Environmental Settlement FundsClassification

DEPARTMENT OF THE TREASURY

26 CFR Parts 1, 301, and 602

[TD 8668]

RIN 1545-AT02

Environmental Settlement Funds--Classification

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

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SUMMARY: This document contains final regulations relating to the

classification of certain organizations as trusts for federal tax

purposes. The final regulations provide guidance to taxpayers on the

proper classification of trusts formed to collect and disburse amounts

for environmental remediation of an existing waste site to discharge

taxpayers' liability or potential liability under applicable

environmental laws.

DATES: These regulations are effective May 1, 1996.

For dates of applicability, see Sec. 301.7701-4(e)(5).

FOR FURTHER INFORMATION CONTACT: James A. Quinn, (202) 622-3060 (not a

toll-free number).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

The collection of information contained in these final regulations

has been reviewed and approved by the Office of Management and Budget

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

control number 1545-1465. This information is required by the IRS to

ensure the proper reporting of items of income and expense of an

environmental remediation trust in which a portion of the trust is

treated as owned by a grantor.

An agency may not conduct or sponsor, and a person is not required

to respond to, a collection of information unless the collection of

information displays a valid control number.

The estimated annual burden per respondent is 4 hours.

Comments concerning the accuracy of this burden estimate and

suggestions for reducing this burden should be sent to the Internal

Revenue Service, Attn: IRS Reports Clearance Officer, T:FP, Washington,

DC 20224, and to the Office of Management and Budget, Attn: Desk

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

Regulatory Affairs, Washington, DC 20503.

Books or records relating to this collection of information must be

retained as long as their contents may become material in the

administration

[[Page 19190]]

of any internal revenue law. Generally, tax returns and tax return

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

Background

On August 4, 1995, the IRS published in the Federal Register a

notice of proposed rulemaking (60 FR 39903) to provide guidance on the

classification of certain organizations as trusts for federal tax

purposes. Written comments responding to the notice were received, and

a public hearing was held on October 26, 1995. After consideration of

the comments received, the proposed regulations are adopted as revised

by this Treasury decision.

Summary of Significant Comments and Revisions

The proposed regulations provide that an environmental remediation

trust is considered a trust for purposes of the Internal Revenue Code.

Under the proposed regulations, a trust is an environmental remediation

trust if the primary purpose of the trust is collecting and disbursing

amounts for environmental remediation of an existing waste site. One

commentator suggested that ``response costs'' should be considered

amounts incurred for environmental remediation. To address this

concern, the final regulations clarify that environmental remediation

includes the costs of remedying and removing environmental

contamination. One commentator also suggested that the final

regulations define the term existing waste site. The final regulations

do not adopt this comment. The term existing waste site should be

sufficiently specific to allow taxpayers to establish an environmental

remediation trust for any contaminated site that currently requires

remediation under environmental laws.

The proposed regulations provide that all contributors to an

environmental remediation trust must have potential liability or a

reasonable expectation of liability under federal, state, or local

environmental laws for environmental remediation of the waste site. A

commentator suggested that the final regulations be clarified to

provide that eligible contributors include contributors with ``actual''

as well as potential liability and contributors who are released from

liability upon their contribution to the trust. The final regulations

clarify that contributors having ``actual'' liability are eligible

contributors. The final regulations do not address the treatment of

contributors that are released from liability by the governmental

authority upon contribution to the trust; the regulations are intended

only to address the tax treatment of environmental remediation trusts

in which contributors continue to have actual or potential liability

(and thus are treated as owners of the trust under section 677). In

situations where one or more contributors are released from liability

by the governmental authority upon contribution to the trust, the rules

for qualified settlement funds may apply to the entire trust. See

Sec. 1.468B-1(c) and (h)(2). If such contributors contribute amounts to

a trust that is separate from the environmental remediation trust,

however, the classification of the environmental remediation trust as a

trust will not be affected.

One commentator suggested that a cross-reference to these

regulations be inserted in Sec. 1.671-4(a) and Sec. 1.677(a)-1(d)

because the proposed regulations address reporting and grantor trust

issues. The final regulations include the suggested cross-references.

Other commentators suggested that the final regulations address the

timing of deductions for contributions to the trust, the treatment of

interest earned by the trust, and other federal tax consequences of the

trust. The final regulations do not adopt these suggestions. The

regulations are limited to the classification of an environmental

remediation trust as a trust for purposes of section 7701 and do not

address or affect the timing or amount of a deduction for environmental

remediation costs. Amounts contributed to an environmental remediation

trust and interest earned on those amounts must be taken into account

under the appropriate federal tax accounting rules, including the

economic performance rules of section 461(h). Under those rules,

taxpayers generally cannot deduct contributions to the trust at the

time of contribution or deduct earnings at the time they are received

by the trust.

The proposed regulations provide that the regulations will apply to

trusts formed on or after the date of publication of final regulations.

One commentator suggested that the final regulations should be

effective, at the trustee's option, to trusts meeting the requirements

of an environmental remediation trust established prior to such date,

effective as of any date designated by the trustee. The commentator

further suggested that, with respect to amounts held in a fund,

account, or trust meeting the requirements of an environmental

remediation trust prior to the date of publication of the final

regulations, the IRS should not challenge the classification of the

fund, account, or trust as a trust for federal tax purposes.

The final regulations are effective for trusts meeting the

definition of an environmental remediation trust that are formed on or

after May 1, 1996. The final regulations may be relied on by trusts

formed before May 1, 1996, if the trust has at all times met all

requirements of the final regulations and the grantors reported items

of income and deduction consistent with the final regulations on

original or amended returns. This provision allows a trust and grantors

that have met all of the requirements of the final regulations

throughout the existence of the trust to treat the trust as an

environmental remediation trust. The final regulations also provide

that, for trusts formed before May 1, 1996, that are not described by

the preceding rule, the Commissioner may permit by letter ruling, in

appropriate circumstances, the final regulations to be applied subject

to appropriate terms and conditions.

Special Analyses

It has been determined that this Treasury decision is not a

significant regulatory action as defined in EO 12866. Therefore, a

regulatory assessment is not required. It has also been determined that

section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5)

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

these regulations, and, therefore, a Regulatory Flexibility Analysis is

not required. Pursuant to section 7805(f) of the Code, the notice of

proposed rulemaking preceding these regulations was submitted to the

Small Business Administration for comment on its impact on small

business.

Drafting Information

The principal author of these regulations is James A. Quinn of the

Office of Assistant Chief Counsel (Passthroughs and Special

Industries). However, other personnel from the IRS and Treasury

Department participated in their development.

List of Subjects

26 CFR Part 1

Income taxes, Reporting and recordkeeping requirements.

26 CFR Part 301

Employment taxes, Estate taxes, Excise taxes, Gift taxes, Income

taxes, Penalties, Reporting and recordkeeping requirements.

26 CFR Part 602

Reporting and recordkeeping requirements.

[[Page 19191]]

Amendments to the Regulations

Accordingly, 26 CFR parts 1, 301, and 602 are amended as follows:

PART 1--INCOME TAXES

Paragraph 1. The authority citation for part 1 continues to read in

part as follows:

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

Par. 2. Section 1.671-4 is amended by adding a sentence to the end

of paragraph (a) as follows:

Sec. 1.671-4 Method of reporting.

(a) * * * Section 301.7701-4(e)(2) of this chapter provides

guidance on how these reporting rules apply to an environmental

remediation trust.

* * * * *

Par. 3. Section 1.677(a)-1 is amended by adding a sentence to the

end of paragraph (d) as follows:

Sec. 1.677(a)-1 Income for benefit of grantor; general rule.

* * * * *

(d) * * * See Sec. 301.7701-4(e) of this chapter for rules on the

classification of and application of section 677 to an environmental

remediation trust.

* * * * *

PART 301--PROCEDURE AND ADMINISTRATION

Par. 4. The authority citation for part 301 continues to read as

follows:

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

Par. 5. Section 301.7701-4(e) is added to read as follows:

Sec. 301.7701-4 Trusts.

* * * * *

(e) Environmental remediation trusts. (1) An environmental

remediation trust is considered a trust for purposes of the Internal

Revenue Code. For purposes of this paragraph (e), an organization is an

environmental remediation trust if the organization is organized under

state law as a trust; the primary purpose of the trust is collecting

and disbursing amounts for environmental remediation of an existing

waste site to resolve, satisfy, mitigate, address, or prevent the

liability or potential liability of persons imposed by federal, state,

or local environmental laws; all contributors to the trust have (at the

time of contribution and thereafter) actual or potential liability or a

reasonable expectation of liability under federal, state, or local

environmental laws for environmental remediation of the waste site; and

the trust is not a qualified settlement fund within the meaning of

Sec. 1.468B-1(a) of this chapter. An environmental remediation trust is

classified as a trust because its primary purpose is environmental

remediation of an existing waste site and not the carrying on of a

profit-making business that normally would be conducted through

business organizations classified as corporations or partnerships.

However, if the remedial purpose is altered or becomes so obscured by

business or investment activities that the declared remedial purpose is

no longer controlling, the organization will no longer be classified as

a trust. For purposes of this paragraph (e), environmental remediation

includes the costs of assessing environmental conditions, remedying and

removing environmental contamination, monitoring remedial activities

and the release of substances, preventing future releases of

substances, and collecting amounts from persons liable or potentially

liable for the costs of these activities. For purposes of this

paragraph (e), persons have potential liability or a reasonable

expectation of liability under federal, state, or local environmental

laws for remediation of the existing waste site if there is authority

under a federal, state, or local law that requires or could reasonably

be expected to require such persons to satisfy all or a portion of the

costs of the environmental remediation.

(2) Each contributor (grantor) to the trust is treated as the owner

of the portion of the trust contributed by that grantor under rules

provided in section 677 and Sec. 1.677(a)-1(d) of this chapter. Section

677 and Sec. 1.677(a)-1(d) of this chapter provide rules regarding the

treatment of a grantor as the owner of a portion of a trust applied in

discharge of the grantor's legal obligation. Items of income,

deduction, and credit attributable to an environmental remediation

trust are not reported by the trust on Form 1041, but are shown on a

separate statement to be attached to that form. See Sec. 1.671-4(a) of

this chapter. The trustee must also furnish to each grantor a statement

that shows all items of income, deduction, and credit of the trust for

the grantor's taxable year attributable to the portion of the trust

treated as owned by the grantor. The statement must provide the grantor

with the information necessary to take the items into account in

computing the grantor's taxable income, including information necessary

to determine the federal tax treatment of the items (for example,

whether an item is a deductible expense under section 162(a) or a

capital expenditure under section 263(a)) and how the item should be

taken into account under the economic performance rules of section

461(h) and the regulations thereunder. See Sec. 1.461-4 of this chapter

for rules relating to economic performance.

(3) All amounts contributed to an environmental remediation trust

by a grantor (cash-out grantor) who, pursuant to an agreement with the

other grantors, contributes a fixed amount to the trust and is relieved

by the other grantors of any further obligation to make contributions

to the trust, but remains liable or potentially liable under the

applicable environmental laws, will be considered amounts contributed

for remediation. An environmental remediation trust agreement may

direct the trustee to expend amounts contributed by a cash-out grantor

(and the earnings thereon) before expending amounts contributed by

other grantors (and the earnings thereon). A cash-out grantor will

cease to be treated as an owner of a portion of the trust when the

grantor's portion is fully expended by the trust.

(4) The provisions of this paragraph (e) may be illustrated by the

following example:

Example. (a) X, Y, and Z are calendar year corporations that are

liable for the remediation of an existing waste site under

applicable federal environmental laws. On June 1, 1996, pursuant to

an agreement with the governing federal agency, X, Y, and Z create

an environmental remediation trust within the meaning of paragraph

(e)(1) of this section to collect funds contributed to the trust by

X, Y, and Z and to carry out the remediation of the waste site to

the satisfaction of the federal agency. X, Y, and Z are jointly and

severally liable under the federal environmental laws for the

remediation of the waste site, and the federal agency will not

release X, Y, or Z from liability until the waste site is remediated

to the satisfaction of the agency.

(b) The estimated cost of the remediation is $20,000,000. X, Y,

and Z agree that, if Z contributes $1,000,000 to the trust, Z will

not be required to make any additional contributions to the trust,

and X and Y will complete the remediation of the waste site and make

additional contributions if necessary.

(c) On June 1, 1996, X, Y, and Z each contribute $1,000,000 to

the trust. The trust agreement directs the trustee to spend Z's

contributions to the trust and the income allocable to Z's portion

before spending X's and Y's portions. On November 30, 1996, the

trustee disburses $2,000,000 for remediation work performed from

June 1, 1996, through September 30, 1996. For the six-month period

ending November 30, 1996, the interest earned on the funds in the

trust was $75,000, which is allocated in equal shares of $25,000 to

X's, Y's, and Z's portions of the trust.

(d) Z made no further contributions to the trust. Pursuant to

the trust agreement, the trustee expended Z's portion of the trust

before expending X's and Y's portion.

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Therefore, Z's share of the remediation disbursement made in 1996 is

$1,025,000 ($1,000,000 contribution by Z plus $25,000 of interest

allocated to Z's portion of the trust). Z takes the $1,025,000

disbursement into account under the appropriate federal tax

accounting rules. In addition, X's share of the remediation

disbursement made in 1996 is $487,500, and Y's share of the

remediation disbursement made in 1996 is $487,500. X and Y take

their respective shares of the disbursement into account under the

appropriate federal tax accounting rules.

(e) The trustee made no further remediation disbursements in

1996, and X and Y made no further contributions in 1996. From

December 1, 1996, to December 31, 1996, the interest earned on the

funds remaining in the trust was $5,000, which is allocated $2,500

to X's portion and $2,500 to Y's portion. Accordingly, for 1996, X

and Y each had interest income of $27,500 from the trust and Z had

interest income of $25,000 from the trust.

(5) This paragraph (e) is applicable to trusts meeting the

requirements of paragraph (e)(1) of this section that are formed on or

after May 1, 1996. This paragraph (e) may be relied on by trusts formed

before May 1, 1996, if the trust has at all times met all requirements

of this paragraph (e) and the grantors have reported items of ,income

and deduction consistent with this paragraph (e) on original or amended

returns. For trusts formed before May 1, 1996, that are not described

in the preceding sentence, the Commissioner may permit by letter

ruling, in appropriate circumstances, this paragraph (e) to be applied

subject to appropriate terms and conditions.

PART 602--OMB CONTROL NUMBERS UNDER THE PAPERWORK REDUCTION ACT

Par. 6. The authority citation for part 602 continues to read as

follows:

Authority: 26 U.S.C. 7805.

Sec. 602.101 [Amended]

Par. 7. In Sec. 602.101, paragraph (c) is amended by adding the

entry ``301.7701-4 . . . . 1545-1465'' in numerical order to the table.

Margaret Milner Richardson,

Commissioner of Internal Revenue.

Approved: April 5, 1996.

Leslie Samuels,

Assistant Secretary of the Treasury.

[FR Doc. 96-10544 Filed 4-30-96; 8:45 am]

BILLING CODE 4830-01-P