# Bulletin No. 1996–42

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Bulletin No. 1996–42
October 15, 1996

HIGHLIGHTS
OF THIS ISSUE
These synopses are intended only as aids to the reader in
identifying the subject matter covered. They may not be relied
upon as authoritative interpretations.

INCOME TAX

EXEMPT ORGANIZATIONS

Rev. Rul. 96–50, page 4.
LIFO; price indexes; department stores. The August
1996 Bureau of Labor Statistics price indexes are
accepted for use by department stores employing the
retail inventory and last-in, first-out inventory methods
for valuing inventories for tax years ended on, or with
reference to, August 31, 1996.

Announcement 96–107, page 27.
A list is given of organizations now classified as private
foundations.

REG–209826–96, page 10.
Proposed regulations under section 671 of the Code
relate to the application of the grantor trust rules to
nonexempt employees’ trusts. A public hearing will be
held on January 15, 1997.
Notice 96–51, page 6.
Inflation-indexed debt instruments. Proposed and temporary regulations under sections 1275(d) and 1286 of
the Code will be issued to provide guidance on the
federal income tax treatment of Treasury InflationProtection Securities and other debt instruments with
similar terms. This notice also describes, in general
terms, the debt instruments that are expected to be
subject to the regulations and how these instruments
are expected to be taxed under the regulations.

Finding Lists begin on page 33.
Announcements of Disbarments and Suspensions begin on page 30.

EMPLOYMENT TAX
Announcement 96–105, page 19.
Comments are solicited on a proposed tip reporting
agreement for use in the hairstyling industry.
Announcement 96–106, page 23.
Comments are solicited on a proposed tip reporting
agreement for use in the gaming industry.

ADMINISTRATIVE
Notice 96–52, page 8.
Work opportunity tax credit; notice of transition rule
under section 51 of the Code. The Service will provide
for a transition period for certain employers that did not
complete Form 8850 by the date an applicant is offered
a job. The transition period will allow employers to
complete and submit Form 8850 to the State Employment Security Agency, although the form was not completed on or before the day the employer offered the
applicant a job.

Mission of the Service
The purpose of the Internal Revenue Service is to
collect the proper amount of tax revenue at the least
cost; serve the public by continually improving the

quality of our products and services; and perform in a
manner warranting the highest degree of public
confidence in our integrity, efficiency and fairness.

Statement of Principles
of Internal Revenue
Tax Administration
The Service also has the responsibility of applying
and administering the law in a reasonable,
practical manner. Issues should only be raised by
examining of ficers when they have merit, never
arbitrarily or for trading purposes. At the same
time, the examining officer should never hesitate
to raise a meritorious issue. It is also important
that care be exercised not to raise an issue or to
ask a court to adopt a position inconsistent with
an established Service position.

The function of the Internal Revenue Service is to
administer the Internal Revenue Code. Tax policy
for raising revenue is determined by Congress.
With this in mind, it is the duty of the Service to
carry out that policy by correctly applying the laws
enacted by Congress; to determine the reasonable
meaning of various Code provisions in light of the
Congressional purpose in enacting them; and to
perform this work in a fair and impartial manner,
with neither a government nor a taxpayer point of view.

Administration should be both reasonable and
vigorous. It should be conducted with as little
delay as possible and with great cour tesy and
considerateness. It should never try to overreach,
and should be reasonable within the bounds of law
and sound administration. It should, however, be
vigorous in requiring compliance with law and it
should be relentless in its attack on unreal tax
devices and fraud.

At the heart of administration is interpretation of the
Code. It is the responsibility of each person in the
Service, charged with the duty of interpreting the
law, to try to find the true meaning of the statutory
provision and not to adopt a strained construction in
the belief that he or she is ‘‘protecting the revenue.’’
The revenue is properly protected only when we ascertain and apply the true meaning of the statute.

2

Introduction
The Internal Revenue Bulletin is the authoritative instrument of the Commissioner of Internal Revenue for
announcing official rulings and procedures of the Internal Revenue Service and for publishing Treasury Decisions, Executive Orders, Tax Conventions, legislation,
court decisions, and other items of general interest. It is
published weekly and may be obtained from the Superintendent of Documents on a subscription basis. Bulletin
contents of a permanent nature are consolidated semiannually into Cumulative Bulletins, which are sold on a
single-copy basis.

court decisions, rulings, and procedures must be considered, and Service personnel and others concerned are
cautioned against reaching the same conclusions in
other cases unless the facts and circumstances are
substantially the same.
The Bulletin is divided into four parts as follows:
Part I.—1986 Code.
This part includes rulings and decisions based on
provisions of the Internal Revenue Code of 1986.

It is the policy of the Service to publish in the Bulletin all
substantive rulings necessary to promote a uniform
application of the tax laws, including all rulings that
supersede, revoke, modify, or amend any of those
previously published in the Bulletin. All published rulings
apply retroactively unless otherwise indicated. Procedures relating solely to matters of internal management
are not published; however, statements of internal
practices and procedures that affect the rights and
duties of taxpayers are published.

Part II.—Treaties and Tax Legislation.
This part is divided into two subparts as follows:
Subpart A, Tax Conventions, and Subpart B, Legislation
and Related Committee Reports.
Part III.—Administrative, Procedural, and Miscellaneous.
To the extent practicable, pertinent cross references to
these subjects are contained in the other Parts and
Subparts. Also included in this part are Bank Secrecy
Act Administrative Rulings. Bank Secrecy Act Administrative Rulings are issued by the Department of the
Treasury’s Office of the Assistant Secretary (Enforcement).

Revenue rulings represent the conclusions of the Service on the application of the law to the pivotal facts
stated in the revenue ruling. In those based on positions
taken in rulings to taxpayers or technical advice to
Service field offices, identifying details and information
of a confidential nature are deleted to prevent unwarranted invasions of privacy and to comply with statutory
requirements.

Part IV.—Items of General Interest.
With the exception of the Notice of Proposed Rulemaking and the disbarment and suspension list included in
this part, none of these announcements are consolidated in the Cumulative Bulletins.

Rulings and procedures reported in the Bulletin do not
have the force and effect of Treasury Department
Regulations, but they may be used as precedents.
Unpublished rulings will not be relied on, used, or cited
as precedents by Service personnel in the disposition of
other cases. In applying published rulings and procedures, the effect of subsequent legislation, regulations,

The first Bulletin for each month includes an index for
the matters published during the preceding month.
These monthly indexes are cumulated on a quarterly and
semiannual basis, and are published in the first Bulletin
of the succeeding quarterly and semi-annual period,
respectively.

The contents of this publication are not copyrighted and may be reprinted freely. A citation of the Internal Revenue Bulletin as the source would be appropriate.
For sale by the Superintendent of Documents U.S. Government Printing Office, Washington, D.C. 20402.

3

Part I. Rulings and Decisions Under the Internal Revenue Code of 1986
Section 472.—Last-in, First-out
Inventories
26 CFR 1.472–1: Last-in, first-out inventories.

LIFO; price indexes; department
stores. The August 1996 Bureau of
Labor Statistics price indexes are accepted for use by department stores
employing the retail inventory and lastin, first-out inventory methods for valuing inventories for tax years ended on,
or with reference to, August 31, 1996.

Rev. Rul. 96–50
The following Department Store Inventory Price Indexes for August 1996
were issued by the Bureau of Labor
Statistics on September 13, 1996. The
indexes are accepted by the Internal
Revenue Service, under § 1.472–1(k) of
the Income Tax Regulations and Rev.
Proc. 86–46, 1986–2 C.B. 739, for appropriate application to inventories of
department stores employing the retail
inventory and last-in, first-out inventory

methods for tax years ended on, or with
reference to, August 31, 1996.
The Department Store Inventory Price
Indexes are prepared on a national basis
and include (a) 23 major groups of
departments, (b) three special combinations of the major groups - soft goods,
durable goods, and miscellaneous goods,
and (c) a store total, which covers all
departments, including some not listed
separately, except for the following:
candy, foods, liquor, tobacco, and contract departments.

BUREAU OF LABOR STATISTICS, DEPARTMENT STORE
INVENTORY PRICE INDEXES BY DEPARTMENT GROUPS
(January 1941 = 100, unless otherwise noted)

Groups

Aug.
1995

Aug.
1996

Percent
Change from
Aug. 1995 to
Aug. 19961

Piece Goods . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Domestics and Draperies . . . . . . . . . . . . . . . . . . . . . . . . .
Women’s and Children’s Shoes . . . . . . . . . . . . . . . . . . . .
Men’s Shoes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Infants’ Wear. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Women’s Underwear . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Women’s Hosiery . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Women’s and Girls’ Accessories . . . . . . . . . . . . . . . . . . .
Women’s Outerwear and Girls’ Wear . . . . . . . . . . . . . . .
Men’s Clothing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Men’s Furnishings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Boys’ Clothing and Furnishings . . . . . . . . . . . . . . . . . . .
Jewelry . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Notions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Toilet Articles and Drugs. . . . . . . . . . . . . . . . . . . . . . . . .
Furniture and Bedding . . . . . . . . . . . . . . . . . . . . . . . . . . .
Floor Coverings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Housewares . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Major Appliances . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Radio and Television . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Recreation and Education2 . . . . . . . . . . . . . . . . . . . . . . . .
Home Improvements2 . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Auto Accessories2 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

534.7
663.1
622.3
923.8
620.6
519.0
287.5
550.4
404.5
604.6
542.4
477.3
1011.2
868.8
861.5
659.2
572.4
783.4
247.7
82.1
114.2
122.2
107.1

524.3
642.6
640.3
895.9
610.3
525.8
287.5
546.2
381.2
611.7
567.9
485.4
1023.8
770.0
885.1
669.2
588.7
810.6
244.8
78.8
112.1
125.9
107.2

21.9
23.1
2.9
23.0
21.7
1.3
0.0
20.8
25.8
1.2
4.7
1.7
1.2
211.4
2.7
1.5
2.8
3.5
21.2
24.0
21.8
3.0
0.1

Groups 1 – 15: Soft Goods . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Groups 16 – 20: Durable Goods . . . . . . . . . . . . . . . . . . . . . . . .
Groups 21 – 23: Misc. Goods2 . . . . . . . . . . . . . . . . . . . . . . . . .

585.2
465.3
114.1

582.9
469.2
113.1

20.4
0.8
20.9

Store Total3 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

544.9

544.0

20.2

1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
13.
14.
15.
16.
17.
18.
19.
20.
21.
22.
23.

1

Absence of a minus sign before percentage change in this column signifies price increase.
Indexes on a January 1986=100 base.
3
The store total index covers all departments, including some not listed separately, except for the following: candy, foods,
liquor, tobacco, and contract departments.
2

4

DRAFTING INFORMATION
The principal author of this revenue
ruling is Stan Michaels of the Office of

Assistant Chief Counsel (Income Tax
and Accounting). For further information
regarding this revenue ruling, contact

5

Mr. Michaels on (202) 622–4970 (not a
toll-free call).

Part III. Administrative, Procedural, and Miscellaneous
Inflation-Indexed Debt Instruments
Notice 96–51
The Department of the Treasury plans
to issue securities that are adjusted for
inflation and deflation (‘‘Treasury
Inflation-Protection Securities’’). See
Amendment to the Uniform Offering
Circular for the Sale and Issue of Marketable Book-Entry Treasury Bills,
Notes and Bonds, which was filed with
the Federal Register on September 25,
1996. To provide guidance on the federal income tax treatment of these securities and other debt instruments with
similar terms, the Internal Revenue Service (IRS) intends to issue proposed and
temporary regulations under §§ 1275(d)
and 1286 of the Internal Revenue Code
prior to the first issuance of the securities. This notice describes, in general
terms, the debt instruments that are
expected to be subject to the regulations
and how these instruments are expected
to be treated under the regulations.
TREASURY
INFLATION-PROTECTION
SECURITIES
As described in the Offering Circular,
a Treasury Inflation-Protection Security
will provide for semiannual payments of
interest and a payment of principal at
maturity. In general, each payment will
be adjusted to take into account any
inflation or deflation that occurs between the issue date of the security and
the payment date.
The principal amount of a Treasury
Inflation-Protection Security will be adjusted for inflation and deflation based
on monthly changes in the nonseasonally adjusted U.S. City Average
All Items Consumer Price Index for All
Urban Consumers (CPI-U), which is
published by the Bureau of Labor Statistics of the Department of Labor. The
inflation-adjusted principal amount of
the security for the first day of any
month will be determined by multiplying the principal amount at issuance by
a fraction, the numerator of which is the
value of the index for the adjustment
date and the denominator of which is
the value of the index for the issue date.
The inflation-adjusted principal amount
of the security for a day other than the
first day of a month will be determined
based on a straight-line interpolation
between the inflation-adjusted principal
amount for the first day of the month

and the inflation-adjusted principal
amount for the first day of the next
month. The value of the index used to
determine the adjustment for the first
day of a particular month will be the
value of the index reported for the third
preceding month.
Each semiannual payment of interest
will be determined by multiplying a
single fixed rate of interest by the
inflation-adjusted principal amount of
the security for the date of the interest
payment. Thus, although the interest rate
will be fixed, the amount of each interest payment will vary with changes in
the principal of the security as adjusted
for inflation and deflation.
A Treasury Inflation-Protection Security also will provide for an additional
payment at maturity if the security’s
inflation-adjusted principal amount for
the maturity date is less than the security’s principal amount at issuance. The
amount of the additional payment will
equal the excess of the security’s principal amount at issuance over the security’s inflation-adjusted principal amount
for the maturity date.
INFLATION-INDEXED DEBT
INSTRUMENTS
In general, the regulations will apply
to an inflation-indexed debt instrument,
regardless of the identity of the issuer.
An inflation-indexed debt instrument
generally will be defined in the regulations as a debt instrument that satisfies
the following conditions:
(1) The debt instrument is issued for
U.S. dollars and all payments of principal and interest on the instrument are
denominated in U.S. dollars.
(2) The principal amount of the debt
instrument is adjusted for inflation and
deflation. The adjustment must be measured by changes in the current value of
a single general price or wage index
published monthly by an agency of the
United States Government (e.g., the
CPI-U). A current value of an index is a
value of the index that has been updated
and published within the six month
period preceding the date of the adjustment.
(3) The debt instrument provides for
an appropriate method to calculate its
inflation-adjusted principal amount for
each day to reflect the monthly changes
in the current value of the price or wage
index. For example, the inflationadjusted principal amount for the first

6

day of each month is determined by
reference to the change in the index for
the third preceding month, and the
inflation-adjusted principal amount for
any other day is determined based on
straight-line interpolation between the
inflation-adjusted principal amount for
the first day of the month and the
inflation-adjusted principal amount for
the first day of the next month.
(4) Each stated interest payment on
the debt instrument, if any, is computed
by multiplying a single fixed rate of
interest by the inflation-adjusted principal amount for the date of the interest
payment.
(5) The payments on the debt instrument are not subject to any contingencies other than the inflation contingency.
For this purpose, a contingency that is
remote or incidental will be ignored. In
addition, a payment will not be contingent merely because of the possibility of
impairment by insolvency, default, or
similar circumstances.
Notwithstanding the condition described in paragraph (5) above, a debt
instrument will not fail to qualify as an
inflation-indexed debt instrument merely
because it provides for a minimum
guarantee payment. A minimum guarantee payment is an additional payment
that is made at maturity if the debt
instrument’s inflation-adjusted principal
amount for the maturity date is less than
the instrument’s principal amount at issuance. The amount of the additional
payment must be no more than the
excess of the debt instrument’s principal
amount at issuance over the instrument’s
inflation-adjusted principal amount for
the maturity date.
An example of a debt instrument that
satisfies the above conditions is a Treasury Inflation-Protection Security.
If a debt instrument qualifies as an
inflation-indexed debt instrument, one of
two methods will apply to account for
qualified stated interest and original issue discount (OID) on the instrument:
the coupon bond method or the discount
bond method. In general, both methods
will measure the amount of qualified
stated interest and OID that accrues on
an inflation-indexed debt instrument
based on changes in the principal
amount of the debt instrument and constant yield principles.
The discount bond method will apply
a formula to determine the amount of

OID that accrues during an accrual
period on an inflation-indexed debt instrument. This formula is based on
changes in the inflation index over the
term of the debt instrument and the
yield of the debt instrument at issuance.
In the case of certain inflation-indexed
debt instruments, however, the accruals
of OID on the debt instruments can
easily be determined without the use of
the formula. Therefore, the regulations
will provide a simplified version of the
discount bond method for these debt
instruments (the coupon bond method).
COUPON BOND METHOD
The coupon bond method will apply
to an inflation-indexed debt instrument
that satisfies two conditions: First, there
is no more than a de minimis difference
between the debt instrument’s issue
price and its principal amount at issuance. Second, all stated interest payable
on the debt instrument is qualified stated
interest. For purposes of the regulations,
stated interest will be qualified stated
interest if it is unconditionally payable
in cash at least annually. The coupon
bond method will apply to Treasury
Inflation-Protection Securities that are
not stripped into principal and interest
components.
If an inflation-indexed debt instrument qualifies for the coupon bond
method, the qualified stated interest payable on the debt instrument will be
taken into account under the taxpayer’s
regular method of accounting. Any increase in the inflation-adjusted principal
amount will be treated as OID for the
period in which the increase occurs. Any
decrease in the inflation-adjusted principal amount (a deflation adjustment) will
be taken into account under the rules for
deflation adjustments described below.
For example, if a taxpayer who uses
the cash receipts and disbursements
method of accounting (cash method)
holds a Treasury Inflation-Protection Security for an entire calendar year, the
taxpayer generally will include in income the interest payments received on
the security during the year. In addition,
the taxpayer will include in income an
amount of OID measured by subtracting
the inflation-adjusted principal amount
of the security for January 1 of the year
from the inflation-adjusted principal
amount of the security for January 1 of
the next year. If the taxpayer uses an
accrual method of accounting rather
than the cash method, the taxpayer will
include in income the qualified stated

interest that accrued on the debt instrument during the year and an amount of
OID measured by subtracting the
inflation-adjusted principal amount of
the security for January 1 of the year
from the inflation-adjusted principal
amount of the security for January 1 of
the next year.
DISCOUNT BOND METHOD
If an inflation-indexed debt instrument does not qualify for the coupon
bond method (e.g., because it is issued
at a discount), the instrument will be
subject to the discount bond method. In
general, the discount bond method will
require taxpayers to make current adjustments to their OID accruals on the
debt instrument to account for changes
in the inflation-adjusted principal
amount.
Under the discount bond method, a
taxpayer will accrue OID using the four
steps provided under § 1.1272-1(b)(1)
of the Income Tax Regulations (constant
yield method). However, the debt instrument’s yield to maturity will be determined as of the issue date by assuming
no inflation or deflation, and the OID
allocable to an accrual period (n) will be
determined by using the following formula:
OID(n) = {AIP(n) × [r + inf(n) +
(r × inf(n))]} 2 QSI(n) where,
r = yield of the debt instrument determined as
of the issue date by assuming no inflation or
deflation, adjusted for the length of the accrual
period;
inf(n) = percentage change in the inflation index
for period (n);
AIP(n) = adjusted issue price at the beginning of
period (n); and
QSI(n) = qualified stated interest allocable to
period (n).

If the formula produces a negative
amount of OID, this amount (deflation
adjustment) will be taken into account
under the rules for deflation adjustments
described below.
DEFLATION ADJUSTMENTS
In general, a deflation adjustment will
reduce the amount of interest includible
in income by a holder with respect to
the debt instrument for the taxable year.
If the amount of the deflation adjustment exceeds the interest otherwise includible in income for the taxable year,
the excess will be treated as an ordinary
loss by the holder for the taxable year.
However, the amount treated as an ordinary loss will be limited to the amount

7

by which the holder’s total interest
inclusions on the debt instrument in
prior taxable years exceed the total
amount treated by the holder as an
ordinary loss on the debt instrument in
prior taxable years. If the deflation adjustment exceeds the interest otherwise
includible in income by the holder with
respect to the debt instrument for the
taxable year and the amount treated as
an ordinary loss for the taxable year,
this excess will be carried forward to
offset interest income on the debt instrument in subsequent taxable years. In
general, any excess remaining upon the
sale, exchange, or retirement of the debt
instrument will result in a loss to the
holder for federal income tax purposes.
Similar rules will apply to determine an
issuer’s interest deductions and income
for the debt instrument.
MINIMUM GUARANTEE
Under both the coupon bond method
and the discount bond method, a minimum guarantee payment as described
above generally will be ignored until the
payment is made. If there is a minimum
guarantee payment, the payment will be
treated as a payment of interest.
ACCRUALS OF QUALIFIED STATED
INTEREST
In certain situations, a taxpayer will
have to determine how much qualified
stated interest, if any, has accrued as of
a certain date on an inflation-indexed
debt instrument. The regulations will
provide that the amount of accrued but
unpaid qualified stated interest as of any
date is determined by using the principles of § 1.446–3(e)(2)(ii) (relating to
notional principal contracts). For example, if the interval between interest
payment dates spans two taxable years,
a taxpayer using an accrual method of
accounting will determine the amount of
accrued qualified stated interest for the
first taxable year by reference to the
inflation-adjusted principal amount for
the last day of the taxable year.
SUBSEQUENT HOLDERS
For purposes of determining whether
a holder acquires an inflation-indexed
debt instrument at a premium or with
market discount, the amount payable at
maturity on the instrument will be
treated as equal to the instrument’s
inflation-adjusted principal amount for

the day the holder acquires the instrument. Any premium or market discount
will be taken into account over the
remaining term of the debt instrument
by making the same assumption.
STRIPS
A Treasury Inflation-Protection Security will be eligible upon issuance for
the Department of the Treasury’s Separate Trading of Registered Interest and
Principal of Securities (STRIPS) program. Under this program, the interest
and principal components of a Treasury
Inflation-Protection Security may be
transferred as separate instruments
(stripped bonds and coupons). In general, § 1286 treats the holder of a
stripped bond (or coupon) as if the
holder purchased a newly issued debt
instrument that has OID. The regulations
will provide that the holder of a component of a Treasury Inflation-Protection
Security that is stripped under the Treasury STRIPS program must use the
discount bond method to account for the
OID on the component.
REOPENINGS
The regulations will provide that a
reopening of Treasury InflationProtection Securities will be a qualified
reopening for purposes of § 1.1275–
2(d)(2), provided the reopening occurs
not more than one year after the original
securities were first issued to the public.
EFFECTIVE DATE
The regulations will apply to debt
instruments issued on or after the date
the regulations are published in the
Federal Register.
REQUEST FOR COMMENTS
The IRS and the Department of the
Treasury request comments on the rules
described in this notice. Comments
should be submitted in writing on or
before October 28, 1996 to: CC:DOM:
CORP:R (Notice 96–51), Room 5226,
Internal Revenue Service, POB 7604,
Ben Franklin Station, Washington, DC
20044. In the alternative, comments (1)
may be hand delivered between the
hours of 8 a.m. and 5 p.m. to CC:DOM:
CORP:R (Notice 96–51), Courier’s
Desk, Internal Revenue Service, 1111
Constitution Ave., NW, Washington, DC,
or (2) may be submitted electronically
via the IRS internet site at http://
www.irs.ustreas.gov/prod/tax_regs/

comments.html. All comments will be
available for public inspection and copying.
CONTACT PERSONS
For further information regarding this
notice, contact Jeffrey W. Maddrey on
(202) 622–4443 or William E. Blanchard on (202) 622–3950 (not toll-free
numbers).
Work Opportunity Tax Credit —
Pre-Screening Notice
Notice 96–52
This Notice provides temporary transition relief for employers with respect
to the Work Opportunity Tax Credit
(WOTC) that was enacted as part of the
Small Business Job Protection Act of
1996, Pub. L. No. 104–188 (August 20,
1996).
BACKGROUND
The WOTC provides a tax credit for
employers who hire individuals belonging to one of the following groups: (1)
qualified recipients of benefits under
AFDC or a successor program; (2)
qualified veterans; (3) qualified exfelons; (4) high-risk youth; (5) vocational rehabilitation referrals; (6) qualified summer youth employees; or (7)
qualified food stamp recipients. See Internal Revenue Code section 51. The
WOTC is effective for wages paid to
qualified individuals whose first day of
work for the employer is on or after
October 1, 1996.
For purposes of the WOTC, a prospective employee is not considered a
member of one of the targeted groups
unless the individual is certified as such
by a State Employment Security Agency
(SESA). The SESA certification requirement may be satisfied in either of two
ways:
Under one approach, an employer
may receive a certification from a
SESA, on or before the day the prospective employee begins work, stating that
the individual is a member of a targeted
group. Section 51(d)(11)(A)(i).
Under the other approach, the employer must complete a ‘‘pre-screening
notice’’ with respect to the prospective
employee on or before the day the
individual is offered employment, and
then, within 21 days after the individual
begins work, must submit that notice,
signed by the individual and the employer under penalties of perjury, to the

8

SESA as part of a request for certification. Section 51(d)(11)(A)(ii). If an employer uses this approach, the employer
must also receive a certification from
the SESA that the individual is, in fact,
a member of a targeted group before
claiming the WOTC with respect to the
individual.
The IRS on September 26, 1996,
issued Form 8850, Work Opportunity
Credit Pre-Screening Notice and Certification Request, to serve as the prescreening notice. This Form will be
available electronically beginning September 27, 1996, through the IRS Home
Page on the World Wide Web (http://
www.irs.ustreas.gov) or by modem directly to 703–321–8020 (not a toll-free
number). Employers may also request
copies of Form 8850 by calling 1–800–
TAX–FORM (1–800–829–3676); however, copies of Form 8850 will not be
available through this toll-free service
until approximately October 15, 1996.
TEMPORARY TRANSITION RELIEF
This Notice provides temporary transition relief for employers that did not
complete Form 8850 at the time a job
offer was made if the following conditions are satisfied:
(1) The job offer was made on or
after August 20, 1996, and on or before
October 31, 1996.
(2) At the time the job offer was
made, the employer reasonably believed,
based on information provided by the
prospective employee, that the individual was a member of a targeted
group.
(3) Form 8850 is properly completed
and signed by both the employer and
the individual, and submitted to the
SESA, by the later of (a) November 21,
1996, or (b) 21 days after the individual begins work for the employer.
An employer seeking to rely on the
temporary transition relief provided by
this Notice should write ‘‘FILED PURSUANT TO NOTICE 96–52’’ across the
top of the Form 8850. The employer
should also strike the words ‘‘I completed this form on or before the day a
job was offered to the applicant and
that’’ from the jurat preceding the signature line of the form.
If these conditions are satisfied, the
Service will treat the Form 8850 as
having been timely completed and submitted to the SESA in accordance with
Code section 51(d)(11)(A)(ii). The

SESA must, however, certify that the
individual named in the form is, in fact,
a member of a targeted group before the
employer may claim the WOTC with
respect to the individual.

Drafting Information
The principal author of this Notice is
Robert Wheeler of the Office of the
Associate Chief Counsel (Employee

9

Benefits and Exempt Organizations). For
further information regarding this Notice, contact Mr. Wheeler on (202) 622–
6060 (not a toll-free call).

Part IV. Items of General Interest
Notice of Proposed Rulemaking
and Notice of Public Hearing
Application of the Grantor Trust
Rules to Nonexempt Employees’
Trusts
REG–209826–96
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Notice of proposed rulemaking and notice of public hearing.
SUMMARY: This document contains
proposed regulations relating to the application of the grantor trust rules to
nonexempt employees’ trusts. The proposed regulations clarify that the grantor
trust rules generally do not apply to
domestic nonexempt employees’ trusts,
and clarify the interaction between the
grantor trust rules, the rules generally
governing the taxation of nonqualified
deferred compensation arrangements,
and the antideferral rules for United
States persons holding interests in foreign entities. The proposed regulations
affect nonexempt employees’ trusts
funding deferred compensation arrangements, as well as U.S. persons holding
interests in certain foreign corporations
and foreign partnerships with deferred
compensation arrangements funded
through foreign nonexempt employees’
trusts. In addition, the proposed regulations affect U.S. persons that have deferred compensation arrangements
funded through certain foreign
nonexempt employees’ trusts. This document also provides notice of a public
hearing on these proposed regulations.
DATES: Written comments must be received by December 26, 1996. Requests
to speak (with outlines of oral comments to be discussed) at the public
hearing scheduled for January 15, 1997,
at 10:00 a.m. must be submitted by
December 24, 1996.
ADDRESSES: Send submissions to:
CC:DOM:CORP:R (REG–209826–96),
room 5226, Internal Revenue Service,
POB 7604, Ben Franklin Station, Washington, DC 20044. Submissions may be
hand delivered between the hours of 8
a.m. and 5 p.m. to: CC:DOM:CORP:R
(REG– 209826–96), Courier’s Desk, Internal Revenue Service, 1111 Constitution Avenue, NW., Washington, DC. The
public hearing will be held in room
2615, Internal Revenue Building, 1111

Constitution Avenue, NW., Washington,
DC. Alternatively, taxpayers may submit
comments electronically via the Internet
by selecting the ‘‘Tax Regs’’ option on
the IRS Home Page, or by submitting
comments directly to the IRS Internet
site at http://www.irs.ustreas.gov/prod/
tax_regs/comments.html.
FOR FURTHER INFORMATION CONTACT: Concerning the regulations,
James A. Quinn, (202) 622–3060; Linda
S. F. Marshall, (202) 622– 6030;
Kristine K. Schlaman (202) 622–3840;
and M. Grace Fleeman (202) 622–3850;
concerning submissions and the hearing,
Michael Slaughter, (202) 622–7190 (not
toll-free numbers).
SUPPLEMENTARY INFORMATION:
Paperwork Reduction Act
The collection of information contained in this notice of proposed
rulemaking has been submitted to the
Office of Management and Budget for
review in accordance with the Paperwork Reduction Act of 1995 (44 U.S.C.
3507(d)). Comments on the collection of
information should be sent to the Office
of Management and Budget, Attn:
Desk Officer for the Department of the
Treasury, Office of Information and
Regulatory Affairs, Washington, DC
20503, with copies to the Internal Revenue Service, Attn: IRS Reports Clearance Officer, T:FP, Washington, DC
20224. Comments on the collection of
information should be received by November 26, 1996. Comments are specifically requested concerning:
Whether the proposed collection of information is necessary for the proper
performance of the functions of the
Internal Revenue Service, including
whether the information will have practical utility;
The accuracy of the estimated burden
associated with the proposed collection
of information (see below);
How the quality, utility, and clarity of
the information to be collected may be
enhanced;
How the burden of complying with the
proposed collection of information may
be minimized, including through the
application of automated collection techniques or other forms of information
technology; and

10

Estimates of capital or start-up costs and
costs of operation, maintenance, and
purchase of services to provide information.
The collection of information in this
proposed regulation is in § 1.671–
1(h)(3)(iii). This information is required
by the IRS to determine accurately the
portion of certain foreign employees’
trusts properly treated as owned by the
employer. This information will be used
to notify the Commissioner that certain
entities are relying on an exception for
reasonable funding. The collection of
information is mandatory. The likely
respondents are businesses or other forprofit organizations.
Estimated total annual reporting burden: 1,000 hours.
The estimated annual burden per respondent varies from .5 hours to 1.5
hours, depending on individual circumstances, with an estimated average of 1
hour.
Estimated number of respondents:
1,000.
Estimated annual frequency of responses: On occasion.
An agency may not conduct or sponsor, and a person is not required to
respond to, a collection of information
unless the collection of information displays a valid control number assigned
by the Office of Management and Budget.
Books or records relating to a collection of information must be retained as
long as their contents may become material in the administration of any internal revenue law. Generally, tax returns
and tax return information are confidential, as required by 26 U.S.C. 6103.
Background
On May 7, 1993, the IRS issued
proposed regulations under section 404A
(58 FR 27219). The section 404A proposed regulations provide that section
404A is the exclusive means by which
an employer may take a deduction or
reduce earnings and profits for amounts
used to fund deferred compensation in
situations other than those in which a
deduction or reduction of earnings and
profits is permitted under section 404
(the ‘‘exclusive means’’ rule).
The section 404A proposed regulations do not provide rules regarding the
treatment of income and ownership of
assets of foreign trusts established to
fund deferred compensation arrangements, but refer to ‘‘other applicable

provisions,’’ including the grantor trust
rules of subpart E of the Internal Revenue Code of 1986, as amended. Thus,
the 1993 proposed section 404A regulations imply that, if an employer cannot
or does not elect section 404A treatment
for a foreign trust established to fund
the employer’s deferred compensation
arrangements, the employer may be
treated as the owner of the entire trust
for purposes of subtitle A of the Code
under sections 671 through 679 even
though all or part of the trust assets are
set aside for purposes of satisfying liabilities under the plan. Conversely,
some commentators believe that, for
U.S. tax purposes, a foreign employer
would not be treated as the owner of
any portion of a foreign trust established
to fund a section 404A qualified foreign
plan even though all or part of the trust
assets might be used for purposes other
than satisfying liabilities under the plan.
A number of different rules, in addition
to the grantor trust rules, potentially
affect the taxation of foreign trusts established to fund deferred compensation
arrangements. These rules include: the
nonexempt deferred compensation trust
rules of sections 402(b) and 404(a)(5);
the partnership rules of subchapter K;
and the antideferral rules, which include
subpart F and the passive foreign investment company (PFIC) rules (sections
1291 through 1297).
Following publication of the proposed
1993 regulations and enactment of section 956A in August of 1993, comments
were received concerning both the asset
ownership rules for foreign employees’
trusts and the ‘‘exclusive means’’ rule
for deductions or reductions in earnings
and profits. These proposed regulations
address only comments concerning income and asset ownership rules for
foreign employees’ trusts for federal
income tax purposes. A foreign employees’ trust is a nonexempt employees’
trust described in section 402(b) that is
part of a deferred compensation plan,
and that is a foreign trust within the
meaning of section 7701(a)(31). Comments concerning the ‘‘exclusive
means’’ rule will be addressed in future
regulations.
Statutory Background
1. Transfers of Property Not Complete
for Tax Purposes
In certain situations, assets that are
owned by a trust as a legal matter may
be treated as owned by another person
for tax purposes. Thus, assets may be

treated as owned by a pension trust for
non-tax legal purposes but not for tax
purposes. This occurs, for example, if
the person who has purportedly transferred assets to the trust retains the
benefits and burdens of ownership. See,
e.g., Frank Lyon Co. v. United States,
435 U.S. 561 (1978); Corliss v. Bowers,
281 U.S. 376 (1930); Grodt & McKay
Realty, Inc. v. Commissioner, 77 T.C.
1221 (1981); Rev. Proc. 75–21 (1975–1
C.B. 715). If, under these principles, no
assets have been transferred to an employees’ trust for federal tax purposes,
these proposed regulations do not apply.
2. Subpart E—Grantors and others
treated as substantial owners
Even if there has been a completed
transfer of trust assets, the subpart E
rules may apply to treat the grantor as
the owner of a portion of the trust for
federal income tax purposes. Subpart E
of part I of subchapter J, chapter 1 of
the Code (sections 671 through 679)
taxes income of a trust to the grantor or
another person notwithstanding that the
grantor or other person may not be a
beneficiary of the trust. Under section
671, a grantor or another person includes in computing taxable income and
credits those items of income, deduction, and credit against tax that are
attributable to or included in any portion
of a trust of which that person is treated
as the owner.
Sections 673 through 679 set forth the
rules for determining when the grantor
or another person is treated as the owner
of a portion of a trust for federal income
tax purposes. Under sections 673
through 678, the grantor trust rules
apply only if the grantor or other person
has certain powers or interests. For
example, section 676 provides that the
grantor is treated as the owner of a
portion of a trust where, at any time, the
power to revest in the grantor title to
that portion is exercisable by the grantor
or a nonadverse party, or both. A grantor
who is the owner of a trust under
subpart E is treated as the owner of the
trust property for federal income tax
purposes. See Rev. Rul. 85–13 (1985–1
C.B. 184). This document is made available by the Superintendent of Documents, U.S. Government Printing Office,
Washington, DC 20402.
Section 679 generally applies to a
U.S. person who directly or indirectly
transfers property to a foreign trust,
subject to certain exceptions described
below. Section 679 generally treats a
U.S. person transferring property to a

11

foreign trust as the owner of the portion
of the trust attributable to the transferred
property for any taxable year of that
person for which there is a U.S. beneficiary of any portion of the trust. In
general, a trust is treated as having a
U.S. beneficiary for a taxable year of
the U.S. transferor unless, under the
terms of the trust, no part of the income
or corpus of the trust may be paid or
accumulated during the taxable year to
or for the benefit of a U.S. person, and
unless no part of the income or corpus
of the trust could be paid to or for the
benefit of a U.S. person if the trust were
terminated at any time during the taxable year. A U.S. person is treated as
having made an indirect transfer to the
foreign trust of property if a non-U.S.
person acts as a conduit with respect to
the transfer or if the U.S. person has
sufficient control over the non-U.S. person to direct the transfer by the nonU.S. person rather than itself.
Section 679(a) provides several exceptions from the application of section
679 for certain compensatory trusts. Under these exceptions, section 679 does
not apply to a trust described in section
404(a)(4) or section 404A. Pursuant to
amendments made in section 1903(b) of
the Small Business Job Protection Act
of 1996 (SBJPA), section 679 also does
not apply to any transfer of property
after February 6, 1995, to a trust described in section 402(b).
3. Taxability
of
beneficiary
of
nonexempt employees’ trust
Section 402(b) provides rules for the
taxability of beneficiaries of a
nonexempt employees’ trust. Under section 402(b)(1), employer contributions to
a nonexempt employees’ trust generally
are included in the gross income of the
employee in accordance with section 83.
Section 402(b)(2) provides that amounts
distributed or made available from a
nonexempt employees’ trust generally
are taxable to the distributee under the
rules of section 72 in the taxable year in
which distributed or made available.
Section 402(b)(4) provides that, under
certain circumstances, a highly compensated employee is taxed each year on
the employee’s vested accrued benefit
(other than the employee’s investment in
the contract) in a nonexempt employees’
trust. Under section 402(b)(3), a beneficiary of a nonexempt employees’ trust
generally is not treated as the owner of
any portion of the trust under subpart E.
The rules of section 402(b) apply to a
beneficiary of a nonexempt employees’

trust regardless of whether the trust is a
domestic trust or a foreign trust.
4. Employer deduction for contributions
to a nonexempt employees’ trust
Section 404(a)(5) provides rules regarding the deductibility of contributions
to a nonqualified deferred compensation
plan. Under section 404(a)(5), any contribution paid by an employer under a
deferred compensation plan, if otherwise
deductible under chapter 1 of the Code,
is deductible only in the taxable year in
which an amount attributable to the
contribution is includible in the gross
income of employees participating in the
plan, and only if separate accounts are
maintained for each employee. Section
1.404(a)–12(b)(1) clarifies that an employer’s deduction for contributions to a
nonexempt employees’ trust is restricted
to the amount of the contribution, and
excludes any income received by the
trust with respect to contributed
amounts.
5. The partnership rules of
subchapter K
A partnership is not subject to income
taxation. However, a partner must take
into account separately on its return its
distributive share of the partnership’s
income, gain, loss, deduction, or credit.
A U.S. partner of a foreign partnership
is subject to U.S. tax on its distributive
share of partnership income. In addition,
a foreign partnership may have a controlled foreign corporation (CFC) partner which must take into account its
distributive share of partnership income,
gain, loss, or deduction in determining
its taxable income. These distributive
share inclusions of the CFC may result
in subpart F income and thus income to
a U.S. shareholder of the CFC. If the
grantor trust rules do not apply to any
portion of a foreign employees’ trust, a
foreign partnership could fund a foreign
employees’ trust in excess of the amount
needed to meet its obligations to its
employees under its deferred compensation plan and yet retain control over the
excess amount. As a result, the foreign
partnership would not have to include
items in taxable income attributable to
the excess amount, and consequently the
U.S. partner or CFC would not have to
include those items in its income.
6. The antideferral rules of subpart F,
including section 956A, and PFIC
A U.S. person that owns stock in a
foreign corporation generally pays no
U.S. tax currently on income earned by
the foreign corporation. Instead, the

United States defers taxation of that
income until it is distributed to the U.S.
person. The antideferral rules, however,
which include subpart F and the PFIC
rules, limit this deferral in certain situations.
Subpart F of part III of Subchapter N
(sections 951 through 964) applies to
CFCs. A foreign corporation is a CFC if
more than 50 percent of the total voting
power of all classes of stock entitled to
vote, or the total value of the stock in
the corporation, is owned by ‘‘U.S.
shareholders’’ (defined as U.S. persons
who own ten percent or more of the
voting power of all classes of stock
entitled to vote) on any day during the
foreign corporation’s taxable year. The
United States generally taxes U.S. shareholders of the CFC currently on their
pro rata share of the CFC’s subpart F
income and sections 956 and 956A
amounts. In effect, the U.S. shareholders
are treated as having received a distribution out of the earnings and profits
(E&P) of the CFC.
The types of income earned by a
foreign employees’ trust (dividends, interest, income equivalent to interest,
rents and royalties, and annuities) are
generally subpart F income. The inclusion under section 956 is based on the
CFC’s investment in U.S. property,
which generally includes stock of a U.S.
shareholder of the CFC. A U.S. shareholder’s section 956A amount for a
taxable year is the lesser of two
amounts. The first amount is the excess
of the U.S. shareholder’s pro rata share
of the CFC’s ‘‘excess passive assets’’
over the portion of the CFC’s E&P
treated as previously included in gross
income by the U.S. shareholder under
section 956A. For purposes of section
956A, ‘‘passive asset’’ includes any asset which produces (or is held for the
production of) passive income, and generally includes property that produces
dividends, interest, income equivalent to
interest, rents and royalties, and annuities, subject to exceptions that generally
are not relevant in this context. The
second amount is the U.S. shareholder’s
pro rata share of the CFC’s ‘‘applicable
earnings’’ to the extent accumulated in
taxable years beginning after September
30, 1993.
Section 1501(a)(2) of SBJPA repeals
section 956A. The repeal is effective for
taxable years of foreign corporations
beginning after December 31, 1996, and
for taxable years of U.S. shareholders
with or within which such taxable years
of foreign corporations end.

12

If a CFC employer is not treated for
federal income tax purposes as the
owner of any portion of a foreign
employees’ trust under the grantor trust
rules, then to the extent that passive
assets contributed by a CFC to a
nonexempt employees’ trust would otherwise result in subpart F consequences
for the CFC and its shareholders, the
CFC’s contribution could allow those
consequences to be avoided. For example, a contribution by a CFC of
passive assets to its foreign employees’
trust could reduce the CFC’s subpart F
earnings and profits, and its applicable
earnings or passive assets for section
956A purposes, and could affect the
CFC’s increase in investment in U.S.
property for purposes of section 956, all
of which could affect a U.S. shareholder’s pro rata subpart F inclusions for the
taxable year.
In contrast to the subpart F rules, the
PFIC rules apply to any U.S. person
who directly or indirectly owns any
stock in a foreign corporation that is a
PFIC under either an income or asset
test. A foreign corporation, including a
CFC, is a PFIC if either (1) 75 percent
or more of its gross income for the
taxable year is passive income or (2) at
least 50 percent of the value of the
corporation’s assets produce passive income or are held for the production of
passive income. For this purpose, passive income generally is the same type
of income (dividends, interest, income
equivalent to interest, rents and royalties, and annuities) that would be earned
by a foreign employees’ trust.
Under the PFIC rules, a U.S. person
who is a direct or indirect shareholder
of a PFIC is subject to a special tax
regime upon either disposition of the
PFIC’s stock or receipt of certain distributions (excess distributions) from the
PFIC. A shareholder, however, may
avoid the application of this special
regime by electing to include its pro rata
share of certain of the PFIC’s passive
income in the year in which the foreign
corporation earns it.
If the grantor trust rules did not apply
to any portion of a foreign employees’
trust, a contribution by a foreign corporation of passive assets to a nonexempt
employees’ trust would enable a U.S.
person to avoid the PFIC rules if those
assets would otherwise generate PFIC
consequences for the foreign corporation
and its shareholders. For example, by
transferring passive assets to its
nonexempt employees’ trust in excess of
the amount needed to meet obligations

to its employees under its deferred compensation plan while retaining control
over the excess amount, a foreign corporation could divest itself of a sufficient
amount of passive assets and the passive
income they produce to avoid meeting
the income and asset tests. Furthermore,
a foreign corporation that is a PFIC
could minimize income inclusions for a
U.S. shareholder that has made an election to include PFIC income currently
by transferring income-producing assets
to a foreign employees’ trust.
Overview of proposed regulations
Under the proposed regulations, an
employer is not treated as an owner of
any portion of a domestic nonexempt
employees’ trust described in section
402(b) for federal income tax purposes.
Section 404(a)(5) and § 1.404(a)–12(b)
provide a deduction to the employer
solely for contributions to a nonexempt
employees’ trust, and not for any income of the trust. This rule is inconsistent with treating the employer as owning any portion of a nonexempt
employees’ trust, which would require
the employer to recognize the trust’s
income that it may not deduct under
section 404(a)(5). Accordingly, such a
trust is treated as a separate taxable trust
that is taxed under the rules of section
641 et seq. The rule in the proposed
regulations is consistent with the holdings of a number of private letter rulings
with respect to nonexempt employees’
trusts and with the Service’s treatment
of trusts that no longer qualify as exempt under 501(a) (because they are no
longer described in section 401(a)) as
separate taxable trusts rather than as
grantor trusts. See also Rev. Rul. 74–
299 (1974–1 C.B. 154). This document
is made available by the Superintendent
of Documents, U.S. Government Printing Office, Washington, DC 20402.
Under the proposed regulations, an
employer generally is not treated as the
owner of any portion of a foreign
nonexempt employees’ trust for federal
income tax purposes, except as provided
under section 679. The proposed regulations, however, also provide that the
grantor trust rules apply to determine
whether an employer that is a CFC or a
U.S. employer is treated as the owner of
a specified ‘‘fractional interest’’ in a
foreign employees’ trust. This rule applies whether or not the employer elects
section 404A treatment for the trust.
Under the proposed regulations, this rule
also applies in the case of an employer

that is a foreign partnership with one or
more partners that are U.S. persons or
CFCs (U.S.-related partnership). Such an
employer is treated as the owner of a
portion of a foreign employees’ trust
under these proposed regulations only if
the employer retains a grantor trust
power or interest over a foreign employees’ trust and has a specified ‘‘fractional
interest’’ in the trust.
Under these proposed regulations, the
grantor trust rules of subpart E do not
apply to a foreign employees’ trust with
respect to a foreign employer other than
a CFC or a U.S.-related foreign partnership, except for cases in which assets
are transferred to a foreign employees’
trust with a principal purpose of avoiding the PFIC rules. The IRS and Treasury will continue to consider whether
these regulations should provide additional antiabuse rules that may be necessary for other purposes, including for
purposes of calculating earnings and
profits, determining the foreign tax
credit limitation, and applying the interest allocation rules of § 1.882–5.
Explanation of provisions
1. § 1.671–1(g): Domestic nonexempt
employees’ trusts
The proposed regulations provide that
an employer is not treated for federal
income tax purposes as an owner of any
portion of a nonexempt employees’ trust
described in section 402(b) that is part
of a deferred compensation plan, and
that is not a foreign trust within the
meaning of section 7701(a)(31), regardless of whether the employer has a
power or interest described in sections
673 through 677 over any portion of the
trust. This rule is analogous to the rule
set forth in § 1.641(a)–0, which provides that subchapter J, including the
grantor trust rules, does not apply to
tax-exempt employees’ trusts.
2. § 1.671–1(h): Subpart E rules for
certain foreign employees’ trusts
The proposed regulations provide
Subpart E rules for foreign employees’
trusts of CFCs, foreign partnerships, and
U.S. employers that apply for all federal
income tax purposes. Under the proposed regulations, except as provided
under section 679 or the proposed regulations (as described below), an employer is not treated as an owner of any
portion of a foreign employees’ trust for
federal income tax purposes. If an employer is treated as the owner of a
portion of a foreign employees’ trust for
federal income tax purposes as de-

13

scribed below, then the employer is
considered to own the trust assets attributable to that portion of the trust for all
federal income tax purposes. Thus, for
example, if an employer is treated as the
owner of a portion of a foreign employees’ trust for federal income tax purposes as described below, then income
of the trust that is attributable to that
portion of the trust increases the employer’s earnings and profits for purposes of sections 312 and 964.
A foreign employees’ trust is a
nonexempt employees’ trust described in
section 402(b) that is part of a deferred
compensation plan, and that is a foreign
trust within the meaning of section
7701(a)(31). The proposed regulations
apply to any foreign employees’ trust of
a CFC or U.S.-related foreign partnership, whether or not a trust funds a
qualified foreign plan (as defined in
section 404A(e)). The proposed regulations clarify that the income inclusion
and asset ownership rules apply to the
entity whose employees or independent
contractors are covered under the deferred compensation plan.
A. Plan of CFC employer
The proposed regulations provide that,
if a CFC maintains a deferred compensation plan funded through a foreign
employees’ trust, then, with respect to
the CFC, the provisions of subpart E
apply to the portion of the trust that is
the fractional interest of the trust described in the proposed regulations.
B. Plan of U.S. employer
The proposed regulations provide that
if a U.S. person maintains a deferred
compensation plan funded through a
foreign employees’ trust, then, with respect to the U.S. person, the provisions
of subpart E apply to the portion of the
trust that is the fractional interest of the
trust described in the proposed regulations.
C. Plan of U.S.-related foreign partnership employer
The proposed regulations provide that,
if a U.S.-related foreign partnership
maintains a deferred compensation plan
funded through a foreign employees’
trust, then, with respect to the U.S.related foreign partnership, the provisions of subpart E apply to the portion
of the trust that is the fractional interest
of the trust described in the proposed
regulations. The IRS and Treasury solicit comments on whether these regulations should provide a safe harbor rule
for a U.S.-related foreign partnership

that maintains a deferred compensation
plan funded through a foreign employees’ trust if U.S. or CFC partnership
interests are de minimis. The IRS and
Treasury specifically solicit comments
concerning the amount of U.S. or CFC
partnership interests that would qualify
as ‘‘de minimis.’’
D. Plan of non-CFC foreign employer
The proposed regulations provide that
a foreign employer that is not a CFC is
treated as an owner of a portion of a
foreign employees’ trust only as provided in the antiabuse rule of § 1.1297–
4.
E. Fractional interest
The fractional interest of a foreign
employees’ trust described above is defined in the proposed regulations as an
undivided fractional interest in the trust
for which the fraction is equal to the
relevant amount determined for the employer’s taxable year divided by the fair
market value of trust assets determined
for the employer’s taxable year.
F. Relevant amount
The relevant amount for the employer’s taxable year is defined in the proposed regulations as the amount, if any,
by which the fair market value of trust
assets, plus the fair market value of any
assets available to pay plan liabilities
(including any amount held under an
annuity contract that exceeds the amount
that is needed to satisfy the liabilities
provided for under the contract) that are
held in the equivalent of a trust within
the meaning of section 404A(b)(5)(A),
exceed the plan’s accrued liability, determined using a projected unit credit
funding method.
The relevant amount is reduced to the
extent the taxpayer demonstrates to the
Commissioner that the relevant amount
is attributable to amounts that were
properly contributed to the trust pursuant to a reasonable funding method, or
experience that is favorable relative to
any actuarial assumptions used that the
Commissioner determines to be reasonable. In addition, if an employer that is
a controlled foreign corporation otherwise would be treated as the owner of a
fractional interest in a foreign employees’ trust, the taxpayer may rely on this
rule only if it so indicates on a statement attached to a timely filed Form
5471. The IRS and Treasury solicit
comments regarding the most appropriate way in which to extend a filing

requirement to partners in U.S.-related
foreign partnerships and other affected
taxpayers.
G. Plan’s accrued liability
Under the proposed regulations, the
plan’s accrued liability for a taxable
year of the employer is computed as of
the plan’s measurement date for the
employer’s taxable year. The plan’s accrued liability is determined using a
projected unit credit funding method,
taking into account only liabilities relating to services performed for the employer or a predecessor employer. In
addition, the plan’s accrued liability is
reduced (but not below zero) by any
liabilities that are provided for under
annuity contracts held to satisfy plan
liabilities.
Because CFCs generally are required
to determine their taxable income by
reference to U.S. tax principles, the
definition of a plan’s ‘‘accrued liability’’
refers to § 1.412(c)(3)–1. This definition generally is intended to track the
method used for calculating pension
costs under Statement of Financial Accounting Standards No. 87, Employers’
Accounting for Pensions (FAS 87),
available from the Financial Accounting
Standards Board, 401 Merritt 7,
Norwalk, CT 06856. Under the method
required to be used to calculate FAS
87’s projected benefit obligation (PBO),
plan costs are based on projected salary
levels. Because many taxpayers already
compute PBO annually to determine the
pension costs of their nonexempt employees’ trusts for financial reporting,
the timing, interval and method to compute plan liabilities under § 1.671–1(h)
should minimize taxpayer burden. The
IRS and Treasury solicit comments regarding the extent to which the proposed regulations conform to existing
procedures under FAS 87 and applicable
foreign law, and regarding appropriate
conforming adjustments.
H. Fair market value of trust assets
Under the proposed regulations, for a
taxable year of the employer, the fair
market value of trust assets, and the fair
market value of retirement annuities or
other assets held in the equivalent of a
trust, equals the fair market value of
those assets, as of the measurement date
for the employer’s taxable year. The fair
market value of these assets is adjusted
to include contributions made between
the measurement date and the end of the
employer’s taxable year.

14

I. De minimis exception
The proposed regulations provide an
exception to the general rule for determining the relevant amount. If the relevant amount would not otherwise be
greater than the plan’s normal cost for
the plan year ending with or within the
employer’s taxable year, then the relevant amount is considered to be zero.
J. Proposed effective date and transition
rules
The proposed regulations are proposed to be prospective. For taxable
years ending prior to September 27,
1996, employers generally would not be
treated for federal income tax purposes
as owning the assets of foreign
nonexempt employees’ trusts (except as
provided under section 679), consistent
with the rules applying to domestic
nonexempt employees’ trusts. A transition rule, for purposes of § 1.671–1(h),
exempts certain amounts from the application of the proposed regulations. This
exemption is phased out over a ten-year
period. There is a special transition rule
for any foreign corporation that becomes
a CFC after September 27, 1996. In
addition, there is a special transition rule
for certain entities that become U.S.related foreign partnerships after September 27, 1996.
3. § 1.671–2: General asset ownership
rules
The proposed regulations provide that
a person who is treated as the owner of
any portion of a trust under subpart E is
considered to own the trust assets attributable to that portion of the trust for all
federal income tax purposes.
4. § 1.1297–4: Subpart E rules for foreign employers that are not controlled
foreign corporations
Under the proposed regulations, a
foreign employer other than a CFC is
not treated as the owner of any portion
of a foreign nonexempt employees’ trust
for purposes of sections 1291 through
1297, except for cases in which a principal purpose for transferring property to
the trust is to avoid classification of a
foreign corporation as a PFIC (as defined in section 1296) or, if the foreign
corporation is classified as a PFIC, in
cases in which a principal purpose for
transferring property to the trust is to
avoid or to reduce taxation of U.S.
shareholders of the PFIC under section
1291 or 1293. The effective date of this
rule is September 27, 1996.

Income inclusion and related asset ownership rules for foreign welfare benefit
plans
The IRS and Treasury solicit comments on the need for (and content of)
income inclusion and asset ownership
rules for foreign welfare benefit trusts.
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 assessment is not required. It
is hereby certified that these regulations
do not have a significant economic
impact on a substantial number of small
entities. This certification is based on
the fact that these regulations will primarily affect U.S. owners of significant
interests in foreign entities, which owners generally are large multinational corporations. This certification is also based
on the fact that the burden imposed by
the collection of information in the
regulation, which is a requirement that
certain entities may rely on an exception
for reasonable funding only if they
indicate such reliance on a statement
attached to a timely filed Form 5471, is
minimal, and, therefore, the collection of
information will not impose a significant
economic impact on such entities.
Therefore, a Regulatory Flexibility
Analysis under the Regulatory Flexibility Act (5 U.S.C. chapter 6) is not
required. 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 business.
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) that are submitted timely to the
IRS. All comments will be available for
public inspection and copying.
A public hearing has been scheduled
for January 15, 1997, at 10:00 a.m. in
room 2615, Internal Revenue Building,
1111 Constitution Avenue, NW., Washington DC. Because of access restrictions, visitors will not be admitted beyond the Internal Revenue Building
lobby more than 15 minutes before the
hearing starts.
The rules of 26 CFR 601.601(a)(3)
apply to the hearing.

Persons that wish to present oral
comments at the hearing must submit
written comments by December 26,
1996, and submit an outline of the
topics to be discussed and the time to be
devoted to each topic (signed original
and eight (8) copies) by December 24,
1996.
A period of 10 minutes will be allotted to each person for making comments.
An agenda showing the scheduling of
the 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 authors of these regulations are James A. Quinn of the Office
of Assistant Chief Counsel (Passthroughs and Special Industries), Linda
S. F. Marshall of the Office of Associate
Chief Counsel (Employee Benefits and
Exempt Organizations), and Kristine K.
Schlaman and M. Grace Fleeman of the
Office of Associate Chief Counsel (International). However, other personnel
from the IRS and Treasury Department
participated in their development.
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 is amended by removing the entry
for sections 1.1291–10T, 1.1294–1T,
1.1295–1T, and 1.1297–3T and adding
entries in numerical order to read as
follows:
Authority: 26 U.S.C. 7805 * * *
Section 1.671–1 also issued under 26
U.S.C. 404A(h) and 672(f)(2)(B). * * *
Section 1.1291–10T also issued under
26 U.S.C. 1291(d)(2).
Section 1.1294–1T also issued under
26 U.S.C. 1294.
Section 1.1295–1T also issued under
26 U.S.C. 1295.
Section 1.1297–3T also issued under
26 U.S.C. 1297(b)(1).
Section 1.1297–4 also issued under 26
U.S.C. 1297(f). * * *
Par. 2. Section 1.671–1 is amended by
adding paragraphs (g) and (h) to read as
follows:

15

§ 1.671–1 Grantors and others treated
as substantial owners; scope.
*

*

*

*

*

(g) Domestic nonexempt employees’
trust—(1) General rule. An employer is
not treated as an owner of any portion
of a nonexempt employees’ trust described in section 402(b) that is part of
a deferred compensation plan, and that
is not a foreign trust within the meaning
of section 7701(a)(31), regardless of
whether the employer has a power or
interest described in sections 673
through 677 over any portion of the
trust. See section 402(b)(3) and
§ 1.402(b)–1(b)(6) for rules relating to
treatment of a beneficiary of a
nonexempt employees’ trust as the
owner of a portion of the trust.
(2) Example. The following example
illustrates the rules of paragraph (g)(1)
of this section:
Example. Employer X provides nonqualified
deferred compensation through Plan A to certain
of its management employees. Employer X has
created Trust T to fund the benefits under Plan A.
Assets of Trust T may not be used for any purpose
other than to satisfy benefits provided under Plan
A until all plan liabilities have been satisfied.
Trust T is classified as a trust under § 301.7701–4
of this chapter, and is not a foreign trust within
the meaning of section 7701(a)(31). Under
§ 1.83– 3(e), contributions to Trust T are considered transfers of property to participants within the
meaning of section 83. On these facts, Trust T is a
nonexempt employees’ trust described in section
402(b). Because Trust T is a nonexempt employees’ trust described in section 402(b) that is part of
a deferred compensation plan, and that is not a
foreign trust within the meaning of section
7701(a)(31), Employer X is not treated as an
owner of any portion of Trust T.

(h) Foreign employees’ trust—
(1) General rules. Except as provided
under section 679 or as provided under
this paragraph (h)(1), an employer is not
treated as an owner of any portion of a
foreign employees’ trust (as defined in
paragraph (h)(2) of this section), regardless of whether the employer has a
power or interest described in sections
673 through 677 over any portion of the
trust.
(i) Plan of CFC employer. If a controlled foreign corporation (as defined in
section 957) maintains a deferred compensation plan funded through a foreign
employees’ trust, then, with respect to
the controlled foreign corporation, the
provisions of subpart E apply to the
portion of the trust that is the fractional
interest described in paragraph (h)(3) of
this section.
(ii) Plan of U.S. employer. If a United
States person (as defined in section
7701(a)(30)) maintains a deferred compensation plan that is funded through a

foreign employees’ trust, then, with respect to the U.S. person, the provisions
of subpart E apply to the portion of the
trust that is the fractional interest described in paragraph (h)(3) of this section.
(iii) Plan of U.S.-related foreign partnership employer— (A) General rule. If
a U.S.-related foreign partnership (as
defined in paragraph (h)(1)(iii)(B) of
this section) maintains a deferred compensation plan funded through a foreign
employees’ trust, then, with respect to
the U.S.-related foreign partnership, the
provisions of subpart E apply to the
portion of the trust that is the fractional
interest described in paragraph (h)(3) of
this section.
(B) U.S.-related foreign partnership.
For purposes of this paragraph (h), a
U.S.-related foreign partnership is a foreign partnership in which a U.S. person
or a controlled foreign corporation owns
a partnership interest either directly or
indirectly through one or more partnerships.
(iv) Application of § 1.1297–4 to
plan of foreign non-CFC employer. A
foreign employer that is not a controlled
foreign corporation may be treated as an
owner of a portion of a foreign employees’ trust as provided in § 1.1297–4.
(v) Application to employer entity.
The rules of paragraphs (h)(1)(i) through
(h)(1)(iv) of this section apply to the
employer whose employees benefit under the deferred compensation plan
funded through a foreign employees’
trust, or, in the case of a deferred
compensation plan covering independent
contractors, the recipient of services performed by those independent contractors, regardless of whether the plan is
maintained through another entity. Thus,
for example, where a deferred compensation plan benefitting employees of a
controlled foreign corporation is funded
through a foreign employees’ trust, the
controlled foreign corporation is considered to be the grantor of the foreign
employees’ trust for purposes of applying paragraph (h)(1)(i) of this section.
(2) Foreign employees’ trust. A foreign employees’ trust is a nonexempt
employees’ trust described in section
402(b) that is part of a deferred compensation plan, and that is a foreign
trust within the meaning of section
7701(a)(31).
(3) Fractional interest for paragraph
(h)(1)—(i) In general. The fractional interest for a foreign employees’ trust
used for purposes of paragraph (h)(1) of
this section for a taxable year of the

employer is an undivided fractional interest in the trust for which the fraction
is equal to the relevant amount for the
employer’s taxable year divided by the
fair market value of trust assets for the
employer’s taxable year.
(ii) Relevant amount—(A) In general.
For purposes of applying paragraph
(h)(3)(i) of this section, and except as
provided in paragraph (h)(3)(iii) of this
section, the relevant amount for the
employer’s taxable year is the amount,
if any, by which the fair market value of
trust assets, plus the fair market value of
any assets available to pay plan liabilities that are held in the equivalent of a
trust within the meaning of section
404A(b)(5)(A), exceed the plan’s accrued liability. The following rules apply
for this purpose:
(1) The plan’s accrued liability is
determined using a projected unit credit
funding method that satisfies the requirements of § 1.412(c)(3)–1, taking
into account only liabilities relating to
services performed through the measurement date for the employer or a predecessor employer.
(2) The plan’s accrued liability is
reduced (but not below zero) by any
liabilities that are provided for under
annuity contracts held to satisfy plan
liabilities.
(3) Any amount held under an annuity contract that exceeds the amount that
is needed to satisfy the liabilities provided for under the contract (e.g., the
value of a participation right under a
participating annuity contract) is added
to the fair market value of any assets
available to pay plan liabilities that are
held in the equivalent of a trust.
(4) If the relevant amount as determined under this paragraph (h)(3)(ii),
without regard to this paragraph
(h)(3)(ii)(A)(4), is greater than the fair
market value of trust assets, then the
relevant amount is equal to the fair
market value of trust assets.
(B) Permissible actuarial assumptions for accrued liability. For purposes
of paragraph (h)(3)(ii)(A) of this section,
a plan’s accrued liability must be calculated using an interest rate and other
actuarial assumptions that the Commissioner determines to be reasonable. It is
appropriate in determining this interest
rate to look to available information
about rates implicit in current prices of
annuity contracts, and to look to rates of
return on high-quality fixed-income investments currently available and expected to be available during the period
prior to maturity of the plan benefits. If

16

the qualified business unit computes its
income or earnings and profits in dollars
pursuant to the dollar approximate separate transactions method under § 1.985–
3, the employer must use an exchange
rate that can be demonstrated to clearly
reflect income, based on all relevant
facts and circumstances, including appropriate rates of inflation and commercial practices.
(iii) Exception for reasonable funding. The relevant amount does not include an amount that the taxpayer demonstrates to the Commissioner is
attributable to amounts that were properly contributed to the trust pursuant to
a reasonable funding method, applied
using actuarial assumptions that the
Commissioner determines to be reasonable, or any amount that the taxpayer
demonstrates to the Commissioner is
attributable to experience that is favorable relative to any actuarial assumptions used that the Commissioner determines to be reasonable. For this
paragraph (h)(3)(iii) to apply to a controlled foreign corporation employer described in paragraph (h)(1)(i) of this
section, the taxpayer must indicate on a
statement attached to a timely filed
Form 5471 that the taxpayer is relying
on this rule. For purposes of this paragraph (h)(3)(iii), an amount is considered contributed pursuant to a reasonable funding method if the amount is
contributed pursuant to a funding
method permitted to be used under
section 412 (e.g., the entry age normal
funding method) that is consistently
used to determine plan contributions. In
addition, for purposes of this paragraph
(h)(3)(iii), if there has been a change to
that method from another funding
method, an amount is considered contributed pursuant to a reasonable funding method only if the prior funding
method is also a funding method described in the preceding sentence that
was consistently used to determine plan
contributions. For purposes of this paragraph (h)(3)(iii), a funding method is
considered reasonable only if the
method provides for any initial unfunded liability to be amortized over a
period of at least 6 years, and for any
net change in accrued liability resulting
from a change in funding method to be
amortized over a period of at least 6
years.
(iv) Reduction for transition amount.
The relevant amount is reduced (but not
below zero) by any transition amount
described in paragraphs (h)(5), (h)(6), or
(h)(7) of this section.

(v) Fair market value of assets. For
purposes of paragraphs (h)(3)(i) and (ii)
of this section, for a taxable year of the
employer, the fair market value of trust
assets, and the fair market value of other
assets held in the equivalent of a trust
within the meaning of section
404A(b)(5)(A), equals the fair market
value of those assets, as of the measurement date for the employer’s taxable
year, adjusted to include contributions
made after the measurement date and by
the end of the employer’s taxable year.
(vi) Annual valuation. For purposes
of determining the relevant amount for a
taxable year of the employer, the fair
market value of plan assets, and the
plan’s accrued liability as described in
paragraphs (h)(3)(ii) and (iii) of this
section, and the normal cost as described in paragraph (h)(4) of this section, must be determined as of a consistently used annual measurement date
within the employer’s taxable year.
(vii) Special rule for plan funded
through multiple trusts. In cases in
which a plan is funded through more
than one foreign employees’ trust, the
fractional interest determined under
paragraph (h)(3)(i) of this section in
each trust is determined by treating all
of the trusts as if their assets were held
in a single trust for which the fraction is
determined in accordance with the rules
of this paragraph (h)(3).
(4) De minimis exception. If the relevant amount is not greater than the
plan’s normal cost for the plan year
ending with or within the employer’s
taxable year, computed using a funding
method and actuarial assumptions as
described in paragraph (h)(3)(ii) of this
section or as described in paragraph
(h)(3)(iii) of this section if the requirements of that paragraph are met, that are
used to determine plan contributions,
then the relevant amount is considered
to be zero for purposes of applying
paragraph (h)(3)(i) of this section.
(5) General rule for transition
amount—(i) General rule. If paragraphs
(h)(6) and (h)(7) of this section do not
apply to the employer, the transition
amount for purposes of paragraph
(h)(3)(iv) of this section is equal to the
preexisting amount multiplied by the
applicable percentage for the year in
which the employer’s taxable year begins.
(ii) Preexisting amount. The preexisting amount is equal to the relevant
amount of the trust, determined without
regard to paragraphs (h)(3)(iv) and
(h)(4) of this section, computed as of

the measurement date that immediately
precedes September 27, 1996, disregarding contributions to the trust made after
the measurement date.
(iii) Applicable percentage. The applicable percentage is equal to 100 percent for the employer’s first taxable year
ending after this document is published
as a final regulation in the Federal
Register and prior taxable years of the
employer, and is reduced (but not below
zero) by 10 percentage points for each
subsequent taxable year of the employer.
(6) Transition amount for new
CFCs—(i) General rule. In the case of
a new controlled foreign corporation
employer, the transition amount for purposes of paragraph (h)(3)(iv) is equal to
the pre-change amount multiplied by the
applicable percentage for the year in
which the new controlled foreign corporation employer’s taxable year begins.
(ii) Pre-change amount. The prechange amount for purposes of paragraph (h)(6)(i) is equal to the relevant
amount of the trust, determined without
regard to paragraphs (h)(3)(iv) and
(h)(4) of this section and disregarding
contributions to the trust made after the
measurement date, for the new controlled foreign corporation employer’s
last taxable year ending before the corporation becomes a new controlled foreign corporation employer.
(iii) Applicable percentage—(A) General rule. Except as provided in paragraph (h)(6)(iii)(B) of this section, the
applicable percentage is equal to 100
percent for a new controlled foreign
corporation employer’s first taxable year
ending after the corporation becomes a
controlled foreign corporation. The applicable percentage is reduced (but not
below zero) by 10 percentage points for
each subsequent taxable year of the new
controlled foreign corporation.
(B) Interim rule. For any taxable year
of a new controlled foreign corporation
employer that ends on or before the date
this document is published as a final
regulation in the Federal Register, the
applicable percentage is equal to 100
percent. The applicable percentage is
reduced by 10 percentage points for
each subsequent taxable year of the new
controlled foreign corporation employer
that ends after the date this document is
published as a final regulation in the
Federal Register.
(iv) New CFC employer. For purposes
of paragraph (h)(6) of this section, a
new controlled foreign corporation employer is a corporation that first becomes a controlled foreign corporation

17

within the meaning of section 957 after
September 27, 1996. A new controlled
foreign corporation employer includes a
corporation that was a controlled foreign
corporation prior to, but not on, September 27, 1996, and that first becomes a
controlled foreign corporation again after September 27, 1996.
(v) Anti-stuffing rule. Notwithstanding paragraph (h)(6)(iii) of this section,
if, prior to becoming a controlled foreign corporation, a corporation contributes amounts to a foreign employees’
trust with a principal purpose of obtaining tax benefits by increasing the prechange amount, the applicable percentage with respect to those amounts is 0
percent for all taxable years of the new
controlled foreign corporation employer.
(7) Transition amount for new U.S.related foreign partnerships—(i) General rule. In the case of a new U.S.related foreign partnership employer, the
transition amount for purposes of paragraph (h)(3)(iv) of this section is equal
to the pre-change amount multiplied by
the applicable percentage for the year in
which the new U.S.-related foreign partnership employer’s taxable year begins.
(ii) Pre-change amount. The prechange amount for purposes of paragraph (h)(7)(i) of this section is equal to
the relevant amount of the trust, determined without regard to paragraphs
(h)(3)(iv) and (h)(4) of this section and
disregarding contributions to the trust
made after the measurement date, for
the entity’s last taxable year ending
before the entity becomes a new U.S.related foreign partnership employer.
(iii) Applicable percentage—(A) General rule. Except as provided in paragraph (h)(7)(iii)(B) of this section, the
applicable percentage is equal to 100
percent for a new U.S.- related foreign
partnership employer’s first taxable year
ending after the entity becomes a new
U.S.-related foreign partnership employer. The applicable percentage is reduced (but not below zero) by 10 percentage points for each subsequent
taxable year of the new U.S.-related
foreign partnership employer.
(B) Interim rule. For any taxable year
of a new U.S.- related foreign partnership employer that ends on or before the
date this document is published as a
final regulation in the Federal Register,
the applicable percentage is equal to 100
percent. The applicable percentage is
reduced by 10 percentage points for
each subsequent taxable year of the new
U.S.-related foreign partnership employer that ends after the date this

document is published as a final regulation in the Federal Register.
(iv) New U.S.-related foreign partnership employer. For purposes of paragraph (h)(7) of this section, a new
U.S.-related foreign partnership employer is an entity that was a foreign
corporation other than a controlled foreign corporation, or that was a foreign
partnership other than a U.S.-related
foreign partnership, and that changes
from this status to a U.S.-related foreign
partnership after September 27, 1996. A
new U.S.-related foreign partnership employer includes a corporation that was a
U.S.-related foreign partnership prior to,
but not on, September 27, 1996, and
that first becomes a U.S.-related foreign
partnership again after September 27,
1996.
(v) Anti-stuffing rule. Notwithstanding paragraph (h)(7)(iii) of this section,
if, prior to becoming a new U.S.- related
foreign partnership employer, an entity
contributes amounts to a foreign employees’ trust with a principal purpose
of obtaining tax benefits by increasing
the pre-change amount, the applicable
percentage with respect to those
amounts is 0 percent for all taxable
years of the new U.S.-related foreign
partnership employer.
(8) Examples. The following examples illustrate the rules of paragraph
(h) of this section. In each example, the
employer has a power or interest described in sections 673 through 677 over
the foreign employees’ trust, and the
monetary unit is the applicable functional currency (FC) determined in accordance with section 985(b) and the
regulations thereunder.
Example 1. (i) Employer X is a controlled
foreign corporation (as defined in section 957).
Employer X maintains a defined benefit retirement
plan for its employees. Employer X’s taxable year
is the calendar year. Trust T, a foreign employees’
trust, is the sole funding vehicle for the plan. Both
the plan year of the plan and the taxable year of
Trust T are the calendar year.
(ii) As of December 31, 1997, Trust T’s measurement date, the fair market value (as described
in paragraph (h)(3)(iv) of this section) of Trust T’s
assets is FC 1,000,000, and the amount of the
plan’s accrued liability is FC 800,000, which
includes a normal cost for 1997 of FC 50,000. The
preexisting amount for Trust T is FC 40,000.
Thus, the relevant amount for 1997 is FC 160,000
(which is greater than the plan’s normal cost for
the year). Employer X’s shareholder does not
indicate on a statement attached to a timely filed
Form 5471 that any of the relevant amount
qualifies for the exception described in paragraph
(h)(3)(iii) of this section. Therefore, the fractional
interest for Employer X’s taxable year ending on
December 31, 1997, is 16 percent. Employer X is
treated as the owner for federal income tax
purposes of an undivided 16 percent interest in

each of Trust T’s assets for the period from
January 1, 1997 through December 31, 1997.
Employer X must take into account a 16 percent
pro rata share of each item of income, deduction
or credit of Trust T during this period in computing its federal income tax liability.
Example 2. Assume the same facts as in
Example 1, except that Employer X’s shareholder
indicates on a statement attached to a timely filed
Form 5471 and can demonstrate to the satisfaction
of the Commissioner that, in reliance on paragraph
(h)(3)(iii) of this section, FC 100,000 of the fair
market value of Trust T’s assets is attributable to
favorable experience relative to reasonable actuarial assumptions used. Accordingly, the relevant
amount for 1997 is FC 60,000. Because the plan’s
normal cost for 1997 is less than FC 60,000, the
de minimis exception of paragraph (h)(4) of this
section does not apply. Therefore, the fractional
interest for Employer X’s taxable year ending on
December 31, 1997, is 6 percent. Employer X is
treated as the owner for federal income tax
purposes of an undivided 6 percent interest in each
of Trust T’s assets for the period from January 1,
1997, through December 31, 1997. Employer X
must take into account a 6 percent pro rata share
of each item of income, deduction or credit of
Trust T during this period in computing its federal
income tax liability.

(9) Effective date. Paragraphs (g) and
(h) of this section apply to taxable years
of an employer ending after September
27, 1996.
Par. 3. Section 1.671–2 is amended by
adding paragraph (f) to read as follows:
§ 1.671–2 Applicable principles
*

*

*

*

*

(f) For purposes of subtitle A of the
Internal Revenue Code, a person that is
treated as the owner of any portion of a
trust under subpart E is considered to
own the trust assets attributable to that
portion of the trust.
Par. 4. Section 1.1297–4 is added to
read as follows:
§ 1.1297–4 Application of subpart E of
subchapter J with respect to foreign
employees’ trusts.
(a) General rules. For purposes of
part VI of subchapter P, chapter 1 of the
Code, a foreign employer that is not a
controlled foreign corporation is not
treated as the owner of any portion of a
foreign employees’ trust (as defined in
§ 1.671–1(h)(2)) except as provided in
this paragraph (a), regardless of whether
the employer has a power or interest
described in sections 673 through 677
over any portion of the trust.
(1) Principal purpose to avoid classification as a passive foreign investment
company. If a principal purpose for a
transfer of property by any person to a
foreign employees’ trust (as defined in
§ 1.671–1(h)(2)) is to avoid classification of a foreign corporation as a passive foreign investment company, then

18

the following rule applies. If the foreign
employer has a power or interest described in sections 673 through 677 over
the trust, then the grantor trust rules of
subpart E of part I of subchapter J,
chapter 1 of the Code will apply, for
purposes of part VI of subchapter P, to a
fixed dollar amount in the trust that is
equal to the fair market value of the
property that is transferred for the purpose of avoiding classification as a
passive foreign investment company.
Whether a principal purpose for a transfer is the avoidance of classification as a
passive foreign investment company will
be determined on the basis of all of the
facts and circumstances, including
whether the amount of assets held by
the foreign employees’ trust is reasonably related to the plan’s anticipated
liabilities, taking into account any local
law and practice relating to proper funding levels.
(2) Principal purpose to reduce or
eliminate taxation under section 1291 or
1293. If a principal purpose for a transfer of property by any person to a
foreign employees’ trust (as defined in
§ 1.671–1(h)(2)) is to reduce or eliminate taxation under section 1291 or
1293, then the following rule applies. If
the foreign employer has a power or
interest described in sections 673
through 677 over the trust, then the
provisions of subpart E will apply, for
purposes of part VI of subchapter P, to a
fixed dollar amount in the trust that is
equal to the fair market value of the
property transferred for the purpose of
reducing or eliminating taxation under
section 1291 or 1293. Whether a principal purpose for a transfer is to reduce or
eliminate taxation under section 1291 or
1293 will be determined on the basis of
all the facts and circumstances, including whether the amount of assets held
by the foreign employees’ trust is reasonably related to the plan’s anticipated
liabilities, taking into account any local
law and practice relating to proper funding levels.
(3) Application to employer entity.
The rules of this section apply to the
employer whose employees benefit under the deferred compensation plan
funded through the foreign employees’
trust, or, in the case of a deferred
compensation plan covering independent
contractors, the recipient of services performed by those independent contractors, regardless of whether the plan is
maintained through another entity. Thus,
for example, where a deferred compensation plan benefitting employees of a

foreign employer that is not a controlled
foreign corporation is funded through a
foreign employees’ trust, the foreign
employer is considered to be the grantor
of the foreign employees’ trust for purposes of this paragraph (a).
(b) Effective date. This section applies to taxable years of a foreign
corporation ending after September 27,
1996.
Margaret Milner Richardson,
Commissioner of Internal Revenue.
(Filed by the Office of the Federal Register on
September 26, 1996, 8:45 a.m., and published in
the issue of the Federal Register for September 27,
1996, 61 F.R. 50778)

Proposed Tip Reporting Agreement
for Use in the Hairstyling Industry
Announcement 96–105
SUMMARY
The Internal Revenue Service is considering expansion of its Market Segment Understanding (MSU) Program as
a means to enhance tax compliance
through taxpayer education and voluntary advance agreements instead of traditional audit techniques. This announcement solicits comments on a
draft model MSU Agreement entitled
Tip Reporting Alternative Commitment
(Hairstyling Industry).
OVERVIEW
The Service developed its MSU Program in 1993 as a means of enhancing
tax compliance while reducing taxpayer
burden. In essence, the Program envisions that the Service and taxpayers in
particular market segments would work
together to improve tax compliance in
those areas through educational efforts
and other collaborative approaches
rather than through traditional audit
techniques.
Since 1995, the Service has entered
into Tip Reporting Alternative Commitment (TRAC) agreements with taxpayers in the food service industry. In
general, these TRAC agreements involve
an educational program for tipped employees and tip reporting procedures for
cash and charged tips. The agreements
also set forth an understanding that both
the employer and employees who comply with the terms of the TRAC agreement will generally not be subject to
challenge by the District Director. The
decision to enter into a TRAC agreement is entirely optional on the part of
the employer.

Taxpayers in the hairstyling industry
have expressed interest in entering into
a TRAC agreement with the Service. To
ensure consistency in these agreements
and provide an opportunity for public
comment prior to expanding this aspect
of the MSU Program, the Service has
developed a draft form of TRAC agreement that could be used as a model for
the hairstyling industry. This draft model
Agreement is entitled ‘‘Tip Reporting
Alternative Commitment (Hairstyling Industry)’’ and is attached to this announcement.
COMMENTS
Written comments must be received
by December 14, 1996. Send submissions to Office of Specialty Taxes, c/o
CC:DOM:CORP:R (Announcement 96–
105), room 5228, Internal Revenue Service, POB 7604, Ben Franklin Station,
Washington, DC 20044. Alternatively,
taxpayers may submit comments electronically via the Internet by selecting
the ‘‘Tax Regs’’ option on the IRS
Home Page, or by submitting comments
directly to the IRS Internet site at
http://www.irs.ustreas.gov/prod/tax_regs/
comments.html. In the alternative, submissions may be hand delivered between the hours of 8 a.m. and 5 p.m. to
Office of Specialty Taxes, c/o
CC:DOM:CORP:R (Announcement 96–
105), Courier’s Desk, Internal Revenue
Service, 1111 Constitution Avenue NW,
Washington, DC.
DRAFTING INFORMATION
The principal author of this announcement is Karin Loverud of the Office of
the Associate Chief Counsel (Employee
Benefits and Exempt Organizations). For
further information regarding this announcement, contact Kathy Mort, MSU
program administrator, Office of Specialty Taxes, on (202) 376–0687 (not a
toll-free call).
Draft release date: 10/15/96
TIP REPORTING ALTERNATIVE
COMMITMENT
(Hairstyling Industry)
between
Department of the Treasury-Internal
Revenue Service
and
[Name of Employer]
(Taxpayer-Employer’s
name, address, and identifying number)

19

(‘‘Employer’’) and the
District Director of Internal Revenue
(‘‘District Director’’) hereby agree to the
following Tip Reporting Alternative
Commitment (‘‘TRAC’’).
The parties agree that the current law
requirements for reporting cash and
charged tips and for determining the
Employer’s liability for Federal Insurance Contribution Act (‘‘FICA’’) taxes
with respect to those tips operate as
described below:
A. Section 6053(a) of the Internal
Revenue Code of 1986, as amended
(‘‘Code’’), requires employees to furnish
one or more written statements to their
employers reporting all tips received in
each calendar month. The statements
must be furnished to the employer by
the 10th day of the following month.
For purposes of both the employer and
employee shares of FICA taxes, the tips
are deemed to be ‘‘remuneration’’ at the
time the employee’s report is furnished
to the employer. Section 3121(q) of the
Code was amended by section 9006 of
the Omnibus Reconciliation Act of
1987, Pub. L. No. 100–203, effective
January 1, 1988, to cross-reference sections 3111(a) and (b) of the Code,
thereby obligating employers to pay the
employer share of FICA taxes on employees’ tip income ‘‘remuneration.’’ Accordingly, effective for tips received
after 1987, an employer must pay its
share of FICA taxes on the tip income
reported to it by its employees under
section 6053(a) of the Code at the time
the income is deemed to be remuneration by section 3121(q) of the Code.
B. If an employee fails to report tip
income to the employer as required by
section 6053(a) of the Code, or underreports tip income to the employer, the
employer’s liability for the portion of
FICA taxes attributable to such tip income is collectible only under the ‘‘notice and demand’’ procedure found in
the last clause of section 3121(q) of the
Code. Under this procedure, the Internal
Revenue Service (‘‘Service’’) provides a
‘‘notice and demand’’ to the employer to
reflect tip income not previously reported by the employee to the employer.
This tip income then becomes ‘‘remuneration’’ under section 3121(q) for purposes of determining the employer’s
share of FICA taxes under sections
3111(a) and (b) of the Code.
C. Under section 6652(b) of the
Code, if an employee fails to report the
tip income received in any calendar
month as required by section 6053(a),
the employee can be assessed a penalty

equal to 50 percent of the additional
employee FICA tax due with respect to
the tip income, unless the employee can
show that the failure is due to reasonable cause and not willful neglect.
In October 1993, the Service implemented nationally its Tip Rate Education
Program (‘‘Program’’). The purpose of
the Program is to ensure maximum
compliance by employees with the provisions of the Code relating to tip
income.
The Service will accept a TRAC
agreement in every District, will permit
all eligible employers to enter into a
TRAC agreement, and will assist applicants in understanding and meeting the
requirements for participation in a
TRAC agreement.
The District Director and the Employer have agreed to resolve disputes
concerning the responsibilities of the
Employer and the District Director under section 3121(q) of the Code and to
establish procedures to prevent such
disputes in the future. Therefore, the
parties agree as follows:
I. DEFINITIONS
A. Employer means
[insert name].
B. Establishment means each of the
establishments listed by name, address,
and identifying number in Attachment
A. [sample attached] If the Employer
has one place of business, that place of
business is an Establishment.
C. Employee means a person employed by the Establishment who directly or indirectly receives tips of at
least $20.00 per month during the
course of the employee’s employment.
D. TRAC application means a signed
request to enter into a TRAC agreement
submitted by mail.
E. District Director means the District Director of Internal Revenue for
[insert name of District] or designee.
II. EFFECTIVE DATE OF
AGREEMENT
A. General rule. Except as described
below, this Agreement is effective on
the first day of the first calendar quarter
following the date the District Director
signs the Agreement.
B. Special rules.
1. Employer with Establishment open
to the public before [insert date program is to go into effect (‘‘date A’’)]—
Applications submitted before [insert
date 1 year later (‘‘date B’’)]. In the

case of an Employer who (1) had one or
more Establishments open to the public
before [insert date A], and (2) submits
its TRAC application before [insert date
B], the TRAC agreement is effective on
the first day of the first calendar quarter
following the quarter in which the application is submitted to the District Director, unless the District Director rejects
the application (with respect to any or
all of the Establishments) in writing
within 3 months after the date of submission. (Section II. B. 5. sets forth the
reasons for which the District Director
may reject a TRAC application.)
2. Employer with no Establishment
open to the public before [insert Date
A]—Applications submitted within 12
months after first Establishment opens.
In the case of an Employer who (1) had
no Establishment open to the public
before [insert date A], and (2) submits
its TRAC application within 12 months
after its first Establishment opens to the
public, the TRAC agreement is effective
on the first day of the first calendar
quarter following the quarter in which
the application is submitted to the District Director, unless the District Director rejects the application (with respect
to any or all of the Establishments) in
writing within 3 months after the date of
submission. (Section II. B. 5. sets forth
the reasons for which a District Director
may reject a TRAC application.)
3. Employer acquisition or public
opening of Establishment—Participation
and nonparticipation in Agreement. If an
Employer acquires or opens to the public an additional Establishment and the
Employer wishes to include the Establishment in the Employer’s TRAC
agreement, the Employer must provide
an addendum to Attachment A to the
District Director within six months after
the date of any such acquisition or
public opening. The addendum will include the name, address, and identifying
number of the acquired or opened Establishment. Such Establishment will be
treated as participating in the TRAC
agreement beginning on the date of
acquisition or public opening, unless the
District Director rejects the application
in writing within three months after the
date of submission of the addendum. If
the Employer does not furnish a timely
addendum, the general rule of Section
II.A. applies, and thus the TRAC agreement will not become effective with
respect to the additional Establishment
until the first day of the first calendar

20

quarter following the date the District
Director agrees in writing to the addendum.
4. Change in Ownership or Control.
If an Employer or Establishment currently participating in a TRAC agreement undergoes a change in ownership
or control, such Employer or Establishment must provide an addendum to
Attachment A to the District Director
within six months after the effective
date of the change. The addendum will
include the name, address, and identifying number of the acquiring entity. The
acquiring entity will be treated as the
successor Employer under the original
TRAC agreement beginning on the date
of change in ownership or control unless
the District Director rejects the addendum in writing within three months of
its submission, in whole or in part, for
the reasons set forth in Section II. B. 5.
Failure to furnish an addendum may
result in a revocation under Section V.B.
as of the last day of the six-month
period.
5. Rejection by the District Director.
The District Director may reject a
TRAC application or addendum for one
of the following reasons:
a. the failure of the Employer to
comply with the rules relating to the
filing of any federal tax return, paying
the amount of any undisputed federal
tax, or making any deposit of federal
taxes;
b. the inability of an Establishment to
comply with the procedures set forth in
Section III.; or
c. the pursuit, by the Internal Revenue Service or another federal agency,
of administrative or judicial action relating to the applicant or related party.
C. Ongoing tip examination. A tip
examination in progress on the date the
Employer submits its TRAC application
will not affect the effective date of this
Agreement.
III. COMMITMENT OF
EMPLOYER
While this Agreement is in effect, the
Employer agrees to the following provisions:
A. Educational Program. The Employer must institute and maintain for
each calendar quarter an educational
program that trains newly hired Employees and periodically updates existing
Employees as to their reporting obligations with respect to tip income received
as either cash tips or charged tips. This
educational program may include on-site
or off-site training by the Establishment,

video programs, and written materials,
such as tip reporting booklets offered as
part of new employee informational materials.
This educational program must emphasize that, in addition to charged tips
attributable to Employees, all cash tips
paid to and retained by the Employees
must be reported to their employing
Establishment. The Employer may illustrate this by informing the Employees of
the Establishment’s charged sales to
cash sales ratio and explaining the correlation between charged tips and cash
tips.
The Employer as part of this program
must explain to the employees their
obligation to maintain for their records
the information required in Form
4070A, Employee’s Daily Record of
Tips. This educational program also
should advise all participants of the
benefits of proper tip reporting (e.g.,
Social Security wage credit history, increased retirement plan contributions,
and creation of adequate records of tip
income).
B. Requirements regarding returns,
taxes, and records.
1. Filing returns.
a. Form 941. Each calendar quarter,
the Employer must comply with the
requirements for filing Form 941, Employer’s Quarterly Federal Tax Return.
The Form 941 must include all charged
and cash tips reported by the Employees
to the employing Establishment(s) in
accordance with the procedures set forth
in Section III. C.
b. Forms W–2. The Employer (or
employing Establishment) must comply
with the requirements for filing Forms
W–2 for all the Employees and include
all reported charged and cash tips on the
Employees’ Forms W–2, including tips
verified or corrected pursuant to Section
III. C.
c. Other returns. The Employer must
comply with the requirements for filing
all other required federal tax returns.
2. Payment and deposit of taxes. The
Employer must comply with the requirements for paying the amount of any
undisputed federal tax that is due and
depositing federal taxes.
3. Maintenance of records. Each Establishment must maintain records of the
following:
a. Gross receipts subject to tipping,
and
b. Charge receipts showing charged
tips.

The Employer must retain these records
for at least 4 years after the April 15
following the calendar year to which the
records relate.
4. Availability of records. Upon the
request of the District Director, the
Employer will make the following quarterly totals available, by Establishment,
for statistical samplings of its Establishments:
a. Gross receipts subject to tipping,
b. Charge receipts showing charged
tips,
c. Total charged tips, and
d. Total tips reported.
C. Employee tip-reporting procedures.
1. Charged Tips. Each Establishment
must establish a procedure under which
a written statement is prepared and
processed on a regular basis (no less
frequently than monthly), reflecting all
charged tips for sales attributable to
each directly tipped Employee. The Establishment must implement reasonable
procedures under which each directly
tipped Employee is given the opportunity to verify or correct any statement of
proposed attribution of charged tips, in
order to reflect tip outs, tip sharing, tip
pooling, and other adjustments. For example, the Establishment would satisfy
this paragraph if it provided a written
statement that contained the following
information: Employee’s charged sales,
Employee’s total charged tips, and the
ratio, as a percentage, of charged tips to
charged sales.
The Establishment must also adopt a
reasonable method for reporting charged
tips received by indirectly tipped Employees. For example, the Employee
may report to the Establishment the
amount and with whom tips were
shared. Alternatively, the directly tipped
Employee may provide to the Establishment a copy of Form 4070A indicating
the shared tips. As another example, the
Establishment could furnish the indirectly tipped Employee a written statement, which that Employee would verify
or correct in a manner similar to the
procedure for directly tipped Employees.
The Employer’s procedures must enable Employees to meet their reporting
requirements under section 6053(a) of
the Code. To meet these requirements,
the Employee must sign the verified or
corrected statement of attributed tips (no
less frequently than monthly) and give
the statement to the Establishment no
later than the 10th day of the month
following the month in which the Employee received the tips.

21

This verified or corrected statement
(if completed by the 10th of the month
for tips received during the preceding
month) will satisfy the Employee’s requirement of reporting charged tips to
the Employer under section 6053(a).
The Employer may satisfy the requirements of the section if it remits charged
tips to the Employees through the payroll system under a method that ensures
reporting of tips by Employees and is
consistent with sections 3102 and 3402
of the Code.
2. Cash Tips. Each Establishment
must establish a procedure under which
a written statement is prepared and
processed on a regular basis (no less
frequently than monthly), reflecting all
cash tips for sales attributable to each
directly tipped Employee. For example,
if the Employee signs for charged tips
on a daily basis, the Employee may
record the amount of cash tips received
at the same time. As another example, a
procedure comparable to the procedure
for charged tips would be appropriate
for cash tips. The Employer may also
provide a separate procedure for reporting cash tips.
IV. COMMITMENT OF DISTRICT
DIRECTOR
A. General rule. Except as provided
in B. below, any section 3121(q) notice
and demand issued to the Employer (or
Establishment) by the District Director
shall be based solely on amounts reflected on one or more of the following
forms:
1. Form 4137, Social Security and
Medicare Tax on Unreported Tip Income, filed by an Employee with his or
her Form 1040, or
2. Form 885–T, Adjustment of Social
Security Tax on Tip Income Not Reported to Employer, prepared at the
conclusion of an employee tip examination.
B. Special rules.
1. Retroactive revocation. In the
event the District Director revokes the
Agreement retroactively as provided under Section V. A. 1., the general rule of
Section IV. A. does not apply.
2. Prospective revocation. In the
event of a revocation under Section V.
A. 2. or 3., or Section V. B., the general
rule in Section IV. A. will apply with
respect to tip income actually received
by (or deemed under section 3121(q) of
the Code to have been paid to) Employees at the Establishment during the

period from the effective date of the
TRAC agreement until the effective date
of revocation.
3. Ongoing Tip Examination. If the
District Director has initiated a tip examination of one or more Establishments prior to the filing of the TRAC
application, the District Director will not
be bound by the general rule of Section
IV. A., with respect to any tip income
actually received by Employees at the
Establishment during any calendar quarters under tip examination. TRAC will
be available to the Employer for all
other calendar quarters as provided in
this Agreement.
C. Compliance review. The District
Director may not evaluate the Employer
(or Establishment) for compliance with
the provisions of Section III. A. (pertaining to the Employer’s educational
program) or Section III. C. (pertaining
to Employee tip-reporting procedures)
until the second calendar quarter following the quarter in which this Agreement
becomes effective. During the first two
calendar quarters of this Agreement the
District may review the Employer’s (or
Establishment’s) progress in complying
with the provisions of those Sections.
D. Examinations and/or inspections
of books and records. The inspection of
books of account or records pursuant to
a tip examination or compliance review
will not preclude or impede (under
section 7605(b) of the Code, section
530(a)(2) of the Revenue Act of 1978,
or any administrative provisions adopted
by the Service) a later examination of a
return or inspection of books of account
or records with respect to any tax period
involved in the tip examination or compliance review. The Service need not
comply with any applicable procedural
restrictions (for example, providing notice under section 7605(b)) before beginning such examination or inspection.
V. REVOCATION
A. Revocation by District Director.
The District Director will revoke this
Agreement only for the following reasons:
1. Failure to comply with Section III.
A. or Section III. C. If the District
Director determines that the Employer
(or any Establishment) has failed to
substantially comply with Section III. A.
(pertaining to the education program) or
Section III. C. (pertaining to employee
tip-reporting procedures), the District
Director may retroactively revoke this
Agreement. The revocation will be effective the first day of the first calendar

quarter of the Employer’s (or Establishment’s) substantial noncompliance. The
District Director must notify the Employer in writing of the revocation and
the Establishment(s) to which the revocation applies. If the revocation applies
to all the Establishments of the Employer, the Agreement will be terminated, as of the above-stated effective
date.
2. Failure to meet requirements of
Section III. B. 1., 2., 3, and 4. If the
Employer (or any Establishment) fails to
meet any of the requirements of Section
III. B. 1., 2., 3., or 4. (pertaining to
filing returns, paying and depositing
taxes, maintenance of records, and availability of records), the District Director
may revoke this Agreement. The revocation will be effective the first day of the
first calendar quarter after the District
Director notifies the Employer in writing that the Agreement no longer applies
to the Employer (or Establishment).
3. Employee underreporting of tips. If
the District Director determines that the
Employees of an Establishment have
collectively and substantially underreported tip income for at least two
continuous calendar quarters despite the
Employer’s (or Establishment’s) substantial compliance with the procedures
in Section III. C. (employee-tipreporting procedures), the District Director may revoke this Agreement with
respect to the Establishment. The revocation will be effective the first day of
the first calendar quarter after the District Director notifies the Employer in
writing that the Agreement no longer
applies to the Establishment. If the revocation applies to all the Establishments
of the Employer, the Agreement will be
terminated, as of the above-stated effective date.
4. Other. In addition to the reasons
for revocation listed in this section, the
District Director may revoke the Agreement when the Internal Revenue Service
or another federal agency pursues an
administrative or judicial action relating
to the Employer or Establishment that is
a party or related party to this Agreement.
B. Revocation by Employer. If the
Employer no longer wishes this Agreement to apply to one or more Establishments, the Employer may revoke this
Agreement with respect to the Establishment(s), by providing written notification to the District Director identifying
the Establishments(s). The revocation by
the Employer will be effective the first

22

day of the first calendar quarter after the
Employer notifies the District Director
in writing. If the revocation applies to
all the Establishments of the Employer,
the Agreement will be terminated, as of
the above-stated effective date. If an
E

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Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/agency%3Airs%3A1bd70a70c1d60a1b. Public record. Not legal advice.