BulletinNo.1997–2 HIGHLIGHTS OFTHISISSUEfor the 1997 plan year and describes methods for the determination and distribution of excess contributions. (Continuedonpage4) FindingListsbeginonpage63

INCOME TAXRev. Rul. 97–1, page 10.Federal rates; adjusted federal rates; adjusted fed-eral long-term rate, and the long-term exempt rate.For purposes of sections 1274, 1288, 382, and othersections of the Code, tables set forth the rates forJanuary 1997.

Rev. Rul. 97–2, page 8.Insurance companies; interest rate tables. Prevailingstate assumed interest rates are provided for thedetermination of reserves under section 807 of theCode for contracts issued in 1996 and 1997. Rev. Rul.92–19 supplemented in part.

Rev. Rul. 97–3, page 5.SBA guaranteed payment rights; participating securi-ties. The Small Business Administration (SBA) is theprimary obligor of the guaranteed payment rights thatare created under its participating security program andinvestors in those rights are treated as owning SBAdebt.

T.D. 8697, page 11.Final regulations under section 7701 of the Codeclassify certain business organizations under an electiveregime.

Notice 97–1, page 22.Revenue rulings and revenue procedures under T.D.8697 obsoleted. Revenue rulings and revenue proce-dures that use the prior classification regulations todifferentiate between partnerships and associations areobsolete to the extent that they rely on those priorregulations.

Notice 97–4, page 24.S corporation subsidiaries. This notice requests com-ments concerning issues raised by section 1308 of theSmall Business Job Protection Act of 1996 whichpermits an S corporation (1) to own 80 percent or more

of the stock of a C corporation, and (2) to elect to own aqualified subchapter S subsidiary (QSSS). This noticealso provides temporary guidance on the manner inwhich a QSSS election must be made and the effectivedate of the election.

Notice 97–5, page 25.Electing small business corporations and banks. Thisnotice provides guidance on the effect of the qualifiedsubchapter S subsidiary (QSSS) election under section1361(b)(3) on banks affiliated with nonbanks; the appli-cation of the S corporation passive investment incomerule of section 1362(d)(3); the application of the interestexpense disallowance rules of section 265; and anautomatic change in method of accounting for bad debts.

EMPLOYEE PLANSRev. Proc. 97–9, page 55.Cash or deferred arrangements; amendments;SIMPLEs. This procedure describes how an employerthat maintains a qualified cash or deferred arrangementmay make the necessary amendment for its qualifiedcash or deferred arrangement to meet the provision fora savings incentive match plan pursuant to section1422 of the Small Business Job Protection Act of 1996.

Announcement 97–2, page 62.Schedule Q; determination letter requests; section401(a)(26). The instructions for completing Schedule Qfor plan years beginning after December 31, 1996, arebeing changed.

Notice 97–2, page 22.Cash or deferred arrangements; nondiscrimination.With respect to cash or deferred arrangements, the noticegives transitional relief for certain nondiscrimination testsfor the 1997 plan year and describes methods for thedetermination and distribution of excess contributions.

(Continued on page 4)

Finding Lists begin on page 63.

Bulletin No. 1997–2January 13, 1997

HIGHLIGHTSOF THIS ISSUEThese synopses are intended only as aids to the reader inidentifying the subject matter covered. They may not be reliedupon as authoritative interpretations.

HIGHLIGHTSOF THIS ISSUE—ContinuedEMPLOYEE PLANS—ContinuedNotice 97–6, page 26.Questions and answers; SIMPLE IRAs. A notice, inquestion and answer format, pertaining to simple IRAsdescribed in section 408(p) of the Code as added by theSmall Business Job Protection Act of 1996, is set forth.

Notice 97–10, page 41.Spousal consent; qualified joint and survivor annu-ities, etc.; sample language. The Service has devel-oped sample language for inclusion in a form providingspousal consent to a participant’s election to waive aqualified joint and survivor annuity or a qualified preretire-ment survivor annuity, in accordance with section 1457 ofthe Small Business Job Protection Act of 1996.

Notice 97–11, page 49.Qualified domestic relations orders; sample lan-guage. The Service has developed sample language forqualified domestic relations orders within the meaning ofsection 414(p) of the Code in accordance with section1457 of the Small Business Job Protection Act of 1996.

ADMINISTRATIVERev. Proc. 97–10, page 59.Change in computing depreciation for retail motorfuels outlets. This procedure is provided for making theelection under section 1120 of the Small Business Job

Protection Act of 1996 to treat retail motor fuels outletsplaced in service before August 20, 1996, as 15-yearproperty under section 168 of the Code. Rev. Proc.92–20 modified.

Notice 97–9, page 35.Adoption assistance. This notice provides general guid-ance concerning the tax credit under section 23 for“qualified adoption expenses” paid or incurred by anindividual and the exclusion from gross income undersection 137 for amounts paid or expenses incurred byan employer for “qualified adoption expenses” under anadoption assistance program.

Announcement 97–1, page 62.Extension of test of mediation procedure for appeals.This announcement extends the test of the mediationprocedure set forth in Announcement 95–86, 1995–44I.R.B. 27, for an additional one-year period beginning onJanuary 13, 1997. The procedure will allow taxpayers,whose cases are not docketed in any court and alreadyin the Appeals administrative process, to request media-tion as a dispute resolution technique.

Announcement 97–3, page 62.A list is provided of organizations that no longer qualifyas organizations to which contributions are deductibleunder section 170 of the Code.

4

Mission of the Service

The purpose of the Internal Revenue Service is tocollect the proper amount of tax revenue at the leastcost; serve the public by continually improving the

quality of our products and services; and perform in amanner warranting the highest degree of publicconfidence in our integrity, efficiency and fairness.

Statement of Principlesof Internal RevenueTax AdministrationThe function of the Internal Revenue Service is toadminister the Internal Revenue Code. Tax policyfor raising revenue is determined by Congress.

With this in mind, it is the duty of the Service tocarry out that policy by correctly applying the lawsenacted by Congress; to determine the reasonablemeaning of various Code provisions in light of theCongressional purpose in enacting them; and toperform this work in a fair and impartial manner,with neither a government nor a taxpayer point of view.

At the heart of administration is interpretation of theCode. It is the responsibility of each person in theService, charged with the duty of interpreting thelaw, to try to find the true meaning of the statutoryprovision and not to adopt a strained construction inthe belief that he or she is ‘‘protecting the revenue.’’The revenue is properly protected only when we as-certain and apply the true meaning of the statute.

The Service also has the responsibility of applyingand administering the law in a reasonable,practical manner. Issues should only be raised byexamining officers when they have merit, neverarbitrarily or for trading purposes. At the sametime, the examining officer should never hesitateto raise a meritorious issue. It is also importantthat care be exercised not to raise an issue or toask a court to adopt a position inconsistent withan established Service position.

Administration should be both reasonable andvigorous. It should be conducted with as littledelay as possible and with great cour tesy andconsiderateness. It should never try to overreach,and should be reasonable within the bounds of lawand sound administration. It should, however, bevigorous in requiring compliance with law and itshould be relentless in its attack on unreal taxdevices and fraud.

2

Introduction

The Internal Revenue Bulletin is the authoritative instru-ment of the Commissioner of Internal Revenue forannouncing official rulings and procedures of the Inter-nal Revenue Service and for publishing Treasury Deci-sions, Executive Orders, Tax Conventions, legislation,court decisions, and other items of general interest. It ispublished weekly and may be obtained from the Superin-tendent of Documents on a subscription basis. Bulletincontents of a permanent nature are consolidated semi-annually into Cumulative Bulletins, which are sold on asingle-copy basis.

It is the policy of the Service to publish in the Bulletin allsubstantive rulings necessary to promote a uniformapplication of the tax laws, including all rulings thatsupersede, revoke, modify, or amend any of thosepreviously published in the Bulletin. All published rulingsapply retroactively unless otherwise indicated. Proce-dures relating solely to matters of internal managementare not published; however, statements of internalpractices and procedures that affect the rights andduties of taxpayers are published.

Revenue rulings represent the conclusions of the Ser-vice on the application of the law to the pivotal factsstated in the revenue ruling. In those based on positionstaken in rulings to taxpayers or technical advice toService field offices, identifying details and informationof a confidential nature are deleted to prevent unwar-ranted invasions of privacy and to comply with statutoryrequirements.

Rulings and procedures reported in the Bulletin do nothave the force and effect of Treasury DepartmentRegulations, but they may be used as precedents.Unpublished rulings will not be relied on, used, or citedas precedents by Service personnel in the disposition ofother cases. In applying published rulings and proce-dures, the effect of subsequent legislation, regulations,

court decisions, rulings, and procedures must be consid-ered, and Service personnel and others concerned arecautioned against reaching the same conclusions inother cases unless the facts and circumstances aresubstantially the same.

The Bulletin is divided into four parts as follows:

Part I.—1986 Code.This part includes rulings and decisions based onprovisions of the Internal Revenue Code of 1986.

Part II.—Treaties and Tax Legislation.This part is divided into two subparts as follows:Subpart A, Tax Conventions, and Subpart B, Legislationand Related Committee Reports.

Part III.—Administrative, Procedural, and Miscellaneous.To the extent practicable, pertinent cross references tothese subjects are contained in the other Parts andSubparts. Also included in this part are Bank SecrecyAct Administrative Rulings. Bank Secrecy Act Administra-tive Rulings are issued by the Department of theTreasury’s Office of the Assistant Secretary (Enforce-ment).

Part IV.—Items of General Interest.With the exception of the Notice of Proposed Rulemak-ing and the disbarment and suspension list included inthis part, none of these announcements are consoli-dated in the Cumulative Bulletins.

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

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

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

3

Part I. Rulings and Decisions Under the Internal Revenue Code of 1986Section 42.—Low-Income HousingCreditThe adjusted applicable federal short-term, mid-

term, and long-term rates are set forth for themonth of January 1997. See Rev. Rul. 97–1, page10.

Section 56.—Adjustments inComputing Alternative MinimumTaxable IncomeIf a taxpayer elects to treat a retail motor fuels

outlet placed in service before August 20, 1996, as15-year property for computing depreciation forregular tax purposes, how is the depreciationcomputed for alternative minimum taxable incomepurposes? See Rev. Proc. 97–10, page 59.

Section 61.—Gross Income Defined26 C.F.R. 1.61–1: Gross Income. (Also §§ 851,856, 895, 7701; 1.851–2, 1.856–2, 1.895–1,301.7701–13A.)

SBA guaranteed payment rights; par-ticipating securities. The Small Busi-ness Administration (SBA) is the pri-mary obligor of the guaranteed paymentrights that are created under its partici-pating security program and investors inthose rights are treated as owning SBAdebt.

Rev. Rul. 97–3

ISSUE

For federal tax purposes, is the SmallBusiness Administration (SBA) the pri-mary obligor of certain guaranteed pay-ment rights that are created under itsparticipating security program?

FACTS

The SBA is an independent agency ofthe United States. Its activities includeregulating and providing financial assis-tance to small business investment com-panies (SBICs), which furnish venturecapital to small business concerns. Oneway SBICs raise money for investmentis by issuing participating securities tothe SBA. See 15 U.S.C. §§ 683 and687(l) (1994). Participating securitiesmay take the form of preferred stock,preferred limited partnership interests, orsimilar instruments. 15 U.S.C. § 683(g)(1994).Regardless of their form, or the rights

they may provide under state and locallaw, all participating securities share thefollowing characteristics. Every partici-pating security entitles the SBA to botha return of capital (Redemption Pay-

ments) and priority distributions thatequal a fixed percentage of theunreturned capital (Prioritized Pay-ments). Redemption Payments have tobe made by the final due date, which inmost cases, is approximately 10 yearsfrom the day the participating security isissued. Before the final due date, aSBIC may make Redemption Paymentsat its discretion, or may be required tomake Redemption Payments for reasonssuch as its insolvency. Prioritized Pay-ments are scheduled to be made at leastannually, but are due only to the extentthat the SBIC has sufficient profits. Anyscheduled amount that goes unpaid ac-cumulates. Every participating securityalso entitles the SBA to receive a por-tion of the SBIC’s remaining profits(Profit Participation Payments) andgives the SBA the right to bar anychanges affecting its interests.Once every quarter, the SBA acquires

new participating securities and as-sembles them into a pool to besecuritized. Every security in a newlyformed pool has the same final due datefor making Redemption Payments anduses the same percentage for calculatingPrioritized Payments. The percentageused to calculate the Prioritized Pay-ments is established with reference tocurrent interest rates.To securitize a pool, the SBA assigns

the Redemption Payments and Priori-tized Payments to a group of underwrit-ers and simultaneously enters into aguarantee relating to the assigned pay-ments (the Payment Guarantee). Allrights in the participating securities,other than the Redemption Paymentsand Prioritized Payments, are retainedby the SBA, and the SBA has no dutyto exercise them for anyone else’s ben-efit. The underwriters transfer the as-signed payments and the Payment Guar-antee to a trust. In exchange, theunderwriters receive a single class ofmarketable trust certificates that in formevidence beneficial ownership of thetransferred assets. Proceeds from theunderwriters’ sale of the trust certificatesare paid to the SBICs whose participat-ing securities make up the pool.Under the Payment Guarantee, the

SBA must disburse quarterly the amountby which (1) the Prioritized Paymentsmade by the SBICs and available to thetrust fall short of (2) the PrioritizedPayments that would be due if Priori-tized Payments had to be made regard-less of financial condition and were paid

in quarterly installments rather than an-nually. 15 U.S.C. § 683(g) (1994).Thus, if a SBIC’s profits are so low thatthe SBIC has no obligation to make aPrioritized Payment, the SBA neverthe-less has to pay, in quarterly installments,the amount that would be owed if theSBIC’s profits were unlimited. Making apayment in this case does not entitle theSBA to seek immediate restitution fromthe SBIC. Instead, the SBA has torecover the payment from whatever fu-ture Prioritized Payments the SBIC maygenerate.The Payment Guarantee also obligates

the SBA to pay any shortfall in a pool’sRedemption Payments. The SBA, there-fore, has to make up any RedemptionPayment that a SBIC fails to pay on thefinal due date or cannot pay whenforced to redeem a participating security(for instance, in the case of insolvencyor commencement of receivership pro-ceedings). Under these circumstances,the right to receive the RedemptionPayment from the SBIC is released bythe trust in favor of the SBA.By the terms of the Payment Guaran-

tee, the obligations of the SBA areunconditional and must be performeddespite any legal or equitable defense.Each time a new pool is created, theSBA will reasonably expect to disburseand not recover, during the pool’s firstthree years, an amount exceeding 15percent of the Prioritized Payments thatwould be due on the participating secu-rities in the pool if Prioritized Paymentshad to be made regardless of financialcondition and were paid in quarterlyinstallments rather than annually. ThePayment Guarantee cannot be trans-ferred separately from the rights to theRedemption Payments and PrioritizedPayments.The trust that holds the Payment

Guarantee and the rights to the Redemp-tion Payments and Prioritized Paymentsis authorized by statute, 15 U.S.C.§ 687l(a) (1994), and governed by anagreement among the SBA, the SBA’sfiscal agent, and an independent trustee.These parties may amend the agreementwithout the consent of the certificateholders, provided the amendment doesnot adversely affect payments on thecertificates.In form, each trust certificate repre-

sents a fractional undivided ownershipinterest in the transferred assets. TheSBA guarantees (the Passthrough Guar-antee) that the certificate holders will

5

receive timely an amount equal to theirproportionate share of all amounts re-ceived by the trust. 15 U.S.C. § 687l(b)(1994). The Passthrough Guarantee isenforceable regardless of the defensesavailable to the SBICs or the trustee.Although the certificate holders can en-force the Passthrough Guarantee, theycannot enforce any obligation of theSBICs. Specifically, the certificate hold-ers have no right to enforce the Priori-tized Payments or Redemption Pay-ments, and the underlying SBICs oweno duty to the certificate holders.The trustee has no duty or authority

to enforce collection of the trust assetsother than the Payment Guarantee. In-stead, the SBA services (at its expense)the Redemption Payments and Priori-tized Payments and has the sole right totake action and assert claims with re-spect to the Redemption Payments andPrioritized Payments. As servicer, theSBA can waive or agree to amend anyterm of any participating security; thosemodifications, however, cannot decreaseor defer the aggregate payments to thetrust. No federal or state law may limitthe exercise by the SBA of its owner-ship rights in the participating securities.15 U.S.C. § 687l(e)(2) (1994).Because the SBA forms a new pool

of participating securities each quarter,several pools may exist at any time. TheSBA has the right (but not the obliga-tion) to replace Redemption Paymentsand Prioritized Payments due on onepool with Redemption Payments andPrioritized Payments due on another.Specifically, if the SBA believes a par-ticipating security in a pool is about tomake a Redemption Payment, the SBAcan exchange the rights to all or part ofthat Redemption Payment (and relatedPrioritized Payments) for the rights toall or part of the Redemption Paymentsand Prioritized Payments due on partici-pating securities in other pools.The SBA can exercise the right of

substitution at any time provided threeconditions are met. These conditions en-sure an adequate match between thepayments relinquished on a redeemingsecurity and the payments to be receivedin exchange from any ‘‘replacement’’securities. First, the sum of the Redemp-tion Payments to be received with re-spect to the replacement securities mustequal the amount of the RedemptionPayment relinquished with respect to theredeeming security. Second, the final duedate for each replacement security mustbe no later than the final due date for theredeeming security. Third, the percentage

used for calculating the Prioritized Pay-ments on each replacement security mustbe no less than the percentage used forcalculating the Prioritized Payments onthe redeeming security.There are common situations in which

the SBA can benefit from using thesubstitution power. For example, if apool holds a 6 percent security that isabout to be redeemed, the SBA canreplace it with an 8 percent securityfrom an older pool. Certificate holdersin the older pool, after receiving theRedemption Payment from the 6 percentsecurity, will no longer be entitled toPrioritized Payments on the redeemedamount. Certificate holders in the 6percent pool will receive PrioritizedPayments from the 8 percent security,but only at a 6 percent rate. Conse-quently, the exchange will advance thetermination of the older, higher interestrate pool, and allow the SBA to retainthe extra 2 percent of Prioritized Pay-ments that are not required to servicethe 6 percent pool.

LAW

The economic substance of a transac-tion generally governs its federal taxconsequences.Gregory v. Helvering, 293U.S. 465 (1935), XIV–1 C.B. 193. Af-fixing a label to an undertaking (forexample, referring to an arrangement asa ‘‘guarantee’’) does not alone decide itscharacter.Sun Oil Co. v. Commissioner,562 F. 2d 258, 263 (3d Cir. 1977);Oesterreich v. Commissioner, 226 F. 2d798, 801–02 (9th Cir. 1955);Boulez v.Commissioner, 83 T.C. 584, 591 (1984);see also Commissioner v. P.G. Lake,Inc., 356 U.S. 260 (1958), 1958–1 C.B.516.

A guarantee of an instrument is asecondary and collateral promise to paythe amounts due under the instrument inthe event the primary obligor (ordinarilythe issuer) defaults.Zappo v. Commis-sioner, 81 T.C. 87–88 (1983);Perry v.Commissioner, 47 T.C. 159, 163 (1966).The Commissioner may recharacterizeany transaction that has the precedingattributes in appearance but not in sub-stance.See Estate of Durkin v. Commis-sioner, 99 T.C. 561, 571 (1992). Howthe transaction may be rechacterized de-pends on the facts, including the termsof the ‘‘guarantee’’ and any relatedagreements and the circumstances exist-ing at the time the ‘‘guarantee’’ is made.

For example, at the time a taxpayer‘‘guarantees’’ an instrument, the financesof the issuer may be so precarious that

the taxpayer (rather than the issuer) isexpected to pay the instrument. Undersuch facts, the taxpayer may be, insubstance, accepting primary (ratherthan secondary) responsibility for theinstrument. Lang v. Commissioner, 32B.T.A. 522 (1935);seeRev. Rul. 94–42,1994–2 C.B. 15. As another example,under the terms of a ‘‘guarantee’’ andany related agreements, a taxpayer mayhave to pay regardless of any default onthe ‘‘guaranteed’’ instrument and mayenjoy beneficial ownership of the instru-ment. Beneficial ownership may be evi-denced by, among other things, a powerin the taxpayer to replace the instrumentor to exercise for its own advantage anyprivileges inherent in the instrument.SeeSchoellkopf v. Commissioner, 32 B.T.A.88 (1935);cf. Rev. Rul. 77–137, 1977–1C.B. 178. Under such facts, the taxpayermay be, in substance, issuing its ownprimary obligation and using the ‘‘guar-anteed’’ instrument to secure that obliga-tion. Rev. Rul. 78–118, 1978–1 C.B.219; see Schoellkopf v. Commissioner.Different facts may support other char-acterizations. No single fact is conclu-sive, and all aspects of a transactionmust be considered to determine itssubstance.

ANALYSIS

The trust holds a group of inseparablerights consisting of the rights to theRedemption Payments, the PrioritizedPayments, and the amounts paid underthe Payment Guarantee. Based on all ofthe facts and circumstances, this groupof rights (the Guaranteed PaymentRights) constitutes, in substance, a pri-mary obligation of the SBA. It does notrepresent an ownership interest in SBICsecurities backed by an SBA guarantee.Among the reasons for this conclusionare not only the differences between thepayment obligations of the SBA and thepayment obligations of the SBICs butalso the continuing interest of the SBAin the participating securities.The payment obligations of the SBA

and the SBICs differ in that the SBAhas to make payments even if the SBICsare not in default. A SBIC has to makea Prioritized Payment only if it hassufficient profits, but the SBA mustdisburse an amount equivalent to thatPrioritized Payment in all events. Also,a SBIC has to make Prioritized Pay-ments only on an annual basis, but theSBA must make payments quarterly.These differences are more than a mat-ter of form. Each time a new pool is

6

created, the SBA will reasonably expectto disburse and not recover, during thepool’s first three years, an amount ex-ceeding 15 percent of the PrioritizedPayments that would be due on theparticipating securities in the pool ifPrioritized Payments had to be maderegardless of financial condition andwere paid in quarterly installmentsrather than annually.In addition, the SBA retains beneficial

ownership of the participating securities.Although, in form, the rights to theRedemption Payments and PrioritizedPayments are transferred to the trust,neither the trust nor the certificate hold-ers enjoy any rights of beneficial owner-ship in the participating securities. Nofederal or state law can limit the exer-cise of the SBA’s ownership rights inthe participating securities, and the SBAmakes no promise to exercise theserights for the trust’s benefit. 15 U.S.C.§ 687l(e)(2) (1994). The SBA nevertransfers its interests in the Profit Par-ticipation Payments and continues toservice (at its expense) the RedemptionPayments and Prioritized Payments.Moreover, neither the trustee nor thecertificate holders can force the SBICsto make these payments. The SBA en-joys a right to replace Redemption Pay-ments and Prioritized Payments due onone pool with Redemption Paymentsand Prioritized Payments due on an-other. This right allows the SBA toexercise control over a participating se-curity for its own rather than the certifi-cate holders’ benefit. It also demon-strates that a certificate does notrepresent an interest in any identifiableparticipating security.

HOLDING

For federal tax purposes, the SBA isthe primary obligor of the GuaranteedPayment Rights created under its partici-pating security program, and the trustcertificate holders are treated as owningindebtedness of the SBA.This revenue ruling is predicated on

the law governing the SBA participatingsecurity program as of December 24,1996. Therefore, before relying on thisrevenue ruling, taxpayers, Service per-sonnel, and others are cautioned to de-termine whether the law referred to hasmaterially changed since that date. See§ 7.01(6), Rev. Proc. 89–14, 1989–1C.B. 814.

DRAFTING INFORMATION

The principal author of this revenueruling is Kenneth Christman of theOffice of Assistant Chief Counsel (Fi-nancial Institutions & Products). Forfurther information regarding this rev-enue ruling contact Mr. Christman on(202) 622–3950 (not a toll-free call).

Section 168.—Accelerated CostRecovery SystemHow does a taxpayer elect to treat a retail motor

fuels outlet placed in service before August 20,1996, as 15-year property for depreciation pur-poses? See Rev. Proc. 97–10, page 59.

Section 265.—Expenses andInterest Relating to Tax-exemptIncome26 CFR 1.265–2: Interest relating to tax-exemptincome.

In an S corporation context, to the extentindebtedness and tax-exempt obligations are takeninto account in applying § 265(b) at the banklevel, are they taken into account again in apply-ing § 265(a) at the shareholder level? See Notice97–5, page 25.

Section 280G.—Golden ParachutePaymentsFederal short-term, mid-term, and long-term

rates are set forth for the month of January 1997.See Rev. Rul. 97–1, page 10.

Section 382.—Limitation on NetOperating Loss Carryforwards andCertain Built-In Losses FollowingOwnership ChangeThe adjusted federal long-term rate is set forth

for the month of January 1997. See Rev. Rul.97–1, page 10.

Section 412.—Minimum FundingStandardsThe adjusted applicable federal short-term, mid-


Section 446.—General Rule forMethods of AccountingIf a taxpayer elects to treat a retail motor fuels

outlet placed in service before August 20, 1996, as15-year property for depreciation purposes, is thiselection a change in method of accounting? SeeRev. Proc. 97–10, page 59.

Section 446.—General Rule forMethods of Accounting26 CFR 1.446–1: General rule for methods ofaccounting.

If a taxpayer elects to treat a retail motor fuelsoutlet place in service before August 20, 1996, as15-year property for depreciation purposes, is thiselection a change in method of accounting? SeeRev. Proc. 97–10, page 59.

Section 467.—Certain Paymentsfor the Use of Property or ServicesThe adjusted applicable federal short-term, mid-


Section 468.—Special Rules forMining and Solid WasteReclamation and Closing CostsThe adjusted applicable federal short-term, mid-


Section 481.—AdjustmentsRequired by Changes in Methods ofAccountingIf a taxpayer elects to treat a retail motor fuels

outlet placed in service before August 20, 1996, as15-year property for depreciation purposes, is anadjustment to taxable income required by thischange in method of accounting? See Rev. Proc.97–10, page 59.

Section 483.—Interest on CertainDeferred PaymentsThe adjusted applicable federal short-term, mid-


Section 807.—Rules for CertainReservesThe adjusted applicable federal short-term, mid-


Insurance companies; interest ratetables. Prevailing state assumed interestrates are provided for the determinationof reserves under section 807 of theCode for contracts issued in 1996 and1997. Rev. Rul. 92–19 supplemented inpart. See Rev. Rul. 97–2 on page 8.

7

Rev. Rul. 97–2

For purposes of § 807(d)(4) of theInternal Revenue Code, for taxable yearsbeginning after December 31, 1995, thisruling supplements the schedules of pre-vailing state assumed interest rates setforth in Rev. Rul. 92–19, 1992–1 C.B.227. This information is to be used byinsurance companies in computing theirreserves for (1) life insurance andsupplementary total and permanent dis-ability benefits, (2) individual annuitiesand pure endowments, and (3) groupannuities and pure endowments. As§ 807(d)(2)(B) requires that the interestrate used to compute these reserves bethe greater of (1) the applicable federalinterest rate, or (2) the prevailing stateassumed interest rate, the table of appli-cable federal interest rates in Rev. Rul.92–19 is also supplemented.Following are supplements to sched-

ules A, B, C, and D to Part III of Rev.Rul. 92–19, providing prevailing stateassumed interest rates for insuranceproducts with different features issued in1996 and 1997, and a supplement to thetable in Part IV of Rev. Rul. 92–19,providing the applicable federal interestrate under § 807(d) for 1996 and 1997.This ruling does not supplement Parts Iand II of Rev. Rul. 92–19.This is the fifth supplement to the

interest rates provided in Rev. Rul.92–19. Earlier supplements were pub-lished in Rev. Rul. 93–58, 1993–2 C.B.241 (interest rates for insurance products

issued in 1992 and 1993), Rev. Rul.94–11, 1994–1 C.B. 196 (1993 and1994), Rev. Rul. 95–4, 1995–1 C.B. 141(1994 and 1995), and Rev. Rul. 96–2,1996–1 C.B. 141 (1995 and 1996).

Part III. Prevailing State AssumedInterest Rates — Products Issued in

Years After 1982.*

Schedule A

STATUTORY VALUATION INTERESTRATES BASED ON THE 1980AMENDMENTS TO THE

NAIC STANDARD VALUATION LAW

A. Life insurance valuation:

GuaranteeDuration(years)

Calendar Yearof Issue

1997

10 or fewer 5.50**More than 10 5.25**but not morethan 20More than 20 4.50**

Source: Rates calculated from themonthly averages, ending June 30, 1996,of Moody’s Corporate Bond Yield Aver-age — Monthly Average Corporates.

** As the applicable federal interest ratefor 1997 of 6.33 percent exceeds thisprevailing state assumed interest rate,

the interest rate to be used for thisproduct under § 807 is 6.33 percent.

* The terms used in the schedules inthis ruling and in Part III of Rev. Rul.92–19 are those used in the StandardValuation Law; the terms are defined inRev. Rul. 92–19.

Part III, Schedule B

STATUTORY VALUATION INTERESTRATES BASED ON THE 1980AMENDMENTS TO THE

NAIC STANDARD VALUATION LAW

B. Single premium immediate annuitiesand annuity benefits involving life con-tingencies arising from other annuitieswith cash settlement options and fromguaranteed interest contracts with cashsettlement options:

Calendar Year ofIssue

Valuation InterestRate

1996 6.75*

Source: Rates calculated from themonthly averages, ending June 30, 1996,of Moody’s Corporate Bond Yield Aver-age — Monthly Average Corporates.The terms used in this schedule arethose used in the Standard ValuationLaw as defined in Rev. Rul. 92–19.

*As this prevailing state assumed inter-est rate exceeds the applicable federalinterest rate for 1996 of 6.63 percent,the interest rate to be used for thisproduct under § 807 is 6.75 percent.

Part III, Schedule C14—1996

STATUTORY VALUATION INTEREST RATESBASED ON NAIC STANDARD VALUATION LAW

FOR 1996CALENDAR YEAR BUSINESSGOVERNED BY THE 1980 AMENDMENTS

C. Valuation interest rates for other annuities and guaranteed interest contracts that are valued on an issue year basis:Valuation Interest Rate

For Plan TypeCash

SettlementOptions?

FutureInterest

Guarantee?Guarantee Duration

(years) A B C

Yes Yes 5 or fewer 6.75 5.75* 5.25*

More than 5, but not 6.50* 5.75* 5.25*more than 10


More than 20 5.00* 4.50* 4.50*

Yes No 5 or fewer 6.75 6.00* 5.50*

More than 5, but not 6.75 6.00* 5.50*more than 10


8

Valuation Interest RateFor Plan Type

More than 20 5.25* 4.75* 4.75*

No Yes or No 5 or fewer 6.75

More than 5, but not 6.50*more than 10 NOT APPLICABLE

More than 10, but not 6.00*more than 20

More than 20 5.00*

Source: Rates calculated from the monthly averages, ending June 30, 1996 of Moody’s Corporate Bond Yield Average —Monthly Average Corporates.

*As the applicable federal interest rate for 1996 of 6.63 percent exceeds this prevailing state assumed interest rate, the interestrate to be used for this product under § 807 is 6.63 percent.

Part III, Schedule D14—1996

STATUTORY VALUATION INTEREST RATESBASED ON NAIC STANDARD VALUATION LAW

FOR 1996CALENDAR YEAR BUSINESSGOVERNED BY THE 1980 AMENDMENTS

D. Valuation interest rates for other annuities and guaranteed interest contracts that are contracts with cash settlement optionsand that are valued on a change in fund basis:

Valuation Interest RateFor Plan Type

CashSettlementOptions?

FutureInterest

Guarantee?Guarantee Duration

(years) A B CYes Yes 5 or fewer 7.25 6.75 5.50*

More than 5, but not 7.00 6.75 5.50*more than 10

More than 10, but not 6.75 6.50* 5.25*more than 20

More than 20 5.75* 5.75* 4.75*

Yes No 5 or fewer 7.50 7.00 5.75*



More than 20 6.00* 6.00* 5.00*

Source: Rates calculated from the monthly averages, ending June 30, 1996, of Moody’s Corporate Bond Yield Average —Monthly Average Corporates.

*As the applicable federal interest rate for 1996 of 6.63 percent exceeds this prevailing state assumed interest rate, the interestrate to be used for this product under § 807 is 6.63 percent.

Part IV. Applicable FederalInterest Rates.

TABLE OF APPLICABLEFEDERAL INTEREST RATESFOR PURPOSES OF § 807

Year Interest Rate

1996 6.631997 6.33

Sources: Rev. Rul. 95–79, 1995–2 C.B.134 for the 1996 rate and Rev. Rul.

96–57, 1996–50 I.R.B. C.B. 5 for the1997 rate.

EFFECT ON OTHER REVENUERULINGS

Rev. Rul. 92–19 is supplemented bythe addition to Part III of that ruling ofprevailing state assumed interest ratesunder § 807 for certain insurance prod-ucts issued in 1996 and 1997 and isfurther supplemented by an addition tothe table in Part IV of Rev. Rul. 92–19

listing applicable federal interest rates.Parts I and II of Rev. Rul. 92–19 are notaffected by this ruling.


The principal author of this revenueruling is Ann H. Logan of the Office ofAssistant Chief Counsel (Financial Insti-tutions and Products). For further infor-mation regarding this revenue rulingcontact her on (202) 622–3970 (not atoll-free call).

9

Section 846.—Discounted UnpaidLosses DefinedThe adjusted applicable federal short-term, mid-

term, and long-term rates are set forth for themonth of January 1997. See Rev. Rul. 97–1, thispage.

Section 851.—Definition ofRegulated Investment Company26 CFR 1.851–2: Limitations.

Are holders of the guaranteed payment rightsthat are created by the Small Business Administra-tion (SBA) under its participating security programtreated as owning SBA debt? See Rev. Rul. 97–3,page 5.

Section 856.—Definition of RealEstate Investment Trusts26 CFR 1.856–2: Limitations.


Section 895.—Income Derived by aForeign Central Bank of Issue FromObligations of the United States orFrom Bank Deposits26 CFR 1.895–1: Income derived by a foreigncentral bank of issue, or by Bank for InternationalSettlements, from obligations of the United Statesor from bank deposits.


Section 1274.—Determination ofIssue Price in the Case of CertainDebt Instruments Issued forProperty(Also Sections 42, 280G, 382, 412, 467, 468, 482,483, 642, 807, 846, 1288, 7520, 7872.)

Federal rates; adjusted federalrates; adjusted federal long-term rate,and the long-term exempt rate. Forpurposes of sections 1274, 1288, 382,and other sections of the Code, tablesset forth the rates for January 1997.

Rev. Rul. 97–1

This revenue ruling provides variousprescribed rates for federal income taxpurposes for January 1997 (the currentmonth.) Table 1 contains the short-term,mid-term, and long-term applicable fed-eral rates (AFR) for the current monthfor purposes of section 1274(d) of theInternal Revenue Code. Table 2 containsthe short-term, mid-term, and long-termadjusted applicable federal rates (ad-justed AFR) for the current month forpurposes of section 1288(b). Table 3sets forth the adjusted federal long-termrate and the long-term tax-exempt ratedescribed in section 382(f). Table 4contains the appropriate percentages fordetermining the low-income housingcredit described in section 42(b)(2) forbuildings placed in service during thecurrent month. Table 5 contains thefederal rate for determining the presentvalue of an annuity, an interest for lifeor for a term of years, or a remainder ora reversionary interest for purposes ofsection 7520. Finally, Table 6 containsthe deemed rate of return for transfersmade during calendar year 1997 topooled income funds described in sec-tion 642(c)(5) that have been in exist-ence for less than 3 taxable years imme-diately preceding the taxable year inwhich the transfer is made.

REV. RUL. 97–1 TABLE 1

Applicable Federal Rates (AFR) for January 1997

Period for Compounding

Annual Semiannual Quarterly Monthly

Short-Term

AFR 5.63% 5.55% 5.51% 5.49%110% AFR 6.20% 6.11% 6.06% 6.03%120% AFR 6.77% 6.66% 6.61% 6.57%130% AFR 7.35% 7.22% 7.16% 7.11%

Mid-Term

AFR 6.10% 6.01% 5.97% 5.94%110% AFR 6.72% 6.61% 6.56% 6.52%120% AFR 7.34% 7.21% 7.15% 7.10%130% AFR 7.96% 7.81% 7.74% 7.69%150% AFR 9.22% 9.02% 8.92% 8.86%175% AFR 10.80% 10.52% 10.39% 10.30%

Long-Term

AFR 6.54% 6.44% 6.39% 6.36%110% AFR 7.21% 7.08% 7.02% 6.98%120% AFR 7.88% 7.73% 7.66% 7.61%130% AFR 8.55% 8.37% 8.28% 8.23%

10


Adjusted AFR for January 1997

Period for Compounding

Annual Semiannual Quarterly Monthly

Short-termadjusted AFR 3.64% 3.61% 3.59% 3.58%

Mid-termadjusted AFR 4.45% 4.40% 4.38% 4.36%

Long-termadjusted AFR 5.35% 5.28% 5.25% 5.22%


Rates Under Section 382 for January 1997

Adjusted federal long-term rate for the current month 5.35%Long-term tax-exempt rate for ownership changes during the current month (the highest of theadjusted federal long-term rates for the current month and the prior two months.) 5.60%


Appropriate Percentages Under Section 42(b)(2) for January 1997

Appropriate percentage for the 70% present value low-income housing credit 8.48%Appropriate percentage for the 30% present value low-income housing credit 3.64%


Rate Under Section 7520 for January 1997

Applicable federal rate for determining the present value of an annuity, an interest for life or aterm of years, or a remainder or reversionary interest 7.4%


Deemed Rate for Transfers to New Pooled Income Funds During 1997

Deemed rate of return for transfers during 1997 to pooled income funds that have been in ex-istence for less than 3 taxable years. 7.2%

Section 1288.—Treatment ofOriginal Issue Discount onTax-Exempt ObligationsThe adjusted applicable federal short-term, mid-


Section 7701.—Definitions26 CFR 301.7701–13A: Post-1969 domestic build-ing and loan association.


26 CFR 301.7701–3: Classification of certainbusiness entities.

T.D. 8697

DEPARTMENT OF THE TREASURYInternal Revenue Service26 CFR Parts 1, 301, and 602

Simplification of EntityClassification Rules

AGENCY: Internal Revenue Service(IRS), Treasury.

ACTION: Final regulations.

SUMMARY: This document contains fi-nal regulations that classify certain busi-ness organizations under an elective re-gime. These regulations replace theexisting classification rules.

DATES: These regulations are effectiveas of January 1, 1997. For dates ofapplicability of these regulations, seeEffective Dates under Supplementary In-formation.

FOR FURTHER INFORMATIONCONTACT: Concerning the regulations,Mark D. Harris, (202) 622–3050; con-cerning foreign organizations, WilliamH. Morris or Ronald M. Gootzeit, (202)622–3880 (not toll-free numbers).

11

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

The collections of information con-tained in these final regulations havebeen reviewed and approved by theOffice of Management and Budget inaccordance with the Paperwork Reduc-tion Act (44 U.S.C. 3507) under controlnumber 1545–1486. Responses to thesecollections of information are requiredto obtain a benefit (to choose an entity’sclassification by election).An agency may not conduct or spon-

sor, and a person is not required torespond to, a collection of informationunless the collection of information dis-plays a valid control number.The estimates of the reporting burden

in these final regulations are reflected inthe burden estimates in Form 8832(Entity Classification Election).Comments concerning the accuracy of

this burden estimate and suggestions forreducing this burden should be sent tothe Internal Revenue Service, Attn:IRS Reports Clearance Officer, T:FP,Washington, DC 20224, and to theOf-fice of Management and Budget, Attn:Desk Officer for the Department of theTreasury, Office of Information andRegulatory Affairs, Washington, DC20503.Books or records relating to these

collections of information must be re-tained as long as their contents maybecome material in the administration ofany internal revenue law. Generally, taxreturns and tax return information areconfidential, as required by 26 U.S.C.6103.

Background

On April 3, 1995, Notice 95–14(1995–1 C.B. 297), relating to classifica-tion of business organizations under sec-tion 7701 of the Code, was published inthe Internal Revenue Bulletin. A noticeof public hearing was published in theFederal Register on May 10, 1995 (60FR 24813). Written comments were re-ceived and a public hearing was held onJuly 20, 1995.

On May 13, 1996, the IRS and Trea-sury issued a notice of proposedrulemaking (61 FR 21989 [PS–43–95,1996–24 I.R.B. 20]) under section 7701.The regulations proposed to replace theexisting regulations for classifying cer-tain business organizations with an elec-tive regime. Comments responding tothe notice were received, and a public

hearing was held on August 21, 1996.After considering the comments thatwere received in response to the noticeof proposed rulemaking and the state-ments made at the public hearing, theproposed regulations are adopted as re-vised by this Treasury decision. Therevisions are discussed below.

Explanation of Provisions

Section 7701(a)(2) of the Code de-fines a partnership to include a syndi-cate, group, pool, joint venture, or otherunincorporated organization, through orby means of which any business, finan-cial operation, or venture is carried on,and that is not a trust or estate or acorporation. Section 7701(a)(3) defines acorporation to include associations,joint-stock companies, and insurancecompanies.The existing regulations for classify-

ing business organizations as associa-tions (which are taxable as corporationsunder section 7701(a)(3)) or as partner-ships under section 7701(a)(2) are basedon the historical differences under locallaw between partnerships and corpora-tions. Treasury and the IRS believe thatthose rules have become increasinglyformalistic. This document replacesthose rules with a much simpler ap-proach that generally is elective.As stated in the preamble to the

proposed regulations, in light of theincreased flexibility under an electiveregime for the creation of organizationsclassified as partnerships, Treasury andthe IRS will continue to monitor care-fully the uses of partnerships in theinternational context and will take ap-propriate action when partnerships areused to achieve results that are inconsis-tent with the policies and rules ofparticular Code provisions or of U.S. taxtreaties.

A. Summary of the Regulations

Section 301.7701–1 provides an over-view of the rules applicable in determin-ing an organization’s classification forfederal tax purposes. The first step inthe classification process is to determinewhether there is a separate entity forfederal tax purposes. The regulationsexplain that certain joint undertakingsthat are not entities under local law maynonetheless constitute separate entitiesfor federal tax purposes; however, notall entities formed under local law arerecognized as separate entities for fed-eral tax purposes. Whether an organiza-tion is treated as an entity for federal

tax purposes is a matter of federal taxlaw, and does not affect the rights andobligations of its owners under locallaw. For example, if a domestic limitedliability company with a single indi-vidual owner is disregarded as an entityseparate from its owner under§ 301.7701–3, its individual owner issubject to federal income tax as if thecompany’s business was operated as asole proprietorship.An organization that is recognized as

a separate entity for federal tax purposesis either a trust or a business entity(unless a provision of the Code ex-pressly provides for special treatment,such as the Qualified Settlement Fundrules (§ 1.468B) or the Real EstateMortgage Investment Conduit (REMIC)rules, see section 860A(a)). The regula-tions provide that trusts generally do nothave associates or an objective to carryon business for profit. The distinctionsbetween trusts and business entities, al-though restated, are not changed bythese regulations.Section 301.7701–2 clarifies that busi-

ness entities that are classified as corpo-rations for federal tax purposes includecorporations denominated as such underapplicable law, as well as associations,joint-stock companies, insurance compa-nies, organizations that conduct certainbanking activities, organizations whollyowned by a State, organizations that aretaxable as corporations under a provi-sion of the Code other than section7701(a)(3), and certain organizationsformed under the laws of a foreignjurisdiction (including a U.S. possession,territory, or commonwealth).The regulations in § 301.7701–2 in-

clude a special grandfather rule, underwhich an entity described in the list offoreign entities treated as per se corpo-rations will nevertheless be classified asother than a corporation. The regulationsalso list certain situations where agrandfathered entity would lose itsgrandfathered status.Any business entity that is not re-

quired to be treated as a corporation forfederal tax purposes (referred to in theregulation as aneligible entity) maychoose its classification under the rulesof § 301.7701–3. Those rules providethat an eligible entity with at least twomembers can be classified as either apartnership or an association, and thatan eligible entity with a single membercan be classified as an association orcan be disregarded as an entity separatefrom its owner. However, if the singleowner of a business entity is a bank (as

12

defined in section 581), then the specialrules applicable to banks will continueto apply to the single owner as if thewholly owned entity were a separateentity.In order to provide most eligible

entities with the classification theywould choose without requiring them tofile an election, the regulations providedefault classification rules that aim tomatch taxpayers’ expectations (and thusreduce the number of elections that willbe needed). The regulations adopt apassthrough default for domestic enti-ties, under which a newly formed eli-gible entity will be classified as apartnership if it has at least two mem-bers, or will be disregarded as an entityseparate from its owner if it has a singleowner. The default for foreign entities isbased on whether the members havelimited liability. Thus a foreign eligibleentity will be classified as an associationif all members have limited liability. Aforeign eligible entity will be classifiedas a partnership if it has two or moremembers and at least one member doesnot have limited liability; the entity willbe disregarded as an entity separatefrom its owner if it has a single ownerand that owner does not have limitedliability. Finally, the default classifica-tion for an existing entity is the classifi-cation that the entity claimed immedi-ately prior to the effective date of theseregulations. An entity’s default classifi-cation continues until the entity elects tochange its classification by means of anaffirmative election.An eligible entity may affirmatively

elect its classification on Form 8832,Entity Classification Election. The regu-lations require that the election besigned by each member of the entity orany officer, manager, or member of theentity who is authorized to make theelection and who represents to havingsuch authorization under penalties ofperjury. An election will not be acceptedunless it includes all of the requiredinformation, including the entity’s tax-payer identifying number (TIN).Taxpayers are reminded that a change

in classification, no matter howachieved, will have certain tax conse-quences that must be reported. For ex-ample, if an organization classified as anassociation elects to be classified as apartnership, the organization and itsowners must recognize gain, if any,under the rules applicable to liquidationsof corporations.a

B. Discussion of Comments on theGeneral Approach and Scope of theRegulations

Several comments requested clarifica-tion with regard to the rules for deter-mining when an owner of an interest inan organization will be respected as abona fide owner for federal tax pur-poses. Some commentators were con-cerned, for example, that certain ownerswould be required to maintain certainnet worth requirements. Other commen-tators, relying on Rev. Rul. 93–4,1993–1 C.B. 225, suggested that if twowholly-owned subsidiaries of a commonparent were the owners of an organiza-tion, those owners would not be re-spected as bona fide owners and theorganization would be treated as havingonly one owner (the common parent).Although the determination of whetheran organization has more than oneowner is based on all the facts andcircumstances, the fact that some or allof the owners of an organization areunder common control does not requirethe common parent to be treated as thesole owner. Consistent with this ap-proach, Rev. Rul. 93–4 treated twowholly owned subsidiaries as associatesand then classified the foreign entitybased on the four corporate characteris-tics under section 7701. While thesefour factors will no longer apply withthe adoption of the regulations, deter-mining whether the subsidiaries are as-sociates continues to be an issue.The IRS has received a number of

comments asking for clarification of thetax treatment of entities that are whollyowned by an Indian tribe and incorpo-rated under tribal law. Treasury and theIRS are currently studying this issue andwill, if necessary, issue separate guid-ance regarding this issue.Most commentators agreed that inclu-

sion of the list of foreign businessentities treated as corporations per sewas appropriate. However, several com-mentators requested clarification aboutcertain foreign business entities on theper se list. Other commentators re-quested clarification whether and howthe list of such corporations might beupdated in the future. The regulationsare clarified with respect to entitiesformed in the following jurisdictions:Aruba, Canada, People’s Republic ofChina, Republic of China (Taiwan), In-dia, Indonesia, Netherlands Antilles, andSweden. Any further modifications willbe announced in a notice of proposedrulemaking and will be prospective only.

Commentators also raised the issue ofhow to determine if a joint venture orother contractual arrangement that isconsidered a separate entity under theseregulations is considered a foreign ordomestic entity. This issue is outside thescope of these regulations and thus isnot addressed in the final regulations.Some commentators raised issues re-

lating to the application of the grandfa-ther rule for certain existing entitiesorganized under foreign statutes in-cluded on the list of per se corporations.In particular, commentators requestedclarification regarding existing entitiesthat would be listed on the per se list.Commentators have asked whether anexisting entity on the per se list whichhad claimed non-corporate status couldretain that status, and, if so, whether itcould subsequently elect to be treated asa corporation. Commentators also askedfor clarification as to the effect of adeemed termination under section708(b)(1)(B) or a division under section708(b)(2)(B) on a grandfathered per seentity.In response to these comments, the

grandfather rules clarify that an entityon the list which was previously disre-garded as a separate entity (i.e., treatedas a branch) or was treated as a partner-ship may continue to be treated as suchwhen the regulations become effective.Moreover, entities on the list whichcontinue to treat themselves as branchesor partnerships after the effective date ofthe regulations may subsequently electto be treated as corporations. However,after such election they may not subse-quently elect to be treated as a partner-ship or a branch. Finally, any termina-tion under section 708(b)(1)(B) (exceptin the case of a sale or exchange ofinterests in an entity described in§ 301.7701–2(d)(2) where the sale orexchange is to a related person withinthe meaning of sections 267(b) and707(b) and occurs no later than 12months after the date the entity isformed) or division under section708(b)(2)(B) will end the grandfatheredstatus of any entity on the per se list,and therefore the successor entity (orentities) will thereafter be permanentlytreated as a corporation.Other commentators suggested that

the requirement that an existing entityincluded on the per se list must haveclaimed passthrough treatment for allprior periods is burdensome and pre-cludes grandfather treatment for entitiesthat restructured in the past and recog-nized the resulting tax consequences. In

13

response to these comments, the regula-tions are modified to indicate that anexisting entity can continue to be treatedas a non-corporate entity if it was inexistence on May 8, 1996, and wasreasonably treated as a non-corporateentity on that date (or formed thereafterpursuant to a written binding contract ineffect on May 8, 1996, in which theparties agreed to engage (directly orindirectly) in an active and substantialbusiness operation in the jurisdiction inwhich the entity is formed, and whichwould otherwise meet the grandfatherrules if the date the entity is formed issubstituted for May 8, 1996). If theentity changed its claimed tax statuswithin the sixty months prior to May 8,1996, the entity and its members musthave recognized the tax consequencesthat resulted from that change in taxstatus. Moreover, the regulations clarifythat the grandfather treatment applies ifno person for whom the entity’s classifi-cation was relevant on May 8, 1996,treats the entity as a corporation forpurposes of filing such person’s federalincome tax returns, information returns,and withholding documents for the pe-riod including May 8, 1996.One commentator suggested that it

was unclear when the classification of aforeign entity is ‘‘relevant’’ for federaltax purposes. This determination is im-portant, as it affects whether the grand-father rule, the default rule for existingentities, or the default rule for a newlyformed foreign entity applies. In gen-eral, an entity’s classification is relevantwhen its classification affects the liabil-ity of any person for federal tax orinformation purposes. The date that theclassification of a foreign entity is rel-evant is the date an event occurs thatcauses an obligation to file a return orstatement for which the classification ofthe entity must be determined.

C. Discussion of Comments Relating tothe Elective Regime

Most of the commentators agreed thatthe default rules included in the pro-posed regulations generally would matchtaxpayers’ expectations. However, somecommentators expressed concern overthe application of the default rule fornewly formed foreign eligible entitieswhich would treat such entities as asso-ciations if no member had unlimitedliability. Specifically, certain commenta-tors noted that under the definition ofunlimited liability in the proposed regu-lations, certain contractual joint ventures

which, under current law, would gener-ally be classified as partnerships, wouldbe treated as associations under thedefault rule. The members of thesecontractual joint ventures are not jointlyand severally liable for all debts of theentity; rather, each member has unlim-ited liability for a certain proportion ofthe debts of the entity. To simplify thedefault rules, the regulations are modi-fied to provide that a newly formedforeign eligible entity will— (1) betreated as a partnership if it has at leasttwo members and at least one memberdoes not have limited liability; (2) betreated as an association if all membersof the entity have limited liability; and(3) be disregarded as an entity separatefrom its owner if it has a single ownerthat does not have limited liability.The regulations are modified to pro-

vide that a member does not havelimited liability if the member, by virtueof being a member, has personal liabil-ity for all or any portion of the debts ofthe entity.Certain commentators asked for clari-

fication of the default rule in the casewhere the relevant statute or law of aparticular country provides for limitedor unlimited liability. Generally, theregulations specify that only the statuteor law is relevant. Where, however, theunderlying statute allows the entity tospecify in its organizational documentswhether the members will have limitedliability, the organizational documentsmay be relevant.Some commentators requested that

taxpayers be allowed to make classifica-tion elections with their first tax returns.The regulations retain the requirementthat elections be made at the beginningof the taxable year. Treasury and theIRS continue to believe that it is appro-priate to determine an entity’s classifica-tion at the time that it begins its opera-tions. Taxpayers can specify the date onwhich an election will be effective,provided that date is not more than 75days prior to the date on which theelection is filed (irrespective of whenthe interest was acquired) and not morethan 12 months after the date the elec-tion was filed. If a taxpayer specifies aneffective date more than 75 days priorto the date on which the election isfiled, the election will be effective 75days prior to the date on which theelection was filed. If a taxpayer speci-fies an effective date more than 12months from the filing date, the electionwill be effective 12 months after the

date the election was filed. No election,whenever filed, will be effective beforeJanuary 1, 1997.One commentator expressed concern

about the ability to make protectiveelections where there is uncertainty, forexample, about an entity’s status as abusiness entity. Such protective electionsare not prohibited under the regulations.The regulations limit the ability of an

entity to make multiple classificationelections by prohibiting more than oneelection to change an entity’s classifica-tion during any sixty month period. Onecommentator suggested that the regula-tions be amended to waive applicationof this rule in certain circumstances,particularly when there has been a sub-stantial change in ownership of theentity. In response to this comment, theregulations permit the Commissioner towaive the application of the sixty monthlimitation by letter ruling. However,waivers will not be granted unless therehas been more than a fifty percentownership change. The sixty monthlimitation only applies to a change inclassification by election; the limitationdoes not apply if the organization’sbusiness is actually transferred to an-other entity.Several commentators requested clari-

fication concerning the classification ofa foreign entity when the classificationof the entity becomes relevant for fed-eral tax purposes after a period duringwhich the classification of the entitywas not relevant. Generally, such anentity will retain its prior classification.However, if the classification of a for-eign eligible entity which was previ-ously relevant for federal tax purposesceases to be relevant for sixty consecu-tive months, the entity’s classificationwill be determined initially under thedefault classification when the classifi-cation of the foreign eligible entityagain becomes relevant.Some commentators requested clarifi-

cation regarding the rule permittingelections to be signed by any authorizedofficer, manager, or member of theelecting entity. The regulations retainthis rule, as it provides taxpayers withflexibility in complying with the elec-tion requirements. The determination ofwhether a person is authorized to makean election is based on local law. Thus,the election can be made by anyoneauthorized to act on behalf of the entity.Several commentators asked for guid-

ance regarding the necessary signatureson the classification election. The regu-lations are modified to provide that if

14

the election is made by all of themembers, each person who is an ownerat the time the election is made mustconsent to the election. However, if anelection is to be effective for any periodprior to the date it is filed, each personwho was an owner between the date theelection is to be effective and the datethe election is filed (even if by anauthorized person), and who is not anowner at the time the election is filed,must also consent to the election.Several commentators requested that

the classification election be coordinatedwith the election under section 856(c)(1)to be a real estate investment trust(REIT). Because the latter election isrequired to be made with the REIT’sfirst tax return, the regulations are modi-fied to provide that an election by aneligible entity to be a REIT will betreated as a deemed election to beclassified as an association, effective forthe entire period during which REITstatus is claimed.Some commentators suggested that

the regulations should not require anentity or its direct or indirect owners toattach a copy of the entity’s election totheir federal tax returns. Specifically,some commentators were concerned thatthe failure of one owner to attach acopy of the election to the owner’sreturn would void an otherwise validelection. The regulations retain the re-quirement that taxpayers must attach acopy of the election to their returns, butclarify that failure to do so will notinvalidate an otherwise valid election.Although the failure to attach a copywill not adversely affect an otherwisevalid election, taxpayers are remindedthat each member of the entity is re-quired to file returns that are consistentwith the entity’s election. Failure toattach the election form to a federal taxor information return as directed in theregulations may give rise to penaltiesagainst the non-filing party. Other appli-cable penalties may also apply to partieswho file federal tax or information re-turns inconsistent with the entity’s elec-tion.One commentator asked for guidance

on the treatment of conversions by elec-tion from partnership to corporation andfrom corporation to partnership. Thisissue is outside the scope of theseclassification rules and thus is not ad-dressed in these regulations. Treasuryand the IRS, however, are actively con-sidering issuing guidance on the treat-ment of such conversions.

D. Effective Dates

The regulations are effective as ofJanuary 1, 1997.The regulations provide a special

transition rule for existing entities. TheIRS will not challenge the prior classifi-cation of an existing eligible entity, oran existing entity described on the perse list, for periods prior to January 1,1997, if— (1) the entity had a reason-able basis (within the meaning of sec-tion 6662) for its claimed classification;(2) the entity and all members of theentity recognized the federal tax conse-quences of any change in the entity’sclassification within the sixty monthsprior to January 1, 1997; and (3) neitherthe entity nor any member had beennotified in writing on or before May 8,1996, that the classification of the entitywas under examination (in which casethe entity’s classification will be deter-mined in the examination).Some commentators were concerned

that an entity organized after May 8,1996, would be excluded from thistransition rule for existing entities. Be-cause § 301.7701–3(f)(2) applies to en-tities that were in existence prior toJanuary 1, 1997, no change is necessaryto provide relief for entities organizedafter May 8, 1996.Some commentators were concerned

about entities that claimed to be trustsfor the period prior to January 1, 1997,but are subsequently determined to bebusiness entities. In that case, the enti-ty’s claimed classification for purposesof applying the provisions of the specialtransition rule will be the business entityclassification claimed by the entity afterit has been determined to be a businessentity.

Effect on other documents

The Service has published a numberof revenue rulings and revenue proce-dures interpreting the section 7701 regu-lations. The Service is currently review-ing these revenue rulings and revenueprocedures to determine which are af-fected by the publication of these regu-lations. See accompanying Notice 97–1.Special AnalysesIt has been determined that this Trea-

sury decision is not a significant regula-tory action as defined in EO 12866.Therefore, a regulatory assessment is notrequired. It also has been determinedthat section 553(b) of the AdministrativeProcedure Act (5 U.S.C. chapter 5) doesnot apply to these regulations. It ishereby certified that these regulations do

not have a significant economic impacton a substantial number of small enti-ties. This certification is based upon thefact that the automatic classificationrules of § 301.7701–2(b) and the defaultclassification rules of § 301.7701–3(b)will operate in such a manner that onlya limited number of entities will need tomake an election under § 301.7701–3(c)to determine their classification. There-fore, a Regulatory Flexibility Analysisunder the Regulatory Flexibility Act (5U.S.C. chapter 6) is not required. Pursu-ant to section 7805(f) of the InternalRevenue Code, the notice of proposedrulemaking preceding these final regula-tions has been submitted to the ChiefCounsel for Advocacy of the SmallBusiness Administration for comment onits impact on small business.

Drafting Information

The principal authors of these regula-tions are Armando Gomez and Mark D.Harris of the Office of Assistant ChiefCounsel (Passthroughs and Special In-dustries) and William H. Morris andRonald M. Gootzeit of the Office ofAssociate Chief Counsel (International).However, other personnel from the IRSand Treasury Department participated intheir development.

* * * * *

Adoption of Amendments to the Regula-tions

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

PART 1—INCOME TAXES

Paragraph 1. The authority citationfor part 1 continues to read in part asfollows:Authority: 26 U.S.C. 7805 * * *Par. 2. Section 1.581–1 is revised to

read as follows:

§ 1.581–1 Banks.

(a) In order to be a bank as definedin section 581, an institution must be acorporation for federal tax purposes. See§ 301.7701–2(b) of this chapter for thedefinition of a corporation.(b) This section is effective as of

January 1, 1997.Par. 3. Section 1.581–2 is amended as

follows:1. Paragraph (a) is removed.2. Paragraphs (b) and (c) are redesig-

nated as paragraphs (a) and (b), respec-tively.

15

3. Newly designated paragraph (a) isamended by revising the second and lastsentences.The revisions read as follows:

§ 1.581–2 Mutual savings banks, build-ing and loan associations, and coopera-tive banks.

(a) * * * See section 593 for specialrules concerning reserves for bad debts.* * * See also section 594 and§ 1.594–1 for special rules governingthe taxation of a mutual savings bankconducting a life insurance business.

* * * * *Par. 4. In § 1.761–1, paragraph (a) is

revised to read as follows:

§ 1.761–1 Terms defined.

(a) Partnership.The termpartnershipmeans a partnership as determined under§§ 301.7701–1, 301.7701–2, and301.7701–3 of this chapter.

* * * * *

PART 301—PROCEDURE ANDADMINISTRATION

Par. 5. The authority citation for part301 continues to read in part as follows:Authority: 26 U.S.C. 7805 * * *Par. 6. Section 301.6109–1 is

amended as follows:1. Paragraph (b)(2)(iii) is amended by

removing the language ‘‘and’’ at the endof the paragraph.2. Paragraph (b)(2)(iv) is amended by

removing the period at the end of theparagraph, and replacing it with thelanguage ‘‘; and’’.3. Paragraph (b)(2)(v) is added.4. The text of paragraph (d)(2) is

redesignated as paragraph (d)(2)(i).5. A paragraph heading is added for

newly designated paragraph (d)(2)(i).6. Paragraph (d)(2)(ii) is added.The revisions and additions read as

follows:

§ 301.6109–1 Identifying numbers.* * * * *

(b) * * *(2) * * *(v) A foreign person that makes an

election under § 301.7701–3(c).* * * * *

(d) * * *(2) Employer identification number—

(i) In general. * * *(ii) Special rule for entities electing

to change their federal tax classificationunder § 301.7701–3(c).Any entity thathas an employer identification numberand then elects under § 301.7701–3(c)

to change its federal tax classificationwill retain that employer identificationnumber.

* * * * *Par. 7. Sections 301.7701–1,

301.7701–2, and 301.7701–3 are revisedto read as follows:

§ 301.7701–1 Classification of organi-zations for federal tax purposes.(a) Organizations for federal tax pur-

poses—(1) In general. The Internal Rev-enue Code prescribes the classificationof various organizations for federal taxpurposes. Whether an organization is anentity separate from its owners for fed-eral tax purposes is a matter of federaltax law and does not depend on whetherthe organization is recognized as anentity under local law.(2) Certain joint undertakings give

rise to entities for federal tax purposes.A joint venture or other contractualarrangement may create a separate entityfor federal tax purposes if the partici-pants carry on a trade, business, finan-cial operation, or venture and divide theprofits therefrom. For example, a sepa-rate entity exists for federal tax purposesif co-owners of an apartment buildinglease space and in addition provideservices to the occupants either directlyor through an agent. Nevertheless, ajoint undertaking merely to share ex-penses does not create a separate entityfor federal tax purposes. For example, iftwo or more persons jointly construct aditch merely to drain surface water fromtheir properties, they have not created aseparate entity for federal tax purposes.Similarly, mere co-ownership of prop-erty that is maintained, kept in repair,and rented or leased does not constitutea separate entity for federal tax pur-poses. For example, if an individualowner, or tenants in common, of farmproperty lease it to a farmer for a cashrental or a share of the crops, they donot necessarily create a separate entityfor federal tax purposes.(3) Certain local law entities not rec-

ognized. An entity formed under locallaw is not always recognized as aseparate entity for federal tax purposes.For example, an organization whollyowned by a State is not recognized as aseparate entity for federal tax purposesif it is an integral part of the State.Similarly, tribes incorporated under sec-tion 17 of the Indian Reorganization Actof 1934, as amended, 25 U.S.C. 477, orunder section 3 of the Oklahoma IndianWelfare Act, as amended, 25 U.S.C.

503, are not recognized as separateentities for federal tax purposes.(4) Single owner organizations. Un-

der §§ 301.7701–2 and 301.7701–3,certain organizations that have a singleowner can choose to be recognized ordisregarded as entities separate fromtheir owners.(b) Classification of organizations.

The classification of organizations thatare recognized as separate entities isdetermined under §§ 301.7701–2,301.7701–3, and 301.7701–4 unless aprovision of the Internal Revenue Code(such as section 860A addressing RealEstate Mortgage Investment Conduits(REMICs)) provides for special treat-ment of that organization. For the classi-fication of organizations as trusts, see§ 301.7701–4. That section providesthat trusts generally do not have associ-ates or an objective to carry on businessfor profit. Sections 301.7701–2 and301.7701–3 provide rules for classifyingorganizations that are not classified astrusts.(c) Qualified cost sharing arrange-

ments. A qualified cost sharing arrange-ment that is described in § 1.482–7 ofthis chapter and any arrangement that istreated by the Commissioner as a quali-fied cost sharing arrangement under§ 1.482–7 of this chapter is not recog-nized as a separate entity for purposesof the Internal Revenue Code. See§ 1.482–7 of this chapter for the propertreatment of qualified cost sharing ar-rangements.(d) Domestic and foreign entities. For

purposes of this section and§§ 301.7701–2 and 301.7701–3, an en-tity is a domestic entity if it is createdor organized in the United States orunder the law of the United States or ofany State; an entity is foreign if it is notdomestic. See sections 7701(a)(4) and(a)(5).(e) State. For purposes of this section

and § 301.7701–2, the termState in-cludes the District of Columbia.(f) Effective date. The rules of this

section are effective as of January 1,1997.

§ 301.7701–2 Business entities; defini-tions.

(a) Business entities. For purposes ofthis section and § 301.7701–3, abusi-ness entityis any entity recognized forfederal tax purposes (including an entitywith a single owner that may be disre-garded as an entity separate from itsowner under § 301.7701–3) that is not

16

properly classified as a trust under§ 301.7701–4 or otherwise subject tospecial treatment under the Internal Rev-enue Code. A business entity with twoor more members is classified for fed-eral tax purposes as either a corporationor a partnership. A business entity withonly one owner is classified as a corpo-ration or is disregarded; if the entity isdisregarded, its activities are treated inthe same manner as a sole proprietor-ship, branch, or division of the owner.(b) Corporations. For federal tax pur-

poses, the termcorporation means—(1) A business entity organized under

a Federal or State statute, or under astatute of a federally recognized Indiantribe, if the statute describes or refers tothe entity as incorporated or as a corpo-ration, body corporate, or body politic;(2) An association (as determined un-

der § 301.7701–3);(3) A business entity organized under

a State statute, if the statute describes orrefers to the entity as a joint-stockcompany or joint-stock association;(4) An insurance company;(5) A State-chartered business entity

conducting banking activities, if any ofits deposits are insured under the Fed-eral Deposit Insurance Act, as amended,12 U.S.C. 1811 et seq., or a similarfederal statute;(6) A business entity wholly owned

by a State or any political subdivisionthereof;(7) A business entity that is taxable

as a corporation under a provision of theInternal Revenue Code other than sec-tion 7701(a)(3); and(8) Certain foreign entities—(i) In

general. Except as provided in para-graphs (b)(8)(ii) and (d) of this section,the following business entities formed inthe following jurisdictions:American Samoa, CorporationArgentina, Sociedad AnonimaAustralia, Public Limited CompanyAustria, AktiengesellschaftBarbados, Limited CompanyBelgium, Societe AnonymeBelize, Public Limited CompanyBolivia, Sociedad AnonimaBrazil, Sociedade AnonimaCanada, Corporation and CompanyChile, Sociedad AnonimaPeople’s Republic of China, Gufen

Youxian GongsiRepublic of China (Taiwan), Ku-fen

Yu-hsien Kung-szuColombia, Sociedad AnonimaCosta Rica, Sociedad AnonimaCyprus, Public Limited CompanyCzech Republic, Akciova Spolecnost

Denmark, AktieselskabEcuador, Sociedad Anonima or

Compania AnonimaEgypt, Sharikat Al-MossahamahEl Salvador, Sociedad AnonimaFinland, Osakeyhtio/AktiebolagFrance, Societe AnonymeGermany, AktiengesellschaftGreece, Anonymos EtairiaGuam, CorporationGuatemala, Sociedad AnonimaGuyana, Public Limited CompanyHonduras, Sociedad AnonimaHong Kong, Public Limited CompanyHungary, ReszvenytarsasagIceland, HlutafelagIndia, Public Limited CompanyIndonesia, Perseroan TerbukaIreland, Public Limited CompanyIsrael, Public Limited CompanyItaly, Societa per AzioniJamaica, Public Limited CompanyJapan, Kabushiki KaishaKazakstan, Ashyk Aktsionerlik

KoghamRepublic of Korea, Chusik HoesaLiberia, CorporationLuxembourg, Societe AnonymeMalaysia, BerhadMalta, Partnership AnonymeMexico, Sociedad AnonimaMorocco, Societe AnonymeNetherlands, Naamloze VennootschapNew Zealand, Limited CompanyNicaragua, Compania AnonimaNigeria, Public Limited CompanyNorthern Mariana Islands, Corpora-

tionNorway, AksjeselskapPakistan, Public Limited CompanyPanama, Sociedad AnonimaParaguay, Sociedad AnonimaPeru, Sociedad AnonimaPhilippines, Stock CorporationPoland, Spolka AkcyjnaPortugal, Sociedade AnonimaPuerto Rico, CorporationRomania, Societe pe ActiuniRussia, Otkrytoye Aktsionernoy

ObshchestvoSaudi Arabia, Sharikat Al-

MossahamahSingapore, Public Limited CompanySlovak Republic, Akciova SpolocnostSouth Africa, Public Limited Com-

panySpain, Sociedad AnonimaSurinam, Naamloze VennootschapSweden, Publika AktiebolagSwitzerland, AktiengesellschaftThailand, Borisat Chamkad

(Mahachon)Trinidad and Tobago, Public Limited

Company

Tunisia, Societe AnonymeTurkey, Anonim SirketUkraine, Aktsionerne Tovaristvo

Vidkritogo TipuUnited Kingdom, Public Limited

CompanyUnited States Virgin Islands, Corpora-

tionUruguay, Sociedad AnonimaVenezuela, Sociedad Anonima or

Compania Anonima(ii) Exceptions in certain cases. The

following entities will not be treated ascorporations under paragraph (b)(8)(i) ofthis section:(A) With regard to Canada, any cor-

poration or company formed under anyfederal or provincial law which providesthat the liability of all of the membersof such corporation or company will beunlimited; and(B) With regard to India, a company

deemed to be a public limited companysolely by operation of Section 43A(1)(relating to corporate ownership of thecompany), section 43A(1A) (relating toannual average turnover), or section43A(1B) (relating to ownership interestsin other companies) of the CompaniesAct, 1956 (or any combination of these),provided that the organizational docu-ments of such deemed public limitedcompany continue to meet the require-ments of section 3(1)(iii) of the Compa-nies Act, 1956.(iii) Public companies. With regard to

Cyprus, Hong Kong, Jamaica, andTrinidad and Tobago, the term publiclimited company includes any limitedcompany which is not a private limitedcompany under the laws of those juris-dictions.(iv) Limited companies. Any refer-

ence to a limited company (whetherpublic or private) in paragraph (b)(8)(i)of this section includes, as the case maybe, companies limited by shares andcompanies limited by guarantee.(v) Multilingual countries. Different

linguistic renderings of the name of anentity listed in paragraph (b)(8)(i) of thissection shall be disregarded. For ex-ample, an entity formed under the lawsof Switzerland as a Societe Anonymewill be a corporation and treated in thesame manner as an Aktiengesellschaft.(c) Other business entities. For fed-

eral tax purposes—(1) The term partnership means a

business entity that is not a corporationunder paragraph (b) of this section andthat has at least two members.(2) Wholly owned entities—(i) In

general. A business entity that has a

17

single owner and is not a corporationunder paragraph (b) of this section isdisregarded as an entity separate fromits owner.(ii) Special rule for certain business

entities. If the single owner of a busi-ness entity is a bank (as defined insection 581), then the special rules ap-plicable to banks will continue to applyto the single owner as if the whollyowned entity were a separate entity.(d) Special rule for certain foreign

business entities—(1) In general. Exceptas provided in paragraph (d)(3) of thissection, a foreign business entity de-scribed in paragraph (b)(8)(i) of thissection will not be treated as a corpora-tion under paragraph (b)(8)(i) of thissection if—(i) The entity was in existence on

May 8, 1996;(ii) The entity’s classification was rel-

evant (as defined in § 301.7701–3(d))on May 8, 1996;(iii) No person (including the entity)

for whom the entity’s classification wasrelevant on May 8, 1996, treats theentity as a corporation for purposes offiling such person’s federal income taxreturns, information returns, and with-holding documents for the taxable yearincluding May 8, 1996;(iv) Any change in the entity’s

claimed classification within the sixtymonths prior to May 8, 1996, occurredsolely as a result of a change in theorganizational documents of the entity,and the entity and all members of theentity recognized the federal tax conse-quences of any change in the entity’sclassification within the sixty monthsprior to May 8, 1996;(v) A reasonable basis (within the

meaning of section 6662) existed onMay 8, 1996, for treating the entity asother than a corporation; and(vi) Neither the entity nor any mem-

ber was notified in writing on or beforeMay 8, 1996, that the classification ofthe entity was under examination (inwhich case the entity’s classificationwill be determined in the examination).(2) Binding contract rule. If a foreign

business entity described in paragraph(b)(8)(i) of this section is formed afterMay 8, 1996, pursuant to a writtenbinding contract (including an acceptedbid to develop a project) in effect onMay 8, 1996, and all times thereafter, inwhich the parties agreed to engage (di-rectly or indirectly) in an active andsubstantial business operation in the ju-risdiction in which the entity is formed,paragraph (d)(1) of this section will be

applied to that entity by substituting thedate of the entity’s formation for May 8,1996.(3) Termination of grandfather sta-

tus—(i) In general. An entity that is nottreated as a corporation under paragraph(b)(8)(i) of this section by reason ofparagraph (d)(1) or (d)(2) of this sectionwill be treated permanently as a corpo-ration under paragraph (b)(8)(i) of thissection from the earliest of:(A) The effective date of an election

to be treated as an association under§ 301.7701–3;(B) A termination of the partnership

under section 708(b)(1)(B) (regardingsale or exchange of 50 percent or moreof the total interest in an entity’s capitalor profits within a twelve month pe-riod); or(C) A division of the partnership un-

der section 708(b)(2)(B).(ii) Special rule for certain entities.

For purposes of paragraph (d)(2) of thissection, paragraph (d)(3)(i)(B) of thissection shall not apply if the sale orexchange of interests in the entity is to arelated person (within the meaning ofsections 267(b) and 707(b)) and occursno later than twelve months after thedate of the formation of the entity.(e) Effective date. The rules of this

section are effective as of January 1,1997.

§ 301.7701–3 Classification of certainbusiness entities.

(a) In general. A business entity thatis not classified as a corporation under§ 301.7701–2(b)(1), (3), (4), (5), (6),(7), or (8) (aneligible entity) can electits classification for federal tax purposesas provided in this section. An eligibleentity with at least two members canelect to be classified as either an asso-ciation (and thus a corporation under§ 301.7701–2(b)(2)) or a partnership,and an eligible entity with a singleowner can elect to be classified as anassociation or to be disregarded as anentity separate from its owner. Para-graph (b) of this section provides adefault classification for an eligible en-tity that does not make an election.Thus, elections are necessary only whenan eligible entity chooses to be classi-fied initially as other than the defaultclassification or when an eligible entitychooses to change its classification. Anentity whose classification is determinedunder the default classification retainsthat classification (regardless of anychanges in the members’ liability that

occurs at any time during the time thatthe entity’s classification is relevant asdefined in paragraph (d) of this section)until the entity makes an election tochange that classification under para-graph (c)(1) of this section. Paragraph(c) of this section provides rules formaking express elections. Paragraph (d)of this section provides special rules forforeign eligible entities. Paragraph (e) ofthis section provides special rules forclassifying entities resulting from part-nership terminations and divisions undersection 708(b). Paragraph (f) of thissection sets forth the effective date ofthis section and a special rule relating toprior periods.(b) Classification of eligible entities

that do not file an election—(1) Domes-tic eligible entities. Except as providedin paragraph (b)(3) of this section, un-less the entity elects otherwise, a domes-tic eligible entity is—(i) A partnership if it has two or

more members; or(ii) Disregarded as an entity separate

from its owner if it has a single owner.(2) Foreign eligible entities—(i) In

general. Except as provided in para-graph (b)(3) of this section, unless theentity elects otherwise, a foreign eligibleentity is—(A) A partnership if it has two or

more members and at least one memberdoes not have limited liability;(B) An association if all members

have limited liability; or(C) Disregarded as an entity separate

from its owner if it has a single ownerthat does not have limited liability.(ii) Definition of limited liability. For

purposes of paragraph (b)(2)(i) of thissection, a member of a foreign eligibleentity has limited liability if the memberhas no personal liability for the debts ofor claims against the entity by reason ofbeing a member. This determination isbased solely on the statute or law pursu-ant to which the entity is organized,except that if the underlying statute orlaw allows the entity to specify in itsorganizational documents whether themembers will have limited liability, theorganizational documents may also berelevant. For purposes of this section, amember has personal liability if thecreditors of the entity may seek satisfac-tion of all or any portion of the debts orclaims against the entity from the mem-ber as such. A member has personalliability for purposes of this paragrapheven if the member makes an agreementunder which another person (whether ornot a member of the entity) assumes

18

such liability or agrees to indemnify thatmember for any such liability.(3) Existing eligible entities—(i) In

general. Unless the entity elects other-wise, an eligible entity in existence priorto the effective date of this section willhave the same classification that theentity claimed under §§ 301.7701–1through 301.7701–3 as in effect on thedate prior to the effective date of thissection; except that if an eligible entitywith a single owner claimed to be apartnership under those regulations, theentity will be disregarded as an entityseparate from its owner under this para-graph (b)(3)(i). For special rules regard-ing the classification of such entities forperiods prior to the effective date of thissection, see paragraph (f)(2) of thissection.(ii) Special rules. For purposes of

paragraph (b)(3)(i) of this section, aforeign eligible entity is treated as beingin existence prior to the effective date ofthis section only if the entity’s classifi-cation was relevant (as defined in para-graph (d) of this section) at any timeduring the sixty months prior to theeffective date of this section. If an entityclaimed different classifications prior tothe effective date of this section, theentity’s classification for purposes ofparagraph (b)(3)(i) of this section is thelast classification claimed by the entity.If a foreign eligible entity’s classifica-tion is relevant prior to the effectivedate of this section, but no federal tax orinformation return is filed or the federaltax or information return does not indi-cate the classification of the entity, theentity’s classification for the period priorto the effective date of this section isdetermined under the regulations in ef-fect on the date prior to the effectivedate of this section.(c) Elections—(1) Time and place for

filing—(i) In general. Except as pro-vided in paragraphs (c)(1)(iv) and (v) ofthis section, an eligible entity may electto be classified other than as providedunder paragraph (b) of this section, or tochange its classification, by filing Form8832, Entity Classification Election,with the service center designated onForm 8832. An election will not beaccepted unless all of the informationrequired by the form and instructions,including the taxpayer identifying num-ber of the entity, is provided on Form8832. See § 301.6109–1 for rules onapplying for and displaying EmployerIdentification Numbers.(ii) Further notification of elections.

An eligible entity required to file a

federal tax or information return for thetaxable year for which an election ismade under paragraph (c)(1)(i) of thissection must attach a copy of its Form8832 to its federal tax or informationreturn for that year. If the entity is notrequired to file a return for that year, acopy of its Form 8832 must be attachedto the federal income tax or informationreturn of any direct or indirect owner ofthe entity for the taxable year of theowner that includes the date on whichthe election was effective. An indirectowner of the entity does not have toattach a copy of the Form 8832 to itsreturn if an entity in which it has aninterest is already filing a copy of theForm 8832 with its return. If an entity,or one of its direct or indirect owners,fails to attach a copy of a Form 8832 toits return as directed in this section, anotherwise valid election under paragraph(c)(1)(i) of this section will not beinvalidated, but the non-filing party maybe subject to penalties, including anyapplicable penalties if the federal tax orinformation returns are inconsistent withthe entity’s election under paragraph(c)(1)(i) of this section.(iii) Effective date of election. An

election made under paragraph (c)(1)(i)of this section will be effective on thedate specified by the entity on Form8832 or on the date filed if no such dateis specified on the election form. Theeffective date specified on Form 8832can not be more than 75 days prior tothe date on which the election is filedand can not be more than 12 monthsafter the date on which the election isfiled. If an election specifies an effectivedate more than 75 days prior to the dateon which the election is filed, it will beeffective 75 days prior to the date it wasfiled. If an election specifies an effectivedate more than 12 months from the dateon which the election is filed, it will beeffective 12 months after the date it wasfiled. If an election specifies an effectivedate before January 1, 1997, it will beeffective as of January 1, 1997.(iv) Limitation. If an eligible entity

makes an election under paragraph(c)(1)(i) of this section to change itsclassification (other than an electionmade by an existing entity to change itsclassification as of the effective date ofthis section), the entity cannot change itsclassification by election again duringthe sixty months succeeding the effec-tive date of the election. However, theCommissioner may permit the entity tochange its classification by electionwithin the sixty months if more than

fifty percent of the ownership interestsin the entity as of the effective date ofthe subsequent election are owned bypersons that did not own any interests inthe entity on the filing date or on theeffective date of the entity’s prior elec-tion.(v) Deemed elections—(A) Exempt

organizations. An eligible entity that hasbeen determined to be, or claims to be,exempt from taxation under section501(a) is treated as having made anelection under this section to be classi-fied as an association. Such election willbe effective as of the first day for whichexemption is claimed or determined toapply, regardless of when the claim ordetermination is made, and will remainin effect unless an election is madeunder paragraph (c)(1)(i) of this sectionafter the date the claim for exemptstatus is withdrawn or rejected or thedate the determination of exempt statusis revoked.(B) Real estate investment trusts. An

eligible entity that files an election un-der section 856(c)(1) to be treated as areal estate investment trust is treated ashaving made an election under thissection to be classified as an association.Such election will be effective as of thefirst day the entity is treated as a realestate investment trust.(vi) Examples. The following ex-

amples illustrate the rules of this para-graph (c)(1):Example 1. On July 1, 1998, X, a domestic

corporation, purchases a 10% interest in Y, aneligible entity formed under Country A law in1990. The entity’s classification was not relevantto any person for federal tax or informationpurposes prior to X’s acquisition of an interest inY. Thus, Y is not considered to be in existence onthe effective date of this section for purposes ofparagraph (b)(3) of this section. Under the appli-cable Country A statute, all members of Y havelimited liability as defined in paragraph (b)(2)(ii)of this section. Accordingly, Y is classified as anassociation under paragraph (b)(2)(i)(B) of thissection unless it elects under this paragraph (c) tobe classified as a partnership. To be classified as apartnership as of July 1, 1998, Y must file a Form8832 by September 13, 1998. See paragraph(c)(1)(i) of this section. Because an electioncannot be effective more than 75 days prior to thedate on which it is filed, if Y files its Form 8832after September 13, 1998, it will be classified asan association from July 1, 1998, until the effec-tive date of the election. In that case, it could notchange its classification by election under thisparagraph (c) during the sixty months succeedingthe effective date of the election.Example 2. (i) Z is an eligible entity formed

under Country B law and is in existence on theeffective date of this section within the meaning ofparagraph (b)(3) of this section. Prior to theeffective date of this section, Z claimed to beclassified as an association. Unless Z files an

19

election under this paragraph (c), it will continueto be classified as an association under paragraph(b)(3) of this section.

(ii) Z files a Form 8832 pursuant to thisparagraph (c) to be classified as a partnership,effective as of the effective date of this section. Zcan file an election to be classified as an associa-tion at any time thereafter, but then would not bepermitted to change its classification by electionduring the sixty months succeeding the effectivedate of that subsequent election.

(2) Authorized signatures—(i) In gen-eral. An election made under paragraph(c)(1)(i) of this section must be signedby—(A) Each member of the electing en-

tity who is an owner at the time theelection is filed; or(B) Any officer, manager, or member

of the electing entity who is authorized(under local law or the entity’s organiza-tional documents) to make the electionand who represents to having such au-thorization under penalties of perjury.(ii) Retroactive elections. For pur-

poses of paragraph (c)(2)(i) of this sec-tion, if an election under paragraph(c)(1)(i) of this section is to be effectivefor any period prior to the time that it isfiled, each person who was an ownerbetween the date the election is to beeffective and the date the election isfiled, and who is not an owner at thetime the election is filed, must also signthe election.(d) Special rules for foreign eligible

entities—(1) For purposes of this sec-tion, a foreign eligible entity’s classifica-tion is relevant when its classificationaffects the liability of any person forfederal tax or information purposes. Forexample, a foreign entity’s classificationwould be relevant if U.S. income waspaid to the entity and the determinationby the withholding agent of the amountto be withheld under chapter 3 of theInternal Revenue Code (if any) wouldvary depending upon whether the entityis classified as a partnership or as anassociation. Thus, the classificationmight affect the documentation that thewithholding agent must receive from theentity, the type of tax or informationreturn to file, or how the return must beprepared. The date that the classificationof a foreign eligible entity is relevant isthe date an event occurs that creates anobligation to file a federal tax return,information return, or statement forwhich the classification of the entitymust be determined. Thus, the classifi-cation of a foreign entity is relevant, forexample, on the date that an interest in

the entity is acquired which will requirea U.S. person to file an informationreturn on Form 5471.(2) Special rule when classification is

no longer relevant. If the classificationof a foreign eligible entity which waspreviously relevant for federal tax pur-poses ceases to be relevant for sixtyconsecutive months, the entity’s classifi-cation will initially be determined underthe default classification when the clas-sification of the foreign eligible entityagain becomes relevant. The date thatthe classification of a foreign entityceases to be relevant is the date anevent occurs that causes the classifica-tion to no longer be relevant, or, if noevent occurs in a taxable year thatcauses the classification to be relevant,then the date is the first day of thattaxable year.(e) Coordination with section 708(b).

Except as provided in § 301.7701–2(d)(3) (regarding termination of grand-father status for certain foreign businessentities), an entity resulting from atransaction described in section708(b)(1)(B) (partnership terminationdue to sales or exchanges) or section708(b)(2)(B) (partnership division) is apartnership.(f) Effective date—(1) In general.

The rules of this section are effective asof January 1, 1997.(2) Prior treatment of existing enti-

ties. In the case of a business entity thatis not described in § 301.7701–2(b)(1),(3), (4), (5), (6), or (7), and that was inexistence prior to January 1, 1997, theentity’s claimed classification(s) will berespected for all periods prior to January1, 1997, if—(i) The entity had a reasonable basis

(within the meaning of section 6662) forits claimed classification;(ii) The entity and all members of the

entity recognized the federal tax conse-quences of any change in the entity’sclassification within the sixty monthsprior to January 1, 1997; and(iii) Neither the entity nor any mem-

ber was notified in writing on or beforeMay 8, 1996, that the classification ofthe entity was under examination (inwhich case the entity’s classificationwill be determined in the examination).Par. 8. Section 301.7701–4 is

amended as follows:1. The last sentence of paragraphs

(b), (c)(1), (c)(2)Example 1, and (c)(2)Example 3are revised.2. Paragraph (f) is added.

The revisions and addition read asfollows:

§ 301.7701–4 Trusts.

* * * * *(b) Business trusts. * * * The fact

that any organization is technically castin the trust form, by conveying title toproperty to trustees for the benefit ofpersons designated as beneficiaries, willnot change the real character of theorganization if the organization is moreproperly classified as a business entityunder § 301.7701–2.(c) * * * (1) * * * An investment

trust with multiple classes of ownershipinterests ordinarily will be classified asa business entity under § 301.7701–2;however, an investment trust with mul-tiple classes of ownership interests, inwhich there is no power under the trustagreement to vary the investment of thecertificate holders, will be classified as atrust if the trust is formed to facilitatedirect investment in the assets of thetrust and the existence of multipleclasses of ownership interests is inciden-tal to that purpose.(2) * * *Example 1. * * * As a consequence,

the existence of multiple classes of trustownership is not incidental to any pur-pose of the trust to facilitate directinvestment, and, accordingly, the trust isclassified as a business entity under§ 301.7701–2.

* * * * *Example 3. * * * Accordingly, the

trust is classified as a business entityunder § 301.7701–2.

* * * * *(f) Effective date. The rules of this

section generally apply to taxable yearsbeginning after December 31, 1960.Paragraph (e)(5) of this section containsrules of applicability for paragraph (e)of this section. In addition, the lastsentences of paragraphs (b), (c)(1), and(c)(2) Example 1andExample 3of thissection are effective as of January 1,1997.Par. 9. Section 301.7701–6 is revised

to read as follows:

§ 301.7701–6 Definitions; person, fidu-ciary.

(a) Person. The termperson includesan individual, a corporation, a partner-ship, a trust or estate, a joint-stockcompany, an association, or a syndicate,group, pool, joint venture, or other unin-corporated organization or group. Theterm also includes a guardian, commit-

20

tee, trustee, executor, administrator,trustee in bankruptcy, receiver, assigneefor the benefit of creditors, conservator,or any person acting in a fiduciarycapacity.(b) Fiduciary—(1) In general. Fidu-

ciary is a term that applies to personswho occupy positions of peculiar confi-dence toward others, such as trustees,executors, and administrators. A fidu-ciary is a person who holds in trust anestate to which another has a beneficialinterest, or receives and controls incomeof another, as in the case of receivers. Acommittee or guardian of the propertyof an incompetent person is a fiduciary.(2) Fiduciary distinguished from

agent. There may be a fiduciary rela-tionship between an agent and a princi-pal, but the word agent does not denotea fiduciary. An agent having entirecharge of property, with authority toeffect and execute leases with tenantsentirely on his own responsibility andwithout consulting his principal, merelyturning over the net profits from theproperty periodically to his principal byvirtue of authority conferred upon himby a power of attorney, is not a fidu-ciary within the meaning of the Internal

Revenue Code. In cases when no legaltrust has been created in the estatecontrolled by the agent and attorney, theliability to make a return rests with theprincipal. (c) Effective date. The rulesof this section are effective as of Janu-ary 1, 1997.

§ 301.7701–7 [Removed]

Par. 10. Section 301.7701–7 is re-moved.

PART 602—OMB CONTROLNUMBERS UNDER THEPAPERWORK REDUCTION ACT

Par. 11. The authority citation for part602 continues to read as follows:Authority: 26 U.S.C. 7805.

§ 602.101 [Amended]

Par. 12. In § 602.101, paragraph (c)is amended by adding a new entry innumerical order to the table to read asfollows:

§ 602.101 OMB Control numbers.

* * * * *

(c) * * *

CFR part or section whereidentified or described

Current OMBcontrol No.

* * * * *301.7701–3 . . . . . . . . . . . . . . . . 1545–1486

* * * * *

Margaret Milner Richardson,Commissioner of Internal Revenue.

Approved December 10, 1996.

Donald C. Lubick,Assistant Secretary of the Treasury.

(Filed by the Office of the Federal Register onDecember 17, 1996, 8:45 a.m., and published inthe issue of the Federal Register for December 18,1996, 61 F.R. 66584)

Section 7520.—Valuation TablesThe adjusted applicable federal short-term, mid-


Section 7872.—Treatment of LoansWith Below-Market Interest RatesThe adjusted applicable federal short-term, mid-


21

Part III. Administrative, Procedural, and MiscellaneousObsolescence of Revenue Rulingsand Revenue Procedures Under TD8697, Simplification of EntityClassification Regulations (Checkthe Box)

Notice 97–1

This notice accompanies TD 8697,Simplification of Entity ClassificationRegulations (published in the FederalRegister on December 18, 1996). Thepurpose of this notice is to alert taxpay-ers to the effect of the regulations onexisting revenue rulings and revenueprocedures that apply the prior classifi-cation regulations under § 7701 of theInternal Revenue Code. Effective Janu-ary 1, 1997, such revenue rulings andrevenue procedures are obsolete to theextent that they use the prior classifica-tion regulations to distinguish betweenpartnerships and associations.The Internal Revenue Service is com-

piling a list of these obsolete documentsthat will be published in the InternalRevenue Bulletin.The principal author of this notice is

Mark D. Harris of the Office of Assis-tant Chief Counsel (Passthroughs andSpecial Industries). For further informa-tion regarding this notice contact Mr.Harris at (202) 622-3050 (not a toll-freecall).

Cash or Deferred Arrangements;Nondiscrimination

Notice 97–2

This notice provides guidance andtransition relief relating to the revisednondiscrimination rules under § 401(k)and § 401(m) of the Internal RevenueCode. The rules applicable to qualifiedcash or deferred arrangements under§ 401(k) and matching and employeecontributions under § 401(m) werechanged by the Small Business JobProtection Act of 1996 (SBJPA), Pub. L.104–188.Under § 401(k) and § 401(m) of the

Code, the actual deferral percentage(ADP) and the actual contribution per-centage (ACP) of highly compensatedemployees (HCEs) are compared withthose of nonhighly compensated em-ployees (NHCEs). Section 1433(c) ofthe SBJPA amends § 401(k)(3)(A) and§ 401(m)(2)(A), effective for plan yearsbeginning after December 31, 1996, toprovide for the use of prior year data in

determining the ADP and ACP ofNHCEs, while current year data is usedfor HCEs. Alternatively, an employermay elect to use current year data fordetermining the ADP and ACP for bothHCEs and NHCEs, but this election mayonly be changed as provided by theSecretary. Prior to the effective date ofthese amendments, plans must use cur-rent year data in determining the ADPand ACP for both HCEs and NHCEs.Section 1433(e) of the SBJPA amends

§ 401(k)(8)(C) and § 401(m)(6)(C), ef-fective for plan years beginning afterDecember 31, 1996, to provide that thedistribution of excess contributions andexcess aggregate contributions will bemade on the basis of the amount ofcontributions by, or on behalf of, eachHCE. Prior to the effective date of theseamendments, plans must distribute ex-cess contributions and excess aggregatecontributions using a method based onthe actual deferral ratio or actual contri-bution ratio of each HCE.This notice provides guidance regard-

ing the determination of the ADP andACP for NHCEs under § 401(k)(3)-(A)(ii) and § 401(m)(2)(A) for planyears beginning after December 31,1996; transition relief for plans thatelect to use current year ADP or ACPdata for the 1997 plan year; and guid-ance regarding the distribution of excesscontributions and excess aggregate con-tributions under § 401(k)(8)(C) and§ 401(m)(6)(C) for plan years beginningafter December 31, 1996.

I. DETERMINATION OF ADP ANDACP FOR NHCEs USING PRIORYEAR DATA

Section 401(k)(3)(A)(ii), as amended,provides that a cash or deferred arrange-ment will not be treated as a qualifiedcash or deferred arrangement unless theactual deferral percentage for eligibleHCEs for the plan year meets a nondis-crimination test when compared to theactual deferral percentage for all othereligible employees for the precedingplan year. Thus, as amended,§ 401(k)(3)(A)(ii) generally requires thecomparison of the current year’s ADPfor HCEs to the prior year’s ADP forNHCEs.For purposes of § 401(k)(3)(A)(ii),

the actual deferral percentage for allother eligible employees for the preced-ing plan year is the ADP for the preced-ing plan year for the group of employ-ees who were NHCEs in the preceding

plan year, using the definition of HCEin effect for the preceding plan year.Thus, for purposes of § 401(k)(3)-(A)(ii), the individuals taken into ac-count in determining the prior year’sADP for NHCEs are those individualswho were NHCEs during the precedingyear, without regard to the individuals’status in the current year. For example,an individual who was an NHCE for thepreceding plan year is included in thiscalculation even if the individual is nolonger employed by the employer or hasbecome an HCE in the current planyear.As a result, the prior year’s ADP for

NHCEs can be calculated as soon as thenecessary data on prior year status,contributions and compensation becomeavailable. For example, for the 1997plan year, if a plan does not provide formatching contributions described in§ 401(m)(4)(A) or qualified nonelectivecontributions described in § 401(m)-(4)(C), the ADP for the 1997 plan yearof HCEs will be compared with theADP for the 1996 plan year of NHCEsin 1996, i.e., with the same ADP used innondiscrimination testing for the 1996plan year under prior law. Future guid-ance will address the conditions underwhich and the extent to which matchingcontributions described in § 401(m)-(4)(A) and qualified nonelective contri-butions described in § 401(m)(4)(C)may be taken into account in determin-ing the current or prior year’s ADP orACP for NHCEs in nondiscriminationtesting for the 1997 plan year and futureplan years.For purposes of determining the prior

year’s ACP for NHCEs under§ 401(m)(2)(A), as amended, rules simi-lar to those used in determining theprior year’s ADP for NHCEs under§ 401(k)(3)(A)(ii) will apply.

II. TRANSITION RELIEF FOR PLANSUSING CURRENT YEAR ADP ORACP DATA FOR THE 1997 PLANYEAR

Under § 401(k)(3)(A)(ii) and§ 401(m)(2)(A), as amended, an em-ployer that elects to use current yeardata in determining the ADP or ACP ofNHCEs for the 1997 plan year or forlater plan years must continue to usecurrent year data for all future planyears, unless the election is changed in amanner provided by the Secretary.Under the transition relief provided

by this notice, a plan that uses current

22

year data in determining the ADP orACP of NHCEs for the 1997 plan yearwill be permitted to use prior year datafor the 1998 plan year without receivingapproval from the Service. For the 1997plan year, no plan amendment or formalelection is required to be made in 1996or 1997 in order to continue to usecurrent year data in determining theADP of NHCEs. The Treasury and theService intend to issue guidance regard-ing the conditions under which employ-ers that elect to use current year data forthe 1998 or a later plan year may switchto using prior year data for subsequentplan years.

III. DISTRIBUTION OF EXCESSCONTRIBUTIONS AND EXCESS AG-GREGATE CONTRIBUTIONS

Section 401(k)(8), as amended, pro-vides a new procedure for correcting aplan’s failure to meet the nondiscrimina-tion test of § 401(k)(3). Under§ 401(k)(8)(B), which was not amendedby the SBJPA, an excess contribution isdetermined for each HCE. Section401(k)(8)(C), prior to amendment, and§ 1.401(k)-1(f)(2) of the Income TaxRegulations provided for the distributionof this amount to each HCE. Parallelrules applied to correction of failure tosatisfy the nondiscrimination test of§ 401(m).The SBJPA amended § 401(k)(8)(C)

to provide that distributions of excesscontributions for any plan year are madeto HCEs on the basis of the amount ofcontributions by, or on behalf of, eachHCE. This amendment does not affectthe total amount of the excess contribu-tions to be distributed, but merely real-locates the distributions among theHCEs.Accordingly, in order to distribute

excess contributions under § 401(k)(8),as amended, the following procedure isused:1. Calculate the dollar amount ofexcess contributions for each af-fected HCE in a manner describedin § 401(k)(8)(B) and § 1.401(k)-1(f)(2). However, in applying theserules, rather than distributing theamount necessary to reduce theactual deferral ratio (ADR) of eachaffected HCE in order of theseemployees’ ADRs, beginning withthe highest ADR, the plan usesthese amounts in step 2.

2. Determine the total of the dollaramounts calculated in step 1.

This total amount in step 2 (totalexcess contributions) should be distrib-uted in accordance with steps 3 and 4below:3. The elective contributions of theHCE with the highest dollaramount of elective contributions arereduced by the amount required tocause that HCE’s elective contribu-tions to equal the dollar amount ofthe elective contributions of theHCE with the next highest dollaramount of elective contributions.This amount is then distributed tothe HCE with the highest dollaramount. However, if a lesser reduc-tion, when added to the total dollaramount already distributed underthis step, would equal the totalexcess contributions, the lesser re-duction amount is distributed.

4. If the total amount distributed isless than the total excess contribu-tions, step 3 is repeated.

If these distributions are made, thecash or deferred arrangement is treatedas meeting the nondiscrimination test of§ 401(k)(3) regardless of whether theADP, if recalculated after distributions,would satisfy § 401(k)(3).A parallel method is used for the

purpose of recharacterizing excess con-tributions under § 401(k)(8)(A)(ii) andfor distributing excess aggregate contri-butions under § 401(m)(6)(C), asamended.After excess and excess aggregate

contributions, if any, have been distrib-uted using the method described above,the multiple use test of § 401(m)(9) isapplied. For purposes of § 401(m)(9), ifa corrective distribution of excess con-tributions has been made, or arecharacterization has occurred, the ADPfor HCEs is deemed to be the largestamount permitted under § 401(k)(3).Similarly, if a corrective distribution ofexcess aggregate contributions has beenmade, the ACP for HCEs is deemed tobe the largest amount permitted under§ 401(m)(2).The method described above for dis-

tributing excess contributions is illus-trated by the following example:For the 1997 plan year, HCE 1 haselective contributions of $8,500 and$85,000 in compensation, for an ADRof 10%, and HCE 2 has elective contri-butions of $9,500 and compensation of$158,333, for an ADR of 6%. As aresult, the ADP for the 2 HCEs underthe plan (HCE 1 and HCE 2) is 8%.The ADP for the NHCEs is 3%. Underthe ADP test of § 401(k)(3)(A)(ii), the

ADP of the two HCEs under the planmay not exceed 5% (i.e., 2 percentagepoints more than the ADP of theNHCEs under the plan).Pursuant to § 401(k)(8)(B), § 1.401-

(k)-1(f)(2), and this notice, the totalexcess contributions for the HCEs isdetermined as follows:Step 1. The elective contributions ofHCE 1 (the HCE with the highestADR) are reduced by $3,400 in orderto reduce the ADR of HCE 1 to 6%($5,100/$85,000), which is the ADRof HCE 2. Because the ADP of theHCEs still exceeds 5%, the ADP testof § 401(k)(3)(A)(ii) is not satisfiedand further reductions in elective con-tributions are necessary. The electivecontributions of HCE 1 and HCE 2are each reduced by one percent ofcompensation ($850 and $1,583 re-spectively). Because the ADP of theHCEs now equals 5%, the ADP testof § 401(k)(3)(A)(ii) is satisfied, andno further reductions in elective con-tributions are necessary.

Step 2. The total excess contributionsfor the HCEs that must be distributedequal $5,833, the total reductions inelective contributions under step 1($3,400 + $850 + $1,583).Pursuant to § 401(k)(8)(C), the $5,833

in total excess contributions for the 1997plan year would then be distributed asfollows:Step 3. The plan distributes $1,000 inelective contributions to HCE 2 (theHCE with the highest dollar amountof elective contributions) in order toreduce the dollar amount of the elec-tive contributions of HCE 2 to$8,500, which is the dollar amount ofthe elective contributions of HCE 1.

Step 4. Because the total amount distrib-uted ($1,000) is less than the totalexcess contributions ($5,833), step 3must be repeated. As the dollaramounts of remaining elective contri-butions for both HCE 1 and HCE 2are equal, the remaining $4,833 ofexcess contributions is then distrib-uted equally to HCE 1 and HCE 2 inthe amount of $2,416.50 each.Under this example, HCE 1 must

receive a total distribution of $2,416.50of excess contributions, and HCE 2must receive a total distribution of$3,416.50 of excess contributions. Thisis true even though the ADR of HCE 1exceeded the ADR of HCE 2. The planis now treated as satisfying the nondis-crimination test of § 401(k)(3) even

23

though the ADP would fail to satisfy§ 401(k)(3), if recalculated after distri-butions.

COMMENTS REQUESTED

The Treasury and the Service invitecomments and suggestions regarding thematters discussed in this notice. Com-ments are specifically requested con-cerning:—The use of qualified matching and

qualified nonelective contributions incomputing the prior year’s ADP forNHCEs, including methods of prevent-ing inappropriate double counting.—The appropriate determination of

the prior year’s ADP for NHCEs whenthe group of employees tested is signifi-cantly different in the current year thanin the prior year.

Comments can be addressed toCC:DOM:CORP:R (Notice 97–2), room5228, Internal Revenue Service, POB7604, Ben Franklin Station, Washington,DC 20044. In the alternative, commentsmay be hand delivered between thehours of 8 a.m. and 5 p.m. toCC:DOM:CORP:R (Notice 97–2), Cou-rier’s Desk, Internal Revenue Service,1111 Constitution Avenue NW., Wash-ington, DC. Alternatively, taxpayers maytransmit comments electronicallyvia the IRS Internet site at http://www.irs.ustreas.gov/prod/tax_regs/comments/html.


The principal authors of this noticeare Kenneth Conn of the EmployeePlans Division and Catherine Fernandezof the Office of the Associate ChiefCounsel (Employee Benefits and Ex-empt Organizations). For further infor-mation regarding this notice, contact theEmployee Plans Division’s telephone as-sistance service between 1:30 and 4:00p.m., Eastern Time, Monday throughThursday at (202) 622–6074/75 or Ken-neth Conn at (202) 622–6214. (Thesetelephone numbers are not toll-freenumbers.)

Subchapter S CorporationSubsidiaries

Notice 97–4

PURPOSE

Section 1308 of the Small BusinessJob Protection Act of 1996, Pub. L. No.104–188, 110 Stat. 1755 (the Act) modi-fied § 1361 of the Internal Revenue

Code to permit an S corporation (1) toown 80 percent or more of the stock ofa C corporation, and (2) to elect to owna qualified subchapter S subsidiary(QSSS).To help taxpayers comply with the

law, the Department of the Treasury andthe Internal Revenue Service intend toissue regulations interpreting § 1308 ofthe Act. This notice solicits commentsfrom taxpayers and practitioners regard-ing the issues listed below. However,any other comments concerning thechanges made by § 1308 of the Act willbe considered in developing regulatoryguidance. This notice also provides tem-porary guidance on the manner in whicha QSSS election must be made and theeffective date of the election.

BACKGROUND

Prior law prohibited a subchapter Scorporation from owning 80 percent ormore of the stock of another corpora-tion. Furthermore, an S corporationcould not have a corporation as a share-holder. Congress modified these con-straints by enacting § 1308 of the Act,effective for taxable years beginningafter December 31, 1996. The Act addednew §§ 1361(b)(3), 1362(d)(3)(F), and1504(b)(8) to the Code, while removing§ 1361(b)(2)(A) and 1361(c)(6).By removing § 1361(b)(2)(A), the

Act permits an S corporation to own 80percent or more of a C corporation. Atthe same time, new § 1504(b)(8) pre-vents an S corporation from joining inthe filing of a consolidated return withits affiliated C corporations, but doesnot prevent the C corporation subsidiaryfrom filing a consolidated return with itsaffiliated C corporations.SeeH.R. Conf.Rep. No. 737, 104th Cong., 2d Sess.224 (1996).Under prior law, the S election of a

corporation with C earnings and profitsterminated if that S corporation receivedpassive income, including dividends, inexcess of 25 percent of gross receiptsfor 3 consecutive years. Section1363(d)(3)(F) modifies that general ruleby excluding dividends from passiveinvestment income to the extent that thedividends are attributable to the activeconduct of a trade or business of a Ccorporation in which the S corporationhas an 80 percent or greater ownershipinterest. However, neither the Act northe legislative history provides rules fordetermining the attribution of dividendsto an active trade or business.

New § 1361(b)(3)(B) defines theterm ‘‘qualified subchapter S subsid-iary’’ as a domestic corporation that isnot an ineligible corporation, if (1) an Scorporation holds 100 percent of thestock of the corporation, and (2) that Scorporation elects to treat the subsidiaryas a QSSS. Section 1361(b)(3)(A) pro-vides that a corporation that is a QSSSis not treated as a separate corporation,and all assets, liabilities, and items ofincome, deduction, and credit of theQSSS are treated as assets, liabilities,and items of income, deduction, andcredit of the parent S corporation.The statutory provisions do not pro-

vide guidance on how the corporationmakes the election, the effective date ofthe election, or how the commingling ofassets, liabilities, and other items occursafter the election is made. The legisla-tive history, however, indicates thatwhen the parent corporation makes theelection, the subsidiary will be deemedto have liquidated under §§ 332 and337 immediately before the election iseffective. SeeS. Rep. No. 281, 104thCong., 2d Sess. 53 (1996)(Senate Re-port); H.R. Rep. No. 586, 104th Cong.,2d Sess. 89 (1996)(House Report).Where the S corporation acquires thestock of the subsidiary in a qualifiedstock purchase, the corporation maymake an election under § 338 withrespect to the subsidiary.Section 1361(b)(3)(C) provides that

any QSSS that ceases to meet therequirements of § 1361(b)(3)(B) will betreated as a new corporation acquiringall of its assets (and assuming all of itsliabilities) immediately before the cessa-tion from its S corporation parent in adeemed exchange for the subsidiary’sstock. Upon the termination,§ 1361(b)(3)(D) provides that theformer QSSS (and any successor corpo-ration) is not eligible to make either aQSSS election or an election to betreated as an S corporation before itsfifth taxable year that begins after thefirst taxable year for which the termina-tion is effective, unless the Secretaryconsents to the election.

REQUEST FOR COMMENTS

The Service and Treasury invite com-ments from the public on issues thatshould be addressed in proposed regula-tions implementing § 1308 of the Act.The Service is particularly interested inreceiving comments on the following:1) The attribution of dividends re-

ceived by an S corporation from an 80

24

percent or greater owned C corporationbetween earnings and profits attributableto the active conduct of a trade orbusiness or to passive investments of theC corporation, particularly in situationswhere the C corporation is a member ofan affiliated group that files a consoli-dated return;2) Issues arising upon the formation

of a QSSS, including those arising fromthe operation of §§ 332 and 337 or§ 338;3) Issues arising upon the termination

of a QSSS; and4) Issues arising when a QSSS elec-

tion is made for a subsidiary that is amember of a consolidated group. Writ-ten comments should be sent to thefollowing address:Internal Revenue ServiceCC:DOM:CORP (NT 97–4;CC:DOM:P&SI:1)

P.O. Box 7604, Ben Franklin StationWashington, DC 20044

In the alternative, comments may behand delivered between the hours of8:00 a.m. and 5:00 p.m. to the courier’sdesk at 1111 Constitution Avenue, NW.,Washington, DC, or submitted electroni-cally via the IRS internet site at http://www.irs.ustreas.gov/prod/tax_regs/comments.html.

TEMPORARY QSSS ELECTIONPROCEDURE

The legislative history supporting§ 1308 of the Act indicates that when aparent corporation makes an election totreat a subsidiary as a QSSS, the subsid-iary will be deemed to have liquidatedunder §§ 332 and 337 immediately be-fore the election is effective.SeeSenateReport at 53; House Report at 89. Whena corporation liquidates under § 332,that corporation must file a CorporateDissolution or Liquidation Form 966within 30 days of the adoption of aliquidating plan or resolution. In addi-tion, that corporation must file a returnfor the short period ending on the datethat it goes out of existence.The Service and Treasury intend to

issue regulations describing the mannerin which a QSSS election must be madeand the effective date of the election.Until regulations are issued, however,taxpayers should follow the procedureslisted in this notice to satisfy the elec-tion requirements.To make the QSSS election, the par-

ent corporation should file a Form 966with the Service Center. When complet-ing the form, the parent corporation

should follow the instructions applicableto that form with the following modifi-cations:1. At the top of the Form 966, print

‘‘FILED PURSUANT TO NO-TICE 97–4.’’

2. In the box labeled ‘‘Employeridentification number’’ (EIN), enterthe subsidiary’s EIN (if appli-cable). If the subsidiary was not inexistence prior to the time of elec-tion and does not have an EIN,there will be no need to obtain ataxpayer identification number forthe subsidiary. In this case, insert‘‘QSSS’’ in the box. (If the parentcorporation chooses to obtain anEIN for the newly-formed QSSS,the parent should check ‘‘Other’’when asked the ‘‘Type of entity’’on the SS–4, and specify that theentity is a QSSS.)

3. In Box 4 on Form 966, enter thedesired effective date for the elec-tion. The election may be effectiveon the date Form 966 is filed or upto 75 days prior to the filing ofForm 966, provided that date isnot before the effective date of§ 1308 of the Act and that thesubsidiary otherwise qualified as aQSSS for the entire period forwhich the retroactive election is ineffect. For these purposes, the re-quirement that Form 966 be filedwithin 30 days of the date in Box4 is ignored.

4. In Box 7c on Form 966, enter thename of the parent. The parent’sEIN should be included in Box 7d.

5. In Box 10 on Form 966, enter‘‘§ 1361(b)(3)(B).’’

6. Form 966 must be signed by acorporate officer authorized to signthe PARENT’s tax return.

Banks and bank holding companiesshould consult Notice 97–5, 1997–2I.R.B., before filing an election underthe procedures listed above.


The principal author of this notice isDeanna L. Walton of the Office ofAssistant Chief Counsel (Passthroughsand Special Industries). For further in-formation regarding this notice contactMs. Walton at (202) 622–3050 (not atoll-free call).

Subchapter S Banks — Sections1362 and 265

Notice 97–5

BACKGROUND

Section 1315 of the Small BusinessJob Protection Act of 1996 (the Act),P.L. 104–188, amended § 1361(b)(2) ofthe Internal Revenue Code to allowbanks (as defined in § 581) that do notuse the reserve method of accountingfor bad debts to qualify as small busi-ness corporations (and therefore qualifyto elect S corporation status), effectivefor tax years beginning after December31, 1996.Section 1308(b) of the Act added new

§ 1361(b)(3) to allow an S corporationto own a qualified subchapter S subsid-iary (QSSS). A subsidiary qualifies as aQSSS if (1) the subsidiary would beeligible to elect subchapter S status if itsstock were owned directly by the share-holders of its S corporation parent; (2)the S corporation parent owns 100 per-cent of the subsidiary’s stock; and (3)the parent elects to treat the subsidiaryas a QSSS. If the QSSS election ismade, the subsidiary is not treated as aseparate corporation, and all the assets,liabilities, and items of income, deduc-tion, and credit of the subsidiary aretreated as the assets, liabilities, anditems of income, deduction, and creditof the parent S corporation.This notice provides guidance on the

effect of the QSSS election under§ 1361(b)(3) on banks affiliated withnonbanks; the application of the S cor-poration passive investment incomerules of § 1362(d)(3); the application ofthe interest expense disallowance rulesof § 265; and an automatic change inmethod of accounting for bad debts.

BANKS AFFILIATED WITHNONBANKS

The Department of the Treasury andthe Internal Revenue Service are con-cerned that the interaction of § 1315and § 1308(b) of the Act creates unin-tended and inappropriate results forbanks that are affiliated with nonbankentities. Treasury and the IRS believethat the special provisions of the Codethat apply to banks should apply only tothe specific state-law entity that quali-fies as a bank under § 581 of the Code;such special bank treatment should notapply to nonbanks, even if the nonbankis affiliated with a bank and the parentelects to treat the subsidiary as a QSSS.

25

Treasury intends to work with Congresson appropriate technical corrections tothe Act to clarify the tax treatment ofbanks affiliated with nonbanks. It isanticipated that any technical correctionswill be effective as of the effective dateof the Act. In the interim, banks (includ-ing banks for which QSSS elections aremade) should continue to comply withapplicable information reporting and fil-ing requirements of the Code (e.g.,§ 6049 (Returns Regarding Payments ofInterest)).

PASSIVE INVESTMENT INCOME

Under § 1362(d)(3)(A), the S electionof a corporation with accumulated earn-ings and profits terminates if the passiveinvestment income of the corporationconstitutes more than 25 percent of itsgross receipts for each of three consecu-tive tax years. In general, § 1362(d)(3)defines ‘‘passive investment income’’ asgross receipts derived from royalties,rents, dividends, interest, annuities, andsales or exchanges of stock or securities.Passive investment income does not in-clude gross receipts directly derivedfrom the active and regular conduct of alending or finance business, providedthe corporation meets the requirementsof § 542(c)(6) (lending or finance com-pany excluded from the definition ofpersonal holding company).Similarly, § 1.1362–2(c)(5)(iii)(B)(1)-

(i) provides that passive investment in-come does not include gross receiptsdirectly derived in the ordinary courseof a trade or business of lending orfinancing. Under § 1.1362–2(c)(5)(iii)-(B)(2), gross receipts directly derived inthe ordinary course of a trade or busi-ness of lending or financing includegain (as well as interest income) fromloans originated in a lending business;however, interest earned from the in-vestment of idle funds in short-termsecurities does not constitute gross re-ceipts directly derived in the ordinarycourse of business.The Service will treat income earned

by an S corporation on the followingbanking assets as gross receipts directlyderived from the active and regularconduct of a banking business—* All loans and REMIC regular inter-ests owned, or considered to beowned, by the bank regardless ofwhether the loan originated in thebank’s business. For these pur-poses, securities described in§ 165(g)(2)(C) are not consideredloans.

* Assets required to be held to con-duct a banking business (such asFederal Reserve Bank, FederalHome Loan Bank, or Federal Agri-cultural Mortgage Bank stock orparticipation certificates issued by aFederal Intermediate Credit Bankwhich represent nonvoting stock inthe bank).

* Assets pledged to a third party tosecure deposits or business for thebank (such as assets pledged toqualify as a depository for federaltaxes or state funds).

* Investment assets (other than assetsspecified in the preceding para-graphs) that are held by the bank tosatisfy reasonable liquidity needs(including funds needed to meetanticipated loan demands).

As a result, income and gain fromthese assets will not be considered sub-ject to the passive investment incomelimitation applicable to S corporations.

INTEREST EXPENSEDISALLOWANCE

Section 265(a)(2) denies taxpayers(including banks) a deduction for inter-est on indebtedness incurred or contin-ued to purchase or carry obligations theinterest on which is wholly exempt fromfederal income taxes.Section 265(b) denies banks and other

financial institutions a deduction for theportion of a bank’s interest expense thatis allocable to tax-exempt interest andnot otherwise disallowed by § 265(a).The portion of a bank’s interest expensethat is allocable to tax-exempt interest isan amount that bears the same ratio tothe interest expense as (1) the bank’saverage adjusted bases of tax-exemptobligations acquired after August 7,1986, bears to (2) the average adjustedbases for all assets of the bank.Section 1366(a)(1) requires S corpora-

tion shareholders to determine their taxliability by taking into account their prorata share of the corporation’snonseparately computed income or lossand their share of the items of income(including tax-exempt income), loss, de-duction, or credit the separate treatmentof which could affect the liability fortax of any shareholder.Because § 265(b) provides a special

disallowance rule for banks, the Servicewill apply § 265(b) only at the banklevel in determining the amount, if any,of the bank’s interest expense that isdisallowed. To the extent indebtednessand tax-exempt obligations are taken

into account in applying § 265(b) at thebank level, they are not taken intoaccount again in applying § 265(a) atthe shareholder level.

AUTOMATIC CHANGE IN METHODOF ACCOUNTING

The Service will issue further guid-ance granting permission for an auto-matic change in method of accountingfor banks that change from the reservemethod of accounting for bad debts.This guidance will permit changes to beeffective as of the bank’s first taxableyear beginning after December 31,1996. A bank that wishes to be an Scorporation effective January 1, 1997,must file the change in method ofaccounting and the S election by March15, 1997.The principal authors of this notice

are Martin Scha¨ffer and Deane Burke ofthe Office of Assistant Chief Counsel(Passthroughs and Special Industries).For further information regarding thisnotice, contact Martin Scha¨ffer or DeaneBurke at (202) 622–3080 (not a toll-freecall).

SIMPLE IRAs; Questions andAnswers

Notice 97–6

PURPOSE

The purpose of this notice is toprovide guidance, in the form of ques-tions and answers, with respect to theSIMPLE plan provisions that are part ofthe Small Business Job Protection Actof 1996 (‘‘SBJPA’’), Pub. Law. 104–188.Section 1421 of the SBJPA estab-

lished a simplified tax-favored retire-ment plan for small employers(‘‘SIMPLE plan’’) under section 408(p)of the Internal Revenue Code. Contribu-tions under a SIMPLE plan are made toindividual retirement accounts or annu-ities (‘‘SIMPLE IRAs’’) that are estab-lished pursuant to the SIMPLE planadopted by the employer.This notice provides guidance solely

with respect to certain issues relating toSIMPLE plans under section 1421 ofthe SBJPA. No inference should bedrawn, however, regarding issues notspecifically addressed in this notice thatmay be suggested by a particular ques-tion and answer or as to why certainquestions, and not others, are included.This notice does not provide guidancewith respect to section 1422 of the

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SBJPA, which provides for a simplified401(k) arrangement within a qualifiedplan that shares many characteristicswith the SIMPLE plans described in thisnotice.

TABLE OF CONTENTS

A. SIMPLE PLANS IN GENERALB. EMPLOYERS THAT CAN ESTAB-

LISH SIMPLE PLANSC. EMPLOYEE ELIGIBILITY TO

PARTICIPATE IN A SIMPLE PLAND. SIMPLE PLAN CONTRIBUTIONSE. EMPLOYEE ELECTIONSF. VESTING REQUIREMENTSG. EMPLOYER ADMINISTRATIVE

AND NOTIFICATION REQUIRE-MENTS

H. TRUSTEE ADMINISTRATIVE RE-QUIREMENTS

I. TAX TREATMENT OF SIMPLEPLANS

J. EXCEPTION FOR USE OF DESIG-NATED FINANCIAL INSTITUTION

K. SIMPLE PLAN ESTABLISHMENT

QUESTIONS AND ANSWERS

A. SIMPLE PLANS IN GENERAL

Q. A–1: What is a SIMPLE plan?A. A–1: A SIMPLE plan is a written

arrangement established under section408(p) of the Code that provides asimplified tax-favored retirement planfor small employers. If an employerestablishes a SIMPLE plan, each em-ployee may choose whether to have theemployer make payments as contribu-tions under the SIMPLE plan or toreceive these payments directly in cash.An employer that chooses to establish aSIMPLE plan must make either match-ing contributions or nonelective contri-butions. All contributions under aSIMPLE plan are made to SIMPLEIRAs.Q. A–2: Can contributions made un-

der a SIMPLE plan be made to any typeof IRA?A. A–2: Contributions under a

SIMPLE plan may only be made to aSIMPLE IRA, not to any other type ofIRA. A SIMPLE IRA is an individualretirement account described in section408(a), or an individual retirement annu-ity described in section 408(b), to whichthe only contributions that can be madeare contributions under a SIMPLE planand rollovers or transfers from anotherSIMPLE IRA.Q. A–3: Can a SIMPLE plan be

maintained on a fiscal year basis?

A. A–3: A SIMPLE plan may onlybe maintained on a calendar year basis.Thus, for example, employer eligibilityto establish a SIMPLE plan (see Q&AsB–1 through B–5) and SIMPLE plancontributions (see Q&As D–1 throughD–6) are determined on a calendar yearbasis.

B. EMPLOYERS THAT CANESTABLISH SIMPLE PLANS

Q. B–1: Can any employer establisha SIMPLE plan?A. B–1: SIMPLE plans may be estab-

lished only by employers that had nomore than 100 employees who earned$5,000 or more in compensation duringthe preceding calendar year (the ‘‘100–employee limitation’’). See Q&As C–4and C–5 for the definition of compensa-tion. For purposes of the 100-employeelimitation, all employees employed atany time during the calendar year aretaken into account, regardless ofwhether they are eligible to participatein the SIMPLE plan. Thus, employeeswho are excludable under the rules ofsection 410(b)(3) or who have not metthe plan’s minimum eligibility require-ments must be taken into account. Em-ployees also include self-employed indi-viduals described in section 401(c)(1)who received earned income from theemployer during the year.Q. B–2: Is there a grace period that

can be used by an employer that ceasesto satisfy the 100-employee limitation?A. B–2: An employer that previously

maintained a SIMPLE plan is treated assatisfying the 100-employee limitationfor the two calendar years immediatelyfollowing the calendar year for which itlast satisfied the 100-employee limita-tion. However, if the failure to satisfythe 100-employee limitation is due to anacquisition, disposition or similar trans-action involving the employer, then thetwo-year grace period will apply only inaccordance with rules similar to therules of section 410(b)(6)(C)(i).Q. B–3: Can an employer make con-

tributions under a SIMPLE plan for acalendar year if it maintains anotherqualified plan?A. B–3: An employer cannot make

contributions under a SIMPLE plan fora calendar year if the employer, or apredecessor employer, maintains a quali-fied plan under which any of its em-ployees receives an allocation of contri-butions (in the case of a definedcontribution plan) or has an increase ina benefit accrued or treated as an ac-

crued benefit under section 411(d)(6) (inthe case of a defined benefit plan) forany plan year beginning or ending inthat calendar year. For this purpose, a‘‘qualified plan’’ means a plan, contract,pension or trust described in section219(g)(5) and includes a qualified plan(described in section 401(a)), a qualifiedannuity plan (described in section403(a)), an annuity contract (describedin section 403(b)), a plan established foremployees of a state, a political subdivi-sion or by an agency or instrumentalityof any state or political subdivision(other than an eligible deferred compen-sation plan described in section 457(b)),a simplified employee pension (‘‘SEP’’)(described in section 408(k)) and a trustdescribed in section 501(c)(18). In ap-plying these rules, transfers, rollovers orforfeitures are disregarded, except to theextent forfeitures replace otherwise re-quired contributions.Q. B–4: Are tax-exempt employers

and governmental entities permitted tomaintain SIMPLE plans?A. B–4: Yes. Excludable contribu-

tions may be made to the SIMPLE IRAof employees of tax-exempt employersand governmental entities on the samebasis as contributions may be made toemployees of other eligible employers.Q. B–5: Do the employer aggregation

and leased employee rules apply forpurposes of the SIMPLE plan rulesunder section 408(p)?A. B–5: For purposes of applying the

SIMPLE plan rules under section408(p), certain related employers (tradesor businesses under common control)are treated as a single employer. Theserelated employers include controlledgroups of corporations under section414(b), partnerships or sole proprietor-ships under common control under sec-tion 414(c), and affiliated service groupsunder section 414(m). In addition,leased employees described in section414(n) are treated as employed by theemployer.Example:Individual P owns BusinessA, a computer rental agency, that has80 employees who received morethan $5,000 in compensation in 1996.Individual P also owns Business B,which repairs computers and has 60employees who received more than$5,000 in compensation in 1996. Indi-vidual P is the sole proprietor of bothbusinesses. Section 414(c) providesthat the employees of partnershipsand sole proprietorships that are undercommon control are treated as em-ployees of a single employer. Thus,

27

for purposes of the SIMPLE planrules, all 140 employees are treated asemployed by Individual P. Therefore,neither Business A nor Business B iseligible to establish a SIMPLE planfor 1997.

C. EMPLOYEE ELIGIBILITY TOPARTICIPATE IN A SIMPLE PLAN

Q. C–1: Which employees of an em-ployer must be eligible to participateunder the SIMPLE plan?A. C–1: If an employer establishes a

SIMPLE plan, all employees of theemployer who received at least $5,000in compensation from the employer dur-ing any 2 preceding calendar years(whether or not consecutive) and whoare reasonably expected to receive atleast $5,000 in compensation during thecalendar year, must be eligible to par-ticipate in the SIMPLE plan for thecalendar year.An employer, at its option, may ex-

clude from eligibility employees de-scribed in section 410(b)(3). These em-ployees are:(1) Employees who are included in aunit of employees covered by anagreement that the Secretary of Laborfinds to be a collective bargainingagreement between employee repre-sentatives and one or more employers,if there is evidence that retirementbenefits were the subject of goodfaith bargaining between such em-ployee representatives and such em-ployer or employers;(2) In the case of a trust establishedor maintained pursuant to an agree-ment that the Secretary of Labor findsto be a collective bargaining agree-ment between air pilots represented inaccordance with Title II of the Rail-way Labor Act and one or moreemployees, all employees not coveredby that agreement; and(3) Employees who are nonresidentaliens and who received no earnedincome (within the meaning of sec-tion 911(d)(2)) from the employer thatconstitutes income from sourceswithin the United States (within themeaning of section 861(a)(3)).

As noted in Q&A B–5, the employeraggregation and leased employee rulesapply for purposes of section 408(p).Thus, for example, if two related em-ployers must be aggregated under therules of section 414(b), all employees ofeither employer who satisfy the eligibil-ity criteria must be allowed to partici-pate in the SIMPLE plan.

Q. C–2: May an employer imposeless restrictive eligibility requirements?A. C–2: An employer may impose

less restrictive eligibility requirementsby eliminating or reducing the prior yearcompensation requirements, the currentyear compensation requirements, orboth, under its SIMPLE plan. For ex-ample, the employer could allow partici-pation for employees who received$3,000 in compensation during any pre-ceding calendar year. However, the em-ployer cannot impose any other condi-tions on participating in a SIMPLE plan.Q. C–3: May an employee participate

in a SIMPLE plan if he or she alsoparticipates in a plan of a differentemployer for the same year?A. C–3: An employee may participate

in a SIMPLE plan even if he or she alsoparticipates in a plan of a differentemployer for the same year. However,the employee’s salary reduction contri-butions are subject to the limitations ofsection 402(g), which provides an aggre-gate limit on the exclusion for electivedeferrals for any individual. Similarly,an employee who participates in aSIMPLE plan and an eligible deferredcompensation plan described in section457(b) is subject to the limitations de-scribed in section 457(c). An employerthat establishes a SIMPLE plan is notresponsible for monitoring compliancewith either of these limitations.Q. C–4: What definition of compen-

sation applies for purposes of theSIMPLE plan rules in the case of anindividual who is not a self-employedindividual?A. C–4: For purposes of the SIMPLE

plan rules, in the case of an individualwho is not a self-employed individual,compensation means the amount de-scribed in section 6051(a)(3) (wages,tips, and other compensation from theemployer subject to income tax with-holding under section 3401(a)), andamounts described in section 6051(a)(8),including elective contributions madeunder a SIMPLE plan, and compensationdeferred under a section 457 plan. Forpurposes of applying the 100-employeelimitation, and in determining whetheran employee is eligible to participate ina SIMPLE plan (i.e., whether the em-ployee had $5,000 in compensation forany 2 preceding years), an employee’scompensation also includes the employ-ee’s elective deferrals under a section401(k) plan, a salary reduction SEP anda section 403(b) annuity contract.Q. C–5: What definition of compen-

sation applies for purposes of the

SIMPLE plan rules in the case of aself-employed individual?A. C–5: For purposes of the SIMPLE

plan rules, in the case of a self-employed individual, compensationmeans net earnings from self-employment determined under section1402(a), prior to subtracting any contri-butions made under the SIMPLE planon behalf of the individual.

D. SIMPLE PLAN CONTRIBUTIONS

Q. D–1: What contributions must anemployer make under a SIMPLE plan?A. D–1: If an employer establishes a

SIMPLE plan, it must make salary re-duction contributions, as described inQ&A D–2, to the extent elected byemployees. In addition, the employermust make employer matching contribu-tions, as described in Q&As D–4 andD–5, or employer nonelective contribu-tions, as described in Q&A D–6. Theseare the only contributions that may bemade under a SIMPLE plan.Q. D–2: What is a salary reduction

contribution?A. D–2: A salary reduction contribu-

tion is a contribution made pursuant toan employee’s election to have anamount contributed to his or herSIMPLE IRA, rather than have theamount paid directly to the employee incash. An employee must be permitted toelect to have salary reduction contribu-tions made at the level specified by theemployee, expressed as a percentage ofcompensation for the year. Additionally,an employer may permit an employee toexpress the level of salary reductioncontributions as a specific dollaramount. An employer may not place anyrestrictions on the amount of an employ-ee’s salary reduction contributions (e.g.,by limiting the contribution percentage),except to the extent needed to complywith the annual limit on the amount ofsalary reduction contributions describedin Q&A D–3.Q. D–3: What is the annual limit on

the amount of salary reduction contribu-tions under a SIMPLE plan?A. D–3: For 1997, the maximum an-

nual amount of salary reduction contri-butions that can be made on behalf ofany employee under a SIMPLE plan is$6,000. This amount will be adjusted bythe Service to reflect any changes in thecost of living.Q. D–4: What employer matching

contribution is generally required undera SIMPLE plan?

28

A. D–4: Under a SIMPLE plan, anemployer is generally required to makea contribution on behalf of each eligibleemployee in an amount equal to theemployee’s salary reduction contribu-tions, up to a limit of 3 percent of theemployee’s compensation for the entirecalendar year.Q. D–5: Can the 3-percent limit on

matching contributions be reduced?A. D–5: The 3-percent limit on

matching contributions is permitted tobe reduced for a calendar year at theelection of the employer, but only if:(1) The limit is not reduced below 1percent;(2) The limit is not reduced for morethan 2 years out of the 5-year periodthat ends with (and includes) the yearfor which the election is effective;and(3) Employees are notified of thereduced limit within a reasonable pe-riod of time before the 60-day elec-tion period during which employeescan enter into salary reduction agree-ments. See Q&A E–1.For purposes of applying the rule

described in paragraph (2) of this Q&AD–5, in determining whether the limitwas reduced below 3 percent for a year,any year before the first year in whichan employer (or a predecessor em-ployer) maintains a SIMPLE plan willbe treated as a year for which the limitwas 3 percent. If an employer choosesto make nonelective contributions for ayear (see Q&A D–6), that year also willbe treated as a year for which the limitwas 3 percent.Q. D–6: May an employer make non-

elective contributions instead of match-ing contributions?A. D–6: As an alternative to making

matching contributions under a SIMPLEplan (as described in Q&A D–4 andD–5), an employer may make nonelec-tive contributions equal to 2 percent ofeach eligible employee’s compensationfor the entire calendar year. The em-ployer’s nonelective contributions mustbe made for each eligible employeeregardless of whether the employeeelects to make salary reduction contribu-tions for the calendar year. The em-ployer may, but is not required to, limitnonelective contributions to eligible em-ployees who have at least $5,000 (orsome lower amount selected by theemployer) of compensation for the year.For purposes of the 2-percent non-

elective contribution, the compensationtaken into account must be limited tothe amount of compensation that may be

taken into account under section401(a)(17) for the year. The section401(a)(17) limit for 1997 is $160,000.This amount will be adjusted by theService for subsequent years to reflectchanges in the cost of living.An employer may substitute the

2-percent nonelective contribution forthe matching contribution for a year,only if:(1) Eligible employees are notifiedthat a 2-percent nonelective contribu-tion will be made instead of a match-ing contribution; and(2) This notice is provided within areasonable period of time before the60-day election period during whichemployees can enter into salary re-duction agreements. See Q&A E–1.

E. EMPLOYEE ELECTIONS

Q. E–1: When must an employee begiven the right to enter into a salaryreduction agreement?A. E–1: During the 60-day period

immediately preceding January 1 of acalendar year (i.e., November 2 to De-cember 31 of the preceding calendaryear), an eligible employee must begiven the right to enter into a salaryreduction agreement for the calendaryear, or to modify a prior agreement(including reducing the amount subjectto this agreement to $0). However, forthe year in which the employee becomeseligible to make salary reduction contri-butions, the period during which theemployee may enter into a salary reduc-tion agreement or modify a prior agree-ment is a 60-day period that includeseither the date the employee becomeseligible or the day before that date. Forexample, if an employer establishes aSIMPLE plan effective as of July 1,1997, each eligible employee becomeseligible to make salary reduction contri-butions on that date and the 60-dayperiod must begin no later than July 1and cannot end before June 30, 1997.During these 60-day periods, employ-

ees have the right to modify their salaryreduction agreements without restric-tions. In addition, for the year in whichan employee becomes eligible to makesalary reduction contributions, the em-ployee must be able to commence thesecontributions as soon as the employeebecomes eligible, regardless of whetherthe 60-day period has ended.Q. E–2: Can a SIMPLE plan provide

additional or longer election periods?A. E–2: Nothing precludes a SIMPLE

plan from providing additional or longer

periods for permitting employees to en-ter into salary reduction agreements orto modify prior agreements. For ex-ample, a SIMPLE plan can provide a90-day election period instead of the60-day period described in Q&A E–1.Similarly, in addition to the 60-dayperiod described in Q&A E–1, aSIMPLE plan can provide quarterlyelection periods during the 30 daysbefore each calendar quarter.Q. E–3: Does an employee have the

right to terminate a salary reductionagreement outside a SIMPLE plan’s nor-mal election period?A. E–3: An employee must be given

the right to terminate a salary reductionagreement for a calendar year at anytime during the year. A SIMPLE planmay provide that an employee whoterminates a salary reduction agreementat any time other than the periodsdescribed in Q&A E–1 or E–2 is noteligible to resume participation until thebeginning of the next calendar year.Q. E–4: Must an employer allow an

employee to select the financial institu-tion to which the employer will makeall SIMPLE plan contributions on behalfof the employee?A. E–4: Generally, under section

408(p), an employer must permit anemployee to select the financial institu-tion for the SIMPLE IRA to which theemployer will make all contributions onbehalf of the employee. If an employeruses Form 5305-SIMPLE as modified inQ&A K–3, the employer may modifypage 3 of Form 5305–SIMPLE (October1996) (Model Salary Reduction Agree-ment) to include a section for employeesto indicate the financial institution theyhave selected and any additional infor-mation necessary to facilitate transmittalof the contribution to that institution.Alternatively, under the exception de-scribed in Q&A J–1, an employer mayrequire that all contributions be made toa designated financial institution.

F. VESTING REQUIREMENTS

Q. F–1: Must contributions under aSIMPLE plan be nonforfeitable?A. F–1: Yes. All contributions under

a SIMPLE plan must be fully vestedand nonforfeitable when made.Q. F–2: May amounts held in a

SIMPLE IRA be withdrawn at anytime?A. F–2: Yes. An employer may not

require an employee to retain any por-tion of the contributions in his or her

29

SIMPLE IRA or otherwise impose anywithdrawal restrictions.

G. EMPLOYER ADMINISTRATIVEAND NOTIFICATIONREQUIREMENTS

Q. G–1: What notification require-ments apply to employers?A. G–1: An employer must notify

each employee, immediately before theemployee’s 60-day election period de-scribed in Q&A E–1, of the employee’sopportunity to enter into a salary reduc-tion agreement or to modify a prioragreement. If applicable, this notifica-tion must disclose an employee‘‘s abilityto select the financial institution thatwill serve as the trustee of the employ-ee’’s SIMPLE IRA as described in Q&AE–4. If an employer uses Form 5305–SIMPLE as modified in Q&A K–3, theemployer may modify page 3 of Form5305–SIMPLE (October 1996) (ModelNotification to Eligible Employees) todisclose an employee‘‘s ability to selectthe financial institution that will serve asthe trustee of the employee’’s SIMPLEIRA as described in Q&A E–4. Thenotification must also include the sum-mary description described in Q&AH–1. In the case of a SIMPLE planestablished using Form 5305–SIMPLE,the summary description requirementmay be satisfied by providing a com-pleted copy of pages one and two ofForm 5305–SIMPLE that reflects theterms of the employer’s plan (includingthe materials provided by the trustee forcompletion of Article VI).Q. G–2: May the notifications regard-

ing a reduced matching contribution(described in Q&A D–5) and a nonelec-tive contribution in lieu of a matchingcontribution (described in Q&A D–6) beprovided at the same time as the notifi-cation of an employee’s opportunity toenter into a salary reduction agreementand the summary description?A. G–2: Yes. An employer is deemed

to provide the notification regarding areduced matching contribution or a non-elective contribution in lieu of a match-ing contribution within a reasonable pe-riod of time before the 60-day electionperiod if, immediately before the 60-dayelection period, this notification is in-cluded with the notification of an em-ployee’s opportunity to enter into asalary reduction agreement.Q. G–3: What reporting penalties un-

der the Code apply if an employer failsto provide one or more of the requirednotices?

A. G–3: If the employer fails to pro-vide one or more of the required noticesdescribed in Q&A G–1, the employerwill be liable, under the Code, for apenalty of $50 per day until the noticesare provided. If the employer shows thatthe failure was due to reasonable cause,the penalty will not be imposed. To theextent that each employee is permittedto select the trustee for his or herSIMPLE IRA pursuant to Q&A E–4,and is so notified in accordance withQ&A G–1, and the information withrespect to the trustee (the name andaddress of the trustee and its withdrawalprocedures) is not available at the timethe employer is required to provide thesummary description, the employer isdeemed to have shown reasonable causefor failure to provide this information toeligible employees, but only if the em-ployer sees to it that this information isprovided to the employee as soon asadministratively feasible once the trusteehas been selected.Q. G–4: What if an eligible employee

is unwilling or unable to establish aSIMPLE IRA?A. G–4: If an eligible employee who

is entitled to a contribution under aSIMPLE plan is unwilling or unable toestablish a SIMPLE IRA with any finan-cial institution prior to the date onwhich the contribution is required to bemade to the SIMPLE IRA of the em-ployee under Q&A G–5 or G–6, anemployer may execute the necessarydocuments to establish a SIMPLE IRAon the employee‘‘s behalf with a finan-cial institution selected by the employer.Q. G–5: When must an employer

make salary reduction contributions un-der a SIMPLE plan?A. G–5: The employer must make

salary reduction contributions to the fi-nancial institution maintaining theSIMPLE IRA no later than the close ofthe 30-day period following the last dayof the month in which amounts wouldotherwise have been payable to theemployee in cash. The Department ofLabor has indicated that most SIMPLEplans are also subject to Title I of theEmployee Retirement Income SecurityAct of 1974 (ERISA). The Departmentof Labor has informed the TreasuryDepartment and the Service that, as amatter of enforcement policy, for theseplans, salary reduction contributionsmust be made to the SIMPLE IRA as ofthe earliest date on which the contribu-tions can reasonably be segregated from

the employer’s general assets, but in noevent later than the 30-day deadlinedescribed above.Q. G–6: When must an employer

make matching and nonelective contri-butions under a SIMPLE plan?A. G–6: Matching and nonelective

employer contributions must be made tothe financial institution maintaining theSIMPLE IRA no later than the due datefor filing the employer’s income taxreturn, including extensions, for the tax-able year that includes the last day ofthe calendar year for which the contri-butions are made.

H. TRUSTEE ADMINISTRATIVEREQUIREMENTS

Q. H–1: What information must aSIMPLE IRA trustee provide to anemployer?A. H–1: Each year, a SIMPLE IRA

trustee must provide the employer spon-soring the SIMPLE plan with a sum-mary description containing the follow-ing information:(1) The name and address of theemployer and the trustee.(2) The requirements for eligibilityfor participation.(3) The benefits provided with re-spect to the arrangement.(4) The time and method of makingelections with respect to the arrange-ment.(5) The procedures for, and effectsof, withdrawals (including rollovers)from the arrangement.

The trustee must provide the summarydescription to the employer earlyenough to allow the employer to meetits notification obligation described inQ&A G–1. However, a trustee is notrequired to provide the summary de-scription prior to agreeing to be thetrustee of a SIMPLE IRA for theSIMPLE plan.A trustee that fails to provide the

employer with a summary plan descrip-tion incurs a $50 penalty, under theCode, for each day the failure continues,unless the trustee shows that the failureis due to reasonable cause. To the extentthat the employer or trustee provides theinformation described in paragraphs (1)through (5) of this Q&A H–1 within thetime period prescribed in Q&A G–1 tothe employee for whom the SIMPLEIRA is established, the trustee of thatSIMPLE IRA is deemed to have shownreasonable cause for failure to providethat information to the employer. Forexample, if the employer provides its

30

name and address and the informationdescribed in paragraphs (2) through (4)of this Q&A H–1, and the effects ofwithdrawal to all eligible employees in aSIMPLE plan in accordance with Q&AG–1, and the trustee provides its nameand address and its procedures for with-drawal to each eligible employee forwhom a SIMPLE IRA is establishedwith the trustee under the SIMPLE plan,the trustee will be deemed to haveshown reasonable cause for failing toprovide the employer the informationdescribed in paragraphs (1) through (5)of this Q&A H–1.In the case of a SIMPLE plan estab-

lished using Form 5305–SIMPLE, atrustee may satisfy this obligation byproviding an employer with a currentcopy of Form 5305–SIMPLE, with in-structions, the information required forcompletion of Article VI, and the nameand address of the financial institution.The trustee should provide guidance tothe employer concerning the need tocomplete the first two pages of Form5305–SIMPLE in accordance with itsplan’s terms and to distribute completedcopies to eligible employees.The trustee of a transfer SIMPLE IRA

is not required to provide the summarydescription described in the precedingparagraph. A SIMPLE IRA is a transferSIMPLE IRA if it is not a SIMPLE IRAto which the employer has made contri-butions under the SIMPLE plan.Q. H–2: What information must a

SIMPLE IRA trustee provide to partici-pants in the SIMPLE plan?A. H–2: Within 30 days after the

close of each calendar year, a SIMPLEIRA trustee must provide each indi-vidual on whose behalf an account ismaintained with a statement of the indi-vidual’’s account balance as of the closeof that calendar year and the accountactivity during that calendar year. Atrustee who fails to provide individualswith this statement incurs a $50 penalty,under the Code, for each day the failurecontinues, unless the trustee shows thatthe failure is due to reasonable cause.However, no penalty will apply if atrustee provides this statement not laterthan January 31 following the calendaryear to which the statement relates. Thetrustee must also provide any otherinformation required to be furnished toIRA holders (e.g., disclosure statementsfor individual retirement plans as re-ferred to in section 1.408–6 of theregulations).

Q. H–3: What information must aSIMPLE IRA trustee provide to theService?A. H–3: Section 408(i) requires the

trustee of an individual retirement ac-count to make reports regarding theseaccounts to the Service. The Serviceintends to modify Form 5498,IndividualRetirement Arrangement Information, torequire that the amount of contributionsto a SIMPLE IRA, rollover contribu-tions, and the fair market value of theaccount be reported, and that contribu-tions to a SIMPLE IRA be identified assuch. A trustee who fails to file thesereports incurs a $50 penalty under theCode for each failure, unless it is shownthat the failure is due to reasonablecause.Q. H–4: Are distributions from a

SIMPLE IRA required to be reported onForm 1099–R?A. H–4: Pursuant to section 6047 of

the Code and section 35.3405–1 of theregulations, the payor of a designateddistribution from an IRA must report thedistribution on Form 1099–R. A distri-bution from a SIMPLE IRA is a desig-nated distribution from an IRA and thusmust be reported on Form 1099–R. TheIRS intends to revise Form 1099–R,Distributions From Pensions, Annuities,Retirement or Profit-sharing Plans,IRAs, Insurance Contracts, Etc., to re-flect the requirements that apply toSIMPLE IRAs. The penalty, under theCode, for failure to report a designateddistribution from an IRA (including aSIMPLE IRA) is determined under sec-tions 6721–6724.Q. H–5: Is a SIMPLE IRA trustee

responsible for reporting whether a dis-tribution to a participant occurred duringthe two-year period described in Q&AI–2?A. H–5: Yes. A SIMPLE IRA trustee

is required to report on Form 1099–Rwhether a distribution to a participantoccurred during the two-year period de-scribed in Q&A I–2. A trustee is permit-ted to prepare this report on the basis ofits own records with respect to theSIMPLE IRA account. A trustee may,but is not required to, take into accountother adequately substantiated informa-tion regarding the date on which anindividual first participated in anySIMPLE plan maintained by the indi-vidual’s employer. See Q&A I–2 on theeffect of distributions within this two-year period.

I. TAX TREATMENT OF SIMPLEPLANS

Q. I–1: What are the tax conse-quences of SIMPLE plan contributions?A. I–1: Contributions to a SIMPLE

IRA are excludable from federal incometax and not subject to federal incometax withholding. Salary reduction contri-butions to a SIMPLE IRA are subject totax under the Federal Insurance Contri-butions Act (‘‘FICA’’), the Federal Un-employment Tax Act (‘‘FUTA’’), and theRailroad Retirement Act (‘‘RRTA’’), andmust be reported on Form W–2, Wageand Tax Statement. Matching and non-elective contributions to a SIMPLE IRAare not subject to FICA, FUTA, orRRTA taxes, and are not required to bereported on Form W–2.Q. I–2: What are the tax conse-

quences when amounts are distributedfrom a SIMPLE IRA?A. I–2: Generally, the same tax re-

sults apply to distributions from aSIMPLE IRA as to distributions from aregular IRA (i.e., an IRA described insection 408(a) or (b)). However, a spe-cial rule applies to a payment or distri-bution received from a SIMPLE IRAduring the two-year period beginning onthe date on which the individual firstparticipated in any SIMPLE plan main-tained by the individual’s employer (the‘‘two-year period’’).Under this special rule, if the addi-

tional income tax on early distributionsunder section 72(t) applies to a distribu-tion within this two-year period, section72(t)(6) provides that the rate of addi-tional tax under this special rule isincreased from 10 percent to 25 percent.If one of the exceptions to applicationof the tax under section 72(t) applies(e.g., for amounts paid after age 59 1/2,after death, or as part of a series ofsubstantially equal payments), the ex-ception also applies to distributionswithin the two-year period and the 25-percent additional tax does not apply.Q. I–3: Are there any special rollover

rules that apply to a distribution from aSIMPLE IRA?A. I–3: Section 408(d)(3)(G) provides

that the rollover provisions of section408(d)(3) apply to a distribution from aSIMPLE IRA during the two-year pe-riod described in Q&A I–2 only if thedistribution is paid into another SIMPLEIRA. Thus, a distribution from aSIMPLE IRA during that two-year pe-riod qualifies as a rollover contribution(and thus is not includable in grossincome) only if the distribution is paid

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into another SIMPLE IRA and satisfiesthe other requirements of section408(d)(3) for treatment as a rollovercontribution.Q. I–4: Can an amount be transferred

from a SIMPLE IRA to another IRA ina tax-free trustee-to-trustee transfer?A. I–4: During the two-year period

described in Q&A I–2, an amount in aSIMPLE IRA can be transferred toanother SIMPLE IRA in a tax-freetrustee-to-trustee transfer. If, during thistwo-year period, an amount is paid froma SIMPLE IRA directly to the trustee ofan IRA that is not a SIMPLE IRA, thepayment is neither a tax-free trustee-to-trustee transfer nor a rollover contribu-tion; the payment is a distribution fromthe SIMPLE IRA and a contribution tothe other IRA that does not qualify as arollover contribution. After the expira-tion of the two-year period, an amountin a SIMPLE IRA can be transferred ina tax-free trustee-to-trustee transfer to anIRA that is not a SIMPLE IRA.Q. I–5: When does the two-year pe-

riod described in Q&A I–2 begin?A. I–5: The two-year period de-

scribed in Q&A I–2 begins on the firstday on which contributions made by theindividual‘‘s employer are deposited inthe individual’’s SIMPLE IRA.Q. I–6: Do the qualification rules of

section 401(a) apply to contributionsunder a SIMPLE plan?A. I–6: None of the qualification

rules of section 401(a) apply to SIMPLEplans. For example, the section 415 and416 rules do not apply to contributionsunder a SIMPLE plan. Similarly, thesection 401(a)(17) limit does not applyto salary reduction contributions andmatching contributions. However, asnoted in Q&A D–6, the amount ofcompensation that may be taken intoaccount for purposes of the 2-percentnonelective contribution is limited to theamount that may be taken into accountunder section 401(a)(17) for the year.Q. I–7: What rules apply to an em-

ployer’s ability to deduct contributionsunder a SIMPLE plan?A. I–7: Pursuant to section 404(m),

contributions under a SIMPLE plan aredeductible in the taxable year of theemployer with or within which the cal-endar year for which contributions weremade ends (without regard to the limita-tions of section 404(a)). For example, ifan employer has a June 30 taxable yearend, contributions under the SIMPLEplan for the calendar year 1997 (includ-ing contributions made in 1997 before

June 30, 1997) are deductible in thetaxable year ending June 30, 1998.Contributions will be treated as madefor a particular taxable year if they aremade on account of that taxable yearand are made by the due date (includingextensions) prescribed by law for filingthe return for the taxable year.

J. EXCEPTION FOR USE OFDESIGNATED FINANCIALINSTITUTION

Q. J–1: Can an employer designate aparticular financial institution to whichall contributions under the SIMPLE planwill be made?A. J–1: Yes. In accordance with sec-

tion 408(p)(7), instead of makingSIMPLE plan contributions to the finan-cial institution selected by each eligibleemployee (see Q&A E–4), an employermay require that all contributions onbehalf of all eligible employees underthe SIMPLE plan be made to SIMPLEIRAs at a particular financial institutionif the following requirements are met:(1) the employer and the financial insti-tution agree that the financial institutionwill be a designated financial institutionunder section 408(p)(7) (‘‘DFI’’) for theSIMPLE plan; (2) the financial institu-tion agrees that, if a participant sorequests, the participant’s balance willbe transferred without cost or penalty toanother SIMPLE IRA (or, after thetwo-year period described in Q&A I–2,to any IRA) at a financial institutionselected by the participant; and (3) eachparticipant is given written notificationdescribing the procedures under which,if a participant so requests, the partici-pant’s balance will be transferred with-out cost or penalty to another SIMPLEIRA (or, after the two-year period de-scribed in Q&A I–2, to any IRA) at afinancial institution selected by the par-ticipant.This Q&A J–1 is illustrated by thefollowing examples:Example 1:A representative of Finan-cial Institution L approaches EmployerB concerning the establishment of aSIMPLE plan. Employer B agrees toestablish a SIMPLE plan for its eli-gible employees. Employer B wouldprefer to avoid writing checks to morethan one financial institution on behalfof employees, and is interested inmaking all contributions under theSIMPLE plan to a single financialinstitution. Employer B and FinancialInstitution L agree that Financial Insti-tution L will be a DFI and Financial

Institution L agrees that, if a partici-pant so requests, it will transfer theparticipant’s balance, without cost orpenalty, to another SIMPLE IRA (or,after the two-year period described inQ&A I–2, to any IRA) at a financialinstitution selected by the participant.A SIMPLE IRA is established for eachparticipating employee of Employer Bat Financial Institution L. Each partici-pant is provided with a written de-scription of how and when the partici-pant may direct that the participant’sbalance attributable to contributionsmade to Financial Institution L betransferred without cost or penalty to aSIMPLE IRA (or, after the two-yearperiod described in Q&A I–2, to anyIRA) at another financial institutionselected by the participant. FinancialInstitution L is a DFI, and Employer Bmay require that all contributions onbehalf of all eligible employees bemade to SIMPLE IRAs at FinancialInstitution L.Example 2:A representative of Finan-cial Institution M approaches Em-ployer C concerning the establishmentof a SIMPLE plan. Employer C in-vites Financial Institution M to makea presentation on its investment op-tions for SIMPLE IRAs to EmployerC’s employees. Each eligible em-ployee receives notification that theemployer must permit the employeeto select which financial institutionwill serve as the trustee of the em-ployee’s SIMPLE IRA (see Q&AG–1). All eligible employees of Em-ployer C voluntarily select FinancialInstitution M to serve as the trustee ofthe SIMPLE IRAs to which EmployerC will make all contributions onbehalf of the employees. FinancialInstitution M is not a DFI merelybecause all eligible employees of Em-ployer C selected Financial InstitutionM to serve as the trustee of theirSIMPLE IRAs and Employer C con-sequently makes all contributions toFinancial Institution M. Therefore, Fi-nancial Institution M is not requiredto transfer SIMPLE IRA balanceswithout cost or penalty.Example 3:Assume the same facts asExample 2, except that Employee Xand Employee Y, who made salaryreduction elections, failed to establishSIMPLE IRAs to receive SIMPLEplan contributions on their behalf be-fore the first date on which EmployerC is required to make a contributionto their SIMPLE IRAs. Employer Cestablishes SIMPLE IRAs at Financial

32

Institution M for these employees andcontributes the amount required totheir accounts. Financial Institution Mis not a DFI merely because Em-ployer C establishes SIMPLE IRAson behalf of Employee X and Em-ployee Y while all other employeesvoluntarily select Financial InstitutionM to serve as the trustee of theSIMPLE IRAs to which Employer Cwill make contributions on their be-half.Q. J–2: May the time and manner in

which a participant may transfer his orher balance without cost or penalty belimited without violating the require-ments of section 408(p)(7)?A. J–2: Yes. Section 408(p)(7) will

not be violated merely because a partici-pant is given only a reasonable periodof time each year in which to transferhis or her balance without cost orpenalty. A participant will be deemed tohave been given a reasonable period oftime in which to transfer his or herbalance without cost or penalty if, foreach calendar year, the participant hasuntil the end of the 60-day perioddescribed in Q&A E–1 to request totransfer, without cost or penalty, his orher balance attributable to SIMPLE plancontributions for the calendar year fol-lowing that 60-day period (or, for theyear in which an employee becomeseligible to make salary reduction contri-butions, for the balance of that year) andsubsequent calendar years.If the time or manner in which a

participant may transfer his or her bal-ance without cost or penalty is limited,any such limitation must be disclosed aspart of the written notification describedin Q&A J–1. In the case of a SIMPLEplan established using Form 5305–SIMPLE, if the summary descriptionrequirement is being satisfied by provid-ing a completed copy of pages one andtwo of Form 5305–SIMPLE, Article VI(Procedures for Withdrawal) must con-tain a clear explanation of any suchlimitation.This Q&A J–2 is illustrated by the

following examples:Example 1:Employer A first estab-lishes a SIMPLE plan effective Janu-ary 1, 1998, and intends to make allcontributions to Financial InstitutionM, which has agreed to serve as aDFI. For the 1998 calendar year,Employer A provides the 60-day elec-tion period described in Q&A E–1beginning November 2, 1997, andnotifies each participant that he or shemay request that his or her balance

attributable to future contributions betransferred from Financial InstitutionM to a SIMPLE IRA at a financialinstitution that the participant selects.The notification states that the trans-fer will be made without cost orpenalty if the participant contacts Fi-nancial Institution M prior to January1, 1998. For the 1998 calendar year,the requirements of section 408(p)(7)will not be violated merely becauseparticipants are given only a 60-dayperiod in which to request to transfertheir balances without cost or penalty.Example 2:Assume the same facts asExample 1. Participant X does notrequest a transfer of her balance byDecember 31, 1997, but requests atransfer of her current balance toanother SIMPLE IRA on July 1,1998. Participant X‘‘s current balancewould not be required to be trans-ferred without cost or penalty becauseParticipant X did not request such atransfer prior to January 1, 1998.However, during the 60-day periodpreceding the 1999 calendar year,Participant X may request a transfer,without cost or penalty, of her balanceattributable to contributions made forthe 1999 calendar year and, if she soelects, for all future calendar years(but not her balance attributable tocontributions for the 1998 calendaryear).Example 3:Assume the same facts asExample 1. Under the terms of theSIMPLE plan, Participant Y becomesan eligible employee on June 1, 1998,and, for Participant Y, the 60-dayperiod described in Q&A E–1 beginson that date. For the 1998 calendaryear, Participant Y will be deemed tohave been given a reasonable amountof time in which to request to trans-fer, without cost or penalty, his bal-ance attributable to contributions forthe balance of the 1998 calendar yearif Financial Institution M allows sucha request to be made prior to July 31,1998.Q. J–3: Is there a limit on the fre-

quency with which a participant’s bal-ance must be transferred without cost orpenalty?A. J–3: In order to satisfy Section

408(p)(7), if a participant acts, withinapplicable reasonable time limits, if any,to request a transfer of his or herbalance, the participant’s balance mustbe transferred on a reasonably frequentbasis. A participant’s balance will be

deemed to be transferred on a reason-ably frequent basis if it is transferred ona monthly basis.Q. J–4: How does a DFI transfer a

participant’s balance without cost orpenalty?A. J–4: In order to satisfy section

408(p)(7), a participant’s balance mustbe transferred in a trustee-to-trusteetransfer directly to a SIMPLE IRA (or,after the two-year period described inQ&A I–2, to any IRA) at the financialinstitution specified by the participant.A transfer is deemed to be made

without cost or penalty if no liquidation,transaction, redemption or terminationfee, or any commission, load (whetherfront-end or back-end) or surrendercharge, or similar fee or charge isimposed with respect to the balancebeing transferred. A transfer will not failto be made without cost or penaltymerely because contributions that a par-ticipant has elected to have transferredwithout cost or penalty are required tobe invested in one specified investmentoption until transferred, even though avariety of investment options are avail-able with respect to contributions thatparticipants have not elected to transfer.This Q&A J–4 is illustrated by thefollowing examples:Example 1: Financial Institution Qagrees to be a DFI for the SIMPLEplan maintained by Employer D. Em-ployer D provides the 60-day electionperiod described in Q&A E–1 begin-ning on November 2 of each year andeach participant is notified that he orshe may request, before the end of the60-day period, a transfer of his or herfuture contributions from FinancialInstitution Q without cost or penaltyto a SIMPLE IRA (or, after thetwo-year period described in Q&AI–2, to any IRA) at a financial institu-tion selected by the participant. Thenotification states that a participant’scontributions that are to be transferredwithout cost or penalty will be in-vested in a specified investment op-tion and will be transferred to thefinancial institution selected by theparticipant on a monthly basis.Financial Institution Q offers variousinvestment options to account holdersof IRA SIMPLE accounts, includinginvestment options with a salescharge. Any participant who does notelect to have his or her balancetransferred to another financial institu-tion may invest the contributionsmade on his or her behalf in anyinvestment option available to account

33

holders of SIMPLE IRA accounts atFinancial Institution Q. However,contributions that a participant haselected to have transferred are auto-matically invested, prior to transfer, ina specified investment option that hasno sales charge. The requirement thata participant’s balance be transferredwithout cost or penalty will not beviolated merely because contributionsthat have been designated to be trans-ferred pursuant to a participant’’selection are automatically invested inone specified investment option andtransferred on a monthly basis to thefinancial institution selected by theparticipant.Example 2:Assume the same facts asin Example 1. Financial Institution Qgenerally charges its IRA accounts areasonable annual administration fee.Financial Institution Q also chargesthis annual administration fee withrespect to SIMPLE IRA accounts,including SIMPLE IRA accounts fromwhich balances must be transferred inaccordance with participants’ transferelections. The requirement that par-ticipants‘‘ balances be transferredwithout cost or penalty will not beviolated merely because a reasonableannual administration fee is chargedto SIMPLE IRA accounts from whichbalances must be transferred in accor-dance with participants’’ transfer elec-tions.Q. J–5: Is the ‘‘without cost or pen-

alty’’ requirement violated if a DFIcharges an employer for a participant‘‘stransfer of his or her balance?A. J–5: The ’’without cost or pen-

alty‘‘ requirement of section 408(p)(7) isnot violated merely because a DFIcharges an employer an amount thattakes into account the financial institu-tion’s responsibility to transfer balancesupon participants’ requests or otherwisecharges an employer for transfers re-quested participants, provided that thecharge is not passed through to theparticipants who request the transfer.

K. SIMPLE PLAN ESTABLISHMENT

Q. K–1: Must an employer establisha SIMPLE plan on January 1?A. K–1: An existing employer may

establish a SIMPLE plan effective onany date between January 1 and October1 of a year beginning after December31, 1996, provided that the employer (orany predecessor employer) did not pre-viously maintain a SIMPLE plan. Thisrequirement does not apply to a new

employer that comes into existence afterOctober 1 of the year the SIMPLE planis established if the employer establishesthe SIMPLE plan as soon as administra-tively feasible after the employer comesinto existence. If an employer (or prede-cessor employer) previously maintaineda SIMPLE plan, the employer mayestablish a SIMPLE plan effective onlyon January 1 of a year.Q. K–2: When must a SIMPLE IRA

be established for an employee?A. K–2: A SIMPLE IRA is required

to be established for an employee priorto the first date by which a contributionis required to be deposited into theemployee’’s SIMPLE IRA (see Q&AsG–5 and G–6).Q. K–3: Will the Service issue model

forms employers can use to establishSIMPLE plans?A. K–3: Yes. On October 31, 1996,

the Service issued Form 5305–SIMPLE,which is a form that may be used by anemployer establishing a SIMPLE planwith a financial institution that is a DFI.The Service also intends to issue amodel form that may be used by anemployer establishing a SIMPLE planthat does not use a DFI. (The Serviceissued Form 5304–SIMPLE on Decem-ber 30, 1996.) Until the Service issuesthis model form, an employer establish-ing a SIMPLE plan that does not use aDFI and wishes to use a model formmay use Form 5305–SIMPLE (October1996), subject to the following modifi-cations:

A. Modifications to the Form:

(1) Form Title: strike the parentheti-cal ‘‘(for Use With a DesignatedFinancial Institution)’’;(2) Item 1 of Article I: strike‘‘SIMPLE individual retirement ac-count or annuity established at thedesignated financial institution(SIMPLE IRA) for’’ and substitute‘‘SIMPLE IRA established by’’;(3) Item 3 of Article III: strike ‘‘tothe designated financial institution forthe IRAs established under thisSIMPLE plan’’ each time it appearsand substitute ‘‘for each eligible em-ployee to the SIMPLE IRA estab-lished at the financial institution se-lected by that employee’’;(4) Item 4 of Article IV: strike thisItem and substitute ‘‘Selection ofIRA Trustee. The employer must per-mit each eligible employee to selectthe financial institution that will serveas trustee, custodian or issuer of the

SIMPLE IRA to which the employerwill make all contributions on behalfof that employee.’’;(5) Item 4 of Article V: strike thisItem; substitute ‘‘SIMPLE IRA . ASIMPLE IRA is an individual retire-ment account described in section408(a), or an individual retirementannuity described in section 408(b), towhich the only contributions that canbe made are contributions under aSIMPLE plan and rollovers or trans-fers from another SIMPLE IRA.’’;(6) Article VI, heading: strike every-thing after the title and substitute‘‘(The employer will provide eachemployee with the procedures forwithdrawals of contributions receivedby the financial institution selected bythat employee unless that financialinstitution provides the procedures di-rectly to the employee.)’’; and(7) Article VII: strike the paragraphpertaining to the agreement to be adesignated financial institution (i.e.,the paragraph that begins ‘‘The under-signed agrees . . .’’) and the relatedname, address, and signature block.

B. Modifications to the Instructions:

(1) Under heading ‘‘What is aSIMPLE Plan?’’: strike ‘‘designatedfinancial institution named in ArticleVII’’ and substitute ‘‘financial institu-tion selected by each eligible em-ployee’’;(2) Under heading ‘‘When to UseForm 5305–SIMPLE’’: strike Item 1and renumber Items 2 and 3 accord-ingly;(3) Under heading ‘‘CompletingForm 5305–SIMPLE’’: strike ‘‘andthe designated financial institution’’;(4) Under heading ‘‘Contributions(Article III) ’’, subheading ‘‘SalaryReduction Contributions’’: strike‘‘designated financial institution forthe employee’s SIMPLE IRA’’ andsubstitute ‘‘financial institution se-lected by each eligible employee’’;(5) Under heading ‘‘Other ImportantInformation About Your SIMPLEPlan’’, subheading ‘‘Timing of Sal-ary Reduction Contributions’’:(a) Strike ‘‘designated financial in-stitution for the SIMPLE IRAs ofall eligible employees’’ and substi-tute ‘‘financial institution selectedby each eligible employee for hisor her SIMPLE IRA’’; and

34

(b) Strike ‘‘the SIMPLE IRA at thedesignated financial institution’’ andsubstitute ‘‘each participant’sSIMPLE IRA’’;

(6) Under heading ‘‘Other Impor-tant Information About YourSIMPLE Plan ’’, subheading ‘‘Em-ployee Notification’’: strike every-thing after the title and substitute‘‘You must notify each eligible em-ployee prior to the employee’s 60-dayelection period described above thathe or she can make or change salaryreduction elections and select the fi-nancial institution that will serve asthe trustee, custodian, or issuer of theemployee’s SIMPLE IRA. In this no-tification, you must indicate whetheryou will provide:1. A matching contribution equal

to your employees’ salary reductioncontributions up to a limit of 3% oftheir compensation;2. A matching contribution equal

to your employees’ salary reductioncontributions subject to a percentagelimit that is between 1% and 3% oftheir compensation; or3. A nonelective contribution equal

to 2% of your employees’ compensa-tion.You can use theModel Notifica-

tion to Eligible Employeeson page 3to satisfy these employee notificationrequirements for this SIMPLE plan,provided you either: (1) modify themodel to disclose employees’ abilityto select the financial institution thatwill serve as the trustee, custodian, orissuer of the employee’s SIMPLEIRA or (2) provide this same disclo-sure in a separate document. ASum-mary Description must also be pro-vided to eligible employees at thistime. This summary description re-quirement may be satisfied by provid-ing a completed copy of pages 1 and2 of Form 5305–SIMPLE (includingthe Article VI Procedures for With-drawals).If you fail to provide the employee

notification (including the summarydescription) described above, you willbe liable for a penalty of $50 per dayuntil the notification is provided. Ifyou can show that the failure was dueto reasonable cause, the penalty willnot be imposed.If the summary description infor-

mation with respect to the financialinstitution (i.e., the name and addressof the financial institution and itswithdrawal procedures) is not avail-able at the time the employee must be

given the summary description, youmust provide the summary descriptionwithout this information. In such acase, you will have reasonable causefor not including this informationwith respect to the financial institu-tion in the summary description.’’;(7) Under heading ‘‘Other Impor-tant Information About YourSIMPLE Plan ’’: strike subheading‘‘ Choosing the Designated FinancialInstitution ’’ and the following threeparagraphs;(8) Strike the heading ‘‘Instructionsfor the Designated Financial Insti-tution ’’ and the subheading ‘‘Com-pleting Form 5305–SIMPLE’’ andthe following paragraph; and(9) Under the subheading ‘‘SummaryDescription’’:(a) In the first paragraph, strike‘‘you’’ and substitute ‘‘the financialinstitution for the SIMPLE IRA ofeach eligible employee’’;(b) In the first paragraph, strike‘‘your procedures for withdrawalsand transfers from the SIMPLEIRAs established under thisSIMPLE plan’’ and substitute ‘‘thatfinancial institution’’s procedures forwithdrawals from SIMPLE IRAs es-tablished at that financial institution,including the financial institution‘‘sname and address’’; and(c) Strike the second paragraph andsubstitute ‘‘There is a penalty of$50 per day for each failure toprovide the summary descriptiondescribed above. However, if thefailure was due to reasonable cause,the penalty will not be imposed.’’

REQUEST FOR COMMENTS

The Service and Treasury requestcomments on the guidance provided inthese questions and answers for use indeveloping any future guidance onSIMPLE plans.Comments can be addressed to

CC:DOM:CORP:R (Notice 97–6), room5228, Internal Revenue Service, POB7604, Ben Franklin Station, Washington,DC 20044. In the alternative, commentsmay be hand delivered between thehours of 8 a.m. and 5 p.m. toCC:DOM:CORP:R (Notice 97–6), Cou-rier’s Desk, Internal Revenue Service,1111 Constitution Avenue NW., Wash-ington, DC. Alternatively, taxpayers maytransmit comments electronically via theIRS Internet site at http://www.irs.ustreas.gov/prod/tax_regs/comments.html

PAPERWORK REDUCTION ACT

The collections of information con-tained in this notice have been reviewedand approved by the Office of Manage-ment and Budget for review in accor-dance with the Paperwork ReductionAct (44 U.S.C. 3507) under controlnumber 1545–1502.An agency may not conduct or spon-

sor, and a person is not required torespond to, a collection of informationunless the collection of information dis-plays a valid control number.The collections of information in this

notice are in the sections headed:Em-ployee Elections, Employer Administra-tive And Notification Requirements,Trustee Administrative Requirements,and SIMPLE Plan Establishments. Thisinformation is required by the IRS toassure compliance with the new provi-sions of the Small Business Job Protec-tion Act of 1996. The likely respondentsare individuals, business or other for-profit institutions, and not-for-profit in-stitutions.The estimated total annual reporting

burden is 769,000 hours. The estimatedaverage annual burden per respondent is2 hours and 34 minutes. The estimatednumber of respondents is 300,000.The estimated annual frequency of

responses is annually.Books or records relating to a collec-

tion of information must be retained aslong as their contents may become ma-terial in the administration of any inter-nal revenue law. Generally, tax returnsand tax return information are confiden-tial, as required by 26 U.S.C. 6103.


The principal author of this notice isCarlton Watkins of the Employee PlansDivision. For further information regard-ing this notice, please contact the Em-ployee Plans Division’s taxpayer assis-tance telephone service at (202) 622–6074/6075 (not a toll-free number),between the hours of 1:30 and 4:00 p.m.Eastern Time, Monday through Thurs-day.

Adoption Assistance

Notice 97–9

Sections 23 and 137, relating to cer-tain adoption expenses, were added tothe Internal Revenue Code by the SmallBusiness Job Protection Act of 1996,Pub. L. 104–188. This notice providesgeneral guidance concerning the tax

35

credit under § 23 for qualified adoptionexpenses paid or incurred by an indi-vidual, and the exclusion from grossincome under § 137 for amounts paidor expenses incurred by an employer forqualified adoption expenses under anadoption assistance program. Both thecredit and the exclusion are effective fortaxable years beginning after December31, 1996. They both generally terminateafter December 31, 2001 (except for thecredit with respect to a child withspecial needs).This notice is divided into six sec-

tions. Section I explains the adoptioncredit. Section II explains the exclusionfrom gross income under an adoptionassistance program. Section III describesthe coordination of the credit and theexclusion. Sections IV and V coverfiling and reporting requirements andthe effective dates of the credit and theexclusion, respectively. Section VI in-vites comments on future guidance re-garding the credit and the exclusion.

I. Adoption Credit.A. In General.Section 23 provides an income tax

credit for qualified adoption expensespaid or incurred by an individual inconnection with the adoption of aneligible child. The phrase ‘‘paid or in-curred’’ refers to the method of account-ing (i.e., cash or accrual) of the indi-vidual. Under a dollar limitation, themaximum credit is $5,000 ($6,000 inthe case of an adoption of a child withspecial needs). See section I.D.1. Thecredit is also subject to an incomelimitation which may reduce or elimi-nate the credit for any particular year.See section I.D.2. For the effective dateand partial expiration date of the credit,see section V.

B. Eligible Child and Child with SpecialNeeds.1. In general.An eligible child is any individual

who, at the time a qualified adoptionexpense is paid or incurred, is under theage of 18, or is physically or mentally

incapable of caring for himself or her-self. For qualified adoption expensespaid or incurred after December 31,2001, an eligible child must also be achild with special needs.2. Child with Special Needs.A child with special needs is an

otherwise eligible child who meets twoadditional requirements. First, a statemust have determined that (1) the childcannot or should not be returned to theparents’ home, and (2) it is reasonableto conclude the child cannot be placedwith adoptive parents without adoptionassistance because of a specific factor orcondition. Examples of a specific factoror condition include a child’s ethnicbackground, age, membership in a mi-nority or sibling group, medical condi-tion, or handicap. Second, a child withspecial needs must be a citizen orresident of the United States. The term‘‘United States’’ includes any possessionof the United States.

C. Qualified Adoption Expenses.‘‘Qualified adoption expenses’’ in-

clude the reasonable and necessaryadoption fees, court costs, attorney’sfees, traveling expenses (includingamounts expended for meals and lodg-ing) while away from home, and otherexpenses that are directly related to, andthe principal purpose of which is for,the legal adoption of an eligible child bythe taxpayer. Qualified adoption ex-penses do not include any expense (1)for which a deduction or credit is al-lowed under any other provision of theCode, (2) to the extent that funds for theexpense are received under any federal,state, or local program, (3) that isincurred in violation of federal or statelaw, (4) that is incurred in carrying outany surrogate parenting arrangement, (5)that is incurred in connection with theadoption of a child of the taxpayer’sspouse, or (6) for which reimbursementis made under an employer program orotherwise. In addition, an expense paid(by a cash basis taxpayer) or incurred(by an accrual basis taxpayer) in a

taxable year beginning before 1997 isnot a qualified adoption expense eligiblefor the credit.

D. Limitations on the Credit.The credit for qualified adoption ex-

penses is subject to a dollar limitationand an income limitation.

1. Dollar Limitation.The maximum amount of qualified

adoption expenses that may be takeninto account for the credit is $5,000($6,000 in the case of an adoption of achild with special needs). The legislativehistory to this provision clarifies that the$5,000 (or $6,000) limitation is withrespect to the adoption of each child andis cumulative over all taxable years(rather than an annual limitation). Seesection I.G., Examples 1 and 2. There-fore, the maximum amount that may betaken into account in connection with ataxpayer’s effort to adopt an eligiblechild is $5,000 (or $6,000), includingqualified adoption expenses paid or in-curred in any unsuccessful attempt toadopt an eligible child before success-fully finalizing the adoption of anothereligible child. See section I.G., Example3. The $5,000 (or $6,000) limitation onqualified adoption expenses applies bothto married individuals and to unmarriedindividuals adopting an eligible child.Therefore, an unmarried couple thatseeks to adopt an eligible child mustapply the $5,000 (or $6,000) limitationto the couple’s combined qualified adop-tion expenses.

2. Income Limitation.If a taxpayer’s modified adjusted

gross income (modified AGI, as definedin section I.D.3. below) is $75,000 orless, the income limitation does notapply and the taxpayer’s allowablecredit is not reduced. If a taxpayer’smodified AGI is $115,000 or more, nocredit is available. If a taxpayer’s modi-fied AGI is between $75,000 and$115,000, the allowable credit is ratablyreduced (but not below zero) as follows:

ALLOWABLE CREDIT = QAE(YR) 2 [QAE(YR) × ( modified AGI 2 $75,000)]$40,000

‘‘QAE(YR)’’ is the amount of qualifiedadoption expenses taken into account forthe taxable year after applying the dollarlimitation.For example, assume that in 1997 an

unmarried individual has modified AGIof $85,000 and pays $5,000 for quali-

fied adoption expenses. The adoptionbecomes final in 1997. The individual’sreduction percentage is 25% ($85,000minus $75,000 equals $10,000; $10,000divided by $40,000 equals 25%). Themaximum credit available is $3,750($5,000 times 25% equals $1,250;

$5,000 minus $1,250 equals $3,750) andis claimed in 1997. In addition, seesection I.G., Example 4.

3. Modified Adjusted Gross Income.

Modified AGI for the taxable year inwhich qualified adoption expenses are

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taken into account is adjusted grossincome for that year determined afterapplying the income exclusion under§ 137, but without applying § 911 (theforeign earned income exclusion or theforeign housing exclusion), § 931 (theexclusion for income from Guam,American Samoa, and the NorthernMariana Islands), and § 933 (the exclu-sion for income from Puerto Rico).

E. Year of Credit.1. Domestic adoptions.The credit for qualified adoption ex-

penses paid or incurred in connectionwith the adoption of an eligible childwho is a citizen or resident of theUnited States at the time the adoptioncommenced (including such amountspaid or incurred in an unsuccessfuleffort to adopt such a child) is allowedin the next taxable year unless theexpenses are paid or incurred in thetaxable year the adoption becomes final.The credit for expenses paid or incurredin the taxable year an adoption becomesfinal is allowed in that year.

2. Foreign adoptions.A special rule applies in the case of

the adoption of an eligible child who isnot a citizen or resident of the UnitedStates at the time the adoption com-menced. The credit is only available foradoptions that become final. Qualifiedadoption expenses paid or incurred inany taxable year before the taxable yearin which the adoption becomes final aretreated as paid or incurred in the taxableyear in which the adoption becomesfinal. Therefore, the credit for qualifiedadoption expenses paid or incurred inthe taxable year in which the adoptionbecomes final, or in any earlier taxableyear, is allowed in the taxable year theadoption becomes final.For example, assume that in 1997 and

1998 an unmarried individual pays$1,000 and $3,000, respectively, ofqualified adoption expenses in connec-tion with the adoption of an eligiblechild who is not a citizen or resident ofthe United States. In 1999, the year theadoption becomes final, the individualpays an additional $4,000 of such ex-penses. The individual’s modified ad-justed gross income for 1999 is lessthan $75,000 (and thus the income limi-tation does not apply). The individualmay claim a credit of $5,000 (the maxi-mum credit permitted) on his or her1999 federal income tax return (the yearthe adoption becomes final).

3. Pre-1997 Expenses.An expense paid (by a cash basis

taxpayer) or incurred (by an accrualbasis taxpayer) in a taxable year begin-ning before 1997 in connection with theadoption (either domestic or foreign) ofan eligible child does not qualify for thecredit. See section V.A.

F. Carryforward of Unused Credit.The adoption credit allowable under

§ 23 is a nonrefundable credit that,along with credits allowable under § 21(relating to dependent care), § 22 (relat-ing to the elderly and the disabled), and§ 25 (relating to interest on home mort-gages), is limited under § 26 to theexcess of the taxpayer’s regular taxliability for the taxable year over thetentative minimum tax for the taxableyear (determined without regard to thealternative minimum tax foreign taxcredit). If § 26 limits the amount of anadoption credit otherwise allowable in aparticular year, the excess may be car-ried forward to the succeeding taxableyear, but not beyond the fifth taxableyear following the taxable year in whichthe credit arose.

G. Examples.The following examples illustrate the

rules described in section I. For pur-poses of these examples, except as oth-erwise provided, assume that each eli-gible child is a citizen of the UnitedStates who is not a child with specialneeds, and that H andW are a marriedcouple who file a joint federal incometax return on the cash basis and seek toadopt one child.Example 1. Dollar limitation.In an effort to adoptan eligible child,H andW pay $4,000 of qualifiedadoption expenses in 1997 and an additional$2,000 of qualified adoption expenses in 1998.The adoption becomes final in 1998. For 1998,HandW have modified AGI of $75,000 or less (andthus the income limitation does not apply).H andW may not claim any qualified adoption expensesas a credit in 1997 because of the 1-year delayrule in section I.E.1.H and W, on their jointfederal income tax return for 1998, may claim$5,000 of qualified adoption expenses as a credit.The remaining $1,000 of qualified adoption ex-pensesH andW paid may never be claimed as acredit.Example 2. Dollar Limitation.Assume the samefacts as in Example 1, except that the child is achild with special needs. H and W, on their jointfederal income tax return for 1998, may claim$6,000 of qualified adoption expenses as a credit.Example 3. Dollar limitation.In an effort to adoptan eligible child,H andW pay $3,000 of qualifiedadoption expenses in January 1997 to Agency1.Although Agency 1 was able to identify aneligible child for H andW to adopt, the adoptionultimately was unsuccessful.H and W then paid$4,000 of qualified adoption expenses to Agency2in September 1997 in a further effort to adopt achild. This time, the effort was successful andH

and W finalized the adoption ofA, an eligiblechild, in December 1997.H andW have modifiedAGI of $75,000 or less (and thus the incomelimitation does not apply). The total amount thatH andWmay take into account in connection withthe adoption of an eligible child is limited to$5,000. See section I.D.1. Thus,H andW, on their1997 joint federal income tax return, may claim$5,000 of qualified adoption expenses as a credit.The remaining $2,000 of qualified adoption ex-pensesH andW paid may never be claimed as acredit.Example 4. Income limitation.In an effort to adoptan eligible child,H andW pay $1,000 of qualifiedadoption expenses in 1997, an additional $2,000 ofthose expenses in 1998, and $4,000 of thoseexpenses in 1999 when the adoption becomesfinal. H andW have modified AGI of $85,000 forall taxable years and thus the income limitationapplies. H and W may not claim any qualifiedadoption expenses as a credit in 1997 because ofthe 1-year delay rule in section I.E.1.H andW, ontheir 1998 joint federal income tax return, maytake into account the $1,000 of qualified adoptionexpenses paid in 1997, subject to any reductionunder the income limitation.H andW’s reductionpercentage for 1998 under the income limitation is25% ($85,000 minus $75,000 equals $10,000;$10,000 divided by $40,000 equals 25%).H andW’s allowable credit for 1998 is $750 ($1,000times 25% equals $250; $1,000 minus $250 equals$750).H andW, on their joint federal income tax returnfor 1999, first reduce the dollar limitation ($5,000)by the amount of qualified adoption expensestaken into account in all prior years ($5,000 minus$1,000 equals $4,000) before applying the incomelimitation. Thus,H andW may take into accountonly $4,000 of the $6,000 of qualified adoptionexpenses paid in 1998 and 1999 on their 1999joint federal income tax return before applying theincome limitation.H andW’s reduction percentagefor 1999 under the income limitation is 25% andtheir allowable credit for 1999 is $3,000 ($4,000times 25% equals $1,000; $4,000 minus $1,000equals $3,000). The remaining $2,000 of qualifiedadoption expenses thatH andW paid in 1998 and1999 ($6,000 minus $4,000 equals $2,000) maynever be claimed as a credit.

II. Adoption Assistance Program.

A. In General.Section 137 provides an exclusion

from an employee’s gross income foramounts paid or expenses incurred byan employer for qualified adoption ex-penses in connection with the adoptionof an eligible child by an employee ifsuch amounts are furnished pursuant toan adoption assistance program. Seesection II.D., which describes the re-quirements of an adoption assistanceprogram. Under a dollar limitation, themaximum exclusion from gross incomeis $5,000 ($6,000 in the case of anadoption of a child with special needs).See section II.F.1. The exclusion is alsosubject to an income limitation, whichmay reduce or eliminate the exclusionfor any particular year. See sectionII.F.2. For the effective date and expira-tion date of the exclusion, see section V.

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B. Eligible Child and Child with Spe-cial Needs.1. In General.An eligible child is any individual

who, at the time a qualified adoptionexpense is paid or incurred, is under theage of 18, or is physically or mentallyincapable of caring for himself or her-self.

2. Child with Special Needs.A child with special needs is an

otherwise eligible child who meets twoadditional requirements. First, a statemust have determined that (1) the childcannot or should not be returned to theparents’ home, and (2) it is reasonableto conclude the child cannot be placedwith adoptive parents without adoptionassistance because of a specific factor orcondition. Examples of a specific factoror condition include a child’s ethnicbackground, age, membership in a mi-nority or sibling group, medical condi-tion, or handicap. Second, a child withspecial needs must be a citizen orresident of the United States. The term‘‘United States’’ includes any possessionof the United States.

C. Qualified Adoption Expenses.

‘‘Qualified adoption expenses’’ in-clude the reasonable and necessaryadoption fees, court costs, attorney’sfees, traveling expenses (includingamounts expended for meals and lodg-ing) while away from home, and otherexpenses that are directly related to, andthe principal purpose of which is for,the legal adoption of an eligible child bythe taxpayer. Qualified adoption ex-penses do not include any expense (1)that is incurred in violation of federal orstate law, (2) that is incurred in carryingout any surrogate parenting arrangement,(3) that is incurred in connection withthe adoption of a child of the taxpayer’sspouse, or (4) that is reimbursed otherthan under an adoption assistance pro-gram that satisfies the requirements of§ 137.

D. Adoption Assistance Program Re-quirements.1. In General.An adoption assistance program is a

separate written plan of an employer for

the exclusive benefit of its employeesunder which the employer providesadoption assistance and which meets therequirements described below. The ex-clusion is not available unless, beforeadoption expenses are incurred by eitherthe employer or employee, the writtenplan is in existence and the employeereceives notification of the existence ofthe plan. An adoption assistance pro-gram may be part of a more comprehen-sive benefit plan and is not required tobe funded. In addition, an employer isnot required to apply to the InternalRevenue Service for a determinationthat the plan is a qualified program.

2. Plan Requirements.A brief description of the plan re-

quirements follows:(a) all employees who are eligible to

participate in the program are requiredto be given reasonable notice of theterms and availability of the program;(b) an adoption assistance program

must benefit the employer’s employeesgenerally and eligibility requirementsmay not discriminate in favor of highlycompensated employees or their depen-dents;(c) shareholders or owners (or their

spouses or dependents) may receive nomore than five percent of all the adop-tion assistance reimbursements or ex-penses paid by the employer during theyear (for this purpose, a shareholder orowner is someone who owns on any dayof the year more than five percent of thestock, or capital or profits interest of theemployer); and(d) an employee receiving payments

under an adoption assistance programmust provide the employer reasonablesubstantiation that payments or reim-bursements made under the programconstitute qualified adoption expenses.Without regard to whether the forego-

ing requirements are satisfied, adoptionreimbursement programs under § 1052of title 10, United States Code (relatingto the armed forces) or § 514 of title14, United States Code (relating tomembers of the Coast Guard) are treatedas adoption assistance programs for pur-poses of the exclusion.

E. Cafeteria Plans.An adoption assistance program that

meets the requirements of § 137 (de-scribed in section II.D.) constitutes aqualified benefit under § 125 of theCode. Consequently, the program maybe offered through a cafeteria plan.

F. Limitations on the Exclusion.The exclusion from gross income for

qualified adoption expenses under anadoption assistance program is subjectto a dollar limitation and an incomelimitation.

1. Dollar Limitation.The maximum amount of qualified

adoption expenses that may be takeninto account is $5,000 ($6,000 in thecase of an adoption of a child withspecial needs). The $5,000 (or $6,000)limitation is with respect to the adoptionof each child and is cumulative over alltaxable years (rather than an annuallimitation). See section II.J., Examples 1and 2. Therefore, the maximum amountthat may be taken into account in con-nection with a taxpayer’s effort to adoptan eligible child is $5,000 (or $6,000),including amounts paid or expenses in-curred for qualified adoption expensesin connection with any unsuccessfulattempt to adopt an eligible child beforesuccessfully finalizing the adoption ofanother eligible child. See section II.J.,Example 3. The $5,000 (or $6,000)limitation on qualified adoption ex-penses applies both to married individu-als and to unmarried individuals adopt-ing an eligible child. Therefore, anunmarried couple that seeks to adopt aneligible child must apply the $5,000 (or$6,000) limitation to the couple’s com-bined qualified adoption expenses.

2. Income Limitation.If a taxpayer’s modified adjusted

gross income (modified AGI) (as de-fined in section II.F.3. below) is $75,000or less, the income limitation does notapply and the taxpayer’s allowable ex-clusion is not reduced. If a taxpayer’smodified AGI is $115,000 or more, noexclusion is available. If a taxpayer’smodified AGI is between $75,000 and$115,000, the allowable exclusion isratably reduced (but not below zero) asfollows:

ALLOWABLE EXCLUSION = QAE(YR) 2 [QAE(YR) × ( modified AGI 2 $75,000)]$40,000

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‘‘QAE(YR)’’ is the amount of qualifiedadoption expenses taken into account forthe taxable year after applying the dollarlimitation.For example, assume that in 1997 an

unmarried employee has modified AGIof $85,000 and is reimbursed $5,000 byhis or her employer under an adoptionassistance program for qualified adop-tion expenses. The employee’s reductionpercentage is 25% ($85,000 minus$75,000 equals $10,000; $10,000 di-vided by $40,000 equals 25%). Themaximum amount of the exclusion fromthe employee’s gross income in 1997 is$3,750 ($5,000 times 25% equals$1,250; $5,000 minus $1,250 equals$3,750). The remaining $1,250 is in-cluded in the employee’s gross incomefor 1997. In addition, see section II.J.,Example 4. For the employee’s taxfiling obligations and responsibilities,see section II.G.2.

3. Modified adjusted gross income.Modified AGI for the taxable year in

which the exclusion may be claimed isadjusted gross income for that year, butwithout applying § 137 (the exclusionfor adoption assistance program pay-ments), § 911 (the foreign earned in-come exclusion or the foreign housingexclusion), § 931 (the exclusion for in-come from Guam, American Samoa, andthe Northern Mariana Islands), and§ 933 (the exclusion for income fromPuerto Rico). Modified AGI as definedfor the exclusion is different from modi-fied AGI as defined for the credit.

G. Tax Withholding, Reporting, and Fil-ing Obligations.1. Employer’s Withholding and Re-

porting Obligations.Amounts paid or expenses incurred

by an employer for qualified adoptionexpenses under an adoption assistanceprogram are not subject to income taxwithholding. However, these amountsare subject to social security and Medi-care taxes (FICA), federal unemploy-ment tax (FUTA), and railroad retire-ment tax withholding. Employers are toreport amounts paid or expenses in-curred for qualified adoption expensesin accordance with appropriate forms(for example, Form W–2) and instruc-tions or other guidance issued by theInternal Revenue Service. See An-nouncement 96–134, 1996–53 I.R.B. 1,for instructions relating to reportingadoption assistance program paymentson Form W–2.

2. Employee’s Tax Filing Obligationsand Responsibilities.As described above, amounts paid or

expenses incurred for qualified adoptionexpenses by an employer under anadoption assistance program are not sub-ject to income tax withholding. There-fore, an employee who receives reim-bursements or payments that do notqualify, or only partially qualify, for theexclusion from gross income (see sec-tions II.F.2. and II.H.2.) must make anappropriate adjustment on Form 1040(in accordance with the form and itsinstructions) to include in gross incomethe taxable portion of the reimburse-ment. In addition, the employee mayneed to make an adjustment to his orher income tax withholding (on FormW–4) or make estimated tax payments(see Publication 505, Tax Withholdingand Estimated Tax) to avoid potentialpenalties for underpayment of tax on thetaxable portion of a reimbursement.

H. Year of Exclusion.1. Domestic Adoptions.In general, amounts are excludable

from the employee’s gross income forthe year in which the employer pays thequalified adoption expense in connectionwith the adoption of an eligible childwho is a citizen or resident of theUnited States at the time the adoptioncommenced.

2. Foreign Adoptions.A special rule applies in the case of

the adoption of an eligible child who isnot a citizen or resident of the UnitedStates at the time the adoption com-menced. The exclusion is only availablefor adoptions that become final.Amounts paid or expenses incurred bythe employer for qualified adoption ex-penses before the taxable year in whichthe adoption becomes final are exclud-able from the employee’s gross incomein the taxable year in which the adop-tion becomes final. Therefore, amountspaid or expenses incurred by the em-ployer under an adoption assistance pro-gram in a taxable year prior to a finaladoption are includible in the employ-ee’s gross income in that year. Theemployee must make an appropriateadjustment on the employee’s Form1040. Provided the adoption becomesfinal before January 1, 2002, the em-ployee may claim the exclusion in thetaxable year in which the adoption be-comes final by making an appropriateadjustment on the employee’s Form1040 for that year. See section II.J.,Example 5. See also section II.G. for

employer and employee tax withholding,reporting, and filing obligations.

I. Reserved.

J. Examples.The following examples illustrate the

rules described in section II. For pur-poses of these examples, except as oth-erwise provided, assume that each eli-gible child is a citizen of the UnitedStates who is not a child with specialneeds, that EmployeeY is married, is acash method taxpayer, and files a jointfederal income tax return withY’sspouse.Y and Y’s spouse seek to adoptone child. Also assume that EmployerXestablishes an adoption assistance pro-gram that meets the requirements of§ 137 on January 1, 1997, and thatY isa plan participant.Example 1. Dollar limitation.In 1997, pursuant tothe adoption assistance program,X pays $5,000 ofqualified adoption expenses on behalf ofY inconnection withY’s effort to adopt an eligiblechild. Y and Y’s spouse have modified AGI of$75,000 or less for 1997 and 1998 (and thus theincome limitation does not apply). In 1997,Y canexclude $5,000 from gross income. In 1998,Xpays an additional $2,000 of qualified adoptionexpenses on behalf ofY. Y must include theadditional amounts in gross income in 1998. Seesection II.G. for X and Y’s tax withholding,reporting, and filing obligations.Example 2. Dollar limitation.Assume the samefacts as in Example 1, except that the child is achild with special needs. In 1997,Y can exclude$5,000 from gross income. In 1998,Y can excludean additional $1,000 from gross income.Y mustinclude the remaining $1,000 in gross income in1998. See section II.G. forX andY’s tax withhold-ing, reporting, and filing obligations.Example 3. Dollar limitation.In 1997, pursuant tothe adoption assistance program,X pays $7,000 ofqualified adoption expenses on behalf ofY inconnection withY’s effort to adopt an eligiblechild ($3,000 of qualified adoption expenses toAgency 1 for an unsuccessful attempt to adopt Aand $4,000 of qualified adoption expenses toAgency 2 for the final adoption ofB). Y and Y’sspouse have modified AGI of $75,000 or less for1997 (and thus the income limitation does notapply). The total amount thatY may take intoaccount in connection with the adoption of aneligible child is limited to $5,000. Thus, in 1997,Y can exclude $5,000 from gross income. Seesection II.F.1. The remaining $2,000 of qualifiedadoption expensesX paid on behalf ofY areincludible in Y’s gross income in 1997. Seesection II.G. for X and Y’s tax withholding,reporting, and filing obligations.Example 4. Income limitation.Pursuant to theadoption assistance program,X pays $3,000 ofqualified adoption expenses in 1997, and $4,000of those expenses in 1998 on behalf ofY inconnection withY’s effort to adopt an eligiblechild. Y and Y’s spouse have modified AGI of$85,000 for all taxable years (and thus the incomelimitation applies). In 1997,Y can exclude $2,250from income. The income limitation reduces themaximum exclusion as follows:Y’s reductionpercentage is 25% [$85,000 minus $75,000 equals$10,000; $10,000 divided by $40,000 equals25%]; $3,000 times 25% equals $750; $3,000

39

minus $750 equals $2,250. In 1998, the incomelimitation reduces the maximum exclusion asfollows: the dollar limitation ($5,000) is reducedby the amount of qualified adoption expensestaken into account for the exclusion in all prioryears ($3,000 in 1997). Thus, of the $4,000 ofqualified adoption expenses paid in 1998,Y maytake into account only $2,000 ($5,000 minus$3,000 equals $2,000) before applying the incomelimitation. Y’s reduction percentage is 25% andYcan exclude $1,500 from income in 1998 ($2,000times 25% equals $500; $2,000 minus $500 equals$1,500). See section II.G. forX and Y’s taxwithholding, reporting, and filing obligations.Example 5. Cafeteria Plan.Assume that for 1997,Y elects $2,400 in adoption assistance offeredunder a calendar year cafeteria plan maintained byX. In December 1997,Y submits, andX reim-burses, a claim of $2,400 for qualified adoptionexpenses incurred byY for services provided in1997 in connection with a foreign adoption. Theadoption becomes final in 1998.Y andY’s spousehave modified adjusted gross income of $75,000or less in 1998 (and thus the income limitationdoes not apply).Y is required to include the$2,400 reimbursement in gross income for the1997 tax year (because of the rules in sectionII.H.2.). However,Y is entitled to exclude $2,400(the reimbursement received in 1997) from grossincome for the 1998 tax year (the year theadoption becomes final) by making an appropriateadjustment toY’s Form 1040 for 1998. See sectionII.G. for X andY’s tax withholding, reporting, andfiling obligations.

III. Coordination of Credit and Exclu-sion.

A. Credit or Exclusion.An individual may claim both a credit

and an exclusion in connection with theadoption of an eligible child. An indi-vidual may not, however, claim both acredit and an exclusion for the sameexpense. For example, assume that in1997 an unmarried individual pays$6,500 in qualified adoption expenses toan adoption agency for the final adop-tion of an eligible child who is not achild with special needs. In that sameyear, the individual’s employer, under anadoption assistance program that satis-fies the requirements of § 137, pays anadditional $5,000 for other qualifiedadoption expenses to a private attorneyon behalf of the employee for theadoption of the child. In 1997, assumingthe individual’s modified AGI is$75,000 or less, the individual mayexclude $5,000 from gross income, andmay claim a credit of $5,000, becausethe exclusion and credit are not for thesame expenses. The remaining $1,500 ofqualified adoption expenses may neverbe claimed as a credit or excluded fromgross income.B. No Credit for Employer Payments.An individual may not claim a credit

for any expense reimbursed by the indi-vidual’s employer, whether or not reim-bursed under an adoption assistance pro-

gram. See section I.C. For example,assume that in 1997 an unmarried indi-vidual pays $1,000 in qualified adoptionexpenses to a private attorney for thefinal adoption in that year of an eligiblechild who is not a child with specialneeds. In the same year, the individual’semployer, under an adoption assistanceprogram that satisfies the requirementsof § 137, pays an additional $7,000 inqualified adoption expenses to an adop-tion agency on behalf of the employee.Assuming the individual’s modified AGIfor 1997 is $75,000 or less, the indi-vidual may exclude $5,000 (of the$7,000 paid by the employer) fromgross income, and may claim a creditfor the $1,000 paid by the individual.The remaining $2,000 of adoption ex-penses paid by the employer may neverbe claimed as a credit (nor excluded),and must be included in the individual’sgross income in 1997.

IV. Filing and Reporting.A. In General.Taxpayers will be required to provide

(on a form to be published by theInternal Revenue Service) available in-formation about the name, age, andtaxpayer identification number (TIN) ofeach eligible child for whom qualifiedadoption expenses are taken into ac-count for purposes of the credit orexclusion. In lieu of such information,taxpayers may be required to furnishother information, including identifica-tion of the agent assisting with theadoption. Taxpayers should maintainrecords to support any adoption credit orexclusion claimed.

B. Married Individuals.Individuals who are married at the

end of the taxable year must file a jointfederal income tax return to claim thecredit or the exclusion unless they livedapart from each other for the last sixmonths of the taxable year and theindividual claiming the credit or theexclusion (1) maintained as his or herhome a household for the eligible childfor more than one-half of the taxableyear, and (2) furnished over one-half ofthe cost of maintaining that householdin that taxable year. For this purpose, anindividual legally separated from his orher spouse under a decree of divorce orseparate maintenance will not be consid-ered married.

C. Forms and Instructions.The Service will publish forms and

instructions with respect to the filing

requirements for individuals and thereporting requirements for employers.

V. Effective Dates of the Credit and theExclusion.

A. Effective Date.Both the credit and the exclusion are

effective for taxable years beginningafter December 31, 1996.

B. Expiration Date.The credit under § 23 for qualified

adoption expenses in connection withthe adoption of an eligible child who isnot a child with special needs expiresfor expenses paid or incurred after De-cember 31, 2001. Therefore, no credit isavailable for those expenses paid (by acash method taxpayer) or incurred (byan accrual method taxpayer) after De-cember 31, 2001. The credit for quali-fied adoption expenses paid or incurredin connection with an adoption of aneligible child with special needs doesnot expire.The exclusion under § 137 for adop-

tion assistance expires after December 31,2001. Therefore, no exclusion from grossincome applies to amounts paid or ex-penses incurred under an adoption assis-tance program after December 31, 2001.In the case of a foreign adoption that

becomes final after December 31, 2001,taxpayers cannot receive either a creditor an exclusion.

VI. Comments on Future Guidance In-vited.

The Service invites comments on fu-ture guidance concerning §§ 23 and137. The Service requests that writtencomments be submitted by [INSERTDATE THAT IS [90] DAYS AFTERDATE OF PUBLICATION OF THISDOCUMENT IN THE INTERNALREVENUE BULLETIN]. Send submis-sions to: CC:DOM:CORP:R (Notice 97–9), Room 5226, Internal Revenue Ser-vice, POB 7604, Ben Franklin Station,Washington, DC 20044. Submissionsmay be hand delivered between thehours of 8 a.m. and 5 p.m. to:CC:DOM:CORP:R (Notice 97–9), Cou-rier’s Desk, Internal Revenue Service,1111 Constitution Avenue, NW, Wash-ington, DC. Alternatively, taxpayers maysubmit comments electronically via theinternet directly to the IRS internet siteat http://www.irs.ustreas.gov/prod/taxregs/comments.html.The principal authors of this notice

are Marilyn E. Brookens of the Officeof the Assistant Chief Counsel (IncomeTax and Accounting), and Sharon Cohenand Catherine Fuller of the Office of the

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Associate Chief Counsel (EmployeeBenefits and Exempt Organizations). Forfurther information regarding the taxcredit portion of the notice, contact Ms.Brookens at (202) 622–4920 (not atoll-free call). For further informationregarding the adoption assistance pro-gram portion of the notice, contact Ms.Cohen or Ms. Fuller on (202) 622–6080(not a toll-free call).

Sample Language for a Spouse’sWaiver to a QJSA or a QPSA

Notice 97–10

I. PURPOSE

This Notice provides sample languagedesigned to make it easier for spousesof plan participants to understand theirrights to survivor annuities under quali-fied plans. The sample language can beincluded in a form used for a spouse toconsent to a participant’s waiver of aqualified joint and survivor annuity(QJSA) or qualified preretirement survi-vor annuity (QPSA), or to a participant’schoice of a non-spouse beneficiary in adefined contribution plan not subject tothe QJSA and QPSA requirements.The language is designed to assist

plan administrators in preparing spousalconsent forms that meet the statutoryrequirements. No one is required to usethe sample language, and plan adminis-trators that choose to use it are free toincorporate all or any part of it in theirspousal consent forms.

II. BACKGROUND

Section 401(a)(11) of the InternalRevenue Code of 1986 provides that, inorder to be qualified under section401(a), all defined benefit plans andcertain defined contribution plans mustprovide benefits in the form of a QJSAand in the form of a QPSA. Section 417permits a participant to waive the QJSAand to elect another form of retirementbenefit, or to waive the right to aQPSA, if the participant’s spouse signs aconsent form.Section 417(a)(3) requires that the

plan provide an explanation to the par-ticipant of the QJSA and of his or herright to waive the QJSA within a rea-sonable time before the participant’sannuity starting date. However, effectivefor plan years beginning after December31, 1996, section 417(a)(7)(A) providesthat a plan can provide the explanationafter the annuity starting date, but therequired election period must not end

earlier than 30 days after notice wasgiven to the participant. Section417(a)(3)(B) requires the plan to providean explanation to the participant of theQPSA and of his or her right to waivethe QPSA within the applicable period,as defined in section 417(a)(3)(B)(ii).Section 417(a)(2)(A)(i) provides that,

in order for a participant to elect towaive the QJSA or QPSA, the spouse ofthe participant must consent in writing tothe election. Section 417(a)(2)(A)(ii)provides that, in general, the waiver of,and the consent to a waiver of, a QJSAmust state the specific nonspouse benefi-ciary who will receive the benefit andthe particular optional form of benefit.The waiver of, and the consent to awaiver of, a QPSA must state the spe-cific nonspouse beneficiary who willreceive the benefit but is not required tostate the form of benefit selected (ifany). However, a plan may permit aspouse to execute a general consent thatallows the participant to waive the QJSAor the QPSA, and change the designatedbeneficiary or the optional form of ben-efit payment, without obtaining furtherconsent of the spouse. Section 1.401(a)–20, Q&A–31(c), of the Regulations pro-vides that a general consent must ac-knowledge that the spouse has the rightto limit his or her consent to a specificbeneficiary and a specific form of pay-ment (where applicable) and that thespouse elects to relinquish both of theserights. Section 417(a)(2)(A)(iii) requiresthat the spouse’s consent acknowledgethe effect of the participant’s waiver ofthe QJSA or QPSA and requires that theconsent be witnessed by a plan represen-tative or a notary public.Under section 401(a)(11), to the extent

a defined contribution plan that is notsubject to the QJSA and QPSA require-ments, the plan must provide that theparticipant’s nonforfeitable account bal-ance be paid in full to the participant’ssurviving spouse upon the participant’sdeath. The account balance can be paidto another beneficiary if the participantso elects and the spouse consents to theelection. In general, the spousal consentmust meet the same conditions as aconsent to the waiver of a QPSA.Section 1457 of the Small Business

Job Protection Act of 1996, Pub. L. No.104–188, directs the Secretary of theTreasury (‘‘Secretary’’) to developsample language, written in a mannercalculated to be understood by the aver-age person, that can be included in aform used for a spouse to consent to aparticipant’s waiver of a QJSA or a

QPSA. This Notice contains the samplelanguage for the spousal consent forms.Section 1457 also directs the Secretaryto publish sample language that can beincluded in a qualified domestic rela-tions order (QDRO). The QDRO samplelanguage is contained in Notice 97–11in this Bulletin.

III. SAMPLE LANGUAGE

The Appendices to this Notice containfour sets of sample language:

• Appendix A contains sample lan-guage that can be included in aspouse’s consent to a participant’swaiver of a QJSA. This languagecan be used for a defined benefitplan and for a defined contributionplan to the extent that it is subjectto section 401(a)(11).

• Appendix B contains sample lan-guage that can be included in aspouse’s consent to a participant’swaiver of a QPSA, and, if the planso provides, to the participant’schoice of a beneficiary other thanthe spouse to receive any survivorbenefit. This language can be usedfor a defined benefit plan.

• Appendix C contains sample lan-guage that can be included in aspouse’s consent to a participant’swaiver of a QPSA, and, if the planso provides, to the participant’schoice of a beneficiary other thanthe spouse to receive any survivorbenefit. This language can be usedfor a defined contribution plan tothe extent that it is subject tosection 401(a)(11).

• Appendix D contains sample lan-guage that can be included in aspouse’s consent to a participant’schoice of a beneficiary other thanthe spouse for a participant’s ac-count balance. This language canbe used for a defined contributionplan to the extent that it is notsubject to section 401(a)(11).

If the plan administrator chooses touse the sample language provided in anAppendix, the sample language shouldbe conformed to the terms of the plan.The plan administrator should read thesample language carefully and selectonly those portions of the sample lan-guage that apply to the particular plan.For example, the sample language inAppendix A refers to certain optionalforms of benefits under the plan, includ-ing a lump sum payment. If a planadministrator decides to include thissample language in the plan’s spousalconsent form, the sample language

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should be compared to the optionalforms of benefit payments available un-der the plan and modified, if necessary,to reflect the plan’s optional forms.Further, spousal consent forms for someplans will need additional language dis-cussing issues specific to the plan.In order for a spouse’s consent to be

valid, the spousal consent form is notrequired to include the specific languagecontained in the Appendices. In allcases, however, spousal consent formsshould be written clearly to ensure thatthe spouse both understands and ac-knowledges the effect of the partici-pant’s waiver of rights.The Appendix provides sample lan-

guage for incorporation in a spousalconsent form only. The Appendix doesnot provide sample language for theexplanation of the QJSA or QPSA thatis required to be provided to the partici-pant or the agreement in which theparticipant waives the QJSA or QPSA.

IV. COMMENTS

Notice 94–23, 1994–1 C.B. 340, re-quested comments from the public to aidin the development of additional guid-ance concerning spousal consent forms.The comments that were made in re-sponse to Notice 94–23 have been takeninto consideration in drafting the samplelanguage accompanying this Notice.The Service invites the public to

comment on the sample language ac-companying this Notice as well as tosuggest possible additional sample lan-guage. Comments can be addressed toCC:DOM:CORP:R (Notice 97–10),Room 5228, Internal Revenue Service,P.O. Box 7604, Ben Franklin Station,Washington, DC 20044. In the alterna-tive, comments may be hand deliveredbetween the hours of 8 a.m. and 5 p.m.to CC:DOM:CORP:R (Notice 97–10),Courier’s Desk, Internal Revenue Ser-vice, 1111 Constitution Avenue, N.W.,Washington, DC. Alternatively, taxpay-ers may transmit comments electroni-cally via the IRS Internet site at ‘http://www.irs.ustreas.gov/prod/tax_regs/comments.html’.


The principal authors of this Noticeare Susan Lennon of the Office of theAssociate Chief Counsel (EmployeeBenefits and Exempt Organizations) andSteven Linder of the Employee PlansDivision. For further information regard-ing this Notice, please contact the Em-ployee Plans Division’s taxpayer assis-

tance telephone service at (202) 622–6074/6075, between the hours of 1:30p.m. and 4 p.m. Eastern Time, Mondaythrough Thursday. Alternatively, pleasecall Ms. Lennon at (202) 622–4606 orMr. Linder at (202) 622–6214. Thesetelephone numbers are not toll-free.

APPENDIX A

SAMPLE LANGUAGE THAT MAYBE INCLUDED IN A SPOUSE’SAGREEMENT TO GIVE UP THERIGHT TO THE QUALIFIEDJOINT AND SURVIVOR ANNUITY(UNDER A DEFINED BENEFITPLAN OR A DEFINED CONTRIBU-TION PLAN)

Instruction: The sample language doesnot address the one-year-of-marriagerule under section 417(d); if a planapplies the one-year rule, the samplelanguage should be modified to explainthis rule.The sample language contains languagein brackets that pertains to a partici-pant’s selection of a non-spouse benefi-ciary to receive death benefits. Thebracketed language should be deleted ifthe plan provides death benefits only tothe participant’s surviving spouse.

1. What is a Qualified Joint and Sur-vivor Annuity (QJSA)?Federal law requires the(name of

plan) to pay retirement benefits in aspecial payment form unless your spousechooses a different payment form andyou agree to that choice. This specialpayment form is often called a ‘‘quali-fied joint and survivor annuity’’ or‘‘QJSA’’ payment form. The QJSA pay-ment form gives your spouse a(insertperiod of QJSA payment, e.g., monthly)retirement payment for the rest of his orher life. This is often called an ‘‘annu-ity.’’ Under the QJSA payment form,after your spouse dies, each(insert pe-riod of QJSA payment, e.g., month)theplan will pay you (insert survivor per-centage for the QJSA form under theplan) percent of the retirement benefitthat was paid to your spouse. The ben-efit paid to you after your spouse dies isoften called a ‘‘survivor annuity’’ or a‘‘survivor benefit.’’ You will receive thissurvivor benefit for the rest of your life.Example

Pat Doe and Pat’s spouse, Robin, re-ceive payments from the plan underthe QJSA payment form. Beginningafter Pat retires, Pat receives $600 eachmonth from the plan. Pat then dies.The plan will pay Robin $(insert ap-

plicable dollar amount for the QJSA)amonth for the rest of Robin’s life.

2. How Can Your Spouse Change theWay Benefits Are Paid?Your spouse and you will receive

benefits from the plan in the specialQJSA payment form required by federallaw unless your spouse chooses a differ-ent payment form and you agree to thechoice. If you agree to change the waythe plan’s retirement benefits are paid,you give up your right to the specialQJSA payments.

3. Do You Have to Give Up YourRight to the QJSA Benefit?Your choice must be voluntary. It is

your personal decision whether youwant to give up your right to the specialQJSA payment form.

4. What Other Benefit Forms CanMy Spouse Choose?

Instruction: The plan administratormay make additions to the paragraphbelow to explain the plan’s optionalforms of benefits. For example, theplan administrator could list all op-tional forms of benefits or provide across-reference to a description of ben-efit options provided to participants.The examples following the paragraphare common optional forms of benefits.The examples should be modified to beconsistent with the plan’s optionalforms of benefits. The plan administra-tor may give additional examples toexplain other available optional forms.

If you agree, your spouse can chooseto have the retirement benefits paid in adifferent form. Other payment formsmay give your spouse larger retirementbenefits while he or she is alive, butmight not pay you any benefits afteryour spouse dies.Example of Single Life Annuity Pay-ment Form

If Pat and Robin Doe receive retire-ment benefits in the special QJSApayment form, Pat would receive re-tirement benefits of $600 each monthfrom the plan until Pat dies andRobin would receive $ (insert appli-cable dollar amount for the QJSA) amonth for the rest of Robin’s life. Patand Robin Doe agree not to receiveretirement benefits in the specialQJSA payment form and decide in-stead to receive payments only duringPat’s life. After Pat retires, Pat willreceive more than $600 each monthfrom the plan until Pat’s death. Robin

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will not receive any payments fromthe plan after Pat’s death.

Example of Lump Sum Payment Form

Pat and Robin Doe agree not toreceive the special QJSA paymentsand decide instead that Pat will re-ceive a single payment equal to thevalue of all of Pat’s retirement ben-efits. In this case, no further paymentswill be made to Pat or Robin.[ If you agree, your spouse can name

someone other than you to receive all ora part of the survivor benefits from theplan after your spouse dies. The personyour spouse selects to receive all or partof the survivor benefits is often called a‘‘beneficiary.’’ If you agree to let yourspouse name someone else as the benefi-ciary for all of the survivor benefits, youwill not receive any payments from theplan after your spouse dies. If you agreeto let your spouse name someone else asthe beneficiary for a part of the survivorbenefits, your survivor benefits will beless than you would have received underthe special QJSA payment form.Example of Naming a BeneficiaryWho Is Not the Spouse

Pat and Robin Doe select a paymentform that has a survivor benefit of$200 a month payable after Pat dies.Pat and Robin agree that 1/2 of thesurvivor benefit will be paid to Robinand 1/2 will be paid to Pat andRobin’s child, Chris. After Pat dies,the plan will pay $100 a month toRobin for the rest of Robin’s life.Chris will also receive payments fromthe plan as long as Chris lives. Chriswill receive less than $100 a monthbecause Chris, being younger thanRobin, is expected to receive pay-ments over a longer period.]

5. Can Your Spouse Make FutureChanges if You Sign this Agreement?

Instruction: The plan administratorshould select Option A if the agreementis a ‘‘specific consent,’’ that is, thespouse agrees to the participant’schoice of a particular form of benefitand beneficiary. The plan administra-tor should select Option B if the agree-ment is a ‘‘general consent,’’ that is,the spouse agrees to allow the partici-pant to choose any form of benefit andany beneficiary without telling thespouse the selection.

Option AIf you sign this agreement, you agree

that benefits under the plan will be paidin the form stated in this agreement.[ You also agree that the beneficiarynamed in this agreement will receive allor a part of the survivor benefits fromthe plan after your spouse has died].Your spouse cannot change the paymentform [ or the beneficiary] unless youagree to the change by signing a newagreement. However, your spouse canchange to the special QJSA paymentform without getting your agreement.

Option BIf you sign this agreement, you agree

that your spouse can choose the form ofpayments that he or she will receivefrom the plan without telling you andwithout getting your agreement.[ Yourspouse can also choose the beneficiarywho will receive any survivor benefitsfrom the plan after your spouse dieswithout telling you and without gettingyour agreement.] Your spouse does notneed to tell you or get your agreementto any future changes in the form ofpayments[ or the beneficiary].You may limit your agreement to a

particular payment form[ and a particu-lar beneficiary]. If you want to allowyour spouse to select only a particularpayment form [and a particular benefi-ciary], do not sign this form. In thatcase, contact the plan administrator formore information and to get a newagreement that lets you state the particu-lar payment form [ and the particularbeneficiary] that you will allow yourspouse to select.

6. Can You Change Your Mind AfterYou Sign this Agreement?

Instruction: The plan administratorshould select Option A if the plan doesnot allow a spouse to revoke his or herconsent. The plan administrator shouldselect Option B if the plan allows aspouse to revoke his or her consent.The language in double brackets inOptions A and B applies only to generalconsent forms. For an explanation of aspecific consent and a general consent,see the Instruction to section 5.

Option AYou cannot change this agreement

after you sign it. Your decision is final[ even if your spouse later chooses adifferent type of retirement benefit orbeneficiary].

Option BYou can change this agreement until

(date). After that date, you cannotchange the agreement[ even if yourspouse later chooses a different type ofretirement benefit or beneficiary]. Ifyou change your mind, you must notifythe plan administrator by (insert the planprocedure for revoking consent) .

7. What Happens to this Agreement ifYou Become Separated or Divorced?Legal separation or divorce may end

your right to survivor benefits from theplan even if you do not sign thisagreement. However, if you becomelegally separated or divorced, you mightbe able to get a special court order(which is called a qualified domesticrelations order or ‘‘QDRO’’) that wouldgive you rights to receive retirementbenefits even if you sign this agreement.If you are thinking about separating orgetting a divorce, you should get legaladvice on your rights to benefits fromthe plan.

8. What Should You Know BeforeSigning this Agreement?

Instruction: The plan administratorshould modify the language below toreflect the plan’s administrative proce-dures and insert the appropriate ad-dress or telephone number.

This is a very important decision. Youshould think very carefully aboutwhether you want to sign this agree-ment. Before signing, be sure that youunderstand what retirement benefits youmay get and what benefits you will nolonger be able to receive.Your spouse should have received

information on the types of retirementbenefits available from the plan. If youhave not seen this information, youshould get it and read it before you signthis agreement. For additional informa-tion, you can contact (name of person ordepartment, such as the Human Re-sources Department) at the followingaddress (or telephone number).

9. Your Agreement

Instruction: The plan administratorshould select Option A if the agreementis a specific consent. The plan adminis-trator should select Option B if theagreement is a general consent. For anexplanation of a specific consent and ageneral consent, see the Instruction tosection 5.

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Option AI, (name of participant’s spouse), am

the spouse of(name of participant). Iunderstand that I have the right to have(name of plan)pay my spouse’s retire-ment benefits in the special QJSA pay-ment form and I agree to give up thatright. I understand that by signing thisagreement, I may receive less moneythan I would have received under thespecial QJSA payment form and I mayreceive nothing after my spouse dies,depending on the payment form [orbeneficiary] that my spouse chooses.I agree that my spouse can receive

retirement benefits in the form of a(insert form of benefit selected). [ I alsoagree to my spouse’s choice of(name ofbeneficiary)as the beneficiary who willreceive (insert percentage of survivorbenefit that will be paid to the benefi-ciary) of the survivor benefits from theplan after my spouse dies.] I understandthat my spouse cannot choose a differ-ent form of retirement benefits[ or adifferent beneficiary] unless I agree tothe change.I understand that I do not have to

sign this agreement. I am signing thisagreement voluntarily.I understand that if I do not sign this

agreement, then my spouse and I willreceive payments from the plan in thespecial QJSA payment form.

Instruction: The plan administratorshould add a line for the spouse’ssignature and a place for the witness’acknowledgment.

Option BI, (name of participant’s spouse), am

the spouse of(name of participant). Iunderstand that I have the right to have(name of plan)pay my spouse’s retire-ment benefits in the special QJSA pay-ment form, and I agree to give up thatright. I understand that by signing thisagreement, I may receive less moneythan I would have received under thespecial QJSA payment form and I mayreceive nothing after my spouse diesdepending on the payment form[ orbeneficiary] that my spouse chooses.I understand that by signing this

agreement, my spouse can choose anyretirement benefit form[ and any ben-eficiary ] that is allowed by the planwithout telling me and without gettingmy agreement. I also understand that myspouse can change the retirement benefitform selected[ or the name of a benefi-ciary ] at any time before retirement

benefits begin without telling me andwithout getting my agreement.I understand that I can limit my

spouse’s choice to a particular retire-ment benefit form [ and a particularbeneficiary who will receive paymentsfrom the plan after the death of myspouse] and that I am giving up thatright.I understand that I do not have to


agreement, then my spouse and I willreceive payments from the plan in thespecial QJSA payment form.


APPENDIX BSAMPLE LANGUAGE THAT MAYBE INCLUDED IN A SPOUSE’SAGREEMENT TO GIVE UP THERIGHT TO THE QUALIFIEDPRERETIREMENT SURVIVOR AN-NUITY UNDER A DEFINED BEN-EFIT PLAN

Instruction: The sample language doesnot address the one-year-of-marriagerule under section 417(d); if a planapplies the one-year rule, the samplelanguage should be modified to explainthis rule.

1. What is a Qualified PreretirementSurvivor Annuity (QPSA)?

Instruction: The final sentence in thesample language before the exampleaddresses situations where a plan paysthe survivor benefit in a lump sum ifthe value of the survivor benefit is$3,500 or less. That sentence should bedeleted if the plan pays survivor ben-efits with a value of $3,500 or less asan annuity.

Federal law gives you the right toreceive a special death benefit from(name of plan) if your spouse diesbefore you, unless your spouse choosesto give up this benefit and you agree tothat choice. You have this right if yourspouse has earned retirement benefitsunder the plan and dies before he or shebegins receiving those benefits (or, ifearlier, before the beginning of the pe-riod for which the retirement benefitsare paid). You have the right to receivethis special (insert period of QPSApayment, e.g., monthly)death benefit for

the rest of your life beginning no laterthan when your spouse could have be-gun receiving retirement benefits. Thespecial death benefit is(insert a percent-age that is no less than the survivorpercentage for the QJSA form under theplan) percent of the retirement benefityour spouse earns before death. Thespecial death benefit is often called a‘‘qualified preretirement survivor annu-ity’’ or ‘‘QPSA’’ benefit. (The plan willpay this death benefit in a lump sum,rather than as a QPSA, if the value ofthe death benefit is $3,500 or less.)Example

Pat Doe dies at age 45 after earning aretirement benefit. The value of Pat’sdeath benefit is more than $3,500. IfPat had lived, Pat could have retiredand begun receiving payments asearly as age 55 under the plan’sterms. The plan will pay a monthlybenefit to Pat’s spouse, Robin Doe,for the rest of Robin’s life. Robin hasthe right to begin receiving the ben-efit no later than when Pat wouldhave been 55 years old.There is a cost for the QPSA benefit.

Your spouse’s retirement benefits will bereduced for this cost.

Instruction: The paragraph aboveshould be deleted if the plan does notreduce a participant’s benefit becauseof the QPSA coverage and does notimpose a charge for the QPSA. If theplan imposes the QPSA charge otherthan by reducing the participant’s re-tirement benefit, this paragraph shouldbe modified accordingly.

2. What Are Your Rights if You Signthis Agreement?Your right to the QPSA benefit pro-

vided by federal law cannot be takenaway unless you agree to give up thatbenefit.

Instruction: The plan administratorshould select Option A if the agreementis intended to waive the QPSA in aplan that imposes a charge for theQPSA. The plan administrator shouldselect Option B if the participant’sspouse is agreeing to allow someoneelse to receive any death benefits,regardless of whether the plan imposesa charge for the QPSA.

Option AIf you sign this agreement, you will

not receive the QPSA benefit and yourspouse’s retirement benefits will not bereduced for the cost of the QPSA ben-efit you give up.

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Option B

You can agree to give up all or partof the QPSA benefit. If you agree togive up all of the QPSA benefit, theplan will pay this benefit to anotherperson selected by your spouse. Theperson your spouse selects to receivethis benefit is often called a ‘‘benefi-ciary’’. If you agree to give up part ofthe QPSA benefit, that part will be paidto the beneficiary named by yourspouse, and you will receive the rest ofthe QPSA benefit. For example, if youagree, your spouse can have the deathbenefits paid to his or her childreninstead of you.

Example of Naming a BeneficiaryWho is Not the Spouse

Pat and Robin Doe agree that Robinwill not receive the QPSA benefit. Patand Robin also decide that 1/2 of thedeath benefits under the plan will bepaid to Robin and 1/2 of the deathbenefits will be paid to Pat andRobin’s child, Chris. The total deathbenefits are $200 per month. After Patdies, the plan will pay $100 a monthto Robin for the rest of Robin’s life.Chris will also receive payments fromthe plan as long as Chris lives. Chriswill receive less than $100 a monthbecause Chris, being younger thanRobin, is expected to receive pay-ments over a longer period.

3. Do You Have to Give Up YourRight to the QPSA Benefit?Your choice must be voluntary. It is

your personal decision whether youwant to give up your right to the QPSAbenefit.

4. Can Your Spouse Make FutureChanges if You Sign this Agreement?

Instruction: Option A is for use if theplan does not allow a non-spousebeneficiary to receive death benefits.Option B is for use in a ‘‘specificconsent agreement,’’ that is, where thespouse agrees to the participant’swaiver of the QPSA and to the partici-pant’s choice of a specific beneficiaryto receive death benefits. Option C isfor use in a ‘‘general consent agree-ment,’’ that is, where the spouse agreesto the participant’s waiver of the QPSAand to allow the participant to selectany other beneficiary to receive thedeath benefits.

Option AEven if you sign this agreement, your

spouse can later select the QPSA benefitfor you without having you sign a newagreement.

Option BIf you sign this agreement, your

spouse cannot change the beneficiarynamed in this agreement unless youagree to the new beneficiary by signinga new agreement. If you agree, yourspouse can change the beneficiary atany time before your spouse beginsreceiving benefits or dies. You do nothave to agree to let your spouse changethe beneficiary. However, your spousecan later select the QPSA benefit foryou without having you sign a newagreement.

Option CIf you sign this agreement, your

spouse can choose the beneficiary whowill receive the QPSA benefit withouttelling you and without getting youragreement. Your spouse can change thebeneficiary at any time before yourspouse begins receiving benefits or dies.You have the right to agree to allow

your spouse to select only a particularbeneficiary. If you want to allow yourspouse to select only a particular benefi-ciary, do not sign this form. In that case,contact the plan administrator for moreinformation and to get a new agreementthat lets you state the particular benefi-ciary that you will allow your spouse toselect.


Instruction: The plan administratorshould select Option A if the plan doesnot allow a spouse to revoke his or herconsent. The plan administrator shouldselect Option B if the plan allows aspouse to revoke his or her consent.The bracketed language in Options Aand B applies only to general consentforms. For an explanation of a specificconsent and a general consent, see theInstruction to section 4.


after you sign it. Your decision is final[ even if your spouse later chooses adifferent beneficiary].


(date). After that date, you cannotchange the agreement[ even if your

spouse later chooses a different benefi-ciary ]. If you change your mind, youmust notify the plan administrator by(the plan procedure for revoking con-sent).

6. What Happens to this Agreement ifYou Become Separated or Divorced?You may lose your right to the QPSA

benefit if your spouse and you becomelegally separated or divorced, even ifyou do not sign this agreement. How-ever, if you become legally separated ordivorced, you might be able to get aspecial court order (which is called aqualified domestic relations order or‘‘QDRO’’) that specifically protects yourrights to receive the QPSA benefit orthat gives you other benefits under thisplan. If you are thinking about separat-ing or getting a divorce, you should getlegal advice on your rights to benefitsfrom the plan.

7. Your Agreement

Instruction: The plan administratorshould select Option A if the agreementis a waiver of the QPSA and the plandoes not allow a non-spouse benefi-ciary to receive a QPSA benefit. Theplan administrator should select Op-tion B if the agreement is a specificconsent to have a different beneficiaryreceive a QPSA benefit. The plan ad-ministrator should select Option C ifthe agreement is a general consent tohave any beneficiary chosen by theparticipant receive a QPSA benefit.For an explanation of a specific con-sent and a general consent, see theInstruction to section 4.

The final sentence in the first and lastparagraphs of the sample language inthis section address situations where aplan pays the survivor benefit in alump sum if the value of the deathbenefit is $3,500 or less. These sen-tences should be deleted if the planpays death benefits with a value of$3,500 or less as an annuity.


the spouse of(name of participant). Iunderstand that I have a right to theQPSA benefit from(name of plan) ifmy spouse dies before he or she beginsreceiving retirement benefits (or, if ear-lier, before the beginning of the periodfor which the retirement benefits arepaid). I also understand that if the valueof the QPSA benefit is $3,500 or less,

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the plan will pay the benefit to me inone lump sum payment.I agree to give up my right to the

QPSA benefits.I understand that by signing this

agreement, I may receive less moneythan I would have received under thespecial QPSA payment form and I mayreceive nothing from the plan after myspouse dies.I understand that I do not have to


agreement, then I will receive the QPSAbenefit if my spouse dies before he orshe begins to receive retirement benefits(or, if earlier, before the beginning ofthe period for which the retirementbenefits are paid). I also understand thatif the value of the QPSA benefit is$3,500 or less, the plan will pay thebenefit to me in one lump sum payment.



the spouse of(name of participant). Iunderstand that I have a right to theQPSA benefit from(name of plan) ifmy spouse dies before he or she beginsreceiving retirement benefits (or, if ear-lier, before the beginning of the periodfor which the retirement benefits arepaid). I also understand that if the valueof the QPSA benefit is $3,500 or less,the plan will pay the benefit to me inone lump sum payment.I agree to give up my right to(insert

percentage)percent of the QPSA benefitand instead to have that benefit paid tothe following beneficiaries:

Name of Beneficiary Percent of QPSA

I understand that my spouse cannotselect a different beneficiary unless Iagree to the change.I understand that by signing this


sign this agreement. I am signing thisagreement voluntarily.

I understand that if I do not sign thisagreement, then I will receive the QPSAbenefit if my spouse dies before he orshe begins to receive retirement benefits(or, if earlier, before the beginning ofthe period for which the retirementbenefits are paid). I also understand thatif the value of the QPSA benefit is$3,500 or less, the plan will pay thebenefit to me in one lump sum payment.


Option CI, (name of participant’s spouse), am


percentage)percent of the QPSA benefitand to allow my spouse to choose anybeneficiary to receive that benefit. Iunderstand by signing this agreement,my spouse can choose the beneficiarywithout telling me and without gettingmy agreement. I also understand that myspouse can change the beneficiary atany time before retirement benefits be-gin without telling me and without get-ting my agreement.I understand that I can limit my

spouse’s choice to a particular benefi-ciary who will receive payments fromthe plan after the death of my spouseand that I am giving up that right.I understand that by signing this



agreement, then I will receive the QPSAbenefit from the plan if my spouse diesbefore he or she begins to receiveretirement benefits (or, if earlier, beforethe beginning of the period for whichthe retirement benefits are paid). I also

understand that if the value of the QPSAbenefit is $3,500 or less, the plan willpay the benefit to me in one lump sumpayment.


Note to plan administrator:A partici-pant in a plan subject to the survivorannuity requirements of section401(a)(11) generally may waive theQPSA benefit with spousal consentonly on or after the first day of theplan year in which the participantattains age 35. However, a plan mayprovide for an earlier waiver withspousal consent, provided that a writ-ten explanation of the QPSA is givento the participant and that the waiverexecuted prior to age 35 becomesinvalid upon the beginning of the planyear in which the participant’s thirty-fifth birthday occurs. If a new waiverand spousal consent is not executed onor after that date, the QPSA benefitmust be provided.

APPENDIX CSAMPLE LANGUAGE THAT MAYBE INCLUDED IN A SPOUSE’SAGREEMENT TO GIVE UP THERIGHT TO A QUALIFIEDPRERETIREMENT SURVIVOR AN-NUITY WITH RESPECT TO A PAR-TICIPANT IN A DEFINED CON-TRIBUTION PLAN TO THEEXTENT THE PLAN IS SUBJECTTO SECTION 401(a)(11)


1. What is a Qualified PreretirementSurvivor Annuity (QPSA)?

Instruction: The final sentence of thesample language before the exampleaddresses situations where a plan paysthe survivor benefit in a lump sum ifthe value of the survivor benefit is$3,500 or less. That sentence should bedeleted if the plan pays survivor ben-efits with a value of $3,500 or less asan annuity.

Your spouse has an account in(nameof plan). The money in the account that

46

your spouse will be entitled to receive iscalled the vested account. Federal lawstates that you will receive a specialdeath benefit that is paid from thevested account if your spouse dies be-fore he or she begins receiving retire-ment benefits (or, if earlier, before thebeginning of the period for which theretirement benefits are paid). You havethe right to receive this(insert period ofQPSA payment, e.g., monthly)paymentfor your life beginning after your spousedies. The special death benefit is oftencalled a ‘‘qualified preretirement survi-vor annuity’’ or ‘‘QPSA’’ benefit. (Theplan will pay this death benefit in alump sum, rather than as a QPSA, if thevalue of the death benefit is $3,500 orless.)

2. Can Your Spouse Choose OtherBeneficiaries to Receive the Account?Your right to the QPSA benefit pro-

vided by federal law cannot be takenaway unless you agree to give up thatbenefit. If you agree, your spouse canchoose to have all or a part of the deathbenefits paid to someone else. The per-son your spouse chooses to receive thedeath benefits is usually called the‘‘beneficiary.’’ For example, if youagree, your spouse can have the deathbenefits paid to his or her childreninstead of you.Example

Pat and Robin Doe agree that Robinwill not receive the QPSA benefit. Patand Robin also decide that 1/2 of thedeath benefits that are paid from Pat’svested account will be paid to Robinand 1/2 of the death benefits will bepaid to Pat and Robin’s child, Chris.The total death benefits are $200 permonth. After Pat dies, the plan willpay $100 a month to Robin for therest of Robin’s life. Chris will alsoreceive payments from the plan aslong as Chris lives. Chris will receiveless than $100 a month because Chris,being younger than Robin, is expectedto receive payments over a longerperiod.

3. Do You Have to Give Up YourRight to the QPSA Benefit?Your choice must be voluntary. It is

your personal decision whether youwant to give up your right to the specialQPSA payment form.

4. Can Your Spouse Change the Ben-eficiary in the Future if You Sign thisAgreement?

Instruction: Option A is for use in a‘‘specific consent agreement,’’ that is,where the spouse agrees to the partici-pant’s waiver of the QPSA and to theparticipant’s choice of a specific ben-eficiary to receive death benefits. Op-tion B is for use in a ‘‘general consentagreement,’’ that is, where the spouseagrees to the participant’s waiver ofthe QPSA and to allow the participantto select any other beneficiary to re-ceive the death benefits.

Option AIf you sign this agreement, your

spouse cannot change the beneficiarynamed in this agreement unless youagree to the new beneficiary by signinga new agreement. If you agree, yourspouse can change the beneficiary atany time before your spouse beginsreceiving benefits or dies. You do nothave to agree to let your spouse changethe beneficiary. However, your spousecan select the QPSA benefit for youwithout getting your agreement.


spouse can choose the beneficiary whowill receive the death benefits withouttelling you and without getting youragreement. Your spouse can change thebeneficiary at any time before he or shebegins receiving benefits or dies.You have the right to agree to allow







(date). After that date, you cannotchange the agreement[ even if yourspouse later chooses a different benefi-ciary ]. If you change your mind, youmust notify the plan administrator by(the plan procedure for revoking con-sent).

6. What Happens to this Agreement ifYou Become Separated or Divorced?You may lose your right to the QPSA

benefit if your spouse and you becomelegally separated or divorced even ifyou do not sign this agreement. How-ever, if you become legally separated ordivorced, you might be able to get aspecial court order (which is called aqualified domestic relations order or‘‘QDRO’’) that specifically protects yourrights to receive the QPSA benefit orthat gives you other benefits under thisplan. If you are thinking about separat-ing or getting a divorce, you should getlegal advice on your rights to benefitsfrom the plan.

7. Your Agreement


The final sentence in the first and lastparagraphs of the sample language inthis section address situations where aplan pays the survivor benefit in alump sum if the value of the deathbenefit is $3,500 or less. These sen-tences should be deleted if the planpays death benefits with a value of$3,500 or less as an annuity.



percentage)percent of the QPSA benefitand instead to have that benefit paid tothe following beneficiaries:

47


I understand that my spouse cannotselect a different beneficiary unless Iagree to the change.I understand that by signing this







percentage)percent of the QPSA benefitand to allow my spouse to choose anybeneficiary to receive that benefit. Iunderstand that by signing this agree-ment, my spouse can choose the benefi-ciary without telling me and withoutgetting my agreement. I also understandthat my spouse can change the benefi-ciary at any time before retirement ben-efits begin without telling me and with-out getting my agreement.I understand that I can limit my

spouse’s choice to a particular benefi-ciary who will receive payments fromthe plan after the death of my spouseand that I am giving up that right.

I understand that by signing thisagreement, I may receive less moneythan I would have received under thespecial QPSA payment form and I mayreceive nothing from the plan after myspouse dies.I understand that I do not have to




Note to plan administrator:A partici-pant in a plan subject to the survivorannuity requirements of section401(a)(11) generally may waive theQPSA benefit with spousal consentonly on or after the first day of theplan year in which the participantattains age 35. However, a plan mayprovide for an earlier waiver withspousal consent, provided that a writ-ten explanation of the QPSA is givento the participant and that the waiverexecuted prior to age 35 becomesinvalid upon the beginning of the planyear in which the participant’s thirty-fifth birthday occurs. If a new waiverand spousal consent is not executed onor after that date, QPSA benefit mustbe provided.

APPENDIX DSAMPLE LANGUAGE THAT MAYBE INCLUDED IN A SPOUSE’SAGREEMENT TO GIVE UP THERIGHT TO BE THE BENEFICIARYOF A PARTICIPANT IN A DEFINEDCONTRIBUTION PLAN TO THEEXTENT THE PLAN IS NOT SUB-JECT TO SECTION 401(a)(11)


1. What Rights Do You Have to Ben-efits After Your Spouse Dies?

Your spouse has an account in(nameof plan). The money in the account thatyour spouse will be entitled to receive iscalled the vested account. Federal lawstates that you will receive the vestedaccount after your spouse dies.Example

Pat Doe dies at age 45 and Pat’svested account in the (name of plan)was $10,000 at the time of Pat’sdeath. The plan will pay the $10,000to Pat’s spouse, Robin Doe (adjustedfor gains and losses after Pat’s death).

2. Can Your Spouse Choose OtherBeneficiaries to Receive the Account?Your right to your spouse’s vested

account provided by federal law cannotbe taken away unless you agree. If youagree, your spouse can elect to have allor part of the vested account paid tosomeone else. Each person your spousechooses to receive a part of the vestedaccount is called a ‘‘beneficiary.’’ Forexample, if you agree, your spouse canhave the vested account paid to his orher children instead of you.Example

Pat and Robin Doe agree that 1/2 ofthe Pat’s vested account will be paidto Robin and 1/2 of the vested ac-count will be paid to Pat’s child,Chris. If Pat’s vested account at thetime of his death is $10,000, the planwill pay $5,000 to Robin and $5,000to Chris (each amount adjusted forgains and losses after Pat’s death).Your spouse cannot have the vested

account paid to someone else unless youagree and sign this agreement.

3. Do You Have to Give Up YourRight to Your Spouse’s Vested Ac-count?Your choice must be voluntary. It is

your personal decision whether youwant to give up your right to yourspouse’s vested account.

4. Can Your Spouse Change the Ben-eficiary in the Future if You Sign thisAgreement?

Instruction: The plan administratorshould select Option A if the agreementis a ‘‘specific consent,’’ that is, wherethe spouse agrees to the beneficiaryselected by the participant. The planadministrator should select Option B ifthe agreement is a ‘‘general consent,’’that is, where the spouse agrees toallow the participant to select anybeneficiary even if the spouse does notknow the identity of the beneficiary.

48

Option AIf you sign this agreement, your

spouse cannot change the beneficiarynamed in this agreement to anyone otherthan you, unless you agree to the newbeneficiary by signing a new agreement.If you agree, your spouse can changethe beneficiary at any time before yourspouse dies.


spouse can choose the beneficiary whowill receive all or part of the vestedaccount without telling you and withoutgetting your agreement. Your spouse canchange the beneficiary at any time be-fore the account is paid out.You have the right to agree to allow







(date). After that date, you cannotchange the agreement[ even if yourspouse later chooses a different benefi-ciary ]. If you change your mind, youmust notify the plan administrator by(insert the plan procedure for revokingconsent). The plan administrator mustreceive this information before(date).

6. What Happens to this Agreement ifYou Become Separated or Divorced?Legal separation or divorce may end

your right to the vested account even ifyou do not sign this agreement. How-

ever, if you become legally separated ordivorced, you might be able to get aspecial court order (which is called aqualified domestic relations order or‘‘QDRO’’) that specifically protects yourrights to the vested account. If you arethinking about separating or getting adivorce, you should get legal advice onyour rights to benefits from the plan.

7. Your Agreement



the spouse of(name of participant). Iunderstand that I have the right to all ofmy spouse’s vested account in the(name of plan)after my spouse dies. Iagree to give up the right to(insertpercentage)of the account and to havethat amount paid to the following ben-eficiaries:


I understand that my spouse cannotchange the name of any beneficiary inthe future unless I agree to the change.I understand that by signing this

agreement, I may receive less moneythan I would have received if I had notsigned this agreement and I may receivenothing from the plan after my spousedies.I understand that I do not have to


agreement, then I will receive myspouse’s vested account under the planwhen my spouse dies.



the spouse of(name of participant). Iunderstand that I have the right to all ofmy spouse’s vested account in the(name of plan)after my spouse dies.

I agree to give up(insert percentage)percent of the account and to have thatamount paid to someone else as thebeneficiary. I understand that by signingthis agreement, my spouse can choosethe beneficiary of the vested accountwithout telling me and without gettingmy agreement. I also understand that bysigning this agreement, my spouse canchange the beneficiary of the vestedaccount in the future without telling meand without getting my agreement again.I understand that by signing this

agreement, I may receive less moneythan I would have received if I had notsigned this agreement and I may receivenothing from the plan after my spousedies.I understand that I can limit my

spouse’s choice to a particular benefi-ciary who will receive the vested ac-count balance and that I am giving upthat right.I understand that I do not have to


agreement, then I will receive myspouse’s account under the plan whenmy spouse dies.


Sample Language for a QualifiedDomestic Relations Order

Notice 97–11

I. PURPOSE

This Notice provides information in-tended to assist domestic relations attor-neys, plan participants, spouses andformer spouses of participants, and planadministrators in drafting and reviewinga qualified domestic relations order(‘‘QDRO’’). The Notice provides samplelanguage that may be included in aQDRO relating to a plan that is quali-fied under § 401(a) or § 403(a) of theInternal Revenue Code of 1986 (‘‘quali-fied plan’’ or ‘‘plan’’) and that is subjectto § 401(a)(13). The Notice also dis-cusses a number of issues that should beconsidered in drafting a QDRO. AQDRO is a domestic relations order thatprovides for payment of benefits from aqualified plan to a spouse, formerspouse, child or other dependent of aplan participant and that meets certainrequirements.

49

A. Statutory QDRO Requirements

Section 401(a)(13)(A) of the Codeprovides that benefits under a qualifiedplan may not be assigned or alienated.Section 401(a)(13)(B) establishes an ex-ception to the antialienation rule forassignments made pursuant to domesticrelations orders that constitute QDROswithin the meaning of § 414(p). A ‘‘do-mestic relations order’’ is defined in§ 414(p)(1)(B) as any judgment, decree,or order (including approval of a prop-erty settlement agreement) that (i) re-lates to the provision of child support,alimony payments, or marital propertyrights to a spouse, former spouse, child,or other dependent of a participant, and(ii) is made pursuant to a State domesticrelations law (including a communityproperty law). There is no exception tothe § 401(a)(13)(A) antialienation rulefor assignments made pursuant to do-mestic relations orders that are notQDROs.Section 414(p)(1)(A) provides, in gen-

eral, that a QDRO is a domestic rela-tions order that creates or recognizes theexistence of an alternate payee’s right,or assigns to an alternate payee theright, to receive all or a portion of thebenefits payable with respect to a par-ticipant under a plan, and that meets therequirements of paragraphs (2) and (3)of § 414(p). Section 414(p)(2) requiresthat a QDRO clearly specify: (A) thename and last known mailing address (ifany) of the participant and of eachalternate payee covered by the order,(B) the amount or percentage of theparticipant’s benefits to be paid by theplan to each alternate payee, or themanner in which that amount or per-centage is to be determined, (C) thenumber of payments or period to whichthe order applies, and (D) each plan towhich the order applies.Section 414(p)(3) provides that a

QDRO cannot require a plan to provideany type or form of benefit, or anyoption, not otherwise provided under theplan; cannot require a plan to provideincreased benefits (determined on thebasis of actuarial value); and cannotrequire the payment of benefits to analternate payee that are required to bepaid to another alternate payee underanother order previously determined tobe a QDRO. Section 414(p)(4)(A)(i)provides that a domestic relations ordershall not be treated as failing to meetthe requirements of § 414(p)(3)(A) (andthus will not fail to be a QDRO) solelybecause the order requires payment of

benefits to an alternate payee on or afterthe participant’s earliest retirement age,even if the participant has not separatedfrom service at that time. Section414(p)(4)(B) defines earliest retirementage as the earlier of (i) the date onwhich the participant is entitled to adistribution under the plan, or (ii) thelater of (I) the date the participantattains age 50, or (II) the earliest dateon which the participant could beginreceiving benefits under the plan if theparticipant separated from service.Section 414(p)(5) permits a QDRO to

provide that the participant’s formerspouse shall be treated as the partici-pant’s surviving spouse for purposes of§§ 401(a)(11) and 417 (relating to theright to receive survivor benefits andrequirements concerning consent to dis-tributions), and that any other spouse ofthe participant shall not be treated as aspouse of the participant for these pur-poses. An alternate payee is definedunder § 414(p)(8) as any spouse, formerspouse, child or other dependent of aparticipant who is recognized by a do-mestic relations order as having a rightto receive all, or a portion of, thebenefits payable under a plan with re-spect to the participant. Section414(p)(10) provides that a plan shall notfail to satisfy the requirements of§ 401(a), 401(k) or 403(b) solely byreason of payments made to an alternatepayee pursuant to a QDRO.

B. Small Business Job ProtectionAct of 1996

Section 1457(a)(2) of the Small Busi-ness Job Protection Act of 1996(‘‘SBJPA’’) directs the Secretary of theTreasury (‘‘Secretary’’) to developsample language for inclusion in a formfor a QDRO described in§ 414(p)(1)(A) of the Code and§ 206(d)(3)(B)(i) of the Employee Re-tirement Income Security Act of 1974(‘‘ERISA’’) that meets the requirementscontained in those sections, and theprovisions of which focus attention onthe need to consider the treatment ofany lump sum payment, qualified jointand survivor annuity (‘‘QJSA’’), orqualified preretirement survivor annuity(‘‘QPSA’’). Accordingly, the Service andTreasury are publishing the discussionand sample QDRO language set forth inthe Appendix to this Notice.Section 1457(a)(1) of the SBJPA di-

rects the Secretary to publish samplelanguage that can be included in a formthat is used for a spouse to consent to aparticipant’s waiver of a QJSA or

QPSA. This sample language for use inspousal consent forms is contained inNotice 97–10 in this Bulletin.

C. Department of Labor Interpre-tive Authority

Section 206(d)(3) of ERISA (29U.S.C. § 1056(d)(3)) contains QDROprovisions that are substantially parallelto those of § 414(p) of the Code. TheDepartment of Labor has jurisdiction tointerpret these provisions (except to theextent provided in § 401(n) of theCode) and the provisions governing thefiduciary duties owed with respect todomestic relations orders and QDROs.Section 401(n) gives the Secretary ofthe Treasury the authority to prescriberules or regulations necessary to coordi-nate the requirements of §§ 401(a)(13)and 414(p), and the regulations issuedby the Department of Labor thereunder,with other Code provisions. The Depart-ment of Labor has reviewed this Notice,including its Appendix, and has advisedthe Service and Treasury that the discus-sion and sample language are consistentwith the views of the Department ofLabor concerning the statutory require-ments for QDROs. This Notice, includ-ing its Appendix, is not intended by theService or Treasury to convey interpre-tations of the statutory requirements ap-plicable to QDROs, but only to provideexamples of language that may be (butare not required to be) used in drafting aQDRO that satisfies these requirements.

II. SAMPLE LANGUAGE

The Appendix to this Notice has twoparts. Part I discusses certain issues thatshould be considered when drafting aQDRO. Part II contains sample languagethat will assist in drafting a QDRO.Drafters who use the sample languagewill need to conform it to the terms ofthe retirement plan to which the QDROapplies, and to specify the amountsassigned and other terms of the QDROso as to achieve an appropriate divisionof marital property or level of familysupport. A domestic relations order isnot required to incorporate the samplelanguage in order to satisfy the require-ments for a QDRO, and a domesticrelations order that incorporates part ofthe sample language may omit ormodify other parts.The sample language addresses a va-

riety of matters, but is not designed toaddress all retirement benefit issues thatmay arise in each domestic relationsmatter or QDRO. Further, some of thesample language, while helpful in facili-

50

tating the administration of a QDRO, isnot necessarily required for the order tosatisfy the requirements for a QDRO.Alternative formulations would be per-missible for use in drafting orders thatmeet the statutory requirements for aQDRO.

III. OTHER SOURCES OF INFOR-MATION

The Pension Benefit Guaranty Corpo-ration (‘‘PBGC’’) recently published abooklet entitled ‘‘Divorce Orders &PBGC,’’ which discusses the specialQDRO rules that apply for plans thathave been terminated and are trusteedby PBGC, and provides model QDROsfor use with those plans. This publica-tion may be obtained by calling PBGC’sCustomer Service Center at 1–800–400–PBGC or electronically via the PBGCinternet site at ‘‘http://www.pbgc.gov’’.Additional information on the rights

of participants and spouses to plan ben-efits can be found in a two-booklet setpublished by the Service, entitled‘‘Looking Out for #2.’’ These bookletsdiscuss retirement benefit choices undera defined contribution or a defined ben-efit plan, and may be obtained bycalling the Internal Revenue Service at1–800–TAX–FORM, and asking forPublication 1565 (defined contributionplans) or Publication 1566 (defined ben-efit plans).

IV. COMMENTS

The Service invites the public tocomment on the QDRO discussion andsample language included in the Appen-dix to this Notice, and welcomes sug-gestions concerning possible additionalsample language. Comments may besubmitted to the Internal Revenue Ser-vice at CC:DOM:CORP:R (Notice 97–11), Room 5226, Internal Revenue Ser-vice, POB 7604, Ben Franklin Station,Washington, D.C. 20044. Alternatively,taxpayers may hand-deliver commentsbetween the hours of 8 a.m. and 5 p.m.to CC:DOM:CORP:R (Notice 97–11),Courier’s desk, Internal Revenue Ser-vice, 1111 Constitution Ave., N.W.,Washington, D.C., or may submit com-ments electronically via the IRS internetsite at ‘‘http://www.irs.ustreas.gov/prod/tax_regs/comments.html’’.


The principal authors of this Noticeare Diane S. Bloom of the EmployeePlans Division and Susan M. Lennon ofthe Office of the Associate Chief Coun-

sel (Employee Benefits and Exempt Or-ganizations); however, other personnelfrom the Service and Treasury contrib-uted to its development. For furtherinformation regarding this Notice, pleasecontact the Employee Plans Division’staxpayer assistance telephone service at(202) 622–6074/6075, between the hoursof 1:30 p.m. and 4 p.m. Eastern Time,Monday through Thursday. Alternatively,please call Ms. Bloom at (202) 622–6214 or Ms. Lennon at (202) 622–4606.Questions concerning QDROs may beaddressed to Susan G. Lahne of thePension and Welfare Benefits Adminis-tration, Department of Labor, at (202)219–7461. These telephone numbers arenot toll-free.

APPENDIX

Part I of this Appendix discussescertain issues that are relevant in draft-ing a qualified domestic relations order(‘‘QDRO’’). Part II of this Appendixcontains sample language that can beused in a QDRO. However, the discus-sion and sample language do not at-tempt to address every issue that mayarise in drafting a QDRO. Also, someparts of the discussion are not relevantto all situations and some parts of thesample language are not appropriate forall QDROs. In formulating a particularQDRO, it is important that the drafterstailor the QDRO to the needs of theparties and ensure that the QDRO isconsistent with the terms of the retire-ment plan to which the QDRO applies.

PART I. DISCUSSION OF QDROREQUIREMENTS AND RELATEDISSUES

In order to be recognized as a QDRO,an order must first be a ‘‘domesticrelations order.’’ A domestic relationsorder is any judgment, decree or order(including approval of a property settle-ment) which (i) relates to the provisionof child support, alimony payments ormarital property rights to a spouse,former spouse, child or other dependentof the plan participant, and (ii) is madepursuant to a State domestic relationslaw (including a community propertylaw). A State authority must actuallyissue an order or formally approve aproposed property settlement before itcan be a domestic relations order. Aproperty settlement signed by a partici-pant and the participant’s former spouseor a draft order to which both partiesconsent is not a domestic relations orderuntil the State authority has adopted it

as an order or formally approved it andmade it part of the domestic relationsproceeding.The sample language in Part II as-

sumes that the QDRO applies to onequalified plan and one alternate payee. Ifa QDRO is intended to cover more thanone qualified plan or alternate payee, theQDRO should clearly state which quali-fied plan and which alternate payee eachprovision is intended to address.The terms of a qualified plan must be

set forth in a written document. Theplan must also establish written QDROprocedures to be used by the planadministrator in determining whether adomestic relations order is a QDRO andin administering QDROs. The plan ad-ministrator maintains copies of the plandocument and the plan’s QDRO proce-dures. If the plan is required underfederal law to have a summary plandescription, or ‘‘SPD,’’ the plan admin-istrator will also have a copy of theSPD. The information in these docu-ments is helpful in drafting a QDRO.The drafter of a QDRO may wish toobtain copies of these documents beforedrafting a QDRO.

A. IDENTIFICATION OF PARTICI-PANT AND ALTERNATE PAYEE

A QDRO must clearly specify thename and last known mailing address (ifany) of the participant and of eachalternate payee covered by the QDRO.In the event that an alternate payee is aminor or legally incompetent, theQDRO should also include the nameand address of the alternate payee’slegal representative. A QDRO can havemore than one alternate payee, such as aformer spouse and a child.The ‘‘participant’’ is the individual

whose benefits under the plan are beingdivided by the QDRO. The participant’sspouse (or former spouse, child, or otherdependent) who receives some or all ofthe plan’s benefits with respect to theparticipant under the terms of theQDRO is the ‘‘alternate payee.’’

B. IDENTIFICATION OF RETIRE-MENT PLAN

A QDRO must clearly identify eachplan to which the QDRO applies. AQDRO can satisfy this requirement bystating the full name of the plan asprovided in the plan document.

C. AMOUNT OF BENEFITS TO BEPAID TO ALTERNATE PAYEE

A QDRO must clearly specify theamount or percentage of the partici-

51

pant’s benefits in the plan that is as-signed to each alternate payee, or themanner in which the amount or percent-age is to be determined. Many factorsshould be taken into account in deter-mining which benefits to assign to analternate payee and how these benefitsare to be assigned. The following dis-cussion highlights some of these factors.Because of the complexity and varietyof the factors that should be considered,and the need to tailor the assignment ofbenefits under a QDRO to the individualcircumstances of the parties, specificsample language regarding the assign-ment of benefits has not been providedin Part II of this Appendix.

1. Types of Benefits

In order to decide how to dividebenefits under a QDRO, the drafter firstshould determine the types of benefitsthe plan provides. Most benefits pro-vided by qualified plans can be classi-fied as (1) retirement benefits that arepaid during the participant’s life and (2)survivor benefits that are paid to benefi-ciaries after the participant’s death. Gen-erally, a QDRO can assign all or aportion of each of these types of ben-efits to an alternate payee. The draftersof a QDRO should coordinate the as-signment of these types of benefits.QDRO drafters should also considerhow the benefits divided under theQDRO may be affected, under the plan,by the death of either the participant orthe alternate payee.

2. Types of Qualified Plans

Another important factor to considerin the drafting of a QDRO is the type ofplan to which the QDRO will apply. Asdiscussed below, the type of plan mayaffect the types of benefits available forassignment, how the parties choose toassign the benefits, and other matters.There are two basic types of qualified

plans to which QDROs apply: definedbenefit plans and defined contributionplans.a. Defined Benefit Plans

A ‘‘defined benefit plan’’ promises topay each participant a specific benefit atretirement. The basic retirement benefitsare usually based on a formula thattakes into account factors such as thenumber of years a participant hasworked for the employer and the partici-pant’s salary. The basic retirement ben-efits are generally expressed in the formof periodic payments for the partici-pant’s life beginning at the plan’s nor-

mal retirement age. This stream of peri-odic payments is generally known as an‘‘annuity.’’ There are special rules thatapply if the participant is married; theserules are discussed in greater detail insection E below. A plan may also pro-vide that these retirement benefits maybe paid in other forms, such as a lumpsum payment.

b. Defined Contribution Plans

A ‘‘defined contribution plan’’ is aretirement plan that provides for anindividual account for each participant.The participant’s benefits are basedsolely on the amount contributed to theparticipant’s account, and any income,expenses, gains and losses, and anyforfeitures of accounts of other partici-pants which may be allocated to suchparticipant’s account. Examples of de-fined contribution plans include a profitsharing plan (including a ‘‘401(k)’’plan), an employee stock ownership plan(an ‘‘ESOP’’) and a money purchasepension plan. Defined contribution planscommonly permit retirement benefits tobe paid in the form of a lump sumpayment of the participant’s entire ac-count balance.

3. Approaches to Dividing Retire-ment Benefits

There are two common approaches todividing retirement benefits in a QDRO:one awards a separate interest in theretirement benefits to the alternatepayee, and the other allows the alternatepayee to share in the payment of theretirement benefits. In drafting a QDROusing either of these approaches, consid-eration should be given to factors suchas whether the plan is a defined benefitplan or defined contribution plan, andthe purpose of the QDRO (such aswhether the QDRO is meant to providespousal support or child support, or todivide marital property).

a. Separate Interest Approach

A QDRO that creates a ‘‘separateinterest’’ divides the participant’s ben-efits into two separate parts: one for theparticipant and one for the alternatepayee. Subject to the terms of the planand as discussed in more detail below, aQDRO may provide that the alternatepayee can determine the form in whichhis or her benefits are paid and whenbenefit payments commence. If benefitsare allocated under the separate interestapproach, the drafters of a QDROshould take into account certain issuesdepending on the type of plan.

(1) Issues Relevant to Defined Ben-efit Plans

The treatment of subsidies providedby a plan and the treatment of futureincreases in benefits due to increases inthe participant’s compensation, addi-tional years of service, or changes in theplan’s provisions are among the mattersthat should be considered when draftinga QDRO that uses the separate interestapproach to allocate benefits under adefined benefit plan.Subsidies.Defined benefit plans may

promise to pay benefits at various timesand in alternative forms. Benefits paid atcertain times or in certain forms mayhave a greater actuarial value than thebasic retirement benefits payable at nor-mal retirement age. When one form ofbenefit has a greater actuarial value thananother form, the difference in value isoften called a subsidy. Plans usuallyprovide that a participant must meetspecific eligibility requirements, such asworking for a minimum number ofyears for the employer that maintainsthe plan, in order to receive the subsidy.For example, a defined benefit plan

may offer an ‘‘early retirement subsidy’’to employees who retire before theplan’s normal retirement age but afterhaving worked for a specific number ofyears for the employer maintaining theplan. In some cases, this subsidizedbenefit provides payments in the formof an annuity that pays the same annualamount as would be paid if the pay-ments commenced instead at the normalretirement age. Because these benefitsare not reduced for early commence-ment, they have a greater actuarial valuethan benefits payable at normal retire-ment age. This subsidy may be availableonly for certain forms of benefit.A QDRO may award to the alternate

payee all or part of the participant’sbasic retirement benefits. A QDRO canalso address the disposition of any sub-sidy to which the participant may be-come entitled after the QDRO has beenentered.Future Increases in the Participant’s

Benefits.A participant’s basic retirementbenefits may increase due to circum-stances that occur after a QDRO hasbeen entered, such as increases in salary,crediting of additional years of service,or amendments to the plan’s provisions,including amendments to provide cost ofliving adjustments. The treatment ofsuch benefit increases should be consid-ered when drafting a QDRO using theseparate interest approach.

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(2) Issues Relevant to Defined Con-tribution Plans

Investment of the amount assigned tothe alternate payee when the account isinvested in more than one investmentvehicle and division of any future allo-cation of contributions or forfeitures tothe participant’s account are among thematters that should be considered whendrafting a QDRO that allocates thealternate payee a separate interest undera defined contribution plan. InvestmentChoices. The participant’s account maybe invested in more than one investmentfund. If the plan provides forparticipant-directed investment of theparticipant’s account, considerationshould be given to how the alternatepayee’s interest will be invested.

Future Allocations.A participant’s ac-count balance may later increase due tothe allocation of contributions or forfei-tures after the QDRO has been entered.A QDRO may provide that the amountsassigned to the alternate payee willinclude a portion of such future alloca-tions.

b. Shared Payment Approach

A QDRO may use the ‘‘shared pay-ment’’ approach, under which benefitpayments from the plan are split be-tween the participant and the alternatepayee. The alternate payee receives pay-ments under this approach only whenthe participant receives payments. AQDRO may provide that the alternatepayee will commence receiving benefitpayments when the participant beginsreceiving payments or at a later stateddate, and that the alternate payee willcease to share in the benefit payments ata stated date (or upon a stated event,provided that adequate notice is given tothe plan). In splitting the benefit pay-ments, the QDRO may award the alter-nate payee either a percentage or adollar amount of each of the partici-pant’s benefit payments; in either case,the amount awarded cannot exceed theamount of each payment to which theparticipant is entitled under the plan. Ifa QDRO awards a percentage of theparticipant’s benefit payments (ratherthan a dollar amount), then, unless theQDRO provides otherwise, the alternatepayee generally will automatically re-ceive a share of any future subsidy orother increase in the participant’s ben-efits.

D. FORM AND COMMENCEMENTOF PAYMENT TO ALTERNATEPAYEE

QDRO drafters should take into ac-count certain issues that may arise inconnection with the alternate payee’schoice of a form of benefit paymentsand the date on which payment willcommence.

1. Separate Interest Approach

a. Form of Alternate Payee’s Ben-efit Payments

A QDRO either may specify a par-ticular form in which payments are tobe made to the alternate payee or mayprovide that the alternate payee maychoose a form of benefit from amongthe options available to the participant.However, federal law provides that thealternate payee cannot receive paymentsin the form of a joint and survivorannuity with respect to the alternatepayee and his or her subsequent spouse.The choice of the form of benefits

should take into account the period overwhich payments will be made. For ex-ample, if the alternate payee elects toreceive a lump sum payment, no furtherpayments will be made by the plan withrespect to the alternate payee’s interest.Any decision concerning the form of

benefit should take into account thedifference, if any, in the actuarial valueof different benefit forms available un-der the plan. For example, as discussedabove, a plan might provide an earlyretirement subsidy that is available onlyfor payment in certain forms.In addition, the forms of benefit avail-

able to the alternate payee may belimited by § 401(a)(9) of the Code,which specifies the date by which ben-efit payments from a qualified plan mustcommence and limits the period overwhich the benefit payments may bemade. Section 1.401(a)(9)–1, Q&A H–4,of the Proposed Income Tax Regulationsaddresses the application of the requiredminimum distribution rules of§ 401(a)(9) to payments to an alternatepayee. The proposed regulation limitsthe period over which benefits may bepaid with respect to the alternate payee’sinterest. For example, the proposedregulation provides that distribution ofthe alternate payee’s separate interestwill not satisfy § 401(a)(9)(A)(ii) of theCode if the separate interest is distrib-uted over the joint lives of the alternatepayee and a designated beneficiary(other than the participant).

b. Commencement of Benefit Pay-ments to Alternate Payee

Under the separate interest approach,the alternate payee may begin receivingbenefits at a different time than theparticipant. A QDRO either may specifya time at which payments are to com-mence to the alternate payee or mayprovide that the alternate payee canelect a time when benefits will com-mence in accordance with the terms ofthe plan. In two circumstances, an alter-nate payee who is given a separateinterest may begin receiving his or herseparate benefit before the participant iseligible to begin receiving payments.First, federal law provides that benefitpayments to the alternate payee maybegin as soon as the participant attainshis or her earliest retirement age. Fed-eral law defines ‘‘earliest retirementage’’ as the earlier of (i) the date onwhich the participant is entitled to adistribution under the plan, or (ii) thelater of (I) the date the participantattains age 50, or (II) the earliest dateon which the participant could beginreceiving benefits under the plan if theparticipant separated from service. Sec-ond, the retirement plan may (but is notrequired to) allow payments to begin toan alternate payee at a date before theearliest retirement date.

2. Shared Payment Approach

As indicated above, under the sharedpayment approach, benefit payments aresplit between the participant and thealternate payee. The alternate payee re-ceives payments in the same form as theparticipant. Further, payments to thealternate payee do not commence beforethe participant has begun to receivebenefits. Payments to the alternate payeecan cease at any time stated in theQDRO but do not continue after pay-ments with respect to the participantcease. As noted above, a QDRO muststate the number of payments or theperiod to which the order applies.

E. SURVIVOR BENEFITS ANDTREATMENT OF FORMERSPOUSE AS PARTICIPANT’SSPOUSE

Survivor benefits include both ben-efits payable to surviving spouses andother benefits that are payable after theparticipant’s death. These benefits canbe awarded to an alternate payee. Indetermining the assignment of survivorbenefits, QDRO drafters should takeinto account that benefits awarded to the

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alternate payee under a QDRO will notbe available to a subsequent spouse ofthe participant or to another beneficiary.QDRO drafters may consult with theplan administrator for information onthe survivor benefits provided under theplan.A QDRO may provide for treatment

of a former spouse of a participant asthe participant’s spouse with respect toall or a portion of the spousal survivorbenefits that must be provided underfederal law. The following discussionexplains the spousal survivor benefitsthat must be offered under a plan, andidentifies issues that should be consid-ered in determining whether to treat thealternate payee as the participant’sspouse.Only a spouse or former spouse of

the participant can be treated as aspouse under a QDRO. A child or otherdependent who is an alternate payeeunder a QDRO cannot be treated as thespouse of a participant.Retirement plans generally need not

provide the special survivor benefits tothe participant’s surviving spouse unlessthe participant is married for at least oneyear. If the retirement plan to which theQDRO relates contains such a one-yearmarriage requirement, then the QDROcannot require that the alternate payeebe treated as the participant’s spouse ifthe marriage lasted for less than oneyear.

1. Qualified Joint and Survivor An-nuity

Federal law generally requires thatdefined benefit plans and certain definedcontribution plans pay retirement ben-efits to participants who were marriedon the participant’s annuity starting date(this is the first day of the first periodfor which an amount is payable to theparticipant) in a special form called aqualified joint and survivor annuity, orQJSA. Under a QJSA, retirement pay-ments are made monthly (or at otherregular intervals) to the participant forhis or her lifetime; after the participantdies, the plan pays the participant’ssurviving spouse an amount each month(or other regular interval) that is at leastone half of the retirement benefit thatwas paid to the participant. At any timethat benefits are permitted to commenceunder the plan, a QJSA must be offeredthat commences at the same time andthat has an actuarial value that is at leastas great as any other form of benefitpayable under the plan at the same time.A married participant can choose to

receive retirement benefits in a formother than a QJSA if the participant’sspouse agrees in writing to that choice.

2. Qualified Preretirement SurvivorAnnuity

Federal law generally requires thatdefined benefit plans and certain definedcontribution plans pay a monthly survi-vor benefit to a surviving spouse for thespouse’s life when a married participantdies prior to the participant’s annuitystarting date, to the extent the partici-pant’s benefit is nonforfeitable under theterms of the plan at the time of his orher death. This benefit is called a quali-fied preretirement survivor annuity, orQPSA. As a general rule, an individualloses the right to the QPSA survivorbenefits when he or she is divorcedfrom the participant. However, if aformer spouse is treated as the partici-pant’s surviving spouse under a QDRO,the former spouse is eligible to receivethe QPSA unless the former spouseconsents to the waiver of the QPSA. Ifthe spouse does not waive the QPSA,the plan may allow the spouse to re-ceive the value of the QPSA in a formother than an annuity.

3. Defined Contribution Plans NotSubject to the QJSA or QPSA Re-quirements

Those defined contribution plans thatare not required to pay benefits tomarried participants in the form of aQJSA or a QPSA are required by federallaw to pay the balance remaining in theparticipant’s account after the participantdies to the participant’s survivingspouse. If the spouse gives written con-sent, the participant can direct that uponhis or her death the account will be paidto a beneficiary other than the spouse,for example, the couple’s children.

4. Alternate Payee Treated asSpouse

A QDRO may provide that an alter-nate payee who is a former spouse ofthe participant will be treated as theparticipant’s spouse for some or all ofthe benefits payable upon the partici-pant’s death, so that the alternate payeewill receive benefits provided to aspouse under the plan. To the extent thata former spouse is to be treated underthe plan as the participant’s spousepursuant to a QDRO, any subsequentspouse of the participant cannot betreated as the participant’s survivingspouse. Thus, QDRO drafters shouldconsider the potential impact of desig-

nating a former spouse as the partici-pant’s spouse on the disposition of sur-vivor benefits among the former spouseand any subsequent spouse of the par-ticipant, as well as the impact on chil-dren or any other beneficiaries desig-nated by the participant in accordancewith the terms of the plan.In determining the portion of the

participant’s benefits for which the alter-nate payee is treated as the spouse, thedrafters should take into account themanner in which benefits are otherwisedivided under the QDRO. In particular,consideration should be given towhether the formula for dividing theparticipant’s benefits for this purposeshould be coordinated with the formulaotherwise used for dividing the benefits.Under a defined benefit plan, or a

defined contribution plan that is subjectto the QJSA and QPSA requirements, tothe extent the former spouse is treatedas the current spouse, the former spousemust consent to payment of retirementbenefits in a form other than a QJSA orto the participant’s waiver of the QPSA.For example, in a defined benefit plan,the participant would not be able toelect to receive a lump sum payment ofthe retirement benefits for which thealternate payee is treated as the partici-pant’s spouse unless the alternate payeeconsents. Similarly, the former spouse’sconsent might be required for any loanto the participant from the plan that issecured by his or her retirement ben-efits. In a defined contribution plan thatis not subject to the QJSA and QPSArequirements, to the extent the QDROtreats the former spouse as the partici-pant’s spouse under the plan, the survi-vor benefits under the plan must be paidto the former spouse unless he or sheconsents to have those benefits paid tosomeone else.

F. TAX TREATMENT OF BENEFITPAYMENTS MADE PURSUANT TOA QDRO

The federal income tax treatment ofretirement benefits is governed by fed-eral law, and a QDRO cannot designatewho will be liable for the taxes owedwhen retirement benefits are paid. For adescription of the tax consequences ofpayments to an alternate payee pursuantto a QDRO, see Internal Revenue Ser-vice Publication 575, ‘‘Pension and An-nuity Income.’’ A local IRS office canprovide this publication, or it may beobtained by calling 1–800–TAX–FORM.

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PART II. SAMPLE LANGUAGEFOR INCLUSION IN QDRO

A. SAMPLE LANGUAGE FORIDENTIFICATION OF PARTICI-PANT AND ALTERNATE PAYEE

The ‘‘Participant’’ is [insert name ofParticipant] . The Participant’s address is[insert Participant’s address]. The Par-ticipant’s social security number is[in-sert Participant’s social security num-ber].The ‘‘Alternate Payee’’ is [insert

name of Alternate Payee]. The Alter-nate Payee’s address is[insert Alter-nate Payee’s address]. The AlternatePayee’s social security number is[insertAlternate Payee’s social security num-ber]. The Alternate Payee is the[de-scribe the Alternate Payee’s relation-ship to Participant] of the Participant.

B. SAMPLE LANGUAGE FORIDENTIFICATION OF RETIRE-MENT PLAN

This order applies to benefits underthe [insert formal name of retirementplan] (‘‘Plan’’).

C. AMOUNT OF BENEFITS TO BEPAID TO ALTERNATE PAYEE

Instruction: The QDRO should clearlyspecify the amount or percentage ofbenefits assigned to the Alternate Payeeor the manner in which the amount orpercentage is to be determined, and thenumber of payments or period to whichthe Order applies. There are manydifferent forms in which benefits maybe paid from a qualified plan. Becauseof the diversity of factors that shouldbe considered, and the need to tailorthe assignment of benefits under aQDRO to meet the needs of the partiesinvolved, specific sample language re-garding the assignment of benefits hasnot been provided. See the discussionin Part I for further information.

D. SAMPLE LANGUAGE FORFORM AND COMMENCEMENT OFPAYMENT TO ALTERNATE PAYEE

Instruction: Drafters using the separateinterest approach may use paragraph 1.Drafters using the shared payment ap-proach may use paragraph 2. Draftersusing the separate interest approach fora portion of the benefits allocated to thealternate payee and the shared paymentapproach for the remainder shouldmodify the sample language to specifythe benefits to which each paragraphprovided below applies.

1. Separate Interest Approach

The Alternate Payee may elect toreceive payment from the Plan of thebenefits assigned to the Alternate Payeeunder this Order in any form in whichsuch benefits may be paid under thePlan to the Participant (other than in theform of a joint and survivor annuitywith respect to the Alternate Payee andhis or her subsequent spouse), but onlyif the form elected complies with theminimum distribution requirements of§ 401(a)(9) of the Internal RevenueCode. Payments to the Alternate Payeepursuant to this Order shall commenceon any date elected by the AlternatePayee (and such election shall be madein accordance with the terms of thePlan), but not earlier than the Partici-pant’s earliest retirement age (or suchearlier date as allowed under the termsof the Plan), and not later than theearlier of (A) the date the Participantwould be required to commence benefitsunder the terms of the Plan or (B) thelatest date permitted by § 401(a)(9) ofthe Internal Revenue Code. For purposesof this Order, the Participant’s earliestretirement age shall be the earlier of (i)the date on which the participant isentitled to a distribution under the Plan,or (ii) the later of (I) the date theParticipant attains age 50, or (II) theearliest date on which the Participantcould begin receiving benefits under theplan if the Participant separated fromservice.

2. Shared Payment Approach

The Alternate Payee shall receivepayments from the Plan of the benefitsassigned to the Alternate Payee underthis Order (including payments attribut-able to the period in which the issue ofwhether this Order is a qualified domes-tic relations order is being determined)commencing as soon as practicable afterthis Order has been determined to be aqualified domestic relations order or, iflater, on the date the Participant com-mences receiving benefit payments fromthe Plan. Payment to the Alternate Payeeshall cease on the earlier of:[insertdate or future event, such as theAlternate Payee’s remarriage], or thedate that payments from the Plan withrespect to the Participant cease.

E. SAMPLE LANGUAGE FORTREATMENT OF FORMERSPOUSE AS PARTICIPANT’SSPOUSE

Instruction: The Alternate Payee maybe treated as the Participant’s spouseonly if the Alternate Payee is theParticipant’s spouse or former spouse,and not if the Alternate Payee is achild or other dependent of the Partici-pant. If the Alternate Payee is theParticipant’s spouse or former spouse,drafters may select sample paragraph1, sample paragraph 2, or sampleparagraph 3. Sample paragraph 1 ap-plies if the Alternate Payee is treatedas the Participant’s spouse for all ofthe spousal survivor benefits payablewith respect to the Participant’s ben-efits under the Plan. Sample paragraph2 applies if the Alternate Payee istreated as the Participant’s spouse fora portion of the spousal survivor ben-efits payable with respect to the Par-ticipant’s benefits under the Plan.Sample paragraph 3 applies if theAlternate Payee is not treated as theParticipant’s spouse for any of thespousal survivor benefits payable withrespect to the Participant’s benefitsunder the Plan.

1. Alternate Payee Treated asSpouse For All Spousal Survivor Ben-efits

The Alternate Payee shall be treatedas the Participant’s spouse under thePlan for purposes of §§ 401(a)(11) and417 of the Code.

2. Alternate Payee Treated asSpouse For a Portion of the SpousalSurvivor Benefits

The Alternate Payee shall be treatedas the Participant’s spouse under thePlan for purposes of §§ 401(a)(11) and417 of the Code with respect to[insertpercentage of benefit or a formula,such as a formula describing the ben-efit earned under the plan duringmarriage].

3. Alternate Payee not Treated asSpouse

The Alternate Payee shall not betreated as the Participant’s spouse underthe Plan.

Rev. Proc. 97–9

SECTION 1. PURPOSE

.01 This revenue procedure providesa model amendment that may be used toassist employers in adopting a plan thatcontains 401(k) SIMPLE provisions.

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The model amendment gives plan spon-sors a way to incorporate 401(k)SIMPLE provisions in plans containingcash or deferred arrangements(‘‘CODAs’’) and matching contributions.The model amendment incorporates thealternative method of satisfying the non-discrimination tests applicable to theseplans as contained in §§ 401(k)(11) and401(m)(10) of the Internal RevenueCode. Sections 401(k)(11) and401(m)(10) were added to the Code by§ 1422 of the Small Business Job Pro-tection Act of 1996, Pub. L. No. 104–188 (‘‘SBJPA’’). This revenue proceduredoes not apply to § 408(p) SIMPLEplans, as described in § 1421 of theSBJPA, under which contributions aremade to employees’ SIMPLE IRAs..02 The model amendment may be

used by organizations or practitionerswith approved master and prototype(‘‘M&P’’) plans, regional prototypeplans, or volume submitter specimenplans to modify the existing plans theysponsor so that employers can establishnew plans containing 401(k) SIMPLEprovisions. Employers that currentlymaintain an M&P plan, a regional proto-type plan or a volume submitter speci-men plan may modify existing 401(k)plans to incorporate 401(k) SIMPLEprovisions. The model amendment mayalso be used by sponsors of individuallydesigned plans to modify existing401(k) plans to incorporate 401(k)SIMPLE provisions. The model amend-ment is available only for sponsors ofplans containing provisions required tosatisfy §§ 401(k), 401(m) and401(a)(30) that have received favorableopinion, notification, advisory, or deter-mination letters that take into accountthe requirements of the Tax Reform Actof 1986, Pub. L. No. 99–514 (‘‘TRA’86’’).

SECTION 2. BACKGROUND ANDGENERAL INFORMATION

.01 New sections 401(k)(11) and401(m)(10) of the Code (‘‘401(k)SIMPLE provisions’’), provide an alter-native method of satisfying the nondis-crimination tests contained in§§ 401(k)(3)(A)(ii) and 401(m)(2), ap-plicable to CODAs. These 401(k)SIMPLE provisions may only beadopted by employers that employed100 or fewer employees earning at least$5,000 in compensation for the preced-ing year. The 401(k) SIMPLE provisionsmay not be adopted by an employerwho maintains another employer-spon-

sored plan covering employees who areeligible to participate in the cash ordeferred arrangement using the 401(k)SIMPLE provisions. Generally, no con-tributions may be made during a year toa plan using the 401(k) SIMPLE provi-sions, other than those contributions de-scribed in section 2.03 below..02 A 401(k) plan that includes

401(k) SIMPLE provisions does nothave to satisfy the actual deferral per-centage and actual contribution percent-age tests otherwise applicable to planscontaining CODAs and matching contri-butions and is not treated as top-heavyunder § 416 of the Code..03 Under a plan containing the

401(k) SIMPLE provisions, each em-ployee may elect to make salary reduc-tion contributions for a year of up to$6,000. The employer must make eithera matching contribution equal to theemployee’s salary reduction contribu-tions, limited to 3% of the employee’scompensation for the year, or a nonelec-tive contribution for all eligible employ-ees equal to 2% of the employee’scompensation for the year. All amountscontributed under 401(k) SIMPLE pro-visions must be nonforfeitable at alltimes..04 The plan year of a plan contain-

ing the 401(k) SIMPLE provisions mustbe the calendar year. An employer main-taining a 401(k) plan on a fiscal yearbasis must convert the plan to a calen-dar year in order to adopt the 401(k)SIMPLE provisions..05 Several additional requirements

apply to plans adopting the modelamendment and include the following:

(1) a special definition of compen-sation for purposes of the 3%matching and 2% nonelective con-tributions described in section 2.03;(2) notification and election periodrequirements; and(3) transitional rules for growingemployers.

.06 Except as provided in section2.02, all other qualification requirementsof the Code continue to apply to a planthat contains 401(k) SIMPLE provisionsincluding the contribution limitations of§ 415; the compensation limitations of§ 401(a)(17); and the requirement thatthe plan as amended continue to beoperated in accordance with its terms. Inaddition, all other requirements appli-cable to 401(k) plans continue to apply,including, the distribution restrictions of§ 401(k)(2)(B) and the general prohibi-tion set forth in § 401(k)(4)(B) on Stateand local governments maintaining a

401(k) plan. Contributions under a plancontaining 401(k) SIMPLE provisionsare deductible subject to the limits of§ 404(a)..07 The model amendment supersedes

any plan provision that is inconsistentwith the provisions of the model amend-ment. For example, if the plan containsa provision that limits any employee’ssalary reduction contributions for a yearto a percentage that results in an amountless than $6,000, the salary reductioncontribution provision of the modelamendment permitting yearly contribu-tions of up to $6,000 will govern..08 Employers adopting a new 401(k)

plan containing the model amendmentmay make it effective as of any date onor after January 1, 1997, but in no eventlater than October 1 of the year inwhich adopted. Employers amending anexisting 401(k) plan to incorporate themodel amendment must make the modelamendment effective as of the followingJanuary 1 unless they are using the 1997Transition Rule described in section 3.

SECTION 3. 1997 TRANSITIONRULE

.01 Employers that have maintained a401(k) plan in 1997 may adopt themodel amendment for 1997 if the fol-lowing conditions are satisfied:(1) the employer adopts the 401(k)SIMPLE provisions by July 1, 1997,effective as of January 1, 1997;(2) the salary reduction contributionsfor the year made prior to adoption ofthe model amendment do not totalmore than $6,000 for each employee;(3) the matching or nonelective con-tributions described in section 2.03are of inherently equal or greatervalue than the contributions requiredunder the plan prior to the amend-ment; and(4) all eligible employees are pro-vided with an election period de-scribed in section 3.3(b)(iv) of themodel amendment..02 If an employer adopts 401(k)

SIMPLE provisions under this transitionrule, the model amendment applies tothe plan for the 1997 year. For example,the cumulative salary reduction contri-butions for the year, including thosemade prior to and those made followingthe adoption of the model amendment,must not total more than $6,000 for anyemployee.

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SECTION 4. USE OF THE MODELAMENDMENT

.01 Sponsors described in section4.02 may amend their plans by adopt-ing, word-for-word, the model amend-ment in the appendix in accordance withthe instructions in this revenue proce-dure. If a sponsor to whom the modelamendment is available pursuant to sec-tion 4.02 adopts the model amendment,neither application to the Service nor auser fee is required. The Service willnot issue new opinion, notification, ad-visory, or determination letters for plansthat are amended solely to add themodel amendment..02 The only sponsors to whom the

model amendment is available are spon-sors of M&P, regional prototype, vol-ume submitter specimen, and individu-ally designed plans that contain CODAprovisions and that have received favor-able opinion, notification, advisory, ordetermination letters that take into ac-count the requirements of TRA ’86under Rev. Proc. 89–9, 1989–1 C.B.780, as modified; Rev. Proc. 89–13,

1989–1 C.B. 801, as modified; Rev.Proc. 90–20, 1990–1 C.B. 495; Rev.Proc. 91–41, 1991–2 C.B. 697; Rev.Proc. 91–66, 1991–2 C.B. 870; Rev.Proc. 93–39, 1993–2 C.B. 513; or Rev.Proc. 96–6, 1996–1 I.R.B. 151..03 Organizations and practitioners

that have approved M&P and regionalprototype plans and volume submitterspecimen plan sponsors that use themodel language must file Form 8837,Notice of Adoption of Revenue Proce-dure Model Amendments.

SECTION 5. REVOCATION OFMODEL AMENDMENT

The model amendment contains amodel revocation clause which permitsemployers to revoke the 401(k) SIMPLEprovisions without terminating the plan.The revocation clause should be ex-ecuted only if the employer wants torevert to the plan provisions that applyin the absence of 401(k) SIMPLE provi-sions. The revocation may be adoptedon any date, but may only becomeeffective on the first day of the calendar

year following the date of adoption.

SECTION 6. RELIANCE

Plans that are amended in accordancewith sections 4 and 5 will not lose theirotherwise applicable extended relianceperiod under Rev. Procs. 89–9 and 89–13, as modified by Rev. Proc. 93–9,1993–1 C.B. 474, or section 13 of Rev.Proc. 93–39. Employers entitled to relyon an opinion, notification, advisory, ordetermination letter will not lose reli-ance on the letter merely because ofthese amendments.


The principal authors of this revenueprocedure are Maxine Terry and RogerKuehnle of the Employee Plans Divi-sion. For further information regardingthis revenue procedure, contact the Em-ployee Plans Division’s taxpayer assis-tance telephone service between 1:30and 4:00 p.m., Eastern Time, Mondaythrough Thursday at (202) 622–6074/6075. (These telephone numbers are nottoll-free numbers.)

APPENDIX

MODEL AMENDMENT UNDER SECTIONS 401(k)(11) AND 401(m)(10)

MODEL AMENDMENT TO ADOPT SIMPLE 401(k) PROVISIONS

SECTION I. SIMPLE 401(K) PROVISIONS

1.1 This amendment adds to the plan SIMPLE 401(k) provisions that are intended to satisfy the requirements of§§ 401(k)(11) and 401(m)(10) of the Internal Revenue Code.1.2 The provisions of sections 3.3, IV, VI, and VII of this amendment apply for a year only if the following conditions are

met:(a) The employer adopting this amendment is an eligible employer. An eligible employer means, with respect to any year, an

employer that had no more than 100 employees who received at least $5,000 of compensation from the employer for thepreceding year. In applying the preceding sentence, all employees of controlled groups of corporations under § 414(b), allemployees of trades or businesses (whether incorporated or not) under common control under § 414(c), all employees ofaffiliated service groups under § 414(m), and leased employees required to be treated as the employer’s employees under§ 414(n), are taken into account.An eligible employer that adopts this amendment and that fails to be an eligible employer for any subsequent year, is treated

as an eligible employer for the 2 years following the last year the employer was an eligible employer. If the failure is due toany acquisition, disposition, or similar transaction involving an eligible employer, the preceding sentence applies only if theprovisions of § 410(b)(6)(C)(i) are satisfied.(b) No contributions are made, or benefits accrued for services during the year, on behalf of any eligible employee under any

other plan, contract, pension, or trust described in § 219(g)(5)(A) or (B), maintained by the employer.1.3 To the extent that any other provision of the plan is inconsistent with the provisions of this amendment, the provisions of

this amendment govern.

SECTION II. DEFINITIONS

2.1 ‘‘Compensation’’ means, for purposes of sections 1.2(a), 3.1 and 3.2, the sum of the wages, tips, and other compensationfrom the employer subject to federal income tax withholding (as described in § 6051(a)(3)) and the employee’s salary reductioncontributions made under this or any other 401(k) plan, and, if applicable, elective deferrals under a § 408(p) SIMPLE plan, aSARSEP, or a § 403(b) annuity contract and compensation deferred under a § 457 plan, required to be reported by theemployer on Form W–2 (as described in § 6051(a)(8)). For self-employed individuals, compensation means net earnings from

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self-employment determined under § 1402(a) prior to subtracting any contributions made under this plan on behalf of theindividual. The provisions of the plan implementing the limit on compensation under § 401(a)(17) apply to the compensationunder Section III.2.2 ‘‘Eligible employee’’ means, for purposes of this amendment, any employee who is entitled to make elective deferrals

described in § 402(g) under the terms of the plan.2.3 ‘‘Year’’ means the calendar year.

SECTION III. CONTRIBUTIONS

3.1 Salary Reduction Contributions(a) Each eligible employee may make a salary reduction election to have his or her compensation reduced for the year in

any amount selected by the employee subject to the limitation in section 3.1(b). The employer will make a salary reductioncontribution to the plan, as an elective deferral, in the amount by which the employee’s compensation has been reduced.(b) The total salary reduction contribution for the year cannot exceed $6,000 for any employee. To the extent permitted by

law, this amount will be adjusted to reflect any annual cost-of-living increases announced by the IRS.3.2 Other Contributions(a) Matching Contributions—Each year, the employer will contribute a matching contribution to the plan on behalf of each

employee who makes a salary reduction election under section 3.1. The amount of the matching contribution will be equal tothe employee’s salary reduction contribution up to a limit of 3% of the employee’s compensation for the full calendar year.(b) Nonelective Contribution—For any year, instead of a matching contribution, the employer may elect to contribute a

nonelective contribution of 2% of compensation for the full calendar year for each eligible employee who received at least$5,000 of compensation from the employer for the year. By inserting a number less than $5,000 here , the employeragrees to substitute this lesser amount for the $5,000 amount in the preceding sentence.3.3 Limitation on Other Contributions(a) General rule—No employer or employee contributions may be made to this plan for the year other than salary reduction

contributions described in section 3.1, matching or nonelective contributions described in section 3.2 and rollover contributionsdescribed in § 1.402(c)–2, Q&A–1(a) of the Income Tax Regulations.(b) 1997 Transition Rule—If the employer has maintained this plan during 1997 prior to adopting this amendment, then

contributions made prior to the amendment are treated as made under sections 3.1 and 3.2 provided that: (i) the employeradopts the 401(k) SIMPLE provisions by July 1, 1997, effective as of January 1, 1997; (ii) the salary reduction contributionsfor the year made prior to adoption of the amendment do not total more than $6,000 for any employee; (iii) the othercontributions set forth in section 3.2 are of inherently equal or greater value than the contributions required under the plan priorto the amendment; and (iv) for 1997, the 60-day election period requirement described in sections 4.1(a) and (b) is deemedsatisfied if the employee may make or modify a salary reduction election during a 60-day election period that begins no laterthan 30 days after the amendment is adopted but in no event later than July 1, 1997.3.4 The provisions of the plan implementing the limitations of § 415 apply to contributions made pursuant to sections 3.1

and 3.2.

SECTION IV. ELECTION AND NOTICE REQUIREMENTS

4.1 Election Period(a) In addition to any other election periods provided under the plan, each eligible employee may make or modify a salary

reduction election during the 60-day period immediately preceding each January 1.(b) For the year an employee becomes eligible to make salary reduction contributions under this amendment, the 60-day

election period requirement of section 4.1(a) is deemed satisfied if the employee may make or modify a salary reductionelection during a 60-day period that includes either the date the employee becomes eligible or the day before.(c) Each employee may terminate a salary reduction election at any time during the year.4.2 Notice Requirements(a) The employer will notify each eligible employee prior to the 60-day election period described in section 4.1 or 3.3(b)(iv)

that he or she can make a salary reduction election or to modify a prior election during that period.(b) The notification described in section 4.2(a) will indicate whether the employer will provide a 3% matching contribution

described in section 3.2(a) or a 2% nonelective contribution described in section 3.2(b).

SECTION V. VESTING REQUIREMENTS

All benefits attributable to contributions made pursuant to this amendment are nonforfeitable at all times.

SECTION VI. TOP-HEAVY RULES

The plan is not treated as a top-heavy plan under § 416 for any year for which the provisions of this amendment areeffective and satisfied.

SECTION VII. NONDISCRIMINATION TESTS

The plan is treated as meeting the requirements of §§ 401(k)(3)(A)(ii) and 401(m)(2) for any year for which the provisionsof this amendment are effective and satisfied.

58

SECTION VIII. EFFECTIVE DATE

This amendment is effective on .

Employer Name By: Signature

Name and Title

Date

MODEL REVOCATION CLAUSE

This amendment is revoked effective as of the first day of the calendar year following(enter the date the revocation is adopted).

Employer Name By: Signature

Name and Title

Date

26 CFR 601.204: Changes in accounting periodsand in methods of accounting.(Also Part I, §§ 56, 168, 446, 481; 1.446–1.)

Rev. Proc. 97–10

SECTION 1. PURPOSE

This revenue procedure provides theexclusive procedure for making the elec-tion under § 1120 of the Small BusinessJob Protection Act of 1996 (the Act) totreat a retail motor fuels outlet placed inservice before August 20, 1996, as 15-year property under § 168 of the Inter-nal Revenue Code. The election setforth in this revenue procedure is avail-able only for the taxpayer’s taxable yearthat includes August 20, 1996, the dateof enactment of the Act.

SECTION 2. BACKGROUND

.01 Section 1120 of the Act amended§ 168(e)(3)(E) to provide that 15-yearproperty includes any § 1250 propertythat is a retail motor fuels outletwhether or not food or other conve-nience items are sold at the outlet. Thelegislative history of the Act providesthat property will qualify as a retailmotor fuels outlet if 50 percent or moreof the gross revenues generated from theproperty are derived from petroleumsales, or 50 percent or more of the floorspace in the property is devoted topetroleum marketing sales. A motor fu-els outlet of 1400 square feet or lessqualifies as a retail motor fuels outletunder the Act without application ofeither 50 percent test. If the property

initially meets (or fails to meet) the50-percent test but subsequently fails tomeet (or meets) the test for more than atemporary period, such failure (or quali-fication) is treated as a change in theuse of property to which § 168(i)(5)applies. S. Rep. No. 281, 104th Cong.,2nd Sess. 14–16 (1996).Section 1120 of the Act also amended

§ 168(g)(3)(B) to provide that the re-covery period for a retail motor fuelsoutlet is 20 years under the alternativedepreciation system of § 168(g)..02 Section 1120 of the Act applies to

property depreciable under § 168 that isplaced in service on or after August 20,1996. Section 1120 of the Act alsoprovides that a taxpayer may elect, inthe form and manner prescribed by theSecretary of the Treasury, to apply§ 1120 to property depreciable under§ 168 that was placed in service beforeAugust 20, 1996. The legislative historyof the Act provides that the Secretarymay treat the election as a change in thetaxpayer’s method of accounting for theproperty and provide rules similar tothose provided in Rev. Proc. 96–31,1996–1 C.B. 714. The legislative historyfurther provides that if a taxpayer hasalready treated the property as 15-yearproperty the taxpayer will be deemed tohave made the election for that property..03 For certain changes in methods of

accounting for depreciation, Rev. Proc.96–31 provides an automatic, prospec-tive method change under which the§ 481(a) adjustment is taken into ac-count in computing the taxable incomein the year of change.

.04 Except as otherwise expresslyprovided, a taxpayer must obtain theconsent of the Commissioner of InternalRevenue to change a method of ac-counting for federal income tax pur-poses. To obtain this consent, a Form3115, Application for Change in Ac-counting Method, generally must befiled within 180 days after the beginningof the taxable year in which the pro-posed change is to be made. Section446(e) and § 1.446–1(e)(2)(i) and (3)(i)of the Income Tax Regulations..05 The Commissioner is authorized

to prescribe administrative proceduressetting forth the limitations, terms, andconditions the Commissioner deemsnecessary to obtain consent for effectinga change in method of accounting andto prevent amounts from being dupli-cated or omitted, including the taxableyear or years in which the § 481(a)adjustment is to be taken into account.Section 1.446–1(e)(3)(ii)..06 In computing taxable income,

§ 481(a) requires a taxpayer to take intoaccount those adjustments necessary toprevent amounts from being duplicatedor omitted when the taxpayer’s taxableincome is computed under a method ofaccounting different from the methodused to compute taxable income for thepreceding taxable year.

SECTION 3. SCOPE.01 Except as otherwise provided in

section 3.02 of this revenue procedure,this revenue procedure applies to§ 1250 property that: (1) qualifies as aretail motor fuels outlet as described in

59

section 2.01 of this revenue procedure;(2) is depreciable under § 168; (3) wasplaced in service before August 20,1996; and (4) was not treated as 15-yearproperty under § 168 in all taxableyears since the property was placed inservice or, if the property changed itsuse from or to a retail motor fuelsoutlet, in all taxable years in which theproperty was a retail motor fuels outlet..02 This revenue procedure does not

apply to: (1) any property depreciableunder § 168 prior to its amendment bythe Tax Reform Act of 1986; or (2) anyproperty for which the taxpayer will bedeemed to have made the retail motorfuels outlet election. A taxpayer will bedeemed to have made this election for:(i) property placed in service before theyear of change (as defined in section5.02 of this revenue procedure) that wastreated as 15-year property under § 168in all taxable years since the propertywas placed in service or, if the propertychanged its use from or to a retail motorfuels outlet, in all taxable years in whichthe property was a retail motor fuelsoutlet; and (ii) property placed in ser-vice during the year of change (or theimmediately preceding taxable year) butbefore August 20, 1996, that was or willbe treated as 15-year property under§ 168 on the taxpayer’s original taxreturn for the year of change (or theimmediately preceding taxable year).

SECTION 4. RETAIL MOTOR FUELSOUTLET ELECTION

.01 In general.A taxpayer may electto treat § 1250 property within thescope of this revenue procedure as 15-year property for § 168 purposes. Thiselection may be made separately foreach property and, once made, is irrevo-cable..02 Effect of election.If a taxpayer

makes the retail motor fuels outlet elec-tion, the taxpayer must change to apermissible depreciation method, recov-ery period, and convention under § 168for the property. Under the general de-preciation system of § 168(a), 15-yearproperty generally is depreciated by us-ing the 150-percent declining balancemethod of depreciation and a 15-yearrecovery period. Under the alternativedepreciation system of § 168(g), a retailmotor fuels outlet is depreciated byusing the straight-line method of depre-ciation and a 20-year recovery period.Under both depreciation systems, theconvention is the half-year conventionunless the mid-quarter convention ap-

plies. The retail motor fuels outlet elec-tion does not revoke any elections previ-ously made by the taxpayer under § 168or enable the taxpayer to make a lateelection to use the straight-line methodor the alternative depreciation system.However, if the taxpayer has no other15-year property (as defined under§§ 168(e)(1) and 168(e)(3)(E)(i) and(ii)) that was placed in service duringthe same taxable year as the retail motorfuels outlet, the taxpayer may elect touse the straight-line method or the alter-native depreciation system for the retailmotor fuels outlet.The retail motor fuels outlet election

also requires the taxpayer to use a20-year recovery period and the straight-line method for the property for alterna-tive minimum tax purposes.See§ 168(g)(3)(B).

SECTION 5. CHANGE IN METHODOF ACCOUNTING

.01 Consent.The retail motor fuelsoutlet election for any property withinthe scope of this revenue procedure is achange in method of accounting. Under§ 1.446–1(e)(2)(i), the consent of theCommissioner is hereby granted to tax-payers to make this method change for§ 1250 property within the scope of thisrevenue procedure. This consent isgranted for the taxpayer’s year ofchange. The consent is conditioned,however, on the taxpayer’s complyingwith this section and section 4 of thisrevenue procedure. If the taxpayer doesnot comply with these sections, thetaxpayer will be deemed to have initi-ated a change in method of accountingwithout obtaining the consent of theCommissioner required under § 446(e)..02 Year of change.The year of

change is the taxpayer’s taxable yearthat includes August 20, 1996, the dateof enactment of the Act..03 Section 481(a) adjustment.(1) Amount of § 481(a) adjust-

ment.The § 481(a) adjustment may bea positive § 481(a) adjustment (increasein taxable income) or negative § 481(a)adjustment (decrease in taxable income).The adjustment equals the differencebetween the total amount of depreciationtaken into account in computing taxableincome for the property under the tax-payer’s present method of accounting,and the total amount of depreciationallowable for the property under thetaxpayer’s proposed method of account-ing, for any taxable year prior to theyear of change. However, if the taxpay-

er’s property underwent a change in useas described in section 2.01 of thisrevenue procedure, the § 481(a) adjust-ment must only take into account thosetaxable years the property qualified as aretail motor fuels outlet.

(2) Section 481(a) adjustment pe-riod. In computing taxable income, ataxpayer must take into account (a) theentire net negative § 481(a) adjustmentin the year of change, or (b) any netpositive § 481(a) adjustment ratablyover 3 years, beginning with the year ofchange.

(3) Alternative minimum tax.Theamounts of the § 481(a) adjustments forregular tax and alternative minimum taxpurposes may differ. The § 481(a) ad-justment relating to the alternative mini-mum taxable income will be included inthe computation of the alternative mini-mum taxable income over the same§ 481(a) adjustment period applicableunder section 5.03(2) of this revenueprocedure. The difference between thetwo § 481(a) adjustments will requirean adjustment to taxable income inorder to arrive at alternative minimumtaxable income. See Form 6251 (Alter-native Minimum Tax—Individuals) andForm 4626 (Alternative Minimum Tax—Corporations)..04 Manner of making method

change.(1) Complete and file a current

Form 3115.The retail motor fuels outletelection is made on the taxpayer’stimely filed (including extensions) origi-nal federal income tax return for theyear of change or on an amended returnfor the year of change filed no later than

* . The election is made byattaching a completed, current Form3115 to the taxpayer’s original oramended return for the year of change.The requirement to file a Form 3115within 180 days after the beginning ofthe year of change is waived in accor-dance with § 1.446–1(e)(3)(ii). In addi-tion, a copy of the Form 3115 must befiled with the national office no laterthan when the original Form 3115 isfiled with the federal income tax returnor the amended return. The copy shouldbe sent to the Commissioner of InternalRevenue, Attention: Office of AssistantChief Counsel (Passthroughs and Spe-cial Industries) CC:DOM:P&SI, P.O.Box 7604, Benjamin Franklin Station,Washington, D.C. 20024.

* Insert the date that is 180 days after thepublication of this revenue procedure.

60

If more than one member of aconsolidated group is making the retailmotor fuels outlet election, the parentcorporation may file a single Form 3115on behalf of the members of the con-solidated group making the election inaccordance with Rev. Proc. 92–90,1992–2 C.B. 501 (or any successor). Seesection 5.02 of Rev. Proc. 92–90 for theinformation required to be submittedwith the Form 3115.

In completing the current Form3115 (Rev. February 1996), the taxpayermust complete Schedule D, Part II,Change in Depreciation or Amortization(page 7 of the Form 3115), and anyother applicable schedule. With respectto Parts I through III on pages 1 and 2of the Form 3115 the taxpayer mustprovide only the information requestedon the following lines:

(a) Part I, Eligibility To RequestChange (page 1)-lines 1, 2a, 2b, 3a, 4a,5a, and 6;

(b) Part II, Description ofChange (page 2)-lines 7, 8, and 10; and

(c) Part III, Section 481(a) Ad-justment (page 2)-lines 20, 22, 23, and25. Include on line 20 the amounts ofthe § 481(a) adjustments for regular taxand alternative minimum tax purposes.The taxpayer does not have to completePart IV, Additional Information (page 3).

(2) No user fee.No user fee isrequired for a Form 3115 filed underthis revenue procedure..05 Basis adjustment.As of the be-

ginning of the year of change, the basisof the property for which the retailmotor fuels outlet election is made mustreflect the reductions required by§ 1016(a)(2) for the depreciation allow-able for the property (as determinedunder the taxpayer’s proposed methodof accounting) for all open and closedyears prior to the year of change..06 Protection from examination

changes.(1) In general.If a taxpayer timely

files a completed Form 3115 to changeits method of accounting in the manner

described in this revenue procedure andotherwise complies with the provisionsof this revenue procedure, the districtdirector may not propose that the tax-payer change the same method of ac-counting as that changed by the tax-payer under this revenue procedure for ayear prior to the year of change pre-scribed in this revenue procedure. Thedistrict director, however, may verify thefacts underlying the method change,including whether the property qualifiesas a retail motor fuels outlet, theamounts of the regular tax and alterna-tive minimum tax § 481(a) adjustments,the § 481(a) adjustment period, and the§ 1016(a)(2) adjustment to the basis ofthe property.

(2) Taxpayer under examination,before an appeals office, or before afederal court.If a change in method ofaccounting under this revenue procedureresults in a positive § 481(a) adjustmentfor an item of property, a taxpayer doesnot receive the protection from examina-tion changes described in section 5.06(1)of this revenue procedure for that prop-erty if, on ** , the method ofaccounting is an issue:

(a) under consideration with re-spect to an examination of the taxpay-er’s federal income tax return for anytaxable year. The issue is under consid-eration if the taxpayer has receivedwritten notification from the examiningagent(s) (e.g., by examination plan, in-formation document request, notificationof proposed adjustments or income taxexamination changes) specifically citingthe method of accounting as an issueunder consideration for the taxableyear(s) under examination;

(b) before an appeals office ofthe Internal Revenue Service with re-spect to an examination of the taxpay-er’s federal income tax return for anytaxable year; or

(c) before a federal court.

SECTION 6. EFFECTIVE DATE

.01 In general. This revenue proce-dure is effective for a taxpayer’s taxableyear that includes August 20, 1996, thedate of enactment of the Act..02 Form 3115 pending with the Ser-

vice. Because this revenue procedureprovides the exclusive procedure formaking the retail motor fuels outletelection, the national office will returnany Form 3115 filed with the nationaloffice under Rev. Proc. 92–20, 1992–1C.B. 685, or Rev. Proc. 96–31 for achange in method of accounting withinthe scope of this revenue procedure. Ataxpayer that has timely filed a Form3115 with the national office prior to thepublication date of this revenue proce-dure must use this revenue procedureand will be so notified to this effect bythe national office. If all of the propertysubject to the Form 3115 appears to bewithin the scope of this revenue proce-dure, any user fee submitted with theForm 3115 will be returned to thetaxpayer..03 Claim for refund pending with the

Service.Because this revenue procedureprovides the exclusive procedure formaking the retail motor fuels outlet elec-tion provided by § 1120 of the Act, theService will deny any claim for refundthat is filed to make this election, exceptfor any amended return filed under sec-tion 5.04(1) of this revenue procedure.

SECTION 7. EFFECT ON OTHERDOCUMENTS

Rev. Proc. 92–20, 1992–1 C.B. 685,is modified.


The principal author of this revenueprocedure is Mark Pitzer of the Officeof Assistant Chief Counsel(Passthroughs and Special Industries).For further information regarding thisrevenue procedure, contact Mark Pitzerat (202) 622–3110 (not a toll-free call).

** Insert the date of publication of this revenueprocedure.

61

Part IV. Items of General InterestExtension of Test of MediationProcedure for Appeals

Announcement 97–1SUMMARY: This document extends thetest of the mediation procedure set forthin Announcement 95–86, 1995–44I.R.B. 27, for an additional one-yearperiod beginning on January 13, 1997.

FOR FURTHER INFORMATION CON-TACT: Thomas Carter Louthan, Director,Office of Dispute Resolution and Spe-cialty Programs, National Office Appeals,(202) 401–4098 (not a toll-free number).

EXTENSION OF TEST OFMEDIATION PROCEDURE FORAPPEALSSummary: This procedure allows tax-payers, in certain cases that are alreadyin the Appeals administrative processand that are not docketed in any court,to request mediation of one or moreissues as a dispute resolution technique.Under the procedure, the taxpayer andAppeals attempt to negotiate a settle-ment, assisted by an objective and neu-tral third party who has no authority toimpose a decision. This document ex-tends the test of the mediation procedureset forth in Announcement 95–86 for anadditional one-year period.

Background: Announcement 95–86,which contains the procedures that tax-payers may use to request mediation,applies to issues in Coordinated Exami-nation Program cases assigned to Ap-peals Team Chiefs. A one-year test ofthe mediation procedure concluded onOctober 30, 1996. During this period,nine requests for mediation were made,in which four were approved. The me-diation program is consistent with IRS’efforts to improve tax administration,provide customer service and reducetaxpayer burden. During the additionalone-year test period, Appeals will trymediation in more cases so that theprogram can be further evaluated.

Effective Date:This Announcement ex-

tends the test of the mediation procedureset forth in Announcement 95–86 for anadditional one-year period beginning onJanuary 13, 1997.

For further information contact:Tho-mas Carter Louthan, Director, Office ofDispute Resolution and Specialty Pro-grams, National Office Appeals, (202)401–4098 (not a toll-free number).

Change to Schedule Q

Announcement 97–2

This announcement modifies ScheduleQ (January 1996) of the Form 5300series applications to reflect amend-ments to § 401(a)(26) of the InternalRevenue Code made by § 1432 of theSmall Business Job Protection Act of1996 (SBJPA), effective for plan yearsbeginning after December 31, 1996.Beginning with the 1997 plan year,

the minimum participation requirementsof § 401(a)(26) apply only to definedbenefit plans. Therefore, until the appli-cation form is revised, applicants re-questing a determination letter for adefined contribution plan for plan yearsbeginning after December 31, 1996,may answer ‘‘Yes’’ to questions 2a and2i of Part II of Schedule Q (January1996). The additional information de-scribed in the instruction to line 2(a)(Demo 2) need not be submitted fordefined contribution plans.Applicants should note that

§ 401(a)(26)(A)(ii) was amended bySBJPA to require a plan to benefit atleast 2 employees (or 1 employee ifthere is only 1 employee) for plan yearsafter December 31, 1996. Schedule Qdoes not reflect this modification to§ 401(a)(26)(A)(ii).

Deletions From Cumulative List ofOrganizations Contributions toWhich are Deductible UnderSection 170 of the Code

Announcement 97–3

The name of an organization that nolonger qualifies as an organization de-scribed in section 170(c)(2) of the Inter-nal Revenue Code of 1986 is listedbelow.Generally, the Service will not disal-

low deductions for contributions madeto a listed organization on or before thedate of announcement in the InternalRevenue Bulletin that an organizationno longer qualifies. However, the Ser-vice is not precluded from disallowing adeduction for any contributions madeafter an organization ceases to qualifyunder section 170(c)(2) if the organiza-tion has not timely filed a suit fordeclaratory judgment under section 7428and if the contributor (1) had knowledgeof the revocation of the ruling or deter-mination letter, (2) was aware that suchrevocation was imminent, or (3) was inpart responsible for or was aware of theactivities or omissions of the organiza-tion that brought about this revocation.If on the other hand a suit for declara-

tory judgment has been timely filed,contributions from individuals and orga-nizations described in section 170(c)(2)that are otherwise allowable will con-tinue to be deductible. Protection undersection 7428(c) would begin on (DATE)1997, and would end on the date thecourt first determines that the organiza-tion is not described in section 170(c)(2)as more particularly set forth in section7428(c)(1). For individual contributors,the maximum deduction protected is$1,000, with a husband and wife treatedas one contributor. This benefit is notextended to any individual who wasresponsible, in whole or in part, for theacts or omissions of the organization thatwere the basis for revocation.

H & M Home for Alternative LivingDetroit, MI

621997-2 I.R.B.

Definition of TermsRevenue rulings and revenue procedures(hereinafter referred to as ‘‘rulings’’)that have an effect on previous rulingsuse the following defined terms to de-scribe the effect:Amplified describes a situation where

no change is being made in a priorpublished position, but the prior positionis being extended to apply to a variationof the fact situation set forth therein.Thus, if an earlier ruling held that aprinciple applied to A, and the newruling holds that the same principle alsoapplies to B, the earlier ruling is ampli-fied. (Compare withmodified, below).Clarified is used in those instances

where the language in a prior ruling isbeing made clear because the languagehas caused, or may cause, some confu-sion. It is not used where a position in aprior ruling is being changed.Distinguished describes a situation

where a ruling mentions a previouslypublished ruling and points out an es-sential difference between them.Modified is used where the substance

of a previously published position isbeing changed. Thus, if a prior rulingheld that a principle applied to A but notto B, and the new ruling holds that itapplies to both A and B, the prior ruling

is modified because it corrects a pub-lished position. (Compare withamplifiedandclarified, above).Obsoleteddescribes a previously pub-

lished ruling that is not considered de-terminative with respect to future trans-actions. This term is most commonlyused in a ruling that lists previouslypublished rulings that are obsoleted be-cause of changes in law or regulations.A ruling may also be obsoleted becausethe substance has been included in regu-lations subsequently adopted.Revoked describes situations where

the position in the previously publishedruling is not correct and the correctposition is being stated in the newruling.Supersededdescribes a situation

where the new ruling does nothing morethan restate the substance and situationof a previously published ruling (orrulings). Thus, the term is used torepublish under the 1986 Code andregulations the same position publishedunder the 1939 Code and regulations.The term is also used when it is desiredto republish in a single ruling a series ofsituations, names, etc., that were previ-ously published over a period of time inseparate rulings. If the new ruling does

more than restate the substance of aprior ruling, a combination of terms isused. For example,modifiedand super-seded describes a situation where thesubstance of a previously published rul-ing is being changed in part and iscontinued without change in part and itis desired to restate the valid portion ofthe previously published ruling in a newruling that is self contained. In this casethe previously published ruling is firstmodified and then, as modified, is su-perseded.Supplementedis used in situations in

which a list, such as a list of the namesof countries, is published in a ruling andthat list is expanded by adding furthernames in subsequent rulings. After theoriginal ruling has been supplementedseveral times, a new ruling may bepublished that includes the list in theoriginal ruling and the additions, andsupersedes all prior rulings in the series.Suspendedis used in rare situations to

show that the previous published rulingswill not be applied pending some futureaction such as the issuance of new oramended regulations, the outcome ofcases in litigation, or the outcome of aService study.

AbbreviationsThe following abbreviations in current use andformerly used will appear in material published inthe Bulletin.

A—Individual.

Acq.—Acquiescence.

B—Individual.

BE—Beneficiary.

BK—Bank.

B.T.A.—Board of Tax Appeals.

C.—Individual.

C.B.—Cumulative Bulletin.

CFR—Code of Federal Regulations.

CI—City.

COOP—Cooperative.

Ct.D.—Court Decision.

CY—County.

D—Decedent.

DC—Dummy Corporation.

DE—Donee.

Del. Order—Delegation Order.

DISC—Domestic International Sales Corporation.

DR—Donor.

E—Estate.

EE—Employee.

E.O.—Executive Order.

ER—Employer.

ERISA—Employee Retirement Income Security Act.

EX—Executor.

F—Fiduciary.

FC—Foreign Country.

FICA—Federal Insurance Contribution Act.

FISC—Foreign International Sales Company.

FPH—Foreign Personal Holding Company.

F.R.—Federal Register.

FUTA—Federal Unemployment Tax Act.

FX—Foreign Corporation.

G.C.M.—Chief Counsel’s Memorandum.

GE—Grantee.

GP—General Partner.

GR—Grantor.

IC—Insurance Company.

I.R.B.—Internal Revenue Bulletin.

LE—Lessee.

LP—Limited Partner.

LR—Lessor.

M—Minor.

Nonacq.—Nonacquiescence.

O—Organization.

P—Parent Corporation.

PHC—Personal Holding Company.

PO—Possession of the U.S.

PR—Partner.

PRS—Partnership.

PTE—Prohibited Transaction Exemption.

Pub. L.—Public Law.

REIT—Real Estate Investment Trust.

Rev. Proc.—Revenue Procedure.

Rev. Rul.—Revenue Ruling.

S—Subsidiary.

S.P.R.—Statements of Procedural Rules.

Stat.—Statutes at Large.

T—Target Corporation.

T.C.—Tax Court.

T.D.—Treasury Decision.

TFE—Transferee.

TFR—Transferor.

T.I.R.—Technical Information Release.

TP—Taxpayer.

TR—Trust.

TT—Trustee.

U.S.C.—United States Code.

X—Corporation.

Y—Corporation.

Z—Corporation.

66

Finding List of Current Action onPreviously Published Items1

Bulletin 1997–1

*Denotes entry since last publication

Revenue Procedures:

92–20Superseded by97–1, 1997–1 I.R.B.11
















1A cumulative finding list for previously publisheditems mentioned in Internal Revenue Bulletins1996–27 through 1996–53 will be found in Inter-nal Revenue Bulletin 1996–27, dated January 6,1997.

64