Part I. Rulings — Internal Revenue Bulletin 1997-6

Section 45B.—Credit for Portion of Employer Social Security Taxes Paid With Respect To Employee Cash Tips

26 CFR 1.45B–1T: Credit for certain employer social security taxes paid with respect to employee tips (Temporary).

T.D. 8699

DEPARTMENT OF THE TREASURY Internal Revenue Service 26 CFR Part 1

Credit for Employer Social Security Taxes Paid on Employee Tips

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Removal of temporary regulations.

SUMMARY: This document removes the temporary regulations pertaining to the credit for employer FICA taxes paid with respect to certain tips received by employees of food or beverage establishments. The temporary regulations were published in the Federal Register on December 23, 1993. Statutory changes made by the Small Business Job Protection Act of 1996 have made these temporary regulations obsolete.

EFFECTIVE DATE: The removal of the temporary regulations is effective January 1, 1994.

FOR FURTHER INFORMATION CONTACT: Jean M. Casey at (202) 622– 6060 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

On December 23, 1993, the IRS published temporary regulations (T.D. 8503

[1994–1 C.B. 17])(58 FR 68033) under section 45B of the Internal Revenue Code of 1986 (Code). Amendments made by section 1112(a) of the Small Business Job Protection Act of 1996 (Public Law 104–188) render the temporary regulations obsolete. Therefore, temporary regulation § 1.45B–1T is being removed.

On December 23, 1993, the IRS also issued a notice of proposed rulemaking (EE–71–93 [1994–1 C.B. 784])(58 FR 68091) under section 45B of the Code. This notice of proposed rulemaking is

being withdrawn in a separate document.

Explanation of Provisions

Section 45B of the Code describes a business tax credit allowable under section 38 for food and beverage establishments. The credit is equal to the employer’s Federal Insurance Contributions Act (FICA) obligation attributable to certain employee tips. The credit is reduced, however, if the nontip wages paid to an employee during a month are less than the amount that would have been payable to the employee at the federal minimum wage rate. The temporary regulations provide that this credit is available only for employer FICA taxes paid after December 31, 1993, with respect to tips received for services performed after December 31, 1993. The temporary regulations also provide that the credit applies only to taxes paid on tips that are reported to the employer by its employees.

Section 1112(a) of the Small Business Job Protection Act of 1996 amended Code section 45B to provide that the credit is available for employer FICA taxes paid after December 31, 1993, regardless of when the services with respect to which the tips are received were performed. Section 1112(a) also provides that the credit is available whether or not the tips on which the employer FICA taxes were paid were reported to the employer by the employee. These provisions are effective as if included in the legislation under which section 45B was originally enacted, and thus render the temporary regulations obsolete.

Drafting Information

The principal author of these regulations is Jean M. Casey of the 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.

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Removal of Temporary Regulations

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 - -

§ 1.45B–1T [Removed]

Par. 2. Section 1.45B–1T is removed.

Margaret Milner Richardson, Commissioner of Internal Revenue.

Approved December 11, 1996.

Donald C. Lubick, Acting Assistant Secretary

of the Treasury.

(Filed by the Office of the Federal Register on December 19, 1996, 8:45 a.m., and published in the issue of the Federal Register for December 20, 1996, 61 F.R. 67212)

Section 56.—Adjustments in Computing Alternative Minimum Taxable Income

26 CFR 1.55–1: Alternative minimum taxable income.

Will the Internal Revenue Service provide approval for taxpayers engaged in the business of farming to change their method of accounting for the income from certain deferred payment sales contracts for purposes of computing their alternative minimum tax. See Notice 97–13, page 13.

Section 1377.—Definitions and Special Rules

26 CFR 1.1377: Pro rata share.

T.D. 8696

DEPARTMENT OF THE TREASURY Internal Revenue Service 26 CFR Parts 1, 18, and 602

Definitions under Subchapter S of the Internal Revenue Code

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final and temporary regulations.

SUMMARY: This document contains final regulations for S corporations and their shareholders relating to the definitions and the special rule provided in section 1377 of the Internal Revenue Code. The final regulations reflect changes to the law made by the Subchapter S Revision Act of 1982 and the Small Business Job Protection Act of 1996. These final regulations are necessary to provide guidance for taxpayers to comply with the law.

EFFECTIVE DATE: These regulations are effective January 1, 1997.

FOR FURTHER INFORMATION CONTACT: Laura Howell, (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 1545–1462. Responses to this collection of information are required to verify the event giving rise to the making of an election under section 1377(a)(2) by an S corporation.

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 varies from .2 hour to .5 hour, depending on individual circumstances, with an estimated average of .25 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 Of- fice of Management and Budget, Attn: Desk Officer for the Department of the Treasury, Office of Information and Regulatory Affairs, Washington, DC 20503. Books or records relating to this collection of information must be retained as long as their contents may become material in the administration 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 12, 1995, the IRS published in the Federal Register a notice of proposed rulemaking (PS–268–82, 1995–2 C.B. 491) containing proposed amendments to the Income Tax Regulations (26 CFR part 1) under section 1377 of the Internal Revenue Code (Code). These amendments were proposed to conform the regulations to the addition of section 1377 to the Code by section 2 of the Subchapter S Revision Act of 1982, Public Law 97–354 (1982–2 C.B. 702, 710). Written comments responding to this notice were received. No public hearing was held because no hearing was requested. On

August 20, 1996, the Small Business Job Protection Act of 1996, Public Law 104–188, 110 Stat. 1755, was enacted. Sections 1306 and 1307 of the Small Business Job Protection Act of 1996 amended section 1377 of the Code. After consideration of all comments received, and the changes to section 1377 by the Small Business Job Protection Act of 1996, the proposed amendments are adopted as revised by this Treasury decision.

Explanation of Provisions

Days on which stock has not been issued

Section 1366(a)(1) requires a shareholder of an S corporation to take into account the shareholder’s pro rata share of the corporation’s items of income, loss, deduction, and credit. Section 1377(a) provides that, except in the case of an election under section 1377(a)(2), each shareholders’s pro rata share of any item for any taxable year shall be the sum of the amounts determined with respect to the shareholder by assigning an equal portion of such item to each day of the taxable year, and then by dividing that portion pro rata among the shares outstanding on such day. The proposed regulations provide that solely for purposes of determining a shareholder’s pro rata share of an item, an S corporation’s taxable year does not include any day on which the corporation has no shareholders.

One commentator suggested that a person who beneficially owns the corporation should be treated as a shareholder of an S corporation for any day on which the corporation has assets and conducts business, but has not issued any stock. The final regulations revise the rule concerning no shareholder days and provide that, solely for purposes of determining a shareholder’s pro rata share of an item for a taxable year under section 1377(a), the beneficial owners of the corporation are treated as the shareholders of the corporation for any day on which the corporation has not issued any stock.

When a Post-Termination Transition Pe- riod Arises

The proposed regulations provide that a post-termination transition period (PTTP) arises following the termination under section 1362(d) of a corporation’s S election. By example, the proposed regulations state that a PTTP arises when a C corporation acquires the assets

of an S corporation in a transaction to which section 381(a)(2) applies. Several commentators requested clarification concerning whether the example results in a termination under section 1362(d) of the corporation’s election to be an S corporation or merely the cessation of the S corporation’s taxable year. The final regulations clarify that, pursuant to the rule in section 1377(b)(1), a PTTP arises the day after the last day that an S corporation was in existence if a C corporation acquires the assets of an S corporation in a transaction to which section 381(a)(2) applies. Changes to section 1377 made by the Small Business Job Protection Act of 1996.

Agreement to Terminate Year

Section 1306 of the Small Business Job Protection Act of 1996 amended section 1377(a)(2) to provide that only the affected shareholders and the corporation must consent to an election to treat the corporation’s taxable year as two taxable years in the event of a complete termination of a shareholder’s interest in the corporation. In addition, the terminating election under section 1377(a)(2) applies only to the affected shareholders. H.R. Conf. Rep. No. 104– 737, 104th Cong. 2d Sess. 222 (1986). The term affected shareholders is defined as the shareholder whose interest is terminated and all shareholders to whom the shareholder has transferred shares during the taxable year. If the shareholder has transferred shares to the corporation, affected shareholders include all persons who are shareholders during the taxable year. The final regulations reflect these changes made to section 1377(a)(2) by the Small Business Job Protection Act of 1996.

Expansion of Post-Termination Transi- tion Period

Section 1307(a) of the Small Business Job Protection Act of 1996 expands the definition of PTTP under section 1377(b)(1) to include the 120-day period beginning on the date of any determination pursuant to an audit of the taxpayer that follows the termination of the S corporation’s election and that adjusts a subchapter S item of income, loss, or deduction of the S corporation during the S period. In addition, the definition of determination is expanded to include any determination under section 1313(a). The effect of this change is to expand the definition of determination to include a final disposition by the Secre

tary of a claim for refund and certain agreements between the Secretary and any person relating to the tax liability of the person. The final regulations reflect these changes made to section 1377(b) by section 1307 of the Small Business Job Protection Act of 1996.

Coordination With Other Provisions and Other Clarifying Changes

In response to comments, the final regulations add cross-references and make certain clarifying revisions. The proposed regulations coordinate the application of the terminating election under section 1377(a)(2) with the election that may be made under § 1.1368– 1(g)(2) when there is a qualifying disposition by: (i) removing the section 1377 reference in § 1.1368–1(g)(1) because all of the rules for a section 1377(a)(2) terminating election are now entirely stated in these final regulations; and (ii) amending § 1.1368–1(g)(2) to provide that a qualifying disposition election cannot be made if a transfer results in a termination of the shareholder’s entire interest as a shareholder.

The proposed regulations provide that a section 1377(a)(2) terminating election must contain the written consent of each shareholder. The final regulations revise the shareholder consent rules by removing the written consent requirement for each shareholder. The final regulations merely require an S corporation to include a statement by the corporation that each affected shareholder and the corporation consent to the election.

In response to comments, the final regulations clarify that a shareholder’s entire interest in an S corporation is not terminated if the shareholder retains ownership of any stock, including an interest treated as stock under § 1.1361– 1(l), that would result in the shareholder continuing to be considered a shareholder of the corporation for purposes of section 1362(a)(2). In addition, the final regulations clarify that a shareholder whose entire interest in an S corporation is terminated in an event for which a terminating election was made is not required to consent to an election under section 1377(a)(2) for a subsequent termination of another shareholder within the taxable year unless the shareholder is an affected shareholder with respect to the subsequent termination.

Effective Date

These regulations apply to taxable years of an S corporation beginning after December 31, 1996.

Special Analysis

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) does not apply to these regulations, and because the notice of proposed rulemaking preceding the regulations was issued prior to March 29, 1996, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not apply. 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 Laura Howell, Office of Assistant Chief Counsel (Passthroughs and Special Industries). However, other personnel from the IRS and Treasury Department participated in their development.

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Adoption of Amendments to the Regula- tions

Accordingly, 26 CFR parts 1, 18, and 602 are amended as follows:

PART 1—INCOME TAXES

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

Authority: 26 U.S.C. 7805. - - Section 1.1377–1 also issued under 26 U.S.C. 1377(a)(2) and (c). - - Par. 2. Section 1.1368–0 is amended by:

Revising the entry for paragraphs (g) and (g)(1) of § 1.1368–1.
Adding an entry for paragraph (g)(2)(iv) of § 1.1368–1.

The revisions and addition read as follows:

§ 1.1368–0 Table of contents.

- - - -

§ 1.1368–1 Distributions by S corpora- tions.

- - - - (g) Special rule.

(1) Election to terminate year under § 1.1368–1(g)(2).

(2) - -

(iv) Coordination with election under section 1377(a)(2).

- - - - Par. 3. Section 1.1368–1 is amended

by:

Revising the heading for paragraph (g).
Revising paragraph (g)(1).
Adding paragraph (g)(2)(iv). The revisions and addition read as follows:

§ 1.1368–1 Distributions by S corpora- tions.

- - - -

(g) Special rule —(1) Election to ter- minate year under § 1.1368–1(g)(2). If an election is made under paragraph (g)(2) of this section to terminate the year when there is a qualifying disposition, this section applies as if the taxable year consisted of separate taxable years, the first of which ends at the close of the day on which there is a qualifying disposition of stock.

(2) - - (iv) Coordination with election under section 1377(a)(2). If the event resulting in a qualifying disposition also results in a termination of a shareholder’s entire interest as described in § 1.1377– 1(b)(4), the election under this paragraph (g)(2) cannot be made. Rather, the election under section 1377(a)(2) and § 1.1377–1(b) may be made. See § 1.1377–1(b) (concerning the election under section 1377(a)(2)). Par. 4. Sections 1.1377–0, 1.1377–1, 1.1377–2, and 1.1377–3 are added under the undesignated center heading ‘‘Small Business Corporations and Their Shareholders’’ to read as follows:

§ 1.1377–0 Table of contents.

The following table of contents is provided to facilitate the use of §§ 1.1377–1 through 1.1377–3:

§ 1.1377–1 Pro rata share.

(a) Computation of pro rata shares. (1) In general. (2) Special rules. (i) Days on which stock has not been issued.

(ii) Determining shareholder for day of stock disposition.

(b) Election to terminate year. (1) In general. (2) Affected shareholders. (3) Effect of the terminating election. (i) In general. (ii) Due date of S corporation return.

(iii) Taxable year of inclusion by shareholder.

(iv) S Corporation that is a partner in a partnership.

(4) Determination of whether an S shareholder’s entire interest has terminated.

(5) Time and manner of making a terminating election.

(i) In general. (ii) Affected shareholders required to consent.

(iii) More than one terminating election.

§ 1.1377–2 Post-termination transition period.

(a) In general. (b) Special rules for post-termination transition period.

(1) Determination under section 1313(a). (2) Written agreement. (3) Implied agreement.

§ 1.1377–3 Effective date.

§ 1.1377–1 Pro rata share.

(a) Computation of pro rata shares (1) In general. For purposes of subchapter S of chapter 1 of the Internal Revenue Code and this section, each shareholder’s pro rata share of any S corporation item described in section 1366(a) for any taxable year is the sum of the amounts determined with respect to the shareholder by assigning an equal portion of the item to each day of the S corporation’s taxable year, and then dividing that portion pro rata among the shares outstanding on that day. See paragraph (b) of this section for rules pertaining to the computation of each shareholder’s pro rata share when an election is made under section 1377(a)(2) to treat the taxable year of an S corporation as if it consisted of two taxable years in the case of a termination of a shareholder’s entire interest in the corporation.

(2) Special rules —(i) Days on which stock has not been issued. Solely for purposes of determining a shareholder’s pro rata share of an item for a taxable year under section 1377(a) and this section, the beneficial owners of the corporation are treated as the shareholders of the corporation for any day on which the corporation has not issued any stock.

(ii) Determining shareholder for day of stock disposition. A shareholder who disposes of stock in an S corporation is treated as the shareholder for the day of the disposition. A shareholder who dies is treated as the shareholder for the day of the shareholder’s death.

(b) Election to terminate year —(1) In general. If a shareholder’s entire interest in an S corporation is terminated during the S corporation’s taxable year and the corporation and all affected shareholders agree, the S corporation may elect under section 1377(a)(2) and this paragraph (b) (terminating election) to apply paragraph (a) of this section to the affected shareholders as if the corporation’s taxable year consisted of two separate taxable years, the first of which ends at the close of the day on which the shareholder’s entire interest in the S corporation is terminated. If the event resulting in the termination of the shareholder’s entire interest also constitutes a qualifying disposition as described in § 1.1368–1(g)(2)(i), the election under § 1.1368–1(g)(2) cannot be made. An S corporation may not make a terminating election if the cessation of a shareholder’s interest occurs in a transaction that results in a termination under section 1362(d)(2) of the corporation’s election to be an S corporation. (See section 1362(e)(3) for an election to have items assigned to each short taxable year under normal tax accounting rules in the case of a termination of a corporation’s election to be an S corporation.) A terminating election is irrevocable and is effective only for the terminating event for which it is made.

(2) Affected shareholders. For purposes of the terminating election under section 1377(a)(2) and paragraph (b) of this section, the term affected sharehold- ers means the shareholder whose interest is terminated and all shareholders to whom such shareholder has transferred shares during the taxable year. If such shareholder has transferred shares to the corporation, the term affected sharehold- ers includes all persons who are shareholders during the taxable year.

(3) Effect of the terminating elec- tion —(i) In general. An S corporation that makes a terminating election for a taxable year must treat the taxable year as separate taxable years for all affected shareholders for purposes of allocating items of income (including tax-exempt income), loss, deduction, and credit; making adjustments to the accumulated adjustments account, earnings and profits, and basis; and determining the tax

effect of a distribution. An S corporation that makes a terminating election must assign items of income (including taxexempt income), loss, deduction, and credit to each deemed separate taxable year using its normal method of accounting as determined under section 446(a). (ii) Due date of S corporation return. A terminating election does not affect the due date of the S corporation’s return required to be filed under section 6037(a) for a taxable year (determined without regard to a terminating election).

(iii) Taxable year of inclusion by shareholder. A terminating election does not affect the taxable year in which an affected shareholder must take into account the affected shareholder’s pro rata share of the S corporation’s items of income, loss, deduction, and credit.

(iv) S corporation that is a partner in a partnership. A terminating election by an S corporation that is a partner in a partnership is treated as a sale or exchange of the corporation’s entire interest in the partnership for purposes of section 706(c) (relating to closing the partnership taxable year), if the taxable year of the partnership ends after the shareholder’s interest is terminated and within the taxable year of the S corporation (determined without regard to any terminating election) for which the terminating election is made.

(4) Determination of whether an S shareholder’s entire interest has termi- nated. For purposes of the terminating election under section 1377(a)(2) and paragraph (b) of this section, a shareholder’s entire interest in an S corporation is terminated on the occurrence of any event through which a shareholder’s entire stock ownership in the S corporation ceases, including a sale, exchange, or other disposition of all of the stock held by the shareholder; a gift under section 102(a) of all the shareholder’s stock; a spousal transfer under section 1041(a) of all the shareholder’s stock; a redemption, as defined in section 317(b), of all the shareholder’s stock, regardless of the tax treatment of the redemption under section 302; and the death of the shareholder. A shareholder’s entire interest in an S corporation is not terminated if the shareholder retains ownership of any stock (including an interest treated as stock under § 1.1361– 1(l)) that would result in the shareholder continuing to be considered a shareholder of the corporation for purposes of section 1362(a)(2). Thus, in determining

whether a shareholder’s entire interest in an S corporation has been terminated, any interest held by the shareholder as a creditor, employee, director, or in any other non-shareholder capacity is disregarded.

(5) Time and manner of making a terminating election —(i) In general. An S corporation makes a terminating election by attaching a statement to its timely filed original or amended return required to be filed under section 6037(a) (that is, a Form 1120S) for the taxable year during which a shareholder’s entire interest is terminated. A single election statement may be filed by the S corporation for all terminating elections for the taxable year. The election statement must include—

(A) A declaration by the S corporation that it is electing under section 1377(a)(2) and this paragraph (b) to treat the taxable year as if it consisted of two separate taxable years;

(B) Information setting forth when and how the shareholder’s entire interest was terminated (for example, a sale or gift);

(C) The signature on behalf of the S corporation of an authorized officer of the corporation under penalties of perjury; and

(D) A statement by the corporation that the corporation and each affected shareholder consent to the S corporation making the terminating election.

(ii) Affected shareholders required to consent. For purposes of paragraph (b)(5)(i)(D) of this section, a shareholder of the S corporation for the taxable year is a shareholder as described in section 1362(a)(2). For example, the person who under § 1.1362–6(b)(2) must consent to a corporation’s S election in certain special cases is the person who must consent to the terminating election. In addition, an executor or administrator of the estate of a deceased affected shareholder may consent to the terminating election on behalf of the deceased affected shareholder.

(iii) More than one terminating elec- tion. A shareholder whose entire interest in an S corporation is terminated in an event for which a terminating election was made is not required to consent to a terminating election made with respect to a subsequent termination within the same taxable year unless the shareholder is an affected shareholder with respect to the subsequent termination.

Example 1. Shareholder’s pro rata share in the case of a partial disposition of stock. (i) On January 6, 1997, X incorporates as a calendar year corporation, issues 100 shares of common stock to each of A and B, and files an election to be an S corporation for its 1997 taxable year. On July 24, 1997, B sells 50 shares of X stock to C. Thus, in 1997, A owned 50 percent of the outstanding shares of X on each day of X’s 1997 taxable year, B owned 50 percent on each day from January 6, 1997, to July 24, 1997 (200 days), and 25 percent from July 25, 1997, to December 31, 1997 (160 days), and C owned 25 percent from July 25, 1997, to December 31, 1997 (160 days). (ii) Because B’s entire interest in X is not terminated when B sells 50 shares to C on July 24, 1997, X cannot make a terminating election under section 1377(a)(2) and paragraph (b) of this section for B’s sale of 50 shares to C. Although B’s sale of 50 shares to C is a qualifying disposition under § 1.1368–1(g)(2)(i), X does not make an election to terminate its taxable year under § 1.1368–1(g)(2). During its 1997 taxable year, X has nonseparately computed income of $720,000.

(iii) For each day in X’s 1997 taxable year, A’s daily pro rata share of X’s nonseparately computed income is $1,000 ($720,000/360 days x 50%). Thus, A’s pro rata share of X’s nonseparately computed income for 1997 is $360,000 ($1,000 x 360 days). B’s daily pro rata share of X’s nonseparately computed income is $1,000 ($720,000/360 x 50%) for the first 200 days of X’s 1997 taxable year, and $500 ($720,000/360 x 25%) for the following 160 days in 1997. Thus, B’s pro rata share of X’s nonseparately computed income for 1997 is $280,000 (($1,000 x 200 days)

($500 x 160 days)). C’s daily pro rata share of X’s nonseparately computed income is $500 ($720,000/360 x 25%) for 160 days in 1997. Thus, C’s pro rata share of X’s nonseparately computed income for 1997 is $80,000 ($500 x 160 days).

Example 2. Shareholder’s pro rata share when an S corporation makes a terminating election under section 1377(a)(2). (i) On January 6, 1997, X incorporates as a calendar year corporation, issues 100 shares of common stock to each of A and B, and files an election to be an S corporation for its 1997 taxable year. On July 24, 1997, B sells B’s entire 100 shares of X stock to C. With the consent of B and C, X makes an election under section 1377(a)(2) and paragraph (b) of this section for the termination of B’s entire interest arising from B’s sale of 100 shares to C. As a result of the election, the pro rata shares of B and C are determined as if X’s taxable year consisted of two separate taxable years, the first of which ends on July 24, 1997, the date B’s entire interest in X terminates. Because A is not an affected shareholder as defined by section 1377(a)(2)(B) and paragraph (b)(2) of this section, the treatment as separate taxable years does not apply to A.

(ii) During its 1997 taxable year, X has nonseparately computed income of $720,000. Under X’s normal method of accounting, $200,000 of the $720,000 of nonseparately computed income is allocable to the period of January 6, 1997, through July 24, 1997 (the first deemed taxable year), and the remaining $520,000 is allocable to the period of July 25, 1997, through December 31, 1997 (the second deemed taxable year).

(iii) B’s pro rata share of the $200,000 of nonseparately computed income for the first deemed taxable year is determined by assigning the $200,000 of nonseparately computed income to each day of the first deemed taxable year ($200,000/200 days = $1,000 per day). Because B held 50% of X’s authorized and issued shares on

each day of the first deemed taxable year, B’s daily pro rata share for each day of the first deemed taxable year is $500 ($1,000 per day x 50%). Thus, B’s pro rata share of the $200,000 of nonseparately computed income for the first deemed taxable year is $100,000 ($500 per day x 200 days). B must report this amount for B’s taxable year with or within which X’s full taxable year ends (December 31, 1997).

(iv) C’s pro rata share of the $520,000 of nonseparately computed income for the second deemed taxable year is determined by assigning the $520,000 of nonseparately computed income to each day of the second deemed taxable year ($520,000/160 days = $3,250 per day). Because C held 50% of X’s authorized and issued shares on each day of the second deemed taxable year, C’s daily pro rata shares for each day of the second deemed taxable year is $1,625 ($3,250 per day x 50%). Therefore, C’s pro rata share of the $520,000 of nonseparately computed income is $260,000 ($1,625 per day x 160 days). C must report this amount for C’s taxable year with or within which X’s full taxable year ends (December 31, 1997).

§ 1.1377–2 Post-termination transition period.

(a) In general. For purposes of subchapter S of chapter 1 of the Internal Revenue Code (Code) and this section, the term post-termination transition pe- riod means—

(1) The period beginning on the day after the last day of the corporation’s last taxable year as an S corporation and ending on the later of—

(i) The day which is 1 year after such last day; or

(ii) The due date for filing the return for the last taxable year as an S corporation (including extensions);

(2) The 120-day period beginning on the date of any determination pursuant to an audit of the taxpayer which follows the termination of the corporation’s election and which adjusts a subchapter S item of income, loss, or deduction of the corporation arising during the S period (as defined in section 1368(e)(2)); and (3) The 120-day period beginning on the date of a determination that the corporation’s election under section 1362(a) had terminated for a previous taxable year.

(b) Special rules for post-termination transition period. Pursuant to section 1377(b)(1) and paragraph (a)(1) of this section, a post-termination transition period arises the day after the last day that an S corporation was in existence if a C corporation acquires the assets of the S corporation in a transaction to which section 381(a)(2) applies. However, if an S corporation acquires the assets of another S corporation in a transaction to which section 381(a)(2) applies, a post

termination transition period does not arise. (See § 1.1368–2(d)(2) for the treatment of the acquisition of the assets of an S corporation by another S corporation in a transaction to which section 381(a)(2) applies.) The special treatment under section 1371(e)(1) of distributions of money by a corporation with respect to its stock during the post-termination transition period is available only to those shareholders who were shareholders in the S corporation at the time of the termination.

(c) Determination defined. For purposes of section 1377(b)(1) and paragraph (a) of this section, the term deter- mination means—

(1) A determination as defined in section 1313(a);

(2) A written agreement between the corporation and the Commissioner (including a statement acknowledging that the corporation’s election to be an S corporation terminated under section 1362(d)) that the corporation failed to qualify as an S corporation;

(3) For a corporation subject to the audit and assessment provisions of subchapter C of chapter 63 of subtitle A of the Code, the expiration of the period specified in section 6226 for filing a petition for readjustment of a final S corporation administrative adjustment finding that the corporation failed to qualify as an S corporation, provided that no petition was timely filed before the expiration of the period; and

(4) For a corporation not subject to the audit and assessment provisions of subchapter C of chapter 63 of subtitle A of the Code, the expiration of the period for filing a petition under section 6213 for the shareholder’s taxable year for which the Commissioner has made a finding that the corporation failed to qualify as an S corporation, provided that no petition was timely filed before the expiration of the period.

(d) Date a determination becomes ef- fective —(1) Determination under section 1313(a). A determination under paragraph (c)(1) of this section becomes effective on the date prescribed in section 1313 and the regulations thereunder.

(2) Written agreement. A determination under paragraph (c)(2) of this section becomes effective when it is signed by the district director having jurisdiction over the corporation (or by another Service official to whom authority to sign the agreement is delegated) and by an officer of the corporation authorized to sign on its behalf. Neither the request for a written agreement nor the terms of

- - - 1.1377–1 . . . . . . . . . . . . 1545–1462

Margaret Milner Richardson, Commissioner of Internal Revenue.

the written agreement suspend the running of any statute of limitations.

(3) Implied agreement. A determination under paragraph (c)(3) or (4) of this section becomes effective on the day after the date of expiration of the period specified under section 6226 or 6213, respectively.

§ 1.1377–3 Effective date.

Sections 1.1377–1 and 1.1377–2 apply to taxable years of an S corporation beginning after December 31, 1996.

PART 18—TEMPORARY INCOME TAX REGULATIONS UNDER THE SUBCHAPTER S REVISION ACT OF 1982

Par. 5. The authority citation for part 18 continues to read as follows:

Authority: 26 U.S.C. 7805.

Section 18.1377–1 [Removed]

Par. 6. Section 18.1377–1 is removed.

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 as follows:

Removing the following entry from the table:

§ 602.101 OMB Control numbers.

- - - - (c) - -

CFR part or section where identified and described

Current

OMB control No.

- - - 18.1377–1 . . . . . . . . . . . 1545–0130

Adding an entry in numerical order to the table to read as follows:

§ 602.101 OMB Control numbers.

- - - - (c) - -

CFR part or section where identified and described

Current OMB control

No.

Approved November 1, 1996.

Donald C. Lubick, Acting Assistant Secretary

of the Treasury.

(Filed by the Office of the Federal Register on December 20, 1996, 8:45 a.m., and published in the issue of the Federal Register for December 23, 1996, 61 F.R. 67454)

Section 4082.—Exemptions for Diesel Fuel

26 CFR 48.4082–5T: Diesel fuel; Alaska (tempo- rary).

T.D. 8693

DEPARTMENT OF THE TREASURY Internal Revenue Service 26 CFR Part 48

Diesel Fuel Excise Tax; Special Rules for Alaska

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Temporary regulations.

SUMMARY: This document contains temporary regulations relating to the application of the diesel fuel excise tax to fuel used in Alaska. The regulations implement certain changes made by the Small Business Job Protection Act of 1996. They affect certain enterers, refiners, retailers, terminal operators, throughputters, wholesale distributors, and users. The text of these regulations also serves as the text of REG–247678– 96, page 17, this Bulletin.

DATES: These regulations are effective December 17, 1996. For dates of applicability of these regulations, see §§ 48.4082–5T(g) and 48.6715–2T(b).

FOR FURTHER INFORMATION CONTACT: Frank Boland (202) 622– 3130 (not a toll-free call).

SUPPLEMENTARY INFORMATION:

Background

Section 4081 imposes a tax on certain removals, entries, and sales of diesel fuel. However, under section 4082, tax is not imposed if, among other conditions, the diesel fuel is indelibly dyed in accordance with Treasury regulations. Dyed diesel fuel can be used legally in nontaxable uses such as for heating oil, as fuel in stationary engines, or as fuel in nonhighway vehicles. A substantial penalty under section 6715 applies if

dyed diesel fuel is used for a taxable purpose such as in a registered highway vehicle.

A similar dyeing regime for diesel fuel is required by regulations issued under the Clean Air Act. That Act prohibits the use on highways of diesel fuel with a sulfur content exceeding prescribed levels. The Environmental Protection Agency (EPA) requires this ‘‘high sulfur’’ diesel fuel to be dyed.

Section 1801 of the Small Business Job Protection Act of 1996 amends section 4082 to create an exception to the IRS dyeing requirement. Under this amendment, which is effective October 1, 1996, the IRS dyeing requirement does not apply to diesel fuel that is removed, entered, or sold in a state for ultimate sale or use in an area of such state during the period such area is exempted from EPA’s sulfur content and fuel dyeing requirements if the use of the fuel is certified pursuant to Treasury regulations.

Section 211(i)(4) of the Clean Air Act allows EPA to exempt the states of Alaska and Hawaii from the Clean Air Act’s sulfur content requirements. In response to a petition from Alaska, the EPA granted a permanent exemption for remote areas of Alaska (that is, areas that are not served by the Federal Aid Highway System). In addition, a temporary exemption was granted for urban areas. This temporary exemption, which was originally scheduled to expire after September 30, 1996, has been extended by the EPA (61 FR 42812 (August 19, 1996)) for 24 months, or until a decision is made on Alaska’s petition for a permanent exemption, whichever period is shorter.

Thus, under current EPA rules, the entire state of Alaska is exempt from the Clean Air Act’s sulfur content requirements and, consequently, from the EPA’s dyeing requirements. No part of Hawaii or any other state is similarly exempt.

Explanation of Provisions

These temporary regulations generally establish a system for collecting the federal diesel fuel tax at the wholesale level in Alaska. This system is similar to the pre-1994 federal system under section 4091 and the present system used by the state of Alaska for state fuel tax. The person liable for tax under the temporary regulations generally will be

a person who is licensed by Alaska as a qualified dealer.

Under the temporary regulations, a qualified dealer may buy undyed diesel fuel tax free at a terminal rack and sell the fuel tax free to another qualified dealer or to a buyer for the buyer’s own nontaxable use. However, a qualified dealer is liable for tax when it sells to a buyer for the buyer’s taxable use or to a reseller that is not a qualified dealer.

A qualified dealer must keep adequate records to document the exempt nature of its nontaxable sales. Although the temporary regulations do not prescribe any specific documentation, taxpayers may consider using a format similar to the notification certificate in § 48.4081–5 as proof of tax-free sales between qualified dealers. As proof of tax-free sales for nontaxable uses, taxpayers may consider using Alaska’s exemption certificate, when appropriate, or an adaptation of the certificate presently used to support tax-free sales of aviation fuel that is found in Notice 88–132, 1988–2 C.B. 552, 555. The IRS will consider whether the final regulations should specify model certificates to be used for documenting nontaxable transactions in the future.

Taxpayers are cautioned that the uses that are exempt from Alaska’s state tax are not identical to the uses that are exempt from the federal tax. For example, Alaska exempts sales to all nonprofit organizations described in section 501(c)(3); the comparable federal rule exempts only sales to nonprofit educational organizations.

Taxpayers should also note that diesel fuel that is dyed in accordance with existing IRS regulations will continue to be exempt from the section 4081 tax in Alaska.

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) does not apply to these regulations and, because these regulations do not impose on small entities a collection of information requirement, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not apply. Therefore, a Regulatory Flexibility Analysis is not required. Pursuant to section 7805(f) of the Internal Revenue Code, this temporary regulation will be

submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on its impact on small business.

Drafting Information

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

- - - -

Adoption of Amendments to the Regula- tions

Accordingly, 26 CFR part 48 is amended as follows:

PART 48—MANUFACTURERS AND RETAILERS EXCISE TAXES

Paragraph 1. The authority citation for part 48 is amended by adding an entry in numerical order to read in part as follows:

Authority: 26 U.S.C. 7805 - - Section 48.4082–5T also issued under 26 U.S.C. 4082. - - Par. 2. Section 48.4082–5T is added to read as follows:

§ 48.4082–5T Diesel fuel; Alaska (tem- porary).

(a) Application . This section applies to diesel fuel removed, entered, or sold in Alaska for ultimate sale or use in an exempt area of Alaska.

(b) Definitions. Exempt area of Alaska means the area of Alaska in which the sulfur content requirements for diesel fuel (see section 211(i) of the Clear Air Act (42 U.S.C. 7545(i))) do not apply because the Administrator of the Environmental Protection Agency has granted an exemption under section 211(i)(4) of that Act.

Nontaxable use means a use described in section 4082(b). Qualified dealer means any person that holds a qualified dealer license from the state of Alaska.

(c) Tax-free removals and entries . Notwithstanding § 48.4082–1, tax is not imposed by section 4081 on the removal or entry of any diesel fuel in an exempt area of Alaska if—

(1) The person that would be liable for tax under § 48.4081–2 or 48.4081–3 is a taxable fuel registrant and satisfies the requirements of paragraph (e) of this section;

Customs Service. The Act directed the Treasury Department to adopt temporary regulations to implement the new section.

On March 11, 1994, temporary regulations were published in the Federal Register (59 FR 11547) specifying the procedure by which return information may be disclosed to officers and employees of the United States Customs Service, and describing the conditions and restrictions on the use and redisclosure of that information. A notice of proposed rulemaking (DL–21– 94) cross-referencing the temporary regulations was published in the Fed- eral Register for the same day (59 FR 11566). The IRS received two comments on the proposed regulations but did not hold a public hearing. After consideration of the comments, this Treasury decision adopts the proposed regulations without revision. The comments are discussed below.

Explanation of Provisions

The regulations authorize disclosure of return information only to the extent necessary to the purposes authorized by the statute, i.e., ascertaining the correctness of entries in audits under the Tariff Act of 1930 and other actions to recover any loss of revenue or collect amounts determined to be due and owing as a result of these audits. The regulations permit redisclosure to the Department of Justice for civil enforcement actions related to these collection efforts. Consistent with the statute’s legislative history, the regulations prohibit disclosure of information (i) relating to Advance Pricing Agreements (as described in Rev. Proc. 91–22 (1991–1 C.B. 526)), or (ii) covered by tax treaties and executive agreements with respect to which the United States is a party. The regulations also specifically prohibit any use or redisclosure of the information by the Customs Service in a manner inconsistent with section 6103 and the regulations.

Notice to Taxpayers/Importers

One commentator suggested that the regulations should provide taxpayers with advance notice of a Customs Service request for tax data and an opportunity to comment upon or object to the request. The legislation authorizing these disclosures did not, however, make any provision for such advance notice and pre-disclosure challenges to Customs

(2) In the case of a removal from a terminal, the terminal is an approved terminal; and

(3) The owner of the diesel fuel immediately after the removal or entry holds the fuel for its own use in a nontaxable use or is a qualified dealer.

(d) Sales after removals and en- tries —(1) In general . Paragraph (c) of this section does not apply with respect to diesel fuel that is subsequently sold by a qualified dealer unless—

(i) The fuel is sold in an exempt area of Alaska;

(ii) The buyer purchases the fuel for its own use in a nontaxable use or is a qualified dealer; and

(iii) The seller satisfies the requirements of paragraph (e) of this section.

(2) Tax imposed at time of sale; liability for tax. Notwithstanding §§ 48.4081–2 and 48.4081–3, in any case in which paragraph (c) of this section does not apply with respect to diesel fuel because of a subsequent sale by a qualified dealer, the tax with respect to that fuel is imposed at the time of the subsequent sale and the qualified dealer is liable for the tax.

(3) Rate of tax. For the rate of tax, see section 4081.

(e) Evidence of tax-free transactions . The requirements of section 4082(c)(2) (relating to certification) and this paragraph (e) are satisfied if the person otherwise liable for tax is able to show the district director satisfactory evidence of the exempt nature of the transaction and has no reason to believe that the evidence is false. Satisfactory evidence may include copies of qualified dealer licenses or exemption certificates obtained for state tax purposes.

(f) Cross reference . For the tax on previously untaxed diesel fuel that is used for a taxable purpose, see § 48.4082–4.

(g) Effective date . This section is applicable with respect to diesel fuel removed or entered after December 31, 1996. Par. 3. Section 48.6715–2T is added to read as follows:

§ 48.6715–2T Application of section 6715(a)(3) to Alaska (temporary).

(a) In general . The penalty provided by section 6715(a)(3) for willful alteration of dyed fuel will not be assessed if the alteration occurs in an exempt area of Alaska.

(b) Effective date . This section is applicable October 1, 1996.

Margaret Milner Richardson, Commissioner of Internal Revenue.

Approved November 27, 1996.

Donald C. Lubick, Acting Assistant Secretary

of the Treasury.

(Filed by the Office of the Federal Register on December 16, 1996, 8:45 a.m., and published in the issue of the Federal Register for December 17, 1996, 61 F.R. 66215)

Section 6103.—Confidentiality and Disclosure of Returns and Return Information

26 CFR 301.6103(l)(14)–1: Disclosure of return information to United States Customs Service.

T.D. 8694

DEPARTMENT OF THE TREASURY Internal Revenue Service 26 CFR Part 301

Disclosure of Return Information to the U.S. Customs Service

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

SUMMARY: These amendments to the regulations under 26 CFR part 301 implement section 6103(l)(14) of the Internal Revenue Code, which authorizes the disclosure of certain return information to the U.S. Customs Service. The regulations specify the procedure by which return information may be disclosed and describe the conditions and restrictions on the use of the information by the U.S. Customs Service.

EFFECTIVE DATE: These regulations are effective December 17, 1996.

FOR FURTHER INFORMATION CONTACT: Donald Squires, 202–622–4570 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

The North American Free Trade Agreement Implementation Act (Act), Public Law 103–182, 107 Stat. 2057, was signed into law on December 8, 1993. Section 522 of the Act added section 6103(l)(14) to the Internal Revenue Code (Code), authorizing the IRS to disclose certain tax data to the U.S.

Service requests for disclosure of tax data. Such procedures would, moreover, run counter to the existing statutory scheme of section 6103. Disclosures under section 6103 are governed by the requirements of that statute and applicable regulations, none of which offers a procedural opportunity for a taxpayer to challenge, in advance, a proposed disclosure of tax information by the IRS.

The same commentator suggested that, in the alternative, a taxpayer should be notified in the event of a disclosure so the taxpayer can prepare its response to inquiries from the Customs Service that might be based on such tax data. Otherwise, the commentator argued, the taxpayer would be forced to defend itself against an ‘‘unexpressed suspicion’’ based on information the taxpayer does not know the Customs Service has obtained and possibly has misinterpreted.

Nothing in the statute’s legislative history suggests that Congress intended the Service to notify taxpayers upon disclosure of their tax data to the Customs Service. As noted above, such a requirement would be at odds with general practice under section 6103. Moreover, the IRS understands that the usual practice of the Customs Service is not to request information from the IRS unless the data has been first directly requested from, but not provided by, importers. When importers receive such a request, therefore, they will effectively be on notice, whether or not they choose to comply with the request, that the Customs Service is likely to consider tax information in the course of its audit.

Misinterpretation of Tax Data by Cus- toms

Both commentators expressed a concern that due to the different reporting requirements of the IRS and the Customs Service, tax data is susceptible to misinterpretation by Customs Service auditors. For example, it was noted that the cost of goods reported for tax pur

poses includes certain amounts ( e.g., duty, transportation, insurance, storage, design costs) not relevant to, or included in, the value of goods for customs purposes.

Congress was aware when it enacted the legislation, however, that IRS tax information may not correlate exactly with the information required to be reported to the Customs Service. Congress nonetheless concluded that the value of the tax information to the Customs Service would outweigh the possible difficulties caused by the necessity of adjusting the IRS data for use in Customs Service audits. Moreover, the Customs Service has informed the IRS that the Customs Service is committed to a policy of full disclosure and communication with importers during audits. In light of that policy, any apparent discrepancies between tax data and Customs Service reporting will be brought to the attention of the importer when discovered in order to allow the importer to explain or reconcile the data. The Customs Service also notes that importers have an additional opportunity to review and comment upon the findings of an auditor before the preparation of the auditor’s final report.

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) does not apply to these regulations, and because the notice of proposed rulemaking preceding the regulations was issued prior to March 29, 1996, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not apply. Pursuant to section 7805(f) of the Internal Revenue Code, the notice of proposed rulemaking preceding these regulations was submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on their impact on small business.

Drafting Information

The principal author of these regulations is Donald Squires, Office of the Assistant Chief Counsel (Disclosure Litigation), IRS. However, other personnel from the IRS, Customs Service and Treasury Department participated in their development.

List of Subjects in 26 CFR Part 301

Employment taxes, Estate taxes, Excise taxes, Gift taxes, Income taxes, Penalties, Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

Accordingly, 26 CFR part 301 is amended as follows:

PART 301—PROCEDURE AND ADMINISTRATION

Paragraph 1. The authority citation for part 301 is amended by removing the entry for Section 301.6103(l)(14)–1T’’ and adding an entry in numerical order to read as follows:

Authority: 26 U.S.C. 7805 - - Section 301.6103(l)(14)–1 also issued under 26 U.S.C. 6103(l)(14). - - § 301.6103(l)(14)–1T [Redesignated as § 301.6103(l)(14)–1]

Par. 2. Section 301.6103(l)(14)–1T is redesignated as § 301.6103(l)(14)–1 and the section heading is amended by removing the language ‘‘(temporary)’’.

Margaret Milner Richardson, Commissioner of Internal Revenue.

Approved November 13, 1996.

Donald C. Lubick, Acting Assistant Secretary

of the Treasury.

(Filed by the Office of the Federal Register on December 16, 1996, 8:45 a.m., and published in the issue of the Federal Register for December 17, 1996, 61 F.R. 66218)