Bulletin No. 1999–11

Internal Revenue

bulletin

Bulletin No. 1999–11

March 15, 1999

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

Rev. Rul. 99–12, page 6.

Fringe benefits aircraft valuation formula. For purposes

of section 1.61–21(g) of the Income Tax Regulations, relating to the rule for valuing noncommercial flights on employer-provided aircraft, the Standard Industry Fare Level

(SIFL) cents-per-mile rates and terminal charges in effect for

the first half of 1999 are set forth.

election for regulated investment companies (RICs) that are

shareholders of PFICs.

EMPLOYEE PLANS

REG–209103–89, page 10.

Proposed regulations under section 79 of the Code relate to

the uniform premium rates used to calculate the cost of

group-term life insurance provided to employees. A public

hearing is scheduled for May 6, 1999.

REG–104072–97, page 12.

Proposed regulations under section 7701 of the Code

recharacterize, for tax purposes, financing arrangements involving fast-pay stock. A public hearing is scheduled for April

8, 1999.

REG–106388–98, page 27.

Proposed regulations under section 25A of the Code relate

to the Hope Scholarship Credit and the Lifetime Learning

Credit.

REG–106905–98, page 39.

Proposed regulations under section 861 of the Code relate

to the allocation of loss recognized on the disposition of

stock and other personal property. A public hearing is

scheduled for May 26, 1999.

REG–114841–98, page 41.

Proposed regulations under section 663 of the Code provide

that substantively separate and independent shares of different beneficiaries are to be treated as separate estates for

purposes of computing distributable net income. A public

hearing is scheduled for April 22, 1999.

Notice 99–14, page 7.

This notice withdraws guidance proposed in April 1992

under the passive foreign investment company (PFIC) rules

of section 1291 of the Code relating to a mark-to-market

EXEMPT ORGANIZATIONS

Announcement 99–20, page 53.

A list is given of organizations now classified as private foundations.

ADMINISTRATIVE

Rev. Proc. 99–18, page 7.

Election to treat certain debt substitutions as realization events. This procedure provides for an election that

will allow taxpayers to treat a debt substitution, in certain circumstances, as a realization event even though it does not

result in a significant modification under section 1.1001–3

of the Income Tax Regulations.

REG–114664–97, page 21.

Proposed regulations under section 42 of the Code relate to

the low-income housing credit including the procedures for

compliance monitoring by state and local housing agencies

(Agencies), the requirements for making carryover allocations, and the rules for correction of administrative errors or

omissions by Agencies. A public hearing is scheduled for

May 27, 1999.

Finding Lists begin on page 58.

Announcement Relating to Court Decisions begins on page 5.

Announcement of Declaratory Judgment Proceedings Under Section 7428 begins on page 56.

Department of the Treasury

Internal Revenue Service

Continued on page 4

Mission of the Service

and by applying the tax law with integrity and fairness to

all.

Provide America’s taxpayers top quality service by helping them understand and meet their tax responsibilities

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.

dures 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, court decisions, rulings, and proce-

The first Bulletin for each month includes a cumulative index

for the matters published during the preceding months.

These monthly indexes are cumulated on a quarterly and

semiannual basis, and are published in the first Bulletin of the

succeeding quarterly and semiannual 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, DC 20402.

3

HIGHLIGHTS

OF THIS ISSUE—Continued

ADMINISTRATIVE—Continued

Announcement 99–21, page 55.

REG–119192–98, page 45.

This document provides notice of a public hearing on proposed regulations, REG–246256–96, 1998–34 I.R.B. 9,

under section 4958 of the Code relating to the excise tax on

excess benefit transactions. The hearing is scheduled for

March 16, 1999, at 1 p.m. (EDT), and will continue on March

17, 1999, at 1 p.m., if necessary.

Proposed regulations under sections 1201 and 1204 of the

Internal Revenue Restructing and Reform Act of 1998 relate

to the adoption by the IRS of a balanced system to measure

organizational performance within the IRS. A public hearing

is scheduled for May 13, 1999.

March 15, 1999

4

1999–11 I.R.B.

Announcement Relating to Court Decisions

It is the policy of the Internal Revenue

Service to announce at an early date

whether it will follow the holdings in certain cases. An Action on Decision is the

document making such an announcement.

An Action on Decision will be issued at

the discretion of the Service only on unappealed issues decided adverse to the

government. Generally, an Action on Decision is issued where its guidance would

be helpful to Service personnel working

with the same or similar issues. Unlike a

Treasury Regulation or a Revenue Ruling,

an Action on Decision is not an affirmative statement of Service position. It is not

intended to serve as public guidance and

may not be cited as precedent.

Actions on Decisions shall be relied

upon within the Service only as conclusions applying the law to the facts in the

particular case at the time the Action on

Decision was issued. Caution should be

exercised in extending the recommendation of the Action on Decision to similar

cases where the facts are different. Moreover, the recommendation in the Action

on Decision may be superseded by new

legislation, regulations, rulings, cases, or

Actions on Decisions.

Prior to 1991, the Service published acquiescence or nonacquiescence only in

certain regular Tax Court opinions. The

Service has expanded its acquiescence

program to include other civil tax cases

where guidance is determined to be helpful. Accordingly, the Service now may acquiesce or nonacquiesce in the holdings

of memorandum Tax Court opinions, as

well as those of the United States District

Courts, Claims Court, and Circuit Courts

of Appeal. Regardless of the court deciding the case, the recommendation of any

Action on Decision will be published in

the Internal Revenue Bulletin.

The recommendation in every Action

on Decision will be summarized as acquiescence, acquiescence in result only,

or nonacquiescence. Both “acquiescence” and “acquiescence in result only”

mean that the Service accepts the holding

of the court in a case and that the Service

will follow it in disposing of cases with

the same controlling facts. However, “acquiescence” indicates neither approval

nor disapproval of the reasons assigned

by the court for its conclusions; whereas,

“acquiescence in result only” indicates

disagreement or concern with some or all

of those reasons. Nonacquiescence signifies that, although no further review was

sought, the Service does not agree with

the holding of the court and, generally,

will not follow the decision in disposing

of cases involving other taxpayers. In reference to an opinion of a circuit court of

appeals, a nonacquiescence indicates that

the Service will not follow the holding on

a nationwide basis. However, the Service

will recognize the precedential impact of

the opinion on cases arising within the

venue of the deciding circuit.

The announcements published in the

weekly Internal Revenue Bulletins are

consolidated semiannually and annually.

The semiannual consolidation appears in

the first Bulletin for July and in the Cumulative Bulletin for the first half of the

year, and the annual consolidation appears in the first Bulletin for the following January and in the Cumulative Bulletin for the last half of the year.

The Commissioner ACQUIESCES in

the following decision:

Oshkosh Truck Corporation v. United

States,

123 F.3d 1477 (Fed. Cir. 1997)1

1 Acquiescence in result only relating to whether the 12-percent excise tax imposed under I.R.C. section 4052 on the first retail sale of specially designed trucks to

the United States Army is computed by adding to the vehicle sales price a “presumed markup percentage” as decribed in subsections (b)(3) and (4) of section 4052

and Treas. Reg. Section 145.4052–1(d)(7).

1999–11 I.R.B.

5

March 15, 1999

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

Section 61.—Gross Income

Defined

Rev. Rul. 99–12

multiplying the SIFL cents-per-mile rates

applicable for the period during which the

flight was taken by the appropriate aircraft multiple provided in section 1.6121(g)(7) and then adding the applicable

terminal charge. The SIFL cents-per-mile

rates in the formula and the terminal

charge are calculated by the Department

of Transportation and are reviewed semiannually.

The following chart sets forth the terminal charges and SIFL mileage rates:

Fringe benefits aircraft valuation

formula. For purposes of section

1.61–21(g) of the Income Tax Regulations, relating to the rule of valuing noncommercial flights on employer-provided

aircraft, the Standard Industry Fare Level

(SIFL) cents-per-mile rates and terminal

charges in effect for the first half of 1999

are set forth.

For purposes of the taxation of fringe

benefits under section 61 of the Internal

Revenue Code, section 1.61-21(g) of the

Income Tax Regulations provides a rule

for valuing noncommercial flights on employer-provided aircraft. Section 1.6121(g)(5) provides an aircraft valuation

formula to determine the value of such

flights. The value of a flight is determined under the base aircraft valuation

formula (also known as the Standard Industry Fare Level formula or SIFL) by

Period During Which

the Flight Was Taken

Terminal

Charge

SIFL Mileage

Rates

1/1/99 – 6/30/99

$32.69

Up to 500 miles = $.1788 per mile

26 CFR 1.61–21: Taxation of fringe benefits.

501-1500 miles = $.1364 per mile

Over 1500 miles = $.1311 per mile

DRAFTING INFORMATION

The principle author of this revenue

ruling is Kathleen Edmondson of the Office of the Associate Chief Counsel (Employee Benefits and Exempt Organizations). For further information regarding

this revenue ruling, contact Ms. Edmondson on (202) 622-6080 (not a toll-free

call).

March 15, 1999

Section 1001.—Determination

of Amount of and Recognition of

Gain or Loss

26 CFR 1.1001–3: Modification of debt

instruments.

The revenue procedure provides for an election

that will allow taxpayers to treat a debt substitution,

in certain circumstances, as a realization event even

though it does not result in a significant modification under section 1.1001–3 of the Income Tax Regulations. See Rev. Proc. 99–18, page 7.

6

Section 1275.—Other

Definitions and Special Rules

26 CFR 1.1275–2: Special rules relating to debt

instruments.

The revenue procedure provides for an election

that will allow taxpayers to treat a debt substitution,

in certain circumstances, as a realization event even

though it does not result in a significant modification under section 1.1001–3 of the Income Tax Regulations. See Rev. Proc. 99–18, page 7.

1999–11 I.R.B.

Part III. Administrative, Procedural, and Miscellaneous

Withdrawal of Guidance Under

Section 1291 Relating to Markto-Market Elections for RICs

Notice 99–14

Associate Chief Counsel (International).

However, other personnel from the IRS

and Treasury Department participated in

developing the withdrawal notice.

* * * * *

AGENCY: Internal Revenue Service

(IRS), Treasury.

Partial Withdrawal of Proposed

Amendments to the Regulations

ACTION: Partial withdrawal of proposed

regulations.

Accordingly, under the authority of 26

U.S.C. 7805, §1.1291–8 of the proposed

amendments to 26 CFR part 1 published

at 57 F.R. 11024 (April 1, 1992), is withdrawn.

SUMMARY: This document withdraws

§1.1291–8 of the notice of proposed rulemaking (INTL–941–86, 1992–1 C.B.

1124) that was published in the Federal

Register on April 1, 1992, providing

guidance under the passive foreign investment company (PFIC) rules relating to the

mark to market election for regulated investment companies (RICs) that are

shareholders of PFICs.

DATES: Section 1.1291–8 of the proposed regulations published at 57 FR

11024 (April 1, 1992) is withdrawn February 2, 1999.

FOR FURTHER INFORMATION CONTACT: Robert Laudeman of the Office of

Associate Chief Counsel (International),

Internal Revenue Service, 1111 Constitution Ave., NW, Washington, DC 20224.

Telephone (202) 622-3840, not a toll-free

number.

SUPPLEMENTARY INFORMATION:

Background

On April 1, 1992 (57 F.R. 110224), the

IRS issued proposed regulations providing, in part, an election under which certain RICs could mark to market their stock

in certain PFICs. In the Taxpayer Relief

Act of 1997 Congress enacted section

1296(e)(2) of the Internal Revenue Code,

which allows certain RICs to elect to mark

to market their PFIC stock. Accordingly,

the IRS is withdrawing proposed regulations §1.1291-8. Future guidance will be

issued providing rules for all PFIC shareholders, including RICs, on how to mark

to market certain PFIC stock.

Drafting Information

The principal author of this withdrawal

notice is Robert Laudeman, Office of the

1999–11 I.R.B.

Robert E. Wenzel,

Deputy Commissioner of

Internal Revenue.

(Filed by the Office of the Federal Register on February 1, 1999, 8:45 a.m., and published in the issue

of the Federal Register for February 2, 1999, 64 F.R.

5015)

26 CFR 601.601: Rules and regulations.

(Also Part I, sections 1001; 1.1001–3, 1.1275–2.)

Rev. Proc. 99–18

SECTION 1. PURPOSE

This revenue procedure provides for an

election that will facilitate the substitution

of some or all of the debt instruments from

two or more outstanding issues of debt

with debt instruments from a new issue.

Under the election, taxpayers can treat a

substitution of debt instruments, in certain

circumstances, as a realization event for

federal income tax purposes even though

it does not result in a significant modification under § 1.1001–3 of the Income Tax

Regulations (and, therefore, is not an exchange for purposes of § 1.1001–1(a)).

Under section 4 of this revenue procedure,

taxpayers do not recognize any realized

gain or loss on the date of the substitution.

Instead, the gain or loss generally is taken

into account as income or deductions over

the term of the new debt instruments.

SECTION 2. BACKGROUND

.01 Under § 1.1001–1(a), gain or loss is

realized from the exchange of property

for other property differing materially either in kind or in extent.

.02 Section 1.1001–3 provides rules to

determine whether a modification of the

7

terms of a debt instrument results in an

exchange of the original debt instrument

for a modified instrument that differs materially either in kind or in extent. Under

§ 1.1001–3, a modification of a debt instrument results in an exchange for purposes of § 1.1001–1(a) if the modification is significant. A modification that is

not significant does not result in an exchange for purposes of § 1.1001–1(a).

Section 1.1001–3 applies to any modification of a debt instrument, regardless of

the form of the modification (including

an exchange of a new instrument for an

existing instrument).

.03 Under § 1.1001–3(c), a modification means any alteration, including any

deletion or addition, in whole or in part,

of a legal right or obligation of the issuer

or a holder of a debt instrument, whether

the alteration is evidenced by an express

agreement (oral or written), conduct of

the parties, or otherwise.

.04 In general, a modification of a debt

instrument is a significant modification

under § 1.1001–3 only if, based on all the

facts and circumstances, the legal rights

or obligations that are altered and the degree to which they are altered are economically significant. Section 1.1001–

3(e) provides rules to determine whether

certain modifications, such as a change in

yield or the timing of payments, constitute significant modifications.

.05 If the terms of a debt instrument are

modified to defer one or more payments

and the modification does not result in an

exchange under § 1.1001–3, § 1.1275–

2(j) provides rules to account for the modified debt instrument. Under § 1.1275–

2(j), solely for purposes of §§ 1272 and

1273 of the Internal Revenue Code, the

debt instrument is treated as retired and

then reissued on the date of the modification for an amount equal to the instrument’s adjusted issue price on that date.

As a result, the debt instrument is retested

for original issue discount based on the

instrument’s adjusted issue price and the

remaining payments, as modified, to be

made on the instrument. If the debt instrument has original issue discount as a

result of the modification, both the issuer

and the holder account for the original

March 15, 1999

issue discount over the remaining term of

the instrument. See §§ 163(e) and 1272.

.06 An issuer may want to refinance

and consolidate debt instruments (“old

debt”) from two or more outstanding issues of debt into debt instruments (“new

debt”) from a single new issue. In general, if the terms of the new debt are not

materially different from the terms of the

old debt, substituting the new debt for the

old debt does not result in a significant

modification of the old debt under

§ 1.1001–3. Therefore, the substitution of

the new debt for the old debt in the consolidation is not a realization event for

federal income tax purposes. However,

under § 1.1275–2(j), some or all of the

new debt may have original issue discount in varying amounts, depending

upon the terms of the old debt for which

the new debt was substituted. As a result,

the new debt may not be fungible.

SECTION 3. SCOPE

This revenue procedure applies to the

substitution of new debt for old debt if all

of the following conditions are satisfied:

.01 Debt instruments from a single new

issue are being substituted for debt instruments from two or more old issues of

debt. (It is not necessary, however, for

any single holder of the old debt to have

held debt instruments from more than one

of the old issues.)

.02 The substitution does not result in a

significant modification of the old debt

under § 1.1001–3 and, therefore, is not a

realization event under § 1.1001–1.

.03 The new debt and the old debt are

publicly traded (within the meaning of

§ 1.1273–2(f)).

.04 The old debt was issued at par or

with a de minimis amount of original

issue discount or premium. (For purposes

of this condition, the de minimis amount

for premium is determined using the principles of § 1.1273–1(d).)

.05 The new debt is issued at par or

with a de minimis amount of original

issue discount or premium. (For purposes

of this condition, the issue price of the

new debt is determined under § 1.1273–2

rather than under § 1.1275–2(j), and the

de minimis amount for premium is determined using the principles of § 1.1273–

1(d).)

March 15, 1999

.06 Neither the new debt nor the old

debt is—

(1) a contingent payment debt instrument (within the meaning of § 1.1275–4),

(2) a tax-exempt obligation (as defined in § 1275(a)(3)), or

(3) a convertible debt instrument

(within the meaning of § 1.1272–1(e)).

.07 All payments on the old debt and

the new debt are denominated in, or determined solely by reference to, U.S. dollars,

and the functional currency of the business unit issuing the new debt is the U.S.

dollar.

.08 The issuer and one or more holders

of the old debt make the election provided

in section 4.01 of this revenue procedure.

SECTION 4. APPLICATION

.01 Election.

(1) Manner of making the election.

The issuer and the holders make the election under this revenue procedure by

agreeing in writing to treat the substitution as a realization event for federal income tax purposes and to comply with the

provisions of this revenue procedure. The

written agreement must be entered into no

later than the last day of the month in

which the substitution occurs.

For example, the written agreement to

make the election may be evidenced by a

statement in the offering documents for

the substitution that—

(a) the issuer, by distributing the

documents, elects under this revenue procedure to treat the substitution as a realization event for federal income tax purposes,

(b) any holder of old debt that

tenders its old debt for new debt as part of

the substitution thereby makes the election under this revenue procedure, and

(c) the issuer and the holders who

have tendered their old debt for the new

debt (“electing holders”) will comply

with the provisions of this revenue procedure.

(2) Statement attached to return. If

an election is made under section 4.01(1)

of this revenue procedure, the issuer must

attach a signed statement to its timely

filed (including extensions) federal income tax return for the taxable year in

which the substitution occurs. On the

statement, the issuer must—

8

(a) identify the old debt for which

new debt was substituted,

(b) identify the new debt that was

substituted for the old debt,

(c) indicate the issue price of the

new debt, and

(d) indicate that the election was

made under this revenue procedure.

.02 Treatment of substitution. If an

election is made under this revenue procedure, the issuer and the electing holders

must report the substitution for federal income tax purposes as a repurchase of the

old debt in exchange for the new debt in

the taxable year in which the substitution

occurs. However, the issuer must account

for this deemed exchange under the rules

described in section 4.03 of this revenue

procedure and each electing holder must

account for this deemed exchange under

the rules described in section 4.04 of this

revenue procedure.

.03 Issuer’s treatment. The issuer must

take into account over the term of the new

debt any difference between the adjusted

issue prices of the old debt and the issue

price of the new debt (as determined

under § 1.1273–2). If the aggregate issue

price of the new debt that is transferred to

electing holders as a substitute for the old

debt is greater than the aggregate adjusted

issue prices of the old debt for which it is

substituted, the issuer treats the difference

as a reduction in the aggregate issue price

of the new debt. As a result, the difference is taken into account by the issuer

over the term of the new debt as increased

original issue discount or as reduced bond

issuance premium (within the meaning of

§ 1.163–13). If the aggregate issue price

of the new debt that is transferred to electing holders as a substitute for the old debt

is less than the aggregate adjusted issue

prices of the old debt for which it is substituted, the issuer treats the difference as

an increase in the aggregate issue price of

the new debt. As a result, the difference is

taken into account by the issuer over the

term of the new debt as reduced original

issue discount or increased bond issuance

premium.

.04 Electing holder’s treatment.

(1) In general. Notwithstanding any

provision of subtitle A of the Internal

Revenue Code (including §§ 356(a) and

1276(a)), an electing holder does not rec-

1999–11 I.R.B.

ognize any gain or loss as a result of the

deemed exchange. Instead, the holder’s

basis (immediately after the substitution)

in the new debt is the same as the holder’s

adjusted basis (determined as of the date

of the substitution) in the debt instruments

for which the new debt was substituted.

In addition, the holder’s holding period

for the new debt includes the holder’s

holding period for the old debt.

(2) Market discount.

(a) In general. If the stated redemption price at maturity of the new

debt (as determined under § 1.1273–1(b))

is greater than the holder’s basis (immediately after the substitution) in the new

debt, the holder treats the difference as

market discount on the new debt and the

new debt as a market discount bond (unless the amount of the discount is a de

minimis amount within the meaning of

§ 1278(a)(2)(C)). See §§ 1276 and 1278

for the treatment of market discount.

(The issue date of the old debt rather than

the issue date of the new debt is used to

determine whether the new debt is a

short-term obligation for purposes of

§ 1278(a)(1)(B)(i).) See section

4.04(2)(b) below for the treatment of any

accrued market discount on the old debt.

(b) Accrued market discount. The

rules in this section 4.04(2)(b) apply if, as

of the date of the substitution, there is any

accrued market discount on the old debt

that has not been taken into account by

the holder as ordinary income. If, under

section 4.04(2)(a) above, there is no market discount on the new debt or the

amount of any market discount on the

new debt is a de minimis amount, the

amount of accrued market discount on the

new debt is zero, and the accrued market

discount on the old debt is ignored. If,

under section 4.04(2)(a) above, the

amount of market discount on the new

debt is more than a de minimis amount,

the lesser of this market discount and the

accrued market discount on the old debt is

treated by the holder, as of the date of the

1999–11 I.R.B.

substitution, as accrued market discount

on the new debt. (Solely for purposes of

determining the accruals of any additional

market discount on the new debt, the

holder’s basis is increased by the amount

of the accrued market discount on the old

debt that is treated as accrued market discount on the new debt.)

(3) Bond premium. If the holder’s

basis in the new debt (immediately after

the substitution) is greater than the stated

redemption price at maturity of the new

debt (as determined under § 1.1273–1(b)),

the holder treats the difference as bond

premium on the new debt. See §§ 1.171–

1 through 1.171–5 for the treatment of

bond premium.

SECTION 5. EFFECTIVE PERIOD

This revenue procedure applies to substitutions that occur between March 1,

1999, and June 30, 2000.

SECTION 6. REQUEST FOR

COMMENTS

The Internal Revenue Service requests

comments on this revenue procedure, including comments on whether this revenue procedure should be made permanent. Persons that wish to comment on

this revenue procedure may submit comments by May 31, 1999, to: CC:DOM:

CORP:R (RP–102721–99), 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 (RP–102721–99),

Courier’s Desk, Internal Revenue Service, 1111 Constitution Avenue, NW,

Washington DC. Alternatively, comments may be submitted via the Internet

by selecting the “Tax Regs” option of the

IRS Home Page or by submitting them directly to the IRS Internet site at

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

comments.html. Comments will be available for public inspection.

9

SECTION 7. PAPERWORK

REDUCTION ACT

The collections of information contained in this revenue procedure have

been reviewed and approved by the Office of Management and Budget (OMB)

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

number 1545-1647.

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

OMB control number.

The collections of information in this

revenue procedure are in section 4.01.

This information is required to determine

whether a taxpayer has made the election

under this revenue procedure. The collections of information are required to obtain

a benefit. The likely respondents are

business or other for-profit institutions.

The estimated total annual reporting

and/or recordkeeping burden is 75 hours.

The estimated annual burden per respondent/recordkeeper varies from 1/2

hour to 1 hour, depending on individual

circumstances, with an estimated average

of 3/4 hour. The estimated number of respondents is 100.

The estimated annual frequency of responses is on occasion.

Books or records relating to a collection of information must be retained as

long as their contents may become material in the administration of any internal

revenue law. Generally tax returns and

tax return information are confidential, as

required by 26 U.S.C. 6103.

CONTACT PERSON

For further information regarding this

revenue procedure, contact William E.

Blanchard of the Office of Assistant Chief

Counsel (Financial Institutions and Products) on (202) 622-3950 (not a toll free

call).

March 15, 1999

Part IV. Items of General Interest

Notice of Proposed Rulemaking

and Notice of Public Hearing

Group Term Insurance;

Uniform Premiums

REG–209103–89

AGENCY: Internal Revenue Service

(IRS), Treasury.

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

SUMMARY: This document contains

proposed regulations that revise the uniform premium table used to calculate the

cost of group-term life insurance coverage provided to an employee by an employer. These proposed regulations provide guidance to employers who must use

the uniform premium table to calculate

the cost of group-term insurance includible in the gross income of their employees. This document also provides notice

of a public hearing on these proposed regulations.

DATES: Comments must be received by

April 13, 1999. Requests to speak and

outlines of topics to be discussed at the

public hearing scheduled for May 6,

1999, must be received by April 15,

1999. The IRS requests comments on the

clarity of the proposed rule and how it

may be made easier to read.

ADDRESSES: Send submissions to:

CC:DOM:CORP:R (REG–209103–89),

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–209103–89), 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 Room

2615, Internal Revenue Building, 1111

Constitution Avenue NW, Washington,

DC.

March 15, 1999

FOR FURTHER INFORMATION CONTACT: Concerning the regulations, Betty

J. Clary, (202) 622-6070; concerning submissions and the hearing, Michael

Slaughter, (202) 622-7190 (not toll-free

numbers).

SUPPLEMENTARY INFORMATION:

Background

This document contains proposed

amendments to the Income Tax Regulations under section 79 of the Internal Revenue Code. These proposed regulations

revise the uniform premium rates used to

calculate the cost of group-term life insurance provided to employees. Section 79

generally permits an employee to exclude

from gross income the cost of $50,000 of

group-term life insurance coverage. The

remaining cost of the group-term life insurance is included in the employee’s

gross income to the extent it exceeds the

amount, if any, paid by the employee for

the coverage. The cost of the group-term

insurance is determined on the basis of

five-year age brackets prescribed by regulations.

The uniform premiums are set forth in

the regulations in Table I entitled “Uniform Premiums for $1,000 of Group-term

Life Insurance Protection.” Section 1.79–

3(d)(2). A table was initially published on

July 6, 1966 (31 F.R. 9199), and the table

was revised on December 6, 1983 (48

F.R. 54595). The December 6, 1983 revision was made to reflect changes in mortality since 1966, using 1975-1979 mortality experience reported by the Society

of Actuaries. The December 6, 1983 revision extrapolated the reported mortality

experience to 1982, and reflected a revised gender mix and load factor. For

years after 1988, new factors were added

to the table for ages above 64, pursuant to

section 5013 of the Technical and Miscellaneous Revenue Act of 1988. See 57

F.R. 33635 (July 30, 1992).

The IRS and Treasury have concluded

that the section 79 table should be revised

because there has been a significant improvement in mortality since the 19751979 period (even after taking into account the projection to 1982). This

conclusion is based on information on the

10

group-term life mortality experience of 13

issuers covering the 1985-1989 period, as

compiled by the Society of Actuaries, as

well as other data on mortality trends.

The IRS and Treasury contemplate continuing to monitor future changes in mortality experience and would expect to

update the section 79 table when a significant change in the cost of group-term life

insurance is evidenced.

Summary of Regulations

These proposed regulations revise the

uniform premium table used to calculate

the cost of group-term life insurance coverage provided to an employee by an employer. The proposed new table has been

developed based on mortality experience

for individuals covered by group-term life

insurance during the 1985-1989 period, as

reflected in a Society of Actuaries report.

The mortality rates were adjusted for improvements in mortality from 1988 (the

weighted midpoint for the data used in

the1985-89 study) through 2000, based

on the same rates of mortality improvement that were adopted by the Society of

Actuaries Group Annuity Valuation Table

Task Force for the period 1988-1994.

Separate mortality rates were derived for

males and females, and the section 79

table reflects a 50/50 blend of the male

and female mortality rates. The resulting

mortality projections have been adjusted

to reflect a 10 percent load factor. The

uniform premium rates under the proposed revision would be lower in all age

groups than the rates under the current

section 79 regulations.

Comments are requested regarding the

proposed premium rates.

Proposed Effective Date

These regulations are proposed to be

effective July 1, 1999. A special effective

date rule applies to any policy of life insurance issued under a plan in existence

before the proposed general July 1, 1999

effective date if the policy would not be

treated as carried directly or indirectly by

an employer under section 1.79–0 of the

Income Tax Regulations using the current

section 79 table. In this case, if the special rule applies, the policy would continue to be treated as not carried directly

1999–11 I.R.B.

or indirectly by an employer until the first

plan year that begins after July 1, 1999.

Because income imputed under section

79 is generally subject to FICA tax which

is withheld from the employee’s pay, and

because the withholding often is applied

periodically from payrolls during the

year, many employers will need to modify

their payroll-based withholding systems

and related information collection procedures before the effective date. The proposed July 1, 1999 effective date is intended to provide the benefits of having

the lower income inclusions take effect as

early as possible while avoiding the additional costs that would arise if employers

did not have adequate time to implement

the changes before the effective date

(which would necessitate special adjustments to correct overwithholding that

would have occurred after the effective

date and before implementation of the

new table).

Comments are requested regarding the

proposed effective date.

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 these 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.

Comment and Public Hearing

Before these proposed regulations are

adopted as final regulations, consideration will be given to electronic and written comments (a signed original and eight

(8) copies) that are timely submitted to

the IRS. The IRS and Treasury specifically request comments on the clarity of

the proposed regulations and how it may

be made easier to understand. All comments will be available for public inspection and copying.

1999–11 I.R.B.

A public hearing has been scheduled for

Thursday, May 6, 1999, at 10:00 a.m. in

Room 2615, Internal Revenue Building,

1111 Constitution Avenue NW, Washington, DC. Due to building security procedures, visitors must enter the 10th Street

entrance, located between Constitution

and Pennsylvania Avenues, NW. In addition, all visitors must present photo identification to enter the building. Because of

access restrictions, visitors will not be admitted beyond the immediate entrance

area more than 15 minutes before the

hearing starts. For information about having your name placed on the building access list to attend the hearing, see the

“FOR FURTHER INFORMATION CONTACT” section of this preamble.

The rules of 26 CFR 601(a)(3) apply to

the hearing. Persons who wish to present

oral comments at the hearing must submit

written comments and an outline of the

topics to be discussed and the time devoted to each topic (a signed original and

eight (8) copies) by April 15, 1999.

A period of 10 minutes will be allotted

to each person for making comments.

An agenda showing the scheduling of

the speakers will be prepared after the

deadline for receiving outlines has

passed. Copies of the agenda will be

available free of charge at the hearing.

Drafting Information

3. New paragraph (e) is added.

The revision and addition read as follows:

§1.79–3 Determination of amount equal

to cost of group-term life insurance.

* * * * *

(d) * * *

(2) For the cost of group-term life insurance provided after June 30, 1999, the

following table sets forth the cost of

$1,000 of group-term life insurance provided for one month, computed on the

basis of 5-year age brackets. See 26 CFR

1.79–3(d)(2) in effect prior to [DATE

FINAL REGULATIONS ARE EFFECTIVE] and contained in the 26 CFR,

part1, edition revised as of April 1, 1998,

for a table setting forth the cost of groupterm life insurance provided before July

1, 1999. For purposes of Table I, the age

of the employee is the employee’s attained age on the last day of the employee’s taxable year.

TABLE I. – UNIFORM PREMIUMS

FOR $1,000 OF GROUP-TERM LIFE

INSURANCE PROTECTION

5-year age bracket

Cost per $1,000

of protection for

one month

Proposed Amendments to the Regulations

Under 25 . . . . . . . . . . . . . . . . . . . . $0.05

25 to 29 . . . . . . . . . . . . . . . . . . . .

.06

30 to 34 . . . . . . . . . . . . . . . . . . . .

.08

35 to 39 . . . . . . . . . . . . . . . . . . . .

.09

40 to 44 . . . . . . . . . . . . . . . . . . . .

.10

45 to 49 . . . . . . . . . . . . . . . . . . . .

.15

50 to 54 . . . . . . . . . . . . . . . . . . . .

.23

55 to 59 . . . . . . . . . . . . . . . . . . . .

.43

60 to 64 . . . . . . . . . . . . . . . . . . . .

.66

65 to 69 . . . . . . . . . . . . . . . . . . . . 1.27

70 and above . . . . . . . . . . . . . . . . 2.06

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

* * * * *

The principal author of these regulations is Betty J. Clary, Office of the Associate Chief Counsel (Employee Benefits

and Exempt Organizations). However,

other personnel from the IRS and the

Treasury Department participated in their

development.

* * * * *

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 1.79–3 is amended as

follows:

1. Paragraph (d)(2) is revised.

2. Paragraph (e) and (f) are redesignated as paragraph (f) and (g) respectively.

11

(e) Effective date—(1) General effective date for table. Except as provided in

paragraph (e)(2) of this section, the table

in paragraph (d)(2) of this section is effective July 1, 1999.

(2) Effective date for table for purposes of section 1.79–0. A policy of life

insurance issued under a plan in existence

on June 30, 1999, which would not be

treated as carried directly or indirectly by

an employer under §1.79–0, taking into

March 15, 1999

account the Table I in effect on that date,

shall continue to be treated as a policy

that is not carried directly or indirectly by

the employer until the first plan year beginning after the general effective date in

paragraph (e)(1) of this section.

* * * * *

Robert E. Wenzel,

Deputy Commissioner of

Internal Revenue.

(Filed by the Office of the Federal Register on January 12, 1999, 8:45 a.m., and published in the issue of

the Federal Register for January 13, 1999, 64 F.R.

2164)

Notice of Proposed Rulemaking

and Notice of Public Hearing

Recharacterizing Financing

Arrangements Involving

Fast-Pay Stock

REG–104072–97

AGENCY: Internal Revenue Service

(IRS), Treasury.

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

SUMMARY: This document contains

proposed regulations that recharacterize,

for tax purposes, financing arrangements

involving fast-pay stock. The regulations

are necessary to prevent taxpayers from

using fast-pay stock to achieve inappropriate tax avoidance. The regulations affect corporations that issue fast-pay stock,

holders of fast-pay stock, and other shareholders that may claim tax benefits purported to result from arrangements involving fast-pay stock. This document

also provides notice of a public hearing

on the proposed regulations.

DATES: Written comments must be received by April 6, 1999. Outlines of topics to be discussed at the public hearing

scheduled for April 8, 1999, at 10 a.m.

must be received by March 18, 1999.

ADDRESSES: Send submissions: to

CC:DOM:CORP:R (REG–104072–97),

room 5226, Internal Revenue Service,

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

March 15, 1999

hand delivered Monday through Friday

between the hours of 8 a.m. and 5 p.m. to:

CC:DOM:CORP:R (REG–104072–97),

Courier’s Desk, Internal Revenue Service, 1111 Constitution Avenue, NW,

Washington, DC. Alternatively, taxpayers

may submit comments via the Internet by

selecting the “Tax Regs” option of the

IRS Home Page or by submitting them directly to the IRS Internet site at

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

comments.html. The public hearing will

be held in room 2615, 1111 Constitution

Avenue, NW, Washington, DC.

FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations, Jonathan Zelnik at (202) 622-3940;

concerning submissions of comments, the

hearing, and/or to be placed on the building access list to attend the hearing,

LaNita VanDyke at (202) 622-7190 (not

toll-free numbers).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

The collection of information contained in this notice of proposed rulemaking has been submitted to the Office of

Management and Budget for review in

accordance with the Paperwork Reduction Act of 1995 (44 U.S.C. 3507(d)).

Comments on the collection of information should be sent to the Office of Management and Budget, Attn: Desk Officer

for the Department of the Treasury, Office

of Information and Regulatory Affairs,

Washington, DC 20503, with copies to

the Internal Revenue Service, Attn: IRS

Reports Clearance Officer, OP:FS:FP,

Washington, DC 20224. Comments on

the collection of information should be received by March 8, 1999. Comments are

specifically requested concerning:

Whether the proposed collection of information is necessary for the proper performance of the functions of the Internal

Revenue Service, including whether the

collection will have a practical utility;

The accuracy of the estimated burden

associated with the proposed collection of

information (see below);

How the quality, utility, and clarity of

the information to be collected may be

enhanced;

How the burden of complying with the

12

proposed collection of information may

be minimized, including through the application of automated collection techniques or other forms of information technology; and

Estimates of capital or start-up costs and

costs of operation, maintenance, and purchase of services to provide information.

The collection of information is in

§1.7701(l)–3(f) and §1.7701(l)–3(g). The

collection of information is mandatory.

The likely respondents are individuals,

businesses, and other organizations.

Estimated total annual burden: 50 hours

Estimated average annual burden per respondent: 1 hour

Estimated number of respondents: 50

Estimated annual frequency of responses:

Annually

An agency may not conduct or sponsor,

and a person is not required to respond to,

a collection of information unless the collection of information displays a valid

control number assigned by the Office of

Management and Budget.

Books or records relating to a collection of information must be retained as

long as their contents may become material in the administration of any internal

revenue law. Generally, tax returns and

tax information are confidential, as required by 26 U.S.C. 6103.

Background

On February 27, 1997, the IRS issued

Notice 97–21, 1997–1 C.B. 407, which

relates to financing arrangements involving fast-pay stock. Among other things,

the notice informs the public that the IRS

and Treasury Department expect to issue

regulations recharacterizing these

arrangements to prevent tax avoidance.

Notice 97–21 requested comments, but

none have been received.

Explanation of Provisions

A. TAX-AVOIDANCE

ARRANGEMENTS USING

FAST-PAY STOCK

Notice 97–21 addresses two-party financing arrangements that are structured

as multi-party arrangements to let one or

more of the parties avoid tax. Instead of

one party directly providing financing to

the other, they both acquire stock (with

different characteristics) in a conduit en-

1999–11 I.R.B.

tity. The arrangement is structured so that

the party providing the financing has a decreasing claim on the conduit entity (and

its assets) while the party receiving the financing has an increasing claim on the

conduit entity (and its assets). Economically, both parties benefit from the conduit entity’s income. For tax purposes,

however, the entity’s income is allocated

almost entirely to the party providing the

financing, allowing the other party to

claim unwarranted tax benefits.

Notice 97–21 describes in detail a typical fast-pay stock financing arrangement.

The parties to the arrangement include:

(1) a person seeking financing (the sponsor), (2) investors who are willing to provide financing and typically are not subject to federal income tax (the investors),

and (3) a corporation that is generally

subject to tax only at the shareholder level

(a conduit entity). The conduit entity issues a class of self-amortizing stock (the

fast-pay stock) to the investors and a class

of other stock (the benefited stock) to the

sponsor. The fast-pay stock is structured

so that during an initial period, the dividends made with respect to the stock are

substantial and relatively certain while the

dividends made with respect to the benefited stock are insignificant. After the initial period, the dividend rate of the fastpay stock, the stock’s effective

redemption value, or both, decline.

Economically, the fast-pay stock is

self-amortizing because the distributions

made with respect to the fast-pay stock

are in part a return on the investors’ investment and in part a return of their investment. For tax purposes, however, the parties characterize the fast-pay stock

distributions entirely as dividends (that is,

entirely as a return on the investment).

Consequently, the investors’ reported taxable income—overstated dividend income

followed by an overstated capital loss on

disposition of the fast-pay stock— fails to

clearly reflect their economic income.

(Investors that are tax-exempt suffer no

disadvantage from this arrangement.)

Characterizing the distributions made

with respect to the fast-pay stock solely as

dividends has the corresponding effect of

understating the taxable income on the

benefited stock (the stock held by the

sponsor) during the initial period. Instead

of receiving dividends attributable to its

share of the conduit entity’s income, the

1999–11 I.R.B.

sponsor’s economic income takes the form

of an increasing ownership interest in the

conduit entity. Because the fast-pay stock

is economically self-amortizing, each distribution reduces the investors’ claim on

the conduit entity (and its assets) and increases the sponsor’s claim. By treating a

fast-pay arrangement according to its

form, the sponsor reports taxable income

that fails to clearly reflect its economic income. An individual sponsor, for example, reports little or no dividend income.

Instead, the individual reports gain on disposing of its benefited stock; thus, deferring tax on its economic income and converting that income from ordinary to

capital. A corporate sponsor not only reports little or no dividend income, but can

avoid reporting gain on the disposition of

its benefited stock, thereby entirely eliminating tax on its economic income. (If a

corporate sponsor has a sufficient interest

in the conduit entity, the sponsor may succeed to the conduit entity’s assets tax-free

by liquidating or reorganizing the conduit

entity; thus, avoiding a taxable disposition

of the benefited stock).

In substance, the investors (the fast-pay

shareholders) are financing the sponsor’s

investment in the conduit entity. Although nominally shareholders in the conduit entity, the investors have a limited,

diminishing claim to the entity (and its assets). The sponsor’s claim, by contrast, is

residual and long-term. Thus, a fast-pay

arrangement is effectively a leveraged

arrangement in which the sponsor uses

untaxed income from the conduit entity to

repay the investors.

B. THE PROPOSED REGULATIONS

1. In General

To prevent the avoidance of tax, the

Secretary may issue regulations under

section 7701(l) recharacterizing any multiple-party financing transaction as a

transaction directly among any two or

more of the parties. The proposed regulations exercise this authority by recharacterizing certain fast-pay arrangements. A

fast-pay arrangement is any financing

arrangement in which a corporation has

outstanding two or more classes of stock,

one of which is fast-pay stock. The regulations identify fast-pay arrangements and

recharacterize certain of them as arrangements directly between the holders of the

13

fast-pay stock and the other shareholders

(the benefited shareholders) in the corporation. The regulations also impose reporting requirements on certain corporations with outstanding fast-pay stock and

on certain shareholders that participate in

fast-pay arrangements. These reporting

requirements apply to all fast-pay

arrangements, whether or not they are

subject to recharacterization.

Notice 97–21 describes specific models

for recharacterizing fast-pay arrangements. For purposes of determining the

income of the shareholders of a corporation with outstanding fast-pay stock, these

models ignore the separate existence of

the corporation and treat the fast-pay

shareholders and benefited shareholders

as owning the corporation’s underlying

assets. Although this approach prevents

tax avoidance, the IRS and Treasury Department have concluded that it may not

best reflect the financing relationship between the fast-pay shareholders and the

benefited shareholders. In addition, the

approach of the notice may be difficult for

taxpayers to apply if the corporation has a

complex capital structure, multiple assets

(including active businesses), or both.

To address these concerns, the proposed

regulations treat the fast-pay shareholders

as acquiring instruments issued by the benefited shareholders instead of acquiring interests in the assets of the corporation.

This approach better reflects the financing

relationship between the fast-pay shareholders and the benefited shareholders. It

also removes the burden of determining

each party’s ownership interest in the assets of the corporation. Thus, the regulations provide an approach that is easier to

apply and more narrowly tailored than the

models described in Notice 97–21.

2. Fast-Pay Stock and Benefited Stock

Under the proposed regulations, stock

is fast-pay stock if it is structured to provide for dividends that economically represent a return (in whole or in part) of the

holder’s investment rather than only a return on the holder’s investment. Stock is

presumed to be fast-pay stock if it has, by

design, a dividend rate that is reasonably

expected to decline, or an issue price that

exceeds the amount at which the holder

can be compelled to dispose of the stock.

A taxpayer may rebut these presumptions

March 15, 1999

only by clearly showing that no dividend

represents an economic return (in whole

or in part) of the holder’s investment.

Generally, whether stock is fast-pay

stock must be determined based on all the

facts and circumstances, including any related agreements such as options or forward contracts. A related agreement is

any direct or indirect, oral or written,

agreement between the holder of the stock

and the issuing corporation, or between

the holder of the stock and one or more

other shareholders in the corporation.

The determination that stock is fast-pay

stock is made when the stock is issued,

and whenever there is a significant modification in the terms of the stock or the related agreements, or a significant change

in the relevant facts and circumstances.

The proposed regulations define benefited stock by reference to fast-pay stock.

With respect to a class of fast-pay stock,

all other stock in the corporation (including any other class of fast-pay stock) is

benefited stock. For fast-pay arrangements in which there is more than one

class of benefited stock, the parties must

apply the general recharacterization rules

among the different classes as appropriate

to match the arrangement’s economic substance.

3. Fast-Pay Arrangements Subject to

Recharacterization

Under the proposed regulations, if the

corporation with outstanding fast-pay

stock is either a regulated investment

company (RIC) or a real estate investment

trust (REIT), the fast-pay arrangement is

automatically recharacterized. If the corporation is neither a RIC nor a REIT, the

Commissioner may (at the Commissioner’s discretion) recharacterize the

fast-pay arrangement in cases where the

Commissioner determines that a principal

purpose for the structure of the fast-pay

arrangement is the avoidance of tax. This

rule applies to all parties to a fast-pay

arrangement, without regard to whether

such parties acquired their interests as

part of an initial offering or later (by purchase or other transfer).

By not automatically recharacterizing

all fast-pay arrangements, the regulations

prevent taxpayers from using the recharacterization rules for other tax avoidance

purposes. For example, shareholders of a

March 15, 1999

controlled foreign corporation cannot circumvent the purposes of United States tax

law (including treaties) by using the

recharacterization rules to exploit inconsistencies between the treatment of a fastpay arrangement by the United States and

foreign jurisdictions. It is expected that

the Commissioner will closely scrutinize

fast-pay arrangements in which the corporation with outstanding fast-pay stock is a

foreign corporation.

4. Model for Recharacterizing Fast-Pay

Arrangements

a. In General

The proposed regulations treat the fastpay shareholders as holding financing instruments issued by the benefited shareholders rather than as holding fast-pay

stock in the corporation. The corporation

is the paying agent on the financing instruments but has no other relationship to

the fast-pay shareholders.

Under the proposed regulations, the financing instruments have the same payment terms as the fast-pay stock. The

timing and amount of payments made

with respect to the financing instruments,

therefore, match the timing and amount of

distributions made with respect to the

fast-pay stock. Nothing in the regulations

characterizes the financing instruments.

The character of the financing instruments (for example, stock or debt) must

be determined under general tax principles and depends on all the facts and circumstances.

The benefited shareholders are treated

as first issuing the financing instruments

in exchange for cash equal to the fair market value of the fast-pay stock (taking into

account any related agreements), and then

as contributing the cash to the corporation

(thereby increasing their basis in the benefited stock). Distributions made with respect to the fast-pay stock are treated as

first made with respect to the benefited

stock, and then as used by the benefited

shareholders to make payments on the financing instruments.

b. Rule for Multiple Classes of Benefited

Stock

The proposed regulations do not describe detailed rules for fast-pay arrangements in which there is more than one

14

class of benefited shareholders. Instead,

as mentioned before, the regulations provide a general rule that requires recharacterization among the different classes as

appropriate to match the economic substance of the fast-pay arrangement.

c. Rules for Disposition of Benefited

Stock

The proposed regulations provide special rules for dispositions of benefited

stock. On the sale of benefited stock, in

addition to any consideration actually received, the seller is treated as receiving

the amount necessary to terminate its position with respect to the financing instruments at fair market value. Similarly, the

buyer is treated as paying that amount and

as issuing new financing instruments to

the fast-pay shareholders.

d. Rule Preserving Pre-effective Date

Gain

The proposed regulations provide a

special basis adjustment rule to ensure

that unrealized gain on benefited stock is

not inappropriately eliminated. Because

the regulations do not apply to amounts

accrued or paid in taxable years ending

before February 27, 1997 (pre-effective

years), a benefited shareholder will have

economic income, but not taxable income, attributable to pre-effective years if

the form of a fast-pay arrangement is respected for those years. This economic

income is reflected as unrealized gain in

the benefited stock.

Absent a special basis adjustment rule,

the general recharacterization rule would

eliminate this unrealized gain. Although

the regulations do not apply to amounts

accrued or paid in pre-effective years, the

regulations recharacterize fast-pay

arrangements from their inception. Thus,

in cases in which the fast-pay arrangement was entered into in a pre-effective

year, the general recharacterization rule

increases a benefited shareholder’s basis

in its stock as of the inception of the transaction, even though the regulations do not

require the benefited shareholder to include deemed dividend distributions attributable to the pre-effective years. Consequently, this increase in basis without

corresponding dividend income eliminates the unrealized gain from the pre-effective years.

1999–11 I.R.B.

To preserve the unrealized gain resulting from the economic income attributable to pre-effective years, the proposed

regulations provide a special basis adjustment rule. After taking into account any

basis increase under the general rule, a

benefited shareholder must decrease its

basis in its benefited stock by the amount

(if any) that (1) its taxable income attributable to the fast-pay arrangement for preeffective years, computed by recharacterizing the fast-pay arrangement under the

regulations, exceeds (2) its taxable income attributable to the fast-pay arrangement for pre-effective years, computed

without applying the recharacterization

rules of the regulations. In this way, a

benefited shareholder’s economic income

attributable to taxable years before the effective date of the regulations is not eliminated by the basis provisions of the general recharacterization rules and may be

realized when the benefited shareholder

disposes of its benefited stock.

e. Rule Prohibiting the Affirmative Use

of These Regulations to Avoid Tax

Imposed by the Code

The proposed regulations prohibit a

taxpayer from affirmatively using the automatic recharacterization rules if a principal purpose for using such rules is the

avoidance of any tax imposed by the

Code. With respect to such a taxpayer,

the Commissioner may depart from the

automatic recharacterization rules and

treat (for all purposes of the Code) the

fast-pay arrangement in accordance with

its form or its economic substance. This

anti-abuse rule applies on a taxpayer-bytaxpayer basis. For example, if a foreign

person acquires fast-pay stock in a REIT

and a principal purpose for acquiring such

stock is to reduce United States withholding taxes by applying the automatic

recharacterization rules, the Commissioner may, for purposes of determining

the foreign person’s United States tax

consequences (namely, withholding tax),

depart from the automatic recharacterization rules and treat the foreign person as

holding fast-pay stock in the REIT.

5. Withholding

A corporation that issues fast-pay stock

is a withholding agent for payments made

1999–11 I.R.B.

(or deemed made) under a fast-pay

arrangement. Generally, if a fast-pay

arrangement is recharacterized under the

automatic recharacterization rules, a withholding agent must withhold in accordance with the transaction as recharacterized. A different rule applies, however, if

the withholding agent knows or has reason to know that any taxpayer entered

into the fast-pay arrangement with a principal purpose of using the recharacterization rules to avoid tax under section

871(a) or section 881. In that case, for

each payment made (or deemed made) to

such taxpayer under the arrangement, the

withholding agent must withhold under

section 1441 or section 1442 the higher of

(1) the amount of withholding that applies

to such payment determined under the

form of the arrangement, or (2) the

amount of withholding that applies to

such payment determined under the automatic recharacterization rules. Also,

when the withholding agent knows or has

reason to know that the Commissioner

has exercised the discretion to depart

from the automatic recharacterization

rules for a taxpayer, the withholding agent

must withhold on payments made (or

deemed made) to that taxpayer in accordance with the characterization of the

fast-pay arrangement imposed by the

Commissioner.

The withholding agent’s liability to

withhold on payments to foreign individuals is described in new proposed

§1.1441–7(g). The same rules apply to

payments (or deemed payments) to foreign corporations under §1.1442–1.

6. Reporting Requirements

In general, a corporation that has fastpay stock outstanding at any time during

the taxable year must attach a statement to

its federal income tax return. This rule

does not apply to a corporation that is a

controlled foreign corporation (CFC) as

defined in section 957, a foreign personal

holding company (FPHC) as defined in

section 552, or a passive foreign investment company (PFIC) as defined in section 1297. Instead, certain shareholders

(and officers and directors of FPHCs) of

those corporations must attach a statement to their returns.

The statement must identify the corporation that has outstanding fast-pay stock

15

and must recite the terms of the fast-pay

stock and the date on which the fast-pay

stock was issued. In addition, to the extent the filing person knows or has reason

to know such information, the statement

must contain the names and the taxpayer

identification numbers of the shareholders

of any class of stock that is not traded on

an established securities market as described in §1.7704-1(b).

7. Election to Limit Taxable Income

Attributable to a Recharacterized

Fast-Pay Arrangement for Taxable

Years Ending After February 26,

1997, and Before the Date These

Regulations Are Published as Final

Regulations in the Federal Register.

The regulations are proposed to be effective February 27, 1997, and to cover

all taxable years ending after February 26,

1997. Thus, the regulations will apply to

all amounts accrued or paid on or after the

first day of the first taxable year ending

after February 26, 1997.

Because the proposed effective date relates to the date Notice 97–21 was issued

to the public, and because the regulations

adopt different recharacterization rules

from the ones described in the notice, the

regulations permit a shareholder of a

recharacterized fast-pay arrangement to

limit its taxable income attributable to the

arrangement for certain taxable years.

Specifically, for taxable years ending

after February 26, 1997, and before the

date these regulations are finalized, a

shareholder may limit its taxable income

attributable to a fast-pay arrangement

recharacterized under the regulations, to

the taxable income that would result if the

fast-pay arrangement were recharacterized under Notice 97–21. Any amount

excluded under the limit must be included

as an adjustment to taxable income in the

shareholder’s first taxable year that includes the date the regulations are finalized. Under the regulations, a shareholder

that has elected to apply the limit must include a statement in its books and records

identifying each fast-pay arrangement for

which the election was made, and the

amount excluded from taxable income

under the election for each fast-pay

arrangement.

Shareholders who take advantage of

the limit enjoy only a deferral of taxable

March 15, 1999

income: Any amount excluded under the

limit is later included as an adjustment.

Thus, the sole benefit of making the election is a timing difference. This result is

appropriate because over the life of a fastpay arrangement a shareholder has the

same amount of taxable income whether

the fast-pay arrangement is recharacterized under Notice 97–21 or under the regulations. The IRS and Treasury Department invite comments concerning the

limit and whether there are fast-pay

arrangements in which any difference between a shareholder’s taxable income determined under Notice 97–21 and the

shareholder’s taxable income determined

under the regulations is other than a timing difference.

Notice 97–21 describes two types of

fast-pay arrangements. Hence, calculating the limit requires appropriately

recharacterizing the fast-pay arrangement

under the notice. In the first type of fastpay arrangement that the notice describes,

the corporation with outstanding fast-pay

stock holds income-producing assets issued by a third party. Notice 97–21 treats

the benefited shareholders (one of which

is called the “sponsor” in the notice) as

acquiring the assets of the corporation directly from the sellers of those assets.

The notice treats the fast-pay shareholders

(called “investors” in the notice) as acquiring the assets of the corporation either

from the sellers of those assets or from the

benefited shareholders in an income

“stripping” transaction. Thus, both the

fast-pay shareholders and benefited shareholders are regarded as owning directly

the corporation’s assets.

In the second type of fast-pay arrangement that Notice 97–21 describes, the

corporation with outstanding fast-pay

stock holds a debt instrument issued by

the sponsor (a benefited shareholder). In

this situation, the notice treats the sponsor

as having issued one or more instruments

directly to the holders of the fast-pay

stock. Thus, for purposes of determining

the sponsor’s taxable income, the sponsor’s obligation under any asset held by

the corporation is ignored.

Special Analyses

It has been determined that this notice

of proposed rulemaking is not a signifi-

March 15, 1999

cant regulatory action as defined in E.O.

12866. Therefore, a regulatory assessment is not required. It is hereby certified

that these regulations will not have a significant economic impact on a substantial

number of small entities. This certification is based on the understanding of the

IRS and Treasury Department that the

total number of fast-pay arrangements is

fewer than 100, that the number of entities engaging in transactions affected by

these regulations is not substantial and, of

those entities, few or none are small entities within the meaning of the Regulatory

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

Therefore, a Regulatory Flexibility

Analysis is not required. Pursuant to section 7805(f) of the Internal Revenue

Code, this notice of proposed rulemaking

will be submitted to the Chief Counsel for

Advocacy of the Small Business Administration for comments on its impact on

small businesses.

Comments and Public Hearing

Before these proposed regulations are

adopted as final regulations, consideration will be given to any written comments (a signed original and eight (8)

copies) that are submitted timely to the

IRS. All comments will be available for

public inspection and copying. The IRS

and Treasury Department specifically request comments on the clarity of the proposed rule and how it may be made easier

to understand.

A public hearing has been scheduled

for April 8, 1999, beginning at 10 a.m. in

room 2615 of the Internal Revenue

Building, 1111 Constitution Avenue, NW,

Washington, DC. Due to building security procedures, visitors must enter at the

10th Street entrance, located between

Constitution and Pennsylvania Avenues,

NW. In addition, all visitors must present

photo identification to enter the building.

Because of access restrictions, visitors

will not be admitted beyond the immediate entrance area more than 15 minutes

before the hearing starts. For information about having your name placed on

the building access list to attend the hearing, see the “FOR FURTHER INFORMATION CONTACT” section of this

preamble.

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

16

apply to the hearing. Persons that wish to

present oral comments at the hearing must

submit written comments by April 6,

1999, and submit an outline of the topics

to be discussed and the time to be devoted

to each topic (a signed original and eight

(8) copies) by March 18, 1999.

A period of 10 minutes will be allotted

to each person for making comments.

An agenda showing the scheduling of

the speakers will be prepared after the

deadline for receiving outlines has

passed. Copies of the agenda will be

available free of charge at the hearing.

Proposed Effective Date

These regulations are proposed to be

effective February 27, 1997, and apply to

taxable years ending after February 26,

1997. Thus, all amounts accrued or paid

on or after the first day of the first taxable

year ending after February 26, 1997, will

be subject to the regulations, regardless of

when a particular share of the stock or a

particular debt instrument was issued.

The statement required under

§1.7701(l)–3(f) is proposed to apply to

taxable years (of the taxpayer required to

file the statement) ending after the date

the regulations are published as final regulations in the Federal Register.

Drafting Information

The principal authors of these regulations are Jonathan Zelnik and Marshall

Feiring of the Office of the Assistant

Chief Counsel (Financial Institutions &

Products). However, other personnel

from the IRS and Treasury Department

participated in their development.

* * * * *

Proposed Amendments to the Regulations

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

PART 1—INCOME TAXES

Paragraph 1. The authority citation for

part 1 is amended by adding an entry in

numerical order to read as follows:

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

Section 1.7701(l)–3 also issued under

26 U.S.C. 7701(l). * * *

Par. 2. Section 1.1441–7 is amended as

follows:

1999–11 I.R.B.

1. Paragraph (g) is redesignated as

paragraph (h) and is revised.

2. New paragraph (g) is added.

The addition and revision read as follows:

§1.1441–7 General provisions relating

to withholding agents.

* * * * *

(g) Fast-pay arrangements—(1) In

general. A corporation that issues fastpay stock in a fast-pay arrangement described in §1.7701(l)–3(b)(1) is a withholding agent with respect to fast-pay

dividends paid under the arrangement and

any deemed payments with respect to the

arrangement under the recharacterization

rules of §1.7701(l)–3(c). Except as provided in this paragraph (g)(1) or in paragraph (g)(2) of this section, the withholding tax rules under section 1441 and

section 1442 apply with respect to a fastpay arrangement described in §1.7701(l)–

3(c)(1)(i) in accordance with the recharacterization rules provided in §1.7701(l)–

3(c). In all cases, notwithstanding paragraph (g)(2) of this section, if at any time

the withholding agent knows or has reason to know that the Commissioner has

exercised the discretion under

§1.7701(l)–3(d) to depart from the recharacterization rules of §1.7701(l)–3(c) for a

taxpayer, the withholding agent must

withhold on payments made (or deemed

made) to that taxpayer in accordance with

the characterization of the fast-pay

arrangement imposed by the Commissioner under §1.7701(l)–3(d).

(2) Exception. If at any time the withholding agent knows or has reason to

know that any taxpayer entered into a

fast-pay arrangement with a principal purpose of applying the recharacterization

rules of §1.7701(l)–3(c) to avoid tax

under section 871(a) or section 881, then

for each payment made or deemed made

to such taxpayer under the arrangement,

the withholding agent must withhold,

under section 1441 or section 1442, the

higher of—

(i) The amount of withholding that

would apply to such payment determined

under the form of the arrangement; or

(ii) The amount of withholding that

would apply to deemed payments determined under the recharacterization rules

of §1.7701(l)–3(c).

1999–11 I.R.B.

(3) Liability. Any person required to

deduct and withhold tax under this paragraph (g) is made liable for that tax by

section 1461, and is also liable for applicable penalties and interest for failing to

comply with section 1461.

(4) Examples. The following examples

illustrate the rules of this paragraph (g):

Example 1. REIT W issues shares of fast-pay

stock to foreign individual A, a resident of Country

C. United States source dividends paid to residents

of C are subject to a 30 percent withholding tax. W

issues all shares of benefited stock to foreign individuals who are residents of Country D. D’s income

tax convention with the United States reduces the

United States withholding tax on dividends to 15

percent. Under §1.7701(l)–3(c), the dividends paid

by W to A are deemed to be paid by W to the benefited shareholders. W has reason to know that A entered into the fast-pay arrangement with a principal

purpose of using the recharacterization rules of

§1.7701(l)–3(c) to reduce United States withholding

tax. W must withhold at the 30 percent rate on the

dividends deemed paid to its benefited shareholders

because the amount of withholding that applies to

such payments determined under the form of the

arrangement is higher than the amount of withholding that applies to such payments determined under

§1.7701(l)–3(c).

Example 2. The facts are the same as in Example

1 of this paragraph (g)(4) except that W does not

know, or have reason to know, that A entered the

arrangement with a principal purpose of using the

recharacterization rules of §1.7701(l)–3(c) to reduce

United States withholding tax. Further, the Commissioner has not exercised the discretion under

§1.7701(l)–3(d) to depart from the recharacterization rules of §1.7701(l)–3(c). Accordingly, W must

withhold tax at a 15 percent rate on the dividends

deemed paid to the benefited shareholders.

(5) Effective date. This paragraph (g)

applies to payments made (or deemed

made) on or after January 6, 1999.

(h) Effective date. Except as otherwise

provided in paragraph (f)(3) or (g)(5) of

this section, this section applies to payments made after December 31, 1999.

Par. 3. Section 1.7701(l)–3 is added to

read as follows:

§1.7701(l)–3 Recharacterizing financing

arrangements involving fast-pay stock.

(a) Purpose and scope. This section is

intended to prevent the avoidance of tax

by persons participating in fast-pay arrangements (as defined in paragraph (b)(1)

of this section) and should be interpreted

in a manner consistent with this purpose.

This section applies to all fast-pay

arrangements. Paragraph (c) of this section recharacterizes certain fast-pay

17

arrangements to ensure the participants are

taxed in a manner reflecting the economic

substance of the arrangements. Paragraph

(f) of this section imposes reporting requirements on certain participants.

(b) Definitions—(1) Fast-pay arrangement. A fast-pay arrangement is any

arrangement in which a corporation has

outstanding for any part of its taxable year

two or more classes of stock, at least one

of which is fast-pay stock.

(2) Fast-pay stock—(i) Defined. Stock

is fast-pay stock if it is structured so that

dividends (as defined in section 316) paid

by the corporation with respect to the

stock are economically (in whole or in

part) a return of the holder’s investment

(as opposed to only a return on the

holder’s investment). Unless clearly

demonstrated otherwise, stock is presumed to be fast-pay stock if—

(A) It is structured to have a dividend

rate that is reasonably expected to decline

(as opposed to a dividend rate that is reasonably expected to fluctuate or remain

constant); or

(B) It is issued for an amount that exceeds (by more than a de minimis amount,

as determined under the principles of

§1.1273–1(d)) the amount at which the

holder can be compelled to dispose of the

stock.

(ii) Determination. The determination

of whether stock is fast-pay stock is based

on all the facts and circumstances, including any related agreements such as options or forward contracts. A related

agreement is any direct or indirect agreement or understanding, oral or written,

between the holder of the stock and the issuing corporation, or between the holder

of the stock and one or more other shareholders in the corporation. The determination is made when the stock is issued

and whenever there is a significant modification in the terms of the stock or the related agreements, or a significant change

in the relevant facts and circumstances.

(3) Benefited stock defined. With respect to a class of fast-pay stock, all other

stock in the corporation (including any

other class of fast-pay stock) is benefited

stock.

(c) Recharacterization of certain fastpay arrangements—(1) Scope. This paragraph (c) applies to any fast-pay arrangement—

March 15, 1999

(i) In which the corporation that has

outstanding fast-pay stock is a regulated

investment company (RIC) (as defined in

section 851) or a real estate investment

trust (REIT) (as defined in section 856);

or

(ii) If the Commissioner determines

that a principal purpose for the structure

of the fast-pay arrangement is the avoidance of any tax imposed by the Code.

Application of this paragraph (c)(1)(ii) is

at the Commissioner’s discretion, and a

determination under this paragraph

(c)(1)(ii) applies to all parties to the fastpay arrangement, including transferees.

(2) Recharacterization. A fast-pay

arrangement described in paragraph (c)(1)

of this section is recharacterized as an

arrangement directly between the benefited shareholders and the fast-pay shareholders. The inception and resulting relationships of the recharacterized

arrangement are deemed to be as follows:

(i) Relationship between benefited

shareholders and fast-pay shareholders.

The benefited shareholders issue financial

instruments (the financing instruments)

directly to the fast-pay shareholders in exchange for cash equal to the fair market

value of the fast-pay stock at the time of

issuance (taking into account any related

agreements). The financing instruments

have the same payment terms as the fastpay stock. Thus, the timing and amount

of the payments made with respect to the

financing instruments always match the

timing and amount of the distributions

made with respect to the fast-pay stock.

(ii) Relationship between benefited

shareholders and corporation. The benefited shareholders contribute to the corporation the cash they receive for issuing the

financing instruments. Distributions

made with respect to the fast-pay stock

are distributions made by the corporation

with respect to the benefited shareholders’ benefited stock.

(iii) Relationship between fast-pay

shareholders and corporation. For purposes of determining the relationship between the fast-pay shareholders and the

corporation, the fast- pay stock is ignored.

The corporation is the paying agent of the

benefited shareholders with respect to the

financing instruments.

(3) Other rules—(i) Character of the

financing instruments. The character of a

March 15, 1999

financing instrument (for example, stock

or debt) is determined under general tax

principles and depends on all the facts and

circumstances.

(ii) Multiple classes of benefited stock.

If there is more than one class of benefited stock, the recharacterization rules of

this paragraph (c) apply among the different classes as appropriate to match the

economic substance of the fast-pay

arrangement.

(iii) Sale of benefited stock. If one person sells benefited stock to another—

(A) In addition to any consideration actually paid and received for the benefited

stock, the buyer is deemed to pay and the

seller is deemed to receive the amount

necessary to terminate the seller’s position in the financing instruments at fair

market value; and

(B) The buyer is deemed to issue financing instruments to the fast-pay shareholders in exchange for the amount necessary to terminate the seller’s position in

the financing instruments.

(iv) Adjustment to basis for amounts

accrued or paid in taxable years ending

before February 27, 1997. In the case of

a fast-pay arrangement involving amounts

accrued or paid in taxable years ending

before February 27, 1997, and recharacterized under this paragraph (c), a benefited shareholder must decrease its basis

in any benefited stock (as determined

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

by the amount (if any) that—

(A) Its income attributable to the benefited stock (reduced by deductions attributable to financing instruments) for taxable years ending before February 27,

1997, computed by recharacterizing the

fast-pay arrangement under this paragraph (c); exceeds

(B) Its income attributable to such

stock for taxable years ending before February 27, 1997, computed without applying the rules of this paragraph (c).

(d) Prohibition against affirmative use

of recharacterization by taxpayers. A taxpayer may not use the rules of paragraph

(c) of this section if a principal purpose

for using such rules is the avoidance of

any tax imposed by the Code. Thus, with

respect to such taxpayer, the Commissioner may depart from the rules of this

section and recharacterize (for all purposes of the Code) the fast-pay arrange-

18

ment in accordance with its form or its

economic substance. For example, if a

foreign person acquires fast-pay stock in a

REIT and a principal purpose for acquiring such stock is to reduce United States

withholding taxes by applying the rules of

paragraph (c) of this section, the Commissioner may, for purposes of determining

the foreign person’s United States tax

consequences (namely, withholding tax),

depart from the rules of paragraph (c) of

this section and treat the foreign person as

holding fast-pay stock in the REIT.

(e) Examples. The following examples

illustrate the rules of paragraph (c) of this

section:

Example 1. Decline in dividend rate. (i) Facts.

Corporation X issues 100 shares of A Stock and 100

shares of B Stock for $1,000 per share. By its terms,

a share of B Stock is reasonably expected to pay a

$110 dividend in years 1 through 10 and a $30 dividend each year thereafter. If X liquidates, the holder

of a share of B Stock is entitled to a preference equal

to the share’s issue price. Otherwise, the B Stock

cannot be redeemed at either X’s or the shareholder’s option.

(ii) Analysis. When issued, the B Stock has a

dividend rate that is reasonably expected to decline

from an annual rate of 11 percent of its issue price to

an annual rate of 3 percent of its issue price. Since

the B Stock is structured to have a declining dividend rate, the B Stock is fast-pay stock, and the A

Stock is benefited stock.

Example 2. Issued at a premium. (i) Facts. The

facts are the same as in Example 1 of this paragraph

(e) except that a share of B Stock is reasonably expected to pay an annual $110 dividend as long as it

is outstanding, and Corporation X has the right to redeem the B Stock for $400 a share at the end of year

10.

(ii) Analysis. The B Stock is structured so that

the issue price of the B Stock ($1,000) exceeds (by

more than a de minimis amount) the price at which

the holder can be compelled to dispose of the stock

($400). Thus, the B Stock is fast-pay stock, and the

A Stock is benefited stock.

Example 3. Recharacterization illustrated. (i)

Facts. On formation, REIT Y issues 100 shares of C

Stock and 100 shares of D Stock for $1,000 per

share. By its terms, a share of D Stock is reasonably

expected to pay a $110 dividend in years 1 through

10 and a $30 dividend each year thereafter. In years

1 through 10, persons holding a majority of the D

Stock must consent before Y may take any action

that would result in Y liquidating or dissolving,

merging or consolidating, losing its REIT status, or

selling substantially all of its assets. Thereafter, Y

may take these actions without consent so long as

the D Stock shareholders receive $400 in exchange

for their D Stock.

(ii) Analysis. When issued, the D Stock has a

dividend rate that is reasonably expected to decline

from an annual rate of 11 percent of its issue price to

an annual rate of 3 percent of its issue price. In addition, the $1,000 issue price of a share of D Stock ex-

1999–11 I.R.B.

ceeds the price at which the shareholder can be compelled to dispose of the stock ($400). Thus, the D

Stock is fast-pay stock, and the C Stock is benefited

stock. Because Y is a REIT, the fast-pay arrangement is recharacterized under paragraph (c) of this

section.

(iii) Recharacterization. The fast-pay arrangement is recharacterized as follows:

(A) Under paragraph (c)(2)(i) of this section, the

C Stock shareholders are treated as issuing financing

instruments to the D Stock shareholders in exchange

for $100,000 ($1,000, the fair market value of each

share of D Stock, multiplied by 100, the number of

shares).

(B) Under paragraph (c)(2)(ii) of this section, the

C Stock shareholders are treated as contributing

$200,000 to Y (the $100,000 received for the financing instruments, plus the $100,000 actually paid for

the C Stock) in exchange for the C Stock.

(C) Under paragraph (c)(2)(ii) of this section,

each distribution with respect to the D Stock is

treated as a distribution with respect to the C Stock.

(D) Under paragraph (c)(2)(iii) of this section,

the C Stock shareholders are treated as making payments with respect to the financing instruments, and

Y is treated as the paying agent of the financing instruments for the C Stock shareholders.

Example 4. Transfer of benefited stock illustrated. (i) Facts. The facts are the same as in Example 3 of this paragraph (e). Near the end of year 5, a

person holding one share of C Stock sells it for

$1,300. The buyer is unrelated to REIT Y or to any

of the D Stock shareholders. At the time of the sale,

the amount needed to terminate the seller’s position

in the financing instruments at fair market value is

$747.

(ii) Benefited shareholder’s treatment on sale.

Under paragraph (c)(3)(iii)(A) of this section, the

seller’s amount realized is $2,047 ($1,300, the

amount actually received, plus $747, the amount

necessary to terminate the seller’s position in the financing instruments at fair market value). The

seller’s gain on the sale of the common stock is $47

($2,047, the amount realized, minus $2,000, the

seller’s basis in the common stock). The seller has

no income or deduction with respect to terminating

its position in the financing instruments.

(iii) Buyer’s treatment on purchase. Under paragraph (c)(3)(iii)(A) of this section, the buyer’s basis

in the share of D Stock is $2,047 ($1,300, the

amount actually paid, plus $747, the amount needed

to terminate the seller’s position in the financing instruments at fair market value). Under paragraph

(c)(3)(iii)(B) of this section, simultaneous with the

sale, the buyer is treated as issuing financing instruments to the fast-pay shareholders in exchange for

$747, the amount necessary to terminate the seller’s

position in the financing instruments at fair market

value.

Example 5. Fast-pay arrangement involving

amounts accrued or paid in a taxable year ending

before February 27, 1997. (i) Facts. Y is a calendar

year taxpayer. In June 1996, Y acquires shares of

REIT T benefited stock for $15,000. In December

1996, Y receives dividends of $100. Under the

recharacterization rules of paragraph (c)(2) of this

section, Y’s 1996 income attributable to the benefited stock is $1,200, Y’s 1996 deduction attribut-

1999–11 I.R.B.

able to financing instruments is $500, and Y’s basis

in the benefited stock is $25,000.

(ii) Analysis. Under paragraph (c)(3)(iv) of this

section, Y’s basis in the benefited stock is reduced

by $600. This is the amount by which Y’s 1996 income from the fast-pay arrangement as recharacterized under this section ($1,200 of income attributable to the benefited stock less $500 of deductions

attributable to the financing instruments), exceeds

Y’s 1996 income from the fast-pay arrangement as

not recharacterized under this section ($100 of income attributable to the benefited stock). Thus, in

1997 when the fast-pay arrangement is recharacterized, Y’s basis in the benefited stock is $24,400.

(f) Reporting requirement—(1) Filing

requirements—(i) In general. A corporation that has fast-pay stock outstanding at

any time during the taxable year must attach the statement described in paragraph

(f)(2) of this section to its federal income

tax return for such taxable year. This

paragraph (f)(1)(i) does not apply to a

corporation described in paragraphs

(f)(1)(ii), (iii), or (iv) of this section.

(ii) Controlled foreign corporation. In

the case of a controlled foreign corporation (CFC), as defined in section 957, that

has fast-pay stock outstanding at any time

during its taxable year (during which time

it was a CFC), each controlling United

States shareholder (within the meaning of

§1.964–1(c)(5)) must attach the statement

described in paragraph (f)(2) of this section to the shareholder’s Form 5471 for

the CFC’s taxable year. The provisions of

section 6038 and the regulations under

section 6038 apply to any statement required by this paragraph (f)(1)(ii).

(iii) Foreign personal holding company. In the case of a foreign personal

holding company (FPHC), as defined in

section 552, that has fast-pay stock outstanding at any time during its taxable

year (during which time it was a FPHC),

each United States citizen or resident who

is an officer, director, or 10-percent shareholder (within the meaning of section

6035(e)(1)) of such FPHC must attach the

statement described in paragraph (f)(2) of

this section to his or her Form 5471 for

the FPHC’s taxable year. The provisions

of sections 6035 and 6679 and the regulations under sections 6035 and 6679 apply

to any statement required by this paragraph (f)(1)(iii).

(iv) Passive foreign investment company. In the case of a passive foreign investment company (PFIC), as defined in

19

section 1297, that has fast-pay stock outstanding at any time during its taxable

year (during which time it was a PFIC),

each shareholder that has elected (under

section 1295) to treat the PFIC as a qualified electing fund and knows or has reason to know that the PFIC has outstanding

fast-pay stock must attach the statement

described in paragraph (f)(2) of this section to the shareholder’s Form 8621 for

the PFIC’s taxable year. Each shareholder owning 10 percent or more of the

shares of the PFIC (by vote or value) is

presumed to know that the PFIC has issued fast-pay stock. The provisions of

sections 1295(a)(2) and 1298(f) and the

regulations under those sections (including §1.1295–1T(f)(2)) apply to any statement required by this paragraph (f)(1)(iv).

(2) Statement. The statement required

under this paragraph (f) must say, “This

fast-pay stock disclosure statement is required by §1.7701(l)–3(f) of the income

tax regulations.” The statement must also

identify the corporation that has outstanding fast-pay stock and must contain the

date on which the fast-pay stock was issued, the terms of the fast-pay stock, and

(to the extent the filing person knows or

has reason to know such information) the

names and taxpayer identification numbers of the shareholders of any class of

stock that is not traded on an established

securities market (as described in

§1.7704–1(b)).

(g) Effective date—(1) In general. Except as provided in paragraph (g)(4) of

this section (relating to reporting requirements), this section applies to taxable

years ending after February 26, 1997.

Thus, all amounts accrued or paid during

the first taxable year ending after February 26, 1997, are subject to this section.

(2) Election to limit taxable income attributable to a recharacterized fast-pay

arrangement for taxable years ending

after February 26, 1997, and before the

date these regulations are published as

final regulations in the Federal

Register—(i) Limit and adjustment. For

taxable years ending after February 26,

1997, and before the date these regulations are published as final regulations in

the Federal Register, a shareholder may

limit its taxable income attributable to a

fast-pay arrangement recharacterized

under paragraph (c) of this section, to the

March 15, 1999

taxable income that would result if the

fast-pay arrangement were recharacterized under Notice 97–21, 1997–1 C.B.

407, see §601.601(d)(2) of this chapter.

Any amount a shareholder excludes from

taxable income under this paragraph

(g)(2)(i) must be included as an adjustment to taxable income in the shareholder’s first taxable year that includes

the date these regulations are published as

final regulations in the Federal Register.

A shareholder that has elected to limit its

taxable income under this paragraph

(g)(2)(i) must include a statement in its

books and records identifying each fastpay arrangement to which the limit was

applied and providing the amount excluded from taxable income for each such

fast-pay arrangement.

(ii) The following examples illustrate

the rules of this paragraph (g)(2). For

purposes of these examples, assume that

the last year a shareholder may limit its

taxable income under this paragraph

(g)(2) is 1998.

Example 1. Fast-pay arrangement recharacterized under Notice 97-21; REIT holds third-party

debt. (i) Facts.

(A) REIT Y is formed on January 1, 1998, at

which time it issues 1,000 shares of fast-pay stock

and 1,000 shares of benefited stock for $100 per

share. Y and all of its shareholders have calendar

taxable years. All shareholders of Y have elected to

accrue market discount based on a constant interest

rate, to include the market discount in income as it

accrues, and to amortize bond premium.

(B) For years 1 through 5, the fast-pay stock has

an annual dividend rate of $17 per share ($17,000

for the class); in later years, the fast-pay stock has an

annual dividend rate of $1 per share ($1,000 for the

class). At the end of year 5, and thereafter, a share

of fast-pay stock can be acquired by Y in exchange

for $50 ($50,000 for the class).

(C) On the day Y is formed, it acquires a fiveyear mortgage note (the note) issued by an unrelated

third party for $200,000. The note provides for annual interest payments on December 31 of $18,000

(a coupon interest rate of 9.0 percent, compounded

annually), and one payment of principal at the end of

5 years. The note can be prepaid, in whole or in

part, at any time.

(ii) Recharacterization under Notice 97–21. (A)

In general. One way to recharacterize the fast-pay

arrangement under Notice 97–21 is to treat the fastpay shareholders and the benefited shareholders as if

they jointly purchased the note from the issuer with

the understanding that over the five-year term of the

note the benefited shareholders would use their

share of the interest to buy (on a dollar-for-dollar

basis) the fast-pay shareholders’ portion of the note.

The benefited shareholders’ and the fast-pay shareholders’ yearly taxable income under Notice 97–21

March 15, 1999

can then be calculated after determining their initial

portions of the note and whether those initial portions are purchased at a discount or premium.

(B) Determining initial portions of the debt instrument. The fast-pay shareholders’ and the benefited shareholders’ initial portions of the note can be

determined by comparing the present values of their

expected cash flows. As a class, the fast-pay shareholders expect to receive cash flows of $135,000 (five

annual payments of $17,000, plus a final payment of

$50,000). As a class, the benefited shareholders expect to receive cash flows of $155,000 (five annual

payments of $1,000, plus a final payment of

$150,000). Using a discount rate equal to the yield to

maturity (as determined under §1.1272–1(b)(1)(i)) of

the mortgage note (9.0 percent, compounded annually), the present value of the fast-pay shareholders’

cash flows is $98,620, and the present value of the

benefited shareholders’ cash flows is $101,380. Thus,

the fast-pay shareholders initially acquire 49 percent

of the note at a $1,380 premium (that is, they paid

$100,000 for $98,620 of principal in the note). The

benefited shareholders initially acquire 51 percent of

the note at a $1,380 discount (that is, they paid

$100,000 for $101,380 of principal in the note).

Under section 171, the fast-pay shareholders’ premium is amortizable based on their yield in their initial portion of the note (8.57 percent, compounded annually). The benefited shareholders’ discount accrues

based on the yield in their initial portion of the note

(9.35 percent, compounded annually).

(C) Taxable income under Notice 97–21. Under

Notice 97-21, the fast-pay shareholders’ 1998 taxable income attributable to the fast-pay arrangement

is $8,574 ($8.57 per $100 invested), computed by

subtracting the amortizable premium ($302) from

the interest income from their portion of the note

($8,876). The benefited shareholders’ 1998 taxable

income attributable to the fast-pay arrangement is

$9,353 ($9.35 per $100 invested), computed by

adding the accrued discount ($229) to the interest income from their portion of the note ($9,124).

(iii) Taxable income under the recharacterization

of this section. Assume the financing instruments

are debt instruments. Under the recharacterization

rules of paragraph (c) of this section, the fast-pay

shareholders’ 1998 taxable income attributable to

the fast-pay arrangement is $8,574 ($8.57 per $100

invested), which is the interest income from the financing instruments. The benefited shareholders’

1998 taxable income attributable to the fast-pay

arrangement is $9,426 ($9.43 per share of benefited

stock), computed by subtracting the interest income

accrued on the financing instruments ($8,574) from

the dividend income actually and deemed paid on

the benefited stock ($18,000).

(iv) Limit on taxable income under this paragraph (g)(2). (A) Fast-pay shareholders. For 1998,

the fast-pay shareholders have the same taxable income under the recharacterization of Notice 97–21

($8,574) as they have under the recharacterization of

paragraph (c) of this section ($8,574). Thus, the

limit under paragraph (g)(2)(i) of this section is unavailable to the fast-pay shareholders.

(B) Benefited shareholders. For 1998, the benefited shareholders have taxable income attributable

to the fast-pay arrangement of $9,353 ($9.35 per

$100 invested) under the recharacterization of No-

20

tice 97–21, and taxable income of $9,426 ($9.43 per

share of benefited stock) under the recharacterization of paragraph (c) of this section. Thus, under

paragraph (g)(2)(i) of this section, a benefited shareholder may elect to limit its taxable income attributable to the fast-pay arrangement to $9.35 for each

share of benefited stock. Any amount an electing

shareholder excludes from taxable income($0.08 per

share of benefited stock) must later be included as

an adjustment. (If all benefited shareholders elect

the limit, then as a class the later adjustment to taxable income is $73.)

Example 2. REIT holds debt issued by a benefited

shareholder. (i) Facts. The facts are the same as in

Example 1 of this paragraph (g)(2) except that corporation Z holds 800 shares (80 percent) of the benefited stock, and Z, instead of a third party, issues

the mortgage note acquired by Y.

(ii) Recharacterization under Notice 97–21. Because Y holds a debt instrument issued by Z, the

fast-pay arrangement is recharacterized under Notice 97–21 as an arrangement in which Z issued one

or more instruments directly to the fast-pay shareholders and the other benefited shareholders. Consistent with this recharacterization, Z is treated as issuing a debt instrument to the fast-pay shareholders

for $100,000. The debt instrument provides for five

annual payments of $17,000 and an additional payment of $50,000 in year five. Thus, the debt instrument’s yield to maturity is 8.57 percent per annum,

compounded annually. Z is also treated as issuing a

debt instrument to the other benefited shareholders

for $20,000 (200 shares multiplied by $100, or 20

percent of the $100,000 paid to Y by the benefited

shareholders as a class). This debt instrument provides for five annual payments of $200 and an additional payment of $30,000 in year five. The debt instrument’s yield to maturity is 9.30 percent per

annum, compounded annually. For 1998, Z’s interest expense is $10,435 ($8,574 attributable to the

debt instruments held by the fast-pay shareholders,

and $1,861 attributable to the debt instruments held

by the other benefited shareholders).

(iii) Recharacterization under this section. Assume the financing instruments are debt instruments.

Under the recharacterization rules of paragraph (c)

of this section, for 1998, Z has dividend income of

$14,400 (800 shares multiplied by $18, or 80 percent of $18,000), and total interest expense of

$24,859 ($18,000 of interest accrued on the note

held by Y, and $6,859 of interest accrued on the financing instruments).

(iv) Limit on taxable income under this paragraph (g)(2). For 1998, Z has a taxable loss attributable to the fast-pay arrangement of $10,435 under

the recharacterization of Notice 97-21, and a taxable

loss of $10,459 ($14,400 of dividends, minus

$24,859 of total interest expense) under the recharacterization of paragraph (c) of this section. Thus, for

1998, Z’s taxable loss attributable to the fast-pay

arrangement is $10,459 (the amount determined

under paragraph (c) of this section), and the limit of

paragraph (g)(2)(i) of this section is unavailable to Z.

(3) Rule to comply with this section.

To comply with this section for each taxable year in which it failed to do so, a tax-

1999–11 I.R.B.

payer should file an amended return. For

taxable years ending before the date these

regulations are published as final regulations, a taxpayer that has complied with

Notice 97–21, 1997–1 C.B. 407, (see

§601.601(d)(2) of this chapter) is considered to have complied with this section.

(4) Reporting requirements. The reporting requirements of paragraph (f) of

this section apply to taxable years (of the

person required to file the statement) ending after the date these regulations are

published as final regulations in the Federal Register.

John Dalrymple,

Deputy Commissioner of

Internal Revenue.

(Filed by the Office of the Federal Register on January 5, 1999, 8:45 a.m., and published in the issue of

the Federal Register for January 6, 1999, 64 F.R.

805)

Notice of Proposed Rulemaking

and Notice of Public Hearing

Compliance Monitoring and

Miscellaneous Issues Relating to

the Low-Income Housing Credit

REG–114664–97

AGENCY: Internal Revenue Service

(IRS), Treasury.

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

SUMMARY: This document contains

proposed amendments to various existing

final regulations concerning the low-income housing tax credit including the

procedures for compliance monitoring by

state and local housing agencies (Agencies), the requirements for making carryover allocations, and the rules for Agencies’ correction of administrative errors or

omissions. In addition, regulations are

being proposed involving the independent

verification of information on sources and

uses of funds submitted by taxpayers to

Agencies. These amendments and proposed regulations affect owners of lowincome housing projects who have

claimed the credit and the Agencies who

administer the credit. This document also

provides notice of a public hearing on

these proposed regulations.

1999–11 I.R.B.

DATES: Written and electronic comments must be received by May 6, 1999.

Outlines of topics to be discussed at the

public hearing scheduled for May 27,

1999, must be received by April 8, 1999.

ADDRESSES: Send submissions to:

CC:DOM:CORP:R (REG–114664–97),

room 5226, Internal Revenue Service,

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

hand-delivered Monday through Friday

between the hours of 8 a.m. and 5 p.m. to:

CC:DOM:CORP:R (REG–114664–97),

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 room 2615, Internal Revenue Building, 1111 Constitution Avenue, NW, Washington, DC.

FOR FURTHER INFORMATION CONTACT: Concerning the regulations, Paul

Handleman, (202) 622-3040; concerning

submissions, the hearing, and/or to be

placed on the building access list to attend

the hearing, LaNita Van Dyke, (202) 6227180 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

The collections of information contained in §§1.42–5 and 1.42–13 previously have been reviewed and approved

by the Office of Management and Budget

for review under control numbers 15451291 and 1545-1357, respectively; all of

these paperwork requirements will be

consolidated under control number 15451357. The new collections of information

contained in this notice of proposed rulemaking have been submitted to the Office of Management and Budget for review in accordance with the Paperwork

Reduction Act of 1995 (44 U.S.C.

3507(d)).

Comments on the collections of information should be sent to the Office of

Management and Budget, Attn: Desk

Officer for the Department of the Treasury, Office of Information and Regula-

21

tory Affairs, Washington, DC 20503, with

copies to the Internal Revenue Service,

Attn: IRS Reports Clearance Officer,

OP:FS:FP, Washington, DC 20224. Comments on the collections of information

should be received by March 9, 1999.

Comments are specifically requested concerning:

Whether the proposed collection of information is necessary for the proper performance of the functions of the IRS, including whether the information will have

practical utility;

The accuracy of the estimated burden associated with the proposed collection of

information (see below);

How the quality, utility, and clarity of the

information to be collected may be enhanced;

How the burden of complying with the

proposed collection of information may

be minimized, including through the application of automated collection techniques or other forms of information technology; and

Estimates of capital or start-up costs and

costs of operation, maintenance, and purchase of services to provide information.

The requirement for the collections of

information in this notice of proposed

rulemaking is in §§1.42–5, 1.42–13, and

1.42–17. The information is required by

the IRS to verify compliance with the requirements of section 42. The collections

of information are mandatory. The likely

respondents/recordkeepers are individuals, state and local governments, businesses or other for-profit institutions, nonprofit institutions, and small businesses or

organizations.

Estimated total annual reporting and

recordkeeping burden for §1.42–5:

102,500 hours.

For §1.42–5, the estimated annual burden

per respondent varies from .5 hour to 3

hours for taxpayers and 250 to 5,000

hours for Agencies, with an estimated average of 1 hour for taxpayers and 1,500

hours for Agencies.

Estimated number of respondents for

§1.42–5 : 20,000 taxpayers and 55 Agencies.

Estimated total annual reporting and

recordkeeping burden for §1.42–13: 289

hours.

For §1.42–13, the estimated annual burden per respondent varies from .5 hour to

March 15, 1999

10 hours for taxpayers and Agencies, with

an estimated average of 3.5 hours for taxpayers and 3 hours for Agencies.

Estimated number of respondents for

§1.42–13: 43 taxpayers and 43 Agencies.

Estimated total annual reporting and

recordkeeping burden for §1.42–17:

2,110 hours.

For §1.42–17, the estimated annual burden per respondent varies from .5 hour to

2 hours for taxpayers and .5 hour to 5

hours for Agencies, with an estimated average of 1 hour for taxpayers and 2 hours

for Agencies.

Estimated number of respondents for

§1.42–17: 2,000 taxpayers and 55 Agencies.

Estimated annual frequency of responses:

once a year.

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 unless it displays a

valid control number assigned by the Office of Management and Budget.

Books or records relating to a collection of information must be retained as

long as their contents may become material in the administration of any internal

revenue law. Generally, tax returns and

tax return information are confidential, as

required by 26 U.S.C. 6103.

Background

On March 28, 1997, the General Accounting Office (GAO) submitted a report

to Congress, “Tax Credits: Opportunities

to Improve Oversight of the Low-Income

Housing Program,” (GAO/GGD/RCED97–55), recommending certain revisions

to existing Agency procedures for compliance with the low-income housing credit

and requirements under qualified allocation plans for verifying taxpayers’ sources

and uses of funds for low-income housing

projects. Consistent with these proposals,

the proposed regulations amend existing

regulation §1.42–5 to require Agencies: (i)

to report annually their compliance monitoring activities to the IRS; (ii) to conduct

on-site habitability inspections of low-income housing projects; and (iii) to review

local government reports on building code

violations. In addition, the proposed regulations provide that qualified allocation

plans require taxpayers to submit indepen-

March 15, 1999

dent verification on sources and uses of

funds for low-income projects.

The proposed regulations also contain

amendments to the Income Tax Regulations (26 CFR part 1) including §1.42–6

(carryover allocations), §1.42–11 (provision of services), §1.42–12 (effective

dates and transitional rules), and

§1.42–13 (correction of administrative errors and omissions) that are issued under

the authority granted by section 42(n).

Explanation of Provisions

Compliance Monitoring

Section 42(m)(1)(B)(iii) provides that

an allocation plan is not qualified unless it

contains a procedure that the Agency (or

an agent of, or private contractor hired by,

the Agency) will follow in monitoring

compliance with the provisions of section

42. The Agency is to notify the IRS of

any noncompliance of which the Agency

becomes aware.

Section 42(m)(1)(B)(iii) is effective on

January 1, 1992, and applies to all buildings for which the low-income housing

credit determined under section 42 is, or

has been, allowable at any time. Allocation plans must have complied with the

requirements of §1.42–5 by June 30,

1993. Section 42(m)(1)(B)(iii) and

§1.42–5 do not require monitoring for

whether a low-income housing project is

in compliance with the requirements of

section 42 prior to January 1, 1992. However, if an Agency becomes aware of noncompliance that occurred prior to January

1, 1992, the Agency is required to notify

the IRS of that noncompliance.

The current compliance monitoring

regulations require an Agency, at a minimum, to review tenant income certifications and rent charges of projects using

one of the following three monitoring options: (1) review the owners’ annual income certifications, including the documentation supporting the certifications for

at least 50 percent of the Agency’s low-income projects, and tenant rent records in

at least 20 percent of the low-income units

in these projects; (2) make annual on-site

inspections of at least 20 percent of the

projects, and review the low-income certification, the documentation supporting the

certification, and rent record for each ten-

22

ant in at least 20 percent of the low-income units in those projects; or (3) obtain

from all project owners tenant income and

rent records for each low-income unit and,

for at least 20 percent of the projects, review the annual tenant income certification, backup income documentation, and

rent record for each low-income tenant in

at least 20 percent of the low-income units

in those projects.

The GAO report recommended that an

Agency conduct regular on-site inspections of projects and obtain building code

inspection reports performed by the local

government unit. The GAO found that

desk audits (monitoring options 1 and 3

above) failed to detect violations involving the physical condition of buildings.

In addition, site visits allow an Agency to

directly assess the compliance status of

projects and the physical condition of

buildings. Consistent with these proposals, the proposed regulations remove the

three monitoring options and require, at

least once every three (3) years, that each

Agency conduct on-site inspections of all

buildings in each low-income housing

project and, for each tenant in at least 20

percent of the project’s low-income units

selected by the Agency, review the lowincome certification, the documentation

supporting such certification, and the rent

record. The proposed regulations also require, at a minimum, by the end of the

calendar year following the year the last

building in a project is placed in service,

that the Agency conduct on-site inspections of the projects and review the lowincome certification, the documentation

supporting such certification, and the rent

record for each tenant in the project. As

part of the inspection requirements, the

proposed regulations also require the

Agency to determine whether the project

is suitable for occupancy, taking into account local health, safety, and building

codes. Agencies may delegate this determination only to a state or local government unit responsible for making building

code inspections. The three-year inspection requirement is proposed to be effective on the date the final regulations are

published in the Federal Register. The

placed-in-service year inspection requirement is proposed to be effective for buildings placed in service on or after the date

1999–11 I.R.B.

the final regulations are published in the

Federal Register.

The current compliance monitoring

regulations require the owner of a project,

at a minimum, to certify annually that for

the preceding 12-month period each

building in the project was suitable for occupancy, taking into account local health,

safety, and building codes. Based on the

GAO recommendation, the proposed regulations revise this certification by also

requiring the owner of the project to certify that for the preceding 12-month period the state or local government unit responsible for making building code

inspections did not issue a report of a violation for the project. If the governmental

unit issued a report of a violation, the

owner will be required to attach a copy of

the report of the violation to the annual

certification submitted to the Agency.

The proposed regulations also adopt

the GAO recommendation that Agencies

report annually to the IRS on compliance

monitoring activities. It is anticipated

Form 8610, “Annual Low-Income Housing Credit Agencies Report,” will be revised to require an Agency to confirm annually that it has satisfied the new

compliance monitoring requirements involving: (1) the once every three-year onsite inspections and review of the low-income certification, the documentation

supporting such certification, and the rent

record for each tenant in at least 20 percent of the low-income units selected by

the Agency; and (2) the on-site inspections relating to the placed-in-service year

and review of the low-income certification, the documentation supporting such

certification, and the rent record for each

low-income tenant in the project.

The current compliance monitoring

regulations require Agencies to report a

correction of noncompliance or failure to

certify if the correction occurs within the

correction period defined in §1.42–

5(e)(4). The proposed regulations clarify

that the Agency is required to file Form

8823, “Low-Income Housing Credit

Agencies Report of Noncompliance,”

with the IRS reporting the correction of

the noncompliance or failure to certify regardless of when the correction occurs

during the compliance period. This requirement is proposed to be effective on

the date the final regulations are published in the Federal Register.

1999–11 I.R.B.

Sources and Uses of Funds

The GAO report recommended that

IRS regulations be amended to establish

clear requirements to ensure independent

verification of taxpayer’s key information

on sources and uses of funds submitted to

an Agency. Without assurance of reliable

and complete cost and financing information, Agencies are vulnerable to providing

more (or fewer) tax credits to projects

than are actually needed. Under section

42(m)(2)(A), the housing credit dollar

amount allocated to a project should not

exceed the amount the Agency determines

is necessary for the financial feasibility of

the project and its viability as a qualified

low-income housing project throughout

the credit period. In making this determination, section 42(m)(2)(B) requires that

the Agency must consider: (i) the sources

and uses of funds and the total financing

planned for the project, (ii) any proceeds

or receipts expected to be generated by

reason of tax benefits, (iii) the percentage

of the housing credit dollar amount used

for project costs other than the costs of intermediaries, and (iv) the reasonableness

of the developmental and operational

costs of the project. The requirement in

section 42(m)(2)(B)(iii) is not to be applied so as to impede the development of

projects in hard-to-develop areas.

In its report, the GAO determined that

an Agency must make three critical judgments in awarding credits: (1) the reasonableness of developer costs because the

Agency is to award no more credits to a

project than a specified percentage of certain Agency-approved project development costs; (2) the reasonableness of the

financing arrangements for the project because the Agency is required to base an

award of credit on the financial need of a

project subject to the limit computed on

Agency-approved development costs; and

(3) criteria for pricing the credit (for example, use of an appropriate rate to convert credits into an equity investment

amount).

So that an Agency may more accurately

determine the amount of credits to be

awarded, the GAO proposed three alternative recommendations: (1) an examination or audit, which would provide a reasonable basis for an independent public

accountant to issue an opinion on the

overall reliability of a project’s financial

23

information taken as a whole; (2) a review, which would consist of inquiries

and application of analytical procedures

that might bring to the accountant’s attention significant matters affecting a project’s financial information but would not

provide assurance that the accountant

would become aware of all significant

matters that would be disclosed in an

audit; or (3) agreed-upon procedures,

which would provide an accountant with

a basis to issue a report of findings based

on the specified procedures but not a basis

to issue an opinion on the reliability of the

financial information.

Because the first alternative provides

the most reliable independent verification

on sources and uses of funds, the proposed regulations require that a taxpayer

must obtain an opinion by a certified public accountant, based upon the accountant’s audit or examination, on the financial determinations and certifications

provided by the taxpayer to the Agency,

including the costs that may qualify for

inclusion in eligible basis under section

42(d) and the amount of the credit under

section 42. This opinion must be submitted to the Agency before the Agency issues the Form 8609, “Low-Income Housing Credit Allocation Certification.” This

requirement is proposed to be effective on

the date the final regulations are published in the Federal Register.

Buildings Qualifying for Carryover

Allocations

The proposed regulations amend the

carryover allocation regulations by requiring the Agency to file a form (to be

prescribed by the IRS) that summarizes

the carryover allocation document described in §1.42–6(d)(2) with the

Agency’s Form 8610 for the year the allocation is made. The new form will be

filed with the Form 8610 in lieu of the

original carryover allocation document.

Taxpayers must continue to file a copy of

the carryover allocation document with

the Form 8609 for the building for the

first year the credit is claimed.

Correction of Administrative Errors and

Omissions

Housing credit agencies may correct

administrative errors and omissions with

respect to allocations and recordkeeping

March 15, 1999

if the correction occurs within a reasonable period of time after discovery of the

error or omission. The current administrative error and omission regulations define an administrative error or omission as

a mistake that results in a document that

inaccurately reflects the intent of the

Agency at the time the document is originally completed or, if the mistake affects

a taxpayer, a document that inaccurately

reflects the intent of the Agency and the

affected taxpayer at the time the document is originally completed. However,

an administrative error or omission does

not include a misinterpretation of the applicable rules and regulations under section 42. Agencies must obtain prior approval from the Secretary to correct an

administrative error or omission if the

correction is not made before the close of

the calendar year of the error or omission

and the correction: (1) is a numerical

change to the housing credit dollar

amount allocated for the building or project; (2) affects the determination of any

component of the state’s housing credit

ceiling under section 42(h)(3)(C); or (3)

affects the state’s unused housing credit

carryover that is assigned to the Secretary

under section 42(h)(3)(D).

The proposed regulations would provide automatic approval for correcting an

administrative error or omission in an allocation document (a Form 8609, or a carryover allocation document under the requirements of section 42(h)(1)(E) or (F)

and §1.42–6(d)(2)) that either did not accurately reflect the number of buildings

constructed by the affected taxpayer, or

transposed the information for one or

more buildings with other buildings in a

project.

If the automatic approval provision applies to the administrative error or omission, the proposed regulations require the

Agency to amend the allocation document. If correcting the administrative

error or omission requires adding a Building Identification Number (B.I.N.) to the

amended allocation document, the proposed regulations require that the Agency

must include any B.I.N.(s) already existing for the buildings in the document and,

if possible, number the additional

B.I.N.(s) sequentially from the existing

B.I.N.(s). In addition, the Agency must

file the amended allocation document

March 15, 1999

with an amended Form 8610. This provision is proposed to be effective on the

date the final regulations are published in

the Federal Register.

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. It is hereby certified that the collections of information in these regulations

will not have a significant economic impact on a substantial number of small entities. This certification is based upon the

fact that any burden on taxpayers is minimal. Furthermore, an Agency is not a

“small entity” for purposes of the Regulatory Flexibility Act (5 U.S.C. chapter 6).

Accordingly, a Regulatory Flexibility

Analysis under the Regulatory Flexibility

Act is not required. Pursuant to section

7805(f) of the Internal Revenue Code,

this notice of proposed rulemaking will be

submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on its impact on small

business.

trance area more than 15 minutes before

the hearing starts. For information about

having your name placed on the building

access list to attend the hearing, see the

“FOR FURTHER INFORMATION

CONTACT” section of this preamble.

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

apply to the hearing.

Persons that wish to present oral comments at the hearing must submit written

and electronic comments and an outline

of the topics to be discussed and the time

to be devoted to each topic (signed original and eight (8) copies) by April 8, 1999.

A period of 10 minutes will be allotted

to each person for making comments.

An agenda showing the scheduling of

the speakers will be prepared after the

deadline for receiving outlines has

passed. Copies of the agenda will be

available free of charge at the hearing.

Drafting Information

The principal author of these regulations is Paul F. Handleman, Office of the

Assistant Chief Counsel (Passthroughs

and Special Industries), IRS. However,

other personnel from the IRS and Treasury Department participated in their development.

* * * * *

Comments and Public Hearing

Proposed Amendments to the Regulations

Before these proposed regulations are

adopted as final regulations, consideration will be given to any written comments (a signed original and eight (8)

copies) that are submitted timely to the

IRS. The IRS and Treasury specifically

request comments on the clarity of the

proposed rule and how it may be made

easier to understand. All comments will

be available for public inspection and

copying.

A public hearing has been scheduled

for Thursday, May 27, 1999, at 10 a.m. in

room 2615, Internal Revenue Building,

1111 Constitution Avenue, NW, Washington DC. Due to building security procedures, visitors must enter at the 10th

Street entrance, located between Constitution and Pennsylvania Avenues, NW. In

addition, all visitors must present photo

identification to enter the building. Because of access restrictions, visitors will

not be admitted beyond the immediate en-

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

24

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 * * *

Section 1.42–17 also issued under 26

U.S.C. 42(n); * * *

Par. 2. Section 1.42-5 is amended by:

1. Revising paragraphs (c)(1)(v),

(c)(1)(vi) and (c)(2)(ii).

2. Removing the language “If a monitoring procedure includes the review provision described in paragraph (c)(2)(ii)(B)

of this section, the” from the second sentence in paragraph (c)(2)(iii) and adding

“The” in its place.

3. Removing the language “paragraph

(c)(2)(ii)(A), (B), and (C) of this section”

from the first sentence in paragraph

(c)(4)(i) and adding “paragraph (c)(2)(ii)

of this section” in its place.

1999–11 I.R.B.

4. Removing the language “An

Agency chooses the review requirement

of paragraph (c)(2)(ii)(A) of this section

and some of the buildings selected for review are” from the first sentence in the

example in paragraph (c)(4)(iii) and

adding “An Agency selects for review” in

its place.

5. Adding paragraph (c)(5).

6. Revising the last sentence in paragraph (d).

7. Removing the language “(c)(2)(ii)(A), (B), or (C) of this section (whichever is applicable)” from paragraph (e)(2)

and adding the language “(c)(2)(ii) of this

section” in its place.

8. Adding a sentence at the end of

paragraph (e)(3)(i).

9. Removing the language “paragraph

(e)(3) of this section” in the third sentence

in paragraph (f)(1)(i) and adding “paragraphs (c)(5) and (e)(3) of this section” in

its place.

10. Adding two sentences at the end of

paragraph (h).

The revisions and additions read as follows:

§1.42–5 Monitoring compliance with

low-income housing credit requirements.

* * * * *

(c) * * *

(1) * * *

(v) All units in the project were for use

by the general public (as defined in

§1.42–9) and used on a nontransient basis

(except for transitional housing for the

homeless provided under section 42(i)(3)(B)(iii) or single-room-occupancy

units rented on a month-by-month basis

under section 42(i)(3)(B)(iv));

(vi) Each building in the project was

suitable for occupancy, taking into account local health, safety, and building

codes, and the State or local government

unit responsible for making building code

inspections did not issue a report of a violation for any building in the project. If a

report of a violation was issued by the

governmental unit, the owner must attach

a copy of the report of the violation to the

annual certification submitted to the

Agency under paragraph (c)(1) of this

section;

(2) * * *

(ii) Require that with respect to each

low-income housing project—

1999–11 I.R.B.

(A) The Agency conduct on-site inspections of all buildings in the project by

the end of the calendar year following the

year the last building in the project is

placed in service and review the low-income certification, the documentation

supporting such certification, and the rent

record for each low-income tenant; and

(B) At least once every three (3) years,

the Agency conduct on-site inspections of

all buildings in the project, and, for each

tenant in at least 20 percent of the project’s low-income units selected by the

Agency, review the low-income certification, the documentation supporting such

certification, and the rent record; and

* * * * *

(5) Agency reports of compliance monitoring activities. The Agency must report its compliance monitoring activities

annually on Form 8610, “Annual Low-Income Housing Credit Agencies Report.”

(d) * * * In addition, in connection with

the on-site inspections required by paragraph (c)(2)(ii) of this section, the Agency

must determine whether the project is

suitable for occupancy, taking into account local health, safety, and building

codes. Notwithstanding paragraph (f) of

this section, this determination may be

delegated only to a State or local government unit responsible for making building

code inspections.

(e) * * *

(3) * * *

(i) * * * For noncompliance or failure

to certify that is corrected after the end of

the correction period, the Agency is required to file Form 8823 with the Service

reporting the correction of the noncompliance or failure to certify regardless of

when the correction occurs during the 15year compliance period under section

42(i)(1).

graph (c)(1)(vi) of this section (involving

whether a State or local government unit

responsible for making building code inspections issued a report or a violation for

the project), paragraph (c)(2)(ii)(B) of

this section (the low-income certifications, the documentation supporting such

certifications, and the rent records), paragraph (c)(5) of this section (involving the

requirement to report the Agency’s compliance monitoring activities to the Service), paragraph (d) of this section (involving habitability requirements), and

paragraph (e)(3) of this section (involving

the requirement to report corrected noncompliance or failure to certify after the

end of the correction period) are effective

on the date the final regulations are published in the Federal Register.

Par. 3. Section 1.42-6 is amended by

removing the first sentence in paragraph

(d)(4)(ii) and adding two sentences in its

place to read as follows:

§1.42–6 Buildings qualifying for

carryover allocations.

* * * * *

(d) * * *

(4) * * *

(ii) Agency. The Agency must retain

the original carryover allocation document made under paragraph (d)(2) of this

section and file the form (to be prescribed

by the IRS) that summarizes the carryover

allocation document. This form is filed

with the Agency’s Form 8610 that accounts for the year the allocation is made.

***

* * * * *

Par. 4. Section 1.42–11 is amended by

revising the last sentence in paragraph

(b)(3)(ii)(A) to read as follows:

§1.42–11 Provision of services.

* * * * *

* * * * *

(h) * * * In addition, the requirement in

paragraph (c)(2)(ii)(A) of this section (involving on-site inspections relating to the

placed-in-service year and review of the

low-income certifications, the documentation supporting such certifications, and

the rent records) is effective for buildings

placed in service on or after the date the

final regulations are published in the Federal Register. The requirements in para-

(b) * * *

(3) * * *

(ii) * * * (A) * * * For a building described in section 42(i)(3)(B)(iii) (relating

to transitional housing for the homeless)

or section 42(i)(3)(B)(iv) (relating to single room occupancy), a supportive service includes any service provided to assist tenants in locating and retaining

permanent housing.

25

March 15, 1999

* * * * *

Par. 5. Section 1.42–12 is amended by

adding paragraph (c) to read as follows:

§1.42–12 Effective dates and transitional

rules.

* * * * *

(c) The rule set forth in §1.42–

6(d)(4)(ii) relating to the requirement that

state and local housing agencies file the

form to be prescribed by the Internal Revenue Service that summarizes the carryover allocation document is effective for

forms the due date of which are on or

after March 8, 1999.

Par. 6. Section 1.42–13 is amended by:

1. Revising the introductory text of

paragraph (b)(3)(iii).

2. Adding paragraphs (b)(3)(vi),

(b)(3)(vii), and (b)(3)(viii).

3. Adding a sentence at the end of

paragraph (d).

The revisions and additions read as follows:

§1.42–13 Rules necessary and

appropriate; housing credit agencies’

correction of administrative errors and

omissions.

* * * * *

(b) * * *

(3) * * *

(iii) Secretary’s prior approval required. Except as provided in paragraph

(b)(3)(vi) of this section, an Agency must

obtain the Secretary’s prior approval to

correct an administrative error or omission, as described in paragraph (b)(2) of

this section, if the correction is not made

before the close of the calendar year of

the error or omission and the correction—

* * * * *

(vi) Secretary’s automatic approval.

The Secretary grants automatic approval

to correct an administrative error or omission described in paragraph (b)(2) of this

section if—

(A) The correction is not made before

the close of the calendar year of the error

or omission and the correction is a numerical change to the housing credit dollar

amount allocated for the building or multiple-building project;

(B) The administrative error or omis-

March 15, 1999

sion resulted in an allocation document

(the Form 8609, “Low-Income Housing

Credit Allocation Certification,” or the allocation document under the requirements

of section 42(h)(1)(E) or (F) and §1.42–

6(d)(2)) that either did not accurately reflect the number of buildings constructed

by the affected taxpayer (for example, the

affected taxpayer built 10 buildings instead

of 8 buildings having the same total number of units), or transposed the information

for one or more buildings with other buildings in the multiple-building project;

(C) The administrative error or omission does not affect the Agency’s ranking

of the building(s) or project and the total

amount of credit the Agency allocated to

the building(s) or project;

(D) The Agency corrects the administrative error or omission no later than one

year after the building(s) were placed in

service by the affected taxpayer; and

(E) The Agency corrects the administrative error or omission by following the

procedures described in paragraph

(b)(3)(vii) of this section.

(vii) How Agency corrects errors or

omissions subject to automatic approval.

An Agency corrects an administrative

error or omission described in paragraph

(b)(3)(vi) of this section by—

(A) Amending the allocation document

described in paragraph (b)(3)(vi)(B) of

this section to correct the administrative

error or omission. The Agency will indicate on the amended allocation document

that it is making the “correction under

§1.42–13(b)(3)(vii)”. If correcting the allocation document requires including any

additional B.I.N.(s) in the document, the

document must include any B.I.N.(s) already existing for the buildings. If possible, the additional B.I.N.(s) should be sequentially numbered from the existing

B.I.N.(s);

(B) Amending, if applicable, the form

to be prescribed by the Service that summarizes the allocation document (see

§1.42–6 (d)(4)(ii)) and attaching a copy

of this form to an amended Form 8610,

“Annual Low-Income Housing Credit

Agencies Report,” for the year the allocation was made. The Agency will indicate

on the forms that it is making the “correction under §1.42–13(b)(3)(vii)”;

(C) Amending, if applicable, the Form

8609 and attaching the original of this

amended form to an amended Form 8610

26

for either the year the allocation was

made or the year the building was placed

in service by the affected taxpayer. The

Agency will indicate on the forms that it

is making the “correction under §1.42–

13(b)(3)(vii)”;

(D) Filing the amended Form 8610

with the Service. When completing the

amended Form 8610, the Agency should

follow the specific instructions for the

Form 8610 under the heading “Amended

Report”; and

(E) Mailing a copy of any amended allocation document and any amended Form

8609 to the affected taxpayer.

(viii) Other approval procedures. The

Secretary may grant automatic approval to

correct other administrative errors or

omissions as designated in one or more

documents published either in the Federal

Register or in the Internal Revenue Bulletin (see § 601.601(d)(2) of this chapter).

* * * * *

(d) * * * Paragraphs (b)(3)(vi), (vii),

and (viii) of this section are effective on

the date the final regulations are published in the Federal Register.

Par. 7. Section 1.42–17 is added to

read as follows:

§1.42–17 Qualified Allocation Plan.

(a) Requirements—(1) In general.

[Reserved]

(2) Selection criteria. [Reserved]

(3) Agency evaluation. Section

42(m)(2)(A) requires that the housing

credit dollar amount allocated to a project

should not exceed the amount the Agency

determines is necessary for the financial

feasibility of the project and its viability

as a qualified low-income housing project

throughout the credit period. In making

this determination, the Agency must consider—

(i) The sources and uses of funds and

the total financing planned for the project.

The taxpayer must certify to the Agency

the full extent of all federal, state, and

local subsidies that apply (or which the

taxpayer expects to apply) to the project.

The taxpayer must also certify to the

Agency all other sources of funds and all

development costs for the project. The

taxpayer’s certification should be sufficiently detailed to enable the Agency to

ascertain the nature of the costs that will

1999–11 I.R.B.

comprise the total financing package, including subsidies and the anticipated syndication or placement proceeds to be

raised. Development cost information,

whether or not includible in eligible basis

under section 42(d), that should be provided to the Agency includes, but is not

limited to, site acquisition costs, construction contingency, general contractor’s

overhead and profit, architect and engineer’s fees, permit and survey fees, insurance premiums, real estate taxes during

construction, title and recording fees, construction period interest, financing fees,

organizational costs, rent-up and marketing costs, accounting and auditing costs,

working capital and operating deficit reserves, syndication and legal fees, developer fees, and other costs;

(ii) Any proceeds or receipts expected

to be generated by reason of tax benefits;

(iii) The percentage of the housing

credit dollar amount used for project costs

other than the costs of intermediaries.

This requirement should not be applied so

as to impede the development of projects

in hard-to-develop areas under section

42(d)(5)(C); and

(iv) The reasonableness of the developmental and operational costs of the project.

(4) Timing of Agency evaluation. The

financial determinations and certifications

required under paragraph (a)(3) of this

section must be made at each of the following times:

(i) The time of the application for the

housing credit dollar amount.

(ii) The time of the allocation of the

housing credit dollar amount.

(iii) The date the building is placed in

service.

(iv) After the building is placed in service, and before the Agency issues the

Form 8609, “Low-Income Housing

Credit Allocation Certification.”

(5) Special rule for final determinations and certifications. For the Agency’s

evaluation under paragraph (a)(4)(iv) of

this section, the taxpayer must obtain an

opinion by a certified public accountant,

based upon the accountant’s audit or examination, on the financial determinations and certifications in paragraphs

(a)(3)(i) through (iii) of this section, including the costs that may qualify for inclusion in eligible basis under section

1999–11 I.R.B.

42(d) and amount of the credit under section 42.

(6) Bond financed projects. A project

qualifying under section 42(h)(4) is not

entitled to any credit unless the governmental unit that issued the bonds (or on

behalf of which the bonds were issued),

or the Agency responsible for issuing the

Form(s) 8609 to the project, makes determinations under rules similar to the rules

in paragraphs (a)(3), (4), and (5) of this

section.

(b) Effective date. This section is effective on the date final regulations are

published in the Federal Register.

Robert E. Wenzel,

Deputy Commissioner of

Internal Revenue.

(Filed by the Office of the Federal Register on January 7, 1999, 8:45 a.m., and published in the issue of

the Federal Register for January 8, 1999, 64 F.R.

1143)

Notice of Proposed Rulemaking

and Notice of Public Hearing

Education Tax Credits

REG–106388–98

AGENCY: Internal Revenue Service

(IRS), Treasury.

ACTION: Notice of proposed rulemaking and requests to hold a videoconference public hearing.

SUMMARY: This document contains

proposed regulations relating to the Hope

Scholarship Credit and the Lifetime

Learning Credit in section 25A of the Internal Revenue Code. These proposed

regulations provide guidance to individuals who may claim the Hope Scholarship

Credit or the Lifetime Learning Credit for

certain postsecondary educational expenses. This document also announces

that a public hearing will be held on the

proposed regulations upon request and

that persons outside the Washington, DC,

area who wish to testify at the hearing

may request that the IRS videoconference

the hearing to their sites.

DATES: Written or electronically generated comments must be received by April

27

6, 1999. Requests to videoconference the

hearing to other sites must be received by

March 8, 1999.

ADDRESSES: Send submissions to:

CC:DOM:CORP:R (REG–106388–98),

room 5226, Internal Revenue Service,

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

hand delivered Monday through Friday

between the hours of 8 a.m. and 5 p.m. to:

CC:DOM:CORP:R (REG–106388–98),

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 IRS

will publish the time and date of the public hearing and the locations of any videoconferencing sites in the Federal Register.

FOR FURTHER INFORMATION CONTACT: Concerning the regulations,

Donna Welch, (202) 622-4910; concerning submissions of comments, the hearing, and/or to be placed on the building

access list to attend the hearing, contact

Michael L. Slaughter, (202) 622-7190

(not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

The collection of information contained in this notice of proposed rulemaking has been submitted to the Office of

Management and Budget for review in accordance with the Paperwork Reduction

Act of 1995 (44 U.S.C. 3507(d)). Comments on the collection of information

should be sent to the Office of Management and Budget, Attn: Desk Officer for

the Department of the Treasury, Office of

Information and Regulatory Affairs,

Washington, DC 20503, with copies to

the Internal Revenue Service, Attn: IRS

Reports Clearance Officer, OP:FS:FP,

Washington, DC 20224. Comments on

the collection of information should be received by March 8, 1999. Comments are

specifically requested concerning:

March 15, 1999

Whether the proposed collection of information is necessary for the proper performance of the functions of the Internal

Revenue Service, including whether the

information will have practical utility;

The accuracy of the estimated burden

associated with the proposed collection of

information (see below);

How the quality, utility, and clarity of

the information to be collected may be enhanced;

How the burden of complying with the

proposed collection of information may

be minimized, including through the

application of automated collection techniques or other forms of information technology; and

Estimates of capital or start-up costs and

costs of operation, maintenance, and purchase of services to provide information.

The collection of information in this

proposed regulation is in §1.25A–1(d)

and (f). Taxpayers must elect to claim an

education credit by attaching Form 8863,

“Education Credits (Hope and Lifetime

Learning Credits),” to a timely filed (including extensions) federal income tax return for the taxable year in which a credit

is claimed. This collection of information

is required in order for a taxpayer to elect

to claim an education credit. This information will be used to carry out the internal revenue laws. The likely respondents

are individuals.

The reporting burden contained in

§1.25A–1(d) and (f) is reflected in the

burden of Form 8863, “Education Credits

(Hope and Lifetime Learning Credits),”

and Form 1040, “U.S. Individual Income

Tax Return.”

An agency may not conduct or sponsor,

and a person is not required to respond to,

a collection of information unless it displays a valid control number assigned by

the Office of Management and Budget.

Books or records relating to a collection of information must be retained as

long as their contents may become

material in the administration of any internal revenue law. Generally, tax returns

and tax return information are confidential, as required by 26 U.S.C. 6103.

’97)) added section 25A to the Internal

Revenue Code to provide the Hope Scholarship Credit and the Lifetime Learning

Credit (education credits). In general, the

Hope Scholarship Credit and the Lifetime

Learning Credit allow taxpayers to claim

a nonrefundable credit against their federal income taxes for certain postsecondary educational expenses. On November 17, 1997, the IRS published

Notice 97–60 (1997–46 I.R.B. 8) to provide general guidance on the higher education tax incentives enacted by TRA ’97,

including the Hope Scholarship Credit

and the Lifetime Learning Credit. This

document contains proposed amendments

to the Income Tax Regulations (26 CFR

part 1) to provide detailed guidance on the

education credits in section 25A.

TRA ’97 also added section 6050S to

the Code, which requires eligible educational institutions to file information returns to assist taxpayer and the IRS in determining the education credit that

taxpayers may claim under section 25A.

The IRS has published several notices outlining the limited information returns that

are required for 1998 and 1999. On December 22, 1997, the IRS published Notice 97–73 (1997–51 I.R.B. 16), which describes the information that must be

reported for 1998. On September 8, 1998,

the IRS published Notice 98–46 (1998–36

I.R.B. 21), which extends the application

of Notice 97–73 to information returns required under section 6050S for 1999. Finally, on December 7, 1998, the IRS published Notice 98–59 (1998–49 I.R.B. 16),

which modified the two prior Notices by

providing that an eligible educational institution is not required to file information

returns under section 6050S for 1998 or

1999 with respect to either: (1) students

who are enrolled during the year only in

courses for which the student receives no

academic credit from the educational institution; or (2) nonresident alien students,

unless requested to do so by the student.

The IRS and the Treasury Department intend to issue separate regulations on the

information reporting required under section 6050S for years after 1999.

Background

1. Calculation of Education Credit and

General Eligibility Requirements

The Taxpayer Relief Act of 1997 (Public Law 105-34 (111 Stat. 788) (TRA

March 15, 1999

Explanation of Provisions

Under the proposed regulations, a tax-

28

payer may claim a nonrefundable education credit equal to the total of the Hope

Scholarship Credit and the Lifetime

Learning Credit allowed for the taxpayer,

the taxpayer’s spouse, and any claimed

dependents. An education credit in excess of a taxpayer’s tax liability for the

taxable year can not be refunded. As with

other personal credits, section 25A does

not allow a carryforward of an unused education credit or a carryforward of excess

qualified expenses.

The proposed regulations provide rules

for the coordination of the Hope Scholarship Credit and the Lifetime Learning

Credit. The proposed regulations provide

that, in the same taxable year, a taxpayer

may claim a Hope Scholarship Credit for

each eligible student’s qualified tuition

and related expenses and a Lifetime

Learning Credit for one or more other students’ qualified tuition and related expenses. The regulations provide that a

taxpayer may claim either the Hope

Scholarship Credit or the Lifetime Learning Credit, but not both, for the qualified

tuition and related expenses of the same

student in the same taxable year. A Hope

Scholarship Credit may be claimed for the

qualified tuition and related expenses (up

to a specified limit described below) of

each eligible student. The Lifetime

Learning Credit may be claimed for the

aggregate amount of qualified tuition and

related expenses (up to a specified limit

described below) of those students for

whom no Hope Scholarship Credit is

claimed.

Consistent with the income limitations

in section 25A(d), the proposed regulations provide that the education credit allowed is phased out for taxpayers with

modified adjusted gross income between

$40,000 and $50,000 ($80,000 and

$100,000 for taxpayers filing a joint return) for the taxable year. For taxable

years beginning after 2001, these amounts

will be adjusted for inflation. Based on

the definition in section 25A(d)(3), the

regulations define modified adjusted

gross income as the adjusted gross income (as defined in section 62) of the taxpayer for the taxable year increased by

any amount excluded from gross income

under section 911, 931, or 933 (relating to

income earned abroad or from certain

U.S. possessions or Puerto Rico). The

amount of an otherwise allowable educa-

1999–11 I.R.B.

tion credit for a taxable year that is reduced solely by reason of the modified

adjusted gross income limitation can not

be carried forward and claimed in a subsequent taxable year.

Consistent with the requirements in

section 25A(e)(1), the proposed regulations provide that a taxpayer must elect to

claim the education credit. The election

must be made by attaching Form 8863,

“Education Credits (Hope and Lifetime

Learning Credits),” to the taxpayer’s federal income tax return for the taxable year

in which the credit is claimed. Consistent

with the identification requirements in

section 25A(g)(1), the regulations provide

that a taxpayer must include on the federal income tax return the name and taxpayer identification number of each student for whom the credit is claimed.

Consistent with the requirements in

section 25A(e)(2), the proposed regulations provide that no education credit is

allowed for a taxable year for the qualified tuition and related expenses of a student if: (1) during the taxable year, a distribution is made to, or on behalf of, the

student from an education individual retirement account described in section

530(b); and (2) any portion of the distribution is excluded from gross income

under section 530(d)(2).

The proposed regulations provide guidance on the rules for claiming an education credit in the case of a dependent. The

regulations provide that, if the student is a

claimed dependent of another taxpayer,

only that taxpayer may claim the education credit for the student’s qualified tuition and related expenses. The regulations explain that, if the taxpayer is

eligible to, but does not, claim the student

as a dependent, only the student may

claim the education credit for the student’s

qualified tuition and related expenses.

2. Definitions

The proposed regulations provide that a

claimed dependent is a dependent (as defined in section 152) for whom a deduction under section 151 is allowed on the

taxpayer’s federal income tax return for

the taxable year in which the credit is

claimed.

Based on the requirements of section

25A(f)(2), the proposed regulations provide that an eligible educational institu-

1999–11 I.R.B.

tion means a college, university, vocational school, or other postsecondary educational institution that: (1) is described

in section 481 of the Higher Education

Act of 1965 (HEA) (20 U.S.C. 1088) as in

effect on August 5, 1997 (generally all accredited public, nonprofit, and proprietary

postsecondary institutions); and (2) participates in a federal student financial aid

program under title IV of the HEA (20

U.S.C. 1070 et seq.) or is certified by the

Department of Education as eligible to

participate in such a program but chooses

not to participate.

The proposed regulations provide that

academic period means a quarter, semester, trimester, or other period of study

(such as a summer school session) as reasonably determined by the eligible educational institution. Neither section 25A nor

its legislative history defines the term

academic period. Additionally, the Department of Education does not have a

recognized definition of academic period.

The definition in the regulation is intended to include institutions that use traditional academic terms and institutions

that do not use academic terms, but for

example use clock hours or credit hours.

The IRS and Treasury invite comments on

this definition of academic period as well

as suggestions on alternative definitions.

Based on the definition in section

25A(f)(1), the proposed regulations define qualified tuition and related expenses

as the tuition and fees required for the enrollment or attendance of a student for

courses of instruction at an eligible educational institution. This definition is generally consistent with the definition of tuition and fees contained in section 472(1)

of the HEA (20 U.S.C. 1087ll(1)). See

H.R. Conf. Rep. No. 599, 105th Cong., 2d

Sess., at p. 321 (1998). The regulations

provide that, in general, the test for determining whether a fee is treated as a qualified tuition and related expense is whether

the fee is required to be paid to the eligible educational institution by students as a

condition of the students’ enrollment or

attendance at the institution. The regulations specifically provide that qualified

tuition and related expenses include fees

for books, supplies, and equipment used

in a course of study only i

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