Part I. Rulings — Internal Revenue Bulletin 1996-4

Labor Statistics on December 14, 1995. The indexes are accepted by the Internal Revenue Service, under § 1.472–1(k) of the Income Tax Regulations and Rev. Proc. 86–46, 1986–2 C.B. 739, for appropriate application to inventories of department stores employing the retail inventory and lastin, first-out inventory methods for tax years ended on, or with reference to, November 30, 1995.

The Department Store Inventory Price Indexes are prepared on a national basis and include (a) 23 major groups of departments, (b) three special combinations of the major groups—soft goods, durable goods, and miscellaneous goods, and (c) a store total, which covers all departments, including some not listed separately, except for the following: candy, foods, liquor, tobacco, and contract departments.

Section 170.—Charitable Contributions and Gifts

26 CFR 1.170A–1: Charitable Contributions and Gifts

If a partnership makes a charitable contribution of property, are the partners’ bases in their partnership interests decreased to reflect the contribution. See Rev. Rul. 96–11, page 28.

Section 267.—Losses, Expenses, and Interest with respect to Transactions between Related Taxpayers.

26 CFR 1.267(d)–1: Amount of gain where loss previously disallowed.

If gain from the sale of partnership property is not recognized due to §§ 707(b)(1) and 267(d) of the Internal Revenue Code, are the partners’ bases in their partnership interests incrased under

§ 705(a)(1) to reflect that gain? See Rev. Rul. 96–10, page 27.

§ 472.—Last-in, First-out Inventories

26 CFR 1.472–1: Last-in, first-out inventories.

LIFO; price indexes; department stores. The November 1995 Bureau of Labor Statistics price indexes are accepted for use by department stores employing the retail inventory and lastin, first-out inventory methods for valuing inventories for tax years ended on, or with reference to, November 30, 1995.

Rev. Rul. 96–9

The following Department Store Inventory Price Indexes for November 1995 were issued by the Bureau of

BUREAU OF LABOR STATISTICS, DEPARTMENT STORE INVENTORY PRICE INDEXES BY DEPARTMENT GROUPS

(January 1941 = 100, unless otherwise noted)

Groups Nov. 1994 Nov. 1995

Percent Change from Nov. 1994 to Nov. 1995 ¹

Piece Goods. . . . . . . . . . . . . . . . . . . . . . . . . . . 486.9 509.3 4.6
Domestics and Draperies . . . . . . . . . . . . . . . . 641.4 632.0 –1.5
Women’s and Children’s Shoes . . . . . . . . . . 640.6 637.8 –0.4
Men’s Shoes . . . . . . . . . . . . . . . . . . . . . . . . . . 914.2 921.8 0.8
Infants’ Wear. . . . . . . . . . . . . . . . . . . . . . . . . . 623.0 636.8 2.2
Women’s Underwear . . . . . . . . . . . . . . . . . . . 529.5 527.8 –0.3
Women’s Hosiery . . . . . . . . . . . . . . . . . . . . . . 281.1 288.2 2.5
Women’s and Girls’ Accessories . . . . . . . . . 578.0 559.8 –3.1
Women’s Outerwear and Girls’ Wear. . . . . 432.0 419.3 –2.9
Men’s Clothing . . . . . . . . . . . . . . . . . . . . . . . . 614.9 623.7 1.4
Men’s Furnishings. . . . . . . . . . . . . . . . . . . . . . 577.5 572.7 –0.8
Boys’ Clothing and Furnishings. . . . . . . . . . 486.9 485.5 –0.3
Jewelry . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1007.9 1001.1 –0.7
Notions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 748.5 776.6 3.8
Toilet Articles and Drugs . . . . . . . . . . . . . . . 852.9 875.3 2.6
Furniture and Bedding . . . . . . . . . . . . . . . . . . 637.5 661.2 3.7
Floor Coverings. . . . . . . . . . . . . . . . . . . . . . . . 553.8 555.4 0.3
Housewares . . . . . . . . . . . . . . . . . . . . . . . . . . . 781.1 248.7 0.1
Major Appliances . . . . . . . . . . . . . . . . . . . . . . 248.4 248.7 0.1
Radio and Television . . . . . . . . . . . . . . . . . . . 84.3 79.9 –5.2
Recreation and Education ² . . . . . . . . . . . . . . 115.3 113.4 –1.6
Home Improvements ² . . . . . . . . . . . . . . . . . . . 120.8 121.9 0.9
Auto Accessories ² . . . . . . . . . . . . . . . . . . . . . . 106.3 107.0 0.7

BUREAU OF LABOR STATISTICS, DEPARTMENT STORE INVENTORY PRICE INDEXES BY DEPARTMENT GROUPS

(January 1941 = 100, unless otherwise noted)—Continued

Groups Nov. 1994 Nov. 1995

Percent Change from Nov. 1994 to Nov. 1995 ¹

Groups 1—15: Soft Goods. . . . . . . . . . . . . . . . . . 598.6 595.2 –0.6

Groups 16—20: Durable Goods . . . . . . . . . . . . . 464.1 465.0 0.2

Groups 21—23: Misc. Goods ² . . . . . . . . . . . . . . . 114.4 113.5 –0.8

Store Total ³ . . . . . . . . . . . . . . . . . . . . . . . . . 552.1 550.7 –0.3

1Absence of a minus sign before percentage change in this column signifies price increase. 2Indexes on a January 1986=100 base. 3The store total index covers all departments, including some not listed separately, except for the following: candy, foods, liquor, tobacco, and contract departments.

DRAFTING INFORMATION

The principal author of this revenue ruling is Stan Michaels of the Office of Assistant Chief Counsel (Income Tax and Accounting). For further information regarding this revenue ruling, contact Mr. Michaels on (202) 622-4970 (not a toll-free call).

Section 702.—Income and Credits of Partner

26 CFR 1.702–1: Income and Credits of Partner

If a partnership makes a charitable contribution of property, are the partners’ bases in their partnership interests decreased to reflect the contribution. See Rev. Rul. 96–11, page 28.

Section 482.—Allocation of Income and Deductions Among Taxpayers

26 CFR 1.482–0: Outline of regulations under section 482.

T.D. 8632

DEPARTMENT OF THE TREASURY Internal Revenue Service 26 CFR Parts 1, 301 and 602

Section 482 Cost Sharing Regulations

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

SUMMARY: This document contains

final regulations relating to qualified cost sharing arrangements under section 482 of the Internal Revenue Code. These regulations reflect changes to section 482 made by the Tax Reform Act of 1986, and provide guidance to revenue agents and taxpayers implementing the changes.

DATES: These regulations are effective January 1, 1996.

These regulations are applicable for taxable years beginning on or after January 1, 1996.

FOR FURTHER INFORMATION CONTACT: Lisa Sams of the Office of Associate Chief Counsel (International), IRS (202) 622–3840 (not a tollfree number).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

The collections of information contained in these final regulations have been reviewed and approved by the Office of Management and Budget in accordance with the Paperwork Reduction Act (44 U.S.C. 3507) under control number 1545–1364. Responses to these collections of information are required to determine whether an intangible development arrangement is a qualified cost sharing arrangement and who are the participants in such arrangement.

An agency may not conduct or sponsor, and a person is not required to respond to, a collection of information unless the collection of information displays a valid control number.

The estimated average annual burden per recordkeeper is 8 hours. The estimated average annual burden per respondent is 0.5 hour.

Comments concerning the accuracy of this burden estimate and suggestions for reducing this burden should be sent to the Internal Revenue Service, Attn: IRS Reports Clearance Officer, T:FP, Washington, DC 20224, and to the Office of Management and Budget, Attn: Desk Officer for the Department of the Treasury, Office of Information and Regulatory Affairs, Washington, DC 20503.

Books and records relating to these collections of information must be retained as long as their contents may become material in the administration of any internal revenue law. Generally, tax returns and tax return information are confidential, as required by 26 U.S.C. 6103.

Background

Section 482 was amended by the Tax Reform Act of 1986, Public Law 99– 514, 100 Stat. 2085, 2561, et. seq. (1986–3 C.B. (Vol. 1) 1, 478). On January 30, 1992, a notice of proposed rulemaking concerning the section 482 amendment in the context of cost sharing was published in the Federal Register (INTL–0372–88, 57 FR 3571

[1992–1 C.B. 1164]).

Written comments were received with respect to the notice of proposed rulemaking, and a public hearing was held on August 31, 1992. After consideration of all the comments, the proposed regulations under section 482 are adopted as revised by this Treasury

decision, and the corresponding temporary regulations (which contain the cost sharing regulations as in effect since 1968) are removed.

Explanation of Provisions

Introduction

The Tax Reform Act of 1986 (the Act) amended section 482 to require that consideration for intangible property transferred in a controlled transaction be commensurate with the income attributable to the intangible. The Conference Committee report to the Act indicated that in revising section 482, Congress did not intend to preclude the use of bona fide research and development cost sharing arrangements as an appropriate method of allocating income attributable to intangibles among related parties. The Conference Committee report stated, however, that in order for cost sharing arrangements to produce results consistent with the commensurate-with-income standard, (a) a cost sharer should be expected to bear its portion of all research and development costs, on unsuccessful as well as successful products, within an appropriate product area, and the costs of research and development at all relevant development stages should be shared, (b) the allocation of costs generally should be proportionate to profit as determined before deduction for research and development, and (c) to the extent that one party contributes funds toward research and development at a significantly earlier point in time than another (or is otherwise putting its funds at risk to a greater extent than the other) that party should receive an appropriate return on its investment. See H.R. Rep. 99–281, 99th Cong., 2d Sess. (1986) at II–638.

The Conference Committee report to the Act recommended that the IRS conduct a comprehensive study and consider whether the regulations under section 482 (issued in 1968) should be modified in any respect.

The White Paper

In response to the Conference Committee’s directive, the IRS and the Treasury Department issued a study of intercompany pricing [Notice 88–123 (1988–2 C.B. 458)] on October 18, 1988 (the White Paper). The White Paper suggested that most bona fide

cost sharing arrangements should have certain provisions. For example, the White Paper stated that most product areas covered by cost sharing arrangements should be within three-digit Standard Industrial Classification codes, that most participants should be assigned exclusive geographic rights in developed intangibles (and should predict benefits and divide costs accordingly) and that marketing intangibles should be excluded from bona fide cost sharing arrangements.

Comments on the White Paper indicated that, in practice, there was a great deal of variety in the terms of bona fide cost sharing arrangements, and that if the White Paper’s suggestions were incorporated in regulations, the regulations would unduly restrict the availability of cost sharing.

The 1992 proposed regulations

The IRS issued proposed cost sharing regulations on January 30, 1992 (INTL–0372–88, 57 FR 3571). In general, the proposed regulations allowed more flexibility than anticipated by the White Paper, relying on anti-abuse tests rather than requiring standard cost sharing provisions.

The proposed regulations stated that in order to be qualified, a cost sharing arrangement had to meet the following five requirements: (1) the arrangement had to have two or more eligible participants, (2) the arrangement had to be recorded in writing contemporaneously with the formation of the cost sharing arrangement, (3) the eligible participants had to share the costs and risks of intangible development in return for a specified interest in any intangible produced, (4) the arrangement had to reflect a reasonable effort by each eligible participant to share costs and risks in proportion to anticipated benefits from using developed intangibles, and (5) the arrangement had to meet certain administrative requirements. The key requirements were that participants had to be eligible and that costs and risks had to be proportionate to benefits.

Under the proposed regulations, only a controlled taxpayer that would use developed intangibles in the active conduct of its trade or business was eligible to participate in a cost sharing arrangement. This requirement was considered necessary to ensure that controlled foreign entities were not

established simply to participate in cost sharing arrangements without performing any other meaningful function, and to ensure that each participant’s share of anticipated benefits was measurable.

The proposed regulations allowed costs to be divided based on any measurement that would reasonably predict cost sharing benefits ( e.g., anticipated units of production or anticipated sales). However, the basis for measuring anticipated benefits and dividing costs was checked by a cost-tooperating-income ratio. The method for dividing costs was presumed to be unreasonable if a U.S. participant’s ratio of shared costs to operating income attributable to developed intangibles was grossly disproportionate to the cost-to-operating-income ratio of the other participants.

If a U.S. participant’s cost-tooperating-income ratio was not grossly disproportionate, a section 482 allocation could still be made under three circumstances: (a) if the cost-tooperating-income ratio was disproportionate (allocation of costs), (b) if the pool of costs shared was too broad or too narrow, so that the U.S. participant was paying for research that it would not use (allocation of costs), or (c) if the cost-to-operating-income ratio was substantially disproportionate, such that a transfer of an intangible could be deemed to have occurred (allocation of income).

Under the proposed regulations, the IRS could also make an allocation of income to reflect a buy-in or buy-out event, that is, a transfer of an intangible that could occur, for example, when a participant joined or left a cost sharing arrangement.

Comments on the 1992 proposed regulations

The 1992 proposed cost sharing regulations were generally well received. However, there were five areas of particular concern to commenters. The first was the mechanical use of cost-to-operating-income ratios as a standard for measuring the reasonableness of an effort to share costs in proportion to anticipated benefits. Commenters noted that operating income attributable to developed intangibles was difficult to measure, and that other bases for measuring benefits might produce more reliable results. Commenters also believed that the

Section 1.482–7(b) contains the requirements for a qualified cost sharing arrangement. This provision substantially tracks the proposed regulations. A modification was made in the second requirement which now directs that the arrangement provide a method to calculate each controlled participant’s share of intangible development costs, based on factors that can reasonably be expected to reflect anticipated benefits. The new standard is intended to ensure that cost sharing arrangements will not be disregarded by the IRS as long as the factors upon which an estimate of benefits was based were reasonable, even if the estimate proved to be inaccurate.

Section 1.482–7(b)(4) requires that a cost sharing arrangement be set forth in writing and contain a number of specified provisions, including the interest that each controlled participant will receive in any intangibles developed pursuant to the arrangement. The intangibles developed under a cost sharing arrangement are referred to as the ‘‘covered intangibles.’’ It is possible that the research activity undertaken may result in development of intangible property that was not foreseen at the inception of the cost sharing arrangement; any such property is also included within the definition of the term covered intangibles. The prescriptive rules in relation to the scope of the intangible development area under the proposed regulations are eliminated in favor of a flexible definition that encompasses any research and development actually undertaken under the cost sharing arrangement.

Section 1.482–7(c) provides rules for being a participant in a qualified cost sharing arrangement. Unlike the proposed regulations, the final regulations permit participation by unrelated persons, which are referred to as ‘‘uncontrolled participants.’’ Controlled taxpayers may be participants, referred to as ‘‘controlled participants,’’ if they satisfy the conditions set forth in these rules. These qualification rules replace the proposed regulations’ concept of ‘‘eligible participant.’’ The tax treatment of controlled taxpayers that do not qualify as controlled participants provided in §1.482–7(c)(4) essentially tracks the treatment provided for ineligible participants under the proposed regulations.

The requirements for being a controlled participant are basically the same as in the proposed regulations. In

ratios might be overused, leading to adjustments to costs in every year, and to many deemed transfers of intangibles. In addition, commenters stated that the ratios did not provide any certainty that a cost sharing arrangement would not be disregarded, since a ‘‘grossly disproportionate’’ ratio was not numerically defined.

The second area of concern was the eligible participant requirement. Commenters argued that separate research entities (with no separate active trade or business) should be allowed to participate in cost sharing arrangements, as should marketing affiliates. Commenters also argued that transfers of intangibles to unrelated entities should not disqualify a participant, and that foreign-to-foreign transfers should not necessarily be monitored. Some comments also stated that controlled entities should be able to participate even if their cost sharing payments would be characterized differently for purposes of foreign law.

The third area of concern was the regulations’ requirement that every participant be able to benefit from every intangible developed under a cost sharing arrangement. Commenters stated that the regulations should allow both single-product cost sharing arrangements and umbrella cost sharing arrangements ( i.e., cost sharing arrangements under which a broad category of a controlled group’s research and development would be covered).

The fourth area of concern was the buy-in and buy-out rules. There were some suggestions for clarifying and simplifying the rules. For example, comments urged that the regulations provide that one participant’s abandonment of its rights would not necessarily confer benefits on the other participants, and that a new participant need not always make a buy-in payment when joining a cost sharing arrangement. Suggestions for simplifying the rules generally consisted of proposed safe harbors for valuing intangibles.

The final general area of concern was the administrative requirements. Several commenters suggested that annual adjustments to the method used to share costs should not be required. Commenters also suggested that taxpayers not be required to attach their cost sharing arrangements to their returns, and that the time period for producing records be increased.

In addition to these general areas of concern, commenters noted that there

should be more guidance about when the IRS would deem a cost sharing arrangement to exist. Commenters also argued that existing cost sharing arrangements should be grandfathered, or that there should be a longer transition period. Commenters suggested that financial accounting rules be used to calculate costs to be shared, and that the IRS address the impact of currency fluctuations on the cost-to-operatingincome ratios. Finally, commenters asked that the regulations clarify that a cost sharing arrangement would not be deemed to create a partnership or a U.S. trade or business.

The final regulations

Without fundamentally altering the policies of the 1992 proposed regulations, the final regulations reflect numerous modifications in response to the comments described above. They also reflect the approach of the final section 482 regulations relating to transfers of tangible and intangible property.

Section 1.482–7(a)(1) defines a cost sharing arrangement as an agreement for sharing costs in proportion to reasonably anticipated benefits from the individual exploitation of interests in the intangibles that are developed. In order to claim the benefits of the safe harbor, a taxpayer must also satisfy certain formal requirements (enumerated in §1.482–7(b)). The district director may apply the cost sharing rules to any arrangement that in substance constitutes a cost sharing arrangement, notwithstanding any failure to satisfy particular requirements of the safe harbor. It is further provided that a qualified cost sharing arrangement, or an arrangement treated in substance as such, will not be treated as a partnership. (A corresponding provision is added to §301.7701–3 pertaining to the definition of a partnership.) Neither will a foreign participant be treated as engaged in a trade or business within the United States solely by virtue of its participation in such an arrangement.

Section 1.482–7(a)(2) restates the general rule of cost sharing in a manner intended to emphasize its limitation on allocations: no section 482 allocation will be made with respect to a qualified cost sharing arrangement, except to make each controlled participant’s share of the intangible development costs equal to its share of reasonably anticipated benefits.

benefits must be used, taking into account the factors set forth in §1.482– 1(c)(2)(ii). The measurement basis used must be consistent for all controlled participants. The regulations provide that benefits may be measured directly or indirectly. In addition, regardless of whether a direct or indirect basis of measurement is employed, it may be necessary to make adjustments to account for material differences in the activities that controlled participants perform in connection with exploitation of covered intangibles, such as between wholesale and retail distribution.

Section 1.482–7(f)(3)(iii) describes the scope of various indirect bases for measuring benefits, such as units, sales, and operating profit. Indirect bases other than those enumerated may be employed as long as they bear a relationship to benefits.

Section 1.482–7(f)(3)(iv) discusses projections used to estimate benefits. Projections required for this purpose generally include a determination of the time period between the inception of the research and development and the receipt of benefits, a projection of the time over which benefits will be received, and a projection of the benefits anticipated for each year in which it is anticipated that the intangible will generate benefits. However, the regulations note that in certain circumstances, current annual benefit shares may be used in lieu of projections.

Section 1.482–7(f)(3)(iv)(B) states that a significant divergence between projected and actual benefit shares may indicate that the projections were not reliable. A significant divergence is defined as divergence in excess of 20% between projected and actual benefit shares. If there is a significant divergence, which is not due to an unforeseeable event, then the district director may use actual benefits as the most reliable basis for measuring benefits. Conversely, no allocation will be made based on a divergence that is not considered significant as long as the estimate is made using the most reliable basis for measuring benefits.

For purposes of the 20% test, all non-U.S. controlled participants are treated as a single controlled participant in order that a divergence by a foreign controlled participant with a very small share of the total costs will not necessarily trigger an allocation (section 1.482–7(f)(3)(iv)(D), Example 8, il

particular, a controlled participant must use or reasonably expect to use covered intangibles in the active conduct of a trade or business. Thus, an entity that chiefly provides services ( e.g., as a contract researcher) may not be a controlled participant. These provisions are necessary for the reason that they are necessary to the proposed regulations: to prevent foreign controlled entities from being established simply to participate in cost sharing arrangements. In accordance with §1.482– 7(c)(4) mentioned above, service entities (such as contract researchers) may furnish research and development services to the members of a qualified cost sharing arrangement, with the appropriate consideration for such assistance in the research and development undertaken in the intangible development area being governed by the rules in §1.482–4(f)(3)(iii) (Allocations with respect to assistance provided to the owner). In the case of a controlled research entity, the appropriate arm’s length compensation would generally be determined under the principles of §1.482–2(b) (Performance of services for another). Each controlled participant would be deemed to incur as part of its intangible development costs a share of such compensation equal to its share of reasonably anticipated benefits.

As under the proposed regulations, the activity of another person may be attributed to a controlled taxpayer for purposes of meeting the active conduct requirement. However, modified language is adopted to be more precise concerning the intended requirements for attribution. These requirements were phrased in the proposed regulations as bearing the risk and receiving the benefits of the attributed activity. Under the final regulations, the attribution will be made only in cases in which the controlled taxpayer exercises substantial managerial and operational control over the attributed activities.

As under the proposed regulations, a principal purpose to use cost sharing to accomplish a transfer or license of covered intangibles to uncontrolled or controlled taxpayers will defeat satisfaction of the active conduct requirement. However, a principal purpose will not be implied where there are legitimate business reasons for subsequently licensing covered intangibles.

The subgroup rules of the proposed regulations are eliminated. Their major purpose is accomplished by a simpler

provision (see the discussion of §1.482–7(h)). In addition, the final regulations treat all members of a consolidated group as a single participant.

Section 1.482–7(d) defines intangible development costs as operating expenses other than depreciation and amortization expense, plus an arm’s length charge for tangible property made available to the cost sharing arrangement. Costs to be shared include all costs relating to the intangible development area, which, as noted, comprises any research actually undertaken under the cost sharing arrangement. As under the proposed regulations, the district director may adjust the pool of costs shared in order to properly reflect costs that relate to the intangible development area.

Section 1.482–7(e) defines anticipated benefits as additional income generated or costs saved by the use of covered intangibles. The pool of benefits may also be adjusted in order to properly reflect benefits that relate to the intangible development area.

Section 1.482–7(f) governs cost allocations by the district director in order to make a controlled participant’s share of costs equal to its share of reasonably anticipated benefits. Anticipated benefits of uncontrolled participants will be excluded from anticipated benefits in calculating the benefits shares of controlled participants. A share of reasonably anticipated benefits will be determined using the most reliable estimate of benefits. This rule echoes the best method rule for determining the most reliable measure of an arm’s length result under §1.482–1(c).

The reliability of an estimate of benefits principally depends on two factors: the reliability of the basis for measuring benefits used and the reliability of the projections used. The cost-to-operating-income ratio used in the proposed regulations to check the reasonableness of an effort to share costs in proportion to anticipated benefits has not been included in the final regulations. Rather, the final regulations provide that an allocation of costs or income may be made if the taxpayer did not use the most reliable estimate of benefits, which depends on the facts and circumstances of each case.

Section 1.482–7(f)(3)(ii) provides that in estimating a controlled participant’s share of benefits, the most reliable basis for measuring anticipated

regulatory action as defined in EO 12866. Therefore, a regulatory assessment is not required. It also has been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) and the Regulatory Flexibility Act (5 U.S.C. chapter 6) do not apply to these regulations, and, therefore, a Regulatory Flexibility Analysis is not required. Pursuant to section 7805(f) of the Internal Revenue Code, the notice of proposed rulemaking preceding these regulations was submitted to the Small Business Administration for comment on its impact on small business.

Drafting Information

The principal author of these regulations is Lisa Sams, Office of Associate Chief Counsel (International), IRS. However, other personnel from the IRS and Treasury Department participated in their development.

- - - - -

Adoption of Amendments to the Regulations

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

PART 1—INCOME TAXES

Paragraph 1. The authority for part 1 is amended by adding an entry for section 1.482–7 to read as follows:

Authority: 26 U.S.C. 7805. * * * Section 1.482–7 is also issued under 26 U.S.C. 482. * * *

Par. 2. Section 1.482–0 is amended by:

Removing the entry for §1.482– 7T.
Adding the entry for §1.482–7 to read as follows:

§1.482–0 Outline of regulations under 482.

- - - - -

§1.482–7 Sharing of costs.

(a) In general. (1) Scope and application of the rules in this section. (2) Limitation on allocations. (3) Cross references. (b) Qualified cost sharing arrangement.

lustrates this rule). Section 1.482–7(f)(3)(iv)(B) and (C) notes that adjustments among foreign controlled participants will only be made if the adjustment will have a substantial U.S. tax impact, for example, under subpart F.

Section 1.482–7(f)(4) states that cost allocations must be reflected for tax purposes in the year in which costs were incurred. This reflects a change from the rule in the 1992 proposed regulations, which stated that cost allocations would be included in income in the taxable year under review, even if the costs to be allocated were incurred in a prior taxable year. The purpose of the change was to match up cost adjustments with the year to which they relate in accordance with the clear reflection of income principle of section 482.

Section 1.482–7(g) provides buy-in and buy-out rules that are similar to the rules in the proposed regulations. However, some of the clarifications suggested by commenters have been incorporated in these rules. A ‘‘substantially disproportionate’’ cost-tooperating-income ratio will no longer trigger an adjustment to income under these rules. However, if, after any cost allocations authorized by §1.482– 7(a)(2), the economic substance of the arrangement is inconsistent with the terms of the arrangement over a period of years (for example, through a consistent pattern of one controlled participant bearing an inappropriately high or low share of the cost of intangible development), then the district director may impute an agreement consistent with the course of conduct. In that case, one or more of the participants would be deemed to own a greater interest in covered intangibles than provided under the arrangement, and must receive buy-in payments from the other participants.

The rules do not provide safe harbor methods for valuing intangibles, but rely on the intangible valuation rules of §§1.482–1 and 1.482–4 through 1.482– 6. To the extent some participants furnish a disproportionately greater amount of existing intangibles to the arrangement, they must be compensated by royalties by the participants who furnish a disproportionately lesser amount of existing intangibles to the arrangement. Buy-in payments owed are netted against payments owing, and only the net payment is treated as a royalty. No implication is intended that

netting of cross royalties is permissible outside of the qualified cost sharing safe harbor rules.

Section 1.482–7(h) provides rules regarding the character of payments made pursuant to a qualified cost sharing arrangement. Cost sharing payments received are generally treated as reductions of research and development expense. A net approach is applied to foster simplicity and generally preserve the character of items actually incurred by a participant to the extent not reimbursed. In addition, for purposes of the research credit determined under section 41, cost sharing payments among controlled participants will be treated as provided for intra-group transactions in §1.41–8(e). Finally, any payment that in substance constitutes a cost sharing payment will be treated as such, regardless of its characterization under foreign law. This rule is intended to enable foreign entities to participate in cost sharing arrangements with U.S. controlled participants even if foreign law does not recognize cost sharing. This rule obviated the main reason for the subgroup rules which, as noted, have accordingly been eliminated.

Section 1.482–7(i) requires that controlled participants must use a consistent accounting method for measuring costs and benefits, and must translate foreign currencies on a consistent basis. To the extent that the accounting method materially differs from U.S. generally accepted accounting principles, any such material differences must be documented, as provided in §1.482–7(j)(2)(iv).

Section 1.482–7(j) provides simplified recordkeeping and reporting requirements. It is anticipated that many of the background documents necessary for purposes of this section will be kept pursuant to section 6662(e) and the regulations thereunder.

Section 1.482–7(k) provides that this regulation is effective for taxable years beginning on or after January 1, 1996.

Section 1.482–7(l) allows a one-year transition period for taxpayers to conform their cost sharing arrangements with the requirements of the final regulations. A longer period was not considered necessary, given the increased flexibility and the reduced number of administrative requirements of the final regulations.

Special Analyses

It has been determined that this Treasury decision is not a significant

(c) Participant. (1) In general. (2) Active conduct of a trade or business. (i) Trade or business. (ii) Active conduct. (iii) Examples. (3) Use of covered intangibles in the active conduct of a trade or business. (i) In general. (ii) Example. (4) Treatment of a controlled taxpayer that is not a controlled participant. (i) In general. (ii) Example. (5) Treatment of consolidated group. (d) Costs. (1) Intangible development costs. (2) Examples. (e) Anticipated benefits. (1) Benefits. (2) Reasonably anticipated benefits. (f) Cost allocations. (1) In general. (2) Share of intangible development costs. (i) In general. (ii) Example. (3) Share of reasonably anticipated benefits. (i) In general. (ii) Measure of benefits. (iii) Indirect bases for meas

within the United States solely by reason of its participation in such an arrangement. See generally §1.864– 2(a). (2) Limitation on allocations . The district director shall not make allocations with respect to a qualified cost sharing arrangement except to the extent necessary to make each controlled participant’s share of the costs (as determined under paragraph (d) of this section) of intangible development under the qualified cost sharing arrangement equal to its share of reasonably anticipated benefits attributable to such development, under the rules of this section. If a controlled taxpayer acquires an interest in intangible property from another controlled taxpayer (other than in consideration for bearing a share of the costs of the intangible’s development), then the district director may make appropriate allocations to reflect an arm’s length consideration for the acquisition of the interest in such intangible under the rules of §§1.482–1 and 1.482–4 through 1.482– 6. See paragraph (g) of this section. An interest in an intangible includes any commercially transferable interest, the benefits of which are susceptible of valuation. See §1.482–4(b) for the definition of an intangible.

(3) Cross references . Paragraph (c) of this section defines participant. Paragraph (d) of this section defines the costs of intangible development. Paragraph (e) of this section defines the anticipated benefits of intangible development. Paragraph (f) of this section provides rules governing cost allocations. Paragraph (g) of this section provides rules governing transfers of intangibles other than in consideration for bearing a share of the costs of the intangible’s development. Rules governing the character of payments made pursuant to a qualified cost sharing arrangement are provided in paragraph (h) of this section. Paragraph (i) of this section provides accounting requirements. Paragraph (j) of this section provides administrative requirements. Paragraph (k) of this section provides an effective date. Paragraph (l) provides a transition rule.

(b) Qualified cost sharing arrange- ment . A qualified cost sharing arrangement must—

(1) Include two or more participants; (2) Provide a method to calculate each controlled participant’s share of intangible development costs, based on

uring anticipated benefits. (A) Units used, produced or sold. (B) Sales. (C) Operating profit. (D) Other bases for measuring anticipated benefits. (E) Examples. (iv) Projections used to esti

(5) Conduct inconsistent with the terms of a cost sharing arrangement. (6) Failure to assign interests under a qualified cost sharing arrangement. (7) Form of consideration. (i) Lump sum payments. (ii) Installment payments. (iii) Royalties. (8) Examples. (h) Character of payments made pursuant to a qualified cost sharing arrangement. (1) In general. (2) Examples. (i) Accounting requirements. (j) Administrative requirements. (1) In general. (2) Documentation. (3) Reporting requirements. (k) Effective date. (l) Transition rule.

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Par. 3. Section 1.482–7 is added to read as follows:

§1.482–7 Sharing of costs .

(a) In general —(1) Scope and ap- plication of the rules in this section . A cost sharing arrangement is an agreement under which the parties agree to share the costs of development of one or more intangibles in proportion to their shares of reasonably anticipated benefits from their individual exploitation of the interests in the intangibles assigned to them under the arrangement. A taxpayer may claim that a cost sharing arrangement is a qualified cost sharing arrangement only if the agreement meets the requirements of paragraph (b) of this section. Consistent with the rules of §1.482–1(d)(3)(ii)(B) (Identifying contractual terms), the district director may apply the rules of this section to any arrangement that in substance constitutes a cost sharing arrangement, notwithstanding a failure to comply with any requirement of this section. A qualified cost sharing arrangement, or an arrangement to which the district director applies the rules of this section, will not be treated as a partnership to which the rules of subchapter K apply. See §301.7701–3(e) of this chapter. Furthermore, a participant that is a foreign corporation or nonresident alien individual will not be treated as engaged in trade or business

mate anticipated benefits. (A) In general. (B) Unreliable projections. (C) Foreign-to-foreign adjustments. (D) Examples. (4) Timing of allocations. (g) Allocations of income, deductions or other tax items to reflect transfers of intangibles (buy-in). (1) In general. (2) Pre-existing intangibles. (3) New controlled participant. (4) Controlled participant relinquishes interests.

factors that can reasonably be expected to reflect that participant’s share of anticipated benefits;

(3) Provide for adjustment to the controlled participants’ shares of intangible development costs to account for changes in economic conditions, the business operations and practices of the participants, and the ongoing development of intangibles under the arrangement; and

(4) Be recorded in a document that is contemporaneous with the formation (and any revision) of the cost sharing arrangement and that includes—

(i) A list of the arrangement’s participants, and any other member of the controlled group that will benefit from the use of intangibles developed under the cost sharing arrangement;

(ii) The information described in paragraphs (b)(2) and (b)(3) of this section;

(iii) A description of the scope of the research and development to be undertaken, including the intangible or class of intangibles intended to be developed;

(iv) A description of each participant’s interest in any covered intangibles. A covered intangible is any intangible property that is developed as a result of the research and development undertaken under the cost sharing arrangement (intangible development area);

(v) The duration of the arrangement; and

(vi) The conditions under which the arrangement may be modified or terminated and the consequences of such modification or termination, such as the interest that each participant will receive in any covered intangibles.

(c) Participant —(1) In general . For purposes of this section, a participant is a controlled taxpayer that meets the requirements of this paragraph (c)(1) (controlled participant) or an uncontrolled taxpayer that is a party to the cost sharing arrangement (uncontrolled participant). See §1.482–1(i)(5) for the definitions of controlled and uncontrolled taxpayers. A controlled taxpayer may be a controlled participant only if it—

(i) Uses or reasonably expects to use covered intangibles in the active conduct of a trade or business, under the rules of paragraphs (c)(2) and (c)(3) of this section;

(ii) Substantially complies with the accounting requirements described in paragraph (i) of this section; and

(iii) Substantially complies with the administrative requirements described in paragraph (j) of this section.

(2) Active conduct of a trade or business —(i) Trade or business . The rules of §1.367(a)–2T(b)(2) apply in determining whether the activities of a controlled taxpayer constitute a trade or business. For this purpose, the term controlled taxpayer must be substituted for the term foreign corporation .

(ii) Active conduct . In general, a controlled taxpayer actively conducts a trade or business only if it carries out substantial managerial and operational activities. For purposes only of this paragraph (c)(2), activities carried out on behalf of a controlled taxpayer by another person may be attributed to the controlled taxpayer, but only if the controlled taxpayer exercises substantial managerial and operational control over those activities.

(iii) Examples . The following examples illustrate this paragraph (c)(2):

Example 1 . Foreign Parent (FP) enters into a cost sharing arrangement with its U.S. Subsidiary (USS) to develop a cheaper process for manufacturing widgets. USS is to receive the right to exploit the intangible to make widgets in North America, and FP is to receive the right to exploit the intangible to make widgets in the rest of the world. However, USS does not manufacture widgets; rather, USS acts as a distributor for FP’s widgets in North America. Because USS is simply a distributor of FP’s widgets, USS does not use or reasonably expect to use the manufacturing intangible in the active conduct of its trade or business, and thus USS is not a controlled participant.

Example 2 . The facts are the same as in Example 1, except that USS contracts to have widgets it sells in North America made by a related manufacturer (that is not a controlled participant) using USS’ cheaper manufacturing process. USS purchases all the manufacturing inputs, retains ownership of the work in process as well as the finished product, and bears the risk of loss at all times in connection with the operation. USS compensates the manufacturer for the manufacturing functions it performs and receives substantially all of the intangible value attributable to the cheaper manufacturing process. USS exercises substantial managerial and operational control over the manufacturer to ensure USS’s requirements are satisfied concerning the timing, quantity, and quality of the widgets produced. USS uses the manufacturing intangible in the active conduct of its trade or business, and thus USS is a controlled participant.

(3) Use of covered intangibles in the active conduct of a trade or business (i) In general . A covered intangible will not be considered to be used, nor will the controlled taxpayer be considered to reasonably expect to use it, in the active conduct of the controlled

taxpayer’s trade or business if a principal purpose for participating in the arrangement is to obtain the intangible for transfer or license to a controlled or uncontrolled taxpayer.

(ii) Example . The following example illustrates the absence of such a principal purpose:

Example . Controlled corporations A, B, and C enter into a qualified cost sharing arrangement for the purpose of developing a new technology. Costs are shared equally among the three controlled taxpayers. A, B, and C have the exclusive rights to manufacture and sell products based on the new technology in North America, South America, and Europe, respectively. When the new technology is developed, C expects to use it to manufacture and sell products in most of Europe. However, for sound business reasons, C expects to license to an unrelated manufacturer the right to use the new technology to manufacture and sell products within a particular European country owing to its relative remoteness and small size. In these circumstances, C has not entered into the arrangement with a principal purpose of obtaining covered intangibles for transfer or license to controlled or uncontrolled taxpayers, because the purpose of licensing the technology to the unrelated manufacturer is relatively insignificant in comparison to the overall purpose of exploiting the European market.

(4) Treatment of a controlled tax- payer that is not a controlled participant —(i) In general . If a controlled taxpayer that is not a controlled participant (within the meaning of this paragraph (c)) provides assistance in relation to the research and development undertaken in the intangible development area, it must receive consideration from the controlled participants under the rules of §1.482–4(f)(3)(iii) (Allocations with respect to assistance provided to the owner). For purposes of paragraph (d) of this section, such consideration is treated as an operating expense and each controlled participant must be treated as incurring a share of such consideration equal to its share of reasonably anticipated benefits (as defined in paragraph (f)(3) of this section).

(ii) Example . The following example illustrates this paragraph (c)(4):

Example . (i) U.S. Parent (USP), one foreign subsidiary (FS), and a second foreign subsidiary constituting the group’s research arm (R+D) enter into a cost sharing agreement to develop manufacturing intangibles for a new product line A. USP and FS are assigned the exclusive rights to exploit the intangibles respectively in the United States and Europe, where each presently manufactures and sells various existing product lines. R+D, whose activity consists solely in carrying out research for the group, is assigned the rights to exploit the new technology in Asia,

cost allocation authorized by paragraph (a)(2) of this section is appropriate for a taxable year, a controlled participant’s share of intangible development costs for the taxable year under a qualified cost sharing arrangement must be compared to its share of reasonably anticipated benefits under the arrangement. A controlled participant’s share of intangible development costs is determined under paragraph (f)(2) of this section. A controlled participant’s share of reasonably anticipated benefits under the arrangement is determined under paragraph (f)(3) of this section. In determining whether benefits were reasonably anticipated, it may be appropriate to compare actual benefits to anticipated benefits, as described in paragraph (f)(3)(iv) of this section.

(2) Share of intangible development costs —(i) In general . A controlled participant’s share of intangible development costs for a taxable year is equal to its intangible development costs for the taxable year (as defined in paragraph (d) of this section), divided by the sum of the intangible development costs for the taxable year (as defined in paragraph (d) of this section) of all the controlled participants.

(ii) Example . The following example illustrates this paragraph (f)(2):

Example . (i) U.S. Parent (USP), Foreign Subsidiary (FS), and Unrelated Third Party (UTP) enter into a cost sharing arrangement to develop new audio technology. In the first year of the arrangement, the controlled participants incur $2,250,000 in the intangible development area, all of which is incurred directly by USP. In the first year, UTP makes a $250,000 cost sharing payment to USP, and FS makes a $800,000 cost sharing payment to USP, under the terms of the arrangement. For that year, the intangible development costs borne by USP are $1,200,000 (its $2,250,000 intangible development costs directly incurred, minus the cost sharing payments it receives of $250,000 from UTP and $800,000 from FS); the intangible development costs borne by FS are $800,000 (its cost sharing payment); and the intangible development costs borne by all of the controlled participants are $2,000,000 (the sum of the intangible development costs borne by USP and FS of $1,200,000 and $800,000, respectively). Thus, for the first year, USP’s share of intangible development costs is 60% ($1,200,000 divided by $2,000,000), and FS’s share of intangible development costs is 40% ($800,000 divided by $2,000,000).

(ii) For purposes of determining whether a cost allocation authorized by paragraph §1.482– 7(a)(2) is appropriate for the first year, the district director must compare USP’s and FS’s shares of intangible development costs for that year to their shares of reasonably anticipated benefits. See paragraph (f)(3) of this section.

(3) Share of reasonably anticipated benefits —(i) In general . A controlled

where no group member presently operates, but which is reliably projected to be a major market for product A. R+D will license the Asian rights to an unrelated third party. It is reliably projected that the shares of reasonably anticipated benefits of USP and FS ( i.e., not taking R+D into account) will be 66 2/3% and 33 1/3%, respectively. The parties’ agreement provides that USP and FS will reimburse 40% and 20%, respectively, of the intangible development costs incurred by R+D with respect to the new intangible.

(ii) R+D does not qualify as a controlled participant within the meaning of paragraph (c) of this section. Therefore, R+D is treated as a service provider for purposes of this section and must receive arm’s length consideration for the assistance it is deemed to provide to USP and FS, under the rules of §1.482–4(f)(3)(iii). Such consideration must be treated as intangible development costs incurred by USP and FS in proportion to their shares of reasonably anticipated benefits ( i.e., 66 2/3% and 33 1/3%, respectively). R+D will not be considered to bear any share of the intangible development costs under the arrangement.

(iii) The Asian rights nominally assigned to R+D under the agreement must be treated as being held by USP and FS in accordance with their shares of the intangible development costs ( i.e., 66 2/3% and 33 1/3%, respectively). See paragraph (g)(6) of this section. Thus, since under the cost sharing agreement the Asian rights are owned by R+D, the district director may make allocations to reflect an arm’s length consideration owed by R+D to USP and FS for these rights under the rules of §§1.482–1 and 1.482–4 through 1.482–6.

(5) Treatment of consolidated group . For purposes of this section, all members of the same affiliated group (within the meaning of section 1504(a)) that join in the filing of a consolidated return for the taxable year under section 1501 shall be treated as one taxpayer.

(d) Costs —(1) Intangible develop- ment costs . For purposes of this section, a controlled participant’s costs of developing intangibles for a taxable year mean all of the costs incurred by that participant related to the intangible development area, plus all of the cost sharing payments it makes to other controlled and uncontrolled participants, minus all of the cost sharing payments it receives from other controlled and uncontrolled participants. Costs incurred related to the intangible development area consist of the following items: operating expenses as defined in §1.482–5(d)(3), other than depreciation or amortization expense, plus (to the extent not included in such operating expenses, as defined in §1.482–5(d)(3)) the charge for the use of any tangible property made available to the qualified cost sharing arrangement. If tangible property is made

available to the qualified cost sharing arrangement by a controlled participant, the determination of the appropriate charge will be governed by the rules of §1.482–2(c) (Use of tangible property). Intangible development costs do not include the consideration for the use of any intangible property made available to the qualified cost sharing arrangement. See paragraph (g)(2) of this section. If a particular cost contributes to the intangible development area and other areas or other business activities, the cost must be allocated between the intangible development area and the other areas or business activities on a reasonable basis. In such a case, it is necessary to estimate the total benefits attributable to the cost incurred. The share of such cost allocated to the intangible development area must correspond to covered intangibles’ share of the total benefits. Costs that do not contribute to the intangible development area are not taken into account.

(2) Examples . The following examples illustrate this paragraph (d):

Example 1 . Foreign Parent (FP) and U.S. Subsidiary (USS) enter into a qualified cost sharing arrangement to develop a better mousetrap. USS and FP share the costs of FP’s research and development facility that will be exclusively dedicated to this research, the salaries of the researchers, and reasonable overhead costs attributable to the project. They also share the cost of a conference facility that is at the disposal of the senior executive management of each company but does not contribute to the research and development activities in any measurable way. In this case, the cost of the conference facility must be excluded from the amount of intangible development costs.

Example 2 . U.S. Parent (USP) and Foreign Subsidiary (FS) enter into a qualified cost sharing arrangement to develop a new device. USP and FS share the costs of a research and development facility, the salaries of researchers, and reasonable overhead costs attributable to the project. USP also incurs costs related to field testing of the device, but does not include them in the amount of intangible development costs of the cost sharing arrangement. The district director may determine that the field testing costs are intangible development costs that must be shared.

(e) Anticipated benefits —(1) Bene- fits . Benefits are additional income generated or costs saved by the use of covered intangibles.

(2) Reasonably anticipated benefits . For purposes of this section, a controlled participant’s reasonably anticipated benefits are the aggregate benefits that it reasonably anticipates that it will derive from covered intangibles.

(f) Cost allocations —(1) In general . For purposes of determining whether a

participants’ revenues ( e.g., through a price premium on the products they sell) without affecting their costs substantially. Sales by each controlled participant are unlikely to provide a reliable basis for measuring benefits unless each controlled participant operates at the same market level ( e.g., manufacturing, distribution, etc.).

(C) Operating profit . Operating profit of each controlled participant from the activities in which covered intangibles are exploited may be used as an indirect basis for measuring its anticipated benefits. This basis of measurement will be more reliable to the extent that such profit is largely attributable to the use of covered intangibles, or if the share of profits attributable to the use of covered intangibles is expected to be similar for each controlled participant. This circumstance is most likely to arise when covered intangibles are integral to the activity that generates the profit and the activity could not be carried on or would generate little profit without use of those intangibles.

(D) Other bases for measuring an- ticipated benefits . Other bases for measuring anticipated benefits may, in some circumstances, be appropriate, but only to the extent that there is expected to be a reasonably identifiable relationship between the basis of measurement used and additional income generated or costs saved by the use of covered intangibles. For example, a division of costs based on employee compensation would be considered unreliable unless there were a relationship between the amount of compensation and the expected income of the controlled participants from the use of covered intangibles.

(E) Examples . The following examples illustrate this paragraph (f)(3)(iii):

Example 1 . Foreign Parent (FP) and U.S. Subsidiary (USS) both produce a feedstock for the manufacture of various high-performance plastic products. Producing the feedstock requires large amounts of electricity, which accounts for a significant portion of its production cost. FP and USS enter into a cost sharing arrangement to develop a new process that will reduce the amount of electricity required to produce a unit of the feedstock. FP and USS currently both incur an electricity cost of X% of its other production costs and rates for each are expected to remain similar in the future. How much the new process, if it is successful, will reduce the amount of electricity required to produce a unit of the feedstock is uncertain, but it will be about the same amount for both companies. Therefore, the cost savings each company is expected to

participant’s share of reasonably anticipated benefits under a qualified cost sharing arrangement is equal to its reasonably anticipated benefits (as defined in paragraph (e)(2) of this section), divided by the sum of the reasonably anticipated benefits (as defined in paragraph (e)(2) of this section) of all the controlled participants. The anticipated benefits of an uncontrolled participant will not be included for purposes of determining each controlled participant’s share of anticipated benefits. A controlled participant’s share of reasonably anticipated benefits will be determined using the most reliable estimate of reasonably anticipated benefits. In determining which of two or more available estimates is most reliable, the quality of the data and assumptions used in the analysis must be taken into account, consistent with §1.482–1(c)(2)(ii) (Data and assumptions). Thus, the reliability of an estimate will depend largely on the completeness and accuracy of the data, the soundness of the assumptions, and the relative effects of particular deficiencies in data or assumptions on different estimates. If two estimates are equally reliable, no adjustment should be made based on differences in the results. The following factors will be particularly relevant in determining the reliability of an estimate of anticipated benefits—

(A) The reliability of the basis used for measuring benefits, as described in paragraph (f)(3)(ii) of this section; and

(B) The reliability of the projections used to estimate benefits, as described in paragraph (f)(3)(iv) of this section.

(ii) Measure of benefits . In order to estimate a controlled participant’s share of anticipated benefits from covered intangibles, the amount of benefits that each of the controlled participants is reasonably anticipated to derive from covered intangibles must be measured on a basis that is consistent for all such participants. See paragraph (f)(3)(iii)(E), Example 8, of this section. Anticipated benefits are measured either on a direct basis, by reference to estimated additional income to be generated or costs to be saved by the use of covered intangibles, or on an indirect basis, by reference to certain measurements that reasonably can be assumed to be related to income generated or costs saved. Such indirect bases of measurement of anticipated benefits are described in paragraph (f)(3)(iii) of this section. A controlled participant’s an

ticipated benefits must be measured on the most reliable basis, whether direct or indirect. In determining which of two bases of measurement of reasonably anticipated benefits is most reliable, the factors set forth in §1.482– 1(c)(2)(ii) (Data and assumptions) must be taken into account. It normally will be expected that the basis that provided the most reliable estimate for a particular year will continue to provide the most reliable estimate in subsequent years, absent a material change in the factors that affect the reliability of the estimate. Regardless of whether a direct or indirect basis of measurement is used, adjustments may be required to account for material differences in the activities that controlled participants undertake to exploit their interests in covered intangibles. See Example 6 of paragraph (f)(3)(iii)(E) of this section.

(iii) Indirect bases for measuring anticipated benefits . Indirect bases for measuring anticipated benefits from participation in a qualified cost sharing arrangement include the following:

(A) Units used, produced or sold . Units of items used, produced or sold by each controlled participant in the business activities in which covered intangibles are exploited may be used as an indirect basis for measuring its anticipated benefits. This basis of measurement will be more reliable to the extent that each controlled participant is expected to have a similar increase in net profit or decrease in net loss attributable to the covered intangibles per unit of the item or items used, produced or sold. This circumstance is most likely to arise when the covered intangibles are exploited by the controlled participants in the use, production or sale of substantially uniform items under similar economic conditions.

(B) Sales . Sales by each controlled participant in the business activities in which covered intangibles are exploited may be used as an indirect basis for measuring its anticipated benefits. This basis of measurement will be more reliable to the extent that each controlled participant is expected to have a similar increase in net profit or decrease in net loss attributable to covered intangibles per dollar of sales. This circumstance is most likely to arise if the costs of exploiting covered intangibles are not substantial relative to the revenues generated, or if the principal effect of using covered intangibles is to increase the controlled

development and the receipt of benefits, a projection of the time over which benefits will be received, and a projection of the benefits anticipated for each year in which it is anticipated that the intangible will generate benefits. A projection of the relevant basis for measuring anticipated benefits may require a projection of the factors that underlie it. For example, a projection of operating profits may require a projection of sales, cost of sales, operating expenses, and other factors that affect operating profits. If it is anticipated that there will be significant variation among controlled participants in the timing of their receipt of benefits, and consequently benefit shares are expected to vary significantly over the years in which benefits will be received, it may be necessary to use the present discounted value of the projected benefits to reliably determine each controlled participant’s share of those benefits. If it is not anticipated that benefit shares will significantly change over time, current annual benefit shares may provide a reliable projection of anticipated benefit shares. This circumstance is most likely to occur when the cost sharing arrangement is a long-term arrangement, the arrangement covers a wide variety of intangibles, the composition of the covered intangibles is unlikely to change, the covered intangibles are unlikely to generate unusual profits, and each controlled participant’s share of the market is stable.

(B) Unreliable projections . A significant divergence between projected benefit shares and actual benefit shares may indicate that the projections were not reliable. In such a case, the district director may use actual benefits as the most reliable measure of anticipated benefits. If benefits are projected over a period of years, and the projections for initial years of the period prove to be unreliable, this may indicate that the projections for the remaining years of the period are also unreliable and thus should be adjusted. Projections will not be considered unreliable based on a divergence between a controlled participant’s projected benefit share and actual benefit share if the amount of such divergence for every controlled participant is less than or equal to 20% of the participant’s projected benefit share. Further, the district director will not make an allocation based on such divergence if the difference is due to an extraordinary event, beyond the

achieve after implementing the new process are similar relative to the total amount of the feedstock produced. Under the cost sharing arrangement FP and USS divide the costs of developing the new process based on the units of the feedstock each is anticipated to produce in the future. In this case, units produced is the most reliable basis for measuring benefits and dividing the intangible development costs because each participant is expected to have a similar decrease in costs per unit of the feedstock produced.

Example 2 . The facts are the same as in Example 1, except that USS pays X% of its other production costs for electricity while FP pays 2X% of its other production costs. In this case, units produced is not the most reliable basis for measuring benefits and dividing the intangible development costs because the participants do not expect to have a similar decrease in costs per unit of the feedstock produced. The district director determines that the most reliable measure of benefit shares may be based on units of the feedstock produced if FP’s units are weighted relative to USS’ units by a factor of 2. This reflects the fact that FP pays twice as much as USS as a percentage of its other production costs for electricity and, therefore, FP’s savings per unit of the feedstock would be twice USS’s savings from any new process eventually developed.

Example 3 . The facts are the same as in Example 2, except that to supply the particular needs of the U.S. market USS manufactures the feedstock with somewhat different properties than FP’s feedstock. This requires USS to employ a somewhat different production process than does FP. Because of this difference, it will be more costly for USS to adopt any new process that may be developed under the cost sharing agreement. In this case, units produced is not the most reliable basis for measuring benefit shares. In order to reliably determine benefit shares, the district director offsets the reasonably anticipated costs of adopting the new process against the reasonably anticipated total savings in electricity costs.

Example 4 . U.S. Parent (USP) and Foreign Subsidiary (FS) enter into a cost sharing arrangement to develop new anesthetic drugs. USP obtains the right to use any resulting patent in the U.S. market, and FS obtains the right to use the patent in the European market. USP and FS divide costs on the basis of anticipated operating profit from each patent under development. USP anticipates that it will receive a much higher profit than FS per unit sold because drug prices are uncontrolled in the U.S., whereas drug prices are regulated in many European countries. In this case, the controlled taxpayers’ basis for measuring benefits is the most reliable.

Example 5 . (i) Foreign Parent (FP) and U.S. Subsidiary (USS) both manufacture and sell fertilizers. They enter into a cost sharing arrangement to develop a new pellet form of a common agricultural fertilizer that is currently available only in powder form. Under the cost sharing arrangement, USS obtains the rights to produce and sell the new form of fertilizer for the U.S. market while FP obtains the rights to produce and sell the fertilizer for the rest of the world. The costs of developing the new form of fertilizer are divided on the basis of the anticipated sales of fertilizer in the participants’ respective markets.

(ii) If the research and development is successful the pellet form will deliver the fertilizer

more efficiently to crops and less fertilizer will be required to achieve the same effect on crop growth. The pellet form of fertilizer can be expected to sell at a price premium over the powder form of fertilizer based on the savings in the amount of fertilizer that needs to be used. If the research and development is successful, the costs of producing pellet fertilizer are expected to be approximately the same as the costs of producing powder fertilizer and the same for both FP and USS. Both FP and USS operate at approximately the same market levels, selling their fertilizers largely to independent distributors.

(iii) In this case, the controlled taxpayers’ basis for measuring benefits is the most reliable.

Example 6 . The facts are the same as in Example 5, except that FP distributes its fertilizers directly while USS sells to independent distributors. In this case, sales of USS and FP are not the most reliable basis for measuring benefits unless adjustments are made to account for the difference in market levels at which the sales occur.

Example 7 . Foreign Parent (FP) and U.S. Subsidiary (USS) enter into a cost sharing arrangement to develop materials that will be used to train all new entry-level employees. FP and USS determine that the new materials will save approximately ten hours of training time per employee. Because their entry-level employees are paid on differing wage scales, FP and USS decide that they should not divide costs based on the number of entry-level employees hired by each. Rather, they divide costs based on compensation paid to the entry-level employees hired by each. In this case, the basis used for measuring benefits is the most reliable because there is a direct relationship between compensation paid to new entry-level employees and costs saved by FP and USS from the use of the new training materials.

Example 8 . U.S. Parent (USP), Foreign Subsidiary 1 (FS1) and Foreign Subsidiary 2 (FS2) enter into a cost sharing arrangement to develop computer software that each will market and install on customers’ computer systems. The participants divide costs on the basis of projected sales by USP, FS1, and FS2 of the software in their respective geographic areas. However, FS1 plans for sound business reasons not only to sell but also to license the software, and FS1’s licensing income (which is a percentage of the licensees’ sales) is not counted in the projected benefits. In this case, the basis used for measuring the benefits of each participant is not the most reliable because all of the benefits received by participants are not taken into account. In order to reliably determine benefit shares, FS1’s projected benefits from licensing must be included in the measurement on a basis that is the same as that used to measure its own and the other participants’ projected benefits from sales ( e.g., all participants might measure their benefits on the basis of operating profit).

(iv) Projections used to estimate anticipated benefits —(A) In general . The reliability of an estimate of anticipated benefits also depends upon the reliability of projections used in making the estimate. Projections required for this purpose generally include a determination of the time period between the inception of the research and

control of the participants, that could not reasonably have been anticipated at the time that costs were shared. For purposes of this paragraph, all controlled participants that are not U.S. persons will be treated as a single controlled participant. Therefore, an adjustment based on an unreliable projection will be made to the cost shares of foreign controlled participants only if there is a matching adjustment to the cost shares of controlled participants that are U.S. persons. Nothing in this paragraph (f)(3)(iv)(B) will prevent the district director from making an allocation if the taxpayer did not use the most reliable basis for measuring anticipated benefits. For example, if the taxpayer measures anticipated benefits based on units sold, and the district director determines that another basis is more reliable for measuring anticipated benefits, then the fact that actual units sold were within 20% of the projected unit sales will not preclude an allocation under this section.

(C) Foreign-to-foreign adjustments . Notwithstanding the limitations on adjustments provided in paragraph (f)(3)(iv)(B) of this section, adjustments to cost shares based on an unreliable projection also may be made solely among foreign controlled participants if the variation between actual and projected benefits has the effect of substantially reducing U.S. tax.

(D) Examples . The following examples illustrate this paragraph (f)(3)(iv):

Example 1 . (i) Foreign Parent (FP) and U.S. Subsidiary (USS) enter into a cost sharing arrangement to develop a new car model. The participants plan to spend four years developing the new model and four years producing and selling the new model. USS and FP project total sales of $4 billion and $2 billion, respectively, over the planned four years of exploitation of the new model. Cost shares are divided for each year based on projected total sales. Therefore, USS bears 66 2/3% of each year’s intangible development costs and FP bears 33 1/3% of such costs.

(ii) USS typically begins producing and selling new car models a year after FP begins producing and selling new car models. The district director determines that in order to reflect USS’ one-year lag in introducing new car models, a more reliable projection of each participant’s share of benefits would be based on a projection of all four years of sales for each participant, discounted to present value.

Example 2 . U.S. Parent (USP) and Foreign Subsidiary (FS) enter into a cost sharing arrangement to develop new and improved household cleaning products. Both participants have sold household cleaning products for many years and have stable market shares. The products under development are unlikely to

produce unusual profits for either participant. The participants divide costs on the basis of each participant’s current sales of household cleaning products. In this case, the participants’ future benefit shares are reliably projected by current sales of cleaning products.

Example 3 . The facts are the same as in Example 2, except that FS’s market share is rapidly expanding because of the business failure of a competitor in its geographic area. The district director determines that the participants’ future benefit shares are not reliably projected by current sales of cleaning products and that FS’s benefit projections should take into account its growth in sales.

Example 4 . Foreign Parent (FP) and U.S. Subsidiary (USS) enter into a cost sharing arrangement to develop synthetic fertilizers and insecticides. FP and USS share costs on the basis of each participant’s current sales of fertilizers and insecticides. The market shares of the participants have been stable for fertilizers, but FP’s market share for insecticides has been expanding. The district director determines that the participants’ projections of benefit shares are reliable with regard to fertilizers, but not reliable with regard to insecticides; a more reliable projection of benefit shares would take into account the expanding market share for insecticides.

Example 5 . U.S. Parent (USP) and Foreign Subsidiary (FS) enter into a cost sharing arrangement to develop new food products, dividing costs on the basis of projected sales two years in the future. In year 1, USP and FS project that their sales in year 3 will be equal, and they divide costs accordingly. In year 3, the district director examines the participants’ method for dividing costs. USP and FS actually accounted for 42% and 58% of total sales, respectively. The district director agrees that sales two years in the future provide a reliable basis for estimating benefit shares. Because the differences between USP’s and FS’s actual and projected benefit shares are less than 20% of their projected benefit shares, the projection of future benefits for year 3 is reliable.

Example 6 . The facts are the same as in Example 5, except that the in year 3 USP and FS actually accounted for 35% and 65% of total sales, respectively. The divergence between USP’s projected and actual benefit shares is greater than 20% of USP’s projected benefit share and is not due to an extraordinary event beyond the control of the participants. The district director concludes that the projection of anticipated benefit shares was unreliable, and uses actual benefits as the basis for an adjustment to the cost shares borne by USP and FS.

Example 7 . U.S. Parent (USP), a U.S. corporation, and its foreign subsidiary (FS) enter a cost sharing arrangement in year 1. They project that they will begin to receive benefits from covered intangibles in years 4 through 6, and that USP will receive 60% of total benefits and FS 40% of total benefits. In years 4 through 6, USP and FS actually receive 50% each of the total benefits. In evaluating the reliability of the participants’ projections, the district director compares these actual benefit shares to the projected benefit shares. Although USP’s actual benefit share (50%) is within 20% of its projected benefit share (60%), FS’s actual benefit share (50%) is not within 20% of its projected benefit share (40%). Based on this discrepancy, the district director may conclude that the participants’ projections were not reliable and may use actual

benefit shares as the basis for an adjustment to the cost shares borne by USP and FS.

Example 8. Three controlled taxpayers, USP, FS1 and FS2 enter into a cost sharing arrangement. FS1 and FS2 are foreign. USP is a United States corporation that controls all the stock of FS1 and FS2. The participants project that they will share the total benefits of the covered intangibles in the following percentages: USP 50%; FS1 30%; and FS2 20%. Actual benefit shares are as follows: USP 45%; FS1 25%; and FS2 30%. In evaluating the reliability of the participants’ projections, the district director compares these actual benefit shares to the projected benefit shares. For this purpose, FS1 and FS2 are treated as a single participant. The actual benefit share received by USP (45%) is within 20% of its projected benefit share (50%). In addition, the non-US participants’ actual benefit share (55%) is also within 20% of their projected benefit share (50%). Therefore, the district director concludes that the participants’ projections of future benefits were reliable, despite the fact that FS2’s actual benefit share (30%) is not within 20% of its projected benefit share (20%).

Example 9 . The facts are the same as in Example 8 . In addition, the district director determines that FS2 has significant operating losses and has no earnings and profits, and that FS1 is profitable and has earnings and profits. Based on all the evidence, the district director concludes that the participants arranged that FS1 would bear a larger cost share than appropriate in order to reduce FS1’s earnings and profits and thereby reduce inclusions USP otherwise would be deemed to have on account of FS1 under subpart F. Pursuant to §1.482–7 (f)(3)(iv)(C), the district director may make an adjustment solely to the cost shares borne by FS1 and FS2 because FS2’s projection of future benefits was unreliable and the variation between actual and projected benefits had the effect of substantially reducing USP’s U.S. income tax liability (on account of FS1 subpart F income).

Example 10 . (i) (A) Foreign Parent (FP) and U.S. Subsidiary (USS) enter into a cost sharing arrangement in 1996 to develop a new treatment for baldness. USS’s interest in any treatment developed is the right to produce and sell the treatment in the U.S. market while FP retains rights to produce and sell the treatment in the rest of the world. USS and FP measure their anticipated benefits from the cost sharing arrangement based on their respective projected future sales of the baldness treatment. The following sales projections are used:

Sales ($ millions)

Year USS FP

1997 5 10 1998 20 20 1999 30 30 2000 40 40 2001 40 40 2002 40 40 2003 40 40 2004 20 20 2005 10 10 2006 5 5

(B) in 1997, the first year of sales, USS is projected to have lower sales than FP due to lags in U.S. regulatory approval for the baldness treatment. In each subsequent year USS and FP are projected to have equal sales. Sales are

participants, is a transfer of intangible property, and the district director may make appropriate allocations, under the provisions of §§1.482–1 and 1.482–4 through 1.482–6, to reflect an arm’s length consideration for the transfer. See paragraphs (g)(3), (4), and (5) of this section. Paragraph (g)(6) of this section provides rules for assigning unassigned interests under a qualified cost sharing arrangement.

(2) Pre-existing intangibles . If a controlled participant makes preexisting intangible property in which it owns an interest available to other controlled participants for purposes of research in the intangible development area under a qualified cost sharing arrangement, then each such other controlled participant must make a buyin payment to the owner. The buy-in payment by each such other controlled participant is the arm’s length charge for the use of the intangible under the rules of §§1.482–1 and 1.482–4 through 1.482–6, multiplied by the controlled participant’s share of reasonably anticipated benefits (as defined in paragraph (f)(3) of this section). A controlled participant’s payment required under this paragraph (g)(2) is deemed to be reduced to the extent of any payments owed to it under this paragraph (g)(2) from other controlled participants. Each payment received by a payee will be treated as coming pro rata out of payments made by all payors. See paragraph (g)(8), Example 4, of this section. Such payments will be treated as consideration for a transfer of an interest in the intangible property made available to the qualified cost sharing arrangement by the payee. Any payment to or from an uncontrolled participant in consideration for intangible property made available to the qualified cost sharing arrangement will be shared by the controlled participants in accordance with their shares of reasonably anticipated benefits (as defined in paragraph (f)(3) of this section). A controlled participant’s payment required under this paragraph (g)(2) is deemed to be reduced by such a share of payments owed from an uncontrolled participant to the same extent as by any payments owed from other controlled participants under this paragraph (g)(2). See paragraph (g)(8), Example 5, of this section.

(3) New controlled participant . If a new controlled participant enters a qualified cost sharing arrangement and acquires any interest in the covered

projected to build over the first three years of the period, level off for several years, and then decline over the final years of the period as new and improved baldness treatments reach the market.

(ii) To account for USS’s lag in sales in the first year, the present discounted value of sales over the period is used as the basis for measuring benefits. Based on the risk associated with this venture, a discount rate of 10 percent is selected. The present discounted value of projected sales is determined to be approximately $154.4 million for USS and $158.9 million for FP. On this basis USS and FP are projected to obtain approximately 49.3% and 50.7% of the benefit, respectively, and the costs of developing the baldness treatment are shared accordingly.

(iii) (A) In the year 2002 the district director examines the cost sharing arrangement. USS and FP have obtained the following sales results through the year 2001:

Sales ($ millions)

Year USS FP

1997 0 17 1998 17 35 1999 25 41 2000 38 41 2001 39 41

(B) USS’s sales initially grew more slowly than projected while FP’s sales grew more quickly. In each of the first three years of the period the share of total sales of at least one of the parties diverged by over 20% from its projected share of sales. However, by the year 2001 both parties’ sales had leveled off at approximately their projected values. Taking into account this leveling off of sales and all the facts and circumstances, the district director determines that it is appropriate to use the original projections for the remaining years of sales. Combining the actual results through the year 2001 with the projections for subsequent years, and using a discount rate of 10%, the present discounted value of sales is approximately $141.6 million for USS and $187.3 million for FP. This result implies that USS and FP obtain approximately 43.1% and 56.9%, respectively, of the anticipated benefits from the baldness treatment. Because these benefit shares are within 20% of the benefit shares calculated based on the original sales projections, the district director determines that, based on the difference between actual and projected benefit shares, the original projections were not unreliable. No adjustment is made based on the difference between actual and projected benefit shares.

Example 11 . (i) The facts are the same as in Example 10, except that the actual sales results through the year 2001 are as follows:

Sales ($ millions) Year USS FP

1997 0 17 1998 17 35 1999 25 44 2000 34 54 2001 36 55

(ii) Based on the discrepancy between the projections and the actual results and on consideration of all the facts, the district director determines that for the remaining years the following sales projections are more reliable than the original projections:

Sales ($ millions) Year USS FP

2002 36 55 2003 36 55 2004 18 28 2005 9 14 2006 4.5 7

(iii) Combining the actual results through the year 2001 with the projections for subsequent years, and using a discount rate of 10%, the present discounted value of sales is approximately $131.2 million for USS and $229.4 million for FP. This result implies that USS and FP obtain approximately 35.4% and 63.6%, respectively, of the anticipated benefits from the baldness treatment. These benefit shares diverge by greater than 20% from the benefit shares calculated based on the original sales projections, and the district director determines that, based on the difference between actual and projected benefit shares, the original projections were unreliable. The district director adjusts costs shares for each of the taxable years under examination to conform them to the recalculated shares of anticipated benefits.

(4) Timing of allocations . If the district director reallocates costs under the provisions of this paragraph (f), the allocation must be reflected for tax purposes in the year in which the costs were incurred. When a cost sharing payment is owed by one member of a qualified cost sharing arrangement to another member, the district director may make appropriate allocations to reflect an arm’s length rate of interest for the time value of money, consistent with the provisions of §1.482–2(a) (Loans or advances).

(g) Allocations of income, deduc- tions or other tax items to reflect transfers of intangibles (buy-in) —(1) In general . A controlled participant that makes intangible property available to a qualified cost sharing arrangement will be treated as having transferred interests in such property to the other controlled participants, and such other controlled participants must make buyin payments to it, as provided in paragraph (g)(2) of this section. If the other controlled participants fail to make such payments, the district director may make appropriate allocations, under the provisions of §§1.482–1 and 1.482–4 through 1.482–6, to reflect an arm’s length consideration for the transferred intangible property. Further, if a group of controlled taxpayers participates in a qualified cost sharing arrangement, any change in the controlled participants’ interests in covered intangibles, whether by reason of entry of a new participant or otherwise by reason of transfers (including deemed transfers) of interests among existing

intangibles, then the new participant must pay an arm’s length consideration, under the provisions of §§1.482–1 and 1.482–4 through 1.482–6, for such interest to each controlled participant from whom such interest was acquired.

(4) Controlled participant relin- quishes interests . A controlled participant in a qualified cost sharing arrangement may be deemed to have acquired an interest in one or more covered intangibles if another controlled participant transfers, abandons, or otherwise relinquishes an interest under the arrangement, to the benefit of the first participant. If such a relinquishment occurs, the participant relinquishing the interest must receive an arm’s length consideration, under the provisions of §§1.482–1 and 1.482–4 through 1.482–6, for its interest. If the controlled participant that has relinquished its interest subsequently uses that interest, then that participant must pay an arm’s length consideration, under the provisions of §§1.482–1 and 1.482–4 through 1.482–6, to the controlled participant that acquired the interest.

(5) Conduct inconsistent with the terms of a cost sharing arrangement . If, after any cost allocations authorized by paragraph (a)(2) of this section, a controlled participant bears costs of intangible development that over a period of years are consistently and materially greater or lesser than its share of reasonably anticipated benefits, then the district director may conclude that the economic substance of the arrangement between the controlled participants is inconsistent with the terms of the cost sharing arrangement. In such a case, the district director may disregard such terms and impute an agreement consistent with the controlled participants’ course of conduct, under which a controlled participant that bore a disproportionately greater share of costs received additional interests in covered intangibles. See §1.482–1(d)(3)(ii)(B) (Identifying contractual terms) and §1.482– 4(f)(3)(ii) (Identification of owner). Accordingly, that participant must receive an arm’s length payment from any controlled participant whose share of the intangible development costs is less than its share of reasonably anticipated benefits over time, under the provisions of §§1.482–1 and 1.482–4 through 1.482–6.

(6) Failure to assign interests under a qualified cost sharing arrangement .

If a qualified cost sharing arrangement fails to assign an interest in a covered intangible, then each controlled participant will be deemed to hold a share in such interest equal to its share of the costs of developing such intangible. For this purpose, if cost shares have varied materially over the period during which such intangible was developed, then the costs of developing the intangible must be measured by their present discounted value as of the date when the first such costs were incurred.

(7) Form of consideration . The consideration for an acquisition described in this paragraph (g) may take any of the following forms:

(i) Lump sum payments . For the treatment of lump sum payments, see §1.482–4(f)(5) (Lump sum payments);

(ii) Installment payments . Installment payments spread over the period of use of the intangible by the transferee, with interest calculated in accordance with §1.482–2(a) (Loans or advances); and

(iii) Royalties . Royalties or other payments contingent on the use of the intangible by the transferee.

(8) Examples . The following examples illustrate allocations described in this paragraph (g):

Example 1 . In year one, four members of a controlled group enter into a cost sharing arrangement to develop a commercially feasible process for capturing energy from nuclear fusion. Based on a reliable projection of their future benefits, each cost sharing participant bears an equal share of the costs. The cost of developing intangibles for each participant with respect to the project is approximately $1 million per year. In year ten, a fifth member of the controlled group joins the cost sharing group and agrees to bear one-fifth of the future costs in exchange for part of the fourth member’s territory reasonably anticipated to yield benefits amounting to onefifth of the total benefits. The fair market value of intangible property within the arrangement at the time the fifth company joins the arrangement is $45 million. The new member must pay onefifth of that amount (that is, $9 million total) to the fourth member from whom it acquired its interest in covered intangibles.

Example 2 . U.S. Subsidiary (USS), Foreign Subsidiary (FS) and Foreign Parent (FP) enter into a cost sharing arrangement to develop new products within the Group X product line. USS manufactures and sells Group X products in North America, FS manufactures and sells Group X products in South America, and FP manufactures and sells Group X products in the rest of the world. USS, FS and FP project that each will manufacture and sell a third of the Group X products under development, and they share costs on the basis of projected sales of manufactured products. When the new Group X products are developed, however, USS ceases to manufacture Group X products, and FP sells its Group X

products to USS for resale in the North American market. USS earns a return on its resale activity that is appropriate given its function as a distributor, but does not earn a return attributable to exploiting covered intangibles. The district director determines that USS’ share of the costs (one-third) was greater than its share of reasonably anticipated benefits (zero) and that it has transferred an interest in the intangibles for which it should receive a payment from FP, whose share of the intangible development costs (one-third) was less than its share of reasonably anticipated benefits over time (twothirds). An allocation is made under §§1.482–1 and 1.482–4 through 1.482–6 from FP to USS to recognize USS’ one-third interest in the intangibles. No allocation is made from FS to USS because FS did not exploit USS’ interest in covered intangibles.

Example 3 . U.S. Parent (USP), Foreign Subsidiary 1 (FS1), and Foreign Subsidiary 2 (FS2) enter into a cost sharing arrangement to develop a cure for the common cold. Costs are shared USP–50%, FS1–40% and FS2–10% on the basis of projected units of cold medicine to be produced by each. After ten years of research and development, FS1 withdraws from the arrangement, transferring its interests in the intangibles under development to USP in exchange for a lump sum payment of $10 million. The district director may review this lump sum payment, under the provisions of §1.482–4(f)(5), to ensure that the amount is commensurate with the income attributable to the intangibles.

Example 4 . (i) Four members A, B, C, and D of a controlled group form a cost sharing arrangement to develop the next generation technology for their business. Based on a reliable projection of their future benefits, the participants agree to bear shares of the costs incurred during the term of the agreement in the following percentages: A 40%; B 15%; C 25%; and D 20%. The arm’s length charges, under the rules of §§1.482–1 and 1.482–4 through 1.482–6, for the use of the existing intangible property they respectively make available to the cost sharing arrangement are in the following amounts for the taxable year: A 80X; B 40X; C 30X; and D 30X. The provisional (before offsets) and final buy-in payments/receipts among A, B, C, and D are shown in the table as follows:

(All amounts stated in X’s)

A B C D

PAYMENTS - 40 �� 21 �� 37.5 �� 30 RECEIPTS 48 34 22.5 24

FINAL 8 13 � 15 �� 6 �

(ii) The first row/first column shows A’s provisional buy-in payment equal to the product of 100X (sum of 40X, 30X, and 30X) and A’s share of anticipated benefits of 40%. The second row/first column shows A’s provisional buy-in receipts equal to the sum of the products of 80X and B’s, C’s, and D’s anticipated benefits shares (15%, 25%, and 20%, respectively). The other entries in the first two rows of the table are similarly computed. The last row shows the final buy-in receipts/payments after offsets. Thus, for the taxable year, A and B are treated as receiving the 8X and 13X, respectively, pro rata out of payments by C and D of 15X and 6X, respectively.

Example 5 . A and B, two members of a controlled group form a cost sharing arrangement

well as the additional documentation specified in this paragraph (j)(2), and must provide any such documentation to the Internal Revenue Service within 30 days of a request (unless an extension is granted by the district director). Documents necessary to establish the following must also be maintained—

(i) The total amount of costs incurred pursuant to the arrangement;

(ii) The costs borne by each controlled participant;

(iii) A description of the method used to determine each controlled participant’s share of the intangible development costs, including the projections used to estimate benefits, and an explanation of why that method was selected;

(iv) The accounting method used to determine the costs and benefits of the intangible development (including the method used to translate foreign currencies), and, to the extent that the method materially differs from U.S. generally accepted accounting principles, an explanation of such material differences; and

(v) Prior research, if any, undertaken in the intangible development area, any tangible or intangible property made available for use in the arrangement, by each controlled participant, and any information used to establish the value of pre-existing and covered intangibles.

(3) Reporting requirements . A controlled participant must attach to its U.S. income tax return a statement indicating that it is a participant in a qualified cost sharing arrangement, and listing the other controlled participants in the arrangement. A controlled participant that is not required to file a U.S. income tax return must ensure that such a statement is attached to Schedule M of any Form 5471 or to any Form 5472 filed with respect to that participant.

(k) Effective date . This section is effective for taxable years beginning on or after January 1, 1996.

(l) Transition rule . A cost sharing arrangement will be considered a qualified cost sharing arrangement, within the meaning of this section, if, prior to January 1, 1996, the arrangement was a bona fide cost sharing arrangement under the provisions of §1.482–7T (as contained in the 26 CFR part 1 edition revised as of April 1, 1995), but only if the arrangement is amended, if necessary, to conform with

with an unrelated third party C to develop a new technology useable in their respective businesses. Based on a reliable projection of their future benefits, A and B agree to bear shares of 60% and 40%, respectively, of the costs incurred during the term of the agreement. A also makes available its existing technology for purposes of the research to be undertaken. The arm’s length charge, under the rules of §§1.482–1 and 1.482– 4 through 1.482–6, for the use of the existing technology is 100X for the taxable year. Under its agreement with A and B, C must make a specified cost sharing payment as well as a payment of 50X for the taxable year on account of the pre-existing intangible property made available to the cost sharing arrangement. B’s provisional buy-in payment (before offsets) to A for the taxable year is 40X (the product of 100X and B’s anticipated benefits share of 40%). C’s payment of 50X is shared provisionally between A and B in accordance with their shares of reasonably anticipated benefits, 30X (50X times 60%) to A and 20X (50X times 40%) to B. B’s final buy-in payment (after offsets) is 20X (40X less 20X). A is treated as receiving the 70X total provisional payments (40X plus 30X) pro rata out of the final payments by B and C of 20X and 50X, respectively.

(h) Character of payments made pursuant to a qualified cost sharing arrangement —(1) In general . Payments made pursuant to a qualified cost sharing arrangement (other than payments described in paragraph (g) of this section) generally will be considered costs of developing intangibles of the payor and reimbursements of the same kind of costs of developing intangibles of the payee. For purposes of this paragraph (h), a controlled participant’s payment required under a qualified cost sharing arrangement is deemed to be reduced to the extent of any payments owed to it under the arrangement from other controlled or uncontrolled participants. Each payment received by a payee will be treated as coming pro rata out of payments made by all payors. Such payments will be applied pro rata against deductions for the taxable year that the payee is allowed in connection with the qualified cost sharing arrangement. Payments received in excess of such deductions will be treated as in consideration for use of the tangible property made available to the qualified cost sharing arrangement by the payee. For purposes of the research credit determined under section 41, cost sharing payments among controlled participants will be treated as provided for intra-group transactions in §1.41-8(e). Any payment made or received by a taxpayer pursuant to an arrangement that the district director determines not to be a qualified cost sharing arrangement, or a payment made or received

pursuant to paragraph (g) of this section, will be subject to the provisions of §§1.482–1 and 1.482–4 through 1.482–6. Any payment that in substance constitutes a cost sharing payment will be treated as such for purposes of this section, regardless of its characterization under foreign law.

(2) Examples . The following examples illustrate this paragraph (h):

Example 1 . U.S. Parent (USP) and its wholly owned Foreign Subsidiary (FS) form a cost sharing arrangement to develop a miniature widget, the Small R. Based on a reliable projection of their future benefits, USP agrees to bear 40% and FS to bear 60% of the costs incurred during the term of the agreement. The principal costs in the intangible development area are operating expenses incurred by FS in Country Z of 100X annually, and operating expenses incurred by USP in the United States also of 100X annually. Of the total costs of 200X, USP’s share is 80X and FS’s share is 120X, so that FS must make a payment to USP of 20X. This payment will be treated as a reimbursement of 20X of USP’s operating expenses in the United States. Accordingly, USP’s Form 1120 will reflect an 80X deduction on account of activities performed in the United States for purposes of allocation and apportionment of the deduction to source. The Form 5471 for FS will reflect a 100X deduction on account of activities performed in Country Z, and a 20X deduction on account of activities performed in the United States.

Example 2 . The facts are the same as in Example 1, except that the 100X of costs borne by USP consist of 5X of operating expenses incurred by USP in the United States and 95X of fair market value rental cost for a facility in the United States. The depreciation deduction attributable to the U.S. facility is 7X. The 20X net payment by FS to USP will first be applied in reduction pro rata of the 5X deduction for operating expenses and the 7X depreciation deduction attributable to the U.S. facility. The 8X remainder will be treated as rent for the U.S. facility.

(i) Accounting requirements . The accounting requirements of this paragraph are that the controlled participants in a qualified cost sharing arrangement must use a consistent method of accounting to measure costs and benefits, and must translate foreign currencies on a consistent basis.

(j) Administrative requirements —(1) In general . The administrative requirements of this paragraph consist of the documentation requirements of paragraph (j)(2) of this section and the reporting requirements of paragraph (j)(3) of this section.

(2) Documentation . A controlled participant must maintain sufficient documentation to establish that the requirements of paragraphs (b)(4) and (c)(1) of this section have been met, as

the provisions of this section by December 31, 1996.

§1.482–7T [Removed]

Par. 4. Section 1.482–7T is removed.

PART 301—PROCEDURE AND ADMINISTRATION

Par. 5. The authority for part 301 continues to read in part as follows:

Authority: 26 U.S.C. 7805. * * * Par. 6. Section 301.7701–3 is amended by adding paragraph (e) to read as follows:

§301.7701–3 Partnerships .

(e) Qualified cost sharing arrange- ments . A qualified cost sharing arrangement that is described in §1.482–7 of this chapter and any arrangement that is treated by the Service as a qualified cost sharing arrangement under §1.482–7 of this chapter is not classified as a partnership for purposes of the Internal Revenue Code. See §1.482–7 of this chapter for the proper treatment of qualified cost sharing arrangements.

PART 602—OMB CONTROL NUMBERS UNDER THE PAPERWORK REDUCTION ACT

Par. 7. The authority citation for part 602 continues to read as follows: Authority: 26 U.S.C. 7805. Par. 8. In §602.101, paragraph (c) is amended by adding an entry to the table in numerical order to read as follows: ‘‘1.482–7 . . . . . . . . . . . . . 1545–1364’’.

mation is required by the IRS to insure the proper reporting of income and proceeds paid to a trust any portion of which is treated as owned by the grantor or another person.

An agency may not conduct or sponsor, and a person is not required to respond to, a collection of information unless the collection of information displays a valid control number.

The estimated annual burden per respondent is 30 minutes.

Books or records relating to this collection of information must be retained as long as their contents may become material in the administration of any internal revenue law. Generally, tax returns and tax return information are confidential, as required by 26 U.S.C. 6103.

Background

On July 22, 1994, the IRS published in the Federal Register a notice of proposed rulemaking and notice of public hearing (59 FR 37450 [PS–79– 93, 1994–2 C.B. 916]) proposing amendments to the Income Tax Regulations (26 CFR part 1) under section 671 of the Internal Revenue Code (Code) and to the Procedure and Administration Regulations (26 CFR part 301) under sections 6012 and 6109 of the Code.

Written comments responding to the notice were received. A public hearing was held on September 21, 1994, pursuant to the notice published in the Federal Register on July 22, 1994. After consideration of all written and oral comments regarding the proposed amendments, those amendments are adopted as revised by this Treasury decision.

Explanation of provisions and significant changes in the final regulations

Subject to certain new limitations under §1.671–4(b)(6) and (7), discussed

Margaret Milner Richardson,

Commissioner of

Internal Revenue.

Section 671.—Trust Income, Deductions, and Credit Attributable to Grantors and Others as Substantial Owners

26 CFR 1.671–4: Method of reporting.

T.D. 8633

DEPARTMENT OF THE TREASURY Internal Revenue Service 26 CFR Parts 1, 25, 301, and 602

Grantor Trust Reporting Requirements

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

SUMMARY: This document contains final regulations relating to the method of reporting for trusts that are treated as owned by grantors or other persons under the provisions of subpart E (section 671 and following), part I, subchapter J, chapter 1 of the Internal Revenue Code. These regulations are intended to reduce the current filing burden on trustees, to provide necessary information to grantors or other persons treated as the owners of trusts, to reduce any cases of duplicate filing, and to provide more meaningful information to the IRS. These regulations affect grantors and trustees of trusts that are treated as owned by grantors or other persons, as well as persons who are required to file information returns with respect to payments to these trusts.

DATES: These regulations are effective January 1, 1996.

For dates of applicability of these regulations, see §1.671–4(h).

FOR FURTHER INFORMATION CONTACT: Steven Schneider, (202) 622-3060 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

The collection of information contained in these final regulations has been reviewed and approved by the Office of Management and Budget in accordance with the Paperwork Reduction Act (44 U.S.C. 3507) under control number 1545–1442. This infor

Approved November 30, 1995.

Leslie Samuels, Assistant Secretary of

the Treasury.

(Filed by the Office of the Federal Register on

December 19, 1995, 8:45 a.m., and published in the issue of the Federal Register for December 20, 1995, 60 F.R. 65553)

below, §1.671–4(b) of the final regulations retains the optional alternative methods of reporting contained in the proposed regulations published on July 22, 1994. Several comments were submitted requesting confirmation that the alternative methods of reporting described in the proposed regulations are optional and not mandatory. Section 1.671–4(b) of the final regulations clarifies that the trustee of a trust all of which is treated as owned by one or more grantors or other persons may, but is not required to, report pursuant to one of the alternative methods.

Certain commentators were unsure of which persons are considered payors for purposes of the alternative filing methods. The final regulations define the term payor as including any person who is required by any provision of the Code and the regulations thereunder to make any type of information return with respect to the trust for the taxable year.

With respect to the alternative methods of reporting, several commentators were unsure of the items and the amounts of income that must be reported on any Forms 1099 required to be filed by the trustee. Section 1.671– 4(b)(5) of the final regulations clarifies that the amounts that must be included on any Forms 1099 required to be filed by the trustee do not include any amounts that are reportable by the payor on an information return other than Form 1099.

For example, in the case of a trustee who furnishes the name, TIN, and address of the trust to all payors pursuant to §1.671–4(b)(2)(i)(B) of the final regulations, the trustee does not include items of income attributable to an interest in a partnership on any Forms 1099 filed by the trustee because those items are reportable by the partnership on Schedule K–1 of Form 1065 (reporting distributive shares to members of a partnership). While the statement furnished to the grantor or other person treated as the owner of the trust by the trustee will show all items of income, deduction, and credit attributable to the partnership interest, those items will not be reported to the IRS by the trustee on any type of form.

Several commentators were unsure of the dates by which a trustee must file any required Forms 1099 and must furnish any required statements to grantors or other persons treated as

owners of the trust. Section 1.671–4(c) of the final regulations provides that the due date for any Forms 1099 required to be filed with the IRS by a trustee is the due date otherwise in effect for filing Forms 1099. Currently, the due date is February 28 of the following year.

Section 1.671–4(d) of the final regulations provides that the due date for the statement required to be furnished by a trustee to the grantor or other person treated as an owner of the trust is the date specified by section 6034A(a). Currently, the due date is April 15 of the following year.

Comments were received requesting clarification of the trustee’s obligation, under the first of the alternative reporting methods, to furnish the name and TIN of the grantor to all payors. The final regulations provide that: (1) a trustee may not report under the first alternative reporting method unless the grantor or other person treated as the owner of the trust provides to the trustee a complete Form W–9 or other acceptable substitute form; (2) a trustee reporting under the first alternative reporting method acts as the agent of the grantor or other person treated as the owner of the trust for purposes of furnishing backup withholding information to a payor; and (3) the payor may rely on the name and TIN provided to the payor by the trustee. If the Form W–9 indicates that the grantor or other person is subject to backup withholding, then the trustee must notify all payors of reportable interest and dividend payments of the requirement to backup withhold.

Comments were received requesting clarification of the annuity and unitrust payment dates under §25.2702–3 of the Gift Tax Regulations for trusts electing one of the alternative methods of reporting. The final regulations contain conforming amendments to §25.2702– 3(b)(1)(i) and §25.2702–3(c)(1)(i). One commentator noted the need for more guidance concerning the reporting requirements for widely held fixed investment trusts. Because that guidance is outside the scope of this regulation, the final regulations do not provide special rules for these trusts. However IRS and Treasury anticipate providing guidance for these trusts in a separate project and would welcome comments from interested taxpayers and practitioners regarding such guidance.

Several of the comments received with respect to the proposed regulations emphasized the necessity of making the trustee’s choice to report under one of the alternative methods revocable. The final regulations provide that a trustee who has reported pursuant to one of the alternative methods may report pursuant to the general rule requiring the trustee to file a Form 1041 for any subsequent taxable years of the trust, provided that certain conditions are met.

The final regulations provide that the trustee of a trust all of which is treated as owned by one grantor or one other person that is an exempt recipient for information reporting purposes may not report under an alternative method. However, if the trust is treated as owned by two or more grantors or other persons, the trustee may report pursuant to the alternative method for multiple grantors if (1) at least one grantor or one other person who is treated as an owner of the trust is a person who is not an exempt recipient for information reporting purposes and (2) the trustee reports without regard to whether any of the grantors or other persons treated as owners of the trust are exempt recipients for information reporting purposes.

The final regulations also provide that the trustee of a trust all of which is treated as owned by one grantor or other person whose taxable year is a fiscal year may not report under an alternative method. However, the trustee of a trust that is treated as owned by two or more grantors or other persons may report pursuant to the alternative method for multiple grantors even though one or more of the grantors or other persons treated as an owner of the trust has a taxable year that is the fiscal year.

In addition, the final regulations provide that a trustee of a trust that is a qualified subchapter S trust as defined in section 1361(d)(3) may not report under an alternative method.

The final regulations also provide that the trustee of a trust may not report under an alternative method if any person who is treated as an owner of the trust is not a United States person.

Effective date and transition rule

The final regulations are effective for taxable years beginning on or after

trustee must furnish the grantor or other person treated as the owner of the trust with a statement that—

( 1 ) Shows all items of income, deduction, and credit of the trust for the taxable year;

( 2 ) Identifies the payor of each item of income;

( 3 ) Provides the grantor or other person treated as the owner of the trust with the information necessary to take the items into account in computing the grantor’s or other person’s taxable income; and

( 4 ) Informs the grantor or other person treated as the owner of the trust that the items of income, deduction and credit and other information shown on the statement must be included in computing the taxable income and credits of the grantor or other person on the income tax return of the grantor or other person.

(B) The trustee is not required to file any type of return with the Internal Revenue Service.

(iii) Additional obligations of the trustee when name, TIN, and address of the trust are furnished to payors —(A) Obligation to file Forms 1099 . The trustee must file with the Internal Revenue Service the appropriate Forms 1099, reporting the income or gross proceeds paid to the trust during the taxable year, and showing the trust as the payor and the grantor or other person treated as the owner of the trust as the payee. The trustee has the same obligations for filing the appropriate Forms 1099 as would a payor making reportable payments, except that the trustee must report each type of income in the aggregate, and each item of gross proceeds separately. See paragraph (b)(5) of this section regarding the amounts required to be included on any Forms 1099 filed by the trustee.

(B) Obligation to furnish statement . ( 1 ) Unless the grantor or other person treated as the owner of the trust is the trustee or a co-trustee of the trust, the trustee must also furnish to the grantor or other person treated as the owner of the trust a statement that—

( i ) Shows all items of income, deduction, and credit of the trust for the taxable year;

( ii ) Provides the grantor or other person treated as the owner of the trust with the information necessary to take the items into account in computing the grantor’s or other person’s taxable income; and

January 1, 1996, subject to a requirement that certain trustees file a final Form 1041 before adopting one of the alternative methods of reporting. The final regulations retain the transition rule contained in the proposed regulations providing that, for taxable years beginning prior to January 1, 1996, the IRS will not challenge the manner of reporting by trustees of certain trusts.

Special Analyses

It has been determined that this Treasury decision is not a significant regulatory action as defined in EO 12866. Therefore, a regulatory assessment is not required. It has also been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) and the Regulatory Flexibility Act (5 U.S.C. chapter 6) do not apply to these regulations, and, therefore, a Regulatory Flexibility Analysis is not required. Pursuant to section 7805(f) of the Code, the notice of proposed rulemaking preceding these regulations was submitted to the Small Business Administration for comment on its impact on small business.

Drafting Information

The principal author of these regulations is Robert Rio, formerly of the Office of Assistant Chief Counsel (Passthroughs and Special Industries), IRS. However, other personnel from the IRS and Treasury Department participated in their development.

- - - - -

Adoption of Amendments to the Regulations

Accordingly, 26 CFR parts 1, 25, 301, and 602 are amended as follows:

PART 1—INCOME TAXES

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

Authority: 26 U.S.C. 7805. * * * Par. 2. Section 1.671–4 is revised to read as follows:

§1.671-4 Method of reporting .

(a) Portion of trust treated as owned by the grantor or another person . Except as otherwise provided in para

graph (b) of this section, items of income, deduction, and credit attributable to any portion of a trust which, under the provisions of subpart E (section 671 and following), part I, subchapter J, chapter 1 of the Internal Revenue Code, is treated as owned by the grantor or another person are not reported by the trust on Form 1041, but are shown on a separate statement to be attached to that form.

(b) A trust all of which is treated as owned by one or more grantors or other persons —(1) In general . In the case of a trust all of which is treated as owned by one or more grantors or other persons, and which is not described in paragraph (b)(6) or (7) of this section, the trustee may, but is not required to, report by one of the methods described in this paragraph (b) rather than by the method described in paragraph (a) of this section. A trustee may not report, however, pursuant to paragraph (b)(2)(i)(A) of this section unless the grantor or other person treated as the owner of the trust provides to the trustee a complete Form W–9 or acceptable substitute Form W– 9 signed under penalties of perjury. See section 3406 and the regulations thereunder for the information to include on, and the manner of executing, the Form W–9, depending upon the type of reportable payments made.

(2) A trust all of which is treated as owned by one grantor or by one other person —(i) In general . In the case of a trust all of which is treated as owned by one grantor or one other person, the trustee reporting under this paragraph (b) must either—

(A) Furnish the name and taxpayer identification number (TIN) of the grantor or other person treated as the owner of the trust, and the address of the trust, to all payors during the taxable year, and comply with the additional requirements described in paragraph (b)(2)(ii) of this section; or

(B) Furnish the name, TIN, and address of the trust to all payors during the taxable year, and comply with the additional requirements described in paragraph (b)(2)(iii) of this section.

(ii) Additional obligations of the trustee when name and TIN of the grantor or other person treated as the owner of the trust and the address of the trust are furnished to payors . (A) Unless the grantor or other person treated as the owner of the trust is the trustee or a co-trustee of the trust, the

( iii ) Informs the grantor or other person treated as the owner of the trust that the items of income, deduction and credit and other information shown on the statement must be included in computing the taxable income and credits of the grantor or other person on the income tax return of the grantor or other person.

( 2 ) By furnishing the statement, the trustee satisfies the obligation to furnish statements to recipients with respect to the Forms 1099 filed by the trustee.

(iv) Examples . The following examples illustrate the provisions of this paragraph (b)(2):

Example 1 . G, a United States citizen, creates an irrevocable trust which provides that the ordinary income is to be payable to him for life and that on his death the corpus shall be distributed to B, an unrelated person. Except for the right to receive income, G retains no right or power which would cause him to be treated as an owner under sections 671 through 679. Under the applicable local law, capital gains must be added to corpus. Since G has a right to receive income, he is treated as an owner of a portion of the trust under section 677. The tax consequences of any items of capital gain of the trust are governed by the provisions of subparts A, B, C, and D (section 641 and following), part I, subchapter J, chapter 1 of the Internal Revenue Code. Because not all of the trust is treated as owned by the grantor or another person, the trustee may not report by the methods described in paragraph (b)(2) of this section.

Example 2 . (i)(A) On January 2, 1996, G, a United States citizen, creates a trust all of which is treated as owned by G. The trustee of the trust is T. During the 1996 taxable year the trust has the following items of income and gross proceeds:

Interest . . . . . . . . . . . . . . . . . . . . . . . . . . $2,500 Dividends . . . . . . . . . . . . . . . . . . . . . . . . . . 3,205 Proceeds from sale of B stock . . . . . . . 2,000

(B) The trust has no items of deduction or credit.

(ii)(A) The payors of the interest paid to the trust are X ($2,000), Y ($300), and Z ($200). The payors of the dividends paid to the trust are A ($3,200), and D ($5). The payor of the gross proceeds paid to the trust is D, a brokerage firm, which held the B stock as the nominee for the trust. The B stock was purchased by T for $1,500 on January 3, 1996, and sold by T on November 29, 1996. T chooses to report pursuant to paragraph (b)(2)(i)(B) of this section, and therefore furnishes the name, TIN, and address of the trust to X, Y, Z, A, and D. X, Y, and Z each furnish T with a Form 1099–INT showing the trust as the payee. A furnishes T with a Form 1099–DIV showing the trust as the payee. D does not furnish T with a Form 1099–DIV because D paid a dividend of less than $10 to T. D furnishes T with a Form 1099–B showing the trust as the payee.

(B) On or before February 28, 1997, T files a Form 1099–INT with the Internal Revenue Service on which T reports interest attributable

to G, as the owner of the trust, of $2,500; a Form 1099–DIV on which T reports dividends attributable to G, as the owner of the trust, of $3,205; and a Form 1099-B on which T reports gross proceeds from the sale of B stock attributable to G, as the owner of the trust, of $2,000. On or before April 15, 1997, T furnishes a statement to G which lists the following items of income and information necessary for G to take the items into account in computing G’s taxable income:

Interest . . . . . . . . . . . . . . . . . . . . . . . . . . . $2,500 Dividends . . . . . . . . . . . . . . . . . . . . . . . . . . 3,205 Gain from sale of B stock . . . . . . . . . . . . 500

Information regarding sale of B stock:

Proceeds . . . . . . . . . . . . . . . . . . . . . . . . $2,000 Basis . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,500 Date acquired . . . . . . . . . . . . . . . . . . 1/03/96 Date sold . . . . . . . . . . . . . . . . . . . . . 11/29/96

(C) T informs G that any items of income, deduction and credit and other information shown on the statement must be included in computing the taxable income and credits of the grantor or other person on the income tax return of the grantor or other person.

(D) T has complied with T’s obligations under this section.

(iii)(A) Same facts as paragraphs (i) and (ii) of this Example 2, except that G contributed the B stock to the trust on January 2, 1996. On or before April 15, 1997, T furnishes a statement to G which lists the following items of income and information necessary for G to take the items into account in computing G’s taxable income:

Interest . . . . . . . . . . . . . . . . . . . . . . . . . . . $2,500 Dividends . . . . . . . . . . . . . . . . . . . . . . . . . . 3,205

Information regarding sale of B stock:

Proceeds . . . . . . . . . . . . . . . . . . . . . . . . $2,000 Date sold . . . . . . . . . . . . . . . . . . . . . 11/29/96

(B) T informs G that any items of income, deduction and credit and other information shown on the statement must be included in computing the taxable income and credits of the grantor or other person on the income tax return of the grantor or other person.

Example 3 . On January 2, 1996, G, a United States citizen, creates a trust all of which is treated as owned by G. The trustee of the trust is T. The only asset of the trust is an interest in C, a common trust fund under section 584(a). T chooses to report pursuant to paragraph (b)(2)(i)(B) of this section and therefore furnishes the name, TIN, and address of the trust to C. C files a Form 1065 and a Schedule K–1 (Partner’s Share of Income, Credits, Deductions, etc.) showing the name, TIN, and address of the trust with the Internal Revenue Service and furnishes a copy to T. Because the trust did not receive any amounts described in paragraph (b)(5) of this section, T does not file any type of return with the Internal Revenue Service. On or before April 15, 1997, T furnishes G with a statement that shows all items of income, deduction, and credit of the trust for the 1996 taxable year. In addition, T informs G that any items of income, deduction and credit and other information shown on the statement must be included in computing the taxable income and

credits of the grantor or other person on the income tax return of the grantor or other person. T has complied with T’s obligations under this section.

(3) A trust all of which is treated as owned by two or more grantors or other persons —(i) In general . In the case of a trust all of which is treated as owned by two or more grantors or other persons, the trustee must furnish the name, TIN, and address of the trust to all payors for the taxable year, and comply with the additional requirements described in paragraph (b)(3)(ii) of this section.

(ii) Additional obligations of trustee —(A) Obligation to file Forms 1099 . The trustee must file with the Internal Revenue Service the appropriate Forms 1099, reporting the items of income paid to the trust by all payors during the taxable year attributable to the portion of the trust treated as owned by each grantor or other person, and showing the trust as the payor and each grantor or other person treated as an owner of the trust as the payee. The trustee has the same obligations for filing the appropriate Forms 1099 as would a payor making reportable payments, except that the trustee must report each type of income in the aggregate, and each item of gross proceeds separately. See paragraph (b)(5) of this section regarding the amounts required to be included on any Forms 1099 filed by the trustee.

(B) Obligation to furnish statement . ( 1 ) The trustee must also furnish to each grantor or other person treated as an owner of the trust a statement that—

( i ) Shows all items of income, deduction, and credit of the trust for the taxable year attributable to the portion of the trust treated as owned by the grantor or other person;

( ii ) Provides the grantor or other person treated as an owner of the trust with the information necessary to take the items into account in computing the grantor’s or other person’s taxable income; and

( 2 ) Except for the requirements pursuant to section 3406 and the regula

tions thereunder, by furnishing the statement, the trustee satisfies the obligation to furnish statements to recipients with respect to the Forms 1099 filed by the trustee.

(4) Persons treated as payors —(i) In general . For purposes of this section, the term payor means any person who is required by any provision of the Internal Revenue Code and the regulations thereunder to make any type of information return (including Form 1099 or Schedule K–1) with respect to the trust for the taxable year, including persons who make payments to the trust or who collect (or otherwise act as middlemen with respect to) payments on behalf of the trust.

(ii) Application to brokers and cus- tomers . For purposes of this section, a broker, within the meaning of section 6045, is considered a payor. A customer, within the meaning of section 6045, is considered a payee. (5) Amounts required to be included on Forms 1099 filed by the trustee —(i) In general . The amounts that must be included on any Forms 1099 required to be filed by the trustee pursuant to this section do not include any amounts that are reportable by the payor on an information return other than Form 1099. For example, in the case of a trust which owns an interest in a partnership, the trust’s distributive share of the income and gain of the partnership is not includible on any Forms 1099 filed by the trustee pursuant to this section because the distributive share is reportable by the partnership on Schedule K-1.

(ii) Example . The following example illustrates the provisions of this paragraph (b)(5):

Example . (i)(A) On January 2, 1996, G, a United States citizen, creates a trust all of which is treated as owned by G. The trustee of the trust is T. The assets of the trust during the 1996 taxable year are shares of stock in X, an S corporation, a limited partnership interest in P, shares of stock in M, and shares of stock in N. T chooses to report pursuant to paragraph (b)(2)(i)(B) of this section and therefore furnishes the name, TIN, and address of the trust to X, P, M, and N. M furnishes T with a Form 1099–DIV showing the trust as the payee. N does not furnish T with a Form 1099–DIV because N paid a dividend of less than $10 to T. X and P furnish T with Schedule K–1 (Shareholder’s Share of Income, Credits, Deductions, etc.) and Schedule K–1 (Partner’s Share of Income, Credits, Deductions, etc.), respectively, showing the trust’s name, TIN, and address.

(B) For the 1996 taxable year the trust has the following items of income and deduction:

Dividends paid by M . . . . . . . . . . . . . . . . . $12 Dividends paid by N . . . . . . . . . . . . . . . . . . . 6

Administrative expense . . . . . . . . . . . . . . . . $20

Items reported by X on Schedule K–1 attributable to trust’s shares of stock in X:

Interest . . . . . . . . . . . . . . . . . . . . . . . . . . . $20 Dividends . . . . . . . . . . . . . . . . . . . . . . . . . . 35

Items reported by P on Schedule K-1 attributable to trust’s limited partnership interest in P:

Ordinary income . . . . . . . . . . . . . . . . . . $300

(ii)(A) On or before February 28, 1997, T files with the Internal Revenue Service a Form 1099DIV on which T reports dividends attributable to G as the owner of the trust in the amount of $18. T does not file any other returns.

(B) T has complied with T’s obligation under paragraph (b)(2)(iii)(A) of this section to file the appropriate Forms 1099.

(6) Trusts that cannot report under this paragraph (b) . The following trusts cannot use the methods of reporting described in this paragraph (b)—

(i) A common trust fund as defined in section 584(a);

(ii) A trust that has its situs or any of its assets located outside the United States;

(iii) A trust that is a qualified subchapter S trust as defined in section 1361(d)(3); (iv) A trust all of which is treated as owned by one grantor or one other person whose taxable year is a fiscal year;

(v) A trust all of which is treated as owned by one grantor or one other person who is not a United States person; or

(vi) A trust all of which is treated as owned by two or more grantors or other persons, one of whom is not a United States person.

(7) Grantors or other persons who are treated as owners of the trust and are exempt recipients for information reporting purposes —(i) Trust treated as owned by one grantor or one other person . The trustee of a trust all of which is treated as owned by one grantor or one other person may not report pursuant to this paragraph (b) if the grantor or other person is an exempt recipient for information reporting purposes.

(ii) Trust treated as owned by two or more grantors or other persons . The trustee of a trust, all of which is treated as owned by two or more grantors or other persons, may not report pursuant to this paragraph (b) if one or more

grantors or other persons treated as owners are exempt recipients for information reporting purposes unless—

(A) At least one grantor or one other person who is treated as an owner of the trust is a person who is not an exempt recipient for information reporting purposes; and

(B) The trustee reports without regard to whether any of the grantors or other persons treated as owners of the trust are exempt recipients for information reporting purposes.

(8) Husband and wife who make a single return jointly . A trust all of which is treated as owned by a husband and wife who make a single return jointly of income taxes for the taxable year under section 6013 is considered to be owned by one grantor for purposes of this paragraph (b).

(c) Due date for Forms 1099 re- quired to be filed by trustee . The due date for any Forms 1099 required to be filed with the Internal Revenue Service by a trustee pursuant to this section is the due date otherwise in effect for filing Forms 1099.

(d) Due date and other requirements with respect to statement required to be furnished by trustee . The due date for the statement required to be furnished by a trustee to the grantor or other person treated as an owner of the trust pursuant to this section is the date specified by section 6034A(a). The trustee must maintain in its records a copy of the statement furnished to the grantor or other person treated as an owner of the trust for a period of three years from the due date for furnishing such statement specified in this paragraph (d).

(e) Backup withholding require- ments —(1) Trustee reporting under paragraph (b)(2)(i)(A) of this section . In order for the trustee to be able to report pursuant to paragraph (b)(2)(i)(A) of this section and to furnish to all payors the name and TIN of the grantor or other person treated as the owner of the trust, the grantor or other person must provide a complete Form W–9 to the trustee in the manner provided in paragraph (b)(1) of this section, and the trustee must give the name and TIN shown on that Form W– 9 to all payors. In addition, if the Form W–9 indicates that the grantor or other person is subject to backup withholding, the trustee must notify all payors of reportable interest and dividend payments of the requirement to backup

withhold. If the Form W–9 indicates that the grantor or other person is not subject to backup withholding, the trustee does not have to notify the payors that backup withholding is not required. The trustee should not give the Form W–9, or a copy thereof, to a payor because the Form W–9 contains the address of the grantor or other person and paragraph (b)(2)(i)(A) of this section requires the trustee to furnish the address of the trust to all payors and not the address of the grantor or other person. The trustee acts as the agent of the grantor or other person for purposes of furnishing to the payors the information required by this paragraph (e)(1). Thus, a payor may rely on the name and TIN provided to the payor by the trustee, and, if given, on the trustee’s statement that the grantor is subject to backup withholding.

(2) Other backup withholding re- quirements . Whether a trustee is treated as a payor for purposes of backup withholding is determined pursuant to section 3406 and the regulations thereunder.

(f) Penalties for failure to file a correct Form 1099 or furnish a correct statement . A trustee who fails to file a correct Form 1099 or to furnish a correct statement to a grantor or other person treated as an owner of the trust as required by paragraph (b) of this section is subject to the penalties provided by sections 6721 and 6722 and the regulations thereunder.

(g) Changing reporting methods (1) Changing from reporting by filing Form 1041 to a method described in paragraph (b) of this section . If the trustee has filed a Form 1041 for any taxable year ending before January 1, 1996 (and has not filed a final Form 1041 pursuant to §1.671–4(b)(3) (as contained in the 26 CFR part 1 edition revised as of April 1, 1995)), or files a Form 1041 for any taxable year thereafter, the trustee must file a final Form 1041 for the taxable year which ends after January 1, 1995, and which immediately precedes the first taxable year for which the trustee reports pursuant to paragraph (b) of this section, on the front of which form the trustee must write: ‘‘Pursuant to §1.671–4(g), this is the final Form 1041 for this grantor trust.’’. (2) Changing from reporting by a method described in paragraph (b) of this section to the filing of a Form

1041 . The trustee of a trust who reported pursuant to paragraph (b) of this section for a taxable year may report pursuant to paragraph (a) of this section for subsequent taxable years. If the trustee reported pursuant to paragraph (b)(2)(i)(A) of this section, and therefore furnished the name and TIN of the grantor to all payors, the trustee must furnish the name, TIN, and address of the trust to all payors for such subsequent taxable years. If the trustee reported pursuant to paragraph (b)(2)(i)(B) or (b)(3)(i) of this section, and therefore furnished the name and TIN of the trust to all payors, the trustee must indicate on each Form 1096 (Annual Summary and Transmittal of U.S. Information Returns) that it files (or appropriately on magnetic media) for the final taxable year for which the trustee so reports that it is the final return of the trust.

(3) Changing between methods de- scribed in paragraph (b) of this section —(i) Changing from furnishing the TIN of the grantor to furnishing the TIN of the trust . The trustee of a trust who reported pursuant to paragraph (b)(2)(i)(A) of this section for a taxable year, and therefore furnished the name and TIN of the grantor to all payors, may report pursuant to paragraph (b)(2)(i)(B) of this section, and furnish the name and TIN of the trust to all payors, for subsequent taxable years.

(ii) Changing from furnishing the TIN of the trust to furnishing the TIN of the grantor . The trustee of a trust who reported pursuant to paragraph (b)(2)(i)(B) of this section for a taxable year, and therefore furnished the name and TIN of the trust to all payors, may report pursuant to paragraph (b)(2)(i)(A) of this section, and furnish the name and TIN of the grantor to all payors, for subsequent taxable years. The trustee, however, must indicate on each Form 1096 (Annual Summary and Transmittal of U.S. Information Returns) that it files (or appropriately on magnetic media) for the final taxable year for which the trustee reports pursuant to paragraph (b)(2)(i)(B) of this section that it is the final return of the trust.

(4) Example . The following example illustrates the provisions of paragraph (g) of this section:

Example . (i) On January 3, 1994, G, a United States citizen, creates a trust all of which is treated as owned by G. The trustee of the trust is T. On or before April 17, 1995, T files with the

Internal Revenue Service a Form 1041 with an attached statement for the 1994 taxable year showing the items of income, deduction, and credit of the trust. On or before April 15, 1996, T files with the Internal Revenue Service a Form 1041 with an attached statement for the 1995 taxable year showing the items of income, deduction, and credit of the trust. On the Form 1041, T states that ‘‘pursuant to §1.671-4(g), this is the final Form 1041 for this grantor trust.’’ T may report pursuant to paragraph (b) of this section for the 1996 taxable year.

(ii) T reports pursuant to paragraph (b)(2)(i)(B) of this section, and therefore furnishes the name, TIN, and address of the trust to all payors, for the 1996 and 1997 taxable years. T chooses to report pursuant to paragraph (a) of this section for the 1998 taxable year. On each Form 1096 (Annual Summary and Transmittal of U.S. Information Returns) which T files for the 1997 taxable year (or appropriately on magnetic media), T indicates that it is the trust’s final return. On or before April 15, 1999, T files with the Internal Revenue Service a Form 1041 with an attached statement showing the items of income, deduction, and credit of the trust. On the Form 1041, T uses the same TIN which T used on the Forms 1041 and Forms 1099 it filed for previous taxable years. T has complied with T’s obligations under paragraph (g)(2) of this section.

(h) Effective date and transition rule —(1) Effective date . The trustee of a trust any portion of which is treated as owned by one or more grantors or other persons must report pursuant to this section for taxable years beginning on or after January 1, 1996.

(2) Transition rule . For taxable years beginning prior to January 1, 1996, the Internal Revenue Service will not challenge the manner of reporting of—

(i) A trustee of a trust all of which is treated as owned by one or more grantors or other persons who did not report in accordance with §1.671–4(a) (as contained in the 26 CFR part 1 edition revised as of April 1, 1995) as in effect for taxable years beginning prior to January 1, 1996, but did report in a manner substantially similar to one of the reporting methods described in paragraph (b) of this section; or

(ii) A trustee of two or more trusts all of which are treated as owned by one or more grantors or other persons who filed a single Form 1041 for all of the trusts, rather than a separate Form 1041 for each trust, provided that the items of income, deduction, and credit of each trust were shown on a statement attached to the single Form 1041.

(i) Cross-reference . For rules relating to employer identification numbers, and to the obligation of a payor of income or proceeds to the trust to furnish to the payee a statement to recipient, see §301.6109–1(a)(2) of this chapter.

Par. 3. Section 1.6012–3 is amended by revising paragraph (a)(9) to read as follows:

§1.6012–3 Returns by fiduciaries .

(a) - * * (9) A trust any portion of which is treated as owned by the grantor or another person pursuant to sections 671 through 678 . In the case of a trust any portion of which is treated as owned by the grantor or another person under the provisions of subpart E (section 671 and following) part I, subchapter J, chapter 1 of the Internal Revenue Code see §1.671–4.

- - - - -

PART 25—GIFT TAX; GIFTS MADE AFTER DECEMBER 31, 1954

Par. 4. The authority citation for part 25 continues to read in part as follows: Authority: 26 U.S.C. 7805. * * * Par. 5. Section 25.2702–3 is amended by adding a sentence to the end of paragraphs (b)(1)(i) and (c)(1)(i), respectively, to read as follows:

§25.2702–3 Qualified interests.

- - - - -

(b) - * * (1) - * * (i) * * * If the trustee reports for the taxable year pursuant to §1.671–4(b) of this chapter, the annuity payment must be made no later than the date by which the trustee would have been required to file the Federal income tax return of the trust for the taxable year (without regard to extensions) had the trustee reported pursuant to §1.671–4(a) of this chapter.

- - - - -

(c) - * * (1) - * * (i) * * * If the trustee reports for the taxable year pursuant to §1.671–4(b) of this chapter, the unitrust payment must be made no later than the date by which the trustee would have been required to file the Federal income tax return of the trust for the taxable year (without regard to extensions) had the trustee reported pursuant to §1.671–4(a) of this chapter.

- - - - -

PART 301—PROCEDURE AND ADMINISTRATION

Par. 6. The authority citation for part 301 continues to read in part as follows:

Authority: 26 U.S.C. 7805. * * * Par. 7. Section 301.6109–1 is amended by revising paragraph (a)(2) to read as follows:

§301.6109–1 Identifying numbers .

(a) - * * (2) A trust all of which is treated as owned by the grantor or another per- son pursuant to sections 671 through 678 —(i) Obtaining a taxpayer identi- fication number . If a trust does not have a taxpayer identification number and the trustee furnishes the name and taxpayer identification number of the grantor or other person treated as the owner of the trust and the address of the trust to all payors pursuant to §1.671–4(b)(2)(i)(A) of this chapter, the trustee need not obtain a taxpayer identification number for the trust until either the first taxable year of the trust in which all of the trust is no longer owned by the grantor or another person, or until the first taxable year of the trust for which the trustee no longer reports pursuant to §1.671–4(b)(2)(i)(A) of this chapter. If the trustee has not already obtained a taxpayer identification number for the trust, the trustee must obtain a taxpayer identification number for the trust as provided in paragraph (d)(2) of this section in order to report pursuant to §1.671–4(a), (b)(2)(i)(B), or (b)(3)(i) of this chapter.

(ii) Obligations of persons who make payments to certain trusts . Any payor that is required to file an information return with respect to payments of income or proceeds to a trust must show the name and taxpayer identification number that the trustee has furnished to the payor on the return. Regardless of whether the trustee furnishes to the payor the name and taxpayer identification number of the grantor or other person treated as an owner of the trust, or the name and taxpayer identification number of the trust, the payor must furnish a statement to recipients to the trustee of the trust, rather than to the grantor or other person treated as the owner of the trust. Under these circumstances, the payor satisfies the obligation to show the name and taxpayer

identification number of the payee on the information return and to furnish a statement to recipients to the person whose taxpayer identification number is required to be shown on the form.

(iii) Persons treated as payors . For purposes of this paragraph (a)(2), the term payor means a person described in §1.671–4(b)(4) of this chapter.

- - - - -

PART 602—OMB CONTROL NUMBERS UNDER THE PAPERWORK REDUCTION ACT

Par. 8. The authority citation for part 602 continues to read as follows: Authority: 26 U.S.C. 7805. Par. 9. In §602.101, paragraph (c) is amended in the table by revising the entry for 1.671–4 to read ‘‘1.671–4 . . . . 1545–1442’’.

Approved December 5, 1995.

Leslie Samuels, Assistant Secretary of

the Treasury.

(Filed by the Office of the Federal Register on

December 20, 1995, 8:45 a.m., and published in the issue of the Federal Register for December 21, 1995, 60 F.R. 66085)

Section 703.— Partnership Computations

26 CFR 1.703–1: Partnership Computations

If a partnership makes a charitable contribution of property, are the partners’ bases in their partnership interests decreased to reflect the contribution. See Rev. Rul. 96–11, page 28.

Section 705.—Determination of Basis in Partner’s Interest

26 CFR 1.705–1: Determination of basis of partner’s interest. (Also §§ 267, 707; 1.267(d)–1, 1.707–1.)

Basis of partner’s interest; sale between partnerships. Partners’ bases in their partnership interests are decreased to reflect losses on the sale of partnership property to a related partnership that are disallowed under section 707(b)(1) of the Internal Revenue Code. Partners’ bases in their part

Margaret Milner Richardson,

Commissioner of

Internal Revenue.

nership interests are increased to reflect gain from the sale of partnership property that is not recognized under sections 267(d) and 707(b)(1) of the Code.

Rev. Rul. 96–10

ISSUE

(1) If a loss on the sale of partnership property is disallowed under § 707(b)(1) of the Internal Revenue Code, are the partners’ bases in their partnership interests decreased under § 705(a)(2) to reflect the disallowed loss?

(2) If gain from the sale of partnership property is not recognized due to §§ 707(b)(1) and 267(d), are the partners’ bases in their partnership interests increased under § 705(a)(1) to reflect that gain?

FACTS

A and B contribute cash to form PRS, a general partnership. Under the partnership agreement, each item of income, gain, loss, and deduction of the partnership is allocated 75 percent to A and 25 percent to B . A is also a partner in PRS2, a general partnership. Under the partnership agreement, each item of income, gain, loss, and deduction of the partnership is allocated 60 percent to A and 40 percent to C . A, B, and C are unrelated to each other.

In year 1, PRS sells Property to PRS2 at its fair market value of $80 x . The adjusted basis of Property at the time of the sale is $100 x .

In year 5, PRS2 sells Property to an unrelated party for its fair market value of $90 x . The adjusted basis of Property at the time of the sale is $80 x .

LAW AND ANALYSIS

Section 1001(a) provides that the gain from the sale or other disposition of property shall be the excess of the amount realized therefrom over the adjusted basis and the loss shall be the excess of the adjusted basis over the amount realized. Section 1001(c) requires that the entire amount of this gain or loss be recognized, except as otherwise provided in subtitle A of the Code.

Section 707(b)(1) provides that no deduction shall be allowed for losses

from sales or exchanges of property (other than an interest in the partnership) between a partnership and a person owning, directly or indirectly, more than 50 percent of the capital interest or the profits interest in the partnership or between two partnerships in which the same persons own, directly or indirectly, more than 50 percent of the capital interests or profits interests.

Section 707(b)(1) also provides that, in the case of a subsequent sale or exchange by a transferee described in § 707(b)(1), § 267(d) applies as if the loss were disallowed under § 267(a)(1). Section 267(d) provides that, if a taxpayer acquires property by sale or exchange from a transferor who, on the transaction, sustained a loss not allowable as a deduction by reason of § 267(a)(1), then any gain realized by the taxpayer on a sale or other disposition of the property shall be recognized only to the extent that the gain exceeds so much of the loss as is properly allocable to the property sold or otherwise disposed of by the taxpayer.

Section 705(a)(1) provides that the adjusted basis of a partner’s interest in a partnership shall be increased by the sum of the partner’s distributive share for the taxable year and prior taxable years of: (1) taxable income of the partnership as determined under § 703(a), (2) income of the partnership exempt from income tax, and (3) the excess of the deductions for depletion over the basis of the property subject to depletion.

Section 705(a)(2) provides that the adjusted basis of a partner’s interest in a partnership shall be decreased (but not below zero) by distributions by the partnership and by the sum of the partner’s distributive share for the taxable year and prior taxable years of: (1) losses of the partnership, and (2) expenditures of the partnership not deductible in computing its taxable income and not properly chargeable to capital account.

into account by its partners only once. In addition, as provided in § 705(a)(1)(B) and (a)(2)(B), adjustments must also be made to reflect certain nontaxable events in the partnership. For example, a partner’s share of nontaxable income (such as exempt income) is added to the basis of the partner’s interest because, without a basis adjustment, the partner could recognize gain with respect to the tax-exempt income, for example, on the sale or redemption of the partner’s interest, and the benefit of the tax-exempt income would be lost to the partner. Similarly, a partner’s share of nondeductible expenditures must be deducted from the partner’s basis in order to prevent that amount from giving rise to a loss to the partner on a sale or a redemption of the partner’s interest in the partnership. See H.R. Rep. No. 1337, 83d Cong., 2d Sess. A225 (1954); S. Rep. No. 1622, 83d Cong., 2d Sess. 384 (1954). In determining whether a transaction results in exempt income within the meaning of § 705(a)(1)(B) or a nondeductible, noncapital expenditure within the meaning of § 705(a)(2)(B), the proper inquiry is whether the transaction has a permanent effect on the partnership’s basis in its assets, without a corresponding current or future effect on its taxable income. PRS realizes a $20 x loss on the sale of Property to PRS2 ($100 x adjusted basis less $80 x amount realized). Pursuant to § 707(b)(1), this loss is not deductible in computing taxable income because A owns more than 50 percent of the profits interest in both PRS and PRS2 . Consequently, the sale results in a permanent decrease in the aggregate basis for the assets of PRS that is not taken into account by PRS in determining its taxable income and will not be taken into account for federal income tax purposes in any other manner. Therefore, for purposes of § 705(a)(2)(B), the loss on the sale of Property, and the resulting permanent decrease in partnership basis, is an expenditure of the partnership not deductible in computing its taxable income and not properly chargeable to capital account. Cf . § 1.704–1(b)(2)(iv)( i )( 3 ) (losses disallowed under § 707(b) treated as § 705(a)(2)(B) expenditures for purposes of maintaining partners’ capital accounts); § 1.701–2(f), Example 2 (req u i r i n g a d j u s t m e n t s u n d e r § 705(a)(2)(B) for reductions in the basis of stock held by a partnership following an extraordinary dividend under § 1059).

Reducing the partners’ bases in their partnership interests by their respective shares of the partnership’s $20 x loss preserves the intended detriment of not allowing losses from sales or exchanges between partnerships and related persons to be deducted. If the partners’ bases in their partnership interests were not reduced by the amount of the partnership’s disallowed loss, the partners could subsequently recognize this loss (or a reduced gain), for example, upon a disposition of their partnership interests.

Under the PRS agreement, A ’s distributive share of the partnership loss is $15 x and B ’s distributive share is $5 x . Accordingly, the basis of A ’s interest in PRS is decreased by $15 x and the basis of B ’s interest in PRS is decreased by $5 x .

PRS2 realizes a gain of $10 x on the subsequent sale of Property ($90 x amount realized less $80 x adjusted basis). Pursuant to §§ 707(b)(1) and 267(d), PRS2 must recognize the gain only to the extent that it exceeds the amount of PRS ’s disallowed loss. PRS2 ’s gain on the sale ($10 x ) does not exceed PRS ’s disallowed loss ($20 x ) and, therefore, PRS2 does not recognize any gain on the sale of Property. Consequently, the sale of Property results in a permanent increase in the aggregate basis of the assets of PRS2 that is not taken into account by PRS2 in determining its taxable income and will not be taken into account for federal income tax purposes in any other manner. Therefore, for purposes of § 705(a)(1)(B), the gain realized but not recognized by PRS2 on the sale of Property, and the resulting permanent increase in basis, is income of the partnership exempt from tax.

Increasing the partner’s bases in their partnership interests by their respective shares of the unrecognized gain on the sale of Property preserves the intended benefit of §§ 707(b)(1) and 267(d). If the partners’ bases in their partnership interests were not increased by the amount of the partnership’s unrecognized gain, the partners could subsequently recognize this gain (or a reduced loss), for example, upon a disposition of their partnership interests.

Under the PRS2 agreement, A ’s distributive share of the partnership gain is $6 x and C ’s distributive share is $4 x . Accordingly, the basis of A ’s

interest in PRS2 is increased by $6 x and the basis of C ’s interest in PRS2 is increased by $4 x .

HOLDINGS

(1) If a loss on the sale of partnership property is disallowed under § 707(b)(1), the basis of each partner’s interest in the partnership is decreased (but not below zero) under § 705(a)(2) by the partner’s share of that loss.

(2) If gain from the sale of partnership property is not recognized under §§ 707(b)(1) and 267(d), the basis of each partner’s interest in the partnership is increased under § 705(a)(1) by the partner’s share of that gain.

DRAFTING INFORMATION

For further information regarding this revenue ruling contact Deborah Harrington at (202) 622-3050 (not a toll-free call).

26 CFR 1.7-5–1: Adjustments to basis of partner’s interest in partnership. (Also §§ 170, 702, 703; 1.170A–1, 1.702–1, 1.703–1.)

Charitable contribution by part- nership. A charitable contribution of property by a partnership reduces each partner’s basis in the partnership by the amount of the partner’s share of the partnership’s basis in the property contributed.

Rev. Rul. 96–11

ISSUE

If a partnership makes a charitable contribution of property, are the partners’ bases in their partnership interests decreased to reflect the contribution?

FACTS

A and B each contribute an equal amount of cash to form PRS, a general partnership. Under the PRS agreement, each item of income, gain, loss, and deduction of the partnership is allocated 50 percent to A and 50 percent to B . PRS has unencumbered property, X, with a basis of $60 x and a fair market value of $100 x . PRS contributes X in a transaction that qualifies as a charitable contribution under § 170(c) of the In

ternal Revenue Code. The charitable contribution is not subject to the limitations of § 170(e)(1).

LAW AND ANALYSIS

Section 170(a) allows as a deduction any charitable contribution (as defined in § 170(c)) payment of which is made within the taxable year. The deduction provided by § 170(a) is subject to the limitations of § 170(b).

Section 1.170A–1(c)(1) of the Income Tax Regulations provides that, if a charitable contribution is made in property other than money, the amount of the contribution is the fair market value of the property at the time of the contribution reduced as provided by § 170(e)(1) and paragraph (a) of § 1.170A–4, or § 170(e)(3) and paragraph (c) of § 1.170A–4A.

Section 703(a)(2)(C) provides that the taxable income of a partnership is computed in the same manner as in the case of an individual except that the deduction for charitable contributions provided in § 170 is not allowed to the partnership. However, under § 702(a)(4) each partner takes into account separately the partner’s distributive share of the partnership’s charitable contributions (as defined in § 170(c)).

Section 1.170A–1(h)(7) provides that a partner’s distributive share of charitable contributions actually paid by a partnership during its taxable year may be allowed as a deduction in the partner’s separate return for the partner’s taxable year with or within which the taxable year of the partnership ends, to the extent that the aggregate of the partner’s share of the partnership contributions and the partner’s own contributions does not exceed the limitations in § 170(b).

Section 705(a)(1) provides that the adjusted basis of a partner’s interest in a partnership shall be increased by the sum of the partner’s distributive share for the taxable year and prior taxable years of: (1) taxable income of the partnership as determined under § 703(a); (2) income of the partnership exempt from income tax; and (3) the excess of the deductions for depletion over the basis of the property subject to depletion.

Section 705(a)(2) provides that the adjusted basis of a partner’s interest in a partnership shall be decreased (but not below zero) by distributions by the partnership and by the sum of the

partner’s distributive share for the taxable year and prior taxable years of: (1) losses of the partnership; and (2) expenditures of the partnership not deductible in computing its taxable income and not properly chargeable to capital account.

The adjustments to the basis of a partner’s interest in a partnership under § 705 are necessary to prevent inappropriate or unintended benefits or detriments to the partners. Generally, the basis of a partner’s interest in a partnership is adjusted to reflect the tax allocations of the partnership to that partner. This ensures that the income and loss of the partnership are taken into account by its partners only once. In addition, as provided in § 705(a)(1)(B) and (a)(2)(B), adjustments must also be made to reflect certain nontaxable events in the partnership. For example, a partner’s share of nontaxable income (such as exempt income) is added to the basis of the partner’s interest because, without a basis adjustment, the partner could recognize gain with respect to the tax-exempt income, for example, on a sale or redemption of the partner’s interest, and the benefit of the tax-exempt income would be lost to the partner. Similarly, a partner’s share of nondeductible expenditures must be deducted from the partner’s basis in order to prevent that amount from giving rise to a loss to the partner on a sale or a redemption of the partner’s interest in the partnership. See H.R. Rep. No. 1337, 83d Cong., 2d Sess. A225 (1954); S. Rep. No. 1622, 83d Cong., 2d Sess. 384 (1954).

In determining whether a transaction results in exempt income within the meaning of § 705(a)(1)(B), or a nondeductible, noncapital expenditure within the meaning of § 705(a)(2)(B), the proper inquiry is whether the transaction has a permanent effect on the partnership’s basis in its assets, without a corresponding current or future effect on its taxable income. Pursuant to § 703(a)(2)(C), the contribution of X by PRS is not taken into account by PRS in computing its taxable income. Consequently, the contribution results in a permanent decrease in the aggregate basis of the assets of PRS that is not taken into account by PRS in determining its taxable income and will not be taken into account for federal income tax purposes in any other manner. Therefore, for purposes of § 705(a)(2)(B), the contribution of X, and the resulting

permanent decrease in partnership basis, is an expenditure of the partnership not deductible in computing its taxable income and not properly chargeable to capital account. Cf. § 1.701–2(f), Example 2 (requiring adjustments under § 705(a)(2)(B) for reductions in the basis of stock held by a partnership following an extraordinary dividend under § 1059).

Reducing the partners’ bases in their partnership interests by their respective shares of the permanent decrease in the partnership’s basis in its assets preserves the intended benefit of providing a deduction (in circumstances not under § 170(e)) for the fair market value of appreciated property without recognition of the appreciation. By contrast, reducing the partners’ bases in their partnership interests by the fair market value of the contributed property would subsequently cause the partners to recognize gain (or a reduced loss), for example, upon a disposition of their partnership interests, attributable to the unrecognized appreciation in X at the time of this contribution.

Under the PRS agreement, partnership items are allocated equally between A and B . Accordingly, the basis of A ’s and B ’s interests in PRS is each decreased by $30 x .

HOLDING

If a partnership makes a charitable contribution of property, the basis of each partner’s interest in the partnership is decreased (but not below zero) by the partner’s share of the partnership’s basis in the property contributed.

DRAFTING INFORMATION

The principal author of this revenue ruling is Terri A. Belanger of the Office of Assistant Chief Counsel (Passthroughs and Special Industries). For further information regarding this revenue ruling contact Ms. Belanger at (202) 622-3080 (not a toll-free call).

Section 707.—Transactions between Partner and Partnership.

26 CFR 1.707–1: Transactions between partner and partnership.

If loss on the sale of partnership property is disallowed under § 707(b)(1) of the Internal Revenue Code, are the partners’ bases in their

partnership interests decreased to reflect the disallowed loss? See Rev. Rul 96–10, page 00.

Section 3406.—Backup Withholding

26 CFR 31.3406–0: Outline of the backup withholding regulations.

T.D. 8637

DEPARTMENT OF THE TREASURY Internal Revenue Service 26 CFR Parts 1, 31, 35a, 301, and 602

Backup Withholding, Statement Mailing Requirements, and Due Diligence

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final and temporary regulations.

SUMMARY: This document provides final rules on backup withholding under sections 3406(a)(1)(A), (C), and (D) of the Internal Revenue Code of 1986 (Code) when a payee fails to provide a taxpayer identification number in the required manner to a person required to make an information return, when a payee is subject to notified payee underreporting, or when a payee fails to certify, under penalties of perjury, that the payee is not subject to backup withholding due to notified payee underreporting.

This document also provides final rules on the manner for providing a statement to a payee under sections 6042(c), 6044(e), 6049(c), and 6050N(b) of the Code. This document also contains temporary regulations on the effective date of §§35a.9999–1 through 35a.9999–5, Temporary Employment Tax Regulations under the Interest and Dividend Tax Compliance Act of 1983. The text of these temporary regulations also serves as the text of the proposed regulations set forth in the notice of proposed rulemaking on this subject in *** [IA–33–95, page 00, this Bulletin].

DATES: These regulations are effective December 21, 1995. These regulations are applicable to transactions occurring after December 31, 1996.

FOR FURTHER INFORMATION CONTACT: Renay France of the Of

fice of Assistant Chief Counsel (Income Tax and Accounting) with respect to domestic transactions, 202-622-4910 (not a toll-free number); and Teresa Burridge Hughes of the Office of Assistant Chief Counsel (International) with respect to international transactions, 202-622-3880 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

The collection of information contained in this final regulation has been reviewed and approved by the Office of Management and Budget in accordance with the requirements of the Paperwork Reduction Act (44 U.S.C. 3507) under control number 1545–0112. Responses to this collection of information are mandatory.

An agency may not conduct or sponsor, and a person is not required to respond to, a collection of information unless the collection of information displays a valid control number.

The estimated annual burden per respondent/recordkeeper is approximately 1 hour, depending on individual circumstances.

Comments concerning the accuracy of this burden estimate and suggestions for reducing this burden should be directed to the Internal Revenue Service, Attn: IRS Reports Clearance Officer, PC:FP, Washington, D.C. 20224, and to the Office of Management and Budget, Attention: Desk Officer for the Department of the Treasury, Office of Information and Regulatory Affairs, Washington, D.C. 20503.

Background

On October 4, 1983, the Federal Register published Temporary Employment Tax Regulations under the Interest and Dividend Tax Compliance Act of 1983 (26 CFR part 35a) under sections 3406 and 6676(b) of the Internal Revenue Code of 1954 (26 CFR part 35a.9999–1; TD 7916 (48 FR

45362), as amended on November 25, 1983, by TD 7922 (48 FR 53111), on November 23, 1987, by TD 8163 (52 FR 44861), and on April 11, 1989, by TD 8248 (54 FR 14341). Additional temporary regulations were published in the Federal Register on November 25, 1983 (26 CFR part 35a.9999–2; TD 7922 (48 FR 53106), as amended on December 20, 1983, by TD 7929 (48 FR 56342), on March 13, 1984, by TD 7922 (49 FR 9417), on November 23, 1987, by TD 8163, and on April 11, 1989, by TD 8248 (54 FR 14341)), on December 20, 1983 (26 CFR part 35a.9999–3; TD 7929 (48 FR 56332), as amended on January 3, 1984, by TD 7933 (49 FR 63), on August 22, 1984, by TD 7966 (49 FR 33236), on November 23, 1987, by TD 8163 (52 FR 44861), and on April 11, 1989, by TD 8248 (54 FR 14341)), on February 28, 1984 (26 CFR part 35a.9999–3A; TD 7946 (49 FR 7227)), on August 22, 1984 (26 CFR part 35a.9999–4T, TD 7966 (49 FR 33237), as amended on August 29, 1984, by TD 7972 (49 FR 34340); and 26 CFR part 35a.9999–5, TD 7967 (49 FR 33240), as amended on September 19, 1984, by TD 7973 (49 FR 36645), on August 20, 1985, by TD 8046 (50 FR 33526), on April 3, 1986, by TD 8046 (51 FR 11447), on December 19, 1986, by TD 8110 (51 FR 45453), and on May 19, 1988, by TD 8202 (53 FR 17927)), on April 23, 1987 (26 CFR part 35a.3406–2; TD 8137 (52 FR 13430)), and on November 23, 1987 (26 CFR part 35a.3406–1; TD 8163 (52 FR 44861), as amended on April 11, 1989, by TD 8248 (54 FR 14341). Those regulations were published primarily to provide guidance under the Interest and Dividend Tax Compliance Act of 1983.

Proposed regulations on backup withholding, the statement mailing requirements, and due diligence were published in the Federal Register on September 27, 1990, 55 FR 39427. Those regulations were proposed under regulations file number IA–224–82 and RIN 1545–AE20, which numbers were closed in error. These final regulations are issued under regulations file number IA–31–95 and RIN 1545–AT76.

A public hearing on the proposed regulations was held on March 4, 1991. The public submitted written comments on the proposed regulations. After consideration of those comments, the proposed regulations are adopted as revised by this Treasury decision.

Explanation of Provisions

I. Overview .

The proposed regulations contain rules on the requirement to backup withhold, which section 3406 imposes in four situations. First, backup withholding under section 3406(a)(1)(A) applies if a payee fails to provide a taxpayer identification number (TIN) in the required manner (the A trigger or certification). Second, backup withholding under section 3406(a)(1)(B) applies if the Service or a broker notifies a payor that a payee provided an incorrect TIN (the B trigger). Third, backup withholding under section 3406(a)(1)(C) applies if the Service or a broker notifies a payor that a payee is subject to notified payee underreporting, i.e., the payee has failed to report and pay tax on reportable interest and dividends (the C trigger). Fourth, backup withholding under section 3406(a)(1)(D) applies if a payee fails to certify, when required, that the payee is not subject to backup withholding under section 3406(a)(1)(C) (the D trigger). Because the IRS published final regulations on the B trigger as a separate project (TD 8409) in 1992, the final regulations in this document address only the other three triggers, sections 3406(a)(1)(A), (C), and (D). The final regulations on these triggers considerably shorten as well as simplify the proposed regulations. In addition, the final regulations contain several modifications to the proposed regulations relating to grantor trusts, S corporations, reportable payments, and certain foreign provisions.

II. Changes regarding grantor trusts,

S corporations, reportable payments, and certain foreign provisions .

A. Grantor trusts—proposed §31.3406(a)–2 . The proposed regulations provide that a grantor trust with ten or fewer grantors is not a payor under section 3406 and, as a result, has no obligation to withhold under section 3406 on reportable payments flowing through the trust and includible in the gross income of its grantors. However, a grantor trust with eleven or more grantors is a payor and must withhold under section 3406 on reportable payments to its grantors who are subject to such withholding.

the payee certifies that the payee is not subject to the C trigger, but only if the payor discovers while processing the Form W–9 or administering the account that the Form W–9 is false because the IRS previously notified the payor to withhold on the payee under the C trigger. Commentators argued that this discovery standard was unclear and potentially burdensome. As a result, the final regulations clarify when a payor may not rely on a Form W–9 provided by the payee.

Under the final regulations, a payor has knowledge that a payee opening a new account with the payor is subject to withholding under section 3406(a)(1)(C), and thus must commence backup withholding on reportable interest and dividend payments to the new account, only if (1) the employee or individual agent of the payor receiving the Form W–9 knows at the time the payee opens the account that the payee’s statement under section 3406(a)(1)(D) is not true; (2) at the time the payor processes the Form W–9 or in administering the account to which it relates, the payor discovers that the payee is currently subject to withholding under section 3406(a)(1)(C) on a pre-existing account with the payor; (3) the payor uses a single Form W–9 for multiple accounts of the payee; or (4) the payor uses a universal identifier to associate all of the payee’s accounts with the payor and other accounts under that universal identifier have been identified as subject to withholding under section 3406(a)(1)(C). See §31.3406(c)–1(c)(3)(iii).

C. Including certain dates in the notice that the payor must send to a payee—proposed §31.3406(c)–1(c)(2)- (ii) and (iii) . A commentator objected to the proposed rule requiring a payor to include the following dates in the notice informing a payee that backup withholding for the C trigger has begun or will begin: (1) the last date before the payor must commence backup withholding, and (2) the date the payor received the notice from the IRS. The significant date for the payee is the date backup withholding begins on the payee’s account. Therefore, to ease payors’ administrative costs, the final regulations require the payor to include only the date the payor started (or plans to start) backup withholding in the notice to the payee. See §31.3406(c)–1(d)(2)(iii).

D. Monitoring accounts subject to withholding—proposed §31.3406(c)–1-

Recently, the IRS issued proposed regulations under section 671 on the methods of reporting by grantor trusts. These proposed regulations provide two regimes for reporting, one for a grantor trust that is owned (or treated as owned) by one grantor and another for a grantor trust that is owned by two or more grantors. To avoid confusion and thereby promote simplification, the final backup withholding regulations are conformed to these regimes. Accordingly, under these final regulations a grantor trust with two or more grantors is considered a payor and must withhold on payments to its grantors who are subject to backup withholding. For purposes of determining the number of grantors, a husband and wife filing a joint return are considered one grantor. See §31.3406(a)–2(b)(4).

B. S corporations—proposed §31.3406(a)–2(c)(3) . Under an exception in the proposed regulations defining payors, a partnership making a payment of a distributive share to a partner is not considered a payor. The exception does not include S corporations. Because the tax treatment of both entities is similar, the final regulations provide that an S corporation making a similar distribution is not a payor under section 3406. See §31.3406(a)–2(c)(3).

C. Transferred short-term obliga- tions—proposed §31.3406(b)(2)–2 . The proposed regulations provide that a subsequent holder of a short-term obligation with original issue discount may establish the purchase price at which the subsequent holder purchased the obligation. That purchase price is then treated as the original issue price for purposes of computing the amount of original issue discount subject to backup withholding. To reduce the paperwork of issuers and payors of these obligations, the final regulations provide that a payor may disregard the subsequent holder’s purchase price if the payor’s computer or recordkeeping system is not able to accept that price without substantial manual intervention. See §31.3406(b)(2)–2(c)(1)(ii).

D. Foreign provisions . The proposed regulations contained several provisions on international transactions that are not included in the final regulations. For those international provisions relating to section 3406, the temporary regulations under §35a.9999 remain in effect.

III. The C trigger (payee

underreporting) .

A. Identifying the account subject to the C trigger—proposed §31.3406(c)– 1(b)(3)(i) and (iv) . The proposed regulations provide that a payor must withhold under section 3406(a)(1)(C) on reportable interest or dividend payments to all existing accounts of a payee that the payor can identify exercising reasonable care. Commentators suggested several modifications to or clarifications of the reasonable care standard. For example, some commentators suggested that the procedures for locating and identifying an account of a payee subject to the C trigger should more closely resemble the procedures for identifying an account subject to the B trigger. In response to this comment, the final regulations modify the procedures for identifying accounts subject to the C trigger, and thus require a payor to identify those accounts by identifying accounts with the same TIN as the one provided in the notice from the IRS to the payor that advises the payor to commence withholding on accounts of a payee.

Commentators also informed the IRS that some computer systems use a universal account number that retrieves all accounts of a payee with that payor. In light of this information, the final regulations require payors with such systems to identify all accounts that can be so retrieved.

Some commentators also addressed the requirement under the proposed regulations that a payor search for accounts of a payee on the computer or other recordkeeping system for the region, division, or branch that serves the geographic area in which the payee’s mailing address is located. These commentators questioned whether payors must search every such computer or record system. The final regulations clarify that a payor need not search a computer or other recordkeeping system if it is highly unlikely that the system contains an account of the payee that should be identified as one subject to the C trigger. See §31.3406(c)–1(c)(3)(ii).

B. Newly opened accounts—pro- posed §31.3406(c)–1(b)(3)(ii) . Under the proposed regulations, if a payee subject to the C trigger has one account with a payor and subsequently opens another account, the payor may not rely on the subsequent Form W–9 on which

(e) . Commentators asked the IRS to address how long a payor must monitor an account identified as one subject to the C trigger, if that account later becomes dormant. The final regulations provide that a payor is not required to backup withhold on dormant accounts. In this connection, backup withholding terminates no later than the close of the third calendar year ending after the later of (1) the date that the payor pays the last reportable payment to that account, or (2) the date that the payor received a notice from the IRS to impose the C trigger on that account. See §31.3406(c)–1(e)(3).

IV. Special rules for acquiring

accounts (including a readily tradable instrument) or selling a readily tradable instrument .

A. By electronic transmission—pro- posed §31.3406(d)–3 . A payee can acquire by electronic transmission an account or an instrument that earns reportable interest or dividends. Under the proposed regulations the payor, at its option, may permit a payee to furnish the certifications relating to the A and D triggers within 30 days after the establishment or acquisition of the account or the instrument (30-day period) by electronic transmission, provided that the payee furnishes the payee’s TIN at the time of the establishment or the acquisition. However, if the payee makes any withdrawal within the 30-day period and before the payor receives the payee’s certifications, the payor must withhold to the extent of any reportable interest or dividends paid to the payee during the 30-day period and at the time of withdrawal.

The proposed regulations provide comparable rules for the sale of a readily tradable instrument by electronic transmission. In this context, the payee is permitted to withdraw (or reinvest) up to 69 percent of the gross proceeds from the sale during the relevant 30-day period.

Commentators requested that backup withholding be applied in the same manner whether the electronic transmission involves the establishment or acquisition of an account or a readily tradable instrument or the sale of a readily tradable instrument. In response to this comment, the final regulations provide that backup withholding applies if the payee withdraws more than

69 percent of the reportable interest or dividends paid to the payee during the relevant 30-day period and at the time of withdrawal, but only if the payor has not received the payee’s certifications relating to the A and D triggers at the time of the withdrawal. See §31.3406(d)–3(a).

B. By mail—proposed §31.3406(d)– 3(a)(1) . The proposed regulations provide that a payee may provide the certifications relating to the A and D triggers within 30 days after a payee establishes or acquires a readily tradable instrument by mail before January 1, 1985, provided the payee furnishes the payee’s TIN upon the establishment or acquisition. The proposed regulations do not provide a similar rule for the sale of a readily tradable instrument by mail.

To simplify the procedures for entering into investments which do not occur in person, the final regulations provide a 30-day rule for the establishment or acquisition of an account or readily tradable instrument by mail and extend the 30-day rule to the sale of a readily tradable instrument by mail. Under the final regulations, if the payee furnishes the payee’s TIN before the transaction, backup withholding applies during the 30-day period only if the payee withdraws more than 69 percent of the reportable payment and if the payor has not received the payee’s certifications relating to the A or D triggers, whichever applies, at the time of the withdrawal. See §31.3406(d)– 3(a). V. Section 3406 confidentiality issues—proposed §31.3406(f)–1(a) . Section 3406(f) provides that a payor may not use information obtained under section 3406 except for meeting a requirement of that section. Commentators requested clarification on what actions a payor or broker may take, consistent with section 3406(f), in response to a payee’s failure to provide the payee’s TIN under section 3406(a)(1)(A). The final regulations provide that a payor who closes an account at or before the end of a calendar year in which the payee opens the account without providing the payee’s TIN or documentation of foreign status, as required, during that year will not, in the absence of evidence to the contrary, be deemed in violation of section 3406(f). Another commentator inquired whether prohibiting a payee from with

drawing funds from the payee’s account is a violation of section 3406(f). The final regulations clarify that refusing to allow a payee to withdraw funds from the payee’s account solely because the payee has not furnished a TIN violates section 3406(f). See §31.3406(f)–1(b)(1).

VI. Exemptions from backup

withholding .

A. Interaction of information report- ing and backup withholding exemp- tions—proposed §31.3406(g)–1(a) . Several commentators questioned the interaction between the rules exempting payees from information reporting and those exempting payees from backup withholding. The class of recipients exempt from information reporting is larger than the class exempt from backup withholding. The final regulations clarify that the list of the payees that are specifically exempt from backup withholding is not exclusive and that other payees that are exempt from information reporting also are exempt from backup withholding. See §31.3406(g)–1(a)(2).

B. Interest on certain life-insurance contracts—proposed §31.3406(g)–1(a)- (4) . Commentators requested that the temporary exemption from backup withholding for interest payments made before January 1, 1992, on ‘‘advance premiums’’, ‘‘prepaid premiums’’, or ‘‘premium deposit funds’’, on certain insurance policies be made permanent. The final regulations provide an extension through December 31, 1996.

C. Payments reportable under sec- tion 6047—proposed §31.3406(g)–2(c)- (1) and (2) . Commentators noted that, contrary to the position set forth in the proposed regulations, backup withholding does not apply to designated distributions paid after December 31, 1984. The final regulations clarify that backup withholding does not apply to those payments. See §31.3406(g)–2(d).

D. Awaiting-TIN certificate—pro- posed §31.3406(g)–3 . Commentators requested simplification of the backup withholding rules applicable to accounts for which a payor has received an awaiting-TIN certification. One suggestion was that backup withholding should not apply during the period (up to 60 days) that the payee is waiting for the payee’s TIN if no more than 69 percent of the reportable payment is withdrawn during the 60-day period.

The final regulations adopt this suggestion. Therefore, backup withholding is deferred during the 60-day period unless the payee makes a withdrawal (of more than $500 in one transaction) during that time or has failed to provide the certification relating to the D trigger. If the payee makes a withdrawal of more than $500 in one transaction during the 60-day period, backup withholding applies to the extent of any reportable interest or dividends made to the account during the 60-day period and at the time of withdrawal unless the payee reserves 31 percent of all reportable payments made to the account during that period. Payors may elect, however, to impose withholding during the 60-day period. See §31.3406(g)–3(a)(2) and (3).

Commentators requested clarification of the interaction of the awaiting-TIN rules for post-1983 accounts or instruments and the obligation of the payee to provide the certification relating to the D trigger that the payee is not subject to backup withholding due to the C trigger. The final regulations clarify that in spite of the awaiting-TIN certification, backup withholding applies under section 3406(a)(1)(D) during the 60-day period if the payee has not provided this certification to the payor. See §31.3406(g)–3(a)(1).

A commentator asked whether the 60-day period refers to calendar or business days. Accordingly, the final regulations clarify that the term ‘‘day’’ means a calendar day. See §§31.3406(g)–3 and 31.3406(h)–1(e).

VII. Other changes .

A. Identifying the person listed on a joint account as the one subject to withholding—proposed §31.3406(h)– 2(a) . Under the proposed regulations, a payor of a reportable payment to a joint account may treat the first person listed on the account (or on the instrument) as the payee subject to information reporting and backup withholding. The final regulations provide that the relevant payee is the one whose name and TIN combination the payor uses for information reporting purposes, whether or not that account or instrument registration lists that payee first. See §31.3406(h)–2(a)(1).

B. Backup withholding on payments made in property—proposed §31.3406- (h)–2(b) . Under the proposed regulations, a payor making a reportable

payment in property subject to backup withholding must withhold on an amount equal to the fair market value of the property. The obligation to withhold occurs at the time the property is paid to the payee. Consequently, the payor must find an alternative source, such as another account of the payee, from which the payor can satisfy its backup withholding liability. Otherwise, the payor must continue to look for accounts of the payee to satisfy the payor’s backup withholding liability. A commentator suggested that the final regulations add an ending date after which a payor no longer has to search for alternative sources from which to satisfy a backup withholding obligation arising from a payment in property. According to this commentator, the obligation should extinguish after a reasonable period of time. In response to this comment, the final regulations provide that a payor’s obligation to backup withhold on property terminates on the earlier of the date sufficient cash is deposited to the account to fully satisfy the obligation or the close of the fourth calendar year after the obligation arose. See §31.3406(h)–2(b)(2)(ii).

C. Gross-up of payments by middle- men—proposed §31.3406(h)–2(d) . Under the proposed regulations, a middleman is required to remit the full amount due a payee unless one of the requirements for imposing backup withholding exists at the time of payment. Thus, the middleman is required to remit the full amount even though an upstream payor erroneously withheld on that payment to the middleman. In that event, the middleman may recover the difference between the amount received and the amount paid to the payee, i.e., 31 percent, by seeking a refund from the upstream payor or by taking an equivalent credit against the next required deposit of employment taxes. One commentator noted that the middleman payor incurs a loss in the time value of money measured from the time it pays the full amount due to the payee to the time the payor receives a refund or credit. Because of this, the commentator suggested that the regulations allow the middleman to remit only the net amount due its payee. This suggestion presents several problems. First, it requires a new reconciliation process to correlate the backup withholding reflected on the upstream payor’s Form 945 with the backup withholding

shown as withheld tax on the payee’s income tax return. Second, the suggestion produces an anomalous result, namely, withholding occurs even though none of the statutory conditions requiring withholding exist. For these reasons the final regulations do not adopt this suggestion.

D. Refund of amount erroneously subject to backup withholding—pro- posed §31.6413(a)–3 . Under the proposed regulations, a payor must refund an amount previously withheld under the C trigger if the IRS instructs the payor to do so. This provision is also set forth in §35a.9999–3 Q/A–38 of the Temporary Employment Tax Regulations issued under the Interest and Dividend Tax Compliance Act of 1983, as amended by TD 8248 (54 FR 18713) on May 2, 1989. One commentator suggested eliminating this refund provision. This rule was needed initially to allow refunds in certain cases where payees had interest or dividend income subject to backup withholding under the C trigger but had no income tax liability on this income. The IRS has subsequently enhanced its C withholding program to eliminate C notices to payors in such cases. Thus, the final regulations adopt the suggestion and delete the proposed rule. See §31.6413(a)–3.

E. Effective date . The final regulations are effective for reportable payments made and transactions occurring after December 31, 1996, and, optionally, for reportable payments made and transactions occurring on or after December 21, 1995. See §31.3406(i)–1.

F. Coordination with the temporary regulations—§§35a.9999–1 through 35a.9999–5 . The temporary regulations issued under 26 CFR Part 35a are not effective for noninternational transactions occurring on and after the effective date of the final regulations. The temporary regulations, however, remain effective for the due diligence safe harbor and for international transactions, including transactions involving a foreign payee, a foreign payor, or a payment from sources without the United States.

G. Statement mailing requirement— proposed §§1.6042–5, 1.6044–6, 1.6049–6, and 1.6050N–1 . These final regulations set forth rules on the manner in which a payor who is required to file an information return for dividends and corporate earnings and profits, patronage dividends, interest,

and royalties under sections 6042(c), 6044(e), 6049(c), and 6050N(b), respectively, must provide a copy of that information return to the payee, i.e., payee statement mailing.

The proposed regulations limit the permissible nontax enclosures includible in a statement mailing. Several commentators requested that the inclusion of additional nontax enclosures be permitted. This suggestion was not adopted because the relevant legislative history indicates that Congress wanted to substantially restrict the nontax enclosures in a statement mailing.

H. Correct identifying number for estates—proposed §301.6109–1 . The final regulations clarify that the taxpayer identification number to be used to identify estates of decedents is the employer identification number (rather than a social security number).

Special Analyses

It has been determined that this Treasury decision is not a significant regulatory action as defined in E.O. 12866. Therefore, a regulatory assessment is not required. It has also been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) and the Regulatory Flexibility Act (5 U.S.C. chapter 6) do not apply to these regulations, and therefore, a Regulatory Flexibility Analysis is not required. Pursuant to section 7805(f) of the Internal Revenue Code, the notice of proposed rulemaking preceding these regulations was submitted to the Small Business Administration for comment on its impact on small business.

Drafting Information

The principal author of these regulations is Renay France of the Office of Assistant Chief Counsel (Income Tax and Accounting), IRS. However, other personnel from the IRS and Treasury Department participated in their development.

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Adoption of Amendments to the Regulations

The amendments to 26 CFR parts 1, 31, 35a, 301, and 602 read as follows:

PART 1—INCOME TAXES

Paragraph 1. The authority for part 1 continues to read in part as follows:

Authority: 26 U.S.C. 7805 * * * Section 1.6049–6 also issued under 6049(a), (b), and (d). * * * Par. 2. Section 1.6042–4 is revised as follows:

§1.6042–4 Statements to recipients of dividend payments .

(a) Requirement . A person required to make an information return under section 6042(a)(1) and §1.6042–2 must furnish a statement to each recipient whose identifying number is required to be shown on the related information return for dividend payments.

(b) Form of the statement . The statement required by paragraph (a) of this section must be either the official Form 1099 prescribed by the Internal Revenue Service for the respective calendar year or an acceptable substitute statement that contains provisions that are substantially similar to those of the official Form 1099 for the respective calendar year. For further guidance on how to prepare an acceptable substitute statement, see Rev. Proc. 95–30 (1995– 27 I.R.B. 9) (or its successor), republished as ‘‘Rules and Specifications for Private Printing of Substitute Forms 1096, 1098, 1099 Series, 5498, and W– 2G.’’ See §601.601(d)(2) of this chapter.

(c) Aggregation of payments . A payor may aggregate on one Form 1099 all payments made to a recipient with respect to each separate account during a calendar year.

(d) Manner of providing statements to recipients —(1) In general . The Form 1099, or acceptable substitute statement, must be provided to the recipient either in person or by first-class mail to the recipient’s last known address in a statement mailing.

(2) Statement mailing requirement . The mailing required under section 6042(c) of a Form 1099 to a payeerecipient must qualify as a statement mailing. A statement mailing must contain the required Form 1099 or acceptable substitute statement (written statement) and must comply with enclosure and envelope restrictions.

(i) Enclosure restrictions . To qualify as a statement mailing, the mailing cannot contain any enclosures except those

listed in this paragraph (d)(2)(i). Moreover, no promotional or advertising material is permitted in the mailing of the written statement. Even a de minimis amount of promotional or advertising material violates the statement mailing requirement. However, a logo on the envelope containing the written statement and on nontax enclosures described in paragraph (d)(2)(i)(A) through (D) of this section does not violate the written statement requirement. The written statement required under section 6042(c) and paragraph (a) of this section may be perforated to a check or to a statement of the recipient-payee’s specific account with the payor described in paragraph (d)(2)(i)(A) or (C) of this section. The enclosure to which the written statement is perforated must contain, in a bold and conspicuous type, the legend: ‘‘Important Tax Return Document Attached.’’ The enclosures permitted in a mailing are limited to—

(A) A check with respect to the account reported on the written statement;

(B) A letter explaining why a check with respect to such account is not enclosed with the written statement (for example, because a dividend has not been declared payable);

(C) A statement of the taxpayerrecipient’s specific account with the payor if payments on such account are reflected on the written statement;

(D) A letter limited to an explanation of the tax consequences of the information set forth on the enclosed written statement;

(E) Payee statements related to other Forms 1099, Form 1098, and Form 5498 (or the account balance on a Form 5498), Forms W–2 and W–2G; and

(F) Any document concerning the solicitation of the Form W–9 or Form W–8.

(ii) Envelope and delivery restric- tions —(A) Envelope restrictions . The outside of the envelope in which the written statement is mailed and each nontax enclosure enclosed in the envelope must contain, in a bold and conspicuous type, the legend: ‘‘Important Tax Return Document Enclosed.’’ For purposes of this paragraph (d)(2)(ii), a nontax enclosure is any item listed in paragraphs (d)(2)(i)(A) through (C) of this section. However, a payor is not required to include the legend on the outside of an envelope

containing only the enclosures in paragraph (d)(2)(i)(D) through (F) of this section.

(B) Delivery restrictions . The requirement to provide the written statement in person or by first-class mail may be satisfied by sending the written statement and any enclosures described in paragraph (d)(2)(i) of this section by intra-office mail, provided that intraoffice mail is used by the payor in sending account activity, balance information, and other correspondence to the payee. If a payor does not personally deliver the written statement ( i.e., the Form 1099 or its acceptable substitute) to the recipient or mail it to the recipient in a statement mailing as described in this paragraph (d), the payor is considered to have failed to mail the statement required under section 6042(c) and will be subject to the penalty under section 6722.

(e) Time for furnishing statements (1) In general . Each statement required by section 6042(c) and this section to be furnished to any person for a calendar year must be furnished to such person after November 30 of the year and on or before January 31 (February 10 in the case of a nominee filing under §1.6042–2(a)(1)(iii)) of the following year, but no statement may be furnished before the final dividend for the calendar year has been paid. However, the statement may be furnished at any time after April 30 if it is furnished with the final dividend for the calendar year.

(2) Extensions of time . For good cause upon written application of the person required to furnish statements under this section, the Director, Martinsburg Computing Center, may grant an extension of time not exceeding 30 days in which to furnish such statements. The application must be addressed to the Director, Martinsburg Computing Center, and must contain a full recital of the reasons for requesting the extension to aid the Director in determining the period of the extension, if any, that will be granted. Such a request in the form of a letter to the Director, Martinsburg Computing Center, signed by the applicant will suffice as an application. The application must be filed on or before the date prescribed in paragraph (e)(1) of this section.

(3) Last day for furnishing state- ment . For provisions relating to the time for performance of an act when

the last day prescribed for performance falls on Saturday, Sunday, or a legal holiday, see section 7503 and §301.7503–1 of this chapter (Regulations on Procedure and Administration).

(f) Penalty . For provisions relating to the penalty for the failure to furnish a statement under this section, see section 6722.

(g) Effective date . This section is effective for payee statements due after December 31, 1995, without regard to extensions. For the substantially similar statement mailing requirements that apply with respect to forms required to be filed after October 22, 1986, and before January 1, 1996, see Rev. Proc. 84–70 (1984–2 C.B. 716) (or successor revenue procedures). See §601.601(d)(2) of this chapter.

Par. 3. Section 1.6044–5 is revised as follows:

§1.6044–5 Statements to recipients of patronage dividends .

(a) Requirement . A person required to make an information return under section 6044(a)(1) and §1.6044–2 must furnish a statement to each recipient whose identifying number is required to be shown on the related information return for patronage dividends paid.

(b) Form, manner, and time for pro- viding statements to recipients . The statement required by paragraph (a) of this section must be either the official Form 1099 prescribed by the Internal Revenue Service for the respective calendar year or an acceptable substitute statement. The rules under §1.6042–4 (relating to statements with respect to dividends) apply comparably in determining the form of an acceptable substitute statement permitted by this section. Those rules also apply for purposes of determining the manner of and time for providing the Form 1099 or its acceptable substitute to a recipient under this section. However, each Form 1099 or acceptable substitute statement required by this section must be furnished on or before January 31 of the following year, but no statement may be furnished before the final payment has been made for the calendar year.

(c) Penalty . For provisions relating to the penalty for the failure to furnish a statement under this section, see section 6722.

(d) Effective date . This section is effective for payee statements due after

December 31, 1995, without regard to extensions. For the substantially similar statement mailing requirements that apply with respect to forms required to be filed after October 22, 1986, and before January 1, 1996, see Rev. Proc. 84–70 (1984–2 C.B. 716) (or successor revenue procedures). See §601.601(d)(2) of this chapter.

Par. 4. Section 1.6049–6 is amended by:

Revising the section heading.
Removing the language ‘‘section 3451’’ and adding ‘‘section 3406’’ in each of the following locations:

a. Paragraph (a), second sentence. b. Paragraph (a), third sentence. c. Paragraph (a), fourth sentence. 3. Removing the language ‘‘section 3451’’ and adding ‘‘section 3406’’ in each of the following locations:

a. Paragraph (b)(1)(ii). b. Paragraph (b)(2)(ii). 4. Adding paragraph (e). 5. Removing the authority citation at the end of the section.

The revision and additions read as follows:

§1.6049–6 Statements to recipients of interest payments and holders of obligations for attributed original issue discount .

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(e) Statements to recipients —(1) Re- quirement . A person required to make an information return under section 6049(a) and §1.6049–4 must furnish a statement to each recipient whose identifying number is required to be shown on the related information return for interest or original issue discount paid or accrued.

(2) Form, manner, and time for pro- viding statements to recipients . The statement required by paragraph (e)(1) of this section must be either the official Form 1099 prescribed by the Internal Revenue Service for the respective calendar year or an acceptable substitute statement. The rules under §1.6042–4 (relating to statements with respect to dividends) apply comparably in determining the form of an acceptable substitute statement permitted by this paragraph (e). Those rules also apply for purposes of determining the manner of and time for providing the Form 1099 or its acceptable substitute to a recipient under paragraph (e)(1) of

this section. However, with respect to original issue discount, the Form 1099 or acceptable substitute statement required by paragraph (e)(1) of this section must show the aggregate amount of original issue discount includible in the gross income by the recipient for the calendar year with respect to the obligation (determined by applying the rules of §1.6049–4(b)(2)), and the amount, serial number, or other identifying number of each obligation with respect to which a return is being made. With respect to interest or original issue discount, the Form 1099 or acceptable substitute statement required by paragraph (e)(1) of this section must be furnished to the recipient on or before January 31 of the year following the calendar year for which the return under section 6049(a)(1) was required to be made.

(3) Penalty . For provisions relating to the penalty for the failure to furnish a statement under this section, see section 6722.

(4) Effective date . This paragraph (e) is effective for payee statements due after December 31, 1995, without regard to extensions. For the substantially similar statement mailing requirements that apply with respect to forms required to be filed after October 22, 1986, and before January 1, 1996, see Rev. Proc. 84–70 (1984–2 C.B. 716) (or successor revenue procedures). See §601.601(d)(2) of this chapter.

Par. 5. Section 1.6050N–1 is added to read as follows:

§1.6050N–1 Statements to recipients of royalties .

(a) Requirement . A person required to make an information return under section 6050N(a) must furnish a statement to each recipient whose name is required to be shown on the related information return for royalties paid.

and time for providing the Form 1099 or its acceptable substitute statement to a recipient under this section.

(c) Penalty . For provisions relating to the penalty for failure to furnish a statement under this section, see section 6722.

(d) Effective date . This section is effective for payee statements due after December 31, 1995, without regard to extensions. For the substantially similar statement mailing requirements that apply with respect to forms required to be filed after October 22, 1986, and before January 1, 1996, see Rev. Proc. 84–70 (1984–2 C.B. 716) (or successor revenue procedures). See §601.601(d)(2) of this chapter.

PART 31—EMPLOYMENT TAXES AND COLLECTION OF INCOME TAX AT SOURCE

Par. 6. The authority for Part 31 is amended by removing the entry for §31.3406(d)–5 and by adding an entry in numerical order to read as follows:

Authority: 26 U.S.C. 7805. * * * Sections 31.3406(a)–1 through 31.3406(i)–1 also issued under 26 U.S.C. 3406(i).

Par. 7. Section 31.3406-0 is revised to read as follows:

§31.3406–0 Outline of the backup withholding regulations .

This section lists paragraphs contained in §§31.3406(a)–1 through 31.3406(i)–1.

§31.3406(a)–1 Backup withholding requirement on reportable payments .

§31.3406(a)–2 Definition of payors obligated to backup withhold .

(a) In general. (b) Middlemen treated as payors. (c) Persons not treated as payors.

withholding and time when backup withholding is imposed with respect to short-term obligations. (c) Transferred short-term obliga

tions with cash payments prior to maturity.

§31.3406(a)–3 Scope and extent of accounts subject to backup withholding .

§31.3406(a)–4 Time when payments are considered to be paid and subject to backup withholding .

(a) Timing.

(1) In general. (2) Special rules for dividends. (b) Amounts reportable under sec

tion 6045. (1) In general. (2) Special rule for interest ac

crued on bonds. (c) Middlemen.

(1) In general. (2) Special rule for common

trust funds. (3) Special rule for certain

grantor trusts.

§31.3406(b)(2)–1 Reportable interest payment .

(a) Interest subject to backup with

holding. (1) In general. (2) Special rule for tax-exempt

interest. (b) Amount subject to backup

withholding. (1) In general. (2) Special rule to adjust for

premature withdrawal penalty.

§31.3406(b)(2)–2 Original issue discount .

(a) Original issue discount subject

to backup withholding. (b) Amount subject to backup

(a) Overview. (b) Conditions that invoke the

backup withholding requirement. (1) Conditions applicable to all

reportable payments. (2) Conditions applicable only

(or not permitted) to establish purchase price. (3) Transferred obligation. (d) Amount subject to backup

tions. (1) Subsequent holder may

establish purchase price. (2) Subsequent holder unable

to reportable interest or dividend payments. (c) Exceptions. (d) Cross references.

withholding and time when backup withholding is imposed with respect to long-term obligations. (1) No cash payments prior to

maturity. (2) Registered long-term obliga

(3) Transferred registered long

(3) Payor identification of ac

term obligations with payments prior to maturity. (e) Bearer long-term obligations.

(1) Payments prior to maturity. (2) Payments at maturity.

§31.3406(b)(3)–2 Reportable barter exchanges and gross proceeds of sales of securities or commodities by brokers .

(a) Transactions subject to backup

withholding. (b) Amount subject to backup

counts of the payee subject to backup withholding due to notified payee underreporting. (d) Notice from payors of backup

§31.3406(b)(2)–3 Window transactions .

withholding due to notified payee underreporting. (1) In general. (2) Procedures. (e) Period during which backup

withholding is required. (1) In general. (2) Stop withholding. (3) Dormant accounts. (f) Notice to payees from the Internal Revenue Service. (1) Notice period. (2) Payee subject to backup

(a) Requirement to backup with

hold. (b) Window transaction defined. (c) Manner of furnishing taxpayer

identification number in the case of a window transaction.

withholding. (1) In general. (2) Forward contracts, including

foreign currency contracts, and regulated futures contracts. (3) Security sales made through

a margin account. (4) Security short sales. (5) Fractional shares.

§31.3406(b)(2)–4 Reportable dividend payment .

§31.3406(b)(3)–3 Reportable payments by certain fishing boat operators .

withholding. (3) Disclosure of names of

payors and brokers. (4) Backup withholding certifi

(a) Dividends subject to backup

cation. (g) Determination by the Internal

withholding. (b) Dividends not subject to back

(a) Payments subject to backup

withholding. (b) Amount subject to backup

up withholding. (c) Amount subject to backup

withholding.

withholding. (1) In general. (2) Reasonable estimate of amount of dividend subject to backup withholding. (3) Reinvested dividends.

backup withholding. (b) Amount subject to backup

§31.3406(b)(3)–4 Reportable payments of royalties .

Revenue Service that backup withholding should not start or should be stopped. (1) In general. (2) Date notice to stop backup

w i t h h o l d i n g w i l l b e provided. (3) Grounds for determination. (4) No underreporting. (5) Correcting any payee under

(a) Royalty payments subject to

§31.3406(b)(2)–5 Reportable patronage dividend payment .

§31.3406(b)(4)–1 Exemption for certain minimal payments .

withholding.

(a) Patronage dividends subject to

reporting. (6) Undue hardship. (7) Bona fide dispute. (h) Payees filing a joint return.

backup withholding. (b) Amount subject to backup

withholding. (1) Failure to provide taxpayer

identification number or notification of incorrect taxpayer identification number. (2) Notified payee underreport

(a) In general. (b) Manner of making the election. (c) How to annualize.

(1) In general. (2) Special aggregation rule for

(1) In general. (2) Exceptions. (i) [Reserved.] (j) Penalties.

reportable interest and dividends. (d) Exception for window transac

§31.3406(d)–1 Manner required for furnishing a taxpayer identification number .

ing or payee certification failure.

tions and original issue discount.

(a) Requirement to backup with

hold. (b) Reportable interest or dividend

§31.3406(b)(3)–1 Reportable payments of rents, commissions, nonemployee compensation, etc.

§31.3406(c)–1 Notified payee underreporting of reportable interest or dividend payments .

(a) Section 6041 and 6041A(a)

payments subject to backup withholding. (b) Amount subject to backup

(a) Overview. (b) Definitions.

(1) Notified payee underreport

withholding. (1) In general. (2) Net commissions. (3) Payments aggregating $600

ing. (2) Payee underreporting. (c) Notice to payors regarding

account. (1) Manner required for fur nishing a taxpayer identification number with respect to a pre-1984 account or instrument. (2) Determination of pre-1984

account or instrument. (3) Manner required for fur

or more for the calendar year.

backup withholding due to notified payee underreporting. (1) In general. (2) Additional requirements for

payors that are also brokers.

nishing a taxpayer identification number with respect to an account or instrument that is not a pre-1984 account.

(4) Special rule with respect to

payee. (c) Payor’s reliance on information

(2) Form of notice by payor to

(5) Notification from the Social

the acquisition of a readily tradable instrument in a transaction between certain parties acting without the assistance of a broker. (c) Brokerage account.

from broker. (1) In general. (2) Amount subject to backup

Security Administration (or the Internal Revenue Service) validating a name/TIN combination. (h) Payors must use newly

provided certified number. (i) Effective date. (j) Examples.

(1) Manner required for fur nishing a taxpayer identification number with respect to a brokerage relationship that is not a post-1983 brokerage account. (2) Manner required for fur

(a) Overview. (b) Definitions and special rules.

withholding.

§31.3406(d)–5 Backup withholding when the Service or a broker notifies the payor to withhold because the payee’s taxpayer identification number is incorrect .

(a) In general. (b) Failure to furnish a taxpayer

§31.3406(e)–1 Period during which backup withholding is required .

nishing a taxpayer identification number with respect to a post-1983 brokerage account. (d) Rents, commissions, non

name/TIN combination. (2) Definition of account. (3) Definition of business day. (4) Certain exceptions. (c) Notice regarding an incorrect

(1) Definition of an incorrect

identification number in the manner required. (1) Start withholding. (2) Stop withholding. (c) Notification of an incorrect

employee compensation, and certain fishing boat operators, etc.—Manner required for furnishing a taxpayer identification number.

name/TIN combination. (1) In general. (2) Additional requirements for

payors that are also brokers. (3) Payor identification of the

taxpayer identification number. (d) Notified payee underreporting. (e) Payee certification failure.

(1) Start withholding. (2) Stop withholding. (f) Rule for determining when the payor receives a taxpayer identification number or certificate from a payee.

§31.3406(d)–2 Payee certification failure .

(a) Requirement to backup with hold. (b) Exceptions.

§31.3406(d)–3 Special 30-day rules for certain reportable payments .

(a) Confidentiality and liability for

violation. (b) Permissible use of information.

(1) In general. (2) Window transactions. (c) Specific restrictions on the use

of information.

§31.3406(f)–1 Confidentiality of information .

(a) Accounts or readily tradable

instruments acquired directly from the payor (including a broker who holds an instrument in street name) by electronic transmission or by mail. (b) Sale of an instrument for a

customer by electronic transmission or by mail. (c) Application to foreign payees.

account or accounts of the payee that have the incorrect taxpayer identification number. (4) Special rule for joint accounts. (5) Date of receipt. (d) Notice from payors of backup

withholding due to an incorrect name/TIN combination. (1) In general. (2) Procedures. (e) Period during which backup

withholding is required due to notification of an incorrect name/TIN combination. (1) In general. (2) Grace periods. (3) Dormant accounts. (f) Manner required for payee to furnish certified taxpayer identification number. (g) Receipt of two notices within

(a) Exempt recipients.

§31.3406(g)–1 Exception for payments to certain payees and certain other payments .

§31.3406(d)–4 Special rules for readily tradable instruments acquired through a broker .

(1) In general. (2) Nonexclusive list. (b) Determination of whether a

§31.3406(g)–2 Exception for reportable payments for which backup withholding is otherwise required .

(a) In general. (b) Payment of wages. (c) Distribution from a pension,

annuity, or other plan of deferred compensation. (d) Gambling winnings.

person is described in paragraph (a)(1) of this section. (c) Prepaid or advance premium

(a) Readily tradable instruments

acquired through post-1983 brokerage accounts with a broker who is not a payor. (1) In general. (2) Additional requirements. (3) Transactions entered into

life-insurance contracts.

through a brokerage account that is not a post-1983 brokerage account. (4) Payor must notify payee. (b) Notices.

(1) Form of notice by broker to

a 3-year period. (1) In general. (2) Notice to payee who has

provided two incorrect name/TIN combinations within 3 calendar years. (3) Period during which backup

withholding is required due to a second notice of an incorrect name/TIN combination within 3 calendar years. (4) Receipt of two notices in

one calendar year.

payor.

(1) In general. (2) Definition of a reportable

gambling winning and determination of amount subject to backup withholding. (3) Special rules. (e) Certain real estate transactions. (f) Certain payments after an acquisition of accounts or instruments. (g) Certain gross proceeds.

(d) Adjustment of prior withhold

rency. [Reserved] (f) Coordination with other sections. (g) Tax liabilities and penalties. (h) To whom payor is liable for

ing by middleman. (e) Conversion of amounts paid in

foreign currency into United States dollars. (1) C o n v e r t i b l e f o r e i g n currency. (2) Nonconvertible foreign cur

§31.3406(g)–3 Exemption while payee is waiting for a taxpayer identification number .

§31.3406(h)–3 Certificates .

amount withheld.

(a) In general.

(1) Backup withholding not re

(a) Prescribed form to furnish in

formation under penalties of perjury. (1) In general. (2) Use of a single or multiple

quired for 60 days. (2) Reserve method. (3) Alternative rule; 7-day grace period. (b) Special rule for readily trad

able instruments. (c) Exceptions.

(1) In general. (2) Special rule for amounts

Forms W–9 for accounts of the same payee. (b) Prescribed form to furnish a

noncertified taxpayer identification number. (c) Forms prepared by payors or

brokers. (1) Substitute forms; in general. (2) Form for exempt recipient. (d) Special rule for brokers. (e) Reasonable reliance on

subject to reporting under section 6045 other than proceeds of redemptions of bearer obligations. (d) Awaiting-TIN certificate. (e) Form for awaiting-TIN certifi

certificate. (1) In general. (2) Circumstances establishing

cate.

§31.3406(h)–1 Definitions .

(a) In general. (b) Taxpayer identification number.

(1) In general. (2) Obviously incorrect number. (c) Broker. (d) Readily tradable instrument. (e) Day. (f) Business day.

§31.3406(h)–2 Special rules .

(1) Accounts or instruments

that are not pre-1984 accounts and brokerage relationships that are post-1983 brokerage accounts. (2) Accounts or instruments

reasonable reliance. (f) Who may sign certificate. (1) In general. (2) N - t i f i e d p a y e e underreporting. (g) Retention of certificates.

31.3406(g)–3, 31.3406(h)–1 through 31.3406(h)–3, and 31.3406(i)–1 are added to read as follows:

§31.3406(a)–1 Backup withholding requirement on reportable payments .

(a) Overview . Under section 3406, a payor must deduct and withhold 31 percent of a reportable payment if a condition for withholding exists. Re- portable payments mean interest and dividend payments (as defined in section 3406(b)(2)) and other reportable payments (as defined in section 3406(b)(3)). The conditions described in paragraph (b)(1) of this section apply to all reportable payments, including reportable interest and dividend payments. The conditions described in paragraph (b)(2) of this section apply only to reportable interest and dividend payments.

(b) Conditions that invoke the back- up withholding requirement —(1) Conditions applicable to all reportable payments . A payor of a reportable payment must deduct and withhold under section 3406 if—

(i) The payee of the reportable payment does not furnish the payee’s taxpayer identification number to the payor, as required in section 3406(a)(1)(A) and §31.3406(d)–1; or

(ii) The Internal Revenue Service or a broker notifies the payor that the taxpayer identification number furnished by its payee for a reportable payment is incorrect, as described in section 3406(a)(1)(B) and §31.3406(d)–5. (2) Conditions applicable only to reportable interest or dividend pay- ments . A payor of a reportable interest or dividend payment must deduct and withhold under section 3406 if—

(i) The Internal Revenue Service or a broker notifies the payor that its payee has underreported interest or dividend income, as described in section 3406(a)(1)(C) and §31.3406(c)–1; or

(ii) The payee fails to certify to the payor or broker that the payee is not subject to withholding due to notified payee underreporting, as described in section 3406(a)(1)(D) and §31.3406(d)– 2. (c) Exceptions . The requirement to withhold does not apply to certain minimal payments as described in §31.3406(b)(4)–1 or to payments exempt from withholding under §§31.3406(g)–1 through 31.3406(g)–3.

(a) Joint accounts.

(1) Relevant name and taxpayer

identification number combination. (2) Optional rule for accounts

that are pre-1984 accounts and brokerage relationships that are not post-1983 brokerage accounts. (h) Cross references.

subject to backup withholdi n g u n d e r s e c t i o n 3406(a)(1)(B) or (C) where the names are switched. (3) Joint foreign payees. (b) Backup withholding from an

alternative source. (1) In general. (2) Exceptions for payments

§31.3406(i)–1 Effective date .

Par. 8. Sections 31.3406(a)–1 through 31.3406(a)–4, 31.3406(b)(2)–1 t h r o u g h 3 1 . 3 4 0 6 ( b ) ( 2 ) – 5, 3 1 . 3 4 0 6 ( b ) ( 3 ) – 1 t h r o u g h 31.3406(b)(3)–4, 31.3406(b)(4)–1, 31.3406(c)–1, 31.3406(d)–1 through 3 1 . 3 4 0 6 ( d ) – 4, 3 1 . 3 4 0 6 ( e ) – 1, 31.3406(f)–1, 31.3406(g)–1 through

made in property. (c) Trusts.

(d) Cross references . For the definition of payor, see §31.3406(a)-2. For the definition of taxpayer identification number, see §31.3406(h)–1(b).

§31.3406(a)–2 Definition of payors obligated to backup withhold .

(a) In general . Payor means any person who is required to make an information return with respect to any reportable payment (as described in section 3406(b)) under section 6041, 6041A(a), 6042, 6044, 6045, 6049, 6050A, or 6050N, including any middleman as described in paragraph (b) of this section.

(b) Middlemen treated as payors . A person who receives or collects a reportable payment on behalf of or for the account of a payee is a middleman and is treated as the payor of the payment. These persons include, but are not limited to—

(1) A custodian of a payee’s account, such as a bank, financial institution, or brokerage firm acting as custodian of an account;

(2) A nominee, including the joint owner of an account or instrument, except if the joint owners are husband and wife or if the payment is actually owned by another person whose name is also shown on the information return filed with respect to the payment;

(3) A broker holding a security (including stock) for a customer in street name;

(4) A grantor trust established after December 31, 1995, all of which is owned by two or more grantors, and for this purpose spouses filing a joint return are considered to be one grantor;

(5) A common trust fund; and (6) A partnership or an S corporation that makes a reportable payment.

(c) Persons not treated as payors . The following persons are not treated as payors for purposes of section 3406 if the person does not have a reporting obligation under the section on information reporting to which the payment relates:

(1) An agent of the payor who is acting on behalf of the payor in making the payment and who has not entered into an agreement with the payor (for further guidance see Rev. Proc. 84–33 (1984–1 C.B. 502), and §601.601(d)(2) of this chapter), such as a bank that acts as a paying agent in making a payment of dividends on behalf of a

corporation (although payments made by the agent are considered to be payments made by the payor, and thus are subject to withholding, reporting, and the depositing requirements pertaining to section 3406 as if they were made by the payor itself, and failure by the agent so to withhold, report, or deposit is considered to be failure by the payor);

(2) A trust (other than a grantor trust as described in paragraph (b)(4) of this section) that files a Form 1041 and furnishes each beneficiary a Form K–1 containing information required to be shown on an information return, including amounts withheld under section 3406; or (3) A partnership making a payment of a distributive share or an S corporation making a similar distribution.

§31.3406(a)–3 Scope and extent of accounts subject to backup withhold- ing . A payor who is required to withhold under §31.3406(a)–1 must withhold—

(a) On the accounts subject to withholding under §31.3406(a)–1(b)(1)(i) or (b)(2)(ii); and

(b) On the accounts subject to withholding under §31.3406(a)–1(b)(1)(ii) or (b)(2)(i), as described under §31.3406(d)–5 (relating to notification of incorrect TIN) or §31.3406(c)–1 (relating to notified payee underreporting), respectively.

§31.3406(a)–4 Time when payments are considered to be paid and subject to backup withholding .

(a) Timing —(1) In general . If backup withholding is required under section 3406 on a reportable payment (as defined in section 3406(b)), the payor must withhold at the time it makes the payment to the payee or to the payee’s account that is subject to withholding. Amounts are considered paid when they are credited to the account of, or made available to, the payee. Amounts are not considered paid solely because they are posted ( e.g., an informational notation on the payee’s passbook) if they are not actually credited to the payee’s account or made available to the payee. See paragraph (c) of this section for the timing of withholding by a middleman.

(2) Special rules for dividends . For purposes of section 3406 and this section—

(i) Record date earlier than payment date . In the case of stock for which the record date is earlier than the payment date, the dividends are considered paid on the payment date.

(ii) Dividends paid in corporate re- organizations . In the case of a corporate reorganization, if a payee is required to exchange stock held in the former corporation for stock in the new corporation before the dividends that have been paid with respect to the stock in the new corporation will be provided to the payee, the dividend is considered paid on the date the payee actually exchanges the stock and receives the dividend.

(b) Amounts reportable under sec- tion 6045 —(1) In general . Notwithstanding paragraph (a) of this section, in the case of a transaction reportable under section 6045 (except in the case of forward contracts (including foreign currency contracts), regulated futures contracts, and security short sales), the obligation to withhold under section 3406 arises on the date the sale is entered on the books of the broker or the date the exchange occurs as provided in §1.6045–1(f)(3) of this chapter. A broker (in its capacity as payor) is not required, however, to satisfy its withholding liability until payment is made. See §31.3406(b)(3)– 2(b)(2) for special rules applicable to forward contracts (including foreign currency contracts), regulated futures contracts, and security short sales.

(2) Special rule for interest accrued on bonds . For purposes of determining the time that interest is considered paid and subject to withholding under section 3406 when bonds are sold between interest payment dates, the portion of the sales price representing interest accrued to the date of sale is considered a portion of a reportable payment of gross proceeds under section 6045 (provided that the accrued interest is not tax-exempt as described in section 103(a), relating to certain governmental obligations), and is not considered to be a payment of interest for purposes of section 6049.

(c) Middlemen —(1) In general . Any middleman (as defined in §31.3406(a)– 2(b)) must withhold under section 3406 at the time the reportable payment is received by or credited to the middleman. If the middleman makes or credits the reportable payment to the payee prior to the middleman’s receipt of the corresponding payment, the middleman may withhold at the time the reportable

payment is made or credited to the payee.

(2) Special rule for common trust funds . A common trust fund (as defined in section 584) must withhold either—

(i) At the time the reportable payment is received by or credited to the common trust fund as provided in paragraph (c)(1) of this section;

(ii) On the date on which the assets of the common trust fund are valued; or

(iii) At the time the common trust fund pays or credits the reportable payment to a participant of the common trust fund.

(3) Special rule for certain grantor trusts . For grantor trusts described in §31.3406(a)–2(b)(4), reportable payments made to the trust are treated as paid by the trust to each grantor, in an amount equal to the distribution made by the trust to each grantor, on the date that the reportable payment is paid to the trust (except for gross proceeds reportable under section 6045). Paragraph (b)(2) of this section applies to a grantor trust making a payment of gross proceeds under section 6045 subject to withholding under section 3406. For purposes of this paragraph (c)(3) a husband and wife filing a joint return are considered to be one grantor.

§31.3406(b)(2)–1 Reportable interest payment .

(a) Interest subject to backup withholding —(1) In general . A payment of a kind, and to a payee, that is required to be reported under section 6049 (relating to returns regarding interest and original issue discount) is a reportable payment for purposes of section 3406, subject to the special rules of §31.3406(b)(2)–2 (relating to original issue discount) and §31.3406(b)(2)–3 (relating to window transactions). See §31.6051–4 for the requirement to furnish a statement to the payee if tax is withheld under section 3406.

(2) Special rule for tax-exempt inter- est . When an issuer is required to make an information return under §1.6049– 4(d)(8) of this chapter because a payee provided a signed written statement on the envelope or shell incorrectly claiming that the interest was exempt from taxation under section 103(a) (as described in §1.6049–5(b)(1)(ii) of this chapter), the issuer is not required to impose withholding under section 3406.

(b) Amount subject to backup with- holding —(1) In general . The amount of interest subject to withholding under section 3406 is the amount subject to reporting under section 6049.

(2) Special rule to adjust for prema- ture withdrawal penalty . Solely for purposes of computing the amount subject to withholding under section 3406, the payor may elect not to withhold from the portion of any interest payment that is not received by the payee because a penalty is in fact imposed for premature withdrawal of funds deposited in a time savings account, certificate of deposit, or similar class of deposit.

§31.3406(b)(2)–2 Original issue discount .

(a) Original issue discount subject to backup withholding . The amount of original issue discount, treated as interest, subject to withholding under section 3406 is the amount subject to reporting under section 6049, but is limited to the amount of cash paid. In addition, if an original issue discount obligation, subject to reporting under section 6045, is sold prior to maturity and with respect to the seller a condition exists for imposing withholding under section 3406 on the gross proceeds, then withholding under §31.3406(b)(3)–2 applies to the gross proceeds of the sale reportable under section 6045, and not to the amount of any original issue discount includible in the gross income of the seller for the calendar year of the sale. See §31.6051–4 for the requirement to furnish a statement to the payee if tax is withheld under section 3406.

(b) Amount subject to backup with- holding and time when backup with- holding is imposed with respect to short-term obligations . In the case of an obligation with a fixed maturity date not exceeding one year from the date of issue (a short-term obligation), withholding under section 3406 applies to any payment of original issue discount on the obligation includible in the gross income of the holder to the extent of the cash amount of the payment. See §1.1273–1 of this chapter to determine the amount of original issue discount on a short-term obligation. See §1.446– 2(e)(1) of this chapter to determine the amount of a payment treated as original issue discount.

establish purchase price —(i) In gen- eral . At maturity of a short-term obligation, a subsequent holder ( i.e., any person who purchased or otherwise obtained the obligation after the obligation was issued to the original holder) may establish the price of the obligation. The price established by the subsequent holder must then be treated as the original issue price for purposes of computing the amount of the original issue discount subject to withholding under section 3406. The price of a short-term obligation may be established by confirmation receipt or other record of a similar type or, if the obligation is redeemed by or through the person from whom the obligation was purchased or otherwise obtained, by the records of the person from whom or through whom the obligation was purchased or otherwise obtained. The subsequent holder is not required to certify under penalties of perjury that the price determined under this paragraph (c)(1)(i) is correct.

(ii) Exception . A payor may elect to disregard the price at which the subsequent holder purchased or otherwise obtained the obligation if the payor’s computer or recordkeeping system on which the details of the obligation are stored is not able to accept that price without significant manual intervention.

(2) Subsequent holder unable (or not permitted) to establish purchase price . If a subsequent holder fails (or is unable, pursuant to paragraph (c)(1)(ii) of this section) to establish the purchase price of the obligation, then the person redeeming the obligation must determine the amount subject to withholding under section 3406 as though the obligation had been purchased by the holder on the date of issue. If the person redeeming the obligation is the issuer of the obligation, then the issuer must determine the amount subject to withholding from its records. If a person other than the issuer of the obligation redeems the obligation and the obligation is listed in Internal Revenue Service Publication 1212, List of Original Issue Discount Obligations, that person must determine the amount subject to withholding by using the issue price indicated in Publication 1212. (3) Transferred obligation . If a short-term obligation is transferred, no part of the purchase price is considered a reportable interest payment under section 6049. Withholding under section 3406 applies, however, to the

of interest with respect to any of the following obligations:

(1) An interest coupon in bearer form that is subject to taxation ( i.e., other than exempt interest described in §1.6049–5(b)(1)(ii) of this chapter);

(2) A United States savings bond; or (3) A discount obligation having a maturity at issue of one year or less, including commercial paper and bankers’ acceptances that are in definitive form ( i.e., evidenced by a paper document other than a confirmation receipt) but not including short-term government obligations (as defined in section 1271(a)(3)(B)).

(c) Manner of furnishing taxpayer identification number in the case of a window transaction . A payee must furnish the payee’s taxpayer identification number to the payor with respect to a window transaction either orally or in writing at the time that the window transaction occurs. See §31.3406(g)– 3(c)(1)(i), which provides that a payee may not claim the payee is awaiting receipt of a taxpayer identification number with respect to a window transaction. The payee is not required to certify, under penalties of perjury, that the taxpayer identification number provided is correct.

§31.3406(b)(2)–4 Reportable dividend payment .

(a) Dividends subject to backup withholding . A payment of a kind, and to a payee, that is required to be reported under section 6042 (relating to returns regarding payments of dividends and corporate earnings and profits) is a reportable payment for purposes of section 3406. See paragraph (b) of this section for certain dividends not subject to withholding under section 3406. See §31.6051–4 for the requirement to furnish a statement to the payee if tax is withheld under section 3406.

(b) Dividends not subject to backup withholding. Except as provided in §31.3406(b)(3)–2 (relating to transactions reportable under section 6045), withholding under section 3406 does not apply to—

(1) Any amount treated as a taxable dividend by reason of section 302 (relating to redemptions of stock), section 304 (relating to redemptions through the use of related corporations), section 306 (relating to disposition of certain stock), section 356

gross proceeds of the sale of the obligation if the transfer is subject to reporting under section 6045 and a condition exists for imposing withholding. For the rules regarding withholding for amounts subject to reporting under section 6045, see §31.3406(b)(3)–2.

(d) Amount subject to backup with- holding and time when backup with- holding is imposed with respect to long-term obligations —(1) No cash payments prior to maturity . In the case of an obligation with a fixed maturity date that is more than one year from the date of issue (a long-term obligation) and with no cash payments prior to maturity, withholding under section 3406 applies at the maturity of the obligation to the amount of original issue discount includible in the gross income of the holder for the calendar year in which the obligation matures. The amount required to be withheld must not exceed the amount of the cash payment.

(2) Registered long-term obligations with cash payments prior to maturity . In the case of a long-term obligation in registered form that provides for cash payments prior to maturity, withholding under section 3406 applies at the time cash payments are made to the sum of the amounts of qualified stated interest and original issue discount includible in the gross income of the holder for the calendar year in which the cash payments are made. The amount required to be withheld at the time of any cash payment, however, must not exceed the amount of the cash payment. If more than one cash payment is made during a calendar year, the tax that is required to be withheld with respect to original issue discount must be allocated among all the expected cash payments in the ratio that each cash payment bears to the total of the expected cash payments.

(3) Transferred registered long-term obligations with payments prior to maturity . In the case of a long-term obligation that is transferred after its issuance from the original holder, the amount subject to withholding under section 3406 with respect to a subsequent holder is the amount of original issue discount includible in the gross income of all holders during the calendar year (without regard to any amount paid by a subsequent holder at the time of transfer). If the person redeeming the obligation at maturity is the issuer of the obligation, the issuer

must determine the amount subject to withholding through its records by treating the holder as if he were the original holder. If a person redeeming the obligation at maturity is a person other than the issuer of the obligation, and the obligation is listed in Internal Revenue Service Publication 1212, List of Original Issue Discount Obligations, the person must determine the amount subject to withholding by using the issue price indicated in Publication 1212. (e) Bearer long-term obligations . In the case of a bearer long-term obligation with cash payments prior to maturity—

(1) Payments prior to maturity . Withholding under section 3406 applies prior to maturity only to the payment of qualified stated interest (and not to any amount of original issue discount) includible in the gross income of the holder for the calendar year.

(2) Payments at maturity . At maturity of the obligation, withholding applies to the sum of any qualified stated interest payment made at maturity and the total amount of original issue discount includible in the gross income of the holder during the calendar year of maturity. The amount required to be withheld at the time of the cash payment, however, must not exceed the amount of the cash payment.

§31.3406(b)(2)–3 Window transactions .

(a) Requirement to backup withhold . Withholding under section 3406 applies to a window transaction (as defined in paragraph (b) of this section) only if the payee does not furnish a taxpayer identification number to the payor in the manner required in paragraph (c) of this section or furnishes an obviously incorrect number as described in §31.3406(h)–1(b)(2). Withholding does not apply to a window transaction even though the Internal Revenue Service notifies the payor of the payee’s incorrect taxpayer identification number under section 3406(a)(1)(B) or of notified payee underreporting under section 3406(a)(1)(C). The payee in a window transaction is not required to certify under penalties of perjury that the payee is not subject to withholding due to notified payee underreporting (as described in §31.3406(d)–2(b)(2)).

(b) Window transaction defined . Window transaction means a payment

ing under paragraph (b)(1) of this section, but only if 50 percent or more of that reportable amount is paid in money. Thus, a payor is required to withhold according to this paragraph (b)(2) on a payment if—

(i) There has been a notified payee underreporting described in section 3406(a)(1)(C) and §31.3406(c)–1 or there has been a payee certification failure described in section 3406(a)(1)(D) and §31.3406(d)–2; (ii) The payor makes a reportable payment subject to reporting under section 6044 to the payee; and

(iii) Fifty percent or more of the payment is in cash or by qualified check.

§31.3406(b)(3)–1 Reportable payments of rents, commissions, nonemployee compensation, etc.

(a) Section 6041 and 6041A(a) pay- ments subject to backup withholding . A payment of a kind, and to a payee, that is required to be reported under section 6041 (relating to information reporting of rents, commissions, nonemployee compensation, etc.) or a payment that is required to be reported under section 6041A(a) (relating to information reporting of payments to nonemployees for services) is a reportable payment for purposes of section 3406. See paragraph (b) of this section for an exception concerning payments aggregating less than $600. See §31.6051–4 for the requirement to furnish a statement to the payee if tax is withheld under section 3406.

(b) Amount subject to backup with- holding —(1) In general . The amount of a payment described in paragraph (a) of this section subject to withholding under section 3406 is the amount subject to reporting under section 6041 or section 6041A(a).

(2) Net commissions . Withholding under section 3406 does not apply to net commissions paid to unincorporated special agents with respect to insurance policies that are subject to reporting under section 6041, provided that no cash is actually paid by the payor to the special agent.

(3) Payments aggregating $600 or more for the calendar year —(i) In general . A payment is a reportable payment under paragraph (a) of this section only if the aggregate amount of the current payment and all previous payments to the payee during the

(relating to receipt of additional consideration in connection with certain reorganizations), or section 1081(e)(2) (relating to certain distributions pursuant to an order of the Securities and Exchange Commission);

(2) Any exempt-interest dividend, as defined in section 852(b)(5)(A), paid by a regulated investment company; or

(3) Any amount paid or treated as paid during a year by a regulated investment company, provided that the payor reasonably estimates, as provided in paragraph (c)(2) of this section, that 95 percent or more of all dividends paid or treated as paid during the year are exempt-interest dividends.

(c) Amount subject to backup with- holding —(1) In general . The amount of a dividend subject to withholding under section 3406 is the amount subject to reporting under section 6042, including any dividend that is reinvested pursuant to a plan under which a shareholder may elect to receive stock as a dividend instead of property. Except as otherwise provided in this paragraph (c), withholding applies to the entire amount of the distribution.

(2) Reasonable estimate of amount of dividend subject to backup withhold- ing . Pursuant to section 6042(b)(3) and §1.6042–3(c) of this chapter, if the payor is unable to determine the portion of a distribution that is a dividend, the entire amount of the distribution must be treated as a dividend for information reporting under section 6042. Hence, withholding applies to the entire amount of the distribution. If a payor is able reasonably to estimate under section 6042 and §1.6042–3(c) of this chapter the portion of a distribution that is not a dividend, however, the payor must not withhold on that portion (which is not considered a dividend). A payor making a payment, all or a portion of which may not be a dividend, may use previous experience to estimate the portion of a distribution that is not a dividend. The payor’s estimate is considered reasonable if—

(i) The estimate does not exceed the proportion of the distributions made by the payor during the most recent calendar year for which a Form 1099 was required to be filed that was not reported by the payor as a dividend; and

(ii) The payor has no reasonable basis to expect that the proportion of the distribution that is not a dividend

will be substantially different for the current year.

(3) Reinvested dividends . In the case of a dividend paid pursuant to a dividend reinvestment plan, withholding under section 3406 applies, pursuant to §31.3406(a)–4(a), at the time and to the amount made available to the shareholder or credited to the shareholder’s account. At the discretion of the payor, withholding under section 3406 need not be applied to any excess of the fair market value of the shares of stock received by the shareholder or credited to the shareholder’s account over the purchase price of the shares (including shares acquired by the shareholder at a discount in connection with the dividend distribution) or to any fee that is paid by the payor in the nature of a broker’s fee for purchase of the stock or service charge for maintenance of the shareholder’s account. The payor must, however, treat any excess amounts and fees on a consistent basis for each calendar year.

§31.3406(b)(2)–5 Reportable patronage dividend payment .

(a) Patronage dividends subject to backup withholding . A payment of a kind, and to a payee, that is required to be reported under section 6044 (relating to returns regarding patronage dividends) is a reportable payment for purposes of section 3406. See §31.6051–4 for the requirement to furnish a statement to the payee if tax is withheld under section 3406.

(b) Amount subject to backup withholding —(1) Failure to provide taxpayer identification number or noti- fication of incorrect taxpayer identi- fication number . For purposes of sections 3406(a)(1)(A) and (B), the amount of a payment described in paragraph (a) of this section that is subject to withholding under section 3406 is the amount subject to reporting under section 6044, but only to the extent the payment is made in money. For purposes of this paragraph (b), money includes cash or a qualified check (as defined in section 1388(c)(4)). (2) Notified payee underreporting or payee certification failure . For purposes of sections 3406(a)(1)(C) and (D), the amount of a payment described in paragraph (a) of this section that is subject to withholding under section 3406 is the amount subject to withhold

calendar year aggregate $600 or more. The amount subject to withholding is the entire amount of the payment that causes the total amount paid to the payee to equal $600 or more and the amount of any subsequent payments made to the payee during the calendar year. This paragraph (b)(3)(i) does not apply to gambling winnings (as provided in §31.3406(g)–2(e)(1)).

(ii) Exceptions —(A) The $600 ag- gregation rule . The $600 aggregation rule of paragraph (b)(3)(i) of this section does not apply if the payor was required to make an information return under section 6041 or 6041A(a) for the preceding calendar year with respect to payments to the payee, or the payor was required to withhold under section 3406 during the preceding calendar year with respect to payments to the payee that were reportable under section 6041 or 6041A(a).

(B) Determination of whether pay- ments aggregate $600 or more . In determining whether payments to a payee aggregate $600 or more during a calendar year for purposes of withholding under section 3406, the payor must aggregate only payments of the same kind made to the same payee. For this purpose, payments are of the same kind if they are of the same type, regardless of whether they are reportable under the same section. However, a payor with different paying departments making reportable payments of the same kind is not required to aggregate payments made by all those departments unless it is the payor’s customary method to aggregate those payments. A payor may, in its discretion, aggregate—

( 1 ) Payments not of the same kind to the same payee, reportable under either section 6041 or 6041A(a); and

( 2 ) Payments reportable under section 6041 with payments reportable under section 6041A(a).

§31.3406(b)(3)–2 Reportable barter exchanges and gross proceeds of sales of securities or commodities by brokers .

(a) Transactions subject to backup withholding . A payment of a kind, and to a payee, that any broker (as defined in section 6045(c) and §1.6045–1(a)(1) of this chapter) or any barter exchange (as defined in section 6045(c) and §1.6045–1(a)(4) of this chapter) is required to report under section 6045 is

a reportable payment for purposes of section 3406. See §31.6051–4 for the requirement to furnish a statement to the payee if tax is withheld under section 3406.

(b) Amount subject to backup with- holding —(1) In general . The amount subject to withholding under section 3406 is the amount subject to reporting under section 6045. The amount subject to withholding with respect to broker reporting is the amount of gross proceeds (as determined under §1.6045–1(d)(5) of this chapter). The amount subject to withholding with respect to barter exchanges is the amount received by any member or client (as determined under §1.6045– 1(f)(4) of this chapter). (2) Forward contracts, including foreign currency contracts, and regu- lated futures contracts —(i) In general . If a customer is subject to withholding under section 3406 with respect to a forward contract (subject to information reporting under §1.6045–1(c)(5) of this chapter), including a foreign currency contract (as defined in section 1256(g)(2)), or a regulated futures contract (as defined in section 1256(g)(1)), or with respect to an account through which those contracts are disposed of or acquired, the broker must withhold on both of the following amounts:

(A) All cash or property withdrawn from the account by the customer during the relevant year; and

(B) The amount of cash in the account available for withdrawal by the customer at the relevant year-end (including both gross proceeds and variation margin).

(ii) Rules concerning withdrawals . A withdrawal includes the use of money (including both gross proceeds and variation margin) or property in the account to purchase any property other than property acquired in connection with the closing of a contract. For this purpose, the acceptance of a warehouse receipt or other taking of delivery to close a contract is in connection with the closing of a contract only if the property acquired is disposed of by the close of the seventh trading day following the trading day that the customer takes delivery under the contract. In addition, making delivery to close a contract is in connection with the closing of a contract only if the broker is able to determine that the property used to close the contract was acquired

no earlier than the seventh trading day prior to the trading day on which delivery is made. Withdrawals do not include repayments of debt incurred in connection with making or taking delivery that meets the requirements of this paragraph (b)(2). Withdrawals also do not include payments of commissions, fees, transfers of cash from the account to another futures account that is subject to this paragraph (b)(2) or cash withdrawals traceable to dispositions of property other than futures (not including profit on the contract separately reportable under §1.6045– 1(c)(5)(i)( b ) of this chapter). (iii) Special rule for forward con- tracts, including foreign currency con- tracts, and regulated futures contracts . The determination of whether the customer is subject to withholding under section 3406 with respect to an account containing forward contracts, including foreign currency contracts, or regulated futures contracts must be made at the time of the cash or property withdrawals or the relevant year-end, whichever is applicable.

(3) Security sales made through a margin account . The amount described in paragraph (a) of this section that is subject to withholding under section 3406 in the case of a security sale made through a margin account (as defined in 12 CFR part 220 (Regulation T)) is the gross proceeds (as defined in §1.6045–1(d)(5) of this chapter) of the sale. The amount required to be withheld with respect to the sale, however, is limited to the amount of cash available for withdrawal by the customer immediately after the settlement of the sale. For this purpose, the amount available for withdrawal by the customer does not include amounts required to satisfy margin maintenance under Regulation T, rules and regulations of the National Association of Securities Dealers and national securities exchanges, and generally applicable self-imposed rules of the margin account carrier.

(4) Security short sales —(i) Amount subject to backup withholding . The amount subject to withholding under section 3406 with respect to a short sale of securities is the gross proceeds (as defined in §1.6045–1(d)(5) of this chapter) of the short sale. At the option of the broker, however, the amount subject to withholding may be the gain upon the closing of the short sale (if any); consequently, the obligation to withhold under section 3406 would be

amount is more than $10, withholding applies even if $10 or less is actually paid to the payee during the calendar year. For purposes of computing the annualized amount, the payor may assume that February always consists of 28 days and that the year always consists of 360 days. For amounts that are deposited with a payor in a new account or certificate between the dates on which the payor customarily pays or credits interest, the payor may assume that the period for which the interest is paid is the payor’s customary period for paying or crediting interest.

(2) Special aggregation rule for re- portable interest and dividends . If a payor maintains records that reflect multiple holdings of one payee and the payor makes an aggregate payment of reportable interest or dividends (as defined in section 3406(b)(2)) with respect to those multiple holdings (such as a dividend check that reflects payment on all stock owned by the payee), the payor must annualize the aggregate payment.

(d) Exception for window transac- tions and original issue discount . A payor is not required to annualize payments made in window transactions (as defined in §31.3406(b)(2)–3(b)) or payments of original issue discount. With respect to a window transaction, however, the payor is required to aggregate all payments made in the same transaction ( e.g., payments made with respect to coupons or obligations presented for payment at the same time as described in §1.6049–4(e)(4) of this chapter).

§31.3406(c)–1 Notified payee underreporting of reportable interest or dividend payments .

(a) Overview . Withholding under section 3406(a)(1)(C) applies to any reportable interest or dividend payment (as defined in section 3406(b)(2)) made with respect to an account of a payee if the Internal Revenue Service or a broker notifies a payor under paragraph (c)(1) or (2) of this section that the payee is subject to withholding due to notified payee underreporting (as defined in paragraph (b)(1) of this section), and the payor is required under paragraph (c)(3) of this section to identify that account. After receiving the notice and identifying accounts, the payor must notify the payee, in accordance with paragraph (d) of this section,

deferred until the closing transaction. A broker may use this alternative method of determining the amount subject to withholding under section 3406 with respect to a short sale only if at the time the short sale is initiated, the broker expects that the amount of gain realized upon the closing of the short sale will be determinable from the broker’s records. If, due to events unforeseen at the time the short sale was initiated, the broker is unable to determine the basis of the property used to close the short sale, the property must be assumed for this purpose to have a basis of zero.

(ii) Time of backup withholding . The determination of whether a short seller is subject to withholding under section 3406 must be made on the date of the initiation or closing, as the case may be, or on the date that the initiation or closing, as the case may be, is entered on the broker’s books and records.

(5) Fractional shares . A broker is not required to withhold under section 3406 with respect to a sale of a fractional share of stock resulting in less than $20 of gross proceeds (as described in §5f.6045–1(c)(3)(ix) of this chapter).

§31.3406(b)(3)–3 Reportable payments by certain fishing boat operators .

(a) Payments subject to backup with- holding . A payment of a kind, and to a payee, that is required to be reported under section 6050A (relating to information reporting by certain fishing boat operators) is a reportable payment for purposes of section 3406. See §31.6051–4 for the requirement to furnish a statement to the payee if tax is withheld under section 3406.

(b) Amount subject to backup with- holding . The amount described in paragraph (a) of this section subject to withholding under section 3406 is the amount subject to reporting under section 6050A, but only to the extent the amount is paid in money and represents a share of the proceeds of the catch.

§31.3406(b)(3)–4 Reportable payments of royalties .

(a) Royalty payments subject to backup withholding . A payment of a kind, and to a payee, that is required to be reported under section 6050N (relating to information reporting of pay

ments of royalties) is a reportable payment for purposes of section 3406. See §31.6051–4 for the requirement to furnish a statement to the payee if tax is withheld under section 3406.

(b) Amount subject to backup with- holding . In general, the amount described in paragraph (a) of this section that is subject to withholding under section 3406 is the amount subject to reporting under section 6050N. However, if the reportable payment is for an oil or gas interest, the amount subject to withholding is the net amount the payee receives ( i.e., the gross proceeds less production-related taxes such as state severance taxes).

§31.3406(b)(4)–1 Exemption for certain minimal payments .

(a) In general . A payor of reportable interest or dividends (as described in section 3406(b)(2)) or of royalties (as described in section 3406(b)(3)(E)) may elect not to withhold from a payment that does not exceed $10 and that on an annualized basis does not exceed $10 (see paragraph (c) of this section). A broker or barter exchange may elect not to withhold on gross proceeds of $10 or less without regard to the annualization requirement. See §31.6051–4 for the requirement to furnish a statement to the payee if tax is withheld under section 3406.

(b) Manner of making the election . The election not to withhold from payments that do not exceed $10 can be made only for payments described in paragraph (a) of this section. The election may be made on a paymentby-payment basis.

(c) How to annualize —(1) In gen- eral . To annualize a reportable interest payment, dividend payment, or royalty payment, a payor must calculate what the amount of the payment would be if it were paid for a 1-year period (instead of the period for which it actually is paid). The annualized amount is determined by dividing the amount of the payment by the number of days in the period for which it is being paid and then multiplying that result by the number of days in the year. If the annualized amount is $10 or less, the payor may elect not to withhold on that payment regardless of whether more than $10 may be or has been paid to the payee in other reportable payments during the calendar year. Conversely, if the annualized

payee underreporting on reportable interest or dividends made with respect to the account.

(3) Payor identification of accounts of the payee subject to backup with- holding due to notified payee under- reporting —(i) In general —(A) Notice from the Internal Revenue Service . If a payor receives a notice from the Internal Revenue Service under paragraph (c)(1) of this section, the payor must identify, exercising reasonable care, all accounts using the same taxpayer identification number for information reporting purposes as the one provided in the notice. The notice may provide, however, that the payor need only identify the account or accounts corresponding to any account number or designation and related taxpayer identification number used for information reporting purposes as that listed on the notice.

(B) Notice from a broker . If a payor receives a notice from a broker under paragraphs (c)(1) and (2) of this section, the payor is not required to identify any account other than the account identified in the notice.

(ii) Exercise of reasonable care . If an account identified pursuant to paragraph (c)(3)(i)(A) of this section contains a customer identifier that can be used to retrieve systemically any other accounts that use the same taxpayer identification number for information reporting purposes, the payor must identify all accounts that can be so retrieved. Otherwise, a payor is considered to exercise reasonable care in identifying accounts subject to withholding under section 3406(a)(1)(C) if the payor searches any computer or other recordkeeping system for the region, division, or branch that serves the geographic area in which the payee’s mailing address is located and that was established (or is maintained) to reflect reportable interest or dividend payments.

(iii) Newly opened accounts . (A) In general, a new account is not subject to withholding under section 3406(a)(1)(C) if the payee provides to the payor a Form W–9 (or other acceptable substitute) on which the payor may reasonably rely (within the meaning of §31.3406(h)–3(e)(2) without regard to §31.3406(h)–3(e)(2)(v)), unless the payor has actual knowledge (within the meaning of paragraph (c)(3)(iii)(B) of this section) that the statements made on the form are not true.

that withholding due to notified payee underreporting has started. Paragraph (e) of this section describes the period for which withholding due to notified payee underreporting is required. Paragraph (f) of this section provides rules concerning notices that the Internal Revenue Service will send to a payee before notifying a payor that the payee is subject to withholding due to notified payee underreporting. Paragraph (g) of this section provides rules that a payee can use to prevent withholding due to notified payee underreporting from starting or to stop it once it has started. Paragraph (h) of this section provides special rules for joint accounts of payees who have filed a joint return. See section 6682 for the penalties that may apply to a payee subject to withholding under section 3406(a)(1)(C).

(b) Definitions —(1) Notified payee underreporting . Notified payee under- reporting means that the Internal Revenue Service has—

(i) Determined that there was a payee underreporting (as defined in paragraph (b)(2) of this section);

(ii) Mailed at least four notices under paragraph (f)(1) of this section to the payee (over a period of at least 120 days) with respect to the underreporting; and

(iii) Assessed any deficiency attributable to the underreporting in the case of any payee who has filed a return.

(2) Payee underreporting —(i) In general . Payee underreporting means that the Internal Revenue Service has determined, for a taxable year, that—

(A) A payee failed to include in the payee’s return of tax under chapter 1 of the Internal Revenue Code for that year any portion of a reportable interest or dividend payment required to be shown on that tax return; or

(B) A payee may be required to file a return for that year and to include a reportable interest or dividend payment in the return, but failed to file the return.

(ii) Payments included in making payee underreporting determination . The determination of whether there is payee underreporting is made by treating as reportable interest or dividend payments, all payments of dividends reported under section 6042, all patronage dividends reported under section 6044, and all interest and original issue discount reported under section 6049, regardless of whether withholding due to notified payee underreporting applies to those payments.

(c) Notice to payors regarding back- up withholding due to notified payee underreporting —(1) In general . If the Internal Revenue Service or a broker notifies a payor that a payee is subject to withholding due to notified payee underreporting, the payor must—

(i) Identify any accounts of the payee under the rules of paragraph (c)(3) of this section; and

(ii) Notify the payee and withhold under section 3406 on reportable interest or dividend payments made with respect to any identified account under the rules of paragraphs (d) and (e) of this section.

(2) Additional requirements for payors that are also brokers —(i) In general . A broker must notify the payor of a readily tradable instrument that the payee of the instrument is subject to withholding due to notified payee underreporting if—

(A) The broker (in its capacity as a payor) receives a notice from the Internal Revenue Service under paragraph (c)(1) of this section that a payee is subject to withholding due to notified payee underreporting and the broker is required to identify an account of the payee under paragraph (c)(3) of this section;

(B) The payee subsequently acquires the instrument from the broker through the same account; and

(C) The acquisition of the instrument occurs after the close of the 30th business day after the date that the broker receives the notice (or on any earlier date that the broker may begin applying this paragraph (c)(2) after receipt of the notice described in paragraph (c)(1) of this section).

(ii) Transfer out of street name . For purposes of this paragraph (c)(2), an acquisition includes a transfer of an instrument out of street name into the name of the registered owner ( i.e., the payee).

(iii) Method of providing notice . A broker must provide the notice required under this paragraph (c)(2) to the payor of the instrument with the transfer instructions for the acquisition. See §31.3406(d)–4(a)(2).

(iv) Termination of obligation to provide information . The obligation of a broker to provide notice to payors under this paragraph (c)(2) terminates simultaneously with the termination of the broker’s obligation to withhold (in its capacity as payor) due to notified

(B) For purposes of paragraph (c)(3)(iii)(A) of this section, a payor is considered to have actual knowledge that a payee’s statement that the payee is not subject to withholding under section 3406(a)(1)(C) is not true if—

( 1 ) The employee or individual agent of the payor who receives the payee’s certification knows that the statement is not true;

( 2 ) In conducting the investigation, if any, required by paragraph (c)(3)(iii)(C) of this section, the payor identifies any other accounts of the payee that are already subject to w i t h h o l d i n g u n d e r s e c t i o n 3406(a)(1)(C); or ( 3 ) In the course of processing the certification or in administering an account to which a certification relates, the payor discovers that the payor was previously notified by the Internal Revenue Service that the payee is subject to withholding under section 3406(a)(1)(C) and no notice was received to stop withholding pursuant to section 3406(c)(3) prior to the time of the discovery.

(C) Except as provided in this paragraph (c)(3)(iii)(C), a payor is not required to investigate whether the statements made on the Form W–9 described in paragraph (c)(3)(iii)(A) of this section are true. If, however, in opening a new account, the payor relies on the same Form W–9 (or appropriate substitute) that it relied on previously in opening another account, the payor must investigate whether any such existing account is subject to withholding under section 3406(a)(1)(C). Similarly, if the payor utilizes a universal account system described in the first sentence of paragraph (c)(3)(ii) of this section, and in opening a new account the payor searches its records to determine whether the new account should be identified under an existing identifier (because the payee has existing accounts with the payor), the payor must investigate whether any existing accounts identified with the same identifier are subject to withholding under section 3406(a)(1)(C).

(d) Notice from payors of backup withholding due to notified payee underreporting —(1) In general . If a payor receives notice from the Internal Revenue Service or a broker under paragraph (c)(1) of this section and is required to identify an account under paragraph (c)(3) of this section as an account of the payee, the payor must

notify the payee in accordance with paragraph (d)(2) of this section that withholding due to notified payee underreporting has started.

(2) Procedures . The payor must send the notice required by paragraph (d)(1) of this section to the payee no later than 15 days after the date that the payor makes the first payment subject to withholding due to notified payee underreporting. The payor must send the notice by first-class mail to the payee at the payee’s last known address. The notice to the payee required by paragraph (d)(1) of this section must state—

(i) That the Internal Revenue Service has given notice that the payee has underreported reportable interest or dividends;

(ii) That, as a result of the underreporting, the payor is required under section 3406(a)(1)(C) of the Internal Revenue Code to withhold 31 percent of reportable interest or dividend payments made to the payee;

(iii) The date that the payor started (or plans to start) withholding due to notified payee underreporting under section 3406(a)(1)(C);

(iv) The account number or numbers that are subject to withholding due to notified payee underreporting;

(v) That the payee must obtain a determination from the Internal Revenue Service in order to stop the withholding due to notified payee underreporting; and

(vi) That while the payee is subject to withholding due to notified payee underreporting, the payee may not certify to a payor making reportable interest or dividend payments (or to a broker acquiring a readily tradable instrument for the payee) that the payee is not subject to withholding due to notified underreporting.

(e) Period during which backup withholding is required - (1) In gen- eral . If a payor receives notice from the Internal Revenue Service or a broker under paragraph (c)(1) of this section, the payor must impose withholding under section 3406(a)(1)(C) on all reportable interest or dividend payments with respect to any account of the payee required to be identified under paragraph (c)(3) of this section made after the close of the 30th business day after the day on which the payor receives that notice and before the stop date (as described in paragraph (e)(2) of this section). A payor may

choose to start withholding under this paragraph (e)(1) at any time during the 30-business-day period described in the preceding sentence.

(2) Stop withholding —(i) When no underreporting exists or undue hard- ship exists —(A) Stop date . In the case of a determination under paragraph (g)(3)(i) or (iii) of this section that no underreporting exists or that an undue hardship exists, the stop date is the day that is 30 days after the earlier of—

( 1 ) The date on which the payor receives written notification from the Internal Revenue Service under paragraph (g) of this section that withholding is to stop; or

( 2 ) The date on which the payor receives a copy of the written certification provided to the payee by the Internal Revenue Service under paragraph (g) of this section that withholding is to stop.

(B) Acceleration of stop date . A payor may choose to stop withholding at any time during the 30-day period described in paragraph (e)(2)(i)(A) of this section.

(ii) When underreporting is cor- rected or bona fide dispute exists . In the case of a determination under paragraph (g)(3)(ii) or (iv) of this section that the underreporting has been corrected or that a bona fide dispute exists, the stop date occurs on the first day of January (immediately following a period of at least twelve months ending on October 15 of any calendar year in which the determination has been made) or if later, the stop date determined under paragraph (e)(2)(i) of this section.

(3) Dormant accounts . The requirement that a payor withhold under this paragraph (e) on reportable interest or dividend payments made with respect to an account terminates no later than the close of the third calendar year ending after the later of—

(i) The date that the most recent reportable interest or dividend payment was made with respect to that account; or

(ii) The date that the payor received notice under paragraph (c)(1) of this section.

(f) Notice to payees from the Inter- nal Revenue Service —(1) Notice period . After the Internal Revenue Service determines under paragraph (b)(2) of this section that payee underreporting exists, the Internal Revenue

Service will mail to the payee at least four notices over a period of at least 120 days (the notice period) before payors will be notified under paragraph (c)(1) of this section that the payee is subject to withholding due to notified payee underreporting. The notices may be accompanied by, or incorporated in, other notices provided to the payee by the Internal Revenue Service.

(2) Payee subject to backup with- holding . After the Internal Revenue Service provides the notices described in paragraph (f)(1) of this section, the Internal Revenue Service will send notices to payors under paragraph (c)(1) of this section unless—

(i) A payee obtains a determination under paragraph (g) of this section; or

(ii) In the case of a payee who has filed a tax return, the Internal Revenue Service has not assessed the deficiency attributable to the underreporting.

(3) Disclosure of names of payors and brokers . Pursuant to section 3406(c)(5) the Internal Revenue Service may require a payee subject to withholding due to notified payee underreporting to disclose the names of all the payee’s payors of reportable interest or dividend payments and the names of all of the brokers with whom the payee has accounts which may involve reportable interest or dividend payments. To the extent required in the request from the Internal Revenue Service, the payee must also provide the payee’s account numbers and other information necessary to identify the payee’s accounts.

(4) Backup withholding certification . After a payee receives a final notice from the Internal Revenue Service under paragraph (f)(1) of this section, the payee is not permitted to certify to any payor or broker, under penalties of perjury, that the payee is not subject to withholding under section 3406(a)(1)(C), until the payee receives the certification from the Internal Revenue Service under paragraph (g) of this section advising the payee that the payee is no longer subject to withholding under section 3406(a)(1)(C). A final notice will contain the information described in this paragraph (f)(4). See sections 6682 and 7205(b) for civil and criminal penalties for making a false certification.

(g) Determination by the Internal Revenue Service that backup withhold- ing should not start or should be stopped —(1) In general . A payee may

prevent withholding due to notified payee underreporting from starting, or stop the withholding once it has started, by requesting and receiving a determination from the Internal Revenue Service under one or more of the provisions of paragraph (g)(3) of this section. Following its review of a request for a determination under paragraph (g)(3) of this section, the Internal Revenue Service will either make the determination or provide the payee with a written report informing the payee that the request for determination is being denied and the reasons for the denial. If a determination is made during the notice period (as defined in paragraph (f)(1) of this section), the payee is not subject to withholding due to notified payee underreporting with respect to any taxable year for which a determination was made. If a determination is made after the notice period, the Internal Revenue Service will, at the time prescribed in paragraph (g)(2) of this section, provide written certification to a payee that withholding is to stop, and will notify payors who were contacted pursuant to paragraph (c)(1) of this section to stop withholding. A broker who (in its capacity as payor) under this paragraph (g)(1) receives a notice from the Internal Revenue Service or a copy of the certification provided to a payee by the Internal Revenue Service is not required to provide a corresponding notice to any payors whom the broker has previously notified under paragraph (c)(2) of this section.

(2) Date notice to stop backup with- holding will be provided —(i) Under- reporting corrected or bona fide dis- pute . If the Internal Revenue Service makes a determination under paragraph (g)(3)(ii) or (iv) of this section during the 12-month period ending on October 15 of any calendar year (as described in paragraph (e)(2)(ii) of this section), the Internal Revenue Service will provide the certification and the notices described in paragraph (g)(1) of this section no later than December 1 of that calendar year.

(ii) No underreporting or undue hardship . If the Internal Revenue Service makes a determination under paragraph (g)(3)(i) or (iii) of this section, the Internal Revenue Service will provide the notices described in paragraph (g)(1) of this section no later than the 45th day after the day on which the Internal Revenue Service makes its determination.

(3) Grounds for determination . The Internal Revenue Service will make a determination that withholding due to notified payee underreporting should not start or should stop once it has started if the payee—

(i) Shows that there was no payee underreporting (as provided in paragraph (g)(4) of this section) for each taxable year with respect to which the Internal Revenue Service determined under paragraph (b)(2) of this section that there was payee underreporting;

(ii) Corrects any payee underreporting (as provided in paragraph (g)(5) of this section) for each taxable year with respect to which the Internal Revenue Service determined under paragraph (b)(2) of this section that there was payee underreporting;

(iii) Shows that withholding will cause or is causing an undue hardship (as defined in paragraph (g)(6) of this section) and that it is unlikely that the payee will underreport interest or dividend payments again; or

(iv) Shows that a bona fide dispute exists regarding whether any underreporting has occurred (as provided in paragraph (g)(7) of this section) for each taxable year with respect to which the Internal Revenue Service determined under paragraph (b)(2) of this section that there was payee underreporting.

(4) No underreporting . A payee may show that no underreporting of reportable interest or dividends payments exists by presenting—

(i) Receipts or other satisfactory documentation to the Internal Revenue Service showing that all taxes relating to the payments were reported; or

(ii) Evidence showing that the payee did not have to file a return for the taxable year in question ( e.g., because the payee did not make enough income) or that the underreporting determination was based upon a factual, clerical, or other error.

(5) Correcting any payee under- reporting —(i) Before issuance of a statutory notice of deficiency . Before a statutory notice of deficiency is issued to a payee pursuant to section 6212, the payee may correct underreporting—

(A) By filing a return if one was not previously filed and including the unreported interest and dividends thereon;

(B) By filing an amended return in the event a return was filed and

apply to both payees ( i.e., the husband and wife). As a result, both payees are subject to withholding on accounts in their individual names as well as accounts in their joint names. Either or both payees may satisfy the criteria for a determination that no payee underreporting exists, that the underreporting has been corrected, or that a bona fide dispute exists (as provided in paragraph (g)(3)(i), (ii), or (iv) of this section). Both payees, however, must satisfy the criteria for a determination that withholding will cause or is causing undue hardship (as provided in paragraph (g)(3)(iii) of this section).

(2) Exceptions —(i) Innocent spouse . A spouse who files a joint return may obtain a determination that withholding should stop or not start with respect to payments made to his or her individual accounts, if the spouse shows that—

(A) He or she did not underreport income because he or she is a spouse described in section 6013(e), i.e, innocent spouse; or

(B) There is a bona fide dispute regarding whether he or she is an innocent spouse and hence did not underreport income.

(ii) Divorced or legally separated payee . A payee who, at the time of the request for a determination under paragraph (g) of this section, is divorced or separated under state law may obtain a determination that undue hardship exists (or would exist) under paragraph (g)(3)(iii) of this section with respect to reportable interest or dividend payments made to his or her individual accounts if the divorced or legally separated payee satisfies the criteria for a determination under paragraph (g)(6) of this section.

(i) Reserved . (j) Penalties . For the application of penalties related to this section, see sections 6682 and 7205(b).

§31.3406(d)–1 Manner required for furnishing a taxpayer identification number .

(a) Requirement to backup withhold . Withholding under section 3406(a)(1)(A) applies to a reportable payment (as defined in section 3406(b)) if the payee does not furnish the payee’s taxpayer identification number to the payor in the manner required by this section. The period for which withholding is required is described in §31.3406(e)–

including the unreported interest and dividends thereon; or

(C) By consenting to the additional assessment according to applicable notices and forms sent to the payee by the Internal Revenue Service with respect to the underreporting, and paying taxes, penalties, and interest due with respect to any underreported interest or dividend payments.

(ii) After issuance of a statutory notice of deficiency . After a statutory notice of deficiency is issued to a payee—

(A) The payee may correct underreporting at any time, by filing a return if one was not previously filed and paying the entire deficiency and any other taxes including penalties and interest attributable to any payee underreporting of interest or dividend payments; or

(B) The payee may correct underreporting after the mailing of the statutory notice of deficiency but before the expiration of the 90-day or 150-day period described in section 6213(a) or, if a petition is filed with the United States Tax Court, before the decision of the Tax Court is final, by making a remittance to the Internal Revenue Service of the amounts described in paragraph (g)(5)(ii)(A) of this section. The payee must specifically designate in writing that the remittance is a deposit in the nature of a cash bond.

(iii) Special rules . For purposes of paragraph (g)(5)(ii) of this section, the payee will not be deemed to have corrected the payee underreporting under paragraph (g)(5)(ii)(B) of this section after the remittance is returned to the payee in the manner described in any applicable administrative procedure. For further guidance on a deposit in the nature of a cash bond, see subparagraph 2 of section 4.01 of Rev. Proc. 84–58 (1984–2 C.B. 501). (See §601.601(d)(2) of this chapter.) Once the remittance is returned to the payee, the rules of this section will apply. If the Internal Revenue Service previously contacted payors of the payee to start withholding with respect to the notified payee underreporting, however, the Internal Revenue Service will recontact those payors to start withholding under paragraph (c)(1) of this section with respect to the payee underreporting without regard to paragraph (f) of this section.

(6) Undue hardship —(i) In general . A determination of undue hardship will

be based on the overall impact to the payee of having reportable interest or dividend payments withheld at a 31 percent rate under section 3406. In addition, a determination of undue hardship will be made only if the Internal Revenue Service concludes that it is unlikely that any payee underreporting will occur again.

(ii) Factors . Factors that will be considered in determining whether withholding causes undue hardship include, but are not limited to, the following—

(A) Whether estimated tax payments, and other credits for current tax liabilities, or amounts withheld on employee wages or pensions, in addition to withholding under section 3406, would cause significant overwithholding;

(B) The payee’s health, including the payee’s ability to pay foreseeable medical expenses;

(C) The extent of the payee’s reliance on interest and dividend payments to meet necessary living expenses and the existence, if any, of other sources of income;

(D) Whether other income of the payee is limited or fixed ( e.g., social security, pension, and unearned income);

(E) The payee’s ability to sell or liquidate stocks, bonds, bank accounts, trust accounts, or other assets, and the consequences of doing so;

(F) Whether the payee reported and timely paid the most recent year’s tax liability, including interest and dividend income; and

(G) Whether the payee has filed a bankruptcy petition with the United States Bankruptcy Court.

(7) Bona fide dispute . The Internal Revenue Service may make a determination under this paragraph (g)(7) if there is a dispute between the payee and the Internal Revenue Service on a question of fact or law that is material to a determination under paragraph (g)(3)(i) of this section and, based upon all the facts and circumstances, the Internal Revenue Service finds that the dispute is asserted in good faith by the payee and there is a reasonable basis for the payee’s position.

(h) Payees filing a joint return —(1) In general . For purposes of this section, if payee underreporting is found to exist with respect to a joint return, then the provisions of this section

1(b). See §31.3406(d)–3(a) and (b) for special rules when an account is established directly with, or an instrument is acquired directly from, the payor by electronic transmission or by mail, or an instrument is sold through a broker by electronic transmission or by mail. See §31.3406(d)–4 for special rules applicable to readily tradable instruments acquired through a broker. See §31.3406(h)–3(e) for the rules on when a payor may rely on a Form W– 9. See also §31.3406(g)–3 for rules regarding a payee awaiting receipt of a taxpayer identification number. See the applicable information reporting sections and section 6109 and the regulations thereunder to determine whose taxpayer identification number should be provided.

(b) Reportable interest or dividend account —(1) Manner required for fur- nishing a taxpayer identification num- ber with respect to a pre–1984 account or instrument . A payee must furnish the payee’s taxpayer identification number to the payor with respect to any obligation, deposit, certificate, share, membership, contract, investment, account, or other relationship or instrument established or acquired on or before December 31, 1983 (a pre– 1984 account) and with respect to which the payor makes a reportable interest or dividend payment (as defined in section 3406(b)(2)). The manner of determining whether an account or an instrument is a pre–1984 account is described in paragraph (b)(2) of this section. The payee of a pre–1984 account may furnish the payee’s taxpayer identification number to the payor orally or in writing. The payee is not required to certify under penalties of perjury that the taxpayer identification number is correct.

(2) Determination of pre–1984 ac- count or instrument —(i) In general . An account that is in existence before January 1, 1984, will be considered a pre–1984 account, regardless of whether additional deposits are made to the account on or after January 1, 1984. An account established as an expansion of a credit union prime account in existence prior to January 1, 1984, constitutes a pre–1984 account. If funds taken from one account in existence prior to January 1, 1984, are used to create a new account on or after that date, however, the new account does not constitute a pre–1984 account except as provided in the preceding sentence. An instrument ac

quired prior to January 1, 1984, is a pre–1984 account. Regardless of when an instrument was acquired, if it is negotiated in a window transaction as defined in §31.3406(b)(2)–3(b), it is treated as an instrument acquired after December 31, 1983. An obligation in bearer form and subject to reporting under section 6045, whenever acquired, is not a pre–1984 account. Any instrument, whenever acquired, that is held in a brokerage account is considered a pre–1984 account if the brokerage account is not a post–1983 brokerage account (as described in paragraph (c)(1)(ii) of this section). If shares of a corporation are held before January 1, 1984 (or considered held before that date by operation of this paragraph (b)(2)), and additional shares are acquired by the holder, irrespective of whether the shares are received by reason of a stock dividend, investing new cash, or otherwise, the new shares, in the discretion of the payor, may be considered a pre–1984 account. In the case of a qualified employee trust that distributes instruments in kind, any instrument distributed from the trust is considered a pre–1984 account with respect to employees who were participants in the trust before 1984. Similarly, when a payor offers participants in a plan the opportunity to purchase stock of the payor after a specified time, using the money that the payee invested during that period of time, the stock so purchased after December 31, 1983, is considered a pre–1984 account with respect to participants in the plan who either owned shares or invested money in the plan before January 1, 1984. (ii) Account or instrument automat- ically acquired on the maturity or termination of an account . When an account is opened, or an instrument is acquired, automatically on the maturity or termination of an account that was in existence or an instrument that was held before January 1, 1984 (or considered to have been in existence or held before that date by operation of this paragraph (b)(2)(ii)), without the participation of the payee, the new account or instrument, in the discretion of the payor, may be considered a pre–1984 account. For purposes of the preceding sentence, a payee is not considered to have participated in the acquisition of the new account or instrument solely because the payee failed to exercise a right to withdraw funds at the maturity or termination of the old account or instrument.

(iii) Insurance policies . In the case of insurance policies in effect on December 31, 1983, the election of a dividend accumulation option pursuant to which interest is paid (as defined in §1.6049–5(a)(4) of this chapter), or the creation of an account in which proceeds of a policy are held for the policy beneficiary, may, in the payor’s discretion, be treated as a pre–1984 account.

(iv) Acquisitions of accounts and in- struments —(A) Pre–1984 or post–1983 status known . If a payor acquires accounts or instruments of another payor (including through a tax-free reorganization under section 368), the acquiring payor must treat the persons specified in this paragraph (b)(2)(iv)(A) as having the same requirement to furnish a taxpayer identification number in the manner required under this paragraph (b) to the acquiring payor for information reporting, withholding, and related tax provisions as existed with respect to the payor whose accounts or instruments were acquired. Persons specified in this paragraph (b)(2)(iv)(A) are persons who held accounts or instruments in the other payor immediately before the acquisition and who receive an account or instrument in the acquiring payor immediately after the acquisition.

(B) Pre–1984 or post–1983 status unknown . If the acquiring payor, as described in paragraph (b)(2)(iv)(A) of this section, is unable to identify from the business records of the other payor whether any or all of the accounts or instruments of the persons specified in paragraph (b)(2)(iv)(A) of this section are pre–1984 (or post–1983) accounts or instruments, then the acquiring payor may treat these unidentified accounts or instruments as pre–1984 accounts or instruments.

(C) Cross reference . See §31.3406(g)–2(g) for the limited exception from w i t h h o l d i n g u n d e r s e c t i o n 3406(a)(1)(A) on accounts or instruments described in paragraphs (b)(2)(iv)(A) and (B) of this section for which the payor does not have a taxpayer identification number.

(3) Manner required for furnishing a taxpayer identification number with respect to an account or instrument that is not a pre–1984 account . A payee who receives reportable interest or dividend payments (as defined in section 3406(b)(2)) from a payor must certify under penalties of perjury that

the taxpayer identification number the payee furnishes to the payor is the payee’s correct taxpayer identification number. The payee must make the certification only with respect to an account or instrument that is not a pre– 1984 account (as described in paragraph (b)(2) of this section). See §31.3406(h)–3 for a description of the certificate on which the certification must be made. See §31.3406(d)–2 for the requirement that the payee must certify under penalties of perjury that the payee is not subject to withholding due to notified payee underreporting. See §31.3406(d)–3(a) with respect to an account established directly with, or an instrument acquired directly from, the payor by electronic transmission or by mail. See §31.3406(d)–4 for the rules applicable to readily tradable instruments acquired through a broker.

(4) Special rule with respect to the acquisition of a readily tradable instru- ment in a transaction between certain parties acting without the assistance of a broker . If a payee, at any time, acquires a readily tradable instrument without the assistance of a broker, and no party to the acquisition is a broker or an agent of the payor, the payee must furnish the payee’s taxpayer identification number to the payor prior to the time reportable payments are made on the instrument. The payee is not required to certify under penalties of perjury that the number is correct. See §31.3406(d)–2 for the rule that a payee is not subject to withholding due to notified payee underreporting with respect to a readily tradable instrument acquired in the manner described in this paragraph (b)(4). A broker is considered to provide assistance in the acquisition of an instrument if the person effecting the acquisition would be required to make an information return under section 6045 if such person were to sell the instrument. See §31.3406(d)–4 for rules relating to an acquisition of a readily tradable instrument when a broker is involved.

(c) Brokerage account —(1) Manner required for furnishing a taxpayer identification number with respect to a brokerage relationship that is not a post–1983 brokerage account —(i) In general . With respect to any instrument, investment, or deposit made through a brokerage account that is not a post–1983 brokerage account, a payee must furnish the payee’s taxpayer identification number to the broker either orally or in writing. The payee is

not required to certify under penalties of perjury that the taxpayer identification number is correct. See paragraph (b)(2)(i) of this section for the rule that any instrument, whenever acquired, that is held in a brokerage account that is not a post–1983 brokerage account, is considered held in an account that is not a post–1983 brokerage account. For example, in 1983 a payee established and acquired a readily tradable instrument from a brokerage account; no activity took place through that account until the payee purchased a readily tradable instrument in 1995. That readily tradable instrument is not held in a post–1983 brokerage account; therefore, the payee need not certify under penalties of perjury that the payee’s taxpayer identification number is correct.

(ii) Definition of a brokerage ac- count that is not a post–1983 bro- kerage account . A brokerage account that was established by a payee before January 1, 1984, through which during 1983 the broker either bought or sold securities for the payee or held securities on behalf of the payee as a nominee ( i.e., in street name), is an account that is not a post–1983 brokerage account.

(2) Manner required for furnishing a taxpayer identification number with respect to a post–1983 brokerage account —(i) In general . With respect to a post–1983 brokerage account, the payee must furnish the payee’s taxpayer identification number to the broker and certify under penalties of perjury that the taxpayer identification number furnished is correct, except as provided in §31.3406(d)–3(b).

(ii) Definition of a post–1983 bro- kerage account . A brokerage account established after December 31, 1983 (or before January 1, 1984, through which during 1983 the broker neither bought nor sold securities nor held securities on behalf of the payee as a nominee ( i.e., in street name)), is a post–1983 brokerage account.

(d) Rents, commissions, nonemployee compensation, and certain fishing boat operators, etc.—Manner required for furnishing a taxpayer identification number . For accounts, contracts, or relationships subject to information reporting under section 6041 (relating to information reporting at source on rents, royalties, salaries, etc.), section 6041A(a) (relating to information reporting of payments for nonemployee

services), section 6050A (relating to information reporting by certain fishing boat operators), or section 6050N (relating to information reporting of payments of royalties), the payee must furnish the payee’s taxpayer identification number to the payor either orally or in writing. Except as provided in §31.3406(d)–5, the payee is not required to certify under penalties of perjury that the taxpayer identification number is correct regardless of when the account, contract, or relationship is established.

§31.3406(d)–2 Payee certification failure .

(a) Requirement to backup withhold . Withholding under section 3406(a)(1)(D) applies to a reportable interest or dividend payment (as defined in section 3406(b)(2)) if, and only if, the payee fails to certify to the payor, under penalties of perjury, that the payee is not subject to withholding due to notified payee underreporting under section 3406(a)(1)(C). The period for which withholding applies is described in §31.3406(e)–1(e). See §31.3406(d)– 3(a) for special rules when an account is established directly with, or an instrument is acquired directly from, the payor by electronic transmission or by mail. See §31.3406(c)–1(c)(3)(iv) for rules with respect to a payor’s reliance on a payee certification for a new account following notified payee underreporting. See §31.3406(d)–4 for special rules relating to the acquisition of a readily tradable instrument through a broker. The certificate on which the certification should be made is described in §31.3406(h)–3.

(b) Exceptions . Withholding under section 3406(a)(1)(D) and paragraph (a) of this section does not apply to reportable interest or dividend payments (as defined in section 3406(b)(2)) made—

(1) With respect to a pre–1984 account (as defined in §31.3406(d)– 1(b)(1)); (2) In a window transaction (as defined in §31.3406(b)(2)–3(b));

(3) With respect to a readily tradable instrument described in §31.3406(d)– 1(b)(2)(iv) or §31.3406(d)–4(a)(3); or (4) During the period and with respect to an account or readily tradable instrument described in §31.3406(d)–3.

mutual fund). A notice including the information described in paragraph (b)(1) of this section fulfills the broker’s requirement to give notice to the payor. Once the broker transmits the transfer instructions containing the information required by this section, the broker has no further responsibility to obtain a missing taxpayer identification number or missing certification or to provide additional notices to the payee or payor with respect to the acquisition of the instrument. Upon receiving the notice from a broker, the payor must impose withholding on the account pursuant to §31.3406(a)–1.

(3) Transactions entered into through a brokerage account that is not a post– 1983 brokerage account . If a broker acquires readily tradable instruments for a payee through an account (with the broker) that is not a post–1983 brokerage account (as defined in §31.3406(d)–1(c)(1)), and the broker is not the payor of the instruments, the broker must furnish the payee’s taxpayer identification number to the payor. In addition, if the broker has been notified by the Internal Revenue Service that the payee is subject to withholding under section 3406 either because of an incorrect taxpayer identification number or due to notified payee underreporting as described in sections 3406(a)(1)(B) or (C), respectively, the broker must notify the payor of the instrument to impose withholding with respect to that payee and transmit the information in the manner described in this paragraph (a). After a payor receives a notice from a broker pursuant to section 3406(d)(2)(B) and this paragraph (a), the payor must impose withholding on any accounts of the payee paying reportable interest or dividends as defined in section 3406(b)(2) in accordance with §31.3406(a)– 1. (4) Payor must notify payee —(i) Failure to provide certifications . If a payor is notified by a broker, as required in paragraph (a)(1) of this section, that a payee is subject to withholding because the payee failed to provide the certifications, as described in §31.3406(d)–2(a) and §31.3406(d)– 1(b)(3) and (c)(2), and the payor has not received the certifications from the payee, then the payor must notify the payee that withholding has started (or will start) no later than 15 days after the payor makes the first payment to the payee that is subject to withholding under section 3406. A notice that

§31.3406(d)–3 Special 30-day rules for certain reportable payments .

(a) Accounts or readily tradable in- struments acquired directly from the payor (including a broker who holds an instrument in street name) by electronic transmission or by mail . In the case of an account established directly with, or a readily tradable instrument acquired directly from, the payor by means of electronic transmission ( i.e., telephone or wire instruction) or by mail, the payor may permit the payee to furnish the certifications required in §31.3406(d)–1(b)(3) (relating to certification that the payee’s taxpayer identification number is correct) and §31.3406(d)–2 (relating to certification of notified payee underreporting) within 30 days after the establishment or acquisition without subjecting the account to withholding during the 30 days. The preceding sentence applies only if the payee furnishes a taxpayer identification number to the payor at the time of the establishment or acquisition, and the payee does not withdraw more than 69 percent of a reportable interest or dividend payment before the certifications are received within the 30 days. If the payee does not provide the required certifications within 30 days of the establishment or acquisition, the payor must withhold 31 percent of any reportable interest or dividend payments made to the account after its acquisition. For purposes of this section, an account or instrument is considered acquired directly from the payor if the instrument was acquired by the payee without the assistance of a broker or the instrument was acquired directly from a broker who holds the instrument as nominee for the payee ( i.e., in street name) and who is considered a payor under §31.3406(a)–2.

(b) Sale of an instrument for a customer by electronic transmission or by mail . The special 30-day rules set forth in paragraph (a) of this section apply comparably with respect to certification of the taxpayer identification number for the sale of an instrument under section 6045 (as described in §31.3406(b)(3)–2) through a post–1983 brokerage account (as described in §31.3406(d)–1(c)(2)) for a customer by electronic transmission or by mail. However, these rules apply only if the payee furnishes the payee’s taxpayer identification number before the sale occurs. For purposes of applying those 30-day rules under this paragraph (b), a

payee’s reinvestment of the gross proceeds of the sale into other instruments constitutes a withdrawal.

(c) Application to foreign payees . The rules of paragraphs (a) and (b) of this section also apply to a payee from whom the payor is required to obtain a Form W–8 or a substitute of the form or is to obtain other evidence of foreign status (pursuant to the relevant regulations issued under sections 6049 and 6045), provided the payee represents orally or otherwise, before or at the time of the acquisition or sale of the instrument or the establishment of the account, that the payee is not a United States citizen or resident.

§31.3406(d)–4 Special rules for readily tradable instruments acquired through a broker .

(a) Readily tradable instruments ac- quired through post–1983 brokerage accounts with a broker who is not a payor —(1) In general . If a readily tradable instrument is acquired through a post–1983 brokerage account (as defined in §31.3406(d)–1(c)(2)) and the broker is not the payor of the instrument (as defined in §31.3406(a)–2(b)(3)), the broker must—

(i) Obtain once with respect to each account the certifications described in §31.3406(d)–2(a) and §31.3406(d)– 1(b)(3) and (c)(2) from the payee (relating to certification regarding payee underreporting and taxpayer identification number, respectively);

(ii) Furnish the payee’s taxpayer identification number to the payor; and

(iii) Notify the payor to impose withholding if the payee fails to make either of the required certifications to the broker or if the broker has been notified by the Internal Revenue Service before the acquisition of the instrument that the payee is subject to withholding due to notified payee underreporting under section 3406(a)(1)(C) or that the payee is subject to withholding because the payee’s taxpayer identification number is incorrect under section 3406(a)(1)(B) (as described in §31.3406(d)–5).

(2) Additional requirements . The broker must give the information required by paragraphs (a)(1)(ii) and (iii) of this section to the payor with the transfer instructions for the acquisition (including account registration instructions transmitted by a broker in the case of acquisitions of shares in a

contains the information described in paragraph (b)(2) of this section satisfies the payor’s requirement to give notice to the payee. If the broker notifies the payor that the payee failed to make a required certification and the payor has received the certification from the payee, the payor may disregard the notice from the broker.

(ii) Notified payee underreporting and incorrect taxpayer identification number . The payor must notify the payee under this section if the Internal Revenue Service or a broker notifies the payor to withhold either because of an incorrect taxpayer identification number under section 3406(a)(1)(B) (as described in §31.3406(d)–5) or due to notified payee underreporting under section 3406(a)(1)(C) (as described in §31.3406(c)–1). If a payor is notified by the Internal Revenue Service or a broker with respect to a readily tradable instrument, the payor may not ignore the notice even if the payee previously provided the payee’s taxpayer identification number under penalties of perjury to the payor and even if the payee certified to the payor that the payee is not subject to backup withholding due to a notified payee underreporting. See §31.3406(d)– 5(c)(1) and (2) and (f)(2) for notice requirements under section 3406(a)(1)(B) due to an incorrect taxpayer identification number. See §31.3406(c)–1(c)(2) for notice requirements under section 3406(a)(1)(C) due to notified payee underreporting.

(b) Notices —(1) Form of notice by broker to payor . A broker who is required under paragraphs (a)(1)(iii) and (2) of this section to notify the payor with respect to a readily tradable instrument may notify the payor in connection with the transfer instructions by means of magnetic media, machine readable document, or any other medium, provided that the notice includes the following information—

(i) The payee’s name, address, and taxpayer identification number (if provided to the broker); and

(ii) A statement that the payee is subject to withholding under section 3406(a)(1)(A), (B), (C), or (D) of the Internal Revenue Code, whichever section applies; and

(iii) When applicable, a statement that the broker was notified by the Internal Revenue Service that the payee is subject to withholding under sections 3406(a)(1)(B) or (C).

(2) Form of notice by payor to payee . A payor who is required to notify a payee that the payee is subject to withholding must provide notice that is substantially similar to the following—

(i) For a notification concerning a failure to provide a taxpayer identification number in the required manner under section 3406(a)(1)(A) or a failure to make the following certification described in section 3406(a)(1)(D):

Recently, you purchased (identify security acquired). Because of the existence of one or more of the following conditions, payments of interest, dividends, and other reportable amounts that are made to you will be subject to withholding of tax at a 31 percent rate: (specify the condition or conditions, described below, that are applicable)

(1) You failed to provide a taxpayer identification number, or failed to provide this number under penalties of perjury, in connection with the purchase of the acquired security. (An individual’s taxpayer identification number is his or her social security number.)

(2) You failed to certify, under penalties of perjury, that you are not subject to withholding due to notified payee underreporting as required under section 3406(a)(1)(D) of the Internal Revenue Code.

If condition (1) applies, you may stop withholding by providing your taxpayer identification number on the enclosed Form W–9, signing the form, and returning it to us. If you do not have a taxpayer identification number, but have applied (or will soon apply) for one, you may so indicate on the Form W– 9. Withholding may apply during the 60-day period you are waiting for your taxpayer identification number. You must provide us with your taxpayer identification number promptly after you receive it in order to avoid withholding after the end of the 60-day period or to stop withholding if it has already begun. Certain persons, described on the enclosed Form W–9, are exempt from withholding. Follow the instructions on that form if applicable to you.

If condition (2) applies, you may stop withholding by certifying on the enclosed Form W–9 that you are not subject to withholding due to notified payee underreporting, signing the form, and returning it to us.

If more than one condition applies, you must remove all applicable conditions to stop withholding.

Please address any questions concerning this notice to: [Insert payor identifying information].

(Do not address questions to the broker who purchased the securities for you.)

(ii) For the form of the notice concerning imposition of withholding due to an incorrect taxpayer identification number, see §31.3406(d)–5(d)(2) and (g)(2).

(iii) For the form of the notice concerning the imposition of withhold

ing due to notified payee underreporting, see §31.3406(c)–1(d)(2).

(c) Payor’s reliance on information from broker —(1) In general . A payor of an instrument acquired by a payee through a broker may rely on the information that the payor receives from the broker pursuant to paragraphs (a) and (b) of this section.

(2) Amount subject to backup with- holding . The payor is required to withhold under section 3406 depending on the payor’s customary method of making payment on an instrument or instruments owned by a payee. If it is the practice of a payor to combine in one account all readily tradable instruments of the same issue owned by a payee and if only certain of those instruments are subject to withholding, the payor must withhold on the aggregate payment made with respect to all the instruments in the account. Otherwise, the payor must withhold on the payment made on the instrument or instruments with respect to which the payee is subject to withholding.

§31.3406(e)–1 Period during which backup withholding is required .

(a) In general . A payor must withhold under section 3406 at a rate of 31 percent on any reportable payment (as defined in section 3406(b)) made to a payee during the period described in this section (irrespective of the number of conditions for imposing withholding under section 3406 that exist with respect to the payee). A payor must continue to withhold under section 3406 until no condition for imposing backup withholding exists with respect to the payee.

(b) Failure to furnish a taxpayer identification number in the manner required —(1) Start withholding . A payor is required to withhold under section 3406(a)(1)(A) at a rate of 31 percent on any reportable payment (as defined in section 3406(b)) at the time the payor pays the reportable payment (as described in §31.3406(a)–4) to a payee if—

(i) The payor has not received the payee’s taxpayer identification number in the manner required in §31.3406(d)– 1; or (ii) The payor has received notice from a broker (as required in §31.3406(d)–4(a)(1)(iii)) with respect to a readily tradable instrument that the payee did not furnish a taxpayer identification

withholding under section 3406(a)(1)(A). A payor, except as provided in §§31.3406(d)–3 and 31.3406(g)–3, may not prohibit a payee who fails to furnish the payee’s taxpayer identification number in the manner required in §31.3406(d)–1 from withdrawing any funds in the account.

(2) Window transactions . In the case of a window transaction (as defined in §31.3406(b)(2)–3(b)), a payor may, without violating the Internal Revenue Code, refuse to redeem or may refuse to make payment if the payee fails to provide a taxpayer identification number regardless of when the obligation was issued or acquired.

(c) Specific restrictions on the use of information . Except as provided in paragraph (b) of this section, a payor or broker is not permitted to—

(1) Close an account (or instrument) of a payee solely because that payee (or the account of a payee) is subject to withholding under section 3406(a)(1)(A), (B), (C), or (D);

(2) Refuse to open an account or to issue an instrument if the person fails to certify, under penalties of perjury, that the person is not subject to withholding under section 3406(a)(1)(C) (relating to notified payee underreporting);

(3) Use information obtained under section 3406 (including a payee’s failure or inability to certify that the payee is not subject to withholding due to notified payee underreporting or the fact that the account is subject to withholding), surcharge an account ( i.e., charge an account more than the fee charged a similar account that was not subject to withholding under section 3406), or use that information to determine whether to open or close an account, whether to issue or redeem an instrument, or whether to extend credit to the payee.

§31.3406(g)–1 Exception for payments to certain payees and certain other payments .

(a) Exempt recipients —(1) In gen- eral . A payor of any reportable payment (as defined in section 3406(b)) must not withhold under section 3406 if the payee is—

(i) An organization exempt from taxation under section 501(a) or an individual retirement account;

(ii) The United States or any wholly owned agency or instrumentality thereof;

number to the broker in the manner required in §31.3406(d)–1 and the payor has not received the taxpayer identification number from the payee in this manner.

(2) Stop withholding . The payor must stop withholding under section 3406(a)(1)(A) within 30 days after the payor receives—

(i) The payee’s taxpayer identification number in the manner required under §31.3406(d)–1; or

(ii) A statement, in such form and containing such information as is required under applicable regulations, that the payee is not a United States person.

(c) Notification of an incorrect tax- payer identification number . See §31.3406(d)–5(e) and (g)(3) for the period for which withholding is required in the case of notification of an incorrect taxpayer identification number.

(d) Notified payee underreporting . See §31.3406(c)–1(e) for the period for which withholding is required in the case of notified payee underreporting.

(e) Payee certification failure —(1) Start withholding . A payor is required to withhold under section 3406(a)(1)(D) at a rate of 31 percent on any reportable interest or dividend payment (as defined in section 3406(b)(2)) at the time the payor pays such reportable interest or dividend payment (as described in §31.3406(a)–4) to a payee if—

(i) The payor has not received from the payee the certification required in §31.3406(d)–2; or

(ii) The payor has received notice from a broker (as required in §31.3406(d)–4(a)(1)(iii)) with respect to a readily tradable instrument that the payee did not make the required certification and the payor has not received the required certification from the payee.

(2) Stop withholding . The payor must stop withholding under section 3406(a)(1)(D) on any reportable interest or dividend payment within 30 days after the payor receives the certification from the payee in the manner required by §31.3406(d)–2.

(f) Rule for determining when the payor receives a taxpayer identification number or certificate from a payee . In determining whether a payee has failed to provide a taxpayer identification number or any certification to a payor (including a Form W–8 or substitute

form), a payor is required to process the taxpayer identification number or certification within 30 days after the payor receives the taxpayer identification number or certification from the payee or in certain cases, from a broker. Thus, the payor may take up to 30 days to treat the taxpayer identification number or a certificate as having been received.

§31.3406(f)–1 Confidentiality of information.

(a) Confidentiality and liability for violation . Pursuant to section 3406(f) no person may use any information obtained under section 3406 for any purpose except for the purpose of complying with the requirements of section 3406 or for purposes permitted under section 6103 (subject to the safeguards of section 6103). See section 7431 for civil damages for violating the confidential use of the information (subject to an exception for good faith).

(b) Permissible use of information (1) In general . A payor or broker may transmit information on a Form W–9, Form W–8, or other acceptable form relating to withholding to the department, institution, or firm (or to any employee therein) responsible for withholding or processing of taxpayer identification numbers, certifications described in §31.3406(h)–3, or other substitute forms. In addition, a broker may notify the payor with respect to a readily tradable instrument of the requirement to withhold and the condition or conditions for imposing withholding (as described in §31.3406(d)– 4) that exist with respect to the payee. A payor or broker may, without violating the Internal Revenue Code, close an account of, refuse to open an account for, issue an instrument to, or redeem an instrument for, a person solely because the person fails to furnish the person’s taxpayer identification number or documentation of foreign status in the manner required in §31.3406(d)–1 and §31.3406(g)–1, respectively. A payor who closes an account of a payee in the calendar year in which the account was opened and during which no taxpayer identification number or evidence of foreign status was provided for that account will be presumed in the absence of evidence to the contrary to have closed the account without violating section 3406(f) even though the payee is subject to backup

(iii) A state, the District of Columbia, a possession of the United States, any political subdivision of any of the foregoing, or any wholly owned agency or instrumentality of any one or more of the foregoing;

(iv) A foreign government, a political subdivision of a foreign government, or any wholly owned agency or instrumentality of any one or more of the foregoing (as defined in regulations under section 892); or

(v) An international organization or any wholly owned agency or instrumentality thereof (as defined in section 7701(a)(18)). (2) Nonexclusive list . Paragraph (a)(1) of this section does not prescribe an exclusive list of payees that are exempt from information reporting and also are exempt from withholding under section 3406.

(b) Determination of whether a per- son is described in paragraph (a)(1) of this section . The determination of whether a person is a payee described in paragraph (a)(1) of this section must be made as provided in the applicable provisions of section 6049 and the regulations issued thereunder. A payor, even if permitted to treat a person as an exempt recipient without requiring a certificate under the provisions of section 6049, may require a payee, otherwise not required to file a certificate regarding its exempt status, to file a certificate and may treat a payee who fails to file the certificate as a person who is not an exempt recipient. See §31.3406(h)–3 for a description of the Form W–9 or a substitute form prescribed under section 3406 for claiming exempt status.

(c) Prepaid or advance premium life-insurance contracts . A payor of a reportable payment (as defined in section 3406(b)(1)) may, but is not required to, withhold under section 3406 on reportable payments made from January 1, 1984, to December 31, 1996, on prepaid or advance premium life-insurance contracts to a payee who is the owner for tax purposes of the prepaid or advance premium lifeinsurance contract. For purposes of this exception from backup withholding, a prepaid or advance premium lifeinsurance contract is one entered into on or before June 30, 1984, by the payee and under which the increment in value of the prepaid or advance premium is used for the payment of premiums during the period in which

the exception from backup withholding applies.

§31.3406(g)–2 Exception for reportable payments for which withholding is otherwise required .

(a) In general . A payor of a reportable payment (as defined in section 3406(b)) must not withhold under section 3406 if the payment is subject to withholding under any other provision of the Internal Revenue Code.

(b) Payment of wages . A payor who is required to make an information return under section 6041 with respect to a payment of wages (as defined in section 3401) because, e.g., the employee makes a certification under section 3402(n) (relating to employees incurring no income tax liability), must not withhold under section 3406 on those wages.

(c) Distribution from a pension, an- nuity, or other plan of deferred com- pensation . An amount reportable under section 6047, such as a designated distribution under section 3405, is not a reportable payment subject to withholding under section 3406. See section 3406(b). Designated distributions not subject to withholding under section 3406 include— (1) Distributions from a pension, annuity, profit-sharing, stock bonus plan, or other plan deferring the receipt of compensation;

(2) Distributions from an individual retirement account or annuity;

(3) Distributions from an owneremployee plan; and

(4) Certain surrenders of life insurance contracts.

(d) Gambling winnings —(1) In gen- eral . A payor of a reportable gambling winning must not withhold under section 3406 if tax is required to be withheld from the gambling winning under section 3402(q) (relating to the extension of withholding to certain gambling winnings). If the reportable gambling winning is not required to be withheld upon under section 3402(q), withholding under section 3406 applies to the gambling winning if, and only if, the payee does not furnish a taxpayer identification number to the payor. Section 31.3406(b)(3)–1(b)(3) does not apply to a reportable gambling winning. The payor of a reportable gambling winning is not required to aggregate all such winnings made to a payee

during a calendar year, nor is the payor required to determine whether an information return was required to be made with respect to the payee for the preceding year.

(2) Definition of a reportable gam- bling winning and determination of amount subject to backup withholding . For purposes of withholding under section 3406, a reportable gambling winning is any gambling winning subject to information reporting under section 6041. The amount of a reportable gambling winning is—

(i) The amount paid with respect to the amount of the wager reduced, at the option of the payor; by

(ii) The amount of the wager. (3) Special rules . Amounts paid with respect to identical wagers are treated as paid with respect to a single wager. The determination of whether wagers are identical is made under §31.3402(q)–1(c)(1)(ii). In addition, a gambling winning (other than a winning from bingo, keno, or slot machines) is a reportable gambling winning only if the amount paid with respect to the wager is $600 or more and if the proceeds are at least 300 times as large as the amount wagered. See §7.6041–1 of this chapter to determine whether a winning from bingo, keno, or slot machines is a reportable gambling winning and thus subject to withholding under section 3406. (e) Certain real estate transactions . A real estate reporting person (the socalled broker) as defined in section 6045(e)(2) must not withhold under section 3406 on a payment made with respect to a real estate transaction that is subject to reporting under sections 6045(a) and (e) and §1.6045–4 of this chapter.

(f) Certain payments after an ac- quisition of accounts or instruments . A payor who acquires pre–1984 accounts or instruments described in §31.3406(d)–1(b)(2)(iv) for which the payor does not have a taxpayer identification number or has an obviously incorrect taxpayer identification number as defined in §31.3406(h)–1(b)(2) must start withholding under section 3406(a)(1)(A) and §31.3406(d)–1 on those accounts or instruments no later than sixty days following the date of the payor’s acquisition of those accounts or instruments.

(g) Certain gross proceeds . No withholding under section 3406 is required with respect to any portion of the

original issue discount on an instrument or security that is subject to withholding under section 3406 as reportable gross proceeds of such instrument or security under section 6045.

§31.3406(g)–3 Exemption while payee is waiting for a taxpayer identification number .

(a) In general —(1) Backup with- holding not required for 60 days . If a payor has received an awaiting-TIN certificate from a payee with respect to an account or instrument receiving reportable interest or dividends as described in section 3406(b)(2), the payor must exempt the payee from withholding under section 3406(a)(1)(A) during the 60-day exemption period to the extent and in the manner described in either paragraph (a)(2) or (3) of this section. The 60-day exemption period means the 60-consecutiveday period beginning with the day the payor receives the awaiting-TIN certificate. The payor must withhold under section 3406 beginning after the 60-day exemption period if the payor has not received a taxpayer identification number from the payee in the manner required in §31.3406(d)–1. Regardless of whether the payee provides an awaiting-TIN certificate to a payor, the payor is required to withhold under section 3406(a)(1)(D) and §31.3406(d)– 2 on reportable interest or dividend payments as described in §31.3406(d)– 2 if the payee fails to certify, under penalties of perjury, that the payee is not subject to withholding due to notified payee underreporting as required in section 3406(a)(1)(D) and §31.3406(d)–2.

(2) Reserve method . A payor must not withhold under section 3406 during the 60-day exemption period unless the payee (or a joint payee in the case of a joint account) desires to make a withdrawal of more than $500 of either principal or interest from the account in any single transaction during the period. If a payee (or a joint payee) desires to make a withdrawal of more than $500 during the 60-day exemption period, the payor is required under section 3406 to withhold 31 percent of all reportable payments made during the period and at the time of withdrawal unless the payee reserves 31 percent of all reportable payments made to the account during the period.

(3) Alternative rule; 7-day grace period —(i) In general . A payor who

receives an awaiting-TIN certificate may elect, on a payee-by-payee basis or in general, to exempt reportable interest or dividend payments to a payee from withholding under section 3406 applying the rules in paragraph (a)(3)(ii) or (iii) of this section.

(ii) Withholding on withdrawals . Under this paragraph (a)(3)(ii), a payor must obtain a certified taxpayer identification number from the payee within 60 days after the date that the payor receives the awaiting-TIN certification. In addition, the payor must withhold under section 3406 on any withdrawals made after the close of 7 business days after the date the awaiting-TIN certification is received and before the earlier of the date that the payor receives a certified taxpayer identification number from the payee, the date the account is closed (in which case the payor must withhold on any reportable payment made at the time the account or relationship is closed), or the date withholding under section 3406 starts on all reportable payments made to the account, instrument, or relationship. All cash withdrawals in an amount up to the reportable payments made from the day after the date of receipt of the awaiting-TIN certification to the date of withdrawal are treated as reportable payments.

(iii) Withholding regardless of with- drawals . Under this paragraph (a)(3)(iii), a payor must start withholding under section 3406 on the account not later than 7 business days after the date the payor receives the awaiting-TIN certification on reportable payments thereafter made to the account (whether or not the payee makes a cash withdrawal). The payor must withhold under section 3406 until the earlier of the date the payor receives a certified taxpayer identification number from the payee, the date the account is closed, or the date withholding under section 3406 starts on all reportable payments made to the account, instrument, or relationship. The payor must obtain a certified taxpayer identification number from the payee within 60 days after the date that the payor receives the awaiting-TIN certificate or undertake a mailing each year soliciting the certified taxpayer identification number from the payee until the earlier of the calendar year that the certified taxpayer identification number is received, or the calendar year in which the account is closed. However, if the account is closed in December of a calendar year,

the mailing must be made after the account is closed and before January 31 of the subsequent calendar year. (b) Special rule for readily tradable instruments . The 60-day awaiting-TIN exemption described in paragraph (a)(1) of this section applies to payments made with respect to readily tradable instruments only if the payee provides an awaiting-TIN certificate directly to the payor. If a broker acquires a readily tradable instrument through a post–1983 brokerage account (as described in §31.3406(d)–1(c)(2)) for a payee who has no taxpayer identification number, the broker must advise the payor as required in §31.3406(d)– 4(a)(1) that the payee failed to provide a taxpayer identification number under penalties of perjury, regardless of whether the payee provides an awaiting-TIN certificate to the broker. Once a payor is notified by a broker that a payee failed to provide a taxpayer identification number in the required manner, or that the payee is subject to withholding under section 3406(a)(1)(B) or (C), the payor must impose withholding under section 3406 for the appropriate period described in §31.3406(e)–1.

(c) Exceptions —(1) In general . The 60-day awaiting-TIN exemption described in paragraph (a) of this section does not apply to—

(i) Window transactions (as defined in §31.3406(b)(2)–3(b));

(ii) Redemptions of bearer obligations that are subject to reporting under section 6045; or

(iii) Other amounts that are subject to reporting under section 6045 (except as described in paragraph (c)(2) of this section).

(2) Special rule for amounts subject to reporting under section 6045 other than proceeds of redemptions of bearer obligations . If a broker’s customer does not provide a taxpayer identification number to the broker, and the broker effects a sale that is subject to reporting under section 6045 (other than a redemption of a bearer obligation), §31.3406(d)–3(b) applies, whether or not the sale is pursuant to an instruction by electronic transmission, provided the customer furnishes an awaiting-TIN certificate to the broker before the sale. For purposes of this paragraph (c)(2), the 30-day period provided in §31.3406(d)–3(b) is a 60day period.

(d) Awaiting-TIN certificate . A payee qualifies for the 60-day awaiting

TIN exemption provided in paragraph (a) of this section if the payee furnishes a written statement to the payor, signed under penalties of perjury, that the payee has not been issued a taxpayer identification number, that the payee has applied for a taxpayer identification number or intends to apply for a number in the near future, and that the payee understands that if the payee does not provide a number to the payor within 60 days, the payor is required under section 3406 to withhold 31 percent of any reportable payment thereafter made to the payee until the payor receives a number, and 31 percent of a withdrawal to the extent of reportable payments made to the payee during the 60-day period, as described in paragraph (a) of this section. Language that is substantially similar to the awaiting-TIN certification on Form W– 9 will satisfy the requirements of this paragraph (d).

(e) Form for awaiting-TIN certifi- cate . A payor may use Form W–9 for the awaiting-TIN certificate, or a payor may include language that is substantially similar to the awaiting-TIN certification on Form W–9 in any other document of the payor. See §31.3406(h)–3, which provides that Form W–9 is the prescribed form but permits use of substitute forms, and specifies the length of time the payor is required to retain the form. If Form W–9 is used, the payee should write ‘‘Applied For’’ in the space reserved for the taxpayer identification number.

§31.3406(h)–1 Definitions .

(a) In general . For purposes of section 3406 and the regulations thereunder, the definitions of this section apply.

(b) Taxpayer identification num- ber —(1) In general . Taxpayer identi- fication number means the identifying number assigned to a person under section 6109 (relating to identifying numbers, generally a nine-digit social security number for an individual and a nine-digit employer identification number for a nonindividual, e.g., a corporation, partnership, trust, or estate). An obviously incorrect number is not considered a taxpayer identification number. See §31.6011(b)–2 and §301.6109–1 of this chapter for provisions relating to obtaining a taxpayer identification number.

(2) Obviously incorrect number . Ob- viously incorrect number means a

number that does not contain nine digits or a number that includes an alpha character as one of the nine digits.

(c) Broker . Broker is defined in section 6045(c)(1) and §1.6045–1(a)(1) of this chapter. If there could be more than one broker with respect to any acquisition, only the broker having the closest contact (as determined under §5f.6045–1(c)(3)(ii) and (iii) of this chapter) with the payee is treated as a broker. In the case of any instrument, the term broker does not include any person who is the payor with respect to the instrument as described in §31.3406(a)–2.

(d) Readily tradable instrument . Readily tradable instrument means—

(1) Any instrument that is part of an issue any portion of which is traded on an established securities market (within the meaning of section 453(f)(5)); or

(2) Any instrument that is regularly quoted by brokers or dealers making a market.

(e) Day . Day means a calendar day unless specified otherwise under any section of the regulations under section 3406. For example, see §§31.3406(d)– 5(a) and 31.3406(g)–3(a)(2). (f) Business day . Business day means any day other than a Saturday, Sunday, or legal holiday (within the meaning of section 7503).

§31.3406(h)–2 Special rules .

(a) Joint accounts —(1) Relevant name and taxpayer identification num- ber combination . For purposes of identifying the account subject to withholding under sections 3406(a)(1)(B) and (C), the relevant name and taxpayer identification number combination is that which is used for information reporting purposes.

(2) Optional rule for accounts sub- ject to backup withholding under sec- tion 3406(a)(1)(B) or (C) where the names are switched . See §31.3406(d)– 5(c)(4)(iii) under which a payor may withhold under section 3406(a)(1)(B) as required even though the names or taxpayer identification numbers on the account have been switched. The rules under §31.3406(d)–5(c)(4)(iii) may be applied comparably by a payor who is required to withhold under section 3406(a)(1)(C). (3) Joint foreign payees —(i) In gen- eral . If the first payee listed on an

account or instrument provides the penalties of perjury statement regarding its foreign status, withholding under section 3406 applies unless—

(A) Every joint payee provides the statement regarding foreign status (pursuant to the relevant regulations issued under sections 6045 and 6049); or

(B) Any one of the joint payees who has not established foreign status provides a taxpayer identification number to the payor in the manner required in §31.3406(d)–1.

(ii) Information reporting on an ac- count including foreign payees . If any one of the joint payees who has not established foreign status provides a taxpayer identification number under paragraph (a)(3)(i)(B) of this section, that number is the taxpayer identification number that is required to be furnished for purposes of information reporting and withholding under section 3406. (b) Backup withholding from an alternative source —(1) In general . A payor may not withhold under section 3406 from a source maintained by the payor other than the source with respect to which there exists a liability to withhold under section 3406 with respect to the payee. See section 3403 and §31.3403–1, which provide that the payor is liable for the amount required to be withheld regardless of whether the payor withholds.

(2) Exceptions for payments made in property —(i) Backup withholding from alternative source . In the case of a payment that is made in property (other than money), the payor must withhold under section 3406 31 percent of the fair market value of the property determined immediately before or on the date of payment. The payor may withhold under section 3406 from the principal amount being deposited with the payor or from another source maintained by the payee with the payor. The source from which the tax is withheld under section 3406 must be payable to at least one of the persons listed on the account subject to withholding. If the account or source is not payable exclusively to the same person or persons listed on the account subject to withholding under section 3406, then the payor must obtain a written statement from all other persons to whom the account or source is payable authorizing the payor to withhold under section 3406 from the alternative account or source. A payor that elects to

withhold under section 3406 from an alternative source may determine the account or source from which the tax is to be withheld, or may allow the payee to designate the alternative source. A payee may not, however, require a payor to withhold under section 3406 from a specific alternative source. See §31.3402(q)–1(d), Example 5, for methods of withholding on prizes, awards, and gambling winnings paid in property other than cash.

(ii) Deferral of withholding . If the payor cannot locate, using reasonable care (following procedures substantially similar to those set forth in §31.3406(d)–5(c)(3)(ii)(A) and (B)), an alternative source of cash from which the payor may satisfy its withholding obligation pursuant to paragraph (b)(2)(i) of this section, the payor may defer its obligation to withhold under section 3406, except for reportable payments of property made in connection with prizes, awards, or gambling winnings, until the earlier of—

(A) The date the payor makes a cash payment to the account subject to withholding under section 3406 or cash is otherwise deposited in the account in a sufficient amount to satisfy the obligation in full; or

(B) The close of the fourth calendar year after the obligation arose.

(iii) Barter exchanges . In the case of a barter exchange that issues scrip to, or credits the account of, a member or client of the exchange in payment for property or services, the barter exchange may withhold under section 3406 from— (A) The scrip or credit, if converted to cash in order to satisfy the deposit requirements of section 6302 and §31.6302–4; or

(B) Any other source maintained by the exchange for the member or client in the manner described in paragraph (b)(2) of this section.

(c) Trusts . Withholding under section 3406 applies to reportable payments made to a trust if any of the conditions for imposing withholding under section 3406 apply to the trust. Generally, a trust is not a payor and will not be required to withhold under section 3406 on reportable payments that it makes to its beneficiary who is subject to withholding under section 3406. The preceding sentence does not apply, however, to a grantor trust with two or more grantors described in §31.3406(a)–2(b)(4), which is treated

as a middleman payor. The trustee of a trust described in this paragraph (c) may certify that the trust’s taxpayer identification number is correct and that the trust is not subject to withholding due to notified payee underreporting, without regard to the status of the beneficiaries of the trust.

(d) Adjustment of prior withholding by middlemen . A middleman payor (as defined in §31.3406(a)–2(b)) who receives a payment from which tax has been erroneously withheld under section 3406 may seek a refund of the tax withheld by the payor from whom the middleman payor received the payment (referred to as the ‘‘upstream payor’’). Alternatively, the middleman payor may obtain a refund of the tax by claiming a credit for the amount of tax withheld by the upstream payor against the deposit of any tax imposed by this chapter which the middleman payor is required to withhold and deposit (as described in section 6413 and §31.6413(a)–2). In either case, the middleman payor must pay or credit the gross amount of the payment (including the tax withheld) to its payee as though it had received the gross amount of the payment from the upstream payor and must withhold under section 3406 only if one of the conditions for imposing backup withholding exists with respect to its payee. If its payee is not subject to withholding under section 3406, the middleman payor must pay or credit the full amount of the payment to the payee. See §31.6413(a)–3 regarding repayment by a payor of tax erroneously collected from a payee.

(e) Conversion of amounts paid in foreign currency into United States dollars —(1) Convertible foreign cur- rency . If a payment is made in a currency other than the United States dollar, the amount subject to withholding under section 3406 is determined by applying the statutory rate of backup withholding to the foreign currency payment and converting the amount withheld into United States dollars on the date of payment at the spot rate (as defined in §1.988–1(d)(1) of this chapter) or pursuant to a reasonable spot rate convention. For example, a withholding agent may use a month-end spot rate or a monthly average spot rate. A spot rate convention must be used consistently with respect to all non-dollar amounts withheld and from year to year. Such convention cannot be changed without the consent of the Commissioner.

(2) Nonconvertible foreign currency .

[Reserved]

(f) Coordination with other sections . For purposes of section 31, chapter 24 (other than section 3402(n)) of subtitle C of the Internal Revenue Code (relating to employment taxes and collection of income tax at source) and so much of subtitle F (other than section 7205) of the Internal Revenue Code (relating to procedure and administration) as relates to this chapter, and the regulations thereunder—

(1) An amount required to be withheld under section 3406 must be treated as a tax required to be withheld under section 3402;

(2) An amount withheld under section 3406 must be treated as an amount withheld under section 3402;

(3) An amount withheld under section 3406 must be deposited as required under §31.6302–4;

(4) Wages includes the gross amount of any reportable payment (as defined in section 3406(b)) except for purposes of section 6014 (relating to an election by the taxpayer not to compute the tax on his annual return);

(5) Employee includes a payee of any reportable payment; and

(6) Employer includes a payor who is required to withhold the tax under section 3406 (as defined in §31.3406(a)–2(a)) with respect to any reportable payment (as defined in section 3406(b)). (g) Tax liabilities and penalties . A payor is subject to the same civil and criminal penalties for failing to impose withholding under section 3406 as an employer who fails to withhold on a payment of wages. In addition, a broker may be subject to the penalty under section 6705 (failure of a broker to provide notice to a payor).

(h) To whom payor is liable for amount withheld . A payor is not liable to any person for any amount withheld under section 3406. A payor is liable only to the United States for an amount that is required to be withheld as provided in §31.3403–1.

§31.3406(h)–3 Certificates .

(a) Prescribed form to furnish infor- mation under penalties of perjury —(1) In general . Except as provided in paragraph (c) of this section, the Form W–9 is the form prescribed under section 3406 on which the payee

certifies, under penalties of perjury, that—

(i) The taxpayer identification number furnished to the payor is correct (as required in §31.3406(d)–1 and §31.3406(d)–5);

(ii) The payee is not subject to withholding due to notified payee underreporting (as required in §31.3406(d)– 2); (iii) The payee is an exempt recipient (as described in §31.3406(g)–1); or

(iv) The payee is awaiting receipt of a taxpayer identification number (as described in §31.3406(g)–3).

(2) Use of a single or multiple Forms W–9 for accounts of the same payee . A valid Form W–9 must include the name and taxpayer identification number of the payee. Except as provided in paragraph (b) of this section, the payee must sign under penalties of perjury and date the Form W–9 in order to satisfy the requirements of this section. A payor or broker may require a payee to furnish a separate Form W–9 for each obligation, deposit, certificate, share, membership, contract, or other instrument, or one Form W–9 for all the payee’s obligations or relationships with the payor or broker. In addition, a payee of a mutual fund that has a common investment advisor or common principal underwriter with other mutual funds (within the same family of funds) may be permitted, in the discretion of the mutual fund, to provide one Form W–9 with respect to shares acquired or owned in any of the funds.

(b) Prescribed form to furnish a noncertified taxpayer identification number . With respect to accounts or other relationships where the payee is not required to certify, under penalties of perjury, that the taxpayer identification number being furnished is correct, the payor or broker may obtain the taxpayer identification number orally or may use Form W–9, a substitute form, or any other document, but the payee is not required to sign the form.

(c) Forms prepared by payors or brokers —(1) Substitute forms; in gen- eral . A payor or broker may prepare and use a form that contains provisions that are substantially similar to those of the official Form W–9. A payor or broker may use any document relating to the transaction, such as the signature card for an account, so long as the certifications are clearly set forth. A payor or broker who uses a substitute

form may furnish orally or in writing the instructions for the Form W–9 that relate to the account. A payor or broker may refuse to accept certifications (including the official Form W–9) that are not made on the form or forms provided by the payor or broker. A payor or broker may refuse to accept a certification provided by a payee only if the payor or broker furnishes the payee with an acceptable form immediately upon receipt of an unacceptable form or within 5 business days of receipt of an unacceptable form. An acceptable form for this purpose must contain a notice that the payor or broker has refused to accept the form submitted by the payee and that the payee must submit the acceptable form provided by the payor in order for the payee not to be subject to withholding under section 3406. If the payor or broker requires the payee to furnish a form for each account of the payee, the payor or broker is not required to furnish an acceptable form until the payee furnishes the payor or broker with the payee’s account numbers. A payor or broker may use separate substitute forms to have a payee certify under penalties of perjury that—

(i) The payee’s taxpayer identification number is correct; and

(ii) The payee is not subject to withholding under section 3406 due to notified payee underreporting.

(2) Form for exempt recipient . A payor or broker may use a substitute form for the payee to certify, under penalties of perjury, that the payee is an exempt recipient (described in §31.3406(g)–1 or described in the respective reporting section), provided the form contains provisions that are substantially similar to those of the official Form W–9 relating to exempt recipients. A certificate must be prepared in accordance with the instructions applicable to exempt recipients on Form W–9, and must set forth fully and clearly the data called for therein. If a payor will treat the payee as an exempt recipient only if the payee files a certificate as to its exempt status, the certificate is valid only if it contains the payee’s taxpayer identification number. Thus, a payee must include the payee’s taxpayer identification number on a certificate that a payor requires to be made in order to treat the payee as an exempt recipient.

(d) Special rule for brokers . A broker may act as the payee’s agent for

purposes of furnishing a taxpayer identification number or certification to a payor with respect to any readily tradable instrument (as defined in §31.3406(h)–1(d)) provided the payee provides a taxpayer identification number on Form W–9 or other acceptable substitute form to the broker. The payor may rely on a taxpayer identification number provided by the broker unless certification is required (as described in §31.3406(d)–4) and the broker notifies the payor that the number was not certified.

(e) Reasonable reliance on certifi- cate —(1) In general . A payor is not liable for the tax imposed under section 3406 if the payor’s failure to deduct and withhold the tax is due to reasonable reliance, as defined in paragraph (e)(2) of this section, on a Form W–9 (or other acceptable substitute) required by this section.

(2) Circumstances establishing rea- sonable reliance . For purposes of paragraph (e)(1) of this section, a payor can reasonably rely on a Form W–9 (or other acceptable substitute) unless—

(i) The form does not contain the name and taxpayer identification number of the payee (or does not state, in lieu of a taxpayer identification number, that the payee is awaiting receipt of a taxpayer identification number ( i.e., an awaiting-TIN certificate));

(ii) The form is not signed and dated by the payee;

(iii) The form does not contain the statement, when required, that the payee is not subject to withholding due to notified payee underreporting;

(iv) The payee has deleted the jurat or other similar provisions by which the payee certifies or affirms the correctness of the statements contained on the form; or

(v) For purposes of section 3406(a)(1)(C), the payor is required to subject the account to which the form relates to withholding under section 3406(a)(1)(C) under the circumstances described in §31.3406(c)–1(c)(3)(iii).

(f) Who may sign certificate —(1) In general . A Form W–9 or other acceptable substitute form may be signed by any person who is authorized to sign a declaration under penalties of perjury on behalf of the payee as provided in section 6061 and the regulations thereunder (relating to who may sign generally for an individual, which includes certain agents who may sign returns and other documents), section

the first and third sentences of paragraph (a)(1) to read as follows:

§31.6011(a)–6 Final returns .

(a) In general —(1) Federal Insur- ance Contributions Act; income tax withheld from wages and nonpayroll payments . An employer (or other person) who is required to make a return on a particular form pursuant to §31.6011(a)–1, §31.6011(a)–4, or §31.6011(a)–5, and who in any return period ceases to pay wages or nonpayroll payments in respect of which he is required to make a return on that form, must make the return for the period as a final return. * * * Every such person filing a final return (other than a final return on Form 942 or Form 943) must furnish information showing the date of the last payment of wages (as defined in section 3121(a) or section 3401(a)), and, if appropriate, the date of the last payment of nonpayroll payments defined in §31.6011(a)–4(b). * * *

- - - - -

Par. 11. Sections 31.6051–4 and 31.6413(a)–3 are added to read as follows:

§31.6051–4 Statement required in case of backup withholding .

(a) Statements required from payor . Every payor of any reportable payment (as defined in section 3406(b)(1)) who is required to deduct and withhold tax under section 3406 must furnish to the payee a written statement containing the information required by paragraph (c) of this section.

(b) Prescribed form . The prescribed form for the statement required by this section is Form 1099. In the case of any reportable interest or dividend payment as defined in section 3406(b)(2), the prescribed form is the Form 1099 required in §1.6042–4 of this chapter (relating to payments of dividends), §1.6044–5 of this chapter (relating to payments of patronage dividends), or §1.6049-6(e) of this chapter (relating to payments of interest or original issue discount). Statements required to be furnished by this section will be treated as statements required by the respective sections with respect to any reportable payment, except that the statement required under this section must include the amount of tax

6062 and the regulations thereunder (relating to who may sign corporate returns), and section 6063 and the regulations thereunder (relating to who may sign partnership returns).

(2) Notified payee underreporting . A payee who has not been notified that he is subject to withholding under section 3406(a)(1)(C) as a result of notified payee underreporting may make the certification related to notified payee underreporting. In addition, a payee who was subject to withholding under section 3406(a)(1)(C) due to notified payee underreporting may certify that he is not subject to withholding under section 3406(a)(1)(C) due to notified payee underreporting if the Internal Revenue Service has provided the payee with written certification that withholding under section 3406(a)(1)(C) due to notified payee underreporting has terminated.

(g) Retention of certificates —(1) Ac- counts or instruments that are not pre– 1984 accounts and brokerage relation- ships that are post–1983 brokerage accounts . With respect to an account or instrument that is not a pre–1984 account (as described in §31.3406(d)– 1(b)(3)), or with respect to a brokerage relationship that is a post–1983 brokerage account (as described in §31.3406(d)–1(c)(2)), a payor or broker who receives a Form W–9 or other acceptable substitute form related to withholding under section 3406 must retain the form in its records for 3 years from the date the account is opened or the instrument is purchased. The form may be retained on microfilm or microfiche.

(2) Accounts or instruments that are pre–1984 accounts and brokerage rela- tionships that are not post–1983 bro- kerage accounts . With respect to a pre– 1984 account (as described in §31.3406(d)–1(b)(1)) or with respect to a brokerage relationship that is not a post–1983 brokerage account (as described in §31.3406(d)–1(c)(1)), a payor or broker is not required to retain any Form W–9 or other acceptable substitute form. If, however, the payor or broker requires the payee to file only one Form W–9 or substitute form for all accounts or instruments of the payee, the payor or broker must retain the single form in the manner and for the period of time described in paragraph (g)(1) of this section if that form relates to any account or instrument that is not a pre–1984 account or relates to a post–1983 brokerage ac

count. If a payee has certified that the payee is an exempt recipient described in §31.3406(g)–1, the payor or broker must retain the form unless the payor or broker can establish the existence of procedures that are reasonably calculated to ensure that a payee who has so certified is accurately identified in the payor’s or broker’s records.

(h) Cross references . For the requirement to file an information return (and furnish the related statement) with respect to a reportable payment, particularly if that payment has been subject to withholding under section 3406, see subtitle F, chapter 61, subparts B and C of the Internal Revenue Code. See §31.6302–4 for the requirement to deposit amounts withheld under section 3406 on either a monthly or semi-weekly basis. See §31.6011(a)– 4(b) for the requirement to file Form 945, Annual Return of Withheld Federal Income Tax, to reflect amounts withheld under section 3406. See §31.6071(a)–1 for the time for filing the Form 945.

§31.3406(i)–1 Effective date .

Sections 31.3406-0 through 31.3406(i)–1 (except §§31.3406(d)–5 and 31.3406(g)–1(c) and except for international transactions) are effective after December 31, 1996, and, optionally, for reportable payments made and transactions occurring on or after December 21, 1995. For the effective date of §31.3406(d)–5, see §31.3406(d)–5(i). Section 31.3406(g)–1(c) is effective before January 1, 1997. See §§35a.9999–0T through 35a.9999–5 of this chapter for rules that apply to international transactions after December 31, 1996.

Par. 9. Section 31.6011(a)–5(a) is amended by:

Removing the word ‘‘or’’ immediately after the language ‘‘941PR,’’ in the first and third sentences of paragraph (a)(1).
Adding the language ‘‘, or Form 945’’ immediately after the language ‘‘Form 941VI’’ in the first and third sentences of paragraph (a)(1).
Adding the language ‘‘(or other person)’’ immediately after the word ‘‘employer’’ in the second, third, fourth, and sixth sentences of paragraph (a)(1).
Removing the authority citation at the end of the section.

Par. 10. Section 31.6011(a)–6 is amended by revising the heading and

refund and must provide a copy of the receipt to the payee (a canceled check or an entry in a statement is sufficient, provided that the check or statement contains a specific notation that it is a refund of tax erroneously withheld);

(ii) Not report on a Form 1099 as tax withheld any amount which the payor or broker has refunded to a payee; and

(iii) Not deposit the amount erroneously withheld if the payor or broker has not deposited the amount of the tax prior to the time that the refund is made to the payee.

(2) Adjustment after the deposit of the tax . For purposes of paragraph (b)(1) of this section, if the amount erroneously withheld has been deposited prior to the time that the refund is made to the payee, the payor or broker may adjust any subsequent deposit of the tax collected under chapter 24 of the Internal Revenue Code that the payor or broker is required to make in the amount of the tax that has been refunded to the payee.

PART 35a—TEMPORARY EMPLOYMENT TAX REGULATIONS UNDER THE INTEREST AND DIVIDEND TAX COMPLIANCE ACT OF 1983

Par. 12. The authority citation for part 35a is amended by removing the entry for 35a.3406–2 to read, in part, as follows:

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

§35a.3406–2 [Removed]

Par. 13. Section 35a.3406–2 is removed.

Par. 14. Section 35a.9999-0T is added to read as follows:

§35a.9999–0T Effective date (temporary) .

In general, the provisions of §§35a.9999–1, 35a.9999–2, 35a.9999– 3, 35a.9999–3A, 35a.9999–4T, and 35a.9999–5 are effective before January 1, 1997. The provisions of those sections remain effective after December 31, 1996, however, for purposes of §301.6724–1(g) of this chapter, relating to due diligence safe harbor, and for international transactions, including transactions involving a foreign payee, a foreign payor, a foreign office of a

withheld under section 3406. In no event will a statement be required under this section if a statement with the same information is required to be furnished to the recipient under another section.

(1) The name, address, and taxpayer identification number of the person receiving any reportable payment;

(2) The amount subject to reporting under section 6041, 6041A(a), 6042, 6044, 6045, 6049, 6050A, or 6050N whether or not the amount of the reportable payment is less than the amount for which an information return is required. If tax is withheld under section 3406, the statement must show the amount of the payment withheld upon;

(3) The amount of tax deducted and withheld under section 3406;

(4) The name and address of the person filing the form;

(5) A legend stating that such amount is being reported to the Internal Revenue Service; and

(6) Such other information as is required by the form.

(d) Time for furnishing statements . The statement must be furnished to the payee no later than January 31 of the year following the calendar year in which the payment was made.

(e) Aggregation . The payor or broker may combine the information required to be shown under this section with information required to be shown under another section even if they do not relate to the same type of reportable payment.

§31.6413(a)–3 Repayment by payor of tax erroneously collected from payee .

(a) In general —(1) Erroneous with- holding under section 3406 of the Internal Revenue Code . If a payor or broker withholds under section 3406 from a payee in error or withholds more than the proper amount of the tax under section 3406, the payor or broker may refund the amount erroneously withheld as provided in section 6413 and this section. A payor or broker will be considered to have withheld erroneously under section 3406 only if the amount is withheld because of an error by the payor or broker ( e.g., an error in flagging or identifying an

account that is subject to withholding under section 3406). The payor or broker may, in its discretion, treat the amount withheld as an amount erroneously withheld and refund it to the payee if—

(i) The payor or broker requires a payee described in §31.3406(g)–1(a) or described in a provision of the Internal Revenue Code requiring the reporting of a payment subject to withholding under section 3406 to certify that it is an exempt recipient, the payee fails to make the required certification, and the payor or broker subsequently withholds under section 3406 from a payment to the payee;

(ii) The payor or broker does not require the payee to certify concerning its exempt status and the payor or broker withholds under section 3406; or

(iii) The payor or broker withholds under section 3406 from a payee after the payee provides a taxpayer identification number or required certification (including the certification relating to foreign status described in §1.6049– 5(b)(2)(iv) of this chapter or §1.6045– 1(g)(1) of this chapter) to the payor, but before the payor or broker treats the number or required certification as having been received under §31.3406(e)–1(b).

(2) Limitation . For purposes of paragraph (a)(1) of this section, if a payor or broker withholds because the payor or broker has not received a taxpayer identification number or required certification and the payee subsequently provides a taxpayer identification number or a required certification to the payor, the payor or broker may not refund the amount to the payee.

(b) Refunding amounts erroneously withheld —(1) Time and manner . If a payor or broker withholds under section 3406 from a payee in error (including withholding more than the correct amount, as described in paragraph (a) of this section), the payor or broker may refund the amount erroneously withheld to the payee if the refund is made prior to the end of the calendar year and prior to the time the payor or broker furnishes a Form 1099 to the payee with respect to the payment for which the erroneous withholding occurred. If the amount of the erroneous withholding is refunded to the payee, the payor or broker must—

(i) Keep as part of its records a receipt showing the date and amount of

U.S. bank or broker, or a payment from sources without the United States. See §§31.3406–0 through 31.3406(i)–1 of this chapter for rules that apply to other transactions after December 31, 1996.

PART 301—PROCEDURE AND ADMINISTRATION

Par. 15. The authority for part 301 continues to read in part as follows:

Authority: 26 U.S.C. 7805 * * * Par. 16. Section 301.6109–1 is amended by:

Revising the third sentence in paragraph (a)(1).
Revising the first sentence in paragraph (h).

The revised sentences read as follows:

§301.6109–1 Identifying numbers .

(a) In general —(1) Social security numbers and employer identification numbers . * * * Social security numbers identify individual persons, while employer identification numbers identify corporations, partnerships, nonprofit associations, trusts, estates of decedents, and similar nonindividual persons. * * *

- - - - -

(h) Effective date . The provisions of this section are effective for information that must be furnished after April 15, 1974, except that the requirement that an estate obtain an Employer Identification Number applies on and after January 1, 1984. * * *

602—OMB CONTROL NUMBERS UNDER THE PAPERWORK REDUCTION ACT

Par 17. The authority for part 602 continues to read as follows:

Authority: 26 U.S.C. 7805. Par. 18. In §602.101, paragraph (c) is amended by adding an entry to the table in numerical order to read as follows: ‘‘§31.3406(a)–1—§31.3406(i)–1 . . . 1545–0112’’.

Dated November 28, 1995.

Cynthia G. Beerbower, Deputy Assistant Secretary

of the Treasury.

FACTS

Situation 1 . Plan P is a group health plan subject to the COBRA continuation coverage requirements of § 4980B of the Internal Revenue Code. P covers eligible employees and their eligible spouses and dependent children. The benefits under P are provided solely through a contract with insurance company I .

I charges P one of two premium rates for each eligible employee covered under P : a rate of $150 per month where only the employee is covered (the ‘‘individual rate’’), and a rate of $400 per month where a spouse or one or more dependent children are covered together with the employee (the ‘‘family rate’’). There are no experience rebates or dividends under P ’s contract with I .

Employee E has a spouse S . A qualifying event occurs that results in a loss of coverage under P for E and S . Neither E nor S is disabled at the time of the qualifying event. COBRA continuation coverage is elected for E and S . I charges P the family rate for covering E and S, and P requires that E and S jointly pay 102 percent of the family rate.

Situation 2 . (a) The facts are the same as in situation 1, except that, instead of COBRA continuation coverage being elected for both E and S, it is elected only for S . I charges P the family rate for S ’s coverage, and P requires that S pay 102 percent of the family rate.

(b) The facts are the same as in paragraph (a) of this situation 2 except that P requires that S pay 102 percent of the individual rate.

LAW

Title X of the Consolidated Omnibus Budget Reconciliation Act of 1985 (COBRA), P.L. 99–272, established continuation coverage requirements for certain group health plans (the ‘‘COBRA continuation coverage requirements’’). These requirements, as amended by subsequent legislation, are now codified in § 4980B of the Code. Section 4980B imposes an excise tax if a plan subject to the COBRA continuation coverage requirements fails to comply with those requirements.

Under § 4980B(f)(1) of the Code, ‘‘qualified beneficiaries’’ (generally defined in § 4980B(g)(1) as employees,

Margaret Milner Richardson,

Commissioner of

Internal Revenue.

(Filed by the Office of the Federal Register on

December 20, 1995, 8:45 a.m., and published in the issue of the Federal Register for December 21, 1995, 60 F.R. 66105)

Section 3504.—Acts to be Performed by Agents

26 CFR 31.3504–1: Acts to be performed by agents.

Description of acts that may be performed by reporting agents is provided. See Rev. Proc. 96– 17, page 69.

26 CFR 31.3504–1: Acts to be performed by agents.

Requirements for the magnetic tape filing of Forms 940, 941, and 945 by reporting agents are described. See Rev. Proc. 96–18, page 73.

26 CFR 31.3504–1: Acts to be performed by agents.

Requirements for the electronic filing of Form 941 by reporting agents are described. See Rev. Proc. 96–19, page 80.

Section 4980B.—Continuation Coverage Requirements of Group Health Plans

Two COBRA premium issues. Guidance is given on two premium issues that arise under the continuation coverage requirements for group health plans in section 4980B of the Code.

Rev. Rul. 96–8

ISSUES

(1) Under the facts of situation 1 below, may the plan require that two qualified beneficiaries receiving COBRA continuation coverage with respect to the same qualifying event jointly pay 102 percent of the family rate?

(2)(a) Under the facts of situation 2(a) below, may the plan require that a sole qualified beneficiary receiving COBRA continuation coverage pay 102 percent of the family rate?

(b) Under the facts of situation 2(b) below, may the plan require that a sole qualified beneficiary receiving COBRA continuation coverage pay 102 percent of the individual rate?

dependent child C who also lost coverage under P as a result of the qualifying event, P would also fail to meet the COBRA continuation coverage requirements by requiring the payment of 102 percent of the family rate if COBRA continuation coverage were elected only for C (or only for E ).

(2)(b) In situation 2(b), P requires that S pay 102 percent of the individual rate. As noted above, under the facts of situation 2(b), the sole qualified beneficiary S is not similarly situated to the family category of beneficiaries, which includes only groups of two or more individuals. However, it is a reasonable interpretation of the statutory requirements for P to determine that S, a sole qualified beneficiary receiving COBRA continuation coverage, is similarly situated to the employee-only category of beneficiaries, for whom P is charged the individual rate, and that the applicable premium for S is the individual rate. Consequently, if P operates in good faith compliance with this interpretation, P will not fail to meet the COBRA continuation coverage requirements by requiring that S pay 102 percent of the individual rate.

The conclusion in situation 2(b) is the same in any case where COBRA continuation coverage is elected only for one qualified beneficiary in a family. Thus, if E and S had a dependent child C who also lost coverage under P as a result of the qualifying event, it would be a reasonable interpretation of the statutory requirements for P to require the payment of up to 102 percent of the individual rate if COBRA continuation coverage were elected only for C (or only for E ).

HOLDINGS

(1) Under the facts of situation 1, the plan will not fail to meet the COBRA continuation coverage requirements merely because it, in good faith, requires that two qualified beneficiaries receiving COBRA continuation coverage with respect to the same qualifying event jointly pay up to 102 percent of the family rate.

(2)(a) Under the facts of situation 2(a), the plan will fail to meet the COBRA continuation coverage requirements by requiring that a sole qualified beneficiary receiving COBRA continuation coverage pay 102 percent of the family rate.

their spouses, and their dependent children) are entitled to elect COBRA continuation coverage upon the occurrence of ‘‘qualifying events.’’ A qualifying event is an event such as a termination of employment, death, divorce, or other event described in § 4980B(f)(3), if the event results in a loss of coverage under the plan.

Section 4980B(f)(2)(C) permits a plan to require the payment of a premium for any period of COBRA continuation coverage, but limits that premium to 102 percent of the applicable premium for that period. (This limit is increased to 150 percent of the applicable premium in cases where a qualified beneficiary has obtained an extension of the maximum required period of COBRA continuation coverage under § 4980B(f)(2)(B) because of disability at the time of the qualifying event.)

The applicable premium is defined in § 4980B(f)(4)(A) of the Code, with respect to any period of continuation coverage of qualified beneficiaries, as the cost to the plan for that period of the coverage for similarly situated beneficiaries with respect to whom a qualifying event has not occurred (without regard to whether the cost is paid by the employer or the employee). Under § 4980B(f)(4)(C), the applicable premium is required to be determined for a period of 12 months, and the determination must be made before the beginning of that period.

Under § 4980B(f)(5)(B) of the Code, if there is a choice among types of coverage under the plan, each qualified beneficiary is entitled to make a separate election among the types of coverage. H.R. Conf. Rep. No. 841, 99th Cong., 2d Sess. II–859 (1986) clarifies that each qualified beneficiary is entitled to a separate election of continuation coverage, and that a spouse or dependent child can elect continuation coverage even when the employee does not.

In accordance with H.R. Conf. Rep. No. 453, 99th Cong., 1st Sess. 563 (1985), until final regulations are published, the excise tax imposed by § 4980B will not apply if employers and group health plans operate in good faith compliance with a reasonable interpretation of the statutory requirements.

ANALYSIS

(1) P is charged two rates for plan beneficiaries with respect to whom a

qualifying event has not occurred, an individual rate for coverage of the employee only, and a family rate for coverage of the employee and a spouse or one or more dependents. In situation 1, both E and S are receiving COBRA continuation coverage. If there had not been a qualifying event, E and S would have belonged to the category of beneficiaries consisting of an employee and one or more family members (a spouse or one or more dependent children), all of whom are covered as a family. Because I charges P the family rate for an employee in this category, it is a reasonable interpretation of the statutory requirements for P to determine that the family rate is the applicable premium for E and S . Consequently, if P operates in good faith compliance with this interpretation, P will not fail to meet the COBRA continuation coverage requirements by requiring that E and S jointly pay 102 percent of the family rate.

The conclusion in situation 1 is the same for any two or more qualified beneficiaries with respect to the same qualifying event. Thus, if E and S had a dependent child C who also lost coverage under P as a result of the qualifying event, it would be a reasonable interpretation of the statutory requirements for P to require the joint payment of up to 102 percent of the family rate if COBRA continuation coverage were elected for E and C . The conclusion in situation 1 would also be the same if COBRA continuation coverage were elected for S and C because these two qualified beneficiaries are members of the same family, and they are similarly situated to the category of two or more beneficiaries from the same family.

(2)(a) In situation 2(a), only spouse S has COBRA continuation coverage. As an individual, the sole qualified beneficiary S is not similarly situated to the family category of beneficiaries, which includes only groups of two or more individuals. Consequently, it is not a reasonable interpretation of the statutory requirements for P to determine that the applicable premium for S is the family rate, and P fails to meet the COBRA continuation coverage requirements in situation 2(a) by requiring that S pay 102 percent of the family rate.

The conclusion in situation 2(a) is the same in any case where COBRA continuation coverage is elected only for one qualified beneficiary in a family. Thus, if E and S had a

(b) Under the facts of situation 2(b), the plan will not fail to meet the COBRA continuation coverage requirements merely because it, in good faith, requires that a sole qualified beneficiary receiving COBRA continuation coverage pay up to 102 percent of the individual rate.

DRAFTING INFORMATION

The principal author of this revenue ruling is Russ Weinheimer of the Office of the Associate Chief Counsel (Employee Benefits and Exempt Organizations). For further information regarding this revenue ruling, contact Mr. Weinheimer at (202) 622-4695 (not a toll-free number).

Section 6011.—General Requirements of Return, Statement or List

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

Procedures for execution of tax returns by an agent is provided. See Rev. Proc. 96–17, page 69.

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

Procedures for execution of an electronically filed Form 941 by an agent is provided. See Rev. Proc. 96–19, page 80.

26 CFR 31.6011(a)–8: Composite return in lieu of specified form.

Procedures for using a composite return instead in lieu of paper Forms 940, 941, or 945 is provided. See Rev. Proc. 96–18, page 73.

Section 6011.—General Requirement of Return, Statement or List

26 CFR 31.6011(a)–8: Composite return in lieu of specified form.

Procedures for using a composite return instead in lieu of a paper Form 941. See Rev. Proc. 96– 19, page 80.

Section 6012.—Persons Required to Make Returns of Income

26 CFR 1.6012–5: Composite return in lieu of specified form.

What are the requirements for participation in the 1996 On-Line Filing Program for the Form 1040 series? See Rev. Proc. 96–20, page 88.

Section 6051.—Receipts for Employees

26 CFR 31.6051–1: Statements for employees.

T.D. 8636

DEPARTMENT OF THE TREASURY Internal Revenue Service 26 CFR Parts 31 and 301

Time for Furnishing Wage Statements on Termination of Employer’s Operations

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

SUMMARY: This document contains final regulations concerning the time for furnishing wage statements to employees and for filing wage statements with the Social Security Administration upon the termination of an employer’s operations. These regulations will affect employers and their employees in the year the employer ceases to pay wages. These regulations are intended to improve the wage reconciliation process between the Social Security Administration and the IRS.

EFFECTIVE DATE: These regulations are effective January 1, 1997.

ADDRESSES: Send submissions to: CC:DOM:CORP:T:R (EE–83–89), Room 5228, Internal Revenue Service, POB 7604, Ben Franklin Station, Washington, DC 20044. In the alternative, submissions may be hand delivered between the hours of 8 a.m. and 5 p.m. to: CC:DOM:CORP:T:R (EE–83–89), Courier’s Desk. Internal Revenue Service, 1111 Constitution Avenue NW, Washington, DC.

FOR FURTHER INFORMATION CONTACT: Jean M. Casey, (202) 622-6040 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

On December 22, 1994, the Federal Register (59 FR 65982 [EE–83–89, 1995–1 C.B. 845]) published a notice of proposed rulemaking which required an employer to furnish Forms W–2 to

employees and to file Forms W–2 and W–3 with the Social Security Administration (SSA) at the same time that the employer is required to file the final Form 941 with the IRS.

Written comments responding to the notice of proposed rulemaking were received. A public hearing was held on May 8, 1995, pursuant to a notice published in the Federal Register on March 24, 1995 (60 FR 15526). After consideration of the comments that were received in response to the notice of proposed rulemaking and at the hearing, the IRS and Treasury adopt the proposed regulations, as amended and revised by this Treasury decision.

Explanation of Revisions and Summary of Comments

Availability of Forms W–2

The regulations, as proposed, would have required an employer who ceases paying wages to furnish Form W–2 to employees and file Forms W–2 and W– 3 with SSA on or before the date on which the final Form 941 is required to be filed with the IRS. Form 941 is generally due quarterly, on or before the last day of the first calendar month following the period for which it is made ( i.e., April 30, July 31, October 31, and January 31). Consequently, if an employer ceased paying wages in the first quarter of the calendar year, the Forms 941, W–2 and W–3 would be due by April 30. Some commentators expressed concern that Forms W–2 and W–3 are not available in the first quarter of the calendar year. Commentators questioned whether using prior year Forms W–2 was an acceptable alternative if current year forms were unavailable.

Under the Internal Revenue Code and the existing regulations, an employee may request the Form W–2 at any time during the year if the employee is terminated and there is no reasonable expectation on the part of the employer or the employee of further employment during the calendar year. Therefore, Forms W– 2 are available from the IRS, either through the mail or at the district offices, in January of each year. Specifications for the private printing of substitute Forms W–2, however, are not always available during the first quarter of the calendar year. Thus, during this period, employers may be limited to using the Forms W–2 printed by the IRS. Neither prior year Forms W–2 nor

the prior year specifications for the private printing of substitute Forms W– 2 should be used for filing Forms W–2 on an expedited basis for the current year because such procedures could result in significant processing errors.

Availability of Magnetic Media Specifications

Commentators questioned whether magnetic media specifications would be available in the first quarter of the calendar year for employers who are required to file on an expedited basis under the proposed regulations. Regulation section 301.6011–2 and Notice 90– 15, 1990–1 C.B. 326, generally require an employer to file Forms W–2 with SSA on magnetic media if the employer is required to file 250 or more Forms W–2 in a calendar year. Employers who do not meet the 250 return threshold may also file their Forms W–2 with SSA on magnetic media.

It is not certain that magnetic media specifications, which are issued by SSA, will be available in the first quarter of the calendar year for employers who are required to file on an expedited basis. The Commissioner has the authority to provide for reasonable extensions of time, upon written application, for an employer to furnish Forms W–2 to employees and file Forms W–2 and W– 3 with SSA. To assure that filers need not shift from magnetic media to paper filings in order to comply with the expedited filing requirements, the final regulations affirm that the Commissioner may adopt automatic extension procedures where appropriate.

It is anticipated that the Commissioner will establish automatic extension procedures to the extent necessary to permit employers that terminate operations a reasonable period of time, after the issuance of specifications, to make their filings on magnetic media.

It is further anticipated that these procedures will include appropriate automatic extensions of time to file expedited Forms W–2 both for employers required to file on magnetic media and for employers who have filed on magnetic media in the past whether or not required to do so. Even though Forms W–2 are furnished to employees on paper, the automatic extension procedures are anticipated to apply to the employee copy of the Form W–2 as well as the SSA copy in order to avoid the complexities and potential errors

that could arise from processing these forms at significantly different times.

It is also anticipated that the published procedure will provide for an automatic extension to a specified date which permits employers a reasonable period of time after the issuance of specifications to make their filings on magnetic media. This date will be communicated to filers sufficiently early in the year to permit adequate systems planning. In providing for these procedures, it is necessary to balance the practical issues of compliance with the concern for timely submission of information to SSA. Thus, if prior to a future year, it is anticipated that specifications will be issued sufficiently early in the year to permit a reasonable period of time for filing, while still complying with the due dates otherwise required in this regulation, the Commissioner may suspend the automatic extension procedures for that year. Discretionary extensions would continue to be considered on a case-by-case basis.

Comments are requested on the automatic extension procedures and their implementation.

Regulation section 301.6011–2(c)(4) provides that the Commissioner may, upon application, waive the requirement to file on magnetic media in the case of hardship. The final regulations clarify that the unavailability of the specifications for magnetic media filing of Form W–2 will be treated as creating a hardship. Therefore, an employer has the option of applying for a waiver from the requirement to file Forms W–2 on magnetic media and may instead file the Forms W–2 on paper. The employer must apply for a waiver within 45 days of the due date of the return.

Employers may also contact their local SSA Magnetic Media Coordinator for guidance on how to report on magnetic media. The Coordinators are listed in the annual Technical Instructions Bulletin (TIB–4) published by SSA.

Extension Procedures

Regulation section 31.6051–1(d)(2) provides procedures for an employer to request an extension of time to furnish Forms W–2 to employees. Regulation section 31.6081(a)–1 provides similar procedures for employers to request an extension of time to file Forms W–2 and W–3 with SSA. These procedures apply to employers who are required to furnish Forms W–2 to employees or file

Forms W–2 and W–3 with SSA on an expedited basis. Thus, an employer who, under the final regulations, is required to furnish and file the Forms W– 2 on an expedited basis may request an extension of time if necessary.

Additional month to provide Forms W– 2 and W–3 to SSA

Under existing regulations Forms W– 2 and W–3 are due to SSA one month after they are due to the employees. This provides employers an opportunity to correct any errors found by employees before filing the Forms W–2 with SSA. Some commentators noted that providing the Forms W–2 to SSA at the same time the forms are provided to the employees eliminates the opportunity for corrections currently provided by the regulations. To minimize the need for employers to file corrected Forms W–2 (Form W–2c, Statement of Corrected Income and Tax Amounts), the final regulations include a suggested one month additional period for providing the Forms W–2 to SSA. Thus, Forms W–2 would be due to employees at the same time as the final Form 941 (generally one month after the end of the quarter). Forms W–2 and W–3 would be due to SSA two months after the final Form 941 is due.

Modification of Revenue Procedure 84–77

In Revenue Procedure 84–77, 1984–2 C.B. 753, the IRS provided procedures for preparing and filing certain forms, including Form 941, Form W–2 and Form W–3, when a successor employer acquires substantially all of the property (1) used in a trade or business of a predecessor employer, or (2) used in a separate unit of a trade or business of a predecessor, and in connection with, or immediately after the acquisition (but during the same calendar year) the successor employs individuals who were employed in the trade or business of the predecessor immediately prior to the acquisition. Under the standard procedure described in Rev. Proc. 84–77, both the predecessor and successor employer report the wages they paid employees on Form W–2. Under the alternate procedure, the predecessor is relieved from furnishing Form W–2 to any employee who is employed by the successor employer and from filing such Forms W–2 with SSA. Instead, the suc

Section 31.6051–1(d) also issued under 26 U.S.C. 6051. Section 31.6051–2 also issued under 26 U.S.C. 6051 * * * Section 31.6071–1 also issued under 26 U.S.C. 6071 * * * Section 31.6081–1 also issued under 26 U.S.C. 6081 * * *

Par. 2. Section 31.6051–1, paragraph (d) is amended as follows:

Paragraph (d)(1) is redesignated as (d)(1)(i).
Paragraph (d)(1)(ii) is added.
Paragraph (d)(2) is revised. The addition and revision read as follows:

§31.6051–1 Statements for employees .

(d) - * * (1)(i) * * * (ii) Expedited furnishing —(A) Gen- eral rule . If an employer is required to make a final return under §31.6011(a)– 6(a)(1) (relating to the final return for Federal Insurance Contributions Act taxes and income tax withholding from wages) on Form 941, or a variation thereof, the employer must furnish the statement required by this section on or before the date required for filing the final return. See §31.6071(a)–1(a)(1). However, if the final return under §31.6011(a)–6(a)(1) is a monthly return, as described in §31.6011(a)–5, the employer must furnish the statement required by this section on or before the last day of the month in which the final return is required to be filed. See §31.6071(a)–1(a)(2). Except as provided in paragraph (d)(2)(i) of this section, in no event may an employer furnish the statement required by this section later than January 31 of the year succeeding the calendar year to which it relates. The requirements set forth in this paragraph (d)(1)(ii) do not apply to employers with respect to employees whose wages are for domestic service in the private home of the employer. See §31.6011(a)–1(a)(3).

(B) Requests by employees . An employer is not permitted to furnish a statement pursuant to the provisions of the third sentence of paragraph (d)(1)(i) of this section (relating to written requests by terminated employees for Form W–2) at a time later than that required by the provisions of paragraph (d)(1)(ii)(A) of this section.

cessor employer assumes the predecessor’s reporting obligation for those employees. The preamble to the proposed regulation stated that, other than modifying the time frame for the standard procedure, the proposed regulation would not affect the validity of Rev. Proc. 84–77.

One commentator questioned whether the proposed regulation expedited the filing requirements for the predecessor employer with regard to individuals who are not employed by the successor employer. If the predecessor employer ceases to pay wages, ( i.e., is required to file a final Form 941), the predecessor employer is required under these regulations to furnish Forms W–2 on an expedited basis to those individuals who are not employed by the successor employer. The predecessor employer must also file Forms W–2 and W–3 with SSA on an expedited basis for those individuals who are not employed by the successor employer. Revenue Procedure 84–77 is being modified to reflect this change.

Some commentators asked how the proposed regulations apply in the context of mergers. If a final Form 941 is not filed because a merger does not involve the cessation of business operations but only a change in corporate or business form, the expedited filing requirements are inapplicable.

Use of an agent

One commentator suggested the final regulations provide an exception from expedited filing for an employer that appoints an agent to assume the employer’s reporting obligation. A similar exception was suggested in the case of a controlled group of corporations in which one member of the group acts as the payroll agent for the group. Because there is no practically effective enforceable manner for shifting liability for reporting from an employer to an agent and for assuring that the agent will satisfy the reporting obligations, these suggestions were not adopted.

Application to Returns filed by Employers for Employees in Guam, U.S. Virgin Islands, American Samoa, Commonwealth of the Northern Mariana Islands and Puerto Rico.

One commentator questioned whether the proposed regulations applied to wage statements furnished to employees

and filed with SSA by employers for employees in Guam, U.S. Virgin Islands, American Samoa, Commonwealth of the Northern Mariana Islands and Puerto Rico. While these employers file variations of the Forms 941, W–2 and W–3, they are subject to the filing requirements for Forms 941, W–2 and W–3. In addition, employees of these employers receive social security credit on the same basis as employers who file the Forms 941, W–2 and W–3. Thus, these employers are subject to the regulations.

Special Analyses

It has been determined that this Treasury decision is not a significant regulatory action as defined in EO 12866. Therefore, a regulatory assessment is not required. It also has been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) and the Regulatory Flexibility Act (5 U.S.C. chapter 6) do not apply to these regulations, and, therefore, a Regulatory Flexibility Analysis is not required. Pursuant to section 7805(f) of the Internal Revenue Code, the notice of proposed rulemaking preceding these regulations was submitted to the Small Business Administration for comment on its impact on small business.

Drafting Information

The principal author of these regulations is Jean M. Casey, Office of the Associate Chief Counsel (Employee Benefits and Exempt Organizations), IRS. However, other personnel from the IRS and Treasury Department participated in their development.

- - - - -

Adoption of Amendments to the Regulations

Accordingly, 26 CFR part 31 and part 301 are amended as follows:

PART 31—EMPLOYMENT TAXES AND COLLECTION OF INCOME TAX AT SOURCE

Paragraph 1. The authority citation for part 31 is amended by adding the following entries in numerical order to read as follows:

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

(2) Extensions of time —(i) In general ( a ) The Director, Martinsburg Computing Center, may grant an extension of time in which to furnish to employees the statements required by this section. A request may be made by a letter to the Director, Martinsburg Computing Center. The request must contain:

(1) The employer’s name and address ;

(2) The employer’s taxpayer identi- fication number ;

(3) The type of return (i.e., Form W– 2) ; and (4) A concise statement of the rea- sons for requesting the extension .

( b ) The application must be mailed or delivered on or before the applicable due date prescribed in paragraph (d)(1) of this section for furnishing the statements required by this section.

( c ) In any case in which an employer is unable, by reason of illness, absence, or other good cause, to sign a request for an extension, any person standing in close personal or business relationship to the employer may sign the request on his behalf, and shall be considered as a duly authorized agent for this purpose, provided the request sets forth a reason for a signature other than the employer’s and the relationship existing between the employer and the signer. For provisions relating to extensions of time for filing the Social Security Administration copies of the statement, see §31.6081(a)–1(a)(3).

(ii) Automatic Extension of Time . The Commissioner may, in appropriate cases, publish procedures for automatic extensions of time to furnish Forms W– 2 where the employer is required to furnish the Form W–2 on an expedited basis.

- - - - -

Par. 3. Section 31.6051–2, paragraph (c), first sentence is revised to read as follows:

§31.6051–2 Information returns on Form W–3 and Internal Revenue Service copies of Form W–2.

- - - - -

(c) Cross references . For provisions relating to the time for filing the information returns required by this section and to extensions of the time for filing, see §§ 31.6071(a)–1(a)(3) and 31.6081(a)–1(a)(3), respectively. * * *

Par. 4. Section 31.6071(a)–1(a)(3) is amended as follows:

Paragraph (a)(3)(i) is removed.
Paragraph (a)(3)(ii) is redesignated as paragraph (a)(3)(i) and the heading is revised.
A new paragraph (a)(3)(ii) is added.

The addition and revision read as follows:

§31.6071(a)–1 Time for filing returns and other documents .

(a) - * * (3) - * * (i) General rule . * * * (ii) Expedited filing —(A) General rule . If an employer who is required to make a return pursuant to §31.6011(a)– 1 or §31.6011(a)–4 is required to make a final return on Form 941, or a variation thereof, under §31.6011(a)–6(a)(1) (relating to the final return for Federal Insurance Contributions Act taxes and income tax withholding from wages), the return which is required to be made under §31.6051–2 must be filed on or before the last day of the second calendar month following the period for which the final return is filed. The requirements set forth in this paragraph (a)(3)(ii) do not apply to employers with respect to employees whose wages are for domestic service in the private home of the employer. See §31.6011(a)– 1(a)(3). (B) Effective date . This paragraph (a)(3)(ii) is effective January 1, 1997.

- - - - -

Par. 5. Section 31.6081(a)–1(a)(3) is revised to read as follows:

§31.6081(a)–1 Extensions of time for filing returns and other documents .

(a) - * * (3) Information returns of employers on Forms W–2 and W–3 —(i) In gen- eral . The Director, Martinsburg Computing Center, may grant an extension of time in which to file the Social Security Administration copy of Forms W–2 and the accompanying transmittal form which constitutes an information return under paragraph §31.6051–2(a). The request must contain a concise statement of the reasons for requesting the extension. The request must be mailed or delivered on or before the date on which the employer is required to file the Form W–2 with the Social Security Administration.

(ii) Automatic Extension of Time . The Commissioner may, in appropriate cases, publish procedures for automatic extensions of time to file Forms W–2 where the employer is required to file the Form W–2 on an expedited basis.

- - - - -

PART 301—PROCEDURE AND ADMINISTRATION

Par. 6. The authority citation for part 301 continues to read in part as follows: Authority: 26 U. S. C. 7805 * * * Par. 7. Section 301.6011–2(c)(4)(i) is revised to read as follows:

§301.6011–2 Required use of magnetic media .

- - - - -

(c) - * * (4) Waiver . (i) The Commissioner may waive the requirements of this section if hardship is shown in a request for waiver filed in accordance with this paragraph (c)(4)(i). The principal factor in determining hardship will be the amount, if any, by which the cost of filing the information returns in accordance with this section exceeds the cost of filing the returns on other media. Notwithstanding the forgoing, if an employer is required to make a final return on Form 941, or a variation thereof, and expedited filing of Forms W–2 is required, the unavailability of specifications for magnetic media filing will be treated as creating a hardship. See §31.6071(a)–1(a)(3)(ii). A request for waiver should be filed at least 45 days before the due date of the information return in order for the Service to have adequate time to respond to the request for waiver. The waiver will specify the type of information return and the period to which it applies and will be subject to such terms and conditions regarding the method of reporting as may be prescribed by the Commissioner.

- - - - -

Margaret Milner Richardson,

Commissioner of

Internal Revenue.

Approved December 12, 1995.

Leslie Samuels, Assistant Secretary of

the Treasury

(Filed by the Office of the Federal Register on

December 20, 1995, 8:45 a.m., and published in the issue of the Federal Register for December 21, 1995, 60 F.R. 66139)

26 CFR 1.6061–1: Signing of returns and other documents by individuals.

What are the requirements for participation in the 1996 On-Line Filing Program for the Form 1040 series? See Rev. Proc. 96–20, page 88.

Section 6061.—Signing of Returns and Other Documents

26 CFR 31.6061–1: Signature of returns and other documents.

Procedures for signing a reporting agent authorization and tax returns are described. See Rev. Proc. 96–17, page 69.

Section 6071.—Time for Filing Returns and Other Documents

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

Time for filing Forms 940, 941, and 945 is provided. See Rev. Proc. 96–18, page 73.

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

Time for filing Form 941 is provided. See Rev. Proc. 96–19, page 80.

Section 6302.—Mode or Time of Collection

26 CFR 31.6302–1: Federal tax deposit rules for withheld income taxes and taxes under the Federal Insurance Contributions Act (FICA) attributable to payments made after December 31, 1992.

Scope of a reporting agent’s authorization to transmit federal tax deposit payments is described. See Rev. Proc. 96–17, page 69.

26 CFR 31.6302–1T: Federal tax deposit rules for withheld income taxes and taxes under the Federal Insurance Contributions Act (FICA)— deposits required to be made by electronic funds transfer after December 31, 1994 (temporary).

Scope of a reporting agent’s authorization to transmit electronic federal tax deposits is described. See Rev. Proc. 96–17, page 69.