These synopses are intended only as aids to the reader in

Agency decision

Ask Donna

What actually matters in this document.

Text

Bulletin No. 1997–9

March 3, 1997

HIGHLIGHTS

OF THIS ISSUE

These synopses are intended only as aids to the reader in

identifying the subject matter covered. They may not be relied

upon as authoritative interpretations.

INCOME TAX

EXEMPT ORGANIZATIONS

Rev. Rul. 97–9, page 4.

Medical and dental expenses. Amounts paid to obtain

a controlled substance (such as marijuana), in violation

of federal law, are not deductible expenses for medical

care under section 213 of the Code.

Announcement 97–17, page 23.

A list is given of organizations now classified as private

foundations.

T.D. 8709, page 5.

REG–242996–96, page 18.

Final, temporary, and proposed regulations under section 1275 of the Code relate to the federal income tax

treatment of inflation-indexed debt instruments. A public

hearing will be held on the proposed regulations on April

30, 1997.

REG–252233–96, page 19.

Proposed regulations under section 368 of the Code

provide certain reorganizations, transfers by the acquiring corporation of target assets or stock to certain

controlled corporations, and transfers of target assets to

partnerships, will not disqualify the transaction from

satisfying the continuity of interest and business enterprise requirements. A public hearing will be held on May

7, 1997.

EMPLOYEE PLANS

Notice 97–16, page 15.

Weighted average interest rate update. Guidelines are

set forth for determining for Februar y 1997, 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).

Finding Lists begin on page 26.

Monthly Index for February on page 28.

EMPLOYMENT TAX

T.D. 8706, page 11.

Final regulations under section 3402 of the Code relate

to Form W–4, Employee’s Withholding Allowance Certificate.

Page 17.

Social security domestic employee coverage threshold. The Commissioner of the Social Security Administration has determined the domestic employee coverage

threshold amount for 1997.

ADMINISTRATIVE

Rev. Proc. 97–17, page 15.

Mortgage revenue bonds; mortgage credit certificates; average annual mortgage originations. A list is

set forth of the average annual aggregate principal

amount of mortgages executed during the years 1992,

1993, and 1994 for each state, the District of Columbia, Guam, Puerto Rico, and the Virgin Islands to assist

issuers of mortgage revenue bonds and mortgage credit

certificates in determining whether the required portion

of loans are made available in targeted areas as

described in section 143(h) of the Code. Rev. Proc.

95–14 is obsolete, except as provided in section 5.02

of this procedure.

Announcement 97–15, page 23.

Rev. Proc. 97–10, 1997–2 I.R.B. 59, relating to the

change in computing depreciation for retail motor fuels

outlets, is corrected.

Announcement 97–16, page 23.

Notice 97–9, 1997–2 I.R.B. 35, regarding adoption

assistance, is corrected.

Mission of the Service

The purpose of the Internal Revenue Service is to

collect the proper amount of tax revenue at the least

cost; serve the public by continually improving the

quality of our products and services; and perform in a

manner warranting the highest degree of public

confidence in our integrity, efficiency and fairness.

Statement of Principles

of Internal Revenue

Tax Administration

The Service also has the responsibility of applying

and administering the law in a reasonable,

practical manner. Issues should only be raised by

examining of ficers when they have merit, never

arbitrarily or for trading purposes. At the same

time, the examining officer should never hesitate

to raise a meritorious issue. It is also important

that care be exercised not to raise an issue or to

ask a court to adopt a position inconsistent with

an established Service position.

The function of the Internal Revenue Service is to

administer the Internal Revenue Code. Tax policy

for raising revenue is determined by Congress.

With this in mind, it is the duty of the Service to

carry out that policy by correctly applying the laws

enacted by Congress; to determine the reasonable

meaning of various Code provisions in light of the

Congressional purpose in enacting them; and to

perform this work in a fair and impartial manner,

with neither a government nor a taxpayer point of view.

Administration should be both reasonable and

vigorous. It should be conducted with as little

delay as possible and with great cour tesy and

considerateness. It should never try to overreach,

and should be reasonable within the bounds of law

and sound administration. It should, however, be

vigorous in requiring compliance with law and it

should be relentless in its attack on unreal tax

devices and fraud.

At the heart of administration is interpretation of the

Code. It is the responsibility of each person in the

Service, charged with the duty of interpreting the

law, to try to find the true meaning of the statutory

provision and not to adopt a strained construction in

the belief that he or she is ‘‘protecting the revenue.’’

The revenue is properly protected only when we ascertain and apply the true meaning of the statute.

Introduction

The Internal Revenue Bulletin is the authoritative instrument of the Commissioner of Internal Revenue for

announcing official rulings and procedures of the Internal Revenue Service and for publishing Treasury Decisions, Executive Orders, Tax Conventions, legislation,

court decisions, and other items of general interest. It is

published weekly and may be obtained from the Superintendent of Documents on a subscription basis. Bulletin

contents of a permanent nature are consolidated semiannually into Cumulative Bulletins, which are sold on a

single-copy basis.

court decisions, rulings, and procedures must be considered, and Service personnel and others concerned are

cautioned against reaching the same conclusions in

other cases unless the facts and circumstances are

substantially the same.

The Bulletin is divided into four parts as follows:

Part I.—1986 Code.

This part includes rulings and decisions based on

provisions of the Internal Revenue Code of 1986.

It is the policy of the Service to publish in the Bulletin all

substantive rulings necessary to promote a uniform

application of the tax laws, including all rulings that

supersede, revoke, modify, or amend any of those

previously published in the Bulletin. All published rulings

apply retroactively unless otherwise indicated. Procedures relating solely to matters of internal management

are not published; however, statements of internal

practices and procedures that affect the rights and

duties of taxpayers are published.

Part II.—Treaties and Tax Legislation.

This part is divided into two subparts as follows:

Subpart A, Tax Conventions, and Subpart B, Legislation

and Related Committee Reports.

Part III.—Administrative, Procedural, and Miscellaneous.

To the extent practicable, pertinent cross references to

these subjects are contained in the other Parts and

Subparts. Also included in this part are Bank Secrecy

Act Administrative Rulings. Bank Secrecy Act Administrative Rulings are issued by the Department of the

Treasury’s Office of the Assistant Secretary (Enforcement).

Revenue rulings represent the conclusions of the Service on the application of the law to the pivotal facts

stated in the revenue ruling. In those based on positions

taken in rulings to taxpayers or technical advice to

Service field offices, identifying details and information

of a confidential nature are deleted to prevent unwarranted invasions of privacy and to comply with statutory

requirements.

Part IV.—Items of General Interest.

With the exception of the Notice of Proposed Rulemaking and the disbarment and suspension list included in

this part, none of these announcements are consolidated in the Cumulative Bulletins.

Rulings and procedures reported in the Bulletin do not

have the force and effect of Treasury Department

Regulations, but they may be used as precedents.

Unpublished rulings will not be relied on, used, or cited

as precedents by Service personnel in the disposition of

other cases. In applying published rulings and procedures, the effect of subsequent legislation, regulations,

The first Bulletin for each month includes an index for

the matters published during the preceding month.

These monthly indexes are cumulated on a quarterly and

semiannual basis, and are published in the first Bulletin

of the succeeding quarterly and semi-annual period,

respectively.

The contents of this publication are not copyrighted and may be reprinted freely. A citation of the Internal Revenue Bulletin as the source would be appropriate.

For sale by the Superintendent of Documents U.S. Government Printing Office, Washington, D.C. 20402.

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

Section 25.—Interest on Certain

Home Mortgages

26 CFR 1.25–4T: Qualified mortgage credit certificate program (temporary).

The average annual aggregate principal amount

of mortgages executed during 1992, 1993, 1994

are set forth for use by issuers of mortgage credit

certificates in determining if the required portion

of loans under sections 25(c)(2)(A)(iii)(V) and

143(h) of the Code are made available in targeted

areas. See Rev. Proc. 97–17, page 15.

Section 103.—State and Local

Bonds

26 CFR 1.103–1: Interest upon obligations of a

State, Territory, etc.

The average annual aggregate principal amount

of mortgages executed during 1992, 1993, 1994

are set forth for use by issuers of qualified

mortgage bonds in determining if the required

portion of loans are made available in targeted

areas under section 143(h) of the Code. See Rev.

Proc. 97–17, page 15.

Section 143.—Mortgage Revenue

Bonds: Qualified Mortgage Bond

and Qualified Veterans’ Mortgage

Bond

26 CFR 6a.103A–2: Qualified mortgage bond.

The average annual aggregate principal amount

of mortgages executed during 1992, 1993, 1994

are set forth for use by issuers of qualified

mortgage bonds and mortgage credit certificates in

determining if the required portion of loans are

made available in targeted areas under section

143(h) of the Code. See Rev. Proc. 97–17, page

15.

Section 213.—Medical, Dental,

Etc., Expenses

26 CFR 1.213–1: Medical, dental, etc., expenses.

Medical and dental expenses.

Amounts paid to obtain a controlled

substance (such as marijuana), in violation of federal law, are not deductible

expenses for medical care under section

213 of the Code.

Rev. Rul. 97–9

ISSUE

Is an amount paid to obtain a controlled substance (such as marijuana) for

medical purposes, in violation of federal

law, a deductible expense for medical

care under § 213 of the Internal Revenue Code?

FACTS

Based on the recommendation of a

physician, A purchased marijuana and

used it to treat A’s disease in a state

whose laws permit such purchase and

use.

LAW AND ANALYSIS

Section 213(a) allows a deduction for

uncompensated expenses of an individual for medical care to the extent

such expenses exceed 7.5 percent of

adjusted gross income. Section 213(d)(1)

provides, in part, that ‘‘medical care’’

means amounts paid for the cure, mitigation, and treatment of disease. However, under § 213(b) an amount paid for

medicine or a drug is an expense for

medical care under § 213(a) only if the

medicine or drug is a prescribed drug or

insulin. Section 213(d)(3) provides that

a ‘‘prescribed drug’’ is a drug or biological that requires a prescription of a

physician for its use by an individual.

Section 1.213–1(e)(2) of the Income

Tax Regulations provides, in part, that

the term ‘‘medicine and drugs’’ includes

only items that are ‘‘legally procured.’’

Section 1.213–1(e)(1)(ii) provides that

amounts expended for illegal operations

or treatments are not deductible.

Rev. Rul. 78–325, 1978–2 C.B. 124,

holds that amounts paid by a taxpayer

for laetrile, prescribed by a physician for

the medical treatment of the taxpayer’s

illness, are expenses for medicine and

drugs that are deductible under § 213.

The revenue ruling states that the

laetrile was purchased and used in a

locality where its sale and use were

legal.

Rev. Rul. 73–201, 1973–1 C.B. 140,

holds that amounts paid for a vasectomy

and an abortion are expenses for medical care that are deductible under § 213.

The revenue ruling states that neither

procedure was illegal under state law.

A’s purchase and use of marijuana

were permitted under the laws of A’s

state. However, marijuana is listed as a

controlled substance on Schedule I of

the Controlled Substances Act (CSA),

21 U.S.C. §§ 801–971. 21 U.S.C.

§ 812(c). Except as authorized by the

CSA, it is unlawful for any person to

manufacture, distribute, or dispense, or

possess with intent to manufacture, distribute, or dispense, a controlled substance. 21 U.S.C. § 841(a). Further, it is

unlawful for any person knowingly or

intentionally to possess a controlled sub-

stance except as authorized by the CSA.

21 U.S.C. 844(a). Generally, the CSA

does not permit the possession of controlled substances listed on Schedule I,

even for medical purposes, and even

with a physician’s prescription.

Notwithstanding state law, a controlled substance (such as marijuana),

obtained in violation of the CSA, is not

‘‘legally procured’’ within the meaning

of § 1.213–1(e)(2). Further, an amount

expended to obtain a controlled substance (such as marijuana) in violation

of the CSA is an amount expended for

an illegal treatment within the meaning

of § 1.213–1(e)(1)(ii). Accordingly, A

may not deduct under § 213 the amount

A paid to purchase marijuana.

HOLDING

An amount paid to obtain a controlled

substance (such as marijuana) for medical purposes, in violation of federal law,

is not a deductible expense for medical

care under § 213. This holding applies

even if the state law requires a prescription of a physician to obtain and use the

controlled substance and the taxpayer

obtains a prescription.

EFFECT ON OTHER DOCUMENTS

Rev. Rul. 78–325 is obsoleted. Subsequent to the issuance of Rev. Rul.

78–325, the courts have upheld the Food

and Drug Administration determination

that generally prohibits interstate commerce in laetrile under the Food, Drug,

and Cosmetic Act, 21 U.S.C. §§ 331

and 355(a). See United States v.

Rutherford, 442 U.S. 544 (1979);

Rutherford v. United States, 806 F.2d

1455 (10th Cir. 1986). Thus, notwithstanding state and local law, laetrile

cannot be legally procured within the

meaning of § 1.213–1(e)(2). Accordingly, amounts paid to obtain laetrile are

not deductible under § 213.

Rev. Rul. 73–201 is clarified to reflect that the medical procedures at issue

in that revenue ruling are not illegal

under federal law.

DRAFTING INFORMATION

The principal authors of this revenue

ruling are Donna M. Crisalli and Sharon

Hester of the Office of Assistant Chief

Counsel (Income Tax and Accounting).

For further information regarding this

revenue ruling, contact Ms. Crisalli or

Ms. Hester on (202) 622–4920 (not a

toll-free call).

Section 1275.—Other Definitions

and Special Rules

26 CFR 1.1275–7T: Inflation-indexed debt instruments (temporary).

T.D. 8709

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

Inflation-Indexed Debt Instruments

AGENCY: Internal Revenue Service

(IRS), Treasury.

ACTION: Temporary and final regulations.

SUMMARY: This document contains

temporary regulations relating to the

federal income tax treatment of

inflation-indexed debt instruments, including Treasury Inflation-Indexed Securities. The text of the temporary regulations also serves as the text of REG–

242996–96, page 18. This document

also contains amendments to final regulations to reflect the addition of the

temporary regulations. The regulations

in this document provide needed guidance to holders and issuers of inflationindexed debt instruments.

EFFECTIVE DATE: The regulations are

effective January 6, 1997.

FOR FURTHER INFORMATION CONTACT: Jeffrey W. Maddrey, (202) 622–

3940, or William E. Blanchard, (202)

622–3950 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Background

The Department of the Treasury published final rules describing the terms

and conditions of new debt instruments

that it plans to issue. The payments on

these debt instruments (Treasury

Inflation-Indexed Securities) will be indexed for inflation and deflation.

On June 14, 1996, the IRS published

final regulations in the Federal Register

relating to certain debt instruments that

provide for contingent payments (61 FR

30133). The preamble to the final regulations indicates that the noncontingent

bond method described in § 1.1275–

4(b) might be inappropriate for the

Treasury Inflation-Indexed Securities.

On October 15, 1996, the IRS published

Notice 96–51 (1996–42 I.R.B. 6), which

announced the IRS’s intention to issue

temporary and proposed regulations that

would provide guidance on the federal

income tax treatment of the Treasury

Inflation-Indexed Securities and other

debt instruments with similar terms.

This document contains the temporary

regulations described in Notice 96–51.

Explanation of provisions

A. In general

The temporary regulations provide

rules for the treatment of certain debt

instruments that are indexed for inflation

and deflation, including Treasury

Inflation-Indexed Securities. The temporary regulations generally require holders and issuers of inflation-indexed debt

instruments to account for interest and

original issue discount (OID) using constant yield principles. In addition, the

temporary regulations generally require

holders and issuers of inflation-indexed

debt instruments to account for inflation

and deflation by making current adjustments to their OID accruals.

B. Applicability

The temporary regulations apply to

inflation-indexed debt instruments. In

general, an inflation-indexed debt instrument is a debt instrument that (1) is

issued for cash, (2) is indexed for

inflation and deflation (as described below), and (3) is not otherwise a contingent payment debt instrument. The temporary regulations do not apply,

however, to certain debt instruments,

such as debt instruments issued by

qualified state tuition programs.

C. Indexing methodology

A debt instrument is considered indexed for inflation and deflation if the

payments on the instrument are indexed

by reference to the change in value of a

general price or wage index over the

term of the instrument. Specifically, the

amount of each payment on an inflationindexed debt instrument must equal the

product of (1) the amount of the payment that would be payable on the

instrument (determined as if there were

no inflation or deflation over the term of

the instrument) and (2) the ratio of the

value of the reference index for the

payment date to the value of the reference index for the issue date.

The reference index for a debt instrument is the mechanism for measuring

inflation and deflation over the term of

the instrument. This mechanism associates the value of a single qualified

inflation index for a particular month

with a specified day of a succeeding

month. For example, under the terms of

the Treasury Inflation-Indexed Securities, the reference index for the first day

of a month is the value of a qualified

inflation index for the third preceding

month. The reference index must be

reset once a month to the current value

of a qualified inflation index. Between

reset dates, the value of the reference

index is determined through straight-line

interpolation.

A qualified inflation index is a general price or wage index that is updated

and published at least monthly by an

agency of the United States Government. A general price or wage index is

an index that measures price or wage

changes in the economy as a whole. An

index is not general if it only measures

price or wage changes in a particular

segment of the economy. For example,

the non-seasonally adjusted U.S. City

Average All Items Consumer Price Index for All Urban Consumers (CPI-U),

which is published by the Bureau of

Labor Statistics of the Department of

Labor, is a qualified inflation index

because it measures general price

changes in the economy. By contrast,

the gasoline price component of the

CPI-U is not a qualified inflation index

because it only measures price changes

in a particular segment of the economy.

D. Coupon bond method

The temporary regulations provide a

simplified method of accounting for

qualified stated interest and inflation

adjustments on certain inflation-indexed

debt instruments (the coupon bond

method). To qualify for the coupon bond

method, an inflation-indexed debt instrument must satisfy two conditions. First,

there must be no more than a de

minimis difference between the debt

instrument’s issue price and its principal

amount for the issue date. Second, all

stated interest on the debt instrument

must be qualified stated interest. Because Treasury Inflation-Indexed Securities that are not stripped into principal

and interest components satisfy both of

these conditions, the coupon bond

method applies to these securities.

If an inflation-indexed debt instrument qualifies for the coupon bond

method, the stated interest payable on

the debt instrument is taken into account

under the taxpayer’s regular method of

accounting. Any increase in the

inflation-adjusted principal amount is

treated as OID for the period in which

the increase occurs. Any decrease in the

inflation-adjusted principal amount is

taken into account under the rules for

deflation adjustments described below.

For example, if a taxpayer holds a

Treasury Inflation-Indexed Security for

an entire calendar year and the taxpayer

uses the cash receipts and disbursements

method of accounting (cash method), the

taxpayer generally includes in income

the interest payments received on the

security during the year. In addition, the

taxpayer includes in income an amount

of OID measured by subtracting the

inflation-adjusted principal amount of

the security at the beginning of the year

from the inflation-adjusted principal

amount of the security at the end of the

year. If the taxpayer uses an accrual

method of accounting rather than the

cash method, the taxpayer includes in

income the qualified stated interest that

accrued on the debt instrument during

the year and an amount of OID measured by subtracting the inflationadjusted principal amount of the security

at the beginning of the year from the

inflation-adjusted principal amount of

the security at the end of the year.

E. Discount bond method

If an inflation-indexed debt instrument does not qualify for the coupon

bond method (for example, because it is

issued at a discount), the instrument is

subject to the discount bond method. In

general, the discount bond method requires holders and issuers to make current adjustments to their OID accruals to

account for inflation and deflation.

Under the discount bond method, a

taxpayer determines the amount of OID

allocable to an accrual period by using

steps similar to those provided in

§ 1.1272–1(b)(1). First, the taxpayer determines the yield to maturity of the

debt instrument as if there were no

inflation or deflation over the term of

the instrument. Second, the taxpayer

determines the length of the accrual

periods to be used to allocate OID over

the term of the debt instrument, provided no accrual period is longer than

one month. Third, the taxpayer determines the percentage change in the

value of the reference index during the

accrual period by comparing the value

at the beginning of the period to the

value at the end of the period. Fourth,

the taxpayer determines the OID allocable to the accrual period by using a

formula that takes into account both the

yield of the debt instrument and the

percentage change in the value of the

reference index during the period. Fifth,

the taxpayer allocates to each day in the

accrual period a ratable portion of the

OID for the accrual period (the daily

portions). If the daily portions for an

accrual period are positive amounts,

these amounts are taken into account

under section 163(e) by an issuer and

under section 1272 by a holder. If the

daily portions for an accrual period are

negative amounts, these amounts are

taken into account under the rules for

deflation adjustments described below.

Under Notice 96–51, the discount

bond method would have allowed qualified stated interest. The temporary regulations, however, provide that no interest

payments on an inflation-indexed debt

instrument subject to the discount bond

method are qualified stated interest. The

Treasury and the IRS believe that this

change simplifies the taxation of an

inflation-indexed debt instrument subject

to the discount bond method.

G. Minimum guarantee

Certain inflation-indexed debt instruments may provide for an additional

payment at maturity (a minimum guarantee payment) if the total amount of

inflation-adjusted principal paid on the

debt instrument is less than the instrument’s stated principal amount. Under

both the coupon bond method and the

discount bond method, a minimum guarantee payment is ignored until the payment is made. If a minimum guarantee

payment is made, the payment is treated

as interest on the date it is paid.

In general, the temporary regulations

only allow a debt instrument that is

indexed by reference to the CPI–U to

provide for a minimum guarantee payment. The Treasury and the IRS believe

that there is only a small possibility that

the total amount of principal paid on a

debt instrument indexed to the CPI–U

will be less than the instrument’s stated

principal amount. In this case, it is

appropriate to ignore the minimum guarantee payment until it is paid.

H. Principal amount for the issue date

F. Deflation adjustments

The temporary regulations treat deflation adjustments in a manner consistent

with the treatment of net negative adjustments on contingent payment debt

instruments under § 1.1275–4(b)(6)(iii).

If a holder has a deflation adjustment

for a taxable year, the deflation adjustment first reduces the amount of interest

otherwise includible in income with respect to the debt instrument for the

taxable year. If the amount of the deflation adjustment exceeds the interest otherwise includible in income for the

taxable year, the holder treats the excess

as an ordinary loss in the taxable year.

However, the amount treated as an ordinary loss is limited to the amount by

which the holder’s total interest inclusions on the debt instrument in prior

taxable years exceed the total amount

treated by the holder as an ordinary loss

on the debt instrument in prior taxable

years. If the deflation adjustment exceeds the interest otherwise includible in

income by the holder with respect to the

debt instrument for the taxable year and

the amount treated as an ordinary loss

for the taxable year, the excess is carried forward to offset interest income on

the debt instrument in subsequent taxable years. Similar rules apply to determine an issuer’s interest deductions and

income for the debt instrument.

For purposes of the temporary regulations, if an inflation-indexed debt instrument is issued with pre-issuance accrued

interest, the principal amount of the

instrument for the issue date includes an

adjustment for inflation or deflation.

This adjustment is measured by the

change in the value of the reference

index between the date on which interest starts to accrue (the dated date in the

case of a Treasury Inflation-Indexed

Security) and the issue date. The stated

principal amount of a debt instrument

under the regulations, however, is not

adjusted for inflation or deflation between the date on which interest starts

to accrue and the issue date. Therefore,

the stated principal amount of the debt

instrument is the same regardless of

whether interest accrues on the instrument from the issue date or from an

earlier date. The stated principal amount

of a Treasury Inflation-Indexed Security

is the par amount of the security, as

defined in the final rules published by

the Treasury Department describing the

terms and conditions of Treasury

Inflation-Indexed Securities.

When there is a difference between

the stated principal amount of an

inflation-indexed debt instrument and its

principal amount for the issue date, the

instrument’s principal amount for the

issue date generally is used for purposes

of applying the rules in the temporary

regulations to the instrument. For example, the debt instrument’s principal

amount for the issue date is used to

determine whether the instrument qualifies for the coupon bond method. The

temporary regulations require the use of

a debt instrument’s stated principal

amount rather than its principal amount

for the issue date to measure the amount

of a minimum guarantee payment.

I. Strips

Treasury Inflation-Indexed Securities

are eligible for the Department of the

Treasury’s Separate Trading of Registered Interest and Principal of Securities

(STRIPS) program. Under this program,

the interest and principal components of

a Treasury Inflation-Indexed Security

may be transferred as separate instruments (stripped bonds and coupons). In

general, section 1286 treats the holder of

a stripped bond (or coupon) as if the

holder purchased a newly issued debt

instrument that has OID. The temporary

regulations provide that the holder of a

component of a Treasury InflationIndexed Security that is stripped under

the Treasury STRIPS program must use

the discount bond method to account for

the OID on the component.

J. Information reporting

The temporary regulations do not provide any new information reporting

rules for inflation-indexed debt instruments. The OID and any qualified stated

interest on an inflation-indexed debt

instrument should be reported on Form

1099–OID. The IRS plans to issue guidance for the reporting of OID on Treasury Inflation-Indexed Securities that are

stripped under the STRIPS program.

K. Effective date

The temporary regulations apply to an

inflation-indexed debt instrument issued

on or after January 6, 1997.

Special Analyses

It has been determined that this Treasury decision is not a significant regulatory action as defined in EO 12866.

Therefore, a regulatory assessment is not

required. It also has been determined

that section 553(b) of the Administrative

Procedure Act (5 U.S.C. chapter 5) does

not apply to these regulations and, because the regulations do not impose a

collection of information on small entities, the Regulatory Flexibility Act (5

U.S.C. chapter 6) does not apply. Pursuant to section 7805(f) of the Internal

Revenue Code, these temporary regulations will be submitted to the Chief

Counsel for Advocacy of the Small

Business Administration for comment on

their impact on small business.

Drafting Information

The principal author of the regulations is Jeffrey W. Maddrey, Office of

Assistant Chief Counsel (Financial Institutions and Products). However, other

personnel from the IRS and Treasury

Department participated in their development.

Adoption of Amendments to the Regulations

Accordingly, 26 CFR part 1 is

amended as follows:

Part 1—INCOME TAXES

Paragraph 1. The authority citation for

part 1 is amended by adding two entries

in numerical order to read as follows:

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

Section 1.1275–7T also issued under 26

U.S.C. 1275(d). * * *

Section 1.1286–2T also issued under 26

U.S.C. 1286(f). * * *

Par. 2. Section 1.1271–0 is amended

by—

1. Revising the second sentence of

paragraph (a);

2. Revising the introductory text of

paragraph (b); and

3. Adding entries for § 1.1275–7T in

paragraph (b).

The revisions and additions read as

follows:

§ 1.1271–0 Original issue discount; effective date; table of contents.

(a) * * * Taxpayers, however, may

rely on these sections (as contained in

26 CFR part 1 revised April 1, 1996) for

debt instruments issued after December

21, 1992, and before April 4, 1994.

(b) Table of contents. This section

lists captioned paragraphs contained in

§§ 1.1271–1 through 1.1275–7T.

§ 1.1275–7T Inflation-indexed debt instruments (temporary).

(a) Overview.

(b) Applicability.

(1) In general.

(2) Exceptions.

(1) Inflation-indexed debt instrument.

(2) Reference index.

(3) Qualified inflation index.

(4) Inflation-adjusted principal amount.

(5) Minimum guarantee payment.

(d) Coupon bond method.

(1) In general.

(2) Applicability.

(3) Qualified stated interest.

(4) Inflation adjustments.

(5) Example.

(e) Discount bond method.

(1) In general.

(2) No qualified stated interest.

(3) OID.

(4) Example.

(f) Special rules.

(1) Deflation adjustments.

(2) Adjusted basis.

(3) Subsequent holders.

(4) Minimum guarantee.

(5) Temporary unavailability of a qualified inflation index.

(g) Reopenings.

(h) Effective date.

Par. 3. Section 1.1275–4 is amended

by—

1. Removing the word ‘‘or’’ from the

end of paragraph (a)(2)(vi);

2. Redesignating paragraph (a)(2)(vii)

as paragraph (a)(2)(viii); and

3. Adding

new

paragraph

(a)(2)(vii).

The addition reads as follows:

§ 1.1275–4 Contingent payment debt

instruments.

(a) * * *

(2) * * *

(vii) An inflation-indexed debt instrument (as defined in § 1.1275–7T); or

Par. 4. Section 1.1275–7T is added to

read as follows:

§ 1.1275–7T Inflation-indexed debt instruments (temporary).

(a) Overview. This section provides

rules for the federal income tax treatment of an inflation-indexed debt instrument. If a debt instrument is an

inflation-indexed debt instrument, one of

two methods will apply to the instrument: the coupon bond method (as described in paragraph (d) of this section)

or the discount bond method (as described in paragraph (e) of this section).

Both methods determine the amount of

OID that is taken into account each year

by a holder or an issuer of an inflationindexed debt instrument.

(b) Applicability—(1) In general. Except as provided in paragraph (b)(2) of

this section, this section applies to an

inflation-indexed debt instrument as defined in paragraph (c)(1) of this section.

For example, this section applies to

Treasury Inflation-Indexed Securities.

(2) Exceptions. This section does not

apply to an inflation-indexed debt instrument that is also—

(i) A debt instrument (other than a

tax-exempt obligation) described in section 1272(a)(2) (for example, U.S. savings bonds, certain loans between natural persons, and short-term taxable

obligations); or

(ii) A debt instrument subject to section 529 (certain debt instruments issued

by qualified state tuition programs).

(1) Inflation-indexed debt instrument.

An inflation-indexed debt instrument is

a debt instrument that satisfies the following conditions:

(i) Issued for cash. The debt instrument is issued for U.S. dollars and all

payments on the instrument are denominated in U.S. dollars.

(ii) Indexed for inflation and deflation. Except for a minimum guarantee

payment (as defined in paragraph (c)(5)

of this section), each payment on the

debt instrument is indexed for inflation

and deflation. A payment is indexed for

inflation and deflation if the amount of

the payment is equal to—

(A) The amount that would be payable if there were no inflation or deflation over the term of the debt instrument, multiplied by

(B) A ratio, the numerator of which

is the value of the reference index for

the date of the payment and the denominator of which is the value of the

reference index for the issue date.

(iii) No other contingencies. No payment on the debt instrument is subject

to a contingency other than the inflation

contingency or the contingencies described in this paragraph (c)(1)(iii). A

debt instrument may provide for—

(A) A minimum guarantee payment

as defined in paragraph (c)(5) of this

section; or

(B) Payments under one or more alternate payment schedules if the payments under each payment schedule are

indexed for inflation and deflation and a

payment schedule for the debt instrument can be determined under

§ 1.1272–1(c). (For purposes of this

section, the rules of § 1.1272–1(c) are

applied to the debt instrument by assuming that no inflation or deflation will

occur over the term of the instrument.)

(2) Reference index. The reference index is an index used to measure inflation and deflation over the term of a

debt instrument. To qualify as a reference index, an index must satisfy the

following conditions:

(i) The value of the index is reset

once a month to a current value of a

single qualified inflation index (as defined in paragraph (c)(3) of this section).

For this purpose, a value of a qualified

inflation index is current if the value has

been updated and published within the

preceding six month period.

(ii) The reset occurs on the same day

of each month (the reset date).

(iii) The value of the index for any

date between reset dates is determined

through straight-line interpolation.

(3) Qualified inflation index. A qualified inflation index is a general price or

wage index that is updated and published at least monthly by an agency of

the United States Government (for example, the non-seasonally adjusted U.S.

City Average All Items Consumer Price

Index for All Urban Consumers (CPI–

U), which is published by the Bureau of

Labor Statistics of the Department of

Labor).

(4) Inflation-adjusted

principal

amount. For any date, the inflationadjusted principal amount of an

inflation-indexed debt instrument is an

amount equal to—

(i) The outstanding principal amount

of the debt instrument (determined as if

there were no inflation or deflation over

the term of the instrument), multiplied

(ii) A ratio, the numerator of which is

the value of the reference index for the

date and the denominator of which is

the value of the reference index for the

issue date.

(5) Minimum guarantee payment. In

general, a minimum guarantee payment

is an additional payment made at maturity on a debt instrument if the total

amount of inflation-adjusted principal

paid on the instrument is less than the

instrument’s stated principal amount.

The amount of the additional payment

must be no more than the excess, if any,

of the debt instrument’s stated principal

amount over the total amount of

inflation-adjusted principal paid on the

instrument. An additional payment is not

a minimum guarantee payment unless

the qualified inflation index used to

determine the reference index is either

the CPI–U or an index designated for

this purpose by the Commissioner in the

Federal Register or the Internal Rev-

enue Bulletin (see § 601.601(d)(2)(ii) of

this chapter). See paragraph (f)(4) of

this section for the treatment of a minimum guarantee payment.

(d) Coupon bond method—(1) In

general. This paragraph (d) describes

the method (coupon bond method) to be

used to account for qualified stated

interest and inflation adjustments (OID)

on an inflation-indexed debt instrument

described in paragraph (d)(2) of this

section.

(2) Applicability. The coupon bond

method applies to an inflation-indexed

debt instrument that satisfies the following conditions:

(i) Issued at par. The debt instrument

is issued at par. A debt instrument is

issued at par if the difference between

its issue price and principal amount for

the issue date is less than the de

minimis amount. For this purpose, the

de minimis amount is determined using

the principles of § 1.1273–1(d).

(ii) All stated interest is qualified

stated interest. All stated interest on the

debt instrument is qualified stated interest. For purposes of this paragraph (d),

stated interest is qualified stated interest

if the interest is unconditionally payable

in cash, or is constructively received

under section 451, at least annually at a

single fixed rate. Stated interest is payable at a single fixed rate if the amount

of each interest payment is determined

by multiplying the inflation adjusted

principal amount for the payment date

by the single fixed rate.

(3) Qualified stated interest. Under

the coupon bond method, qualified

stated interest is taken into account

under the taxpayer’s regular method of

accounting. The amount of accrued but

unpaid qualified stated interest as of any

date is determined by using the principles of § 1.446–3(e)(2)(ii) (relating to

notional principal contracts). For example, if the interval between interest

payment dates spans two taxable years,

a taxpayer using an accrual method of

accounting determines the amount of

accrued qualified stated interest for the

first taxable year by reference to the

inflation-adjusted principal amount at

the end of the first taxable year.

(4) Inflation adjustments—(i) Current

accrual. Under the coupon bond

method, an inflation adjustment is taken

into account for each taxable year in

which the debt instrument is outstanding.

(ii) Amount of inflation adjustment.

For any relevant period (such as the

taxable year or the portion of the tax-

able year during which a taxpayer holds

an inflation-indexed debt instrument),

the amount of the inflation adjustment is

equal to—

(A) The sum of the inflation-adjusted

principal amount at the end of the

period and the principal payments made

during the period, minus

(B) The inflation-adjusted principal

amount at the beginning of the period.

(iii) Positive inflation adjustments. A

positive inflation adjustment is OID.

(iv) Negative inflation adjustments. A

negative inflation adjustment is a deflation adjustment that is taken into account under the rules of paragraph (f)(1)

of this section.

(5) Example. The following example

illustrates the coupon bond method:

Example. (i) Facts. On October 15, 1997, X

purchases at original issue, for $100,000, a debt

instrument that is indexed for inflation and deflation. The debt instrument matures on October 15,

1999, has a stated principal amount of $100,000,

and has a stated interest rate of 5 percent,

compounded semiannually. The debt instrument

provides that the principal amount is indexed to

the CPI–U. Interest is payable on April 15 and

October 15 of each year. The amount of each

interest payment is determined by multiplying the

inflation-adjusted principal amount for each interest payment date by the stated interest rate,

adjusted for the length of the accrual period. The

debt instrument provides for a single payment of

the inflation-adjusted principal amount at maturity.

In addition, the debt instrument provides for an

additional payment at maturity equal to the excess,

if any, of $100,000 over the inflation-adjusted

principal amount at maturity. X uses the cash

receipts and disbursements method of accounting

and the calendar year as its taxable year.

(ii) Indexing methodology. The debt instrument

provides that the inflation-adjusted principal

amount for any day is determined by multiplying

the principal amount of the instrument for the

issue date by a ratio, the numerator of which is

the value of the reference index for the day the

inflation-adjusted principal amount is to be determined and the denominator of which is the value

of the reference index for the issue date. The value

of the reference index for the first day of a month

is the value of the CPI–U for the third preceding

month. The value of the reference index for any

day other than the first day of a month is

determined based on a straight-line interpolation

between the value of the reference index for the

first day of the month and the value of the

reference index for the first day of the next month.

(iii) Inflation-indexed debt instrument subject to

the coupon bond method. Under paragraph (c)(1)

of this section, the debt instrument is an inflationindexed debt instrument. Because there is no

difference between the debt instrument’s issue

price ($100,000) and its principal amount for the

issue date ($100,000) and because all stated

interest is qualified stated interest, the coupon

bond method applies to the instrument.

(iv) Reference index values. Assume the following table lists the relevant reference index values

for 1997 through 1999:

Date

Reference index value

October 15, 1997

January 1, 1998

April 15, 1998

October 15, 1998

January 1, 1999

100

101

103

105

(v) Treatment of X in 1997. X does not receive

any payments of interest on the debt instrument in

1997. Therefore, X has no qualified stated interest

income for 1997. X, however, must take into

account the inflation adjustment for 1997. The

inflation-adjusted principal amount for January 1,

1998, is $101,000 ($100,000 x 101/100). Therefore, the inflation adjustment for 1997 is $1,000,

the inflation-adjusted principal amount for January

1, 1998 ($101,000) minus the principal amount for

the issue date ($100,000). X includes the $1,000

inflation adjustment in income as OID in 1997.

(vi) Treatment of X in 1998. In 1998, X

receives two payments of interest: On April 15,

1998, X receives a payment of $2,575 ($100,000 x

103/100 x .05/2), and on October 15, 1998, X

receives a payment of $2,625 ($100,000 x 105/100

x .05/2). Therefore, X’s qualified stated interest

income for 1998 is $5,200 ($2,575 + $2,625). X

also must take into account the inflation adjustment for 1998. The inflation-adjusted principal

amount for January 1, 1999, is $99,000 ($100,000

x 99/100). Therefore, the inflation adjustment for

1998 is negative $2,000, the inflation-adjusted

principal amount for January 1, 1999 ($99,000)

minus the inflation-adjusted principal amount for

January 1, 1998 ($101,000). Because the amount

of the inflation adjustment is negative, it is a

deflation adjustment. Under paragraph (f)(1)(i) of

this section, X uses this $2,000 deflation adjustment to reduce the interest otherwise includible in

income by X with respect to the debt instrument

in 1998. Therefore, X includes $3,200 in income

for 1998, the qualified stated interest income for

1998 ($5,200) minus the deflation adjustment

($2,000).

(e) Discount bond method—(1) In

general. This paragraph (e) describes the

method (discount bond method) to be

used to account for OID on an inflationindexed debt instrument that does not

qualify for the coupon bond method.

(2) No qualified stated interest. Under the discount bond method, no interest on an inflation-indexed debt instrument is qualified stated interest.

(3) OID. Under the discount bond

method, the amount of OID that accrues

on an inflation-indexed debt instrument

is determined as follows:

(i) Step one: Determine the debt instrument’s yield to maturity. The yield

of the debt instrument is determined

under the rules of § 1.1272–1(b)(1)(i).

In calculating the yield under those rules

for purposes of this paragraph (e)(3)(i),

the payment schedule of the debt instrument is determined as if there were no

inflation or deflation over the term of

the instrument.

(ii) Step two: Determine the accrual

periods. The accrual periods are deter-

mined under the rules of § 1.1272–

1(b)(1)(ii). However, no accrual period

can be longer than 1 month.

(iii) Step three: Determine the percentage change in the reference index

during the accrual period. The percentage change in the reference index during

the accrual period is equal to—

(A) The ratio of the value of the

reference index at the end of the period

to the value of the reference index at the

beginning of the period,

(B) Minus one.

(iv) Step four: Determine the OID

allocable to each accrual period. The

OID allocable to an accrual period (n) is

determined by using the following formula:

OID(n) = AIP(n) × [r + inf(n) + (r × inf(n))] in

which,

r = yield of the debt instrument as determined

under paragraph (e)(3)(i) of this section (adjusted for the length of the accrual period);

inf(n) = percentage change in the value of the

reference index for period (n) as determined

under paragraph (e)(3)(iii) of this section; and

AIP(n) = adjusted issue price at the beginning of

period (n).

(v) Step five: Determine the daily

portions of OID. The daily portions of

OID are determined and taken into

account under the rules of § 1.1272–

1(b)(1)(iv). If the daily portions determined under this paragraph (e)(3)(v) are

negative amounts, however, these

amounts (deflation adjustments) are

taken into account under the rules for

deflation adjustments described in paragraph (f)(1) of this section.

(4) Example. The following example illustrates

the discount bond method:

Example. (i) Facts. On November 15, 1997, X

purchases at original issue, for $91,403, a zerocoupon debt instrument that is indexed for inflation and deflation. The principal amount of the

debt instrument for the issue date is $100,000. The

debt instrument provides for a single payment on

November 15, 2000. The amount of the payment

will be determined by multiplying $100,000 by a

fraction, the numerator of which is the CPI–U for

September 2000, and the denominator of which is

the CPI–U for September 1997. The debt instrument also provides that in no event will the

payment on November 15, 2000, be less than

$100,000. X uses the cash receipts and disbursements method of accounting and the calendar year

as its taxable year.

(ii) Inflation-indexed debt instrument. Under

paragraph (c)(1) of this section, the instrument is

an inflation-indexed debt instrument. The debt

instrument’s principal amount for the issue date

($100,000) exceeds its issue price ($91,403) by

$8,597, which is more than the de minimis amount

for the debt instrument ($750). Therefore, the

coupon bond method does not apply to the debt

instrument. As a result, the discount bond method

applies to the debt instrument.

(iii) Yield and accrual period. Assume X

chooses monthly accrual periods ending on the

15th day of each month. The yield of the debt

instrument is determined as if there were no

inflation or deflation over the term of the instrument. Therefore, based on the issue price of

$91,403 and an assumed payment at maturity of

$100,000, the yield of the debt instrument is 3

percent, compounded monthly.

(iv) Percentage change in reference index. Assume that the CPI–U for September 1997 is 160;

for October 1997 is 161.2; and for November

1997 is 161.7. The value of the reference index

for November 15, 1997, is 160, the value of the

CPI–U for September 1997. Similarly, the value of

the reference index for December 15, 1997, is

161.2, and for January 15, 1998, is 161.7. The

percentage change in the reference index from

November 15, 1997, to December 15, 1997, (inf1)

is 0.0075 (161.2/160 2 1); the percentage change

in the reference index from December 15, 1997, to

January 15, 1998, (inf2) is 0.0031 (161.7/161.2 2

1).

(v) Treatment of X in 1997. For the accrual

period ending on December 15, 1997, r is .0025

(.03/12), inf1 is .0075, and the product of r and

inf1 is .00001875. Under paragraph (e)(3) of this

section, the amount of OID allocable to the

accrual period ending on December 15, 1997, is

$916. This amount is determined by multiplying

the issue price of the debt instrument ($91,403) by

.01001875 (the sum of r, inf1, and the product of r

and inf1). The adjusted issue price of the debt

instrument on December 15, 1997, is $92,319

($91,403 + $916). For the accrual period ending

on January 15, 1998, r is .0025 (.03/12), inf2 is

.0031, and the product of r and inf2 is .00000775.

Under paragraph (e)(3) of this section, the amount

of OID allocable to the accrual period ending on

January 15, 1998, is $518. This amount is determined by multiplying the adjusted issue price of

the debt instrument ($92,319) by .00560775 (the

sum of r, inf2, and the product of r and inf2).

Because the accrual period ending on January 15,

1998, spans two taxable years, only $259 of this

amount ($518/30 days x 15 days) is allocable to

1997. Therefore, X includes $1,175 of OID in

income for 1997 ($916 + $259).

(f) Special rules. The following rules

apply to an inflation-indexed debt instrument:

(1) Deflation adjustments—(i) Holder.

A deflation adjustment reduces the

amount of interest otherwise includible in

income by a holder with respect to the

debt instrument for the taxable year. For

purposes of this paragraph (f)(1)(i), interest includes OID, qualified stated interest, and market discount. If the amount

of the deflation adjustment exceeds the

interest otherwise includible in income

by the holder with respect to the debt

instrument for the taxable year, the excess is treated as an ordinary loss by the

holder for the taxable year. However, the

amount treated as an ordinary loss is

limited to the amount by which the

holder’s total interest inclusions on the

debt instrument in prior taxable years

exceed the total amount treated by the

holder as an ordinary loss on the debt

instrument in prior taxable years. If the

deflation adjustment exceeds the interest

otherwise includible in income by the

holder with respect to the debt instrument for the taxable year and the amount

treated as an ordinary loss for the taxable

year, this excess is carried forward to

reduce the amount of interest otherwise

includible in income by the holder with

respect to the debt instrument for subsequent taxable years.

(ii) Issuer. A deflation adjustment reduces the interest otherwise deductible

by the issuer with respect to the debt

instrument for the taxable year. For

purposes of this paragraph (f)(1)(ii), interest includes OID and qualified stated

interest. If the amount of the deflation

adjustment exceeds the interest otherwise deductible by the issuer with respect to the debt instrument for the

taxable year, the excess is treated as

ordinary income by the issuer for the

taxable year. However, the amount

treated as ordinary income is limited to

the amount by which the issuer’s total

interest deductions on the debt instrument in prior taxable years exceed the

total amount treated by the issuer as

ordinary income on the debt instrument

in prior taxable years. If the deflation

adjustment exceeds the interest otherwise deductible by the issuer with respect to the debt instrument for the

taxable year and the amount treated as

ordinary income for the taxable year,

this excess is carried forward to reduce

the interest otherwise deductible by the

issuer with respect to the debt instrument for subsequent taxable years. If

there is any excess remaining upon the

retirement of the debt instrument, the

issuer takes the excess amount into

account as ordinary income.

(2) Adjusted basis. A holder’s adjusted basis in an inflation-indexed debt

instrument is determined under

§ 1.1272–1(g). However, a holder’s adjusted basis in the debt instrument is

decreased by the amount of any deflation adjustment the holder takes into

account to reduce the amount of interest

otherwise includible in income or treats

as an ordinary loss with respect to the

instrument during the taxable year. The

decrease occurs when the deflation adjustment is taken into account under

paragraph (f)(1) of this section.

(3) Subsequent holders. A holder determines the amount of acquisition premium or market discount on an

inflation-indexed debt instrument by reference to the adjusted issue price of the

instrument on the date the holder acquires the instrument. A holder determines the amount of bond premium on

an inflation-indexed debt instrument by

assuming that the amount payable at

maturity on the instrument is equal to

the instrument’s inflation-adjusted principal amount for the day the holder

acquires the instrument. Any premium

or market discount is taken into account

over the remaining term of the debt

instrument as if there were no further

inflation or deflation. See section 171

for additional rules relating to the amortization of bond premium and sections

1276 through 1278 for additional rules

relating to market discount.

(4) Minimum guarantee. Under both

the coupon bond method and the discount bond method, a minimum guarantee payment is ignored until the payment is made. If there is a minimum

guarantee payment, the payment is

treated as interest on the date it is paid.

(5) Temporary unavailability of a

qualified inflation index. Notwithstanding any other rule of this section, an

inflation-indexed debt instrument may

provide for a substitute value of the

qualified inflation index if and when the

publication of the value of the qualified

inflation index is temporarily delayed.

The substitute value may be determined

by the issuer under any reasonable

method. For example, if the CPI–U is

not reported for a particular month, the

debt instrument may provide that a

substitute value may be determined by

increasing the last reported value by the

average monthly percentage increase in

the qualified inflation index over the

preceding twelve months. The use of a

substitute value does not result in a

reissuance of the debt instrument.

(g) Reopenings. For purposes of

§ 1.1275–2(d)(2), a reopening of Treasury Inflation-Indexed Securities is a

qualified reopening if—

(1) The terms of the securities issued

in the reopening are the same as the

terms of the original securities; and

(2) The reopening occurs not more

than one year after the original securities were first issued to the public.

(h) Effective date. This section applies to an inflation-indexed debt instrument issued on or after January 6, 1997.

Par. 5. Section 1.1286–2T is added to

read as follows:

§ 1.1286–2T Stripped inflation-indexed

debt instruments (temporary).

Stripped inflation-indexed debt instruments. If a Treasury Inflation-Indexed

Security is stripped under the Department of the Treasury’s Separate Trading

of Registered Interest and Principal of

Securities (STRIPS) program, the holders of the principal and coupon components must use the discount bond

method (as described in § 1.1275–

7T(e)) to account for the original issue

discount on the components.

Margaret Milner Richardson,

Commissioner of Internal Revenue.

Approved December 6, 1996.

Donald C. Lubick,

Acting Assistant Secretary

of the Treasury.

(Filed by the Office of the Federal Register on

December 31, 1996, and published in the issue of

the Federal Register for January 6, 1997, 62 F.R.

615)

Section 3402.—Income Tax

Collected at Source

26 CFR 31.3402(f)(5)–1: Form and contents of

withholding exemption certificates.

T.D. 8706

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 31 and 602

Electronic Filing of Form W–4

AGENCY: Internal Revenue Service

(IRS), Treasury.

ACTION: Final regulations.

SUMMARY: This document contains

final regulations relating to Form W–4,

Employee’s Withholding Allowance Certificate. The final regulations authorize

employers to establish electronic systems for use by employees in filing their

Forms W–4. The regulations provide

employers and employees with guidance

necessary to comply with the law. The

regulations affect employers that establish electronic systems and their employees.

EFFECTIVE DATE: These final regulations are effective January 2, 1997.

FOR FURTHER INFORMATION CONTACT: Karin Loverud, (202) 622–6060

(not a toll-free number).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

The collection of information contained in these final regulations has 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

1545–1435. Responses to this collection

of information are mandatory.

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 is 20 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 this collection of information must be retained

as long as their contents may become

material in the administration of any

internal revenue law. Generally, tax returns and tax return information are

confidential, as required by 26 U.S.C.

6103. Background

On April 15, 1994, a notice of proposed rulemaking [EE–45–93] containing proposed regulations relating to

Form W–4, Employee’s Withholding Allowance Certificate, was published in

the Federal Register (59 FR 18057).

On December 21, 1994, temporary

regulations (T.D. 8577) clarifying the

existing proposed regulations were published in the Federal Register (59 FR

65712). A notice of proposed rulemaking (EE–45–93) cross-referencing the

temporary regulations was published in

the Federal Register for the same day

(59 FR 65740).

Written comments responding to these

notices were received. Public hearings

were requested and were held on July

15, 1994, and November 7, 1995.

After consideration of all the comments, the proposed regulations under

section 3402(f) are adopted as revised

by this Treasury decision. The comments and revisions are discussed below.

Explanation of Revisions and Summary

of Comments

1. Relationship between paper and electronic Forms W–4. A withholding exemption certificate (Form W–4) may be

in either paper or electronic form.

Therefore, an employee will furnish a

Form W–4 to the employer either on

paper or electronically. To clarify that an

electronic Form W–4 has the same

status as a paper Form W–4, the final

regulations make minor revisions to

§ 31.3402(f)(5)–1, Form and contents of

withholding exemption certificates. Further, the final regulations appear as

§ 31.3402(f)(5)–1(c), rather than in a

separate regulations section limited to

electronic forms.

2. Electronic filing by all employees.

The existing proposed and temporary

regulations require employers that establish electronic systems to provide employees with the option of filing paper

or electronic Forms W–4. Several commentators requested that employers be

allowed to adopt systems under which

all employees file Forms W–4 electronically. These commentators stated that a

system under which all employees file

electronically would reduce employer

burden in terms of costs and time (for

example, eliminate maintenance of duplicative paper and electronic systems).

Similarly, it would reduce employee

burden in terms of time and choosing a

filing option.

The IRS and Treasury want to assist

in reducing burdens on both employers

and employees and to make it as easy as

possible for employers to adopt less

burdensome systems. The final regulations permit an employer to adopt a

system under which all employees file

Forms W–4 electronically. The IRS and

Treasury expect, however, that an employer will make a paper option reasonably available upon request to any employee who has a serious objection to

using the electronic system or whose

access to, or ability to use, the system

may be limited (for example, as a result

of a disability). The paper option would

be satisfied, for example, if the employer informs employees how they can

obtain a paper Form W–4 and where

they should submit the completed paper

Form W–4. The IRS and Treasury also

expect that employers will comply with

all applicable law governing the workplace and terms and conditions of employment, such as the Americans with

Disabilities Act (42 U.S.C. 12112(a)).

Compliance with these regulations does

not guarantee that a system for filing

Forms W–4 electronically is in compliance with those applicable laws.

3. Electronic Forms W–4. Several commentators recommended that electronic

systems be allowed for all Forms W–4

without exception. The prior proposed

and temporary regulations specifically

exclude (1) Forms W–4 required upon

commencement of employment (initial

Form W–4), and (2) Forms W–4 required to be furnished to the IRS by

employers because more than 10 withholding exemptions are claimed or, if

the employee is expected to earn more

than $200 per week, exemption from

withholding is claimed.

Initial Form W–4. Section 3402(f)(2)(A)

of the Internal Revenue Code (Code)

requires a new employee to furnish the

employer with a signed withholding exemption certificate. Section 6061 requires all Forms W–4 to be signed. See

discussion below under ‘‘5. Signature

under penalties of perjury’’ and

§ 301.6061–1(b), which states that the

Secretary may prescribe in forms, instructions, or other appropriate guidance

the method of signing any return, statement, or other document required to be

made under any provision of the internal

revenue laws or regulations. The final

regulations permit electronic systems to

include Forms W–4 required upon commencement of employment.

Forms W–4 claiming more than 10

exemptions or exemption from withholding. Section 31.3402(f)(2)–1(g) requires employers to submit to the IRS

copies of certain Forms W–4 furnished

to them by their employees. The Forms

W–4 required to be submitted are those

on which the employee claims either (1)

more than 10 withholding exemptions,

or (2) exemption from withholding (and

the employee is expected to earn more

than $200 per week).

Under § 31.3402(f)(2)–1(g)(5), if the

IRS determines that a Form W–4, a

copy of which was submitted to the

IRS, is defective, the IRS will notify in

writing both the employer and the employee. (The notice is referred to as a

‘‘lock-in letter.’’) A Form W–4 is defective if (1) the IRS determines that the

Form W–4 contains a materially incorrect statement, or (2) following communication with the employee, the IRS

lacks sufficient information to determine

whether the certificate is correct. The

lock-in letter issued by the IRS advises

the employer that the employee either is

not entitled to claim exemption from

withholding or is not entitled to claim

more withholding exemptions than the

number specified by the IRS in the

notice, or both. If the employee subsequently files a new Form W–4, the

employer may withhold on the basis of

that new Form W–4 only if the new

Form W–4 is consistent with the lock-in

letter. The employer must continue to

withhold on the basis of that advice

until the IRS revokes in writing its

lock-in letter.

The final regulations permit electronic

systems to include Forms W–4 on

which employees claim more than 10

withholding exemptions or exemption

from withholding. However, the IRS and

Treasury expect that electronic systems,

alone or in conjunction with the rest of

an employer’s payroll system, will ensure compliance with the advice contained in a lock-in letter. For instance,

an electronic system can ensure compliance with a lock-in letter by prohibiting

an employee for whom a lock-in letter

was issued from filing any electronic

Form W–4 or prohibiting the employee

from claiming more withholding exemptions than the number specified in the

IRS notice. Additionally, an employer

may choose to require any employee to

file a paper Form W–4 if the employee

wishes to claim more than 10 withholding exemptions or exemption from withholding.

4. Submission of certain Forms W–4 to

IRS. Section 31.3402(f)(2)–1(g) requires

employers to submit to the IRS copies

of Forms W–4 on which the employee

claims either more than 10 withholding

exemptions or exemption from withholding (and the employee is expected

to earn more than $200 per week).

Generally, the copies are sent quarterly

to the IRS along with the employer’s

Form 941, Employer’s Quarterly Federal

Tax Return. Copies can also be submitted earlier and more often to the employer’s IRS service center.

Employers that establish electronic

systems will satisfy the requirement of

§ 31.3402(f)(2)–1(g) if they furnish the

Form W–4 information on magnetic

media. Before using magnetic media,

employers must submit Form 4419, Application for Filing Information Returns

Magnetically/Electronically, to request

authorization. Rev. Proc. 92–80 (1992–2

C.B. 465) contains specifications for

filing Forms W–4 on magnetic tape and

on 5¼- and 3½-inch magnetic diskettes.

Electronic transmission of Form W–4

information to the IRS is not yet available.

5. Signature under penalties of perjury.

Section 6061 of the Code requires that

any return, statement, or other document

required to be made under any provision

of the Code or regulations be signed.

Section 6065 requires that any such

document contain or be verified by a

written declaration that it is made under

the penalties of perjury. These requirements apply to all Forms W–4, including those filed electronically, and are

reflected in § 31.3402(f)(5)–1(c)(iii) of

the final regulations.

Although sections 6061 and 6065 apply to all Forms W–4, the IRS and

Treasury are concerned that some electronic systems established under the

temporary regulations may not include a

signature under penalties of perjury. The

final regulations, therefore, include guidance on the perjury statement and the

electronic signature.

For certain Forms W–4, the final

regulations treat the signature-underpenalties-of-perjury-statement requirement as satisfied until January 1, 1999.

This special rule applies only if the

system precludes the electronic filing of

Forms W–4 required upon commencement of employment and Forms W–4

claiming more than 10 withholding exemptions or exemption from withholding. Moreover, the special rule applies

only to Forms W–4 filed electronically

before the earlier of (1) January 1, 1999,

or (2) the first date on which the

employer’s electronic system permits the

filing of Forms W–4 required upon

commencement of employment or

Forms W–4 claiming more than 10

withholding exemptions or exemption

from withholding.

The IRS and Treasury will consider

written comments pertaining to the provisions relating to signatures under penalties of perjury. Submissions should be

sent to: CC:DOM:CORP:R (T.D. 8706),

room 5228, Internal Revenue Service,

POB 7604, Ben Franklin Station, Washington, DC 20044. Alternatively, taxpayers may submit comments electronically

via the Internet by selecting the ‘‘Tax

Regs’’ option on the IRS Home Page, or

by submitting comments directly to the

IRS

Internet

site

http://

www.irs.ustreas.gov/prod/tax_regs/

comments.html. Submissions may be

hand delivered between the hours of 8

a.m. and 5 p.m. to: CC:DOM:CORP:R

(T.D. 8706), Courier’s Desk, Internal

Revenue Service, 1111 Constitution Avenue NW, Washington, DC.

PART 31—EMPLOYMENT TAXES

AND COLLECTION OF INCOME

TAX AT SOURCE

6. Employer retention of Forms W–4

and predecessor and successor employers. One commentator requested guidance concerning the period for which

paper Forms W–4 are required to be

retained under § 31.6001–1(e) after the

employer establishes an electronic system and in predecessor-employer/

successor-employer situations. Electronic

Forms W–4 have the same status as

paper Forms W–4. Therefore, guidance

that applies to paper Forms W–4 also

applies to electronic Forms W–4. For

further information, see Rev. Proc.

91–59 (1991–2 C.B. 841) (information

regarding the retention of records using

a variety of automatic data processing

systems); and section 5 of Rev. Proc.

96–60 (1996–53 I.R.B.) (predecessor/

successor situations).

Paragraph 1. The authority citation for

part 31 is amended by adding an entry

for Section 31.3402(f)(5)–1 to read as

follows:

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

Special Analyses

(a) Form W–4. * * * Blank copies of

paper Forms W–4 will be supplied to

employers upon request to the Internal

Revenue Service. * * *

(b) Invalid Form W–4. * * *

general. An employer may establish a

system for its employees to file withholding exemption certificates electronically.

(2) Requirements—(i) In general.

The electronic system must ensure that

the information received is the information sent, and must document all occasions of employee access that result in

the filing of a Form W–4. In addition,

the design and operation of the electronic system, including access procedures, must make it reasonably certain

that the person accessing the system and

filing the Form W–4 is the employee

identified in the form.

(ii) Same information as paper Form

W–4. The electronic filing must provide

the employer with exactly the same

information as the paper Form W–4.

(iii) Jurat and signature requirements.

The electronic filing must be signed by

the employee under penalties of perjury.

It has been determined that this Treasury decision is not a significant regulatory action as defined in EO 12866.

Therefore, a regulatory assessment is not

required. It also has been determined

that section 553(b) of the Administrative

Procedure Act (5 U.S.C. chapter 5) does

not apply to these regulations, and,

because the notice of proposed rulemaking preceding the regulations was issued

prior to March 29, 1996, the Regulatory

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

not apply. Pursuant to section 7805(f) of

the Code, the notice of proposed

rulemaking preceding these regulations

was submitted to the Small Business

Administration for comment on its impact on small business.

Drafting Information

The principal author of these regulations is Karin Loverud, Office of the

Associate Chief Counsel (Employee

Benefits and Exempt Organizations),

IRS. However, other personnel from the

IRS and Treasury Department participated in their development.

Adoption of Amendments to the Regulations

Accordingly, 26 CFR parts 31 and

602 are amended as follows:

Section 31.3402(f)(5)–1 also issued under 26 U.S.C. 3402(i) and (m). * * *

Par. 2. Section 31.3402(f)(5)–1 is

amended as follows:

1. Headings are added to paragraphs

(a) and (b).

2. The fourth sentence of paragraph

(a) is revised.

3. Paragraph (c) is added.

4. The authority citation which follows the end of the section is removed.

The revisions and additions read as

follows:

§ 31.3402(f)(5)–1 Form and contents of

withholding exemption certificates.

(A) Jurat. The jurat (perjury statement) must contain the language that

appears on the paper Form W–4. The

electronic program must inform the employee that he or she must make the

declaration contained in the jurat and

that the declaration is made by signing

the Form W–4. The instructions and the

language of the jurat must immediately

follow the employee’s income tax withholding selections and immediately precede the employee’s electronic signature.

(B) Electronic signature. The electronic signature must identify the employee filing the electronic Form W–4

and authenticate and verify the filing.

For this purpose, the terms ‘‘authenticate’’ and ‘‘verify’’ have the same meanings as they do when applied to a

written signature on a paper Form W–4.

An electronic signature can be in any

form that satisfies the foregoing requirements. The electronic signature must be

the final entry in the employee’s Form

W–4 submission.

(iv) Copies of electronic Forms W–4.

Upon request by the Internal Revenue

Service, the employer must supply a

hardcopy of the electronic Form W–4

and a statement that, to the best of the

employer’s knowledge, the electronic

Form W–4 was filed by the named

employee. The hardcopy of the electronic Form W–4 must provide exactly

the same information as, but need not be

a facsimile of, the paper Form W–4.

(3) Effective date—(i) In general.

This paragraph applies to all withholding exemption certificates filed electronically by employees on or after

January 2, 1997.

(ii) Special rule for certain Forms

W–4. In the case of an electronic system

that precludes the filing of Forms W–4

required on commencement of employment and Forms W–4 claiming more

than 10 withholding exemptions or exemption from withholding, the requirements of paragraph (c)(2)(iii) of this

section will be treated as satisfied if the

Form W–4 is filed electronically before

January 1, 1999.

§ 31.3402(f)(5)–2T [Removed]

Par. 3. Section 31.3402(f)(5)–2T is

removed.

PART 602—OMB CONTROL NUMBERS UNDER THE PAPERWORK

REDUCTION ACT

Par. 4. The authority citation for part

602 continues to read as follows:

Authority: 26 U.S.C. 7805.

Par. 5. In § 602.101, paragraph (c) is

amended by:

1. Removing the entry for 31.3402(f)(5)–

2T from the table.

§ 602.101 OMB Control numbers.

CFR part or section

where identified and

described

§ 602.101 OMB Control numbers.

Current OMB

control No.

31.3402(f)(5)–2T . . . . . . 1545–1435

2. Revising the entry for 31.3402(f)(5)–

1 to read as follows:

CFR part or section

where identified and

described

Current OMB

control No.

31.3402(f)(5)–1. . . . . . . . 1545–0010

1545–1435

Margaret Milner Richardson,

Commissioner of Internal Revenue.

Approved December 12, 1996.

Donald C. Lubick,

Acting Assistant Secretary

of the Treasury.

(Filed by the Office of the Federal Register on

December 31, 1996, 8:45 a.m., and published in

the issue of the Federal Register for January 2,

1997, 62 F.R. 22)

Part III. Administrative, Procedural, and Miscellaneous

Weighted Average Interest Rate

Update

Notice 97–16

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 January

1997 is 6.83 percent.

The following rates were determined

for the plan years beginning in the

month shown below.

Month

Year

Weighted Average

90% to 107%

Permissible Range

90% to 110%

Permissible Range

February

1997

6.88

6.19 to 7.36

6.19 to 7.57

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).

26 CFR 601.201: Rulings and determination letters.

(Also Part I, Sections 25, 103, 143; 1.25–4T,

1.103–1, 6a.103A–2.)

Rev. Proc. 97–17

SECTION 1. PURPOSE

This revenue procedure provides issuers of qualified mortgage bonds, as

defined in § 143(a) of the Internal Revenue Code, and issuers of mortgage

credit certificates, as defined in § 25(c),

with a list of the average annual aggregate principal amount of mortgages executed during the calendar years 1992,

1993, and 1994 for each state, the

District of Columbia, Guam, Puerto

Rico, and the Virgin Islands.

SECTION 2. BACKGROUND

.01 Section 103(a) provides that, except as provided in § 103(b), gross

income does not include interest on any

state or local bond. Section 103(b)(1)

provides that § 103(a) shall not apply to

any private activity bond that is not a

‘‘qualified bond’’ within the meaning of

§ 141. Under § 141(e) the term ‘‘qualified bond’’ includes any private activity

bond that (1) is a qualified mortgage

bond, (2) meets the volume cap requirements under § 146, and (3) meets the

applicable requirements under § 147.

.02 Section 143(a)(1)(A) provides that

the term ‘‘qualified mortgage bond’’

means a bond that is issued as part of a

qualified mortgage issue. Section

143(a)(2)(A) provides that the term

‘‘qualified mortgage issue’’ means an

issue of one or more bonds by a state or

political subdivision thereof, but only if

(i) all proceeds of the issue (exclusive

of issuance costs and a reasonably required reserve) are to be used to finance

owner-occupied residences; (ii) the issue

meets the requirements of subsections

(c), (d), (e), (f), (g), (h), (i), and (m)(7)

of § 143; (iii) the issue does not meet

the private business tests of paragraphs

(1) and (2) of § 141(b); and (iv) with

respect to amounts received more than

10 years after the date of issuance,

repayments of $250,000 or more of

principal on financing provided by the

issue are used not later than the close of

the first semiannual period beginning

after the date the prepayment (or complete repayment) is received to redeem

bonds that are part of the issue.

.03 An issue of bonds meets the

requirements of subsection (h) of § 143

only if a sufficient portion of the bond

proceeds is made available (with reasonable diligence) for owner-financing of

targeted area residences for at least one

year after the date on which ownerfinancing is first made available with

respect to targeted area residences. The

applicable portion of bond proceeds to

be made available must be equal to or

greater than an amount that is the lesser

of (1) 20 percent of the proceeds of the

issue that are devoted to providing

owner-financing, or (2) 40 percent of

the average annual aggregate principal

amount of mortgages executed during

the immediately preceding 3 calendar

years for single-family, owner-occupied

residences in targeted areas within the

jurisdiction of the issuing authority.

.04 A targeted area residence, defined

in § 143(j), is a residence in either a

qualified census tract or an area of

chronic economic distress. A ‘‘qualified

census tract’’ means a census tract in

which 70 percent or more of the families have income which is 80 percent or

less of the statewide median family

income, based on the most recent decennial census for which data are available.

See Rev. Proc. 93–38, 1993–2 C.B. 483,

for the most recent list of qualified

census tracts for each state and the

District of Columbia; that list is based

on data from the 1990 census. Section

143(j)(3) defines an ‘‘area of chronic

economic distress’’ (‘‘ACED’’) as an

area (i) designated by the state as meeting the standards established by the state

for purposes of § 143(j), and (ii) the

designation of which has been approved

by the Secretary of Treasury and the

Secretary of Housing and Urban Development in accordance with criteria set

forth in § 143(j)(3)(B). See Rev. Proc.

88–31, 1988–1 C.B. 832, for the procedures to obtain an ACED designation.

.05 When determining the portion of

the proceeds that must be made available for owner-financing of targeted area

residences under the 40 percent limitation in § 143(h)(2), issuers of mortgage

revenue bonds may rely upon the

amount produced by the following safe

harbor formula described in § 6a.103A–

2(h)(3) of the temporary Income Tax

Regulations (issued under former

§ 103A(h) of the 1954 Code):

P =

.2 (X x Z)

where

P = Required portion to be made available to targeted areas,

X = Average annual aggregate principal

amount of mortgages executed

during the immediately preceding

3 calendar years for single-family

owner-occupied residences within

P = Required portion to be made available to targeted areas,

the state in which the issuing jurisdiction is located,

Y = The total population within the

state, based on the most recent

decennial census for which data

are available, and

Z = The total population in the targeted

areas located within the issuer’s

jurisdiction, based on the most

recent decennial census for which

data are available.

An issuing jurisdiction may use estimates of X published by the Treasury

Department when computing the safe

harbor formula. The specified portion

required to be made available in targeted

areas is a minimum amount so that more

than the minimum amount may be (but

need not be) made available in targeted

areas. See § 6a.103A–2(h)(4).

.06 Section 25(c)(2)(A)(ii) provides

that a state or a political subdivision

thereof may elect to exchange all or part

of its qualified mortgage bond authority

for authority to issue the mortgage

credit certificates described in § 25(c).

The election must be in accordance with

§ 1.25–4T(c).

State

Alabama

Alaska

Arizona

Arkansas

California

Colorado

Connecticut

Delaware

District of Columbia

Florida

Georgia

Hawaii

Idaho

Illinois

Indiana

Iowa

Kansas

Kentucky

Louisiana

Maine

Maryland

Massachusetts

Michigan

Minnesota

Mississippi

Missouri

Montana

.07 Section 25(a) provides, in general,

that the recipient of a mortgage credit

certificate (MCC) may claim a credit

against income tax equal to the product

of the certificate credit rate and the

interest paid or accrued by the taxpayer

during the taxable year on the remaining

principal of the certified indebtedness

amount.

.08 Section 25(b)(2) defines the certified indebtedness amount as the amount

of indebtedness that is incurred by the

taxpayer to acquire the taxpayer’s principal residence, as a qualified home

improvement loan, or as a qualified

rehabilitation loan, and is specified in

the MCC.

.09 Section 25(c)(2)(A)(iii)(V) provides that the indebtedness certified by

MCCs must meet the requirements of

§ 143(h) concerning the portion of

loans to be placed in targeted areas. See

also § 1.25–4T(g) of the temporary

regulations.

.10 The average annual mortgage

originations for 1990, 1991, and 1992

were published in Rev. Proc. 95–14,

1995–1 C.B. 520. Section 5.01 of Rev.

Proc. 95–14 provides that issuers may

continue to rely on the average annual

mortgage originations in Rev. Proc.

Gross Mortgage Originations for Owner-Occupied Homes

1992

1993

1994

9,292

2,678

13,811

5,110

110,252

21,599

9,139

2,042

978

42,634

21,522

5,068

3,502

33,894

16,693

4,662

6,986

8,656

6,033

2,304

23,366

14,513

21,014

26,875

4,122

14,251

2,589

10,688

3,581

22,004

5,746

119,554

27,361

13,117

1,735

1,931

49,952

26,963

5,118

3,757

34,271

20,016

4,204

7,096

9,125

7,169

2,914

28,045

19,401

22,918

29,609

4,716

15,995

2,912

7,835

2,393

15,478

4,303

105,353

16,865

8,487

1,402

1,191

41,612

18,487

3,649

2,963

27,148

14,648

3,056

4,676

7,098

6,091

2,360

32,406

11,760

15,466

15,632

3,218

11,266

1,777

95–14 until those averages are rendered

obsolete by a new revenue procedure,

such as this one.

.11 The average annual mortgage

originations are developed by the Department of Housing and Urban Development (HUD) for publication by the

Service. The mortgage originations are

based on data and procedures that are

employed in the HUD-coordinated surveys of mortgage lending activity for 1to 4-family dwellings. The estimates of

mortgage volume for 1- to 4-family

dwellings in each state are adjusted

from a special tabulation of the HUDsponsored Annual Housing Survey to

reflect only the amount of mortgages

originated that were secured by owneroccupied residences.

SECTION 3. APPLICATION

The average annual mortgage originations, based on mortgage loan originations secured by owner-occupied residences during 1992, 1993, and 1994, for

each state, the District of Columbia,

Guam, Puerto Rico, and the Virgin Islands are listed below (dollars in millions).

Three-Year

Total

Average Annual

Mortgage Originations

27,815

8,652

51,293

15,159

335,159

65,825

30,743

5,179

4,100

134,198

66,972

13,835

10,222

95,313

51,357

11,922

18,758

24,879

19,293

7,578

83,817

45,674

59,398

72,116

12,056

41,512

7,278

9,272

2,884

17,098

5,053

111,720

21,942

10,248

1,726

1,367

44,733

22,324

4,612

3,407

31,771

17,119

3,974

6,253

8,293

6,431

2,526

27,939

15,225

19,799

24,039

4,019

13,837

2,426

State

Nebraska

Nevada

New Hampshire

New Jersey

New Mexico

New York

North Carolina

North Dakota

Ohio

Oklahoma

Oregon

Pennsylvania

Rhode Island

South Carolina

South Dakota

Tennessee

Texas

Utah

Vermont

Virginia

Washington

West Virginia

Wisconsin

Wyoming

Guam

Puerto Rico

Virgin Islands

Gross Mortgage Originations for Owner-Occupied Homes

1992

1993

1994

4,242

5,960

2,415

22,194

4,078

36,824

21,943

2,801

25,532

6,481

5,925

27,263

2,071

8,019

1,579

14,029

41,049

9,138

992

32,722

18,779

2,417

13,244

1,527

5,008

104

SECTION 4. EFFECT ON OTHER

REVENUE PROCEDURES

Rev. Proc. 95–14 is obsolete except

as provided in section 5.02 of this

revenue procedure.

SECTION 5. EFFECTIVE DATES

.01 Issuers of qualified mortgage

bonds or mortgage credit certificates

may rely on this revenue procedure

during the period beginning March 3,

1997, the date of publication of this

revenue procedure in the Internal Revenue Bulletin, and ending on the date as

of which this revenue procedure is rendered obsolete by a new revenue procedure.

.02 With respect to qualified mortgage

bonds sold, and bond authority elected

to be exchanged for authority to issue

mortgage credit certificates, before April

2, 1997, 30 days after the publication of

this Rev. Proc. 97–17 in the Internal

Revenue Bulletin, issuers may continue

to rely on the list of average annual

mortgage originations that is contained

in Rev. Proc. 95–14.

5,070

7,282

3,156

19,736

4,656

36,750

23,303

3,626

29,422

7,387

6,559

33,214

3,301

8,470

1,565

18,395

49,761

11,988

1,260

42,008

22,076

2,658

12,833

1,490

7,354

2,188

7,568

2,461

11,805

3,634

33,956

16,221

2,090

21,376

5,474

5,267

20,361

1,720

6,447

922

13,458

41,681

7,381

891

29,670

18,063

2,039

8,664

1,834

7,990

Drafting Information

The principal author of this revenue

procedure is Patricia M. Monahan of the

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

further information regarding this revenue procedure contact Ms. Monahan on

(202) 622–4122 (not a toll-free call).

Social Security

Domestic Employee Coverage

Threshold

General. Section 2 of the ‘‘Social

Security Domestic Employment Reform

Act of 1994’’ (Pub. L. 103–387) increased the threshold for coverage of a

domestic employee’s wages paid per

employer from $50 per calendar quarter

to $1,000 in calendar year 1994. The

statute holds the coverage threshold at

the $1,000 level for 1995 and then

increases the threshold in $100 increments for years after 1995. The formula

for increasing the threshold is provided

in section 3121(x) of the Internal Revenue Code.

Three-Year

Total

Average Annual

Mortgage Originations

11,500

20,810

8,032

53,735

12,368

107,530

61,467

8,517

76,330

19,342

17,751

80,838

7,092

22,936

4,066

45,882

132,491

28,507

3,143

104,400

58,918

7,114

34,741

4,851

281

20,352

244

3,833

6,937

2,677

17,912

4,123

35,843

20,489

2,839

25,443

6,447

5,917

26,946

2,364

7,645

1,355

15,294

44,164

9,502

1,048

34,800

19,639

2,371

11,580

1,617

6,784

Computation. Under the new formula,

the domestic employee coverage threshold amount for 1997 shall be equal to

the 1995 amount of $1,000 multiplied

by the ratio of the national average

wage index for 1995 to that for 1993.

The national average wage index for

1993 was previously determined to be

$23,132.67. The national average wage

index for 1995 is $24,705.66 as determined above. If the amount so determined is not a multiple of $100, it shall

be rounded to the next lower multiple of

$100.

Domestic Employee Coverage Threshold Amount. The ratio of the national

average wage index for 1995,

$24,705.66, compared to that for 1993,

$23,132.67, is 1.0679986. Multiplying

the 1995 domestic employee coverage

threshold amount of $1,000 by the ratio

of 1.0679986 produces the amount of

$1,068.00, which must then be rounded

to $1,000. Accordingly, the domestic

employee coverage threshold amount is

determined to be $1,000 for 1997.

Part IV. Items of General Interest

Notice of Proposed Rulemaking

Inflation-Indexed Debt Instruments

REG–242996–96

AGENCY: Internal Revenue Service

(IRS), Treasury.

ACTION: Notice of proposed rulemaking by cross-reference to temporary

regulations and notice of public hearing.

SUMMARY: In T.D. 8709, page 5, the

IRS is issuing temporary regulations relating to the federal income tax treatment of inflation-indexed debt instruments, including Treasury InflationIndexed Securities. The text of the

temporary regulations also serves as the

text of the proposed regulations. This

document also provides notice of a public hearing on the proposed regulations.

DATES: Comments must be received

by April 7, 1997. Requests to appear

and outlines of topics to be discussed at

the public hearing scheduled for April

30, 1997, at 10 a.m. must be received

by April 9, 1997.

ADDRESSES: Send submissions to:

CC:DOM:CORP:R (REG–242996–96),

room 5226, Internal Revenue Service,

POB 7604, Ben Franklin Station, Washington, DC 20044. Submissions may be

hand delivered between the hours of 8

a.m. and 5 p.m. to: CC:DOM:CORP:R

(REG–242996–96), Courier’s Desk, Internal Revenue Service, 1111 Constitution Avenue NW, Washington, DC. Alternatively, taxpayers may submit

comments electronically via the internet

by selecting the ‘‘Tax Regs’’ option of

the IRS Home Page or by submitting

comments directly to the IRS internet

site at http://www.irs.ustreas.gov/prod/

tax_regs/comments.html. A public hearing will be held in the NYU Classroom,

room 2615, Internal Revenue Building,

1111 Constitution Avenue NW, Washington, DC.

FOR FURTHER INFORMATION

CONTACT: Concerning the regulations,

William E. Blanchard, (202) 622–3950,

or Jeffrey W. Maddrey, (202) 622–3940;

concerning submissions and the hearing,

Mike Slaughter, (202) 622–7190 (not

toll-free numbers).

SUPPLEMENTARY INFORMATION:

Background

T.D. 8709 amends the Income Tax

Regulations (26 CFR part 1) relating to

1997–9

I.R.B.

sections 1275 and 1286 of the Internal

Revenue Code. The temporary regulations provide rules relating to inflationindexed debt instruments, including

Treasury Inflation-Indexed Securities.

The text of the temporary regulations

also serves as the text of the proposed

regulations. The preamble to the temporary regulations explains the temporary

regulations.

Special Analyses

It has been determined that this notice

of proposed rulemaking is not a significant regulatory action as defined in EO

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

determined that section 553(b) of the

Administrative Procedure Act (5 U.S.C.

chapter 5) does not apply to these

regulations and, because the regulations

do not impose a collection of information on small entities, the Regulatory

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

not apply. Pursuant to section 7805(f) of

the Internal Revenue Code, this notice

of proposed rulemaking will be submitted to the Chief Counsel for Advocacy

of the Small Business Administration for

comment on its impact on small business.

Comments and Public Hearing

Before these proposed regulations are

adopted as final regulations, consideration will be given to any comments

that are submitted timely (in the manner

described in the ADDRESSES portion

of this preamble) to the IRS. All comments will be available for public inspection and copying.

A public hearing has been scheduled

for April 30, 1997, at 10 a.m. in the

NYU Classroom, room 2615, Internal

Revenue Building, 1111 Constitution

Avenue NW, Washington, DC. Because

of access restrictions, visitors will not be

admitted beyond the building lobby

more than 15 minutes before the hearing

starts.

The rules of 26 CFR 601.601(a)(3)

apply to the hearing.

Persons who wish to present oral

comments at the hearing must submit

comments by April 7, 1997, and submit

an outline of the topics to be discussed

and the time to be devoted to each topic

by April 9, 1997.

A period of 10 minutes will be allotted to each person for making comments.

An agenda showing the scheduling of

the speakers will be prepared after the

deadline for receiving outlines has

passed. Copies of the agenda will be

available free of charge at the hearing.

Drafting Information

The principal author of these regulations is William E. Blanchard, Office of

Assistant Chief Counsel (Financial Institutions and Products). However, other

personnel from the IRS and the Treasury

Department participated in their development.

Proposed Amendments to the Regulations

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

Part 1—INCOME TAXES

Paragraph 1. The authority citation

for part 1 is amended by adding two

entries in numerical order to read as

follows:

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

Section 1.1275–7 also issued under 26

U.S.C. 1275(d). ***

Section 1.1286–2 also issued under 26

U.S.C. 1286(f). ***

Par. 2. Section 1.1275–7 is added to

read as follows:

§ 1.1275–7 Inflation-indexed debt instruments.

[The text of this proposed section is

the same as the text of § 1.1275–7T

published in T.D. 8709, page 5.]

Par. 3. Section 1.1286–2 is added to

read as follows:

§ 1.1286–2 Inflation-indexed debt instruments.

[The text of this proposed section is

the same as the text of § 1.1286–2T

published in T.D. 8709, page 5.]

Margaret Milner Richardson,

Commissioner of Internal Revenue.

(Filed by the Office of the Federal Register on

December 31, 1996, and published in the issue of

the Federal Register for January 6, 1997, 62 F.R.

694)

Notice of Proposed Rulemaking

and Notice of Public Hearing

Continuity of Interest and Business

Enterprise

REG–252233–96

AGENCY: Internal Revenue Service

(IRS), Treasury

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

SUMMARY: This document proposes

rules providing that for certain reorganizations, transfers by the acquiring corporation of target assets or stock to certain

controlled corporations, and under prescribed conditions, transfers of target

assets to partnerships, will not disqualify

the transaction from satisfying the continuity of interest and continuity of business enterprise requirements. This document also provides notice of a public

hearing on these proposed regulations.

DATES: Comments must be received by

April 3, 1997. Requests to speak and

outlines of topics to be discussed at the

public hearing scheduled for Wednesday,

May 7, 1997 must be received by

Wednesday, April 16, 1997.

ADDRESSES: Send submissions to:

CC:DOM:CORP:R (REG–252233–96),

room 5228, Internal Revenue Service,

POB 7604, Ben Franklin Station, Washington, DC 20044. Submissions may be

hand delivered between the hours of 8

a.m. and 5 p.m. to CC:DOM:CORP:R

(REG–252233–96), Courier’s Desk, Internal Revenue Service, 1111 Constitution Avenue, NW, Washington, DC. Alternatively, taxpayers may submit

comments electronically via the Internet

by selecting the ‘‘Tax Regs’’ option on

the IRS Home Page, or by submitting

comments directly to the IRS Internet

site at http://www.irs.ustreas.gov/prod/

tax_regs/comments.html. The public

hearing will be held in the Auditorium,

Internal Revenue Building, 1111 Constitution Avenue NW, Washington DC.

FOR FURTHER INFORMATION CONTACT: Concerning the regulations,

Marlene Peake Oppenheim, (202) 622–

7750; concerning submissions and the

hearing, Christina Vasquez, (202) 622–

6808 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Background

This document contains proposed

amendments to the Income Tax Regula-

tions (26 CFR part 1) under section 368.

The proposed regulations establish rules

providing that for certain reorganizations

transfers by the acquiring corporation of

target corporation assets or stock to

certain controlled corporations and under prescribed conditions transfers of

target assets to partnerships, will not

disqualify the transaction from satisfying

the continuity of interest and continuity

of business enterprise requirements.

Explanation of Proposed Regulations

A. Remote Continuity of interest

1. Overview

The Internal Revenue Code of 1986

(Code) provides general nonrecognition

treatment for reorganizations specifically

described in section 368 of the Code.

Literal compliance with the statutory

requirements is not sufficient, however,

for nonrecognition treatment.

The Supreme Court, in Groman v.

Commissioner, 302 U.S. 82 (1937), and

Helvering v. Bashford, 302 U.S. 454

(1938), established the basis of what has

become known as the ‘‘remote continuity of interest doctrine.’’ Under this

doctrine, stock consideration received by

the target corporation’s (T) shareholders

does not provide continuity unless the

target assets or stock are ultimately held

by the corporation that issued the stock.

Thus, if T transfers its assets to an

acquiring corporation (P), in exchange

for stock of the corporation controlling

P (see Groman), or if P acquires the T

assets but pursuant to the plan of reorganization transfers them to a controlled

subsidiary (S) (see Bashford), the continuity of interest requirement is not satisfied.

Congress has substantially limited the

remote continuity of interest doctrine. In

1954, Congress enacted section

368(a)(2)(C) which provides that P’s

transfer of T assets acquired in a reorganization under section 368(a)(1)(A)

(merger or consolidation) or section

368(a)(1)(C) (asset acquisition) to S

does not disqualify the reorganization.

Section 368(a)(1)(C) was also amended

to provide that P can acquire T assets

directly in exchange for voting stock of

a corporation in control of P (a triangular C reorganization).

In the 1960’s, the Treasury Department and IRS issued several revenue

rulings attempting to clarify to what

extent the remote continuity doctrine

had remaining vitality. Where the guidance held that the remote continuity

doctrine applied to disqualify the transaction from reorganization treatment,

Congress at times responded by amending the relevant Code section and overturning the result. For example, Rev.

Rul. 63–234 (1963–2 C.B. 148) held

that remote continuity remained an issue

for section 368(a)(1)(B) reorganizations.

The following year Congress responded

by amending section 368(a)(1)(B), permitting P to acquire T’s stock in exchange for stock of the corporation

controlling P (a triangular B reorganization). Congress also amended section

368(a)(2)(C) to provide that P can transfer T stock acquired in a reorganization

under section 368(a)(1)(B) to S without

disqualifying the reorganization.

Similarly, when Rev. Rul. 67–326

(1967–2 C.B. 143) held that a merger of

T into S in exchange for stock of the

corporation controlling S (a forward

triangular merger) violated the continuity of interest doctrine, Congress responded in the following year by enacting section 368(a)(2)(D), which provides

that a forward triangular merger qualifies as a section 368(a)(1)(A) reorganization.

In contrast, Rev. Rul. 64–73 (1964–1

C.B. 142) held that a transaction qualified as a section 368(a)(1)(C) reorganization where P and P’s second tier

subsidiary acquired all the T assets in

exchange for P stock. The transaction

was viewed as an acquisition of substantially all the T assets by P.

2. Transfers of T assets or stock to

controlled corporations

The proposed regulations curtail the

remote continuity of interest doctrine by

providing that assets can be transferred

among members of a ‘‘qualified group.’’

A qualified group consists of one or

more chains of corporations connected

through stock ownership with the ‘‘issuing corporation,’’ but only if the issuing

corporation owns directly stock meeting

the requirements of section 368(c) in at

least one other corporation, and stock

meeting the requirements of section

368(c) in each of the corporations (except the issuing corporation) is owned

directly by one of the other corporations. The issuing corporation is the

acquiring corporation (as that term is

used in section 368(a)), except in transactions where use of stock of a corporation in control of the acquiring corporation is permitted. Where stock of the

controlling corporation is used, the controlling corporation is the issuing corporation.

1997–9

I.R.B.

The proposed regulations generally

permit transfers or successive transfers

of assets or stock to members of the

qualified group. Thus, continuity of interest is not violated where there are

transfers or successive transfers of T

stock (or transfers of the T assets after a

T stock acquisition) or T assets (or

transfers of the acquiring corporation’s

stock after a T asset acquisition) among

members of the qualified group. The

Treasury Department and IRS solicit

comments on whether the qualified

group should be defined other than by

reference to section 368(c).

The proposed regulations are limited

to asset or stock transfers following

transactions that otherwise qualify as

section 368(a)(1)(A), (B), (C), or (G)

(meeting the requirements of sections

354(b)(1)(A) and (B)) reorganizations

(covered reorganizations). Section

368(a)(2)(C) by its terms does not apply

to acquisitive section 368(a)(1)(D) or

section 368(a)(1)(F) reorganizations. The

Treasury Department and IRS solicit

comments as to whether the rules in the

proposed regulations should be extended

to these other reorganization provisions

or to section 355 divisive transactions.

3. Transfer of T assets to a partnership

Whether the transfer of assets to a

partnership (PRS) by the corporate

transferor partner (PTR) disqualifies an

otherwise qualifying covered reorganization depends in part on whether PRS is

viewed as an aggregate of its partners or

as an entity separate from the partners.

The treatment of PRS as an aggregate or

entity must be determined on the basis

of the characterization most appropriate

for the situation. H.R. Conf. Rep. No.

2543, 83d Cong., 2d Sess. 59 (1954).

Cf. § 1.701–2(e)(1) of the Income Tax

Regulations.

The Treasury Department and IRS

believe it is appropriate to treat PRS as

an aggregate of its partners in analyzing

a transaction with respect to continuity

of interest. Thus, the proposed regulations provide that PTR’s transfer of T

assets to PRS does not violate the

continuity of interest requirement.

The proposed regulations do not permit the transfer of stock to PRS where

the Code imposes a control requirement

in section 368. See sections 368(a)(1)(B)

and (C), sections 368(a)(2)(D) and (E),

and section 368(a)(2)(C). In addition,

the transfer of T assets to PRS may

violate the continuity of business enterprise (COBE) requirement.

1997–9

I.R.B.

B. Continuity of business enterprise

1. Overview

Section 1.368–1(b) requires that reorganizations afford a continuity of business enterprise under modified corporate

form. COBE requires that P either (i)

continue T’s historic business (business

continuity) or (ii) use a significant portion of T’s historic business assets in a

business (asset continuity). § 1.368–

1(d)(2). The proposed regulations provide a framework for applying the existing COBE regulations to situations

where the T assets or stock are transferred to certain controlled corporations

or assets are transferred to partnerships.

2. Transfer of T assets or stock to a

controlled corporation

The proposed regulations provide that,

under prescribed conditions, COBE is

not violated by reason of the fact that

part or all of the T assets or stock are

transferred among members of a qualified group. Thus, the COBE requirement

is not violated where there are transfers

or successive transfers of T stock (or

transfers of the T assets after a T stock

acquisition) or T assets (or transfers of

the acquiring corporation’s stock after a

T asset acquisition) among members of

the qualified group.

3. Transfer of T assets to a partnership

The proposed regulations provide that,

under prescribed conditions, COBE is

not violated by reason of the fact that

part or all of the T assets are transferred

to PRS by PTR. The proposed regulations adopt an aggregate approach in

determining whether COBE has been

satisfied when T assets are transferred to

PRS following a T asset or T stock

acquisition. Thus, the proposed regulations provide that for purposes of the

business continuity test, PTR will be

treated as conducting a business of PRS

if PTR has active and substantial management functions as a partner with

regard to the business (cf. Rev. Rul.

92–17 (1992–1 C.B. 142)) or if PTR’s

partnership interest in PRS represents a

significant interest in the PRS business.

Furthermore, in determining whether

PTR satisfies the asset continuity test (i)

PTR will be treated as owning the assets

of PRS in accordance with PTR’s interest in PRS, and (ii) PTR will be treated

as conducting a business of PRS under

the rules applicable to business continuity.

COBE requires a facts and circumstances analysis. Thus, the proposed

regulations also state that the fact that

PTR meets the business continuity requirements of § 1.368–1(d)(2)(i) and

1(d)(3) through active and substantial

management of a PRS business tends to

establish COBE, but the fact that PTR

conducts a PRS business is not alone

sufficient.

C. Effect on other authorities

The proposed regulations apply only

for the purpose of determining the effect

that transfers of assets or stock following a reorganization have on the continuity of interest and COBE requirements. They do not address any other

issues concerning the qualification of a

transaction as a reorganization.

Thus, the proposed regulations do not

expand the scope of triangular reorganizations. Under current law, a T asset or

stock acquisition in exchange for stock

of a grandparent (or higher tier) corporation does not qualify as a reorganization. See Rev. Rul. 74–564 (1974–2

C.B. 124) and Rev. Rul. 74–565

(1974–2 C.B. 125). The proposed regulations do not change this result.

The proposed regulations do not provide guidance on whether the ‘‘solely

for voting stock’’ requirement is satisfied in a section 368(a)(1)(C) reorganization when a corporation other than the

acquiring corporation assumes target liabilities. See generally Rev. Rul. 70–107

(1970–1 C.B. 78).

Furthermore, the proposed regulations

do not modify the section 381 regulations which provide rules concerning

which entity inherits the tax attributes of

T in an asset acquisition.

The Treasury Department and IRS

solicit comments on these issues.

Proposed Effective Date

The revisions and additions in the

proposed regulations apply to transactions occurring after these regulations

are published as final regulations in the

Federal Register, except that they shall

not apply to transactions occurring pursuant to a written agreement which is

(subject to customary conditions) binding on or before these regulations are

published as final regulations in the

Federal Register.

Effect on Other Documents

The Treasury Department and IRS

solicit comments on what IRS publications should be modified or obsoleted

when the proposed regulations are published as final regulations.

Special Analyses

Drafting Information

It has been determined that this notice

of proposed rulemaking is not a significant regulatory action as defined in EO

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

determined that section 553(b) of the

Administrative Procedure Act (5 U.S.C.

chapter 5) does not apply to these

regulations, and because the regulations

do not impose a collection of information on small entities, the Regulatory

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

not apply. Pursuant to section 7805(f) of

the Internal Revenue Code, this notice

of proposed rulemaking will be submitted to the Chief Counsel for Advocacy

of the Small Business Administration for

comment on its impact on small business.

The principal author of the proposed

regulations is Marlene Peake Oppenheim of the Office of Assistant Chief

Counsel (Corporate), IRS. However,

other personnel from the Treasury and

IRS participated in their development.

Comments and Public Hearing

Before these proposed regulations are

adopted as final regulations, consideration will be given to any written comments (a signed original and eight copies) that are submitted timely to the

Internal Revenue Service. Alternatively,

taxpayers may submit comments electronically via the Internet by selecting

the ‘‘Tax Regs’’ option on the IRS

Home Page, or by submitting comments

directly to the IRS Internet site at

http://www.irs.ustreas.gov/prod/tax_regs/

comments.html. All comments will be

available for public inspection and copying.

A public hearing has been scheduled

for Wednesday, May 7, 1997, beginning

at 10 a.m., in the Auditorium, Internal

Revenue Building, 1111 Constitution

Avenue, NW, Washington, DC. Because

of access restrictions, visitors will not be

admitted beyond the Internal Revenue

Building lobby more than 15 minutes

before the hearing starts.

The rules of 26 CFR 601.601(a)(3)

apply to the hearing.

Persons who wish to present oral

comments at the hearing must request to

speak, and submit an outline of topics to

be discussed and the time to be devoted

to each topic by Wednesday, April 16,

1997.

A period of 10 minutes will be allocated to each person for making comments.

An agenda showing the scheduling of

the speakers will be prepared after the

deadline for receiving outlines has

passed. Copies of the agenda will be

available free of charge at the hearing.

Proposed Amendments to the Regulations

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

PART 1—INCOME TAXES

Paragraph 1. The authority citation for

part 1 continues to read in part as

follows:

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

Par. 2. Section 1.368–1 as proposed to

be amended at 61 FR 67514 is amended

by:

1. Adding two sentences after the

sixth sentence of paragraph (b).

2. Redesignating paragraph (d)(5) as

paragraph (d)(6).

3. Adding a new paragraph (d)(5).

4. Adding three sentences to the end

of newly designated paragraph (d)(6)

introductory text.

5. Adding Example 6 through Example 10 to newly designated paragraph

(d)(6).

6. Adding paragraph (f).

The additions read as follows:

§ 1.368–1 Purpose and scope of exception of reorganization exchanges.

(b) * * * Rules concerning continuity

of interest as applied to section

368(a)(1)(A), (B), (C), or (G) (meeting

the

requirements

sections

354(b)(1)(A) and (B)) are in paragraph

(f) of this section. The preceding sentence applies to transactions occurring

after these regulations are published as

final regulations in the Federal Register

except that it shall not apply to any

transactions occurring pursuant to a

written agreement which is (subject to

customary conditions) binding on or

before these regulations are published as

final regulations in the Federal Register. * * *

(d) * * *

(5) Transfers of assets or stock to

controlled corporations and partnerships—(i) Scope. The following rules of

paragraphs (d)(5)(ii) through (vi) of this

section apply in determining whether the

continuity of business enterprise requirement of paragraph (d)(1) of this section

is satisfied with respect to transactions

otherwise qualifying as reorganizations

under section 368(a)(1)(A), (B), (C), or

(G) (meeting the requirements of sections 354(b)(1)(A) and (B)).

(ii) Transfers to members of a qualified group. Continuity of business enterprise continues to be satisfied where

there are transfers or successive transfers of target (T) stock (or transfers of T

assets after a stock acquisition) or T

assets (or transfers of the acquiring

corporation’s stock after a T asset acquisition) among members of a qualified

group as defined in paragraph (d)(5)(iii)

of this section.

(iii) Qualified group. A qualified

group is one or more chains of corporations connected through stock ownership

with the issuing corporation as defined

in paragraph (d)(5)(iv) of this section,

but only if the issuing corporation owns

directly stock meeting the requirements

of section 368(c) in at least one other

corporation, and stock meeting the requirements of section 368(c) in each of

the corporations (except the issuing corporation) is owned directly by one of

the other corporations.

(iv) Issuing corporation. The issuing

corporation is the acquiring corporation

(as that term is used in section 368(a)),

except in transactions where the use of

stock of a corporation in control of the

acquiring corporation is permitted.

Where stock of the controlling corporation is used, the controlling corporation

is the issuing corporation.

(v) Partnerships—(A) For purposes

of the business continuity test of paragraph (d)(3) of this section, the corporate transferor partner (PTR) will be

treated as conducting a business of a

partnership (PRS) where—

(1) PTR has active and substantial

management functions as a partner with

respect to the PRS business; or

(2) PTR’s interest in PRS represents

a significant interest in the PRS business.

(B) For purposes of the asset continuity test of paragraph (d)(4) of this

section—

(1) PTR will be treated as owning the

assets of PRS in accordance with PTR’s

interest in PRS; and

(2) PTR will be treated as conducting

a PRS business if PTR meets the requirement of paragraph (d)(5)(v)(A)(1)

or (2) of this section.

conducting a business of PRS under

1997–9

I.R.B.

paragraph (d)(5)(v)(A) of this section

tends to establish the requisite continuity, but is not alone sufficient.

(vi) This paragraph (d)(5) applies to

transactions occurring after these regulations are published as final regulations

in the Federal Register except that it

shall not apply to any transactions occurring pursuant to a written agreement

which is (subject to customary conditions) binding on or before these regulations are published as final regulations

in the Federal Register.

(6) * * * All corporations have only

one class of common stock outstanding.

Example 6 through Example 10 of this

paragraph (d)(6) apply to transactions

occurring after these regulations are

published as final regulations in the

Federal Register except that they shall

not apply to any transactions occurring

pursuant to a written agreement which is

(subject to customary conditions) binding on or before these regulations are

published as final regulations in the

Federal Register. The examples are as

follows:

Example 6. Qualified group and business continuity. (a) Facts. T operates a bakery which makes

and supplies delectable pastries and cookies to a

few select locations. The acquiring corporate

group consists of numerous corporations which

produce a variety of baked goods for distribution

around the world. Holding Company (HC) owns

80 percent of the stock of P. Pursuant to a plan, T

transfers all of its assets to P solely in exchange

for HC voting stock, which T distributes to its

shareholders. P owns 80 percent of the stock of

S1; S1 owns 80 percent of the stock of S2, which

also makes and supplies pastries and cookies. To

amalgamate the T business into HC’s affiliated

group, P would like to operate T’s business in S2.

Pursuant to the plan, P transfers the T assets to S1;

S1 then transfers the T assets to S2.

(b) Continuity of business enterprise. HC, P, S1,

and S2 are members of a qualified group as

defined in paragraph (d)(5)(iii) of this section.

Under paragraph (d)(5)(ii) of this section, continuity of business enterprise continues to be satisfied

where T’s historic business is transferred to a

member of the qualified group. The same results

would occur if T had been acquired by P for HC

voting stock in a reorganization described in

section 368(a)(1)(B) and the T stock had been

transferred from P to S1 and from S1 to S2.

Example 7. Transfers of assets to multiple

controlled corporations. (a) Facts. T operates an

auto parts distributorship. Pursuant to a plan, T

merges into P and the T shareholders receive

solely P stock. P owns 80 percent of the stock of

S1. S1 owns 80 percent of the stock of ten

subsidiaries, S2 through S11. S2 through S11 each

separately operate a full service gas station. As

part of the plan, P transfers T’s auto parts to S1,

which in turn transfers some of the parts to each

of its ten subsidiaries. No one subsidiary receives

a significant portion of T’s historic business assets.

Each of S1’s subsidiaries will use the T assets

1997–9

I.R.B.

received in the operation of its full service gas

station. No S1 subsidiary will be an auto parts

distributor.

(b) Continuity of business enterprise. P, S1, and

the respective subsidiaries are members of a

qualified group as defined in paragraph (d)(5)(iii)

of this section. Under paragraph (d)(5)(ii) of this

section, continuity of business enterprise continues

to be satisfied where all of T’s historic business

assets are transferred among members of the

qualified group. Even though no one corporation

is using a significant portion of T’s historic

business assets in a business, the continuity of

business enterprise requirement is satisfied because

the qualified group is using a significant portion of

T’s historic business assets in a business.

Example 8. Transfer of a historic T business to

PRS — active and substantial management.

(a) Facts. T manufactures custom ski boots. T

transfers all of its assets to P solely in exchange

for P voting stock, which T then distributes to its

shareholders. P plans to continue manufacturing

ski boots and to expand this operation. As part of

the expansion, P and R (an unrelated party) form a

new partnership (PRS). As part of the plan of

reorganization, P (PTR) transfers T’s ski boot

business to PRS in exchange for a 20 percent

interest in PRS. R transfers cash in exchange for

its interest in PRS. PTR performs active and

substantial management functions for PRS including the decision-making regarding significant business decisions of PRS and regular participation in

the overall supervision, direction and control of

the employees of PRS in operating the ski boot

business.

(b) Continuity of business enterprise. Under

paragraph (d)(5)(v)(A)(1) of this section, PTR is

treated as conducting T’s historic business because

the officers of PTR perform active and substantial

management functions for the ski boot business in

PRS. Thus, the continuity of business enterprise

requirement is satisfied because PTR is treated as

continuing to conduct T’s historic business.

(f)(1)(ii) of this section, the continuity of interest

requirement is satisfied even though the assets are

transferred to PRS in exchange for an interest in

PRS.

Example 9. Transfer of a historic T business to

PRS — significant interest. (a) Facts. The facts

are the same as in Example 8 except that PTR’s

officers do not operate the ski boot business, and

PTR owns a 33 1/3 percent interest in PRS.

(b) Continuity of business enterprise. Under

paragraph (d)(5)(v)(A)(2) of this section, PTR is

treated as conducting T’s historic ski boot business

because PTR’s 33 1/3 percent interest in PRS

represents a significant interest in the PRS ski

boot business.

(f)(1)(ii) of this section, the continuity of interest

requirement is satisfied even though the assets are

transferred to PRS in exchange for an interest in

PRS.

Example 10. Transfer of T’s historic assets to

PRS. (a) Facts. T manufactures silk. T transfers

all of its assets to P solely in exchange for P

voting stock, which T then distributes to its

shareholders. P manufactures clothing and has

been buying silk from T. P (PTR) and R (an

unrelated party) own interests in a partnership

(PRS) which owns and maintains warehouse facilities. As part of the plan of reorganization, PTR

transfers the T assets to PRS, increasing PTR’s

percentage interest in PRS from 20 to 33 1/3

percent. PTR decides to buy its silk from a

different manufacturer and converts T’s plant

facilities into warehouses.

(b) Continuity of business enterprise. Under

paragraph (d)(5)(v)(A)(2), PTR is treated as being

in the business of owning and maintaining warehouse space because of PTR’s significant interest

in PRS. Furthermore, under paragraph (d)(5)(v)(B)

of this section, PTR is treated as owning the assets

of PRS in accordance with its interest in the

partnership. Thus, the continuity of business enterprise requirement is satisfied because PTR continues to use a significant portion of T’s historic

assets in a business.

(f)(1)(ii) of this section, the continuity of interest

requirement continues to be satisfied even though

the assets are transferred to PRS in exchange for

an interest in PRS.

(f) Continuity of interest and asset or

stock transfers. (1) Scope. The following rules apply to transactions otherwise

qualifying as a reorganization under section 368(a)(1)(A), (B), (C), or (G)

(meeting the requirements of sections

354(b)(1)(A) and (B)):

(i) Transfers to members of a qualified group. Continuity of interest is

satisfied where there are transfers or

successive transfers of target (T) stock

(or transfers of T assets after a stock

acquisition) or T assets (or transfers of

the acquiring corporation’s stock after a

T asset acquisition) among members of

a qualified group as defined in paragraph (d)(5)(iii) of this section.

(ii) Partnerships. Continuity of interest is satisfied even where T assets (or

transfers of T assets following a T stock

acquisition) are transferred to a partnership in exchange for a partnership interest.

(2) Example. The rules of this paragraph (f) are illustrated by the following

example. P represents the acquiring corporation and T represents the target

corporation. Also see Example 8 through

Example 10 in paragraph (d)(6) of this

section. The example is as follows:

Example. Transfers to corporations in the qualified group. (a) Facts. T manufactures playground

equipment, including launch ramps and half pipes

for skateboarding, in-line skating, and bicycling.

The P affiliated group is engaged in architectural

design and construction. A holding company (HC)

owns 80 percent of the stock of each of P and S1.

S1 in turn, owns 80 percent of the stock of S2,

and S2 owns 80 percent of the stock of S3. T

transfers all of its assets to P in exchange for HC

voting stock, which T distributes to its shareholders. HC transfers all of the P stock to S1. S1 in

turn transfers all of the P stock to S2, and S2

transfers the P stock to S3.

(b) Continuity of interest. HC, P, S1, S2 and S3

are members of a qualified group as defined in

paragraph (d)(5)(iii) of this section. Under paragraph (f)(1)(i) of this section, the successive

transfers of the P stock to other members of the

qualified group do not violate the continuity of

interest requirement.

Par. 3. In § 1.368–2, paragraph (f) is

amended by removing the second sen-

tence and adding two new sentences in

its place to read as follows:

§ 1.368–2 Definition of terms.

(f) * * * A corporation remains a

party to the reorganization even though

assets are transferred among members of

a qualified group as defined in § 1.368–

1(d)(5)(iii). The preceding sentence applies to transactions occurring after

these regulations are published as final

regulations in the Federal Register except that it shall not apply to any

transactions occurring pursuant to a

written agreement which is (subject to

customary conditions) binding on or

before these regulations are published as

final regulations in the Federal Register.

***

Margaret Milner Richardson,

Commissioner of Internal Revenue.

(Filed by the Office of the Federal Register on

January 2, 1997, 8:45 a.m., and published in the

issue of the Federal Register for January 3, 1997,

62 F.R. 361)

Rev. Proc. 97–10; Correction

Announcement 97–15

This announcement is a correction to

Rev. Proc. 97–10, 1997–2 I.R.B. 59,

which provides the exclusive procedure

for making the election under § 1120 of

the Small Business Job Protection Act

of 1996 to treat a retail motor fuels

outlet placed in service before August

20, 1996, as 15-year property under

§ 168 of the Code. As the result of a

printing error, two dates were omitted

from the revenue procedure. The date

‘‘July 14, 1997,’’ should be inserted in

section 5.04(1) of the revenue procedure. The date ‘‘January 13, 1997,’’

should be inserted in section 5.06(2) of

the revenue procedure.

The principal author of this announcement is Mark Pitzer of the Office of

Assistant Chief Counsel (Passthroughs

and Special Industries). For further information regarding this announcement,

contact Mark Pitzer at (202) 622–3110

(not a toll-free call).

Announcement 97–16

The following correction should be

made to Notice 97–9, Adoption Assistance, 1997–2 I.R.B. 35.

The second sentence of the first paragraph of Section VI. ‘‘Comments on

Future Guidance Invited’’ should be corrected to read: ‘‘The Service requests

that written comments be submitted by

April 14, 1997.’’ It currently says ‘‘The

Service requests that written comments

be submitted by [INSERT DATE THAT

IS [90] DAYS AFTER DATE OF PUBLICATION OF THIS DOCUMENT IN

THE INTERNAL REVENUE BULLETIN].’’ A new sentence three is added as

follows: ‘‘All comments will be available for public inspection and copying.’’

Foundations Status of Certain

Organizations

Announcement 97–17

The following organizations have

failed to establish or have been unable

to maintain their status as public charities or as operating foundations. Accordingly, grantors and contributors may not,

after this date, rely on previous rulings

or designations in the Cumulative List

of Organizations (Publication 78), or on

the presumption arising from the filing

of notices under section 508(b) of the

Code. This listing does not indicate that

the organizations have lost their status

as organizations described in section

501(c)(3), eligible to receive deductible

contributions.

Former Public Charities. The following organizations (which have been

treated as organizations that are not

private foundations described in section

509(a) of the Code) are now classified

as private foundations:

A Cord, Inc., Princeton, NJ

Active Community Coalition Efforts