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Bulletin No. 1996–3

January 16, 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

Announcement 96–4, page 50.

An announcement discusses the publication of mortality

tables for use under section 412(1) for individuals

entitled to benefits on account of disability. The

announcement requests comments on the tables published in Rev. Rul. 96–7.

Rev. Rul. 96–4, page 16.

Section 1274A inflation-adjusted numbers for 1996. This

ruling provides the dollar amounts, increased by the

1996 inflation-adjustment, for section 1274A of the

Code. Rev. Rul. 95–10 supplemented and superseded.

EMPLOYMENT TAX

Rev. Rul. 96–5, page 29.

CPI adjustment for below-market loans–1996. The

amount that section 7872(g) of the Code permits a

taxpayer to lend to a qualified continuing care facility

without incurring imputed interest is published and

adjusted for inflation for years 1987–1996. Rev. Rul.

95–11 supplemented and superseded.

T.D. 8634, page 17.

Final regulations relating to the income tax withholding

requirement on distribution of profits from certain

gaming activities made to members of Indian tribes

under section 3402(r) of the Code.

T.D. 8631, page 7.

EE–34–95, page 49.

Temporary and proposed regulations under section 411

of the Code relating to the requirements of section

204(h) of the Employee Retirement Income Security

Act of 1974, as amended, relating to defined benefit

plans and to individual account plans that are subject

to the funding standards of section 302 of ERISA.

ADMINISTRATIVE

Notice 96–1, page 30.

Notice of intention to issue regulations under section

1396 of the Code. The Service will clarify the relevant

period under section 1396(d)(1)(A) during which substantially all of the services performed by an employee

for his or her employer must be performed within an

empowerment zone in a trade or business of the

employer.

T.D. 8635, page 5.

Final and temporary regulations under sections 401

and 408 that provide guidance to nonbank trustees

with respect to the adequacy of net worth requirements

that must be satisfied in order to be or remain an

approved nonbank trustee.

Rev. Proc. 96–12, page 30.

Life insurance partnerships. The Service will not rule on

certain issues raised in connection with the transfer of a

life insurance policy to an unincorporated organization.

Rev. Proc. 96–3 amplified.

EMPLOYEE PLANS

Rev. Proc. 96–13, page 31.

Updated competent authority procedure. This procedure

sets forth the procedures concerning requests by

taxpayers for assistance of the U.S. competent authority

Rev. Rul. 96–7, page 12.

Disability mortality tables. This ruling provides mortality

tables for use under section 412(1) for plan years after

1995 to calculate current liability for individuals entitled

to benefits on account of disability.

(Continued on page 4)

Finding Lists begin on page 52.

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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 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.

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.

The Service also has the responsibility of applying

and administering the law in a reasonable,

practical manner. Issues should only be raised by

examining officers 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.

Administration should be both reasonable and

vigorous. It should be conducted with as little

delay as possible and with great courtesy 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.

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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.

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.

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.

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,

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.

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 Miscellanous.

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).

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.

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 Bulletin Index-Digest System, a research and

reference service supplementing the Bulletin, may be

obtained from the Superintendent of Documents on a

subscription basis. It consists of four Services: Service

No. 1, Income Tax; Service No. 2, Estate and Gift

Taxes; Service No. 3, Employment Taxes; Service No.

4, Excise Taxes. Each Service consists of a basic

volume and a cumulative supplement that provides (1)

finding lists of items published in the Bulletin, (2)

digests of revenue rulings, revenue procedures, and

other published items, and (3) indexes of Public Laws,

Treasury Decisions, and Tax Conventions.

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.

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HIGHLIGHTS

OF THIS ISSUE—Continued

Rev. Proc. 96–15, page 41.

Advance valuation of art. Donors of art appraised at

$50,000 or more and executors or administrators of

estates including art appraised at $50,000 or more

may request that the Service issue a statement of value

for the art. Rev. Proc. 66–49 modified.

ADMINISTRATIVE—Continued

under the provisions of an income, estate or gift tax

treaty to which the United States is a party. Rev. Procs.

91–23 and 91–26 superseded; Rev. Proc. 91–22

amplified; Rev. Rul. 72–437 modified; Rev. Rul 92–75

clarified.

Rev. Proc. 96–16, page 45.

Letter rulings; tax-exempt obligations. Revised procedures

are provided for obtaining a letter ruling under sections

103, 141–150, 1394, and 7871(c) of the Code. Rev.

Procs. 88–32 and 88–33 obsoleted.

Rev. Proc. 96–14, page 41.

Obtaining relief. This procedure prescribes additional

conditions associated with obtaining relief otherwise

available under Rev. Proc. 65–17, 1965–1 C.B. 833.

Rev. Rul. 82–80 and Rev. Proc. 65–17 modified; Rev.

Proc. 91–24 superseded.

T.D. 8630, page 19.

Final income, estate, and gift regulations relating to

actuarial tables exceptions.

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Part I. Rulings and Decisions Under the Internal Revenue Code of 1986

Section 101.—Certain Death Benefits

The Service will not rule on certain issues

raised in connection with the transfer of a life

insurance policy to an unincorporated organization. See Rev. Proc. 96–12, page 30.

Section 103.—Interest on State and

Local Bonds

EFFECTIVE DATE: These regulations

are effective December 20, 1995.

FOR FURTHER INFORMATION

CONTACT: Marjorie Hoffman, (202)

622-6030 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

A revenue procedure sets forth procedures for

requesting a ruling under §§ 103, 141–150, 1395,

and 7871(c) of the Code. See Rev. Proc. 96–16,

page 45.

Section 170.—Charitable, etc.,

Contributions and Gifts

26 CFR 1.170A–13: Recordkeeping and return

requirements for deductions for charitable

contributions.

The contributor of art appraised at $50,000 or

more may request that the Service issue a

Statement of Value for the art. See Rev. Proc.

96–15, page 41.

Section 401.—Qualified Pension,

Profit-sharing, and Stock Bonus

Plans

26 CFR 1.401(f)–1: Certain custodial accounts

on annuity contracts.

T.D. 8635

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

Nonbank Trustee Net Worth

Requirements

AGENCY: Internal Revenue Service

(IRS), Treasury.

ACTION: Final

regulations.

and

temporary

SUMMARY: This document contains

regulations that provide guidance to

nonbank trustees with respect to the

adequacy of net worth requirements

that must be satisfied in order to be or

remain an approved nonbank trustee.

These regulations affect nonbank

trustees and custodians of individual

retirement accounts, and nonbank

custodians of qualified plans and taxsheltered annuities.

On December 6, 1994, temporary

regulations (TD 8570 [1994–2 C.B.

49]) under section 401 were published

in the Federal Register (59 FR 62570).

A notice of proposed rulemaking (EE–

38–94 [1994–2 C.B. 49]), crossreferencing the temporary regulations,

was published in the Federal Register

(59 FR 62644) on the same day. The

temporary regulations provide guidance

on the adequacy of net worth requirements for nonbank trustees and custodians of individual retirement plans,

and for nonbank custodians of custodial

accounts of qualified plans and taxsheltered annuities.

After consideration of all of the

comments, the temporary regulations

are replaced and the proposed regulations are adopted as revised by this

Treasury decision. Because section

401(d)(1), under which § 1.401–12 was

originally issued, was repealed by

section 237(a) of the Tax Equity and

Fiscal Responsibility Act of 1982,

Public Law 97–248 (1982), these final

regulations also move all the rules for

nonbank trustees and custodians that

were previously in § 1.401–12(n) to

§ 1.408–2.

Explanation of Provisions

The fiduciary conduct rules for nonbank trustees and custodians under

longstanding Treasury regulations require nonbank trustees and custodians

to maintain a minimum amount of net

worth in order to qualify as an

approved nonbank trustee or custodian.

Under this requirement, the nonbank

trustee or custodian’s net worth must

exceed the greater of a specified dollar

amount or a percentage of the value of

all assets held in fiduciary accounts of

retirement plans. A primary objective

of this adequacy-of-net-worth requirement has been to ensure that nonbank

trustees and custodians maintain a level

of solvency commensurate with their

financial and fiduciary responsibilities.

Under the general net worth requirement, nonbank trustees and custodians

may not accept new accounts unless

their net worth exceeds the greater of

$100,000 or four percent of the value

of all assets held in fiduciary accounts.

Additionally, nonbank trustees and

custodians must take whatever steps are

necessary (including the relinquishment

of fiduciary accounts) to ensure that

their net worth exceeds the greater of

$50,000 or two percent of the value of

all assets held by them in fiduciary

accounts.

For passive nonbank trustees and

custodians (qualified nonbank entities

that have no discretion to direct the

investment of assets), the percentage

requirements are lower. Specifically,

passive nonbank trustees and custodians may not accept new accounts

unless their net worth exceeds the

greater of $100,000 or two percent of

the value of all assets held in fiduciary

accounts. Additionally, they must take

appropriate action (including the relinquishment of fiduciary accounts) to

ensure that their net worth exceeds the

greater of $50,000 or one percent of

the value of assets held in their

fiduciary accounts.

The proposed and temporary regulations provide a special rule for passive

nonbank trustees and custodians that

are broker-dealers and members of the

Securities Investor Protection Corporation (SIPC). The proposed and temporary regulations provide that, to the

extent that assets held in any fiduciary

accounts are insured by SIPC in the

event of the member’s liquidation

($500,000 per account, $100,000 of

which may be cash), the assets will be

disregarded in determining the value of

assets held in fiduciary accounts by the

trustee or custodian for purposes of the

percentage part of the net worth

requirement.

The final regulations adopt the provisions of the proposed and temporary

regulations. In addition, in response to

comments, the final regulations extend

the SIPC-related relief to all nonbank

trustees and custodians that are brokerdealers and members of SIPC rather

than limiting the relief to passive

nonbank trustees and custodians. The

final regulations provide that the

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amount of the minimum net worth

requirement for nonbank trustees and

custodians that are SIPC members is

reduced by either two percent of assets

insured by SIPC (in the case of the

minimum net worth requirement that

applies to a trustee or custodian accepting additional accounts) or one percent

of assets insured by SIPC (in the case

of the minimum net worth requirement

that must be satisfied to avoid a

mandatory relinquishment of accounts).

An example in the regulations illustrates this rule.

The final regulations also retain the

rule in the proposed and temporary

regulations that increased the initial net

worth requirement for all nonbank

trustees and custodians. The purpose of

the rule is to better assure that the

enterprises are sound and well-funded

during their start-up period. This initial

net worth requirement requires all new

entities applying for nonbank trustee or

custodian status to have a net worth of

not less than $250,000 for the most

recent taxable year preceding the applicant’s initial application.

This new initial net worth requirement applies only to applications received after January 5, 1995. Previously approved nonbank trustees and

custodians need only satisfy the ongoing net worth requirement.

Special Analyses

It has been determined that this

Treasury decision is not a significant

regulatory action as defined in EO

12866. Therefore, a regulatory assessment is not required. It also has been

determined that section 553(b) of the

Administrative Procedure Act (5 U.S.C.

chapter 5) and the Regulatory Flexibility Act (5 U.S.C. chapter 6) do not

apply to these regulations, and, therefore, a Regulatory Flexibility Analysis

is not required. Pursuant to section

7805(f) of the Internal Revenue Code,

the notice of proposed rulemaking

preceding these regulations was submitted to the Small Business Administration for comment on its impact on

small business.

Drafting Information

The principal author of these regulations is Marjorie Hoffman, Office of

the Associate Chief Counsel,

(Employee Benefits and Exempt Organizations) IRS. However, other person-

nel from the IRS and Treasury Department participated in their development.

Adoption of Amendments to the

Regulations

Accordingly, 26 CFR part 1 is

amended as follows:

PART 1—INCOME TAXES

Paragraph 1. The authority citation

for part 1 is amended by adding an

entry in numerical order to read as

follows:

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

§ 1.401–12 also issued under 26

U.S.C. 401(d)(1). * * *

§§ 1.401–12 and 1.408–2 [Amended]

Par. 2. Paragraph (n) of § 1.401–12

is redesignated as paragraph (e) of

§ 1.408–2 and the authority citation

immediately following § 1.401–12 is

removed.

§ 1.401–12T [Removed]

Par. 3.

removed.

Section

1.401–12T

§ 1.401(f)–1 [Amended]

Par. 4. Section 1.401(f)–1 is

amended by:

1. Removing the language ‘‘section

401(d)(1) and the regulations thereunder’’ and adding ‘‘§ 1.408–2(e)’’ in

its place in the last sentence of

paragraph (b)(1)(ii).

2. Removing the language ‘‘401(d)(1) and adding ‘‘408(n)’’ in its place in

paragraph (d)(1).

Par. 5. Section 1.408–2 is amended

by:

1. Removing the language ‘‘401(d)(1)’’ and adding ‘‘408(n)’’ in its place

in paragraph (b)(2)(i).

2. Removing the language ‘‘(b)(2)(ii)’’ and adding ‘‘(e)’’ in its place in

paragraph (b)(2)(i).

3. Removing paragraph (b)(2)(ii).

4. Redesignating (b)(2)(iii) as (b)(2)(ii)

5. Removing newly redesignated

paragraphs (e)(1) and (e)(9).

6. Further redesignating paragraphs

(e)(2) through (e)(8) as paragraphs

(e)(1) through (e)(7), respectively.

7. Removing the language ‘‘For the

plan years to which this paragraph

applies, the’’ and adding ‘‘The’’ in its

place, and removing the language ‘‘(c)(1)(i)’’ and adding ‘‘(b)’’ in its place,

in the first sentence of newly designated paragraph (e)(1).

8. Removing the language ‘‘401’’

and adding ‘‘408’’ in its place, and

removing the language ‘‘(n)(3) to

(n)(7)’’ and adding ‘‘(e)(2) to (e)(6)’’

in its place, in the second sentence of

newly designated paragraph (e)(1).

9. Removing the language ‘‘Commissioner of Internal Revenue, Attention: E:EP, Internal Revenue Service,

Washington, D.C. 20224’’ and adding

‘‘the address prescribed by the Commissioner in revenue rulings, notices,

and other guidance published in the

Internal Revenue Bulletin (see

§ 601.601(d)(2)(ii)(b) of this chapter)’’

in its place in the third sentence of

newly designated paragraph (e)(1), in

the last sentence of newly designated

(e)(6)(9)(iv), and in the first sentence

of newly designated (e)(6)(v)(B).

10. Removing the language ‘‘(n)(8)’’

and adding ‘‘(e)(7)’’ in its place in the

last sentence of newly designated paragraph (e)(1).

11. Removing the language ‘‘(n)(6)’’

and adding ‘‘(e)(5)’’ in its place in

newly designated paragraph (e)(2)(iv).

12. Redesignating newly designated

paragraph (e)(5)(ii)(A) as paragraph

(e)(5)(ii)(E).

13. Removing the language ‘‘(n)(7)(i)(A)’’ and adding ‘‘(e)(6)(i)(A)’’ in

its place in newly designated paragraph

(e)(5)(ii)(B)(2) and in newly designated

paragraph (e)(5)(ii)(C)(2).

14. Removing the language ‘‘(n)(6)(iii)(A)’’ and adding ‘‘(e)(5)(iii)(A)’’ in

its place in newly designated paragraph

(e)(5)(iii)(B).

15. Removing the language ‘‘(n)(6)(vi)’’ and adding ‘‘(e)(5)(vi)’’ in its

place in newly designated paragraph

(e)(5)(v)(A).

16. Removing the language ‘‘(n)(6)(viii)(C)’’ and adding ‘‘(e)(5)(viii)(C)’’

in its place in newly designated paragraph (e)(5)(vi).

17. Removing the language ‘‘(n)(3)(v)’’ and adding ‘‘(e)(2)(v)’’ in its

place, and removing the language

‘‘(n)(8)’’ and adding ‘‘(e)(7)’’ in its

place, in newly designated paragraph

(e)(5)(viii).

18. Removing the language ‘‘(n)(6)(i)(A)(3)’’ and adding ‘‘(e)(5)(i)(A)-

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(3)’’ in its place, and removing the

language ‘‘(n)(5)(ii)(E)’’ and adding

‘‘(e)(4)(ii)(E)’’ in its place, in the third

sentence of newly designated paragraph

(e)(6)(i)(A).

19. Removing the language ‘‘(n)(7)(iii)(A)(3)’’ and adding ‘‘(e)(6)(iii)(A)(3)’’ in its place in newly designated

paragraph (e)(6)(iii)(C).

20. Revising newly redesignated

paragraphs (e)(5)(ii)(A) and adding

(e)(5)(ii)(D).

21. The revisions and addition read

as follows:

§ 1.408–2 Individual retirement

accounts

(e) * * *

(5) * * *

(ii) Adequacy of net worth—(A) Initial net worth requirement. In the case

of applications received after January

5, 1995, no initial application will be

accepted by the Commissioner unless

the applicant has a net worth of not

less than $250,000 (determined as of

the end of the most recent taxable

year). Thereafter, the applicant must

satisfy the adequacy of net worth

requirements of paragraph (e)(6)(ii)(B)

and (C) of this section.

(D) Assets held by members of

SIPC—1) For purposes of satisfying

the adequacy-of-net worth requirement

of this paragraph, a special rule is

provided for nonbank trustees that are

members of the Securities Investor

Protection Corporation (SIPC) created

under the Securities Investor Protection

Act of 1970 (SIPA)(15 U.S.C. § 78aaa

et seq, as amended). The amount that

the net worth of a nonbank trustee that

is a member of SIPC must exceed is

reduced by two percent for purposes of

paragraph (e)(5)(ii)(B)(2), and one percent for purposes of paragraph (e)(5)(ii)(C)(2), of the value of assets (determined on an account-by-account basis)

held for the benefit of customers (as

defined in 15 U.S.C. § 78fff–2(e)(4)) in

fiduciary accounts by the nonbank

trustee to the extent of the portion of

each account that does not exceed the

dollar limit on advances described in

15 U.S.C. § 78fff–3(a), as amended,

that would apply to the assets in that

account in the event of a liquidation

proceeding under the SIPA.

(2) The provisions of this special

rule for assets held in fiduciary accounts by members of SIPC are illustrated in the following example.

Example—(a) Trustee X is a broker-dealer and

is a member of the Securities Investment

Protection Corporation. Trustee X also has been

approved as a nonbank trustee for individual

retirement accounts (IRAs) by the Commissioner

but not as a passive nonbank trustee. Trustee X

is the trustee for four IRAs. The total assets of

each IRA (for which Trustee X is the trustee) as

of the most recent valuation date before the last

day of Trustee X’s taxable year ending in 1995

are as follows: the total assets for IRA–1 is

$3,000,000 (all of which is invested in securities); the value of the total assets for IRA–2

is $500,000 ($200,000 of which is cash and

$300,000 of which is invested in securities), the

value of the total assets for IRA–3 is $400,000

(all of which is invested in securities); and the

value of the total assets of IRA–4 is $200,000

(all of which is cash). The value of all assets

held in fiduciary accounts, as defined in § 1.408–

2(e)(6)(viii)(A), is $4,100,000.

(b) The dollar limit on advances described in

15 U.S.C. § 78fff–3(a) that would apply to the

assets in each account in the event of a

liquidation proceeding under the Securities Investor Protection Act of 1970 in effect as of the

last day of Trustee X’s taxable year ending in

1995 is $500,000 per account (no more that

$100,000 of which is permitted to be cash).

Thus, the dollar limit that would apply to IRA–1

is $500,000; the dollar limit for IRA–2 is

$400,000 ($100,000 of the cash and the $300,000

of the value of the securities); the dollar limit for

IRA–3 is $400,000 (the full value of the account

because the value of the account is less than

$500,000 and no portion of the account is cash);

and the dollar limit for IRA–4 is $100,000 (the

entire account is cash and the dollar limit per

account for cash is $100,000). The aggregate

dollar limits of the four IRAs is $1,400,000.

§ 1.408–2(e)(6)(ii)(B) is determined as follows

for Trustee X: (1) four percent of $4,100,000

equals $164,000; (2) two percent of $1,400,000

equals $28,000; and (3) $164,000 minus $28,000

equals $136,000. Thus, because $136,000 exceeds $100,000, the minimum net worth necessary for Trustee X to accept new accounts for

1996 is $136,000.

(d) For 1996, the amount determined under

§ 1.408–2(e)(6)(ii)(C) for Trustee X is determined as follows: (1) two percent of $4,100,000

equals $82,000; (2) one percent of $1,400,000

equals $14,000; and (3) $82,000 minus $14,000

equals $68,000. Thus, because $68,000 exceeds

$50,000, the minimum net worth necessary for

Trustee X to avoid a mandatory relinquishment

of accounts for 1996 is $68,000.

Approved December 12, 1995.

Leslie Samuels,

Assistant Secretary of

the Treasury.

(Filed by the Office of the Federal Register on

December 19, 1995, 8:45 a.m., and published

in the issue of the Federal Register for

December 20, 1995, 60 F.R. 65547)

Section 411.—Minimum Vesting

Standards

26 CFR 1.411(d)–6T: Section 204(h) notice.

T.D. 8631

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 1 and 602

Notice of Significant Reduction in

the Rate of Future Benefit Accrual

AGENCY: Internal Revenue Service

(IRS), Treasury.

ACTION: Temporary regulations.

SUMMARY: This document contains

temporary regulations that provide

guidance concerning the requirements

of section 204(h) of the Employee

Retirement Income Security Act of

1974, as amended (ERISA), relating to

defined benefit plans and to individual

account plans that are subject to the

funding standards of section 302 of

ERISA. It requires the plan administrator to give notice of certain plan

amendments to participants in the plan

and certain other parties. The text of

these temporary regulations also serves

as the text of the proposed regulations

set forth in the notice of proposed

rulemaking on this subject published in

* * * [EE–34–95, page 49, this

Bulletin.]

EFFECTIVE DATE: December 15,

1995.

FOR FURTHER INFORMATION

CONTACT: Betty J. Clary, (202)

622-6070 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

Margaret Milner Richardson,

Commissioner of

Internal Revenue.

These regulations are being issued

without prior notice and public proce-

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dure pursuant to the Administrative

Procedure Act (5 U.S.C. 553). For this

reason, the collection of information

contained in these regulations has been

reviewed and, pending receipt and

evaluation of public comments, approved by the Office of Management

and Budget under control number

1545–1477. Responses to this collection of information are required under

section 204(h) of ERISA upon the

adoption of certain amendments to

pension plans.

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.

For further information concerning

this collection of information, and

where to submit comments on the

collection of information and the accuracy of the estimated burden and

suggestions for reducing this burden,

please refer to the preamble to the

cross-referencing notice of proposed

rulemaking published in * * * [EE–

34–95, page 00, this Bulletin].

The regulations do not involve any

issue of confidentiality.

Background

This document contains temporary

regulations that provide guidance on

section 204(h) of the Employee Retirement Income Security Act of 1974, as

amended (ERISA), 29 U.S.C. 1054(h).

Section 204(h) of ERISA was added by

section 11006(a) of the SingleEmployer Pension Plan Amendments

Act of 1986 (Title XI of Public Law

99–272), and was amended by section

1879(u)(1) of the Tax Reform Act of

1986, Public Law 99–514. Pursuant to

section 101(a) of the Reorganization

Plan No. 4 of 1978, 29 U.S.C. 1001nt,

the Secretary of the Treasury has

authority to issue regulations under

parts 2 and 3 of subtitle B of title I of

ERISA (including section 204 of

ERISA). Under section 104 of Reorganization Plan No. 4, the Secretary

of Labor retains enforcement authority

with respect to parts 2 and 3 of subtitle

B of title I of ERISA, but, in

exercising such authority, is bound by

the regulations issued by the Secretary

of the Treasury.

Prior guidance relating to the requirements of section 204(h) has been

provided in Rev. Proc. 89–65 (1989–2

C.B. 786) and Rev. Proc. 94–13 (1994–

1 C.B. 566), and under Notice 87–21

(1987–1 C.B. 458), Notice 88–131

(1988–2 C.B. 546), Notice 89–92

(1989–2 C.B. 410), and Notice 90–73

(1990–2 C.B. 353). These temporary

regulations provide further guidance, in

the form of Questions and Answers.

The provisions in this Treasury

Decision are needed immediately to

provide guidance to the public with

respect to the notice requirements of

section 204(h) of ERISA. Issues related

to section 204(h) arise in connection

with a broad range of plan amendments, including amendments prompted

by recent changes in the law. Therefore, it is found impracticable and

contrary to the public interest to issue

this Treasury decision with prior notice

under 5 U.S.C. 553(b).

Explanation of Provisions

Section 204(h) of ERISA applies if a

defined benefit plan or an individual

account plan that is subject to the

funding standards of section 302 of

ERISA is amended to provide for a

significant reduction in the rate of

future benefit accrual. It requires the

plan administrator to give written

notice of the amendment to participants

in the plan, alternate payees, and

employee organizations representing

participants in the plan (or to a person

designated, in writing, to receive the

notice on behalf of a participant,

alternate payee, or employee organization). The notice must set forth the plan

amendment and its effective date and

must be provided after adoption of the

amendment and not less than 15 days

before the effective date of the

amendment.

A plan amendment that is subject to

the notice requirements of section

204(h) of ERISA may also be subject

to additional reporting and disclosure

requirements under title I of ERISA,

such as the requirement to provide a

summary of material modifications. See

sections 102(a) and 104(a) of ERISA,

29 U.S.C. 1022 and 1024, and the

regulations thereunder for guidance on

when a summary of material modifications must be provided. Section 204(h)

notice must be provided at least 15

days in advance of the effective date of

an amendment significantly reducing

the future rate of benefit accrual, even

though a summary of material modifications describing the amendment is

provided at a later date.

Section 204(h) of ERISA does not

apply to an amendment that does not

affect the rate of future benefit accrual.

These regulations clarify that an

amendment to a defined benefit plan

that does not affect the annual benefit

commencing at normal retirement age

does not affect the rate of future

benefit accrual for purposes of section

204(h). Accordingly, the regulations

provide that the plan administrator of a

defined benefit plan is not required to

provide section 204(h) notice with

respect to an amendment that does not

affect the future annual benefit payable

at normal retirement age, even if the

amendment affects other forms of payment (such as a single sum distribution) or benefits commencing at a date

other than normal retirement age (such

as an early retirement benefit).

The regulations also clarify that an

amendment to an individual account

plan that does not change the amount

of future allocations to participants’

accounts does not affect the rate of

future benefit accrual for purposes of

section 204(h) of ERISA. Accordingly,

section 204(h) notice is not required

with respect to any such amendment.

Even if an amendment affects the

rate of future benefit accrual, section

204(h) notice is required only if the

amendment significantly reduces the

rate of future benefit accrual. Under the

regulations, whether an amendment

significantly reduces the rate of future

benefit accrual is to be determined

based on reasonable expectations taking

into account all relevant facts and

circumstances.

The regulations delegate to the Commissioner of Internal Revenue the

authority to provide that section 204(h)

notice need not be provided with

respect to plan amendments that the

Commissioner determines are necessary

or appropriate, as a result of a change

in federal law, to maintain compliance

with the law. The Commissioner may

exercise this authority only through the

publication of revenue rulings, notices,

and other guidance in the Internal

Revenue Bulletin.

In situations in which section 204(h)

notice is required with respect to an

amendment, the regulations provide

guidance on the participants, alternate

payees, and employee organizations to

whom the notice must be provided.

Specifically, the regulations provide

that the plan administrator is not

required to provide notice to a partici-

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pant or alternate payee whose rate of

future benefit accrual is reasonably

expected not to be reduced by the

amendment. For example, notice need

not be provided to participants (such as

former employees with a vested benefit

under the plan) who, prior to the

amendment, were not entitled to accrue

future benefits under the plan. Moreover, under the regulations, section

204(h) notice is not required to be

provided to an employee organization

unless it represents one or more participants to whom section 204(h) notice is

required to be provided. Finally, the

regulations clarify that employees who

have not yet become participants in the

plan are not taken into account for any

purpose under section 204(h) of

ERISA.1 Thus, the plan administrator is

not required to provide section 204(h)

notice to such employees.

The regulations provide that a plan

that is terminated in accordance with

title IV of ERISA is deemed to satisfy

section 204(h) not later than the date of

termination established under section

4048 of ERISA. Accordingly, section

204(h) does not require that any further

benefits accrue under the plan after that

date. However, if that date of termination is deferred, benefits continue to

accrue until the deferred date of

termination absent an effective cessation of accruals as of an earlier

specified date.

If the plan is not amended to

significantly reduce the rate of future

benefit accrual prior to the termination,

section 204(h) notice is not required.

However, the regulations also affirm

that section 204(h) applies to an

amendment that is effective prior to the

termination date and clarify that, if

section 204(h) notice is required, it can

be provided either with or as part of

the notice of intent to terminate or

separately.

The regulations also provide two

rules applicable in situations in which a

plan administrator was required to

provide section 204(h) notice with

respect to an amendment but failed to

provide timely notice to some of the

parties to whom notice was required to

be provided. The first rule applies

when the plan administrator fails to

provide timely notice with respect to

more than a de minimis percentage of

the parties to whom section 204(h)

1This is not intended to affect the rights of

employees under other provisions of ERISA.

notice was required. In such a situation,

the amendment becomes effective in

accordance with its terms with respect

to a participant to whom notice was

required if the participant was provided

with timely notice and any employee

organization representing the participant was also provided with timely

notice. The amendment also becomes

effective in accordance with its terms

with respect to an alternate payee to

whom notice was required if the

alternate payee was provided with

timely notice.

The second rule applies in a situation

in which the plan administrator made a

good faith effort to comply with

section 204(h) of ERISA with respect

to an amendment, failed to provide

timely section 204(h) notice to no more

than a de minimis percentage of the

parties to whom notice was required,

and provided timely notice to all

employee organizations with respect to

whom section 204(h) notice was required. In such a situation, if the plan

administrator, promptly upon discovery

of the omission, provides section

204(h) notice to all parties who were

required to be provided such notice but

were omitted, the plan amendment

becomes effective in accordance with

its terms with respect to all parties to

whom section 204(h) notice was required, including those who did not

receive notice prior to discovery of the

omission.

Effective Dates

These temporary regulations are

effective for amendments adopted on or

after December 15, 1995, and amendments effective by their terms on or

after December 30, 1995.

Special Analyses

It has been determined that this

Treasury decision is not a significant

regulatory action as defined in EO

12866. Therefore, a regulatory assessment is not required. It also has been

determined that section 553(b) of the

Administrative Procedure Act (5 U.S.C.

chapter 5) and the Regulatory Flexibility Act (5 U.S.C. chapter 6) do not

apply to these regulations, and, therefore, a Regulatory Flexibility Analysis

is not required. Pursuant to section

7805(f) of the Internal Revenue Code,

these temporary regulations will be

submitted to the Chief Counsel for

Advocacy of the Small Business Administration for comment on their

impact on small business.

Drafting Information

The principal author of these regulations is Betty J. Clary, Office of the

Associate Chief Counsel (Employee

Benefits and Exempt Organizations),

IRS. However, other personnel from

the IRS and Treasury Department

participated in their development.

Adoption of Amendments to the

Regulations

Accordingly, 26 CFR parts 1 and

602 are amended as follows:

PART 1—INCOME TAXES

Paragraph 1. The authority citation

for part 1 is amended by adding an

entry for section 1.411(d)–6T to read as

follows:

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

Section 1.411(d)–6T also issued under

Reorganization Plan No. 4 of 1978, 29

U.S.C. 1001nt. * * *

Par. 2. 1.411(d)–6T is added to read

as follows:

1.411(d)–6T Section 204(h) notice.

Q–1: What are the requirements of

section 204(h) of the Employee Retirement Income Security Act of 1974, as

amended (ERISA)?

A–1: (a) Requirements of section

204(h). Section 204(h) of ERISA generally requires written notice of an

amendment to certain plans that provides for a significant reduction in the

rate of future benefit accrual. Section

204(h) generally requires the notice to

be provided to plan participants, alternate payees, and employee organizations. The plan administrator must

provide the notice after adoption of the

plan amendment and not less than 15

days before the effective date of the

plan amendment.

(b) Other notice requirements. Other

provisions of law may require that certain parties be notified of a plan amendment. See, for example, sections 102

and 104 of ERISA, and the regulations

thereunder, for the requirements relating

to summary plan descriptions and summaries of material modifications.

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Q–2: To which plans does section

204(h) of ERISA apply?

A–2: Section 204(h) of ERISA applies to defined benefit plans subject to

part 2 of subtitle B of title I of ERISA

and to individual account plans subject

to such part 2 and to the funding

standards of section 302 of ERISA.

Accordingly, individual account plans

that are not subject to the funding

standards of section 302, such as

profit-sharing and stock bonus plans,

are not subject to section 204(h).

Q–3: What is section 204(h) notice?

A–3: Section 204(h) notice is notice

that complies with section 204(h) of

ERISA and the rules in this section.

Q–4: For which amendments is

section 204(h) notice required?

A–4: (a) In general. Section 204(h)

notice is required for an amendment to

a plan described in Q&A–2 of this

section that provides for a significant

reduction in the rate of future benefit

accrual.

(b) Delegation of authority to Commissioner. The Commissioner of Internal Revenue may provide through

publication in the Internal Revenue

Bulletin of revenue rulings, notices, or

other documents (see 601.601(d)(2) of

this chapter) that section 204(h) notice

need not be provided for plan amendments otherwise described in paragraph

(a) of this Q&A–4 that the Commissioner determines to be necessary or

appropriate, as a result of changes in

the law, to maintain compliance with

the requirements of the Internal Revenue Code of 1986, as amended (Code)

(including requirements for tax

qualification), ERISA, or other applicable federal law.

Q–5: What is an amendment that

affects the rate of future benefit accrual

for purposes of section 204(h) of

ERISA?

A–5: (a) In general—(1) Defined

benefit plans. For purposes of section

204(h) of ERISA, an amendment to a

defined benefit plan affects the rate of

future benefit accrual only if it is

reasonably expected to change the

amount of the future annual benefit

commencing at normal retirement age.

(2) Individual account plans. For

purposes of section 204(h), an amendment to an individual account plan

affects the rate of future benefit accrual

only if it is reasonably expected to

change the amounts allocated in the

future to participants’ accounts.

Changes in the investments or investment options under an individual account plan are not taken into account

for this purpose.

(b) Determination of rate of future

benefit accrual. In accordance with

paragraph (a) of this Q&A–5, the rate

of future benefit accrual is determined

without regard to optional forms of

benefit (other than the annual benefit

described in paragraph (a) of this

Q&A–5), early retirement benefits, or

retirement-type subsidies, within the

meaning of such terms as used in

section 411(d)(6) of the Code (section

204(g) of ERISA). The rate of future

benefit accrual is also determined without regard to ancillary benefits and

other rights or features as defined in

1.401(a)(4)–4(e).

Example 1. A plan is amended with respect to

future benefit accruals to eliminate a right to

commencement of a benefit prior to normal

retirement age. Because the amendment does not

affect the annual benefit commencing at normal

retirement age, it does not reduce the rate of

future benefit accrual for purposes of section

204(h).

Example 2. A plan is amended to modify the

assumptions used in converting an annuity form

of distribution to a single sum form of distribution. The use of these modified assumptions

results in a lower single sum. Because the

amendment does not affect the annual benefit

commencing at normal retirement age, it does

not reduce the rate of future benefit accrual for

purposes of section 204(h).

Q–6: What plan provisions are taken

into account in determining whether

there has been a reduction in the rate

of future benefit accrual?

A–6: (a) Plan provisions taken into

account. All plan provisions that may

affect the rate of future benefit accrual

of participants or alternate payees must

be taken into account in determining

whether an amendment provides for a

significant reduction in the rate of

future benefit accrual. Such provisions

include, for example, the dollar amount

or percentage of compensation on

which benefit accruals are based; in the

case of a plan using the permitted

disparity under section 401(l) of the

Code, the amount of disparity between

the excess benefit percentage or excess

contribution percentage and the base

benefit percentage or base contribution

percentage (all as defined in section

401(l)); the definition of service or

compensation taken into account in

determining an employee’s benefit ac-

crual; the method of determining average compensation for calculating benefit accruals; the definition of normal

retirement age in a defined benefit

plan; the exclusion of current participants from future participation; benefit

offset provisions; minimum benefit

provisions; the formula for determining

the amount of contributions and forfeitures allocated to participants’ accounts

in an individual account plan; and the

actuarial assumptions used to determine

contributions under a target benefit

plan (as defined in 1.401(a)(4)–

8(b)(3)(i)).

(b) Plan provisions not taken into

account. Plan provisions that do not

affect the rate of future benefit accrual

of participants or alternate payees are

not taken into account in determining

whether there has been a reduction in

the rate of future benefit accrual. For

example, provisions such as vesting

schedules or optional forms of benefit

(other than the annual benefit described

in Q&A–5(a) of this section) are not

taken into account.

Example. A defined benefit plan provides a

normal retirement benefit equal to 50% of final

average compensation times a fraction (not in

excess of one), the numerator of which equals

the number of years of participation in the plan

and the denominator of which equals 20. A plan

amendment that changes the numerator or

denominator of that fraction must be taken into

account in determining whether there has been a

reduction in the rate of future benefit accrual.

Q–7: What is the basic principle

used in determining whether an amendment provides for a significant reduction in the rate of future benefit accrual

for purposes of section 204(h) of

ERISA?

A–7: Whether an amendment provides for a significant reduction in the

rate of future benefit accrual for

purposes of section 204(h) of ERISA is

determined based on reasonable expectations taking into account the relevant

facts and circumstances at the time the

amendment is adopted.

Q–8: Are employees who have not

yet become participants in a plan at the

time an amendment to the plan is

adopted taken into account for any

purpose in applying section 204(h) of

ERISA with respect to the amendment?

A–8: No. Employees who have not

yet become participants in a plan at the

time an amendment to the plan is

adopted are not taken into account for

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adopted taken into account for any

purpose in applying section 204(h) of

ERISA with respect to the amendment?

A–8: No. Employees who have not

yet become participants in a plan at the

time an amendment to the plan is

adopted are not taken into account for

any purpose in applying section 204(h)

of ERISA with respect to the amendment. Thus, if section 204(h) notice is

required with respect to an amendment,

the plan administrator need not provide

section 204(h) notice to such

employees.

Q–9: If section 204(h) notice is

required with respect to an amendment,

must such notice be provided to participants or alternate payees whose rate of

future benefit accrual is not reduced by

the amendment?

A–9: (a) In general. A plan administrator need not provide section 204(h)

notice to any participant whose rate of

future benefit accrual is reasonably

expected not to be reduced by the

amendment, nor to any alternate payee

under an applicable qualified domestic

relations order whose rate of future

benefit accrual is reasonably expected

not to be reduced by the amendment. A

plan administrator need not provide

section 204(h) notice to an employee

organization unless the employee organization represents a participant to

whom section 204(h) notice is required

to be provided.

(b) Facts and circumstances test.

Whether a participant or alternate

payee is described in paragraph (a) of

this Q&A–9 is determined based on all

relevant facts and circumstances at the

time the amendment is adopted.

Example 1. Plan A is amended to reduce

significantly the rate of future benefit accrual of

all current employees who are participants in the

plan. It is reasonable to expect based on the facts

and circumstances that the amendment will not

reduce the rate of future benefit accrual of

former employees who are currently receiving

benefits or that of former employees who are

entitled to vested benefits. Accordingly, the plan

administrator is not required to provide section

204(h) notice to such former employees.

Example 2. Assume in Example 1 that Plan A

also covers two groups of alternate payees. The

alternate payees in the first group are entitled to

a certain percentage or portion of the former

spouse’s accrued benefit, and for this purpose the

accrued benefit is determined at the time the

former spouse begins receiving retirement benefits under the plan. The alternate payees in the

second group are entitled to a certain percentage

or portion of the former spouse’s accrued

benefit, and for this purpose the accrued benefit

was determined at the time the qualified

domestic relations order was issued by the court.

It is reasonable to expect that the benefits to be

received by the second group of alternate payees

will not be affected by any reduction in a former

spouse’s rate of future benefit accrual. Accordingly, the plan administrator is not required to

provide section 204(h) notice to the alternate

payees in the second group.

Example 3. Plan B covers hourly employees

and salaried employees. Plan B provides the

same rate of benefit accrual for both groups. The

employer amends Plan B to reduce significantly

the rate of future benefit accrual of the salaried

employees only. At that time, it is reasonable to

expect that only a small percentage of hourly

employees will become salaried in the future.

Accordingly, the plan administrator is not required to provide section 204(h) notice to the

participants who are currently hourly employees.

Example 4. Plan C covers employees in

Division M and employees in Division N. Plan C

provides the same rate of benefit accrual for both

groups. The employer amends Plan C to reduce

significantly the rate of future benefit accrual of

employees in Division M. At that time, it is

reasonable to expect that in the future only a

small percentage of employees in Division N

will be transferred to Division M. Accordingly,

the plan administrator is not required to provide

section 204(h) notice to the participants who are

employees in Division N.

Example 5. Assume the same facts as in

Example 4, except that at the time the amendment is adopted, it is expected that soon

thereafter Division N will be merged into

Division M in connection with a corporate

reorganization (and the employees in Division N

will become subject to the plan’s amended

benefit formula applicable to the employees in

Division M). In this instance, the plan administrator must provide section 204(h) notice to the

participants who are employees in Division M

and to the participants who are employees in

Division N.

Q–10: Does a notice fail to comply

with section 204(h) of ERISA if it

contains a summary of the amendment

and the effective date, without the text

of the amendment itself?

A–10: No, the notice does not fail to

comply with section 204(h) of ERISA

merely because the notice contains a

summary of the amendment, rather than

the text of the amendment, if the

summary is written in a manner calculated to be understood by the average

plan participant and contains the effective date. The summary need not

explain how the individual benefit of

each participant or alternate payee will

be affected by the amendment.

Q–11: How may section 204(h)

notice be provided?

A–11: A plan administrator may use

any method reasonably calculated to

ensure actual receipt of the section

204(h) notice. First class mail to the

last known address of the party is an

acceptable delivery method. Likewise,

hand delivery is acceptable. Section

204(h) notice may be enclosed along

with other notice provided by the

employer or plan administrator.

Q–12: If a plan administrator fails to

provide section 204(h) notice to more

than a de minimis percentage of participants and alternate payees to whom

section 204(h) notice is required to be

provided, will the plan administrator be

considered to have complied with

section 204(h) of ERISA with respect

to participants and alternate payees

who were provided with timely section

204(h) notice?

A–12: The plan administrator will be

considered to have complied with

section 204(h) of ERISA with respect

to a participant to whom section 204(h)

notice is required to be provided if the

participant and any employee organization representing the participant were

provided with timely section 204(h)

notice. The plan administrator will be

considered to have complied with

section 204(h) with respect to an

alternate payee to whom section 204(h)

notice is required to be provided if the

alternate payee was provided with

timely section 204(h) notice. Accordingly, the amendment will become

effective in accordance with its terms

with respect to those participants and

alternate payees.

Q–13: Will a plan be considered to

have complied with section 204(h) of

ERISA if the plan administrator

provides section 204(h) notice to all

but a de minimis percentage of participants and alternate payees to whom

section 204(h) notice must be

provided?

A–13: The plan will be considered to

have complied with section 204(h) of

ERISA and the amendment will become effective in accordance with its

terms with respect to all parties to

whom section 204(h) notice was required to be provided (including those

who did not receive notice prior to

discovery of the omission), if the plan

administrator—

(a) Has made a good faith effort to

comply with the requirements of section 204(h);

(b) Has provided section 204(h)

notice to each employee organization

that represents any participant to whom

section 204(h) notice is required to be

provided;

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204(h) notice to no more than a de

minimis percentage of participants and

alternate payees to whom section

204(h) notice is required to be

provided; and

(d) Provides section 204(h) notice to

those participants and alternate payees

promptly upon discovering the

oversight.

Q–14: How does section 204(h) of

ERISA apply to a plan that is terminated in accordance with title IV of

ERISA?

A–14: (a) On and after termination

date. Notwithstanding paragraph (b) of

this Q&A–14 or any other provisions

of this section, a plan that is terminated

in accordance with title IV of ERISA is

deemed to have satisfied section 204(h)

of ERISA not later than the termination

date (or date of termination, as applicable) established under section 4048 of

ERISA. Accordingly, section 204(h)

would not require that any additional

benefits accrue after such date.

(b) Amendment effective before termination date. An amendment that is

effective before the termination date (or

date of termination, as applicable)

established under section 4048 of

ERISA is subject to section 204(h).

Accordingly, if such amendment provides for a significant reduction in the

rate of future benefit accrual, the plan

administrator must provide section

204(h) notice (either separately or with

or as part of the notice of intent to

terminate) with respect to the amendment. However, if a plan is not

amended to reduce significantly the

rate of future benefit accrual before the

termination date (for example, the plan

continues existing benefit accruals until

the termination date), section 204(h)

notice is not required.

Q–15: When does section 204(h) of

ERISA become effective?

A–15: (a) Statutory effective date.

With respect to defined benefit plans,

section 204(h) of ERISA generally

applies to plan amendments adopted on

or after January 1, 1986. With respect

to individual account plans, section

204(h) applies to plan amendments

adopted on or after October 22, 1986.

(b) Regulatory effective date. This

section applies to amendments adopted

on or after December 15, 1995, and

amendments effective by their terms on

or after December 30, 1995.

PART 602—OMB CONTROL

NUMBERS UNDER THE

PAPERWORK REDUCTION ACT

Par. 6. The authority citation for part

602 continues to read as follows:

Authority: 26 U.S.C. 7805.

Par. 7. In 602.101, paragraph (c) is

amended by adding to the table in

numerical order the entry ‘‘1.411(d)–

6T . . . 1545–1477’’.

Margaret Milner Richardson,

Commissioner of

Internal Revenue.

Approved December 5, 1995.

Leslie Samuels,

Assistant Secretary

of the Treasury.

(Filed by the Office of the Federal Register on

December 12, 1995, 1:23 p.m., and published

in the issue of the Federal Register for

December 15, 1995, 60 F.R. 64401)

Section 412.—Minimum Funding

Standards

Disability mortality tables. This ruling provides mortality tables for use

under section 412(1) for plan years

after 1995 to calculate current liability

for individuals entitled to benefits on

account of disability.

Rev. Rul. 96–7

ISSUE

What alternative mortality tables

may be used to calculate a plan’s

current liability under § 412(l) of the

Internal Revenue Code for individuals

who are entitled to benefits under the

plan on account of disability?

LAW AND ANALYSIS

Section 412(l) provides additional

funding requirements for certain underfunded defined benefit pension plans

that have more than 100 participants

and that are not multiemployer plans.

In general, the additional funding requirements are determined based on a

plan’s unfunded current liability.

Section 751(a) of the Retirement

Protection Act of 1994 added § 412(l)(7)(C)(ii) to the Code, effective for

plan years beginning after December

31, 1994. Section 412(l)(7)(C)(ii)

provides that, for purposes of determining current liability, the mortality table

used shall be the table prescribed by

the Secretary, and sets forth the basis

for establishing a table. For plan years

beginning before the effective date of

the first tables prescribed under

§ 412(l)(7)(C)(ii)(II), the table must be

based on the prevailing commissioners’

standard table (described in § 807(d)(5)(A)) used to determine reserves for

group annuity contracts issued on January 1, 1993. Rev. Rul. 95–28, 1995–1

C.B. 74, sets forth this mortality table.

Section 412(l)(7)(C)(iii)(I) provides

that, for plan years beginning after

December 31, 1995, the Secretary shall

establish mortality tables that may be

used, in lieu of the tables under

§ 412(l)(7)(C)(ii), to determine current

liability under § 412(l) for individuals

who are entitled to benefits under the

plan on account of disability. The

Secretary must establish separate tables

for individuals whose disabilities occurred in plan years beginning before

January 1, 1995, and for individuals

whose disabilities occur in plan years

beginning after December 31, 1994.

Under § 412(l)(7)(C)(iii)(II), the mortality table for individuals whose disabilities occur in plan years beginning

after December 31, 1994, applies only

with respect to individuals who are

disabled within the meaning of title II

of the Social Security Act and the

regulations thereunder.

The alternative mortality tables

provided for under § 412(l)(7)(C)(iii)

are permitted to be used in the

specified circumstances, but are not

required to be used. For any individual

for whom these alternative mortality

tables are not used, the mortality table

prescribed under § 412(l)(7)(C)(ii) must

be used.

The alternative mortality tables

provided under § 412(l)(7)(C)(iii) may

be used only for individuals who are

entitled to benefits under the plan on

account of disability. For this purpose,

an individual is entitled to benefits

under a plan on account of disability if,

because of the occurrence of a disability, the individual is entitled to

receive a benefit to which the individual would not be entitled in the

absence of the disability. For example,

an individual is entitled to benefits

under a plan on account of disability if,

upon the occurrence of a disability at a

time before the individual would have

been entitled to receive an unreduced

normal retirement benefit upon retire-

SEQ 0102 JOB A02-005-008 PAGE-0013 PART 1 PAGE 11

REVISED 28MAY96 AT 09:49 BY LR DEPTH: 65.01 PICAS WIDTH 44.10 PICAS

COMPOSITE COLOR

778/20049/28MAY96/A02-005

ment, the individual is entitled to

receive the same annuity that would

have been payable to the individual

upon retirement at normal retirement

age. As a further example, an individual is entitled to benefits under a plan

on account of disability if the individual, who would not otherwise be

earning service credits, is credited with

years of service for the period of

disability. On the other hand, an

individual is not entitled to benefits on

account of disability if the individual

separates from the service of the

employer because of a disability, but

merely receives the same benefit that

would have been payable if the individual had separated from service without

the occurrence of the disability.

For purposes of § 412(l)(7)(C)(iii),

any individual who has become entitled

to benefits under a plan on account of

disability continues to be considered

entitled to benefits under the plan on

account of disability until the individual recovers from disability and becomes entitled to different benefits

under the plan than the individual

would have been entitled to if the

individual had not recovered.

Under § 412(l), nothing prohibits the

use of an additional actuarial assumption that meets the requirements of

§ 412(c) regarding the probability of

recovery from disability.

HOLDING

The mortality tables provided below,

as applicable, may be used for plan

years beginning after December 31,

1995, in lieu of the mortality table

required to be used under § 412(l)(7)(C)(ii), for purposes of determining

current liability. The first mortality

table provided below may be used for

plan years beginning after December

31, 1995, in lieu of the mortality table

required to be used under § 412(l)(7)(C)(ii), for purposes of determining

current liability for individuals entitled

to benefits under the plan on account

of disability, whose disabilities occurred in plan years beginning before

January 1, 1995. The second mortality

table provided below may be used for

plan years beginning after December

31, 1995, in lieu of the mortality table

required to be used under § 412(l)(7)(C)(ii), for purposes of determining

current liability for individuals entitled

to benefits under the plan on account

of disability, whose disabilities occur in

plan years beginning after December

31, 1994. This second mortality table

may be used only for individuals who

are disabled within the meaning of title

II of the Social Security Act and the

regulations thereunder. The mortality

table required to be used under

§ 412(l)(7)(C)(ii) must be used for

individuals whose disabilities occur in

plan years beginning after December

31, 1994, but who are not disabled

within the meaning of title II of the

Social Security Act and the regulations

thereunder.

MORTALITY TABLE FOR

DISABILITIES OCCURRING IN

PLAN YEARS BEGINNING

BEFORE JANUARY 1, 1995

The following mortality table is the

mortality table that is permitted to be

used for individuals entitled to benefits

under the plan on account of disability,

whose disabilities occurred in plan

years beginning before January 1,

1995. The table sets forth the number

living based upon a starting population

of one million lives at age 15 (lx), and

the annual rate of mortality (qx), to be

used for each age and each gender.

Age

lx male

qx male

1,000,000.00

993,755.00

987,302.55

980,639.24

973,757.12

966,651.61

959,318.59

951,752.45

943,947.13

935,899.03

927,603.22

919,054.43

910,248.97

901,179.25

891,844.84

882,241.45

872,369.17

862,228.75

851,820.79

841,146.62

830,193.21

819,051.19

807,672.93

796,058.59

784,206.07

772,113.62

759,778.33

747,194.88

734,358.82

0.006245

0.006493

0.006749

0.007018

0.007297

0.007586

0.007887

0.008201

0.008526

0.008864

0.009216

0.009581

0.009964

0.010358

0.010768

0.011190

0.011624

0.012071

0.012531

0.013022

0.013421

0.013892

0.014380

0.014889

0.015420

0.015976

0.016562

0.017179

0.017831

Age

lx male

qx male

100

101

102

103

104

105

721,264.47

707,905.93

694,278.03

680,375.11

666,192.01

651,724.99

636,970.59

621,922.79

606,612.92

590,922.88

574,923.05

558,674.00

542,220.49

525,592.21

508,806.38

491,872.79

474,804.81

457,623.99

440,358.30

423,041.21

405,706.67

388,374.88

371,050.64

353,728.52

336,395.82

319,039.81

301,662.35

284,282.98

266,936.32

249,671.14

232,542.70

215,594.76

199,001.51

182,877.01

167,291.87

152,303.86

137,959.57

124,296.89

111,345.90

99,130.69

87,670.29

76,978.73

67,065.64

57,936.13

49,590.54

42,023.97

35,225.71

29,178.79

23,859.59

19,237.51

15,275.06

11,928.20

9,135.98

6,866.27

5,053.89

3,634.74

2,547.40

1,734.31

1,142.76

725.59

440.36

252.21

0.018521

0.019251

0.020025

0.020846

0.021716

0.022639

0.023624

0.024617

0.025865

0.027076

0.028263

0.029451

0.030667

0.031937

0.033281

0.034700

0.036185

0.037729

0.039325

0.040976

0.042720

0.044607

0.046684

0.049000

0.051594

0.054468

0.057612

0.061019

0.064679

0.068604

0.072881

0.076965

0.081027

0.085222

0.089592

0.094182

0.099034

0.104194

0.109705

0.115609

0.121952

0.128777

0.136128

0.144048

0.152581

0.161771

0.171662

0.182297

0.193720

0.205975

0.219106

0.234086

0.248436

0.263954

0.280803

0.299154

0.319185

0.341086

0.365052

0.393102

0.427255

0.469531

SEQ 0103 JOB A02-005-008 PAGE-0014 PART 1 PAGE 11

REVISED 28MAY96 AT 09:49 BY LR DEPTH: 65.01 PICAS WIDTH 44.10 PICAS

COMPOSITE COLOR

778/20049/28MAY96/A02-005

Age

106

107

108

109

110

lx male

133.79

63.96

26.45

8.85

2.12

qx male

0.521945

0.586518

0.665268

0.760215

1.000000

Age

lx female

qx female

1,000,000.00

995,333.00

990,482.74

985,445.15

980,210.46

974,774.22

969,130.27

963,270.91

957,189.78

950,880.94

944,337.93

937,552.86

930,519.34

923,229.65

915,678.56

907,861.41

899,776.90

891,425.18

882,808.66

873,926.72

864,760.10

855,347.19

845,727.96

835,918.36

825,931.64

815,779.29

805,471.10

795,015.28

784,417.73

773,683.76

762,817.37

751,819.83

740,692.90

729,436.59

718,049.35

706,529.69

694,875.48

683,083.44

671,149.97

659,071.29

646,843.54

634,462.95

621,925.33

609,227.48

596,366.08

583,338.46

570,142.76

556,778.05

543,244.44

529,542.73

515,675.60

501,646.64

487,461.08

473,125.82

0.004667

0.004873

0.005086

0.005312

0.005546

0.005790

0.006046

0.006313

0.006591

0.006881

0.007185

0.007502

0.007834

0.008179

0.008537

0.008905

0.009282

0.009666

0.010061

0.010489

0.010885

0.011246

0.011599

0.011947

0.012292

0.012636

0.012981

0.013330

0.013684

0.014045

0.014417

0.014800

0.015197

0.015611

0.016043

0.016495

0.016970

0.017470

0.017997

0.018553

0.019140

0.019761

0.020417

0.021111

0.021845

0.022621

0.023441

0.024307

0.025222

0.026187

0.027205

0.028278

0.029408

0.030598

Age

100

101

102

103

104

105

106

107

108

109

110

lx female

458,649.12

444,042.06

429,334.06

414,343.43

399,018.52

383,316.35

367,204.41

350,849.13

334,322.73

317,660.08

300,889.54

284,034.61

267,118.64

250,167.29

233,211.70

216,290.80

199,453.64

182,760.77

166,285.25

150,112.35

134,339.29

119,072.57

104,425.22

90,514.11

77,513.20

65,453.62

54,380.11

44,344.97

35,398.06

27,538.17

20,821.64

15,237.59

10,739.65

7,246.85

4,645.98

2,806.90

1,576.47

807.44

366.67

141.42

43.15

9.08

qx female

0.031848

0.033123

0.034916

0.036986

0.039352

0.042033

0.044540

0.047104

0.049840

0.052794

0.056017

0.059556

0.063460

0.067777

0.072556

0.077845

0.083693

0.090148

0.097260

0.105075

0.113643

0.123012

0.133216

0.143634

0.155581

0.169181

0.184537

0.201757

0.222043

0.243899

0.268185

0.295187

0.325225

0.358897

0.395842

0.438360

0.487816

0.545886

0.614309

0.694884

0.789474

1.000000

MORTALITY TABLE FOR

DISABILITIES OCCURRING IN

PLAN YEARS BEGINNING AFTER

DECEMBER 31, 1994

The following mortality table is the

mortality table that is permitted to be

used for individuals entitled to benefits

under the plan on account of disability,

whose disabilities occur in plan years

beginning after December 31, 1994.

This mortality table may be used only

for individuals who are disabled within

the meaning of title II of the Social

Security Act and the regulations thereunder. The table sets forth the number

living based upon a starting population

of one million lives at age 15 (lx), and

the annual rate of mortality (qx), to be

used for each age and each gender.

Age

lx male

qx male

1,000,000.00

977,990.00

955,983.27

933,994.70

912,028.08

890,098.36

868,217.07

846,396.17

824,646.33

802,983.70

781,417.96

759,962.57

738,629.66

717,428.04

696,375.11

675,484.55

654,773.52

634,258.81

613,958.72

593,889.03

574,050.16

554,426.83

535,032.43

515,880.41

496,981.64

478,348.31

459,992.65

441,927.82

424,167.18

406,724.58

389,613.27

372,847.04

356,439.16

340,401.90

324,747.15

309,486.31

294,629.73

280,186.69

266,165.58

252,573.31

239,416.00

226,698.23

214,423.88

202,611.48

191,251.46

180,334.83

169,854.13

159,803.52

150,178.23

140,971.86

132,171.12

123,755.92

115,701.64

107,981.56

100,569.49

93,445.75

86,597.67

80,018.07

73,704.40

67,655.48

61,863.77

56,362.97

0.022010

0.022502

0.023001

0.023519

0.024045

0.024583

0.025133

0.025697

0.026269

0.026857

0.027457

0.028071

0.028704

0.029345

0.029999

0.030661

0.031331

0.032006

0.032689

0.033405

0.034184

0.034981

0.035796

0.036634

0.037493

0.038373

0.039272

0.040189

0.041122

0.042071

0.043033

0.044007

0.044993

0.045989

0.046993

0.048004

0.049021

0.050042

0.051067

0.052093

0.053120

0.054144

0.055089

0.056068

0.057080

0.058118

0.059172

0.060232

0.061303

0.062429

0.063669

0.065082

0.066724

0.068642

0.070834

0.073284

0.075979

0.078903

0.082070

0.085606

0.088918

0.092208

SEQ 0104 JOB A02-006-009 PAGE-0015 PART 1 PAGE 15

REVISED 28MAY96 AT 09:50 BY LR DEPTH: 65.01 PICAS WIDTH 46 PICAS

COMPOSITE COLOR

778/20049/28MAY96/A02-006

Age

100

101

102

103

104

105

106

107

108

109

110

lx male

51,165.85

46,273.11

41,682.08

37,387.58

33,382.88

29,660.19

26,211.21

23,027.49

20,100.52

17,421.88

14,983.27

12,776.35

10,792.63

9,023.30

7,458.99

6,089.63

4,904.27

3,890.97

3,036.83

2,325.95

1,748.10

1,286.68

925.38

648.55

441.54

290.94

184.73

112.11

64.21

34.06

16.28

6.73

2.25

0.54

qx male

Age

lx female

qx female

Age

0.095625

0.099216

0.103030

0.107113

0.111515

0.116283

0.121464

0.127108

0.133262

0.139974

0.147292

0.155265

0.163939

0.173363

0.183585

0.194653

0.206615

0.219519

0.234086

0.248436

0.263954

0.280803

0.299154

0.319185

0.341086

0.365052

0.393102

0.427255

0.469531

0.521945

0.586518

0.665268

0.760215

1.000000

784,858.55

771,002.66

756,967.32

742,759.05

728,382.95

713,846.61

699,156.36

684,320.96

669,348.02

654,246.86

639,027.11

623,698.13

608,271.58

592,758.22

577,169.87

561,518.75

545,818.12

530,081.10

514,321.79

498,555.25

482,796.42

467,060.15

451,363.19

435,721.20

420,151.58

404,670.67

389,296.02

374,044.96

358,935.41

343,984.68

329,210.53

314,630.79

300,262.86

286,202.15

272,444.41

258,935.53

245,644.11

232,559.14

219,685.59

207,037.63

194,619.72

182,441.59

170,495.31

158,783.99

147,313.91

136,095.07

125,142.14

114,474.65

104,116.98

94,098.43

84,452.59

75,216.18

66,428.15

58,128.08

50,354.26

43,141.82

36,520.54

0.017654

0.018204

0.018770

0.019355

0.019957

0.020579

0.021219

0.021880

0.022561

0.023263

0.023988

0.024734

0.025504

0.026298

0.027117

0.027961

0.028832

0.029730

0.030655

0.031609

0.032594

0.033608

0.034655

0.035733

0.036846

0.037993

0.039176

0.040395

0.041653

0.042950

0.044287

0.045666

0.046828

0.048070

0.049584

0.051331

0.053268

0.055356

0.057573

0.059979

0.062574

0.065480

0.068690

0.072237

0.076156

0.080480

0.085243

0.090480

0.096224

0.102508

0.109368

0.116837

0.124948

0.133736

0.143234

0.153477

0.164498

100

101

102

103

104

105

106

107

108

109

110

Age

lx female

qx female

1,000,000.00

992,223.00

984,166.15

975,824.36

967,186.36

958,246.66

948,999.58

939,437.46

929,553.63

919,343.42

908,800.39

897,918.41

886,692.64

875,115.09

863,185.52

850,903.25

838,273.30

825,302.69

812,012.85

798,530.18

0.007777

0.008120

0.008476

0.008852

0.009243

0.009650

0.010076

0.010521

0.010984

0.011468

0.011974

0.012502

0.013057

0.013632

0.014229

0.014843

0.015473

0.016103

0.016604

0.017121

lx female

qx female

30,512.99

25,132.57

20,382.24

16,253.39

12,725.67

9,767.37

7,336.57

5,382.92

3,850.09

2,681.85

1,803.85

1,156.23

698.55

392.33

200.95

91.25

35.20

10.74

2.26

0.176332

0.189011

0.202571

0.217045

0.232467

0.248870

0.266289

0.284758

0.303433

0.327385

0.359020

0.395842

0.438360

0.487816

0.545886

0.614309

0.694884

0.789474

1.000000

EFFECTIVE DATE

This revenue ruling is effective for

plan years beginning after December

31, 1995.

DRAFTING INFORMATION

The principal author of this revenue

ruling is Edward Sypher of the

Employee Plans Division. For further

information regarding this revenue ruling, please contact the Employee Plans

Division’s taxpayer assistance telephone service at (202) 622-6076 between 2:30 and 4:00 Eastern time (not

a toll-free number) Monday through

Thursday. Mr. Sypher’s number is

(202) 622-6245 (also not a toll-free

number).

Section 483. Interest on Certain

Deferred Payments

26 CFR 1.483–1: Computation of interest on

certain deferred payments.

As defined by section 1274A, the definitions

for both ‘‘qualified debt instruments’’ and ‘‘cash

method debt instruments’’ have dollar ceilings on

the stated principal amount. The limits to the

stated principal amount are adjusted for inflation

for sales or exchanges occurring in the 1996

calendar year. See Rev. Rul. 96–4, page 16.

Section 761.—Definitions

The Service will not rule on certain issues

raised in connection with the transfer of a life

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insurance policy to an unincorporated organization. See Rev. Proc. 96–12, page 30.

Section 1274. Determination of Issue

Price in the Case of Certain Debt

Instruments Issued for Property

26 CFR 1.1274A–1: Special rules for certain

transactions where stated principal amount does

not exceed $2,800,000.

As defined by section 1274A, the definitions

for both ‘‘qualified debt instruments’’ and ‘‘cash

method debt instruments’’ have dollar ceilings on

the stated principal amount. The limits to the

stated principal amount are adjusted for inflation

for sales or exchanges occurring in the 1996

calendar year. See Rev. Rul. 96–4, this page.

Section 1274A.—Special Rules for

Certain Transactions Where Stated

Principal Amount Does Not Exceed

$2,800,000

(Also §§ 1274, 483; 1.483–1, 1.1274A–1.)

Section 1274A inflation-adjusted numbers for 1996. This ruling provides the

dollar amounts, increased by the 1996

inflation-adjustment, for section 1274A

of the Code. Rev. Rul. 95–10 supplemented and superseded.

Rev. Rul. 96–4

This revenue ruling provides the

dollar amounts, increased by the 1996

inflation adjustment, for § 1274A of

the Internal Revenue Code.

BACKGROUND

In general, §§ 483 and 1274 of the

Code determine the principal amount of

a debt instrument given in consideration for the sale or exchange of

nonpublicly traded property. In addition, any interest on a debt instrument

subject to § 1274 is taken into account

under the original issue discount provisions of the Code. Section 1274A,

however, modifies the rules under

§§ 483 and 1274 for certain types of

debt instruments.

In the case of a ‘‘qualified debt

instrument,’’ the discount rate used for

purposes of §§ 483 and 1274 of the

Code may not exceed 9 percent,

compounded semiannually. Section

1274A(b) defines a qualified debt

instrument as any debt instrument

given in consideration for the sale or

exchange of property (other than new

§ 38 property within the meaning of

§ 48(b), as in effect on the day before

the date of enactment of the Revenue

Reconciliation Act of 1990) if the

stated principal amount of the instrument does not exceed the amount

specified in § 1274A(b). For debt instruments arising out of sales or

exchanges before January 1, 1990, this

amount is $2,800,000.

In the case of a ‘‘cash method debt

instrument,’’ as defined in § 1274A(c)

of the Code, the borrower and lender

may elect to use the cash receipts and

disbursements method of accounting. In

particular, for any cash method debt

instrument, § 1274 does not apply, and

interest on the instrument is accounted

for by both the borrower and the lender

under the cash method of accounting.

A cash method debt instrument is a

qualified debt instrument that meets the

following additional requirements: (A)

In the case of instruments arising out

of sales or exchanges before January 1,

1990, the stated principal amount does

not exceed $2,000,000, (B) The lender

does not use an accrual method of

accounting and is not a dealer with

respect to the property sold or exchanged, (C) Section 1274 would have

applied to the debt instrument but for

an election under § 1274A(c); and (D)

An election under § 1274A(c) is jointly

made with respect to the debt instrument by the borrower and lender.

Section 1.1274A–1(c)(1) of the Income

Tax Regulations provides rules concerning the time for, and manner of,

making this election.

Section 1274A(d)(2) of the Code

provides that, for any debt instrument

arising out of a sale or exchange during

any calendar year after 1989, the dollar

amounts stated in § 1274A(b) and

§ 1274A(c)(2)(A) are increased by the

inflation adjustment for the calendar

year. Any increase due to the inflation

adjustment is rounded to the nearest

multiple of $100 (or, if the increase is

a multiple of $50 and not of $100, the

increase is increased to the nearest

multiple of $100). The inflation adjustment for any calendar year is the

percentage (if any) by which the CPI

for the preceding calendar year exceeds

the CPI for calendar year 1988. Section

1274A(d)(2)(B) defines the CPI for any

calendar year as the average of the

Consumer Price Index as of the close

of the 12-month period ending on

September 30 of that calendar year.

INFLATION-ADJUSTED

AMOUNTS

For debt instruments arising out of

sales or exchanges after December 31,

1989, the inflation-adjusted amounts

under § 1274A are shown in Table 1.

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TABLE 1

REV. RUL. 96–4

Inflation-Adjusted Amounts Under § 1274A

Calendar Year

of Sale

or Exchange

1274A(b) Amount

(qualified debt

instrument

1274A(c) (2) (A) Amount

(cash method debt

instrument)

1990

1991

1992

1993

1994

1995

1996

$2,933,200

$3,079,600

$3,234,900

$3,332,400

$3,433,500

$3,523,600

$3,622,500

$2,095,100

$2,199,700

$2,310,600

$2,380,300

$2,452,500

$2,516,900

$2,587,500

Note: These inflation adjustments were computed using the All-Urban, Consumer Price Index, 1982-1984 base,

published by the Bureau of Labor Statistics.

EFFECT ON OTHER DOCUMENTS

Rev. Rul. 95–10, 1995–1 C.B. 168,

is supplemented and superseded.

Section 3402.—Income Tax Collected

at Source

26 CFR 31.3402(r)–1: Withholding on

distributions of Indian gaming profits to tribal

members.

T.D. 8634

The principal author of this revenue

ruling is David B. Silber of the Office

of the Assistant Chief Counsel (Financial Institutions and Products). For

further information regarding this revenue ruling contact Mr. Silber on (202)

622-3930 (not a toll-free call).

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 31

Withholding on Distributions of Indian

Gaming Profits to Tribal Members

AGENCY: Internal Revenue Service

(IRS), Treasury.

26 CFR 20.2031–6: Valuation of household

and personal effects.

Executors and administrators of estates including art appraised at $50,000 or more may request

that the Service issue a Statement of Value for

the art. See Rev. Proc. 96–15, page 41.

Section 2512.—Valuation of Gifts

26 CFR 25.2512–1: Valuation of property, in

general.

The donor of a gift of art appraised at $50,000

or more may request that the Service issue a

Statement of Value for the art. See Rev. Proc.

96–15, page 41.

SUPPLEMENTARY INFORMATION:

Background

DRAFTING INFORMATION

Section 2031.—Definition of Gross

Estate

FOR FURTHER INFORMATION

CONTACT: Rebecca Wilson (202)

622-6040 (not a toll-free number).

ACTION: Final regulations.

SUMMARY: This document contains

final regulations relating to the income

tax withholding requirement on distributions of profits from certain gaming activities made to members of

Indian tribes under section 3402(r) of

the Internal Revenue Code of 1986.

Those affected by the regulations are

persons, including Indian tribes, making payments to members of Indian

tribes from net revenues of certain

gaming activities conducted or licensed

by the tribes. Also affected are members of Indian tribes who receive the

payments.

DATES: These regulations are effective

December 19, 1995. For the date of

applicability, see § 31.3402(r)–1(b).

This document contains amendments

to the Employment Tax Regulations

(26 CFR part 31) under section

3402(r). Section 3402(r) was added by

section 701 of the Uruguay Round

Agreements Act, which approved the

trade agreements resulting from the

Uruguay Round of multilateral trade

negotiations under the auspices of the

General Agreement on Tariffs and

Trade (GATT) and the Statement of

Administrative Action to implement the

Agreements.

On December 22, 1994, temporary

regulations (TD 8574 [1995–1 C.B.

194]) relating to withholding on distributions of Indian gaming profits to

tribal members under section 3402(r)

were published in the Federal Register

(59 FR 65939). A notice of proposed

rulemaking (EE–60–94 [1995–1 C.B.

857]) cross-referencing the temporary

regulations was published in the Federal Register for the same day (59 FR

65982). No public hearing was requested or held.

Also on December 22, 1994, the IRS

mailed a copy of Notice 1026, providing withholding tables for use in 1995,

to Indian tribes and gaming establishments listed with the National Indian

Gaming Commission. For 1996 and

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subsequent years, tables will be printed

in a supplement to Circular E.

The IRS received written comments

responding to the notice of proposed

rulemaking. After consideration of the

comments, the regulations proposed by

EE–60–94 are adopted as revised by

this Treasury decision, and the corresponding temporary regulations are

withdrawn. The regulations contain no

substantive changes.

Explanation of Provisions

1. Indian Gaming Regulatory Act.

Net revenue from certain gaming activities conducted or licensed by an

Indian tribe may be used to make

taxable distributions to members of the

Indian tribe. The tribe must notify its

members of the tax liability at the time

the payments are made. 25 U.S.C.

2710(b)(3) and (d)(1).

2. Prior law. Prior to the addition of

section 3402(r) in 1994, a tribe was not

required to withhold on these distributions to tribal members except to the

extent backup withholding rules applied

under section 3406.

3. Code section 3402(r). Section

3402(r) generally requires that, for

payments made after December 31,

1994, persons, including Indian tribes,

making payments to members of Indian

tribes from the net revenues of certain

gaming activities conducted or licensed

by the tribes deduct and withhold

income taxes from those payments.

Section 3402(r) provides that the withholding amount be calculated assuming

that the taxpayer is single and has one

exemption.

4. Legislative history. The legislative

history of section 3402(r) indicates that

the goal of the new withholding requirement was to make it easier for

tribal members who receive gaming

distributions to meet their tax

responsibilities:

Distributions of net revenues from

gaming activity by an Indian tribe may

result in significant tax liability to the

tribe’s members. Establishing withholding on such payments will more closely

match estimated tax payments to ultimate tax liability. For some tribal

members, this change may eliminate

the need to make quarterly estimated

tax payments. For others, it will reduce

the likelihood that they will face

penalties for underpayment of tax at

the time of tax filing.

H.R. Rep. No. 826, 103d Cong., 2d

Sess., pt.1, at 170–171 (1994).

5. Proposed regulations. The proposed regulations implement the withholding method prescribed by section

3402(r). They also permit additional

withholding by agreement between the

tribal member and the tribe.

6. Comments and final regulations.

The IRS received only two written

comments on the proposed regulations.

After consideration of both comments,

the proposed regulations are adopted

with no substantive changes.

No comments were received from

the Chief Counsel for Advocacy of the

Small Business Administration.

Special Analyses

It has been determined that this

Treasury decision is not a significant

regulatory action as defined in EO

12866. Therefore, a regulatory assessment is not required. It also has been

determined that section 553(b) of the

Administrative Procedure Act (5 U.S.C.

chapter 5) and the Regulatory Flexibility Act (5 U.S.C. chapter 6) do not

apply to these regulations, and, therefore, a Regulatory Flexibility Analysis

is not required. Pursuant to section

7805(f) of the Internal Revenue Code,

the notice of proposed rulemaking

preceding these regulations was submitted to the Small Business Administration for comment on its impact on

small business.

Drafting Information

The principal author of the regulations is Rebecca Wilson, Office of the

Associate Chief Counsel (Employee

Benefits and Exempt Organizations),

IRS. However, other personnel from

the IRS and Treasury Department

participated in their development.

Adoption of Amendments to the

Regulations

Accordingly, 26 CFR part 31 is

amended as follows:

PART 31—EMPLOYMENT TAXES

AND COLLECTION OF INCOME

TAX AT SOURCE

Paragraph 1. The authority citation

for part 31 is amended by removing the

entry for section 31.3402(r)–1T and

adding an entry in numerical order to

read as follows:

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

Section 31.3402(r)–1 also issued under

26 U.S.C. 3402(p) and (r),* * *

Par. 2. Section 31.3402(r)–1 is added

to read as follows:

§ 31.3402(r)–1 Withholding on

distributions of Indian gaming profits

to tribal members.

(a)(1) General rule. Section

3402(r)(1) requires every person, including an Indian tribe, making a

payment to a member of an Indian tribe

from the net revenues of any class II or

class III gaming activity, as defined in

25 U.S.C. 2703, conducted or licensed

by such tribe to deduct and withhold

from such payment a tax in an amount

equal to such payment’s proportionate

share of the annualized tax, as that

term is defined in section 3402(r)(3).

(2) Withholding tables. Except as

provided in paragraph (a)(4) of this

section, the amount of a payment’s

proportionate share of the annualized

tax shall be determined under the

applicable table provided by the

Commissioner.

(3) Annualized amount of payment.

Section 3402(r)(5) provides that payments shall be placed on an annualized

basis under regulations prescribed by

the Secretary. A payment may be

placed on an annualized basis by

multiplying the amount of the payment

by the total number of payments to be

made in a calendar year. For example,

a monthly payment may be annualized

by multiplying the amount of the

payment by 12. Similarly, a quarterly

payment may be annualized by multiplying the amount of the payment by 4.

(4) Alternate withholding procedures—(i) In general. Any procedure

for determining the amount to be

deducted and withheld under section

3402(r) may be used, provided that the

amount of tax deducted and withheld is

substantially the same as it would be

using the tables provided by the

Commissioner under paragraph (a)(2)

of this section. At the election of an

Indian tribe, the amount to be deducted

and withheld under section 3402(r)

shall be determined in accordance with

this alternate procedure.

(ii) Method of election. It is sufficient for purposes of making an election under this paragraph (a)(4) that an

Indian tribe evidence the election in

any reasonable way, including use of a

particular method. Thus, no written

election is required.

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5. Additional withholding permitted.

Consistent with the provisions of section 3402(p), a tribal member and a

tribe may enter into an agreement to

provide for the deduction and withholding of additional amounts from payments in order to satisfy the anticipated

tax liability of the tribal member. The

agreement may be made in a manner

similar to that described in

§ 31.3402(p)–1 (with respect to voluntary withholding agreements between

employees and employers).

(b) Effective date. This section applies to payments made after December

31, 1994.

§ 31.3402(r)–1T [Removed]

Par. 3. Section 31.3402(r)–1T is

removed.

Margaret Milner Richardson,

Commissioner of

Internal Revenue.

Approved November 28, 1995.

ACTION: Final regulations.

SUMMARY: This document contains

final income, estate, and gift tax

regulations relating to exceptions to the

use of the valuation tables in the

regulations for valuing annuities, interests for life or a term of years, and

remainder or reversionary interests, the

valuation of which was the subject of

final regulations published on June 10,

1994. These regulations are necessary

in order to provide guidance consistent

with court decisions concluding that the

valuation tables are not to be used in

certain situations.

EFFECTIVE DATE: These regulations

are effective December 13, 1995.

FOR FURTHER INFORMATION

CONTACT: William L. Blodgett, telephone (202) 622-3090 (not a toll-free

number).

SUPPLEMENTARY INFORMATION:

Background

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 1, 20, and 25

On June 10, 1994, the IRS published

in the Federal Register (59 FR 30100)

final income tax regulations under

sections 170, 642, 664 and 7520 of the

Internal Revenue Code (Code), and

final estate and gift tax regulations

under sections 2031, 2512 and 7520 of

the Code providing actuarial tables to

be used in valuing annuities, interests

for life or a term of years, and

remainder or reversionary interests under section 7520. On June 10, 1994,

the IRS also published in the Federal

amendments to the income, estate, and

gift tax regulations prescribing circumstances when the published actuarial

tables cannot be used to value interests.

This regulation finalizes those

amendments.

Written comments responding to the

notice of proposed rulemaking were

received. Requests for a public hearing

were also received but were subsequently withdrawn. After consideration

of all the comments received, those

amendments are revised and adopted by

this Treasury decision.

Actuarial Tables Exceptions

Explanation of Provisions

AGENCY: Internal Revenue Service

(IRS), Treasury.

Section 7520(a), which is effective

for transfers after April 30, 1989,

Leslie Samuels,

Assistant Secretary

of the Treasury.

(Filed by the Office of the Federal Register on

December 18, 1995, 8:45 a.m., and published

in the issue of the Federal Register for

December 19, 1995, 60 F.R. 65237)

Section 7478.—Declaratory

Judgements Relating to Status of

Certain Governmental Obligations

A revenue procedure sets forth procedures for

requesting a ruling under §§ 103, 141–150, 1395,

and 7871(c) of the Code. See Rev. Proc. 96–16,

page 45.

Section 7520.—Valuation Tables

26 CFR 1.7520–3: Limitation on the

application of section 7520.

T.D. 8630

provides that the value of annuities,

interests for life or a term of years, and

remainder or reversionary interests is to

be determined under tables published

by the IRS. Section 7520(e) provides

that, for purposes of section 7520, the

term tables includes formulas. Section

7520(b) provides that section 7520

shall not apply for purposes of any

provision specified in regulations. The

Conference Report accompanying the

Technical and Miscellaneous Revenue

Act of 1988, H.R. Conf. Rep. No.

1104, 100th Cong., 2d Sess. 113 (1988)

(1988–3 C.B. 603), states that section

7520 does not apply in ‘‘situations

specified in Treasury regulations.’’ A

summary of the principal comments

received and revisions made in the

final regulations in response to those

comments is provided below.

1. Valuation of Annuities, Income

Interests, etc.

Under the proposed regulations, the

tables cannot be used if the instrument

of transfer does not provide the beneficiary of the annuity, income interest,

or remainder interest with the degree of

beneficial enjoyment that is consistent

with the traditional character of that

property interest under applicable local

law. One comment letter suggested

that, as a result of enactment of section

2702, it may no longer be necessary to

prescribe special rules in the case of a

trust corpus consisting of nonproductive property. It was decided to retain

these rules because this issue will

continue to arise in certain situations

where section 2702 does not apply;

e.g., the valuation of a gift of an

income interest for purposes of determining the section 2503(b) gift tax

exclusion; the valuation of the bequest

of an income interest for purposes of

the section 2013 estate tax credit.

In response to comments, the final

regulations provide additional guidance

for determining under what circumstances a life tenant or term certain

beneficiary of tangible property possesses adequate beneficial use such that

the tables would be used to value the

interest.

A number of comments were received on the valuation of an annuity

that is payable from a trust corpus that

will exhaust prior to the annuitant

reaching the presumed terminal age

prescribed by the tables (age 110).

Under the proposed regulations, the

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interest would be valued, not as a right

to receive the annuity for the life of the

annuitant, but rather as the right to

receive the annuity for the shorter of

the life of the annuitant or the date on

which the corpus will exhaust. One

commentator agreed that the possibility

of exhaustion of corpus should be

taken into account in cases of relatively

severe underfunding of the trust. However, it was suggested that, if the

underfunding was relatively less severe,

it should be disregarded. After further

consideration of this issue, the IRS has

concluded that the method described in

the proposed regulations for determining the value of the annuity is consistent with fundamental principles for

determining present value and longstanding IRS position. See, Rev. Rul.

77–454 (1977–2 C.B. 351); Rev. Rul.

70–452 (1970–2 C.B. 199); Moffett v.

Commissioner, 269 F.2d 738 (4th Cir.

1959); United States v. Dean, 224 F.2d

26 (1st Cir. 1955). However, in response to requests, the explanation of

the methodology and computation has

been amplified.

2. Terminal Illness

Under the proposed regulations, the

tables cannot be used if the individual,

who is the measuring life with respect

to the property interest, is terminally

ill. Under the proposed regulations, the

individual is terminally ill if that

individual was known to have an

incurable illness or deteriorating physical condition such that there is at least

a 50 percent probability that the

individual will die within one year.

One commentator suggested that the

value of a property interest that is

dependent upon a measuring life should

be determined in all events based on

the mortality component contained in

Table 80CNSMT (which is based on

the life experience of the general

population), rather than a mortality

component that reflects the actual

terminally ill condition of the individual. The commentator also suggested

that if departure from the actuarial

tables is deemed appropriate in the case

of terminally ill individuals, then the

standard in Rev. Rul. 80–80 (1980–1

C.B. 194), which is not explicitly

expressed in the form of a percentage

probability of survival (as is the

standard in the proposed regulations),

adequately differentiates between individuals that should not be considered

terminally ill and those that should.

This commentator also questioned

whether a percentage probability standard, such as the one used in the

proposed regulations, would be feasible

to administer.

The IRS continues to believe that

mortality tables such as Table

80CNSMT should not be used to

predict the survival probabilities of an

individual whose time of death is

reasonably predictable based on the

facts presented. To determine whether

the proposed test for classifying an

individual as terminally ill would be

feasible, the IRS consulted with a

number of medical specialists. Medical

experts called upon to assess the

probability of survival of a terminally

ill individual base their assessment on

statistical compilations of the percentage of individuals who survive for a

specified period of time when suffering

with a particular disease. Thus, the IRS

believes that a test for classifying an

individual as terminally ill can reasonably be based upon the probability of

survival for a specified period of time.

One commentator suggested that the

mortality test should take into account

the actual period of survival after the

transfer. For example, if the individual

actually survived for one year, that

individual should not be deemed to

have been terminally ill. Although

post-transaction events are not ordinarily determinative for valuation

purposes, such events may provide

evidence of value as of the valuation

date. Accordingly, the final regulations

provide a presumption that if the

individual who is the measuring life

survives for eighteen months or longer

after the transfer, that individual shall

be presumed to have not been terminally ill on the date of the transfer

unless the contrary is established by

clear and convincing evidence.

The commentator also questioned

whether the proposed test for classifying an individual as terminally ill

would result in the classification of

elderly people suffering from the general infirmities of old age as ‘‘terminally ill.’’ The IRS continues to believe

that the test should be consistently

applied to people of all ages. Under the

regulations, the individual must be

inflicted with an incurable illness or

other deteriorating physical condition

that is life threatening. Thus, elderly

people suffering from the general infirmities of old age, but not from a

specific incurable life-threatening illness, would not be considered termi-

nally ill under the test. Consequently, if

an elderly person has one or more

illnesses, none of which, standing alone

or considered together, is lifethreatening, that person would not be

considered to be terminally ill.

The same commentator suggested

that ‘‘knowledge’’ of the terminal

illness should be limited to actual

knowledge by the taxpayer or the

decedent, rather than to ‘‘knowledge’’

by any of the parties involved. However, limitation of the requisite

‘‘knowledge’’ to the taxpayer or decedent would present a significant burden

to the IRS regarding proof and would

present opportunities for easy circumvention. Thus, the IRS believes that the

requirement that the condition of the

individual be ‘‘known,’’ although not

necessarily by the taxpayer or decedent, is reasonable.

Commentators suggested that the

regulations should make it clear that a

special actuarial factor taking into

account a transferor’s terminal illness

may be used in valuing a transfer to a

pooled income fund. The final regulations incorporate that suggestion.

Comments were received that the

language in § 20.7520–3(b)(3)(ii) of

the proposed regulations regarding the

valuation of a property interest that is

based upon a terminally ill measuring

life, for purposes of determining the

applicable credit for tax on prior

transfers under section 2013, was ambiguous. Generally, if the final determination of the estate tax liability in

the transferor’s estate was dependent

on the valuation of the life interest

received by the transferee, then the

value of the property transferred, for

purposes of determining the credit

allowable for the transferee’s estate, is

the value determined previously for the

transferor’s estate. Section 20.7520–

3(b)(3)(ii) of the final regulations clarifies this rule. The IRS invites comments on whether the value of a

reversionary interest under section 673

should be determined without regard to

the physical condition of the decedent

immediately before death, a related

issue that was raised by commentators.

3. Application of Actuarial Tables

One commentator suggested that the

tables prescribed by the regulations

must be used for valuing all interests

transferred between April 30, 1989 (the

effective date of section 7520) and

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December December 13, 1995 (the effective date of the regulations). However, these regulations generally adopt

principles established in case law and

published IRS positions. See, e.g.,

O’Reilly v. Commissioner, 973 F.2d

1403 (8th Cir. 1992), rem’d, T.C.M.

1994–61 (underproductive income interest); Estate of McLendon v. Commissioner, T.C.M. 1993–459; Rev. Rul.

80–80 (1980–1 C.B. 194) (terminal

illness of measuring life); Moffett v.

Commissioner, 269 F.2d 738 (4th Cir.

1959); Rev. Rul. 77–454 (1977–2 C.B.

351) (exhausting corpus). There is no

indication that Congress intended to

supersede this well-established case law

and administrative ruling position when

it enacted section 7520. Consequently,

in the case of transfers prior to the

effective date of these regulations, the

question of whether a particular interest

must be valued based on the tables will

be resolved based on applicable case

law and revenue rulings.

Special Analyses

It has been determined that this

Treasury decision is not a significant

regulatory action as defined in EO

12866. Therefore, a regulatory assessment is not required. It also has been

determined that section 553(b) of the

Administrative Procedure Act (5 U.S.C.

chapter 5) and the Regulatory Flexibility Act (5 U.S.C. chapter 6) do not

apply to these regulations, and, therefore, a Regulatory Flexibility Analysis

is not required. Pursuant to section

7805(f) of the Internal Revenue Code,

the notice of proposed rulemaking

preceding these regulations was submitted to the Small Business Administration for comment on its impact on

small business.

Drafting Information

The principal author of these regulations is William L. Blodgett, Office of

Assistant Chief Counsel (Passthroughs

and Special Industries), IRS. However,

other personnel from the IRS and

Treasury Department participated in

their development.

Adoption of

Regulations

Amendments

the

Accordingly, 26 CFR parts 1, 20 and

25 are amended as follows:

Part 1—INCOME TAXES

Paragraph 1. The authority citation

for part 1 continues to read in part as

follows:

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

Par. 2. Section 1.7520–3 is amended

by revising paragraph (b) and adding a

sentence at the end of paragraph (c) to

read as follows:

§ 1.7520–3 Limitation on the

application of section 7520.

(b) Other limitations on the application of section 7520—(1) In general—

(i) Ordinary beneficial interests. For

purposes of this section:

(A) An ordinary annuity interest is

the right to receive a fixed dollar

amount at the end of each year during

one or more measuring lives or for

some other defined period. A standard

section 7520 annuity factor for an

ordinary annuity interest represents the

present worth of the right to receive

$1.00 per year for a defined period,

using the interest rate prescribed under

section 7520 for the appropriate month.

If an annuity interest is payable more

often than annually or is payable at the

beginning of each period, a special

adjustment must be made in any computation with a standard section 7520

annuity factor.

(B) An ordinary income interest is

the right to receive the income from, or

the use of, property during one or more

measuring lives or for some other

defined period. A standard section 7520

income factor for an ordinary income

interest represents the present worth of

the right to receive the use of $1.00 for

a defined period, using the interest rate

prescribed under section 7520 for the

appropriate month.

an interest in property at the end of one

or more measuring lives or some other

defined period. A standard section 7520

remainder factor for an ordinary remainder or reversionary interest represents the present worth of the right to

receive $1.00 at the end of a defined

period, using the interest rate prescribed under section 7520 for the

appropriate month.

(ii) Certain restricted beneficial interests. A restricted beneficial interest

is an annuity, income, remainder, or

reversionary interest that is subject to a

contingency, power, or other restriction, whether the restriction is provided

for by the terms of the trust, will, or

other governing instrument or is caused

by other circumstances. In general, a

standard section 7520 annuity, income,

or remainder factor may not be used to

value a restricted beneficial interest.

However, a special section 7520 annuity, income, or remainder factor may

be used to value a restricted beneficial

interest under some circumstances. See

paragraph (b)(4) Example 2 of this

section, which illustrates a situation

where a special section 7520 actuarial

factor is needed to take into account

the shorter life expectancy of the

terminally ill measuring life. See

§ 1.7520–1(c) for requesting a special

factor from the Internal Revenue

Service.

(iii) Other beneficial interests. If,

under the provisions of this paragraph

(b), the interest rate and mortality

components prescribed under section

7520 are not applicable in determining

the value of any annuity, income,

remainder, or reversionary interest, the

actual fair market value of the interest

(determined without regard to section

7520) is based on all of the facts and

circumstances if and to the extent

permitted by the Internal Revenue

Code provision applicable to the property interest.

(2) Provisions of governing instrument and other limitations on source of

payment—(i) Annuities. A standard

section 7520 annuity factor may not be

used to determine the present value of

an annuity for a specified term of years

or the life of one or more individuals

unless the effect of the trust, will, or

other governing instrument is to ensure

that the annuity will be paid for the

entire defined period. In the case of an

annuity payable from a trust or other

limited fund, the annuity is not considered payable for the entire defined

period if, considering the applicable

section 7520 interest rate at the valuation date of the transfer, the annuity is

expected to exhaust the fund before the

last possible annuity payment is made

in full. For this purpose, it must be

assumed that it is possible for each

measuring life to survive until age 110.

For example, for a fixed annuity

payable annually at the end of each

year, if the amount of the annuity

payment (expressed as a percentage of

the initial corpus) is less than or equal

to the applicable section 7520 interest

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rate at the date of the transfer, the

corpus is assumed to be sufficient to

make all payments. If the percentage

exceeds the applicable section 7520

interest rate and the annuity is for a

definite term of years, multiply the

annual annuity amount by the Table B

term certain annuity factor, as described in § 1.7520–1(c)(1), for the

number of years of the defined period.

If the percentage exceeds the applicable

section 7520 interest rate and the

annuity is payable for the life of one or

more individuals, multiply the annual

annuity amount by the Table B annuity

factor for 110 years minus the age of

the youngest individual. If the result

exceeds the limited fund, the annuity

may exhaust the fund, and it will be

necessary to calculate a special section

7520 annuity factor that takes into

account the exhaustion of the trust or

fund. This computation would be modified, if appropriate, to take into account

annuities with different payment terms.

See § 25.7520–3(b)(2)(v) Example 5 of

this chapter, which provides an illustration involving an annuity trust that is

subject to exhaustion.

(ii) Income and similar interests—

(A) Beneficial enjoyment. A standard

section 7520 income factor for an

ordinary income interest may not be

used to determine the present value of

an income or similar interest in trust

for a term of years or for the life of

one or more individuals unless the

effect of the trust, will, or other

governing instrument is to provide the

income beneficiary with that degree of

beneficial enjoyment of the property

during the term of the income interest

that the principles of the law of trusts

accord to a person who is unqualifiedly

designated as the income beneficiary of

a trust for a similar period of time.

This degree of beneficial enjoyment is

provided only if it was the transferor’s

intent, as manifested by the provisions

of the governing instrument and the

surrounding circumstances, that the

trust provide an income interest for the

income beneficiary during the specified

period of time that is consistent with

the value of the trust corpus and with

its preservation. In determining whether

a trust arrangement evidences that

intention, the treatment required or

permitted with respect to individual

items must be considered in relation to

the entire system provided for in the

administration of the subject trust.

Similarly, in determining the present

value of the right to use tangible

property (whether or not in trust) for

one or more measuring lives or for

some other specified period of time, the

interest rate component prescribed under section 7520 and § 1.7520–1 may

not be used unless, during the specified

period, the effect of the trust, will or

other governing instrument is to

provide the beneficiary with that degree

of use, possession, and enjoyment of

the property during the term of interest

that applicable state law accords to a

person who is unqualifiedly designated

as a life tenant or term holder for a

similar period of time.

(B) Diversions of income and

corpus. A standard section 7520 income factor for an ordinary income

interest may not be used to value an

income interest or similar interest in

property for a term of years or for one

or more measuring lives if—

(1) The trust, will, or other governing instrument requires or permits the

beneficiary’s income or other enjoyment to be withheld, diverted, or

accumulated for another person’s benefit without the consent of the income

beneficiary; or

(2) The governing instrument requires or permits trust corpus to be

withdrawn from the trust for another

person’s benefit during the income

beneficiary’s term of enjoyment without the consent of and accountability to

the income beneficiary for such

diversion.

(iii) Remainder and reversionary

interests. A standard section 7520

remainder interest factor for an ordinary remainder or reversionary interest

may not be used to determine the

present value of a remainder or reversionary interest (whether in trust or

otherwise) unless, consistent with the

preservation and protection that the law

of trusts would provide for a person

who is unqualifiedly designated as the

remainder beneficiary of a trust for a

similar duration, the effect of the

administrative and dispositive provisions for the interest or interests that

precede the remainder or reversionary

interest is to assure that the property

will be adequately preserved and protected (e.g., from erosion, invasion,

depletion, or damage) until the remainder or reversionary interest takes

effect in possession and enjoyment.

This degree of preservation and protection is provided only if it was the

transferor’s intent, as manifested by the

provisions of the arrangement and the

surrounding circumstances, that the

entire disposition provide the remainder

or reversionary beneficiary with an

undiminished interest in the property

transferred at the time of the termination of the prior interest.

(iv) Pooled income fund interests. In

general, pooled income funds are created and administered to achieve a

special rate of return. A beneficial

interest in a pooled income fund is not

ordinarily valued using a standard

section 7520 income or remainder

interest factor. The present value of a

beneficial interest in a pooled income

fund is determined according to rules

and special remainder factors prescribed in § 1.642(c)–6 and, when

applicable, the rules set forth in paragraph (b)(3) of this section, if the

individual who is the measuring life is

terminally ill at the time of the transfer.

(3) Mortality component. The mortality component prescribed under section 7520 may not be used to determine

the present value of an annuity, income

interest, remainder interest, or reversionary interest if an individual who is

a measuring life is terminally ill at the

time of the transaction. For purposes of

this paragraph (b)(3), an individual

who is known to have an incurable

illness or other deteriorating physical

condition is considered terminally ill if

there is at least a 50 percent probability

that the individual will die within 1

year. However, if the individual survives for eighteen months or longer

after the date of the transaction, that

individual shall be presumed to have

not been terminally ill at the time of

the transaction unless the contrary is

established by clear and convincing

evidence.

(4) Examples. The provisions of this

paragraph (b) are illustrated by the

following examples:

Example 1. Annuity funded with unproductive

property. The taxpayer transfers corporation

stock worth $1,000,000 to a trust. The trust

provides for a 6 percent ($60,000 per year)

annuity in cash or other property to be paid to a

charitable organization for 25 years and for the

remainder to be distributed to the donor’s child.

The trust specifically authorizes, but does not

require, the trustee to retain the shares of stock.

The section 7520 interest rate for the month of

the transfer is 8.2 percent. The corporation has

paid no dividends on this stock during the past 5

years, and there is no indication that this policy

will change in the near future. Under applicable

state law, the corporation is considered to be a

sound investment that satisfies fiduciary standards. Therefore, the trust’s sole investment in

this corporation is not expected to adversely

affect the interest of either the annuitant or the

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remainder beneficiary. Considering the 6 percent

annuity payout rate and the 8.2 percent section

7520 interest rate, the trust corpus is considered

sufficient to pay this annuity for the entire 25year term of the trust, or even indefinitely.

Although it appears that neither beneficiary

would be able to compel the trustee to make the

trust corpus produce investment income, the

annuity interest in this case is considered to be

an ordinary annuity interest, and the standard

section 7520 annuity factor may be used to

determine the present value of the annuity. In

this case, the section 7520 annuity factor would

represent the right to receive $1.00 per year for a

term of 25 years.

Example 2. Terminal illness. The taxpayer

transfers property worth $1,000,000 to a charitable remainder unitrust described in section

664(d)(2) and § 1.664–3. The trust provides for a

fixed-percentage 7 percent unitrust benefit (each

annual payment is equal to 7 percent of the trust

assets as valued at the beginning of each year) to

be paid quarterly to an individual beneficiary for

life and for the remainder to be distributed to a

charitable organization. At the time the trust is

created, the individual beneficiary is age 60 and

has been diagnosed with an incurable illness and

there is at least a 50 percent probability of the

individual dying within 1 year. Assuming the

presumption in paragraph (b)(3) of this section

does not apply, because there is at least a 50

percent probability that this beneficiary will die

within 1 year, the standard section 7520 unitrust

remainder factor for a person age 60 from the

valuation tables may not be used to determine

the present value of the charitable remainder

interest. Instead, a special unitrust remainder

factor must be computed that is based on the

section 7520 interest rate and that takes into

account the projection of the individual beneficiary’s actual life expectancy.

(5) Additional limitations. Section

7520 does not apply to the extent as

may otherwise be provided by the

Commissioner.

with respect to transactions after December 13, 1995.

PART 20—ESTATE TAX; ESTATES

OF DECEDENTS DYING AFTER

AUGUST 16, 1954

Par. 3. The authority citation for part

20 continues to read in part as follows:

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

Par. 4. Section 20.7520–3 is

amended by revising paragraph (b) and

adding a sentence at the end of

paragraph (c) to read as follows:

§ 20.7520–3 Limitation on the

application of section 7520.

(b) Other limitations on the application of section 7520—(1) In general—

(i) Ordinary beneficial interests. For

purposes of this section:

(A) An ordinary annuity interest is

the right to receive a fixed dollar

amount at the end of each year during

one or more measuring lives or for

some other defined period. A standard

section 7520 annuity factor for an

ordinary annuity interest represents the

present worth of the right to receive

$1.00 per year for a defined period,

using the interest rate prescribed under

section 7520 for the appropriate month.

If an annuity interest is payable more

often than annually or is payable at the

beginning of each period, a special

adjustment must be made in any

computation with a standard section

7520 annuity factor.

(B) An ordinary income interest is

the right to receive the income from or

the use of property during one or more

measuring lives or for some other

defined period. A standard section 7520

income factor for an ordinary income

interest represents the present worth of

the right to receive the use of $1.00 for

a defined period, using the interest rate

prescribed under section 7520 for the

appropriate month.

an interest in property at the end of one

or more measuring lives or some other

defined period. A standard section 7520

remainder factor for an ordinary remainder or reversionary interest represents the present worth of the right to

receive $1.00 at the end of a defined

period, using the interest rate prescribed under section 7520 for the

appropriate month.

(ii) Certain restricted beneficial interests. A restricted beneficial interest

is an annuity, income, remainder, or

reversionary interest that is subject to

any contingency, power, or other

restriction, whether the restriction is

provided for by the terms of the trust,

will, or other governing instrument or

is caused by other circumstances. In

general, a standard section 7520 annuity, income, or remainder factor may

not be used to value a restricted

beneficial interest. However, a special

section 7520 annuity, income, or remainder factor may be used to value a

restricted beneficial interest under some

circumstances. See paragraphs (b)(2)(v)

Example 4 and (b)(4) Example 1 of this

section, which illustrate situations

where special section 7520 actuarial

factors are needed to take into account

limitations on beneficial interests. See

§ 20.7520–1(c) for requesting a special

factor from the Internal Revenue

Service.

(iii) Other beneficial interests. If,

under the provisions of this paragraph

(b), the interest rate and mortality

components prescribed under section

7520 are not applicable in determining

the value of any annuity, income,

remainder, or reversionary interest, the

actual fair market value of the interest

(determined without regard to section

7520) is based on all of the facts and

circumstances if and to the extent

permitted by the Internal Revenue

Code provision applicable to the property interest.

(2) Provisions of governing instrument and other limitations on source of

payment—(i) Annuities. A standard

section 7520 annuity factor may not be

used to determine the present value of

an annuity for a specified term of years

or the life of one or more individuals

unless the effect of the trust, will, or

other governing instrument is to ensure

that the annuity will be paid for the

entire defined period. In the case of an

annuity payable from a trust or other

limited fund, the annuity is not considered payable for the entire defined

period if, considering the applicable

section 7520 interest rate at the valuation date of the transfer, the annuity is

expected to exhaust the fund before the

last possible annuity payment is made

in full. For this purpose, it must be

assumed that it is possible for each

measuring life to survive until age 110.

For example, for a fixed annuity

payable annually at the end of each

year, if the amount of the annuity

payment (expressed as a percentage of

the initial corpus) is less than or equal

to the applicable section 7520 interest

rate at the date of the transfer, the

corpus is assumed to be sufficient to

make all payments. If the percentage

exceeds the applicable section 7520

interest rate and the annuity is for a

definite term of years, multiply the

annual annuity amount by the Table B

term certain annuity factor, as described in § 20.7520–1(c)(1), for the

number of years of the defined period.

If the percentage exceeds the applicable

section 7520 interest rate and the

annuity is payable for the life of one or

more individuals, multiply the annual

annuity amount by the Table B annuity

factor for 110 years minus the age of

the youngest individual. If the result

exceeds the limited fund, the annuity

may exhaust the fund, and it will be

necessary to calculate a special section

7520 annuity factor that takes into

account the exhaustion of the trust or

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fund. This computation would be modified, if appropriate, to take into account

annuities with different payment terms.

See § 25.7520–3(b)(2)(v) Example 5 of

this chapter, which provides an illustration involving an annuity trust that is

subject to exhaustion.

(ii) Income and similar interests—

(A) Beneficial enjoyment. A standard

section 7520 income factor for an

ordinary income interest may not be

used to determine the present value of

an income or similar interest in trust

for a term of years, or for the life of

one or more individuals, unless the

effect of the trust, will, or other

governing instrument is to provide the

income beneficiary with that degree of

beneficial enjoyment of the property

during the term of the income interest

that the principles of the law of trusts

accord to a person who is unqualifiedly

designated as the income beneficiary of

a trust for a similar period of time.

This degree of beneficial enjoyment is

provided only if it was the transferor’s

intent, as manifested by the provisions

of the governing instrument and the

surrounding circumstances, that the

trust provide an income interest for the

income beneficiary during the specified

period of time that is consistent with

the value of the trust corpus and with

its preservation. In determining whether

a trust arrangement evidences that

intention, the treatment required or

permitted with respect to individual

items must be considered in relation to

the entire system provided for in the

administration of the subject trust.

Similarly, in determining the present

value of the right to use tangible

property (whether or not in trust) for

one or more measuring lives or for

some other specified period of time, the

interest rate component prescribed under section 7520 and § 1.7520–1 of this

chapter may not be used unless, during

the specified period, the effect of the

trust, will or other governing instrument is to provide the beneficiary with

that degree of use, possession, and

enjoyment of the property during the

term of interest that applicable state

law accords to a person who is

unqualifiedly designated as a life tenant

or term holder for a similar period of

time.

(B) Diversions of income and

corpus. A standard section 7520 income factor for an ordinary income

interest may not be used to value an

income interest or similar interest in

property for a term of years, or for one

or more measuring lives, if—

(1) The trust, will, or other governing instrument requires or permits the

beneficiary’s income or other enjoyment to be withheld, diverted, or

accumulated for another person’s benefit without the consent of the income

beneficiary; or

(2) The governing instrument requires or permits trust corpus to be

withdrawn from the trust for another

person’s benefit without the consent of

the income beneficiary during the

income beneficiary’s term of enjoyment

and without accountability to the income beneficiary for such diversion.

(iii) Remainder and reversionary

interests. A standard section 7520

remainder interest factor for an ordinary remainder or reversionary interest

may not be used to determine the

present value of a remainder or reversionary interest (whether in trust or

otherwise) unless, consistent with the

preservation and protection that the law

of trusts would provide for a person

who is unqualifiedly designated as the

remainder beneficiary of a trust for a

similar duration, the effect of the

administrative and dispositive provisions for the interest or interests that

precede the remainder or reversionary

interest is to assure that the property

will be adequately preserved and protected (e.g., from erosion, invasion,

depletion, or damage) until the remainder or reversionary interest takes

effect in possession and enjoyment.

This degree of preservation and protection is provided only if it was the

transferor’s intent, as manifested by the

provisions of the arrangement and the

surrounding circumstances, that the

entire disposition provide the remainder

or reversionary beneficiary with an

undiminished interest in the property

transferred at the time of the termination of the prior interest.

(iv) Pooled income fund interests. In

general, pooled income funds are created and administered to achieve a

special rate of return. A beneficial

interest in a pooled income fund is not

ordinarily valued using a standard

section 7520 income or remainder

interest factor. The present value of a

beneficial interest in a pooled income

fund is determined according to rules

and special remainder factors prescribed in § 1.642(c)–6 of this chapter

and, when applicable, the rules set

forth under paragraph (b)(3) of this

section if the individual who is the

measuring life is terminally ill at the

time of the transfer.

(v) Examples. The provisions of this

paragraph (b)(2) are illustrated by the

following examples:

Example 1. Unproductive property. A died,

survived by B and C. B died two years after A.

A’s will provided for a bequest of corporation

stock in trust under the terms of which all of the

trust income was paid to B for life. After the

death of B, the trust terminated and the trust

property was distributed to C. The trust specifically authorized, but did not require, the trustee

to retain the shares of stock. The corporation

paid no dividends on this stock during the 5

years before A’s death and the 2 years before

B’s death. There was no indication that this

policy would change after A’s death. Under

applicable state law, the corporation is considered to be a sound investment that satisfies

fiduciary standards. The facts and circumstances,

including applicable state law, indicate that B did

not have the legal right to compel the trustee to

make the trust corpus productive in conformity

with the requirements for a lifetime trust income

interest under applicable local law. Therefore,

B’s life income interest in this case is considered

nonproductive. Consequently, B’s income interest

may not be valued actuarially under this section.

Example 2. Beneficiary’s right to make trust

productive. The facts are the same as in Example

1, except that the trustee is not specifically

authorized to retain the shares of stock. Further,

the terms of the trust specifically provide that B,

the life income beneficiary, may require the

trustee to make the trust corpus productive

consistent with income yield standards for trusts

under applicable state law. Under that law, the

minimum rate of income that a productive trust

may produce is substantially below the section

7520 interest rate for the month of A’s death. In

this case, because B has the right to compel the

trustee to make the trust productive for purposes

of applicable local law during the beneficiary’s

lifetime, the income interest is considered an

ordinary income interest for purposes of this

paragraph, and the standard section 7520 life

income interest factor may be used to determine

the present value of B’s income interest.

Example 3. Discretionary invasion of corpus.

The decedent, A, transferred property to a trust

under the terms of which all of the trust income

is to be paid to A’s child for life and the

remainder of the trust is to be distributed to a

grandchild. The trust authorizes the trustee

without restriction to distribute corpus to A’s

surviving spouse for the spouse’s comfort and

happiness. In this case, because the trustee’s

power to invade trust corpus is unrestricted, the

exercise of the power could result in the

termination of the income interest at any time.

Consequently, the income interest is not considered an ordinary income interest for purposes of

this paragraph, and may not be valued actuarially

under this section.

Example 4. Limited invasion of corpus. The

decedent, A, bequeathed property to a trust under

the terms of which all of the trust income is to

be paid to A’s child for life and the remainder is

to be distributed to A’s grandchild. The trust

authorizes the child to withdraw up to $5,000 per

year from the trust corpus. In this case, the

child’s power to invade trust corpus is limited to

an ascertainable amount each year. Annual

invasions of any amount would be expected to

progressively diminish the property from which

the child’s income is paid. Consequently, the

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income interest is not considered an ordinary

income interest for purposes of this paragraph,

and the standard section 7520 income interest

factor may not be used to determine the present

value of the income interest. Nevertheless, the

present value of the child’s income interest is

ascertainable by making a special actuarial

calculation that would take into account not only

the initial value of the trust corpus, the section

7520 interest rate for the month of the transfer,

and the mortality component for the child’s age,

but also the assumption that the trust corpus will

decline at the rate of $5,000 each year during the

child’s lifetime. The child’s right to receive an

amount not in excess of $5,000 per year may be

separately valued in this instance and, assuming

the trust corpus would not exhaust before the

child would attain age 110, would be considered

an ordinary annuity interest.

Example 5. Power to consume. The decedent,

A, devised a life estate in 3 parcels of real estate

to A’s surviving spouse with the remainder to a

child, or, if the child doesn’t survive, to the

child’s estate. A also conferred upon the spouse

an unrestricted power to consume the property,

which includes the right to sell part or all of the

property and to use the proceeds for the spouse’s

support, comfort, happiness, and other purposes.

Any portion of the property or its sale proceeds

remaining at the death of the surviving spouse is

to vest by operation of law in the child at that

time. The child predeceased the surviving

spouse. In this case, the surviving spouse’s

power to consume the corpus is unrestricted, and

the exercise of the power could entirely exhaust

the remainder interest during the life of the

spouse. Consequently, the remainder interest that

is includible in the child’s estate is not

considered an ordinary remainder interest for

purposes of this paragraph and may not be

valued actuarially under this section.

(3) Mortality component—(i) Terminal illness. Except as provided in

paragraph (b)(3)(ii) of this section, the

mortality component prescribed under

section 7520 may not be used to

determine the present value of an

annuity, income interest, remainder

interest, or reversionary interest if an

individual who is a measuring life is

terminally ill at the time of the

decedent’s death. For purposes of this

paragraph (b)(3), an individual who is

known to have an incurable illness or

other deteriorating physical condition is

considered terminally ill if there is at

least a 50 percent probability that the

individual will die within 1 year.

However, if the individual survives for

eighteen months or longer after the

date of the decedent’s death, that

individual shall be presumed to have

not been terminally ill at the date of

death unless the contrary is established

by clear and convincing evidence.

(ii) Terminal illness exceptions. In

the case of the allowance of the credit

for tax on a prior transfer under section

2013, if a final determination of the

federal estate tax liability of the transferor’s estate has been made under

circumstances that required valuation of

the life interest received by the transferee, the value of the property transferred, for purposes of the credit

allowable to the transferee’s estate,

shall be the value determined previously in the transferor’s estate. Otherwise, for purposes of section 2013, the

provisions of paragraph (b)(3)(i) of this

section shall govern in valuing the

property transferred. The value of a

decedent’s reversionary interest under

sections 2037(b) and 2042(2) shall be

determined without regard to the physical condition, immediately before the

decedent’s death, of the individual who

is the measuring life.

(iii) Death resulting from common

accidents. The mortality component

prescribed under section 7520 may not

be used to determine the present value

of an annuity, income interest, remainder interest, or reversionary interest if the decedent, and the individual

who is the measuring life, die as a

result of a common accident or other

occurrence.

(4) Examples. The provisions of

paragraph (b)(3) of this section are

illustrated by the following examples:

Example 1. Terminal illness. The decedent

bequeaths $1,000,000 to a trust under the terms

of which the trustee is to pay $103,000 per year

to a charitable organization during the life of the

decedent’s child. Upon the death of the child, the

remainder in the trust is to be distributed to the

decedent’s grandchild. The child, who is age 60,

has been diagnosed with an incurable illness, and

there is at least a 50 percent probability of the

child dying within 1 year. Assuming the

presumption provided for in paragraph (b)(3)(i)

of this section does not apply, the standard life

annuity factor for a person age 60 may not be

used to determine the present value of the

charitable organization’s annuity interest because

there is at least a 50 percent probability that the

child, who is the measuring life, will die within

1 year. Instead, a special section 7520 annuity

factor must be computed that takes into account

the projection of the child’s actual life

expectancy.

Example 2. Deaths resulting from common

accidents, etc. The decedent’s will establishes a

trust to pay income to the decedent’s surviving

spouse for life. The will provides that, upon the

spouse’s death or, if the spouse fails to survive

the decedent, upon the decedent’s death the trust

property is to pass to the decedent’s children.

The decedent and the decedent’s spouse die

simultaneously in an accident under circumstances in which it was impossible to determine

who survived the other. Even if the terms of the

will and applicable state law presume that the

decedent died first with the result that the

property interest is considered to have passed in

trust for the benefit of the spouse for life, after

which the remainder is to be distributed to the

decedent’s children, the spouse’s life income

interest may not be valued by use of the

mortality component described under section

7520. The result would be the same even if it

was established that the spouse survived the

decedent.

(5) Additional limitations. Section

7520 does not apply to the extent as

may otherwise be provided by the

Commissioner.

with respect to estates of decedents

dying after December 13, 1995.

PART 25—GIFT TAX; GIFTS

MADE AFTER DECEMBER 31,

1954

Par. 5. The authority citation for part

25 continues to read in part as follows:

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

Par. 6. In the list below, for each

section indicated in the left column,

remove the language in the middle

column and add the language in the

right column:

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Section

Remove

Add

25.2522(c)–3(c)(2)(i)

6th sentence

(e)(2)(ii), (iii), and (iv)

(c)(2)(ii), (iii), and (iv)

25.2522 (c)–3(c)(2)(vi)(a) 2nd

sentence

subdivision (v)

paragraph (c)(2)(vi)

25.2522 (c)–3(c)(2)(vii)(a) sentence

subdivision (vi)

paragraph (c)(2)(vii)

25.2522 (c)–3(d)(2) introductory text

subdivision (iv), (V), or (vi) of

paragraph (c)(2)

paragraph (c)(2)(v), (vi), or (vii)

25.2522 (c)–3(d)(2)(iv) 1st sentence

paragraph (c)(2)(v)

paragraph (c)(2)(vi)

25.2522 (c)–3(d)(2)(iv), Example (1)

1st sentence

paragraph (c)(2)(v)

paragraph (c)(2)(vi)

25.2522 (c)–3(d)(2)(iv), Example (2)

1st sentence

paragraph (c)(2)(v)

paragraph (c)(2)(vi)

25.2522 (c)–3(d)(2)(iv), Example (3)

1st sentence (in each place it

appears)

paragraph (c)(2)(v)

paragraph (c)(2)(vi)

25.2522 (c)–3(d)(2)(iv), Example (4)

last sentence

paragraph (c)(2)(V)(e)

paragraph (c)(2)(vi)(e)

25.2522(c)–3(d)(2)(v)

paragraph (c)(2)(vi)

paragraph (c)(2)(vii)

Par. 7. Section 25.7520–3 is

amended by revising paragraph (b) and

adding a sentence at the end of

paragraph (c) to read as follows:

interest represents the present worth of

the right to receive the use of $1.00 for

a defined period, using the interest rate

prescribed under section 7520 for the

appropriate month. However, in the

case of certain gifts made after October

8, 1990, if the donor does not retain a

qualified annuity, unitrust, or reversionary interest, the value of any interest

retained by the donor is considered to

be zero if the remainder beneficiary is

a member of the donor’s family. See

§ 25.2702–2.

an interest in property at the end of one

or more measuring lives or some other

defined period. A standard section 7520

remainder factor for an ordinary remainder or reversionary interest represents the present worth of the right to

receive $1.00 at the end of a defined

period, using the interest rate prescribed under section 7520 for the

appropriate month.

(ii) Certain restricted beneficial interests. A restricted beneficial interest

is an annuity, income, remainder, or

reversionary interest that is subject to

any contingency, power, or other

restriction, whether the restriction is

provided for by the terms of the trust,

will, or other governing instrument or

is caused by other circumstances. In

general, a standard section 7520 annuity, income, or remainder factor may

not be used to value a restricted

beneficial interest. However, a special

section 7520 annuity, income, or remainder factor may be used to value a

restricted beneficial interest under some

circumstances. See paragraphs (b)(2)(v)

Example 5 and (b)(4) of this section,

which illustrate situations in which

special section 7520 actuarial factors

are needed to take into account limitations on beneficial interests. See

§ 25.7520–1(c) for requesting a special

factor from the Internal Revenue

Service.

(iii) Other beneficial interests. If,

under the provisions of this paragraph

(b), the interest rate and mortality

components prescribed under section

7520 are not applicable in determining

the value of any annuity, income,

remainder, or reversionary interest, the

actual fair market value of the interest

(determined without regard to section

7520) is based on all of the facts and

circumstances if and to the extent

permitted by the Internal Revenue

Code provision applicable to the property interest.

(2) Provisions of governing instrument and other limitations on source of

payment—(i) Annuities. A standard

section 7520 annuity factor may not be

used to determine the present value of

an annuity for a specified term of years

or the life of one or more individuals

unless the effect of the trust, will, or

§ 25.7520–3 Limitation on the

application of section 7520.

(b) Other limitations on the application of section 7520— (1) In general—

(i) Ordinary beneficial interests. For

purposes of this section:

(A) An ordinary annuity interest is

the right to receive a fixed dollar

amount at the end of each year during

one or more measuring lives or for

some other defined period. A standard

section 7520 annuity factor for an

ordinary annuity interest represents the

present worth of the right to receive

$1.00 per year for a defined period,

using the interest rate prescribed under

section 7520 for the appropriate month.

If an annuity interest is payable more

often than annually or is payable at the

beginning of each period, a special

adjustment must be made in any

computation with a standard section

7520 annuity factor.

(B) An ordinary income interest is

the right to receive the income from or

the use of property during one or more

measuring lives or for some other

defined period. A standard section 7520

income factor for an ordinary income

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other governing instrument is to ensure

that the annuity will be paid for the

entire defined period. In the case of an

annuity payable from a trust or other

limited fund, the annuity is not considered payable for the entire defined

period if, considering the applicable

section 7520 interest rate on the

valuation date of the transfer, the

annuity is expected to exhaust the fund

before the last possible annuity payment is made in full. For this purpose,

it must be assumed that it is possible

for each measuring life to survive until

age 110. For example, for a fixed

annuity payable annually at the end of

each year, if the amount of the annuity

payment (expressed as a percentage of

the initial corpus) is less than or equal

to the applicable section 7520 interest

rate at the date of the transfer, the

corpus is assumed to be sufficient to

make all payments. If the percentage

exceeds the applicable section 7520

interest rate and the annuity is for a

definite term of years, multiply the

annual annuity amount by the Table B

term certain annuity factor, as described in § 25.7520–1(c)(1), for the

number of years of the defined period.

If the percentage exceeds the applicable

section 7520 interest rate and the

annuity is payable for the life of one or

more individuals, multiply the annual

annuity amount by the Table B annuity

factor for 110 years minus the age of

the youngest individual. If the result

exceeds the limited fund, the annuity

may exhaust the fund, and it will be

necessary to calculate a special section

7520 annuity factor that takes into

account the exhaustion of the trust or

fund. This computation would be modified, if appropriate, to take into account

annuities with different payment terms.

(ii) Income and similar interests—

(A) Beneficial enjoyment. A standard

section 7520 income factor for an

ordinary income interest is not to be

used to determine the present value of

an income or similar interest in trust

for a term of years or for the life of

one or more individuals unless the

effect of the trust, will, or other

governing instrument is to provide the

income beneficiary with that degree of

beneficial enjoyment of the property

during the term of the income interest

that the principles of the law of trusts

accord to a person who is unqualifiedly

designated as the income beneficiary of

a trust for a similar period of time.

This degree of beneficial enjoyment is

provided only if it was the transferor’s

intent, as manifested by the provisions

of the governing instrument and the

surrounding circumstances, that the

trust provide an income interest for the

income beneficiary during the specified

period of time that is consistent with

the value of the trust corpus and with

its preservation. In determining whether

a trust arrangement evidences that

intention, the treatment required or

permitted with respect to individual

items must be considered in relation to

the entire system provided for in the

administration of the subject trust.

Similarly, in determining the present

value of the right to use tangible

property (whether or not in trust) for

one or more measuring lives or for

some other specified period of time, the

interest rate component prescribed under section 7520 and § 1.7520–1 of this

chapter may not be used unless, during

the specified period, the effect of the

trust, will or other governing instrument is to provide the beneficiary with

that degree of use, possession, and

enjoyment of the property during the

term of interest that applicable state

law accords to a person who is unqualifiedly designated as a life tenant

or term holder for a similar period of

time.

(B) Diversions of income and

corpus. A standard section 7520 income factor for an ordinary income

interest may not be used to value an

income interest or similar interest in

property for a term of years, or for one

or more measuring lives, if—

(1) The trust, will, or other governing instrument requires or permits the

beneficiary’s income or other enjoyment to be withheld, diverted, or

accumulated for another person’s benefit without the consent of the income

beneficiary; or

(2) The governing instrument requires or permits trust corpus to be

withdrawn from the trust for another

person’s benefit without the consent of

the income beneficiary during the

income beneficiary’s term of enjoyment

and without accountability to the income beneficiary for such diversion.

(iii) Remainder and reversionary

interests. A standard section 7520

remainder interest factor for an ordinary remainder or reversionary interest

may not be used to determine the

present value of a remainder or reversionary interest (whether in trust or

otherwise) unless, consistent with the

preservation and protection that the law

of trusts would provide for a person

who is unqualifiedly designated as the

remainder beneficiary of a trust for a

similar duration, the effect of the

administrative and dispositive provisions for the interest or interests that

precede the remainder or reversionary

interest is to assure that the property

will be adequately preserved and protected (e.g., from erosion, invasion,

depletion, or damage) until the remainder or reversionary interest takes

effect in possession and enjoyment.

This degree of preservation and protection is provided only if it was the

transferor’s intent, as manifested by the

provisions of the arrangement and the

surrounding circumstances, that the

entire disposition provide the remainder

or reversionary beneficiary with an

undiminished interest in the property

transferred at the time of the termination of the prior interest.

(iv) Pooled income fund interests. In

general, pooled income funds are created and administered to achieve a

special rate of return. A beneficial

interest in a pooled income fund is not

ordinarily valued using a standard

section 7520 income or remainder

interest factor. The present value of a

beneficial interest in a pooled income

fund is determined according to rules

and special remainder factors prescribed in § 1.642(c)–6 of this chapter

and, when applicable, the rules set

forth under paragraph (b)(3) of this

section if the individual who is the

measuring life is terminally ill at the

time of the transfer.

(v) Examples. The provisions of this

paragraph (b)(2) are illustrated by the

following examples:

Example 1. Unproductive property. The donor

transfers corporation stock to a trust under the

terms of which all of the trust income is payable

to A for life. Considering the applicable federal

rate under section 7520 and the appropriate life

estate factor for a person A’s age, the value of

A’s income interest, if valued under this section,

would be $10,000. After A’s death, the trust is to

terminate and the trust property is to be

distributed to B. The trust specifically authorizes,

but does not require, the trustee to retain the

shares of stock. The corporation has paid no

dividends on this stock during the past 5 years,

and there is no indication that this policy will

change in the near future. Under applicable state

law, the corporation is considered to be a sound

investment that satisfies fiduciary standards. The

facts and circumstances, including applicable

state law, indicate that the income beneficiary

would not have the legal right to compel the

trustee to make the trust corpus productive in

conformity with the requirements for a lifetime

trust income interest under applicable local law.

Therefore, the life income interest in this case is

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considered nonproductive. Consequently, A’s

income interest may not be valued actuarially

under this section.

Example 2. Beneficiary’s right to make trust

productive. The facts are the same as in Example

1, except that the trustee is not specifically

authorized to retain the shares of corporation

stock. Further, the terms of the trust specifically

provide that the life income beneficiary may

require the trustee to make the trust corpus

productive consistent with income yield standards for trusts under applicable state law. Under

that law, the minimum rate of income that a

productive trust may produce is substantially

below the section 7520 interest rate on the

valuation date. In this case, because A, the

income beneficiary, has the right to compel the

trustee to make the trust productive for purposes

of applicable local law during A’s lifetime, the

income interest is considered an ordinary income

interest for purposes of this paragraph, and the

standard section 7520 life income factor may be

used to determine the value of A’s income

interest. However, in the case of gifts made after

October 8, 1990, if the donor was the life income

beneficiary, the value of the income interest

would be considered to be zero in this situation.

See § 25.2702–2.

Example 3. Annuity trust funded with unproductive property. The donor, who is age 60,

transfers corporation stock worth $1,000,000 to a

trust. The trust will pay a 6 percent ($60,000 per

year) annuity in cash or other property to the

donor for 10 years or until the donor’s prior

death. Upon the termination of the trust, the trust

property is to be distributed to the donor’s child.

The section 7520 rate for the month of the

transfer is 8.2 percent. The corporation has paid

no dividends on the stock during the past 5

years, and there is no indication that this policy

will change in the near future. Under applicable

state law, the corporation is considered to be a

sound investment that satisfies fiduciary standards. Therefore, the trust’s sole investment in

this corporation is not expected to adversely

affect the interest of either the annuity beneficiary or the remainder beneficiary. Considering the

6 percent annuity payout rate and the 8.2 percent

section 7520 interest rate, the trust corpus is

considered sufficient to pay this annuity for the

entire 10-year term of the trust, or even

indefinitely. The trust specifically authorizes, but

does not require, the trustee to retain the shares

of stock. Although it appears that neither

beneficiary would be able to compel the trustee

to make the trust corpus produce investment

income, the annuity interest in this case is

considered to be an ordinary annuity interest, and

a section 7520 annuity factor may be used to

determine the present value of the annuity. In

this case, the section 7520 annuity factor would

represent the right to receive $1.00 per year for a

term of 10 years or the prior death of a person

age 60.

Example 4. Unitrust funded with unproductive

property. The facts are the same as in Example

3, except that the donor has retained a unitrust

interest equal to 7 percent of the value of the

trust property, valued as of the beginning of each

year. Although the trust corpus is nonincomeproducing, the present value of the donor’s

retained unitrust interest may be determined by

using the section 7520 unitrust factor for a term

of years or a prior death.

Example 5. Eroding corpus in an annuity trust.

(i) The donor, who is age 60 and in normal

health, transfers property worth $1,000,000 to a

trust. The trust will pay a 10 percent ($100,000

per year) annuity to a charitable organization for

the life of the donor, payable annually, and the

remainder will be distributed to the donor’s

child. The section 7520 rate for the month of the

transfer is 6.8 percent. First, it is necessary to

determine whether the annuity may exhaust the

corpus before all annuity payments are made.

Because it is assumed that any measuring life

may survive until age 110, any life annuity could

require payments until the measuring life reaches

age 110. Based on a section 7520 interest rate of

6.8 percent, the determination of whether the

annuity may exhaust the corpus before the

annuity payments are made is computed as

follows:

Age to which life annuity may continue 110

less: Age of measuring life at date

of transfer . . . . . . . . . . . . . . . . . . . . . . . . .60

Number of years annuity may

continue . . . . . . . . . . . . . . . . . . . . . . . . .50

Annual annuity payment . . . . . . . .$100,000.00

times: Table B annuity factor for 50

years . . . . . . . . . . . . . . . . . . . . . . . . . . .14.1577

Present value of term certain

annuity . . . . . . . . . . . . . . . . . .$1,415,770.00

(ii) Since the present value of an annuity for a

term of 50 years exceeds the corpu

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