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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.

2

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

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

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

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

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

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

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

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

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

3

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

4

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

5

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.

6

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.
(c) Definitions.
(1) Inflation-indexed debt instrument.
(2) Reference index.

7

(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
a
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).
(c) Definitions. The following definitions apply for purposes of this section:
(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
by
(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-

8

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
99

(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-

9

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

10

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.

11

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

12

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
at
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. * * *
(c) Electronic Form W–4—(1) In
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

13

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.
*

*

*

*

(c) * * *
CFR part or section
where identified and
described

§ 602.101 OMB Control numbers.

*
*

*

*

*

*

(c) * * *
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
*
*
*
*
*

14

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

15

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

Y
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

16

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
99
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
94
7,354
66

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
88
7,990
74

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.

17

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
94
6,784
81

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.

18

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

19

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

20

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
of
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

21

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.
(C) The fact that PTR is treated as
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,

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Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/agency%3Airs%3A76de5c6538e140c3. Public record. Not legal advice.