INCOME TAX

Rev. Rul. 2001–3, page 319.Federal rates; adjusted federal rates; adjusted feder-al long-term rate, and the long-term exempt rate. Forpurposes of sections 1274, 1288, 382, and other sectionsof the Code, tables set forth the rates for January 2001.

Rev. Rul. 2001–4, page 295.Aircraft maintenance costs. Costs incurred by a taxpay-er to perform work on its aircraft airframe as part of a heavymaintenance visit generally are deductible as ordinary andnecessary business expenses under section 162 of theCode. However, costs incurred in conjunction with a heavymaintenance visit must be capitalized to the extent theymaterially add to the value of, substantially prolong the use-ful life of, or adapt the airframe to a new or different use. Inaddition, costs incurred as part of a plan of rehabilitation,modernization, or improvement must be capitalized. Rev.Proc. 99–49 modified and amplified.

T.D. 8911, page 321.Final regulations under sections 7508 and 7508A of theCode authorize the Service to postpone certain tax-relateddeadlines due either to service in a combat zone or aPresidentially declared disaster. The regulations list thetypes of taxpayers who are affected and the acts for whichthe deadlines may be postponed. The regulations also pro-vide that the Service may specify additional acts that may bepostponed in other guidance, such as revenue rulings, rev-enue procedures, notices, announcements, or news releas-es.

T.D. 8913, page 300.Final regulations under section 355(d) of the Code relate torecognition of gain on certain distributions of stock or secu-rities of a controlled corporation.

REG–107566–00, page 346.Proposed regulations under section 355(e) of the Code gen-erally require corporations to recognize gain on certain dis-tributions of stock or securities of a subsidiary corporation ifthe distribution is part of a plan that also involves the acqui-sition by one or more persons of a 50 percent or greaterinterest in the corporation making the distribution or the cor-poration being distributed. A public hearing is scheduled forMay 15, 2001.

Notice 2001–5, page 327.This notice provides guidance to partnerships regarding theneed for both the terminated partnership and the new part-nership to file a final short-year partnership tax return fol-lowing a partnership termination under section 708(b)(1)(B)of the Code.

Notice 2001–12, page 328.Cost-of-living adjustments for 2001. This notice clarifiesRev. Proc. 2001–13, on page 337 of this Bulletin, to providethat the inflation-adjustment amounts set forth in Part I ofsection 3 of that revenue procedure are the applicableamounts for 2001 in accordance with the recently enactedlegislation. Rev. Proc. 2001–13 clarified.

Rev. Proc. 2001–12, page 335.This procedure details safe harbor conditions under whichthe transfer of a REMIC noneconomic residual interest orFASIT ownership interest is presumed to be accomplishedwithout an intention to impede the assessment or collectionof tax. Taxpayers may rely on the safe harbors fromFebruary 4, 2000 (the date proposed regulations were filedwith the Federal Register), until the date specified in futurepublished guidance.

Internal Revenue

bbuulllleettiinnBulletin No. 2001–3

January 16, 2001

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

Department of the TreasuryInternal Revenue Service

Finding Lists begin on page ii.

(Continued on the next page)

January 16, 2001 2001–3 I.R.B.

Rev. Proc. 2001–13, page 337.Cost-of-living adjustments for 2001. This procedure pro-vides cost-of-living adjustments for the tax rate tables for indi-viduals, estates, and trusts, the standard deduction amounts,the personal exemption, and several other items that use theadjustment method provided for the tax rate tables. TheService also provides the adjustment for eligible long-termcare premiums and another item that uses the adjustmentmethod provided for eligible long-term care premiums. Also,see Notice 2001–12, page 328 of this Bulletin, for a deter-mination of the applicable inflation-adjustment amounts for2001.

Rev. Proc. 2001–14, page 343.This procedure sets forth the maximum face amount of qual-ified zone academy bonds that may be issued by each State,the District of Columbia, and the possessions of the UnitedStates during 2001.

EMPLOYMENT TAX

Rev. Proc. 2001–9, page 328.Electronic filing, Form 940. This procedure provides tax-payers, reporting agents, transmitters, and software devel-opers with the reqiurements for electronically filing Form940, Employer’s Annual Federal Unemployment (FUTA) TaxReturn, as part of the Form 940 e-file Program. Rev. Proc.96–17 modified.

Announcement 2001–7, page 357.This document contains a correction to Announcement2000–97, 2000–48 I.R.B. 557. Employers are advised thatthe use of Code V (Income from the exercise of nonstatuto-ry stock options) in box 12 of Form W-2 is optional for the2001 Form W-2.

EXCISE TAX

Notice 2001–6, page 327.Mileage awards. This notice provides guidance on theapplication of the excise tax on the amount paid for air trans-portation to amounts paid for frequent flyer miles. Under thenotice, amounts paid for mileage awards that cannot beredeemed for taxable transportation are not subject to tax.

ADMINISTRATIVE

Rev. Proc. 2001–9, page 328.Electronic filing, Form 940. This procedure provides tax-payers, reporting agents, transmitters, and software devel-opers with the requirements for electronically filing Form940, Employer’s Annual Federal Unemployment (FUTA) TaxReturn, as part of the Form 940 e-file Program. Rev. Proc.96–17 modified.

Announcement 2001–6, page 357.An updated edition of Publication 547, Casualties, Disasters,and Thefts (Business and Nonbusiness) (revised December2000), will be available soon.

Announcement 2001–7, page 357.This document contains a correction to Announcement 2000-97, 2000–48 I.R.B. 557. Employers are advised that the useof Code V (Income from the exercise of nonstatutory stockoptions) in box 12 of Form W-2 is optional for the 2001 FormW-2.

Announcement 2001–8, page 357.An updated edition of Publication 583, Starting a Businessand Keeping Records (revised December 2000), is nowavailable.

Announcement 2001–9, page 357.Test of mediation procedure for appeals. Thisannouncement extends the test of the mediation procedureset forth in Announcement 98–99, 1998–2 C.B. 650, for anadditional one-year period beginning on January 16, 2001,the date this announcement is published in the InternalRevenue Bulletin.

2001–3 I.R.B. January 16, 2001

The Internal Revenue Bulletin is the authoritative instrumentof the Commissioner of Internal Revenue for announcing offi-cial rulings and procedures of the Internal Revenue Serviceand for publishing Treasury Decisions, Executive Orders, TaxConventions, legislation, court decisions, and other items ofgeneral interest. It is published weekly and may be obtainedfrom the Superintendent of Documents on a subscriptionbasis. Bulletin contents are consolidated semiannually intoCumulative Bulletins, which are sold on a single-copy basis.

It is the policy of the Service to publish in the Bulletin all sub-stantive rulings necessary to promote a uniform applicationof the tax laws, including all rulings that supersede, revoke,modify, or amend any of those previously published in theBulletin. All published rulings apply retroactively unless oth-erwise indicated. Procedures relating solely to matters of in-ternal management are not published; however, statementsof internal practices and procedures that affect the rightsand duties of taxpayers are published.

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

Rulings and procedures reported in the Bulletin do not havethe force and effect of Treasury Department Regulations,but they may be used as precedents. Unpublished rulingswill not be relied on, used, or cited as precedents by Ser-vice personnel in the disposition of other cases. In applyingpublished rulings and procedures, the effect of subsequentlegislation, regulations, court decisions, rulings, and proce-

dures must be considered, and Service personnel and oth-ers concerned are cautioned against reaching the sameconclusions in other cases unless the facts and circum-stances are substantially the same.

The Bulletin is divided into four parts as follows:

Part I.—1986 Code.This part includes rulings and decisions based on provisionsof 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, Legislation and RelatedCommittee Reports.

Part III.—Administrative, Procedural, and Miscellaneous.To the extent practicable, pertinent cross references tothese subjects are contained in the other Parts and Sub-parts. Also included in this part are Bank Secrecy Act Ad-ministrative Rulings. Bank Secrecy Act Administrative Rul-ings are issued by the Department of the Treasury’s Officeof the Assistant Secretary (Enforcement).

Part IV.—Items of General Interest.This part includes notices of proposed rulemakings, disbar-ment and suspension lists, and announcements.

The first Bulletin for each month includes a cumulative indexfor the matters published during the preceding months.These monthly indexes are cumulated on a semiannualbasis, and are published in the first Bulletin of the succeed-ing semiannual period, respectively.

The IRS Mission

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

and by applying the tax law with integrity and fairness toall.

Introduction

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

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

Section 1.—Tax Imposed

The Service provides inflation adjustments tothe tax rate tables for individuals, trusts, and es-tates for taxable years beginning in 2001. In addi-tion, the amounts of certain reductions allowedagainst the unearned income of minor children incomputing the “kiddie tax” are adjusted. Also ad-justed are the amounts used to determine whethera parent may elect to report the “kiddie tax” onthe parent’s return. See Rev. Proc. 2001–13, page337.

Section 32.—Earned Income

The Service provides inflation adjustments to thelimitations on the earned income tax credit for tax-able years beginning in 2001. See Rev. Proc.2001–13, page 337.

Section 42.—Low-IncomeHousing Credit

The adjusted applicable federal short-term, mid-term, and long-term rates are set forth for themonth of January 2001. See Rev. Rul. 2001–3,page 319.

Section 59.—Other Definitionsand Special Rules for theAlternative Minimum Tax

The Service provides an inflation adjustment tothe exemption amount used in computing the alter-native minimum tax for a minor child subject to the“kiddie tax” for taxable years beginning in 2001.See Rev. Proc. 2001–13, page 337.

Section 63.—Taxable IncomeDefined

The Service provides inflation adjustments to thestandard deduction amounts (including the limita-tion in the case of certain dependents, and the addi-tional standard deduction for the aged or blind) fortaxable years beginning in 2001. See Rev. Proc.2001–13, page 337.

Section 68.—Overall Limitationon Itemized Deductions

The Service provides inflation adjustments to theoverall limitation on itemized deductions for taxableyears beginning in 2001. See Rev. Proc. 2001–13,page 337.

Section 132.—Certain FringeBenefits

The Service provides inflation adjustments to thelimitations on the exclusion of income for a quali-fied transportation fringe for taxable years begin-ning in 2001. See Rev. Proc. 2001–13, page 337.

Section 135.—Income FromUnited States Savings BondsUsed to Pay Higher EducationTuition and Fees

The Service provides inflation adjustments to thelimitation on the exclusion of income from UnitedStates savings bonds for taxpayers who pay quali-fied higher education expenses for taxable years be-ginning in 2001. See Rev. Proc. 2001–13, page 337.

Section 151.—Allowance ofDeductions for PersonalExemptions

The Service provides inflation adjustments to thepersonal exemption and to the threshold amounts ofadjusted gross income above which the exemptionamount phases out for taxable years beginning in2001. See Rev. Proc. 2001–13, page 337.

Section 162.—Trade or BusinessExpenses

26 CFR 1.162–1: Business expenses.(Also sections 263; 263A; sections 1.162–4,1.263(a)–1, 1.263A–1)

Aircraft maintenance costs. Costs in-curred by a taxpayer to perform work onits aircraft airframe as part of a heavymaintenance visit generally are deductibleas ordinary and necessary business ex-penses under section 162 of the Code.However, costs incurred in conjuctionwith a heavy maintenance visit must becapitalized to the extent they materiallyadd to the value of, substantially prolongthe useful life of, or adapt the airframe toa new or different use. In addition, costsincurred as part of a plan of rehabilitation,modernization, or improvement must becapitalized.

Rev. Rul. 2001–4

ISSUE

Are costs incurred by a taxpayer to per-form work on its aircraft airframe, includ-ing the costs of a “heavy maintenancevisit,” deductible as ordinary and neces-sary business expenses under § 162 of theInternal Revenue Code, or must they becapitalized under §§ 263 and 263A?

FACTS

X is a commercial airline engaged in thebusiness of transporting passengers andfreight throughout the United States andabroad. To conduct its business, X ownsor leases various types of aircraft. As acondition of maintaining its operating li-cense and airworthiness certification forthese aircraft, X is required by the FederalAviation Administration “FAA” to estab-lish and adhere to a continuous mainte-nance program for each aircraft within itsfleet. These programs, which are designedby X and the aircraft’s manufacturer andapproved by the FAA, are incorporatedinto each aircraft’s maintenance manual.The maintenance manuals require a vari-ety of periodic maintenance visits at vari-ous intervals during the operating lives ofeach aircraft. The most extensive of thesefor X is termed a “heavy maintenancevisit” (also known in the industry as a “Dcheck,” “heavy C check,” or “overhaul”),which is required to be performed by Xapproximately every eight years of aircraftoperation. The purpose of a heavy main-tenance visit, according to X’s mainte-nance manual, is to prevent deteriorationof the inherent safety and reliability levelsof the aircraft equipment and, if such dete-rioration occurs, to restore the equipmentto their inherent levels.

In each of the following three situa-tions, X reasonably anticipated at the timethe aircraft was placed in service that theaircraft would be useful in its trade orbusiness for up to 25 years, taking into ac-count the repairs and maintenance neces-sary to keep the aircraft in an ordinarilyefficient operating condition. In addition,each of the aircraft in the following threesituations is fully depreciated for federalincome tax purposes at the time of theheavy maintenance visit.

2001–3 I.R.B. 295 January 16, 2001

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

January 16, 2001 296 2001–3 I.R.B.

Situation 1

In 2000, X incurred $2 million for thelabor and materials necessary to perform aheavy maintenance visit on the airframe ofAircraft 1, which X acquired in 1984 for$15 million (excluding the cost of engines).To perform the heavy maintenance visit, Xextensively disassembled the airframe, re-moving items such as its engines, landinggear, cabin and passenger compartmentseats, side and ceiling panels, baggagestowage bins, galleys, lavatories, floorboards, cargo loading systems, and flightcontrol surfaces. As specified by X’s main-tenance manual for Aircraft 1, X then per-formed certain tasks on the disassembledairframe for the purpose of preventing dete-rioration of the inherent safety and reliabil-ity levels of the airframe. These tasks in-cluded lubrication and service; operationaland visual checks; inspection and func-tional checks; restoration of minor partsand components; and removal, discard, andreplacement of certain life-limited singlecell parts, such as cartridges, canisters,cylinders, and disks.

Whenever the execution of a task re-vealed cracks, corrosion, excessive wear,or dysfunctional operation, X was re-quired by the maintenance manual to re-store the airframe to an acceptable condi-tion. This restoration involved burnishingcorrosion; repairing cracks, dents,gouges, punctures, or scratches by bur-nishing, blending, stop-drilling, or apply-ing skin patches or doublers over the af-fected area; tightening or replacing looseor missing fasteners, rivets, screws, bolts,nuts, or clamps; repairing or replacingtorn or damaged seals, gaskets, or valves;repairing or replacing damaged or miss-ing placards, decals, labels, or stencils;additional cleaning, lubricating, or paint-ing; further inspecting or testing, includ-ing the use of sophisticated non-destruc-tive inspection methods; repairingfiberglass or laminated parts; replacingbushings, bearings, hinges, handles,switches, gauges, or indicators; repairingchaffed or damaged wiring; repairing oradjusting various landing gear or flightsurface control cables; replacing lightbulbs, window panes, lenses, or shields;replacing anti-skid materials and stops onfloors, pedals, and stairways; replacingfloor boards; and performing minor re-pairs on ribs, spars, frames, longerons,stringers, beams, and supports.

In addition to the tasks describedabove, X also performed additional workas part of the heavy maintenance visit forAircraft 1. This work included applyingcorrosion prevention and control com-pounds; stripping and repainting the air-craft exterior; and cleaning, repairing, andpainting airframe interior items such asseats, carpets, baggage stowage bins, ceil-ing and sidewall panels, lavatories, gal-leys, and passenger service units. Otheradditional work included implementingcertain outstanding service bulletins(“SBs”) issued by the aircraft manufactur-er and airworthiness directives (“ADs” )issued by the FAA. Implementing theseSBs and ADs involved inspecting specificskin locations and applying doublers overthe areas where cracks were found;inspecting bolts or fasteners at specificlocations, and replacing those found to bebroken, worn, or missing; and installingstructural reinforcements between bodyframes in a small area in the lower aftfuselage to reduce skin wrinkling andreplacing a small number of the wrinkledskin panels in this area with stronger skinpanels.

None of the work performed by X aspart of the heavy maintenance visit(including the execution of SBs and ADs)for Aircraft 1 resulted in a materialupgrade or addition to its airframe orinvolved the replacement of any (or a sig-nificant portion of any) major componentor substantial structural part of the air-frame. This work maintained the relativevalue of the aircraft. The value of the air-craft declines as it ages even if the heavymaintenance work is performed.

After 45 days, the heavy maintenancevisit was completed, and Aircraft 1 wasreassembled, tested, and returned to X’sfleet. X then continued to use Aircraft 1for the same purposes and in the samemanner that it did prior to the perfor-mance of the heavy maintenance visit.The performance of the heavy mainte-nance visit did not extend the useful lifeof the airframe beyond the 25-year usefullife that X anticipated when it acquired theairframe.

Situation 2

Also in 2000, X incurred costs to per-form work in conjunction with a heavymaintenance visit on the airframe ofAircraft 2. The heavy maintenance visit

on Aircraft 2 involved all of the samework described in Situation 1. In addi-tion, X found significant wear and corro-sion of fuselage skins of Aircraft 2 thatnecessitated more extensive work thanwas performed on Aircraft 1. Namely, Xdecided to remove all of the skin panelson the belly of Aircraft 2’s fuselage andreplace them with new skin panels. Thereplaced skin panels represented a signifi-cant portion of all of the skin panels ofAircraft 2, and the work performed mate-rially added to the value of the airframe.

Because Aircraft 2 was already out ofservice and its airframe disassembled forthe heavy maintenance visit, X also per-formed certain modifications to the air-frame. These modifications involvedinstalling a cabin smoke and fire detectionand suppression system, a ground proxim-ity warning system, and an air phone sys-tem to enable passengers to send andreceive voice calls, faxes, and other elec-tronic data while in flight.

Situation 3

Also in 2000, X decided to make sub-stantial improvements to Aircraft 3, whichwas 22 years old and nearing the end of itsanticipated useful life, for the purpose ofincreasing its reliability and extending itsuseful life. X’s improvement of Aircraft3 involved many modifications to thestructure, exterior, and interior of the air-frame. The modifications includedremoving all the belly skin panels on theaircraft’s fuselage and replacing themwith new skin panels; replacing the metalsupports under the lavatories and galleys;removing the wiring in the leading edgesof both wings and replacing it with newwiring; removing the fuel tank bladders,harnesses, wiring systems, and connectorsand replacing them with new components;opening every lap joint on the airframeand replacing the epoxy and rivets used toseal the lap joints with a non-corrosivesealant and larger rivets; reconfiguringand upgrading the avionics and the equip-ment in the cockpit; replacing all theseats, overhead bins, sidewall panels, par-titions, carpeting, windows, galleys, lava-tories, and ceiling panels with new items;installing a cabin smoke and fire detectionsystem, and a ground proximity warningsystem; and painting the exterior of theaircraft. The work performed on Aircraft3 also included modifications necessary to

terminate every aging aircraft AD applic-able to Aircraft 3.

In order to upgrade the airframe to thedesired level, X performed much of thesame work that would be performed dur-ing a heavy maintenance visit (asdescribed in Situation 1). The result ofthe work performed on Aircraft 3 was tomaterially increase the value of the air-frame and substantially prolong its usefullife.

LAW

Section 162 and § 1.162–1(a) of theIncome Tax Regulations allow a deduc-tion for all the ordinary and necessaryexpenses paid or incurred during the tax-able year in carrying on any trade or busi-ness, including “incidental repairs.”

Section 1.162–4 allows a deduction forthe cost of incidental repairs that neithermaterially add to the value of the proper-ty nor appreciably prolong its useful life,but keep it in an ordinarily efficient oper-ating condition. However, § 1.162–4 alsoprovides that the cost of repairs in thenature of replacements that arrest deterio-ration and appreciably prolong the life ofthe property must be capitalized anddepreciated in accordance with § 167.

Section 263(a) provides that no deduc-tion is allowed for (1) any amount paid outfor new buildings or permanent improve-ments or betterments made to increase thevalue of any property or estate or (2) anyamount expended in restoring property orin making good the exhaustion thereof forwhich an allowance has been made. Seealso § 1.263(a)–1(a).

Section 1.263(a)–1(b) provides that cap-ital expenditures include amounts paid orincurred to (1) add to the value, or substan-tially prolong the useful life, of propertyowned by the taxpayer, or (2) adapt prop-erty to a new or different use. However,that regulation also provides that amountspaid or incurred for incidental repairs andmaintenance of property within the mean-ing of § 162 and § 1.162–4 are not capitalexpenditures under § 1.263(a)–1.

Section 263A provides that the directand indirect costs properly allocable toreal or tangible personal property pro-duced by the taxpayer must be capitalized.Section 263A(g)(1) provides that, for pur-poses of § 263A, the term “produce”includes construct, build, install, manu-facture, develop, or improve.

The United States Supreme Court hasspecifically recognized that the “decisivedistinctions [between capital and ordinaryexpenditures] are those of degree and not ofkind,” and a careful examination of the par-ticular facts of each case is required.Deputy v. du Pont, 308 U.S. 488, 496(1940), quoting Welch v. Helvering, 290U.S. 111, 114 (1933). To determinewhether certain costs should be classified ascapital expenditures or as repair and main-tenance expenses, “it is appropriate to con-sider the purpose, the physical nature, andthe effect of the work for which the expen-ditures were made.” American BembergCorp. v. Commissioner, 10 T.C. 361, 376(1948), aff’d, 177 F.2d 200 (6th Cir. 1949).

Any properly performed repair, no mat-ter how routine, could be considered toprolong the useful life and increase thevalue of the property if it is comparedwith the situation existing immediatelyprior to that repair. Consequently, courtshave articulated a number of ways to dis-tinguish between deductible repairs andnon-deductible capital improvements.For example, in Illinois Merchants TrustCo. v. Commissioner, 4 B.T.A. 103, 106(1926), acq., V-2 C.B. 2, the courtexplained that repair and maintenanceexpenses are incurred for the purpose ofkeeping the property in an ordinarily effi-cient operating condition over its probableuseful life for the uses for which the prop-erty was acquired. Capital expenditures,in contrast, are for replacements, alter-ations, improvements, or additions thatappreciably prolong the life of the proper-ty, materially increase its value, or make itadaptable to a different use. In Estate ofWalling v. Commissioner, 373 F.2d 190,192–193 (3rd Cir. 1966), the courtexplained that the relevant distinctionbetween capital improvements and repairsis whether the expenditures were made to“put” or “keep” property in ordinary effi-cient operating condition. In Plainfield-Union Water Co. v. Commissioner, 39T.C. 333, 338 (1962), nonacq. on othergrounds, 1964–2 C.B. 8., the court statedthat if the expenditure merely restores theproperty to the state it was in before thesituation prompting the expenditure aroseand does not make the property morevaluable, more useful, or longer-lived,then such an expenditure is usually con-sidered a deductible repair. In contrast, acapital expenditure is generally consid-

ered to be a more permanent increment inthe longevity, utility, or worth of the prop-erty. The Supreme Court’s decision inINDOPCO Inc. v. Commissioner, 503U.S. 79 (1992) does not affect these gen-eral principles. See Rev. Rul. 94–12,1994–1 C.B. 36; Ingram Industries, Inc. v.Commissioner, T.C.M. 2000–323.

Even if the expenditures include thereplacement of numerous parts of an asset,if the replacements are a relatively minorportion of the physical structure of theasset, or of any of its major parts, such thatthe asset as whole has not gained material-ly in value or useful life, then the costsincurred may be deducted as incidentalrepairs or maintenance expenses. SeeBuckland v. United States, 66 F.Supp. 681,683 (D. Conn. 1946) (costs to replace allwindow sills in factory building weredeductible repairs). See also, e.g., Libby &Blouin Ltd. v. Commissioner, 4 B.T.A. 910(1926) (costs to replace all the tubing insugar evaporator, which were small parts ina large machine, were deductible repairs).The same conclusion is true even if suchminor portion of the asset is replaced withnew and improved materials. See, e.g.,Badger Pipeline v. Commissioner, T.C.M.1997–457 (costs to replace 1,000 feet ofpipeline in a 25-mile section of pipelinewere deductible repairs, regardless ofwhether the new pipe was of better qualityor has a longer life).

If, however, a major component or asubstantial structural part of the asset isreplaced and, as a result, the asset as awhole has increased in value, lifeexpectancy, or use then the costs of thereplacement must be capitalized. See,e.g., Denver & Rio Grande Western R.R.Co. v. Commissioner, 279 F.2d 368 (10thCir. 1960) (costs to replace major portionof a viaduct - all of the floor planks and85-90% of the stringers - were capitalexpenditures); P. Dougherty Co. v.Commissioner, 159 F.2d 269, 272 (4thCir. 1946) (costs to replace entire sternsection of barge with new materials werecapital expenditures); Vanalco Inc. v.Commissioner, T.C.M. 1999-265 (cost toreplace the cell lining, an essential andsubstantial component of the cell, wasrequired to be capitalized); Stark v.Commissioner, T.C.M. 1999-1 (cost toreplace building roof were capital expen-ditures); Rev. Rul. 88–57, 1988–2 C.B.36, modified by Rev. Rul. 94–38, 1994–1

2001–3 I.R.B. 297 January 16, 2001

C.B. 35 (costs to perform major cyclicalrehabilitations on railroad freight traincars as part of a plan of rehabilitation inwhich all of the structural componentswere either reconditioned or replacedwere capital expenditures).

In addition, although the high cost ofthe work performed may be considered indetermining whether an expenditure iscapital in nature, cost alone is not dispos-itive. Compare R.R. Hensler, Inc. v.Commissioner, 73 T.C. 168, 177 (1979),acq. in result, 1980–2 C.B. 1 (the fact thattaxpayer’s expense was large does notchange its character as ordinary);Buckland at 683 (replacements of rela-tively minor proportions of the entirephysical asset constitute repairs evenwhere high in cost); and AmericanBemberg, 10 T.C. 361 (1948) (deductionallowed for drilling and grouting to pre-vent cave-ins even though the total cost ofthe expenditures exceeded $1.1 million),with Wolfsen Land & Cattle Co. v.Commissioner, 72 T.C. 1, 17 (1979) (coststo dragline an irrigation ditch were capitalexpenditures, in part, because they couldbe as high as the cost to construct a newditch); and Stoeltzing v. Commissioner,266 F.2d 374, 376 (3d Cir. 1959) (expen-ditures could not be incidental repairsbecause they exceeded by almost 200%the cost of the building).

Similarly, the fact that a taxpayer isrequired by a regulatory authority to makecertain repairs or to perform certain main-tenance on an asset in order to continueoperating the asset in its business does notmean that the work performed materiallyincreases the value of such asset, substan-tially prolongs its useful life, or adapts itto a new use. See, e.g., Midland EmpirePacking Co. v. Commissioner, 14 T.C.635 (1950), acq., 1950–2 C.B. 3 (costs ofapplying concrete liner to basement wallsand floors in order to satisfy federal meatinspectors were deductible repairs); L&LMarine Service Inc. v. Commissioner,T.C.M. 1987–428 (work performed onbarges that was necessary to enable thebarges to continue to qualify for sea dutywas a deductible repair).

The characterization of any cost as adeductible repair or capital improvementdepends on the context in which the cost isincurred. Specifically, where an expendi-ture is made as part of a general plan ofrehabilitation, modernization, and improve-

ment of the property, the expenditure mustbe capitalized, even though, standing alone,the item may be classified as one of repairor maintenance. United States v. Wehrli,400 F.2d 686, 689 (10th Cir. 1968).Whether a general plan of rehabilitationexists, and whether a particular repair ormaintenance item is part of it, are questionsof fact to be determined based upon all thesurrounding facts and circumstances,including, but not limited to, the purpose,nature, extent, and value of the work done.Id. at 690. The existence of a written plan,by itself, is not sufficient to trigger the planof rehabilitation doctrine. See Moss v.Commissioner, 831 F.2d 833, 842 (9th Cir.1987); Vanalco v. Commissioner, T.C.M.1999–265.

In general, the courts have applied theplan of rehabilitation doctrine to require ataxpayer to capitalize otherwisedeductible repair and maintenance costswhere the taxpayer has a plan to makesubstantial capital improvements to prop-erty and the repairs are incidental to thatplan. See, e.g., California Casket Co. v.Commissioner, 19 T.C. 32 (1952), acq.,1953–1 C.B. 3 (costs of repairing thefoundation although not in the originalplan became, when undertaken, incidentalto and involved in the plan of completelyrenovating and remodeling an old ware-house building); Stoeltzing at 377 (coststo renovate old building by shoring upfloors; constructing steps, landing andnew driveway; replacing wiring andplumbing; installing new roof; plastering;insulating; performing carpentry work;patching the gutters; and removing rub-bish must be capitalized as part of plan ofrehabilitation); Bank of Houston v.Commissioner, T.C.M. 1960–110 (costsincurred for various repairs incident to thereconstruction and renovation of a bankbuilding must be capitalized as part of ageneral plan of rehabilitation).

On the other hand, the courts and theService have not applied the plan of reha-bilitation doctrine to situations where theplan did not include substantial capitalimprovements and repairs to the sameasset, the plan primarily involved repairand maintenance items, or the work wasperformed merely to keep the property inan ordinarily efficient operating condi-tion. See, e.g., Moss at 840 (repairsincurred in conjunction with a hotelremodeling project not required to be cap-

italized as part of a plan of rehabilitationbecause the project’s capital expenditureswere not of the nature or scope necessaryto trigger the plan of rehabilitation doc-trine); Schroeder v. Commissioner,T.C.M. 1996–336 (costs of renovatingbarns were not required to be capitalizedas part of a plan of rehabilitation wheremost of the renovation costs were repairsand maintenance to keep the barns in anefficient operating condition); Rev. Rul.70–392, 1970–2 C.B. 33 (costs incurredto relocate existing capital assets in orderto install new assets intended to increase autility’s distribution voltage were notrequired to be capitalized as part of a gen-eral plan of rehabilitation because therelocation merely kept the existing assetsin an ordinarily efficient operating condi-tion).

ANALYSIS

In Situation 1, the heavy maintenancevisit on Aircraft 1 primarily involvedinspecting, testing, servicing, repairing,reconditioning, cleaning, stripping, andrepainting numerous airframe parts andcomponents. The heavy maintenancevisit did not involve replacements, alter-ations, improvements, or additions to theairframe that appreciably prolonged itsuseful life, materially increased its value,or adapted it to a new or different use.Rather, the heavy maintenance visit mere-ly kept the airframe in an ordinarily effi-cient operating condition over its antici-pated useful life for the uses for which theproperty was acquired. See IllinoisMerchant Trust Co. at 106; Estate ofWalling at 192–193; Ingram Industries,Inc. at 538–539. The fact that the taxpay-er was required to perform the heavymaintenance visit to maintain its airwor-thiness certificate does not affect thisdetermination. See Midland EmpirePacking at 642.

Although the heavy maintenance visitdid involve the replacement of numerousairframe parts with new parts, none ofthese replacements required the substitu-tion of any (or a significant portion ofany) major components or substantialstructural parts of the airframe so that theairframe as a whole increased in value,life expectancy, or use. CompareBuckland at 683 with P. Dougherty at 272.Thus, the facts in Situation 1 are distin-guishable from those in Rev. Rul. 88–57

January 16, 2001 298 2001–3 I.R.B.

in which all of the structural componentsof a railroad freight car were either recon-ditioned or replaced so that the car wasrestored to a “like new” condition with anew, additional service life of 12 to 14years. Moreover, the heavy maintenancevisit also did not restore the airframe, ormake good exhaustion for which anallowance had been made, within themeaning of § 263(a)(2). In order to havea restoration under § 263(a)(2), muchmore extensive work would have to bedone so as to substantially prolong theuseful life of the airframe. See Denver &Rio Grande at 373. Thus, the costs of theheavy maintenance visit constituteexpenses for incidental repairs and main-tenance under §1.162-4.

Finally, the costs of the heavy mainte-nance visit are not required to be capital-ized under §§ 263 or 263A as part of aplan of rehabilitation, modernization, orimprovement to the airframe. Becausethe heavy maintenance visit involved onlyrepairs for the purpose of keeping the air-frame in an ordinarily efficient operatingcondition, it did not include the type ofsubstantial capital improvements neces-sary to trigger the plan of rehabilitationdoctrine. See Schroeder v. Commissioner,T.C.M. 1996–336; Moss at 842.Accordingly, the costs incurred by X forthe heavy maintenance visit in Situation 1may be deducted as ordinary and neces-sary business expenses under §162.

In Situation 2, in addition to perform-ing all of the work described in Situation1 on Aircraft 2, X replaced all of the skinpanels on the belly of the fuselage andinstalled a cabin smoke and fire detectionand suppression system, a ground proxim-ity warning system and an air phone sys-tem. Because the replacement of the skinpanels involved replacing a significantportion of the airframe’s skin panels(which in the aggregate represented a sub-stantial structural part of the airframe)thereby materially adding to the value ofand improving the airframe, the cost ofreplacing the skin panels must be capital-ized. See Vanalco, T.C.M. 1999–265; P.Dougherty at 272. In addition, the addi-tions and upgrades to Aircraft 2 in theform of the fire protection, air phone, andground proximity warning systems mustbe capitalized because they materiallyimproved the airframe. See Phillips andEaston Supply Co. v. Commissioner, 20

T.C 455, 460 (1953). Accordingly, thecosts incurred by X for labor and materi-als allocable to these capital improve-ments must be treated as capital expendi-tures under § 263. Moreover, because theimprovement of property constitutes production within the meaning of § 263A(g)(1), X is required to capitalizeunder § 263A the direct costs and a prop-er share of the allocable indirect costsassociated with these improvements.

Further, the mere fact that these capitalimprovements were made at the sametime that the work described in Situation1 was performed on Aircraft 2 does notrequire capitalization of the cost of theheavy maintenance visit under the plan ofrehabilitation doctrine. Whether a gener-al plan of rehabilitation exists is a ques-tion of fact to be determined based on allthe facts and circumstances. See Wehrli at690. X’s plan in Situation 2 was not torehabilitate Aircraft 2, but merely to per-form discrete capital improvements to theairframe. See Moss at 839; Schroeder v.Commissioner, T.C.M. 1996–336; Rev.Rul. 70–392. For this reason, the facts ofSituation 2 are distinguishable from Rev.Rul. 88–57, which involved a major reha-bilitation that constituted a plan of reha-bilitation undertaken near the end of thefreight car’s life for the purpose of restor-ing it to a “like new” condition.Accordingly, the costs of the workdescribed in Situation 1 are not part of ageneral plan of rehabilitation, moderniza-tion, or improvement to the airframe. Thecosts incurred by X for the work per-formed on Aircraft 2 must be allocatedbetween capital improvements, whichmust be capitalized under §§ 263 and263A, and repairs and maintenance,which may be deducted under § 162.

In Situation 3, X is required to capital-ize under § 263 the costs of all the workperformed on Aircraft 3. The work inSituation 3 involved replacements ofmajor components and significant por-tions of substantial structural parts thatmaterially increased the value and sub-stantially prolonged the useful life of theairframe. See P. Dougherty at 272 andRev. Rul. 88–57. In addition, the value ofAircraft 3 was materially increased as aresult of material additions, alterationsand upgrades that enabled X to operateAircraft 3 in an improved way. SeeDominion Resources, 48 F. Supp. 2d 527,

553. In contrast to Situation 1, the exten-siveness of the work performed onAircraft 3 constitutes a restoration withinthe meaning of §263(a)(2). See, e.g.Denver & Rio Grande at 373.

X performed much of the same work onAircraft 3 that would be performed during aheavy maintenance visit (as described inSitutation 1) (“Situation 1-type work”).Although these costs, standing alone, gen-erally are deductible expenses under § 162,in this context, they are incurred as part ofa general plan of rehabilitation, moderniza-tion, and improvement to the airframe ofAircraft 3 and X is required to capitalizeunder §§ 263 and 263A the costs of thatwork. See Wehrli at 689–90. In this situa-tion, X planned to perform substantial capi-tal improvements to upgrade the airframeof Aircraft 3 for the purpose of increasingits reliability and extending its useful life.See Rev. Rul. 88–57. The Situation 1-typework was incidental to X’s plan to upgradeAircraft 3. See California Casket at 38. Theeffect of all the work performed on Aircraft3, including the inspection, repair, andmaintenance items, is to materially increasethe value of the airframe and substantiallyprolong its useful life. Thus, all the workperformed by X on Aircraft 3 is part of ageneral plan of rehabilitation, moderniza-tion, and improvement to the airframe andthe costs associated with this work must becapitalized under § 263. Further, becausethe improvement of the airframe constitutesproduction of property within the meaningof § 263A(g)(1), X is required to capitalizeunder § 263A the direct costs and a propershare of the allocable indirect costs associ-ated with this improvement plan.

The conclusions in this ruling would bethe same whether X transported onlyfreight or only passengers.

HOLDINGS

Costs incurred by a taxpayer to performwork on its aircraft airframe as part of aheavy maintenance visit generally aredeductible as ordinary and necessary busi-ness expenses under § 162. However, costsincurred in conjunction with a heavy main-tenance visit must be capitalized to theextent they materially add to the value of,substantially prolong the useful life of, oradapt the airframe to a new or different use.In addition, costs incurred as part of a planof rehabilitation, modernization, orimprovement must be capitalized.

2001–3 I.R.B. 299 January 16, 2001

APPLICATION

Any change in a taxpayer’s method ofaccounting to conform with this revenue rul-ing is a change in method of accounting towhich the provisions of §§ 446 and 481 andthe regulations thereunder apply. A taxpayerwanting to change its method of accountingto conform with the holding in this revenueruling must follow the automatic change inaccounting method provisions of Rev. Proc.99–49, 1999–2 C.B. 725, provided thechange is made for the first taxable year end-ing after January 16, 2001. However, thescope limitations in section 4.02 of Rev.Proc. 99–49 do not apply unless the taxpay-er’s method of accounting for costs incurredto perform work on its aircraft airframes isan issue pending, within the meaning of sec-tion 6.01(6) of Rev. Proc. 2000–38, 2000–40I.R.B. 310, at the time the Form 3115 is filedwith the national office. If the taxpayer isunder examination, before an appeals office,or before a federal court with respect to anyincome tax issue, the taxpayer must providea copy of the Form 3115, Application forChange in Accounting Method, to the exam-ining agent, appeals officer, or counsel forthe government, as appropriate, at the sametime that it files the copy of the Form 3115with the national office. The Form 3115must contain the name(s) and telephonenumber(s) of the examining agent(s),appeals officer, or counsel for the govern-ment, as appropriate.

EFFECT ON OTHER DOCUMENTS

Rev. Proc. 99–49 is modified and ampli-fied to include the prospective change inaccounting method in the APPENDIX.Rev. Rul. 88–57 is distinguished.

DRAFTING INFORMATION

The principal author of this revenueruling is Merrill D. Feldstein of the Officeof Associate Chief Counsel (Income Taxand Accounting). For further informationregarding this revenue ruling, contact Ms.Feldstein or Beverly Katz at (202) 622-4950 (not a toll-free call).

Section 170.—Charitable, Etc.,Contributions and Gifts

The Service provides inflation adjustments to the“insubstantial benefit” guidelines for calendar year2001. Under the guidelines, a charitable contributionis fully deductible even though the contributor re-

cieves “insubstantial benefits” from the charity. SeeRev. Proc. 2001–13, page 337.

Section 213.—Medical, Dental,Etc., Expenses

The Service provides inflation adjustments to thelimitation on the amount of eligible long-term carepremiums includible in the term “medical care,” fortaxable years beginning in 2001. See Rev. Proc.2001–13, page 337.

Section 220.—Medical SavingsAccounts

The Service provides inflation adjustments to theamounts used to determine whether a health plan is a“high deductible health plan” for purposes of deter-mining whether an individual is eligible for a deduc-tion for cash paid to a medical savings account fortaxable years beginning in 2001. See Rev. Proc.2001–13, page 337.

Section 263.—CapitalExpenditures

26 CFR 1.263 (a)–1: Capital expenditures; ingeneral.

Costs incurred by a taxpayer in conjunction witha heavy maintenance visit on an aircraft airframemust be capitalized to the extent they materially addto the value of, substantially prolong the useful lifeof, or adapt the airframe to a new or different use. Inaddition, costs incurred as part of a plan of rehabili-tation, modernization, or improvement must be capi-talized. See Rev. Rul. 2001–4, page 295.

Section 263A.—Capitalizationand Inclusion in Inventory Costsof Certain Expenses

26 CFR 1.263A–1: Uniform capitalization of costs.

Costs incurred by a taxpayer in conjunction witha heavy maintenance visit on an aircraft airframemust be capitalized to the extent they materially addto the value of, substantially prolong the useful lifeof, or adapt the airframe to a new or different use. Inaddition, costs incurred as part of a plan of rehabili-tation, modernization, or improvement must be capi-talized. See Rev. Rul. 2001–4, page 295.

Section 280G.—GoldenParachute Payments

Federal short-term, mid-term, and long-termrates are set forth for the month of January 2001. SeeRev. Rul. 2001–3, page 319.

Section 355.—Distribution ofStock and Securities of aControlled Coporation

26 CFR 1.355–6: Recognition of gain on certaindistributions of stock or securities in controlledcorporation.

T.D. 8913

DEPARTMENT OF THE TREASURYInternal Revenue Service26 CFR Part 1

Guidance Under Section 355(d);Recognition of Gain on CertainDistributions of Stock orSecurities

AGENCY: Internal Revenue Service(IRS), Treasury.

ACTION: Final regulations.

SUMMARY: This document containsfinal regulations relating to recognition ofgain on certain distributions of stock orsecurities of a controlled corporation.These final regulations affect corpora-tions and their shareholders. These regu-lations reflect the enactment of section355(d) of the Internal Revenue Code bythe Omnibus Budget Reconciliation Actof 1990.

DATES: Effective Date: These regula-tions are effective December 20, 2000.

Applicability Date: These regulationsapply to distributions occurring after De-cember 20, 2000, except they do notapply to distributions occurring pursuantto a written agreement which is (subjectto customary conditions) binding on De-cember 20, 2000, and at all times there-after.

FOR FURTHER INFORMATION CON-TACT: Michael N. Kaibni, (202) 622-7550 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

On May 3, 1999, the IRS and Treasuryissued a notice of proposed rulemaking(REG–106004–98, 1999–1 C.B. 1072) inthe Federal Register (64 F.R. 23554) set-ting forth rules under section 355(d) of theInternal Revenue Code relating to therecognition of gain on certain distribu-tions of stock or securities of a controlled

January 16, 2001 300 2001–3 I.R.B.

corporation. Generally, section 355(d)requires recognition of gain on a distribu-tion of stock or securities of a controlledcorporation (Controlled) (as though theControlled stock or securities were sold tothe distributee at its fair market value) if,immediately after the distribution, anyperson holds disqualified stock of the dis-tributing corporation (Distributing) or ofany distributed Controlled that constitutesa 50 percent or greater interest.Disqualified stock is stock in Distributingacquired by purchase after October 9,1990, and during the five-year period(taking into account section 355(d)(6))ending on the date of distribution (thefive-year period), or Controlled stockeither (1) acquired by purchase during thefive-year period or (2) distributed withrespect to either disqualified Distributingstock or on Distributing securitiesacquired by purchase during the five-yearperiod. No public hearing regarding theseproposed regulations was held. Writtencomments to the notice were received.After consideration of all the comments,the proposed regulations are adopted asrevised by this Treasury decision. Theprincipal revisions are discussed below.

Explanation of Revisions andSummary of Comments

1. Purposes of Section 355(d) NotViolated

Generally, Congress intended section355(d) to prevent taxpayers from usingsection 355 to dispose of subsidiaries insale-like transactions, or to obtain a fairmarket value stepped-up basis for futuredispositions, without incurring a corpo-rate level tax. See H.R. Rep 101–881, at341 (1990). Under proposed§1.355–6(b)(3), section 355(d) does notapply to a distribution that does not vio-late its purposes (the purpose exception).As proposed, the purpose exceptionapplies if the effect of the distribution andany related transaction is that a disquali-fied person neither increases an interest inDistributing or Controlled nor obtains apurchased basis in Controlled stock. Adisqualified person is any person that,immediately after a distribution, holdsdisqualified stock in Distributing orControlled that constitutes a 50 percent orgreater interest (under section 355(d)(4)and proposed §1.355–6(c)). The pro-

posed regulations define purchased basisas basis in Controlled stock that is dis-qualified stock, unless the Controlledstock and the Distributing stock on whichthe Controlled stock is distributed aretreated as acquired by purchase solelyunder the attribution rules of section355(d)(8) and proposed §1.355–6(e)(1).Commentators have expressed concernthat certain distributions of stock maytechnically constitute disqualified distrib-utions under the proposed regulations, yetdo not appear to violate the purposes ofsection 355(d). Section 1.355–6(b)(3)has been expanded and clarified in thefinal regulations to prevent the applicationof section 355(d) in the case of certaintransactions that do not violate its purpos-es. (Under the final regulations, certainreferences to stock include securities.)The revisions are explained below.

a. Technical clarification of disqualifiedperson

The definition of “disqualified person”in the proposed regulations could be readto include persons who hold disqualifiedstock in Distributing or Controlled butwho did not directly or indirectly pur-chase that stock. This could result in cer-tain distributions that should not violatethe purposes of section 355(d) neverthe-less being disqualified distributions. Thefinal regulations clarify that the term “dis-qualified person” includes only a personthat meets that definition because of itsown purchase of “disqualified stock” (orwho receives stock in Controlled withrespect to stock that the person pur-chased).

b. Related transactions

Commentators suggested that some“related acquisitions” of stock inDistributing or Controlled prior to or fol-lowing a distribution should not be takeninto account in determining if the purposerule applies. The IRS and Treasury agreethat in many cases a related acquisitionthat increases a disqualified person’sinterest in Distributing or Controlledshould not be taken into account. In addi-tion, the IRS and Treasury are concernedthat the proposed regulations could beinterpreted to allow taxpayers, by relyingon certain other related transactions, toavoid section 355(d) inappropriately,

where a distribution of stock, if viewedindependently, would constitute a disqual-ified distribution. For example, where adistribution of Controlled stock to aDistributing shareholder constitutes a dis-qualified distribution, a subsequent butrelated distribution of that stock shouldnot have the effect of “cleansing” the priordisqualified distribution. Based on theseconcerns, and a belief that other provi-sions of the final regulations will ade-quately address the effect of related trans-actions (e.g., the anti-avoidanceprovision, §1.355–6(b)(4)), the final regu-lations remove the reference to relatedtransactions in the purpose rule.

c. Fractional shares

Some commentators requested that deminimis increases in interest in the stockof Distributing or Controlled should bedisregarded in determining whether thepurpose rule applies. The final regula-tions provide that an issuance of cash inlieu of fractional shares is disregarded inapplying the purpose exception.

2. Disqualified Stock

Generally, under the proposed regula-tions, disqualified stock is any stock inDistributing or Controlled acquired bypurchase during the five-year period andany Controlled stock received in a distrib-ution to the extent attributable to distribu-tions on any stock in Distributingacquired by purchase during the five-yearperiod. The definition of disqualifiedstock has been modified in the final regu-lations. The final regulations provide thatstock of Distributing or Controlled that isacquired by a purchase within the five-year period (including such stock treatedas indirectly acquired by purchase undersection 355(d)(8) or §1.355–6(e)(1), (2),(3) or (4) of the final regulations) ceasesto be acquired by that purchase if the basisresulting from the purchase is eliminated.Basis in the stock of a corporation (or inan interest in another entity) is eliminatedif (and when) it would no longer be takeninto account by any person in determininggain or loss on a sale or exchange of anystock of such corporation (or an interest inthe other entity). Basis is not eliminated,however, if it is allocated between stockof two corporations under §1.358–2(a).

For example, under the proposed regu-lations, a direct purchase by Distributing

2001–3 I.R.B. 301 January 16, 2001

of all of the stock in Controlled, followedby a distribution of the Controlled corpo-ration stock is a disqualified distribution.Under the final regulations, because thedistribution of Controlled will result in anelimination of the basis that resulted fromDistributing’s purchase of Controlledstock, the Controlled stock would nolonger be treated as purchased. TheControlled stock is therefore not disquali-fied stock and the distribution ofControlled would not be a disqualifieddistribution. Further, any purchases ofstock of lower tier subsidiaries ofControlled that arise under section355(d)(8) as a result of Distributing’s pur-chase of Controlled also would cease tobe treated as purchased whenDistributing’s basis in Controlled is elim-inated. Thus, in the example above, ifControlled has a subsidiary that wouldhave been deemed purchased byDistributing when Distributing purchasedthe Controlled stock, the stock of that sub-sidiary would cease to be treated as pur-chased when Distributing’s basis inControlled is eliminated.

In general, basis of stock resulting from apurchase also is treated as eliminated if suchstock is transferred to another person in anexchange or other transfer to which§1.355–6(e)(2) or (3) (relating to carryoverbasis and exchange basis transactions)applies. The elimination of basis as a resultof the transfer, however, does not affect thedeemed purchase under §1.355–6(e)(2) or(3) that arises as a result of the transfer.Thus, for example, if Apurchases Controlledstock and subsequently transfers that stock toDistributing in a reorganization qualifyingunder section 368(a)(1)(B) in exchange forDistributing stock, A’s basis in Controlled iseliminated. Under §1.355–6(e)(3), A isdeemed to purchase the Distributing stockon the date Apurchased the Controlled stock.The elimination of A’s basis in Controlleddoes not affect A’s deemed purchase of itsstock in Distributing (i.e., A’s exchangedbasis in its Distributing stock resulting fromits deemed purchase of that stock is not elim-inated). Also, Distributing is deemed under§1.355–6(e)(2) to have purchased theControlled stock on the date A purchased theControlled stock. The elimination of A’sbasis in Controlled does not affect thedeemed purchase by Distributing of theControlled stock (i.e., Distributing’s carry-over basis in its Controlled stock resulting

from its deemed purchase of that stock is noteliminated).

Under section 355(d)(3)(b)(ii) and§1.355–6(b)(2)(i)(B)(2), disqualifiedstock includes Controlled stock receivedin exchange for Distributing stockacquired by purchase. In a split-off orsplit-up, the distributee shareholder willexchange its stock in Distributing forControlled stock in an exchange describedin §1.355–6(e)(3). Technically, under thebasis elimination rule, this would causethe Distributing stock held by such share-holder to no longer be treated as “acquiredby purchase” at the time of the distribu-tion. As a result, the distributedControlled stock would not be received inexchange for Distributing stock “acquiredby purchase,” and thus, would not be dis-qualified stock. In order to prevent thisresult, §1.355–(6)(b)(2)(iii)(B)(3) pro-vides that basis resulting from a purchaseof Distributing stock that is exchanged forControlled stock is not eliminatednotwithstanding that §1.355–6(e)(3)applies to the exchange.

The modified definition of disqualifiedstock eliminates the need for the “pur-chased interest no longer held” rule of§1.355–6(b)(3)(iv) of the proposed regu-lations, since transactions that result in thepurchased interest no longer being heldalso will result in an elimination of basis.Accordingly, that paragraph has beendeleted. Examples have been added illus-trating the effect of the changes discussed.

3. Purchase

Section 355(d)(5) provides that, withcertain exceptions, a purchase means anyacquisition, but only if (1) the basis of theproperty acquired in the hands of theacquirer is not determined in whole or inpart by reference to the adjusted basis ofsuch property in the hands of the personfrom whom acquired, or under section1014(a), and (2) the property is notacquired in an exchange to which section351, 354, 355 or 356 applies. The pro-posed regulations follow the statutory def-inition of a purchase and provide exam-ples of both purchase and non-purchaseacquisitions. See §1.355–6(d).

a. Section 338

An example in the proposed regulationsillustrates that if a section 338 election is

made pursuant to an acquisition of stock,the stock acquired is treated as purchasedfor purposes of section 355(d)(5)(A) (See§1.355–6(d)(1)(iii) Example 2). Theexample further illustrates that any stockheld by the acquired target (and deemedsold to new target) also is purchased stock.The final regulations provide that stockacquired in a qualified stock purchase withrespect to which a section 338 election (ora section 338(h)(10) election) is made isnot treated as purchased for purposes ofsection 355(d)(5)(A). However, the finalregulations retain the rule that any stockheld by old target that is treated as pur-chased by new target is treated as acquiredby purchase for purposes of section355(d)(5)(A) (unless a section 338 elec-tion or 338(h)(10) election also is madewith respect to that purchase).

b. Partnerships

Section 1.355–6(d)(2)(v)(A) of the finalregulations clarifies that an acquisition ofstock (or an interest in another entity) by apartner pursuant to the liquidation of apartnership interest is a purchase of thestock (or other interest) acquired at thetime of the liquidation of the partnership.Under §1.355–6(d)(2)(v)(B) of the finalregulations, if the adjusted basis of stock(or an interest in another entity) held by apartnership is increased under section734(b), a proportionate amount of thestock (or other interest) will be treated aspurchased at the time of the basis adjust-ment. The amount purchased is deter-mined by reference to the amount of thebasis adjustment over the fair market valueof the stock (or other interest) at the timeof the adjustment.

c. Transfers of cash, cash items,marketable stock and debt of thetransferor

i. Transferred With Respect to an ActiveTrade or Business

Under section 355(d)(5)(B), a purchaseincludes any acquisition of property in anexchange to which section 351 applies tothe extent the property is acquired inexchange for any cash or cash item, anymarketable stock or security, or any debtof the transferor. The proposed regula-tions provide certain exceptions to pur-chase treatment under section

January 16, 2001 302 2001–3 I.R.B.

355(d)(5)(B). An acquisition of stock inexchange for any cash or cash item, mar-ketable stock or debt of the transferor in asection 351 transaction generally is not apurchase if the transferor transfers theitems as part of an active trade or businessand the transferred items do not exceed thereasonable needs of the trade or business(the active business exception). See§1.355–6(d)(3)(iv). The proposed regula-tions require, in part, that the transfereecontinue the active conduct of the trade orbusiness. Commentators have expressedconcern that this requirement would pre-vent a retransfer of the assets to a lowertier corporation within the same affiliatedgroup. In §1.355–6(d)(3)(iv)(4)(E), thefinal regulations clarify that a transfer ofassets does not fail to meet the active busi-ness exception solely because the transfer-ee transfers the assets to another memberof the transferee’s affiliated group if therequirements for the active businessexception in §1.355–6(d)(3)(iv)(A)(1),(2), (3) and (4) would be met if the trans-feror had transferred the assets directly tothe final transferee.

ii. Transfers Between Members of theSame Affiliated Group

Under the proposed regulations, anacquisition of stock in exchange for anycash or cash item, marketable stock orsecurity, or debt of the transferor in a sec-tion 351 transaction is generally not a pur-chase if the transferor corporation or cor-porations, the transferee corporation(whether formed in the transaction oralready existing), and any distributed con-trolled corporation of the transferee cor-poration are members of the same affiliat-ed group as defined in section 1504(a)before the section 351 transaction (if thetransferee corporation is in existencebefore the transaction). See§1.355–6(d)(3)(v) for additional require-ments. The final regulations clarify thatthe cash or cash item, marketable stock orsecurity, or debt of the transferor that istransferred must not have been acquiredfrom a nonmember in a related transactionin which section 362(a) or (b) applies todetermine the basis in the acquired assets.Examples in the final regulations havebeen modified to reflect this clarification.See §1.355–6(d)(4)(iii) and (d)(5)(iii)illustrating the effects of a forward andreverse triangular merger, respectively.

The final regulations also eliminate therequirement that distributed controlledcorporations be a member of the groupbefore the section 351 transaction.

iii. Certain Section 355 and Section 305Distributions

Under §1.355–6(d)(1)(i)(B) of the pro-posed regulations, stock acquired in a dis-tribution to which section 355 applies,whether in exchange for stock or pro rata,is not a purchase within the meaning ofsection 355(d). The final regulations in§1.355–6(e)(4) modify this rule to pro-vide that if a distributing corporation dis-tributes any stock of a controlled corpora-tion with respect to recently purchaseddistributing stock in a distribution thatqualifies under section 355, the stock isdeemed to be acquired by purchase by thedistributee on the date the distributeeacquired the recently purchased distribut-ing stock. For this purpose, recently pur-chased distributing stock is stock in thedistributing corporation acquired by pur-chase (determined without regard to theattribution rules of section 355(d)(8) and§1.355–6(e)(1)) by the distributee duringthe five-year period with respect to thatdistribution. A similar rule is added withrespect to distributions of stock under sec-tion 305(a) to the extent section 307(a)applies to determine the recipient’s basis.

4. Whether a Person Holds a 50 Percentor Greater Interest

a. Exchanged basis rule and plan orarrangement

Section 1.355–6(c) of the proposed reg-ulations provides rules for determining if aperson holds a 50 percent or greater inter-est in Distributing or Controlled. Undersection 355(d)(7)(B) and §1.355–6(c)(4), iftwo or more persons act pursuant to a planor arrangement with respect to acquisitionsof stock or securities in Distributing orControlled, those persons are treated as oneperson for purposes of section 355(d). Arule has been added to the final regulationsclarifying the application of this rule in thecontext of an exchanged basis transactionwith respect to purchased stock. If two ormore persons do not act pursuant to a planor arrangement with respect to an acquisi-tion of stock in a corporation (the first cor-poration), a subsequent exchange basisacquisition will not result in such persons

being treated as one person, even if theacquisition of the second corporation’sstock is pursuant to a plan or arrangement.An example has been added illustrating theeffect of this rule.

b. Options

Section 1.355–6(c)(3) of the proposedand final regulations generally providesthat options outstanding when the distrib-ution occurs are treated as exercised whenissued or last transferred if two criteria aremet. First, the deemed exercise wouldcause a person to be a disqualified person.Second, immediately after the distribu-tion, taking into account all the facts andcircumstances, it is reasonably certain theoption will be exercised. Commentatorssuggested that the “reasonably certain tobe exercised” test be replaced with a“principal purpose to avoid section355(d)” standard patterned on the regula-tions under section 382. The IRS andTreasury continue to believe, however,that the more objective standard of theproposed regulations is appropriate.

In response to a comment, the final reg-ulations exclude from the definition ofoptions cash settlement options, phantomstock, stock appreciation rights, andnational principal contracts. However, tothe extent that such instruments are exer-cisable into stock, they still would be sub-ject to the deemed exercise rule of thefinal regulations under §1.355–6(c)(3)(v)as an “other instrument that provides forthe right to purchase, issue, redeem, ortransfer stock.” The final regulationshave also added a rule for substitutedoptions treating the substituted option asissued on the date the original option wasissued.

5. Statistical Sampling

Under §1.355–6(f)(1) of the proposedregulations, a distributing corporationmust determine whether a disqualifiedperson holds its stock or the stock of anydistributed controlled corporation. Under§1.355–6(f)(4), a distributing corporationmay, absent actual knowledge with regardto a particular shareholder, presume thatno less-than-five-percent shareholder of acorporation acquired stock or securitiesby purchase during the five-year period.In §1.355–6(f)(5) Example 3, the finalregulations clarify that application of sta-tistical sampling procedures to estimate

2001–3 I.R.B. 303 January 16, 2001

the basis of shares acquired in certainreorganizations does not have the effect ofgiving actual knowledge of a purchase ofstock beyond the sample group.

6. Administrative Remedies

A comment urged the adoption of vari-ous forms of administrative relief fromthe recognition of gain in a disqualifieddistribution. The suggested forms ofrelief included the issuance of private let-ter rulings granting tax free treatment inappropriate cases, gain recognition agree-ments, stock basis waivers, or some com-bination of the above. Section 355(d)applies at a specific time (at the time ofthe disqualified distribution) and requiresDistributing to recognize gain as if it hadsold Controlled at its fair market value atthat time. Accordingly, the IRS andTreasury Department do not believe that itwould be appropriate to adopt any ofthese administrative relief provisions.Basis reduction or gain recognition agree-ments could result in either a completeavoidance or a deferral of gain recogni-tion. Moreover, the IRS and Treasury donot believe that granting exceptions tosection 355(d) by private letter ruling isappropriate. However, the final regula-tions include a new provision stating thatthe Commissioner may provide by guid-ance published in the Internal RevenueBulletin that other distributions are notdisqualified distributions because they donot violate the purposes of section 355(d).

Special Analyses

It has been determined that thisTreasury decision is not a significant reg-ulatory action as defined in ExecutiveOrder 12866. Therefore, a regulatoryassessment is not required. It also hasbeen determined that section 553(b) of theAdministrative Procedure Act (5 U.S.C.chapter 5) does not apply to these regula-tions and, because these regulations donot impose a collection of information onsmall entities, the Regulatory FlexibilityAct (5 U.S.C. chapter 6) does not apply.Therefore, a Regulatory FlexibilityAnalysis is not required. Pursuant to sec-tion 7805(f) of the Internal RevenueCode, these regulations were submitted tothe Chief Counsel for Advocacy of theSmall Business Administration for com-ment on its impact on small business.

Drafting Information

The principal author of these regula-tions is Michael N. Kaibni of the Office ofthe Associate Chief Counsel (Corporate).However, other personnel from the IRSand Treasury Department participated intheir development.

* * * * *

Adoption of Amendments to theRegulations

Accordingly, 26 CFR part 1 is amendedas follows:

PART 1—INCOME TAXES

Paragraph 1. The authority citation forpart 1 is amended by adding an entry innumerical order to read in part as follows:

Authority: 26 U.S.C. 7805 * * *Section 1.355–6 also issued under 26U.S.C. 355(d)(9). * * *

Par. 2. Section 1.355–0 is amended byrevising the section heading, adding intro-ductory text, removing the existing entryfor §1.355–6, and adding new entries for§1.355–6 to read as follows:

§1.355–0 Table of Contents.

To facilitate the use of §§1.355–1through 1.355–6, this section lists the fol-lowing major paragraphs in those sections. * * * * *

§1.355–6 Recognition of gain on certaindistributions of stock or securities incontrolled corporation.

a. Conventions.1. Examples.2. Five-year period.3. Distributing securities.4. Marketable securities.b. General rules and purposes of section355(d).1. Disqualified distributions in general. 2. Disqualified stock.i. In general.ii. Purchase.iii. Exceptions.(A) Purchase eliminated.(B) Deemed purchase eliminated.(C) Elimination of basis.(1) General rule.(2) Special rule for transferred andexchanged basis property.(3) Special rule for Split-offs and Split-

ups.(D) Special rule if basis allocatedbetween two corporations.3. Certain distributions not disqualifieddistributions because purposes of section355(d) not violated.i. In general.ii. Disqualified person.iii. Purchased basis.iv. Increase in interest because paymentof cash in lieu of fractional shares.v. Other exceptions.vi. Examples. 4. Anti-avoidance rule.i. In general.ii. Example.c. Whether a person holds a 50 percentor greater interest.1. In general.2. Valuation.3. Effect of options, warrants, convert-ible obligations, and other similar inter-ests.i. Application. ii. General rule. iii. Options deemed newly issued andsubstituted options.A) Exchange, adjustment, or alterationof existing option.B) Certain compensatory options.C) Substituted options.iv. Effect of treating an option as exer-cised.A) In general. B) Stock purchase agreement or similararrangement. v. Instruments treated as options. vi. Instruments generally not treated asoptions. A) Escrow, pledge, or other securityagreements. B) Compensatory options.(1) General rule.(2) Exception.C) Certain stock conversion features. D) Options exercisable only upon death,disability, mental incompetency, or sepa-ration from service.E) Rights of first refusal. F) Other enumerated instruments. vii. Reasonably certain that the optionwill be exercised.A) In general. B) Stock purchase agreement or similararrangement.viii. Examples. 4. Plan or arrangement.

January 16, 2001 304 2001–3 I.R.B.

i. In general. ii. Understanding. iii. Examples.iv. Exception.(A) Subsequent disposition.(B) Example.d. Purchase.1. In general.i. Definition of purchase under section355(d)(5)(A). ii. Section 355 distributions. iii. Example. 2. Exceptions to definition of purchaseunder section 355(d)(5)(A). i. Acquisition of stock in a transactionwhich includes other property or money.A) Transferors and shareholders oftransferor or distributing corporations.(1) In general. (2) Exception.B) Transferee corporations.(1) In general.(2) Exception. C) Examples. ii. Acquisition of stock in a distributionto which section 305(a) applies. iii. Section 1036(a) exchange.iv. Section 338 elections.(A) In general.(B) Example.(v) Partnership distribution.(A) Section 732(b).(B) Section 734(b).3. Certain section 351 exchanges treatedas purchases.i. In general. A) Treatment of stock received by trans-feror.B) Multiple classes of stock.ii. Cash item, marketable stock.iii. Exception for certain acquisitions.A) In general.B) Example.iv. Exception for assets transferred aspart of an active trade or business.A) In general. B) Active conduct of a trade or business. C) Reasonable needs of the trade orbusiness. D) Consideration of all facts and cir-cumstances. E) Successive transfers.v. Exception for transfer between mem-bers of the same affiliated group.A) In general. B) Examples. 4. Triangular asset reorganizations.

i. Definition. ii. Treatment.iii. Example. 5. Reverse triangular reorganizationsother than triangular asset reorganiza-tions.i. In general.ii. Letter ruling and closing agreement.iii. Example.6. Treatment of group structure changes.i. In general.ii. Adjustments to basis of higher-tiermembers.iii. Example.7. Special rules for triangular asset reor-ganizations, other reverse triangular reor-ganizations, and group structure changes.e. Deemed purchase and timing rules.1. Attribution and aggregation.i. In general. ii. Purchase of additional interest.iii. Purchase between persons treated asone person. iv. Purchase by a person already treatedas holding stock under section355(d)(8)(A).v. Examples. 2. Transferred basis rule.3. Exchanged basis rule.i. In general. ii. Example. (4) Certain section 355 or section 305distributions.(i) Section 355.(ii) Section 305.(5) Substantial diminution of risk.(i) In general.(ii) Property to which suspensionapplies.iii. Risk of loss substantially diminished.iv. Special class of stock.f. Duty to determine stockholders.1. In general.2. Deemed knowledge of contents ofsecurities filings.3. Presumptions as to securities filings.4. Presumption as to less-than-five-per-cent shareholders.5. Examples.g. Effective date.

Par. 3. Section 1.355–6 is revised toread as follows:

§1.355–6 Recognition of gain on certaindistributions of stock or securities in con-trolled corporation—(a) Conventions— (1)Examples. For purposes of the examples inthis section, unless otherwise stated, as-

sume that P, S, T, X, Y, N, HC, D, D1, D2,D3, and C are corporations, A and B are in-dividuals, shareholders are not treated asone person under section 355(d)(7), stockhas been owned for more than five yearsand section 355(d)(6) and paragraph (e)(4)of this section do not apply, no electionunder section 338 (if available) is made,and all transactions described are respectedunder general tax principles, including thestep transaction doctrine. No inferenceshould be drawn from any example as towhether any requirements of section 355other than those of section 355(d), as speci-fied, are satisfied.

(2) Five-year period. For purposes ofthis section, the term five-year periodmeans the five-year period (determinedafter applying section 355(d)(6) and para-graph (e)(4) of this section) ending on thedate of the distribution, but in no eventbeginning earlier than October 10, 1990.

(3) Distributing securities. For pur-poses of determining if stock of any con-trolled corporation received in the distrib-ution is disqualified stock described insection 355(d)(3)(B)(ii)(II) (relating to adistribution of controlled corporationstock on any securities in the distributingcorporation acquired by purchase duringthe five-year period), references in thissection to stock of a corporation that is orbecomes a distributing corporation in-cludes securities of the corporation. Sim-ilarly, a reference to stock in paragraph(c)(4) of this section (relating to a plan orarrangement) includes securities.

(4) Marketable securities. Unless oth-erwise stated, any reference in this sectionto marketable stock includes marketablesecurities.

(b) General rules and purposes of sec-tion 355(d)—(1) Disqualified distribu-tions in general. In the case of a disquali-fied distribution, any stock or securities inthe controlled corporation shall not betreated as qualified property for purposesof section 355(c)(2) or 361(c)(2). In gen-eral, a disqualified distribution is any dis-tribution to which section 355 (or somuch of section 356 as relates thereto) ap-plies if, immediately after the distribu-tion—

(i) Any person holds disqualified stockin the distributing corporation that consti-tutes a 50 percent or greater interest insuch corporation; or

2001–3 I.R.B. 305 January 16, 2001

(ii) Any person holds disqualified stockin the controlled corporation (or, if stockof more than one controlled corporation isdistributed, in any controlled corporation)that constitutes a 50 percent or greater in-terest in such corporation.

(2) Disqualified stock—(i) In general.Disqualified stock is—

(A) Any stock in the distributing corpo-ration acquired by purchase during thefive-year period; and

(B) Any stock in any controlled corpo-ration—

(1) Acquired by purchase during thefive-year period; or

(2) Received in the distribution to theextent attributable to distributions on anystock in the distributing corporation ac-quired by purchase during the five-yearperiod.

(ii) Purchase. For the definition of apurchase for purposes of section 355(d)and this section, see section 355(d)(5) andparagraph (d) of this section.

(iii) Exceptions—(A) Purchase elimi-nated. Stock (or an interest in another en-tity) that is acquired by purchase (includ-ing stock (or another interest) that istreated as acquired by purchase underparagraph (e)(2), (3), or (4) of this sec-tion) ceases to be acquired by that pur-chase if (and when) the basis resultingfrom the purchase is eliminated. For pur-poses of this paragraph (b)(2)(iii), basisresulting from the purchase is basis in thestock (or in an interest in another entity)that is directly purchased during the five-year period or that is treated as acquiredby purchase during such period underparagraph (e)(2), (3), or (4) of this sec-tion.

(B) Deemed purchase eliminated.Stock (or an interest in another entity) thatis deemed purchased under section355(d)(8) or paragraph (e)(1) of this sec-tion shall cease to be treated as purchasedif (and when) the basis resulting from thepurchase that effects the deemed purchaseis eliminated.

(C) Elimination of basis—(1) Generalrule. Basis in the stock of a corporation(or in an interest in another entity) is elim-inated if (and when) it would no longer betaken into account by any person in deter-mining gain or loss on a sale or exchangeof any stock of such corporation (or an in-terest in the other entity). Basis is noteliminated, however, if it is allocated be-

tween stock of two corporations under§1.358–2(a).

(2) Special rule for transferred and ex-changed basis property. Basis of stock(or an interest in another entity) resultingfrom a purchase (the first purchase) iseliminated if (and when) such stock (orother interest) is subsequently transferredto another person in an exchange or othertransfer to which paragraph (e)(2) or (3)of this section applies (the second pur-chase). The elimination of basis in stock(or in another interest) resulting from thefirst purchase, however, does not elimi-nate the basis resulting from the secondpurchase in the stock (or other interest)that is treated as acquired by purchase bythe acquirer in a transaction to whichparagraph (e)(2) of this section applies orby the person making the exchange in atransaction to which paragraph (e)(3) ofthis section applies.

(3) Special rule for Split-offs and Split-ups. Under section 355(d)(3)(B)(ii) andparagraph (b)(2)(i)(B)(2) of this section,disqualified stock includes controlled cor-poration stock received in exchange fordistributing corporation stock acquired bypurchase. Solely for purposes of deter-mining whether controlled corporationstock received in a distribution in ex-change for distributing corporation stockis disqualified stock described in that sec-tion and paragraph immediately after thedistribution, paragraph (b)(2)(iii)(C)(2) ofthis section does not apply to the ex-change to eliminate basis resulting from apurchase of that distributing corporationstock (notwithstanding that paragraph(e)(3) of this section applies to the ex-change).

(D) Special rule if basis allocated be-tween two corporations. If the share-holder of a distributing corporation, pur-suant to §1.358–2, allocates basisresulting from a purchase between thestock of two or more corporations then,following such allocation, the determina-tion of whether such basis has been elimi-nated shall be made separately with re-spect to the stock of each suchcorporation.

(3) Certain distributions not disquali-fied distributions because purposes ofsection 355(d) not violated—(i) In gen-eral. Notwithstanding the provisions ofsection 355(d)(2) and this paragraph (b), adistribution is not a disqualified distribu-

tion if the distribution does not violate thepurposes of section 355(d) as provided inthis paragraph (b)(3). A distribution doesnot violate the purposes of section 355(d)if the effect of the distribution is neither—

(A) To increase ownership (combineddirect and indirect) in the distributing cor-poration or any controlled corporation bya disqualified person; nor

(B) To provide a disqualified personwith a purchased basis in the stock of anycontrolled corporation.

(ii) Disqualified person. A disqualifiedperson is any person (taking into accountsection 355(d)(7) and paragraph (c)(4) ofthis section) that, immediately after a dis-tribution, holds (directly or indirectlyunder section 355(d)(8) and paragraph(e)(1) of this section) disqualified stock inthe distributing corporation or controlledcorporation that—

(A) The person—(1) Acquired by purchase under section

355(d)(5) or (8) and paragraphs (d) and(e) of this section during the five-year pe-riod, or

(2) Received in the distribution to theextent attributable to distributions on anystock in the distributing corporationacquired by purchase under section355(d)(5) or (8) and paragraphs (d) and(e) of this section by that person duringthe five-year period; and

(B) Constitutes a 50 percent or greaterinterest in such corporation (under section355(d)(4) and paragraph (c) of this sec-tion).

(iii) Purchased basis. In general, a pur-chased basis is basis in controlled corpo-ration stock that is disqualified stock.However, basis in controlled corporationstock that is disqualified stock will not betreated as purchased basis if the controlledcorporation stock and any distributingcorporation stock with respect to whichthe controlled corporation stock is distrib-uted are treated as acquired by purchasesolely under the attribution rules of sec-tion 355(d)(8) and paragraph (e)(1) of thissection. The prior sentence will not apply,however, if the distributing corporationstock is treated as acquired by purchaseunder the attribution rules as a result ofthe acquisition of an interest in a partner-ship (the purchased partnership), and fol-lowing the distribution, the controlledcorporation stock is directly held by thepurchased partnership (or a chain of part-

January 16, 2001 306 2001–3 I.R.B.

nerships that includes the purchased part-nership).

(iv) Increase in interest because ofpayment of cash in lieu of fractionalshares. Any increase in direct or indirectownership in the distributing corporationor any controlled corporation by a dis-qualified person because of a payment ofcash in lieu of issuing fractional shareswill be disregarded for purposes of para-graph (b)(3)(i)(A) of this section if thepayment of the cash is solely to avoid theexpense and inconvenience of issuingfractional share interests, and does notrepresent separately bargained for con-sideration.

(v) Other exceptions. The Commissionermay provide by guidance published in theInternal Revenue Bulletin that other distribu-tions are not disqualified distributionsbecause they do not violate the purposes ofsection 355(d).

(vi) Examples. The following exam-ples illustrate this paragraph (b)(3):

Example 1. Stock distributed in spin-off; no pur-chased basis. D owns all of the stock of D1, and D1owns all the stock of C. A purchases 60 percent of theD stock for cash. Within five years of A’s purchase,D1 distributes the C stock to D. A is treated as havingpurchased 60 percent of the stock of both D1 and C onthe date A purchases 60 percent of the D stock underthe attribution rules of section 355(d)(8) and paragraph(e)(1) of this section. The C stock received by D isattributable to a distribution on purchased D1 stockunder section 355(d)(3)(B)(ii). Accordingly, the D1and C stock each is disqualified stock under section355(d)(3) and paragraph (b)(2) of this section, and A isa disqualified person under paragraph (b)(3)(ii) of thissection. However, the purposes of section 355(d)under paragraph (b)(3)(i) of this section are not violat-ed. A did not increase direct or indirect ownership inD1 or C. In addition, D’s basis in the C stock is not apurchased basis under paragraph (b)(3)(iii) of this sec-tion because both the D1 and the C stock are treated asacquired by purchase solely under the attribution rulesof section 355(d)(8) and paragraph (e)(1) of this sec-tion. Accordingly, D1’s distribution of the C stock toD is not a disqualified distribution under section355(d)(2) and paragraph (b)(1) of this section.

Example 2. Stock distributed in spin-off; pur-chased basis. The facts are the same as Example 1,except that D immediately further distributes the Cstock to its shareholders (including A) pro rata. TheD and C stock each is disqualified stock under sec-tion 355(d)(3) and paragraph (b)(2) of this section,and A is a disqualified person under paragraph(b)(3)(ii) of this section. The purposes of section355(d) under paragraph (b)(3)(i) of this section areviolated. A did not increase direct or indirect own-ership in D or C. However, A’s basis in the C stockis a purchased basis under paragraph (b)(3)(iii) ofthis section because the D stock is not treated asacquired by purchase solely under the attributionrules of section 355(d)(8) and paragraph (e)(1) ofthis section. Accordingly, the further distribution is

a disqualified distribution under section 355(d)(2)and paragraph (b)(1) of this section.

Example 3. Stock distributed in split-off withownership increase; purchased basis. The facts arethe same as Example 1, except that D immediatelyfurther distributes the C stock to A in exchange forA’s purchased stock in D. The C stock received byA is attributable to a distribution on purchased Dstock under section 355(d)(3)(B)(ii), and A’s basis inthe C stock is determined by reference to the adjust-ed basis of A’s purchased D stock under paragraph(e)(3) of this section. (Under paragraph(b)(2)(iii)(B)(3) of this section, the basis resultingfrom A’s purchase of D stock is not eliminated sole-ly for purposes of determining if the C stockacquired by A is disqualified stock immediately afterthe distribution, notwithstanding that paragraph(e)(3) of this section applies to the exchange.)Accordingly, the D stock and the C stock each is dis-qualified stock under section 355(d)(3) and para-graph (b)(2) of this section, and A is a disqualifiedperson under paragraph (b)(3)(ii) of this section.The purposes of section 355(d) under paragraph(b)(3)(i) of this section are violated because Aincreased its ownership in C from a 60 percent indi-rect interest to a 100 percent direct interest, andbecause A’s basis in the C stock is a purchased basisunder paragraph (b)(3)(iii) of this section.Accordingly, the further distribution is a disqualifieddistribution under section 355(d)(2) and paragraph(b)(1) of this section.

Example 4. Stock distributed in spin-off; pur-chased basis. D1 owns all the stock of C. D pur-chases all of the stock of D1 for cash. Within fiveyears of D’s purchase of D1, P acquires all of thestock of D1 from D in a section 368(a)(1)(B) reor-ganization that is not a reorganization under section368(a)(1)(A) by reason of section 368(a)(2)(E), andD1 distributes all of its C stock to P. P is treated ashaving acquired the D1 stock by purchase on thedate D acquired it under the transferred basis rule ofsection 355(d)(5)(C) and paragraph (e)(2) of thissection. P is treated as having purchased all of the Cstock on the date D purchased the D1 stock under theattribution rules of section 355(d)(8) and paragraph(e)(1) of this section, and the C stock received by Pis attributable to a distribution on purchased D1stock under section 355(d)(3)(B)(ii). Accordingly,the D1 and C stock each is disqualified stock undersection 355(d)(3) and paragraph (b)(2) of this sec-tion, and P is a disqualified person under paragraph(b)(3)(ii) of this section. The purposes of section355(d) under paragraph (b)(3)(i) of this section areviolated. P did not increase direct or indirect owner-ship in D1 or C. However, P’s basis in the C stockis a purchased basis under paragraph (b)(3)(iii) ofthis section because the D1 stock is not treated asacquired by purchase solely under the attributionrules of section 355(d)(8) and paragraph (e)(1) ofthis section. Accordingly, D1’s distribution of the Cstock to P is a disqualified distribution under section355(d)(2) and paragraph (b)(1) of this section.

Example 5. Stock distributed in split-off withownership increase; no purchased basis. P owns 50percent of the stock of D, the remaining D stock isowned by unrelated persons, D owns all the stock ofC, and A purchases all of the P stock from the Pshareholders. Within five years of A’s purchase, Ddistributes all of the C stock to P in exchange for P’sD stock. A is treated as having purchased 50 percent

of the stock of both D and C on the date A purchas-es the P stock under the attribution rules of section355(d)(8) and paragraph (e)(1) of this section. TheC stock received by P is attributable to a distributionon purchased D stock under section 355(d)(3)(B)(ii).Accordingly, the D stock and the C stock each is dis-qualified stock under section 355(d)(3) and para-graph (b)(2) of this section, and A is a disqualifiedperson under paragraph (b)(3)(ii) of this section. Thepurposes of section 355(d) under paragraph (b)(3)(i)of this section are violated because, even though P’sbasis in the C stock is not a purchased basis underparagraph (b)(3)(iii) of this section, A increased itsdirect or indirect ownership in C from a 50 percentindirect interest to a 100 percent indirect interest.Accordingly, D’s distribution of the C stock to P is adisqualified distribution under section 355(d)(2) andparagraph (b)(1) of this section.

Example 6. Stock distributed in split-off with noownership increase; no purchased basis. A purchas-es all of the stock of T. T later merges into D in asection 368(a)(1)(A) reorganization and Aexchanges its purchased T stock for 60 percent of thestock of D. D owns all of the stock of D1 and D2,D1 and D2 each owns 50 percent of the stock of D3,and D3 owns all of the stock of C. Within five yearsof A’s purchase of the T stock, D3 distributes the Cstock to D1 in exchange for all of D1’s D3 stock. Ais treated as having acquired 60 percent of the Dstock by purchase on the date A purchases the Tstock under paragraph (e)(3) of this section. A istreated as having purchased 60 percent of the stockof D1, D2, D3, and C on the date A purchases the Tstock under the attribution rules of section 355(d)(8)and paragraph (e)(1) of this section. The C stockreceived by D1 is attributable to a distribution onpurchased D3 stock under section 355(d)(3)(B)(ii).Accordingly, the D3 stock and the C stock each isdisqualified stock under section 355(d)(3) and para-graph (b)(2) of this section, and A is a disqualifiedperson under paragraph (b)(3)(ii) of this section.However, the purposes of section 355(d) under para-graph (b)(3)(i) of this section are not violated. A didnot increase direct or indirect ownership in D3 or C,and D1’s basis in the C stock is not a purchased basisunder paragraph (b)(3)(iii) of this section becausethe D3 stock is treated as acquired by purchase sole-ly under the attribution rules of section 355(d)(8)and paragraph (e)(1) of this section. Accordingly,D3’s distribution of the C stock to D1 is not a dis-qualified distribution under section 355(d)(2) andparagraph (b)(1) of this section.

Example 7. Purchased basis eliminated by liqui-dation; stock distributed in spin-off. P owns 30 per-cent of the stock of D, D owns all of the stock of D1,and D1 owns all of the stock of C. P purchases theremaining 70 percent of the D stock for cash. Withinfive years of P’s purchase, P liquidates D in a trans-action qualifying under sections 332 and 337(a), andD1 then distributes the stock of C to P. Prior to theliquidation, P is treated as having purchased 70 per-cent of the stock of D1 and C on the date P purchas-es the D stock under the attribution rules of section355(d)(8)(B) and paragraph (e)(1) of this section.After the liquidation, however, under paragraph(b)(2)(iii) of this section, P is not treated as havingacquired by purchase the D1 or the C stock undersection 355(d)(8)(B) and paragraph (e)(1) of thissection because P’s basis in the D stock is eliminat-ed in the liquidation of D. Under section 334(b)(1),

2001–3 I.R.B. 307 January 16, 2001

P’s basis in the D1 stock is determined by referenceto D’s basis in the D1 stock and not by reference toP’s basis in D. Paragraph (d)(2)(i)(B) of this sectiondoes not treat the D1 stock as newly purchased in P’shands because no gain or loss was recognized by Din the liquidation. Accordingly, neither the D1 stocknor the C stock is disqualified stock under section355(d)(3) and paragraph (b)(2) of this section in P’shands, and the distribution is not a disqualified dis-tribution under section 355(d)(2) and paragraph(b)(1) of this section.

Example 8. Purchased basis eliminated byupstream merger; stock distributed in spin-off. Downs all of the stock of D1, and D1 owns all of thestock of C. P purchases 60 percent of the D stock forcash. Within five years of P’s purchase, D mergesinto P in a section 368(a)(1)(A) reorganization, withthe D shareholders other than P receiving solely Pstock in exchange for their D stock, and D1 then dis-tributes the stock of C to P. Prior to the merger, P istreated as having purchased 60 percent of the stockof D1 and C on the date P purchases the D stockunder the attribution rules of section 355(d)(8) andparagraph (e)(1) of this section. After the merger,however, under paragraph (b)(2)(iii) of this section,P is not treated as having acquired by purchase theD1 or the C stock under section 355(d)(8)(B) andparagraph (e)(1) of this section because P’s basis inthe D stock is eliminated in the merger. Under sec-tion 362(b), P’s basis in the D1 stock is determinedby reference to D’s basis in the D1 stock and not byreference to P’s basis in D. Paragraph (d)(2)(i)(B) ofthis section does not treat the D1 stock as newly pur-chased in P’s hands because no gain or loss was rec-ognized by D in the merger. Accordingly, neither theD1 stock nor the C stock is disqualified stock undersection 355(d)(3) and paragraph (b)(2) of this sec-tion in P’s hands, and the distribution is not a dis-qualified distribution under section 355(d)(2) andparagraph (b)(1) of this section.

Example 9. Purchased basis eliminated by distri-bution; stock distributed in spin-off. A purchases allthe stock of C for cash on Date 1. D acquires all ofthe stock of C from A in a section 368(a)(1)(B) reor-ganization that is not a reorganization under section368(a)(1)(A) by reason of section 368(A)(1)(E). Areceives ten percent of the D stock in the transaction.The remaining D stock is owned by B. Within fiveyears of A’s purchase of the C stock, D distributes allthe stock of C pro rata to A and B. Under the trans-ferred basis rule of paragraph (e)(2) of this section,D is treated as having purchased all of the C stock onthe date A acquired it. Under the exchanged basisrule of paragraph (e)(3) of this section, A is treatedas having purchased its D stock on Date 1 and A istreated as having purchased ten percent of the Cstock on Date 1 under the attribution rules of section355(d)(8) and paragraph (e)(3) of this section.Moreover, under paragraph (b)(2)(iii)(C) of this sec-tion, A’s basis in the C stock resulting from A’s Date1 purchase of C stock is eliminated. After the distri-bution, A’s and B’s bases in their C stock are deter-mined by reference to the bases of their D stockunder §1.358–2(a)(2) (and not by reference to D’sbasis in the C stock). D’s basis in the stock of Cresulting from its deemed purchase of that stockunder paragraph (e)(2) of this section is eliminatedby the distribution of the C stock because it wouldno longer be taken into account by any person indetermining gain or loss on the sale of C stock.

Therefore, the C stock distributed to A and B is notdisqualified stock as a result of D’s purchase of C.However, A’s basis in its D stock resulting from itsdeemed purchase of that stock under paragraph(e)(3) of this section is not eliminated. Therefore,A’s ten percent interest in the stock of D is disquali-fied stock. Furthermore, A’s ten percent interest inthe stock of C is disqualified stock because the dis-tribution of the C stock is attributable to A’s D stockthat was acquired by purchase. However, there hasnot been a disqualified distribution because no per-son, immediately after the distribution, holds dis-qualified stock in either D or C that constitutes a 50percent or greater interest in such corporation.

Example 10. Allocation of purchased basis ana-lyzed separately. (i) P owns all the stock of D. Dpurchases all the stock of D1 for cash on Date 1. D1owns all the stock of C (which owns all the stock ofC1) and S. Within five years of Date 1, D1 distrib-utes all the stock of C to D. The D1 and C stock eachis disqualified stock under section 355(d)(3) andparagraph (b)(2) of this section, and D is a disquali-fied person under paragraph (b)(3)(ii) of this section.The purposes of section 355(d) under paragraph(b)(3)(i) of this section are violated. D did notincrease direct or indirect ownership in D1 or C.However, D’s basis in the C stock is a purchasedbasis under paragraph (b)(3)(iii) of this sectionbecause the D1 stock is not treated as acquired bypurchase solely under the attribution rules of section355(d)(8) and paragraph (e)(1) of this section.Accordingly, the distribution is a disqualified distri-bution under section 355(d) and paragraph (b)(1) ofthis section. D’s basis in the D1 stock is allocatedpursuant to §1.358–2 between the D1 stock and theC stock. Therefore, under paragraph (e)(4) of thissection, the C stock is deemed to be acquired by pur-chase on Date 1, the date D purchased all the stockof D1. If thereafter, and within five years of Date 1,C were to distribute all the stock of C1 to D, that dis-tribution would also be a disqualified distributionbecause of D’s deemed purchase of the stock of C.

(ii) Following the distribution of the stock of C byD1, and within five years of Date 1, D distributes allthe stock of D1 to P. Under paragraph (b)(2)(iii)(D)of this section, the determination of whether D’sbasis in D1 has been eliminated shall be made with-out regard to D’s allocated basis in C. After the dis-tribution, P’s basis in the D1 stock is determined byreference to its basis in its D stock under§1.358–2(a)(2) (and not by reference to D’s basis inthe D1 stock). D’s basis in the D1 stock resultingfrom the purchase of that stock is eliminated by thedistribution of the D1 stock because it would nolonger be taken into account by any person in deter-mining gain or loss on the sale of D1 stock.Therefore, the D1 stock distributed to P is not dis-qualified stock as a result of D’s purchase of D1.Moreover, a subsequent distribution of the S stockby D1 to P would not be a disqualified distributionbecause both the D1 and S stock would cease to betreated as purchased when D’s basis in D1 has beeneliminated.

(4) Anti-avoidance rule—(i) In general.Notwithstanding any provision of section355(d) or this section, the Commissionermay treat any distribution as a disqualifieddistribution under section 355(d)(2) andparagraph (b)(1) of this section if the distri-

bution or another transaction or transactionsare engaged in or structured with a principalpurpose to avoid the purposes of section355(d) or this section with respect to thedistribution. Without limiting the preced-ing sentence, the Commissioner may deter-mine that the existence of a related person,intermediary, pass-through entity, or similarperson (an intermediary) should be disre-garded, in whole or in part, if the interme-diary is formed or availed of with a princi-pal purpose to avoid the purposes of section355(d) or this section.

(ii) Example. The following exampleillustrates this paragraph (b)(4):

Example. Post-distribution redemption. B whol-ly owns D, which wholly owns C. With a principalpurpose to avoid the purposes of section 355(d), A,B, D, and C engage in the following transactions. Apurchases 45 of 100 shares of the only class of Dstock. Within five years after A’s purchase, D dis-tributes all of its 100 shares in C to A and B pro rata.D then redeems 20 shares of B’s D stock, and Credeems 20 shares of B’s C stock. After the redemp-tion, A owns 45 shares and B owns 35 shares in eachof D and C. Under paragraph (b)(4)(i) of this sec-tion, the Commissioner may treat A as owning dis-qualified stock in D and C that constitutes a 50 per-cent or greater interest in D and C immediately afterthe distribution. Under that treatment, the distribu-tion is a disqualified distribution under section355(d)(2) and paragraph (b)(1) of this section.

(c) Whether a person holds a 50 per-cent or greater interest—(1) In general.Under section 355(d)(4), 50 percent orgreater interest means stock possessing atleast 50 percent of the total combined vot-ing power of all classes of stock entitledto vote or at least 50 percent of the totalvalue of shares of all classes of stock.

(2) Valuation. For purposes of section355(d)(4) and this section, all shares ofstock within a single class are consideredto have the same value. But see paragraph(c)(3)(vii)(A) of this section (determina-tion of whether it is reasonably certainthat an option will be exercised).

(3) Effect of options, warrants, convert-ible obligations, and other similar inter-ests—(i) Application. This paragraph(c)(3) provides rules to determine whenan option is treated as exercised for pur-poses of section 355(d) (other than section355(d)(6)). Except as provided in thisparagraph (c)(3), an option is not treatedas exercised for purposes of section355(d). This paragraph (c)(3) does notaffect the determination of whether aninstrument is an option or stock undergeneral principles of tax law (such as sub-stance over form).

January 16, 2001 308 2001–3 I.R.B.

(ii) General rule. In determiningwhether a person has acquired by pur-chase a 50 percent or greater interestunder section 355(d)(4), an option toacquire stock (as described in paragraphs(c)(3)(v) and (vi) of this section) that hasnot been exercised when a distributionoccurs is treated as exercised on the dateit was issued or most recently transferredif—

(A) Its exercise (whether by itself or inconjunction with the deemed exercise ofone or more other options) would cause aperson to become a disqualified person;and

(B) Immediately after the distribution,it is reasonably certain (as described inparagraph (c)(3)(vii) of this section) thatthe option will be exercised.

(iii) Options deemed newly issued andsubstituted options—(A) Exchange,adjustment, or alteration of existingoption. For purposes of this paragraph(c)(3), each of the following is treated as anew issuance or transfer of an existingoption only if it materially increases thelikelihood that an option will be exer-cised—

(1) An exchange of an option for anoth-er option or options;

(2) An adjustment to the terms of anoption (including an adjustment pursuantto the terms of the option);

(3) An adjustment to the terms of theunderlying stock (including an adjustmentpursuant to the terms of the stock);

(4) A change to the capital structure ofthe issuing corporation; and

(5) An alteration to the fair marketvalue of issuing corporation stock throughan asset transfer (other than regular, ordi-nary dividends) or through any othermeans.

(B) Certain compensatory options. Anoption described in paragraph(c)(3)(vi)(B)(2) of this section is treatedas issued on the date it becomes transfer-able.

(C) Substituted options. If an option(existing option) is exchanged for anotheroption or options (substituted option oroptions) and paragraph (c)(3)(iii)(A) ofthis section does not apply to treat suchexchange as a new issuance or transfer ofthe existing option, the substituted optionor options will be treated as issued ormost recently transferred on the date that

the existing option was issued or mostrecently transferred.

(iv) Effect of treating an option as exer-cised—(A) In general. For purposes ofsection 355(d), an option that is treated asexercised under this paragraph (c)(3) istreated as exercised both for purposes ofdetermining the percentage of the votingpower of stock owned by the holder and forpurposes of determining the percentage ofthe value of stock owned by the holder.

(B) Stock purchase agreement or simi-lar arrangement. If a stock purchaseagreement or similar arrangement isdeemed exercised, the purchaser is treatedas having purchased the stock under theterms of the agreement or arrangement asthough all covenants had been satisfiedand all contingencies met. The agreementor arrangement is deemed to have beenexercised as of the date it is entered into ormost recently assigned.

(v) Instruments treated as options. Forpurposes of this paragraph (c)(3), exceptto the extent provided in paragraph(c)(3)(vi) of this section, the following aretreated as options: A call option, warrant,convertible obligation, the conversionfeature of convertible stock, put option,redemption agreement (including a rightto cause the redemption of stock), notion-al principal contract (as defined in§1.446–3(c)) that provides for the pay-ment of amounts in stock, stock purchaseagreement or similar arrangement, or anyother instrument that provides for theright to purchase, issue, redeem, or trans-fer stock (including an option on anoption).

(vi) Instruments generally not treated asoptions. For purposes of this paragraph(c)(3), the following are not treated asoptions, unless issued, transferred, or listedwith a principal purpose to avoid the appli-cation of section 355(d) or this section:

(A) Escrow, pledge, or other securityagreements. An option that is part of asecurity arrangement in a typical lendingtransaction (including a purchase moneyloan), if the arrangement is subject to cus-tomary commercial conditions. For thispurpose, a security arrangement includes,for example, an agreement for holdingstock in escrow or under a pledge or othersecurity agreement, or an option toacquire stock contingent upon a defaultunder a loan.

(B) Compensatory options—(1)General rule. An option to acquire stockin a corporation with customary terms andconditions, provided to an employee,director, or independent contractor in con-nection with the performance of servicesfor the corporation or a person related to itunder section 355(d)(7)(A) (and that isnot excessive by reference to the servicesperformed) and that—

(i) Is nontransferable within the mean-ing of §1.83–3(d); and

(ii) Does not have a readily ascertain-able fair market value as defined in§1.83–7(b).

(2) Exception. Paragraph (c)(3)(vi)-(B)(1) of this section ceases to apply to anoption that becomes transferable.

(C) Certain stock conversion features.The conversion feature of convertiblestock, provided that—

(1) The stock is not convertible for atleast five years after issuance or transfer;and

(2) The terms of the conversion featuredo not require the tender of any consider-ation other than the stock being converted.

(D) Options exercisable only upondeath, disability, mental incompetency, orseparation from service. Any optionentered into between stockholders of acorporation (or a stockholder and the cor-poration) with respect to the stock ofeither stockholder that is exercisable onlyupon the death, disability, mental incom-petency of the stockholder, or, in the caseof stock acquired in connection with theperformance of services for the corpora-tion or a person related to it under section355(d)(7)(A) (and that is not excessive byreference to the services performed), thestockholder’s separation from service.

(E) Rights of first refusal. A bona fideright of first refusal regarding the corpo-ration’s stock with customary terms,entered into between stockholders of acorporation (or between the corporationand a stockholder).

(F) Other enumerated instruments.Any other instruments specified in regula-tions, a revenue ruling, or a revenue pro-cedure. See §601.601(d)(2) of this chap-ter.

(vii) Reasonably certain that the optionwill be exercised—(A) In general. Thedetermination of whether, immediatelyafter the distribution, an option is reason-

2001–3 I.R.B. 309 January 16, 2001

ably certain to be exercised is based on allthe facts and circumstances. In applyingthe previous sentence, the fair marketvalue of stock underlying an option isdetermined by taking into account controlpremiums and minority and blockage dis-counts.

(B) Stock purchase agreement or simi-lar arrangement. A stock purchase agree-ment or similar arrangement is treated asreasonably certain to be exercised if theparties’ obligations to complete the trans-action are subject only to reasonable clos-ing conditions.

(viii) Examples. The following exam-ples illustrate this paragraph (c)(3):

Example 1. D owns all of the stock of C. A pur-chases 40 percent of D’s only class of stock and anoption to purchase D stock from D, that if deemedexercised, would result in A owning a total of 60 per-cent of the stock of D. Assume that no control pre-mium or minority or blockage discount applies to theD stock underlying the option. The option permits Ato acquire the D stock at $30 per share, and D’s stockhas a fair market value of $27 per share on the datethe option is issued. The option is subject to no con-tingencies or restrictive covenants, may be exercisedwithin five years after its issuance, and is notdescribed in paragraph (c)(3)(vi) of this section(regarding instruments generally not treated asoptions). Within five years of A’s purchase of the Dstock and option, D distributes the stock of its sub-sidiary C pro rata and A receives 40 percent of the Cstock in the distribution. Immediately after the dis-tribution, D’s stock has a fair market value of $30per share and C’s stock has a fair market value of$15 per share. At the time of the distribution, Aexchanges A’s option for an option to purchase 20percent of the D stock at $20 per share and an optionto purchase 20 percent of the C stock at $10 pershare. The exchange of the options in D for optionsin D and C did not materially increase the likelihoodthat the options would be exercised. Nonetheless,based on all the facts and circumstances, it is rea-sonably certain, immediately after the distribution,that A will exercise its options. Under paragraph(c)(3)(iii)(C) of this section, the substituted optionsare treated as issued on the date the original optionwas issued. Accordingly, the options are treated asexercised by A on the date that A purchased the orig-inal option. A is treated as owning 60 percent of theD stock and 60 percent of the C stock that is dis-qualified stock, and the distribution is a disqualifieddistribution under section 355(d)(2) and paragraph(b)(1) of this section.

Example 2. D owns all of the stock of C. A pur-chases 37 percent of D’s only class of stock. B owns38 percent of the D stock, and the remaining 25 per-cent is owned by 20 individuals, each of whom ownsless than five percent of D’s stock. A purchases anoption to purchase an additional 14 percent of the Dstock from shareholders other than B for $50 pershare. The option is subject to no contingencies orrestrictive covenants, may be exercised within fiveyears after its issuance, and is not described in para-graph (c)(3)(vi) of this section. Within five years ofA’s purchase of the option and 37 percent interest in

D, D distributes the stock of its subsidiary C pro rataand A receives 37 percent of the C stock in the dis-tribution. At the time of the distribution, Aexchanges its option for an option to purchase 14percent of the D stock at $25 per share and an optionto purchase 14 percent of the C stock at $25 pershare. Assume that, although a shareholder thatowned no D or C stock would pay only $20 per sharefor D or C stock immediately after the distribution, ashareholder in A’s position would pay $30 per sharefor 14 percent of the stock of D or C because of thecontrol premium which attaches to the shares. Thecontrol premium is taken into account under para-graph (c)(3)(vii)(A) of this section to determinewhether A is reasonably certain to exercise theoptions. The exchange of the options in D foroptions in D and C did not materially increase thelikelihood that the options would be exercised.Nonetheless, based on all the facts and circum-stances, it is reasonably certain, immediately afterthe distribution, that A will exercise its options.Under paragraph (c)(3)(iii)(C) of this section, thesubstituted options are treated as issued on the datethe original option was issued. Accordingly, theoptions are treated as exercised by A on the date thatA purchased the original option. Under paragraph(c)(2) of this section, all shares of D and C are con-sidered to have the same value to determine theamount of stock A is treated as purchasing under theoptions. A is treated as owning 51 percent of the Dstock and 51 percent of the C stock that is disquali-fied stock, and the distribution is a disqualified dis-tribution under section 355(d)(2).

(4) Plan or arrangement—(i) In gener-al. Under section 355(d)(7)(B), if two ormore persons act pursuant to a plan orarrangement with respect to acquisitionsof stock in the distributing corporation orcontrolled corporation, those persons aretreated as one person for purposes of sec-tion 355(d).

(ii) Understanding. For purposes ofsection 355(d)(7)(B), two or more per-sons who are (or will after an acquisitionbecome) shareholders (or are treated asshareholders under paragraph (c)(3)(ii) ofthis section) act pursuant to a plan orarrangement with respect to an acquisi-tion of stock only if they have a formal orinformal understanding among them-selves to make a coordinated acquisitionof stock. A principal element in deter-mining if such an understanding exists iswhether the investment decision of eachperson is based on the investment deci-sion of one or more other existing orprospective shareholders. However, theparticipation by creditors in formulating aplan for an insolvency workout or a reor-ganization in a title 11 or similar case(whether as members of a creditors’ com-mittee or otherwise) and the receipt ofstock by creditors in satisfaction ofindebtedness pursuant to the workout or

reorganization do not cause the creditorsto be considered as acting pursuant to aplan or arrangement.

(iii) Examples. The following exam-ples illustrate paragraph (c)(4)(ii) of thissection:

Example 1. D has 1,000 shares of common stockoutstanding. A group of 20 unrelated individualswho previously owned no D stock (the Group) agreeamong themselves to acquire 50 percent or more ofD’s stock. The Group is not a person under section7701(a)(1). Subsequently, pursuant to their under-standing, the members of the Group purchase 600shares of D common stock from the existing Dshareholders (a total of 60 percent of the D stock),with each member purchasing 30 shares. Underparagraph (c)(4)(ii) of this section, the members ofthe Group have a formal or informal understandingamong themselves to make a coordinated acquisitionof stock. Their interests are therefore aggregatedunder section 355(d)(7)(B), and they are treated asone person that purchased 600 shares of D’s stockfor purposes of section 355(d).

Example 2. D has 1,000 shares of outstandingstock owned by unrelated individuals. D’s manage-ment is concerned that D may become subject to atakeover bid. In separate meetings, D’s managementmeets with potential investors who own no stock andare friendly to management to convince them toacquire D’s stock based on an understanding that Dwill assemble a group that in the aggregate willacquire more than 50 percent of D’s stock.Subsequently, 15 of these investors each purchasesfour percent of D’s outstanding stock. Under para-graph (c)(4)(ii) of this section, the 15 investors havea formal or informal understanding among them-selves to make a coordinated acquisition of stock.Their interests are therefore aggregated under sec-tion 355(d)(7)(B), and they are treated as one personthat purchased 600 shares of D stock for purposes ofsection 355(d).

Example 3. (i) D has 1,000 shares of outstandingstock owned by unrelated individuals. An invest-ment advisor advises its clients that it believes D’sstock is undervalued and recommends that theyacquire D stock. Acting on the investment advisor’srecommendation, 20 unrelated individuals each pur-chases 30 shares of the outstanding D stock. Eachclient’s decision was not based on the investmentdecisions made by one or more other clients.Because there is no formal or informal understand-ing among the clients to make a coordinated acquisi-tion of D stock, their interests are not aggregatedunder section 355(d)(7)(B) and they are treated asmaking separate purchases.

(ii) The facts are the same as in paragraph (i) ofthis Example 3, except that the investment advisor isalso the underwriter (without regard to whether it isa firm commitment or best efforts underwriting) fora primary or secondary offering of D stock. Theresult is the same.

(iii) The facts are the same as in paragraph (i) ofthis Example 3, except that, instead of an investmentadvisor recommending that clients purchase D stock,the trustee of several trusts qualified under section401(a) sponsored by unrelated corporations causeseach trust to purchase the D stock. The result is thesame, provided that the trustee’s investment decisionmade on behalf of each trust was not based on the

January 16, 2001 310 2001–3 I.R.B.

investment decision made on behalf of one or moreof the other trusts.

(iv) Exception—(A) Subsequent dispo-sition. If two or more persons do not actpursuant to a plan or arrangement withinthe meaning of this paragraph (c)(4) withrespect to an acquisition of stock in a cor-poration (the first corporation), a subse-quent acquisition in which such personsexchange their stock in the first corpora-tion for stock in another corporation (thesecond corporation) in a transaction inwhich the basis of the second corpora-tion’s stock in the hands of such personsis determined in whole or in part by ref-erence to the basis of their stock in thefirst corporation, will not result in suchpersons being treated as one person, evenif the acquisition of the second corpora-tion’s stock is pursuant to a plan orarrangement.

(B) Example. The following exampleillustrates this paragraph (c)(4)(iv):

Example. In an initial public offering of D stockon Date 1, 100 investors independently purchase onepercent each of the D stock. Two years later, Dmerges into P (in a reorganization described in sec-tion 368(a)(1)(A)) and, pursuant to the plan of reor-ganization, the D shareholders exchange their Dstock for 50 percent of the stock of P. The D share-holders approve the plan by a two-thirds vote, asrequired by state law. Under section 358(a), eachshareholder’s basis in its P stock is determined byreference to the basis of the D stock it purchased.Under paragraph (e)(3) of this section, the former Dshareholders are treated as purchasing their P stockon Date 1. The investors do not become a single per-son under paragraph (c)(4) of this section withrespect to the deemed purchase of the P stock onDate 1 by virtue of their acquisition of the P stockpursuant to the merger on Date 2.

(d) Purchase—(1) In general—(i)Definition of purchase under section355(d)(5)(A). Under section 355(d)–(5)-(A), except as otherwise provided in sec-tion 355(d)(5)(B) and (C), a purchasemeans any acquisition, but only if—

(A) The basis of the property acquiredin the hands of the acquirer is not deter-mined—

(1) In whole or in part by reference to theadjusted basis of such property in the handsof the person from whom acquired; or

(2) Under section 1014(a); and (B) The property is not acquired in an

exchange to which section 351, 354, 355,or 356 applies.

(ii) Section 355 distributions.Paragraph (d)(1)(i)(B) of this sectionincludes all section 355 distributions,whether in exchange (in whole or in part)for stock or pro rata.

(iii) Example. The following exampleillustrates this paragraph (d)(1):

Example. Section 304(a)(1) acquisition. A, whoowns all of the stock of P and T, sells the T stock toP for cash. The T stock is not marketable stockunder section 355(d)(5)(B)(ii) and paragraph(d)(3)(ii) of this section. A is treated under section304(a)(1) as receiving a distribution in redemptionof the P stock. Under section 302(d), the deemedredemption is treated as a section 301 distribution.Assume that under sections 304(b)(2) and 301(c)(1),all of the distribution is a dividend. A and P are treat-ed in the same manner as if A had transferred the Tstock to P in exchange for stock of P in a transactionto which section 351(a) applies, and P had thenredeemed the stock P was treated as issuing in thetransaction. Under section 362(a), P’s basis in the Tstock is determined by reference to A’s adjustedbasis in the T stock, and there is no basis increase inthe T stock because A recognizes no gain on thedeemed transfer. Accordingly, P’s acquisition of theT stock from A is not a purchase by P under section355(d)(5)(A)(i)(I) and paragraphs (d)(1)(i)(A)(1)and (d)(2)(i)(B) of this section.

(2) Exceptions to definition of purchaseunder section 355(d)(5)(A). The follow-ing acquisitions are not treated as pur-chases under section 355(d)(5)(A):

(i) Acquisition of stock in a transactionwhich includes other property or money—(A) Transferors and shareholders oftransferor or distributing corporations—(1) In general. An acquisition of stockpermitted to be received by a transferor ofproperty without the recognition of gainunder section 351(a), or permitted to bereceived without the recognition of gainunder section 354, 355, or 356 is not apurchase to the extent section 358(a)(1)applies to determine the recipient’s basisin the stock received, whether or not therecipient recognizes gain under section351(b) or 356. But see paragraph (e)(3) ofthis section (interest received in exchangefor purchased interest in exchanged basistransaction treated as purchased).

(2) Exception. To the extent there isreceived in the exchange or distribution,in addition to stock described in para-graph (d)(2)(i)(A)(1) of this section, stockthat is other property under section 351(b)or 356(a)(1), the stock is treated as pur-chased on the date of the exchange or dis-tribution for purposes of section 355(d).

(B) Transferee corporations—(1) In gen-eral. An acquisition of stock by a corpora-tion is not a purchase to the extent section334(b) or 362(a) or (b) applies to determinethe corporation’s basis in the stockreceived. But see section 355(d)(5)(C) andparagraph (e)(2) of this section (purchasedproperty transferred in transferred basis

transaction is treated as purchased by trans-feree).

(2) Exception. If a corporation acquiresstock, the stock is treated as purchased onthe date of the stock acquisition for pur-poses of section 355(d)—

(i) If the liquidating corporation recog-nizes gain or loss with respect to the trans-ferred stock as described in section334(b)(1); or

(ii) To the extent the basis of the trans-ferred stock is increased through therecognition of gain by the transferor undersection 362(a) or (b).

(C) Examples. The following examplesillustrate this paragraph (d)(2)(i):

Example 1. (i) A owns all the stock of T. Tmerges into D in a transaction qualifying under sec-tion 368(a)(1)(A), with A exchanging all of the Tstock for D stock and $100 cash. Under section356(a)(1), A recognizes $100 of the realized gain onthe transaction. Under section 358(a)(1), A’s basis inthe D stock equals A’s basis in the T stock, decreasedby the $100 received and increased by the gain rec-ognized, also $100. Under paragraph (d)(2)(i)(A) ofthis section, A is not treated as having purchased theD stock for purposes of section 355(d)(5).

(ii) The facts are the same as in paragraph (i) ofthis Example 1, except that rather than D stock and$100 cash, A receives D stock and stock in C, a cor-poration not a party to the reorganization, with a fairmarket value of $100. Under section 358(a)(2), A’sbasis in the C stock is its fair market value, or $100.Under paragraph (d)(2)(i)(A)(2) of this section, A istreated as having purchased the C stock, but not theD stock, for purposes of section 355(d)(5).

Example 2. A purchases all of the stock of D,which is not marketable stock, on Date 1 for $90.Within five years of A’s purchase, on Date 2, A con-tributes the D stock to P in exchange for P stockworth $90 and $10 cash in a transaction qualifyingunder section 351. A recognizes a gain of $10 as aresult of the transfer. Under section 362(a), P’s basisin D is $100. P is treated as having purchased 90percent ($90 worth) of the D stock on Date 1 undersection 355(d)(5)(C) and paragraph (e)(2) of thissection and as having purchased 10 percent ($10worth) of the D stock on Date 2 under paragraph(d)(2)(i)(B)(2)(ii) of this section.

(ii) Acquisition of stock in a distribu-tion to which section 305(a) applies. Anacquisition of stock in a distribution qual-ifying under section 305(a) is not a pur-chase to the extent section 307(a) appliesto determine the recipient’s basis.However, to the extent the distribution isof rights to acquire stock, see paragraph(c)(3) of this section for rules regardingoptions, warrants, convertible obligations,and other similar interests.

(iii) Section 1036(a) exchange. Anexchange of stock qualifying under sec-tion 1036(a) is not a purchase by eitherparty to the exchange to the extent the

2001–3 I.R.B. 311 January 16, 2001

basis of the property acquired equals thatof the property exchanged under section1031(d).

(iv) Section 338 elections—(A) In gen-eral. Stock acquired in a qualified stockpurchase with respect to which a section338 election (or a section 338(h)(10) elec-tion) is made is not treated as a purchasefor purposes of section 355(d)(5)(A).However, any stock (or an interest inanother entity) held by old target that istreated as purchased by new target is treat-ed as acquired by purchase for purposesof section 355(d)(5)(A) unless a section338 election or section 338(h)(10) elec-tion also is made for that stock. See§1.338–2T(c) for the definitions of sec-tion 338 election, section 338(h)(10) elec-tion, old target, and new target.

(B) Example. The following exampleillustrates this paragraph (d)(2)(iv):

Example. T owns all of the stock of S and noother assets. X acquires all of the T stock from theT shareholders for cash and makes an election undersection 338. Under section 338(a) and (b), T, as OldT, is treated as having sold all of its assets at fairmarket value and purchased the assets as a new cor-poration, New T, as of the beginning of the day afterthe acquisition date. Under paragraph (d)(2)(iv)(A)of this section, X is not treated as having purchasedthe T stock. Absent a section 338 election or a sec-tion 338(h)(10) election with respect to S, New T istreated as having purchased all of the S stock undersection 355(d)(5)(A).

(v) Partnership distributions—(A)Section 732(b). An acquisition of stock(or an interest in another entity) in a liqui-dation of a partner’s interest in a partner-ship in which basis is determined pursuantto section 732(b) is a purchase at the timeof the liquidation.

(B) Section 734(b). If the adjustedbasis of stock (or an interest in anotherentity) held by a partnership is increasedunder section 734(b), a proportionateamount of the stock (or other interest) willbe treated as purchased at the time of thebasis adjustment, determined by referenceto the amount of the basis adjustment (butnot in excess of the fair market value ofthe stock (or other interest) at the time ofthe adjustment) over the fair market valueof the stock (or other interest) at the timeof the adjustment.

(3) Certain section 351 exchangestreated as purchases—(i) In general–(A)Treatment of stock received by transferor.Under section 355(d)(5)(B), a purchaseincludes any acquisition of property in anexchange to which section 351 applies to

the extent the property is acquired inexchange for any cash or cash item, anymarketable stock, or any debt of the trans-feror. The property treated as acquired bypurchase is the property received by thetransferor in the exchange.

(B) Multiple classes of stock. If thetransferor in a transaction described insection 355(d)(5)(B) receives stock orsecurities of more than one class, orreceives both stock and securities, thenthe amount of stock or securities pur-chased is determined in a manner that cor-responds to the allocation of basis to thestock or securities under section 358. See§1.358–2(b).

(ii) Cash item, marketable stock. Forpurposes of section 355(d)(5)(B) and thisparagraph (d)(3), either or both of theterms cash item and marketable stockinclude personal property within themeaning of section 1092(d)(1) and§1.1092(d)–1, without giving effect tosection 1092(d)(3).

(iii) Exception for certainacquisitions—(A) In general. Except tothe extent provided in paragraph (e)(3) ofthis section (interest received in exchangefor purchased interest in exchanged basistransaction treated as purchased), anacquisition of stock in a corporation in asection 351 transaction by one or morepersons in exchange for an amount ofstock in another corporation (the trans-ferred corporation) that meets the require-ments of section 1504(a)(2) is not a pur-chase by the transferor or transferors,regardless of whether the stock of thetransferred corporation is marketablestock under section 355(d)(5)(B)(ii) andparagraph (d)(3)(ii) of this section.

(B) Example. The following exampleillustrates this paragraph (d)(3)(iii):

Example. D’s two classes of stock, voting com-mon and nonvoting preferred, are both widely heldand publicly traded. The nonvoting preferred stockis stock described in section 1504(a)(4). Assumethat all of the D stock is marketable stock under sec-tion 355(d)(5)(B)(ii) and paragraph (d)(3)(ii) of thissection. D’s board of directors proposes that, forvalid business purposes, D’s common stock shouldbe held by a holding company, HC, but its preferredstock should not be transferred to HC. As proposed,the D common shareholders exchange their D stocksolely for HC common stock in a section 351(a)transaction. The D preferred shareholders retaintheir stock. HC acquires an amount of D stock thatmeets the requirements of section 1504(a)(2).Although the D common stock was marketable stockin the hands of the D shareholders immediatelybefore the transfer, and the D nonvoting preferred

stock is marketable stock after the transfer, the Dshareholders are not treated as having acquired theHC stock by purchase (except to the extent theexchanged basis rule of paragraph (e)(3) of this sec-tion may apply to treat HC stock as purchased on thedate the exchanged D stock was purchased).

(iv) Exception for assets transferred aspart of an active trade or business—(A)In general. Except to the extent providedin paragraph (e)(3) of this section, anacquisition not described in paragraph(d)(3)(iii) of this section of stock inexchange for any cash or cash item, anymarketable stock, or any debt of the trans-feror in a section 351 transaction is not apurchase if—

(1) The transferor is engaged in the activeconduct of a trade or business under para-graph (d)(3)(iv)(B) of this section and thetransferred items (including debt incurred inthe ordinary course of the trade or business)are used in the trade or business;

(2) The transferred items do not exceedthe reasonable needs of the trade or busi-ness under paragraph (d)(3)(iv)(C) of thissection;

(3) The transferor transfers the items aspart of the trade or business; and

(4) The transferee continues the activeconduct of the trade or business.

(B) Active conduct of a trade or busi-ness. For purposes of this paragraph(d)(3)(iv), whether, with respect to thetrade or business at issue, the transferorand transferee are engaged in the activeconduct of a trade or business is deter-mined under §1.355–3(b)(2) and (3),except that—

(1) Conduct is tested before the transfer(with respect to the transferor) and afterthe transfer (with respect to the transferee)rather than immediately after a distribu-tion; and

(2) The trade or business need not havebeen conducted for five years before itstransfer, but it must have been conductedfor a sufficient period of time to establishthat it is a viable and ongoing trade orbusiness.

(C) Reasonable needs of the trade orbusiness. For purposes of this paragraph(d)(3)(iv), the reasonable needs of thetrade or business include only the amountof cash or cash items, marketable stock, ordebt of the transferor that a prudent busi-ness person apprised of all relevant factswould consider necessary for the presentand reasonably anticipated future needs ofthe business. Transferred items may be

January 16, 2001 312 2001–3 I.R.B.

considered necessary for reasonablyanticipated future needs only if the trans-feror and transferee have specific, defi-nite, and feasible plans for their use.Those plans must require that itemsintended for anticipated future needsrather than present needs be used as expe-ditiously as possible consistent with thebusiness purpose for retention of theitems. Future needs are not reasonablyanticipated if they are uncertain or vagueor where the execution of the plan fortheir use is substantially postponed. Thereasonable needs of a trade or business aregenerally its needs at the time of the trans-fer of the business including the items.However, for purposes of applying sec-tion 355(d) to a distribution, events andconditions after the transfer and throughthe date immediately after the distribution(including whether plans for the use oftransferred items have been consummatedor substantially postponed) may be con-sidered to determine whether at the timeof the transfer the items were necessaryfor the present and reasonably anticipatedfuture needs of the business.

(D) Consideration of all facts and cir-cumstances. All facts and circumstancesare considered in determining whetherthis paragraph (d)(3)(iv) applies.

(E) Successive transfers. A transfer ofassets does not fail to meet the require-ments of paragraph (d)(3)(iv)(A)(4) ofthis section solely because the transfereetransfers the assets directly (or indirectlythrough other members) to another mem-ber of the transferee’s affiliated group, asdefined in §1.355–3(b)(4)(iv) (the finaltransferee), if the requirements of para-graphs (d)(3)(iv)(A)(1), (2), (3) and (4) ofthis section would be met if the transferorhad transferred the assets directly to thefinal transferee.

(v) Exception for transfer betweenmembers of the same affiliated group—(A) In general. Except to the extent pro-vided in paragraph (e)(3) of this section,an acquisition of stock (whether actual orconstructive) not described in paragraphs(d)(3)(iii) and (iv) of this section inexchange for any cash or cash item, mar-ketable stock, or debt of the transferor in asection 351 transaction is not a purchaseif—

(1) The transferor corporation or corpo-rations and the transferee corporation(whether formed in the transaction oralready existing) are members of the same

affiliated group as defined in section1504(a) before the section 351 transaction(if the transferee corporation is in exis-tence before the transaction);

(2) The cash or cash item, marketablestock or debt of the transferor are notincluded in assets that are acquired (ortreated as acquired) by the transferor (oranother member of the transferor’s affili-ated group) from a nonmember in a relat-ed transaction in which section 362(a) or(b) applies to determine the basis in theacquired assets; and

(3) The transferor corporation or corpo-rations, the transferee corporation, andany distributed controlled corporation ofthe transferee corporation do not cease tobe members of such affiliated group inany transaction pursuant to a plan thatincludes the section 351 transaction(including any distribution of a controlledcorporation by the transferee corpora-tion). But see paragraph (b)(4) of this sec-tion where the transfer is made for a prin-cipal purpose to avoid the purposes ofsection 355(d).

(B) Examples. The following examplesillustrate this paragraph (d)(3)(v):

Example 1. Publicly traded P has wholly ownedS since 1990. S is engaged in the telecommunica-tions business and the business of computer softwaredevelopment. S is developing new software for usein the managed health care industry. Over a periodof four years beginning on January 31, 2000, P con-tributes a substantial amount of cash to S solely forthe purpose of funding the software development.On completion of the software in January of 2004,60 percent of the value of the S stock is attributableto the cash contributions made within the last fouryears. The P group’s primary lender requires that Sseparately incorporate the software and relatedassets and distribute the new subsidiary to P as acondition of providing required funding to marketthe software. Accordingly, on February 1, 2004, Sforms N, contributes the software and related assetsto N, and distributes all of the N stock to P in a trans-action intended to qualify under section 355(a). P, S,and N will not leave the affiliated group in any trans-action related to the cash contributions. Under para-graph (d)(3)(v)(A) of this section, P’s cash contribu-tions to S are not treated as purchases of additional Sstock, and the distribution of N from S to P is not adisqualified distribution under section 355(d)(2) andparagraph (b)(1) of this section.

Example 2. On Date 1, P contributes cash to itssubsidiary S with a principal purpose to increase itsstock basis in S. Sixty percent of the value of P’s Sstock is attributable to the cash contribution. Underparagraph (b)(4) of this section (anti-avoidancerule), 60 percent of the S stock is treated as pur-chased under section 355(d)(5)(B), notwithstandingparagraph (d)(3)(v)(A) of this section. Accordingly,any distribution of a subsidiary of S to P within thefive-year period after Date 1 will be a disqualifieddistribution, regardless of whether P, S, and any dis-

tributed S subsidiary remain affiliated after the dis-tribution and any transactions related to the cashcontribution.

(4) Triangular asset reorganizations—(i) Definition. A triangular asset reorga-nization is a reorganization that qualifiesunder—

(A) Section 368(a)(1)(A) or (G) by rea-son of section 368(a)(2)(D);

(B) Section 368(a)(1)(A) by reason ofsection 368(a)(2)(E) (regardless ofwhether section 368(a)(3)(E) applies),unless the transaction also qualifies aseither a section 351 transfer or a reorgani-zation under section 368(a)(1)(B); or

(C) Section 368(a)(1)(C), and stock ofthe controlling corporation rather than theacquiring corporation is exchanged for theacquired corporation’s properties.

(ii) Treatment. Notwithstanding sec-tion 355(d)(5)(A), for purposes of section355(d), the controlling corporation in atriangular asset reorganization is treatedas having—

(A) Acquired the assets of the acquiredcorporation (and as having assumed anyliabilities assumed by the controlling cor-poration’s subsidiary corporation or towhich the acquired corporation’s assetswere subject (the acquired liabilities)) in atransaction in which the controlling cor-poration’s basis in the acquired corpora-tion’s assets was determined under section362(b); and

(B) Transferred the acquired assets andacquired liabilities to its subsidiary corpo-ration in a section 351 transfer.

(iii) Example. The following exampleillustrates this paragraph (d)(4):

Example. Forward triangular reorganization. Pforms S with $25 of cash and T merges into S in areorganization qualifying under section 368(a)(1)(A)by reason of section 368(a)(2)(D) in which the Tshareholders receive $70 of P stock and $15 of cashin exchange for their T stock. T is not a commonparent of a consolidated group of corporations. Theremaining $10 of cash with which P formed S willnot be used in the acquired business. T’s assets con-sist only of assets part of and used in its businesswith a value of $80, and $5 of cash that is not part ofor used in T’s business. T has no liabilities. S willuse T’s business assets in T’s business (which willbecome S’s business), but will invest the $5 of cashin an unrelated passive investment. Under para-graph (d)(4)(ii) of this section, P is treated as acquir-ing the T assets in a transaction in which P’s basis inthe T assets was determined under section 362(b)and contributing them to S in a section 351 transfer.Under paragraph (d)(3)(v) of this section, $10 (of thetotal $25) of cash contributed by P to S upon S’sformation is not treated as a purchase of S stock.The $15 (of the total $25) of cash contributed by Pto S upon S’s formation that is paid to T’s share-

2001–3 I.R.B. 313 January 16, 2001

holders is not treated as a purchase of S stock. Theexception in paragraph (d)(3)(v) of this section doesnot apply to the $5 of cash from T’s business becauseP is treated as having acquired T’s assets in a relatedtransaction in which section 362(b) applies to deter-mine P’s basis in such assets. Accordingly, P is treat-ed under section 355(d)(5)(B) and paragraph(d)(3)(iv) of this section as having purchased $5 ofthe S stock, but is not deemed to have purchased theremaining $80 of the S stock.

(5) Reverse triangular reorganizationsother than triangular asset reorganiza-tions—(i) In general. Except as providedin paragraph (d)(5)(ii) of this section, if atransaction qualifies as a reorganizationunder section 368(a)(1)(A) by reason ofsection 368(a)(2)(E) and also as either areorganization under section 368(a)(1)(B)or a section 351 transfer, then either sec-tion 355(d)(5)(B) (and paragraphs(d)(3)(i) through (iv) of this section) or355(d)(5)(C) (and paragraph (e)(2) of thissection) applies. Regardless of whichmethod the controlling corporationemploys to determine its basis in the sur-viving corporation stock under§1.358–6(c)(2)(ii) or §1.1502–30(b), thetotal amount of surviving corporationstock treated as purchased by the control-ling corporation will equal the higher of—

(A) The amount of surviving corpora-tion stock that would be treated as pur-chased (on the date of the deemed section351 transfer) by the controlling corpora-tion if the controlling corporationacquired the surviving corporation’sassets and assumed its liabilities in atransaction in which the controlling cor-poration’s basis in the surviving corpora-tion assets was determined under section362(b), and then transferred the acquiredassets and liabilities to the surviving cor-poration in a section 351 transfer (see§§1.358–6(c)(1) and (2)(ii)(A), and1.1502–30(b)); or

(B) The amount of surviving corpora-tion stock that would be treated as pur-chased (on the date the surviving corpora-tion shareholders purchased theirsurviving corporation stock) if the con-trolling corporation acquired the stock ofthe surviving corporation in a transactionin which the basis in the surviving corpo-ration’s stock was determined under sec-tion 362(b) (see §§1.358–6(c)(2)(ii)(B)and 1.1502–30(b)).

(ii) Letter ruling and closing agree-ment. If a controlling corporation obtainsa letter ruling and enters into a closing

agreement under section 7121 in which itagrees to determine its basis in survivingcorporation stock under §1.358–6(c)-(2)(ii)(A), or under §1.1502–30(b) byapplying §1.358–6(c)(2)(ii)(A) (deemedasset acquisition and transfer by control-ling corporation), then section355(d)(5)(B) and paragraph (d)(3)(i)through (iv) of this section apply, and sec-tion 355(d)(5)(C) and paragraph (e)(2) ofthis section do not apply. If a controllingcorporation obtains a letter ruling andenters into a closing agreement under sec-tion 7121 under which it agrees to deter-mine its basis in surviving corporationstock under §1.358–6(c)(2)(ii)(B), orunder §1.1502–30(b) by applying§1.358–6(c)(2)(ii)(B) (deemed stockacquisition), then section 355(d)(5)(C)and paragraph (e)(2) of this section apply,and section 355(d)(5)(B) and paragraphs(d)(3)(i) through (iv) of this section do notapply.

(iii) Example. The following exampleillustrates this paragraph (d)(5):

Example. Reverse triangular reorganization;purchase. (i) A purchases 60 percent of the stock ofD on Date 1. D owns no cash items, marketablestock, or transferor debt, but holds cash that is notpart of or used in D’s trade or business under para-graph (d)(3)(iv) of this section and that represents 20percent of D’s value. On Date 2, P forms S, and Smerges into D in a reorganization qualifying undersection 368(a)(1)(B) and under section 368(a)(1)(A)by reason of section 368(a)(2)(E). In the reorgani-zation, P acquires all of the D stock in exchangesolely for P stock. After Date 2, and within fiveyears after Date 1, D distributes its wholly ownedsubsidiary C to P. P does not obtain a letter rulingand enter into a closing agreement under paragraph(d)(5)(ii) of this section. P would acquire 20 percentof the D stock by purchase on Date 2 under para-graph (d)(5)(i)(A) of this section by operation of sec-tion 355(d)(5)(B) and paragraph (d)(3)(iv) of thissection. The exception in paragraph (d)(3)(v) of thissection does not apply because D was not affiliatedwith P before the transaction in which the section351 transfer is deemed to occur and D’s assets aretreated as acquired by P in a related transaction inwhich section 362(b) applies to determine P’s basisin the D assets. P would acquire 60 percent of the Dstock by purchase on Date 1 under paragraph(d)(5)(i)(B) of this section because, under the trans-ferred basis rule of section 355(d)(5)(C) and para-graph (e)(2) of this section, P is treated as though Ppurchased the D stock on the date A purchased it.Accordingly, under paragraph (d)(5)(i) of this sec-tion, P is treated as acquiring the higher amount (60percent) by purchase on Date 1. D’s distribution ofC to P is a disqualified distribution under section355(d)(2) and paragraph (b)(1) of this section. Inaddition, A is treated as acquiring the P stock by pur-chase on Date 1 under paragraph (e)(3) of this sec-tion because A’s basis in the P stock is determined by

reference to A’s basis in the D stock.(ii) The facts are the same as in paragraph (i) of

this Example, except that P obtains a letter ruling andenters into a closing agreement under which it agreesto determine its basis in the D stock under§1.358–6(c)(2)(ii)(A). Under paragraph (d)(5)(ii) ofthis section, section 355(d)(5)(B) (and paragraphs(d)(3)(i) through (iv) of this section) applies, andsection 355(d)(5)(C) (and paragraph (e)(2) of thissection) does not apply. Accordingly, P is treated asacquiring only 20 percent of the D stock by purchaseon Date 2. D’s distribution of C to P is not a dis-qualified distribution under section 355(d)(2) andparagraph (b)(1) of this section.

(6) Treatment of group structurechanges—(i) In general. Notwithstand-ing section 355(d)(5)(A), for purposes ofsection 355(d), if a corporation succeedsanother corporation as the common parentof a consolidated group in a group struc-ture change to which §1.1502–31 applies,the new common parent is treated as hav-ing acquired the assets and assumed theliabilities of the former common parent ina transaction in which the new commonparent’s basis in the former common par-ent’s assets was determined under section362(b), and then transferred the acquiredassets and liabilities to the former com-mon parent (or, if the former commonparent does not survive, to the new com-mon parent’s subsidiary) in a section 351transfer, with the new common parent andformer common parent being treated asnot in the same affiliated group at the timeof the transfer for purposes of applyingparagraph (d)(3)(v) of this section(notwithstanding §1.1502–31(c)(2)).

(ii) Adjustments to basis of higher-tiermembers. A higher-tier member that indi-rectly owns all or part of the former com-mon parent’s stock after a group structurechange is treated as having purchased thestock of an immediate subsidiary to theextent that the higher-tier member’s basisin the subsidiary is increased under§1.1502–31(d)(4).

(iii) Example. The following exampleillustrates this paragraph (d)(6):

Example. P is the common parent of a consoli-dated group, and T is the common parent of anothergroup. P has owned S for more than five years, andthe fair market value of the S stock is $50. T’s assetsconsist only of non-marketable stock of direct andindirect wholly owned subsidiaries with a value of$50, assets used in its business with a value of $50,and $50 of marketable stock that is not part of orused in T’s business. T has no liabilities. T mergesinto S with the T shareholders receiving solely Pstock with a value of $150 in exchange for their Tstock in a section 368(a)(2)(D) reorganization. Swill use T’s business assets in T’s business (which

January 16, 2001 314 2001–3 I.R.B.

will become S’s business), but will hold the $50 ofmarketable stock for investment purposes. Assumethat the transaction is a reverse acquisition under§1.1502–75(d)(3) because the T shareholders, as aresult of owning T stock, own more than 50 percentof the value of P’s stock immediately after the trans-action. Thus, the transaction is a group structurechange under §1.1502–33(f)(1). Under paragraph(d)(6) of this section, P is treated as having acquiredthe assets of T in a transaction in which P’s basis inthe T assets was determined under section 362(b),and then transferred the acquired assets to S in a sec-tion 351 transfer, with P and T being treated as not inthe same affiliated group at the time of the transfersolely for purposes of paragraph (d)(3)(v) of thissection. The exception in paragraph (d)(3)(v) of thissection (transfers within an affiliated group) does notapply. Accordingly, P is treated under section355(d)(5)(B) and paragraph (d)(3)(iv) of this sectionas having purchased $50 of the S stock (attributableto the marketable stock), but is not deemed to havepurchased the remaining $150 of the S stock.

(7) Special rules for triangular assetreorganizations, other reverse triangularreorganizations, and group structurechanges. The amount of acquiring sub-sidiary, surviving corporation, or formercommon parent stock that is treated aspurchased under paragraph (c)(4),(5)(i)(A), or (6) of this section (by opera-tion of section 355(d)(5)(B) and para-graphs (d)(3)(i) through (iv) of this sec-tion) is adjusted to reflect any basisadjustment under—

(i) Section 1.358–6(c)(2)(i)(B) and (C)(reduction of basis adjustment in reversetriangular reorganization where control-ling corporation acquires less than all ofthe surviving corporation stock),§1.1502–30(b) (applying §1.358–6(c)-(2)(i)(B) and (C) to a consolidated group),and §1.1502–31(d)(2)(ii) (reduction ofbasis adjustment in group structurechange where new common parentacquires less than all of the former com-mon parent stock); or

(ii) Section 1.358–6(d) (reduction ofbasis adjustment in any triangular reor-ganization to the extent controlling cor-poration does not provide considera-tion), §1.1502–30(b) (applying§1.358–6(d) (except §1.358–6(d)(2)) toa consolidated group), and§1.1502–31(d)(1) (reduction of basisadjustment in group structure change tothe extent new common parent does notprovide consideration).

(e) Deemed purchase and timingrules—(1) Attribution and aggregation—

(i) In general. Under section 355(d)-(8)(B), if any person acquires by purchasean interest in any entity, and the person is

treated under section 355(d)(8)(A) asholding any stock by reason of holdingthe interest, the stock shall be treated asacquired by purchase on the later of thedate of the purchase of the interest in theentity or the date the stock is acquired bypurchase by such entity.

(ii) Purchase of additional interest. If aperson and an entity are treated as a singleperson under section 355(d)(7), and theperson later purchases an additional inter-est in the entity, the person is treated aspurchasing on the date of the later pur-chase the amount of stock attributed fromthe entity to the person under section355(d)(8)(A) as a result of the additionalinterest.

(iii) Purchase between persons treatedas one person. If two persons are treatedas one person under section 355(d)(7),and one later purchases stock from theother, the date of the later purchase is usedfor purposes of determining when thefive-year period commences.

(iv) Purchase by a person alreadytreated as holding stock under section355(d)(8)(A). If a person who is alreadytreated as holding stock under section355(d)(8)(A) later directly purchases suchstock, the date of the later direct purchaseis used for purposes of determining whenthe five-year period commences.

(v) Examples. The following examplesillustrate this paragraph (e)(1):

Example 1. On Date 1, A purchases 10 percent ofthe stock of P, which has held 100 percent of thestock of T for more than five years at the time of A’spurchase. A is deemed to have purchased 10 percentof P’s T stock on Date 1. If A later purchases anadditional 41 percent of the stock of P on Date 2, Ais deemed to have purchased an additional 41 per-cent of P’s T stock on Date 2. Because A and P arenow related persons under section 267(b), they aretreated as one person under section 355(d)(7)(A),and A is treated as owning all of P’s T stock. A istreated as acquiring 51 percent of the T stock by pur-chase at the times of A’s respective purchases of Pstock on Date 1 and Date 2. The remaining 49 per-cent of T stock is treated as acquired when Pacquired the T stock, more than five years beforeDate 1. If P distributes T after Date 2 and within fiveyears after Date 1, the distribution will be a disqual-ified distribution under section 355(d)(2) and para-graph (b)(1) of this section.

Example 2. A has owned 60 percent of the stockof P for more than five years, and P has owned 40percent of the stock of T for more than five years. Aand P are treated as one person, and A is treated asowning 40 percent of the stock of T for more thanfive years. If P later purchases an additional 20 per-cent of the stock of T on Date 1, A is treated asacquiring by purchase the additional 20 percent of Tstock on Date 1. If A then purchases an additional 10

percent of the stock of P on Date 2, under paragraph(e)(1)(i) of this section, A is deemed to have pur-chased on Date 2 an additional four percent of the Tstock (10 percent of the 40 percent that P originallyowned). In addition, even though A and P werealready treated as one person under section355(d)(7)(A), A also is deemed to have purchasedtwo percent of the T stock on Date 2 (10 percent ofthe 20 percent of the T stock that it was treated aspurchasing on Date 1). A is still treated as owningall 60 percent of the T stock owned by P. However,of the 60 percent, A is treated as having purchased 18percent of the T stock on Date 1 and 6 percent of theT stock on Date 2, for a total of 24 percent purchasedstock.

Example 3. A purchases a 20 percent interest inpartnership M on Date 1. M has owned 30 percentof the stock and 25 percent of the securities of Pfor more than five years. P has owned 40 percentof the stock and 100 percent of the securities of Tfor more than five years. Under section318(a)(2)(C) as modified by section 355(d)(8)(A),M is deemed to own 12 percent of the stock (30percent of the 40 percent P owns) and 30 percentof the securities (30 percent of the 100 percent Powns) of T. Under sections 318(a)(2)(A) and355(d)(8)(B), A is deemed to have purchased 2.4percent of the stock (20 percent of the 12 percentM is deemed to own) and 6 percent of the securi-ties (20 percent of the 30 percent M is deemed toown) of T on Date 1. Similarly, A is deemed tohave purchased 6 percent of the stock (20 percentof the 30 percent M owns) and five percent of thesecurities (20 percent of the 25 percent M owns) ofP on Date 1. If M later purchases an additional 10percent of P stock on Date 2, M is deemed to havepurchased four percent of the stock (10 percent ofthe 40 percent P owns) and 10 percent of the secu-rities (10 percent of the 100 percent P owns) of Ton Date 2. A is deemed to have purchased two per-cent of the stock of P on Date 2 (20 percent of the10 percent M purchased). A is also deemed to havepurchased 0.8 percent of the stock (20 percent ofthe four percent M is deemed to have purchased)and two percent of the securities (20 percent of the10 percent M is deemed to have purchased) of T onDate 2.

Example 4. A and B are brother and sister. Formore than five years, A has owned 75 percent of thestock of P, and B has owned 25 percent of the stockof P. A and B are treated as one person under section267(b), and the stock of each is treated as purchasedon the date it was purchased by A and B, respective-ly. If B later purchases 50 percent of the P stockfrom A on Date 1, A and B are still treated as oneperson. However, under paragraph (e)(3)(iii) of thissection, the 50 percent of P stock that B purchasedfrom A is treated as purchased on Date 1.

(2) Transferred basis rule. If any per-son acquires property from another personwho acquired the property by purchase(determined with regard to section355(d)(5) and paragraphs (d) and (e)(2),(3) and (4) of this section, but withoutregard to section 355(d)(8) and paragraph(e)(1) of this section), and the adjustedbasis of the property in the hands of theacquirer is determined in whole or in part

2001–3 I.R.B. 315 January 16, 2001

by reference to the adjusted basis of theproperty in the hands of the other person,the acquirer is treated as having acquiredthe property by purchase on the date itwas so acquired by the other person. Therule in this paragraph (e)(2) applies, forexample, where stock of a corporationacquired by purchase is subsequentlyacquired in a section 351 transfer or areorganization qualifying under section368(a)(1)(B), but does not apply if thestock of a former common parent isacquired in a group structure change towhich §1.1502–31 applies. But see para-graph (d)(2)(i)(B)(2) of this section forsituations where the stock is treated aspurchased on the date of a transfer.

(3) Exchanged basis rule—(i) In gener-al. If any person acquires an interest in anentity (the first interest) by purchase(determined with regard to section355(d)(5) and paragraphs (d) and (e)(2),(3) and (4) of this section, but withoutregard to section 355(d)(8) and paragraph(e)(1) of this section), and the first interestis exchanged for an interest in the same oranother entity (the second interest) wherethe adjusted basis of the second interest isdetermined in whole or in part by refer-ence to the adjusted basis of the first inter-est, then the second interest is treated ashaving been purchased on the date thefirst interest was purchased. The rule inthis paragraph (e)(3) applies only toexchanges that are not treated otherwisetreated as purchases under section355(d)(5) and paragraph (d) of this sec-tion. The rule in this paragraph (e)(3)applies, for example, where stock of acorporation acquired by purchase is sub-sequently exchanged for other stock in asection 351, 354, or 1036(a) exchange.But see paragraph (d)(2)(i)(A)(2) of thissection for situations where the stock istreated as purchased on the date of anexchange or distribution.

(ii) Example. The following exampleillustrates this paragraph (e)(3):

Example. A purchases 50 percent of the stock ofT on Date 1. On Date 2, T merges into D in a sec-tion 368(a)(1)(A) reorganization, with A exchangingall of the T stock solely for stock of D. Under sec-tion 358(a), A’s basis in the D stock is determined byreference to the basis of the T stock it purchased.Accordingly, A is treated as having purchased the Dstock on Date 1, and has a purchased basis in the Dstock under paragraph (b)(3)(iii) of this section.

(4) Certain section 355 or section 305distributions—(i) Section 355. If a dis-tributing corporation distributes any stock

of a controlled corporation with respect torecently purchased distributing stock in adistribution that qualifies under section355 (or so much of section 356 as relatesto section 355), such controlled corpora-tion stock is deemed to be acquired bypurchase by the distributee on the date thedistributee acquired the recently pur-chased distributing stock. Recently pur-chased distributing stock is stock in thedistributing corporation acquired by pur-chase (determined with regard to section355(d)(5) and paragraphs (d) and (e)(2),(3), and (4) of this section, but withoutregard to section 355(d)(8) and paragraph(e)(1) of this section) by the distributeeduring the five-year period with respect tothat distribution.

(ii) Section 305. If a corporation dis-tributes its stock in a distribution thatqualifies under section 305(a), the stockreceived in the distribution (to the extentsection 307(a) applies to determine therecipient’s basis) is deemed to be acquiredby purchase by the recipient on the date(if any) that the recipient acquired by pur-chase (determined with regard to section355(d)(5) and paragraphs (d) and (e)(2),(3), and (4) of this section), the stock withrespect to which the distribution is made.

(5) Substantial diminution of risk—(i) Ingeneral. If section 355(d)(6) applies to anystock for any period, the running of anyfive-year period set forth in section355(d)(3) is suspended during such period.

(ii) Property to which suspensionapplies. Section 355(d)(6) applies to anystock for any period during which theholder’s risk of loss with respect to suchstock, or with respect to any portion of theactivities of the corporation, is (directly orindirectly) substantially diminished by anoption, a short sale, any special class ofstock, or any other device or transaction.

(iii) Risk of loss substantially dimin-ished. Whether a holder’s risk of loss issubstantially diminished under section355(d)(6) and paragraph (e)(5)(ii) of thissection will be determined based on allfacts and circumstances relating to thestock, the corporate activities, andarrangements for holding the stock.

(iv) Special class of stock. For purpos-es of section 355(d)(6) and paragraph(e)(5)(ii) of this section, the term specialclass of stock includes a class of stock thatgrants particular rights to, or bears partic-ular risks for, the holder or the issuer withrespect to the earnings, assets, or attribut-

es of less than all the assets or activities ofa corporation or any of its subsidiaries.The term includes, for example, trackingstock and stock (or any related instru-ments or arrangements) the terms ofwhich provide for the distribution(whether or not at the option of any partyor in the event of any contingency) of anycontrolled corporation or other specifiedassets to the holder or to one or more per-sons other than the holder.

(f) Duty to determine stockholders—(1)In general. In determining whether sec-tion 355(d) applies to a distribution ofcontrolled corporation stock, a distribut-ing corporation must determine whether adisqualified person holds its stock or thestock of any distributed controlled corpo-ration. This paragraph (f) provides rulesregarding this determination and theextent to which a distributing corporationmust investigate whether a disqualifiedperson holds stock.

(2) Deemed knowledge of contents ofsecurities filings. A distributing corpora-tion is deemed to have knowledge of theexistence and contents of all schedules,forms, and other documents filed with orunder the rules of the Securities andExchange Commission, including withoutlimitation any Schedule 13D or 13G (orany similar schedules) and amendments,with respect to any relevant corporation.

(3) Presumption as to securities filings.Absent actual knowledge to the contrary, indetermining whether section 355(d)applies to a distribution, a distributing cor-poration may presume, with respect tostock that is reporting stock (while suchstock is reporting stock), that every share-holder or other person required to file aschedule, form, or other document with orunder the rules of the Securities andExchange Commission as of a given datehas filed the schedule, form, or other docu-ment as of that date and that the contents offiled schedules, forms, or other documentsare accurate and complete. Reportingstock is stock that is described in Rule13d–1(i) of Regulation 13D (17 CFR240.13d–1(i)) (or any rule or regulation togenerally the same effect) promulgated bythe Securities and Exchange Commissionunder the Securities Exchange Act of 1934(15 U.S.C. 78a et seq.).

(4) Presumption as to less-than-five-percent shareholders. Absent actualknowledge (or deemed knowledge underparagraph (f)(2) of this section) immedi-

January 16, 2001 316 2001–3 I.R.B.

ately after the distribution to the contrarywith regard to a particular shareholder, adistributing corporation may presume thatno less-than-five-percent shareholder of acorporation acquired stock or securitiesby purchase under section 355(d)(5) or (8)and paragraphs (d) and (e) of this sectionduring the five-year period. For purpos-es of this paragraph (f), a less-than-five-percent shareholder is a person that, at notime during the five-year period, holdsdirectly (or by application of paragraph(c)(3)(ii) of this section, but not by appli-cation of section 355(d)(7) or (8)) stockpossessing five percent or more of thetotal combined voting power of all classesof stock entitled to vote or the total valueof shares of all classes of stock of a cor-poration. However, this presumption doesnot apply to any less-than-five-percentshareholder that, at any time during thefive-year period—

(i) Is related under section 355(d)(7)(A)to a shareholder in the corporation that is,at any time during the five-year period,not a less-than-five-percent shareholder;

(ii) Acted pursuant to a plan or arrange-ment, with respect to acquisitions of thecorporation’s stock or securities undersection 355(d)(7)(B) and paragraph (c)(4)of this section, with a shareholder in thecorporation that is, at any time during thefive-year period, not a less-than-five-per-cent shareholder; or

(iii) Holds stock or securities that isattributed under section 355(d)(8)(A) to ashareholder in the corporation that is, atany time during the five-year period, not aless-than-five-percent shareholder.

(5) Examples. The following examplesillustrate this paragraph (f):

Example 1. Publicly traded corporation; noschedules filed. D is a widely held and publicly trad-ed corporation with a single class of reporting stockand no other class of stock. Assume that applicablefederal law requires any person that directly holdsfive percent or more of the D stock to file a schedulewith the Securities and Exchange Commission with-in 10 days after an acquisition. D distributes itswholly owned subsidiary C pro rata. D determinesthat no schedule, form, or other document has beenfiled with respect to its stock or the stock of anyother relevant corporation during the five-year peri-od or within 10 days after the distribution.Immediately after the distribution, D has no knowl-edge that any of its shareholders are (or were at anytime during the five-year period) not less-than-five-percent shareholders, or that any particular share-holder acquired D stock by purchase under section355(d)(5) or (8) and paragraphs (d) and (e) of thissection during the five-year period. Under para-graph (f)(3) of this section, D may presume it has no

shareholder that is or was not a less-than-five-per-cent shareholder during the five-year period due tothe absence of any filed schedules, forms, or otherdocuments. Under paragraph (f)(4) of this section,D may presume that none of its less-than-five-per-cent shareholders acquired D’s stock by purchaseduring the five-year period. Accordingly, D maypresume that section 355(d) does not apply to thedistribution of C.

Example 2. Publicly traded corporation; sched-ule filed. The facts are the same as those in Example1, except that D determines that, as of 10 days afterthe distribution, only one schedule has been filedwith respect to its stock. That schedule disclosesthat X acquired 15 percent of the D stock one yearbefore the distribution. Absent contrary knowledge,D may rely on the presumptions in paragraph (f)(3)of this section and so may presume that X is its onlyshareholder that is or was not a less-than-five-per-cent shareholder during the five-year period. D maynot rely on the presumption in paragraph (f)(4) ofthis section with respect to X. In addition, D maynot rely on the presumption in paragraph (f)(4) ofthis section with respect to any less-than-five-per-cent shareholder that, at any time during the five-year period, is related to X under section355(d)(7)(A), acted pursuant to a plan or arrange-ment with X under section 355(d)(7)(B) and para-graph (c)(4) of this section with respect to acquisi-tions of D stock, or holds stock that is attributed to Xunder section 355(d)(8)(A). Accordingly, underparagraph (f)(1) of this section, to determinewhether section 355(d) applies, D must determine:whether X acquired its directly held D stock by pur-chase under section 355(d)(5) and paragraphs (d)and (e)(2) and (3) of this section during the five-yearperiod; whether X is treated as having purchased anyadditional D stock under section 355(d)(8) and para-graph (e)(1) of this section during the five-year peri-od; and whether X is related to, or acquired its Dstock pursuant to a plan or arrangement with, one ormore of D’s other shareholders during the five-yearperiod under section 355(d)(7)(A) or (B) and para-graph (c)(4) of this section, and if so, whether thoseshareholders acquired their D stock by purchaseunder section 355(d)(5) or (8) and paragraphs (d)and (e) of this section during the five-year period.

Example 3. Acquisition of publicly traded corpo-ration. The facts are the same as those in Example1, except that P acquires all of the D stock in a sec-tion 368(a)(1)(B) reorganization that is not also areorganization under section 368(a)(1)(A) by reasonof section 368(a)(2)(E), and D distributes C to P oneyear later. Because D was widely held, P applies sta-tistical sampling procedures that involve less than50% of D’s outstanding shares, to estimate the basisof all shares acquired, instead of surveying eachshareholder. Under the deemed purchase rule of sec-tion 355(d)(5)(C) and paragraph (e)(2) of this sec-tion, P is treated as having acquired the D stock bypurchase on the date the D shareholders acquired theD stock by purchase. Even though D has no less-than-five-percent shareholder immediately after thedistribution, D may rely on the presumptions in para-graphs (f)(3) and (4) of this section to determinewhether and to what extent the D stock is treated aspurchased during the five-year period in P’s handsunder the deemed purchase rule of section355(d)(5)(C) and paragraph (e)(2) of this section.Accordingly, D may presume that section 355(d)

does not apply to the distribution of C to P. Thisresult would not change even if the statistical sam-pling that involves less than 50 percent of D’s out-standing shares indicated that more than 50% of D’sshares were acquired by purchase during the five-year period.

Example 4. Non-publicly traded corporation. Dis owned by 20 shareholders and has a single class ofstock that is not reporting stock. D knows that Aowns 40 percent of the D stock, and D does notknow that any other shareholder has owned as muchas five percent of the D stock at any time during thefive-year period. D may not rely on the presumptionin paragraph (f)(3) of this section because its stock isnot reporting stock. D may not rely on the presump-tion in paragraph (f)(4) of this section with respect toA. In addition, D may not rely on the presumptionin paragraph (f)(4) of this section for any less-than-five-percent shareholder that, at any time during thefive-year period, is related to A under section355(d)(7)(A), acted pursuant to a plan or arrange-ment with A under section 355(d)(7)(B) and para-graph (c)(4) of this section with respect to acquisi-tions of D stock, or holds stock that is attributed to Aunder section 355(d)(8)(A). D may rely on the pre-sumption in paragraph (f)(4) of this section for less-than-five-percent shareholders that during the five-year period are not related to A, did not act pursuantto a plan or arrangement with A, and do not holdstock attributed to A. Accordingly, under paragraph(f)(1) of this section, to determine whether section355(d) applies, D must determine: that A is its onlyshareholder that is (or was at any time during thefive-year period) not a less-than-five-percent share-holder; whether A acquired its directly held D stockby purchase under section 355(d)(5) and paragraphs(d) and (e)(2) and (3) of this section during the five-year period; whether A is treated as having pur-chased any additional D stock under section355(d)(8) and paragraph (e)(1) of this section duringthe five-year period; and whether A is related to, oracquired its D stock pursuant to a plan or arrange-ment with, one or more of D’s other shareholdersduring the five-year period under section355(d)(7)(A) or (B) and paragraph (c)(4) of this sec-tion, and if so, whether those shareholders acquiredtheir D stock by purchase under section 355(d)(5) or(8) and paragraphs (d) and (e) of this section duringthe five-year period.

(g) Effective date. This section appliesto distributions occurring after December20, 2000, except that they do not apply toany distributions occurring pursuant to awritten agreement which is (subject tocustomary conditions) binding onDecember 20, 2000, and at all times there-after.

Robert E. Wenzel,Deputy Commissioner of

Internal Revenue.

Approved December 11, 2000.

Jonathan Talisman,Acting Assistant Secretary

of the Treasury.

2001–3 I.R.B. 317 January 16, 2001

January 16, 2001 318 2001–3 I.R.B.

(Filed by the Office of the Federal Register on De-cember 19, 2000, 8:45 a.m., and published in theissue of the Federal Register for December 20, 2000,65 F.R. 79719)

Section 382.—Limitation on NetOperating Loss Carryforwardsand Certain Built-In LossesFollowing Ownership Change

The adjusted applicable federal long-term rate isset forth for the month of January 2001. See Rev.Rul. 2001–3, page 319.

Section 412.—Minimum FundingStandards

The adjusted applicable federal short-term, mid-term, and long-term rates are set forth for the monthof January 2001. See Rev. Rul. 2001–3, page 319.

Section 467.—Certain Paymentsfor the Use of Property orServices

The adjusted applicable federal short-term, mid-term, and long-term rates are set forth for the monthof January 2001. See Rev. Rul. 2001–3, page 319.

Section 468.—Special Rules forMining and Solid WasteReclamation and Closing Costs

The adjusted applicable federal short-term, mid-term, and long-term rates are set forth for the monthof January 2001. See Rev. Rul. 2001–3, page 319.

Section 482.—Allocation ofIncome and Deductions AmongTaxpayers

Federal short-term, mid-term, and long-termrates are set forth for the month of January 2001. SeeRev. Rul. 2001–3, page 319.

Section 483.—Interest onCertain Deferred Payments

The adjusted applicable federal short-term,mid-term, and long-term rates are set forth for the

month of January 2001. See Rev. Rul. 2001–3,page 319.

Section 512.—UnrelatedBusiness Taxable Income

The Service provides an inflation adjustment tothe maximum amount of annual dues that can bepaid to certain agricultural or horticultural organiza-tions without any portion being treated as unrelatedtrade or business income by reason of any benefitsor privileges available to members for taxable yearsbeginning in 2001. See Rev. Proc. 2001–13, page337.

Section 513.—Unrelated Tradeor Business

The Service provides inflation adjustments to themaximum amount of a “low cost article” for taxableyears beginning in 2001. Funds raised through acharity’s distribution of “low cost articles” will notbe treated as unrelated business income to the char-ity. See Rev. Proc. 2001–13, page 337.

Section 642.—Special Rules forCredits and Deductions

Federal short-term, mid-term, and long-termrates are set forth for the month of January 2001. SeeRev. Rul. 2001–3, page 319.

Section 685.—Treatment ofFuneral Trusts

The Service provides an inflation adjustment tothe maximum amount of contributions that may bemade to a qualified funeral trust for contracts en-tered in calendar year 2001. See Rev. Proc.2001–13, page 337.

Section 807.—Rules for CertainReserves

The adjusted applicable federal short-term, mid-term, and long-term rates are set forth for the monthof January 2001. See Rev. Rul. 2001–3, page 319.

Section 846.—DiscountedUnpaid Losses Defined

The adjusted applicable federal short-term, mid-

term, and long-term rates are set forth for themonth of January 2001. See Rev. Rul. 2001–3,page 319.

Section 860E.—Treatment ofIncome in Excess of DailyAccruals on Residual Interests

26 CFR 1.860E–1: Treatment of taxable income of aresidual interest holder in excess of daily accruals.

This procedure details safe harbor conditionsunder which the transfer of a REMIC noneconomicresidual interest or FASIT ownership interest is pre-sumed to be accomplished without an intention toimpede the assessment or collection of tax. Taxpay-ers may rely on the safe harbors from February 4,2000 (the date proposed regulations were filed withthe Federal Register) until the date specified in fu-ture published guidance. See Rev. Proc. 2001–12,page 335.

Section 860H.—Taxation of aFASIT; Other General Rules

This procedure details safe harbor conditionsunder which the transfer of a REMIC noneconomicresidual interest or FASIT ownership interest is pre-sumed to be accomplished without an intention toimpede the assessment or collection of tax. Taxpay-ers may rely on the safe harbors from February 4,2000 (the date proposed regulations were filed withthe Federal Register) until the date specified in fu-ture published guidance. See Rev. Proc. 2001–12,page 335.

Section 877.—Expatriation toAvoid Tax

The Service provides inflation adjustments toamounts used to determine whether an individual’sloss of United States citizenship had the avoidanceof the United States tax as one of its principal pur-poses for calendar year 2001. See Rev. Proc.2001–13, page 337.

Section 1274.—Determinationof Issue Price in the Case ofCertain Debt Instruments Issuedfor Property

(Also Sections 42, 280G, 382, 412, 467, 468, 482,483, 642, 807, 846, 1288, 7520, 7872.)

Federal rates; adjusted federal rates;adjusted federal long-term rate, andthe long-term exempt rate. For pur-

2001–3 I.R.B. 319 January 16, 2001

poses of sections 1274, 1288, 382, andother sections of the Code, tables set forththe rates for January 2001.

Rev. Rul. 2001–3

This revenue ruling provides variousprescribed rates for federal income taxpurposes for January 2001 (the current)month). Table 1 contains the short-term,mid-term, and long-term applicable feder-al rates (AFR) for the current month forpurposes of section 1274(d) of the

Internal Revenue Code. Table 2 containsthe short-term, mid-term, and long-termadjusted applicable federal rates (adjustedAFR) for the current month for purposesof section 1288(b). Table 3 sets forth theadjusted federal long-term rate and thelong-term tax-exempt rate described insection 382(f). Table 4 contains theappropriate percentages for determiningthe low-income housing credit describedin section 42(b)(2) for buildings placed inservice during the current month. Table 5

contains the federal rate for determiningthe present value of an annuity, an interestfor life or for a term of years, or a remain-der or a reversionary interest for purposesof section 7520. Finally, Table 6 containsthe deemed rate of return for transfersmade during calendar year 2001 to pooledincome funds described in § 642(c)(5)that have been in existence for less than 3taxable years immediately preceding thetaxable year in which the transfer is made.

REV. RUL. 2001–3 TABLE 1

Applicable Federal Rates (AFR) for January 2001

Period for Compounding

Annual Semiannual Quarterly Monthly

Short-TermAFR 5.90% 5.82% 5.78% 5.75%

110% AFR 6.50% 6.40% 6.35% 6.32%120% AFR 7.10% 6.98% 6.92% 6.88%130% AFR 7.71% 7.57% 7.50% 7.45%

Mid-TermAFR 5.61% 5.53% 5.49% 5.47%

110% AFR 6.17% 6.08% 6.03% 6.00%120% AFR 6.75% 6.64% 6.59% 6.55%130% AFR 7.32% 7.19% 7.13% 7.08%150% AFR 8.47% 8.30% 8.22% 8.16%175% AFR 9.91% 9.68% 9.57% 9.49%

Long-TermAFR 5.78% 5.70% 5.66% 5.63%

110% AFR 6.37% 6.27% 6.22% 6.19%120% AFR 6.96% 6.84% 6.78% 6.74%130%AFR 7.55% 7.41% 7.34% 7.30%

REV. RUL. 2001–3 TABLE 2

Applicable Federal Rates (AFR) for January 2001

Period for Compounding

Annual Semiannual Quarterly Monthly

Short-Termadjusted AFR 4.18% 4.14% 4.12% 4.10%

Mid-Termadjusted AFR 4.52% 4.47% 4.45% 4.43%

Long-Termadjusted AFR 5.24% 5.17% 5.14% 5.12%

REV. RUL. 2001-3 TABLE 3

Rates Under Section 382 for January 2001

Adjusted federal long-term rate for the current month 5.24%

Long-term tax-exempt rate for ownership changes during the current month (the highest of the adjusted federal long-term rates for the current month and the prior two months.) 5.39%

January 16, 2001 320 2001–3 I.R.B.

REV. RUL. 2001-3 TABLE 4

Appropriate Percentages Under Section 42(b)(2) for January 2001

Appropriate percentage for the 70% present value low-income housing credit 8.33%

Appropriate percentage for the 30% present value low-income housing credit 3.57%

REV. RUL. 2001-3 TABLE 5

Rate Under Section 7520 for January 2001

Applicable federal rate for determining the present value of an annuity, an interest for lifeor a term of years, or a remainder or reversionary interest 6.8%

REV. RUL. 2001-3 TABLE 6

Deemed Rate for Transfers to New Pooled Income Funds During 2001

Deemed rate of return for transfers during 2001 to pooled income funds that have been in existence for less than 3 taxable years 6.6%

Section 1288.—Treatment ofOriginal Issue Discounts on Tax-Exempt Obligations

The adjusted applicable federal short-term, mid-term, and long-term rates are set forth for the monthof January 2001. See Rev. Rul. 2001–3 page 319.

Section 2032A.—Valuation ofCertain Farm, Etc., RealProperty

The Service provides an inflation adjustment to themaximum amount by which the value of certain farmand other qualified real property included in a decen-dent’s gross estate may be decreased for purposes ofvaluing the estate of a decedent dying in calendar year2001. See Rev. Proc. 2001–13, page 337.

Section 2503.—Taxable Gifts

The Service provides an inflation adjustment to theamount of gifts that may be made to a person in a cal-endar year without including the amount in taxablegifts for calendar year 2001. See Rev. Proc. 2001–13,page 337.

Section 2523.—Gift to Spouse

The Service provides an inflation adjustment tothe amount of gifts that may be made in a calendaryear to a spouse who is not a citizen of the UnitedStates without including the amount in taxable giftsfor calendar year 2001. See Rev. Proc. 2001–13,page 337.

Section 2631.—GST Exemption

The Service provides an inflation adjustment tothe amount of the generation-skipping transfer tax

exemption for calendar year 2001. See Rev. Proc.2001–13, page 337.

Section 4001.—PassengerVehicles

The Service provides inflation adjustments tothe price above which a passenger vehicle becomessubject to an excise tax for transactions occurringin calendar year 2001. See Rev. Proc. 2001–13,page 337.

Section 4003.—Special Rules

The Service provides inflation adjustments to theprice above which a passenger vehicle becomes sub-ject to an excise tax for transactions occurring in cal-endar year 2001. (Price includes the price of instal-lation of parts or accessories on a passenger vehiclewithin six months of the date after the vehicle was

first placed in service.) See Rev. Proc. 2001–13,page 337.

Section 4261.—Imposition ofTax; In General.

This notice provides rules relating to the airtransportation tax imposed by § 4261(a) of the In-ternal Revenue Code on amounts paid for the rightto provide mileage awards. The notice reflectschanges made by § 1031(c)(2) of the Taxpayer Re-lief Act of 1997, 1997–4 (Vol. 1) C.B. 2, 144, whichadded § 4261(e)(3) to the Code. See Notice 2001–6,page 327.

Section 4261(c).—Use ofInternational Travel Facilities

The Service provides an inflation adjustment tothe amount of the excise tax on passenger air trans-portation beginning or ending in the United Statesfor calendar year 2001. See Rev. Proc. 2001–13,page 337.

Section 6011.—GeneralRequirement of Return,Statement, or List

26 CFR 31.6011(a)–3: Returns under FederalUnemployment Tax Act.

What are the requirements of the Form 940 e-fileProgram, which allows taxpayers, reporting agents,transmitters, and software developers to electroni-cally file a Form 940, Employer’s Annual FederalUnemployment (FUTA) Tax Return? See Rev. Proc.2001–9, page 328.

26 CFR 31.6011(a)–7: Execution of returns.

What are the requirements of the Form 940 e-fileProgram, which allows taxpayers, reporting agents,transmitters, and software developers to electroni-cally file a Form 940, Employer’s Annual FederalUnemployment (FUTA) Tax Return? See Rev. Proc.2001–9, page 328.

Section 6033.—Returns byExempt Organizations

The Service provides an inflation adjustment tothe amount of dues certain exempt organizationswith nondeductible lobbying expenditures cancharge and still be excepted from reporting require-ments for taxable years beginning in 2001. See Rev.Proc. 2001–13, page 337.

Section 6039F.—Notice of LargeGifts Received From ForeignPersons

The Service provides an inflation adjustment tothe amount of gifts in a taxable year from foreignperson(s) that triggers a reporting requirement for aUnited States person for taxable years beginning in2001. See Rev. Proc. 2001–13, page 337.

Section 6061.—Signing ofReturns and Other Documents

26 CFR 301.6061–1: Signing of returns and otherdocuments.

What are the requirements of the Form 940 e-fileProgram, which allows taxpayers, reporting agents,transmitters, and software developers to electroni-cally file a Form 940, Employer’s Annual FederalUnemployment (FUTA) Tax Return? See Rev. Proc.2001–9, page 328.

Section 6071.—Time for FilingReturns and Other Documents

26 CFR 31.6071(a)–1: Time for filing returns andother documents.

What are the requirements of the Form 940 e-fileProgram, which allows taxpayers, reporting agents,transmitters, and software developers to electroni-cally file a Form 940, Employer’s Annual FederalUnemployment (FUTA) Tax Return? See Rev. Proc.2001–9, page 328.

Section 6323.—Validity andPriority Against Certain Persons

The Service provides inflation adjustments forcalendar year 2001 to (1) the maximum amount of acasual sale of personal property below which a fed-eral tax lien will not be valid against a purchaser ofthe property, and (2) the maximum amount of a con-tract for the repair or improvement of certain resi-dential property at or below which a federal tax lienwill not be valid against a mechanic’s lienor. SeeRev. Proc. 2001–13, page 337.

Section 6334.—PropertyExempt From Levy

The Service provides inflation adjustments to thevalue of certain property exempt from levy (fuel,provisions, furniture, household personal effects,arms for personal use, livestock, poultry, and booksand tools of a trade, business, or profession) for cal-endar year 2001. See Rev. Proc. 2001–13, page 337.

Section 6601.—Interest onUnderpayment, Nonpayment, orExtension of Time for Payment,of Tax

The Service provides an inflation adjustment tothe amount used to determine the amount of interestcharged on a certain portion of the estate tax payablein installments for the estate of a decedent dying incalendar year 2001. See Rev. Proc. 2001–13, page337.

Section 6651.—Failure to FileTax Return or to Pay Tax

26 CFR 301.6651–1: Failure to file tax return or topay tax.

What are the requirements of the Form 940 e-fileProgram, which allows taxpayers, reporting agents,transmitters, and software developers to electroni-cally file a Form 940, Employer’s Annual FederalUnemployment (FUTA) Tax Return? See Rev. Proc.2001–9, page 328.

Section 7430.—Awarding ofCosts and Certain Fees

The Service provides an inflation adjustment tothe hourly limit on attorney fees that may beawarded in a judgement or settlement of an adminis-trative or judicial proceeding concerning the deter-mination, collection, or refund of tax, interest, orpenalty for calendar year 2001. See Rev. Proc.2001–13, page 337.

Section 7508.—Time forPerforming Certain ActsPostponed by Reason of Servicein Combat Zone

26 CFR 301.7508–1: Time for performing certainacts postponed by reason of service in a combatzone.

26 CFR 301.7508A–1: Postponement of certain tax-related deadlines by reason of Presidentiallydeclared disaster.

T.D. 8911

DEPARTMENT OF THE TREASURYInternal Revenue Service26 CFR Part 301

Relief for Service in CombatZone and for PresidentiallyDeclared Disaster

2001–3 I.R.B. 321 January 16, 2001

AGENCY: Internal Revenue Service(IRS), Treasury.

ACTION: Final regulations.

SUMMARY: This document containsfinal regulations relating to the post-ponement of certain tax-related dead-lines due either to service in a combatzone or a Presidentially declared disas-ter. The regulations reflect changes tothe law made by the Taxpayer Relief Actof 1997. The regulations affect taxpay-ers serving in a combat zone and taxpay-ers affected by a Presidentially declareddisaster.

DATES: Effective Date: These regula-tions are effective December 30, 1999.Applicability Date: For dates of applica-bility, see §§301.7508–1(b) and301.7508A–1(h).

FOR FURTHER INFORMATION CON-TACT: Bridget E. Finkenaur, (202) 622-4940 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

This document contains amendmentsto the Regulations on Procedure andAdministrat ion (26 CFR part 301)under section 7508 of the Internal Rev-enue Code (Code), relating to postpone-ment of certain acts by reason of servicein a combat zone, and section 7508A,relating to postponement of certain tax-related deadlines by reason of a Presi-dentially declared disaster. Section7508A was added to the Code by sec-tion 911 of the Taxpayer Relief Act of1997, Public Law 105–34 (111 Stat.788), effective for any period for per-forming an act that has not expired be-fore August 5, 1997.

A notice of proposed rulemaking(REG–101492–98, 2000–3 I.R.B. 326)was published in the Federal Register(64 F.R. 73444) on December 30, 1999.No public hearing was requested orheld. One comment letter was received.After consideration of the comments,the proposed regulations are adopted asmodified by this Treasury decision. Thecomments are discussed below.

Summary of Comments

1. IRA and Pension ContributionDeadlines

Section 301.7508A–1(c)(1) of the pro-posed regulations lists various tax-relateddeadlines that may be postponed. Thecommentator recommends that deadlinesfor contributions to an individual retire-ment account (IRA) or a pension plan beadded to the list. The final regulationsadopt this recommendation and also addthe deadline for rollover contributions.

2. Notification of IRS When TaxpayerMoves Out of Disaster Area

The commentator suggests that the IRSdevelop a simple procedure for taxpayersto notify the IRS when they move out of aPresidentially declared disaster area. Thecommentator believes that the notificationwould ensure that relief under section7508A will automatically apply to a tax-payer who has moved out of aPresidentially declared disaster area.Such taxpayers could also be advised ofany further relevant filing guidanceregarding the disaster.

The final regulations do not adopt thissuggestion because it is not necessary fortaxpayers moving out of a disaster area tonotify the IRS to obtain relief under sec-tion 7508A. When a Presidentiallydeclared disaster occurs, the IRS makes adecision whether to grant relief to taxpay-ers affected by the disaster. If a decisionis made to grant relief, the IRS identifiesmost affected taxpayers located in the dis-aster area and places a marker on theaffected tax accounts. A subsequentchange of address will not remove themarker from the tax account. Thus, anaffected taxpayer who relocates outside adisaster area will still automaticallyreceive disaster relief.

Because the IRS may not be able to iden-tify all taxpayers potentially affected by aPresidentially declared disaster, some tax-payers may have to identify themselves tothe IRS to receive relief. To ensure thatthey receive the relief for which they areeligible, the IRS typically issues publicguidance, such as a news release, thatdescribes how to claim relief. The guidanceinstructs taxpayers how to note on their taxreturn that they are affected taxpayers, andwhat, if any, additional information shouldbe attached. When the IRS processes thesetax returns, it manually places the disasterrelief marker on the tax account.Subsequent changes of address will notaffect the grant of relief.

3. Definition of Affected Taxpayer

The regulations list seven types ofaffected taxpayers, including “any busi-ness whose principal place of business islocated in a covered disaster area.” Thecommentator recommends that this defin-ition be expanded to include all owners ofa business.

The final regulations do not adopt thisrecommendation. The IRS and TreasuryDepartment believe that the definition ofaffected taxpayer in the proposed regula-tions is sufficiently broad to cover all tax-payers within the intended scope of sec-tion 7508A. Although the final regulationsdo not provide a specific rule for businessowners (other than sole proprietors), theIRS may nonetheless make a determina-tion based on the facts and circumstancesin a particular case that a business owneris an affected taxpayer under either§301.7508A–1(d)(1)(iv), which applies toan individual whose principal residence isnot located in a disaster area, but whoserecords necessary to meet the deadline fora specified act are maintained in a covereddisaster area, or under §301.7508A–1(d)(1)(vii), which applies to any otherperson determined by the IRS to be affect-ed by a Presidentially declared disaster.For example, in the case of a partnership,it is expected that partners whose abilityto meet a deadline is significantly affectedby a Presidentially declared disaster willbe granted relief.

4. Deadline for Tax Deposits

The commentator also recommendsthat the deadline for tax deposits undersection 6302 be added to the list. Thecommentator states that no distinctionshould be drawn between tax paymentsand tax deposits and that allowing a post-ponement of deposits would be less cum-bersome than waiving the section 6656deposit penalties for reasonable cause. Tothe contrary, due to the frequency withwhich tax deposits are due, the IRSbelieves it would be more administrative-ly cumbersome to defer those deadlines.However, in cases where taxpayers areunable to make timely tax deposits undersection 6302 because of a Presidentiallydeclared disaster, the IRS will consider areasonable cause waiver of the section6656 failure to deposit penalty on a caseby case basis. The IRS believes such a

January 16, 2001 322 2001–3 I.R.B.

system is more administrable. Thus, thiscomment has not been adopted by thefinal regulations.

Explanation of Other Revisions

Section 301.7508A–1(c)(1) of the finalregulations expands the acts for whichdisaster relief is available to include: thefiling of generation-skipping transfer taxreturns; the payment of generation-skip-ping transfer tax; and the filing of anypetition with the Tax Court.

Sections 301.7508A–1(d)(1)(ii) and(iv) of the final regulations have beenrevised to clarify that affected taxpayerincludes any business entity or sole pro-prietor whose principal place of businessis located in a covered disaster area.

Example 5 of the final regulations clar-ifies the application of section 7508A tothe lookback period in section6511(b)(2)(A). This period limits theamount that may be refunded to the tax-payer when a timely claim is filed undersection 6511(a). In Example 5, H and Wtimely file their 2001 income tax return onApril 15, 2002. Example 5 states that anamended return for 2001 will be timely ifit is filed on or before July 14, 2005. Asclarified by the final regulations, Example5 further states that the section6511(b)(2)(A) lookback period runs fromJuly 14, 2005, back to April 15, 2002.Thus, the taxpayers are allowed a refundof estimated tax and tax withheld fromwages for 2001, deemed paid on April 15,2002, under section 6513(b).

The final regulations also clarifyExamples 6 and 7. Under §301.7508A–1(f)of the final regulations, if there is an exten-sion of time to file income tax returns undersection 6081 and to pay income tax withrespect to such returns under section 6161,and a postponement of tax-related dead-lines under section 7508A, interest on anunderpayment that arises during such peri-od is abated under section 6404(h) for theperiod of time disregarded under section7508A. This is illustrated by Example 8.By contrast, in Examples 6 and 7, exten-sions were not granted under sections 6081and 6161 and interest was not abated undersection 6404(h). Therefore, in Examples 6and 7, no interest abatement would be per-mitted regardless of whether the underpay-ment arose before or during the extensionperiod. Therefore, Examples 6 and 7 are

amended by removing the statement thatinterest is not abated “because the under-payment arose prior to the extension peri-od” and clarifying that because no exten-sions under sections 6081 and 6161 weregranted, interest was not abated under sec-tion 6404(h).

Special Analyses

It has been determined that these finalregulations are not a significant regulato-ry action as defined in Executive Order12866. Therefore, a regulatory assess-ment is not required. It also has beendetermined that section 553(b) of theAdministrative Procedure Act (5 U.S.C.chapter 5) does not apply to these regula-tions, and because these regulations donot impose a collection of information onsmall entities, the Regulatory FlexibilityAct (5 U.S.C. chapter 6) does not apply.Pursuant to section 7805(f) of the Code,the notice of proposed rulemaking preced-ing these final regulations was submittedto the Chief Counsel for Advocacy of theSmall Business Administration for com-ment on their impact on small business.

Drafting Information

The principal author of these regula-tions is Bridget E. Finkenaur, Office ofAssociate Chief Counsel, Procedure andAdministration (Administrative Pro-visions and Judicial Practice Division).However, other personnel from the IRSand Treasury Department participated intheir development.

* * * * *

Amendments to the Regulations

Accordingly, 26 CFR part 301 isamended as follows:

PART 301—PROCEDURE ANDADMINISTRATION

Paragraph 1. The authority citation forpart 301 is amended by adding entries innumerical order to read in part as follows:

Authority: 26 U.S.C. 7805 * * *Section 301.7508–1 also issued under

26 U.S.C. 7508(a)(1)(K);Section 301.7508A–1 also issued under

26 U.S.C. 7508(a)(1)(K) and 7508A(a); ** *

Par. 2. Section 301.7508–1 is added toread as follows:

§ 301.7508–1 Time for performingcertain acts postponed by reason ofservice in a combat zone.

(a) General rule. The period of timethat may be disregarded for performingcertain acts under section 7508 applies toacts described in section 7508(a)(1) and toother acts specified in a revenue ruling,revenue procedure, notice, or other guid-ance published in the Internal RevenueBulletin (see §601.601(d)(2) of this chap-ter).

(b) Effective date. This section appliesto any period for performing an act thathas not expired before December 30,1999.

Par. 3. Section 301.7508A–1 is addedto read as follows:

§301.7508A–1 Postponement of certaintax-related deadlines by reason ofPresidentially declared disaster.

(a) Scope. This section provides rulesby which the Internal Revenue Service(IRS) may postpone deadlines for per-forming certain acts with respect to taxesother than taxes not administered by theIRS such as firearms tax (chapter 32, sec-tion 4181); harbor maintenance tax (chap-ter 36, section 4461); and alcohol andtobacco taxes (subtitle E).

(b) Postponed deadlines. For any tax,penalty, additional amount, or addition tothe tax of an affected taxpayer (as definedin paragraph (d)(1) of this section), theIRS may disregard a period of up to 90days in determining, under the internalrevenue laws—

(1) Whether any or all of the actsdescribed in paragraph (c) of this sectionwere performed within the time pre-scribed; and

(2) The amount of any credit or refund.(c) Acts for which a period may be dis-

regarded—(1) Acts performed by taxpay-ers. Paragraph (b) of this section appliesto the following acts performed by affect-ed taxpayers (as defined in paragraph(d)(1) of this section)—

(i) Filing any return of income tax,estate tax, gift tax, generation-skippingtransfer tax, excise tax (other thanfirearms tax (chapter 32, section 4181);harbor maintenance tax (chapter 36, sec-tion 4461); and alcohol and tobacco taxes(subtitle E)), or employment tax (includ-

2001–3 I.R.B. 323 January 16, 2001

ing income tax withheld at source andincome tax imposed by subtitle C or anylaw superseded thereby);

(ii) Paying any income tax, estate tax,gift tax, generation-skipping transfer tax,excise tax (other than firearms tax (chap-ter 32, section 4181); harbor maintenancetax (chapter 36, section 4461); and alco-hol and tobacco taxes (subtitle E)),employment tax (including income taxwithheld at source and income taximposed by subtitle C or any law super-seded thereby), any installment of thosetaxes (including payment under section6159 relating to installment agreements),or of any other liability to the UnitedStates in respect thereof, but not includingdeposits of taxes pursuant to section 6302and the regulations under section 6302;

(iii) Making contributions to a qualifiedretirement plan (within the meaning ofsection 4974(c)) under section 219(f)(3),404(a)(6), 404(h)(1)(B), or 404(m)(2);making distributions under section408(d)(4); recharacterizing contributionsunder section 408A(d)(6); or making arollover under section 402(c), 403(a)(4),403(b)(8), or 408(d)(3);

(iv) Filing a petition with the TaxCourt, or for review of a decision ren-dered by the Tax Court;

(v) Filing a claim for credit or refund ofany tax;

(vi) Bringing suit upon a claim forcredit or refund of any tax; and

(vii) Any other act specified in a rev-enue ruling, revenue procedure, notice,announcement, news release, or otherguidance published in the InternalRevenue Bulletin (see §601.601(d)(2) ofthis chapter).

(2) Acts performed by the government.Paragraph (b) of this section applies to thefollowing acts performed by the govern-ment—

(i) Assessing any tax;(ii) Giving or making any notice or

demand for the payment of any tax, orwith respect to any liability to the UnitedStates in respect of any tax;

(iii) Collecting by the Secretary, bylevy or otherwise, of the amount of anyliability in respect of any tax;

(iv) Bringing suit by the United States,or any officer on its behalf, in respect ofany liability in respect of any tax;

(v) Allowing a credit or refund of anytax;

and (vi) Any other act specified in a rev-

enue ruling, revenue procedure, notice, orother guidance published in the InternalRevenue Bulletin (see §601.601(d)(2) ofthis chapter).

(d) Definitions—(1) Affected taxpayermeans–-

(i) Any individual whose principal resi-dence (for purposes of section 1033(h)(4))is located in a covered disaster area;

(ii) Any business entity or sole propri-etor whose principal place of business islocated in a covered disaster area;

(iii) Any individual who is a reliefworker affiliated with a recognized gov-ernment or philanthropic organization andwho is assisting in a covered disaster area;

(iv) Any individual whose principalresidence (for purposes of section1033(h)(4)), or any business entity or soleproprietor whose principal place of busi-ness is not located in a covered disasterarea, but whose records necessary to meeta deadline for an act specified in para-graph (c) of this section are maintained ina covered disaster area;

(v) Any estate or trust that has taxrecords necessary to meet a deadline foran act specified in paragraph (c) of thissection and that are maintained in a cov-ered disaster area;

(vi) The spouse of an affected taxpayer,solely with regard to a joint return of thehusband and wife; or

(vii) Any other person determined bythe IRS to be affected by a Presidentiallydeclared disaster (within the meaning ofsection 1033(h)(3)).

(2) Covered disaster area means anarea of a Presidentially declared disaster(within the meaning of section1033(h)(3)) to which the IRS has deter-mined paragraph (b) of this sectionapplies.

(e) Notice of postponement of certainacts. If any tax-related deadline is post-poned under section 7508A and this sec-tion, the IRS will publish a revenue rul-ing, revenue procedure, notice,announcement, news release, or otherguidance published in the InternalRevenue Bulletin (see §601.601(d)(2) ofthis chapter) describing the acts post-poned, the number of days disregardedwith respect to each act, the time period towhich the postponement applies, and thelocation of the covered disaster area.

Guidance under this paragraph (e) will bepublished as soon as practicable after thedeclaration of a Presidentially declareddisaster.

(f) Abatement of interest under section6404(h). In the case of a Presidentiallydeclared disaster, if there is an extensionof time to file income tax returns undersection 6081 and to pay income tax withrespect to such returns under section6161, and, in addition, a postponement oftax-related deadlines under section7508A, interest on an underpayment ofincome tax that arises during such periodwill be abated under section 6404(h) forthe period of time disregarded under sec-tion 7508A in addition to the period oftime covered by the extension of time tofile and the extension of time to pay.

(g) Examples. The rules of this sectionare illustrated by the following examples:

Example 1. (i) Corporation M, a calendar yeartaxpayer, has its principal place of business inCounty A in State X. Pursuant to a timely filedrequest for extension of time to file, Corporation M’s1999 Form 1120, “U.S. Corporation Income TaxReturn,” is due on September 15, 2000. Also due onSeptember 15, 2000, is Corporation M’s third quar-ter estimated tax payment for 2000. CorporationM’s 2000 third quarter Form 720, “Quarterly FederalExcise Tax Return,” and third quarter Form 941,“Employer’s Quarterly Federal Tax Return,” are dueon October 31, 2000. In addition, Corporation Mhas an employment tax deposit due on September15, 2000.

(ii) On September 1, 2000, a hurricane strikesCounty A. On September 6, 2000, the Presidentdeclares a disaster within the meaning of section1033(h)(3). The IRS determines that County A inState X is a covered disaster area and publishes guid-ance informing taxpayers that for acts described inparagraph (c) of this section that are required to beperformed within the period beginning onSeptember 1, 2000, and ending on November 6,2000, 90 days will be disregarded in determiningwhether the acts are performed timely.

(iii) Because Corporation M’s principal place ofbusiness is in County A, Corporation M is an affect-ed taxpayer. Accordingly, Corporation M’s 1999Form 1120 will be filed timely if filed on or beforeDecember 14, 2000. Corporation M’s 2000 thirdquarter estimated tax payment will be made timely ifpaid on or before December 14, 2000. In addition,because excise and employment tax returns aredescribed in paragraph (c) of this section,Corporation M’s 2000 third quarter Form 720 andthird quarter Form 941 will be filed timely if filed onor before January 29, 2001. However, becausedeposits of taxes are excluded from the scope of para-graph (c) of this section, Corporation M’s employ-ment tax deposit is due on September 15, 2000. Inaddition, Corporation M’s deposits relating to thethird quarter Form 720 are due without extension.

Example 2. The facts are the same as in Example1, except that during 2000, Corporation M’s 1996

January 16, 2001 324 2001–3 I.R.B.

Form 1120 is being examined by the IRS. Pursuantto a timely filed request for extension of time to file,Corporation M timely filed its 1996 Form 1120 onSeptember 15, 1997. Without application of thissection, the statute of limitations on assessment for1996 income tax will expire on September 15, 2000.However, pursuant to paragraph (c) of this section,assessment of tax is one of the government acts forwhich up to 90 days may be disregarded. The IRSdetermines that an extension of the statute of limita-tions is necessary and appropriate under these cir-cumstances. Because the September 15, 2000, expi-ration date of the statute of limitations on assessmentfalls within the period of the disaster as described inthe IRS’s published guidance, the 90 day period dis-regarded under paragraph (b) of this section beginson September 16, 2000, and ends on December 14,2000. Accordingly, the statute of limitations onassessment for Corporation M’s 1996 income taxwill expire on December 14, 2000.

Example 3. The facts are the same as in Example2, except that the examination of the 1996 taxableyear was completed earlier in 2000, and on July 28,2000, the IRS mailed a statutory notice of deficien-cy to Corporation M. Without application of thissection, Corporation M has 90 days (or until October26, 2000) to file a petition with the Tax Court.However, pursuant to paragraph (c) of this section,filing a petition with the Tax Court is one of the tax-payer acts for which up to 90 days may be disre-garded. Because Corporation M is an affected tax-payer, Corporation M’s petition to the Tax Court willbe filed timely if filed on or before January 24, 2001.

Example 4. (i) H and W, individual calendar yeartaxpayers, intend to file a joint Form 1040, “U.S.Individual Income Tax Return,” for the 2001 taxableyear and are required to file a Schedule H,“Household Employment Taxes.” The joint return isdue on April 15, 2002. H and W fully and timelypaid all taxes for the 2001 taxable year, includingdomestic service employment taxes, through with-holding and estimated tax payments. H and W’sprincipal residence is in County B in State Y.

(ii) On April 2, 2002, a severe ice storm strikesCounty B. On April 5, 2002, the President declaresa disaster within the meaning of section 1033(h)(3).The IRS determines that County B in State Y is acovered disaster area and publishes guidanceinforming taxpayers that for acts described in para-graph (c) of this section that are required to be per-formed within the period beginning on April 2, 2002,and ending on April 19, 2002, 90 days will be disre-garded in determining whether the acts are per-formed timely.

(iii) Because H and W’s principal residence is inCounty B, H and W are affected taxpayers. BecauseApril 15, 2002, the due date of H and W’s 2001Form 1040 and Schedule H, falls within the periodof the disaster as described in the IRS publishedguidance, the 90 day period disregarded under para-graph (b) of this section begins on April 16, 2002,and ends on July 14, 2002, a Sunday. Pursuant tosection 7503, if the last day for performing an actfalls on Saturday, Sunday, or a legal holiday, the per-formance of the act shall be considered timely if it isperformed on the next succeeding day that is not aSaturday, Sunday, or legal holiday. Accordingly, Hand W’s 2001 Form 1040 and Schedule H will befiled timely if filed on or before July 15, 2002.

Example 5. (i) H and W, residents of County C in

State Z, want to file an amended return to request arefund of 2001 taxes. H and W timely filed their2001 income tax return on April 15, 2002. Withoutapplication of section 7508A, under section 6511(a),H and W’s amended 2001 tax return must be filed onor before April 15, 2005.

(ii) On April 1, 2005, an earthquake strikesCounty C. On April 5, 2005, the President declaresa disaster within the meaning of section 1033(h)(3).The IRS determines that County C in State Z is acovered disaster area and publishes guidanceinforming taxpayers that for acts described in para-graph (c) of this section that are required to be per-formed within the period beginning on April 1, 2005,and ending on April 19, 2005, 90 days will be disre-garded in determining whether the acts are per-formed timely.

(iii) Under paragraph (c) of this section, filing aclaim for refund of tax is one of the taxpayer acts forwhich up to 90 days may be disregarded. Ninetydays are disregarded under paragraph (b)(1) of thissection beginning on April 16, 2005, and ending onJuly 14, 2005. Accordingly, H’s and W’s claim forrefund for 2001 taxes will be timely if filed on orbefore July 14, 2005. Moreover, in applying thelookback period in section 6511(b)(2)(A), whichlimits the amount of the allowable refund, the periodfrom July 14, 2005, back to April 16, 2005, is disre-garded under paragraph (b)(2) of this section. Thus,if the claim is filed on or before July 14, 2005,amounts deemed paid on April 15, 2002, under sec-tion 6513(b), such as estimated tax and tax withheldfrom wages, will have been paid within the lookbackperiod of section 6511(b)(2)(A).

Example 6. (i) L is an unmarried, calendar yeartaxpayer whose principal residence is located inCounty R in State T. L does not timely file a 2001Form 1040, “U.S. Individual Income Tax Return,”which is due on April 15, 2002, and does not timelypay tax owed on that return. Absent reasonablecause, L is subject to the failure to file and failure topay penalties under section 6651 beginning on April16, 2002.

(ii) On May 10, 2002, a tornado strikes County R.On May 14, 2002, the President declares a disasterwithin the meaning of section 1033(h)(3). The IRSdetermines that County R in State T is a covered dis-aster area and publishes guidance informing taxpay-ers that for acts described in paragraph (c) of thissection that are required to be performed within theperiod beginning on May 10, 2002, and ending onJune 27, 2002, 90 days will be disregarded in deter-mining whether the acts are timely.

(iii) On May 31, 2002, L files a 2001 Form 1040,“U.S. Individual Income Tax Return,” and pays thetax owed for 2001.

(iv) Because L’s principal residence is in CountyR, L is an affected taxpayer. For purposes of penal-ties under section 6651, 90 days are disregardedunder paragraph (b) of this section beginning onMay 10, 2002. Because L files the return on May31, 2002, the penalties under section 6651 will runfrom April 16, 2002, until May 10, 2002. Becausethere is no extension of time to file returns undersection 6081 and no extension of time to pay undersection 6161, interest is not abated under section6404(h), and L is liable for the underpayment inter-est for the entire period of April 16, 2002, throughMay 31, 2002.

Example 7. The facts are the same as in Example

6, except L does not file the 2001 Form 1040 untilNovember 25, 2002. Ninety days are disregardedunder paragraph (b) of this section beginning on May10, 2002, and ending on August 8, 2002. Therefore,the section 6651 penalties will run from April 16,2002, until May 10, 2002, and from August 9, 2002,until November 25, 2002. Because there is no exten-sion of time to file returns under section 6081 and noextension of time to pay under section 6161, interest isnot abated under section 6404(h), and L will remainliable for underpayment interest for the entire period ofApril 16, 2002, through November 25, 2002.

Example 8. (i) H and W, individual calendar yeartaxpayers, intend to file a joint Form 1040, “U.S.Individual Income Tax Return,” for the 2001 taxableyear. The joint return is due on April 15, 2002. Aftercredits for withholding under section 31 and estimatedtax payments, H and W owe tax for the 2001 taxableyear. H and W’s principal residence is in County D inState Q.

(ii) On March 1, 2002, severe flooding strikesCounty D. On March 5, 2002, the President declaresa disaster within the meaning of section 1033(h)(3).The IRS determines that County D in State Q is a cov-ered disaster area and publishes guidance informingtaxpayers that for acts described in paragraph (c) ofthis section that are required to be performed withinthe period beginning on March 1, 2002, and ending onApril 25, 2002, 90 days will be disregarded in deter-mining whether the acts are performed timely. Theguidance also grants affected taxpayers an additional6-month extension of time to file returns under section6081 and an additional 6-month extension of time topay under section 6161.

(iii) Because H and W’s principal residence is inCounty D, H and W are affected taxpayers. Pursuant tothe published guidance, H and W have until January13, 2003, to file their return and pay the tax. This dateis computed as follows: Under sections 6081 and6161, H and W will have an additional 6 months, untilOctober 15, 2002, to file and pay the tax. Further,under paragraph (f) of this section, 90 days are disre-garded in determining the period of the extension.Therefore, H and W’s return and payment of tax will betimely if filed and paid on or before January 13, 2003.In addition, under section 6404(h), underpayment inter-est under section 6601 is abated for the entire period,from April 16, 2002, until January 13, 2003.

(h) Effective date. This section appliesto disasters declared after December 30,1999.

Robert E. Wenzel,Deputy Commissioner

of Internal Revenue.

Approved November 30, 2000.

Jonathan Talisman,Acting Assistant Secretary

of the Treasury.

(Filed by the Office of the Federal Register on De-cember 14, 2000, 8:45 a.m., and published in theissue of the Federal Register for December 15, 2000,65 F.R. 78409)

2001–3 I.R.B. 325 January 16, 2001

Section 7520.—Valuation Tables

The adjusted applicable federal short-term, mid-term, and long-term rates are set forth for the monthof January 2001. See Rev. Rul. 2001–3 page 319.

Section 7702B.—Treatment ofQualified Long-Term CareInsurance

The Service provides an inflation adjustment tothe stated dollar amount of the per diem limitation

regarding periodic payments received under a quali-fied long-term care insurance contract or periodicpayments received under a life insurance contractthat are treated as paid by reason of the death of achronically ill individual for calendar year 2001. SeeRev. Proc. 2001–13, page 337.

Section 7872.—Treatment ofLoans With Below-MarketInterest Rates

The adjusted applicable federal short-term, mid-term, and long-term rates are set forth for the month

of January 2001. See Rev. Rul. 2001–3 page 319.

January 16, 2001 326 2001–3 I.R.B.

Partnership Termination - FinalShort-Year Tax Return

Notice 2001–5

This notice provides guidance to part-nerships regarding the need to file a finalshort-year partnership tax return follow-ing a partnership termination under§708(b)(1)(B) of the Internal RevenueCode. Questions have arisen regardingwhether a terminated partnership files afinal short-year tax return given that thenew partnership resulting from the termi-nation will continue to use the employeridentification number of the terminatedpartnership.

A partnership terminates for tax pur-poses under § 708(b)(1)(B) as a result ofthe sale or exchange of 50 percent or moreof the total interest in partnership capitaland profits within a 12-month period. Theregulations under § 708(b) were modifiedin 1997 to provide that following the ter-mination of a partnership, the terminatedpartnership is deemed to contribute all itsassets and liabilities to a new partnershipin exchange for an interest in the newpartnership; and, immediately thereafter,the terminated partnership distributesinterests in the new partnership to the pur-chasing partner and the other remainingpartners in proportion to their respectiveinterests in the terminated partnership inliquidation of the terminated partnership.

Section 301.6109–1(d)(2)(iii) of theProcedure and Administration Regulationsprovides that the new partnership that isformed as a result of the termination of apartnership under § 708(b)(1)(B) will retainthe employer identification number of theterminated partnership.

Section 1.706–1(c)(1) of the IncomeTax Regulations provides that in the caseof a termination, the partnership taxableyear closes for all partners as of the dateof termination. Thus, the taxable year ofthe partnership terminates with the termi-nation of the partnership under § 708(b)(1)(B). Under § 6031(a) everypartnership that is required to file a returnmust file a return of partnership incomefor each taxable year of the partnership.

Under § 443(a)(2), a return is requiredto be made for a period of less than 12months if the taxpayer is in existence for

only part of what would otherwise be itstaxable year.

Accordingly, a partnership that termi-nates under § 708(b)(1)(B) is required tofile a short-year final return for the taxableyear ending with the date of its termina-tion. The new partnership is required tofile a return for its taxable year beginningafter the date of termination of the termi-nated partnership.

The principal author of this notice isStephen J. Coleman of the Office of theAssociate Chief Counsel (Passthroughsand Special Industries). For further infor-mation regarding this notice contact Mr.Coleman at (202) 622-3060 (not a tollfree call).

Air Transportation Excise Tax;Amount Paid for the Right toAward Miles

Notice 2001–6

This notice provides rules relating tothe air transportation tax imposed by § 4261(a) of the Internal Revenue Codeon amounts paid for the right to providemileage awards. The notice reflectschanges made by § 1031(c)(2) of theTaxpayer Relief Act of 1997, 1997–4(Vol. 1) C.B. 2, 144, which added § 4261(e)(3) to the Code. Section4261(e)(3) provides that the tax imposedby § 4261(a) applies to any amount paid(and the value of any other benefit provid-ed) for the right to provide mileageawards for, or other reductions in the costof, any transportation of persons by air.The Treasury Department and the InternalRevenue Service expect to issue the sub-stance of this notice as a regulation at alater date. Until that regulation is pub-lished, persons responsible for collectingthe tax and persons responsible for payingthe tax may rely on the guidance providedin this notice.

Section 4261(a) imposes a 7.5 percentexcise tax on amounts paid for taxabletransportation. Taxable transportationincludes most domestic air transportation(that is, transportation between points inthe United States) and certain air trans-portation beginning or ending in southernCanada or northern Mexico. With the

exception of these Canadian and Mexicanflights, the tax does not apply to air trans-portation between the United States and aforeign country, which is subject to theinternational arrival and departure taximposed by § 4261(c), or to entirely for-eign air transportation, which is not taxed.

Section 4261(e)(3) was enacted for thepurpose of “clarifying that the air trans-portation excise tax applies to paymentsto air carriers (and related parties) for theright to award air travel benefits.” H.R.Conf. Rep. No. 105–220, at 555 (1997),1997–4 (Vol. 2) C.B. 2025. Thus, becausethe Treasury Department and the IRShave concluded that this clarification wasintended as a backstop to the 7.5 percenttax imposed by § 4261(a), the newmileage award rules should not apply withrespect to mileage awards for air trans-portation that would not, under any cir-cumstances, be subject to the tax imposedby § 4261(a) or with respect to mileageawards that will otherwise be fully subjectto that tax.

Regulations under § 4261(e)(3) willprovide the following rules concerningmileage awards:

(1) Amounts paid for mileage awardsthat cannot be redeemed for taxable trans-portation (for example, awards usableonly on a foreign air carrier) are not sub-ject to tax.

(2) Amounts paid by an air carrier toanother air carrier, whether foreign ordomestic, for mileage awards that can beredeemed for taxable transportation arenot subject to tax to the extent those mileswill be awarded in connection with thepurchase of air transportation subject tothe tax imposed by § 4261(a).

(3) Amounts paid by an air carrier toanother air carrier, whether foreign ordomestic, for mileage awards that can beredeemed for taxable transportation aresubject to tax to the extent those miles willbe awarded other than in connection withthe purchase of air transportation subjectto the tax imposed by § 4261(a).

Air carriers may use any reasonablemethod to allocate amounts paid (and thevalue of any other benefits provided)between purchased mileage that cannot beredeemed for taxable transportation orthat will be awarded in connection withthe purchase of air transportation that is

2001–3 I.R.B. 327 January 16, 2001

Part III. Administrative, Procedural, and Miscellaneous

subject to the tax imposed by § 4261(a)and purchased mileage that does not meeteither of these conditions.

These rules apply to amounts paid afterSeptember 30, 1997. However, anyamount paid after June 11, 1997, by onemember of a controlled group for amileage award that is furnished by anoth-er member of the controlled group afterSeptember 30, 1997, is treated as paidafter September 30, 1997.

The principal author of this notice isPatrick S. Kirwan of the Office ofAssociate Chief Counsel (Passthroughsand Special Industries). For further infor-mation regarding this notice contact Mr.Kirwan at (202) 622-3130 (not a toll-freecall).

Inflation-Adjusted Amounts for2001

Notice 2001–12

PURPOSE

This notice clarifies Rev. Proc.2001–13, 2001–3 I.R.B. (Jan. 16, 2001),to provide that the inflation-adjustmentamounts set forth in Part I of section 3 ofthat revenue procedure are the applicableamounts for 2001 in light of recentlyenacted legislation.

BACKGROUND

Section 3 of Rev. Proc. 2001–13,released on December 15, 2000, set forthtwo alternative sets of inflation adjust-ment figures for 2001 for certain items.Part I of section 3 provided the figures forthese items that would apply if certainlegislation, pending on the date ofrelease, were to be enacted. Part II of sec-tion 3 provided alternative figures forthese items that would apply if the pend-ing legislation were not enacted. Section2.02 of Rev. Proc. 2001–13 stated that theService would issue subsequent notifica-tion clarifying whether the amounts setforth in Part I or Part II of section 3 are infact the appropriate figures for 2001.

The then-pending legislation was sub-sequently enacted as section 308 of H.R.5662, the Community Renewal Tax ReliefAct of 2000 (the “Act”), the text of whichwas incorporated by reference in section

1(a)(7) of the Consolidated Appropria-tions Act of 2001, Public Law 106–554,106th Cong., 2nd Sess. (Dec. 21, 2000).

APPLICATION

As a result of section 308 of the Act,the tax tables and other items adjustedfor inflation for 2001 in Rev. Proc.2001–13 are required to reflect theunpublished corrections made by theBureau of Labor Statistics in theConsumer Price Index for All UrbanConsumers for September 1999 throughDecember 1999. Thus, the applicableinflation-adjusted amounts for 2001 arethose set forth in Part I of section 3 ofRev. Proc. 2001–13. Part II of section 3should be disregarded. The specificitems that are affected are:

(1) the tax rate tables (set forth in sec-tion 3.01);

(2) certain figures relating to theearned income tax credit (section 3.03);

(3) the aggregate amount of giftsreceived from foreign persons for purpos-es of information reporting under § 6039F(section 3.22); and

(4) the amount used to determine thevalidity of certain tax liens under § 6323(b)(7) (section 3.23).

EFFECT ON OTHER DOCUMENTS

Rev. Proc. 2001–13 is clarified.

DRAFTING INFORMATION

The principal author of this notice is PaulE. Tellier of the Office of Associate ChiefCounsel (Income Tax & Accounting). Forfurther information regarding this noticecontact Mr. Tellier at (202) 622-4930 (nota toll-free call).

26 CFR. 601.602: Tax forms and instructions. (AlsoPart I, secs. 6011, 6061, 6071, 6651; 31.6011(a)–3,31.6011(a)–7, 31.6061–1, 301.6061–1,31.6071(a)–1, 301.6651–1)

Rev. Proc. 2001–9

Table of Contents SECTION 1. PURPOSE SECTION 2. BACKGROUND SECTION 3. SCOPE SECTION 4. DEFINITIONS SECTION 5. APPLICATION FOR THEFORM 940 e-file PROGRAM

SECTION 6. ACCEPTANCE IN THEFORM 940 e-file PROGRAM SECTION 7. ELECTRONIC FILING OFFORM 940 SECTION 8. RESPONSIBILITIES OFPARTICIPANTS IN FORM 940 e-filePROGRAMSECTION 9. ALTERNATIVE FILINGPROCEDURES SECTION 10. REVISION OF COM-PUTER SPECIFICATIONS BY THESERVICE SECTION 11. ADVERTISING STAN-DARDS SECTION 12. REASONS FOR SUS-PENSION SECTION 13. ADMINISTRATIVE RE-VIEW PROCESS FOR PROPOSEDSUSPENSION SECTION 14. EFFECT OF SUSPENSION SECTION 15. APPEAL OF SUSPEN-SION SECTION 16. PENALTY FOR FAIL-URE TO TIMELY FILE A RETURN SECTION 17. INTERNAL REVENUESERVICE CONTACTSECTION 18. EFFECT ON OTHERDOCUMENTSSECTION 19. EFFECTIVE DATE SECTION 20. PAPERWORK REDUC-TION ACT

SECTION 1. PURPOSE

This revenue procedure provides therequirements for electronically filing theForm 940, Employer’s Annual FederalUnemployment (FUTA) Tax Return in the“Form 940 e-file Program.” Under “IRS e-file for Business,” there are two optionsfor electronically filing Form 940: 940 e-file Option and 940 On-Line Option, bothsimilar to the 941 e-file and 941 On-Lineoptions. There is no 940 TeleFile option atthis time. The technical specifications forfiling Form 940 electronically are pub-lished separately in Publication 3715,Technical Specifications Guide for theElectronic Filing of Form 940, Employer’sAnnual Federal Unemployment (FUTA)Tax Return. This revenue procedure doesnot address the requirements of the Form941 e-file Program, which can be found inRev. Proc. 99–39, 1999–2 C.B. 532.

SECTION 2. BACKGROUND

.01 Section 6011(a) of the InternalRevenue Code provides that any person

January 16, 2001 328 2001–3 I.R.B.

liable for any tax imposed by this title, orfor the collection thereof, must make areturn or statement according to the formsand regulations prescribed by theSecretary. Every person required to makea return or statement must include thereinthe information required by such forms orregulations.

.02 Section 31.6011(a)–3 of theRegulations on Employment Taxes andCollection of Income Tax at Source pro-vides in general that every person mustmake a return of tax under the FederalUnemployment Tax Act for each calendaryear in which the person is an employer asdefined in section 31.3306(a)–1. Exceptas otherwise provided, Form 940 is theform prescribed for making the return.

.03 Section 31.6011(a)–7 provides thateach return, together with any prescribedcopies or supporting data, must be filledin and disposed of in accordance with theforms, instructions, and regulationsapplicable thereto. The return may bemade by an agent in the name of the per-son required to make the return if anacceptable power of attorney is filed withthe Internal Revenue Service office withwhich such person is required to filereturns and if such a return includes alltaxes required to be reported by such per-son on such return. Form 8655, ReportingAgent Authorization for MagneticTape/Electronic Filers, is an acceptablepower of attorney, if prepared in accor-dance with the requirements set forth inRev. Proc. 96–17, 1996–1 C.B. 633, asmodified by section 18 of this revenueprocedure.

.04 Section 31.6061–1 provides that thereturn may be signed for the taxpayer byan agent that is fully authorized in accor-dance with section 31.6011(a)–7 to makesuch return. An agent may sign the Form940 on behalf of a taxpayer that has avalid form on file with the Service.

.05 Section 301.6061–1 of the Regula-tions on Procedure and Administrationprovides that the Secretary may prescribein forms, instructions, or other appropriateguidance the method for signing anyreturn, statement, or other documentrequired to be made under any provisionof the internal revenue laws or regula-tions. The Service has prescribed inPublication 3715 that an electronically-filed Form 940 is signed by the entry ofthe Authorized Signatory’s Personal

Identification Number (“PIN”). .06 Section 31.6071(a)–1(c) generally

provides that each return of the taximposed by the Federal UnemploymentTax Act required to be made under section31.6011(a)–3 must be filed on or beforethe last day of the first calendar monthfollowing the period for which it is made.However, that regulation also providesthat a return may be filed on or before the10th day of the second calendar monthfollowing the tax period if timely depositsunder section 6302(c) of the Code and theregulations thereunder have been made infull payment of such tax due for the peri-od.

.07 Procedures for the magnetic filingof Form 940 are in Rev. Proc. 96–18,1996–1 C.B. 637, and the specificationsare in Publication 1314. For further infor-mation, see Publication 1314, Form940—Employer’s Federal UnemploymentTax Return (FUTA): File Specifications,Processing Criteria, and Record Layoutsfor Magnetic Tape Filing.

SECTION 3. SCOPE

.01 The Form 940 e-file Programapplies to electronically-filed Forms 940for the year ending December 31, 2000,and thereafter that are timely filed. Lateand/or amended Forms 940 must not befiled electronically. A violation of theserestrictions may cause a ProcessingInterruption (as defined in section 4.10 ofthis revenue procedure). Late and/oramended Forms 940 must be filed bypaper only.

.02 The Form 940 e-file Programapplies only to the Form 940. The Form940 e-file Program does not apply to theForm 940 (PR), Employer’s AnnualFederal Unemployment (FUTA) TaxReturn (Puerto Rican Version) or theForm 940 EZ, Employer’s Annual FederalUnemployment (FUTA) Tax Return. Donot file the listed forms electronically.Taxpayers who currently file a paperForm 940 EZ, however, may wish to elec-tronically file a Form 940.

SECTION 4. DEFINITIONS

.01 Form 940 e-file Program. The pro-gram within “IRS e-file for Business” thatprovides two options for electronically fil-ing Forms 940, Employer’s AnnualFederal Unemployment (FUTA) Tax

Return: 940 e-file Option and 940 On-Line Option.

.02 940 e-file Option. The option forelectronically filing a Form 940 in theForm 940 e-file Program that allows tax-payers to use a Reporting Agent to pre-pare, sign and electronically file Form 940for the taxpayer.

.03 940 On-Line Option. The optionfor electronically filing a Form 940 in theForm 940 e-file Program that allows tax-payers to use the World Wide Web, via aTransmitter, to electronically file Form940.

.04 Authorized Signatory. AnAuthorized Signatory is a person who isauthorized to use a PIN to sign returnsfiled by or through an Electronic Filerunder the Form 940 e-file Program or dur-ing software development testing.

.05 Electronic Filer. An ElectronicFiler may be a:

(1) Reporting Agent. A ReportingAgent (“Agent”), commonly called a“payroll service,” is an accounting ser-vice, franchiser, bank, or other person thatcomplies with Rev. Proc. 96–17, as modi-fied by section 18 of this revenue proce-dure, and is authorized to prepare, sign,and electronically file a Form 940 for ataxpayer by using the 940 e-file Option ofthe Form 940 e-file Program;

(2) Software Developer. A SoftwareDeveloper develops software for the pur-poses of (a) formatting returns accordingto the Service’s electronic return specifi-cations in Publication 3715; and/or (b)transmitting electronic returns directly tothe Service. A Software Developer mayalso sell its software. A SoftwareDeveloper may develop software for the940 e-file Option and/or the 940 On-LineOption of the Form 940 e-file Program; or

(3) Transmitter. A Transmitter is afirm, organization, or individual thatreceives returns and Letters ofApplication electronically from its clients,reformats the data (if necessary), batchesthe data with returns or electronic Lettersof Application from other clients, and thentransmits the data to the Service. ATransmitter does not have signatureauthority for the taxpayers that it services.A Transmitter receives the data from itsclients via the World Wide Web and trans-mits the data to the Service by using theOn-Line Option of the Form 940 e-fileProgram.

2001–3 I.R.B. 329 January 16, 2001

.06 On-Line Filer. An On-Line Filer isa taxpayer that electronically files a Form940 through a Transmitter using a person-al computer, modem, and commercial taxpreparation software.

.07 Electronic Filing Help Desks TheElectronic Filing Help Desks (“e-file” HelpDesks) in Austin, Texas, and in Memphis,Tennessee, are responsible for the adminis-tration of the Form 940 e-file Program. Seesection 17 of this revenue procedure for adescription of their respective responsibili-ties, and the address and telephone numberof each e-file Help Desk.

.08 Letter of Application. A Letter ofApplication (“LOA”) is a paper or elec-tronic request that is submitted to theService by a prospective Electronic Fileror On-Line Filer to participate in the Form940 e-file Program and, if submitted by anAuthorized Signatory, to receive aPersonal Identification Number. A sam-ple LOA is printed in Publication 3715.

.09 Personal Identification Number. APersonal Identification Number (“PIN”) isa number assigned by the Service to theAuthorized Signatory for purposes ofsigning an electronically-filed Form 940.

.10 Processing Interruption. AProcessing Interruption is an abnormaltermination of a program run caused bythe electronic data submitted by anElectronic Filer.

.11 Reporting Agent Authorization. AReporting Agent Authorization(“Authorization”) allows a taxpayer todesignate an Agent. The Authorizationmay be submitted on Form 8655, or anyother instrument that complies with Rev.Proc. 96–17, as modified by section 18 ofthis revenue procedure. An Authorizationmust be submitted for each taxpayer onthe Reporting Agent’s List.

.12 Reporting Agent’s List. For purpos-es of the Form 940 e-file Program, aReporting Agent’s List (“Agent’s List”)identifies all taxpayers for whom anAgent will file Forms 940 electronically.A separate Authorization must be submit-ted for each taxpayer on the Agent’s List.The Agent’s List must contain each tax-payer’s employer identification number(“EIN”).

.13 User identification/password. Theuser identification/password (“userid/pass-word”) consists of an identification number(userid) issued by the Service and a confi-

dential set of characters (password) that,when used in conjunction with each other,permit an Electronic Filer access to theForm 940 e-file Program.

.14 Validated Reporting Agent’s List. AValidated Reporting Agent’s List(“Validated Agent’s List”) is a list of tax-payers and their EINs prepared by anAgent that is confirmed and assignedname controls by the Service. A ValidatedAgent’s List is to be used as a source forthe identification of each taxpayer by anElectronic Filer that is an Agent. Once theService returns a Validated Agent’s List,the Agent must use it to fill in certainrequired fields (for example, the namecontrol field) of the electronic transmis-sion. See Publication 3715.

SECTION 5. APPLICATION FOR THEFORM 940 e-file PROGRAM

.01 A prospective Electronic Filer mustfirst submit an LOA to the Service to par-ticipate in the Form 940 e-file Program.The LOA of a prospective Electronic Filermay be submitted electronically or bypaper. See Publication 3715 for a sampleLOA for an Agent, a Software Developer,and a Transmitter, and the application pro-cedures.

.02 A prospective On-Line Filer mustsubmit an electronic LOA through aTransmitter to participate in the Form 940e-file Program. A prospective On-LineFiler must use the electronic LOA provid-ed in the commercial tax preparation soft-ware used by the taxpayer in order to par-ticipate in the Form 940 e-file Program.The Transmitter is required to batch andbundle the electronic LOA files, and thentransmit those files to the Service. TheTransmitter is required to send anacknowledgment to the On-Line Filer toverify that the electronic LOA was trans-mitted successfully to the Service.

.03 In addition to the LOA, an Agentmust also include an Agent’s List, provid-ing the names of all taxpayers for which itwill file returns. Each name on theAgent’s List must be accompanied by anAuthorization made on Form 8655, oracceptable substitute, except as providedin section 5.04 of this revenue procedure.See Rev. Proc. 96–17, as modified by sec-tion 18 of this revenue procedure, for gen-eral instructions on preparing Form 8655.See section 6.10 of this revenue procedure

for instructions on adding names to, ordeleting names from, the Agent’s List.

.04 A revised Authorization is notrequired to replace an Authorization madeon Form 8655 with a revision date beforeOctober 1995 (or its equivalent) that waspreviously submitted to the Service by anAgent, if the Authorization places norestriction on the medium for filing Form940, and the Agent:

(1) advises its client that its Forms940 may be filed electronically, and pro-vides the client with the option of reject-ing electronic filing as the medium for fil-ing its Forms 940. An Agent may use themost efficient and timely method of clear-ly providing this notification to a client. Aclient’s rejection of electronic filing for itsForms 940 must be submitted in writingto the Agent; and

(2) immediately removes from itselectronic filing client base any client thatrejects having its Forms 940 filed elec-tronically.

SECTION 6. ACCEPTANCE IN THEFORM 940 e-file PROGRAM

.01 A prospective Electronic Filer orOn-Line Filer will receive an acceptanceor rejection regarding its LOA for theForm 940 e-file Program within 45 daysof the Service’s receipt of their completedLOA.

.02 An Electronic Filer that is acceptedin the Form 940 e-file Program will berequired to submit a successful test trans-mission before being granted approval tofile tax returns. Details regarding testrequirements may be found in Publication3715.

.03 After evaluating the test file, theService will notify an Electronic Filer inwriting of approval or denial of electronicfiling privileges. An approval remains ineffect unless the Electronic Filer:

(1) that is an Agent fails to complywith the Authorization requirements ofsections 5.03 and 5.04 of this revenueprocedure;

(2) that is a Software Developer failsto comply with the requirements of sec-tion 8.04 of this revenue procedure;

(3) that is a Transmitter fails to com-ply with the requirements of section 8.03of this revenue procedure; or

(4) is suspended from the Form 940e-file Program. See section 14 of this rev-

January 16, 2001 330 2001–3 I.R.B.

enue procedure for the effect of a suspen-sion.

.04 The acceptance by the Service of aSoftware Developer as an ElectronicFiler:

(1) establishes only that the test elec-tronic transmission(s) are formatted prop-erly and may be processed by the Service;

(2) is not an endorsement by theService of the software or the quality ofservices provided by the SoftwareDeveloper; and

(3) does not entitle the SoftwareDeveloper to electronically file Forms940 unless the Software Developer is alsoaccepted in the Form 940 e-file Programas an Agent or Transmitter.

.05 If an LOA is approved, the Servicewill send the following:

(1) for an Electronic Filer, a notifica-tion of approval that will contain theuserid/password, and information andprocedures regarding signing onto thesystem for electronically filing Forms940; and

(2) for an Authorized Signatory, aPIN that may be used only by theAuthorized Signatory named in the LOA.

.06 Upon receipt of the document(s)referenced in section 6.05 of this revenueprocedure, the Electronic Filer mustreturn the following documents to theService:

(1) an acknowledgment signed byeach employee recipient of the userid/pass-word indicating possession of, and respon-sibility for, the userid/password; and

(2) where applicable, an acknowl-edgment signed by the AuthorizedSignatory indicating possession of, andresponsibility for, the proper use of thePIN for signing tax returns (pursuant to § 301.6061–1) filed in the Form 940 e-fileProgram.See Publication 3715 for a sampleuserid/password and PIN receipt.

.07 Upon receipt of the PIN referencedin section 6.05(2) of this revenue proce-dure, the On-Line Filer must return anacknowledgment signed by theAuthorized Signatory indicating posses-sion of, and responsibility for, the properuse of the PIN for signing tax returns(pursuant to § 301.6061–1) filed in theForm 940 e-file Program.

.08 The Service will activate theuserid/password and the PIN upon receiv-

ing the Electronic Filer’s or On-LineFiler’s acknowledgments referenced insections 6.06 and 6.07 of this revenue pro-cedure.

.09 If a prospective Electronic Filer thatis an Agent is denied, or does not receive,approval to participate in the Form 940 e-file Program before the end of the yearfor which the Forms 940 will be filed, theAgent may file the Forms 940 on magnet-ic tape (if the Agent meets the require-ments of Rev. Proc. 96–18) or preparepaper Forms 940. See section 9.02 of thisrevenue procedure for the circumstancesthat must exist for an Electronic Filer whois an Agent to use a Form 8655 as author-ity to sign and file a paper Form 940.

.10 After a Reporting Agent is notifiedthat the application for electronically fil-ing Forms 940 has been approved, theAgent may need to add and delete taxpay-ers’ names from the Agent’s List.

(1) To add taxpayers, the Agent mustsubmit an Add Llist with names to beadded, their respective employer identifi-cation numbers, and Authorization foreach taxpayer added to the Agent’s List.The Service will validate and mail the val-idated Add List to the Agent within 10business days of receiving the Add List.

(2) To delete taxpayers, the Agentmust submit a Delete List with the namesto be deleted, and if known, a short state-ment indicating which taxpayers will notremain in business.

SECTION 7. ELECTRONIC FILING OFFORM 940

.01 An Electronic Filer that is an Agentmust ensure that a current electronic Form940 is filed on or before the due date ofthe return. The due dates prescribed forfiling paper Forms 940 with the Servicealso apply to returns filed under the Form940 e-file Program. Forms 940 are due onor before the last day of the first calendarmonth following the calendar year forwhich the return is made. However, areturn for which all tax deposits weremade when due may be filed by the 10thday of the second calendar month follow-ing the end of the calendar year.

.02 An Electronic Filer that is aTransmitter must ensure that an electronicForm 940 is transmitted to the Service onor before the due date of the return, asdescribed in sec. 7.01, without regard to

extensions. .03 An electronically-filed Form 940 is

not considered filed until it has beenacknowledged as accepted for processingby the Service. If an electronically-filedForm 940 is transmitted to the Service onor before the return due date, andacknowledged as accepted for processing,the return will be deemed timely filed. Ifan electronically-filed Form 940 is initial-ly transmitted to the Service on or beforethe return due date and is ultimatelyrejected, but the Electronic Filer complieswith section 7.04 or 7.05 of this revenueprocedure, as appropriate, and the On-Line Filer also complies with section 7.06of this revenue procedure, the return willbe deemed timely filed.

.04 An electronic transmission thatcauses a Processing Interruption will notbe accepted for processing by the Service.An Electronic Filer that is an Agent willbe asked to resubmit the return(s). If theelectronic transmission is acknowledgedas rejected by the Service, the Agentshould correct the error(s) and retransmitthe return(s) on the same calendar day. Ifthe Agent chooses not to have the previ-ously-rejected return retransmitted, or ifthe return still cannot be accepted for pro-cessing, a paper Form 940 (or a Form 940on magnetic tape if the Electronic Filermeets the requirements of Rev. Proc.96–18) must be filed by the later of: (1)the due date of the return; or (2) withinfive calendar days of the rejection ornotice that the return cannot be retrans-mitted, with an explanation of why thereturn is being filed after the due date.For the penalty for failure to file a timelyreturn, see section 16 of this revenue pro-cedure.

.05 If a Processing Interruption occurswith an Electronic Filer that is aTransmitter, and the Transmitter cannotpromptly correct any transmission errorthat causes an electronic transmission tobe rejected, then the Transmitter, within24 hours of receiving the rejectionacknowledgment, must take reasonablesteps to inform the On-Line Filer that thereturn has not been filed. When theTransmitter advises the On-Line Filer thatthe return has not been filed, theTransmitter must provide the On-LineFiler with the reject code(s), an explana-tion of the reject code(s), and the

2001–3 I.R.B. 331 January 16, 2001

sequence number of each reject code(s).See Publication 3715 for an explanationof the reject codes.

.06 If the On-Line Filer chooses not tohave the electronic portion of the returncorrected and transmitted to the Service,or if the electronic portion of the returncannot be accepted for processing by theService, the On-Line Filer must file apaper Form 940 by the later of: (1) the duedate of the return; or (2) within five cal-endar days of the rejection acknowledg-ment described in section 7.05, with anexplanation of why the return is beingfiled after the due date. For the penaltyfor failure to file a timely return, see sec-tion 16 of this revenue procedure.

SECTION 8. RESPONSIBILITIES OFPARTICIPANTS IN FORM 940 e-filePROGRAM

.01 To ensure that complete returns areaccurately and efficiently filed, ElectronicFilers must comply with the technicalspecifications detailed in Publication3715.

.02 An Electronic Filer or On-Line Filermust comply with the following applica-ble userid/password and PIN require-ments:

(1) if an Electronic Filer suspectsthat the confidentiality of the userid/pass-word has been compromised, theElectronic Filer must contact the Austin,Texas, e-file Help Desk within 24 hoursfor instructions on how to proceed. Seesection 17 of this revenue procedure forService contact information;

(2) the Electronic Filer or On-LineFiler is responsible for ensuring that thePIN remains the confidential informationof the Authorized Signatory. If theElectronic Filer or On-Line Filer suspectsthat the confidentiality of the PIN hasbeen compromised, the Electronic Filer orOn-Line Filer must contact the Austin,Texas, e-file Help Desk within 24 hoursfor instructions on how to proceed. Seesection 17 of this revenue procedure forService contact information;

(3) if the Authorized Signatorychanges, the Electronic Filer or On-LineFiler must notify the Service of the nameand title of the new Authorized Signatoryfor the electronically-filed Form 940 andapply for a new PIN no later than 15 daysbefore the filing of another return. Afterthis notification, the Service will deacti-

vate the current PIN and issue a new PINto the new Authorized Signatory. Thenew Authorized Signatory must submit aPIN receipt as specified in section 6.06 or6.07 of this revenue procedure in order toactivate the new PIN; and

(4) the Authorized Signatory mustmanually enter the PIN signature for eachtransmission of electronically-filed Forms940.

.03 An Electronic Filer that is aTransmitter must:

(1) retrieve the acknowledgment file(in which the Service states whether itaccepts or rejects the electronic portion ofa taxpayer’s return for processing) withintwo work days of transmission;

(2) match the acknowledgment fileto the original transmission file and sendto the On-Line Filer either:

(a) an acceptance notice withintwo days of retrieving the acknowledg-ment file; or

(b) a rejection notice within 24hours of retrieving the acknowledgmentfile;

(3) immediately contact the appro-priate service center for further instruc-tions if an acknowledgment of acceptancefor processing has not been received bythe Transmitter within two work days oftransmission or if a Transmitter receivesan acknowledgment for a return that wasnot transmitted on the designated trans-mission;

(4) promptly correct any transmis-sion error that causes an electronic trans-mission to be rejected; and

(5) ensure the security of all trans-mitted data.

.04 An Electronic Filer that is aSoftware Developer must:

(1) promptly correct any softwareerror that may cause, or causes, an elec-tronic return to be rejected;

(2) promptly distribute any such soft-ware correction;

(3) ensure that any software packagethat will be used to transmit returns frommultiple Electronic Filers that are Agents hasthe capability of combining these returnsinto one Service transmission file; and

(4) not incorporate into its software aService-assigned PIN.

.05 An Agent must retain the followingmaterial for four years after the due dateof the return, unless otherwise notified bythe Service:

(1) a complete copy of the electroni-cally-filed Form 940;

(2) a copy of the Service’s acknowl-edgement of receipt of the return; and

(3) a copy of each Authorization. .06 An Electronic Filer that is an Agent

or a Transmitter must: (1) provide the taxpayer with a copy

of the taxpayer’s electronically-filedForm 940. This information may be pro-vided on a replica or an official form or inany other format that provides all of thereturn information and references the linenumbers of the official form);

(2) advise the taxpayer to retain acopy of the return and any supportingmaterial; and

(3) provide the taxpayer, uponrequest, with the date the return was trans-mitted to the Service and the date theService acknowledged receipt of the tax-payer’s return.

SECTION 9. ALTERNATIVE FILINGPROCEDURES

.01 Procedures for the filing of Form940 on magnetic tape are in Rev. Proc.96–18 and the specifications are inPublication 1314.

.02 An Electronic Filer that is an Agentmay use an Authorization to sign and filea paper Form 940 under the following cir-cumstances:

(1) the late receipt of payroll infor-mation from a taxpayer would jeopardizethe timely submission of the taxpayer’sreturn;

(2) the amendment of returns filedunder the Form 940 e-file Program;

(3) the rejection of an electronictransmission that would jeopardize thetimely submission of the taxpayer’sreturn;

(4) an authorization by the Servicefor an Agent to file paper Forms 940instead of electronically-filed Forms 940;

(5) the suspension of an Agent fromthe Form 940 e-file Program as providedin section 14.02(3) of this revenue proce-dure; or

(6) a prospective Electronic Filer thatis an Agent is denied, or does not receive,approval to participate in the Form 940 e-file Program before the end of the yearfor which the Forms 940 will be filed.

.03 An Agent may prepare a paperForm 940 for the taxpayer’s signature. Ataxpayer’s authorized representative that

January 16, 2001 332 2001–3 I.R.B.

is not an Agent participating in the Form940 e-file Program (including a suspendedAgent) must have a valid power of attor-ney (usually a Form 2848, Power ofAttorney and Declaration ofRepresentative) that authorizes the repre-sentative to sign and file a paper Form 940on behalf of a taxpayer.

.04 Each paper Form 940 must besigned by the taxpayer, the taxpayer’sauthorized representative, or a participat-ing Agent to the extent permitted undersection 9.02 of this revenue procedure.

SECTION 10. REVISION OFCOMPUTER SPECIFICATIONS BYTHE SERVICE

.01 If Publication 3715 is revised, theService, if necessary, will advise all cur-rent Electronic Filers to submit test filesprior to filing under the new specifica-tions. Failure to submit a test file maylater result in a Processing Interruption,which may result in a notice of suspen-sion. See section 12 of this revenue pro-cedure concerning the reasons for suspen-sion of electronic filing privileges.

.02 If an Electronic Filer is unable tocomply with the changes in specifications,the Electronic Filer must contact theappropriate e-file Help Desk for furtherinstructions. See section 17 of this rev-enue procedure for Service contact infor-mation.

SECTION 11. ADVERTISINGSTANDARDS

.01 An Electronic Filer must: (1) comply with the advertising and

solicitation provisions of 31 CFR Part 10(Treasury Department Circular No. 230).This circular prohibits the use or partici-pation in the use of any form of publiccommunication containing a false, fraud-ulent, misleading, deceptive, undulyinfluencing, coercive, or unfair statementor claim. In addition, advertising mustnot imply a special relationship with theService, Financial Management Service(“FMS”), or the Treasury Department;

(2) adhere to all relevant federal,state, and local consumer protection laws;

(3) not use the Service’s name,“Internal Revenue Service” or “IRS”,within a firm’s name;

(4) not use improper or misleadingadvertising in relation to the Form 940 e-file Program;

(5) not carry the Service, FMS, orother Treasury Seals on its advertisingmaterial;

(6) clearly state the names of allcooperating parties if advertising for acooperative electronic return filing project(public/private sector);

(7) pre-record any radio or televisionadvertisement and keep a copy of thisadvertisement for a period of at least 36months from the date of the last transmis-sion or use; and

(8) retain a copy of any actual directmailing or fax communications, alongwith a list or other description of personsto whom the communication was mailed,faxed, or otherwise distributed for a peri-od of at least 36 months from the date ofthe last mailing, fax, or distribution.

.02 Acceptance to participate in theForm 940 e-file Program does not implyendorsement by the Service, FMS, or theTreasury Department of the software orquality of services provided.

SECTION 12. REASONS FORSUSPENSION

.01 The Service reserves the right tosuspend an Electronic Filer from the Form940 e-file Program for the following rea-sons (this list is not all-inclusive):

(1) submitting tax returns for whichthe Service did not receive Authoriza-tions;

(2) repeatedly submitting tax returnsthat cause a Processing Interruption;

(3) submitting tax returns that causea Processing Interruption after failing tosubmit the test file required by section6.02 of this revenue procedure;

(4) failing to comply with theresponsibilities of an Electronic Filer setforth in section 8 of this revenue proce-dure;

(5) failing to abide by the advertisingstandards in section 11 of this revenueprocedure; or

(6) significant complaints about anElectronic Filer’s performance in theForm 940 e-file Program.

.02 If the Electronic Filing Coordinatorinforms an Electronic Filer that a certainaction is a reason for suspension and theaction continues, the service center direc-tor may send the Electronic Filer a noticeproposing suspension of the ElectronicFiler. However, a notice proposing sus-pension may be sent without a warning if

the Electronic Filer’s action indicates anintentional disregard of rules. A noticeproposing suspension will describe thereason(s) for the proposed suspension,and indicate the length of the suspensionand the conditions that need to be metbefore the suspension will terminate.

.03 An Electronic Filer that is an Agentor Transmitter has an obligation to notifyits Form 940 e-file Program clients whenthat Agent or Transmitter is suspendedfrom filing under the Form 940 e-fileProgram as provided in sections 14.02(4)and 14.03 of this revenue procedure. TheService reserves the right to extend theperiod of suspension of any Agent orTransmitter that fails to comply with thisrequirement.

SECTION 13. ADMINISTRATIVEREVIEW PROCESS FOR PROPOSEDSUSPENSION

.01 An Electronic Filer that receives anotice proposing suspension may requestan administrative review prior to the pro-posed suspension taking effect.

.02 The request for an administrativereview must be in writing and containdetailed reasons, with supporting docu-mentation, for withdrawal of the proposedsuspension.

.03 The written request for an adminis-trative review and a copy of the noticeproposing suspension must be deliveredto the Electronic Filing Coordinator with-in 30 calendar days of the date on thenotice proposing suspension. TheElectronic Filing Coordinator will for-ward the written request to the NationalProgram Analyst for Electronic Filing ofBusiness Returns (“National Coor-dinator”) if the service center directorcontinues to believe that suspension iswarranted.

.04 After consideration of the writtenrequest for an administrative review, theNational Coordinator will either issue asuspension letter or notify the ElectronicFiler in writing that the proposed suspen-sion is withdrawn.

.05 If an Electronic Filer receives a sus-pension letter, the Electronic FilingCoordinator’s subsequent determinationof whether a reason for suspension hasbeen corrected is not subject to review orappeal.

.06 If an Electronic Filer does not time-ly submit a written request for an admin-

2001–3 I.R.B. 333 January 16, 2001

istrative review, the service center directorwill issue a suspension letter.

.07 Failure to submit a written request foran administrative review within the 30-dayperiod described in section 13.03 of thisrevenue procedure irrevocably terminatesthe Electronic Filer’s right to an administra-tive review of the proposed suspension.

SECTION 14. EFFECT OFSUSPENSION

.01 An Electronic Filer’s suspensionwill continue for the length of time speci-fied in the suspension letter, or until theconditions for terminating the suspensionhave been met, whichever is later.

.02 In the case of an Electronic Filerthat is an Agent, the following additionalrules apply:

(1) if a Form 940 is due (withoutregard to extensions) within 60 days fromthe date on the suspension letter, theAgent may file the Form 940 under theForm 940 e-file Program;

(2) if a Form 940 is due (withoutregard to extensions) more than 60 daysfrom the date on the suspension letter, theAgent may not file the Form 940 underthe Form 940 e-file Program;

(3) if a suspended Agent has a powerof attorney from a taxpayer that autho-rizes the Agent to sign and file Form 940,the suspended Agent will be able to signand file a paper Form 940 for the taxpay-er. See section 9.03 of this revenue pro-cedure. Form 8655 does not authorize thefiling of paper Forms 940 outside of theForm 940 e-file Program; and

(4) an Agent must provide writtennotification of a suspension to a taxpayerat least 45 days before the due date of thetaxpayer’s first return affected by the sus-pension. This notification must be provid-ed even though the Agent may believethat the Agent will be able to meet theconditions for terminating the suspensionbefore the due date.

.03 A Transmitter that receives a sus-pension letter described in section 13.04from the Service may not accept any fur-ther LOAs from prospective On-LineFilers that want to participate in the Form940 e-file Program and must immediatelyinform current On-Line Filers of itsinability to transmit Forms 940 during itssuspension

.04 An Electronic Filer will be able toparticipate in the Form 940 e-file Program

from which the Electronic Filer was sus-pended, without reapplying to the Form940 e-file Program, after:

(1) the stated suspension periodexpires; and

(2) the reason(s) for suspension iscorrected.

SECTION 15. APPEAL OFSUSPENSION

.01 If an Electronic Filer receives a sus-pension letter from the NationalCoordinator, the Electronic Filer is enti-tled to appeal, by written protest, to theNational Director of Appeals. The writtenprotest must be sent to the NationalCoordinator, who will forward it to theNational Director of Appeals. During theappeals process, the suspension remainsin effect.

.02 The written protest must bereceived by the National Coordinatorwithin 30 calendar days of the date of thesuspension letter. The written protestmust contain detailed reasons, with sup-porting documentation, for termination ofthe suspension.

.03 Within 15 calendar days of receipt ofa written protest, the National Coordinatorwill forward the file on the Electronic Filerand the material described in section 15.02of this revenue procedure to the NationalDirector of Appeals.

.04 Failure to appeal within the 30-dayperiod described in section 15.02 of thisrevenue procedure irrevocably terminatesthe Electronic Filer’s right to appeal thesuspension.

SECTION 16. PENALTY FORFAILURE TO TIMELY FILE ARETURN

Section 6651(a)(1) provides that foreach month (or part thereof) a return is notfiled when required (determined withregard to any extensions of time for fil-ing), there is a penalty of 5 percent of theunpaid tax not to exceed 25 percent,absent reasonable cause. A taxpayer doesnot establish reasonable cause simply byengaging a competent Electronic Filer tofile the taxpayer’s return. However, if theElectronic Filer has reasonable causeunder § 6651(a) for failing to timely filethe taxpayer’s return, the taxpayer willalso have reasonable cause for that failure,and the failure-to-file penalty will be abat-ed.

SECTION 17. INTERNAL REVENUESERVICE CONTACT

.01 The responsibility for the Form 940e-file Program is divided between theElectronic Filing Help Desk of the AustinService Center and the MemphisElectronic Filing Desk. Questions shouldbe directed to the appropriate ElectronicFiling Help Desk as follows:

(1) All questions regarding applica-tion to the Form 940 e-file Program,acceptance into the Form 940 e-fileProgram, userid/passwords, and PINsshould be directed to the Austin ServiceCenter e-file Help Desk at the followingaddress or telephone number:

AddressInternal Revenue ServiceAustin Service CenterElectronic Filing Help DeskP.O. Box 1231Stop 6380 AUSCAustin, TX 78767Attention: Electronic Filing

Telephone Number:(512) 460-8900 (not a toll-free number)

(2) All questions regarding the 940On-Line Option (that allows taxpayers touse the World Wide Web, via a Transmitter,to file Form 940 electronically) should bedirected to the Austin Service Center e-fileHelp Desk at the address or telephone num-ber identified in section 17.01(1) of thisrevenue procedure.

(3) All questions concerning the 940e-file Option (that allows taxpayers to usea Reporting Agent to prepare, sign andelectronically file Form 940 for the tax-payer), except those matters identified insection 17.01(1) of this revenue proce-dure, should be directed to the MemphisElectronic Help Desk at the followingaddress or telephone number:

AddressMemphis Electronic Filing DeskP.O. Box 30309 AMFMemphis, TN 38130ATTN: ELF Unit Stop 26

Telephone Number(901) 546-2690 Ext. 7519

.02 General information about electron-ic filing of tax forms can be found at thefollowing web site:

Web site for electronic services: www.irs.gov/prod/elec_svs

January 16, 2001 334 2001–3 I.R.B.

.03 All questions regarding publica-tions may be directed to the followingweb site:

Web site for publications:www.irs.gov/forms_pubs

SECTION 18 EFFECT ON OTHERDOCUMENTS

Section 6.05 of Rev. Proc. 96–17,1996–1 C.B. 633, is modified to providethe same relief as set forth in section 5.04of this revenue procedure (regarding anAgent not having to replace a previouslysubmitted Authorization under certain cir-cumstances).

SECTION 19. EFFECTIVE DATE

This revenue procedure is effective fortaxable years commencing afterDecember 31, 1999.

SECTION 20. PAPERWORKREDUCTION ACT

The collections of information containedin this revenue procedure have beenreviewed and approved by the Office ofManagement and Budget in accordance withthe Paperwork Reduction Act (44 U.S.C.3507) under control number 1545–1710.

An agency may not conduct or sponsor,and a person is not required to respond to, acollection of information unless the collec-tion of information displays a valid controlnumber.

The collections of information in thisrevenue procedure are in sections 5, 6, 7,8, 10, and 11. This information is requiredby the Service to implement the Form 940e-file Program and to enable taxpayers tofile their Forms 940 electronically. Theinformation will be used to ensure thattaxpayers receive accurate and essentialinformation regarding the filing of theirelectronic returns and to identify personsinvolved in the filing of electronic returns.The collections of information arerequired to retain the benefit of participat-ing in the Form 940 e-file Program. Thelikely respondents are business or otherfor-profit institutions; federal, state orlocal governments; nonprofit institutions;and small businesses or organizations.

The estimated total annual reportingand recordkeeping burden is 207,127hours. The estimated annual burden perrespondent/recordkeeper varies from 10minutes to 5 hours, depending on individ-

ual circumstances, with an estimatedaverage of 32 minutes. The estimatednumber of respondents and recordkeepersis 390,685. The estimated annual fre-quency of responses is on occasion.

Books or records relating to a collec-tion of information must be retained aslong as their contents may become mater-ial in the administration of any internalrevenue law. Generally, tax returns andtax return information are confidential, asrequired by 26 U.S.C. 6103.

26 CFR 601.105: Examination of returns andclaims for refund, credit, or abatement;determination of correct tax liability. (Also Part I,§§ 860E, 860H; 1.860E–1.)

Rev. Proc. 2001–12

SECTION 1. PURPOSE

This revenue procedure sets forth a safeharbor for establishing the lack ofimproper knowledge under § 1.860E–1(c)of the Income Tax Regulations for trans-fers of noneconomic residual interests inreal estate mortgage investment conduits(REMICs) and ownership interests inFinancial Asset Securitization InvestmentTrusts (FASITs).

SECTION 2. BACKGROUND

The current regulations governingREMICs contain rules governing the trans-fer of noneconomic residual interests inREMICs. In general, a transfer of a noneco-nomic residual interest is disregarded for alltax purposes if a significant purpose of thetransfer is to enable the transferor to impedethe assessment or collection of tax. This pur-pose exists if the transferor, at the time of thetransfer, either knew or should have knownthat the transferee would be unwilling orunable to pay taxes due on its share of theREMIC’s taxable income.

The current regulations also contain a safeharbor for establishing the lack of a purposeto impede the assessment or collection oftax. Under the safe harbor, a transferor of anoneconomic residual interest in a REMICis presumed to lack this purpose if tworequirements are satisfied. First, the transfer-or must conduct a reasonable investigationof the transferee’s financial condition.Second, the transferor must secure a repre-sentation from the transferee stating that thetransferee understands the tax obligations

associated with holding a residual interestand intends to pay those taxes.

The Internal Revenue Service andTreasury have been concerned that sometransferors of residual interests have claimedthey satisfy the safe harbor even though theeconomics of a transfer clearly indicate thetransferees are unwilling or unable to pay thetax associated with holding the interest. Forthis reason, on February 7, 2000, the Servicepublished in the Federal Register a notice ofproposed rulemaking (65 Fed. Reg. 5807)designed to clarify the safe harbor. The pro-posed regulation explains that the safe har-bor is unavailable unless the present value ofthe anticipated tax liabilities associated withholding the residual interest does not exceedthe sum of: (1) the present value of any con-sideration given to the transferee to acquirethe interest; (2) the present value of theexpected future distributions on the interest;and (3) the present value of the anticipatedtax savings associated with holding the inter-est as the REMIC generates losses. Thisclarification is proposed to be effective onFebruary 4, 2000. The notice of proposedrulemaking published on February 7, 2000also contained proposed rules for FASITs.Proposed § 1.860H–6(g) provides require-ments for transfers of FASIT ownershipinterests and adopts a safe harbor for estab-lishing lack of improper knowledge by ref-erence to the safe harbor provisions of theREMIC regulations.

Some commentators have stated that,although current regulations are inadequate,the proposed regulations are inappropriatelyrestrictive. This revenue procedure sets forthan alternate safe harbor that may be usedwhile the Service and Treasury consider thecomments on the proposed regulations.

SECTION 3. SCOPE

This revenue procedure applies to alltransfers of noneconomic residual inter-ests in REMICs. The principles set forthin this revenue procedure, appropriatelyadjusted with respect to terminology andother technical differences between theREMIC and FASIT provisions, also applyto transfers of ownership interests inFASITs. See section 8 for applicability.

SECTION 4. PROCEDURE

A transferor of a residual interest in aREMIC is presumed not to have improp-er knowledge under § 1.860E–1(c) of theregulations if–

2001–3 I.R.B. 335 January 16, 2001

.01 The transferor conducted, at thetime of the transfer, a reasonable investi-gation of the financial condition of thetransferee and, as a result of the investiga-tion, the transferor found that the transfer-ee had historically paid its debts as theycame due and found no significant evi-dence to indicate that the transferee willnot continue to pay its debts as they comedue in the future;

.02 The transferee represents to thetransferor that it understands that, as theholder of the residual interest, the trans-feree may incur tax liabilities in excess ofany cash flows generated by the interestand that the transferee intends to paytaxes associated with holding the residualinterest as they become due; and

.03 Either section 5 or section 6 is sat-isfied.

SECTION 5. FORMULA TEST

.01 The present value of the anticipatedtax liabilities associated with holding theresidual interest does not exceed the sum of–

(1) The present value of any consid-eration given to the transferee to acquirethe interest;

(2) The present value of the expect-ed future distributions on the interest; and

(3) The present value of the antici-pated tax savings associated with holdingthe interest as the REMIC generates loss-es.

.02 For purposes of section 5.01 of thisrevenue procedure, both of the followingrules apply:

(1) The transferee is assumed to paytax at a rate equal to the highest rate of taxspecified in § 11(b)(1) of the InternalRevenue Code; and

(2) Present values are computedusing a discount rate equal to the applica-ble Federal rate prescribed by § 1274(d)compounded semiannually. (A lower dis-count rate may be used if the transfereecan demonstrate that it regularly borrows,in the course of its trade or business, sub-stantial funds at such lower rate fromunrelated third parties.)

SECTION 6. ASSET TEST

.01 The following three requirementsmust be satisfied–

(1) At the time of the transfer, and at

the close of each of the transferee’s twofiscal years preceding the year of transfer,the transferee’s gross assets for financialreporting purposes exceed $100 millionand its net assets for financial reportingpurposes exceed $10 million;

(2) The transferee is an eligible cor-poration (as defined in § 860L(a)(2)) thatmakes a written agreement that any sub-sequent transfer of the interest will be toanother eligible corporation in a transac-tion that satisfies section 4; and

(3) The facts and circumstancesknown to the transferor on or before thedate of the transfer must not reasonablyindicate that the taxes associated with theresidual interest will not be paid. Theconsideration given to the transferee toacquire the noneconomic residual interestin the REMIC is only one factor to beconsidered. However, if the amount ofconsideration is so low that under any setof reasonable assumptions a reasonableperson would conclude that the taxesassociated with holding the residual inter-est will not be paid, then the transferor isdeemed to know that the transferee cannotor will not pay. In determining whetherthe amount is too low, the specific termsof the formula test in section 5 of this rev-enue procedure need not be used.

.02 For purposes of section 6.01 of thisrevenue procedure, all of the followingrules apply:

(1) The gross assets and net assets ofa transferee do not include any obligationof any person related to the transferee (asdefined in § 860L(g)) or any other asset ifa principal purpose for holding or acquir-ing that asset is to permit the transferee tosatisfy section 6 of this revenue proce-dure;

(2) A transfer fails to meet therequirements of section 6 of this revenueprocedure if the transferor knows, or hasreason to know, that the transferee willnot honor the restrictions on subsequenttransfers of the residual interest; and

(3) Section 6.01(2) fails to be satisfiedin the case of any transfer or assignment ofthe interest to a foreign branch of an eligi-ble corporation or any other arrangementby which the interest is at any time subjectto net tax by a foreign country or posses-sion of the United States.

SECTION 7. EXAMPLES

.01 Example 1. Transfer to partnership.X transfers a noneconomic residual inter-est in a REMIC to Partnership P. Y and Zare the partners of P. The transfer doesnot satisfy the formula test of section 5.Even if Y and Z are eligible corporationsthat satisfy section 6.01(1) and that makethe written agreement in section 6.01(2),the transfer fails to qualify under section 4because P is a partnership rather than aneligible corporation.

.02 Example 2. Transfer to corporationwithout capacity to carry additional resid-ual interests. During the first ten months ofa year, Bank transfers five residual intereststo Corporation U under circumstancesmeeting the requirements of section 6.Bank is the major creditor of U and for thatreason has access to U’s financial records.During the last month of the year, Banktransfers three additional residual intereststo U. At the time of transfer, U’s financialrecords indicate it has retained the previ-ously transferred residual interests. Bankhas knowledge of U’s financial circum-stances, including the aggregate tax liabili-ties it has assumed with respect to REMICresidual interests, that would reasonablycause Bank to conclude that U will beunable to meet its tax liabilities when due.The transfers in the last month of the yearfail to satisfy section 4 and 6.01(3) becauseBank has reason to know that U will not beable to pay the tax due on those interests.

SECTION 8. EFFECTIVE DATE

This revenue procedure applies to alltransfers of noneconomic residual inter-ests in REMICs and all transfers of FASITownership interests occurring on or afterFebruary 4, 2000, until the date specifiedin future published guidance.

DRAFTING INFORMATION

A principal author of this revenue pro-cedure is Courtney Shepardson of theOffice of Associate Chief Counsel(Financial Institutions and Products). Forfurther information regarding this revenueprocedure contact Courtney Shepardsonat (202) 622-3940 (not a toll-free call).

January 16, 2001 336 2001–3 I.R.B.

26 CFR 601.602: Tax forms and instructions. (Also Part I, §§ 1, 32, 59, 63, 68, 132, 135, 151, 170, 213, 220, 512, 513, 685, 877, 2032A, 2503, 2523, 2631, 4001, 4003, 4261, 6033, 6039F, 6323, 6334, 6601,7430, 7702B)

Rev. Proc. 2001–13

Table of Contents

SECTION 1. PURPOSE

SECTION 2. CHANGES

SECTION 3. 2001 ADJUSTED ITEMS

Part I – Inflation-adjusted Items Applicable if Pending Legislation is Enacted

Code Section.01 Tax Rate Tables . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .1(a)-(e).02 Unearned Income of Minor Children Taxed as if Parent’s Income (“Kiddie Tax”) . . . . . . . . . . . . . . . . . . . . . . . . .1(g).03 Earned Income Tax Credit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .32.04 Alternative Minimum Tax Exemption for a Child Subject to the “Kiddie Tax” . . . . . . . . . . . . . . . . . . . . . . . . . . .59(j).05 Standard Deduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .63.06 Overall Limitation on Itemized Deductions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .68.07 Qualified Transportation Fringe . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .132(f).08 Income from United States Savings Bonds for Taxpayers Who Pay Qualified Higher

Education Expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .135.09 Personal Exemption . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .151.10 Eligible Long-Term Care Premiums . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .213(d)(10).11 Medical Savings Accounts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .220.12 Treatment of Dues Paid to Agricultural or Horticultural Organizations. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .512(d).13 Insubstantial Benefit Limitations for

Contributions Associated with Charitable Fund-Raising Campaigns . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .513(h).14 Funeral Trusts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .685.15 Expatriation to Avoid Tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .877.16 Valuation of Qualified Real Property in Decedent’s Gross Estate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .2032A.17 Annual Exclusion for Gifts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .2503 & 2523.18 Generation-Skipping Transfer Tax Exemption . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .2631.19 Luxury Automobile Excise Tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .4001 & 4003.20 Passenger Air Transportation Excise Tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .4261.21 Reporting Exception for Certain Exempt Organizations with Nondeductible

Lobbying Expenditures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .6033(e)(3).22 Notice of Large Gifts Received from Foreign Persons . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .6039F.23 Persons against Which a Federal Tax Lien is Not Valid . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .6323.24 Property Exempt from Levy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .6334.25 Interest on a Certain Portion of the Estate Tax Payable in Installments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .6601(j).26 Attorney Fee Awards . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .7430.27 Periodic Payments Received under Qualified Long-Term Care Insurance Contracts or under

Certain Life Insurance Contracts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .7702B(d)

Part II – Inflation-adjusted Items Applicable if Pending Legislation is not Enacted

Code Section.01 Tax Rate Tables . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .1(a)-(e).03 Earned Income Tax Credit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .32.22 Notice of Large Gifts Received from Foreign Persons . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .6039F.23 Persons against Which a Federal Tax Lien is Not Valid . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .6323

2001–3 I.R.B. 337 January 16, 2001

SECTION 4. EFFECTIVE DATE

SECTION 5. DRAFTINGINFORMATION

SECTION 1. PURPOSE

This revenue procedure sets forth infla-tion adjusted items for 2001.

SECTION 2. CHANGES

.01 This revenue procedure reflects theunpublished corrections made by the Bu-reau of Labor Statistics (BLS) in the Con-sumer Price Index for All Urban Con-sumers (CPI-U) for September 1999through December 1999 that will be re-

quired if the Taxpayer Relief Act of 2000is enacted. The 2000 Act passed theHouse as H.R. 2614 on October 26, 2000.A provision having the same effect is con-tained in the Community Renewal TaxRelief Act of 2000 pending in the Con-gress as of the date of publication of thisrevenue procedure. Specific items that

would be affected by the legislation are:(1) the tax rate tables (set forth in

section 3.01 of this revenue procedure);(2) certain figures relating to the

earned income tax credit (section 3.03);(3) the aggregate amount of gifts

received from foreign persons for purpos-es of information reporting § 6039F (sec-tion 3.22); and

(4) the amount used to determine thevalidity of certain tax liens under

§ 6323(b)(7) (section 3.23)..02 Part I of section 3 of this revenue

procedure reflects the figures that willapply if the legislation is enacted. Part IIof section 3 provides the alternative fig-ures for items affected by the legislationthat will apply in the event that the 2000Act is not enacted. The Service willissue subsequent notification clarifyingwhether the amounts set forth in Part I orPart II are applicable for 2001.

.03 There are no changes from the pre-ceding year in the list of items adjusted.

SECTION 3. 2001 ADJUSTED ITEMS

Part I – Inflation-adjusted ItemsApplicable if Pending Legislation isEnacted

.01 Tax Rate Tables. For tax yearsbeginning in 2001, the tax rate tablesunder § 1 are as follows:

January 16, 2001 338 2001–3 I.R.B.

TABLE 1 - Section 1(a). — MARRIED INDIVIDUALS FILING JOINT RETURNS AND SURVIVING SPOUSES

If Taxable Income Is: The Tax Is:

Not Over $45,200 15% of the taxable income

Over $45,200 $6,780.00 plus 28% ofbut not over $109,250 the excess over $45,200

Over $109,250 $24,714.00 plus 31% ofbut not over $166,500 the excess over $109,250

Over $166,500 $42,461.50 plus 36% ofbut not over $297,350 the excess over $166,500

Over $297,350 $89,567.50 plus 39.6% ofthe excess over $297,350

TABLE 2 - Section 1(b). — HEADS OF HOUSEHOLDS

If Taxable Income Is: The Tax Is:

Not Over $36,250 15% of the taxable income

Over $36,250 $5,437.50 plus 28% of but not over $93,650 the excess over $36,250

Over $93,650 $21,509.50 plus 31% ofbut not over $151,650 the excess over $93,650

Over $151,650 $39,489.50 plus 36% ofbut not over $297,350 the excess over $151,650

Over $297,350 $91,941.50 plus 39.6% ofthe excess over $297,350

TABLE 3 - Section 1(c). — UNMARRIED INDIVIDUALS (OTHER THAN SURVIVING SPOUSES AND HEADS OF HOUSEHOLDS)

If Taxable Income Is: The Tax Is:

Not Over $27,050 15% of the taxable income

Over $27,050 $4,057.50 plus 28% ofbut not over $65,550 the excess over $27,050

Over $65,550 $14,837.50 plus 31% ofbut not over $136,750 the excess over $65,550

Over $136,750 $36,909.50 plus 36% ofbut not over $297,350 the excess over $136,750

Over $297,350 $94,725.50 plus 39.6% ofthe excess over $297,350

2001–3 I.R.B. 339 January 16, 2001

TABLE 4 - Section 1(d). — MARRIED INDIVIDUALS FILING SEPARATE RETURNS

If Taxable Income Is: The Tax Is:

Not Over $22,600 15% of the taxable income

Over $22,600 $3,390.00 plus 28% ofbut not over $54,625 the excess over $22,600

Over $54,625 $12,357.00 plus 31% ofbut not over $83,250 the excess over $54,625

Over $83,250 $21,230.75 plus 36% ofbut not over $148,675 the excess over $83,250

Over $148,675 $44,783.75 plus 39.6% ofthe excess over $148,675

TABLE 5 - Section 1(e). — ESTATES AND TRUSTS

If Taxable Income Is: The Tax Is:

Not Over $1,800 15% of the taxable income

Over $1,800 $270.00 plus 28% ofbut not over $4,250 the excess over $1,800

Over $4,250 $956.00 plus 31% ofbut not over $6,500 the excess over $4,250

Over $6,500 $1,653.50 plus 36% ofbut not over $8,900 the excess over $6,500

Over $8,900 $2,517.50 plus 39.6% ofthe excess over $8,900

.02 Unearned Income of MinorChildren Taxed as if Parent’s Income (the“Kiddie Tax”). For tax years beginning in2001, the amount in § 1(g)(4)(A)(ii)(I),which is used to reduce the net unearnedincome reported on the child’s return thatis subject to the “kiddie tax,” is $750.(This amount is the same as the $750standard deduction amount provided insection 3.05(2) of this revenue proce-dure.) The same $750 amount is used forpurposes of § 1(g)(7) (that is, determining

whether a parent may elect to include achild’s gross income in the parent’s grossincome and for calculating the “kiddietax”).

.03 Earned Income Tax Credit.(1) In general. For tax years begin-

ning in 2001, the following amounts areused to determine the earned income taxcredit under § 32(b). The “earned incomeamount” is the amount of earned incomeat or above which the maximum amountof the earned income tax credit is allowed.

The “threshold phaseout amount” is theamount of modified adjusted grossincome (or, if greater, earned income)above which the maximum amount of thecredit begins to phase out. The “complet-ed phaseout amount” is the amount ofmodified adjusted gross income (or ifgreater, earned income) at or above whichno credit is allowed.

Maximum Threshold CompletedNumber Amount of Earned Income Phaseout Phaseoutof Children the Credit Amount Amount Amount

1 $2,428 $ 7,140 $13,090 $28,281

2 or more $4,008 $10,020 $13,090 $32,121

None $ 364 $ 4,760 $ 5,950 $10,710

The Internal Revenue Service, in theinstructions for the Form 1040 series, pro-vides tables showing the amount of theearned income tax credit for each type oftaxpayer.

(2) Excessive investment income.For tax years beginning in 2001, theearned income tax credit is denied under

§ 32(i) if the aggregate amount of certaininvestment income exceeds $2,450.

.04 Alternative Minimum TaxExemption for a Child Subject to the“Kiddie Tax.” For tax years beginning in2001, in the case of a child to whom the § 1(g) “kiddie tax” applies, the exemptionamount under § 55 and § 59(j) for purpos-

es of the alternative minimum tax under § 55 may not exceed the sum of (A) suchchild’s earned income for the taxable year,plus (B) $5,350.

.05 Standard Deduction.(1) In general. For tax years begin-

ning in 2001, the standard deductionamounts under § 63(c)(2) are as follows:

Filing Status Standard Deduction

MARRIED INDIVIDUALS FILING JOINT RETURNS $7,600AND SURVIVING SPOUSES (§ 1(a))

HEADS OF HOUSEHOLDS (§ 1(b)) $6,650

UNMARRIED INDIVIDUALS (OTHER THAN SURVIVING $4,550SPOUSES AND HEADS OF HOUSEHOLDS) (§ 1(c))

MARRIED INDIVIDUALS FILING SEPARATE $3,800RETURNS (§ 1(d))

January 16, 2001 340 2001–3 I.R.B.

(2) Dependent. For tax years begin-ning in 2001, the standard deductionamount under § 63(c)(5) for an individualwho may be claimed as a dependent byanother taxpayer may not exceed thegreater of $750, or the sum of $250 andthe individual’s earned income.

(3) Aged and blind. For tax yearsbeginning in 2001, the additional standarddeduction amounts under § 63(f) for theaged and for the blind are $900 for each.These amounts are increased to $1,100 ifthe individual is also unmarried and not asurviving spouse.

.06 Overall Limitation on ItemizedDeductions. For tax years beginning in2001, the “applicable amount” of adjustedgross income under § 68(b), above whichthe amount of otherwise allowable item-

ized deductions is reduced under § 68, is$132,950 (or $66,475 for a separate returnfiled by a married individual).

.07 Qualified Transportation Fringe.For tax years beginning in 2001, themonthly limitation under § 132(f)(2)(A),regarding the aggregate fringe benefitexclusion amount for transportation in acommuter highway vehicle and any transitpass, is $65. The monthly limitationunder § 132(f)(2)(B) regarding the fringebenefit exclusion amount for qualifiedparking is $180.

.08 Income from United States SavingsBonds for Taxpayers Who Pay QualifiedHigher Education Expenses. For taxyears beginning in 2001, the exclusionunder § 135, regarding income fromUnited States savings bonds for taxpayers

who pay qualified higher educationexpenses, begins to phase out for modi-fied adjusted gross income above $83,650for joint returns and $55,750 for otherreturns. This exclusion completely phas-es out for modified adjusted gross incomeof $113,650 or more for joint returns and$70,750 or more for other returns.

.09 Personal Exemption.(1) Exemption amount. For tax years

beginning in 2001, the personal exemp-tion amount under § 151(d) is $2,900.

(2) Phaseout. For tax years begin-ning in 2001, the personal exemptionamount begins to phase out at, and is com-pletely phased out after, the followingadjusted gross income amounts:

Threshold CompletedFiling Status Phaseout Amount Phaseout Amount AfterCode § 1(a) $199,450 $321,950Code § 1(b) $166,200 $288,700Code § 1(c) $132,950 $255,450Code § 1(d) $ 99,725 $160,975

.10 Eligible Long-Term Care Premiums. For tax years beginning in 2001, the limitations under § 213(d), regarding eligible long-term care premiums includible in the term “medical care,” are as follows:

Attained age before the close of the taxable year:

40 or less . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 230More than 40 but not more than 50 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 430More than 50 but not more than 60. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 860More than 60 but not more than 70. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $2,290More than 70.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $2,860

.11 Medical Savings Accounts.(1) Self-only coverage. For tax years

beginning in 2001, the term “highdeductible health plan” as defined in § 220(c)(2)(A) means, in the case of self-only coverage, a health plan which has an

annual deductible that is not less than$1,600 and not more than $2,400, andunder which the annual out-of-pocketexpenses required to be paid (other thanfor premiums) for covered benefits doesnot exceed $3,200.

(2) Family coverage. For tax yearsbeginning in 2001, the term “highdeductible health plan” means, in the caseof family coverage, a health plan whichhas an annual deductible that is not lessthan $3,200 and not more than $4,800,

and under which the annual out-of-pocketexpenses required to be paid (other thanfor premiums) for covered benefits doesnot exceed $5,850.

.12 Treatment of Dues Paid toAgricultural or Horticultural Organizations.For tax years beginning in 2001, the limita-tion under § 512(d)(1), regarding the exemp-tion of annual dues required to be paid by amember to an agricultural or horticulturalorganization, is $116.

.13 Insubstantial Benefit Limitationsfor Contributions Associated withCharitable Fund-Raising Campaigns.

(1) Low cost article. For tax yearsbeginning in 2001, the unrelated businessincome of certain exempt organizationsunder § 513(h)(2) does not include a “lowcost article” of $7.60 or less.

(2) Other insubstantial benefits. Fortax years beginning in 2001, the $5, $25,and $50 guidelines in section 3 of Rev.Proc. 90–12, 1990–1 C.B. 471 (as ampli-fied and modified), for disregarding thevalue of insubstantial benefits received bya donor in return for a fully deductiblecharitable contribution under § 170, are$7.60, $38, and $76, respectively.

.14 Funeral Trusts. For a contractentered into during calendar year 2001 fora “qualified funeral trust,” as defined in § 685, the trust may not accept aggregatecontributions by or for the benefit of anindividual in excess of $7,500.

.15 Expatriation to Avoid Tax. For cal-endar year 2001, the thresholds usedunder § 877(a)(2), regarding whether anindividual’s loss of United States citizen-ship had the avoidance of United Statestaxes as one of its principal purposes, aremore than $115,000 for “average annualnet income tax” and $579,000 or more for“net worth.”

.16 Valuation of Qualified RealProperty in Decedent’s Gross Estate. Foran estate of a decedent dying in calendaryear 2001, if the executor elects to use thespecial use valuation method under § 2032A for qualified real property, theaggregate decrease in the value of quali-fied real property resulting from electingto use § 2032A that is taken into accountfor purposes of the estate tax may notexceed $800,000.

.17 Annual Exclusion for Gifts.(1) For calendar year 2001, the first

$10,000 of gifts to any person (other thangifts of future interests in property) arenot included in the total amount of tax-able gifts under § 2503 made during thatyear.

(2) For calendar year 2001, the first$106,000 of gifts to a spouse who is nota citizen of the United States (other thangifts of future interests in property) arenot included in the total amount of tax-able gifts under §§ 2503 and 2523(i)(2)made during that year.

.18 Generation-Skipping Transfer TaxExemption. For calendar year 2001, thegeneration-skipping transfer tax exemp-tion under § 2631, which is allowed indetermining the “inclusion ratio” definedin § 2642, is $1,060,000.

.19 Luxury Automobile Excise Tax. Forcalendar year 2001, the excise tax under§§ 4001 and 4003 is imposed on the firstretail sale of a passenger vehicle (includ-ing certain parts or accessories installedwithin six months of the date after thevehicle was first placed in service), to theextent the price exceeds $38,000.

.20 Passenger Air TransportationExcise Tax. For calendar year 2001, thetax under § 4261(c) on any amount paid(whether within or without the UnitedStates) for any transportation of any per-son by air, if such transportation begins orends in the United States, generally is$12.80. However, in the case of a domes-tic segment beginning or ending in Alaskaor Hawaii as described in § 4261(c)(3),the tax only applies to departures and is atthe rate of $6.40.

.21 Reporting Exception for CertainExempt Organizations with NondeductibleLobbying Expenditures. For tax years begin-ning in 2001, the annual per person, family,or entity dues limitation to qualify for thereporting exception under § 6033(e)(3) (andsection 5.05 of Rev. Proc. 98–19, 1998–7I.R.B. 30), regarding certain exempt organi-zations with nondeductible lobbying expen-ditures, is $81 or less.

.22 Notice of Large Gifts Received fromForeign Persons. For tax years beginningin 2001, recipients of gifts from certainforeign persons may have to report thesegifts under § 6039F if the aggregate valueof gifts received in a taxable year exceeds$11,273.

.23 Persons against Which a Federal

Tax Lien is Not Valid. For calendar year2001, a federal tax lien is not valid against(1) certain purchasers under § 6323(b)(4)that purchased personal property in acasual sale for less than $1,100, or (2) amechanic’s lienor under § 6323(b)(7) thatrepaired or improved certain residentialproperty if the contract price with theowner is not more than $5,490.

.24 Property Exempt from Levy. Forcalendar year 2001, the value of property exempt from levy under § 6334(a)(2)(fuel, provisions, furniture, and otherhousehold personal effects, as well asarms for personal use, livestock, and poul-try) may not exceed $6,560. The value ofproperty exempt from levy under § 6334(a)(3) (books and tools necessaryfor the trade, business, or profession ofthe taxpayer) may not exceed $3,280.

.25 Interest on a Certain Portion of theEstate Tax Payable in Installments. Foran estate of a decedent dying in calendaryear 2001, the dollar amount used todetermine the “2-percent portion” (forpurposes of calculating interest under § 6601(j)) of the estate tax payable ininstallments under § 6166 is $1,060,000.

.26 Attorney Fee Awards. For feesincurred in calendar year 2001, the attor-ney fee award limitation under § 7430(c)(1)(B)(iii) is $140 per hour.

.27 Periodic Payments Received underQualified Long-Term Care InsuranceContracts or under Certain LifeInsurance Contracts. For calendar year2001, the stated dollar amount of the perdiem limitation under § 7702B(d)(4),regarding periodic payments receivedunder a qualified long-term care insurancecontract or periodic payments receivedunder a life insurance contract that aretreated as paid by reason of the death of achronically ill individual, is $200.

Part II – Inflation-adjusted ItemsApplicable if Pending Legislation is notEnacted

.01 Tax Rate Tables. For tax yearsbeginning in 2001, the tax rate tablesunder § 1 are as follows:

2001–3 I.R.B. 341 January 16, 2001

TABLE 1 - Section 1(a). — MARRIED INDIVIDUALS FILING JOINT RETURNS AND SURVIVING SPOUSES

If Taxable Income Is: The Tax Is:

Not Over $45,200 15% of the taxable income

Over $45,200 $6,780.00 plus 28% ofbut not over $109,250 the excess over $45,200

Over $109,250 $24,714.00 plus 31% ofbut not over $166,450 the excess over $109,250

Over $166,450 $42,446.00 plus 36% ofbut not over $297,300 the excess over $166,450

Over $297,300 $89,552.00 plus 39.6% ofthe excess over $297,300

January 16, 2001 342 2001–3 I.R.B.

TABLE 2 - Section 1(b). — HEADS OF HOUSEHOLDS

If Taxable Income Is: The Tax Is:

Not Over $36,250 15% of the taxable income

Over $36,250 $5,437.50 plus 28% of but not over $93,600 the excess over $36,250

Over $93,600 $21,495.50 plus 31% ofbut not over $151,600 the excess over $93,600

Over $151,600 $39,475.50 plus 36% ofbut not over $297,300 the excess over $151,600

Over $297,300 $91,927.50 plus 39.6% ofthe excess over $297,300

TABLE 3 - Section 1(c). — UNMARRIED INDIVIDUALS (OTHER THAN SURVIVING SPOUSESAND HEADS OF HOUSEHOLDS)

If Taxable Income Is: The Tax Is:

Not Over $27,050 15% of the taxable income

Over $27,050 $4,057.50 plus 28% ofbut not over $65,550 the excess over $27,050

Over $65,550 $14,837.50 plus 31% ofbut not over $136,750 the excess over $65,550

Over $136,750 $36,909.50 plus 36% ofbut not over $297,300 the excess over $136,750

Over $297,300 $94,707.50 plus 39.6% ofthe excess over $297,300

TABLE 4 - Section 1(d). — MARRIED INDIVIDUALS FILING SEPARATE RETURNS

If Taxable Income Is: The Tax Is:

Not Over $22,600 15% of the taxable income

Over $22,600 $3,390.00 plus 28% ofbut not over $54,625 the excess over $22,600

Over $54,625 $12,357.00 plus 31% ofbut not over $83,225 the excess over $54,625

Over $83,225 $21,223.00 plus 36% ofbut not over $148,650 the excess over $83,225

Over $148,650 $44,776.00 plus 39.6% ofthe excess over $148,650

TABLE 5 - Section 1(e). — ESTATES AND TRUSTS

If Taxable Income Is: The Tax Is:

Not Over $1,800 15% of the taxable income

Over $1,800 $270.00 plus 28% ofbut not over $4,250 the excess over $1,800

Over $4,250 $956.00 plus 31% ofbut not over $6,500 the excess over $4,250

Over $6,500 $1,653.50 plus 36% ofbut not over $8,900 the excess over $6,500

Over $8,900 $2,517.50 plus 39.6% ofthe excess over $8,900

2001–3 I.R.B. 343 January 16, 2001

.03 Earned Income Tax Credit.(1) In general. For tax years begin-

ning in 2001, the following amounts areused to determine the earned income taxcredit under § 32(b). The “earned incomeamount” is the amount of earned income

at or above which the maximum amountof the earned income tax credit is allowed.The “threshold phaseout amount” is theamount of modified adjusted grossincome (or, if greater, earned income)above which the maximum amount of the

credit begins to phase out. The “complet-ed phaseout amount” is the amount ofmodified adjusted gross income (or ifgreater, earned income) at or above whichno credit is allowed.

Maximum Threshold CompletedNumber Amount of Earned Income Phaseout Phaseoutof Children the Credit Amount Amount Amount

1 $2,424 $ 7,130 $13,090 $28,260

2 or more $4,008 $10,020 $13,090 $32,121

None $ 364 $ 4,760 $ 5,950 $10,710

.22 Notice of Large Gifts Received fromForeign Persons. For tax years beginning in2001, recipients of gifts from certain foreignpersons may have to report these gifts under§ 6039F if the aggregate value of giftsreceived in a taxable year exceeds $11,271.

.23 Persons against Which a FederalTax Lien is Not Valid. For calendar year2001, a federal tax lien is not valid against(1) certain purchasers under § 6323(b)(4)that purchased personal property in acasual sale for less than $1,100, or (2) amechanic’s lienor under § 6323(b)(7) thatrepaired or improved certain residentialproperty if the contract price with theowner is not more than $5,480.

SECTION 4. EFFECTIVE DATE

.01 General Rule. Except as providedin section 4.02, this revenue procedureapplies to tax years beginning in 2001.

.02 Calendar Year Rule. This revenueprocedure applies to transactions orevents occurring in calendar year 2001 forpurposes of section 3.14 (funeral trusts),section 3.15 (expatriation to avoid tax),

section 3.16 (valuation of qualified realproperty in decedent’s gross estate), sec-tion 3.17 (annual exclusion for gifts), sec-tion 3.18 (generation-skipping transfer taxexemption), section 3.19 (luxury automo-bile excise tax), section 3.20 (passengerair transportation excise tax), section 3.23(persons against which a federal tax lien isnot valid), section 3.24 (property exemptfrom levy), section 3.25 (interest on a cer-tain portion of the estate tax payable ininstallments), section 3.26 (attorney feeawards), and section 3.27 (periodic pay-ments received under qualified long-termcare insurance contracts or under certainlife insurance contracts).

SECTION 5. DRAFTINGINFORMATION

The principal author of this revenueprocedure is Paul Tellier of the Office ofAssociate Chief Counsel (Income Tax andAccounting). For further informationregarding this revenue procedure, contactMr. Tellier at (202) 622-4930 (not a toll-free call).

26 CFR 601.601: Rules and regulations.(Also Part I, § 1397E)

Rev. Proc. 2001–14

SECTION 1. PURPOSE

This revenue procedure sets forth themaximum face amount of Qualified ZoneAcademy Bonds (“Bond” or “Bonds”)that may be issued for each State during2001. For this purpose “State” includesthe District of Columbia and the posses-sions of the United States.

SECTION 2. BACKGROUND

.01 Section 226 of the Taxpayer ReliefAct of 1997, Pub. L. 105–34, 111 Stat.821 (1997), added § 1397E to the InternalRevenue Code to provide a credit to hold-er of Bonds under certain circumstancesso that the Bonds generally can be issuedwithout discount or interest. Ninety-fivepercent of Bond proceeds are to be usedfor qualified purposes, as defined by § 1397E(d)(5), with respect to a qualified

zone academy, as defined by § 1397E-(d)(4).

.02 Section 1397E(e)(1), as amendedby § 509 of the Tax Relief Extension Actof 1999, Pub. L. 106–170, 113 Stat. 1860(1999) provides that the aggregateamount of Bonds that may be issued forthe States is limited to $400 million foreach of the years, 1998, 1999, 2000, and2001 (the “national limitation”). Thisamount is to be allocated among theStates by the Secretary on the basis oftheir respective populations below thepoverty level (as defined by the Office ofManagement and Budget) and is to befurther allocated by each State to quali-

fied zone academies within the State orpossession.

.03 Section 1397E(e)(4), as amended,by § 509 of the Tax Relief Extension Actof 1999, Pub. L. 106–170, 113 Stat. 1860(1999) provides that any carryforward ofa limitation amount may be carried onlyto the first 2 years (3 years for carryfor-wards from 1998 or 1999) following theunused limitation year. For this purposea limitation amount shall be treated asused on a first–in first–out basis.

.04 Rev. Proc. 98–9, 1998–1 C.B. 341,Rev. Proc. 98–57, 1998–2 C.B. 682, andRev. Proc. 2000–10, 2000–2 I.R.B. 287,respectively, allocated the national limita-

tion for 1998, 1999, and 2000 among theStates and possessions.

SECTION 3. SCOPE

This revenue procedure applies toBonds issued under § 1397E during2001.

SECTION 4. NATIONAL QUALIFIEDZONE ACADEMY BONDLIMITATION FOR 2001

The total face amount of bonds thatmay be issued in 2001 is $400 million.This amount is allocated among the Statesas follows:

January 16, 2001 344 2001–3 I.R.B.

STATE MAXIMUM FACE AMOUNT OF BONDS THAT MAY BE ISSUED DURING 2001 (thousands of dollars)

ALABAMA $ 7,641ALASKA 545ARIZONA 6,640ARKANSAS 4,343CALIFORNIA 52,969COLORADO 3,899CONNECTICUT 2,699DELAWARE 908DISTRICT OF COLUMBIA 896FLORIDA 21,699GEORGIA 11,635HAWAII 1,496IDAHO 2,015ILLINOIS 13,905INDIANA 4,611IOWA 2,492KANSAS 3,750KENTUCKY 5,550LOUISIANA 9,721MAINE 1,538MARYLAND 4,372MASSACHUSETTS 8,367MICHIGAN 11,080MINNESOTA 3,982MISSISSIPPI 5,162MISSOURI 7,346MONTANA 1,595NEBRASKA 2,103NEVADA 2,368NEW HAMPSHIRE 1,071NEW JERSEY 7,356NEW MEXICO 4,171NEW YORK 29,712NORTH CAROLINA 11,961NORTH DAKOTA 954OHIO 15,643OKLAHOMA 4,939

STATE MAXIMUM FACE AMOUNT OF BONDS THAT MAY BE ISSUED DURING 2001 (thousands of dollars)

OREGON $ 4,839PENNSYLVANIA 13,056RHODE ISLAND 1,136SOUTH CAROLINA 5,265SOUTH DAKOTA 654TENNESSEE 7,557TEXAS 34,818UTAH 1,406VERMONT 667VIRGINIA 6,288WASHINGTON 6,333WEST VIRGINIA 3,285WISCONSIN 5,229WYOMING 644AMERICAN SAMOA 350GUAM 251NORTHERN MARIANAS 408PUERTO RICO 26,308VIRGIN ISLANDS 372

2001–3 I.R.B. 345 January 16, 2001

SECTION 6. EFFECTIVE DATE

This revenue procedure applies toBonds issued after December 31, 2000.

DRAFTING INFORMATION

The principal author of this revenue pro-cedure is David White of the Office of As-sistant Chief Counsel (Tax Exempt/Employ-

ment Tax/Government Entities). For furtherinformation regarding this revenue proce-dure contact Mr. White at (202) 622-3980(not a /toll free call).

Notice of Proposed Rulemakingand Notice of Public Hearing

Guidance Under Section 355(e);Recognition of Gain on CertainDistributions of Stock orSecurities In Connection With anAcquisition.

REG–107566–00

AGENCY: Internal Revenue Service(IRS), Treasury.

ACTION: Notice of proposed rulemak-ing and notice of public hearing.

SUMMARY: This document contains pro-posed regulations relating to recognition ofgain on certain distributions of stock or secu-rities of a controlled corporation in connec-tion with an acquisition. Changes to the ap-plicable law were made by the TaxpayerRelief Act of 1997. These proposed regula-tions affect corporations and are necessary toprovide them with guidance needed to com-ply with these changes. This document alsoprovides notice of a public hearing on theseproposed regulations.

DATES: Written or electronic commentsmust be received by April 24, 2001. Out-lines of topics to be discussed at the publichearing scheduled for May 15, 2001, at 10a.m. must be received by April 24, 2001.

ADDRESSES: Send submissions to:CC:M&SP:RU (REG–107566–00), room5226, Internal Revenue Service, POB7604, Ben Franklin Station, Washington,DC 20044. Submissions may be handdelivered Monday through Friday be-tween the hours of 8 a.m. and 5 p.m. to:CC:M&SP:RU (REG–107566–00),Courier’s Desk, Internal Revenue Ser-vice, 1111 Constitution Avenue, NW.,Washington, DC. Alternatively, taxpayersmay submit comments electronically via the Internet by selecting the “TaxRegs” option on the IRS Home Page, orby submitting comments directly to theIRS Internet site at http://www.irs.ustreas.gov/tax_regs/regslist.html. Thepublic hearing will be held in Room 4718,Internal Revenue Building, 1111 Consti-tution Avenue, NW., Washington, DC.

FOR FURTHER INFORMATION CON-TACT: Concerning the proposed regula-

tions, Brendan P. O’Hara, (202) 622-7530; concerning submissions of com-ments, delivering comments, the hearing,and/or to be placed on the building accesslist to attend the hearing, Guy R. Traynor,(202) 622-7180 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Background

A. State of the Law Before Section355(e)

Section 355 generally provides that, if acorporation distributes to its shareholdersstock of a corporation that it controlsimmediately before the distribution andcertain other conditions are met, neitherthe distributing corporation (hereinafterreferred to as Distributing) nor its share-holders recognize gain or loss. A numberof the conditions for tax free treatment(for example, the continuity of interestrequirement of §1.355–2(c), the “nodevice” requirement of section355(a)(1)(B), the 5-year active businessrequirement of section 355(b), and thelimitation on disqualified stock under sec-tion 355(d)) operate to limit the circum-stances in which Distributing or the con-trolled corporation (hereinafter referred toas Controlled) can undergo changes ofcontrol in conjunction with a distributionthat qualifies for corporate and sharehold-er-level nonrecognition under section 355.Nevertheless, prior to the enactment ofsection 355(e), it was possible for suchchanges to occur, for example, in the con-text of tax free reorganizations, whilequalifying for tax free treatment undersection 355. See, e.g., Commissioner v.Mary Archer W. Morris Trust, 367 F.2d794 (4th Cir. 1966).

B. Enactment of Section 355(e)

Section 355(e), which was enacted in1997, provides that the stock of a con-trolled corporation generally will not bequalified property under section 355(c)(2)or section 361(c)(2) if the stock is distrib-uted as “part of a plan (or series of relatedtransactions) pursuant to which 1 or morepersons acquire directly or indirectlystock representing a 50-percent or greaterinterest in the distributing corporation or

any controlled corporation.” Thus, if sec-tion 355(e) applies to a distribution,Distributing is taxed on the amount bywhich the distributed stock’s fair marketvalue exceeds its basis. Distributee share-holders receive Controlled stock tax free,but do not increase their bases to reflectthe corporate level gain recognized byDistributing on the distribution.

Section 355(e)(2)(B) provides that,unless the taxpayer establishes otherwise, aplan (or series of related transactions) (here-inafter referred to as a plan) exists if “1 ormore persons acquire directly or indirectlystock representing a 50-percent or greaterinterest in the distributing corporation orany controlled corporation during the 4-year period beginning on the date which is2 years before the date of the distribution.”

The committee reports state that section355 was intended to permit the tax freedivision of existing business arrange-ments among existing shareholders. Thereports state that “[i]n cases in which it isintended that new shareholders willacquire ownership of a business in con-nection with a spin off, the transactionmore closely resembles a corporate leveldisposition of the portion of the businessthat is acquired” and provide that gain isrecognized “if, pursuant to a plan orarrangement in existence on the date ofdistribution, either the controlled or dis-tributing corporation is acquired . . ..”H.R. Rep. No. 105–148, at 462 (1997);see also S. Rep. No. 105–33, at 139–40(1997) (slight variation in language). TheConference Report adds, “[a]s under theHouse bill and Senate amendment, a pub-lic offering of sufficient size can result inan acquisition that causes gain recognitionunder the provision.” H.R. Conf. Rep.No. 105–220, at 533 (1997).

C. Previous Proposal of Regulations

On August 24, 1999, the IRS and theDepartment of the Treasury publishedproposed regulations under section 355(e)(REG–116733–98, 1999–2 C.B. 392) inthe Federal Register (64 F.R. 46155)(hereinafter referred to as the 1999 pro-posed regulations). The 1999 proposedregulations provided the exclusive meansby which a taxpayer could establish that adistribution and an acquisition were not

January 16, 2001 346 2001–3 I.R.B.

Part IV. Items of General Interest

part of a plan, and required that the tax-payer must establish the absence of a planwith clear and convincing evidence.

A public hearing regarding the 1999proposed regulations was held on March2, 2000. In addition, written commentswere received. Commentators assertedthat the approach of the 1999 proposedregulations, providing exclusive rebuttalsfor establishing that transactions are notpart of a plan, was inappropriate becauseit unfairly limited the evidence taxpayerscould produce that may be relevant towhether transactions are part of a plan. Inaddition, commentators argued that sec-tion 355(e) does not require the IRS andthe Department of the Treasury to adopt aclear and convincing evidence standardfor establishing whether transactions arepart of a plan. Further, commentatorswere concerned that the exclusive rebut-tals contained in the 1999 proposed regu-lations may not be available in cases inwhich there was an intent to facilitate anyacquisition, regardless of its type or size,even if the acquisition being tested wasnot the intended acquisition. Finally, oneof the rebuttals in the 1999 proposed reg-ulations was only available if the taxpay-er proves, among other things, that “[a]tthe time of the distribution, neither thedistributing corporation, the controlledcorporation, nor their controlling share-holders reasonably would have anticipat-ed that it was more likely than not that oneor more persons would acquire a 50-per-cent or greater interest in the distributingcorporation or the controlled corporationwithin 2 years after the distribution . . .who would not have acquired such inter-ests if the distribution had not occurred.”1999 Prop. Reg. §1.355–7(a)(2)(iii)(B).Many commentators indicated that deter-mining whether it was reasonably antici-pated that an event was more likely thannot to occur was impractical and that theconsequent uncertainty inhibited normalbusiness transactions.

Explanation of Provisions

After consideration of the commentsreceived, the IRS and the Department ofthe Treasury have decided to withdraw the1999 proposed regulations and issue newproposed regulations (hereinafter referredto as the 2000 proposed regulations) toprovide guidance concerning the interpre-

tation of the phrase “plan (or series ofrelated transactions).” The 2000 proposedregulations also address the determinationof Distributing’s gain when multiple con-trolled corporations are distributed andthe distributions are part of a plan pur-suant to which a 50-percent or greaterinterest in one or more, but not all, of thedistributed controlled corporations isacquired.

The IRS and the Department of theTreasury plan to issue regulationsaddressing other issues arising under sec-tion 355(e), including the definition of anacquisition, the application of the aggre-gation and attribution rules, the treatmentof successors and predecessors, and theadministration of the statute of limitationsprovision of section 355(e)(4)(E).Comments concerning the 2000 proposedregulations, the additional issuesdescribed above, and other issues thatshould be addressed in regulations arewelcome.

A. Plan or Series of RelatedTransactions

The 2000 proposed regulations providethat whether a distribution and an acquisi-tion are part of a plan is determined basedon all the facts and circumstances. Theyinclude nonexclusive lists of facts and cir-cumstances to be considered in makingthe determination. Because the determi-nation of whether a plan exists is depen-dent on the facts and circumstances, the2000 proposed regulations provide a gen-eral statement of the policy underlyingwhether a distribution and an acquisitionare part of a plan for purposes of section355(e).

In the case of an acquisition after a dis-tribution, the 2000 proposed regulationsprovide that, in general, the distributionand acquisition are considered part of aplan if Distributing, Controlled, or any oftheir respective controlling shareholdersintended, on the date of the distribution,that the acquisition or a similar acquisi-tion occur in connection with the distribu-tion. The reference to “a similar acquisi-tion” ensures that changes in the terms ofthe acquisition intended at the time of thedistribution (including, in certain circum-stances, a substitution of acquirer) do notprevent the distribution and the acquisi-tion that actually occurs from being con-

sidered part of a plan.In the case of an acquisition before a

distribution, the 2000 proposed regula-tions provide that, in general, the distribu-tion and acquisition are considered part ofa plan if Distributing, Controlled, or anyof their respective controlling sharehold-ers intended, on the date of the acquisi-tion, that a distribution occur in connec-tion with the acquisition.

As indicated above, the facts and cir-cumstances surrounding the distributionand the acquisition must be examined todetermine whether the transactions wereintended to occur in connection with eachother. In addition, the 2000 proposed reg-ulations contain six safe harbor provisionsthat, when applicable, provide that theacquisition and distribution are not part ofa plan.

Under the 2000 proposed regulations,Distributing must test each acquisition ofDistributing or Controlled stock to deter-mine whether it is part of a plan thatincludes a distribution. The 2000 pro-posed regulations aggregate all acquisi-tions of stock of a corporation that arepursuant to a plan including a particulardistribution to determine whether the 50percent threshold of section355(e)(2)(A)(ii) is met.

1. Facts and Circumstances

For those situations to which the safeharbor provisions do not apply, the 2000proposed regulations provide two nonex-clusive lists of facts and circumstances(hereinafter referred to as factors) to con-sider in assessing whether an acquisitionand a distribution are part of a plan. Onelist of factors tends to demonstrate that adistribution and an acquisition are part ofa plan and the other list tends to demon-strate that a distribution and an acquisitionare not part of a plan. The weight of thefactors depends on the particular case.The existence of a plan should not bedetermined merely by comparing thenumber of factors tending to show that theacquisition and distribution are, or are not,part of a plan.

Plan Factors

Many of the factors tending to showthat a distribution and an acquisition arepart of a plan (the plan factors) focus onwhether Distributing, Controlled or their

2001–3 I.R.B. 347 January 16, 2001

respective controlling shareholders partic-ipated in discussions with outside partiesregarding the second transaction of thepair being tested before the first transac-tion occurred (factors (i), (ii), (iii), (iv),(v), and (vi)). Such discussions provideevidence that Distributing, Controlled orany of their respective controlling share-holders had an intent that the transactionsoccur in connection with each other.

Other plan factors (factors (vii), (viii),and (ix)) inquire into other indications ofthe intent of Distributing, Controlled andtheir respective controlling shareholders.Factor (vii) considers whether the distrib-ution was motivated by a business pur-pose to facilitate the acquisition or a sim-ilar acquisition of Distributing orControlled. The operating rule in pro-posed §1.355–7(e)(1)(i) states that evi-dence of a business purpose to facilitatean acquisition of Distributing orControlled exists if there was a reasonablecertainty that within 6 months after thedistribution an acquisition would occur,an agreement, understanding, or arrange-ment would exist, or substantial negotia-tions would occur regarding an acquisi-tion. The operating rule in proposed§1.355–7(e)(1)(ii) applies to acquisitionsbefore a distribution, asking whether theacquisition occurred after the date of thepublic announcement of the planned dis-tribution, or whether, at the time of theacquisition, it was reasonably certain thatwithin 6 months after the acquisition thedistribution would occur, an agreement,understanding, or arrangement wouldexist, or substantial negotiations wouldoccur regarding the distribution. Theoperating rule in proposed §1.355–7(e)(2)provides that the fact that internal discus-sions occurred may be indicative of thebusiness purpose that motivated the distri-bution. The operating rule contained inproposed §1.355–7(e)(3) provides that, ifDistributing distributes Controlled stockintending, in whole or substantial part, todecrease the likelihood of the acquisitionof Distributing or Controlled by separat-ing it from another corporation that islikely to be acquired, Distributing is treat-ed as having a business purpose to facili-tate the acquisition of the corporation thatwas acquired.

The rule regarding reasonable certaintyis necessary to implement section 355(e)because where a taxpayer was reasonably

certain that an acquisition would occur,that acquisition was likely to be taken intoaccount in determining whether to effect adistribution. While the IRS and theDepartment of the Treasury believe thatreasonable certainty (even where no dis-cussions with potential acquirers haveoccurred) is relevant in determiningwhether a plan exists, it should be notedthat this concept is significantly modifiedfrom the 1999 proposed regulations. Thisoperating rule will apply only in caseswhere there was a strong probability that,within 6 months after the distribution, anacquisition would occur, an agreement,understanding, or arrangement wouldexist, or substantial negotiations wouldoccur.

Factor (viii) considers whether anacquisition and a distribution occuredwithin 6 months of each other, or whetherthere was an agreement, understanding,arrangement, or substantial negotiationsregarding the second transaction (or, if anacquisition is the second transaction, asimilar acquisition) within 6 months afterthe first transaction.

Finally, factor (ix) examines whetherthe debt allocation between Distributingand Controlled made an acquisition ofDistributing or Controlled likely in orderto service the debt.Nonplan Factors

The 2000 proposed regulations alsoprovide a nonexclusive list of factorstending to show that a distribution and anacquisition are not part of a plan (the non-plan factors). Just as discussions withoutside parties about the second transac-tion prior to the first transaction tend toshow that Distributing, Controlled or theirrespective controlling shareholders had anintent that the second transaction occur inconnection with the first transaction, theabsence of such discussions tends to showthat the transactions did not occur in con-nection with each other. Thus, there arenonplan factors that are analogous to theplan factors related to discussions (factors(i), (ii), and (iv)).

The existence of a corporate businesspurpose, other than a business purpose tofacilitate the acquisition or a similaracquisition, that motivated Distributing,in whole or substantial part, to make thestock distribution tends to show that a dis-tribution and an acquisition are not part ofa plan (factor (vi)). The presence of a

business purpose to facilitate the acquisi-tion or a similar acquisition is relevant indetermining the extent to which the distri-bution was motivated in whole or sub-stantial part by another corporate businesspurpose within the meaning of §1.355–2.Analyzing whether there is another sub-stantial corporate business purpose for thedistribution in light of an acquisition-related purpose is similar to analyzingwhether there is a corporate business pur-pose for a distribution in light of thepotential avoidance of federal taxes. See§1.355–2(b)(1) and (5), Example 8. Thus,another business purpose must be real andsubstantial even in light of the acquisitionbusiness purpose. In making this determi-nation, the operating rules in proposed§1.355–7(e) apply.

Factors (iii) and (v) consider whetherthere was an identifiable, unexpectedchange in market or business conditionsafter the first of the two transactions beingtested that resulted in the second, unex-pected transaction. Factor (vii) considerswhether the distribution would haveoccurred at approximately the same timeand in similar form regardless of theacquisition or a previously proposed sim-ilar acquisition.

2. Safe Harbors

The 2000 proposed regulations includesix safe harbor provisions. A distributionand an acquisition are not part of a plan ifthey are described in one of the safe har-bors. The first two safe harbors addressacquisitions more than 6 months after adistribution. Safe Harbor I applies to anacquisition more than 6 months after adistribution if there was no agreement,understanding, arrangement, or substan-tial negotiations concerning the acquisi-tion before a date that is 6 months after thedistribution and the distribution was moti-vated in whole or substantial part by acorporate business purpose other than abusiness purpose to facilitate an acquisi-tion. The nonacquisition corporate busi-ness purpose for the distribution is con-sidered in light of any business purpose tofacilitate an acquisition, and the operatingrules in proposed §1.355–7(e) apply.

Safe Harbor II, like Safe Harbor I,applies only to acquisitions more than 6months after a distribution for which therewas no agreement, understanding,arrangement, or substantial negotiations

January 16, 2001 348 2001–3 I.R.B.

concerning the acquisition before a datethat is 6 months after the distribution.However, where Safe Harbor I applies tocases where the distribution was motivat-ed in whole or substantial part by a nonac-quisition business purpose, Safe Harbor IIapplies to situations where the distributionwas motivated in whole or substantial partby a business purpose to facilitate anacquisition. Under Safe Harbor II, anacquisition will not be treated as part of aplan with a distribution if the distributionwas motivated in whole or substantial partby a corporate business purpose to facili-tate an acquisition or acquisitions of nomore than 33 percent of the stock ofDistributing or Controlled, and no morethan 20 percent of the stock of the corpo-ration whose stock was acquired in theacquisition or acquisitions that motivatedthe distribution was either acquired or thesubject of an agreement, understanding,arrangement, or substantial negotiationsbefore a date that is 6 months after the dis-tribution. Safe Harbor II is intended toalleviate the concerns commentatorsexpressed about the unavailability of therebuttals in the 1999 proposed regulationsif the distribution was motivated by anintent to facilitate an acquisition regard-less of its type or size.

Safe Harbors III and IV address acqui-sitions and distributions more than 2 yearsapart. Under Safe Harbor III, acquisitionsmore than 2 years after a distribution arenot pursuant to a plan if there is no agree-ment, understanding, arrangement, orsubstantial negotiations concerning theacquisition at the time of the distributionor within 6 months thereafter. Under SafeHarbor IV, acquisitions more than 2 yearsbefore a distribution are not part of a planif there is no agreement, understanding,arrangement, or substantial negotiationsconcerning the distribution at the time ofthe acquisition or within 6 months there-after.

Safe Harbor V provides that an acquisi-tion of Distributing or Controlled stockthat is listed on an established market (asdefined in the 2000 proposed regulations)is not part of a plan if the stock is trans-ferred between shareholders of Distribut-ing or Controlled who are not 5-percentshareholders. In general, a person will beconsidered a 5-percent shareholder if,immediately before or after each transfer,the person owns, directly or indirectly, or

together with related persons (asdescribed in sections 267(b) and 707(b)),5 percent or more of any class of stock ofthe corporation whose stock is trans-ferred.

Safe Harbor VI provides that an acqui-sition of stock by an employee or directorin connection with the performance ofservices, including an acquisition result-ing from the exercise of certain compen-satory stock options, is not part of a plan.

3. Agreement, Understanding,Arrangement, or Substantial Negotiations

There are many references in the 2000proposed regulations to the existence ofan agreement, understanding, arrange-ment, or substantial negotiations. The2000 proposed regulations do not definethose concepts precisely. A binding con-tract clearly is included as an agreementbut, depending on all relevant facts andcircumstances, parties can have an agree-ment, understanding, or arrangement eventhough they have not reached agreementon all terms. Under certain circum-stances, such as in public offerings or auc-tions of Distributing’s or Controlled’sstock, an agreement, understanding,arrangement, or substantial negotiationscan exist regarding an acquisition even ifthe acquirer has not been specificallyidentified.

4. Options

The 2000 proposed regulations enu-merate interests treated as options. Ifstock of Distributing or Controlled isacquired pursuant to an option, the optionis treated as an agreement to acquire stockon the date of writing unless Distributingestablishes that, on the later of the date ofthe stock distribution or the writing of theoption, the option was not more likelythan not to be exercised. The 2000 pro-posed regulations also address the treat-ment of an agreement, understanding, orarrangement to write an option and sub-stantial negotiations regarding the writingof an option. The 2000 proposed regula-tions exempt certain options from treat-ment as options unless they are written,transferred, or listed with a principal pur-pose of avoiding the application of section355(e) or the 2000 proposed regulations.The enumerated exceptions cover certaincommercially customary options that are

unlikely to be used to avoid section 355(e)or the 2000 proposed regulations.

B. Any Controlled Corporation

Section 355(e)(2)(A)(ii) provides thatsection 355(e)(1), which causesDistributing to recognize its gain inControlled stock as if Distributing hadsold the stock for its fair market value,applies to any distribution to which sec-tion 355 (or so much of section 356 asrelates to section 355) applies and “whichis part of a plan . . . pursuant to which 1 ormore persons acquire directly or indirect-ly stock representing a 50-percent orgreater interest in the distributing corpora-tion or any controlled corporation”(emphasis added). A question has arisenconcerning the measure of gain toDistributing if, pursuant to a plan, thestock of more than 1 controlled corpora-tion is distributed and stock representing a50-percent or greater interest is acquiredin some, but not all, of the distributed con-trolled corporations. The 2000 proposedregulations clarify that under those cir-cumstances, Distributing only recognizesgain on the stock of the distributed con-trolled corporations that were subject to50-percent or greater acquisitions. IfDistributing is the acquired corporation, itmust recognize gain on all of the distrib-uted controlled corporations.

Proposed Effective Date

The regulations in this section are pro-posed to apply to distributions occurringafter the regulations in this section arepublished as final regulations in theFederal Register.

Special Analyses

It has been determined that this noticeof proposed rulemaking is not a signifi-cant regulatory action as defined inExecutive Order 12866. Therefore, a reg-ulatory assessment is not required. It hasalso been determined that section 553(b)of the Administrative Procedure Act (5U.S.C. chapter 5) does not apply to theseregulations, and, because the regulationsdo not impose a collection of informationon small entities, the RegulatoryFlexibility Act (5 U.S.C. chapter 6) doesnot apply. Pursuant to section 7805(f) ofthe Internal Revenue Code, this notice ofproposed rulemaking will be submitted to

2001–3 I.R.B. 349 January 16, 2001

the Chief Counsel for Advocacy of theSmall Business Administration for com-ment on its impact on small business.

Comments and Public Hearing

Before these proposed regulations areadopted as final regulations, considerationwill be given to any written comments(preferably a signed original and eight (8)copies) and comments sent via theInternet that are submitted timely to theIRS. The Department of the Treasury andthe IRS specifically request comments onthe clarity of the proposed regulations andhow they may be made easier to under-stand. All comments will be available forpublic inspection and copying.

A public hearing has been scheduledfor May 15, 2001, beginning at 10 a.m. inRoom 4718, Internal Revenue Building,1111 Constitution Avenue, NW.,Washington, DC. Due to building securi-ty procedures, visitors must enter at the10th Street entrance, located betweenConstitution and Pennsylvania Avenues,NW. In addition, all visitors must presentphoto identification to enter the building.Because of access restrictions, visitorswill not be admitted beyond the immedi-ate entrance area more than 15 minutesbefore the hearing starts. For informationabout having your name placed on thebuilding access list to attend the hearing,see the “FOR FURTHER INFORMA-TION CONTACT” section of this pream-ble.

The rules of 26 CFR 601.601(a)(3)apply to the hearing. Persons who wish topresent oral comments at the hearing mustsubmit written or electronic commentsand an outline of the topics to be dis-cussed and the time to be devoted to eachtopic (preferably a signed original andeight (8) copies) by April 24, 2001. Aperiod of 10 minutes will be allotted toeach person for making comments. Anagenda showing the scheduling of thespeakers will be prepared after the dead-line for receiving outlines has passed.Copies of the agenda will be availablefree of charge at the hearing.

Drafting Information

The principal author of these proposedregulations is Brendan P. O’Hara, Officeof the Associate Chief Counsel(Corporate). However, other personnelfrom the Department of the Treasury and

the IRS participated in their develop-ment.

* * * * *

Proposed Amendments to theRegulations

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

PART 1—INCOME TAXES

Paragraph 1. The authority citation forpart 1 is amended by adding an entry innumerical order to read in part as follows:Authority: 26 U.S.C. 7805 * * *Section 1.355–7 also issued under 26U.S.C. 355(e)(5). * * *

Par. 2. Section 1.355–0 is amended byrevising the section heading and addingintroductory text and an entry for§1.355–7 to read in part as follows:

§1.355–0 Outline of sections.

In order to facilitate the use of§§1.355–1 through 1.355–7, this sectionlists the major paragraphs in those sec-tions as follows:* * * * *

§1.355–7 Recognition of gain on certaindistributions of stock or securities inconnection with an acquisition.

(a) In general.(b) Plan.(c) Multiple acquisitions.(d) Facts and circumstances.(e) Operating rules.(1) Reasonable certainty evidence ofbusiness purpose to facilitate an acquisi-tion.(2) Internal discussion evidence of busi-ness purpose.(3) Hostile takeover defense.(4) Effect of distribution on trading instock.(5) Consequences of section 355(e) dis-regarded for certain purposes.(6) Substantial diminution of risk.(f) Safe harbors.(1) Safe Harbor I.(2) Safe Harbor II.(3) Safe Harbor III.(4) Safe Harbor IV.(5) Safe Harbor V.(i) In general.(ii) Special rules.(6) Safe Harbor VI.(g) Stock acquired by exercise of

options, warrants, convertible obliga-tions, and other similar interests.(1) Treatment of options.(i) General rule.(ii) Agreement, understanding, arrange-ment, or substantial negotiations to writean option.(2) Instruments treated as options.(3) Instruments generally not treated asoptions.(i) Escrow, pledge, or other securityagreements. (ii) Compensatory options.(iii) Options exercisable only upon death,disability, mental incompetency, or sepa-ration from service.(iv) Rights of first refusal.(v) Other enumerated instruments.(h) Multiple controlled corporations.(i) [Reserved](j) Valuation.(k) Definitions.(1) Agreement, understanding, arrange-ment, or substantial negotiations.(2) Controlled corporation.(3) Controlling shareholder.(4) Established market.(5) Five-percent shareholder.(l) [Reserved](m) Examples.(n) Effective date.

Par. 3. Section 1.355–7 is added to readas follows:

§1.355–7 Recognition of gain on certaindistributions of stock or securities inconnection with an acquisition.

(a) In general. Except as provided insection 355(e) and in this section, section355(e) applies to any distribution—

(1) To which section 355 (or so much ofsection 356 as relates to section 355)applies; and

(2) That is part of a plan (or series ofrelated transactions) (hereinafter, plan)pursuant to which 1 or more personsacquire directly or indirectly stock repre-senting a 50-percent or greater interest inthe distributing corporation (Distributing)or any controlled corporation(Controlled).

(b) Plan. (1) Whether a distributionand an acquisition are part of a plan isdetermined based on all the facts and cir-cumstances. In general, in the case of anacquisition after a distribution, the distrib-ution and the acquisition are consideredpart of a plan if Distributing, Controlled,

January 16, 2001 350 2001–3 I.R.B.

or any of their respective controllingshareholders intended, on the date of thedistribution, that the acquisition or a sim-ilar acquisition occur in connection withthe distribution. In general, in the case ofan acquisition before a distribution, theacquisition and the distribution are con-sidered part of a plan if Distributing,Controlled, or any of their respective con-trolling shareholders intended, on the dateof the acquisition, that a distribution occurin connection with the acquisition.

(2) For purposes of paragraph (b)(1) ofthis section, the actual acquisition and theintended acquisition may be similar eventhough the identity of the person acquir-ing stock of Distributing or Controlled(acquirer), the timing of the acquisition orthe terms of the actual acquisition are dif-ferent from the intended acquisition. Forexample, in the case of a public offeringor auction, the actual acquisition and theintended acquisition may be similar eventhough there are changes in the terms ofthe stock, the class of stock being offered,the size of the offering, the timing of theoffering, the price of the stock, or the par-ticipants in the public offering or auction.

(c) Multiple acquisitions. All acquisi-tions of stock of Distributing orControlled that are considered to be partof a plan with a distribution pursuant toparagraph (b) of this section will beaggregated for purposes of the 50-percenttest of paragraph (a)(2) of this section.

(d) Facts and circumstances. (1) Thefacts and circumstances to be consideredin demonstrating whether a distributionand an acquisition are part of a planinclude, but are not limited to, the factsand circumstances specified in paragraphs(d)(2) and (d)(3) of this section. Theweight to be given each of the facts andcircumstances depends on the particularcase. Therefore, whether a distributionand an acquisition are part of a plan doesnot depend on the relative number of factsand circumstances present under para-graph (d)(2) as compared to paragraph(d)(3) of this section.

(2) Among the facts and circumstancestending to show that a distribution and anacquisition are part of a plan are the fol-lowing:

(i) In the case of an acquisition (otherthan involving a public offering or auc-tion) after a distribution, Distributing orControlled and the acquirer (or any of

their respective controlling shareholders)discussed the acquisition or a similaracquisition by the acquirer before the dis-tribution. The weight to be accorded thediscussions depends on the nature, extentand timing of the discussions. The exis-tence of an agreement, understanding,arrangement or substantial negotiations atthe time of the distribution is given sub-stantial weight.

(ii) In the case of an acquisition (otherthan involving a public offering or auc-tion) after a distribution, Distributing orControlled and a potential acquirer (orany of their respective controlling share-holders) discussed an acquisition beforethe distribution and a similar acquisitionby a different person occurred after thedistribution. The weight to be accordedthe discussions depends on the nature,extent and timing of the discussions andthe similarity of the acquisition actuallyoccurring to the acquisition discussedbefore the distribution.

(iii) In the case of an acquisitioninvolving a public offering or auctionafter a distribution, Distributing orControlled (or any of their respective con-trolling shareholders) discussed the acqui-sition with an investment banker or otheroutside adviser before the distribution.The weight to be accorded the discussionsdepends on the nature, extent and timingof the discussions.

(iv) In the case of an acquisition beforea distribution, Distributing or Controlledand the acquirer (or any of their respectivecontrolling shareholders) discussed a dis-tribution before the acquisition. Theweight to be accorded the discussionsdepends on the nature, extent and timingof the discussions.

(v) In the case of an acquisition beforea distribution, Distributing or Controlledand a potential acquirer (or any of theirrespective controlling shareholders) dis-cussed a distribution before the acquisi-tion and a similar acquisition by a differ-ent person occurred before thedistribution. The weight to be accordedthe discussions depends on the nature,extent and timing of the discussions andthe similarity of the acquisition actuallyoccurring to the potential acquisition thatwas discussed.

(vi) In the case of an acquisition involv-ing a public offering or auction before adistribution, Distributing or Controlled

(or any of their respective controllingshareholders) discussed a distributionwith an investment banker or other out-side adviser before the acquisition. Theweight to be accorded the discussionsdepends on the nature, extent and timingof the discussions.

(vii) In the case of an acquisition eitherbefore or after a distribution, the distribu-tion was motivated by a business purposeto facilitate the acquisition or a similaracquisition of Distributing or Controlled.

(viii) In the case of an acquisition eitherbefore or after a distribution, the acquisi-tion and the distribution occurred within 6months of each other or there was anagreement, understanding, arrangement,or substantial negotiations regarding thesecond transaction within 6 months afterthe first transaction. Also, in the case ofan acquisition occurring after a distribu-tion, there was an agreement, understand-ing, arrangement, or substantial negotia-tions regarding a similar acquisition at thetime of the distribution or within 6 monthsthereafter.

(ix) In the case of an acquisition eitherbefore or after a distribution, the debt allo-cation between Distributing andControlled made an acquisition ofDistributing or Controlled likely in orderto service the debt.

(3) Among the facts and circumstancestending to show that a distribution and anacquisition are not part of a plan are thefollowing:

(i) In the case of an acquisition (otherthan involving a public offering or auc-tion) after a distribution, neitherDistributing nor Controlled and theacquirer or any potential acquirer (nor anyof their respective controlling sharehold-ers) discussed the acquisition or a similaracquisition before the distribution.

(ii) In the case of an acquisition involv-ing a public offering or auction after a dis-tribution, neither Distributing norControlled (nor any of their respective con-trolling shareholders) discussed the acquisi-tion with an investment banker or other out-side adviser before the distribution.

(iii) In the case of an acquisition after adistribution, there was an identifiable,unexpected change in market or businessconditions occurring after the distributionthat resulted in the acquisition that wasotherwise unexpected at the time of thedistribution.

2001–3 I.R.B. 351 January 16, 2001

(iv) In the case of an acquisition (otherthan involving a public offering or auc-tion) before a distribution, neitherDistributing nor Controlled and theacquirer (nor any of their respective con-trolling shareholders) discussed a distrib-ution before the acquisition. This para-graph (d)(3)(iv) does not apply if theacquisition occurred after the date of thepublic announcement of the planned dis-tribution.

(v) In the case of an acquisition beforea distribution, there was an identifiable,unexpected change in market or businessconditions occurring after the acquisitionthat resulted in a distribution that was oth-erwise unexpected.

(vi) In the case of an acquisition eitherbefore or after a distribution, the distribu-tion was motivated in whole or substantialpart by a corporate business purpose(within the meaning of §1.355–2(b)) otherthan a business purpose to facilitate theacquisition or a similar acquisition ofDistributing or Controlled. The presenceof a business purpose to facilitate theacquisition or a similar acquisition ofDistributing or Controlled is relevant indetermining the extent to which the distri-bution was motivated by a corporate busi-ness purpose (within the meaning of§1.355–2(b)) other than a business pur-pose to facilitate the acquisition or a sim-ilar acquisition of Distributing orControlled.

(vii) In the case of an acquisition eitherbefore or after a distribution, the distribu-tion would have occurred at approximate-ly the same time and in similar formregardless of the acquisition or a similaracquisition (including a previously pro-posed similar acquisition that did notoccur).

(e) Operating rules. The operatingrules contained in this paragraph (e) applyfor all purposes of this section.

(1) Reasonable certainty evidence ofbusiness purpose to facilitate an acquisi-tion. (i) In the case of an acquisition aftera distribution, if, at the time of the distrib-ution, it was reasonably certain that beforea date that is 6 months after the distribu-tion an acquisition would occur, an agree-ment, understanding, or arrangementwould exist, or substantial negotiationswould occur regarding an acquisition ofDistributing or Controlled, the reasonablecertainty is evidence of a business pur-

pose to facilitate an acquisition ofDistributing or Controlled.

(ii) In the case of an acquisition beforea distribution, if the acquisition occurredafter the date of the public announcementof the planned distribution, or if, at thetime of the acquisition, it was reasonablycertain that before a date that is 6 monthsafter the acquisition the distributionwould occur, an agreement, understand-ing, or arrangement would exist, or sub-stantial negotiations would occur regard-ing the distribution, the publicannouncement or reasonable certainty isevidence of a business purpose to facili-tate an acquisition of Distributing orControlled.

(2) Internal discussions evidence ofbusiness purpose. The fact that internaldiscussions regarding an acquisitionoccurred may be indicative of the busi-ness purpose that motivated the distribu-tion.

(3) Hostile takeover defense. IfDistributing distributes Controlled stockintending, in whole or substantial part, todecrease the likelihood of the acquisitionof Distributing or Controlled by separat-ing it from another corporation that islikely to be acquired, Distributing will betreated as having a business purpose tofacilitate the acquisition of the corpora-tion that was likely to be acquired.

(4) Effect of distribution on trading instock. The fact that the distribution madeall or a part of the stock of Controlledavailable for trading or made Distributingor Controlled’s stock trade more activelyis not taken into account in determiningwhether the distribution and an acquisi-tion of Distributing or Controlled stockwere part of a plan.

(5) Consequences of section 355(e) dis-regarded for certain purposes. For pur-poses of determining the intentions of therelevant parties under this section, theconsequences of the application of section355(e), and the existence of any contrac-tual indemnity by Controlled for taxresulting from the application of section355(e) caused by an acquisition ofControlled, are disregarded.

(6) Substantial diminution of risk. Therunning of any time period prescribed inthis section shall be suspended for anyperiod during which risk of loss is sub-stantially diminished under the principlesof section 355(d)(6)(B).

(f) Safe harbors—(1) Safe Harbor I. (i)A distribution and an acquisition occur-ring after the distribution will not be con-sidered part of a plan if—

(A) The acquisition occurred more than6 months after the distribution and therewas no agreement, understanding,arrangement, or substantial negotiationsconcerning the acquisition before a datethat is 6 months after the distribution; and

(B) The distribution was motivated inwhole or substantial part by a corporatebusiness purpose (within the meaning of§1.355–2(b)) other than a business pur-pose to facilitate an acquisition ofDistributing or Controlled.

(ii) For purposes of paragraph(f)(1)(i)(B) of this section, the presence ofa business purpose to facilitate an acquisi-tion of Distributing or Controlled is rele-vant in determining the extent to whichthe distribution was motivated by a corpo-rate business purpose (within the meaningof §1.355–2(b)) other than a business pur-pose to facilitate an acquisition ofDistributing or Controlled.

(2) Safe Harbor II. A distribution andan acquisition occurring after the distribu-tion will not be considered part of a planif—

(i) The acquisition occurred more than6 months after the distribution and therewas no agreement, understanding,arrangement, or substantial negotiationsconcerning the acquisition before a datethat is 6 months after the distribution; and

(ii) The distribution was motivated inwhole or substantial part by a corporatebusiness purpose (within the meaning of§1.355–2(b)) to facilitate an acquisition oracquisitions of no more than 33 percent ofthe stock of Distributing or Controlled,and no more than 20 percent of the stockof the corporation (whose stock wasacquired in the acquisition or acquisitionsthat motivated the distribution) was eitheracquired or the subject of an agreement,understanding, arrangement, or substan-tial negotiations before a date that is 6months after the distribution.

(3) Safe Harbor III. If an acquisitionoccurs more than 2 years after a distribu-tion and there was no agreement, under-standing, arrangement, or substantialnegotiations concerning the acquisition atthe time of the distribution or within 6months thereafter, the acquisition and thedistribution are not part of a plan.

January 16, 2001 352 2001–3 I.R.B.

(4) Safe Harbor IV. If an acquisitionoccurs more than 2 years before a distrib-ution, and there was no agreement, under-standing, arrangement, or substantialnegotiations concerning the distribution atthe time of the acquisition or within 6months thereafter, the acquisition and thedistribution are not part of a plan.

(5) Safe Harbor V—(i) In general. Anacquisition of Distributing or Controlledstock that is listed on an established mar-ket is not part of a plan if the acquisitionis pursuant to a transfer between share-holders of Distributing or Controlled, nei-ther of whom is a 5-percent shareholder.For purposes of the preceding sentence,the term 5-percent shareholder is definedin paragraph (k)(5) of this section, exceptthat the corporation can rely on Schedules13D and 13G (or any similar schedules)filed with the Securities and ExchangeCommission to identify its 5-percentshareholders.

(ii) Special rules—(A) This paragraph(f)(5) does not apply to public offerings orredemptions.

(B) This paragraph (f)(5) does notapply to a transfer of stock by or to a per-son who, pursuant to a formal or informalunderstanding with other persons (thecoordinating group), has joined in coordi-nated transfers of stock if, at any time dur-ing the period the understanding exists,the coordinating group owns, in the aggre-gate, 5 percent or more of the stock of thecorporation whose stock is transferred(determined by vote or value) immediate-ly before or after each transfer or at thetime of the distribution. A principal ele-ment in determining if such an under-standing exists is whether the investmentdecision of each person is based on theinvestment decision of 1 or more otherexisting or prospective shareholders.

(C) This paragraph (f)(5) does notapply to a transfer of stock by or to a per-son if the corporation the stock of whichis being transferred knows, or has reasonto know, that the person (or a coordinatinggroup, treating it as a single person)intends to become a 5-percent sharehold-er at any time during the 4-year periodbeginning 2 years before the distribution.

(6) Safe Harbor VI. If stock ofDistributing or Controlled is acquired byan employee or director of Distributing,Controlled, or a person related toDistributing or Controlled under section

355(d)(7)(A), in connection with the per-formance of services as an employee ordirector for the corporation or a personrelated to it under section 355(d)(7)(A)(and that is not excessive by reference tothe services performed) in a transaction towhich section 83 applies, the acquisitionis not an acquisition that is part of a planas described in paragraph (b)(1) of thissection.

(g) Stock acquired by exercise ofoptions, warrants, convertible obligations,and other similar interests—(1) Treatmentof options—(i) General rule. For purpos-es of this section, if stock of Distributingor Controlled is acquired pursuant to anoption, the option will be treated as anagreement to acquire the stock on the datethe option is written unless Distributingestablishes that on the later of the date ofthe stock distribution or the writing of theoption, the option was not more likelythan not to be exercised. The determina-tion of whether an option was more likelythan not to be exercised is based on all thefacts and circumstances, taking controlpremiums and minority and blockage dis-counts into account in determining the fairmarket value of stock underlying anoption.

(ii) Agreement, understanding, ar-rangement, or substantial negotiations towrite an option. If there is an agreement,understanding, or arrangement to write anoption, the option will be treated as writ-ten on the date of the agreement, under-standing, or arrangement. If an agree-ment, understanding, or arrangement towrite an option is reached, or an option iswritten, more than 6 months but not morethan 2 years after the distribution, andthere were substantial negotiationsregarding the writing of the option or theacquisition of the stock underlying theoption before the end of the 6-month peri-od beginning on the date of the distribu-tion, the option will be treated as writtenwithin 6 months after the distribution.

(2) Instruments treated as options. Forpurposes of this paragraph (g), except tothe extent provided in paragraph (g)(3) ofthis section, call options, warrants, con-vertible obligations, the conversion fea-ture of convertible stock, put options,redemption agreements (including rightsto cause the redemption of stock), anyother instruments that provide for theright or possibility to issue, redeem, or

transfer stock (including an option on anoption), or any other similar interests aretreated as options.

(3) Instruments generally not treated asoptions. For purposes of this paragraph(g), the following are not treated asoptions unless (in the case of paragraphs(g)(3)(i), (iii), and (iv) of this section)written, transferred (directly or indirect-ly), or listed with a principal purpose ofavoiding the application of section 355(e)or this section.

(i) Escrow, pledge, or other securityagreements. An option that is part of asecurity arrangement in a typical lendingtransaction (including a purchase moneyloan), if the arrangement is subject to cus-tomary commercial conditions. For thispurpose, a security arrangement includes,for example, an agreement for holdingstock in escrow or under a pledge or othersecurity agreement, or an option toacquire stock contingent upon a defaultunder a loan.

(ii) Compensatory options. An optionto acquire stock in Distributing orControlled with customary terms and con-ditions provided to an employee or direc-tor of Distributing, Controlled, or a personrelated to Distributing or Controlled undersection 355(d)(7)(A), in connection withthe performance of services as an employ-ee or director for the corporation or a per-son related to it under section355(d)(7)(A) (and that is not excessive byreference to the services performed) andthat immediately after the distribution andwithin 6 months thereafter—

(A) Is nontransferable within the mean-ing of §1.83–3(d); and

(B) Does not have a readily ascertain-able fair market value as defined in§1.83–7(b).

(iii) Options exercisable only upondeath, disability, mental incompetency,or separation from service. Any optionentered into between shareholders of acorporation (or a shareholder and thecorporation) that is exercisable onlyupon the death, disability, or mentalincompetency of the shareholder, or, inthe case of stock acquired in connectionwith the performance of services for thecorporation or a person related to itunder section 355(d)(7)(A) (and that isnot excessive by reference to the ser-vices performed), the shareholder’s sep-aration from service.

2001–3 I.R.B. 353 January 16, 2001

(iv) Rights of first refusal. A bona fideright of first refusal regarding the corpo-ration’s stock with customary terms,entered into between shareholders of acorporation (or between the corporationand a shareholder).

(v) Other enumerated instruments.Any other instrument the Commissionermay designate in revenue procedures,notices, or other guidance published in theInternal Revenue Bulletin. See§601.601(d)(2) of this chapter.

(h) Multiple controlled corporations.Only the stock or securities of a controlledcorporation in which 1 or more personsacquire directly or indirectly stock repre-senting a 50-percent or greater interest aspart of a plan involving the distribution ofthat corporation will be treated as notqualified property under section 355(e)(1)if—

(1) The stock or securities of more than1 controlled corporation are distributed indistributions to which section 355 (or somuch of section 356 as relates to section355) applies; and

(2) One or more persons do not acquire,directly or indirectly, stock representing a50-percent or greater interest inDistributing pursuant to a plan involvingany of those distributions.

(i) [Reserved](j) Valuation. Except as provided in

paragraph (g)(1)(i) of this section, for pur-poses of section 355(e) and this section,all shares of stock within a single class areconsidered to have the same value. Thus,control premiums and minority and block-age discounts within a single class are nottaken into account.

(k) Definitions—(1) Agreement, under-standing, arrangement, or substantialnegotiations. Whether an agreement,understanding, or arrangement existsdepends on the facts and circumstances.The parties do not necessarily have tohave entered into a binding contract orhave reached agreement on all terms tohave an agreement, understanding, orarrangement. However, an agreement,understanding, or arrangement clearlyexists if enforceable rights to acquirestock exist. In public offerings or auc-tions by Distributing or Controlled ofDistributing or Controlled’s stock, anagreement, understanding, arrangement,or substantial negotiations can exist evenif the acquirer has not been specifically

identified. The existence of such anagreement, understanding, arrangement,or substantial negotiations will be basedon discussions with an investment bankeror other outside adviser.

(2) Controlled corporation. For pur-poses of this section, a controlled corpora-tion is a corporation the stock of which isdistributed in a distribution to which sec-tion 355 (or so much of section 356 asrelates to section 355) applies.

(3) Controlling shareholder. (i) A con-trolling shareholder of a corporation thestock of which is not listed on an estab-lished market is any person who, directlyor indirectly, or together with related per-sons (as described in sections 267(b) and707(b)), possesses voting power inDistributing or Controlled representing ameaningful voice in the governance of thecorporation.

(ii) A controlling shareholder of a cor-poration the stock of which is listed on anestablished market is a 5-percent share-holder who actively participates in themanagement or operation of the corpora-tion.

(iii) For purposes of this section, a per-son is a controlling shareholder if that per-son meets the definition of controllingshareholder in this paragraph (k)(3)immediately before or immediately afterthe acquisition being tested.

(iv) If a distribution precedes an acqui-sition, Controlled’s controlling sharehold-ers immediately after the distribution areconsidered Controlled’s controlling share-holders at the time of the distribution.

(4) Established Market. An establishedmarket is—

(i) A national securities exchange regis-tered under section 6 of the SecuritiesExchange Act of 1934 (15 U.S.C. 78f);

(ii) An interdealer quotation systemsponsored by a national securities associ-ation registered under section 15A of theSecurities Act of 1934 (15 U.S.C. 78o–3);or

(iii) Any additional market that theCommissioner may designate in revenueprocedures, notices, or other guidancepublished in the Internal Revenue Bulletin(see §601.601(d)(2) of this chapter).

(5) Five-percent shareholder. A personwill be considered a 5-percent sharehold-er of a corporation the stock of which islisted on an established market if the per-son owns, directly or indirectly, or togeth-

er with related persons (as described insections 267(b) and 707(b)) 5 percent ormore of any class of stock of the corpora-tion whose stock is transferred. A personis a 5-percent shareholder if the personmeets the requirements of the precedingsentence immediately before or after eachtransfer. All options are treated as exer-cised for the purpose of determiningwhether the shareholder is a 5-percentshareholder.

(l) [Reserved](m) Examples. The following exam-

ples illustrate paragraphs (a) through (k)of this section. Throughout these exam-ples, assume that Distributing (D) ownsall of the stock of Controlled (C). Assumefurther that D distributes the stock of C ina distribution to which section 355 appliesand to which section 355(d) does notapply. Unless otherwise stated, assumethe corporations do not have controllingshareholders. No inference should bedrawn from any example concerningwhether any requirements of section 355other than those of section 355(e) are sat-isfied. The examples are as follows:

Example 1. Unwanted assets. (i) D is in business1. C is in business 2. D is relatively small in its indus-try. D wants to combine with X, a larger corporationalso engaged in business 1. X and D begin negotiat-ing for X to acquire D, but X does not want to acquireC. To facilitate the acquisition of D by X, D agrees todistribute all the stock of C pro rata before the acqui-sition. D and X enter into a binding contract for D tomerge into X subject to several conditions. D distrib-utes C and D merges into X one month later. As aresult of the merger, D’s former shareholders own lessthan 50 percent of the stock of X.

(ii) No Safe Harbor applies to this acquisition.(iii) The issue is whether the distribution of C and

the merger of D into X are part of a plan. To deter-mine whether the distribution of C and the merger ofD into X are part of a plan, D must consider all thefacts and circumstances, including those describedin paragraph (d) of this section.

(iv) The following tends to show that the distrib-ution of C and the merger of D into X are part of aplan: X and D discussed the acquisition before thedistribution (paragraph (d)(2)(i) of this section), Dwas motivated by a business purpose to facilitate themerger (paragraph (d)(2)(vii) of this section), andthe distribution and the merger occurred within 6months of each other (paragraph (d)(2)(viii) of thissection). Because the merger was not only dis-cussed, but was agreed to, before the distribution, thefact described in paragraph (d)(2)(i) of this section isgiven substantial weight.

(v) None of the facts and circumstances listed inparagraph (d)(3) of this section, tending to show thata distribution and an acquisition are not part of aplan, exist in this case.

(vi) The distribution of C and the merger of Dinto X are part of a plan under paragraph (b)(1) ofthis section.

January 16, 2001 354 2001–3 I.R.B.

Example 2. Substituted acquirer. (i) The factsare the same as in Example 1, except that after D dis-tributes C, X is unable to fulfill one of the conditionsof the merger agreement and the merger of D into Xdoes not occur. Y, one of X’s competitors, perceivesthis as an opportunity and begins discussing with Da merger into Y. Five months after D distributes C,D merges into Y. As a result of the merger, the Dshareholders own less than 50 percent of the out-standing Y stock.

(ii) No Safe Harbor applies to this acquisition.(iii) The issue is whether the distribution of C and

the merger of D into Y are part of a plan. To deter-mine whether the distribution of C and the merger ofD into Y are part of a plan, D must consider all thefacts and circumstances, including those describedin paragraph (d) of this section.

(iv) The following tends to show that the distrib-ution of C and the merger of D into Y are part of aplan: X, a potential acquirer, and D discussed anacquisition before the distribution and a similaracquisition by Y occurred (paragraph (d)(2)(ii) ofthis section), D was motivated by a business purposeto facilitate an acquisition similar to the merger withY (paragraph (d)(2)(vii) of this section), and the dis-tribution and the merger occurred within 6 months ofeach other (paragraph (d)(2)(viii) of this section).

(v) As in Example 1, none of the facts and cir-cumstances listed in paragraph (d)(3) of this sectionexist in this case. Although a substituted acquireracquired D, the merger of D into Y was similar to thenegotiated merger of D into X.

(vi) The distribution of C and the merger of Dinto Y are part of a plan under paragraph (b)(1) ofthis section.

Example 3. Public offering. (i) D’s managers,directors, and investment banker discuss the possi-bility of offering D stock to the public. They decidea public offering of 50 percent of D’s stock with Das a stand alone corporation would be in D’s bestinterest. To facilitate a stock offering by D of 50 per-cent of its stock, D distributes all the stock of C prorata to D’s shareholders. D issues new sharesamounting to 50 percent of its stock to the public ina public offering 7 months after the distribution.

(ii) No Safe Harbor applies to this acquisition.Safe Harbor V, relating to public trading, does notapply to public offerings (paragraph (f)(5)(ii)(A) ofthis section).

(iii) The issue is whether the distribution of C andthe public offering by D are part of a plan. To deter-mine whether the distribution of C and the publicoffering by D are part of a plan, D must consider allthe facts and circumstances, including thosedescribed in paragraph (d) of this section.

(iv) The following tends to show that the distrib-ution of C and the public offering by D are part of aplan: D discussed the public offering with its invest-ment banker before the distribution (paragraph(d)(2)(iii) of this section), D was motivated by abusiness purpose to facilitate the public offering(paragraph (d)(2)(vii) of this section), and there weresubstantial negotiations regarding the public offeringwithin 6 months after the distribution (paragraph(d)(2)(viii) of this section).

(v) None of the facts and circumstances listed inparagraph (d)(3) of this section, tending to show thata distribution and an acquisition are not part of aplan, exist in this case.

(vi) The distribution of C and the public offering

by D are part of a plan under paragraph (b)(1) of thissection.

Example 4. Public offering followed by unex-pected opportunity—(i) Facts. D’s managers, direc-tors, and investment banker discuss the possibility ofoffering C stock to the public. D decides to distrib-ute C pro rata to D’s shareholders solely to facilitatea 20 percent stock offering by C. To take advantageof favorable market conditions, C issues new sharesamounting to 20 percent of its stock in a public offer-ing 1 month before D distributes its remaining 80percent of the C stock. The public offering docu-ments disclose the intended distribution of C, whichis expected to occur shortly after the public offering.At the time of the distribution, it is not reasonablycertain that an acquisition will occur, an agreement,understanding, or arrangement concerning an acqui-sition will exist, or substantial negotiations concern-ing an acquisition will occur within 6 months. Twomonths after the distribution, C is approached unex-pectedly regarding an opportunity to acquire X. Fivemonths after the distribution, C acquires X inexchange for 40 percent of the C stock.

(ii) Public offering. (A) No Safe Harbor appliesto the public offering. Safe Harbor V, related to pub-lic trading, does not apply to public offerings (para-graph (f)(5)(ii)(A) of this section).

(B) The issue is whether the 20 percent publicoffering by C and the distribution by D of theremaining C stock are part of a plan. To determinewhether the distribution and the public offering arepart of a plan, D must consider all the facts and cir-cumstances, including those described in paragraph(d) of this section.

(C) Under paragraph (d)(2) of this section, thefollowing tends to show that the distribution of Cand the public offering are part of a plan: D dis-cussed the distribution with its investment bankerbefore the public offering (paragraph (d)(2)(vi) ofthis section), D was motivated by a business purposeto facilitate the public offering (paragraph(d)(2)(vii) of this section), and the public offeringand the distribution occurred within 6 months ofeach other (paragraph (d)(2)(viii) of this section).

(D) None of the facts and circumstances listed inparagraph (d)(3) of this section, tending to show thata distribution and an acquisition are not part of aplan, exist in this case.

(E) The public offering of C and the distributionof C are part of a plan under paragraph (b)(1) of thissection.

(iii) X acquisition. (A) No Safe Harbor applies tothe X acquisition.

(B) The issue is whether the distribution of C andthe acquisition by C of X are part of a plan. To deter-mine whether the distribution of C and the acquisi-tion by C of X are part of a plan, D must consider allthe facts and circumstances, including thosedescribed in paragraph (d) of this section.

(C) Under paragraph (d)(2) of this section, the fol-lowing tends to show that the distribution of C andacquisition by C of X are part of a plan: The distribu-tion and the acquisition occurred within 6 months ofeach other (paragraph (d)(2)(viii) of this section). Thefact described in paragraph (d)(2)(vii) of this sectiondoes not exist in this case because D’s business pur-pose was to facilitate the public offering and C’sacquisition of X is not similar to that acquisition.

(D) Under paragraph (d)(3) of this section, the fol-lowing tends to show that the distribution of C and the

acquisition by C of X are not part of a plan: NeitherD, C, nor their respective controlling shareholders dis-cussed the acquisition of X or a similar acquisitionwith potential acquirers before the distribution (para-graph (d)(3)(i) of this section), D had a substantialbusiness purpose for the distribution other than a busi-ness purpose to facilitate the acquisition of X or a sim-ilar acquisition (paragraph (d)(3)(vi) of this section),and the distribution would have occurred at approxi-mately the same time and in similar form regardless ofthe acquisition of X (paragraph (d)(3)(vii) of this sec-tion). The distribution was announced and accom-plished to facilitate the 20 percent public offering byC. D and C were unaware of the opportunity toacquire X at the time of the distribution.

(E) Weighing the facts and circumstances, theacquisition by C of X and the distribution of C by Dare not part of a plan under paragraph (b)(1) of thissection.

(F) If C’s acquisition of X had occurred morethan 6 months after the distribution and had not beenthe subject of an agreement, understanding, arrange-ment, or substantial negotiations before the date thatis 6 months after the distribution, Safe Harbor IIwould have applied to C’s acquisition of X.

Example 5. Hot market. (i) D is a widely heldcorporation the stock of which is listed on an estab-lished market. D announces a distribution of C anddistributes C pro rata to D’s shareholders. By con-tract, C agrees to indemnify D for any imposition oftax under section 355(e) caused by the acts of C.The distribution is motivated by a desire to improveD’s access to financing at preferred customer inter-est rates, which will be more readily available if Dseparates from C. At the time of the distribution,although D has not been approached by any potentialacquirer of C, it is reasonably certain that within 6months after the distribution either an acquisition ofC will occur or there will be an agreement, under-standing, arrangement, or substantial negotiationsregarding an acquisition of C. Corporation Yacquires C in a merger described in section368(a)(2)(E) within 6 months after the distribution.The C shareholders receive less than 50 percent ofthe stock of Y in the exchange.

(ii) No Safe Harbor applies to this acquisition.(iii) The issue is whether the distribution of C and

the acquisition of C by Y are part of a plan. Todetermine whether the distribution of C and theacquisition of C by Y are part of a plan, D must con-sider all the facts and circumstances, including thosedescribed in paragraph (d) of this section.

(iv) Under paragraph (d)(2) of this section, thefollowing tends to show that the distribution of Cand the acquisition of C by Y are part of a plan: Theacquisition and the distribution occurred within 6months of each other (paragraph (d)(2)(viii) of thissection). In addition, the distribution may be moti-vated by a business purpose to facilitate the acquisi-tion or a similar acquisition because there is evi-dence of a business purpose to facilitate anacquisition by reason of the fact that at the time ofthe distribution it was reasonably certain that anacquisition of C would occur or there would be anagreement, understanding, arrangement, or substan-tial negotiations regarding an acquisition of C with-in 6 months after the distribution (paragraphs(d)(2)(vii) and (e)(1)(i) of this section).

(v) Under paragraph (d)(3) of this section, the fol-lowing tends to show that the distribution of C and

2001–3 I.R.B. 355 January 16, 2001

the acquisition of C by Y are not part of a plan:Neither D, C, nor their respective controlling share-holders discussed the acquisition or a similar acqui-sition with Y or any other potential acquirers beforethe distribution (paragraph (d)(3)(i) of this section).Furthermore, D may be able to demonstrate that thedistribution was motivated in whole or substantialpart by a corporate business purpose other than abusiness purpose to facilitate the acquisition or asimilar acquisition (paragraph (d)(3)(vi) of this sec-tion). D’s stated purpose for the distribution (facili-tating D’s access to favorable financing) must beevaluated in light of the evidence of a business pur-pose to facilitate an acquisition. D also may be ableto demonstrate that the distribution would haveoccurred at approximately the same time and in sim-ilar form regardless of the acquisition (paragraph(d)(3)(vii) of this section).

(vi) Under paragraph (e)(5) of this section, theexistence of the indemnity is irrelevant in analyzingwhether the distribution and acquisition of C are partof a plan.

(vii) In determining whether the distribution of Cand the acquisition of C by Y are part of a plan, oneshould consider the importance of D’s stated businesspurpose for the distribution in light of the reasonablecertainty that C would be acquired or there would bean agreement, understanding, arrangement, or substan-tial negotiations regarding an acquisition of C within 6months after the distribution. If D’s stated businesspurpose for the distribution is substantial even thoughthe reasonable certainty that C would be acquired isevidence of a business purpose to facilitate an acquisi-tion, and if D would have distributed C regardless ofY’s acquisition of C, Y’s acquisition of C and D’s dis-tribution of C are not part of a plan.

Example 6. Unexpected opportunity. (i) D, thestock of which is listed on an established market,announces that it will distribute all the stock of C prorata to D’s shareholders. At the time of the announce-ment, the distribution is motivated wholly by a corpo-rate business purpose (within the meaning of§1.355–2(b)) other than a business purpose to facili-tate an acquisition. After the announcement butbefore the distribution, widely held X becomes avail-able as an acquisition target. There were no discus-sions between D and X before the announcement. Dnegotiates with and acquires X before the distribution.After the acquisition, X’s former shareholders own 55percent of D’s stock. D distributes the stock of C prorata within 6 months after the acquisition of X.

(ii) No Safe Harbor applies to this acquisition.(iii) The issue is whether the acquisition of X by

D and the distribution of C are part of a plan. Todetermine whether the distribution of C and theacquisition of X by D are part of a plan, D must con-sider all the facts and circumstances, including thosedescribed in paragraph (d) of this section.

(iv) Under paragraph (d)(2) of this section, thefollowing tends to show that the acquisition of X byD and the distribution of C are part of a plan: Theacquisition and the distribution occurred within 6months of each other (paragraph (d)(2)(viii) of thissection). Also, the distribution may be motivated bya business purpose to facilitate the acquisition or asimilar acquisition because there is evidence of abusiness purpose to facilitate an acquisition by rea-son of the fact that the acquisition occurred after thepublic announcement of the planned distribution

(paragraphs (d)(2)(vii) and (e)(1)(ii) of this section).(v) Under paragraph (d)(3) of this section, D

would assert that the following tends to show thatthe distribution of C and the acquisition of X by Dare not part of a plan: The distribution was motivat-ed by a corporate business purpose other than a busi-ness purpose to facilitate the acquisition or a similaracquisition (paragraph (d)(3)(vi) of this section), andthe distribution would have occurred at approxi-mately the same time and in similar form regardlessof the acquisition (paragraph (d)(3)(vii) of this sec-tion). That D decided to distribute C and announcedthat decision before it became aware of the opportu-nity to acquire X suggests that the distribution wouldhave occurred at approximately the same time and insimilar form regardless of D’s acquisition of X. X’slack of participation in the decision also helps estab-lish that fact.

(vi) In determining whether the distribution of Cand acquisition of X by D are part of a plan, oneshould consider the importance of D’s business pur-pose for the distribution in light of D’s opportunityto acquire X. If D can establish that the distributioncontinued to be motivated by the stated business pur-pose, and if D would have distributed C regardless ofD’s acquisition of X, then D’s acquisition of X andD’s distribution of C are not part of a plan.

Example 7. Multiple acquisitions—(i) Facts.(A) D, the stock of which is listed on an establishedmarket, engages in business 1. C engages in busi-ness 2. D has a business strategy of growth throughacquisitions and is interested in continually expand-ing business 1. D’s ownership of C has been animpediment to acquisitions by D. D believes the dis-tribution of C will make its acquisition programmore economical overall, regardless of D’s successwith any particular acquisition target. D has no spe-cific goals regarding how much D stock will be usedfor acquisitions.

(B) D and its investment banker identify X and Yas potential acquisition targets before D publiclyannounces the planned distribution. After D pub-licly announces the distribution, the sole purpose ofwhich is to facilitate acquisitions by D, but beforethe distribution date, D negotiates with X, but has nocontact with Y. D distributes all of the C stock. Onemonth after the distribution, D consummates thenegotiated acquisition of X. A, X’s sole sharehold-er, receives 30 percent of D’s stock. Seven monthsafter the distribution, D begins negotiating with Y.One year after the distribution, D acquires Y. Y’sshareholders receive 19 percent of D’s stock. Afterthe distribution, D and its investment banker identi-fy Z as another desirable target. Eighteen monthsafter the distribution, D acquires Z. Z’s shareholdersreceive 17 percent of D’s stock. If aggregated, theacquisitions of X, Y and Z would result in a changein the stock ownership of D of more than 50 percent.

(ii) X acquisition. (A) No Safe Harbor applies tothe X acquisition.

(B) The issue is whether the distribution of C andthe acquisition of X by D are part of a plan. Todetermine whether the distribution of C and theacquisition of X by D are part of a plan, D must con-sider all the facts and circumstances, including thosedescribed in paragraph (d) of this section.

(C) Under paragraph (d)(2) of this section, thefollowing tends to show that the distribution of Cand the acquisition of X by D are part of a plan: D

and X discussed the acquisition before the distribu-tion (paragraph (d)(2)(i) of this section), D had abusiness purpose to facilitate the X acquisition or asimilar acquisition (paragraph (d)(2)(vii) of this sec-tion), and the distribution and the X acquisitionoccurred within 6 months of each other (paragraph(d)(2)(viii) of this section).

(D) None of the facts and circumstances listed inparagraph (d)(3) of this section, tending to show thata distribution and an acquisition are not part of aplan, exist in this case.

(E) The distribution of C and the acquisition of X arepart of a plan under paragraph (b)(1) of this section.

(iii) Y acquisition. (A) No Safe Harbor applies tothe Y acquisition. Safe Harbor I does not applybecause the distribution was not motivated in wholeor substantial part by a corporate business purpose(within the meaning of §1.355–2(b)) other than abusiness purpose to facilitate an acquisition. SafeHarbor II does not apply because D’s business pur-pose to facilitate acquisitions was not limited to 33percent or less of the D stock. Also, more than 20percent of D’s stock was acquired in an acquisitionthat motivated the distribution before the date thatwas 6 months after the distribution (D’s acquisitionof X using 30 percent of D’s stock 1 month after thedistribution).

(B) The issue is whether the distribution of C andthe acquisition of Y by D are part of a plan. To deter-mine whether the distribution of C and the acquisi-tion of Y by D are part of a plan, D must consider allthe facts and circumstances, including thosedescribed in paragraph (d) of this section.

(C) Under paragraph (d)(2) of this section, thefollowing tends to show that the distribution of Cand the acquisition of Y by D are part of a plan: Dand a potential acquirer (X) discussed an acquisitionbefore the distribution and a similar acquisition witha different acquirer (Y) occurred (paragraph(d)(2)(ii) of this section) and D had a business pur-pose to facilitate the Y acquisition or a similar acqui-sition (paragraph (d)(2)(vii) of this section).

(D) None of the facts and circumstances listed inparagraph (d)(3) of this section, tending to show thata distribution and an acquisition are not part of aplan, exist in this case.

(E) The distribution of C and the acquisition of Y arepart of a plan under paragraph (b)(1) of this section.

(iv) Z acquisition. The analysis is identical to theY acquisition. The distribution of C and the acquisi-tion of Z are part of a plan under paragraph (b)(1) ofthis section.

(v) Under paragraph (c) of this section, all acqui-sitions of stock of D pursuant to a plan involving adistribution will be aggregated for purposes of the50-percent test of paragraph (a)(2) of this section.Because the acquisitions by D of X, Y, and Z areeach part of a plan involving D’s distribution of C,those three acquisitions are aggregated.

(n) Effective date. This section appliesto distributions occurring after these regu-lations are published as final regulationsin the Federal Register.

Robert E. Wenzel,Deputy Commissioner

of Internal Revenue.

January 16, 2001 356 2001–3 I.R.B.

(Filed by the Office of the Federal Register on De-cember 29, 2000, 8:45 a.m., and published in theissue of the Federal Register for January 2, 2001, 66F.R. 66)

New Revision of Publication547, Casualties, Disasters, andThefts

Announcement 2001–6

Publication 547, revised December2000, will be available soon from the In-ternal Revenue Service. It replaces theFebruary 1999 revision.

This publication explains the tax treat-ment of casualties, thefts, and losses ondeposits.

You can get a copy of this publication bycalling 1-800-TAX-FORM (1-800-829-3676). You can also write to the IRS FormsDistribution Center nearest you. Check yourincome tax package for the address. Thepublication is also available on the IRSInternet web site at www.irs.gov.

New Code V for the 2001 FormW-2, Box 12; Correction

Announcement 2001–7

Purpose

The purpose of this announcement is toadvise employers of a change to An-nouncement 2000–97(2000–48 I.R.B.557). Announcement 2000–97 advisedemployers that a new code (Code V—In-come from the exercise of nonstatutorystock options) was added for use in box12. In response to employer concernsabout implementing the reporting proce-dures, the use of Code V is optional forthe 2001 Forms W-2.

Nonstatutory Stock Options

When an employee (or former employee)exercises nonstatutory stock option(s), em-ployers are currently required to include theexcess of the fair market value of the stockreceived upon exercise of the option(s) overthe amount paid for that stock on Form W-2in boxes 1, 3 (up to the social security wagebase), and 5. Any compensation related tothe exercise of the nonstatutory stock op-tion(s) currently included in boxes 1, 3 (ifapplicable), and 5 should also be reportedseparately in box 12, using Code V. Thisseparate reporting in box 12 is optional forthe 2001 Forms W-2.

New Revision of Publication583, Starting a Business andKeeping Records

Announcement 2001–8

Publication 583, revised December2000, is now available from the InternalRevenue Service. It replaces the January1999 revision.

This publication provides basic federaltax and recordkeeping information forpeople who are starting a business.

You can get a copy of this publication bycalling 1-800-TAX-FORM (1-800-829-3676). You can also write to the IRS FormsDistribution Center nearest you. Checkyour income tax package for the address.The publication is also available on the IRSInternet web site at www.irs.gov.

Extension of Test of MediationProcedure for Appeals

Announcement 2001–9

Summary: This document extends thetest of the mediation procedure set forth

in Announcement 98–99, 1998–2 C.B.650, for an additional one-year period be-ginning on January 16, 2001, the date thisannouncement is published in the InternalRevenue Bulletin.

The mediation procedure allows tax-payers, in certain cases that are already inthe Appeals administrative process andthat are not docketed in any court, to re-quest mediation of one or more issues as adispute resolution technique. Under theprocedure, the taxpayer and Appeals at-tempt to negotiate a settlement, assistedby an objective and neutral third partywho has no authority to impose a deci-sion.

Background: Announcement 98–99,which contains the procedures that taxpay-ers may use to request mediation, applies tofactual issues involving an adjustment of $1million or more that are already in theAppeals administrative process. A two-year test of the mediation procedure con-cluded on November 15, 2000.

As Appeals transitions to its modern-ized structure, it is considering proposalsto expand its alternative dispute resolution(ADR) processes. After this review iscompleted, Appeals plans to promulgateguidance expanding the mediation pro-gram as provided for under § 7123(b)(1)of the Internal Revenue Code.

Changes: To meet the goals of theService’s restructuring, Appeals has reor-ganized its staffing. Therefore, positionand office titles in Announcement 98–99are substituted as follows, along with anupdated mailing address for HeadquartersAppeals:

2001–3 I.R.B. 357 January 16, 2001

Position Title Changes

Old New

National Director of Appeals Chief AppealsAssistant Regional Director of Appeals (ARDA-LC) Area DirectorAppeals Associate Chief Appeals Team ManagerAppeals Team Chief Appeals Team Case Leader

January 16, 2001 358 2001–3 I.R.B.

Office Title/Address Changes

Old New

National Director of Appeals Chief Appeals901 D Street, SW 1099 14th Street, NWBox 68 Suite 4200 - EastWashington, DC 20024 Washington, DC 20005Attn: C:AP:ADR & CS, Room 236 Attn: Appeals LMSB Operations

National Office Appeals Headquarters Appeals

Appeals Region Appeals Area

Office of Alternative Dispute Resolution Appeals LMSB Operationsand Customer Service Programs

In addition to the above changes,responsibility for the management of theAppeals mediation program has beentransferred from the Office of AlternativeDispute Resolution and Customer ServicePrograms to Appeals LMSB Operations.

Effective Date: This Announcementextends the test of the mediation proce-

dure set forth in Announcement 98–99,for an additional one-year period begin-ning on January 16, 2001, the date thisAnnouncement is published in theInternal Revenue Bulletin.

Drafting Information: The author ofthis announcement is Sandy Cohen,Appeals LMSB Operations, Headquarters

Appeals. For further information regard-ing this announcement, call Mr. Cohen at(202) 694-1818 (not a toll-free number).

2001–3 I.R.B. i January 16, 2001

Revenue 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 whereno change is being made in a prior pub-lished position, but the prior position isbeing extended to apply to a variation ofthe fact situation set forth therein. Thus,if an earlier ruling held that a principleapplied to A, and the new ruling holdsthat the same principle also applies to B,the earlier ruling is amplified. (Comparewith modified, below).

Clarified is used in those instanceswhere 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 situationwhere a ruling mentions a previouslypublished ruling and points out an essen-tial difference between them.

Modified is used where the substanceof 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 it ap-

plies to both A and B, the prior ruling ismodified because it corrects a publishedposition. (Compare with amplified andclarified, above).

Obsoleted describes a previously pub-lished ruling that is not considered deter-minative with respect to future transac-tions. This term is most commonly usedin a ruling that lists previously publishedrulings that are obsoleted because ofchanges in law or regulations. A rulingmay also be obsoleted because the sub-stance has been included in regulationssubsequently adopted.

Revoked describes situations where theposition in the previously published rul-ing is not correct and the correct positionis being stated in the new ruling.

Superseded describes a situation wherethe new ruling does nothing more thanrestate the substance and situation of apreviously published ruling (or rulings).Thus, the term is used to republish underthe 1986 Code and regulations the sameposition published under the 1939 Codeand regulations. The term is also usedwhen it is desired to republish in a singleruling a series of situations, names, etc.,that were previously published over a pe-riod of time in separate rulings. If the

new ruling does more than restate thesubstance of a prior ruling, a combinationof terms is used. For example, modifiedand superseded describes a situationwhere the substance of a previously pub-lished ruling is being changed in part andis continued 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 super-seded.

Supplemented is used in situations inwhich a list, such as a list of the names ofcountries, 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 be pub-lished that includes the list in the originalruling and the additions, and supersedesall prior rulings in the series.

Suspended is used in rare situations toshow 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 and for-merly used will appear in material published in theBulletin.

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 Contributions 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.

Definition of Terms

January 16, 2001 ii 2001–3 I.R.B.

Numerical Finding List1

Bulletins 2001–1 and 2

Announcements:

2001–1, 2001–2 I.R.B. 2772001–2, 2001–2 I.R.B. 2772001–3, 2001–2 I.R.B. 2782001–4, 2001–2 I.R.B. 2862001–5, 2001–2 I.R.B. 286

Notices:

2001–1, 2001–2 I.R.B. 2612001–2, 2001–2 I.R.B. 2652001–3, 2001–2 I.R.B. 2672001–4, 2001–2 I.R.B. 267

Railroad Retirement Quarterly Rates:

2001–2 I.R.B. 258

Revenue Procedures:

2001–1, 2001–1 I.R.B. 12001–2, 2001–1 I.R.B. 792001–3, 2001–1 I.R.B. 1112001–4, 2001–1 I.R.B. 1212001–5, 2001–1 I.R.B. 1642001–6, 2001–1 I.R.B. 1942001–7, 2001–1 I.R.B. 2362001–8, 2001–1 I.R.B. 2392001–10, 2001–2 I.R.B. 2722001–11, 2001–2 I.R.B. 275

Revenue Rulings:

2001–2, 2001–2 I.R.B. 255

Treasury Decisions:

8910, 2001–2 I.R.B. 258

1 A cumulative list of all revenue rulings, revenueprocedures, Treasury decisions, etc., published inInternal Revenue Bulletins 2000–27 through2000–52 is in Internal Revenue Bulletin 2001–1,dated January 2, 2001.

2001–3 I.R.B. iii January 16, 2001

Finding List of Current Actions onPreviously Published Items1

Bulletins 2001–1 and 2

Announcement:

99–79Superseded byAnn. 2001–3, 2001–2 I.R.B. 278

Cumulative Bulletin:

1998–2Corrected byAnn. 2001–5, 2001–2 I.R.B. 286

Notices:

Notice 2000–21Superseded byNotice 2001–1, 2001–2 I.R.B. 261

Revenue Procedures:

99–49Modified and amplified byRev. Proc. 2001–10, 2001–2 I.R.B. 272

2000–1Superseded byRev. Proc. 2001–1, 2001–1 I.R.B. 1

2000–2Superseded byRev. Proc. 2001–2, 2001–1 I.R.B. 79

2000–3Superseded byRev. Proc. 2001–3, 2001–1 I.R.B. 111

2000–4Superseded byRev. Proc. 2001–4, 2001–1 I.R.B. 121

2000–5Superseded byRev. Proc. 2001–5, 2001–1 I.R.B. 164

2000–6Superseded byRev. Proc. 2001–6, 2001–1 I.R.B. 194

2000–7Superseded byRev. Proc. 2001–7, 2001–1 I.R.B. 236

2000–8Superseded byRev. Proc. 2001–8, 2001–1 I.R.B. 239

2000–22Modified and superseded byRev. Proc. 2001–10, 2001–2 I.R.B. 272

Treasury Decisions:

8889Corrected byAnn. 2001–4, 2001–2 I.R.B. 286

1 A cumulative list of current actions on previouslypublished items in Internal Revenue Bulletins2000–27 through 2000–52 is in Internal RevenueBulletin 2001–1, dated January 2, 2001.

INTERNAL REVENUE BULLETINThe Introduction at the beginning of this issue describes the purpose and content of this publication. The weekly Internal Revenue

Bulletin is sold on a yearly subscription basis by the Superintendent of Documents. Current subscribers are notified by theSuperintendent of Documents when their subscriptions must be renewed.

CUMULATIVE BULLETINSThe contents of this weekly Bulletin are consolidated semiannually into a permanent, indexed, Cumulative Bulletin. These are

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