[Federal Register Volume 69, Number 164 (Wednesday, August 25, 2004)]
[Proposed Rules]
[Pages 52217-52219]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 04-19479]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-108637-03]
RIN 1545-BB94


Accrual for Certain REMIC Regular Interests

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking and notice of public hearing.

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SUMMARY: This document contains proposed regulations relating to the 
accrual of original issue discount (OID) on certain real estate 
mortgage investment conduit (REMIC) regular interests. The proposed 
regulations are necessary to provide guidance to REMICs, REMIC regular 
interest holders and information reporters regarding the accrual of 
OID. This document also provides notice of a public hearing on the 
proposed regulations.

DATES: Written or electronic comments must be received by November 23, 
2004. Outlines of topics to be discussed at the public hearing 
scheduled for November 17, 2004, must be received by October 27, 2004.

ADDRESSES: Send submissions to: CC:PA:LPD:PR (REG-108637-03), room 
5203, Internal Revenue Service, PO Box 7604, Ben Franklin Station, 
Washington, DC 20044. Submissions may be hand-delivered Monday through 
Friday between the hours of 8 a.m. and 4 p.m. to CC:PA:LPD:PR (REG-
108637-03), Courier's Desk, Internal Revenue Service, 1111 Constitution 
Avenue, NW., Washington, DC, or sent electronically, via the IRS 
Internet site at http://www.irs.gov/regs or via the Federal eRulemaking 
Portal at http://www.regulations.gov (IRS--REG-108637-03). The public 
hearing will be held in the Auditorium, Internal Revenue Building, 1111 
Constitution Avenue, NW., Washington, DC.

FOR FURTHER INFORMATION CONTACT: Concerning the regulations, contact 
Rebecca Asta at (202) 622-3930. To be placed on the building access 
list for the hearing, contact Sonya Cruse at (202) 622-7180.

SUPPLEMENTARY INFORMATION:

Background and Explanation of Provisions

1. General Background

    A debt instrument may provide for qualified stated interest (QSI) 
(that is, certain periodic payments of stated interest), OID, or both. 
Sections 163(e) and 1271 through 1275 provide rules for the treatment 
of OID on debt instruments. In general, the holder of a debt instrument 
includes OID in income as it accrues, even if the holder generally uses 
a cash method of accounting. A holder of a REMIC regular interest 
includes QSI in income under an accrual method of accounting because 
section 860B(b) requires that amounts includible in gross income with 
respect to a REMIC regular interest be determined under an accrual 
method.
    For many debt instruments, only one or two days separate the date 
on which the holder becomes entitled to a payment (the record date) 
from the date on which the holder receives payment (the payment date). 
For REMIC regular interests, however, the record date may precede the 
payment date by 15 to 30 days.

2. Current REMIC Accrual Practice

    Under the governing contract provisions, REMIC regular interests 
generally accrue interest from the issue date to the final record date, 
and holders become entitled to receive interest payments based on 
month-end record dates. The IRS and the Treasury Department understand, 
however, that,

[[Page 52218]]

in general, REMIC servicers have interpreted the OID rules to require 
or permit holders' OID to accrue for tax purposes over the period from 
payment date to payment date and have treated QSI as accruing over the 
same periods. To compensate for accruing QSI and OID beyond the final 
record date to the final payment date, the servicers have treated QSI 
and OID on REMIC regular interests as not accruing from the date of 
issue for a period equal to the number of days between the record date 
and payment date. In effect, for tax purposes, the tax accrual of QSI 
and OID lags the legal accrual of interest by the delayed payment 
period.
    For tax purposes, as of the date a REMIC regular interest is 
purchased in the secondary market, the purchaser begins to accrue QSI 
and OID, and the seller ceases to accrue QSI and OID. A purchaser that 
holds the instrument until the final payment date or redemption accrues 
QSI and OID past the final record date as long as it holds the 
instrument. A purchaser that begins to accrue QSI and OID on the 
purchase date gives up the benefit of the lag in the beginning of the 
accrual period. As a result, the delayed accrual system causes the last 
secondary market purchaser of a REMIC regular interest to accrue for 
tax purposes an additional number of days of QSI and OID equal to the 
number of days between the record and payment dates, and too much QSI 
and OID is allocated to the last secondary purchaser of the REMIC 
regular interest. Moreover, because of principal payments, the holder 
will earn interest on a declining principal balance, while the lagging 
tax accruals will be based on a higher principal amount between record 
dates and payment dates in many instances. Consequently, a secondary 
market purchaser that is not the last secondary market purchaser will 
experience tax accruals in excess of legal entitlements if the regular 
interest has significant stated principal and bears interest at a 
stated rate.

3. Overview of the Proposed Regulations

    The proposed rules address the misallocation of QSI and OID by 
creating a special rule for accruing OID on REMIC regular interests 
that provide for a delay between record and payment dates. Under the 
proposed regulations, the period over which OID accrues generally 
coincides with the period over which the holder's right to interest 
payments accrues under the governing contract provisions.
    Generally, under the proposed regulations, if the terms of a REMIC 
regular interest provide for a delay between the record and payment 
dates, the initial accrual period begins on the date of issuance of the 
regular interest, and the final accrual period ends on the final record 
date of that REMIC regular interest. By shifting the entire tax accrual 
schedule, this special rule allocates all QSI and OID to the period 
between the issue date and the final record date of the instrument and 
none to the period between the final record date and final payment 
date. For purposes of calculating OID in the final accrual period with 
the methodology described in section 1272(a)(6), but for no other 
purpose, payments on the REMIC regular interest after the end of that 
accrual period that are included in the stated redemption price at 
maturity of the instrument (such as the payment on the final payment 
date) are treated as being made during the final accrual period.
    The IRS and Treasury Department recognize that, although the 
proposed regulations result in a more accurate allocation of QSI and 
OID among REMIC regular interest holders, some economic accuracy may be 
sacrificed by ending the accrual of OID before final payments are made 
on the regular interests. Therefore, the proposed regulations are 
limited to REMIC regular interests with delayed payment periods of 
fewer than 32 days. The regulation regarding REMIC regular interests 
with delayed payment periods of more than 31 days is reserved. The IRS 
and Treasury Department request comments on whether additional guidance 
is needed for these REMIC regular interests.

4. Accrual of Qualified Stated Interest

    Section 1.1272-1(a) requires a holder to include QSI in income 
under the holder's regular method of accounting. Section 1.446-2(b) 
requires a holder, as well as the issuer, to accrue QSI ratably over 
the accrual period to which it is attributable. In addition, section 
860B(b) requires a holder of a regular interest to accrue amounts into 
gross income regardless of the holder's overall method of accounting. 
The amounts that must be so accrued include QSI. The Treasury 
Department and the IRS understand that many REMIC servicers have 
accrued QSI over the same period as OID. It is intended that, with 
respect to the accrual periods referenced in Sec.  1.446-2(b), the 
initial accrual period for QSI will begin on the date of issuance and 
the final accrual period for QSI will end on the final record date. As 
a result, the QSI accrues over the same period as the OID.

Proposed Effective Date

    These regulations are proposed to apply to any REMIC regular 
interest issued after the date the final regulations are published in 
the Federal Register. The proposed regulations provide automatic 
consent for the holder of a REMIC regular interest to change its method 
of accounting for OID under the final regulations. The change is 
proposed to be made on a cut-off basis and, thus, does not affect REMIC 
regular interests issued before the date the final regulations are 
published in the Federal Register.
    The Treasury Department and the IRS are concerned regarding the 
extent to which holders of REMIC regular interests will be aware that 
changes in accounting methods for QSI may be necessary to comply with 
the special rule in the proposed regulations. If a holder of REMIC 
regular interests relies on data provided on behalf of the REMIC rather 
than performing its own computations, the holder may be unaware that 
these rules will have required newly issued REMICs to alter the accrual 
periods over which interest reported to holders is computed. The 
Treasury Department and the IRS request comments on the way in which a 
change in accounting method for QSI should be effected.
    The Treasury Department and the IRS request comments concerning the 
extent to which any other debt instruments provide for a significant 
delay between record and payment dates and, if some do, whether rules 
like those in the proposed regulations should be extended to them. Any 
comments received will be considered in connection with the publication 
of final regulations in the Federal Register.

Special Analyses

    It has been determined that this notice of proposed rulemaking is 
not a significant regulatory action as defined in Executive Order 
12866. Therefore, a regulatory flexibility assessment is not required. 
It has also been determined that section 553(b) of the Administrative 
Procedures Act (5 U.S.C. chapter 5) does not apply to these 
regulations, and because the regulation does not impose a collection of 
information on small entities, the Regulatory Flexibility Act (5 U.S.C. 
chapter 6) does not apply. Pursuant to section 7805(f) of the Internal 
Revenue Code, this notice of proposed rulemaking will be submitted to 
the Chief Counsel for Advocacy of the Small Business Administration for 
comment on its impact on small businesses.

[[Page 52219]]

Comments and Public Hearing

    Before these proposed regulations are adopted as final regulations, 
consideration will be given to any written comments (a signed original 
and eight (8) copies) or electronic comments that are submitted timely 
to the IRS. The Treasury Department and IRS specifically request 
comments on the clarity of the proposed rules and how they may be made 
easier to understand. All comments will be available for public 
inspection and copying.
    A public hearing has been scheduled for November 17, 2004, 
beginning at 10 a.m. in the Auditorium of the Internal Revenue 
Building, 1111 Constitution Avenue, NW., Washington, DC. Due to 
building security procedures, visitors must enter at the Constitution 
Avenue entrance. All visitors must present photo identification to 
enter the building. Because of access restrictions, visitors will not 
be admitted beyond the immediate entrance area more than 30 minutes 
before the hearing starts. For information about having your name 
placed on the building access list to attend the hearing, see the FOR 
FURTHER INFORMATION CONTACT section of this preamble.
    The rules of 26 CFR 601.601(a)(3) apply to the hearing. Persons who 
wish to present oral comments at the hearing must submit written or 
electronic comments by November 23, 2004 and an outline of the topics 
to be discussed and the time to be devoted to each topic (signed 
original and eight (8) copies) by October 27, 2004. A period of 10 
minutes will be allotted to each person for making comments. An agenda 
showing the schedule of speakers will be prepared after the deadline 
for receiving outlines has passed. Copies of the agenda will be 
available free of charge at the hearing.

Drafting Information

    The principal author of these proposed regulations is Rebecca Asta 
of the Office of Associate Chief Counsel (Financial Institutions and 
Products). However, other personnel from the IRS and Treasury 
Department participated in their development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations

    Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART 1--INCOME TAXES

    Paragraph 1. The authority citation for part 1 continues to read in 
part as follows:

    Authority: 26 U.S.C. 7805 * * *

    Par. 2. Section 1.1271-0 is amended by adding entries for Sec.  
1.1275-2(l) and (m) to read as follows:


Sec.  1.1271-0  Original issue discount; effective date; table of 
contents.

* * * * *

Sec.  1.1275-2 Special rules relating to debt instruments.

* * * * *
    (l) [Reserved].
    (m) Special rule for certain REMIC regular interests.
    (1) Scope.
    (2) General rules.
    (3) Special rule for calculation of OID in final accrual period.
    (4) Definition of record date.
    (5) Accrual of qualified stated interest.
    (6) Example.
    (7) Treatment of REMIC regular interests if the record dates and 
the payment dates are separated by more than thirty-one days.
    (8) Effective date.
* * * * *
    Par. 3. Section 1.1275-2 is amended by adding new paragraphs (l) 
and (m) to read as follows:


Sec.  1.1275-2  Special rules relating to debt instruments.

* * * * *
    (l) [Reserved].
    (m) Special rules for certain REMIC regular interests--(1) Scope. 
If the terms of a REMIC regular interest (as defined in section 
860G(a)(1)) provide for a delay between its record dates and the 
associated payment dates, the initial accrual period and final accrual 
period for that regular interest are determined under this paragraph 
(m). Except as provided in paragraph (m)(7) of this section, this 
paragraph (m) does not apply to a REMIC regular interest if the record 
dates and the payment dates are separated by more than thirty-one days.
    (2) General rules--(i) Initial accrual period. The initial accrual 
period for a REMIC regular interest subject to this paragraph (m) 
begins on issuance of the REMIC regular interest.
    (ii) Final accrual period. The final accrual period for a REMIC 
regular interest subject to this paragraph (m) ends on the final record 
date of the REMIC regular interest.
    (3) Special rule for calculation of OID in final accrual period. In 
applying section 1272(a)(6)(A) to calculate OID in the final accrual 
period for a REMIC regular interest subject to this paragraph (m), 
payments after the end of the final accrual period of amounts included 
in the stated redemption price at maturity are treated as payments 
during the final accrual period.
    (4) Definition of record date. For purposes of this paragraph (m), 
a record date of a REMIC regular interest is a date, provided by the 
terms of the REMIC regular interest, on which the holder becomes 
entitled to a payment (of interest or principal) that is to be made on 
a subsequent payment date.
    (5) Accrual of qualified stated interest. See Sec.  1.446-2 for the 
accrual of qualified stated interest.
    (6) Example. The following example illustrates the application of 
this paragraph (m).

    Example. REMIC X issues regular interests on January 1, 2009. 
The terms of the regular interests provide for payments of interest 
and principal to the persons who hold the regular interests on the 
last day of the calendar month (the record date). Each such payment 
is to be made on the fifteenth day of the succeeding calendar month 
(the payment date). The last payment with respect to the regular 
interests issued by REMIC X is to be made on January 15, 2014, to 
persons who hold the regular interests on December 31, 2013. Under 
this paragraph (m), the initial accrual period begins on the date of 
issuance, January 1, 2009, and the last accrual period ends on the 
last record date, December 31, 2013.
    (7) Treatment of REMIC regular interests if the record dates and 
the payment dates are separated by more than thirty-one days. 
[Reserved]
    (8) Effective date--(i) In general. This paragraph (m) applies to 
REMIC regular interests issued after the date the final regulations are 
published in the Federal Register.
    (ii) Automatic consent to change method of accounting. Taxpayers 
are hereby granted the Commissioner's consent under section 446(e) to 
change their method of accounting for REMIC regular interests to which 
this paragraph (m) applies if--
    (A) The change involves changing accrual periods to accrual periods 
allowed by this paragraph (m);
    (B) The change is made for the first taxable year of the taxpayer 
during which the taxpayer holds a REMIC regular interest to which the 
rules of this paragraph (m) apply; and
    (C) The change in method of accounting is effected on a cut-off 
basis.

Deborah M. Nolan,
Acting Deputy Commissioner for Services and Enforcement.
[FR Doc. 04-19479 Filed 8-24-04; 8:45 am]
BILLING CODE 4830-01-P