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Bulletin No. 1996–6

February 5, 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

Notice 96–9, page 26.

Guidelines are set forth for determining for January

1996, the weighted average interest rate and the

resulting permissible range of interest rates used to

calculate current liability for purposes of the full

funding limitation of section 412(c)(7) of the Code as

amended by the Omnibus Budget Reconciliation Act of

1987 and by the Uruguay Round Agreements Act

(GATT).

Rev. Rul. 96–14, page 20.

Federal rates; adjusted federal rates; adjusted federal

long-term rate, and the long-term exempt rate. For

purposes of sections 1274, 1288, 382, and other

sections of the Code, tables set forth the rates for

February 1996.

T.D. 8641, page 4.

Final regulations under sections 597 and 7507 of the

Code relating to the treatment of acquisition of certain

financial institutions and certain tax consequences of

Federal financial assistance to financial institutions.

ADMINISTRATIVE

Notice 96–5, page 22.

Estimated tax payments for individuals. The Service will

waive penalties for individuals who are residents of the

District of Columbia, Connecticut, Delaware, Kentucky,

Maine, Maryland, Massachusetts, New Hampshire, New

Jersey, New York, North Carolina, Pennsylvania, Rhode

Island, Vermont, Virginia, and West Virginia for the 4th

installment payment of estimated tax if that payment

was made on or before 1/22/96.

INTL–3–95, page 29.

Proposed regulations under section 863 of the Code

relating to the source of income from sales of inventory

and natural resources produced in one jurisdiction and

sold in another jurisdiction. A public hearing will be

held on April 16, 1996.

EMPLOYEE PLANS

Notice 96–7, page 22.

Capital expenditures. Public comment is invited on

approaches the Service should consider to address

issues raised under sections 162 and 263 of the Code

particularly in light of INDOPCO vs Commissioner, 503

U.S. 79 (1992).

Notice 96–8, page 23.

Determining amount of single sum distributions from cash

balance plans. This notice provides guidance concerning

the requirements of section 411(a) and 417(e) with

respect to the determination of the amount of a single

sum distribution from a cash balance plan. The notice

also describes proposed guidance to be issued later in

regulations that would provide a list of standard indices

and associated margins for use by cash balance plans

in determining the amount of interest credits.

DL–1–95, page 28.

Proposed regulations under section 6103 of the Code

relate to the disclosure of returns and return information in connection with the procurement of property and

services for tax administration purposes.

Finding Lists begin on page 45.

Announcement of Disbarments and Suspensions begin on page 42.

Monthly Index for January begins on page 47.

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

Section 42.—Low-Income Housing

Credit

The adjusted applicable federal short-term,

mid-term, and long-term rates are set forth for

the month of February 1996. See Rev. Rul. 96–

14, page 20.

Section 280G.—Golden Parachute

Payments

Federal short-term, mid-term, and long-term

rates are set forth for the month of February

1996. See Rev. Rul. 96–14, page 20.

Section 382.—Limitation on Net

Operating Loss Carryforwards and

Certain Built-In Losses Following

Ownership Change

The adjusted federal long-term rate is set forth

for the month of February 1996. See Rev. Rul.

96–14, page 20.

Section 412.—Minimum Funding

Standards

The adjusted applicable federal short-term,

mid-term, and long-term rates are set forth for

the month of February 1996. See Rev. Rul. 96–

14, page 20.

Section 467.—Certain Payments for

the Use of Property or Services

The adjusted applicable federal short-term,

mid-term, and long-term rates are set forth for

the month of February 1996. See Rev. Rul. 96–

14, page 20.

Section 468.—Special Rules for

Mining and Solid Waste Reclamation

and Closing Costs

The adjusted applicable federal short-term,

mid-term, and long-term rates are set forth for

the month of February 1996. See Rev. Rul. 96–

14, page 20.

Section 483.—Interest on Certain

Deferred Payments

Section 597.—Treatment of

Transactions in Which Federal

Financial Assistance Provided

26 CFR 1.597–1: Definitions

T.D. 8641

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 1, 301 and 602

Treatment of Acquisition of Certain

Financial Institutions; Certain Tax

Consequences of Federal Financial

Assistance to Financial Institutions

AGENCY: Internal Revenue Service

(IRS), Treasury.

ACTION: Final regulations.

SUMMARY: This document contains

final regulations relating to Federal

financial assistance, as defined in section 597(c) of the Internal Revenue

Code, that is received by a financially

troubled bank or thrift institution, and

to acquisitions of financially troubled

bank or thrift institutions in which

Federal financial assistance is provided.

This document also contains final

regulations under section 7507. These

regulations provide guidance concerning the proper tax treatment of various

transactions involving the receipt of

Federal financial assistance.

DATES: These regulations are effective

December 21, 1995.

For dates of applicability, see the

‘‘§1.597-7 Effective date’’ section under the ‘‘SUPPLEMENTARY INFORMATION’’ portion of the preamble and

the effective date provisions (§1.597–7)

of this document.

FOR FURTHER INFORMATION

CONTACT: Steven M. Flanagan at

202-622-7790, Vicki J. Hyche at

202-622-7530, William D. Alexander at

202-622-7710, or Steven R. Glickstein

at 202-622-4439 (not toll-free

numbers).

SUPPLEMENTARY INFORMATION:

The adjusted applicable federal short-term,

mid-term, and long-term rates are set forth for

the month of February 1996. See Rev. Rul. 96–

14, page 20.

Paperwork Reduction Act

The collections of information contained in these final regulations have

been reviewed and approved by the

Office of Management and Budget in

accordance with the Paperwork Reduction Act (44 U.S.C. 3507) under

control number 1545–1300. Responses

to these collections of information are

required to track deferred income and

its subsequent recapture, elect to disaffiliate earlier than would otherwise be

permitted, elect to apply the provisions

of the regulation retroactively, and

report uncollected income tax.

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.

The estimated annual burden per

respondent/recordkeeper varies from 1

hour to 11 hours, depending on individual circumstances, with an estimated

average of 4.4 hours.

Comments concerning the accuracy

of this burden estimate and suggestions

for reducing this burden should be sent

to the Internal Revenue Service, Attn:

IRS Reports Clearance Officer T:FP,

Washington, DC 20224, and to the

Office of Management and Budget,

Attn: Desk Officer for the Department

of the Treasury, Office of Information

and Regulatory Affairs, Washington,

DC 20503.

Books or records relating to these

collections of information must be

retained as long as their contents may

become material in the administration

of any internal revenue law. Generally,

tax returns and tax return information

are confidential, as required by 26

U.S.C. 6103.

Background

This document contains final regulations under section 597, as amended by

section 1401 of the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (Public Law 101–73)

(FIRREA). The regulations provide

guidance for banks and domestic building and loan associations (Institutions)

and their affiliates in connection with

receipt of Federal financial assistance

(FFA), as defined in section 597(c).

Section 597(a) delegates to the Secretary of the Treasury authority to

prescribe regulations concerning ‘‘any

transaction in which Federal financial

assistance is provided.’’ These regula-

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tions are issued under the authority of

section 597(a).

This document also amends the

regulations under section 7507 to reflect the treatment of FFA under

FIRREA.

The IRS published proposed regulations under sections 597 and 7507 on

April 22, 1992 (57 FR 14794, FI–46–

89, 1992–1 C.B. 1037).

Public Comments and the Final

Regulations

The IRS received comments on the

proposed regulations, and a public

hearing was held on July 17, 1992.

After consideration of the comments

and the statements made at the hearing,

the proposed regulations are adopted as

revised by this Treasury decision. The

principal comments and revisions are

discussed below.

§1.597–2 Taxation of FFA

Section 1.597–2 contains rules concerning accounting for FFA as income.

The final regulations retain the proposed rule that, generally, FFA is

income to the failed Institution when it

is received or accrued in accordance

with the Institution’s method of accounting. Section 1.597–2(c) contains

rules permitting certain Institutions to

defer the inclusion of FFA.

Deferral formula without Continuing

Equity. Under the proposed regulations,

unresolved Institutions without Continuing Equity were permitted to defer

inclusion of FFA in excess of amounts

determined under a formula. The proposed formula required current inclusion equal to the sum of liabilities less

aggregate adjusted basis at the beginning of the assistance year (representing losses already recognized), plus

loss in the current year (disregarding

FFA). The proposed formula generally

allowed the Institution the benefit of

any prior losses of its owners’ equity,

but offset any losses of creditors’

capital by the inclusion of FFA. However, with respect to losses during the

year FFA is received, the proposed

formula did not distinguish between

losses of owners’ equity and losses of

creditors’ capital and, therefore, offset

losses of owners’ equity by inclusion

of FFA. The formula (together with

related recapture rules) in the final

regulations has been changed to reflect

that the owners’ equity is the first

capital lost and, in a transaction without Continuing Equity, is not offset by

inclusion of FFA.

Deferral formula with Continuing

Equity. The proposed regulations allowed deferral under different conditions where Continuing Equity is present. In that case, the Institution must

include currently, in addition to the

normal formula amount, income equal

to all net operating loss carryovers

available to it. Also, an Institution with

Continuing Equity must recapture deferred FFA at least as quickly as pro

rata over a maximum of six years,

regardless of whether it recognizes all

of its built-in losses during that time.

Commentators suggested that the

proposed regulations unfairly limited

deferral for Institutions with Continuing

Equity and recommended the same deferral formula apply in all cases. They

criticized the Continuing Equity concept because it focused on the identity

of the Institution’s shareholders after

the assistance transaction.

Under the definition of Continuing

Equity in the proposed regulations, an

Institution generally would have Continuing Equity if five percent or more

of its stock at the end of a taxable year

was owned by shareholders who owned

stock before the Institution was placed

in receivership by a supervisory agency

(Agency) or first received FFA. The

five percent reference was misleading

because, under §1.597–5, a 50 percent

change in ownership generally results

in a deemed Taxable Transfer (now

defined in §1.597–5(a)(1)) in which the

failed Institution is treated as a New

Entity. The deferral rules do not apply

after a deemed Taxable Transfer. The

final regulations thus clarify that Continuing Equity exists only if the Institution is not (i) a Bridge Bank, (ii) in

Agency receivership, or (iii) treated as

a New Entity. The modification to the

definition of Continuing Equity is not

intended as a substantive change. The

Continuing Equity deferral provisions

apply only to the limited number of

‘‘open bank’’ resolutions not subject to

the deemed Taxable Transfer rules. (As

discussed below, the Taxable Transfer

definitions have also been modified to

clarify that most ‘‘open bank’’ assisted

transactions are treated as Taxable

Transfers.)

The final regulations do not eliminate the special treatment of Institutions with Continuing Equity. The

regulations provide deferral rules to

ameliorate a timing mismatch between

FFA income and related losses. Deferral is not designed to allow built-in

losses to offset operating income instead of FFA or to permit the permanent elimination of any subsidy

provided by Agency. The requirement

that Institutions with Continuing Equity

recapture their deferred FFA within six

years is a reasonable safeguard against

indefinite deferral of FFA income. The

results under these rules are comparable in effect to those applicable to

acquirors in Taxable Transfers.

The final regulations do, however,

modify the Continuing Equity formula,

which, in the proposed regulations,

counted some losses twice. Recognized

losses represented in the first prong of

the formula (liabilities minus asset

bases) may comprise part of the third

prong (net operating losses available to

the Institution or its consolidated

group). The final regulations correct

this double counting of losses.

Transfers of money and property to

Agency. The proposed regulations contained rules for taxing FFA if money or

property is also transferred to Agency.

These rules, together with rules for the

treatment of FFA received pursuant to

a Loss Guarantee, have been clarified,

reorganized, and restated in §1.597–

2(d).

The proposed regulations provided

an offset or deduction for payments by

an Institution to Agency to the extent

of previously received FFA. The rule

as proposed provided limited relief for

payments made to Agency by a New

Entity or Acquiring, because they receive little or no FFA. However, an

assisted acquisition can result in income to a New Entity or Acquiring in

the form of built-in gain. Under section

597(c) and §1.597–3(b), an instrument

issued to Agency by a New Entity or

Acquiring is, in effect, disregarded. If a

New Entity or Acquiring issues its

instrument to Agency in connection

with the acquisition of an Institution,

the value of the instrument is not

included in the purchase price. Consequently, a New Entity or Acquiring

may have a basis shortfall in the assets

acquired (or deemed acquired) from the

failed Institution. The final regulations

provide a New Entity or Acquiring a

purchase price adjustment upon any

transfer to Agency (e.g., in satisfaction

of the disregarded instrument).

In response to comments, the final

regulations also specifically provide for

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repayments to Agency by Institution

affiliates. Moreover, the final regulations provide that if Agency sells an

Institution’s instrument to a third party,

the sales price is treated as a repayment

to Agency by the issuer. Furthermore,

the instrument is treated as having been

newly issued by the issuer to the holder

at that time. The IRS and Treasury

believe that this is an appropriate time

for the issuer to offset FFA or increase

its basis, because the sales price

reasonably fixes the value of the

instrument, and any subsequent cost

associated with the instrument should

be accounted for in accordance with

the nature of the instrument.

§1.597–4(g) Elective disaffiliation

The proposed regulations would allow a consolidated group to elect (after

the regulations became final) to exclude an Institution in receivership

from its group. The election potentially

requires the inclusion of a ‘‘toll

charge’’ in the income of those members owning the common stock of the

Institution (the member shareholders).

The amount of the toll charge is the

excess of the disaffiliated Institution’s

liabilities over the adjusted basis of its

assets. The toll charge is intended to

reflect the amount that would be

included in income if Agency were to

provide the entire amount of FFA

necessary to restore the Institution’s

solvency at the time of the event

permitting disaffiliation. Commentators

suggested that the final regulations

should include the toll charge in the

income of the disaffiliated Institution

(rather than its member shareholders),

provide the group with a ‘‘toll charge

deduction,’’ and clarify the ability of

the member shareholders to take a

worthless stock deduction.

Toll charge. Commentators suggested that the final regulations include

the toll charge in the income of the

failed Institution rather than its member

shareholders. According to the commentators, including the toll charge in

the income of the member shareholders

may result in disadvantageous state tax

consequences in those states where

banking corporations are not permitted

to file consolidated returns with nonbanking corporations. Under the proposed regulations, a bank holding corporation (the disaffiliated Institution’s

shareholder) would have to include in

income the toll charge without the

benefit of the Institution’s offsetting

losses.

The IRS and Treasury agree that the

toll charge is more appropriately included in the income of the Institution

(i.e., the entity that is reimbursed by

Agency for its loss), because the toll

charge represents accelerated FFA income. Thus, the final regulations

provide that the Institution, rather than

its member shareholders, takes the toll

charge into income.

Toll charge deduction. Under the

proposed regulations, the Institution

does not recognize built-in losses on

disaffiliation. One commentator suggested the final regulations provide for

a ‘‘toll charge deduction’’ for the

excess of the Institution’s adjusted

basis over its liabilities. According to

the commentator, such a deduction is

appropriate because the Institution incurred economic loss while it was a

member of the consolidated group,

before the Institution was placed in

receivership by Agency.

The commentator’s recommendation

is not adopted in the final regulations

because a toll charge deduction would

accelerate recognition of losses in

advance of realization. Such a deduction is particularly inappropriate because federal banking laws now permit

placing solvent institutions in receivership. In such cases, it is uncertain

whether the loss represented by such a

deduction will ever be realized.

Worthless stock deduction. Under the

proposed regulations, if an election to

disaffiliate is made, the members of the

consolidated group are treated as having disposed of their stock in the

Institution. One commentator suggested

that the final regulations clarify that,

upon disaffiliation, the Institution’s

stock is worthless.

The final regulations address the

commentator’s concerns by providing

that, as a consequence of the election,

the members of the consolidated group

treat their stock in the Institution as

worthless if the Institution is factually

insolvent on the date the Institution is

placed in receivership (or on the date

the consolidated group is deemed to

make the election to disaffiliate). This

rule preempts otherwise applicable tests

for worthlessness under section 165

and §1.1502–19. Any worthless stock

deduction is subject to the limitations

of the loss disallowance regulations

(§§1.337(d)–1 and 1.1502–20).

Consistency rule. Under the proposed

regulations, a consolidated group could

elect to disaffiliate a subsidiary Institu-

tion only if the Institution was its first

subsidiary placed in Agency receivership after the enactment of FIRREA.

The election made for the first subsidiary bound all future subsidiaries placed

in Agency receivership. To address the

concern that the scope of the proposed

consistency rule was too broad, the

final regulations modify the consistency

rule to require, generally, that a consolidated group must elect consistently

only for subsidiary Institutions placed

in Agency receivership within five

years of each other.

§1.597–5 Taxable Transfers

Section 597 applies to FFA and

transactions in connection with which

FFA is provided. The proposed regulations generally define a Taxable Transfer as a transfer of deposit liabilities or

stock while an Institution is under

Agency Control. However, IRS and

Treasury now understand that it is

possible for Agency to resolve an

Institution under its control without

providing assistance, or to provide

assistance without placing an Institution

under its control. In light of this

information, the final regulations refine

the definition of a Taxable Transfer.

Under the final regulations, Taxable

Transfers include the transfer of any

deposit liability in connection with

which FFA is provided or the transfer

of any asset for which Agency has an

obligation (e.g., assets covered by Loss

Guarantees). Certain transfers of stock

cause a Taxable Transfer if FFA is

provided in connection with the transfer, if the Institution is a Bridge Bank

or if the Institution has a balance in its

deferred FFA account. The phrase ‘‘in

connection with’’ should be interpreted

broadly. If any party to a transaction

receives FFA, all parties and all related

transactions are within the scope of

these regulations. To provide certainty

regarding tax treatment for purchasers

of stock of subsidiaries of Institutions

under Agency Control, the final regulations treat all transactions in which

such a subsidiary leaves its group as

Taxable Transfers.

§1.597–6 Limitation on collection of

income tax

Limitation where tax is borne by

Agency. The proposed regulations

provided that income tax attributable to

the receipt of FFA or gain on a

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Taxable Transfer would not be collected from an Institution without Continuing Equity if Agency would bear

the burden of the tax. Commentators

suggested that the limitation on noncollection in cases of Continuing

Equity is inappropriate because it requires Agency to gross-up any assistance paid to cover the tax thereon.

The final regulations retain the limitation on noncollection in cases of

Continuing Equity. The IRS and Treasury believe that the limitation is

appropriate for transactions in which

Agency assists an Institution while

allowing old shareholders to retain their

ownership. Noncollection should not

inure to the benefit of the Institution’s

old shareholders, who would have use

of the Institution’s losses while escaping responsibility for the tax on related

FFA income. The congressional purpose in FIRREA to eliminate any tax

subsidy for assisted transactions requires that the IRS not waive its rights

as a creditor in cases where all other

creditors and equity holders retain their

rights.

Transferee liability. The proposed

regulations limited the collection of a

failed Institution’s income taxes from a

transferee in a Taxable Transfer (i.e., a

New Entity or Acquiring). This rule

would not apply if (similar to the

Continuing Equity rule discussed above

under the heading ‘‘Deferral formula

with Continuing Equity’’) there is a

five percent overlap in the ownership

of the transferor Institution and the

New Entity or Acquiring.

Commentators suggested that the

final regulations should not include the

five percent overlap exception because

the exception appears to punish former

owners of Institutions, Institutions have

difficulty tracking ownership, and the

exception contains no limits on aggregation.

Because good faith purchasers of

assets for value generally do not have

transferee liability, the final regulations

clarify that Acquiring (the purchaser of

Institution’s assets in an actual Taxable

Transfer) is not subject to such liability

in any case. This rule applies even if

shareholders of Acquiring were shareholders of the selling Institution.

The final regulations do not, however, except a New Entity (the resulting

corporation in a deemed Taxable

Transfer) from collection if the Institution’s previous equity interests remain

outstanding in the New Entity, or are

reacquired or exchanged for consideration. As in those cases in which a

Taxable Transfer does not occur, the

IRS should remain a creditor if all

other creditors retain their interests and

the Institution’s previous equity interests had retained value. However, by

focusing on whether previous equity

interests retain value, the final regulations eliminate the need to track or

aggregate ownership and do not penalize any particular potential acquirors.

§1.597–7 Effective Date

As proposed, these final regulations

generally apply to taxable years ending

on or after April 22, 1992. However,

the provisions of these regulations do

not apply to FFA received or accrued

for taxable years ending after April 22,

1992, in connection with an Agency

assisted acquisition that occurs before

April 22, 1992. Taxpayers not subject

to these regulations must comply with

an interpretation of the statute that is

reasonable in light of the legislative

history and applicable administrative

pronouncements. For this purpose, the

rules contained in Notice 89–102

(1989–2 C.B. 436) apply to the extent

provided in the Notice.

An irrevocable election is available

to apply the regulations to taxable

years prior to the general effective

date. However, the election cannot be

made if the Institution’s statute of

limitations has expired or a section 338

election was available but not made for

the Institution. In addition, consistent

treatment is required in ‘‘open bank’’

resolutions that would result under the

regulations in deemed Taxable Transfers before April 22, 1992.

The proposed regulations required an

electing taxpayer to extend the statute

of limitations for all items for three

years from the date of filing the

election. The final regulations adopt a

commentator’s suggestion that the taxpayer extend the statute of limitations

only for items affected by application

of the regulations.

An Institution or consolidated group

makes the election on its first annual

income tax return filed on or after

March 15, 1996. However, to make the

affirmative election to disaffiliate under

§1.597–4(g)(5) for an Institution placed

in Agency receivership in a taxable

year ending before April 22, 1992, a

consolidated group must send the affected Institution the required statement

advising it of the elective disaffiliation

on or before May 31, 1996. In that

case, the consolidated group is deemed

to have elected retroactive application

of these regulations but must nevertheless attach the required statement to its

first annual income tax return filed on

or after March 15, 1996.

The final regulations provide that

taxpayers may rely on the provisions of

the proposed regulations to the extent

they acted in reliance on the proposed

regulations prior to December 21,

1995. Such reliance must be reasonable

and transactions with respect to which

such taxpayers rely must be consistent

with the overriding policies of section

597, as expressed in the legislative

history, as well as the overriding

policies of the proposed regulations.

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 is hereby

certified that these regulations do not

have a significant economic impact on

a substantial number of small entities.

This certification is based on the fact

that these regulations will generally

only apply to certain financially troubled financial institutions and the consolidated groups, if any, to which they

belong. Therefore, a Regulatory Flexibility Analysis under the Regulatory

Flexibility Act (5 U.S.C. chapter 6) is

not required. Pursuant to section

7805(f) of the Internal Revenue Code,

the notice of proposed rulemaking

preceding these regulations was submitted to the Chief Counsel for Advocacy

of the Small Business Administration

for comment on its impact on small

business.

Drafting Information

The principal author of these regulations is Steven M. Flanagan, Office of

the Assistant Chief Counsel (Corporate), 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, 301

and 602 are amended as follows:

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PART 1—INCOME TAXES

Paragraph 1. The authority for part 1

is amended by adding the following

citation:

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

Sections 1.597–1 through 1.597–7 also

issued under 26 U.S.C. 597 and 1502.

Par. 2. Sections 1.597–1 through

1.597–7 are added to read as follows:

§1.597–1 Definitions.

For purposes of the regulations under

section 597—

(a) Unless the context otherwise requires, the terms consolidated group,

member and subsidiary have the meanings provided in §1.1502–1; and

(b) The following terms have the

meanings provided below—

Acquiring. The term Acquiring

means a corporation that is a transferee

in a Taxable Transfer, other than a

deemed transferee in a Taxable Transfer described in §1.597–5(b).

Agency. The term Agency means the

Resolution Trust Corporation, the Federal Deposit Insurance Corporation, any

similar instrumentality of the United

States government, and any predecessor

or successor of the foregoing (including

the Federal Savings and Loan Insurance Corporation).

Agency Control. An Institution or

entity is under Agency Control if

Agency is conservator or receiver of

the Institution or entity, or if Agency

has the right to appoint any of the

Institution’s or entity’s directors.

Agency Obligation. The term Agency

Obligation means a debt instrument

that Agency issues to an Institution or

to a direct or indirect owner of an

Institution.

Bridge Bank. The term Bridge Bank

means an Institution that is organized

by Agency to hold assets and liabilities

of another Institution and that continues

the operation of the other Institution’s

business pending its acquisition or

liquidation, and that is any of the

following—

(1) A national bank chartered by the

Comptroller of the Currency under section 11(n) of the Federal Deposit Insurance Act (12 U.S.C. 1821(n)) or section 21A(b)(10)(A) of the Federal Home

Loan Bank Act (12 U.S.C. 1441a(b)(10)(A)) or any successor sections;

(2) A Federal savings association

chartered by the Director of the Office

of Thrift Supervision under section

21A(b)(10)(A) of the Federal Home

Loan Bank Act (12 U.S.C. 1441a(b)(10)(A)) or any successor section; or

(3) A similar Institution chartered

under any other statutory provisions.

Consolidated Subsidiary. The term

Consolidated Subsidiary means a member of the consolidated group of which

an Institution is a member that bears

the same relationship to the Institution

that the members of a consolidated

group bear to their common parent

under section 1504(a)(1).

Continuing Equity. An Institution has

Continuing Equity for any taxable year

if, on the last day of the taxable year,

the Institution is not (1) a Bridge Bank,

(2) in Agency receivership, or (3)

treated as a New Entity.

Controlled Entity. The term Controlled Entity means an entity under

Agency Control.

Federal Financial Assistance (FFA).

The term Federal Financial Assistance

(FFA), as defined by section 597(c),

means any money or property provided

by Agency to an Institution or to a

direct or indirect owner of stock in an

Institution under section 406(f) of the

National Housing Act (12 U.S.C.

1729(f)), section 21A(b)(4) of the

Federal Home Loan Bank Act (12

U.S.C. 1441a(b)(4)), section 11(f) or

13(c) of the Federal Deposit Insurance

Act (12 U.S.C. 1821(f), 1823(c)), or

under any similar provision of law.

Any such money or property is FFA,

regardless of whether the Institution or

any of its affiliates issues Agency a

note or other obligation, stock, warrants, or other rights to acquire stock in

connection with Agency’s provision of

the money or property. FFA includes

Net Worth Assistance, Loss Guarantee

payments, yield maintenance payments,

cost to carry or cost of funds reimbursement payments, expense reimbursement or indemnity payments, and

interest (including original issue discount) on an Agency Obligation.

Institution. The term Institution

means an entity that is, or immediately

before being placed under Agency

Control was, a bank or domestic

building and loan association within the

meaning of section 597 (including a

Bridge Bank). Except as otherwise

provided in the regulations under section 597, the term Institution includes a

New Entity or Acquiring that is a bank

or domestic building and loan association within the meaning of section 597.

Loss Guarantee. The term Loss

Guarantee means an agreement pursuant to which Agency or a Controlled

Entity guarantees or agrees to pay an

Institution a specified amount upon the

disposition or charge-off (in whole or

in part) of specific assets, an agreement

pursuant to which an Institution has a

right to put assets to Agency or a

Controlled Entity at a specified price,

or a similar arrangement.

Net Worth Assistance. The term Net

Worth Assistance means money or

property (including an Agency Obligation to the extent it has a fixed

principal amount) that Agency provides

as an integral part of a Taxable

Transfer, other than FFA that accrues

after the date of the Taxable Transfer.

For example, Net Worth Assistance

does not include Loss Guarantee payments, yield maintenance payments,

cost to carry or cost of funds reimbursement payments, or expense reimbursement or indemnity payments. An

Agency Obligation is considered to

have a fixed principal amount notwithstanding an agreement providing for its

adjustment after issuance to reflect a

more accurate determination of the

condition of the Institution at the time

of the acquisition.

New Entity. The term New Entity

means the new corporation that is

treated as purchasing all of the assets

of an Old Entity in a Taxable Transfer

described in §1.597–5(b).

Old Entity. The term Old Entity

means the Institution or Consolidated

Subsidiary that is treated as selling all

of its assets in a Taxable Transfer

described in §1.597–5(b).

Residual Entity. The term Residual

Entity means the entity that remains

after an Institution transfers deposit

liabilities to a Bridge Bank.

Taxable Transfer. The term Taxable

Transfer has the meaning provided in

§1.597–5(a)(1).

§1.597–2 Taxation of Federal

Financial Assistance.

(a) Inclusion in income—(1) In general. Except as otherwise provided in

the regulations under section 597, all

FFA is includible as ordinary income

to the recipient at the time the FFA is

received or accrued in accordance with

the recipient’s method of accounting.

The amount of FFA received or accrued is the amount of any money, the

fair market value of any property (other

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than an Agency Obligation), and the

issue price of any Agency Obligation

(determined under §1.597–3(c)(2)). An

Institution (and not the nominal recipient) is treated as receiving directly any

FFA that Agency provides in a taxable

year to a direct or indirect shareholder

of the Institution, to the extent money

or property is transferred to the Institution pursuant to an agreement with

Agency.

(2) Cross references. See paragraph

the timing of inclusion of certain FFA.

See paragraph (d) of this section for

additional rules regarding the treatment

of FFA received in connection with

transfers of money or property to

Agency or a Controlled Entity, or paid

pursuant to a Loss Guarantee. See

§1.597–5(c)(1) for additional rules regarding the inclusion of Net Worth

Assistance in the income of an

Institution.

(b) Basis of property that is FFA. If

FFA consists of property, the Institution’s basis in the property equals the

fair market value of the property (other

than an Agency Obligation) or the

issue price of the Agency Obligation,

as determined under §1.597–3(c)(2).

FFA—(1) Scope. This paragraph (c)

limits the amount of FFA an Institution

must include in income currently under

certain circumstances and provides

rules for the deferred inclusion in

income of amounts in excess of those

limits. This paragraph (c) does not

apply to a New Entity or Acquiring.

(2) Amount currently included in

income by an Institution without Continuing Equity. The amount of FFA an

Institution without Continuing Equity

must include in income in a taxable

year under paragraph (a)(1) of this

section is limited to the sum of—

(i) The excess at the beginning of

the taxable year of the Institution’s

liabilities over the adjusted bases of the

Institution’s assets; and

(ii) The amount by which the excess

for the taxable year of the Institution’s

deductions allowed by chapter 1 of the

Internal Revenue Code (other than net

operating and capital loss carryovers)

over its gross income (determined

without regard to FFA) is greater than

the excess at the beginning of the

taxable year of the adjusted bases of

the Institution’s assets over the Institution’s liabilities.

(3) Amount currently included in

income by an Institution with Continu-

ing Equity. The amount of FFA an

Institution with Continuing Equity must

include in income in a taxable year

under paragraph (a)(1) of this section is

limited to the sum of—

(i) The excess at the beginning of

the taxable year of the Institution’s

liabilities over the adjusted bases of the

Institution’s assets;

(ii) The greater of—

(A) The excess for the taxable year

of the Institution’s deductions allowed

by chapter 1 of the Internal Revenue

Code (other than net operating and

capital loss carryovers) over its gross

income (determined without regard to

FFA); or

(B) The excess for the taxable year

of the deductions allowed by chapter 1

of the Internal Revenue Code (other

than net operating and capital loss

carryovers) of the consolidated group

of which the Institution is a member on

the last day of the Institution’s taxable

year over the group’s gross income

(determined without regard to FFA);

and

(iii) The excess of the amount of

any net operating loss carryover of the

Institution (or in the case of a carryover from a consolidated return year

of the Institution’s current consolidated

group, the net operating loss carryover

of the group) to the taxable year over

the amount described in paragraph

(c)(3)(i) of this section.

(4) Deferred FFA—(i) Maintenance

of account. An Institution must

establish a deferred FFA account commencing in the first taxable year in

which it receives FFA that is not

currently included in income under

paragraph (c)(2) or (c)(3) of this

section, and must maintain that account

in accordance with the requirements of

this paragraph (c)(4). The Institution

must add the amount of any FFA that

is not currently included in income

under paragraph (c)(2) or (c)(3) of this

section to its deferred FFA account.

The Institution must decrease the balance of its deferred FFA account by the

amount of deferred FFA included in

income under paragraphs (c)(4)(ii), (iv)

and (v) of this section. (See also

paragraph (d)(5)(i)(B) of this section

for other adjustments that decrease the

deferred FFA account.) If, under paragraph (c)(3) of this section, FFA is not

currently included in income in a

taxable year, the Institution thereafter

must maintain its deferred FFA account

on a FIFO (first in, first out) basis

(e.g., for purposes of the first sentence

of paragraph (c)(4)(iv) of this section).

(ii) Deferred FFA recapture. In any

taxable year in which an Institution has

a balance in its deferred FFA account,

it must include in income an amount

equal to the lesser of the amount

described in paragraph (c)(4)(iii) of this

section or the balance in its deferred

FFA account.

(iii) Annual recapture amount—(A)

Institutions without Continuing

Equity—(1) In general. In the case of

an Institution without Continuing

Equity, the amount described in this

paragraph (c)(4)(iii) is the amount by

which—

(i) The excess for the taxable year of

the Institution’s deductions allowed by

chapter 1 of the Internal Revenue Code

(other than net operating and capital

loss carryovers) over its gross income

(taking into account FFA included in

income under paragraph (c)(2) of this

section); is greater than

(ii) The Institution’s remaining

equity as of the beginning of the

taxable year.

(2) Remaining equity. The Institution’s remaining equity is—

(i) The amount at the beginning of

the taxable year in which the deferred

FFA account was established equal to

the adjusted bases of the Institution’s

assets minus the Institution’s liabilities

(which amount may be positive or

negative); plus

(ii) The Institution’s taxable income

(computed without regard to any carryover from any other year) in any

subsequent taxable year or years; minus

(iii) The excess in any subsequent

taxable year or years of the Institution’s deductions allowed by chapter 1

of the Internal Revenue Code (other

than net operating and capital loss

carryovers) over its gross income.

(B) Institutions with Continuing

Equity. In the case of an Institution

with Continuing Equity, the amount

described in this paragraph (c)(4)(iii) is

the amount by which the Institution’s

deductions allowed by chapter 1 of the

Internal Revenue Code (other than net

operating and capital loss carryovers)

exceed its gross income (taking into

account FFA included in income under

paragraph (c)(3) of this section).

(iv) Additional deferred FFA recapture by an Institution with Continuing

Equity. To the extent that, as of the end

of a taxable year, the cumulative

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amount of FFA deferred under paragraph (c)(3) of this section that an

Institution with Continuing Equity has

recaptured under this paragraph (c)(4)

is less than the cumulative amount of

FFA deferred under paragraph (c)(3) of

this section that the Institution would

have recaptured if that FFA had been

included in income ratably over the six

taxable years immediately following

the taxable year of deferral, the Institution must include that difference in

income for the taxable year. An Institution with Continuing Equity must include in income the balance of its

deferred FFA account in the taxable

year in which it liquidates, ceases to do

business, transfers (other than to a

Bridge Bank) substantially all of its

assets and liabilities, or is deemed to

transfer all of its assets under §1.597–

5(b).

(v) Optional accelerated recapture

of deferred FFA. An Institution that has

a deferred FFA account may include in

income the balance of its deferred FFA

account on its timely filed (including

extensions) original income tax return

for any taxable year that it is not under

Agency Control. The balance of its

deferred FFA account is income on the

last day of that year.

(5) Exceptions to limitations on use

of losses. In computing an Institution’s

taxable income or alternative minimum

taxable income for a taxable year,

sections 56(d)(1), 382 and 383 and

§§1.1502–15, 1.1502–21 and 1.1502–

22 do not limit the use of the attributes

of the Institution to the extent, if any,

that the inclusion of FFA (including

recaptured FFA) in income results in

taxable income or alternative minimum

taxable income (determined without

regard to this paragraph (c)(5)) for the

taxable year. This paragraph (c)(5)

does not apply to any limitation under

section 382 or 383 or §1.1502–15,

1.1502–21 or 1.1502–22 that arose in

connection with or prior to a corporation becoming a Consolidated Subsidiary of the Institution.

(6) Operating rules—(i) Bad debt

reserves. For purposes of paragraphs

(c)(2), (c)(3) and (c)(4) of this section,

the adjusted bases of an Institution’s

assets are reduced by the amount of the

Institution’s reserves for bad debts

under section 585 or 593, other than

supplemental reserves under section

593.

(ii) Aggregation of Consolidated

Subsidiaries. For purposes of this para-

graph (c), an Institution is treated as a

single entity that includes the income,

expenses, assets, liabilities, and attributes of its Consolidated Subsidiaries, with appropriate adjustments to

prevent duplication.

(iii) Alternative minimum tax. To

compute the alternative minimum taxable income attributable to FFA of an

Institution for any taxable year under

section 55, the rules of this section, and

related rules, are applied by using

alternative minimum tax basis, deductions, and all other items required to be

taken into account. All other alternative

minimum tax provisions continue to

apply.

(7) Earnings and profits. FFA that is

not currently included in income under

this paragraph (c) is included in earnings and profits for all purposes of the

Internal Revenue Code to the extent

and at the time it is included in income

under this paragraph (c).

(d) Transfers of money or property

to Agency, and property subject to a

Loss Guarantee—(1) Transfers of

property to Agency. The transfer of

property to Agency or a Controlled

Entity is a taxable sale or exchange in

which the Institution is treated as

realizing an amount equal to—

(i) The property’s fair market value;

(ii) For property subject to a Loss

Guarantee, the greater of the property’s

fair market value or the guaranteed

value or price at which the property

can be put at the time of transfer.

(2) FFA with respect to property

covered by a Loss Guarantee other

than on transfer to Agency. (i) FFA

provided pursuant to a Loss Guarantee

with respect to covered property is

included in the amount realized with

respect to the property to the extent the

total amount realized does not exceed

the greater of—

(A) The property’s fair market

value; or

(B) The guaranteed value or price at

which the property can be put at the

time of transfer.

(ii) For the purposes of this paragraph (d)(2), references to an amount

realized include amounts obtained in

whole or partial satisfaction of loans,

amounts obtained by virtue of charging

off or marking to market covered

property, and other amounts similarly

related to property, whether or not

disposed of.

(3) Treatment of FFA received in

exchange for property. FFA included in

the amount realized for property under

this paragraph (d) is not includible in

income under paragraph (a)(1) of this

section. The amount realized is treated

in the same manner as if realized from

a person other than Agency or a Controlled Entity. For example, gain attributable to FFA received with respect

to a capital asset retains its character as

capital gain. Similarly, FFA received

with respect to property that has been

charged off for income tax purposes is

treated as a recovery to the extent of

the amount previously charged off. Any

FFA provided in excess of the amount

realized under this paragraph (d) is

includible in income under paragraph

(a)(1) of this section.

(4) Adjustment to FFA—(i) In general. If an Institution pays or transfers

money or property to Agency or a Controlled Entity, the amount of money

and fair market value of the property is

an adjustment to its FFA to the extent

the amount paid and transferred exceeds the amount of money and fair

market value of property Agency or a

Controlled Entity provides in exchange.

(ii) Deposit insurance. This paragraph (d)(4) does not apply to amounts

paid to Agency with respect to deposit

insurance.

(iii) Treatment of an interest held by

Agency or a Controlled Entity—(A) In

general. For purposes of this paragraph

(d), an interest described in §1.597–

3(b) is not treated as property when

transferred by the issuer to Agency or a

Controlled Entity nor when acquired

from Agency or a Controlled Entity by

the issuer.

(B) Dispositions to persons other

than issuer. On the date Agency or a

Controlled Entity transfers an interest

described in §1.597–3(b) to a holder

other than the issuer, Agency or a

Controlled Entity, the issuer is treated

for purposes of this paragraph (d)(4) as

having transferred to Agency an

amount of money equal to the sum of

the amount of money and the fair

market value of property that was paid

by the new holder as consideration for

the interest.

(iv) Consolidated groups. For purposes of this paragraph (d), an Institution will be treated as having made any

transfer to Agency or a Controlled

Entity that was made by any other

member of its consolidated group. The

consolidated group must make appro-

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priate investment basis adjustments to

the extent the member transferring

money or other property is not the

member that received FFA.

(5) Manner of making adjustments to

FFA—(i) Reduction of FFA and deferred FFA. An Institution adjusts its

FFA under paragraph (d)(4) of this

section by reducing in the following

order and in an aggregate amount not

greater than the adjustment—

(A) The amount of any FFA that is

otherwise includible in income for the

taxable year (before application of

paragraph (c) of this section); and

(B) The balance (but not below

zero) in the deferred FFA account, if

any, maintained under paragraph (c)(4)

of this section.

(ii) Deduction of excess amounts. If

the amount of the adjustment exceeds

the sum of the amounts described in

paragraph (d)(5)(i) of this section, the

Institution may deduct the excess to the

extent the deduction does not exceed

the amount of FFA included in income

for prior taxable years reduced by the

amount of deductions allowable under

this paragraph (d)(5)(ii) in prior taxable

years.

(iii) Additional adjustments. Any adjustment to FFA in excess of the sum

of the amounts described in paragraphs

(d)(5)(i) and (ii) of this section is

treated—

(A) By an Institution other than a

New Entity or Acquiring, as a deduction of the amount in excess of FFA

received that is required to be transferred to Agency under section 11(g) of

the Federal Deposit Insurance Act (12

U.S.C. 1821(g)); or

(B) By a New Entity or Acquiring,

as an adjustment to the purchase price

paid in the Taxable Transfer (see

§1.338(b)–3T).

(e) Examples. The following examples illustrate the provisions of this

section:

justed basis of its assets ($100 million) at the

beginning of the taxable year. Pursuant to

§1.597–2(c)(4)(i), M must establish a deferred

FFA account for the remaining $10 million.

(ii) If Agency instead lends M the $30

million, M’s indebtedness to Agency is disregarded and the results are the same as in

paragraph (i) of this Example 1. Section 597(c);

§§1.597–1(b) (defining FFA) and 1.597–3(b).

Example 2. Transfer of property to Agency. (i)

Institution M, a calendar year taxpayer without

Continuing Equity because it is in Agency

receivership, is not a member of a consolidated

group and has not been acquired in a Taxable

Transfer. At the beginning of 1998, M’s

remaining equity is $0 and M has a deferred

FFA account of $10 million. Agency does not

provide any FFA to M in 1998. During the year,

M transfers property not covered by a Loss

Guarantee to Agency and does not receive any

consideration. The property has an adjusted basis

of $5 million and a fair market value of $1

million at the time of the transfer. M has no

other taxable income or loss in 1998.

(ii) Under §1.597–2(d)(1), M is treated as

selling the property for $1 million, its fair market

value, thus recognizing a $4 million loss ($5

million – $1 million). In addition, because M did

not receive any consideration from Agency,

under §1.597–2(d)(4) M has an adjustment to

FFA of $1 million, the amount by which the fair

market value of the transferred property ($1

million) exceeds the consideration M received

from Agency ($0). Because no FFA is provided

to M in 1998, this adjustment reduces the

balance of M’s deferred FFA account to $9

million ($10 million – $1 million). Section

1.597–2(d)(5)(i)(B). Because M’s $4 million loss

causes M’s deductions to exceed its gross

income by $4 million in 1998 and M has no

remaining equity, under §1.597–2(c)(4)(iii)(A) M

must include $4 million of deferred FFA in

income, and must decrease the remaining $9

million balance of its deferred FFA account by

the same amount, leaving a balance of $5

million.

Example 3. Loss Guarantee. Institution Q, a

calendar year taxpayer, sells an asset covered by

a Loss Guarantee to an unrelated third party for

$4,000. Q’s adjusted basis in the asset at the

time of sale and the asset’s guaranteed value are

both $10,000. Pursuant to the Loss Guarantee,

Agency pays Q $6,000 ($10,000 – $4,000). Q’s

amount realized from the sale of the asset is

$10,000 ($4,000 from the third party and $6,000

from Agency). Section 1.597–2(d)(2). Q realizes

no gain or loss on the sale ($10,000 – $10,000 =

$0), and therefore includes none of the $6,000 of

FFA it receives pursuant to the Loss Guarantee

in income. Section 1.597–2(d)(3).

Example 1. Timing of inclusion of FFA in

income. (i) Institution M, a calendar year

taxpayer without Continuing Equity because it is

in Agency receivership, is not a member of a

consolidated group and has not been acquired in

a Taxable Transfer. On January 1, 1997, M has

assets with a total adjusted basis of $100 million

and total liabilities of $120 million. M’s

deductions do not exceed its gross income

(determined without regard to FFA) for 1997.

Agency provides $30 million of FFA to M in

1997. The amount of this FFA that M must

include in income in 1997 is limited by §1.597–

2(c)(2) to $20 million, the amount by which M’s

liabilities ($120 million) exceed the total ad-

(a) Ownership of assets. For all

income tax purposes, an Institution is

treated as the owner of all assets

covered by a Loss Guarantee, yield

maintenance agreement, or cost to carry

or cost of funds reimbursement agreement, regardless of whether Agency (or

a Controlled Entity) otherwise would

be treated as the owner under general

principles of income taxation.

(b) Debt and equity interests received by Agency. Debt instruments,

§1.597–3 Other rules.

stock, warrants, or other rights to

acquire stock of an Institution (or any

of its affiliates) that Agency or a

Controlled Entity receives in connection with a transaction in which FFA is

provided are not treated as debt, stock

or other equity interests of or in the

issuer for any purpose of the Internal

Revenue Code while held by Agency

or a Controlled Entity. On the date

Agency or a Controlled Entity transfers

an interest described in this paragraph

(b) to a holder other than Agency or a

Controlled Entity, the interest is treated

as having been newly issued by the

issuer to the holder with an issue price

equal to the sum of the amount of

money and the fair market value of

property paid by the new holder in

exchange for the interest.

this paragraph (c), the original issue

discount rules of sections 1271 et seq.

apply to Agency Obligations.

(2) Issue price of Agency Obligations provided as Net Worth Assistance.

The issue price of an Agency Obligation that is provided as Net Worth

Assistance and that bears interest at

either a single fixed rate or a qualified

floating rate (and provides for no

contingent payments) is the lesser of

the sum of the present values of all

payments due under the obligation,

discounted at a rate equal to the

applicable federal rate (within the

meaning of section 1274(d)(1) and (3))

in effect for the date of issuance, or the

stated principal amount of the obligation. The issue price of an Agency

Obligation that bears a qualified floating rate of interest (within the meaning

of §1.1275–5(b)) is determined by

treating the obligation as bearing a

fixed rate of interest equal to the rate

in effect on the date of issuance under

the obligation.

(3) Adjustments to principal amount.

Except as provided in §1.597–5(d)(2)(iv), this paragraph (c)(3) applies if

Agency modifies or exchanges an

Agency Obligation provided as Net

Worth Assistance (or a successor obligation). The issue price of the modified

or new Agency Obligation is determined under paragraphs (c)(1) and (2)

of this section. If the issue price is

greater than the adjusted issue price of

the existing Agency Obligation, the

difference is treated as FFA. If the

issue price is less than the adjusted

issue price of the existing Agency

Obligation, the difference is treated as

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an adjustment to FFA under §1.597–

2(d)(4).

(d) Successors. To the extent necessary to effectuate the purposes of the

regulations under section 597, an entity’s treatment under the regulations

applies to its successor. A successor

includes a transferee in a transaction to

which section 381(a) applies or a

Bridge Bank to which another Bridge

Bank transfers deposit liabilities.

(e) Loss disallowance. For purposes

of §1.1502–20, FFA and the amount

described in §1.597–4(g)(3) are treated

as an extraordinary gain disposition

within the meaning of §1.1502–20(c)(2)(i) and a Taxable Transfer is treated

as an applicable asset acquisition under

section 1060(c) within the meaning of

§1.1502–20(c)(2)(i)(A)(4).

(f) Losses and deductions with respect to covered assets. Prior to the

disposition of an asset covered by a

Loss Guarantee, the asset cannot be

charged off, marked to a market value,

depreciated, amortized, or otherwise

treated in a manner that supposes an

actual or possible diminution of value

below the greater of the asset’s highest

guaranteed value or the highest price at

which the asset can be put.

(g) Anti-abuse rule. The regulations

under section 597 must be applied in a

manner consistent with the purposes of

section 597. Accordingly, if, in structuring or engaging in any transaction, a

principal purpose is to achieve a tax

result that is inconsistent with the

purposes of section 597 and the regulations thereunder, the Commissioner can

make appropriate adjustments to income, deductions and other items that

would be consistent with those

purposes.

§1.597–4 Bridge Banks and Agency

Control.

(a) Scope. This section provides

rules that apply to a Bridge Bank or

other Institution under Agency Control

and to transactions in which an Institution transfers deposit liabilities

(whether or not the Institution also

transfers assets) to a Bridge Bank.

(b) Status as taxpayer. A Bridge

Bank or other Institution under Agency

Control is a corporation within the

meaning of section 7701(a)(3) for all

purposes of the Internal Revenue Code

and is subject to all Internal Revenue

Code provisions that generally apply to

corporations, including those relating to

methods of accounting and to requirements for filing returns, even if Agency

owns stock of the Institution.

change. The imposition of Agency

Control, the cancellation of Institution

stock by Agency, a transaction in

which an Institution transfers deposit

liabilities to a Bridge Bank, and an

election under paragraph (g) of this

section are disregarded in determining

whether an ownership change has

occurred within the meaning of section

382(g).

(d) Transfers to Bridge Banks—(1)

In general. Except as otherwise

provided in paragraph (g) of this

section, the rules of this paragraph (d)

apply to transfers to Bridge Banks. In

general, a Bridge Bank and its associated Residual Entity are together

treated as the successor entity to the

transferring Institution. If an Institution

transfers deposit liabilities to a Bridge

Bank (whether or not it also transfers

assets), the Institution recognizes no

gain or loss on the transfer and the

Bridge Bank succeeds to the transferring Institution’s basis in any transferred assets. The associated Residual

Entity retains its basis in any assets it

continues to hold. Immediately after

the transfer, the Bridge Bank succeeds

to and takes into account the transferring Institution’s items described in

section 381(c) (subject to the conditions and limitations specified in section 381(c)), taxpayer identification

number (‘‘TIN’’), deferred FFA account, and account receivable for future

FFA as described in paragraph (g)(4)(ii) of this section. The Bridge Bank

also succeeds to and continues the

transferring Institution’s taxable year.

(2) Transfers to a Bridge Bank from

multiple Institutions. If two or more

Institutions transfer deposit liabilities to

the same Bridge Bank, the rules in

paragraph (d)(1) of this section are

modified to the extent provided in this

paragraph (d)(2). The Bridge Bank

succeeds to the TIN and continues the

taxable year of the Institution that

transfers the largest amount of deposits.

The taxable years of the other transferring Institutions close at the time of the

transfer. If all the transferor Institutions

are members of the same consolidated

group, the Bridge Bank’s carryback of

losses to the Institution that transfers

the largest amount of deposits is not

limited by section 381(b)(3). The limitations of section 381(b)(3) do apply

to the Bridge Bank’s carrybacks of

losses to all other transferor Institutions. If the transferor Institutions are

not all members of the same consolidated group, the limitations of section

381(b)(3) apply with respect to all

transferor Institutions. See paragraph

(g)(6)(ii) of this section for additional

rules that apply if two or more Institutions that are not members of the

same consolidated group transfer deposit liabilities to the same Bridge

Bank.

(e) Treatment of Bridge Bank and

Residual Entity as a single entity. A

Bridge Bank and its associated Residual Entity or Entities are treated as a

single entity for income tax purposes

and must file a single combined income

tax return. The Bridge Bank is responsible for filing all income tax returns

and statements for this single entity and

is the agent of each associated Residual

Entity to the same extent as if the

Bridge Bank were the common parent

of a consolidated group including the

Residual Entity. The term Institution

includes a Residual Entity that files a

combined return with its associated

Bridge Bank.

(f) Rules applicable to members of

consolidated groups—(1) Status as

members. Unless an election is made

under paragraph (g) of this section,

Agency Control of an Institution does

not terminate the Institution’s membership in a consolidated group. Stock of a

subsidiary that is canceled by Agency

is treated as held by the members of

the consolidated group that held the

stock prior to its cancellation. If an

Institution is a member of a consolidated group immediately before it

transfers deposit liabilities to a Bridge

Bank, the Bridge Bank succeeds to the

Institution’s status as the common

parent or, unless an election is made

under paragraph (g) of this section, as a

subsidiary of the group. If a Bridge

Bank succeeds to an Institution’s status

as a subsidiary, its stock is treated as

held by the shareholders of the transferring Institution, and the stock basis

or excess loss account of the Institution

carries over to the Bridge Bank. A

Bridge Bank is treated as owning stock

owned by its associated Residual Entities, including for purposes of determining membership in an affiliated

group.

(2) No 30-day election to be excluded from consolidated group. Neither an Institution nor any of its

Consolidated Subsidiaries may be excluded from a consolidated group for a

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taxable year under §1.1502–

76(b)(5)(ii), as contained in 26 CFR

part 1 edition revised April 1, 1994, if

the Institution is under Agency Control

at any time during the year.

(3) Coordination with consolidated

return regulations. The provisions of

the regulations under section 597 take

precedence over conflicting provisions

in the regulations under section 1502.

(g) Elective disaffiliation—(1) In

general. A consolidated group of which

an Institution is a subsidiary may elect

irrevocably not to include the Institution in its affiliated group if the

Institution is placed in Agency receivership (whether or not assets or

deposit liabilities of the Institution are

transferred to a Bridge Bank). See

paragraph (g)(6) of this section for

circumstances under which a consolidated group is deemed to make this

election.

(2) Consequences of election. If the

election under this paragraph (g) is

made with respect to an Institution, the

following consequences occur immediately before the subsidiary Institution

to which the election applies is placed

in Agency receivership (or, in the case

of a deemed election under paragraph

(g)(6) of this section, immediately

before the consolidated group is

deemed to make the election) and in

the following order—

(i) All adjustments of the Institution

and its Consolidated Subsidiaries under

section 481 are accelerated;

(ii) Deferred intercompany gains and

losses with respect to the Institution

and its Consolidated Subsidiaries are

taken into account and the Institution

and its Consolidated Subsidiaries take

into account any other items required

under the regulations under section

1502 for members that become nonmembers within the meaning of

§1.1502–32(d)(4);

(iii) The taxable year of the Institution and its Consolidated Subsidiaries

closes and the Institution includes the

amount described in paragraph (g)(3)

of this section in income as ordinary

income as its last item for that taxable

year;

(iv) The members of the consolidated group owning the common stock

of the Institution include in income any

excess loss account with respect to the

Institution’s stock under §1.1502-19

and any other items required under the

regulations under section 1502 for

members that own stock of corpora-

tions that become nonmembers within

the meaning of §1.1502–32(d)(4); and

(v) If the Institution’s liabilities exceed the aggregate fair market value of

its assets on the date the Institution is

placed in Agency receivership (or, in

the case of a deemed election under

paragraph (g)(6) of this section, on the

date the consolidated group is deemed

to make the election), the members of

the consolidated group treat their stock

in the Institution as worthless. (See

§§1.337(d)–1 and 1.1502–20 for potential limitations on the group’s worthless

stock deduction.) In all other cases, the

consolidated group will be treated as

owning stock of a nonmember corporation until such stock is disposed of or

becomes worthless under rules otherwise applicable.

(3) Toll charge. The amount described in this paragraph (g)(3) is the

excess of the Institution’s liabilities

over the adjusted bases of its assets

immediately before the Institution is

placed in Agency receivership (or, in

the case of a deemed election under

paragraph (g)(6) of this section, immediately before the consolidated group is

deemed to make the election). In

computing this amount, the adjusted

bases of an Institution’s assets are

reduced by the amount of the Institution’s reserves for bad debts under

section 585 or 593, other than supplemental reserves under section 593. For

purposes of this paragraph (g)(3), an

Institution is treated as a single entity

that includes the assets and liabilities of

its Consolidated Subsidiaries, with appropriate adjustments to prevent duplication. The amount described in this

paragraph (g)(3) for alternative minimum tax purposes is determined using

alternative minimum tax basis, deductions, and all other items required to be

taken into account. In computing the

increase in the group’s taxable income

or alternative minimum taxable income,

sections 56(d)(1), 382 and 383 and

§§1.1502–15, 1.1502–21 and 1.1502–

22 do not limit the use of the attributes

of the Institution and its Consolidated

Subsidiaries to the extent, if any, that

the inclusion of the amount described

in this paragraph (g)(3) in income

would result in the group having

taxable income or alternative minimum

taxable income (determined without

regard to this sentence) for the taxable

year. The preceding sentence does not

apply to any limitation under section

382 or 383 or §§1.1502–15, 1.1502–21,

or 1.1502–22 that arose in connection

with or prior to a corporation becoming

a Consolidated Subsidiary of the

Institution.

(4) Treatment of Institutions after

disaffiliation—(i) In general. If the

election under this paragraph (g) is

made with respect to an Institution,

immediately after the Institution is

placed in Agency receivership (or, in

the case of a deemed election under

paragraph (g)(6) of this section, immediately after the consolidated group is

deemed to make the election), the

Institution and each of its Consolidated

Subsidiaries are treated for income tax

purposes as new corporations that are

not members of the electing group’s

affiliated group. Each new corporation

retains the TIN of the corresponding

disaffiliated corporation and is treated

as having received the assets and

liabilities of the corresponding disaffiliated corporation in a transaction to

which section 351 applies (and in

which no gain was recognized under

section 357(c) or otherwise). Thus, the

new corporation has no net operating

or capital loss carryforwards. An election under this paragraph (g) does not

terminate the single entity treatment of

a Bridge Bank and its Residual Entities

provided in paragraph (e) of this

section.

(ii) FFA. A new Institution is treated

as having a non-interest bearing, nontransferable account receivable for future FFA with a basis equal to the

amount described in paragraph (g)(3)

of this section. If a disaffiliated Institution has a deferred FFA account at the

time of its disaffiliation, the corresponding new Institution succeeds to

and takes into account that deferred

FFA account.

(iii) Filing of consolidated returns.

If a disaffiliated Institution has Consolidated Subsidiaries at the time of its

disaffiliation, the corresponding new

Institution is required to file a consolidated income tax return with the subsidiaries in accordance with the regulations under section 1502.

(iv) Status as Institution. If an Institution is disaffiliated under this paragraph (g), the resulting new corporation

is treated as an Institution for purposes

of the regulations under section 597

regardless of whether it is a bank or

domestic building and loan association

within the meaning of section 597.

(v) Loss carrybacks. To the extent a

carryback of losses would result in a

refund being paid to a fiduciary under

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section 6402(i), an Institution or Consolidated Subsidiary with respect to

which an election under this paragraph

(g) (other than under paragraph (g)(6)(ii) of this section) applies is allowed

to carry back losses as if the Institution

or Consolidated Subsidiary had continued to be a member of the consolidated group that made the election.

(5) Affirmative election—(i) Original

Institution—(A) Manner of making

election. Except as otherwise provided

in paragraph (g)(6) of this section, a

consolidated group makes the election

provided by this paragraph (g) by

sending a written statement by certified

mail to the affected Institution on or

before the later of 120 days after its

placement in Agency receivership or

May 31, 1996. The statement must contain the following legend at the top of

the page: ‘‘THIS IS AN ELECTION

UNDER §1.597–4(g) TO EXCLUDE

THE BELOW-REFERENCED INSTITUTION AND CONSOLIDATED

SUBSIDIARIES FROM THE AFFILIATED GROUP,’’ and must include the

names and taxpayer identification numbers of the common parent and of the

Institution and Consolidated Subsidiaries to which the election applies, and

the date on which the Institution was

placed in Agency receivership. The

consolidated group must send a similar

statement to all subsidiary Institutions

placed in Agency receivership during

the consistency period described in

paragraph (g)(5)(ii) of this section.

(Failure to satisfy the requirement in

the preceding sentence, however, does

not invalidate the election with respect

to any subsidiary Institution placed in

Agency receivership during the consistency period described in paragraph

(g)(5)(ii) of this section.) The consolidated group must include a copy of any

election statement and accompanying

certified mail receipt as part of its first

income tax return filed after the due

date under this paragraph (g)(5) for

such statement. A statement must be

attached to this return indicating that

the individual who signed the election

was authorized to do so on behalf of

the consolidated group. Agency cannot

make this election under the authority

of section 6402(i) or otherwise.

(B) Consistency limitation on affirmative elections. A consolidated group

may make an affirmative election under

this paragraph (g)(5) with respect to a

subsidiary Institution placed in Agency

receivership only if the group made, or

is deemed to have made, the election

under this paragraph (g) with respect to

every subsidiary Institution of the

group placed in Agency receivership on

or after May 10, 1989 and within five

years preceding the date the subject

Institution was placed in Agency

receivership.

(ii) Effect on Institutions placed in

receivership simultaneously or subsequently. An election under this paragraph (g), other than under paragraph

(g)(6)(ii) of this section, applies to the

Institution with respect to which the

election is made or deemed made (the

original Institution) and each subsidiary

Institution of the group placed in

Agency receivership or deconsolidated

in contemplation of Agency Control or

the receipt of FFA simultaneously with

the original Institution or within five

years thereafter.

(6) Deemed Election—(i) Deconsolidations in contemplation. If one or

more members of a consolidated group

deconsolidate (within the meaning of

§1.1502-19(c)(1)(ii)(B)) a subsidiary

Institution in contemplation of Agency

Control or the receipt of FFA, the

consolidated group is deemed to make

the election described in this paragraph

(g) with respect to the Institution on

the date the deconsolidation occurs. A

subsidiary Institution is conclusively

presumed to have been deconsolidated

in contemplation of Agency Control or

the receipt of FFA if either event

occurs within six months after the

deconsolidation.

(ii) Transfers to a Bridge Bank from

multiple groups. On the day an Institution’s transfer of deposit liabilities to a

Bridge Bank results in the Bridge Bank

holding deposit liabilities from both a

subsidiary Institution and an Institution

not included in the subsidiary Institution’s consolidated group, each consolidated group of which a transferring

Institution or the Bridge Bank is a

subsidiary is deemed to make the election described in this paragraph (g)

with respect to its subsidiary Institution. If deposit liabilities of another

Institution that is a subsidiary member

of any consolidated group subsequently

are transferred to the Bridge Bank, the

consolidated group of which the Institution is a subsidiary is deemed to

make the election described in this

paragraph (g) with respect to that

Institution at the time of the subsequent

transfer.

(h) Examples. The following examples illustrate the provisions of this

section:

Facts. Corporation X, the common parent of a

consolidated group, owns all the stock (with a

basis of $4 million) of Institution M, an

insolvent Institution with no Consolidated Subsidiaries. At the close of business on April 30,

1996, M has $4 million of deposit liabilities, $1

million of other liabilities, and assets with an

adjusted basis of $4 million and a fair market

value of $3 million.

Example 1. Effect of receivership on consolidation. On May 1, 1996, Agency places M in

receivership and begins liquidating M. X does

not make an election under §1.597–4(g). M

remains a member of the X consolidated group

after May 1, 1996. Section 1.597–4(f)(1).

Example 2. Effect of Bridge Bank on

consolidation—(i) Additional facts. On May 1,

1996, Agency places M in receivership and

causes M to transfer all of its assets and deposit

liabilities to Bridge Bank MB.

(ii) Consequences without an election to disaffiliate. M recognizes no gain or loss from the

transfer and MB succeeds to M’s basis in the

transferred assets, M’s items described in section

381(c) (subject to the conditions and limitations

specified in section 381(c)) and TIN. Section

1.597–4(d)(1). (If M had a deferred FFA

account, MB would also succeed to that account.

Section 1.597–4(d)(1).) MB continues M’s taxable year and succeeds to M’s status as a

member of the X consolidated group after May

1, 1996. Section 1.597–4(d)(1) and (f). MB and

M are treated as a single entity for income tax

purposes. Section 1.597–4(e).

(iii) Consequences with an election to disaffiliate. If, on July 1, 1996, X makes an election

under §1.597–4(g) with respect to M, the

following consequences are treated as occurring

immediately before M was placed in Agency

receivership. M must include $1 million ($5

million of liabilities — $4 million of adjusted

basis) in income as of May 1, 1996. Section

1.597–4(g)(2) and (3). M is then treated as a new

corporation that is not a member of the X

consolidated group and that has assets (including

a $1 million account receivable for future FFA)

with a basis of $5 million and $5 million of

liabilities received from disaffiliated corporation

M in a section 351 transaction. New corporation

M retains the TIN of disaffiliated corporation M.

Section 1.597–4(g)(4). Immediately after the

disaffiliation, new corporation M is treated as

transferring its assets and deposit liabilities to

Bridge Bank MB. New corporation M recognizes

no gain or loss from the transfer and MB

succeeds to M’s TIN and taxable year. Section

1.597–4(d)(1). Bridge Bank MB is treated as a

single entity that includes M and has $5 million

of liabilities, an account receivable for future

FFA with a basis of $1 million, and other assets

with a basis of $4 million. Section 1.597–4(d)(1).

§1.597–5 Taxable Transfers.

(a) Taxable Transfers—(1) Defined.

The term Taxable Transfer means—

(i) A transaction in which an entity

transfers to a transferee other than a

Bridge Bank—

(A) Any deposit liability (whether or

not the Institution also transfers assets),

if FFA is provided in connection with

the transaction; or

(B) Any asset for which Agency or

a Controlled Entity has any financial

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obligation (e.g., pursuant to a Loss

Guarantee or Agency Obligation); or

(ii) A deemed transfer of assets

described in paragraph (b) of this

section.

(2) Scope. This section provides

rules governing Taxable Transfers.

Rules applicable to both actual and

deemed asset acquisitions are provided

in paragraphs (c) and (d) of this

section. Special rules applicable only to

deemed asset acquisitions are provided

in paragraph (e) of this section.

(b) Deemed asset acquisitions upon

stock purchase—(1) In general. In a

deemed transfer of assets under this

paragraph (b), an Institution (including

a Bridge Bank or a Residual Entity) or

a Consolidated Subsidiary of the Institution (the Old Entity) is treated as

selling all of its assets in a single

transaction and is treated as a new

corporation (the New Entity) that purchases all of the Old Entity’s assets at

the close of the day immediately

preceding the occurrence of an event

described in paragraph (b)(2) of this

section. However, such an event results

in a deemed transfer of assets under

this paragraph (b) only if it occurs—

(i) In connection with a transaction

in which FFA is provided;

(ii) While the Old Entity is a Bridge

Bank;

(iii) While the Old Entity has a

positive balance in a deferred FFA

account (see §1.597–2(c)(4)(v) regarding the optional accelerated recapture

of deferred FFA); or

(iv) With respect to a Consolidated

Subsidiary, while the Institution of

which it is a Consolidated Subsidiary is

under Agency Control.

(2) Events. A deemed transfer of

assets under this paragraph (b) results

if the Old Entity—

(i) Becomes a non-member within

the meaning of §1.1502–32(d)(4) of its

consolidated group (other than pursuant

to an election under §1.597–4(g));

(ii) Becomes a member of an affiliated group of which it was not

previously a member (other than pursuant to an election under §1.597–

4(g)); or

(iii) Issues stock such that the stock

that was outstanding before the imposition of Agency Control or the occurrence of any transaction in connection

with the provision of FFA represents

50 percent or less of the vote or value

of its outstanding stock (disregarding

stock described in section 1504(a)(4)

and stock owned by Agency or a

Controlled Entity).

(3) Bridge Banks and Residual Entities. If a Bridge Bank is treated as

selling all of its assets to a New Entity

under this paragraph (b), each associated Residual Entity is treated as

simultaneously selling its assets to a

New Entity in a Taxable Transfer

described in this paragraph (b).

FFA in connection with a Taxable

Transfer. A transferor in a Taxable

Transfer is treated as having directly

received immediately before a Taxable

Transfer any Net Worth Assistance that

Agency provides to the New Entity or

Acquiring in connection with the transfer. (See §1.597–2(a) and (c) for rules

regarding the inclusion of FFA in

income and §1.597–2(a)(1) for related

rules regarding FFA provided to shareholders.) The Net Worth Assistance is

treated as an asset of the transferor that

is sold to the New Entity or Acquiring

in the Taxable Transfer.

(2) Amount realized in a Taxable

Transfer. In a Taxable Transfer described in paragraph (a)(1)(i) of this

section, the amount realized is determined under section 1001(b) by reference to the consideration paid for the

assets. In a Taxable Transfer described

in paragraph (a)(1)(ii) of this section,

the amount realized is the sum of the

grossed-up basis of the stock acquired

in connection with the Taxable Transfer (excluding stock acquired from the

Old or New Entity), plus the amount of

liabilities assumed or taken subject to

in the deemed transfer, plus other

relevant items. The grossed-up basis of

the acquired stock equals the acquirors’

basis in the acquired stock divided by

the percentage of the Old Entity’s stock

(by value) attributable to the acquired

stock.

(3) Allocation of amount realized—

(i) In general. The amount realized

under paragraph (c)(2) of this section is

allocated among the assets transferred

in the Taxable Transfer in the same

manner as amounts are allocated among

assets under §§1.338(b)–2T(b), (c)(1)

and (2).

(ii) Modifications to general rule.

This paragraph (c)(3)(ii) modifies certain of the allocation rules of paragraph

(c)(3)(i) of this section. Agency Obligations and assets covered by Loss

Guarantees in the hands of the New

Entity or Acquiring are treated as Class

II assets. Stock of a Consolidated

Subsidiary is treated as a Class II asset

to the extent the fair market value of

the Consolidated Subsidiary’s Class I

and Class II assets exceeds the amount

of its liabilities. The fair market value

of an Agency Obligation is deemed to

equal its adjusted issue price immediately before the Taxable Transfer.

The fair market value of an asset

covered by a Loss Guarantee immediately after the Taxable Transfer is

deemed to be not less than the greater

of the asset’s highest guaranteed value

or the highest price at which the asset

can be put.

(d) Treatment of a New Entity and

Acquiring—(1) Purchase price. The

purchase price for assets acquired in a

Taxable Transfer described in paragraph (a)(1)(i) of this section is the

cost of the assets acquired. See

§1.1060–1T(c)(1). The purchase price

for assets acquired in a Taxable Transfer described in paragraph (a)(1)(ii) of

this section is the sum of the grossedup basis of the stock acquired in

connection with the Taxable Transfer

(excluding stock acquired from the Old

or New Entity), plus the amount of

liabilities assumed or taken subject to

in the deemed transfer, plus other

relevant items. The grossed-up basis of

the acquired stock equals the acquirors’

basis in the acquired stock divided by

the percentage of the Old Entity’s stock

(by value) attributable to the acquired

stock. FFA provided in connection with

a Taxable Transfer is not included in

the New Entity’s or Acquiring’s purchase price for the acquired assets. Any

Net Worth Assistance so provided is

treated as an asset of the transferor sold

to the New Entity or Acquiring in the

Taxable Transfer.

(2) Allocation of basis—(i) In general. Except as otherwise provided in

this paragraph (d)(2), the purchase

price determined under paragraph

(d)(1) of this section is allocated

among the assets transferred in the

Taxable Transfer in the same manner

as amounts are allocated among assets

under §1.338(b)–2T(b), (c)(1) and (2).

(ii) Modifications to general rule.

The allocation rules contained in paragraph (c)(3)(ii) of this section apply to

the allocation of basis among assets

acquired in a Taxable Transfer. No

basis is allocable to Agency’s agreement to provide Loss Guarantees, yield

maintenance payments, cost to carry or

cost of funds reimbursement payments,

or expense reimbursement or indemnity

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payments. A New Entity’s basis in

assets it receives from its shareholders

is determined under general principles

of income taxation and is not governed

by this paragraph (d).

(iii) Allowance and recapture of

additional basis in certain cases. If the

fair market value of the Class I and

Class II assets acquired in a Taxable

Transfer is greater than the New

Entity’s or Acquiring’s purchase price

for the acquired assets, the basis of the

Class I and Class II assets equals their

fair market value. The amount by

which the fair market value of the

Class I and Class II assets exceeds the

purchase price is included ratably as

ordinary income by the New Entity or

Acquiring over a period of six taxable

years beginning in the year of the

Taxable Transfer. The New Entity or

Acquiring must include as ordinary

income the entire amount remaining to

be recaptured under the preceding

sentence in the taxable year in which

an event occurs that would accelerate

inclusion of an adjustment under section 481.

(iv) Certain post-transfer adjustments—(A) Agency Obligations. If an

adjustment to the principal amount of

an Agency Obligation or cash payment

to reflect a more accurate determination

of the condition of the Institution at the

time of the Taxable Transfer is made

before the earlier of the date the New

Entity or Acquiring files its first posttransfer income tax return or the due

date of that return (including extensions), the New Entity or Acquiring

must adjust its basis in its acquired

assets to reflect the adjustment. In

making adjustments to the New Entity’s or Acquiring’s basis in its acquired assets, paragraph (c)(3)(ii) of

this section is applied by treating an

adjustment to the principal amount of

an Agency Obligation pursuant to the

first sentence of this paragraph

(d)(2)(iv)(A) as occurring immediately

before the Taxable Transfer. (See

§1.597–3(c)(3) for rules regarding other

adjustments to the principal amount of

an Agency Obligation.)

(B) Assets covered by a Loss Guarantee. If, immediately after a Taxable

Transfer, an asset is not covered by a

Loss Guarantee but the New Entity or

Acquiring has the right to designate

specific assets that will be covered by a

Loss Guarantee, the New Entity or

Acquiring must treat any asset so

designated as having been subject to

the Loss Guarantee at the time of the

Taxable Transfer. The New Entity or

Acquiring must adjust its basis in the

covered assets and in its other acquired

assets to reflect the designation in the

manner provided by paragraph (d)(2) of

this section. The New Entity or Acquiring must make appropriate adjustments

in subsequent taxable years if the

designation is made after the New

Entity or Acquiring files its first posttransfer income tax return or the due

date of that return (including extensions) has passed.

(e) Special rules applicable to Taxable Transfers that are deemed asset

acquisitions—(1) Taxpayer identification numbers. Except as provided in

paragraph (e)(3) of this section, a New

Entity succeeds to the TIN of the

transferor in a deemed sale under

paragraph (b) of this section.

(2) Consolidated Subsidiaries—(i) In

general. A Consolidated Subsidiary

that is treated as selling its assets in a

Taxable Transfer under paragraph (b)

of this section is treated as engaging

immediately thereafter in a complete

liquidation to which section 332 applies. The consolidated group of which

the Consolidated Subsidiary is a member does not take into account gain or

loss on the sale, exchange, or cancellation of stock of the Consolidated

Subsidiary in connection with the Taxable Transfer.

(ii) Certain minority shareholders.

Shareholders of the Consolidated Subsidiary that are not members of the

consolidated group that includes the

Institution do not recognize gain or loss

with respect to shares of Consolidated

Subsidiary stock retained by the shareholder. The shareholder’s basis for that

stock is not affected by the Taxable

Transfer.

(3) Bridge Banks and Residual Entities—(i) In general. A Bridge Bank or

Residual Entity’s sale of assets to a

New Entity under paragraph (b) of this

section is treated as made by a single

entity under §1.597–4(e). The New

Entity deemed to acquire the assets of

a Residual Entity under paragraph (b)

of this section is not treated as a single

entity with the Bridge Bank (or with

the New Entity acquiring the Bridge

Bank’s assets) and must obtain a new

TIN.

(ii) Treatment of consolidated

groups. At the time of a Taxable

Transfer described in paragraph

(a)(1)(ii) of this section, treatment of a

Bridge Bank as a subsidiary member of

a consolidated group under §1.597–

4(f)(1) ceases. However, the New

Entity deemed to acquire the assets of

a Residual Entity is a member of the

selling consolidated group after the

deemed sale. The group’s basis or

excess loss account in the stock of the

New Entity that is deemed to acquire

the assets of the Residual Entity is the

group’s basis or excess loss account in

the stock of the Bridge Bank immediately before the deemed sale, as

adjusted for the results of the sale.

(4) Certain returns. If an Old Entity

without Continuing Equity is not a

subsidiary of a consolidated group at

the time of the Taxable Transfer, the

controlling Agency must file all income

tax returns for the Old Entity for

periods ending on or prior to the date

of the deemed sale described in paragraph (b) of this section that are not

filed as of that date.

(5) Basis limited to fair market

value. If all of the stock of the

corporation is not acquired on the date

of the Taxable Transfer, the Commissioner may make appropriate adjustments under paragraphs (c) and (d) of

this section to the extent using a

grossed-up basis of the stock of a

corporation results in an aggregate

amount realized for, or basis in, the

assets other than the aggregate fair

market value of the assets.

(f) Examples. The following examples illustrate the provisions of this

section:

Example 1. Branch sale resulting in Taxable

Transfer.

(i) Institution M is a calendar year

taxpayer in Agency receivership. M is not a

member of a consolidated group. On January 1,

1997, M has $200 million of liabilities (including

deposit liabilities) and assets with an adjusted

basis of $100 million. M has no income or loss

for 1997 and, except as described below,

receives no FFA. On September 30, 1997,

Agency causes M to transfer six branches (with

assets having an adjusted basis of $1 million)

together with $120 million of deposit liabilities

to N. In connection with the transfer, Agency

provides $121 million in cash to N.

(ii) The transaction is a Taxable Transfer in

which M receives $121 million of Net Worth

Assistance. Section 1.597–5(a)(1). (M is treated

as directly receiving the $121 million of Net

Worth Assistance immediately before the Taxable Transfer. Section 1.597–5(c)(1).) M transfers branches having a basis of $1 million and is

treated as transferring $121 million in cash (the

Net Worth Assistance) to N in exchange for N’s

assumption of $120 million of liabilities. Thus,

M realizes a loss of $2 million on the transfer.

The amount of the FFA M must include in its

income in 1997 is limited by §1.597–2(c) to

$102 million, which is the sum of the $100

million excess of M’s liabilities ($200 million)

over the total adjusted basis of its assets ($100

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million) at the beginning of 1997, plus the $2

million excess for the taxable year, which results

from the Taxable Transfer, of M’s deductions

(other than carryovers) over its gross income

other than FFA. M must establish a deferred

FFA account for the remaining $19 million of

FFA. Section 1.597–2(c)(4).

(iii) N, as Acquiring, must allocate its $120

million purchase price for the assets acquired

from M among those assets. Cash is a Class I

asset. The branch assets are in Classes III and

IV. N’s adjusted basis in the cash is its amount,

i.e., $121 million. Section 1.597–5(d)(2). Because this amount exceeds N’s purchase price for

all of the acquired assets by $1 million, N

allocates no basis to the other acquired assets

and, under §1.597–5(d)(2), must recapture the $1

million excess at an annual rate of $166,667 in

the six consecutive taxable years beginning with

1997 (subject to acceleration for certain events).

Example 2. Stock issuance by Bridge Bank

causing Taxable Transfer. (i) On April 1, 1996,

Institution P is placed in receivership and caused

to transfer assets and liabilities to Bridge Bank

PB. On August 31, 1996, the assets of PB consist of $20 million in cash, loans outstanding

with an adjusted basis of $50 million and a fair

market value of $40 million, and other nonfinancial assets (primarily branch assets and

equipment) with an adjusted basis of $5 million.

PB has deposit liabilities of $95 million and

other liabilities of $5 million. P, the Residual

Entity, holds real estate with an adjusted basis of

$10 million and claims in litigation having a zero

basis. P retains no deposit liabilities and has no

other liabilities (except its liability to Agency for

having caused its deposit liabilities to be

satisfied).

(ii) On September 1, 1996, Agency causes PB

to issue 100 percent of its common stock for $2

million cash to X. On the same day, Agency

issues a $25 million note to PB. The note bears a

fixed rate of interest in excess of the applicable

federal rate in effect for September 1, 1996.

Agency provides Loss Guarantees guaranteeing

PB a value of $50 million for PB’s loans outstanding.

(iii) The stock issuance is a Taxable Transfer

in which PB is treated as selling all of its assets

to a new corporation, New PB. Section 1.597–

5(b)(1). PB is treated as directly receiving $25

million of Net Worth Assistance (the issue price

of the Agency Obligation) immediately before

the Taxable Transfer. Section 1.597–3(c)(2);

§1.597–5(c)(1). The amount of FFA PB must include in income is determined under §1.597–2(a)

and (c). PB in turn is deemed to transfer the note

to New PB in the Taxable Transfer, together

with $20 million of cash, all its loans outstanding (with a basis of $50 million) and its other

non-financial assets (with a basis of $5 million).

The amount realized by PB from the sale is $100

million, the amount of PB’s liabilities deemed to

be assumed by New PB. This amount realized

equals PB’s basis in its assets and thus, PB

realizes no gain or loss on the transfer to New

PB.

(iv) Residual Entity P also is treated as selling

all its assets (consisting of real estate and claims

in litigation) for $0 (the amount of consideration

received by P) to a new corporation (New P) in a

Taxable Transfer. Section 1.597–5(b)(3). (P’s

only liability is to Agency and a liability to

Agency is not treated as a debt under §1.597–

3(b).) Thus, P realizes a $10 million loss on the

transfer to New P. The combined return filed by

PB and P for 1996 will reflect a total loss on the

Taxable Transfer of $10 million ($0 for PB and

$10 million for P). Section 1.597–5(e)(3). That

return also will reflect FFA income from the Net

Worth Assistance, determined under §1.597–2(a)

and (c).

(v) New PB is treated as having acquired the

assets it acquired from PB for $100 million, the

amount of liabilities assumed. In allocating basis

among these assets, New PB treats the Agency

note and the loans outstanding (which are

covered by Loss Guarantees) as Class II assets.

For the purpose of allocating basis, the fair

market value of the Agency note is deemed to

equal its adjusted issue price immediately before

the transfer, $25 million. The fair market value

of the loans is deemed not to be less than the

guaranteed value of $50 million.

(vi) New P is treated as having acquired its

assets for no consideration. Thus its basis in its

assets immediately after the transfer is zero. New

PB and New P are not treated as a single entity.

Section 1.597–5(e)(3).

Example 3. Taxable Transfer of previously disaffiliated Institution. (i) Corporation X, the

common parent of a consolidated group, owns all

the stock of Institution M, an insolvent Institution with no Consolidated Subsidiaries. On April

30, 1996, M has $4 million of deposit liabilities,

$1 million of other liabilities, and assets with an

adjusted basis of $4 million and a fair market

value of $3 million. On May 1, 1996, Agency

places M in receivership. X elects under §1.597–

4(g) to disaffiliate M. Accordingly, as of May 1,

1996, new corporation M is not a member of the

X consolidated group. On May 1, 1996, Agency

causes M to transfer all of its assets and

liabilities to Bridge Bank MB. Under §1.597–

4(e), MB and M are thereafter treated as a single

entity which has $5 million of liabilities, an

account receivable for future FFA with a basis of

$1 million, and other assets with a basis of $4

million. Section 1.597–4(g)(4).

(ii) During May 1996, MB earns $25,000 of

interest income and accrues $20,000 of interest

expense on depositor accounts and there is no

net change in deposits other than the additional

$20,000 of interest expense accrued on depositor

accounts. MB pays $5,000 of wage expenses and

has no other items of income or expense.

(iii) On June 1, 1996, Agency causes MB to

issue 100 percent of its stock to corporation Y.

In connection with the stock issuance, Agency

provides an Agency Obligation for $2 million

and no other FFA.

(iv) The stock issuance results in a Taxable

Transfer. Section 1.597–5(b). MB is treated as

receiving the Agency Obligation immediately

prior to the Taxable Transfer. Section 1.597–

5(c)(1). MB has $1 million of basis in its

account receivable for FFA. This receivable is

treated as satisfied, offsetting $1 million of the

$2 million of FFA provided by Agency in connection with the Taxable Transfer. The status of

the remaining $1 million of FFA as includible

income is determined as of the end of the taxable

year under §1.597–2(c). However, under §1.597–

2(b), MB obtains a $2 million basis in the

Agency Obligation received as FFA.

(v) Under §1.597–5(c)(2), in the Taxable

Transfer, Old Entity MB is treated as selling, to

New Entity MB, all of Old Entity MB’s assets,

having a basis of $6,020,000 (the original $4

million of asset basis as of April 30, 1996, plus

$20,000 net cash from May 1996 activities, plus

$2 million in the Agency Obligation received as

FFA), for $5,020,000, the amount of Old Entity

MB’s liabilities assumed by New Entity MB

pursuant to the Taxable Transfer. Therefore, Old

Entity MB recognizes, in the aggregate, a loss of

$1 million from the Taxable Transfer.

(vi) Because this $1 million loss causes Old

Entity MB’s deductions to exceed its gross

income (determined without regard to FFA) by

$1 million, Old Entity MB must include in its

income the $1 million of FFA not offset by the

FFA receivable. Section 1.597–2(c). (As of May

1, 1996, Old Entity MB’s liabilities ($5,000,000)

did not exceed MB’s $5 million adjusted basis of

its assets. For the taxable year, MB’s deductions

of $1,025,000 ($1,000,000 loss from the Taxable

Transfer, $20,000 interest expense and $5,000 of

wage expense) exceeded its gross income (disregarding FFA) of $25,000 (interest income) by

$1,000,000. Thus, under §1.597–2(c), MB includes in income the entire $1,000,000 of FFA

not offset by the FFA receivable.)

(vii) Therefore, Old Entity MB’s taxable income for the taxable year ending on the date of

the Taxable Transfer is $0.

(viii) Residual Entity M is also deemed to

engage in a deemed sale of its assets to New

Entity M under §1.597–5(b)(3), but there are no

tax consequences as M has no assets or liabilities

at the time of the deemed sale.

(ix) Under §1.597–5(d)(1), New Entity MB is

treated as purchasing Old Entity MB’s assets for

$5,020,000, the amount of New Entity MB’s

liabilities. Of this, $2,000,000 is allocated to the

$2 million Agency Obligation, and $3,020,000 is

allocated to the other assets New Entity MB is

treated as purchasing in the Taxable Transfer.

Example 4. Loss Sharing. Institution N acquires assets and assumes liabilities of another

Institution in a Taxable Transfer. Among the

assets transferred are three parcels of real estate.

In the hands of the transferring Institution, these

assets had book values of $100,000 each. In

connection with the Taxable Transfer, Agency

agrees to reimburse Institution N for 80 percent

of any loss (based on the original book value)

realized on the disposition or charge-off of the

three properties. This arrangement constitutes a

Loss Guarantee. Thus, in allocating basis, Institution N treats the three parcels as Class II assets.

By virtue of the arrangement with the Agency,

Institution N is assured that the parcels will not

be worth less to it than $80,000 each, because

even if the properties are worthless, Agency will

reimburse 80 percent of the loss. Although

Institution could obtain payments under the Loss

Guarantee if the properties are worth more, it is

not guaranteed that it will realize more than

$80,000. Accordingly, $80,000 is the highest

guaranteed value of the three parcels. Institution

N will allocate basis to the Class II assets up to

their fair market value. For this purpose, the fair

market value of the three parcels is not less than

$80,000 each. Section 1.597–5(d)(2)(ii); §1.597–

5(c)(3)(ii).

§1.597–6 Limitation on collection of

income tax.

(a) Limitation on collection where

tax is borne by Agency. If an Institution

without Continuing Equity (or any of

its Consolidated Subsidiaries) is liable

for income tax that is attributable to the

inclusion in income of FFA or gain

from a Taxable Transfer, the tax will

not be collected if it would be borne by

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Agency. The final determination of

whether the tax would be borne by

Agency is within the sole discretion of

the Commissioner. In determining

whether tax would be borne by

Agency, the Commissioner will disregard indemnity, tax-sharing, or similar obligations of Agency, an Institution, or its Consolidated Subsidiaries.

Collection of the several income tax

liability under §1.1502–6 from members of an Institution’s consolidated

group other than the Institution or its

Consolidated Subsidiaries is not affected by this section. Income tax will

continue to be subject to collection

except as specifically limited in this

section. This section does not apply to

taxes other than income taxes.

(b) Amount of tax attributable to

FFA or gain on a Taxable Transfer.

For purposes of paragraph (a) of this

section, the amount of income tax in a

taxable year attributable to the inclusion of FFA or gain from a Taxable

Transfer in the income of an Institution

(or a Consolidated Subsidiary) is the

excess of the actual income tax liability

of the Institution (or the consolidated

group in which the Institution is a

member) over the income tax liability

of the Institution (or the consolidated

group in which the Institution is a

member) determined without regard to

FFA or gain or loss on the Taxable

Transfer.

taxpayer must specify on the front page

of Form 1120 (U.S. Corporate Income

Tax Return), to the left of the space

provided for ‘‘Total Tax,’’ the amount

of income tax for the taxable year that

is potentially not subject to collection

under this section. If an Institution is a

subsidiary member of a consolidated

group, the amount specified as not

subject to collection is zero.

(d) Assessments of tax to offset

refunds. Income tax that is not collected under this section will be assessed and, thus, used to offset any

claim for refund made by or on behalf

of the Institution, the Consolidated

Subsidiary or any other corporation

with several liability for the tax.

(e) Collection of taxes from Acquiring or a New Entity—(1) Acquiring.

No income tax liability (including the

several liability for taxes under

§1.1502–6) of a transferor in a Taxable

Transfer will be collected from

Acquiring.

(2) New Entity. Income tax liability

(including the several liability for taxes

under §1.1502–6) of a transferor in a

Taxable Transfer will be collected from

a New Entity only if stock that was

outstanding in the Old Entity remains

outstanding as stock in the New Entity

or is reacquired or exchanged for

consideration.

(f) Effect on section 7507. This

section supersedes the application of

section 7507, and the regulations thereunder, for the assessment and collection of income tax attributable to FFA.

§1.597–7 Effective date.

(a) FIRREA effective date. Section

597, as amended by section 1401 of the

Financial Institutions Reform, Recovery, and Enforcement Act of 1989

(FIRREA), Public Law 101–73, is

generally effective for any FFA received or accrued by an Institution on

or after May 10, 1989, and for any

transaction in connection with which

such FFA is provided, unless the FFA

is provided in connection with an

acquisition occurring prior to May 10,

1989. See §1.597–8 for rules regarding

FFA received or accrued on or after

May 10, 1989, that relates to an

acquisition that occurred before May

10, 1989.

(b) Effective date of regulations.

Except as otherwise provided in this

section, §§1.597–1 through 1.597–6

apply to taxable years ending on or

after April 22, 1992. However, the

provisions of §§1.597–1 through

1.597–6 do not apply to FFA received

or accrued for taxable years ending on

or after April 22, 1992, in connection

with an Agency assisted acquisition

within the meaning of Notice 89–102

(1989–2 C.B. 436; see §601.601(d)(2))

(which does not include a transfer to a

Bridge Bank), that occurs before April

22, 1992. Taxpayers not subject to

§§1.597–1 through 1.597–6 must comply with an interpretation of the statute

that is reasonable in light of the

legislative history and applicable administrative pronouncements. For this

purpose, the rules contained in Notice

89–102 apply to the extent provided in

the Notice.

years and transactions—(1) In general.

Except as limited in this paragraph (c),

an election is available to apply

§§1.597–1 through 1.597–6 to taxable

years prior to the general effective date

of these regulations. A consolidated

group may elect to apply §§1.597–1

through 1.597–6 for all members of the

group in all taxable years to which

section 597, as amended by FIRREA,

applies. The common parent makes the

election for the group. An entity that is

not a member of a consolidated group

may elect to apply §§1.597–1 through

1.597–6 to all taxable years to which

section 597, as amended by FIRREA,

applies for which it is not a member of

a consolidated group. The election is

irrevocable.

(2) Election unavailable in certain

cases—(i) Statute of limitations closed.

The election cannot be made if the

period for assessment and collection of

tax has expired under the rules of

section 6501 for any taxable year in

which §§1.597–1 through 1.597–6

would affect the determination of the

electing entity’s or group’s income,

deductions, gain, loss, basis, or other

items.

(ii) No section 338 election under

Notice 89–102. The election cannot be

made with respect to an Institution if,

under Notice 89–102, it was a Target

with respect to which a qualified stock

purchase was made, a timely election

under section 338 was not made, and

on April 22, 1992, a timely election

under section 338 could not be made.

(iii) Inconsistent treatment of Institution that would be New Entity. If,

under §1.597–5(b), an Institution would

become a New Entity before April 22,

1992, the election cannot be made with

respect to that Institution unless elections are made by all relevant persons

such that §§1.597–1 through §1.597–6

apply both before and after the deemed

sale under §1.597–5. However, this

requirement does not apply if, under

§§1.597–1 through §1.597–6, the Institution would not have Continuing

Equity prior to the deemed sale.

(3) Expense reimbursements. Notice

89–102, 1989–2 C.B. 436, provides

that reimbursements paid or accrued

pursuant to an expense reimbursement

or indemnity arrangement are not included in income but the taxpayer may

not deduct, or otherwise take into

account, the item of cost or expense to

which the reimbursement or indemnity

payment relates. With respect to an

Agency assisted acquisition within the

meaning of Notice 89–102 that occurs

before April 22, 1992, a taxpayer that

elects to apply these regulations retroactively under this paragraph (c) may

continue to account for these items

under the rules of Notice 89–102.

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(4) Procedural rules—(i) Manner of

making election. An Institution or

consolidated group makes the election

provided by this paragraph (c) by

attaching a written statement to, and

including it as a part of, the taxpayer’s

or consolidated group’s first annual

income tax return filed on or after

March 15, 1996. The statement must

contain the following legend at the top

of the page: ‘‘THIS IS AN ELECTION

UNDER §1.597–7(c),’’ and must contain the name, address and employer

identification number of the taxpayer or

common parent making the election.

The statement must include a declaration that ‘‘TAXPAYER AGREES TO

EXTEND THE STATUTE OF LIMITATIONS ON ASSESSMENT FOR

THREE YEARS FROM THE DATE

OF THE FILING OF THIS ELECTION UNDER §1.597–7(c), IF THE

LIMITATIONS PERIOD WOULD EXPIRE EARLIER WITHOUT SUCH

EXTENSION, FOR ANY ITEMS AFFECTED IN ANY TAXABLE YEAR

BY THE FILING OF THIS ELECTION,’’ and a declaration that either

‘‘AMENDED RETURNS WILL BE

FILED FOR ALL TAXABLE YEARS

AFFECTED BY THE FILING OF

THIS ELECTION WITHIN 180 DAYS

OF MAKING THIS STATEMENT,

UNLESS SUCH REQUIREMENT IS

WAIVED IN WRITING BY THE

DISTRICT DIRECTOR OR HIS DELEGATE’’ or ‘‘ALL RETURNS PREVIOUSLY FILED ARE CONSISTENT

WITH THE PROVISIONS OF

§§1.597–1 THROUGH 1.597–6,’’ and

be signed by an individual who is

authorized to make the election under

this paragraph (c) on behalf of the

taxpayer. An election with respect to a

consolidated group must be made by

the common parent of the group, not

Agency, and applies to all members of

the group.

(ii) Effect of elective disaffiliation.

To make the affirmative election described in §1.597–4(g)(5) for an Institution placed in Agency receivership in

a taxable year ending before April 22,

1992, the consolidated group must send

the affected Institution the statement

described in §1.597–4(g)(5) on or

before May 31, 1996. Notwithstanding

the requirements of paragraph (c)(4)(i)

of this section, a consolidated group

sending such a statement is deemed to

make the election described in, and to

agree to the conditions contained in,

this paragraph (c). The consolidated

group must nevertheless attach the

statement described in paragraph

(c)(4)(i) of this section to its first

annual income tax return filed on or

after March 15, 1996.

(d) Reliance on prior guidance—(1)

Notice 89–102. Taxpayers may rely on

Notice 89–102, 1989–2 C.B. 436, to

the extent they acted in reliance on that

Notice prior to April 22, 1992. Such

reliance must be reasonable and transactions with respect to which taxpayers

rely must be consistent with the overriding policies of section 597, as

expressed in the legislative history.

(2) Notice FI–46–89—(i) In general.

Notice FI–46–89 was published in the

Federal Register on April 23, 1992 (57

FR 14804). Taxpayers may rely on the

provisions of §§1.597–1 through

1.597–6 of that notice to the extent

they acted in reliance on those provisions prior to December 21, 1995. Such

reliance must be reasonable and transactions with respect to which taxpayers

rely must be consistent with the overriding policies of section 597, as

expressed in the legislative history, as

well as the overriding policies of notice

FI–46–89.

(ii) Taxable Transfers. Any taxpayer

described in this paragraph (d) that,

under notice FI–46–89, would be a

New Entity or Acquiring with respect

to a Taxable Transfer on or after April

22, 1992, and before December 21,

1995, may apply the rules of that notice with respect to such transaction.

PART 301—PROCEDURE AND

ADMINISTRATION

Par. 3. The authority citation for part

301 is amended by adding entries in

numerical order to read as follows:

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

Section 301.7507–1 also issued under 26 U.S.C. 597.

Section 301.7507–9 also issued under 26 U.S.C. 597. * * *

Par. 4. Section 301.7507–1 is

amended by adding paragraph (b)(4) to

read as follows:

§301.7507–1 Banks and trust

companies covered.

(b) * * *

(4) The term ceased to do business

means the bank no longer accepts

deposits or makes loans and discounts,

and is winding up its affairs and is in

the process of liquidating its assets to

pay depositors. A bank will not be

considered to have ceased to do business on account of a transaction in

which the bank—

(i) Transfers assets and liabilities to

a Bridge Bank in a transfer described

in §1.597–4 of this chapter;

(ii) Transfers assets and liabilities to

any person in a transaction to which

section 381(a) applies or in which the

transferee receives property with a

transferred basis;

(iii) Transfers assets or liabilities to

any person in a transaction in which

Federal Financial Assistance (as defined in section 597) is provided to any

party to the transaction, unless all the

Federal Financial Assistance is deposit

insurance under §301.7507–9(d); or

(iv) Transfers assets or liabilities to

any person in a transaction similar to

any transaction described in paragraphs

(b)(4)(i) through (iii) of this section.

This paragraph (b)(4) applies to taxable

years ending on or after April 22,

1992.

Par. 5. Section 301.7507–9 is

amended by adding a sentence to the

end of paragraph (d) to read as follows:

§301.7507–9 Termination of

immunity.

(d) * * * For taxable years ending

on or after April 22, 1992, deposit

insurance does not include Federal

Financial Assistance (as defined in

section 597) and other payments described in section 597(a) prior to its

amendment by the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 and, therefore, such

payments must be taken into account to

determine whether a bank’s assets are

sufficient to meet claims of depositors.

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 entries in numerical order to the table to read as

follows:

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(Filed by the Office of the Federal Register on

December 20, 1995, 8:45 a.m., and published

in the issue of the Federal Register for

December 21, 1995, 60 F.R. 66091)

§602.101 OMB Control numbers.

and other sections of the Code, tables

set forth the rates for February 1996.

Rev. Rul. 96–14

Section 807.—Rules for Certain

Reserves

CFR part or section

where identified

and described

1.597–2

1.597–4

1.597–6

1.597–7

Current OMB

control number

. . . . . . . . . . . . . . . . 1545–1300

The adjusted applicable federal short-term,

mid-term, and long-term rates are set forth for

the month of February 1996. See Rev. Rul. 96–

14, page 20.

Margaret Milner Richardson,

Commissioner of

Internal Revenue.

Approved December 4, 1995.

Cynthia G. Beerbower,

Deputy Assistant Secretary

of the Treasury.

Section 846.—Discounted Unpaid

Losses Defined

The adjusted applicable federal short-term,

mid-term, and long-term rates are set forth for

the month of February 1996. See Rev. Rul. 96–

14, page 20.

Section 1274.—Determination of

Issue Price in the Case of Certain

Debt Instruments Issued for Property

(Also Sections 42, 280G, 382, 412, 467, 468,

483, 807, 846, 1288, 7520, 7872.)

Federal rates; adjusted federal

rates; adjusted federal long-term rate,

and the long-term exempt rate. For

purposes of sections 1274, 1288, 382,

This revenue ruling provides various

prescribed rates for federal income tax

purposes for February 1996 (the current

month). Table 1 contains the shortterm, mid-term, and long-term applicable federal rates (AFR) for the current

month for purposes of section 1274(d)

of the Internal Revenue Code. Table 2

contains the short-term, mid-term, and

long-term adjusted applicable federal

rates (adjusted AFR) for the current

month for purposes of section 1288(b).

Table 3 sets forth the adjusted federal

long-term rate and the long-term taxexempt rate described in section 382(f).

Table 4 contains the appropriate percentages for determining the lowincome housing credit described in

section 42(b)(2) for buildings placed in

service during the current month. Finally, Table 5 contains the federal rate

for determining the present value of an

annuity, an interest for life or for a

term of years, or a remainder or a

reversionary interest for purposes of

section 7520.

REV. RUL. 96–14 TABLE 1

Applicable Federal Rates (AFR) for February 1996

Period for Compounding

Annual

Semiannual

Quarterly

Monthly

5.32%

5.86%

6.40%

5.25%

5.78%

6.30%

5.22%

5.74%

6.25%

5.19%

5.71%

6.22%

5.61%

6.17%

6.75%

8.47%

9.91%

5.53%

6.08%

6.64%

8.30%

9.68%

5.49%

6.03%

6.59%

8.22%

9.57%

5.47%

6.00%

6.55%

8.16%

9.49%

6.09%

6.71%

7.33%

6.00%

6.60%

7.20%

5.96%

6.55%

7.14%

5.93%

6.51%

7.09%

Short-Term

AFR

110% AFR

120% AFR

Mid-Term

AFR

110% AFR

120% AFR

150% AFR

175% AFR

Long-Term

AFR

110% AFR

120% AFR

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REV. RUL. 96–14 TABLE 2

Adjusted AFR for February 1996

Period for Compounding

Annual

Semiannual

Quarterly

Monthly

Short-term

adjusted AFR

3.66%

3.63%

3.61%

3.60%

Mid-term

adjusted AFR

4.42%

4.37%

4.35%

4.33%

Long-term

adjusted AFR

5.27%

5.20%

5.17%

5.14%

REV. RUL. 95–79 TABLE 3

Rates Under Section 382 for February 1996

Adjusted federal long-term rate for the current month

5.27%

Long-term tax-exempt rate for ownership changes during the current month (the highest of the

adjusted federal long-term rates for the current month and the prior two months).

5.46%

REV. RUL. 96–14 TABLE 4

Appropriate Percentages Under Section 42(b)(2)

for February 1996

Appropriate percentage for the 70% present value low-income housing credit

8.37%

Appropriate percentage for the 30% present value low-income housing credit

3.59%

REV. RUL. 96–14 TABLE 5

Rate Under Section 7520 for February 1996

Applicable federal rate for determining the present value of an annuity, an interest for life or

a term of years, or a remainder or reversionary interest

Section 1288.—Treatment of Original

Issue Discount on Tax-Exempt

Obligations

The adjusted applicable federal short-term,

mid-term, and long-term rates are set forth for

the month of February 1996. See Rev. Rul. 96–

14, page 20.

6.8%

Section 7520.—Valuation Tables

Section 7872.—Treatment of Loans

with Below-Market Interest Rates

The adjusted applicable federal short-term,

mid-term, and long-term rates are set forth for

the month of February 1996. See Rev. Rul. 96–

14, page 20.

The adjusted applicable federal short-term,

mid-term, and long-term rates are set forth for

the month of February 1996. See Rev. Rul. 96–

14, page 20.

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Part III. Administrative, Procedural, and Miscellaneous

Estimated Tax Payments for

Individuals

Notice 96–5

This notice provides that the Internal

Revenue Service will waive penalties

for certain individuals for the 4th

installment payment of estimated tax if

that payment is made on or before

January 22, 1996. Under § 6654(c) of

the Internal Revenue Code, the due

date for the 4th installment payment of

estimated tax by individuals is January

15 of the following taxable year. Because January 15, 1996, is a Federal

holiday, a payment of the 4th installment of estimated tax made on January

16, 1996, is considered timely.

Due to the blizzard that occurred on

January 7 and 8, 1996, the 4th

installment payment of estimated tax

made by individuals who are residents

of the District of Columbia, Connecticut, Delaware, Kentucky, Maine, Maryland, Massachusetts, New Hampshire,

New Jersey, New York, North Carolina, Pennsylvania, Rhode Island, Vermont, Virginia, and West Virginia will

be considered timely if made on or

before January 22, 1996. The waiver is

automatic for these individuals.

Alternatively, under § 6654(h), all

individuals who file their 1995 individual income tax returns on or before

January 31, 1996, and pay the entire

balance due with the return, do not

have to make the 4th installment payment of estimated tax.

DRAFTING INFORMATION

The principal author of this notice is

Margaret A. Owens of the Office of

Assistant Chief Counsel (Income Tax

and Accounting). For further information regarding this notice, contact Ms.

Owens on (202) 622-6232 (not a tollfree call).

Request for Comments on Further

Capitalization Guidance

Notice 96–7

This notice invites public comment

on approaches the Service should consider to address issues raised under

§§ 162 and 263 of the Internal Revenue

Code particularly in light of INDOPCO, Inc. v. Commissioner, 503 U.S.

79 (1992).

BACKGROUND

Section 162(a) allows a deduction for

all the ordinary and necessary expenses

paid or incurred during the taxable year

in carrying on any trade or business.

Section 263 generally prohibits deductions for capital expenditures. Section 263(a)(1) provides that no deduction is allowed for any amount paid out

for new buildings or for permanent

improvements or betterments made to

increase the value of any property or

estate. Under § 263(a)(2), no deduction

is allowed for any amount expended in

restoring property or in making good

the exhaustion thereof for which an

allowance is or has been made in the

form of a deduction for depreciation,

amortization, or depletion.

In INDOPCO, the Supreme Court of

the United States concluded that certain

legal and professional fees incurred by

a corporation to facilitate a friendly

acquisition of the corporation created

significant long-term benefits for the

taxpayer and, therefore, were capital

expenditures. In reaching this decision,

the Court specifically rejected the

argument that its decision in Commissioner v. Lincoln Savings & Loan

Association, 403 U.S. 345 (1971),

should be read as holding ‘‘that only

expenditures that create or enhance

separate and distinct assets are to be

capitalized under § 263.’’ INDOPCO at

86–87 (emphasis in original). The

Court further stated that ‘‘[a]lthough

the mere presence of an incidental

future benefit—‘some future aspect’—

may not warrant capitalization, a taxpayer’s realization of benefits beyond

the year in which the expenditure is

incurred is undeniably important in

determining whether the appropriate tax

treatment is immediate deduction or

capitalization.’’ INDOPCO at 87

(emphasis in original).

The Service believes that the INDOPCO decision did not change the

fundamental legal principles for determining whether a particular expenditure

may be deducted or must be capitalized. Since the decision in INDOPCO, the Service has issued a variety

of revenue rulings applying §§ 162(a)

and 263(a) to specific expenditures. For

example, the Service ruled that the

INDOPCO decision did not change the

treatment of advertising costs (Rev.

Rul. 92–80, 1992–2 C.B. 57), incidental repair costs (Rev. Rul. 94–12,

1994–1 C.B. 36), or severance payments (Rev. Rul. 94–77, 1994–2 C.B.

19), all of which are generally deductible under § 162.

REQUEST FOR PUBLIC COMMENT

The Service continues to receive

numerous informal inquiries regarding

issues of capitalization. Taxpayers

should be aware that, in appropriate

circumstances, they can receive private

letter rulings on the deductibility or

capitalization of specific expenditures.

The Service welcomes comments on

possible changes to the private letter

ruling process that would facilitate

advance resolution of these issues. In

addition, the Service requests comments concerning: (1) whether general

guidance clarifying the fundamental

principles of capitalization would aid in

resolving capitalization issues; (2) what

specific approaches, principles, or issues such guidance should address; and

(3) whether safe-harbor amortization

periods should be provided for certain

capitalizable expenditures and what

data would support any suggested

periods.

Written comments should be submitted by May 6, 1996. Written comments

should be sent to: Internal Revenue

Service, Attn: CC:DOM:CORP:R (IABranch 5), Room 5228, P.O. Box 7604,

Ben Franklin Station, Washington, D.C.

20044. All materials submitted will be

available for public inspection and

copying. During its review of the

comments, the Service will continue to

process private letter rulings and continue to resolve issues under §§ 162

and 263(a) raised in examinations.

DRAFTING INFORMATION

The principal author of this notice is

John Moriarty of the Office of Assistant Chief Counsel (Income Tax and

Accounting). For further information

regarding this notice, contact Mr. Moriarty on (202) 622-4950 (not a toll-free

call).

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Cash Balance Pension Plans

Notice 96–8

I. Purpose

This notice describes and requests

comments on proposed guidance concerning the application of sections 411

and 417(e) to single sum distributions

under defined benefit pension plans

that are cash balance plans. The proposed guidance is being described in

this notice in order to permit advance

public comment in anticipation of the

publication of regulations that incorporate the proposed guidance.

II. Background

A. General description of cash

balance plans

In general terms, a cash balance plan

is a defined benefit pension plan that

defines benefits for each employee by

reference to the amount of the

employee’s hypothetical account balance. An employee’s hypothetical account balance is credited with hypothetical allocations and hypothetical

earnings determined under a formula

selected by the employer and set forth

in the plan. These hypothetical allocations and hypothetical earnings are

designed to mimic the allocations of

actual contributions and actual earnings

to an employee’s account that would

occur under a defined contribution

plan. Cash balance plans often specify

that hypothetical earnings (referred to

in this notice as interest credits) are

determined using an interest rate or rate

of return under a variable outside index

(e.g., the annual yield on one-year

Treasury securities). Most cash balance

plans also are designed to permit, after

termination of employment, a distribution of an employee’s entire accrued

benefit in the form of a single sum

distribution equal to the employee’s

hypothetical account balance as of the

date of the distribution. Many cash

balance plans also provide that if

distribution is in the form of an

annuity, the amount of the annuity is

determined by dividing the hypothetical

account balance by an annuity conversion factor.

As explained below, in order to

comply with sections 411(a) and 417(e)

in calculating the amount of a single

sum distribution under a cash balance

plan, the balance of the employee’s

hypothetical account must be projected

to normal retirement age and then the

employee must be paid at least the

present value, determined in accordance with section 417(e), of that

projected hypothetical account balance.

If a cash balance plan provides interest

credits using an interest rate that is

higher than the section 417(e) applicable interest rate, payment of a single

sum distribution equal to the hypothetical account balance as a complete

distribution of the employee’s accrued

benefit may result either in a violation

of section 417(e) or a forfeiture in

violation of section 411(a). This is

because, in such a case, the present

value of the employee’s accrued benefit, determined using the section 417(e)

applicable interest rate, will generally

exceed the hypothetical account balance. The following example illustrates

this potential problem.

Example. A cash balance plan provides for

interest credits at a fixed rate of 8% per annum

that are not conditioned on continued employment, and for annuity conversions using the

section 417(e) applicable interest rate and mortality table. A fully vested employee with a

hypothetical account balance of $45,000 terminates employment at age 45 and elects an

immediate single sum distribution. At the time of

the employee’s termination, the section 417(e)

applicable interest rate is 6.5%.

The projected balance of the employee’s

hypothetical account as of normal retirement age

is $209,743. If $209,743 is discounted to age 45

at 6.5% (the section 417(e) applicable interest

rate), the present value equals $59,524.

Accordingly, if the plan paid the hypothetical

account balance of $45,000, instead of $59,524,

the employee would receive $14,524 less than

the amount to which the employee is entitled.

Even if a cash balance plan provides

interest credits using an interest rate

that exceeds the section 417(e) applicable interest rate, the plan can satisfy

sections 417(e) and 411(a). Such a plan

would provide that the amount of any

single sum distribution is equal to the

present value of the employee’s accrued benefit determined in a manner

that satisfies sections 411(a) and 417(e)

even if the amount of the single sum

exceeds the employee’s hypothetical

account balance. Thus, in the example

above, the plan would satisfy sections

411(a) and 417(e) if the employee

received a single sum distribution of

$59,524 (the present value of the

employee’s accrued benefit) rather than

$45,000 (the employee’s hypothetical

account balance).

B. Existing regulatory safe harbor

for cash balance plans

Section 1.401(a)(4)–8(c) of the Income Tax Regulations, as issued in

September 1991, provides a safe harbor

testing method for cash balance plans.

Under this method, a cash balance plan

could be tested for nondiscrimination

as though it were a defined contribution plan with actual allocations equal

to the amount of the hypothetical

allocations credited for the plan year.

In order to use the safe harbor, a cash

balance plan must satisfy certain design

requirements that relate to the accrued

benefit and valuation rules that are

unique to defined benefit plans.

Comments on the September 1991

regulations expressed concern that the

safe harbor plan design requirements

reflected an interpretation by the Service and Treasury of the qualification

requirements that, in certain cases,

would require cash balance plans to

pay a single sum distribution in excess

of the hypothetical account balance.

Guidance was requested on the circumstances in which a cash balance plan

(whether or not it qualifies for safe

harbor nondiscrimination testing) is

permitted to distribute a single sum

distribution equal to the hypothetical

account balance without violating section 411(a) or 417(e).

When revised regulations under section 401(a)(4) were issued in September 1993, the safe harbor testing

method for cash balance plans was left

unchanged. The Preamble to those

regulations indicated that the safe harbor testing method for cash balance

plans had generated significant comment and that further guidance would

be issued at a later date.

III. Analysis

A. Nonforfeiture and accrual rules

A cash balance plan is a defined

benefit plan, not a defined contribution

plan, because the benefits provided are

not based solely on actual contributions

and forfeitures allocated to an

employee’s account and the actual

investment experience and expenses of

the plan allocated to the account.

Section 411(a)(7) defines an employee’s accrued benefit differently for

defined benefit plans than for defined

contribution plans. Also, defined benefit plans are subject to a number of

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statutory provisions that do not apply

to defined contribution plans. These

include the rules of section 411(b)(1)

that limit ‘‘backloading’’ of accruals;

the valuation rules of section 417(e);

and the definitely determinable benefits

requirement of section 401(a)(25).

These provisions limit the extent to

which a cash balance plan can mimic

the benefit and accrual structure of a

defined contribution plan.

Under section 411(a)(2), an employee’s accrued benefit must become

nonforfeitable in accordance with one

of the schedules specified in that

section. Under §1.411(a)–7(a)(1)(ii),

the term ‘‘accrued benefits’’ generally

refers only to pension or retirement

benefits. Under section 411(b)(1), the

accrual of the retirement benefits payable at normal retirement age must

satisfy one of the rules in section

411(b)(1)(A), (B) or (C).

Under a cash balance plan, the retirement benefits payable at normal

retirement age are determined by reference to the hypothetical account balance as of normal retirement age, including benefits attributable to interest

credits to that age. Thus, benefits

attributable to interest credits must be

taken into account in determining

whether the accrual of the retirement

benefits under a cash balance plan

satisfies one of the rules in section

411(b)(1)(A), (B) or (C). Moreover,

benefits attributable to interest credits

are in the nature of accrued benefits

within the meaning of §1.411(a)–7(a),

rather than ancillary benefits, and thus,

once accrued, must become nonforfeitable in accordance with a vesting

schedule that satisfies section 411(a).

Cash balance plans can be categorized based on when the benefits

attributable to interest credits accrue.

Under one type of cash balance plan

(referred to in this notice as a frontloaded interest credit plan), future

interest credits to an employee’s hypothetical account balance are not conditioned upon future service. (Of course,

benefits attributable to future interest

credits may be forfeited in accordance

with the plan’s vesting provisions, to

the extent permitted under section 411.)

Thus, in the case of a frontloaded

interest credit plan, the benefits attributable to future interest credits with

respect to a hypothetical allocation

accrue at the same time that the benefits attributable to the hypothetical

allocation accrue. As a result, if an

employee terminates employment and

defers distribution to a later date,

interest credits will continue to be

credited to that employee’s hypothetical

account.

A second type of cash balance plan

(referred to in this notice as a backloaded interest credit plan) conditions

future interest credits upon further

service. In the case of a backloaded

interest credit plan, benefits attributable

to interest credits do not accrue until

the interest credits are credited to the

employee’s account. Because backloaded interest credit plans typically

will not satisfy any of the accrual rules

in section 411(b)(1)(A), (B) or (C), it is

anticipated that the proposed guidance

will address only frontloaded interest

credit plans.

B. Single sum distributions from

frontloaded interest credit plans

As indicated above, most cash balance plans are designed to permit a

distribution of an employee’s entire

accrued benefit, after termination of

employment, in the form of a single

sum equal to the employee’s hypothetical account balance as of the date of

the distribution. In order for a defined

benefit plan to satisfy section 417(e),

any single sum distribution payable to

an employee from the plan must not be

less than the nonforfeitable portion of

the present value of the employee’s

accrued benefit under section 411(a)(7)

(determined using the applicable interest rate and mortality table under

section 417(e)).

1. Determination of the accrued

benefit

In the case of a frontloaded interest

credit plan, an employee’s accrued

benefit as of any date before attainment

of normal retirement age is based on

the employee’s hypothetical account

balance as of normal retirement age,

including future interest credits to that

age. If such a plan specifies a fixed

interest rate for use in determining

future interest credits, the employee’s

hypothetical account balance as of

normal retirement age (including future

interest credits) can be calculated precisely before normal retirement age.

However, if a frontloaded interest

credit plan specifies a variable outside

index for use in determining the

amount of interest credits, the precise

dollar amount of an employee’s hypo-

thetical account balance as of normal

retirement age (including future interest

credits to normal retirement age), and

thus the precise dollar amount of the

employee’s accrued benefit as of any

date before normal retirement age,

cannot be calculated prior to normal

retirement age.

A frontloaded interest credit plan

that specifies a variable outside index

for use in determining the amount of

interest credits must prescribe the

method for reflecting future interest

credits in the calculation of an

employee’s accrued benefit. In order to

comply with section 401(a)(25), the

method, including actuarial assumptions, if applicable, must preclude

employer discretion. Further, in determining the amount of an employee’s

accrued benefit, a forfeiture, within the

meaning of §1.411(a)–4T, will result if

the value of future interest credits is

projected using a rate that understates

the value of those credits or if the plan

by its terms reduces the interest rate or

rate of return used for projecting future

interest credits. A forfeiture in violation

of section 411(a) also will occur if, in

determining the amount of an

employee’s accrued benefit, future interest credits are not taken into account

(i.e., there is no projection of future

interest credits) and this has the same

effect as using a rate that understates

the value of future interest credits.

2. Calculation of the present value

of the employee’s accrued

benefit

In the case of a frontloaded interest

credit plan, a single sum distribution

optional form of benefit equal to the

hypothetical account balance will satisfy section 417(e) only if the single

sum distribution is not less than the

present value of the employee’s accrued benefit calculated in accordance

with the applicable interest rate and

mortality table under section 417(e)(3).

As noted above, the amount of the

employee’s accrued benefit must be

determined using a method of reflecting future interest credits that satisfies

section 401(a)(25) and that does not

create a forfeiture in violation of

section 411(a).

3. Situations in which the present

value will not exceed the

hypothetical account balance

A frontloaded interest credit plan

might provide that the amount of

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interest credits is determined using a

variable interest rate or rate of return

that, by its terms, is no greater than the

applicable interest rate under section

417(e)(3). For example, a plan that has

been amended to comply with the

changes to section 417(e) made by the

Retirement Protection Act of 1994

(RPA ’94) might provide that interest

credits are determined using the lesser

of the current rate of interest on 30year Treasury securities or the current

yield on 1-year Treasury Constant

Maturities. Under such a plan, future

interest credits can, without violating

section 411(a), be projected to normal

retirement age using a rate that is no

greater than the applicable interest rate

under section 417(e)(3). In that case,

assuming that the annuity conversion

factor under the plan is not less than

the annuity conversion factor determined using the applicable interest rate

and mortality table under section

417(e)(3), the employee’s hypothetical

account balance will equal or exceed

the present value of the employee’s

accrued benefit determined in accordance with section 417(e). Thus, a single

sum distribution equal to the

employee’s hypothetical account balance under such a plan will satisfy

sections 411(a) and 417(e).

In other cases, a single sum distribution equal to an employee’s hypothetical account balance will satisfy sections

417(e) and 411(a) if (a) the annuity

conversion factor is not less than the

annuity conversion factor determined

using the applicable interest rate and

mortality table under section 417(e)(3),

(b) under the method for reflecting

future interest credits in the calculation

of an employee’s accrued benefit, the

future interest credits are projected

using a rate that is no greater that the

applicable interest rate under section

417(e)(3), and (c) this projection does

not result in a forfeiture in violation of

section 411(a).

By contrast, if the interest rate or

rate of return under the plan used in

determining the amount of interest

credits is high relative to the section

417(e)(3) interest rate, the plan cannot

distribute a single sum equal to the

employee’s hypothetical account balance and satisfy sections 411(a) and

417(e). If such a plan provided that, in

determining an employee’s accrued

benefit, the rate used for projecting the

amount of future interest credits was no

greater than the interest rate under

section 417(e)(3), the projection would

result in a forfeiture. Alternatively, if

the plan provided for interest credits to

be projected using a rate that exceeded

the section 417(e) interest rate but then

provided for the benefit to be discounted using that same higher rate, the

plan would violate section 417(e).

C. Effect of defining the accrued

benefit as the hypothetical

account balance

The requirements referred to in this

notice apply even in the case of a cash

balance plan that defines an employee’s

accrued benefit as an amount equal to

the employee’s hypothetical account

balance. Section 411(a)(7) defines the

accrued benefit in terms of benefits

payable under the plan at normal

retirement age. In a cash balance plan,

for an employee who has not attained

normal retirement age, whether the

employee’s retirement benefit payable

at normal retirement age under the plan

includes benefits attributable to future

interest credits depends on whether

those benefits have accrued.

If benefits attributable to future

interest credits have accrued, and those

benefits are disregarded when benefits

commence before normal retirement

age, the plan has effectively conditioned entitlement to the benefits attributable to those future interest

credits on the employee not taking a

distribution prior to normal retirement

age. Pursuant to §1.411(a)–4T, a right

that is conditioned under the plan on a

subsequent forbearance is a forfeitable

right. Accordingly, conditioning entitlement to benefits on the employee not

taking a distribution violates the nonforfeitability requirements of section

411(a).

Alternatively, if the benefits attributable to future interest credits have not

accrued and will accrue only as of the

later dates when the interest credits are

included in the hypothetical account

balance, the timing of those later

accruals must be taken into account in

applying the accrual rules of section

411(b)(1). As a result, such a plan

typically will not satisfy those accrual

rules.

IV. Description of proposal

A. Variable interest rates that may

be assumed for these purposes

to be no greater than the 30year Treasury interest rate

It is anticipated that the regulations

will set forth a list of standard indices

and associated margins for use with

frontloaded interest credit plans that

provide interest credits equal to the

product of the balance of the hypothetical account and the current value of a

variable index. (It is anticipated that

this proposal will apply without regard

to how frequently the rate used to

determine interest credits is compounded.) Under a frontloaded interest

credit plan that, for this purpose,

specifies a variable index equal to the

PBGC immediate rate or the sum of

one of the standard indices and a

margin not greater than the specified

margin associated with that standard

index, no impermissible forfeiture

would result from projecting that the

rate used to determine future interest

credits for an employee is no greater

than the applicable interest rate under

section 417(e)(3), as amended by RPA

’94. Thus, if such a plan has been

amended to comply with the changes to

section 417(e) made by RPA ’94, the

employee’s entire accrued benefit could

be distributed in the form of a single

sum distribution equal to the

employee’s hypothetical account balance without violating section 411(a) or

417(e), provided that the plan provides

the appropriate annuity conversion

factors.

The table below provides the proposed list of standard indices and

associated margins. The discount rates

on Treasury bills and the yields on

Treasury Constant Maturities are the

rates reported in the Federal Reserve

Bulletin, and the Consumer Price Index

is CPI-U, as reported by the Department of Labor. Authority would be

delegated to the Commissioner to approve other indices and associated

margins.

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Standard Index

Associated

Margin

The discount rate on 3-month Treasury Bills

175 basis

points

The discount rate on 6-month Treasury Bills or 12month Treasury Bills

150 basis

points

The yield on 1-year Treasury Constant Maturities

100 basis

points

The yield on 2-year Treasury Constant Maturities or

3-year Treasury Constant Maturities

50 basis

points

The yield on 5-year Treasury Constant Maturities or

7-year Treasury Constant Maturities

25 basis

points

The yield on 10-year Treasury Constant Maturities or

any longer period Treasury Constant Maturities

0 basis points

Annual rate of change of the Consumer Price Index

3 percentage

points

In developing these standard indices

and associated margins, the Service and

Treasury took into account the historical relationship between each of these

indices and the rate of interest on 30year Treasury securities.

Under the proposal, if a frontloaded

interest credit plan specified a variable

index for use in determining the

amount of interest credits that is equal

to the sum of a standard index (listed

in the table above) and a margin that

exceeds the specified margin associated

with that standard index, distribution of

a single sum equal to the employee’s

hypothetical account balance would not

satisfy both section 411(a) and section

417(e). If such a plan provided that the

rate used for projecting the amount of

future interest credits was no greater

than the interest rate under section

417(e)(3), the projection would result

in a forfeiture. Alternatively, if a

frontloaded interest credit plan provided for interest credits to be projected using a rate that exceeded the

section 417(e) interest rate but then

provided for the benefit to be discounted using that same higher rate, the

plan would violate section 417(e).

B. Guidance will be prospective

The anticipated regulations will be

effective prospectively. In addition, for

plan years beginning before the regulations are effective, a frontloaded inter-

est credit plan would not be disqualified for failing to satisfy section 411(a)

or 417(e) if the amount of the distribution satisfied those sections based on a

reasonable, good-faith interpretation of

the applicable provisions of the Code,

taking into account pre-existing guidance. For this purpose, plans that

comply with the guidance in this notice

are deemed to be applying a reasonable, good faith interpretation.

V. Comments

The Service and Treasury invite

comments on the proposal described in

this notice. Comments are specifically

requested on other indices for which

guidance may be appropriate and on

guidance that would facilitate the transition to use of an approved index

(including possible guidance with respect to the application of section

411(d)(6)). Any suggestion of an index

(and associated margin, if any) should

include an analysis of the historical

relationship between the index and the

rate for 30-year Treasury securities.

Comments should be submitted in writing, referencing Notice 96–7, and addressed to—

Associate Chief Counsel

(Employee Benefits and Exempt

Organizations)

CC:EBEO

ATTN: Cash Balance Guidance

Room 5214

Internal Revenue Service

1111 Constitution Ave., N.W.

Washington, D.C. 20224

VI. Drafting information

The principal author of this notice is

Marjorie Hoffman of the Office of the

Associate Chief Counsel (Employee

Benefits and Exempt Organizations).

For further information, contact Ms.

Hoffman at 202-622-6030 (not a tollfree number).

Weighted Average Interest Rate

Update

Notice 96–9

Notice 88–73 provides guidelines for

determining the weighted average interest rate and the resulting permissible

range of interest rates used to calculate

current liability for the purpose of the

full funding limitation of § 412(c)(7) of

the Internal Revenue Code as amended

by the Omnibus Budget Reconciliation

Act of 1987 and as further amended by

the Uruguay Round Agreements Act,

Pub. L. 103–465 (GATT).

The average yield on the 30-year

Treasury Constant Maturities for December 1995 is 6.06 percent.

The following rates were determined

for the plan years beginning in the

month shown below.

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Month

Year

Weighted

Average

January

1996

7.05

Drafting Information

The principal author of this notice is

Donna Prestia of the Employee Plans

Division. For further information regarding this notice, call (202) 622-6076

between 2:30 and 4:00 p.m. Eastern

time (not a toll-free number). Ms.

Prestia’s number is (202) 622-7377

(also not a toll-free number).

90% to 108%

Permissible

Range

90% to 110%

Permissible

Range

6.35 to 7.62

6.35 to 7.76

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