Escrow Funds and Other Similar Funds

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-209619-93]

RIN 1545-AR82

Escrow Funds and Other Similar Funds

AGENCY: Internal Revenue Service (IRS), Treasury.

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

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SUMMARY: This document contains proposed regulations relating to the

designation of the person required to report the income earned on

qualified settlement funds and certain other funds, trusts, and escrow

accounts, and other related rules. The proposed regulations would

affect qualified settlement funds, qualified escrow accounts and

qualified trusts established in connection with deferred like-kind

exchanges, escrow accounts established in connection with sales of

property, disputed ownership funds, and parties to these escrow

accounts, trusts, and funds. This document also provides notice of a

public hearing on these proposed regulations.

DATES: Written comments must be received by May 3, 1999. Requests to

speak and outlines of topics to be discussed at the public hearing

scheduled for May 12, 1999, at 10 a.m., must be received by April 21,

1999.

ADDRESSES: Send submissions to: CC:DOM:CORP:R (REG-209619-93), 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-

209619-93), 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, Washington, DC.

FOR FURTHER INFORMATION CONTACT: Concerning the regulations, Michael L.

Gompertz of the Office of Assistant Chief Counsel (Income Tax &

Accounting), (202) 622-4910; concerning submissions of comments, the

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

hearing, Michael Slaughter, (202) 622-7190 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

The 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 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 collections of information should be received by

April 2, 1999. Comments are specifically requested concerning:

Whether the proposed collections of information are 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

collections 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 collections 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 service to provide information.

The collections of information in this proposed regulation are in

Secs. 1.468B-

[[Page 4802]]

1(k)(2), 1.468B-1(k)(3)(iv), 1.468B-6(e)(1), 1.468B-6(f), 1.468B-7(d),

1.468B-8(f), 1.468B-8(g)(1), 1.468B-9(c)(1), and 1.468B-9(f)(3).

The collections of information in Secs. 1.468B-1(k)(3)(iv), 1.468B-

6(e)(1), 1.468B-7(d), 1.468B-8(g)(1), and 1.468B-9(c)(1) are satisfied

by including the required information on Forms 1099, 1041, 1120, or

1120-SF. The burden for these requirements is reflected in the burden

estimates for these forms.

The other collections of information in this proposed regulation

(in Secs. 1.468B-1(k)(2), 1.468B-6(f), 1.468B-8(f), and 1.468B-9(f)(3))

are discussed below.

The collection of information in Sec. 1.468B-1(k)(2) is an election

statement attached to a tax return filed for a qualified settlement

fund (QSF). The statement notifies the IRS that the transferor to the

QSF has elected grantor trust treatment for the QSF. This collection is

required to obtain a benefit.

The collections of information in Secs. 1.468B-6(f) and 1.468B-8(f)

are statements that third parties must provide to an escrow holder,

trustee, or administrator to enable the escrow holder, trustee, or

administrator to properly report the income of an escrow account or

trust on Form 1099. These collections are mandatory.

The collection of information in Sec. 1.468B-9(f)(3) is a statement

that a transferor must provide with respect to the transfer of cash or

property to a disputed ownership fund. This collection is mandatory.

The likely respondents are individuals, business or other for-

profit institutions, small businesses or organizations, nonprofit

institutions, and government entities.

Estimated total annual reporting burden: 4,650 hours.

Estimated average annual burden per respondent: .5 hours.

Estimated number of respondents: 9,300.

Estimated annual frequency of responses: on occasion.

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 and 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

This notice contains proposed amendments to the Income Tax

Regulations (26 CFR part 1) under section 468B of the Internal Revenue

Code. Section 468B was added to the Code by section 1807(a)(7)(A) of

the Tax Reform Act of 1986 (Public Law 99-514, 100 Stat. 2814) and was

amended by section 1018(f) of the Technical and Miscellaneous Revenue

Act of 1988 (Public Law 100-647, 102 Stat. 3582). Section 468B(g)

provides that nothing in any provision of law shall be construed as

providing that an escrow account, settlement fund, or similar fund is

not subject to current income tax. Section 468B(g) further provides

that the Secretary shall prescribe regulations providing for the

taxation of any such account or fund whether as a grantor trust or

otherwise.

On December 23, 1992, final regulations (TD 8459) under section

468B(g) were published in the Federal Register (57 FR 60983). The

regulations provide guidance concerning qualified settlement funds, but

do not address other types of funds, escrow accounts, or trusts subject

to current taxation under section 468B(g).

Section 1.468B-1(c) defines a qualified settlement fund (QSF) as a

fund, account, or trust meeting three requirements. A QSF is a separate

taxpayer subject to tax on its modified gross income. QSF

classification is not elective. The preamble to the QSF regulations

(see 1993-1 C.B. 69) states that the IRS and the Treasury Department

rejected an elective approach because it would result in inconsistent

tax treatment for similar funds, claimants, or transferors, and

accompanying complexity.

The preamble to the QSF regulations also states (see 1993-1 C.B.

73) that future regulations will address the tax treatment of funds,

accounts, or trusts other than QSFs, specifically, escrow accounts used

in the sale of property and section 1031 qualified escrow accounts.

Section 1031(a)(3) was added to the Internal Revenue Code by

section 77 of the Tax Reform Act of 1984 (Public Law 98-369, 98 Stat.

595). On May 1, 1991, final regulations (TD 8346) under section

1031(a)(3) were published in the Federal Register (56 FR 19933). These

regulations were amended by final regulations (TD 8535) published in

the Federal Register for April 20, 1994 (59 FR 18747). The regulations

provide four safe harbors, the use of any of which will result in a

determination that the taxpayer (i.e., the party transferring the

property in the exchange) is not in actual or constructive receipt of

money or other property for purposes of section 1031. In particular,

the regulations provide that the taxpayer is not in actual or

constructive receipt of money or other property held in a qualified

escrow account or qualified trust. Section 1.1031(k)-1(g)(3) defines

qualified escrow account and qualified trust.

The regulations under section 1031(a)(3) do not address the

taxation of income earned on a qualified escrow or qualified trust. The

preamble to these regulations (see 1991-1 C.B. 154) states that this

issue will be addressed in future regulations.

Explanation of Provisions

1. Election To Treat a QSF as a Grantor Trust Under Sec. 1.468B-1(k) of

the Proposed Regulations

The proposed regulations provide that if there is only one

transferor to a QSF, the transferor is allowed to make an election that

results in the QSF being treated as a grantor trust all of which is

treated as owned by the transferor. In general, the election is made on

a statement attached to the first Form 1041 filed on behalf of the QSF.

The transferor may make a grantor trust election whether or not the

requirements are otherwise satisfied for classification of the QSF as a

grantor trust.

In general, grantor trust treatment for a QSF is available under

the proposed regulations only if the QSF is established after the date

final regulations are published in the Federal Register. However, the

proposed regulations provide a narrow exception applicable to any QSF

established by the U.S. government on or before the date final

regulations are published if the QSF would otherwise have been

classified as a grantor trust in the absence of the QSF regulations

(see Rev. Rul. 77-230 (1977-2 C.B. 214)). Under the exception, such a

QSF will be automatically treated as a grantor trust for all taxable

years and a grantor trust election is thus unnecessary. If a QSF is

established after the date final regulations are published, a grantor

trust election will be required in order for the QSF to be treated as a

grantor trust. This rule applies whether or not the U.S. government is

the grantor.

2. Section 1031 Qualified Escrow Accounts and Qualified Trusts Under

Sec. 1.468B-6 of the Proposed Regulations

In general, the proposed regulations treat the assets of a

qualified escrow account or qualified trust established in connection

with a deferred exchange

[[Page 4803]]

under section 1031(a)(3) as owned by the taxpayer, i.e., the party that

transfers the relinquished property. Thus, the taxpayer is taxable on

the income earned on these assets. However, if the transferee or the

qualified intermediary has all the beneficial use and enjoyment of the

assets of a qualified escrow account or qualified trust, then the

assets of the escrow account or trust are treated as owned by the

transferee or qualified intermediary, and the income earned on the

assets is taxable to the transferee or qualified intermediary.

Further, the proposed regulations require the escrow holder of a

qualified escrow account or trustee of a qualified trust to report the

income of the escrow account or trust on Forms 1099 to the extent the

information reporting provisions of the Code otherwise require the

filing of Forms 1099. In general, the taxpayer is treated as the payee

of the income of the escrow account or trust unless the parties to the

transaction provide a statement to the escrow holder or trustee

indicating that the transferee or qualified intermediary is the payee.

Such a statement must be provided if the transferee or qualified

intermediary has all the beneficial use and enjoyment of the assets of

the escrow account or trust.

The proposed regulations provide that the escrow holder or trustee

is not liable for penalties under sections 6721 and 6722 if the escrow

holder or trustee relies on an incorrect statement provided to the

escrow holder or trustee (see above) or relies on the parties' failure

to provide such a statement.

The proposed regulations also provide that if the transferee or the

qualified intermediary has all the beneficial use and enjoyment of the

assets of a qualified escrow account or trust, the deferred exchange

may involve a below-market loan of these assets from the taxpayer to

the transferee or qualified intermediary subject to the provisions of

section 7872.

3. Pre-closing Escrows Under Sec. 1.468B-7 of the Proposed Regulations

A pre-closing escrow is an escrow account, trust, or fund that

satisfies five requirements. First, it must be established in

connection with a sale or exchange of real or personal property.

Second, it must be funded with a down payment, earnest money, or

similar payment prior to the sale or exchange of the property (as

determined for federal income tax purposes). Third, its assets must be

used to secure the purchaser's obligation to pay the purchase price (in

the case of an exchange of property, the term purchaser means the

transferee of the property and the term purchase price means the

required consideration for the property). Fourth, its assets (including

income earned thereon) must be paid to the purchaser or otherwise used

for the purchaser's benefit, for example, as a credit against the

purchase price. Fifth, it must not be a qualified escrow or qualified

trust established in connection with a deferred section 1031 exchange.

The proposed regulations treat the assets of a pre-closing escrow

as owned by the purchaser for federal income tax purposes. Thus, the

income earned on the assets is taxable to the purchaser. The escrow

holder, trustee, or other person responsible for administering a pre-

closing escrow must report the income of the escrow on Forms 1099 to

the extent the information reporting provisions of the Code otherwise

require the filing of Forms 1099.

4. Contingent At-closing Escrows Under Sec. 1.468B-8 of the Proposed

Regulations

The proposed regulations provide rules for taxing the income of a

contingent at-closing escrow, which is an escrow account, trust, or

fund satisfying three requirements. First, a contingent at-closing

escrow must be established in connection with the sale or exchange of

real or personal property used in a trade or business or held for

investment (other than an exchange to which section 354, 355, or 356

applies). Second, the assets of the escrow must be distributable to the

purchaser or seller based on bona fide contingencies that will be

resolved after the sale or exchange (as determined for federal income

tax purposes). (If a contingent at-closing escrow is established in

connection with an exchange of property, rather than a sale, the term

purchaser refers to the transferee of the property and the term seller

refers to the transferor of the property.) Thus, for example, the

agreement between the parties may provide that all or a portion of the

assets of the escrow are distributable to the purchaser if specified

liabilities associated with the property arise within a specified

period of time after closing or if certain earnings targets are not met

by a specified date. Third, the escrow must not be a qualified escrow

account or qualified trust established in connection with a deferred

section 1031 exchange.

Prior to the date (called the determination date) on which the

specified events occur or fail to occur, thereby fixing the amounts

payable from the escrow to the purchaser and seller, the proposed

regulations provide that the assets of the escrow are treated as owned

by the purchaser, and the income earned on the assets is thus taxable

to the purchaser.

Beginning on the determination date, the proposed regulations

provide that the purchaser and the seller are taxable on the income of

the escrow corresponding to their respective ownership interests in

each asset of the escrow. Further, the proposed regulations require the

purchaser and seller to provide the escrow holder, trustee, or other

administrator of the escrow with a statement within 30 days of the

determination date indicating what these ownership interests are. Also,

the escrow holder, trustee, or other administrator is required to

prepare Forms 1099 to report the income of a contingent at-closing

escrow to the extent the information reporting provisions of the Code

otherwise require the filing of Forms 1099.

In preparing the Forms 1099, the escrow holder, trustee, or other

administrator may rely on the statement (discussed above) provided to

the administrator within 30 days of the determination date. Also, if

the statement is not provided, the escrow holder, trustee, or other

administrator may rely on the parties' failure to provide a statement

and continue to treat the purchaser as the owner. The administrator's

ability to rely on a statement, or its absence, protects the

administrator from liability for penalties under sections 6721 and

6722.

5. Disputed Ownership Funds Under Sec. 1.468B-9 of the Proposed

Regulations

A disputed ownership fund (DOF) is an escrow account, trust, or

fund other than a QSF that satisfies three requirements. First, a DOF

must be established to hold money or property subject to conflicting

claims of ownership. Second, a DOF must be subject to the continuing

jurisdiction of a court of law or equity. Third, money or property

cannot be paid or distributed from a DOF to a claimant without court

approval. An interpleader fund may qualify as a DOF.

In general, a DOF is taxed under the proposed regulations as if it

were a qualified settlement fund if all the DOF's assets are passive

investment assets, for example, cash or cash equivalents, stock, and

debt obligations. However, if the DOF holds assets other than passive

investment assets (for example, real estate or business property the

ownership of which is in dispute), the DOF is taxed as if it were a C

corporation. The claimants to the fund may, however, submit a letter

ruling request proposing an alternative method of taxation if they

believe that

[[Page 4804]]

there is a more appropriate method of taxing a DOF than under the rules

stated above.

In addition to providing rules for the taxation of the income of a

DOF, the proposed regulations also provide rules concerning the

transfer of property to and from a DOF. In particular, a transfer of

property to a DOF is not a sale or other disposition by the transferor

under section 1001(a) if the transferor claims ownership of the

transferred property. Also, a DOF is not allowed a deduction for a

distribution of disputed property to a claimant and the distribution is

not a taxable event to the DOF.

6. Request for Comments

Comments are requested on the appropriate tax treatment of a fund,

account, or trust that meets the requirements for more than one type of

entity subject to the proposed regulations. Comments are also requested

on the appropriate tax treatment of a fund, account, or trust that

changes over time so that a different portion of the proposed

regulations would apply to it. For example, an escrow initially may

meet the requirements for a contingent at-closing escrow, but may

subsequently satisfy the requirements for a DOF. This could occur if a

dispute were to arise between the purchaser and the seller concerning

their respective interests in the escrow after the determination date

and the administrator of the DOF files an interpleader action to

resolve the dispute.

Comments are also requested concerning the appropriate tax

treatment of a contingent-at-closing escrow if multiple contingencies

are specified in the agreement between the purchaser and the seller.

The proposed regulations provide that (1) the income of a contingent

at-closing escrow is taxable entirely to the purchaser prior to the

determination date, and (2) the determination date is the date on which

(or by which) the last of the contingent events has either occurred or

failed to occur. Therefore, if multiple contingencies are provided for

in the agreement between the parties and some, but not all, of the

contingencies have been resolved, the proposed regulations provide that

the income of the escrow is taxable entirely to the purchaser (because

the determination date has not yet occurred) regardless of the effect

of the contingencies that have been resolved. The purchaser is thus

taxed on all the income earned on the escrow even though it may be

known (based on the resolution of one or more contingencies) that a

fixed portion of the escrowed assets will be distributed to the seller.

The proposed rule is simple and easy to administer because it treats

the escrow in a unitary manner and avoids the need for multiple

determination dates. Arguably, however, a more complex approach should

be adopted involving a separate determination date for each

contingency. Under the more complex approach, as each contingency is

resolved, a new determination would be made concerning the taxation of

the fund's income. The income earned on the fund's assets would be

taxable to the purchaser and seller in accordance with their ownership

interests as determined on each determination date as each separate

contingency is resolved.

Comments are also requested on the requirement that the assets of a

contingent at-closing escrow must be distributable to the purchaser or

seller based on bona fide contingencies that are resolved after the

sale or exchange. Issues may arise as to whether a particular

contingency is bona fide in at least two ways: whether the outcome is

sufficiently in doubt and whether the effect of the outcome on the fund

is significant. A contingency may not be bona fide if the parties can

reasonably be expected to know the outcome, e.g., a contingency based

on whether, in ten years, the consumer price index will be at least

equal to the consumer price index today. In addition, a contingency may

not be bona fide if the effect on the fund is minimal even though the

outcome is uncertain.

Finally, comments are requested regarding whether there are other

types of funds for which rules under section 468B are required.

7. Proposed Effective Date

In general, the regulations are proposed to be applicable for QSFs,

qualified escrow accounts and qualified trusts, pre-closing escrows,

contingent at-closing escrows, and DOFs established after the date

final regulations are published in the Federal Register. However, the

proposed regulations contain transition rules.

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. 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. An initial regulatory flexibility analysis has been prepared

for the collections of information contained in this notice of proposed

rulemaking under 5 U.S.C. 603. The analysis is set forth below.

Initial Regulatory Flexibility Act Analysis

The objective of the proposed regulations is to ensure that the

income of certain escrow accounts, trusts, and funds is subject to

current taxation by identifying the proper party or parties subject to

tax and by requiring appropriate information reporting for the income

of the escrow account, trust, or fund. Section 468B(g) provides the

legal basis for the requirements of the proposed regulations. The IRS

and Treasury Department are not aware of any federal rules that may

duplicate, overlap, or conflict with the proposed regulations.

An explanation is provided below of the burdens on small entities

resulting from the requirements of the proposed regulations. Also, a

description is provided of alternative rules that were considered by

the IRS and the Treasury Department but rejected as too burdensome.

1. Grantor Trust Election Under Sec. 1.468B-1(k)

Under Sec. 1.468B-1(k), the transferor to a QSF may elect to have

the QSF treated as a grantor trust all of which is treated as owned by

the transferor (grantor trust election). If the transferor makes the

grantor trust election, the administrator of the QSF must file Form

1041 rather than the QSF income tax return, Form 1120-SF.

Approximately 900 QSF returns are filed each year. Only a small

number of these returns are filed for newly created QSFs. Because a

grantor trust election may be made only for the year in which a QSF is

established, and may only be made for a QSF that has one transferor,

the IRS and Treasury Department believe that a very small number of

grantor trust elections will be made each year.

Because of the availability of the grantor trust election, the

proposed regulations provide a choice of filing Form 1041 or Form 1120-

SF in certain situations. Small entities may choose the filing

requirement that is less burdensome.

The alternative to the proposed regulations is to retain the

current rules for QSFs and not provide qualifying taxpayers with the

opportunity to make a grantor trust election.

[[Page 4805]]

2. Qualified Escrow Accounts and Qualified Trusts Established in

Connection With Deferred Exchanges; Pre-closing Escrows; and Contingent

At-Closing Escrows

Sections 1.468B-6(e)(1), 1.468B-7(d), and 1.468B-8(g)(1) require

specified escrow holders, trustees, and administrators to file Forms

1099 with the IRS and furnish payee statements in accordance with the

information reporting requirements of subpart B, Part III, subchapter

A, chapter 61, Subtitle F of the Internal Revenue Code.

Also, Sec. 1.468B-6(f) requires the parties to a qualified escrow

account or qualified trust to provide a statement to the escrow holder

or trustee if the qualified intermediary or transferee has all the

beneficial use and enjoyment of the assets of the escrow account or

trust. This statement facilitates the filing of Forms 1099 by the

escrow holder or trustee.

Similarly, Sec. 1.468B-8(f) requires the parties to a contingent

at-closing escrow to provide statements to the escrow holder or other

administrator. These statements facilitate the filing of Forms 1099 by

the escrow holder or other administrator.

The IRS and Treasury Department estimate that annually there are

approximately 16,000 deferred exchange transactions involving the

creation of a qualified escrow account or qualified trust;

approximately 200,000 transactions involving the creation of a pre-

closing escrow; and approximately 10,000 transactions involving the

creation of a contingent at-closing escrow.

As an alternative to the proposed regulations, the IRS and the

Treasury Department considered, but rejected as too burdensome, a rule

that would have required the filing of grantor trust returns (Form

1041) for qualified escrow accounts and qualified trusts, pre-closing

escrows, and contingent at-closing escrows. Instead of requiring

grantor trust returns, the proposed regulations require the filing of

Forms 1099. This is less burdensome on small entities because, unlike

Form 1041, Form 1099 is simple, does not require a signature, and

requires only the reporting of gross income.

Further, the IRS and the Treasury Department considered an

alternative rule for contingent at-closing escrows under which the

income of the escrow for the period before the determination date would

have been taxable to the purchaser or the seller depending on the

required tax treatment by the purchaser and seller of the principal

amount deposited into the escrow. This alternative rule would not have

provided certainty, would have required a difficult legal analysis

(namely, the determination of the required tax treatment of the

principal amount deposited into the escrow), and would have required

the purchaser and seller to provide a signed statement to the

administrator of the escrow identifying the party to whom the

administrator should report the income for the period before the

determination date. Under the proposed regulations, the income of the

escrow is always taxable to the purchaser for the period before the

determination date, thereby eliminating the need for a signed statement

to be provided to the administrator and the need to determine the

required tax treatment of the principal amount deposited into the

escrow. This rule is simpler than the alternative.

3. Disputed Ownership Funds (DOFs)

Section 1.468B-9(c)(1) of the proposed regulations generally

provides that a DOF is taxable as a QSF if all its assets are passive

investment assets or taxable as a C corporation in all other cases.

However, the regulations also provide that if there is a more

appropriate method of taxing a DOF, the claimants to the fund may

request a private letter ruling to permit the use of that method.

Section 1.468B-9(f)(3) of the proposed regulations requires that a

transferor provide a statement to the administrator of a DOF that

itemizes the cash or property transferred to the DOF during the

calendar year. The statement must also indicate the DOF's basis and

holding period in the property.

The IRS and the Treasury Department estimate that annually there

are approximately 5,000 transactions involving the creation of a

disputed ownership fund.

As an alternative to the proposed regulations, the IRS and the

Treasury Department considered, but rejected as too burdensome, a rule

that would have required all DOFs to file corporate income tax returns

(Form 1120) regardless of the nature of the assets held by the DOF.

This alternative was rejected because it was concluded that a QSF

return (Form 1120-SF) is more appropriate than a corporate income tax

return if all the assets of the DOF are passive investment assets. The

proposed regulations thus impose less of an administrative burden on

small entities than would have resulted from the alternative rule as

Form 1120-SF is generally easier to prepare than Form 1120. Only DOFs

that hold assets other than passive investment assets will be required

to file Form 1120 under the proposed regulations. In addition, the

proposed regulations provide taxpayers with the additional flexibility

of being able to request an alternative method of taxation if that

method is more appropriate than QSF or C corporation treatment as

provided under the general rule.

There are no known alternative rules that are less burdensome to

small entities but that accomplish the purpose of the statute. The IRS

and Treasury Department request comments from small entities concerning

possible alternatives to these rules.

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) or electronic comments that are submitted timely

(in the manner described in the ADDRESSES portion of the preamble) to

the IRS. The IRS and Treasury Department request comments on the

clarity of the proposed rules and how they can be made easier to

understand. All comments will be available for public inspection and

copying.

A public hearing is scheduled for May 12, 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 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) apply to the hearing.

Persons who wish to present oral comments at the hearing must

submit written comments by May 3, 1999 and submit an outline of the

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

original and eight (8) copies) by April 21, 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.

[[Page 4806]]

Drafting Information

The principal author of these proposed regulations is Michael L.

Gompertz of the Office of Assistant Chief Counsel (Income Tax and

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

Department participated in their development.

List of Subjects in 26 CFR Part 1

Income taxes, Reporting and recordkeeping requirements.

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

entries in numerical order to read as follows:

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

Sec. 1.468B-6 also issued under 26 U.S.C. 468B.

Sec. 1.468B-7 also issued under 26 U.S.C. 468B.

Sec. 1.468B-8 also issued under 26 U.S.C. 468B.

Sec. 1.468B-9 also issued under 26 U.S.C. 468B. * * *

Par. 2. Section 1.468B-0 is amended as follows:

1. The introductory text is revised.

2. The entry for Sec. 1.468B-1, paragraph (k), is redesignated as

paragraph (l).

3. A new entry for Sec. 1.468B-1, paragraph (k), is added.

4. The section heading in the entry for Sec. 1.468B-5 is revised.

5. New entries are added for Secs. 1.468B-5, paragraph (c), 1.468B-

6, 1.468B-7, 1.468B-8, and 1.468B-9.

6. The revised and added provisions read as follows:

Sec. 1.468B-0 Table of contents.

This section lists the table of contents for Secs. 1.468B-1 through

1.468B-9.

Sec. 1.468B-1 Qualified settlement funds.

* * * * *

(k) Election to treat a qualified settlement fund as a subpart E

trust.

(1) In general.

(2) Manner of making grantor trust election.

(i) In general.

(ii) Requirements for election statement.

(3) Effect of making the election.

* * * * *

Sec. 1.468B-5 Effective dates and transition rules applicable to

qualified settlement funds.

* * * * *

(c) Grantor trust elections under Sec. 1.468B-1(k).

(1) In general.

(2) Qualified settlement funds established by the U.S.

government on or before the date of publication of final regulations

in the Federal Register.

Sec. 1.468B-6 Qualified escrow accounts and qualified trusts used

in deferred exchanges of like-kind property under section

1031(a)(3).

(a) Scope.

(b) Definitions.

(c) Income of qualified escrow account or qualified trust.

(1) In general.

(2) Transferee or qualified intermediary has all the beneficial

use and enjoyment of assets of a qualified escrow account or

qualified trust.

(d) Application of section 7872.

(e) Reporting obligations of the escrow holder or trustee.

(1) In general.

(2) Person treated as payee.

(3) Relief from penalties for filing incorrect information

return or payee statement.

(f) Statement provided to escrow holder or trustee.

(g) Effective date.

(1) In general.

(2) Transition rule.

(h) Examples.

Sec. 1.468B-7 Pre-closing escrows.

(a) Scope.

(b) Definition.

(c) Taxation of pre-closing escrows.

(d) Reporting obligations of the administrator.

(e) Effective date.

(1) In general.

(2) Transition rule.

(f) Example.

Sec. 1.468B-8 Contingent at-closing escrows.

(a) Scope.

(b) Definitions.

(c) Tax liability of purchaser and seller for the period prior

to the determination date.

(d) Transfer of interest in the assets of the escrow on the

determination date.

(e) Tax liability of purchaser and seller for the period

beginning on the determination date.

(f) Statement required to be provided to administrator within 30

days after the determination date.

(g) Reporting obligations of the administrator.

(1) In general.

(2) Person treated as payee.

(3) Relief from penalties for filing incorrect information

return or payee statement.

(h) Effective date.

(1) In general.

(2) Transition rule.

(i) [Reserved]

(j) Example.

Sec. 1.468B-9 Disputed ownership funds.

(a) In general.

(b) Definitions.

(c) Taxation of a disputed ownership fund.

(1) In general.

(2) Exception.

(3) Special rules.

(d) Basis of property held by a disputed ownership fund.

(e) Request for prompt assessment.

(f) Rules applicable to the transferor.

(1) Transfer of property.

(i) In general.

(ii) Exceptions.

(2) Economic performance.

(i) In general.

(ii) Obligations of the transferor.

(3) Statement to the disputed ownership fund and the Internal

Revenue Service.

(i) In general.

(ii) Information required on statement.

(A) In general.

(B) Combined statements.

(4) Distributions to transferors.

(i) In general.

(ii) Exception.

(iii) Deemed distributions.

(g) Distribution to a claimant other than a transferor.

(h) Effective date.

(1) In general.

(2) Transition rule.

(i) [Reserved].

(j) Examples.

Par. 3. Section 1.468B-1 is amended by redesignating paragraph (k)

as paragraph (l) and adding a new paragraph (k) to read as follows:

Sec. 1.468B-1 Qualified settlement funds.

* * * * *

(k) Election to treat a qualified settlement fund as a subpart E

trust--(1) In general. If a qualified settlement fund has only one

transferor (see paragraph (d)(1) of this section for the definition of

transferor), the transferor may make an irrevocable election (grantor

trust election) to treat the qualified settlement fund as a trust all

of which is treated as owned by the transferor under section 671 and

the regulations thereunder. A grantor trust election may be made

whether or not the qualified settlement fund would be classified, in

the absence of paragraph (b) of this section, as a trust all of which

is treated as owned by the transferor under section 671 and the

regulations thereunder.

(2) Manner of making grantor trust election--(i) In general. To

make a grantor trust election, a transferor must attach an election

statement satisfying the requirements of paragraph (k)(2)(ii) of this

section to a timely filed (including extensions) Form 1041 that the

administrator files on behalf of the qualified settlement fund for the

taxable year in which the qualified settlement fund is established.

However, if a Form 1041 would not otherwise be required to be filed

(for example, because the provisions of Sec. 1.671-4(b) are

applicable), then the transferor makes a grantor trust election by

attaching an election statement satisfying the requirements of

paragraph (k)(2)(ii) of this section to a timely filed (including

extensions) income tax return of the transferor for the taxable year in

which the qualified settlement fund is established.

[[Page 4807]]

(ii) Requirements for election statement. The election statement

must include a statement by the transferor that the transferor will

treat the qualified settlement fund as a grantor trust. The election

statement must also include the transferor's name, signature, address,

taxpayer identification number, and the legend, ``Sec. 1.468B-1(k)

Election''. The election statement and the statement described in

Sec. 1.671-4(a) may be combined into a single statement.

(3) Effect of making the election. If a grantor trust election is

made--

(i) Paragraph (b) of this section, and Secs. 1.468B-2, 1.468B-3,

and 1.468B-5 do not apply to the qualified settlement fund. However,

this section (except for paragraph (b) of this section) and

Sec. 1.468B-4 apply to the qualified settlement fund;

(ii) The qualified settlement fund is treated for federal income

tax purposes as a trust all of which is treated as owned by the

transferor under section 671 and the regulations thereunder;

(iii) The transferor must take into account in computing the

transferor's income tax liability all items of income, deduction, and

credit (including capital gains and losses) of the qualified settlement

fund in accordance with Sec. 1.671-3(a)(1); and

(iv) The reporting obligations imposed by Sec. 1.671-4 on the

trustee of a trust apply to the administrator.

* * * * *

Par. 4. Section 1.468B-5 is amended by revising the section heading

and adding paragraph (c) to read as follows:

Sec. 1.468B-5 Effective dates and transition rules applicable to

qualified settlement funds.

* * * * *

(c) Grantor trust elections under Sec. 1.468B-1(k)--(1) In general.

A transferor may make a grantor trust election under Sec. 1.468B-1(k)

only if the qualified settlement fund is established after the date of

publication of final regulations in the Federal Register.

(2) Qualified settlement funds established by the U.S. government

on or before the date of publication of final regulations in the

Federal Register. If the U.S. government, or any agency or

instrumentality thereof, establishes a qualified settlement fund on or

before the date of publication of final regulations in the Federal

Register, and the fund would have been classified as a trust all of

which is treated as owned by the U.S. government under section 671 and

the regulations thereunder without regard to the regulations under

section 468B, then the U.S. government is deemed to have made a grantor

trust election under Sec. 1.468B-1(k), and the election is effective

for all taxable years of the fund.

Par. 5. Sections 1.468B-6 through 1.468B-9 are added to read as

follows:

Sec. 1.468B-6 Qualified escrow accounts and qualified trusts used in

deferred exchanges of like-kind property under section 1031(a)(3).

(a) Scope. This section provides rules under section 468B(g)

relating to the current taxation of income of a qualified escrow

account or qualified trust established in connection with a deferred

exchange under section 1031(a)(3).

(b) Definitions. As used in this section, deferred exchange,

relinquished property, replacement property, qualified escrow account,

qualified trust, qualified intermediary, exchange period, and escrow

holder have the same meanings as in Sec. 1.1031(k)-1. Also, as used in

this section, taxpayer means the transferor of the relinquished

property, and transferee means the person who is treated as owning the

relinquished property for federal income tax purposes after its

transfer by the taxpayer. Further, owner means the person treated as

owning the assets of the qualified escrow account or qualified trust

under paragraph (c) of this section.

(c) Income of qualified escrow account or qualified trust--(1) In

general. Except as otherwise provided in paragraph (c)(2) of this

section, and except for purposes of determining whether a transaction

qualifies as a deferred exchange, the taxpayer is the owner. Thus, the

taxpayer must take into account in computing the taxpayer's income tax

liability all items of income, deduction, and credit (including capital

gains and losses) of the qualified escrow account or qualified trust.

(2) Transferee or qualified intermediary has all the beneficial use

and enjoyment of assets of a qualified escrow account or qualified

trust. If the transferee or the qualified intermediary has all the

beneficial use and enjoyment of assets of a qualified escrow account or

qualified trust, the transferee or qualified intermediary is the owner.

Thus, the transferee or qualified intermediary must take into account

in computing its income tax liability all items of income, deduction,

and credit (including capital gains and losses) of the account or

trust. The following factors, and other relevant facts and

circumstances in a particular case, will be considered in determining

whether the transferee or the qualified intermediary, rather than the

taxpayer, has the beneficial use and enjoyment of assets of an account

or trust and thus is the owner--

(i) Which person enjoys the use of the earnings of the account or

trust;

(ii) Which person receives the benefit from appreciation, if any,

in the value of the assets of the account or trust; and

(iii) Which person is subject to a risk of loss from a decline, if

any, in the value of the assets of the account or trust.

(d) Application of section 7872. If the transferee or the qualified

intermediary is the owner under paragraph (c)(2) of this section,

section 7872 may apply if the deferred exchange involves a below-market

loan from the taxpayer to the owner. See section 7872(c)(1) for the

loans to which section 7872 applies.

(e) Reporting obligations of the escrow holder or trustee-- (1) In

general. The escrow holder of a qualified escrow account and the

trustee of a qualified trust must, for each calendar year (or portion

thereof) that the account or trust is in existence, report the income

of the account or trust on Forms 1099 in accordance with the

information reporting requirements of subpart B, Part III, subchapter

A, chapter 61, Subtitle F of the Internal Revenue Code. The Forms 1099

must show the escrow holder or trustee as the payor and must show the

proper payee. See paragraph (e)(2) of this section for the

determination of the proper payee.

(2) Person treated as payee. In satisfying the reporting

obligations of paragraph (e)(1) of this section, the following rules

apply to the escrow holder of a qualified escrow account and the

trustee of a qualified trust--

(i) If no written statement described in paragraph (f) of this

section is provided to the escrow holder or trustee, the escrow holder

or trustee must treat the taxpayer as the owner and the payee of the

income of the account or trust; and

(ii) If a written statement described in paragraph (f) of this

section is provided to the escrow holder or trustee, the escrow holder

or trustee must treat the person specified on the statement (see

paragraph (f)(3) of this section) as the owner and the payee of the

income of the account or trust.

(3) Relief from penalties for filing incorrect information return

or payee statement. For purposes of sections 6721 and 6722, the escrow

holder of a qualified escrow account or trustee of a qualified trust

will not be treated as failing to file or furnish a correct information

return or payee statement solely because, in preparing a Form 1099, the

escrow holder or trustee relies on a statement described in paragraph

(f) of this section and therefore treats the

[[Page 4808]]

person specified on the statement (see paragraph (f)(3) of this

section) as the owner and the payee of the income of the account or

trust. If a statement described in paragraph (f) of this section is not

provided to the escrow holder or trustee, the escrow holder or trustee

will not be treated as failing to file or furnish a correct information

return or payee statement solely because, in preparing a Form 1099, the

escrow holder or trustee relies on the absence of the statement and

therefore treats the taxpayer as the owner and the payee of the income

of the account or trust.

(f) Statement provided to escrow holder or trustee. If under

paragraph (c)(2) of this section, the qualified intermediary or

transferee is the owner, the taxpayer and the owner must furnish to the

escrow holder or trustee a statement that--

(1) Is signed by the taxpayer and the owner;

(2) Is furnished to the escrow holder or trustee within 30 days

after the taxpayer transfers the relinquished property; and

(3) Specifies the person treated as the owner and thus as the payee

of the income of the account or trust.

(g) Effective date--(1) In general. This section applies to

qualified escrow accounts and qualified trusts established after the

date of publication of final regulations in the Federal Register.

(2) Transition rule. With respect to a qualified escrow account or

qualified trust established after August 16, 1986, but on or before the

date of publication of final regulations in the Federal Register, the

Internal Revenue Service will not challenge a reasonable, consistently

applied method of taxation for income earned by the account or trust.

The Internal Revenue Service will also not challenge a reasonable,

consistently applied method for reporting such income.

(h) Examples. The provisions of this section may be illustrated by

the following examples in which T is the taxpayer, B is the transferee,

and QI is the qualified intermediary:

Example 1. (i) T uses the calendar year as the taxable year and

the cash receipts and disbursements method of accounting. T enters

into a deferred exchange agreement with B. Under the agreement, T

will transfer property (the relinquished property) to B, and B must

transfer to T within the exchange period consideration (cash or

replacement property or both) having the same market value as that

of the relinquished property. B's obligations under the agreement

are secured by the assets of a qualified escrow account. The

deferred exchange does not involve the use of a qualified

intermediary.

(ii) Under the agreement, B must deposit cash into the qualified

escrow account equal to the agreed upon fair market value of the

relinquished property on the date the property is transferred to B.

The agreement provides that the cash deposited into the escrow

account must be invested in a money market fund.

(iii) The agreement provides that B is entitled to receive the

interest earned on the escrow account in consideration for B's

performance of services in connection with the exchange.

(iv) On September 1, 1999, T transfers the relinquished property

to B. The property is unencumbered and has a fair market value of

$100,000 on September 1, 1999. B deposits $100,000 into a qualified

escrow account. The $100,000 is invested in accordance with the

exchange agreement in a money market fund. During 1999, $2,000 of

interest is earned on the escrow account. During January 2000, an

additional $400 of interest is earned on the escrow account. On

February 1, 2000, B uses $100,000 of the funds in the escrow account

to purchase replacement property identified by T, and on this same

date B transfers the replacement property to T. The interest earned

on the escrow account, $2,400, is paid to B from the escrow account

in consideration for B's performance of services.

(v) Paragraph (c)(1) of this section applies and T must take

into account in computing T's income tax liability for 1999 and 2000

the $2400 of interest earned on the escrow account in those years

even though the interest is paid to B as compensation for B's

services. Paragraph (c)(1) of this section applies for the following

reasons. T, rather than B, enjoys the use of the earnings of the

escrow account since the earnings are used to discharge T's

obligation to pay B for B's services. B is not considered to have

all the beneficial use and enjoyment of the assets of the escrow

account merely because the compensation that B is entitled to

receive is based on the earnings of the escrow account.

(vi) The escrow holder must file Forms 1099 for 1999 and 2000

and furnish T with payee statements with respect to the interest

earned on the escrow in 1999 and 2000. See paragraph (e)(1) of this

section.

Example 2. (i) The facts are the same as in Example 1 except

that the agreement between B and T requires B to pay $100,000 to QI;

under the agreement between T and QI, QI is obligated to transfer to

T within the exchange period consideration (cash or replacement

property or both) equal to $100,000 plus interest thereon at 4

percent compounded semiannually; QI's obligation to transfer this

consideration is secured by the $100,000 received from B, which QI

must deposit into a qualified escrow account; the assets of the

escrow account must be invested in a money market fund; and, as

compensation for QI's performance of services to facilitate the

deferred exchange, QI is entitled to receive the excess of the

interest earned on the escrow account over the amount of interest

(computed at 4 percent compounded semiannually) payable to T in cash

or property.

(ii) QI deposits the $100,000 received from B into a qualified

escrow account, and the $100,000 is invested in a money market fund

earning interest at 4.8 percent compounded semiannually. During

1999, $1,600 of interest is earned on the escrow account. During

January 2000, an additional $400 of interest is earned on the escrow

account. On February 1, 2000, QI uses $101,667 of the funds in the

escrow account to purchase replacement property, which is

transferred to T. This transfer satisfies QI's obligations under the

agreement because $1,667 is the amount of interest that is earned on

$100,000 at 4 percent compounded semiannually for 5 months. Of the

$2,000 in interest earned on the escrow account in 1999 and 2000,

$1,667 is used to purchase replacement property, and the remaining

$333 is paid in cash to QI as compensation for QI's services.

(iii) Paragraph (c)(1) of this section applies and T must take

into account in computing T's income tax liability for 1999 and 2000

the $2000 of interest earned on the escrow account in those years

even though $333 of the interest is paid to QI as compensation for

QI's services.

(iv) The escrow holder must file Forms 1099 and furnish T with

payee statements with respect to the $2000 of interest earned on the

escrow in 1999 and 2000. See paragraph (e)(1) of this section.

Sec. 1.468B-7 Pre-closing escrows.

(a) Scope. This section provides rules under section 468B(g) for

the taxation of income earned on pre-closing escrows.

(b) Definition. A pre-closing escrow is an escrow account, trust,

or fund--

(1) Established in connection with the sale or exchange of real or

personal property;

(2) Funded with a down payment, earnest money, or similar payment

that is deposited into the escrow prior to the sale or exchange of the

property;

(3) Used to secure the obligation of the purchaser to pay the

purchase price for the property (in the case of an exchange, purchaser

means the transferee of the property, and purchase price means the

required consideration for the property);

(4) The assets of which, including the income earned thereon, will

be paid to the purchaser or otherwise distributed for the purchaser's

benefit when the property is sold or exchanged (for example, by being

distributed to the seller as a credit against the purchase price); and

(5) Which is not a qualified escrow account or qualified trust

established in connection with a deferred exchange under section

1031(a)(3).

(c) Taxation of pre-closing escrows. The purchaser is treated for

federal income tax purposes as owning the assets of a pre-closing

escrow. Thus, the purchaser must take into account in computing the

purchaser's income tax liability all items of income, deduction, and

credit (including capital gains and losses) of the escrow.

[[Page 4809]]

(d) Reporting obligations of the administrator. For each calendar

year (or portion thereof) that a pre-closing escrow is in existence,

the escrow agent, escrow holder, trustee, or other person responsible

for administering the escrow (the administrator) must report the income

of the escrow on Forms 1099 in accordance with the information

reporting requirements of subpart B, Part III, subchapter A, chapter

61, Subtitle F of the Internal Revenue Code. The Form 1099 must show

the administrator as the payor and the purchaser as the payee.

(e) Effective date--(1) In general. The provisions of this section

apply to pre-closing escrows established after the date of publication

of final regulations in the Federal Register.

(2) Transition rule. With respect to a pre-closing escrow

established after August 16, 1986, but on or before the date of

publication of final regulations in the Federal Register, the Internal

Revenue Service will not challenge a reasonable, consistently applied

method of taxation for income earned by the escrow. The Internal

Revenue Service will also not challenge a reasonable, consistently

applied method for reporting such income.

(f) Example. The provisions of this section may be illustrated by

the following example:

Example. P enters into a contract with S for the purchase of

residential property owned by S for the price of $200,000. P is

required to deposit $10,000 of earnest money into an escrow. At

closing, the $10,000 and the interest earned thereon will be

credited against the purchase price of the property. The escrow is a

pre-closing escrow. P is treated as owning the assets of the escrow,

and P is taxable on the interest earned on the escrow prior to

closing. The escrow holder must report the income earned on the

escrow on Forms 1099 and furnish payee statements to P. The Forms

1099 must show the escrow holder as the payor and P as the payee.

Sec. 1.468B-8 Contingent at-closing escrows.

(a) Scope. This section provides rules under section 468B(g) for

the taxation of income earned on a contingent at-closing escrow, which

is defined in paragraph (b) of this section. No inference should be

drawn from this section concerning the tax treatment of a contingent

at-closing escrow, or of parties to the escrow, under sections of the

Internal Revenue Code other than section 468B. See also paragraph (d)

of this section.

(b) Definitions. For purposes of this section, the following

definitions apply--

Administrator means an escrow agent, escrow holder, trustee, or

other person responsible for administering an escrow account, trust, or

fund (the purchaser or the seller may be the administrator);

Contingent at-closing escrow means an escrow account, trust, or

fund that satisfies the following requirements--

(1) The escrow is established in connection with the sale or

exchange (other than an exchange to which section 354, 355, or 356

applies) of real or personal property used in a trade or business or

held for investment (including stock in a corporation or an interest in

a partnership);

(2) Depending on whether events specified in the agreement between

the purchaser and the seller that are subject to bona fide

contingencies (not including events that are certain, or reasonably

certain, to occur, such as the passage of time, or that are certain, or

reasonably certain, not to occur) either occur or fail to occur, the

escrow's assets (except for assets set aside for taxes or expenses)

will be distributable--

(i) Entirely to the purchaser;

(ii) Entirely to the seller; or

(iii) In part, to the purchaser with the remainder to the seller;

and

(3) The escrow is not a qualified escrow account or qualified trust

established in connection with a deferred exchange under section

1031(a)(3);

Determination date means the date on which (or by which) the last

of the events subject to a bona fide contingency specified in the

agreement between the purchaser and the seller (referred to in the

definition of contingent at-closing escrow) has either occurred or

failed to occur;

Purchaser means, in the case of an exchange of property, the

transferee of the property; and

Seller means, in the case of an exchange of property, the

transferor of the property.

(c) Tax liability of purchaser and seller for the period prior to

the determination date. For the period prior to the determination date,

the purchaser is treated as owning the assets of the contingent at-

closing escrow for federal income tax purposes. Thus, in computing the

purchaser's income tax liability, the purchaser must take into account

all items of income, deduction, and credit (including capital gains and

losses) of the escrow until the determination date.

(d) Transfer of interest in the assets of the escrow on the

determination date. No inference should be drawn from this section

whether, for purposes of Internal Revenue Code sections other than

468B, there is a transfer of ownership of the assets of a contingent

at-closing escrow on the determination date from the purchaser to the

seller or from the seller to the purchaser, or the tax consequences of

such a transfer. Thus, for example, if there is a transfer of ownership

of the assets of the escrow from the purchaser to the seller on the

determination date for purposes of other Code sections, no inference

should be drawn from this section whether any portion of the amount

transferred is unstated interest. See Sec. 1.483-4.

(e) Tax liability of purchaser and seller for the period beginning

on the determination date. For the period beginning on the

determination date, the purchaser and the seller must each take into

account in determining their income tax liabilities the income,

deductions, and credits (including capital gains and losses)

corresponding to their ownership interests in the assets of the escrow.

(f) Statement required to be provided to administrator within 30

days after the determination date. Within 30 days after the

determination date, the purchaser and the seller must provide the

administrator with a written statement that--

(1) Is signed by the purchaser and the seller;

(2) Specifies the determination date; and

(3) Specifies the purchaser's and seller's ownership interests in

each asset of the escrow.

(g) Reporting obligations of the administrator--(1) In general. The

administrator of a contingent at-closing escrow must, for each calendar

year (or portion thereof) that the escrow is in existence, report the

income of the escrow on Forms 1099 in accordance with the information

reporting requirements of subpart B, Part III, subchapter A, chapter

61, Subtitle F of the Internal Revenue Code. The Forms 1099 must show

as payor the administrator of the escrow and as payee the person (or

persons) treated as the payee (or payees) under paragraph (g)(2) of

this section.

(2) Person treated as payee. In satisfying the reporting

obligations of paragraph (g)(1) of this section, the following rules

apply to the administrator--

(i) For the period prior to the determination date, the

administrator must treat the purchaser as the payee of the income of

the escrow;

(ii) For the period beginning on the determination date, if the

written statement described in paragraph (f) of this section is timely

provided to the administrator, the administrator must treat as the

payee (or payees) of the income of the escrow the purchaser or seller

(or both) in accordance with their

[[Page 4810]]

respective ownership interests as shown on the statement; and

(iii) If the written statement described in paragraph (f) of this

section is not provided to the administrator, the administrator must

continue to treat the purchaser as the payee of the income of the

escrow.

(3) Relief from penalties for filing incorrect information return

or payee statement. For purposes of sections 6721 and 6722, the

administrator will not be treated as failing to file or furnish a

correct information return or payee statement solely because, in

preparing a Form 1099, the administrator relies on a statement

described in paragraph (f) of this section and therefore treats the

purchaser or seller (or both) as the payee (or payees) of the income of

the escrow in accordance with their respective ownership interests in

the assets of the escrow as shown on the statement. If a statement

described in paragraph (f) of this section is not provided to the

administrator, the administrator will not be treated as failing to file

or furnish a correct information return or payee statement solely

because, in preparing a Form 1099, the administrator relies on the

absence of the statement and therefore treats the purchaser as the

payee.

(h) Effective date--(1) In general. The provisions of this section

apply to contingent at-closing escrows that are established after the

date of publication of final regulations in the Federal Register.

(2) Transition rule. With respect to a contingent at-closing escrow

established after August 16, 1986, but on or before the date of

publication of final regulations in the Federal Register, the Internal

Revenue Service will not challenge a reasonable, consistently applied

method of taxation for income earned by the escrow. The Internal

Revenue Service will also not challenge a reasonable, consistently

applied method for reporting such income.

(i) [Reserved]

(j) Example. The provisions of this section may be illustrated by

the following example:

Example. (i) P and S are corporations. In 1999, P enters into a

contract with S for the purchase of rental real estate. On October

1, 1999, the date of sale, S transfers the real estate to P, and P

pays S a portion of the purchase price, $9,000,000. P deposits the

remaining portion of the purchase price, $850,000, into an escrow

account as required by the contract. H is the escrow holder.

(ii) The contract provides that the escrow balance as of

November 1, 2000, is payable entirely to P, entirely to S, or

partially to P and partially to S depending on the amount, if any,

by which the average rental income from the real estate during a

specified testing period ending on September 30, 2000, exceeds one

or more specified earnings targets.

(iii) According to the terms of the contract, the income earned

on the escrow must be accumulated and is not currently distributable

to P or S during the period prior to November 1, 2000.

(iv) During the testing period specified in the contract between

P and S, the average rental income earned on the property exceeds

one (but not all) of the specified earnings targets. As a result, on

September 30, 2000, the end of the testing period, P became entitled

to 40% of the escrow assets and S became entitled to 60% of the

escrow assets.

(v) On October 30, 2000, P and S provide H with the written

statement described in paragraph (f) of this section. The written

statement is thus provided within 30 days of September 30, 2000. The

statement indicates that P's ownership interest in each asset of the

escrow is 40 percent and S's ownership interest in each asset is 60

percent.

(vi) The escrow is a contingent at-closing escrow. September 30,

2000, is the determination date because this is the date on which

the testing period ends. As of this date, all contingencies

specified in the contract are resolved.

(vii) P must take into account all of the income, deductions,

and credits (including capital gains and losses) of the escrow in

computing P's income tax liability for the period prior to September

30, 2000. See paragraph (c) of this section.

(viii) For the period beginning on September 30, 2000, P must

take into account in computing P's income tax liability 40 percent

of each item of income, deduction, and credit of the escrow

(including capital gains and losses), and S must take into account

in computing S's income tax liability 60 percent of these items. See

paragraph (e) of this section.

(ix) H is subject to the information reporting requirements of

paragraph (g)(1) of this section. H must file Forms 1099 and furnish

payee statements to reflect the fact that prior to September 30,

2000, P is the payee of all the income of the escrow, and for the

period beginning on September 30, 2000, P is the payee of 40 percent

of the income, and S is the payee of 60 percent of the income.

Sec. 1.468B-9 Disputed ownership funds.

(a) In general. An escrow account, trust, or fund that is not a

qualified settlement fund is a disputed ownership fund if--

(1) It is established to hold money or property subject to

conflicting claims of ownership;

(2) The escrow account, trust, or fund is subject to the continuing

jurisdiction of a court; and

(3) Money or property cannot be paid or distributed from the escrow

account, trust, or fund to, or on behalf of, a claimant or a transferor

without the approval of the court.

(b) Definitions. For purposes of this section--

(1) Administrator means the person designated as such by the court

having jurisdiction over a disputed ownership fund. If no person is

designated, the administrator is the escrow agent, escrow holder,

trustee, receiver, or other person responsible for administering the

fund;

(2) Claimant means a person, including a transferor, who claims

ownership of, or a legal or equitable interest in, money or property

held by a disputed ownership fund;

(3) Court means a court of law or equity of the United States, any

state (including the District of Columbia), territory, possession, or

political subdivision thereof;

(4) Related person means any person who is related to the

transferor within the meaning of section 267(b) or 707(b)(1);

(5) Transferor means, in general, a person that transfers to a

disputed ownership fund money or property that is subject to

conflicting claims of claimants. However, a payor of interest or other

income earned by a disputed ownership fund is not a transferor (unless

the payor is also a claimant). A transferor may also be a claimant.

(c) Taxation of a disputed ownership fund--(1) In general. For

federal income tax purposes, a disputed ownership fund is treated as

the owner of all assets that it holds. A disputed ownership fund is

treated as a C corporation for purposes of subtitle F of the Internal

Revenue Code, and the administrator of the fund must obtain an employer

identification number for the fund, make all required income tax and

information returns, and deposit all payments of tax. Also, except as

otherwise provided in this section, a disputed ownership fund is

taxable as if it were either--

(i) A qualified settlement fund under Sec. 1.468B-2 if all the

assets transferred to the fund by or on behalf of transferors are

passive investment assets, for example, cash or cash equivalents,

stock, and debt obligations; or

(ii) A C corporation in all other cases.

(2) Exception. If there is a more appropriate method of taxing a

disputed ownership fund than as provided in paragraph (c)(1) of this

section, the claimants to the fund may submit a private letter ruling

request proposing an alternative method of taxation.

(3) Special rules. (i) In general, money or property subject to

conflicting claims of claimants (disputed property) that is transferred

to a disputed ownership fund by, or on behalf of, a transferor is

excluded from the gross income of the fund. However, this exclusion

does not

[[Page 4811]]

apply to income earned on assets of the fund such as--

(A) Payments to a disputed ownership fund made in compensation for

late or delayed transfers of money or property;

(B) Dividends on stock of a transferor (or a related person) held

by the fund; and

(C) Interest on debt of a transferor (or a related person) held by

the fund.

(ii) A distribution to a claimant of disputed property by a

disputed ownership fund is not a taxable event to the fund.

(iii) A disputed ownership fund is not allowed a deduction for a

distribution of disputed property to, or on behalf of, a transferor or

a claimant.

(iv) Upon the termination of a disputed ownership fund, if the fund

has an unused net operating loss carryover under section 172, an unused

capital loss carryover under section 1212, or an unused tax credit

carryover, or if the fund has, for its last taxable year, deductions in

excess of gross income, the claimant to whom the fund's net assets are

distributable will succeed to and take into account the fund's unused

net operating loss carryover, unused capital loss carryover, unused tax

credit carryover, or excess of deductions over gross income for the

last taxable year of the fund. If the fund's net assets are

distributable to more than one claimant, the unused net operating loss

carryover, unused capital loss carryover, unused tax credit carryover,

or excess of deductions over gross income for the last taxable year

must be allocated among the claimants in proportion to the value of the

assets distributable to each claimant from the fund.

(v) In the case of a disputed ownership fund taxable as if it were

a C corporation under paragraph (c)(1)(ii) of this section, this

section does not, in general, restrict the fund's use of an otherwise

allowable method of accounting or taxable year.

(vi) Appropriate adjustments must be made by a disputed ownership

fund or transferors to the fund to prevent the fund and the transferors

from taking into account the same item of income, deduction, gain,

loss, or credit more than once or from omitting such items.

(d) Basis of property held by a disputed ownership fund. In

general, the initial basis of property transferred by, or on behalf of,

a transferor to a disputed ownership fund is the fair market value of

the property on the date of transfer to the fund as determined by the

transferor for purposes of the rules in paragraph (f)(1)(i) of this

section. However, if paragraph (f)(1)(ii) of this section applies, the

fund's initial basis in the property is the same as the basis of the

transferor immediately before the transfer to the fund.

(e) Request for prompt assessment. A disputed ownership fund is

eligible to request the prompt assessment of tax under section 6501(d).

For purposes of section 6501(d), a disputed ownership fund is treated

as dissolving on the date the fund no longer has any assets (other than

a reasonable reserve for potential tax liabilities and related

professional fees) and will not receive any more transfers.

(f) Rules applicable to the transferor--(1) Transfer of property--

(i) In general. A transferor must treat a transfer of property to a

disputed ownership fund as a sale or other disposition of that property

for purposes of section 1001(a). In computing the gain or loss, the

amount realized by the transferor is the fair market value of the

property on the date the transfer is made to the disputed ownership

fund.

(ii) Exceptions. A transfer of property to a disputed ownership

fund is not a sale or other disposition of the property for purposes of

section 1001(a) if--

(A) The transferor claims ownership of the transferred property

immediately before and immediately after the transfer to the fund; or

(B) The transferor is an agent, fiduciary, or other person acting

in a similar capacity acting on behalf of a person claiming ownership

of the transferred property immediately before and immediately after

the transfer to the fund.

(2) Economic performance--(i) In general. For purposes of section

461(h), if a transferor has a liability to one or more claimants for

which economic performance would otherwise occur under Sec. 1.461-4(g)

when the transferor makes a payment to the claimant or claimants,

economic performance occurs with respect to the liability to the extent

the transferor makes a transfer to a disputed ownership fund to resolve

or satisfy that liability, but only if the transferor and related

persons are not claimants and have no right to receive payments or

distributions from the fund.

(ii) Obligations of the transferor. With respect to a transferor

described in paragraph (f)(2)(i) of this section, economic performance

does not occur when the transferor transfers to a disputed ownership

fund its debt (or the debt of a related person). Instead, economic

performance occurs as the transferor (or related person) makes

principal payments on the debt. Similarly, economic performance does

not occur when the transferor transfers to a disputed ownership fund

its obligation (or the obligation of a related person) to provide

property in the future or to make a payment described in Sec. 1.461-

4(g). Instead, economic performance occurs with respect to such an

obligation as property or payments are provided or made to the disputed

ownership fund or a claimant.

(3) Statement to the disputed ownership fund and the Internal

Revenue Service--(i) In general. By February 15 of the year following

each calendar year in which a transferor (or other person acting on

behalf of a transferor) makes a transfer to a disputed ownership fund,

the transferor (or other person) must provide a statement to the

administrator of the fund setting forth the information described in

paragraph (f)(3)(ii) of this section. The transferor must attach a copy

of the statement to (and as part of) its timely filed income tax return

(including extensions) for the taxable year of the transferor in which

the transfer is made.

(ii) Information required on statement--(A) In general. The

statement required by paragraph (f)(3)(i) of this section must include

the following information--

(1) A legend, ``Sec. 1.468B-9(f) Statement'', at the top of the

first page;

(2) The transferor's name, address, and taxpayer identification

number;

(3) The disputed ownership fund's name, address, and employer

identification number;

(4) The date of each transfer;

(5) The amount of cash transferred;

(6) A description of property transferred, the disputed ownership

fund's basis in the property as provided in paragraph (d) of this

section, and, if the rules of paragraph (f)(1)(ii) of this section

apply, the fund's holding period on the date of transfer; and

(7) Whether or not the transferor is also a claimant.

(B) Combined statements. If a disputed ownership fund has more than

one transferor, any two or more of the transferors may provide a

combined statement to the administrator that does not identify the

amount of cash or the property transferred by a particular transferor.

If a combined statement is used, however, each transferor must include

with its copy of the statement that is attached to its income tax

return a schedule describing each asset that the transferor transferred

to the disputed ownership fund.

(4) Distributions to transferors--(i) In general. A transferor must

include in gross income any distribution to a transferor (including a

deemed distribution described in paragraph (f)(4)(iii) of this section)

from a disputed

[[Page 4812]]

ownership fund. If property is distributed, the amount includible in

gross income and the basis in that property is generally the fair

market value of the property on the date of distribution.

(ii) Exception. The gross income of a transferor does not include a

distribution to the transferor of property from a disputed ownership

fund if the transferor previously transferred the property to the fund

and paragraph (f)(1)(ii) of this section applied to that transfer.

Also, the transferor's gross income does not include a distribution of

money from the disputed ownership fund equal to the net income earned

on that property while it was held by the fund. Further, the

transferor's basis in the property is the same as the disputed

ownership fund's basis in the property immediately before the

distribution to the transferor.

(iii) Deemed distributions. If a disputed ownership fund makes a

distribution on behalf of a transferor to a person that is not a

claimant, the distribution is deemed made by the fund to the

transferor. The transferor, in turn, is deemed to have made a payment

to the actual recipient.

(g) Distribution to a claimant other than a transferor. Whether a

claimant other than a transferor must include in gross income a

distribution of money or property from a disputed ownership fund is

generally determined by reference to the claim in respect of which the

distribution is made. If a disputed ownership fund distributes property

to a claimant other than a transferor in satisfaction of the claimant's

claim of ownership to that property, the claimant's basis in the

property must be adjusted to reflect the adjustments to the basis of

the property required under section 1016 for the period the property

was held by the fund.

(h) Effective date--(1) In general. This section applies to

disputed ownership funds established after the date of publication of

final regulations in the Federal Register.

(2) Transition rule. With respect to a disputed ownership fund

established after August 16, 1986, but on or before the date of

publication of final regulations in the Federal Register, the Internal

Revenue Service will not challenge a reasonable, consistently applied

method of taxation for income earned by the fund, transfers to the

fund, and distributions made by the fund.

(i) [Reserved].

(j) Examples. The following examples illustrate the rules of this

section:

Example 1. (i) Prior to A's death, A was the insured under a

life insurance contract (policy) issued by X, an insurance company.

A's current spouse and A's former spouse each claim to be the

beneficiary under the policy and thus entitled to the policy

proceeds ($1 million). In 1999, X files an interpleader action and

deposits the policy proceeds into the registry of the court. On June

1, 2000, a final determination is made that A's current spouse is

the beneficiary under the policy and thus entitled to the funds held

in the registry of the court. These funds are distributed to A's

current spouse.

(ii) The funds held in the registry of the court consisting of

the policy proceeds and the earnings thereon are a disputed

ownership fund taxable as if it were a qualified settlement fund.

See paragraph (c)(1)(i) of this section. The fund's gross income

does not include the $1 million transferred to the fund by X.

Example 2. (i) Two unrelated individuals, A and B, claim

ownership of certain rental property. A claims to have purchased the

property from B's father. However, B asserts that the purported sale

to A was ineffective and that B acquired ownership of the property

through intestate succession upon the death of B's father. For

several years, A has maintained the property and received the rent

from the property.

(ii) Pending the resolution of the title dispute between A and

B, the title to the property is transferred into a court-supervised

escrow on February 1, 2000. Also, on that date the court appoints R

as receiver for the property. R collects the rent earned on the

property and hires employees necessary for the maintenance of the

property. The rents paid to R cannot be distributed to A or B

without the court's approval.

(iii) On June 1, 2001, the court makes a final determination

that the rental property is owned by B. The court orders B to refund

to A the purchase price paid by A to B's father plus interest on

that amount from February 1, 2000. Also, the court orders that a

distribution be made to B of all funds held in the court registry

consisting of the rent collected by R and the income earned thereon.

In addition, title to the property is returned to B.

(iv) The rental property and the funds held by the court

registry are held in a disputed ownership fund.

(v) A is the transferor to the fund. A does not realize gain or

loss under section 1001(a) on A's transfer of the property to the

disputed ownership fund.

(vi) The fund is taxable as if it were a C corporation because

the rental property is not a passive investment asset. See paragraph

(c)(1)(ii) of this section. The fund is not taxable upon receipt of

the property. The fund's initial basis in the property is the same

as A's adjusted basis immediately before the transfer to the fund.

The fund's gross income includes the rents paid to R and the income

earned thereon. For the period between February 1, 2000, and June 1,

2001, the fund may be allowed deductions for depreciation and for

the costs of maintenance of the property because the fund is treated

as owning the property during this period. See sections 162, 167,

and 168.

(vii) The fund is not allowed a deduction for the distribution

to B of the rent earned on the property while held by the fund (or

the income earned thereon). No tax consequences to the fund result

from this distribution or from the fund's transfer of the rental

property to B pursuant to the court's determination that B owns the

property.

Par. 6. Section 1.1031(k)-1 is amended by adding a sentence at the

end of paragraphs (g)(3)(i) and (h)(2) to read as follows:

Sec. 1.1031(k)-1 Treatment of deferred exchanges.

* * * * *

(g) * * *

(3) * * * (i) * * * For rules under section 468B(g) relating to the

current taxation of income of a qualified escrow account or qualified

trust, see Sec. 1.468B-6.

* * * * *

(h) * * *

(2) * * * For rules under section 468B(g) relating to the current

taxation of income of a qualified escrow account or qualified trust,

see Sec. 1.468B-6.

* * * * *

Michael P. Dolan,

Deputy Commissioner of Internal Revenue.

[FR Doc. 99-1515 Filed 1-29-99; 8:45 am]

BILLING CODE 4830-01-U