponsorship. The drinks, refreshments and prizes provided by the 
corporation are a qualified sponsorship payment, which is not income 
from an unrelated trade or business.
    Example 2. N, an art museum, organizes an exhibition and receives a 
large payment from a corporation to help fund the exhibition. N 
recognizes the corporation's support by using the corporate name and 
established logo in materials publicizing the exhibition, which include 
banners, posters, brochures and public service announcements. N also 
hosts a dinner for the corporation's executives. The fair market value 
of the dinner exceeds 2% of the total payment. N's use of the corporate 
name and logo in connection with the exhibition constitutes 
acknowledgment of the sponsorship. However, because the fair market 
value of the dinner exceeds 2% of the total payment, the dinner is a 
substantial return benefit. Only that portion of the payment, if any, 
that N can demonstrate exceeds the fair market value of the dinner is a 
qualified sponsorship payment.
    Example 3. O coordinates sports tournaments for local charities. An 
auto manufacturer agrees to underwrite the expenses of the tournaments. 
O recognizes the auto manufacturer by including the manufacturer's name 
and established logo in the title of each tournament as well as on 
signs, scoreboards and other printed material. The auto manufacturer 
receives complimentary admission passes and pro-am playing spots for 
each tournament that have a combined fair market value in excess of 2% 
of the total payment. Additionally, O displays the latest models of the 
manufacturer's premier luxury cars at each tournament. O's use of the 
manufacturer's name and logo and display of cars in the tournament area 
constitute acknowledgment of the sponsorship. However, the admission 
passes and pro-am playing spots are a substantial return benefit. Only 
that portion of the payment, if any, that O can demonstrate exceeds the 
fair market value of the admission passes and pro-am playing spots is a 
qualified sponsorship payment.
    Example 4. P conducts an annual college football bowl game. P sells 
to commercial broadcasters the right to broadcast the bowl game on 
television and radio. A major corporation agrees to be the exclusive 
sponsor of the bowl game. The detailed contract between P and the 
corporation provides that in exchange for a $1,000,000 payment, the name 
of the bowl game will include the name of the corporation. In addition, 
the contract provides that the corporation's name and established logo 
will appear on player's helmets and uniforms, on the scoreboard and 
stadium signs, on the playing field, on cups used to serve drinks at the 
game, and on all related printed material distributed in connection with 
the game. P also agrees to give the corporation a block of game passes 
for its employees and to provide advertising in the bowl game program 
book. The fair market value of the passes is $6,000, and the fair market 
value of the program advertising is $10,000. The agreement is contingent 
upon

[[Page 225]]

the game being broadcast on television and radio, but the amount of the 
payment is not contingent upon the number of people attending the game 
or the television ratings. The contract provides that television cameras 
will focus on the corporation's name and logo on the field at certain 
intervals during the game. P's use of the corporation's name and logo in 
connection with the bowl game constitutes acknowledgment of the 
sponsorship. The exclusive sponsorship arrangement is not a substantial 
return benefit. Because the fair market value of the game passes and 
program advertising ($16,000) does not exceed 2% of the total payment 
(2% of $1,000,000 is $20,000), these benefits are disregarded and the 
entire payment is a qualified sponsorship payment, which is not income 
from an unrelated trade or business.
    Example 5. Q organizes an amateur sports team. A major pizza chain 
gives uniforms to players on Q's team, and also pays some of the team's 
operational expenses. The uniforms bear the name and established logo of 
the pizza chain. During the final tournament series, Q distributes free 
of charge souvenir flags bearing Q's name to employees of the pizza 
chain who come out to support the team. The flags are valued at less 
than 2% of the combined fair market value of the uniforms and 
operational expenses paid. Q's use of the name and logo of the pizza 
chain in connection with the tournament constitutes acknowledgment of 
the sponsorship. Because the fair market value of the flags does not 
exceed 2% of the total payment, the entire amount of the funding and 
supplied uniforms are a qualified sponsorship payment, which is not 
income from an unrelated trade or business.
    Example 6. R is a liberal arts college. A soft drink manufacturer 
enters into a binding, written contract with R that provides for a large 
payment to be made to the college's English department in exchange for R 
agreeing to name a writing competition after the soft drink 
manufacturer. The contract also provides that R will allow the soft 
drink manufacturer to be the exclusive provider of all soft drink sales 
on campus. The fair market value of the exclusive provider component of 
the contract exceeds 2% of the total payment. R's use of the 
manufacturer's name in the writing competition constitutes 
acknowledgment of the sponsorship. However, the exclusive provider 
arrangement is a substantial return benefit. Only that portion of the 
payment, if any, that R can demonstrate exceeds the fair market value of 
the exclusive provider arrangement is a qualified sponsorship payment.
    Example 7. S is a noncommercial broadcast station that airs a 
program funded by a local music store. In exchange for the funding, S 
broadcasts the following message: ``This program has been brought to you 
by the Music Shop, located at 123 Main Street. For your music needs, 
give them a call today at 555-1234. This station is proud to have the 
Music Shop as a sponsor.'' Because this single broadcast message 
contains both advertising and an acknowledgment, the entire message is 
advertising. The fair market value of the advertising exceeds 2% of the 
total payment. Thus, the advertising is a substantial return benefit. 
Unless S establishes that the amount of the payment exceeds the fair 
market value of the advertising, none of the payment is a qualified 
sponsorship payment.
    Example 8. T, a symphony orchestra, performs a series of concerts. A 
program guide that contains notes on guest conductors and other 
information concerning the evening's program is distributed by T at each 
concert. The Music Shop makes a $1,000 payment to T in support of the 
concert series. As a supporter of the event, the Music Shop receives 
complimentary concert tickets with a fair market value of $85, and is 
recognized in the program guide and on a poster in the lobby of the 
concert hall. The lobby poster states that, ``The T concert is sponsored 
by the Music Shop, located at 123 Main Street, telephone number 555-
1234.'' The program guide contains the same information and also states, 
``Visit the Music Shop today for the finest selection of music CDs and 
cassette tapes.'' The fair market value of the advertisement in the 
program guide is $15. T's use of the Music Shop's name, address and 
telephone number in the lobby poster constitutes acknowledgment of the 
sponsorship. However, the combined fair market value of the 
advertisement in the program guide and complimentary tickets is $100 
($15 + $85), which exceeds 2% of the total payment (2% of $1,000 is 
$20). The fair market value of the advertising and complimentary 
tickets, therefore, constitutes a substantial return benefit and only 
that portion of the payment, or $900, that exceeds the fair market value 
of the substantial return benefit is a qualified sponsorship payment.
    Example 9. U, a national charity dedicated to promoting health, 
organizes a campaign to inform the public about potential cures to fight 
a serious disease. As part of the campaign, U sends representatives to 
community health fairs around the country to answer questions about the 
disease and inform the public about recent developments in the search 
for a cure. A pharmaceutical company makes a payment to U to fund U's 
booth at a health fair. U places a sign in the booth displaying the 
pharmaceutical company's name and slogan, ``Better Research, Better 
Health,'' which is an established part of the company's identity. In 
addition, U grants the pharmaceutical company a license to use U's logo 
in marketing its products to health care providers around the country. 
The fair market value of the license exceeds 2% of the total payment 
received from the company.

[[Page 226]]

U's display of the pharmaceutical company's name and slogan constitutes 
acknowledgment of the sponsorship. However, the license granted to the 
pharmaceutical company to use U's logo is a substantial return benefit. 
Only that portion of the payment, if any, that U can demonstrate exceeds 
the fair market value of the license granted to the pharmaceutical 
company is a qualified sponsorship payment.
    Example 10. V, a trade association, publishes a monthly scientific 
magazine for its members containing information about current issues and 
developments in the field. A textbook publisher makes a large payment to 
V to have its name displayed on the inside cover of the magazine each 
month. Because the monthly magazine is a periodical within the meaning 
of paragraph (b) of this section, the section 513(i) safe harbor does 
not apply. See Sec.  1.512(a)-1(f).
    Example 11. W, a symphony orchestra, maintains a Web site containing 
pertinent information and its performance schedule. The Music Shop makes 
a payment to W to fund a concert series, and W posts a list of its 
sponsors on its Web site, including the Music Shop's name and Internet 
address. W's Web site does not promote the Music Shop or advertise its 
merchandise. The Music Shop's Internet address appears as a hyperlink 
from W's Web site to the Music Shop's Web site. W's posting of the Music 
Shop's name and Internet address on its Web site constitutes 
acknowledgment of the sponsorship. The entire payment is a qualified 
sponsorship payment, which is not income from an unrelated trade or 
business.
    Example 12. X, a health-based charity, sponsors a year-long 
initiative to educate the public about a particular medical condition. A 
large pharmaceutical company manufactures a drug that is used in 
treating the medical condition, and provides funding for the initiative 
that helps X produce educational materials for distribution and post 
information on X's Web site. X's Web site contains a hyperlink to the 
pharmaceutical company's Web site. On the pharmaceutical company's Web 
site, the statement appears, ``X endorses the use of our drug, and 
suggests that you ask your doctor for a prescription if you have this 
medical condition.'' X reviewed the endorsement before it was posted on 
the pharmaceutical company's Web site and gave permission for the 
endorsement to appear. The endorsement is advertising. The fair market 
value of the advertising exceeds 2% of the total payment received from 
the pharmaceutical company. Therefore, only the portion of the payment, 
if any, that X can demonstrate exceeds the fair market value of the 
advertising on the pharmaceutical company's Web site is a qualified 
sponsorship payment.

[T.D. 8991, 67 FR 20438, Apr. 25, 2002]



Sec.  1.513-5  Certain bingo games not unrelated trade or business.

    (a) In general. Under section 513(f), and subject to the limitations 
in paragraph (C) of this section, in the case of an organization subject 
to the tax imposed by section 511, the term unrelated trade or business 
does not include any trade or business that consists of conducting bingo 
games (as defined in paragraph (d) of this section).
    (b) Exception. The provisions of this section shall not apply with 
respect to any bingo game otherwise excluded from the term unrelated 
trade or business by reason of section 513(a)(1) and Sec.  1.513-1(e)(1) 
(relating to trades or businesses in which substantially all the work is 
performed without compensation).
    (c) Limitations--(1) Bingo games must be legal. Paragraph (a) of 
this section shall not apply with respect to any bingo game conducted in 
violation of State or local law.
    (2) No commercial competition. Paragraph (a) of this section shall 
not apply with respect to any bingo game conducted in a jurisdiction in 
which bingo games are ordinarily carried out on a commercial basis. 
Bingo games are ordinarily carried out on a commercial basis within a 
jursidiction if they are regularly carried on (within the meaning of 
Sec.  1.513-1(c)) by for-profit organizations in any part of that 
jurisidiction. Normally, the entire State will constitute the 
appropriate jurisdiction for determining whether bingo games are 
ordinarily carried out on a commercial basis. However, if State law 
permits local jurisdictions to determine whether bingo games may be 
conducted by for-profit organizations, or if State law limits or 
confines the conduct of bingo games by for-profit organizations to 
specific local jurisdictions, then the local jurisdiction will 
constitute the appropriate jurisdiction for determining whether bingo 
games are ordinarily carried out on a commercial basis.
    (3) Examples. The application of this paragraph is illustrated by 
the examples that follow. In each example, it is assumed that the bingo 
games referred to are operated by individuals who are compensated for 
their services. Accordingly, none of the bingo games would

[[Page 227]]

be excluded from the term unrelated trade or business under section 513 
(a) (1).

    Example 1. Church Z, a tax-exempt organization, conducts weekly 
bingo games in State O. State and local laws in State O expressly 
provide that bingo games may be conducted by tax-exempt organizations. 
Bingo games are not conducted in State O by any for-profit businesses. 
Since Z's bingo games are not conducted in violation of State or local 
law and are not the type of activity ordinarily carried out on a 
commercial basis in State O, Z's bingo games do not constitute unrelated 
trade or business.
    Example 2. Rescue Squad X, a tax-exempt organization, conducts 
weekly bingo games in State M. State M has a statutory provision that 
prohibits all forms of gambling including bingo games. However, that law 
generally is not enforced by State officials against local charitable 
organizations such as X that conduct bingo games to raise funds. Since 
bingo games are illegal under State law, X's bingo games constitute 
unrelated trade or business regardless of the degree to which the State 
law is enforced.
    Example 3. Veteran's organizations Y and X, both tax-exempt 
organizations, are organized under the laws of State N. State N has a 
statutory provision that permits bingo games to be conducted by tax-
exempt organizations. In addition, State N permits bingo games to be 
conducted by for-profit organizations in city S, a resort community 
located in county R. Several for-profit organizations conduct nightly 
bingo games in city S. Y conducts weekly bingo games in city S. X 
conducts weekly bingo games in county R. Since State law confines the 
conduct of bingo games by for-profit organizations to city S, and since 
bingo games are regularly carried on there by those organizations, Y's 
bingo games conducted in city S constitute unrelated trade or business. 
However, X's bingo games conducted in county R outside of city S do not 
constitute unrelated trade or business.

    (d) Bingo game defined. A bingo game is a game of chance played with 
cards that are generally printed with five rows of five squares each. 
Participants place markers over randomly called numbers on the cards in 
an attempt to form a preselected pattern such as a horizontal, vertical, 
or diagonal line, or all four corners. The first participant to form the 
preselected pattern wins the game. As used in this section, the term 
bingo game means any game of bingo of the type described above in which 
wagers are placed, winners are determined, and prizes or other property 
is distributed in the presence of all persons placing wagers in that 
game. The term bingo game does not refer to any game of chance 
(including, but not limited to, keno games, dice games, card games, and 
lotteries) other than the type of game described in this paragraph.
    (e) Effective date. Section 513(f) and this section apply to taxable 
years beginning after December 31, 1969.

[T.D. 7699, 45 FR 33970, May 21, 1980]



Sec.  1.513-6  Certain hospital services not unrelated trade or business.

    (a) In general. Under section 513(e), the furnishing of a service 
listed in section 501(e)(1)(A) by a hospital to one or more other 
hospitals will not constitute unrelated trade or business if--
    (1) The service is provided solely to hospitals that have facilities 
to serve not more than 100 inpatients,
    (2) The service would, if performed by the recipient hospital, 
constitute an activity consistent with that hospital's exempt purposes, 
and
    (3) The service is provided at a fee not in excess of actual cost, 
including straight line depreciation and a reasonable rate of return on 
the capital goods used to provide the service. For purposes of this 
section, a rate of return on capital goods will be considered reasonable 
provided that it does not exceed, on an annual basis, the percentage 
described below which is based on the average of the rates of interest 
on special issues of public debt obligations issued to the Federal 
Hospital Insurance Trust Fund for each of the months included in the 
taxable year of the hospital duringwhich the captial goods are used in 
providing the service. Determinations as to the cost of services and the 
applicable rate of return should be made as prescribed by 42 U.S.C. 
1395x(v)(1) (A) and (B) and the regulations thereunder (permitting a 
health care facility to be reimbursed under the Medicare program for the 
reasonable cost of (its) services, including, in the case of certain 
proprietary facilities, a reasonable return on equity capital). For 
taxable years beginning on or before May 14, 1986, the rate of return 
shall be one and one-half times the average of the rates of interest on 
public debt obligations described above

[[Page 228]]

which were in effect on or before April 20, 1983.
    (b) Hospital defined. As used in this section the word hospital 
means a hospital described in section 170(b)(1)(A)(iii).
    (c) Example. The provisions of this section are illustrated by the 
following example:

    Example. A large metropolitan hospital provides various services to 
other hospitals. The hospital furnishes a purchasing service to 
hosptials N and O, a data processing service to hospitals R and S, and a 
food service to hospitals X and Y. All the hospitals are described in 
section 170(b)(1)(A)(iii). All the hospitals have facilities to serve 
not more than 100 inpatients except hospital N. The services are 
furnished at cost to all hospitals except that hospital R is charged a 
fee in excess of cost for its use of the data processing service. The 
purchasing service constitutes unrelated trade or business because it is 
not provided solely to hospitals having facilities to serve not more 
than 100 inpatients.
    The data processing service constitutes unrelated trade or business 
because it is provided at a fee in excess of cost. The food service 
satisfies all three requirements of paragraph (a) of this section and 
does not constitute unrelated trade or business.

    (d) Effective date. Section 513(e) and this section apply to taxable 
years beginning after December 31, 1953.

[T.D. 8075, 51 FR 5322, Feb. 13, 1986; 51 FR 8490, Mar. 12, 1986]



Sec.  1.513-7  Travel and tour activities of tax exempt organizations.

    (a) Travel tour activities that constitute a trade or business, as 
defined in Sec.  1.513-1(b), and that are not substantially related to 
the purposes for which exemption has been granted to the organization 
constitute an unrelated trade or business with respect to that 
organization. Whether travel tour activities conducted by an 
organization are substantially related to the organization's exempt 
purpose is determined by looking at all relevant facts and 
circumstances, including, but not limited to, how a travel tour is 
developed, promoted and operated. Section 513(c) and Sec.  1.513-1(b) 
also apply to travel tour activity. Application of the rules of section 
513(c) and Sec.  1.513-1(b) may result in different treatment for 
individual tours within an organization's travel tour program.
    (b) Examples. The provisions of this section are illustrated by the 
following examples. In all of these examples, the travel tours are 
priced to produce a profit for the exempt organization. The examples are 
as follows:

    Example 1. O, a university alumni association, is exempt from 
federal income tax under section 501(a) as an educational organization 
described in section 501(c)(3). As part of its activities, O operates a 
travel tour program. The program is open to all current members of O and 
their guests. O works with travel agencies to schedule approximately 10 
tours annually to various destinations around the world. Members of O 
pay $x to the organizing travel agency to participate in a tour. The 
travel agency pays O a per person fee for each participant. Although the 
literature advertising the tours encourages O's members to continue 
their lifelong learning by joining the tours, and a faculty member of 
O's related university frequently joins the tour as a guest of the 
alumni association, none of the tours includes any scheduled instruction 
or curriculum related to the destinations being visited. The travel 
tours made available to O's members do not contribute importantly to the 
accomplishment of O's educational purpose. Rather, O's program is 
designed to generate revenues for O by regularly offering its members 
travel services. Accordingly, O's tour program is an unrelated trade or 
business within the meaning of section 513(a).
    Example 2. N is an organization formed for the purpose of educating 
individuals about the geography and culture of the United States. It is 
exempt from federal income tax under section 501(a) as an educational 
and cultural organization described in section 501(c)(3). N engages in a 
number of activities to accomplish its purposes, including offering 
courses and publishing periodicals and books. As one of its activities, 
N conducts study tours to national parks and other locations within the 
UnitedStates. The study tours are conducted by teachers and other 
personnel certified by the Board of Education of the State of P. The 
tours are directed toward students enrolled in degree programs at 
educational institutions in P, as reflected in the promotional 
materials, but are open to all who agree to participate in the required 
study program. Each tour's study program consists of instruction on 
subjects related to the location being visited on the tour. During the 
tour, five or six hours per day are devoted to organized study, 
preparation of reports, lectures, instruction and recitation by the 
students. Each tour group brings along a library of material related to 
the subject being studied on the tour. Examinations are given at the end 
of each tour and the P StateBoard of

[[Page 229]]

Education awards academic credit for tour participation. Because the 
tours offered by N include a substantial amount of required study, 
lectures, report preparation, examinations and qualify for academic 
credit, the tours are substantially related to N's educational purpose. 
Accordingly, N's tour program is not an unrelated trade or business 
within the meaning of section 513(a).
    Example 3. R is a section 501(c)(4) social welfare organization 
devoted to advocacy on a particular issue. On a regular basis throughout 
the year, R organizes travel tours for its members to Washington, DC. 
While in Washington, the members follow a schedule according to which 
they spend substantially all of their time during normal business hours 
over several days attending meetings with legislators and government 
officials and receiving briefings on policy developments related to the 
issue that is R's focus. Members do have some time on their own in the 
evenings to engage in recreational or social activities of their own 
choosing. Bringing members to Washington to participate in advocacy on 
behalf of the organization and learn about developments relating to the 
organization's principal focus is substantially related to R's social 
welfare purpose. Therefore, R's operation of the travel tours does not 
constitute an unrelated trade or business within the meaning of section 
513(a).
    Example 4. S is a membership organization formed to foster cultural 
unity and to educate X Americans about X, their country of origin. It is 
exempt from federal income tax under section 501(a) and is described in 
section 501(c)(3) as an educational and cultural organization. 
Membership in S is open to all Americans interested in the X heritage. 
As part of its activities, S sponsors a program of travel tours to X. 
The tours are divided into two categories. Category A tours are trips to 
X that are designed to immerse participants in the X history, culture 
and language. Substantially all of the daily itinerary includes 
scheduled instruction on the X language, history and cultural heritage, 
and visits to destinations selected because of their historical or 
cultural significance or because of instructional resources they offer. 
Category B tours are also trips to X, but rather than offering scheduled 
instruction, participants are given the option of taking guided tours of 
various X locations included in their itinerary. Other than the optional 
guided tours, Category B tours offer no instruction or curriculum. 
Destinations of principally recreational interest, rather than 
historical or cultural interest, are regularly included on Category B 
tour itineraries. Based on the facts and circumstances, sponsoring 
Category A tours is an activity substantially related to S's exempt 
purposes, and does not constitute an unrelated trade or business within 
the meaning of section 513(a). However, sponsoring Category B tours does 
not contribute importantly to S's accomplishment of its exempt purposes 
and, thus, constitutes an unrelated trade or business within the meaning 
of section 513(a).
    Example 5. T is a scientific organization engaged in environmental 
research. T is exempt from federal income tax under section 501(a) as an 
organization described in section 501(c)(3). T is engaged in a long-term 
study of how agricultural pesticide and fertilizer use affects the 
populations of various bird species. T collects data at several bases 
located in an important agricultural region of country U. The minutes of 
a meeting of T's Board of Directors state that, after study, the Board 
has determined that non-scientists can reliably perform needed data 
collection in the field, under supervision of T's biologists. The Board 
minutes reflect that the Board approved offering one-week trips to T's 
bases in U, where participants will assist T's biologists in collecting 
data for the study. Tour participants collect data during the same hours 
as T's biologists. Normally, data collection occurs during the early 
morning and evening hours, although the work schedule varies by season. 
Each base has rustic accommodations and few amenities, but country U is 
renowned for its beautiful scenery and abundant wildlife. T promotes the 
trips in its newsletter and on its Internet site and through various 
conservation organizations. The promotional materials describe the work 
schedule and emphasize the valuable contribution made by trip 
participants to T's research activities. Based on the facts and 
circumstances, sponsoring trips to T's bases in country U is an activity 
substantially related to T's exempt purpose, and, thus, does not 
constitute an unrelated trade or business within the meaning of section 
513(a).
    Example 6. V is an educational organization devoted to the study of 
ancient history and cultures and is exempt from federal income tax under 
section 501(a) as an organization described in section 501(c)(3). In 
connection with its educational activities, V conducts archaeological 
expeditions around the world, including in the Y region of country Z. In 
cooperation with the National Museum of Z, V recently presented an 
exhibit on ancient civilizations of the Y region of Z, including 
artifacts from the collection of the Z National Museum. V instituted a 
program of travel tours to V's archaeological sites located in the Y 
region. The tours were initially proposed by V staff members as a means 
of educating the public about ongoing field research conducted by V. V 
engaged a travel agency to handle logistics such as accommodations and 
transportation arrangements. In preparation for the tours, V developed 
educational materials relating to each archaeological site to be visited 
on the tour, describing in detail the layout of the site,

[[Page 230]]

the methods used by V's researchers in exploring the site, the 
discoveries made at the site, and their historical significance. V also 
arranged special guided tours of its exhibit on the Y region for 
individuals registered for the travel tours. Two archaeologists from V 
(both of whom had participated in prior archaeological expeditions in 
the Y region) accompanied the tours. These experts led guided tours of 
each site and explained the significance of the sites to tour 
participants. At several of the sites, tour participants also met with a 
working team of archaeologists from V and the National Museum of Z, who 
shared their experiences. V prepared promotional materials describing 
the educational nature of the tours, including the daily trips to V's 
archaeological sites and the educational background of the tour leaders, 
and providing a recommended reading list. The promotional materials do 
not refer to any particular recreational or sightseeing activities. 
Based on the facts and circumstances, sponsoring trips to the Y region 
is an activity substantially related to V's exempt purposes. The 
scheduled activities, which include tours of archaeological sites led by 
experts, are part of a coordinated educational program designed to 
educate tour participants about the ancient history of the Y region of Z 
and V's ongoing field research. Therefore, V's tour program does not 
constitute an unrelated trade or business within the meaning of section 
513(a).
    Example 7. W is an educational organization devoted to the study of 
the performing arts and is exempt from federal income tax under section 
501(a) as an organization described in section 501(c)(3). In connection 
with its educational activities, W presents public performances of 
musical and theatrical works. Individuals become members of W by making 
an annual contribution to W of $q. Each year, W offers members an 
opportunity to travel as a group to one or more major cities in the 
United States or abroad. In each city, tour participants are provided 
tickets to attend a public performance of a play, concert or dance 
program each evening. W also arranges a sightseeing tour of each city 
and provides evening receptions for tour participants. W views its tour 
program as an important means to develop and strengthen bonds between W 
and its members, and to increase their financial and volunteer support 
of W. W engaged a travel agency to handle logistics such as 
accommodations and transportation arrangements. No educational materials 
are prepared by W or provided to tour participants in connection with 
the tours. Apart from attendance at the evening cultural events, the 
tours offer no scheduled instruction, organized study or group 
discussion. Although several members of W's administrative staff 
accompany each tour group, their role is to facilitate member 
interaction. The staff members have no special expertise in the 
performing arts and play no educational role in the tours. W prepared 
promotional materials describing the sightseeing opportunities on the 
tours and emphasizing the opportunity for members to socialize 
informally and interact with one another and with W staff members, while 
pursuing shared interests. Although W's tour program may foster goodwill 
among W members, it does not contribute importantly to W's educational 
purposes. W's tour program is primarily social and recreational in 
nature. The scheduled activities, which include sightseeing and 
attendance at various cultural events, are not part of a coordinated 
educational program. Therefore, W's tour program is an unrelated trade 
or business within the meaning of section 513(a).

[T.D. 8874, 65 FR 5773, Feb. 7, 2000; 65 FR 16143, Mar. 27, 2000]



Sec.  1.514(a)-1  Unrelated debt-financed income and deductions.

    (a) Income includible in gross income:
    (1) Percentage of income taken into account--(i) In general. For 
taxable years beginning after December 31, 1969, there shall be included 
with respect to each debt-financed property (as defined in section 514 
and Sec.  1.514(b)-1) as an item of gross income derived from an 
unrelated trade or business the amount of unrelated debt-financed income 
(as defined in subdivision (ii) of this subparagraph). See paragraph 
(a)(5) of Sec.  1.514(c)-1 for special rules regarding indebtedness 
incurred before June 28, 1966, applicable for taxable years beginning 
before January 1, 1972, and for special rules applicable to churches or 
conventions or associations of churches.
    (ii) Unrelated debt-financed income. The unrelated debt-financed 
income with respect to each debt-financed property is an amount which is 
the same percentage (but not in excess of 100 percent) of the total 
gross income derived during the taxable year from or on account of such 
property as:
    (a) The average acquisition indebtedness (as defined in subparagraph 
(3) of this paragraph) with respect to the property is of
    (b) The average adjusted basis of such property (as defined in 
subparagraph (2) of this paragraph).
    (iii) Debt/basis percentage. The percentage determined under 
subdivision (ii) of this subparagraph is hereinafter referred to as the 
debt/basis percentage.

[[Page 231]]

    (iv) Example. Subdivisions (i), (ii), and (iii) of this subparagraph 
are illustrated by the following example. For purposes of this example 
it is assumed that the property is debt-financed property.

    Example. X, an exempt trade association, owns an office building 
which in 1971 produces $10,000 of gross rental income. The average 
adjusted basis of the building for 1971 is $100,000, and the average 
acquisition indebtedness with respect to the building for 1971 is 
$50,000. Accordingly, the debt/basis percentage for 1971 is 50 percent 
(the ratio of $50,000 to $100,000). Therefore, the unrelated debt-
financed income with respect to the building for 1971 is $5,000 (50 
percent of $10,000).

    (v) Gain from sale or other disposition. If debt-financed property 
is sold or otherwise disposed of, there shall be included in computing 
unrelated business taxable income an amount with respect to such gain 
(or loss) which is the same percentage (but not in excess of 100 
percent) of the total gain (or loss) derived from such sale or other 
disposition as:
    (a) The highest acquisition indebtedness with respect to such 
property during the 12-month period, preceding the date of disposition, 
is of
    (b) The average adjusted basis of such property.

The tax on the amount of gain (or loss) included in unrelated business 
taxable income pursuant to the preceding sentence shall be determined in 
accordance with the rules set forth in subchapter P, chapter 1 of the 
Code (relating to capital gains and losses). See also section 511(d) and 
the regulations thereunder (relating to the minimum tax for tax 
preferences).
    (2) Average adjusted basis--(i) In general. The average adjusted 
basis of debt-financed property is the average amount of the adjusted 
basis of such property during that portion of the taxable year it is 
held by the organization. This amount is the average of:
    (a) The adjusted basis of such property as of the first day during 
the taxable year that the organization holds the property, and
    (b) The adjusted basis of such property as of the last day during 
the taxable year that the organization holds the property


See section 1011 and the regulations thereunder for determination of the 
adjusted basis of property.
    (ii) Adjustments for prior taxable years. For purposes of 
subdivision (i) of this subparagraph, the determination of the average 
adjusted basis of debt-financed property is not affected by the fact 
that the organization was exempt from taxation for prior taxable years. 
Proper adjustment must be made under section 1011 for the entire period 
since the acquisition of the property. For example, adjustment must be 
made for depreciation for all prior taxable years whether or not the 
organization was exempt from taxation for any such years. Similarly, the 
fact that only a portion of the depreciation allowance may be taken into 
account in computing the percentage of deductions allowable under 
section 514(a)(2) does not affect the amount of the adjustment for 
depreciation which is used in determining average adjusted basis.
    (iii) Cross reference. For the determination of the basis of debt-
financed property acquired in a complete or partial liquidation of a 
corporation in exchange for its stock, see Sec.  1.514(d)-1.
    (iv) Example. This subparagraph may be illustrated by the following 
example. For purposes of this example it is assumed that the property is 
debt-financed property.

    Example. On July 10, 1970, X, an exempt educational organization, 
purchased an office building for $510,000, using $300,000 of borrowed 
funds. During 1970 the only adjustment to basis is $20,000 for 
depreciation. As of December 31, 1970, the adjusted basis of the 
building is $490,000 and the indebtedness is still $300,000. X files its 
return on a calendar year basis. Under these circumstances, the debt/
basis percentage for 1970 is 60 percent, calculated in the following 
manner:

 
                                                                Basis
 
As of July 10, 1970 (acquisition date).....................     $510,000
As of December 31, 1970....................................      490,000
                                                            ------------
    Total..................................................    1,000,000
 


Average Adjusted basis:
[GRAPHIC] [TIFF OMITTED] TC08OC91.000

Debt/basis percentage:

Average acquisition indebtedness ($300,000) / Average adjusted basis 
          ($500,000) = 60 percent


[[Page 232]]


For an illustration of the determination of the debt/basis percentage as 
changes in the acquisition indebtedness occur, see example 1 of 
subparagraph (3)(iii) of this paragraph.

    (3) Average acquisition indebtedness--(i) In general. The average 
acquisition indebtedness with respect to debt-financed property is the 
average amount of the outstanding principal indebtedness during that 
portion of the taxable year the property is held by the organization.
    (ii) Computation. The average acquisition indebtedness is computed 
by determining the amount of the outstanding principal indebtedness on 
the first day in each calendar month during the taxable year that the 
organization holds the property, adding these amounts together, and then 
dividing this sum by the total number of months during the taxable year 
that the organization held such property. A fractional part of a month 
shall be treated as a full month in computing average acquisition 
indebtedness.
    (iii) Examples. The application of this subparagraph may be 
illustrated by the following examples. For purposes of these examples it 
is assumed that the property is debt-financed property.

    Example 1. Assume the facts as stated in the example in subparagraph 
(2)(iv) of this paragraph, except that beginning July 20, 1970, the 
organization makes payments of $21,000 a month ($20,000 of which is 
attributable to principal and $1,000 to interest). In this situation, 
the average acquisition indebtedness for 1970 is $250,000. Thus, the 
debt/basis percentage for 1970 is 50 percent, calculated in the 
following manner:

 
                                                           Indebtedness
                                                           on the first
                                                            day in each
                                                          calendar month
                                                             that the
                                                            property is
                                                               held
 
Month:
  July..................................................        $300,000
  August................................................         280,000
  September.............................................         260,000
  October...............................................         240,000
  November..............................................         220,000
  December..............................................         200,000
                                                         ---------------
      Total.............................................       1,500,000
 

Average acquisition indebtedness:
$1,500,000 / 6 months = $250,000

Debt/basis percentage:
Average acquisition indebtedness ($250,000) / Average adjusted basis 
          ($500,000) = 50 percent
    Example 2. Y, an exempt organization, owns stock in a corporation 
which it does not control. At the beginning of the year, Y has an 
outstanding principal indebtedness with respect to such stock of 
$12,000. Such indebtedness is paid off at the rate of $2,000 per month 
beginning January 30, so that it is retired at the end of 6 months. The 
average acquisition indebtedness for the taxable year is $3,500, 
calculated in the following manner:

 
                                                           Indebtedness
                                                           on the first
                                                            day in each
                                                          calendar month
                                                             that the
                                                            property is
                                                               held
 
Month:
  January...............................................         $12,000
  February..............................................          10,000
  March.................................................           8,000
  April.................................................           6,000
  May...................................................           4,000
  June..................................................           2,000
  July thru December....................................               0
                                                         ---------------
      Total.............................................          42,000
 

Average acquisition indebtedness:
[GRAPHIC] [TIFF OMITTED] TC08OC91.001

    (4) Indeterminate price--(i) In general. If an exempt organization 
acquires (or improves) property for an indeterminate price, the initial 
acquisition indebtedness and the unadjusted basis shall be determined in 
accordance with subdivisions (ii) and (iii) of this paragraph, unless 
the organization has obtained the consent of the Commissioner to use 
another method to compute such amounts.
    (ii) Unadjusted basis. For purposes of this subparagraph, the 
unadjusted basis of property (or of an improvement) is the fair market 
value of the property (or improvement) on the date of acquisition (or 
the date of completion of the improvement). The average adjusted basis 
of such property shall be determined in accordance with paragraph (a)(2) 
of this section.
    (iii) Initial acquisition indebtedness. For purposes of this 
subparagraph, the initial acquisition indebtedness is the fair market 
value of the property (or improvement) on the date of acquisition (or 
the date of completion of the improvement) less any down payment or 
other initial payment applied to the principal indebtedness. The average 
acquisition indebtednessith respect to

[[Page 233]]

such property shall be computed in accordance with paragraph (a)(3) of 
this section.
    (iv) Example. The application of this subparagraph may be 
illustrated by the following example. For purposes of this example it is 
assumed that the property is debt-financed property.

    Example. On January 1, 1971, X, an exempt trade association, 
acquires an office building for a down payment of $310,000 and an 
agreement to pay 10 percent of the income generated by the building for 
10 years. Neither the sales price nor the amount which X is obligated to 
pay in the future is certain. The fair market value of the building on 
the date of acquisition is $600,000. The depreciation allowance for 1971 
is $40,000. Unless X obtains the consent of the Commissioner to use 
another method, the unadjusted basis of the property is $600,000 (the 
fair market value of the property on the date of acquisition), and the 
initial acquisition indebtedness is $290,000 (fair market value of 
$600,000 less initial payment of $310,000). Under these circumstances, 
the average adjusted basis of the property for 1971 is $580,000, 
calculated as follows:

[Initial fair market value + (initial fair market value less 
          depreciation)] / 2 = [$600,000 + ($600,000 - $40,000)] / 2 = 
          $580,000.

    If no payment other than the initial payment is made in 1971, the 
average acquisition indebtedness for 1971 is $290,000. Thus, the debt/
basis percentage for 1971 is 50 percent, calculated as follows:

Average acquisition indebtedness / average adjusted basis = $290,000 / 
          $580,000 = 50 percent

    (b) Deductions--(1) Percentage of deductions taken into account. 
Except as provided in subparagraphs (4) and (5) of this paragraph, there 
shall be allowed as a deduction with respect to each debt-financed 
property an amount determined by applying the debt/basis percentage to 
the sum of the deductions allowable under subparagraph (2) of this 
paragraph.
    (2) Deductions allowable. The deductions allowable are those items 
allowed as deductions by chapter 1 of the Code which are directly 
connected with the debt-financed property or the income therefrom 
(including the dividends received deductions allowed by sections 243, 
244, and 245), except that:
    (i) The allowable deductions are subject to the modifications 
provided by section 512(b) on computation of the unrelated business 
taxable income, and
    (ii) If the debt-financed property is of a character which is 
subject to the allowance for depreciation provided in section 167, such 
allowance shall be computed only by use of the straight-line method of 
depreciation.
    (3) Directly connected with. To be directly connected with debt-
financed property or the income therefrom, an item of deduction must 
have proximate and primary relationship to such property or the income 
therefrom. Expenses, depreciation, and similar items attributable solely 
to such property are proximately and primarily related to such property 
or the income therefrom, and therefore qualify for deduction, to the 
extent they meet the requirements of subparagraph (2) of this paragraph. 
Thus, for example, if the straight-line depreciation allowance for an 
office building is $10,000 a year, an organization would be allowed a 
deduction for depreciation of $10,000 if the entire building were debt-
financed property. However, if only one-half of the building were 
treated as debt-financed property, then the depreciation allowed as a 
deduction would be $5,000. (See example 2 of Sec.  1.514(b)-
1(b)(1)(iii).)
    (4) Capital losses--(i) In general. If the sale or exchange of debt-
financed property results in a capital loss, the amount of such loss 
taken into account in the taxable year in which the loss arises shall be 
computed in accordance with paragraph (a)(1)(v) of this section. If, 
however, any portion of such capital loss not taken into account in such 
year may be carried back or carried over to another taxable year, the 
debt/basis percentage is not applied to determine what portion of such 
capital loss may be taken as a deduction in the year to which such 
capital loss is carried.
    (ii) Example. This subparagraph is illustrated by the following 
example. For purposes of this example it is assumed that the property is 
debt-financed property.

    Example. X, an exempt educational organization, owns securities 
which are capital assets and which it has held for more than 6 months. 
In 1972 X sells the securities at a loss of $20,000. The debt/basis 
percentage with respect to computing the gain (or loss)

[[Page 234]]

derived from the sale of the securities is 40 percent. Thus, X has 
sustained a capital loss of $8,000 (40 percent of $20,000) with respect 
to the sale of the securities. For 1972 and the preceding three taxable 
years X has no other capital transactions. Under these circumstances, 
the $8,000 of capital loss may be carried over to the succeeding 5 
taxable years without further application of the debt/basis percentage.

    (5) Net operating loss--(i) In general. If, after applying the debt/
basis percentage to the income derived from debt-financed property and 
the deductions directly connected with such income, such deductions 
exceed such income, the organization has sustained a net operating loss 
for the taxable year. This amount may be carried back or carried over to 
other taxable years in accordance with section 512(b)(6). However, the 
debt/ basis percentage shall not be applied in such other years to 
determine the amounts that may be taken as a deduction in those years.
    (ii) Example. This subparagraph may be illustrated by the following 
example. For purposes of this example it is assumed that the property is 
debt-financed property.

    Example. During 1974, Y, an exempt organization, receives $20,000 of 
rent from a building which it owns. Y has no other unrelated business 
taxable income for 1974. For 1974 the deductions directly connected with 
this building are property taxes of $5,000, interest of $5,000 on the 
acquisition indebtedness, and salary of $15,000 to the manager of the 
building. The debt/basis percentage for 1974 with respect to the 
building is 50 percent. Under these circumstances, Y shall take into 
account in computing its unrelated business taxable income for 1974, 
$10,000 of income (50 percent of $20,000) and $12,500 (50 percent of 
$25,000) of the deductions directly connected with such income. Thus, 
for 1974 Y has sustained a net operating loss of $2,500 ($10,000 of 
income less $12,500 of deductions) which may be carried back or carried 
over to other taxable years without further application of the debt/
basis percentage.

[T.D. 7229, 37 FR 28143, Dec. 21, 1972]



Sec.  1.514(a)-2  Business lease rents and deductions for taxable 
years beginning before January 1, 1970.

    (a) Effective date. This section applies to taxable years beginning 
before January 1, 1970.
    (b) In general--(1) Rents includible in gross income. There shall be 
included with respect to each business lease, as an item of gross income 
derived from an unrelated trade or business, an amount which is the same 
percentage (but not in excess of 100 percent) of the total rents derived 
during the taxable year under such lease as:
    (i) The amount of the business lease indebtedness at the close of 
the taxable year of the lessor tax-exempt organization, with respect to 
the premises covered by such lease, is of
    (ii) The adjusted basis of such premises at the close of such 
taxable year


For definition of business lease as a lease for a term of more than 5 
years, and for rules for determining the computation of such 5-year term 
in certain specific situations, see Sec.  1.514(f)-1. For definition of 
business lease indebtedness and allocation of business lease 
indebtedness where only a portion of the property is subject to a 
business lease, see Sec.  1.514(g)-1.
    (2) Determination of basis. For purposes of the unrelated business 
income tax the basis (unadjusted) of property is determined under 
section 1012, and the adjusted basis of property is determined under 
section 1011. The determination of the adjusted basis of property is not 
affected by the fact that the organization was exempt from tax for prior 
taxable years. Proper adjustment must be made under section 1011 for the 
entire period since the acquisition of the property. Thus adjustment 
must be made for depreciation for all taxable years whether or not the 
organization was exempt from tax for any of such years. Similarly, for 
taxable years during which the organization is subject to the tax on 
unrelated business taxable income the fact that only a portion of the 
deduction for depreciation is taken into account under paragraph (c)(1) 
of this section does not affect the amount of the adjustment for 
depreciation.
    (3) Examples. The application of this paragraph may be illustrated 
by the following examples, in each of which it is assumed that the 
taxpayer makes its returns under section 511 on the basis of the 
calendar year, and that the lease is not substantially related to the 
purpose for which the organization is granted exemption from tax.


[[Page 235]]


    Example 1. Assume that a tax-exempt educational organization 
purchased property in 1952 for $600,000, using borrowed funds, and 
leased the building for a period of 20 years. Assume further that the 
adjusted basis of such building at the close of 1954 is $500,000 and 
that, at the close of 1954, $200,000 of the indebtedness incurred to 
acquire the property remains outstanding. Since the amount of the 
outstanding indebtedness is two-fifths of the adjusted basis of the 
building at the close of 1954, two-fifths of the gross rental received 
from the building during 1954 shall be included as an item of gross 
income in computing unrelated business taxable income. If, at the close 
of a subsequent taxable year, the outstanding indebtedness is $100,000 
and the adjusted basis of the building is $400,000, one-fourth of the 
gross rental for such taxable year shall be included as an item of gross 
income in computing unrelated business taxable income for such taxable 
year.
    Example 2. Assume that a tax-exempt organization owns a four-story 
building, that in 1954 it borrows $100,000 which it uses to improve the 
whole building, and that it thereafter in 1954 rents the first and 
second floors of the building under six-year leases at rentals of $4,000 
a year. The third and fourth floors of the building are leased on a 
yearly basis during 1954. Assume, also, that the adjusted basis of the 
real property at the end of 1954 (after reflecting the expenditures for 
improving the building) is $200,000, allocable equally to each of the 
four stories. Under these facts, only one-half of the real property is 
subject to a business lease since only one-half is rented under a lease 
for more than 5 years. See Sec.  1.514(f)-1. The percentage of the rent 
under such lease which is taken into account is determined by the ratio 
which the allocable part of the business lease indebtedness bears to the 
allocable part of the adjusted basis of the real property, that is, the 
ratio which one-half of the $100,000 of business lease indebtedness 
outstanding at the close of 1954, or $50,000, bears to one-half of the 
adjusted basis of the business lease premises at the close of 1954, or 
$100,000. The percentage of rent which is business lease income for 1954 
is, therefore, one-half (the ratio of $50,000 to $100,000) of $8,000, or 
$4,000, and this amount of $4,000 is considered an item of gross income 
derived from an unrelated trade or business.

    (c) Deductions--(1) Deductions allowable against gross income. The 
same percentage is used in determining both the portion of the rent and 
the portion of the deductions taken into account with respect to the 
business lease in computing unrelated business taxable income. Such 
percentage is applicable only to the sum of the following deductions 
allowable under section 161:
    (i) Taxes and other expenses paid or accrued during the taxable year 
upon or with respect to the real property subject to the business lease;
    (ii) Interest paid or accrued during the taxable year on the 
business lease indebtedness;
    (iii) A reasonable allowance for exhaustion, wear and tear 
(including a reasonable allowance for obsolescence) of the real property 
subject to such lease.


Where only a portion of the real property is subject to the business 
lease, there shall be taken into account only those amounts of the 
above-listed deductions which are properly allocable to the premises 
covered by such lease.
    (2) Excess deductions. The deductions allowable under subparagraph 
(1) of this paragraph with respect to a business lease are not limited 
by the amount included in gross income with respect to the rent from 
such lease. Any excess of such deductions over such gross income shall 
be applied against other items of gross income in computing unrelated 
business taxable income taxable under section 511(a).
    (3) Example. The application of this paragraph may be illustrated by 
the following example:

    Example. Assume the same facts as those in example 1 in paragraph 
(b)(3) of this section. Assume, also that for 1954 the organization pays 
taxes of $4,000 on the property, interest of $6,000 on its business 
lease indebtedness, and that the depreciation allowable for 1954 under 
section 167 is $10,000. Under the facts set forth in such example 1 and 
in this example, the deductions to be taken into account for 1954 in 
computing unrelated business taxable income would be two-fifths of the 
total of the deductions of $20,000, that is $8,000.

[T.D. 7229, 37 FR 28145, Dec. 21, 1972]



Sec.  1.514(b)-1  Definition of debt-financed property.

    (a) In general. For purposes of section 514 and the regulations 
thereunder, the term debt-financed property means any property which is 
held to produce income (e.g., rental real estate, tangible personal 
property, and corporate stock), and with respect to which there is an 
acquisition indebtedness (determined without regard to whether the 
property is debt-financed property) at any time during the taxable year. 
The

[[Page 236]]

term income is not limited to recurring income but applies as well to 
gains from the disposition of property. Consequently, when any property 
held to produce income by an organization which is not used in a manner 
described in section 514(b)(1) (A), (B), (C), or (D) is disposed of at a 
gain during the taxable year, and there was an acquisition indebtedness 
outstanding with respect to such property at any time during the 12-
month period preceding the date of disposition (even though such period 
covers more than 1 taxable year), such property is debt-financed 
property. For example, assume that on June 1, 1972, an organization is 
given mortgaged, unimproved property which it does not use in a manner 
described in section 514(b)(1) (A), (B), (C), or (D) and that the 
organization assumes payment ofthe mortgage on such property. On July 
15, 1972, the organization sells such property for a gain. Such property 
is debt-financed property and such gain is taxable as unrelated debt-
financed income. See section 514(c) and Sec.  1.514(c)-1 for rules 
relating to when there is acquisition indebtedness with respect to 
property. See paragraph (a) of Sec.  1.514(a)-1 for rules determining 
the amount of income or gain from debt-financed property which is 
treated as unrelated debt-financed income.
    (b) Exceptions--(1) Property related to certain exempt purposes. (i) 
To the extent that the use of any property is substantially related 
(aside from the need of the organization for income or funds or the use 
it makes of the profits derived) to the exercise or performance by an 
organization of its charitable, educational, or other purpose or 
function constituting its basis for exemption under section 501 (or, in 
the case of an organization described in section 511(a)(2)(B), to the 
exercise or performance of any purpose or function designated in section 
501(c)(3)) such property shall not be treated as debt-financed property. 
See Sec.  1.513-1 for principles applicable in determining whether there 
is a substantial relationship to the exempt purpose of the organization.
    (ii) If substantially all of any property is used in a manner 
described in subdivision (i) of this subparagraph, such property shall 
not be treated as debt-financed property. In general the preceding 
sentence shall apply if 85 percent or more of the use of such property 
is devoted to the organization's exempt purpose. The extent to which 
property is used for a particular purpose shall be determined on the 
basis of all the facts and circumstances. These may include (where 
appropriate):
    (a) A comparison of the portion of time such property is used for 
exempt purposes with the total time such property is used,
    (b) A comparison of the portion of such property that is used for 
exempt purposes with the portion of such property that is used for all 
purposes, or
    (c) Both the comparisons described in (a) and (b) of this 
subdivision.
    (iii) This subparagraph may be illustrated by the following 
examples. For purposes of these examples it is assumed that the 
indebtedness is acquisition indebtedness.

    Example 1. W, an exempt organization, owns a computer with respect 
to which there is an outstanding principal indebtedness and which is 
used by W in the performance of its exempt purpose. W sells time for the 
use of the computer to M corporation on occasions when the computer is 
not in full-time use by W. W uses the computer in furtherance of its 
exempt purpose more than 85 percent of the time it is in use and M uses 
the computer less than 15 percent of the total operating time the 
computer is in use. In this situation, substantially all the use of the 
computer is related to the performance of W's exempt purpose. Therefore, 
no portion of the computer is treated as debt-financed property.
    Example 2. X, an exempt college, owns a four story office building 
which has been purchased with borrowed funds. In 1971, the lower two 
stories of the building are used to house computers which are used by X 
for administrative purposes. The top two stories are rented to the 
public for purposes not described in section 514(b)(1) (A), (B), (C), or 
(D). The gross income derived by X from the building is $6,000, all of 
which is attributable to the rents paid by tenants. There are $2,000 of 
expenses, allocable equally to each use of the building. The average 
adjusted basis of the building for1971 is $100,000, and the outstanding 
principal indebtedness throughout 1971 is $60,000. Thus, the average 
acquisition indebtedness for 1971 is $60,000. In accordance with 
subdivision (i) of this subparagraph, only the upper half of the 
building is debt-financed property. Consequently, only the

[[Page 237]]

rental income and the deductions directly connected with such income are 
to be taken into account in computing unrelated business taxable income. 
The portion of such amounts to be taken into account is determined by 
multiplying the $6,000 of rental income and $1,000 of deductions 
directly connected with such rental income by the debt/basis percentage. 
The debt/basis percentage is the ratio which the allocable part of the 
average acquisition indebtedness is of the allocable part of the average 
adjusted basis of the property, that is, the ratio which $30,000 (one-
half of $60,000) bears to $50,000 (one-half of $100,000). Thus, the 
debt/basis percentage for 1971 is 60 percent (the ratio of $30,000 to 
$50,000). Under these circumstances, X shall include net rental income 
of $3,000 in its unrelated business taxable income for 1971, computed as 
follows:

Total rental income.........................................      $6,000
Deductions directly connected with rental income............      $1,000
Debt/basis percentage ($30,000/$50,000).....................         60%
Rental income treated as gross income from an unrelated           $3,600
 trade or business (60 percent of $6,000)...................
Less the allowable portion of deductions directly connected         $600
 with such income (60 percent of $1,000)....................
                                                             -----------
Net rental income included by X in computing its unrelated        $3,000
 business taxable income pursuant to section 514............
                                                             ===========
 

    Example 3. Assume the facts as stated in example 2 except that on 
December 31, 1971, X sells the building and realizes a long-term capital 
gain of $10,000. This is X's only capital transaction for 1971. An 
allocable portion of this gain is subject to tax. This amount is 
determined by multiplying the gain related to the nonexempt use, $5,000 
(one-half of $10,000), by the ratio which the debtedness for the 12-
month period preceding the date of sale, $30,000 (one-half of $60,000), 
is of the allocable part of the average adjusted basis, $50,000 (one-
half of $100,000). Thus, the debt/basis percentage with respect to 
computing the gain (or loss) derived from the sale of the building is 60 
percent (the ratio of $30,000 to $50,000). Consequently, $3,000 (60 
percent of $5,000) is a net section 1201 gain (capital gain net income 
for taxable years beginning after December 31, 1976). The portion of 
such gain which is taxable shall be determined in accordance with rules 
contained in subchapter P, chapter 1 of the Code (relating to capital 
gains and losses). See also section 511(d) and the regulations 
thereunder (relating to the minimum tax for tax preferences).

    (2) Property used in an unrelated trade or business--(i) In general. 
To the extent that the gross income from any property is treated as 
income from the conduct of an unrelated trade or business, such property 
shall not be treated as debt-financed property. However, any gain on the 
disposition of such property which is not included in the income of an 
unrelated trade or business by reason of section 512(b)(5) is includible 
as gross income derived from or on account of debt-financed property 
under paragraph (a)(1) of Sec.  1.514(a)-1.
    (ii) Amounts specifically taxable under other provisions of the 
Code. Section 514 does not apply to amounts which are otherwise included 
in the computation of unrelated business taxable income, such as rents 
from personal property includible pursuant to section 512(b)(13) or 
rents and interest from controlled organizations includible pursuant to 
section 512(b)(3). See paragraph (1)(5) of Sec.  1.512(b)-1 for the 
rules determining the manner in which amounts are taken into account 
where such amounts may be included in the computation of unrelated 
business taxable income by operation of more than one provision of the 
Code.
    (3) Examples. Subparagraphs (1) and (2) of this paragraph may be 
illustrated by the following examples. For purposes of these examples it 
is assumed that the indebtedness is acquisition indebtedness.

    Example 1. X, an exempt scientific organization, owns a 10-story 
office building. During 1972, four stories are occupied by X's 
administrative offices, and the remaining six stories are rented to the 
public for purposes not described in section 514(b)(1) (A), (B), (C), or 
(D). On December 31, 1972, the building is sold and X realizes a long-
term capital gain of $100,000. This is X's only capital transaction for 
1972. The debt/basis percentage with respect to computing the gain (or 
loss) derived from the sale of the building is 30 percent. Since 40 
percent of the building was used for X's exempt purpose, only 60 percent 
of the building is debt-financed property. Thus, only $60,000 of the 
gain (60 percent of $100,000) is subject to this section. Consequently, 
the amount of gain treated as unrelated debt-financed income is $18,000 
($60,000 multiplied by the debt/basis percentage of 30 percent). The 
portion of such $18,000 which is taxable shall be determined in 
accordance with the rules contained in subchapter P, chapter 1 of the 
Code. See also section 511(d) and the regulations thereunder (relating 
to the minimum tax for tax preferences).
    Example 2. Y, an exempt organization, owns two properties, a 
restaurant and an office building. In 1972, all the space in the office

[[Page 238]]

building, except for the portion utilized by Y to house the 
administrative offices of the restaurant, is rented to the public for 
purposes not described in section 514(b)(1) (A), (B), (C), or (D). The 
average adjusted basis of the office building for 1972 is $2 million. 
The outstanding principal indebtedness throughout 1972 is $1 million. 
Thus, the highest acquisition indebtedness in the calendar year of 1972 
is $1 million. It is determined that 30 percent of the space in the 
office building is used for the administrative functions engaged in by 
the employees of the organization with respect to the restaurant. Since 
the income attributable to the restaurant is attributable to the conduct 
of an unrelated trade or business, only 70 percent of the building is 
treated as debt-financed property for purposes of determining the 
portion of the rental income which is unrelated debt-financed income. On 
December 31, 1972, the office building is sold and Y realizes a long-
term capital gain of $250,000. This is Y's only capital transaction for 
1972. In accordance with subparagraph (2)(i) of this paragraph, all the 
gain derived from this sale is taken into account in computing the 
amount of such gain subject to tax. The portion of such gain which is 
taxable is determined by multiplying the $250,000 gain by the debt/basis 
percentage. The debt/basis percentage is the ratio which the highest 
acquisition indebtedness for the 12-month period preceding the date of 
sale, $1 million, is of the averageadjusted basis, $2 million. Thus, the 
debt/basis percentage with respect to computing the gain (or loss) 
derived from the sale of the building is 50 percent (the ratio of $1 
million to $2 million). Consequently, $125,000 (50 percent of $250,000) 
is a net section 1201 gain (net capital gain for taxable years beginning 
after December 31, 1976). The amount of such gain which is taxable shall 
be determined in accordance with the rules contained in subchapter P, 
chapter 1 of the Code. See also section 511(d) and the regulations 
thereunder.
    Example 3. (a) Z, an exempt university, owns all the stock of M, a 
nonexempt corporation. During 1971 M leases from Z University a factory 
unrelated to Z's exempt purpose and a dormitory for the students of Z, 
for a total annual rent of $100,000: $80,000 for the factory and $20,000 
for the dormitory. During 1971, M has $500,000 of taxable income, 
disregarding the rent paid to Z: $150,000 from the dormitory and 
$350,000 from the factory. The factory is subject to a mortgage of 
$150,000. Its average adjusted basis for 1971 is determined to be 
$300,000. Z's deductions for 1971 with respect to the leased property 
are $4,000 for the dormitory and $16,000 for the factory. In accordance 
with subdivision (ii) of this subparagraph, section 514 applies only to 
that portion of the rent which is excluded from the computation of 
unrelated business taxable income by operation of section 512(b)(3) and 
not included in such computation pursuant to section 512(b)(13). Since 
all the rent received by Z is derived from real property, section 
512(b)(3) would exclude all such rent from computation of Z's unrelated 
business taxable income. However, 70 percent of the rent paid to Z with 
respect to the factory and 70 percent of the deductions directly 
connected with such rent shall be taken into account by Z in determining 
its unrelated business taxable income pursuant to section 512(b)(15), 
computed as follows:

M's taxable income (disregarding rent paid to Z)............    $500,000
Less taxable income from dormitory..........................    $150,000
                                                             -----------
Excess taxable income.......................................    $350,000
Ratio ($350,000/$500,000)...................................      \7/10\
Total rent paid to Z........................................    $100,000
Total deductions ($4,000 + $16,000).........................     $20,000
Rental income treated under section 512(b)(15) as gross          $70,000
 income from an unrelated trade or business (\7/10\ of
 $100,000)..................................................
Less deductions directly connected with such income (\7/10\      $14,000
 of $20,000)................................................
                                                             -----------
Net rental income included by Z in computing its unrelated       $56,000
 business taxable income pursuant to section 512(b)(15).....
 

    (b) Since only that portion of the rent derived from the factory and 
the deductions directly connected with such rent not taken into account 
pursuant to section 512(b)(15) may be included in computing unrelated 
business taxable income by operation of section 514, only $10,000 
($80,000 minus $70,000) of rent and $2,000 ($16,000 minus $14,000) of 
deductions are so taken into account. The portion of such amounts to be 
taken into account is determined by multiplying the $10,000 of income 
and $2,000 of deductions by the debt/basis percentage. The debt/basis 
percentage is the ratio which the average acquisition indebtedness 
($150,000) is of the average adjusted basis of the property ($300,000). 
Thus, the debt/basis percentage for 1971 is 50 percent (the ratio of 
$150,000 to $300,000). Under these circumstances, Z shall include net 
rental income of $4,000 in its unrelated business taxable income for 
1971, computed as follows:

Total rents.................................................     $10,000
Deductions directly connected with such rents...............      $2,000
Debt/basis percentage ($150,000/$300,000)...................         50%
Rental income treated as gross income from an unrelated           $5,000
 trade or business (50 percent of $10,000)..................
Less the allowable portion of deductions directly connected       $1,000
 with such income (50 percent of $2,000)....................
Net rental income included by Z in computing its unrelated        $4,000
 business taxable income pursuant to section 514............
 

    (4) Property related to research activities. To the extent that the 
gross income from any property is derived from research activities 
excluded from the tax on unrelated business income by paragraph (7), 
(8), or (9) of section

[[Page 239]]

512(b), such property shall not be treated as debt-financed property.
    (5) Property used in thrift shops, etc. To the extent that property 
is used in any trade or business which is excepted from the definition 
of unrelated trade or business by paragraph (1), (2), or (3) of section 
513(a), such property shall not be treated as debt-financed property.
    (6) Use by a related organization. For purposes of subparagraph (1), 
(4), or (5) of this paragraph, use of property by a related exempt 
organization (as defined in paragraph (c)(2)(ii) of this section) for a 
purpose described in such subparagraphs shall be taken into account in 
order to determine the extent to which such property is used for a 
purpose described in such subparagraphs.
    (c) Special rules--(1) Medical clinic. Property is not debt-financed 
property if it is real property subject to a lease to a medical clinic, 
and the lease is entered into primarily for purposes which are 
substantially related (aside from the need of such organization for 
income or funds or the use it makes of the rents derived) to the 
exercise or performance by the lessor of its charitable, educational, or 
other purpose or function constituting the basis for its exemption under 
section 501. For example, assume that an exempt hospital leases all of 
its clinic space to an unincorporated association of physicians and 
surgeons who, by the provisions of the lease, agree to provide all of 
the hospital's out-patient medical and surgical services and to train 
all of the hospital's residents and interns. In this situation, the 
rents received by the hospital from this clinic are not to be treated as 
unrelated debt-financed income.
    (2) Related exempt uses--(i) In general. Property owned by an exempt 
organization and used by a related exempt organization or by an exempt 
organization related to such related exempt organization shall not be 
treated as debt-financed property to the extent such property is used by 
either organization in furtherance of the purpose constituting the basis 
for its exemption under section 501. Furthermore, property shall not be 
treated as debt-financed property to the extent such property is used by 
a related exempt organization for a purpose described in paragraph 
(b)(4) or (5) of this section.
    (ii) Related organizations. For purposes of subdivision (i) of this 
subparagraph, an exempt organization is related to another exempt 
organization only if:
    (a) One organization is an exempt holding company described in 
section 501(c)(2) and the other organization receives the profits 
derived by such exempt holding company,
    (b) One organization has control of the other organization within 
the meaning of paragraph (1)(4) of Sec.  1.512(b)-1,
    (c) More than 50 percent of the members of one organization are 
members of the other organization, or
    (d) Each organization is a local organization which is directly 
affiliated with a common state, national, or international organization 
which is also exempt.
    (iii) Examples. This subparagraph may be illustrated by the 
following examples. For purposes of these examples it is assumed that 
the indebtedness is acquisition indebtedness.

    Example 1. M, an exempt trade association described in section 
501(c)(6), leases 70 percent of the space of an office building for 
furtherance of its exempt purpose. The title to such building is held by 
N, an exempt holding company described in section 501(c)(2), which 
acquired title to the building with borrowed funds. The other 30 percent 
of the space in this office building is leased to L, a nonstock exempt 
trade association described in section 501(c)(6). L uses such office 
space in furtherance of its exemptpurpose. The members of L's Board of 
Trustees serves for fixed terms and M's Board of Directors has the power 
to select all such members. N pays over to M all the profits it derives 
from the leasing of space in this building to M and L. Accordingly, M is 
related to N (as such term is defined in subdivision (ii)(a) of this 
subparagraph) and L is related to M (as such term is defined in 
subdivision (ii)(b) of this subparagraph). Under these circumstances, 
since all the available space in the building is leased to either an 
exempt organization related to the exempt organization holding title to 
the building or an exempt organization related to such related exempt 
organization, no portion of the building is treated as debt-financed 
property.
    Example 2. W, an exempt labor union described in section 501(c)(5), 
owns a 10-story office building which has been purchased

[[Page 240]]

with borrowed funds. Five floors of the building are used by W in 
furtherance of its exempt purpose. Four of the other floors are rented 
to X which is an exempt voluntary employees' beneficiary association 
described in section 501(c)(9), operated for the benefit of W's members. 
X uses such office space in furtherance of its exempt purpose. Seventy 
percent of the members of W are also members of X. Accordingly, X is 
related to W (as such term is defined in subdivision (ii)(c) of this 
subparagraph). The remaining floor of the building is rented to the 
general public for purposes not described in section 514(b)(1) (A), (B), 
(C), or (D). Under thesecircumstances, no portion of this building is 
treated as debt-financed property since more than 85 percent of the 
office space available in this building is used either by W or X, an 
exempt organization related to W, in furtherance of their respective 
exempt purpose. See paragraph (b)(1) of this section for rules relating 
to the use of property substantially related to an exempt purpose. See 
paragraph (b)(6) of this section for rules relating to uses by related 
exempt organizations.
    Example 3. Assume the same facts as in example 2, except that W and 
X are each exempt local labor unions described in section 501(c)(5) 
having no common membership and are each affiliated with N, an exempt 
international labor union described in section 501(c)(5). Under these 
circumstances, no portion of this building is treated as debt-financed 
property since more than 85 percent of the office space available in 
this building is used either by W or X, an exempt organization related 
to W, in furtherance of their respective exempt purpose.
    Example 4. Assume the same facts as in example 3, except that W and 
X are directly affiliated with different exempt international labor 
unions and that W and X are not otherwise affiliated with, or members 
of, a common exempt organization, other than an association of 
international labor unions. Under these circumstances, the portions of 
this building which are rented to X and to the general public are 
treated as debt-financed property since X is not related to W and W uses 
less than 85 percent of the building for its exempt purpose.

    (3) Life income contracts. (i) Property shall not be treated as 
debt-financed property when:
    (a) An individual transfers property to a trust or a fund subject to 
a contract providing that the income is to be paid to him or other 
individuals or both for a period of time not to exceed the life of such 
individual or individuals in a transaction in which the payments to the 
individual or individuals do not constitute the proceeds of a sale or 
exchange of the property so transferred, and
    (b) The remainder interest is payable to an exempt organization 
described in section 501(c)(3).
    (ii) Subdivision (i) of this subparagraph is illustrated by the 
following example.

    Example. On January 1, 1967, A transfers property to X, an exempt 
organization described in section 501(c)(3), which immediately places 
the property in a fund. On January 1, 1971, A transfers additional 
property to X, which property is also placed in the fund. In exchange 
for each transfer, A receives income participation fund certificates 
which entitle him to a proportionate part of the fund's income for his 
life and for the life of another individual. None of the payments made 
by X are treated by the recipients as the proceeds of a sale or exchange 
of the property transferred. In this situation, none of the property 
received by X from A is treated as debt-financed property.

    (d) Property acquired for prospective exempt use--(1) Neighborhood 
land--(i) In general. If an organization acquires real property for the 
principal purpose of using the land in the exercise or performance of 
its exempt purpose, commencing within 10 years of the time of 
acquisition, such property will not be treated as debt-financed 
property, so long as (a) such property is in the neighborhood of other 
property owned by the organization which is used in the performance of 
its exempt purpose, and (b) the organization does not abandon its intent 
to use the land in such a manner within the 10-year period. The rule 
expressed in this subdivision is hereinafter referred to as the 
neighborhood land rule.
    (ii) Neighborhood defined. Property shall be considered in the 
neighborhood of property owned and used by the organization in the 
performance of its exempt purpose if the acquired property is contiguous 
with the exempt purpose property or would be contiguous with such 
property except for the interposition of a road, street, railroad, 
stream, or similar property. If the acquired property is not contiguous 
with exempt function property, it may still be in the neighborhood of 
such property, but only if it is within 1 mile of such property and the 
facts and circumstances of

[[Page 241]]

the particular situation make the acquisition of contiguous property 
unreasonable. Some of the criteria to consider in determining this 
question include the availability of land and the intended future use of 
the land. For example, a university attempts to purchase land contiguous 
to its present campus but cannot do so because the owners either refuse 
to sell or ask unreasonable prices. The nearest land of sufficient size 
and utility is a block away from the campus. The university purchases 
such land. Under these circumstances, the contiguity requirement is 
unreasonable and the land purchased would be considered neighborhood 
land.
    (iii) Exception. The neighborhood land rule shall not apply to any 
property after the expiration of 10 years from the date of acquisition. 
Further, the neighborhood land rule shall apply after the first 5 years 
of the 10-year period only if the organization establishes to the 
satisfaction of the Commissioner that future use of the acquired land in 
furtherance of the organization's exempt purpose before the expiration 
of the 10-year period is reasonably certain. In order to satisfy the 
Commissioner, the organization does not necessarily have to show binding 
contracts. However, it must at least have a definite plan detailing a 
specific improvement and a completion date, and some affirmative action 
toward the fulfillment of such a plan. This information shall be 
forwarded to the Commissioner of Internal Revenue, Washington, DC 20224, 
for a ruling at least 90 days before the end of the fifth year after 
acquisition of the land.
    (2) Actual use. If the neighborhood land rule is inapplicable 
because:
    (i) The acquired land is not in the neighborhood of other property 
used by the organization in performance of its exempt purpose, or
    (ii) The organization (for the period after the first 5 years of the 
10-year period) is unable to establish to the satisfaction of the 
Commissioner that the use of the acquired land for its exempt purposes 
within the 10-year period is reasonably certain


but the land is actually used by the organization in furtherance of its 
exempt purpose within the 10-year period, such property (subject to the 
provisions of subparagraph (4) of this paragraph) shall not be treated 
as debt-financed property for any period prior to such conversion.
    (3) Limitations--(i) Demolition or removal required. (a) 
Subparagraphs (1) and (2) of this paragraph shall apply with respect to 
any structure on the land when acquired by the organization, or to the 
land occupied by the structure, only so long as the intended future use 
of the land in furtherance of the organization's exempt purpose requires 
that the structure be demolished or removed in order to use the land in 
such a manner. Thus, during the first 5 years after acquisition (and for 
subsequent years if there is a favorable ruling in accordance with 
subparagraph (1)(iii) of this paragraph) improved property is not debt-
financed so long as the organization does not abandon its intent to 
demolish the existing structures and use the land in furtherance of its 
exempt purpose. Furthermore, if there is an actual demolition of such 
structures, the use made of the land need not be the one originally 
intended. Therefore, the actual use requirement of this subdivision may 
be satisfied by using the land in any manner which furthers the exempt 
purpose of the organization.
    (b) Subdivision (i)(a) of this subparagraph may be illustrated by 
the following examples. For purposes of the following examples it is 
assumed that but for the application of the neighborhood land rule such 
property would be debt-financed property.

    Example 1. An exempt university acquires a contiguous tract of land 
on which there is an apartment building. The university intends to 
demolish the apartment building and build classrooms and does not 
abandon this intent during the first 4 years after acquisition. In the 
fifth year after acquisition it abandons the intent to demolish and 
sells the apartment building. Under these circumstances, such property 
is not debt-financed property for the first 4 years after acquisition 
even though there was no eventual demolition or use made of such land in 
furtherance of the university's exempt purpose. However, such property 
is debt-financed property as of the time in the fifth year that the 
intent to demolish the building is abandoned and any gain on the sale of 
property is subject to section 514.

[[Page 242]]

    Example 2. Assume the facts as stated in Example 1 except that the 
university did not abandon its intent to demolish the existing building 
and construct a classroom building until the eighth year after 
acquisition when it sells the property. Assume further that the 
university did not receive a favorable ruling in accordance with 
subparagraph (1)(iii) of this paragraph. Under these circumstances, the 
building is debt- financed property for the sixth, seventh, and eighth 
years. It is not, however, treated as debt-financed property for the 
first 5 years after acquisition.
    Example 3. Assume the facts as stated in Example 2 except that the 
university received a favorable ruling in accordance with subparagraph 
(1)(iii) of this paragraph. Under these circumstances, the building is 
not debt-financed property for the first 7 years after acquisition. It 
only becomes debt-financed property as of the time in the eighth year 
when the university abandoned its intent to demolish the existing 
structure.
    Example 4. (1) Assume that a university acquires a contiguous tract 
of land containing an office building for the principal purpose of 
demolishing the office building and building a modern dormitory. Five 
years later the dormitory has not been constructed, and the university 
has failed to satisfy the Commissioner that the office building will be 
demolished and the land will be used in furtherance of its exempt 
purpose (and consequently has failed to obtain a favorable ruling under 
subparagraph (1)(iii) of this paragraph). In the ninth taxable year 
after acquisition the university converts the office building into an 
administration building. Under these circumstances, during the sixth, 
seventh, and eighth years after acquisition, the office building is 
treated as debt-financed property because the office building was not 
demolished or removed. Therefore, the income derived from such property 
during these years shall be subject to the tax on unrelated business 
income.
    (2) Assume that instead of converting the office building to an 
administration building, the university demolishes the office building 
in the ninth taxable year after acquisition and then constructs a new 
administration building. Under these circumstances, the land would not 
be considered debt-financed property for any period following the 
acquisition, and the university would be entitled to a refund of taxes 
paid on the income derived from such property for the sixth through 
eighth taxable years after the acquisition in accordance with 
subparagraph (4) of this paragraph.

    (ii) Subsequent construction. Subparagraphs (1) and (2) of this 
paragraph do not apply to structures erected on the land after the 
acquisition of the land.
    (iii) Property subject to business lease. Subparagraphs (1) and (2) 
of this paragraph do not apply to property subject to a lease which is a 
business lease (as defined in Sec.  1.514(f)-1) whether the organization 
acquired the property subject to the lease or whether it executed the 
lease subsequent to acquisition. If only a portion of the real property 
is subject to a lease, paragraph (c) of Sec.  1.514(f)-1 applies in 
determining whether such lease is a business lease.
    (4) Refund of taxes. (i) If an organization has not satisfied the 
actual use condition of subparagraph (2) of this paragraph or paragraph 
(e)(3) of this section before the date prescribed by law (including 
extensions) for filing the return for the taxable year, the tax for such 
year shall be computed without regard to the application of such actual 
use condition. However, if:
    (a) A credit or refund of any overpayment of taxes is allowable for 
a prior taxable year as a result of the satisfaction of such actual use 
condition, and
    (b) Such credit or refund is prevented by the operation of any law 
or rule of law (other than chapter 74, relating to closing agreements 
and compromises)


such credit or refund may nevertheless be allowed or made, if a claim is 
filed within 1 year after the close of the taxable year in which such 
actual use condition is satisfied. For a special rule with respect to 
the payment of interest at the rate of 4 percent per annum, see section 
514(b)(3)(D), prior to its amendment by section 7(b) of the Act of 
January 3, 1975 (Pub. L. 93-625, 88 Stat. 2115).
    (ii) This subparagraph may be illustrated by the following example. 
For purposes of this example it is assumed that but for the neighborhood 
land rule such property would be debt-financed property.

    Example. Y, a calendar year exempt organization, acquires real 
property in January 1970, which is contiguous with other property used 
by Y in furtherance of its exempt purpose. However, Y does not satisfy 
the Commissioner by January 1975, that the existing structure will be 
demolished and the land will be used in furtherance of its exempt 
purpose. In accordance with this subparagraph, from 1975 until the 
property is converted to an exempt use, the income derived from such 
property shall be subject to the tax on unrelated business income. 
During July 1979, Y

[[Page 243]]

demolishes the existing structure on the land and begins using the land 
in furtherance of its exempt purpose. At this time Y may file claims for 
refund for the open years 1976 through 1978. Further, in accordance with 
this subparagraph, Y may also file a claim for refund for 1975, even 
though a claim for such taxable year may be barred by the statute of 
limitations, provided such claim is filed before the close of 1980.

    (e) Churches--(1) In general. If a church or association or 
convention of churches acquires real property, for the principal purpose 
of using the land in the exercise or performance of its exempt purpose, 
commencing within 15 years of the time of acquisition, such property 
shall not be treated as debt-financed property so long as the 
organization does not abandon its intent to use the land in such a 
manner within the 15-year period.
    (2) Exception. This paragraph shall not apply to any property after 
the expiration of the 15-year period. Further, this paragraph shall 
apply after the first 5 years of the 15-year period only if the church 
or association or convention of churches establishes to the satisfaction 
of the Commissioner that use of the acquired land in furtherance of the 
organization's exempt purpose before the expiration of the 15-year 
period is reasonably certain. For purposes of the preceding sentence, 
the rules contained in paragraph (d)(1)(iii) of this section with 
respect to satisfying the Commissioner that the exempt organization 
intends to use the land within the prescribed time in furtherance of its 
exempt purpose shall apply.
    (3) Actual use. If the church or association or convention of 
churches for the period after the first 5 years of the 15-year period is 
unable to establish to the satisfaction of the Commissioner that the use 
of the acquired land for its exempt purpose within the 15-year period is 
reasonably certain, but such land is in fact converted to an exempt use 
within the 15-year period, the land (subject to the provisions of 
paragraph (d)(4) of this section) shall not be treated as debt-financed 
property for any period prior to such conversion.
    (4) Limitations. The limitations stated in paragraph (d)(3)(i) and 
(ii) of this section shall similarly apply to the rules contained in 
this paragraph.

[T.D. 7229, 37 FR 28146, Dec. 21, 1972; 39 FR 6607, Feb. 21, 1974, as 
amended by T.D. 7384, 40 FR 49322, Oct. 22, 1975; T.D. 7632, 44 FR 
42681, July 20, 1979; T.D. 7728, 45 FR 72651, Nov. 3, 1980]



Sec.  1.514(c)-1  Acquisition indebtedness.

    (a) In general--(1) Definition of acquisition indebtedness. For 
purposes of section 514 and the regulations thereunder, the term 
acquisition indebtedness means, with respect to any debt-financed 
property, the outstanding amount of:
    (i) The principal indebtedness incurred by the organization in 
acquiring or improving such property.
    (ii) The principal indebtedness incurred before the acquisition or 
improvement of such property if such indebtedness would not have been 
incurred but for such acquisition or improvement; and
    (iii) The principal indebtedness incurred after the acquisition or 
improvement of such property if such indebtedness would not have been 
incurred but for such acquisition or improvement and the incurrence of 
such indebtedness was reasonably foreseeable at the time of such 
acquisition or improvement


Whether the incurrence of an indebtedness is reasonably foreseeable 
depends upon the facts and circumstances of each situation. The fact 
that an organization did not actually foresee the need for the 
incurrence of an indebtedness prior to the acquisition or improvement 
does not necessarily mean that the subsequent incurrence of indebtedness 
was not reasonably foreseeable.
    (2) Examples. The application of subparagraph (1) of this paragraph 
may be illustrated by the following examples:

    Example 1. X, an exempt organization, pledges some of its investment 
securities with a bank for a loan and uses the proceeds of such loan to 
purchase an office building which it leases to the public for purposes 
other than those described in section 514(b)(1) (A), (B), (C), or (D). 
The outstanding principal indebtedness with respect to the loan 
constitutes acquisition indebtedness incurred prior to the acquisition 
which would

[[Page 244]]

not have been incurred but for such acquisition.
    Example 2. Y, an exempt scientific organization, mortgages its 
laboratory to replace working capital used in remodeling an office 
building which Y rents to an insurance company for purposes not 
described in section 514(b)(1) (A), (B), (C), or (D). The indebtedness 
is acquisition indebtedness since such indebtedness, though incurred 
subsequent to the improvement of the office building, would not have 
been incurred but for such improvement, and the indebtedness was 
reasonably foreseeable when, to make such improvement, Y reduced its 
working capital below the amount necessary to continue current 
operations.
    Example 3. (a) U, an exempt private preparatory school, as its sole 
educational facility owns a classroom building which no longer meets the 
needs of U's students. In 1971, U sells this building for $3 million to 
Y, a corporation which it does not control. U receives $1 million as a 
down payment from Y and takes back a purchase money mortgage of $2 
million which bears interest at 10 percent per annum. At the time U 
became the mortgagee of the $2 million purchase money mortgage, U 
realized that it would have to construct a new classroom building and 
knew that it would have to incur an indebtedness in the construction of 
the new classroom building. In 1972, U builds a new classroom building 
for a cost of $4 million. In connection with the construction of this 
building, U borrows $2.5 million from X Bank pursuant to a deed of trust 
bearing interest at 6 percent perannum. Under these circumstances, $2 
million of the $2.5 million borrowed to finance construction of the new 
classroom building would not have been borrowed but for the retention of 
the $2 million purchase money mortgage. Since such indebtedness was 
reasonably foreseeable, $2 million of the $2.5 million borrowed to 
finance the construction of the new classroom building is acquisition 
indebtedness with respect to the purchase money mortgage and the 
purchase money mortgage is debt-financed property.
    (b) In 1972, U receives $200,000 in interest from Y (10 percent of 
$2 million) and makes a $150,000 interest payment to X (6 percent of 
$2.5 million). In addition, assume that for 1972 the debt/basis 
percentage is 100 percent ($2 million/$2 million). Accordingly, all the 
interest and all the deductions directly connected with such interest 
income are to be taken into account in computing unrelated business 
taxable income. Thus, $200,000 of interest income and $120,000 ($150,000 
x $2 million/$2.5 million) of deductions directly connected with such 
interest income are taken into account. Under these circumstances, U 
shall include net interest income of $80,000 ($200,000 of income less 
$120,000 of deductions directly connected with such income) in its 
unrelated business taxable income for 1972.
    Example 4. In 1972 X, an exempt organization, forms a partnership 
with A and B. The partnership agreement provides that all three partners 
shall share equally in the profits of the partnership, shall each invest 
$3 million, and that X shall be a limited partner. X invests $1 million 
of its own funds in the partnership and $2 million of borrowed funds. 
The partnership purchases as its sole asset an office building which is 
leased to the general public for purposes other than those described in 
section 514(b)(1) (A), (B), (C), or (D). The office building cost the 
partnership $24 million of which $15 million is borrowed from Y bank. 
This loan is secured by a mortgage on the entire office building. By 
agreement with Y bank, X is held not to be personally liable for payment 
of such mortgage. By reason of section 702(b) the character of any item 
realized by the partnership and included in the partner's distributive 
share shall be determined as if the partner realized such item directly 
from the source from which it was realized by the partnership and in the 
same manner. Therefore, a portion of X's income from the building is 
debt-financed income. Under these circumstances, since both the $2 
million indebtedness incurred by X in acquiring its partnership interest 
and $5 million, the allocable portion of the partnership'sindebtedness 
incurred with respect to acquiring the office building which is 
attributable to X in computing the debt/basis percentage (one-third of 
$15 million), were incurred in acquiring income-producing property, X 
has acquisition indebtedness of $7 million ($2 million plus $5 million). 
Similarly, the allocable portion of the partnership's adjusted basis in 
the office building which is attributable to X in computing the debt-
basis percentage is $8 million (one-third of $24 million). Assuming no 
payment with respect to either indebtedness and no adjustments to basis 
in 1972, X's average acquisition indebtedness is $7 million and X's 
average adjusted basis is $8 million for such year. Therefore, X's debt/
basis percentage with respect to its share of the partnership income for 
1972 is 87.5 percent ($7 million/$8 million).

    (3) Changes in use of property. Since property used in a manner 
described in section 514(b)(1) (A), (B), (C), or (D) is not considered 
debt-financed property, indebtedness with respect to such property is 
not acquisition indebtedness. However, if an organization converts such 
property to a use which is not described in section 514(b)(1) (A), (B), 
(C), or (D) and such property is otherwise treated as debt-financed 
property, the outstanding principal indebtedness with respect to such 
property will

[[Page 245]]

thereafter be treated as acquisition indebtedness. For example, assume 
that in 1971 a university borrows funds to acquire an apartment building 
as housing for married students. In 1974 the university rents the 
apartment building to the public for purposes not described in section 
514(b)(1) (A), (B), (C), or (D). The outstanding principal indebtedness 
is acquisition indebtedness as of the time in 1974 when the building is 
first rented to the public.
    (4) Continued indebtedness. If:
    (i) An organization sells or exchanges property, subject to an 
indebtedness (incurred in a manner described in subparagraph (1) of this 
paragraph),
    (ii) Acquires another property without retiring the indebtedness, 
and
    (iii) The newly acquired property is otherwise treated as debt-
financed property


the outstanding principal indebtedness with respect to the acquired 
property is acquisition indebtedness, even though the original property 
was not debt-financed property. For example, to house its administrative 
offices, an exempt organization purchases a building with $600,000 of 
its own funds and $400,000 of borrowed funds secured by a pledge of its 
securities. It later sells the building for $1,000,000 without redeeming 
the pledge. It uses these proceeds to purchase an apartment building 
which it rents to the public for purposes not described in section 
514(b)(1) (A), (B), (C), or (D). The indebtedness of $400,000 is 
acquisition indebtedness with respect to the apartment building even 
though the office building was not debt-financed property.
    (5) Indebtedness incurred before June 28, 1966. For taxable years 
beginning before January 1, 1972, acquisition indebtedness does not 
include any indebtedness incurred before June 28, 1966, unless such 
indebtedness was incurred on rental real property subject to a business 
lease and such indebtedness constituted business lease indebtedness. 
Furthermore, in the case of a church or convention or association of 
churches, the preceding sentence applies without regard to whether the 
indebtedness incurred before June 28, 1966, constituted business lease 
indebtedness.
    (b) Property acquired subject to lien--(1) Mortgages. Except as 
provided in subparagraphs (3) and (4) of this paragraph, whenever 
property is acquired subject to a mortgage, the amount of the 
outstanding principal indebtedness secured by such mortgage is treated 
as acquisition indebtedness with respect to such property even though 
the organization did not assume or agree to pay such indebtedness. The 
preceding sentence applies whether property is acquired by purchase, 
gift, devise, bequest, or any other means. Thus, for example, assume 
that an exempt organization pays $50,000 for real property valued at 
$150,000 and subject to a $100,000 mortgage. The $100,000 of outstanding 
principal indebtedness is acquisition indebtedness just as though the 
organization had borrowed $100,000 to buy the property.
    (2) Other liens. For purposes of this paragraph, liens similar to 
mortgages shall be treated as mortgages. A lien is similar to a mortgage 
if title to property is encumbered by the lien for the benefit of a 
creditor. However, in the case where State law provides that a tax lien 
attaches to property prior to the time when such lien becomes due and 
payable, such lien shall not be treated as similar to a mortgage until 
after it has become due and payable and the organization has had an 
opportunity to pay such lien in accordance with State law. Liens similar 
to mortgages include (but are not limited to):

    (i) Deeds of trust,
    (ii) Conditional sales contracts,
    (iii) Chattel mortgages,
    (iv) Security interests under the Uniform Commercial Code,
    (v) Pledges,
    (vi) Agreements to hold title in escrow, and
    (vii) Tax liens (other than those described in the third sentence of 
this subparagraph).
    (3) Certain encumbered property acquired by gift, bequest or 
devise--(i) Bequest or devise. Where property subject to a mortgage is 
acquired by an organization by bequest or devise, the outstanding 
principal indebtedness secured by such mortgage is not to be treated as 
acquisition indebtedness during the 10-year period following the date of 
acquisition. For purposes of the

[[Page 246]]

preceding sentence, the date of acquisition is the date the organization 
receives the property.
    (ii) Gifts. If an organization acquires property by gift subject to 
a mortgage, the outstanding principal indebtedness secured by such 
mortgage shall not be treated as acquisition indebtedness during the 10-
year period following the date of such gift, so long as:
    (a) The mortgage was placed on the property more than 5 years before 
the date of the gift, and
    (b) The property was held by the donor for more than 5 years before 
the date of the gift


For purposes of the preceding sentence, the date of the gift is the date 
the organization receives the property.
    (iii) Limitation. Subdivisions (i) and (ii) of this subparagraph 
shall not apply if:
    (a) The organization assumes and agrees to pay all or any part of 
the indebtedness secured by the mortgage, or
    (b) The organization makes any payment for the equity owned by the 
decedent or the donor in the property (other than a payment pursuant to 
an annuity excluded from the definition of acquisition indebtedness by 
paragraph (e) of this section)


Whether an organization has assumed and agreed to pay all or any part of 
an indebtedness in order to acquire the property shall be determined by 
the facts and circumstances of each situation.
    (iv) Examples. The application of this subparagraph may be 
illustrated by the following examples:

    Example 1. A dies on January 1, 1971. His will devises an office 
building subject to a mortgage to U, an exempt organization described in 
section 501(c)(3). U does not at any time assume the mortgage. For the 
period 1971 through 1980, the outstanding principal indebtedness secured 
by the mortgage is not acquisition indebtedness. However, after December 
31, 1980, the outstanding principal indebtedness secured by the mortgage 
is acquisition indebtedness if the building is otherwise treated as 
debt-financed property.
    Example 2. Assume the facts as stated in example 1 except that on 
January 1, 1975, U assumes the mortgage. After January 1, 1975, the 
outstanding principal indebtedness secured by the mortgage is 
acquisition indebtedness if the building is otherwise treated as debt-
financed property.

    (4) Bargain sale before October 9, 1969. Where property subject to a 
mortgage is acquired by an organization before October 9, 1969, the 
outstanding principal indebtedness secured by such mortgage is not to be 
treated as acquisition indebtedness during the 10-year period following 
the date of acquisition if:
    (i) The mortgage was placed on the property more than 5 years before 
the purchase, and
    (ii) The organization paid the seller a total amount no greater than 
the amount of the seller's cost (including attorney's fees) directly 
related to the transfer of such property to the organization, but in any 
event no more than 10 percent of the value of the seller's equity in the 
property transferred.
    (c) Extension of obligations--(1) In general. An extension, renewal, 
or refinancing of an obligation evidencing a preexisting indebtedness is 
considered as a continuation of the old indebtedness to the extent the 
outstanding principal amount thereof is not increased. Where the 
principal amount of the modified obligation exceeds the outstanding 
principal amount of the preexisting indebtedness, the excess shall be 
treated as a separate indebtedness for purposes of section 514 and the 
regulations thereunder. For example, if the interest rate on an 
obligation incurred prior to June 28, 1966, by an exempt university is 
modified subsequent to such date, the modified obligation shall be 
deemed to have been incurred prior to June 28, 1966. Thus, such an 
indebtedness will not be treated as acquisition indebtedness for taxable 
years beginning before January 1, 1972, unless the original indebtedness 
was business lease indebtedness (as defined in Sec.  1.514(g)-1).
    (2) Extension or renewal. In general, any modification or 
substitution of the terms of an obligation by the organization shall be 
an extension or renewal of the original obligation, rather than the 
creation of a new indebtedness to the extent that the outstanding 
principal amount of the indebtedness is not increased. The following are 
examples of acts which result in the extension or renewal of an 
obligation:
    (i) Substitution of liens to secure the obligation;

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    (ii) Substitution of obligees, whether or not with the consent of 
the organization;
    (iii) Renewal, extension or acceleration of the payment terms of the 
obligation; and
    (iv) Addition, deletion, or substitution of sureties or other 
primary or secondary obligors.
    (3) Allocation. In cases where the outstanding principal amount of 
the modified obligation exceeds the outstanding principal amount of the 
unmodified obligation and only a portion of such refinanced indebtedness 
is to be treated as acquisition indebtedness, payments on the amount of 
the refinanced indebtedness shall be apportioned prorata between the 
amount of the preexisting indebtedness and the excess amount. For 
example, assume that an organization has an outstanding principal 
indebtedness of $500,000 which is treated as acquisition indebtedness. 
It borrows another $100,000, which is not acquisition indebtedness, from 
the same lending institution and gives the lender a $600,000 note for 
its total obligation. In this situation, a payment of $60,000 on the 
amount of the total obligation would reduce the acquisition indebtedness 
by $50,000 and the excess indebtedness by $10,000.
    (d) Indebtedness incurred in performing exempt purpose. Acquisition 
indebtedness does not include the incurrence of an indebtedness inherent 
in the performance or exercise of the purpose or function constituting 
the basis of the organization's exemption. Thus, acquisition 
indebtedness does not include the indebtedness incurred by an exempt 
credit union in accepting deposits from its members or the obligation 
incurred by an exempt organization in accepting payments from its 
members to provide such members with insurance, retirement or other 
similar benefits.
    (e) Annuities--(1) Requirements. The obligation to make payment of 
an annuity is not acquisition indebtedness if the annuity meets all the 
following requirements:
    (i) It must be the sole consideration (other than a mortgage to 
which paragraph (b)(3) of this section applies) issued in exchange for 
the property acquired;
    (ii) At the time of the exchange, the present value of the annuity 
(determined in accordance with subparagraph (2) of this paragraph) must 
be less than 90 percent of the value of the prior owner's equity in the 
property received in the exchange;
    (iii) The annuity must be payable over the life of one individual in 
being at the time the annuity is issued, or over the lives of two 
individuals in being at such time; and
    (iv) The annuity must be payable under a contract which:
    (a) Does not guarantee a minimum number of payments or specify a 
maximum number of payments, and
    (b) Does not provide for any adjustment of the amount of the annuity 
payments by reference to the income received from the transferred 
property or any other property.
    (2) Valuation. For purposes of this paragraph, the value of an 
annuity at the time of exchange shall be computed in accordance with 
section 1011(b), Sec.  1.1011-2(e)(1)(iii)(b)(2), and section 3 of Rev. 
Rul. 62-216, C.B. 1962-2, 30.
    (3) Examples. The application of this paragraph may be illustrated 
by the following examples. For purposes of these examples it is assumed 
that the property transferred is used for purposes other than those 
described in section 514(b)(1) (A), (B), (C), or (D).

    Example 1. On January 1, 1971, X, an exempt organization, receives 
property valued at $100,000 from donor A, a male aged 60. In return X 
promises to pay A $6,000 a year for the rest of A's life, with neither a 
minimum nor maximum number of payments specified. The annuity is payble 
on December 31, of each year. The amounts paid under the annuity are not 
dependent on the income derived from the property transferred to X. The 
present value of this annuity is $81,156, determined in accordance with 
Table A of Rev. Rul. 62-216. Since the value of the annuity is less than 
90 percent of A's equity in the property transferred and the annuity 
meets all the other requirements of subparagraph (1) of this paragraph, 
the obligation to make annuity payments is not acquisition indebtedness.
    Example 2. On January 1, 1971, B transfers an office building to Y, 
an exempt university, subject to a mortgage. In return Y agrees to pay B 
$5,000 a year for the rest of his life, with neither a minimum nor 
maximum number of payments specified. The amounts paid under the annuity 
are not dependent on the income derived from the

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property transferred to Y. It is determined that the actual value of the 
annuity is less than 90 percent of the value of B's equity in the 
property transferred. Y does not assume the mortgage. For the taxable 
years 1971 through 1980, the outstanding principal indebtedness secured 
by the mortgage is not treated as acquisition indebtedness. Further, Y's 
obligation to make annuity payments to B never constitutes acquisition 
indebtedness.

    (f) Certain Federal financing. Acquisition indebtedness does not 
include an obligation to finance the purchase, rehabilitation, or 
construction of housing for low and moderate income persons to the 
extent that it is insured by the Federal Housing Administration. Thus, 
for example, to the extent that an obligation is insured by the Federal 
Housing Administration under section 221(d)(3) (12 U.S.C. 1715(I)(d)(3)) 
or section 236 (12 U.S.C. 1715z-1) of title II of the National Housing 
Act, as amended, the obligation is not acquisition indebtedness.
    (g) Certain obligations of charitable remainder trusts. For purposes 
of section 664(c) and Sec.  1.664-1(c), a charitable remainder trust (as 
defined in Sec.  1.664-1(a)(1)(iii)(a) does not incur acquisition 
indebtedness when the sole consideration it is required to pay in 
exchange for unencumbered property is an annuity amount or a unitrust 
amount (as defined in Sec.  1.664-1(a)(1)(iii)(b) and (c)).

[T.D. 7229, 37 FR 28151, Dec. 21, 1972; 38 FR 21918, Aug. 14, 1973; T.D. 
7698, 45 FR 33973, May 21, 1980]



Sec.  1.514(c)-2  Permitted allocations under section 514(c)(9)(E).

    (a) Table of contents. This paragraph contains a listing of the 
major headings of this Sec.  1.514(c)-2.

    (a) Table of contents.
    (b) Application of section 514(c)(9)(E), relating to debt-financed 
real property held by partnerships.
    (1) In general.
    (i) The fractions rule.
    (ii) Substantial economic effect.
    (2) Manner in which fractions rule is applied.
    (i) In general.
    (ii) Subsequent changes.
    (c) General definitions.
    (1) Overall partnership income and loss.
    (i) Items taken into account in determining overall partnership 
income and loss.
    (ii) Guaranteed payments to qualified organizations.
    (2) Fractions rule percentage.
    (3) Definitions of certain terms by cross reference to partnership 
regulations.
    (4) Example.
    (d) Exclusion of reasonable preferred returns and guaranteed 
payments.
    (1) Overview.
    (2) Preferred returns.
    (3) Guaranteed payments.
    (4) Reasonable amount.
    (i) In general.
    (ii) Safe harbor.
    (5) Unreturned capital.
    (i) In general.
    (ii) Return of capital.
    (6) Timing rules.
    (i) Limitation on allocations of income with respect to reasonable 
preferred returns for capital.
    (ii) Reasonable guaranteed payments may be deducted only when paid 
in cash.
    (7) Examples.
    (e) Chargebacks and offsets.
    (1) In general.
    (2) Disproportionate allocations.
    (i) In general.
    (ii) Limitation on chargebacks of partial allocations.
    (3) Minimum gain chargebacks attributable to nonrecourse deductions.
    (4) Minimum gain chargebacks attributable to distribution of 
nonrecourse debt proceeds.
    (i) Chargebacks disregarded until allocations made.
    (ii) Certain minimum gain chargebacks related to returns of capital.
    (5) Examples.
    (f) Exclusion of reasonable partner-specific items of deduction or 
loss.
    (g) Exclusion of unlikely losses and deductions.
    (h) Provisions preventing deficit capital account balances.
    (i) [Reserved]
    (j) Exception for partner nonrecourse deductions.
    (1) Partner nonrecourse deductions disregarded until actually 
allocated.
    (2) Disproportionate allocation of partner nonrecourse deductions to 
a qualified organization.
    (k) Special rules.
    (1) Changes in partnership allocations arising from a change in the 
partners' interests.
    (2) De minimis interest rule.
    (i) In general.
    (ii) Example.
    (3) De minimis allocations disregarded.
    (4) Anti-abuse rule.
    (l) [Reserved]
    (m) Tiered partnerships.
    (1) In general.
    (2) Examples.
    (n) Effective date.
    (1) In general.

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    (2) General effective date of the regulations.
    (3) Periods after June 24, 1990, and prior to December 30, 1992.
    (4) Periods prior to the issuance of Notice 90-41.
    (5) Material modifications to partnership agreements.

    (b) Application of section 514(c)(9)(E), relating to debt-financed 
real property held by partnerships--(1) In general. This Sec.  1.514(c)-
2 provides rules governing the application of section 514(c)(9)(E). To 
comply with section 514(c)(9)(E), the following two requirements must be 
met:
    (i) The fractions rule. The allocation of items to a partner that is 
a qualified organization cannot result in that partner having a 
percentage share of overall partnership income for any partnership 
taxable year greater than that partner's fractions rule percentage (as 
defined in paragraph (c)(2) of this section).
    (ii) Substantial economic effect. Each partnership allocation must 
have substantial economic effect. However, allocations that cannot have 
economic effect must be deemed to be in accordance with the partners' 
interests in the partnership pursuant to Sec.  1.704-1(b)(4), or (if 
Sec.  1.704-1(b)(4) does not provide a method for deeming the 
allocations to be in accordance with the partners' interests in the 
partnership) must otherwise comply with the requirements of Sec.  1.704-
1(b)(4). Allocations attributable to nonrecourse liabilities or partner 
nonrecourse debt must comply with the requirements of Sec.  1.704-2(e) 
or Sec.  1.704-2(i).
    (2) Manner in which fractions rule is applied--(i) In general. A 
partnership must satisfy the fractions rule both on a prospective basis 
and on an actual basis for each taxable year of the partnership, 
commencing with the first taxable year of the partnership in which the 
partnership holds debt-financed real property and has a qualified 
organization as a partner. Generally, a partnership does not qualify for 
the unrelated business income tax exception provided by section 
514(c)(9)(A) for any taxable year of its existence unless it satisfies 
the fractions rule for every year the fractions rule applies. However, 
if an actual allocation described in paragraph (e)(4), (h), (j)(2), or 
(m)(1)(ii) of this section (regarding certain allocations that are 
disregarded or not taken into account for purposes of the fractions rule 
until an actual allocation is made) causes the partnership to violate 
the fractions rule, the partnership ordinarily is treated as violating 
the fractions rule only for the taxable year of the actual allocation 
and subsequent taxable years. For purposes of applying the fractions 
rule, the term partnership agreement is defined in accordance with Sec.  
1.704-1(b)(2)(ii)(h), and informal understandings are considered part of 
the partnership agreement in appropriate circumstances. See paragraph 
(k) of this section for rules relating to changes in the partners' 
interests and de minimis exceptions to the fractions rule.
    (ii) Subsequent changes. A subsequent change to a partnership 
agreement that causes the partnership to violate the fractions rule 
ordinarily causes the partnership's income to fail the exception 
provided by section 514(c)(9)(A) only for the taxable year of the change 
and subsequent taxable years.
    (c) General definitions--(1) Overall partnership income and loss. 
Overall partnership income is the amount by which the aggregate items of 
partnership income and gain for the taxable year exceed the aggregate 
items of partnership loss and deduction for the year. Overall 
partnership loss is the amount by which the aggregate items of 
partnership loss and deduction for the taxable year exceed the aggregate 
items of partnership income and gain for the year.
    (i) Items taken into account in determining overall partnership 
income and loss. Except as otherwise provided in this section, the 
partnership items that are included in computing overall partnership 
income or loss are those items of income, gain, loss, and deduction 
(including expenditures described in section 705(a)(2)(B)) that increase 
or decrease the partners' capital accounts under Sec.  1.704-
1(b)(2)(iv). Tax items allocable pursuant to section 704(c) or Sec.  
1.704-1(b)(2)(iv)(f)(4) are not included in computing overall 
partnership income or loss. Nonetheless, allocations pursuant to section 
704(c) or Sec.  1.704-

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1(b)(2)(iv)(f)(4) may be relevant in determining that this section is 
being applied in a manner that is inconsistent with the fractions rule. 
See paragraph (k)(4) of this section.
    (ii) Guaranteed payments to qualified organizations. Except to the 
extent otherwise provided in paragraph (d) of this section--
    (A) A guaranteed payment to a qualified organization is not treated 
as an item of partnership loss or deduction in computing overall 
partnership income or loss; and
    (B) Income that a qualified organization may receive or accrue with 
respect to a guaranteed payment is treated as an allocable share of 
overall partnership income or loss for purposes of the fractions rule.
    (2) Fractions rule percentage. A qualified organization's fractions 
rule percentage is that partner's percentage share of overall 
partnership loss for the partnership taxable year for which that 
partner's percentage share of overall partnership loss will be the 
smallest.
    (3) Definitions of certain terms by cross reference to partnership 
regulations. Minimum gain chargeback, nonrecourse deduction, nonrecourse 
liability, partner nonrecourse debt, partner nonrecourse debt minimum 
gain, partner nonrecourse debt minimum gain chargeback, partner 
nonrecourse deduction, and partnership minimum gain have the meanings 
provided in Sec.  1.704-2.
    (4) Example. The following example illustrates the provisions of 
this paragraph (c).

    Example. Computation of overall partnership income and loss for a 
taxable year. (i) Taxable corporation TP and qualified organization QO 
form a partnership to own and operate encumbered real property. Under 
the partnership agreement, all items of income, gain, loss, deduction, 
and credit are allocated 50 percent to TP and 50 percent to QO. Neither 
partner is entitled to a preferred return. However, the partnership 
agreement provides for a $900 guaranteed payment for services to QO in 
each of the partnership's first two taxable years. No part of the 
guaranteed payments qualify as a reasonable guaranteed payment under 
paragraph (d) of this section.
    (ii) The partnership violates the fractions rule. Due to the 
existence of the guaranteed payment, QO's percentage share of any 
overall partnership income in the first two years will exceed QO's 
fractions rule percentage. For example, the partnership might have 
bottom-line net income of $5,100 in its first taxable year that is 
comprised of $10,000 of rental income, $4,000 of salary expense, and the 
$900 guaranteed payment to QO. The guaranteed payment would not be 
treated as an item of deduction in computing overall partnership income 
or loss because it does not qualify as a reasonable guaranteed payment. 
See paragraph (c)(1)(ii)(A) of this section. Accordingly, overall 
partnership income for the year would be $6,000, which would consist of 
$10,000 of rental income less $4,000 of salary expense. See paragraph 
(c)(1)(i) of this section. The $900 QO would include in income with 
respect to the guaranteed payment would be treated as an allocable share 
of the $6,000 of overall partnership income. See paragraph (c)(1)(ii)(B) 
of this section. Therefore, QO's allocable share of the overall 
partnership income for the year would be $3,450, whichwould be comprised 
of the $900 of income pertaining to QO's guaranteed payment, plus QO's 
$2,550 allocable share of the partnership's net income for the year (50 
percent of $5,100). QO's $3,450 allocable share of overall partnership 
income would equal 58 percent of the $6,000 of overall partnership 
income and would exceed QO's fractions rule percentage, which is less 
than 50 percent. (If there were no guaranteed payment, QO's fractions 
rule percentage would be 50 percent. However, the existence of the 
guaranteed payment to QO that is not disregarded for purposes of the 
fractions rule pursuant to paragraph (d) of this section means that QO's 
fractions rule percentage is less than 50 percent.)

    (d) Exclusion of reasonable preferred returns and guaranteed 
payments--(1) Overview. This paragraph (d) sets forth requirements for 
disregarding reasonable preferred returns for capital and reasonable 
guaranteed payments for capital or services for purposes of the 
fractions rule. To qualify, the preferred return or guaranteed payment 
must be set forth in a binding, written partnership agreement.
    (2) Preferred returns. Items of income (including gross income) and 
gain that may be allocated to a partner with respect to a current or 
cumulative reasonable preferred return for capital (including 
allocations of minimum gain attributable to nonrecourse liability (or 
partner nonrecourse debt) proceeds distributed to the partner as a 
reasonable preferred return) are disregarded in computing overall 
partnership income or loss for purposes of the fractions rule. 
Similarly, if a partnership

[[Page 251]]

agreement effects a reasonable preferred return with an allocation of 
what would otherwise be overall partnership income, those items 
comprising that allocation are disregarded in computing overall 
partnership income for purposes of the fractions rule.
    (3) Guaranteed payments. A current or cumulative reasonable 
guaranteed payment to a qualified organization for capital or services 
is treated as an item of deduction in computing overall partnership 
income or loss, and the income that the qualified organization may 
receive or accrue from the current or cumulative reasonable guaranteed 
payment is not treated as an allocable share of overall partnership 
income or loss. The treatment of a guaranteed payment as reasonable for 
purposes of section 514(c)(9)(E) does not affect its possible 
characterization as unrelated business taxable income under other 
provisions of the Internal Revenue Code.
    (4) Reasonable amount--(i) In general. A guaranteed payment for 
services is reasonable only to the extent the amount of the payment is 
reasonable under Sec.  1.162-7 (relating to the deduction of 
compensation for personal services). A preferred return or guaranteed 
payment for capital is reasonable only to the extent it is computed, 
with respect to unreturned capital, at a rate that is commercially 
reasonable based on the relevant facts and circumstances.
    (ii) Safe harbor. For purposes of this paragraph (d)(4), a rate is 
deemed to be commercially reasonable if it is no greater than four 
percentage points more than, or if it is no greater than 150 percent of, 
the highest long-term applicable federal rate (AFR) within the meaning 
of section 1274(d), for the month the partner's right to a preferred 
return or guaranteed payment is first established or for any month in 
the partnership taxable year for which the return or payment on capital 
is computed. A rate in excess of the rates described in the preceding 
sentence may be commercially reasonable, based on the relevant facts and 
circumstances.
    (5) Unreturned capital--(i) In general. Unreturned capital is 
computed on a weighted-average basis and equals the excess of--
    (A) The amount of money and the fair market value of property 
contributed by the partner to the partnership (net of liabilities 
assumed, or taken subject to, by the partnership); over
    (B) The amount of money and the fair market value of property (net 
of liabilities assumed, or taken subject to, by the partner) distributed 
by the partnership to the partner as a return of capital.
    (ii) Return of capital. In determining whether a distribution 
constitutes a return of capital, all relevant facts and circumstances 
are taken into account. However, the designation of distributions in a 
written partnership agreement generally will be respected in determining 
whether a distribution constitutes a return of capital, so long as the 
designation is economically reasonable.
    (6) Timing rules--(i) Limitation on allocations of income with 
respect to reasonable preferred returns for capital. Items of income and 
gain (or part of what would otherwise be overall partnership income) 
that may be allocated to a partner in a taxable year with respect to a 
reasonable preferred return for capital are disregarded for purposes of 
the fractions rule only to the extent the allocable amount will not 
exceed--
    (A) The aggregate of the amount that has been distributed to the 
partner as a reasonable preferred return for the taxable year of the 
allocation and prior taxable years, on or before the due date (not 
including extensions) for filing the partnership's return for the 
taxable year of the allocation; minus
    (B) The aggregate amount of corresponding income and gain (and what 
would otherwise be overall partnership income) allocated to the partner 
in all prior years.
    (ii) Reasonable guaranteed payments may be deducted only when paid 
in cash. If a partnership that avails itself of paragraph (d)(3) of this 
section would otherwise be required (by virtue of its method of 
accounting) to deduct a reasonable guaranteed payment to a qualified 
organization earlier than the taxable year in which it is paid in cash, 
the partnership must delay the deduction of the guaranteed payment until

[[Page 252]]

the taxable year it is paid in cash. For purposes of this paragraph 
(d)(6)(ii), a guaranteed payment that is paid in cash on or before the 
due date (not including extensions) for filing the partnership's return 
for a taxable year may be treated as paid in that prior taxable year.
    (7) Examples. The following examples illustrate the provisions of 
this paragraph (d).

    Facts. Qualified organization QO and taxable corporation TP form a 
partnership. QO contributes $9,000 to the partnership and TP contributes 
$1,000. The partnership borrows $50,000 from a third party lender and 
purchases an office building for $55,000. At all relevant times the safe 
harbor rate described in paragraph (d)(4)(ii) of this section equals 10 
percent.
    Example 1. Allocations made with respect to preferred returns. (i) 
The partnership agreement provides that in each taxable year the 
partnership's distributable cash is first to be distributed to QO as a 
10 percent preferred return on its unreturned capital. To the extent the 
partnership has insufficient cash to pay QO its preferred return in any 
taxable year, the preferred return is compounded (at 10 percent) and is 
to be paid in future years to the extent the partnership has 
distributable cash. The partnership agreement first allocates gross 
income and gain 100 percent to QO, to the extent cash has been 
distributed to QO as a preferred return. All remaining profit or loss is 
allocated 50 percent to QO and 50 percent to TP.
    (ii) The partnership satisfies the fractions rule. Items of income 
and gain that may be specially allocated to QO with respect to its 
preferred return are disregarded in computing overall partnership income 
or loss for purposes of the fractions rule because the requirements of 
paragraph (d) of this section are satisfied. After disregarding those 
allocations, QO's fractions rule percentage is 50 percent (see paragraph 
(c)(2) of this section), and under the partnership agreement QO may not 
be allocated more than 50 percent of overall partnership income in any 
taxable year.
    (iii) The facts are the same as in paragraph (i) of this Example 1, 
except that QO's preferred return is computed on unreturned capital at a 
rate that exceeds a commercially reasonable rate. The partnership 
violates the fractions rule. The income and gain that may be specially 
allocated to QO with respect to the preferred return is not disregarded 
in computing overall partnership income or loss to the extent it exceeds 
a commercially reasonable rate. See paragraph (d) of this section. As a 
result, QO's fractions rule percentage is less than 50 percent (see 
paragraph (c)(2) of this section), and allocations of income and gain to 
QO with respect to its preferred return could result in QO being 
allocated more than 50 percent of the overall partnership income in a 
taxable year.
    Example 2. Guaranteed payments and the computation of overall 
partnership income or loss. (i) The partnership agreement allocates all 
bottom-line partnership income and loss 50 percent to QO and 50 percent 
to TP throughout the life of the partnership. The partnership agreement 
provides that QO is entitled each year to a 10 percent guaranteed 
payment on unreturned capital. To the extent the partnership is unable 
to make a guaranteed payment in any taxable year, the unpaid amount is 
compounded at 10 percent and is to be paid in future years.
    (ii) Assuming the requirements of paragraph (d)(6)(ii) of this 
section are met, the partnership satisfies the fractions rule. The 
guaranteed payment is disregarded for purposes of the fractions rule 
because it is computed with respect to unreturned capital at the safe 
harbor rate described in paragraph (d)(4)(ii) of this section. 
Therefore, the guaranteed payment is treated as an item of deduction in 
computing overall partnership income or loss, and the corresponding 
income that QO may receive or accrue with respect to the guaranteed 
payment is not treated as an allocable share of overall partnership 
income or loss. See paragraph (d)(3) of this section. Accordingly, QO's 
fractions rule percentage is 50 percent (see paragraph (c)(2) of this 
section), and under the partnership agreement QO may not be allocated 
more than 50 percent of overall partnership income in any taxable year.

    (e) Chargebacks and offsets--(1) In general. The following 
allocations are disregarded in computing overall partnership income or 
loss for purposes of the fractions rule--
    (i) Allocations of what would otherwise be overall partnership 
income that may be made to chargeback (i.e., reverse) prior 
disproportionately large allocations of overall partnership loss (or 
part of the overall partnership loss) to a qualified organization, and 
allocations of what would otherwise be overall partnership loss that may 
be made to chargeback prior disproportionately small allocations of 
overall partnership income (or part of the overall partnership income) 
to a qualified organization;
    (ii) Allocations of income or gain that may be made to a partner 
pursuant to a minimum gain chargeback attributable to prior allocations 
of nonrecourse deductions to the partner;

[[Page 253]]

    (iii) Allocations of income or gain that may be made to a partner 
pursuant to a minimum gain chargeback attributable to prior allocations 
of partner nonrecourse deductions to the partner and allocations of 
income or gain that may be made to other partners to chargeback 
compensating allocations of other losses, deductions, or section 
705(a)(2)(B) expenditures to the other partners; and
    (iv) Allocations of items of income or gain that may be made to a 
partner pursuant to a qualified income offset, within the meaning of 
Sec.  1.704-1(b)(2)(ii)(d).
    (v) Allocations made in taxable years beginning on or after January 
1, 2002, that are mandated by statute or regulation other than 
subchapter K of chapter 1 of the Internal Revenue Code and the 
regulations thereunder.
    (2) Disproportionate allocations--(i) In general. To qualify under 
paragraph (e)(1)(i) of this section, prior disproportionate allocations 
may be reversed in full or in part, and in any order, but must be 
reversed in the same ratio as originally made. A prior allocation is 
disproportionately large if the qualified organization's percentage 
share of that allocation exceeds its fractions rule percentage. A prior 
allocation is disproportionately small if the qualified organization's 
percentage share of that allocation is less than its fractions rule 
percentage. However, a prior allocation (or allocations) is not 
considered disproportionate unless the balance of the overall 
partnership income or loss for the taxable year of the allocation is 
allocated in a manner that would independently satisfy the fractions 
rule.
    (ii) Limitation on chargebacks of partial allocations. Except in the 
case of a chargeback allocation pursuant to paragraph (e)(4) of this 
section, and except as otherwise provided by the Internal Revenue 
Service by revenue ruling, revenue procedure, or, on a case-by-case 
basis, by letter ruling, paragraph (e)(1)(i) of this section applies to 
a chargeback of an allocation of part of the overall partnership income 
or loss only if that part consists of a pro rata portion of each item of 
partnership income, gain, loss, and deduction (other than nonrecourse 
deductions, as well as partner nonrecourse deductions and compensating 
allocations) that is included in computing overall partnership income or 
loss.
    (3) Minimum gain chargebacks attributable to nonrecourse deductions. 
Commencing with the first taxable year of the partnership in which a 
minimum gain chargeback (or partner nonrecourse debt minimum gain 
chargeback) occurs, a chargeback to a partner is attributable to 
nonrecourse deductions (or separately, on a debt-by-debt basis, to 
partner nonrecourse deductions) in the same proportion that the 
partner's percentage share of the partnership minimum gain (or 
separately, on a debt-by-debt basis, the partner nonrecourse debt 
minimum gain) at the end of the immediately preceding taxable year is 
attributable to nonrecourse deductions (or partner 
nonrecoursedeductions). The partnership must determine the extent to 
which a partner's percentage share of the partnership minimum gain (or 
partner nonrecourse debt minimum gain) is attributable to deductions in 
a reasonable and consistent manner. For example, in those cases in which 
none of the exceptions contained in Sec.  1.704-2(f) (2) through (5) are 
relevant, a partner's percentage share of the partnership minimum gain 
generally is attributable to nonrecourse deductions in the same ratio 
that--
    (i) The aggregate amount of the nonrecourse deductions previously 
allocated to the partner but not charged back in prior taxable years; 
bears to
    (ii) The sum of the amount described in paragraph (e)(3)(i) of this 
section, plus the aggregate amount of distributions previously made to 
the partner of proceeds of a nonrecourse liability allocable to an 
increase in partnership minimum gain but not charged back in prior 
taxable years.
    (4) Minimum gain chargebacks attributable to distribution of 
nonrecourse debt proceeds--(i) Chargebacks disregarded until allocations 
made. Allocations of items of income and gain that may be made pursuant 
to a provision in the partnership agreement that charges back minimum 
gain attributable to the distribution of proceeds of a nonrecourse 
liability (or a partner nonrecourse debt) are taken into account

[[Page 254]]

for purposes of the fractions rule only to the extent an allocation is 
made. (See paragraph (d)(2) of this section, pursuant to which there is 
permanently excluded chargeback allocations of minimum gain that are 
attributable to proceeds distributed as a reasonable preferred return.)
    (ii) Certain minimum gain chargebacks related to returns of capital. 
Allocations of items of income or gain that (in accordance with Sec.  
1.704-2(f)(1)) may be made to a partner pursuant to a minimum gain 
chargeback attributable to the distribution of proceeds of a nonrecourse 
liability are disregarded in computing overall partnership income or 
loss for purposes of the fractions rule to the extent that the 
allocations (subject to the requirements of paragraph (e)(2) of this 
section) also charge back prior disproportionately large allocations of 
overall partnership loss (or part of the overall partnership loss) to a 
qualified organization. This exception applies only to the extent the 
disproportionately large allocation consisted of depreciation from real 
property (other than items of nonrecourse deduction or partner 
nonrecourse deduction) that subsequently was used to secure the 
nonrecourse liability providing the distributed proceeds, and only if 
those proceeds were distributed as a return of capital and in the same 
proportion as the disproportionately large allocation.
    (5) Examples. The following examples illustrate the provisions of 
this paragraph (e).

    Example 1. Chargebacks of disproportionately large allocations of 
overall partnership loss. (i) Qualified organization QO and taxable 
corporation TP form a partnership. QO contributes $900 to the 
partnership and TP contributes $100. The partnership agreement allocates 
overall partnership loss 50 percent to QO and 50 percent to TP until 
TP's capital account is reduced to zero; then 100 percent to QO until 
QO's capital account is reduced to zero; and thereafter 50 percent to QO 
and 50 percent to TP. Overall partnership income is allocated first 100 
percent to QO to chargeback overall partnership loss allocated 100 
percent to QO, and thereafter 50 percent to QO and 50 percent to TP.
    (ii) The partnership satisfies the fractions rule. QO's fractions 
rule percentage is 50 percent. See paragraph (c)(2) of this section. 
Therefore, the 100 percent allocation of overall partnership loss to QO 
is disproportionately large. See paragraph (e)(2)(i) of this section. 
Accordingly, the 100 percent allocation to QO of what would otherwise be 
overall partnership income (if it were not disregarded), which charges 
back the disproportionately large allocation of overall partnership 
loss, is disregarded in computing overall partnership income and loss 
for purposes of the fractions rule. The 100 percent allocation is in the 
same ratio as the disproportionately large loss allocation, and the rest 
of the allocations for the taxable year of the disproportionately large 
loss allocation will independently satisfy the fractions rule. See 
paragraph (e)(2)(i) of this section. After disregarding the chargeback 
allocation of 100 percent of what would otherwise be overall partnership 
income, QO will not be allocated a percentage share of overall 
partnership income in excess of its fractions rule percentage for any 
taxable year.
    Example 2. Chargebacks of disproportionately small allocations of 
overall partnership income. (i) Qualified organization QO and taxable 
corporation TP form a partnership. QO contributes $900 to the 
partnership and TP contributes $100. The partnership purchases real 
property with money contributed by its partners and with money borrowed 
by the partnership on a recourse basis. In any year, the partnership 
agreement allocates the first $500 of overall partnership income 50 
percent to QO and 50 percent to TP; the next $100 of overall partnership 
income 100 percent to TP (as an incentive for TP to achieve significant 
profitability in managing the partnership'soperations); and all 
remaining overall partnership income 50 percent to QO and 50 percent to 
TP. Overall partnership loss is allocated first 100 percent to TP to 
chargeback overall partnership income allocated 100 percent to TP at any 
time in the prior three years and not reversed; and thereafter 50 
percent to QO and 50 percent to TP.
    (ii) The partnership satisfies the fractions rule. QO's fractions 
rule percentage is 50 percent because qualifying chargebacks are 
disregarded pursuant to paragraph (e)(1)(i) in computing overall 
partnership income or loss. See paragraph (c)(2) of this section. The 
zero percent allocation to QO of what would otherwise be overall 
partnership loss is a qualifying chargeback that is disregarded because 
it is in the same ratio as the income allocation it charges back, 
because the rest of the allocations for the taxable year of that income 
allocation will independently satisfy the fractions rule (see paragraph 
(e)(2)(i) of this section), and because it charges back an allocation of 
zero overall partnership income to QO, which is proportionately smaller 
(i.e., disproportionately small) than QO's 50 percent fractions rule 
percentage. After disregarding the chargeback allocation of 100 percent 
of what would otherwise be overall partnership loss,

[[Page 255]]

QO will not be allocated a percentage share of overall partnership 
income in excess of its fractions rule percentage for any taxable year.
    Example 3. Chargebacks of partner nonrecourse deductions and 
compensating allocations of other items. (i) Qualified organization QO 
and taxable corporation TP form a partnership to own and operate 
encumbered real property. QO and TP each contribute $500 to the 
partnership. In addition, QO makes a $300 nonrecourse loan to the 
partnership. The partnership agreement contains a partner nonrecourse 
debt minimum gain chargeback provision and a provision that allocates 
partner nonrecourse deductions to the partner who bears the economic 
burden of the deductions in accordance with Sec.  1.704-2. The 
partnership agreement also provides that to the extent partner 
nonrecourse deductions are allocated to QO in any taxable year, other 
compensating items of partnership loss or deduction (and, if 
appropriate, section 705(a)(2)(B) expenditures) will first be allocated 
100 percent to TP. In addition, to the extent items of income or gain 
are allocated to QO in any taxable year pursuant to a partner 
nonrecourse debt minimum gain chargeback of deductions, items of 
partnership income and gain will first be allocated 100 percent to TP. 
The partnership agreement allocates all other overall partnership income 
or loss 50 percent to QO and 50 percent to TP.
    (ii) The partnership satisfies the fractions rule on a prospective 
basis. The allocations of the partner nonrecourse deductions and the 
compensating allocation of other items of loss, deduction, and 
expenditure that may be made to TP (but which will not be made unless 
there is an allocation of partner nonrecourse deductions to QO) are not 
taken into account for purposes of the fractions rule until a taxable 
year in which an allocation is made. See paragraph (j)(1) of this 
section. In addition, partner nonrecourse debt minimum gain chargebacks 
of deductions and allocations of income or gain to other partners that 
chargeback compensating allocations of other deductions are disregarded 
in computing overall partnership income or loss for purposes of the 
fractions rule. See paragraph (e)(1)(iii) of this section. Since all 
other overall partnership income and loss is allocated 50 percent to QO 
and 50 percent to TP, QO's fractions rule percentage is 50 percent (see 
paragraph (c)(2) of this section), and QO will not be allocated a 
percentage share of overall partnership income in excess of its 
fractions rule percentage for any taxable year.
    (iii) The facts are the same as in paragraph (i) of this Example 3, 
except that the partnership agreement provides that compensating 
allocations of loss or deduction (and section 705(a)(2)(B) expenditures) 
to TP will not be charged back until year 10. The partners expect $300 
of partner nonrecourse deductions to be allocated to QO in year 1 and 
$300 of income or gain to be allocated to QO in year 2 pursuant to the 
partner nonrecourse debt minimum gain chargeback provision.
    (iv) The partnership fails to satisfy the fractions rule on a 
prospective basis under the anti-abuse rule of paragraph (k)(4) of this 
section. If the partners' expectations prove correct, at the end of year 
2, QO will have been allocated $300 of partner nonrecourse deductions 
and an offsetting $300 of partner nonrecourse debt minimum gain. 
However, the $300 of compensating deductions and losses that may be 
allocated to TP will not be charged back until year 10. Thus, during the 
period beginning at the end of year 2 and ending eight years later, 
there may be $300 more of unreversed deductions and losses allocated to 
TP than to QO, which would be inconsistent with the purpose of the 
fractions rule.
    Example 4. Minimum gain chargeback attributable to distributions of 
nonrecourse debt proceeds. (i) Qualified organization QO and taxable 
corporation TP form a partnership. QO contributes $900 to the 
partnership and TP contributes $100. The partnership agreement generally 
allocates overall partnership income and loss 90 percent to QO and 10 
percent to TP. However, the partnership agreement contains a minimum 
gain chargeback provision, and also provides that in any partnership 
taxable year in which there is a chargeback of partnership minimum gain 
to QO attributable to distributions of proceeds of nonrecourse 
liabilities, all other items comprising overall partnership income or 
loss will be allocated in a manner such that QO is not allocated more 
than 90 percent of the overall partnership income for the year.
    (ii) The partnership satisfies the fractions rule on a prospective 
basis. QO's fractions rule percentage is 90 percent. See paragraph 
(c)(2) of this section. The chargeback that may be made to QO of minimum 
gain attributable to distributions of nonrecourse liability proceeds is 
taken into account for purposes of the fractions rule only to the extent 
an allocation is made. See paragraph (e)(4) of this section. 
Accordingly, that potential allocation to QO is disregarded in applying 
the fractions rule on a prospective basis (see paragraph (b)(2) of this 
section), and QO is treated as not being allocated a percentage share of 
overall partnership income in excess of its fractions rule percentage in 
any taxable year. (Similarly, QO is treated as not being allocated items 
of income or gain in a taxable year when the partnership has an overall 
partnership loss.)
    (iii) In year 3, the partnership borrows $400 on a nonrecourse basis 
and distributes it to QO as a return of capital. In year 8, the 
partnership has $400 of gross income and cash flow and $300 of overall 
partnership income,

[[Page 256]]

and the partnership repays the $400 nonrecourse borrowing.
    (iv) The partnership violates the fractions rule for year 8 and all 
future years. Pursuant to the minimum gain chargeback provision, the 
entire $400 of partnership gross income is allocated to QO. Accordingly, 
notwithstanding the curative provision in the partnership agreement that 
would allocate to TP the next $44 (($400 / .9) x 10%) of income and gain 
included in computing overall partnership income, the partnership has no 
other items of income and gain to allocate to QO. Because the $400 of 
gross income actually allocated to QO is taken into account for purposes 
of the fractions rule in the year an allocation is made (see paragraph 
(e)(4) of this section), QO's percentage share of overall partnership 
income in year 8 is greater than 100 percent. Since this exceeds QO's 
fractions rule percentage (i.e., 90 percent), the partnership violates 
the fractions rule for year 8 and all subsequent taxable years. See 
paragraph (b)(2) of this section.

    (f) Exclusion of reasonable partner-specific items of deduction or 
loss. Provided that the expenditures are allocated to the partners to 
whom they are attributable, the following partner-specific expenditures 
are disregarded in computing overall partnership income or loss for 
purposes of the fractions rule--
    (1) Expenditures for additional record-keeping and accounting 
incurred in connection with the transfer of a partnership interest 
(including expenditures incurred in computing basis adjustments under 
section 743(b));
    (2) Additional administrative costs that result from having a 
foreign partner;
    (3) State and local taxes or expenditures relating to those taxes; 
and
    (4) Expenditures designated by the Internal Revenue Service by 
revenue ruling or revenue procedure, or, on a case-by-case basis, by 
letter ruling. (See Sec.  601.601(d)(2)(ii)(b) of this chapter).
    (g) Exclusion of unlikely losses and deductions. Unlikely losses or 
deductions (other than items of nonrecourse deduction) that may be 
specially allocated to partners that bear the economic burden of those 
losses or deductions are disregarded in computing overall partnership 
income or loss for purposes of the fractions rule, so long as a 
principal purpose of the allocation is not tax avoidance. To be excluded 
under this paragraph (g), a loss or deduction must have a low likelihood 
of occurring, taking into account all relevant facts, circumstances, and 
information available to the partners (including bona fide financial 
projections). The types of events that may give rise to unlikely losses 
or deductions, depending on the facts and circumstances, include tort 
and other third-party litigation that give rise to unforeseen 
liabilities in excess of reasonable insurance coverage; unanticipated 
labor strikes; unusual delays in securing required permits or licenses; 
abnormal weather conditions (considering the season and the job site); 
significant delays in leasing property due to an unanticipated severe 
economic downturn in the geographic area; unanticipated cost overruns; 
and the discovery of environmental conditions that require remediation. 
No inference is drawn as to whether a loss or deduction is unlikely from 
the fact that the partnership agreement includes a provision for 
allocating that loss or deduction.
    (h) Provisions preventing deficit capital account balances. A 
provision in the partnership agreement that allocates items of loss or 
deduction away from a qualified organization in instances where 
allocating those items to the qualified organization would cause or 
increase a deficit balance in its capital account that the qualified 
organization is not obligated to restore (within the meaning of Sec.  
1.704-1(b)(2)(ii) (b) or (d)), is disregarded for purposes of the 
fractions rule in taxable years of the partnership in which no such 
allocations are made pursuant to the provision. However, this exception 
applies only if, at the time the provision becomes part of the 
partnership agreement, all relevant facts, circumstances, and 
information (including bona fide financial projections) available to the 
partners reasonably indicate that it is unlikely that an allocation will 
be made pursuant to the provision during the life of the partnership.
    (i) [Reserved]
    (j) Exception for partner nonrecourse deductions--(1) Partner 
nonrecourse deductions disregarded until actually allocated. Items of 
partner nonrecourse deduction that may be allocated to a partner 
pursuant to Sec.  1.704-2, and compensating allocations of other items 
of

[[Page 257]]

loss, deduction, and section 705(a)(2)(B) expenditures that may be 
allocated to other partners, are not taken into account for purposes of 
the fractions rule until the taxable years in which they are allocated.
    (2) Disproportionate allocation of partner nonrecourse deductions to 
a qualified organization. A violation of the fractions rule will be 
disregarded if it arises because an allocation of partner nonrecourse 
deductions to a qualified organization that is not motivated by tax 
avoidance reduces another qualified organization's fractions rule 
percentage below what it would have been absent the allocation of the 
partner nonrecourse deductions.
    (k) Special rules--(1) Changes in partnership allocations arising 
from a change in the partners' interests. A qualified organization that 
acquires a partnership interest from another qualified organization is 
treated as a continuation of the prior qualified organization partner 
(to the extent of that acquired interest) for purposes of applying the 
fractions rule. Changes in partnership allocations that result from 
other transfers or shifts of partnership interests will be closely 
scrutinized (to determine whether the transfer or shift stems from a 
prior agreement, understanding, or plan or could otherwise be expected 
given the structure of the transaction), but generally will be taken 
into account only in determining whether the partnership satisfies the 
fractions rule in the taxable year of the change and subsequent taxable 
years.
    (2) De minimis interest rule--(i) In general. Section 
514(c)(9)(B)(vi) does not apply to a partnership otherwise subject to 
that section if--
    (A) Qualified organizations do not hold, in the aggregate, interests 
of greater than five percent in the capital or profits of the 
partnership; and
    (B) Taxable partners own substantial interests in the partnership 
through which they participate in the partnership on substantially the 
same terms as the qualified organization partners.
    (ii) Example. Partnership PRS has two types of limited partnership 
interests that participate in partnership profits and losses on 
different terms. Qualified organizations (QOs) only own one type of 
limited partnership interest and own no general partnership interests. 
In the aggregate, the QOs own less than five percent of the capital and 
profits of PRS. Taxable partners also own the same type of limited 
partnership interest that the QOs own. These limited partnership 
interests owned by the taxable partners are 30 percent of the capital 
and profits of PRS. Thirty percent is a substantial interest in the 
partnership. Therefore, PRS satisfies paragraph (k)(2) of this section 
and section 514(c)(9)(B)(vi) does not apply.
    (3) De minimis allocations disregarded. A qualified organization's 
fractions rule percentage of the partnership's items of loss and 
deduction, other than nonrecourse and partner nonrecourse deductions, 
that are allocated away from the qualified organization and to other 
partners in any taxable year are treated as having been allocated to the 
qualified organization for purposes of the fractions rule if--
    (i) The allocation was neither planned nor motivated by tax 
avoidance; and
    (ii) The total amount of those items of partnership loss or 
deduction is less than both--
    (A) One percent of the partnership's aggregate items of gross loss 
and deduction for the taxable year; and
    (B) $50,000.
    (4) Anti-abuse rule. The purpose of the fractions rule is to prevent 
tax avoidance by limiting the permanent or temporary transfer of tax 
benefits from tax-exempt partners to taxable partners, whether by 
directing income or gain to tax-exempt partners, by directing losses, 
deductions, or credits to taxable partners, or by some other similar 
manner. This section may not be applied in a manner that is inconsistent 
with the purpose of the fractions rule.
    (l) [Reserved]
    (m) Tiered partnerships--(1) In general. If a qualified organization 
holds an indirect interest in real property through one or more tiers of 
partnerships (a chain), the fractions rule is satisfied only if--
    (i) The avoidance of tax is not a principal purpose for using the 
tiered-ownership structure (investing in separate real properties 
through separate chains of partnerships so that section

[[Page 258]]

514(c)(9)(E) is, effectively, applied on a property-by-property basis is 
not, in and of itself, a tax avoidance purpose); and
    (ii) The relevant partnerships can demonstrate under any reasonable 
method that the relevant chains satisfy the requirements of paragraphs 
(b)(2) through (k) of this section. For purposes of applying Sec.  
1.704-2(k) under the independent chain approach described in Example 3 
of paragraph (m)(2) of this section, allocations of items of income or 
gain that may be made pursuant to a provision in the partnership 
agreement that charges back minimum gain are taken into account for 
purposes of the fractions rule only to the extent an allocation is made.
    (2) Examples. The following examples illustrate the provisions of 
this paragraph (m).

    Example 1. Tiered partnerships--collapsing approach. (i) Qualified 
organization QO3 and taxable individual TP3 form upper-tier partnership 
P2. The P2 partnership agreement allocates overall partnership income 20 
percent to QO3 and 80 percent to TP3. Overall partnership loss is 
allocated 30 percent to QO3 and 70 percent to TP3. P2 and taxable 
individual TP2 form lower-tier partnership P1. The P1 partnership 
agreement allocates overall partnership income 60 percent to P2 and 40 
percent to TP2. Overall partnership loss is allocated 40 percent to P2 
and 60 percent to TP2. The only asset of P2 (which has no outstanding 
debt) is its interest in P1. P1 purchases real property with money 
contributed by its partners and with borrowed money. There is no tax 
avoidance purpose for the use of the tiered-ownership structure, which 
is illustrated by the following diagram.
[GRAPHIC] [TIFF OMITTED] TR13MY94.006

    (ii) P2 can demonstrate that the P2/P1 chain satisfies the 
requirements of paragraphs (b)(2) through (k) of this section by 
collapsing the tiered-partnership structure. On a collapsed basis, QO3's 
fractions rule percentage is 12 percent (30 percent of 40 percent). See 
paragraph (c)(2) of this section. P2 satisfies the fractions rule 
because QO3 may not be allocated more than 12 percent (20 percent of 60 
percent) of overall partnership income in any taxable year.
    Example 2. Tiered partnerships--entity-by-entity approach. (i) 
Qualified organization QO3A is a partner with taxable individual TP3A in 
upper-tier partnership P2A. Qualified organization QO3B is a partner 
with taxable individual TP3B in upper-tier partnership P2B. P2A, P2B, 
and taxable individual TP2 are partners in lower-tier partnership P1, 
which owns encumbered real estate. None of QO3A, QO3B, TP3A, TP3B or TP2 
has a direct or indirect ownership interest in each other. P2A has been 
established for the purpose of investing in numerous real estate 
properties independently of P2B and its partners. P2B has been 
established for the purpose of investing in numerous real estate 
properties independently of P2A and its partners. Neither P2A nor P2B 
has outstanding debt. There is no tax avoidance purpose for the use of 
the tiered-ownership structure, which is illustrated by the following 
diagram.
[GRAPHIC] [TIFF OMITTED] TR13MY94.007

    (ii) The P2A/P1 chain (Chain A) will satisfy the fractions rule if 
P1 and P2A can demonstrate in a reasonable manner that they satisfy the 
requirements of paragraphs (b)(2) through (k) of this section. The P2B/
P1 chain (Chain B) will satisfy the fractions rule if P1 and P2B can 
demonstrate in a reasonable manner that they satisfy the requirements of 
paragraphs (b)(2) through (k) of this section. To meet its burden, P1 
treats P2A and P2B as qualified organizations. Provided that the 
allocations that may be made by P1 would satisfy the fractions rule if 
P2A and P2B were direct qualified organization partners in P1, Chain A 
will satisfy the fractions rule (for the benefit of QO3A) if the 
allocations that may be made by P2A satisfy the requirements of 
paragraphs (b)(2) through (k) of this section. Similarly, Chain B will 
satisfy the fractions rule (for the benefit of QO3B) if the allocations 
that may be made by P2B satisfy the requirements of paragraphs (b)(2) 
through (k) of this section. Under these facts, QO3A does not have to 
know how income and loss may be allocated by P2B, and QO3B does not have 
to know how income and loss may be allocated by P2A. QO3A's and QO3B's 
burden would not change even if TP2 were not a partner in P1.
    Example 3. Tiered partnerships--independent chain approach. (i) 
Qualified organization QO3 and taxable corporation TP3 form upper-tier 
partnership P2. P2 and taxable corporation TP2 form lower-tier 
partnership P1A. P2 and qualified organization QO2 form lower-tier 
partnership P1B. P2 has no outstanding

[[Page 259]]

debt. P1A and P1B each purchase real property with money contributed by 
their respective partners and with borrowed money. Each partnership's 
real property is completely unrelated to the real property owned by the 
other partnership. P1B's allocations do not satisfy the requirements of 
paragraphs (b)(2) through (k) of this section because of allocations 
that may be made to QO2. However, if P2's interest in P1B were 
completely disregarded, the P2/P1A chain would satisfy the requirements 
of paragraphs (b)(2) through (k) of this section. There is no tax 
avoidance purpose for the use of the tiered-ownership structure, which 
is illustrated by the following diagram.
[GRAPHIC] [TIFF OMITTED] TR13MY94.008

    (ii) P2 satisfies the fractions rule with respect to the P2/P1A 
chain, but only if the P2 partnership agreement allocates those items 
allocated to P2 by P1A separately from those items allocated to P2 by 
P1B. For this purpose, allocations of items of income or gain that may 
be made pursuant to a provision in the partnership agreement that 
charges back minimum gain, are taken into account for purposes of the 
fractions rule only to the extent an allocation is made. See paragraph 
(m)(1)(ii) of this section. P2 does not satisfy the fractions rule with 
respect to the P2/P1B chain.

    (n) Effective date--(1) In general. Section 514(c)(9)(E), as amended 
by sections 2004(h) (1) and (2) of the Technical and Miscellaneous 
Revenue Act of 1988, Pub. L. 100-647, applies generally with respect to 
property acquired by partnerships after October 13, 1987, and to 
partnership interests acquired after October 13, 1987.
    (2) General effective date of the regulations. Section 1.514(c)-2 
(a) through (m) applies with respect to partnership agreements entered 
into after December 30, 1992, property acquired by partnerships after 
December 30, 1992, and partnership interests acquired by qualified 
organizations after December 30, 1992 (other than a partnership interest 
that at all times after October 13, 1987, and prior to the acquisition 
was held by a qualified organization). For this purpose, paragraphs (a) 
through (m) of this section will be treated as satisfied with respect to 
partnership agreements entered into on or before May 13, 1994, property 
acquired by partnerships on or before May 13, 1994, and partnership 
interests acquired by qualified organizations on or before May 13, 1994, 
if the guidance set forth in (paragraphs (a) through (m) of Sec.  
1.514(c)-2 of) PS-56-90, published at 1993-5 I.R.B. 42, February 1, 
1993, is satisfied. (See Sec.  601.601(d)(2)(ii)(b) of this chapter).
    (3) Periods after June 24, 1990, and prior to December 30, 1992. To 
satisfy the requirements of section 514(c)(9)(E) with respect to 
partnership agreements entered into after June 24, 1990, property 
acquired by partnerships after June 24, 1990, and partnership interests 
acquired by qualified organizations after June 24, 1990, (other than a 
partnership interest that at all times after October 13, 1987, and prior 
to the acquisition was held by a qualified organization) to which 
paragraph (n)(2) of this section does not apply, paragraphs (a) through 
(m) of this section must be satisfied as of the first day that section 
514(c)(9)(E) applies with respect to the partnership, property, or 
acquired interest. For this purpose, paragraphs (a) through (m) of this 
section will be treated as satisfied if the guidance in sections I 
through VI of Notice 90-41, 90-1 C.B. 350, (see Sec.  
601.601(d)(2)(ii)(b) of this chapter) has been followed.
    (4) Periods prior to the issuance of Notice 90-41. With respect to 
partnerships commencing after October 13, 1987, property acquired by 
partnerships after October 13, 1987, and partnership interests acquired 
by qualified organizations after October 13, 1987, to which neither 
paragraph (n)(2) nor (n)(3) of this section applies, the Internal 
Revenue Service will not challenge an interpretation of section 
514(c)(9)(E) that is reasonable in light of the underlying purposes of 
section 514(c)(9)(E) (as reflected in its legislative history) and that 
is consistently applied as of the first day that section 514(c)(9)(E) 
applies with respect to the partnership, property, or acquired interest. 
A reasonable interpretation includes an interpretation that 
substantially follows the guidance in either sections I through VI of 
Notice 90-41, (see

[[Page 260]]

Sec.  601.601(d)(2)(ii)(b) of this chapter) or paragraphs (a) through 
(m) of this section.
    (5) Material modifications to partnership agreements. A material 
modification will cause a partnership agreement to be treated as a new 
partnership agreement in appropriate circumstances for purposes of this 
paragraph (n).

[T.D. 8539, 59 FR 24928, May 13, 1994, as amended by T.D. 9047, 68 FR 
12825, Mar. 18, 2003]



Sec.  1.514(d)-1  Basis of debt-financed property acquired in corporate
liquidation.

    (a) If debt-financed property is acquired by an exempt organization 
in a complete or partial liquidation of a corporation in exchange for 
its stock, the organization's basis in such property shall be the same 
as it would be in the hands of the transferor corporation, increased by 
the amount of gain recognized to the transferor corporation upon such 
distribution and by the amount of any gain which is includible, on 
account of such distribution, in the gross income of the organization as 
unrelated debt-financed income.
    (b) The application of this section may be illustrated by the 
following example:

    Example. On July 1, 1970, T, an exempt trust, exchanges $15,000 of 
borrowed funds for 50 percent of the shares of M Corporation's stock. M 
uses $35,000 of borrowed funds in acquiring depreciable assets which are 
not used at any time for purposes described in section 514(b)(1) (A), 
(B), (C), or (D). On July 1, 1978, and for the 12-month period preceding 
this date, T's acquisition indebtedness with respect to M's stock has 
been $3,000. On this date, there is a complete liquidation of M 
Corporation to which section 331(a)(1) applies. In the liquidation T 
receives a distribution in kind of depreciable assets and assumes $7,000 
of M's indebtedness which remains unpaid with respect to the depreciable 
assets. On this date, M's adjusted basis of these depreciable assets is 
$9,000, and such assets have a fair market value of $47,000. M 
recognizes gain of $6,000 with respect to this liquidation pursuant to 
sections 1245 and 1250. T realizes a gain of $25,000 (the difference 
between the excess of fair market value of the property received over 
the indebtedness assumed, $40,000 ($47,000-$7,000) and T's basis in M's 
stock, $15,000). A portion of this gain is to be treated as unrelated 
debt-financed income. This amount is determined by multiplying T's gain 
of $25,000 by the debt/basis percentage. The debt/basis percentage is 20 
percent, the ratio which the average acquisition indebtedness ($3,000) 
is of the average adjusted basis ($15,000). Thus, $5,000 (20 percent of 
$25,000) is unrelated debt-financed income. This amount and the gain 
recognized pursuant to sections 1245 and 1250 are added to M's basis to 
determine T's basis in the property received. Consequently, T's basis in 
the property received from M Corporation is $20,000, determined as 
follows:

M Corporation's adjusted basis..............................      $9,000
Gain recognized by M Corporation on the distribution........       6,000
Unrelated debt-financed income recognized by T with respect        5,000
 to the distribution........................................
                                                             -----------
T's transferred basis.......................................      20,000
 


[T.D. 7229, 37 FR 28153, Dec. 21, 1972]



Sec.  1.514(e)-1  Allocation rules.

    Where only a portion of property is debt-financed property, proper 
allocation of the basis, indebtedness, income, and deductions with 
respect to such property must be made to determine the amount of income 
or gain derived from such property which is to be treated as unrelated 
debt-financed income. See examples 2 and 3 of paragraph (b)(1)(iii) of 
Sec.  1.514(b)-1 and examples 1, (2), and (3) of paragraph (b)(3)(iii) 
of Sec.  1.514(b)-1 for illustrations of proper allocation.

[T.D. 7229, 37 FR 28153, Dec. 21, 1972]



Sec.  1.514(f)-1  Definition of business lease.

    (a) In general. The term business lease means any lease, with 
certain exceptions discussed in paragraph (c) of this section, for a 
term of more than 5 years of real property by an organization subject to 
section 511 (or by a partnership of which it is a member) if at the 
close of the organization's taxable year there is a business lease 
indebtedness as defined in section 514(g) and Sec.  1.514(g)-1 with 
respect to such property. For the purpose of this section the term real 
property and the term premises include personal property of the lessor 
tax-exempt organization leased by it to a lessee of its real estate if 
the lease of such personal property is made under, or in connection 
with, the lease of such real estate. For amounts of business lease rents 
and deductions to be included in computing unrelated business taxable 
income for taxable

[[Page 261]]

years beginning before January 1, 1970, see Sec.  1.514(a)-2.
    (b) Special rules. (1) In computing the term of the lease, the 
period for which a lease may be renewed or extended by reason of an 
option contained therein shall be considered as part of the term. For 
example, a 3-year lease with an option for renewal for another such 
period is considered a lease for a term of 6 years. Another example is 
the case of a 1-year lease with option of renewal for another such term, 
where the parties at the end of each year renew the arrangement. In this 
case, during the fifth year (but not during the first 4 years), the 
lease falls within the 5-year rule, since the lease then involves 5 
years and there is an option for the sixth year. In determining the term 
of the lease, an option for renewal of the lease is taken into account 
whether or not the exercise of the option depends upon conditions or 
contingencies.
    (2) If the property is acquired subject to a lease, the term of such 
lease shall be considered to begin on the date of such acquisition. For 
example, if an exempt organization purchases, in whole or in part with 
borrowed funds, real property subject to a 10-year lease which has 3 
years left to run, and such lease contains no right of renewal or 
extension, the lease shall be considered a 3-year lease and hence does 
not meet the definition of a business lease in section 514(f) and 
paragraph (a) of this section. However, if this lease contains an option 
to renew for a period of 3 years or more, it is a business lease.
    (3) Under the provisions of section 514(f)(2)(B) a lease is 
considered as continuing for more than 5 years if the same lessee has 
occupied the premises for a total period of more than 5 years, whether 
the occupancy is under one or more leases, renewals, extensions, or 
continuations. Continued occupancy shall be considered to be by the same 
lessee if the occupants during the period are so related that losses in 
respect of sales or exchanges of property between them would be 
disallowed under section 267(a). Such period shall be considered as 
commencing not earlier than the date of the acquisition of the property 
by the tax-exempt organization or trust. This rule is applicable only in 
the sixth and succeeding years of such occupancy by the same lessee. 
See, however, paragraph (c)(3) of this section.
    (c) Exceptions. (1) A lease shall not be considered a business lease 
if such lease is entered into primarily for a purpose which is 
substantially related (aside from the need of such organization for 
income or funds, or the use it makes of the rents derived) to the 
exercise or performance by such organization of its charitable, 
educational, or other purpose or function constituting the basis for its 
exemption. For example, where a tax-exempt hospital leases real property 
owned by it to an association of doctors for use as a clinic, the rents 
derived under such lease would not be included in computing unrelated 
business taxable income if the clinic is substantially related to the 
carrying on of hospital functions. See Sec.  1.513-1 for principles 
applicable in determining whether there is a substantial relationship to 
the exempt purpose of an organization.
    (2) A lease is not a business lease if the lease is of premises in a 
building primarily designed for occupancy and occupied by the tax-exempt 
organization.
    (3) If a lease for more than 5 years to a tenant is for only a 
portion of the real property, and space in the real property is rented 
during the taxable year under a lease for not more than 5 years to any 
other tenant of the tax-exempt organization, all leases of the real 
property for more than 5 years shall be considered as business leases 
during the taxable year only if:
    (i) The rents derived from the real property during the taxable year 
under leases for more than 5 years represent 50 percent or more of the 
total rents derived during the taxable year from the real property; or 
the area of the premises occupied under leases for more than 5 years 
represents, at any time during the taxable year, 50 percent or more of 
the total area of the real property rented at such time; or
    (ii) The rent derived from the real property during the taxable year 
from any tenant under a lease for more than 5 years, or from a group of 
tenants (under such leases) who are either members of an affiliated 
group (as defined in section 1504) or are partners,

[[Page 262]]

represents more than 10 percent of the total rents derived during the 
taxable year from such property; or the area of the premises occupied by 
any one such tenant, or by any such group of tenants, represents at any 
time during the taxable year more than 10 percent of the total area of 
the real property rented at such time


In determining whether 50 percent or more of the total rents are derived 
from leases for more than 5 years, or whether 50 percent or more of the 
total area is occupied under leases for more than 5 years:
    (iii) An occupancy which is considered to be a lease of more than 5 
years solely by reason of the provisions of paragraph (b)(3) of this 
subparagraph shall not be treated as such a lease for purposes of 
subdivision (i) of this subparagraph, and
    (iv) An occupancy which is considered to be a lease of more than 5 
years solely by reason of the provisions of paragraph (b)(3) of this 
section shall be treated as such a lease for purposes of subdivision 
(ii) of this subparagraph, and
    (v) If during the last half of the term of a lease a new lease is 
made to take effect after the expiration of such lease, the unexpired 
portion of the first lease will not be added to the second lease to 
determine whether such second lease is a lease for more than 5 years for 
purposes of subdivision (i) of this subparagraph.
    (4) The application of subparagraph (3) of this paragraph may be 
illustrated by the following example:

    Example. In 1954 an educational organization, which is on the 
calendar year basis, begins the erection of an 11-story apartment 
building using funds borrowed for that purpose, and immediately leases 
for a 10-year term the first floor to a real estate development company 
to sublet for stores and shops. As fast as the new apartments are 
completed, they are rented on an annual basis. At the end of 1959 all 
except the 10th and 11th floors are rented. Those two floors are 
completed during 1960 and rented. Assume that for 1954 and each 
subsequent taxable year through 1959, and for the taxable year 1963, the 
gross rental for the first floor represents more than 10 percent of the 
total gross rents derived during the taxable year from the building. 
Under this set of facts the 10-year lease of the first floor would be 
considered to be a business lease for all except the taxable years 1961, 
1962, and 1964.

[T.D. 7229, 37 FR 28154, Dec. 21, 1972]



Sec.  1.514(g)-1  Business lease indebtedness.

    (a) Definition. The term business lease indebtedness means, with 
respect to any real property leased by a tax-exempt organization for a 
term of more than 5 years, the unpaid amount of:
    (1) The indebtedness incurred by the lessor tax-exempt organization 
in acquiring or improving such property;
    (2) The indebtedness incurred by the lessor tax-exempt organization 
prior to the acquisition or improvement of such property if such 
indebtedness would not have been incurred but for such acquisition or 
improvement; and
    (3) The indebtedness incurred by the lessor tax-exempt organization 
subsequent to the acquisition or improvement of such property if such 
indebtedness would not have been incurred but for such acquisition or 
improvement and the incurrence of the indebtedness was reasonably 
foreseeable at the time of such acquisition or improvement


See paragraph (i) of this section with respect to subsidiary 
corporations.
    (b) Examples. The rules of section 514(g) respecting business leases 
also cover certain cases where the leased property itself is not subject 
to an indebtedness. For example, they apply to cases such as the 
following:

    Example 1. A university pledges some of its investment securities 
with a bank for a loan and uses the proceeds of such loan to purchase 
(either directly or through a subsidiary corporation) a building, which 
building is subject to a lease that then has more than 5 years to run. 
This would be an example of a business lease indebtedness incurred prior 
to the acquisition of the property which would not have been incurred 
but for such acquisition.
    Example 2. If the building itself in example 1 in this paragraph is 
later mortgaged to raise funds to release the pledged securities, the 
lease would continue to be a business lease.
    Example 3. If a scientific organization mortgages its laboratory 
building to replace working capital used in remodeling another one of 
its buildings or a building held by its subsidiary corporation, which 
other building is free of indebtedness and is subject to a lease that 
then has more than 5 years to run, the lease would be a business lease 
inasmuch

[[Page 263]]

as the indebtedness though incurred subsequent to the improvement of 
such property would not have been incurred but for such improvement, and 
the incurrence of the indebtedness was reasonably foreseeable when, to 
make such improvement, the organization reduced its working capital 
below the amount necessary to continue current operations.

    (c) Property acquired subject to lien. Where real property is 
acquired subject to a mortgage or similar lien, whether the acquisition 
be by gift, bequest, devise, or purchase, the amount of the indebtedness 
secured by such mortgage or lien is a business lease indebtedness 
(unless paragraph (d)(1) of this section applies) even though the lessor 
does not assume or agree to pay the indebtedness. For example, a 
university pays $100,000 for real estate valued at $300,000 and subject 
to a $200,000 mortgage. For the purpose of the tax on unrelated business 
taxable income, the result is the same as if $200,000 of borrowed funds 
had been used to buy the property.
    (d) Certain property acquired by gifts, etc. (1) Where real property 
was acquired by gift, bequest, or devise, before July 1, 1950, subject 
to a mortgage or other similar lien, the amount of such mortgage or 
other similar lien shall not be considered as an indebtedness of the 
lessor tax-exempt organization incurred in acquiring such property. An 
indebtedness not otherwise covered by this exception is not brought 
within the exception by reason of a transfer of the property between a 
parent and its subsidiary corporation.
    (2) Where real property was acquired by gift, bequest, or devise, 
before July 1, 1950, subject to a lease requiring improvements in such 
property upon the happening of stated contingencies, indebtedness 
incurred in improving such property in accordance with the terms of such 
lease shall not be considered as indebtedness described in section 
514(g) and in this section. An indebtedness not otherwise covered by 
this exception is not brought within the exception by reason of a 
transfer of the property between a parent and its subsidiary 
corporation.
    (e) Certain corporations described in section 501(c)(2). In the case 
of a title holding corporation described in section 501(c)(2), all of 
the stock of which was acquired before July 1, 1950, by an organization 
described in section 501(c) (3), (5), or (6) (and more than one-third of 
such stock was acquired by such organization by gift or bequest), any 
indebtedness incurred by such corporation before July 1, 1950, and any 
indebtedness incurred by such corporation on or after such date in 
improving real property in accordance with the terms of a lease entered 
into before such date, shall not be considered an indebtedness described 
in section 514(g) and in this section with respect to either such 
section 501(c)(2) corporation or such section 501(c) (3), (5), or (6) 
organization.
    (f) Certain trusts described in section 401(a). In the case of a 
trust described in section 401(a), or in the case of a corporation 
described in section 501(c)(2) all of the stock of which was acquired 
before March 1, 1954, by such a trust, any indebtedness incurred by such 
trust or such corporation before such date, in connection with real 
property which is leased before such date, and any indebtedness incurred 
by such trust or such corporation on or after such date necessary to 
carry out the terms of such lease, shall not be considered as an 
indebtedness described in section 514(g) and in this section.
    (g) Business lease on portion of property. Where only a portion of 
the real property is subject to a business lease, proper allocation of 
the indebtedness applicable to the whole property must be made to the 
premises covered by the lease. See example 2 of paragraph (b)(3) of 
Sec.  1.514(a)-2.
    (h) Special rule applicable to trusts described in section 401(a). 
If an employees' trust described in section 401(a) lends any money to 
another such employees' trust of the same employer, for the purpose of 
acquiring or improving real property, such loan will not be treated as 
an indebtedness of the borrowing trust except to the extent that the 
loaning trust:
    (1) Incurs any indebtedness in order to make such loan;
    (2) Incurred indebtedness before the making of such loan which would 
not have been incurred but for the making of such loan; or
    (3) Incurred indebtedness after the making of such loan which would 
not have been incurred but for the making

[[Page 264]]

of such loan and which was reasonably foreseeable at the time of making 
such loan.
    (i) Subsidiary corporations. The provisions of section 514(f), (g), 
and (h) are applicable whether or not a subsidiary corporation of the 
type described in section 501(c)(2) is availed of in making the business 
lease. For example, assume a parent organization borrows funds to 
purchase realty and sets up a separate section 501(c)(2) corporation as 
a subsidiary to hold the property. Such subsidiary corporation leases 
the property for a period of more than 5 years, collects the rents and 
pays over all of the income, less expenses, to the parent organization, 
the parent organization being liable for the indebtedness. Under these 
assumed facts, the lease by section 501(c)(2) subsidiary corporation 
would be a business lease with respect to such subsidiary corporation, 
and the rental income would be subject to the tax, whether or not the 
subsidiary itself assumes the indebtedness and whether or not the 
property is subject to the indebtedness.
    (j) Certain trusts described in section 501(c)(17). (1) In the case 
of a supplemental unemployment benefit trust described in section 
501(c)(17), or in the case of a corporation described in section 
501(c)(2) all of the stock of which was acquired before January 1, 1960, 
by such a trust, any indebtedness incurred by such trust or such 
corporation before such date, in connection with real property which is 
leased before such date, and any indebtedness incurred by such trust or 
such corporation on or after such date necessary to carry out the terms 
of such lease, shall not be considered as an indebtedness described in 
section 514(g) and in this section.
    (2) If a supplemental unemployment benefit trust described in 
section 501(c)(17) lends any money to another such supplemental 
unemployment benefit trust forming part of the same plan, for the 
purpose of acquiring or improving real property, such loan will not be 
treated as an indebtedness of the borrowing trust except to the extent 
that the loaning trust:
    (i) Incurs any indebtedness in order to make such loan;
    (ii) Incurred indebtedness before the making of such loan which 
would not have been incurred but for the making of such loan; or
    (iii) Incurred indebtedness after the making of such loan which 
would not have been incurred but for the making of such loan and which 
was reasonably foreseeable at the time of making such loan.

[T.D. 7229, 37 FR 28155, Dec. 21, 1972]

                          Farmers' Cooperatives



Sec.  1.521-1  Farmers' cooperative marketing and purchasing 
associations; requirements for exemption under section 521.

    (a)(1) Cooperative associations engaged in the marketing of farm 
products for farmers, fruit growers, livestock growers, dairymen, etc., 
and turning back to the producers the proceeds of the sales of their 
products, less the necessary operating expenses, on the basis of either 
the quantity or the value of the products furnished by them, are exempt 
from income tax except as otherwise provided in section 522, or part I, 
subchapter T chapter 1 of the Code, and the regulations thereunder. For 
instance, cooperative dairy companies which are engaged in collecting 
milk and disposing of it or the products thereof and distributing the 
proceeds, less necessary operating expenses, among the producers upon 
the basis of either the quantity or the value of milk or of butterfat in 
the milk furnished by such producers, are exempt from the tax. If the 
proceeds of the business are distributed in anyother way than on such a 
proportionate basis, the association does not meet the requirements of 
the Code and is not exempt. In other words, nonmember patrons must be 
treated the same as members insofar as the distribution of patronage 
dividends is concerned. Thus, if products are marketed for nonmember 
producers, the proceeds of the sale, less necessary operating expenses, 
must be returned to the patrons from the sale of whose goods such 
proceeds result, whether or not such patrons are members of the 
association. In order to show its cooperative nature and to establish 
compliance with the requirement of the Code that

[[Page 265]]

the proceeds of sales, less necessary expenses, be turned back to all 
producers on the basis of either the quantity or the value of the 
products furnished by them, it is necessary for such an association to 
keep permanent records of the business done both with members and 
nonmembers. The Code does not require, however, that the association 
keep ledger accounts with each producer selling through the association. 
Any permanent records which show that the association was operating 
during the taxable year on a cooperative basis in the distribution of 
patronage dividends to all producers will suffice. While under the Code 
patronage dividends must be paid to all producers on the same basis, 
this requirement is complied with if an association instead of paying 
patronage dividends to nonmember producers incash, keeps permanent 
records from which the proportionate shares of the patronage dividends 
due to nonmember producers can be determined, and such shares are made 
applicable toward the purchase price of a share of stock or of a 
membership in the association. See, however, paragraph (c)(1) of Sec.  
1.1388-1 for the meaning of payment in money for purposes of qualifying 
a written notice of allocation.
    (2) An association which has capital stock will not for such reason 
be denied exemption (i) if the dividend rate of such stock is fixed at 
not to exceed the legal rate of interest in the State of incorporation 
or 8 percent per annum, whichever is greater, on the value of the 
consideration for which the stock was issued, and (ii) if substantially 
all of such stock (with the exception noted below) is owned by producers 
who market their products or purchase their supplies and equipment 
through the association. Any ownership of stock by others than such 
actual producers must be satisfactorily explained in the association's 
application for exemption. The association will be required to show that 
the ownership of its capital stock has been restrictedas far as possible 
to such actual producers. If by statutory requirement all officers of an 
association must be shareholders, the ownership of a share of stock by a 
nonproducer to qualify him as an officer will not destroy the 
association's exemption. Likewise, if a shareholder for any reason 
ceases to be a producer and the association is unable, because of a 
constitutional restriction or prohibition or other reason beyond the 
control of the association, to purchase or retire the stock of such 
nonproducer, the fact that under such circumstances a small amount of 
the outstanding capital stock is owned by shareholders who are no longer 
producers will not destroy the exemption. The restriction placed on the 
ownership of capital stock of an exempt cooperative association shall 
not apply to nonvoting preferred stock, provided the owners of such 
stock are not entitled or permitted to participate, directly or 
indirectly, in the profits of the association, upon dissolution or 
otherwise, beyond the fixed dividends.
    (3) The accumulation and maintenance of a reserve required by State 
statute, or the accumulation and maintenance of a reasonable reserve or 
surplus for any necessary purpose, such as to provide for the erection 
of buildings and facilities required in business or for the purchase and 
installation of machinery and equipment or to retire indebtedness 
incurred for such purposes, will not destroy the exemption. An 
association will not be denied exemption because it markets the products 
of nonmembers, provided the value of the products marketed for 
nonmembers does not exceed the value of the products marketed for 
members. Anyone who shares in the profits of a farmers' cooperative 
marketing association, and is entitled to participate in the management 
of the association, must be regarded as a member of such association 
within the meaning of section 521.
    (b) Cooperative associations engaged in the purchasing of supplies 
and equipment for farmers, fruit growers, livestock growers, dairymen, 
etc., and turning over such supplies and equipment to them at actual 
cost, plus the necessary operating expenses, are exempt. The term 
supplies and equipment as used in section 521 includes groceries and all 
other goods and merchandise used by farmers in the operation and 
maintenance of a farm or farmer's household. The provisions of paragraph 
(a) of this section relating to a reserve

[[Page 266]]

or surplus and to capital stock shall apply to associations coming under 
this paragraph. An association which purchases supplies and equipment 
for nonmembers will not for such reason be denied exemption, provided 
the value of the purchases for nonmembers does not exceed the value of 
the supplies and equipment purchased for members, and provided the value 
of the purchases made for nonmembers who are not producers does not 
exceed 15 percent of the value of all its purchases.
    (c) In order to be exempt under either paragraph (a) or (b) of this 
section an association must establish that it has no taxable income for 
its own account other than that reflected in a reserve or surplus 
authorized in paragraph (a) of this section. An association engaged both 
in marketing farm products and in purchasing supplies and equipment is 
exempt if as to each of its functions it meets the requirements of the 
Code. Business done for the United States or any of its agencies shall 
be disregarded in determining the right to exemption under section 521 
and this section. An association to be entitled to exemption must not 
only be organized but actually operated in the manner and for the 
purposes specified in section 521.
    (d) Cooperative organizations engaged in occupations dissimilar from 
those of farmers, fruit growers, and the like, are not exempt.
    (e) An organization is not exempt from taxation under this section 
merely because it claims that it complies with the requirements 
prescribed therein. In order to establish its exemption every 
organization claiming exemption under section 521 is required to file a 
Form 1028. The Form 1028, executed in accordance with the instructions 
on the form or issued therewith, should be filed with the district 
director for the internal revenue district in which is located the 
principal place of business or principal office of the organization. 
However, an organization which has been granted exemption under the 
provisions of the Internal Revenue Code of 1939 or prior law may rely on 
that ruling, unless affected by substantive changes in the Internal 
Revenue Code of 1954 or any changes in the character, purposes, or 
methods of operation of the organization, and it is not necessary in 
such case for the organization to request a new determination as to its 
exempt status.
    (f) A cooperative association will not be denied exemption merely 
because it makes payments solely in nonqualified written notices of 
allocation to those patrons who do not consent as provided in section 
1388 and Sec.  1.1388-1, but makes payments of 20 percent in cash and 
the remainder in qualified written notices of allocation to those 
patrons who do so consent. Nor will such an association be denied 
exemption merely because, in the case of patrons who have so consented, 
payments of less than $5 are made solely in nonqualified written notices 
of allocation while payments of $5 or more are made in the form of 20 
percent in cash and the remainder in qualified written notices of 
allocation. In addition, a cooperative association will not be denied 
exemption if it pays a smaller amount of interest or dividends on 
nonqualified written notices of allocation held by persons who have not 
consented as provided in section 1388 and Sec.  1.1388-1 (or on per-unit 
retain certificates issued to patrons who are not qualifying patrons 
with respect thereto within the meaning of Sec.  1.61-5(d)(2)) than it 
pays on qualified written notices of allocation held by persons who have 
so consented (or on per-unit retain certificates issued to patrons who 
are qualifying patrons with respect thereto) provided that the amount of 
the interest or dividend reduction isreasonable in relation to the fact 
that the association receives no tax benefit with respect to such 
nonqualified written notices of allocation (or such certificates issued 
to nonqualifying patrons) until redeemed. However, such an association 
will be denied exemption if it otherwise treats patrons who have not 
consented (or are not qualifying patrons) differently from patrons who 
have consented (or are qualifying patrons), either with regard to the 
original payment or allocation or with regard to the redemption of 
written notices of allocation or per-unit retain certificates. For 
example, if such an association pays patronage dividends in the form of 
written notices of allocation accompanied by qualified checks, and 
provides that any

[[Page 267]]

patron who does not cash his check within a specified time will forfeit 
the portion of the patronage dividend represented by such check, then 
the cooperative association will be denied exemption under this section 
as it does not treat all patrons alike.

[T.D. 6500, 25 FR 11737, Nov. 26, 1960, as amended by T.D. 6643, 28 FR 
3162, Apr. 2, 1963; T.D. 6855, 30 FR 13135, Oct. 15, 1965]



Sec.  1.522-1  Tax treatment of farmers' cooperative marketing and
purchasing associations exempt under section 521.

    (a) In general. (1) Section 522 is applicable to farmers', fruit 
growers', or like associations organized and operated on a cooperative 
basis in the manner prescribed in section 521. Although such an 
association is subject to both normal tax and surtax, as in the case of 
corporations generally, certain special rules for the computation of 
taxable income are provided in section 522(b) and Sec.  1.522-2. For the 
purpose of any law which refers to organizations exempt from income 
taxes such an association shall, however, be considered as an 
organization exempt under section 501. Thus, the provisions of section 
243, providing a credit for dividends received from a domestic 
corporation subject to taxation, are not applicable to dividends 
received from a cooperative association subject to section 522. The 
provisions of section 1501, relating to consolidated returns, are 
likewise not applicable.
    (2) Rules governing the manner in which amounts allocated as 
patronage dividends, refunds, or rebates are to be taken into account in 
computing the taxable income of such an association are set forth in 
Sec.  1.522-3. For the tax treatment, as to patrons, of amounts received 
during the taxable year as patronage dividends, rebates, or refunds, see 
section 61 and Sec.  1.61-5.
    (b) Meaning of terms. For purposes of Sec. Sec.  1.522-1 to 1.522-3, 
inclusive, Sec. Sec.  1.6044-1 and 1.61-5, the following terms shall 
have the meaning ascribed below:
    (1) Cooperative association. The term cooperative association 
includes any corporation operating on a cooperative basis and allocating 
amounts to patrons on the basis of the business done with or for such 
patrons, except that the term does not include any cooperative or 
nonprofit corporation (including any cooperative or nonprofit 
corporation engaged in rural electrification) exempt from taxation under 
section 501(a) and described in section 501(c) (12) or (15) or any 
corporation subject to a tax imposed by subchapter L, chapter 1 of the 
Code (relating to insurance companies).
    (2) Patron. The term patron includes any person with whom or for 
whom the cooperative association does business on a cooperative basis, 
whether a member or a nonmember of the cooperative association, and 
whether an individual, a trust, estate, partnership, company, 
corporation, or cooperative association.
    (3) Allocation. The term allocation includes distributions made by a 
cooperative association to a patron in cash, merchandise, capital stock, 
revolving fund certificates, retain certificates, certificates of 
indebtedness, letters of advice, similar documents, or in any other 
manner whereby there is disclosed to a patron the dollar amount 
apportioned on the books of the association for the account of such 
patron. Thus, a mere credit to the account of a patron on the books of 
the cooperative association, without disclosure to the patron, is not an 
allocation.
    (4) Patronage dividends, rebates, and refunds. The term patronage 
dividend, rebate, or refund includes any amount allocated by a 
cooperative association, to the account of a patron on the basis of the 
business done with or for such patron. The following are not patronage 
dividends, rebates, or refunds:
    (i) Amounts distributed in redemption of capital stock, or in 
redemption or satisfaction of certificates of indebtedness, revolving 
fund certificates, retain certificates, letters of advice, or other 
similar documents;
    (ii) Amounts allocated (whether in cash, merchandise, capital stock, 
revolving fund certificates, retain certificates, certificates of 
indebtedness, letters of advice, or in some other manner that discloses 
to each patron the amount of such dividend, refund, or rebate) by the 
association for products of members or other patrons to the extent

[[Page 268]]

such amounts are fixed without reference to the earnings of the 
cooperative association. For this purpose, the term earnings includes 
the excess of amounts retained (or assessed) by the association to cover 
expenses or other items over the amount of such expenses or other items.
    (c) Examples. The application of paragraph (b) of this section may 
be illustrated by the following examples:

    Example 1. Cooperative A, a marketing association operating on a 
pooling basis, receives the products of patron W on January 5, 1954. On 
the same day Cooperative A advances to W 45 cents per unit for the 
products so delivered and allocates to him a retain certificate having a 
face value calculated at the rate of 5 cents per unit. During the 
operatiion of the pool, and before substantially all the products in the 
pool are disposed of, Cooperative A advances to W an additional 40 cents 
per unit, the amount being determined by reference to the market price 
of the products sold and the anticipated price of the unsold products. 
At the close of the pool on November 10, 1954, Cooperative A determines 
the excess of its receipts over the sum of its expenses and its previous 
advances to patrons, and allocates to W an additional 3 cents per unit 
and shares of the capital stock of A having an aggregate of face value 
calculated at the rate of 2 cents per unit.
    The amount of patronage dividends, rebates, or refunds allocated to 
W during 1954 amount to 5 cents per unit, consisting of the aggregate of 
the following per-unit allocations: The amount of cash distribution (3 
cents), and the face value of the capital stock of A (2 cents), which 
are fixed with reference to the earnings of A. The amount of the two 
distributions in cash (85 cents) and the face amount of the retain 
certificate (5 cents), which are fixed without reference to the earnings 
of A, do not constitute patronage dividends, rebates, or refunds.
    Example 2. Cooperative B, a marketing association operating on a 
pooling basis, receives the products of patron X on March 5, 1954. On 
the same day Cooperative B pays to X $1.00 per unit for such products, 
this amount being determined by reference to the market price of the 
product when received, and issues to him a participation certificate 
having no face value but which entitles X on the close of the pool to 
the proceeds derived from the sale of his products less the previous 
payment of $1.00 and the expenses and other charges attributable to such 
products. On March 5, 1957, Cooperative B, having sold the products in 
the pool, having deducted the previous payments for such products, and 
having determined the expenses and other charges of the pool, redeems 
the participation certificate of X in cash for 10 cents per unit. The 
allocation made to X during 1957, amounting to 10 cents per unit, is a 
patronage dividend, rebate, or refund. Neither the payment to X in 1954 
of $1.00 nor the issuance to him of the participation certificate in 
that year constitutes a patronage dividend, rebate, or refund within the 
meaning of this section.
    Example 3. Cooperative C, a purchasing association, obtains supplies 
for patron Y on May 1, 1954, and receives in return therefor $100. On 
February 1, 1955, Cooperative C, having determined the excess of its 
receipts over its costs and expenses, allocates to Y a cash distribution 
of $1.00 and a revolving fund certificate of a face amount of $1.00. The 
amount of patronage dividends, rebates, or refunds allocated to Y for 
1955 is $2.00, the aggregate of the cash distribution of $1.00, and the 
face amount, $1.00, of the revolving fund certificate.
    Example 4. Cooperative D, a service association, sells the products 
of members on a fee basis. It receives the products of patron Z under an 
agreement not to pool his products with those of other members, to sell 
his products, and to deliver to him the proceeds of the sale. Patron Z 
makes payments to Cooperative D during 1954 aggregating $75 for service 
rendered him by Cooperative D during that year. On May 15, 1955, 
Cooperative D, having determined the excess of its receipts over its 
costs and expenses, allocates to Z a cash distribution of $2.00. Such 
amount is a patronage dividend, rebate, or refund allocated by 
Cooperative D during 1955.

    (d) Returns of exempt cooperative associations. For requirements of 
annual returns by exempt cooperative associations, see sections 6012 and 
6072(d) and paragraph (f) of Sec.  1.6012-2.



Sec.  1.522-2  Manner of taxation of cooperative associations subject
to section 522.

    (a) In general. Farmers', fruit growers', or like associations, 
organized and operated in compliance with the requirements of section 
521 and Sec.  1.521-1 shall be subject to the taxes imposed by section 
11 or section 1201, except that there shall be allowed as deductions 
from gross income, in addition to the other deductions allowable under 
chapter 1 of the Code, certain special deductions provided in section 
522(b)(1)(A) and paragraph (c) of this section, and section 522(b)(1)(B) 
and paragraph (d) of this section. Amounts allocated as patronage 
dividends, refunds, or rebates, whether in cash, merchandise, capital 
stock, revolving fund

[[Page 269]]

certificates, retain certificates, certificates of indebtedness, letters 
of advice, or in some other manner that discloses to each patron the 
dollar amount allocated, with respect to patronage for the taxable year 
or for preceding taxable years, shall be taken into account in the 
manner provided in section 522 and in Sec.  1.522-3.
    (b) Cooperative association exempt from tax before January 1, 1952. 
(1) For the purpose of determining the method of accounting under 
section 446 in the case of a cooperative association which was exempt 
from tax for taxable years beginning prior to January 1, 1952, the 
method of accounting, recognized under sections 41, 42, and 43 of the 
Internal Revenue Code of 1939 and the regulations prescribed thereunder 
and utilized in the return of such association for its last taxable year 
to which the Internal Revenue Code of 1939 was applicable, shall be 
deemed to constitute the method of accounting regularly employed by the 
cooperative association. Any change from this method may be made only if 
permission is obtained from the Commissioner to change to another 
recognized method in accordance with section 446 and the regulations 
thereunder.
    (2) In any case where inventories are an income-producing factor, 
see sections 471 and 472 and the regulations thereunder. The elective 
method of inventorying goods provided in section 472 may be adopted by 
the cooperative association for any taxable year beginning after 
December 31, 1953, inaccordance with the requirements of section 472 and 
the regulations thereunder. However, in order to use such method for 
such a taxable year the cooperative association (unless it has used such 
method for a taxable year beginning after 1951 and before 1954 pursuant 
to an election exercised as provided in 26 CFR (1939) 39.22(d)-3 
(Regulations 118) must exercise the election provided in section 472 and 
the regulations thereunder, even if it may have utilized such method for 
accounting purposes for taxable years beginning before January 1, 1952.
    (3) The following rules shall be applicable in computing the net 
operating loss deduction provided in section 172: No net operating loss 
carryover shall be allowed from a taxable year beginning prior to 
January 1, 1952, for which the cooperative association was exempt from 
tax under section 101(12) of the Internal Revenue Code of 1939. In the 
case of a taxable year beginning prior to January 1, 1952, for which the 
association was not exempt under section 101(12) of the Internal Revenue 
Code of 1939 and of any taxable year beginning after December 31, 1951, 
the amount of the net operating loss carryback or carryover from such 
year shall not be reduced by reference to the income of any taxable year 
beginning prior to January 1, 1952, for which the association was exempt 
from tax under section 101(12) of the Internal Revenue Code of 1939. 
However, any taxable year beginning prior to January 1, 1952, for which 
the cooperative association was exempt under section 101(12) of the 
Internal Revenue Code of 1939 shall be taken into account in determining 
the period for which a net operating loss may be carried back or carried 
over, as the case may be.
    (4) The adjustments to the cost or other basis provided in sections 
1011 and 1016 and the regulations thereunder, are applicable for the 
entire period since the acquisition of the property. Thus, proper 
adjustment to basis must be made under section 1016 for depreciation, 
obsolescence, amortization, and depletion for all taxable years 
beginning prior to January 1, 1952, although the cooperative association 
was exempt from tax under section 521 or corresponding provisions of 
prior law for such years. However, no adjustment for percentage or 
discovery depletion is to be made for any year during which the 
association was exempt from tax. If a cooperative association has made a 
proper election in accordance with section 1020 and the regulations 
prescribed thereunder with respect to a taxable year beginning before 
1952 in which the association was not exempt from tax, the adjustment to 
basis for depreciation for such years shall be limited in accordance 
with the provisions of section 1016(a)(2).
    (5) In the case of tax exempt and partially taxable bonds purchased 
at a premium and subject to amortization under section 171, proper 
adjustment to

[[Page 270]]

basis must be made to reflect amortization with respect to such premium 
from the date of acquisition of the bond. (For principles governing the 
method of computation, see the example in paragraph (b) of Sec.  1.1016-
9, relating to mutual savings banks, building and loan associations, and 
cooperative banks.) The basis of a fully taxable bond purchased at a 
premium shall be adjusted from the date of the election to amortize such 
premium in accordance with the provisions of section 171 except that no 
adjustment shall be allowable for such portion of the premium 
attributable to the period prior to the election.
    (6) In the case of a mortgage acquired at a premium where the 
principal of such mortgage is payable in installments, adjustments to 
the basis for the premium must be made for all taxable years (whether or 
not the association was exempt from tax under section 521 during such 
years) in which installment payments are received. Such adjustments may 
be made on an individual mortgage basis or on a composite basis by 
reference to the average period of payments of the mortgage loans of 
such association. For the purpose of this adjustment, the term premium 
includes the excess of the acquisition value of the mortgage over its 
maturity value. The acquisition value of the mortgage is the cost 
including buying commissions, attorneys' fees or brokerage fees, but 
such value does not include amounts paid for accrued interest.
    (c) Deduction for dividends paid. There is allowable as a deduction 
from the gross income of a cooperative association operated in 
compliance with the requirements of section 521 and Sec.  1.521-1, 
amounts paid as dividends during the taxable year upon the capital stock 
of the cooperative association. For the purpose of the preceding 
sentence, the term capital stock includes common stock (whether voting 
or nonvoting), preferred stock, or any other form of capital represented 
by capital retain certificates, revolving fund certificates, letters of 
advice, or other evidence of a proprietary interest in a cooperative 
association. Such deduction is applicable only to the taxable year in 
which the dividends are actually or constructively paid to the holder of 
capital stock or other proprietary interest of the cooperative 
association. If a dividend is paid by check and the check bearing a date 
within the taxable year is deposited in the mail, in a cover properly 
stamped and addressed tothe shareholder at his last known address, at 
such time that in the ordinary handling of the mails the check would be 
received by such holder within the taxable year, a presumption arises 
that the dividend was paid to such holder in such year. The 
determination of whether a dividend has been paid to such holder by the 
corporation during its taxable year is in no way dependent upon the 
method of accounting regularly employed by the corporation in keeping 
its books. For further rules as to the determination of the right to a 
deduction for dividends paid, under certain specific circumstances, see 
section 561 and the regulations thereunder.
    (d) Deduction for amounts allocated from income not derived from 
patronage. There is allowable as a deduction from the gross income of a 
cooperative association operated in compliance with the requirements of 
section 521 and Sec.  1.521-1 amounts allocated during the taxable year 
to patrons with respect to its income not derived from patronage 
(whether or not such income was derived during such taxable year) 
whether such amounts are paid in cash, merchandise, capital stock, 
revolving fund certificates, retain certificates, certificates of 
indebtedness, letters of advice, or in some other manner that discloses 
to each patron the dollar amount allocated to him. For this purpose, 
allocations made after the close of the taxable year and on or before 
the 15th day of the ninth month following the close of the taxable year 
shall be considered as made on the last day of such taxable year to the 
extent that such allocations are attributable toincome derived during 
the taxable year or during years prior to the taxable year. As used in 
this paragraph, the term income not derived from patronage means 
incidental income derived from sources not directly related to the 
marketing, purchasing, or service activities of the cooperative 
association. For example, income derived from the lease of premises, 
from investment in securities,

[[Page 271]]

from the sale or exchange of capital assets, constitutes income not 
derived from patronage. Business done with the United States shall 
constitute income not derived from patronage. In order that the 
deduction for income not derived from patronage may be applicable, it is 
necessary that the amount sought to be deducted be allocated on a 
patronage basis in proportion, insofar as is practicable, to the amount 
of business done by or for patrons during the period to which such 
income is attributable. Thus, if capital gains are realized from the 
sale or exchange of capital assets acquired and disposed of during the 
taxable year, income realized from such gains must be allocated to 
patrons of such year in proportion to theamount of business done by such 
patrons during the taxable year. Similarly, if capital gains are 
realized by the association from the sale or exchange of capital assets 
held for a period of more than one taxable year income realized from 
such gains must be allocated, in proportion insofar as is practicable, 
to the patrons of the taxable years during which the asset was owned by 
the association, and to the amount of business done by such patrons 
during such taxable years.



Sec.  1.522-3  Patronage dividends, rebates, or refunds; treatment as
to cooperative associations entitled to tax treatment under section 522.

    (a) General rule. Patronage dividends, refunds, or rebates, 
allocated by a cooperative association entitled to tax treatment under 
section 522 to a patron shall be taken into account in computing the 
gross income of such association for the taxable year, as an increase in 
its other cost of goods sold in the case of an association marketing 
products for patrons, or as a reduction in its gross receipts, in the 
case of an association purchasing supplies and equipment or performing 
services for patrons, as the case may be, if:
    (1) The allocation is made in fulfillment and satisfaction of a 
valid obligation of such association to the patron, which obligation was 
in existence prior to the receipt by the cooperative association of the 
amount allocated, and
    (2) The allocation is made on or before the 15th day of the ninth 
month following the close of the taxable year in which the amounts 
allocated were received by the cooperative association


For the purpose of subparagraph (1) of this paragraph, amounts allocated 
by a cooperative association entitled to tax treatment under section 522 
will be deemed allocated in fulfillment and satisfaction of a valid 
enforceable obligation, if made pursuant to provisions of the bylaws, 
articles of incorporation, or other contract, whereby the association is 
obligated to make such allocation after the retention of reasonable 
reserves and after payment of dividends on capital stock or other 
proprietary capital interests. Notwithstanding the provisions of 
subparagraphs (1) and (2) of this paragraph, amounts allocated as 
patronage dividends, refunds, or rebates during the taxable year, on or 
before the 15th day of the ninth month following the close of such year, 
with respect to patronage for years preceding the taxable year, shall be 
taken into account as an increase in its other cost of goods sold, or as 
a reduction in gross receipts, for the taxable year, as the case may be, 
where retention as reasonable reserves of the amounts so allocated 
beyond the year in which earned was proper in accordance with the 
provisions of section 521 and where the allocation is made to the patron 
on a patronage basis is proportion insofar as is practicable, to the 
amount of business done by such patrons during the taxable year or years 
in which the retained amounts were received by the cooperative 
association.
    (b) Examples. This section may be illustrated by the following 
examples:

    Example 1. E, a cooperative association entitled to tax treatment 
under section 522, organized without capital stock, is engaged in the 
business of marketing products for its patrons on a non-pool basis. The 
by-laws of Cooperative E provide that there shall be allocated to 
patrons as patronage dividends within a reasonable time following the 
close of the year all of the gross returns from sales, less expenses of 
operation for the year and amounts retained as reasonable reserves 
necessary to the operation of Cooperative E. At the close of the taxable 
year, 1954, it is determined that from the gross returns from sales less 
operating expenses and all taxes for such year, $5,000 is to be retained 
as reasonable reserves for various necessary purposes of Cooperative E. 
It is assumed that

[[Page 272]]

the retention of such amount is proper in accordance with the provisions 
of section 521. Such $5,000 is apportioned on the books of Cooperative E 
to patrons of 1954 on a patronage basis, or permanent records are kept 
from which an apportionment to such patrons can be made. On March 1, 
1955, pursuant tothe terms of the by-laws, $200,000, the balance of the 
gross returns for the taxable year, is allocated to patrons of 1954 on 
the basis of patronage. $100,000 of such $200,000 is allocated in cash. 
The remaining $100,000 is allocated in retain certificates, bearing no 
interest and redeemable in the discretion of the Board of Directors of 
Cooperative E. There may be added to the cost of goods sold by 
Cooperative E for 1954, $200,000 ($100,000 in cash, $100,000 in retain 
certificates), the total amount allocated as patronage dividends, 
rebates, or refunds in fulfillment and satisfaction of the obligation of 
the by-laws, on March 1, 1955, before the 15th day of the ninth month 
following the close of 1954. There may not be added to the cost of goods 
sold by Cooperative E for 1954, $5,000, the amount retained as reserves 
apportioned on the books, but not allocated as patronage dividends, 
rebates, or refunds.
    Example 2. The facts are the same as example 1, it additionally 
appearing that at the close of 1955 it is determined by Cooperative E to 
allocate as cash patronage dividends, rebates, or refunds to patrons of 
1954, $5,000, the amount retained as reasonable reserves for 1954 in 
accordance with the provisions of section 521. On March 1, 1956, such 
amount is allocated. There may be added to the cost of goods sold by 
Cooperative E for 1955, $5,000, the amount allocated with respect to 
patronage of a preceding year, 1954, properly maintained as a reserve 
under section 521.



Sec.  1.522-4  Taxable years affected.

    Section 522 and Sec. Sec.  1.522-1, 1.522-2, and 1.522-3, are 
applicable to taxable years beginning before January 1, 1963, and also 
to amounts paid during taxable years beginning after December 31, 1962, 
the tax treatment of which is not prescribed in section 1382 and the 
regulations thereunder.

[T.D. 6643, 28 FR 3163, Apr. 2, 1963]



Sec.  1.527-1  Political organizations; generally.

    Section 527 provides that a political organization is considered an 
organization exempt from income taxes for the purpose of any law which 
refers to organizations exempt from income taxes. A political 
organization is subject to tax only to the extent provided in section 
527. In general, a political organization is an organization that is 
organized and operated primarily for an exempt function as defined in 
Sec.  1.527-2(c). Section 527 provides that a political organization is 
taxed on its political organization taxable income (see Sec.  1.527-4) 
which, in general, does not include the exempt function income (see 
Sec.  1.527-3) of the political organization. Furthermore, section 527 
provides that an exempt organization, other than a political 
organization, may be subject to tax under section 527 when it expends an 
amount for an exempt function, see Sec.  1.527-6. The taxation of 
newsletter funds is provided under section 527(g) and Sec.  1.527-7. A 
special rule for principal campaign committees is provided under section 
527(h) and Sec.  1.527-9.

[T.D. 8041, 50 FR 30817, July 30, 1985]



Sec.  1.527-2  Definitions.

    For purposes of section 527 and these regulations:
    (a) Political organization--(1) In general. A political organization 
is a party, committee, association, fund, or other organization (whether 
or not incorporated) organized and operated primarily for the purpose of 
directly or indirectly accepting contributions or making expenditures 
for an exempt function activity (as defined in paragraph (c) of this 
section). Accordingly, a political organization may include a committee 
or other group which accepts contributions or makes expenditures for the 
purpose of promoting the nomination of an individual for an elective 
public office in a primary election, or in a meeting or caucus of a 
political party. A segregated fund (as defined in paragraph (b) of this 
section) established and maintained by an individual may qualify as a 
political organization.
    (2) Organizational test. A political organization meets the 
organizational test if its articles of organization provide that the 
primary purpose of the organization is to carry on one or more exempt 
functions. A political organization is not required to be formally 
chartered or established as a corporation, trust, or association. If an 
organization has no formal articles of organization, consideration is 
given to statements of the members of the organization at the time the 
organization is

[[Page 273]]

formed that they intend to operate the organization primarily to carry 
on one or more exempt functions.
    (3) Operational test. A political organization does not have to 
engage exclusively in activities that are an exempt function. For 
example, a political organization may:
    (i) Sponsor nonpartisan educational workshops which are not intended 
to influence or attempt to influence the selection, nomination, 
election, or appointment of any individual for public office,
    (ii) Pay an incumbent's office expenses, or
    (iii) Carry on social activities which are unrelated to its exempt 
function,

provided these are not the organization's primary activities. However, 
expenditures for purposes described in the preceding sentence are not 
for an exempt function. See Sec.  1.527-2 (c) and (d). Furthermore, it 
is not necessary that a political organization operate in accordance 
with normal corporate formalities as ordinarily established in bylaws or 
under state law.
    (b) Segregated fund--(1) General rule. A segregated fund is a fund 
which is established and maintained by a political organization or an 
individual separate from the assets of the organization or the personal 
assets of the individual. The purpose of such a fund must be to receive 
and segregate exempt function income (and earnings on such income) for 
use only for an exempt function or for an activity necessary to fulfill 
an exempt function. Accordingly, the amounts in the fund must be 
dedicated for use only for an exempt function. Thus, expenditures for 
the establishment or administration of a political organization or the 
solicitation of political contributions may be made from the segregated 
fund, if necessary to fulfill an exempt function. The fund must be 
clearly identified and established for the pruposes intended. A savings 
or checking account into which only contributions to the political 
organization are placed and from which only expenditures for exempt 
functions are made may be a segregated fund. If an organization that had 
designated a fund to be a segregated fund for purposes of segregating 
amounts referred to in section 527(c)(3) (A) through (D), expends more 
than an insubstantial amount from the segregated fund for activities 
that are not for an exempt function during a taxable year, the fund will 
not be treated as a segregated fund for such year. In such a case 
amounts referred to in section 527(c)(3)(A)-(D),segregated in such fund 
will not be exempt function income. Further, if more than insubstantial 
amounts segregated for an exempt function in prior years are expended 
for other than an exempt function the facts and circumstances may 
indicate that the fund was never a segregated fund as defined in this 
paragraph.
    (2) Record keeping. The organization or individual maintaining a 
segregated fund must keep records that are adequate to verify receipts 
and disbursements of the fund and identify the exempt function activity 
for which each expenditure is made.
    (c) Exempt function--(1) Directly related expenses. An exempt 
function, as defined in section 527(e)(2), includes all activities that 
are directly related to and support the process of influencing or 
attempting to influence the selection, nomination, election, or 
appointment of any individual to public office or office in a political 
organization (the selection process). Whether an expenditure is for an 
exempt function depends upon all the facts and circumstances. Generally, 
where an organization supports an individual's campaign for public 
office, the organization's activities and expenditures in futherance of 
the individual's election or appointment to that office are for an 
exempt function of the organization. The individual does not have to be 
an announced candidate for the office. Furthermore, the fact that an 
individual never becomes a candidate is not crucial in determining 
whether an organization is engaging in an exempt function. An activity 
engaged in between elections which is directly related to, and supports, 
the process of selection, nomination, or election of an individual in 
the next applicable political campaign is an exempt function activity.
    (2) Indirect expenses. Expenditures that are not directly related to 
influencing or attempting to influence the

[[Page 274]]

selection process may also be an expenditure for an exempt function by a 
political organization. These are expenses which are necessary to 
support the directly related activities of the political organization. 
Activities which support the directly related activities are those which 
must be engaged in to allow the political organization to carry out the 
activity of influencing or attempting to influence the selection 
process. For example, expenses for overhead and record keeping are 
necessary to allow the political organization to be established and to 
engage in political activities. Similarly, expenses incurred in 
soliciting contributions to the political organization are necessary to 
support the activities of the political organization.
    (3) Terminating activities. An exempt function includes an activity 
which is in furtherance of the process of terminating a political 
organization's existence. For example, where a political organization is 
established for a single campaign, payment of campaign debts after the 
conclusion of the campaign is an exempt function activity.
    (4) Illegal expenditures. Expenditures which are illegal or are for 
a judicially determined illegal activity are not considered expenditures 
in furtherance of an exempt function, even though such expenditures are 
made in connection with the selection process.
    (5) Examples. The following examples illustrate the principles of 
paragraph (c) of this section. The term exempt function when used in the 
following examples means exempt function within the meaning of section 
527(e)(2).
    (i) Example 1. A wants to run for election to public office in State 
X. A is not a candidate. A travels throughout X in order to rally 
support for A's intended candidacy. While in X, A attends a convention 
of an organization for the purpose of attempting to solicit its support. 
The amount expended for travel, lodging, food, and similar expenses are 
for an exempt function.
    (ii) Example 2. B, a member of the United States House of 
Representatives, is a candidate for reelection. B travels with B's 
spouse to the district B represents. B feels it is important for B's 
reelection that B's spouse accompany B. While in the district, B makes 
speeches and appearances for the purpose of persuading voters to reelect 
B. The travel expenses of B and B's spouse are for an exempt function.
    (iii) Example 3. C is a candidate for public office. In connection 
with C's campaign, C takes voice and speech lessons to improve C's 
skills. The expenses for these lessons are for an exempt function.
    (iv) Example 4. D, an officeholder and candidate for reelection, 
purchases tickets to a testimonial dinner. D's attendance at the dinner 
is intended to aid D's reelection. Such expenditures are for an exempt 
function.
    (v) Example 5. E, an officeholder, expends amounts for periodicals 
of general circulation in order to keep informed on national and local 
issues. Such expenditures are not for an exempt function.
    (vi) Example 6. N is an organization described in section 501(c) and 
is exempt from taxation under section 501(a). F is employed as president 
of N. F, as a representative of N, testifies in response to a written 
request from a Congressional committee in support of the confirmation of 
an individual to a cabinet position. The expenditures by N that are 
directly related to F's testimony are not for an exempt function.
    (vii) Example 7. P is a political organization described in section 
527(e)(2). Between elections P does not support any particular 
individual for public office. However, P does train staff members for 
the next election, drafts party rules, implements party reform 
proposals, and sponsors a party convention. The expenditures for these 
activities are for an exempt function.
    (viii) Example 8. Q is a political organization described in section 
527(e)(2). Q finances seminars and conferences which are intended to 
influence persons who attend to support individuals to public office 
whose political philosophy is in harmony with the political philosophy 
of Q. The expenditures for these activities are for an exempt function.
    (d) Public office. The facts and circumstances of each case will 
determine whether a particular Federal, State, or local office is a 
public office. Principles consistent with those found under Sec.  
53.4946-1(g)(2) (relating to the definition of public office) will be 
applied.


[[Page 275]]


    (e) Principal campaign committee. A principal campaign committee is 
the political committee designated by a candidate for Congress as his or 
her principal campaign committee for purposes of section 302(e) of the 
Federal Election Campaign Act of 1971 (2 U.S.C. section 432(e)), as 
amended, and section 527(h) and Sec.  1.527-9.

[T.D. 7744, 45 FR 85731, Dec. 30, 1980, as amended by T.D. 8041, 50 FR 
30817, July 30, 1985]



Sec.  1.527-3  Exempt function income.

    (a) General rule. (1) For purposes of section 527, exempt function 
income consists solely of amounts received as:
    (i) Contributions of money or other property,
    (ii) Membership dues, fees, or assessments from a member of a 
political organization, or
    (iii) Proceeds from a political fund raising or entertainment event, 
or proceeds from the sale of political campaign materials, which are not 
received in the ordinary course of any trade or business,

but only to the extent such income is segregated for use only for exempt 
functions of the political organization.
    (2) Income will be considered segregated for use only for an exempt 
function only if it is received into and disbursed from a segregated 
fund as defined in Sec.  1.527-2(b).
    (b) Contributions. The rules of section 271(b)(2) apply in 
determining whether the transfer of money or other property constitutes 
a contribution. Generally, money or other property, whether solicited 
personally, by mail, or through advertising, qualifies as a 
contribution. In addition, to the extent a political organization 
receives Federal, State, or local funds under the $1 checkoff provision 
(sections 9001-9013), or any other provision for financing of campaigns, 
such amounts are to be treated as contributions.
    (c) Dues, fees, and assessments. Amounts received as membership fees 
and assessments from members of a political organization may constitute 
exempt function income to the political organization. Membership fees 
and assessments received in consideration for services, goods, or other 
items of value do not constitute exempt function income. However, filing 
fees paid by an individual directly or indirectly to a political party 
in order that the individual may run as a candidate in a primary 
election of the party (or run in a general election as a candidate of 
that party) are to be treated as exempt function income. For example, 
some States provide that a certain percentage of the first year's salary 
of the office sought must be paid to the State as a filing (or 
qualifying) fee and party assessment. The State then transfers part of 
this fee to the candidate's party. In such a case, the entire amount 
transferred to the party is to be treated as exempt function income. 
Furthermore, amounts paid by an individual directly to the party as a 
qualification fee are treated similarly.
    (d) Fund raising events--(1) In general. Amounts received from fund 
raising and entertainment events are eligible for treatment as exempt 
function income if the events are political in nature and are not 
carried on in the ordinary course of a trade or business. Whether an 
event is political in nature depends on all facts and circumstances. One 
factor that indicates an event is a political event is the extent to 
which the event is related to a political activity aside from the need 
of the organization for income or funds. For example, an event that is 
intended to rally and encourage support for an individual for public 
office would be a political fund raising event. Examples of political 
events can include dinners, breakfasts, receptions, picnics, dances, and 
athletic exhibitions.
    (2) Ordinary course of any trade or business. Whether an activity is 
in the ordinary course of a trade or business depends on the facts and 
circumstances of each case. Generally, proceeds from casual, sporadic 
fund raising or entertainment events are not in the ordinary course of a 
trade or business. Factors to be taken into account in determining 
whether an activity is a trade or business include the frequency of the 
activity, the manner in which the activity is conducted, and the span of 
time over which the activity is carried on.
    (e) Sale of campaign materials. Amounts received from the sale of 
campaign materials are eligible for

[[Page 276]]

treatment as exempt function income if the sale is not carried on in the 
ordinary course of a trade or business (as defined in paragraph (d)(2) 
of this section), and is related to a political activity of the 
organization aside from the need of such organization for income or 
funds. Proceeds from the sale of political memorabilia, bumper stickers, 
campaign buttons, hats, shirts, political posters, stationery, jewelry, 
or cookbooks are related to such a political acitivity where such items 
can be identified as relating to distributing political literature or 
organizing voters to vote for a candidate for public office.

[T.D. 7744, 45 FR 85732, Dec. 30, 1980]



Sec.  1.527-4  Special rules for computation of political organization
taxable income.

    (a) In general. Political organization taxable income is determined 
according to the provisions of section 527(b) and the rules set forth in 
this section.
    (b) Limitation on capital losses. If for any taxable year a 
political organization has a net capital loss, the rules of sections 
1211(a) and 1212(a) apply.
    (c) Allowable deductions--(1) In general. To be deductible in 
computing political organization taxable income, expenses, depreciation, 
and similar items must not only qualify as deductions allowed by chapter 
1 of the Code, but must also be directly connected with the production 
of political organization taxable income.
    (2) Directly connected with defined. To be directly connected with 
the production of political organization taxable income, an item of 
deduction must have a proximate and primary relationship to the 
production of such income and have been incurred in the production of 
such income. Items of deduction attributable solely to items of 
political organization taxable income are proximately and primarily 
related to such income. Whether an item of deduction is incurred in the 
production of political organization taxable income is determined on the 
basis of all the facts and circumstances of each case.
    (3) Dual use of facilities or personnel. Expenses, depreciation, and 
similar items that are attributable to the production of exempt function 
income andpolitical organization taxable income shall be allocated 
between the two on a reasonable and consistent basis. For example, where 
facilities are used both for an exempt function of the organization and 
for the production of political organization taxable income, expenses, 
depreciation, and similar items attributable to such facilities (for 
example, items of overhead) shall be allocated between the two uses of a 
reasonable and consistent basis. Similarly, where personnel are employed 
both for an exempt function and for the production of political 
organization taxable income, expenses and similar items attributable to 
such personnel (for example, items of salary) shall be allocated between 
the activities on a reasonable and consistent basis. The portion of any 
such item so allocated to the production of political organization 
taxable income is directly connected with such income and is allowable 
as a deduction in computing political organization taxable income to the 
extent that it qualifies as an item of deduction allowed by chapter 1 of 
the Code. Thus, for example, assume that X, a political organization, 
pays its manager a salary of $10,000 a year and that it derives 
political organization taxable income. If 10 percent of the manager's 
time during the year is devoted to deriving X's gross income (other than 
exempt function income), a deduction of $1,000 (10 percent of $10,000) 
would generally be allowable for purposes of computing X's political 
organization taxable income.

[T.D. 7744, 45 FR 85733, Dec. 30, 1980]



Sec.  1.527-5  Activities resulting in gross income to an individual
or political organization.

    (a) In general--(1) General rule. Amounts expended by a political 
organization for an exempt function are not income to the individual or 
individuals on whose behalf such expenditures are made. However, where a 
political organization expends any other amount for the personal use of 
any individual, the individual on whose behalf the amount is expended 
will be in receipt of income. Amounts are expended for the personal use 
of an individual where a direct or indirect financial benefit accrues to 
such individual. For example,

[[Page 277]]

if a political organization pays a personal legal obligation of a 
candidate for public office, such as the candidate's federal income tax 
liability, the amount paid is includible in such candidate's gross 
income. Similarly, if a political organization expends anyamount of its 
exempt function income for other than an exempt function, and the 
expenditure results in a direct or indirect financial benefit to the 
political organization, it must include the amount of such expenditure 
in its gross income. For example, if a political organization expends 
exempt function income for making an improvement or addition to its 
facilities, or for equipment, which is not necessary for or used in 
carrying out an exempt function, the amount of the expenditure will be 
included in the political organization's gross income. However, if a 
political organization expends exempt function income to make ordinary 
and necessary repairs on the facilities the political organization uses 
in conducting its exempt function, such amounts will not be included in 
the political organization's gross income.
    (2) Expenditure for an illegal activity. Expenditures by a political 
organization that are illegal or for an activity that is judicially 
determined to be illegal are treated as amounts not segregated for use 
only for the exempt function and shall be included in the political 
organization's taxable income. However, expenses incurred in defense of 
civil or criminal suits against the organization are not treated as 
taxable to the organization. Similarly, voluntary reimbursement to the 
participants in the illegal activity for similar expenses incurred by 
them are not taxable to the organization if the organization can 
demonstrate that such payments do not constitute a part of the 
inducement to engage in the illegal activity or part of the agreed upon 
compensation therefor. However, if the organization entered into an 
agreement with the participants to defray such expenses as part of the 
inducement, such payments would be treated as an expenditure for an 
illegal activity. Except where necessary to prevent the period of 
limitation for assessment and collection of a tax from expiring, a 
notice of deficiency will not generally be issued until after there has 
been a final determination of illegality by an appropriate court in a 
criminal proceeding.
    (b) Certain uses not treated as income to a candidate. Except as 
otherwise provided in paragraph (a) of this section, if a political 
organization:
    (1) Contributes any amount to or for the use of any political 
organization described in section 527(e)(1) or newsletter fund described 
in section 527(g),
    (2) Contributes any amount to or for the use of any organization 
described in paragraph (1) and (2) of section 509(a) which is exempt 
from taxation under section 501(a), or
    (3) Deposits any amount in the general fund of the U.S. Treasury or 
in the general fund of any State or local government,

such amount shall not be treated as an amount expended for the personal 
use of a candidate or other person. No deduction shall be allowed under 
the Internal Revenue Code of 1954 for the contribution or deposit 
described in the preceding sentence.
    (c) Excess funds--(1) General rule. Generally, funds controlled by a 
political organization or other person after a campaign or election are 
excess funds and are treated as expended for the personal use of the 
person having control over the ultimate use of such funds. However, such 
funds will not be treated as excess funds to the extent they are:
    (i) Transferred within a reasonable period of time by the person 
controlling the funds in accordance with paragraph (b) of this section, 
or
    (ii) Held in reasonable anticipation of being used by the political 
organization for future exempt functions.
    (2) Excess funds transferred at death. Where excess funds are held 
by an individual who dies, and these funds go to the individual's estate 
or any other person (other than an organization or fund described in 
paragraph (b) of this section), the funds are income of the decedent and 
will be included in the decedent's gross estate unless the estate or 
other person receiving such funds transfers the funds within a 
reasonable period of time in accordance with paragraph (b) of this 
section.

[[Page 278]]


This paragraph (c)(2) will not apply where the individual who dies 
provides that the funds be transferred to an organization or fund 
described in paragraph (b) of this section.

[T.D. 7744, 45 FR 85733, Dec. 30, 1980]



Sec.  1.527-6  Inclusion of certain amounts in the gross income of an
exempt organization which is not a political organization.

    (a) Exempt organizations--General rule. If an organization described 
in section 501(c) which is exempt from tax under section 501(a) expends 
any amount for an exempt function, it may be subject to tax. There is 
included in the gross income of such organization for the taxable year 
an amount equal to the lesser of:
    (1) The net investment income of such organization for the taxable 
year, or
    (2) The aggregate amount expended during the taxable year for an 
exempt function.

The amount included will be treated as political organization taxable 
income.
    (b) Exempt function expenditures--(1) Directly related expenses. (i) 
Except as provided in this section, the term exempt function will 
generally have the same meaning it has in Sec.  1.527-2(c). Thus, 
expenditures which are directly related to the selection process as 
defined in Sec.  1.527-2(c)(1) are expenditures for an exempt function. 
Expenditures for indirect expenses as defined in Sec.  1.527-2(c)(2), 
when made by a section 501(c) organization are for an exempt function 
only to the extent provided in paragraph (b)(2) of this section. 
Expenditures of a section 501 (c) organization which are otherwise 
allowable under the Federal Election Campaign Act or similar State 
statute are for an exempt function only to the extent provided in 
paragraph (b)(3) of this section.
    (ii) An expenditure may be made for an exempt function directly or 
through another organization. A section 501(c) organization will not be 
absolutely liable under section 527(f)(1) for amounts transferred to an 
individual or organization. A section 501(c) organization is, however, 
required to take reasonable steps to ensure that the transferee does not 
use such amounts for an exempt function.
    (2) Indirect expenses. [Reserved]
    (3) Expenditures allowed by Federal Election Campaign Act. 
[Reserved]
    (4) Appointments or confirmations. Where an organization described 
in paragraph (a) of this section appears before any legislative body in 
response to a written request by such body for the purpose of 
influencing the appointment or confirmation of an individual to a public 
office, any expenditure directly related to such appearance is not 
treated as an expenditure for an exempt function.
    (5) Nonpartisan activity. Expenditures for nonpartisan activities by 
an organization to which paragraph (a) of this section applies are not 
expenditures for an exempt function. Nonpartisan activities include 
voter registration and get-out-the-vote campaigns. To be nonpartisan 
voter registration and get-out-the-vote campaigns must not be 
specifically identified by the organization with any candidate or 
political party.
    (c) Character of items included in gross income--(1) General rule. 
The items of income included in the gross income of an organization 
under paragraph (a) of this section retain their character as ordinary 
income or capital gain.
    (2) Special rule in determining character of item. If the amount 
included in gross income is determined under paragraph (a)(2)(ii) of 
this section, the character of the items of income is determined by 
multiplying the total amount included in gross income under such 
paragraph by a fraction, the numerator of which is the portion of the 
organization's net investment income that is gain from the sale or 
exchange of a capital asset, and the denominator of which is the 
organization's net investment income. For example, if $5,000 is included 
in the gross income of an organization under paragraph (a)(2) of this 
section, and the organization had $100,000 of net investment income of 
which $10,000 is long term capital gain, then $500 would be treated as 
long term capital gain:

[[Page 279]]

[GRAPHIC] [TIFF OMITTED] TC08OC91.002

    (d) Modifications. The modifications described in section 527(c)(2) 
apply in computing the tax under paragraph (a)(2) of this section. Thus, 
no net operating loss is allowed under section 172 nor is any deduction 
allowed under part VIII of subchapter B. However, there is allowed a 
specific deduction of $100.
    (e) Transfer not treated as exempt function expenditures. Provided 
the provisions of this paragraph (e) are met, a transfer of political 
contributions or dues collected by a section 501(c) organization to a 
separate segregated fund as defined in paragraph (f) of this section is 
not treated as an expenditure for an exempt function (within the meaning 
of Sec.  1.527-2(c)). Such transfers must be made promptly after the 
receipt of such amounts by the section 501(c) organization, and must be 
made directly to the separate segregated fund. A transfer is considered 
promptly and directly made if:
    (1) The procedures followed by the section 501(c) organization 
satisfy the requirements of applicable Federal or State campaign law and 
regulations;
    (2) The section 501(c) organization maintains adequate records to 
demonstrate that amounts transferred in fact consist of political 
contributions or dues, rather than investment income; and
    (3) The political contributions or dues transferred were not used to 
earn investment income for the section 501(c) organization.
    (f) Separate segregated fund. An organization or fund described in 
section 527(f)(3) is a separate segregated fund. To avoid the 
application of paragraph (a) of this section, an organization described 
in section 501(c) that is exempt from taxation under section 501(a) may, 
if it is consistent with its exempt status, establish and maintain such 
a separate segregated fund to receive contributions and make 
expenditures in a political campaign. If such a fund meets the 
requirements of Sec.  1.527-2(a) (relating to the definition of a 
political organization), it shall be treated as a political organization 
subject to the provisions of section 527. A segregated fund established 
under the Federal Election Campaign Act will continue to be treated as a 
segregated fund when it engages in exempt function activities as defined 
in Sec.  1.527-2(c), relating to State campaigns.
    (g) Effect of expenditures on exempt status. Section 527(f) and this 
section do not sanction the intervention in any political campaign by an 
organization described in section 501(c) if such activity is 
inconsistent with its exempt status under section 501(c). For example, 
an organization described in section 501(c)(3) is precluded from 
engaging in any political campaign activities. The fact that section 527 
imposes a tax on the exempt function (as defined in Sec.  1.527-2(c)) 
expenditures of section 501(c) organizations and permits such 
organizations to establish separate segregated funds to engage in 
campaign activities does not sanction the participation in these 
activities by section 501(c)(3) organizations.

[T.D. 7744, 45 FR 85734, Dec. 30, 1980]



Sec.  1.527-7  Newsletter funds.

    (a) In general. For purposes of this section, a fund established and 
maintained by an individual who holds, has been elected to, or is a 
candidate (within the meaning of section 41(c)(2)) for nomination or 
election to, any Federal, State, or local elective public office for the 
use by such individual exclusively for an exempt function, as defined in 
paragraph (c) of this section, shall be a newsletter fund. If assets of 
a newsletter fund are used for any purpose other than the exempt 
function of the newsletter fund as defined in paragraph

[[Page 280]]

(c) of this section, such amount shall be treated as expended for the 
personal use of the individual who established and maintained such fund. 
In addition, future contributions to such fund are treated as income to 
the individual who established and maintained the fund. In such a case, 
the facts and circumstances may indicate that the fund was never 
established and maintained exclusively for an exempt function as defined 
in paragraph (c) of this section.
    (b) Determination of taxable income. A newsletter fund shall be 
treated as if it were a political organization for purposes of 
determining its taxable income. However, the specific $100 deduction 
provided by section 527(c)(2)(A) shall not be allowed.
    (c) Exempt function. For purposes of this section, the exempt 
function of a newsletter fund consists solely of the preparation and 
circulation of the newsletter. Among the expenditures treated as 
preparation and circulation expenditures of the newsletter are:
    (1) Secretarial services,
    (2) Printing,
    (3) Addressing, and
    (4) Mailing.
    (d) Nonexempt function purposes. Newsletter fund assets may not be 
used for campaign activities. Therefore, an exempt function of a 
newsletter fund does not include:
    (1) Expenditures for an exempt function as defined in Sec.  1.527-
2(c) or
    (2) Transfers of unexpended amounts to a political organization 
described in section 527(e)(1).
    (e) Excess funds. Excess funds held by a newsletter fund which has 
ceased to engage in the preparation and circulation of the newsletter 
are treated as expended for the personal use of the individual who 
established and maintained such fund. However, to the extent such excess 
funds are within a reasonable period of time:
    (1) Contributed to or for the use of any organization described in 
paragraph (1) or (2) of section 509(a) which is exempt from taxation 
under section 501(a),
    (2) Deposited in the general fund of the U.S. Treasury or in the 
general fund of any State or local government (including the District of 
Columbia), or
    (3) Contributed to any other newsletter fund as described in 
paragraph (a) of this section,

the excess funds are not treated as expended for the personal use of 
such individual. In such a case the individual is not allowed a 
deduction under the Internal Revenue Code of 1954 for such contribution 
or deposit.

[T.D. 7744, 45 FR 85735, Dec. 30, 1980]



Sec.  1.527-8  Effective date; filing requirements; and miscellaneous
provisions.

    (a) Assessment and collections. Since the taxes imposed by section 
527 are taxes imposed by subtitle A of the Code, all provisions of law 
and of the regulations applicable to the taxes imposed by subtitle A are 
applicable to the assessment and collection of the taxes imposed by 
section 527. Organizations subject to the tax imposed by section 527 are 
subject to the same provisions, including penalties, as are provided for 
corporations, in general, except that the requirements of section 6154 
concerning the payment of estimated tax do not apply. See, generally, 
sections 6151, et. seq., and the regulations prescribed thereunder, for 
provisions relating to payment of tax.
    (b) Returns. For requirements of filing annual returns with respect 
to political organization taxable income, see section 6012 (a) (6) and 
the applicable regulations.
    (c) Taxable years, method of accounting, etc. The taxable year 
(fiscal year or calendar year, as the case may be) of a political 
organization is determined without regard to the fact that such 
organization may have been exempt from tax during any prior period. See 
sections 441 and 446, and the regulations thereunder in this part, and 
section 7701 and the regulations in Part 301 of this chapter 
(Regulations on Procedure and Administration). Similarly, in computing 
political organization taxable income, the determination of the taxable 
year for which an item of income or expense is taken into account is 
made under the provisions of sections 441, 446, 451, 461, and the 
regulations thereunder, whether or not the item arose during a taxable 
year beginning before, on, or after the effective date of the provisions 
imposing a tax

[[Page 281]]

upon political organization taxable income. If a method for treating bad 
debts was selected in a return of income (other than an information 
return) for a previous taxable year, the taxpayer must follow such 
method in its returns under section 527, unless such method is changed 
inaccordance with the provisions of Sec.  1.166-1. A taxpayer who has 
not previously selected a method for treating bad debts may, in its 
first return under section 6012 (a) (6), exercise the option granted in 
Sec.  1.166-1.
    (d) Effective date. Except as provided in paragraph (b)(2) of Sec.  
1.527-6 and in paragraph (a) of Sec.  1.527-9, the regulations under 
section 527 apply to taxable years beginning after December 31, 1974.

[T.D. 7744, 45 FR 85735, Dec. 30, 1980, as amended by T.D. 8041, 50 FR 
30817, July 30, 1985]



Sec.  1.527-9  Special rule for principal campaign committees.

    (a) In general. Effective with respect to taxable years beginning 
after December 31, 1981, the tax imposed by section 527(b) on the 
political organization taxable income of a principal campaign committee 
shall be computed by multiplying the political organization taxable 
income by the appropriate rates of tax specified in section 11(b). The 
political organization taxable income of a campaign committee not a 
principal campaign committee is taxed at the highest rate of tax 
specified in section 11(b). A candidate for Congress may designate one 
political committee to serve as his or her principal campaign committee 
for purposes of section 527(h)(1). If a designation is made, it shall be 
made in accordance with the requirements of paragraph (b) of this 
section. A candidate for Congress may have only one designation in 
effect at any time. Under 11 CFR 102.12, no political committee may be 
designated as the principal campaign committee of more than one 
candidate for Congress. Further, no political committee that supports or 
has supported more than one candidate for Congress may be designated as 
a principal campaign committee. No designation need be made where there 
is only one political campaign committee with respect to a candidate.
    (b) Manner of designation. If a candidate for Congress elects to 
make a designation under section 527(h) and this section, he or she 
shall designate his or her principal campaign committee by appending a 
copy of his or her Statement of Candidacy (that is, the Federal Election 
Commission Form 2, or equivalent statement that the candidate filed with 
the Federal Election Commission under 11 CFR 101.1(a)), to the Form 
1120-POL filed by the principal campaign committee for each taxable year 
for which the designation is effective. This designation may also be 
made by appending to the Form 1120-POL statement containing the 
following information: The name and address of the candidate for 
Congress; his or her taxpayer identification number; his or her party 
affiliation and the office sought; the district and State in which the 
office is sought; and the name and address of the principal campaign 
committee. This designation shall be made on or before the due date (as 
extended) for filing Form 1120-POL. Only a candidate for Congress may 
make a designation in accordance with this paragraph.
    (c) Manner of revoking designation. A designation of a principal 
campaign committee that has been filed in accordance with this section 
may be revoked only with the consent of the Commissioner. In general, 
the Commissioner will grant such consent in every case where the 
candidate for Congress has revoked his or her designation in compliance 
with the requirements of the Federal Election Commission by filing an 
amended Statement of Organization or its equivalent pursuant to 11 CFR 
102.2(a)(2). In the case of the revocation of the designation of a 
principal campaign committee by a candidate followed by the designation 
of another principal campaign committee by such candidate, for purposes 
of determining the appropriate rate of tax under section 11(b) for a 
taxable year, the political organization taxable income of the first 
principal campaign committee shall be treated as that of the subsequent 
principal campaign committee. In a case where consent to revoke a 
designation of a principal

[[Page 282]]

campaign committee is granted and a new designation is filed, the 
Commissioner may condition his consent upon the agreement of the 
candidate for Congress to insure compliance with the preceding sentence.

[T.D. 8041, 50 FR 30817, July 30, 1985]

                         Homeowners Associations



Sec.  1.528-1  Homeowners associations.

    (a) In general. Section 528 only applies to taxable years of 
homeowners associations beginning after December 31, 1973. To qualify as 
a homeowners association an organization must either be a condominium 
management association or a residential real estate management 
association. For the purposes of Section 528 and the regulations under 
that section, the term homeowners association shall refer only to an 
organization described in section 528. Cooperative housing corporations 
and organizations based on a similar form of ownership are not eligible 
to be taxed as homeowners associations. As a general rule, membership in 
either a condominium management association or a residential real estate 
management association is confined to the developers and the owners of 
the units, residences, or lots. Furthermore, membership in either type 
of association is normally required as a condition of such ownership. 
However, if the membership of an organization consists of other 
homeowners associations, the owners of units, residences, or lots who 
are members of such other homeowners associations will be treated as the 
members of the organization for the purposes of the regulations under 
section 528.
    (b) Condominium. The term condominium means an interest in real 
property consisting of an undivided interest in common in a portion of a 
parcel of real property (which may be a fee simple estate or an estate 
for years, such as a leasehold or subleasehold) together with a separate 
interest in space in a building located on such property. An interest in 
property is not a condominium unless the undivided interest in the 
common elements are vested in the unit holders. In addition, a 
condominium must meet the requirements of applicable state or local law 
relating to condominiums or horizontal property regimes.
    (c) Residential real estate management association. Residential real 
estate management associations are normally composed of owners of 
single-family residential units located in a subdivision, development, 
or similar area. However, they may also include as members, owners of 
multiple-family dwelling units located in such areas. They are commonly 
formed to administer and enforce covenants relating to the architecture 
and appearance of the real estate development as well as to perform 
certain maintenance duties relating to common areas.
    (d) Tenants. Tenants will not be considered members for purposes of 
meeting the source of income test under section 528(c)(1)(B) and Sec.  
1.528-5. However, the fact that tenants of members of a homeowners 
association are permitted to be members of the association will not 
disqualify an association under section 528(c)(1) if it otherwise meets 
the requirements of section 528(c) and these regulations.

[T.D. 7692, 45 FR 26321, Apr. 18, 1980]



Sec.  1.528-2  Organized and operated to provide for the acquisition,
construction, management, maintenance and care of association property.

    (a) Organized and operated--(1) Organized. To be treated as a 
homeowners association an organization must be organized and operated 
primarily for the purpose of carrying on one or more of the exempt 
functions of a homeowners association. For the purposes of section 528 
and these regulations, the exempt functions of a homeowners association 
are the acquisition, construction, management, maintenance, and care of 
association property. In determining whether an organization is 
organized and operated primarily to carry on one or more exempt 
functions, all the facts and circumstances of each case shall be 
considered. For example, when an organization provides in its articles 
of organization that its sole purpose is to carry on one or more exempt 
functions, in the absence of other relevant factors it will be 
considered to have met the organizational test. (The term articles

[[Page 283]]

of organization means the organization's corporate charter, trust 
instruments, articles of association or other instrument by which it is 
created.)
    (2) Operated. An organization will be treated as being operated for 
the purpose of carrying on one or more of the exempt functions of a 
homeowners association if it meets the provisions of Sec. Sec.  1.528-5 
and 1.528-6.
    (b) Terms to be interpreted according to common meaning and usage. 
As used in section 528 and these regulations, the terms acquisition, 
construction, management, maintenance, and care are to be interpreted 
according to their common meaning and usage. For example, maintenance of 
association property includes the painting and repairing of such 
property as well as the gardening and janitorial services associated 
with its upkeep. Similarly, the term construction of association 
property includes covenants or other rules for preserving the 
architectural and general appearance of the area. The term also includes 
regulations relating to the location, color and allowable building 
materials to be used in all structures. (For the definition of 
association property see Sec.  1.528-3.)

[T.D. 7692, 45 FR 26321, Apr. 18, 1980]



Sec.  1.528-3  Association property.

    (a) Property owned by the organization. Association property 
includes real and personal property owned by the organization or owned 
as tenants in common by the members of the organization. Such property 
must be available for the common benefit of all members of the 
organization and must be of a nature that tends to enhance the 
beneficial enjoyment of the private residences by their owners. If two 
or more facilities or items of property of a similar nature are owned by 
a homeowners association, and if the use of any particular facility or 
item is restricted to fewer than all association members, such 
facilities or items neverthelesswill be considered association property 
if all association members are treated equitably and have similar rights 
with respect to comparable items or facilities. Among the types of 
property that ordinarily will be considered association property are 
swimming pools and tennis courts. On the other hand, facilities or areas 
set aside for the use of nonmembers, or in fact used primarily by 
nonmembers, are not association property for the purposes of this 
section. For example, property owned by an organization for the purpose 
of leasing it to groups consisting primarily of nonmembers to be used as 
a meeting place or a retreat will not be considered association 
property.
    (b) Property normally owned by a governmental unit. Association 
property also includes areas and facilities traditionally recognized and 
accepted as being of direct governmental concern in the exercise of the 
powers and duties entrusted to governments to regulate community health, 
safety and welfare. Such areas and facilities would normally include 
roadways, parklands, sidewalks, streetlights and firehouses. Property 
described in this paragraph will be considered association property 
regardless of whether it is owned by the organization itself, by its 
members as tenants in common or by a governmental unit and used for the 
benefit of the residents of such unit including the members of the 
organization.
    (c) Privately owned property. Association property may also include 
property owned privately by members of the organization. However, to be 
so included the condition of such property must affect the overall 
appearance or structure of the residential units which make up the 
organization. Such property may include the exterior walls and roofs of 
privately owned residences as well as the lawn and shrubbery on 
privately owned land and any other privately owned property the 
appearance of which may directly affect the appearance of the entire 
organization. However, privately owned property will not be considered 
association property unless:
    (1) There is a covenant or similar requirement relating to exterior 
appearance or maintenance that applies on the same basis to all such 
property (or to a reasonable classification of such property);
    (2) There is a pro rata mandatory assessment (at least once a year) 
on all members of the association for maintaining such property; and

[[Page 284]]

    (3) Membership in the organization is a condition of ownership of 
such property.

[T.D. 7692, 45 FR 26321, Apr. 18, 1980]



Sec.  1.528-4  Substantiality test.

    (a) In general. In order for an organization to be considered a 
condominium management association or a residential real estate 
management association (and therefore in order for it to be considered a 
homeowners association), substantially all of its units, lots or 
buildings must be used by individuals for residences. For the purposes 
of applying paragraph (b) or (c) of this section, and organization which 
has attributes of both a condominium management association and a 
residential real estate management association shall be considered that 
association which, based on all the facts and circumstances, it more 
closely resembles. In addition, those paragraphs shall be applied based 
on conditions existing on the last day of the organization's taxable 
year.
    (b) Condominium management associations. Substantially all of the 
units of a condominium management association will be considered as used 
by individuals for residences if at least 85% of the total square 
footage of all units within the project is used by individuals for 
residential purposes. If a completed unit has never been occupied, it 
will nonetheless be considered as used for residential purposes if, 
based on all the facts and circumstances, it appears to have been 
constructed for use as a residence. Similarly, a unit which is not 
occupied but which has been in the past will be considered as used for 
residential purposes if, based on all the facts and circumstances, it 
appears that it was constructed for use as a residence, and the last 
individual to occupy it did in fact use it as a residence. Units which 
are used for purposes auxiliary to residential use (such as laundry 
areas, swimming pools, tennis courts, storage rooms and areas used by 
maintenance personnel) shall be considered used for residential 
purposes.
    (c) Residential real estate management associations. Substantially 
all of the lots or buildings of a residential real estate management 
association (including unimproved lots) will be considered as used by 
individuals as residences if at least 85% of the lots are zoned for 
residential purposes. Lots shall be treated as zoned for residential 
purposes even if under such zoning lots may be used for parking spaces, 
swimming pools, tennis courts, schools, fire stations, libraries, 
churches and other similar purposes which are auxiliary to residential 
use. However, commercial shopping areas (and their auxiliary parking 
areas) are not lots zoned for residential purposes.
    (d) Exception. Notwithstanding any other provision of this section, 
a unit, or building will not be considerd used for residential purposes, 
if for more than one-half the days in the association's taxable year, 
such unit, or building is occupied by a person or series of persons, 
each of whom so occupies such unit, or building for less than 30 days.

[T.D. 7692, 45 FR 26322, Apr. 18, 1980; T.D. 7692, 45 FR 24879, May 23, 
1980]



Sec.  1.528-5  Source of income test.

    An organization cannot qualify as a homeowners association under 
section 528 for a taxable year unless 60 percent or more of its gross 
income for such taxable year is exempt function income as defined in 
Sec.  1.528-9. The determiniation of whether an organization meets the 
provisions of this section shall be made after the close of the 
organization's taxable year.

[T.D. 7692, 45 FR 26322, Apr. 18, 1980]



Sec.  1.528-6  Expenditure test.

    (a) In general. An organization cannot qualify as a homeowners 
association under section 528 for a taxable year unless 90 percent or 
more of its expenditures for such taxable year are qualifying 
expenditures as defined in paragraphs (b) and (c) of this section. The 
determination of whether an organization meets the provisions of this 
section shall be made after the close of the organization's taxable 
year. Investments or transfers of funds to be held to meet future costs 
shall not be taken into account as expenditures. For example, transfers 
to a sinking fund account for the replacement of a roof would not be 
considered an expenditure for the purposes of this section even if

[[Page 285]]

the roof is association property. In addition, excess assessments which 
are either rebated to members or applied against the members' following 
year's assessments will not be considered an expenditure for the 
purposes of this section.
    (b) Qualifying expenditures. Qualifying expenditures are 
expenditures by an organization for the acquisition, construction, 
management, maintenance, and care of the organization's association 
property. They include both current operating and capital expenditures 
on association property. Qualifying expenditures include expenditures on 
association property despite the fact that such property may produce 
income which is not exempt function income. Thus expenditures on a 
swimming pool are qualifying expenditures despite the fact that fees 
from guests of members using the pool are not exempt function income. 
Where expenditures by an organization are used both for association 
property as well as other property, an allocation shall be made between 
the two uses on a reasonable basis. Only that portion of the 
expenditures which is properly allocable to the acquisition, 
construction, management, maintenance or care of association property, 
shall constitute qualifying expenditures.
    (c) Examples of qualifying expenditures. Qualifying expenditures may 
include (but are not limited to) expenditures for:
    (1) Salaries of an association manager and secretary;
    (2) Paving of streets;
    (3) Street signs;
    (4) Security personnel;
    (5) Legal fees;
    (6) Upkeep of tennis courts;
    (7) Swimming pools;
    (8) Recreation rooms and halls;
    (9) Replacement of common buildings, facilities, air conditioning, 
etc;
    (10) Insurance premiums on association property;
    (11) Accountant's fees;
    (12) Improvement of private property to the extent it is association 
property; and
    (13) Real estate and personal property taxes imposed on association 
property by a State or local government.

[T.D. 7692, 45 FR 26322, Apr. 18, 1980]



Sec.  1.528-7  Inurement.

    An organization is not a homeowners association if any part of its 
net earnings inures (other than as a direct result of its engaging in 
one or more exempt functions) to the benefit of any private person. 
Thus, to the extent that members receive a benefit from the general 
maintenance, etc., of association property, this benefit generally would 
not constitute inurement. If an organization pays rebates from amounts 
other than exempt function income, such rebates will constitute 
inurement. In general, in determining whether an organization is in 
violation of this section, the principles used in making similar 
determinations under Section 501(c) will be applied.

[T.D. 7692, 45 FR 26323, Apr. 18, 1980]



Sec.  1.528-8  Election to be treated as a homeowners association.

    (a) General rule. An organization wishing to be treated as a 
homeowners association under section 528 and this section for a taxable 
year must elect to be so treated. Except as otherwise provided in this 
section such election shall be made by the filing of a properly 
completed Form 1120-H (or such other form as the Secretary may 
prescribe). A separate election must be made for each taxable year.
    (b) Taxable years ending after December 30, 1976. For taxable years 
ending after December 30, 1976, the election must be made not later than 
the time, including extensions, for filing an income tax return for the 
year in which the election is to apply.
    (c) Taxable years ending before December 31, 1976, for which a 
return was filed before January 31, 1977. For taxable years ending 
before December 31, 1976, for which a return was filed before January 
31, 1977, the election must be made not later than the time provided by 
law for filing a claim for credit or refund of overpayment of taxes for 
the year in which the election is to apply. Such an election shall be 
made by filing an amended return on Form 1120-H (or such other form as 
the Secretary may prescribe).
    (d) Taxable years ending before December 31, 1976, for which a 
return was not filed before January 31, 1977. For taxable

[[Page 286]]

years ending before December 31, 1976, for which a return was not filed 
before January 31, 1977, the election must be made by October 20, 1980. 
Instead of making such an election in the manner described in paragraph 
(a) of this section, such an election may be made by a statement 
attached to the applicable income tax return or amended return for the 
year in which the election is made. The statement should identify the 
election being made, the period for which it applies and the taxpayer's 
basis for making the election.
    (e) Revocation of exempt status. If an organization is notified 
after the close of a taxable year that its exemption for such taxable 
year under section 501(a) is being revoked retroactively, it may make a 
timely election under section 528 for such taxable year. Notwithstanding 
any other provisions of this section, such an election will be 
considered timely if it is made within 6 months after the date of 
revocation. The preceding sentence shall apply to revocations made after 
April 18, 1980. If the revocation was made on or before April 18, 1980, 
the election will be considered timely if it is made before the 
expiration of the period for filing a claim for credit or refund for the 
taxable year for which it is to apply.
    (f) Effect of election--(1) Revocation. An election to be treated as 
an organization described in section 528 is binding on the organization 
for the taxable year and may not be revoked without the consent of the 
Commissioner.
    (2) Exception. Notwithstanding paragraph (f)(1) of this section, an 
election under this section may be revoked prior to July 18, 1980. Such 
a revocation shall be made by filing a statement with the director of 
the Internal Revenue Service Center with whom the return of the 
organization for the year in which the revocation is to apply was filed. 
The statement shall include the following information:
    (i) The name of the organization.
    (ii) The fact that it is revoking an election made under section 
528.
    (iii) The taxable year for which the revocation is to apply.

[T.D. 7692, 45 FR 26323, Apr. 18, 1980]



Sec.  1.528-9  Exempt function income.

    (a) General rule. For the purposes of section 528 exempt function 
income consists solely of income which is attributable to membership 
dues, fees, or assessments of owners of residential units or residential 
lots. It is not necessary that the source of income be labeled as 
membership dues, fees, or assessments. What is important is that such 
income be derived from owners of residential units or residential lots 
in their capacity as owner-members rather than in some other capacity 
such as customers for services. Generally, for the membership dues, 
fees, or assessments with respect to a residential unit or lot to be 
exempt function income, the unit must be used for (or the unit or lot 
must be expected to be used) for residential purposes. However, dues, 
fees, or assessments paid to an organization by a developerwith respect 
to unfinished or finished but unsold units or lots shall be exempt 
function income even though the developer does not use the units or 
lots. If an assessment is more in the nature of a fee for the provision 
of services in the course of a trade or business than a fee for a common 
activity undertaken by a collective group of owners for the purpose of 
enhancing or maintaining the value of their residences, the assessment 
will not be considered exempt function income to the organization. 
Furthermore, income attributable to dues, fees, or assessments will not 
be considered exempt function income unless each member's liability for 
payment arises solely from membership in the association. Dues, fees, or 
assessments that are based on the extent, if any, to which a member 
avails him or herself of a facility or facilities are not exempt 
function income. For the purposes of section 528, dues, fees, or 
assessments which are based on the assessed value or size of property 
will be considered as arising solely as a result of membership in the 
organization. Regardless of the organization's method of accounting, 
excess assessments during a taxable year which are either rebated to the 
members or applied to their future assessments are not considered gross 
income and therefore will not be considered exempt function income for 
such taxable year. However, if

[[Page 287]]

such excess assessments are applied to a future year's assessments, they 
will be considered gross income and exempt function income for that 
future year. In addition, assessments in a taxable year, such as an 
assessment for a capital improvement, which are not treated as gross 
income do not enter into the determination of whether the organization 
meets the source of income test for that taxable year.
    (b) Examples of exempt function income. Assessments which are 
considered more in the nature of a fee for common activity than for the 
providing of services and which will therefore generally be considered 
exempt function income include assessments made for the purpose of:
    (1) Paying the principal and interest on debts incurred for the 
acquisition of association property;
    (2) Paying real estate taxes on association property;
    (3) Maintaining association property;
    (4) Removing snow from public areas; and
    (5) Removing trash.
    (c) Examples of receipts which are not exempt function income. 
Exempt function income does not include:
    (1) Amounts which are not includible in the organization's gross 
income other than by reason of section 528 (for example, tax-exempt 
interest);
    (2) Amounts received from persons who are not members of the 
association;
    (3) Amounts received from members for special use of the 
organization's facilities, the use of which is not available to all 
members as a result of having paid the dues, fees or assessments 
required to be paid by all members;
    (4) Interest earned on amounts set aside in a sinking fund;
    (5) Amounts received for work done on privately owned property which 
is not association property; or
    (6) Amounts received from members in return for their transportation 
to or from shopping areas, work location, etc.
    (d) Special rule. Notwithstanding paragraphs (a) and (c)(3) of this 
section, amounts received from members or tenants of residential units 
owned by members (notwithstanding Sec.  1.528-1(d)) for special use of 
an association's facilities will be considered exempt function income 
if:
    (1) The amounts paid by the members are not paid more than once in 
any 12 month period; and
    (2) The privilege obtained from the payment of such amounts lasts 
for the entire 12 month period or portion thereof in which the facility 
is commonly in use.

Thus, amounts received as the result of payments by members of a yearly 
fee for use of tennis courts or a swimming pool shall be considered 
exempt function income. However, amounts received for the use of a 
building for an evening, weekend, week, etc., shall not be considered 
exempt function income.

[T.D. 7692, 45 FR 26323, Apr. 18, 1980]



Sec.  1.528-10  Special rules for computation of homeowners association
taxable income and tax.

    (a) In general. Homeowners association taxable income shall be 
determined according to the provisions of section 528(d) and the rules 
set forth in this section.
    (b) Limitation on capital losses. If for any taxable year a 
homeowners association has a net capital loss, the rules of sections 
1211(a) and 1212(a) shall apply.
    (c) Allowable deductions--(1) In general. To be deductible in 
computing the unrelated business taxable income of a homeowners 
association, expenses, depreciation and similar items must not only 
qualify as items of deduction allowed by chapter 1 of the Code but must 
also be directly connected with the production of gross income 
(excluding exempt function income). To be directly connected with the 
production of gross income (excluding exempt function income), an item 
of deduction must have both proximate and primary relationship to the 
production of such income and have been incurred in the production of 
such income. Items of deduction attributable solely to items of gross 
income (excluding exempt function income) are proximately and primarily 
related to such income. Whether an item of deduction is incurred in the 
production of gross income (excluding exempt function income) is 
determined on the basis of all the facts and circumstances involved in 
each case.

[[Page 288]]

    (2) Dual use of facilities or personnel. Where facilities are used 
both for exempt functions of the organization and for the production of 
gross income (excluding exempt function income), expenses, depreciation 
and similar items attributable to such facilities (for example, items of 
overhead) shall be allocated between the two uses on a reasonable basis. 
Similarly where personnel are employed both for exempt functions and for 
the production of gross income (excluding exempt function income), 
expenses and similar items attributable to such personnel (for example, 
items of salary) shall be allocated between the two activities on a 
reasonable basis. The portion of any such item so allocated to the 
production of gross income (excluding exempt function income) is 
directly connected with such income and shall be allowable as a 
deduction in computing homeowners association taxable income to the 
extent that it qualifies as an item of deduction allowed by chapter 1 of 
the Code. Thus, for example, assume that X, a homeowners association, 
pays its manager a salary of $10,000 a year and that it derives gross 
income other than exempt function income. If 10 percent of the manager's 
time during the year is devoted to deriving X's gross income (other than 
exempt function income), a deduction of $1,000 (10 percent of $10,000) 
would generally be allowable for purposes of computing X's homeowners 
association taxable income.
    (d) Investment credit. A homeowners association is not entitled to 
an investment credit.
    (e) Cross reference. For the definition of exempt function income, 
see Sec.  1.528-9.

[T.D. 7692, 45 FR 26324, Apr. 18, 1980]

                         Qualified ABLE Programs

    Source: T.D. 9923, 85 FR 74034, Nov. 19, 2020, unless otherwise 
noted.



Sec.  1.529A-0  Table of contents.

    This section lists the following captions contained in Sec. Sec.  
1.529A-1 through 1.529A-8.

Sec.  1.529A-1 Exempt status of qualified ABLE program and definitions.

    (a) In general.
    (b) Definitions.
    (1) ABLE account.
    (2) Contribution.
    (3) Designated beneficiary.
    (4) Disability certification.
    (5) Distribution.
    (6) Earnings.
    (7) Earnings ratio.
    (8) Eligible individual.
    (9) Excess contribution.
    (10) Excess aggregate contribution.
    (11) Investment in the account.
    (12) Member of the family.
    (13) Program-to-program transfer.
    (14) Qualified ABLE program.
    (15) Qualified disability expenses.
    (16) Rollover.
    (c) Applicability date.

Sec.  1.529A-2 Qualified ABLE program.

    (a) In general.
    (b) Established and maintained by a State or agency or 
instrumentality of a State.
    (1) Established.
    (2) Maintained.
    (i) In general.
    (ii) Multiple States, agencies, or instrumentalities.
    (3) Community Development Financial Institutions (CDFIs).
    (c) Establishment of an ABLE account and signature authority.
    (1) Establishment of the ABLE account.
    (2) Signature authority.
    (3) Only one ABLE account.
    (4) Beneficial interest.
    (d) Eligible individual.
    (1) Documentation.
    (2) Frequency of recertification.
    (3) Loss of qualification as an eligible individual.
    (e) Disability certification.
    (1) In general.
    (2) Marked and severe functional limitations.
    (3) Compassionate allowance list.
    (4) Additional guidance.
    (5) Restriction on use of certification.
    (f) Change of designated beneficiary.
    (1) In general.
    (2) Change effective upon death.
    (g) Contributions.
    (1) Permissible property.
    (2) Annual contributions limit.
    (3) Cumulative limit.
    (4) Return of excess contributions, excess compensation 
contributions, and excess aggregate contributions.
    (5) Restriction of contributors.
    (h) Qualified disability expenses.
    (1) In general.
    (2) Example.
    (i) Separate accounting.
    (j) Program-to-program transfers.
    (k) Carryover of attributes.
    (1) In general.
    (2) Annual contribution limit.

[[Page 289]]

    (3) Investment direction limit.
    (l) Investment direction.
    (m) No pledging of interest as security.
    (n) No sale or exchange.
    (o) Post-death payments.
    (p) Reporting requirements.
    (q) Applicability date.

Sec.  1.529A-3 Tax treatment.

    (a) Taxation of distributions.
    (1) In general.
    (2) Additional period.
    (b) Additional exclusions from gross income.
    (1) Rollover.
    (2) Program-to-program transfers.
    (3) Change of designated beneficiary.
    (4) Payments to creditors post-death.
    (c) Computation of earnings.
    (d) Additional tax on amounts includible in gross income.
    (1) In general.
    (2) Exceptions.
    (e) Tax on excess contributions.
    (f) Filing requirements.
    (g) No inference outside section 529A.
    (h) Applicability date.

Sec.  1.529A-4 Gift, estate, and generation-skipping transfer taxes.

    (a) Contributions.
    (1) In general.
    (2) Generation-skipping transfer (GST) tax.
    (3) Designated beneficiary as contributor.
    (b) Distributions.
    (c) Transfer to another designated beneficiary.
    (d) Transfer tax on death of designated beneficiary.
    (e) Applicability date.

Sec.  1.529A-5 Reporting of the establishment of and contributions to an 
          ABLE account.

    (a) In general.
    (b) Additional definitions.
    (1) Filer.
    (2) TIN.
    (c) Requirement to file return.
    (1) Form of return.
    (2) Information included on return.
    (3) Time and manner of filing return.
    (d) Requirement to furnish statement.
    (1) In general.
    (2) Time and manner of furnishing statement.
    (3) Copy of Form 5498-QA.
    (e) Request for TIN of designated beneficiary.
    (f) Penalties.
    (1) Failure to file return.
    (2) Failure to furnish TIN.
    (g) Applicability date.

Sec.  1.529A-6 Reporting of distributions from and termination of an 
          ABLE account.

    (a) In general.
    (b) Requirement to file return.
    (1) Form of return.
    (2) Information included on return.
    (3) Information excluded.
    (4) Time and manner of filing return.
    (c) Requirement to furnish statement.
    (1) In general.
    (2) Time and manner of furnishing statement.
    (3) Copy of Form 1099-QA.
    (d) Request for TIN of contributor(s).
    (1) In general.
    (2) Exception.
    (e) Penalties.
    (1) Failure to file return.
    (2) Failure to furnish TIN.
    (f) Applicability date.

Sec.  1.529A-7 Electronic furnishing of statements to designated 
          beneficiaries and contributors.

    (a) Electronic furnishing of statements.
    (1) In general.
    (2) Consent.
    (3) Required disclosures.
    (4) Format.
    (5) Notice.
    (6) Access period.
    (b) Applicability date.

Sec.  1.529A-8 Applicability dates and transition relief.

    (a) Applicability dates.
    (b)Transition relief.
    (1) In general.
    (2) Transition period.
    (3) Compliance after transition period.



Sec.  1.529A-1  Exempt status of qualified ABLE program and definitions.

    (a) In general. A qualified ABLE program described in section 529A 
is exempt from Federal income tax, except for the tax imposed under 
section 511 on any unrelated business taxable income of that program. 
See Sec.  1.511-2(e).
    (b) Definitions. For purposes of section 529A, this section and 
Sec. Sec.  1.529A-2 through 1.529A-8--
    (1) ABLE account means an account established under a qualified ABLE 
program and owned by the designated beneficiary of that account.
    (2) Contribution means any payment directly allocated to an ABLE 
account for the benefit of a designated beneficiary, including amounts 
transferred to an ABLE account between December 22, 2017, and January 1, 
2026, from a qualified tuition program described in section 529.
    (3) Designated beneficiary means the individual for whom the account 
was established at a time when he or she was an eligible individual or 
who has succeeded the former designated beneficiary in that capacity 
(successor designated beneficiary). The designated

[[Page 290]]

beneficiary is the owner of the ABLE account. If the designated 
beneficiary is not able to exercise signature authority over his or her 
ABLE account or chooses to have an ABLE account established but not to 
exercise signature authority, references to the designated beneficiary 
with respect to his or her actions include actions by the person with 
signature authority over the account. See Sec.  1.529A-2(c)(1) and (2).
    (4) Disability certification means a certification to establish a 
certain level of an individual's physical or mental impairment that 
meets the requirements described in Sec.  1.529A-2(e).
    (5) Distribution means any payment from an ABLE account. However, a 
program-to-program transfer, a Medicaid reimbursement under Sec.  
1.529A-2(o), or a payment of administrative or investment fees charged 
by a qualified ABLE program is not a distribution.
    (6) Earnings attributable to an ABLE account are the excess of the 
total account balance on a particular date over the investment in the 
account as of that date.
    (7) Earnings ratio as applied to a particular distribution means the 
amount of earnings attributable to the ABLE account as of the date of 
the distribution, divided by the total account balance on that same 
date.
    (8) Eligible individual for a taxable year means an individual who 
either:
    (i) Is receiving benefits under title II or XVI of the Social 
Security Act based on blindness or disability or whose entitlement to 
such benefits under title XVI has been suspended solely due to excess 
income or resources, provided that such blindness or disability occurred 
before the date on which the individual attained age 26 (and, for this 
purpose, an individual is deemed to attain age 26 on his or her 26th 
birthday); or
    (ii) Is the subject of a disability certification filed with the 
Secretary of the Treasury or his delegate (Secretary) for that taxable 
year.
    (9) Excess contribution means the amount by which the amount 
contributed during the taxable year of the designated beneficiary to an 
ABLE account exceeds the limit in effect under section 2503(b) for the 
calendar year in which the taxable year of the designated beneficiary 
begins.
    (10) Excess aggregate contribution means--
    (i) The amount contributed during the taxable year of the designated 
beneficiary that causes the total of amounts contributed since the 
establishment of the ABLE account (or of an ABLE account for the same 
designated beneficiary that was rolled into the current ABLE account) to 
exceed the limit in effect under section 529(b)(6); or
    (ii) In the context of the safe harbor in Sec.  1.529A-2(g)(3), the 
amount contributed that causes the account balance to exceed the limit 
in effect under section 529(b)(6).
    (11) Investment in the account means--
    (i) The sum of all contributions made to the ABLE account, reduced 
by the aggregate amount of contributions included in distributions, if 
any, made from the account; or
    (ii) In the case of a rollover contribution into an ABLE account, 
the amount of the rollover contribution that constituted the amount 
described in paragraph (b)(11)(i) of this section with respect to the 
ABLE account from which the rollover contribution was made.
    (12) Member of the family means a sibling, whether by blood or by 
adoption, and includes a brother, sister, stepbrother, stepsister, half-
brother, and half-sister.
    (13) Program-to-program transfer means--
    (i) The direct transfer of the entire balance of an ABLE account 
into an ABLE account of the same designated beneficiary after which the 
transferor ABLE account is closed upon completion of the transfer; or
    (ii) The direct transfer of part or all of the balance to an ABLE 
account of another eligible individual who is a member of the family of 
the former designated beneficiary.
    (14) Qualified ABLE program means a program established and 
maintained by a State, or agency or instrumentality of a State, under 
which an ABLE account may be established by and for the benefit of the 
account's designated

[[Page 291]]

beneficiary who is an eligible individual, and that meets the 
requirements described in Sec.  1.529A-2.
    (15) Qualified disability expenses means any expenses incurred at a 
time when the designated beneficiary is an eligible individual that 
relate to the blindness or disability of the designated beneficiary of 
an ABLE account, including expenses that are for the benefit of the 
designated beneficiary in maintaining or improving his or her health, 
independence, or quality of life. See Sec.  1.529A-2(h). However, any 
expenses incurred at a time when a designated beneficiary is neither 
disabled nor blind within the meaning of Sec.  1.529A-1(b)(8)(i) or 
Sec.  1.529A-2(e)(1)(i), even if the designated beneficiary is an 
eligible individual for that entire taxable year, do not relate to 
blindness or disability and therefore are not qualified disability 
expenses.
    (16) Rollover means a contribution to an ABLE account of a 
designated beneficiary (or of an eligible individual who is a member of 
the family of the designated beneficiary) of all or a portion of an 
amount distributed from the designated beneficiary's ABLE account, 
provided the contribution is made within 60 days of the date of the 
withdrawal and, in the case of a rollover to the designated 
beneficiary's ABLE account, no rollover has been made to an ABLE account 
of the designated beneficiary within the 12 month period immediately 
preceding the rollover to the ABLE account.
    (c) Applicability date. This section applies to calendar years 
beginning on or after January 1, 2021. See Sec.  1.529A-8 for the 
provision of transition relief.



Sec.  1.529A-2  Qualified ABLE program.

    (a) In general. A qualified ABLE program is a program established 
and maintained by a State, or an agency or instrumentality of a State, 
that satisfies all of the requirements of this section and under which--
    (1) An ABLE account may be established for the purpose of meeting 
the qualified disability expenses of the designated beneficiary of the 
account;
    (2) A designated beneficiary is limited to only one ABLE account at 
a time except as otherwise provided in paragraph (c)(3) of this section;
    (3) Any person may make contributions to such an ABLE account, 
subject to the limitations described in paragraph (g) of this section; 
and
    (4) Distributions (other than returns of contributions as described 
in paragraph (g)(4) of this section) may be made only to or for the 
benefit of the designated beneficiary of the ABLE account.
    (b) Established and maintained by a State or agency or 
instrumentality of a State--(1) Established. A program is established by 
a State or its agency or instrumentality if the program is initiated by 
State statute or regulation or by an act of a State official or agency 
with the authority to act on behalf of the State.
    (2) Maintained--(i) In general. A program is maintained by a State 
or an agency or instrumentality of a State if--
    (A) The State or its agency or instrumentality sets all of the terms 
and conditions of the program, including but not limited to who may 
contribute to the program, who may be a designated beneficiary of the 
program, and what benefits the program may provide; and
    (B) The State or its agency or instrumentality is actively involved 
on an ongoing basis in the administration of the program, including 
supervising the implementation of decisions relating to the investment 
of assets contributed under the program. Factors that are relevant in 
determining whether a State or its agency or instrumentality is actively 
involved in the administration of the program include, but are not 
limited to: Whether the State or its agency or instrumentality provides 
services to designated beneficiaries that are not provided to persons 
who are not designated beneficiaries; whether the State or its agency or 
instrumentality establishes detailed operating rules for administering 
the program; whether officials of the State or its agency or 
instrumentality play a substantial role in the operation of the program, 
including selecting, supervising, monitoring, auditing, and terminating 
the relationship with any private contractors that provide services 
under the program; whether the State or its agency or instrumentality 
holds

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the private contractors that provide services under the program to the 
same standards and requirements that apply when private contractors 
handle funds that belong to the State or its agency or instrumentality 
or provide services to the State or its agency or instrumentality; 
whether the State or its agency or instrumentality provides funding for 
the program; and whether the State or its agency or instrumentality acts 
as trustee or holds program assets directly or for the benefit of the 
designated beneficiaries. For example, if the State or its agency or 
instrumentality exercises the same authority over the funds invested in 
the program as it does over the investments in or pool of funds of a 
State employees' defined benefit pension plan, then the State or its 
agency or instrumentality will be considered actively involved on an 
ongoing basis in the administration of the program.
    (ii) Multiple States, agencies, or instrumentalities. A program may 
be maintained by two or more States or the agencies or instrumentalities 
of two or more States if the program meets the requirements of paragraph 
(b)(2)(i) of this section for each of the States represented. If a State 
or an agency or instrumentality of a State participates in such a 
consortium of States or agencies or instrumentalities of States, the 
consortium's program is considered to be the program of each State 
represented.
    (3) Community Development Financial Institutions (CDFIs). In 
addition to having the ability to contract with private contractors as 
provided in paragraph (b)(2)(i)(B) of this section, a State or its 
agency or instrumentality or qualified ABLE program may contract with 
one or more Community Development Financial Institutions (CDFIs) (as 
defined in 12 U.S.C. 4702(5) and 12 CFR 1805.104) to perform some or all 
of the services described in paragraphs (b)(2)(i)(A) and (B) of this 
section.
    (c) Establishment of an ABLE account and signature authority--(1) 
Establishment of the ABLE account--(i) In general. A qualified ABLE 
program must provide that an ABLE account may be established only for an 
eligible individual.
    (A) The ABLE account may be established by the eligible individual;
    (B) The ABLE account may be established by a person selected by the 
eligible individual; or
    (C) If an eligible individual (whether a minor or adult) is unable 
to establish his or her own ABLE account, an ABLE account may be 
established on behalf of the eligible individual by the eligible 
individual's agent under a power of attorney or, if none, by a 
conservator or legal guardian, spouse, parent, sibling, grandparent of 
the eligible individual, or a representative payee appointed for the 
eligible individual by the Social Security Administration (SSA), in that 
order.
    (ii) Authority. A qualified ABLE program may accept a certification, 
made under penalties of perjury, from the person seeking to establish an 
ABLE account as to the basis for the person's authority to establish the 
ABLE account, and that there is no other person with a higher priority, 
under paragraphs (c)(1)(i)(A), (B), and (C) of this section, to 
establish the ABLE account.
    (2) Signature authority--(i) Signatory. In general, the designated 
beneficiary will have signature authority over his or her ABLE account. 
However, if an individual other than the designated beneficiary 
establishes the account in accordance with paragraph (c)(1)(i)(B) or (C) 
of this section, such individual will have signature authority.
    (A) At any time, the designated beneficiary may remove and replace 
any person with signature authority over the designated beneficiary's 
ABLE account. The replacement may be the designated beneficiary or any 
other person selected by the designated beneficiary.
    (B) The designated beneficiary may designate a successor to the 
person with signature authority. In the absence of any designation of a 
successor by the designated beneficiary, a person with signature 
authority over the designated beneficiary's ABLE account may designate a 
successor, consistent with the ordering rules in paragraph (c)(1)(i)(C) 
of this section.
    (ii) Co-signatories. A qualified ABLE program may permit an ABLE 
account to have co-signatories, consistent with

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paragraph (c)(1)(i)(C) of this section. If co-signatories are permitted, 
all of the other provisions of this paragraph (c)(2) continue to apply, 
and references to the signatory refer to the co-signatories acting 
separately or jointly, as determined by that qualified ABLE program.
    (iii) Authority over sub-accounts. The person with signature 
authority over the ABLE account may appoint and from time to time may 
remove, replace, or name a successor for any person with signature 
authority over a sub-account described in paragraph (c)(3)(iii) of this 
section.
    (3) Only one ABLE account--(i) In general. Except as provided in 
paragraph (c)(3)(ii) of this section, a designated beneficiary is 
limited to one ABLE account at a time, regardless of where located. To 
ensure that this requirement is met, a qualified ABLE program must 
obtain a verification, signed under penalties of perjury by the person 
establishing the ABLE account, that the individual establishing the ABLE 
account neither knows nor has reason to know that the eligible 
individual already has an existing ABLE account (other than an ABLE 
account that will terminate with the rollover or program-to-program 
transfer of its assets into the new ABLE account) before that program 
can permit the establishment of an ABLE account for that eligible 
individual. In the case of a rollover, the ABLE account from which 
amounts were distributed must be closed as of the 60th day after the 
date of the distribution in order to allow the account receiving the 
rollover to be treated as an ABLE account.
    (ii) Treatment of additional accounts. If an individual is the 
designated beneficiary of an ABLE account established in accordance with 
paragraph (c)(1) of this section, no other account subsequently 
established for that individual under a qualified ABLE program 
(additional account) will be an ABLE account. The preceding sentence 
does not apply to an additional account, and that additional account is 
an ABLE account, if--
    (A) The additional account is established for the purpose of 
receiving a rollover or program-to-program transfer;
    (B) All of the contributions to the additional account are returned 
in accordance with the rules that apply to the return of excess 
contributions and excess aggregate contributions under paragraph (g)(4) 
of this section; or
    (C) All amounts in the additional account are transferred to the 
designated beneficiary's preexisting ABLE account and any excess 
contributions and excess aggregate contributions are returned in 
accordance with the rules that apply to the return of excess 
contributions and excess aggregate contributions under paragraph (g)(4) 
of this section.
    (iii) Sub-accounts. A qualified ABLE program may establish an ABLE 
account (primary account) that may include multiple sub-accounts. The 
person with signature authority over the ABLE account, at any time and 
from time to time, may create one or more sub-accounts, may transfer 
funds in the ABLE account to one or more of the sub-accounts, and may 
close one or more of the sub-accounts, to facilitate the acquisition of 
certain goods or services for the designated beneficiary. Each sub-
account may have a different person with signature authority over that 
sub-account, appointed in accordance with the rules of paragraph 
(c)(2)(iii) of this section, and that person's authority is limited to 
making distributions from that sub-account. The primary account and the 
sub-accounts collectively constitute a single ABLE account and therefore 
must be aggregated for all purposes, including without limitation the 
limit on the number of permissible changes in investment direction under 
paragraph (l) of this section, the contribution limits under paragraphs 
(g)(2) and (3) of this section, the computation of gross income and 
other tax provisions, and the reporting requirements.
    (iv) Investment options. A qualified ABLE program may offer 
different investment options within each ABLE account without violating 
the only-one-ABLE-account rule in this paragraph (c)(3). For example, an 
ABLE account may include a cash fund as well as one or more stock or 
bond funds.
    (4) Beneficial interest. A person other than the designated 
beneficiary with

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signature authority over the ABLE account of the designated beneficiary 
may neither have nor acquire any beneficial interest in the ABLE account 
during the lifetime of the designated beneficiary and must administer 
the ABLE account for the benefit of the designated beneficiary of the 
account.
    (d) Eligible individual--(1) Documentation--(i) In general. Whether 
an individual is an eligible individual is determined for each taxable 
year of that individual, and that determination applies for the entire 
year. A qualified ABLE program must specify the documentation that an 
individual must provide, both at the time an ABLE account is established 
and thereafter, in order to ensure that the designated beneficiary of 
the ABLE account is, and continues to be, determined an eligible 
individual. For purposes of determining whether an individual is an 
eligible individual, a disability certification as described in 
paragraph (e)(1) of this section will be deemed to be filed with the 
Secretary once the qualified ABLE program has received the disability 
certification or a disability certification has been deemed to have been 
received under the rules of the qualified ABLE program, which 
information the qualified ABLE program will file in accordance with the 
filing requirements under Sec.  1.529A-5(c)(2)(iv).
    (ii) Safe harbor. A qualified ABLE program may establish that an 
individual is an eligible individual if the person establishing the ABLE 
account certifies under penalties of perjury--
    (A) The basis for the individual's status as an eligible individual 
(entitlement to benefits based on blindness or disability under title II 
or XVI of the Social Security Act, or a disability certification 
described in paragraph (e)(1) of this section);
    (B) That the individual is blind or has a medically determinable 
physical or mental impairment as described in paragraph (e)(1)(i) of 
this section;
    (C) That such blindness or disability occurred before the date on 
which the individual attained age 26 (and, for this purpose, an 
individual is deemed to attain age 26 on his or her 26th birthday);
    (D) If the basis of the individual's eligibility is a disability 
certification, that the individual has received and agrees to retain a 
written diagnosis as described in paragraph (e)(1)(iii) of this section, 
accompanied by the name and address of the diagnosing physician and the 
date of the written diagnosis;
    (E) The applicable diagnostic code from those listed on Form 5498-QA 
(or in the instructions to such form) identifying the type of the 
individual's impairment;
    (F) That the person establishing the account is the individual who 
will be the designated beneficiary of the account or is the person 
authorized under paragraph (c)(1)(i) of this section to establish the 
account; and
    (G) If required by the qualified ABLE program, the information 
provided by the diagnosing physician as to the categorization of the 
disability that may be used to determine, under the particular State's 
program, the appropriate frequency of required recertifications.
    (2) Frequency of recertification--(i) In general. A determination of 
eligibility must be made annually unless the qualified ABLE program 
adopts a different method of ensuring a designated beneficiary's 
continuing status as an eligible individual. Alternative methods may 
include, without limitation, the use of certifications by the designated 
beneficiary under penalties of perjury, and the imposition of different 
recertification frequencies for different types of impairments.
    (ii) Considerations. In developing its rules on recertification, a 
qualified ABLE program may take into consideration whether an impairment 
is incurable and, if so, the likelihood that a cure may be found in the 
future. For example, a qualified ABLE program may provide that the 
initial certification will be deemed to be valid for a stated number of 
years, which may vary with the type of impairment. Even if the qualified 
ABLE program imposes an enforceable obligation on the designated 
beneficiary or other person with signature authority over the ABLE 
account to promptly report changes in the designated beneficiary's 
condition that would result in the designated beneficiary's failing to 
satisfy the definition of an eligible individual, the designated 
beneficiary will be considered an eligible individual until the

[[Page 295]]

end of the taxable year in which the change in the designated 
beneficiary's condition occurred. A qualified ABLE program that is 
compliant with the rules regarding recertification will not be 
considered to be noncompliant solely because a designated beneficiary 
fails to comply with this enforceable obligation.
    (3) Loss of qualification as an eligible individual. If the 
designated beneficiary of an ABLE account ceases to be an eligible 
individual, then for each taxable year in which the designated 
beneficiary is not an eligible individual, the account will continue to 
be an ABLE account, the designated beneficiary will continue to be the 
designated beneficiary of the ABLE account (and will be referred to as 
such), and the ABLE account will not be deemed to have been distributed. 
However, beginning on the first day of the designated beneficiary's 
first taxable year for which the designated beneficiary does not satisfy 
the definition of an eligible individual, additional contributions to 
the designated beneficiary's ABLE account must not be accepted by the 
qualified ABLE program. In addition, no expense incurred at a time when 
a designated beneficiary is neither disabled nor blind within the 
meaning of Sec.  1.529A-1(b)(8)(i) or Sec.  1.529A-2(e)(1)(i), whichever 
had applied, is a qualified disability expense even if the individual is 
an eligible individual for the rest of the year under paragraph 
(d)(1)(i) of this section. If the designated beneficiary subsequently 
again satisfies the definition of an eligible individual, contributions 
to the designated beneficiary's ABLE account again may be accepted, 
subject to the contribution limits under section 529A, and expenses that 
are incurred thereafter may meet the definition of a qualified 
disability expense in Sec.  1.529A-1(b)(15) and paragraph (h) of this 
section.
    (e) Disability certification--(1) In general. Except as provided in 
paragraph (e)(3) of this section or in additional guidance described in 
paragraph (e)(4) of this section, a disability certification with 
respect to an individual, that will be deemed filed with the Secretary 
as provided in paragraph (d)(1)(i) of this section, and is deemed 
satisfactory to the Secretary, is a certification signed under penalties 
of perjury by the individual, or by another individual establishing the 
ABLE account for the individual, that--
    (i) Certifies that the individual--
    (A) Has a medically determinable physical or mental impairment that 
results in marked and severe functional limitations (as defined in 
paragraph (e)(2) of this section), and that--
    (1) Can be expected to result in death; or
    (2) Has lasted or can be expected to last for a continuous period of 
not less than 12 months; or
    (B) Is blind (within the meaning of section 1614(a)(2) of the Social 
Security Act);
    (ii) Certifies that such blindness or disability occurred before the 
date on which the individual attained age 26 (and, for this purpose, an 
individual is deemed to attain age 26 on his or her 26th birthday); and
    (iii) Includes a certification that the individual has obtained and 
will continue to retain a copy of the individual's diagnosis relating to 
the individual's relevant impairment or impairments, signed by a 
physician meeting the criteria of section 1861(r)(1) of the Social 
Security Act (42 U.S.C. 1395x(r)) and including the name and address of 
the diagnosing physician and the date of the diagnosis.
    (2) Marked and severe functional limitations. For purposes of 
paragraph (e)(1) of this section, the phrase marked and severe 
functional limitations means the standard of disability in the Social 
Security Act for children claiming Supplemental Security Income for the 
Aged, Blind, and Disabled (SSI) benefits based on disability (see 20 CFR 
416.906), but without regard to age or to whether the individual engages 
in substantial gainful activity. Specifically, this is a level of 
severity that meets, medically equals, or functionally equals the 
severity of any listing in appendix 1 of subpart P of 20 CFR part 404. 
See 20 CFR 416.906, 416.924 and 416.926a. Such phrase also includes any 
impairment or standard of disability identified in future guidance 
published in the Internal Revenue Bulletin (see

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Sec.  601.601(d)(2) of this chapter). Consistent with the regulations 
promulgated by the SSA, the level of severity is determined by taking 
into account the effect of the individual's prescribed treatment. See 20 
CFR 416.930.
    (3) Compassionate allowance list. Conditions listed in the ``List of 
Compassionate Allowances Conditions'' maintained by the SSA are deemed 
to meet the requirements of section 529A(e)(1)(B) regarding the filing 
of a disability certification, if the condition was present and produced 
marked and severe functional limitations before the date on which the 
individual attained age 26. To establish that an individual with such a 
condition satisfies the definition of an eligible individual, the 
individual must identify the condition and certify to the qualified ABLE 
program both the presence of the condition and its resulting marked and 
severe functional limitations prior to age 26, in a manner specified by 
the qualified ABLE program.
    (4) Additional guidance. Additional guidance on conditions deemed to 
meet the requirements of section 529A(e)(1)(B) may be identified in 
future guidance published in the Internal Revenue Bulletin. See Sec.  
601.601(d)(2) of this chapter.
    (5) Restriction on use of certification. No inference may be drawn 
from a disability certification described in this paragraph (e) for 
purposes of establishing eligibility for benefits under title II, XVI, 
or XIX of the Social Security Act.
    (f) Change of designated beneficiary--(1) In general. A qualified 
ABLE program must permit a change in the designated beneficiary of an 
ABLE account made during the life of the designated beneficiary. At the 
time when the change becomes effective, the successor designated 
beneficiary must be an eligible individual. However, a qualified ABLE 
program may limit the change in designated beneficiary to a member of 
the family as defined in Sec.  1.529A-1(b)(12) of the current designated 
beneficiary.
    (2) Change effective upon death. A qualified ABLE program may permit 
a change in the designated beneficiary of an ABLE account, made during 
the life of the designated beneficiary, to take effect upon the death of 
the designated beneficiary. The amount to be transferred pursuant to 
such a beneficiary designation is first subject to the payment of any 
qualified disability expenses incurred before the designated 
beneficiary's death but not yet paid and those described in paragraph 
(o) of this section, and is subject to the provisions of Sec.  1.529A-4.
    (g) Contributions--(1) Permissible property. Except in the case of a 
program-to-program transfer or a change in designated beneficiary to a 
new designated beneficiary who is an eligible individual and a member of 
the family of the former designated beneficiary, contributions to an 
ABLE account may be made only in cash. A qualified ABLE program may 
allow cash contributions to be made in the form of a check, money order, 
credit card, electronic transfer, after-tax payroll deduction, or 
similar method.
    (2) Annual contributions limit--(i) In general. Except as provided 
in paragraph (g)(2)(ii) of this section, a qualified ABLE program must 
provide that no contribution to an ABLE account will be accepted to the 
extent such contribution, when added to all other contributions (whether 
from the designated beneficiary or one or more other persons) to that 
ABLE account made during the designated beneficiary's taxable year 
causes the total of such contributions during that year to exceed the 
amount in effect under section 2503(b) for the calendar year in which 
the designated beneficiary's taxable year begins. See paragraph (k)(2) 
of this section for purposes of applying the rules in this paragraph 
(g)(2) to rollovers, program-to-program transfers, and designated 
beneficiary changes.
    (ii) Additional contributions by an employed designated 
beneficiary--(A) In general. An employed designated beneficiary defined 
in paragraph (g)(2)(iii)(A) of this section may contribute amounts up to 
the limit specified in paragraph (g)(2)(ii)(B) of this section in 
addition to the amount specified in paragraph (g)(2)(i) of this section. 
Although a designated beneficiary's contributions subject to this 
compensation income limit do not have

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to be made from that compensation income, any contribution of the 
designated beneficiary's compensation income made directly by the 
designated beneficiary's employer is a contribution made by the 
designated beneficiary. Once the designated beneficiary has made 
contributions equal to the limit described in paragraph (g)(2)(ii)(B) of 
this section, additional contributions by the designated beneficiary may 
be made if permissible under paragraph (g)(2)(i) of this section.
    (B) Amount of additional permissible contribution. Any additional 
contribution made by the designated beneficiary pursuant to paragraph 
(g)(2)(ii)(A) of this section is limited to the lesser of--
    (1) The designated beneficiary's compensation as defined by section 
219(f)(1) for the taxable year; or
    (2) An amount equal to the applicable poverty line, as defined in 
paragraph (g)(2)(iii)(B) of this section, for a one-person household for 
the calendar year preceding the calendar year in which the designated 
beneficiary's taxable year begins.
    (iii) Additional definitions. In addition to the definitions in 
Sec.  1.529A-1(b), the following definitions also apply for the purposes 
of this section--
    (A) Employed designated beneficiary means a designated beneficiary 
who is an employee (including an employee within the meaning of section 
401(c)), with respect to whom no contribution is made for the taxable 
year to--
    (1) A defined contribution plan (within the meaning of section 
414(i)) with respect to which the requirements of sections 401(a) or 
403(a) are met;
    (2) An annuity contract described in section 403(b); and
    (3) An eligible deferred compensation plan described in section 
457(b).
    (B) Applicable poverty line means the amount provided in the poverty 
guidelines updated periodically in the Federal Register by the U.S. 
Department of Health and Human Services under the authority of 42 U.S.C. 
9902(2) for the State of residence of the employed designated 
beneficiary. If the designated beneficiary lives in more than one State 
during the taxable year, the applicable poverty line is the poverty line 
for the State in which the designated beneficiary resided longer than in 
any other State during that year.
    (C) Excess compensation contribution means the amount by which the 
amount contributed during the taxable year of an employed designated 
beneficiary to the designated beneficiary's ABLE account exceeds the 
limit in effect under section 529A(b)(2)(B)(ii) and paragraph 
(g)(2)(ii)(B) of this section for the calendar year in which the taxable 
year of the employed designated beneficiary begins.
    (iv) Example. The provisions of paragraph (g)(2)(ii) of this section 
may be illustrated by the following example: In 2020, A, an employed 
designated beneficiary as defined in paragraph (g)(2)(iii)(A) of this 
section, lives in Hawaii. A's compensation, as defined by section 
219(f)(1), for 2020 is $20,000. The poverty line for a one-person 
household in Hawaii was $14,380 in 2019. Because A's compensation 
exceeded the applicable poverty line amount, A's additional permissible 
contribution in 2019 is limited to $14,380, the amount of the 2019 
applicable poverty line.
    (v) Ensuring contribution limit is met--(A) Responsibility. The 
employed designated beneficiary, or the person acting on his or her 
behalf, is solely responsible for ensuring that the requirements in 
section 529A(b)(2)(B)(ii) and paragraph (g)(2)(ii) of this section are 
met and for maintaining adequate records for that purpose.
    (B) Certification. A qualified ABLE program may allow a designated 
beneficiary (or the person acting on his or her behalf) to certify, 
under penalties of perjury, and in the manner specified by the qualified 
ABLE program that--
    (1) The designated beneficiary is an employed designated 
beneficiary; and
    (2) The designated beneficiary's contributions of compensation are 
not excess compensation contributions.
    (3) Cumulative limit--(i) In general. A qualified ABLE program must 
provide adequate safeguards to prevent aggregate contributions on behalf 
of a designated beneficiary in excess of the limit established by that 
State under section 529(b)(6). For purposes of the preceding sentence, 
aggregate contributions on behalf of a designated beneficiary include 
contributions to

[[Page 298]]

any prior ABLE account maintained by any State or its agency or 
instrumentality for the same designated beneficiary, or any former 
designated beneficiary to the extent his or her ABLE account funds were 
transferred to the designated beneficiary's ABLE account. The transfer 
of a designated beneficiary's ABLE account from one qualified ABLE 
program to another with a lower cumulative limit will not violate this 
rule, but qualified ABLE programs must prohibit subsequent contributions 
under this general rule. For purposes of this paragraph (g)(3), 
contributions do not include rollovers, program-to-program transfers or 
a designated beneficiary change to a new designated beneficiary who is 
an eligible individual and member of the family of the former designated 
beneficiary as defined in Sec.  1.529A-1(b)(12).
    (ii) Safe harbor. A qualified ABLE program maintained by a State or 
its agency or instrumentality satisfies the requirement under section 
529A(b)(6) if it refuses to accept any additional contribution to an 
ABLE account (except as provided to the contrary in paragraph (g)(3)(i) 
of this section) while the balance in that account equals or exceeds the 
limit established by that State under section 529(b)(6). Nevertheless, 
without regard to the categories of transfers that caused the account 
balance to exceed the State limit, once the account balance falls below 
that limit, additional contributions, subject to the annual 
contributions limit under paragraph (g)(2) of this section and the limit 
established by such State under section 529(b)(6), again may be 
accepted.
    (4) Return of excess contributions, excess compensation 
contributions, and excess aggregate contributions. If an excess 
contribution as defined in Sec.  1.529A-1(b)(9), an excess compensation 
contribution as defined in paragraph (g)(2)(iii)(C) of this section, or 
an excess aggregate contribution as defined in Sec.  1.529A-1(b)(10) is 
deposited into or allocated to the ABLE account of a designated 
beneficiary, a qualified ABLE program must return that excess 
contribution, excess compensation contribution, or excess aggregate 
contribution, including all net income attributable to that 
contribution, as determined under the rules set forth in Sec.  1.408-11 
(treating references to an IRA as references to an ABLE account and 
references to returned contributions under section 408(d)(4) as 
references to excess contributions or excess aggregate contributions), 
to the person or persons who made that contribution. Each excess 
contribution, excess compensation contribution, and excess aggregate 
contribution must be returned to its contributor(s) on a last-in-first-
out basis until the entire excess, along with all net income 
attributable to such excess, has been returned. In the case of an excess 
compensation contribution, the employed designated beneficiary, or the 
person acting on the employed designated beneficiary's behalf, is 
responsible for identifying any excess compensation contribution and for 
requesting the return of the excess compensation contribution. Returned 
contributions must be received by the contributor(s) on or before the 
due date (including extensions) of the Federal income tax return of the 
designated beneficiary for the taxable year in which the excess 
contribution or excess aggregate contribution was made. See Sec.  
1.529A-3(a) for Federal income tax considerations for the 
contributor(s). If an excess contribution or excess aggregate 
contribution and the net income attributable to the excess contribution 
or excess aggregate contribution are returned to a contributor other 
than the designated beneficiary, the qualified ABLE program must notify 
the designated beneficiary of such return at the time of the return. No 
notification is required if amounts are rejected by the qualified ABLE 
program before they are deposited into or allocated to the designated 
beneficiary's ABLE account.
    (5) Restriction of contributors. A qualified ABLE program may allow 
the designated beneficiary, from time to time, to restrict who may make 
contributions to the designated beneficiary's ABLE account.
    (h) Qualified disability expenses--(1) In general. Qualified 
disability expenses are expenses incurred that relate to the blindness 
or disability of the designated beneficiary of the ABLE account and are 
for the benefit of that designated beneficiary in maintaining

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or improving his or her health, independence, or quality of life. See 
Sec.  1.529A-1(b)(15). Such expenses include, but are not limited to, 
expenses related to the designated beneficiary's education, housing, 
transportation, employment training and support, assistive technology 
and related services, personal support services, health, prevention and 
wellness, financial management and administrative services, legal fees, 
expenses for oversight and monitoring, and funeral and burial expenses, 
as well as other expenses that may be identified from time to time in 
future guidance published in the Internal Revenue Bulletin. See Sec.  
601.601(d)(2) of this chapter. Qualified disability expenses include 
basic living expenses and are not limited to items for which there is a 
medical necessity or which solely benefit an individual with a 
disability.
    (2) Example. The following example illustrates this paragraph (h): 
B, an individual, has a medically determined mental impairment that 
causes marked and severe limitations on B's ability to navigate and 
communicate. A smart phone would enable B to navigate and communicate 
more safely and effectively, thereby helping B to maintain B's 
independence and to improve B's quality of life. Therefore, the expense 
of buying, using, and maintaining a smart phone that is used by B would 
be a qualified disability expense.
    (i) Separate accounting. A program will not be treated as a 
qualified ABLE program unless it provides separate accounting for each 
ABLE account. Separate accounting requires that contributions for the 
benefit of a designated beneficiary and any earnings attributable 
thereto must be allocated to that designated beneficiary's ABLE account. 
Whether or not a program provides each designated beneficiary an annual 
account statement showing the total account balance, the investment in 
the account, the accrued earnings, and the distributions from the 
account, the program must give this information to the designated 
beneficiary upon request.
    (j) Program-to-program transfers. A qualified ABLE program may 
permit a change of qualified ABLE program or a change of designated 
beneficiary by means of a program-to-program transfer as defined in 
Sec.  1.529A-1(b)(13). In that event, subject to any contrary provisions 
or limitations adopted by the qualified ABLE program, rules similar to 
the rules of Sec.  1.401(a)(31)-1, Q&A-3 and 4 (which apply for purposes 
of a direct rollover from a qualified plan to an eligible retirement 
plan) apply for purposes of determining whether an amount is paid in the 
form of a program-to-program transfer.
    (k) Carryover of attributes--(1) In general. Upon a rollover, 
program-to-program transfer, or change of designated beneficiary, all of 
the attributes of the former ABLE account relevant for purposes of 
calculating the investment in the account are applicable to the 
recipient ABLE account. The portion of the rollover or transfer amount 
that constituted investment in the account from which the distribution 
or transfer was made is added to investment in the recipient ABLE 
account. In addition, the portion of the rollover or transfer amount 
that constituted earnings of the account from which the distribution or 
transfer was made is added to the earnings of the recipient ABLE 
account.
    (2) Annual contribution limit. Upon a rollover or program-to-program 
transfer, for purposes of applying the annual contribution limit under 
paragraph (g)(2) of this section to the transferee account, annual 
contributions to the designated beneficiary's transferor ABLE account 
during the taxable year in which the rollover or program-to-program 
transfer occurs are included. However, upon a change of designated 
beneficiary, or upon a rollover or program-to-program transfer to the 
ABLE account of a different designated beneficiary who is both a member 
of the family as defined in Sec.  1.529A-1(b)(12) and an eligible 
individual, no amounts contributed to the prior designated beneficiary's 
ABLE account are included when applying the annual contribution limit 
under paragraph (g)(2) of this section.

[[Page 300]]

    (3) Investment direction limit. Upon a rollover or program-to-
program transfer, the number of investment directions by the designated 
beneficiary include the number of investment directions made prior to 
the rollover or program-to-program transfer during the same taxable year 
for purposes of paragraph (l) of this section. However, upon a change of 
designated beneficiary, or upon a rollover or program-to-program 
transfer to the ABLE account of a different designated beneficiary who 
is both a member of the family as defined in Sec.  1.529A-1(b)(12) and 
an eligible individual, the number of investment directions made for the 
prior designated beneficiary's ABLE account are not included in 
determining the number of investment directions made for the new 
designated beneficiary's ABLE account in that same year.
    (l) Investment direction. A program will not be treated as a 
qualified ABLE program unless it provides that the designated 
beneficiary of an ABLE account established under such program may 
direct, whether directly or indirectly, the investment of any 
contributions to the program (or any earnings thereon) no more than two 
times in any calendar year. Such an investment direction does not 
include a request to transfer any part of the account balance from an 
investment option to a cash equivalent option to effectuate a 
distribution, or the automatic rebalancing of the assets of an ABLE 
account to maintain the asset allocation level chosen when the account 
was established or by a subsequent investment direction.
    (m) No pledging of interest as security for a loan. A program will 
not be treated as a qualified ABLE program unless the terms of the 
program, or a State statute or regulation that governs the program, 
prohibit any interest in the program or any portion thereof from being 
used as security for a loan. For this purpose, the program 
administrator's advance of funds to satisfy a withdrawal request during 
the period between the sale of an asset in the ABLE account (whose value 
is sufficient to satisfy the withdrawal request) and the clearing or 
settlement of that sale, does not constitute a loan, pledge, or grant of 
security for a loan. Similarly, the use of checking accounts or debit 
cards to facilitate a qualified ABLE program's ability to make 
distributions will not be treated as a pledge or grant of security for a 
loan during the period between the use of the check or debit card and 
the clearing or settlement of that transaction, provided that the ABLE 
program does not advance funds to a designated beneficiary in excess of 
the amount in the designated beneficiary's ABLE account.
    (n) No sale or exchange. A qualified ABLE program must ensure that 
no interest in an ABLE account may be sold or exchanged.
    (o) Post-death payments. A qualified ABLE program must provide that 
a portion or all of the balance remaining in the ABLE account of a 
deceased designated beneficiary must be distributed to a State that 
files a claim against the designated beneficiary or the ABLE account 
itself with respect to benefits provided to the designated beneficiary 
under that State's Medicaid plan established under title XIX of the 
Social Security Act. The payment of such claim (if any) will be made 
only after providing for the payment from the designated beneficiary's 
ABLE account of the designated beneficiary's funeral and burial expenses 
(including the unpaid balance of a pre-death contract for those 
services) and all outstanding payments due for his or her other 
qualified disability expenses, and will be limited to the amount of the 
total medical assistance paid for the designated beneficiary after the 
establishment of the ABLE account over the amount of any premiums paid, 
whether from the ABLE account or otherwise by or on behalf of the 
designated beneficiary, to a Medicaid Buy-In program under any such 
State Medicaid plan. The establishment of the ABLE account is the date 
on which the ABLE account was established or, if earlier, the date on 
which was established any ABLE account for the same designated 
beneficiary from which amounts were rolled over or transferred to the 
ABLE account, but in no event earlier than the date on which the 
designated beneficiary became the designated beneficiary of the account 
from which amounts were transferred. After the expiration of the 
applicable statute of

[[Page 301]]

limitations for filing Medicaid claims against the designated 
beneficiary's estate, a qualified ABLE program may distribute the 
balance of the ABLE account to the successor designated beneficiary or, 
if none, to the deceased designated beneficiary's estate. A State law 
prohibiting the filing of such a claim against either the ABLE account 
or the designated beneficiary's estate will not prevent that State's 
program from being a qualified ABLE program.
    (p) Reporting requirements. A qualified ABLE program must comply 
with all applicable reporting requirements, including without limitation 
those described in Sec. Sec.  1.529A-5 through 1.529A-7.
    (q) Applicability date. This section applies to calendar years 
beginning on or after January 1, 2021. See Sec.  1.529A-8 for the 
provision of transition relief.



Sec.  1.529A-3  Tax treatment.

    (a) Taxation of distributions--(1) In general. Each distribution 
from an ABLE account consists of an earnings portion of the account 
(computed in accordance with paragraph (c) of this section) and 
investment in the account. If the total amount distributed from an ABLE 
account to or for the benefit of the designated beneficiary of that ABLE 
account during his or her taxable year does not exceed the qualified 
disability expenses of the designated beneficiary paid during that year, 
no amount distributed is includible in the gross income of the 
designated beneficiary for that year. If the total amount distributed 
from an ABLE account to or for the benefit of the designated beneficiary 
of that ABLE account during his or her taxable year exceeds the 
qualified disability expenses of the designated beneficiary paid during 
that year (regardless of when incurred), the distributions from the ABLE 
account, except to the extent excluded from gross income under this 
section or any other provision of chapter 1 of the Internal Revenue 
Code, must be included in the gross income of the designated beneficiary 
in the manner provided under this section and section 72. The amount to 
be included in gross income is based on the earnings portion of each 
distribution, computed in accordance with paragraph (c) of this section. 
The earnings portion that is includible in gross income is the sum of 
the earnings portion of all distributions made in that year, reduced by 
an amount that bears the same ratio to the total earnings portion as the 
amount of qualified disability expenses paid during the year bears to 
such total distributions during the year. If an excess contribution or 
excess aggregate contribution is returned within the time period 
required in Sec.  1.529A-2(g)(4), any net income distributed is 
includible in the gross income of the contributor(s) in the taxable year 
in which the excess contribution or excess aggregate contribution was 
made.
    (2) Additional period. The designated beneficiary may treat as 
having been paid during the preceding taxable year qualified disability 
expenses paid on or before the 60th day immediately following the end of 
the designated beneficiary's preceding taxable year. Qualified 
disability expenses treated, pursuant to the rule in the preceding 
sentence, as having been paid during the designated beneficiary's 
taxable year immediately prior to the year of their actual payment may 
not be included in the total qualified disability expenses for the year 
in which they were paid.
    (b) Additional exclusions from gross income--(1) Rollover. A 
rollover as defined in Sec.  1.529A-1(b)(16) is not included in gross 
income under paragraph (a) of this section.
    (2) Program-to-program transfers. A program-to-program transfer as 
defined in Sec.  1.529A-1(b)(13) is not a distribution and is not 
included in gross income under paragraph (a) of this section.
    (3) Change of designated beneficiary--(i) In general. A change of 
designated beneficiary of an ABLE account is not treated as a 
distribution for purposes of section 529A, and is not included in gross 
income under paragraph (a) of this section, if the successor designated 
beneficiary is--
    (A) An eligible individual for the taxable year in which the change 
is made; and
    (B) A member of the family (as defined in Sec.  1.529A-1(b)(12)) of 
the former designated beneficiary.
    (ii) Other designated beneficiary changes. In the case of any change 
of

[[Page 302]]

designated beneficiary not described in paragraph (b)(3)(i) of this 
section, the former designated beneficiary of that ABLE account will be 
treated as having received a distribution of the fair market value of 
the assets in that ABLE account on the date on which the change is made 
to the new designated beneficiary.
    (4) Payments to creditors post-death. Distributions made after the 
death of the designated beneficiary in payment of outstanding 
obligations due for qualified disability expenses, as well as the 
funeral and burial expenses of the designated beneficiary, are not 
included in gross income of the designated beneficiary or his or her 
estate. Included among these obligations is the post-death payment of 
any part of a claim filed against the deceased designated beneficiary or 
his or her estate or ABLE account by a State with respect to benefits 
provided to the designated beneficiary under that State's Medicaid plan.
    (c) Computation of earnings. The earnings portion of a distribution 
is equal to the product of the amount of the distribution and the 
earnings ratio, as defined in Sec.  1.529A-1(b)(7). The balance of the 
distribution (the amount of the distribution minus the earnings portion 
of that distribution) is the portion of that distribution that 
constitutes the return of investment in the account.
    (d) Additional tax on amounts includible in gross income--(1) In 
general. If any amount of a distribution from an ABLE account is 
includible in the gross income of a person for any taxable year under 
paragraph (a) of this section (includible amount), the income tax 
imposed on that person by chapter 1 of the Internal Revenue Code will be 
increased by an amount equal to 10 percent of the includible amount.
    (2) Exceptions--(i) Distributions on or after the death of the 
designated beneficiary. Paragraph (d)(1) of this section does not apply 
to any distribution made from the ABLE account on or after the death of 
the designated beneficiary to the estate of the designated beneficiary, 
to an heir or legatee of the designated beneficiary, or to a creditor 
described in paragraph (b)(4) of this section.
    (ii) Returned excess contributions and additional accounts. 
Paragraph (d)(1) of this section does not apply to any return made in 
accordance with Sec.  1.529A-2(g)(4) of an excess contribution as 
defined in Sec.  1.529A-1(b)(9), an excess compensation contribution as 
defined in Sec.  1.529A-2(g)(2)(iii)(C), excess aggregate contribution 
as defined in Sec.  1.529A-1(b)(10), or an additional account as 
referenced in Sec.  1.529A-2(c)(3)(ii)(A), (B), or (C).
    (e) Tax on excess contributions. Under section 4973(h), a 
contribution to an ABLE account in excess of the annual contributions 
limit described in Sec.  1.529A-2(g)(2) is subject to an excise tax in 
an amount equal to 6 percent of the excess contribution. However, any 
the excess contribution or excess compensation contribution as defined 
in Sec.  1.529A-2(g)(2)(iii)(C) returned in accordance with the 
provisions of Sec.  1.529A-2(g)(4) is not treated as a contribution.
    (f) Filing requirements. A qualified ABLE program is not required to 
file Form 990, ``Return of Organization Exempt From Income Tax,'' Form 
1041, ``U.S. Income Tax Return for Estates and Trusts,'' or Form 1120, 
``U.S. Corporation Income Tax Return.'' However, a qualified ABLE 
program is required to file Form 990-T, ``Exempt Organization Business 
Income Tax Return,'' if such filing would be required under the rules of 
Sec. Sec.  1.6012-2(e) and 1.6012-3(a)(5) if the ABLE program were an 
organization described in those sections.
    (g) No inference outside section 529A. The rules provided in this 
section concerning the Federal tax treatment of contributions apply only 
for purposes of the application of section 529A. No inference is 
intended with respect to the application of any other Code provisions or 
Federal tax doctrines. For example, a contribution made by an employer 
to the ABLE account of an employee or an employee's family member is 
subject to the rules governing the Federal taxation of compensation.
    (h) Applicability date. This section applies to calendar years 
beginning on or after January 1, 2021. See Sec.  1.529A-8 for the 
provision of transition relief.

[[Page 303]]



Sec.  1.529A-4  Gift, estate, and generation-skipping transfer taxes.

    (a) Contributions--(1) In general. Each contribution by a person to 
an ABLE account other than by the designated beneficiary of that account 
is treated as a completed gift to the designated beneficiary of the 
account for gift tax purposes. Under the applicable Federal gift tax 
rules, a contribution from a corporation, partnership, trust, estate, or 
other entity is treated as a gift by the shareholders, partners, or 
other beneficial owners in proportion to their respective ownership 
interests in the entity. See Sec.  25.2511-1(c) and (h) of this chapter. 
A gift to an ABLE account is not treated as either a gift of a future 
interest in property, or a qualified transfer under section 2503(e). To 
the extent a contributor's gifts to the designated beneficiary, 
including gifts paid into the designated beneficiary's ABLE account, do 
not exceed the annual limit in section 2503(b), the contribution is not 
a taxable gift. This provision, however, does not change any other 
provision applicable to the transfer. For example, a contribution by the 
employer of the designated beneficiary's parent continues to constitute 
earned income to the parent and then a gift by the parent to the 
designated beneficiary. The timely return of an excess contribution or 
an excess aggregate contribution in accordance with Sec.  1.529A-2(g)(4) 
is not a taxable gift.
    (2) Generation-skipping transfer (GST) tax. To the extent the 
contribution into an ABLE account is a nontaxable gift for Federal gift 
tax purposes, the inclusion ratio for purposes of the GST tax will be 
zero pursuant to section 2642(c)(1).
    (3) Designated beneficiary as contributor. A designated beneficiary 
may make a contribution to fund his or her own ABLE account. That 
contribution is not a gift.
    (b) Distributions. No distribution from an ABLE account to or for 
the benefit of the designated beneficiary is treated as a taxable gift 
to that designated beneficiary.
    (c) Transfer to another designated beneficiary. Neither gift tax nor 
generation-skipping transfer tax applies to the transfer (by rollover, 
program-to-program transfer, or change of beneficiary) of part or all of 
an ABLE account to the ABLE account of a different designated 
beneficiary if the successor designated beneficiary is both an eligible 
individual and a member of the family (as described in Sec.  1.529A-
1(b)(12)) of the designated beneficiary. Any other transfer will 
constitute a gift by the designated beneficiary to the successor 
designated beneficiary, and the usual gift and GST tax rules will apply.
    (d) Transfer tax on death of designated beneficiary. Upon the death 
of the designated beneficiary, the designated beneficiary's ABLE account 
is includible in his or her gross estate for estate tax purposes under 
section 2031. The payment of outstanding qualified disability expenses 
and the payment of certain claims made by a State under its Medicaid 
plan may be deductible for estate tax purposes if the requirements of 
section 2053 are satisfied.
    (e) Applicability date. This section applies to calendar years 
beginning on or after January 1, 2021. See Sec.  1.529A-8 for the 
provision of transition relief.



Sec.  1.529A-5  Reporting of the establishment of and contributions
to an ABLE account.

    (a) In general. A filer defined in paragraph (b)(1) of this section 
must, with respect to each ABLE account--
    (1) File an annual information return, as described in paragraph (c) 
of this section, with the Internal Revenue Service; and
    (2) Furnish an annual statement, as described in paragraph (d) of 
this section, to the designated beneficiary of the ABLE account.
    (b) Additional definitions. In addition to the definitions in Sec.  
1.529A-1(b), the following definitions also apply for purposes of this 
section--
    (1) Filer means the State or its agency or instrumentality that 
establishes and maintains the qualified ABLE program under which an ABLE 
account is established. The filing may be done by either an officer or 
employee of the State or its agency or instrumentality having control of 
the qualified ABLE program, or the officer's or employee's designee.

[[Page 304]]

    (2) TIN means taxpayer identification number as defined in section 
7701(a)(41).
    (c) Requirement to file return--(1) Form of return. For purposes of 
reporting the information described in paragraph (c)(2) of this section, 
the filer must file Form 5498-QA, ``ABLE Account Contribution 
Information,'' or any successor form, together with Form 1096, ``Annual 
Summary and Transmittal of U.S. Information Returns.''
    (2) Information included on return. With respect to each ABLE 
account, the filer must include on the return--
    (i) The name, address, and TIN of the designated beneficiary of the 
ABLE account;
    (ii) The name, address, and TIN of the filer;
    (iii) Information regarding the establishment of the ABLE account, 
as required by the form and its instructions;
    (iv) Information regarding the disability certification or other 
basis for eligibility of the designated beneficiary, as required by the 
form and its instructions. For further information regarding eligibility 
and disability certification, see Sec.  1.529A-2(d) and (e), 
respectively;
    (v) The total amount of any contributions made with respect to the 
ABLE account during the calendar year; such contributions do not include 
any contribution rejected and returned to the contributor before being 
deposited into or allocated to the ABLE account or any excess 
contributions, excess compensation contributions, or excess aggregate 
contributions returned as described in Sec.  1.529A-2(g)(4);
    (vi) The fair market value of the ABLE account as of the last day of 
the calendar year; and
    (vii) Any other information required by the form, its instructions, 
or published guidance. See Sec. Sec.  601.601(d) and 601.602 of this 
chapter.
    (3) Time and manner of filing return--(i) In general. Except as 
provided in paragraph (c)(3)(ii) of this section, the information 
returns required under this paragraph must be filed on or before May 31 
of the year following the calendar year with respect to which the return 
is being filed, in accordance with the forms and their instructions.
    (ii) Extensions of time. See Sec. Sec.  1.6081-1 and 1.6081-8 for 
rules relating to extensions of time to file information returns 
required in this section.
    (iii) Electronic filing. See Sec.  301.6011-2 of this chapter for 
rules relating to electronic filing. See also Instructions for Forms 
1099-QA and 5498-QA, Distributions From ABLE Accounts and ABLE Account 
Contribution Information.
    (iv) Substitute forms. The filer may file the returns required under 
this paragraph (c) on an acceptable substitute form. See Publication 
1179, ``General Rules and Specifications for Substitute Forms 1096, 
1098, 1099, 5498, and Certain Other Information Returns.''
    (d) Requirement to furnish statement--(1) In general. The filer must 
furnish a statement to the designated beneficiary of the ABLE account 
for which it is required to file a Form 5498-QA (or any successor form). 
The statement must include--
    (i) The information required under paragraph (c)(2) of this section;
    (ii) A legend that identifies the statement as important tax 
information that is being furnished to the Internal Revenue Service; and
    (iii) The name and address of the office or department of the filer 
that is the information contact for questions regarding the ABLE account 
to which the Form 5498-QA relates.
    (2) Time and manner of furnishing statement--(i) In general. Except 
as provided in paragraph (d)(2)(ii) of this section, the filer must 
furnish the statement described in paragraph (d)(1) of this section to 
the designated beneficiary on or before March 15 of the year following 
the calendar year with respect to which the statement is being 
furnished. If mailed, the statement must be sent to the designated 
beneficiary's last known address. The statement may be furnished 
electronically, as provided in Sec.  1.529A-7.
    (ii) Extensions of time. The Internal Revenue Service may, at its 
discretion, grant an extension of time to furnish statements required in 
this section.
    (3) Copy of Form 5498-QA. The filer may satisfy the requirement of 
this paragraph (d) by furnishing either a copy of Form 5498-QA (or 
successor form) or an acceptable substitute form. See Publication 1179, 
``General Rules and Specifications for Substitute

[[Page 305]]

Forms 1096, 1098, 1099, 5498, and Certain Other Information Returns.''
    (e) Request for TIN of designated beneficiary. The filer must 
request the TIN of the designated beneficiary at the time the ABLE 
account is established if the filer does not already have a record of 
the designated beneficiary's correct TIN. The filer must clearly notify 
the designated beneficiary that the law requires the designated 
beneficiary to furnish a TIN so that it may be included on an 
information return to be filed by the filer. The designated beneficiary 
may provide his or her TIN in any manner including orally, in writing, 
or electronically. If the TIN is furnished in writing, no particular 
form is required. Form W-9, ``Request for Taxpayer Identification Number 
and Certification,'' may be used, or the request may be incorporated 
into the forms related to the establishment of the ABLE account.
    (f) Penalties--(1) Failure to file return. The section 6693 penalty 
may apply to the filer that fails to file information returns at the 
time and in the manner required by this section, unless it is shown that 
such failure is due to reasonable cause. See section 6693 and Sec.  
301.6693-1 of this chapter.
    (2) Failure to furnish TIN. The section 6723 penalty may apply to 
any designated beneficiary who fails to furnish his or her TIN to the 
filer. See section 6723, and Sec.  301.6723-1 of this chapter, for rules 
relating to the penalty for failure to furnish a TIN.
    (g) Applicability date. The rules of this section apply to 
information returns required to be filed, and payee statements required 
to be furnished, after December 31, 2020. See Sec.  1.529A-8 for the 
provision of transition relief.



Sec.  1.529A-6  Reporting of distributions from and termination of an
ABLE account.

    (a) In general. The filer as defined in Sec.  1.529A-5(b)(1) must, 
with respect to each ABLE account from which any distribution is made or 
which is terminated during the calendar year--
    (1) File an annual information return, as described paragraph (b) of 
this section, with the Internal Revenue Service; and
    (2) Furnish an annual statement, as described in paragraph (c) of 
this section, to the designated beneficiary of the ABLE account and to 
each contributor who received a returned contribution in accordance with 
Sec.  1.529A-2(g)(4) attributable to the calendar year.
    (b) Requirement to file return--(1) Form of return. For purposes of 
reporting the information in paragraph (b)(2) of this section, the filer 
must file Form 1099-QA, ``Distributions From ABLE Accounts,'' or any 
successor form, together with Form 1096, ``Annual Summary and 
Transmittal of U.S. Information Returns.''
    (2) Information included on return. The filer must include on the 
return--
    (i) The name, address, and TIN of the recipient of the payment, 
whether the designated beneficiary of the ABLE account or any 
contributor who received a returned contribution in accordance with 
Sec.  1.529A-2(g)(4) attributable to the calendar year;
    (ii) The name, address, and TIN of the filer;
    (iii) Whether the return is being filed with respect to the 
designated beneficiary or to a contributor;
    (iv) The aggregate amount of distributions or returned contributions 
(including net income attributable to the returned contributions) from 
the ABLE account to the recipient during the calendar year;
    (v) Information as to basis and earnings with respect to such 
distributions or returns of contributions;
    (vi) Information regarding termination (if any) of the ABLE account 
if the recipient is the designated beneficiary;
    (vii) Information regarding each program-to-program transfer from 
the ABLE account during the designated beneficiary's taxable year; and
    (viii) Any other information required by the form, its instructions, 
or published guidance. See Sec. Sec.  601.601(d) and 601.602 of this 
chapter.
    (3) Information excluded. A State filing a claim against the estate 
or ABLE account of a deceased designated beneficiary with respect to 
benefits provided to the designated beneficiary under that State's 
Medicaid plan is a creditor, and not a beneficiary, so the

[[Page 306]]

payment of the claim is not a distribution from the ABLE account and 
should not be reported as such on the Form 1099-QA for that year.
    (4) Time and manner of filing return--(i) In general. Except as 
provided in paragraph (b)(4)(ii) of this section, the Forms 1099-QA and 
1096 must be filed on or before February 28 (March 31 if filing 
electronically) of the year following the calendar year with respect to 
which the return is being filed, in accordance with the forms and their 
instructions.
    (ii) Extensions of time. See Sec. Sec.  1.6081-1 and 1.6081-8 for 
rules relating to extensions of time to file information returns 
required in this section.
    (iii) Electronic filing. See Sec.  301.6011-2 of this chapter for 
rules relating to electronic filing. See also Instructions for Forms 
1099-QA and 5498-QA, Distributions From ABLE Accounts and ABLE Account 
Contribution Information.
    (iv) Substitute forms. The filer may file the return required under 
this paragraph (b) on an acceptable substitute form. See Publication 
1179, ``General Rules and Specifications for Substitute Forms 1096, 
1098, 1099, 5498, and Certain Other Information Returns.''
    (c) Requirement to furnish statement--(1) In general. The filer must 
furnish a statement to the designated beneficiary and each contributor 
(if any) of the ABLE account for which it is required to file a Form 
1099-QA (or any successor form). The statement must include--
    (i) The information required under paragraph (b)(2) of this section.
    (ii) A legend that identifies the statement as important tax 
information that is being furnished to the Internal Revenue Service; and
    (iii) The name and address of the office or department of the filer 
that is the information contact for questions regarding the ABLE account 
to which the Form 1099-QA relates.
    (2) Time and manner of furnishing statement--(i) In general. Except 
as provided in paragraph (c)(2)(ii) of this section, a filer must 
furnish the statement described in paragraph (c)(1) of this section to 
the designated beneficiary or contributor on or before January 31 of the 
year following the calendar year with respect to which the statement is 
being furnished. If mailed, the statement must be sent to the 
recipient's last known address. The statement may be furnished 
electronically, as provided in Sec.  1.529A-7.
    (ii) Extensions of time. The Internal Revenue Service may, at its 
discretion, grant an extension of time to furnish statements required in 
this section.
    (3) Copy of Form 1099-QA. A filer may satisfy the requirement of 
this paragraph (c) by furnishing either a copy of Form 1099-QA (or 
successor form) or an acceptable substitute form. See Publication 1179, 
``General Rules and Specifications for Substitute Forms 1096, 1098, 
1099, 5498, and Certain Other Information Returns.''
    (d) Request for TIN of contributor(s)--(1) In general. Except as 
provided in paragraph (d)(2) of this section, a filer must request the 
TIN of each contributor to the ABLE account at the time a contribution 
is made, if the filer does not already have a record of that person's 
correct TIN.
    (2) Exception. If the filer has a system in place to identify and 
reject amounts that either would constitute an excess contribution or 
excess aggregate contribution (as defined in Sec.  1.529A-1(b)(9) or 
(10), respectively) or were contributed to an additional ABLE account as 
described in Sec.  1.529A-2(c)(3)(ii)(C) (excess amounts) before those 
excess amounts are deposited into or allocated to an ABLE account, the 
filer need not request the TIN of each contributor at the time of 
contribution. A filer with such a system must request a contributor's 
TIN only if and when an excess contribution or excess aggregate 
contribution nevertheless is deposited into or allocated to an account 
and the filer must return the excess amounts including net income to the 
contributor. The filer must clearly notify each such contributor to the 
account that the law requires that person to furnish a TIN so that it 
may be included on an information return to be filed by the filer. The 
contributor may provide his or her TIN in any manner including orally, 
in writing, or electronically. If the TIN is furnished in writing, no 
particular form is required. Form W-9, ``Request for Taxpayer 
Identification Number and Certification,'' may be

[[Page 307]]

used, or the request may be incorporated into the forms related to the 
establishment of the ABLE account.
    (e) Penalties--(1) Failure to file return. The section 6693 penalty 
may apply to a filer that fails to file information returns at the time 
and in the manner required by this section, unless it is shown that such 
failure is due to reasonable cause. See section 6693 and Sec.  301.6693-
1 of this chapter.
    (2) Failure to furnish TIN. The section 6723 penalty may apply to 
any contributor who fails to furnish his or her TIN to the filer in 
accordance with paragraph (d) of this section. See section 6723, and 
Sec.  301.6723-1 of this chapter, for rules relating to the penalty for 
failure to furnish a TIN.
    (f) Applicability date. The rules of this section apply to 
information returns required to be filed, and payee statements required 
to be furnished, after December 31, 2020. See Sec.  1.529A-8 for the 
provision of transition relief.



Sec.  1.529A-7  Electronic furnishing of statements to designated
beneficiaries and contributors.

    (a) Electronic furnishing of statements--(1) In general. A filer 
required under Sec.  1.529A-5 or Sec.  1.529A-6 to furnish a written 
statement to a designated beneficiary of or contributor to an ABLE 
account may furnish the statement in an electronic format in lieu of a 
paper format. A filer who meets the requirements of paragraphs (a)(2) 
through (6) of this section is treated as furnishing the required 
statement.
    (2) Consent--(i) In general. The recipient of the statement must 
have affirmatively consented to receive the statement in an electronic 
format. The consent may be made electronically in any manner that 
reasonably demonstrates that the recipient can access the statement in 
the electronic format in which it will be furnished to the recipient. 
Alternatively, the consent may be made in a paper document if it is 
confirmed electronically.
    (ii) Withdrawal of consent. The consent requirement of this 
paragraph (a)(2) is not satisfied if the recipient withdraws the consent 
and the withdrawal takes effect before the statement is furnished. The 
filer may provide that a withdrawal of consent takes effect either on 
the date it is received by the filer or on another date no more than 60 
days later. The filer also may provide that a request for a paper 
statement will be treated as a withdrawal of consent.
    (iii) Change in hardware or software requirements. If a change in 
the hardware or software required to access the statement creates a 
material risk that the recipient will not be able to access the 
statement, the filer must, prior to changing the hardware or software, 
provide the recipient with a notice. The notice must describe the 
revised hardware and software required to access the statement and 
inform the recipient that a new consent to receive the statement in the 
revised electronic format must be provided to the filer if the recipient 
does not want to withdraw the consent. After implementing the revised 
hardware and software, the filer must obtain from the recipient, in the 
manner described in paragraph (a)(2)(i) of this section, a new consent 
or confirmation of consent to receive the statement electronically.
    (iv) Examples. For purposes of the following examples that 
illustrate the rules of this paragraph (a)(2), assume that the 
requirements of Sec.  1.529A-7(a)(3) have been met:
    (A) Example 1. Filer F sends Recipient R a letter stating that R may 
consent to receive statements required under Sec.  1.529A-5 or Sec.  
1.529A-6 electronically on a website instead of in a paper format. The 
letter contains instructions explaining how to consent to receive the 
statements electronically by accessing the website, downloading the 
consent document, completing the consent document, and emailing the 
completed consent back to F. The consent document posted on the website 
uses the same electronic format that F will use for the electronically 
furnished statements. R reads the instructions and submits the consent 
in the manner provided in the instructions. R has consented to receive 
the statements electronically in the manner described in paragraph 
(a)(2)(i) of this section.
    (B) Example 2. Filer F sends Recipient R an email stating that R may 
consent to receive statements required under Sec.  1.529A-5 or Sec.  
1.529A-6 electronically instead of in a paper format. The email

[[Page 308]]

contains an attachment instructing R how to consent to receive the 
statements electronically. The email attachment uses the same electronic 
format that F will use for the electronically furnished statements. R 
opens the attachment, reads the instructions, and submits the consent in 
the manner provided in the instructions. R has consented to receive the 
statements electronically in the manner described in paragraph (a)(2)(i) 
of this section.
    (C) Example 3. Filer F posts a notice on its website stating that 
Recipient R may receive statements required under Sec.  1.529A-5 or 
Sec.  1.529A-6 electronically instead of in a paper format. The website 
contains instructions on how R may access a secure web page and consent 
to receive the statements electronically. By accessing the secure web 
page and giving consent, R has consented to receive the statements 
electronically in the manner described in paragraph (a)(2)(i) of this 
section.
    (3) Required disclosures--(i) In general. Prior to, or at the time 
of, a recipient's consent, the filer must provide to the recipient a 
clear and conspicuous disclosure statement containing each of the 
disclosures described in paragraphs (a)(3)(ii) through (viii) of this 
section.
    (ii) Paper statement. The recipient must be informed that the 
statement will be furnished on paper if the recipient does not consent 
to receive it electronically.
    (iii) Scope and duration of consent. The recipient must be informed 
of the scope and duration of the consent. For example, the recipient 
must be informed whether the consent applies to statements furnished 
every year after the consent is given until it is withdrawn in the 
manner described in paragraph (a)(3)(v)(A) of this section, or only to 
the statement required to be furnished on or before the due date 
immediately following the date on which the consent is given.
    (iv) Post-consent request for a paper statement. The recipient must 
be informed of any procedure for obtaining a paper copy of the 
recipient's statement after giving the consent and whether a request for 
a paper statement will be treated as a withdrawal of consent.
    (v) Withdrawal of consent. The recipient must be informed that--
    (A) The recipient may withdraw a consent by writing (electronically 
or on paper) to the person or department whose name, mailing address, 
and email address is provided in the disclosure statement;
    (B) The filer will confirm, in writing (electronically or on paper), 
the withdrawal and the date on which it takes effect; and
    (C) A withdrawal of consent does not apply to a statement that was 
furnished electronically in the manner described in this paragraph (a) 
before the date on which the withdrawal of consent takes effect.
    (vi) Notice of termination. The recipient must be informed of the 
conditions under which a filer will cease furnishing statements 
electronically to the recipient.
    (vii) Updating information. The recipient must be informed of the 
procedures for updating the information needed by the filer to contact 
the recipient. The filer must inform the recipient of any change in the 
filer's contact information.
    (viii) Hardware and software requirements. The recipient must be 
provided with a description of the hardware and software required to 
access, print, and retain the statement, and the date when the statement 
will no longer be available on the website.
    (4) Format. The electronic version of the statement must contain all 
required information. See Publication 1179, ``General Rules and 
Specifications for Substitute Forms 1096, 1098, 1099, 5498, and Certain 
Other Information Returns.''
    (5) Notice--(i) In general. If the statement is furnished on a 
website, the filer must notify the recipient that the statement is 
posted on a website. The notice may be delivered by mail, electronic 
mail, or in person. The notice must provide instructions on how to 
access and print the statement. The notice must include the following 
statement in capital letters, ``IMPORTANT TAX RETURN DOCUMENT 
AVAILABLE.'' If the notice is provided by electronic mail, the foregoing 
statement must be in the subject line of the electronic mail.

[[Page 309]]

    (ii) Undeliverable electronic address. If an electronic notice 
described in paragraph (a)(5)(i) of this section is returned as 
undeliverable, and the correct electronic address cannot be obtained 
from the filer's records or from the recipient, then the filer must 
furnish the notice by mail or in person within 30 days after the 
electronic notice is returned.
    (iii) Corrected statements. If the filer has corrected a recipient's 
statement that was furnished electronically, the filer must furnish the 
corrected statement to the recipient electronically. If the recipient's 
statement was furnished through a website posting and the filer has 
corrected the statement, the filer must notify the recipient that it has 
posted the corrected statement on the website within 30 days of such 
posting in the manner described in paragraph (a)(5)(i) of this section. 
The corrected statement or the notice must be furnished by mail or in 
person if--
    (A) An electronic notice of the website posting of an original 
statement or the corrected statement was returned as undeliverable; and
    (B) The recipient has not provided a new email address.
    (6) Access period. Statements furnished on a website must be 
retained on the website through October 15 of the year following the 
calendar year to which the statements relate (or the first business day 
after such October 15 if October 15 falls on a Saturday, Sunday, or 
legal holiday). The filer must maintain access to corrected statements 
that are posted on the website through October 15 of the year following 
the calendar year to which the statements relate (or the first business 
day after such October 15 if October 15 falls on a Saturday, Sunday, or 
legal holiday) or the date 90 days after the corrected statements are 
posted, whichever is later. The rules in this paragraph (a)(6) do not 
replace the filer's obligation to keep records under section 6001 and 
Sec.  1.6001-1(a).
    (b) Applicability date. This section applies to statements required 
to be furnished after December 31, 2020. See Sec.  1.529A-8 for the 
provision of transition relief.



Sec.  1.529A-8  Applicability dates and transition relief.

    (a) Applicability dates. Except as otherwise provided in paragraph 
(b) of this section, Sec. Sec.  1.529A-1 through 1.529A-4 apply for 
calendar years beginning on or after January 1, 2021, Sec. Sec.  1.529A-
5 and 1.529A-6 apply to information returns required to be filed, and 
payee statements required to be furnished, after December 31, 2020, and 
Sec.  1.529A-7 applies to statements required to be furnished after 
December 31, 2020.
    (b) Transition relief--(1) In general. Any program purporting to be 
a qualified ABLE program will not be disqualified during the transition 
period set forth in paragraph (b)(2) of this section (transition period) 
solely because of noncompliance with one or more provisions of 
Sec. Sec.  1.529A-1 through 1.529A-7, provided that the program is 
established and operated in accordance with a reasonable, good faith 
interpretation of section 529A. Similarly, no ABLE account established 
and maintained under a program that meets the requirements of this 
paragraph will fail to qualify as an ABLE account during the transition 
period. However, to be a qualified ABLE program and an ABLE account 
under such a program after the transition period, the program and each 
account established and maintained under the program must be in 
compliance with Sec. Sec.  1.529A-1 through 1.529A-7 by the end of the 
transition period. In no event, however, will a complete failure to file 
and furnish reports, information returns and payee statements required 
under section 529A(d)(1) for any accounts established and maintained 
under the program (including for calendar years beginning prior to 
January 1, 2021), be deemed to be due to reasonable cause for purposes 
of avoiding penalties imposed under section 6693.
    (2) Transition period. For purposes of paragraph (b)(1) of this 
section, the transition period begins with the establishment of the 
program purporting to be a qualified ABLE program and continues through 
the later of--
    (i) November 21, 2022; or
    (ii) The day immediately preceding the first day of the qualified 
ABLE program's first taxable year beginning

[[Page 310]]

after the close of the first regular session of the State legislature 
that begins after November 19, 2020. If a State has a two-year 
legislative session, each calendar year of such session will be deemed 
to be a separate regular session of the State legislature for purposes 
of this paragraph.
    (3) Compliance after transition period. After the transition period, 
a program and an account established and maintained under that program 
must be in compliance with Sec. Sec.  1.529A-1 through 1.529A-7.

          Corporations Used To Avoid Income Tax on Shareholders



Corporations Improperly Accumulating Surplus--Table of Contents





Sec.  1.531-1  Imposition of tax.

    Section 531 imposes (in addition to the other taxes imposed upon 
corporations by chapter 1 of the Code) a graduated tax on the 
accumulated taxable income of every corporation described in section 532 
and Sec.  1.532-1. In the case of an affiliated group which makes or is 
required to make a consolidated return see Sec.  1.1502-43. All of the 
taxes on corporations under chapter 1 of the Code are treated as one tax 
for purposes of assessment, collection, payment, period of limitations, 
etc. See section 535 and Sec. Sec.  1.535-1, 1.535-2, and 1.535-3 for 
the definition and determination of accumulated taxable income.

(Secs. 1502 and 7805 of the Internal Revenue Code of 1954 (68A Stat. 
637, 917; 26 U.S.C. 1502, 7805))

[T.D. 6500, 25 FR 11737, Nov. 26, 1960, as amended by T.D. 7244, 37 FR 
28897, Dec. 30, 1972; T.D. 7937, 49 FR 3462, Jan. 27, 1984]



Sec.  1.532-1  Corporations subject to accumulated earnings tax.

    (a) General rule. (1) The tax imposed by section 531 applies to any 
domestic or foreign corporation (not specifically excepted under section 
532(b) and paragraph (b) of this section) formed or availed of to avoid 
or prevent the imposition of the individual income tax on its 
shareholders, or on the shareholders of any other corporation, by 
permitting earnings and profits to accumulate instead of dividing or 
distributing them. See section 533 and Sec.  1.533-1, relating to 
evidence of purpose to avoid income tax with respect to shareholders.
    (2) The tax imposed by section 531 may apply if the avoidance is 
accomplished through the formation or use of one corporation or a chain 
of corporations. For example, if the capital stock of the M Corporation 
is held by the N Corporation, the earnings and profits of the M 
Corporation would not be returned as income subject to the individual 
income tax until such earnings and profits of the M Corporation were 
distributed to the N Corporation and distributed in turn by the N 
Corporation to its shareholders. If either the M Corporation or the N 
Corporation was formed or is availed of for the purpose of avoiding or 
preventing the imposition of the individual income tax upon the 
shareholders of the N Corporation, the accumulated taxable income of the 
corporation so formed or availed of (M or N, as the case may be) is 
subject to the tax imposed by section 531.
    (b) Exceptions. The accumulated earnings tax imposed by section 531 
does not apply to a personal holding company (as defined in section 
542), to a foreign personal holding company (as defined in section 552), 
or to a corporation exempt from tax under subchapter F, chapter 1 of the 
Code.
    (c) Foreign corporations. Section 531 is applicable to any foreign 
corporation, whether resident or nonresident, with respect to any income 
derived from sources, within the United States, if any of its 
shareholders are subject to income tax on the distributions of the 
corporation by reason of being (1) citizens or residents of the United 
States, or (2) nonresident alien individuals to whom section 871 is 
applicable, or (3) foreign corporations if a beneficial interest therein 
is owned directly or indirectly by any shareholder specified in 
subparagraph (1) or (2) of this paragraph.



Sec.  1.533-1  Evidence of purpose to avoid income tax.

    (a) In general. (1) The Commissioner's determination that a 
corporation was formed or availed of for the purpose of avoiding income 
tax with respect to

[[Page 311]]

shareholders is subject to disproof by competent evidence. Section 
533(a) provides that the fact that earnings and profits of a corporation 
are permitted to accumulate beyond the reasonable needs of the business 
shall be determinative of the purpose to avoid the income tax with 
respect to shareholders unless the corporation, by the preponderance of 
the evidence, shall prove to the contrary. The burden of proving that 
earnings and profits have been permitted to accumulate beyond the 
reasonable needs of the business may be shifted to the Commissioner 
under section 534. See Sec. Sec.  1.534-1 through 1.534-4. Section 
533(b) provides that the fact that the taxpayer is a mere holding or 
investment company shall be prima facie evidence of the purpose to avoid 
income tax with respect to shareholders.
    (2) The existence or nonexistence of the purpose to avoid income tax 
with respect to shareholders may be indicated by circumstances other 
than the conditions specified in section 533. Whether or not such 
purpose was present depends upon the particular circumstances of each 
case. All circumstances which might be construed as evidence of the 
purpose to avoid income tax with respect to shareholders cannot be 
outlined, but among other things, the following will be considered:
    (i) Dealings between the corporation and its shareholders, such as 
withdrawals by the shareholders as personal loans or the expenditure of 
funds by the corporation for the personal benefit of the shareholders,
    (ii) The investment by the corporation of undistributed earnings in 
assets having no reasonable connection with the business of the 
corporation (see Sec.  1.537-3), and
    (iii) The extent to which the corporation has distributed its 
earnings and profits.

The fact that a corporation is a mere holding or investment company or 
has an accumulation of earnings and profits in excess of the reasonable 
needs of the business is not absolutely conclusive against it if the 
taxpayer satisfies the Commissioner that the corporation was neither 
formed nor availed of for the purpose of avoiding income tax with 
respect to shareholders.
    (b) General burden of proof and statutory presumptions. The 
Commissioner may determine that the taxpayer was formed or availed of to 
avoid income tax with respect to shareholders through the medium of 
permitting earnings and profits to accumulate. In the case of litigation 
involving any such determination (except where the burden of proof is on 
the Commissioner under section 534), the burden of proving such 
determination wrong by a preponderance of the evidence, together with 
the corresponding burden of first going forward with the evidence, is on 
the taxpayer under principles applicable to income tax cases generally. 
For the burden of proof in a proceeding before the Tax Court with 
respect to the allegation that earnings and profits have been permitted 
to accumulate beyond the reasonable needs of the business, see section 
534 and Sec. Sec.  1.534-2 through 1.534-4. For a definition of a 
holding or investment company, see paragraph (c) of this section. For 
determination of the reasonable needs of the business, see section 537 
and Sec. Sec.  1.537-1 through 1.537-3. If the taxpayer is a mere 
holding or investment company, and the Commissioner therefore determines 
that the corporation was formed or availed of for the purpose of 
avoiding income tax with respect to shareholders, then section 533(b) 
gives further weight to the presumption ofcorrectness already arising 
from the Commissioner's determination by expressly providing an 
additional presumption of the existence of a purpose to avoid income tax 
with respect to shareholders. Further, if it is established (after 
complying with section 534 where applicable) that earnings and profits 
were permitted to accumulate beyond the reasonable needs of the business 
and the Commissioner has therefore determined that the corporation was 
formed or availed of for the purpose of avoiding income tax with respect 
to shareholders, then section 533(a) adds still more weight to the 
Commissioner's determination. Under such circumstances, the existence of 
such an accumulation is made determinative of the purpose to avoid 
income tax with respect to shareholders

[[Page 312]]

unless the taxpayer proves to the contrary by the preponderance of the 
evidence.
    (c) Holding or investment company. A corporation having practically 
no activities except holding property and collecting the income 
therefrom or investing therein shall be considered a holding company 
within the meaning of section 533(b). If the activities further include, 
or consist substantially of, buying and selling stocks, securities, real 
estate, or other investment property (whether upon an outright or 
marginal basis) so that the income is derived not only from the 
investment yield but also from profits upon market fluctuations, the 
corporation shall be considered an investment company within the meaning 
of section 533(b).
    (d) Small business investment companies. A corporation which is 
licensed to operate as a small business investment company under the 
Small Business Investment Act of 1958 (15 U.S.C. ch. 14B) and the 
regulations thereunder (13 CFR part 107) will generally be considered to 
be a mere holding or investment company within the meaning of section 
533(b). However, the presumption of the existence of the purpose to 
avoid income tax with respect to shareholders which results from the 
fact that such a company is a mere holding or investment company will be 
considered overcome so long as such company:
    (1) Complies with all the provisions of the Small Business 
Investment Act of 1958 and the regulations thereunder; and
    (2) Actively engages in the business of providing funds to small 
business concerns through investment in the equity capital of, or 
through the disbursement of long-term loans to, such concerns in such 
manner and under such terms as the company may fix in accordance with 
regulations promulgated by the Small Business Administration (see secs. 
304 and 305 of the Small Business Investment Act of 1958, as amended (15 
U.S.C. 684, 685)).

On the other hand, if such a company violates or fails to comply with 
any of the provisions of the Small Business Investment Act of 1958, as 
amended, or the regulations thereunder, or ceases to be actively engaged 
in the business of providing funds to small business concerns in the 
manner provided in subparagraph (2) of this paragraph, it will not be 
considered to have overcome the presumption by reason of any rules 
provided in this paragraph.

[T.D. 6500, 25 FR 11737, Nov. 26, 1960, as amended by T.D. 6652, 28 FR 
4786, May 14, 1963]



Sec.  1.533-2  Statement required.

    The corporation may be required to furnish a statement of its 
accumulated earnings and profits, the payment of dividends, the name and 
address of, and number of shares held by, each of its shareholders, the 
amounts that would be payable to each of the shareholders if the income 
of the corporation were distributed and other information required under 
section 6042.



Sec.  1.534-1  Burden of proof as to unreasonable accumulations generally.

    For purposes of applying the presumption provided for in section 
533(a) and in determining the extent of the accumulated earnings credit 
under section 535(c)(1), the burden of proof with respect to an 
allegation by the Commissioner that all or any part of the earnings and 
profits of the corporation have been permitted to accumulate beyond the 
reasonable needs of the business may vary under section 534 as between 
litigation in the Tax Court and that in any other court. In case of a 
proceeding in a court other than the Tax Court, see paragraph (b) of 
Sec.  1.533-1.



Sec.  1.534-2  Burden of proof as to unreasonable accumulations in
cases before the Tax Court.

    (a) Burden of proof on Commissioner. Under the general rule provided 
in section 534(a), in any proceeding before the Tax Court involving a 
notice of deficiency based in whole or in part on the allegation that 
all or any part of the earnings and profits have been permitted to 
accumulate beyond the reasonable needs of the business, the burden of 
proof with respect to such allegation is upon the Commissioner if:
    (1) A notification, as provided for in section 534(b) and paragraph 
(c) of this section, has not been sent to the taxpayer; or

[[Page 313]]

    (2) A notification, as provided for in section 534(b) and paragraph 
(c) of this section, has been sent to the taxpayer and, in response to 
such notification, the taxpayer has submitted a statement, as provided 
in section 534(c) and paragraph (d) of this section, setting forth the 
ground or grounds (together with facts sufficient to show the basis 
thereof) on which it relies to establish that all or any part of its 
earnings and profits have not been permitted to accumulate beyond the 
reasonable needs of the business. However, the burden of proof in the 
latter case is upon the Commissioner only with respect to the relevant 
ground or grounds set forth in the statement submitted by the taxpayer, 
and only if such ground or grounds are supported by facts (contained in 
the statement) sufficient to show the basis thereof.
    (b) Burden of proof on the taxpayer. The burden of proof in a Tax 
Court proceeding with respect to an allegation that all or any part of 
the earnings and profits have been permitted to accumulate beyond the 
reasonable needs of the business is upon the taxpayer if:
    (1) A notification, as provided for in section 534(b) and paragraph 
(c) of this section, has been sent to the taxpayer and the taxpayer has 
not submitted a statement, in response to such notification, as provided 
in section 534(c) and paragraph (d) of this section; or
    (2) A statement has been submitted by the taxpayer in response to 
such notification, but the ground or grounds on which the taxpayer 
relies are not relevant to the allegation or, if relevant, the statement 
does not contain facts sufficient to show the basis thereof.
    (c) Notification to the taxpayer. Under section 534(b) a 
notification informing the taxpayer that the proposed notice of 
deficiency includes an amount with respect to the accumulated earnings 
tax imposed by section 531 may be sent by registered mail (or by 
certified or registered mail, if the notification is mailed after 
September 2, 1958) to the taxpayer at any time before the mailing of the 
notice of deficiency in the case of a taxable year beginning after 
December 31, 1953, and ending after August 16, 1954. See Sec.  1.534-4 
for rules relating to taxable years subject to the Internal Revenue Code 
of 1939. See section 534(d) and Sec.  1.534-3 with respect to a 
notification in the case of a jeopardy assessment.
    (d) Statement by taxpayer. (1) A taxpayer who has received a 
notification, as provided in section 534(b) and paragraph (c) of this 
section, that the proposed notice of deficiency includes an amount with 
respect to the accumulated earnings tax imposed by section 531, may, 
under section 534(c), submit a statement that all or any part of the 
earnings and profits of the corporation have not been permitted to 
accumulate beyond the reasonable needs of the business. Such statement 
shall set forth the ground or grounds (together with facts sufficient to 
show the basis thereof) on which the taxpayer relies to establish that 
there has been no accumulation of earnings and profits beyond the 
reasonable needs of the business. See paragraphs (a) and (b) of this 
section for rules concerning the effect of the statement with respect to 
burden of proof. See Sec. Sec.  1.537-1 to 1.537-3, inclusive, relating 
to reasonable needs of the business.
    (2) The taxpayer's statement, under section 534(c) and this 
paragraph, must be submitted to the Internal Revenue office which issued 
the notification (referred to in section 534(b) and paragraph (c) of 
this section) within 60 days after the mailing of such notification. If 
the taxpayer is unable, for good cause, to submit the statement within 
such 60-day period, an additional period not exceeding 30 days may be 
granted upon receipt in the Internal Revenue office concerned (before 
the expiration of the 60-day period provided herein) of a request from 
the taxpayer, setting forth the reasons for such request. See section 
534(d) and Sec.  1.534-3 with respect to a statement in the case of a 
jeopardy assessment.



Sec.  1.534-3  Jeopardy assessments in Tax Court cases.

    In the case of a jeopardy assessment, a notice of deficiency is 
required to be sent to the taxpayer by registered mail (or by certified 
or registered mail, if the notice is mailed after September 2, 1958) 
within 60 days after the making of the assessment. See section 6861. If 
a jeopardy assessment is made before the

[[Page 314]]

mailing of the deficiency notice, then in the case of a proceeding in 
the Tax Court, if the deficiency notice informs the taxpayer that an 
amount of accumulated earnings tax is included in the deficiency, such 
notice shall constitute the notification provided for in section 534(b) 
and paragraph (c) of Sec.  1.534-2. Under such circumstances the 
statement described in section 534(c) and paragraph (d) of Sec.  1.534-2 
shall instead be included in the taxpayer's petition to the Tax Court, 
if the taxpayer desires to submit such statement. See paragraph (b) of 
Sec.  1.534-2, relating to burden of proof on the taxpayer.



Sec.  1.535-1  Definition.

    (a) The accumulated earnings tax is imposed by section 531 on the 
accumulated taxable income. Accumulated taxable income is the taxable 
income of the corporation with the adjustments prescribed by section 
535(b) and Sec.  1.535-2, minus the sum of the dividends paid deduction 
and the accumulated earnings credit. See section 561 and the regulations 
thereunder, relating to the definition of the deduction for dividends 
paid, and section 535(c) and Sec.  1.535-3, relating to the accumulated 
earnings credit.
    (b) In the case of a foreign corporation, whether resident or 
nonresident, which files or causes to be filed a return, the accumulated 
taxable income shall be the taxable income from sources within the 
United States with the adjustments prescribed by section 535(b) and 
Sec.  1.535-2 minus the sum of the dividends paid deduction and the 
accumulated earnings credit. In the case of a foreign corporation which 
files no return, the accumulated taxable income shall be the gross 
income from sources within the United States without allowance of any 
deductions (including the accumulated earnings credit).

[T.D. 6500, 25 FR 11737, Nov. 26, 1960, as amended by T.D. 7244, 37 FR 
28897, Dec. 30, 1972]



Sec.  1.535-2  Adjustments to taxable income.

    (a) Taxes--(1) United States taxes. In computing accumulated taxable 
income for any taxable year, there shall be allowed as a deduction the 
amount by which Federal income and excess profits taxes accrued during 
the taxable year exceed the credit provided by section 33 (relating to 
taxes of foreign countries and possessions of the United States), except 
that no deduction shall be allowed for (i) the accumulated earnings tax 
imposed by section 531 (or a corresponding section of a prior law), (ii) 
the personal holding company tax imposed by section 541 (or a 
corresponding section of a prior law), and (iii) the excess profits tax 
imposed by subchapter E, chapter 2 of the Internal Revenue Code of 1939, 
for taxable years beginning after December 31, 1940. The deduction is 
for taxes accrued during the taxable year, regardless of whether the 
corporation uses an accrual method of accounting, the cash receipts and 
disbursements method, or any other allowable method of accounting. In 
computing the amount of taxes accrued, an unpaid tax which is being 
contested is not considered accrued until the contest is resolved.
    (2) Taxes of foreign countries and United States possessions. In 
determining accumulated taxable income for any taxable year, if the 
taxpayer chooses the benefits of section 901 for such taxable year, a 
deduction shall be allowed for:
    (i) The income, war profits, and excess profits taxes imposed by 
foreign countries or possessions of the United States and accrued during 
such taxable year, and
    (ii) In the case of a domestic corporation, the foreign income taxes 
deemed to be paid for such taxable year under section 902(a) in 
accordance with Sec. Sec.  1.902-1 and 1.902-2 or section 960(a)(1) in 
accordance with Sec.  1.960-7.

In no event shall the amount under subdivision (ii) of this subparagraph 
exceed the amount includible in gross income with respect to such taxes 
under section 78 and Sec.  1.78-1. The credit for such taxes provided by 
section 901 shall not be allowed against the accumulated earnings tax 
imposed by section 531. See section 901(a).
    (b) Charitable contributions. Section 535(b)(2) provides that, in 
computing the accumulated taxable income of a corporation, the deduction 
for charitable contributions shall be computed without regard to section 
170(b)(2).

[[Page 315]]

Thus, the amount of charitable contributions made during the taxable 
year not allowable as a deduction under section 170 by reason of the 
limitations imposed by section 170(b)(2) shall be allowed as a deduction 
in computing accumulated taxable income for the taxable year. However, 
any excess of the amount of the charitable contributions made in a prior 
taxable year over the amount allowed as a deduction under section 170 
for such year shall not be allowed as a deduction from taxable income in 
computing accumulated taxable income for the taxable year.
    (c) Special deductions disallowed. Sections 241 through 248 provide 
for the allowance of special deductions for such items as partially tax-
exempt interest, certain dividends received, dividends paid on certain 
preferred stock of public utilities, and organizational expenses. Such 
special deductions, except the deduction provided by section 248 
(relating to organizational expenses) shall be disallowed in computing 
accumulated taxable income.
    (d) Net operating loss. The net operating loss deduction provided in 
section 172 is not allowed for purposes of computing accumulated taxable 
income.
    (e) Capital losses. (1) Losses from sales or exchanges of capital 
assets during the taxable year, which are disallowed as deductions under 
section 1211(a) in computing taxable income, shall be allowed as 
deductions in computing accumulated taxable income.
    (2) The computation of the capital losses allowable as a deduction 
in computing accumulated taxable income may be illustrated by the 
following example:

    Example. X Corporation has capital losses of $30,000 which are 
disallowed under section 1211(a) for the taxable year ended December 31, 
1956. This amount represents a loss of $25,000 from the sale or exchange 
of capital assets during the taxable year ended December 31, 1956, plus 
a $5,000 capital loss carryover resulting from the sale or exchange of 
capital assets during the taxable year ended December 31, 1955. In 
computing accumulated taxable income for the taxable year ended December 
31, 1956, only the loss of $25,000 arising from the sale or exchange of 
capital assets during that taxable year will be allowed as a deduction.

    (f) Long-term capital gains. (1) There is allowed as a deduction in 
computing accumulated taxable income, the excess of the net long-term 
capital gain for the taxable year over the net short-term capital loss 
for such year (determined without regard to the capital loss carryover 
provided in section 1212) minus the taxes attributable to such excess as 
provided by section 535(b)(6). The tax attributable to such excess is 
the difference between:
    (i) The taxes (except the accumulated earnings tax) imposed by 
subtitle A of the Code for such year, and
    (ii) The taxes (except the accumulated earnings tax) imposed by 
subtitle A computed for such year as if taxable income were reduced by 
the excess of the net long-term capital gain over net short-term capital 
loss (including the capital loss carryover to such year)


Where the tax (except the accumulated earnings tax) imposed by subtitle 
A includes an amount computed under section 1201(a)(2), the tax 
attributable to such excess is such amount computed under section 
1201(a)(2).
    (2) The application of the rule in subparagraph (1) of this 
paragraph may be illustrated by the following example:

    Example. Assume that D Corporation, for the taxable year ended 
December 31, 1956, has taxable income of $103,000 of which $8,000 is the 
excess of net long-term capital gain of $12,000 over a net short-term 
capital loss of $9,000. The $9,000 net short-term capital loss includes 
a capital loss carryover of $5,000. The amount allowable as a deduction 
under section 535(b)(6) and subparagraph (1) of this paragraph is 
$7,250, computed as follows: Net long-term capital gain less net short-
term capital loss (computed without regard to the capital loss 
carryover) is $8,000 (that is, $12,000 net long-term capital gain less 
$4,000 net short-term capital loss computed without regard to the 
capital loss carryover of $5,000). The tax attributable to the excess of 
net long-term capital gain over net short-term capital loss (computed by 
taking the capital loss carryover into account) is $750, that is, 25 
percent of such excess of $3,000, computed under section 1201(a)(2). The 
difference of $7,250 ($8,000 less $750) is the amount allowable as a 
deduction in computing accumulated taxable income.

    (3) Section 631(c) (relating to gain or loss in the case of disposal 
of coal or domestic iron ore) shall have no application in determining 
the amount of

[[Page 316]]

the deduction allowable under section 535(b)(6).
    (g) Capital loss carrybacks and carryovers. Capital losses carried 
to a taxable year under section 1212(a) shall have no application for 
purposes of computing accumulated taxable income for such year.
    (h) Bank affiliates. There is allowed the deduction provided by 
section 601 in the case of bank affiliates (as defined in section 2 of 
the Banking Act of 1933; 12 U. S. C. 221a(c)).

[T.D. 6500, 25 FR 11737, Nov. 26, 1960, as amended by T.D. 6805, 30 FR 
3209, Mar. 9, 1965; T.D. 6841, 30 FR 9305, July 27, 1965; T.D. 7301, 39 
FR 964, Jan. 4, 1974; T.D. 7649, 44 FR 60086, Oct. 18, 1979]



Sec.  1.535-3  Accumulated earnings credit.

    (a) In general. As provided in section 535(a) and Sec.  1.535-1, the 
accumulated earnings credit, provided by section 535(c), reduces taxable 
income in computing accumulated taxable income. In the case of a 
corporation, not a mere holding or investment company, the accumulated 
earnings credit is determined as provided in paragraph (b) of this 
section and, in the case of a holding or investment company, as provided 
in paragraph (c) of this section.
    (b) Corporation which is not a mere holding or investment company--
(1) General rule. (i) In the case of a corporation, not a mere holding 
or investment company, the accumulated earnings credit is the amount 
equal to such part of the earnings and profits of the taxable year which 
is retained for the reasonable needs of the business, minus the 
deduction allowed by section 535(b)(6) (see paragraph (f) of Sec.  
1.535-2, relating to the deduction for long-term capital gains). In no 
event shall the accumulated earnings credit be less than the minimum 
credit provided for in section 535(c)(2) and subparagraph (2) of this 
paragraph. The amount of the earnings and profits for the taxable year 
retained is the amount by which the earnings and profits for the taxable 
year exceed the dividends paid deduction for such taxable year. See 
section 561 and Sec. Sec.  1.561-1 and 1.561-2, relating to the 
deduction for dividends paid.
    (ii) In determining whether any amount of the earnings and profits 
of the taxable year has been retained for the reasonable needs of the 
business, the accumulated earnings and profits of prior years will be 
taken into consideration. Thus, for example, if such accumulated 
earnings and profits of prior years are sufficient for the reasonable 
needs of the business, then any earnings and profits of the current 
taxable year which are retained will not be considered to be retained 
for the reasonable needs of the business. See section 537 and Sec. Sec.  
1.537-1 and 1.537-2.
    (2) Minimum credit. Section 535(c)(2) provides for the allowance of 
a minimum accumulated earnings credit in the case of a corporation which 
is not a mere holding or investment company. Except as otherwise 
provided in section 243(b)(3) and Sec.  1.243-5 (relating to effect of 
100-percent dividends received deduction under section 243(b)) and 
sections 1561, 1562, and 1564 (relating to limitations on certain tax 
benefits in the case of certain controlled corporations), in the case of 
such a corporation, this minimum credit shall in no case be less than 
the amount by which $150,000 ($100,000 in the case of taxable years 
beginning before January 1, 1975) exceeds the accumulated earnings and 
profits of the corporation at the close of the preceding taxable year. 
See paragraph (d) of this section for the effect of dividends paid after 
the close of the taxable year in determining accumulated earnings and 
profits at the close of the preceding taxable year. In determining the 
amount of the minimum credit allowable under section 535(c)(2), the 
needs of the business are not taken into consideration. If the taxpayer 
has accumulated earnings and profits at the close of the preceding 
taxable year equal to or in excess of $150,000 ($100,000 in the case of 
taxable years beginning before January 1, 1975), thecredit, if any, is 
determined without regard to section 535(c)(2). It is not intended that 
the provision for the minimum credit shall in any way create an 
inference that an accumulation in excess of $150,000 ($100,000 in the 
case of taxable years beginning before January 1, 1975) is unreasonable. 
The reasonable needs of the business may require the accumulation of 
more or less than $150,000 ($100,000 in the case of taxable years 
beginning before January 1, 1975), depending upon the circumstances in

[[Page 317]]

the case, but such needs shall not be taken into consideration to any 
extent in cases where the minimum accumulated earnings credit is 
applicable. For a discussion of the reasonable needs of the business, 
see section 537 and Sec. Sec.  1.537-1, 1.537-2, and 1.537-3.
    (3) Illustrations of accumulated earnings credit. The computation of 
the accumulated earnings credit provided by section 535(c) may be 
illustrated by the following examples:

    Example 1. The X Corporation, which is not a mere holding or 
investment company, has accumulated earnings and profits in the amount 
of $125,000 as of December 31, 1974. Thus, the minimum credit provided 
by section 535(c)(2) exceeds the accumulated earnings and profits of X 
by $25,000. It has earnings and profits for the taxable year ended 
December 31, 1975, in the amount of $100,000 and has a dividends paid 
deduction under section 561 in the amount of $30,000 so that the 
earnings and profits for the taxable year which are retained in the 
business amount to $70,000. Assume that it has been determined that the 
earnings and profits for the taxable year which may be retained for the 
reasonable needs of the business amount to $55,000 and that a deduction 
has been allowed under section 535(b)(6) in the amount of $5,000. Since 
the amount by which $150,000 exceeds the accumulated earnings and 
profits at the close of the preceding taxable year is less than $50,000 
($55,000-$5,000), the minimum credit provided by section 535(c)(2) will 
not apply and the accumulated earnings credit must be computed under 
section 535(c)(1) on the basis of the reasonable needs of the business. 
In this case, the accumulated earnings credit for the taxable year ended 
December 31, 1975, will be $50,000 computed as follows:

Earnings and profits of the taxable year determined to be        $55,000
 retained for the reasonable needs of the business............
Less: The deduction for long-term capital gains (less              5,000
 applicable tax) allowed under sec. 535(b)(6).................
                                                               ---------
    Accumulated earnings credit allowable under sec. 535(c)(1)    50,000
 

    Example 2. The Z Corporation which is not a mere holding or 
investment company, has accumulated earnings and profits in the amount 
of $45,000 as of December 31, 1974; it has earnings and profits for the 
taxable year ended December 31, 1975, in the amount of $115,000 and has 
a dividends paid deduction under section 561 in the amount of $10,000, 
so that the earnings and profits for the taxable year which are retained 
amount to $105,000. Assume that it has been determined that the 
accumulated earnings and profits of the taxable year which may be 
retained for the reasonable needs of the business amount to $20,000 and 
that no deduction is allowable for long-term capital gains under section 
535(b)(6). The accumulated earnings credit allowable under section 
535(c)(1) on the basis of the reasonable needs of the business is 
determined to be only $20,000. However, since the amount by which 
$150,000 exceeds the accumulated earnings and profits at the close of 
the preceding taxable year is more than $20,000, the minimum accumulated 
earnings credit provided by section 535(c)(2) is applicable. The 
allowable credit will be the amount by which $150,000 exceeds the 
accumulated earnings and profits at the close of the preceding taxable 
year (i.e., $105,000, $150,000 less $45,000 of accumulated earnings and 
profits at the close of the preceding taxable year).

    (c) Holding and investment companies. Section 535(c)(3) provides 
that, in the case of a mere holding or investment company, the 
accumulated earnings credit shall be the amount, if any, by which 
$150,000 ($100,000 in the case of taxable years beginning before January 
1, 1975) exceeds the accumulated earnings and profits of the corporation 
at the close of the preceding taxable year. Thus, if such a corporation 
has accumulated earnings equal to or in excess of $150,000 ($100,000 in 
the case of taxable years beginning before January 1, 1975) at the close 
of its preceding taxable year, no accumulated earnings credit is 
allowable in computing the accumulated taxable income. See paragraph (c) 
of Sec.  1.533-1 for a definition of a holding or investment company. 
For the accumulated earnings credit of a mere holding or investment 
company which is a member of an affiliated group which has elected the 
100-percent dividends received deduction under section 243(b), see 
section 243(b)(3) and Sec.  1.243-5. For the accumulated earnings credit 
of a mere holding or investment company which is a component member of a 
controlled group of corporations (as defined in section 1563), see 
sections 1561, 1562, and 1564.

(Sec. 1561(a) (83 Stat. 599; 26 U.S.C. 1561(a)))

[T.D. 6500, 25 FR 11737, Nov. 26, 1960, as amended by T.D. 6992, 34 FR 
826, Jan. 18, 1969; T.D. 7181, 37 FR 8066, Apr. 25, 1972; T.D. 7244, 37 
FR 28897, Dec. 30, 1972; T.D. 7376, 40 FR 42744, Sept. 16, 1975; T.D. 
7528, 42 FR 64694, Dec. 28, 1977]



Sec.  1.536-1  Short taxable years.

    Accumulated taxable income for a taxable year consisting of a period 
of

[[Page 318]]

less than 12 months shall not be placed on an annual basis for the 
purpose of the accumulated earnings tax imposed by section 531. In such 
cases accumulated taxable income shall be computed on the basis of the 
taxable income for such period of less than 12 months, adjusted in the 
manner provided by section 535(b) and Sec.  1.535-2.



Sec.  1.537-1  Reasonable needs of the business.

    (a) In general. The term reasonable needs of the business includes 
(1) the reasonably anticipated needs of the business (including product 
liability loss reserves, as defined in paragraph (f) of this section), 
(2) the section 303 redemption needs of the business, as defined in 
paragraph (c) of this section, and (3) the excess business holdings 
redemption needs of the business as described in paragraph (d) of this 
section. See paragraph (e) of this section for additional rules relating 
to the section 303 redemption needs and the excess business holdings 
redemption needs of the business. An accumulation of the earnings and 
profits (including the undistributed earnings and profits of prior 
years) is in excess of the reasonable needs of the business if it 
exceeds the amount that a prudent businessman would consider appropriate 
for the present business purposes and for the reasonably anticipated 
future needs of the business. The need to retain earnings and profits 
must be directly connected with the needs of thecorporation itself and 
must be for bona fide business purposes. For purposes of this paragraph 
the section 303 redemption needs of the business and the excess business 
holdings redemption needs of the business are deemed to be directly 
connected with the needs of the business and for a bona fide business 
purpose. See Sec.  1.537-3 for a discussion of what constitutes the 
business of the corporation. The extent to which earnings and profits 
have been distributed by the corporation may be taken into account in 
determining whether or not retained earnings and profits exceed the 
reasonable needs of the business. See Sec.  1.537-2, relating to grounds 
for accumulation of earnings and profits.
    (b) Reasonable anticipated needs. (1) In order for a corporation to 
justify an accumulation of earnings and profits for reasonably 
anticipated future needs, there must be an indication that the future 
needs of the business require such accumulation, and the corporation 
must have specific, definite, and feasible plans for the use of such 
accumulation. Such an accumulation need not be used immediately, nor 
must the plans for its use be consummated within a short period after 
the close of the taxable year, provided that such accumulation will be 
used within a reasonable time depending upon all the facts and 
circumstances relating to the future needs of the business. Where the 
future needs of the business are uncertain or vague, where the plans for 
the future use of an accumulation are not specific, definite, and 
feasible, or where the execution of such a plan is postponed 
indefinitely, an accumulation cannot be justified on the grounds of 
reasonably anticipated needs of the business.
    (2) Consideration shall be given to reasonably anticipated needs as 
they exist on the basis of the facts at the close of the taxable year. 
Thus, subsequent events shall not be used for the purpose of showing 
that the retention of earnings or profits was unreasonable at the close 
of the taxable year if all the elements of reasonable anticipation are 
present at the close of such taxable year. However, subsequent events 
may be considered to determine whether the taxpayer actually intended to 
consummate or has actually consummated the plans for which the earnings 
and profits were accumulated. In this connection, projected expansion or 
investment plans shall be reviewed in the light of the facts during each 
year and as they exist as of the close of the taxable year. If a 
corporation has justified an accumulation for future needs by plans 
never consummated, the amount of such an accumulation shall be taken 
into account in determining the reasonableness of subsequent 
accumulations.
    (c) Section 303 redemption needs of the business. (1) The term 
section 303 redemption needs means, with respect to the taxable year of 
the corporation in which a shareholder of the corporation

[[Page 319]]

died or any taxable year thereafter, the amount needed (or reasonably 
anticipated to be needed) to redeem stock included in the gross estate 
of such shareholder but not in excess of the amount necessary to effect 
a distribution to which section 303 applies. For purposes of this 
paragraph, the term shareholder includes an individual in whose gross 
estate stock of the corporation is includable upon his death for Federal 
estate tax purposes.
    (2) This paragraph applies to a corporation to which section 303(c) 
would apply if a distribution described therein were made.
    (3) If stock included in the gross estate of a decedent is stock of 
two or more corporations described in section 303(b)(2)(B), the amount 
needed by each such corporation for section 303 redemption purposes 
under this section shall, unless the particular facts and circumstances 
indicate otherwise, be that amount which bears the same ratio to the 
amount described in section 303(a) as the fair market value of such 
corporation's stock included in the gross estate of such decedent bears 
to the fair market value of all of the stock of such corporations 
included in the gross estate. For example, facts and circumstances 
indicating that the allocation prescribed by this subparagraph is not 
required would include notice given to the corporations by the executor 
or administrator of the decedent's estate that he intends to request the 
redemption of stock of only one of such corporations or the redemption 
of stock of such corporations in a ratio which is unrelated to the 
respective fair market values of the stock of the corporations included 
in the decedent's gross estate.
    (4) The provisions of this paragraph apply only to taxable years 
ending after May 26, 1969.
    (d) Excess business holdings redemption needs. (1) The term excess 
business holdings redemption needs means, with respect to taxable years 
of the corporation ending after May 26, 1969, the amount needed (or 
reasonably anticipated to be needed) to redeem from a private foundation 
stock which:
    (i) Such foundation held on May 26, 1969 (or which was received by 
such foundation pursuant to a will or irrevocable trust to which section 
4943(c)(5) applies), and either
    (ii) Constituted excess business holdings on such date or would have 
constituted excess business holdings as of that date if there were taken 
into account (a) stock received pursuant to a will or trust described in 
subdivision (i) of this subparagraph and (b) the reduction in the total 
outstanding stock of the corporation which would have resulted solely 
from the redemption of stock held by the private foundation, or
    (iii) Constituted stock redemption of which before January 1, 1975, 
or after October 4, 1976, and before January 1, 1977, is, by reason of 
section 101(l)(2)(B) of the Tax Reform Act of 1969, as amended by 
section 1309 of the Tax Reform Act of 1976, and Sec.  53.4941(d)-4(b), 
permitted without imposition of tax under section 4941, but only to the 
extent such stock is to be redeemed before January 1, 1975 or after 
October 4, 1976, and before January 1, 1977, or is to be redeemed 
thereafter pursuant to the terms of a binding contract entered into on 
or before such date to redeem all of the stock of the corporation held 
by the private foundation on such date.
    (2) The purpose of subparagraph (1) of this paragraph is to 
facilitate a private-foundation's disposition of certain excess business 
holdings, in order for the private foundation not to be liable for tax 
under section 4943. See section 4943(c) and the regulations thereunder 
for the definition of excess business holdings. For purposes of section 
537(b)(2) and this paragraph, however, any determination of the 
existence of excess business holdings shall be made without taking into 
account the provisions of section 4943(c)(4) which treat certain excess 
business holdings as held by a disqualified person (rather than by the 
private foundation), except that the periods described in section 
4943(c)(4) (B), (C), and (D), if applicable, shall be taken into account 
in determining the period during which an excess business holdings 
redemption need may be deemed to exist. Thus, an excess business 
holdings redemption need may, depending upon the facts and 
circumstances, be deemed to exist for a part or all of the 20-year, 15-
year, or 10-year period specified in section

[[Page 320]]

4943(c)(4)(B) during which the interest in the corporation held by the 
private foundation is treated as held by a disqualified person rather 
than by the private foundation, and, if applicable, (i) any suspension 
of such 20-year, 15-year, or 10-year period as provided by section 
4943(c)(4)(C) and (ii) the 15-year second phase specified in section 
4943(c)(4)(D). The foregoing sentence is not to be construed to prevent 
an accumulation of earnings and profits for the purpose of effecting a 
redemption of excess business holdings at a time or times prior to 
expiration of the periods described in such sentence. This subparagraph 
is not to be construed to prevent an accumulation of earnings and 
profits for the purpose of effecting a redemption described in 
subdivision (iii) of subparagraph (1) of this paragraph.
    (3) The extent of an excess business holdings redemption need cannot 
exceed the total number of shares of stock so held or received by the 
private foundation (i) redemption of which alone would sufficiently 
reduce such private foundation's proportionate share of the 
corporation's total outstanding stock in order for the private 
foundation not to be liable for tax under section 4943, or (ii) 
redemption of which is, by reason of Sec.  53.4941(d)-4(b), permitted 
without imposition of tax under section 4941 provided that such 
redemption is accomplished within the period and in the manner 
prescribed in subdivision (iii) of subparagraph (1) of this paragraph. 
Thus, excess business holdings of a private foundation attributable to 
an increase in the private foundation's proportionate share of the 
corporation's total outstanding stock by reason of a redemption of stock 
after May 26, 1969, from any person other than the private foundation do 
not give rise to an excess business holdings redemption need.
    (4) For purposes of subdivision (ii) of subparagraph (1) of this 
paragraph, an excess business holdings redemption need can arise with 
respect to shares of the corporation's stock under section 537(a)(3) 
only following actual acquisition by the private foundation of such 
shares and their characterization as an excess business holding. Thus, 
this paragraph does not apply to an accumulation of earnings and profits 
in one taxable year in anticipation of redemption of excess business 
holdings to be acquired by a private foundation in a subsequent year 
pursuant to a will or irrevocable trust to which section 4943(c)(5) 
applies or in anticipation of shares held becoming excess business 
holdings of the private foundation in a subsequent year by reason of 
additional shares to be received by the private foundation in such 
subsequent year pursuant to a will or irrevocable trust to which section 
4943(c)(5) applies. Once having arisen, however, an excess business 
holdings redemption need may continue until redemption of the private 
foundation's excess business holdings described in this paragraph or 
other disposition of such excess business holdings by the private 
foundation.
    (5) Notwithstanding any other provision of this paragraph, an excess 
business holdings redemption need will not be deemed to exist with 
respect to stock held by a private foundation the redemption of which 
would subject any person to tax under section 4941.
    (6) For purposes of subdivision (ii) of subparagraph (1) of this 
paragraph, the number of shares of stock held by a private foundation on 
May 26, 1969 (or received pursuant to a will or irrevocable trust to 
which section 4943(c)(5) applies), redemption of which alone would 
sufficiently reduce such foundation's proportionate share of a 
corporation's total outstanding stock in order for the foundation not to 
be liable for tax under section 4943 may be determined by application of 
the following formula:
[GRAPHIC] [TIFF OMITTED] TC14NO91.159

X = Number of shares to be redeemed.
Y = Maximum percentage of outstanding stock which private foundation can 
          hold without being liable for tax under section 4943.
PH = Number of shares of stock held by private foundation on May 26, 
          1969, or received pursuant to a will or irrevocable trust to 
          which section 4943(c)(5) applies.
SO = Total number of shares of stock outstanding unreduced by any 
          redemption from a person other than the private foundation.


[[Page 321]]


    (7) The provisions of this paragraph may be illustrated by the 
following example:

    Example. (i) On May 26, 1969, Private Foundation A holds 60 of the 
100 outstanding shares of the capital stock of corporation X, which is 
not a disqualified person with respect to A. None of the remaining 40 
shares is owned by a disqualified person within the meaning of section 
4946(a). On June 1, 1975, X redeems 10 shares of its stock from 
individual B, thus reducing its outstanding stock to 90 shares. On June 
1, 1976, A receives 20 additional shares of X stock by bequest under a 
will to which section 4943(c)(5) applies. As of June 1, 1976, then, A 
holds 80 of the 90 outstanding shares of X. Solely for purposes of this 
example and to illustrate the application of this paragraph, it will be 
assumed that in order not to be liable for the initial tax under section 
4943, A must, before the close of the second phase described in section 
4943(c)(4)(D), reduce its proportionate stock interest in X to 35 
percent. A requests X to redeem from it a sufficient number of its 
shares to so reduce its proportionate stock interest in X to 35 percent, 
and X agrees to effect such a redemption.
    (ii) As of May 26, 1969, A's excess business holdings are 25 shares 
of X, the number of shares which A would be required to dispose of to a 
person other than X in order to reduce its proportionate holdings in X 
to no more than 35percent. If the disposition is to be by means of a 
redemption, however, A's excess business holdings on May 26, 1969, for 
purposes of determining X's excess business holdings redemption needs, 
are 39 shares, i.e., the number of shares X would be required to redeem 
in order to reduce A's proportionate stock interest to 35 percent. 
Although the redemption of 10 shares from B on June 1, 1975, creates 
additional excess business holdings of A because it effectively 
increases A's proportionate stock interest in X, this increase does not 
create an additional excess business holdings redemption need because it 
resulted from a redemption from a person other than A. The bequest of 20 
shares of X received by A on June 1, 1976, creates a further excess 
business holdings redemption need as of that date in the amount needed 
(or reasonably anticipated to be needed) to redeem an additional 31 
shares from A, i.e., the number of shares which, when added to the 
excess business holdings of A on May 26, 1969, would have to be redeemed 
to reduce A's proportionate stock interest in X to 35 percent without 
taking the earlier redemption from B into account.

    (e)(1) A determination whether and to what extent an amount is 
needed (or reasonably anticipated to be needed) for the purpose 
described in subparagraph (1) of paragraph (c) or (d) of this section is 
dependent upon the particular circumstances of the case, including the 
total amount of earnings and profits accumulated in prior years which 
may be available for such purpose and the existence of a reasonable 
expectation that a redemption described in paragraph (c) or (d) of this 
section will in fact be effected. Although paragraph (c) or (d) of this 
section may apply even though no redemption of stock is in fact 
effected, the failure to effect such redemption may be taken into 
account in determining whether the accumulation was needed (or 
reasonably anticipated to be needed) for a purpose described in 
paragraph (c) or (d).
    (2) In applying subparagraph (1) of paragraph (c) or (d) of this 
section, the discharge of an obligation incurred to make a redemption 
shall be treated as the making of the redemption.
    (3) In determining whether an accumulation is in excess of the 
reasonable needs of the business for a particular year, the fact that 
one of the exceptions specified in paragraph (c) or (d) of this section 
applies in a subsequent year is not to give rise to an inference that 
the accumulation would not have been for the reasonable needs of the 
business in the prior year. Also, no inference is to be drawn from the 
enactment of section 537(a) (2) and (3) that accumulations in any prior 
year would not have been for the reasonable needs of the business in the 
absence of such provisions. Thus, the reasonableness of accumulations in 
years prior to a year in which one of the exceptions specified in 
paragraph (c) or (d) of this section applies is to be determined solely 
upon the facts and circumstances existing at the times the accumulations 
occur.
    (f) Product liability loss reserves. (1) The term product liability 
loss reserve means, with respect to taxable years beginning after 
September 30, 1979, reasonable amounts accumulated for the payment of 
reasonably anticipated product liability losses, as defined in section 
172(j) and Sec.  1.172-13(b)(1).
    (2) For purposes of this paragraph, whether an accumulation for 
anticipated product liability losses is reasonable in amount and whether 
such anticipated product liability losses are likely to occur shall be 
determined in

[[Page 322]]

light of all facts and circumstances of the taxpayer making such 
accumulation. Some of the factors to be considered in determining the 
reasonableness of the accumulation include the taxpayer's previous 
product liability experience, the extent of the taxpayer's coverage by 
commercial product liability insurance, the income tax consequences of 
the taxpayer's ability to deduct product liability losses and related 
expenses, and the taxpayer's potential future liability due to defective 
products in light of the taxpayer's plans to expand the production of 
products currently being manufactured, provided such plans are specific, 
definite and feasible. Additionally, a factor to be considered in 
determining whether the accumulation is reasonable in amount is whether 
the taxpayer, in accounting for its potential future liability, took 
into account the reasonably estimated present value of the potential 
future liability.
    (3) Only those accumulations made with respect to products that have 
been manufactured, leased, or sold shall be considered as accumulations 
made under this paragraph. Thus, for example, accumulations with respect 
to a product which has not progressed beyond the development stage are 
not reasonable accumulations under this paragraph.

[T.D. 6500, 25 FR 11737, Nov. 26, 1960, as amended by T.D. 7165, 37 FR 
5022, Mar. 9, 1972, 37 FR 5703, Mar. 18, 1972; T.D. 7678, 44 FR 12416, 
Feb. 26, 1980; T.D. 8096, 51 FR 30483, Aug. 27, 1986]



Sec.  1.537-2  Grounds for accumulation of earnings and profits.

    (a) In general. Whether a particular ground or grounds for the 
accumulation of earnings and profits indicate that the earnings and 
profits have been accumulated for the reasonable needs of the business 
or beyond such needs is dependent upon the particular circumstances of 
the case. Listed below in paragraphs (b) and (c) of this section are 
some of the grounds which may be used as guides under ordinary 
circumstances.
    (b) Reasonable accumulation of earnings and profits. Although the 
following grounds are not exclusive, one or more of such grounds, if 
supported by sufficient facts, may indicate that the earnings and 
profits of a corporation are being accumulated for the reasonable needs 
of the business provided the general requirements under Sec. Sec.  
1.537-1 and 1.537-3 are satisfied:
    (1) To provide for bona fide expansion of business or replacement of 
plant;
    (2) To acquire a business enterprise through purchasing stock or 
assets;
    (3) To provide for the retirement of bona fide indebtedness created 
in connection with the trade or business, such as the establishment of a 
sinking fund for the purpose of retiring bonds issued by the corporation 
in accordance with contract obligations incurred on issue;
    (4) To provide necessary working capital for the business, such as, 
for the procurement of inventories;
    (5) To provide for investments or loans to suppliers or customers if 
necessary in order to maintain the business of the corporation; or
    (6) To provide for the payment of reasonably anticipated product 
liability losses, as defined in section 172(j), Sec. Sec.  1.172-
13(b)(1), and 1.537-1(f).
    (c) Unreasonable accumulations of earnings and profits. Although the 
following purposes are not exclusive, accumulations of earnings and 
profits to meet any one of such objectives may indicate that the 
earnings and profits of a corporation are being accumulated beyond the 
reasonable needs of the business:
    (1) Loans to shareholders, or the expenditure of funds of the 
corporation for the personal benefit of the shareholders;
    (2) Loans having no reasonable relation to the conduct of the 
business made to relatives or friends of shareholders, or to other 
persons;
    (3) Loans to another corporation, the business of which is not that 
of the taxpayer corporation, if the capital stock of such other 
corporation is owned, directly or indirectly, by the shareholder or 
shareholders of the taxpayer corporation and such shareholder or 
shareholders are in control of both corporations;
    (4) Investments in properties, or securities which are unrelated to 
the activities of the business of the taxpayer corporation; or

[[Page 323]]

    (5) Retention of earnings and profits to provide against unrealistic 
hazards.

[T.D. 6500, 25 FR 11737, Nov. 26, 1960, as amended by T.D. 8096, 51 FR 
30484, Aug. 27, 1986]



Sec.  1.537-3  Business of the corporation.

    (a) The business of a corporation is not merely that which it has 
previously carried on but includes, in general, any line of business 
which it may undertake.
    (b) If one corporation owns the stock of another corporation and, in 
effect, operates the other corporation, the business of the latter 
corporation may be considered in substance, although not in legal form, 
the business of the first corporation. However, investment by a 
corporation of its earnings and profits in stock and securities of 
another corporation is not, of itself, to be regarded as employment of 
the earnings and profits in its business. Earnings and profits of the 
first corporation put into the second corporation through the purchase 
of stock or securities or otherwise, may, if a subsidiary relationship 
is established, constitute employment of the earnings and profits in its 
own business. Thus, the business of one corporation may be regarded as 
including the business of another corporation if such other corporation 
is a mere instrumentality of the first corporation; that may be 
established by showing that the first corporation owns at least 80 
percent of the voting stock of the second corporation. If the taxpayer's 
ownership of stock is less than 80 percent in the other corporation, the 
determination of whether the funds are employed in a business operated 
by the taxpayer will depend upon the particular circumstances of the 
case. Moreover, the business of one corporation does not include the 
business of another corporation if such other corporation is a personal 
holding company, an investment company, or a corporation not engaged in 
the active conduct of a trade or business.

                       Personal Holding Companies



Sec.  1.541-1  Imposition of tax.

    (a) Section 541 imposes a graduated tax upon corporations classified 
as personal holding companies under section 542. This tax, if 
applicable, is in addition to the tax imposed upon corporations 
generally under section 11. Unless specifically excepted under section 
542(c) the tax applies to domestic and foreign corporations and, to the 
extent provided by section 542(b), to an affiliated group of 
corporations filing a consolidated return. Corporations classified as 
personal holding companies are exempt brom the accumulated earnings tax 
imposed under section 531 but are not exempt from other income taxes 
imposed upon corporations, generally, under any other provisions of the 
Code. Unlike the accumulated earnings tax imposed under section 531, the 
personal holding company tax imposed by section 541 applies to all 
personal holding companies as defined in section 542, whether or not 
they were formed or availed of to avoid income tax upon shareholders. 
See section 6501(f) and Sec.  301.6501(f)-1 of this chapter (Regulations 
on Procedure and Administration) with respect to the period of 
limitation on assessment of personal holding company tax upon failure to 
file a schedule of personal holding company income.
    (b) A foreign corporation, whether resident or nonresident, which is 
classified as a personal holding company is subject to the tax imposed 
under section 541 with respect to its income from sources within the 
United States, even though such income is not fixed or determinable 
annual or periodical income specified in section 881. A foreign 
corporation is not classified as a personal holding company subject to 
tax under section 541 if it is a foreign personal holding company as 
defined in section 552 or if it meets the requirements of the exception 
provided in section 542(c)(10).



Sec.  1.542-1  General rule.

    A personal holding company is any corporation (other than one 
specifically excepted under section 542(c)) which, for the taxable year, 
meets:
    (a) The gross income requirement specified in section 542(a)(1) and 
Sec.  1.542-2, and
    (b) The stock ownership requirement specified in section 542(a)(2) 
and Sec.  1.542-3.


[[Page 324]]



Both requirements must be satisfied with respect to each taxable year.



Sec.  1.542-2  Gross income requirement.

    To meet the gross income requirement it is necessary that at least 
80 percent of the total gross income of the corporation for the taxable 
year be personal holding company income as defined in section 543 and 
Sec. Sec.  1.543-1 and 1.543-2. For the definition of gross income see 
section 61 and Sec. Sec.  1.61-1 through 1.61-14. Under such provisions 
gross income is not necessarily synonymous with gross receipts. Further, 
in the case of transactions in stocks and securities and in commodities 
transactions, gross income for personal holding company tax purposes 
shall include only the excess of gains over losses from such 
transactions. See section 543(b), paragraph (b) (5) and (6) of Sec.  
1.543-1 and Sec.  1.543-2. For determining the character of the amount 
includible in gross income under section 951(a), see paragraph (a) of 
Sec.  1.951-1.

[T.D. 6500, 25 FR 11737, Nov. 26, 1960, as amended by T.D. 6795, 30 FR 
934, Jan. 29, 1965]



Sec.  1.542-3  Stock ownership requirement.

    (a) General rule. To meet the stock ownership requirement, it is 
necessary that at some time during the last half of the taxable year 
more than 50 percent in value of the outstanding stock of the 
corporation be owned, directly or indirectly, by or for not more than 5 
individuals. Any organization or trust to which subparagraph (1) of this 
paragraph applies shall be considered as one individual for purposes of 
this stock ownership requirement subject, however, to the exception in 
subparagraph (2) of this paragraph which is applicable only to taxable 
years beginning after December 31, 1954. Thus, if an organization or 
trust which is considered as an individual owns 51 percent in value of 
the outstanding stock of the corporation at any time during the last 
half of the taxable year, the stock ownership requirement will be met by 
ownership of the required percentage by one individual. See section 544 
and Sec. Sec.  1.544-1 through 1.544-7 for the determination of stock 
ownership.
    (1) An organization or trust considered as an individual. Any of the 
following organizations or trusts shall be considered as an individual:
    (i) An organization to which section 503 applies, namely, any 
organization described in section 501(c)(3) (relating to charitable, 
etc., organizations) or section 401(a) (relating to employees' pension 
trust, etc.) other than an organization excepted from the application of 
section 503 by paragraphs (1) to (5) of section 503(b). Therefore, a 
religious organization (other than a trust) excepted under section 
503(b)(1) is not considered an individual for purposes of the stock 
ownership requirement of section 542(a)(2).
    (ii) A portion of a trust permanently set aside or to be used 
exclusively for the purposes described in section 642(c), relating to 
amounts set aside for charitable purposes, or described in a 
corresponding provision of the prior income tax law (such as section 
162(a), Internal Revenue Code of 1939).
    (2) Exception. For taxable years beginning after December 31, 1954, 
an organization or trust to which subparagraph (1) of this paragraph 
applies shall not be considered an individual if all of the following 
conditions are met:
    (i) It was organized or created before July 1, 1950.
    (ii) At all times on or after July 1, 1950, and before the close of 
the taxable year, it owned all of the common stock and at least 80 
percent of the total number of shares of all other classes of stock of 
the corporation.
    (iii) For the taxable year it is not denied exemption under section 
504(a) or the unlimited charitable deduction under section 681(c). In 
determining whether, for the purpose of section 542(a)(2), exemption is 
not denied under section 504(a) or the unlimited charitable deduction is 
not denied under section 681(c) all the income of the corporation which 
is available for distribution as dividends to its shareholders shall be 
deemed to have been distributed at the close of the taxable year whether 
or not any portion of such income was in fact distributed. If the 
amounts described in section 504(a) or section 681(c), increased by the 
income of the corporation deemed distributed pursuant to the preceding 
sentence, would be sufficient to deny exemption or the unlimited 
charitable

[[Page 325]]

deduction, the organization or trust will be considered to be an 
individual for the purpose of section 542(a)(2). For the purpose of this 
subdivision the restrictions in sections 504(a)(1) and 681(c)(1) against 
unreasonable accumulations will not apply to income attributable to 
property of a decedent dying before January 1, 1951, which was 
transferred during his lifetime to a trust or property that was 
transferred under his will to such trust, and
    (iv) This subparagraph is illustrated by the following example:

    Example. The X Charitable Foundation (an organization described in 
section 501(c)(3) to which section 503 is applicable) has owned all of 
the stock of the Y Corporation since Y's organization in 1949. Both X 
and Y are calendar-year corporations. At the end of the year 1955, X has 
accumulated $100,000 out of income and has actually paid out only 
$75,000 of this amount, leaving a balance of $25,000 on December 31, 
1955. X was not denied an exemption under section 504(a) for the year 
1955. Y, during the calendar year 1955, has $400,000 taxable income of 
which $200,000 is available for distribution as dividends at the end of 
the year. X will be considered to have accumulated out of income during 
the calendar year 1955 the amount of $225,000 for the purpose of 
determining whether it would have been denied an exemption under section 
504(a)(1). If X would have been denied an exemption under section 
504(a)(1) by reason of having been deemed to have accumulated $225,000, 
the stock ownership requirement of section 542(a)(2) and this section 
will have been satisfied. If Y Corporation also satisfies the gross 
income requirement of section 542(a)(1) and Sec.  1.542-2 it will be a 
personal holding company.

    (b) Changes in stock outstanding. It is necessary to consider any 
change in the stock outstanding during the last half of the taxable 
year, whether in the number of shares or classes of stock, or in the 
ownership thereof. Stock subscribed and paid for will be considered as 
stock outstanding, whether or not such stock is evidenced by issued 
certificates. Treasury stock shall not be considered as stock 
outstanding.
    (c) Value of stock outstanding. The value of the stock outstanding 
shall be determined in the light of all the circumstances. The value may 
be determined upon the basis of the company's net worth, earning and 
dividend paying capacity, appreciation of assets, together with such 
other factors as have a bearing upon the value of the stock. If the 
value of the stock is greatly at variance with that reflected by the 
corporate books, the evidence of such value should be filed with the 
return. In any case where there are two or more classes of stock 
outstanding, the total value of all the stock should be allocated among 
the different classes according to the relative value of each class.

[T.D. 6500, 25 FR 11737, Nov. 26, 1960, as amended by T.D. 6739, 29 FR 
7713, June 17, 1964]



Sec.  1.542-4  Corporations filing consolidated returns.

    (a) General rule. A consolidated return under section 1501 shall 
determine the application of the personal holding company tax to the 
group and to any member thereof on the basis of the consolidated gross 
income and consolidated personal holding company income of the group, as 
determined under the regulations prescribed pursuant to section 1502 
(relating to consolidated returns); however, this rule shall not apply 
to either (1) an ineligible affiliated group as defined in section 
542(b)(2) and paragraph (b) of this section, or (2) an affiliated group 
of corporations a member of which is excluded from the definition of a 
personal holding company under section 542(c) and paragraph (c) of this 
section. Thus, in the latter two instances the gross income requirement 
provided in section 542(a)(1) and Sec.  1.542-2 shall apply to each 
individual member of the affiliated group of corporations.
    (b) Ineligible affiliated group. (1) Except for certain affiliated 
railroad corporations, as provided in subparagraph (2) of this 
paragraph, an affiliated group of corporations is an ineligible 
affiliated group and therefore may not use its consolidated gross income 
and consolidated personal holding company income to determine the 
liability of the group or any member thereof for personal holding 
company tax (as provided in paragraph (a) of this section), if (i) any 
member of such group, including the common parent, derived gross income 
from sources outside the affiliated group for the taxable year in an 
amount equal to 10 percent or more of its gross income from all sources 
for

[[Page 326]]

that year and (ii) 80 percent or more of the gross income from sources 
outside the affiliated group consists of personal holding company income 
as defined in section 543 and Sec. Sec.  1.543-1 and 1.543-2. For 
purposes of subdivision (i) of this subparagraph gross income shall not 
include certain dividend income receivedby a common parent from a 
corporation not a member of the affiliated group which qualifies under 
section 542(b)(4) and paragraph (d) of this section. See particularly 
the examples contained in paragraph (d)(2) of this section. 
Intercorporate dividends received by members of the affiliated group 
(including the common parent) are to be included in the gross income 
from all sources for purposes of the test in subdivision (i) of this 
subparagraph. For purposes of subdivision (ii) of this subparagraph, 
section 543 and paragraph (a) of Sec.  1.543-1 shall be applied as if 
the amount of gross income derived from sources outside the affiliated 
group by a corporation which is a member of such group is the gross 
income of such corporation.
    (2) An affiliated group of railroad corporations shall not be 
considered to be an ineligible affiliated group, notwithstanding any 
other provisions of section 542(b)(2) and this paragraph, if the common 
parent of such group would be eligible to file a consolidated return 
under section 141 of the Internal Revenue Code of 1939 prior to its 
amendment by the Revenue Act of 1942 (56 Stat. 798).
    (3) See section 562(d) and Sec.  1.562-3 for dividends paid 
deduction in the case of a distribution by a member of an ineligible 
affiliated group.
    (4) The determination of whether an affiliated group of corporations 
is an ineligible group under section 542(b)(2) and this paragraph, may 
be illustrated by the following examples:

    Example 1. Corporations X, Y, and Z constitute an affiliated group 
of corporations which files a consolidated return for the calendar year 
1954; Corporations Y and Z are wholly-owned subsidiaries of Corporation 
X and derive no gross income from sources outside the affiliated group; 
Corporation X, the common parent, has gross income in the amount of 
$250,000 for the taxable year 1954. $200,000 of such gross income 
consists of dividends received from Corporations Y and Z. The remaining 
$50,000 was derived from sources outside the affiliated group, $40,000 
of which represents personal holding company income as defined in 
section 543. The $50,000 included in the gross income of Corporation X 
and derived from sources outside the affiliated group is more than 10 
percent of X's gross income ($50,000/$250,000) and the $40,000 which 
represents personal holding company income is 80 percent of $50,000 (the 
amount considered to be the gross income of Corporation X). Accordingly, 
Corporations X, Y, and Z would be an ineligible affiliated group and the 
gross income requirement under section 542(a)(1) and Sec.  1.542-2 would 
be applied to each corporation individually.
    Example 2. If, in the above example, only $30,000 of the $50,000 
derived from sources outside the affiliated group by Corporation X 
represented personal holding company income, this group of affiliated 
corporations would not be an ineligible affiliated group. Although the 
$50,000 representing the gross income of Corporation X from sources 
outside the affiliated group is more than 10 percent of its total gross 
income, the amount of $30,000 representing personal holding company 
income is not 80 percent or more of the amount considered to be gross 
income for the purpose of this test. Under section 542(b)(2) and 
subparagraph (1) of this paragraph both the gross income and the 
personal holding company income requirements must be satisfied in 
determining that an affiliated group constitutes an ineligible group. 
Since both of these requirements have not been satisfied in this example 
this group of affiliated corporations would not be an ineligible group.

    (c) Excluded corporations. The general rule for determining 
liability of an affiliated group under paragraph (a) of this section 
shall not apply if any member thereof is a corporation which is 
excluded, under section 542(c), from the definition of a personal 
holding company.
    (d) Certain dividend income received by a common parent. (1) 
Dividends received by the common parent of an affiliated group from a 
corporation which is not a member of the affiliated group shall not be 
included in gross income or personal holding company income, for the 
purpose of the test under section 542(b)(2):
    (i) If such common parent owned, directly or indirectly, more than 
50 percent of the outstanding voting stock of the dividend paying 
corporation at the time such common parent became entitled to the 
dividend, and
    (ii) If the dividend paying corporation is not a personal holding 
company

[[Page 327]]

for the taxable year in which the dividends are paid


Thus, if the tests in subdivisions (i) and (ii) of this subparagraph are 
met, the dividend income received by the common parent from such other 
corporation will not be considered gross income for purposes of the test 
in section 542(b)(2)(A) (paragraph (b) of this section), that is, either 
to determine gross income from sources outside the affiliated group or 
to determine gross income from all sources.
    (2) The application of subparagraph (1) of this paragraph may be 
illustrated by the following examples:

    Example 1. Corporation X is the common parent of Corporation Y and 
Corporation Z and together they constitute an affiliated group which 
files a consolidated return under section 1501. Corporation Y and 
Corporation Z derived no income from sources outside the affiliated 
group. Corporation X, the common parent, had gross income of $100,000 
for the calendar year 1954 of which amount $20,000 represented a 
dividend received from Corporation W, and $4,000 represented interest 
from Corporation T. The remaining gross income of X, $76,000, was 
received from Corporations Y and Z. Corporation X, for its entire 
taxable year, owned 60 percent of the voting stock of Corporation W 
which was not a personal holding company for the calendar year 1954. For 
the purpose of the gross income and personal holding company income test 
under section 542(b)(2) and paragraph (b) of this section, the $20,000 
dividend received from Corporation W would not be included in the gross 
income or personal holding company income of Corporation X. The 
affiliated group would not be an ineligible group under section 
542(b)(2) because 10 percent or more of its gross income was not from 
sources outside the affiliated group as required by section 
542(b)(2)(A). Inasmuch as the $20,000 dividend from Corporation W is not 
included in the gross income of Corporation X for purposes of section 
542(b)(2) Corporation X only has $4,000 gross income from sources 
outside the affiliated group which is only 5 percent of its gross income 
from all sources, $80,000.
    Example 2. If, in example 1, Corporation X owned 50 percent or less 
of the voting stock of Corporation W at the time X became entitled to 
the dividend, or if Corporation W had been a personal holding company 
for the taxable year in which the dividends were paid, the $20,000 
dividends received by Corporation X would be included in gross income 
and personal holding company income of Corporation X for the purpose of 
the test under section 542(b)(2) and paragraph (b) of this section. 
Thus, the affiliated group would be an ineligible affiliated group under 
section 542(b)(2) because 24 percent of its gross income was from 
sources outside the affiliated group ($24,000/$100,000) and 100 percent 
of this $24,000 was personal holding company income.



Sec.  1.543-1  Personal holding company income.

    (a) General rule. The term personal holding company income means the 
portion of the gross income which consists of the classes of gross 
income described in paragraph (b) of this section. See section 543(b) 
and Sec.  1.543-2 for special limitations on gross income and personal 
holding company income in cases of gains from stocks', securities', and 
commodities' transactions.
    (b) Definitions--(1) Dividends. The term dividends includes 
dividends as defined in section 316 and amounts required to be included 
in gross income under section 551 and Sec. Sec.  1.551-1--1.551-2 
(relating to foreign personal holding company income taxed to United 
States shareholders).
    (2) Interest. The term interest means any amounts, includible in 
gross income, received for the use of money loaned. However, (i) 
interest which constitutes rent shall not be classified as interest but 
shall be classified as rents (see subparagraph (10) of this paragraph) 
and (ii) interest on amounts set aside in a reserve fund under section 
511 or 607 of the Merchant Marine Act, 1936 (46 U.S.C. 1161 or 1177), 
shall not be included in personal holding company income.
    (3) Royalties (other than mineral, oil, or gas royalties or certain 
copyright royalties). The term royalties (other than mineral, oil, or 
gas royalties or certain copyright royalties) includes amounts received 
for the privilege of using patents, copyrights, secret processes and 
formulas, good will, trade marks, trade brands, franchises, and other 
like property. It does not, however, include rents. For rules relating 
to rents see section 543(a)(7) and subparagraph (10) of this paragraph. 
For rules relating to mineral, oil, or gas royalties, see section 
543(a)(8) and subparagraph (11) of this paragraph. For rules relating to 
certain copyright royalties for taxable years beginning after December 
31, 1959, see section 543(a)(9) and subparagraph (12) of this paragraph.

[[Page 328]]

    (4) Annuities. The term annuities includes annuities only to the 
extent includible in the computation of gross income. See section 72 and 
Sec. Sec.  1.72-1--1.72-14 for rules relating to the inclusion of 
annuities in gross income.
    (5) Gains from the sale or exchange of stock or securities. (i) 
Except in the case of regular dealers in stock or securities as provided 
in subdivision (ii) of this subparagraph, gross income and personal 
holding company income include the amount by which the gains exceed the 
losses from the sale or exchange of stock or securities. See section 
543(b)(1) and Sec.  1.543-2 for provisions relating to this limitation. 
For this purpose, there shall be taken into account all those gains 
includible in gross income (including gains from liquidating dividends 
and other distributions from capital) and all those losses deductible 
from gross income which are considered under chapter 1 of the Code to be 
gains or losses from the sale or exchange of stock or securities. The 
term stock or securities as used in section 543(a)(2) and this 
subparagraph includes shares or certificates of stock, stock rights or 
warrants, or interest in any corporation (including any joint stock 
company, insurance company, association, or other organization 
classified as a corporation by the Code), certificates of interest or 
participation in any profit-sharing agreement, or in any oil, gas, or 
other mineral property, or lease, collateral trust certificates, voting 
trust certificates, bonds, debentures, certificates of indebtedness, 
notes, car trust certificates, bills of exchange, obligations issued by 
or on behalf of a State, Territory, or political subdivision thereof.
    (ii) In the case of regular dealers in stock or securities there 
shall not be included gains or losses derived from the sale or exchange 
of stock or securities made in the normal course of business. The term 
regular dealer in stock or securities means a corporation with an 
established place of business regularly engaged in the purchase of stock 
or securities and their resale to customers. However, such corporations 
shall not be considered as regular dealers with respect to stock or 
securities which are held for investment. See section 1236 and Sec.  
1.1236-1.
    (6) Gains from futures transactions in commodities. Gross income and 
personal holding company income include the amount by which the gains 
exceed the losses from futures transactions in any commodity on or 
subject to the rules of a board of trade or commodity exchange. See 
Sec.  1.543-2 for provisions relating to this limitation. In general, 
for the purpose of determining such excess, there are included all gains 
and losses on futures contracts which are speculative. However, for the 
purpose of determining such excess, there shall not be included gains or 
losses from cash transactions, or gains or losses by a producer, 
processor, merchant, or handler of the commodity, which arise out of 
bona fide hedging transactions reasonably necessary to the conduct of 
its business in the manner in which such business is customarily and 
usually conducted by others. See section 1233 and Sec.  1.1233-1.
    (7) Estates and trusts. Under section 543(a)(4) personal holding 
company income includes amounts includible in computing the taxable 
income of the corporation under part I, subchapter J, chapter 1 of the 
Code (relating to estates, trusts, and beneficiaries); and any gain 
derived by the corporation from the sale or other disposition of any 
interest in an estate or trust.
    (8) Personal service contracts. (i) Under section 543(a)(5) amounts 
received under a contract under which the corporation is to furnish 
personal services, as well as amounts received from the sale or other 
disposition of such contract, shall be included as personal holding 
company income if:
    (a) Some person other than the corporation has the right to 
designate (by name or by description) the individual who is to perform 
the services, or if the individual who is to perform the services is 
designated (by name or by description) in the contract; and
    (b) At any time during the taxable year 25 percent or more in value 
of the outstanding stock of the corporation is owned, directly or 
indirectly, by or for the individual who has performed, is to perform, 
or may be designated (by name or by description) as the one to perform, 
such services. For this purpose, the amount of stock outstanding

[[Page 329]]

and its value shall be determined in accordance with the rules set forth 
in the last two sentences of paragraph (b) and in paragraph (c) of Sec.  
1.542-3. It should be noted that the stock ownership requirement of 
section 543(a)(5) and this subparagraph relates to the stock ownership 
at any time during the taxable year. For rules relating to the 
determination of stock ownership, see section 544 and Sec. Sec.  1.544-1 
through 1.544-7.
    (ii) If the contract, in addition to requiring the performance of 
services by a 25-percent stockholder who is designated or who could be 
designated (as specified in section 543(a)(5) and subdivision (i) of 
this subparagraph), requires the performance of services by other 
persons which are important and essential, then only that portion of the 
amount received under such contract which is attributable to the 
personal services of the 25-percent stockholder shall constitute 
personal holding company income. Incidental personal services of other 
persons employed by the corporation to facilitate the performance of the 
services by the 25-percent stockholder, however, shall not constitute 
important or essential services. Under section 482 gross income, 
deductions, credits, or allowances between or among organizations, 
trades, or businesses may be allocated if it is determined that 
allocation is necessary in order to prevent evasion of taxes or clearly 
to reflect the income of any such organizations, trades, or businesses.
    (iii) The application of section 543(a)(5) and this subparagraph may 
be illustrated by the following examples:

    Example 1. A, whose profession is that of an actor, owns all of the 
outstanding capital stock of the M Corporation. The M Corporation 
entered into a contract with A under which A was to perform personal 
services for the person or persons whom the M Corporation might 
designate, in consideration of which A was to receive $10,000 a year 
from the M Corporation. The M Corporation entered into a contract with 
the O Corporation in which A was designated to perform personal services 
for the O Corporation in consideration of which the O Corporation was to 
pay the M Corporation $500,000 a year. The $500,000 received by the M 
Corporation from the O Corporation constitutes personal holding company 
income.
    Example 2. Assume the same facts as in example 1, except that, in 
addition to A's contract with the M Corporation, B, whose profession is 
that of a dancer and C, whose profession is that of a singer, were also 
under contract to the M Corporation to perform personal services for the 
person or persons whom the M Corporation might designate, in 
consideration of which they were each to receive $25,000 a year from the 
M Corporation. Neither B nor C were stockholders of the M Corporation. 
The contract entered into by the MCorporation with the O Corporation, in 
addition to designating that A was to perform personal services for the 
O Corporation, designated that B and C were also to perform personal 
services for the O Corporation. Although the O Corporation particularly 
desired the services of A for an entertainment program it planned, it 
also desired the services of B and C, who were prominent in their 
fields, to provide a good supporting cast for the program. The services 
of B and C required under the contract are determined to be important 
and essential; therefore, only that portion of the $500,000 received by 
the M Corporation which is attributable to the personal services of A 
constitutes personal holding company income. The same result would 
obtain although the dancer and the singer required by the contract were 
not designated by name but the contract gave the M Corporation 
discretion to select and provide the services of a singer and a dancer 
for the program and such services were provided.
    Example 3. The N Corporation is engaged in engineering. Its entire 
outstanding capital stock is owned by four individuals. The N 
Corporation entered into a contract with the R Corporation to perform 
engineering services in consideration of which the R Corporation was to 
pay the N Corporation $50,000. The individual who was to perform the 
services was not designated (by name or by description) in the contract 
and no one but the N Corporation had the right to designate (by name or 
by description) such individual. The $50,000 received by the N 
Corporation from the R Corporation does not constitute personal holding 
company income.

    (9) Compensation for use of property. Under section 543(a)(6) 
amounts received as compensation for the use of, or right to use, 
property of the corporation shall be included as personal holding 
company income if, at any time during the taxable year, 25 percent or 
more in value of the outstanding stock of the corporation is owned, 
directly or indirectly, by or for an individual entitled to the use of 
the property. Thus, if a shareholder who meets the stock ownership 
requirement of section 543(a)(6) and this subparagraph uses, or has the 
right to use, a yacht, residence, or other property

[[Page 330]]

owned by the corporation, the compensation to the corporation for such 
use, or right to use, the property constitutes personal holding company 
income. This is true even though the shareholder may acquire the use of, 
or the right to use, the property by means of a sublease or under any 
other arrangement involving parties other than the corporation and the 
shareholder. However, if the personal holding company income of the 
corporation (after excluding any such income described in section 
543(a)(6) and this subparagraph, relating to compensation for use of 
property, and after excluding any such income described in section 
543(a)(7) and subparagraph (10) of this paragraph, relating to rents) is 
not more than 10 percent of its grossincome, compensation for the use of 
property shall not constitute personalholding company income. For 
purposes of the preceding sentence, in determining whether personal 
holding company income is more than 10 percent of gross income, 
copyright royalties constitute personal holding company income, 
regardless of whether such copyright royalties are excluded from 
personal holding company income under section 543(a)(9) and subparagraph 
(12)(ii) of this paragraph. For purposes of applying section 543(a)(6) 
and this subparagraph, the amount of stock outstanding and its value 
shall be determined in accordance with the rules set forth in the last 
two sentences of paragraph (b) and in paragraph (c) of Sec.  1.542-3. It 
should be noted that the stock ownership requirement of section 
543(a)(6) and this subparagraph relates to the stock outstanding at any 
time during the entire taxable year. For rules relating to the 
determination of stock ownership, see section 544 and Sec. Sec.  1.544-1 
through 1.544-7.
    (10) Rents (including interest constituting rents). Rents which are 
to be included as personal holding company income consist of 
compensation (however designated) for the use, or right to use, property 
of the corporation. The term rents does not include amounts includible 
in personal holding company income under section 543(a)(6) and 
subparagraph (9) of this paragraph. The amounts considered as rents 
include charter fees, etc., for the use of, or the right to use, 
property, as well as interest on debts owed to the corporation (to the 
extent such debts represent the price for which real property held 
primarily for sale to customers in the ordinary course of the 
corporation's trade or business was sold or exchanged by the 
corporation). However, if the amount of the rents includible under 
section 543(a)(7) and this subparagraph constitutes 50 percent or more 
of the gross income of the corporation, such rents shall not be 
considered to be personal holding company income.
    (11) Mineral, oil, or gas royalties. (i) The income from mineral, 
oil, or gas royalties is to be included as personal holding company 
income, unless (a) the aggregate amount of such royalties constitutes 50 
percent or more of the gross income of the corporation for the taxable 
year and (b) the aggregate amount of deductions allowable under section 
162 (other than compensation for personal services rendered by the 
shareholders of the corporation) equals 15 percent or more of the gross 
income of the corporation for the taxable year.
    (ii) The term mineral, oil, or gas royalties means all royalties, 
including overriding royalties and, to the extent not treated as loans 
under section 636, mineral production payments, received from any 
interest in mineral, oil, or gas properties. The term mineral includes 
those minerals which are included within the meaning of the term 
minerals in the regulations under section 611.
    (iii) The first sentence of subdivision (ii) of this subparagraph 
shall apply to overriding royalties received from the sublessee by the 
operating company which originally leased and developed the natural 
resource property in respect of which such overriding royalties are 
paid, and to mineral, oil, or gas production payments, only with respect 
to amounts received after September 30, 1958.
    (12) Copyright royalties--(i) In general. The income from copyright 
royalties constitutes, generally, personal holding company income. 
However, for taxable years beginning after December 31, 1959, those 
copyright royalties which come within the definition of copyright 
royalties in section 543(a)(9) and subdivision (iv) of this subparagraph 
shall

[[Page 331]]

be excluded from personal holding company income only if the conditions 
set forth in subdivision (ii) of this subparagraph are satisfied.
    (ii) Exclusion from personal holding company income. For taxable 
years beginning after December 31, 1959, copyright royalties (as defined 
in section 543(a)(9) and subdivision (iv) of this subparagraph) shall be 
excluded from personal holding company income only if the conditions set 
forth in (a), (b), and (c) of this subdivision are met.
    (a) Such copyright royalties for the taxable year must constitute 50 
percent or more of the corporation's gross income. For this purpose, 
copyright royalties shall be computed by excluding royalties received 
for the use of, or the right to use, copyrights or interests in 
copyrights in works created, in whole or in part, by any person who, at 
any time during the corporation's taxable year, is a shareholder.
    (b) Personal holding company income for the taxable year must be 10 
percent or less of the corporation's gross income. For this purpose, 
personal holding company income shall be computed by excluding (1) 
copyright royalties (except that there shall be included royalties 
received for the use of, or the right to use, copyrights or interests in 
copyrights in works created, in whole or in part, by any shareholder 
owning, at any time during the corporation's taxable year, more than 10 
percent in value of the outstanding stock of the corporation), and (2) 
dividends from any corporation in which the taxpayer owns, on the date 
the taxpayer becomes entitled to the dividends, at least 50 percent of 
all classes of stock entitled to vote and at least 50 percent of the 
total value of all classes of stock, provided the corporation which pays 
the dividends meets the requirements of subparagraphs (A), (B), and (C) 
of section 543(a)(9).
    (c) The aggregate amount of the deductions allowable under section 
162 must constitute 50 percent or more of the corporation's gross income 
for the taxable year. For this purpose, the deductions allowable under 
section 162 shall be computed by excluding deductions for compensation 
for personal services rendered by, and deductions for copyright and 
other royalties to, shareholders of the corporation.
    (iii) Determination of stock value and stock ownership. For purposes 
of section 543(a)(9) and this subparagraph, the following rules shall 
apply:
    (a) The amount and value of the outstanding stock of a corporation 
shall be determined in accordance with the rules set forth in the last 
two sentences of paragraph (b) and in paragraph (c) of Sec.  1.542-3.
    (b) The ownership of stock shall be determined in accordance with 
the rules set forth in section 544 and Sec. Sec.  1.544-1 through 1.544-
7.
    (c) Any person who is considered to own stock within the meaning of 
section 544 and Sec. Sec.  1.544-1 through 1.544-7 shall be a 
shareholder.
    (iv) Copyright royalties defined. For purposes of section 543(a)(9) 
and this subparagraph, the term copyright royalties means compensation, 
however designated, for the use of, or the right to use, copyrights in 
works protected by copyright issued under title 17 of the United States 
Code (other than by reason of section 2 or 6 thereof), and to which 
copyright protection is also extended by the laws of any foreign country 
as a result of any international treaty, convention, or agreement to 
which the United States is a signatory. Thus, copyright royalties 
includes not only royalties from sources within the United States under 
protection of United States laws relating to statutory copyrights but 
also royalties from sources within a foreign country with respect to 
United States statutory copyrights protected in such foreign country by 
any international treaty, convention, or agreement to which the United 
States is a signatory. The term copyright royalties includes 
compensation for the use of, or right to use, an interest in any such 
copyrighted works as well as payments from any person for performing 
rights in any such copyrighted works.
    (v) Compensation which is rent. Section 543(a)(9) and subdivisions 
(i) through (iv) of this subparagraph shall not apply to compensation 
which is

[[Page 332]]

rent within the meaning of the second sentence of section 543(a)(7).

[T.D. 6500, 25 FR 11737, Nov. 26, 1960, as amended by T.D. 6739, 29 FR 
7713, June 17, 1964; T.D. 7261, 38 FR 5467, Mar. 1, 1973]



Sec.  1.543-2  Limitation on gross income and personal holding company
income in transactions involving stocks, securities, and commodities.

    (a) Under section 543(b)(1) the gains which are to be included in 
gross income, and in personal holding company income with respect to 
transactions described in section 543(a)(2) and paragraph (b)(5) of 
Sec.  1.543-1, shall be the net gains from the sale or exchange of stock 
or securities. If there is an excess of losses over gains from such 
transactions, such excess (or net loss) shall not be used to reduce 
gross income or personal holding company income for purposes of the 
personal holding company tax. Similarly, under section 543(b)(2) the 
gains which are to be included in gross income, and in personal holding 
company income with respect to transactions described in section 
543(a)(3) and paragraph (b)(6) of Sec.  1.543-1, shall be the net gains 
from commodity transactions which reflect personal holding company 
income. Any excess of losses over gains from such transactions 
(resulting in a net loss) shall not be used to reduce gross income or 
personal holding company income. The capital loss carryover under 
section 1212 shall not be taken into account.
    (b) The application of section 543(b) may be illustrated by the 
following examples:

    Example 1. The P Corporation, not a regular dealer in stocks and 
securities, received rentals of $250,000 for its property from a 25-
percent shareholder, and also had gains of $50,000 during the taxable 
year from the sale of stocks and securities. It also had losses on the 
sale of stocks and securities in the amount of $30,000. Accordingly, P 
Corporation had gross income during the taxable year of $270,000 
($250,000 plus $20,000 net gain from the sales of stocks and 
securities). It had personal holding company income of $20,000. (The 
rentals of $250,000 would not be personal holding company income under 
section 543(a)(6) since the personal holding company income of the 
corporation, $20,000 (after excluding any such income described in 
section 543(a)(6)), is not more than 10 percent of its gross income.)
    Example 2. The R Corporation, not a regular dealer in stocks or 
securities, realized total gains during the taxable year of $900,000 
from commodity futures transactions and $200,000 from the sales of 
stocks and securities. It also sustained total losses of $1,000,000 on 
such commodity futures transactions, resulting in a net gain for the 
taxable year or $100,000. None of the commodity futures transactions are 
hedging or other types of futures transactions excluded from the 
application of section 543(a)(3). No part of the loss on commodity 
futures transactions is to be taken into account in determining personal 
holding company income and gross income for personal holding company tax 
purposes for the taxable year. The full amount of the $200,000 in gains 
from the sales of stocks and securities is to be included in personal 
holding company income and in gross income for personal holding company 
tax purposes for the taxable year.



Sec.  1.544-1  Constructive ownership.

    (a) Rules relating to the constructive ownership of stock are 
provided by section 544 for the purpose of determining whether the stock 
ownership requirements of the following sections are satisfied:
    (1) Section 542(a)(2), relating to ownership of stock by five or 
fewer individuals.
    (2) Section 543(a)(5), relating to personal holding company income 
derived from personal service contracts.
    (3) Section 543(a)(6), relating to personal holding company income 
derived from property used by shareholders.
    (4) Section 543(a)(9), relating to personal holding company income 
derived from copyright royalties.
    (b) Section 544 provides four general rules with respect to 
constructive ownership. These rules are:
    (1) Constructive ownership by reason of indirect ownership. See 
section 544(a)(1) and Sec.  1.544-2.
    (2) Constructive ownership by reason of family and partnership 
ownership. See section 544(a) (2), (4), (5), and (6), and Sec. Sec.  
1.544-3, 1.544-6, and 1.544-7.
    (3) Constructive ownership by reason of ownership of options. See 
section 544(a) (3), (4), (5), and (6), and Sec. Sec.  1.544-4, 1.544-6, 
and 1.544-7.
    (4) Constructive ownership by reason of ownership of convertible 
securities. See section 544(b) and Sec.  1.544-5.

[[Page 333]]


Each of the rules referred to in subparagraphs (2), (3), and (4) of this 
paragraph is applicable only if it has the effect of satisfying the 
stock ownership requirement of the section to which applicable; that is, 
when applied to section 542(a)(2), its effect is to make the corporation 
a personal holding company, or when applied to section 543(a)(5), 
section 543(a)(6), or section 543(a)(9), its effect is to make the 
amounts described in such provisions includible as personal holding 
company income.
    (c) All forms and classes of stock, however denominated, which 
represent the interests of shareholders, members, or beneficiaries in 
the corporation shall be taken into consideration in applying the 
constructive ownership rules of section 544.
    (d) For rules applicable in treating constructive ownership, 
determined by one application of section 544, as actual ownership for 
purposes of a second application of section 544, see section 544(a)(5) 
and Sec.  1.544-6.

[T.D. 6500, 25 FR 11737, Nov. 26, 1960, as amended by T.D. 6739, 29 FR 
7715, June 17, 1964]



Sec.  1.544-2  Constructive ownership by reason of indirect ownership.

    The following example illustrates the application of section 
544(a)(1), relating to constructive ownership by reason of indirect 
ownership:

    Example. A and B, two individuals, are the exclusive and equal 
beneficiaries of a trust or estate which owns the entire capital stock 
of the M Corporation. The M Corporation in turn owns the entire capital 
stock of the N Corporation. Under such circumstances the entire capital 
stock of both the M Corporation and the N Corporation shall be 
considered as being owned equally by A and B as the individuals owning 
the beneficial interest therein.



Sec.  1.544-3  Constructive ownership by reason of family and partnership ownership.

    (a) The following example illustrates the application of section 
544(a)(2), relating to constructive ownership by reason of family and 
partnership ownership.

    Example. The M Corporation at some time during the last half of the 
taxable year, had 1,800 shares of outstanding stock, 450 of which were 
held by various individuals having no relationship to one another and 
none of whom were partners, and the remaining 1,350 were held by 51 
shareholders as follows:

----------------------------------------------------------------------------------------------------------------
          Relationships               Shares          Shares          Shares          Shares          Shares
----------------------------------------------------------------------------------------------------------------
An individual...................          (A)100           (B)20           (C)20           (D)20           (E)20
His father......................          (AF)10          (BF)10          (CF)10          (DF)10          (EF)10
His wife........................          (AW)10          (BW)40          (CW)40          (DW)40          (EW)40
His brother.....................          (AB)10          (BB)10          (CB)10          (DB)10          (EB)10
His son.........................          (AS)10          (BS)40          (CS)40          (DS)40          (ES)40
His daughter by former marriage
 (son's.........................
   half-sister).................        (ASHS)10        (BSHS)40        (CSHS)40        (DSHS)40        (ESHS)40
His brother's wife..............         (ABW)10         (BBW)10         (CBW)10        (DBW)160         (EBW)10
His wife's father...............         (AWF)10         (BWF)10        (CWF)110         (DWF)10         (EWF)10
His wife's brother..............         (AWB)10         (BWB)10         (CWB)10         (DWB)10         (EWB)10
His wife's brother's wife.......        (AWBW)10        (BWBW)10        (CWBW)10        (DWBW)10       (EWBW)110
Individual's partner............          (AP)10  ..............  ..............  ..............  ..............
----------------------------------------------------------------------------------------------------------------


By applying the statutory rule provided in section 544(a)(2) five 
individuals own more than 50 percent of the outstanding stock as 
follows:

A (including AF, AW, AB, AS, ASHS, AP)..........................     160
B (including BF, BW, BB, BS, BSHS)..............................     160
CW (including C, CS, CWF, CWB)..................................     220
DB (including D, DF, DBW).......................................     200
EWB (including EW, EWF, EWBW)...................................     170
                                                                 -------
    Total, or more than 50 percent..............................     910
 

Individual A represents the obvious case where the head of the family 
owns the bulk of the family stock and naturally is the head of the 
group. A's partner owns 10 shares of the stock. Individual B represents 
the case where he is still head of the group because of the ownership of 
stock by his immediate family. Individuals C and D represent cases where 
the individuals fall in groups headed in C's case by his wife and in D's 
case by his brother because of the preponderance of holdings on the part 
of relatives by marriage. Individual E represents the case where the 
preponderant holdings of others eliminate that individual from the 
group.


[[Page 334]]


    (b) For the restriction on the applicability of the family and 
partnership ownership rules of this section, see paragraph (b) of Sec.  
1.544-1. For rules relating to constructive ownership as actual 
ownership, see Sec.  1.544-6.



Sec.  1.544-4  Options.

    The shares of stock which may be acquired by reason of an option 
shall be considered to be constructively owned by the individual having 
the option to acquire such stock. For example: If C, an individual, on 
March 1, 1955, purchases an option, or otherwise comes into possession 
of an option, to acquire 100 shares of the capital stock of M 
Corporation, such 100 shares of stock shall be considered to be 
constructively owned by C as if C had actually acquired the stock on 
that date. If C has an option on an option (or one of a series of 
options) to acquire such stock, he shall also be considered to have 
constructive ownership of the stock which may be acquired by reason of 
the option (or the series of options). Under such circumstances, C shall 
be considered to have acquired constructive ownership of the stock on 
the date he acquired his option. For the restriction on the 
applicability of the rule of this section, see paragraph (b) of Sec.  
1.544-1.



Sec.  1.544-5  Convertible securities.

    Under section 544(b) outstanding securities of a corporation such as 
bonds, debentures, or other corporate obligations, convertible into 
stock of the corporation (whether or not convertible during the taxable 
year) shall be considered as outstanding stock of the corporation. The 
consideration of convertible securities as outstanding stock is subject 
to the exception that, if some of the outstanding securities are 
convertible only after a later date than in the case of others, the 
class having the earlier conversion date may be considered as 
outstanding stock although the others are not so considered, but no 
convertible securities shall be considered as outstanding stock unless 
all outstanding securities having a prior conversion date are also so 
considered. For example, if outstanding securities are convertible in 
1954, 1955 and 1956, those convertible in 1954 can be properly 
considered as outstanding stock without so considering those convertible 
in 1955 or 1956, and those convertible in 1954 and 1955 can be properly 
considered as outstanding stock without so considering those convertible 
in 1956. However, the securities convertible in 1955 could not be 
properly considered as outstanding stock without so considering those 
convertible in 1954 and the securities convertible in 1956 could not be 
properly considered as outstanding stock without so considering those 
convertible in 1954 and 1955. For the restriction on the applicability 
of the rule of this section, see paragraph (b) of Sec.  1.544-1.



Sec.  1.544-6  Constructive ownership as actual ownership.

    (a) General rules. (1) Stock constructively owned by a person by 
reason of the application of the rule provided in section 544(a)(1), 
relating to stock not owned by an individual, shall be considered as 
actually owned by such person for the purpose of again applying such 
rule or of applying the family and partnership rule provided in section 
544(a)(2), in order to make another person the constructive owner of 
such stock, and
    (2) Stock constructively owned by a person by reason of the 
application of the option rule provided in section 544(a)(3) shall be 
considered as actually owned by such person for the purpose of applying 
either the rule provided in section 544(a)(1), relating to stock not 
owned by an individual, or the family and partnership rule provided in 
section 544(a)(2) in order to make another person the constructive owner 
of such stock, but
    (3) Stock constructively owned by an individual by reason of the 
application of the family and partnership rule provided in section 
544(a)(2) shall not be considered as actually owned by such individual 
for the purpose of again applying such rule in order to make another 
individual the constructive owner of such stock.
    (b) Examples. The application of this section may be illustrated by 
the following examples:

    Example 1. A's wife, AW, owns all the stock of the M Corporation, 
which in turn owns all the stock of the O Corporation. The O Corporation 
in turn owns all the stock of the P

[[Page 335]]

Corporation. Under the rule provided in section 544(a)(1), relating to 
stock not owned by an individual, the stock in the P Corporation owned 
by the O Corporation is considered to be owned constructively by the M 
Corporation, the sole shareholder of the O Corporation. Such 
constructive ownership of the stock of the M Corporation is considered 
as actual ownership for the purpose of again applying such rule in order 
to make AW, the sole shareholder of the M Corporation, the constructive 
owner of the stock of the P Corporation. Similarly, the constructive 
ownership of the stock by AW is considered as actual ownership for the 
purpose of applying the family and partnership rule provided in section 
544(a)(2) in order to make A the constructive owner of the stock of the 
P Corporation, if such application is necessary for any of the purposes 
set forth in paragraph (b) of Sec.  1.544-1. But the stock thus 
constructively owned by A may not be considered as actual ownership for 
the purpose of again applying the family and partnership rule in order 
to make another member of A's family, for example, A's father, the 
constructive owner of the stock of the P Corporation.
    Example 2. B, an individual, owns all the stock of the R Corporation 
which has an option to acquire all the stock of the S Corporation, owned 
by C, an individual, who is not related to B. Under the option rule 
provided in section 544(a)(3) the R Corporation may be considered as 
owning constructively the stock of the S Corporation owned by C. Such 
constructive ownership of the stock by the R Corporation is considered 
as actual ownership for the purpose of applying the rule provided in 
section 544(a)(1), relating to stock not owned by an individual, in 
order to make B, the sole shareholder of the R Corporation, the 
constructive owner of the stock of the S Corporation. The stock thus 
constructively owned by B by reason of the application of the rule 
provided in section 544(a)(1) likewise is considered as actual ownership 
for the purpose, if necessary, of applying the family and partnership 
rule provided in section 544(a)(2), in order to make another member of 
B's family, for example, B's wife, BW, the constructive owner of the 
stock of the S Corporation. However, the family and partnership rule 
could not again be applied so as to make still another individual the 
constructive owner of the stock of the S Corporation, that is, the stock 
constructively owned by BW could not be considered as actually owned by 
her in order to make BW's father the constructive owner of such stock by 
a second application of the family and partnership rule.



Sec.  1.544-7  Option rule in lieu of family and partnership rule.

    (a) If, in determining the ownership of stock, such stock may be 
considered as constructively owned by an individual by an application of 
either the family and partnership rule (section 544(a)(2)) or the option 
rule (section 544(a)(3)), such stock shall be considered as owned 
constructively by the individual by reason of the application of the 
option rule.
    (b) The application of this section may be illustrated by the 
following example:

    Example. Two brothers, A and B, each own 10 percent of the stock of 
the M Corporation, and A's wife, AW, also owns 10 percent of the stock 
of such corporation. AW's husband, A, has an option to acquire the stock 
owned by her at any time. It becomes necessary, for one of the purposes 
stated in section 544(a)(4), to determine the stock ownership of B in 
the M Corporation. If the family and partnership rule were the only rule 
that applied in the case, B would be considered, under that rule, as 
owning 20 percent of the stock of the M Corporation, namely, his own 
stock plus the stock owned by his brother. In that event, B could not be 
considered as owning the stock held by AW since (1) AW is not a member 
of B's family and (2) the constructive ownership of such stock by A 
through the application of the family and partnership rule in his case 
is not considered as actual ownership so as to make B the constructive 
owner by a second application of the same rule with respect to the 
ownership of the stock. However, there is more than the family and 
partnership rule involved in this example. As the holder of an option 
upon the stock, A may be considered the constructive owner of his wife's 
stock by the application of the option rule and without reference to the 
family relationship between A and AW. If A is considered as owning the 
stock of his wife by application of the option rule, then such 
constructive ownership by A is regarded as actual ownership for the 
purpose of applying the family and partnership rule so as to make 
another member of A's family, for example, B, the constructive owner of 
the stock. Hence, since A may be considered as owning his wife's stock 
by applying either the family-partnership rule or the option rule, the 
provisions of section 544(a)(6) apply and accordingly A must be 
considered the constructive owner of his wife's stock under the option 
rule rather than the family-partnership rule. B thus becomes the 
constructive owner of 30 percent of the stock of the M corporation, 
namely, his own 10 percent, A's 10 percent, and AW's 10 percent 
constructively owned by A as the holder of an option on the stock.

[[Page 336]]



Sec.  1.545-1  Definition.

    (a) Undistributed personal holding company income is the amount 
which is subject to the personal holding company tax imposed under 
section 541. Undistributed personal holding company income is the 
taxable income of the corporation adjusted in the manner described in 
section 545(b) and Sec.  1.545-2, and section 545(c) and Sec.  1.545-3, 
less the deduction for dividends paid. See part IV (section 561 and 
following), subchapter G, chapter 1 of the Code, and the regulations 
thereunder, relating to the dividends paid deduction.
    (b) For purposes of the imposition of the personal holding company 
tax on a foreign corporation, resident or nonresident, which files or 
causes to be filed a return, the undistributed personal holding company 
income shall be computed on the basis of the taxable income from sources 
within the United States, and such income shall be adjusted in 
accordance with the principles of section 545(b) and Sec.  1.545-2, and 
section 545(c) and Sec.  1.545-3. For purposes of the imposition of such 
tax on a foreign corporation, resident or nonresident, which files no 
return, the undistributed personal holding company income shall be 
computed on the basis of the gross income from sources within the United 
States without allowance of any deductions. For purposes of this 
paragraph, a nonresident foreign corporation will be considered to have 
filed a return for any taxable year ending before September 9, 1958, if 
the return for any such taxable year is filed on or before February 5, 
1960.

[T.D. 6949, 33 FR 5525, Apr. 9, 1968]



Sec.  1.545-2  Adjustments to taxable income.

    (a) Taxes--(1) General rule. (i) In computing undistributed personal 
holding company income for any taxable year, there shall be allowed as a 
deduction the amount by which Federal income and excess profits taxes 
accrued during the taxable year exceed the credit provided by section 33 
(relating to taxes of foreign countries and possessions of the United 
States), and the income, war profits, and excess profits taxes of 
foreign countries and possessions of the United States accrued during 
the taxable year (to the extent provided by subparagraph (3) of this 
paragraph), except that no deduction shall be allowed for (a) the 
accumulated earnings tax imposed by section 531 (or a corresponding 
section of a prior law), (b) the personal holding company tax imposed by 
section 541 (or a corresponding section of a prior law), and (c) the 
excess profits tax imposed by subchapter E, chapter 2 of the Internal 
Revenue Code of 1939, for taxable years beginning after December 31, 
1940. The deduction is for taxes for the taxable year, determined under 
the accrual method of accounting, regardless of whether the corporation 
uses an accrual method of accounting, the cash receipts and disbursement 
method, or any other allowable method of accounting. In computing the 
amount of taxes accrued, an unpaid tax which is being contested is not 
considered accrued until the contest is resolved.
    (ii) However, the taxpayer shall deduct taxes paid, rather than 
taxes accrued, if it used that method with respect to Federal taxes for 
each taxable year for which it was subject to the tax imposed by section 
500 of the Internal Revenue Code of 1939, unless an election is made 
under subparagraph (2) of this paragraph to deduct taxes accrued.
    (2) Election by taxpayer which deducted taxes paid. (i) If the 
corporation was subject to the personal holding company tax imposed by 
section 500 of the Internal Revenue Code of 1939 and, for the purpose of 
that tax, deducted Federal taxes paid rather than such taxes accrued for 
each taxable year for which it was subject to such taxes, the 
corporation may elect for any taxable year ending after June 30, 1954, 
to deduct taxes accrued, including taxes of foreign countries and 
possessions of the United States, rather than taxes paid, for the 
purposes of the tax imposed by section 541 of the Internal Revenue Code 
of 1954. The election shall be made by deducting such taxes accrued on 
Schedule PH, Form 1120, to be filed with the return. The schedule shall, 
in addition, contain a statement that the corporation has made such 
election and shall set forth the year to which such election was first 
applicable. The deduction of taxes accrued in the year of election 
precludes the deduction of

[[Page 337]]

taxes paid during such year. The election, if made, shall be irrevocable 
and the deduction for taxes accrued shall be allowed for the year of 
election and for all subsequent taxable years.
    (ii) Pursuant to section 7851(a)(1)(C), the election provided for in 
subdivision (i) of this subparagraph may be made with respect to a 
taxable year ending after June 30, 1954, even though such taxable year 
is subject to the Internal Revenue Code of 1939.
    (3) Taxes of foreign countries and United States possessions. In 
determining undistributed personal holding company income for any 
taxable year, if the taxpayer chooses the benefits of section 901 for 
such taxable year, a deduction shall be allowed for:
    (i) The income, war profits, and excess profits taxes imposed by 
foreign countries or possessions of the United States and accrued (or 
paid, if required under subparagraph (1)(ii) of this paragraph) during 
such taxable year, and
    (ii) In the case of a domestic corporation, the foreign income taxes 
deemed to be paid for such taxable year under section 902(a) in 
accordance with Sec. Sec.  1.902-1 and 1.902-2 or section 960(a)(1) in 
accordance with Sec.  1.960-7.

In no event shall the amount under subdivision (ii) of this subparagraph 
exceed the amount includible in gross income with respect to such taxes 
under section 78 and Sec.  1.78-1. The credit for such taxes provided by 
section 901 shall not be allowed against the personal holding company 
tax imposed by section 541. See section 901(a).
    (b) Charitable contributions--(1) Taxable years beginning before 
January 1, 1970. (i) Section 545(b)(2) provides that, in computing the 
deduction for charitable contributions for purposes of determining 
undistributed personal holding company income of a corporation for 
taxable years beginning before January 1, 1970, the limitations in 
section 170(b)(1) (A) and (B), relating to charitable contributions by 
individuals, shall apply and section 170(b) (2) and (5), relating to 
charitable contributions by corporations and carryover of certain excess 
charitable contributions made by individuals, respectively, shall not 
apply.
    (ii) Although the limitations of section 170(b)(1) (A) and (B) are 
10 and 20 percent, respectively, of the individual's adjusted gross 
income, the limitations are applied for purposes of section 545(b)(2) by 
using 10 and 20 percent, respectively, of the corporation's taxable 
income as adjusted for purposes of section 170(b)(2), that is, the same 
amount of taxable income to which the 5-percent limitation applied. 
Thus, the term adjusted gross income when used in section 170(b)(1) 
means the corporation's taxable income computed with the adjustments, 
other than the 5-percent limitation, provided in the first sentence of 
section 170(b)(2). However, a further adjustment for this purpose is 
that the taxable income shall also be computed without the deduction of 
the amount disallowed under section 545(b)(8), relating to expenses and 
depreciation applicable to property of the taxpayer. The carryover of 
charitable contributions made in a prior year, otherwise allowable as a 
deduction in computing taxable income to the extent provided in section 
170(b)(2) and, with respect to contributions paid in taxable years 
beginning after December 31, 1963, in section 170(b)(5), shall not be 
allowed as a deduction in computing undistributed personal holding 
company income for any taxable year.
    (iii) See Sec.  1.170-2 with respect to the charitable contributions 
to which the 10-percent limitation is applicable and the charitable 
contributions to which the 20-percent limitation is applicable.
    (2) Taxable years beginning after December 31, 1969. (i) Section 
545(b)(2) provides that, in computing the deduction allowable for 
charitable contributions for purposes of determining undistributed 
personal holding company income of a corporation for taxable years 
beginning after December 31, 1969, the limitations in section 170(b)(1) 
(A), (B), and (D)(i) (relating to charitable contributions by 
individuals) shall apply, and section 170(b)(1)(D)(ii) (relating to 
excess charitable contributions by individuals of certain capital gain 
property, section 170(b)(2) (relating to the 5-percent limitation on 
charitable contributions by corporations), and section 170(d) (relating 
to carryovers of excess contributions of individuals and corporations) 
shall not apply.

[[Page 338]]

    (ii) Although the limitations of section 170(b)(1) (A), (B), and 
(D)(i) are 50, 20, and 30 percent, respectively, of an individual's 
contribution base, these limitations are applied for purposes of section 
545(b)(2) by using 50, 20, and 30 percent, respectively, of the 
corporation's taxable income as adjusted for purposes of section 
170(b)(2), that is, the same amount of taxable income to which the 5-
percent limitation applies. Thus, the term contribution base when used 
in section 170(b)(1) means the corporation's taxable income computed 
with the adjustments, other than the 5-percent limitation, provided in 
section 170(b)(2). However, a further adjustment for this purpose is 
that the taxable income shall also be computed without the deduction of 
the amount disallowed under section 545(b)(8), relating to expenses and 
depreciation applicable to property of the taxpayer. The carryover of 
charitable contributions made in a prior year, otherwise allowable as a 
deduction in computing taxable income to the extent provided in section 
170(b)(1)(D)(ii) and (d), shall not be allowed as a deduction in 
computing undistributed personal holding company income for any taxable 
year.
    (iii) See Sec.  1.170A-8 for the rules with respect to the 
charitable contributions to which the 50-, 20-, and 30-percent 
limitations apply.
    (c) Special deductions disallowed. Part VIII, subchapter B, chapter 
1 of the Code, allows corporations, in computing taxable income, special 
deductions for such matters as partially tax- exempt interest, certain 
dividends received, dividends paid on certain preferred stock of public 
utilities, organizational expenses, etc. See section 241. Such special 
deductions, except the deduction provided by section 248 (relating to 
organizational expenses) shall be disallowed in computing undistributed 
personal holding company income.
    (d) Net operating loss. The net operating loss deduction provided in 
section 172 is not allowed for purposes of the computation of 
undistributed personal holding company income. For purposes of such a 
computation, however, there is allowed as a deduction the amount of the 
net operating loss (as defined in section 172(c)) for the preceding 
taxable year, except that, in computing undistributed personal holding 
company income for a taxable year beginning after December 31, 1957, the 
amount of such net operating loss shall be computed without the 
deductions provided in part VIII (section 241 and following, except 
section 248), subchapter B, chapter 1 of the Code.
    (e) Long-term capital gains. (1) There is allowed as a deduction the 
excess of the net long-term capital gain for the taxable year over the 
net short-term capital loss for such year, minus the taxes attributable 
to such excess, as provided in section 545(b)(5).
    (2) Section 631(c) (relating to gain or loss in the case of disposal 
of coal or domestic iron ore) shall have no application.
    (f) Bank affiliates. There is allowed the deduction provided by 
section 601 in the case of bank affiliates (as defined in section 2 of 
the Banking Act of 1933; 12 U.S.C. 221a (c)).
    (g) Payment of indebtedness incurred prior to January 1, 1934--(1) 
General rule. In computing undistributed personal holding company 
income, section 545(b)(7) provides that there shall be allowed as a 
deduction amounts used or irrevocably set aside to pay or to retire 
indebtedness of any kind incurred before January 1, 1934, if such 
amounts are reasonable with reference to the size and terms of such 
indebtedness. See Sec.  1.545-3 for the deduction in computing 
undistributed personal holding company income of amounts used or 
irrevocably set aside to pay or retire qualified indebtedness (as 
defined in paragraph (d) of Sec.  1.545-3).
    (2) Indebtedness. The term indebtedness means an obligation absolute 
and not contingent, to pay on demand or within a given time, in cash or 
other medium, a fixed amount. The term indebtedness does not include the 
obligation of a corporation on its capital stock. The indebtedness must 
have been incurred (or, if incurred by assumption, assumed) by the 
taxpayer before January 1, 1934. An indebtedness evidenced by bonds, 
notes, or other obligations issued by a corporation is ordinarily 
incurred as of the date such obligations are issued and the amount

[[Page 339]]

of such indebtedness is the amount represented by the face value of the 
obligations. In the case of refunding, renewal, or other change in the 
form of an indebtedness, the giving of a new promise to pay by the 
taxpayer will not have the effect of changing the date the indebtedness 
was incurred.
    (3) Amounts used or irrevocably set aside. The deduction is 
allowable, in any taxable year, only for amounts used or irrevocably set 
aside in that year. The use or irrevocable setting aside must be to 
effect the extinguishment or discharge of indebtedness. In the case of 
refunding, renewal, or other change in the form of an indebtedness, the 
mere giving of a new promise to pay by the taxpayer will not result in 
an allowable deduction. If amounts are set aside in one year, no 
deduction is allowable for such amounts for a later year in which 
actually paid. As long as all other conditions are satisfied, the 
aggregate amount allowable as a deduction for any taxable year includes 
all amounts (from whatever source) used and all amounts (from whatever 
source) irrevocably set aside, irrespective of whether in cash or other 
medium. Double deductions shall not be allowed.
    (4) Reasonableness of the amounts with reference to the size and 
terms of the indebtedness. (i) The reasonableness of the amounts used or 
irrevocably set aside must be determined by reference to the size and 
terms of the particular indebtedness. Hence, all the facts and 
circumstances with respect to the nature, scope, conditions, amount, 
maturity, and other terms of the particular indebtedness must be shown 
in each case.
    (ii) Ordinarily an amount used to pay or retire an indebtedness, in 
whole or in part, at or prior to the maturity and in accordance with the 
terms thereof will be considered reasonable, and may be allowable as a 
deduction for the year in which so used. However, if an amount has been 
set aside in a prior year for payment or retirement of the same 
indebtedness, the amount so set aside shall not be allowed as a 
deduction in the year of the payment.
    (iii) All amounts irrevocably set aside for the payment or 
retirement of an indebtedness in accordance with and pursuant to the 
terms of the obligation, for example, the annual contribution to 
trustees required by the provisions of a mandatory sinking fund 
agreement, will be considered as complying with the requirement of 
reasonableness. To be considered reasonable, it is not necessary that 
the plan of retirement provide for a retroactive setting aside of 
amounts for years prior to that in which the plan is adopted. However, 
if a voluntary plan was adopted before 1934, no adjustment is allowable 
in respect of the amounts set aside in the years prior to 1934.
    (5) Burden of proof. The burden of proof will rest upon the taxpayer 
to sustain the deduction claimed. Therefore, the taxpayer must furnish 
the information required by the return, and such other information as 
the district director may require in substantiation of the deduction 
claimed.
    (6) Allowance to a successor corporation. For allowance of deduction 
for pre-1934 indebtedness to a successor corporation, see section 
381(c)(15).
    (h) Expenses and depreciation applicable to property of the 
taxpayer. (1) In computing undistributed personal holding company income 
in the case of a personal holding company which owns or operates 
property, section 545(b)(8) provides a specific limitation with respect 
to the allowance of deductions for trade or business expenses and 
depreciation allocable to the operation or maintenance of such property. 
Under this limitation, these deductions shall not be allowed in an 
amount in excess of the aggregate amount of the rent or other 
compensation received for the use of, or the right to use, the property, 
unless it is established to the satisfaction of the Commissioner:
    (i) That the rent or other compensation received was the highest 
obtainable, or if none was received, that none was obtainable;
    (ii) That the property was held in the course of a business carried 
on bona fide for profit; and
    (iii) Either that there was reasonable expectation that the 
operation of the property would result in a profit, or that the property 
was necessary to the conduct of the business.
    (2) The burden of proof will rest upon the taxpayer to sustain the 
deduction

[[Page 340]]

claimed. If, in computing undistributed personal holding company income, 
a personal holding company claims deductions for expenses and 
depreciation allocable to the operation and maintenance of property 
owned or operated by the company, in an aggregate amount in excess of 
the rent or other compensation received for the use of, or the right to 
use, the property, it shall attach to its income tax return a statement 
setting forth its claim for allowance of the additional deductions, 
together with a complete statement of the facts and circumstances 
pertinent to its claim and the arguments on which it relies. Such 
statement shall set forth:
    (i) A description of the property;
    (ii) The cost or other basis to the corporation and the nature and 
value of the consideration paid for the property;
    (iii) The name and address of the person from whom the property was 
acquired and the date the property was acquired;
    (iv) The name and address of the person to whom the property is 
leased or rented, or the person permitted to use the property, and the 
number of shares of stock, if any, held by such person and the members 
of his family;
    (v) The nature and gross amount of the rent or other compensation 
received for the use of, or the right to use, the property during the 
taxable year and for each of the five preceding years and the amount of 
the expenses incurred with respect to, and the depreciation sustained 
on, the property for such years;
    (vi) Evidence that the rent or other compensation was the highest 
obtainable or, if none was received, a statement of the reasons 
therefore;
    (vii) A copy of the contract, lease or rental agreement;
    (viii) The purpose for which the property was used;
    (ix) The business, carried on by the corporation, with respect to 
which the property was held and the gross income, expenses, and taxable 
income derived from the conduct of such business for the taxable year 
and for each of the five preceding years;
    (x) A statement of any reasons which existed for expectation that 
the operation of the property would be profitable, or a statement of the 
necessity for the use of the property in the business of the 
corporation, and the reasons why the property was acquired; and
    (xi) Any other information pertinent to the taxpayer's claim.
    (i) Amount of a lien in favor of the United States. (1) If notices 
of lien are filed in the manner provided in section 6323(f), the amount 
of the liability to the United States outstanding at the close of the 
taxable year, and secured by such liens which are in effect at that 
time, shall be allowed as a deduction in computing undistributed 
personal holding company income. However, the amount of such deduction 
which may be allowed for any taxable year shall not exceed the taxable 
income (as adjusted for purposes of determining the undistributed 
personal holding company income, but without regard to the deduction 
under section 545(b)(9)) for such year. The fact that the amount of, or 
any part of, the outstanding obligation to the United States was 
deducted for one taxable year does not prevent its deduction for a 
subsequent taxable year to the extent the obligation is still 
outstanding at the close of the subsequent taxable year and is secured 
by a lien, notice of which has been filed.
    (2) Subparagraph (1) of this paragraph may be illustrated by the 
following example:

    Example. If the taxpayer (on the calendar year basis) is subject to 
a lien (notice of which has been properly filed) in the amount of 
$500,000 at the close of the calendar year 1954 and has taxable income 
of $400,000 for such taxable year, the deduction allowable by reason of 
the lien for the calendar year 1954 is $400,000. If, at the close of the 
taxable year ended December 31, 1955, the taxpayer is still subject to 
the same lien of $500,000 and it has taxable income of $450,000, a 
deduction is allowed by reason of such lien in the amount of $450,000.

    (3) When the obligation secured by the lien in favor of the United 
States has been satisfied or released, the sum of the amounts which have 
been allowed as deductions under section 545(b)(9) in respect of such 
obligation shall be restored to taxable income for the year in which 
such lien is satisfied

[[Page 341]]

or released. If only a part of the obligation secured by the lien has 
been satisfied, the sum of the amounts which have been allowed as 
deductions under section 545(b)(9) in respect of such part shall be 
included in taxable income for the year of the satisfaction for the 
purpose of determining undistributed personal holding company income. It 
should be noted, however, that only the sum of the amounts which have 
been allowed as deductions under section 545(b)(9) and subparagraph (1) 
of this paragraph shall be included in taxable income. Thus, any amounts 
which were allowed as deductions under section 504(e) of the Internal 
Revenue Code of 1939 shall not be included as taxable income for any 
taxable year under section 545(b)(9) and subparagraph (1) of this 
paragraph.
    (4) The application of subparagraph (3) of this paragraph may be 
illustrated by the following example:

    Example. Assume the same facts as in the example in subparagraph (2) 
of this paragraph, and assume further that the corporation has $100,000 
taxable income both for 1956 (before including the $400,000 described 
below) and for 1957. In 1956, the corporation pays $200,000 of the 
obligation, thereby reducing its liability from $500,000 to $300,000. In 
such case, $400,000 is included in taxable income in computing its 
undistributed personal holding company income for 1956, that is, the sum 
of the $200,000 deduction for 1954 and the $200,000 deduction for 1955 
in respect of the liability which is paid in 1956. In 1957, property of 
the corporation is discharged from the lien by reason of the fact that 
the value of the remaining property of the corporation exceeds double 
the outstanding liability. (See section 6325(b)(1).) Since this was not 
a release or satisfaction of the lien, no amount is added to taxable 
income for 1957 with respect to the property discharged from the lien. 
In 1958, the remaining property is released from the lien by reason of a 
bond being accepted under section 6325(a)(2). There is added to taxable 
income in computing undistributed personal holding company income for 
1958, $850,000, that is, the sum of the deductions allowed for 1954, 
1955, 1956, and 1957 in respect of the $300,000 liability, the lien for 
which was released in 1958. This amount of $850,000, is computed as 
follows:

----------------------------------------------------------------------------------------------------------------
                                                                                         Amount
                                                                           Deduction  attributable     Amount
                                                 Outstanding    Taxable   as limited     to part    attributable
                      Year                        liability     income    by taxable   payment of    to release
                                                                            income     $200,000 in   of lien in
                                                                                          1956          1958
----------------------------------------------------------------------------------------------------------------
1954...........................................     $500,000    $400,000    $400,000     $200,000      $200,000
1955...........................................      500,000     450,000     450,000      200,000       250,000
1956...........................................      300,000     500,000     300,000  ............      300,000
1957...........................................      300,000     100,000     100,000  ............      100,000
                                                                                                   =============
    Total......................................  ...........  ..........  ..........  ............      850,000
----------------------------------------------------------------------------------------------------------------

    (5)(i) If an amount has been included in undistributed personal 
holding company income of the personal holding company by reason of 
section 545(b)(9), any shareholder of the company may elect to compute 
his income tax with respect to such of his dividends as are attributable 
to such amount as though such dividends were received ratably over the 
period the lien was in effect.
    (ii) For purposes of section 545(b)(9), the dividends paid during 
the taxable year of the personal holding company (computed as of the 
close of such year) shall be deemed attributable first to undistributed 
personal holding company income by reason of section 545(b)(9) (computed 
as of the close of the taxable year of the personal holding company). If 
the period over which the lien was in effect consists of several taxable 
years of the personal holding company, the dividend deemed received for 
any taxable year shall be deemed received on the last day of such 
taxable year of the personal holding company.
    (iii) Such election shall be made in a statement showing the amount 
of the deduction under section 545(b)(9) for each taxable year of the 
period in which the lien was in effect, the amount of such deduction, if 
any, which was added to undistributed personal holding company income in 
a later year or years as a result of partial satisfaction or release of 
such lien, and the details thereof, the taxable

[[Page 342]]

year or years to which such dividends are allocable, and a computation 
of tax, on the basis of the election, for all taxable years affected by 
such ratable allocation of the dividends. Further, the statement shall 
show the district director's office in which the returns, for the years 
to which the dividends are allocable, were filed, the kind of returns 
which were filed (separate returns or joint returns), and the name and 
address under which the returns were filed. The statement shall be 
attached to the shareholder's return for the taxable year for which the 
dividend would be reported but for such election.
    (iv) The operation of this subparagraph may be illustrated as 
follows: If, in the example under subparagraph (4) of this paragraph, 
shareholder A owns 75 percent in value of the outstanding stock of the 
personal holding company, and receives a dividend of $540,000 from such 
company during 1958 (the total dividend distribution being $720,000) he 
may elect to compute his income tax with respect to the $540,000 in 
dividends for 1958 as if he had received $127,058.82 of such dividends 
for 1954 ($200,000/850,000 of $540,000), $158,823.53 of such dividends 
for 1955 ($250,000/850,000 of $540,000), $190,588.23 of such dividends 
for 1956 ($300,000/850,000 of $540,000), and $63,529.41 of such 
dividends for 1957 ($100,000/850,000 of $540,000). Accordingly, the tax 
computed for 1958 with respect to such dividends shall be the aggregate 
of the taxes attributable to such amounts had they been distributed in 
the respective years.

[T.D. 6500, 25 FR 11737, Nov. 26, 1960, as amended by T.D. 6805, 30 FR 
3209, Mar. 9, 1965; T.D. 6841, 30 FR 9305, July 27, 1965; T.D. 6949, 33 
FR 5526, Apr. 9, 1968; T.D. 7207, 37 FR 20796, Oct. 5, 1972; T.D. 7429, 
41 FR 35492, Aug. 23, 1976; T.D. 7649, 44 FR 60086, Oct. 18, 1979]



Sec.  1.545-3  Special adjustment to taxable income.

    (a) In general. In computing undistributed personal holding company 
income for any taxable year beginning after December 31, 1963, section 
545(c) (1) provides that, except as otherwise provided in section 
545(c), there shall be allowed as a deduction amounts used or amounts 
irrevocably set aside (to the extent reasonable with reference to the 
size and terms of the indebtedness) during such year to pay or retire 
qualified indebtedness (as defined in section 545(c)(3) and paragraph 
(d) of this section). The reasonableness of amounts irrevocably set 
aside shall be determined under the rules of paragraph (g)(4) of Sec.  
1.545-2.
    (b) Amounts used or irrevocably set aside--(1) In general. The 
deduction is allowable, in any taxable year, only for amounts used or 
irrevocably set aside in that year to extinguish or discharge qualified 
indebtedness. If amounts are set aside in 1 year, no deduction is 
allowable for a later year in which such amounts are actually paid. As 
long as all other conditions are satisfied, the aggregate amount 
allowable as a deduction for any taxable year includes all amounts (from 
whatever source) used and all amounts (from whatever source) irrevocably 
set aside, irrespective of whether in cash or other medium. The same 
item shall not be deducted more than once.
    (2) Refunding, etc., of qualified indebtedness. (i) A refunding, 
renewal or mere change in the form of a qualified indebtedness which 
does not involve a substantial change in the economic terms of the 
indebtedness will not result in an allowable deduction whether or not 
funds are obtained from such refunding, renewal, or change in form, and 
whether or not such funds are applied on the prior obligation, and will 
not constitute a reduction in the amount of such qualified indebtedness. 
For purposes of this section, if, in connection with a refunding, 
renewal, or other change in the form of an indebtedness, the rate of 
interest or principal amount of such debt, or the date when payment is 
due with respect to such debt or significantly changed, or if, after the 
refunding, renewal, or other change in the form of such debt, the 
creditor to whom such debt is owed is neither the creditor to whom such 
debt was owed before such refunding, renewal, or other change, nor a 
person standing in a relationship to such creditor described in section 
267(b), then a substantial change in the economic terms of such 
indebtedness will normally have occurred.

[[Page 343]]

    (ii) The application of this subparagraph may be illustrated by the 
following examples:

    Example 1. On December 31, 1963, M owes $10,000 to X represented by 
a 6-percent, 90-day note payable on January 31, 1964. On January 31, 
1964, M renews the debt, giving X a new 6-percent, 90-day note (payable 
on Apr. 30, 1964) and paying the accrued interest on the old note. Since 
the date when payment is due has been significantly changed, a 
substantial change in the economic terms of the indebtedness has 
occurred.
    Example 2. On December 31, 1963, S owes $5,000 to T represented by a 
6-percent note payable on January 1, 1965. On December 23, 1964, S 
liquidates the note, giving T a new note for $5,000 due on January 2, 
1965, and bearing interest at 6 percent. Since the transaction does not 
involve a substantial change in the economic terms of the indebtedness, 
the transaction will not result in an allowable deduction, and the 
amount of the qualified indebtedness will not be reduced.
    Example 3. (i) On December 31, 1963, Q owes $45,000 to R represented 
by a demand note. On July 1, 1964, Q renews $30,000 of the indebtedness 
by issuing a new demand note to R and liquidates $15,000 of the debt. 
Since the principal amount of the debt has been significantly changed, 
there has been a substantial change in the economic terms of the 
indebtedness.
    (ii) If Q had issued renewal notes for $44,000 and had paid only 
$1,000 of the total indebtedness, then a significant change in the 
principal amount of the debt would not have occurred and Q would have 
been entitled to only a $1,000 deduction (the amount actually paid 
during the taxable year). In addition, the amount of qualified 
indebtedness would have been reduced to $44,000.

    (c) Corporations to which applicable. Section 545(c)(2) describes 
the corporations to which section 545(c) applies. In order to qualify 
under section 545(c)(2), the corporation must be one:
    (1) Which for at least one of its two most recent taxable years 
ending before February 26, 1964, was not a personal holding company 
under section 542, but which would have been a personal holding company 
under section 542 for such taxable year if the law applicable for the 
first taxable year beginning after December 31, 1963, had been 
applicable to such taxable year; or
    (2) Which is an acquiring corporation treated as a corporation 
described in subparagraph (1) of this paragraph by reason of section 
381(c)(15) (relating to the carryover of certain indebtedness in 
corporate acquisitions), but only to the extent of the qualified 
indebtedness to which it has succeeded under section 381(c)(15) and the 
indebtedness referred to in paragraph (d)(1)(ii) of this section 
incurred to replace qualified indebtedness to which it has succeeded 
under section 381(c)(15)


The law applicable for the first taxable year beginning after December 
31, 1963, for purposes of this paragraph means part II (section 541 and 
following), subchapter G, chapter 1 of the Code as applicable to such 
year but does not include amendments to other parts of the Code first 
applicable with respect to such year. For an example of a corporation 
described in subparagraph (1) of this paragraph see paragraph (f)(1) of 
Sec.  1.333-5.
    (d) Qualified indebtedness--(1) General definition. Except as 
provided in subparagraphs (2), (3), and (4) of this paragraph the term 
qualified indebtedness means:
    (i) The outstanding indebtedness (as defined in subparagraph (6) of 
this paragraph) incurred after December 31, 1933, and before January 1, 
1964, by the taxpayer (or to which the taxpayer succeeded in a 
transaction to which section 381(c)(15) applies), and
    (ii) The outstanding indebtedness (as defined in subparagraph (6) of 
this paragraph) incurred after December 31, 1963, by the taxpayer (or to 
which the taxpayer succeeded in a transaction to which section 
381(c)(15) applies) for the purpose of making a payment or set-aside 
referred to in paragraph (a) of this section in the same taxable year of 
the debtor in which such indebtedness was incurred. An indebtedness 
shall be deemed not to have been incurred for the purpose of making a 
payment or set-aside referred to in paragraph (a) of this section when 
such indebtedness is a consequence of a refunding, renewal or mere 
change in the form of a qualified indebtedness which does not involve a 
substantial change in the economic terms of the qualified indebtedness. 
(See paragraph (b)(2) of this section for the meaning of substantial 
change in the economic terms of the indebtedness.) In the case of such a 
payment or set-aside which is made on or after the first day of the 
first taxable year beginning after December 31, 1963,

[[Page 344]]

such indebtedness incurred after December 31, 1963, is treated as 
qualified indebtedness only to the extent that the deduction from 
taxable income otherwise allowed by section 545(c)(1) with respect to 
such payment or set-aside is treated as non-deductible by reason of the 
election referred to in paragraph (e) of this section.
    (2) Exception for indebtedness owed to certain shareholders. For 
purposes of subparagraph (1) of this paragraph, qualified indebtedness 
does not include any amounts which were, at any time after December 31, 
1963, and before the payment or set-aside to which this section applies, 
owed directly or indirectly to a person who at such time owned more than 
10 percent in value of the taxpayer's outstanding stock. The rules of 
section 318(a) and the regulations thereunder apply for the purpose of 
determining ownership under this subparagraph. Amounts which cease to be 
qualified indebtedness by reason of this subparagraph may not 
subsequently become qualified indebtedness as a result of any change in 
the facts (for example, a subsequent sale of stock by the person to whom 
the amounts are directly or indirectly owed).
    (3) Reduction for amounts irrevocably set aside. For purposes of 
subparagraph (1) of this paragraph, qualified indebtedness with respect 
to a particular contract is reduced when and to the extent that amounts 
are irrevocably set aside to pay or retire such indebtedness. An amount 
is not considered to be irrevocably set aside if any person could use 
such amount for any purpose other than the retirement of the qualified 
indebtedness with respect to which it was set aside. No deduction is 
allowed under section 545(c)(1) and this section for payments out of 
amounts previously set aside. Thus, for example, if a corporation, which 
is a June 30 fiscal year taxpayer, incurs indebtedness of $1 million on 
February 1, 1962, and, in accordance with its contract of indebtedness, 
irrevocably sets aside $50,000 in a sinking fund on February 1, of each 
of the years 1963, 1964, and 1965, then its qualified indebtedness on 
January 1, 1964, is $950,000 ($1 million less one set-aside of $50,000 
in 1963). The corporation is not allowed a deduction under section 
545(c)(1) for the set-aside of $50,000 made during its taxable year 
ending on June 30, 1964, since section 545(c) is applicable only to 
taxable years beginning after December 31, 1963, but the qualified 
indebtedness is nevertheless reduced by such amount. The corporation is 
allowed a deduction of $50,000 for its taxable year ending June 30, 
1965, as a result of the set-aside made during such taxable year, and 
qualified indebtedness on July 1, 1965, is $850,000. No deduction is 
allowed to the corporation for a payment in any subsequent taxable year 
from the amounts so set aside.
    (4) Reduction on disposition of certain property. (i) Section 
545(c)(6) provides that the total amount of the taxpayer's qualified 
indebtedness (as determined under subdivision (ii) of this subparagraph) 
shall be reduced if property of a character subject to the allowance for 
exhaustion, wear and tear, obsolescence, amortization, or depletion is 
disposed of after December 31, 1963. The reduction is made pro rata (in 
accordance with subdivision (iii) of this subparagraph) for the taxable 
year of such disposition and is equal in total amount to the excess, if 
any, of:
    (a) The adjusted basis of the property disposed of (determined under 
section 1011 and the regulations thereunder) immediately before such 
disposition; over
    (b) The amount of qualified indebtedness which ceased to be 
qualified indebtedness with respect to the taxpayer by reason of the 
assumption of indebtedness by the transferee of the property disposed of 
(whether or not such indebtedness was incurred by the taxpayer in 
connection with the property disposed of).


For purposes of (b) of this subdivision, the transferee will be treated 
as having assumed qualified indebtedness if such transferee acquires 
real estate of which the taxpayer is the legal or equitable owner 
immediately before the transfer and which is subject to indebtedness 
that, with respect to the taxpayer, is qualified indebtedness 
immediately before the transfer, provided the taxpayer shows to the 
satisfaction of the Commissioner that under all the facts and 
circumstances it no longer bears the

[[Page 345]]

burden of discharging such indebtedness.
    (ii) The indebtedness reduced under the rule of this subparagraph is 
the qualified indebtedness which is outstanding with respect to the 
taxpayer immediately after the disposition referred to in subdivision 
(i) of this subparagraph.
    (iii) The reduction with respect to any particular contract of 
indebtedness under the rules of this subparagraph shall be determined by 
multiplying the total reduction (determined under subdivision (i) of 
this subparagraph) by the ratio which the amount of the qualified 
indebtedness owed with respect to such contract by the taxpayer on the 
date referred to in subdivision (ii) of this subparagraph bears to the 
aggregate qualified indebtedness owed by the taxpayer with respect to 
all contracts on such date.
    (5) Total debt consisting of both qualified and nonqualified 
indebtedness. In any case where, with respect to a particular contract 
of indebtedness, a part of the total indebtedness owed with respect to 
such contract is qualified indebtedness and the other part is 
indebtedness which is not qualified indebtedness, then, any amount paid 
or irrevocably set aside with respect to such contract shall be 
allocated between both such parts pro rata unless the taxpayer clearly 
indicates in its return the part of the payment or set-aside which shall 
be allocated to the qualified indebtedness.
    (6) Outstanding indebtedness. For purposes of determining qualified 
indebtedness, the term indebtedness has the same meaning that it has 
under section 545(b)(7) and paragraph (g)(2) of Sec.  1.545-2. 
Indebtedness ceases to be outstanding when the taxpayer no longer has an 
obligation absolute and not contingent with respect to the payment of 
such debt. An indebtedness evidenced by bonds, notes, or other 
obligations issued by a corporation is ordinarily incurred as of the 
date such obligations are issued, and the amount of such indebtedness is 
the amount represented by the face value of the obligations. However, a 
refunding, renewal, or mere change in the form of an indebtedness which 
does not involve a substantial change in the economic terms of the 
indebtedness will not have the effect of changing the date the 
indebtedness was incurred. (See paragraph (b)(2) of this section for the 
meaning of substantial change in the economic terms of the 
indebtedness.) For purposes of this section, the outstanding 
indebtedness of a taxpayer includes a mortgage or other security 
interest on real estate of which such taxpayer is the legal or equitable 
owner (even though the taxpayer is not directly liable on the underlying 
evidence of indebtedness secured by such mortgage or security interest) 
provided such taxpayer shows to the satisfaction of the Commissioner 
that under all of the facts and circumstances it bears the burden of 
discharging such indebtedness. Thus, for example, if X acquires from Y 
property which is subject to a mortgage (X not assuming the indebtedness 
underlying such mortgage) and if X actually bears the burden of 
discharging the indebtedness, then, after the date of acquisition, such 
underlying indebtedness is outstanding indebtedness with respect to X, 
and, since Y's obligation to pay is in fact contingent upon X failing to 
discharge the indebtedness, such indebtedness is not outstanding 
indebtedness with respect to Y.
    (7) Examples. The application of this paragraph may be illustrated 
by the following examples:

    Example 1. M Corporation, a calendar year taxpayer has $600,000 of 
indebtedness outstanding on December 31, 1963 (which was incurred after 
1933), represented by three demand notes. Individuals A and B (who are 
not shareholders) each hold one of M Corporation's notes in the amount 
of $150,000 and N Corporation (which is not a shareholder) holds M 
Corporation's note in the amount of $300,000. The note held by N 
Corporation is secured by a mortgage on certain depreciable real estate 
owned by M Corporation which has an adjusted basis to it on July 1, 
1964, of $500,000. On July 1, 1964, M Corporation sells the depreciable 
real estate to O Corporation in consideration for $200,000 in cash and 
the assumption by O Corporation of the indebtedness on the note held by 
N Corporation. M Corporation borrows $200,000 on September 30, 1964, of 
which amount $150,000 is simultaneously applied to liquidate the note 
held by B. M Corporation's qualified indebtedness is reduced on July 1, 
1964, by $300,000, the qualified indebtedness which ceased to be 
outstanding by reason of

[[Page 346]]

the transfer. In addition, the reduction (computed under section 
545(c)(6) and subparagraph (4) of this paragraph) of M Corporation's 
qualified indebtedness by reason of the disposition of depreciable 
property on July 1, 1964, is as follows:

Outstanding qualified indebtedness after reduction of           $300,000
 qualified indebtedness which ceased to be outstanding by
 reason of the transfer but before the sec. 545(c)(6)
 reduction..................................................
Reduced by:
  The excess of the adjusted basis of depreciable real           200,000
   estate disposed of on July 1, 1964 ($500,000), over the
   amount of qualified indebtedness assumed by O Corporation
   ($300,000)...............................................
                                                             -----------
Qualified indebtedness after reductions from transfer and        100,000
 assumption of indebtedness.................................
 


The pro-rata share of the reduction with respect to each debt is 
computed as follows:

Note held by A:
  Qualified indebtedness owed by taxpayer on the note held      $150,000
   by A before the disposition of depreciable property......
  Less the pro-rata share of the total reduction computed        100,000
   under subparagraph (4) of this paragraph allocable to
   such note $200,000 x ($150,000 / $300,000)...............
                                                             -----------
Qualified indebtedness owed on the note held by A after the       50,000
 transfer...................................................
                                                             ===========
Note held by B:
  Qualified indebtedness owed by taxpayer on the note held      $150,000
   by B before the transfer of depreciable property.........
  Less the pro-rata share of the total reduction computed        100,000
   under subparagraph (4) of this paragraph allocable to
   such note $200,000 x ($150,000 / $300,000)...............
                                                             -----------
  Qualified indebtedness owed on the note held by B after         50,000
   the transfer.............................................
                                                             ===========
 

Of the $150,000 paid by M Corporation on September 30, 1964, to retire 
the note held by B only $50,000 qualified as a use of an amount to pay 
or retire qualified indebtedness and, thus, only $50,000 is allowable as 
a deduction for purposes of computing undistributed personal holding 
company income for 1964.
    Example 2. The facts are the same as in example 1 except that M 
Corporation elects in accordance with paragraph (e) of this section not 
to deduct $25,000 of the $50,000 amount otherwise deductible. Then 
$25,000 of the $200,000 of new indebtedness incurred by M Corporation is 
qualified indebtedness. If the payment on the note held by B had not 
been made until January 1, 1965, then the new indebtedness would not be 
qualified indebtedness since the payment was not made in the taxable 
year in which the new indebtedness was incurred. If M Corporation pays 
$40,000 on April 1 and July 1, 1965, on the indebtedness incurred 
September 30, 1964, then (unless M indicates otherwise in its return for 
1965 in accordance with subparagraph (5) of this paragraph) the payments 
made on such dates must be allocated between qualified and nonqualified 
indebtedness in the following manner:

------------------------------------------------------------------------
                                                  Qualfied  Nonqualified
------------------------------------------------------------------------
April 1 payment:
  $40,000 x $25,000 (qualified) / $200,000          $5,000
   (total indebtedness).........................
  $40,000 x $175,000 (nonqualified) / $200,000    ........     $35,000
   (total indebtedness).........................
July 1 payment:
  $40,000 x $20,000 (qualified) / $160,000           5,000
   (total indebtedness).........................
  $40,000 x $140,000 (nonqualified) / $160,000    ........      35,000
   (total indebtedness).........................
                                                 -----------------------
      Total.....................................    10,000      70,000
------------------------------------------------------------------------


Thus, a total of $10,000 of the two payments would be considered used to 
pay or retire qualified indebtedness. The results in examples 1 and 2 
would be the same if O Corporation purchased the real estate subject to 
the indebtedness (not assuming the indebtedness) on the note held by N 
Corporation, provided M Corporation does not bear the burden of 
discharging such indebtedness after July 1, 1964.
    Example 3. C owns all of the 1000 shares of outstanding capital 
stock of P Corporation. On December 31, 1963, P Corporation, a calendar 
year taxpayer, owes $200,000 of outstanding indebtedness to D 
and$500,000 of outstanding indebtedness to E. These debts were incurred 
after 1933. On January 15, 1964, P Corporation pays $100,000 in partial 
liquidation of the $500,000 indebtedness. On March 15, 1964, P 
Corporation pays $50,000 into a sinking fund with respect to the 
$200,000 indebtedness owed to D. On April 15, 1964, D purchases one-half 
of the shares owned by C, constituting 50 percent in value of P 
Corporation's outstanding stock. P Corporation, on June 15, 1964, pays 
$50,000 into a sinking fund with respect to the indebtedness owed to D. 
For purposes of the March 15, 1964, set-aside, the indebtedness owed to 
D ($200,000) is qualified indebtedness. However, the indebtedness owed 
to D is not qualified indebtedness for purposes of the June set-aside 
with respect to such indebtedness since D is a person who after December 
31, 1963, and before the June set-aside, owned more than 10 percent in 
value of P Corporation's outstanding stock. Moreover, any subsequent 
set-asides made with respect to the indebtedness owed to D will not be 
made with respect to qualified indebtedness even if the shares owned by 
D are subsequently sold. Assuming no payments or set-asides are made by 
P Corporation after June 15, 1964, the P Corporation is entitled to a 
deduction of $150,000 under section 545(c)(1) for the calendar year 1964 
for amounts paid and for amounts irrevocably set aside to pay or retire 
qualified indebtedness, and the total qualified indebtedness at the end 
of 1964 is

[[Page 347]]

$400,000. No additional deduction is allowed in subsequent taxable years 
for amounts paid out of the amounts set aside in 1964.

    (e) Election not to deduct--(1) In general. Section 545(c)(4) 
provides that a taxpayer may elect to treat as nondeductible amounts 
otherwise deductible under section 545(c)(1) for the taxable year. The 
election shall be in the form of a statement of election filed on or 
before the 15th day of the third month following the close of the 
taxable year with respect to which the election applies. The election 
shall be irrevocable after such date.
    (2) Statement of election. The statement of election referred to in 
subparagraph (1) of this paragraph shall be attached to the taxpayer's 
Schedule PH (Form 1120) for the year with respect to which such election 
applies, if such schedule is filed on or before the date referred to in 
subparagraph (1) of this paragraph. If the taxpayer's Schedule PH (Form 
1120) is not filed on or before such date, then the statement of 
election shall clearly set forth the taxpayer's name, address, and 
employer identification number, shall be signed by an officer of the 
taxpayer who is authorized to sign a return of the taxpayer with respect 
to income, and shall be filed with the district director for the 
internal revenue district in which the taxpayer's income tax return (for 
the year with respect to which the election is applicable) would be 
filed. The following information shall be included in the statement of 
election:
    (i) A statement that the taxpayer wishes to elect in accordance with 
section 545(c)(4);
    (ii) The amounts paid or set aside which are to be treated as 
nondeductible under section 545(c)(4) and this section;
    (iii) All information necessary to identify the qualified 
indebtedness with respect to which such amounts were paid or set aside;
    (iv) The date on which such payments or set-asides were made; and
    (v) All information necessary to identify the indebtedness (referred 
to in section 545(c)(3)(A)(ii) and paragraph (d)(1)(ii) of this section) 
incurred for the purpose of making the payments or set-asides which the 
taxpayer elects to treat as nondeductible, including:
    (a) The date on which such indebtedness was incurred;
    (b) The amount of such indebtedness;
    (c) The person or persons to whom such indebtedness is owed; and
    (d) A statement that such person or persons do not own more than 10 
percent in value of the taxpayer's outstanding stock.
    (f) Limitation on deduction--(1) In general. Section 545(c)(5) 
provides certain limitations on the deduction otherwise allowed by 
section 545(c)(1). Such deduction is reduced by the sum of the following 
amounts:
    (i) The amount, if any, by which:
    (a) The deductions allowed for the taxable year and all preceding 
taxable years beginning after December 31, 1963, for exhaustion, wear 
and tear, obsolescence, amortization, or depletion (other than such 
deductions which are disallowed in computing undistributed personal 
holding company income under the rule of paragraph (h) of Sec.  1.545-
2), exceed
    (b) Any reduction, by reason of section 545(c)(5)(A) and this 
subdivision (i), of the deductions otherwise allowed by section 
545(c)(1) for such preceding years; and
    (ii) The amount, if any, by which:
    (a) The deductions allowed under section 545(b)(5) (relating to 
long-term capital gain deduction) in computing undistributed personal 
holding company income for the taxable year and all preceding taxable 
years beginning after December 31, 1963, exceed
    (b) Any reduction, by reason of section 545(c)(5)(B) and this 
subdivision (ii), of the deductions otherwise allowed by section 
545(c)(1) for such preceding years.
    (2) Allocation of reduction. If the total reduction required by 
subparagraph (1) of this paragraph is greater than the amount of the 
payment or set-aside made in respect of qualified indebtedness in a 
taxable year, then the portion of the reduction which is attributable to 
either section 545(c)(5)(A) or section 545(c)(5)(B), as the case may be, 
is that portion which bears the same ratio to the total reduction as the 
total reduction available under either section 545(c)(5)(A) or section 
545(c)(5)(B), respectively, bears to the total reduction available under 
both such sections.

[[Page 348]]

    (3) Example. The provisions of this paragraph may be illustrated by 
the following example:

    Example. (i) Q Corporation, a calendar year taxpayer, has qualified 
indebtedness of $400,000 on January 1, 1964, with respect to which 
payments of $50,000 are made on April 15, 1964, and 1965, and $300,000 
on April 15, 1966. In the years 1964 and 1966, Q Corporation is allowed 
a deduction under section 545(b)(5) of $50,000 for the excess of its net 
long-term capital gain over its net short-term capital loss, minus the 
taxes attributable to such excess. Q Corporation is allowed a 
depreciation deduction of $50,000 for each of its taxable years 1964 
through 1966. Q Corporation is a personal holding company with taxable 
income of $200,000 in each of the years 1964 and 1966.
    (ii) For 1964, in computing undistributed personal holding company 
income, Q Corporation's taxable income is reduced by $50,000 by reason 
of the deduction under section 545(b)(5). No part of the depreciation 
deduction is disallowed under the rule of paragraph (h) of Sec.  1.545-
2. Q Corporation's deduction for payment of qualified indebtedness 
otherwise allowable under section 545(c)(1) and this section is reduced 
to zero by reason of the depreciation deduction and the capital gains 
deduction. The reduction by reason of section 545(c)(5)(A) and 
subparagraph (1)(i) of this paragraph (depreciation) is $25,000 
[($50,000 / $100,000) x $50,000], and the reduction by reason of section 
545(c)(5)(B) and subparagraph (1) (ii) of this paragraph (capital gain) 
is $25,000 [($50,000 / $100,000) x $50,000].
    (iii) For 1966, Q Corporation is allowed a deduction for payment of 
qualified indebtedness of $100,000 computed as follows:

Amount paid in 1966 to retire         ..........  ..........    $300,000
 qualified indebtedness.............
Less the sum of:
  (a) Depreciation deductions           $150,000
   allowed for 1964 through 1966 (3
   x $50,000).......................
      Reduction of deductions in          25,000    $125,000
       preceding taxable years
       (1964).......................
                                     -----------------------------------
  (b) Deduction allowed under            100,000
   section 545(b)(5) (relating to
   long-term capital gains) for 1964
   through 1966.....................
      Reduction of deductions in          25,000      75,000     200,000
       preceding taxable years
       (1964).......................
                                     -----------------------------------
      Deduction after reduction.....  ..........  ..........     100,000
(iv) If, in the year 1966, Q Corporation's depreciation deduction had
 been limited for purposes of computing undistributed personal holding
 company income to $25,000 by reason of section 545(b)(8), then Q
 Corporation's deduction for payment of qualified indebtedness would be
 $125,000, computed as follows:
Amounts paid in 1966 to retire        ..........  ..........    $300,000
 qualified indebtedness.............
Less the sum of:
  (a) Depreciation deductions           $125,000
   allowed for 1964 through 1966....
      Reduction of deductions in          25,000
       preceding taxable year (1964)
                                     -----------------------------------
                                        $100,000
  (b) Deduction allowed under            100,000
   section 545(b)(5) (relating to
   long-term capital gains) for 1964
   through 1966.....................
      Reduction of deductions in          25,000      75,000     175,000
       preceding taxable years
       (1964).......................
                                     -----------------------------------
      Deduction after reduction.....  ..........  ..........     125,000
 

    (g) Burden of proof. The burden of proof rests upon the taxpayer to 
sustain the deduction claimed under this section. In addition to any 
information required by this section, the taxpayer must furnish the 
information required by the return, and such other information as the 
district director may require in substantiation of the deduction 
claimed.
    (h) Application of section 381(c)(15). Under section 381(c)(15), if 
an acquiring corporation assumes liability for qualified indebtedness in 
a transaction to which section 381(a) applies, then the acquiring 
corporation is considered to be the distributor or transferor 
corporation for purposes of section 545(c). Paragraph (c)(2) of this 
section reflects the application of section 381(c)(15) by including an 
acquiring corporation within the definition of corporation to which this 
section applies. Thus, the acquiring corporation is not required to meet 
the requirements of paragraph (c)(1) or paragraph (d)(1) of this section 
with respect to such acquired qualified indebtedness to which section 
381(c)(15) is applicable. All the other provisions of this section apply 
in full to the acquiring corporation with respect to such acquired 
indebtedness.

[T.D. 6949, 33 FR 5526, Apr. 9, 1968; 33 FR 6091, Apr. 20, 1968]

[[Page 349]]



Sec.  1.547-1  General rule.

    Section 547 provides a method under which, by virtue of dividend 
distributions, a corporation may be relieved from the payment of a 
deficiency in the personal holding company tax imposed by section 541 
(or by a corresponding provision of a prior income tax law), or may be 
entitled to a credit or refund of a part or all of any such deficiency 
which has been paid. The method provided by section 547 is to allow an 
additional deduction for a dividend distribution (which meets the 
requirements of this section) in computing undistributed personal 
holding company income for the taxable year for which a deficiency in 
personal holding company tax is determined. The additional deduction for 
deficiency dividends will not, however, be allowed for the purpose of 
determining interest, additional amounts, or assessable penalties, 
computed with respect to the personal holding company tax prior to the 
allowance of the additional deduction for deficiency dividends. Such 
amounts remain payable as if section 547 had not been enacted.



Sec.  1.547-2  Requirements for deficiency dividends.

    (a) In general. There are certain requirements which must be 
fulfilled before a deduction is allowed for a deficiency dividend under 
section 547 and this section. These are:
    (1) The taxpayer's liability for personal holding company tax shall 
be determined only in the manner provided in section 547(c) and 
paragraph (b)(1) of this section.
    (2) The deficiency dividend shall be paid by the corporation on, or 
within 90 days after, the date of such determination and prior to the 
filing of a claim under section 547(e) and paragraph (b)(2) of this 
section for deduction for deficiency dividends. This claim must be filed 
within 120 days after such determination.
    (3) The deficiency dividend must be of such a nature as would have 
permitted its inclusion in the computation of a deduction for dividends 
paid under section 561 for the taxable year with respect to which the 
liability for personal holding company tax exists, if it had been 
distributed during such year. See section 562 and Sec. Sec.  1.562-1 
through 1.562-3. In this connection, it should be noted that under 
section 316(b)(2), the term dividend means (in addition to the usual 
meaning under section 316(a)) any distribution of property (whether or 
not a dividend as defined in section 316(a)) made by a corporation to 
its shareholders, to the extent of its undistributed personal holding 
company income (determined under section 545 and Sec. Sec.  1.545-1 and 
1.545-2 without regard to section 316(b)(2)) for the taxable year in 
respect of which the distribution is made.
    (b) Special rules--(1) Nature and details of determination. (i) A 
determination of a taxpayer's liability for personal holding company tax 
shall, for the purposes of section 547, be established in the manner 
specified in section 547(c) and this subparagraph.
    (ii) The date of determination by a decision of the Tax Court of the 
United States is the date upon which such decision becomes final, as 
prescribed in section 7481.
    (iii) The slate upon which a judgment of a court becomes final, 
which is the date of the determination in such cases, must be determined 
upon the basis of the facts in the particular case. Ordinarily, a 
judgment of a United States district court becomes final upon the 
expiration of the time allowed for taking an appeal, if no such appeal 
is duly taken within such time; and a judgment of the United States 
Court of Claims becomes final upon the expiration of the time allowed 
for filing a petition for certiorari if no such petition is duly filed 
within such time.
    (iv) The date of determination by a closing agreement, made under 
section 7121, is the date such agreement is approved by the 
Commissioner.
    (v) A determination under section 547(c)(3) may be made by an 
agreement signed by the district director or such other official to whom 
authority to sign the agreement is delegated, and by or on behalf of the 
taxpayer. The agreement shall set forth the total amount of the 
liability for personal holding company tax for the taxable year or 
years. An agreement under this subdivision which is signed by the 
district director (or such other official to whom

[[Page 350]]

authority to sign the agreement is delegated) on or after July 15, 1963, 
shall be sent to the taxpayer at his last known address by either 
registered or certified mail. For further guidance regarding the 
definition of last known address, see Sec.  301.6212-2 of this chapter. 
If registered mail is used for such purpose, the date of registration 
shall be treated as the date of determination; if certified mail is used 
for such purpose, the date of the postmark on the sender's receipt for 
such mail shall be treated as the date of determination. However, if a 
dividend is paid by the corporation before such registration or postmark 
date but on or after the date such agreement is signed by the district 
director or such other official to whom authority to sign the agreement 
is delegated, the date of determination shall be such date of signing. 
The date of determination with respect to an agreement which is signed 
by the district director (or such other official to whom authority to 
sign the agreement is delegated) before July 15, 1963, shall be the date 
of the postmark on the cover envelope in which such agreement is sent by 
ordinary mail, except that if a dividend is paid by the corporation 
before such postmark date but on or after the date such agreement is 
signed by the district director or such other official to whom authority 
to sign the agreement is delegated, the date of determination shall be 
such date of signing.
    (2) Claim for deduction--(i) Contents of claim. A claim for 
deduction for a deficiency dividend shall be made with the requisite 
declaration, on Form 976 and shall contain the following information:
    (a) The name and address of the corporation;
    (b) The place and date of incorporation;
    (c) The amount of the deficiency determined with respect to the tax 
imposed by section 541 (or a corresponding provision of a prior income 
tax law) and the taxable year or years involved; the amount of the 
unpaid deficiency or, if the deficiency has been paid in whole or in 
part, the date of payment and the amount thereof; a statement as to how 
the deficiency was established, if unpaid; or if paid in whole or in 
part, how it was established that any portion of the amount paid was a 
deficiency at the time when paid and, in either case whether it was by 
an agreement under section 547(c)(3), by a closing agreement under 
section 7121, or by a decision of the Tax Court or court judgment and 
the date thereof; if established by a final judgment in a suit against 
the United States for refund, the date of payment of the deficiency, the 
date the claim for refund was filed, and the date the suit was brought; 
if established by a Tax Court decision or court judgment, a copy thereof 
shall be attached, together with an explanation of how the decision 
became final; if established by an agreement under section 547(c)(3), a 
copy of such agreement shall be attached;
    (d) The amount and date of payment of the dividend with respect to 
which the claim for the deduction for deficiency dividends is filed;
    (e) A statement setting forth the various classes of stock 
outstanding, the name and address of each shareholder, the class and 
number of shares held by each on the date of payment of the dividend 
with respect to which the claim is filed, and the amount of such 
dividend paid to each shareholder;
    (f) The amount claimed as a deduction for deficiency dividends; and
    (g) Such other information as may be required by the claim form.
    (ii) Filing of claim and corporate resolution. The claim together 
with a certified copy of the resolution of the board of directors or 
other authority, authorizing the payment of the dividend with respect to 
which the claim is filed, shall be filed with the district director for 
the internal revenue district in which the return is filed.
    (iii) Carryover of deficiency dividends paid by acquiring 
corporation. In the case of the acquisition of assets of a corporation 
by another corporation in a distribution or transfer described in 
section 381(a), the distributor or transferor corporation shall be 
entitled to a deduction for any deficiency dividends (as defined in 
section 547(d)) paid by the acquiring corporation with respect

[[Page 351]]

to such distributor or transferor corporation. See section 381(c)(17).

(68A Stat. 192, 917; 26 U.S.C. 547(c), 7805)

[T.D. 6500, 25 FR 11737, Nov. 26, 1960, as amended by T.D. 6657, 28 FR 
5720, June 12, 1963; T.D. 7604, 44 FR 18661, Mar. 29, 1979; T.D. 8939, 
66 FR 2819, Jan. 12, 2001]



Sec.  1.547-3  Claim for credit or refund.

    (a) If a deficiency in personal holding company tax is asserted for 
any taxable year, and the corporation has paid any portion of such 
asserted deficiency, it is entitled to a credit or refund of such 
payment to the extent that such payment constitutes an overpayment as 
the result of a deduction for a deficiency dividend as provided in 
section 547 and Sec. Sec.  1.547-1 through 1.547-7. It should be noted 
that a determination under section 547(c) and paragraph (b)(1) of Sec.  
1.547-2, of taxpayer's liability for personal holding company tax may 
take place subsequent to the time the deficiency was paid. To secure 
credit or refund of such overpayment, the taxpayer must file a claim on 
Form 843 in addition to the claim for the deduction for deficiency 
dividends required under section 547(e) and paragraph (b)(2) of Sec.  
1.547-2.
    (b) No interest shall be allowed on such credit or refund.
    (c) Such credit or refund will be allowed as if, on the date of the 
determination under section 547(c) and paragraph (b)(1) of Sec.  1.547-
2, two years remained before the expiration of the period of limitation 
on the filing of claim for refund for the taxable year to which the 
overpayment relates.



Sec.  1.547-4  Effect on dividends paid deduction.

    The deficiency dividends deduction shall be allowed as of the date 
the claim is filed. No duplication of deductions with respect to any 
deficiency dividends is permitted. If a corporation claims and receives 
the benefit of the provisions of section 547 (or the corresponding 
section 506 of the Internal Revenue Code of 1939, or section 407 of the 
Revenue Act of 1938 (52 Stat. 447)), based upon a distribution of 
deficiency dividends, that distribution does not become a part of the 
dividends paid deduction under section 561. Likewise, it will not be 
made the basis of a dividends paid deduction under section 561 by reason 
of the application of section 563(b), relating to dividends paid after 
the close of the taxable year and on or before the 15th day of the third 
month following the close of such taxable year.



Sec.  1.547-5  Deduction denied in case of fraud or wilful failure to
file timely return.

    No deduction for deficiency dividends shall be allowed under section 
547(a) if the determination contains a finding that any part of the 
deficiency is due to fraud with intent to evade tax, or to wilful 
failure to file an income tax return within the time prescribed by law 
or prescribed by the Secretary or his delegate in pursuance of law. See 
Sec.  1.547-7 for effective date.



Sec.  1.547-6  Suspension of statute of limitations and stay of collection.

    (a) Statute of limitations. If the corporation files a claim for a 
deduction for deficiency dividends under section 547(e) and paragraph 
(b)(2) of Sec.  1.547-2, the running of the statute of limitations upon 
assessment, distraint, and collection in court in respect of the 
deficiency, and all interest, additional amounts, or assessable 
penalties, shall be suspended for a period of two years after the date 
of the determination under section 547(c) and paragraph (b)(1) of Sec.  
1.547-2.
    (b) Stay of collection. If a deficiency in personal holding company 
tax is established by a determination under section 547(c) and paragraph 
(b)(1) of Sec.  1.547-2, collection by distraint or court proceeding 
(except in case of jeopardy), of the deficiency and all interest, 
additional amounts, and assessable penalties, shall be stayed for a 
period of 120 days after the date of such determination, and, to the 
extent any part of such deficiency remains after deduction for 
deficiency dividends, for an additional period until the date the claim 
is disallowed. After such claim is allowed or rejected, either in whole 
or in part, the amount of the deficiency which was not eliminated by the 
application of section 547, together with interest, additional amounts 
and assessable penalties, will be assessed and collected in the usual 
manner.

[[Page 352]]



Sec.  1.547-7  Effective date.

    The deduction for deficiency dividends, in computing personal 
holding company tax for any taxable year, is allowable only with respect 
to determinations under section 547(c) made after November 14, 1954 (the 
date falling 90 days after the date of enactment of the Internal Revenue 
Code of 1954). If the taxable year with respect to which the deficiency 
is asserted began before January 1, 1954, the deficiency dividends 
deduction shall include only the amounts which would have been 
includible in the computation of the basic surtax credit for such 
taxable year under the Internal Revenue Code of 1939. Section 547(g), 
relating to the denial of a deficiency dividends deduction if the 
determination contains a finding that any part of the deficiency is due 
to fraud, etc., shall apply only if the taxable year with respect to 
which the deficiency is asserted begins after December 31, 1953.

                   Foreign Personal Holding Companies



Sec.  1.551-1  General rule.

    Part III (section 551 and following), subchapter G, chapter 1 of the 
Code, does not impose a tax on foreign personal holding companies. The 
undistributed foreign personal holding company income of such companies, 
however, must be included in the manner and to the extent set forth in 
section 551, in the gross income of their United States shareholders, 
that is, the shareholders who are individual citizens or residents of 
the United States, domestic corporations, domestic partnerships, and 
estates or trusts other than estates or trusts the gross income of which 
under subtitle A of the Code includes only income from sources within 
the United States.



Sec.  1.551-2  Amount included in gross income.

    (a) The undistributed foreign personal holding company income is 
included only in the gross income of the United States shareholders who 
were shareholders in the company on the last day of its taxable year on 
which a United States group (as defined in section 552(a)(2)) existed 
with respect to the company. Such United States shareholders, 
accordingly, are determined by the stock holdings as of such specified 
time. This rule applies to every United States shareholder who was a 
shareholder in the company at the specified time regardless of whether 
the United States shareholder is included within the United States 
group. For example, a domestic corporation which is a United States 
shareholder at the specified time must return its distributive share in 
the undistributed foreign personal holding company income even though 
the domestic corporation cannot be included within the United States 
group since, under section 554, the stock it owns in the foreign 
corporation is considered as being owned proportionately by its 
shareholders for the purpose of determining whether the foreign 
corporation is a foreign personal holding company.
    (b) The United States shareholders must include in their gross 
income their distributive shares of that proportion of the undistributed 
foreign personal holding company income for the taxable year of the 
company which is equal in ratio to that which the portion of the taxable 
year up to and including the last day on which the United States group 
with respect to the company existed bears to the entire taxable year. 
Thus, if the last day in the taxable year on which the required United 
States group existed was also the end of the taxable year, the portion 
of the taxable year up to and incding such last day would be equal to 
100 percent and, in such case, the United States shareholders would be 
required to return their distributive shares in the entire undistributed 
foreign personal holding company income. But if the last day on which 
the required United States group existed was September 30, and the 
taxable year was a calendar year, the portion of the taxable year up to 
and including such last day would be equal to nine-twelfths and, in that 
case, the United States shareholders would be required to return their 
distributive shares in only nine-twelfths of the undistributed foreign 
personal holding company income.
    (c) The amount which each United States shareholder must return is 
that amount which he would have received

[[Page 353]]

as a dividend if the above-specified portion of the undistributed 
foreign personal holding company income had in fact been distributed by 
the foreign personal holding company as a dividend on the last day of 
its taxable year on which the required United States group existed. Such 
amount is determined, therefore, by the interest of the United States 
shareholder in the foreign personal holding company, that is, by the 
number of shares of stock owned by the United States shareholder and the 
relative rights of his class of stock, if there are several classes of 
stock outstanding. Thus, if a foreign personal holding company has both 
common and preferred stock outstanding and the preferred shareholders 
are entitled to a specified dividend before any distribution may be made 
to the common shareholders, then the assumed distribution of the stated 
portion of the undistributed foreign personal holding company income 
must first be treated as a payment of the specified dividend on the 
preferred stock before any part may be allocated as a dividend on the 
common stock.
    (d) The assumed distribution of the required portion of the 
undistributed foreign personal holding company income must be returned 
as dividend income by the United States shareholders for their 
respective taxable years in which or with which the taxable year of the 
foreign personal holding company ends. For example, if the M 
Corporation, whose taxable year is the calendar year, is a foreign 
personal holding company for 1954 and if A, one of its United States 
shareholders, makes returns on a calendar year basis, while B, another 
United States shareholder, makes returns on the basis of a fiscal year 
ending November 30, A must return his assumed dividend as income for the 
taxable year 1954 and B must return his distributive share as income for 
the fiscal year ending November 30, 1955. In applying this rule, the 
date as of which the United States group last existed with respect to 
the company is immaterial. Thus, in the foregoing example, if September 
30, 1954, was the last day on which the United States group with respect 
to the M Corporation existed, B would still be required to return his 
assumed dividend as income for the fiscal year ending November 30, 1955, 
even though September 30, 1954, the date as of which the distribution is 
assumed to have been made, does not fall within such fiscal year.
    (e) For the treatment of gain on the sale of certain stock, see 
section 306(f) and paragraph (h) of Sec.  1.306-3.

                      Deduction for Dividends Paid



Sec.  1.561-1  Deduction for dividends paid.

    (a) The deduction for dividends paid is applicable in determining 
accumulated taxable income under section 535, undistributed personal 
holding company income under section 545, undistributed foreign personal 
holding company income under section 556, investment company taxable 
income under section 852, and real estate investment trust taxable 
income under section 857. The deduction for dividends paid includes:
    (1) The dividends paid during the taxable year;
    (2) The consent dividends for the taxable year, determined as 
provided in section 565; and
    (3) In the case of a personal holding company, the dividend 
carryover computed as provided in section 564.
    (b) For dividends for which the dividends paid deduction is 
allowable, see section 562 and Sec.  1.562-1. As to when dividends are 
considered paid, see Sec.  1.561-2.

[T.D. 6500, 25 FR 11737, Nov. 26, 1960, as amended by T.D. 6598, 27 FR 
4093, Apr. 28, 1962]



Sec.  1.561-2  When dividends are considered paid.

    (a) In general. (1) A dividend will be considered as paid when it is 
received by the shareholder. A deduction for dividends paid during the 
taxable year will not be permitted unless the shareholder receives the 
dividend during the taxable year for which the deduction is claimed. See 
section 563 for special rule with respect to dividends paid after the 
close of the taxable year.
    (2) If a dividend is paid by check and the check bearing a date 
within the taxable year is deposited in the mails, in a cover properly 
stamped and addressed to the shareholder at his last

[[Page 354]]

known address, at such time that in the ordinary handling of the mails 
the check would be received by the shareholder within the taxable year, 
a presumption arises that the dividend was paid to the shareholder in 
such year.
    (3) The payment of a dividend during the taxable year to the 
authorized agent of the shareholder will be deemed payment of the 
dividend to the shareholder during such year.
    (4) If a corporation, instead of paying the dividend directly to the 
shareholder, credits the account of the shareholder on the books of the 
corporation with the amount of the dividend, the deduction for a 
dividend paid will not be permitted unless it be shown to the 
satisfaction of the Commissioner that such crediting constituted payment 
of the dividend to the shareholder within the taxable year.
    (5) A deduction will not be permitted for the amount of a dividend 
credited during the taxable year upon an obligation of the shareholder 
to the corporation unless it is shown to the satisfaction of the 
Commissioner that such crediting constituted payment of the dividend to 
the shareholder within the taxable year.
    (6) If the dividend is payable in obligations of the corporation, 
they should be entered or registered in the taxable year on the books of 
the corporation, in the name of the shareholder (or his nominee or 
transferee), and, in the case of obligations payable to bearer, should 
be received in the taxable year by the shareholder (or his nominee or 
transferee) to constitute payment of the dividend within the taxable 
year.
    (7) In the case of a dividend from which the tax has been deducted 
and withheld as required by chapter 3 (section 1441 and following), of 
the Code the dividend is considered as paid when such deducting and 
withholding occur.
    (b) Methods of accounting. The determination of whether a dividend 
has been paid to the shareholder by the corporation during its taxable 
year is in no way dependent upon the method of accounting regularly 
employed by the corporation in keeping its books or upon the method of 
accounting upon the basis of which the taxable income of the corporation 
is computed.
    (c) Records. Every corporation claiming a deduction for dividends 
paid shall keep such permanent records as are necessary (1) to establish 
that the dividends with respect to which such deduction is claimed were 
actually paid during the taxable year and (2) to supply the information 
required to be filed with the income tax return of the corporation. Such 
corporation shall file with its return (i) a copy of the dividend 
resolution; and (ii) a concise statement of the pertinent facts relating 
to the payment of the dividend, clearly specifying (a) the medium of 
payment and (b) if not paid in money, the fair market value and adjusted 
basis (or face value, if paid in its own obligations) on the date of 
distribution of the property distributed and the manner in which such 
fair market value and adjusted basis were determined. Canceled dividend 
checks and receipts obtained from shareholders acknowledging payment of 
dividends paid otherwise than by check need not be filed with the return 
but shall be kept by the corporation as a part of its records.



Sec.  1.562-1  Dividends for which the dividends paid deduction is 
allowable.

    (a) General rule. Except as otherwise provided in section 562 (b) 
and (d), the term dividend, for purposes of determining dividends 
eligible for the dividends paid deduction, refers only to a dividend 
described in section 316 (relating to definition of dividends for 
purposes of corporate distributions). No distribution, however, which is 
preferential within the meaning of section 562(c) and Sec.  1.562-2 
shall be eligible for the dividends paid deduction. Moreover, when 
computing the dividends paid deduction with respect to a U.S. person (as 
defined in section 957(d)), no distribution which is excluded from the 
gross income of a foreign corporation under section 959(b) with respect 
to such person or from gross income of such person under section 959(a) 
shall be eligible for suchdeduction. Further, for purposes of the 
dividends paid deduction, the term dividend does not include a 
distribution in liquidation unless the distribution is treated as a 
dividend under section 316(b)(2) and paragraph (b)(2) of Sec.  1.316-1, 
or under section

[[Page 355]]

333(e)(1) and paragraph (c) of Sec.  1.333-4 or paragraph (c)(2), 
(d)(1)(ii), or (d)(2) of Sec.  1.333-5, or qualifies under section 
562(b) and paragraph (b) of this section. If a dividend is paid in 
property (other than money) the amount of the dividends paid deduction 
with respect to such property shall be the adjusted basis of the 
property in the hands of the distributing corporation at the time of the 
distribution. See paragraph (b)(2) of this section for special rules 
with respect to liquidating distributions by personal holding companies 
occurring during a taxable year of the distributing corporation 
beginning after December 31, 1963. Also see section 563 for special 
rules with respect to dividends paid after the close of the taxable 
year.
    (b) Distributions in liquidation--(1) General rule--(i) In general. 
In the case of amounts distributed in liquidation by any corporation 
during a taxable year of such corporation beginning before January 1, 
1964, or by a corporation other than a personal holding company (as 
defined in section 542) or a foreign personal holding company (as 
defined in section 552) during a taxable year of such a corporation 
beginning after December 31, 1963, section 562(b) makes an exception to 
the general rule that a deduction for dividends paid is permitted only 
with respect to dividends described in section 316. In order to qualify 
under that exception, the distribution must be one either in complete or 
partial liquidation of a corporation pursuant to sections 331, 332, or 
333. See subparagraph (2) of this paragraph for rules relating to the 
treatment of distributions in complete liquidation made by a corporation 
which is a personal holding company to corporate shareholders during a 
taxable year of such distributing corporation beginning after December 
31, 1963. As provided by section 346(a), for the purpose of section 
562(b), a partial liquidation includes a redemption of stock to which 
section 302 applies. Amounts distributed in liquidation in a transaction 
which is preceded, or followed, by a transfer to another corporation of 
all or part of the assets of the liquidating corporation, may not be 
eligible for the dividends paid deduction.
    (ii) Amount of dividends paid deduction allowable--(a) General rule. 
In the case of distributions in liquidation with respect to which a 
deduction for dividends paid is permissible under subdivision (i) of 
this subparagraph, the amount of the deduction is equal to the part of 
such distribution which is properly chargeable to the earnings and 
profits accumulated after February 28, 1913. To determine the amount 
properly chargeable to the earnings and profits accumulated after 
February 28, 1913, there must be deducted from the amount of the 
distribution that part allocable to capital account. The capital 
account, for the purposes of this subdivision, includes not only amounts 
representing the par or stated value of the stock with respect to which 
the liquidation distribution is made, but also that stock's proper share 
of the paid-in surplus, and such other corporate items, if any, which, 
for purposes of income taxation, are treated like capital in that they 
are not taxable dividends when distributed but are applied against and 
reduce the basis of the stock. The remainder of the distribution in 
liquidation is, ordinarily, properly chargeable to the earnings and 
profits accumulated after February 28, 1913. Thus, if there is a deficit 
in earnings and profits on the first day of a taxable year, and the 
earnings and profits for such taxable year do not exceed such deficit, 
no dividends paid deduction would be allowed for such taxable year with 
respect to a distribution in liquidation; if the earnings and profits 
for such taxable year exceed the deficit in earnings and profits which 
existed on the first day of such taxable year, then a dividends paid 
deduction would be allowed to the extent of such excess.
    (b) Special rule. Section 562(b)(1)(B) provides that in the case of 
a complete liquidation occurring within 24 months after the adoption of 
a plan of liquidation the amount of the deduction is equal to the 
earnings and profits for each taxable year in which distributions are 
made. Thus, if there is a distribution in liquidation pursuant to 
section 333, or a distribution in complete liquidation pursuant to 
section 331(a)(1) or 332 which occurs within a 24-month period after the 
adoption of a

[[Page 356]]

plan of liquidation, a dividends paid deduction will be allowable to the 
extent of the current earnings and profits for the taxable year or years 
even though there was a deficit in earnings and profits on the first day 
of such taxable year or years. In computing the earnings and profits for 
the taxable year in which the distributions are made, computation shall 
be made with the inclusion of capital gains and without any deduction 
for capital losses.
    (c) Examples. The application of this subparagraph may be 
illustrated by the following examples:

    Example 1. The Y Corporation, which makes its income tax returns on 
the calendar year basis, was organized on January 1, 1910, with an 
authorized and outstanding capital stock of 2,000 shares of common stock 
of a par value of $100 each and 1,000 shares of participating preferred 
stock of a par value of $100 each. The preferred stock was to receive 
annual dividends of $7 per share and $100 per share on complete 
liquidation of the corporation in priority to any payments on common 
stock, and was to participate equally with the common stock in either 
instance after the common stock had received a similar amount. However, 
the preferred stock was redeemable in whole or in part at the option of 
the board of directors at any time at $106 per share plus its proportion 
of the earnings of the company at the time of such redemption. In 1910 
the preferred stock was issued at $106 per share, for a total of 
$106,000 and the common stock was issued, at $100 per share, for a total 
of $200,000. On July 15, 1954, the company had a paid-in surplus of 
$6,000, consisting of the premium received on the preferred stock; 
earnings and profits of $30,000 accumulated prior to March 1, 1913; and 
earnings and profits accumulated since February 28, 1913, of $75,000. On 
July15, 1954, the option with respect to the preferred stock was 
exercised and the entire amount of such stock was redeemed at $141 per 
share or a total of $141,000 in a transaction upon which gain or loss to 
the distributees resulting from the exchange was determined and 
recognized under section 302(a). The amount of the distribution 
allocable to capital account was $116,000 ($100,000 attributable to par 
value, $6,000 attributable to paid-in surplus, and $10,000 attributable 
to earnings and profits accumulated prior to March 1, 1913). The 
remainder, $25,000 ($141,000, the amount of the distribution, less 
$116,000, the amount allocable to capital account) is properly 
chargeable to the earnings and profits accumulated since February 28, 
1913, and is deductible as dividends paid.
    Example 2. The M Corporation, a calendar year taxpayer, is 
completely liquidated on November 1, 1955, pursuant to a plan of 
liquidation adopted April 1, 1955. On January 1, 1955, the M Corporation 
has a deficit in earnings and profits of $100,000. During the period 
January 1, 1955, to the date of liquidation, November 1, 1955, it has 
earnings and profits of $10,000. The M Corporation is entitled to a 
dividends paid deduction in the amount of $10,000 as a result of its 
distribution in complete liquidation on November 1, 1955.
    Example 3. The N Corporation, a calendar year taxpayer, is 
completely liquidated on July 1, 1958, pursuant to a plan of liquidation 
adopted February 1, 1955. No distributions in liquidation were made 
pursuant to the plan of liquidation adopted February 1, 1955, until the 
distribution in complete liquidation on July 1, 1958. On January 1, 
1958, N Corporation had a deficit in earnings and profits of $30,000. 
During the period January 1, 1958, to the date of liquidation, July 1, 
1958, the N Corporation has earnings and profits of $5,000. The N 
Corporation is not entitled to any deduction for dividends paid as a 
result of the distribution in complete liquidation on July 1, 1958. If 
the earnings and profits for the period January 1, 1958, to July 1, 
1958, had been $32,000, the N Corporation would have been entitled to a 
deduction for dividends paid in the amount of $2,000.

    (2) Special rule--(i) Distributions to corporate shareholders. In 
the case of amounts distributed in complete liquidation of a personal 
holding company (as defined in section 542) within 24 months after the 
adoption of a plan of liquidation, section 562(b)(2) makes a further 
exception to the general rule that a deduction for dividends paid is 
permitted only with respect to dividends described in section 316. The 
exception referred to in the preceding sentence applies only to 
distributions made in any taxable year of the distributing corporation 
beginning after December 31, 1963. Under the exception, the amount of 
any distribution within the 24-month period pursuant to the plan shall 
be treated as a dividend for purposes of computing the dividends paid 
deduction, but:
    (a) Only to the extent that such amount is distributed to corporate 
distributees, and
    (b) Only to the extent that such amount represents such corporate 
distributees' allocable share of undistributed personal holding company 
income for the taxable year of such distribution (computed without 
regard to section 316(b)(2)(B) and section 562(b)(2))


[[Page 357]]



Amounts distributed in liquidation in a transaction which is preceded, 
or followed, by a transfer to another corporation of all or part of the 
assets of the liquidating corporation, may not be eligible for the 
dividends paid deduction.
    (ii) Corporate distributees' allocable share. For purposes of 
subdivision (i)(b) of this subparagraph:
    (a) Except as provided in (b) of this subdivision, the corporate 
distributees' allocable share of undistributed personal holding company 
income for the taxable year of the distribution (computed without regard 
to sections 316(b)(2)(B) and 562(b)(2)) shall be determined by 
multiplying such undistributed personal holding company income by the 
ratio which the aggregate value of the stock held by all corporate 
shareholders immediately before the record date of the last liquidating 
distribution in such year bears to the total value of all stock 
outstanding on such date. For rules applicable in a case where the 
distributing corporation has more than one class of stock, see (c) of 
this subdivision (ii).
    (b) If more than one liquidating distribution was made during the 
year, and if, after the record date of the first distribution but before 
the record date of the last distribution, there was a change in the 
relative shareholdings as between corporate shareholders and 
noncorporate shareholders, then the corporate distributees' allocable 
share of undistributed personal holding company income for the taxable 
year of the distributions (computed without regard to sections 
316(b)(2)(B) and 562(b)(2)) shall be determined as follows:
    (1) First, allocate the corporation's undistributed personal holding 
company income for the taxable year among the distributions made during 
such year by reference to the ratio which the aggregate amount of each 
distribution bears to the total amount of all distributions during such 
year;
    (2) Second, determine the corporate distributees' allocable share of 
the corporation's undistributed personal holding company income for each 
distribution by multiplying the amount determined under (1) of this 
subdivision (b) for each distribution by the ratio which the aggregate 
value of the stock held by all corporate shareholders immediately before 
the record date of such distribution bears to the total value of all 
stock outstanding on such date; and
    (3) Last, determine the sum of the corporate distributees' allocable 
share of the corporation's undistributed personal holding company income 
for all such distributions


For rules applicable in a case where the distributing corporation has 
more than one class of stock, see (c) of this subdivision (ii).
    (c) Where the distributing corporation has more than one class of 
stock:
    (1) The undistributed personal holding company income for the 
taxable year in which, or in respect of which, the distribution was made 
shall be treated as a fund from which dividends may properly be paid and 
shall be allocated between or among the classes of stock in a manner 
consistent with the dividend rights of such classes under local law and 
the pertinent governing instruments, such as, for example, the 
distributing corporation's articles or certificate of incorporation and 
bylaws;
    (2) The corporate distributees' allocable share of the undistributed 
personal holding company income for each class of stock shall be 
determined separately in accordance with the rules set forth in (a) and 
(b) of this subdivision (ii) as if each class of stock were the only 
class of stock outstanding; and
    (3) The sum of the corporate distributees' allocable share of the 
undistributed personal holding company income for the taxable year in 
which, or in respect of which, the distribution was made shall be the 
sum of the corporate distributees' allocable share of the undistributed 
personal holding company income for all classes of stock.
    (d) For purposes of this subdivision (ii), in any case where the 
record date of a liquidating distribution cannot be ascertained, the 
record date of the distribution shall be the date on which the 
liquidating distribution was actually made.
    (iii) Example. The application of this subparagraph may be 
illustrated by the following example:


[[Page 358]]


    Example. O Corporation, a calendar year taxpayer is completely 
liquidated on December 31, 1964, pursuant to a plan of liquidation 
adopted July 1, 1964. No distributions in liquidation were made pursuant 
to the plan of liquidation adopted July 1, 1964, until the distribution 
in complete liquidation on December 31, 1964. O Corporation has 
undistributed personal holding company income of $300,000 for the year 
1964 (computed without regard to section 316(b)(2)(B) and section 
562(b)(2)). On December 31, 1964, immediately before the record date of 
the distribution in complete liquidation, P Corporation owns 100 shares 
of O Corporation's outstanding stock and individual A owns the remaining 
200 shares. All shares are equal in value. The amount which represents P 
Corporation's allocable share of undistributed personal holding company 
income is $100,000(100 shares / 300 shares x $300,000), and for purposes 
of computing the dividends paid deduction, such amount is treated as a 
dividend under section 562(b)(2) provided that the liquidating 
distribution to P Corporation equals or exceeds $100,000. P Corporation 
does not treat the $100,000 distributed to it as a dividend to which 
section 301 applies. For an example of the treatment of the distribution 
to individual A see example 5 of paragraph (e) of Sec.  1.316-1.

    (iv) Distributions to noncorporate shareholders. For the rules for 
determining the extent to which distributions in complete liquidation 
made to noncorporate shareholders by a personal holding company are 
dividends within the meaning of section 562(a), see section 316(b)(2)(B) 
and paragraph (b)(2) of Sec.  1.316-1.
    (c) Special definition of dividend for nonliquidating distributions 
by personal holding companies. Section 316(b)(2)(A) provides that in the 
case of a corporation which, under the law applicable to the taxable 
year in which or in respect of which a distribution is made, is a 
personal holding company, the term dividend (in addition to the general 
meaning set forth in section 316(a)) also means a nonliquidating 
distribution to its shareholders to the extent of the corporation's 
undistributed personal holding company income (determined under section 
545 without regard to such distributions) for the taxable year in which 
or in respect of which the distribution is made. See paragraph (b)(1) of 
Sec.  1.316-1.

[T.D. 6949, 33 FR 5529, Apr. 9, 1968, as amended by T.D. 7767, 46 FR 
11265, Feb. 6, 1981]



Sec.  1.562-2  Preferential dividends.

    (a) Section 562(c) imposes a limitation upon the general rule that a 
corporation is entitled to a deduction for dividends paid with respect 
to all dividends which it actually pays during the taxable year. Before 
a corporation may be entitled to any such deduction with respect to a 
distribution regardless of the medium in which the distribution is made, 
every shareholder of the class of stock with respect to which the 
distribution is made must betreated the same as every other shareholder 
of that class, and no class of stock may be treated otherwise than in 
accordance with its dividend rights as a class. The limitation imposed 
by section 562(c) is unqualified, except in the case of an actual 
distribution made in connection with a consent distribution (see section 
565), if the entire distribution composed of such actual distribution 
and consent distribution is not preferential. The existence of a 
preference is sufficient to prohibit the deduction regardless of the 
fact (1) that such preference is authorized by all the shareholders of 
the corporation or (2) that the part of the distribution received by the 
shareholder benefited by the preference is taxable to him as a dividend. 
A corporation will not be entitled to a deduction for dividends paid 
with respect to any distribution upon a class of stock if there is 
distributed to any shareholder of such class (in proportion to the 
number of shares held by him) more or less than his pro rata part of the 
distribution as compared with the distribution made to any other 
shareholder of the same class. Nor will a corporation be entitled to a 
deduction for dividends paid in the case of any distribution upon a 
class of stock if there is distributed upon such class of stock more or 
less than the amount to which it is entitled as compared with any other 
class of stock. A preference exists if any rights to preference inherent 
in any class of stock are violated. The disallowance, where any 
preference in fact exists, extends to the entire amount of the 
distribution and not merely to a part of such distribution. As used in 
this section, the term distribution includes a dividend as defined in 
subchapter C, chapter 1 of the Code,

[[Page 359]]

and a distribution in liquidation referred to in section 562(b).
    (b) The application of the provisions of section 562(c) may be 
illustrated by the following examples:

    Example 1. A, B, C, and D are the owners of all the shares of class 
A common stock in the M Corporation, which makes its income tax returns 
on a calendar year basis. With the consent of all the shareholders, the 
M Corporation on July 15, 1954, declared a dividend of $5 a share 
payable in cash on August 1, 1954, to A. On September 15, 1954, it 
declared a dividend of $5 a share payable in cash on October 1, 1954, to 
B, C, and D. No allowance for dividends paid for the taxable year 1954 
is permitted to the M Corporation with respect to any part of the 
dividends paid on August 1, 1954, and October 1, 1954.
    Example 2. The N Corporation, which makes its income tax returns on 
the calendar year basis, has a capital of $100,000 (consisting of 1,000 
shares of common stock of a par value of $100) and earnings or profits 
accumulated after February 28, 1913, in the amount of $50,000. In the 
year 1954, the N Corporation distributes $7,500 in cancellation of 50 
shares of the stock owned by three of the four shareholders of the 
corporation. No deduction for dividends paid is permissible under 
section 562(c) and paragraph (a) of this section with respect to such 
distribution.
    Example 3. The P Corporation has two classes of stock outstanding, 
10 shares of cumulative preferred, owned by E, entitled to $5 per share 
and on which no dividends have been paid for two years, and 10 shares of 
common, owned by F. On December 31, 1954, the corporation distributes a 
dividend of $125, $50 to E, and $75 to F. The corporation is entitled to 
no deduction for any part of such dividend paid, since there has been a 
preference to F. If, however, the corporation had distributed $100 to E 
and $25 to F, it would have been entitled to include $125 as a dividend 
paid deduction.



Sec.  1.562-3  Distributions by a member of an affiliated group.

    A personal holding company which files or is required to file a 
consolidated return with other members of an affiliated group may be 
required to file a separate personal holding company schedule by reason 
of the limitations and exceptions provided in section 542(b) and Sec.  
1.542-4. Section 562(d) provides that in such case the dividends paid 
deduction shall be allowed to the personal holding company, with respect 
to a distribution made to any member of the affiliated group, if such 
distribution would constitute a dividend if it were made to a 
shareholder which is not a member of the affiliated group.



Sec.  1.563-1  Accumulated earnings tax.

    In the determination of the dividends paid deduction for purposes of 
the accumulated earnings tax imposed by section 531, a dividend paid 
after the close of any taxable year and on or before the 15th day of the 
third month following the close of such taxable year shall be considered 
as paid during such taxable year, and shall not be included in the 
computation of the dividends paid deduction for the year of payment. 
However, the rule provided in section 563(a) is not applicable to 
dividends paid during the first two and one-half months of the first 
taxable year of the corporation subject to tax under chapter 1 of the 
Internal Revenue Code of 1954.



Sec.  1.563-2  Personal holding company tax.

    In the case of a personal holding company subject to the provisions 
of section 541, dividends paid after the close of the taxable year and 
before the 15th day of the third month thereafter shall be included in 
the computation of the dividends paid deduction for the taxable year 
only if the taxpayer so elects in its return for such taxable year. The 
election shall be made by including such dividends in computing its 
dividends paid deduction. The amount of such dividends which may be 
included in computing the dividends paid deduction for the taxable year 
shall not exceed either:
    (a) The undistributed personal holding company income of the 
corporation for the taxable year, computed without regard to this 
section, or
    (b) In the case of a taxable year beginning after December 31, 1969, 
20 percent (10 percent, in the case of a taxable year beginning before 
Jan. 1, 1970) of the sum of the dividends paid during the taxable year 
(not including consent dividends), computed without regard to this 
section


In computing the amount of the dividends paid deduction allowable for 
any taxable year, the amount allowed by

[[Page 360]]

reason of section 563(b) for any preceding taxable year is considered a 
dividend paid in such preceding taxable year and not in the year of 
actual distribution. Thus, a double deduction is not allowable.

[T.D. 7079, 35 FR 18587, Dec. 8, 1970]



Sec.  1.563-3  Dividends considered as paid on last day of taxable year.

    (a) General rule. Where a distribution made after the close of the 
taxable year is considered as paid during such taxable year, for 
purposes of applying section 562(a) the distribution shall be considered 
as made on the last day of such taxable year.
    (b) Personal holding company tax. In the case of a corporation which 
under the law applicable to the taxable year in respect of which a 
distribution is made under section 563(b) and Sec.  1.563-2 is a 
personal holding company under the law applicable to such taxable year, 
section 316(b)(2) provides that the term dividend means (in addition to 
the general rule under section 316(a)) any distribution to the extent of 
the corporation's undistributed personal holding company income 
(determined under section 545 without regard to distributions under 
section 316(b)(2)) for such year. See paragraph (b) of Sec.  1.316-1.
    (c) Dividends paid on or before December 15, 1955. The Act of June 
15, 1955 (Public Law 74, 84th Cong., 69 Stat. 136), repealed sections 
452 and 462 of the Code, relating to prepaid income and reserve for 
estimated expenses. Under section 4(c)(4) of that Act, dividends paid 
after the 15th day of the third month following the close of the taxable 
year and on or before December 15, 1955, may be treated as having been 
paid on the last day of the taxable year for purposes of the accumulated 
earnings tax or the personal holding company tax and in the case of 
regulated investment companies, but only to the extent that such 
dividends are attributable to an increase in taxable income for the 
taxable year by reason of the repeal of sections 452 and 462. See 
paragraph (b) of Sec.  1.9000-8, relating to treatment of certain 
dividends, prescribed pursuant to section 4(c)(4) of the Act of June 15, 
1955.



Sec.  1.564-1  Dividend carryover.

    (a) General rule. The dividend carryover from the two preceding 
years, allowable only to personal holding companies, is includible in 
the dividends paid deduction under section 561. It is computed as 
follows:
    (1) If, for each of the preceding two years, the deduction for 
dividends paid under section 561 (determined without regard to the 
dividend carryover to each such year) exceeds the taxable income 
(adjusted as provided in section 545 for purposes of determining 
undistributed personal holding company income) then the dividend 
carryover to the taxable year is the sum of both such excess amounts.
    (2) If the deduction for dividends paid under section 561 for the 
second preceding year (determined without regard to the dividend 
carryover to such year) exceeds the taxable income for such year 
(adjusted as provided in section 545), and if the taxable income for the 
first preceding year (as so adjusted) exceeds the dividends paid 
deduction for such first preceding year (as so determined), then the 
dividend carryover to the taxable year shall be such excess amount for 
the second preceding year, less such excess amount for the first 
preceding year.
    (3) If for the first preceding year the deduction for dividends paid 
under section 561 (determined without regard to the dividend carryover 
to such year) exceeds the taxable income (adjusted as provided in 
section 545) for such year, and such excess is not present in the second 
preceding year, then the dividend carryover to the taxable year shall be 
such excess amount for the first preceding year.
    (b) Dividend carryover from year in which taxpayer was not a 
personal holding company. In computing the dividend carryover, the 
taxable income as adjusted under section 545 of any preceding taxable 
year shall be determined as if the corporation was, under the law 
applicable to such taxable year, a personal holding company.
    (c) Dividend carryover from year in which taxpayer was subject to 
1939 Code. In a case where the first or the second preceding taxable 
year began before the taxpayer's first taxable year under the Internal 
Revenue Code of 1954, the

[[Page 361]]

amount of the dividend carryover shall be determined under the Internal 
Revenue Code of 1939.
    (d) Statement to be filed with return. Every corporation claiming a 
dividend carryover for any taxable year shall file with its return for 
such year a concise statement setting forth the amount of the dividend 
carryover claimed and all material and pertinent facts relative thereto, 
including a detailed schedule showing the computation of the dividend 
carryover claimed.
    (e) Computation of dividend carryover. The computation of the 
dividend carryover may be illustrated by the following examples:

    Example 1. The X Corporation, which files its income tax returns on 
the calendar year basis, has taxable income, adjusted as required by 
section 545, in the amount of $110,000 and has a dividends paid 
deduction of $150,000 for the year 1954. For 1955, its taxable income, 
adjusted as required by section 545, is $200,000 and its dividends paid 
deduction is $300,000. The dividend carryover to the year 1956 is 
$140,000, computed as follows:

Dividends paid deduction for 1954...........................    $150,000
Taxable income for 1954.....................................     110,000
                                                             -----------
Dividend carryover from 1954................................      40,000
                                                             ===========
Dividends paid deduction for 1955...........................     300,000
Taxable income for 1955.....................................     200,000
                                                             -----------
Dividend carryover from 1955................................     100,000
                                                             ===========
Dividend carryover for 2 preceding taxable years, allowable      140,000
 as a deduction for the year 1956...........................
 

    Example 2. The Y Corporation, which files its income tax returns on 
the calendar year basis, has taxable income, adjusted as required by 
section 545, in the amount of $100,000 and has a dividends paid 
deduction of $150,000 for the year 1954. For 1955, its taxable income, 
adjusted as required by section 545, is $200,000 and its dividends paid 
deduction is $170,000. The dividend carryover to the year 1956 is 
$20,000 computed as follows:

Dividends paid deduction for 1954...........................    $150,000
Taxable income for 1954.....................................     100,000
                                                             -----------
Dividend carryover from 1954................................      50,000
                                                             ===========
Taxable income for 1955.....................................     200,000
Dividends paid deduction for 1955...........................     170,000
                                                             -----------
Excess of taxable income over dividends paid deduction......      30,000
                                                             ===========
Dividend carryover for second preceding taxable year,             20,000
 allowable as a deduction for the year 1956.................
 



Sec.  1.565-1  General rule.

    (a) Consent dividends. The dividends paid deduction, as defined in 
section 561, includes the consent dividends for the taxable year. A 
consent dividend is a hypothetical distribution (as distinguished from 
an actual distribution) made by:
    (1) A corporation that has a reasonable basis to believe that it is 
subject to the accumulated earnings tax imposed in part I of subchapter 
G, chapter 1 of the Code, or
    (2) A corporation described in part II (personal holding companies 
or a corporation with adjusted income from rents described in section 
543(a)(2)(A) which utilizes the consent dividends described in section 
543(a)(2)(B)(iii) to avoid personal holding company status) or part III 
(foreign personal holding companies) of subchapter G or in part I 
(regulated investment companies) or part II (real estate investment 
trusts) of subchapter M, chapter 1 of the Code.

A consent dividend may be made by a corporation described in this 
paragraph to any person who owns consent stock on the last day of the 
taxable year of such corporation and who agrees to treat the 
hypothetical distribution as an actual dividend, subject to the 
limitations in section 565, Sec.  1.565-2, and paragraph (c)(2) of this 
section, by filing a consent at the time and in the manner specified in 
paragraph (b) of this section.
    (b) Making and filing of consents. (1) A consent shall be made on 
Form 972 in accordance with this section and the instructions on the 
form issued therewith. It may be made only by or on behalf of a person 
who was the actual owner on the last day of the corporation's taxable 
year of any class of consent stock, that is, the person who would have 
been required to include in gross income any dividends on such stock 
actually distributed on the last day of such year. Form 972 shall 
contain or be verified by a written declaration that it is made under 
the penalties of perjury. In the consent such person must agree to 
include in gross income for his taxable year in which or with which the 
taxable year of the corporation ends a specific amount as a taxable 
dividend.

[[Page 362]]

    (2) See paragraph (c) of this section and Sec.  1.565-2 for the 
rules as to when all or a portion of the amount so specified will be 
disregarded for tax purposes.
    (3) A consent may be filed at any time not later than the due date 
(including extensions) of the corporation's income tax return for the 
taxable year for which the dividends paid deduction is claimed. With 
such return, and not later than the due date (including extensions) 
thereof, the corporation must file Forms 972 for each consenting 
shareholder, and a return on Form 973 showing by classes the stock 
outstanding on the first and last days of the taxable year, the dividend 
rights of such stock, distributions made during the taxable year to 
shareholders, and giving all the other information required by the form. 
For taxable years beginning before January 1, 2003, the Form 973 filed 
with the corporation's income tax return shall contain or be verified by 
a written declaration that is made under the penalties of perjury and 
the Forms 972 filed with the return must be duly executed by the 
consenting shareholders. For taxable years beginning after December 31, 
2002, the Form 973 filed with the corporation's income tax return shall 
be verified by signing the return and the Forms 972 filed with the 
return must be duly executed by the consenting shareholders or, if 
unsigned, must contain the same information as the duly executed 
originals. If the corporation submits unsigned Forms 972 with its return 
for a taxable year beginning after December 31, 2002, the duly executed 
originals are records that the corporation must retain and keep 
available for inspection in the manner required by Sec.  1.6001-1(e).
    (c) Taxability of amounts specified in consents. (1) The filing of a 
consent is irrevocable, and except as otherwise provided in section 
565(b), Sec.  1.565-2, and paragraph (c)(2) of this section, the full 
amount specified in a consent filed by a shareholder of a corporation 
described in paragraph (a) of this section shall be included in the 
gross income of the shareholder as a taxable dividend. Where the 
shareholder is taxable on a dividend only if received from sources 
within the United States, the amount specified in the consent of the 
shareholder shall be treated as a dividend from sources within the 
United States in the same manner as if the dividend has been paid in 
money to the shareholder on the last day of the corporation's taxable 
year. See paragraph (b) of this section relating to the making and 
filing of consents, and section 565(e) and Sec.  1.565-5, with respect 
to the payment requirement in the case of nonresident aliens and foreign 
corporations.
    (2) To the extent that the Commissioner determines that the 
corporation making a consent dividend is not a corporation described in 
paragraph (a) of this section, the amount specified in the consent is 
not a consent dividend and the amount specified in the consent will not 
be included in the gross income of the shareholder. In addition, where a 
corporation is described in paragraph (a)(1) but not paragraph (a)(2) of 
this section, to the extent that the Commissioner determines that the 
amount specified in a consent is larger than the amount of earnings 
subject to the accumulated earnings tax imposed by part I of subchapter 
G, such excess is not a consent dividend under paragraph (a) of this 
section and will not be included in the gross income of the shareholder.
    (3) Except as provided in section 565(b), Sec.  1.565-2 and 
paragraph (c)(2) of this section, once a shareholder's consent is filed, 
the full amount specified in such consent must be included in the 
shareholder's gross income as a taxable dividend, and the ground upon 
which a deduction for consent dividends is denied the corporation does 
not affect the taxability of a shareholder whose consent has been filed 
for the amount specified in the consent. For example, although described 
in part I, II, or III of subchapter G, or part I or II of subchapter M, 
chapter 1 of the Code, the corporation's taxable income (as adjusted 
under section 535(b), 545(b), 556(b), 852(b)(2), or 857(b)(2), as 
appropriate) may be less than the total of the consent dividends.
    (4) A shareholder who is a nonresident alien or a foreign 
corporation is taxable on the full amount of the consent dividend that 
otherwise qualifies under this section even though that payment has not 
been made as required by section 565(e) and Sec.  1.565-5.

[[Page 363]]

    (5) Income of a foreign corporation is not subject to the tax on 
accumulated earnings under part I of subchapter G, chapter 1 of the Code 
except to the extent of U.S. source income, adjusted as permitted under 
section 535. See section 535 (b) and (d) and Sec.  1.535-1(b). 
Therefore, foreign source earnings (other than those distributions 
subject to resourcing under section 535(d)) of a foreign corporation 
that is not described in paragraph (a)(2) of this section cannot qualify 
for consent dividend treatment. Accordingly, a consent dividend made by 
a foreign corporation described in paragraph (a)(1) of this section 
shall not be effective with respect to all of the corporation's 
earnings, but shall relate solely to earnings which would have been, in 
the absence of the consent dividend, subject to the accumulated earnings 
tax.

[T.D. 8244, 54 FR 10538, Mar. 14, 1989, as amended by T.D. 9100, 68 FR 
70705, Dec. 19, 2003; T.D. 9300, 71 FR 71042, Dec. 8, 2006]



Sec.  1.565-2  Limitations.

    (a) General rule. Amounts specified in consents filed by 
shareholders or other beneficial owners of a corporation described in 
Sec.  1.565-1(a) are not treated as consent dividends to the extent 
that--
    (1) They would constitute a preferential dividend or
    (2) They would not constitute a dividend (as defined in section 
316),

if distributed in money to shareholders on the last day of the taxable 
year of the corporation. If any portion of any amount specified in a 
consent filed by a shareholder of a corporation described in the 
preceding sentence is not treated as a consent dividend under section 
565(b) and this section, it is disregarded for all tax purposes. For 
example, it is not taxable to the consenting shareholder, and paragraph 
(c) of Sec.  1.565-1 is not applicable to this portion of the amount 
specified in the consent.
    (b) Preferential distribution. (1) A preferential distribution is an 
actual distribution, or a consent distribution, or a combination of the 
two, which involves a preference to one or more shares of stock as 
compared with other shares of the same class or to one class of stock as 
compared with any other class of stock. See section 562(c) and Sec.  
1.562-2.
    (2) The application of section 565 (b) (1) and Sec.  1.565-2 (b) may 
be illustrated by the following examples:

    Example 1. The X Corporation, a personal holding company, which 
makes its income tax returns on the calendar year basis, has 200 shares 
of stock outstanding, owned by A and B in equal amounts. On December 15, 
1987, the corporation distributes $600 to B and $100 to A. As a part of 
the same distribution, A executes a consent to include $500 in his gross 
income as a taxable dividend although such amount is not distributed to 
him. The X Corporation, assuming the other requirements of section 565 
have been complied with, is entitled to a consent dividends deduction of 
$500. Although the consent dividend is deemed to have been paid on 
December 31, 1987, the last day of the taxable year of the corporation, 
the total amount of all distributions constitutes a single 
nonpreferential distribution of $1200.
    Example 2. The Y corporation, a personal holding company, which 
makes its income tax returns on the calendar year basis, has one class 
of consent stock outstanding, owned in equal amounts by A, B, and C. If 
A and B each receive a distribution in cash of $5,000 and C consents to 
include $3,000 in gross income as a taxable dividend, the combined 
actual and consent distribution of $13,000 is preferential. See section 
562 (c) and Sec.  1.562-2 (a). Similarly, if no one receives a 
distribution in cash, but A and B each consents to include $5,000 as a 
taxable dividend in gross income and C agrees to include only $3,000, 
the entire consent distribution is preferential.
    Example 3. The Z Corporation, which makes its income tax returns on 
the calendar year basis and is subject, for the taxable year in 
question, to the accumulated earnings tax, has only two classes of stock 
outstanding, each class being consent stock and consisting of 500 
shares. Class A, with a par value of $40 per share, is entitled to two-
thirds of any distribution of earnings and profits. Class B, with a par 
value of $20 per share, is entitled to one-third of any distribution of 
earnings and profits. On December 15, 1987, there is distributed on the 
class B stock $2 per share, or $1,000, and shareholders of the class A 
stock consent to include in gross income amounts equal to $2 per share, 
or $1,000. The entire distribution of $2,000 is preferential, inasmuch 
as the class B stock has received more than its pro rata share of the 
combined amounts of the actual distributions and the consent 
distributions.

    (c) Section 316 limitation. (1) An additional limitation under 
section 565 (b)

[[Page 364]]

is that the amounts specified in consents which may be treated as 
consent dividends cannot exceed the amounts which would constitute a 
dividend (as defined in section 316) if the corporation had distributed 
the total specified amounts in money to shareholders on the last day of 
the taxable year of the corporation. If only a portion of such total 
would constitute a dividend, then only a corresponding portion of each 
specified amount is treated as a consent dividend.
    (2) The application of section 565 (b) (2) and Sec.  1.565-2 (c) may 
be illustrated by the following example:

    Example. The X Corporation, a corporation described in Sec.  1.565-
(a) (1) or (2), which makes its income tax returns on the calendar year 
basis, has only one class of stock outstanding, owned in equal amounts 
by A and B. It makes no distributions during the taxable year 1987. Its 
earnings and profits for the calendar year 1987 amount to $8,000, there 
being at the beginning of such year no accumulated earnings or profits. 
A and B execute proper consents to include $5,000 each in their gross 
income as a dividend received by them on December 31, 1987. The sum of 
the amounts specified in the consents executed by A and B is $10,000, 
but if $10,000 had actually been distributed by the X corporation on 
December 31, 1987, only $8,000 would have constituted a dividend under 
section 316 (a). The amount which could be considered as consent 
dividends in computing the dividends paid deduction for purposes of the 
accumulated earnings tax is limited to $8,000, or $4,000 of the $5,000 
specified in each consent. The remaining $1,000 in each consent is 
disregarded for all tax purposes. (In the case of a personal holding 
company, see also the example in Sec.  1.565-3(b).)

[T.D. 8244, 54 FR 10539, Mar. 14, 1989]



Sec.  1.565-3  Effect of consent.

    (a) General rule. The amount of the consent dividend that is 
described in paragraph (a) of Sec.  1.565-1 shall be considered, for all 
purposes of the Code, as if it were distributed in money by the 
corporation to the shareholder on the last day of the taxable year of 
the corporation, received by the shareholder on such day, and 
immediately contributed by the shareholder as paid-in capital to 
thecorporation on such day. Thus, the amount of the consent dividend 
will be treated by the shareholder as a dividend. The shareholder will 
be entitled to the dividends received deduction under section 243 or 245 
with respect to such consent dividend. The basis of the shareholder's 
consent stock in a corporation will be increased by the amount thus 
treated in his hands as a dividend which he is considered as having 
contributed to the corporation as paid-in capital. The amount of the 
current dividend will also be treated as a dividend received from 
sources within the United States in the same manner as if the dividend 
had been paid in money to the shareholders. Among other effects of the 
consent dividend, the earnings and profits of the corporation will be 
decreased by the amount of the consent dividends. Moreover, if the 
shareholder is a corporation, its accumulated earnings and profits will 
be increased by the amount of the consent dividend with respect to which 
it makes a consent.
    (b) Example. The application of section 565 (c) may be illustrated 
by the following example:

    Example. Corporation A, a personal holding company and a calendar 
year taxpayer, has one shareholder, individual B, whose consent to 
include $10,000 in his gross income for the calendar year 1987 has been 
timely filed. A has $8,000 of earnings and profits at the beginning of 
1987. A has $10,000 of undistributed personal holding company income 
(determined without regard to distributions under section 316(b)(2)) for 
1987. B must include $10,000 in his gross income as a taxable income and 
is treated as having immediately contributed $10,000 to A as paid-in 
capital. See section 316(b)(2).

[T.D. 8244, 54 FR 10540, Mar. 14, 1989]



Sec.  1.565-4  Consent dividends and other distributions.

    Section 565(d) provides a rule applicable where a distribution is 
made in part in consent dividends and in part in money or other 
property. With respect to such a distribution the entire amount 
specified in the consents and the amount of such money or other property 
shall be considered together. Thus, if as a part of the same 
distribution consents are filed by some of the shareholders and cash is 
distributed to other shareholders, for example, those who may be 
unwilling to sign consents, the total amount of the cash and the amounts 
specified in the consents will

[[Page 365]]

be viewed as a single distribution to determine the tax effects of such 
distribution. For example, the total of such amounts must be considered 
to determine whether the distribution (including the amounts specified 
in the consents) is preferential and whether any part of such 
distribution would not be dividends if the total amounts specified in 
the consents were distributed in cash. See paragraph (b)(2) of Sec.  
1.565-2 for examples illustrating the treatment of distributions which 
consist in part of consent dividends and in part of other property.



Sec.  1.565-5  Nonresident aliens and foreign corporations.

    (a) Withholding. In the event that a corporation makes a consent 
dividend, as described in Sec.  1.565-1 (a), to a shareholder that is 
subject to a withholding tax under section 1441 or 1442 on a 
distribution of cash or other property, the corporation must remit an 
amount of tax equal to the withholding tax that would be imposed under 
section 1441 or 1442 if an actual cash distribution equal to the consent 
dividend had been paid to the shareholder on the last day of the 
corporation's taxable year. Such payment must be in one of the following 
forms:
    (1) Cash,
    (2) United States postal money order,
    (3) Certified check drawn on a domestic bank, provided that the law 
of the place where the bank is located does not permit the certification 
to be rescinded prior to presentation,
    (4) A cashier's check of a domestic bank, or
    (5) A draft on a domestic bank or a foreign bank maintaining a 
United States agency or branch and payable in United States funds.

The amount of such payment shall be credited against the tax imposed on 
the shareholder.
    (b) [Reserved]

[T.D. 8244, 54 FR 10540, Mar. 14, 1989]



Sec.  1.565-6  Definitions.

    (a) Consent stock. (1) The term consent stock includes what is 
generally known as common stock. It also includes participating 
preferred stock, the participation rights of which are unlimited.
    (2) The definition of consent stock may be illustrated by the 
following example:

    Example. If in the case of the X Corporation, a personal holding 
company, there is only one class of stock outstanding, it would all be 
consent stock. If, on the other hand, there were two classes of stock, 
class A and class B, and class A was entitled to 6 percent before any 
distribution could be made on class B, but class B was entitled to 
everything distributed after class A had received its 6 percent, only 
class B stock would be consent stock. Similarly, if class A, after 
receiving its 6 percent, was to participate equally or in some fixed 
proportion with class B until it had received a second 6 percent, after 
which class B alone was entitled to any further distributions, only 
class B stock would be consent stock. The same result would follow if 
the order of preferences were class A 6 percent, then class B 6 percent, 
then class A a second 6 percent, either alone or in conjunction with 
class B, then class B the remainder. If, however, class A stock is 
entitled to ultimate participation without limit as to amount, then it, 
too, may be consent stock. For example, if class A is to receive 3 
percent and then share equally or in some fixed proportion with class B 
in the remainder of the earnings or profits distributed, both class A 
stock and class B stock are consent stock.

    (b) Preferred dividends. (1) The term preferred dividends includes 
all fixed amounts (whether determined by percentage of par value, a 
stated return expressed in a certain number of dollars per share, or 
otherwise) the distribution of which on any class of stock is a 
condition precedent to a further distribution of earnings or profits 
(not including a distribution in partial or complete liquidation). A 
distribution, though expressed in terms of a fixed amount, is not a 
preferred dividend, however, unless it is preferred over a subsequent 
distribution within the taxable year upon some class or classes of stock 
other than one on which it is payable.
    (2) The definition of preferred dividends may be illustrated by the 
following example:

    Example. If, in the case of the X Corporation, there are only two 
classes of stock outstanding, class A and class B, and class A is 
entitled to a distribution of 6 percent of par, after which the balance 
of the earnings and profits are distributable on class B exclusively, 
class A's 6 percent is a preferred dividend. If the order of preferences 
is class A $6

[[Page 366]]

per share, class B $6 per share, then class A and class B in fixed 
proportions until class A receives $3 more per share, then class B the 
remainder, all of class A's $9 per share and $6 per share of the amount 
distributable on class B are preferred dividends. The amount which class 
B is entitled to receive in conjunction with the payment to class A of 
its last $3 per share is not a preferred dividend, because the payment 
of such amount is preferred over no subsequent distribution except one 
made on class B itself. Finally, if a distribution must be $6 on class 
A, $6 on class B, then on class A and class B share and share alike, the 
distribution on class A of $6 and the distribution on class B of $6 are 
both preferred dividends.

[54 FR 10540, Mar. 14, 1989]

                          Banking Institutions



Rules of General Application to Banking Institutions--Table of Contents





Sec.  1.581-1  Banks.

    (a) In order to be a bank as defined in section 581, an institution 
must be a corporation for federal tax purposes. See Sec.  301.7701-2(b) 
of this chapter for the definition of a corporation.
    (b) This section is effective as of January 1, 1997.

[T.D. 8697, 61 FR 66588, Dec. 18, 1996]



Sec.  1.581-2  Mutual savings banks, building and loan associations,
and cooperative banks.

    (a) While the general principles for determining the taxable income 
of a corporation are applicable to a mutual savings bank, a building and 
loan association, and a cooperative bank not having capital stock 
represented by shares, there are certain exceptions and special rules 
governing the computation in the case of such institutions. See section 
593 for special rules concerning reserves for bad debts. See section 591 
and Sec.  1.591-1, relating to dividends paid by banking corporations, 
for special rules concerning deductions for amounts paid to, or credited 
to the accounts of, depositors or holders of withdrawable accounts as 
dividends. See also section 594 and Sec.  1.594-1 for special rules 
governing the taxation of a mutual savings bank conducting a life 
insurance business.
    (b) For the purpose of computing the net operating loss deduction 
provided in section 172, any taxable year for which a mutual savings 
bank, building and loan association, or a cooperative bank not having 
capital stock represented by shares was exempt from tax shall be 
disregarded. Thus, no net operating loss carryover shall be allowed from 
a taxable year beginning before January 1, 1952, and, in the case of any 
taxable year beginning after December 31, 1951, the amount of the net 
operating loss carryback or carryover from such year shall not be 
reduced by reference to the income of any taxable year beginning before 
January 1, 1952.

[T.D. 6500, 25 FR 11737, Nov. 26, 1960; 25 FR 14021, Dec. 31, 1960, as 
amended by T.D. 8697, 61 FR 66588, Dec. 18, 1996]



Sec.  1.581-3  Definition of bank prior to September 28, 1962.

    Prior to September 28, 1962, for purposes of sections 582 and 584, 
the term bank means a bank or trust company incorporated and doing 
business under the laws of the United States (including laws relating to 
the District of Columbia), of any State, or of any Territory, a 
substantial part of the business of which consists of receiving deposits 
and making loans and discounts, or of exercising fiduciary powers 
similar to those permitted to national banks under section 11(k) of the 
Federal Reserve Act (38 Stat. 262; 12 U.S.C. 248(k)), and which is 
subject by law to supervision and examination by State, Territorial, or 
Federal authority having supervision over banking institutions. Such 
term also means a domestic building and loan association.

[T.D. 6651, 28 FR 4950, May 17, 1963]



Sec.  1.582-1  Bad debts, losses, and gains with respect to securities
held by financial institutions.

    (a) Bad debt deduction for banks. A bank, as defined in section 581, 
is allowed a deduction for bad debts to the extent and in the manner 
provided by subsections (a), (b), and (c) of section 166 with respect to 
a debt which has become worthless in whole or in part and which is 
evidenced by a security (a bond, debenture, note, certificate, or other 
evidence of indebtedness to pay a fixed or determinable sum of money) 
issued by any corporation (including

[[Page 367]]

governments and their political subdivisions), with interest coupons or 
in registered form.
    (b) Worthless stock in affiliated bank. For purposes of section 
165(g)(1), relating to the deduction for losses involving worthless 
securities, if the taxpayer is a bank (as defined in section 581) and 
owns directly at least 80 percent of each class of stock of another 
bank, stock in such other bank shall not be treated as a capital asset.
    (c) Pre-1970 sales and exchanges of bonds, etc., by banks. For 
taxable years beginning before July 12, 1969, with respect to the 
taxation under subtitle A of the Code of a bank (as defined in section 
581), if the losses of the taxable year from sales or exchanges of 
bonds, debentures, notes, or certificates, or other evidences of 
indebtedness, issued by any corporation (including one issued by a 
government or political subdivision thereof), exceed the gains of the 
taxable year from such sales or exchanges, no such sale or exchange 
shall be considered a sale or exchange of a capital asset.
    (d) Post-1969 sales and exchanges of securities by financial 
institutions. For taxable years beginning after July 11, 1969, the sale 
or exchange of a security is not considered the sale or exchange of a 
capital asset if such sale or exchange is made by a financial 
institution to which any of the following sections applies: Section 585 
(relating to banks), 586 (relating to small business investment 
companies and business development corporations), or 593 (relating to 
mutual savings banks, domestic building and loan associations, and 
cooperative banks). This paragraph shall apply to determine the 
character of gain or loss from the sale or exchange of a security 
notwithstanding any other provision of subtitle A of the Code, such as 
section 1233 (relating to short sales). However, this paragraph shall 
have no effect in the determination of whether a security is a capital 
asset under section 1221 for purposes of applying any other provision of 
the Code, such as section 1232 (relating to original issue discount). 
For purposes of this paragraph, a security is a bond, debenture, note, 
or certificate or other evidence of indebtedness, issued by any person. 
See paragraphs (e) and (f) of this section for special transitional 
rules applicable, respectively, to banks and to small business 
investment companies and business development corporations.
    (e) Transition rule for qualifying securities held by banks--(1) In 
general. Notwithstanding the provisions of paragraph (d) of this 
section, if the net long-term capital gain from sales and exchanges of 
qualifying securities exceeds the net short-term capital loss from such 
sales and exchanges in any taxable year beginning after July 11, 1969, 
such excess shall be treated as long-term capital gain, but in an amount 
not to exceed the net gain from sales and exchanges of securities in 
such year. For purposes of computing such net gain, a capital loss 
carried to the taxable year under section 1212 shall not be taken into 
account. See section 1222 and the regulations thereunder for definitions 
of the terms net long-term capital gain and net short-term capital loss. 
For purposes of this paragraph:
    (i) The term security means a security within the meaning of 
paragraph (d) of this section.
    (ii) The term qualifying security means a security which is held by 
the bank on July 11, 1969, and continuously thereafter until it is first 
sold or exchanged by the bank


See also subparagraph (4) of this paragraph for rules under which the 
time certain securities are held is deemed to include a period of time 
determined under section 1223 (1) and (2) with respect to such security.
    (2) Computation of capital gain or loss. For purposes of this 
paragraph, the amount of gain or loss from the sale or exchange of a 
qualifying security treated as capital gain or loss is determined by 
multiplying the amount of gain or loss recognized from such sale or 
exchange by a fraction the numerator of which is the number of days 
before July 12, 1969, that such security was held by the bank and the 
denominator of which is the sum of the number of days included in the 
numerator and the number of days the security was held by the bank after 
July 11, 1969.
    (3) Special rules. For purposes of subparagraphs (1) and (2) of this 
paragraph, the following items are not taken into account:

[[Page 368]]

    (i) Any amount treated as original issue discount under section 
1232, and
    (ii) Any amount which, without regard to section 582(c) and this 
section, would be treated as gain or loss from the sale or exchange of 
property which is not a capital asset, such as an amount which is 
realized from the sale or exchange of a security which is held by a bank 
as a dealer in securities.
    (4) Holding period in certain cases. For purposes of this paragraph:
    (i) The time a security received in an exchange is deemed to have 
been held by a bank includes a period of time determined under section 
1223(1) with respect to such security.
    (ii) The time a security transferred to a bank from another bank is 
deemed to have been held by the transferee bank includes a period of 
time determined under section 1223(2) with respect to such security


For example, if a bank on December 3, 1972, surrendered an obligation of 
the United States which it held as a capital asset on July 11, 1969, in 
a transaction to which section 1037 applied, the time during which the 
newly received obligation is deemed to have been held includes the time 
during which the surrendered obligation was deemed to have been held by 
the bank. Because the surrendered obligation was held on July 11, 1969, 
the newly acquired obligation is deemed to have been held on that date 
and is a qualifying security. The period during which the surrendered 
obligation is deemed to have been held is taken into account in 
computing the fraction determined under subparagraph (2) of this 
paragraph with respect to the newly received obligation.
    (5) Examples. The provisions of this paragraph may be illustrated by 
the following examples:

    Example 1. Bank A, a calendar year taxpayer, purchased a qualifying 
security on July 14, 1968, and held it to maturity on August 20, 1970, 
when it was redeemed. The redemption resulted in a taxable gain of 
$10,000. The security was held by the bank for 363 days before July 12, 
1969, and for a total of 768 days. During the taxable year, the bank had 
no other gains and no losses from sales or exchanges of qualifying 
securities, but had a net loss of $4,000 from sales of securities other 
than qualifying securities. The portion of the gain from the redemption 
of the qualifying security treated as capital gain under subparagraph 
(2) of this paragraph is $4,726.56 (363/768 x $10,000). Because the net 
gain of the taxable year from sales and exchanges of securities, $6,000 
($10,000-$4,000), exceeds the portion of the gain on the sale of the 
qualifying security treated as capital gain under this paragraph, 
$4,726.56 is treated as long-term capital gain on the sale of the 
qualifying security for the taxable year.
    Example 2. Assume the same facts as in example 1, except that the 
bank's net loss of the taxable year from the sale of securities other 
than qualifying securities was $7,000. The amount considered as long-
term capital gain under this paragraph is limited by the amount of gain 
on the sale of securities to $3,000 ($10,000-$7,000).

    (f) Small business investment companies and business development 
corporations--(1) Election. In the case of a small business investment 
company or a business development corporation, described in section 
586(a), section 582(c) does not apply for taxable years beginning after 
July 11, 1969, and before July 11, 1974, unless the taxpayer elects that 
such section shall apply. In the case of a small business investment 
company, see paragraph (a)(1) of Sec.  1.1243-1 if such an election is 
made, but see paragraph (a)(2) of Sec.  1.1243-1 if such an election is 
not made. Such election applies to all such taxable years and, except as 
provided in subparagraph (3) of this paragraph, is irrevocable. Such 
election must be made not later than (i) the time, including extensions 
thereof, prescribed by law for filing the taxpayer's income tax return 
for its first taxable year beginning after July 11, 1969, or (ii) June 
8, 1970, whichever is later.
    (2) Manner of making election. An election pursuant to the 
provisions of this paragraph is made by the taxpayer by a written 
statement attached to the taxpayer's income tax return (or an amended 
return) for its first taxable year beginning after July 11, 1969. Such 
statement shall indicate that the election is made pursuant to section 
433(d) of the Tax Reform Act of 1969 (83 Stat. 624). The taxpayer shall 
attach to its income tax return for each subsequent taxable year to 
which such election is applicable a statement indicating that the 
election has been made and the amount to which it applies for such year.

[[Page 369]]

    (3) Revocation of election. An election made pursuant to 
subparagraph (2) of this paragraph shall be irrevocable unless:
    (i) A written application for consent to revoke the election, 
setting forth the reasons therefor, is filed with the Commissioner 
within 90 days after the permanent regulations relating to section 
433(d)(2) of the Tax Reform Act of 1969 (83 Stat. 624) are filed with 
the Office of the Federal Register, and
    (ii) The Commissioner consents to the revocation.

The revocation is effective for all taxable years to which the election 
applied.

[T.D. 7171, 37 FR 5620, Mar. 17, 1972; 37 FR 6400, Mar. 29, 1972]



Sec.  1.584-1  Common trust funds.

    (a) Method of taxation. A common trust fund maintained by a bank is 
not subject to taxation under this chapter and is not considered a 
corporation. Its participants are taxed on their proportionate share of 
income from the common trust fund.
    (b) Conditions for qualification. (1) For a fund to be qualified as 
a common trust fund it must be maintained by a bank (as defined in 
section 581) in conformity with the rules and regulations of the 
Comptroller of the Currency, exclusively for the collective investment 
and reinvestment of contributions to the fund by the bank. The bank may 
either act alone or with one or more other fiduciaries, but it must act 
solely in its capacity as one or a combination of the following: (i) As 
a trustee of a trust created by will, deed, agreement, declaration of 
trust, or order of court; (ii) as an executor of a will or as an 
administrator of an estate; (iii) as a guardian (by whatever name known 
under local law) of the estate of an infant, of an incompentent 
individual, or of an absent individual; or (iv) on or after October 3, 
1976, as a custodian of a UniformGifts to Minors account. A Uniform 
Gifts to Minors account is an account established pursuant to a State 
law substantially similar to the Uniform Gifts to Minors Act. (See the 
Uniform Gifts to Minors Act of 1956 or the Uniform Gifts to Minors Act 
of 1966, as published by the National Conference of Commissioners on 
Uniform State Laws.) The Commissioner will publish a list of the States 
whose laws he determines to be substantially similar to such uniform 
acts. A bank that maintains a Uniform Gifts to Minors Act account must 
establish, to the satisfaction of the Commissioner or his delegate, that 
with respect to the account the bank has duties and responsibilities 
similar to the duties and responsibilities of a trustee or guardian.
    (2) A common trust fund may be a participant in another common trust 
fund.
    (c) Affiliated groups. For taxable years beginning after December 
31, 1975, two or more banks that are members of the same affiliated 
group (within the meaning of section 1504) are treated, for purposes of 
section 584, as one bank for the period of their affiliation. A common 
trust fund may be maintained by one or by more than one member of an 
affiliated group. Any member of the group may, but need not, contribute 
to the fund. Further, for purposes of this paragraph, members of an 
affiliated group may be, but need not be, co-trustees of the common 
trust fund.

[T.D. 6500, 25 FR 11737, Nov. 26, 1960, as amended by T.D. 7935, 49 FR 
1694, Jan. 13, 1984]



Sec.  1.584-2  Income of participants in common trust fund.

    (a) Each participant in a common trust fund is required to include 
in computing its taxable income for its taxable year within which or 
with which the taxable year of the fund ends, whether or not distributed 
and whether or not distributable:
    (1) Its proportionate share of short-term capital gains and losses, 
computed as provided in Sec.  1.584-3;
    (2) Its proportionate share of long-term capital gains and losses, 
computed as provided in Sec.  1.584-3; and
    (3) Its proportionate share of the ordinary taxable income or the 
ordinary net loss of the common trust fund, computed as provided in 
Sec.  1.584-3.
    (b) Any tax withheld at the source from income of the fund (e.g., 
under section 1441) is deemed to have been withheld proportionately from 
the participants to whom such income is allocated.

[[Page 370]]

    (c)(1) The proportionate share of each participant's short-term 
capital gains and losses, long-term capital gains and losses, ordinary 
taxable income or ordinary net loss, dividends and interest received, 
and tax withheld at the source shall be determined under the method of 
accounting adopted by the bank in accordance with the written plan by 
which the common trust fund is established and administered, provided 
such method clearly reflects the income of each participant.
    (2) Items of income and deductions shall be allocated to the periods 
between valuation dates established by the plan within the taxable year 
in which they were realized. Ordinary taxable income or ordinary net 
loss, short-term capital gains and losses, long-term capital gains and 
losses, and tax withheld at the source shall be computed for each 
period. The participants' proportionate shares of income and losses for 
each period shall then be determined.
    (3) For taxable years beginning on or after September 22, 1980, any 
amount of income or loss of the common trust fund which is included in 
the computation of a participant's taxable income for the taxable year 
shall be treated as income or loss from an unrelated trade or business 
to the extent that such amount would have been income or loss from an 
unrelated trade or business if such participant had made directly the 
investments of the common trust fund.
    (4) The provisions of this paragraph may be illustrated by the 
following example:

    Example. (i) The plan of a common trust fund provides for quarterly 
valuation dates and for the computation and the distribution of the 
income upon a quarterly basis, except that there shall be no 
distribution of capital gains. The participants are as follows: Trusts 
A, B, C, and D for the first quarter; Trusts A, B, C, and E for the 
second quarter; and Trusts A, B, F, and G for the third and fourth 
quarters, the participants having equal participating interests. As 
computed upon the quarterly basis, the ordinary taxable income, the 
short-term capital gain, and the long-term capital loss for the taxable 
year were as follows:

----------------------------------------------------------------------------------------------------------------
                                                                    First    Second   Third    Fourth
                                                                   quarter  quarter  quarter  quarter    Total
----------------------------------------------------------------------------------------------------------------
Ordinary taxable income..........................................    $200     $300     $200     $400      $1,100
Short-term capital gain..........................................     200      100      200      100         600
Long-term capital loss...........................................     100      200      100      200         600
----------------------------------------------------------------------------------------------------------------

    (ii) The participants' shares of ordinary taxable income are as 
follows:

                                 Participants' Shares of Ordinary Taxable Income
----------------------------------------------------------------------------------------------------------------
                                                                    First    Second   Third    Fourth
                           Participant                             quarter  quarter  quarter  quarter    Total
----------------------------------------------------------------------------------------------------------------
A................................................................     $50      $75      $50     $100        $275
B................................................................      50       75       50      100         275
C................................................................      50       75   .......  .......        125
D................................................................      50   .......  .......  .......         50
E................................................................  .......      75   .......  .......         75
F................................................................  .......  .......      50      100         150
G................................................................  .......  .......      50      100         150
                                                                  ----------------------------------------------
  Total..........................................................     200      300      200      400       1,100
----------------------------------------------------------------------------------------------------------------

    (iii) The participants' shares of the short-term capital gain are as 
follows:

             Participants' Shares of Short-Term Capital Gain
------------------------------------------------------------------------
                                First    Second   Third    Fourth
         Participant           quarter  quarter  quarter  quarter  Total
------------------------------------------------------------------------
A............................     $50      $25      $50      $25    $150
B............................      50       25       50       25     150
C............................      50       25   .......  .......     75
D............................      50   .......  .......  .......     50
E............................  .......      25   .......  .......     25
F............................  .......  .......      50       25      75
G............................  .......  .......      50       25      75
                              ------------------------------------------
  Total......................     200      100      200      100     600
------------------------------------------------------------------------

    (iv) The participants' shares of the long-term capital loss are as 
follows:

             Participants' Shares of Long-Term Capital Loss
------------------------------------------------------------------------
                                First    Second   Third    Fourth
         Participant           quarter  quarter  quarter  quarter  Total
------------------------------------------------------------------------
A............................     $25      $50      $25      $50    $150
B............................      25       50       25       50     150
C............................      25       50   .......  .......     75
D............................      25   .......  .......  .......     25
E............................  .......      50   .......  .......     50
F............................  .......  .......      25       50      75
G............................  .......  .......      25       50      75
                              ------------------------------------------
  Total......................     100      200      100      200     600
------------------------------------------------------------------------


[[Page 371]]

    (v) If in the above example the common trust fund also had short-
term capital losses and long-term capital gains, the treatment of such 
gains or losses would be similar to that accorded to the short-term 
capital gains and long-term capital losses in the above example.
    (vi) Assume in the above example that participant Trust A qualified 
as a trust forming part of a pension, profit sharing, or stock bonus 
plan under section 401(a). Assume further that 20 percent of the 
ordinary taxable income of the common trust fund would be unrelated 
business taxable income (as defined under section 512(a)(1)) if received 
directly by Trust A. Under paragraph (c)(3), participant Trust A, for 
purposes of computing its taxable income, must treat its proportionate 
share of the common trust fund's ordinary taxable income as income from 
an unrelated trade or business to the extent such amount would have been 
income from an unrelated trade or business if Trust A had directly made 
the investments of the common trust fund. Therefore, participant Trust A 
must take into account 20 percent of its proportionate share of the 
common trust fund's ordinary taxable income as income from an unrelated 
trade or business.

    (d) The provisions of part I, subchapter J, chapter 1 of the Code, 
or, as the case may be, the provisions of subchapters D, F, or H of 
chapter 1 of the Code, are applicable in determining the extent to which 
each participant's proportionate share of any income or loss of the 
common trust fund is taxable to the participant, or to a person other 
than the participant.

[T.D. 6500, 25 FR 11737, Nov. 26, 1960, as amended by T.D. 7935, 49 FR 
1694, Jan. 13, 1984; T.D. 8662, 61 FR 19546, May 2, 1996]



Sec.  1.584-3  Computation of common trust fund income.

    The taxable income of the common trust fund shall be computed in the 
same manner and on the same basis as in the case of an individual, 
except that:
    (a) No deduction shall be allowed under section 170 (relating to 
charitable, etc., contributions and gifts);
    (b) The gains and losses from sales or exchanges of capital assets 
of the common trust fund are required to be segregated. A common trust 
fund is not allowed the benefit of the capital loss carryover provided 
by section 1212; and
    (c) The ordinary taxable income (the excess of the gross income over 
deductions) or the ordinary net loss (the excess of the deductions over 
the gross income) shall be computed after excluding all items of gain 
and loss from sales or exchanges of capital assets.

[T.D. 6500, 25 FR 11737, Nov. 26, 1960, as amended by T.D. 7935, 49 FR 
1694, Jan. 13, 1984]



Sec.  1.584-4  Admission and withdrawal of participants in the common
trust fund.

    (a) Gain or loss. The common trust fund realizes no gain or loss by 
the admission or withdrawal of a participant, and the basis of the 
assets and the period for which they are deemed to have been held by the 
common trust fund for the purposes of section 1202 are unaffected by 
such an admission or withdrawal. For taxable years of participants 
ending after April 7, 1976, and for transfers occurring after that date, 
the transfer of property by a participant to a common trust fund is 
treated as a sale or exchange of the property transferred. If a 
participant withdraws the whole or any part of its participating 
interest from the common trust fund, such withdrawal shall be treated as 
a sale or exchange by the participant of the participating interest or 
portion thereof which is so withdrawn. A participant is not deemed to 
have withdrawn any part of its participating interest in the common 
trust fund so as to have completed a closed transaction by reason of the 
segregation and administration of an investment of the fund, pursuant to 
the provisions of 12 CFR 9.18(b)(7) (or, for periods before September 
28, 1962, 12 CFR206.17(c)(7)), for the benefit of all the then 
participants in the common trust fund. Such segregated investment shall 
be considered as held by, or on behalf of, the common trust fund for the 
benefit ratably of all participants in the common trust fund at the time 
of segregation, and any income or loss arising from its administration 
and liquidation shall constitute income or loss to the common trust fund 
apportionable among the participants for whose benefit the investment 
was segregated. When a participating interest is transferred by a bank, 
or by two or more banks that are members of the same affiliated group 
(within the meaning of section 1504), as a result of the combination of

[[Page 372]]

two or more common trust funds or the division of a single common trust 
fund, the transfer to the surviving or divided fund is not considered to 
be an admission or a withdrawal if the combining, dividing, and 
resulting common trust funds have diversified portfolios. For purposes 
of this paragraph (a), a common trust fund has a diversified portfolio 
if it satisfies the 25 and 50-percent tests of section 368(a)(2)(F)(ii), 
applying the relevant provisions of section 368(a)(2)(F). However, 
Government securities are included in total assets for purposes of the 
denominator of the 25 and 50-percent tests (unless the Government 
securities are acquired to meet the 25 and 50-percent tests), but are 
not treated as securities of an issuer for purposes of the numerator of 
the 25 and 50-percent tests. In addition, for a transfer of a 
participating interest in a division of a common trust fund not to be 
considered an admission or withdrawal, each participant's pro 
ratainterest in each of the resulting common trust funds must be 
substantially the same as was the participant's pro rata interest in the 
dividing fund. However, in the case of the division of a common trust 
fund maintained by two or more banks that are members of the same 
affiliated group resulting from the termination of such affiliation, the 
division will be treated as meeting the requirements of the preceding 
sentence if the written plans of operation of the resulting common trust 
funds are substantially identical to the plan of operation of the 
dividing common trust fund, each of the assets of the dividing common 
trust fund are distributed substantially pro rata to each of the 
resulting common trust funds, and each participant's aggregate interest 
in the assets of the resulting common trust funds of which he or she is 
a participant is substantially the same as was the participant's pro 
rata interest in the assets of the dividing common trust fund. The plan 
of operation of a resulting common trust fund will not be considered to 
be substantially identical to that of the dividing common trust fund 
where, for example, the plan of operation of the resulting common trust 
fund contains restrictions as to the types of participants that may 
invest in the common trust fund where such restrictions were not present 
in the plan of operation of the dividing common trust fund.
    (b) Basis for gain or loss upon withdrawal. The participant's gain 
or loss upon withdrawal of its participating interest or portion thereof 
shall be measured by the difference between the amount received upon 
such withdrawal and the adjusted basis of the participating interest or 
portion thereof withdrawn plus the additions prescribed in paragraph (c) 
of this section and minus the reductions prescribed in paragraph (d) of 
this section. The amount received by the participant shall be the sum of 
any money plus the fair market value of property (other than money) 
received upon such withdrawal. The basis of the participating interest 
or portion thereof withdrawn shall be the sum of any money plus the fair 
market value of any property (other than money) contributed by the 
participant to the common trust fund to acquire the participating 
interest or portion thereof withdrawn. Such basis shall not be reduced 
on account of the segregation of any investment in the common trust fund 
pursuant to the provisions of 12 CFR 9.18(b)(7) (or, for periods before 
September 28, 1962, 12 CFR 206.17(c)(7)). For the purpose of making the 
adjustments, additions, and reductions with respect to basis as 
prescribed in this paragraph, the ward, rather than the guardian, shall 
be deemed to be the participant; and the grantor, rather than the trust, 
shall be deemed to be the participant, to the extent that the income of 
the trust is taxable to the grantor under subpart E (section 671 and 
following), part I, subchapter J, chapter 1 of the Code.
    (c) Additions to basis. As prescribed in paragraph (b) of this 
section, in computing the gain or loss upon the withdrawal of a 
participating interest or portion thereof, there shall be added to the 
basis of the participating interest or portion thereof withdrawn an 
amount equal to the aggregate of the following items (to the extent that 
they were properly allocated to the participant for a taxable year of 
the common trust fund and were not distributed to the participant prior 
to withdrawal):

[[Page 373]]

    (1) Wholly exempt income of the common trust fund for any taxable 
year,
    (2) Net income of the common trust fund for the taxable years 
beginning after December 31, 1935, and prior to January 1, 1938,
    (3) Net short-term capital gain of the common trust fund for each 
taxable year beginning after December 31, 1937,
    (4) The excess of the gains over the losses recognized to the common 
trust fund upon sales or exchanges of capital assets held (i) for more 
than 18 months for taxable years beginning after December 31, 1937, and 
before January 1, 1942, (ii) for more than 6 months for taxable years 
beginning after December 31, 1941, and before January 1, 1977, (iii) for 
more than 9 months for taxable years beginning in 1977, and (iv) for 
more than 1 year for taxable years beginning after December 31, 1977, 
and
    (5) Ordinary net or taxable income of the common trust fund for each 
taxable year beginning after December 31, 1937.
    (d) Reductions in basis. As prescribed in paragraph (b) of this 
section, in computing the gain or loss upon the withdrawal of a 
participating interest or portion thereof, the basis of the 
participating interest or portion thereof withdrawn shall be reduced by 
such portions of the following items as were allocable to the 
participant with respect to the participating interest or portion 
thereof withdrawn:
    (1) The amount of the excess of the allowable deductions of the 
common trust fund over its gross income for the taxable years beginning 
after December 31, 1935, and before January 1, 1938, and
    (2) The amount of the net short-term capital loss, net long-term 
capital loss, and ordinary net loss of the common trust fund for each 
taxable year beginning after December 31, 1937.
    (e) Effective date. The eighth sentence of paragraph (a) of this 
section is effective for combinations and divisions of common trust 
funds completed on or after May 2, 1996.

[T.D. 6500, 25 FR 11737, Nov. 26, 1960, as amended by T.D. 6651, 28 FR 
4950, May 17, 1963; T.D. 7935, 49 FR 1695, Jan. 13, 1984; T.D. 8662, 61 
FR 19546, May 2, 1996; 61 FR 39072, July 26, 1996]



Sec.  1.584-5  Returns of banks with respect to common trust funds.

    For rules applicable to filing returns of common trust funds, see 
section 6032 and the regulations thereunder.



Sec.  1.584-6  Net operating loss deduction.

    The net operating loss deduction is not allowed to a common trust 
fund. Each participant in a common trust fund, however, will be allowed 
the benefits of such deduction. In the computation of such deduction, a 
participant in a common trust fund shall take into account its pro rata 
share of items of income, gain, loss, deduction, or credit of the common 
trust fund. The character of any such item shall be determined as if the 
participant had realized such item directly from the source from which 
realized by the common trust fund, or incurred such item in the same 
manner as incurred by the common trust fund.



Sec.  1.585-1  Reserve for losses on loans of banks.

    (a) General rule. As an alternative to a deduction from gross income 
under section 166(a) for specific debts which become worthless in whole 
or in part, a financial institution to which section 585 and this 
section apply shall be allowed a deduction under section 585(a) (or, for 
taxable years beginning before January 1, 1987, section 166(c)), for a 
reasonable addition to a reserve for bad debts provided such financial 
institution has adopted or adopts the reserve method of treating bad 
debts in accordance with paragraph (b) of Sec.  1.166-1. In the case of 
such a taxpayer the amount of the reasonable addition to such reserve 
for a taxable year beginning after July 11, 1969, shall be an amount 
determined by the taxpayer which does not exceed the amount computed 
under Sec.  1.585-2. Such reasonable addition for the taxable year shall 
be an amount at least equal to the amount provided by Sec.  1.585-
2(a)(2). For each taxable year the taxpayer must include in its income 
tax return (or amended return) for that year a computation of the amount 
of the addition determined under this section showing the method used to 
determine that amount. The use of a particular method in the return for 
a taxable year is not a binding election by

[[Page 374]]

the taxpayer to apply such method either for such taxable year or for 
subsequent taxable years. A financial institution to which section 585 
and this section apply which adopts the reserve method is not entitled 
to charge off any bad debts pursuant to section 166(a) with respect to a 
loan (as defined in Sec.  1.585-2(e)(2). Except as provided by Sec.  
1.585-3, the reserve for bad debts of a financial institution to which 
section 585 and this section apply shall be established and maintained 
in the same manner as is provided by section 585 (or, for taxable years 
beginning before January 1, 1987, section 166(c)) and theregulations 
under section 166 with respect to reserves for bad debts. Except as 
provided by this section, no deduction is allowable for an addition to a 
reserve for losses on loans as defined in Sec.  1.585-2(e)(2) of a 
financial institution to which section 585 and this section apply. For 
rules relating to deduction with respect to debts which are not loans 
(as defined in Sec.  1.585-2(e)(2)), see section 166(a) and the 
regulations thereunder. For rules relating to a debt evidenced by a 
security (as defined in section 165(g)(2)(C), see sections 166 and 
582(a) and the regulations thereunder. For the definition of certain 
terms, see paragraph (e) of Sec.  1.585-2. For rules relating to a 
transaction to which section 381(a) applies, see Sec.  1.585-4. For 
rules relating to large banks, see Sec. Sec.  1.585-5 through 1.585-8.
    (b) Application of section--(1) In general. Except as provided in 
paragraph (b)(2) of this section, section 585 and this section apply to 
the following financial institutions--
    (i) Any bank (as defined in section 581 and the regulations 
thereunder) other than a mutual savings bank, domestic building and loan 
association, or cooperative bank, to which section 593 applies; and
    (ii) Any corporation to which paragraph (b)(1)(i) of this section 
would apply except for the fact that it is a foreign corporation and in 
the case of any such foreign corporation, the rules provided by section 
585(a) and (b), this section, Sec. Sec.  1.585-2, 1.585-3, and 1.585-4 
apply only with respect to loans outstanding the interest on which is 
effectively connected with the conduct of a banking business within the 
United States.
    (2) Exception. For taxable years beginning after December 31, 1986, 
section 585(a) and (b) and this section do not apply to any large bank 
(as defined in Sec.  1.585-5(b)). For these years, a large bank may not 
deduct any amount under section 585 or any other section for an addition 
to a reserve for bad debts.

(Sec. 585(b)(4), of the Internal Revenue Code of 1954 (83 Stat. 618; (26 
U.S.C. 585(b)(4))))

[T.D. 7532, 43 FR 3109, Jan. 23, 1978, as amended by T.D. 8513, 58 FR 
68757, Dec. 29, 1993; 59 FR 15502, Apr. 1, 1994]



Sec.  1.585-2  Addition to reserve.

    (a) In general--(1) Maximum addition. For taxable years beginning 
before January 1, 1988, the maximum reasonable addition to the reserve 
for losses on loans as defined in paragraph (e)(2) of this section is 
the amount allowable under the percentage method provided by paragraph 
(b) of this section or the experience method provided by paragraph (c) 
of this section, whichever is greater. For taxable years beginning after 
December 31, 1987, the maximum reasonable addition to the reserve for 
losses on loans is the amount determined under the experience method 
provided by paragraph (c) of this section.
    (2) Minimum addition. For taxable years beginning after December 31, 
1976, and before January 1, 1988, a taxpayer to which this section 
applies shall make a minimum addition to the reserve for losses on loans 
as defined in paragraph (e)(2) of this section. For purposes of this 
subparagraph, the term minimum addition means an addition to the reserve 
for losses on loans in an amount equal to the lesser of (i) the amount 
allowable under section 585 (b)(3)(A) and paragraph (c)(1)(ii) of this 
section, or (ii) the maximum amount allowable under section 585 (b)(2) 
and paragraph (b) of this section. For taxable years beginning after 
December 31, 1987, a taxpayer to which this section applies shall make a 
minimum addition to the reserve for losses on loans for each taxable 
year in an amount equal to the amount allowable under section 585 
(b)(3)(A) and paragraph (c)(1)(ii) of this section.

[[Page 375]]

    (b) Percentage method--(1) In general--(i) Maximum addition. Except 
as limited under subparagraph (2) of this paragraph, the maximum 
reasonable addition to the reserve for losses on loans under the 
percentage method for a taxable year is the amount determined under 
paragraph (b)(1) (ii), (iii), or (iv) of this section, whichever is 
applicable. For purposes of this paragraph, the term allowable 
percentage means 1.8 percent for taxable years beginning before 1976; 
1.2 percent for taxable years beginning after 1975 but before 1982; 1.0 
percent for taxable years beginning in 1982; and 0.6 percent for taxable 
years beginning after 1982 and before 1988. This paragraph does not 
apply for taxable years beginning after 1987.
    (ii) Reserve less than allowable percentage of eligible loans. (A) 
If the reserve for losses on loans as of the close of the base year is 
less than the allowable percentage for the taxable year multiplied by 
the eligible loans outstanding at the close of the base year, the amount 
determined under this subdivision for the taxable year is the amount 
necessary to increase the balance of the reserve for losses on loans as 
of the close of the taxable year to an amount equal to the allowable 
percentage for the taxable year multiplied by the eligible loans 
outstanding at the close of that year, except that the amount determined 
with respect to the reserve deficiency shall not exceed one-fifth of the 
reserve deficiency. For purposes of this section, the term reserve 
deficiency means the excess of the allowable percentage for the taxable 
year multiplied by the eligible loans outstanding at the close of the 
base year over the reserve forlosses on loans as of the close of the 
base year. Where a taxpayer has recoveries of bad debts for a taxable 
year which exceed the bad debts sustained for such year, the taxpayer is 
not required to reduce its otherwise permissible current addition by the 
amount of the net recovery. A reasonable addition attributable to an 
increase in eligible loans outstanding at the close of the taxable year 
over eligible loans outstanding at the close of the base year may be 
made only for the portion of such increase which does not exceed the 
excess of eligible loans outstanding at the close of the taxable year 
over the sum of the amount of eligible loans outstanding at the close of 
the base year and the amount of previous increases in such loans for 
which an addition was made in taxable years ending after the close of 
the base year. For purposes of this subdivision, the order in which the 
factors which make up the annual reserve addition shall be claimed is:
    (1) An amount equal to one-fifth of the reserve deficiency;
    (2) Net bad debts charged to the reserve; and
    (3) An amount attributable to an increase in the amount of eligible 
loans outstanding.
    (B) For its first taxable year, a newly organized financial 
institution to which Sec.  1.585-1 and this section apply shall be 
considered to have no reserve deficiency. For example, a new financial 
institution would compute its annual reserve addition by including in 
such addition an amount not in excess of the sum of (1) the amount of 
its net bad debts charged to the reserve for the taxable year, and (2) 
the allowable percentage of the increase in its eligible loans 
outstanding at the close of the taxable year over the amount of its 
loans outstanding (zero) at the end of the year preceding its first 
taxable year. Such amount would be subject to the 0.6 percent 
limitations provided in subparagraph (2) of the paragraph.
    (C) The application of the rules provided by this subdivision may be 
illustrated by the following example:

    Example. The X Bank is a commercial bank which has a calendar year 
as its taxable year. X adopted the reserve method of accounting for bad 
debts in 1950. On December 31, 1969, X has $1,000,000 of outstanding 
eligible loans and a balance of $13,000 in its reserve for losses on 
loans. The base year is 1969 and, consequently, X has a reserve 
deficiency of $5,000 ((1.8% x $1,000,000) - $13,000).
    (a) During 1970, X has net bad debts of $1,000 charged to the 
reserve for losses on loans. On December 31, 1970, X has $1,050,000 of 
outstanding eligible loans. The maximum reasonable addition under the 
percentage method is $2,900 which consists of $1,000 of reserve 
deficiency (\1/5\ x $5,000), the $1,000 in net bad debts charged to the 
reserve for losses on loans, and $900 attributable to the increase in 
the balance of eligible loans (1.8% x ($1,050,000 - $1,000,000)). 
Assuming that X makes an addition to the reserve for losses on loans of 
$2,900 for the year, the balance of

[[Page 376]]

the reserve as of December 31, 1970 is $14,900 ($13,000 - $1,000 + 
$2,900).
    (b) During 1971, X has net bad debts of $1,000 charged to the 
reserve for losses on loans. On December 31, 1971, X has $800,000 of 
outstanding eligible loans. The allowable percentage of eligible loans 
is $14,400 (1.8% x $800,000). The maximum reasonable addition under the 
percentage method is $500 which is a portion of one-fifth of the reserve 
deficiency. Assuming that X makes an addition to the reserve for losses 
on loans of $500 for the year, the balance of the reserve as of December 
31, 1971, is $14,400 ($14,900 - $1,000 + $500).
    (c) During 1972, X has net bad debts of $600 charged to the reserve 
for losses on loans. On December 31, 1972, X has $850,000 of outstanding 
eligible loans. The allowable percentage of eligible loans is $15,300 
(1.8% x $850,000). The maximum reasonable addition under the percentage 
method is $1,500 which consists of $1,000 of reserve deficiency (\1/5\ x 
$5,000) and $500 of the net bad debts charged to the reserve for losses 
on loans in 1971. Even though the full addition with respect to the 
reserve deficiency in 1971 was not made, the amount of the addition that 
can be made in 1972 with respect to the reserve deficiency is limited to 
one-fifth of such deficiency. Assuming that X makes an addition to the 
reserve for losses on loans of $1,500 for the year, the balance of the 
reserve as of December 31, 1972, is $15,300 ($14,400 - $600 + $1,500).
    (d) During 1973, X did not have any net bad debts charged to the 
reserve for losses on loans. On December 31, 1973, X has $1,000,000 of 
outstanding eligible loans. The allowable percentage of eligible loans 
is $18,000 (1.8% x $1,000,000). The maximum reasonable addition under 
the percentage method is $2,100 which consists of $1,000 of reserve 
deficiency (\1/5\ x $5,000), $500 of net bad debts charged to the 
reserve for losses in 1971, and $600 of net bad debts charged to the 
reserve in 1972. Although outstanding eligible loans increased from 
$850,000 in 1972 to $1,000,000 in 1973, no addition is permitted with 
respect to the increase because the amount of eligible loans outstanding 
at the close of 1973 ($1,000,000) does not exceed the sum of the amount 
of such loans at the close of the base year ($1,000,000) and the amount 
of previous increases in such loans for which an addition was made in 
taxable years ending after the close of the base year ($50,000 loan 
increase in 1970). Assuming that X makes an addition to the reserve for 
losses on loans of $2,100, the balance of the reserve as of December 31, 
1973, is $17,400 ($15,300 + $2,100).

    (iii) Reserve equal to or greater than allowable percentage and 
eligible loans have not declined. If the reserve for losses on loans as 
of the close of the base year is equal to or greater than the allowable 
percentage for the taxable year multiplied by the eligible loans 
outstanding at the close of the base year and if the amount of eligible 
loans outstanding at the close of the taxable year is equal to or 
greater than the amount of eligible loans outstanding at the close of 
the base year, the amount determined under this subdivision is the 
amount necessary to increase the reserve to the greater of (A) the 
allowable percentage for the taxable year multiplied by the eligible 
loans outstanding at the close of the year, or (B) the balance of the 
reserve as of the close of the base year. The application of the rule 
provided by this subdivision may be illustrated by the following 
example:

    Example. The M Bank is a commercial bank which has a calendar year 
as its taxable year. M adopted the reserve method of accounting for bad 
debts in 1950. On December 31, 1969, M has $1,000,000 of outstanding 
eligible loans and a balance of $20,000 in its reserve for losses on 
loans.
    (a) During 1970, M has net bad debts of $1,000 charged to the 
reserve for losses on loans. On December 31, 1970, M has $1,100,000 of 
outstanding eligible loans. The allowable percentage of eligible loans 
is $19,800 (1.8% x $1,100,000). The maximum reasonable addition under 
the percentage method is $1,000 which is the amount sufficient to 
increase the balance of the reserve as of the close of the taxable year 
to the balance of the reserve as of the close of the 1969 base year 
($20,000). Assuming that M makes an addition to the reserve for losses 
on loans of $1,000 for the year, the balance of the reserve as of 
December 31, 1970, is $20,000 ($20,000 - $1,000 + $1,000).
    (b) During 1971, M has net bad debts of $1,000 charged to the 
reserve for losses on loans. On December 31, 1971, M has $1,300,000 of 
outstanding eligible loans. The allowable percentage of eligible loans 
is $23,400 (1.8% x $1,300,000). The maximum reasonable addition under 
the percentage method is $4,400 which is the amount sufficient to 
increase the balance of the reserve to the allowable percentage of 
eligible loans outstanding at the close of the taxable year. Assuming 
that M makes an addition to the reserve for losses on loans of $4,400 
for the year, the balance of the reserve as of December 31, 1971, is 
$23,400 ($20,000 - $1,000 + $4,400).
    (c) During 1972, M has net bad debts of $1,000 charged to the 
reserve for losses on loans. On December 31, 1972, M has $1,200,000 of 
outstanding eligible loans. The allowable percentage of eligible loans 
is $21,600 (1.8% x $1,200,000). No reasonable addition may be made under 
the percentage method because

[[Page 377]]

the reserve for losses on loans ($22,400, i.e., $23,400-$1,000) is 
greater than the allowable percentage of eligible loans outstanding at 
the close of the taxable year ($21,600) and the balance of the reserve 
as of the close of the base year ($20,000). Assuming that no amount is 
added under the experience method provided by paragraph (c) of this 
section, the balance of the reserve for losses on loans as of December 
31, 1972, is $22,400 ($23,400-$1,000).
    (d) During 1973, M has net bad debts of $1,000 charged to the 
reserve for losses on loans. On December 31, 1973, M has $1,200,000 of 
outstanding eligible loans. The allowable percentage of eligible loans 
is $21,600 (1.8% x $1,200,000). The maximum reasonable addition under 
the percentage method is $200 which is the amount sufficient to increase 
the reserve for losses on loans to the allowable percentage of eligible 
loans outstanding at the close of the taxable year. Assuming that M 
makes an addition to the reserve for losses on loans of $200 for the 
year, the balance of the reserve as of December 31, 1973, is $21,600 
($22,400-$1,000 + $200).

    (iv) Reserve greater than allowable percentage and eligible loans 
have declined. If the reserve for losses on loans as of the close of the 
base year is equal to or greater than the allowable percentage of 
eligible loans outstanding at such time and if the amount of eligible 
loans at the close of the taxable year is less than the amount of 
eligible loans outstanding at the close of the base year, the amount 
determined under this subdivision is the amount necessary to increase 
the balance of the reserve to the amount which bears the same ratio to 
eligible loans outstanding at the close of the taxable year as the 
balance of the reserve as of the close of the base year bears to the 
amount of eligible loans outstanding at the close of the base year. The 
application of the rule provided by this subdivision may be illustrated 
by the following example:

    Example. The N Bank is a commercial bank which has a calendar year 
as its taxable year. N adopted the reserve method of accounting for bad 
debts in 1950. On December 31, 1969, N has $1,000,000 of outstanding 
eligible loans and a balance of $20,000 in its reserve for losses on 
loans.
    (a) During 1970, N has net bad debts of $3,000 charged to the 
reserve for losses on loans. On December 31, 1970, N has $900,000 of 
outstanding eligible loans. The maximum reasonable addition under the 
percentage method is $1,000, which is the amount necessary to increase 
the balance of the reserve to the amount ($18,000) which bears the same 
ratio to eligible loans outstanding at the close of the taxable year 
($900,000) as the balance of the reserve as of the close of the base 
year ($20,000) bears to the amount of the eligible loans outstanding at 
the close of the base year ($1,000,000). Assuming that N makes an 
addition to the reserve for losses on loans of $1,000 for the year, the 
balance of the reserve as of December 31, 1970, is $18,000 ($20,000-
$3,000 + $1,000).
    (b) During 1971, N has net bad debts of $1,000 charged to the 
reserve for losses on loans. On December 31, 1971, N has $1,100,000 of 
outstanding eligible loans. The maximum reasonable addition under the 
percentage method, determined under subdivision (iii) of this 
subparagraph, is $3,000 which is the amount necessary to increase the 
balance of the reserve to the greater of the allowable percentage of 
eligible loans outstanding at the close of the taxable year ($19,800) or 
the balance of the reserve at the close of the base year ($20,000). 
Assuming that N makes an addition to the reserve for losses on loans of 
$3,000 for the year, the balance of the reserve as of December 31, 1971 
is $20,000 ($18,000-$1,000 + $3,000).

    (2) Limitations. Notwithstanding any other provision of this 
paragraph, the maximum reasonable addition to the reserve for losses on 
loans under the percentage method shall not exceed the greater of:
    (i) Six-tenths of 1 percent of the eligible loans outstanding at the 
close of the taxable year, or
    (ii) An amount sufficient to increase the reserve for losses on 
loans at the close of the taxable year to six-tenths of 1 percent of the 
eligible loans outstanding at the close of the taxable year.
    The application of the rules provided by this subparagraph may be 
illustrated by the following example:

    Example. The Y Bank begins business as a commercial bank on July 1, 
1974. Y adopts the calendar year as its taxable year and the reserve 
method of accounting for bad debts.
    (a) During 1974, Y has net bad debts of $1,000. On December 31, 
1974, Y has $1,000,000 of outstanding eligible loans. Under subparagraph 
(1)(ii)(B) of this paragraph, because Y is a newly-organized financial 
institution, there is no reserve deficiency. Except for the limitations 
of this subparagraph, the maximum reasonable addition under subparagraph 
(1)(ii)(A) of this paragraph would be the amount of net bad debts 
charged to the reserve for losses ($1,000) plus the allowable percentage 
of outstanding eligible loans at the close of the taxable year $18,000 
(1.8% x

[[Page 378]]

$1,000,000). However, because of the limitations of this subparagraph, 
the maximum reasonable addition to the reserve for losses on loans under 
the percentage method is an amount sufficient to increase the balance of 
the reserve for losses on loans to $6,000 which is 0.6 percent of the 
eligible loans outstanding at the close of the taxable year. Assuming 
that Y makes an addition to the reserve for losses on loans of $7,000 
for the year, the balance of the reserve as of December 31, 1974, is 
$6,000 ($7,000-$1,000). The $7,000 consists of the $1,000 in net bad 
debts and $6,000 attributable to the increase in eligible loans 
outstanding.
    (b) During 1975, Y has net bad debts of $1,000 charged to the 
reserve for losses on loans. On December 31, 1975, Y has $1,000,000 of 
outstanding eligible loans. Except for the limitations of this 
subparagraph, the maximum reasonable addition under subparagraph 
(1)(ii)(A) of this paragraph would be the amount of net bad debts 
charged to the reserve for losses ($1,000) plus an amount attributable 
to the increase in the amount of eligible loans outstanding with respect 
to which no reasonable addition was allowed in 1974 ($12,000, i.e., 
$18,000-$6,000). However, because of the limitations of this paragraph, 
the maximum reasonable addition to the reserve for losses on loans under 
the percentage method is $6,000 which is an amount equal to 0.6 percent 
of the eligible loans outstanding at the close of the taxable year. This 
amount consists of net bad debts of $1,000 and $5,000 attributable to a 
portion of the increase in eligible loans in 1974 with respect to which 
no reasonable addition was allowable for 1974. Assuming that Y makes an 
addition to the reserve for losses on loans of $6,000 for the year, the 
balance of the reserve as of December 31, 1975, is $11,000 ($6,000-
$1,000 + $6,000).
    (c) During 1976, Y has net bad debts charged to the reserve for 
losses on loans of $1,000. On December 31, 1976, Y has $1,000,000 in 
outstanding eligible loans. At the close of 1975 (Y's base year for 
1976), the amount of outstanding eligible loans was also $1,000,000. 
Consequently, there is a reserve deficiency of $1,000 ((1.2% x 
$1,000,000)--$11,000). The maximum reasonable addition to the reserve 
for losses under subparagraph (1)(ii)(A) of this paragraph is $1,200 
which consists of one-fifth of the reserve deficiency ($1,000 x \1/5\ = 
$200) and the net bad debts charged to the reserve for losses on loans 
for the year ($1,000). Because that amount is less than 0.6 percent of 
the eligible loans outstanding at the close of the taxable year (0.6% x 
$1,000,000 = $6,000), the limitations of this subparagraph do not apply. 
Assuming that Y makes an addition to the reserve for losses on loans of 
$1,200 for the year, the balance of the reserve as of December 31, 1976, 
is $11,200 ($11,000-$1,000 + $1,200).

    (c) Experience method--(1) In general--(i) Maximum addition. The 
amount determined under this paragraph for a taxable year is the amount 
necessary to increase the balance of the reserve for losses on loans (as 
of the close of the taxable year) to the greater of the amount 
determined under subdivision (ii) or (iii) of this subparagraph. For 
special rules for a new financial institution, see subparagraph (2) of 
this paragraph.
    (ii) Six-year moving average amount. The amount determined under 
this subdivision is the amount which bears the same ratio to loans 
outstanding at the close of the taxable year as (A) the total bad debts 
sustained during the taxable year and the 5 preceding taxable years (or, 
with the approval of the Commissioner, a shorter period), adjusted for 
recoveries of bad debts during such period, bears to (B) the sum of the 
loans outstanding at the close of such 6 (or fewer) taxable years. For 
purposes of applying this subdivision, a period shorter than 6 years 
generally would be appropriate only where there is a change in the type 
of a substantial portion of the loans outstanding such that the risk of 
loss is substantially increased. For example, if the major portion of a 
bank's portfolio of loans changes fromagricultural loans to industrial 
loans which results in a substantial increase in the risk of loss, a 
period shorter than 6 years may be appropriate. Similarly, a bank which 
has recently altered its lending practices to include in its portfolio 
of loans consumer-installment loans, when it had previously made only 
commercial loans, may also qualify to use a period shorter than six 
years. A decline in the general economic conditions in the area, which 
substantially increase the risk of loss, is a relevant factor which may 
be considered. In any case, however, approval to use a shorter period 
will not be granted unless the taxpayer supplies specific evidence that 
the loans outstanding at the close of the taxable years for the shorter 
period requested are not comparable in nature and risk to loans 
outstanding at the close of the six taxable years. The fact that a 
bank's bad debt experience has shown a substantial increase is not, by 
itself, sufficient to justify use of a

[[Page 379]]

shorter period. If approval is granted to use a shorter period, the 
experience for those taxable years which are excluded shall not be used 
for any subsequent year. A request for approval to exclude the 
experience of a prior taxable year shall not be considered unless it is 
sent to the Commissioner at least 30 days before the close of the first 
taxable year for which such approval is requested.
    (iii) Base year amount. The amount determined under this subdivision 
is the lower of (A) the balance of the reserve as of the close of the 
base year, or (B) if the amount of loans outstanding at the close of the 
taxable year is less than the amount of loans outstanding at the close 
of the base year, the amount which bears the same ratio to loans 
outstanding at the close of the taxable year as the balance of the 
reserve as of the close of the base year bears to the amount of loans 
outstanding at the close of the base year.
    (2) Special rules for new financial institutions--(i) In general. In 
the case of any taxable year preceded by less than 5 authorization years 
(as defined in paragraph (e)(5) of this section), subparagraph (1) of 
this paragraph shall be applied with the adjustments provided by 
subdivision (ii) of this subparagraph.
    (ii) Adjustments. (A) The total bad debts for the 6-year period 
computed under subparagraph (1)(ii)(A) of this paragraph shall be the 
sum of:
    (1) The bad debts sustained by the taxpayer during its authorization 
years, adjusted for recoveries of bad debts for such years, and
    (2) That fraction of the total bad debts sustained by a comparable 
bank (as defined in paragraph (e)(7) of this section) during the 
comparison years (as defined in paragraph (e)(6) of this section), 
adjusted for recoveries of bad debts for such years, which bears the 
same ratio to such total as the average loans outstanding of the 
taxpayer during the authorization years bears to the average loans 
outstanding of the comparable bank during the comparison years.
    (B) The total amount of loans outstanding during the 6-year period 
computed under subparagraph (1)(ii)(B) of this paragraph shall be six 
times the average loans outstanding of the taxpayer during the 
authorization years.
    (d) Change in accounting method from specific charge-off method to 
reserve method of treating bad debts--(1) In general. If a bank is 
granted permission in accordance with Sec.  1.446-1(e)(3) to change its 
method of accounting for bad debts from a method under which specific 
bad debt items are deducted to the reserve method of treating bad debts, 
the taxpayer shall effect the change as provided in subparagraphs (2) 
and (3) of this paragraph.
    (2) Initial balance of the reserve. The initial balance of the 
reserve at the close of the year of change shall be no less than the 
minimum addition as described in paragraph (a)(2) of this section and 
shall be no larger than the greater of:
    (i) The allowable percentage of eligible loans outstanding at the 
close of the taxable year of change, or
    (ii) The amount which bears the same ratio to loans outstanding at 
the close of the taxable year as the total bad debts sustained during 
the taxable year and the 5 preceding taxable years (or, with the 
approval of the Commissioner, a shorter period), adjusted for recoveries 
of bad debts during such period, bears to the sum of the loans 
outstanding at the close of such 6 or fewer taxable years.

In the case of taxable years beginning after 1987, the initial balance 
of the reserve at the end of the year of change shall be the amount 
specified in subdivision (ii) of this subparagraph.
    (3) Deduction with respect to initial balance. The deduction with 
respect to the initial balance of the reserve at the close of the 
taxable year of change, determined under subparagraph (2) of this 
paragraph, is allowable ratably over a period of 10 years commencing 
with the taxable year of change (or a shorter period as may be approved 
by the Commissioner). Thus, the bad debt deduction under section 166 for 
the taxable year of change will consist of the amount of debts 
determined to be wholly or partially worthless and charged-off during 
such taxable year plus one-tenth (if a 10-year period is used) of the 
amount of the reserve determined under subparagraph (2) of this 
paragraph. For each of the 9 taxable

[[Page 380]]

years following the taxable year of change, the bad debt deduction will 
consist of the reasonable addition to the reserve for bad debts for each 
such year as provided by section 585, as otherwise determined, plus one-
tenth of the amount determined to be theinitial balance of the reserve 
under subparagraph (2) of this paragraph. The amount established as a 
bad debt reserve for the taxable year of change under subparagraph (2) 
of this paragraph shall be considered as the balance of the reserve for 
purposes of determining the amount of subsequent additions to such 
reserve, even though the entire amount of the reserve may not have been 
deducted under section 585(a)(1) or former section 166(c) because of the 
requirement that it be deducted over a number of years.
    (e) Definitions--(1) Base year--(i) Percentage method. For purposes 
of paragraph (b) of this section (relating to the percentage method), 
the term base year means: For years beginning before 1976, the last 
taxable year beginning on or before July 11, 1969; for taxable years 
beginning after 1975 but before 1983, the last taxable year beginning 
before 1976; and, for taxable years beginning after 1982, the last 
taxable year beginning before 1983. However, for purposes of section 
585(b)(2)(A) the term base year means the last taxable year before the 
most recent adoption of the percentage method, if later than the base 
year as determined under the preceding sentence.
    (ii) Experience method. For purposes of paragraph (c) of this 
section (relating to the experience method), the term base year means 
(A) the last taxable year before the most recent adoption of the 
experience method, or (B) the last taxable year beginning on or before 
July 11, 1969, which ever is later; and for taxable years beginning 
after 1987, the last taxable year beginning before 1988.
    (iii) Example. The application of the rules provided by this 
subparagraph may be illustrated by the following example:

    Example. The T Bank is a commercial bank which has a calendar year 
as its taxable year. T adopted the reserve method of accounting for bad 
debts in 1950. On December 31, 1969, T has $1,000,000 of outstanding 
eligible loans and a balance of $19,300 in its reserve for losses on 
loans.
    (a) During 1970, T has net bad debts of $1,000 charged to the 
reserve for losses on loans. On December 31, 1970, T has $1,050,000 of 
outstanding eligible loans. T elects the percentage method. The base 
year is 1969. The maximum reasonable addition under the percentage 
method of $1,000 which is the amount sufficient to increase the balance 
of the reserve as of the close of the taxable year to the balance of the 
reserve as of the close of the base year 1969 ($19.300). Assuming that T 
makes an addition to the reserve for losses on loans of $1,000 for the 
year, the balance of the reserve for losses on loans as of December 31, 
1970, is $19,300 ($19,300-$1,000 + $1,000).
    (b) During 1971, T has net bad debts of $8,000 charged to the 
reserve for losses on loans. On December 31, 1971, T has $1,100,000 of 
outstanding eligible loans. T elects the experience method. The base 
year is 1970. The maximum reasonable addition under the experience 
method is $8,000 which is the amount sufficient to increase the balance 
of the reserve as of the close of the taxable year to the balance of the 
reserve as of the close of the 1970 base year ($19,300). Assuming that T 
makes an addition to the reserve for losses on loans of $8,000 for the 
year, the balance of the reserve for losses on loans as of December 31, 
1971, is $19,300, ($19,300-$8,000 + $8,000).
    (c) During 1972, T has net bad debts of $1,000 charged to the 
reserve for losses on loans. On December 31, 1972, T has $1,200,000 of 
outstanding eligible loans. T elects the percentage method. The base 
year is 1971 and there is a reserve deficiency of $500 ((1.8% x 
$1,100,000)-$19,300). The maximum reasonable addition under the 
percentage method is $2,900 which consists of $100 of reserve deficiency 
(\1/5\ x $500), the $1,000 in net bad debts charged to the reserve for 
losses on loans, and $1,800 attributable to the increase in the balance 
of eligible loans (1.8% x ($1,200,000-$1,100,000)). Assuming that T 
makes an addition to the reserve for losses on loans of $2,900 for the 
year, the balance of the reserve for losses on loans as of December 31, 
1972, is $21,200 ($19,300-$1,000 + $2,900).

    (2) Loan--(i) General rule. For purposes of this section and 
Sec. Sec.  1.585-1, 1.585-3, and 1.585-4, the term loan means debt as 
the term debt is used in section 166 and the regulations thereunder. The 
term loan includes (but is not limited to) the following items:
    (A) An overdraft in one or more deposit accounts by a customer in 
good faith whether or not other deposit accounts of the same customer 
have balances in excess of the overdraft;
    (B) A bankers acceptance purchased or discounted by a bank; and

[[Page 381]]

    (C) A loan participation to the extent that the taxpayer bears a 
risk of loss.
    For purposes of (B) of this subdivision (i), a bankers acceptance 
shall be considered as a loan made by the bank which purchased or 
discounted the bankers acceptance and not a loan made by the originating 
bank.
    (ii) Exceptions. Notwithstanding the provisions of subdivision (i) 
of this subparagraph, the term loan does not include the following 
items:
    (A) Discount or interest receivable reflected in the face amount of 
an outstanding loan, which discount or interest has not been included in 
gross income;
    (B) For taxable years beginning after December 31, 1976, commercial 
paper, however acquired by the bank, including, for example, short-term 
promissory notes which may be purchased on the open market;
    (C) For taxable years beginning after December 31, 1976, a debt 
evidenced by a security (as defined in section 165(g)(2)(C) and the 
regulations thereunder);
    (D) Any loan which is entered into or acquired for the primary 
purpose of enlarging the otherwise available bad debt deduction;
    (E) Loans which have been contractually committed to the extent that 
funds have not been disbursed to the borrower or disbursed on behalf of 
the borrower; and
    (F) Any transaction which is in violation of a Federal or State 
statute that governs the activities of the financial institution.
    (3) Eligible loan--(i) General rule. For purposes of this section 
and Sec. Sec.  1.585-3 and 1.585-4, the term eligible loan means a loan 
(as defined in subparagraph (2) of this paragraph) which is incurred in 
the course of the normal customer loan activities of a financial 
institution and which is not a loan described in subdivision (ii) of 
this subparagraph. Nothing within the preceding sentence will be 
construed to exclude from the term eligible loan a bona fide loan in a 
new market or under a novel repayment arrangement if the likelihood of 
nonrepayment is at least as great as that of other customer loans of the 
financial institution.
    (ii) Exceptions. Loans which do not constitute eligible loans 
include:
    (A) A loan to a bank (as defined in section 581 and the regulations 
thereunder) or to a domestic branch of a foreign corporation to which 
Sec.  1.585-1 applies, including a repurchase transaction or other 
similar transaction;
    (B) Bank funds on deposit in any bank (foreign or domestic) such as 
a deposit represented by a certificate of deposit or any other form of 
instrument evidencing the deposit of a sum of money with the issuing 
bank that will be available on or after a stated date or period of time;
    (C) A sale or loan of Federal funds irrespective of the purchaser or 
borrower;
    (D) A loan, to the extent that it is directly or indirectly made to, 
guaranteed by, or insured by the United States, a possession or 
instrumentality thereof, or a State or political subdivision thereof; 
and
    (E) A loan which is secured by a deposit in the lending financial 
institution or in a bank as defined in section 581 or a domestic branch 
of a foreign corporation to which this section applies to the extent 
that the financial institution has control over withdrawal of such 
deposit.
    (iii) Definition of loan which is secured by a deposit. For purposes 
of subdivision (ii)(E) of this subparagraph:
    (A) A loan is considered secured if the loan is on the security of 
any instrument which makes the deposit specific security for the payment 
of the loan, provided that such instrument is of such a nature that in 
the event of default the deposit could be subjected to the satisfaction 
of the loan;
    (B) A deposit includes a guarantee deposit in the form of a 
holdback, pledged collateral that has been reduced to cash, and loan 
payments that are maintained in a separate account; and
    (C) Control over the withdrawal of a deposit is evidenced by 
possession of a passbook, certificate of deposit, note, or other similar 
instrument the possession of which is normally required to permit 
withdrawal. The lending financial institution does not have control over 
withdrawal of the deposit if the

[[Page 382]]

deposit can be withdrawn without consent of the lending financial 
institution. Thus, the lending financial institution normally does not 
have control over the withdrawal of a deposit in an account merely 
because the borrower agrees to maintain a minimum, average, or 
compensating balance.
    (4) Predecessor. For purposes of this section, the term predecessor 
means (i) any taxpayer which transferred more than 50 percent of the 
total amount of its assets to the taxpayer and is described in Sec.  
1.585-1, or (ii) any predecessor of such predecessor.
    (5) Authorization years. For purposes of this section, the term 
authorization years means the number of years, containing 12 complete 
months, between (i) the first day of the first full taxable year of the 
taxpayer for which it (or any predecessor) was authorized to do business 
as a financial institution described in Sec.  1.585-1, and (ii) the 
taxable year.
    (6) Comparison years. For purposes of this section, the term 
comparison years means those consecutive taxable years containing 12 
complete months of a comparable bank, the last of which ends within 12 
months immediately preceding the beginning of the first taxable year of 
the taxpayer, which are equal in number to six minus the number of 
authorization years of the taxpayer.
    (7) Comparable bank. For purposes of this section, the term 
comparable bank means all the financial institutions described in Sec.  
1.585-1 located within the same Federal Reserve district.
    (8) Average loans outstanding. For purposes of this section, the 
term average loans outstanding means the sum of the loans outstanding at 
the close of each taxable year of a period divided by the number of 
taxable years in such period.
    (9) Adjusted for recoveries of bad debts. For purposes of this 
section, the term adjusted for recoveries of bad debts means an 
adjustment for the full amount recovered with respect to bad debts 
previously charged to the reserve during any of the applicable taxable 
years.

(Sec. 585(b)(4), of the Internal Revenue Code of 1954 (83 Stat. 618; (26 
U.S.C. 585(b)(4))))

[T.D. 7532, 43 FR 3109, Jan. 23, 1978, as amended by T.D. 7835, 47 FR 
42342, Sept. 27, 1982; T.D. 8513, 58 FR 68757, Dec. 29, 1993]



Sec.  1.585-3  Special rules.

    (a) Treatment of reserve. For taxable years beginning after July 11, 
1969, if a financial institution to which section 585 and Sec.  1.585-1 
apply establishes a reserve pursuant to section 585(a) (or, for taxable 
years beginning before January 1, 1987, section 166(c)), any bad debt in 
respect of a loan (whether or not such loan is an eligible loan) must be 
charged to the reserve for losses on loans provided for by Sec.  1.585-1 
for the taxable year in which the bad debt occurs. For such a year, any 
recovery of a bad debt previously charged to the reserve account in 
respect of a loan (whether or not such loan is an eligible loan) must be 
credited to such reserve in the taxable year of recovery regardless of 
whether such credit causes the reserve to exceed the permissible amount. 
If, as a result of net recoveries during the taxable year, the reserve 
balance exceeds the permissible amount, a taxpayer is not required to 
report the excess as taxable income. In such a case, the excess over the 
otherwise permissible amount in the reserve account precludes current 
reasonable additions to the reserve and may affect future reasonable 
additions. Recoveries of bad debts which were not charged to the reserve 
shall not be credited to such reserve, but shall be treated as taxable 
income subject to the provisions of section 111. No item other than a 
loan as defined in Sec.  1.585-2 (e)(2) shall be charged to the reserve 
for losses on loans.
    (b) Accounting for reserve. A financial institution to which section 
585 and Sec.  1.585-1 apply which establishes a reserve pursuant to 
section 585(a) (or, for taxable years beginning before January 1, 1987, 
section 166(c)) shall establish and maintain a permanent record of such 
reserve. Copies of Federal income tax returns and amended returns with 
attached schedules satisfy the requirements of this paragraph provided 
that such returns are permanently maintained by the financial 
institution and the balance of the reserve for losses on loans 
established pursuant to section 585(a) (or former section 166(c)) can be 
readily reconciled with the reservefor losses on loans maintained by the 
financial institution for financial statement purposes. The requirements 
of

[[Page 383]]

this paragraph would also be satisfied if a financial institution 
establishes and maintains a permanent subsidiary ledger reflecting an 
account for the reserve for losses on loans established pursuant to 
section 585(a) (or former section 166(c)) provided the balance in such 
account can be readily reconciled with the balance of the reserve for 
losses on loans for financial statement purposes maintained in any other 
ledger. The permanent records maintained pursuant to this section must 
reflect any changes in the amount initially added to the reserve for 
losses on loans and the amount finally determined by the taxpayer to be 
a reasonable addition to the reserve for losses on loans.

(Sec. 585(b)(4), of the Internal Revenue Code of 1954 (83 Stat. 618; (26 
U.S.C. 585(b)(4))))

[T.D. 7532, 43 FR 3114, Jan. 23, 1978, as amended by T.D. 8513, 58 FR 
68757, Dec. 29, 1993]



Sec.  1.585-4  Reorganizations and asset acquisitions.

    (a) In general. In computing a reasonable addition to the reserve 
for losses on loans for the first taxable year ending after a 
transaction to which section 381(a) applies and for subsequent taxable 
years, the separate reserves for losses on loans, the amount of loans 
outstanding, the total bad debts sustained (adjusted for recoveries), 
and the amount of eligible loans outstanding of the distributor or 
transferor corporation and the acquiring corporation (or, in the case of 
a consolidation, the transferor corporations) shall be combined for all 
applicable years. Thus, for example, in applying Sec.  1.585-2(c)(1)(i) 
for the first taxable year ending after the distribution or transfer, 
the total bad debts sustained during the 5 preceding taxable years are 
the sum of the bad debts sustained by the acquiring corporation for the 
5 preceding taxable years and bad debts sustained by the distributor or 
transferor corporation for the taxable year ending on the date of 
distribution or transfer and the 4 preceding taxable years.
    (b) Base year and base year amounts of acquiring corporation--(1) 
Base year. For transactions to which section 381(a) applies, the base 
year of the acquiring corporation for the first taxable year ending 
after the date of distribution or transfer shall be the last taxable 
year ending on or before the date of distribution or transfer. The 
balance of the reserve, the amount of loans outstanding, and the amount 
of eligible loans outstanding at the close of such base year shall be 
determined in accordance with the provisions of subparagraph (2)(i) of 
this paragraph. For taxable years subsequent to the first taxable year 
ending after the date of distribution or transfer, the base year of the 
acquiring corporation shall be the more recent of the base year provided 
by the first sentence of this subparagraph or the base year provided by 
Sec.  1.585-2(e)(1). If Sec.  1.585-2(e)(1) provides the more recent 
base year, the balance of the reserve for losses on loans, the amount of 
loans outstanding, and the amount of eligible loans outstanding shall be 
determined at the close of such base year without regard to this 
paragraph.
    (2) Base year amounts--(i) Method of determination. The balance of 
the reserve for losses on loans, the amount of loans outstanding, and 
the amount of eligible loans outstanding at the close of the base year 
provided by the first sentence of subparagraph (1) of this paragraph 
shall be the total of such amounts of the distributor or transferor 
corporation and the acquiring corporation (or, in the case of a 
consolidation, the transferor corporations) at the close of what would 
have been their respective base years determined under Sec.  1.585-
2(e)(1) if the distribution or transfer to which section 381(a) applies 
had not occurred, except that the method (experience or percentage) used 
or adopted by the acquiring corporation to determine its reasonable 
addition to a reserve for losses on loans for the first taxable year 
ending after the date of the distribution or transfer shall be 
considered to be the method that the distributor or transferor 
corporation (or, in the case of a consolidation, that the transferor 
corporation) would have used or adopted for its first taxable year 
ending after the date of distribution or transfer if the distribution or 
transfer had not occurred.
    (ii) Examples. The application of the rule provided by this 
subparagraph may be illustrated by the following examples:


[[Page 384]]


    Example 1. The X Corporation and the Y Corporation are commercial 
banks both of which have a calendar year as a taxable year. Both X and Y 
adopted the reserve method of accounting for bad debts prior to July 11, 
1969. For the taxable year 1970 through 1973, X and Y determined their 
reasonable additions to a reserve for losses on loans as defined in 
Sec.  1.585-2(e)(2) under the percentage method. On June 30, 1974, the X 
Bank is merged into the Y Bank; for its short taxable year ending on 
June 30, 1974, X determines its reasonable addition under the percentage 
method. If, for the taxable year ending on December 31, 1974 (the first 
taxable year ending after the date of distribution or transfer), Y 
determines its reasonable addition to a reserve for losses on loans 
under the percentage method, then at the close of the base year the 
reserve balance, the amount of outstanding loans, and the amount of 
eligible loans outstanding are the sum of X's and Y's respective amounts 
at the close of the taxable year endingDecember 31, 1969 (the base year 
of both X and Y determined under Sec.  1.585-2(e)(1) as if the 
distribution or transfer had not taken place). If, instead of the above, 
Y adopts the experience method of determining its reasonable addition to 
a reserve for losses for the taxable year 1974, than at the close of the 
base year (1973) the reserve balances, the amount of loans outstanding, 
and the amount of eligible loans outstanding are the sum of X's 
respective amounts at the close of its short taxable year ending on June 
30, 1974 (X's last taxable year before its (Y's) most recent adoption of 
the experience method) and of Y's respective amounts at the close of its 
taxable year 1973 (Y's last taxable year before its most recent adoption 
of the experience method).
    Example 2. The M Corporation and the N Corporation are commercial 
banks. M has a fiscal year ending September 30, as its taxable year and 
N has a calendar year as its taxable year. Both M and N adopted the 
reserve method of accounting for bad debts prior to July 11, 1969. For 
the taxable years ending in 1970, 1971, and 1972, M determined its 
reasonable addition to a reserve for losses under the percentage method; 
for the taxable year ending in 1973 M adopted the experience method. For 
the taxable years 1970 through 1973 N determined its reasonable addition 
under the percentage method. M is merged into N on June 30, 1974, and 
for its short taxable year ending on June 30, 1974, M determines its 
reasonable addition under the experience method. If, for the taxable 
year ending on December 31, 1974 (thefirst taxable year ending after the 
date of distribution or transfer), N determines its reasonable addition 
to a reserve for losses under the percentage method, then at the close 
of the base year (1973) the reserve balance, the amount of loans 
outstanding, and the amount of eligible loans outstanding are the sum of 
M's respective amounts at the close of (a) if M had a reserve deficiency 
as of June 30, 1974, its short taxable year ending on June 30, 1974 (M's 
last taxable year before its (N's) most recent adoption of the 
percentage method), or (b) if M did not have a reserve deficiency, the 
taxable year ending on September 30, 1969, and N's respective amounts at 
the close of its taxable year 1979. If, instead of the above, N adopts 
the experience method for the taxable year 1974, then at the close of 
the base year the reserve balance, the amount of outstanding loans, and 
the amount of eligible loans outstanding are the sum of M's respective 
amounts at the close of its taxable year ending on September 30, 1972 
(the last taxable year before M's most recent adoption of the experience 
method), and N's respective amounts at the close of the taxable year 
1973 (the last taxable year ending before N's most recent adoption of 
the experience method).

(Sec. 585(b)(4), of the Internal Revenue Code of 1954 (83 Stat. 618; (26 
U.S.C. 585(b)(4))))

[T.D. 7532, 43 FR 3114, Jan. 23, 1978]



Sec.  1.585-5  Denial of bad debt reserves for large banks.

    (a) General rule. For taxable years beginning after December 31, 
1986, a large bank (as defined in paragraph (b) of this section) may not 
deduct any amount under section 585 or any other section for an addition 
to a reserve for bad debts. However, for these years, except as provided 
in Sec.  1.585-7, a large bank may deduct amounts allowed under section 
166(a) for specific debts that become worthless in whole or in part. Any 
large bank that maintained a reserve for bad debts under section 585 for 
the taxable year immediately preceding its disqualification year (as 
defined in paragraph (d)(1) of this section) must follow the rules 
prescribed by Sec.  1.585-6 or Sec.  1.585-7 for changing from the 
reserve method of accounting for bad debts that is allowed by section 
585, to the specific charge-off method of accounting for bad debts, in 
its disqualification year. However, except as may be provided otherwise 
in regulations prescribed under section 593, the rules prescribed by 
Sec. Sec.  1.585-6 and 1.585-7 do not apply to a large bank that 
maintained a reserve for bad debts under section 593 for the taxable 
year immediately preceding its disqualification year.
    (b) Large bank--(1) General definition. For purposes of this 
section, a large

[[Page 385]]

bank is any institution described in Sec.  1.585-1(b)(1) (i) or (ii) if, 
for the taxable year (or for any preceding taxable year beginning after 
December 31, 1986)--
    (i) The average total assets of the institution (determined under 
paragraph (c) of this section) exceed $500,000,000; or
    (ii) The institution is a member of a parent-subsidiary controlled 
group (as defined in paragraph (d)(2) of this section) and the average 
total assets of the group exceed $500,000,000.
    (2) Large bank resulting from transfer by large bank--(i) In 
general. If a corporation acquires the assets of a large bank (as 
defined in this paragraph (b)) in an acquisition to which paragraph 
(b)(2) (ii), (iii) or (iv) of this section applies, the acquiring 
corporation (the acquiror) is treated as a large bank for any taxable 
year ending after the date of the acquisition in which it is an 
institution described in Sec.  1.585-1(b)(1) (i) or (ii).
    (ii) Transfer of significant portion of assets where control is 
retained. This paragraph (b)(2)(ii) applies to any direct or indirect 
acquisition of a significant portion of a large bank's assets if, after 
the acquisition, the transferor large bank owns more than 50 percent (by 
vote or value) of the outstanding stock of the acquiror. For this 
purpose, stock of an acquiror is considered owned by a transferor bank 
if the stock is owned by any member of a parent-subsidiary controlled 
group (as defined in paragraph (d)(2) of this section) of which the bank 
is a member, by any related party within the meaning of section 267(b) 
or 707(b), or by any person that received the stock in a transaction to 
which section 355 applies.
    (iii) Transfer to which section 381 applies. This paragraph 
(b)(2)(iii) applies to any acquisition to which section 381(a) applies 
if, immediately after the acquisition, the acquiror's principal method 
of accounting for bad debts (determined under Sec.  1.381(c)(4)-1(c)(2)) 
with respect to its banking business is the specific charge-off method. 
In applying Sec.  1.381(c)(4)-1(c)(2) for this purpose, the following 
rules apply: A transferor large bank is considered to use the specific 
charge-off method for all of its loans immediately before the 
acquisition; an acquiror is considered to use a reserve method for all 
of its loans immediately before the acquisition; and all banking 
businesses of the acquiror immediately after the acquisition are treated 
as one integrated business. See Sec. Sec.  1.585-6(c)(3) and 1.585-
7(d)(2) for rules on the treatment of assets acquired from large banks 
in section 381(a) transactions.
    (iv) Transfer of substantially all assets to related party. This 
paragraph (b)(2)(iv) applies to any direct or indirect acquisition of 
substantially all of a large bank's assets if the transferor large bank 
and the acquiror are related parties before or after the acquisition and 
a principal purpose of the acquisition is to avoid treating the acquired 
assets as those of a large bank. A transferor bank and an acquiror are 
considered to be related parties for this purpose if they are members of 
the same parent-subsidiary controlled group (as defined in paragraph 
(d)(2) of this section) or related parties within the meaning of section 
267(b) or 707(b).
    (3) Examples. The following examples illustrate the principles of 
this paragraph (b):

    Example 1. Bank M, a calendar year taxpayer, is an institution 
described in Sec.  1.585-1(b)(1)(i). For its taxable year beginning on 
January 1, 1987, M has average total assets of $600 million. Since M's 
average total assets for 1987 exceed $500 million, M is a large bank for 
that year. Pursuant to Sec.  1.585-5(d)(1), 1987 is M's disqualification 
year. If M maintained a bad debt reserve under section 585 for its 
immediately preceding taxable year (1986), M must change in 1987 to the 
specific charge-off method of accounting for bad debts, in accordance 
with Sec.  1.585-6 or Sec.  1.585-7.
    Example 2. Assume the same facts as in Example 1. Also assume that 
in 1988 M disposes of a portion of its assets and, as a result, M's 
average total assets for taxable year 1988 fall to $400 million. M 
remains a large bank for taxable year 1988 and succeeding taxable years, 
since its average total assets for a preceding taxable year (1987) 
beginning after December 31, 1986, exceeded $500 million.
    Example 3. Bank P, a calendar year taxpayer, is an institution 
described in Sec.  1.585-1(b)(1)(i). P has average total assets of $300 
million for its taxable year beginning on January 1, 1988. For the same 
year, P is a member of a parent-subsidiary controlled group (within the 
meaning of Sec.  1.585-5(d)(2)) that has average total assets of $800 
million. In February 1989, the group sells its stock in P to several 
individual investors. P is a large

[[Page 386]]

bank for taxable year 1988 because it is a member of a group described 
in Sec.  1.585-5(b)(1)(ii) for that year. P also is a large bank for 
taxable year 1989 and succeeding taxable years because it was a member 
of a group described in Sec.  1.585-5(b)(1)(ii) for a preceding taxable 
year (1988) beginning after December 31, 1986.
    Example 4. Assume the same facts as in Example 3, except that P's 
stock is purchased by a corporation that is not a large bank under Sec.  
1.585-5(b). Also assume that the purchasing corporation elects under 
section 338 to treat the stock purchase as an asset acquisition. Under 
section 338, P is considered to have sold all of its assets on the 
purchase date and is treated as a new corporation that purchased these 
assets on the next day. Since P is treated as a new corporation, its 
prior membership in a group described in Sec.  1.585-5(b)(1)(ii) does 
not cause it to be treated as a large bank for taxable years ending 
after the date of its sale by the group. However, P may be treated as a 
large bank because of new membership in such a group or pursuant to 
Sec.  1.585-5(b)(1)(i) or (b)(2).
    Example 5. Bank Q is a large bank, within the meaning of Sec.  
1.585-5(b)(1), for its taxable year beginning on January 1, 1988, and 
hence for all later years. On March 1, 1989, Q transfers $200 million of 
its $600 million of assets to Bank R, a newly created subsidiary, in a 
transaction to which section 351 applies; these assets are R's only 
assets. On the same day, Q then spins off R in a transaction to which 
section 355 applies. After these transactions, the shareholders of Q own 
more than 50 percent of R's outstanding stock. Although R's average 
total assets do not exceed $500 million, R becomes a large bank on March 
1, 1989, pursuant to Sec.  1.585-5(b)(2)(ii). These transactions do not 
affect Q's status as a large bank.
    Example 6. Bank S is a large bank, within the meaning of Sec.  
1.585-5(b)(1)(ii), for its taxable year beginning on January 1, 1987. As 
a result, S changes to the specific charge-off method of accounting for 
bad debts in that year. Bank T, which is not a large bank under Sec.  
1.585-5(b), uses the reserve method of accounting for bad debts. On June 
30, 1988, T acquires substantially all of S's assets in a transaction to 
which section 381(a) applies. Immediately before the acquisition, S's 
banking business has total assets of $200 million, and T's has total 
assets of $250 million. To determine whether T is a large bank under 
Sec.  1.585-5(b)(2)(iii) for taxable years ending after the acquisition, 
it is necessary to determine T's principal method of accounting for bad 
debts with respect to its banking business immediately after the 
acquisition. This determination requires an application of Sec.  
1.381(c)(4)-1(c)(2). For this purpose, T's original and acquired banking 
businesses are treated as an integrated business. Applying Sec.  
1.381(c)(4)-1(c)(2), it is determined that the business's principal 
method of accounting for bad debts immediately after the acquisition is 
the reserve method. Hence, the acquisition does not cause T to become a 
large bank under Sec.  1.585-5(b)(2)(iii).

    (c) Average total assets--(1) In general. For purposes of paragraph 
(b)(1) of this section, and except as otherwise provided in paragraph 
(c)(3)(ii) of this section, the average total assets of an institution 
or group for any taxable year are determined by--
    (i) Computing, for each report date (as defined in paragraph (c)(2) 
of this section) within the taxable year, the amount of total assets (as 
defined in paragraph (c)(3) of this section) held by the institution or 
group as of the close of business on the report date;
    (ii) Adding these amounts; and
    (iii) Dividing the sum of these amounts by the number of report 
dates within the taxable year.
    (2) Report date--(i) Institutions--(A) In general. A report date for 
an institution generally is the last day of the regular period for which 
the institution must report to its primary Federal regulatory agency. 
However, an institution that is required to report to its primary 
Federal regulatory agency more frequently than quarterly may choose the 
last day of the calendar quarter as its report date, and an institution 
that is required to report to its primary Federal regulatory agency less 
frequently than quarterly must choose the last day of the calendar 
quarter as its report date. If an institution does not have a Federal 
regulatory agency, its primary State regulatory agency is considered its 
primary Federal regulatory agency for purposes of this paragraph 
(c)(2)(i)(A). In the case of a short taxable year that does not 
otherwise include a report date, the first or last day of the taxable 
year is the institution's report date for the year.
    (B) Alternative report date. In lieu of the report date prescribed 
by paragraph (c)(2)(i)(A) of this section, for any taxable year an 
institution may choose as its report date the last day of any regular 
interval in the taxable year that is more frequent than quarterly (such 
as bi-monthly, monthly, weekly, or daily).
    (ii) Groups. If all members of a parent-subsidiary controlled group 
have

[[Page 387]]

the same taxable year, a report date for the group is the report date, 
determined under paragraph (c)(2)(i) of this section, for any one member 
of the group that is an institution described in Sec.  1.585-1(b)(1) (i) 
or (ii). The same report date must be used in applying paragraph 
(b)(1)(ii) of this section to all members of the group for a taxable 
year. If all members of a parent-subsidiary controlled group do not have 
the same taxable year, a report date for the group must be determined 
under similar principles.
    (iii) Member of group for only part of taxable year. If an 
institution is a member of a parent-subsidiary controlled group for only 
part of a taxable year, paragraph (b)(1)(ii) of this section is applied 
to the institution for that year on the basis of the group's average 
total assets for the portion of the year that the institution is a 
member of the group. Thus, only the group's report dates (as determined 
under paragraph (c)(2)(ii) of this section) that are included in that 
portion of the year are taken into account in determining the group's 
average total assets for purposes of applying paragraph (b)(1)(ii) of 
this section to the institution. If no report date of the group is 
included in that portion of the year, the first or last day of that 
portion of the year must be treated as the group's report date for 
purposes of this paragraph (c)(2)(iii).
    (3) Total assets--(i) All corporations. The amount of total assets 
held by an institution or group is the amount of cash, plus the sum of 
the adjusted bases of all other assets, held by the institution or 
group. For this purpose, the adjusted basis of an asset generally is its 
basis for Federal income tax purposes, determined under sections 1012, 
1016 and other applicable sections of the Internal Revenue Code. In 
determining the amount of total assets held by a group, any asset of a 
member of the group that is an interest in another member of the group 
is not to be counted.
    (ii) Foreign corporations. In determining the amount of total assets 
held by a foreign corporation, all of the corporation's assets are taken 
into account, including those that are not effectively connected with 
the conduct of a banking business within the United States. In the case 
of a foreign corporation that is not engaged in a trade or business in 
the United States, the adjusted basis of an asset must be determined 
substantially in accordance with United States tax principles as 
provided in regulations under section 964. In the case of a foreign 
corporation that is engaged in a trade or business in the United States, 
the amount of its average total assets for a taxable year (within the 
meaning of paragraph (c)(1) of this section) is the amount of the 
corporation's average worldwide assets used for purposes of computing 
the interest expense deduction allowable under section 882 and Sec.  
1.882-5 for the taxable year.
    (4) Estimated adjusted tax bases--(i) In general. The amount of the 
adjusted Federal income tax bases (tax bases) of assets held on a report 
date may be estimated, for purposes of applying paragraph (c)(3) of this 
section. This estimate must be based on the adjusted bases of the assets 
on that date as determined by reference to the asset holder's books and 
records maintained for financial reporting purposes (book bases). The 
estimate must reflect any change in the ratio between the asset holder's 
tax and book bases of assets that occurs during the taxable year, and 
the estimate must assume that this change occurs ratably. If an 
institution or group member estimates the tax bases of assets held on 
any report date during a taxable year, it must do so for all assets 
(other than cash) held on that report date, and it must do so for all 
other report dates during the year. However, the tax bases of assets may 
not be estimated for any report date that is the first or last day of 
the taxable year or that is determined under paragraph (c)(2)(i)(B) of 
this section.
    (ii) Formulas. The estimated amount of the tax bases of assets held 
on any report date during a taxable year is based on the following 
variables: The total book bases of the assets on the report date (B); 
the asset holder's tax/book ratio as of the close of the preceding 
taxable year (R); and the result (whether positive or negative) obtained 
when R is subtracted from the asset holder's tax/book ratio as of the 
close of

[[Page 388]]

the current taxable year (Y). For purposes of determining R and Y, an 
asset holder's tax/book ratio is the ratio of the total tax bases of all 
of the holder's assets (other than cash), to the total book bases of 
those assets. If an asset holder's taxable year is the calendar year and 
its report date is the last day of the calendar quarter, its estimated 
tax bases of assets held on the first three report dates of the year are 
determined under the following formulas:

1st Report Date = B x (R + \1/4\Y)
2nd Report Date = B x (R + \1/2\Y)

3rd Report Date = B x (R + \3/4\Y)

    (5) Examples. The following examples illustrate the principles of 
this paragraph (c):

    Example 1. Bank U is a fiscal year taxpayer, and its fiscal year 
ends on January 31. U reports to its primary Federal regulatory agency 
as of the last day of the calendar quarter. U does not choose under 
Sec.  1.585-5(c)(2)(i)(B) a report date more frequent than quarterly. 
Thus, U's report dates under Sec.  1.585-5(c)(2)(i)(A) are March 31, 
June 30, September 30, and December 31. For its taxable year beginning 
on February 1, 1987, U has total assets (within the meaning of Sec.  
1.585-5(c)(3)) of $480 million on March 31, $490 million on June 30, 
$510 million on September 30, and $540 million on December 31. Thus, 
pursuant to Sec.  1.585-5(c)(1), U's average total assets for its 
taxable year beginning on February 1, 1987, are $505 million.
    Example 2. Bank W is a calendar year taxpayer, and its report date 
(within the meaning of Sec.  1.585-5(c)(2)(i)(A)) is the last day of the 
calendar quarter. Pursuant to Sec.  1.585-5(c)(4), W chooses to estimate 
the tax bases of its assets for 1990. Therefore, W must estimate the tax 
bases of all of its assets (other than cash) for its first three report 
dates in 1990. Since W's fourth report date (December 31) is the last 
day of its taxable year, the tax bases of its assets may not be 
estimated for this date. The adjusted tax bases ofall of W's assets 
(other than cash) are $450z on December 31, 1989, and $480z on December 
31, 1990. The book bases of those assets are $500z on December 31, 1989; 
$520z on March 31, 1990; $540z on June 30, 1990; $560z on September 30, 
1990; and $600z on December 31, 1990. Applying the formulas provided in 
Sec.  1.585-5(c)(4)(ii), W's tax/book ratio as of the close of 1989 (R), 
is 0.9 (450z/500z). W's tax/book ratio as of the close of 1990 is 0.8 
(480z/600z). Thus, Y is -0.1. The estimated adjusted tax bases of all of 
W's assets (other than cash) on the first three report dates of 1990 are 
as follows:
[GRAPHIC] [TIFF OMITTED] TC14NO91.160

    (d) Definitions. The following definitions apply for purposes of 
this section and Sec. Sec.  1.585-6, 1.585-7 and 1.585-8:
    (1) Disqualification year. A bank's disqualification year is its 
first taxable year beginning after December 31, 1986, for which the bank 
is a large bank within the meaning of paragraph (b) of this section.
    (2) Parent-subsidiary controlled group. A parent-subsidiary 
controlled group includes all of the members of a controlled group of 
corporations described in section 1563(a)(1). The members of such a 
group are determined without regard to whether any member is an excluded 
member described in section 1563(b)(2), a foreign entity, or a 
commercial bank.
    (3) Example. The following example illustrates the principles of 
this paragraph (d):

    Example. Bank X is a large bank within the meaning of Sec.  1.585-
5(b)(1)(i). Bank Y is not a large bank under Sec.  1.585-5(b), and it 
maintains a bad debt reserve under section 585. In 1988, X purchases all 
of the stock of Y. If the acquisition causes Y to become a member of a 
parent-subsidiary controlled group described in Sec.  1.585-5(b)(1)(ii), 
Y is a large bank beginning in its first taxable year that ends after 
the date of the acquisition. Pursuant to Sec.  1.585-5(d)(1), this year 
is Y's disqualification year. Y must change in this year to the specific 
charge-off method of accounting for bad debts, in accordance with Sec.  
1.585-6 or Sec.  1.585-7.

[T.D. 8513, 58 FR 68757, Dec. 29, 1993; 59 FR 15502, Apr. 1, 1994]



Sec.  1.585-6  Recapture method of changing from the reserve method
of section 585.

    (a) General rule. This section applies to any large bank (as defined 
in Sec.  1.585-5(b)) that maintained a reserve for bad debts under 
section 585 for the taxable

[[Page 389]]

year immediately preceding its disqualification year (as defined in 
Sec.  1.585-5(d)(1)) and that does not elect the cut-off method set 
forth in Sec.  1.585-7. Except as otherwise provided in paragraphs (c) 
and (d) of this section, any bank to which this section applies must 
include in income the amount of its net section 481(a) adjustment (as 
defined in paragraph (b)(3) of this section) over the four-year period 
beginning with the bank's disqualification year. If a bank follows the 
rules prescribed by thissection, its change to the specific charge-off 
method of accounting for bad debts in its disqualification year will be 
treated as a change in accounting method that is made with the consent 
of the Commissioner. Paragraph (b) of this section specifies the portion 
of the net section 481(a) adjustment to be included in income in each 
year of the recapture period; paragraph (c) of this section provides 
rules on the effect of disposing of loans; and paragraph (d) of this 
section provides rules on the suspension of recapture by financially 
troubled banks.
    (b) Four-year spread of net section 481(a) adjustment--(1) In 
general. If a bank to which this section applies does not make the 
election allowed by paragraph (b)(2) of this section, the bank must 
include in income the following portions of its net section 481(a) 
adjustment in each year of the four-year recapture period: 10 percent in 
the bank's disqualification year; 20 percent in its first taxable year 
after its disqualification year; 30 percent in its second taxable year 
after its disqualification year; and 40 percent in its third taxable 
year after its disqualification year.
    (2) Election to include more than 10 percent in disqualification 
year. A bank to which this section applies may elect to include in 
income, in its disqualification year, any percentage of its net section 
481(a) adjustment that is larger than 10 percent. Any such election must 
be made at the time and in the manner prescribed by Sec.  1.585-8. If a 
bank makes such an election, the bank must include in income the 
remainder, if any, of its net section 481(a) adjustment in the following 
portions: \2/9\ of the remainder in the bank's first taxable year after 
its disqualification year; \1/3\ of the remainder in its second taxable 
year after its disqualification year; and \4/9\ of the remainder in its 
third taxable year after its disqualification year. For this purpose, 
the remainder of a bank's net section 481(a) adjustment is any portion 
of the adjustment that the bank does not elect to include in income in 
its disqualification year.
    (3) Net section 481(a) adjustment. For purposes of this section, the 
amount of a bank's net section 481(a) adjustment is the amount of the 
bank's reserve for bad debts as of the close of the taxable year 
immediately preceding its disqualification year. Since the change from 
the reserve method of section 585 is initiated by the taxpayer, the 
amount of the bank's bad debt reserve for this purpose is not reduced by 
amounts attributable to taxable years beginning before 1954.
    (4) Examples. The following examples illustrate the principles of 
this paragraph (b):

    Example 1. Bank M is a large bank within the meaning of Sec.  1.585-
5(b). M's disqualification year is its taxable year beginning on January 
1, 1989, and M maintained a bad debt reserve under section 585 for the 
preceding taxable year. Pursuant to Sec.  1.585-5(a), M must change from 
the reserve method of accounting for bad debts to the specific charge-
off method in its disqualification year. M does not elect the cut-off 
method set forth in Sec.  1.585-7. Thus, M must follow the recapture 
method set forth in this Sec.  1.585-6. M's net section 481(a) 
adjustment, as defined in Sec.  1.585-6(b)(3), is $2 million. M does not 
make the election allowed by Sec.  1.585-6(b)(2). Pursuant to Sec.  
1.585-6(b)(1), M must include the following amounts in income: $200,000 
in taxable year 1989; $400,000 in 1990; $600,000 in 1991; and $800,000 
in 1992.
    Example 2. Assume the same facts as in Example 1, except that M 
elects under Sec.  1.585-6(b)(2) to recapture 55 percent of its net 
section 481(a) adjustment in its disqualification year. Pursuant to 
Sec.  1.585-6(b)(2), M must include the following amounts in income: 
$1,100,000 in taxable year 1989; $200,000 in 1990; $300,000 in 1991; and 
$400,000 in 1992.

    (c) Effect of disposing of loans--(1) In general. Except as provided 
in paragraphs (c)(2) and (c)(3) of this section, if a bank to which this 
section applies sells or otherwise disposes of any of its outstanding 
loans on or after the first day of its disqualification year, the 
disposition does not affect the bank's obligation under this section to 
include in

[[Page 390]]

income the amount of its net section 481(a) adjustment, and the 
disposition does not affect the amount of this adjustment.
    (2) Cessation of banking business--(i) In general. If a bank to 
which this section applies ceases to engage in the business of banking 
before it is otherwise required to include in income the full amount of 
its net section 481(a) adjustment, the bank must include in income the 
remaining amount of the adjustment in the taxable year in which it 
ceases to engage in the business of banking. For this purpose, and 
except as provided in paragraph (c)(2)(ii) of this section, whether a 
bank ceases to engage in the business of banking is determined under the 
principles of Sec.  1.446-1(e)(3)(ii) and its administrative procedures.
    (ii) Transition rule. A bank that ceases to engage in the business 
of banking as the result of a transaction to which section 381(a) 
applies is not treated as ceasing to engage in the business of banking 
if, on or before March 29, 1994, either the transaction occurs or the 
bank enters into a binding written agreement to carry out the 
transaction.
    (3) Certain section 381 transactions. This paragraph (c)(3) applies 
if a bank to which this section applies transfers outstanding loans to 
another corporation on or after the first day of the bank's 
disqualification year (and before it has included in income the full 
amount of its net section 481(a) adjustment) in a transaction to which 
section 381(a) applies, and under paragraph (c)(2) (i) or (ii) of this 
section the transferor bank is not treated as ceasing to engage in the 
business of banking as a result of the transaction. If this paragraph 
(c)(3) applies, the acquiring corporation (the acquiror) steps into the 
shoes of the transferor with respect to using the recapture method 
prescribed by this section and assumes all of the transferor's rights 
and obligations under paragraph (b) of this section. The unrecaptured 
balance of the transferor's net section 481(a) adjustment carries over 
in the transaction to the acquiror, and the acquiror must complete the 
four-year recapture procedure begun by the transferor. In applying this 
procedure, the transferor's taxable year that ends on or includes the 
date of the acquisition and the acquiror's first taxable year ending 
after the date of the acquisition represent two consecutive taxable 
years within the four-year recapture period.
    (4) Examples. The following examples illustrate the principles of 
this paragraph (c):

    Example 1. Bank P is a bank to which this Sec.  1.585-6 applies. P's 
disqualification year is its taxable year beginning on January 1, 1989, 
and P recaptures 10 percent of its net section 481(a) adjustment in that 
year pursuant to Sec.  1.585-6(b)(1). In July 1990 P disposes of a 
portion of its loan portfolio in a transaction to which section 381(a) 
does not apply, and P continues to engage in the business of banking. 
Pursuant to Sec.  1.585-6(c)(1), the disposition does not affect P's 
obligation under Sec.  1.585-6(b)(1) to recapture the remainder of its 
net section 481(a) adjustment in 1990, 1991 and 1992. Nor does the 
disposition affect the amount of the adjustment.
    Example 2. Assume the same facts as in Example 1, except that P 
ceases to engage in the business of banking in 1990, as determined under 
the principles of Sec.  1.446-1(e)(3)(ii) and its administrative 
procedures. Pursuant to Sec.  1.585-6(c)(2)(i), in 1990 P must include 
in income the remaining 90 percent of its net section 481(a) adjustment.
    Example 3. Assume the same facts as in Example 1, except that P's 
1990 disposition of loans is a transaction to which section 381(a) 
applies, P ceases to engage in the business of banking as a result of 
the transaction, and P's taxable year ends on the date of the 
transaction. Thus, in the transaction, P transfers substantially all of 
its loans to an acquiring corporation (Q). Q is a calendar year 
taxpayer. Because the transaction occurred before March 29, 1994, the 
transition rule of Sec.  1.585-6(c)(2)(ii) applies, and P is not treated 
as ceasing to engage in the business of banking. Pursuant to Sec.  
1.585-6(c)(3), Q steps into P's shoes with respect to using the 
recapture method prescribed by Sec.  1.585-6. The unrecaptured balance 
of P's net section 481(a) adjustment carries over to Q in the section 
381(a) transaction, and Q must complete the four-year recapture 
procedure begun by P. Pursuant to Sec. Sec.  1.585-6(b) and 1.585-
6(c)(3), P includes 20 percent of its net section 481(a) adjustment in 
income in its taxable year ending on the date of the section 381(a) 
transaction, and Q includes 30 percent of the adjustment in income in 
1990 and 40 percent in 1991.
    Example 4. Assume the same facts as in Example 3. Assume also that Q 
becomes a large bank under Sec.  1.585-5(b) as a result of the 
transaction and maintained a bad debt reserve immediately before the 
transaction. Q

[[Page 391]]

must change to the specific charge-off method for all of its loans in 
the first taxable year that it is a large bank. Thus, Q not only 
completes the recapture procedure begun by P but also follows the rules 
prescribed by Sec.  1.585-6 or Sec.  1.585-7 with respect to its own 
reserve.
    Example 5. Assume the same facts as in Example 3. Assume also that Q 
is not a large bank after the transaction and properly establishes a bad 
debt reserve for the loans it receives in the transaction. This 
establishment of the reserve results in a new negative section 481(a) 
adjustment. Thus, Q not only completes the recapture procedure begun by 
P but also takes into account the new negative adjustment as required 
under section 381.

    (d) Suspension of recapture by financially troubled banks--(1) In 
general. Except as provided in paragraph (d)(2) of this section, a bank 
that is financially troubled (within the meaning of paragraph (d)(3) of 
this section) for any taxable year must not include any amount in income 
under paragraphs (a) and (b) of this section for that taxable year and 
must disregard that taxable year in applying paragraphs (a) and (b) of 
this section to other taxable years. See paragraph (d)(4) of this 
section for rules on determining estimated tax payments of financially 
troubled banks, and see paragraph (d)(5) of this section for examples 
illustrating this paragraph (d).
    (2) Election to recapture. A bank that is financially troubled 
(within the meaning of paragraph (d)(3) of this section) for its 
disqualification year may elect to include in income, in one taxable 
year, any percentage of its net section 481(a) adjustment that is 
greater than 10 percent. This election may be made for the bank's 
disqualification year, for the first taxable year after the 
disqualification year in which the bank is not financially troubled 
(within the meaning of paragraph (d)(3) of this section), or for any 
intervening taxable year. Any such election must be made at the time and 
in the manner prescribed by Sec.  1.585-8. A bank that makes this 
election must include an amount in income under paragraphs (a) and (b) 
of this section in the year for which the election is made (election 
year) and must not disregard this year in applying paragraphs (a) and 
(b) of this section to other taxable years. Such a bank must follow the 
rules of paragraph (b)(2) of this section in applying paragraph (b) of 
this section to later taxable years, treating the election year as the 
disqualification year for purposes of applying paragraph (b)(2) of this 
section. However, if the bank is financially troubled for any year after 
its election year, the bank must not include any amount in income under 
paragraphs (a) and (b) of this section for the later year and must 
disregard the later year in applying paragraphs (a) and (b) of this 
section to other taxable years.
    (3) Definition of financially troubled--(i) In general. For purposes 
of this section, a bank is considered financially troubled for any 
taxable year if the bank's nonperforming loan percentage for that year 
exceeds 75 percent. For this purpose, a bank's nonperforming loan 
percentage is the percentage determined by dividing the sum of the 
outstanding balances of the bank's nonperforming loans (as defined in 
paragraph (d)(3)(iii) of this section) as of the close of each quarter 
of the taxable year, by the sum of the amounts of the bank's equity (as 
defined in paragraph (d)(3)(iv) of this section) as of the close of each 
such quarter. The quarters for a short taxable year of at least 3 months 
are the same as those of the bank's annual accounting period, except 
that quarters ending before or after the short year are disregarded. If 
a taxable year consists of less than 3 months, the first or last day of 
the taxable year is treated as the last day of its only quarter. In lieu 
of determining its nonperforming loan percentageon the basis of loans 
and equity as of the close of each quarter of the taxable year, a bank 
may, for all years, determine this percentage on the basis of loans and 
equity as of the close of each report date (as defined in Sec.  1.585-
5(c)(2), without regard to Sec.  1.585-5(c)(2)(i)(B)). In the case of a 
bank that is a foreign corporation, all nonperforming loans and equity 
of the bank are taken into account, including loans and equity that are 
not effectively connected with the conduct of a banking business within 
the United States.
    (ii) Parent-subsidiary controlled groups--(A) In general. If a bank 
is a member of a parent-subsidiary controlled group (as defined in Sec.  
1.585-

[[Page 392]]

5(d)(2)) for the taxable year, the nonperforming loans and the equity of 
all members of the bank's financial group (as determined under paragraph 
(d)(3)(ii)(B) of this section) are treated as the nonperforming loans 
and the equity of the bank for purposes of paragraph (d)(3)(i) of this 
section. However, any equity interest that a member of a bank's 
financial group holds in another member of this group is not to be 
counted in determining equity. Similarly, any loan that a member of a 
bank's financial group makes to another member of the group is not to be 
counted in determining nonperforming loans. All banks that are members 
of the same parent-subsidiary controlled group must (for all taxable 
years that they are members of this group) determine their nonperforming 
loan percentage on the basis of the close of each quarter of the taxable 
year, or all must (for all such taxable years) determine this percentage 
on the basis of the close of each report date (as determined under Sec.  
1.585-5(c)(2)(ii), applied without regard to Sec.  1.585-5(c)(2)(i)(B)).
    (B) Financial group--(1) In general. All banks that are members of 
the same parent-subsidiary controlled group must (for all taxable years 
that they are members of this group) determine their financial group 
under paragraph (d)(3)(ii)(B)(2) of this section, or all must (for all 
such taxable years) determine their financial group under paragraph 
(d)(3)(ii)(B)(3) of this section.
    (2) Financial institution members of parent-subsidiary controlled 
group. A bank's financial group, determined under this paragraph 
(d)(3)(ii)(B)(2), consists of all financial institutions within the 
meaning of section 265(b)(5) (and comparable foreign financial 
institutions) that are members of the parent-subsidiary controlled group 
of which the bank is a member.
    (3) All members of parent-subsidiary controlled group. A bank's 
financial group, determined under this paragraph (d)(3)(ii)(B)(3), 
consists of all members of the parent-subsidiary controlled group of 
which the bank is a member.
    (iii) Nonperforming loan--(A) In general. For purposes of this 
section, a nonperforming loan is any loan (as defined in paragraph 
(d)(3)(iii)(B) of this section) that is considered to be nonperforming 
by the holder's primary Federal regulatory agency. Nonperforming loans 
include the following types of loans as defined by the Federal Financial 
Institutions Examination Council: Loans that are past due 90 days or 
more and still accruing; loans that are in nonaccrual status; and loans 
that are restructured troubled debt. A loan is not considered to be 
nonperforming merely because it is past due, if it is past due less than 
90 days. The outstanding balances of nonperforming loans are determined 
on the basis of amounts that are required to be reported to the holder's 
primary Federal regulatory agency. For purposes of this paragraph 
(d)(3)(iii)(A), a holder that does not have a Federal regulatory agency 
is treated as Federally regulated under the standards prescribed by the 
Federal Financial Institutions Examination Council.
    (B) Loan. For purposes of paragraph (d)(3)(iii)(A) of this section, 
a loan is any extension of credit that is defined and treated as a loan 
under the standards prescribed by the Federal Financial Institutions 
Examination Council. (Accordingly, a troubled debt restructuring that is 
in substance a foreclosure or repossession is not considered a loan.) In 
addition, a debt evidenced by a security issued by a foreign government 
is treated as a loan if the security is issued as an integral part of a 
restructuring of one or more troubled loans to the foreign government 
(or an agency or instrumentality thereof). Similarly, a deposit with the 
central bank of a foreign country is treated as a loan if the deposit is 
made under a deposit facility agreement that is entered into as an 
integral part of a restructuring of one or more troubled loans to the 
foreign country's government (or an agency or instrumentality thereof).
    (iv) Equity. For purposes of this section, the equity of a bank or 
other financial institution is its equity (i.e., assets minus 
liabilities) as required to be reported to the institution's primary 
Federal regulatory agency (or, if the institution does not have a 
Federal regulatory agency, as required under the standards prescribed by 
the Federal Financial Institutions Examination

[[Page 393]]

Council). The balance in a reserve for bad debts is not treated as 
equity.
    (4) Estimated tax payments of financially troubled banks. For 
purposes of applying section 6655(e)(2)(A)(i) with respect to any 
installment of estimated tax, a bank that is financially troubled as of 
the due date of the installment is treated as if no amount will be 
included in income under paragraphs (a) and (b) of this section for the 
taxable year. For this purpose, a bank is considered financially 
troubled as of the due date of an installment of estimated tax only if 
its nonperforming loan percentage (computed under paragraph (d)(3) of 
this section) would exceed 75 percent for a short taxable year ending on 
that date. For purposes of computing this nonperforming loan percentage, 
the ending of such a short taxable year would not cause the last day of 
that year to be treated as the last day of a quarter of the taxable 
year.
    (5) Examples. The following examples illustrate the principles of 
this paragraph (d):

    Example 1. Bank R is a bank to which this Sec.  1.585-6 applies. R's 
disqualification year is its taxable year beginning on January 1, 1987. 
R is not financially troubled (within the meaning of Sec.  1.585-
6(d)(3)) for taxable year 1987 or for any taxable year after 1989, but 
it is financially troubled for taxable years 1988 and 1989. Since R is 
not financially troubled for its disqualification year, R must include 
an amount in income under Sec.  1.585-6 (a) and (b) for that year 
(taxable year 1987). R may make the election allowed by Sec.  1.585-
6(b)(2) for that year. Since R is financially troubled for taxable years 
1988 and 1989, pursuant to Sec.  1.585-6(d)(1) R does not include any 
amount in income under Sec.  1.585-6 (a) and (b) for these years, and it 
treats taxable years 1990, 1991 and 1992 as the first, second and third 
taxable years after its disqualification year for purposes of applying 
Sec.  1.585-6 (a) and (b).
    Example 2. Assume the same facts as in Example 1, except that R is 
financially troubled for taxable year 1987 (its disqualification year). 
R may make the election allowed by Sec.  1.585-6(d)(2) for 1987 (the 
disqualification year), for 1990 (the first year after the 
disqualification year in which R is not financially troubled), or for 
1988 or 1989 (the intervening years). R elects to include 60 percent of 
its net section 481(a) adjustment in income in 1987. Thus, the remainder 
of the adjustment, for purposes of applying the rules of Sec.  1.585-
6(b)(2), is 40 percent. R must include in income \2/9\ of the remainder 
in 1990, \1/3\ of the remainder in 1991, and \4/9\ of the remainder in 
1992.
    Example 3. Bank S, which is not a member of a parent-subsidiary 
controlled group, is a bank to which this Sec.  1.585-6 applies. S's 
disqualification year is its taxable year beginning on January 1, 1987. 
S determines its nonperforming loan percentage under Sec.  1.585-6(d)(3) 
on a quarterly basis. S is not financially troubled for taxable year 
1987 and includes 10 percent of its net section 481(a) adjustment in 
income in that year. S's outstanding balance of nonperforming loans (as 
defined in Sec.  1.585-6(d)(3)(iii)) is $80 million on March 31, 1988; 
$68 million on June 30, 1988; and $59 million on September 30, 1988. The 
amount of S's equity (as defined in Sec.  1.585-6(d)(3)(iv)) is $100 
million on each of these threedates. Thus, S's nonperforming loan 
percentage, computed under Sec.  1.585-6(d)(3), would be 80 percent (80/
100) for a short taxable year ending on April 15 or June 15, 74 percent 
[(80 + 68) / 200] for a short taxable year ending on September 15, and 
69 percent [(80 + 68 + 59) / 300] for a short taxable year ending on 
December 15. Since S's nonperforming loan percentage for a short taxable 
year ending on April 15 or June 15 would exceed 75 percent, pursuant to 
Sec.  1.585-6(d)(4) S is considered financially troubled as of these 
dates. Thus, S is treated as if no amount will be included in income 
under Sec.  1.585-6 (a) and (b) for the year for purposes of applying 
section 6655(e)(2)(A)(i) with respect to the installments of estimated 
tax that are due on April 15, 1988, and June 15, 1988. However, since 
S's nonperforming loan percentage for a short taxable year ending on 
September 15 or December 15 would not exceed 75 percent, S is not 
considered financially troubled as of these dates. Thus, S is treated as 
if 20 percent of its net section 481(a) adjustment will be included in 
income under Sec.  1.585-6 (a) and (b) for the year for purposes of 
applying section 6655(e)(2)(A)(i) with respect to the installments of 
estimated tax that are due on September 15, 1988, and December 15, 1988.

[T.D. 8513, 58 FR 68760, Dec. 29, 1993; 59 FR 15502, Apr. 1, 1994]



Sec.  1.585-7  Elective cut-off method of changing from the reserve
method of section 585.

    (a) General rule. Any large bank (as defined in Sec.  1.585-5(b)) 
that maintained a reserve for bad debts under section 585 for the 
taxable year immediately preceding its disqualification year (as defined 
in Sec.  1.585-5(d)(1)) may elect to use the cut-off method set forth in 
this section. Any such election must be made at the time and in the 
manner prescribed by Sec.  1.585-8. If a bank makes this election, the 
bank must maintain its bad debt reserve for its pre- disqualification 
loans, as prescribed in

[[Page 394]]

paragraph (b) of this section, and the bank must include in income any 
excess balance in this reserve, as required by paragraph (c) of this 
section. The bank may not deduct, for its disqualification year or any 
subsequent taxable year, any amount allowed under section 166(a) for 
pre-disqualification loans (as defined in paragraph (b)(2) of this 
section) that become worthless in whole or in part, except as allowed by 
paragraph (b)(1) of this section. However, except as provided in 
paragraph (d)(3) of this section, the bank may deduct, for its 
disqualification year or any subsequent taxable year, amounts allowed 
under section 166(a) for loans that the bank originates or acquires on 
or after the first day of its disqualification year and that become 
worthless in whole or in part. If a bank makes the election allowed by 
this paragraph (a), its change to the specific charge-off method of 
accounting for bad debts in its disqualification year does not give rise 
to a section 481(a) adjustment.
    (b) Maintaining reserve for pre-disqualification loans--(1) In 
general. A bank that makes the election allowed by paragraph (a) of this 
section must maintain its bad debt reserve for its pre-disqualification 
loans (as defined in paragraph (b)(2) of this section). Except as 
provided in paragraph (d)(3) of this section, the bank must charge 
against the reserve the amount of any losses resulting from these loans 
(including losses resulting from the sale or other disposition of these 
loans), and the bank must add to the reserve the amount of recoveries 
with respect to these loans. In general, the reserve must be maintained 
in the manner provided by former section 166(c) of the Internal Revenue 
Code and the regulations thereunder. However, after the balance in the 
reserve is reduced to zero, the bank is to account for any losses and 
recoveries with respect to outstanding pre-disqualification loans under 
the specific charge-off method of accounting for bad debts, as if the 
bank always had accounted for these loans under this method.
    (2) Definition of pre-disqualification loans. For purposes of this 
section, a pre-disqualification loan of a bank is any loan that the bank 
held on the last day of its taxable year immediately preceding its 
disqualification year (as defined in Sec.  1.585-5(d)(1)). If the amount 
of a pre-disqualification loan is increased during or after the 
disqualification year, the amount of the increase is not treated as a 
pre-disqualification loan.
    (c) Amount to be included in income when reserve balance exceeds 
loan balance. If, as of the close of any taxable year, the balance in a 
bank's reserve that is maintained under paragraph (b) of this section 
exceeds the balance of the bank's outstanding pre-disqualification 
loans, the bank must include in income the amount of the excess for the 
taxable year. The balance in the reserve is then reduced by the amount 
of this excess. See paragraph (d) of this section for rules on the 
application of this paragraph (c) when a bank disposes of loans.
    (d) Effect of disposing of loans--(1) In general. Except as provided 
in paragraphs (d)(2) and (d)(3) of this section, if a bank that makes 
the election allowed by paragraph (a) of this section sells or otherwise 
disposes of any of its outstanding pre-disqualification loans, the bank 
is to reduce the balance of its outstanding pre-disqualification loans 
by the amount of the loans disposed of, for purposes of applying 
paragraph (c) of this section.
    (2) Section 381 transactions. If a bank that makes the election 
allowed by paragraph (a) of this section transfers outstanding pre-
disqualification loans to another corporation in a transaction to which 
section 381(a) applies, the acquiring corporation (the acquiror) must 
follow the rules of paragraph (d)(2)(i) or (ii) of this section.
    (i) Acquiror completes cut-off method of change. Except as provided 
in paragraph (d)(2)(ii) of this section, the acquiror steps into the 
shoes of the transferor in the section 381(a) transaction with respect 
to using the cut-off method of change. Thus, the transferor's bad debt 
reserve immediately before the section 381(a) transaction carries over 
to the acquiror, and the acquiror must complete the cut-off method begun 
by the transferor. For purposes of completing the transferor's cut-off 
method, the acquiror's balance of outstanding pre-disqualification loans 
immediately after the section

[[Page 395]]

381(a) transaction is the balance of these loans that it receives in the 
transaction, and the acquiror assumes all of the transferor's rights and 
obligations under this section.
    (ii) Acquiror uses reserve method. If the acquiror is not a large 
bank (within the meaning of Sec.  1.585-5(b)) immediately after the 
section 381(a) transaction and uses a reserve method of accounting for 
bad debts attributable to the pre-disqualification loans (and any other 
loans) received in the transaction, the acquiror does not step into the 
shoes of the transferor with respect to using the cut-off method of 
change. The transferor's bad debt reserve immediately before the section 
381(a) transaction carries over to the acquiror, but the acquiror does 
not continue the cut-off method begun by the transferor. If the six-year 
moving average amount (as defined in Sec.  1.585-2(c)(1)(ii)) for all of 
the loans received in the transaction exceeds the balance of the reserve 
that carries over to the acquiror, the acquiror increases this balance 
by the amount of the excess. Any such increase in the reserve results in 
a negative section 481(a) adjustment that is taken into account as 
required under section 381.
    (3) Dispositions intended to change the status of pre-
disqualification loans. This paragraph (d)(3) applies if a bank that 
makes the election allowed by paragraph (a) of this section sells, 
exchanges, or otherwise disposes of a significant amount of its pre-
disqualification loans (as defined in paragraph (b)(2) of this section) 
and a principal purpose of the transaction is to avoid the provisions of 
this section by increasing the amount of loans for which deductions are 
allowable under the specific charge-off method. If this paragraph (d)(3) 
applies, the District Director may disregard the disposition for 
purposes of paragraphs (b)(1) and (d)(1) of this section or treat the 
replacement loans as pre-disqualification loans. If loans are so treated 
as pre-disqualification loans, no deductions are allowable under the 
specific charge-off method for the loans, except as provided in 
paragraph (b)(1) of this section, and the disposition that causes the 
loans to be so treated may be disregarded for purposes of paragraphs 
(b)(1) and (d)(1) of this section. If a bank sells pre-disqualification 
loans and uses the proceeds of the sale to originate new loans, this 
paragraph (d)(3) does not apply to the transaction.
    (e) Examples. The following examples illustrate the principles of 
this section:

    Example 1. Bank M is a bank that properly elects to use the cut-off 
method set forth in this Sec.  1.585-7. M's disqualification year is its 
taxable year beginning on January 1, 1987. On December 31, 1986, M had 
outstanding loans of $700 million (pre-disqualification loans), and the 
balance in its bad debt reserve was $10 million. M must maintain its 
reserve for its pre-disqualification loans in accordance with Sec.  
1.585-7(b), and it may not deduct any addition to this reserve for 
taxable year 1987 or any later year. For these years, M may deduct 
amounts allowed under section 166(a) for loans that it originates or 
acquires after December 31, 1986, and that become worthless in whole or 
in part.
    Example 2. Assume the same facts as in Example 1. Also assume that 
in 1987 M collects $150 million of its pre- disqualification loans, M 
determines that $2 million of its pre-disqualification loans are 
worthless, and M recovers $1 million of pre-disqualification loans that 
it had previously charged against the reserve as worthless. On December 
31, 1987, the balance in M's bad debt reserve is $9 million ($10 million 
- $2 million + $1 million), and the balance of its outstanding pre-
disqualification loans is $548 million ($700 million - $150 million - $2 
million).
    Example 3. Assume the same facts as in Examples 1 and 2. Also assume 
that on December 31, 1990, the balance in M's bad debt reserve is $5 
million and the balance of its outstanding pre-disqualification loans is 
$25 million. In 1991 M collects $21 million of its outstanding pre-
disqualification loans and determines that $1 million of its outstanding 
pre-disqualification loans are worthless. Thus, on December 31, 1991, 
the balance in M's bad debt reserve is $4 million ($5 million - $1 
million), and the balance of its outstanding pre-disqualification loans 
is $3 million ($25 million - $21 million - $1 million). Accordingly, M 
must include $1 million ($4 million - $3 million) in income in taxable 
year 1991, pursuant to Sec.  1.585-7(c). On January 1, 1992, the balance 
in M's reserve is $3 million ($4 million - $1 million).
    Example 4. Assume the same facts as in Examples 1 through 3. Also 
assume that in 1992 M transfers substantially all of its assets to 
another corporation (N) in a transaction to which section 381(a) 
applies, and N is treated as a large bank under Sec.  1.585-5(b)(2) for 
taxable years ending after the date of the transaction. Pursuant to 
Sec.  1.585-7(d)(2)(i), N steps into M's shoes with respect to using the 
cut-

[[Page 396]]

off method. M's bad debt reserve immediately before the section 381(a) 
transaction carries over to N, and N must complete the cut-off procedure 
begun by M. For this purpose, N's balance of outstanding pre-
disqualification loans immediately after the section 381(a) transaction 
is the balance of these loans that it receives from M.
    Example 5. Assume the same facts as in Examples 1 through 4, except 
that N is not treated as a large bank after the section 381(a) 
transaction. Also assume that N uses the reserve method of section 585 
and plans to use this method for all of the loans it acquires from M 
(including loans that were not pre-disqualification loans). Pursuant to 
Sec.  1.585-7(d)(2)(ii), M's bad debt reserve immediately before the 
section 381(a) transaction carries over to N in the transaction; 
however, N does not continue the cut-off procedure begun by M and does 
not treat any loan as a pre-disqualification loan. If the six-year 
moving average amount (as defined in Sec.  1.585-2(c)(1)(ii)) for all of 
N's newly acquired loans exceeds the balance of the reserve that carries 
over to N, N increases this balance by the amount of the excess. Any 
such increase in the reserve results in a negative section 481(a) 
adjustment that is taken into account as required under section 381.

[T.D. 8513, 58 FR 68762, Dec. 29, 1993; 59 FR 15502, Apr. 1, 1994]



Sec.  1.585-8  Rules for making and revoking elections under Sec. 
Sec.  1.585-6 and 1.585-7.

    (a) Time of making elections--(1) In general. Any election under 
Sec.  1.585-6(b)(2), Sec.  1.585-6(d)(2) or Sec.  1.585-7(a) must be 
made on or before the later of--
    (i) February 28, 1994; or
    (ii) The due date (taking extensions into account) of the electing 
bank's original tax return for its disqualification year (as defined in 
Sec.  1.585-5(d)(1)) or, for elections under Sec.  1.585-6(d)(2), the 
year for which the election is made.
    (2) No extension of time for payment. Payments of tax due must be 
made in accordance with chapter 62 of the Internal Revenue Code. 
However, if an election under Sec.  1.585-6(b)(2), Sec.  1.585-6(d)(2) 
or Sec.  1.585-7(a) is made or revoked on or before February 28, 1994 
and the making or revoking of the election results in an underpayment of 
estimated tax (within the meaning of section 6655(a)) with respect to an 
installment of estimated tax due on or before the date the election was 
so made or revoked, no addition to tax will be imposed under section 
6655(a) with respect to the amount of the underpayment attributable to 
the making or revoking of the election.
    (b) Manner of making elections--(1) In general. Except as provided 
in paragraph (b)(2) of this section, an electing bank must make any 
election under Sec.  1.585-6(b)(2), Sec.  1.585-6(d)(2) or Sec.  1.585-
7(a) by attaching a statement to its tax return (or amended return) for 
its disqualification year or, for elections under Sec.  1.585-6(d)(2), 
the year for which the election is made. This statement must contain the 
following information:
    (i) The name, address and taxpayer identification number of the 
electing bank;
    (ii) The nature of the election being made (i.e., whether the 
election is to include in income more than 10 percent of the bank's net 
section 481(a) adjustment under Sec.  1.585-6 (b)(2) or (d)(2) or to use 
the cut-off method under Sec.  1.585-7); and
    (iii) If the election is under Sec.  1.585-6(b)(2) or (d)(2), the 
percentage being elected.
    (2) Certain tax returns filed before December 29, 1993. A bank is 
deemed to have made an election under Sec.  1.585-6(b)(2) or (d)(2) if 
the bank evidences its intent to make an election under section 
585(c)(3)(A)(iii)(I) or section 585(c)(3)(B)(ii) for its 
disqualification year (or, for elections under Sec.  1.585-6(d)(2), the 
election year), by designating a specific recapture amount on its tax 
return or amended return for that year (or attaching a statement in 
accordance with Sec.  301.9100-7T(a)(3)(i) of this chapter), and the 
return is filed before December 29, 1993. A bank is deemed to have made 
an election under Sec.  1.585-7(a) if the bank evidences its intent to 
make an election under section 585(c)(4) for its disqualification year 
by attaching a statement in accordance with Sec.  301.9100-7T(a)(3)(i) 
of this chapter to its tax return or amended return for that year, and 
the return is filed before December 29, 1993.
    (c) Revocation of elections--(1) On or before final date for making 
election. An election under Sec.  1.585-6(b)(2), Sec.  1.585-6(d)(2) or 
Sec.  1.585-7(a) may be revoked

[[Page 397]]

without the consent of the Commissioner on or before the final date 
prescribed by paragraph (a)(1) of this section for making the election. 
To do so, the bank that made the election must file an amended tax 
return for its disqualification year (or, for elections under Sec.  
1.585-6(d)(2), the year for which the election was made) and attach a 
statement that--
    (i) Includes the bank's name, address and taxpayer identification 
number;
    (ii) Identifies and withdraws the previous election; and
    (iii) If the bank is making a new election under Sec.  1.585-
6(b)(2), Sec.  1.585-6(d)(2) or Sec.  1.585-7(a), contains the 
information described in paragraphs (b)(1)(ii) and (b)(1)(iii) of this 
section.
    (2) After final date for making election. An election under Sec.  
1.585-6(b)(2), Sec.  1.585-6(d)(2) or Sec.  1.585-7(a) may be revoked 
only with the consent of the Commissioner after the final date 
prescribed by paragraph (a)(1) of this section for making the election. 
The Commissioner will grant this consent only in extraordinary 
circumstances.
    (d) Elections by banks that are members of parent-subsidiary 
controlled groups. In the case of a bank that is a member of a parent-
subsidiary controlled group (as defined in Sec.  1.585-5(d)(2)), any 
election under Sec.  1.585-6(b)(2), Sec.  1.585-6(d)(2) or Sec.  1.585-
7(a) with respect to the bank is to be made separately by the bank. An 
election made by one member of such a group is not binding on any other 
member of the group.
    (e) Elections made or revoked by amended return on or before 
February 28, 1994. This paragraph (e) applies to any election that a 
bank seeks to make under paragraph (b) of this section, or revoke under 
paragraph (c) of this section, by means of an amended return that is 
filed on or before February 28, 1994. To make or revoke an election to 
which this paragraph (e) applies, a bank must file (before expiration of 
each applicable period of limitations under section 6501) this amended 
return and amended returns for all taxable years after the taxable year 
for which the election is made or revoked by amended return, to any 
extent necessary to report the bank's tax liability in a manner 
consistent with the making or revoking of the election by amended 
return.

[T.D. 8513, 58 FR 68764, Dec. 29, 1993; 59 FR 4583, Feb. 1, 1994; 59 FR 
15502, Apr. 1, 1994]

                       Mutual Savings Banks, Etc.



Sec.  1.591-1  Deduction for dividends paid on deposits.

    (a) In general. (1) In the case of a taxpayer described in paragraph 
(c)(1) or (2) of this section, whichever is applicable, there are 
allowed as deductions from gross income amounts which during the taxable 
year are paid to, or credited to the accounts of, depositors or holders 
of accounts as dividends or interest on their deposits or withdrawable 
accounts, if such amounts paid or credited are withdrawable on demand 
subject only to customary notice of intention to withdraw.
    (2) The deduction provided in section 591 is applicable to the 
taxable year in which amounts credited as dividends or interest become 
withdrawable by the depositor or holder of an account subject only to 
customary notice of intention to withdraw. Thus, amounts which, as of 
the last day of the taxable year, are credited as dividends or interest, 
but which are not withdrawable by depositors or holders of accounts 
until the following business day, are deductible under section 591 in 
the year subsequent to the taxable year in which they were so credited. 
A deduction under this section will not be denied by reason of the fact 
that the amounts credited as dividends or interest, otherwise deductible 
under section 591, are subject to the terms of a pledge agreement 
between the taxpayer and the depositor or holder of an account. In the 
case of a domestic building and loan association having nonwithdrawable 
capital stock represented by shares, no deduction is allowable under 
this section for amounts paid or credited as dividends on such shares. 
In the case of a taxable year ending after December 31, 1962, for 
special rules governing the treatment of dividends or interest paid or 
credited for periods representing more than 12 months, see section 
461(e).
    (b) Serial associations, bonus plans, etc. If a taxpayer described 
in paragraph

[[Page 398]]

(c)(1) or (2) of this section, whichever is applicable, operates in 
whole or in part as a serial association, maintains a bonus plan, or 
issues shares, or accepts deposits, subject to fines, penalties, 
forfeitures, or other withdrawal fees, it may deduct under section 591 
the total amount credited as dividends or interest upon such shares or 
deposits, credited to a bonus account for such shares or deposits, or 
allocated to a series of shares for the taxable year, notwithstanding 
that as a customary condition of withdrawal:
    (1) Amounts invested in, and earnings credited to, series shares 
must be withdrawn in multiples of even shares, or
    (2) Such taxpayer has the right, pursuant to bylaw, contract, or 
otherwise, to retain or recover a portion of the total amount invested 
in, or credited as earnings upon, such shares or deposits, such bonus 
account, or series of shares, as a fine, penalty, forfeiture, or other 
withdrawal fee


In any taxable year in which the right referred to in subparagraph (2) 
of this paragraph is exercised, there is includible in the gross income 
of such taxpayer for such taxable year amounts retained or recovered by 
the taxpayer pursuant to the exercise of such right. If the provisions 
of paragraph (a) of Sec.  1.163-4 (relating to deductions for original 
issue discount) apply to deposits made with respect to a certificate of 
deposit, time deposit, bonus plan or other deposit arrangement, the 
provisions of this paragraph shall not apply.
    (c) Effective date. The provisions of paragraphs (a) and (b) of this 
section shall apply to:
    (1) Dividends or interest paid or credited after October 16, 1962, 
by any taxpayer which (at the time of such payment or credit) qualifies 
as (i) a mutual savings bank not having capital stock represented by 
shares, (ii) a domestic building and loan association (as defined in 
section 7701(a)(19)), (iii) a cooperative bank (as defined in section 
7701(a)(32)), or (iv) any other savings institution chartered and 
supervised as a savings and loan or similar association under Federal or 
State law; and
    (2) Dividends paid or credited before October 17, 1962, by any 
taxpayer which (at the time of such payment or credit) qualifies as (i) 
a mutual savings bank not having capital stock represented by shares, 
(ii) a cooperative bank without capital stock organized and operated for 
mutual purposes and without profit, or (iii) a domestic building and 
loan association (as defined in section 7701(a)(19) before amendment by 
section 6(c) of the Revenue Act of 1962 (76 Stat. 982)).

[T.D. 6728, 29 FR 5855, May 5, 1964, as amended by T.D. 7154, 36 FR 
24997, Dec. 28, 1971]



Sec.  1.592-1  Repayment of certain loans by mutual savings banks,
building and loan associations, and cooperative banks.

    There is deductible, under section 592, from the gross income of a 
mutual savings bank not having capital stock represented by shares, a 
domestic building and loan association, or a cooperative bank without 
capital stock organized and operated for mutual purposes and without 
profit, amounts paid by such institutions during the taxable year in 
repayment of loans made before September 1, 1951, by the United States 
or any agency or instrumentality thereof which is wholly owned by the 
United States, or by any mutual fund established under the authority of 
the laws of any State. For example, amounts paid by such institution in 
repayment of loans made by the Reconstruction Finance Corporation before 
September 1, 1951, are deductible under this section. Section 592 is not 
applicable, however, in the case of amounts paid in repayment of loans 
made by an agency or instrumentality not wholly owned by the United 
States.



Sec.  1.594-1  Mutual savings banks conducting life insurance business.

    (a) Scope of application. Section 594 applies to the case of a 
mutual savings bank not having capital stock represented by shares which 
conducts a life insurance business, if:
    (1) The conduct of the life insurance business is authorized under 
State law,
    (2) The life insurance business is carried on in a separate 
department of the bank,
    (3) The books of account of the life insurance business are 
maintained separately from other departments of the bank, and

[[Page 399]]

    (4) The life insurance department of the bank would, if it were 
treated as a separate corporation, qualify as a life insurance company 
under section 801.
    (b) Computation of tax. In the case of a mutual savings bank 
conducting a life insurance business to which section 594 is applicable, 
the tax upon such bank consists of the sum of the following:
    (1) A partial tax computed under section 11 upon the taxable income 
of the bank determined without regard to any items of income or 
deduction properly allocable to the life insurance department, and
    (2) A partial tax computed on the income (or, in the case of taxable 
years beginning before January 1, 1955, the taxable income (as defined 
in section 803)) of the life insurance department determined without 
regard to any items of income or deduction not properly allocable to 
such department, at the rates and in the manner provided in subchapter L 
(section 801 and following), chapter 1 of the Code, with respect to life 
insurance companies.



Sec.  1.596-1  Limitation on dividends received deduction.

    (a) In general. For taxable years beginning after July 11, 1969, in 
the case of mutual savings banks, domestic building and loan 
associations, and cooperative banks, if the addition to the reserve for 
losses on qualifying real property loans for the taxable year is 
determined under section 593(b)(2) (relating to the percentage of 
taxable income method), the total amount allowed as a deduction with 
respect to dividends received under part VIII, subchapter B, chapter 1, 
subtitle A of the Code (section 241 et seq.) (determined without regard 
to section 596 and this section) for such taxable year is reduced as 
provided by this section. In such case, the dividends received deduction 
otherwise determined under part VIII, subchapter B, chapter 1, subtitle 
A of the Code, is reduced by an amount equal to the applicable 
percentage for such year (determined solely under subparagraphs (A) and 
(B) of section 593(b)(2) and the regulations thereunder) of such total 
amount.
    (b) Example. The provisions of this section may be illustrated by 
the following example:

    Example. X Corporation, a domestic building and loan association, 
determines the addition to its reserve for losses on qualifying real 
property loans under section 593(b)(2) for its taxable year beginning in 
1971. During that taxable year, X Corporation received a total of 
$100,000 as dividends from domestic corporations subject to tax under 
chapter 1 of the Code. X Corporation received no other dividends during 
the taxable year. Under part VIII, subchapter B, chapter 1, subtitle A 
of the Code, a deduction, determined without regard to section 596 and 
this section, of $85,000 would be allowed with respect to the dividends. 
For the taxable year, the applicable percentage, determined under 
subparagraphs (A) and (B) of section 593(b)(2), is 54 percent. Under 
section 596 and this section, the amount allowed as a deduction under 
section 243 and the regulations thereunder is reduced by $45,900 (54 
percent of $85,000) to $39,100 ($85,000 less $45,900).

    (c) Dividends received by members of a controlled group. If a thrift 
institution that computes a deduction under section 593(b)(2) is a 
member of a controlled group of corporations (within the meaning of 
section 1563(a), determined by substituting 50 percent for 80 percent 
each place it appears therein) and if the thrift institution, without a 
bona fide business purpose, transfers stock, directly or indirectly, to 
another member of the group, the Commissioner may allocate any dividends 
with respect to the stock to the thrift institution. If the Commissioner 
allocates a dividend to a thrifty institution under this paragraph (c), 
the Commissioner will also make appropriate correlative adjustments to 
the income of any other member of the group involved in the allocation, 
at a time and in a manner consistent with the procedures of Sec.  1.482-
1(d)(2). This paragraph (c) applies to taxable years ending on or after 
August 30, 1975.

[T.D. 7149, 36 FR 20944, Nov. 2, 1971, as amended by T.D. 7631, 44 FR 
40496, July 11, 1979; T.D. 9849, 84 FR 9235, Mar. 14, 2019]



Sec.  1.597-1  Definitions.

    For purposes of the regulations under section 597--
    (a) Unless the context otherwise requires, the terms consolidated 
group,

[[Page 400]]

member and subsidiary have the meanings provided in Sec.  1.1502-1; and
    (b) The following terms have the meanings provided below--
    Acquiring. The term Acquiring means a corporation that is a 
transferee in a Taxable Transfer, other than a deemed transferee in a 
Taxable Transfer described in Sec.  1.597-5(b).
    Agency. The term Agency means the Resolution Trust Corporation, the 
Federal Deposit Insurance Corporation, any similar instrumentality of 
the United States government, and any predecessor or successor of the 
foregoing (including the Federal Savings and Loan Insurance 
Corporation).
    Agency Control. An Institution or entity is under Agency Control if 
Agency is conservator or receiver of the Institution or entity, or if 
Agency has the right to appoint any of the Institution's or entity's 
directors.
    Agency Obligation. The term Agency Obligation means a debt 
instrument that Agency issues to an Institution or to a direct or 
indirect owner of an Institution.
    Agency Receivership. An Instit ution or entity is under Agency 
Receivership if an Agency is acting as receiver for such Institution or 
entity.
    Average Reimbursement Rate. The term Average Reimbursement Rate 
means the percentage of losses (as determined under the terms of the 
Loss Share Agreement) that would be reimbursed by an Agency or a 
Controlled Entity if every asset subject to a Loss Share Agreement were 
disposed of for the Third-Party Price. The Average Reimbursement Rate is 
determined at the time of the Taxable Transfer and is not adjusted for 
any changes in Third-Party Price over the life of any asset subject to 
the Loss Share Agreement or the prior disposition of any asset subject 
to the Loss Share Agreement.
    Bridge Bank. The term Bridge Bank means an Institution that is 
organized by Agency to hold assets and liabilities of another 
Institution and that continues the operation of the other Institution's 
business pending its acquisition or liquidation, and that is any of the 
following--
    (1) A national bank chartered by the Comptroller of the Currency 
under section 11(n) of the Federal Deposit Insurance Act (12 U.S.C. 
1821(n)) or section 21A(b)(10)(A) of the Federal Home Loan Bank Act (12 
U.S.C. 1441a(b)(10)(A)) or any successor sections;
    (2) A Federal savings association chartered by the Director of the 
Office of Thrift Supervision under section 21A(b)(10)(A) of the Federal 
Home Loan Bank Act (12 U.S.C. 1441a(b)(10)(A)) or any successor section; 
or
    (3) A similar Institution chartered under any other statutory 
provisions.
    Consolidated Subsidiary. The term Consolidated Subsidiary means a 
corporation that both:
    (i) Is a member of the same consolidated group as an Institution; 
and
    (ii) Would be a member of the affiliated group that would be 
determined under section 1504(a) if the Institution were the common 
parent thereof.
    Continuing Equity. An Institution has Continuing Equity for any 
taxable year if, on the last day of the taxable year, the Institution is 
not a Bridge Bank, in Agency Receivership, or treated as a New Entity.
    Controlled Entity. The term Controlled Entity means an entity under 
Agency Control.
    Covered Asset. The term Covered Asset means an asset subject to a 
Loss Guarantee. The fair market value of a Covered Asset equals the 
asset's Expected Value.
    Expected Value. The term Expected Value means the sum of the Third-
Party Price for a Covered Asset and the amount that an Agency or a 
Controlled Entity would pay under the Loss Guarantee if the asset 
actually were sold for the Third-Party Price. For purposes of the 
preceding sentence, if an asset is subject to a Loss Share Agreement, 
the amount that an Agency or a Controlled Entity would pay under a Loss 
Guarantee with respect to the asset is determined by multiplying the 
amount of loss that would be realized under the terms of the Loss Share 
Agreement if the asset were disposed of at the Third-Party Price by the 
Average Reimbursement Rate.
    Federal Financial Assistance (FFA). The term Federal Financial 
Assistance (FFA), as defined by section 597(c), means any money or 
property provided by Agency to an Institution or to a direct or indirect 
owner of stock in an

[[Page 401]]

Institution under section 406(f) of the National Housing Act (12 U.S.C. 
1729(f)), section 21A(b)(4) of the Federal Home Loan Bank Act (12 U.S.C. 
1441a(b)(4)), section 11(f) or 13(c) of the Federal Deposit Insurance 
Act (12 U.S.C. 1821(f), 1823(c)), or under any similar provision of law. 
Any such money or property is FFA, regardless of whether the Institution 
or any of its affiliates issues Agency a note or other obligation, 
stock, warrants, or other rights to acquire stock in connection with 
Agency's provision of the money or property. FFA includes Net Worth 
Assistance, Loss Guarantee payments, yield maintenance payments, cost to 
carry or cost of funds reimbursement payments, expense reimbursement or 
indemnity payments, and interest (including original issue discount) on 
an Agency Obligation.
    Institution. The term Institution means an entity that is, or 
immediately before being placed under Agency Control was, a bank or 
domestic building and loan association within the meaning of section 597 
(including a Bridge Bank). Except as otherwise provided in the 
regulations under section 597, the term Institution includes a New 
Entity or Acquiring that is a bank or domestic building and loan 
association within the meaning of section 597.
    Loss Guarantee. The term Loss Guarantee means an agreement pursuant 
to which an Agency or a Controlled Entity guarantees or agrees to pay an 
Institution a specified amount upon the disposition or charge-off (in 
whole or in part) of specific assets, an agreement pursuant to which an 
Institution has a right to put assets to an Agency or a Controlled 
Entity at a specified price, a Loss Share Agreement, or a similar 
arrangement.
    Loss Share Agreement. The term Loss Share Agreement means an 
agreement pursuant to which an Agency or a Controlled Entity agrees to 
reimburse the guaranteed party a percentage of losses realized.
    Net Worth Assistance. The term Net Worth Assistance means money or 
property (including an Agency Obligation to the extent it has a fixed 
principal amount) that Agency provides as an integral part of a Taxable 
Transfer, other than FFA that accrues after the date of the Taxable 
Transfer. For example, Net Worth Assistance does not include Loss 
Guarantee payments, yield maintenance payments, cost to carry or cost of 
funds reimbursement payments, or expense reimbursement or indemnity 
payments. An Agency Obligation is considered to have a fixed principal 
amount notwithstanding an agreement providing for its adjustment after 
issuance to reflect a more accurate determination of the condition of 
the Institution at the time of the acquisition.
    New Entity. The term New Entity means the new corporation that is 
treated as purchasing all of the assets of an Old Entity in a Taxable 
Transfer described in Sec.  1.597-5(b).
    Old Entity. The term Old Entity means the Institution or 
Consolidated Subsidiary that is treated as selling all of its assets in 
a Taxable Transfer described in Sec.  1.597-5(b).
    Residual Entity. The term Residual Entity means the entity that 
remains after an Institution transfers deposit liabilities to a Bridge 
Bank.
    Taxable Transfer. The term Taxable Transfer has the meaning provided 
in Sec.  1.597-5(a)(1).
    Third-Party Price. The term Third-Party Price means the amount that 
a third party would pay for an asset absent the existence of a Loss 
Guarantee.

[T.D. 8641, 60 FR 66094, Dec. 21, 1995, as amended by T.D. 9825, 82 FR 
48619, Oct. 19, 2017]



Sec.  1.597-2  Taxation of FFA.

    (a) Inclusion in income--(1) In general. Except as otherwise 
provided in the regulations under section 597, all FFA is includible as 
ordinary income to the recipient at the time the FFA is received or 
accrued in accordance with the recipient's method of accounting. The 
amount of FFA received or accrued is the amount of any money, the fair 
market value of any property (other than an Agency Obligation), and the 
issue price of any Agency Obligation (determined under Sec.  1.597-
3(c)(2)). An Institution (and not the nominal recipient) is treated as 
receiving directly any FFA that an Agency provides in a taxable year to 
a direct or indirect shareholder of the Institution, to the

[[Page 402]]

extent the money or property is transferred to the Institution pursuant 
to an agreement with an Agency.
    (2) Cross references. See paragraph (c) of this section for rules 
regarding the timing of inclusion of certain FFA. See paragraph (d) of 
this section for additional rules regarding the treatment of FFA 
received in connection with transfers of money or property to an Agency 
or a Controlled Entity, or paid pursuant to a Loss Guarantee. See Sec.  
1.597-5(c)(1) for additional rules regarding the inclusion of Net Worth 
Assistance in the income of an Institution.
    (b) Basis of property that is FFA. If FFA consists of property, the 
Institution's basis in the property equals the fair market value of the 
property (other than an Agency Obligation) or the issue price of the 
Agency Obligation (as determined under Sec.  1.597-3(c)(2)).
    (c) Timing of inclusion of certain FFA--(1) Scope. This paragraph 
(c) limits the amount of FFA an Institution must include in income 
currently under certain circumstances and provides rules for the 
deferred inclusion in income of amounts in excess of those limits. This 
paragraph (c) does not apply to a New Entity or an Acquiring.
    (2) Amount currently included in income by an Institution without 
Continuing Equity. The amount of FFA an Institution without Continuing 
Equity must include in income in a taxable year under paragraph (a)(1) 
of this section is limited to the sum of--
    (i) The excess at the beginning of the taxable year of the 
Institution's liabilities over the adjusted bases of the Institution's 
assets; and
    (ii) The amount by which the excess for the taxable year of the 
Institution's deductions allowed by chapter 1 of the Internal Revenue 
Code (Code) (other than net operating and capital loss carryovers) over 
its gross income (determined without regard to FFA) is greater than the 
excess at the beginning of the taxable year of the adjusted bases of the 
Institution's assets over the Institution's liabilities.
    (3) Amount currently included in income by an Institution with 
Continuing Equity. The amount of FFA an Institution with Continuing 
Equity must include in income in a taxable year under paragraph (a)(1) 
of this section is limited to the sum of--
    (i) The excess at the beginning of the taxable year of the 
Institution's liabilities over the adjusted bases of the Institution's 
assets;
    (ii) The greater of--
    (A) The excess for the taxable year of the Institution's deductions 
allowed by chapter 1 of the Code (other than net operating and capital 
loss carryovers) over its gross income (determined without regard to 
FFA); or
    (B) The excess for the taxable year of the deductions allowed by 
chapter 1 of the Code (other than net operating and capital loss 
carryovers) of the consolidated group of which the Institution is a 
member on the last day of the Institution's taxable year over the 
group's gross income (determined without regard to FFA); and
    (iii) The excess of the amount of any net operating loss carryover 
of the Institution (or in the case of a carryover from a consolidated 
return year of the Institution's current consolidated group, the net 
operating loss carryover of the group) to the taxable year over the 
amount described in paragraph (c)(3)(i) of this section.
    (4) Deferred FFA--(i) Maintenance of account. An Institution must 
establish a deferred FFA account commencing in the first taxable year in 
which it receives FFA that is not currently included in income under 
paragraph (c)(2) or (3) of this section, and must maintain that account 
in accordance with the requirements of this paragraph (c)(4). The 
Institution must add the amount of any FFA that is not currently 
included in income under paragraph (c)(2) or (3) of this section to its 
deferred FFA account. The Institution must decrease the balance of its 
deferred FFA account by the amount of deferred FFA included in income 
under paragraphs (c)(4)(ii), (iv), and (v) of this section. (See also 
paragraphs (d)(4) and (d)(5)(i)(B) of this section for other adjustments 
that decrease the deferred FFA account.) If, under paragraph (c)(3) of 
this section, FFA is not currently included in income in a taxable year, 
the Institution thereafter must maintain its deferred FFA account on

[[Page 403]]

a FIFO (first in, first out) basis (for example, for purposes of the 
first sentence of paragraph (c)(4)(iv) of this section).
    (ii) Deferred FFA recapture. In any taxable year in which an 
Institution has a balance in its deferred FFA account, it must include 
in income an amount equal to the lesser of the amount described in 
paragraph (c)(4)(iii) of this section or the balance in its deferred FFA 
account.
    (iii) Annual recapture amount--(A) Institutions without Continuing 
Equity--(1) In general. In the case of an Institution without Continuing 
Equity, the amount described in this paragraph (c)(4)(iii) is the amount 
by which--
    (i) The excess for the taxable year of the Institution's deductions 
allowed by chapter 1 of the Code (other than net operating and capital 
loss carryovers) over its gross income (taking into account FFA included 
in income under paragraph (c)(2) of this section) is greater than
    (ii) The Institution's remaining equity as of the beginning of the 
taxable year.
    (2) Remaining equity. The Institution's remaining equity is--
    (i) The amount at the beginning of the taxable year in which the 
deferred FFA account was established equal to the adjusted bases of the 
Institution's assets minus the Institution's liabilities (which amount 
may be positive or negative); plus
    (ii) The Institution's taxable income (computed without regard to 
any carryover from any other year) in any subsequent taxable year or 
years; minus
    (iii) The excess in any subsequent taxable year or years of the 
Institution's deductions allowed by chapter 1 of the Code (other than 
net operating and capital loss carryovers) over its gross income.
    (B) Institutions with Continuing Equity. In the case of an 
Institution with Continuing Equity, the amount described in this 
paragraph (c)(4)(iii) is the amount by which the Institution's 
deductions allowed by chapter 1 of the Code (other than net operating 
and capital loss carryovers) exceed its gross income (taking into 
account FFA included in income under paragraph (c)(3) of this section).
    (iv) Additional deferred FFA recapture by an Institution with 
Continuing Equity. To the extent that, as of the end of a taxable year, 
the cumulative amount of FFA deferred under paragraph (c)(3) of this 
section that an Institution with Continuing Equity has recaptured under 
this paragraph (c)(4) is less than the cumulative amount of FFA deferred 
under paragraph (c)(3) of this section that the Institution would have 
recaptured if that FFA had been included in income ratably over the six 
taxable years immediately following the taxable year of deferral, the 
Institution must include that difference in income for the taxable year. 
An Institution with Continuing Equity must include in income the balance 
of its deferred FFA account in the taxable year in which it liquidates, 
ceases to do business, transfers (other than to a Bridge Bank) 
substantially all of its assets and liabilities, or is deemed to 
transfer all of its assets under Sec.  1.597-5(b).
    (v) Optional accelerated recapture of deferred FFA. An Institution 
that has a deferred FFA account may include in income the balance of its 
deferred FFA account on its timely filed (including extensions) original 
federal income tax return for any taxable year that it is not under 
Agency Control. The balance of its deferred FFA account is income on the 
last day of that year.
    (5) Exceptions to limitations on use of losses. In computing an 
Institution's taxable income or alternative minimum taxable income for a 
taxable year, sections 56(d)(1), 382, and 383 and Sec. Sec.  1.1502-15, 
1.1502-21, and 1.1502-22 (or Sec. Sec.  1.1502-15A, 1.1502-21A, and 
1.1502-22A, as appropriate) do not limit the use of the attributes of 
the Institution to the extent, if any, that the inclusion of FFA 
(including recaptured FFA) in income results in taxable income or 
alternative minimum taxable income (determined without regard to this 
paragraph (c)(5)) for the taxable year. This paragraph (c)(5) does not 
apply to any limitation under section 382 or 383 or Sec.  1.1502-15, 
Sec.  1.1502-21, or Sec.  1.1502-22 (or Sec.  1.1502-15A, Sec.  1.1502-
21A, or Sec.  1.1502-22A,

[[Page 404]]

as appropriate) that arose in connection with or prior to a corporation 
becoming a Consolidated Subsidiary of the Institution.
    (6) Operating rules--(i) Bad debt reserves. For purposes of 
paragraphs (c)(2), (3), and (4) of this section, the adjusted bases of 
an Institution's assets are reduced by the amount of the Institution's 
reserves for bad debts under section 585 or 593, other than supplemental 
reserves under section 593.
    (ii) Aggregation of Consolidated Subsidiaries. For purposes of this 
paragraph (c), an Institution is treated as a single entity that 
includes the income, expenses, assets, liabilities, and attributes of 
its Consolidated Subsidiaries, with appropriate adjustments to prevent 
duplication.
    (iii) Alternative minimum tax. To compute the alternative minimum 
taxable income attributable to FFA of an Institution for any taxable 
year under section 55, the rules of this section, and related rules, are 
applied by using alternative minimum tax basis, deductions, and all 
other items required to be taken into account. All other alternative 
minimum tax provisions continue to apply.
    (7) Earnings and profits. FFA that is not currently included in 
income under this paragraph (c) is included in earnings and profits for 
all purposes of the Code to the extent and at the time it is included in 
income under this paragraph (c).
    (d) Transfers of money or property to an Agency, and Covered 
Assets--(1) Transfers of property to an Agency. Except as provided in 
paragraph (d)(4)(iii) of this section, the transfer of property to an 
Agency or a Controlled Entity is a taxable sale or exchange in which the 
Institution is treated as realizing an amount equal to the property's 
fair market value.
    (2) FFA with respect to Covered Assets other than on transfer to an 
Agency--(i) FFA provided pursuant to a Loss Guarantee with respect to a 
Covered Asset is included in the amount realized with respect to the 
Covered Asset.
    (ii) If an Agency makes a payment to an Institution pursuant to a 
Loss Guarantee with respect to a Covered Asset owned by an entity other 
than the Institution, the payment will be treated as made directly to 
the owner of the Covered Asset and included in the amount realized with 
respect to the Covered Asset when the Covered Asset is sold or charged 
off. The payment will be treated as further transferred through chains 
of ownership to the extent necessary to reflect the actual receipt of 
such payment. Any such transfer, if a deemed distribution, will not be a 
preferential dividend for purposes of sections 561, 562, 852, or 857.
    (iii) For the purposes of this paragraph (d)(2), references to an 
amount realized include amounts obtained in whole or partial 
satisfaction of loans, amounts obtained by virtue of charging off or 
marking to market a Covered Asset, and other amounts similarly related 
to property, whether or not disposed of.
    (3) Treatment of FFA received in exchange for property. FFA included 
in the amount realized for property under this paragraph (d) is not 
includible in income under paragraph (a)(1) of this section. The amount 
realized is treated in the same manner as if realized from a person 
other than an Agency or a Controlled Entity. For example, gain 
attributable to FFA received with respect to a capital asset retains its 
character as capital gain. Similarly, FFA received with respect to 
property that has been charged off for federal income tax purposes is 
treated as a recovery to the extent of the amount previously charged 
off. Any FFA provided in excess of the amount realized under this 
paragraph (d) is includible in income under paragraph (a)(1) of this 
section.
    (4) Adjustment to FFA--(i) In general. If an Institution pays or 
transfers money or property to an Agency or a Controlled Entity, the 
amount of money and the fair market value of the property is an 
adjustment to its FFA to the extent the amount paid and transferred 
exceeds the amount of money and the fair market value of any property 
that an Agency or a Controlled Entity provides in exchange.
    (ii) Deposit insurance. This paragraph (d)(4) does not apply to 
amounts paid to an Agency with respect to deposit insurance.
    (iii) Treatment of an interest held by an Agency or a Controlled 
Entity--(A) In

[[Page 405]]

general. For purposes of this paragraph (d), an interest described in 
Sec.  1.597-3(b) is not treated as property when transferred by the 
issuer to an Agency or a Controlled Entity nor when acquired from an 
Agency or a Controlled Entity by the issuer.
    (B) Dispositions to persons other than issuer. On the date an Agency 
or a Controlled Entity transfers an interest described in Sec.  1.597-
3(b) to a holder other than the issuer, an Agency, or a Controlled 
Entity, the issuer is treated for purposes of this paragraph (d)(4) as 
having transferred to an Agency an amount of money equal to the sum of 
the amount of money and the fair market value of property that was paid 
by the new holder as consideration for the interest.
    (iv) Affiliated groups. For purposes of this paragraph (d), an 
Institution is treated as having made any transfer to an Agency or a 
Controlled Entity that was made by any other member of its affiliated 
group. The affiliated group must make appropriate basis adjustments or 
other adjustments to the extent the member transferring money or other 
property is not the member that received FFA.
    (5) Manner of making adjustments to FFA--(i) Reduction of FFA and 
deferred FFA. An Institution adjusts its FFA under paragraph (d)(4) of 
this section by reducing in the following order and in an aggregate 
amount not greater than the adjustment--
    (A) The amount of any FFA that is otherwise includible in income for 
the taxable year (before application of paragraph (c) of this section); 
and
    (B) The balance (but not below zero) in the deferred FFA account, if 
any, maintained under paragraph (c)(4) of this section.
    (ii) Deduction of excess amounts. If the amount of the adjustment 
exceeds the sum of the amounts described in paragraph (d)(5)(i) of this 
section, the Institution may deduct the excess to the extent the 
deduction does not exceed the amount of FFA included in income for prior 
taxable years reduced by the amount of deductions allowable under this 
paragraph (d)(5)(ii) in prior taxable years.
    (iii) Additional adjustments. Any adjustment to FFA in excess of the 
sum of the amounts described in paragraphs (d)(5)(i) and (ii) of this 
section is treated--
    (A) By an Institution other than a New Entity or an Acquiring, as a 
deduction of the amount in excess of FFA received that is required to be 
transferred to an Agency under section 11(g) of the Federal Deposit 
Insurance Act (12 U.S.C. 1821(g)); or
    (B) By a New Entity or an Acquiring, as an adjustment to the 
purchase price paid in the Taxable Transfer (see Sec.  1.338-7).
    (e) Examples. The following examples illustrate the provisions of 
this section:

    Example 1. Timing of inclusion of FFA in income. (i) Institution M, 
a calendar-year taxpayer without Continuing Equity because it is in 
Agency Receivership, is not a member of a consolidated group and has not 
been acquired in a Taxable Transfer. On January 1, 2018, M has assets 
with a total adjusted basis of $100 million and total liabilities of 
$120 million. M's deductions do not exceed its gross income (determined 
without regard to FFA) for 2018. The Agency provides $30 million of FFA 
to M in 2018. The amount of this FFA that M must include in income in 
2018 is limited by paragraph (c)(2) of this section to $20 million, the 
amount by which M's liabilities ($120 million) exceed the total adjusted 
basis of its assets ($100 million) at the beginning of the taxable year. 
Pursuant to paragraph (c)(4)(i) of this section, M must establish a 
deferred FFA account for the remaining $10 million.
    (ii) If the Agency instead lends M the $30 million, M's indebtedness 
to the Agency is disregarded and the results are the same as in 
paragraph (i) of this Example 1 under section 597(c), paragraph (b) of 
Sec.  1.597-1, and paragraph (b) of Sec.  1.597-3.
    Example 2. Transfer of property to an Agency. (i) Institution M, a 
calendar-year taxpayer without Continuing Equity because it is in Agency 
Receivership, is not a member of a consolidated group and has not been 
acquired in a Taxable Transfer. At the beginning of 2018, M's remaining 
equity is $0 and M has a deferred FFA account of $10 million. The Agency 
does not provide any FFA to M in 2018. During the year, M transfers 
property not subject to a Loss Guarantee to the Agency and does not 
receive any consideration. The property has an adjusted basis of $5 
million and a fair market value of $1 million at the time of the 
transfer. M has no other taxable income or loss in 2018.
    (ii) Under paragraph (d)(1) of this section, M is treated as selling 
the property for $1

[[Page 406]]

million, its fair market value, thus recognizing a $4 million loss ($5 
million-$1 million). In addition, because M did not receive any 
consideration from the Agency, under paragraph (d)(4) of this section M 
has an adjustment to FFA of $1 million, the amount by which the fair 
market value of the transferred property ($1 million) exceeds the 
consideration M received from the Agency ($0). Because no FFA is 
provided to M in 2018, this adjustment reduces the balance of M's 
deferred FFA account to $9 million ($10 million-$1 million) under 
paragraph (d)(5)(i)(B) of this section. Because M's $4 million loss 
causes M's deductions to exceed its gross income by $4 million in 2018 
and M has no remaining equity, under paragraph (c)(4)(iii)(A) of this 
section M must include $4 million of deferred FFA in income and must 
decrease the remaining $9 million balance of its deferred FFA account by 
the same amount, leaving a balance of $5 million.
    Example 3. Loss Guarantee. Institution Q, a calendar-year taxpayer, 
holds a Covered Asset (Asset Z). Q's adjusted basis in Asset Z is 
$10,000. Q sells Asset Z to an unrelated third party for $4,000. 
Pursuant to the Loss Guarantee, an Agency pays Q $6,000 ($10,000-
$4,000). Q's amount realized from the sale of Asset Z is $10,000 ($4,000 
from the third party and $6,000 from the Agency) under paragraph (d)(2) 
of this section. Q realizes no gain or loss on the sale ($10,000-$10,000 
= $0), and therefore includes none of the $6,000 of FFA it receives 
pursuant to the Loss Guarantee in income under paragraph (d)(3) of this 
section.

[T.D. 9825, 82 FR 48620, Oct. 19, 2017]



Sec.  1.597-3  Other rules.

    (a) Ownership of assets. For all federal income tax purposes, an 
Agency is not treated as the owner of assets subject to a Loss 
Guarantee, yield maintenance agreement, or cost to carry or cost of 
funds reimbursement agreement, regardless of whether it otherwise would 
be treated as the owner under general federal income tax principles.
    (b) Debt and equity interests received by an Agency. Debt 
instruments, stock, warrants, or other rights to acquire stock of an 
Institution (or any of its affiliates) that an Agency or a Controlled 
Entity receives in connection with a transaction in which FFA is 
provided are not treated as debt, stock, or other equity interests of or 
in the issuer for any purpose of the Internal Revenue Code while held by 
an Agency or a Controlled Entity. On the date an Agency or a Controlled 
Entity transfers an interest described in this paragraph (b) to a holder 
other than an Agency or a Controlled Entity, the interest is treated as 
having been newly issued by the issuer to the holder with an issue price 
equal to the sum of the amount of money and the fair market value of 
property paid by the new holder in exchange for the interest.
    (c) Agency Obligations--(1) In general. Except as otherwise provided 
in this paragraph (c), the original issue discount rules of sections 
1271 et seq. apply to Agency Obligations.
    (2) Issue price of Agency Obligations provided as Net Worth 
Assistance. The issue price of an Agency Obligation that is provided as 
Net Worth Assistance and that bears interest at either a single fixed 
rate or a qualified floating rate (and provides for no contingent 
payments) is the lesser of the sum of the present values of all payments 
due under the obligation, discounted at a rate equal to the applicable 
Federal rate (within the meaning of section 1274(d)(1) and (3)) in 
effect for the date of issuance, or the stated principal amount of the 
obligation. The issue price of an Agency Obligation that bears a 
qualified floating rate of interest (within the meaning of Sec.  1.1275-
5(b)) is determined by treating the obligation as bearing a fixed rate 
of interest equal to the rate in effect on the date of issuance under 
the obligation.
    (3) Adjustments to principal amount. Except as provided in Sec.  
1.597-5(d)(2)(iv), this paragraph (c)(3) applies if an Agency modifies 
or exchanges an Agency Obligation provided as Net Worth Assistance (or a 
successor obligation). The issue price of the modified or new Agency 
Obligation is determined under paragraphs (c)(1) and (2) of this 
section. If the issue price is greater than the adjusted issue price of 
the existing Agency Obligation, the difference is treated as FFA. If the 
issue price is less than the adjusted issue price of the existing Agency 
Obligation, the difference is treated as an adjustment to FFA under 
Sec.  1.597-2(d)(4).
    (d) Successors. To the extent necessary to effectuate the purposes 
of the regulations under section 597, an entity's treatment under the 
regulations applies to its successor. A successor includes a transferee 
in a transaction to

[[Page 407]]

which section 381(a) applies or a Bridge Bank to which another Bridge 
Bank transfers deposit liabilities.
    (e) [Reserved]
    (f) Losses and deductions with respect to Covered Assets. Prior to 
the disposition of a Covered Asset, the asset cannot be charged off, 
marked to a market value, depreciated, amortized, or otherwise treated 
in a manner that supposes an actual or possible diminution of value 
below the asset's fair market value. See Sec.  1.597-1(b).
    (g) Anti-abuse rule. The regulations under section 597 must be 
applied in a manner consistent with the purposes of section 597. 
Accordingly, if, in structuring or engaging in any transaction, a 
principal purpose is to achieve a federal income tax result that is 
inconsistent with the purposes of section 597 and the regulations 
thereunder, the Commissioner can make appropriate adjustments to income, 
deductions, and other items that would be consistent with those 
purposes.

[T.D. 9825, 82 FR 48622, Oct. 19, 2017]



Sec.  1.597-4  Bridge Banks and Agency Control.

    (a) Scope. This section provides rules that apply to a Bridge Bank 
or other Institution under Agency Control and to transactions in which 
an Institution transfers deposit liabilities (whether or not the 
Institution also transfers assets) to a Bridge Bank.
    (b) Status as taxpayer. A Bridge Bank or other Institution under 
Agency Control is a corporation within the meaning of section 7701(a)(3) 
for all purposes of the Internal Revenue Code (Code) and is subject to 
all Code provisions that generally apply to corporations, including 
those relating to methods of accounting and to requirements for filing 
returns, even if an Agency owns stock of the Institution.
    (c) No section 382 ownership change. The imposition of Agency 
Control, the cancellation of Institution stock by an Agency, a 
transaction in which an Institution transfers deposit liabilities to a 
Bridge Bank, and an election under paragraph (g) of this section are 
disregarded in determining whether an ownership change has occurred 
within the meaning of section 382(g).
    (d) Transfers to Bridge Banks--(1) In general. Except as otherwise 
provided in paragraph (g) of this section, the rules of this paragraph 
(d) apply to transfers to Bridge Banks. In general, a Bridge Bank and 
its associated Residual Entity are together treated as the successor 
entity to the transferring Institution. If an Institution transfers 
deposit liabilities to a Bridge Bank (whether or not it also transfers 
assets), the Institution recognizes no gain or loss on the transfer and 
the Bridge Bank succeeds to the transferring Institution's basis in any 
transferred assets. The associated Residual Entity retains its basis in 
any assets it continues to hold. Immediately after the transfer, the 
Bridge Bank succeeds to and takes into account the transferring 
Institution's items described in section 381(c) (subject to the 
conditions and limitations specified in section 381(c)), taxpayer 
identification number (TIN), deferred FFA account, and account 
receivable for future FFA as described in paragraph (g)(4)(ii) of this 
section. The Bridge Bank also succeeds to and continues the transferring 
Institution's taxable year.
    (2) Transfers to a Bridge Bank from multiple Institutions. If two or 
more Institutions transfer deposit liabilities to the same Bridge Bank, 
the rules in paragraph (d)(1) of this section are modified to the extent 
provided in this paragraph (d)(2). The Bridge Bank succeeds to the TIN 
and continues the taxable year of the Institution that transfers the 
largest amount of deposits. The taxable years of the other transferring 
Institutions close at the time of the transfer. If all the transferor 
Institutions are members of the same consolidated group, the Bridge 
Bank's carryback of losses to the Institution that transfers the largest 
amount of deposits is not limited by section 381(b)(3). The limitations 
of section 381(b)(3) do apply to the Bridge Bank's carrybacks of losses 
to all other transferor Institutions. If the transferor Institutions are 
not all members of the same consolidated group, the limitations of 
section 381(b)(3) apply with respect to all transferor Institutions. See 
paragraph (g)(6)(ii) of this section for additional rules that apply if 
two or

[[Page 408]]

more Institutions that are not members of the same consolidated group 
transfer deposit liabilities to the same Bridge Bank.
    (e) Treatment of Bridge Bank and Residual Entity as a single entity. 
A Bridge Bank and its associated Residual Entity or Entities are treated 
as a single entity for federal income tax purposes and must file a 
single combined federal income tax return. The Bridge Bank is 
responsible for filing all federal income tax returns and statements for 
this single entity and is the agent of each associated Residual Entity 
to the same extent as if the Bridge Bank were the agent for a 
consolidated group, within the meaning of Sec.  1.1502-77, including the 
Residual Entity. The term Institution includes a Residual Entity that 
files a combined return with its associated Bridge Bank.
    (f) Rules applicable to members of consolidated groups--(1) Status 
as members. Unless an election is made under paragraph (g) of this 
section, Agency Control of an Institution does not terminate the 
Institution's membership in a consolidated group. Stock of a subsidiary 
that is canceled by an Agency is treated as held by the members of the 
consolidated group that held the stock prior to its cancellation. If an 
Institution is a member of a consolidated group immediately before it 
transfers deposit liabilities to a Bridge Bank, the Bridge Bank succeeds 
to the Institution's status as the common parent or, unless an election 
is made under paragraph (g) of this section, as a subsidiary of the 
group. If a Bridge Bank succeeds to an Institution's status as a 
subsidiary, its stock is treated as held by the shareholders of the 
transferring Institution, and the stock basis or excess loss account of 
the Institution carries over to the Bridge Bank. A Bridge Bank is 
treated as owning stock owned by its associated Residual Entities, 
including for purposes of determining membership in an affiliated group.
    (2) Coordination with consolidated return regulations. The 
provisions of the regulations under section 597 take precedence over 
conflicting provisions in the regulations under section 1502.
    (g) Elective disaffiliation--(1) In general. A consolidated group of 
which an Institution is a subsidiary may elect irrevocably not to 
include the Institution in its affiliated group if the Institution is 
placed in Agency Receivership (whether or not assets or deposit 
liabilities of the Institution are transferred to a Bridge Bank). See 
paragraph (g)(6) of this section for circumstances under which a 
consolidated group is deemed to make this election.
    (2) Consequences of election. If the election under this paragraph 
(g) is made with respect to an Institution, the following consequences 
occur immediately before the subsidiary Institution to which the 
election applies is placed in Agency Receivership (or, in the case of a 
deemed election under paragraph (g)(6) of this section, immediately 
before the consolidated group is deemed to make the election) and in the 
following order--
    (i) All adjustments of the Institution and its Consolidated 
Subsidiaries under section 481 are accelerated;
    (ii) Deferred intercompany gains and losses and intercompany items 
with respect to the Institution and its Consolidated Subsidiaries are 
taken into account and the Institution and its Consolidated Subsidiaries 
take into account any other items required under the regulations under 
section 1502 for members that become nonmembers within the meaning of 
Sec.  1.1502-32(d)(4);
    (iii) The taxable year of the Institution and its Consolidated 
Subsidiaries closes and the Institution includes the amount described in 
paragraph (g)(3) of this section in income as ordinary income as its 
last item for that taxable year;
    (iv) The members of the consolidated group owning the common stock 
of the Institution include in income any excess loss account with 
respect to the Institution's stock under Sec.  1.1502-19 and any other 
items required under the regulations under section 1502 for members that 
own stock of corporations that become nonmembers within the meaning of 
Sec.  1.1502-32(d)(4); and
    (v) If the Institution's liabilities exceed the aggregate fair 
market value of its assets on the date the Institution is placed in 
Agency Receivership (or, in the case of a deemed election under 
paragraph (g)(6) of this section, on the date the consolidated group is 
deemed to make the election), the members of

[[Page 409]]

the consolidated group treat their stock in the Institution as 
worthless. (See Sec. Sec.  1.337(d)-2, 1.1502-35(f), and 1.1502-36 for 
rules applicable when a member of a consolidated group is entitled to a 
worthless stock deduction with respect to stock of another member of the 
group.) In all other cases, the consolidated group will be treated as 
owning stock of a nonmember corporation until such stock is disposed of 
or becomes worthless under rules otherwise applicable.
    (3) Toll charge. The amount described in this paragraph (g)(3) is 
the excess of the Institution's liabilities over the adjusted bases of 
its assets immediately before the Institution is placed in Agency 
Receivership (or, in the case of a deemed election under paragraph 
(g)(6) of this section, immediately before the consolidated group is 
deemed to make the election). In computing this amount, the adjusted 
bases of an Institution's assets are reduced by the amount of the 
Institution's reserves for bad debts under section 585 or 593, other 
than supplemental reserves under section 593. For purposes of this 
paragraph (g)(3), an Institution is treated as a single entity that 
includes the assets and liabilities of its Consolidated Subsidiaries, 
with appropriate adjustments to prevent duplication. The amount 
described in this paragraph (g)(3) for alternative minimum tax purposes 
is determined using alternative minimum tax basis, deductions, and all 
other items required to be taken into account. In computing the increase 
in the group's taxable income or alternative minimum taxable income, 
sections 56(d)(1), 382, and 383 and Sec. Sec.  1.1502-15, 1.1502-21, and 
1.1502-22 (or Sec. Sec.  1.1502-15A, 1.1502-21A, and 1.1502-22A, as 
appropriate) do not limit the use of the attributes of the Institution 
and its Consolidated Subsidiaries to the extent, if any, that the 
inclusion of the amount described in this paragraph (g)(3) in income 
would result in the group having taxable income or alternative minimum 
taxable income (determined without regard to this sentence) for the 
taxable year. The preceding sentence does not apply to any limitation 
under section 382 or 383 or Sec.  1.1502-15, Sec.  1.1502-21, or Sec.  
1.1502-22 (or Sec.  1.1502-15A, Sec.  1.1502-21A, or Sec.  1.1502-22A, 
as appropriate) that arose in connection with or prior to a corporation 
becoming a Consolidated Subsidiary of the Institution.
    (4) Treatment of Institutions after disaffiliation--(i) In general. 
If the election under this paragraph (g) is made with respect to an 
Institution, immediately after the Institution is placed in Agency 
Receivership (or, in the case of a deemed election under paragraph 
(g)(6) of this section, immediately after the consolidated group is 
deemed to make the election), the Institution and each of its 
Consolidated Subsidiaries are treated for federal income tax purposes as 
new corporations that are not members of the electing group's affiliated 
group. Each new corporation retains the TIN of the corresponding 
disaffiliated corporation and is treated as having received the assets 
and liabilities of the corresponding disaffiliated corporation in a 
transaction to which section 351 applies (and in which no gain was 
recognized under section 357(c) or otherwise). Thus, the new corporation 
has no net operating or capital loss carryforwards. An election under 
this paragraph (g) does not terminate the single entity treatment of a 
Bridge Bank and its Residual Entities provided in paragraph (e) of this 
section.
    (ii) FFA. A new Institution is treated as having a non-interest 
bearing, nontransferable account receivable for future FFA with a basis 
equal to the amount described in paragraph (g)(3) of this section. If a 
disaffiliated Institution has a deferred FFA account at the time of its 
disaffiliation, the corresponding new Institution succeeds to and takes 
into account that deferred FFA account.
    (iii) Filing of consolidated returns. If a disaffiliated Institution 
has Consolidated Subsidiaries at the time of its disaffiliation, the 
corresponding new Institution is required to file a consolidated federal 
income tax return with the subsidiaries in accordance with the 
regulations under section 1502.
    (iv) Status as Institution. If an Institution is disaffiliated under 
this paragraph (g), the resulting new corporation is treated as an 
Institution for purposes of the regulations under section 597 regardless 
of whether it is a

[[Page 410]]

bank or domestic building and loan association within the meaning of 
section 597.
    (v) Loss carrybacks. To the extent a carryback of losses would 
result in a refund being paid to a fiduciary under section 6402(k), an 
Institution or Consolidated Subsidiary with respect to which an election 
under this paragraph (g) (other than under paragraph (g)(6)(ii) of this 
section) applies is allowed to carry back losses as if the Institution 
or Consolidated Subsidiary had continued to be a member of the 
consolidated group that made the election.
    (5) Affirmative election--(i) Original Institution--(A) Manner of 
making election. Except as otherwise provided in paragraph (g)(6) of 
this section, a consolidated group makes the election provided by this 
paragraph (g) by sending a written statement by certified mail to the 
affected Institution on or before 120 days after its placement in Agency 
Receivership. The statement must contain the following legend at the top 
of the page: ``THIS IS AN ELECTION UNDER Sec.  1.597-4(g) TO EXCLUDE THE 
INSTITUTION AND CONSOLIDATED SUBSIDIARIES REFERENCED IN THIS STATEMENT 
FROM THE AFFILIATED GROUP,'' and must include the names and TINs of the 
common parent and of the Institution and Consolidated Subsidiaries to 
which the election applies, and the date on which the Institution was 
placed in Agency Receivership. The consolidated group must send a 
similar statement to all subsidiary Institutions placed in Agency 
Receivership during the consistency period described in paragraph 
(g)(5)(ii) of this section. (Failure to satisfy the requirement in the 
preceding sentence, however, does not invalidate the election with 
respect to any subsidiary Institution placed in Agency Receivership 
during the consistency period described in paragraph (g)(5)(ii) of this 
section.) The consolidated group must retain a copy of the statement 
sent to any affected or subsidiary Institution (and the accompanying 
certified mail receipt) as proof that it mailed the statement to the 
affected Institution, and the consolidated group must make the statement 
and receipt available for inspection by the Commissioner upon request. 
The consolidated group must include an election statement as part of its 
first federal income tax return filed after the due date under this 
paragraph (g)(5) for such statement. A statement must be attached to 
this return indicating that the individual who signed the election was 
authorized to do so on behalf of the consolidated group. The agent for 
the group, within the meaning of Sec.  1.1502-77, takes all actions 
required under this paragraph (g)(5)(i)(A) to make the election provided 
under this paragraph (g)(5) for the consolidated group. An Agency cannot 
make the election provided under this paragraph (g)(5) under the 
authority of section 6402(k) or otherwise.
    (B) Consistency limitation on affirmative elections. A consolidated 
group may make an affirmative election under this paragraph (g)(5) with 
respect to a subsidiary Institution placed in Agency Receivership only 
if the group made, or is deemed to have made, the election under this 
paragraph (g) with respect to every subsidiary Institution of the group 
placed in Agency Receivership within five years preceding the date the 
subject Institution was placed in Agency Receivership.
    (ii) Effect on Institutions placed in receivership simultaneously or 
subsequently. An election under this paragraph (g), other than under 
paragraph (g)(6)(ii) of this section, applies to the Institution with 
respect to which the election is made or deemed made (the original 
Institution) and each subsidiary Institution of the group placed in 
Agency Receivership or deconsolidated in contemplation of Agency Control 
or the receipt of FFA simultaneously with the original Institution or 
within five years thereafter.
    (6) Deemed election--(i) Deconsolidations in contemplation. If one 
or more members of a consolidated group deconsolidate (within the 
meaning of Sec.  1.1502-19(c)(1)(ii)(B)) a subsidiary Institution in 
contemplation of Agency Control or the receipt of FFA, the consolidated 
group is deemed to make the election described in this paragraph (g) 
with respect to the Institution on the date the deconsolidation occurs. 
A subsidiary Institution is conclusively presumed to have been

[[Page 411]]

deconsolidated in contemplation of Agency Control or the receipt of FFA 
if either event occurs within six months after the deconsolidation.
    (ii) Transfers to a Bridge Bank from multiple groups. On the day an 
Institution's transfer of deposit liabilities to a Bridge Bank results 
in the Bridge Bank holding deposit liabilities from both a subsidiary 
Institution and an Institution not included in the subsidiary 
Institution's consolidated group, each consolidated group of which a 
transferring Institution or the Bridge Bank is a subsidiary is deemed to 
make the election described in this paragraph (g) with respect to its 
subsidiary Institution. If deposit liabilities of another Institution 
that is a subsidiary member of any consolidated group subsequently are 
transferred to the Bridge Bank, the consolidated group of which the 
Institution is a subsidiary is deemed to make the election described in 
this paragraph (g) with respect to that Institution at the time of the 
subsequent transfer.
    (h) Examples. The following examples illustrate the provisions of 
this section:

    Facts. Corporation X, the common parent of a consolidated group, 
owns all the stock (with a basis of $4 million) of Institution M, an 
insolvent Institution with no Consolidated Subsidiaries. At the close of 
business on April 30, 2018, M has $4 million of deposit liabilities, $1 
million of other liabilities, and assets with an adjusted basis of $4 
million and a fair market value of $3 million.
    Example 1. Effect of receivership on consolidation. On May 1, 2018, 
M is placed in Agency Receivership and the Agency begins liquidating M. 
X does not make an election under paragraph (g) of this section. M 
remains a member of the X consolidated group after May 1, 2018 under 
paragraph (f)(1) of this section.
    Example 2. Effect of Bridge Bank on consolidation--(i) Additional 
facts. On May 1, 2018, M is placed in Agency Receivership and the Agency 
causes M to transfer all of its assets and deposit liabilities to Bridge 
Bank MB.
    (ii) Consequences without an election to disaffiliate. M recognizes 
no gain or loss from the transfer and MB succeeds to M's basis in the 
transferred assets, M's items described in section 381(c) (subject to 
the conditions and limitations specified in section 381(c)), and TIN 
under paragraph (d)(1) of this section. (If M had a deferred FFA 
account, MB would also succeed to that account under paragraph (d)(1) of 
this section.) MB continues M's taxable year and succeeds to M's status 
as a member of the X consolidated group after May 1, 2018 under 
paragraphs (d)(1) and (f) of this section. MB and M are treated as a 
single entity for federal income tax purposes under paragraph (e) of 
this section.
    (iii) Consequences with an election to disaffiliate. If, on July 1, 
2018, X makes an election under paragraph (g) of this section with 
respect to M, the following consequences are treated as occurring 
immediately before M was placed in Agency Receivership. M must include 
$1 million ($5 million of liabilities -$4 million of adjusted basis) in 
income as of May 1, 2018 under paragraph (g)(2) and (3) of this section. 
M is then treated as a new corporation that is not a member of the X 
consolidated group and that has assets (including a $1 million account 
receivable for future FFA) with a basis of $5 million and $5 million of 
liabilities received from disaffiliated corporation M in a section 351 
transaction. New corporation M retains the TIN of disaffiliated 
corporation M under paragraph (g)(4) of this section. Immediately after 
the disaffiliation, new corporation M is treated as transferring its 
assets and deposit liabilities to Bridge Bank MB. New corporation M 
recognizes no gain or loss from the transfer and MB succeeds to M's TIN 
and taxable year under paragraph (d)(1) of this section. Bridge Bank MB 
is treated as a single entity that includes M and has $5 million of 
liabilities, an account receivable for future FFA with a basis of $1 
million, and other assets with a basis of $4 million under paragraph 
(d)(1) of this section.

[T.D. 9825, 82 FR 48623, Oct. 19, 2017]



Sec.  1.597-5  Taxable Transfers.

    (a) Taxable Transfers--(1) Defined. The term Taxable Transfer 
means--
    (i) A transaction in which an entity transfers to a transferee other 
than a Bridge Bank--
    (A) Any deposit liability (whether or not the Institution also 
transfers assets), if FFA is provided in connection with the 
transaction; or
    (B) Any asset for which an Agency or a Controlled Entity has any 
financial obligation (for example, pursuant to a Loss Guarantee or 
Agency Obligation); or
    (ii) A deemed transfer of assets described in paragraph (b) of this 
section.
    (2) Scope. This section provides rules governing Taxable Transfers. 
Rules applicable to both actual and deemed asset acquisitions are 
provided in paragraphs (c) and (d) of this section. Special rules 
applicable only to deemed

[[Page 412]]

asset acquisitions are provided in paragraph (e) of this section.
    (b) Deemed asset acquisitions upon stock purchase--(1) In general. 
In a deemed transfer of assets under this paragraph (b), an Institution 
(including a Bridge Bank or a Residual Entity) or a Consolidated 
Subsidiary of the Institution (the Old Entity) is treated as selling all 
of its assets in a single transaction and is treated as a new 
corporation (the New Entity) that purchases all of the Old Entity's 
assets at the close of the day immediately preceding the occurrence of 
an event described in paragraph (b)(2) of this section. However, such an 
event results in a deemed transfer of assets under this paragraph (b) 
only if it occurs--
    (i) In connection with a transaction in which FFA is provided;
    (ii) While the Institution is a Bridge Bank;
    (iii) While the Institution has a positive balance in a deferred FFA 
account (see Sec.  1.597-2(c)(4)(v) regarding the optional accelerated 
recapture of deferred FFA); or
    (iv) With respect to a Consolidated Subsidiary, while the 
Institution of which it is a Consolidated Subsidiary is under Agency 
Control.
    (2) Events. A deemed transfer of assets under this paragraph (b) 
results if the Institution or Consolidated Subsidiary--
    (i) Becomes a non-member (within the meaning of Sec.  1.1502-
32(d)(4)) of its consolidated group, other than pursuant to an election 
under Sec.  1.597-4(g);
    (ii) Becomes a member of an affiliated group of which it was not 
previously a member, other than pursuant to an election under Sec.  
1.597-4(g); or
    (iii) Issues stock such that the stock that was outstanding before 
the imposition of Agency Control or the occurrence of any transaction in 
connection with the provision of FFA represents 50 percent or less of 
the vote or value of its outstanding stock (disregarding stock described 
in section 1504(a)(4) and stock owned by an Agency or a Controlled 
Entity).
    (3) Bridge Banks and Residual Entities. If a Bridge Bank is treated 
as selling all of its assets to a New Entity under this paragraph (b), 
each associated Residual Entity is treated as simultaneously selling its 
assets to a New Entity in a Taxable Transfer described in this paragraph 
(b).
    (c) Treatment of transferor--(1) FFA in connection with a Taxable 
Transfer. A transferor in a Taxable Transfer is treated as having 
directly received immediately before a Taxable Transfer any Net Worth 
Assistance that an Agency provides to the New Entity or the Acquiring in 
connection with the transfer. (See Sec.  1.597-2(a) and (c) for rules 
regarding the inclusion of FFA in income and Sec.  1.597-2(a)(1) for 
related rules regarding FFA provided to shareholders.) The Net Worth 
Assistance is treated as an asset of the transferor that is sold to the 
New Entity or the Acquiring in the Taxable Transfer.
    (2) Amount realized in a Taxable Transfer. In a Taxable Transfer 
described in paragraph (a)(1)(i) of this section, the amount realized is 
determined under section 1001(b) by reference to the consideration paid 
for the assets. In a Taxable Transfer described in paragraph (a)(1)(ii) 
of this section, the amount realized is the sum of the grossed-up basis 
of the stock acquired in connection with the Taxable Transfer (excluding 
stock acquired from the Old or New Entity), plus the amount of 
liabilities assumed or taken subject to in the deemed transfer, plus 
other relevant items. The grossed-up basis of the acquired stock equals 
the acquirers' basis in the acquired stock divided by the percentage of 
the Old Entity's stock (by value) attributable to the acquired stock.
    (3) Allocation of amount realized--(i) In general. The amount 
realized under paragraph (c)(2) of this section is allocated among the 
assets transferred in the Taxable Transfer in the same manner as amounts 
are allocated among assets under Sec.  1.338-6(b) and (c)(1) and (2).
    (ii) Modifications to general rule. This paragraph (c)(3)(ii) 
modifies certain of the allocation rules of paragraph (c)(3)(i) of this 
section. Agency Obligations and Covered Assets in the hands of the New 
Entity or the Acquiring are treated as Class II assets. Stock of a 
Consolidated Subsidiary is treated as a Class II asset to the extent the 
fair market value of the Consolidated Subsidiary's Class I and Class II 
assets (see Sec.  1.597-1(b)) exceeds the amount of its

[[Page 413]]

liabilities. The fair market value of an Agency Obligation is deemed to 
equal its adjusted issue price immediately before the Taxable Transfer.
    (d) Treatment of a New Entity and an Acquiring--(1) Purchase price. 
The purchase price for assets acquired in a Taxable Transfer described 
in paragraph (a)(1)(i) of this section is the cost of the assets 
acquired. See Sec.  1.1060-1(c)(1). All assets transferred in related 
transactions pursuant to an option included in an agreement between the 
transferor and the Acquiring in the Taxable Transfer are included in the 
group of assets among which the consideration paid is allocated for 
purposes of determining the New Entity's or the Acquiring's basis in 
each of the assets. The purchase price for assets acquired in a Taxable 
Transfer described in paragraph (a)(1)(ii) of this section is the sum of 
the grossed-up basis of the stock acquired in connection with the 
Taxable Transfer (excluding stock acquired from the Old or New Entity), 
plus the amount of liabilities assumed or taken subject to in the deemed 
transfer, plus other relevant items. The grossed-up basis of the 
acquired stock equals the acquirers' basis in the acquired stock divided 
by the percentage of the Old Entity's stock (by value) attributable to 
the acquired stock. FFA provided in connection with a Taxable Transfer 
is not included in the New Entity's or the Acquiring's purchase price 
for the acquired assets. Any Net Worth Assistance so provided is treated 
as an asset of the transferor sold to the New Entity or the Acquiring in 
the Taxable Transfer.
    (2) Allocation of basis--(i) In general. Except as otherwise 
provided in this paragraph (d)(2), the purchase price determined under 
paragraph (d)(1) of this section is allocated among the assets 
transferred in the Taxable Transfer in the same manner as amounts are 
allocated among assets under Sec.  1.338-6(b) and (c)(1) and (2).
    (ii) Modifications to general rule. The allocation rules contained 
in paragraph (c)(3)(ii) of this section apply to the allocation of basis 
among assets acquired in a Taxable Transfer. No basis is allocable to an 
Agency's agreement to provide Loss Guarantees, yield maintenance 
payments, cost to carry or cost of funds reimbursement payments, or 
expense reimbursement or indemnity payments. A New Entity's basis in 
assets it receives from its shareholders is determined under general 
federal income tax principles and is not governed by this paragraph (d).
    (iii) Allowance and recapture of additional basis in certain cases. 
The basis of Class I and Class II assets equals their fair market value. 
See Sec.  1.597-1(b). If the fair market value of the Class I and Class 
II assets exceeds the purchase price for the acquired assets, the excess 
is included ratably as ordinary income by the New Entity or the 
Acquiring over a period of six taxable years beginning in the year of 
the Taxable Transfer. The New Entity or the Acquiring must include as 
ordinary income the entire amount remaining to be recaptured under the 
preceding sentence in the taxable year in which an event occurs that 
would accelerate inclusion of an adjustment under section 481.
    (iv) Certain post-transfer adjustments--(A) Agency Obligations. If 
an adjustment to the principal amount of an Agency Obligation or cash 
payment to reflect a more accurate determination of the condition of the 
Institution at the time of the Taxable Transfer is made before the 
earlier of the date the New Entity or the Acquiring files its first 
post-transfer federal income tax return or the due date of that return 
(including extensions), the New Entity or the Acquiring must adjust its 
basis in its acquired assets to reflect the adjustment. In making 
adjustments to the New Entity's or the Acquiring's basis in its acquired 
assets, paragraph (c)(3)(ii) of this section is applied by treating an 
adjustment to the principal amount of an Agency Obligation pursuant to 
the first sentence of this paragraph (d)(2)(iv)(A) as occurring 
immediately before the Taxable Transfer. (See Sec.  1.597-3(c)(3) for 
rules regarding other adjustments to the principal amount of an Agency 
Obligation.)
    (B) Covered Assets. If, immediately after a Taxable Transfer, an 
asset is not subject to a Loss Guarantee but the New Entity or the 
Acquiring has the right to designate specific assets that will be 
subject to the Loss Guarantee, the New Entity or the Acquiring

[[Page 414]]

must treat any asset so designated as having been subject to the Loss 
Guarantee at the time of the Taxable Transfer. The New Entity or the 
Acquiring must adjust its basis in the Covered Assets and in its other 
acquired assets to reflect the designation in the manner provided by 
paragraph (d)(2) of this section. The New Entity or the Acquiring must 
make appropriate adjustments in subsequent taxable years if the 
designation is made after the New Entity or the Acquiring files its 
first post-transfer federal income tax return or the due date of that 
return (including extensions) has passed.
    (e) Special rules applicable to Taxable Transfers that are deemed 
asset acquisitions--(1) Taxpayer Identification Numbers. Except as 
provided in paragraph (e)(3) of this section, the New Entity succeeds to 
the TIN of the Old Entity in a deemed sale under paragraph (b) of this 
section.
    (2) Consolidated Subsidiaries--(i) In general. A Consolidated 
Subsidiary that is treated as selling its assets in a Taxable Transfer 
under paragraph (b) of this section is treated as engaging immediately 
thereafter in a complete liquidation to which section 332 applies. The 
consolidated group of which the Consolidated Subsidiary is a member does 
not take into account gain or loss on the sale, exchange, or 
cancellation of stock of the Consolidated Subsidiary in connection with 
the Taxable Transfer.
    (ii) Certain minority shareholders. Shareholders of the Consolidated 
Subsidiary that are not members of the consolidated group that includes 
the Institution do not recognize gain or loss with respect to shares of 
Consolidated Subsidiary stock retained by the shareholder. The 
shareholder's basis for that stock is not affected by the Taxable 
Transfer.
    (3) Bridge Banks and Residual Entities--(i) In general. A Bridge 
Bank or Residual Entity's sale of assets to a New Entity under paragraph 
(b) of this section is treated as made by a single entity under Sec.  
1.597-4(e). The New Entity deemed to acquire the assets of a Residual 
Entity under paragraph (b) of this section is not treated as a single 
entity with the Bridge Bank (or with the New Entity acquiring the Bridge 
Bank's assets) and must obtain a new TIN.
    (ii) Treatment of consolidated groups. At the time of a Taxable 
Transfer described in paragraph (a)(1)(ii) of this section, treatment of 
a Bridge Bank as a subsidiary member of a consolidated group under Sec.  
1.597-4(f)(1) ceases. However, the New Entity that is deemed to acquire 
the assets of a Residual Entity is a member of the selling consolidated 
group after the deemed sale. The group's basis or excess loss account in 
the stock of the New Entity that is deemed to acquire the assets of the 
Residual Entity is the group's basis or excess loss account in the stock 
of the Bridge Bank immediately before the deemed sale, as adjusted for 
the results of the sale.
    (4) Certain returns. If an Old Entity without Continuing Equity is 
not a subsidiary of a consolidated group at the time of the Taxable 
Transfer, the controlling Agency must file all federal income tax 
returns for the Old Entity for periods ending on or prior to the date of 
the deemed sale described in paragraph (b) of this section that are not 
filed as of that date.
    (5) Basis limited to fair market value. If all of the stock of the 
corporation is not acquired on the date of the Taxable Transfer, the 
Commissioner may make appropriate adjustments under paragraphs (c) and 
(d) of this section to the extent using a grossed-up basis of the stock 
of a corporation results in an aggregate amount realized for, or basis 
in, the assets other than the aggregate fair market value of the assets.
    (f) Examples. The following examples illustrate the provisions of 
this section. For purposes of these examples, an Institution's loans are 
treated as if they were a single asset. However, in applying these 
regulations, the fair market value of each loan (including, for purposes 
of a Covered Asset, the Third-Party Price and the Expected Value) must 
be determined separately.

    Example 1. Branch sale resulting in Taxable Transfer. (i) 
Institution M is a calendar-year taxpayer in Agency Receivership. M is 
not a member of a consolidated group. On January 1, 2018, M has $200 
million of liabilities (including deposit liabilities) and assets with 
an adjusted basis of $100 million. M has no income or loss for 2018 and, 
except as otherwise described in this paragraph (i), M receives no

[[Page 415]]

FFA. On September 30, 2018, the Agency causes M to transfer six branches 
(with assets having an adjusted basis of $1 million) together with $120 
million of deposit liabilities to N. In connection with the transfer, 
the Agency provides $121 million in cash to N.
    (ii) The transaction is a Taxable Transfer in which M receives $121 
million of Net Worth Assistance under paragraph (a)(1) of this section. 
(M is treated as directly receiving the $121 million of Net Worth 
Assistance immediately before the Taxable Transfer under paragraph 
(c)(1) of this section.) M transfers branches having a basis of $1 
million and is treated as transferring $121 million in cash (the Net 
Worth Assistance) to N in exchange for N's assumption of $120 million of 
liabilities. Thus, M realizes a loss of $2 million on the transfer. The 
amount of the FFA M must include in its income in 2018 is limited by 
paragraph (c) of Sec.  1.597-2 to $102 million, which is the sum of the 
$100 million excess of M's liabilities ($200 million) over the total 
adjusted basis of its assets ($100 million) at the beginning of 2018 and 
the $2 million excess for the taxable year (which results from the 
Taxable Transfer) of M's deductions (other than carryovers) over its 
gross income other than FFA. M must establish a deferred FFA account for 
the remaining $19 million of FFA under paragraph (c)(4) of Sec.  1.597-
2.
    (iii) N, as the Acquiring, must allocate its $120 million purchase 
price for the assets acquired from M among those assets. Cash is a Class 
I asset. The branch assets are in Classes III and IV. N's adjusted basis 
in the cash is its amount, that is, $121 million under paragraph (d)(2) 
of this section. Because this amount exceeds N's purchase price for all 
of the acquired assets by $1 million, N allocates no basis to the other 
acquired assets and, under paragraph (d)(2) of this section, must 
recapture the $1 million excess at an annual rate of $166,667 in the six 
consecutive taxable years beginning with 2018 (subject to acceleration 
for certain events).
    Example 2. Stock issuance by Bridge Bank causing Taxable Transfer. 
(i) On April 1, 2018, Institution P is placed in Agency Receivership and 
the Agency causes P to transfer assets and liabilities to Bridge Bank 
PB. On August 31, 2018, the assets of PB consist of $20 million in cash, 
loans outstanding with an adjusted basis of $50 million and a Third-
Party Price of $40 million, and other non-financial assets (primarily 
branch assets and equipment) with an adjusted basis of $5 million. PB 
has deposit liabilities of $95 million and other liabilities of $5 
million. P, the Residual Entity, holds real estate with an adjusted 
basis of $10 million and claims in litigation having a zero basis. P 
retains no deposit liabilities and has no other liabilities (except its 
liability to the Agency for having caused its deposit liabilities to be 
satisfied).
    (ii) On September 1, 2018, the Agency causes PB to issue 100 percent 
of its common stock for $2 million cash to X. On the same day, the 
Agency issues a $25 million note to PB. The note bears a fixed rate of 
interest in excess of the applicable Federal rate in effect for 
September 1, 2018. The Agency provides Loss Guarantees guaranteeing PB a 
value of $50 million for PB's loans outstanding.
    (iii) The stock issuance is a Taxable Transfer in which PB is 
treated as selling all of its assets to a new corporation, New PB, under 
paragraph (b)(1) of this section. PB is treated as directly receiving 
$25 million of Net Worth Assistance (the issue price of the Agency 
Obligation) immediately before the Taxable Transfer under paragraph 
(c)(2) of Sec.  1.597-3 and paragraph (c)(1) of this section. The amount 
of FFA PB must include in income is determined under paragraphs (a) and 
(c) of Sec.  1.597-2. PB in turn is deemed to transfer the note (with a 
basis of $25 million) to New PB in the Taxable Transfer, together with 
$20 million of cash, all its loans outstanding (with a basis of $50 
million) and its other non-financial assets (with a basis of $5 
million). The amount realized by PB from the sale is $100 million (the 
amount of PB's liabilities deemed to be assumed by New PB). This amount 
realized equals PB's basis in its assets; thus, PB realizes no gain or 
loss on the transfer to New PB.
    (iv) Residual Entity P also is treated as selling all its assets 
(consisting of real estate and claims in litigation) for $0 (the amount 
of consideration received by P) to a new corporation (New P) in a 
Taxable Transfer under paragraph (b)(3) of this section. (P's only 
liability is to the Agency and a liability to the Agency is not treated 
as a debt under paragraph (b) of Sec.  1.597-3.) P's basis in its assets 
is $10 million; thus, P realizes a $10 million loss on the transfer to 
New P. The combined return filed by PB and P for 2018 will reflect a 
total loss on the Taxable Transfer of $10 million ($0 for PB and $10 
million for P) under paragraph (e)(3) of this section. That return also 
will reflect FFA income from the Net Worth Assistance, determined under 
paragraphs (a) and (c) of Sec.  1.597-2.
    (v) New PB is treated as having acquired the assets it acquired from 
PB for $100 million, the amount of liabilities assumed. In allocating 
basis among these assets, New PB treats the Agency note and the loans 
outstanding (which are Covered Assets) as Class II assets. For the 
purpose of allocating basis, the fair market value of the Agency note is 
deemed to equal its adjusted issue price immediately before the transfer 
($25 million), and the fair market value of the loans is their Expected 
Value, $50 million (the sum of the $40 million Third-Party Price and the 
$10 million that the Agency would pay if PB sold the loans for $40 
million) under paragraph (b) of Sec.  1.597-1. Alternatively, if the 
Third-Party Price for the loans were $60 million, then the

[[Page 416]]

fair market value of the loans would be $60 million, and there would be 
no payment from the Agency.
    (vi) New P is treated as having acquired its assets for no 
consideration. Thus, its basis in its assets immediately after the 
transfer is zero. New PB and New P are not treated as a single entity 
under paragraph (e)(3) of this section.
    Example 3. Taxable Transfer of previously disaffiliated Institution. 
(i) Corporation X, the common parent of a consolidated group, owns all 
the stock of Institution M, an insolvent Institution with no 
Consolidated Subsidiaries. On April 30, 2018, M has $4 million of 
deposit liabilities, $1 million of other liabilities, and assets with an 
adjusted basis of $4 million. On May 1, 2018, M is placed in Agency 
Receivership. X elects under paragraph (g) of Sec.  1.597-4 to 
disaffiliate M. Accordingly, as of May 1, 2018, new corporation M is not 
a member of the X consolidated group. On May 1, 2018, the Agency causes 
M to transfer all of its assets and liabilities to Bridge Bank MB. Under 
paragraphs (e) and (g)(4) of Sec.  1.597-4, MB and M are thereafter 
treated as a single entity which has $5 million of liabilities, an 
account receivable for future FFA with a basis of $1 million, and other 
assets with a basis of $4 million.
    (ii) During May 2018, MB earns $25,000 of interest income and 
accrues $20,000 of interest expense on depositor accounts and there is 
no net change in deposits other than the additional $20,000 of interest 
expense accrued on depositor accounts. MB pays $5,000 of wage expenses 
and has no other items of income or expense.
    (iii) On June 1, 2018, the Agency causes MB to issue 100 percent of 
its stock to Corporation Y. In connection with the stock issuance, the 
Agency provides an Agency Obligation for $2 million and no other FFA.
    (iv) The stock issuance results in a Taxable Transfer under 
paragraph (b) of this section. MB is treated as receiving the Agency 
Obligation immediately prior to the Taxable Transfer under paragraph 
(c)(1) of this section. MB has $1 million of basis in its account 
receivable for FFA. This receivable is treated as satisfied, offsetting 
$1 million of the $2 million of FFA provided by the Agency in connection 
with the Taxable Transfer. The status of the remaining $1 million of FFA 
as includible income is determined as of the end of the taxable year 
under paragraph (c) of Sec.  1.597-2. However, under paragraph (b) of 
Sec.  1.597-2, MB obtains a $2 million basis in the Agency Obligation 
received as FFA.
    (v) Under paragraph (c)(2) of this section, in the Taxable Transfer, 
Old Entity MB is treated as selling, to New Entity MB, all of Old Entity 
MB's assets, having a basis of $6,020,000 (the original $4 million of 
asset basis as of April 30, 2018, plus $20,000 net cash from May 2018 
activities, plus the $2 million Agency Obligation received as FFA), for 
$5,020,000, the amount of Old Entity MB's liabilities assumed by New 
Entity MB pursuant to the Taxable Transfer. Therefore, Old Entity MB 
recognizes, in the aggregate, a loss of $1 million from the Taxable 
Transfer.
    (vi) Because this $1 million loss causes Old Entity MB's deductions 
to exceed its gross income (determined without regard to FFA) by $1 
million, Old Entity MB must include in its income the $1 million of FFA 
not offset by the FFA receivable under paragraph (c) of Sec.  1.597-2. 
(As of May 1, 2018, Old Entity MB's liabilities ($5 million) did not 
exceed MB's $5 million adjusted basis of its assets. For the taxable 
year, MB's deductions of $1,025,000 ($1 million loss from the Taxable 
Transfer, $20,000 interest expense and $5,000 of wage expense) exceeded 
its gross income (disregarding FFA) of $25,000 (interest income) by $1 
million. Thus, under paragraph (c) of Sec.  1.597-2, MB includes in 
income the entire $1 million of FFA not offset by the FFA receivable.)
    (vii) Therefore, Old Entity MB's taxable income for the taxable year 
ending on the date of the Taxable Transfer is $0.
    (viii) Residual Entity M is also deemed to engage in a deemed sale 
of its assets to New Entity M under paragraph (b)(3) of this section, 
but there are no federal income tax consequences as M has no assets or 
liabilities at the time of the deemed sale.
    (ix) Under paragraph (d)(1) of this section, New Entity MB is 
treated as purchasing Old Entity MB's assets for $5,020,000, the amount 
of New Entity MB's liabilities. Of this, $2 million is allocated to the 
$2 million Agency Obligation, and $3,020,000 is allocated to the other 
assets New Entity MB is treated as purchasing in the Taxable Transfer.
    Example 4. Loss Guarantee. On January 1, 2018, Institution N 
acquires assets and assumes liabilities of another Institution in a 
Taxable Transfer. In exchange for assuming $1,100,000 of the 
transferring Institution's liabilities, N acquires Net Worth Assistance 
of $200,000, loans with an unpaid principal balance of $1 million, and 
two foreclosed properties each having a book value of $100,000 in the 
hands of the transferring Institution. In connection with the Taxable 
Transfer, an Agency guarantees N a price of $800,000 on the disposition 
or charge-off of the loans and a price of $80,000 on the disposition or 
charge-off of each of the foreclosed properties. This arrangement 
constitutes a Loss Guarantee. The Third-Party Price is $500,000 for the 
loans and $50,000 for each of the foreclosed properties. For basis 
allocation purposes, the loans and foreclosed properties are Class II 
assets because they are Covered Assets, and N must allocate basis to 
such assets equal to their fair market value under paragraphs (c)(3)(ii) 
and (d)(2)(ii) and (iii) of this section. The fair market value of the 
loans is their Expected Value, $800,000 (the sum of the $500,000 Third-
Party Price and the

[[Page 417]]

$300,000 that the Agency would pay if N sold the loans for $500,000). 
The fair market value of each foreclosed property is its Expected Value, 
$80,000 (the sum of the $50,000 Third-Party Price and the $30,000 that 
the Agency would pay if N sold the foreclosed property for $50,000) 
under paragraph (b) of Sec.  1.597-1. Accordingly, N's basis in the 
loans and in each of the foreclosed properties is $800,000 and $80,000, 
respectively. Because N's aggregate basis in the cash, loans, and 
foreclosed properties ($1,160,000) exceeds N's purchase price 
($1,100,000) by $60,000, N must include $60,000 in income ratably over 
six years under paragraph (d)(2)(iii) of this section.
    Example 5. Loss Share Agreement. (i) The facts are the same as in 
Example 4 of this paragraph (f) except that, in connection with the 
Taxable Transfer, the Agency agrees to reimburse Institution N in an 
amount equal to zero percent of any loss realized (based on the $1 
million unpaid principal balance of the loans and the $100,000 book 
value of each of the foreclosed properties) on the disposition or 
charge-off of the Covered Assets up to $200,000; 50 percent of any loss 
realized between $200,000 and $700,000; and 95 percent of any additional 
loss realized. This arrangement constitutes a Loss Guarantee that is a 
Loss Share Agreement. Thus, the Covered Assets are Class II assets, and 
N allocates basis to such assets equal to their fair market value under 
paragraphs (c)(3)(ii) and (d)(2)(ii) and (iii) of this section. Because 
the Third-Party Price for all of the Covered Assets is $600,000 
($500,000 for the loans and $50,000 for each of the foreclosed 
properties), the Average Reimbursement Rate is 33.33% ((($200,000 x 0%) 
+ ($400,000 x 50%) + ($0 x 95%))/$600,000). The Expected Value of the 
loans is $666,667 ($500,000 Third-Party Price + $166,667 (the amount of 
the loss if the loans were disposed of for the Third-Party Price x 
33.33%)), and the Expected Value of each foreclosed property is $66,667 
($50,000 Third-Party Price + $16,667 (the amount of the loss if the 
foreclosed property were sold for the Third-Party Price x 33.33%)) under 
paragraph (b) of Sec.  1.597-1. For purposes of allocating basis, the 
fair market value of the loans is $666,667 (their Expected Value), and 
the fair market value of each foreclosed property is $66,667 (its 
Expected Value) under paragraph (b) of Sec.  1.597-1.
    (ii) At the end of 2018, the Third-Party Price for the loans drops 
to $400,000, and the Third-Party Price for each of the foreclosed 
properties remains at $50,000. The fair market value of the loans at the 
end of Year 2 is their Expected Value, $600,000 ($400,000 Third-Party 
Price + $200,000 (the amount of the loss if the loans were disposed of 
for the Third-Party Price x 33.33%) (the Average Reimbursement Rate does 
not change)). Thus, if the loans otherwise may be charged off, marked to 
a market value, depreciated, or amortized, then the loans may be marked 
down to $600,000. The fair market value of each of the foreclosed 
properties remains at $66,667 ($50,000 Third-Party Price + $16,667 (the 
amount of the loss if the foreclosed property were sold for the Third-
Party Price x 33.33%)). Therefore, the foreclosed properties may not be 
charged off or depreciated in 2018.

[T.D. 9825, 82 FR 48625, Oct. 19, 2017, as amended at 82 FR 61177, Dec. 
27, 2017]



Sec.  1.597-6  Limitation on collection of federal income tax.

    (a) Limitation on collection where federal income tax is borne by an 
Agency. If an Institution without Continuing Equity (or any of its 
Consolidated Subsidiaries) is liable for federal income tax that is 
attributable to the inclusion in income of FFA or gain from a Taxable 
Transfer, the federal income tax will not be collected if it would be 
borne by an Agency. The final determination of whether the federal 
income tax would be borne by an Agency is within the sole discretion of 
the Commissioner. In determining whether federal income tax would be 
borne by an Agency, the Commissioner will disregard indemnity, tax-
sharing, or similar obligations of an Agency, an Institution, or its 
Consolidated Subsidiaries. Collection of the several federal income tax 
liability under Sec.  1.1502-6 from members of an Institution's 
consolidated group other than the Institution or its Consolidated 
Subsidiaries is not affected by this section. Federal income tax will 
continue to be subject to collection except as specifically limited in 
this section. This section does not apply to taxes other than federal 
income taxes.
    (b) Amount of federal income tax attributable to FFA or gain on a 
Taxable Transfer. For purposes of paragraph (a) of this section, the 
amount of federal income tax in a taxable year attributable to the 
inclusion of FFA or gain from a Taxable Transfer in the income of an 
Institution (or a Consolidated Subsidiary) is the excess of the actual 
federal income tax liability of the Institution (or the consolidated 
group in which the Institution is a member) over the federal income tax 
liability of the Institution (or the consolidated group in which the 
Institution is a member) determined without regard to

[[Page 418]]

FFA or gain or loss on the Taxable Transfer.
    (c) Reporting of uncollected federal income tax. A taxpayer must 
specify on a statement included with its Form 1120 (U.S. Corporate 
Income Tax Return) the amount of federal income tax for the taxable year 
that is potentially not subject to collection under this section. If an 
Institution is a subsidiary member of a consolidated group, the amount 
specified as not subject to collection is zero.
    (d) Assessments of federal income tax to offset refunds. Federal 
income tax that is not collected under this section will be assessed 
and, thus, used to offset any claim for refund made by or on behalf of 
the Institution, the Consolidated Subsidiary, or any other corporation 
with several liability for the federal income tax.
    (e) Collection of federal income taxes from an Acquiring or a New 
Entity--(1) Acquiring. No federal income tax liability (including the 
several liability for federal income taxes under Sec.  1.1502-6) of a 
transferor in a Taxable Transfer will be collected from an Acquiring.
    (2) New Entity. Federal income tax liability (including the several 
liability for federal income taxes under Sec.  1.1502-6) of a transferor 
in a Taxable Transfer will be collected from a New Entity only if stock 
that was outstanding in the Old Entity remains outstanding as stock in 
the New Entity or is reacquired or exchanged for consideration.
    (f) Effect on section 7507. This section supersedes the application 
of section 7507, and the regulations thereunder, for the assessment and 
collection of federal income tax attributable to FFA.

[T.D. 9825, 82 FR 48629, Oct. 19, 2017]



Sec.  1.597-7  Effective/applicability dates.

    (a) FIRREA effective date. Section 597, as amended by section 1401 
of the Financial Institutions Reform, Recovery, and Enforcement Act of 
1989 (Public Law 101-73, 103 Stat 183 (1989)) (FIRREA) is generally 
effective for any FFA received or accrued by an Institution on or after 
May 10, 1989, and for any transaction in connection with which such FFA 
is provided, unless the FFA is provided in connection with an 
acquisition occurring prior to May 10, 1989. See Sec.  1.597-8 for rules 
regarding FFA received or accrued on or after May 10, 1989, that relates 
to an acquisition that occurred before May 10, 1989.
    (b) Applicability date of Sec. Sec.  1.597-1 through 1.597-6. 
Sections 1.597-1 through 1.597-6 apply on or after October 19, 2017, 
except with respect to FFA provided pursuant to a written agreement that 
is binding before October 19, 2017, and that continues to be binding at 
all times after such date, in which case Sec. Sec.  1.597-1 through 
1.597-6 as contained in 26 CFR part 1, revised April 1, 2017, will 
continue to apply unless the taxpayer elects to apply Sec. Sec.  1.597-1 
through 1.597-6 on a retroactive basis pursuant to paragraph (c) of this 
section.
    (c) Elective application to prior years and transactions--(1) In 
general. Except as limited in this paragraph (c), an election is 
available to apply Sec. Sec.  1.597-1 through 1.597-6 to taxable years 
beginning prior to October 19, 2017. A consolidated group may elect to 
apply Sec. Sec.  1.597-1 through 1.597-6 for all members of the group in 
all taxable years to which section 597, as amended by FIRREA, applies. 
The agent for the group, within the meaning of Sec.  1.1502-77, makes 
the election provided by this paragraph (c) for the consolidated group. 
An entity that is not a member of a consolidated group may elect to 
apply Sec. Sec.  1.597-1 through 1.597-6 to all taxable years to which 
section 597, as amended by FIRREA, applies for which it is not a member 
of a consolidated group. The election provided by this paragraph (c) is 
irrevocable.
    (2) Election unavailable if statute of limitations closed. The 
election provided by this paragraph (c) cannot be made if the period for 
assessment and collection of federal income tax has expired under the 
rules of section 6501 for any taxable year in which Sec. Sec.  1.597-1 
through 1.597-6 would affect the determination of the electing entity's 
or group's income, deductions, gain, loss, basis, or other items.
    (3) Manner of making election. An Institution or consolidated group 
makes the election provided by this paragraph (c) by including a written 
statement as a part of the taxpayer's or consolidated group's first 
annual federal income tax return filed on or after October 19, 2017.

[[Page 419]]

The statement must contain the following legend at the top of the page: 
``THIS IS AN ELECTION UNDER Sec.  1.597-7(c),'' and must contain the 
name, address, and taxpayer identification number of the taxpayer or 
agent for the group making the election. The statement must include a 
declaration that ``TAXPAYER AGREES TO EXTEND THE STATUTE OF LIMITATIONS 
ON ASSESSMENT FOR THREE YEARS FROM THE DATE OF THE FILING OF THIS 
ELECTION UNDER Sec.  1.597-7(c), IF THE LIMITATIONS PERIOD WOULD EXPIRE 
EARLIER WITHOUT SUCH EXTENSION, FOR ANY ITEMS AFFECTED IN ANY TAXABLE 
YEAR BY THE FILING OF THIS ELECTION,'' and a declaration that either 
``AMENDED RETURNS WILL BE FILED FOR ALL TAXABLE YEARS AFFECTED BY THE 
FILING OF THIS ELECTION WITHIN 180 DAYS OF MAKING THIS STATEMENT, UNLESS 
SUCH REQUIREMENT IS WAIVED IN WRITING BY THE INTERNAL REVENUE SERVICE'' 
or ``ALL RETURNS PREVIOUSLY FILED ARE CONSISTENT WITH THE PROVISIONS OF 
Sec. Sec.  1.597-1 THROUGH 1.597-6.'' An election with respect to a 
consolidated group must be made by the agent for the group, not an 
Agency, and applies to all members of the group.

[T.D. 9825, 82 FR 48629, Oct. 19, 2017]



Sec.  1.597-8  Transitional rules for Federal financial assistance.

    (a) Scope. This section provides transitional rules for the tax 
consequences of Federal financial assistance received or accrued on or 
after May 10, 1989, if the assistance payment relates to an acquisition 
that occurred before that date.
    (b) Transitional rules. The tax consequences of any payment of 
Federal financial assistance received or accrued on or after May 10, 
1989, are governed by the applicable provisions of section 597 that were 
in effect prior to the Financial Institutions Reform, Recovery, and 
Enforcement Act of 1989 (``FIRREA'') if either--
    (1) The payment--
    (i) Is pursuant to an acquisition of a bank or domestic building and 
loan association before May 10, 1989,
    (ii) Is provided pursuant to an assistance agreement executed before 
May 10, 1989,
    (iii) Is provided to a party to that agreement or to such other 
party as the Commissioner may determine appropriate by letter ruling or 
other written guidance, and
    (iv) Would, if provided before May 10, 1989, have been governed by 
applicable provisions of section 597 that were in effect prior to 
FIRREA; or
    (2) The payment--
    (i) Represents a prepayment of (or a payment in lieu of) a fixed or 
contingent right to Federal financial assistance that would have 
satisfied the conditions of paragraphs (b)(1)(i), (ii) and (iv) of this 
section, and
    (ii) Is provided to a party described in paragraph (b)(1)(iii) of 
this section
    (c) Definition of Federal financial assistance. Federal financial 
assistance for purposes of this section has the meaning prescribed by 
section 597(c) as amended by FIRREA.
    (d) Examples. The following examples illustrate the provisions of 
this section:

    Example 1. X corporation acquired Y, a domestic building and loan 
association on September 10, 1988. Pursuant to a written agreement 
executed at the time of the acquisition, Y received Federal financial 
assistance that included a note bearing a market rate of interest, the 
right to future payments if certain assets were sold at a loss, and the 
right to future payments if the income produced by certain assets was 
less than an agreed upon amount. On December 1, 1991, an agreement was 
executed in which Y relinquished its rights to Federal financial 
assistance under the September 10, 1988 agreement in return for a lump 
sum payment. The lump sum payment represented a prepayment of the 
principal and accrued but unpaid interest for the note, and the rights 
to the contingent future loss and income payments. The entire prepayment 
is excluded from the income of Y because it is a prepayment of Federal 
financial assistance and the assistance (i) would have been provided 
pursuant to an acquisition that occurred before May 10, 1989, would have 
been provided pursuant to an assistance agreement executed before May 
10, 1989, and would, if it had been provided prior to May 10, 1989, have 
been governed by a pre-FIRREA version of section 597; and (ii) the 
prepayment is paid to a party to the assistance agreement.
    Example 2. The facts are the same as those in Example 1, except that 
the note bears an above market rate of interest and part of the

[[Page 420]]

lump sum represents a premium payment for the note. The portion of the 
lump sum allocable to the premium payment is also excluded from the 
income of Y because the payment represents the present value of the 
right to future Federal financial assistance in the form of interest.
    Example 3. The facts are the same as those in Example 1, except that 
a portion of the lump sum payment represents compensation for additional 
expenses Y may incur in the future because of termination of the 
September 10, 1988 agreement. The portion of the lump sum payment 
allocable to the compensation for additional expenses must be included 
in the income of Y because it is not a prepayment of Federal financial 
assistance provided for by a written agreement entered into prior to May 
10, 1989.
    Example 4. The facts are the same as those in Example 1, except that 
instead of a new assistance agreement, the September 10, 1988 assistance 
agreement was modified on December 1, 1991. The modified agreement 
provided new Federal financial assistance in addition to the amounts 
previously agreed to. None of the new Federal financial assistance is 
governed by this regulation because the new assistance was not provided 
for by a written agreement entered into prior to May 10, 1989. The 
modification does not, however, affect the tax treatment of assistance 
provided for by the agreement prior to its modification.

    (e) Effective date. This section is effective April 23, 1992 for 
assistance received or accrued on or after May 10, 1989 in connection 
with acquisitions before that date.

[T.D. 8406, 57 FR 14795, Apr. 23, 1992. Redesignated and amended by T.D. 
8471, 58 FR 18149, Apr. 8, 1993]

                             Bank Affiliates



Sec.  1.601-1  Special deduction for bank affiliates.

    (a) The special deduction described in section 601 is allowed:
    (1) To a holding company affiliate of a bank, as defined in section 
2 of the Banking Act of 1933 (12 U.S.C. 221a), which holding company 
affiliate holds, at the end of the taxable year, a general voting permit 
granted by the Board of Governors of the Federal Reserve System.
    (2) In the amount of the earnings or profits of such holding company 
affiliate which, in compliance with section 5144 of the Revised Statutes 
(12 U.S.C. 61), has been devoted by it during the taxable year to the 
acquisition of readily marketable assets other than bank stock.
    (3) Upon certification by the Board of Governors of the Federal 
Reserve System to the Commissioner that such an amount of the earnings 
or profits has been so devoted by such affiliate during the taxable year


No deduction is allowable under section 601 for the amount of readily 
marketable assets in excess of what is required by section 5144 of the 
Revised Statutes (12 U.S.C. 61) to be acquired by such affiliate, or in 
excess of the taxable income for the taxable year computed without 
regard to the special deductions for corporations provided in part VIII 
(section 241 and following), subchapter B, chapter 1 of the Code. Nor 
may the aggregate of the deductions allowable under section 601 and the 
credits allowable under the corresponding provision of any prior income 
tax law for all taxable years exceed the amount required to be devoted 
under such section 5144 to the acquisition of readily marketable assets 
other than bank stock.
    (b) Every taxpayer claiming a deduction provided for in section 601 
shall attach to its return a supplementary statement setting forth all 
the facts and information upon which the claim is predicated, including 
such facts and information as the Board of Governors of the Federal 
Reserve System may prescribe as necessary to enable it, upon the request 
of the Commissioner subsequent to the filing of the return, to certify 
to the Commissioner the amount of earnings or profits devoted to the 
acquisition of such readily marketable assets. A certified copy of such 
supplementary statement shall be forwarded by the taxpayer to the Board 
of Governors at the time of the filing of the return. The holding 
company affiliate shall also furnish the Board of Governors such further 
information as the Board shall require. For the requirements with 
respect to the amount of such readily marketable assets which must be 
acquired and maintained by a holding company affiliate to which a voting 
permit has been granted, see section 5144(b) and (c) of the Revised 
Statutes (12 U.S.C. 61).

[[Page 421]]

                            Natural Resources



Deductions--Table of Contents





Sec.  1.611-0  Regulatory authority.

    Sections 1.611-1 through 1.614-8, inclusive, are prescribed under 
the authority granted the Secretary or his delegate by section 611(a) of 
the Code to prescribe regulations under which a reasonable allowance for 
depletion and depreciation of improvements shall be allowed, according 
to the peculiar conditions in each case, in the case of mines, oil and 
gas wells, other natural deposits and timber.

[T.D. 6965, 33 FR 10692, July 26, 1968]



Sec.  1.611-1  Allowance of deduction for depletion.

    (a) Depletion of mines, oil and gas wells, other natural deposits, 
and timber--(1) In general. Section 611 provides that there shall be 
allowed as a deduction in computing taxable income in the case of mines, 
oil and gas wells, other natural deposits, and timber, a reasonable 
allowance for depletion. In the case of standing timber, the depletion 
allowance shall be computed solely upon the adjusted basis of the 
property. In the case of other exhaustible natural resources the 
allowance for depletion shall be computed upon either the adjusted 
depletion basis of the property (see section 612, relating to cost 
depletion) or upon a percentage of gross income from the property (see 
section 613, relating to percentage depletion), whichever results in the 
greater allowance for depletion for any taxable year. In no case will 
depletion based upon discovery value be allowed.
    (2) See Sec.  1.611-5 for methods of depreciation relating to 
improvements connected with mineral or timber properties.
    (3) See paragraph (d) of this section for definition of terms.
    (b) Economic interest. (1) Annual depletion deductions are allowed 
only to the owner of an economic interest in mineral deposits or 
standing timber. An economic interest is possessed in every case in 
which the taxpayer has acquired by investment any interest in mineral in 
place or standing timber and secures, by any form of legal relationship, 
income derived from the extraction of the mineral or severance of the 
timber, to which he must look for a return of his capital. For an 
exception in the case of certain mineral production payments, see 
section 636 and the regulations thereunder. A person who has no capital 
investment in the mineral deposit or standing timber does not possess an 
economic interest merely because through a contractual relation he 
possesses a mere economic or pecuniary advantage derived from 
production. For example, an agreement between the owner of an economic 
interest and another entitling the latter to purchase or process the 
product upon production or entitling the latter to compensation for 
extraction or cutting does not convey a depletable economic interest. 
Further, depletion deductions with respect to an economic interest of a 
corporation are allowed to the corporation and not to its shareholders.
    (2) No depletion deduction shall be allowed the owner with respect 
to any timber, coal, or domestic iron ore that such owner has disposed 
of under any form of contract by virtue of which he retains an economic 
interest in such timber, coal, or iron ore, if such disposal is 
considered a sale of timber, coal, or domestic iron ore under section 
631 (b) or (c).
    (c) Special rules--(1) In general. For the purpose of the equitable 
apportionment of depletion among the several owners of economic 
interests in a mineral deposit or standing timber, if the value of any 
mineral or timber must be ascertained as of any specific date for the 
determination of the basis for depletion, the values of such several 
interests therein may be determined separately, but, when determined as 
of the same date, shall together never exceed the value at that date of 
the mineral or timber as a whole.
    (2) Leases. In the case of a lease, the deduction for depletion 
under section 611 shall be equitably apportioned between the lessor and 
lessee. In the case of a lease or other contract providing for the 
sharing of economic interests in a mineral deposit or standing timber, 
such deduction shall be computed by each taxpayer by reference to the 
adjusted basis of his property determined

[[Page 422]]

in accordance with sections 611 and 612, or computed in accordance with 
section 613, if applicable, and the regulations thereunder.
    (3) Life tenant and remainderman. In the case of property held by 
one person for life with remainder to another person, the deduction for 
depletion under section 611 shall be computed as if the life tenant were 
the absolute owner of the property so that he will be entitled to the 
deduction during his life, and thereafter the deduction, if any, shall 
be allowed to the remainderman.
    (4) Mineral or timber property held in trust. If a mineral property 
or timber property is held in trust, the allowable deduction for 
depletion is to be apportioned between the income beneficiaries and the 
trustee on the basis of the trust income from such property allocable to 
each, unless the governing instrument (or local law) requires or permits 
the trustee to maintain a reserve for depletion in any amount. In the 
latter case, the deduction is first allocated to the trustee to the 
extent that income is set aside for a depletion reserve, and any part of 
the deduction in excess of the income set aside for the reserve shall be 
apportioned between the income beneficiaries and the trustee on the 
basis of the trust income (in excess of the income set aside for the 
reserve) allocable to each. For example:
    (i) If under the trust instrument of local law the income of a trust 
computed without regard to depletion is to be distributed to a named 
beneficiary, the beneficiary is entitled to the deduction to the 
exclusion of the trustee.
    (ii) If under the trust instrument or local law the income of a 
trust is to be distributed to a named beneficiary, but the trustee is 
directed to maintain a reserve for depletion in any amount, the 
deduction is allowed to the trustee (except to the extent that income 
set aside for the reserve is less than the allowable deduction). The 
same result would follow if the trustee sets aside income for a 
depletion reserve pursuant to discretionary authority to do so in the 
governing instrument


No effect shall be given to any allocation of the depletion deduction 
which gives any beneficiary or the trustee a share of such deduction 
greater than his pro rata share of the trust income, irrespective of any 
provisions in the trust instrument, except as otherwise provided in this 
paragraph when the trust instrument or local law requires or permits the 
trustee to maintain a reserve for depletion.
    (5) Mineral or timber property held by estate. In the case of a 
mineral property or timber property held by an estate the deduction for 
depletion under section 611 shall be apportioned between the estate and 
the heirs, legatees, and devisees on the basis of income of the estate 
from such property which is allocable to each.
    (d) Definitions. As used in this part, and the regulations 
thereunder, the term:
    (1) Property means--(i) in the case of minerals, each separate 
economic interest owned in each mineral deposit in each separate tract 
or parcel of land or an aggregation or combination of such mineral 
interests permitted under section 614 (b), (c), (d), or (e); and (ii) in 
the case of timber, an economic interest in standing timber in each 
tract or block representing a separate timber account (see paragraph (d) 
of Sec.  1.611-3). For rules with respect to waste or residue of prior 
mining, see paragraph (c) of Sec.  1.614-1. When, in the regulations 
under this part, either the word mineral or timber precedes the word 
property, such adjectives are used only to classify the type of property 
involved. For further explanation of the term property, see section 614 
and the regulations thereunder.
    (2) Fair market value of a property is that amount which would 
induce a willing seller to sell and a willing buyer to purchase.
    (3) Mineral enterprise is the mineral deposit or deposits and 
improvements, if any, used in mining or in the production of oil and 
gas, and only so much of the surface of the land as is necessary for 
purposes of mineral extraction. The value of the mineral enterprise is 
the combined value of its component parts.
    (4) Mineral deposit refers to minerals in place. When a mineral 
enterprise is acquired as a unit, the cost of any interest in the 
mineral deposit or deposits is that proportion of the total cost of the 
mineral enterprise which the value of the interest in the deposit or

[[Page 423]]

deposits bears to the value of the entire enterprise at the time of its 
acquisition.
    (5) Minerals includes ores of the metals, coal, oil, gas, and all 
other natural metallic and nonmetallic deposits, except minerals derived 
from sea water, the air, or from similar inexhaustible sources. It 
includes but is not limited to all of the minerals and other natural 
deposits subject to depletion based upon a percentage of gross income 
from the property under section 613 and the regulations thereunder.

[T.D. 6500, 25 FR 11737, Nov. 26, 1960, as amended by T.D. 6841, 30 FR 
9305, July 27, 1965; T.D. 7261, 38 FR 5467, Mar. 1, 1973]



Sec.  1.611-2  Rules applicable to mines, oil and gas wells, and other
natural deposits.

    (a) Computation of cost depletion of mines, oil and gas wells, and 
other natural deposits. (1) The basis upon which cost depletion is to be 
allowed in respect of any mineral property is the basis provided for in 
section 612 and the regulations thereunder. After the amount of such 
basis applicable to the mineral property has been determined for the 
taxable year, the cost depletion for that year shall be computed by 
dividing such amount by the number of units of mineral remaining as of 
the taxable year (see subparagraph (3) of this paragraph), and by 
multiplying the depletion unit, so determined, by the number of units of 
mineral sold within the taxable year (see subparagraph (2) of this 
paragraph). In the selection of a unit of mineral for depletion, 
preference shall be given to the principal or customary unit or units 
paid for in the products sold, such as tons of ore, barrels of oil, or 
thousands of cubic feet of natural gas.
    (2) As used in this paragraph, the phrase number of units sold 
within the taxable year:
    (i) In the case of a taxpayer reporting income on the cash receipts 
and disbursements method, includes units for which payments were 
received within the taxable year although produced or sold prior to the 
taxable year, and excludes units sold but not paid for in the taxable 
year, and
    (ii) In the case of a taxpayer reporting income on the accrual 
method, shall be determined from the taxpayer's inventories kept in 
physical quantities and in a manner consistent with his method of 
inventory accounting under section 471 or 472


The phrase does not include units with respect to which depletion 
deductions were allowed or allowable prior to the taxable year.
    (3) The number of units of mineral remaining as of the taxable year 
is the number of units of mineral remaining at the end of the year to be 
recovered from the property (including units recovered but not sold) 
plus the number of units sold within the taxable year as defined in this 
section.
    (4) In the case of a natural gas well where the annual production is 
not metered and is not capable of being estimated with reasonable 
accuracy, the taxpayer may compute the cost depletion allowance in 
respect of such property for the taxable year by multiplying the 
adjusted basis of the property by a fraction, the numerator of which is 
equal to the decline in rock pressure during the taxable year and the 
denominator of which is equal to the expected total decline in rock 
pressure from the beginning of the taxable year to the economic limit of 
production. Taxpayers computing depletion by this method must keep 
accurate records of periodical pressure determinations.
    (5) If an aggregation of two or more separate mineral properties is 
made during a taxable year under section 614, cost depletion for each 
such property shall be computed separately for that portion of the 
taxable year ending immediately before the effective date of the 
aggregation. Cost depletion with respect to the aggregated property 
shall be computed for that portion of the taxable year beginning on such 
effective date. The allowance for cost depletion for the taxable year 
shall be the sum of such cost depletion computations. For purposes of 
this paragraph, each such portion of the taxable year shall be 
considered as a taxable year. Similar rules shall be applied where a 
separate mineral property is properly removed from an existing 
aggregation during a taxable year. See section 614 and the regulations 
thereunder for rules relating to the effective

[[Page 424]]

date of an aggregation of mineral interests and for rules relating to 
the adjusted basis of an aggregation.
    (6) The apportionment of the deduction among the several owners of 
economic interests in the mineral deposit or deposits will be made as 
provided in paragraph (c) of Sec.  1.611-1.
    (b) Depletion accounts of mineral property. (1) Every taxpayer 
claiming and making a deduction for depletion of mineral property shall 
keep a separate account in which shall be accurately recorded the cost 
or other basis provided by section 1012, of such property together with 
subsequent allowable capital additions to each account and all the other 
adjustments required by section 1016.
    (2) Mineral property accounts shall thereafter be credited annually 
with the amounts of the depletion so computed in accordance with section 
611 or 613 and the regulations thereunder; or the amounts of the 
depletion computed in shall be credited to depletion reserve accounts. 
No further deductions for cost depletion shall be allowed when the sum 
of the credits for depletion equals the cost or other basis of the 
property, plus allowable capital additions. However, depletion 
deductions may be allowable thereafter computed upon a percentage of 
gross income from the property. See section 613 and the regulations 
thereunder. In no event shall percentage depletion in excess of cost or 
other basis of the property be credited to the improvements account or 
the depreciation reserve account.
    (c) Determination of mineral contents of deposits. (1) If it is 
necessary to estimate or determine with respect to any mineral deposit 
as of any specific date the total recoverable units (tons, pounds, 
ounces, barrels, thousands of cubic feet, or other measure) of mineral 
products reasonably known, or on good evidence believed, to have existed 
in place as of that date, the estimate or determination must be made 
according to the method current in the industry and in the light of the 
most accurate and reliable information obtainable. In the selection of a 
unit of estimate, preference shall be given to the principal unit (or 
units) paid for in the product marketed. The estimate of the recoverable 
units of the mineral products in the deposit for the purposes of 
valuation and depletion shall include as to both quantity and grade:
    (i) The ores and minerals in sight, blocked out, developed, or 
assured, in the usual or conventional meaning of these terms with 
respect to the type of the deposits, and
    (ii) Probable or prospective ores or minerals (in the corresponding 
sense), that is, ores or minerals that are believed to exist on the 
basis of good evidence although not actually known to occur on the basis 
of existing development. Such probable or prospective ores or minerals 
may be estimated:
    (a) As to quantity, only in case they are extensions of known 
deposits or are new bodies or masses whose existence is indicated by 
geological surveys or other evidence to a high degree of probability, 
and
    (b) As to grade, only in accordance with the best indications 
available as to richness.
    (2) If the number of recoverable units of mineral in the deposit has 
been previously estimated for the prior year or years, and if there has 
been no known change in the facts upon which the prior estimate was 
based, the number of recoverable units of mineral in the deposit as of 
the taxable year will be the number remaining from the prior estimate. 
However, for any taxable year for which it is ascertained either by the 
taxpayer or the district director from any source, such as operations or 
development work prior to the close of the taxable year, that the 
remaining recoverable mineral units as of the taxable year are 
materially greater or less than the number remaining from the prior 
estimate, then the estimate of the remaining recoverable units shall be 
revised, and the annual cost depletion allowance with respect to the 
property for the taxable year and for subsequent taxable years will be 
based upon the revised estimate until a change in the facts requires 
another revision. Such revised estimate will not, however, change the 
adjusted basis for depletion.
    (d) Determination of fair market value of mineral properties, and 
improvements, if any. (1) If the fair market value of

[[Page 425]]

the mineral property and improvements at a specified date is to be 
determined for the purpose of ascertaining the basis, such value must be 
determined, subject to approval or revision by the district director, by 
the owner of such property and improvements in the light of the 
conditions and circumstances known at that date, regardless of later 
discoveries or developments or subsequent improvements in methods of 
extraction and treatment of the mineral product. The district director 
will give due weight and consideration to any and all factors and 
evidence having a bearing on the market value, such as cost, actual 
sales and transfers of similar properties and improvements, bona fide 
offers, market value of stock or shares, royalties and rentals, 
valuation for local or State taxation, partnership accountings, records 
of litigation in which the value of the property and improvements was in 
question, the amount at which the property and improvements may have 
been inventoried or appraised in probate or similar proceedings, and 
disinterested appraisals by approved methods.
    (2) If the fair market value must be ascertained as of a certain 
date, analytical appraisal methods of valuation, such as the present 
value method will not be used:
    (i) If the value of a mineral property and improvements, if any, can 
be determined upon the basis of cost or comparative values and 
replacement value of equipment, or
    (ii) If the fair market value can reasonably be determined by any 
other method.
    (e) Determination of the fair market value of mineral property by 
the present value method. (1) To determine the fair market value of a 
mineral property and improvements by the present value method, the 
essential factors must be determined for each mineral deposit. The 
essential factors in determining the fair market value of mineral 
deposits are:
    (i) The total quantity of mineral in terms of the principal or 
customary unit (or units) paid for in the product marketed,
    (ii) The quantity of mineral expected to be recovered during each 
operating period,
    (iii) The average quality or grade of the mineral reserves,
    (iv) The allocation of the total expected profit to the several 
processes or operations necessary for the preparation of the mineral for 
market,
    (v) The probable operating life of the deposit in years,
    (vi) The development cost,
    (vii) The operating cost,
    (viii) The total expected profit,
    (ix) The rate at which this profit will be obtained, and
    (x) The rate of interest commensurate with the risk for the 
particular deposit.
    (2) If the mineral deposit has been sufficiently developed, the 
valuation factors specified in subparagraph (1) of this paragraph may be 
determined from past operating experience. In the application of factors 
derived from past experience, full allowance should be made for probable 
future variations in the rate of exhaustion, quality or grade of the 
mineral, percentage of recovery, cost of development, production, 
interest rate, and selling price of the product marketed during the 
expected operating life of the mineral deposit. Mineral deposits for 
which these factors cannot be determined with reasonable accuracy from 
past operating experience may also be valued by the present value 
method; but the factors must be deduced from concurrent evidence, such 
as the general type of the deposit, the characteristics of the district 
in which it occurs, the habit of the mineral deposits, the intensity of 
mineralization, the oil-gas ratio, the rate at which additional mineral 
has been disclosed by exploitation, the stage of the operating life of 
the deposit, and any other evidence tending to establish a reasonable 
estimate of the required factors.
    (3) Mineral deposits of different grades, locations, and probable 
dates of extraction should be valued separately. The mineral content of 
a deposit shall be determined in accordance with paragraph (c) of this 
section. In estimating the average grade of the developed and 
prospective mineral, account should be

[[Page 426]]

taken of probable increases or decreases as indicated by the operating 
history. The rate of exhaustion of a mineral deposit should be 
determined with due regard to the limitations imposed by plant capacity, 
by the character of the deposit, by the ability to market the mineral 
product, by labor conditions, and by the operating program in force or 
reasonably to be expected for future operations. The operating life of a 
mineral deposit is that number of years necessary for the exhaustion of 
both the developed and prospective mineral content at the rate 
determined as above. The operating life of oil and gas wells is also 
influenced by the natural decline in pressure and flow, and by voluntary 
or enforced curtailment of production. The operating cost includes all 
current expense of producing, preparing, and marketing the mineral 
product sold (due consideration being given to taxes) exclusive of 
allowable capital additions, as described in Sec. Sec.  1.612-2 and 
1.612-4, and deductions for depreciation and depletion, but including 
cost of repairs. This cost of repairs is not to be confused with the 
depreciation deduction by which the cost of improvements is returned to 
the taxpayer free from tax. In general, no estimates of these factors 
will be approved by the district director which are not supported by the 
operating experience of the property or which are derived from different 
and arbitrarily selected periods.
    (4) The value of each mineral deposit is measured by the expected 
gross income (the number of units of mineral recoverable in marketable 
form multiplied by the estimated market price per unit) less the 
estimated operating cost, reduced to a present value as of the date for 
which the valuation is made at the rate of interest commensurate with 
the risk for the operating life, and further reduced by the value at 
that date of the improvements and of the capital additions, if any, 
necessary to realize the profits. The degree of risk is generally lowest 
in cases where the factors of valuation are fully supported by the 
operating record of the mineral enterprise before the date for which the 
valuation is made. On the other hand, higher risks ordinarily attach to 
appraisals upon any other basis.
    (f) Revaluation of mineral property not allowed. No revaluation of a 
mineral property whose value as of any specific date has been determined 
and approved will be made or allowed during the continuance of the 
ownership under which the value was so determined and approved, except 
in the case of misrepresentation or fraud or gross error as to any facts 
known on the date as of which the valuation was made. Revaluation on 
account of misrepresentation or fraud or such gross error will be made 
only with the written approval of the Commissioner.
    (g) Statement to be attached to return when valuation, depletion, or 
depreciation of mineral property or improvements are claimed. (1) For 
the first taxable year ending before December 31, 1967, for which a 
taxpayer asserts a value for any mineral property or improvement as of a 
specific date or claims a deduction for depletion, or depreciation, 
there shall be attached to the return of the taxpayer for such taxable 
year a statement setting forth, in complete, summary form, the pertinent 
information required by this paragraph with respect to each such mineral 
property or improvement (including oil and gas properties or 
improvements). The summary statement shall be deemed a part of the 
income tax return to which it relates. In addition to such summary 
statement, the taxpayer must assemble, segregate and have readily 
available at his principal place of business, all the supporting data 
(listed in subparagraphs (2), (3), and (4) of this paragraph) which is 
used in compiling the summary statement. For taxable years after such 
first taxable year, and ending before December 31, 1967, the taxpayer 
need attach to his return only an explanation of the changes, if any, in 
the information previously furnished. For example, when a taxpayer has 
filed adequate maps with the district director he may be relieved of 
filing further maps of the same area, if all additional information 
necessary for keeping the maps up-to-date is filed each year. In any 
case in which any of the information required by this paragraph has been 
previously filed by the taxpayer

[[Page 427]]

(including information furnished in accordance with corresponding 
provisions of prior regulations), such information need not be filed 
again, but a statement should be attached to the return of the taxpayer 
indicating clearly when and in what form such information was previously 
filed. For provisions relating to the data which shall be submitted with 
returns for taxable years ending on or after December 31, 1967, see 
subparagraph (5) of this paragraph.
    (2) The information referred to in subparagraph (1) of this 
paragraph is as follows:
    (i) An adequate map showing the name, description, location, date of 
surveys, and identification of the deposit or deposits;
    (ii) A description of the character of the taxpayer's property, 
accompanied by a copy of the instrument or instruments by which it was 
acquired;
    (iii) The date of acquisition of the property, the exact terms and 
dates of expiration of all leases involved, and if terminated, the 
reasons therefor;
    (iv) The cost of the mineral property and improvements, stating the 
amount paid to each vendor, with his name and address;
    (v) The date as of which the mineral property and improvements are 
valued, if a valuation is necessary to establish the basis as provided 
by section 1012;
    (vi) The value of the mineral property and improvements on that date 
with a statement of the precise method by which it was determined;
    (vii) An allocation of the cost or value among the mineral property, 
improvements and the surface of the land for purposes other than mineral 
production;
    (viii) The estimated number of units of each kind of mineral at the 
end of the taxable year, and also at the date of acquisition, if 
acquired during the taxable year or at the date as of which any 
valuation is made, together with an explanation of the method used in 
the estimation, the name and address of the person making the estimate, 
and an average analysis which will indicate the quality of the mineral 
valued, including the grade or gravity in the case of oil;
    (ix) The number of units sold and the number of units for which 
payment was received or accrued during the year for which the return is 
made (in the case of newly developed oil and gas deposits it is 
desirable that this information be furnished by months);
    (x) The gross amount received from the sale of mineral;
    (xi) The amount of depreciation for the taxable year and the amount 
of cost depletion for the taxable year;
    (xii) The amounts of depletion and depreciation, if any, stated 
separately, which for each and every prior year:
    (a) Were allowed (see section 1016(a)(2)),
    (b) Were allowable, and
    (c) Would have been allowable without reference to percentage or 
discovery depletion;
    (xiii) The fractions (however measured) of gross production from the 
deposit or deposits to which the taxpayer and other persons are entitled 
together with the names and addresses of such other persons; and
    (xiv) Any other data which will be helpful in determining the 
reasonableness of the valuation asserted or of the deductions claimed.
    (3) In the case of oil and gas properties, the following information 
with respect to each property is required in addition to that 
information set forth in subparagraph (2) of this paragraph:
    (i) The number of acres of producing oil or gas land and, if 
additional acreage is claimed to be proven, the amount of such acreage 
and the reasons for believing it to be proven;
    (ii) The number of wells producing at the beginning and end of the 
taxable year;
    (iii) The date of completion of each well finished during the 
taxable year;
    (iv) The date of abandonment of each well abandoned during the 
taxable year;
    (v) Maps showing the location of the tracts or leases and of the 
producing and abandoned wells, dry holes, and proven oil and gas lands 
(the maps should show depth, initial production, and date of completion 
of each well, etc., to the extent that these data are available);
    (vi) The number of pay sands and average thickness of each pay sand 
or zone;

[[Page 428]]

    (vii) The average depth to the top of each of the different pay 
sands;
    (viii) The annual production of the deposit or of the individual 
wells, if the latter information is available, from the beginning of its 
productivity to the end of the taxable year, the average number of wells 
producing during each year, and the initial daily production of each 
well (the extent to which oil or gas is used for fuel on the premises 
should be stated with reasonable accuracy);
    (ix) All available data regarding change in operating conditions, 
such as unit operation, proration, flooding, use of air-gas lift, 
vacuum, shooting, and similar information, which have a direct effect on 
the production of the deposit; and
    (x) Available geological information having a probable bearing on 
the oil and gas content; information with respect to edge water, water 
drive, bottom hole pressures, oil-gas ratio, porosity of reservoir rock, 
percentage of recovery, expected date of cessation of natural flow, 
decline in estimated potential, and characteristics similar to 
characteristics of other known fields.
    (4) For rules relating to an additional statement to be attached to 
the return when the depletion deduction is computed upon a percentage of 
gross income from the property, see Sec.  1.613-6.
    (5) A taxpayer who claims a total deduction of more than $200 for 
depletion of mines, oil and gas wells, or other natural deposits for the 
taxable year ending on or after December 31, 1967, and before December 
31, 1968, shall submit with his return for such taxable year a filled-
out Form M (Mines and Other Natural Deposits--Depletion Data) or Form O 
(Oil and Gas Depletion Data). See section 6011(a). For the purpose of 
this subparagraph, the determination under section 631(c) of gain or 
loss upon the disposition of coal or domestic iron ore with a retained 
economic interest shall not be regarded as the claiming of a deduction 
for depletion. Such forms shall be filed for any subsequent taxable year 
if the Commissioner determines that the forms are required for such 
year. Where appropriate, both Form M and Form O shall be filed. Forms M 
and O shall be deemed to be part of the return to which they relate. If 
a taxpayer mines more than one mineral, a separate Form M shall be filed 
for each such mineral. If a taxpayer has both domestic and foreign 
properties, separate forms shall be filed for each country in which a 
taxpayer's properties are located. All data relating to a taxpayer's 
domestic oil and gas properties shall be summarized on a single Form O, 
and data relating to a taxpayer's domestic mineral properties (other 
than oil and gas properties) shall be summarized on a single Form M for 
each mineral. Similarly, all data relating to a taxpayer's oil and gas 
properties in a specific foreign country shall be summarized on a single 
Form O, and data relating to a taxpayer's mineral properties (other than 
oil and gas properties) in a specific foreign country shall be 
summarized on a single Form M for each mineral. In addition, the 
taxpayer shall assemble, segregate, and have readily available at his 
principal place of business, the data listed in subparagraphs (2), (3), 
and (4) of this paragraph.

[T.D. 6500, 25 FR 11737, Nov. 26, 1960, as amended by T.D. 6938, 32 FR 
17518, Dec. 7, 1967; T.D. 7170, 37 FR 5373, Mar. 15, 1972]



Sec.  1.611-3  Rules applicable to timber.

    (a) Capital recoverable through depletion allowance in case of 
timber. In general, the capital remaining in any year recoverable 
through depletion allowances is the basis provided by section 612 and 
the regulations thereunder. For the method of determining fair market 
value and quantity of timber, see paragraphs (d), (e), and (f) of this 
section. For capitalization of carrying charges, see section 
1016(a)(1)(A). Amounts paid or incurred in connection with the planting 
of timber (including planting for Christmas tree purposes) shall be 
capitalized and recoverable through depletion allowances. Such amounts 
include, for example, expenditures made for the preparation of the 
timber site for planting or for natural seeding and the cost of 
seedlings. The apportionment of deductions between the several owners of 
economic interests in standing timber will be made as provided in 
paragraph (c) of Sec.  1.611-1.
    (b) Computation of allowance for depletion of timber for taxable 
year. (1) The

[[Page 429]]

depletion of timber takes place at the time timber is cut, but the 
amount of depletion allowable with respect to timber that has been cut 
may be computed when the quantity of cut timber is first accurately 
measured in the process of exploitation. To the extent that depletion is 
allowable in a particular taxable year with respect to timber the 
products of which are not sold during such year, the depletion so 
allowable shall be included as an item of cost in the closing inventory 
of such products for such year.
    (2) The depletion unit of the timber for a given timber account in a 
given year shall be the quotient obtained by dividing (i) the basis 
provided by section 1012 and adjusted as provided by section 1016, of 
the timber on hand at the beginning of the year plus the cost of the 
number of units of timber acquired during the year plus proper additions 
to capital, by (ii) the total number of units of timber on hand in the 
given account at the beginning of the year plus the cost of the number 
of units of timber acquired during the year plus the number of units 
acquired during the year plus (or minus) the number of units required to 
be added (or deducted) by way of correcting the estimate of the number 
of units remaining available in the account. The number of units of 
timber of a given timber account cut during any taxable year multiplied 
by the depletion unit of that timber account applicable to such year 
shall be the amount of depletion allowable for the taxable year. Those 
taxpayers who keep their accounts on a monthly basis may, at their 
option, keep their depletion accounts on such basis, in which case the 
amount allowable on account of depletion for a given month will be 
determined in the manner outlined herein for a given year. The total 
amount of the allowance for depletion in any taxable year shall be the 
sum of the amounts allowable for the several timber accounts. For a 
description of timber accounts, see paragraphs (c) and (d) of this 
section.
    (3) When a taxpayer has elected to treat the cutting of timber as a 
sale or exchange of such timber under the provisions of section 631(a), 
he shall reduce the timber account containing such timber by an amount 
equal to the adjusted depletion basis of such timber. In computing any 
further gain or loss on such timber, see paragraph (e) of Sec.  1.631-1.
    (c) Timber depletion accounts on books. (1) Every taxpayer claiming 
or expecting to claim a deduction for depletion of timber property shall 
keep accurate ledger accounts in which shall be recorded the cost or 
other basis provided by section 1012 of the property and land together 
with subsequent allowable capital additions in each account and all 
other adjustments provided by section 1016 and the regulations 
thereunder.
    (2) In such accounts there shall be set up separately the quantity 
of timber, the quantity of land, and the quantity of other resources, if 
any, and a proper part of the total cost or value shall be allocated to 
each after proper provision for immature timber growth. See paragraph 
(d) of this section. The timber accounts shall be credited each year 
with the amount of the charges to the depletion accounts computed in 
accordance with paragraph (b) of this section or the amount of the 
charges to the depletion accounts shall be credited to depletion reserve 
accounts. When the sum of the credits for depletion equals the cost or 
other basis of the timber property, plus subsequent allowable capital 
additions, no further deduction for depletion will be allowed.
    (d) Aggregating timber and land for purposes of valuation and 
accounting. (1) With a view to logical and reasonable valuation of 
timber, the taxpayer shall include his timber in one or more accounts. 
In general, each such account shall include all of the taxpayer's timber 
which is located in one block. A block may be an operation unit which 
includes all the taxpayer's timber which would logically go to a single 
given point of manufacture. In those cases in which the point of 
manufacture is at a considerable distance, or in which the logs or other 
products will probably be sold in a log or other market, the block may 
be a logging unit which includes all of the taxpayer's timber which 
would logically be removed by a single logging development. Blocks may 
also be established by geographical or political boundaries

[[Page 430]]

or by logical management areas. Timber acquired under cutting contracts 
should be carried in separate accounts and shall not constitute part of 
any block. In exceptional cases, provided there are good and substantial 
reasons, and subject to approval or revision by the district director on 
audit, the taxpayer may divide the timber in a given block into two or 
more accounts. For example, timber owned on February 28, 1913, and that 
purchased subsequently may be kept in separate accounts, or timber owned 
on February 28, 1913, and the timber purchased since that date in 
several distinct transactions may be kept in several distinct accounts. 
Individual tree species or groups of tree species may be carried in 
distinct accounts, or special timber products may be carried in distinct 
accounts. Blocks may be divided into two or more accounts based on the 
character of the timber or its accessibility, or scattered tracts may be 
included in separate accounts. If such a division is made, a proper 
portion of the total value or cost, as the case may be, shall be 
allocated to each account.
    (2) The timber accounts mentioned in subparagraph (1) of this 
paragraph shall not include any part of the value or cost, as the case 
may be, of the land. In a manner similar to that prescribed in 
subparagraph (1) of this paragraph, the land in a given block may be 
carried in a single land account or may be divided into two or more 
accounts on the basis of its character or accessibility. When such a 
division is made, a proper portion of the total value or cost, as the 
case may be, shall be allocated to each account.
    (3) The total value or total cost, as the case may be, of land and 
timber shall be equitably allocated to the timber and land accounts, 
respectively. In cases in which immature timber growth is a factor, a 
reasonable portion of the total value or cost shall be allocated to such 
immature timber, and when the timber becomes merchantable such value or 
cost shall be recoverable through depletion allowances.
    (4) Each of the several land and timber accounts carried on the 
books of the taxpayer shall be definitely described as to their location 
on the ground either by maps or by legal descriptions.
    (5) For good and substantial reasons satisfactory to the district 
director, or as required by the district director on audit, the timber 
or the land accounts may be readjusted by dividing individual accounts, 
by combining two or more accounts, or by dividing and recombining 
accounts.
    (e) Determination of quantity of timber. Each taxpayer claiming or 
expecting to claim a deduction for depletion is required to estimate 
with respect to each separate timber account the total units (feet board 
measure, log scale, cords, or other units) of timber reasonably known, 
or on good evidence believed, to have existed on the ground on March 1, 
1913, or on the date of acquisition of the property, whichever date is 
applicable in determining the basis for cost depletion. This estimate 
shall state as nearly as possible the number of units which would have 
been found present by careful estimate made on the specified date with 
the object of determining 100 percent of the quantity of timber which 
the area covered by the specific account would have produced on that 
date if all of the merchantable timber had been cut and utilized in 
accordance with the standards of utilization prevailing in that region 
at that time. If subsequently during the ownership of the taxpayer 
making the return, as the result of the growth of the timber, of changes 
in standards of utilization, of losses not otherwise accounted for, of 
abandonment of timber, or of operations or development work, it is 
ascertained either by the taxpayer or the district director that there 
remain on the ground, available for utilization, more or less units of 
timber at the close of the taxable year (or at the close of the month if 
the taxpayer keeps his depletion accounts on a monthly basis) than 
remain in the timber account or accounts on the basis of the original 
estimate, then the original estimate (but not the basis for depletion) 
shall be revised. The depletion unit shall be changed when such revision 
has been made. The annual charge to the depletion account with respect 
to the property shall be computed by using such revised unit for the 
taxable year for which the revision is made and

[[Page 431]]

all subsequent taxable years until a change in facts requires another 
revision.
    (f) Determination of fair market value of timber property. (1) If 
the fair market value of the property at a specified date is the basis 
for depletion deductions, such value shall be determined, subject to 
approval or revision by the district director upon audit, by the owner 
of the property in the light of the most reliable and accurate 
information available with reference to the condition of the property as 
it existed at that date, regardless of all subsequent changes, such as 
changes in surrounding circumstances, and methods of exploitation, in 
degree of utilization, etc. Such factors as the following will be given 
due consideration:
    (i) Character and quality of the timber as determined by species, 
age, size, condition, etc.;
    (ii) The quantity of timber per acre, the total quantity under 
consideration, and the location of the timber in question with reference 
to other timber;
    (iii) Accessibility of the timber (location with reference to 
distance from a common carrier, the topography and other features of the 
ground upon which the timber stands and over which it must be 
transported in process of exploitation, the probable cost of 
exploitation and the climate and the state of industrial development of 
the locality); and
    (iv) The freight rates by common carrier to important markets.
    (2) The timber in each particular case will be valued on its own 
merits and not on the basis of general averages for regions; however, 
the value placed upon it, taking into consideration such factors as 
those mentioned in this paragraph, will be coistent with that of other 
similar timber in the region. The district director will give weight and 
consideration to any and all facts and evidence having a bearing on the 
market value, such as cost, actual sales and transfers of similar 
properties, the margin between the cost of production and the price 
realized for timber products, market value of stock or shares, royalties 
and rentals, valuation for local or State taxation, partnership 
accountings, records of litigation in which the value of the property 
has been involved, the amount at which the property may have been 
inventoried or appraised in probate or similar proceedings, 
disinterested appraisals by approved methods, and other factors.
    (g) Revaluation of timber property not allowed. No revaluation of a 
timber property whose value as of any specific date has been determined 
and approved will be made or allowed during the continuance of the 
ownership under which the value was so determined and approved, except 
in the case of misrepresentation or fraud or gross error as to any facts 
known on the date as of which the valuation was made. Revaluation on 
account of misrepresentation or fraud or such gross error will be made 
only with the written approval of the Commissioner. The depletion unit 
shall be revised when such a revaluation of a timber property has been 
made and the annual charge to the depletion account with respect to the 
property shall be computed by using such revised unit for the taxable 
year for which such revision is made and for all subsequent taxable 
years.
    (h) Reporting and recordkeeping requirements--(1) Taxable years 
beginning before January 1, 2002. A taxpayer claiming a deduction for 
depletion of timber for a taxable year beginning before January 1, 2002, 
shall attach to the income tax return of the taxpayer a filled-out Form 
T (Timber) for the taxable year covered by the income tax return, 
including the following information--
    (i) A map where necessary to show clearly timber and land acquired, 
timber cut, and timber and land sold;
    (ii) Description of, cost of, and terms of purchase of timberland or 
timber, or cutting rights, including timber or timber rights acquired 
under any type of contract;
    (iii) Profit or loss from sale of land, or timber, or both;
    (iv) Description of timber with respect to which claim for loss, if 
any, is made;
    (v) Record of timber cut;
    (vi) Changes in each timber account as a result of purchase, sale, 
cutting, reestimate, or loss;
    (vii) Changes in improvements accounts as the result of additions to 
or

[[Page 432]]

deductions from capital and depreciation, and computation of profit or 
loss on sale or other disposition of such improvements;
    (viii) Operation data with respect to raw and finished material 
handled and inventoried;
    (ix) Statement as to application of the election under section 
631(a) and pertinent information in support of the fair market value 
claimed thereunder;
    (x) Information with respect to land ownership and capital 
investment in timberland; and
    (xi) Any other data which will be helpful in determining the 
reasonableness of the depletion or depreciation deductions claimed in 
the return.
    (2) Taxable years beginning after December 31, 2001. A taxpayer 
claiming a deduction for depletion of timber on a return filed for a 
taxable year beginning after December 31, 2001, shall attach to the 
income tax return of the taxpayer a filled-out Form T (Timber) for the 
taxable year covered by the income tax return. In addition, the taxpayer 
must retain records sufficient to substantiate the right of the taxpayer 
to claim the deduction, including a map, where necessary, to show 
clearly timber and land acquired, timber cut, and timber and land sold 
for as long as their contents may become material in the administration 
of any internal revenue law.

[T.D. 6500, 25 FR 11737, Nov. 26, 1960; 25 FR 14021, Dec. 31, 1960, as 
amended by T.D. 8989, 67 FR 20031, Apr. 24, 2002; T.D. 9040, 68 FR 4921, 
Jan. 31, 2003]



Sec.  1.611-4  Depletion as a factor in computing earnings and profits
for dividend purposes.

    For rules with respect to computation of earnings and profits where 
depletion is a factor in the case of corporations, see paragraph (c)(1) 
of Sec.  1.312-6.



Sec.  1.611-5  Depreciation of improvements.

    (a) In general. Section 611 provides in the case of mines, oil and 
gas wells, other natural deposits, and timber that there shall be 
allowed as a deduction a reasonable allowance for depreciation of 
improvements. Such allowance shall include exhaustion, wear and tear, 
and obsolescence. The deduction allowed under section 611 shall be 
determined under the provisions of section 167 and the regulations 
thereunder. For purposes of section 167 the unit of production method 
may, under appropriate circumstances, be considered a reasonable method 
under section 167(a), and therefore, not subject to the limitations 
prescribed by section 167(b).
    (b) Special rules for mines, oil and gas wells, other natural 
deposits and timber. (1) For principles governing the apportioning of 
depreciation allowances under sections 611 and 167 in the case of 
property held by one person for life with remainder to another or in the 
case of property held in trust or by an estate, see Sec.  1.167(h)-1.
    (2) A reasonable allowance for depreciation on account of 
obsolescence or decay shall be required in an appropriate case during 
periods when the improvement is not used in production or is used in 
producing at a rate below its normal capacity. This rule is applicable 
whether or not the taxpayer uses the unit of production method.
    (3) See sections 615 and 616 and the regulations thereunder for 
special rules for treatment of allowances for depreciation of 
improvements with respect to the exploration and development of a mine 
or other natural deposit (other than oil or gas).
    (4) In the case of operating oil or gas properties, the deduction 
for depreciation shall be allowed for those costs of improvements such 
as machinery, tools, equipment, pipes, and other similar items and the 
costs of installation which are not treated as a deductible expense 
under section 263(c). See Sec.  1.612-4.
    (c) Accounting and recordkeeping. See Sec.  1.167(a)-7 for 
accounting and recordkeeping requirements for taxpayers claiming 
deductions under section 611 and this section.

[T.D. 6500, 25 FR 11737, Nov. 26, 1960, as amended by T.D. 6712, 29 FR 
3655, Mar. 24, 1964; T.D. 6836, 30 FR 8902, July 15, 1965]



Sec.  1.612-1  Basis for allowance of cost depletion.

    (a) In general. The basis upon which the deduction for cost 
depletion under section 611 is to be allowed in respect of any mineral 
or timber property is

[[Page 433]]

the adjusted basis provided in section 1011 for the purpose of 
determining gain upon the sale or other disposition of such property 
except as provided in paragraph (b) of this section. The adjusted basis 
of such property is the cost or other basis determined under section 
1012, relating to the basis of property, adjusted as provided in section 
1016, relating to adjustments to basis, and the regulations under such 
sections. In the case of the sale of a part of such property, the 
unrecovered basis thereof shall be allocated to the part sold and the 
part retained.
    (b) Special rules. (1) The basis for cost depletion of mineral or 
timber property does not include:
    (i) Amounts recoverable through depreciation deductions, through 
deferred expenses, and through deductions other than depletion, and
    (ii) The residual value of land and improvements at the end of 
operations


In the case of any mineral property the basis for cost depletion does 
not include amounts representing the cost or value of land for purposes 
other than mineral production. Furthermore, in the case of certain 
mineral properties, such basis does not include exploration or 
development expenditures which are treated under section 615(b) or 
616(b) as deferred expenses to be taken into account as deductions on a 
ratable basis as the units of minerals benefited thereby are produced 
and sold. However, there shall be included in the basis for cost 
depletion of oil and gas property the amounts of capitalized drilling 
and development costs which, as provided in Sec.  1.612-4, are 
recoverable through depletion deductions. In the case of timber 
property, the basis for cost depletion does not include amounts 
representing the cost or value of land.
    (2) Where a taxpayer elects to treat the cutting of timber as a sale 
or exchange of such timber, the basis for cost depletion shall be the 
fair market value of such timber as of the first day of the taxable year 
in which such timber is cut and such value shall be considered for such 
taxable year and all subsequent taxable years as the cost of such timber 
for all purposes for which such cost is a necessary factor. See section 
631(a).
    (c) Cross references. In cases where the valuation, revaluation, or 
mineral content of deposits is a factor, see paragraphs (c), (d), (e), 
and (f) of Sec.  1.611-2. In cases where the valuation, revaluation, or 
quantity of timber is a factor, see paragraphs (e), (f), and (g) of 
Sec.  1.611-3. For definitions of the terms property, fair market value, 
mineral enterprise, mineral deposit, and minerals, see paragraph (d) of 
Sec.  1.611-1. For rules with respect to treatment of depletion accounts 
on taxpayers' books, see paragraph (b) of Sec.  1.611-2 in the case of 
mineral property, and paragraph (c) of Sec.  1.611-3 in the case of 
timber property.



Sec.  1.612-2  Allowable capital additions in case of mines.

    (a) In general. Expenditures for improvements and for replacements, 
not including expenditures for ordinary and necessary maintenance and 
repairs, shall ordinarily be charged to capital account recoverable 
through depreciation deductions. Expenditures for equipment (including 
its installation and housing) and for replacements thereof, which are 
necessary to maintain the normal output solely because of the recession 
of the working faces of the mine and which:
    (1) Do not increase the value of the mine, or
    (2) Do not decrease the cost of production of mineral units, or
    (3) Do not represent an amount expended in restoring property or in 
making good the exhaustion thereof for which an allowance is or has been 
made shall be deducted as ordinary and necessary business expenses.
    (b) Special rule. For special provisions applicable to treatment of 
expenditures for certain exploration and development costs (other than 
for the acquisition, restoration, or betterment of improvements) with 
respect to minerals other than oil or gas, see sections 615 and 616 and 
the regulations thereunder.



Sec.  1.612-3  Depletion; treatment of bonus and advanced royalty.

    (a) Bonus. (1) If a bonus in addition to royalties is received upon 
the grant of an economic interest in a mineral deposit, or standing 
timber, there shall

[[Page 434]]

be allowed to the payee as a cost depletion deduction in respect of the 
bonus an amount equal to that proportion of his basis for depletion as 
provided in section 612 and Sec.  1.612-1 which the amount of the bonus 
bears to the sum of the bonus and the royalties expected to be received. 
Such allowance shall be deducted from the payee's basis for depletion 
and the remainder of the basis is recoverable through depletion 
deductions as the royalties are thereafter received. (But see paragraph 
(e) of this section.) For example, a taxpayer leases mineral property to 
another reserving a one-eighth royalty and in addition receives a bonus 
of $10,000. Assuming that the taxpayer's basis with respect to the 
mineral property is $21,000 and that the royalties expected to be 
received are estimated to total $20,000, the depletion on the bonus 
would be $7,000:

[$21,000 (basis) x $10,000 (bonus)] / $30,000 (bonus plus estimated 
royalties).


The remaining $14,000 of basis will be recovered through depletion as 
the royalties are received.
    (2) If the grant of an economic interest in a mineral deposit or 
standing timber with respect to which a bonus was received expires, 
terminates, or is abandoned before there has been any income derived 
from the extraction of mineral or cutting of timber, the payee shall 
adjust his capital account by restoring thereto the depletion deduction 
taken on the bonus and a corresponding amount must be returned as income 
in the year of such expiration, termination, or abandonment.
    (3) In the case of the payor, payment of the bonus constitutes a 
capital investment made for the acquisition of an economic interest in a 
mineral deposit or standing timber recoverable through the depletion 
allowance. See paragraph (c)(5)(ii) of Sec.  1.613-2 in cases in which 
percentage depletion is used.
    (b) Advanced royalties. (1) If the owner of an operating interest in 
a mineral deposit or standing timber is required to pay royalties on a 
specified number of units of such mineral or timber annually whether or 
not extracted or cut within the year, and may apply any amounts paid on 
account of units not extracted or cut within the year against the 
royalty on the mineral or timber thereafter extracted or cut, the payee 
shall compute cost depletion on the number of units so paid for in 
advance of extraction or cutting and shall treat the amount so 
determined as an allowable deduction for depletion from the gross income 
of the year in which such payment or payments are made. No deduction for 
depletion by such payee shall be claimed or allowed in any subsequent 
year on account of the extraction or cutting in such year of any mineral 
or timber so paid for in advance and for which deduction has once been 
made. (But see paragraph (e) of this section.)
    (2) If the right to extract minerals or to cut timber against which 
the advanced royalties may be applied expires, terminates, or is 
abandoned before all such minerals or timber have been extracted or cut, 
the payee shall adjust his capital account by restoring thereto the 
depletion deductions made in prior years on account of any units of 
mineral or timber paid for in advance but not extracted or cut, and a 
corresponding amount must be returned as income for the year of such 
expiration, termination or abandonment. (But see paragraph (e) of this 
section.)
    (3) The payor shall treat the advanced royalties paid or accrued in 
connection with mineral property as deductions from gross income for the 
year the mineral product, in respect of which the advanced royalties 
were paid or accrued, is sold. For purposes of the preceding sentence, 
in the case of mineral sold before production the mineral product is 
considered to be sold when the mineral is produced (i.e., when a mineral 
product first exists). However, in the case of advanced mineral 
royalties paid or accrued in connection with mineral property as a 
result of a minimum royalty provision, the payor, at his option, may 
instead treat the advanced royalties as deductions from gross income for 
the year in which the advanced royalties are paid or accrued. See 
section 446 (relating to general rule for methods of accounting) and the 
regulations thereunder. For purposes of this paragraph, a minimum 
royalty provision requires that a substantially

[[Page 435]]

uniform amount of royalties be paid at least annually either over the 
life of the lease or for a period of at least 20 years, in the absence 
of mineral production requiring payment of aggregate royalties in a 
greater amount. For purposes of the preceding sentence, in the case of a 
lease which is subject to renewal or extension, the period for which it 
can be renewed or extended shall be treated as part of the term of the 
original lease. For special rules applicable when the payor is a 
sublessor of coal or domestic iron ore, see paragraph (b)(3) of Sec.  
1.631-3. Every taxpayer who pays or accrues advanced royalties resulting 
from a minimum royalty provision must make an election as to the 
treatment of all such advanced royalties in his return for the first 
taxable year ending after December 31, 1939, in which the advanced 
royalties are paid or accrued. The taxpayer's treatment of the advanced 
royalties for the first year shall be deemed to be the exercise of the 
election. Accordingly, a failure to deduct the advanced royalties for 
that year will constitute an election to have all the advanced royalties 
treated as deductions for the year of the sale of the mineral product in 
respect of which the advanced royalties are paid or accrued. See section 
7807(b)(2). For additional rules relating to elections in the case of 
partners and partnerships, see section 703(b) and the regulations 
thereunder. the provisions of this subparagraph do not allow as 
deductions from gross income amounts disallowed as deductions under 
other provisions of the Code, such as section 461 (relating to general 
rule for taxable year of deduction), section 465 (relating to deductions 
limited to amount at risk in case of certain activities), or section 
704(d) (relating to limitation on allowance to partners of partnership 
losses).
    (4) The application of subparagraphs (2) and (3) of this paragraph 
may be illustrated by the following examples:

    Example 1. B leased certain mineral lands from A under a lease in 
which A reserved a royalty of 10 cents a ton on minerals mined and sold 
by B. The lease also provided that B had to pay an annual minimum 
royalty of $10,000 representing the amount due on 100,000 tons of the 
particular mineral whether or not B mined and sold that amount. It was 
further provided that, if B did not mine and sell 100,000 tons in any 
year, he could mine and sell in any subsequent year the amount of 
mineral on which he had paid the royalty without the payment of any 
additional royalty. However, this right of recoupment was limited to 
minerals mined and sold in any later year in excess of the 100,000 tons 
represented by the $10,000 minimum royalty required to be paid for that 
later year. Assume that in 1956 B paid A the minimum royalty of $10,000, 
but mined and sold only 60,000 tons of the mineral and that in 1957 he 
abandoned the lease without any further production. Since the $10,000 
represents royalties on 100,000 tons of mineral and only 60,000 tons 
were mined and sold, A must restore in 1957 to his capital account the 
depletion deductions taken in 1956 on $4,000 on account of the 40,000 
tons paid for in advance but not mined and sold, and must also return 
the corresponding amount as income in 1957.
    Example 2. Assume that B, under the lease in example 1, paid the 
$10,000 minimum royalty and mined no minerals in 1956 but that in 1957 B 
mined and sold 200,000 tons of mineral. If this is B's first such 
expenditure, B has an option, for the purpose of computing taxable 
income under section 63, to deduct in 1956 the $10,000 paid in that year 
although no mineral was mined, or to take the deduction in 1957 when the 
mineral, for which the $10,000 was paid in 1956, was mined and sold. 
(For treatment under percentage depletion, see example in paragraph 
(c)(5)(iii) of Sec.  1.613-2.)

    (c) Delay rental. (1) A delay rental is an amount paid for the 
privilege of deferring development of the property and which could have 
been avoided by abandonment of the lease, or by commencement of 
development operations, or by obtaining production.
    (2) Since a delay rental is in the nature of rent it is ordinary 
income to the payee and not subject to depletion. The payor may at his 
election deduct such amount as an expense, or under section 266 and the 
regulations thereunder, charge it to depletable capital account.
    (d) Percentage depletion deduction with respect to bonus and 
advanced royalty. In lieu of the allowance based on cost depletion 
computed under paragraphs (a) and (b) of this section, the payees 
referred to therein may be allowed a depletion deduction in respect of 
any bonus or advanced royalty for the taxable year in an amount computed 
on the basis of the percentage of gross income from the property as 
provided in

[[Page 436]]

section 613 and the regulations thereunder. However, for special rules 
applicable to certain bonuses and advanced royalties received in 
connection with oil or gas properties, see paragraph (j) of Sec.  
1.613A-3.
    (e) Cross reference. In the case of bonuses and advanced royalties 
received in connection with a contract of disposal of timber covered by 
section 631(b) or coal or iron ore covered by section 631(c), see that 
section and the regulations thereunder.

[T.D. 6500, 25 FR 11737, Nov. 26, 1960, as amended by T.D. 6841, 30 FR 
9305, July 27, 1965; T.D. 7523, 42 FR 63641, Dec. 19, 1977; T.D. 8348, 
56 FR 21938, May 13, 1991]



Sec.  1.612-4  Charges to capital and to expense in case of oil and
gas wells.

    (a) Option with respect to intangible drilling and development 
costs. In accordance with the provisions of section 263(c), intangible 
drilling and development costs incurred by an operator (one who holds a 
working or operating interest in any tract or parcel of land either as a 
fee owner or under a lease or any other form of contract granting 
working or operating rights) in the development of oil and gas 
properties may at his option be chargeable to capital or to expense. 
This option applies to all expenditures made by an operator for wages, 
fuel, repairs, hauling, supplies, etc., incident to and necessary for 
the drilling of wells and the preparation of wells for the production of 
oil or gas. Such expenditures have for convenience been termed 
intangible drilling and development costs. They include the cost to 
operators of any drilling or development work (excluding amounts payable 
only out of production or gross or net proceeds from production, if such 
amounts are depletable income to the recipient, and amounts properly 
allocable to cost of depreciable property) done for them by contractors 
under any form of contract, including turnkey contracts. Examples of 
items to which this option applies are, all amounts paid for labor, 
fuel, repairs, hauling, and supplies, or any of them, which are used:
    (1) In the drilling, shooting, and cleaning of wells,
    (2) In such clearing of ground, draining, road making, surveying, 
and geological works as are necessary in preparation for the drilling of 
wells, and
    (3) In the construction of such derricks, tanks, pipelines, and 
other physical structures as are necessary for the drilling of wells and 
the preparation of wells for the production of oil or gas.


In general, this option applies only to expenditures for those drilling 
and developing items which in themselves do not have a salvage value. 
For the purpose of this option, labor, fuel, repairs, hauling, supplies, 
etc., are not considered as having a salvage value, even though used in 
connection with the installation of physical property which has a 
salvage value. Included in this option are all costs of drilling and 
development undertaken (directly or through a contract) by an operator 
of an oil and gas property whether incurred by him prior or subsequent 
to the formal grant or assignment to him of operating rights (a 
leasehold interest, or other form of operating rights, or working 
interest); except that in any case where any drilling or development 
project is undertaken for the grant or assignment of a fraction of the 
operating rights, only that part of the costs thereof which is 
attributable to such fractional interest is within this option. In the 
excepted cases, costs of the project undertaken, including depreciable 
equipment furnished, to the extent allocable to fractions of the 
operating rights held by others, must be capitalized as the depletable 
capital cost of the fractional interest thus acquired.
    (b) Recovery of optional items, if capitalized. (1) Items returnable 
through depletion: If the taxpayer charges such expenditures as fall 
within the option to capital account, the amounts so capitalized and not 
deducted as a loss are returnable through depletion insofar as they are 
not represented by physical property. For the purposes of this section 
the expenditures for clearing ground, draining, road making, surveying, 
geological work, excavation, grading, and the drilling, shooting, and 
cleaning of wells, are considered not to be represented by physical 
property, and when charged to capital account are returnable through 
depletion.
    (2) Items returnable through depreciation: If the taxpayer charges 
such

[[Page 437]]

expenditures as fall within the option to capital account, the amounts 
so capitalized and not deducted as a loss are returnable through 
depreciation insofar as they are represented by physical property. Such 
expenditures are amounts paid for wages, fuel, repairs, hauling, 
supplies, etc., used in the installation of casing and equipment and in 
the construction on the property of derricks and other physical 
structures.
    (3) In the case of capitalized intangible drilling and development 
costs incurred under a contract, such costs shall be allocated between 
the foregoing classes of items specified in subparagraphs (1) and (2) 
for the purpose of determining the depletion and depreciation 
allowances.
    (4) Option with respect to cost of nonproductive wells: If the 
operator has elected to capitalize intangible drilling and development 
costs, then an additional option is accorded with respect to intangible 
drilling and development costs incurred in drilling a nonproductive 
well. Such costs incurred in drilling a nonproductive well may be 
deducted by the taxpayer as an ordinary loss provided a proper election 
is made in the return for the first taxable year beginning after 
December 31, 1942, in which such a nonproductive well is completed. Such 
election with respect to intangible drilling and development costs of 
nonproductive wells is a new election, and, when made, shall be binding 
for all subsequent years. Any taxpayer who incurs optional drilling and 
development costs in drilling a nonproductive well must make a clear 
statement of election under this option in the return for the first 
taxable year beginning after December 31, 1942, in which such 
nonproductive well is completed. The absence of a clear indication in 
such return of an election to deduct as ordinary losses intangible 
drilling and development costs of nonproductive wells shall be deemed to 
be an election to recover such costs through depletion to the extent 
that they are not represented by physical property, and through 
depreciation to the extent that they are represented by physical 
property.
    (c) Nonoptional items distinguished. (1) Capital items: The option 
with respect to intangible drilling and development costs does not apply 
to expenditures by which the taxpayer acquires tangible property 
ordinarily considered as having a salvage value. Examples of such items 
are the costs of the actual materials in those structures which are 
constructed in the wells and on the property, and the cost of drilling 
tools, pipe, casing, tubing, tanks, engines, boilers, machines, etc. The 
option does not apply to any expenditure for wages, fuel, repairs, 
hauling, supplies, etc., in connection with equipment, facilities, or 
structures, not incident to or necessary for the drilling of wells, such 
as structures for storing or treating oil or gas. These are capital 
items and are returnable through depreciation.
    (2) Expense items: Expenditures which must be charged off as 
expense, regardless of the option provided by this section, are those 
for labor, fuel, repairs, hauling, supplies, etc., in connection with 
the operation of the wells and of other facilities on the property for 
the production of oil or gas.
    (d) Manner of making election. The option granted in paragraph (a) 
of this section to charge intangible drilling and development costs to 
expense may be exercised by claiming intangible drilling and development 
costs as a deduction on the taxpayer's return for the first taxable year 
in which the taxpayer pays or incurs such costs; no formal statement is 
necessary. If the taxpayer fails to deduct such costs as expenses in 
such return, he shall be deemed to have elected to recover such costs 
through depletion to the extent that they are not represented by 
physical property, and through depreciation to the extent that they are 
represented by physical property.
    (e) Effect of option and election. This section does not grant a new 
option under paragraph (a) of this section or new election under 
paragraph (b) of this section. Section 3 of the Act of October 23, 1962 
(Public Law 87-863, 76 Stat. 1142) granted any taxpayer who had 
exercised an option to capitalize intangible drilling and development 
costs under Regulations 111, Sec.  29.23(m)-16 (1939 Code) or 
Regulations 118, Sec.  39.23(m)-16 (1939 Code) a new option for the 
first taxable year ending after October 22, 1962, to deduct such costs 
as

[[Page 438]]

expenses. Unless he has exercised the new option granted by such Act, 
any taxpayer who exercised an option or made an election under the 
regulations described in the preceding sentence is, by such option or 
election, bound with respect to all intangible drilling and development 
costs (whether made before January 1, 1954, or after December 31, 1953) 
in connection with oil and gas properties. See section 7807(b)(2). Any 
taxpayer who has not made intangible drilling and development 
expenditures in any taxable year beginning after December 31, 1942, 
prior to his first taxable year beginning after December 31, 1953, and 
ending after August 16, 1954, must exercise the option granted in 
paragraph (a) of this section in the return for the first taxable year 
in which the taxpayer pays or incurs such expenditures. If such return 
is required by law (including extensions thereof) to be filed before 
November 1, 1965, the option under paragraph (a) of this section, or the 
election under paragraph (b) of this section, may be exercised or 
changed not later than November 1, 1965. The exercise of or change in 
such option or election shall be effective with respect to the earliest 
taxable year to which the option or election is applicable in respect of 
which assessment of a deficiency or credit or refund of an overpayment, 
as the case may be, resulting from such exercise or change is not 
prevented by any law or rule of law on the date such option is exercised 
or such election is made. Any such option or election shall be binding 
upon the taxpayer for the first taxable year for which it is effective 
and for all subsequent taxable years.

[T.D. 6836, 30 FR 8902, July 15, 1965]



Sec.  1.612-5  Charges to capital and to expense in case of geothermal
wells.

    (a) Option with respect to intangible drilling and development 
costs. In accordance with the provisions of section 263(c), intangible 
drilling and development costs incurred by an operator (one who holds a 
working or operating interest in any tract or parcel of land either as a 
fee owner or under a lease or any other form of contract granting 
working or operating rights) in the development of a geothermal deposit 
(as defined in section 613(e)(3) and the regulations thereunder) may at 
the operator's option be chargeable to capital or to expense. This 
option applies to all expenditures made by an operator for wages, fuel, 
repairs, hauling, supplies, etc., incident to and necessary for the 
drilling of wells and the preparation of wells for the production of 
geothermal steam or hot water. Such expenditures have for convenience 
been termed intangible drilling and development costs. They include the 
cost to operators of any drilling or development work (excluding amounts 
payable only out of production or gross or net proceeds from production, 
if such amounts are depletable income to the recipient, and amounts 
properly allocable to cost of depreciable property) done for them by 
contractors under any form of contract, including turnkey contracts. 
Examples of items to which this option applies are all amounts paid for 
labor, fuel, repairs, hauling, and supplies, or any of them, which are 
used:
    (1) In the drilling, shooting, and cleaning of wells,
    (2) In such clearing of ground, draining, road making, surveying, 
and geological work as are necessary in preparation for the drilling of 
wells, and
    (3) In the construction of such derricks, tanks, pipelines, and 
other physical structures as are necessary for the drilling of wells and 
the preparation of wells for the production of geothermal steam or hot 
water.


In general, this option applies only to expenditures for those drilling 
and developing items which in themselves do not have a salvage value. 
For the purpose of this option, labor, fuel, repairs, hauling, supplies, 
etc. are not considered as having a salvage value, even though used in 
connection with the installation of physical property which has a 
salvage value. Included in this option are all costs of drilling and 
development undertaken (directly or through a contract) by an operator 
of a geothermal property whether incurred by the operator prior or 
subsequent to the formal grant or assignment of operating rights (a 
leasehold interest, or other form of operating rights, or working 
interest); except that in any case where any drilling or development 
project is undertaken for the grant or

[[Page 439]]

assignment of a fraction of the operating rights, only that part of the 
costs thereof which is attributable to such fractional interest is 
within this option. In the excepted cases, costs of the project 
undertaken, including depreciable equipment furnished, to the extent 
allocable to fractions of the operating rights held by others, must be 
capitalized as the depletable capital cost of the fractional interest 
thus acquired.
    (b) Recovery of optional items, if capitalized. (1) Items 
recoverable through depletion: If the taxpayer charges such expenditures 
as fall within the option to capital account, the amounts so capitalized 
and not deducted as a loss are recoverable through depletion insofar as 
they are not represented by physical property. For the purposes of this 
section the expenditures for clearing ground, draining, road making, 
surveying, geological work, excavation, grading, and the drilling, 
shooting, and cleaning of wells, are considered not to be represented by 
physical property, and when charged to capital account are recoverable 
through depletion.
    (2) Items recoverable through depreciation: If the taxpayer charges 
such expenditures as fall within the option to capital account, the 
amounts so capitalized and not deducted as a loss are recoverable 
through depreciation insofar as they are represented by physical 
property. Such expenditures are amounts paid for wages, fuel, repairs, 
hauling, supplies, etc. used in the installation of casing and equipment 
and in the construction on the property of derricks and other physical 
structures.
    (3) In the case of capitalized intangible drilling and development 
costs incurred under a contract, such costs shall be allocated between 
the foregoing classes of items specified in paragraphs (b)(1) and (2) of 
this section for the purpose of determining the depletion and 
depreciation allowances.
    (4) Option with respect to cost of nonproductive wells: If the 
operator has elected to capitalize intangible drilling and development 
costs; then an additional option is accorded with respect to intangible 
drilling and development costs incurred in drilling a nonproductive 
well. Such costs incurred in drilling a nonproductive well may be 
deducted by the taxpayer as an ordinary loss provided a proper election 
is made in the taxpayer's original or amended return for the first 
taxable year ending on or after October 1, 1978, in which such a 
nonproductive well is completed. The taxpayer must make a clear 
statement of election under this option in the return or amended return. 
The election may be revoked by the filing of an amended return that does 
not contain such a statement. The absence of a clear indication in such 
return of an election to deduct as ordinary losses intangible drilling 
and development costs of nonproductive wells shall be deemed to be an 
election to recover such costs through depletion to the extent that they 
are not represented by physical property, and through depreciation to 
the exent that they are represented by physical property. Upon the 
expiration of the time for filing a claim for credit or refund of any 
overpayment of tax imposed by chapter 1 of the Code with respect to the 
first taxable year ending on or after October 1, 1978 in which a 
nonproductive well is completed, the taxpayer is bound for all 
subsequent years by his exercise of the option to deduct intangible 
drilling and development costs of nonproductive wells as an ordinary 
loss or his deemed election to recover such costs through depletion or 
depreciation.
    (c) Nonoptional items distinguished--(1) Capital Items: The option 
with respect to intangible drilling and development costs does not apply 
to expenditures by which the taxpayer acquires tangible property 
ordinarily considered as having a salvage value. Examples of such items 
are the costs of the actual materials in those structures which are 
constructed in the wells and on the property, and the cost of drilling 
tools, pipe, casing, tubing, tanks, engines, boilers, machines, etc. The 
option does not apply to any expenditure for wages, fuel, repairs, 
hauling, supplies, etc., in connection with equipment, facilities, or 
structures, not incident to or necessary for the drilling of wells, such 
as structures for treating geothermal steam or hot water. These are 
capital items and are recoverable through depreciation.

[[Page 440]]

    (2) Expense items: Expenditures which must be charged off as 
expense, regardless of the option provided by this section, are those 
for labor, fuel, repairs, hauling, supplies, etc., in connection with 
the operation of the wells and of other facilities on the property for 
the production of geothermal steam or hot water.
    (d) Manner of making election. The option granted in paragraph (a) 
of this section to charge intangible drilling and development costs to 
expense may be exercised by claiming intangible drilling and development 
costs as a deduction on the taxpayer's original or amended return for 
the first taxable year ending on or after October 1, 1978, in which the 
taxpayer pays or incurs such costs with respect to a geothermal well 
commenced on or after that date. No formal statement is necessary. The 
exercise of the option may be revoked by the filing of an amended return 
that does not claim such a deduction. If the taxpayer fails to deduct 
such costs as expenses in any such return, he shall be deemed to have 
elected to recover such costs through depletion to the extent that they 
are not represented by physical property, and through depreciation to 
the extent that they are represented by physical property. Upon the 
expiration of the time for filing a claim for credit or refund of any 
overpayment of tax imposed by chapter 1 of the Code with respect to the 
first taxable year ending on or after October 1, 1978, in which the 
taxpayer pays or incurs intangible drilling and development costs with 
respect to a goethermal well commenced on or after that date, the 
taxpayer is bound by his exercise of the option to charge such costs to 
expense or his deemed election to recover such costs through depletion 
or depreciation for that year and for all subsequent years.
    (e) Effective date. The option granted by paragraph (a) of this 
section is available only for taxable years ending on or after October 
1, 1978, with respect to geothermal wells commenced on or after that 
date.

(Secs. 263, 9805, Internal Revenue Code of 1954 (92 Stat. 3201, 26 
U.S.C. 362; 68A Stat. 917, 26 U.S.C. 7805))

[T.D. 7806, 47 FR 4061, Jan. 28, 1982]



Sec.  1.613-1  Percentage depletion; general rule.

    (a) In general. In the case of a taxpayer computing the deduction 
for depletion under section 611 with respect to minerals on the basis of 
a percentage of gross income from the property, as defined in section 
613(c) and Sec. Sec.  1.613-3 and 1.613-4, the deduction shall be the 
percentage of the gross income as specified in section 613(b) and Sec.  
1.613-2. The deduction shall not exceed 50 percent (100 percent in the 
case of oil and gas properties for taxable years beginning after 
December 31, 1990) of the taxpayer's taxable income from the property 
(computed without regard to the allowance for depletion). The taxable 
income shall be computed in accordance with Sec.  1.613-5. In no case 
shall the deduction for depletion computed under this section be less 
than the deduction computed upon the cost or other basis of the property 
provided in section 612 and the regulations thereunder. The 
apportionment of the deduction between the several owners of economic 
interests in a mineral deposit will be made as provided in paragraph (c) 
of Sec.  1.611-1. For rules with respect to ``gross income from the 
property'' and for definition of the term ``mining,'' see Sec. Sec.  
1.613-3 and 1.613-4. For definitions of the terms ``property,'' 
``mineral deposit,'' and ``minerals,'' see paragraph (d) of Sec.  1.611-
1.
    (b) Denial of percentage depletion in case of oil and gas wells. 
Except as otherwise provided in section 613A and the regulations 
thereunder, in the case of oil or gas which is produced after December 
31, 1974, and to which gross income is attributable after that date, the 
allowance for depletion shall be computed without regard to section 613.

[T.D. 8348, 56 FR 21938, May 13, 1991, as amended by T.D. 8437, 57 FR 
43899, Sept. 23, 1992]



Sec.  1.613-2  Percentage depletion rates.

    (a) In general. Subject to the provisions of paragraph (b) of this 
section and as provided in section 613(b), in the case of mines, wells, 
or other natural deposits, a taxpayer may deduct as an allowance for 
depletion under section 611 the percentages of gross income

[[Page 441]]

from the property as set forth in subparagraphs (1), (2), and (3) of 
this paragraph.
    (1) Without regard to situs of deposits. The following rates are 
applicable to the minerals listed in this subparagraph regardless of the 
situs of the deposits from which the minerals are produced:
    (i) 27\1/2\ percent--Gas wells, oil wells.
    (ii) 23 percent--Sulfur, uranium.
    (iii) 15 percent--Ball clay, bentonite, china clay, metal mines, \1\ 
sagger clay, rock asphalt, vermiculite.
---------------------------------------------------------------------------

    \1\ Not applicable if the rate prescribed in subparagraph (2) of 
this paragraph is applicable.
---------------------------------------------------------------------------

    (iv) 10 percent--Asbestos, \1\ brucite, coal, lignite, perlite, 
sodium chloride, wollastonite.
    (v) 5 percent--Brick and tile clay, gravel, mollusk shells 
(including clam shells and oyster shells), peat, pumice, sand, scoria, 
shale, stone (except dimension or ornamental stone). If from brine 
wells--Bromine, calcium chloride, magnesium chloride.
    (2) Production from United States deposits. A rate of 23 percent is 
applicable to the minerals listed in this subparagraph if \2\ produced 
from deposits within the United States: \3\
---------------------------------------------------------------------------

    \2\ The rate prescribed in this subparagraph does not apply except 
to the extent that alumina and aluminum compounds are extracted 
therefrom.
    \3\ Applicable only for taxable years beginning before January 1, 
1964.

---------------------------------------------------------------------------
Zircon.


Ores of the following metals--

Antimony.
Beryllium. \4\
Bismuth.
Cadmium.3\
Cobalt.te.
Columbium.
Leadndum.
Lithium.r.
Manganese.
Mercury..
Nickel..
Platinum.
latinum group metals.
Tantalum.ystals (radio grade).
Thorium.
Tin.k Steatite talc.
Titanium.
Tungsten.
Vanadium.
Zinc.

    (3) Other minerals. A rate of 15 percent is applicable to the 
minerals listed in this subparagraph regardless of the situs of the 
deposits from which the minerals are produced, provided the minerals are 
not used or sold for use by the mine owner or operator as rip rap, 
ballast, road material, rubble, concrete aggregates, or for similar 
purposes. If, however, such minerals are sold or used for the purposes 
described in the preceding sentence, a rate of 5 percent is applicable 
to any of such minerals unless sold on bid in direct competition with a 
bona fide bid to sell any of the minerals listed in subdivision (iii) of 
subparagraph (1) of this paragraph, in which case the rate is 15 
percent. In addition, the provisions of this subparagraph are not 
applicable with respect to any of the minerals listed herein if the rate 
prescribed in subparagraph (2) of this paragraph is applicable.

Aplite.
Barite.
Bauxite.
Beryl. \5\
Borax.
Calcium carbonates.
Clay, refractory and fire. \6\
Diatomaceous earth.
Dolomite.
Fedlspar.
Flake Graphite.
     
---------------------------------------------------------------------------

    \4\ Applicable only for taxable years beginning after December 31, 
1963.
    \5\ Applicable only for taxable years beginning before January 1, 
1964.
    \6\ Not applicable for taxable years beginning after December 31, 
1960.
---------------------------------------------------------------------------

    (4) For purposes of this section, the term all other minerals does 
not include (i) soil, sod, dirt, turf, water, or mosses; or (ii) 
minerals from sea water, the air, or similar inexhaustible sources. 
However, the term all other minerals is not limited in meaning to the 
minerals listed in section 613(b), but includes all other minerals 
(except those to which a specific percentage rate applies under 
subparagraphs (1), (2), (3), (4), and (5) of section 613(b)): For 
example, gypsum, novaculite, natural mineral pigments, quartz sand and 
quartz pebbles, graphite and kyanite (if section 613(b)(2)(B) does not 
apply), and anorthosite to the extent that alumina and aluminum 
compounds are not extracted therefrom. The 15-percent rate applies to 
such all other minerals when used or sold for use by the mine owner

[[Page 442]]

or operator for purposes other than as rip rap, ballast, road material, 
rubble, concrete aggregates, or for similar purposes. When any such 
minerals are used or sold for use by the mine owner or operator as rip 
rap, ballast, road material, rubble, concrete aggregates, or for similar 
purposes, the 5-percent rate applies except that, when sold for such use 
by the mine owner or operator on a bid in direct competition with a bona 
fide bid to sell a mineral listed in section 613(b)(3), the 15-percent 
rate applies. For example, limestone sold on a bid in direct competition 
with a bona fide bid to sell rock asphalt for road building purposes may 
be entitled to a 15-percent rate. In every case the taxpayer must 
establish to the satisfaction of the district director that there was a 
bona fide bid to sell a mineral listed under section 613(b)(3) by a 
person other than the taxpayer, and that the mineral sold by the 
taxpayer was sold on a bid in direct competition with such bona fide bid 
to sell such other material. \7\
---------------------------------------------------------------------------

    \7\ The 15-percent rate is applicable only to stone used or sold for 
use by the mine owner or operator as dimension stone or ornamental 
stone.

---------------------------------------------------------------------------
All other minerals

    (b) Definition of terms. (1) For purposes of this section, the 
minerals indicated below shall have the following meanings:
    (i) Clay, brick and tile--Clay used or sold for use in the 
manufacture of common brick, drain and roofing tile, sewer pipe, flower 
pots, and kindred products (other than clay specifically identified as a 
clay for which a 15 percent rate of percentage allowance is provided).
    (ii) Clay, refractory and fire--Clay which has a pyrometric cone 
equivalent of 19 or higher.
    (iii) Pumice--All pumice including pumicite.
    (iv) Scoria--Only scoria produced from natural deposits.
    (2) For purposes of this section, the term United States means the 
States and the District of Columbia. See section 7701(a)(9).
    (3) For purposes of this section, the term dimension stone means 
blocks and slabs of natural stone, subsequently cut to definite shapes 
and sizes and used or sold for such uses as building stone (excluding 
rubble), monumental stone, paving blocks, curbing and flagging. For 
purposes of this section, ornamental stone means blocks and slabs of 
natural stone, subsequently cut to definite shapes and sizes and used or 
sold for use for making ornaments or statues.
    (c) Rules for application of paragraph (a) of this section. (1) In 
no case may the allowance for depletion computed upon the basis of a 
percentage of gross income from the property exceed 50 percent of the 
taxpayer's taxable income from the property (computed without allowance 
for depletion). For rules relating to the computation of such taxable 
income, see Sec.  1.613-5.
    (2) In cases in which there are produced from a mineral property two 
or more minerals, each entitled to a different percentage depletion rate 
under section 613(b) and this section or any of which is entitled to 
cost depletion only, the percentage depletion allowance is the sum of 
the results obtained by applying the percentage applicable to each 
mineral (zero, if not entitled to percentage depletion) to the gross 
income from the property attributable to such mineral. The sum so 
computed is subject to the limitation provided in section 613(a) and 
Sec.  1.613-1, that is, 50 percent of the taxpayer's taxable income from 
the property (computed without allowance for depletion). Such taxable 
income (computed in accordance with Sec.  1.613-4) is the total taxable 
income resulting from the sale of all minerals produced from the mineral 
property (as defined in section 614 and the regulations thereunder). The 
provisions of this subparagraph may be illustrated by the following 
examples:

    Example 1. Pyrite, an iron sulfide, may be sold for either its 
sulfur content or its iron

[[Page 443]].
Barnet.
content, or both. Sulfur is entitled to a percentage depletion deduction 
based on 23 percent of gross income from the property whereas the 
percentage depletion deduction for iron is based on 15 percent of such 
gross income. Therefore, in the case of a taxpayer who sells pyrite for 
both its sulfur and iron content, 23 percent of his gross income from 
sulfur plus 15 percent of his gross income from iron would be his 
maximum allowable percentage depletion deduction. However, this maximum 
deduction would be subject to the limitation provided for in section 
613(a), i.e., 50 percent of taxable income from the property (computed 
without allowance for depletion), such taxable income being the overall 
taxable income resulting from the sale of both minerals contained in the 
deposit.
    Example 2. Oil and gas are produced from a single mineral property 
of a taxpayer who operates a retail outlet for the sale of oil products 
within the meaning of section 613A(d)(2). The taxpayer is not entitled 
to percentage depletion on the gross income attributable to the oil, but 
is entitled to percentage depletion on the gross income attributable to 
gas which is regulated gas under section 613A(b)(2)(B). Accordingly, the 
taxpayer's maximum allowable percentage depletion deduction would be 
zero percent of gross income from the property with respect to oil, plus 
22 percent (see section 613A(b)(1)) of gross income from the property 
with respect to gas. This maximum deduction would be subject to the 
limitation provided for in section 613(a), i.e., 50 percent of taxable 
income from the property (computed without allowance for depletion), 
such taxable income being the overall taxable income resulting from the 
sale of both oil and gas. However, in the case of oil or gas production 
which qualifies for percentage depletion under section 613A(c), see the 
special allocation rules contained in section 613A(c)(7) (C) and (E) and 
Sec.  1.613A-4.

    (3) Except as provided in section 613(d) and the regulations 
thereunder relating to special rules for determining rates of depletion 
for taxable years ending after December 31, 1953, to which the Internal 
Revenue Code of 1939 applies:
    (i) The percentage rates set forth in this section are applicable 
only for taxable years beginning after December 31, 1953, and ending 
after August 16, 1954; and
    (ii) The percentage rates set forth in 26 CFR (1939) 39.23(m)-5 
(Regulations 118) are applicable for taxable years beginning before 
January 1, 1954, or ending before August 17, 1954.
    (4) Percentage depletion is not allowable with respect to the income 
from a disposal of coal (including lignite) or domestic iron ore (as 
defined in paragraph (e) of Sec.  1.631-3) with a retained economic 
interest to the extent that such income is treated as from a sale of 
coal or iron ore under section 631(c) and Sec.  1.631-3. Rents or 
royalties paid or incurred by a taxpayer with respect to coal (including 
lignite) or domestic iron ore shall be excluded by such taxpayer in 
determining gross income from the property without regard to the 
treatment under section 631(c) of such rents and royalties in the hands 
of the recipient.
    (5)(i) In all cases there shall be excluded in determining the gross 
income from the property an amount equal to any rents or royalties 
(which are depletable income to the payee) which are paid or incurred by 
the taxpayer in respect of the property and are not otherwise excluded 
from gross income from the property. The following example illustrates 
this rule:

    Example. A leases coal-bearing lands to B on condition that B will 
annually pay a royalty of 25 cents a ton on coal mined and sold by B. 
During the year 1956, B mines and sells f.o.b. mine 100,000 tons of coal 
for $600,000. In computing gross income from the property for the year 
1956, B will exclude $25,000 (100,000 tons x $0.25) in computing his 
allowable percentage depletion deduction. B's allowable percentage 
depletion deduction (without reference to the limitation based on 
taxable income from the property) for the year 1956 will be $57,500 
(($600,000-$25,000) x 10 percent).

    (ii) If bonus payments have been paid in respect of the property in 
any taxable year or any prior taxable years, there shall be excluded in 
determining the gross income from the property, an amount equal to that 
part of such payments which is allocable to the product sold (or 
otherwise giving rise to gross income) for the taxable year. For 
purposes of the preceding sentence, bonus payments include payments by 
the lessee with respect to a production payment which is treated as a 
bonus under section 636(c). Such a production payment is equally 
allocable to all mineral from the mineral property burdened thereby. The 
following examples illustrate the provisions of this subdivision:

    Example 1. In 1956, A leases oil bearing lands to B, receiving 
$200,000 as a bonus and

[[Page 444]]

reserving a royalty of one-eighth of the proceeds of all oil produced 
and sold. It is estimated at the time the lease is entered into that 
there are 1,000,000 barrels of oil recoverable. In 1956, B produces and 
sells 100,000 barrels for $240,000. In computing his gross income from 
the property for the year 1956, B will exclude $30,000 (\1/8\ of 
$240,000), the royalty paid to A, and $20,000 (100,000 bbls. sold/
1,000,000 bbls. estimated to be available x $200,000 bonus), the portion 
of the bonus allocable to the oil produced and sold during the year. 
However, in computing B's taxable income under section 63, the $20,000 
attributable to the bonus payment shall not be either excluded or 
deducted from B's gross income computed under section 61. (See paragraph 
(a)(3) of Sec.  1.612-3.)
    Example 2. In 1971, C leases to D oil bearing lands estimated to 
contain 1,000,000 barrels of oil, reserving a royalty of one-eighth of 
the proceeds of all oil produced and sold and a $500,000 production 
payment payable out of 50 percent of the first oil produced and sold 
attributable to the seven-eighths operating interest. In 1972, D 
produces and sells 100,000 barrels of oil. In computing his gross income 
from the property for the year 1972, D will exclude, in addition to the 
royalty paid to C, $50,000 (100,000 bbls. sold/1,000,000 bbls. estimated 
to be available x $500,000 treated under section 636(c) as a bonus), the 
portion of the production payment allocable to the oil produced and sold 
during the taxable year. However, in computing D's taxable income under 
section 63, the $50,000 attributable to the retained production payment 
shall not be either excluded or deducted from D's gross income computed 
under section 61.

    (iii) If advanced royalties have been paid in respect of the 
property in any taxable year, the amount excluded from gross income from 
the property of the payor for the current taxable year on account of 
such payment, shall be an amount equal to the deduction for such taxable 
year taken on account of such payment pursuant to paragraph (b)(3) of 
Sec.  1.612-3.

    Example. If B in example 2 in paragraph (b)(4) of Sec.  1.612-3, 
elects to deduct in 1956 the $10,000 paid to A in that year, he must 
exclude the same amount from gross income from the property in 1956; 
however, if B elects to defer the deduction until 1957 when he mined and 
sold the mineral, he must exclude the $10,000 from gross income from the 
property in 1957.

[T.D. 6500, 25 FR 11737, Nov. 26, 1960, as amended by T.D. 6841, 30 FR 
9306, July 27, 1965; T.D. 7170, 37 FR 5374, Mar. 15, 1972; T.D. 7261, 38 
FR 5467, Mar. 1, 1973; T.D. 7487, 42 FR 24263, May 13, 1977]



Sec.  1.613-3  Gross income from the property.

    Oil and gas wells. In the case of oil and gas wells, gross income 
from the property, as used in section 613(c)(1), means the amount for 
which the taxpayer sells the oil or gas in the immediate vicinity of the 
well. If the oil or gas is not sold on the premises but is manufactured 
or converted into a refined product prior to sale, or is transported 
from the premises prior to sale, the gross income from the property 
shall be assumed to be equivalent to the representative market or filed 
price of the oil or gas before conversion or transportation.

[T.D. 6500, 25 FR 11737, Nov. 26, 1960, as amended by T.D. 6965, 33 FR 
10692, July 26, 1968; T.D. 8474, 58 FR 25557, Apr. 27, 1993]



Sec.  1.613-4  Gross income from the property in the case of minerals 
other than oil and gas.

    (a) In general. The rules contained in this section are applicable 
to the determination of gross income from the property in the case of 
minerals other than oil and gas and the rules contained in Sec.  1.613-3 
are not applicable to such determination, notwithstanding provisions to 
the contrary in Sec.  1.613-3. The term gross income from the property, 
as used in section 613(c)(1), means, in the case of a mineral property 
other than an oil or gas property, gross income from mining. Gross 
income from mining is that amount of income which is attributable to the 
extraction of the ores or minerals from the ground and the application 
of mining processes, including mining transportation. For the purpose of 
this section, ordinary treatment processes (applicable to the taxable 
years beginning before January 1, 1961) and treatment processes 
considered as mining (applicable to the taxable years beginning after 
December 31, 1960) will be referred to as mining processes. Processes, 
including packaging and transportation, which do not qualify as mining 
will be referred to as nonmining processes. Also for the purpose of this 
section, transportation which qualifies as mining will be referred to as 
mining transportation and transportation which does not qualify as 
mining

[[Page 445]]

will be referred to as nonmining transportation. See paragraph (f) of 
this section for the definition of the term mining and paragraph (g) of 
this section for rules relating to nonmining processes.
    (b) Sales prior to the application of nonmining processes including 
nonmining transportation. (1) Subject to the adjustments required by 
paragraph (e)(1) of this section, gross income from mining means (except 
as provided in subparagraph (2) of this paragraph) the actual amount for 
which the ore or mineral is sold if the taxpayer sells the ore or 
mineral:
    (i) As it emerges from the mine, prior to the application of any 
process other than a mining process or any transportation, or
    (ii) After application of only mining processes, including mining 
transportation, and before any nonmining transportation


If the taxpayer sells his ore or mineral in more than one form, and if 
only mining processes are applied to the ore or mineral, gross income 
from mining is the actual amount for which the various forms of the ore 
or mineral are sold, after any adjustments required by paragraph (e)(1) 
of this section. For example, if, at his mine or quarry, a taxpayer 
sells several sizes of crushed gypsum and also sells gypsum fines 
produced as an incidental byproduct of his crushing operations, without 
applying any nonmining processes, gross income from mining will 
ordinarily be the total amount for which such crushed gypsum and fines 
are actually sold. See paragraphs (f) and (g) of this section for 
provisions defining mining and nonmining processes for various minerals.
    (2) In the case of sales between members of a controlled group 
(including sales as to which the district director exercises his 
authority under section 482 and the regulations thereunder), the prices 
for such sales (which shall be deemed to be the actual amount for which 
the ore or mineral is sold) shall be determined, if possible, by use of 
the representative market or field price method, as described in 
paragraph (c) of this section; otherwise such prices shall be determined 
by the appropriate pricing method as provided in paragraph (d)(1) of 
this section. For the definitions of the terms controlled and group, see 
paragraph (j) (1) and (2) of this section.
    (c) Cases where a representative market or field price for the 
taxpayer's ore or mineral can be ascertained--(1) General rule. If the 
taxpayer processes the ore or mineral before sale by the application of 
nonmining processes (including nonmining transportation), or uses it in 
his operations, gross income from mining shall be computed by use of the 
representative market or field price of an ore or mineral of like kind 
and grade as the taxpayer's ore or mineral after the application of the 
mining processes actually applied (if any), including mining 
transportation (if any), and before any nonmining transportation, 
subject to any adjustments required by paragraph (e)(1) of this section. 
See paragraph (e)(2)(i) of this section for certain other situations in 
which this paragraph shall apply. The objective in computing gross 
income from mining by the representative market or field price method is 
to ascertain, on the basis of an analysis of actual competitive sales by 
the taxpayer or others, the dollar figure or amount which most nearly 
represents the approximate price at which the taxpayer, in light of 
market conditions, could have sold his ores or minerals if, prior to the 
application of nonmining processes, the taxpayer had sold the quantities 
and types of ores and minerals to which he applied nonmining processes. 
If it is possible to determine a market or field price under the 
provisions of this paragraph, and if that price is determined to be 
representative, the taxpayer's gross income from mining shall be 
determined on the basis of that price and not under the provisions of 
paragraph (d) of this section. The taxpayer's own actual sales prices 
for ores or minerals of like kind and grade shall be taken into account 
when establishing market or field prices, provided that those sales are 
determined to be representative.
    (2) Criteria for determining whether an ore or mineral is of like 
kind and grade as the taxpayer's ore or mineral. An ore or mineral will 
be considered to be of like kind and grade as the taxpayer's ore or 
mineral if, in common commercial practice, it is sufficiently similar in 
chemical, mineralogical, or physical

[[Page 446]]

characteristics to the taxpayer's ore or mineral that it is used, or is 
commercially suitable for use, for essentially the same purposes as the 
uses to which the taxpayer's ore or mineral is put. Whether an ore or 
mineral is of like kind and grade as the taxpayer's ore or mineral will 
generally be determined by reference to industrial or commercial 
specifications and by consideration of chemical and physical data 
relating to the minerals and deposits in question. The fact that the 
taxpayer applies slightly different size reduction processes, or the 
fact that the taxpayer uses slightly different benefication processes, 
or the fact that the taxpayer sells his ore or mineral for different 
purposes, will not, in itself, prevent another person's ore or mineral 
from being considered to be of like kind and grade as the taxpayer's ore 
or mineral. On the other hand, the fact that the taxpayer's ore or 
mineral is suitable for the same general commercial use as another 
person's ore or mineral will not cause the two ores or minerals to be 
considered to be of like kind and grade if the desirable natural 
constituents of the two ores or minerals are markedly different 
substances. For example, anthracite coal will not be considered to be of 
like kind as bituminous coal merely because both types of coal can be 
used as fuel. Similarly, bituminous coal which does not possess coking 
qualities will not be considered to be of like grade as bituminous 
coking coal. However, in the case of a taxpayer who mines and uses his 
bituminous coal in the production of coke, all bituminous coals in the 
same marketing area will be considered to be of like kind, and all such 
bituminous coals having the same or similar coking quality suitable for 
commercial use by coke producers will be considered to be of like grade 
as the coal mined and used by the taxpayer


Fine distinctions between various grades of minerals are to be avoided 
unless those distinctions are clearly shown to have genuine commercial 
significance.
    (3) Factors to be considered in determining the representative 
market or field price for the taxpayer's ore or mineral. In determining 
the representative market or field price for the taxpayer's ore or 
mineral, consideration shall be given only to prices of ores or minerals 
of like kind and grade as the taxpayer's ore or mineral and with which, 
under commercially accepted standards, the taxpayer's ore or mineral 
would be considered to be in competition if it were sold under the 
conditions described in paragraph (b)(1) of this section. A weighted 
average of the competitive selling prices of ores or minerals of like 
kind and grade as the taxpayer's, beneficiated only by mining processes, 
if any, in the relevant markets, although not determinative of the 
representative market or field price, is an important factor in the 
determination of that price. The taxpayer's own competitive sales prices 
for minerals which have been subjected only to mining processes shall be 
taken into account in computing such a weighted average. For purposes of 
the preceding sentence, if the district director has exercised his 
authority under section 482 and the regulations thereunder and has 
determined the appropriate price with respect to specific sales 
transactions by the taxpayer, that price shall be deemed to be a 
competitive sales price for those transactions. Sales or purchases, 
including the taxpayer's, of ores or minerals of like kind and grade as 
the taxpayer's, will be taken into consideration in determining the 
representative market or field price for the taxpayer's ore or mineral 
only if those sales or purchases are the result of competitive 
transactions. The identity of the taxpayer's relevant markets (including 
their accessibility to the taxpayer), and the representative market or 
field price within those markets, are necessarily factual determinations 
to be made on the basis of the facts and circumstances of each 
individual case. For the purpose of determining the representative 
market or field price for the taxpayer's ore or mineral, exceptional, 
insignificant, unusual, tie-in, or accommodation sales shall be 
disregarded. Except as provided above, representative market or field 
prices shall not be determined by reference to prices established 
between members of a controlled group. See paragraph (j) of this section 
for the definitions of the terms controlled and group.

[[Page 447]]
Gilsonite.
    (4) Use of prices of mineral of different grade. If there is no 
representative market or field price for a mineral of like kind and 
grade as the taxpayer's, representative market or field prices for an 
ore or mineral which is of like kind but which is not of like grade as 
his ore or mineral may be used, with appropriate adjustments for 
differences in mineral content. Representative market or field prices of 
an ore or mineral of like kind but not of like grade may be used only if 
such adjustments are readily ascertainable. For example, it may be 
appropriate in a particular case to establish the representative market 
or field price for an ore having 50 percent X mineral content by 
reference to the representative market or field price for the same kind 
of ore having 60 percent X mineral content with an appropriate 
adjustment for the differences in the valuable mineral content of the 
two ores, any differences in processing costs attributable to 
impurities, and any other relevant factors.
    (5) Information to be furnished by a taxpayer computing gross income 
from mining by use of a representative market or field price. A taxpayer 
who computes his gross income from mining pursuant to the provisions of 
this paragraph shall attach to his return a summary statement indicating 
the prices used by him in computing gross income from mining under this 
paragraph and the source of his information as to those prices, and the 
relevant supporting data shall be assembled, segregated, and made 
readily available at the taxpayer's principal place of business.
    (6) Limitation on gross income from mining computed under the 
provisions of this paragraph. It shall be presumed that a price is not a 
representative market or field price for the taxpayer's ore or mineral 
if the sum of such price plus the total of all costs of the nonmining 
processes (including nonmining transportation) which the taxpayer 
applies to his ore or mineral regularly exceeds the taxpayer's actual 
sales price of his product. For example, if on a regular basis the total 
of all costs of nonmining processes applied by the taxpayer to coal for 
the purpose of making coke is $12 per ton, and if the taxpayer's actual 
sale price for such coke is $18 per ton, a price of $7 per ton would not 
be a representative market or field price for the taxpayer's coal which 
is used for making coke. In order to rebut the presumption set forth in 
the first sentence of this subparagraph, it must be established that the 
loss on nonmining operations is directly attributable to unusual, 
peculiar and nonrecurring factors rather than to the use of a market or 
field price which is not representative. For example, the first sentence 
of this subparagraph shall not apply if the taxpayer establishes in an 
appropriate case that the loss on nonmining operations is directly 
attributable to an event such as a fire, flood, explosion, earthquake, 
or strike.
    (d) Cases where a representative market or field price cannot be 
ascertained--(1) General rule. (i) If it is impossible to determine a 
representative market or field price as described in paragraph (c) of 
this section then, except as provided in subdivision (ii) of this 
subparagraph, gross income from mining shall be computed by use of the 
proportionate profits method as set forth in subparagraph (4) of this 
paragraph. A method of computing gross income from mining under the 
provisions of this paragraph shall not be deemed to be a method of 
accounting for purposes of paragraph (e) of Sec.  1.446-1.
    (ii)(a) The Office of the Assistant Commissioner (Technical) may 
determine that a method of computation is more appropriate than the 
proportionate profits method or the method being used by the taxpayer. 
The taxpayer may request such a determination (see (d) of this 
subdivision (ii)). If the taxpayer is using a method of computation 
which has been determined by the Office of Assistant Commissioner 
(Technical) to be more appropriate than the proportionate profits 
method, such method shall continue to be used until it is determined by 
the Office of Assistant Commissioner (Technical) that either the 
proportionate profits method or another method is more appropriate.
    (b) The proportionate profits method is more appropriate than the 
method being used under (a) if, under the particular facts and 
circumstances, the

[[Page 448]]

method being used under (a) consistently fails to clearly reflect gross 
income from mining and the proportionate profits method more clearly 
reflects gross income from mining for the taxable year.
    (c) An alternative method (a method other than the method being used 
under (a) (if any) and the proportionate profits method) is more 
appropriate than the method being used under (a) (if any) and the 
proportionate profits method if, under the particular facts and 
circumstances, the latter methods consistently fail to clearly reflect 
gross income from mining, and the alternative method being considered 
more clearly reflects gross income from mining on a consistent basis 
than the method being used under (a) (if any) and the proportionate 
profits method. When determining whether a method of computation clearly 
reflects gross income from mining, it is relevant to compare the gross 
income from mining produced by such method with the gross income from 
mining, on an equivalent amount of production, which results from the 
computation methods used by competitors. When determining the 
acceptability of proposed alternative methods, primary consideration 
will be given to computation methods based upon representative charges 
for ores, minerals, products, or services. See paragraph (c) of this 
section for principles determining the representative character of a 
charge.
    (d) Application for permission to compute gross income from mining 
by use of an alternative method shall be made by submitting a request to 
the Commissioner of Internal Revenue, Attention: Assistant Commissioner 
(Technical), Washington, DC 20224.
    (e) Among the alternative methods of computation to which 
consideration will be given, provided that the requirements of this 
subdivision (ii) are met, are the methods listed in subparagraphs (5), 
(6), and (7) of this paragraph. The order in which these methods are 
listed is not significant, and the listing of these methods does not 
preclude a request to make use of a method which is not listed.
    (iii) Approval and continued use of any method of computation under 
this paragraph depends upon all the facts and circumstances in each 
case, and shall be subject to such terms and conditions as may be 
necessary in the opinion of the Commissioner to reflect clearly the 
gross income from mining. Accordingly, the use of such a method for any 
taxable year shall be subject to review and change.
    (2) Costs to be used in computing gross income from mining by use of 
methods based on the taxpayer's costs. In determining the taxpayer's 
gross income from mining by use of methods based on the taxpayer's 
costs, only costs actually paid or incurred shall be taken into 
consideration. In general, if the taxpayer has consistently employed a 
reasonable method of determining the costs of the various individual 
phases of his mining and nonmining processes (such as extraction, 
loading for shipment, calcining, packaging, etc.), such method shall not 
be disturbed. The amount of any particular item to be taken into account 
shall, for taxable years beginning after November 30, 1968, be the 
amount used in determining the taxpayer's income for tax purposes. For 
example, the depreciation lives, methods, and records used for tax 
purposes, if different from those used for book purposes, shall be the 
basis for determining the amount of depreciation to be used. However, a 
taxpayer may continue to use a reasonable method for determining those 
costs on the basis of the amounts computed for cost control or similar 
financial or accounting books and records if that method has been used 
consistently and is applied to the determination of all those costs.
    (3) Treatment of particular items in computing gross income from the 
mining by use of methods based on the taxpayer's costs. (i) Except as 
specifically provided elsewhere in this section, when determining gross 
income from mining by use of methods based on the taxpayer's costs, the 
costs attributable to mining transportation shall be treated as mining 
costs, and the costs attributable to nonmining transportation shall be 
treated as nonmining costs. Accordingly, except as specifically provided 
elsewhere in this section, all profits attributable to mining 
transportation shall be treated as mining profits, and

[[Page 449]]

all profits attributable to nonmining transportation shall be treated as 
nonmining profits. For this purpose, mining transportation means so much 
of the transportation of ores or minerals (whether or not by common 
carrier) from the point of extraction from the ground to plants or mills 
in which other mining processes are applied thereto as is not in excess 
of 50 miles or, if the taxpayer files an application pursuant to 
paragraph (h) of this section and the Commissioner finds that both the 
physical and other requirements are such that the ores or minerals must 
be transported a greater distance to such plants or mills, the 
transportation over the greater distance. Further, for this purpose, 
nonmining transportation includes the transportation (whether or not by 
common carrier) of ores, minerals, or the products produced therefrom, 
from the point of extraction from the ground to nonmining facilities, or 
from a mining facility to a nonmining facility, or from one nonmining 
facility to another, or from a nonmining facility to the customers who 
purchase the taxpayer's first marketable product or group of products. 
See paragraph (e)(2) of this section for provisions relating to 
purchased transportation to the customer and paragraph (g)(3) of this 
section for provisions relating to transportation the primary purpose of 
which is marketing or distribution. In the absence of other methods 
which clearly reflect the costs of the various phases of transportation, 
the cost attributable to nonmining transportation shall be an amount 
which is in the same ratio to the costs incurred for the total 
transportation as the distance of the nonmining transportation is to the 
distance of the total transportation. As an example, where the plants or 
mills in which mining processes are applied to ores or minerals are in 
excess of 50 miles from the point of extraction from the ground (or in 
excess of a greater distance approved by the Commissioner), the costs 
incurred for transportation to those plants or mills in excess of 50 
miles (or of that greater distance) shall be treated as nonmining costs 
in determining gross income from mining. Accordingly, all profits 
attributable to that excess transportation are treated as nonmining 
profits. However, except in the case of transportation performed in 
conveyances owned or leased by the taxpayer, the preceding sentence 
shall apply only to taxable years beginning after November 30, 1968.
    (ii) In determining gross income from mining by use of methods based 
on the taxpayer's costs, a process shall not be considered as a mining 
process to the extent it is applied to ores, minerals, or other 
materials with respect to which the taxpayer is not entitled to a 
deduction for depletion under section 611. The costs of such 
nondepletable ores, minerals, or materials; the costs of the processes 
(including blending, size reduction, etc.) applied thereto; and the 
transportation costs thereof, if any, shall be considered as nominating 
costs in determining gross income from mining. If a mining process is 
applied to an admixture of depletable and nondepletable material, the 
cost of the process and the cost of transportation, if any, attributable 
to the nondepletable material shall be considered as nonmining costs in 
determining gross income from mining. Accordingly, all profits 
attributable thereto are treated as nonmining profits. In the absence of 
other methods which clearly reflect the cost attributable to the 
processing and transportation, if any, of the nondepletable admixed 
material, that cost shall be deemed to be that proportion of the costs 
which the tonnage of nondepletable material bears to the total tonnage 
of both depletable and nondepletable material.
    (iii) In determining gross income from mining by use of methods 
based on the taxpayer's costs:
    (a) The costs attributable to containers, bags, packages, pallets, 
and similar items as well as the costs of materials and labor 
attributable to bagging, packaging, palletizing, or similar operations 
shall be considered as nonmining costs.
    (b) The costs attributable to the bulk loading of manufactured 
products shall be considered as nonmining costs.
    (c) The costs attributable to the operation of warehouses or 
distribution terminals for manufactured products shall be considered as 
nonmining costs


[[Page 450]]



Accordingly, all profits attributable thereto are treated as nonmining 
profits.
    (iv) In computing gross income from mining by the use of methods 
based on the taxpayer's costs, the principles set forth in paragraph (c) 
of Sec.  1.613-5 shall apply when determining whether selling expenses 
and trade association dues are to be treated, in whole or in part, as 
mining costs or as nonmining costs. To the extent that selling expenses 
and trade association dues are treated as nonmining costs, all profits 
attributable thereto are treated as nonmining profits.
    (v) See paragraph (e)(1) of this section for provisions excluding 
certain allowances from the taxpayer's gross sales and costs of his 
first marketable product or group of products.
    (4) Proportionate profits method. (i) The objective of the 
proportionate profits method of computation is to ascertain gross income 
from mining by applying the principle that each dollar of the total 
costs paid or incurred to produce, sell, and transport the first 
marketable product or group of products (as defined in subdivision (iv) 
of this subparagraph) earns the same percentage of profit. Accordingly, 
in the proportionate profits method no ranking of costs is permissible 
which results in excluding or minimizing the effect of any costs 
incurred to produce, sell, and transport the first marketable product or 
group of products. For purposes of this subparagraph, members of a 
controlled group shall be treated as divisions of a single taxpayer. See 
paragraph (j) of this section for the definitions of the terms 
controlled and group.
    (ii) The proportionate profits method of computation is applied by 
multiplying the taxpayer's gross sales (actual or constructive) of his 
first marketable product or group of products (after making the 
adjustments required by paragraph (e) of this section) by a fraction 
whose numerator is the sum of all the costs allocable to those mining 
processes which are applied to produce, sell, and transport the first 
marketable product or group of products, and whose denominator is the 
total of all the mining and nonmining costs paid or incurred to produce, 
sell, and transport the first marketable product or group of products 
(after making the adjustments required by this paragraph and paragraph 
(e) of this section). The method as described herein is merely a 
restatement of the method formerly set forth in the second sentence of 
Regulations 118, section 39.23(m)-1 (e)(3) (1939 Code). The 
proportionate profits method of computation may be illustrated by the 
following equation:
[GRAPHIC] [TIFF OMITTED] TC08OC91.003

    (iii) Those costs which are paid or incurred by the taxpayer to 
produce, sell, and transport the first marketable product or group of 
products, and which are not directly identifiable with either a 
particular mining process or a particular nonmining process shall, in 
the absence of a specific provision of this section providing an 
apportionment method, be apportioned to mining and to nonmining by use 
of a method which is reasonable under the circumstances. One method 
which may be reasonable in a particular case is an allocation based on 
the proportion that the direct costs of mining processes and the direct 
costs of nonmining processes bear to each other. For example, the salary 
of a corporate officer engaged in overseeing all of the taxpayer's 
processes is an expense which may reasonably be apportioned on the basis 
of the ratio between the direct costs of mining and nonmining processes. 
On the other hand, an expense such as workmen's compensation premiums 
would normally be apportioned on the basis of direct labor costs. For 
the rule relating to selling expenses, see paragraph (c)(4) of Sec.  
1.613-5.

[[Page 451]]

    (iv) As used in this section, the term first marketable product or 
group of products means the product (or group of essentially the same 
products) produced by the taxpayer as a result of the application of 
nonmining processes, in the form or condition in which such product or 
products are first marketed in significant quantities by the taxpayer or 
by others in the taxpayer's marketing area. For this purpose, bulk and 
packaged products are considered to be essentially the same product. 
Sales between members of a controlled group (as defined in paragraph (j) 
of this section) shall not be considered in making a determination under 
this subdivision. The first marketable product or group of products does 
not include any product which results from additional manufacturing or 
other nonmining processes applied to the product or products first 
marketed in significant quantities by the taxpayer or others in the 
taxpayer's marketing area. For example, if a cement manufacturer sells 
his own finished cement in bulk and bags and also sells concrete blocks 
or dry ready-mix aggregates containing additives, the finished cement, 
in bulk and bags, constitutes the first marketable product or group of 
products produced by him. Similarly, if an integrated iron ore and steel 
producer sells both pig iron in various sizes and rolled sheet iron or 
shapes, his first marketable product is the pig iron in its various 
sizes. Further, if an integrated clay and brick producer sells both 
unglazed bricks and tiles of various shapes and sizes and additionally 
manufactured bricks and tiles which are specially glazed, the unglazed 
products, both packaged and unpackaged, constitute his first marketable 
product or group of products.
    (v)(a) As used in this subparagraph, the term gross sales (actual or 
constructive) means the total of the taxpayer's actual competitive sales 
to others of the first marketable product or group of products, plus the 
taxpayer's constructive sales of the first marketable product or group 
of products used or retained for use in his own subsequent operations, 
subject to the adjustments required by paragraph (e) of this section. 
See (b) of this subdivision in the case of actual sales between members 
of controlled groups and in the case of constructive sales. A 
constructive sale occurs when a miner-manufacturer is deemed, for 
percentage depletion purposes, to be selling the first marketable 
product or group of products to himself.
    (b) In the case of sales between members of a controlled group as to 
which the district director has exercised his authority under section 
482 and the regulations thereunder and has determined the appropriate 
price with respect to specific sales transactions, that price shall be 
deemed, for those transactions, to be the actual amount for which the 
first marketable product or group of products is sold for purposes of 
this subdivision (v). In the case of all other sales between members of 
a controlled group, and in the case of constructive sales, the prices 
for such sales shall be determined by use of the principles set forth in 
paragraph (c) of this section, subject to the adjustments required by 
paragraph (e) of this section. In the case of constructive sales, see 
paragraph (c)(4) of this section for rules relating to information to be 
furnished by the taxpayer.
    (vi) The provisions of this subparagraph may be illustrated by the 
following examples:

    Example 1. (a) Facts. A is engaged in the mining of a mineral to 
which section 613 applies and in the application thereto of nonmining 
processes. During 1968, A incurred extraction costs of $35,000; other 
mining costs of $56,000; $150,000 for manufacturing costs; $46,000 for 
other nonmining processes; and $14,000 for the company president's 
salary and similiar costs resulting from both nonmining and mining 
processes. During that year, A produced and sold 70,000 tons of his 
first marketable product for an actual gross sales price of $420,000, 
after the adjustments required by paragraph (e) of this section. A 
representative market or field price for A's mineral before the 
application of nonmining processes cannot be established.
    (b) Computation. (1) The computation of A's gross income from mining 
by use of the proportionate profits method involves two steps. The first 
step is to apportion A's costs to mining and to nonmining. A apportions 
the company president's salary and similiar costs to mining and to 
nonmining in the manner described in the second and third sentences of 
subdivision (iii) of this subparagraph, and apportions his remaining 
costs as follows:

[[Page 452]]



------------------------------------------------------------------------
                  Cost                     Mining   Nonmining    Total
------------------------------------------------------------------------
Extraction.............................    $35,000  .........    $35,000
Other mining processes.................     56,000  .........     56,000
Manufacturing..........................  .........   $150,000    150,000
Other nonmining processes..............  .........     46,000     46,000
                                        --------------------------------
    Subtotal...........................     91,000    196,000    287,000
President's salary and similar costs...      4,439      9,561     14,000
                                        --------------------------------
    Total costs........................     95,439    205,561    301,000
------------------------------------------------------------------------

    (2) The second step is to apply the proportionate profits fraction 
so as to compute A's gross income from mining. To do this, A first 
computes his gross sales of his first marketable group of products, in 
this case $420,000. A multiplies his actual gross sales of $420,000 by 
the proportionate profits fraction, whose numerator consists of his 
total mining costs ($95,439) and whose denominator consists of his total 
costs ($301,000). Thus, A's gross income from mining is $133,170 (i.e., 
95,439/301,000ths of A's actual gross sales of $420,000).
    Example 2. B, who leases a mineral property from C, is engaged in 
the mining of a mineral to which section 613 applies and in the 
application thereto of nonmining processes. Pursuant to the terms of the 
lease, B is required to pay C 10 cents for each ton of mineral which B 
mines. During 1971, B extracted 100,000 tons of mineral. He sold his 
first marketable product for an actual gross sales price of $225,000 
after the adjustments required by paragraph (e) of this section. A 
representative market or field price for B's mineral before the 
application of nonmining processes cannot be established. During 1971, 
with respect to the 100,000 tons of mineral extracted, B incurred mining 
costs of $50,000 and nonmining costs of $100,000, and paid $10,000 to C 
as C's royalty. Since the royalty payment is considered to be C's share 
of the gross income from mining under section 613(a), it is not 
considered to be either a mining cost or a nonmining cost of B. B's 
gross income from mining is $65,000 under the proportionate profits 
method, determined as follows: The $225,000 gross receipts must be 
multiplied by the proportionate profits fraction which is $50,000 mining 
costs over $150,000 total costs ($50,000 + $100,000 nonmining costs). 
Since the resulting $75,000 is the total gross income from mining with 
respect to the property, it must be allocated between B's lease interest 
and C's royalty interest. The $10,000 paid to C must be subtracted from 
the $75,000 leaving $65,000 which represents B's gross income from 
mining. C's gross income from mining is the royalty he received or 
$10,000.

    (5) Representative schedule method. The representative schedule 
method is a pricing formula which uses representative finished product 
prices, penalties, charges and adjustments, established in arms-length 
transactions between unrelated parties, to determine the market or field 
price for a crude mineral product. The representative character of a 
price, penalty, charge, or adjustment shall be determined by applying 
the principles set forth in paragraph (c) of this section. The 
representative schedule method is principally intended for use in those 
industries in which such a schedule-type pricing method is in general 
use to determine the price paid to unintegrated mineral producers for 
their crude mineral product. For example, if unintegrated producers of 
copper concentrate in a particular field or market customarily sell 
their product at prices which are determined in accordance with a 
schedule-type pricing formula, consideration will be given to the 
determination of concentrate prices for integrated copper producers in 
accordance with the same pricing formula. The representative schedule 
method shall not be used if it is impossible to determine one or more of 
the elements in the representative schedule formula by reference to 
prices, penalties, charges, or adjustments established in representative 
transactions between unrelated parties. See paragraph (c) of this 
section for principles determining the representative character of a 
charge.
    (6) Method using prices outside the taxpayer's market. Under the 
other market method the taxpayer uses representative market or field 
prices established outside his markets, provided that conditions there 
are substantially the same as in his markets. For example, it may be 
appropriate in a particular case to establish the representative market 
or field price for pellets containing 60 percent iron which are produced 
and used in market area X by reference to the representative market or 
field price for pellets containing 60 percent iron which are produced 
and sold in adjacent market area Y, provided that conditions in the two 
marketing areas are shown to be substantially the same.
    (7) Rate of return on investment method. [Reserved]

[[Page 453]]

    (e) Reductions of sales price in computing gross income from 
mining--(1) Discounts. If a taxpayer computes gross income from mining 
under the provisions of paragraph (b)(1) of this section, trade 
discounts and, for taxable years beginning after November 30, 1968, cash 
discounts actually allowed by the taxpayer shall be subtracted from the 
sale price of the taxpayer's ore or mineral. If a taxpayer computes 
gross income from mining under the provisions of paragraph (c) of this 
section, any such discounts actually allowed (if not otherwise taken 
into account) by the person or persons making the sales on the basis of 
which the representative market or field price for the taxpayer's ore or 
mineral is to be determined shall be subtracted from the sale price in 
computing such representative market or field price. If a taxpayer 
computes gross income from mining under the provisions of paragraph (d) 
of this section, such discounts actually allowed (if not otherwise taken 
into account) shall be subtracted from the gross sales (actual or 
constructive), and shall not be considered a cost, of the first 
marketable product or group of products. The provisions of this 
subparagraph shall apply to arrangements which have the same effect as 
trade or cash discounts, regardless of the form of the arrangements.
    (2) Purchased transportation to the customer. (i) A taxpayer who 
computes gross income from mining under the provisions of paragraph (c) 
of this section and who sells his ore or mineral after the application 
of only mining processes but after nonmining transportation shall use as 
the representative market or field price his delivered price (if 
otherwise representative) reduced by costs paid or incurred by him for 
purchased transportation to the customer as defined in subdivision (iii) 
of this subparagraph. If the transportation by the taxpayer is not 
purchased transportation to the customer, or if the taxpayer does not 
sell the ore or mineral until after the application of nonmining 
processes, and if other producers in the taxpayer's marketing area sell 
significant quantities of an ore or mineral of like kind and grade after 
the application of only mining processes but after purchased 
transportation to the customer, the representative delivered price at 
which the ore or mineral is sold by those other producers reduced by 
representative costs of purchased transportation to the customer paid or 
incurred by those producers shall be used by the taxpayer as the 
representative market or field price for his ore or mineral in applying 
paragraph (c) of this section. Furthermore, appropriate adjustments 
shall be made to take into account differences in mode of transportation 
and distance. When applying this subdivision, the representative market 
or field price so computed shall not exceed the taxpayer's delivered 
price less his actual costs of transportation to the customer. For 
purposes of this subdivision, any delivered price shall be adjusted as 
provided in subparagraph (1) of this paragraph.
    (ii) If a taxpayer computes gross income from mining under the 
provisions of paragraph (d) of this section, the cost of purchased 
transportation to the customer (as defined in subdivision (iii) of this 
subparagraph) shall be excluded from the gross sales of his first 
marketable product or group of products (after any adjustments required 
by subparagraph (1) of this paragraph), and from the denominator of the 
proportionate profits fraction, so as not to attribute profits to the 
cost of that transportation. Similar transportation cost adjustments may 
be made, if appropriate, in the case of other methods of computation 
which are based on the taxpayer's costs. For the treatment of costs and 
profits attributable to transportation which is not purchased 
transportation to the customer as defined in subdivision (iii) of this 
subparagraph, see paragraph (d)(3)(i) of this section.
    (iii) For purposes of this section, the term purchased 
transportation to the customer means, in general, nonmining 
transportation of the taxpayer's minerals or mineral products to the 
customer:
    (a) Which is not performed in conveyances owned or leased directly 
or indirectly, in whole or in part, by the taxpayer,
    (b) Which is performed solely to deliver the taxpayer's minerals or 
mineral products to the customer, rather than to transport such minerals 
or

[[Page 454]]

products for packaging or other additional processing by the taxpayer 
(other than incidental storage or handling), and
    (c) With respect to which the taxpayer ordinarily does not earn any 
profit


For purposes of the preceding sentence, transportation which is 
performed by a person controlling or controlled by the taxpayer (within 
the meaning of paragraph (j)(1) of this section) shall be deemed to have 
been performed in conveyances owned or leased by the taxpayer unless it 
is established by the taxpayer that the price charged by the controlling 
or controlled person for such transportation constitutes an arm's-length 
charge (under the standard described in paragraph (b)(1) of Sec.  1.482-
1). The term purchased transportation to the customer includes 
transportation to a warehouse, terminal, or distribution facility owned 
or operated by the taxpayer, provided that such transportation is 
performed under the conditions described in the first sentence of this 
subdivision. A taxpayer will not be deemed ordinarily to earn a profit 
on transportation merely because charges for the transportation are 
included in the stated selling price, rather than being separately 
stated or segregated from other billing. A taxpayer will not be deemed 
ordinarily to earn a profit on transportation if the rates for the 
transportation constitute an arm's-length charge ordinarily paid by 
shippers of the same product in similar circumstances. If a taxpayer 
computes gross income from mining under the provisions of paragraph (d) 
of this section, the term purchased transportation to the customer 
refers to transportation which conforms to the other requirements of 
this subdivision and which is performed to transport the taxpayer's 
first marketable product or group of products (as defined in paragraph 
(d)(4)(iv) of this section) rather than to transport minerals or mineral 
products which do not yet constitute the taxpayer's first marketable 
product or group of products.
    (iv) The provisions of this subparagraph may be illustrated by the 
following examples:

    Example 1. A is engaged in the mining of an ore of mineral M and in 
the production and sale of M concentrate. A retains a portion of his 
concentrate for use in his own nonmining operations. During 1968, A sold 
100,000 tons of M concentrate of ore mined and processed by him, which 
sales constituted a significant portion of his total production. Eighty 
thousand tons of that concentrate were sold by A on the basis of a 
representative price (after adjustments required by subparagraph (1) of 
this paragraph) of $30 per ton f.o.b. mine or plant, resulting in gross 
income from mining of $2,400,000. The remaining 20,000 tons were sold by 
A, both directly and through terminals, on the basis of a delivered 
price (after adjustments required by subparagraph (1) of this paragraph) 
at City X of $40 per ton. The delivered price included $15 per ton cost 
of purchased transportation from the mine or plant to customers in City 
X. The representative market or field price of the concentrate sold by A 
on the basis of a delivered price is $25 per ton, determined by 
subtracting the cost of the purchased transportation to the customer 
($15 per ton) from the delivered price for the concentrate ($40 per 
ton). Accordingly, A's gross income from mining with respect to the 
20,000 tons of M concentrate sold on a delivered basis is $500,000. The 
representative market or field price for the concentrate retained by A 
and used in his own nonmining operations may be computed by reference to 
the weighted average price for both A's f.o.b. mine and A's delivered 
sales of concentrate, with the delivered sales prices reduced in the 
manner described above. On this basis, the representative market or 
field price for the retained concentrate is $29 per ton.
    Example 2. B is engaged in the mining of an ore of mineral N and in 
the production of N concentrate. B retained all but an insignificant 
amount of his concentrate for use in his own nonmining operations. Other 
producers in B's marketing area sell significant amounts of N 
concentrate of like kind and grade, both on an f.o.b. mine or plant 
basis and on a delivered basis. In this case, the prices for both the 
f.o.b. and the delivered sales made by other producers (after any 
adjustments required by subparagraph (1) of this paragraph), after 
reduction of the delivered prices by the cost of purchased 
transportation to the customer, shall, if such prices are otherwise 
representative, be taken into account in establishing the representative 
market or field price for the N concentrate produced and used by B.

    (f) Definition of mining--(1) In general. The term mining includes 
only:
    (i) The extraction of ores or minerals from the ground;

[[Page 455]]

    (ii) Mining processes, as described in subparagraphs (2) through (6) 
of this paragraph; and
    (iii) So much of the transportation (whether or not by common 
carrier) of ores or minerals from the point of extraction of the ores or 
minerals from the ground to the plants or mills in which the processes 
referred to in subdivision (ii) of this subparagraph are applied thereto 
as is not in excess of 50 miles, and, if the Commissioner finds that 
both the physical and other requirements are such that the ores or 
minerals must be transported a greater distance to such plants or mills, 
the transportation over such greater distance as the Commissioner 
authorizes. See paragraph (h) of this section for rules relating to the 
filing of applications to treat as mining any transportation in excess 
of 50 miles.
    (2) Definition of mining processes. (i) As used in subparagraph 
(1)(ii) of this paragraph, the term mining processes means, for taxable 
years beginning before January 1, 1961, the ordinary treatment processes 
normally applied by mine owners or operators in order to obtain the 
commercially marketable mineral product or products, including the 
following processes (and the processes necessary or incidental thereto), 
and, for taxable years beginning after December 31, 1960, the following 
processes (and the processes necessary or incidental thereto):
    (a) In the case of coal--cleaning, breaking, sizing, dust allaying, 
treating to prevent freezing, and loading for shipment;
    (b) In the case of sulfur recovered by the Frasch process--cleaning, 
pumping to vats, cooling, breaking, and loading for shipment;
    (c) In the case of iron ore, bauxite, ball and sagger clay, rock 
asphalt, and ores or minerals which are customarily sold in the form of 
a crude mineral product (as defined in subparagraph (3)(iv) of this 
paragraph):
    (1) Where applied for the purpose of bringing to shipping grade and 
form (as defined in subparagraph (3)(iii) of this paragraph)--sorting, 
concentrating, sintering, and substantially equivalent processes, and
    (2) Loading for shipment.
    (d) In the case of lead, zinc, copper, gold, silver, uranium, or 
fluorspar ores, potash, and ores or minerals which are not customarily 
sold in the form of the crude mineral product--crushing, grinding, and 
beneficiation by concentration (gravity, flotation, amalgamation, 
electrostatic, or magnetic), cyanidation, leaching, crystallization, 
precipitation (but not including electrolytic deposition, roasting, 
thermal or electric smelting, or refining), or by substantially 
equivalent processes or combination of processes used in the separation 
or extraction of the product or products from the ore or the mineral or 
minerals from other material from the mine or other natural deposit; and
    (e) In the case of the following ores or minerals:
    (1) The furnacing of quicksilver ores,
    (2) The pulverization of talc,
    (3) The burning of magnesite, and
    (4) The sintering and nodulizing of phosphate rock.
    (ii) The term mining processes also includes the following processes 
(and, except as otherwise provided in this subdivision, the processes 
necessary or incidental thereto):
    (a) For taxable years beginning after December 31, 1960, in the case 
of calcium carbonates and other minerals when used in making cement--all 
processes (other than preheating the kiln feed) applied prior to the 
introduction of the kiln feed into the kiln, but not including any 
subsequent process;
    (b) For taxable years beginning after December 31, 1960, and before 
November 14, 1966, in the case of clay to which former section 
613(b)(5)(B) applied, and for taxable years beginning after November 13, 
1966, in the case of clay to which section 613(b) (5) or (6) (B) 
applies--crushing, grinding, and separating the clay from waste, but not 
including any subsequent process;
    (c) For taxable years beginning after October 9, 1969, in the case 
of minerals (other than sodium chloride) extracted from brines pumped 
from a saline perennial lake (as defined in paragraph (b) of Sec.  
1.613-2)--the extraction of such minerals from the brines, but in no 
case including any further processing or refining of such extracted 
minerals; and

[[Page 456]]

    (d) For taxable years beginning after December 30, 1969, in the case 
of oil shale (as defined in paragraph (b) of Sec.  1.613-2)--extraction 
from the ground, crushing, loading into the retort, and retorting, but 
in no case hydrogenation, refining, or any other process subsequent to 
retorting.
    (iii) A process is necessary to another related process if it is 
prerequisite to the performance of the other process. For example, if 
the concentrating of low-grade iron ores to bring to shipping grade and 
form cannot be effectively accomplished without fine pulverization, such 
pulverization shall be treated as a process which is necessary to the 
concentration process. Accordingly, because concentration is a mining 
process, such pulverization is also a mining process. Furthermore, if 
mining processes cannot be effectively applied to a mineral without 
storage of the mineral while awaiting the application of such processes, 
such storage shall be treated as a process which is necessary to the 
accomplishment of such mining processes. A process is incidental to 
another related process if the cost thereof is insubstantial in relation 
to the cost of the other process, or if the process is merely the 
coincidental result of the application of the other process. For 
example, the sprinkling of coal, prior to loading for shipment, with 
dots of paper to identify the coal for trade-name purposes will be 
considered incidental to the loading where the cost of that sprinkling 
is insubstantial in relation to the cost of the loading process. Also, 
where crushing of a crude mineral is treated as a mining process, the 
production of fines as a byproduct is ordinarily the coincidental result 
of the application of a mining process. If a taxpayer demonstrates that, 
as a factual matter, a particular process is necessary or incidental to 
a process named as a mining process in section 613(c)(4) of this 
paragraph, the necessary or incidental process will also be considered a 
mining process.
    (iv) The term mining does not include purchasing minerals from 
another. Accordingly, the processes listed in this paragraph shall be 
considered as mining processes only to the extent that they are applied 
by a mine owner or operator to an ore or mineral in respect of which he 
is entitled to a deduction for depletion under section 611. The 
application of these processes to purchased ores, minerals, or materials 
does not constitute mining.
    (3) Processes recognized as mining for ores or minerals covered by 
section 613(c)(4)(C). (i) As used in section 613(c)(4)(C) and 
subparagraph (2)(i) (c) of this paragraph, the terms sorting and 
concentrating mean the process of eliminating substantial amounts of the 
impurities or foreign matter associated with the ores or minerals in 
their natural state, or of separating two or more valuable minerals or 
ores, without changing the physical or chemical identity of the ores or 
minerals. Examples of sorting and concentrating processes are hand or 
mechanical sorting, magnetic separation, gravity concentration, jigging, 
the use of shaking or concentrating tables, the use of spiral 
concentrators, the use of sluices or sluice boxes, sink-and-float 
processes, classifiers, hydrotators and flotation processes. Under 
section 613(c)(4)(C), sorting and concentration will be considered 
mining processes only where they are applied to bring an ore or mineral 
to shipping grade and form.
    (ii) As used in section 613(c)(4)(C) and subparagraph (2)(i)(c) of 
this paragraph, the term sintering means the agglomeration of fine 
particles by heating to a temperature at which incipient, but not 
complete, fusion occurs. Sintering will be considered a mining process 
only where it is applied to an ore or mineral, or a concentrate of an 
ore or mineral, as an auxiliary process necessary to bring the ore or 
mineral to shipping form. A thermal action which is applied in the 
manufacture of a finished product will not be considered to be a mining 
process even though such thermal action may cause the agglomeration of 
fine particles by incipient fusion, and even though such action does not 
cause a chemical change in the agglomerated particles. For example, the 
sintering of finely ground iron ore concentrate, prior to shipment from 
the concentration plant, for the purpose of preventing the risk of loss 
of the finely divided particles during shipment is considered a mining 
process. On the other hand, for example, a heating process applied to 
expand or harden

[[Page 457]]

clay, shale, perlite, vermiculite, or other materials in the course of 
the manufacture of lightweight aggregate or other building materials is 
not considered to be a mining process.
    (iii) As used in section 613(c)(4)(C) and this section, to bring to 
shipping grade and form means, with respect to taxable years beginning 
after December 31, 1960, to bring (by the application of mining 
processes at the mine or concentration plant) the quality or size of an 
ore or mineral to the stage or stages at which the ore or mineral is 
shipped to customers or used in nonmining processes (as defined in 
paragraph (g) of this section) by the taxpayer.
    (iv) An ore or mineral is customarily sold in the form of a crude 
mineral product, within the meaning of section 613 (c)(4)(C), if a 
significant portion of the production thereof is sold or used in a 
nonmining process prior to the alteration of its inherent mineral 
content by some form of beneficiation, concentration, or ore dressing. 
An ore or mineral does not lose its classification as a crude mineral 
product by reason of the fact that, before sale or use in a nonmining 
process, the ore or mineral may be crushed or subjected to other 
processes which do not alter its inherent mineral content. Whether the 
portion of production sold or used in the form of a crude mineral 
product is a significant portion of the total production of an ore or 
mineral is a question of fact.
    (4) Type of processes recognized as mining for ores or minerals 
covered by section 613(c)(4)(D). Cyanidation, leaching, crystallization, 
and precipitation, which are listed in section 613(c)(4)(D) as treatment 
processes considered as mining, and the processes (or combination of 
processes) which are substantially equivalent thereto, will be 
recognized as mining only to the extent that they are applied to the 
taxpayer's ore or mineral for the purpose of separation or extraction of 
the valuable mineral product or products from the ore, or for the 
purpose of separation or extraction of the mineral or minerals from 
other material extracted from the mine or other natural deposit. A 
process, no matter how denominated, will not be recognized as mining if 
the process beneficiates the ore or mineral to the degree that such 
process, in effect, constitutes smelting, refining, or any other 
nonmining process within the meaning of paragraph (g) of this section. 
As used in section 613(c)(4)(D) and subparagraph (2)(i) (d) of this 
paragraph, the term concentration has the meaning set forth in the first 
two sentences of subparagraph (3)(i) of this paragraph.
    (5) Processes recognized as mining under section 613(c)(4)(I). Under 
the authority granted the Secretary or his delegate in section 
613(c)(4)(I), the processes which are described in subdivisions (i) 
through (iv) of this subparagraph, and the processes necessary or 
incidental thereto, are recognized as mining processes for taxable years 
beginning after December 31, 1960. The processes described in 
subdivisions (i) through (iv) of this subparagraph are in addition to 
the specific processes recognized as mining under section 613(c)(4). 
Such additional processes are:
    (i) Crushing and grinding, but not fine pulverization (as defined in 
paragraph (g) (6) (v) of this section);
    (ii) Size classification processes applied to the products of an 
allowable mining process;
    (iii) Drying to remove free water, provided that such drying does 
not change the physical or chemical identity or composition of the 
mineral; and
    (iv) Washing or cleaning the surface of mineral particles (including 
the washing of sand and gravel and the treatment of kaolin particles to 
remove surface stains), provided that such washing or cleaning does not 
activate or otherwise change the physical or chemical structure of the 
mineral particles.
    (6) In the case of a process applied subsequent to a nonmining 
process, see paragraph (g)(2) of this section.
    (g) Nonmining processes--(1) General rule. Unless they are otherwise 
provided for in paragraph (f) of this section as mining processes (or 
are necessary or incidental to processes listed therein), the following 
processes are not considered to be mining processes--electrolytic 
deposition, roasting, calcining, thermal or electric smelting, refining, 
polishing, fine pulverization, blending with other materials, treatment 
effecting a chemical change,

[[Page 458]]

thermal action, and molding or shaping. See subparagraph (6) of this 
paragraph for definitions of certain of these terms.
    (2) Processes subsequent to nonmining processes. Notwithstanding any 
other provision of this section, a process applied subsequent to a 
nonmining process (other than nonmining transportation) shall also be 
considered to be a nonmining process. Exceptions to this rule shall be 
made, however, in those instances in which the rule would discriminate 
between similarly situated producers of the same mineral. For example, 
roasting is specifically designated in subparagraph (1) of this 
paragraph as a nonmining process, but in the case of minerals referred 
to in section 613(c)(4)(C) sintering is recognized as a mining process. 
If certain impurities in an ore can only be removed by roasting in order 
to bring it to the same shipping grade and form as a competitive 
sintered ore of the same kind which requires no roasting, the subsequent 
sintering of the roasted ore will be treated as a mining process. In 
that case, however, the roasting of the ore will nonetheless continue to 
be treated as a nonmining process.
    (3) Transportation for the purpose of marketing or distribution; 
storage. Transportation the primary purpose of which is marketing, 
distribution, or delivery for the application of only nonmining 
processes shall not be considered as mining. Nor shall transportation be 
considered as mining merely because, during the course of such 
transportation, some extraneous matter is removed from the ore or 
mineral by the operation of forces of nature, such as evaporation, 
drainage, or gravity flow. Similarly, storage or warehousing of 
manufactured products shall not be considered as mining. The preceding 
sentence shall apply even though, during the course of such storage or 
warehousing, some extraneous matter is removed from the ore or mineral 
by the operation of forces of nature, such as evaporation, drainage, or 
gravity flow.
    (4) Manufacturing, etc. The production, packaging, distribution, and 
marketing of manufactured products, and the processes necessary or 
incidental thereto, are nonmining processes.
    (5) Transformation processes. Processes which effect a substantial 
physical or chemical change in a crude mineral product, or which 
transform a crude mineral product into new or different mineral 
products, or into refined or manufactured products, are nonmining 
processes except to the extent that such processes are allowed as mining 
processes under section 613(c) or under paragraph (f) of this section.
    (6) Definitions. As used in section 613(c)(5) and this section:
    (i) The term calcining refers to processes used to expel the 
volatile portions of a mineral by the application of heat, as, for 
example, the burning of carbonate rock to produce lime, the heating of 
gypsum to produce calcined gypsum or plaster of Paris, or the heating of 
clays to reduce water of crystallization.
    (ii) The term thermal smelting refers to processes which reduce, 
separate, or remove impurities from ores or minerals by the application 
of heat, as, for example, the furnacing of copper concentrates, the 
heating of iron ores, concentrates, or pellets in a blast furnace to 
produce pig iron, or the heating of iron ores or concentrates in a 
direct reduction kiln to produce a feed for direct conversion into 
steel.
    (iii) The term refining refers to processes (other than mining 
processes designated in section 613(c)(4) or this section) used to 
eliminate impurities or foreign matter from smelted or partially 
processed metallic and nonmetallic ores and minerals, as, for example, 
the refining of blister copper. In general, a refining process is 
designed to achieve a high degree of purity by removing relatively small 
amounts of impurities or foreign matter from smelted or partially 
processed ores or minerals.
    (iv) The term polishing refers to processes used to smooth the 
surface of minerals, as, for example, sawing applied to finish rough cut 
blocks of stone, sand finishing, buffing, or otherwise smoothing blocks 
of stone.
    (v) The term fine pulverization refers to any grinding or other size 
reduction process applied to reduce the normal topsize of a mineral 
product to less than .0331 inches, which is the size

[[Page 459]]

opening in a No. 20 Screen (U.S. Standard Sieve Series). A mineral 
product will be considered to have a normal topsize of .0331 inches if 
at least 98 percent of the product will pass through a No. 20 Screen 
(U.S. Standard Sieve Series), provided that at least 5 percent of the 
product is retained on a No. 45 Screen (U.S. Standard Sieve Series). 
Compliance with the normal topsize test may also be demonstrated by 
other tests which are shown to be reasonable in the circumstances. The 
normal topsize test shall be applied to the product of the operation of 
each separate and distinct piece of size reduction equipment utilized 
(such as a roller mill), rather than to the final products for sale. 
Fine pulverization includes the repeated recirculation of material 
through crushing or grinding equipment to accomplish fine pulverization. 
Separating or screening the product of a fine pulverization process 
(including separation by air or water flotation) shall be treated as a 
nonmining process.
    (vi) The term blending with other materials refers to processes used 
to blend different kinds of minerals with one another, as, for example, 
blending iodine with common salt for the purpose of producing iodized 
table salt.
    (vii) The term treatment effecting a chemical change refers to 
processes which transform or modify the chemical composition of a crude 
mineral, as, for example, the coking of coal. The term does not include 
the use of chemicals to clean the surface of mineral particles provided 
that such cleaning does not make any change in the physical or chemical 
structure of the mineral particles.
    (viii) The term thermal action refers to processes which involve the 
application of artificial heat to ores or minerals, such as, for 
example, the burning of bricks, the coking of coal, the expansion or 
popping of perlite, the exfoliation of vermiculite, the heat treatment 
of garnet, and the heating of shale, clay, or slate to produce 
lightweight aggregates. The term does not include drying to remove free 
water.
    (h) Application to treat, as mining, transportation in excess of 50 
miles. If a taxpayer desires to include in the computation of his gross 
income from mining transportation in excess of 50 miles from the point 
of extraction of the minerals from the ground, he shall file an original 
and one copy of an application for the inclusion of such greater 
distance with the Commissioner of Internal Revenue, Washington, DC 
20224. The application must include a statement setting forth in detail 
the facts concerning the physical and other requirements which prevented 
the construction and operation of the plant (in which mining processes, 
as defined in paragraph (f) of this section, are applied) at a place 
nearer to the point of extraction from the ground. These facts must be 
sufficient to apprise the Commissioner of the exact basis of the 
application. If the taxpayer's return is filed prior to receipt of 
notice of the Commissioner's action upon the application, a copy of such 
application shall be attached to the return. If, after an application is 
approved by the Commissioner, there is a material change in any of the 
facts relied upon in such application, a new application must be 
submitted by the taxpayer.
    (i) Extraction from waste or residue. Extraction of ores or minerals 
from the ground means not only the extraction of ores or minerals from a 
deposit, but also the extraction by mine owners or operators of ores or 
minerals from waste or residue of their prior mining. It is immaterial 
whether the waste or residue results from the process of extraction from 
the ground or from application of mining processes as defined in 
paragraph (f) of this section. However, extraction of ores or minerals 
from waste or residue which results from processes which are not 
allowable as mining processes is not treated as mining. Extraction of 
ores or minerals from the ground does not include extraction of ores or 
minerals by the purchaser of waste or residue or the purchaser of the 
rights to extract ores or minerals from waste or residue. The term 
purchaser does not apply to any person who acquires a mineral property, 
including waste or residue, in a tax-free exchange, such as a corporate 
reorganization, from a person who was entitled to a depletion allowance 
upon ores or minerals produced from such waste or residue, or from a 
person who

[[Page 460]]

would have been entitled to such depletion allowance had section 
613(c)(3) been in effect at the time of the transfer. The term purchaser 
also does not apply to a lessee who has renewed a mineral lease if the 
lessee was entitled to a depletion allowance (or would have been so 
entitled had section 613(c)(3) been in effect at the time of the 
renewal) upon ores or minerals produced from waste or residue before 
renewal of the lease. It is not necessary, for purposes of the preceding 
sentence, that the mineral lease contain an option for renewal. The term 
purchaser does include a person who acquires waste or residue in a 
taxable transaction, even though such waste or residue is acquired 
merely as an incidental part of the entire mineral enterprise. For 
special rules with respect to certain corporate acquisitions referred to 
in section 381(a), see section 381(c)(18) and the regulations 
thereunder.
    (j) Definition of controlled group. When used in this section:
    (1) The term controlled includes any kind of control, direct or 
indirect, whether or not legally enforceable, and however exercisable or 
exercised. It is the reality of the control which is decisive, not its 
form or the mode of its exercise. A presumption of control arises if 
income or deductions have been arbitrarily shifted.
    (2) The term group means the organizations, trades, or businesses 
owned or controlled by the same interests.

[T.D. 7170, 37 FR 5374, Mar. 15, 1972]



Sec.  1.613-5  Taxable income from the property.

    (a) General rule. The term taxable income from the property 
(computed without allowance for depletion), as used in section 613 and 
this part, means gross income from the property as defined in section 
613(c) and Sec. Sec.  1.613-3 and 1.613-4, less all allowable deductions 
(excluding any deduction for depletion) which are attributable to mining 
processes, including mining transportation, with respect to which 
depletion is claimed. These deductible items include operating expenses, 
certain selling expenses, administrative and financial overhead, 
depreciation, taxes deductible under section 162 or 164, losses 
sustained, intangible drilling and development costs, exploration and 
development expenditures, etc. See paragraph (c) of this section for 
special rules relating to discounts and to certain of these deductible 
items. Expenditures which may be attributable both to the mineral 
property upon which depletion is claimed and to other activities shall 
be properly apportioned to the mineral property and to such other 
activities. Furthermore, where a taxpayer has more than one mineral 
property, deductions which are not directly attributable to a specific 
mineral property shall be properly apportioned among the several 
properties. In determining the taxpayer's taxable income from the 
property, the amount of any particular item to be taken into account 
shall be determined in accordance with the principles set forth in 
paragraph (d)(2) and (3) of Sec.  1.613-4.
    (b) Special rule; decrease in mining expenses resulting from gain 
recognized under section 1245(a)(1). (1) If during any taxable year 
beginning after December 31, 1962, the taxpayer disposes of an item of 
section 1245 property (as defined in section 1245(a)(3)) which has been 
used in connection with a mineral property, then for the purpose of 
computing the taxable income from such mineral property for such taxable 
year, the allowable deductions taken into account with respect to 
expenses of mining (that is, expenses attributable to a mineral property 
other than an oil and gas property) shall be decreased by an amount 
equal to the portion of any gain recognized under section 1245(a)(1) 
(relating to treatment of gain from dispositions of certain depreciable 
property as ordinary income) which is properly allocable to such mineral 
property in respect of which the taxable income is being computed. The 
portion of such gain which is properly allocable to such mineral 
property shall bear the same ratio to the total of such gain as:
    (i) The portion of the adjustments reflected in the adjusted basis 
(as such term is defined in paragraph (a)(2) of Sec.  1.1245-2, relating 
to definition of recomputed basis) of such section 1245 property, which 
were allowable as deductions from the gross income from the property (as 
defined in section 613 (c) and Sec.  1.613-3) in computing the taxable

[[Page 461]]

income from such mineral property, bears to
    (ii) The total of the adjustments reflected in the adjusted basis of 
such section 1245 property.
    (2) For the purposes of this paragraph, the adjustments reflected in 
the adjusted basis of the section 1245 property disposed of shall be 
deemed to have been taken into account in computing the taxable income 
from the mineral property for any taxable year notwithstanding that for 
the taxable year the allowance for depletion was determined without 
reference to percentage depletion under section 613.
    (3) If the amount of gain described in subparagraph (1) of this 
paragraph allocable to a mineral property for a taxable year exceeds the 
allowable deductions otherwise taken into account in computing the 
taxable income from the mineral property for the taxable year, the 
excess may not be taken into account in computing the taxable income 
from the mineral property for any other taxable year.
    (4) To the extent that the adjustments reflected in the adjusted 
basis of the section 1245 property are allocable to mineral property 
which the taxpayer no longer owns in the taxable year in which he 
disposes of the section 1245 property, the gain recognized under section 
1245(a)(1) does not result in any tax benefit to the taxpayer under this 
paragraph since he has no taxable income from the mineral property for 
such year. However, if a taxpayer has, in the taxable year in which he 
disposes of an item of section 1245 property, only a portion of the 
original mineral property to which gain described in subparagraph (1) of 
this paragraph with respect to the section 1245 property is properly 
allocable, the entire amount of that gain shall nevertheless be taken 
into account in computing the taxable income of the remaining portion of 
the mineral property. Furthermore, the fact that a mineral property to 
which section 1245 gain is properly allocable is (in the taxable year in 
which the taxpayer disposes of an item of section 1245 property) no 
longer in existence merely because the mineral property has been made a 
part of an aggregation or has been deaggregated will not result in the 
loss of tax benefits under this section. Accordingly,
    (i) If a taxpayer has made an aggregation of mineral properties (see 
section 614 and the regulations thereunder), the amount of any gain 
described in subparagraph (1) of this paragraph which is properly 
allocable to the aggregation shall include the portion of any gain which 
would be properly allocable to the mineral properties which existed 
separately prior to the aggregation and of which the aggregation is or 
was composed, if the prior mineral properties had not been aggregated; 
and
    (ii) If a taxpayer has deaggregated a mineral property, the amount 
of any gain described in subparagraph (1) of this paragraph which is 
properly allocable to each of the resulting mineral properties shall 
include a part of the portion of any gain which would be properly 
allocable to the prior aggregation if the aggregation had not been 
deaggregated, the part properly allocable to each of the resulting 
properties being determined by allocating the gain between the resulting 
properties in the same manner as basis is allocated between them for tax 
purposes (see paragraph (a)(2) of Sec.  1.614-6 and example 5 of 
subparagraph (7) of this paragraph).
    (5) In any case in which it is necessary to determine the portion of 
any gain recognized under section 1245(a)(1) which is properly allocable 
to the mineral property in respect of which the taxable income is being 
computed, the taxpayer shall have available permanent records of all the 
facts necessary to determine with reasonable accuracy the amount of such 
portion. In the absence of such records, none of the gain recognized 
under section 1245(a)(1) shall be allocable to such mineral property.
    (6) As used in this paragraph, the term mineral property has the 
meaning assigned to it by section 614 and Sec.  1.614-1.
    (7) The provisions of this paragraph may be illustrated by the 
following examples:

    Example 1. A, who uses the calendar year as his taxable year, 
operated and treated as separate properties mines Nos. 1 and 2. On 
January 1, 1963, A acquired a truck which was section 1245 property. 
During 1963 and 1964 the

[[Page 462]]

truck was used 25 percent of the time at mine No. 1 and 75 percent of 
the time at mine No. 2. For each such year the depreciation adjustments 
allowed in respect of the truck were $800 (the amount allowable). In 
computing the taxable income from mines Nos. 1 and 2 for each such year, 
$200 (25 percent of $800) of the depreciation adjustments was allocated 
by A to mine No. 1 and $600 (75 percent of $800) to mine No. 2. Thus, 
for the 2 years, the total of the depreciation adjustments on the truck 
was $1,600, of which $400 was allocated to mine No. 1 and $1,200 to mine 
No. 2. On January 1, 1965, A recognized upon sale of the truck a gain of 
$500 to which section 1245(a)(1) applied. During 1965, A did not 
recognize any other gain to which section 1245(a)(1) applied. In 
computing taxable income from the mines for 1965, the expenses otherwise 
required to be taken into account are reduced by $125 (that is $400/
$1,600 of $500) for mine No. 1 and by $375 (that is $1,200/$1,600 of 
$500) for mine No. 2.
    Example 2. The situation is the same as in example 1, except that 
the truck in question is used 25 percent of the time at mine No. 1, and 
75 percent of the time in a nonmining business owned by A. Accordingly, 
in computing taxable income from A's mines for 1965, the expenses for 
mine No. 1 otherwise required to be taken into account are reduced by 
$125 (that is $400/$1,600 of $500), but no reduction is made in the 
expenses for mine No. 2, since the truck in question was not used in 
connection with that mineral property.
    Example 3. The situation is the same as in example 1, except that 
the truck in question was used exclusively at mine No. 1 in 1963. On 
January 1, 1964, the truck was transferred to mine No. 2, and was used 
exclusively at mine No. 2 during the remaining period prior to its sale. 
However, A continued to own and operate mine No. 1. For the 2 years 1963 
and 1964, the total of the depreciation adjustments on the truck was 
$1,600, of which $800 was allocated to mine No. 1 and $800 to mine No. 
2. In computing taxable income from A's mines for 1965, the expenses for 
mines Nos. 1 and 2 otherwise required to be taken into account are 
reduced by $250 each (that is $800/$1,600 of $500). If A had sold mine 
No. 1 on January 1, 1964, no reduction in expenses would be allowable as 
a result of the operation of the truck at mine No. 1, since A would no 
longer have owned mine No. 1 in the year in which the truck was sold.
    Example 4. On January 1, 1963, B, who uses the calendar year as his 
taxable year and who normally allocates depreciation costs to mines 
according to the percentage of time which the depreciable asset is used 
with respect to the mines, acquired a truck which was section 1245 
property. During 1963 the truck was used exclusively on mine No. 1, 
which B operated and treated as a separate property. The depreciation 
adjustments allowed in respect of the truck for 1963 were $1,000 (the 
amount allowable), which amount was allocated to mine No. 1 in computing 
the taxable income therefrom. On January 1, 1964, B acquired and began 
operating mine No. 2 and elected under section 614(c) to aggregate and 
treat as one property mines Nos. 1 and 2. During 1964 B used the truck 
60 percent of the time for mine No. 1 and 40 percent of the time for 
mine No. 2. For 1964 the depreciation adjustments allowed in respect of 
the truck were $1,000 (the amount allowable), which amount was allocated 
to the aggregation of mines Nos. 1 and 2 in computing the taxable income 
therefrom. On December 31, 1964, B sold mine No. 2. For 1965 the 
depreciation adjustments allowed in respect to the truck were $1,000 
(the amount allowable), which amount was allocated to mine No. 1 in 
computing the taxable income therefrom. On January 1, 1966, B recognized 
gain upon sale of the truck of $600 to which section 1245(a)(1) applied. 
In computing the taxable income from mine No. 1 for 1966, the expenses 
otherwise required to be taken into account are reduced by $600, since 
all the depreciation adjustments allowed with respect to the truck, 
including those allowed with respect to the use of the truck at mine No. 
2 ($400 for 1964), relate to the same mineral property from which B had 
taxable income in 1966, the taxable year in which he sold the truck.
    Example 5. On January 1, 1962, A, who uses the calendar year as his 
taxable year, elected under section 614(c) to aggregate and treat as one 
mineral property his operating mineral interests in mines Nos. 1 and 2. 
On January 1, 1963, A acquired a truck which was section 1245 property, 
to be used at both mine No. 1 and mine No. 2. A later elected (with the 
consent of the Commissioner) to deaggregate mines Nos. 1 and 2, and this 
deaggregation became effective on January 1, 1964. At the time of 
deaggregation, half of the tax basis of the aggregated property was 
allocated to mine No. 1, and the other half to mine No. 2. During each 
of the years 1963 and 1964, the truck was used 25 percent of the time on 
mine No. 1 and 75 percent of the time on mine No. 2, and the 
depreciation adjustments allowed in respect of the truck were $800 (the 
amount allowable). On January 1, 1965, A recognized upon sale of the 
truck a gain of $500 to which section 1245(a)(1) applied. In computing 
taxable income from A's mines for 1965, the expenses otherwise required 
to be taken into account are reduced by $187.50 (that is half of $250 
for 1963 and $200/$800 of $250 for 1964) for mine No. 1 and by $312.50 
(that is half of $250 for 1963 and $600/$800 of $250 for 1964) for mine 
No. 2.

    (c) Treatment of particular items in computing taxable income from 
the property. In determining taxable income

[[Page 463]]

from the property under the provisions of paragraph (a) of this section:
    (1) Trade or cash discounts (or allowances determined to have the 
same effect as trade or cash discounts) which are actually allowed to 
the taxpayer in connection with the acquisition of property, supplies, 
or services shall not be included in the cost of such property, 
supplies, or services.
    (2) Intangible drilling and development costs which are deducted 
under section 263(c) and Sec.  1.612-4 shall be subtracted from the 
gross income from the property.
    (3) Exploration and development expenditures which are deducted for 
the taxable year under sections 615, 616, or 617 shall be subtracted 
from the gross income from the property.
    (4)(i) Selling expenses, if any, paid or incurred with respect to a 
raw mineral product shall be subtracted from gross income from the 
property. See subdivision (iii) of this subparagraph for the definition 
of the term raw mineral product. For example, the selling expenses paid 
or incurred by a producer of raw mineral products with respect to 
products such as crude oil, raw gas, coal, iron ore, or crushed dolomite 
shall be subtracted from gross income from the property.
    (ii) A reasonable portion of the expenses of selling a refined, 
manufactured, or fabricated product shall be subtracted from gross 
income from the property. Such reasonable portion shall be equivalent to 
the typical selling expenses which are incurred by unintegrated miners 
or producers in the same mineral industry so as to maintain equality in 
the tax treatment of unintegrated miners or producers in comparison with 
integrated miner-manufacturers or producer-manufacturers. If 
unintegrated miners or producers in the same mineral industry do not 
typically incur any selling expenses, then no portion of the expenses of 
selling a refined, manufactured, or fabricated product shall be 
subtracted from gross income from the property when determining the 
taxpayer's taxable income from the property.
    (iii) For purposes of this subparagraph, a product will be 
considered to be a raw mineral product if (in the case of oil and gas) 
it is sold in the immediate vicinity of the well or if (in the case of 
minerals other than oil and gas) it is sold under the conditions 
described in paragraph (b)(1) of Sec.  1.613-4. In addition, a product 
will be considered to be a raw mineral product if only insubstantial 
value is added to the product by nonmining processes (or, in the case of 
oil and gas, by conversion or transportation processes). For example, in 
the case of a producer of crushed granite poultry grit, both bulk and 
bagged grit will be deemed to be a raw mineral product for purposes of 
the selling expense rule set forth in this subparagraph.
    (iv) The term selling expenses, for purposes of this subparagraph, 
includes sales management salaries, rent of sales offices, sales 
clerical expenses, salesmen's salaries, sales commissions and bonuses, 
advertising expenses, sales traveling expenses, and similar expenses, 
together with an allocable share of the costs of supporting services, 
but the term does not include delivery expenses.
    (5) Taxes which are taken as a credit rather than as a deduction or 
which are capitalized shall not be subtracted from the gross income from 
the property.
    (6) Trade association dues paid or incurred by a producer of crude 
oil or gas or a raw mineral product shall be subtracted from the gross 
income from the property. See subparagraph (4) (iii) of this paragraph 
for the definition of the term raw mineral product. In addition, a 
reasonable portion of the trade association dues incurred by a producer 
of a refined, manufactured, or fabricated product shall also be 
subtracted from gross income from the property if the activities of the 
association relate to production, treatment and marketing of the crude 
oil or gas or raw mineral product. One reasonable method of allocating 
the trade association dues described in the preceding sentence is an 
allocation based on the proportion that the direct costs of mining 
processes and the direct costs of nonmining processes (or in the case of 
oil and gas, conversion and transportation processes) bear to each 
other. The foregoing rules shall apply even though one of the principal 
purposes of an association is

[[Page 464]]

to advise, promote, or assist in the production, marketing, or sale of 
refined, manufactured, or fabricated products. For example, a reasonable 
portion of the trade association dues paid to an association which 
promotes the sale of cement, refined petroleum, or copper products shall 
be subtracted from gross income from the property.

[T.D. 6955, 33 FR 6968, May 9, 1968. Redesignated by T.D. 7170, 37 FR 
5374, Mar. 15, 1972, as amended by T.D. 7170, 37 FR 5381, Mar. 15, 1972]



Sec.  1.613-6  Statement to be attached to return when depletion is
claimed on percentage basis.

    In addition to the requirements set forth in paragraph (g) of Sec.  
1.611-2, a taxpayer who claims the percentage depletion deduction under 
section 613 for any taxable year shall attach to his return for such 
year a statement setting forth in complete, summary form, with respect 
to each property for which such deduction is allowable, the following 
information:
    (a) All data necessary for the determination of the gross income 
from the property, as defined in Sec. Sec.  1.613-3 from 1.613-4, 
including:
    (1) Amounts paid as rents or royalties including amounts which the 
recipient treats under section 631(c),
    (2) Proportion and amount of bonus excluded, and
    (3) Amounts paid to holders of other interests in the mineral 
deposit.
    (b) All additional data necessary for the determination of the 
taxable income from the property (computed without the allowance for 
depletion), as defined in Sec.  1.613-5.

[T.D. 7170, 37 FR 5382, Mar. 15, 1972]



Sec.  1.613-7  Application of percentage depletion rates provided in 
section 613(b) to certain taxable years ending in 1954.

    (a) Election of taxpayer. In the case of any taxable year ending 
after December 31, 1953, to which the Internal Revenue Code of 1939 is 
applicable, the taxpayer may elect in accordance with section 613(d) and 
this section to apply the appropriate percentage depletion rate 
specified in section 613 in respect of any mineral property (within the 
meaning of the 1939 Code). In the case of mines, wells, or other natural 
deposits listed in section 613(b), the election may be made by the 
taxpayer irrespective of whether his depletion allowance with respect to 
the property for the taxable year was computed upon the basis of cost, 
discovery value, or upon a percentage of gross income from the property. 
Once made, the election shall be irrevocable with respect to the 
property for which it is exercised. The election may be made for any 
mineral property of the taxpayer and need not be made for all such 
properties. Gross income from the property and net income from the 
property shall have the same meaning as those terms are used in 26 CFR 
(1939) 39.23(m)-1 (Regulations 118).
    (b) Computation of depletion allowance. The depletion allowance for 
any taxable year with respect to any property for which the taxpayer 
makes the election under section 613(d) shall be an amount equal to the 
sum of:
    (1) That portion of a tentative allowance, computed under the 
provisions of the Internal Revenue Code of 1939 (without regard to 
paragraph (1) of section 613(d)), which the number of days in the 
taxable year prior to January 1, 1954, bears to the total number of days 
in such taxable year; plus
    (2) That portion of a tentative allowance, computed by using the 
appropriate percentage depletion rate specified in section 613(b) (but 
otherwise computed under the provisions of the Internal Revenue Code of 
1939), which the number of days in the taxable year after December 31, 
1953, bears to the total number of days in such taxable year


In the case of any taxable year beginning after December 31, 1953, and 
ending before August 17, 1954, the depletion allowance with respect to 
any property for which the taxpayer makes the election under section 
613(d) shall be computed under the provisions of the Internal Revenue 
Code of 1939, except that the appropriate percentage depletion rate 
specified in section 613(b) shall be used. In making such computation, 
gross income from the property and net income from the property shall be 
determined in the same manner as specified in paragraph (a) of this 
section.

[[Page 465]]

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

    Example 1. A is a taxpayer who reports income on the basis of a 
taxable year ending June 30. For the taxable year ended June 30, 1954, A 
had gross income from a uranium property in the amount of $100,000 and 
his depletion allowance was computed with reference to percentage 
depletion. His net income from this property, for purposes of limiting 
the depletion allowance, was $40,000. The 15-percent rate of depletion 
provided for in the Internal Revenue Code of 1939 for metal mines 
resulted in a depletion allowance for the taxable year of $15,000. 
Percentage depletion computed with reference to the 23-percent rate 
provided for uranium under section 613(b) is $23,000 ($100,000 times 23 
percent). However, the allowance computed on this basis is limited to 
$20,000 (50 percent of A's net income from the property). If A exercises 
the election provided for in section 613(d) his depletion allowance for 
the taxable year is the aggregate of $7,561.64 (184/365 times $15,000) 
plus $9,917.80 (181/365 times $20,000) or $17,479.44
    Example 2. Assume the same facts as in example 1 except that A's 
depletion allowance was computed on the basis of cost and amounted to 
$17,500. If the election is made, A's allowance for the taxable year is 
the aggregate of $8,821.92 (184/365 times $17,500) plus $9,917.80 (181/
365 times $20,000) or $18,739.72.

    (d) Requirement for making election. (1) The election under section 
613(d) shall be made by filing a statement with the district director 
with whom the income tax return was filed for the taxable year to which 
the election is applicable. Such statement shall indicate that an 
election is being made under section 613(d), shall contain a 
recomputation of the depletion allowance and the tax liability for all 
taxable years affected by the exercise of the election, and shall be 
accompanied either by a claim for refund or credit or by an amended 
return or returns, whichever is appropriate.
    (2) If the treatment of any item upon which a tax previously 
determined was based, or if the application of any provisions of the 
internal revenue laws with respect to such tax, depends upon the amount 
of income (e.g., charitable contributions, foreign tax credit, dividends 
received credit, and medical expenses), readjustment in these 
particulars will be necessary as part of any recomputation in conformity 
with the change in the amount of the income which results solely from 
the making of the election under section 613(d).
    (e) Administrative provisions; etc. (1) Section 36(b) of the 
Technical Amendments Act of 1958 (72 Stat. 1633) provides as follows:

    Sec. 36. Percentage depletion rates for certain taxable years ending 
in 1954. * * *
    (b) Statute of limitations, etc.; interest. If refund or credit of 
any overpayment resulting from the application of the amendment made by 
subsection (a) of this section is prevented on the date of the enactment 
of this Act, or within 6 months from such date, by the operation of any 
law or rule of law (other than section 3760 of the Internal Revenue Code 
of 1939 or section 7121 of the Internal Revenue Code of 1954, relating 
to closing agreements, and other than section 3761 of the Internal 
Revenue Code of 1939 or section 7122 of the Internal Revenue Code of 
1954, relating to compromises), refund or credit of such overpayment 
may, nevertheless, be made or allowed if claim therefor is filed within 
6 months from such date. No interest shall be paid on any overpayment 
resulting from the application of the amendment made by subsection (a) 
of this section.

    (2) If refund or credit of any overpayment resulting from the 
application of section 613(d) is prevented on September 2, 1958, or on 
or before March 2, 1959, by the operation of any law or rule of law 
(other than section 3760 of the Internal Revenue Code of 1939 or section 
7121 of the Internal Revenue Code of 1954, relating to closing 
agreements, and other than section 3761 of the Internal Revenue Code of 
1939 or section 7122 of the Internal Revenue Code of 1954, relating to 
compromises), refund or credit of such overpayment may, nevertheless, be 
made or allowed if claim therefor is filed on or before March 2, 1959. 
If such refund or credit is not prevented on or before March 2, 1959, 
the time for filing claim therefor shall be governed by the rules of law 
generally applicable to credits and refunds.
    (3) The amount of any refund or credit which is allowable by reason 
of section 613(d) shall not exceed the decrease in income tax liability 
resulting solely from the application of the percentage rates specified 
in section 613(b). No interest shall be allowed or paid on any 
overpayment resulting from the application of section 613(d).
    (4) For purposes of this section the decrease in income tax 
liability shall be

[[Page 466]]

the amount by which the tax previously determined (as defined in section 
3801(d) of the Internal Revenue Code of 1939) exceeds the tax as 
recomputed under section 613(d) and this section.
    (f) Adjustment to basis. Proper adjustment shall be made to the 
basis of any property as required by section 113(b)(1) of the Internal 
Revenue Code of 1939 and 26 CFR (1939) 39.113(b)(1)-1(c) (Regulations 
118) to reflect any change in the depletion allowance resulting from the 
application of section 613(d) of the Internal Revenue Code of 1954.

[T.D. 6500, 25 FR 11737, Nov. 26, 1960. Redesignated by T.D. 7170, 37 FR 
5374, Mar. 15, 1972]



Sec.  1.613A-0  Limitations on percentage depletion in the case of oil 
and gas wells; table of contents.

    This section lists the paragraphs contained in Sec. Sec.  1.613A-0 
through 1.613A-7.

Sec.  1.613A-1 Post-1974 limitations on percentage depletion in case of 
                    oil and gas wells; general rule.

        Sec.  1.613A-2 Exemption for certain domestic gas wells.

 Sec.  1.613A-3 Exemption for independent producers and royalty owners.

    (a) General rules.
    (b) Phase-out table.
    (c) Applicable percentage.
    (d) Production in excess of depletable quantity.
    (1) Primary production.
    (2) Secondary or tertiary production.
    (3) Taxable income from the property.
    (4) Examples.
    (e) Partnerships.
    (1) General rule.
    (2) Initial allocation of adjusted basis of oil or gas property 
among partners.
    (i) General rule.
    (ii) Allocation methods.
    (3) Adjustments by partnership to allocated adjusted bases.
    (i) Capital expenditures by partnership.
    (ii) Admission of a new partner or increase in partner's interest.
    (A) In general.
    (B) Allocation of basis to contributing partner.
    (C) Reduction of existing partners' bases.
    (iii) Determination of aggregate of partners' adjusted bases in the 
property.
    (A) In general.
    (B) Written data.
    (C) Assumptions.
    (iv) Withdrawal of partner or decrease in partner's interest.
    (A) In general.
    (B) Special rule for determining a withdrawing partner's basis in 
the property.
    (v) Effective date.
    (4) Determination of a partner's interest in partnership capital or 
income.
    (5) Special rules on allocation of adjusted basis to partners.
    (6) Miscellaneous rules.
    (7) Examples.
    (f) S corporations.
    (g) Trusts and estates.
    (h) Businesses under common control; members of the same family.
    (1) Component members of a controlled group.
    (2) Aggregation of business entities under common control.
    (3) Allocation among members of the same family.
    (4) Special rules.
    (5) Examples.
    (i) Transfer of oil or gas property.
    (1) General rule.
    (i) In general.
    (ii) Examples.
    (2) Transfers after October 11, 1990.
    (i) General rule.
    (ii) Transfer.
    (iii) Transferee.
    (iv) Effective date.
    (v) Examples.
    (j) Percentage depletion with respect to bonuses and advanced 
royalties.
    (1) Amounts received or accrued after August 16, 1986.
    (2) Amounts received or accrued before August 17, 1986.
    (k) Special rules for fiscal year taxpayers.
    (l) Information furnished by partnerships, trusts, estates, and 
operators.

 Sec.  1.613A-4 Limitations on application of Sec.  1.613A-3 exemption.

    (a) Limitation based on taxable income.
    (b) Retailers excluded.
    (c) Certain refiners excluded.

           Sec.  1.613A-5 Election under section 613A (c) (4).

               Sec.  1.613A-6 Recordkeeping requirements.

    (a) Principal value of property demonstrated.
    (b) Production from secondary or tertiary processes.
    (c) Retention of records.

                       Sec.  1.613A-7 Definitions.

    (a) Domestic.
    (b) Natural gas.
    (c) Regulated natural gas.
    (d) Natural gas sold under fixed contract.
    (e) Qualified natural gas from geopressured brine.
    (f) Average daily production.
    (g) Crude oil.

[[Page 467]]

    (h) Depletable oil quantity.
    (i) Depletable natural gas quantity.
    (j) Barrel.
    (k) Secondary or tertiary production.
    (l) Controlled group of corporations.
    (m) Related person.
    (n) Transfer.
    (o) Transferee.
    (p) Interest in proven oil or gas property.
    (q) Amount disallowed.
    (r) Retailer.
    (s) Refiner.

[T.D. 8348, 56 FR 21938, May 13, 1991, as amended by T.D. 8437, 57 FR 
43899, Sept. 23, 1992]



Sec.  1.613A-1  Post-1974 limitations on percentage depletion in case
of oil and gas wells; general rule.

    Except as otherwise provided in section 613A and the regulations 
thereunder, in the case of oil or gas which is produced after December 
31, 1974, and to which gross income from the property is attributable 
after such year, the allowance for depletion under section 611 with 
respect to any oil or gas well shall be computed without regard to 
section 613. In the case of a taxable year beginning before January 1, 
1975, and ending after that date, the percentage depletion allowance 
(but not the cost depletion allowance) with respect to oil and gas wells 
for such taxable year shall be determined by treating the portion 
thereof in 1974 as if it were a short taxable year for purposes of 
section 613 and the portion thereof in 1975 as if it were a short 
taxable year for purposes of section 613A.

[T.D. 7487, 42 FR 24264, May 13, 1977]



Sec.  1.613A-2  Exemption for certain domestic gas wells.

    (a) The allowance for depletion under section 611 shall be computed 
in accordance with section 613 with respect to:
    (1) Regulated natural gas (as defined in paragraph (c) of Sec.  
1.613A-7),
    (2) Natural gas sold under a fixed contract (as defined in paragraph 
(d) of Sec.  1.613A-7), and
    (3) Any geothermal deposit in the United States or in a possession 
of the United States that is determined to be a gas well within the 
meaning of former section 613(b)(1)(A) (as in effect before enactment of 
the Tax Reduction Act of 1975) for taxable years ending after December 
31, 1974, and before October 1, 1978 (see section 613(e) for depletion 
on geothermal deposits thereafter),
    (b) For taxable years ending after September 30, 1978, the allowance 
for depletion under section 611 shall be computed in accordance with 
section 613 with respect to any qualified natural gas from geopressured 
brine (as defined in paragraph (e) of Sec.  1.613A-7), and 10 percent 
shall be deemed to be specified in section 613(b) for purposes of 
section 613(a).
    (c) For special rules applicable to partnerships, S corporations, 
trusts, and estates, see paragraphs (e), (f), and (g) of Sec.  1.613A-3.
    (d) The provisions of this section may be illustrated by the 
following examples:

    Example 1. A is a producer of natural gas which is sold by A under a 
contract in effect on February 1, 1975. The contract provides for an 
increase in the price of the gas sold under the contract to the highest 
price paid to a producer for natural gas in the area. The gas sold by A 
qualifies under section 613A(b)(1)(B) for percentage depletion as gas 
sold under a fixed contract until its price increases, but is presumed 
not to qualify thereafter unless A demonstrates by clear and convincing 
evidence that the price increase in no event takes increases in tax 
liabilities into account.
    Example 2. B is a producer of natural gas which is sold by B under a 
contract in effect on February 1, 1975. The contract provides that 
beginning January 1, 1980, the price of the gas may be renegotiated. 
Such a provision does not disqualify gas from qualifying for the 
exemption under section 613A(b)(1)(B) with respect to the gas sold prior 
to January 1, 1980. However, gas sold on or after January 1, 1980, does 
not qualify for the exemption whether or not the price of the gas is 
renegotiated.

[T.D. 8348, 56 FR 21939, May 13, 1991, as amended by T.D. 8437, 57 FR 
43899, Sept. 23, 1992; 58 FR 6678, Feb. 1, 1993]



Sec.  1.613A-3  Exemption for independent producers and royalty owners.

    (a) General rules. (1) Except as provided in section 613A(d) and 
Sec.  1.613A-4, the allowance for depletion under section 611 with 
respect to oil or gas which is produced after December 31, 1974, and to 
which gross income from the property is attributable after that

[[Page 468]]

date, shall be computed in accordance with section 613 with respect to:
    (i) So much of the taxpayer's average daily production (as defined 
in paragraph (f) of Sec.  1.613A-7) of domestic crude oil (as defined in 
paragraphs (a) and (g) of Sec.  1.613A-7) as does not exceed the 
taxpayer's depletable oil quantity (as defined in paragraph (h) of Sec.  
1.613A-7), and
    (ii) So much of the taxpayer's average daily production of domestic 
natural gas (as defined in paragraphs (a) and (b) of Sec.  1.613A-7) as 
does not exceed the taxpayer's depletable natural gas quantity (as 
defined in paragraph (i) of Sec.  1.613A-7), and the applicable 
percentage (determined in accordance with the table in paragraph (c) of 
this section shall be deemed to be specified in section 613(b) for 
purposes of section 613(a).
    (2) Except as provided in section 613A(d) and Sec.  1.613A-4, the 
allowance for depletion under section 611 with respect to oil or gas 
which is produced after December 31, 1974, and to which gross income 
from the property is attributable after that date and before January 1, 
1984, shall be computed in accordance with section 613 with respect to:
    (i) So much of the taxpayer's average daily secondary or tertiary 
production (as defined in paragraph (k) of Sec.  1.613A-7) of domestic 
crude oil as does not exceed the taxpayer's depletable oil quantity 
(determined without regard to section 613A(c)(3)(A)(ii), as in effect 
prior to the Revenue Reconciliation Act of 1990), and
    (ii) So much of the taxpayer's average daily secondary or tertiary 
production of domestic natural gas as does not exceed the taxpayer's 
depletable natural gas quantity (determined without regard to section 
613A(c)(3)(A)(ii), as in effect prior to the Revenue Reconciliation Act 
of 1990), and 22 percent shall be deemed to be specified in section 
613(b) for purposes of section 613(a).
    (3) For purposes of this section, there shall not be taken into 
account any production with respect to which percentage depletion is 
allowed pursuant to section 613A(b) or is not allowable by reason of 
section 613A(c)(9), as in effect prior to the Revenue Reconciliation Act 
of 1990.
    (4) The provisions of this paragraph may be illustrated by the 
following examples:

    Example 1. A, a calendar year taxpayer, owns an oil producing 
property with 100,000 barrels of production to which income was 
attributable for 1975 and a gas producing property with 1,200,000,000 
cubic feet of production to which income was attributable for 1975. 
Under section 613A(c)(4), the oil equivalent of 1,200,000,000 cubic feet 
of gas is 200,000 barrels, bringing A's total production of oil and gas 
to which income was attributable for 1975 to the equivalent of 300,000 
barrels of oil. A's average daily production was 821.92 barrels (300,000 
barrels / 365 days) which is less than the depletable oil quantity 
(2,000 barrels) before reduuction for any election by A under section 
613A(c)(4). Accordingly, A may make an election with respect to A's 
entire gas production and thereby be entitled to percentage depletion 
with respect to A's entire 1975 income from production of oil and gas. 
A's allowable depletion pursuant to section 613A(c) and A's oil and gas 
properties would be the amount determined under section 613(a) computed 
at the 22 percent rate specified in section 613A(c)(5), as in effect 
prior to the Revenue Reconciliation Act 1990, for 1975.
    Example 2. B, a calendar year taxpayer, owns oil producing 
properties with 365,000 barrels of production to which income was 
attributable for 1975. B was a retailer of oil and gas for only the last 
3 months of 1975. B's average daily production for 1975 was 1,000 
barrels (365,000 barrels / 365 days).
    Example 3. C, a calendar year taxpayer, owns property X with 500,000 
barrels of primary production to which income was attributable for 1975 
and property Y with 200,000 barrels of primary production to which 
income was attributable for 1975. Property Y had been transferred to C 
on January 1, 1975, on which date it was a proven property. Therefore, 
the exemption under section 613A(c)(1) does not apply to C with respect 
to production from property Y. In determining C's depletable oil 
quantity for the year, the production from property Y is not taken into 
account. Thus, C's average daily prduction for 1975 was 1,369.86 barrels 
(500,000 barrels / 365).
    Example 4. D owns an oil property with producing wells X and Y on 
it. In 1975 D converts well X into an injection well. Prior to the 
application of the secondary process, it is estimated that without the 
application of the process the annual production from well X would have 
been 50x barrels of oil and from well Y would have been 100x barrels of 
oil. For the taxable year in which injection is commenced production 
from well X is 10x barrels and from well Y is 180x barrels.

[[Page 469]]

Fortyx barrels of oil [190x barrels of oil (actual production from the 
property)--150x barrels (estimate of primary production from the 
property)] qualify as secondary production.
    Example 5. E, a calendar year taxpayer, owns a domestic oil well 
which produced 100,000 barrels of oil in 1980. The proceeds from the 
sale of 15,000 barrels of that production are not includible in E's 
income until 1981. The 15,000 barrels produced in 1980 are included in 
E's average daily production for 1981 and excluded from such production 
for 1980. The tentative quantity and the percentage depletion rate for 
1981 are applicable to the 15,000 barrels of oil.

    (b) Phase-out table. For purposes of section 613A(c)(3)(A)(i) and 
Sec.  1.613A-7(h) (relating to depletable oil quantity)--

------------------------------------------------------------------------
                                                          The tentative
In the case of production after 1974 and to which gross    quantity in
    income from the property is attributable for the     barrels per day
                     calendar year:                            is:
------------------------------------------------------------------------
1975...................................................            2,000
1976...................................................            1,800
1977...................................................            1,600
1978...................................................            1,400
1979...................................................            1,200
1980 and thereafter....................................            1,000
------------------------------------------------------------------------

    (c) Applicable percentage. For purposes of section 613A(c)(1) and 
paragraph (a) of this section--

------------------------------------------------------------------------
   In the case of production after 1974 and to which
gross income from the property is attributable for the   The applicable
                    calendar year:                       percentage is:
------------------------------------------------------------------------
1975..................................................                22
1976..................................................                22
1977..................................................                22
1978..................................................                22
1979..................................................                22
1980..................................................                22
1981..................................................                20
1982..................................................                18
1983..................................................                16
1984 and thereafter...................................                15
------------------------------------------------------------------------

    (d) Production in excess of depletable quantity--(1) Primary 
production. (i) If the taxpayer's average daily production of domestic 
crude oil exceeds his depletable oil quantity, the allowance for 
depletion pursuant to section 613A(c)(1)(A) and paragraph (a)(1)(i) of 
this section with respect to oil produced during the taxable year from 
each property in the United States shall be that amount which bears the 
same ratio to the amount of depletion which would have been allowable 
under section 613(a) for all of the taxpayer's oil produced from the 
property during the taxable year (computed as if section 613 applied to 
all of the production at the rate specified in paragraph (c) of this 
section) as the amount of his depletable oil quantity bears to the 
aggregate number of barrels representing the average daily production of 
domestic crude oil of the taxpayer for such year.
    (ii) If the taxpayer's average daily production of domestic natural 
gas exceeds his depletable natural gas quantity, the allowance for 
depletion pursuant to section 613A(c)(1)(B) and paragraph (a)(1)(ii) of 
this section with respect to natural gas produced during the taxable 
year from each property in the United States shall be that amount which 
bears the same ratio to the amount of depletion which would have been 
allowable pursuant to section 613(a) for all of the taxpayer's natural 
gas produced from the property during the taxable year (computed as if 
section 613 applied to all of the production at the rate specified in 
paragraph (c) of this section) as the amount of his depletable natural 
gas quantity in cubic feet bears to the aggregate number of cubic feet 
representing the average daily production of domestic natural gas of the 
taxpayer for such year.
    (2) Secondary or tertiary production. (i) If the taxpayer's average 
daily secondary or tertiary production of domestic crude oil exceeds his 
depletable oil quantity (determined without regard to section 
613A(c)(3)(A)(ii), as in effect prior to the Revenue Reconciliation Act 
of 1990), the allowance for depletion pursuant to section 
613A(c)(6)(A)(i), as in effect prior to the Revenue Reconciliation Act 
of 1990, and paragraph (a)(2)(i) of this section with respect to oil 
produced during the taxable year from each property in the United States 
shall be that amount which bears the same ratio to the amount of 
depletion which would have been allowable pursuant to section 613(a) for 
all of the taxpayer's secondary or tertiary production of oil from the 
property during the taxable year (computed as if section 613 applied to 
all of the production at the rate specified in paragraph (a)(2) of this 
section) as the amount of his depletable oil quantity (determined 
without regard to section 613A(c)(3)(A)(ii), as in

[[Page 470]]

effect prior to the Revenue Reconciliation Act of 1990) bears to the 
aggregate number of barrels representing the average daily secondary or 
tertiary production of domestic crude oil of the taxpayer for such year.
    (ii) If the taxpayer's average daily secondary or tertiary 
production of domestic natural gas exceeds his depletable natural gas 
quantity (determined without regard to section 613A(c)(3)(A)(ii), as in 
effect prior to the Revenue Reconciliation Act of 1990), the allowance 
for depletion pursuant to section 613A(c)(6)(A)(ii), as in effect prior 
to the Revenue Reconciliation Act of 1990, and paragraph (a)(2)(ii) of 
this section with respect to natural gas produced during the taxable 
year from each property in the United States shall be that amount which 
bears the same ratio to the amount of depletion which would have been 
allowable pursuant to section 613(a) for all of the taxpayer's secondary 
or tertiary production of natural gas from the property during the 
taxable year (computed as if section 613 applied to all of the 
production at the rate specified in paragraph (a)(2) of this section) as 
the amount of his depletable natural gas quantity in cubic feet 
(determined without regard to section 613A(c)(3)(A)(ii), as in effect 
prior to the Revenue Reconciliation Act of 1990) bears to the aggregate 
number of cubic feet representing the average daily secondary or 
tertiary production of domestic natural gas of the taxpayer for such 
year.
    (iii) This paragraph (d)(2) shall not apply after December 31, 1983.
    (3) Taxable income from the property. If both oil and gas are 
produced from the property during the taxable year, then for purposes of 
section 613A(c)(7) (A) and (B) and paragraph (d) of this section the 
taxable income from the property, in applying the taxable income 
limitation in section 613(a), shall be allocated between the oil 
production and the gas production in proportion to the gross income from 
the property during the taxable year from each. If both gas with respect 
to which section 613A(b) and Sec.  1.613A-2 apply and oil or gas with 
respect to which section 613A(c) and this section apply are produced 
from the property during the taxable year, then for purposes of section 
613A(d)(1) and paragraph (a) of Sec.  1.613A-4 the taxable income from 
the property, in applying the taxable income limitation in section 
613(a), shall also be so allocated. In addition, if both primary 
production and secondary or tertiary production (to which gross income 
from the property is attributable before January 1, 1984) are produced 
from the property during the taxable year and the total amount of 
production is in excess of the depletable quantity, then for purposes of 
paragraph (d) of this section the taxable income from the property, in 
applying the taxable income limitation in section 613(a), shall also be 
so allocated.
    (4) Examples. The application of this paragraph may be illustrated 
by the following examples:

    Example 1. A owns Y and Z oil producing properties. With respect to 
properties Y and Z, the percentage depletion allowable pursuant to 
section 613(a) (computed as if section 613 applied to all of the 
production at the rate specified in section 613A(c)(5)) for 1975 was 
$100x and $200x, respectively. A's average daily production for 1975 was 
4,000 barrels. A's allowable depletion pursuant to section 613A(c) with 
respect to property Y was $50x ($100x depletion x 2,000 depletable oil 
quantity/ 4,000 average daily production). A's allowable depletion 
pursuant to section 613A(c) with respect to property Z was $100x ($200x 
depletion x 2,000 depletable oil quantity/ 4,000 average daily 
production).
    Example 2. B owns gas producing properties which had secondary gas 
production for 1975 of 3,285,000,000 cubic feet, which under section 
613A(c)(4) is equivalent to 547,500 barrels of oil. B's average daily 
secondary production of gas for 1975 was equivalent to 1,500 barrels 
(547,500 barrels / 365). B elected to have section 613A(c)(4) apply to 
the gas production. With respect to the production, the percentage 
depletion allowable pursuant to section 613(a) (computed at the rate 
specified in section 613A(c)(6)(A), as in effect prior to the Revenue 
Reconciliation Act of 1990) was $150x. B also owns an oil producing 
property which had primary oil production for 1975 of 365,000 barrels. 
B's average daily production of oil for 1975 was 1,000 barrels (365,000 
/ 365). With respect to the oil property, the percentage depletion 
allowable pursuant to section 613(a) (computed as if section 613 applied 
to all of the production at the rate specified in section 613A(c)(5), as 
in effect prior to the Revenue Reconciliation Act of 1990) was $100x. 
B's depletable oil quantity for 1975 was 500 barrels (2,000 barrels 
tentative quantity

[[Page 471]]

-1,500 barrels average daily secondary production). B's allowable 
depletion pursuant to section 613A(c) with respect to the oil property 
was $50x ($100x depletion x 500 depletable oil quantity/ 1,000 average 
daily production).
    Example 3. Assume the same facts as in Example 2 except that B's 
primary production was 6,000,000 cubic feet of natural gas daily rather 
than its equivalent under section 613A(c)(4) of 1,000 barrels of oil and 
that B elected to have that section apply to such gas. B's allowable 
depletion pursuant to section 613A(c) with respect to B's primary 
production is $50x, the same as in example 2.
    Example 4. C is a partner with a one-third interest in Partnerships 
CDE and CFG with each partnership owning a single oil property. C's 
percentage depletion allowable under section 613(a) (computed as if 
section 613 applied to all of the production at the rate specified in 
section 613A(c)(5), as in effect prior to the Revenue Reconciliation Act 
of 1990) for 1975 was $20x with respect to 495,000 barrels (his 
allocable share of Partnership CDE production) and $40x with respect to 
600,000 barrels (his allocable share of Partnership CFG production). C's 
average daily production is 3,000 barrels (1,095,000 total production / 
365 days). C's allowable depletion pursuant to section 613A(c) with 
respect to C's share of the production of Partnership CDE is $13.33x 
($20x depletion x 2,000 depletable oil quantity/ 3,000 average daily 
production). C's allowable depletion pursuant to section 613A(c) with 
respect to C's share of the production of Partnership CFG is $26.67x 
($40x depletion x 2,000 depletable oil quantity/ 3,000 average daily 
production). See Sec.  1.613A-3(e) for the rules on computing depletion 
in the case of a partnership.
    Example 5. H owns a property which, during H's fiscal year which 
began on June 1, 1975, and ended on May 31, 1976, produced gas 
qualifying under section 613A(b) and oil qualifying under section 
613A(c). For the fiscal year H's gross income from the property was 
$400x, of which $100x was from gas and $300x was from oil. For the oil 
his gross income from the property for the period beginning June 1, 
1975, and ending December 31, 1975, was $100x and for the 1976 portion 
of the fiscal year was $200x. The percentage depletion allowance (before 
applying the 50 percent limitation of section 613(a) or the 65 percent 
limitation of section 613A(d)(1)) was $22x for the gas, $22x for the oil 
in 1975, and $44x for the oil in 1976. H's taxable income from the 
property for the fiscal year was $100x. In accordance with paragraph 
(d)(3) of this section, the taxable income from the property is 
allocated $25x to the gas:
[GRAPHIC] [TIFF OMITTED] TC08OC91.004

    $25x to the 1975 oil:
    [GRAPHIC] [TIFF OMITTED] TC08OC91.005
    
    and $50x to the 1976 oil:
    [GRAPHIC] [TIFF OMITTED] TC08OC91.006
    

With the application of the 50 percent of taxable income from the 
property limitation, the allowable percentage depletion (computed 
without reference to section 613A) is limited to $12.50x for the gas, 
$12.50x for the oil in 1975, and $25x for the oil in 1976.

    (e) Partnerships--(1) General rule. In the case of a partnership, 
the depletion allowance under section 611 with respect to production 
from domestic oil and gas properties shall be computed

[[Page 472]]

separately by the partners and not by the partnership. The determination 
of whether cost or percentage depletion is applicable is to be made at 
the partner level. The partnership must allocate to each partner the 
partner's proportionate share of the adjusted basis of each partnership 
oil or gas property in accordance with the provisions of paragraphs 
(e)(2) through (e)(6) of this section. This allocation of the adjusted 
basis of oil or gas property does not affect a partner's adjusted basis 
in his or her partnership interest.
    (2) Initial allocation of adjusted basis of oil or gas property 
among partners--(i) General rule. Each partner shall be allocated his or 
her proportionate share of the adjusted basis of each partnership 
domestic oil or gas property. The initial allocation of adjusted basis 
is to be made as of the later of the date of acquisition of the oil or 
gas property by the partnership or January 1, 1975.
    (ii) Allocation methods. Except as otherwise provided in paragraph 
(e)(5) of this section, the provisions of this paragraph (e)(2)(ii) 
govern the determination under paragraph (e)(2)(i) of this section of a 
partner's proportionate share of the adjusted basis of oil or gas 
property. Each partner's proportionate share is determined in accordance 
with the partner's proportionate interest in partnership capital at the 
time of the allocation unless both--
    (A) The partnership agreement provides that a partner's share of the 
adjusted basis of one or more properties is determined in accordance 
with his or her proportionate interest in partnership income; and
    (B) At the time of allocation under the partnership agreement the 
share of each partner in partnership income is reasonably expected to be 
substantially unchanged throughout the life of the partnership, other 
than changes merely to reflect the admission of a new partner, an 
increase in a partners' interest in consideration for money, property, 
or services, or a partial or complete withdrawal of an existing partner


If the requirements of paragraph (e)(2)(ii) (A) and (B) of this section 
are met, a partner's proportionate share is determined in accordance 
with his or her proportionate interest in partnership income. The 
partners' shares of adjusted basis are determined on a property-by-
property basis. Accordingly, the basis of one property may be allocated 
in proportion to capital and the basis of another property may be 
allocated in proportion to income. See Sec. Sec.  1.613A-3(e)(5) and 
1.704-1(b)(4)(v) for special rules concerning allocation of the adjusted 
basis of oil and gas properties.
    (3) Adjustments by partnership to allocated adjusted bases--(i) 
Capital expenditures by partnership. Appropriate adjustments shall be 
made to the partners' adjusted bases in any domestic oil and gas 
property for any partnership capital expenditures relating to such 
property that are made after the initial allocation. These adjustments 
shall be allocated among the partners in accordance with the principles 
set forth in paragraph (e)(2)(ii) of this section.
    (ii) Admission of a new partner or increase in partner's interest--
(A) In general. Upon a contribution of money, other property, or 
services to the partnership by a new or existing partner (``contributing 
partner'') as consideration for an interest in the partnership, the 
partnership shall allocate, in accordance with paragraph (e)(3)(ii)(B) 
of this section, a share of the partnership's basis in each existing oil 
and gas property to the contributing partner, and each existing partner 
shall reduce, in accordance with paragraph (e)(3)(ii)(C) of this 
section, his or her share of the partnership's basis in such property.
    (B) Allocation of basis to contributing partner. The partnership 
shall allocate to a contributing partner his or her proportionate share 
(determined under paragraph (e)(2)(ii) of this section in accordance 
with the partner's proportionate interest in partnership capital or 
income) of the partnership's adjusted basis in each existing partnership 
oil or gas property. For purposes of this allocation, the partnership's 
adjusted basis in such property equals the aggregate of its partner's 
adjusted bases in the property, as determined under paragraph 
(e)(3)(iii) of this section.
    (C) Reduction of existing partners' bases. Each existing partner's 
basis in each existing partnership oil or gas

[[Page 473]]

property is reduced by the percentage of the partnership's aggregate 
basis in the property that is allocated to the contributing partner. 
Thus, if one-third of the partnership's aggregate basis in a property is 
allocated to a contributing partner because the contributing partner has 
a one-third interest in partnership capital, after the admission of the 
contributing partner each existing partner's basis (including the 
contributing partner's pre-existing basis if such partner is also an 
existing partner) in each property equals the partner's basis (prior to 
the admission) reduced by one-third.
    (iii) Determination of aggregate of partners' adjusted bases in the 
property--(A) In general. To determine the aggregate of its partners' 
adjusted bases for purposes of this paragraph (e)(3), the partnership 
must determine each partner's adjusted basis under either paragraph 
(e)(3)(iii)(B) (written data) or paragraph (e)(3)(iii)(C) (assumptions) 
of this section. The partnership is permitted to determine the bases of 
some partners under paragraph (e)(3)(iii)(B) of this section and of 
others under paragraph (e)(3)(iii)(C) of this section. For this purpose, 
a partner's basis in an oil or gas property does not include any basis 
adjustment under section 743(b).
    (B) Written data. A partnership may determine a partners' basis in 
an oil or gas property by using written data provided by a partner 
stating the amount of the partner's adjusted basis or depletion 
deductions with respect to the property unless the partnership knows or 
has reason to know that the written data is inaccurate. In determining 
depletion deductions, a partner must treat as actually deducted any 
amount disallowed and carried over as a result of the 65 percent-of-
income limitation of section 613A(d)(1). If a partnership does not 
receive written data upon which it may rely, the partnership must use 
the assumptions provided in paragraph (e)(3)(iii)(C) of this section in 
determining a partner's adjusted basis in an oil or gas property.
    (C) Assumptions. Except as provided in paragraph (e)(3)(iv)(B) of 
this section, a partnership that does not use written data pursuant to 
paragraph (e)(3)(iii)(B) of this section to determine a partner's basis 
must use the following assumptions to determine the partner's adjusted 
basis in an oil and gas property:
    (1) The partner deducted his or her share of deductions under 
section 263(c) in the first year in which the partner could claim a 
deduction for such amounts, unless the partnership elected to capitalize 
such amounts;
    (2) The partner was not subject to the 65 percent-of-income 
limitation of section 613A(d)(1) with respect to the partner's depletion 
allowance under section 611; and
    (3) The partner was not subject to the following limitations, with 
respect to the partner's depletion allowance under section 611, except 
to the extent a limitation applied at the partnership level: the taxable 
income limitation of section 613(a); the depletable quantity limitations 
of section 613A(c); the prohibition against claiming percentage 
depletion on transferred proven property under section 613A(c)(9), prior 
to its repeal; or the limitations of section 613A(d) (2), (3), and (4) 
(exclusion of retailers and refiners).
    (iv) Withdrawal of partner or decrease in partner's interest--(A) In 
general. Upon a distribution of money or other property to a withdrawing 
partner as consideration for an interest in the partnership, the 
withdrawing partner's adjusted basis in each domestic oil or gas 
property that continues to be held by the partnership is allocated to 
the remaining partners in proportion to their proportionate interest in 
partnership capital or income after taking into account any increase or 
decrease as a result of the event giving rise to the reallocation. A 
similar rule shall apply in the case of a diminution of a continuing 
partner's interest in the partnership.
    (B) Special rule for determining a withdrawing partner's basis in 
the property. If a partnership is required to determine a withdrawing 
partner's adjusted basis using the assumptions under paragraph 
(e)(3)(iii)(C) of this section, the partnership may rebut the assumption 
in paragraph (e)(3)(iii)(C)(3) of this section that the withdrawing 
partner was not subject to the limitations of sections 613A(d) (2), (3), 
and (4) exclusion of retailers and refiners) by demonstrating

[[Page 474]]

that the withdrawing partner was subject to the limitations of sections 
613A(d) (2), (3), or (4).
    (v) Effective date. The provisions of Sec.  1.613A-3(e)(3) (i) 
through (iv) are effective for taxable years beginning after May 13, 
1991. However, a partnership may elect to apply these provisions to 
taxable years beginning on or before May 13, 1991.
    (4) Determination of a partner's interest in partnership capital or 
income. For purposes of this paragraph (e), a partner's interest in 
partnership capital or income is determined by taking into account all 
facts and circumstances relating to the economic arrangement of the 
partners. See the factors listed in Sec.  1.704-1(b)(3)(ii).
    (5) Special rules on allocation of adjusted basis to partners. An 
allocation or reallocation of the adjusted basis of oil or gas property 
is pursuant to this paragraph (e) of this section deemed to be in 
accordance with the partner's proportionate interest in partnership 
capital or income for purposes of this paragraph (e) where so provided 
in Sec.  1.704-1(b)(4)(v). In addition, in connection with a revaluation 
described in Sec.  1.704-1(b)(2)(iv)(f), the basis of an oil or gas 
property is allocated among the partners based on the principles used 
under Sec.  1.704-1(b)(4)(i) of allocating tax items to take into 
account variations between the adjusted basis of the property and its 
fair market value. In the case of an oil or gas property contributed to 
a partnership by a partner, section 704(c) is taken into account in 
determining the partner's share of the adjusted basis.
    (6) Miscellaneous rules. (i) Each partner must separately keep 
records of his or her share of the adjusted basis in each domestic oil 
or gas property of the partnership, adjust his or her share of such 
basis pursuant to section 1016 (including adjustments for any depletion 
allowed or allowable with respect to such property), and use that 
adjusted basis each year in the computation of his or her cost depletion 
or in the computation of his or her gain or loss on the disposition 
(including abandonment) of the property by the partnership.
    (ii) The adjusted basis of a partner's interest in a partnership is 
decreased (but not below zero) pursuant to section 705(a)(3) by the 
amount of the depletion deduction allowed or allowable to the partner 
with respect to a domestic oil or gas property to the extent such 
deduction does not exceed the proportionate share of the adjusted basis 
of such property allocated to the partner under section 613A(c)(7)(D), 
as adjusted by the partner after the initial allocation. Section 
705(a)(1)(C) does not apply to depletion deductions that are not 
included in a partner's distributive share under section 702. 
Accordingly, the adjusted basis of a partner's interest in a partnership 
is not increased under section 705(a)(1)(C) with respect to depletion of 
oil or gas properties. See Sec.  1.705-1(a)(2)(iii).
    (iii) Upon the disposition of an oil or gas property by the 
partnership, each partner must subtract the partner's adjusted basis in 
the property from his or her allocable portion of the amount realized 
from the sale of the property to determine gain or loss. The partner's 
allocable portion of amount realized must, except to the extent governed 
by section 704(c) (or related principles under Sec.  1.704-1(b)(4)(i)), 
be determined in accordance with Sec.  1.704-1(b)(4)(v). Except as 
otherwise provided (e.g., section 751), the sale of a partnership 
interest is not treated as a sale of an oil and gas property.
    (iv) In the case of a transfer of an interest in a partnership, the 
transferor partner's adjusted basis in each partnership oil or gas 
property carries over to the transferee partner. If an election under 
section 754 (relating to optional adjustment to the basis of partnership 
property) is in effect, such basis is adjusted in accordance with 
section 743.
    (v) For purposes of section 732 (relating to basis of distributed 
property other than money) and section 734(b) (relating to optional 
adjustment to basis of partnership property), the partnership's adjusted 
basis in oil and gas property is an amount equal to the aggregate of its 
partners' adjusted bases in the property as determined under the rules 
provided in paragraph (e)(3) of this section.
    (7) Examples. The provisions of this paragraph may be illustrated by 
the following examples:


[[Page 475]]


    Example 1. A, B, and C have equal interests in capital in 
Partnership ABC. On January 1, 1992, the partnership acquired a 
producing domestic oil property. The partnership's basis in the property 
was $90x. The partnership allocated the adjusted basis of the property 
to each partner in proportion to the partner's interest in partnership 
capital. Accordingly, each partner was allocated an adjusted basis of 
$30x. Each partner must separately compute his or her depletion 
allowance. The amount of percentage depletion allowable for each partner 
for 1992 was $10x. On January 1, 1993, each partner's adjusted basis in 
the property was $20x ($30x minus $10x). On January 1, 1993, the oil 
property was sold for $150x. Each partner's gain was $30x ($50x 
allocable share of amount realized minus the partner's adjusted basis of 
$20x). Each partner must adjust the partner's adjusted basis in his or 
her partnership interest to reflect the gain.
    Example 2. The facts are the same as in Example 1 except that on 
January 1, 1993, the property was not sold but transferred by the 
partnership to partner A. A's basis in the property was $60x (the sum of 
A's, B's, and C's adjusted bases in the property).
    Example 3. The facts are the same as in Example 1 with the exception 
that in 1992 C was a retailer of oil and gas and was only entitled to a 
cost depletion deduction of $5x. C's gain from the sale of the mineral 
property on January 1, 1993, was $25x ($50x allocable share of amount 
realized minus C's adjusted basis of $25x ($30x minus $5x)).
    Example 4. D, a calendar year taxpayer, is a partner in Partnership 
DEF which owns a domestic producing oil property. On January 1, 1993, 
the partnership's adjusted basis in the property was $900x. On January 
1, 1993, D's adjusted basis in D's partnership interest was $300x and 
D's adjusted basis in the partnership's oil property was $300x. D's 
allowable percentage depletion for 1993 with respect to production from 
the oil property was $50x. On January 1, 1994, D's adjusted basis in D's 
partnership interest was $250x and D's adjusted basis in the 
partnership's oil property was $250x ($300x minus $50x).
    Example 5. On January 1, 1990, G has an adjusted basis of $5x in 
partnership GH's proven domestic oil property, which is the sole asset 
of the partnership. On January 1, 1990 G sells G's partnership interest 
to I for $100x when the election under section 754 is in effect. I has a 
special basis adjustment for the oil property of $95x (the difference 
between I's basis, $100x, and I's share of the basis of the partnership 
property, $5x). I is not entitled to percentage depletion with respect 
to I's distributive share of the oil property income because I is a 
transferee of an interest in a proven oil property. However, I is 
entitled to cost depletion and for this purpose I's interest in the oil 
property has an adjusted basis to I of $100x ($5x, plus I's special 
basis adjustment of $95x).
    Example 6. On January 1, 1960, Partnership JK acquired a domestic 
producing oil property. On January 1, 1990, the partnership's adjusted 
basis in the property was zero. On January 1, 1990, L is admitted as a 
partner to the partnership. Since the partnership's adjusted basis in 
the oil property is zero, L's proportionate share of the basis in the 
property is also zero. L is not entitled to percentage depletion because 
L is a transferee of a proven oil property (see paragraph (g) of this 
section). Since the property's basis is zero, L is also not entitled to 
any cost depletion with respect to production from the property.
    Example 7. (i) O and P have equal interests in capital in 
Partnership OP. On January 1, 1991, the partnership acquired an unproven 
domestic oil property X the basis of which is $200x to the partnership. 
The partnership allocates $100x of the basis of the property to each 
partner in accordance with each partner's proportionate interest in 
partnership capital. For the 1991 taxable year, O has a $10x cost 
depletion allowance and P has a $25x percentage depletion allowance. 
Accordingly, at the end of the 1991 taxable year, O's adjusted basis in 
the property is $90x, and P's adjusted basis in the property is $75x. On 
January 1, 1992, Q is admitted as an equal partner. The partnership does 
not use written data from the partners and must therefore assume that 
each partner was entitled to $25x depletion based on the assumptions 
provided in Sec.  1.613A-3(e)(3)(iii). This would result in a $50x 
combined depletion allowance for the partners and an aggregate adjusted 
basis in the oil property of $150x. Accordingly, the partnership 
allocates $50x of the basis of the property to Q, one-third of the 
aggregate adjusted basis determined by the partnership. O and P must 
each reduce their basis in the property by one-third. Accordingly, after 
the admission of Q, O's adjusted basis in the property is $60x ($90x 
minus $30x), and P's adjusted basis in the property is $50x ($75x minus 
$25x).
    (ii) Assume the same facts as in paragraph (i) of this Example 7 
except that O informs the partnership that its adjusted basis in the 
property is $90x (determined without regard to section 613A(d)(1)). The 
partnership uses the written data provided by O and determines the 
aggregate adjusted basis in the property to be $165x ($90x + $75x). 
Accordingly, the partnership allocates $55x (\1/3\ of $165x) of the 
basis of the property to Q, and O and P must each reduce their adjusted 
basis in the property by one-third, as in paragraph (i) of this Example 
7. Thus, after the admission of Q, O's adjusted basis in the property is 
$60x and P's adjusted basis in the property is $50x.


[[Page 476]]


    (f) S corporations. For purposes of section 613A(c)(13), adjustments 
to shareholders' adjusted bases in any domestic oil or gas property to 
reflect capital expenditures by S corporations, the addition of a new 
shareholder or an increase in a shareholder's interest by reason of a 
contribution to the S corporation, the redemption of a shareholder's 
interest, or other appropriate transaction shall be made in accordance 
with principles similar to the principles under Sec.  1.613A-3(e) 
applicable to the entry or withdrawal of a partner.
    (g) Trusts and estates. (1) In the case of production from domestic 
oil and gas properties held by a trust or estate, the depletion 
allowance under section 611 shall be computed initially by the trust or 
estate. The determination of whether cost or percentage depletion is 
applicable shall be made at the trust or estate level, but such 
determination shall not result in the disallowance of cost depletion to 
a beneficiary of a trust or estate for whom cost depletion exceeds 
percentage depletion. The limitations contained in section 613A (c) and 
(d), other than section 613A(d)(1), shall be applied at the trust or 
estate level in its computation of percentage depletion pursuant to 
section 613A and shall also be applied by a beneficiary with respect to 
any percentage depletion apportioned to the beneficiary by the trust or 
estate. The limitation of section 613A(d)(1) shall be applied by each 
taxpayer (i.e., trust, estate or beneficiary) only with respect to its 
allocable share of percentage depletion under section 611(b) (3) or (4). 
For purposes of adjustments to the basis of oil or gas properties held 
by a trust or estate, in the absence of clear and convincing evidence to 
the contrary, it shall be presumed that no beneficiary is affected by 
any section 613A (d) limitations or by the rules contained in section 
613A(c)(8) and (9) (relating to businesses under common control and 
members of the same family and to transfers, respectively), as in effect 
prior to the Revenue Reconciliation Act of 1990, or has any oil or gas 
production from sources other than the trust or estate.
    (2) The provisions of this paragraph may be illustrated by the 
following examples.

    Example 1. A is the income beneficiary of a trust the only asset of 
which is a domestic producing oil property. The trust instrument 
requires that an amount which equals 10 percent of the gross income from 
the property be set aside annually as a reserve for depletion. In 1975 
the property a had production of 1,095,000 barrels of oil. The trust's 
gross income from the property in 1975 was $30,000x. In that year, after 
setting aside $3,000x of income for the reserve for depletion, the 
trustee distributed the remaining income to A which represented 80 
percent of the trust's net income. The percentage depletion computed by 
the trust with respect to the production (computed as if section 613 
applied to all of the production at the rate specified in section 
613A(c)(5), as in effect prior to the Revenue Reconciliation Act of 
1990) for 1975 was $6,600x. The trust's average daily production for 
1975 was 3,000 barrels (1,095,000 / 365 days). The trust's allowable 
depletion pursuant to section 613A(c) with respect to the production was 
$4,400x:
[GRAPHIC] [TIFF OMITTED] TC08OC91.007


Pursuant to Sec.  1.611-1(c)(4)(ii), the percentage depletion of $4,400x 
was apportioned between the trustee and A so that the trustee received 
$3,000x (an amount equal to the amount of income set aside for the 
reserve for depletion) and A received $1,400x of the depletion 
deduction. The $1,400x depletion received by A is attributable to 80 
percent of the trust's depletable oil quantity, i.e., 1,600 barrels per 
day.
    Example 2. B, a retailer of oil and gas, is the income beneficiary 
of a trust the only asset of which is a domestic producing oil property. 
In 1975 the trustee distributed one-half of the trust's net income and 
accumulated the other one-half for the benefit of the remainderman. One-
half of the percentage depletion computed by the trust with respect to 
the production from the property was apportioned to B. Since B is a 
retailer of oil and gas, B is not entitled to deduct any of

[[Page 477]]

the percentage depletion apportioned to B. However, B is entitled to 
take cost depletion with respect to one-half of the production from the 
oil property, notwithstanding the fact that depletion was computed at 
the trust level on the basis of percentage depletion.

    (h) Businesses under common control; members of the same family--(1) 
Component members of a controlled group. For purposes of only the 
depletable quantity limitations contained in section 613A (c) and this 
section, component members of a controlled group of corporations (as 
defined in paragraph (1) of Sec.  1.613A-7) shall be treated as one 
taxpayer. Accordingly, the group shares the depletable oil (or natural 
gas) quantity prescribed for a taxpayer for the taxable year and the 
secondary production (to which gross income from the property is 
attributable before January 1, 1984) of a member of the group will 
reduce the other members' share of the group's depletable quantity.
    (2) Aggregation of business entities under common control. If 50 
percent or more of the beneficial interest in any two or more entities 
(i.e., corporations, trust, or estates) is owned by the same or related 
persons (taking into account only each person who owns at least 5 
percent of the beneficial interest in an entity and with respect to such 
person his or her entire interest) as defined in paragraph (m) (2) of 
Sec.  1.613A-7, the tentative quantity determined under the table in 
section 613A(c)(3)(B) (as in effect prior to the Revenue Reconciliation 
Act of 1990) for a taxpayer for the taxable year shall be allocated 
among all such entities in proportion to their respective production. 
This paragraph (h)(2) shall not apply to component members of a 
controlled group of corporations (as defined in Sec.  1.613A-7 (1)). For 
purposes of determining ownership interest, an interest owned by or for 
a corporation, partnership, trust, or estate shall be considered as 
owned directly both by itself and proportionately by its shareholders, 
partners, or beneficiaries, as the case may be.
    (3) Allocation among members of the same family. In the case of 
individuals who are members of the same family, the tentative quantity 
determined under the table in section 613A (c)(3)(B) (as in effect prior 
to the Revenue Reconciliation Act of 1990) for a taxpayer for the 
taxable year shall be allocated among such individuals in proportion to 
the respective production of barrels of domestic crude oil (and the 
equivalent in barrels to the cubic feet of natural gas determined under 
paragraph (h)(4)(ii) of this section) during the period in question by 
such individuals.
    (4) Special rules. For purposes of section 613A (c)(8) and this 
section--
    (i) The family of an individual includes only his spouse and minor 
children, and
    (ii) Each 6,000 cubic feet of domestic natural gas shall be treated 
as 1 barrel of domestic crude oil.
    (5) Examples. The application of this paragraph may be illustrated 
by the following examples:

    Example 1. A owns 50 percent of the stock of Corporation M and 50 
percent of the stock of Corporation N. Both corporations are calendar 
year taxpayers. For 1975 Corporation M's production of domestic crude 
oil was 8,000,000 barrels (365,000 of which was secondary production) 
and Corporation N's was 2,000,000 barrels (all of which was primary 
production). The tentative quantity (2,000 barrels per day) determined 
under the table in section 613A (c)(3)(B) (as in effect prior to the 
Revenue Reconciliation Act of 1990) must be allocated between the two 
corporations in proportion to their respective barrels of production of 
domestic crude oil during the taxable year. Corporation M's allocable 
share of the tentative quantity is 1,600 barrels:
[GRAPHIC] [TIFF OMITTED] TC08OC91.008


and Corporation N's allocable share is 400 barrels:
[GRAPHIC] [TIFF OMITTED] TC08OC91.009

    With respect to M's primary production, M's depletable oil quantity 
is 600 barrels (1,600 barrels - 1,000 barrels [365,000 secondary 
production / 365 days]). N's depletable oil quantity, unaffected by M's 
secondary production, is 400 barrels.
    Example 2. Assume the same facts as in Example 1 except that 
Corporation M is a retailer and Corporation N is not selling its oil 
through Corporation M. Because Corporation M is a retailer, no portion 
of the tentative quantity is allocated to Corporation M. Accordingly, 
Corporation N's depletable oil quantity is the entire 2,000 barrels per 
day because section 613A (c), which contains the

[[Page 478]]

allocation requirements, is inapplicable to retailers.
    Example 3. Corporations O and P are members of a controlled group 
and are treated as one taxpayer as provided in paragraph (h)(1) of this 
section. Corporation O owns oil properties A and B. Property A had 
primary production for 1975 of 800,000 barrels of oil. Property B had 
secondary production for 1975 of 365,000 barrels of oil. Corporation P 
owns oil property C which had primary production of 660,000 barrels for 
1975. The allowable percentage depletion with respect to property B's 
secondary production was $360x. The controlled group's average daily 
production was 4,000 barrels [(800,000 + 660,000) / 365]. The controlled 
group's depletable oil quantity was 1,000 barrels [2,000 tentative 
quantity - 1,000 average daily secondary production (365,000 / 365)]. 
The allowable percentage depletion pursuant to section 613 (a) (computed 
as if section 613 applied to all of the production at the rate specified 
in section 613A (c)(5), as in effect prior to the Revenue Reconciliation 
Act of 1990) was $800x with respect to production from property A and 
$660x with respect to production from property C.
    Corporation O's allowable depletion pursuant to section 613A (c) 
with respect to property B's secondary production (for which depletion 
is allowable before primary production) for 1975 was $360x. Corporation 
O's allowable depletion pursuant to section 613A (c) with respect to 
property A was $200x:
[GRAPHIC] [TIFF OMITTED] TC08OC91.010

    Therefore, Corporation O's allowable depletion pursuant to section 
613A (c) was $560x ($360x relating to property B plus $200x relating to 
property A). Corporation P's allowable depletion pursuant to section 
613A (c) with respect to property C was $165x:
[GRAPHIC] [TIFF OMITTED] TC08OC91.011

    (i) Transfer of oil or gas property--(1) General rule--(i) In 
general. Except as provided in paragraph (i)(2) of this section, in the 
case of a transfer (as defined in paragraph (n) of Sec.  1.613A-7) of an 
interest in any proven oil or gas property (as defined in paragraph (p) 
of Sec.  1.613A-7), paragraph (a)(1) of this section shall not apply to 
a transferee (as defined in paragraph (o) of Sec.  1.613A-7) with 
respect to production of crude oil or natural gas attributable to such 
interest, and such production shall not be taken into account for any 
computation by the transferee under this section.
    (ii) Examples. The provisions of this subparagraph may be 
illustrated by the following examples:

    Example 1. On January 1, 1975, Individual A transfers proven oil 
properties to Corporation M in an exchange to which section 351 applies 
for shares of its stock. Since there is no allocation requirement 
pursuant to section 613A(c)(8) between A (the transferor) and 
Corporation M (the transferee), the transfer of the proven properties by 
A is a transfer for purposes of section 613A(c)(9) (as in effect prior 
to the Revenue Reconciliation Act of 1990) and percentage depletion is 
not allowable to Corporation M with respect to such properties.
    Example 2. On January 1, 1975, Corporation N sells proven oil 
property to Corporation O, its wholly-owned subsidiary. Because the 
transfer was made between corporations which are members of the same 
controlled group of corporations, Corporation O is entitled to 
percentage depletion with respect to production from the property so 
long as the tentative oil quantity is allocated between the two 
corporations. If Corporation N were a retailer, the tentative oil 
quantity would not be required to be allocated between the two 
corporations (see example 2 of Sec.  1.613A-3(h)(5)), and Corporation O 
would not be entitled to percentage depletion on the production from the 
property.
    Example 3. B, owner of a proven oil property, died on January 1, 
1975. Pursuant to the provisions of B's will, B's estate transferred

[[Page 479]]

the oil property on April 1, 1975, into a trust. On July 1, 1976, 
pursuant to a requirement in B's will, the trustee distributed the oil 
property to C. The transfer of the oil property by the estate to the 
trust and the later distribution of the property by the trust to C are 
transfers at death. Therefore, the trust was entitled to compute 
percentage depletion with respect to the production from the oil 
property when the property was owned by the trust and C is entitled to 
percentage depletion with respect to production from the oil property 
after the trust distributes the property to C.
    Example 4. On January 1, 1975, property which produces oil resulting 
from secondary processes was transferred to D. The exemption under 
section 613A(c) applies to D because section 613A(c)(9) (relating to 
transfers of oil or gas property), as in effect in 1975, does not apply 
with respect to secondary production. In addition, even if at the time 
of the transfer the production from the property was primary and D 
applied secondary processes to the property transferred and obtained 
secondary production, D would be entitled to percentage depletion with 
respect to the secondary production.
    Example 5. On July 1, 1975, E and F entered into a contract whereby 
F is given the privilege of drilling a well on E's unproven property, 
and if F does so F is to own the entire working interest in the property 
until F has recoverd all the costs of drilling, equipping, and operating 
the well. Thereafter, 50 percent of the working interest would revert to 
E. In accordance with the contract, 50 percent of the working interest 
reverted to E on July 1, 1976. F is entitled to percentage depletion 
because the transfer of the working interest to F occurred when the 
property was unproven on July 1, 1975, which is the date of the contract 
establishing F's right to the working interest. E is entitled to 
percentage depletion with respect to this working interest since the 
reversion of such interest with respect to which E was eligible for 
percentage depletion is not a transfer. However, if on the date of the 
contract E's property was proven (although not proven when E acquired 
the property), F would not be entitled to claim percentage depletion 
with respect to any of the working interest income. Nonetheless, E would 
still be entitled to percentage depletion with respect to E's working 
interest since the reversion of the interest is not a transfer.
    Example 6. On January 1, 1975, G subleased an oil property to H, 
retaining a \1/8\ royalty interest with the option to convert G's 
royalty into a 50-percent working interest. On July 1, 1975, the 
property was proven and on July 1, 1976, G exercised G's option. G is 
entitled to claim percentage depletion with respect to G's working 
interest since the conversion of the royalty interest which is eligible 
for percentage depletion pursuant to section 613A(c) into an interest 
which constituted part of an interest previously owned by G is not a 
transfer pursuant to Sec.  1.613A-7(n)(8).
    Example 7. I and J (both of whom are minors) are beneficiaries of a 
trust which owned a proven oil property. The oil property was 
transferred to the trust on January 1, 1975, by the father of I and J. 
For 1975, the trustee allocated all the income from the oil property to 
I. For 1976, the trustee allocated all the income from such property to 
J. On January 1, 1977, the trustee distributed the property to I and J 
as equal tenants in common. Since I, J, and their father are members of 
the same family within the meaning of section 613A(c)(8)(C), the 
transfer of the property to the trust by the father, the shifting of 
income between I and J, and the distribution of the oil property by the 
trust to I and J are not transfers for purposes of section 613A(c)(9) 
(as in effect prior to the Revenue Reconciliation Act of 1990). However, 
the distribution of the oil property will constitute a transfer to each 
distributee on the date on which the distributee reaches majority under 
state law.
    Example 8. In 1975, K transferred a proven oil property productive 
at 5,000 feet to L. Subsequent to the transfer, L drilled new wells on 
the property finding another reservoir at 10,000 feet. The two zones 
were combined under section 614 as a single property. L is not entitled 
to percentage depletion on the gross income attributable to the 
production from the productive zone at 5,000 feet, but is entitled to 
percentage depletion on the gross income attributable to the production 
from the productive zone at 10,000 feet because that zone was not part 
of the proven property until the date of development expenses by L, 
which is after the date of the transfer. Accordingly, L's maximum 
allowable percentage depletion deduction for 1975 would be zero percent 
of gross income from the property with respect to the production from 
5,000 feet, plus 22 percent of gross income from the property with 
respect to the production from 10,000 feet. This maximum deduction would 
be subject to the limitation provided for in section 613(a), i.e.,50 
percent of ``taxable income from the property (computed without 
allowance for depletion),'' such taxable income being the overall 
taxable income resulting from the sale of production from both zones, 
and would also be subject to the limitations provided in section 613A. 
The production from the productive zone at 5,000 feet is not taken into 
account in determining K's depletable oil quantity for the year.
    Example 9. On July 1, 1975, M transferred an oil property with a 
fair market value of $100x to N. On February 1, 1976, N commenced 
production of oil from the property. The fair market value of the 
property on February 1, 1976, as reduced by actual costs incurred by

[[Page 480]]

N for equipment and intangible drilling and development costs, was 
$300x. Because the value of the property on transfer was not 50 percent 
or more of the value on February 1, 1976, the property transferred to N 
was not a proven property (see Sec.  1.613A-7(p)). However, if there had 
been only marginal production from the property so that the fair market 
value of the property on February 1, 1976, was $40x rather than $300x, 
the property transferred to N would have been a proven property provided 
the other requirements of a proven property were met.
    Example 10. O is the owner of a remainder interest in a trust 
created January 1, 1970. On that date, the trust held oil and gas 
properties. On January 1, 1976, O's interest for the first time entitled 
O to the trust's income from oil and gas production from the properties. 
The reversion of the remainder interest to O is not a transfer (see 
Sec.  1.613A-7(n)(7)). Accordingly, the transfer of the interest in oil 
and gas property to O is deemed to have occurred on January 1, 1970, the 
date O's interest was created.
    Example 11. On January 1, 1976, P, Q, and R entered into a 
partnership for the acquisition of oil and gas leases. It was agreed 
that the sharing of income will be divided equally among P, Q, and R. 
However, it was further agreed that with respect to the first production 
obtained from each property acquired P will receive 80 percent thereof 
and Q and R each will receive 10 percent thereof until $100x has been 
received by P. Assume these allocations have substantial economic effect 
under section 704 of the Code and the regulations thereunder. On 
February 1, 1976, Partnership PQR acquired an unproven property and 
production therefrom was shared pursuant to the partnership agreement. P 
is entitled to percentage depletion with respect to the production 
allocated to him since the transfer of right to the production is deemed 
to have been made on the date the partnership agreement became 
applicable to the specific property, at which time the property was 
unproven. See Sec.  1.613A-7(n) for rules relating to the definition of 
transfer. Similarly, when $100x has been obtained and Q and R each 
commence receiving 33\1/3\ percent of the revenue, Q and R are entitled 
to percentage depletion with respect to their entire interests. However, 
if the property had been proven when acquired by the partnership, P, Q, 
and R would not be entitled to claim any percentage depletion with 
respect to production from the property.
    Example 12. On December 30, 1960, S placed producing oil property in 
trust for the benefit of S's nephew, T, and executed a trust agreement 
which required the trustee of the trust to transfer the oil property to 
T on January 1, 1975. The trustee's transfer of the oil property to T on 
January 1, 1975, is deemed to have occurred on December 30, 1960 (see 
Sec.  1.613A-7(n)). Since the transfer is deemed to have occurred before 
January 1, 1975, section 613A(c) applies with respect to the production 
from the oil property. Moreover, if the trustee was not required to 
transfer the oil property on a specific date but was given discretion to 
select the date of transfer, the transfer of such property would still 
be deemed to have occurred on December 30, 1960. However, the result 
would be different if the trust agreement had provided that the trustee, 
at the trustee's discretion, may transfer the oil property to T on 
January 1, 1975, but is not under any obligation to transfer the 
property to T on January 1, 1975, or on any other date. Since the 
transfer was discretionary, the date of the actual transfer governs.
    Example 13. On January 1, 1974, U acquired an oil property. On 
February 1, 1974, U granted V an option to purchase the oil property. V 
exercised V's option on March 2, 1975, and subsequently the oil property 
was conveyed to V. The date of the transfer was March 2, 1975, the day V 
exercised V's option (on which date both parties were bound).
    Example 14. On July 1, 1974, W executed a deed conveying oil and gas 
property to X. W delivered the deed to X on January 1, 1975. Under state 
law, the mere execution of the deed without delivery did not give X any 
rights in the property. Title to the oil property passed to X on the 
date of delivery. Therefore, the date of transfer was January 1, 1975.
    Example 15. Y, owner of a proven oil property, transferred Y's 
interest therein on July 25, 1975, to a revocable trust of which Y is 
treated as the owner under section 676. Y is not deemed a transferee and 
section 613A(c) applies to Y because immediately preceding the transfer 
Y was entitled to percentage depletion on the production from the 
property.
    Example 16. On January 1, 1975, a proven oil property was 
transferred to Z; therefore, section 613A(c)(1) did not apply with 
respect to the production from such property. After Z's death, neither 
Z's estate nor its beneficiaries are entitled to percentage depletion 
with respect to the decedent's oil property since Z was a transferee of 
proven property.
    Example 17. Partnership ABC, owner of proven oil and gas properties, 
admitted D as a partner in 1975 in consideration of cash. The shares of 
Partners A, B, and C of the partnership income were proportionately 
reduced so that D had a 25 percent interest in the income. D is not 
entitled to percentage depletion with respect to D's share of 
partnership oil and gas income because D is a transferee for purposes of 
section 613A(c)(9) (as in effect prior to the Revenue Reconciliation Act 
of 1990). See Sec.  1.613A-7(n).
    Example 18. On January 1, 1975, E and F formed Partnership EF to 
which E contributed proven oil property. For 1975, pursuant to the 
partnership agreement 70 percent of the mineral income from the property 
was

[[Page 481]]

allocated to E and 30 percent of the mineral income from the property 
was allocated F. F is not entitled to percentage depletion with respect 
to production from the property because F is a transferee of an interest 
in proven property. However, E is not a transferee of an interest in 
proven property because E was entitled to percentage depletion on the 
oil produced with respect to the property immediately before the 
transfer. Therefore, E is entitled to percentage depletion with respect 
to the income allocated to E. However, if in 1976 the partnership 
agreement were revised so that E's interest in the income was increased 
by 10 percent, E would not be entitled to percentage depletion with 
respect to the additional 10 percent interest because E is a transferee 
with respect thereto.
    Example 19. G is the owner of a \1/3\ interest in a partnership 
owning a proven oil property, and as such is entitled to \1/3\ of the 
income from the property. G received a distribution on July 1, 1975, 
from the partnership of a \1/3\ interest in the proven oil property. 
Although the transfer of such interest is a transfer for purposes of 
section 613A(c)(9) (as in effect prior to the Revenue Reconciliation Act 
of 1990), G is still entitled to percentage depletion with respect to 
the \1/3\ interest in the oil production from the property since G was 
entitled to percentage depletion on such production with respect to such 
property immediately before the transfer. If the entire property were 
distributed to G, G's percentage depletion allowance would still be 
based on only \1/3\ of the oil produced.
    Example 20. H and I contributed property X and property Y 
respectively to Partnership HI. The partnership agreement provides that 
all the gross income from property X is to be allocated to H and all the 
gross income from property Y is to be allocated to I. Assume these 
allocations have substantial economic effect under section 704 of the 
Code and the regulations thereunder. For 1975 H and I each received 
$100x gross income. Although the contributions of the properties by H 
and I are transfers for purposes of section 613A(c)(9) (as in effect 
prior to the Revenue Reconciliation Act of 1990), both H and I are 
entitled to percentage depletion with respect to the $100x income 
received since each was entitled to a percentage depletion allowance 
with respect to the property contributed immediately before the 
transfer. However, if no special allocation of income were made but H 
and I are to share equally in the income from both properties, each 
would be entitled to a depletion allowance based on only one-half of the 
production with respect to the property he had contributed. If property 
X produces $100x of gross income from the property and property Y 
produces $200x of gross income from the property, H would be entitled to 
percentage depletion but only with respect to $50x (50 percent of $100x) 
of gross income from the property and I would be entitled to percentage 
depletion with respect to $100x (50 percent of $200x) of gross income 
from the property.

    (2) Transfers after October 11, 1990--(i) General rule. Section 
613A(c) (9) and (10), as in effect prior to the Revenue Reconciliation 
Act of 1990 (relating to prohibition of percentage depletion on 
transferred proven properties) has been repealed effective for transfers 
after October 11, 1990. Accordingly, a transferee of a proven oil or gas 
property transferred after October 11, 1990 is permitted to claim 
percentage depletion with respect to production from the property. For 
purposes of transfers of property occurring before October 12, 1990 
under section 613A(c)(10), prior to its repeal, the disposition of stock 
after October 11, 1990 by a transferor will not result in a reduction in 
the depletable quantity of the transferee corporation under section 
613A(c)(10)(F).
    (ii) Transfer. The term ``transfer'' has the same meaning as under 
Sec.  1.613A-7(n).
    (iii) Transferee. A person shall not be treated as a transferee with 
respect to a transferred property to the extent that such person held an 
interest in the property but was not entitled to a percentage depletion 
allowance on mineral produced with respect to the property immediately 
before the transfer. Thus, for example, if a taxpayer who is not 
entitled to claim percentage depletion on a proven property transfers 
the property to a partnership for an interest in the partnership, the 
taxpayer is not a transferee with respect to the property in the hands 
of the partnership.
    (iv) Effective date. The provisions of paragraph (i)(2) of Sec.  
1.613A-3 are effective for transfers occurring after May 13, 1991. 
However, a taxpayer may elect to apply these provisions to transfers 
occurring after October 11, 1990 and on or before May 13, 1991.
    (v) Examples. The examples below illustrate the provisions of this 
subparagraph. The examples ignore the application of any restriction on 
percentage depletion other than the proven property transfer rule.

    Example 1. On December 31, 1991, A transfers a proven oil property 
to B. B may claim percentage depletion with respect to production from 
the property regardless of whether

[[Page 482]]

production from the property was eligible for percentage depletion in 
A's hands (even if A were a retailer or refiner of oil or gas).
    Example 2. On October 10, 1990, A transfers a proven oil property to 
B. B may not claim percentage depletion with respect to production from 
the property.
    Example 3. On January 1, 1990, C purchases a proven oil property. 
Because C is a transferee of a proven property, production from the 
property is not eligible for percentage depletion in C's hands. On 
December 31, 1991, C contributes the property to Corporation M, an S 
corporation in which C owns 100 percent of the stock. The contribution 
of the property is a transfer, but C is not a transferee with respect to 
the property in the hands of the corporation. Accordingly, C may not 
claim percentage depletion with respect to production from the property. 
However, if prior to the contribution C had been entitled to claim 
percentage depletion with respect to production from the property, C 
would be entitled to claim percentage depletion with respect to 
production from the property after the contribution.
    Example 4. On December 31, 1991, C contributes a proven oil property 
(with respect to which C is not entitled to claim percentage depletion) 
to Corporation N, an S corporation in which C owns 30 percent and D owns 
70 percent of the stock. The contribution of the property is a transfer, 
but C is not a transferee with respect to the property in the hands of 
the corporation. Accordingly, C may not claim percentage depletion with 
respect to C's share of the production from the property. D is a 
transferee with respect to the property in the hands of Corporation N, 
and may claim percentage depletion with respect to D's share of 
production from the property.
    Example 5. On December 31, 1991, D transfers a proven oil property 
(with respect to which D is not entitled to claim percentage depletion) 
to DE, an equal partnership between D and E. E is a transferee with 
respect to the property and may claim percentage depletion with respect 
to production from the property allocated to E under the DE partnership 
agreement. D is not a transferee with respect to the property, and may 
not claim percentage depletion with respect to production from the 
property allocated to D under the DE partnership agreement. However, if 
D had been entitled to claim percentage depletion with respect to 
production from the property, then D would be entitled to claim 
percentage depletion with respect to production from the property in the 
hands of DE.
    Example 6. On January 1, 1990, Corporation P contributes a proven 
property to Corporation O, its wholly owned subsidiary. Under Sec.  
1.613A-7(n)(4), the contribution is not treated as a transfer, but only 
for so long as the tentative quantity is required under section 
613A(c)(8) to be allocated between P and O. On December 31, 1991, P 
sells 90% of the O stock to an unrelated person; accordingly, the 
tentative quantity is no longer required under section 613A(c)(8) to be 
allocated between P and O. After the sale of O stock, production from 
the property in O's hands is eligible for percentage depletion because a 
transfer of a proven property is deemed to occur upon the transfer of 
the stock.
    Example 7. On October 10, 1990, G transfers a proven oil property to 
his minor son, H. G had been entitled to claim percentage depletion with 
respect to production from the property. Under Sec.  1.613A-7(n)(5), H 
is permitted to claim percentage depletion for so long as G and H are 
related persons under section 613A(c)(8)(C). On December 31, 1991, H 
reaches majority and is no longer related to G under section 
613A(c)(8)(C). H is entitled to continue to claim percentage depletion 
on production from the property because the property is treated as being 
transferred to H on December 31, 1991.
    Example 8. On December 31, 1991, I sells a proven property to J, her 
husband. I had not been entitled to claim percentage depletion with 
respect to production from the property. Under Sec.  1.613A-7(n)(5), the 
sale is not a transfer because it is made between persons related under 
section 613A(c)(8). Accordingly, J may not claim percentage depletion 
with respect to production from the property. If, however, I had been 
entitled to claim percentage depletion with respect to production from 
the property, J would be entitled to claim percentage depletion with 
respect to production from the property.
    Example 9. On December 31, 1991, L inherits a proven property from 
K. K had not been entitled to claim percentage depletion with respect to 
production from the property. Under Sec.  1.613A-7(n)(1), the 
inheritance is not a transfer. Accordingly, L may not claim percentage 
depletion with respect to production from the property. If, however, K 
had been entitled to claim percentage depletion with respect to 
production from the property, L would be entitled to claim percentage 
depletion with respect to production from the property.
    Example 10. On December 31, 1991, Corporation R, a calendar year 
taxpayer, made an S election effective for the taxable year beginning 
January 1, 1992 and succeeding taxable years. Since Corporation R is 
deemed to have transferred its oil and gas properties on January 1, 
1992, the shareholders of Corporation R are eligible to claim percentage 
depletion with respect to the production from the properties.
    Example 11. Assume the same facts as in Example 10 except that 
Corporation R makes the S election on December 31, 1989, effective for 
the taxable year beginning January 1, 1990 and succeeding taxable years. 
Since Corporation R is deemed to have transferred its

[[Page 483]]

oil and gas properties on January 1, 1990, the shareholders of 
Corporation R are not eligible to claim percentage depletion with 
respect to the production from the properties.

    (j) Percentage depletion with respect to bonuses and advanced 
royalties--(1) Amounts received or accrued after August 16, 1986. In 
computing the percentage depletion allowance pursuant to section 613A(c) 
with respect to amounts received or accrued after August 16, 1986, there 
shall not be taken into account any advance royalty (to the extent that 
actual production during the taxable year is insufficient to earn such 
royalty), lease bonus, or other amount payable without regard to 
production, even though the amount may be taken into account for 
purposes of sections 61 and 612 (relating to definitions of gross income 
and cost depletion, respectively).
    (2) Amounts received or accrued before August 17, 1986. (i) A lease 
bonus or advanced royalty received or accrued before August 17, 1986, 
with respect to oil or gas property shall be taken into account for 
purposes of percentage depletion in the taxable year such payment is 
includible in income. Percentage depletion shall be determined according 
to the depletion rate and depletable oil and natural gas limitations of 
section 613A(c)(1) and Sec.  1.613A-3(a) applicable on the date of such 
inclusion. The payee of the bonus or advanced royalty shall apply the 
depletable oil and natural gas quantity limitations by attributing a 
specific number of barrels of oil or cubic feet of natural gas to the 
lease bonus or advanced royalty. The determination of the number of 
barrels of oil or cubic feet of natural gas shall be based on the 
average price of oil or gas produced from the property during the 
taxable year. If oil or gas is not produced from the property during 
that year, or if the oil or gas is not sold before conversion or 
transportation from the premises, the number of barrels of oil or cubic 
feet of gas shall be based on a price (as of the date of the bonus or 
advanced royalty) determined under the constructive pricing principles 
applicable under section 613(a), generally the representative market or 
field price. In the case where no oil or gas has been produced in such 
year, the constructive price applicable to the type of production 
expected to be produced from the property shall apply. However, if the 
first actual production from the property in a later year is different 
from the type of production upon which the conversion of the bonus or 
advanced royalty into barrels of oil or cubic feet of gas was based and 
the period of limitations on assessment has not expired (see section 
6501) for the year in which the lease bonus or advanced royalty is 
includible in income, the taxpayer should promptly file an amended 
return, if necessary. In the amended return the conversion shall be 
recomputed taking into account the pricing applicable to the actual 
production. For purposes of paragraph (f) of Sec.  1.613A-7, the number 
of barrels of oil or cubic feet of natural gas attributed to a lease 
bonus or advanced royalty is deemed to have been extracted on the date 
the bonus or advanced royalty is includible in the payee's income.
    (ii) For purposes of applying the depletable oil and natural gas 
quantity limitations in taxable years after the year in which the 
advanced royalty payment is included in income, the payee of an advanced 
royalty which is recouped out of future production shall not include 
production which recoups the advanced royalty in such later years. The 
payor of a bonus or advanced royalty that is not recouped from future 
production may reduce the production to be taken into account for 
purposes of applying the depletable quantity limitations in each year in 
which the payor's gross income from the property is adjusted under Sec.  
1.613-2(c)(5)(ii) to reflect the bonus paid by an amount determined by 
dividing the portion of the bonus required to be excluded from the 
payor's gross income from the property by the price of oil or gas 
applicable to the payee for converting the bonus into barrels of oil or 
cubic feet of gas.
    (iii) See Sec.  1.612-3 (a)(2) and (b)(2) for rules relating to the 
requirement that certain depletion deductions allowed with respect to 
lease bonuses and advanced royalties be restored to income.
    (k) Special rules for fiscal year taxpayers. In applying this 
section to a taxable year which is not a calendar year, each portion of 
such taxable year which occurs during a single calendar

[[Page 484]]

year shall be treated as if it were a short taxable year.
    (l) Information furnished by partnerships, trusts, estates, and 
operators. Each partnership, trust, or estate producing domestic crude 
oil or natural gas, and each operator of a well from which domestic 
crude oil or natural gas was produced, shall provide each partner, 
beneficiary, or person holding a nonoperating interest, as the case may 
be, with all information in its possession necessary to determine the 
amount of his depletion deduction allowable with respect to such crude 
oil or natural gas. For example, for each property a partnership is 
required to provide each partner with partnership information relating 
to the partner's allocable share of gross income from the property, the 
partner's allocable share of operating expenses, the partner's allocable 
share of depreciation, the partner's share of allocated overhead, the 
partner's share of estimated reserves, the partner's share of production 
in barrels or cubic feet for the taxable year, the partner's original 
share of the partnership adjusted basis of properties producing domestic 
crude oil or domestic natural gas, the partner's allocable share of any 
adjustments made to the basis of such properties by the partnership, and 
the percentage by which existing partners must reduce their bases in a 
partnership oil or gas property upon entry of a partner by contribution. 
In addition, upon the disposition of an oil or gas property by the 
partnership, the partnership shall inform each partner of his allocable 
portion of the amount realized from the sale of the property.

[T.D. 8348, 56 FR 21939, May 13, 1991; 57 FR 4913, Feb. 10, 1992; 57 FR 
9599, Mar. 19, 1992, as amended by T.D. 8437, 57 FR 43900, Sept. 23, 
1992; 57 FR 60474, Dec. 21, 1992; 58 FR 6678, Feb. 1, 1993]



Sec.  1.613A-4  Limitations on application of Sec.  1.613A-3 exemption.

    (a) Limitation based on taxable income. (1) The aggregate amount of 
a taxpayer's deductions allowed pursuant to section 613A(c) for the 
taxable year shall not exceed 65 percent of the taxpayer's taxable 
income (reduced in the case of an individual by the zero bracket amount 
for taxable years beginning after December 31, 1976, and before January 
1, 1987) for the year, adjusted to eliminate the effects of:
    (i) Any depletion with respect to an oil or gas property (other than 
a gas property with respect to which the depletion allowance for all 
production is determined pursuant to section 613A(b)) for which 
percentage depletion would exceed cost depletion in the absence of the 
depletable quantity limitations contained in section 613A(c) (1) and (6) 
(as in effect prior to the Revenue Reconciliation Act of 1990) or the 
taxable income limitation contained in section 613A(d)(1);
    (ii) Any net operating loss carryback to the taxable year under 
section 172;
    (iii) Any capital loss carryback to the taxable year under section 
1212; and
    (iv) In the case of a trust, any distributions to its beneficiaries, 
except in the case of any trust where any beneficiary of such trust is a 
member of the family (as defined in section 267(c)(4)) of a settlor who 
created inter vivos and testamentary trusts for members of the family 
and such settlor died within the last 6 days of the 5th month in 1970, 
and the law in the jurisdiction in which such trust was created requires 
all or a portion of the gross or net proceeds of any royalty or other 
interest in oil, gas, or other mineral representing any percentage 
depletion allowance to be allocated to the principal of the trust.

The amount disallowed (as defined in paragraph (q) of Sec.  1.613A-7) 
shall be carried over to the succeeding year and treated as an amount 
allowable as a deduction pursuant to section 613A(c) for such succeeding 
year, subject to the 65-percent limitation of section 613A(d)(1). For 
rules relating to corporations filing a consolidated return, see the 
regulations under section 1502. With respect to fiscal year taxpayers, 
except as provided in Sec.  1.613A-1 for taxable years beginning before 
January 1, 1975, and ending after that date, the limitation shall be 
calculated on the entire fiscal year and not applied with respect to 
each short period included in a fiscal year. For purposes of basis 
adjustments and

[[Page 485]]

determining whether cost depletion exceeds percentage depletion with 
respect to the production from a property, any amount disallowed as a 
deduction after the application of this paragraph shall be allocated to 
the respective properties from which the oil or gas was produced in 
proportion to the percentage depletion otherwise allowable to such 
properties pursuant to section 613A(c). Accordingly, the maximum amount 
which may be allowable as a deduction pursuant to section 613A(c) after 
application of this paragraph (65 percent x adjusted taxable income) 
shall be allocated to properties for which percentage depletion pursuant 
to section 613A(c) would be allowed in the absence of the limitation 
contained in section 613A(d)(1) by application of the same proportion. 
However, once it is determined that after application of this paragraph 
cost depletion exceeds percentage depletion with respect to a property, 
the maximum amount determined under the preceding sentence shall be 
reallocated among the remaining properties, and the portion of the 
amount disallowed which is allocable to such property shall be the 
amount by which percentage depletion pursuant to section 613A(c) before 
application of this paragraph exceeds cost depletion. See example 1 of 
paragraph (a)(2) of this section. If the taxpayer becomes entitled to 
the deduction in a later year (i.e., because the disallowed depletion 
does not exceed 65 percent of the taxpayer's taxable income for that 
year after taking account of any percentage depletion deduction 
otherwise allowable for that year), then the basis of the taxpayer's 
properties must be adjusted downward (but not below zero) by the amount 
of the deduction in proportion to the portion of the amount disallowed 
to the respective properties in the year of the disallowance. However, 
if the property in question was disposed of by the taxpayer prior to the 
beginning of such later year, the amount of the deduction in such later 
year shall be reduced by the difference between the taxpayer's adjusted 
basis in the property at the time it is disposed of and the adjusted 
basis which the taxpayer would have had in the property in the absence 
of the 65-percent limitation.
    (2) The application of this paragraph may be illustrated by the 
following examples:

    Example 1. A owns producing oil properties M, N, and O. With respect 
to property M, the depletion allowable pursuant to section 613A(c) for 
1975 without regard to section 613A(d)(1) was $60 x (cost depletion 
would have been $40 x ). With respect to property N, the depletion 
allowable pursuant to section 613A(c) for 1975 without regard to section 
613A(d)(1) was $90 x (cost depletion would have been zero). With respect 
to property O, the depletion pursuant to section 613A(c) for 1975 
without regard to section 613A(d)(1) was $50 x (cost depletion would 
have been $10X). A's taxable income (as adjusted under Sec.  1.613A-
4(a)(1)) for 1975 was $100 x ; accordingly, A's percentage depletion 
pursuant to section 613A(c) for 1975 must be reduced from $200 x to $65 
x (65 percent x $100 x taxable income). Of that amount, $19.5 x :
[GRAPHIC] [TIFF OMITTED] TC08OC91.012

is tentatively allocated to property M, $29.25 x :
[GRAPHIC] [TIFF OMITTED] TC08OC91.013

is tentatively allocated to property N, and $16.25 x :
[GRAPHIC] [TIFF OMITTED] TC08OC91.014

is tentatively allocated to property O.
    Since cost depletion of $40 x with respect to property M exceeded 
the percentage depletion of $19.5 x allowable on such property, A 
claimed the cost depletion. Accordingly, the only percentage depletion 
deduction allowable to A pursuant to section 613A(c) for 1975 is with 
respect to properties N and O. Therefore, the $65 x ceiling applies to 
the percentage depletion allowable on properties N and O. Of that 
amount, $41.79 x :
[GRAPHIC] [TIFF OMITTED] TC08OC91.015

is allocated to property N, and $23.21 x :
[GRAPHIC] [TIFF OMITTED] TC08OC91.016


[[Page 486]]



is allocated to property O.
    Accordingly, A is allowed a total depletion deduction of $105 x ($40 
x cost depletion on property M + $41.79 x percentage depletion on 
property N + $23.21 x percentage depletion on property O). The amount 
disallowed to A under section 613A(d)(1) is $95 x ($200 x aggregate 
depletion allowable before application of section 613A(d)(1) - $105 x 
[$40 x cost depletion allowable on property M + $41.79 x percentage 
depletion allowable on property N after application of section 
613A(d)(1) + $23.21 x depletion allowable on property O after 
application of section 613A(d)(1)]). For purposes of basis adjustments, 
$20 x ($60 x percentage depletion before limitation - $40 x cost 
depletion allowed) of the amount disallowed is allocated to property M. 
The balance of the amount disallowed of $75 x is allocated $48.21 x :
[GRAPHIC] [TIFF OMITTED] TC08OC91.017

to property N, and
[GRAPHIC] [TIFF OMITTED] TC08OC91.018

to property O.
    Example 2. The amount disallowed to B as a deduction under this 
paragraph is $50x for 1975 and $125x for 1976 (including the $50x 
carried over from 1975). B may carry forward the $125x as a deduction to 
1977 and subsequent years.
    Example 3. C is a fiscal year taxpayer whose fiscal year ended on 
May 31, 1975. For purposes of applying the 65 percent of taxable income 
limitation, the period beginning January 1, 1975, and ending May 31, 
1975, is treated as a short taxable year. The depletion allowable 
pursuant to section 613A(c) without regard to section 613A(d)(1) for 
such short taxable year was $80x and A's taxable income (as adjusted 
under Sec.  1.613A-4(a)(1)) during such short taxable year was $100x. 
Only $65x (65 percent x $100x adjusted taxable income) of the deduction 
pursuant to section 613A(c) was deductible for such portion of 1975, in 
addition to any percentage depletion allowable for June 1, 1974, through 
December 31, 1974. With respect to the taxable year commencing June 1, 
1975, and ending May 31, 1976, the 65 percent limitation is applied to 
the taxable income for the entire taxable year.
    Example 4. Under the trust law of State X, a trustee is required to 
allocate 22 percent of gross mineral income to the principal of a trust 
for purposes of maintaining a reserve for depletion and the depletion 
deduction is entirely allocated to the trustee. In 1975 the gross income 
of a trust in State X the only assets of which were oil properties was 
$1,000. The trust's allowable percentage depletion pursuant to section 
613A(c) without regard to section 613A(d)(1) was $220. The trust 
incurred expenses of $150 for the taxable year and made distributions to 
beneficiaries (who are not described in the exception for family members 
set forth in paragraph (a)(1)(iv) of this section) of $630 ($1,000 gross 
income -$220 allocated to principal -$150 expenses). The trust's 
deduction for personal exemption under section 642(b) is $300. For 
purposes of applying the 65 percent limitation, the trust's taxable 
income was $550 ($1,000 gross income -$150 expenses -$300 exemption). 
The limitation under section 613A(d)(1) was $357.50 (65% x $550 taxable 
income). Accordingly, the trust's percentage depletion allowance was 
unaffected by the 65 percent limitation.
    Example 5. In 1980 the gross income of the estate of D was $1,000. 
The only assets of the estate were oil properties. The estate's adjusted 
basis in the oil properties was $0. The estate's allowable percentage 
depletion pursuant to section 613A(c) without regard to section 
613A(d)(1) was $220. The estate incurred expenses of $150 for the 
taxable year and made distributions to beneficiaries of $425. The 
distributions thus equaled one half of the net income of the estate 
(ignoring depletion). Under section 611(b)(4), the percentage depletion 
is apportioned equally between the estate and its beneficiary. The 
distribution amount of $425 is deductible under section 661(a) in 
computing the taxable income of the estate. For purposes of applying the 
65 percent limitation to the percentage depletion apportioned to the 
estate, the estate's taxable income was $0 ($1,000 gross income -$150 
expenses -$425 distribution -$600 exemption). The limitation under 
section 613A(d)(1) was therefore also $0 (65% x $0 taxable income). 
Accordingly, the $110 amount is disallowed to the estate for the taxable 
year but may be carried forward by the estate as a deduction to 1981 and 
subsequent years. The beneficiaries shall apply the 65 percent 
limitation to the $110 percentage depletion apportioned to them based on 
their respective taxable incomes.
    Example 6. In 1975 E sold an oil property for which E's adjusted 
basis was $20x. The amount disallowed for 1975 to E under section 
613A(d) was $10x. The amount of the carryover under that section to 1976 
was $0 ($10x disallowed amount -$10x [$20x adjusted basis of property on 
sale -$10x adjusted basis which taxpayer would have had in the property 
in the absence of the 65-percent limitation]). However, if the adjusted 
basis of the property on disposition had been $0, the amount of the 
carryover to 1976 would have been $10x ($10x disallowed amount -$0 
adjusted basis of property on sale).
    Example 7. In 1975 F owned producing properties M, N, O, P, Q, and 
R. With respect to

[[Page 487]]

property M, the allowable cost depletion was $100x (the allowable 
percentage depletion pursuant to section 613A(c) without regard to the 
depletable quantity and taxable income limitations contained in section 
613A(c)(1), (6) and (d)(1) would have been $90x). With respect to 
property N, the allowable percentage depletion pursuant to section 
613A(c) before applying section 613A(d)(1) was $80x (cost depletion 
would have been $0). With respect to property O, the allowable cost 
depletion was $60x (the allowable percentage depletion pursuant to 
section 613A(c) would have been $70x, except that the application of 
section 613A(d)(1) reduced allowable percentage depletion to less than 
$60x). With respect to property P, the allowable percentage depletion 
pursuant to section 613A(b) was $55x (cost depletion would have been 
$40x). With respect to property Q, which produces both gas subject to 
section 613A(b)(1)(B) and oil subject to section 613A(c), the allowable 
percentage depletion was $45x (cost depletion would have been $40x). 
With respect to property R, the allowable cost depletion was $40x (the 
allowable percentage depletion pursuant to section 613A(c) would have 
been $50x, except that the application of section 613A(c)(7)(A) reduced 
allowable percentage depletion to less than $40x). Under paragraph 
(a)(1)(i) of this section, for purposes of applying the 65 percent 
limitation under section 613A(d)(1), F's taxable income must be reduced 
by the allowable depletion with respect to property M (for which cost 
depletion exceeded percentage depletion even in the absence of section 
613A(c)(1), (6), and (d)) and property P (for which all depletion is 
determined pursuant to section 613A(b)), but shall not be reduced by the 
allowable depletion with respect to properties N, O, Q, and R.

    (b) Retailers excluded. (1) Section 613A(c) and Sec.  1.613A-3 shall 
not apply in the case of any taxpayer who is a retailer as defined in 
paragraph (r) of Sec.  1.613A-7.
    (2) The application of this paragraph may be illustrated by the 
following examples (those that involve sales through retail outlets 
assume, unless otherwise stated, that the $5,000,000 gross receipts 
requirement section 613A(d)(2) is met):

    Example 1. A, owner of producing oil and gas properties, also owns 5 
percent in value of the stock of Corporation M, a retailer of oil and 
gas. None of A's production is sold through Corporation M. Since A may 
benefit from Corporation M's sales of oil and gas through A's ownership 
interest in Corporation M, A is considered to be selling oil or natural 
gas through Corporation M, a related person. Accordingly, the exemption 
under section 613A(c) does not apply to A, even though none of A's 
production is sold through Corporation M.
    Example 2. Assume the same facts as in Example 1 except that A has 
gross receipts of $2 million from sales of oil for the taxable year from 
A's retail outlets and Corporation M has gross receipts of $4 million 
from sales of oil for the taxable year from its retail outlets. For 
purposes of the $5 million gross receipts requirement of section 
613A(d)(2), A is treated as having gross receipts of $6 million. 
Accordingly, the exemption under section 613A(c) does not apply to A.
    Example 3. Corporation N, a retailer of oil and gas, owns 5 percent 
in value of the stock of Corporation O, owner of producing oil and gas 
properties. None of Corporation O's production is sold through 
Corporation N. Since Corporation O has no direct or indirect ownership 
interest in Corporation N, and therefore does not benefit from 
Corporation N's sales of oil and gas, and since none of Corporation O's 
production is sold through Corporation N, the exemption under section 
613A(c) applies to Corporation O.
    Example 4. Corporation P, a producer of oil, owns 70 percent in 
value of the stock of Corporation Q. Corporation Q owns 30 percent in 
value of the stock of Corporation R. Corporation R owns 30 percent in 
value of the stock of Corporation S, a retailer of oil and gas. P 
indirectly owns 6.3 percent (70 percent x 30 percent x 30 percent) in 
value of the stock of Corporation S. Since P may benefit from 
Corporation S's sales of oil and gas through P's indirect ownership 
interest in Corporation S, P is not entitled to percentage depletion.
    Example 5. B is the owner of certain oil and gas properties in Texas 
and is also the owner of a service station in Washington, DC, which B 
leases to Corporation T. None of B's production is sold to Corporation 
T. The exemption under section 613A(c) applies to B. However, if sales 
of B's production were made to Corporation T and the gross receipts from 
such sales of B's production to Corporation T exceed 5 million dollars, 
the exemption under section 613A(c) would not apply to B because B is 
selling oil or natural gas to a person given authority to occupy a 
retail outlet leased by the taxpayer, B.
    Example 6. C has a \1/8\ royalty interest and Corporation U has a 
\7/8\ working interest in an oil property. Corporation V, a retailer of 
oil, owns 5 percent in value of the stock of Corporation U. C has no 
interest in either corporation. All of the production from the property 
is sold through Corporation V, C receiving from Corporation U \1/8\ of 
its receipts therefrom. The exemption under section 613A(c) does not 
apply to Corporation U because Corporation U is selling oil of natural 
gas through Corporation V, a related person that is a retailer. However, 
the exemption

[[Page 488]]

applies to C because C, as owner of a nonoperating mineral interest, is 
not treated as an operator of a retail outlet merely because C's oil and 
gas is sold on C's behalf through a retail outlet operated by an 
unrelated person.
    Example 7. D owns and operates retail grocery stores where refined 
oil may be purchased. D also owns oil and gas producing properties. If 
the sales of refined oil at each store location constitute less than 5 
percent of the gross receipts from all sales made at that store, D is 
not considered a retailer by reason of such sales.
    Example 8. Lessee E sells natural gas to lessor F directly from a 
wellhead gathering pipelines system for F's local agricultural use, in 
transactions incidental to the acquisition of a natural gas lease. The 
sales of natural gas to F are not sales through a retail outlet.
    Example 9. Corporation W produces natural gas, some of which it 
sells at retail. For purposes of determining whether Corporation W is a 
retailer selling gas through a retail outlet within the meaning of Sec.  
1.613A-7(r), the business office of Corporation W where a purchaser 
would normally contact the corporation with respect to its sales to the 
purchaser is considered the place at which those sales of natural gas 
are made.
    Example 10. G, husband, is the sole owner and operator of a retail 
outlet which sells oil and gas. H, wife, owns producing oil and gas 
properties. G is not related to H for purposes of section 613A(d).
    Example 11. I, husband, and J, wife, are community property owners 
of 10 percent in value of the stock of Corporation X which is a retailer 
of oil and gas. I and J are each treated as owning 5 percent of 
Corporation X. Therefore, neither I nor J qualify for the exemption 
under section 613A(c).
    Example 12. Corporation Y, an electing small business corporation as 
defined in section 1371 (as in effect prior to the enactment of the 
subchapter S Revision Act of 1982), owns producing oil and gas 
properties. K, a retailer of oil and gas, is a 50 percent interest 
shareholder of Corporation Y. None of Corporation Y's production is sold 
through K. Corporation Y is eligible for percentage depletion.
    Example 13. Corporation Z, a producer of natural gas, makes bulk 
sales of natural gas to industrial users. For purposes of determining 
whether Corporation Z is a retailer under Sec.  1.613A-7(r), the bulk 
sales are disregarded.
    Example 14. L, a calendar year taxpayer, is the owner of a producing 
oil property. On September 1, 1976, L purchased a chain of gasoline 
service stations. Therefore, L was a retailer of oil and gas for the 
last 122 days of 1976. L's gross income from the oil property for the 
taxable year was $150x and L's taxable income from the property was 
$30x. L is treated as a retailer with respect to $50x of gross income 
from the property ($150x x 122/366) and $10x of taxable income from the 
property ($30x x 122/366). Therefore, L is entitled to percentage 
depletion with respect to $100x of gross income from the property ($150x 
minus $50x). However, the allowable percentage depletion is limited by 
the 50 percent of taxable income from the property limitation to $10x 
(50 percent times $20x taxable income ($30x minus $10x)).
    Example 15. Corporation M is a partner in Partnership MNO which is 
the owner of an operating interest in a producing oil property. 
Corporation P, a retailer of oil and gas, owns 5 percent in value of the 
stock of Corporation M. Partnership MNO sells its production to 
Corporation P. Corporation M is retailing oil through Corporation P, a 
related person, because its share of the oil is being sold on its behalf 
by the partnership through a retail outlet operated by a person related 
to Corporation M. Therefore, the exemption under section 613A(c) does 
not apply to Corporation M.
    Example 16. AA and BB are beneficiaries of a trust which is a 
retailer of oil and gas. AA has an interest in the income of the trust 
for AA's lifetime which, actuarially determined, represents more than 5 
percent of the beneficial interests in the trust. BB's interest in the 
trust, which entitles BB to 5 percent of the corpus of the trust 5 years 
after AA's death, represents less than 5 percent of the beneficial 
interests in the trust prior to AA's death and represents more than 5 
percent after AA's death. The trust is a related person of AA but not BB 
while AA is alive. Accordingly, during AA's lifetime BB is not 
disqualified from the exemption provided by section 613A(c), but AA is.
    Example 17. Assume the same facts as in Example 16, except that AA's 
interest in the income of the trust represents 4 percent of the 
beneficial interests in the trust. AA is disqualified from the exemption 
provided by section 613A(c) with respect to the income from the trust 
but not with respect to income from other sources.

    (c) Certain refiners excluded. (1) Section 613A(c) and Sec.  1.613A-
3 shall not apply in the case of any taxpayer who is a refiner as 
defined in paragraph (s) of Sec.  1.613A-7.
    (2) The provisions of this paragraph may be illustrated by the 
following examples:

    Example 1. Corporation M owns a refinery which has refinery runs in 
excess of 50,000 barrels on at least one day during the taxable year. 
Corporation M also owns a 5 percent interest in Corporation N, owner of 
producing oil and gas properties. None of Corporation N's production is 
sold to Corporation M. The exemption under section 613A(c)

[[Page 489]]

does not apply to Corporation N because Corporation M, a related person 
of Corporation N, engages in the refining of crude oil.
    Example 2. A and B are equal partners in Partnership AB, which owns 
oil and gas producing properties. A owns a refinery which has refinery 
runs in excess of 50,000 barrels on at least one day during the taxable 
year and which buys all of Partnership AB's production. B has no 
ownership interest in any refinery. B is not a refiner.

[T.D. 8348, 56 FR 21946, May 13, 1991; 57 FR 4913, Feb. 10, 1992]



Sec.  1.613A-5  Election under section 613A(c)(4).

    The election under section 613A(c)(4) is an annual election which 
the taxpayer may make by claiming percentage depletion deductions for 
the taxable year based upon such election. The election may be made, on 
an original or amended tax return or a claim for credit or refund, at 
any time prior to the expiration of the statutory period (including any 
extensions thereof) for the filing of a claim for credit or refund by 
the taxpayer. The election may be changed by the taxpayer by filing an 
amended return or a claim for credit or refund. The election allows the 
taxpayer to treat as his depletable natural gas quantity an amount equal 
to 6,000 cubic feet multiplied by the number of barrels of the 
taxpayer's depletable oil quantity to which the election applies. The 
election applies to secondary or tertiary production, as well as primary 
production, but in determining the taxpayer's depletable natural gas 
quantity with respect to secondary or tertiary production the taxpayer's 
depletable oil quantity shall be determined without regard to section 
613A(c)(3)(A)(ii) with respect to production from secondary or tertiary 
processes.

[T.D. 7487, 42 FR 24264, May 13, 1977]



Sec.  1.613A-6  Recordkeeping requirements.

    (a) Principal value of property demonstrated. In the case of a 
transfer (as defined in Sec.  1.613A-7(n)) after December 31, 1974, of 
an interest in an oil or gas property (as defined in Sec.  1.613A-7(p)), 
the transferee (as defined in section 1.613A-7(o)) shall keep records 
showing the terms of the transfer, any geological and geophysical data 
in the possession of the transferee or other exploratory data with 
respect to the property transferred, and any other information which 
bears upon the question of whether at the time of the transfer the 
principal value of the property transferred had been demonstrated by 
prospecting, exploration, and discovery work.
    (b) Production from secondary or tertiary processes. Every taxpayer 
who claims depletion with respect to oil or gas produced by secondary or 
tertiary processes (as defined in Sec.  1.613A-7(k)) shall keep records 
of the secondary and tertiary processes applied and maintain records of 
the amount of production so resulting.
    (c) Retention of records. The records required by this section shall 
be kept at all times available for inspection by authorized Internal 
Revenue officers or employees, and shall be retained so long as the 
contents may become material in the administration of any Internal 
Revenue law.

[T.D. 7487, 42 FR 24264, May 13, 1977]



Sec.  1.613A-7  Definitions.

    For purposes of section 613A and the regulations thereunder--
    (a) Domestic. The term domestic, as applied to oil and gas wells (or 
to production from such wells), refers to wells located in the United 
States or in a possession of the United States, as defined in section 
638 and the regulations thereunder.
    (b) Natural gas. The term natural gas means any product (other than 
crude oil as defined in paragraph (g) of this section) of an oil or gas 
well if a deduction for depletion is allowable under section 611 with 
respect to such product.
    (c) Regulated natural gas. Natural gas is considered to be 
``regulated'' only if all of the following requirements are met:
    (1) The gas must be domestic gas produced and sold by the producer 
(whether for himself or on behalf of another person) before July 1, 
1976,
    (2) The price for which the gas is sold by the producer must not be 
adjusted to reflect to any extent the increase in liability of the 
seller for tax under chapter 1 of the Code by reason of the repeal of 
percentage depletion for gas,

[[Page 490]]

    (3) The sale of the gas must have been subject to the jurisdiction 
of the Federal Power Commission for regulatory purposes,
    (4) An order or certificate of the Federal Power Commission must be 
in effect (or a proceeding to obtain such an order or certificate must 
have been instituted), and
    (5) The price at which the gas is sold must be taken into account, 
directly or indirectly, in the issuance of the order or certificate by 
the Federal Power Commission. Price increases after February 1, 1975, 
are presumed to take increases in tax liabilities into account unless 
the taxpayer demonstrates to the contrary by clear and convincing 
evidence that the increases are wholly attributable to a purpose or 
purposes unrelated to the repeal of percentage depletion for gas (e.g., 
where the record of the Federal Power Commission clearly establishes 
that the Commission did not take the repeal into account). Increases to 
reflect additional State and local real property or severance taxes, 
increases for additional operating costs (such as costs of secondary or 
tertiary processes), adjustments for inflation, increases for additional 
drilling and related costs, or increases to reflect changes in the 
quality of gas sold, are some examples of increases that are not 
attributable to the repeal of percentage depletion for gas. In the 
absence of a statement in writing by the Federal Power Commission that 
the price of the gas in question was not in fact regulated, the 
requirement of paragraph (c)(5) of this section is deemed to have been 
met in any case in which the Federal Power Commission issued an order or 
certificate approving the sale to an interstate pipeline company or, in 
a case in which it is established by the taxpayer that the Federal Power 
Commission has influenced the price of such gas, an order or certificate 
permitting the interstate transportation of such gas. In addition, an 
``emergency'' sale of natural gas to an interstate pipeline, which, 
pursuant to the authority contained in 18 CFR 2.68, 2.70, 157.22, and 
157.29, may be made without prior order approving the sale, is deemed to 
have met the requirements of paragraph (c) (3), (4), and (5) of this 
section. For purposes of meeting the requirements under this paragraph, 
it is not necessary that the total gas production from a property 
qualify as ``regulated natural gas.'' The determination of whether 
mineral production is ``regulated natural gas'' shall be made with 
respect to each sale of the mineral or minerals produced.
    (d) Natural gas sold under a fixed contract. The term natural gas 
sold under a fixed contract means domestic natural gas sold by the 
producer (whether for himself or on behalf of another person) under a 
contract, in effect on February 1, 1975, and at all times thereafter 
before such sale, under which the price for the gas during such period 
cannot be adjusted to reflect to any extent the increase in liabilities 
of the seller for tax under chapter 1 of the Code by reason of the 
repeal of percentage depletion for gas. The term may include gas sold 
under a fixed contract even though production sold under the contract 
had previously been treated as regulated natural gas. Price increases 
after February 1, 1975, are presumed to take increases in tax 
liabilities into account unless the taxpayer demonstrates to the 
contrary by clear and convincing evidence. Paragraph (c) of this section 
provides examples of increases which do not take increases in tax 
liabilities into account. However, if an adjustment provided for in the 
contract permits the possible increase in federal income tax liability 
of the seller to be taken into account to any extent, the gas sold under 
the contract after such an increase becomes permissible is not gas sold 
under a fixed contract. If the adjustment provided for in the contract 
provides for an increase in the price of the contract to the highest 
price paid to a producer for natural gas in the area, or if the price 
may be renegotiated, then gas sold under the contract after such an 
increase becomes permissible is presumed not to be sold under a fixed 
contract unless the taxpayer demonstrates by clear and convincing 
evidence that the price increase in no event takes increases in tax 
liabilities into account. For purposes of meeting the requirements of 
this paragraph, it is not necessary that the total gas production from a 
property qualify as ``natural gas sold under

[[Page 491]]

a fixed contract,'' for the determination of ``natural gas sold under a 
fixed contract'' is to be made with respect to each sale of each type of 
natural gas sold pursuant to each contract.
    (e) Qualified natural gas from geopressured brine. The term 
``qualified natural gas from geopressured brine'' means any natural gas 
which is determined in accordance with section 503 of the Natural Gas 
Policy Act of 1978 to be produced from geopressured brine and which is 
produced from any well the drilling of which began after September 30, 
1978, and before January 1, 1984.
    (f) Average daily production. (1) The term average daily production 
means the taxpayer's aggregate production of domestic crude oil or 
natural gas, as the case may be, which is extracted after December 31, 
1974, and to which gross income from the property is attributable during 
the taxable year divided by the number of days in such year. As used in 
the preceding sentence the term taxpayer includes a small business 
corporation as defined in section 1371 (as in effect prior to the 
enactment of the subchapter S Revision Act of 1982) and the regulations 
thereunder. Notwithstanding the provisions of Sec.  1.612-3 and except 
as provided in Sec.  1.613A-3(j)(2), in computing the average daily 
production for a taxable year only oil or gas which has been actually 
produced by the close of such taxable year is taken into account. 
Average daily production does not include production resulting from 
secondary or tertiary processes to which gross income from the property 
is attributable before January 1, 1984.
    (2) In the case of a fiscal-year taxpayer, paragraph (f)(1) of this 
section shall be applied separately to each short taxable year under 
section 613A(c)(11), as in effect prior to the Revenue Reconciliation 
Act of 1990.
    (3) In the case of a taxpayer holding a partial interest in the 
production from any property (including an interest of a partner in 
property of a partnership or a net profit interest) such taxpayer's 
production shall be considered to be that amount of such production 
determined by multiplying the total production (which is produced after 
December 31, 1974, and to which gross income from the property is 
attributable during the taxable year) of the property by the taxpayer's 
percentage participation in the gross revenues from the property during 
the year. However, the portion of trust (or estate) production allocable 
to a beneficiary shall not exceed that amount of the trust's (or 
estate's) depletable oil quantity determined by multiplying such 
quantity by the beneficiary's percentage interest in the trust's (or 
estate's) gross income from the property.
    (g) Crude oil. For purposes of section 613A and the regulations 
thereunder, the term crude oil means--
    (1) A mixture of hydrocarbons which existed in the liquid phase in 
natural underground reservoirs and which remains liquid at atmospheric 
pressure after passing through surface separating facilities,
    (2) Hydrocarbons which existed in the gaseous phase in natural 
underground reservoirs but which are liquid at atmospheric pressure 
after being recovered from oil well (casinghead) gas in lease 
separators, and
    (3) Natural gas liquid recovered from gas well effluent in lease 
separators or field facilities before any conversion process has been 
applied to such production.
    (h) Depletable oil quantity. The taxpayer's depletable oil quantity, 
within the meaning of section 613A(c)(1)(A), shall be equal to the 
tentative quantity determined under the table contained in section 
613A(c)(3)(B) and paragraph (b) of Sec.  1.613A-3 (except that, in the 
case of determinations with respect to days prior to January 1, 1984, 
such quantity shall be reduced (but not below zero) by the taxpayer's 
average daily secondary or tertiary production for the taxable year).
    (i) Depletable natural gas quantity. The taxpayer's depletable 
natural gas quantity, within the meaning of section 613A(c)(1)(B), shall 
be equal to 6,000 cubic feet multiplied by the number of barrels of the 
taxpayer's depletable oil quantity to which the taxpayer elects to have 
section 613A(c)(4) apply. The taxpayer's depletable oil quantity for any 
taxable year shall be reduced (in addition to any reduction required to 
be made under paragraph (h) of this section) by the number of barrels 
with

[[Page 492]]

respect to which an election under section 613A(c)(4) for natural gas 
has been made. See Sec.  1.613A-5.
    (j) Barrel. The term barrel means 42 United States gallons.
    (k) Secondary or tertiary production. For purposes of section 613A 
the term secondary or tertiary production means the increased production 
of domestic crude oil or natural gas from a property at any time after 
the application of a secondary or tertiary process. The increased 
production is the excess of actual production over the maximum primary 
production which would have resulted during the taxable year if the 
secondary or tertiary process had not been applied. The increased 
production may be due to an increase in either the rate or the duration 
of recovery. A secondary or tertiary process is a process applied for 
the recovery of hydrocarbons in which liquids, gases, or other matter is 
injected into the reservoir to supplement or augment the natural forces 
required to move the hydrocarbons through the reservoir. However, no 
process which must be introduced early in the productive life of the 
mineral property in order to be reasonably effective (such as cycling of 
gas in the case of a gas-condensate reservoir) is a secondary or 
tertiary process. A process (such as fire flooding or miscible fluid 
injection) introduced early in the productive life of the mineral 
property will not be disqualified as a secondary or tertiary process if 
a later introduction of the process in the property would still have 
been reasonably effective.
    (l) Controlled group of corporations. The term controlled group of 
corporations has the meaning given to such term by section 1563(a), 
except that section 1563(b)(2) shall not apply and except that ``more 
than 50 percent'' shall be substituted for `` at least 80 percent'' each 
place it appears in section 1563(a).
    (m) Related person. (1) A person is a related person to another 
person, within the meaning of section 613A(d) (2) and (4), paragraphs 
(b) and (c) of Sec.  1.613A-4, and paragraphs (r) and (s) of this 
section, if either a significant ownership interest in such person is 
held by the other, or a third person has a significant ownership 
interest in both such persons. For purposes of determining a significant 
ownership interest, an interest owned by or for a corporation, 
partnership, trust, or estate shall be considered as owned directly both 
by itself and proportionately by its shareholders, partners, or 
beneficiaries, as the case may be. The term significant ownership 
means--
    (i) With respect to any corporation, direct or indirect ownership of 
5 percent or more in value of the outstanding stock of such corporation,
    (ii) With respect to a partnership, direct or indirect ownership of 
5 percent or more interest in the profits or capital of such 
partnership, and
    (iii) With respect to an estate or trust, direct or indirect 
ownership of 5 percent or more of the beneficial interests in such 
estate or trust. The relative percentage ownership of beneficiaries of 
an estate or trust in the beneficial interests therein shall be 
determined under actuarial principles.
    (2) A person is a ``related person'' to another person, within the 
meaning of section 613A(c)(8)(B) and paragraph (h)(2) of Sec.  1.613A-3, 
if such persons are members of the same controlled group of corporations 
or if the relationship between such persons would result in a 
disallowance of losses under section 267 or 707(b), except that for this 
purpose the family of an individual includes only the individual's 
spouse and minor children.
    (n) Transfer. The term transfer means any change in ownership for 
federal tax purposes after December 31, 1974, by sale, exchange, gift, 
lease, sublease, assignment, contract, or other disposition (including 
any contribution to or any distribution by a corporation, partnership, 
or trust), any change in the membership of a partnership or the 
beneficiaries of a trust, or any other change by which a taxpayer's 
proportionate share of the income subject to depletion of an oil or gas 
property is increased. For taxable years beginning after 1982, the term 
``transfer'' includes an election by a C corporation to be an S 
corporation (properties deemed transferred by the C corporation on the 
day the election first becomes effective) and a termination of an S 
election (each shareholder's pro rata share of

[[Page 493]]

assets of S corporation deemed transferred to C corporation on the day 
that the termination first becomes effective). However, the term does 
not include--
    (1) A transfer of property at death (including a distribution by an 
estate, whether or not a pro rata distribution),
    (2) An exchange to which section 351 applies,
    (3) A change of beneficiaries of a trust by reason of the death, 
birth, or adoption of any vested beneficiary if the transferee was a 
beneficiary of the trust or is a lineal descendant of the settlor or any 
other vested beneficiary of the trust, except in the case of any trust 
where any beneficiary of the trust is a member of the family (as defined 
in section 267(c)(4)) of a settlor who created inter vivos and 
testamentary trusts for members of the family and the settlor died 
within the last six days of the fifth month in 1970, and the law in the 
jurisdiction in which the trust was created requires all or a portion of 
the gross or net proceeds of any royalty or other interest in oil, gas, 
or other mineral representing any percentage depletion allowance to be 
allocated to the principal of the trust,
    (4) A transfer of property between corporations which are members of 
the same controlled group of corporations (as defined in section 
613A(c)(8)(D)(i)),
    (5) A transfer of property between business entities which are under 
common control (within the meaning of section 613A(c)(8)(B)) or between 
related persons in the same family (within the meaning of section 
613A(c)(8)(C)),
    (6) A transfer of property between a trust and members of the same 
family (within the meaning of section 613A(c)(8)(C)) to the extent that 
both (i) the beneficiaries of the trust are and continue to be members 
of the family that transferred the property, and (ii) the tentative oil 
quantity is allocated among the members of such family,
    (7) A reversion of all or part of an interest with respect to which 
the taxpayer was eligible for percentage depletion pursuant to section 
613A(c), or
    (8) A conversion of a retained interest which is eligible for such 
depletion into an interest which constituted all or part of an interest 
previously owned by the taxpayer also eligible for such depletion.

However, paragraph (n) (2), (4), and (5) of this section shall apply 
only so long as the tentative quantity determined under the table 
contained in section 613A(c)(3)(B) (as in effect prior to the Revenue 
Reconciliation Act of 1990) is required to be allocated under section 
613A(c)(8) between the transferor and transferee, or among members of a 
controlled group of corporations. In the case of an individual 
transferor, the allocation test of the preceding sentence shall not be 
failed merely because of the death of the transferor. For purposes of 
paragraph (n) (3) and (6), an individual adopted by a beneficiary is a 
lineal descendant of that beneficiary. For purposes of paragraph (n) (7) 
and (8), a taxpayer previously ineligible for percentage depletion 
solely by reason of section 613A(d) (2) or (4) will be considered to 
have been eligible for such depletion. A transfer is deemed to occur on 
the day on which a contract or other commitment to transfer the property 
becomes binding upon both the transferor and transferee, or, if no such 
contract or commitment is made, on the day on which ownership of the 
interest in oil or gas property passes to the transferee.
    (o) Transferee. The term ``transferee'', as used in section 
613A(c)(9), paragraph (i)(1) of Sec.  1.613A-3, and this section 
includes the original transferee of proven property and his or her 
successors in interest (excluding successors in interest of proven 
property transferred after October 11, 1990). A person shall not be 
treated as a transferee of an interest in a proven oil or gas property 
to the extent that such person was entitled to a percentage depletion 
allowance on mineral produced with respect to the property immediately 
before the transfer. However, a person shall be treated as a transferee 
of an interest in a proven property to the extent that the interest such 
person receives is greater than the interest in the property the person 
held immediately before the transfer. For example, where the owner of a 
proven oil property transfers his or her entire interest therein to a 
partnership of which he or she is a member and, as a consequence, 
becomes entitled to a depletion allowance based on

[[Page 494]]

only one-third of the oil produced with respect to that property, the 
owner (the transferor) is not denied percentage depletion with respect 
to the one-third interest in oil production which the owner still 
possesses. If the partnership agreement had made an effective allocation 
(under section 704 and Sec.  1.704.1) of all the income in respect of 
such property to the transferor partner, that partner would be entitled 
to percentage depletion on the entire oil production from that property. 
For this purpose, a person who has transferred oil or gas property 
pursuant to a unitization or pooling agreement shall be treated as 
having been entitled to a depletion allowance immediately before the 
transfer to that person of the interest in the unit or pool with respect 
to all of the mineral in respect of which the person receives gross 
income from the property pursuant to the unitization or pooling 
agreement, except to the extent such income is attributable to 
consideration paid by that person for such interest in addition to that 
person's contribution of the oil or gas property and equipment affixed 
thereto.
    (p) Interest in proven oil or gas property. The term interest in an 
oil or gas property means an economic interest in oil or gas property. 
An economic interest includes working or operating interests, royalties, 
overriding royalties, net profits interests, and, to the extent not 
treated as loans under section 636, production payments from oil or gas 
properties. The term also includes an interest in a partnership, S 
corporation, small business corporation, or trust holding an economic 
interest in oil or gas property but does not include shares of stock in 
a corporation (other than an S corporation and small business 
corporation) owning such an interest. An oil or gas property is 
``proven'' if its principal value has been demonstrated by prospecting, 
exploration, or discovery work. The principal value of the property has 
been demonstrated by prospecting, exploration, or discovery work only if 
at the time of the transfer--
    (1) Any oil or gas has been produced from a deposit, whether or not 
produced by the taxpayer or from the property transferred;
    (2) Prospecting, exploration, or discovery work indicate that it is 
probable that the property will have gross income from oil or gas from 
the deposit sufficient to justify development of the property; and
    (3) The fair market value of the property is 50 percent or more of 
the fair market value of the property, minus actual expenses of the 
transferee for equipment and intangible drilling and development costs, 
at the time of the first production from the property subsequent to the 
transfer and before the tansferee transfers his or her interest.

For purposes of this paragraph, the property is to be determined by 
applying section 614 and the regulations thereunder to the transferee at 
the time of the transfer. If the transfer is of an interest in a 
partnership, S corporation, small business corporation, or trust, the 
determination shall be made with respect to each property owned by the 
partnership, S corporation, small business corporation, or trust. The 
term prospecting, exploration, or discovery work includes activities 
which produce information relating to the existence, location, extent, 
or quality of any deposit of oil or gas, such as seismograph surveys and 
drilling activities (whether for exploration or for the production of 
oil or gas).
    (q) Amount disallowed. The amount disallowed, within the meaning of 
section 613A(d)(1) and paragraph (a) of Sec.  1.613A-4, is the excess of 
the amount of the aggregate of the taxpayer's allowable depletion 
deductions (whether based upon cost or percentage depletion) computed 
without regard to section 613A(d)(1) over the amount of the aggregate of 
such deductions computed with regard to such section. The disallowed 
amount shall be carried over to the succeeding year and treated as an 
amount allowable as a deduction pursuant to section 613A(c) for the 
succeeding year, subject to the 65-percent limitation of section 
613A(d)(1) and the rules contained in Sec.  1.613A-4(a).
    (r) Retailer. (1) Except as otherwise provided in paragraph (r)(2) 
of this section, the term retailer means any taxpayer who directly, or 
through a related person (as defined in paragraph

[[Page 495]]

(m)(1) of this section), sells oil or natural gas, or any product 
derived from oil or natural gas--
    (i) Through any retail outlet operated by the taxpayer or a related 
person, or
    (ii) To any person--
    (A) Obligated under an agreement or contract with the taxpayer or a 
related person to use a trademark, trade name, or service mark or name 
owned by such taxpayer or a related person, in marketing or distributing 
oil or natural gas or any product derived from oil or natural gas, or
    (B) Given authority, pursuant to an agreement or contract with the 
taxpayer or a related person, to occupy any retail outlet owned, leased, 
or in any way controlled by the taxpayer or a related person.

For purposes of the preceding sentence, bulk sales (i.e., sales in very 
large quantities) of oil or natural gas (but not bulk sales of any 
product derived from oil or natural gas) to commercial or industrial 
users shall be disregarded. Bulk sales made after September 18, 1982, of 
aviation fuels to the Department of Defense shall be also disregarded. 
In addition, sales of oil or natural gas (whether or not produced by the 
taxpayer), or of any product derived from oil or natural gas, which are 
made outside the United States shall be disregarded if no domestic 
production of oil, natural gas (or products derived therefrom) of the 
taxpayer or a related person is exported during the taxable year or the 
immediately preceding taxable year.
    (2) Notwithstanding paragraph (r)(1) of this section, the taxpayer 
shall not be considered a retailer in any case where, during the taxable 
year of the taxpayer, the combined gross receipts from sales (excluding 
sales for resale) of oil or natural gas, or products derived therefrom, 
of all retail outlets taken into account under paragraph (r)(1) of this 
section (including sales through a retail outlet of oil, natural gas, or 
a product derived from oil or natural gas which had previously been the 
subject of a sale described in paragraph (r)(1)(ii) of this section) do 
not exceed $5 million. If the taxpayer's combined gross receipts for the 
taxable year exceed $5 million, the taxpayer will be treated as a 
retailer as of the first day in which a retail sale was made. For 
purposes of paragraph (r)(1) of this section, a taxpayer shall be deemed 
to be selling oil or natural gas (or a product derived therefrom) 
through a related person in any case in which any sale of oil or natural 
gas (or a derivative product) by the related person produces gross 
income from which the taxpayer may benefit by reason of the taxpayer's 
direct or indirect ownership interest in the related person. In such 
cases (and in any other case in which the taxpayer is selling through a 
retail outlet referred to in section 613A(d)(2)(A) or is selling such 
items to a person described in section 613A(d)(2)(B)), it is immaterial 
whether the oil or natural gas which is sold, or from which is derived a 
product which is sold, was produced by the taxpayer. A taxpayer shall be 
deemed to be selling oil or natural gas (or a derivative product) 
through a retail outlet operated by a related person in any case in 
which a related person who operates a retail outlet acquires for resale 
oil or natural gas (or a derivative product) which the taxpayer produced 
or caused to be made available for acquisition by the related person 
pursuant to an arrangement whereby some or all of the taxpayer's 
production is marketed. An owner of a nonoperating mineral interest 
(such as a royalty) shall not be treated as an operator of a retail 
outlet merely because the owner's oil or gas is sold on the owner's 
behalf through a retail outlet operated by an unrelated person. In 
addition, the mere fact that a member of a partnership is a retailer 
shall not result in characterization of the remaining partners as 
retailers. However, any partner of a partnership who has a 5 percent or 
more interest in any entity actually engaging in retail activities 
(including the partnership or another entity to which the partnership is 
related) is treated as a retailer. See paragraph (m)(1) of this section 
for rules on the ownership interest by partners in an entity related to 
a partnership. Similarly, if a trust or estate is a retailer, only its 
beneficiaries having a 5 percent or more current income interest from 
the trust or estate are treated as retailers. A person who is a retailer 
during a portion of the taxable

[[Page 496]]

year shall be treated as a retailer with respect to a fraction of that 
person's gross and taxable income from oil or gas properties for the 
taxable year, the numerator of which is the number of days during the 
taxable year in which the taxpayer is a retailer and the denominator of 
which is the total number of days during the taxable year; except that a 
person who ceases to be a retailer during the taxable year before the 
first production of oil or gas during such year shall not be treated as 
a retailer for any portion of such year.
    (3) For purposes of this paragraph (r), the term any product derived 
from oil or natural gas means gasoline, kerosene, Number 2 fuel oil, 
refined lubricating oils, diesel fuel, butane, propane, and similar 
products which are recovered from petroleum refineries or extracted from 
natural gas in field facilities or natural gas processing plants. The 
term retail outlet means any place where sales of oil or natural gas 
(excluding bulk sales of such items to commercial or industrial users), 
or a product of oil or natural gas (excluding bulk sales of aviation 
fuels to the Department of Defense), accounting for more than 5 percent 
of the gross receipts from all sales made at such place during the 
taxpayer's taxable year, are systematically made for any purpose other 
than for resale. For this purpose, sales of oil or natural gas, or any 
product derived from oil or natural gas, to a person for refining are 
considered as sales made for resale.
    (s) Refiner. A person is a refiner if such person or a related 
person (as defined in paragraph (m)(1) of this section) engages in the 
refining of crude oil (whether or not owned by such person or related 
person) and if the total refinery runs of such person and any related 
persons exceed 50,000 barrels on any day during the taxable year. A 
refinery run is the volume of inputs of crude oil (excluding any product 
derived from oil) into the refining stream. For purposes of this 
paragraph, crude oil refined outside the United States shall be taken 
into account. Refining is any operation by which the physical or 
chemical characteristics of crude oil are changed, exclusive of such 
operations as passing crude oil through separators to remove gas, 
placing crude oil in settling tanks to recover basic sediment and water, 
dehydrating crude oil, and blending of crude oil products.

[T.D. 8348, 56 FR 21949, May 13, 1991; 57 FR 4913, Feb. 10, 1992, as 
amended by T.D. 8437, 57 FR 43903, Sept. 23, 1992; 58 FR 6678, Feb. 1, 
1993]



Sec.  1.614-0  Introduction.

    Section 614 relates to the definition of property and to the various 
special rules by means of which taxpayers are permitted to aggregate or 
combine separate properties or to treat such properties as separate. 
These rules are set forth in detail in Sec. Sec.  1.614-1 through 1.614-
8. Section 1.614-1 sets forth rules under section 614(a) relating to the 
definition of the term property. Section 1.614-2 contains the rules 
relating to the election under section 614(b), as it existed prior to 
its amendment by section 226(a) of the Revenue Act of 1964, to aggregate 
operating mineral interests. In the case of mines, the rules contained 
in Sec.  1.614-2 are applicable only to taxable years beginning before 
January 1, 1958, to which the Internal Revenue Code of 1954 applies. In 
the case of oil and gas wells, the rules contained in Sec.  1.614-2 are 
applicable only to taxable years beginning before January 1, 1964, to 
which the Internal Revenue Code of 1954 applies. In the case of oil and 
gas wells, the taxpayer may, however, for taxable years beginning before 
January 1, 1964, treat any operating mineral interests as if section 614 
(a) and (b) (as it existed prior to its amendment by section 226(a) of 
the Revenue Act of 1964) had not been enacted. If any operating mineral 
interests are so treated, the rules contained in Sec.  1.614-2 are not 
applicable to such interests and such interests are, in respect of 
taxable years beginning before January 1, 1964, subject to the rules set 
forth in Sec.  1.614-4 relating to the Internal Revenue Code of 1939 
treatment of separate operating mineral interests in the case of oil and 
gas wells. Section 1.614-3 prescribes the rules relating to the election 
under section 614(c)(1) permitting the aggregation of operating mineral 
interests in the cases of mines for taxable years beginning after 
December 31, 1957. Section 1.614-3 also sets forth rules relating to the 
election under section 614(c)(2) in the case of

[[Page 497]]

mines by means of which a taxpayer is permitted to treat a single 
operating mineral interest as more than one such interest for taxable 
years beginning after December 31, 1957. At the election of the taxpayer 
with respect to an operating unit, the rules contained in Sec.  1.614-3 
are also applicable to taxable years beginning before January 1, 1958, 
to which the Internal Revenue Code of 1954 applies. If the taxpayer 
makes such an election, the rules contained in Sec.  1.614-2 are not 
applicable to any of the operating mineral interests which are part of 
the operating unit with respect to which the election described in Sec.  
1.614-3 is made. Section 1.614-5 sets forth the rules relating to the 
aggregation of nonoperating mineral interests. Section 1.614-6 contains 
the rules relating to basis, holding period, and abandonment and 
casualty losses where properties have been aggregated or combined. 
Section 1.614-7 relates to the extension of time for performing certain 
acts. Section 1.614-8 contains the rules relating to the elections under 
section 614(b) as amended by section 226(a) of the Revenue Act of 1964 
to treat separate operating mineral interests in the case of oil and gas 
wells as separate properties or in combination for taxable years 
beginning after December 31, 1963.

[T.D. 6859, 30 FR 13699, Oct. 28, 1965]



Sec.  1.614-1  Definition of property.

    (a) General rule. (1) For purposes of subtitle A of the Code, in the 
case of mines, wells, and other natural deposits, the term property 
means each separate interest owned by the taxpayer in each mineral 
deposit in each separate tract or parcel of land.
    (2) The term interest means an economic interest in a mineral 
deposit. See paragraph (b) of Sec.  1.611-1. The term includes working 
or operating interests, royalties, overriding royalties, net profits 
interests, and, to the extent not treated as loans under section 636, 
production payments.
    (3) The term tract or parcel of land is merely descriptive of the 
physical scope of the land to which the taxpayer's interest relates. It 
is not descriptive of the nature of his rights or interests in the land. 
All contiguous areas (even though separately described) included in a 
single conveyance or grant or in separate conveyances or grants at the 
same time from the same owner constitute a single separate tract or 
parcel of land. Areas included in separate conveyances or grants 
(whether or not at the same time) from separate owners are separate 
tracts or parcels of land even though the areas described may be 
contiguous. If the taxpayer's rights or interests within the same tract 
or parcel of land are dissimilar, then each such dissimilar interest 
constitutes a separate property. If the taxpayer's rights or interests 
(whether or not dissimilar) within the same tract or parcel of land 
relate to more than one separate mineral deposit, then his interest with 
respect to each such separate deposit is a separate property.
    (4) Upon the transfer of a property in any transaction in which the 
basis of such property in the hands of the transferee is determined by 
reference to the basis of such property in the hands of the transferor, 
such property shall, notwithstanding the provisions of subparagraph (3) 
of this paragraph, retain the same status and identity in the hands of 
the transferee as it had in the hands of the transferor. See paragraph 
(c) of Sec.  1.614-6 if the transferor has made a binding election to 
treat a separate mineral interest as a separate property, to treat a 
separate mineral interest as more than one property under section 
614(c), or to treat two or more separate mineral interests as an 
aggregated or combined property under section 614(b) (as it existed 
either before or after its amendment by section 226(a) of the Revenue 
Act of 1964), (c), or (e).
    (5) The provisions of this paragraph may be illustrated by the 
following examples:

    Example 1. A taxpayer owns one tract of land under which lie three 
separate and distinct seams of coal. Therefore, the taxpayer owns three 
separate mineral interests each of which constitutes a separate 
property.
    Example 2. A taxpayer conducts mining operations on eight tracts of 
land as a single unit. He acquired his interests in each of the eight 
tracts from separate owners. Even if each tract of land contains part of 
the same mineral deposit, the taxpayer owns eight separate mineral 
interests each of which constitutes a separate property.

[[Page 498]]

    Example 3. A taxpayer owns a tract of land under which lies one 
mineral deposit. The taxpayer operates a well on part of the tract and 
leases to another operator the mineral rights in the remainder retaining 
a royalty interest therein. The taxpayer thereafter owns two separate 
mineral interests each of which constitutes a separate property.
    Example 4. In 1954, a taxpayer acquires from a single owner, in a 
single deed, three noncontiguous tracts of mineral land for a single 
consideration. Even if each tract contains part of the same mineral 
deposit, the taxpayer owns three separate mineral interests each of 
which constitutes a separate property.
    Example 5. In 1954, taxpayer A simultaneously acquires in fee two 
contiguous tracts of mineral land from two separate owners. The same 
mineral deposit underlies both tracts. Thereafter, taxpayer A owns two 
separate mineral interests each of which constitutes a separate 
property.
    Example 6. Assume that in 1955, taxpayer A, in example 5, leases the 
two contiguous tracts of mineral land that he acquired in 1954 to 
taxpayer B by means of a single lease. Thereafter, taxpayer B owns one 
mineral interest which constitutes a separate property for such time as 
the lease continues in existence.
    Example 7. Assume that in 1955, taxpayer A, in example 5, sells at 
the same time all the mineral land he acquired in 1954 to taxpayer B. 
Thereafter, taxpayer B owns one mineral interest which constitutes a 
separate property. If taxpayer B acquires the mineral land in a 
transaction in which the basis of such mineral land in his hands is 
determined by reference to the basis of such mineral land in the hands 
of taxpayer A, then taxpayer B owns two separate mineral interests each 
of which constitutes a separate property.
    Example 8. In 1954, taxpayer A simultaneously acquires two 
contiguous leasehold interests from two separate owners. The same 
mineral deposit underlies both tracts. Thereafter, taxpayer A owns two 
separate mineral interests each of which constitutes a separate 
property.
    Example 9. In 1955, taxpayer A, in example 8, simultaneously assigns 
the two leases to taxpayer B. Thereafter, taxpayer B owns two separate 
mineral interests each of which constitutes a separate property.

    (b) Separation of interests treated as single property under prior 
regulations. Each separate mineral interest which, in accordance with 
paragraph (a) of this section, is a separate property shall be so 
treated, notwithstanding the fact that the taxpayer under paragraph (i) 
of Sec.  39.23(m)-1 of this chapter (Regulations 118) and corresponding 
provisions of prior regulations may have treated more than one of such 
interests as a single property. The basis of each such separate property 
must be established by a reasonable method. See, however, section 614 
(b) and (d) (as they existed prior to amendment by section 226 of the 
Revenue Act of 1964), section 614 (c) and (e), and Sec. Sec.  1.614-2, 
1.614-3, 1.614-4, and 1.614-5 for special rules relating to the 
treatment of two or more separate mineral interests as a single 
property.
    (c) Treatment of a waste bank or residue. A waste bank or residue of 
prior mining, the extraction of ores or minerals from which is treated 
as mining under section 613(c)(3), shall not be considered to be a 
separate mineral deposit but is a part of the mineral deposit from which 
it was extracted. However, if the owner of such waste bank or residue 
has disposed of the deposit from which the waste bank or residue was 
accumulated, or if the waste bank or residue cannot practicably be 
attributed to a particular deposit of the owner, the waste bank or 
residue will be regarded as a separate deposit.

[T.D. 6524, 26 FR 147, Jan. 10, 1961, as amended by T.D. 6859, 30 FR 
13699, Oct. 28, 1965; T.D. 7261, 38 FR 5467, Mar. 1, 1973]



Sec.  1.614-2  Election to aggregate separate operating mineral interests
under section 614(b) prior to its amendment by Revenue Act of 1964.

    (a) General rule. (1) The provisions of this section relate to the 
election, under section 614(b) prior to its amendment by section 226(a) 
of the Revenue Act of 1964, to aggregate separate operating mineral 
interests, and, unless otherwise indicated, all references in this 
section to section 614(b) or any paragraph or subparagraph thereof are 
references to section 614(b) or a paragraph or subparagraph thereof as 
it existed prior to such amendment. Notwithstanding the preceding 
sentence, the definitions contained in paragraphs (b) and (c) of this 
section shall apply both before and after such amendment. All references 
in this section to section 614(d) are references to section 614(d) as it 
existed prior to its amendment by section 226(b)(3) of the Revenue Act 
of 1964.

[[Page 499]]

    (2) A taxpayer who owns two or more separate operating mineral 
interests, which constitute part or all of an operating unit, may elect 
under section 614(b) and this section to form one aggregation of any two 
or more of such operating mineral interests and to treat such 
aggregation as one property. Any operating mineral interest which the 
taxpayer does not elect to include within the aggregation within the 
time prescribed in paragraph (d) of this section shall be treated as a 
separate property. The aggregation of separate properties which results 
from exercising the election shall be considered as one property for all 
purposes of subtitle A of the Code. The preceding sentence does not 
preclude the use of more than one account under a single method of 
computing depreciation or the use of more than one method of computing 
depreciation under section 167, if otherwise proper. Any reasonable and 
consistently applied method or methods of computing depreciation of the 
improvements made with respect to the separate properties aggregated may 
be continued in accordance with section 167 and the regulations 
thereunder. Operating interests in different minerals which comprise 
part or all of the same operating unit may be included in the 
aggregation. It is not necessary for purposes of the aggregation that 
the separate operating mineral interests be included in a single tract 
or parcel of land or in contiguous tracts or parcels of land so long as 
such interests are a part of the same operating unit. Under section 
614(b), a taxpayer cannot elect to form more than one aggregation of 
separate operating mineral interests within one operating unit. For 
definitions of operating mineral interest and operating unit see 
respectively paragraphs (b) and (c) of this section.
    (b) Operating mineral interest defined. The term operating mineral 
interest means a separate mineral interest as described in section 
614(a), in respect of which the costs of production are required to be 
taken into account by the taxpayer for purposes of computing the 
limitation of 50 percent of the taxable income from the property in 
determining the deduction for percentage depletion computed under 
section 613, or such costs would be so required to be taken into account 
if the mine, well, or other natural deposit were in the production 
stage. The term does not include royalty interests or similar interests, 
such as production payments or net profits interests. For the purpose of 
determining whether a mineral interest is an operating mineral interest, 
costs of production do not include intangible drilling and development 
costs, exploration expenditures under section 615, or development 
expenditures under section 616. Taxes, such as production taxes, payable 
by holders of nonoperating interests are not considered costs of 
production for this purpose. A taxpayer may not aggregate operating 
mineral interests and nonoperating mineral interests such as royalty 
interests.
    (c) Operating unit defined. (1) The term operating unit refers to 
the operating mineral interests which are operated together for the 
purpose of producing minerals. An operating unit of a particular 
taxpayer must be determined on the basis of his own operations. It is 
recognized that operating units may not be uniform in the various 
natural resources industries or in any one of the natural resources 
industries, such as coal, oil and gas, and the like. As to a particular 
taxpayer, business reasons may require the formation of operating units 
that vary in size and content. The term operating unit refers to a 
producing unit, and not to an administrative or sales organization. 
Among the factors which indicate that mineral interests are operated 
together as a unit are:
    (i) Common field or operating personnel,
    (ii) Common supply and maintenance facilities,
    (iii) Common processing or treatment plants, and
    (iv) Common storage facilities


However, operating mineral interests which are geographically widespread 
may not be treated as parts of the same operating unit merely because a 
single set of accounting records, a single executive organization, or a 
single sales force is maintained by the taxpayer with respect to such 
interests, or

[[Page 500]]

merely because the products of such interests are processed at the same 
treatment plant.
    (2) If aggregated, an undeveloped operating mineral interest shall 
be aggregated only with those interests with which it will be operated 
as a unit when it reaches the production stage.
    (3) While a taxpayer may operate an operating mineral interest 
through an agent, a coowner may aggregate only his operating mineral 
interests that are actually operated as a unit. For example, if A owned 
and actually operated the entire working interest in lease X and also 
owned an undivided fraction of lease Y in which B owned the remaining 
interest and which B actually operated as a unit with lease Z, A may not 
aggregate his interest in lease X with his undivided interest in lease 
Y, since they are not actually operated as a unit.
    (4) The determination of the taxpayer as to what constitutes an 
operating unit is to be accepted unless there is a clear and convincing 
basis for a change in such determination.
    (d) Manner and scope of election--(1) Election; when made. (i) 
Except as provided in subparagraph (2)(ii) of this paragraph, the 
election under section 614(b) and paragraph (a) of this section to treat 
a mineral interest as part of an aggregation shall be made not later 
than the time prescribed by law for filing the taxpayer's income tax 
return (including extensions thereof), for whichever of the following 
taxable years is the later:
    (a) The first taxable year beginning after December 31, 1953, and 
ending after August 16, 1954, or
    (b) The first taxable year in which any expenditure for exploration, 
development, or operation in respect of the separate operating mineral 
interest is made by the taxpayer after the acquisition of such interest


See, however, paragraph (c) of Sec.  1.614-6 as to the binding effect of 
an election where the basis of a separate operating mineral interest in 
the hands of the taxpayer is determined by reference to the basis in the 
hands of a transferor. The election under section 614(b) may not be made 
with respect to any taxable year beginning after December 31, 1957, 
except in the case of oil and gas wells. See paragraph (e) of this 
section for rules with respect to the termination of the election under 
section 614(b) except in the case of oil and gas wells. If an 
expenditure has been made in respect of a separate operating mineral 
interest, it is immaterial whether or not any proven deposit has been 
discovered with respect to such interest when such expenditure has been 
made. The provisions of this subdivision may be illustrated by the 
following example:

    Example. Taxpayer A is producing from an oil and gas horizon and in 
1958 he drills for the purpose of locating a deeper horizon which will 
be operated in the same operating unit as the upper producing horizon. 
At the end of the taxable year 1958 he has expended $50,000 drilling for 
the purpose of locating a deeper horizon although at such time there is 
no assurance that such a horizon will be found. If taxpayer A desires to 
aggregate the deeper horizon, if found, with the upper horizon under 
section 614(b), he must elect to do so in his return for 1958. If the 
election to aggregate the upper and lower horizons as one property is 
made, the drilling expenditures with respect to the prospective lower 
horizon must be taken into account along with the income and expenses 
with respect to the upper producing horizon in computing the depletion 
allowance on the aggregated property.


However, where expenditures for development of, or production from, a 
particular mineral deposit result in the discovery of another mineral 
deposit, the election with respect to such other deposit shall be made 
for the taxable year in which it is discovered and not for the taxable 
year in which the expenditures were first made which resulted in such 
discovery.
    (ii) Except in the case of oil and gas wells, if a taxpayer fails to 
make an election under section 614(b) to aggregate a particular 
operating mineral interest on or before the time prescribed for the 
making of such election, such interest will be treated as if an election 
had been made under section 614(b) to treat it as a separate property 
and it cannot be included in any aggregation within the operating unit 
of which it is a part unless the taxpayer obtains the consent of the 
Commissioner. However, where the taxpayer owns more than one property 
within an operating unit, but has elected to treat such properties

[[Page 501]]

separately and one or more additional operating mineral interests are 
subsequently acquired, any one or more of the latter may be aggregated 
with one of the existing separate properties within the operating unit 
but not with more than one of them since they cannot be validly 
aggregated with each other.
    (iii) In the case of oil and gas wells, if the taxpayer fails to 
make an election under section 614(b) with respect to a particular 
operating mineral interest on or before the time prescribed for the 
making of such election, the taxpayer shall be deemed to have treated 
such interest under the provisions of section 614(d). See section 614(d) 
and Sec.  1.614-4.
    (iv) For purposes of section 614(b), the acquisition of an option to 
acquire an economic interest in minerals in place does not constitute 
the acquisition of a mineral interest. Thus, a taxpayer who makes 
expenditures for the exploration of minerals on a particular tract under 
an option to acquire an economic interest in minerals in place is not 
required to make an election with respect to such interest at that time. 
Furthermore, the election need not be made in the taxable year in which 
payments are made for the acquisition of a lease, such as the payment of 
a bonus, unless exploratory, development, or operation expenditures are 
made thereafter with respect to the property in that year.
    (2) Election; how made. (i) The election under section 614(b) must 
be made by a statement attached to the income tax return of the taxpayer 
for the first taxable year for which the election is made. This 
statement shall indicate that the taxpayer is making an aggregation of 
separate operating mineral interests within an operating unit under 
section 614(b) and shall contain a description of the aggregation and 
describe the operating mineral interests within the operating unit which 
are to be treated as separate properties apart from the aggregation. A 
general description, accompanied by maps appropriately marked, which 
accurately circumscribes the scope of the aggregation and identifies the 
properties which are to be treated separately will be sufficient. The 
statement shall also contain a description of the operating unit in 
sufficient detail to show that the aggregated operating mineral 
interests are properly within a single operating unit. See paragraph (c) 
of this section. The taxpayer shall maintain adequate records and maps 
in support of the above information. In the event expenditures are first 
made on an operating mineral interest within an operating unit after an 
election with respect to the aggregation of interests in that operating 
unit has been made, the taxpayer shall furnish only information 
describing such operating mineral interest, its location in the 
operating unit, and whether it is to be included within the aggregation.
    (ii) If the taxpayer made or did not make the election under section 
614(b) with respect to a particular operating mineral interest and the 
last day prescribed by law for filing the return (including extensions 
of time therefor) on which the election was required to be made falls on 
or before May 1, 1961, consent is hereby given to the taxpayer to make 
or change the election not later than May 1, 1961. Any such election or 
change of such election shall be effective with respect to the earliest 
taxable year to which the election is applicable in respect of which 
assessment of a deficiency or credit or refund of an overpayment, as the 
case may be, resulting from such election or change is not prevented by 
any law or rule of law on the date such election or change is made. An 
election or change of election made pursuant to this subdivision shall 
be binding upon the taxpayer for the first taxable year for which it is 
effective and for all subsequent taxable years unless consent to a 
different treatment is obtained from the Commissioner. (See, however, 
paragraph (e) of this section for rules relating to the termination and 
nonapplicability of the election under section 614(b) except in the case 
of oil and gas wells.) Such election or change shall be made in the form 
of a statement setting forth the nature of the election or change, 
including information substantially the same as that required by 
subdivision (i) of this subparagraph, and shall be accompanied by an 
amended return or returns if necessary or, if appropriate, a

[[Page 502]]

claim for refund or credit. The appropriate documents must be filed on 
or before May 1, 1961 with the district director for the district in 
which the original return was filed.
    (3) Election; when effective. If a taxpayer has elected to aggregate 
an operating mineral interest, the date on which the aggregation becomes 
effective is the earliest date within the taxable year affected, on 
which the taxpayer incurred any expenditure for exploration, 
development, or operation of such interest. The application of this rule 
may be illustrated by the following examples:

    Example 1. In 1953, a taxpayer owned and operated mineral interests 
Nos. 1, 2, and 3. All three interests form one operating unit. The 
taxpayer, who files his return on a calendar year basis, continued to 
own and operate these interests during the year 1954, and in his return 
for that year, filed on April 15, 1955, elected to aggregate these three 
interests. As the result of this election, the aggregation was effective 
for all purposes of subtitle A of the Code as of January 1, 1954.
    Example 2. Assume that, on March 1, 1955, the taxpayer described in 
example 1 acquired operating mineral interest No. 4 which was also a 
part of the operating unit composed of operating mineral interests Nos. 
1, 2, and 3, that he made his first expenditure for exploration with 
respect to operating mineral interest No. 4 on September 1, 1955, and 
that, in his return filed on April 15, 1956, he elected to aggregate 
operating mineral interest No. 4 with the aggregation consisting of Nos. 
1, 2, and 3. As the result of that election, operating mineral interest 
No. 4 became a part of the aggregation for all purposes of subtitle of 
the Code on September 1, 1955.

    (4) Election; binding effect. A valid election made under section 
614(b) and this section shall be binding upon the taxpayer for the 
taxable year for which made and all subsequent taxable years unless 
consent to make a change is obtained from the Commissioner. However, see 
paragraph (e) of this section for rules with respect to the termination 
of the election under section 614(b) except in the case of oil and gas 
wells. For rules relating to the binding effect of an election where the 
basis of a separate or an aggregated property in the hands of the 
transferee is determined by reference to the basis in the hands of the 
transferor, see paragraph (c) of Sec.  1.614-6. A taxpayer can neither 
include within the aggregation a separate operating mineral interest 
which he had previously elected to treat separately, nor exclude from 
the aggregation a separate operating mineral interest previously 
included therein unless consent to do so is obtained from the 
Commissioner. A change in tax consequences alone is not sufficient to 
obtain consent to change the treatment of an operating mineral interest. 
However, consent may be appropriate where, for example, there has been a 
substantial change in the taxpayer's operations so that a major part of 
an aggregation becomes a part of another operating unit. Applications 
for consent shall be made in writing to the Commissioner of Internal 
Revenue, Washington, DC 20224. The application must be accompanied by a 
statement indicating the reason or reasons for the change and furnishing 
the information required under subdivision (i) of subparagraph (2) of 
this paragraph, unless such information has been previously filed and is 
current.
    (5) Invalid aggregations--(i) In general. In addition to 
aggregations which are invalid under section 614(b) because of the 
failure to make timely elections, aggregations may be invalid under such 
section in situations which may be divided into two general categories. 
The first category involves basic aggregations which were timely but 
otherwise initially invalid. The second category involves invalid 
additions of operating mineral interests to basic aggregations which 
additions became subject to the election in years subsequent to the year 
in which the initial basic aggregation or aggregations were formed.
    (ii) Invalid basic aggregations. The term invalid basic aggregations 
refers to those aggregations which are initially invalid. Generally, 
such basic aggregations will be invalid because more than one 
aggregation has been formed within an operating unit or because 
operating mineral interests in two or more operating units have been 
improperly aggregated. For any year in which an invalid basic 
aggregation exists, each operating mineral interest included in such 
aggregation shall be treated for all purposes as a separate property 
unless consent is obtained from the Commissioner to treat any such 
interest in

[[Page 503]]

a different manner. Consent will be granted in appropriate cases as, for 
example, where the taxpayer demonstrates that he inadvertently formed an 
invalid basic aggregation. The provisions of this subdivision may be 
illustrated by the following examples:

    Example 1. In 1953, taxpayer A owned six operating mineral 
interests, designated No. 1 through No. 6, and he continued to own and 
operate such interests during 1954. He acquired no other operating 
mineral interests during such year. All six of these operating mineral 
interests form one operating unit. Assume that A elected under section 
614(b) to aggregate operating mineral interests Nos. 1 through 3 into 
one aggregation and Nos. 4 through 6 into another aggregation. Since A 
has formed two aggregations in one operating unit, they are invalid 
basic aggregations. Therefore, interests Nos. 1 through 6 must be 
treated as separate properties for 1954 and all subsequent taxable years 
unless consent is obtained from the Commissioner to treat any of such 
interests in a different manner.
    Example 2. Assume the same facts as in example 1 and assume also 
that, in his return for 1954, A correctly elected to aggregate all six 
operating mineral interests into one aggregation under section 614(b). 
Assume further that all these operating mineral interests continued to 
be in one operating unit for the years 1954, 1955, and 1956 but that, 
because of changes in the facts and circumstances of A's operations, in 
1957 operating mineral interests Nos. 1, 2, and 3 became a part of one 
operating unit and Nos. 4, 5, and 6 became a part of another operating 
unit. Notwithstanding the change in operations, the election made by A 
shall continue to be binding unless consent to change such election is 
obtained from the Commissioner.

    (iii) Invalid additions. The term additions refers to the additions 
that a taxpayer makes by electing to aggregate an operating mineral 
interest with an aggregation formed in a previous year. Such additions 
will be invalid where the taxpayer either elected to aggregate an 
operating mineral interest with an invalid basic aggregation or elected 
to aggregate an operating mineral interest which is part of one 
operating unit with an aggregation of operating mineral interests which 
is a part of another operating unit. An operating mineral interest which 
is invalidly added to either a valid basic aggregation or to an invalid 
basic aggregation shall be considered as a separate property unless 
consent is obtained from the Commissioner to treat such interest in a 
different manner. The following are examples of invalid additions:

    Example 1. In 1953, taxpayer A owned six operating mineral interests 
designated No. 1 through No. 6 and he continued to own and operate such 
interests during 1954. He acquired no other operating mineral interests 
during that year. Nos. 1 through 3 formed one operating unit and Nos. 4 
through 6 formed another operating unit. In his return for 1954, A 
incorrectly elected to aggregate all six operating mineral interests 
into one aggregation under section 614(b). In 1955, A acquired and 
commenced development of operating mineral interest No. 7 which is 
correctly a part of the operating unit of which operating mineral 
interests Nos. 1, 2, and 3 are a part. A elected under section 614(b), 
for the year 1955, to aggregate operating mineral interest No. 7 with 
the invalid basic aggregation composed of Nos. 1 through 6. Since 
operating mineral interest No. 7 was aggregated with an invalid basic 
aggregation, it is an invalid addition and must be treated as a separate 
property unless consent is obtained from the Commissioner to treat it in 
a different manner.
    Example 2. In 1953, taxpayer A owned nine operating mineral 
interests designated No. 1 through No. 9. During 1954, he continued to 
own and operate such interests and acquired no other operating mineral 
interest. Interests No. 1 through No. 3 form one operating unit, Nos. 4 
through 6 form another operating unit, and Nos. 7 through 9 form a third 
operating unit. For the year 1954, A elected under section 614(b) to 
aggregate operating mineral interests Nos. 1, 2, 3, and 4 into one 
aggregation, to treat Nos. 5 and 6 as separate properties, and to 
aggregate Nos. 7, 8, and 9 into another aggregation. Assume that in 1955 
A acquired and commenced development of operating mineral interest No. 
10 which was a part of the operating unit composed of Nos. 1, 2, and 3. 
Assume further that he elected under section 614(b) to aggregate No. 10 
with the aggregation composed of Nos. 7, 8, and 9. This would be an 
invalid addition to a valid basic aggregation since operating mineral 
interest No. 10 was not properly a part of the operating unit formed by 
Nos. 7, 8, and 9. Therefore, interest No. 10 must be treated as a 
separate property for 1955 and all subsequent taxable years unless 
consent is obtained from the Commissioner to treat it in a different 
manner. However, the valid basic aggregation composed of interests Nos. 
7 through 9 is not affected by the invalid addition of interest No. 10.
    Example 3. Assume the same facts as in example 2 except that A 
elected under section

[[Page 504]]

614(b) in 1955 to aggregate No. 10 with the aggregation of Nos. 1 
through 4. This would also be an invalid addition because the 
aggregation composed of Nos. 1 through 4 is an invalid basic aggregation 
since operating mineral interest No. 4 is not a part of the operating 
unit consisting of Nos. 1, 2, and 3. Therefore, interest No. 10 must be 
treated as a separate property for 1955 and all subsequent taxable years 
unless consent is obtained from the Commissioner to treat such interest 
in a different manner.

    (e) Termination of election--(1) Taxable years beginning after 
December 31, 1963, in the case of oil and gas wells. In the case of oil 
and gas wells, the election provided for under section 614(b) and 
paragraph (a) of this section to form an aggregation of separate 
operating mineral interests shall not apply with respect to any taxable 
year beginning after December 31, 1963. In addition, if a taxpayer 
treated certain separate operating mineral interests in a single tract 
or parcel of land as separate rather than as an aggregation and decides 
to continue such treatment for taxable years beginning after December 
31, 1963, he must make an appropriate election under section 614(b) as 
amended by the Revenue Act of 1964. See Sec.  1.614-8.
    (2) Taxable years beginning after December 31, 1957, in the case of 
mines. Except in the case of oil and gas wells, the election provided 
for under section 614(b) and paragraph (a) of this section to form an 
aggregation of separate operating mineral interests shall not apply with 
respect to any taxable year beginning after December 31, 1957. Thus, if 
a taxpayer makes a binding election under section 614(b) to form an 
aggregation of separate operating mineral interests within an operating 
unit for taxable years beginning before January 1, 1958, he must make a 
new election for the first taxable year beginning after December 31, 
1957, under section 614(c) within the time prescribed in Sec.  1.614-3 
if he wishes to aggregate any separate operating mineral interests 
within such operating unit. A new election must be made under section 
614(c) notwithstanding the fact that the aggregation formed under 
section 614(b) would constitute a valid aggregation under section 
614(c). Failure to make such an election within the time prescribed 
shall constitute an election to treat each separate operating mineral 
interest within the operating unit as a separate property for taxable 
years beginning after December 31, 1957.
    (3) Taxable years beginning before January 1, 1958, in the case of 
mines. An election made under section 614(b) and paragraph (a) of this 
section to form an aggregation of separate operating mineral interests 
within a particular operating unit shall not apply with respect to any 
taxable year beginning prior to January 1, 1958, for which the taxpayer 
makes an election under section 614(c)(3)(B) and paragraph (f)(2) of 
Sec.  1.614-3 which is applicable to any separate operating mineral 
interest within the same operating unit. The provisions of this 
subparagraph may be illustrated by the following examples:

    Example 1. In 1953, taxpayer A owned six separate operating mineral 
interests, designated No. 1 through No. 6, which he operated as a unit. 
Operating mineral interests Nos. 1 through 5 comprise a mine, and 
operating mineral interest No. 6 represents one mineral deposit in a 
single tract of land which is being extracted by means of two mines. 
Taxpayer A previously made a binding election under section 614(b) to 
aggregate operating mineral interests Nos. 1 through 5 and to treat 
operating mineral interest No. 6 as a separate property. Under section 
614(c)(2) and (3)(B) taxpayer A makes an election which is applicable 
for the taxable year 1954 and all subsequent taxable years to treat 
operating mineral interest No. 6 as two separate operating mineral 
interests. Therefore, the previous election of taxpayer A to aggregate 
operating mineral interests Nos. 1 through 5 under section 614(b) does 
not apply. Unless taxpayer A also makes an election to aggregate 
operating mineral interests Nos. 1 through 5 as one property under 
section 614(c)(1) and (3)(B) within the time prescribed in paragraph 
(f)(2) of Sec.  1.614-3, he shall be deemed to have made an election to 
treat each of such interests as a separate property for 1954 and all 
subsequent taxable years.
    Example 2. In 1953, taxpayer B owned six separate operating mineral 
interests, designated No. 1 through No. 6, which he operated as a unit. 
Operating mineral interests Nos. 1 through 3 comprise a mine and Nos. 4 
through 6 comprise a second mine. Taxpayer B previously made a binding 
election under section 614(b) to aggregate operating mineral interests 
Nos. 1 through 8 and to treat Nos. 4 through 6 as separate properties. 
Under section 614(c) (1) and (3)(B) taxpayer B makes

[[Page 505]]

an election which is applicable for the taxable year 1954 and all 
subsequent taxable years to aggregate operating mineral interests Nos. 4 
through 6 as one property. The previous election of the taxpayer under 
section 614(b) to aggregate operating mineral interests Nos. 1 through 3 
does not apply even though such aggregation would constitute a valid 
aggregation if formed under section 614(c)(1). Therefore, if taxpayer B 
wishes to continue to treat operating mineral interests Nos. 1 through 3 
as one property, he must also make an election to do so under section 
614(c) (1) and (3)(B) within the time prescribed in paragraph (f)(2) of 
Sec.  1.614-3.

    (4) Bases of separate operating mineral interests. If an aggregation 
formed under section 614(b) is terminated by reason of the provisions of 
section 614(b)(4)(A), is terminated under section 614(b)(4)(B) for any 
taxable year after the first taxable year to which the election under 
section 614(b) applies, or is terminated by reason of the provisions of 
section 614(b) as amended by the Revenue Act of 1964, the bases of the 
separate operating mineral interests (and combinations thereof) included 
in such aggregation shall be determined in accordance with the rules 
contained in paragraph (a)(2) of Sec.  1.614-6 as of the first day of 
the first taxable year for which the termination is effective. However, 
if by reason of the provisions of section 614(b)(4)(B), an election to 
aggregate under section 614(b) does not apply for any taxable year for 
which such election was made, the bases of the separate operating 
mineral interests included in the aggregation formed under section 
614(b) shall be determined without regard to the election under section 
614(b).
    (f) Alternative treatment of separate operating mineral interests in 
the case of oil and gas wells. For rules relating to an alternative 
treatment of separate operating mineral interests in the case of oil and 
gas wells, see Sec.  1.614-4.

[T.D. 6524, 26 FR 147, Jan. 10, 1961, as amended by T.D. 6859, 30 FR 
13700, Oct. 28, 1965]



Sec.  1.614-3  Rules relating to separate operating mineral interests
in the case of mines.

    (a) Election to aggregate separate operating mineral interests--(1) 
General rule. Except in the case of oil and gas wells, a taxpayer who 
owns two or more separate operating mineral interests, which constitute 
part or all of the same operating unit, may elect under section 
614(c)(1) and this paragraph to form an aggregation of all such 
operating mineral interests which comprise any one mine or any two or 
more mines and to treat such aggregation as one property. The aggregated 
property which results from the exercise of such election shall be 
considered as one property for all purposes of subtitle A of the Code. 
The preceding sentence does not preclude the use of more than one 
account under a single method of computing depreciation or the use of 
more than one method of computing depreciation under section 167, if 
otherwise proper. Any reasonable and consistently applied method or 
methods of computing depreciation of the improvements made with respect 
to the separate properties aggregated may be continued in accordance 
with section 167 and the regulations thereunder. It is not necessary for 
purposes of the aggregation that the separate operating mineral 
interests be included in a single tract or parcel of land or in 
contiguous tracts or parcels of land so long as such interests 
constitute part or all of the same operating unit. A taxpayer may elect 
to form more than one aggregation of separate operating mineral 
interests within one operating unit so long as each aggregation consists 
of all the separate operating mineral interests which comprise any one 
mine or any two or more mines. Thus, no aggregation may include any 
separate operating mineral interest which is a part of a mine without 
including all of the separate operating mineral interests which comprise 
such mine in the first taxable year for which the election to aggregate 
is effective. Any separate operating mineral interest which becomes a 
part of such mine in a subsequent taxable year must also be included in 
such aggregation as of the taxable year that such interest becomes a 
part of such mine. The taxable year in which such interest becomes a 
part of such mine shall be determined upon the basis of the facts and 
circumstances of the particular case. If a taxpayer fails to make an 
election under this paragraph to aggregate a particular operating 
mineral interest

[[Page 506]]

(other than an interest which becomes a part of a mine with respect to 
which the interests have been aggregated in a prior taxable year) on or 
before the last day prescribed for making such an election, such 
interest shall be treated as if an election had been made to treat it as 
a separate property. A taxpayer may not aggregate operating mineral 
interests and nonoperating mineral interests such as royalty interests. 
For definitions of the terms operating mineral interest, operating unit, 
and mine, see respectively paragraphs (c), (d), and (e) of this section.
    (2) Aggregation in subsequent taxable years. If the taxpayer has 
made an election under section 614(c)(1) for a particular taxable year 
with respect to any operating mineral interest or interests within a 
particular operating unit, and if, for a subsequent taxable year, the 
taxpayer desires to make an election with respect to an additional 
operating mineral interest within the same operating unit, then whether 
or not the taxpayer may elect to include such additional interest in an 
aggregation or treat it as a separate property depends upon the nature 
of such additional interest and of the taxpayer's previous elections. If 
the additional interest is a part of a mine with respect to which the 
other interests have been aggregated, the additional interest must be 
included in such aggregation. If the additional interest is a part of a 
mine with respect to which the other interests have been treated as 
separate properties, the additional interest must be treated as a 
separate property. If the additional interest is part of a mine which 
previously consisted of only a single interest which has not been 
aggregated with any other mine, such additional interest may be 
aggregated or treated as a separate property. If the additional interest 
is an entire mine, it may, at the election of the taxpayer, (i) be added 
to any aggregation within the same operating unit, (ii) be aggregated 
with any other single interest which is an entire mine provided both 
interests are within the same operating unit even though such single 
interest has previously been treated as a separate property, or (iii) be 
treated as a separate property.
    (b) Election to treat a single operating mineral interest as more 
than one property--(1) General rule. Except in the case of oil and gas 
wells, a taxpayer who owns a separate operating mineral interest in a 
mineral deposit in a single tract or parcel of land may elect under 
section 614(c)(2) and this paragraph to treat such interest as two or 
more separate operating mineral interests if such mineral deposit is 
being developed or extracted by means of two or more mines. In order for 
this election to be applicable, there must be at least two mines with 
respect to each of which an expenditure for development or operation has 
been made by the taxpayer. The election under section 614(c)(2) may also 
be made with respect to a separate operating mineral interest formed by 
a previous election under section 614(c)(2) at such time as the mineral 
deposit previously allocated to such interest is being developed or 
extracted by means of two or more mines. If there is more than one 
mineral deposit in a single tract or parcel of land, an election under 
section 614(c)(2) with respect to any one of such mineral deposits has 
no application to the other mineral deposits. The election under section 
614(c)(2) may not be made with respect to an aggregated property or with 
respect to any operating mineral interest which is a part of any 
aggregation formed by the taxpayer unless the taxpayer obtains consent 
from the Commissioner. Such consent will not be granted where the 
principal purpose for the request to make the election is based on tax 
consequences. Application for such consent shall be made in writing to 
the Commissioner of Internal Revenue, Washington, DC 20224. The 
application must be accompanied by a statement setting forth in detail 
the reason or reasons for the request to exercise the election with 
respect to an aggregated property.
    (2) Allocation of mineral deposit. If the taxpayer elects to treat a 
separate operating mineral interest in a mineral deposit in a single 
tract or parcel of land as more than one separate operating mineral 
interest, then all of such mineral deposit therein and all of the 
portion of the tract or parcel of land allocated thereto must be 
allocated to

[[Page 507]]

the newly formed separate operating mineral interests. A portion of such 
mineral deposit and such tract or parcel of land must be allocated to 
each such newly formed separate operating mineral interest. There must 
be at least one mine, with respect to which an expenditure for 
development or operation has been made by the taxpayer, with respect to 
each such portion. The extent of the portion to be allocated to each 
newly formed separate operating mineral interest is to be determined 
upon the basis of the facts and circumstances of the particular case.
    (3) Basis of newly formed separate operating mineral interests. The 
adjusted basis of each of the separate operating mineral interests 
formed by the making of the election under section 614(c)(2) shall be 
determined by apportioning the adjusted basis of the separate operating 
mineral interest with respect to which such election was made between 
(or among) the newly formed separate operating mineral interests in the 
same proportion as the fair market value of each such newly formed 
interest (as of the date on which the election becomes effective) bears 
to the total fair market value of the interest with respect to which the 
election was made as of such date.
    (4) Aggregation of newly formed separate operating mineral 
interests. Any separate operating mineral interest formed by the making 
of the election under section 614(c)(2) may be included as a part of an 
aggregation subject to the requirements of paragraph (a) of this 
section, provided that the time for making the election under section 
614(c)(1) to include such separate operating mineral interest in such 
aggregation has not expired. See paragraph (f) of this section. The 
provisions of this subparagraph may be illustrated by the following 
example:

    Example. In 1958, taxpayer A acquired two separate operating mineral 
interests designated No. 1 and No. 2. Each is an interest in a single 
mineral deposit in a single tract of land. In the same year, taxpayer A 
made his first development expenditure with respect to a mine on 
operating mineral interest No. 1 and a mine on operating mineral 
interest No. 2. Operating mineral interests Nos. 1 and 2 are operated as 
a unit. Taxpayer A did not elect to aggregate operating mineral 
interests Nos. 1 and 2 under section 614(c)(1) within the time 
prescribed for making such an election. In 1960 taxpayer A made his 
first development expenditure with respect to a second mine on operating 
mineral interest No. 2. Taxpayer A elected under section 614(c)(2) to 
treat operating mineral interest No. 2 as two separate operating mineral 
interests, designated as Nos. 2(a) and 2(b), for the taxable year 1960 
and all subsequent taxable years. No. 2(a) contained the mine for which 
the first development expenditure was made in 1958, and No. 2(b) 
contained the mine for which the first development expenditure was made 
in 1960. If taxpayer A wishes to do so, he may elect to aggregate 
mineral interests Nos. 1 and 2(b) under section 614(c)(1) for the 
taxable year 1960 and all subsequent taxable years since the first 
development expenditure with respect to the mine on operating mineral 
interest No. 2(b) was made during the taxable year 1960. Taxpayer A may 
not elect to aggregate mineral interests Nos. 1 and 2(a) under such 
section since the time for making such an election has expired.

    (c) Operating mineral interest defined. For the definition of the 
term operating mineral interest as used in this section, see paragraph 
(b) of Sec.  1.614-2.
    (d) Operating unit defined. For the definition of the term operating 
unit as used in this section, see paragraph (c) of Sec.  1.614-2.
    (e) Mine defined. For purposes of this section, the term mine means 
any excavation or other workings or series of related excavations or 
related workings, as the case may be, for the purpose of extracting any 
known mineral deposit except oil and gas deposits. For the purpose of 
the preceding sentence, the term excavations or workings includes 
quarries, pits, shafts, and wells (except oil and gas wells). The number 
of excavations or workings that constitute a mine is to be determined 
upon the basis of the facts and circumstances of the particular case 
such as the nature and position of the mineral deposit or deposits, the 
method of mining the mineral, the location of the excavations or other 
workings in relation to the mineral deposit or deposits, and the 
topography of the area. The determination of the taxpayer as to the 
composition of a mine is to be accepted unless there is a clear and 
convincing basis for a change in such determination.
    (f) Manner and scope of election--(1) Election to apply section 
614(c) (1) and (2)

[[Page 508]]

for taxable years beginning after December 31, 1957. Except as provided 
in subparagraphs (2) and (3) of this paragraph, the election under 
section 614(c)(1) and paragraph (a) of this section to treat an 
operating mineral interest as part of an aggregation shall be made under 
section 614(c)(3)(A) not later than the time prescribed by law for 
filing the taxpayer's income tax return (including extensions thereof) 
for whichever of the following taxable years is the later:
    (i) The first taxable year beginning after December 31, 1957, or
    (ii) The first taxable year in which any expenditure for development 
or operation in respect of the separate operating mineral interest is 
made by the taxpayer after the acquisition of such interest


Except as provided in subparagraphs (2) and (3) of this paragraph, the 
election under section 614(c)(2) and paragraph (b) of this section to 
treat a single operating mineral interest as more than one operating 
mineral interest shall be made under section 614(c)(3)(A) not later than 
the time prescribed by law for filing the taxpayer's income tax return 
(including extensions thereof) for whichever of the following taxable 
years is the later:
    (iii) The first taxable year beginning after December 31, 1957, or
    (iv) The first taxable year in which expenditures for development or 
operation of more than one mine in respect of the separate operating 
mineral interest are made by the taxpayer after the acquisition of such 
interest


However, if the latest time at which an election may be made under this 
subparagraph falls on or before May 1, 1961, such election may be made 
or modified at any time on or before May 1, 1961. See paragraph (c) of 
Sec.  1.614-6 as to the binding effect of an election where the basis of 
a separate operating mineral interest in the hands of the taxpayer is 
determined by reference to the basis in the hands of a transferor.
    (2) Election to apply section 614(c) (1) and (2) for taxable years 
beginning before January 1, 1958. In accordance with section 
614(c)(3)(B), the election under section 614(c) (1) and paragraph (a) of 
this section to treat an operating mineral interest as part of an 
aggregation may, at the election of the taxpayer, be made not later than 
the time prescribed by law for filing the taxpayer's income tax return 
(including extensions thereof) for whichever of the following taxable 
years is the later:
    (i) The first taxable year beginning after December 31, 1953, and 
ending after August 16, 1954, for which assessment of a deficiency or 
credit or refund of an overpayment, as the case may be, resulting from 
an election under section 614(c)(1), is not prevented on September 2, 
1958, by the operation of any law or rule of law, or
    (ii) The first taxable year in which any expenditure for development 
or operation in respect of the separate operating mineral interest is 
made by the taxpayer after the acquisition of such interest


In accordance with section 614(c) (3)(B), the election under section 
614(c)(2) and paragraph (b) of this section to treat an operating 
mineral interest as more than one operating mineral interest may, at the 
election of the taxpayer, be made not later than the time prescribed by 
law for filing the taxpayer's income tax return (including extensions 
thereof) for whichever of the following taxable years is the later:
    (iii) The first taxable year beginning after December 31, 1953, and 
ending after August 16, 1954, for which assessment of a deficiency or 
credit or refund of an overpayment, as the case may be, resulting from 
an election under section 614(c)(2), is not prevented on September 2, 
1958, by the operation of any law or rule of law, or
    (iv) The first taxable year in which expenditures for development or 
operation of more than one mine in respect of the separate operating 
mineral interest are made by the taxpayer after the acquisition of such 
interest


However, if the latest time at which an election may be made under this 
subparagraph falls on or before May 1, 1961, such election may be made 
or modified at any time on or before May 1, 1961. See paragraph (c) of 
Sec.  1.614-6 as to the binding effect of an election where the basis of 
a separate operating mineral interest in the hands of the

[[Page 509]]

taxpayer is determined by reference to the basis in the hands of a 
transferor.
    (3) Limitation. If the taxpayer makes an election under section 
614(c) (1) or (2) in accordance with section 614(c)(3)(B) and 
subparagraph (2) of this paragraph with respect to any operating mineral 
interest which constitutes part or all of an operating unit, such 
taxpayer may not make any election under section 614(c) (1) or (2) in 
accordance with section 614(c)(3)(A) and subparagraph (1) of this 
paragraph with respect to any operating mineral interest which 
constitutes part or all of such operating unit. The provisions of this 
subparagraph may be illustrated by the following example:

    Example: In 1953, taxpayer A owned six separate operating mineral 
interests, designated No. 1 through No. 6, which he operated as a unit. 
Operating mineral interests Nos. 1 through 5 comprise a mine, and 
operating mineral interest No. 6 represents one mineral deposit in a 
single tract of land which is being extracted by means of two mines. In 
accordance with section 614(c)(3)(B) and subparagraph (2) of this 
paragraph, taxpayer A elects under section 614(c)(2) to treat operating 
mineral interest No. 6 as two separate operating mineral interests for 
the taxable year 1954 and all subsequent taxable years. Unless taxpayer 
A also makes an election under section 614(c)(1) to aggregate operating 
mineral interests Nos. 1 through 5 for the taxable year 1954 and all 
subsequent taxable years in accordance with section 614(c)(3)(B) and 
subparagraph (2) of this paragraph, he shall be deemed to have made an 
election to treat each of such interests as a separate property. 
Taxpayer A may not elect, under section 614(c) (1) and (3)(A), to 
aggregate operating mineral interests Nos. 1 through 5 for the taxable 
year 1958 or any subsequent taxable year.

    (4) Statute of limitations. If the taxpayer makes any election in 
accordance with section 614(c)(3)(B) and subparagraph (2) of this 
paragraph and if assessment of any deficiency for any taxable year 
resulting from such election is prevented on May 1, 1961, or at any time 
within one year after such first day, by the operation of any law or 
rule of law, such assessment may, nevertheless, be made within one year 
after May 1, 1961. Any election by a taxpayer in accordance with section 
614(c)(3)(B) shall constitute consent to the assessment of any 
deficiency resulting from any such election. If refund or credit of any 
overpayment of income tax resulting from any election made in accordance 
with section 614(c)(3)(B) is prevented on May 1, 1961, or at any time 
within one year after May 1, 1961, by the operation of any law or rule 
of law, refund or credit of such overpayment may, nevertheless, be made 
or allowed but only if claim therefor is filed within one year after May 
1, 1961. This subparagraph shall not apply with respect to any taxable 
year of a taxpayer for which an assessment of a deficiency resulting 
from an election made in accordance with section 614(c)(3)(B) or a 
refund or credit of an overpayment resulting from any such election, as 
the case may be, is prevented by the operation of any law or rule of law 
on September 2, 1958.
    (5) Elections--how made--(i) General rule. Except as provided in 
subdivision (ii) of this subparagraph, an election under section 614(c) 
(1) or (2) and paragraph (a) or (b) of this section must be made by a 
statement attached to the income tax return of the taxpayer for the 
first taxable year for which the election is made. The statement shall 
contain the following information:
    (a) Whether the taxpayer is making an election or elections with 
respect to the operating unit in accordance with section 614(c)(3) (A) 
or (B);
    (b) A description of the operating unit of the taxpayer in 
sufficient detail to identify the operating mineral interests which are 
included within such operating unit;
    (c) A description of each aggregation to be formed within the 
operating unit in sufficient detail to show that each aggregation 
consists of all the separate operating mineral interests which comprise 
any one mine or any two or more mines;
    (d) A description of each separate operating mineral interest within 
the operating unit which is to be treated as a separate property in 
sufficient detail to show that such interest is not a part of any mine 
for which an election to aggregate has been made;
    (e) The taxable year in which the first expenditure for development 
or operation was made by the taxpayer with respect to each separate 
operating mineral interest within the operating

[[Page 510]]

unit, but if the first expenditure for development or operation has not 
been made with respect to a separate operating mineral interest before 
the close of the taxable year for which the election under this section 
is made, such information should also be included;
    (f) A description of each separate operating mineral interest within 
the operating unit which the taxpayer elects to treat as more than one 
such interest under section 614(c)(2) in sufficient detail to show that 
the separate operating mineral interest was not a part of an aggregation 
formed by the taxpayer under section 614(c)(1) for any taxable year 
prior to the taxable year for which the election under section 614(c)(2) 
is made, and to show that the mineral deposit representing the separate 
operating mineral interest is being developed or extracted by means of 
two or more mines;
    (g) The taxable year in which the first expenditure for development 
or operation was made by the taxpayer with respect to each mine on the 
separate operating mineral interest that the taxpayer is electing to 
treat as more than one such interest; and
    (h) The allocation of the mineral deposit representing the separate 
operating mineral interest between (or among) the newly formed interests 
and the method by which such allocation was made


For the purpose of applying subdivisions (e) and (g) of this 
subdivision, if the first expenditure for development or operation with 
respect to a separate operating mineral interest or a mine was made 
prior to the first taxable year for which the election with respect to 
such interest or mine is applicable, the taxpayer may state that such is 
the case in lieu of identifying the exact taxable year in which such 
first expenditure was made. In any case where part of the information 
required under this subdivision can be adequately supplied by means of 
appropriately marked maps, the statement may be accompanied by such maps 
and may omit the required descriptive material to the extent replaced by 
the maps. The taxpayer shall maintain adequate records and maps in 
support of the above information. In the event that the first 
expenditure for development or operation with respect to a separate 
operating mineral interest is made by the taxpayer in a taxable year 
subsequent to the taxable year for which an election under this section 
has been made with respect to the operating unit of which such interest 
is a part, the taxpayer shall furnish information describing such 
interest in sufficient detail to identify it as a part of such operating 
unit, to show whether it is a part of a mine with respect to which the 
interests have previously been aggregated or have previously been 
treated as separate properties, and to indicate whether it is to be 
included within an aggregation.
    (ii) Special rule. If the last day prescribed by law for filing the 
taxpayer's income tax return (including extensions thereof) for the 
first taxable year for which an election under section 614(c) (1) or (2) 
is made falls before May 1, 1961, the statement of election or 
modification thereof for such taxable year must be filed on or before 
May 1, 1961, with the district director for the district in which such 
return was filed. The statement must contain the information as required 
in subdivision (i) of this subparagraph, must indicate the first taxable 
year for which the election contained therein is made, and shall be 
accompanied by an amended return or returns if necessary or, if 
appropriate, a claim for refund or credit.
    (6) Elections; when effective. If the taxpayer has elected to form 
an aggregation under section 614(c)(1) and this section, the date on 
which the aggregation becomes effective is the first day of the first 
taxable year for which the election is made; except that if any separate 
operating mineral interest included in such aggregation was acquired 
after such first day, the date on which the inclusion of such interest 
in such aggregation becomes effective is the date of its acquisition. If 
the taxpayer elects to add another operating mineral interest to such 
aggregation for a subsequent taxable year, the date on which aggregation 
of the additional interest becomes effective is the first day of such 
subsequent taxable year or the date of acquisition of such interest, 
whichever is later. If an operating mineral interest is required to be 
included in the aggregation for a subsequent

[[Page 511]]

taxable year because such interest becomes a part of a mine which the 
taxpayer has previously elected to aggregate, the date on which the 
inclusion of such interest in the aggregation becomes effective is the 
first day of the subsequent taxable year or the date of acquisition of 
such interest, whichever is later. If the taxpayer has elected to treat 
a separate operating mineral interest as more than one such interest, 
the date on which the election becomes effective is the first day of the 
first taxable year for which the election is made or the earliest date 
on which the first expenditure for development or operation has been 
made by the taxpayer with respect to a mine on each newly formed 
separate operating mineral interest, whichever is later.
    (7) Elections; binding effect. A valid election under section 614(c) 
(1) or (2) whether made in accordance with section 614(c)(3) (A) or (B) 
shall be binding upon the taxpayer for the taxable year for which made 
and for all subsequent taxable years unless consent to change the 
treatment of an operating mineral interest with respect to which an 
election has been made is obtained from the Commissioner. For rules 
relating to the binding effect of an election where the basis of a 
separate or an aggregated property in the hands of the transferee is 
determined by reference to the basis in the hands of the transferor, see 
paragraph (c) of Sec.  1.614-6. A taxpayer can neither include within an 
aggregation a separate operating mineral interest which he has 
previously elected to treat as a separate property, nor exclude from an 
aggregation a separate operating mineral interest which he has properly 
elected to include within such aggregation unless consent to do so is 
obtained from the Commissioner. A change in tax consequences alone is 
not sufficient to obtain consent to change the treatment of an operating 
mineral interest. However, consent may be appropriate where, for 
example, there has been a substantial change in the taxpayer's 
operations so that a major part of an aggregation becomes a part of 
another operating unit. Applications for consent shall be made in 
writing to the Commissioner of Internal Revenue, Washington, DC 20224. 
The application must be accompanied by a statement indicating the reason 
or reasons for the change and furnishing the information required in 
subparagraph (5)(i) of this paragraph, unless such information has been 
previously filed and is current.
    (8) Invalid aggregations--(i) General rule. In addition to 
aggregations which are invalid under this section because of the failure 
to make timely elections, aggregations may be invalid under this section 
in situations which may be divided into two general categories. The 
first category involves invalid basic aggregations. The second category 
involves invalid additions to basic aggregations.
    (ii) Invalid basic aggregations. The term invalid basic aggregations 
refers to aggregations which are initially invalid. Generally, a basic 
aggregation is initially invalid because it does not include all the 
separate operating mineral interests which comprise a complete mine or 
mines or because it includes separate operating mineral interests which 
are not part of the same operating unit. If the taxpayer makes an 
invalid basic aggregation, each of the separate operating mineral 
interests included in such aggregation shall be treated as a separate 
property for the first taxable year for which the election is made and 
for all subsequent taxable years unless consent is obtained from the 
Commissioner to treat any such interest in a different manner. Consent 
will be granted in appropriate cases. For example, assume that the 
taxpayer elects to form an aggregation of the operating mineral 
interests which comprise one or more complete mines. If the taxpayer 
demonstrates that he inadvertently failed to include a minor part of one 
of the aggregated mines or inadvertently included a minor part of 
another mine that is not a part of the aggregation, consent will 
ordinarily be granted to maintain the aggregation by including the part 
omitted or by excluding the part included. The provisions of this 
subdivision may be illustrated by the following examples:

    Example 1. In 1958, taxpayer A owned ten operating mineral 
interests, designated No. 1 through No. 10, which he operated as a unit. 
Interests Nos. 1 through 5 comprised mine X, and interests Nos. 6 
through 10 comprised

[[Page 512]]

mine Y. Taxpayer A had made his first development expenditure with 
respect to each of the ten interests before January 1, 1958. Taxpayer A 
elected under section 614(c) (1) and (3)(A) to aggregate interests Nos. 
1 through 8 for 1958 and all subsequent taxable years. The aggregation 
formed by taxpayer A is an invalid basic aggregation because it does not 
include all the operating mineral interests which comprise a complete 
mine or mines. Therefore, interests Nos. 1 through 8 must be treated as 
separate properties for 1958 and all subsequent taxable years unless 
consent is obtained from the Commissioner to treat any of such interests 
in a different manner.
    Example 2. In 1958, taxpayer B owned ten operating mineral interests 
designated No. 1 through No. 10. Interests Nos. 1 through 5 comprised 
mine X, and interests Nos. 6 through 10 comprised mine Y. Taxpayer B had 
made his first development expenditure with respect to each of the ten 
interests before January 1, 1958. Taxpayer B elected under section 
614(c) (1) and (3)(A) to aggregate interests Nos. 1 through 10 for 1958 
and all subsequent taxable years. Upon audit, it was determined that 
mines X and Y were in two separate operating units. Therefore, the 
aggregation formed by taxpayer B is invalid, and interests Nos. 1 
through 10 must be treated as separate properties for 1958 and all 
subsequent taxable years unless consent is obtained from the 
Commissioner to treat any of such interests in a different manner.

    (iii) Invalid additions. The term invalid addition refers to an 
operating mineral interest which is invalidly aggregated with an 
existing aggregation. Generally, an addition is invalid because it is a 
part of a mine and is aggregated with an aggregation which does not 
include other interests which are parts of the same mine, or because it 
is in one operating unit and is included as part of an aggregation which 
is in another operating unit. If an invalid addition is properly a part 
of a mine with respect to which other interests have been validly 
aggregated for a taxable year prior to the first taxable year for which 
the election to aggregate the invalid addition is made, then the invalid 
addition shall be included in the aggregation of which it is properly a 
part for such first taxable year and all subsequent taxable years. Any 
other invalid addition shall be treated as a separate property for the 
first taxable year for which the election to aggregate such addition is 
made and for all subsequent taxable years unless consent is obtained 
from the Commissioner to treat any such interest in a different manner. 
The provisions of this subdivision may be illustrated by the following 
examples:

    Example 1. In 1958, taxpayer A owned six operating mineral 
interests, designated No. 1 through No. 6, which he operated as a unit. 
Interests Nos. 1 through 3 comprised mine X, and interests Nos. 4 
through 6 comprised mine Y. Taxpayer A had made his first development 
expenditure with respect to each of the six interests before January 1, 
1958. Taxpayer A elected under section 614(c) (1) and (3)(A) to 
aggregate interests Nos. 1 through 3 for 1958 and all subsequent taxable 
years. He elected to treat interests Nos. 4 through 6 as separate 
properties for 1958 and all subsequent taxable years. In 1959, taxpayer 
A acquired and made his first development expenditure with respect to 
interest No. 7. Interest No. 7 was a part of the mine composed of 
interests Nos. 4 through 6. Taxpayer A elected under section 614(c) (1) 
and (3)(A) to aggregate interest No. 7 with the aggregation of interests 
Nos. 1 through 3 for 1959 and all subsequent taxable years. Interest No. 
7 is an invalid addition and must be treated as a separate property for 
1959 and all subsequent taxable years. It cannot be aggregated with 
interests Nos. 4 through 6 since taxpayer A has previously elected to 
treat such interests as separate properties. However, the valid basic 
aggregation composed of interests Nos. 1 through 3 is not affected by 
the invalid addition of interest No. 7.
    Example 2. Assume the same facts as in example 1 except that 
taxpayer A elected under section 614(c) (1) and (3)(A) to aggregate 
interests Nos. 1 through 3 as one aggregation and interests Nos. 4 
through 6 as another aggregation for 1958 and all subsequent taxable 
years. The aggregation of interest No. 7 with the aggregation consisting 
of interests Nos. 1 through 3 constitutes an invalid addition. Interest 
No. 7 must be included in the aggregation consisting of interests Nos. 4 
through 6 for 1959 and all subsequent taxable years.
    Example 3. In 1958, taxpayer B owned three operating mineral 
interests, designated No. 1 through No. 3, which comprised mine X. 
Taxpayer B had made his first development expenditure with respect to 
each of the three interests before January 1, 1958. Taxpayer B elected 
under section 614(c) (1) and (3)(A) to aggregate interests Nos. 1 
through 3 for 1958 and all subsequent taxable years. In 1959, taxpayer B 
acquired interests Nos. 4 through 7 which comprised mine Y. Taxpayer B 
made his first development expenditure with respect to each of the four 
interests during 1959. Taxpayer B elected under section 614(c) (1) and 
(3)(A) to aggregate interests Nos. 4 through 6 and to aggregate interest 
No. 7 with the aggregation consisting of interests Nos. 1 through 3 for 
1959 and all subsequent taxable years. The aggregation consisting of 
interests Nos. 4 through 6 is an invalid basic

[[Page 513]]

aggregation, and the aggregation of interest No. 7 is an invalid 
addition. Interests Nos. 4 through 7 must be treated as separate 
properties for 1959 and all subsequent taxable years unless consent is 
obtained from the Commissioner to treat such interests in a different 
manner.

    (g) Special rule as to deductions under section 615(a) prior to 
aggregation--(1) General rule. If an aggregation of operating mineral 
interests under section 614(c)(1) and paragraph (a) of this section 
includes any interest or interests in respect of which exploration 
expenditures, paid or incurred after the acquisition of such interest or 
interests, were deducted by the taxpayer under section 615(a) for any 
taxable year which precedes the date on which such aggregation becomes 
effective, then the tax imposed by chapter 1 of the Code for the taxable 
year or years in which such exploration expenditures were so deducted 
shall be recomputed in accordance with the rules contained in this 
paragraph. If an operating mineral interest is added to such aggregation 
for a subsequent taxable year and exploration expenditures made with 
respect to such interest after its acquisition were deducted by the 
taxpayer under section 615(a) for any taxable year which precedes the 
date on which the aggregation of such additional interest becomes 
effective, then the tax imposed by chapter 1 of the Internal Revenue 
Code of 1954 for the taxable year or years in which such exploration 
expenditures were so deducted shall be recomputed. For purposes of this 
paragraph, such taxable year or years shall be referred to as the 
taxable year or years for which a recomputation is required to be made. 
See paragraph (f)(6) of this section for rules relating to the date on 
which an aggregation becomes effective or the date on which the 
aggregation of an additional interest to an aggregation becomes 
effective. See subparagraph (3) of this paragraph for rules relating to 
the method of recomputation of tax. The provisions of this subparagraph 
may be illustrated by the following examples:

    Example 1. In 1954, taxpayer A owned two operating mineral interests 
designated Nos. 1 and 2. Interest No. 1 was in the production stage 
prior to 1954. The first exploration expenditures with respect to 
interest No. 2 were made by taxpayer A in 1954 and were deducted under 
section 615(a) on his return for that year. In 1955, taxpayer A made his 
first development expenditure with respect to interest No. 2, and 
thereafter it was operated with interest No. 1 as a unit. Taxpayer A 
elected under section 614(c) (1) and (3)(B) to form an aggregation of 
interests Nos. 1 and 2 for 1955 and all subsequent taxable years. 
Taxpayer A must recompute his tax for 1954 in accordance with this 
paragraph.
    Example 2. Assume the same facts as in example 1 except that, in 
1957, taxpayer A acquired another operating mineral interest, designated 
No. 3, made his first exploration expenditures with respect to such 
interest in that year, and deducted such expenditures under section 
615(a) on his return for that year. In 1958, taxpayer A made his first 
development expenditure with respect to interest No. 3. Interest No. 3 
was part of the same operating unit as interests Nos. 1 and 2. Taxpayer 
A elected under section 614(c) (1) and (3)(B) to add interest No. 3 to 
his aggregation of interests Nos. 1 and 2 for 1958 and all subsequent 
taxable years. Taxpayer A must recompute his tax for 1957 in accordance 
with this paragraph.

    (2) Exceptions--(i) Taxable years beginning before January 1, 1958. 
In the case of exploration expenditures deducted by the taxpayer with 
respect to an operating mineral interest for any taxable year beginning 
before January 1, 1958, subparagraph (1) of this paragraph shall apply 
only if the taxpayer has made an election under section 614(c) (1) or 
(2) with respect to the operating unit of which such interest is a part 
and such election applies to the taxable year for which such exploration 
expenditures were deducted. Thus, if the taxpayer does not make an 
election with respect to the operating unit under section 614(c) (1) or 
(2) and (3)(B), subparagraph (1) of this paragraph does not apply in the 
case of exploration expenditures deducted with respect to any operating 
mineral interest which is a part of such operating unit for any taxable 
year beginning before January 1, 1958. The provisions of this 
subdivision may be illustrated by the following examples:

    Example 1. In 1956, taxpayer A acquired two operating mineral 
interests designated Nos. 1 and 2. Interest No. 1 was in the production 
stage at that time. Taxpayer A made his first exploration expenditures 
with respect to interest No. 2 in 1956, 1957, and 1958 and deducted such 
expenditures under section 615(a) on his returns for such years. In 
1959,

[[Page 514]]

taxpayer A made his first development expenditure with respect to 
interest No. 2. Interests Nos. 1 and 2 were operated as a unit. Taxpayer 
A elected under section 614(c) (1) and (3)(A) to aggregate interests 
Nos. 1 and 2 for 1959 and all subsequent taxable years. Only the 
exploration expenditures deducted by the taxpayer for 1958 must be taken 
into account for purposes of applying subparagraph (1) of this 
paragraph.
    Example 2. In 1954, taxpayer B owned two operating mineral 
interests, designated Nos. 1 and 2, which he operated as a unit. 
Interest No. 1 was in the production stage at that time, and interest 
No. 2 represented one mineral deposit in a single tract of land which 
was being extracted by means of two mines. Under section 614(c) (2) and 
(3)(B), taxpayer B elects to treat interest No. 2 as two separate 
operating mineral interests, designated as Nos. 2(a) and 2(b), for 1954 
and all subsequent taxable years. In 1955, taxpayer B acquired operating 
mineral interest No. 3. He made his first exploration expenditures with 
respect to interest No. 3 in 1955, 1956, and 1957 and deducted such 
expenditures under section 615(a) on his returns for such years. In 
1958, taxpayer B made his first development expenditure with respect to 
interest No. 3, and thereafter it was operated with interests Nos. 1, 
2(a), and 2(b) as a unit. Taxpayer B elects under section 614(c) (1) and 
(3)(B) to aggregate interests Nos. 1 and 3 for 1958 and all subsequent 
taxable years. The exploration expenditures deducted by the taxpayer for 
1955, 1956, and 1957 must be taken into account for purposes of applying 
subparagraph (1) of this paragraph since the taxpayer has made an 
election under section 614(c)(2) with respect to the operating unit of 
which interest No. 3 is a part and such election applies to the taxable 
years 1955, 1956, and 1957.

    (ii) Interests formed pursuant to an election under section 
614(c)(2). In the case of exploration expenditures deducted with respect 
to an operating mineral interest which the taxpayer elects to treat as 
more than one such interest under section 614(c)(2) and paragraph (b) of 
this section, subparagraph (1) of this paragraph shall not apply. Thus, 
if the taxpayer deducts exploration expenditures with respect to an 
operating mineral interest, subsequently elects to treat such interest 
as more than one interest under section 614(c)(2), and includes one of 
the newly formed interests in an aggregation under section 614(c)(1), 
subparagraph (1) of this paragraph does not apply in the case of the 
exploration expenditures deducted with respect to the interest which the 
taxpayer elected to treat as more than one interest. The provisions of 
this subdivision may be illustrated by the following examples:

    Example 1. In 1958, taxpayer A acquired two operating mineral 
interests, designated Nos. 1 and 2, which he operated as a unit. Each 
interest was an interest in a single mineral deposit in a single tract 
or parcel of land. There was a mine in the production stage of each of 
two interests at that time. Taxpayer A elected under section 
614(c)(1)(B) to treat interests Nos. 1 and 2 as separate properties. In 
1959 and 1960, taxpayer A made exploration expenditures with respect to 
interest No. 2 for the purpose of extracting the mineral by means of a 
second mine, and he deducted such expenditures on his returns for such 
years. In 1961, taxpayer A made his first development expenditure with 
respect to a second mine on interest No. 2. Taxpayer A elected under 
section 614(c)(2) to treat interest No. 2 as two separate operating 
mineral interests, designated as Nos. 2(a) and 2(b), for 1961 and all 
subsequent taxable years. Interest No. 2(a) contained the producing mine 
and interest No. 2(b) contained the subsequently developed mine. In his 
return for 1961, taxpayer A also elected under section 614(c)(1)(A) to 
aggregate interests Nos. 1 and 2(b) for 1961 and all subsequent taxable 
years. The exploration expenditures deducted with respect to interest 
No. 2 prior to the effective date of the formation of interests Nos. 
2(a) and 2(b) need not be taken into account for purposes of applying 
subparagraph (1) of this paragraph.
    Example 2. In 1954, taxpayer B owned two operating mineral interests 
designated Nos. 1 and 2. Interest No. 1 was an interest in a single 
mineral deposit in a single tract of land which was being extracted by 
means of two mines. Taxpayer B elected under section 614(c) (2) and 
(3)(B) to treat interest No. 1 as two separate operating mineral 
interests, designated as Nos. 1(a) and 1(b), for 1954 and all subsequent 
taxable years. In 1955, 1956, and 1957, taxpayer B made exploration 
expenditures with respect to interest No. 2 and deducted such 
expenditures on his returns for such years. In 1958, taxpayer B made his 
first development expenditure with respect to interest No. 2, and, on 
his return for that year, taxpayer B elected to aggregate interests Nos. 
1(a) and 2 under section 614(c)(1) for 1958 and all subsequent taxable 
years. The exploration expenditures deducted with respect to interest 
No. 2 for 1955, 1956, and 1957 shall be taken into account for purposes 
of applying subparagraph (1) of this paragraph since such exploration 
expenditures were deducted with respect to an interest to which this 
subdivision does not apply.

    (3) Recomputation of tax--(i) General rule. In the case of an 
aggregation

[[Page 515]]

formed under section 614(c)(1) and paragraph (a) of this section in 
respect of which a recomputation of tax is required to be made under the 
provisions of subparagraphs (1) and (2) of this paragraph for any 
taxable year or years, the tax imposed by chapter 1 of the Internal 
Revenue Code of 1954 shall be recomputed for each such taxable year as 
if:
    (a) The taxpayer had elected to form an aggregation for the taxable 
year for which the recomputation is required to be made, and
    (b) Such aggregation had included all the interests included in the 
aggregation formed under section 614(c)(1) except those interests which 
the taxpayer did not own during the taxable year for which the 
recomputation is required to be made and those interests in respect of 
which the taxpayer had made no expenditures for exploration, 
development, or operation before or during the taxable year for which 
the recomputation is required to be made


If a recomputation of tax is required to be made for any taxable year in 
the case of the aggregation of an additional interest to an existing 
aggregation under section 614(c)(1), such recomputation shall be made as 
if:
    (c) The taxpayer had elected to form an aggregation for the taxable 
year for which the recomputation is required to be made, and
    (d) Such aggregation had included all the interests included in the 
aggregation formed under section 614(c)(1) (including any interest which 
the taxpayer had disposed of prior to the date on which the aggregation 
of the additional interest becomes effective) except those interests 
which the taxpayer did not own during the taxable year for which the 
recomputation is required to be made and those interests in respect of 
which the taxpayer had made no expenditures for exploration, 
development, or operation before or during the taxable year for which 
the recomputation is required to be made


For purposes of this paragraph, any aggregation which is treated as 
having been formed under subdivisions (a) and (b) or under subdivisions 
(c) and (d) shall be referred to as the constructed aggregated property.
    (ii) Recomputation of depletion allowance. The taxpayer shall 
compute the depletion allowance with respect to the constructed 
aggregated property for the taxable year for which the recomputation is 
required to be made. In making this computation, cost depletion for such 
taxable year shall be computed with reference to the depletion unit for 
the constructed aggregated property. See paragraph (a) of Sec.  1.611-2. 
Percentage depletion for such taxable year shall not exceed 50 percent 
of the taxable income from the constructed aggregated property computed 
in accordance with Sec.  1.613-5. If a recomputation is required to be 
made for the same taxable year with respect to any other aggregation or 
aggregations formed by the taxpayer under section 614(c)(1), the 
depletion allowance with respect to the other constructed aggregated 
property or properties shall be similarly computed. If, for a taxable 
year in respect of which a recomputation is required, the sum of the 
depletion allowance or allowances as computed under this subdivision is 
less than the sum of the depletion allowance or allowances actually 
deducted for such taxable year with respect to all the properties 
required to be taken into account in making the computation under this 
subdivision, then the total depletion allowance deducted by the taxpayer 
for such taxable year shall be reduced by the difference. The taxable 
income or net operating loss of the taxpayer for such taxable year shall 
be adjusted to reflect such reduction for purposes of the recomputation 
of tax. However, if for a taxable year in respect of which a 
recomputation is required, the sum of the depletion allowance or 
allowances as computed under this subdivision exceeds the sum of the 
depletion allowance or allowances actually deducted for such taxable 
year with respect to all the properties required to be taken into 
account in making the computation under this subdivision, the 
recomputation of tax for such taxable year is disregarded for purposes 
of applying section 614(c)(4) (B), (C), and (D).
    (iii) Effect of recomputation with respect to items based on amount 
of income. In making the recomputation of tax

[[Page 516]]

under this subparagraph for any taxable year, any deduction, credit, or 
other allowance which is based upon the adjusted gross income or taxable 
income of the taxpayer for such year shall be recomputed taking into 
account the adjustment required under subdivision (ii) of this 
subparagraph. For example, if a corporate taxpayer's taxable income is 
increased under the provisions of such subdivision, then the amount of 
charitable contributions which may be deducted under the limitation 
contained in section 170(b)(2) shall be correspondingly increased for 
purposes of the recomputation. Moreover, the effect that the 
recomputation of any deduction, credit, or other allowance for a taxable 
year has on the tax imposed for any other taxable year shall also be 
taken into account for purposes of the recomputation of tax under this 
subparagraph. Any change in items of tax preferences (as defined in 
section 57 and the regulations thereunder) must also be taken into 
account for purposes of the recomputation under this subparagraph.
    (iv) Effect of recomputation with respect to a net operating loss 
and a net operating loss deduction. If the recomputation of tax under 
this subparagraph for the taxable year for which the recomputation is 
required to be made results in a reduction of a net operating loss for 
such year, then the taxpayer shall take into account the effect of such 
reduction on the tax imposed by chapter I of the Internal Revenue Code 
of 1954 (or by corresponding provisions of the Internal Revenue Code of 
1939) for any taxable year affected by such reduction. If the 
recomputation of tax for the taxable year for which the recomputation is 
required to be made results in an increase in taxable income as defined 
in section 172(b)(2) for such year, then the taxpayer shall take into 
account the effect of such increase on the tax imposed by chapter I of 
the Internal Revenue Code of 1954 (or by corresponding provisions of the 
Internal Revenue Code of 1939) for any taxable year affected by such 
increase. Furthermore, in making the recomputation of tax for any 
taxable year for which the recomputation is required to be made, the 
taxpayer shall take into account any change in the net operating loss 
deduction for such year resulting from the recomputation of tax for any 
other taxable year for which a recomputation is required to be made. For 
provisions relating to the net operating loss deduction, see section 172 
and the regulations thereunder. For rules relating to the effect of the 
net operating loss deduction on the minimum tax for tax preferences see 
section 56 and the regulations thereunder and Sec.  1.58-7.
    (v) Determination of increase in tax. If the taxpayer elects to form 
an aggregation or aggregations for a taxable year under section 
614(c)(1) and if a recomputation of tax is required to be made under 
this paragraph for any prior taxable year or years, then the taxpayer 
shall compute the difference between the tax, including the tax imposed 
by section 56 (relating to the minimum tax for tax preferences), as 
recomputed under this subparagraph for such prior taxable year or years 
(and other taxable years affected by the recomputation) and the tax 
liability previously determined (computed without regard to section 
614(c)(4)) with respect to such prior taxable year or years (and other 
taxable years affected by the recomputation). If the taxpayer is 
subsequently required to make a recomputation with respect to any 
taxable year or years for which he has previously made a recomputation, 
then the taxpayer shall compute the difference between the tax as 
subsequently recomputed for such taxable year or years (and other 
taxable years affected by the subsequent recomputation) and the tax as 
previously recomputed for such taxable year or years (and other taxable 
years affected by the subsequent recomputation). For treatment of the 
increase in tax resulting from the recomputation of tax under this 
subparagraph, see subparagraph (4) of this paragraph.
    (4) Treatment of increase in tax--(i) General rule. If the taxpayer 
elects to form an aggregation or aggregations for a taxable year under 
section 614(c)(1) and if a recomputation of tax is required to be made 
for any prior taxable year or years, then the total increase in tax 
resulting from such recomputation determined under subparagraph (3)(v) 
of this paragraph shall

[[Page 517]]

be taken into account in the first taxable year to which the election to 
form such aggregation or aggregations is applicable and in each 
succeeding taxable year until the full amount of such total increase in 
tax has been taken into account. The number of taxable years over which 
such total increase shall be taken into account shall be equal to the 
number of taxable years for which a recomputation of tax is required to 
be made under subparagraph (1) of this paragraph as limited by 
subparagraph (2) of this paragraph and for which such recomputation 
results in a reduction of the taxpayer's depletion allowance under 
subparagraph (3)(ii) of this paragraph. The amount of the increase in 
tax which is to be taken into account in a taxable year is determined by 
dividing the total increase in tax by the number of taxable years over 
which such total increase is to be taken into account. The tax imposed 
by chapter I of the Code for each of the taxable years over which the 
total increase in tax is to be taken into account shall be increased by 
the amount determined in accordance with the preceding sentence. 
However, such increase in tax for each of such taxable years shall have 
no effect upon the determination of the amount of any credit against the 
tax for any of such taxable years. For example, the amount of such 
increase shall not affect the computation of the limitation on the 
foreign tax credit under section 904. The amount of the increase in tax 
which is required to be taken into account by the taxpayer in a 
particular taxable year under section 614(c)(4)(C) shall be treated as a 
tax imposed with respect to such taxable years even though, without 
regard to section 614(c)(4) and this paragraph, such taxpayer would 
otherwise have no tax liability for such taxable year.
    (ii) Increase in tax not determinable as of first taxable year of 
aggregation. If the recomputation of tax under subparagraph (3) of this 
paragraph, for any taxable year or years prior to the first taxable year 
to which the election to form an aggregation or aggregations under 
section 614(c)(1) applies, results in a reduction of any net operating 
loss carryover to a taxable year subsequent to such first taxable year, 
then the total increase in tax resulting from the recomputation is not 
determinable as of such first taxable year. In such case, the total 
increase in tax shall be taken into account in equal installments in the 
first taxable year for which such total increase is determinable and in 
each succeeding taxable year for which a portion of the increase in tax 
would have been taken into account under subdivision (i) of this 
subparagraph if the total increase had been determinable as of the first 
taxable year to which the election to form the aggregation or 
aggregations under section 614(c)(1) applies. The provisions of this 
subdivision may be illustrated by the following example:

    Example. Assume that taxpayer A elects under section 614(c)(1) to 
form an aggregation for 1960 and all subsequent taxable years. Assume 
further that taxpayer A is required to recompute his tax for four prior 
taxable years under subparagraphs (1) and (2) of this paragraph and that 
the recomputation for each of such taxable years results in a reduction 
of taxpayer A's depletion allowance. Under subdivision (i) of this 
subparagraph, the total increase in tax resulting from the recomputation 
is to be taken into account in equal installments in 1960, 1961, 1962, 
and 1963. However, if the total increase in tax is not determinable 
until 1961 because the recomputation for the prior taxable years results 
in the reduction of a net operating loss carryover to 1961, then the 
total increase shall be taken into account in equal installments in 
1961, 1962, and 1963. In like manner, if the total increase in tax is 
not determinable until 1962, it shall be taken into account in equal 
installments in 1962 and 1963.

    (iii) Death or cessation of existence of taxpayer. If the taxpayer 
dies or ceases to exist, the portion of the increase in tax determined 
under subparagraph (3)(v) of this paragraph which has not been taken 
into account under subdivision (i) or (ii) of this subparagraph for 
taxable years prior to the taxable year of the occurrence of such death 
or such cessation of existence, as the case may be, shall be taken into 
account for the taxable year in which such death or such cessation of 
existence, as the case may be, occurs.
    (5) Adjustments to basis of aggregated property. If the taxpayer 
elects to form an aggregated property or properties under section 
614(c)(1) for a taxable year and if a recomputation of tax is required 
to be made for any taxable

[[Page 518]]

year which results in reduction of the depletion allowance previously 
deducted by the taxpayer for such year, then proper adjustments shall be 
made with respect to the adjusted basis of such aggregated property or 
properties. In such a case:
    (i) If the sum of the depletion allowances actually deducted with 
respect to the interests included in a constructed aggregated property 
exceeds the depletion allowance computed under subparagraph (3)(ii) of 
this paragraph with respect to such constructed aggregated property, the 
adjusted basis of the aggregated property formed under section 614(c)(1) 
shall be increased by such excess, and
    (ii) If the depletion allowance computed under subparagraph (3)(ii) 
of this paragraph with respect to a constructed aggregated property 
exceeds the sum of the depletion allowances actually deducted with 
respect to the interests included in such constructed aggregated 
property, the adjusted basis of the aggregated property formed under 
section 614(c)(1) shall be reduced (but not below zero) by such excess.


However, the adjusted basis of an aggregated property formed under 
section 614(c)(1) may be increased only to the extent such excess would 
have resulted in an increase in such adjusted basis if taken into 
account under paragraph (a) of Sec.  1.614-6. Thus, if depletion 
previously allowed with respect to the separate operating mineral 
interests included in the aggregation formed under section 614(c)(1) 
exceeds the total of the unadjusted bases of such interests by $5,000, 
and if the recomputation of tax required to be made under this paragraph 
results in a depletion allowance which is $7,000 less than the depletion 
actually deducted with respect to such interests, then the adjusted 
basis of such aggregation may be increased by only $2,000. If, with 
respect to the same aggregated property formed under section 614(c)(1), 
adjustments to adjusted basis are required under this subparagraph as a 
result of recomputation of tax for two or more taxable years, the total 
or net amount of such adjustments shall be taken into account. Any 
adjustment to the adjusted basis of an aggregation required by this 
subparagraph shall be taken into account as of the effective date of the 
election to form such aggregation under section 614(c)(1) and shall be 
effective for all purposes of subtitle A of the Code. For other rules 
relating to the determination of the adjusted basis of an aggregated 
property, see paragraph (a) of Sec.  1.614-6.

[T.D. 6524, 26 FR 150, Jan. 10, 1961, as amended by T.D. 7170, 37 FR 
5382, Mar. 15, 1972; T.D. 7564, 43 FR 40494, Sept. 12, 1978]



Sec.  1.614-4  Treatment under the Internal Revenue Code of 1939 
with respect to separate operating mineral interests for taxable
years beginning before January 1, 1964, in the case of oil and 
gas wells.

    (a) General rule. (1) All references in this section to section 
614(b) or any paragraph or subparagraph thereof are references to 
section 614(b) or a paragraph or subparagraph thereof as it existed 
prior to its amendment by section 226(a) of the Revenue Act of 1964. All 
references in this section to section 614(d) are references to section 
614(d) as it existed prior to its amendment by section 226(b)(3) of the 
Revenue Act of 1964.
    (2) For taxable years beginning before January 1, 1964, in the case 
of oil and gas wells, a taxpayer may treat under section 614(d) and this 
section any property as if section 614 (a) and (b) had not been enacted. 
For purposes of this section, the term property means each separate 
operating mineral interest owned by the taxpayer in each mineral deposit 
in each separate tract or parcel of land. Separate tracts or parcels of 
land exist not only when areas of land are separated geographically, but 
also when areas of land are separated by means of the execution of 
conveyances or leases. If the taxpayer treats any property or properties 
under this section, the taxpayer must treat each such property as a 
separate property except that the taxpayer may treat any two or more 
properties that are included within the same tract or parcel of land as 
a single property provided such treatment is consistently followed. If 
the taxpayer treats two or more properties as a single property under 
this section, such properties shall be considered as a single property

[[Page 519]]

for all purposes of subtitle A of the Internal Revenue Code of 1954. The 
taxpayer may not make more than one combination of properties within the 
same tract or parcel of land. Thus, if the taxpayer treats two or more 
properties that are included within the same tract or parcel of land as 
a single property, each of the remaining properties included within such 
tract or parcel of land shall be treated as a separate property. If the 
taxpayer has treated two or more properties that are included within the 
same tract or parcel of land as a single property and subsequently 
discovers or acquires an additional mineral deposit within the same 
tract or parcel of land, he may include his interest in such deposit 
with the two or more properties which are being treated as a single 
property or he may treat his interest in such deposit as a separate 
property. If the taxpayer has treated each property included within a 
tract or parcel of land as a separate property and subsequently 
discovers or acquires an additional mineral deposit within the same 
tract or parcel of land, he may combine his interest in such deposit 
with any one of the separate properties included within the tract or 
parcel of land, but not with more than one of them since they cannot be 
validly combined with each other. The taxpayer may not combine 
properties which are included within different tracts or parcels of land 
under this section irrespective of whether such tracts or parcels of 
land are contiguous. The treatment of a property as a separate property 
or the treatment of two or more properties included within a single 
tract or parcel of land as a single property under this section shall be 
binding upon the taxpayer for the first taxable year for which such 
treatment is effective and for all subsequent taxable years beginning 
before January 1, 1964. For the continuation of such treatment under 
Sec.  1.614-8 for taxable years beginning after December 31, 1963, see 
paragraph (d) of Sec.  1.614-8. For provisions relating to the first 
taxable year for which treatment under this section becomes effective, 
see paragraph (d) of this section.
    (b) Treatment consistent with treatment for taxable years prior to 
1954. If the taxpayer has treated properties in a manner consistent with 
the rules contained in paragraph (a) of this section for taxable years 
to which the Internal Revenue Code of 1939 applies and if the taxpayer 
desires to treat such properties under section 614(d), then such 
properties must continue to be treated in the same manner. The 
provisions of this paragraph may be illustrated by the following 
examples:

    Example 1. In 1950, taxpayer A owned two separate tracts of land 
designated No. 1 and No. 2. Each tract contained three mineral deposits. 
In the case of tract No. 1, taxpayer A treated the three mineral 
deposits as a single property. In the case of tract No. 2, taxpayer A 
treated the first mineral deposit as a separate property and treated the 
second and third mineral deposits as a single property. This treatment 
was consistently followed for the taxable years 1950, 1951, 1952, and 
1953. Taxpayer A desires, for 1954 and subsequent taxable years, to 
treat the properties in tracts Nos. 1 and 2 as if section 614 (a) and 
(b) had not been enacted. For 1954 and subsequent taxable years, the 
three deposits in tract No. 1 must be treated as a single property; the 
first deposit in tract No. 2 must be treated as a separate property; and 
the second and third deposits in tract No. 2 must be treated as a single 
property.
    Example 2. Assume the same facts as in example 1 except that, at the 
time the treatment under this section is adopted, assessment of any 
deficiency or credit or refund of any overpayment for the taxable years 
1954 and 1955 resulting from the treatment of properties under this 
section is prevented by the operation of the statute of limitations. For 
1956 and subsequent taxable years, the three deposits in tract No. 1 
must be treated as a single property; the first deposit in tract No. 2 
must be treated as a separate property; and the second and third 
deposits in tract No. 2 must be treated as a single property.

    (c) Bases of separate properties previously included in an 
aggregation under section 614(b). If the taxpayer has made an election 
under section 614(b) to form an aggregation of operating mineral 
interests and if such taxpayer subsequently revokes such election for 
all taxable years for which it was made and treats the properties that 
are included within such aggregation under section 614(d) and this 
section by filing the statement required by paragraph (e) of this 
section, then the adjusted basis of each separate property (as defined 
in paragraph (a) of this section) that is a part of such aggregation 
shall

[[Page 520]]

be determined as if the taxpayer had made no election under section 
614(b). However, if, at the time of the filing of the statement revoking 
the election under section 614(b), assessment of any deficiency or 
credit or refund of any overpayment, as the case may be, resulting from 
such revocation is prevented by the operation of any law or rule of law 
for any taxable year or years for which the election under section 
614(b) was made, then the adjusted basis of each separate property that 
is a part of the aggregation shall be determined in accordance with the 
provisions contained in paragraph (a)(2) of Sec.  1.614.6 as of the 
first day of the first taxable year for which the revocation is 
effective. After determining the adjusted basis of each separate 
property included within the aggregation, the taxpayer may treat such 
properties in any manner which is in accordance with paragraph (a) of 
this section. See, however, paragraph (b) of this section. The 
provisions of this paragraph may be illustrated by the following 
examples:

    Example 1. Taxpayer A owns two separate tracts of land, designated 
No. 1 and No. 2, each of which contains three mineral deposits. The 
interests in the two tracts of land constitute an operating unit as 
defined in paragraph (c) of Sec.  1.614-2. Taxpayer A elects under 
section 614(b) to form an aggregation of all the interests in the 
operating unit for 1954 and all subsequent taxable years. Subsequently, 
taxpayer A revokes such election by filing a statement in accordance 
with paragraph (e) of this section. Such revocation is effective for 
1956 and subsequent taxable years because, at the time of the filing of 
the statement of revocation, assessment of any deficiency or credit or 
refund of any overpayment for the taxable years 1954 and 1955 resulting 
from such revocation is prevented by the operation of the statute of 
limitations. The adjusted bases of the six properties that are included 
within the aggregation shall be determined in accordance with paragraph 
(a)(2) of Sec.  1.614-6 as of the beginning of the taxable year 1956.
    Example 2. Assume the same facts as in example 1 and, in addition, 
assume that for taxable years to which the Internal Revenue Code of 1939 
is applicable, taxpayer A treated the three deposits in tract No. 1 as a 
single property and the three deposits in tract No. 2 as a single 
property. After determining the adjusted basis of each of the six 
properties as illustrated in example 1, the adjusted basis of the three 
properties in tract No. 1 must be combined and the adjusted bases of the 
three properties in tract No. 2 must be combined since the manner in 
which such properties were treated for taxable years to which the 
Internal Revenue Code of 1939 is applicable is consistent with the rules 
contained in paragraph (a) of this section.

    (d) Treatment; when effective. If a taxpayer treats any property in 
accordance with this section, then such treatment shall be effective for 
whichever of the following taxable years is the later:
    (1) The latest taxable year for which an election could have been 
made with respect to such property under section 614(b); or
    (2) The first taxable year beginning after December 31, 1953, and 
ending after August 16, 1954, in respect of which assessment of a 
deficiency or credit or refund of an overpayment, as the case may be, 
resulting from the treatment of such property under this section, is not 
prevented by the operation of any law or rule of law on the date such 
treatment is adopted.
    (e) Manner of adopting the treatment of properties under this 
section. If the taxpayer does not make an election under section 614(b) 
with respect to a property within the time prescribed for making such an 
election, then the taxpayer shall be deemed to have treated such 
property under this section. In such case, the manner in which such 
property is treated in filing the taxpayer's income tax return for the 
first taxable year for which the treatment of such property is effective 
under paragraph (d) of this section shall establish the treatment which 
must be consistently followed with respect to such property for 
subsequent taxable years. However, if the income tax return for such 
first taxable year is filed prior to May 1, 1961, then the taxpayer may 
adopt the treatment provided for under this section with respect to the 
property by filing a statement at any time on or before May 1, 1961, 
with the district director for the district in which the taxpayer's 
income tax return was filed for the first taxable year for which the 
treatment of such property is effective under paragraph (d) of this 
section. Such statement shall set forth the first taxable year for which 
the treatment of the property under this section is effective, shall 
revoke any previous elections made with respect to

[[Page 521]]

such property under section 614(b), shall state the manner in which such 
property was treated for taxable years subject to the Internal Revenue 
Code of 1939, shall state the manner in which such property is to be 
treated under this section, and shall be accompanied by an amended 
return or returns if necessary.
    (f) Certain treatment under this section precludes election to 
aggregate under section 614(b) with respect to the same operating unit. 
If the taxpayer's treatment of any properties that are included within 
an operating unit (as defined in paragraph (c) of Sec.  1.614-2) under 
section 614(d) and this section would constitute an aggregation under 
section 614(b) and if such taxpayer elects, or has elected, to form an 
aggregation within the same operating unit under section 614(b) for any 
taxable year for which the treatment under section 614(d) is effective, 
then the election made under section 614(b) shall not apply for any such 
taxable year.

[T.D. 6524, 26 FR 157, Jan. 10, 1961, as amended by T.D. 6859, 30 FR 
13700, Oct. 28, 1965]



Sec.  1.614-5  Special rules as to aggregating nonoperating mineral
interests.

    (a) Aggregating nonoperating mineral interests for taxable years 
beginning before January 1, 1958. Upon proper showing to the 
Commissioner, a taxpayer who owns two or more separate nonoperating 
mineral interests in a single tract or parcel of land, or in two or more 
contiguous tracts or parcels of land, shall be permitted to aggregate 
all such interests in each separate kind of mineral deposit and treat 
them as one property. Permission will be granted by the Commissioner 
only if the taxpayer establishes that he will sustain an undue hardship 
if such nonoperating mineral interests are not treated as one property. 
Such hardship may exist, for example, if it is impossible for the 
taxpayer to determine the boundaries, source, or costs of the separate 
interests, or if a taxpayer who owns a single royalty interest, 
production payment, or net profits interest cannot determine the 
separate deposits from which his payments will be derived. In no event 
shall undue hardship be deemed to exist solely by reason of tax 
disadvantage. The treatment of such interests as one property shall be 
applicable for all purposes of subtitle A of the Internal Revenue Code 
of 1954. In no event may nonoperating mineral interests in tracts or 
parcels of land which are not contiguous be treated as one property. The 
term two or more contiguous tracts or parcels of land means tracts or 
parcels of land which have common boundaries. Common boundaries include 
survey lines, public roads, or similar easements for the use of land 
without the existence of an intervening mineral right between the tracts 
or parcels of land. Tracts or parcels of land which touch only at a 
common corner are not contiguous. For the definition of nonoperating 
mineral interests, see paragraph (g) of this section.
    (b) Manner and scope of election--(1) Time for filing application 
for permission to aggregate separate nonoperating mineral interests 
under paragraph (a) of this section. The application for permission to 
aggregate separate nonoperating mineral interests under paragraph (a) of 
this section shall be filed at any time on or before May 1, 1961. Such 
application shall indicate the first taxable year for which the 
aggregation is to be formed. If, prior to January 10, 1961, an 
application has been filed, the taxpayer need file only a supplemental 
application containing such additional information as is necessary to 
comply with the requirements of subparagraph (2) of this paragraph.
    (2) Contents of application and returns under permission. The 
application for permission to aggregate nonoperating mineral interests 
under paragraph (a) of this section shall include a complete statement 
of the facts upon which the taxpayer relies to show the undue hardship 
which would result if such an aggregation was not permitted. Such 
application shall also include a description of the nonoperating mineral 
interests owned by the taxpayer within the tract or tracts of land 
involved. A general description, accompanied by maps appropriately 
marked, which accurately circumscribes the scope of the aggregation and 
shows that the taxpayer is aggregating all the nonoperating mineral 
interests in a particular kind of mineral deposit within the tract or 
tracts of land involved will

[[Page 522]]

be sufficient. If the Commissioner grants permission, a copy of the 
letter granting such permission shall be filed with the district 
director for the district in which the taxpayer's income tax return was 
filed for the first taxable year for which such permission applies, and 
shall be accompanied by an amended return or returns if necessary.
    (3) Election; binding effect. The election to aggregate separate 
nonoperating mineral interests under paragraph (a) of this section shall 
be binding upon the taxpayer for the first taxable year for which made 
and all subsequent taxable years beginning before January 1, 1958, 
unless consent to make a change is obtained from the Commissioner. The 
application for consent to make a change must set forth in detail the 
reason or reasons for such change. Consent to a different treatment 
shall not be granted where the principal purpose for such change is due 
to tax consequences. For rules relating to the binding effect of an 
election where the basis of an aggregated property in the hands of the 
transferee is determined by reference to the basis in the hands of the 
transferor, see paragraph (c) of Sec.  1.614-6.
    (4) Aggregations under the Internal Revenue Code of 1939. An 
application for permission to aggregate nonoperating mineral interests 
under paragraph (a) of this section shall be submitted in accordance 
with the requirements of this paragraph notwithstanding the fact that 
the taxpayer may have aggregated such interests for taxable years to 
which the Internal Revenue Code of 1939 is applicable. If such interests 
were aggregated for taxable years to which the Internal Revenue Code of 
1939 applies and the aggregation was approved by the Internal Revenue 
Service for such years after full consideration thereof on its merits, 
such approval will generally be accepted as evidence that undue hardship 
would result if the aggregation were not permitted.
    (c) Termination of aggregation of nonoperating mineral interests--
(1) General rule. Any aggregation of nonoperating mineral interests 
formed under paragraphs (a) and (b) of this section shall not apply with 
respect to any taxable year beginning after December 31, 1957. Thus, if 
a taxpayer makes a binding election to form such an aggregation for 
taxable years beginning before January 1, 1958, then in order to form an 
aggregation with respect to any taxable year beginning after December 
31, 1957, he must obtain permission in accordance with the rules 
prescribed in paragraphs (d) and (e) of this section.
    (2) Bases of separate nonoperating mineral interests. If a taxpayer 
forms an aggregation of nonoperating mineral interests under paragraphs 
(a) and (b) of this section which is terminated under subparagraph (1) 
of this paragraph, the adjusted bases of the separate nonoperating 
mineral interests included in such aggregation shall be determined in 
accordance with paragraph (a)(2) of Sec.  1.614-6.
    (d) Aggregating nonoperating mineral interests for taxable years 
beginning after December 31, 1957, or for earlier taxable years. Upon 
proper showing to the Commissioner, a taxpayer who owns two or more 
separate nonoperating mineral interests in a single tract or parcel of 
land, or in two or more adjacent tracts or parcels of land, shall be 
permitted, under section 614(e), to form an aggregation of all of such 
interests in each separate kind of mineral deposit and treat such 
aggregation as one property. Permission shall be granted by the 
Commissioner only if the taxpayer establishes that a principal purpose 
in forming the aggregation is not the avoidance of tax. The fact that 
the aggregation of nonoperating mineral interests will result in a 
substantial reduction in tax is evidence that avoidance of tax is a 
principal purpose of the taxpayer. An aggregation formed under the 
provisions of this paragraph shall be considered as one property for all 
purposes of the Code. In no event may nonoperating mineral interests in 
tracts or parcels of land which are not adjacent be aggregated and 
treated as one property. The term two or more adjacent tracts or parcels 
of land means tracts or parcels of land that are in reasonably close 
proximity to each other depending on the facts and circumstances of each 
case. Adjacent tracts or parcels of land do not necessarily have any 
common boundaries, and may be separated by intervening mineral rights. 
For the definition of

[[Page 523]]

nonoperating mineral interests, see paragraph (g) of this section.
    (e) Manner and scope of election--(1) Time for filing application 
for permission to aggregate separate nonoperating mineral interests 
under section 614(e). The application for permission to aggregate 
separate nonoperating mineral interests under section 614(e) and 
paragraph (d) of this section shall be made in writing to the 
Commissioner of Internal Revenue, Washington, DC 20224. Such application 
shall be filed within 90 days after the beginning of the first taxable 
year beginning after December 31, 1957, for which aggregation is desired 
or within 90 days after the acquisition of one of the nonoperating 
mineral interests which is to be included in the aggregation, whichever 
is later. However, if the last day on which the application may be filed 
under this paragraph falls before May 1, 1961, such application may be 
filed at any time on or before May 1, 1961. If, prior to January 10, 
1961, an application has been filed, the taxpayer need file only a 
supplemental application containing such additional information as is 
necessary to comply with subparagraph (4) of this paragraph.
    (2) Election to apply section 614(e) retroactively. The application 
for permission to aggregate separate nonoperating mineral interests 
under section 614 (e) and paragraph (d) of this section may be filed, at 
the election of the taxpayer, for any taxable year beginning before 
January 1, 1958, to which the Internal Revenue Code of 1954 is 
applicable. In such case, the application may be filed at any time on or 
before May 1, 1961. Such application shall designate the first taxable 
year for which the aggregation is to be formed. If, prior to January 10, 
1961, an application has been filed, the taxpayer need file only a 
supplemental application containing such additional information as is 
necessary to comply with the requirements of subparagraph (4) of this 
paragraph.
    (3) Limitation. If the taxpayer forms any aggregation of 
nonoperating mineral interests under subparagraph (2) of this paragraph, 
then any aggregation of nonoperating mineral interests formed under 
paragraphs (a) and (b) of this section shall not apply for any taxable 
year. The provisions of this subparagraph may be illustrated by the 
following example:

    Example. In 1954, taxpayer A owns six separate nonoperating mineral 
interests designated No. 1 through No. 6. Interests Nos. 1 through 3 are 
royalty interests in contiguous tracts of land. Interests Nos. 4 through 
6, which are located in an entirely different area from interests Nos. 1 
through 3, are royalty interests in tracts of land which are not 
contiguous but which are adjacent to each other. In 1959 taxpayer A 
obtains permission and elects under section 614(e) and subparagraph (2) 
of this paragraph to form an aggregation of interests Nos. 4 through 6 
for 1956 and all subsequent taxable years. Taxpayer A may not elect to 
form an aggregation of interests Nos. 1 through 3 under paragraphs (a) 
and (b) of this section for 1954 or any subsequent taxable year. If 
taxpayer A wishes to form an aggregation of interests Nos. 1 through 3, 
he must obtain permission under paragraph (d) of this section and this 
paragraph.

    (4) Contents of application and returns under permission. The 
application for permission to aggregate nonoperating mineral interests 
under section 614(e) and paragraph (d) of this section shall include a 
complete statement of the facts upon which the taxpayer relies to show 
that avoidance of tax is not a principal purpose of forming the 
aggregation. Such application shall also include a description of the 
nonoperating mineral interests within the tract or tracts of land 
involved. A general description, accompanied by maps appropriately 
marked, which accurately circumscribes the scope of the aggregation and 
shows that the taxpayer is aggregating all the nonoperating mineral 
interests in a particular kind of mineral deposit within the tract or 
tracts of land involved will be sufficient. If the Commissioner grants 
permission, a copy of the letter granting such permission shall be 
attached to the taxpayer's income tax return for the first taxable year 
for which such permission applies. If the taxpayer has already filed 
such return, a copy of the letter of permission shall be filed with the 
district director for the district in which such return was filed and 
shall be accompanied by an amended return or returns if necessary or, if 
appropriate, a claim for credit or refund.

[[Page 524]]

    (5) Election; binding effect. The election to aggregate separate 
nonoperating mineral interests under section 614 (e) and paragraph (d) 
of this section shall be binding upon the taxpayer for the first taxable 
year for which made and for all subsequent taxable years unless consent 
to make a change is obtained from the Commissioner. The application for 
consent to make a change must set forth in detail the reason or reasons 
for such change. Consent to a different treatment shall not be granted 
where the principal purpose for such change is due to tax consequences. 
For rules relating to the binding effect of an election where the basis 
of an aggregated property in the hands of the transferee is determined 
by reference to the basis in the hands of the transferor, see paragraph 
(c) of Sec.  1.614-6.
    (6) Aggregations under the Internal Revenue Code of 1939. An 
application for permission to aggregate nonoperating mineral interests 
under section 614 (e) and paragraph (d) of this section shall be 
submitted in accordance with the requirements of this paragraph 
notwithstanding the fact that the taxpayer may have aggregated such 
interests for taxable years to which the Internal Revenue Code of 1939 
is applicable. If such interests were aggregated for taxable years to 
which the Internal Revenue Code of 1939 applies and the aggregation was 
approved by the Internal Revenue Service for such years after full 
consideration thereof on its merits, such approval will generally be 
accepted as evidence that avoidance of tax is not a principal purpose of 
forming the aggregation.
    (f) Elections; when effective. If the taxpayer has elected to form 
an aggregation under either paragraph (a) or paragraph (d) of this 
section, the date on which the aggregation becomes effective is the 
first day of the first taxable year for which the election is made; 
except that if any separate nonoperating mineral interest included in 
such aggregation was acquired after such first day, the date on which 
the inclusion of such interest in such aggregation becomes effective is 
the date of its acquisition.
    (g) Definition of nonoperating mineral interests. For purposes of 
this section, nonoperating mineral interests includes only those 
interests described in section 614(a) which are not operating mineral 
interests within the meaning of paragraph (b) of Sec.  1.614-2. The 
taxpayer who holds the operating or working rights in a mineral deposit, 
but is not actually conducting operations with respect to such deposit, 
does not have a nonoperating mineral interest in such deposit 
notwithstanding the fact that he intends to transfer such operating 
rights at a later time.

[T.D. 6524, 26 FR 158, Jan. 10, 1961]



Sec.  1.614-6  Rules applicable to basis, holding period, and abandonment
losses where mineral interests have been aggregated or combined.

    (a) Basis of property resulting from aggregation or combination--(1) 
General rule. (i) When a taxpayer has aggregated as one property two or 
more interests under section 614(b) (prior to its amendment by section 
226(a) of the Revenue Act of 1964), (c), or (e), the unadjusted basis of 
such aggregated property shall be the sum of the unadjusted bases of the 
various mineral interests aggregated. The adjusted basis of the 
aggregated property on the effective date of the aggregation shall be 
the unadjusted basis of the aggregated property, adjusted by the total 
of all adjustments to the bases of the several mineral interests 
aggregated as required by section 1016 to the effective date of 
aggregation. Thereafter, the adjustments to basis required by section 
1016 shall apply to the total adjusted basis of the aggregated property 
for all purposes of subtitle A of the Code.
    (ii) When a taxpayer has combined as one property two or more 
interests under section 614(b) (as amended by section 226(a) of the 
Revenue Act of 1964), the adjusted basis of such combined property shall 
be the sum of:
    (a) The unadjusted bases of all such interests which have never been 
included in an aggregation; and
    (b) The adjusted bases of all such interests which at some time have 
been included in an aggregation, as of the date on which they ceased to 
participate in an aggregation


adjusted by the total of all adjustments to the bases of the several 
mineral interests combined, as required by section 1016,

[[Page 525]]

    (c) In the case of interests described in (a), for the entire period 
of the taxpayer's ownership of such interest; and
    (d) In the case of interests described in (b), for the period, if 
any, between the time of deaggregation and the time of combination.

Thereafter, the adjustments to basis required by section 1016 shall 
apply to the total adjusted basis of the combined property for all 
purposes of subtitle A of the Code.
    (2) Bases upon disposition of part of, or termination of, or change 
in, an aggregated or combined property--(i) In general. (a) When a 
taxpayer has aggregated or combined two or more separate mineral 
interests as one property under section 614(b) (either before or after 
its amendment by section 226(a) of the Revenue Act of 1964), (c), or (e) 
and thereafter sells, exchanges, or otherwise disposes of part of such 
property, the total adjusted basis of the property as of the date of 
sale, exchange, or other disposition shall be apportioned to determine 
the adjusted basis of the part disposed of and the part retained for 
purposes of computing gain or loss, depletion and for all other purposes 
of subtitle A of the Code. Such adjusted basis shall be determined by 
apportioning the total adjusted basis of the property between the part 
of the property disposed of and the part retained in the same proportion 
as the fair market value of each part (as of the date of sale, exchange, 
or other disposition) bears to the total fair market value of the 
property as of such date. For determining gain or loss on the sale or 
exchange of any part of the aggregated or combined property, the 
adjusted basis of the aggregated or combined property (from which the 
adjusted basis of the part is determined) shall not be reduced below 
zero.
    (b) If, for any taxable year after the first taxable year for which 
an aggregation under section 614(b) (prior to its amendment by section 
226(a) of the Revenue Act of 1964), (c), or (e) is effective:
    (1) Any such aggregation is terminated for any reason other than the 
expiration of an aggregation by reason of section 614(b) as amended by 
section 226(a) of the Revenue Act of 1964 (see subdivision (ii) of this 
subparagraph), or
    (2) The treatment of any mineral interests in any such aggregation 
is changed after obtaining the consent of the Commissioner


then the adjusted basis of the aggregated property as of the first day 
of the first taxable year for which such termination or change is 
effective shall be apportioned to determine the adjusted bases of the 
resultant separate mineral interests, as of such first day, for purposes 
of computing gain or loss, depletion, and for all other purposes of 
subtitle A of the Code. The adjusted bases of such separate mineral 
interests shall be determined by apportioning the adjusted basis of the 
aggregated property (as of the first day of the first taxable year for 
which such termination or change is effective) between or among such 
interests in the same proportion as the fair market value of each such 
interest (as of such first day) bears to the total fair market value of 
the aggregated property as of such first day. For the purpose of 
determining the adjusted bases of the separate mineral interests, the 
adjusted basis of the aggregated property (from which the adjusted basis 
of each separate mineral interest is determined) shall not be reduced 
below zero.
    (ii) Allocation of basis of aggregation of operating mineral 
interests in oil and gas wells as of the first day of the first taxable 
year beginning after December 31, 1963--(a) Fair market value method. 
Unless the taxpayer elects to use the allocation of adjustments method 
of determining basis provided in (b) of this subdivision (ii), the 
adjusted basis as of the first day of the first taxable year beginning 
after December 31, 1963, of each interest which was participating in an 
aggregation of operating mineral interests on the day preceding such 
first day shall be determined by multiplying the adjusted basis of the 
aggregation by a fraction the numerator of which is the fair market 
value of such interest and the denominator of which is the fair market 
value of such aggregation. For purposes of this subdivision (a), the 
adjusted basis and the fair market value of the aggregation, and the 
fair market value of such interest, shall be determined as of the day 
preceding the first

[[Page 526]]

day of the first taxable year which begins after December 31, 1963. 
Unless the taxpayer elects to use the allocation of adjustments method, 
he shall obtain accurate and reliable information, and keep records with 
respect thereto, establishing all facts necessary for making the 
computation prescribed in this subdivision (a). See example 5 of 
subparagraph (3) of this paragraph.
    (b) Allocation of adjustments method. (i) The taxpayer may elect to 
determine basis by an allocation of adjustments in lieu of the fair 
market value method prescribed in (a) of this subdivision (ii). In such 
a case, the adjusted basis (as of the first day of the first taxable 
year beginning after December 31, 1963) of each interest which was 
participating in an aggregation of operating mineral interests on the 
day preceding such first day is the unadjusted basis of such interest 
immediately after its acquisition by the taxpayer, adjusted by the total 
of all adjustments to its basis as required by section 1016 to the 
effective date of aggregation, and by that portion of those section 1016 
adjustments to the basis of the aggregation which is reasonably 
attributable to such interest. For this purpose, two or more interests 
which are being combined upon deaggregation shall be treated as one 
interest. An adjustment to the basis of the aggregation is reasonably 
attributable to such interest to the extent that the adjustment thereto 
resulted from inclusion of the interest in the aggregation, even though 
such interest would not have been entitled to the adjustment to the same 
extent if such interest had been treated separately because of the 50 
percent of taxable income limitation or for any other reason. In a case 
in which the amount of a percentage depletion deduction which was 
allowed with respect to an aggregation was limited by the 50 percent of 
taxable income limitation of section 613(a), the portion of such amount 
which is attributable to each of the interests in the aggregation shall 
be determined by multiplying such amount by a fraction, the numerator of 
which is the gross income from such interest and the denominator of 
which is the gross income from the aggregation. The determination as to 
which property a particular adjustment is attributable may be based upon 
records of production or any other facts which establish the 
reasonableness of the determination. See example 6 of subparagraph (3) 
of this paragraph.
    (ii) If, under the adjustment described in (i) of this subdivision 
(b), the total of the adjusted bases of the interests which were 
included in the aggregation exceeds the adjusted basis of the 
aggregation, the adjusted bases of the interests shall be further 
adjusted so that the total of the adjusted bases of the interests equals 
the adjusted basis of the aggregation. This further adjustment shall be 
made by reducing the basis of each interest (other than an interest 
having a basis of zero) by an amount which is determined by multiplying 
such excess by a fraction, the numerator of which is the adjusted basis 
of such interest after making the adjustment described in (i) of this 
subdivision (b) and the denominator of which is the total of the 
adjusted bases of all such interests after making the adjustment 
described in (i) of this subdivision (b). See example 6 of subparagraph 
(3) of this paragraph.
    (iii) The election provided for in this subdivision (b) shall be 
made not later than the time prescribed by law for filing the taxpayer's 
income tax return (including extensions thereof) for the first taxable 
year beginning after December 31, 1963, and shall be made in a statement 
attached to such return.
    (3) The application of subparagraphs (1) and (2) of this paragraph 
may be illustrated by the following examples:

    Example 1. A taxpayer owning three operating mineral interests, 
designated Nos. 1, 2, and 3, within a single operating unit, properly 
elects to aggregate such properties under section 614(b) for the 
calendar year 1954 in his income tax return filed on April 15, 1955. The 
unadjusted bases and adjustments under section 1016 for depletion 
through December 31, 1953, in respect of such properties are as follows:

------------------------------------------------------------------------
                                                             Adjustments
                                                 Unadjusted     under
                                                    basis      Section
                                                                 1016
------------------------------------------------------------------------
No. 1..........................................    $25,000      $27,000
No. 2..........................................     18,000       10,000
No. 3..........................................     15,000        4,000
                                                ------------------------
    Total......................................     58,000       41,000
------------------------------------------------------------------------


[[Page 527]]


The adjusted basis of the aggregated property as of January 1, 1954, is 
$17,000 ($58,000-$41,000).
    Example 2. Assume the same facts as in example 1, except that a 
portion of the aggregated property is sold on June 1, 1956, for $15,000 
which is also the fair market value of such portion on the date of sale. 
In order to determine the gain or loss from this sale as well as the 
adjusted basis of the retained property, an apportionment must be made. 
The aggregated property had a fair market value of $25,000 on the date 
of sale. From January 1, 1954, through May 31, 1956, $10,000 of 
depletion has been allowed with respect to the aggregated property. The 
adjusted basis of the portion sold is determined as follows:
[GRAPHIC] [TIFF OMITTED] TC08OC91.019


Therefore, the gain on this sale of the portion sold is $10,800 
($15,000-$4,200). The adjusted basis of the property retained is $2,800 
($7,000-$4,200).
    Example 3. Assume the same facts as in example 2, except that 
instead of selling, the taxpayer subleases one of the leases making up 
the aggregated property, retaining a one-eighth royalty interest 
therein. The fair market value of such lease is $15,000 on the date of 
the sublease. The adjusted basis of such royalty interest is $4,200 
which is computed as follows:
[GRAPHIC] [TIFF OMITTED] TC08OC91.020

    Example 4. In 1953, a taxpayer owned mineral interests Nos. 1, 2, 
and 3 which he operated as a unit. He owned no other operating interests 
during that year. The unadjusted bases of these properties were $10,000, 
$15,000, and $20,000, respectively, and depletion allowed through 
December 31, 1953, was $5,000 with respect to each property. The 
taxpayer operated these properties during the year 1954 and, in 
addition, operated as part of the unit mineral interest No. 4 which he 
acquired on July 1, 1954, on which date he made the first exploration 
expenditure with respect thereto. He paid $20,000 for No. 4. In his 
return for the calendar year 1954, the taxpayer elected under section 
614(b) to aggregate all of these mineral interests. The taxpayer must 
compute cost depletion for the calendar year 1954 on the basis of an 
aggregated property with an adjusted basis of $30,000 ($45,000-$15,000) 
for the period from January 1 to June 30, and with an adjusted basis of 
$50,000 (less depletion for the first six months) for the period from 
July 1 to December 31. If applicable, the taxpayer must compute 
percentage depletion on the basis of gross income and taxable income 
from the aggregated property for the entire year, including the gross 
income and deductions with respect to operating mineral interest No. 4 
for the period from July 1 to December 31. If a portion of the 
aggregated property is sold during the first six months, its adjusted 
basis must be determined at the time of sale with an adjustment for 
depletion to the date of sale. If percentage depletion is applicable, it 
must be allocated on an equitable basis to the periods prior and 
subsequent to the date of sale in order to determine the adjustment for 
depletion to the date of sale.
    Example 5. A taxpayer owns two operating mineral interests in oil 
wells, designated Nos. 1 and 2, in tract A, and another such interest, 
designated No. 3, in tract B. All three interests are in the same 
operating unit (as defined in paragraph (c) of Sec.  1.614-2). The 
taxpayer, who is on a calendar year basis, has properly elected under 
Sec.  1.614-2 to aggregate such interests for the calendar years 1954 
through 1963. The unadjusted bases and adjustments under section 1016 
for depletion through December 31, 1953, in respect of such interests 
are as follows:

------------------------------------------------------------------------
                                                             Adjustments
                                                 Unadjusted     under
                                                    basis      section
                                                                 1016
------------------------------------------------------------------------
No. 1..........................................    $42,000      $11,000
No. 2..........................................     37,000        4,000
No. 3..........................................     19,000       23,000
                                                ------------------------
    Total......................................     98,000       38,000
------------------------------------------------------------------------


The adjusted basis of the aggregated property as of January 1, 1954, is 
therefore $60,000

[[Page 528]]

($98,000 minus $38,000). The taxpayer properly elects under section 
614(b) and Sec.  1.614-8 to treat Nos. 1 and 2 as separate properties 
for the calendar year 1964 and thereafter and does not elect to use the 
allocation of adjustments method of determining basis provided in 
subparagraph (2) (ii) (b) of this paragraph. No. 3 will be treated as a 
separate property, also, because it is in a different tract than the 
taxpayer's other interests. From January 1, 1954, through December 31, 
1963, $50,000 of depletion has been allowed with respect to the 
aggregated property, leaving an adjusted basis of $10,000 ($60,000 minus 
$50,000) on January 1, 1964. On December 31, 1963, the aggregated 
property has a fair market value of $40,000. Nos. 1, 2, and 3 have fair 
market values of $16,000, $22,000, and $2,000, respectively. 
Accordingly, the adjusted bases of Nos. 1, 2, and 3 on January 1, 1964, 
are $4,000,
[GRAPHIC] [TIFF OMITTED] TC08OC91.021

$5,500 [$10,000 x (22,000/40,000)], and

$500 [$10,000 x (2,000/40,000)] respectively.
    Example 6. A taxpayer owns four operating mineral interests in oil 
wells, designated Nos. 1, 2, 3, and 4. All four interests are in the 
same operating unit and the same tract or parcel of land. The taxpayer, 
who is on a calendar year basis, has properly elected under Sec.  1.614-
2 to aggregate such interests for the calendar years 1954 through 1963. 
The taxpayer properly elects under section 614(b) and paragraph (a) of 
Sec.  1.614-8 to treat Nos. 1 and 2 as separate properties for the 
calendar year 1964 and thereafter. The taxpayer also properly elects to 
use the allocation of adjustments method of determining basis as 
provided in subparagraph (2) (ii) (b) of this paragraph. The unadjusted 
bases of Nos. 1, 2, and combined 3 and 4, the adjustments attributable 
to each, and the deaggregated basis of each (prior to further adjustment 
as provided in subparagraph (2) (ii) (b)(ii) of this paragraph) are as 
follows:

----------------------------------------------------------------------------------------------------------------
                                                                                     Attributable    Basis upon
                                                            Basis upon  Adjustments   adjustments  deaggregation
                                                           acquisition   to time of     during      after first
                                                                        aggregation   aggregation    adjustment
----------------------------------------------------------------------------------------------------------------
No. 1....................................................     $35,000       $1,000       $16,000       $18,000
No. 2....................................................      30,000       11,000        23,000             0
No. 3....................................................      25,000        3,000         5,000   .............
No. 4....................................................      10,000       12,000         9,000         6,000
                                                          ------------------------------------------------------
  Total..................................................     100,000       27,000        53,000        24,000
----------------------------------------------------------------------------------------------------------------


The total of the adjusted bases (prior to further adjustment) of the 
interests which were included in the aggregation is $24,000 while the 
adjusted basis of the aggregation is $20,000 ($100,000 minus the sum of 
$27,000 and $53,000). Therefore, the adjusted bases of the interests are 
further reduced by $4,000 ($24,000 minus $20,000). The adjusted basis of 
No. 1 of $18,000 is further reduced by $3,000 [$4,000 x (18,000 / 
24,000)] to $15,000. Similarly, the adjusted basis of combined Nos. 3 
and 4 of $6,000 is further reduced by $1,000 [$4,000 x (6,000 / 24,000)] 
to $5,000. Assume further that the taxpayer also owns interest No. 5 in 
the same tract or parcel of land, that such interest was not a part of 
any aggregation, that such interest had a basis of $15,000 upon 
acquisition and had subsequent adjustments in reduction of basis 
totalling $17,000, and that the taxpayer does not elect to treat such 
interest as a separate property. In such case, Nos. 3, 4, and 5 will be 
combined. The combination will have an adjusted basis of $3,000, 
determined by adding the unadjusted basis of No. 5 ($15,000) and the 
adjusted bases of combined Nos. 3 and 4 upon deaggregation ($5,000), and 
subtracting from the total thereof ($20,000) the adjustments to No. 5 
($17,000).

    (4) Basis for gain and loss where mineral interests acquired before 
March 1, 1913, are included in an aggregation. Where mineral interests 
acquired before March 1, 1913, are included in an aggregation under 
section 614 (b), (c), or (e), the aggregated property has two bases, one 
for the determination of gain and another for the determination of loss 
upon the disposition of the whole or a part of the aggregated property. 
For the purpose of determining gain, the adjusted basis of the 
aggregated property on the effective date of aggregation shall be the 
sum of:
    (i) The unadjusted bases of those mineral interests acquired on or 
after March 1, 1913, plus
    (ii) The cost of any interest acquired before March 1, 1913 
(adjusted for the period before March 1, 1913), or the fair market value 
of such interest as of March 1, 1913, whichever is greater


and such sum shall be adjusted by the total of all adjustments to the 
bases of the several mineral interests aggregated as required by section 
1016 to the effective date of aggregation. For the purpose of 
determining loss, the adjusted basis of the aggregated property on the 
effective date of aggregation shall be the sum of:
    (iii) The unadjusted bases of those mineral interests acquired on or 
after March 1, 1913, plus

[[Page 529]]

    (iv) The cost of those interests acquired before March 1, 1913, 
adjusted for the period before March 1, 1913


and such sum shall be adjusted by the total of all adjustments to the 
bases of the several mineral interests aggregated as required by section 
1016 to the effective date of aggregation. Thereafter, the adjustments 
to basis required by section 1016 shall apply to the total adjusted 
basis of the aggregated property for all purposes of the Code. Upon 
disposition of a part of the aggregated property, or upon termination of 
the aggregation for any reason, or upon change in the treatment of any 
mineral interests in the aggregation with consent of the Commissioner, 
the adjusted basis for determining gain and the adjusted basis for 
determining loss with respect to each resultant part of the aggregated 
property shall be determined in accordance with subparagraph (2) of this 
paragraph. The provisions of this subparagraph may be illustrated by the 
following examples:

    Example 1. At the close of 1953 a taxpayer owned two operating 
mineral interests designated as Nos. 1 and 2 in the same operating unit. 
Operating mineral interest No. 1 was acquired by the taxpayer before 
March 1, 1913, and on such date its basis with reference to its fair 
market value was $50,000 and its adjusted basis with reference to its 
cost was $44,000. The unadjusted basis of operating mineral interest No. 
2, acquired after March 1, 1913, was $30,000. Adjustments under section 
1016 for depletion from March 1, 1913, through December 31, 1953, were 
$37,000 for operating mineral interest No. 1 and $20,000 for operating 
mineral interest No. 2. Assume that the taxpayer elected for the taxable 
year 1954 to aggregate operating mineral interests Nos. 1 and 2. The 
adjusted basis of the aggregated property as of January 1, 1954, for the 
purpose of determining gain would be $23,000 ($50,000 plus $30,000) 
minus ($37,000 plus $20,000). For the purpose of determining loss, the 
adjusted basis would be $17,000 ($44,000 plus $30,000) minus ($37,000 
plus $20,000).
    Example 2. Assume the same facts as in example 1 and further assume 
that for the taxable years 1954 and 1955, the taxpayer was allowed 
$5,000 of depletion on the aggregated property, that on January 1, 1956, 
he sold a portion of the aggregated property for $20,000, and that, as 
of January 1, 1956, the aggregated property had a fair market value of 
$24,000. At the time of sale, the adjusted basis of the aggregated 
property for the purpose of determining gain was $18,000 ($23,000-
$5,000); and the adjusted basis for the purpose of determining loss was 
$12,000 ($17,000-$5,000). The adjusted basis of the portion sold would 
be computed as follows:
[GRAPHIC] [TIFF OMITTED] TC08OC91.022


Taxpayer's gain would then be computed as follows:
[GRAPHIC] [TIFF OMITTED] TC08OC91.023

The adjusted basis of the portion retained as of January 1, 1956, for 
the purpose of determining gain is $3,000 ($18,000-$15,000). For the 
purpose of determining loss, the adjusted basis is $2,000 ($12,000-
$10,000).
    Example 3. Assume the same facts as in example 2, except that a 
portion of the aggregated property was sold for $5,000 and that the fair 
market value of the aggregated property at the time of sale was $10,000. 
The adjusted basis of the portion sold would be computed as follows:

[[Page 530]]

[GRAPHIC] [TIFF OMITTED] TC08OC91.024


Taxpayers loss would then be computed as follows:
[GRAPHIC] [TIFF OMITTED] TC08OC91.025

    (5) Basis for gain and loss where mineral interests acquired before 
March 1, 1913, are included in a combination and one or more of such 
interests have not previously been included in an aggregation. Where 
mineral interests acquired before March 1, 1913, are included in a 
combination under section 614(b) and Sec.  1.614-8 and one or more of 
such interests have not previously been included in an aggregation, the 
combined property has two bases, one for the determination of gain and 
another for the determination of loss upon the disposition of the whole 
or a part of the combined property. For the purpose of determining gain, 
the adjusted basis of the combined property on the effective date of 
combination shall be the sum of:
    (i) The adjusted bases at the time of deaggregation, as determined 
under subparagraph (2) of this paragraph, of all interests which have 
previously been included in an aggregation,
    (ii) The unadjusted bases of other mineral interests acquired on or 
after March 1, 1913, and
    (iii) The cost of each other interest acquired before March 1, 1913 
(adjusted for the period before March 1, 1913), or the fair market value 
of such interest as of March 1, 1913, whichever is greater


and such sum shall be adjusted by the total of all adjustments to the 
bases of the mineral interests as required by section 1016 to the 
effective date of combination. For the purpose of determining loss, the 
adjusted basis of the combined property on the effective date of 
combination shall be the sum of:
    (iv) The adjusted bases at the time of deaggregation, as determined 
under subparagraph (2) of this paragraph, of all interests which have 
previously been included in an aggregation.
    (v) The unadjusted bases of other mineral interests acquired on or 
after March 1, 1913, and
    (vi) The cost of other mineral interests acquired before March 1, 
1913, adjusted for the period before March 1, 1913


and such sum shall be adjusted by the total of all adjustments to the 
bases of the mineral interests as required by section 1016 to the 
effective date of combination. Thereafter, the adjustments to basis 
required by section 1016 shall apply to the total adjusted basis of the 
combined property for all purposes of the Code. Upon disposition of a 
part of the combined property, the adjusted basis for determining gain 
and the adjusted basis for determining loss with respect to each 
resultant part of the combined property shall be determined in 
accordance with subparagraph (2) of this paragraph.
    (b) Holding period of aggregated or combined properties. Where a 
taxpayer sells or exchanges either a part or all of an aggregated or 
combined property which includes part or all of a mineral interest which 
the taxpayer has held for (1 year 6 months for taxable years beginning 
before 1977; 9 months for taxable years beginning in 1977) or less, the

[[Page 531]]

sales price and adjusted basis attributable to the interest sold must be 
apportioned in proportion to the relative fair market values as of the 
date of sale to determine the amount of income represented by the sale 
of property held for (1 year 6 months for taxable years beginning before 
1977; 9 months for taxable years beginning in 1977) or less. The 
application of this rule may be illustrated by the following example:

    Example. Taxpayer A owns operating mineral interests Nos. 1, 2, and 
3. He acquired interests Nos. 1 and 2 in 1953 but purchased and made 
development expenditures on interest No. 3 on December 1, 1954. In his 
return for the taxable year 1954, taxpayer A elects to aggregate 
interests Nos. 1, 2, and 3 which are operated as a unit. On May 1, 1955, 
taxpayer A sells the north half of the aggregated property which 
includes portions of interests Nos. 1, 2, and 3. The sales price of the 
north half was $80,000; the adjusted basis of the aggregated property as 
of the date of sale was $20,000; and the fair market value of the 
aggregated property as of the date of sale was $100,000. The adjusted 
basis applicable to the north half is computed as follows:
[GRAPHIC] [TIFF OMITTED] TC08OC91.026

    The total gain on the sale is $64,000 ($80,000-$16,000).
    The gain attributable to the sale of the portion held for six months 
or less is computed as follows (assuming that the fair market value of 
the portion of No. 3 included in the sale as of the date of sale was 
$30,000):
[GRAPHIC] [TIFF OMITTED] TC08OC91.027

    The gain on the portion of No. 3 sold is $24,000 ($30,000-$6,000).

    (c) Acquisition of property with transferor's basis. If a separate 
property or an aggregated or combined property is acquired in a 
transaction in which the basis of such property in the hands of the 
taxpayer is determined by reference to the basis of such property in the 
hands of a transferor, then the election of such transferor as to the 
treatment of such separate, aggregated, or combined property shall be 
binding upon the taxpayer for all taxable years ending after the 
transfer unless, in the case of an aggregation, the aggregation 
terminates or consent to make a change is obtained under paragraph (d) 
(4) of Sec.  1.614-2, paragraph (f) (7) of Sec.  1.614-3, or paragraph 
(b) (3) or (e) (5) of Sec.  1.614-5, whichever is applicable.
    (d) Abandonment and casualty losses. In the case of mineral 
interests which are aggregated or combined as one property, no losses 
resulting from worthlessness or abandonment are allowable until all the 
mineral rights in the entire aggregated or combined property are proven 
to be worthless or until the entire aggregated or combined property is 
disposed of or abandoned. Casualty losses are allowable in accordance 
with the rules applicable to casualty losses in general. For rules 
applicable to losses in general, see section 165 and the regulations 
thereunder.

[T.D. 6524, 26 FR 159, Jan. 10, 1961, as amended by T.D. 6859, 30 FR 
13701, Oct. 28, 1965; T.D. 7728, 45 FR 72650, Nov. 3, 1980]

[[Page 532]]



Sec.  1.614-7  Extension of time for performing certain acts.

    Sections 1.614-2 to 1.614-5, inclusive, require certain acts to be 
performed on or before May 1, 1961 (the first day of the first month 
which begins more than 90 days after the regulations under section 614 
were published in the Federal Register as a Treasury decision). The 
district director may, upon good cause shown, extend for a period not 
exceeding 6 months the period within which such acts are to be 
performed, and shall, if the interests of the Government would otherwise 
be jeopardized thereby, grant such an extension only if the taxpayer and 
the district director agree in writing to a corresponding or greater 
extension of the period prescribed for the assessment of the tax, or in 
the case of taxable years described in section 614(c)(3)(E), the 
assessment of the tax resulting from the exercise or change in an 
election.

[T.D. 6561, 26 FR 3523, Apr. 25, 1961]



Sec.  1.614-8  Elections with respect to separate operating mineral
interests for taxable years beginning after December 31, 1963, in the
case of oil and gas wells.

    (a) Election to treat separate operating mineral interests as 
separate properties--(1) General rule. If a taxpayer has more than one 
operating mineral interest in oil and gas wells in one tract or parcel 
of land, he may elect to treat one or more of such interests as separate 
properties for taxable years beginning after December 31, 1963. Any such 
interests with respect to which the taxpayer does not so elect shall be 
combined and treated as one property. Nonoperating mineral interests may 
not be included in such combination. There may be only one such 
combination in one tract or parcel. Any such combination of interests 
shall be considered as one property for all purposes of subtitle A of 
the Code for the period to which the election applies. The preceding 
sentence does not preclude the use of more than one account under a 
single method of computing depreciation or the use of more than one 
method of computing depreciation under section 167, if otherwise proper. 
Any reasonable and consistently applied method or methods of computing 
depreciation of the improvements made with respect to the separate 
interests which are combined may be continued in accordance with section 
167 and the regulations thereunder. Except as provided in paragraph (b) 
of this section, such an interest in one tract or parcel may not be 
combined with such an interest in another tract or parcel. For rules 
with respect to the allocation of the basis of an aggregation of 
separate operating mineral interests under this section among such 
interests as of the first day of the first taxable year beginning after 
December 31, 1963, see paragraph (a) (2) (ii) of Sec.  1.614-6. For the 
definition of operating mineral interest see paragraph (b) of Sec.  
1.614-2.
    (2) Election in respect of newly discovered or acquired interest or 
interest ceasing to participate in cooperative or unit plan of 
operation. (i) If the taxpayer makes an election under this paragraph in 
respect of an operating mineral interest in a tract or parcel of land 
and, after the taxable year for which such election is made, an 
additional operating mineral interest in the same tract or parcel is 
discovered or acquired by the taxpayer or is the subject of an election 
under this paragraph because it ceases to participate in a cooperative 
or unit plan of operation to which paragraph (b) of this section 
applies, the additional operating mineral interest shall be treated:
    (a) If there is no combination of interests in such tract or parcel, 
as a separate property unless the taxpayer elects to combine it with 
another interest, or
    (b) If there is a combination of interests in such tract or parcel, 
as part of such combination unless the taxpayer elects to treat it as a 
separate property.
    (ii) The application of this subparagraph may be illustrated by the 
following example:

    Example. Prior to 1964 a taxpayer acquired, and incurred development 
expenditures with respect to, three operating mineral interests in oil, 
designated Nos. 1, 2, and 3. All three interests are in the same tract 
or parcel of land. For the taxable year 1964, the taxpayer elects to 
treat such interests as three separate properties. During the taxable 
year 1965,

[[Page 533]]

the taxpayer discovers and incurs development costs with respect to a 
fourth operating mineral interest, No. 4, in the same tract of land. 
During the taxable year 1966, the taxpayer discovers and incurs 
development costs with respect to a fifth operating mineral interest, 
No. 5, in the same tract of land. If the taxpayer makes no election 
relative to No. 4 for 1965, such interest will thereafter be treated as 
a separate property. Alternatively, the taxpayer may make an election 
for 1965 to combine No. 4 with any one (and only one) of the three other 
interests and to treat such combination as one property. If, for 
example, he elects to combine No. 4 with No. 3, then in 1966, No. 5 will 
automatically become part of the combination of Nos. 3 and 4 if no 
election is made to treat it as a separate property. After the 
combination of Nos. 3 and 4 is formed, Nos. 1 and 2, which were acquired 
or discovered prior to the formation of the combination and which were 
not included in such combination within the time prescribed, may not be 
included in that or any other combination. However, see subparagraph (3) 
(iv) of this paragraph.

    (3) Manner and scope of election--(i) Election; when made. Except as 
provided hereafter in this subdivision (i), any election under 
subparagraph (1) or (2) of this paragraph shall be made for each 
operating mineral interest not later than the time prescribed by law for 
filing the income tax return (including extensions thereof) for 
whichever of the following taxable years is later:
    (a) The first taxable year beginning after December 31, 1963; or
    (b) The first taxable year in which any expenditure for development 
or operation in respect of such operating mineral interest is made by 
the taxpayer after his acquisition of such interest


Notwithstanding the provisions of (a) and (b), if it is determined that 
the operating mineral interest in respect of which the election is to be 
made was, during what would otherwise be the entire effective period of 
the election insofar as it would apply to the appropriate taxable year 
determined under (a) and (b), participating in a cooperative or unit 
plan of operation to which section 614(b)(3) applies, the election shall 
be made not later than the time prescribed by law for filing the income 
tax return (including extensions thereof) for the taxable year in which 
the interest ceases to participate in the cooperative or unit plan. See 
subdivision (iii) of this subparagraph for provisions relating to the 
effective date of an election and paragraph (b) of this section for 
provisions relating to certain unitization or pooling arrangements. For 
purposes of this subparagraph, expenditures for development include any 
intangible drilling or development costs within the purview of section 
263(c). Delay rentals are not considered as expenditures for 
development. For purposes of this subparagraph, the acquisition of an 
option to acquire an economic interest in minerals in place does not 
constitute the acquisition of a mineral interest.
    (ii) Election; how made. Any election under this paragraph shall be 
made by a statement attached to the income tax return of the taxpayer 
for the first taxable year for which the election is made. This 
statement shall identify by name, code number, or other means the 
operating mineral interests within the same tract or parcel of land 
which the taxpayer is electing to treat as separate properties or in 
combination, as the case may be. The statement shall also identify by 
name, code number, or other means the tract or parcel and shall set 
forth the facts upon which its treatment as a single and entire tract or 
parcel is based. See paragraph (a) (3) of Sec.  1.614-1. However, if the 
taxpayer is electing to treat all of his operating mineral interests in 
a tract or parcel as separate properties, a blanket election with 
respect to all of such interests in that tract or parcel which are owned 
by the taxpayer at the time the election is made will suffice and only 
the tract or parcel itself need be so identified. The taxpayer shall 
maintain and have available records and maps sufficient to clearly 
define the tract or parcel and all of the taxpayer's operating mineral 
interests therein.
    (iii) Election; when combination effective. (a) If, by reason of the 
exercise or nonexercise of an election under this paragraph, a 
combination is formed of two or more operating mineral interests, all of 
which are owned and operated by a taxpayer on the first day of the first 
taxable year beginning after December 31, 1963, and are not 
participating in a cooperative or unit plan of

[[Page 534]]

operation to which paragraph (b) of this section applies on such first 
day, the combination is effective on such first day.
    (b) If, by reason of the exercise or nonexercise of an election 
under this paragraph, a combination of operating mineral interests not 
described in (a) of this subdivision (including a combination described 
in (a) to which another operating mineral interest is added) is formed, 
the date on which each operating mineral interest which is being 
combined by the taxpayer for the first time enters into the combination 
is the later of (1) the earliest date within the taxable year affected 
on which the taxpayer incurred any expenditure for development or 
operation of such interest at a time when such interest was not 
participating in a cooperative or unit plan of operation to which 
paragraph (b) of this section applies, or (2) the earliest date on which 
the taxpayer incurred any expenditure for development or operation of 
any other interest with which such interest is to be combined at a time 
when such other interest was not participating in a cooperative or unit 
plan of operation to which paragraph (b) of this section applies.
    (c) The application of these provisions may be illustrated by the 
following examples:

    Example 1. In 1963, a taxpayer owned and operated mineral interests 
Nos. 1 and 2, both of which are in the same tract or parcel of land. 
Neither No. 1 nor No. 2 participates in a cooperative or unit plan of 
operation. The taxpayer, who is on a calendar year basis, continued to 
own and operate these interests during the year 1964, and made no 
election with respect to such interests in his income tax return for 
that year. As a result, Nos. 1 and 2 are combined as of January 1, 1964.
    Example 2. Assume that the taxpayer described in example 1 
discovered operating mineral interests Nos. 3 and 4 in the same tract or 
parcel of land as Nos. 1 and 2, that he made his first expenditures for 
the development of No. 3 on June 1, 1964, and of No. 4 on September 1, 
1964, and that, in a timely return for 1964, he elected to treat No. 3 
as a separate property and made no election with respect to No. 4. As a 
result, No. 3 is treated as a separate property and No. 4 joins the 
combination of Nos. 1 and 2 as of September 1, 1964.
    Example 3. On March 1, 1964, a taxpayer acquired a tract or parcel 
of land containing operating mineral interests Nos. 1 and 2. The 
taxpayer made his first operating expenditures on No. 1 on April 1, 
1964. On October 1, 1964, the taxpayer made his first development 
expenditures with respect to operating mineral interest No. 2. The 
taxpayer made no election with respect to these interests. As a result, 
Nos. 1 and 2 enter into a combination as of October 1, 1964.

    (iv) Election; binding effect. A valid election made under section 
614(b) and this subparagraph shall be binding upon the taxpayer for the 
first taxable year for which made and for all subsequent taxable years. 
However, notwithstanding the preceding sentence, an election to treat 
one or more operating mineral interests as separate properties shall not 
prevent the making of a later election to combine a newly discovered or 
acquired operating mineral interest with one of such interests, if no 
other combination exists in the tract or parcel of land on the date when 
the later election would become effective under subdivision (iii) of 
this subparagraph. Nor will an election to treat an operating mineral 
interest as a separate property prevent its treatment with another 
interest as a single property under paragraph (b) of this section if 
such interest later participates in a cooperative or unit plan of 
operation to which paragraph (b) applies. For rules relating to the 
binding effect of an election in certain cases in which the basis of a 
separate or combined property in the hands of the transferee is 
determined by reference to the basis in the hands of the transferor, see 
paragraph (c) of Sec.  1.614-6.
    (b) Certain unitization or pooling arrangements. (1) Except as 
provided in this paragraph, if one or more of the taxpayer's operating 
mineral interests, or a part or parts thereof, participate, under a 
voluntary or compulsory unitization or pooling agreement as defined in 
subparagraph (6) of this paragraph, in a single cooperative or unit plan 
of operation, then for the period of such participation in taxable years 
beginning after December 31, 1963, such interest or interests, and part 
or parts thereof, included in such unit, shall be treated for purposes 
of subtitle A of the Code as one property, separate from the interest or 
interests, or part or parts thereof, not included in such unit.

[[Page 535]]

    (2) Subparagraph (1) of this paragraph shall apply to a voluntary 
agreement only if all the operating mineral interests covered by the 
agreement are in the same deposit or are in two or more deposits, the 
joint development or production of which is logical, without taking tax 
benefits into account, from the standpoint of geology, convenience, 
economy, or conservation, and which are in tracts or parcels of land 
which are contiguous or in close proximity. Operating mineral interests 
under a voluntary agreement to which subparagraph (1) does not apply are 
subject to the rules contained in paragraph (a) of this section. For 
purposes of this paragraph an agreement is voluntary unless required by 
the laws or rulings of any State or any agency of any State.
    (3) Notwithstanding the provisions of subparagraph (1) of this 
paragraph, if the taxpayer, for the last taxable year beginning before 
January 1, 1964, treated as separate properties two or more operating 
mineral interests which participate, under a voluntary or compulsory 
unitization or pooling agreement entered into in any taxable year 
beginning before January 1, 1964, in a single cooperative or unit plan 
of operation, and if it is determined that such treatment was proper 
under the law applicable to such taxable year, the taxpayer may continue 
to treat all such interests in a consistent manner for the period of 
such participation. If it is determined that such treatment was not 
proper under the law applicable to such taxable year, or if the taxpayer 
does not continue to treat all such interests in a manner consistent 
with the treatment of them for the last taxable year beginning before 
January 1, 1964, the treatment of the interests shall be in accordance 
with the provisions of subparagraph (1).
    (4) If only a part of an operating mineral interest, which interest 
is not being treated under paragraph (a) of this section as part of a 
combination of interests, participates in a unit or pool, such part 
shall, for the period of its participation in the unit or pool, be 
treated for purposes of this section as being separate from the 
nonparticipating portion of the operating mineral interest of which it 
is a part. A portion of the adjusted basis and of the units of mineral 
of such operating mineral interest remaining at the beginning of the 
period described in the preceding sentence shall be allocated to the 
participating part in accordance with the principles contained in 
paragraph (a)(2)(i)(a) of Sec.  1.614-6 as if such participating part 
had been sold. If participation in the unit or pool ends, the separate 
status of the participating part shall immediately terminate. At such 
time the adjusted basis of such part and the units of mineral with 
respect to such part remaining at the time of termination shall be added 
to the adjusted basis and to the remaining units of mineral of the 
nonparticipating portion of the operating mineral interest. During the 
period of participation in the unit or pool such participating part 
shall not be treated separately from the nonparticipating portion of the 
operating mineral interest in applying section 165.
    (5) Where an operating mineral interest which is being treated under 
paragraph (a) of this section as part of a combination of interests 
begins participation in a unit or pool, the combination shall remain in 
force but the treatment of such participating interest as a part of the 
combination shall be suspended for the period of its participation in 
the unit or pool. If, for example, a taxpayer owns operating mineral 
interests Nos. 1, 2, and 3 in a single tract or parcel of land, elects 
to treat No. 1 as a separate property (with mineral interests Nos. 2 and 
3 thus being combined), is later required by an agency of a State to 
place No. 2 in a unit, and subsequently discovers operating mineral 
interest No. 4 in the same tract or parcel of land, then under paragraph 
(a)(2)(i)(b) of this section No. 4 will automatically be combined with 
No. 3 unless the taxpayer elects to treat it as a separate property. 
Under this subparagraph, an interest may be treated as part of a 
combination for a portion of a taxable year and as part of a unit or 
pool for a portion of a taxable year. At the commencement of 
participation in the unit or pool, a portion of the adjusted basis of 
the combination and a portion of the units of mineral with respect to 
the combination remaining at that time

[[Page 536]]

shall be allocated to such participating interest in accordance with the 
principles contained in paragraph (a)(2)(i)(a) of Sec.  1.614-6 as if 
such interest had been sold. During the period of participation in the 
unit or pool such participating interest is nevertheless treated as a 
part of the combination for purposes of paragraph (d) of Sec.  1.614-6. 
If participation in the unit or pool ends, the treatment of such 
interest as participating in the unit or pool shall immediately 
terminate. At such time, the adjusted basis of the participating 
interest and the units of mineral with respect to such interest 
remaining at the time of termination shall be added to the adjusted 
basis and to the remaining units of mineral of the nonparticipating 
portion of the combination. In determining the adjusted basis of the 
participating interest at the time of termination there shall be taken 
into account any section 1016 adjustments attributable to such interest 
for the period of its participation in the unit or pool. If two or more 
operating mineral interests of the taxpayer participate in a unit or 
pool and are treated as one property under subparagraph (1) of this 
paragraph, and if participation by such interests in the unit or pool 
terminates, the adjusted basis of each such interest at the time of 
termination shall be separately determined. If the total of the adjusted 
bases of such interests upon termination of their participation in the 
unit or pool exceeds the adjusted basis of such one property, then the 
adjusted bases of such interests shall be further adjusted by applying 
the principles contained in paragraph (a)(2)(ii)(b)(ii) of Sec.  1.614-6 
so that the total of the adjusted bases of such interests equals the 
adjusted basis of such one property. In addition, the units of oil and 
gas estimated to be attributable to a participating interest at the time 
of termination of participation shall be restored to the units of oil 
and gas of the combination of which it is a part. The rules stated in 
this subparagraph with respect to an operating mineral interest which is 
being treated under paragraph (a) of this section as part of a 
combination and which begins participation in a unit or pool shall also 
apply to a portion of an operating mineral interest which is being 
treated under paragraph (a) as part of a combination if such portion 
begins participation in a unit or pool.
    (6) As used in this paragraph, the term unitization or pooling 
agreement means an agreement under which two or more persons owning 
operating mineral interests agree to have the interests operated on a 
unified basis and further agree to share in production on a stipulated 
percentage or fractional basis regardless of from which interest or 
interests the oil or gas is produced. In addition, in a situation in 
which one person owns operating mineral interests in several leases, an 
agreement of such person with his several royalty owners to determine 
the royalties payable to each on a stipulated percentage basis 
regardless of from which lease or leases oil or gas is obtained is also 
considered to be a unitization or pooling agreement. No formal cross-
conveyance of properties is necessary. An agreement between co-owners of 
a tract or parcel of land or a part thereof for the development of the 
property by one of such co-owners for the account of all is not a 
unitization or pooling agreement, provided that the agreement does not 
affect ownership of minerals or entitle any such co-owner to share in 
production from any operating mineral interests other than his own.
    (c) Operating mineral interest defined. For the definition of the 
term operating mineral interest as used in this section, see paragraph 
(b) of Sec.  1.614-2.
    (d) Alternative treatment under Internal Revenue Code of 1939. If, 
on the day preceding the first day of the first taxable year beginning 
after December 31, 1963, the taxpayer has any operating mineral 
interests which he treats under section 614(d) (as in effect before the 
amendments made by the Revenue Act of 1964) and Sec.  1.614-4, such 
treatment shall be continued and shall be deemed to have been adopted 
pursuant to the provisions of section 614(b) and paragraph (a) of this 
section. Accordingly, a taxpayer, who has four operating mineral 
interests in a single tract or parcel of land, and who has treated two 
of such interests as one property and two of such interests as separate 
properties under section 614(d) prior to the first day of the first 
taxable year beginning

[[Page 537]]

after December 31, 1963, is deemed to have adopted such treatment 
pursuant to the provisions of section 614(b) and paragraph (a) of this 
section. Hence, in the absence of an election to the contrary, a fifth 
operating mineral interest in the same tract or parcel acquired by the 
taxpayer in a taxable year beginning after December 31, 1963, will, 
after an expenditure for development or operation, be combined with the 
combination of two interests made under section 614(d). Furthermore, an 
election which was made for a taxable year beginning before January 1, 
1964, under section 614(d) as then in effect will be binding for all 
taxable years beginning after December 31, 1963, even though the time 
for making an election under section 614(b) and paragraph (a) of this 
section has not elapsed.

[T.D. 6859, 30 FR 13703, Oct. 28, 1965]



Sec.  1.615-1  Pre-1970 exploration expenditures.

    (a) General rule. Section 615 prescribes rules for the treatment of 
expenditures (paid or incurred before January 1, 1970) for ascertaining 
the existence, location, extent, or quality of any deposit of ore or 
other mineral (other than oil or gas) paid or incurred by the taxpayer 
before the beginning of the development stage of the mine or other 
natural deposit. Such expenditures hereinafter in the regulations under 
section 615 will be referred to as exploration expenditures. The 
development stage of the mine or other natural deposit will be deemed to 
begin at the time when, in consideration of all the facts and 
circumstances (including the actions of the taxpayer), deposits of ore 
or other mineral are shown to exist in sufficient quantity and quality 
to reasonably justify commercial exploitation by the taxpayer. A 
taxpayer who elects under section (e) may treat exploration expenditures 
under either section 615(a) or section 615(b). See Sec.  1.615-6 for the 
method of making the election to treat exploration expenditures under 
section 615. Under section 615(a), a taxpayer may, at his option, deduct 
exploration expenditures paid or incurred in an amount not to exceed 
$100,000 for any taxable year. Under section 615(b) and Sec.  1.615-2, 
he may elect to defer any part of such amount and deduct such part on a 
ratable basis as the units of produced minerals benefited by such 
expenditures are sold. If the taxpayer does not treat exploration 
expenditures under either section 615 (a) or (b) in any year for which 
his election under section 615(e) is effective, the expenditures for 
such year will be charged to depletable capital account. The option to 
deduct under section 615(a) and the election to defer under section 
615(b), however, are subject to the limitation provided in section 
615(c) and Sec.  1.615-4. In the case of certain corporations which are 
members of an affiliated group which has elected the 100 percent 
dividends received deduction under section 243(b), see section 243(b) 
(3) and Sec.  1.243-5 for limitations on the option to deduct under 
section 615(a) and the election to defer under section 615(b).
    (b) Expenditures to which section 615 is not applicable. (1) Section 
615 is not applicable to expenditures which would be allowed as a 
deduction for the taxable year without regard to such section.
    (2) Section 615 is not applicable to expenditures which are 
reflected in improvements subject to allowances for depreciation under 
sections 167 and 611. However, allowances for depreciation of such 
improvements which are used in the exploration of ores or minerals are 
considered exploration expenditures under section 615. If such 
improvements are used only in part for exploration during a taxable 
year, an allocable portion of the allowance for depreciation shall be 
treated as an exploration expenditure.
    (3) Section 615 is applicable to exploration expenditures paid or 
incurred by a taxpayer in connection with the acquisition of a 
fractional share of the working or operating interest to the extent of 
the fractional interest so acquired by the taxpayer. The expenditures 
attributable to the remaining fractional share shall be considered as 
the cost of his acquired interest and shall be recovered through 
depletion allowances. For example, taxpayer A owns mineral leases on 
unexplored mineral lands and agrees to convey an undivided three-fourths 
(\3/4\) interest in such leases to taxpayer B provided B

[[Page 538]]

will pay all of the exploration expenditures for ascertaining the 
existence, location, extent, or quality of any deposit of ore or other 
mineral which will be incurred before the beginning of the development 
stage. B shall treat three-fourths of such amount under section 615, and 
shall treat one-fourth of such amount as part of the cost of his 
interest, recoverable through depletion.
    (4) The provisions of section 615 do not apply to costs of 
exploration which are reflected in the amount which the taxpayer paid or 
incurred to acquire the property. Such provisions apply only to costs 
paid or incurred by the taxpayer for exploration undertaken directly or 
through a contract by the taxpayer. See, however, sections 381(a) and 
381(c) (10) for special rules with respect to deferred exploration 
expenditures in certain corporate acquisitions.

[T.D. 6500, 25 FR 11737, Nov. 26, 1960, as amended by T.D. 7192, 37 FR 
12938, June 30, 1972]



Sec.  1.615-2  Deduction of pre-1970 exploration expenditures in the
year paid or incurred.

    (a) In general. (1) If the election to treat exploration 
expenditures under section 615 has been made or is deemed made under 
Sec.  1.615-6(b) subject to the total limitation of $100,000, a taxpayer 
who has made exploration expenditures prior to January 1, 1970, with 
respect to more than one mine or other natural deposit may deduct for a 
taxable year for which such election is effective any portion of such 
expenditures attributable to each mine or deposit. With respect to a 
particular mine or other natural deposit, a taxpayer who has made the 
election described in the preceding sentence may deduct under section 
615(a) a portion of the exploration expenditures and may defer and 
deduct under section 615(b) the balance of such expenditures. For any 
taxable year for which the election to treat exploration expenditures 
under section 615 is effective, the taxpayer must charge any amount of 
exploration expenditures in excess of $100,000 to capital account and 
must charge to capital account whatever amount has not been deducted 
currently or deferred. For example, taxpayer A who has elected under 
section 615(e) has three mines, X, Y, and Z. In the taxable year 1967, A 
makes exploration expenditures of $75,000 with respect to each mine. The 
total allowable deduction for exploration expenditures is $100,000. A 
deducts $50,000 and defers $25,000 with respect to X. He deducts 
$25,000, and charges to capital account $50,000 with respect to Y, and 
charges to capital account the entire $75,000 paid with respect to Z. 
Thus, A has deducted or deferred $100,000 and capitalized the excess.
    (2) Except as provided in section 615(e) and Sec.  1.615-6, a 
taxpayer cannot change his treatment of exploration expenditures for a 
taxable year after the due date (including extensions of time) for 
filing the return for the taxable year except where it is subsequently 
determined that any part of such exploration expenditures deducted under 
section 615(a) or deferred under section 615(b) are not exploration 
expenditures for the taxable year. Where the taxpayer has made the 
election to treat exploration expenditures under section 615 and it is 
subsequently determined that part of the expenditures deducted under 
section 615(a) or deferred under section 615(b), for a taxable year, 
were not exploration expenditures for such taxable year, the exploration 
expenditures required to be charged to capital account for such taxable 
year by reason of the limitation may be deducted or deferred (to the 
extent of the subsequent determination) and proper adjustment made to 
capital account. A taxpayer claiming a deduction under section 615(a) 
shall indicate clearly on his income tax return the amount of the 
deduction claimed under such section with respect to each mine or other 
natural deposit. Such mine or deposit shall be identified by an adequate 
description.

[T.D. 7192, 37 FR 12938, June 30, 1972]



Sec.  1.615-3  Election to defer pre-1970 exploration expenditures.

    (a) General rule. A taxpayer who makes the election provided in 
section 615(e) may defer any portion of the exploration expenditures 
made before January 1, 1970, with respect to each mine or other natural 
deposit, subject to the limitations described in section

[[Page 539]]

615(c) and Sec.  1.615-4. The amounts so deferred shall be deducted 
ratably as the units of produced ores or minerals discovered or explored 
by reason of such expenditures are sold.
    (b) Effect and manner of making election. (1) The election to defer 
exploration expenditures shall apply only to expenditures for the 
taxable year for which made. However, once made, the election shall be 
binding with respect to the expenditures for that taxable year. Thus, a 
taxpayer cannot revoke his election for any reason whatsoever.
    (2) The election shall be made for each mine or other natural 
deposit by a clear indication on the return or by a statement filed with 
the district director with whom the return was filed, not later than the 
time prescribed by law for filing such return (including extensions 
thereof) for the taxable year to which such election is applicable.
    (c) Expenditures made by the owner who retains a non-operating 
mineral interest. (1) A taxpayer who elects to defer exploration 
expenditures and thereafter transfers his interest in the mine or other 
natural deposit, retaining an economic interest therein, shall deduct an 
amount attributable to such interest on a pro rata basis as the interest 
pays out. For example, a taxpayer who defers exploration expenditures 
and then leases his deposit, retaining a royalty interest therein, shall 
deduct the deferred expenditures ratably as he receives royalties. If 
the taxpayer receives a bonus or advanced royalties in connection with 
the transfer of his interest, he shall deduct deferred expenditures 
allocable to such bonus or advanced royalties in an amount which is in 
the same proportion to the total of such costs as the bonus or advanced 
royalties bears to the bonus and total royalties expected to be 
received. Also, in the case of a transfer of a mine or other natural 
deposit by a taxpayer who retains a production payment therein, he shall 
deduct the exploration expenditures ratably over the payments expected 
to be received.
    (2) Where a taxpayer receives an amount, in addition to retaining an 
economic interest, which amount is treated as from the sale or exchange 
of a capital asset or property treated under section 1231 (except coal 
or iron ore to which section 631(c) applies), the deferred exploration 
expenditures shall be allocated between the interest sold and the 
interest retained in proportion to the fair market values of each 
interest as of the date of sale. The amount allocated to the interest 
sold may not be deducted, but shall be a part of the basis of such 
interest.
    (d) Losses from abandonment. Section 165 and the regulations 
thereunder contain general rules relating to the treatment of losses 
resulting from abandonment.
    (e) Computation of amount of deduction. The amount of the deduction 
allowable during the taxable year is an amount A, which bears the same 
ratio to B (the total deferred exploration expenditures for a particular 
mine or other natural deposit reduced by the amount of such expenditures 
deducted in prior taxable years) as C (the number of units of the ore or 
mineral benefited by such expenditures sold during the taxable year) 
bears to D (the number of units of ore or mineral benefited by such 
expenditures remaining as of the taxable year). For the purposes of this 
proportion, the number of units of ore or mineral benefited by such 
expenditures remaining as of the taxable year is the number of units of 
ore or mineral benefited by the deferred exploration expenditures 
remaining at the end of the year to be recovered from the mine or other 
natural deposit (including units benefited by such expenditures 
recovered but not sold) plus the number of units benefited by such 
expenditures sold within the taxable year. The principles outlined in 
Sec.  1.611-2 are applicable in estimating the number of units remaining 
as of the taxable year and the number of units sold during the taxable 
year. The estimate is subject to revision in accordance with that 
section in the event it is ascertained from any source, such as 
operations or development work, that the remaining units are materially 
greater or less than the number of units remaining from a prior 
estimate.

[T.D. 6500, 25 FR 11737, Nov. 26, 1960, as amended by T.D. 6685, 28 FR 
11405, Oct. 24, 1963; T.D. 6841, 30 FR 9306, July 27, 1965; T.D. 7192, 
37 FR 12939, June 30, 1972]

[[Page 540]]



Sec.  1.615-4  Limitation of amount deductible.

    (a) Taxable years beginning before July 7, 1960. For any taxable 
year beginning before July 7, 1960 (including taxable years of less than 
12 months), a taxpayer may deduct or defer exploration expenditures paid 
or incurred in the taxable year in an amount not in excess of $100,000. 
However, for such taxable years, the taxpayer may not avail himself of 
the provisions of section 615 for more than four taxable years 
(including taxable years of less than 12 months and taxable years 
subject to the Internal Revenue Code of 1939). Such four taxable years 
need not be consecutive. In determining the number of years in which a 
taxpayer has availed himself of section 615, a year for which he makes 
an election to defer exploration expenditures shall count as one year. 
Any subsequent taxable year in which such deferred expenditures are 
deducted shall not be taken into account as one of the four years. For 
purposes of the 4-year limitation, a year in which both a deduction and 
an election to defer are availed of by the taxpayer shall be taken into 
account as only one year.
    (b) Taxable years beginning after July 6, 1960. For any taxable year 
beginning after July 6, 1960 (including taxable years of less than 12 
months), a taxpayer who is otherwise eligible may deduct or defer 
exploration expenditures paid or incurred before January 1, 1970, in the 
lesser of the following amounts:
    (1) The amount paid or incurred in the taxable year,
    (2) $100,000, or
    (3) $400,000 minus all amounts deducted or deferred for taxable 
years ending after December 31, 1950


For purposes of this paragraph, the number of taxable years for which 
the taxpayer availed himself of the provisions of section 615 or the 
corresponding provisions of prior law is immaterial.
    (c) Special rules for previously deferred expenditures. In 
determining whether an election to defer was availed of in applying the 
limitations of paragraphs (a) and (b) of this section, there shall be 
taken into account any year with respect to which amounts were deferred 
but not fully deducted because of a sale or other disposition of the 
mineral property, even though the balance of the deferred amounts was 
treated as part of the basis of the mineral property in determining gain 
or loss from the sale.
    (d) Example of application of provisions. The application of the 
provisions of subparagraphs (a) and (b) of this section may be 
illustrated by the following example:

    Example. A taxpayer on the calendar year basis, who has never 
claimed the benefits of section 615, or section 23(ff) of the 1939 Code, 
expended $200,000 for exploration expenditures during the year 1956. For 
each of the years 1957, 1958, 1959, and 1960 the taxpayer had 
exploration costs of $80,000. The taxpayer deducted or deferred the 
maximum amounts allowed for each of the years 1956, 1957, 1958, and 
1959. None of the $80,000 expenditures for 1960 could be deducted or 
deferred by the taxpayer because he had already deducted or deferred 
exploration expenditures for 4 prior years. In 1961 the taxpayer 
expended $200,000 for exploration expenditures. The maximum amount the 
taxpayer may deduct or defer for the taxable year 1961 is $60,000 
computed as follows:
    (1) Add all yearly amounts deducted or deferred for exploration 
expenditures by the taxpayer for prior years.

------------------------------------------------------------------------
                                                                Deducted
                      Year                       Expenditures      or
                                                                deferred
------------------------------------------------------------------------
1956...........................................     $200,000    $100,000
1957...........................................       80,000      80,000
1958...........................................       80,000      80,000
1959...........................................       80,000      80,000
1960...........................................       80,000           0
                                                ------------------------
    Total......................................  ............    340,000
------------------------------------------------------------------------

    (2) Subtract the sum of the amounts obtained in (1), $340,000, from 
$400,000, the maximum amount allowable to the taxpayer for deductions or 
deferrals of exploration expenditures.

Maximum amount allowable to taxpayer........................    $400,000
Sum of amounts obtained in (1)..............................     340,000
                                                             -----------
                                                                  60,000
 

    (e) Transferee of mineral property. (1) Where an individual or 
corporation transfers any property to the taxpayer and the transfer is 
one to which any of the subdivisions of this subparagraph apply, the 
taxpayer shall take into account for purposes of the 4-year limitation 
described in paragraph (a) of this section, all years that the 
transferor

[[Page 541]]

deducted or deferred exploration expenditures, and for purposes of the 
$400,000 limitation described in paragraph (b) of this section, all 
amounts that the transferor deducted or deferred.
    (i) The taxpayer acquired any mineral property in a transaction 
described in section 23(ff)(3) of the Internal Revenue Code of 1939, 
excluding the reference therein to section 113(a)(13).
    (ii) The taxpayer would be entitled under section 381(c)(10) to 
deduct exploration expenditures if the transferor (or distributor) 
corporation had elected to defer such expenditures. For example, if the 
taxpayer acquired any mineral property in a transaction described in 
section 381(a) (relating to the acquisition of assets through certain 
corporate liquidations and reorganizations), there shall be taken into 
account in applying the limitations of paragraph (a) of this section the 
years in which the transferor exercised the election to defer or deduct 
exploration expenditures, and there shall be taken into account in 
applying the limitations of paragraph (b) of this section any amount so 
deducted or deferred. See also section 381(c)(10) and the regulations 
thereunder.
    (iii) The taxpayer acquired any mineral property under circumstances 
which make applicable the following sections of the Internal Revenue 
Code:
    (a) Section 334(b)(1), relating to the liquidation of a subsidiary 
where the basis of the property in the hands of the distributee is the 
same as it would be in the hands of the transferor.
    (b) Section 362 (a) and (b), relating to property acquired by a 
corporation as paid-in surplus or as a contribution to capital, or in 
connection with a transaction to which section 351 applies.
    (c) Section 372(a), relating to reorganization in certain 
receiverships and bankruptcy proceedings.
    (d) Section 373(b)(1), relating to property of a railroad 
corporation acquired in certain bankruptcy or recivership proceedings.
    (e) Section 1051, relating to property acquired by a corporation 
that is a member of an affiliated group.
    (f) Section 1082, relating to property acquired pursuant to a 
Securities Exchange Commission order.
    (2) For purposes of subparagraph (1) of this paragraph, it is 
immaterial whether a deduction has been allowed or an election has been 
made by the transferor with respect to the specific mineral property 
transferred.
    (3) Where a mineral property is acquired under any circumstance 
except those described in subparagraph (1) of this paragraph, the 
taxpayer is not required to take into account the election exercised by 
or deduction allowed to his transferor.
    (4) For purposes of applying the limitations imposed by section 
615(c): (i) the partner, and not the partnership, shall be considered as 
the taxpayer (see paragraph (a)(8)(iii) of Sec.  1.702-1), and (ii) an 
electing small business corporation, as defined in section 1371(b), and 
not its shareholders, shall be considered as the taxpayer.
    (5) For purposes of subparagraph (1)(iii)(b) of this paragraph: (i) 
if mineral property is acquired from a partnership, the transfer shall 
be considered as having been made by the individual partners, so that 
the number of years for which section 615 has been availed of by each 
partner and the amounts which each partner has deducted or deferred 
under section 615 shall be taken into account, or (ii) if on interest in 
a partnership having mineral property is transferred, the transfer shall 
be considered as a transfer of mineral property by the partner or 
partners relinquishing an interest, so that the number of years for 
which section 615 has been availed of by each such partner and the 
amounts which each such partner has deducted or deferred under section 
615 shall be taken into account.
    (f) Examples. The application of the provisions of this section may 
be illustrated by the following examples:

    Example 1. A calendar year taxpayer who has never claimed the 
benefits of section 615 received in 1956 a mineral deposit from X 
Corporation upon a distribution in complete liquidation of the latter 
under conditions which would make the provisions of section 334(b)(1) 
applicable in determining the basis of the property in the hands of the 
taxpayer. During the year 1955 X Corporation expended $60,000 for 
exploration expenditures which it elected to treat as deferred expenses. 
Assume further that the taxpayer made similar expenditures of $150,000, 
$125,000, $100,000,

[[Page 542]]

$60,000, and $180,000 for the years 1956, 1957, 1958, 1959, and 1961, 
respectively, which the taxpayer elected to deduct for each of those 
years to the extent allowable. No such expenditures were made for 1960. 
On the basis of these facts, the taxpayer may deduct or defer $100,000 
for each of the years 1956, 1957, and 1958. No deduction or deferral is 
allowable for 1959 since the 4-year limitation of paragraph (a) of this 
section applies. The taxpayer may deduct or defer a maximum of $40,000 
for 1961 since the $400,000 limitation of paragraph (b) of this section 
applies, but the 4-year limitation of paragraph (a) does not apply.
    Example 2. Assume the same facts stated in example 1 except that, 
prior to acquisition by the taxpayer of the deposit from X Corporation 
in 1956, X Corporation had acquired the deposit in 1954 in a similar 
distribution from Y Corporation which, in the years 1952 and 1953, 
deducted exploration costs paid in respect of an entirely different 
deposit in the amounts of $30,000 and $50,000, respectively. Under these 
circumstances, the taxpayer may deduct or defer exploration expenditures 
paid or incurred in the amount of $100,000 for 1956. No deduction or 
deferral is allowable to the taxpayer for expenditures made in 1957, 
1958, and 1959 since the 4-year limitation of paragraph (a) applies. The 
taxpayer may deduct or defer a maximum of $100,000 for 1961 since the 4-
year limitation of paragraph (a) of this section no longer applies. If 
the taxpayer deducted or deferred $100,000 for each of the years 1956 
and 1961 and also made exploration expenditures in 1962, the taxpayer 
may deduct or defer a maximum of $60,000 for that year under the 
$400,000 limitation of paragraph (b) of this section.
    Example 3. In 1957, A and B transfer assets to a corporation under 
circumstances making section 351 applicable to such a transfer. Among 
the assets transferred by A is a mineral lease with respect to certain 
coal lands. A has deducted exploration expenditures under section 615 
for the years 1954 and 1956 in the amounts of $50,000 and $100,000, 
respectively, made with respect to other deposits not included in the 
transfer to the corporation. The corporation shall be required to take 
into account the deductions previously made by A for purposes of 
applying the limitations of paragraphs (a) and (b) of this section.
    Example 4. In 1956, A, B, and C form a partnership for the purpose 
of exploring for, developing, and producing uranium. A contributes a 
uranium lease to the partnership. A had individually made exploration 
expenses in the amount of $50,000 and $100,000 with respect to other 
mineral properties not contributed to the partnership and which he has 
deducted under section 615(a) for the years 1954 and 1955, respectively. 
B contributes a uranium lease to the partnership on which he made 
exploration expenditures in the amount of $100,000 in 1955 which he 
elected to defer under section 615(b). This is the only year in which B 
has used section 615. C contributes only cash to the partnership and has 
not previously used section 615. Subject to the limitations of section 
615, for taxable years beginning before July 7, 1960, A may deduct or 
defer exploration expenses for two more taxable years (either as to 
expenditures incurred by him individually or with respect to his 
distributive share of partnership exploration expenses). B may deduct or 
defer exploration expenditures for three more years, and C may deduct or 
defer exploration expenditures for four years. For taxable years 
beginning after July 6, 1960, subject in each case to the $100,000 
limitation per year, A may deduct or defer exploration expenditures in 
an amount not in excess of $250,000 ($400,000-$150,000), either as to 
expenditures incurred by him individually or with respect to his 
distributive share of partnership exploration expenditures. B may 
similarly deduct or defer exploration expenditures in an amount not in 
excess of $300,000 ($400,000-$100,000), and C may deduct or defer 
exploration expenditures in an amount not in excess of $400,000.

[T.D. 6685, 28 FR 11405, Oct. 24, 1963, as amended by T.D. 7192, 37 FR 
12939, June 30, 1972]



Sec.  1.615-5  Time for making election with respect to returns due
on or before May 2, 1960.

    In the case of any taxable year beginning after December 31, 1953, 
and ending after August 16, 1954, the income tax return for which is due 
not later than May 2, 1960, the time for exercising any option or making 
any election under section 615 shall expire on May 2, 1960.



Sec.  1.615-6  Election to deduct under section 615.

    (a) General rule. The election to deduct or defer exploration 
expenditures under section 615 shall be made in a statement filed with 
the director of the Internal Revenue service center with whom the 
taxpayer's income tax return is required to be filed. If the election is 
made within the time period prescribed for filing an income tax return 
(including extensions thereof) for the first taxable year ending after 
September 12, 1966, during which the taxpayer pays or incurs 
expenditures which are within the scope of section 615 and which are

[[Page 543]]

paid or incurred by him after September 12, 1966, this statement shall 
be attached to the taxpayer's income tax return for such taxable year. 
If the election is made after the time prescribed for filing such return 
but before the expiration of the period (described in paragraph (e) of 
this section) for making the election under section 615(e), the 
statement must be signed by the taxpayer or his authorized 
representative. The statement shall be filed even though the taxpayer 
charges to capital account all such expenditures paid or incurred by him 
during such taxable year after such date. The statement shall clearly 
indicate that the taxpayer elects to have section 615 apply to all 
amounts deducted or deferred by him with respect to exploration 
expenditures paid or incurred after September 12, 1966, and before 
January 1, 1970. If the taxpayer desires, he may file this statement by 
attaching it to his return for a taxable year prior to the first taxable 
year ending after September 12, 1966, in which he pays or incurs 
exploration expenditures. Except as provided in paragraph (b) of this 
section, if the taxpayer does not file such a statement within the 
period prescribed by section 615(e) and paragraph (e) of this section, 
any amounts deducted by him with respect to exploration expenditures 
paid or incurred after September 12, 1966, will be deemed to have been 
deducted pursuant to an election under section 617(a).
    (b) Exception. The last sentence of paragraph (a) of this section 
shall not apply if all exploration expenditures paid or incurred by the 
taxpayer after September 12, 1966, and before January 1, 1970, and 
deducted by him on his income tax return for the first taxable year 
ending after September 12, 1966, during which he pays or incurs such 
expenditures are outside the scope of section 617(a) (as it existed 
before its amendment by section 504(b) of the Tax Reform Act of 1969). 
For example, assume that, in his return for his taxable year ending 
December 31, 1966, a calendar-year taxpayer deducts exploration 
expenditures paid or incurred after September 12, 1966, and does not 
attach to his return the statement described in paragraph (a) of this 
section. However, all of the exploration expenditures paid or incurred 
by the taxpayer after September 12, 1966, and before the end of the 
taxable year were paid or incurred with respect to minerals located 
neither in the United States nor on the Outer Continental Shelf. The 
taxpayer will be deemed to have made an election under section 615(e) by 
deducting all or part of those expenditures as expenses in his income 
tax return.
    (c) Information to be furnished. A taxpayer who makes or has made an 
election under section 615(e) with respect to expenditures paid or 
incurred after September 12, 1966, and before January 1, 1970, shall 
indicate clearly on his income tax return for each taxable year for 
which he deducts any such expenditures the amount of the deduction 
claimed under section 615 (a) or (b) with respect to each property or 
mine. The property or mine shall be identified by a description adequate 
to permit application of the rules of section 615(g) (relating to effect 
of transfer of mineral property).
    (d) Effect of election--(1) In general. A taxpayer who has made or 
is deemed to have made an election under section 615(e) may not make an 
election under section 617(a) with respect to expenditures made before 
January 1, 1970, unless, within the period set forth in section 615(e), 
he revokes his election under section 615(e). Except as provided in 
paragraph (a)(2) of Sec.  1.615-2, a taxpayer who makes an election 
under section 615(e) may not change his treatment of exploration 
expenditures deducted, deferred, or capitalized pursuant to such 
election unless he revokes the election made under section 615(e).
    (2) Transfer of mineral property. The binding effect of a taxpayer's 
election under section 615(e) shall not be affected by his receiving 
property with respect to which deductions have been allowed under 
section 617(a). However, see section 615(g)(2) and Sec.  1.615-7 for 
rules under which amounts deducted under section 615 by a transferor may 
be subject to recapture in the hands of a transferee who has made an 
election under section 617(a). See Sec.  1.617-3(d)(2)(ii) for rules 
under which amounts deducted under section 617(a) by a transferor may be 
subject to recapture in the hands of a transferee

[[Page 544]]

who has made an election under section 615(e).
    (e) Time for making election under section 615(e). A taxpayer may 
not make an election under section 615(e) after the expiration of the 3-
year period beginning with the date prescribed by section 6072 or other 
provision of law for filing the taxpayer's income tax return for the 
first taxable year ending after September 12, 1966, in which the 
taxpayer pays or incurs expenditures to which section 615(a) would apply 
if an election were made under section 615(e). This 3-year period shall 
be determined without regard to any extension of time for filing the 
taxpayer's income tax return for such year. An election under section 
615(e) may not be made after the expiration of the 3-year period even 
though the taxpayer charged to capital account, or erroneously deducted 
as development expenditures under section 616, all exploration 
expenditures paid or incurred by him after September 12, 1966, and 
before the end of his first taxable year ending after September 12, 
1966, in which he paid or incurred such expenditures.
    (f) Revocation of section 615(e) election--(1) Manner of revoking 
election. A taxpayer may revoke an election made by him under section 
615(e) by filing with the director of the Internal Revenue service 
center with whom the taxpayer's income tax return is required to be 
filed, within the period set forth in subparagraph (2) of this 
paragraph, a statement, signed by the taxpayer or his authorized 
representative, which sets forth that the taxpayer is revoking the 
election previously made by him with respect to exploration expenditures 
paid or incurred after September 12, 1966, and states with whom and 
where the document making the election was filed. Such revocation shall 
be a revocation for all taxable years for which the taxpayer's election 
was in effect and the taxpayer revoking such an election shall file 
amended income tax returns, reflecting any increase or decrease in tax 
attributable to the revocation of election. In applying the revocation 
of election to the years affected there shall be taken into account the 
effect that any adjustments resulting from the revocation of election 
shall have on other items affected thereby (such as the deduction for 
charitable contributions, the foreign tax credit, net operating loss, 
and other deductions or credits the amount of which is limited by the 
taxpayer's income) and the effect that adjustments of any such items 
have on items in other taxable years.
    (2) Time for revoking election under section 615(e). An election 
under section 615(e) may be revoked at any time before the expiration of 
the 3-year period described in paragraph (e) of this section. Such an 
election may not be revoked after the expiration of the 3-year period.
    (3) Additional information to be furnished by a transferor of 
mineral property. If, before revoking his election, the taxpayer has 
transferred any mineral property with respect to which he deducted 
exploration expenditures paid or incurred after September 12, 1966, and 
before January 1, 1970, to another person in a transaction as a result 
of which the basis of such property in the hands of the transferee is 
determined by reference to the basis in the hands of the transferor, the 
statement submitted pursuant to subparagraph (1) of this paragraph shall 
state that such property has been so transferred and shall identify the 
transferee, the property transferred, and the date of the transfer. The 
preceding sentence shall not apply in the case of any mineral property 
transferred after December 31, 1969.
    (g) Taxable years beginning before September 13, 1966, and ending 
after September 12, 1966--(1) In general. An election made under section 
615(e) applies only to expenditures paid or incurred after September 12, 
1966. The income tax treatment of exploration expenditures paid or 
incurred before September 13, 1966, will be determined in accordance 
with the provisions of section 615 prior to its amendment by the Act of 
September 12, 1966 (Public Law 89-570, 80 Stat. 759). If a taxpayer 
makes an election under section 615(e) in his income tax return for a 
taxable year which begins before September 13, 1966, and which ends 
after September 12, 1966, amounts deducted and amounts deferred under 
section 615

[[Page 545]]

with respect to expenditures paid or incurred during such taxable year 
but before September 13, 1966, will be taken into account in determining 
whether the $100,000 limitation set forth in section 615(a) is reached 
during the taxable year. Similarly, a taxpayer who makes an election 
under section 615(e) shall take into account expenditures deducted or 
deferred under section 615 for the period prior to September 13, 1966, 
in determining when the $400,000 overall limitation set forth in section 
615(c) is reached. The fact that a taxpayer deducts or defers under 
section 615 exploration expenditures paid or incurred prior to September 
13, 1966, shall not affect his right to make an election under section 
617(a) to deduct under section 617 expenditures paid or incurred after 
September 12, 1966.
    (2) Allocation in case of inadequate records. If a taxpayer pays or 
incurs exploration expenditures during a taxable year beginning before 
September 13, 1966, and ending after September 12, 1966, but his records 
as to any mine or property are inadequate to permit a determination of 
the amount paid or incurred during the portion of the year ending after 
September 12, 1966, and the amount paid or incurred on or before such 
date, the exploration expenditures, as to which the records are 
inadequate, paid or incurred with respect to the mine or property during 
the taxable year shall be allocated to each part year (that is, the part 
occurring before September 13, 1966, and the part occurring after 
September 12, 1966) in the same ratio which the number of days in each 
such part year bears to the number of days in the entire taxable year. 
For example, if the records of a calendar year taxpayer for 1966 are 
inadequate to permit a determination of the amount of exploration 
expenditures paid or incurred with respect to a certain mine or property 
after September 12, 1966, and the amount paid or incurred before 
September 13, 1966, 255/365 of the total exploration expenditures paid 
or incurred by the taxpayer with respect to the mine or property during 
1966 shall be allocated to the period beginning January 1, 1966, and 
ending September 12, 1966, and 110/365 of the total exploration 
expenditures paid or incurred with respect to the mine or property 
during 1966 shall be allocated to the period beginning September 13, 
1966, and ending December 31, 1966.
    (3) Partnership elections. With respect to exploration expenditures 
paid or incurred by a partnership before September 13, 1966, the option 
to deduct under section 615(a) and the election to defer under section 
615(b) shall be made by the partnership, rather than by the individual 
partners. With respect to exploration expenditures paid or incurred by a 
partnership after September 12, 1966, all elections under sections 615 
and 617 as to the tax treatment of a partner's distributive share of 
exploration expenditures paid or incurred by a partnership of which he 
is a member shall be made by the individual partner, rather than by the 
partnership. See section 703(b) and the regulations thereunder.

[T.D. 7192, 37 FR 12939, June 30, 1972]



Sec.  1.615-7  Effect of transfer of mineral property.

    (a) Transfer before election by transferor. (1) If mineral property 
is transferred in a transaction as a result of which the basis of the 
property in the hands of the transferee is determined in whole or in 
part by reference to the basis in the hands of the transferor and the 
transferor had not made an election under either section 615(e) or 
617(a) at the time of the transfer, no election made by the transferor 
after the transfer shall apply with respect to expenditures properly 
chargeable to the transferred property which were paid or incurred 
before the date of the transfer.
    (2) For purposes of subparagraph (1) of this paragraph, a transferor 
of mineral property who made an election under section 617(a) or section 
615(e) before the transfer but who revokes such election after such 
transfer and does not make an election under either section before the 
expiration of the 3-year period prescribed by section 6072 or other 
provision of law for filing his income tax return for the taxable year 
in which such transfer occurred shall be treated with respect to such 
property as not having made an election under either section.
    (b) Transfer after election by transferor. If a transferee who at 
the time of the

[[Page 546]]

transfer of a mineral property has not made an election under section 
617(a) receives property in a transaction in which the basis of such 
property in his hands is determined in whole or in part by reference to 
its basis in the hands of the transferor and with respect to such 
property the transferor has deducted expenditures under section 617(a), 
the adjusted exploration expenditures properly chargeable to the 
property immediately after the transfer shall be treated as expenditures 
allowed as deductions under section 617(a) to the transferee. See 
section 617 and the regulations thereunder.
    (c) Transfer after election by transferee. (1) If a transferee who 
makes an election under section 617(a) receives before January 1, 1970, 
mineral property in a transaction in which the basis of such property in 
his hands is determined in whole or in part by reference to the basis of 
the property in the hands of the transferor and the transferor had in 
effect at the time of the transfer an election under section 615(e), an 
amount equal to the total of the amounts allowed as deductions to the 
transferor under section 615 with respect to the transferred mineral 
property shall be treated as expenditures allowed as deductions under 
section 617(a) to the transferee. The preceding sentence shall not apply 
to expenditures which would not have been reflected in the basis of the 
property in the hands of the transferor had the transferor not made the 
section 615(e) election.
    (2) Any expenditures with respect to the transferred property 
deferred by the transferor under section 615(b) which are not allowed as 
deductions to him prior to transfer of the property may not be deducted 
by the transferee and in his hands shall be charged to capital account.

[T.D. 7192, 37 FR 12940, June 30, 1972]



Sec.  1.615-8  Termination of section 615.

    (a) In general. The provisions of section 615 shall not apply to 
exploration expenditures paid or incurred after December 31, 1969. 
Expenditures paid or incurred before January 1, 1970, which were 
deferred under section 615(b) will be deductible under such section 
after such date as the units of ore or mineral discovered or explored by 
reason of such expenditures are sold. An election under section 615(e) 
with respect to expenditures paid or incurred prior to January 1, 1970, 
shall remain in effect with respect to such expenditures unless it is 
revoked under section 615(e) and Sec.  1.615-6. See Sec.  1.615-9 for 
treatment of a section 615(e) election with respect to expenditures paid 
or incurred after December 31, 1969.
    (b) Taxable years beginning before January 1, 1970, and ending after 
December 31, 1969--(1) In general. The termination of section 615 
applies to expenditures paid or incurred after December 31, 1969. The 
income tax treatment of exploration expenditures paid or incurred before 
January 1, 1970, will be determined in accordance with the provisions of 
sections 615 and 617 prior to their amendment by the Tax Reform Act of 
1969 (83 Stat. 487). The fact that on his income tax return for a 
taxable year beginning before January 1, 1970, and ending after December 
31, 1969, a taxpayer deducts under section 615 expenditures paid or 
incurred before January 1, 1970, shall not affect his right to deduct 
under section 617(a) expenditures paid or incurred during such taxable 
year after December 31, 1969.
    (2) Allocation in case of inadequate records. If a taxpayer pays or 
incurs exploration expenditures during a taxable year beginning before 
January 1, 1970, and ending after December 31, 1969, but his records are 
inadequate to permit a determination of the amount paid or incurred 
during the portion of the year ending after December 31, 1969, and the 
amount paid or incurred on or before such date, the exploration 
expenditures as to which the records are inadequate paid or incurred 
with respect to the mine or property during the taxable year shall be 
allocated to each part of the year (that is, the part before January 1, 
1970, and the part occurring after December 31, 1969) in the same ratio 
which the number of days in each such part year bears to the number of 
days in the entire taxable year.

[T.D. 7192, 37 FR 12941, June 30, 1972]



Sec.  1.615-9  Notification under Tax Reform Act of 1969.

    (a) In general. An election under section 615(e) with respect to 
exploration

[[Page 547]]

expenditures paid or incurred prior to January 1, 1970, shall be treated 
as an election under section 617(a) with respect to exploration 
expenditures paid or incurred after December 31, 1969.
    (b) Exception. Paragraph (a) of this section shall not apply to an 
election under section 615(e) if the taxpayer files the notice described 
in paragraph (c) of this section or the taxpayer revokes his election 
under section 615(e) before the date prescribed for the filing of notice 
under paragraph (c)(2) of this section.
    (c) Filing of notice--(1) In general. The notice not to have a 
section 615(e) election treated as a section 617(a) election shall be 
made in a statement filed with the Director of the Internal Revenue 
service center with whom the taxpayer's income tax return is required to 
be filed. If the election is made within the time period prescribed for 
filing an income tax return (including extensions thereof) for the first 
taxable year during which the taxpayer pays or incurs, after December 
31, 1969, expenditures which would be deductible by the taxpayer under 
section 617(a) if he made a valid election to deduct exploration 
expenditures under such section, the statement shall be attached to the 
taxpayer's income tax return for such year. If the statement is filed 
after the time prescribed for filing such return but before the 
expiration of the period (described in paragraph (e) of this section) 
for filing the notice, the statement must be signed by the taxpayer or 
his authorized representative. The statement shall be filed even though 
the taxpayer charges to capital account all such expenditures paid or 
incurred by him after December 31, 1969. If the taxpayer desires, he may 
file this statement by attaching it to his return for a taxable year 
prior to the first taxable year in which he pays or incurs after 
December 31, 1969, expenditures which would be deductible by him under 
section 617(a) if at such time he had in effect a valid election under 
such section.
    (2) Information to be furnished. The notice shall clearly state that 
the taxpayer elects not to have his section 615(e) election treated as 
an election under section 617(a). The notice shall state the first 
taxable year for which the section 615(e) election was effective and 
with whom and where the election was filed.
    (d) Effect of notification. A taxpayer who has filed notice pursuant 
to this section may make an election under section 617(a) with respect 
to exploration expenditures paid or incurred after December 31, 1969, 
without revoking either his section 615(e) election or his notice under 
this section.
    (e) Time for filing notice. A taxpayer may not file the notice 
described in paragraph (c)(1) of this section after the expiration of 
the 3-year period beginning with the date prescribed by section 6072 or 
other provision of law for filing the taxpayer's income tax return for 
the first taxable year in which the taxpayer pays or incurs after 
December 31, 1969, expenditures which would be deductible by him if he 
made the election under section 617(a). This 3-year period shall be 
determined without regard to any extension of time for filing the 
taxpayer's income tax return.

[T.D. 7192, 37 FR 12941, June 30, 1972]



Sec.  1.616-1  Development expenditures.

    (a) General rule. Section 616 prescribes rules for treating 
expenditures paid or incurred during the taxable year by the taxpayer 
for the development of a mine or other natural deposit (other than an 
oil or gas well). Development expenditures under section 616 are those 
which are made after such time when, in consideration of all the facts 
and circumstances (including actions of the taxpayer), deposits of ore 
or other mineral are shown to exist in sufficient quantity and quality 
to reasonably justify commercial exploitation by the taxpayer. Under 
section 616(a), a taxpayer is allowed a deduction for development 
expenditures whether or not such expenditures are made in the 
development or production state of the mine or other natural deposit. 
Under section 616(b), the taxpayer may elect to defer development 
expenditures made in the development or producing stage and to deduct 
such expenditures ratably as the minerals or ores benefited are sold. 
While the mine or other natural deposit is in the development stage, the 
election applies only

[[Page 548]]

to that portion of the development expenditures which is in excess of 
net receipts from the mine or other natural deposit. See Sec.  1.616-2 
for rules with respect to the election to defer. It is not necessary 
that the taxpayer incur the development costs directly. He may engage a 
contractor to make the expenditures on his behalf.
    (b) Expenditures to which section 616 is not applicable. (1) Section 
616 is not applicable to development expenditures which are deductible 
for the taxable year under any other provision of the internal revenue 
laws.
    (2) Section 616 is not applicable to expenditures which are 
reflected in improvements subject to allowances for depreciation under 
sections 167 and 611. However, allowance for depreciation of such 
improvements which are used in the development of ores or minerals are 
considered development expenditures under section 616. If such 
improvements are used only in part for development during a taxable 
year, an allocable portion of the allowance for depreciation shall be 
treated as a development expenditure.
    (3) Section 616 is applicable to development expenditures paid or 
incurred by a taxpayer in connection with the acquisition of a 
fractional share of the working or operating interest to the extent of 
the fractional interest so acquired. The expenditure attributable to the 
remaining fractional share shall be considered as part of the cost of 
his acquired interest and shall be capitalized and recovered through 
depletion allowances. For example, taxpayer A owns mineral leases on 
undeveloped mineral lands. A agrees to convey an undivided three-fourths 
(\3/4\) interest in such leases to B, provided B will pay all of the 
expenditures incurred during the development stage of the deposits on 
these leases. B may deduct three-fourths (\3/4\) of such amount under 
section 616, but shall treat one-fourth of such amount as part of the 
cost of his interest, recoverable through depletion.
    (4) The provisions of section 616 do not apply to costs of 
development paid or incurred by a prior owner which are reflected in the 
amount which the taxpayer paid or incurred to acquire the property. Such 
provisions apply only to costs paid or incurred by the taxpayer for 
development undertaken directly or through contract by the taxpayer. 
See, however, section 381(a) and 381(c)(10) for special rules with 
respect to deferred development expenditures in certain corporate 
acquisitions.
    (c) Mine or other natural deposit. Section 616 has reference to 
expenditures made for the development of a mine or other natural 
deposit. Within an aggregated property, as that term is defined in 
section 614 (b) and (c), or within a single tract or parcel of land, 
there may be more than one mine or other natural deposit. Where a 
property, as determined under section 614, contains more than one mine 
or other natural deposit, the taxpayer may deduct under section 616(a) 
the development expenditures made with respect to one of such mines or 
deposits, and may defer under section 616(b) the development 
expenditures made with respect to another of such mines or deposits. 
Where there is more than one mine with respect to a single underlying 
deposit, the taxpayer may deduct under section 616(a) the development 
expenditures made with respect to one of such mines, and may defer under 
section 616(b) the development expenditures made with respect to another 
of such mines. The taxpayer must treat consistently all development 
expenditures with respect to each such mine or other natural deposit in 
a taxable year. The taxpayer must make a separate determination of the 
units of minerals or ores benefited in a mine or other natural deposit 
(regardless of the computation of the depletion allowance) in order that 
deferred expenditures with respect to such mine or deposit may be 
deducted on a ratable basis. See paragraph (f) of Sec.  1.616-2.



Sec.  1.616-2  Election to defer.

    (a) General rule. In lieu of taking a deduction under section 
616(a), in the taxable year when the development expenditures are paid 
or incurred, a taxpayer may elect under section 616(b) to treat such 
expenditures with respect to each mine or other natural deposit as 
deferred expenses to be deducted ratably as the units of the produced 
ore or

[[Page 549]]

minerals benefited by such expenditures are sold. Section 616(b) is 
applicable to development expenditures paid or incurred both in the 
development and producing stage of the mine or other natural deposit. 
However, in the case of such expenditures made in the development stage, 
this election is applicable only to the excess of the amount of such 
expenditures over the net receipts from the ore or minerals from such 
mine or deposit received or accrued during the development stage and in 
the same taxable year as the expenditures were paid or incurred. Such 
development expenditures not in excess of such net receipts shall be 
subject to the provisions of section 616(a).
    (b) Producing stage; definition of. The mine or other natural 
deposit will be considered to be in a producing stage when the major 
portion of the mineral production is obtained from workings other than 
those opened for the purpose of development, or when the principal 
activity of the mine or other natural deposit is the production of 
developed ores or minerals rather than the development of additional 
ores or minerals for mining.
    (c) Expenditures made by the owner who retains a nonoperating 
interest. (1) A taxpayer who elects to defer development expenditures 
and thereafter transfers his interest in the mine or other natural 
deposit, retaining an economic interest therein, shall deduct an amount 
attributable to such interest on a pro rata basis as the interest pays 
out. For example, a taxpayer who defers development expenditures and 
then leases his deposit, retaining a royalty interest therein, shall 
deduct the deferred expenditures ratably as he receives the royalties. 
If the taxpayer receives a bonus or advanced royalties in connection 
with the transfer of his interest, he shall deduct the deferred 
expenditures allocable to such bonus or advanced royalties in an amount 
which is in the same proportion to the total of such costs as the bonus 
or advanced royalties bears to the bonus and total royalties expected to 
be received. Also, in the case of a transfer of a mine or other natural 
deposit by a taxpayer who retains a production payment therein, he may 
deduct the development expenditures ratably over the payments expected 
to be received.
    (2) Where a taxpayer receives an amount, in addition to retaining an 
economic interest, which amount is treated as from the sale or exchange 
of a capital asset or property treated under section 1231 (except coal 
or iron ore to which section 631(c) applies), the deferred development 
expenditures shall be allocated between the interest sold and the 
interest retained in proportion to the fair market value of each 
interest as of the date of sale. The amount allocated to the interest 
sold may not be deducted, but shall be a part of the basis of such 
interest for the purpose of determining gain or loss upon the sale 
thereof.
    (d) Losses from abandonment. Section 165 and the regulations 
thereunder contain general rules relating to the treatment of losses 
resulting from abandonment.
    (e) Effect of election. (1) The election to defer development 
expenditures shall apply only to expenditures for the taxable year for 
which made. However, once made, the election shall be binding with 
respect to the expenditures for that taxable year. Thus, a taxpayer 
cannot revoke his election for any reason whatsoever.
    (2) The election shall be made for each mine or other natural 
deposit by a clear indication on the return or by a statement filed with 
the district director with whom the return was filed, not later than the 
time prescribed by law for filing such return (including extensions 
thereof) for the taxable year to which such election is applicable.
    (f) Computation of amount of deduction. The amount of the deduction 
allowable during the taxable year is an amount A, which bears the same 
ratio to B (the total deferred development expenditures for a particular 
mine or other natural deposit reduced by the amount of such expenditures 
deducted in prior taxable years) as C (the number of units of the ore or 
mineral benefited by such expenditures sold during the taxable year) 
bears to D (the number of units of ore or mineral benefited by such 
expenditures remaining as of the taxable year). For the purposes of this 
proportion, the number of units of

[[Page 550]]

ore or mineral benefited by such expenditures remaining as of the 
taxable year is the number of units of ore or mineral benefited by the 
deferred development expenditures remaining at the end of the year to be 
recovered from the mine or other natural deposit (including units 
benefited by such expenditures recovered but not sold) plus the number 
of units benefited by such expenditures sold within the taxable year. 
The principles outlined in Sec.  1.611-2 are applicable in estimating 
the number of units remaining as of the taxable year and the number of 
units sold during the taxable year. The estimate is subject to revision 
in accordance with that section in the event it is ascertained, from any 
source, such as operations or development work, that the remaining units 
are materially greater or less than the number of units remaining from a 
prior estimate.

[T.D. 6500, 25 FR 11737, Nov. 26, 1960, as amended by T.D. 6841, 30 FR 
9307, July 27, 1965]



Sec.  1.616-3  Time for making election with respect to returns due
on or before May 2, 1960.

    In the case of any taxable year beginning after December 31, 1953, 
and ending after August 16, 1954, the income tax return for which is due 
not later than May 2, 1960, the time to deduct or defer development 
expenditures for such a year under section 616 (a) or (b) shall expire 
on May 2, 1960.



Sec.  1.617-1  Exploration expenditures.

    (a) General rule. Section 617 prescribes rules for the treatment of 
expenditures paid or incurred after September 12, 1966, for ascertaining 
the existence, location, extent, or quality of any deposit of ore or 
other mineral for which a deduction for depletion is allowable under 
section 613 (other than oil or gas) paid or incurred by the taxpayer 
before the beginning of the development stage of the mine or other 
natural deposit. Such expenditures hereinafter in the regulations under 
section 617 will be referred to as exploration expenditures. The 
development stage of the mine or other natural deposit will be deemed to 
begin at the time when, in consideration of all the facts and 
circumstances (including the actions of the taxpayer), deposits of ore 
or other mineral are disclosed in sufficient quantity and quality to 
reasonably justify commercial exploitation by the taxpayer. For example, 
core drilling expenditures paid or incurred by the taxpayer to ascertain 
the existence of commercially marketable ore are exploration 
expenditures within the meaning of this section. Also, expenditures for 
exploratory drilling from within a producing mine to ascertain the 
existence of what appears (on the basis of all of the facts and 
circumstances known at the time of the expenditures) to be a different 
ore deposit are exploration expenditures within the meaning of this 
section. Expenditures paid or incurred in connection with core drilling 
to further delineate the extent and location of an existing commercially 
marketable deposit to facilitate its development are development 
expenditures. Under section 617(a), a taxpayer may deduct exploration 
expenditures paid or incurred for the exploration of any deposit of ore 
or other mineral subject to the limitation of section 617(h). Under 
section 617(b), a taxpayer shall recapture the exploration expenditures 
previously deducted under section 617(a) either through including in 
income an amount equal to the amount of the adjusted exploration 
expenditures (as defined in section 617(f)) or through disallowance of 
the deduction for depletion under section 611. Certain rules are 
provided in section 617(c) for recapture of exploration expenditures 
made with respect to property for which the taxpayer later receives a 
bonus or royalty. Under section 617(d), gain from dispositions of mining 
property, with respect to which exploration expenditures have been 
previously deducted, is to be recognized notwithstanding certain other 
provisions of the Code.
    (b) Expenditures to which section 617 is not applicable. (1) Section 
617 is not applicable to expenditures which would be allowed as 
deductions for the taxable year without regard to section 617.
    (2) Section 617 is not applicable to expenditures which are 
reflected in improvements subject to allowances for depreciation under 
sections 167 and 611. However, allowances for depreciation of such 
improvements which are used

[[Page 551]]

in the exploration of ores or minerals are considered exploration 
expenditures under section 617. If such improvements are used only in 
part for exploration during the taxable year, an allocable portion of 
the allowance for depreciation shall be treated as an exploration 
expenditure.
    (3) Section 617 is applicable to exploration expenditures paid or 
incurred by a taxpayer in connection with the acquisition of a 
fractional share of the working or operating interest to the extent of 
the fractional interest so acquired by the taxpayer. The expenditures 
attributable to the remaining fractional share shall be considered as 
the cost of his acquired interest and shall be recovered through 
depletion allowances. For example, taxpayer A owns mineral leases on 
unexplored mineral lands and agrees to convey an undivided three-fourths 
(\3/4\) interest in such leases to taxpayer B provided B will pay all of 
the expenses for ascertaining the existence, location, extent, or 
quality of any deposit of ore or other mineral which will be incurred 
before the beginning of the development stage. B may elect to treat 
three-fourths of such amount under section 617. B must treat one-fourth 
of such amount as part of the cost of his interest, recoverable through 
depletion.
    (4) Section 617 is not applicable to costs of exploration which are 
reflected in the amount which the taxpayer paid or incurred to acquire 
the property. Section 617 applies only to costs paid or incurred by the 
taxpayer for exploration undertaken directly or through a contract by 
the taxpayer. See, however, sections 381(a) and 381(c)(10) for special 
rules with respect to deferred exploration expenditures in certain 
corporate acquisitions.
    (5) Section 617 is not applicable to amounts paid or incurred for 
the purpose of ascertaining the existence, location, extent, or quality 
of any deposit of oil or gas or of any mineral with respect to which a 
deduction for percentage depletion is not allowable under section 613. 
The purpose of the expenditure shall be determined by reference to the 
facts and circumstances at the time the expenditure is paid or incurred.
    (c) Elections--(1) Election to deduct under section 617(a). (i) The 
election to deduct exploration expenditures under section 617(a) may be 
made by deducting such expenditures in the taxpayer's income tax return 
for his first taxable year ending after September 12, 1966, for which 
the taxpayer desires to deduct exploration expenditures which are paid 
or incurred by him during such taxable year and after September 12, 
1966. This election may be exercised by deducting such exploration 
expenditures either in the taxpayer's return for such taxable year or in 
an amended return filed before the expiration of the period for filing a 
claim for credit or refund of income tax for such taxable year. Where 
the election is made in an amended return for a taxable year prior to 
the most recent year for which the taxpayer has filed a return, the 
taxpayer shall file amended income tax returns, reflecting any increase 
or decrease in tax attributable to the election, for all subsequent 
taxable years affected by the election for which he has filed income tax 
returns before making the election. See section 617(a)(2)(C) and 
subparagraph (4) of this paragraph for provisions relating to extension 
of the period of limitations for the assessment of any deficiency for 
any taxable year to the extent the deficiency is attributable to an 
election or revocation of an election under section 617(a). In applying 
the election to the years affected, there shall be taken into account 
the effect that any adjustments resulting from the election shall have 
on other items affected thereby (such as the deduction for charitable 
contributions, the foreign tax credit, net operating loss, and other 
deductions or credits the amount of which is limited by the taxpayer's 
income) and the effect that adjustments of any such items have on items 
of other taxable years. Amended returns filed for taxable years 
subsequent to the taxable year for which the election under section 
617(a) is made by amended return shall, where appropriate, apply the 
recapture rules of subsections (b), (c), and (d) of section 617. See 
Sec. Sec.  1.617-3 and 1.617-4.
    (ii) A taxpayer who makes or has made an election under section 
617(a) shall state clearly on his income tax

[[Page 552]]

return for each taxable year for which he deducts exploration 
expenditures the amount of the deduction claimed under section 617(a) 
with respect to each property or mine. Such property or mine shall be 
identified by a description adequate to permit application of the 
recapture rules of section 617 (b), (c), and (d).
    (iii) A taxpayer who has made an election under section 617(a) may 
not make an election under section 615(e) unless, within the period set 
forth in section 615(e), he revokes his election under section 617(a). A 
taxpayer who has made and has not revoked an election under section 
617(a) may not, in his return for the taxable year for which the 
election is made or for any subsequent taxable year, charge to capital 
account any exploration expenditures which are deductible by him under 
section 617(a); and he must deduct all such expenditures as expenses in 
computing adjusted gross income. Any exploration expenditures paid or 
incurred after December 31, 1969, which are not deductible by the 
taxpayer under section 617(a) solely because of the application of 
section 617(h) shall be charged to capital account.
    (2) Time for making elections. The election under section 617(a) may 
be made at any time before the expiration of the period prescribed for 
filing a claim for credit or refund of the tax imposed by chapter 1 for 
the first taxable year for which the taxpayer desires to deduct 
exploration expenditures under section 617(a).
    (3) Revocation of election to deduct. (i) A taxpayer may revoke an 
election made by him under section 617(a) by filing with the Internal 
Revenue service center with which the taxpayer's income tax return is 
required to be filed, within the period set forth in subdivision (ii) of 
this subparagraph, a statement, signed by the taxpayer or his authorized 
representative, which sets forth that the taxpayer is revoking the 
section 617(a) election previously made by him and states with whom and 
where the document making the election was filed. A taxpayer revoking a 
section 617(a) election shall file amended income tax returns which 
reflect any increase or decrease in tax attributable to the revocation 
of election for all taxable years affected by the revocation of election 
for which he has filed income tax returns before revoking the election. 
See section 617(a)(2)(C) and subparagraph (4) of this paragraph for 
provisions relating to extension of the period of limitations for the 
assessment of any deficiency attributable to an election or revocation 
of an election under section 617(a). In applying the revocation of 
election to the years affected, there shall be taken into account the 
effect that any adjustments resulting from the revocation of election 
shall have on other items affected thereby (such as the deduction for 
charitable contributions, the foreign tax credit, net operating loss, 
and other deductions or credits the amount of which is limited by the 
taxpayer's income) and the effect that adjustments of any such items 
have on items of other taxable years.
    (ii) An election under section 617(a) may be revoked before the 
expiration of the last day of the third month following the month in 
which the final regulations under section 617(a) are published in the 
Federal Register. After the expiration of this period, a taxpayer who 
has made an election under section 617(a) may not revoke that election 
unless he obtains the prior consent of the Commissioner of Internal 
Revenue. Consent will not be granted where a principal purpose for the 
revocation of the election is to circumvent the recapture provisions of 
section 517 (b), (c), or (d). The request for consent shall be made in 
writing to the Commissioner of Internal Revenue, Attention T:I:E, 
Washington, DC 20224. The request shall include in detail:
    (a) The reason or reasons for the revocation of election under 
section 617(a);
    (b) An itemization of the taxpayer's deductions under section 
617(a);
    (c) A description of all properties and detailed information of the 
exploration activities with respect to which the taxpayer has taken 
deductions under section 617(a);
    (d) A description of any development or production activities on all 
properties with respect to which exploration expenditures were deducted 
under section 617(a); and
    (e) A recomputation of the tax for each prior taxable year affected 
by the

[[Page 553]]

revocation. A letter setting forth the Commissioner's determination will 
be mailed to the taxpayer. If consent is granted, a copy of the letter 
granting such consent shall be filed with the director of the Internal 
Revenue service center with which the taxpayer's income tax return is 
required to be filed and shall be accompanied by an amended return or 
returns, if necessary.
    (iii) If, before revoking his election, the taxpayer has transferred 
any mineral property with respect to which he deducted exploration 
expenditures under section 617(a), to another person in a transaction as 
a result of which the basis of such property in the hands of the 
transferee is determined in whole or in part by reference to the basis 
in the hands of the transferor, the statement submitted pursuant to 
subdivision (i) of this paragraph shall state that such property has 
been so transferred, shall identify the transferee, the property 
transferred, the date of the transfer, and shall indicate the amount of 
the adjusted exploration expenditures with respect to such property on 
such date.
    (4) Deficiency attributable to election or revocation of election. 
The statutory period for the assessment of any deficiency for any 
taxable year, to the extent such deficiency is attributable to an 
election or revocation of an election under section 617(a), shall not 
expire before the last day of the 2-year period which begins on the day 
after the date on which such election or revocation of election is made; 
and such deficiency may be assessed at any time before the expiration of 
such 2-year period, notwithstanding any law or rule which would 
otherwise prevent such assessment.

[T.D. 7192, 37 FR 12942, June 30, 1972]



Sec.  1.617-2  Limitation on amount deductible.

    (a) Expenditures paid or incurred before January 1, 1970. In the 
case of expenditures paid or incurred before January 1, 1970, a taxpayer 
may deduct exploration expenditures paid or incurred during the taxable 
year with respect to any deposit of ore or other mineral for which a 
deduction for percentage depletion is allowable under section 613 (other 
than oil or gas) in the United States or on the Outer Continental Shelf 
(within the meaning of section 2 of the Outer Continental Shelf Lands 
Act, as amended and supplemented; 43 U.S.C. 1331).
    (b) Expenditures paid or incurred after December 31, 1969. In the 
case of exploration expenditures paid or incurred after December 31, 
1969, with respect to any deposit of ore or other mineral for which a 
deduction for percentage depletion is allowable under section 613 (other 
than oil or gas), a taxpayer may deduct:
    (1) The amount of such expenditures paid or incurred during the 
taxable year with respect to any such deposit in the United States (as 
defined in section 638 and the regulations thereunder), and
    (2) With respect to any such deposit located outside the United 
States (as defined in section 638 and the regulations thereunder) the 
lesser of:
    (i) The amount of the exploration expenditures paid or incurred with 
respect to such deposits during the taxable year, or
    (ii) $400,000 minus the sum of the amount to be deducted under 
subparagraph (1) of this paragraph for the taxable year and all amounts 
deducted or treated as deferred expenses during all preceding taxable 
years under section 617 and section 615 of the Internal Revenue Code of 
1954 and section 23(ff) of the Internal Revenue Code of 1939. See 
paragraph (d) of this section for application of the limitation in the 
case of a transferee of a mining property.
    (c) Examples. The application of the provisions of paragraphs (a) 
and (b) of this section may be illustrated by the following examples:

    Example 1. A, a calendar-year taxpayer who has claimed the benefits 
of section 615, expended $100,000 for exploration expenditures during 
the year 1966. For each of the years 1967, 1968, 1969, and 1970 A had 
exploration costs of $80,000 all with respect to coal deposits located 
within the United States. A deducted or deferred the maximum amounts 
allowable for each of the years 1966 ($100,000), 1967 ($80,000), 1968 
($80,000), and 1969 ($80,000). The $80,000 of exploration expenditures 
for 1970 may be deducted under section 617 by A.
    Example 2. B, a calendar-year taxpayer claimed deductions of 
$100,000 per year under section 615 for the years 1968 and 1969. In 
1970, B deducted $150,000 under section 617 for exploration conducted 
with respect to coal

[[Page 554]]

deposits in the United States. In 1971, B paid $150,000 with respect to 
exploration of tin deposits outside the United States. The maximum 
amount B may deduct with respect to the foreign exploration in 1971 is 
$50,000 computed as follows:
    (a) Add all amounts deducted or deferred for exploration 
expenditures by B for all years:

------------------------------------------------------------------------
                                                                Deducted
                      Year                       Expenditures      or
                                                                deferred
------------------------------------------------------------------------
1968...........................................     $100,000    $100,000
1969...........................................      100,000     100,000
1970...........................................      150,000     150,000
                                                ------------------------
    Total......................................  ............    350,000
------------------------------------------------------------------------

    (b) Subtract from $400,000 (the maximum amount allowable to B for 
deduction of foreign exploration expenditures) the sum of the amounts 
obtained in (a) $350,000:

Maximum amount allowable to taxpayer........................    $400,000
Sum of amounts obtained in (a)..............................     350,000
                                                             -----------
                                                                  50,000
 

    Example 3. Assume the same facts as in example 2 except that in 1971 
in addition to the $150,000 paid with respect to exploration outside the 
United States, B paid $100,000 with respect to exploration within the 
United States. As the following computation indicates, B may not deduct 
any amount with respect to the foreign exploration:
    (a) Add all amounts deducted or deferred for exploration 
expenditures in prior years and the exploration expenditures with 
respect to exploration in the United States to be deducted in 1971:

------------------------------------------------------------------------
                                                                Deducted
                      Year                       Expenditures      or
                                                                deferred
------------------------------------------------------------------------
1968...........................................     $100,000    $100,000
1969...........................................      100,000     100,000
1970...........................................      150,000     150,000
1971...........................................      250,000         \1\
                                                                 100,000
                                                ------------------------
    Total......................................  ............    450,000
------------------------------------------------------------------------
\1\ Domestic.

    (b) Because the sum of the amounts obtained in (a), $450,000, 
exceeds $400,000 no deduction would be allowable to B with respect to 
foreign exploration expenditures for 1971.

    (d) Transferee of mineral property. (1) Where an individual or 
corporation transfers any mining property to the taxpayer, the taxpayer 
shall take into account for purposes of the $400,000 limitation 
described in paragraph (b)(ii) of this section all amounts deducted and 
amounts treated as deferred expenses by the transferor if:
    (i) The taxpayer acquired any mineral property from the transferor 
in a transaction described in section 23(ff)(3) of the Internal Revenue 
Code of 1939, excluding the reference therein to section 113(a)(13),
    (ii) The taxpayer acquired any mineral property by reason of the 
acquisition of assets of a corporation in a transaction described in 
section 381(a) as a result of which the taxpayer succeeds to and takes 
into account the items described in section 381(c),
    (iii) The taxpayer acquired any mineral property under circumstances 
which make applicable any of the following sections of the Internal 
Revenue Code:
    (a) Section 334(b)(1), relating to the liquidation of a subsidiary 
where the basis of the property in the hands of the distributee is the 
same as it would be in the hands of the transferor.
    (b) Section 362 (a) and (b), relating to property acquired by a 
corporation as paid-in surplus or as a contribution to capital, or in 
connection with a transaction to which section 351 applies.
    (c) Section 372(a), relating to reorganization in certain 
receiverships and bankruptcy proceedings.
    (d) Section 373(b)(1), relating to property of a railroad 
corporation acquired in certain bankruptcy or receivership proceedings.
    (e) Section 1051, relating to property acquired by a corporation 
that is a member of an affiliated group.
    (f) Section 1082, relating to property acquired pursuant to a 
Securities Exchange Commission order.
    (2) For purposes of applying the limitations imposed by section 
617(h):
    (i) The partner, and not the partnership, shall be considered as the 
taxpayer (see paragraph (a)(8)(iii) of Sec.  1.702-1), and
    (ii) An electing small business corporation, as defined in section 
1371(b), and not its shareholders, shall be considered as the taxpayer.
    (3) For purposes of subparagraph (1)(iii) (b) of this paragraph, 
relating to a transaction to which section 362 (a) and (b) applies or to 
which section 351 applies:
    (i) If mineral property is acquired from a partnership, the transfer 
shall be considered as having been made by

[[Page 555]]

the individual partners, so that the amounts which each partner has 
deducted or deferred under sections 615 and 617 of the Internal Revenue 
Code of 1954 and section 23(ff) of the Internal Revenue Code of 1939 
shall be taken into account, or
    (ii) If an interest in a partnership having mineral property is 
transferred, the transfer shall be considered as a transfer of mineral 
property by the partner or partners relinquishing an interest, so that 
the amounts which each such partner has deducted or deferred under 
sections 615 and 617 of the Internal Revenue Code of 1954 and section 
23(ff) of the Internal Revenue Code of 1939 shall be taken into account.
    (e) Examples. The application of the provisions of this section may 
be illustrated by the following example:

    Example 1. A calendar year taxpayer (who has never claimed the 
benefits of section 617) received in 1970 a mineral deposit from X 
Corporation upon a distribution in complete liquidation of the latter 
under conditions which make the provisions of section 334(b)(1) 
applicable in determining the basis of the property in the hands of the 
taxpayer. During the year 1969, X Corporation expended $60,000 for 
exploration expenditures which it elected to treat under section 615(b) 
as deferred expenses. Subsequent to the transfer the taxpayer made 
similar expenditures for domestic exploration of $250,000 and $140,000, 
for the years 1970, and 1971, respectively, which the taxpayer elected 
to deduct. In 1972, the taxpayer made expenditures for domestic 
exploration of $100,000 and for foreign exploration of $50,000. The 
taxpayer may deduct the $100,000 domestic exploration expenditures but 
may not deduct any portion of the $50,000 of foreign exploration 
expenditures because the $400,000 limitation of section 617(h) applies.
    Example 2. In 1971, A and B transfer assets to a corporation in a 
transfer to which section 351 applied. Among the assets transferred by A 
is a mineral lease with respect to certain coal lands. A has deducted 
exploration expenditures under section 615 for the years 1968 and 1969 
in the amounts of $50,000 and $100,000, respectively, made with respect 
to other deposits not included in the transfer to the corporation. The 
corporation is required to take into account the deductions previously 
made by A for purpose of applying the $400,000 limitation on deduction 
of foreign exploration expenditures. Thus, if in 1970 the corporation 
incurred $400,000 of foreign exploration expenditures, the maximum which 
it could deduct under section 617(a) is $250,000.

[T.D. 7192, 37 FR 12944, June 30, 1972]



Sec.  1.617-3  Recapture of exploration expenditures.

    (a) In general. (1)(i) Except as provided in subparagraphs (2) and 
(3) of this paragraph, if in any taxable year any mine (as defined in 
paragraph (c) of this section) with respect to which deductions have 
been allowed under section 617(a) reaches the producing stage (as 
defined in paragraph (c) of this section) the deduction for depletion 
under section 611 (whether determined under Sec.  1.611-2 or under 
section 613) with respect to the property shall be disallowed for the 
taxable year and each subsequent taxable year until the aggregate amount 
of depletion which would be allowable but for section 617(b)(1)(B) and 
this subparagraph equals the amount of the adjusted exploration 
expenditures (determined under section 617(f)(1) and paragraph (d) of 
this section) attributable to the mine. The preceding sentence shall 
apply notwithstanding the fact that such mine is not in the producing 
stage at the close of such taxable year. In the case of a taxpayer who 
owns more than one property in a mine with respect to which he has been 
allowed deductions under section 617(a), the depletion deduction 
described in the second preceding sentence shall be disallowed with 
respect to all of the properties until the aggregate amount of depletion 
disallowed under section 617(b)(1)(B) is equal to the adjusted 
exploration expenditures with respect to the mine. In the case of a 
taxpayer who elects under section 614(c)(1) to aggregate a mine, with 
respect to which he has been allowed deductions under section 617(a), 
with another mine, no deduction for depletion will be allowable under 
section 611 with respect to the aggregated property until the amount of 
depletion disallowed under section 617(b)(1)(B) equals the adjusted 
exploration expenditures attributable to all of the producing mines 
included in the aggregated property.
    (ii) If a taxpayer who has made an election under section 617(a) 
receives or accrues a bonus or royalty with respect to a mining property 
with respect

[[Page 556]]

to which deductions have been allowed under section 617(a), the 
deduction for depletion under section 611 with respect to such bonus or 
royalty (whether determined under Sec.  1.611-2 or under section 613) 
shall be disallowed for the taxable year of receipt or accrual and each 
subsequent taxable year until the aggregate amount of the depletion 
disallowed under section 617(c) and this section equals the amount of 
the adjusted exploration expenditures with respect to the property to 
which the bonus or royalty relates. The preceding sentence shall not 
apply if the bonus or royalty is paid with respect to a mineral for 
which a deduction is not allowable under section 617(a). In the case of 
the disposal of coal or domestic iron ore with a retained economic 
interest, see paragraph (a)(2) of Sec.  1.617-4.
    (2) If the taxpayer so elects with respect to all mines as to which 
deductions have been allowed under section 617(a) and which reach the 
producing stage during the taxable year, he shall include in gross 
income (but not gross income from the property for purposes of section 
613) for such taxable year an amount equal to the adjusted exploration 
expenditures (determined under section 617(f)(1) and paragraph (d) of 
this section) with respect to all of such mines. The amount so included 
in income shall be treated for purposes of subtitle A of the Internal 
Revenue Code as expenditures which are paid or incurred on the 
respective dates on which the mines reach the producing stage and which 
are properly chargeable to capital account. The fact that a taxpayer 
does not make the election described in this subparagraph for a taxable 
year during which mines with respect to which deductions have been 
allowed under section 617(a) reach the producing stage shall not 
preclude the taxpayer from making the election with respect to other 
mines which reach the producing stage during subsequent taxable years. 
However, the election described in this subparagraph may not be made for 
any taxable year with respect to any mines which reached the producing 
stage during a preceding taxable year.
    (3) The provisions of section 617(b)(1) and subparagraphs (1) and 
(2) of this paragraph do not apply in the case of any deposit of oil or 
gas. For example, A in exploring for sulphur incurred $500,000 of 
exploration expenditures which he deducted under section 617(a). In the 
following year, A did not find sulphur but on the same mineral property 
located commercially marketable quantities of oil and gas. In computing 
the depletion allowance with respect to the oil and gas, no depletion 
would be disallowed because of section 617(b)(1).
    (4) In the case of exploration expenditures which are paid or 
incurred with respect to a mining property which contains more than one 
mine, the provisions of subparagraphs (1) and (2) of this paragraph 
shall apply only to the amount of the adjusted exploration expenditures 
properly chargeable to the mine or mines which reach the producing stage 
during the taxable year. For example, A owns a mining property which 
contains mines X, Y, and Z. For 1970, A deducted under section 617(a), 
$250,000 with respect to X, $100,000 with respect to Y and $70,000 with 
respect to Z. In 1971, mine X reaches the producing stage. At that time, 
A will only have to recapture the $250,000 attributable to mine X.
    (b) Manner and time for making election. (1) A taxpayer will be 
deemed not to have elected pursuant to section 617(b)(1)(A) and 
paragraph (a)(2) of this section unless he clearly indicates such 
election on his income tax return for the taxable year in which the mine 
with respect to which deductions were allowed under section 617(a) 
reaches the producing stage.
    (2) The election described in paragraph (a)(2) of this section may 
be made (or changed) not later than the time prescribed by law for 
filing the return (including extensions thereof) for the taxable year in 
which the mine with respect to which deductions were allowed under 
section 617(a) reaches the producing stage.
    (c) Definitions--(1) Mine. The term mine includes all quarries, 
pits, shafts, and wells, and any other excavations or workings for the 
purpose of extracting any known deposit of ore or other mineral.
    (2) Producing stage. A mine will be considered to have reached the 
producing stage when (i) the major portion of the mineral production is 
obtained

[[Page 557]]

from workings other than those opened for the purpose of development, or 
(ii) the principal activity of the mine is the production of developed 
ores or minerals rather than the development of additional ores or 
minerals for mining.
    (3) Mining property. The term mining property means any property (as 
the term is defined in section 614(a) after the application of 
subsections (c) and (e) thereof) with respect to which any expenditures 
allowed as deductions under section 617(a) are properly chargeable.
    (d) Adjusted exploration expenditures--(1) In general. The term 
adjusted exploration expenditures means, with respect to any property or 
mine:
    (i) The aggregate amount of the expenditures allowed as deductions 
under section 617(a) for the taxable year and all preceding taxable 
years to the taxpayer or any other person which are properly chargeable 
to such property or mine and which (but for the election under section 
617(a)) would be reflected in the adjusted basis of such property or 
mine, reduced by
    (ii) The excess, if any, of the amount which would have been 
allowable for all taxable years under section 613 but for the deduction 
of such expenditures over the amount allowable for depletion under 
section 611 (determined without regard to section 617(b)(1)(B)). The 
amount determined under the preceding sentence shall be reduced by the 
aggregate of the amounts included in gross income for the taxable year 
and all preceding taxable years under section 617(b) or (c) and the 
amount treated under section 617(d) as gain from the sale or exchange of 
the property which is neither a capital asset nor property described in 
section 1231.
    (iii) If a taxpayer pays or incurs exploration expenditures on a 
property which contains a producing mine and if such taxpayer deducts 
any portion of such expenditures under section 617(a), an amount equal 
to the amount so deducted shall be taken into account in computing the 
taxpayer's taxable income from the property for the purposes of the 
limitation on the percentage depletion deduction under section 613(a) 
and the regulations thereunder. The amount of the adjusted exploration 
expenditures with respect to the producing mine shall be reduced by an 
amount equal to the amount by which the taxpayer's deduction under 
617(a) (described in the preceding sentence) reduces the taxpayer's 
deduction for depletion for the taxable year. See example 1 in 
subparagraph (6) of this paragraph.
    (iv) For purposes of Sec.  1.617-4, the aggregate amount of adjusted 
exploration expenditures with respect to a mining property includes the 
aggregate amount of adjusted exploration expenditures properly allocable 
to all mines on such property.
    (v) (a) For purposes of paragraph (a)(1) of this section, the 
aggregate amount of the adjusted exploration expenditures is determined 
as of the close of the taxpayer's taxable year.
    (b) For purposes of Sec.  1.617-4, the aggregate amount of the 
adjusted exploration expenditures is determined as of the date of the 
disposition of the mining property or portion thereof.
    (2) Adjustments for certain expenditures of other taxpayers or in 
respect of other property. (i) For purposes of subparagraph (1) of this 
paragraph, the exploration expenditures which must be taken into account 
in determining the adjusted exploration expenditures with respect to any 
property or mine are not limited to those expenditures with respect to 
the property disposed of or which entered the production stage nor are 
such expenditures limited to those deducted by the taxpayer. For the 
manner of determining the amount of adjusted exploration expenditures 
immediately after certain dispositions, see subparagraph (4) of this 
paragraph.
    (ii) If a transferee who at the time of the transfer has not made an 
election under section 617(a) (including a transferee who has made an 
election under section 615(e)) receives mineral property in a 
transaction in which the basis of such property in his hands is 
determined in whole or in part by reference to its basis in the hands of 
the transferor and with respect to such property the transferor has 
deducted exploration expenditures under section 617(a), the adjusted 
exploration expenditures immediately after such transfer shall be

[[Page 558]]

treated as exploration expenditures allowed as deductions under section 
617(a) to the transferee.
    (iii) If a transferee who makes an election under section 617(a) 
receives mineral property in a transaction in which the basis of such 
property in his hands is determined in whole or in part by reference to 
the basis of such property in the hands of the transferor and the 
transferor had in effect at the time of the transfer an election under 
section 615(e), an amount equal to the total of the amounts allowed as 
deductions to the transferor under section 615 with respect to the 
transferred property shall be treated as expenditures allowed as 
deductions under section 617(a) to the transferee. The preceding 
sentence shall not apply to expenditures which could not have been 
reflected in the basis of the property in the hands of the transferee 
had the transferor not made the section 615(e) election.
    (iv) The provisions of this subparagraph may be illustrated by the 
following examples:

    Example 1. On July 14, 1969, A purchased mineral property Z for 
$10,000. After deducting exploration expenditures of $20,000 under 
section 617(a), A transferred the property to his son as a gift on July 
9, 1970. Since the exception for gifts in section 617(d)(3) (by 
incorporation by reference of the provisions of section 1245(b)(1)) 
applies, A does not recognize gain under section 617(d). On September 
30, 1972 after deducting exploration expenditures of $150,000 under 
section 617(a), the son transfers the mineral property to corporation X 
in a transaction under which no gain is recognized by the son under 
section 351. Since the exception of section 617(d)(3) (by incorporation 
by reference of the provisions of section 1245(b)(3)) applies, the son 
does not recognize gain under section 617(d). On November 14, 1972, 
corporation X sells the mineral property. No deductions for exploration 
expenditures were taken by corporation X. The amount of the adjusted 
exploration expenditures with respect to mineral property Z to be 
recaptured by corporation X upon such sale is $170,000 (the total amount 
deducted by A and the son).
    Example 2. Assume the same facts as in example 1 except that A 
deducted the $20,000 of exploration expenditures under section 615(a). 
The amount of the adjusted exploration expenditures with respect to 
mineral property Z in corporation X's hands is $170,000 (the $20,000 
deducted under section 615(a) by A plus the $150,000 deducted under 
section 617(a) by the son).

    (3) Allocation of certain expenditures. A project area consists of 
that territory which the taxpayer has determined by analysis of certain 
variables (the size and topography of the area to be explored, existing 
information with respect to that area and nearby areas, and the quantity 
of equipment, men, and money available) can be explored advantageously 
as a single integrated operation. If exploration expenditures are paid 
or incurred with respect to a project area and one or more areas of 
interest are identified within such project area, the entire amount of 
such expenditures shall be allocated equally to each such area of 
interest. If an area of interest contains one or more mines or deposits 
the expenditures allocable to such area of interest shall be allocated 
(i) if only one mine or deposit is located or identified, entirely to 
such mine or deposit, or (ii) if more than one mine or deposit is 
located or identified, equally among the various mines or deposits 
located. For purposes of this subparagraph, the term area of interest 
means each separable, noncontiguous portion of the project area which is 
identified as possessing sufficient mineral-producing potential to merit 
further exploration. The provisions of this subparagraph may be 
illustrated by the following example: A pays $100,000 for the 
exploration of a project area which results in the identification of two 
areas of interest. A pays an additional $60,000 for the exploration of 
one of the areas of interest in which he locates mineral deposit X and 
mineral deposit Y. With respect to the exploration of deposit X he 
incurs an additional $100,000 of expenses and with respect to deposit Y 
he incurs an additional $200,000 of expenses. The exploration 
expenditures properly attributable to deposit X would be $155,000 
($100,000 plus one-half of $50,000 plus one-half of $60,000) and the 
exploration expenditures properly attributable to deposit Y would be 
$255,000 ($200,000 plus one-half of $50,000 plus one-half of $60,000).
    (4) Partnership distributions. The adjusted exploration expenditures 
with respect to any property or mine received by a taxpayer in a 
distribution with respect to all or part of his interest in a 
partnership (i) include the adjusted exploration expenditures (not

[[Page 559]]

otherwise included under section 617(f)(1)) with respect to such 
property or mine immediately prior to such distribution and (ii) shall 
be reduced by the amount of gain to which section 751(b) applies 
realized by the partnership (as constituted after the distribution) on 
the distribution of such property or mine. In the case of any property 
or mine held by a partnership after a distribution to a partner to which 
section 751(b) applies, the adjusted exploration expenditures with 
respect to such property or mine shall be reduced by the amount of gain 
(if any) to which section 751(b) applies realized by such partner with 
respect to such distribution on account of such property or mine.
    (5) Amount of transferee's adjusted exploration expenditures 
immediately after certain acquisitions--(i) Transactions in which basis 
is determined by reference to the cost or fair market value of the 
property transferred. (a) If on the date a person acquires mining 
property his basis for the property is determined solely by reference to 
its cost (within the meaning of section 1012), then on such date the 
amount of the adjusted exploration expenditures for the mining property 
in such person's hands is zero.
    (b) If on the date a person acquires mining property his basis for 
the property is determined solely by reason of the application of 
section 301(d) (relating to basis of property received in corporate 
distribution) or section 334(a) (relating to basis of property received 
in a liquidation in which gain or loss is recognized), then on such date 
the amount of the adjusted exploration expenditures for the mining 
property in such person's hands is zero.
    (c) If on the date a person acquires mining property his basis for 
the property is determined solely under the provisions of section 
334(b)(2) or (c) (relating to basis of property received in certain 
corporate liquidations), then on such date the amount of the adjusted 
exploration expenditures for the mining property in such person's hands 
is zero.
    (d) If on the date a person acquires mining property from a decedent 
such person's basis is determined, by reason of the application of 
section 1014(a), solely by reference to the fair market value of the 
property on the date of the decedent's death or on the applicable date 
provided in section 2032 (relating to alternate valuation date), then on 
the date of acquisition the amount of the adjusted exploration 
expenditures for the mining property in such person's hands is zero.
    (ii) Gifts and certain tax-free transactions. (a) If mining property 
is disposed of in a transaction described in (b) of this subdivision 
(ii), then the amount of the adjusted exploration expenditures for the 
mining property in the hands of a transferee immediately after the 
disposition shall be an amount equal to:
    (1) The amount of the adjusted exploration expenditures with respect 
to the mining property in the hands of the transferor immediately before 
the disposition, minus
    (2) The amount of any gain taken into account under section 617(d) 
by the transferor upon the disposition.
    (b) The transactions referred to in paragraph (d)(5)(ii)(a) of this 
section are:
    (1) A disposition that is in part a sale or exchange and in part a 
gift;
    (2) A disposition that is described in section 617(d) through the 
incorporation by reference of the provisions of section 1245(b)(3) 
(relating to certain tax free transactions); or
    (3) A transfer at death where basis of property in the hands of the 
transferee is determined under section 1022.
    (iii) Property acquired from a decedent. If mining property is 
acquired in a transfer at death to which section 617(d) applies through 
incorporation by reference of the provisions of section 1245(b)(2), the 
amount of the adjusted exploration expenditures with respect to the 
mining property in the hands of the transferee immediately after the 
transfer shall include the amount, if any, of the exploration 
expenditures deducted by the transferee before the decedent's death, to 
the extent that the basis of the mining property (determined under 
section 1014(a)) is required to be reduced under the second sentence of 
section 1014(b)(9) (relating to adjustments to basis where the property 
is acquired from a decedent prior to his death).

[[Page 560]]

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

    Example 1. A owns the working interest in a large tract of land 
located in the United States. A's interest in the entire tract of land 
constitutes one property for purposes of section 614. In the northwest 
corner of this tract is an operating mine, X, producing an ore of 
beryllium, which is entitled to a percentage depletion rate of 22 
percent under section 613(b)(2)(B). During 1971, A conducts an 
exploration program in the southeast corner of this same tract of land, 
and he incurs $400,000 of expenditures to which section 617(a)(1) 
applies in connection with this exploration program. A elects to deduct 
this amount as expenses under section 617(a). During 1971, A's gross 
income from the property computed under section 613 was $1 million, with 
respect to the property encompassing mine X and the area in which 
exploration was conducted. A's taxable income from the property computed 
under section 613, before adjustment to reflect the deductions taken 
with respect to the property during the year under section 617, was 
$400,000. The cost depletion deduction allowable and deducted with 
respect to the property during 1971 was $50,000. The amount of adjusted 
exploration expenditures chargeable to the exploratory mine (hereinafter 
referred to as mine Y) at the close of 1971 is $250,000, computed as 
follows:

Expenditures allowed as deductions under sec.     ...........   $400,000
 617(a).........................................
    Gross income from the property..............   $1,000,000
    22 percent thereof..........................      220,000
    Taxable income from the property, before          400,000
     adjustment to reflect deductions allowed
     under sec. 617 during year.................
    50 percent thereof--tentative deduction.....      200,000
    Taxable income from the property after                  0
     adjustment to reflect deductions allowed
     under sec. 617 during year ($400,000 minus
     $400,000)..................................
    Cost depletion allowed for year.............       50,000
Amount by which allowance for depletion under     ...........    150,000
 sec. 611 was reduced on account of deductions
 under sec. 617 ($200,000 minus $50,000)........
                                                              ----------
Adjusted exploration expenditures at end of 1971  ...........    250,000
 

    Example 2. Assume the same facts as in example 1. Assume further 
that mine Y, with respect to which exploration expenditures were 
deducted in 1971, enters the producing stage in 1972, and that no 
deductions were taken under section 617 with respect to that mine after 
1971. A does not make an election under section 617(b)(1)(A) during 
1972. Assume that the depletion deduction which would be allowable for 
1972 with respect to the property (which includes both mines) but for 
the application of section 617(b)(1)(B) is $100,000. Pursuant to section 
617(b)(1)(B), this depletion deduction is disallowed. Therefore, the 
amount of adjusted exploration expenditures with respect to mine Y at 
the end of 1972 is $150,000 ($250,000 less $100,000).

[T.D. 7192, 37 FR 12945, June 30, 1972, as amended by T.D. 9811, 82 FR 
6238, Jan. 19, 2017]



Sec.  1.617-4  Treatment of gain from disposition of certain mining property.

    (a) In general. (1) In general, section 617(d)(1) provides, that, 
upon a disposition of mining property, the lower of (i) the adjusted 
exploration expenditures (as defined in section 617(f)(1) and paragraph 
(d) of Sec.  1.617-3) with respect to the property, or (ii) the amount, 
if any, by which the amount realized on the sale, exchange, or 
involuntary conversion (or the fair market value of the property on any 
other disposition, exceeds the adjusted basis of the property, shall be 
treated as gain from the sale of exchange of property which is neither a 
capital asset nor property described in section 1231 (that is, shall be 
recognized as ordinary income). However, any amount recognized under the 
preceding sentence shall not be included by the taxpayer in his gross 
income from the property for purposes of section 613. Generally, the 
ordinary income treatment applies even though in the absence of section 
617(d) no gain would be recognized under any other provision of the 
Code. For example, if a corporation distributes mining property as a 
dividend, gain may be recognized as ordinary income to the corporation 
even though, in the absence of section 617, section 311(a) would 
preclude any recognition of gain to the corporation. For an exception to 
the recognition of gain with respect to dispositions which involve 
mineral production payments, see section 636 and the regulations 
thereunder. For the definition of the term mining property, see section 
617(f)(2) and paragraph (c)(3), of Sec.  1.617-3. For exceptions and 
limitations to the application of section 617(d)(1), see section 
617(d)(3) and paragraph (c) of this section.

[[Page 561]]

    (2) In the case of a sale, exchange, or involuntary conversion of 
mining property, the gain to which section 617(d)(1) applies is the 
lower of the adjusted exploration expenditures with respect to such 
property or the excess of the amount realized upon the disposition of 
the property over the adjusted basis of the property. In the case of a 
disposition of mining property other than by a manner described in the 
preceding sentence, the gain to which section 617(d)(1) applies is the 
lower of the adjusted exploration expenditures with respect to such 
property or the excess of the fair market value of the property on the 
date of disposition over the adjusted basis of the property. In the case 
of a disposal of coal or domestic iron ore subject to a retained 
economic interest to which section 631(c) applies, the excess of the 
amount realized over the adjusted basis of the mining property shall be 
treated as equal to the gain, if any, referred to in section 631(c). For 
determination of the amount realized upon a disposition of mining 
property and nonmining property, see paragraph (c)(3)(i) of this 
section.
    (3) The provisions of this paragraph may be illustrated by the 
following examples:

    Example 1. On July 14, 1970, A purchased undeveloped mining property 
for $100,000. During 1970, A incurred with respect to the property, 
$50,000 of exploration expenditures which he deducts under section 
617(a). In 1971, A incurred $150,000 of exploration expenditures with 
respect to the property which he deducts on his income tax return. On 
January 2, 1972, A sells the mining property to B for $250,000. A's gain 
on the sale is $150,000 ($250,000 amount realized minus $100,000 basis). 
Since the excess of the amount realized over the adjusted basis of the 
mining property is less than the adjusted exploration expenditures with 
respect to the property ($200,000), the entire gain is treated as 
ordinary income under section 617(d)(1).
    Example 2. Assume the same facts as in example 1 except that A sells 
the mining property to B for $400,000, thereby realizing gain of 
$300,000 ($400,000 minus $100,000 basis). Since the amount of adjusted 
exploration expenditures with respect to the mining property ($200,000) 
is less than the amount realized upon its disposition ($300,000), an 
amount equal to the amount of adjusted exploration expenditures is 
treated as ordinary income under section 617(d)(1). The remaining 
$100,000 is treated by A without regard to section 617(d)(1).

    (4) Section 617(d) does not apply to losses. Thus, section 617(d) 
does not apply if a loss is realized upon a sale, exchange, or 
involuntary conversion of mining property, nor does section 617(d) apply 
to a disposition of mining property other than by way of sale, exchange, 
or involuntary conversion if at the time of the disposition the fair 
market value of such property is not greater than its adjusted basis.
    (b) Disposition of portion of mining property. (1) For purposes of 
section 617(d)(1) and paragraph (a) of this section, except as provided 
in subparagraph (3) of this paragraph, in the case of the disposition of 
a portion of a mining property (other than an undivided interest), the 
entire amount of the adjusted exploration expenditures with respect to 
such property shall be treated as attributable to such portion to the 
extent of the amount of the gain to which section 617(d)(1) applies. If 
the amount of the gain to which section 617(d)(1) applies is less than 
the amount of the adjusted exploration expenditures with respect to the 
property, the balance of the adjusted exploration expenditures shall 
remain subject to recapture in the hands of the taxpayer under the 
provisions of section 617 (b), (c), and (d). The disposition of a 
portion of a mining property (other than an undivided interest) includes 
the disposition of a geographical portion of a mining property. For 
example, assume that A owns an 80-acre tract of land with respect to 
which he has deducted exploration expenditures under section 617(a). If 
A were to sell the north 40 acres, the entire amount of the adjusted 
exploration expenditures with respect to the 80-acre tract would be 
treated as attributable to the 40-acre portion sold (to the extent of 
the amount of the gain to which section 617(d)(1) applies).
    (2) For purposes of section 617(d)(1), except as provided in 
subparagraph (3) of this paragraph, in the case of the disposition of an 
undivided interest in a mining property (or portion thereof) a 
proportionate part of the adjusted exploration expenditures with respect 
to such property shall be treated as attributable to such undivided 
interest to

[[Page 562]]

the extent of the amount of the gain to which section 617(d)(1) applies. 
For example, assume that A owns an 80-acre tract of land with respect to 
which he has deducted exploration expenditures under section 617(a). If 
A were to sell an undivided 40 percent interest in such tract, 40 
percent of the adjusted exploration expenditures with respect to the 80-
acre tract would be treated as attributable to the 40 percent of the 80-
acre tract disposed of (to the extent of the amount of the gain to which 
section 617(d)(1) applies).
    (3) Section 617(d)(2) and subparagraphs (1) and (2) of this 
paragraph shall not apply to any expenditure to the extent that such 
expenditure relates neither to the portion (or interest therein) 
disposed of nor to any mine, in the property held by the taxpayer before 
the disposition, which has reached the producing stage. In any case 
where a taxpayer disposes of a mining property (or interest therein) and 
treats adjusted exploration expenditures with respect to the mining 
property as if they relate neither to the portion (or interest therein) 
disposed of nor to any mine, in the property held by the taxpayer before 
the disposition, which has reached the producing stage, the taxpayer 
shall attach to its return for the taxable year in which the disposition 
occurred, a statement which includes:
    (i) A description of the portion (or interest therein) disposed of;
    (ii) A description of the mineral property which included the 
portion (or interest therein) disposed of;
    (iii) An itemization of all expenditures deducted under sections 617 
and 615 with respect to such mineral property; and
    (iv) A description of the location of all producing mines on such 
mineral property.
    (c) Exceptions. (1)(i) Section 617(d)(3) provides, through 
incorporation by reference of the provisions of section 1245(b)(1), that 
no gain shall be recognized under section 617(d) upon a disposition by 
gift of mining property. For purposes of this paragraph (c), the term 
gift means, except to the extent that paragraph (c)(1)(ii) of this 
section applies, a transfer of mining property that, in the hands of the 
transferee, has a basis determined under the provisions of section 
1015(a) or 1015(d) (relating to basis of property acquired by gift) or 
section 1022 (relating to the basis of property acquired from certain 
decedents who died in 2010). For reduction in amount of the charitable 
contribution in case of a gift of section 617 property, see section 
170(e) and paragraph (c)(3) of Sec.  1.170-1.
    (ii) Where a disposition of mining property is in part a sale or 
exchange and in part a gift, the gain to which section 617(d) applies is 
the lower of the adjusted exploration expenditures with respect to such 
property or the excess of the amount realized upon the disposition of 
the property over the adjusted basis of such property.
    (2) Section 617(d)(3) provides, through incorporation by reference 
of the provisions of section 1245(b)(2), that, except as provided in 
section 691 (relating to income in respect to a decedent), no gain shall 
be recognized under section 617(d) upon a transfer at death. For 
purposes of this paragraph, the term transfer at death means a transfer 
of mining property which property, in the hands of the transferee, has a 
basis determined under the provisions of section 1014(a) (relating to 
basis of property acquired from a decedent) because of the death of the 
transferor.
    (3)(i) Section 617(d) provides, through incorporation by reference 
of the provisions of section 1245(b)(3), that upon a transfer of 
property described in subdivision (ii) of this subparagraph, the amount 
of gain taken into account by the transferor under section 617(d) shall 
not exceed the amount of gain recognized to the transferor on the 
transfer (determined without regard to section 617). For purposes of 
this subdivision, in case of a transfer of mining property and nonmining 
property in one transaction, the amount realized from the disposition of 
the mining property shall be deemed to be equal to the amount which 
bears the same ratio to the total amount realized as the fair market 
value of the mining property bears to the aggregate fair market value of 
all of the property transferred. The preceding sentence shall be applied 
solely for purposes of computing the portion of the total gain 
(determined without regard to section 617) which shall be recognized as 
ordinary income

[[Page 563]]

under section 617(d). Section 617(d)(3) does not apply to a disposition 
of mining property to an organization (other than a cooperative 
described in section 521) which is exempt from the tax imposed by 
chapter 1 of the Code.
    (ii) The transfers referred to in subdivision (i) of this 
subparagraph are transfers of mining property in which the basis of the 
mining property in the hands of the transferee is determined by 
reference to its basis in the hands of the transferor by reason of the 
application of any of the following provisions:
    (a) Section 332 (relating to distributions in complete liquidation 
of an 80-percent-or-more controlled subsidiary corporation). See 
subdivision (iii) of this subparagraph.
    (b) Section 351 (relating to transfer to a corporation controlled by 
transferor).
    (c) Section 361 (relating to exchanges pursuant to certain corporate 
reorganizations).
    (d) Section 371(a) (relating to exchanges pursuant to certain 
receivership and bankruptcy proceedings).
    (e) Section 374(a) (relating to exchanges pursuant to certain 
railroad reorganizations).
    (f) Section 721 (relating to transfers to a partnership in exchange 
for a partnership interest).
    (g) Section 731 (relating to distributions by a partnership to a 
partner).
    (iii) In the case of a distribution in complete liquidation of an 
80-percent-or-more controlled subsidiary to which section 332 applies, 
the limitation provided in section 617(d)(3), through incorporation by 
reference of the provisions of section 1245(b)(3), is confined to 
instances in which the basis of the mining property in the hands of the 
transferee is determined under section 334(b)(1), by reference to its 
basis in the hands of the transferor. Thus, for example, the limitation 
may apply in respect of a liquidating distribution of mining property by 
an 80-percent-or-more controlled corporation to the parent corporation, 
but does not apply in respect of a liquidating distribution of mining 
property to a minority shareholder. Section 617(d)(3) does not apply to 
a liquidating distribution of property by an 80-percent-or-more 
controlled subsidiary to its parent if the parent's basis for the 
property is determined, under section 334(b)(2), by reference to its 
basis in the stock of the subsidiary.

[T.D. 7192, 37 FR 12947, June 30, 1972, as amended by T.D. 9811, 82 FR 
6239, Jan. 19, 2017]



Sec.  1.617-5  Effective/applicability date.

    Sections 1.617-3 and 1.617-4 apply on and after January 19, 2017. 
For rules before January 19, 2017, see Sec. Sec.  1.617-3 and 1.617-4 as 
contained in 26 CFR part 1 revised as of April 1, 2016.

[T.D. 9811, 82 FR 6239, Jan. 19, 2017]

                           Sales and Exchanges



Sec.  1.631-1  Election to consider cutting as sale or exchange.

    (a) Effect of election. (1) Section 631 (a) provides an election to 
certain taxpayers to treat the difference between the actual cost or 
other basis of certain timber cut during the taxable year and its fair 
market value as standing timber on the first day of such year as gain or 
loss from a sale or exchange under section 1231. Thereafter, any 
subsequent gain or loss shall be determined in accordance with paragraph 
(e) of this section.
    (2) For the purposes of section 631(a) and this section, timber 
shall be considered cut at the time when in the ordinary course of 
business the quantity of timber felled is first definitely determined.
    (3) The election may be made with respect to any taxable year even 
though such election was not made with respect to a previous taxable 
year. If an election has been made under the provisions of section 
631(a), or corresponding provisions of prior internal revenue laws, such 
election shall be binding upon the taxpayer not only for the taxable 
year for which the election is made but also for all subsequent taxable 
years, unless the Commissioner on showing by the taxpayer of undue 
hardship permits the taxpayer to revoke his election for such subsequent 
taxable years. If the taxpayer has revoked a previous election, such 
revocation shall preclude any further elections unless the taxpayer 
obtains the consent of the Commissioner.
    (4) Such election shall apply with respect to all timber which the 
taxpayer

[[Page 564]]

has owned, or has had a contract right to cut, for a period of more than 
1 year (6 months for taxable years beginning before 1977; 9 months for 
taxable years beginning in 1977) prior to when such timber is cut for 
sale or for use in the taxpayer's trade or business, irrespective of 
whether such timber or contract right was acquired before or after the 
election. (For purposes of the preceding sentence, the rules with 
respect to the holding period of property contained in section 1223 
shall be applicable.) However, timber which is not cut for sale or for 
use in the taxpayer's trade or business (for example, firewood cut for 
the taxpayer's own household consumption) shall not be considered to 
have been sold or exchanged upon the cutting thereof.
    (b) Who may make election. (1) A taxpayer who has owned, or has held 
a contract right to cut, timber for a period of more than 1 year (6 
months for taxable years beginning before 1977; 9 months for taxable 
years beginning in 1977) prior to when the timber is cut may elect under 
section 631(a) to consider the cutting of such timber during such year 
for sale or for use in the taxpayer's trade or business as a sale or 
exchange of the timber so cut. In order to have a contract right to cut 
timber within the meaning of section 631(a) and this section, a taxpayer 
must have a right to sell the timber cut under the contract on his own 
account or to use such cut timber in his trade or business.
    (2) For purposes of section 631(a) and this section, the term timber 
includes evergreen trees which are more than six years old at the time 
severed from their roots and are sold for ornamental purposes, such as 
Christmas decorations. Section 631(a) is not applicable to evergreen 
trees which are sold in a live state, whether or not for ornamental 
purposes. Tops and other parts of standing timber are not considered as 
evergreen trees within the meaning of section 631(a). The term evergreen 
trees is used in its commonly accepted sense and includes pine, spruce, 
fir, hemlock, cedar, and other coniferous trees.
    (c) Manner of making election. The election under section 631(a) 
must be made by the taxpayer in his income tax return for the taxable 
year for which the election is applicable, and such election cannot be 
made in an amended return for such year. The election in the return 
shall take the form of a computation under the provisions of section 
631(a) and section 1231.
    (d) Computation of gain or loss under the election. (1) If the 
cutting of timber is considered as a sale or exchange pursuant to an 
election made under section 631(a), gain or loss shall be recognized to 
the taxpayer in an amount equal to the difference between the adjusted 
basis for depletion in the hands of the taxpayer of the timber which has 
been cut during the taxable year and the fair market value of such 
timber as of the first day of the taxable year in which such timber is 
cut. The adjusted basis for depletion of the cut timber shall be based 
upon the number of units of timber cut during the taxable year which are 
considered to be sold or exchanged and upon the depletion unit of the 
timber in the timber account or accounts pertaining to the timber cut, 
and shall be computed in the same manner as is provided in section 611 
and the regulations thereunder with respect to the computation of the 
allowance for depletion.
    (2) The fair market value of the timber as of the first day of the 
taxable year in which such timber is cut shall be determined, subject to 
approval or revision by the district director upon examination of the 
taxpayer's return, by the taxpayer in the light of the most reliable and 
accurate information available with reference to the condition of the 
property as it existed at that date, regardless of all subsequent 
changes, such as changes in surrounding circumstances, methods of 
exploitation, degree of utilization, etc. The value sought will be the 
selling price, assuming a transfer between a willing seller and a 
willing buyer as of that particular day. Due consideration will be given 
to the factors and the principles involved in the determination of the 
fair market value of timber as described in the regulations under 
section 611.
    (3) The fair market value as of the beginning of the taxable year of 
the standing timber cut during the year shall be considered to be the 
cost of

[[Page 565]]

such timber, in lieu of the actual cost or other basis of such timber, 
for all purposes for which such cost is a necessary factor. See 
paragraph (e) of this section.
    (4) For any taxable year for which the cutting of timber is 
considered to be a sale or exchange of such timber under section 631(a), 
the timber so cut shall be considered as property used in the trade or 
business for the purposes of section 1231, along with other property of 
the taxpayer used in the trade or business as defined in section 
1231(b), regardless of whether such timber is 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 or property held by the taxpayer 
primarily for sale to customers in the ordinary course of his trade or 
business. Whether the gain or loss considered to have resulted from the 
cutting of the timber will be considered to be gain or loss resulting 
from the sale or exchange 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) depends upon the application of section 1231 to 
the taxpayer for the taxable year. See section 1231 and the regulations 
thereunder.
    (e) Computation of subsequent gain or loss. (1) In case the products 
of the timber are sold after cutting, either in the form of logs or 
lumber or in the form of manufactured products, the income from such 
actual sales shall be considered ordinary income. When the election 
under section 631(a) is in effect, the cost of standing timber cut 
during the taxable year is determined as if the taxpayer had purchased 
such timber on the first day of the taxable year. Thus, in determining 
the cost of the products so sold, the cost of the timber shall be the 
fair market value on the first day of the taxable year in which the 
standing timber was cut, in lieu of the actual cost or other basis of 
such timber.
    (2) This is also the rule in case the products of the timber cut 
during one taxable year, with respect to which an election has been made 
under section 631(a), are sold during a subsequent taxable year, whether 
or not the election provided in section 631(a) is applicable with 
respect to such subsequent year. If the products of the timber cut 
during a taxable year with respect to which an election under section 
631(a) was made were not sold during such year and are included in 
inventory at the close of such year, the fair market value as of the 
beginning of the year of the timber cut during the year shall be used in 
lieu of the actual cost of such timber in computing the closing 
inventory for such year and the opening inventory for the succeeding 
year. With respect to the costs applicable in the determination of the 
amount of such inventories, there shall be included the fair market 
value of the timber cut, the costs of cutting, logging, and all other 
expenses incident to the cost of converting the standing timber into the 
products in inventory. See section 471 and the regulations thereunder. 
The fact that the fair market value as of the first day of the taxable 
year in which the timber is cut is deemed to be the cost of such timber 
shall not preclude the taxpayer from computing its inventories upon the 
basis of cost or market, whichever is lower, if such is the method used 
by the taxpayer. Nor shall it preclude the taxpayer from computing its 
inventories under the last-in, first-out inventory method provided by 
section 472 if such section is applicable to, and has been elected by, 
the taxpayer.

[T.D. 6500, 25 FR 11737, Nov. 26, 1960; 25 FR 14021, Dec. 31, 1960, as 
amended by T.D. 7730, 45 FR 72650, Nov. 3, 1980]



Sec.  1.631-2  Gain or loss upon the disposal of timber under cutting contract.

    (a) In general. (1) If an owner disposes of timber held for more 
than 1 year (6 months for taxable years beginning before 1977; 9 months 
for taxable years beginning in 1977) before such disposal, under any 
form or type of contract whereby he retains an economic interest in such 
timber, the disposal shall be considered to be a sale of such timber. 
The difference between the amounts realized from disposal of such timber 
in any taxable year and the adjusted basis for depletion thereof shall 
be considered to be a gain or loss upon the sale of such timber for such 
year. Such adjusted basis shall be computed in the same manner as 
provided in section 611

[[Page 566]]

and the regulations thereunder with respect to the allowance for 
depletion. See paragraph (e)(2) of this section for definition of owner. 
For the purpose of determining whether or not the timber disposed of was 
held for more than 1 year (6 months for taxable years beginning before 
1977; 9 months for taxable years beginning in 1977) before such disposal 
the rules with respect to the holding period of property contained in 
section 1223 shall be applicable.
    (2) In the case of such a disposal, the provisions of section 1231 
apply and such timber shall be considered to be property used in the 
trade or business for the taxable year in which it is considered to have 
been sold, along with other property of the taxpayer used in the trade 
or business as defined in section 1231(b), regardless of whether such 
timber is property held by the taxpayer primarily for sale to customers 
in the ordinary course of his trade or business. Whether gain or loss 
resulting from the disposition of the timber which is considered to have 
been sold will be deemed to be gain or loss resulting from a sale of a 
capital asset held for more than 1 year (6 months for taxable years 
beginning before 1977; 9 months for taxable years beginning in 1977) 
will depend upon the application of section 1231 to the taxpayer for the 
taxable year.
    (b) Determination of date of disposal. (1) For purposes of section 
631(b) and this section, the date of disposal of timber shall be deemed 
to be the date such timber is cut. However, if payment is made to the 
owner under the contract for timber before such timber is cut the owner 
may elect to treat the date of payment as the date of disposal of such 
timber. Such election shall be effective only for purposes of 
determining the holding period of such timber. Neither section 631(b) 
nor the election thereunder has any effect on the time of reporting gain 
or loss. See subchapter E, chapter 1 of the Code and the regulations 
thereunder. See paragraph (c)(2) of this section for the effect of 
exercising the election with respect to the payment for timber held for 
1 year (6 months for taxable years beginning before 1977; 9 months for 
taxable years beginning in 1977) or less. See paragraph (d) of this 
section for the treatment of payments received in advance of cutting.
    (2) For purposes of section 631(b) and this section, the date such 
timber is cut means the date when in the ordinary course of business the 
quantity of timber felled is first definitely determined.
    (c) Manner and effect of election to treat date of payment as the 
date of disposal. (1) The election to treat the date of payment as the 
date of disposal of timber shall be evidenced by a statement attached to 
the taxpayer's income tax return filed on or before the due date 
(including extensions thereof) for the taxable year in which the payment 
is received. The statement shall specify the advance payments which are 
subject to the election and shall identify the contract under which the 
payments are made. However, in no case shall the time for making the 
election under section 631(b) expire before the close of March 21, 1958.
    (2) Where the election to treat the date of payment as the date of 
disposal is made with respect to a payment made in advance of cutting, 
and such payment is made 1 year (6 months for taxable years beginning 
before 1977; 9 months for taxable years beginning in 1977) or less from 
the date the timber disposed of was acquired, section 631(b) shall not 
apply to such payment irrespective of the date such timber is cut, since 
the timber was not held for more than six months prior to disposal.
    (d) Payments received in advance of cutting. (1) Where the 
conditions of paragraph (a) of this section are met, amounts received or 
accrued prior to cutting (such as advance royalty payments or minimum 
royalty payments) shall be treated under section 631(b) as realized from 
the sale of timber if the contract of disposal provides that such 
amounts are to be applied as payment for timber subsequently cut. Such 
amounts will be so treated irrespective of whether or not an election 
has been made under paragraph (c) of this section to treat the date of 
payment as the date of disposal. For example, if no election has been 
made under paragraph (c) of this section, amounts received or accrued 
prior to cutting will be treated as realized from the sale of timber, 
provided the timber paid for is

[[Page 567]]

cut more than 1 year (6 months for taxable years beginning before 1977; 
9 months for taxable years beginning in 1977) after the date of 
acquisition of such timber.
    (2) However, if the right to cut timber under the contract expires, 
terminates, or is abandoned before the timber which has been paid for is 
cut, the taxpayer shall treat payments attributable to the uncut timber 
as ordinary income and not as received from the sale of timber under 
section 631(b). Accordingly, the taxpayer shall recompute his tax 
liability for the taxable year in which such payments were received or 
accrued. The recomputation shall be made in the form of an amended 
return where necessary.
    (3)(i) Bonuses received or accrued by an owner in connection with 
the grant of a contract of disposal shall be treated under section 
631(b) as amounts realized from the sale of timber to the extent 
attributable to timber held for more than 1 year (6 months for taxable 
years beginning before 1977; 9 months for taxable years beginning in 
1977).
    (ii) The adjusted depletion basis attributable to the bonus shall be 
determined under the provisions of section 612 and the regulations 
thereunder. This subdivision may be illustrated as follows:

    Example. Taxpayer A has held timber having a depletion basis of 
$90,000 for two months when he enters into a contract of disposal with 
B. B pays A a bonus of $5,000 upon the execution of the contract and 
agrees to pay X dollars per unit of timber to A as the timber is cut. A 
does not exercise the election to treat the date of payment as the date 
of disposal. It is estimated that there are 50,000 units of timber 
subject to the contract and that the total estimated royalties to be 
paid to A will be $95,000. A must report the bonus in the taxable year 
it is received or accrued by him. The portion of the basis of the timber 
attributable to the bonus is determined by the following formula:
[GRAPHIC] [TIFF OMITTED] TC08OC91.028

    (iii) To the extent attributable to timber not held for more than 1 
year (6 months for taxable years beginning before 1977; 9 months for 
taxable years beginning in 1977), such bonuses shall be treated as 
ordinary income subject to depletion. In order to determine the amount 
of the bonus allocable to timber not held for more than 1 year (6 months 
for taxable years beginning before 1977; 9 months for taxable years 
beginning in 1977), the bonus shall be apportioned ratably over the 
estimated number of units of timber covered by the contract of disposal. 
This subdivision may be illustrated as follows:

    Example. Assume under the facts stated in the example in subdivision 
(ii) of this subparagraph that B cuts 10,000 units of timber that have 
been held by A for 1 year (6 months for taxable years beginning before 
1977; 9 months for taxable years beginning in 1977), or less. The amount 
of the bonus (as well as the royalties) attributable to these units must 
be reported as ordinary income subject to depletion. The amount of the 
bonus attributable to these units is determined by the following 
formula:

[[Page 568]]

[GRAPHIC] [TIFF OMITTED] TC08OC91.029


The amount of the depletion attributable to the portion of the bonus 
received for timber held for six months or less is determined by the 
following formula:
[GRAPHIC] [TIFF OMITTED] TC08OC91.030

[GRAPHIC] [TIFF OMITTED] TC08OC91.031

The amount of the bonus attributable to timber held for more than 1 year 
(6 months for taxable years beginning before 1977; 9 months for taxable 
years beginning in 1977), and which is treated under section 631 (b) as 
realized from the sale of timber would be $4,000. The gain on such 
amount is $400 ($4,000-$3,600).

    (iv) If the right to cut timber under the contract of disposal 
expires, terminates, or is abandoned before any timber is cut, the 
taxpayer shall treat the bonus received under such contract as ordinary 
income, not subject to depletion. Accordingly, the taxpayer shall 
recompute his tax liability for the taxable year in which such bonus was 
received. The recomputation shall be made in the form of an amended 
return where necessary.
    (e) Other rules for application of section. (1) Amounts paid by the 
lessee for timber or the acquisition of timber cutting rights, whether 
designated as such or as a rental, royalty, or bonus, shall be treated 
as the cost of timber and constitute part of the lessee's depletable 
basis of the timber, irrespective of the treatment accorded such 
payments in the hands of the lessor.
    (2) The provisions of section 631(b) apply only to an owner of 
timber. An owner of timber means any person who owns an interest in 
timber, including a sublessor and a holder of a contract to cut timber. 
Such owner of timber must have a right to cut timber for sale on his own 
account or for use in his trade or business in order to own an interest 
in timber within the meaning of section 631(b).
    (3) For purposes of section 631(b) and this section, the term timber 
includes evergreen trees which are more than 6 years old at the time 
severed from their roots and are sold for ornamental purposes such as 
Christmas decorations. Tops and other parts of standing timber are not 
considered as evergreen trees within the meaning of section 631(b). The 
term evergreen trees is used in its commonly accepted sense and includes 
pine, spruce, fir, hemlock, cedar, and other coniferous trees.

[T.D. 6500, 25 FR 11737, Nov. 26, 1960; 25 FR 14021, Dec. 31, 1960, as 
amended by T.D. 7728, 45 FR 72650, Nov. 3, 1980]



Sec.  1.631-3  Gain or loss upon the disposal of coal or domestic iron
ore with a retained economic interest.

    (a) In general. (1) The provisions of section 631(c) apply to an 
owner who disposes of coal (including lignite), or iron ore mined in the 
United States, held for more than 1 year (6 months for taxable years 
beginning before 1977; 9 months for taxable years beginning in

[[Page 569]]

1977) before such disposal under any form or type of contract whereby he 
retains an economic interest in such coal or iron ore. The difference 
between the amount realized from disposal of the coal or iron ore in any 
taxable year, and the adjusted depletion basis thereof plus the 
deductions disallowed for the taxable year under section 272, shall be 
gain or loss upon the sale of the coal or iron ore. See paragraph (b)(4) 
of this section for the definition of owner. See paragraph (e) of this 
section for special rules relating to iron ore.
    (2) In the case of such a disposal, the provisions of section 1231 
apply, and the coal or iron ore shall be considered to be property used 
in the trade or business for the taxable year in which it is considered 
to have been sold, along with other property of the taxpayer used in the 
trade or business as defined in section 1231(b), regardless of whether 
the coal or iron ore is property held by the taxpayer primarily for sale 
to customers in the ordinary course of his trade or business. Whether 
gain or loss resulting from the disposition of the coal or iron ore 
which is considered to have been sold will be deemed to be gain or loss 
resulting from a sale of a capital asset held for more than 1 year (6 
months for taxable years beginning before 1977; 9 months for taxable 
years beginning in 1977) will depend on the application of section 1231 
to the taxpayer for the taxable year; i.e., if the gains do not exceed 
the losses, they shall not be considered as gains and losses from sales 
or exchanges of capital assets but shall be treated as ordinary gains 
and losses.
    (b) Rules for application of section. (1) For purposes of section 
631(c) and this section, the date of disposal of the coal or iron ore 
shall be deemed to be the date the coal or iron ore is mined. If the 
coal or iron ore has been held for more than 1 year (6 months for 
taxable years beginning before 1977; 9 months for taxable years 
beginning in 1977) on the date it is mined, it is immaterial that it had 
not been held for more than 1 year (6 months for taxable years beginning 
before 1977; 9 months for taxable years beginning in 1977) on the date 
of the contract. There shall be no allowance for percentage depletion 
provided in section 613 with respect to amounts which are considered to 
be realized from the sale of coal or iron ore under section 631(c).
    (2) The term adjusted depletion basis as used in section 631(c) and 
this section means the basis for allowance of cost depletion provided in 
section 612 and the regulations thereunder. Such adjusted depletion 
basis shall include exploration or development expenditures treated as 
deferred expenses under section 615(b) or 616(b), or corresponding 
provisions of prior income tax laws, and be reduced by adjustments under 
section 1016(a) (9) and (10), or corresponding provisions of prior 
income tax laws, relating to deductions of deferred expenses for 
exploration or development expenditures in the taxable year or any prior 
taxable years. The depletion unit of the coal or iron ore disposed of 
shall be determined under the rules provided in the regulations under 
section 611, relating to cost depletion.
    (3)(i) In determining the gross income, the adjusted gross income, 
or the taxable income of the lessee, the deductions allowable with 
respect to rents and royalties (except rents and royalties paid by a 
lessee with respect to coal or iron ore disposed of by the lessee as an 
owner under section 631(c)) shall be determined without regard to the 
provisions of section 631(c). Thus, the amounts of rents and royalties 
paid or incurred by a lessee with respect to coal or iron ore shall be 
excluded from the lessee's gross income from the property for the 
purpose of determining his percentage depletion without regard to the 
treatment of such rents or royalties in the hands of the recipient under 
this section. See section 613 and the regulations thereunder.
    (ii)(a) However, a lessee who is also a sublessor may dispose of 
coal or iron ore as an owner under section 631(c). Rents and royalties 
paid with respect to coal or iron ore disposed of by such a lessee under 
section 631(c) shall increase the adjusted depletion basis of the coal 
or iron ore and are not otherwise deductible.
    (b) The provisions of this subdivision may be illustrated by the 
following example:


[[Page 570]]


    Example. B is a sublessor of a coal lease; A is the lessor; and C is 
the sublessee. B pays A a royalty of 50 cents per ton. C pays B a 
royalty of 60 cents per ton. The amount realized by B under section 
631(c) is 60 cents per ton and will be reduced by the adjusted depletion 
basis of 50 cents per ton, leaving a gain of 10 cents per ton taxable 
under section 631(c).

    (4)(i) The provision of this section apply only to an owner who has 
disposed of coal or iron ore and retained an economic interest. For the 
purposes of section 631(c) and this section, the word owner means any 
person who owns an economic interest in coal or iron ore in place, 
including a sublessor thereof. A person who merely acquires an economic 
interest and has not disposed of coal or iron ore under a contract 
retaining an economic interest does not qualify under section 631(c). A 
successor to the interest of a person who has disposed of coal or iron 
ore under a contract by virtue of which he retained an economic interest 
in such coal or iron ore is also entitled to the benefits of this 
section. Section 631(c) and this section shall not apply with respect to 
any income realized by any owner as co-adventurer, partner, or principal 
in the mining of such coal or iron ore.
    (ii) The provisions of this subparagraph may be illustrated by the 
following examples:

    Example 1. A owns a tract of coal land in fee. A leases to B the 
right to mine all the coal in this tract in return for a royalty of 30 
cents per ton. B subleases his right to mine coal in this tract to C, 
who agrees to pay A 30 cents per ton and to pay to B an additional 
royalty of 10 cents per ton. Section 631(c) applies to the royalties of 
both A and B, if the other requisites of the section have been met.
    Example 2. Assume the same facts as in example 1, except that A dies 
leaving his royalty interest to D. D has an economic interest in the 
coal in place and qualifies for section 631(c) treatment with respect to 
his share of the royalties since he is a successor in title to A.
    Example. Assume the same facts as in example 1, except that E agrees 
to pay a sum of money to C in return for 10 cents per ton on the coal 
mined by C. E has an economic interest, since he must look solely to the 
extraction of the coal for the return of his investment. However, E has 
not made a disposal of coal under a contract wherein he retains an 
economic interest, and, therefore does not qualify under section 631(c). 
E is entitled to depletion on his royalties.

    (c) Payments received in advance of mining. (1)(i) Where the 
conditions of paragraph (a) of this section are met, amounts received or 
accrued prior to mining shall be treated under section 631(c) as 
received from the sale of coal or iron ore if the contract of disposal 
provides that such amounts are to be applied as payment for coal or iron 
ore subsequently mined. For example, advance royalty payments or minimum 
royalty payments received by an owner of coal or iron ore qualify under 
section 631(c) where the contract of disposal grants the lessee the 
right to apply such royalties in payment of coal or iron ore mined at a 
later time.
    (ii) The provisions of this subparagraph may be illustrated by the 
following example:

    Example. A acquires coal rights on January 1. On January 30, A 
enters into a contract of disposal providing that mining shall begin 
July 2, and mining actually begins no earlier. Any advance payments 
which A receives qualify under section 631(c).

    (2) However, if the right to mine coal or iron ore under the 
contract expires, terminates, or is abandoned before the coal or iron 
ore which had been paid for is mined, the taxpayer shall treat payments 
attributable to the unmined coal or iron ore as ordinary income and not 
as received from the sale of coal or iron ore under section 631(c). 
Accordingly, the taxpayer shall recompute his tax liability for the 
taxable year in which such payments were received. The recomputation 
shall be made in the form of an amended return where necessary.
    (3) Bonuses received or accrued by an owner in connection with the 
grant of a contract of disposal shall be treated under section 631(c) as 
received from the sale of coal or iron ore to the extent attributable to 
coal or iron ore held for more than 1 year (6 months for taxable years 
beginning before 1977; 9 months for taxable years beginning in 1977). 
The rules contained in paragraph (d) of Sec.  1.631-2 relating to 
bonuses in the case of contracts for the disposal of timber shall be 
equally applicable in the case of bonuses received for the grant of a 
contract of disposal of coal or iron ore under this section.

[[Page 571]]

    (d) Nonapplication of section. Section 631(c) shall not affect the 
application of the provisions of subchapter G, chapter 1 of the Code, 
relating to corporations used to avoid income tax on shareholders. For 
example, for the purposes of applying section 543 (relating to personal 
holding companies), the amounts received from a disposal of coal or iron 
ore subject to section 631(c) shall be considered as mineral royalties. 
The determination of whether an amount received under a contract to 
which section 631(c) applies is personal holding company income shall be 
made in accordance with section 543 and the regulations thereunder, 
without regard to section 631(c) or this section. See also paragraph (e) 
of Sec.  1.272-1.
    (e) Special rules with regard to iron ore. (1) With regard to iron 
ore, section 631(c) and this section apply only to amounts received or 
accrued in taxable years beginning after December 31, 1963, attributable 
to iron ore mined in such taxable years.
    (2) Section 631(c) and this section apply only to disposals of iron 
ore mined in the United States.
    (3) For the purposes of section 631(c) and this section, iron ore is 
any ore which is used as a source of iron, including but not limited to 
taconite and jaspilite.
    (4) Section 631(c) shall not apply to any disposal of iron ore to a 
person whose relationship to the person disposing of such iron ore would 
result in the disallowance of losses under section 267 or 707(b).
    (5) Section 631(c)(2) results in the denial of section 631(c) 
treatment in the case of a contract for disposal of iron ore entered 
into with a person owned or controlled, directly or indirectly, by the 
same interests which own or control the person disposing of the iron 
ore, even though section 631(c) treatment would not be denied under the 
provisions of section 631(c)(1). For example, section 631(c) treatment 
is denied in the case of a contract for disposal of iron ore entered 
into between two brother and sister corporations, or a parent 
corporation and its subsidiary. The presence or absence of control shall 
be determined by applying the same standards as are applied under 
section 482 (relating to the allocation of income and deductions between 
taxpayers).

[T.D. 6841, 30 FR 9307, July 27, 1965, as amended by T.D. 7730, 45 FR 
72650, Nov. 3, 1980]



Sec.  1.632-1  Tax on sale of oil or gas properties.

    (a) If the taxpayer, by prospecting and locating claims or by 
exploring or discovering undeveloped claims, has demonstrated the 
principal value of oil or gas property, which prior to his efforts had a 
relatively minor value, the portion of the tax (or, in the case of 
taxable years beginning before Jan. 1, 1971, the surtax) imposed by 
section 1 attributable to a sale of such property, or of any interest of 
the taxpayer therein, shall not exceed 33 percent (or, in the case of 
taxable year beginning before Jan. 1, 1971, 30 percent) of the selling 
price of such property or such interest. Shares of stock in a 
corporation owning oil or gas property do not constitute an interest in 
such property. To determine the application of section 632 to a 
particular case, the taxpayer should first compute the tax (or surtax) 
imposed by section 1 upon his entire taxable income, including the 
taxable income from any sale of such property or interest therein, 
without regard to section 632. The proportion of the tax (or surtax) so 
computed, indicated by the ratio which the taxpayer's taxable income 
from the sale of the property or interest therein, computed as 
prescribed in this section, bears to his total taxable income is the 
portion of the tax attributable to such sale and, if it exceeds 33 
percent (or 30 percent) of the selling price of such property or 
interest, such portion of the tax (or surtax) shall be reduced to that 
amount.
    (b) In determining the portion of the taxable income attributable to 
the sale of such oil or gas property or interest therein, the taxpayer 
shall allocate to the gross income derived from such sale, and to the 
gross income derived from all other sources, the expenses, losses, and 
other deductions properly appertaining thereto and shall apply any 
general expenses, losses, and deductions (which cannot properly be 
otherwise allocated) ratably to the gross income from all sources. The 
gross income derived from the sale of such oil or gas property or 
interest

[[Page 572]]

therein, less the deductions properly appertaining thereto and less its 
proportion of any general deductions, shall be the taxable income 
attributable to such sale. The taxpayer shall submit with his return a 
statement fully explaining the manner in which such expenses, losses, 
and deductions are allocated or apportioned.

[T.D. 6500, 25 FR 11737, Nov. 26, 1960, as amended by T.D. 7117, 36 FR 
9421, May 25, 1971]

                       Mineral Production Payments



Sec.  1.636-1  Treatment of production payments as loans.

    (a) In general. (1)(i) For purposes of subtitle A of the Internal 
Revenue Code of 1954, a production payment (as defined in paragraph (a) 
of Sec.  1.636-3) to which this section applies shall be treated as a 
loan on the mineral property (or properties) burdened thereby and not as 
an economic interest in mineral in place, except to the extent that 
Sec.  1.636-2 or paragraph (b) of this section applies. See paragraph 
(b) of Sec.  1.611-1. A production payment carved out of mineral 
property which remains in the hands of the person carving out the 
production payment immediately after the transfer of such production 
payment shall be treated as a mortgage loan on the mineral property 
burdened thereby. A production payment created and retained upon the 
transfer of the mineral property burdened by such production payment 
shall be treated as a purchase money mortgage loan on the mineral 
property burdened thereby. Such production payments will be referred to 
hereinafter in the regulations under section 636 as carved-out 
production payments and retained production payments, respectively. 
Moreover, in the case of a transaction involving a production payment 
treated as a loan pursuant to this section, the production payment shall 
constitute an item of income (not subject to depletion), consideration 
for a sale or exchange, a contribution to capital, or a gift if in the 
transaction a debt obligation used in lieu of the production payment 
would constitute such an item of income, consideration, contribution to 
capital, or gift, as the case may be. For the definition of the term 
transfer see paragraph (c) of Sec.  1.636-3.
    (ii) The payer of a production payment treated as a loan pursuant to 
this section shall include the proceeds from (or, if paid in kind, the 
value of) the mineral produced and applied to the satisfaction of the 
production payment in his gross income and gross income from the 
property (see section 613(a)) for the taxable year so applied. The payee 
shall include in his gross income (but not gross income from the 
property) amounts received with respect to such production payment to 
the extent that such amounts would be includible in gross income if such 
production payment were a loan. The payer and payee shall determine 
their allowable deductions as if such production payment were a loan. 
See section 483, relating to interest on certain deferred payments in 
the case of a production payment created and retained upon the transfer 
of the mineral property burdened thereby, or in the case of a production 
payment transferred in exchange for property. See section 1232 in the 
case of a production payment which is originally transferred by a 
corporation at a discount and is a capital asset in the hands of the 
payee. In the case of a carved-out production payment treated as a 
mortgage loan pursuant to this section, the consideration received for 
such production payment by the taxpayer who created it is not included 
in either gross income or gross income from the property by such 
taxpayer.
    (2) If a production payment is treated as a loan pursuant to this 
section, no transfer of such production payment or any property burdened 
thereby (other than a transfer between the payer and payee of the 
production payment which, if the production payment were a loan, would 
extinguish the loan) shall cause it to cease to be so treated. For 
example, A sells operating mineral interest X to B for $100,000, subject 
to a $500,000 retained production payment payable out of X. 
Subsequently, A sells the production payment to C, and B sells X to D. C 
and D must treat the production payment as a purchase money mortgage 
loan.
    (3) The provisions of this paragraph may be illustrated by the 
following examples:


[[Page 573]]


    Example 1. On December 22, 1972, A, a cash-basis calendar-year 
taxpayer who owns operating mineral interest X, carves out of X a 
production payment in favor of B for $300,000 plus interest, payable out 
of 50 percent of the first oil produced and sold from X. In 1972, A 
treats the $300,000 received from B for the production payment as the 
proceeds of a mortgage loan on X. In 1973, A produces and sells 125,000 
barrels of oil for $373,500. A pays B $186,750 with respect to the 
production payment, $168,750 being principal and $18,000 being interest. 
In computing his gross income and gross income from the property for the 
year 1973, A includes the $373,500 and takes as deductions the allowable 
expenses paid in production of such mineral. A also takes a deduction 
under section 163 for the $18,000 interest paid with respect to the 
production payment. For 1973, B would treat $18,000 as ordinary income 
not subject to the allowance for depletion under section 611.
    Example 2. Assume the same facts as in example 1 except that the 
principal amount of the production payment is to be increased by the 
amount of the ad valorem tax on the mineral attributable to the 
production payment which is paid by B. Under State law, the ad valorem 
tax with respect to the mineral attributable to the production payment 
is a liability of the owner of the production payment. For 1973, B 
inlcudes the amount received with respect to such taxes as income and 
takes a deduction under section 164 for the taxes paid by him. Since the 
ad valorem taxes paid by B are his liability under State law, A may not 
take a deduction under section 164 for such taxes.
    Example 3. On December 31, 1974, C, a calendar-year taxpayer and 
owner of the operating mineral interest Y, sells Y to D for $10,000 cash 
and retains a $40,000 production payment payable out of Y. At the time D 
acquires the property, it is estimated that 500,000 tons of mineral are 
recoverable from the property. In 1975, D produces a total of 50,000 
tons from the property. D's cost depletion for 1975 is $5,000 determined 
as follows:

Basis in property: $50,000
    Total recoverable units: 500,000
Rate of depletion per ton: $0.10 ($50,000 / 500,000)
Cost depletion for year: $5,000


 ($0.10 x 50,000)

    (b) Exception. (1) A production payment carved out of a mineral 
property (or properties) for exploration or development of such property 
(or properties) shall not be treated as a mortgage loan under section 
636(a) and this section to the extent gross income from the property 
(for purposes of section 613) would not be realized by the taxpayer 
creating such production payment, under the law existing at the time of 
the creation of such production payment, in the absence of section 
636(a). See section 83 and the regulations thereunder, relating to 
property transferred in connection with the performance of services. For 
purposes of section 636(a) and this paragraph, an expenditure is for 
exploration or development to the extent that it is necessary for 
ascertaining the existence, location, extent, or quality of any deposit 
of mineral or is incident to and necessary for the preparation of a 
deposit for the production of mineral. However, an expenditure which 
relates primarily to the production of mineral (as, for example, in the 
case of a pilot water flood program with respect to the secondary 
recovery of oil) is not for exploration or development as those terms 
are used in section 636(a) and this paragraph. Whether or not a 
production payment is carved out for exploration or development shall be 
determined in light of all relevant facts and circumstances, including 
any prior production of mineral from the mineral deposit burdened by the 
production payment. However, a production payment shall not be treated 
as carved out for exploration or development to the extent that the 
consideration for the production payment:
    (i) Is not pledged for use in the future exploration or development 
of the mineral property (or properties) which is burdened by the 
production payment;
    (ii) May be used for the exploration or development of any other 
property, or for any other purpose than that described in subdivision 
(i) of this subparagraph;
    (iii) Does not consist of a binding obligation of the payee of the 
production payment to pay expenses of the exploration or development 
described in subdivision (i) of this subparagraph; or
    (iv) Does not consist of a binding obligation of the payee of the 
production payment to provide services, materials, supplies, or 
equipment for the exploration or development described in subdivision 
(i) of this subparagraph.
    (2) In the case of a carved-out production payment only a portion of 
which is subject to the exception provided in this paragraph, the rules 
contained in paragraph (a) of this section with respect to the treatment 
of income and

[[Page 574]]

deductions where a production payment is treated as a loan shall apply 
to the portion of the taxpayer's income or expenses attributable to the 
production payment which bears the same ratio to the total amount of 
such income or expenses, as the case may be, as the amount of the 
consideration for the production payment which would have been realized 
as income in the absence of section 636(a), by the taxpayer creating 
such production payment, bears to the total consideration to the 
taxpayer for the production payment. For example, A, owner of a mineral 
property, carves out a production payment in favor of B for $600,000 
plus interest in return for $600,000 cash. A pledges to use $400,000 for 
the development of the burdened mineral property. In each of the payout 
years loan treatment applies to one-third of the income and expenses of 
A and B attributable to the production payment.
    (c) Treatment upon disposition or termination of mineral property 
burdened by production payment. (1)(i) In the case of a sale or other 
disposition of the mineral property burdened by a production payment 
treated as a loan pursuant to this section, there shall be included in 
determining the amount realized upon such disposition an amount equal to 
the outstanding principal balance of such production payment on the date 
of such disposition. However, if such a production payment is created in 
connection with the disposition, the amount to be so included shall be 
the fair market value of the production payment, rather than its 
principal amount, if the fair market value is established by clear and 
convincing evidence to be an amount which differs from the principal 
amount. See section 1001 and the regulations thereunder. In determining 
the cost of the transferred mineral property to the transferee for 
purposes of section 1012, the outstanding principal balance of the 
production payment shall be included in the cost.
    (ii) The provisions of this subparagraph may be illustrated by the 
following examples:

    Example 1. A, the owner of mineral property X which is burdened by a 
carved-out production payment to which section 636(a) applies having an 
outstanding principal balance of $10,000, sells property X to B, an 
individual, for $100,000 cash. The amount realized by A on the sale of 
property X is $110,000. B's basis in property X for cost depletion and 
other purposes is also $110,000.
    Example 2. Assume the same facts as in example 1 except that the 
production payment is retained by A in connection with the sale of 
property X to B, that section 636(b) applies to the production payment, 
that the production payment includes, in addition to the $10,000 
principal amount, an additional amount equivalent to interest at a rate 
which precludes application of section 483, and that the fair market 
value of the production payment is $9,000. The amount realized by A on 
the sale of property X is $109,000. B's basis in property X for cost 
depletion and other purposes is $110,000. A's basis in the retained 
production payment is $9,000. If the production payment is paid in full, 
A realizes income of $1,000 plus the amount equivalent to interest, 
which income is includible in A's gross income at the time when such 
amounts would be so includible if such production payment were a loan.
    Example 3. C, the owner of mineral property Y, sells the mineral 
property to D for $500,000 cash. Property Y is burdened by a carved-out 
production payment with an outstanding principal balance of $600,000, 40 
percent of the consideration for which was pledged for the development 
of property Y. The amount realized by C on the sale is $860,000 
($500,000 plus $600,000 x .60). D's basis in property Y for cost 
depletion and other purposes is $860,000.

    (2) In the case of the expiration, termination, or abandonment of a 
mineral property burdened by a production payment treated as a loan 
pursuant to this section, for purposes of determining the amount of any 
loss under section 165 with respect to the burdened mineral property the 
adjusted basis of such property shall be reduced (but not below zero) by 
an amount equal to the outstanding principal balance of such production 
payment on the date of such expiration, termination, or abandonment. 
Thus, in example 2 in subparagraph (1)(ii) of this paragraph, if B 
abandons the mineral property at a time when $5,000 of the principal 
amount of the production payment remains unsatisfied, B's adjusted basis 
immediately before the abandonment would be reduced by $5,000 for 
determining his loss on abandonment under section 165.
    (3) In the case of a transfer of a portion of the mineral property 
burdened by a production payment treated as a

[[Page 575]]

loan pursuant to this section, such production payment shall be 
apportioned between the transferred portion and the retained portion by 
allocating to such transferred portion that part of the outstanding 
principal balance of the production payment which bears the same ratio 
to such balance as the value of such transferred portion (exclusive of 
any value not related to the burdened mineral) bears to the total value 
of the burdened mineral property (exclusive of any value not related to 
the burdened mineral).
    (4) In general, the entire amount of gain or loss realized pursuant 
to this paragraph shall be recognized in the taxable year of such 
realization. See section 1211 for limitation on capital losses. This 
subparagraph shall not affect the applicability of rules providing 
exceptions to the recognition of gain or loss which has been realized 
(e.g., a transfer to which section 351 or 1031 applies). However, see 
section 357(c) with respect to the assumption of liabilities in excess 
of basis in certain tax-free exchanges. Furthermore, in the case of a 
transaction which otherwise qualifies, gain realized on a transfer of a 
mineral property to which section 636(b) applies may be returned on the 
installment method under section 453.

[T.D. 7261, 38 FR 5463, Mar. 1, 1973]



Sec.  1.636-2  Production payments retained in leasing transactions.

    (a) Treatment by lessee. In the case of a production payment (as 
defined in paragraph (a) of Sec.  1.636-3) which is retained by the 
lessor in a leasing transaction (including a sublease or the exercise of 
an option to acquire a lease or sublease), the lessee (or his successors 
in interest) shall treat the retained production payment for purposes of 
subtitle A of the Code as if it were a bonus granted by the lessee to 
the lessor payable in installments. Accordingly, the lessee shall 
include the proceeds from (or, if paid in kind, the value of) the 
mineral produced and applied to the satisfaction of the production 
payment in his gross income for the taxable year so applied. The lessee 
shall capitalize each payment (including any interest and any amounts 
added on to the production payment other than amounts for which the 
lessee would be liable in the absence of the production payment) paid or 
incurred with respect to such production payment. See paragraph 
(c)(5)(ii) of Sec.  1.613-2 for rules relating to computation of 
percentage depletion with respect to a mineral property burdened by a 
production payment treated as a bonus under section 636(c) and this 
section.
    (b) Treatment by lessor. The lessor who retains a production payment 
in a leasing transaction (or his successors in interest) shall treat the 
production payment without regard to the provisions of section 636 and 
Sec.  1.636-1. Thus, the production payment will be treated as an 
economic interest in the mineral in place in the hands of the lessor (or 
his successors in interest) and the receipts in discharge of the 
production payment will constitute ordinary income subject to depletion.
    (c) Example. The provisions of this section may be illustrated by 
the following example:

    Example. In 1971, A leases a mineral property to B reserving a one-
eighth royalty and a production payment (as defined in Sec.  1.636-3(a)) 
with a principal amount of $300,000 plus an amount equivalent to 
interest. In 1972, B pays to A $60,000 with respect to the principal 
amount of the production payment plus $16,350 equivalent to interest. 
The adjusted basis of the property in the hands of B for cost depletion 
and other purposes for 1972 and subsequent years will include (subject 
to proper adjustment under section 1016) the $76,350 paid to A. In 1973, 
B pays to A $60,000 with respect to the principal amount of the 
production payment plus $12,750 equivalent to interest. The adjusted 
basis of the property in the hands of B for cost depletion and other 
purposes for 1973 and subsequent years will include (subject to proper 
adjustment under section 1016) the $72,750 paid to A. The $76,350 
received by A in 1972, and the $72,750 received by A in 1973, will 
constitute ordinary income subject to depletion in the hands of A in the 
years of receipt of such amounts by A.

[T.D. 7261, 38 FR 5465, Mar. 1, 1973]



Sec.  1.636-3  Definitions.

    For purposes of section 636 and the regulations thereunder:
    (a) Production payment. (1) The term production payment means, in 
general, a right to a specified share of the production from mineral in 
place (if, as, and when produced), or the proceeds from

[[Page 576]]

such production. Such right must be an economic interest in such mineral 
in place. It may burden more than one mineral property, and the burdened 
mineral property need not be an operating mineral interest. Such right 
must have an expected economic life (at the time of its creation) of 
shorter duration than the economic life of one or more of the mineral 
properties burdened thereby. A right to mineral in place which can be 
required to be satisfied by other than the production of mineral from 
the burdened mineral property is not an economic interest in mineral in 
place. A production payment may be limited by a dollar amount, a quantum 
of mineral, or a period of time. A right to mineral in place has an 
economic life of shorter duration than the economic life of a mineral 
property burdened thereby only if such right may not reasonably be 
expected to extend in substantial amounts over the entire productive 
life of such mineral property. The term production payment includes 
payments which are commonly referred to as in-oil payments, gas 
payments, or mineral payments.
    (2) A right which is in substance economically equivalent to a 
production payment shall be treated as a production payment for purposes 
of section 636 and the regulations thereunder, regardless of the 
language used to describe such right, the method of creation of such 
right, or the form in which such right is cast (even though such form is 
that of an operating mineral interest). Whether or not a right is in 
substance economically equivalent to a production payment shall be 
determined from all the facts and circumstances. An example of an 
interest which is to be treated as a production payment under this 
subparagraph is that portion of a royalty which is attributable to so 
much of the rate of the royalty which exceeds the lowest possible rate 
of the royalty at any subsequent time (disregarding any reductions in 
the rate of the royalty which are based solely upon changes in volume of 
production within a specified period of no more than 1 year). For 
example, assume that A creates a royalty with respect to a mineral 
property owned by A equal to 5 percent for 5 years and thereafter equal 
to 4 percent for the balance of the life of the property. An amount 
equal to 1 percent for 5 years shall be treated as a production payment. 
On the other hand, if A leases a coal mine to B in return for a royalty 
of 30 cents per ton on the first 500,000 tons of coal produced from the 
mine in each year and 20 cents per ton on all coal in excess of 500,000 
tons produced from the mine in each year, the fact that the royalty may 
decline to 20 cents per ton on some of the coal in each year does not 
result in a production payment of 10 cents per ton of coal on the first 
500,000 tons in any year. Another example of an interest which is to be 
treated as a production payment under this subparagraph is the interest 
in a partnership engaged in operating oil properties of a partner who 
provides capital for the partnership if such interest is subject to a 
right of another person or persons to acquire or terminate it upon terms 
which merely provide for such partner's recovery of his capital 
investment and a reasonable return thereon.
    (b) Property. The term property has the meaning assigned to it in 
section 614(a), without the application of section 614 (b), (c), or (e).
    (c) Transfer. The term transfer means any sale, exchange, gift, 
bequest, devise, or other disposition (including a distribution by an 
estate or a contribution to or distribution by a corporation, 
partnership, or trust).

[T.D. 7261, 38 FR 5465, Mar. 1, 1973]



Sec.  1.636-4  Effective dates of section 636.

    (a) In general. Except as provided hereinafter in this section, 
section 636 and Sec. Sec.  1.636-1, 1.636-2, and 1.636-3 apply to 
production payments created on or after August 7, 1969, other than 
production payments created before January 1, 1971, pursuant to a 
binding contract entered into before August 7, 1969.
    (b) Election. Under section 503(c)(2) of the Tax Reform Act of 1969, 
if the taxpayer so elects, section 636(a) of the Code and Sec. Sec.  
1.636-1 and 1.636-3 apply to all production payments carved out by him 
after the beginning of his last taxable year ending before August 7, 
1969, including such production payments created after such date 
pursuant to a binding contract entered into before

[[Page 577]]

such date. No interest shall be allowed on any refund or credit of any 
overpayment of tax resulting from an election under section 503(c)(2) 
for any taxable year ending before August 7, 1969. The provisions of 
this paragraph may be illustrated by the following example:

    Example. A, a fiscal-year taxpayer whose taxable year ends on 
October 31, carved out and sold (from a producing property) production 
payments on October 1, 1967, and on July 9, 1969. On August 1, 1969, A 
entered into a binding contract to create another carved-out production 
payment (from a different producing property) and the production payment 
was carved out on December 22, 1969. If A elects under section 
503(c)(2), the production payments carved out on July 9, 1969, and 
December 22, 1969, are treated as mortgage loans under section 636(a). 
The production payment carved out on October 1, 1967, is not treated as 
a mortgage loan under section 636(a) because it was carved out before 
the beginning of A's last taxable year ending before August 7, 1969.

    (c) Time and manner of making election. (1) Any election under 
section 503(c)(2) of the Tax Reform Act of 1969 must be made not later 
than May 30, 1973.
    (2) An election under section 503(c)(2) shall be made by a statement 
attached to the taxpayer's income tax return (or amended return) for the 
first taxable year in which the taxpayer created a production payment 
(i) to which the election applies, and (ii) which, in the absence of 
section 636, would not have been treated as a loan. A statement shall 
also be attached to an amended return for each subsequent taxable year 
for which he has filed his income tax return before making the election, 
but only if his tax liability for such year is affected by the election. 
Each such statement shall indicate the taxpayer's election under section 
503(c)(2), and shall identify by date, amount, parties, and burdened 
mineral properties all production payments described in subdivisions (i) 
and (ii) of this subparagraph which have been created by the date on 
which the statement is filed. However, a taxpayer who, prior to the date 
on which permanent regulations under this section are published in the 
Federal Register, made a valid election under section 503(c)(2) pursuant 
to Sec. Sec.  301.9100-17T and 301.9100-18T of this chapter are not 
required to amend statements previously furnished which meet the 
requirements of Sec.  301.9100-17T(b)(1)(ii) of this chapter unless 
requested to do so by the district director. In applying the election to 
the taxable years affected, there shall be taken into account the effect 
that any adjustments resulting therefrom have on other items affected 
thereby and the effect that adjustments of any such items have on other 
taxable years. In the case of a member of a consolidated return group 
(as defined in paragraph (a) of Sec.  1.1502-1), section 503(c)(2) and 
paragraphs (b), (c), and (d) of this section shall be applied as if such 
member filed a separate return.
    (d) Revocation of election. A valid election under section 503(c)(2) 
shall be binding upon the taxpayer unless consent to revoke the election 
is obtained from the Commissioner. The application to revoke such 
election must be made in writing to the Commissioner of Internal 
Revenue, Washington, D.C. 20224, not later than May 30, 1973. Such 
application must set forth the reasons therefor and a recomputation of 
the tax reflecting such revocation for each prior taxable year affected 
by the revocation, whether or not the period of limitations for credit 
or refund or assessment and collection has expired with respect to such 
taxable year. Consent shall not be given in any case in which the 
revocation would result in an increase in the taxpayer's tax liability 
for a taxable year for which such period of limitations has expired 
unless the taxpayer waives his right to assert the statute of 
limitations.
    (e) Special rule. (1) Except as provided in subparagraph (2) of this 
paragraph, in the case of a taxpayer who does not make the election 
provided in section 503(c)(2) of the Tax Reform Act of 1969, section 636 
of the Code applies to production payments carved out during the taxable 
year which includes August 7, 1969, as provided in paragraph (a) of this 
section, only to the extent that the aggregate amount of such production 
payments exceeds the lesser of:
    (i) The excess of:
    (a) The aggregate amount of production payments carved out and sold 
by the taxpayer during the 12-month period immediately preceding his 
taxable

[[Page 578]]

year which includes August 7, 1969, over
    (b) The aggregate amount of production payments carved out and sold 
before August 7, 1969, by the taxpayer during his taxable year which 
includes such date, or
    (ii) The amount necessary to increase the amount of the taxpayer's 
gross income within the meaning of chapter 1 of subtitle A of the Code, 
for his taxable year which includes August 7, 1969, to an amount equal 
to the amount of his deductions (other than any deduction under section 
172) allowable for such year under such chapter


In applying the preceding sentence, production payments carved out for 
exploration or development are to be taken into account only to the 
extent, if any, that gross income from the property (for purposes of 
section 613) would have been realized by the taxpayer creating such 
production payment under the law existing at the time of the creation of 
such production payment, in the absence of section 636(a).
    (2) Subparagraph (1) of this paragraph shall not apply for any 
taxable year for purposes of determining the amount of any deduction for 
cost or percentage depletion allowable under section 611 or the 
limitation on any foreign tax credit under section 904.
    (3) The application of this paragraph may be illustrated by the 
following examples:

    Example 1. (a) A, a calendar-year taxpayer who does not make the 
election provided in section 503(c)(2) of the Tax Reform Act of 1969, 
carves out and sells on December 31, 1968, a $500,000 production 
payment. Further, A carves out and sells on March 4, 1969, a $300,000 
production payment, and on November 14, 1969, a $150,000 production 
payment. None of the production payments are carved out for exploration 
or development. During 1969, A has gross income of $600,000 (determined 
initially for this purpose by treating the $150,000 production payment 
carved out on November 14, 1969, as a loan) and allowable deductions of 
$700,000.
    (b) The provisions of section 636 do not apply to a portion of the 
November 14, 1969, production payment for purposes other than section 
611 and section 904 of the Code, determined as follows:

(1) Amount of production payment carved out in 1969 on or       $150,000
 after August 7, 1969........................................
(2) Amount of production payment carved out during 1968......    500,000
(3) Amount of production payment carved out during 1969          300,000
 taxable year before August 7, 1969..........................
                                                              ----------
(4) Item (2) minus item (3)..................................    200,000
(5) Excess of allowable deductions over gross income for 1969    100,000
(6) Amount of production payment carved out in 1969 on or        100,000
 after August 7, 1969, to which section 636 does not apply
 (lesser of items (1), (4), and (5)).........................
 


Thus, A will not treat $100,000 of the consideration received for the 
production payment carved out on November 14, 1969, as a loan and as a 
result his gross income for 1969 will be $700,000. However, in computing 
percentage depletion, A will not include the $100,000 in gross income 
from property and in computing cost depletion A will not include the 
mineral units attributable thereto. Nor, will A include the $100,000 in 
determining the limitation on foreign tax credit under section 904.
    Example 2. Assume the same facts as in example 1 except that for 
taxable year 1969 A's gross income (determined initially for this 
purpose by treating the November 14, 1969, production payment as a loan) 
exceeds the amount of his allowable deductions under chapter 1 of 
subtitle A of the Code. The entire amount of the November 14, 1969, 
production payment is treated as a mortgage loan under section 636(a).

[T.D. 7261, 38 FR 5465, Mar. 1, 1973, as amended by T.D. 8435, 57 FR 
43896, Sept. 23, 1992]

                         Continental Shelf Areas



Sec.  1.638-1  Continental Shelf areas.

    (a) General rule. For purposes of applying any provision of chapter 
1, 2, 3, or 24 (including section 861(a)(3), 862(a)(3), 1441, 3402, or 
other provisions dealing with the performance of personal services), 
with respect to mines, oil and gas wells, and other natural deposits:
    (1) United States and possession of the United States. The terms 
United States and possession of the United States when used in a 
geographical sense include the seabed and subsoil of those submarine 
areas which are adjacent to the territorial waters of the United States 
or such possession and over which the United States has exclusive 
rights, in accordance with international law, with respect to the 
exploration for, and exploitation of, natural resources. The terms 
Continental Shelf of the United States and Continental Shelf of a 
possession of the United States, as used in this section, refer to the 
seabed and subsoil

[[Page 579]]

included, respectively, in the terms United States and possession of the 
United States, as provided in the preceding sentence.
    (2) Foreign country. The term foreign country when used in a 
geographical sense includes the seabed and subsoil of those submarine 
areas which are adjacent to the territorial waters of the foreign 
country and over which such foreign country has exclusive rights, in 
accordance with international law, with respect to the exploration for, 
and exploitation of, natural resources, but this sentence applies only 
if such foreign country exercises, directly or indirectly, taxing 
jurisdiction with respect to such exploration or exploitation. The term 
foreign continental shelf, as used in this section, refers to the seabed 
and subsoil described in the preceding sentence. A foreign country is 
not to be treated as a country contiguous to the United States by reason 
of the application of section 638 and this section.
    (b) Exercise of taxing jurisdiction. For purposes of paragraph 
(a)(2) of this section, the exercise, directly or indirectly, of taxing 
jurisdiction with respect to the exploration for, or exploitation of, 
natural resources is deemed to include (but is not limited to) those 
cases in which a foreign country:
    (1) Imposes a tax upon assets, equipment, or other property 
connected with or income derived from such exploration or exploitation, 
or
    (2) Requires natural resources referred to in paragraph (a)(2) of 
this section to be transported to points within its landward boundaries 
and then levies a tax upon such natural resources or upon the income 
derived from the sale thereof


A foreign country which, for purposes of paragraph (a)(2) of this 
section, exercises taxing jurisdiction by the imposition of tax upon any 
person, property, or activity engaged in or related to the exploration 
for, or exploitation of, natural resources in the seabed or subsoil 
referred to in paragraph (a)(2) of this section, or the income therefrom 
of any taxpayer, is deemed to exercise taxing jurisdiction over all such 
persons, property, and activities and over all income therefrom of all 
such taxpayers; thus, for example, a foreign country which imposes tax 
upon a person engaged in exploitation of oil and gas wells in its seabed 
and subsoil referred to in paragraph (a)(2) of this section is deemed to 
exercise taxing jurisdiction over property related to exploration for 
other natural deposits in such seabed and subsoil. A foreign country is 
deemed to be imposing tax upon a person, property, activity, or income 
described in the preceding sentence if such foreign country exempts such 
person, property, activity, or income from tax for a period not in 
excess of 10 years from the commencement of such exploration or 
exploitation. Except in the case of a foreign country which is deemed 
under the preceding sentence to impose tax by virtue of an exemption for 
a period not in excess of 10 years, a foreign country which exempts all 
persons, property, and activities engaged in or related to the 
exploration for, or exploitation of, natural resources in the seabed or 
subsoil referred to in paragraph (a)(2) of this section and the income 
therefrom, from taxation is deemed not to be exercising, directly or 
indirectly, taxing jurisdiction for purposes of paragraph (a)(2) of this 
section. For purposes of paragraph (a)(2) of this section, the exercise 
of taxing jurisdiction with respect to any type of tax constitutes the 
exercise of taxing jurisdiction with respect to all types of taxes. 
However, a royalty or other charge (whether payable in a lump sum or 
over a period of time or in amounts dependent upon the volume of 
production of natural resources) for the right to explore for or exploit 
natural resources does not constitute a tax.
    (c) Scope. (1) For purposes of applying this section, persons, 
property, or activities which are engaged in or related to the 
exploration for, or exploitation of, mines, oil and gas wells, or other 
natural deposits need not be physically upon, connected, or attached to 
the seabed or subsoil referred to in subparagraph (1) or (2) of 
paragraph (a) of this section to be deemed to be within the United 
States, a possession of the United States, or a foreign country, as the 
case may be, to the extent provided in subparagraph (2) or (3) and 
subparagraph (4) of this paragraph.

[[Page 580]]

    (2) Persons, property, or activities which are not in a foreign 
country (determined without regard to section 638 or this section), and 
which are engaged in or related to the exploration for, or exploitation 
of, mines, oil and gas wells, or other natural deposits of the seabed or 
subsoil referred to in paragraph (a)(1) of this section, are generally 
within the United States or a possession of the United States, as the 
case may be, unless such persons, property, or activities are solely 
involved in or constitute transportation to (or from) the site of 
exploration or exploitation from (or to) a foreign country, other than 
transportation on a regular basis from (or to) a base of operations.
    (3) Persons, property, or activities which are not in the United 
States or in a third country (determined in each case without regard to 
section 638 or this section), and which are engaged in or related to the 
exploration for, or exploitation of, mines, oil and gas wells, or other 
natural deposits of the seabed or subsoil of a foreign country referred 
to in paragraph (a)(2) of this section, are generally within such 
foreign country, unless such persons, property, or activities are solely 
involved in or constitute transportation to (or from) the site of 
exploration or exploitation from (or to) the United States or a 
possession of the United States or a third country, as the case may be, 
other than transportation on a regular basis from (or to) a base of 
operations.
    (4) Persons, property, or activities are within the United States, a 
possession of the United States, or a foreign country, as the case may 
be, pursuant to this paragraph, only to the extent such persons, 
property, or activities are engaged in or related to the exploration for 
or exploitation of, mines, oil and gas wells, or other natural deposits.
    (d) Natural deposits and natural resources. For purposes of this 
section, the terms natural deposits and natural resources mean nonliving 
resources to which section 611(a) applies. Such terms do not include 
sedentary species (organisms which, at the harvestable stage, either are 
immovable on or under the seabed or are unable to move except in 
constant physical contact with the seabed or subsoil), fish or other 
animal or plant life.
    (e) Rights under international law. Nothing in this section shall 
prejudice or affect the freedoms of the high seas and other rights under 
international law, or the exercise of such freedoms and rights by the 
United States or foreign countries.
    (f) Examples. The application of the provisions of section 638 and 
this section may be illustrated by the following examples:

    Example 1. A, a citizen of the United States employed as an 
engineer, is engaged in the exploitation of oil and is physically 
present on an offshore oil drilling platform operated by employees of L 
Corporation. Such platform is affixed to the foreign continental shelf 
of foreign country X. Assuming that foreign country X exercises taxing 
jurisdiction as provided in paragraph (b) of this section, A is to be 
treated as being employed in foreign country X with respect to 
compensation for his employment for purposes of chapters 1 and 24.
    Example 2. The facts are the same as in example 1 except that B, a 
citizen of the United States engaged in the private practice of law, is 
physically present on such platform for the sole purpose of interviewing 
his client, A, whom he represents in a domestic relations matter. Since 
B is not engaged in activities related to the exploration for, or 
exploitation of, natural deposits, he is not to be treated as being in 
foreign country X for purposes of chapters 1 and 2.
    Example 3. The facts are the same as in example 1 except that C, a 
citizen of the United States engaged in the private practice of 
medicine, is physically present on such platform for the purpose of 
making routine physical examinations of L Corporation's employees who 
are engaged in the exploitation of oil on the platform. C is paid by L 
Corporation to give such examinations on the platform at regular 
intervals in order to determine whether the state of any employee's 
health is such that he should not continue work on the platform. The 
balance of C's medical practice is conducted at his office on the U.S. 
mainland. Since C is engaged in activities related to the exploitation 
of oil, he is treated as being in foreign country X under section 638 
and this section while making physical examinations on L Corporation's 
platform, provided that foreign country X exercise taxing jurisdiction 
as provided in paragraph (b) of this section. For purposes of chapters 1 
and 2, amounts paid by L Corporation to C are treated as derived from 
sources within foreign country X.
    Example 4. C, a nonresident alien individual employed as an engineer 
in a foreign country, designs equipment for use on oil drilling

[[Page 581]]

platforms affixed to the continental shelf of the United States and 
engaged in the exploitation of oil. Although C's activities in this 
respect are related to the exploitation of oil, C is not treated as 
being in the United States under section 638 and this section by reason 
of such activities.
    Example 5. M Corporation, a domestic corporation, chartered a ship 
from N Corporation, also a domestic corporation, under a time charter 
under which N Corporation's personnel continued to navigate and manage 
the shop. M Corporation equipped the ship with special oil exploration 
equipment and furnished its personnel to operate the equipment. The ship 
then commenced to explore for oil in the foreign Continental Shelf of 
foreign country Y. Foreign country Y exercises taxing jurisdiction as 
provided in paragraph (b) of this section. The ship is treated as being 
within foreign country Y under section 638 and this section for the 
period it was engaged in the exploration for oil in such foreign 
Continental Shelf. Thus, the entire income derived during such period by 
N Corporation from the charter is income derived from sources within 
foreign country Y, since N Corporation had property and employees 
engaged in the exploration for oil in such foreign Continental Shelf.
    Example 6. The facts are the same as in example 5 except that C, a 
citizen of the United States, was employed by N Corporation as a cook 
and was physically present on the ship. C's sole duties consisted of 
cooking meals for personnel aboard such ship. In such case, as C's 
activities are related to the exploration for oil, C is to be treated as 
being in foreign country Y under section 638 and this section for the 
period he was aboard such ship while it was engaged in activities 
relating to the exploration for oil in the foreign Continental Shelf 
referred to in example 5. For purposes of chapters 1 and 24, C's 
compensation as a cook for such period is treated as derived from 
sources without the United States.
    Example 7. Z Corporation, a foreign corporation, entered into a 
contract with Y Corporation, a United States corporation, to engage in 
exploratory oil drilling activities on a leasehold held by Y 
Corporation. Such leasehold was located in the Continental Shelf of the 
United States. Since Z Corporation is engaged in and has property and 
activities which are engaged in the exploration for oil, such property 
and activities are to be treated as being in the United States under 
section 638 and this section for the period such property and activities 
were engaged in or related to the exploration for oil in the Continental 
Shelf of the United States and were not in a foreign country. For 
purposes of chapters 1 and 3, amounts paid to Z Corporation pursuant to 
the contract are treated as derived from sources within the United 
States.
    Example 8. M Corporation is a controlled foreign corporation (within 
the meaning of section 957(b)) for its entire taxable year beginning in 
1972. During such taxable year, M Corporation issues a policy of 
insurance relating to fire damage to an offshore oil drilling platform, 
owned by N Corporation (a foreign corporation), which is attached to the 
Continental Shelf of the United States. The income attributable to the 
issuing of such policy would be taxed under subchapter L, chapter 1, 
subtitle A of the Code (as modified, for this purpose, by section 953(b) 
(1), (2), and (3)) if such income were the income of a domestic 
insurance corporation. Since N Corporation's oil drilling platform is 
located within the United States under section 638 and this section, M 
Corporation's income attributable to the issuing of the insurance in 
connection with such platform is income derived from the insurance of 
United States risks, within the meaning of section 953(a)(1)(A).

[T.D. 7277, 38 FR 12740, May 15, 1973]



Sec.  1.638-2  Effective date.

    The specific requirements and limitations of Sec.  1.638-1 apply on 
and after December 30, 1969.

[T.D. 7277, 38 FR 12742, May 15, 1973]



Sec. Sec.  1.639-1.640  [Reserved]

[[Page 583]]



                              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 585]]



                    Table of CFR Titles and Chapters




                      (Revised as of April 1, 2021)

                      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--599)
        VI  National Capital Planning Commission (Parts 600--699)

                    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  Department of Housing and Urban Development (Parts 
                2400--2499)
       XXV  National Science Foundation (Parts 2500--2599)
      XXVI  National Archives and Records Administration (Parts 
                2600--2699)

[[Page 586]]

     XXVII  Small Business Administration (Parts 2700--2799)
    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)

                   Title 5--Administrative Personnel

         I  Office of Personnel Management (Parts 1--1199)
        II  Merit Systems Protection Board (Parts 1200--1299)
       III  Office of Management and Budget (Parts 1300--1399)
        IV  Office of Personnel Management and Office of the 
                Director of National Intelligence (Parts 1400--
                1499)
         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)

[[Page 587]]

    XXVIII  Department of Justice (Parts 3800--3899)
      XXIX  Federal Communications Commission (Parts 3900--3999)
       XXX  Farm Credit System Insurance Corporation (Parts 4000--
                4099)
      XXXI  Farm Credit Administration (Parts 4100--4199)
    XXXIII  U.S. International Development Finance Corporation 
                (Parts 4300--4399)
     XXXIV  Securities and Exchange Commission (Parts 4400--4499)
      XXXV  Office of Personnel Management (Parts 4500--4599)
     XXXVI  Department of Homeland Security (Parts 4600--4699)
    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)

[[Page 588]]

     LXXIV  Federal Mine Safety and Health Review Commission 
                (Parts 8400--8499)
     LXXVI  Federal Retirement Thrift Investment Board (Parts 
                8600--8699)
    LXXVII  Office of Management and Budget (Parts 8700--8799)
      LXXX  Federal Housing Finance Agency (Parts 9000--9099)
   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)
    XCVIII  Council of the Inspectors General on Integrity and 
                Efficiency (Parts 9800--9899)
      XCIX  Military Compensation and Retirement Modernization 
                Commission (Parts 9900--9999)
         C  National Council on Disability (Parts 10000--10049)
        CI  National Mediation Board (Part 10101)

                      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  Agricultural Marketing Service (Federal Grain 
                Inspection Service, Fair Trade Practices Program), 
                Department of Agriculture (Parts 800--899)

[[Page 589]]

        IX  Agricultural Marketing Service (Marketing Agreements 
                and Orders; Fruits, Vegetables, Nuts), Department 
                of Agriculture (Parts 900--999)
         X  Agricultural Marketing Service (Marketing Agreements 
                and Orders; Milk), Department of Agriculture 
                (Parts 1000--1199)
        XI  Agricultural Marketing Service (Marketing Agreements 
                and Orders; Miscellaneous Commodities), Department 
                of Agriculture (Parts 1200--1299)
       XIV  Commodity Credit Corporation, Department of 
                Agriculture (Parts 1400--1499)
        XV  Foreign Agricultural Service, Department of 
                Agriculture (Parts 1500--1599)
       XVI  (Parts 1600--1699) [Reserved]
      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  (Parts 2200--2299) [Reserved]
       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)

[[Page 590]]

         L  Rural Business-Cooperative Service, Rural Housing 
                Service, and Rural Utilities Service, Department 
                of Agriculture (Part 5001)

                    Title 8--Aliens and Nationality

         I  Department of Homeland Security (Parts 1--499)
         V  Executive Office for Immigration Review, Department of 
                Justice (Parts 1000--1399)

                 Title 9--Animals and Animal Products

         I  Animal and Plant Health Inspection Service, Department 
                of Agriculture (Parts 1--199)
        II  Agricultural Marketing Service (Fair Trade Practices 
                Program), 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  (Parts 500--599) [Reserved]
        VI  Farm Credit Administration (Parts 600--699)
       VII  National Credit Union Administration (Parts 700--799)
      VIII  Federal Financing Bank (Parts 800--899)
        IX  (Parts 900--999) [Reserved]
         X  Bureau of Consumer Financial Protection (Parts 1000--
                1099)

[[Page 591]]

        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, Department of the 
                Treasury (Parts 1600--1699)
      XVII  Office of Federal Housing Enterprise Oversight, 
                Department of Housing and Urban Development (Parts 
                1700--1799)
     XVIII  Community Development Financial Institutions Fund, 
                Department of the Treasury (Parts 1800--1899)

               Title 13--Business Credit and Assistance

         I  Small Business Administration (Parts 1--199)
       III  Economic Development Administration, Department of 
                Commerce (Parts 300--399)
        IV  Emergency Steel Guarantee Loan Board (Parts 400--499)
         V  Emergency Oil and Gas Guaranteed Loan Board (Parts 
                500--599)

                    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)

[[Page 592]]

      VIII  Bureau of Economic Analysis, Department of Commerce 
                (Parts 800--899)
        IX  National Oceanic and Atmospheric Administration, 
                Department of Commerce (Parts 900--999)
        XI  National Technical Information Service, Department of 
                Commerce (Parts 1100--1199)
      XIII  East-West Foreign Trade Board (Parts 1300--1399)
       XIV  Minority Business Development Agency (Parts 1400--
                1499)
            Subtitle C--Regulations Relating to Foreign Trade 
                Agreements
        XX  Office of the United States Trade Representative 
                (Parts 2000--2099)
            Subtitle D--Regulations Relating to Telecommunications 
                and Information
     XXIII  National Telecommunications and Information 
                Administration, Department of Commerce (Parts 
                2300--2399) [Reserved]

                    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) [Reserved]

[[Page 593]]

                     Title 20--Employees' Benefits

         I  Office of Workers' Compensation Programs, Department 
                of Labor (Parts 1--199)
        II  Railroad Retirement Board (Parts 200--399)
       III  Social Security Administration (Parts 400--499)
        IV  Employees' Compensation Appeals Board, Department of 
                Labor (Parts 500--599)
         V  Employment and Training Administration, Department of 
                Labor (Parts 600--699)
        VI  Office of Workers' Compensation Programs, Department 
                of Labor (Parts 700--799)
       VII  Benefits Review Board, Department of Labor (Parts 
                800--899)
      VIII  Joint Board for the Enrollment of Actuaries (Parts 
                900--999)
        IX  Office of the Assistant Secretary for Veterans' 
                Employment and Training Service, Department of 
                Labor (Parts 1000--1099)

                       Title 21--Food and Drugs

         I  Food and Drug Administration, Department of Health and 
                Human Services (Parts 1--1299)
        II  Drug Enforcement Administration, Department of Justice 
                (Parts 1300--1399)
       III  Office of National Drug Control Policy (Parts 1400--
                1499)

                      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  United States Agency for Global Media (Parts 500--599)
       VII  U.S. International Development Finance 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)

[[Page 594]]

                          Title 23--Highways

         I  Federal Highway Administration, Department of 
                Transportation (Parts 1--999)
        II  National Highway Traffic Safety Administration and 
                Federal Highway Administration, Department of 
                Transportation (Parts 1200--1299)
       III  National Highway Traffic Safety Administration, 
                Department of Transportation (Parts 1300--1399)

                Title 24--Housing and Urban Development

            Subtitle A--Office of the Secretary, Department of 
                Housing and Urban Development (Parts 0--99)
            Subtitle B--Regulations Relating to Housing and Urban 
                Development
         I  Office of Assistant Secretary for Equal Opportunity, 
                Department of Housing and Urban Development (Parts 
                100--199)
        II  Office of Assistant Secretary for Housing-Federal 
                Housing Commissioner, Department of Housing and 
                Urban Development (Parts 200--299)
       III  Government National Mortgage Association, Department 
                of Housing and Urban Development (Parts 300--399)
        IV  Office of Housing and Office of Multifamily Housing 
                Assistance Restructuring, Department of Housing 
                and Urban Development (Parts 400--499)
         V  Office of Assistant Secretary for Community Planning 
                and Development, Department of Housing and Urban 
                Development (Parts 500--599)
        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) [Reserved]
       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)

[[Page 595]]

      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)
        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--899)
         V  Bureau of Indian Affairs, Department of the Interior, 
                and Indian Health Service, Department of Health 
                and Human Services (Part 900--999)
        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--799)

                   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)

[[Page 596]]

                            Title 29--Labor

            Subtitle A--Office of the Secretary of Labor (Parts 
                0--99)
            Subtitle B--Regulations Relating to Labor
         I  National Labor Relations Board (Parts 100--199)
        II  Office of Labor-Management Standards, Department of 
                Labor (Parts 200--299)
       III  National Railroad Adjustment Board (Parts 300--399)
        IV  Office of Labor-Management Standards, Department of 
                Labor (Parts 400--499)
         V  Wage and Hour Division, Department of Labor (Parts 
                500--899)
        IX  Construction Industry Collective Bargaining Commission 
                (Parts 900--999)
         X  National Mediation Board (Parts 1200--1299)
       XII  Federal Mediation and Conciliation Service (Parts 
                1400--1499)
       XIV  Equal Employment Opportunity Commission (Parts 1600--
                1699)
      XVII  Occupational Safety and Health Administration, 
                Department of Labor (Parts 1900--1999)
        XX  Occupational Safety and Health Review Commission 
                (Parts 2200--2499)
       XXV  Employee Benefits Security Administration, Department 
                of Labor (Parts 2500--2599)
     XXVII  Federal Mine Safety and Health Review Commission 
                (Parts 2700--2799)
        XL  Pension Benefit Guaranty Corporation (Parts 4000--
                4999)

                      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)

[[Page 597]]

        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 Investment Security, Department of the 
                Treasury (Parts 800--899)
        IX  Federal Claims Collection Standards (Department of the 
                Treasury--Department of Justice) (Parts 900--999)
         X  Financial Crimes Enforcement Network, Department of 
                the Treasury (Parts 1000--1099)

                      Title 32--National Defense

            Subtitle A--Department of Defense
         I  Office of the Secretary of Defense (Parts 1--399)
         V  Department of the Army (Parts 400--699)
        VI  Department of the Navy (Parts 700--799)
       VII  Department of the Air Force (Parts 800--1099)
            Subtitle B--Other Regulations Relating to National 
                Defense
       XII  Department of Defense, 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, Department 
                of Defense (Parts 200--399)
        IV  Great Lakes St. 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

[[Page 598]]

         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)
         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  (Parts 1100--1199) [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  National Institute of Standards and Technology, 
                Department of Commerce (Parts 400--599)

[[Page 599]]

           Title 38--Pensions, Bonuses, and Veterans' Relief

         I  Department of Veterans Affairs (Parts 0--199)
        II  Armed Forces Retirement Home (Parts 200--299)

                       Title 39--Postal Service

         I  United States Postal Service (Parts 1--999)
       III  Postal Regulatory Commission (Parts 3000--3099)

                  Title 40--Protection of Environment

         I  Environmental Protection Agency (Parts 1--1099)
        IV  Environmental Protection Agency and Department of 
                Justice (Parts 1400--1499)
         V  Council on Environmental Quality (Parts 1500--1599)
        VI  Chemical Safety and Hazard Investigation Board (Parts 
                1600--1699)
       VII  Environmental Protection Agency and Department of 
                Defense; Uniform National Discharge Standards for 
                Vessels of the Armed Forces (Parts 1700--1799)
      VIII  Gulf Coast Ecosystem Restoration Council (Parts 1800--
                1899)
        IX  Federal Permitting Improvement Steering Council (Part 
                1900)

          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  (Parts 103-001--104-099) [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]

[[Page 600]]

            Subtitle D--Other Provisions Relating to Property 
                Management [Reserved]
            Subtitle E--Federal Information Resources Management 
                Regulations System [Reserved]
            Subtitle F--Federal Travel Regulation System
       300  General (Parts 300-1--300-99)
       301  Temporary Duty (TDY) Travel Allowances (Parts 301-1--
                301-99)
       302  Relocation Allowances (Parts 302-1--302-99)
       303  Payment of Expenses Connected with the Death of 
                Certain Employees (Part 303-1--303-99)
       304  Payment of Travel Expenses from a Non-Federal Source 
                (Parts 304-1--304-99)

                        Title 42--Public Health

         I  Public Health Service, Department of Health and Human 
                Services (Parts 1--199)
   II--III  [Reserved]
        IV  Centers for Medicare & Medicaid Services, Department 
                of Health and Human Services (Parts 400--699)
         V  Office of Inspector General-Health Care, Department of 
                Health and Human Services (Parts 1000--1099)

                   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

[[Page 601]]

        II  Office of Family Assistance (Assistance Programs), 
                Administration for Children and Families, 
                Department of Health and Human Services (Parts 
                200--299)
       III  Office of Child Support Enforcement (Child Support 
                Enforcement Program), Administration for Children 
                and Families, Department of Health and Human 
                Services (Parts 300--399)
        IV  Office of Refugee Resettlement, Administration for 
                Children and Families, Department of Health and 
                Human Services (Parts 400--499)
         V  Foreign Claims Settlement Commission of the United 
                States, Department of Justice (Parts 500--599)
        VI  National Science Foundation (Parts 600--699)
       VII  Commission on Civil Rights (Parts 700--799)
      VIII  Office of Personnel Management (Parts 800--899)
        IX  Denali Commission (Parts 900--999)
         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  Administration for Children and Families, 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 of Fine Arts (Parts 2100--2199)
     XXIII  Arctic Research Commission (Parts 2300--2399)
      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)

[[Page 602]]

       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)
         V  The First Responder Network Authority (Parts 500--599)

           Title 48--Federal Acquisition Regulations System

         1  Federal Acquisition Regulation (Parts 1--99)
         2  Defense Acquisition Regulations System, Department of 
                Defense (Parts 200--299)
         3  Department of Health and Human Services (Parts 300--
                399)
         4  Department of Agriculture (Parts 400--499)
         5  General Services Administration (Parts 500--599)
         6  Department of State (Parts 600--699)
         7  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) [Reserved]
        52  Department of the Navy Acquisition Regulations (Parts 
                5200--5299)

[[Page 603]]

        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)
        99  Cost Accounting Standards Board, Office of Federal 
                Procurement Policy, Office of Management and 
                Budget (Parts 9900--9999)

                       Title 49--Transportation

            Subtitle A--Office of the Secretary of Transportation 
                (Parts 1--99)
            Subtitle B--Other Regulations Relating to 
                Transportation
         I  Pipeline and Hazardous Materials Safety 
                Administration, Department of Transportation 
                (Parts 100--199)
        II  Federal Railroad Administration, Department of 
                Transportation (Parts 200--299)
       III  Federal Motor Carrier Safety Administration, 
                Department of Transportation (Parts 300--399)
        IV  Coast Guard, Department of Homeland Security (Parts 
                400--499)
         V  National Highway Traffic Safety Administration, 
                Department of Transportation (Parts 500--599)
        VI  Federal Transit Administration, Department of 
                Transportation (Parts 600--699)
       VII  National Railroad Passenger Corporation (AMTRAK) 
                (Parts 700--799)
      VIII  National Transportation Safety Board (Parts 800--999)
         X  Surface Transportation Board (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)

[[Page 604]]

        VI  Fishery Conservation and Management, National Oceanic 
                and Atmospheric Administration, Department of 
                Commerce (Parts 600--699)

[[Page 605]]





           Alphabetical List of Agencies Appearing in the CFR




                      (Revised as of April 1, 2021)

                                                  CFR Title, Subtitle or 
                     Agency                               Chapter

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     5, 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, VIII, IX, X, XI; 9, 
                                                  II
Agricultural Research Service                     7, V
Agriculture, Department of                        2, IV; 5, LXXIII
  Advocacy and Outreach, Office of                7, XXV
  Agricultural Marketing Service                  7, I, VIII, IX, X, XI; 9, 
                                                  II
  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
  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
  Rural Development Administration                7, XLII
  Rural Housing Service                           7, XVIII, XXXV
  Rural Utilities Service                         7, XVII, XVIII, XLII
  Secretary of Agriculture, Office of             7, Subtitle A
  Transportation, Office of                       7, XXXIII
  World Agricultural Outlook Board                7, XXXVIII
Air Force, Department of                          32, VII
  Federal Acquisition Regulation Supplement       48, 53
Air Transportation Stabilization Board            14, VI
Alcohol and Tobacco Tax and Trade Bureau          27, I
Alcohol, Tobacco, Firearms, and Explosives,       27, II
     Bureau of
AMTRAK                                            49, VII
American Battle Monuments Commission              36, IV
American Indians, Office of the Special Trustee   25, VII
Animal and Plant Health Inspection Service        7, III; 9, I
Appalachian Regional Commission                   5, IX
Architectural and Transportation Barriers         36, XI
   Compliance Board
[[Page 606]]

Arctic Research Commission                        45, XXIII
Armed Forces Retirement Home                      5, XI; 38, II
Army, Department of                               32, V
  Engineers, Corps of                             33, II; 36, III
  Federal Acquisition Regulation                  48, 51
Benefits Review Board                             20, VII
Bilingual Education and Minority Languages        34, V
     Affairs, Office of
Blind or Severely Disabled, Committee for         41, 51
     Purchase from People Who Are
  Federal Acquisition Regulation                  48, 19
Career, Technical, and Adult Education, Office    34, IV
     of
Census Bureau                                     15, I
Centers for Medicare & Medicaid Services          42, IV
Central Intelligence Agency                       32, XIX
Chemical Safety and Hazard Investigation Board    40, VI
Chief Financial Officer, Office of                7, XXX
Child Support Enforcement, Office of              45, III
Children and Families, Administration for         45, II, III, IV, X, XIII
Civil Rights, Commission on                       5, LXVIII; 45, VII
Civil Rights, Office for                          34, I
Coast Guard                                       33, I; 46, I; 49, IV
Coast Guard (Great Lakes Pilotage)                46, III
Commerce, Department of                           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; 37, IV
  National Marine Fisheries Service               50, II, IV
  National Oceanic and Atmospheric                15, IX; 50, II, III, IV, 
       Administration                             VI
  National Technical Information Service          15, XI
  National Telecommunications and Information     15, XXIII; 47, III, IV
       Administration
  National Weather Service                        15, IX
  Patent and Trademark Office, United States      37, I
  Secretary of Commerce, Office of                15, Subtitle A
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
Council of the Inspectors General on Integrity    5, XCVIII
     and Efficiency
Court Services and Offender Supervision Agency    5, LXX; 28, VIII
     for the District of Columbia
Customs and Border Protection                     19, I
Defense, Department of                            2, XI; 5, XXVI; 32, 
                                                  Subtitle A; 40, VII
  Advanced Research Projects Agency               32, I
  Air Force Department                            32, VII
  Army Department                                 32, V; 33, II; 36, III; 
                                                  48, 51
  Defense Acquisition Regulations System          48, 2
  Defense Intelligence Agency                     32, I
  Defense Logistics Agency                        32, I, XII; 48, 54

[[Page 607]]

  Engineers, Corps of                             33, II; 36, III
  National Imagery and Mapping Agency             32, I
  Navy, Department of                             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
Denali Commission                                 45, IX
Disability, National Council on                   5, C; 34, XII
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
  Career, Technical, and Adult Education, Office  34, IV
       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
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 Policy, National Commission for        1, IV
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, II
  Presidential Documents                          3
  Science and Technology Policy, Office of        32, XXIV; 47, II
  Trade Representative, Office of the United      15, XX
       States
Export-Import Bank of the United States           2, XXXV; 5, LII; 12, IV
Family Assistance, Office of                      45, II

[[Page 608]]

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 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 Permitting Improvement Steering Council   40, IX
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 of                          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
  Federal Acquisition Regulation                  48, 5
  Federal Management Regulation                   41, 102
  Federal Property Management Regulations         41, 101
  Federal Travel Regulation System                41, Subtitle F

[[Page 609]]

  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, XIII
  Community Services, Office of                   45, X
  Family Assistance, Office of                    45, II
  Federal Acquisition Regulation                  48, 3
  Food and Drug Administration                    21, I
  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; 5, XXXVI; 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, Office of, and Multifamily Housing       24, IV
     Assistance Restructuring, Office 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
Immigration and Customs Enforcement Bureau        19, IV
Immigration Review, Executive Office for          8, V
Independent Counsel, Office of                    28, VII
Independent Counsel, Offices of                   28, VI
Indian Affairs, Bureau of                         25, I, V
Indian Affairs, Office of the Assistant           25, VI
     Secretary
Indian Arts and Crafts Board                      25, II
Indian Health Service                             25, V
Industry and Security, Bureau of                  15, VII

[[Page 610]]

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 of                           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 Development Finance Corporation,    5, XXXIII; 22, VII
     U.S.
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 of                            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
  Independent Counsel, Offices of                 28, VI
  Prisons, Bureau of                              28, V
  Property Management Regulations                 41, 128
Labor, Department of                              2, XXIX; 5, XLII
  Benefits Review Board                           20, VII
  Employee Benefits Security Administration       29, XXV
  Employees' Compensation Appeals Board           20, IV
  Employment and Training Administration          20, V
  Federal Acquisition Regulation                  48, 29
  Federal Contract Compliance Programs, Office    41, 60
       of
  Federal Procurement Regulations System          41, 50
  Labor-Management Standards, Office of           29, II, IV

[[Page 611]]

  Mine Safety and Health Administration           30, I
  Occupational Safety and Health Administration   29, XVII
  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, VI
Labor-Management Standards, Office of             29, II, IV
Land Management, Bureau of                        43, II
Legal Services Corporation                        45, XVI
Libraries and Information Science, National       45, XVII
     Commission on
Library of Congress                               36, VII
  Copyright Royalty Board                         37, III
  U.S. Copyright Office                           37, II
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, XCIX
     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     2, XVIII; 5, LIX; 14, V
  Federal Acquisition Regulation                  48, 18
National Agricultural Library                     7, XLI
National Agricultural Statistics Service          7, XXXVI
National and Community Service, Corporation for   2, XXII; 45, XII, XXV
National Archives and Records Administration      2, XXVI; 5, LXVI; 36, XII
  Information Security Oversight Office           32, XX
National Capital Planning Commission              1, IV, VI
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 Geospatial-Intelligence Agency           32, I
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; 37, IV
National Intelligence, Office of Director of      5, IV; 32, XVII
National Labor Relations Board                    5, LXI; 29, I
National Marine Fisheries Service                 50, II, IV
National Mediation Board                          5, CI; 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
National Security Council                         32, XXI; 47, II
National Technical Information Service            15, XI
National Telecommunications and Information       15, XXIII; 47, III, IV, V
   Administration
[[Page 612]]

National Transportation Safety Board              49, VIII
Natural Resource Revenue, Office of               30, XII
Natural Resources Conservation Service            7, VI
Navajo and Hopi Indian Relocation, Office of      25, IV
Navy, Department of                               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
Oklahoma City National Memorial Trust             36, XV
Operations Office                                 7, XXVIII
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, IV, XXXV; 45, VIII
  Federal Acquisition Regulation                  48, 17
  Federal Employees Group Life Insurance Federal  48, 21
       Acquisition Regulation
  Federal Employees Health Benefits Acquisition   48, 16
       Regulation
  Human Resources Management and Labor Relations  5, XCVII
       Systems, Department of Homeland Security
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
Public and Indian Housing, Office of Assistant    24, IX
     Secretary for
Public Contracts, Department of Labor             41, 50
Public Health Service                             42, I
Railroad Retirement Board                         20, II
Reclamation, Bureau of                            43, I
Refugee Resettlement, Office of                   45, IV
Relocation Allowances                             41, 302
Research and Innovative Technology                49, XI
     Administration
Rural Business-Cooperative Service                7, XVIII, XLII
Rural Development Administration                  7, XLII
Rural Housing Service                             7, XVIII, XXXV
Rural Utilities Service                           7, XVII, XVIII, XLII
Safety and Environmental Enforcement, Bureau of   30, II
Saint Lawrence Seaway Development Corporation     33, IV
Science and Technology Policy, Office of, and     32, XXIV; 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 of                              2, VI; 22, I; 28, XI
  Federal Acquisition Regulation                  48, 6

[[Page 613]]

Surface Mining Reclamation and Enforcement,       30, VII
     Office of
Surface Transportation Board                      49, X
Susquehanna River Basin Commission                18, VIII
Tennessee Valley Authority                        5, LXIX; 18, XIII
Trade Representative, United States, Office of    15, XX
Transportation, Department of                     2, XII; 5, L
  Commercial Space Transportation                 14, III
  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
  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 of the                       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
Truman, Harry S. Scholarship Foundation           45, XVIII
United States Agency for Global Media             22, V
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
Veterans Affairs, Department of                   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
Wage and Hour Division                            29, V
Water Resources Council                           18, VI
Workers' Compensation Programs, Office of         20, I, VII
World Agricultural Outlook Board                  7, XXXVIII

[[Page 615]]







                      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
1.25-1T....................................................    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
1.42-5.....................................................    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
1.47-1.....................................................    1545-0155
                                                               1545-0166
1.47-3.....................................................    1545-0155
                                                               1545-0166
1.47-4.....................................................    1545-0123
1.47-5.....................................................    1545-0092
1.47-6.....................................................    1545-0099
1.48-3.....................................................    1545-0155
1.48-4.....................................................    1545-0155
                                                               1545-0808
1.48-5.....................................................    1545-0155
1.48-6.....................................................    1545-0155
1.48-12....................................................    1545-0155
                                                               1545-1783
1.50A-1....................................................    1545-0895
1.50A-2....................................................    1545-0895
1.50A-3....................................................    1545-0895
1.50A-4....................................................    1545-0895
1.50A-5....................................................    1545-0895
1.50A-6....................................................    1545-0895
1.50A-7....................................................    1545-0895
1.50B-1....................................................    1545-0895
1.50B-2....................................................    1545-0895
1.50B-3....................................................    1545-0895
1.50B-4....................................................    1545-0895
1.50B-5....................................................    1545-0895
1.51-1.....................................................    1545-0219

[[Page 616]]

 
                                                               1545-0241
                                                               1545-0244
                                                               1545-0797
1.52-2.....................................................    1545-0219
1.52-3.....................................................    1545-0219
1.56(g)-1..................................................    1545-1233
1.57-5.....................................................    1545-0227
1.58-1.....................................................    1545-0175
1.59-1.....................................................    1545-1903
1.61-2.....................................................    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
1.103A-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
1.132-2....................................................    1545-0771
1.132-5....................................................    1545-0771
1.132-9(b).................................................    1545-1676
1.141-1....................................................    1545-1451
1.141-12...................................................    1545-1451
1.142-2....................................................    1545-1451
1.142(f)(4)-1..............................................    1545-1730
1.148-0....................................................    1545-1098
1.148-1....................................................    1545-1098
1.148-2....................................................    1545-1098
                                                               1545-1347
1.148-3....................................................    1545-1098
                                                               1545-1347
1.148-4....................................................    1545-1098
                                                               1545-1347
1.148-5....................................................    1545-1098
                                                               1545-1490
1.148-6....................................................    1545-1098
                                                               1545-1451
1.148-7....................................................    1545-1098
                                                               1545-1347
1.148-8....................................................    1545-1098
1.148-11...................................................    1545-1098
                                                               1545-1347
1.149(e)-1.................................................    1545-0720
1.150-1....................................................    1545-1347
1.151-1....................................................    1545-0074
1.152-3....................................................    1545-0071
                                                               1545-1783
1.152-4....................................................    1545-0074
1.152-4T...................................................    1545-0074
1.162-1....................................................    1545-0139
1.162-2....................................................    1545-0139
1.162-3....................................................    1545-0139
1.162-4....................................................    1545-0139
1.162-5....................................................    1545-0139
1.162-6....................................................    1545-0139
1.162-7....................................................    1545-0139
1.162-8....................................................    1545-0139
1.162-9....................................................    1545-0139
1.162-10...................................................    1545-0139
1.162-11...................................................    1545-0139
1.162-12...................................................    1545-0139
1.162-13...................................................    1545-0139
1.162-14...................................................    1545-0139
1.162-15...................................................    1545-0139
1.162-16...................................................    1545-0139
1.162-17...................................................    1545-0139
1.162-18...................................................    1545-0139
1.162-19...................................................    1545-0139
1.162-20...................................................    1545-0139
1.162-24...................................................    1545-2115
1.162-27...................................................    1545-1466
1.163-5....................................................    1545-0786
                                                               1545-1132
1.163-8T...................................................    1545-0995
1.163-10T..................................................    1545-0074
1.163-13...................................................    1545-1491
1.163(d)-1.................................................    1545-1421
1.165-1....................................................    1545-0177
1.165-2....................................................    1545-0177
1.165-3....................................................    1545-0177
1.165-4....................................................    1545-0177
1.165-5....................................................    1545-0177
1.165-6....................................................    1545-0177
1.165-7....................................................    1545-0177
1.165-8....................................................    1545-0177
1.165-9....................................................    1545-0177
1.165-10...................................................    1545-0177
1.165-11...................................................    1545-0074
                                                               1545-0177
                                                               1545-0786
1.165-12...................................................    1545-0786
1.166-1....................................................    1545-0123
1.166-2....................................................    1545-1254
1.166-4....................................................    1545-0123
1.166-10...................................................    1545-0123
1.167(a)-5T................................................    1545-1021
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(i)-1.................................................    1545-1331
1.168-5....................................................    1545-0172
1.169-4....................................................    1545-0172

[[Page 617]]

 
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
1.170A-15..................................................    1545-1953
1.170A-16..................................................    1545-1953
1.170A-17..................................................    1545-1953
1.170A-18..................................................    1545-1953
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
1.179-2....................................................    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
1.338(h)(10)-1.............................................    1545-1658
1.338(i)-1.................................................    1545-1990
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

[[Page 618]]

 
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
1.401-14...................................................    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)-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(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
1.432(e)(9)-1T.............................................    1545-2260
1.436-1....................................................    1545-2095
1.441-2....................................................    1545-1748
1.442-1....................................................    1545-0074
                                                               1545-0123
                                                               1545-0134
                                                               1545-0152
                                                               1545-0820
                                                               1545-1748
1.443-1....................................................    1545-0123
1.444-3T...................................................    1545-1036
1.444-4....................................................    1545-1591
1.446-1....................................................    1545-0074
                                                               1545-0152
1.446-4(d).................................................    1545-1412
1.448-1(g).................................................    1545-0152
1.448-1(h).................................................    1545-0152
1.448-1(i).................................................    1545-0152
1.448-2....................................................    1545-1855
1.448-2T...................................................    1545-0152
                                                               1545-1855
1.451-1....................................................    1545-0091
1.451-4....................................................    1545-0123
1.451-6....................................................    1545-0074
1.451-7....................................................    1545-0074
1.453-1....................................................    1545-0152
1.453-2....................................................    1545-0152
1.453-8....................................................    1545-0152
                                                               1545-0228
1.453A-1...................................................    1545-0152
                                                               1545-1134
1.453A-3...................................................    1545-0963
1.454-1....................................................    1545-0074
1.455-2....................................................    1545-0152
1.455-6....................................................    1545-0123

[[Page 619]]

 
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
1.481-4....................................................    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
1.506-1....................................................    1545-2268
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
1.529A-2...................................................    1545-2293
1.529A-5...................................................    1545-2262
1.529A-6...................................................    1545-2262
1.529A-7...................................................    1545-2262
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
1.561-1....................................................    1545-0044
1.561-2....................................................    1545-0123
1.562-3....................................................    1545-0123
1.563-2....................................................    1545-0123
1.564-1....................................................    1545-0123
1.565-1....................................................    1545-0043
                                                               1545-0123
1.565-2....................................................    1545-0043
1.565-3....................................................    1545-0043
1.565-5....................................................    1545-0043
1.565-6....................................................    1545-0043
1.585-1....................................................    1545-0123
1.585-3....................................................    1545-0123
1.585-8....................................................    1545-1290
1.597-2....................................................    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

[[Page 620]]

 
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
1.706-4(f).................................................    1545-0123
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
1.822-5....................................................    1545-1027
1.822-6....................................................    1545-1027
1.822-8....................................................    1545-1027
1.822-9....................................................    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
1.832-4....................................................    1545-1227
1.832-5....................................................    1545-0123
1.848-2(g)(8)..............................................    1545-1287
1.848-2(h)(3)..............................................    1545-1287
1.848-2(i)(4)..............................................    1545-1287
1.851-2....................................................    1545-1010
1.851-4....................................................    1545-0123
1.852-1....................................................    1545-0123
1.852-4....................................................    1545-0123
                                                               1545-0145
1.852-6....................................................    1545-0123
                                                               1545-0144
1.852-7....................................................    1545-0074
1.852-9....................................................    1545-0074
                                                               1545-0123
                                                               1545-0144
                                                               1545-0145
                                                               1545-1783
1.852-11...................................................    1545-1094
1.853-3....................................................    1545-2035
1.853-4....................................................    1545-2035
1.854-2....................................................    1545-0123
1.855-1....................................................    1545-0123
1.856-2....................................................    1545-0123
                                                               1545-1004
1.856-6....................................................    1545-0123
1.856-7....................................................    1545-0123
1.856-8....................................................    1545-0123
1.857-8....................................................    1545-0123
1.857-9....................................................    1545-0074
1.858-1....................................................    1545-0123
1.860-2....................................................    1545-0045
1.860-4....................................................    1545-0045
                                                               1545-1054
                                                               1545-1057
1.860E-1...................................................    1545-1675
1.860E-2(a)(5).............................................    1545-1276
1.860E-2(a)(7).............................................    1545-1276
1.860E-2(b)(2).............................................    1545-1276
1.860G-2...................................................    1545-2110
1.861-2....................................................    1545-0089
1.861-3....................................................    1545-0089
1.861-4....................................................    1545-1900
1.861-8....................................................    1545-0126
1.861-8(e)(6) and (g)......................................    1545-1224
1.861-9T...................................................    1545-0121
                                                               1545-1072
1.861-18...................................................    1545-1594
1.863-1....................................................    1545-1476
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

[[Page 621]]

 
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
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1.927(a)-1T................................................    1545-0935
1.927(d)-2T................................................    1545-0935
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1.1368-1(g)(2).............................................    1545-1139
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1.1402(c)-2................................................    1545-0074
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1.1402(h)-1................................................    1545-0064
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1.1502-77A.................................................    1545-0123
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1.1502-77B.................................................    1545-1699
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1.1503(d)-3................................................    1545-1946
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1.6015(i)-1................................................    1545-0087
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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
1.6654-1...................................................    1545-0087
                                                               1545-0140
1.6654-2...................................................    1545-0087
1.6654-3...................................................    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
1.6696-1...................................................    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

[[Page 626]]

 
5c.305-1...................................................    1545-0110
5c.442-1...................................................    1545-0152
5f.103-1...................................................    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
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
20.2010-2..................................................    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
                                                               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

[[Page 627]]

 
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(r)-1...............................................    1545-0029
31.3121(s)-1...............................................    1545-0029
31.3121(v)(2)-1............................................    1545-1643
31.3302(a)-2...............................................    1545-0028
31.3302(a)-3...............................................    1545-0028
31.3302(b)-2...............................................    1545-0028
31.3302(e)-1...............................................    1545-0028
31.3306(c)(18)-1...........................................    1545-0029
31.3401(a)-1...............................................    1545-0029
31.3401(a)(6)..............................................    1545-1484
31.3401(a)(6)-1............................................    1545-0029
                                                               1545-0096
                                                               1545-0795
31.3401(a)(7)-1............................................    1545-0029
31.3401(a)(8)(A)-1 ........................................    1545-0029
                                                               1545-0666
31.3401(a)(8)(C)-1 ........................................    1545-0029
31.3401(a)(15)-1...........................................    1545-0182
31.3401(c)-1...............................................    1545-0004
31.3402(b)-1...............................................    1545-0010
31.3402(c)-1...............................................    1545-0010
31.3402(f)(1)-1............................................    1545-0010
31.3402(f)(2)-1............................................    1545-0010
                                                               1545-0410
31.3402(f)(3)-1............................................    1545-0010
31.3402(f)(4)-1............................................    1545-0010
31.3402(f)(4)-2............................................    1545-0010
31.3402(f)(5)-1............................................    1545-0010
                                                               1545-1435
31.3402(h)(1)-1............................................    1545-0029
31.3402(h)(3)-1............................................    1545-0010
                                                               1545-0029
31.3402(h)(4)-1............................................    1545-0010
31.3402(i)-(1).............................................    1545-0010
31.3402(i)-(2).............................................    1545-0010
31.3402(k)-1...............................................    1545-0065
31.3402(l)-(1).............................................    1545-0010
31.3402(m)-(1).............................................    1545-0010
31.3402(n)-(1).............................................    1545-0010
31.3402(o)-2...............................................    1545-0415
31.3402(o)-3...............................................    1545-0008
                                                               1545-0010
                                                               1545-0415
                                                               1545-0717
31.3402(p)-1...............................................    1545-0415
                                                               1545-0717
31.3402(q)-1...............................................    1545-0238
                                                               1545-0239
31.3404-1..................................................    1545-0029
31.3405(c)-1...............................................    1545-1341
31.3406(a)-1...............................................    1545-0112
31.3406(a)-2...............................................    1545-0112
31.3406(a)-3...............................................    1545-0112
31.3406(a)-4...............................................    1545-0112
31.3406(b)(2)-1............................................    1545-0112
31.3406(b)(2)-2............................................    1545-0112
31.3406(b)(2)-3............................................    1545-0112
31.3406(b)(2)-4............................................    1545-0112
31.3406(b)(2)-5............................................    1545-0112
31.3406(b)(3)-1............................................    1545-0112
31.3406(b)(3)-2............................................    1545-0112
31.3406(b)(3)-3............................................    1545-0112
31.3406(b)(3)-4............................................    1545-0112
31.3406(b)(4)-1............................................    1545-0112
31.3406(c)-1...............................................    1545-0112
31.3406(d)-1...............................................    1545-0112
31.3406(d)-2...............................................    1545-0112
31.3406(d)-3...............................................    1545-0112
31.3406(d)-4...............................................    1545-0112
31.3406(d)-5...............................................    1545-0112
31.3406(e)-1...............................................    1545-0112
31.3406(f)-1...............................................    1545-0112
31.3406(g)-1...............................................    1545-0096
                                                               1545-0112
                                                               1545-1819
31.3406(g)-2...............................................    1545-0112
31.3406(g)-3...............................................    1545-0112
31.3406(h)-1...............................................    1545-0112
31.3406(h)-2...............................................    1545-0112
31.3406(h)-3...............................................    1545-0112
31.3406(i)-1...............................................    1545-0112
31.3501(a)-1T..............................................    1545-0771
31.3503-1..................................................    1545-0024
31.3504-1..................................................    1545-0029
31.3511-1..................................................    1545-2266
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

[[Page 628]]

 
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
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
48.4041-19.................................................    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
48.4101-1..................................................    1545-1418
48.4101-1T.................................................    1545-1418
48.4101-2..................................................    1545-1418
48.4161(a)-1...............................................    1545-0723

[[Page 629]]

 
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
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

[[Page 630]]

 
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
54.4975-7..................................................    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
54.6011-1..................................................    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
301.6036-1.................................................    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
301.6316-4.................................................    1545-0074
301.6316-5.................................................    1545-0074
301.6316-6.................................................    1545-0074
301.6316-7.................................................    1545-0029
301.6324A-1................................................    1545-0015

[[Page 631]]

 
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
301.6511(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
301.6903-1.................................................    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
301.7705-1.................................................    1545-2266
301.7705-2.................................................    1545-2266
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
                                                               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
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
------------------------------------------------------------------------


[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.govinfo.gov.

[[Page 633]]



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, 2016 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.govinfo.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.govinfo.gov.

                                  2016

26 CFR
                                                                   81 FR
                                                                    Page
Chapter I
1.506-1T Added.....................................................45011

                                  2017

26 CFR
                                                                   82 FR
                                                                    Page
Chapter I
1.501(a)-1 (a)(2), (b)(1), (3) and (f) revised.....................29732
1.501(a)-1T Removed................................................29732
1.501(c)(3)-1 (b)(1)(v), (6) and (h) revised.......................29732
1.501(c)(3)-1T Removed.............................................29733
1.508-1 (a)(2)(i), (ii), (b)(2)(iv), (v) and (c) revised...........29733
1.508-1T Removed...................................................29733
1.597-1 (b) amended................................................48619
1.597-2 Revised....................................................48620
1.597-3 Revised....................................................48622
1.597-4 Revised....................................................48623
1.597-5 Revised....................................................48625
    (f) Example 4 and Example 5 (ii) corrected.....................61177
1.597-6 Revised....................................................48629
1.597-7 Revised....................................................48629
1.617-3 (d)(5)(ii)(b) revised.......................................6238
1.617-4 (c)(1)(i) amended...........................................6239
1.617-5 Added.......................................................6239

                                  2018

                       (No regulations published)

                                  2019

26 CFR
                                                                   84 FR
                                                                    Page
Chapter I
1.501(c)(17)-1 (a)(5) amended.......................................9235
1.501(c)(18)-1 (b)(6) amended.......................................9235
1.501(k)-1 Removed..................................................9235
1.503(c)-1 (d) amended..............................................9235
1.503(e)-4 Removed..................................................9235
1.506-1 Added......................................................35306
1.506-1T Removed...................................................35307
1.512(a)-5 Correction: amendatory instruction amended..............68042
1.512(a)-5T Removed................................................67375
1.512(a)-55 Added..................................................67373
1.551-3 Removed.....................................................9235
1.551-4 Removed.....................................................9235
1.551-5 Removed.....................................................9235
1.552-1 Removed.....................................................9235
1.552-2 Removed.....................................................9235
1.552-3 Removed.....................................................9235
1.552-4 Removed.....................................................9235
1.552-5 Removed.....................................................9235
1.553-1 Removed.....................................................9235
1.554-1 Removed.....................................................9235
1.555-1 Removed.....................................................9235
1.555-2 Removed.....................................................9235
1.556-1 Removed.....................................................9235
1.556-2 Removed.....................................................9235
1.556-3 Removed.....................................................9235
1.586-1 Removed.....................................................9235

[[Page 634]]

1.586-2 Removed.....................................................9235
1.593-1 Removed.....................................................9235
1.593-2 Removed.....................................................9235
1.593-3 Removed.....................................................9235
1.593-4 Removed.....................................................9235
1.593-5 Removed.....................................................9235
1.593-6 Removed.....................................................9235
1.593-6A Removed....................................................9235
1.593.7 Removed.....................................................9235
1.593-8 Removed.....................................................9235
1.593-10 Removed....................................................9235
1.593-11 Removed....................................................9235
1.595-1 Removed.....................................................9235
1.596-1 (a) amended.................................................9235
1.621-1 Undesignated center heading and section removed.............9235

                                  2020

26 CFR
                                                                   85 FR
                                                                    Page
Chapter I
1.509(a)-3 (a)(3)(i) amended; (a)(4) redesignated as (a)(5); new 
        (a)(4) added; (o) revised..................................77979
1.511-2 (e) added..................................................74034
1.512(a)-1 (a) through (c) amended; (h) revised....................77979
1.512(a)-6 Added...................................................77979
1.512(b)-1 (a)(1) revised; (a)(3) amended; (e)(5), (g)(4), and (5) 
        added......................................................77984
1.513-1 (d)(4)(i) in part redesignated as (d)(4)(i)(A); (d)(4)(i) 
        in part redesignated as (d)(4)(i)(B) introductory text; 
        (d)(4)(i) Examples redesignated as (d)(4)(i)(B)(1) through 
        (3); new (d)(4)(i)(A) heading, (B) heading, and (4) added; 
        (d)(4)(i)(B) amended.......................................74034
1.513-1 (a) and (h) amended; (f) and (g) redesignated as (g) and 
        (h); new (f) added.........................................77984
1.529A-0--1.529A-8 Undesignated center heading added...............74034
1.529A-0 Added.....................................................74034
1.529A-1 Added.....................................................74034
1.529A-2 Added.....................................................74034
1.529A-3 Added.....................................................74034
1.529A-4 Added.....................................................74034
1.529A-5 Added.....................................................74034
1.529A-6 Added.....................................................74034
1.529A-7 Added.....................................................74034
1.529A-8 Added.....................................................74034

                                  2021

   (Regulations published from January 1, 2021, through April 1, 2021)

26 CFR
                                                                   86 FR
                                                                    Page
Chapter I
1.512(a)-6 Correction: (a)(3)(i) and (h)(2) amended.................9286


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