Part IV. Item of General — Internal Revenue Bulletin 1997-8

Notice of Proposed Rulemaking and Notice of Public Hearing

Credit for Increasing Research Activities

REG–209494–90

AGENCY: Internal Revenue Service (IRS), Treasury.

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

SUMMARY: This document contains proposed regulations under section 41 of the Internal Revenue Code of 1986 describing when computer software which is developed by (or for the benefit of) a taxpayer primarily for the taxpayer’s internal use can qualify for the credit for increasing research activities. The proposed regulations reflect a change to section 41 made by the Tax Reform Act of 1986. This document also provides notice of a public hearing on these proposed regulations.

DATES: Comments and outlines of topics to be discussed at the public hearing scheduled for May 13, 1997 must be received by April 22, 1997.

ADDRESSES: Send submissions to: CC:DOM:CORP:R (REG–209494–90), room 5228, Internal Revenue Service, POB 7604, Ben Franklin Station, Washington, DC 20044. Submissions may be hand delivered between the hours of 8 a.m. and 5 p.m. to: CC:DOM:CORP:R (REG–209494–90), Courier’s Desk, Internal Revenue Service, 1111 Constitution Avenue NW, Washington, DC. Alternatively, taxpayers may submit comments electronically via the Internet by selecting the ‘‘Tax Regs’’ option of the IRS Home Page, or by submitting comments directly to the IRS Internet site at: http://www.irs.ustreas.gov/prod/ tax_regs/comments.html. The public hearing will be held in the auditorium, Internal Revenue Building, 1111 Constitution Avenue, NW, Washington, DC.

FOR FURTHER INFORMATION CONTACT: Concerning the regulations, Lisa J. Shuman or Robert B. Hanson, 202– 622–3120; concerning submissions and the hearing, Christina Vasquez, 202– 622–7180 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Background

Section 41 of the Internal Revenue Code provides a credit against tax for

increasing research activities. Eligibility for the credit is determined in part on the definition of qualified research under section 41(d)(1). Section 231 of the Tax Reform Act of 1986 (the 1986 Act), 1986–3 C.B. 1, 87, established a new definition of qualified research for purposes of the research credit. Qualified research was narrowed to require that research be undertaken for the purpose of discovering information that is technological in nature and the application of which is intended to be useful in developing a new or improved business component of the taxpayer. In addition, research is eligible for the credit only if substantially all of the activities of the research constitute elements of a process of experimentation for a new or improved function, performance, or reliability or quality. Treasury and the IRS request comments on the appropriate explanation of the terms used in the definition of qualified research under the 1986 Act, in particular, the term process of experimentation .

Section 231 of the 1986 Act also specified that expenditures incurred in certain research, research-related, and non-research activities are to be excluded from eligibility for the credit without reference to the general requirements for credit eligibility. Under section 41(d)(4)(E) of the Code, except to the extent provided in regulations, qualified research does not include research with respect to computer software developed by (or for the benefit of) the taxpayer primarily for the taxpayer’s own use (internal-use software), other than for use in (1) an activity which constitutes qualified research, or (2) a production process whose development meets the requirements in section 41(d)(1) for qualified research (as where the taxpayer is developing robotics and software for the robotics for use in operating a manufacturing process, and the taxpayer’s research costs of developing the robotics are eligible for the credit).

The legislative history indicates that Congress intended to limit the credit for the costs of developing internal-use software to software meeting a high threshold of innovation. In particular, Congress intended that regulations would permit internal-use software to qualify for the credit only if, in addition to satisfying the general requirements for credit eligibility, the taxpayer can establish that the following three-part test is

satisfied: the software is innovative (as where the software results in a reduction in cost, or improvement in speed, that is substantial and economically significant); the software development involves significant risk (as where the taxpayer commits substantial resources to the development of the software and there is substantial uncertainty, because of technical risk, that such resources would not be recovered in a reasonable period of time); and the software is not commercially available for use by the taxpayer (as where the software cannot be purchased, leased, or licensed and used for the intended purpose without modifications that would satisfy the first two requirements). See H.R. Rep. No. 841, 99th Cong., 2d Sess. II–73. Thus, Congress did not intend that the threepart test in the legislative history would apply in lieu of the general requirements for credit eligibility but, rather, intended that the general requirements for credit eligibility of section 41(d) also would have to be satisfied. See H.R. Rep. No. 841 at II–73. The legislative history indicates, however, that Congress did not intend the internal-use software exclusion in section 41(d)(4)(E) to apply to research related to the development of a new or improved package of software and hardware developed as a single product of which the software is an integral part, and that is used directly by the taxpayer in providing technological services to customers in its trade or business (as where a taxpayer develops together a new or improved high technology medical or industrial instrument containing software that processes and displays data received by the instrument, or where a telecommunications company develops a package of new or improved switching equipment plus software to operate the switches). See H.R. Rep. No. 841 at II–74.

Congress intended that regulations incorporating the three-part test in the legislative history as an exception to the exclusion from the definition of qualified research under section 41(d)(4)(E) would be effective on the same date section 41(d)(4)(E) became effective. In Notice 87–12 (1987–1 C.B. 432), the IRS stated that regulations to be issued under section 41(d)(4)(E) would be effective for taxable years beginning after December 31, 1985.

1997–8 I.R.B. 24

to computer software that is developed by (or for the benefit of) the taxpayer primarily for the taxpayer’s internal use is eligible for the research credit only if the software satisfies the requirements of paragraph (e)(2) of this section. Generally, research with respect to computer software is not eligible for the research credit where software is used internally, for example, in general and administrative functions (such as payroll, bookkeeping, or personnel management) or in providing noncomputer services (such as accounting, consulting, or banking services).

(2) Requirements. The requirements of this paragraph (e)(2) are—

(i) The software satisfies the requirements of section 41(d)(1);

(ii) The software is not otherwise excluded under section 41(d)(4) (other than section 41(d)(4)(E)); and

(iii) One of the following conditions is met—

(A) The taxpayer uses the software in an activity that constitutes qualified research (other than the development of the internal-use software itself);

(B) The taxpayer uses the software in a production process that meets the requirements of section 41(d)(1); or

(3) Computer software and hardware developed as a single product. This paragraph (e) does not apply to the development costs of a new or improved package of computer software and hardware developed together by the taxpayer as a single product, of which the software is an integral part, that is used directly by the taxpayer in providing technological services in its trade or business to customers. In these cases, eligibility for the research credit is to be determined by examining the combined hardware-software product as a single product.

(4) Primarily for internal use. All relevant facts and circumstances are to be considered in determining if computer software is developed primarily for the taxpayer’s internal use. If computer software is developed primarily for the taxpayer’s internal use, the requirements of this paragraph (e) apply even though the taxpayer intends to, or subsequently does, sell, lease, or license the computer software.

(5) Special rule. Computer software satisfies the special rule of this para

Explanation of Provisions

The proposed regulations follow the legislative history and provide that internal-use software that meets the general requirements of section 41(d), is innovative, involves significant economic risk, and is not commercially available for use by the taxpayer is not excluded from eligibility for the research credit under section 41(d)(4)(E). Under the proposed regulations, this is a facts and circumstances test. Treasury and the IRS request comments on facts and circumstances, other than those factors enumerated in the legislative history, to be considered in determining whether internal-use software satisfies the three-part test.

Proposed Effective Dates

The amendments are proposed to be effective for taxable years beginning after December 31, 1985.

Special Analyses

It has been determined that this notice of proposed rulemaking is not a significant regulatory action as defined in EO 12866. Therefore, a regulatory assessment is not required. It also has been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to these regulations, and because these regulations do not impose a collection of information on small entities, 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 notice of proposed rulemaking will be submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on its impact on small business.

Comments and Public Hearing

Before these proposed regulations are adopted as final regulations, consideration will be given to any comments that are submitted timely (in the manner described in the ADDRESSES portion of this preamble) to the IRS. All comments will be available for public inspection and copying.

A public hearing has been scheduled for May 13, 1997, at 10 a.m. in the auditorium, Internal Revenue Building, 1111 Constitution Avenue, NW, Washington, DC. Because of access restrictions, visitors will not be admitted beyond the building lobby more than 15 minutes before the hearing starts.

The rules of 26 CFR 601.601(a)(3) apply to the hearing.

Persons that wish to present oral comments at the hearing must submit (in the manner described in the ADDRESSES portion of this preamble) comments and an outline of the topics to be discussed and the time to be devoted to each topic by April 22, 1997.

A period of 10 minutes will be allotted to each person for making comments.

An agenda showing the scheduling of the speakers will be prepared after the deadline for receiving outlines has passed. Copies of the agenda will be available free of charge at the hearing.

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Proposed Amendments to the Regulations

Accordingly, 26 CFR parts 1 and 602 are proposed to be 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 1.41–4 also issued under 26 U.S.C. 41(d)(4)(E). - - Par. 2. Section 1.41–0 is amended by revising the entry for § 1.41–4 to read as follows:

§ 1.41–0 Table of contents.

- - - -

§ 1.41–4 Qualified research for taxable years beginning after December 31, 1985.

(a) through (d) [Reserved]. (e) Internal-use computer software. (1) General rule. (2) Requirements. (3) Computer software and hardware developed as a single product.

(4) Primarily for internal use. (5) Special rule. (6) Application of special rule. (7) Effective date.

- - - -

Par. 3. Section 1.41–4 is revised to read as follows:

§ 1.41–4 Qualified research for taxable years beginning after December 31, 1985.

(a) through (d) [Reserved]. (e) Internal-use computer software (1) General rule. Research with respect

25 1997–8 I.R.B.

graph (e)(5) only if the taxpayer can establish that—

(i) The software is innovative (as where the software results in a reduction in cost, or improvement in speed, that is substantial and economically significant);

(ii) The software development involves significant economic risk (as where the taxpayer commits substantial resources to the development and there is a substantial uncertainty, because of technical risk, that such resources would be recovered within a reasonable period); and

(iii) The software is not commercially available for use by the taxpayer (as where the software cannot be purchased, leased, or licensed and used for the intended purpose without modifications that would satisfy the requirements of paragraphs (e)(5)(i) and (ii) of this section).

(6) Application of special rule. In determining if the special rule of paragraph (e)(5) of this section is satisfied all of the facts and circumstances are considered. The special rule allows the costs of developing internal-use software to be eligible for the research credit only if the software meets a high threshold of innovation. The facts and circumstances analysis takes into account only the results attributable to the development of the new or improved software independent of the effect of any modifications to related hardware or other software. The weight given to any fact or circumstance will depend on the particular case.

(7) Effective date. This paragraph (e) is applicable for taxable years beginning after December 31, 1985.

§§ 1.41–0A through 1.41–8A [Removed]

Par. 4. Sections 1.41–0A through 1.41–8A and the undesignated centerheading preceding these sections are removed.

PART 602—OMB CONTROL NUMBERS UNDER THE PAPERWORK REDUCTION ACT

Par. 5. The authority citation for part 602 continues to read as follows:

Authority: 26 U.S.C. 7805.

Par. 6. In § 602.101, paragraph (c) is amended by removing the following entries from the table:

§ 602.101 OMB Control numbers.

- - - - (c) - -

CFR part or section where identified and described

Current OMB

control No.

comments electronically via the internet by selecting the ‘‘Tax Regs’’ option on the IRS Home Page, or by submitting comments directly to the IRS internet site at http://www.irs.ustreas.gov/prod/ tax_regs/comments.html. The public hearing will be held in the Auditorium, Internal Revenue Service Building, 1111 Constitution Avenue NW, Washington, DC.

FOR FURTHER INFORMATION CONTACT: Concerning the regulations, Gary Geisler, (202) 622–3970; concerning submissions and the hearing, Evangelista Lee, (202) 622–7190 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Background

A nonlife insurance company’s underwriting income equals its premiums earned on insurance contracts during the taxable year less its losses incurred and its expenses incurred. For taxable years beginning on or after January 1, 1993, a company’s premiums earned on insurance contracts during the taxable year is an amount equal to the gross premiums written on insurance contracts during the taxable year, less return premiums and premiums paid for reinsurance, plus 80 percent of unearned premiums at the end of the prior taxable year, less 80 percent of unearned premiums at the end of the current taxable year.

The gross premiums written for an insurance or reinsurance contract is the total amount charged by the insurance company for the insurance coverage provided under the contract, including amounts charged covering the company’s expenses and overhead. Written premiums are generally recorded for the full term of coverage for the year in which the contract is issued. Upon recording a written premium, the company establishes an unearned premium liability to reflect the portion of the written premium which relates to the unexpired portion of the insurance coverage.

The term ‘‘unearned premium’’ historically referred to the portion of the gross premiums written that would have to be returned to the policyholder upon cancellation of the policy and that was in direct proportion to the unexpired term of the policy. See, e.g., Buckeye Union Casualty Co. v. Commissioner, 448 F.2d 228, 230 (6th Cir. 1971), aff’g 54 T.C. 13, 20 n.5 (1970). Cases and rulings expanded this definition to include premiums paid for a future benefit, the cost of which was fixed when

- - - 1.41–4A. . . . . . . . . . . . . . 1545–0074

1.41–4(b) and (c) . . . . . . 1545–0074

Margaret Milner Richardson, Commissioner of Internal Revenue.

(Filed by the Office of the Federal Register on December 31, 1996, 8:45 a.m., and published in the issue of the Federal Register for January 2, 1997, 62 F.R. 81)

Notice of Proposed Rulemaking and Notice of Public Hearing

Determination of Earned Premiums

REG–209839–96

AGENCY: Internal Revenue Service (IRS), Treasury.

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

SUMMARY: This document contains proposed regulations relating to the requirement that insurance companies other than life insurance companies reduce by 20 percent their deductions for increases in unearned premiums. This requirement was enacted as part of the Tax Reform Act of 1986. These regulations are necessary in order to provide guidance to nonlife insurance companies that are subject to the 20 percent reduction rule. This document also contains a notice of a public hearing on the proposed regulations.

DATES: Written comments must be received by April 2, 1997. Requests to speak and outlines of oral comments to be discussed at the public hearing scheduled for April 30, 1997 at 10:00 a.m. must be received by April 2, 1997.

ADDRESSES: Send submissions to: CC:DOM:CORP:R (REG–209839–96), room 5226, Internal Revenue Service, POB 7604, Ben Franklin Station, Washington, DC 20044. Submissions may be hand delivered between the hours of 8 a.m. and 5 p.m. to: CC:DOM:CORP:R REG–209839–96), Courier’s Desk, Internal Revenue Service, 1111 Constitution Avenue NW, Washington, DC. Alternatively, taxpayers may submit the policy was issued. See, e.g., Massa- chusetts Protective Ass’n. v. United States, 114 F.2d 304 (1st Cir. 1940); C.P.A. Co. v. Commissioner, 7 T.C. 912 (1946) (nonlife company), acq. 1947–1 C.B. 1; Rev. Rul. 55–705, 1955–2 C.B. 280. But cf. Bituminous Casualty Corp. v. Commissioner, 57 T.C. 58 (1971), acq. in result 1973–2 C.B. 1 (stating in dictum that ‘‘unearned premiums’’ had a substantially broader definition than the one developed in the cases and rulings cited above).

Prior to 1987, the increase in unearned premiums during the taxable year was deducted from gross premiums written in the computation of premiums earned. For example, if a company on September 1st issued a one-year fire insurance policy with a premium of $1,200, the company on that date would record a gross written premium of $1,200 and establish a $1,200 unearned premium reserve. On December 31st, the company would have earned onethird of the premium, $400, but would have an $800 unearned premium reserve liability for the remaining eight months of coverage to be provided in periods after the close of the taxable year. The subtraction of the full amount of unearned premiums from the gross written premium ‘‘generally reflect[ed]’’ the accounting conventions (often referred to as ‘‘statutory accounting principles’’) used to prepare the annual statement for state insurance regulatory purposes. 2 H.R. Conf. Rep. No. 841, 99th Cong., 2d Sess. II–354 (1986), 1986–3 C.B. (Vol. 4) 354; S. Rep. No. 313, 99th Cong., 2d Sess. 495 (1986), 1986–3 C.B. (Vol. 3) 495; H.R. Rep. No. 426, 99th Cong., 1st Sess. 668 (1985), 1986–3 C.B. (Vol. 2) 668. A nonlife company generally deducts expenses incurred in the taxable year in which the expenses are reported on the company’s annual statement. These expenses include premium acquisition expenses attributable to unearned premiums.

In 1986, Congress determined that the combination of deferring unearned premiums and currently deducting premium acquisition expenses attributable to unearned premiums under the accounting conventions used to prepare a nonlife insurance company’s annual statement resulted in a mismatch of income and expense. Congress decided to require a better measurement of income for Federal income tax purposes. H.R. Rep. No. 426, 1986–3 C.B. (Vol. 2) at 669; S. Rep. No. 313, 1986–3 C.B. (Vol. 3) at

Rather than require a nonlife company to capitalize and amortize premium acquisition expenses, Congress reduced by 20 percent the current deduction for unearned premiums. See section 832(b)(4)(B); 2 H.R. Conf. Rep. No. 841, 1986–3 C.B. (Vol. 4) at 354–55; S. Rep. No. 313, 1986–3 C.B. (Vol. 3) at 495–98; H.R. Rep. No. 426, 1986–3 C.B. (Vol. 2) at 668–70. This reduction in unearned premiums is sometimes referred to as the ‘‘20 percent haircut.’’ The acceleration of income as a result of the 20 percent haircut is intended to be roughly equivalent to denying current deductibility for a portion of the premium acquisition expenses.

Congress intended the 20 percent haircut to apply to all amounts (other than life insurance reserves and title insurance reserves) that were considered unearned premiums for Federal income tax purposes as of 1986. The House Report states that ‘‘[a]ll items which are included in unearned premiums under section 832(b) of present law are subject to this reduction in the deduction.’’ H.R. Rep. No. 426, 1986–3 C.B. (Vol. 2) at 669. In describing the House bill, the Conference Report reiterates that ‘‘[a]ll items which are included in unearned premiums under section 832(b) of present law are subject to this reduction in the deduction’’ and describes the Senate amendment as ‘‘the same as the House bill, except that life insurance reserves which are included in unearned premium reserves under section 832(b)(4) are not subject to this reduction.’’ 2 H.R. Conf. Rep. No. 841, 1986–3 C.B. (Vol. 4) at 354–55. The Report’s description of the Conference agreement states that the agreement ‘‘follows the Senate amendment’’ but ‘‘provides special treatment of title insurance unearned premium reserves.’’ Id. See sections 832(b)(7) and (8) for the rules applicable to life insurance and title insurance reserves.

Following the imposition of the 20 percent haircut on unearned premiums, the National Association of Insurance Commissioners (NAIC) revised the statutory accounting principles used to prepare a nonlife insurance company’s annual statement. In general, these changes permitted a nonlife company to defer recording written premiums and/or to reduce the amount of unearned premiums reported on the company’s annual statement. The affected items included advance premiums, additional premiums on retrospectively rated insurance policies, and the reporting of writ

ten premiums for workers’ compensation policies and certain other casualty policies where the covered risk varies over the policy term.

Prior to 1989, advance premiums were required to be reported in written premiums and unearned premiums on the annual statement for the year in which the advance premiums were received. However, statutory accounting principles now permit advance premiums to be accumulated in a suspense account and reported as a write-in liability on the annual statement. A company electing to use this alternative treatment would not report advance premiums in either written premiums or unearned premiums on the annual statement until the effective date of the underlying coverage.

Statutory accounting principles also required a nonlife insurance company to record an estimated liability for payment of return premiums under retrospectively rated insurance policies (retro credits) as part of the unearned premium liability. Estimates of additional premiums due from insureds under these policies (retro debits) historically were not taken into account except as an offset to the company’s estimated liability for payment of retro credits. Thus, retro debits were not permitted to be shown as assets on the annual statement, and generally were not included in written premiums prior to the year in which the company billed the policyholder for these additional premiums. Beginning in 1988, however, the NAIC permitted retro debits to be shown in an insurance company’s admitted assets, subject to certain limitations. The NAIC currently has under consideration a proposal that would require retro credits to be recorded as a write-in liability on the annual statement, rather than as part of unearned premiums. This proposal would also permit retro credits and retro debits to be taken into account either as adjustments to written premiums or as adjustments to earned premiums for purposes of determining underwriting income on the annual statement.

A nonlife insurance company ordinarily reports the full amount of premiums provided in a casualty insurance policy (including any deferred premium installments) in written premiums and unearned premiums for the year in which the policy is issued. However, for workers’ compensation policies and certain other casualty policies where the covered risk varies over the policy term, some but not all state insurance regulators permit written premiums to be

27 1997–8 I.R.B.

recorded based on installment billings to the policyholder. If the insurance company issues these policies throughout the year, and the premiums for the policies are billed monthly, the portion of the total written premiums that would be shown as unearned premiums is substantially smaller than would be the case if the written premiums and unearned premiums were determined based on the entire policy term. The NAIC currently has under consideration proposed guidance that would require the full amount of the premiums provided in all casualty insurance policies to be reported in written premiums and unearned premiums on the effective date of the related coverage.

Section 832(b)(1)(A) provides that a nonlife insurance company’s income is computed on the basis of the underwriting and investment exhibit of the annual statement approved by the NAIC. Some companies assert that section 832(b)(1)(A) limits application of the 20 percent haircut to the amount of unearned premiums reported on the annual statement. Under this approach, a company that elects for annual statement purposes to report advance premiums as a write-in liability, to offset unearned premiums by retro debits, or to include deferred premiums on policies covering fluctuating risks in written premiums only when billed to the insured, reduces the amount of unearned premiums subject to the 20 percent haircut.

The existing regulations under § 1.832–4(a)(2) state that ‘‘[t]he underwriting and investment exhibit[,] . . . insofar as it is not inconsistent with the provisions of the Code will be recognized and used as a basis for [computing the net income of a nonlife insurance company].’’ However, the regulations recognize that not all items of the exhibit ‘‘reflect . . . income as defined in the Code.’’ Where statutory accounting principles permit a company to elect among alternative accounting practices, one or more of which do not clearly reflect income as defined by the Code, the company is required for Federal tax purposes to use a method that clearly reflects income. Section 446(b) and § 1.446–1(a)(2). Furthermore, an accounting practice used on the annual statement, although specifically mandated by statutory accounting principles, is not used for purposes of computing taxable income if that practice is inconsistent with the Code.

Overview of Proposed Regulations

The proposed regulations define gross premiums written, return premiums, and unearned premiums for tax purposes. The proposed regulations also provide rules for determining when gross premiums written, return premiums, and unearned premiums are taken into account for tax purposes. In this manner, the proposed regulations ensure that items such as advance premiums and retrospective premium adjustments are treated consistently for purposes of the 20 percent haircut on unearned premiums.

Explanation of Provisions

The starting point for determining a nonlife insurance company’s premiums earned for tax purposes is the ‘‘gross premiums written on insurance contracts during the taxable year.’’ Proposed § 1.832–4(a)(4)(i) defines ‘‘gross premiums written on insurance contracts’’ as the total amounts charged by the insurance company for insurance coverage under insurance or reinsurance contracts issued or renewed during the taxable year. Thus, ‘‘gross premiums written’’ includes collected and uncollected premiums.

Proposed § 1.832–4(a)(4)(ii) addresses the treatment of retro debits, which reflect estimates of additional premiums to be received from the insured or the reinsured based on the insurance company’s loss experience during expired coverage periods. Thus, retro debits represent additional gross premiums written rather than offsets to the unearned premium liability for unexpired coverage periods. Treating retro debits as offsets to unearned premiums would reduce the acceleration of income under the 20 percent haircut, and would allow some companies with retro debits exceeding their unearned premiums to report a lesser amount of earned premiums for Federal income tax purposes than for annual statement reporting purposes. This result is contrary to the Congressional intent to accelerate the rate at which premiums are earned for tax purposes in order to correct the mismatching of income and expenses on the annual statement. Accordingly, proposed § 1.832–4(a)(4)(ii) requires retro debits to be included in gross premiums written regardless of the manner in which the retro debits are reported on the underwriting exhibit of the annual statement.

Under section 832(b)(4)(A), an insurance company reduces the amount of gross premiums written on insurance contracts during the taxable year by return premiums and premiums paid for reinsurance. Proposed § 1.832–4(a)(5)(i) defines return premiums as amounts paid or credited to the policyholder in accordance with the terms of an insurance contract, other than policyholder dividends or claims and benefit payments. Thus, return premiums include amounts paid or credited to the policyholder with respect to endorsements and modifications of the terms of coverage of an insurance contract. Return premiums also include amounts returned or credited to the policyholder on cancellation of an insurance contract, including the unearned portion of any deferred or uncollected premiums previously included by the company in gross premiums written and unearned premiums. Finally, return premiums include amounts contractually required to be returned to the ceding company under a reinsurance contract.

The proposed regulations modify the treatment of retro credits under existing law for purposes of determining earned premiums. Since 1943, § 1.832– 4(a)(3)(ii) has provided that the liability for return premiums under a retrospectively rated policy is included in a nonlife company’s unearned premiums for tax purposes. Although retro credits were included in unearned premiums in 1986, these amounts are based on an insured’s loss experience during expired coverage periods, for which the company has already earned the premium. For this reason, proposed § 1.832– 4(a)(5)(ii) provides that a nonlife company’s provision for payment of a retro credit generally is included in return premiums that reduce gross premiums written. However, proposed § 1.832– 4(a)(6)(iv) gives a company the option to include retro credits in unearned premiums to which the 20 percent haircut applies.

The proposed regulations provide timing rules with respect to when a company reports gross premiums written and unearned premiums for tax purposes. Proposed § 1.832–4(a)(7) requires a company to report gross premiums written with respect to an insurance or reinsurance contract for the earlier of the taxable year which includes the effective date of the contract or the taxable year in which all or a part of the gross premium for the contract is received. Thus, the company must report gross premiums written with respect to an insurance contract for the year in which it collects an advance premium. By requiring advance premiums to be included in gross premiums written and unearned premiums, regardless of the manner in which the advance premiums are recorded on the annual statement, the proposed regulations ensure that the treatment of a nonlife insurance company’s advance premiums conforms with the treatment of advance premiums of a life insurance company under section 807(e)(7). The NAIC is considering proposed guidance that would require the premium for the entire term of a property and casualty insurance contract to be recorded as written premium on the effective date of the contract. The proposed NAIC guidance rejects the previous NAIC position that permitted written premiums for workers’ compensation policies and certain other casualty policies where the covered risk varies over the policy term to be recorded when billed. For this reason, the method of reporting gross premiums written for workers’ compensation policies and certain other casualty insurance policies covering fluctuating risks is reserved in the proposed regulations.

Proposed Effective Date

The proposed regulations are proposed to apply to the determination of premiums earned for insurance contracts issued or renewed in taxable years beginning after the date on which final regulations are published in the Federal Register .

Special Analyses

It has been determined that this notice of proposed rulemaking is not a significant regulatory action as defined in Executive Order 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 the regulations do not impose a collection of information on small entitles, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not apply. Pursuant to section 7805(f) of the Internal Revenue Code, this notice of proposed rulemaking will be submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on its impact on small business.

Comments and Public Hearing

Before these proposed regulations are adopted as final regulations, consideration will be given to any written comments (a signed original and 8 copies) that are submitted timely to the IRS. All comments will be available for public inspection and copying.

A public hearing has been scheduled for Wednesday, April 30, 1997 in the Auditorium, Internal Revenue Service Building, 1111 Constitution Avenue NW, Washington, DC. Because of access restrictions, visitors will not be admitted beyond the Internal Revenue Building lobby more than 15 minutes before the hearing starts.

The rules of 26 CFR 601.601(a)(3) apply to the hearing.

Persons that wish to present oral comments at the hearing must submit written comments by April 2, 1997 and submit an outline of the topics to be discussed and the time to be devoted to each topic (a signed original and 8 copies) by April 2, 1997.

A period of 10 minutes will be allotted to each person for making comments.

An agenda showing the scheduling of the speakers will be prepared after the deadline for receiving outlines has passed. Copies of the agenda will be available free of charge at the hearing.

Drafting Information

The principal author of this regulation is Gary Geisler, Office of Assistant Chief Counsel (Financial Institutions and Products). However, other personnel from the IRS and Treasury Department participated in their development.

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Proposed Amendments to the Regulations

Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART 1—INCOME TAXES

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

Authority: 26 U.S.C. 7805 - - Par. 2 Section 1.832–4 is amended as follows:

Paragraph (a)(3) is revised.
Paragraphs (a)(4) and (a)(5) are redesignated as (a)(9) and (a)(10).
New paragraphs (a)(4) through (a)(8) are added.

The additions and revisions read as follows:

§ 1.832–4 Gross income.

(a) - - (3) Premiums earned. The determination of premiums earned on insurance contracts during the taxable year begins with the insurance company’s gross premiums written on insurance contracts during the taxable year, reduced by return premiums and ceded reinsurance premiums. Subject to the exceptions in sections 832(b)(7), 832(b)(8), and 833(a)(3), this amount is increased by 80 percent of the unearned premiums at the end of the preceding taxable year, and is decreased by 80 percent of the unearned premiums at the end of the taxable year.

(4) Gross premiums written —(i) In general. An insurance company’s ‘‘gross premiums written on insurance contracts during the taxable year’’ are the total amounts charged by the insurance company for insurance coverage under insurance or reinsurance contracts issued or renewed by the company during the taxable year.

(ii) Debits on retrospectively rated insurance policies. Gross premiums written include an insurance company’s estimate of the gross additional premiums to be received from the insured or the reinsured with respect to the expired portion of a retrospectively rated insurance or reinsurance contract (retro debits). The retro debits are reported for the taxable year in which the amounts can be reasonably estimated based on information used to compute the insurance company’s loss reserves. An insurance company adjusts gross premiums written to reflect payments from the insured or the reinsured with respect to retro debits, as well as changes in the estimate of retro debits.

(5) Return premiums —(i) In general. Return premiums are amounts paid or credited to the policyholder in accordance with the terms of an insurance contract, other than policyholder dividends or claims and benefit payments. For example, return premiums include amounts returned or credited to the policyholder based on modifications of the terms of an insurance contract. Return premiums also include amounts contractually required to be returned to the ceding company pursuant to a reinsurance contract.

(ii) Credits on retrospectively rated insurance policies. Except as provided in paragraph (a)(6)(iv) of this section, return premiums include an insurance company’s estimate of the gross liability

29 1997–8 I.R.B.

(ii) For the taxable year ending December 31, 1998, IC reports the $500 premium provided in A’s policy in gross premiums written under section 832(b)(4)(A). IC also claims a reduction under section 832(b)(4)(B) for 80% of the $250 of unearned premiums ($200) associated with the policy at the end of the taxable year.

Example 2. (i) The facts are the same as Example 1, except that the term of coverage for the fire insurance policy issued to A begins on January 1, 1999 and ends on December 31, 1999. On December 15, 1998, IC receives $125 from A and agrees to apply this amount as the first premium installment due on the policy.

(ii) Under paragraph (a)(7)(i) of this section, IC reports gross premiums written for the policy issued to A for the taxable year in which the advance premium is received. Thus, for the taxable year ending December 31, 1998, IC includes $500 in its gross premiums written under section 832(b)(4)(A). IC also claims a reduction under section 832(b)(4)(B) for 80% of the $500 of unearned premiums ($400) associated with the policy at the end of the taxable year.

(8) Effective date. Paragraphs (a)(3) through (a)(7) of this section are applicable with respect to the determination of premiums earned for insurance contracts issued or renewed during taxable years beginning after the date on which final regulations are published in the Federal Register .

- - - -

Michael P. Dolan, Acting Commissioner of

Internal Revenue.

(Filed by the Office of the Federal Register on December 31, 1996, 8:45 a.m., and published in the issue of the Federal Register for January 2, 1997, 62 F.R. 72)

Notice of Proposed Rulemaking and Notice of Public Hearing

Recomputation of Life Insurance Reserves

REG–246018–96

AGENCY: Internal Revenue Service (IRS), Treasury.

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

SUMMARY: This document contains proposed regulations relating to the definition of life insurance reserves. The proposed regulations permit the taxpayer or the IRS to recompute certain reserves if those reserves were initially computed or estimated on other than an actuarial basis. The proposed regulations affect both life insurance companies and property and casualty insurance companies. This document also contains a notice of a public hearing on the proposed regulations.

for return premiums to be paid or credited to the insured or the reinsured with respect to the expired portion of a retrospectively rated insurance or reinsurance contract (retro credits). The retro credits are included in return premiums for the taxable year in which the insurance company’s liability to pay or credit these amounts can be reasonably estimated based on information used to compute the company’s loss reserves. An insurance company adjusts return premiums to reflect payments made or amounts credited to the insured or the reinsured with respect to retro credits, as well as changes in the estimate of retro credits.

(iii) Unpaid premiums on cancelled policies. If an insurance contract is cancelled, an insurance company includes in return premiums the unearned portion of any deferred or uncollected premiums previously included in gross premiums written and unearned premiums.

(6) Unearned premiums —(i) In gen- eral. The unearned premium for an insurance or reinsurance contract is the portion of the gross premiums written which is attributable to future insurance coverage to be provided under the contract. An insurance company makes an appropriate adjustment to its unearned premiums for an insurance or reinsurance contract if the contract is reinsured with, or retroceded to, another insurance company.

(ii) Special rules. In computing ‘‘premiums earned on insurance contracts during the taxable year,’’ the amount of unearned premiums includes—

(A) Life insurance reserves (as defined in section 816(b), but computed in accordance with section 807(d));

(B) In the case of a mutual flood or fire insurance company described in section 832(b)(1)(D) (with respect to contracts described in that section) the amount of unabsorbed premium deposits which the company would be obligated to return to its policyholders at the close of the taxable year if all its policies were terminated at that time;

(C) In the case of an interinsurer or reciprocal underwriter which reports unearned premiums on its annual statement net of premium acquisition expenses, the unearned premiums on the company’s annual statement increased by the portion of premium acquisition expenses allocable to those unearned premiums;

(D) In the case of a title insurance company, its discounted unearned premiums (computed in accordance with section 832(b)(8)); and

(E) Amounts treated as unearned premiums pursuant to the optional treatment provided in paragraph (a)(6)(iv) of this section.

(iii) Method of determining unearned premiums. If the risk of loss under an insurance or reinsurance contract arises uniformly over the contract period, the unearned premium attributable to the portion of the insurance coverage which has not expired is computed on a pro rata basis. If the risk of loss does not arise uniformly over the contract period, the insurance company may consider the pattern or incidence of the risk in determining the portion of the gross premium written which is attributable to the portion of the insurance coverage which has not yet expired.

(iv) Option to include retro credits in unearned premiums. An insurance company may include retro credits in unearned premiums under section 832(b)(4) for its first taxable year beginning after the date on which final regulations are published in the Federal Register . Any company exercising this option must apply it consistently to all retro credits with respect to retrospectively rated insurance or reinsurance contracts issued or renewed during the taxable year and all subsequent years.

(7) Method of reporting gross premi- ums written —(i) In general. An insurance company reports gross premiums written with respect to an insurance or reinsurance contract for the earlier of the taxable year which includes the effective date of the contract or the taxable year in which all or a part of the gross premium for the contract is received.

(ii) Method of reporting gross premi- ums written on policies covering fluctu- ating risks. [Reserved]

(iii) Examples. The provisions of this paragraph (a)(7) are illustrated by the following examples:

Example 1. (i) IC is a nonlife insurance company which, pursuant to section 843, files its returns on a calendar year basis. On July 1, 1998, IC issues a fire insurance policy to A, an individual. The policy provides coverage for a oneyear term beginning on July 1, 1998 and ending on June 30, 1999. The premium provided in the policy is $500, which may be paid either in full on the policy effective date or in quarterly installments of $125. A selects the installment payment option. As of December 31, 1998, the policy issued to A remains in force, and IC has collected a total of $250 of installment premiums from A. Assume IC has issued no other policies.

1997–8 I.R.B. 30

DATES: Written comments must be received by April 2, 1997. Requests to speak and outlines of oral comments to be discussed at the public hearing scheduled for Thursday, April 17, 1997, at 10 a.m. must be received by Thursday, March 27, 1997.

ADDRESSES: Send submissions to: CC:DOM:CORP:R (REG–246018–96), room 5226, Internal Revenue Service, POB 7604, Ben Franklin Station, Washington, DC 20044. Submissions may be hand delivered between the hours of 8 a.m. and 5 p.m. to: CC:DOM:CORP:R (REG–246018–96), Courier’s Desk, Internal Revenue Service, 1111 Constitution Avenue NW, Washington, DC. Alternatively, taxpayers may submit comments electronically via the Internet by selecting the ‘‘Tax Regs’’ option on the IRS Home Page, or by submitting comments directly to the IRS Internet site at http://www.irs.ustreas.gov/prod/ tax_regs/comments.html. The public hearing will be held in the Commissioner’s conference room, room 3313, Internal Revenue Service Building, 1111 Constitution Avenue, NW, Washington, DC.

FOR FURTHER INFORMATION CONTACT: Concerning the regulations, Ann Cammack, (202) 622–3970; concerning submissions and the hearing, Evangelista Lee, (202) 622–7190 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Background

To qualify as a life insurance reserve for purposes of Part I of subchapter L of the Internal Revenue Code, a reserve must satisfy various requirements, including the requirement in section 816(b)(1)(A) and § 1.801–4(a)(1) that it be ‘‘computed or estimated on the basis of recognized mortality or morbidity tables and assumed rates of interest.’’ Qualifying as a life reserve under section 816(b) has various consequences. Life reserves are included in the numerator and denominator of the reserve ratio test of section 816(a), which is used to determine when an insurance company is taxed as a life insurance companyunder Part I of subchapter L. Increases in life reserves as defined in section 816(b) are taken into account under section 807(c)(1). In addition, life reserves as defined in section 816(b) are considered part of a nonlife company’s unearned premiums under section 832(b)(4).

Two circuits have construed former section 801(b)(1)(A), which was recodified as section 816(b)(1)(A) in 1984, to prevent reserves held with respect to life, annuity or noncancellable accident and health policies but not computed or estimated using actuarial tables from qualifying as life reserves. The IRS also has held that life reserves must be computed or estimated using actuarial tables under former section 801(b)(1)(A). See e.g., Rev. Rul. 69–302 (1969–2 C.B. 186). The Claims Court, in contrast, has concluded that the statute and regulation do not necessarily require the insurance company to compute its life reserves using actuarial tables, when a different method results in reserves that ‘‘reasonably approximate’’ actuarial reserves.

Rev. Rul. 69–302 held that not only were life reserves required to be computed or estimated on the basis of recognized mortality or morbidity tables and assumed rates of interest, but that reserves for credit life insurance contracts could not be retroactively recomputed in a manner that would enable them to qualify as life reserves. Neither of the cases cited in Rev. Rul. 69–302, however, addressed the question of whether taxpayers or the Commissioner could recompute reserves based on information that was available at the end of the applicable taxable year. Two subsequent cases came to opposite conclusions on this issue.

The reserve ratio test of section 816(a) was intended to distinguish between life and nonlife insurance companies based on the nature of each company’s business, as measured by its reserves. This purpose is not achieved, however, if a company that only issues life insurance, annuity or noncancellable accident and health contracts can elect to be taxed as a nonlife company by failing to use mortality and morbidity tables and assumed rates of interest in computing or estimating its reserves for some of those contracts.

Explanation of Provisions

Proposed § 1.801–4(g)(1) provides that if an insurance company does not compute or estimate its reserves for certain contracts on the basis of mortality or morbidity tables and assumed rates of interest, then the taxpayer or the Commissioner may recompute those reserves on the basis of mortality or morbidity tables and assumed rates of interest. This regulation will apply to reserves for contracts involving, at the

time with respect to which the reserves are computed, life, accident or health contingencies, if such reserves were not initially computed in accordance with the requirements of section 816(b)(1)(A).

Proposed § 1.801–4(g)(2) provides that if the taxpayer or the Commissioner recomputes reserves pursuant to § 1.801–4(g)(1), the reserves satisfy the section 816(b)(1)(A) requirement that a life reserve be computed or estimated using actuarial tables and assumed rates of interest. Assuming that these amounts satisfy the other requirements of section 816(b), the recomputed amounts will be considered life insurance reserves under section 816(b), and the recomputed reserves will be included in both the numerator and the denominator of the reserve ratio test under section 816(a). In addition, the reserves for such contracts will be taken into account under section 807(c)(1) and will be used to compute a nonlife company’s unearned premiums under section 832(b)(4).

Proposed § 1.801–4(g)(3) provides that for purposes of section 816(b)(4) and § 1.801–3(i), which provide that the mean of the beginning and end of year reserves will be used for purposes of section 816(a), (b) and (c), the reserves on a life insurance, annuity or noncancellable accident and health contract must be recomputed for both the beginning and the end of the year.

Proposed § 1.801–4(g)(4) requires that no information acquired after the date as of which the beginning of year reserves were initially computed or estimated may be taken into account in recomputing those reserves under paragraph (g)(1). It also requires that no information acquired after the date as of which the end of year reserves were initially computed or estimated may be taken into account in recomputing those reserves under paragraph (g)(1).

The IRS is considering whether to issue guidance under section 816, including regulations regarding the definition of ‘‘total reserves’’ under section 816(c) as well as redesignating and revising the regulations issued under prior law section 801. The IRS invites comments on this matter.

Proposed Effective Date

Proposed § 1.801–4(g) would be effective with respect to returns filed for taxable years beginning after the publication of the final regulations.

31 1997–8 I.R.B.

final regulations are filed with the Office of the Federal Register.

Michael P. Dolan, Acting Commissioner of

Internal Revenue.

(Filed by the Office of the Federal Register on December 31, 1996, 8:45 a.m., and published in the issue of the Federal Register for January 2, 1997, 62 F.R. 71)

Notice of Proposed Rulemaking

Requirement of Return and Time for Filing

REG–247862–96

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking by cross-reference to temporary regulations.

SUMMARY: In T.D. 8705, page 16, the IRS is issuing regulations that provide that disqualified persons and organization managers liable for section 4958 excise taxes are required to file Form 4720. The regulations also specify the filing date for returns for the period to which the new excise taxes apply retroactively. The text of those temporary regulations also serves as the text of these proposed regulations.

DATES: Written comments must be received by April 2, 1997.

ADDRESSES: Send submissions to: CC:DOM:CORP:R (REG–247862–96), room 5226, Internal Revenue Service, POB 7604 Ben Franklin Station, Washington, DC 20044. Submissions may be hand delivered between the hours of 8 a.m. and 5 p.m. to CC:DOM:CORP:R (REG–247862–96), Courier’s Desk, Internal Revenue Service, 1111 Constitution Avenue NW, Washington, DC. Alternatively, taxpayers may submit comments electronically via the Internet by selecting the ‘‘Tax Regs’’ option of the IRS Home Page, or by submitting comments directly to the IRS Internet site at http://www.irs.ustreas.gov/prod/ tax_regs/comments.html.

FOR FURTHER INFORMATION CONTACT: Phyllis Haney, (202) 622–4290 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

Final and temporary regulations in T.D. 8705 amend the Foundation and

Effect on Other Documents

The IRS will modify, clarify, or obsolete publications as necessary to conform with this regulation as of the date of publication in the Federal Register of the final regulations. See e.g., Rev. Rul. 69–302 (1969–2 C.B. 186). The IRS solicits comments as to whether other publications should be modified or obsoleted.

Special Analyses

It has been determined that this notice of proposed rulemaking is not a significant regulatory action as defined in EO 12866. Therefore, a regulatory assessment is not required. It also has been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to these regulations, and because the regulations do not impose a collection of information on small entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not apply. Pursuant to section 7805(f) of the Internal Revenue Code, this notice of proposed rulemaking will be submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on its impact on small business.

Comments and Public Hearing

A public hearing has been scheduled for Thursday, April 17, 1997 in the Commissioner’s conference room, room 3313, Internal Revenue Service Building at 10:00 a.m. Because of access restrictions, visitors will not be admitted beyond the Internal Revenue Building lobby more than 15 minutes before the hearing starts.

The rules of 26 CFR 601.601(a)(3) apply to the hearing.

Persons that wish to present oral comments at the hearing must submit written comments by March 27, 1997 and submit an outline of the topics to be discussed and the time to be devoted to each topic (a signed original and 8 copies) by March 27, 1997.

A period of 10 minutes will be allotted to each person for making comments.

An agenda showing the scheduling of the speakers will be prepared after the

deadline for receiving outlines has passed. Copies of the agenda will be available free of charge at the hearing.

Drafting Information

The principal author of this regulation is Ann B. Cammack, Office of Assistant Chief Counsel (Financial Institutions and Products). However, other personnel from the IRS and Treasury Department participated in their development.

- - - -

Proposed Amendments to the Regulations

Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART 1—INCOME TAXES

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

Authority: 26 U.S.C. 7805 - - Par. 2. Section 1.801–4 is amended by adding a new paragraph (g) to read as follows:

§ 1.801–4 Life insurance reserves.

- - - - (g) Recomputation of life insurance

reserves —(1) General. If an insurance company does not compute or estimate its reserves for contracts involving, at the time with respect to which the reserves are computed, life, accident or health contingencies, on the basis of mortality or morbidity tables and assumed rates of interest, then the taxpayer or the Commissioner may recompute reserves for those contracts on the basis of mortality or morbidity tables and assumed rates of interest.

(2) Effect of recomputation. If reserves are recomputed pursuant to paragraph (g)(1) of this section, the recomputed reserves satisfy the requirements of section 816(b)(1)(A).

(3) Mean reserve. For purposes of section 816(b)(4) and § 1.801–3(i), if reserves are recomputed pursuant to paragraph (g)(1) of this section for a taxable year, the reserves must be recomputed for both the beginning and the end of the taxable year.

(4) Subsequently acquired informa- tion. No information acquired after the date as of which a reserve was initially computed or estimated may be taken into account in recomputing that reserve under paragraph (g)(1) of this section.

(5) Effective date. This section is applicable with respect to returns filed for taxable years beginning after the date

1997–8 I.R.B. 32

Similar Excise Taxes Regulations (26 CFR part 53) relating to sections 6011 and 6071. The final regulations contain rules relating to the requirement of a return to accompany payment of section 4958 excise taxes; the temporary regulations prescribe the time for filing that return.

The text of those temporary regulations also serves as the text of these proposed regulations. The preamble to the temporary regulations explains the temporary regulations.

These rules were first published in Notice 96–46 (1996–39 I.R.B. 7) (September 23, 1996). The new section 4958 excise taxes were added by section 1311 of the Taxpayer Bill of Rights 2, Public Law 104–168, 110 Stat. 1452, enacted July 30, 1996.

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 the regulation does not impose a collection of information on small entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not apply. Pursuant to section 7805(f) of the Internal Revenue Code, these temporary regulations will be submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on their impact on small business.

Comments and Request for Public Hearing

Before these proposed regulations are adopted as final regulations, consideration will be given to any written comments (a signed original and eight (8) copies) that are submitted timely to the IRS. All comments will be available for public inspection and copying. A public hearing may be scheduled if requested in writing by a person that timely submits written comments. If a public hearing is scheduled, notice of the date, time, and place for the hearing will be published in the Federal Register .

Drafting Information

The principal author of these regulations is Phyllis Haney, Office of Associate Chief Counsel (Employee Benefits and Exempt Organizations). However, other personnel from the IRS and Trea

sury Department participated in their development.

- - - -

Proposed Amendments to the Regulations

Accordingly, 26 CFR part 53 is proposed to be amended as follows:

PART 53—FOUNDATION AND SIMILAR EXCISE TAXES

Paragraph 1. The authority citation for part 53 continues to read as follows:

Authority: 26 U.S.C. 7805. Par. 2. Section 53.6071–1 is amended by adding paragraph (f) to read as follows:

§ 53.6071–1 Time for filing returns.

- - - - (f) [The text of paragraph (f) of this

section is the same as the text of § 53.6071–1T(f) published in T.D. 8705, page 16.

Margaret Milner Richardson, Commissioner of Internal Revenue.

(Filed by the Office of the Federal Register on December 31, 1996, 8:45 a.m., and published in the issue of the Federal Register for January 2, 1997, 62 F. R. 84)

Notice of Proposed Rulemaking

Miscellaneous Sections Affected by the Taxpayer Bill of Rights 2 and the Personal Responsibility and Work Opportunity Reconciliation Act of 1996

REG–248770–96

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking.

SUMMARY: This document contains proposed regulations relating to joint returns, property exempt from levy, interest, penalties, offers in compromise, and the awarding of costs and certain fees. The proposed regulations reflect changes to the law made by the Taxpayer Bill of Rights 2 and a conforming amendment made by the Personal Responsibility and Work Opportunity Reconciliation Act of 1996. The proposed regulations affect taxpayers with respect to filing of returns, interest, penalties, court costs, and payment, deposit, and collection of taxes.

DATES: Written comments and requests for a public hearing must be received by April 2, 1997.

ADDRESSES: Send submissions to: CC:DOM:CORP:R (REG–248770–96), 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:R (REG–248770–96), Courier’s Desk, Internal Revenue Service, 1111 Constitution Avenue NW, Washington, DC. Finally, taxpayers may submit comments electronically via the INTERNET by selecting the ‘‘Tax Regs’’ option on the IRS Home Page, or by submitting comments directly to the IRS Internet site at http://www.irs. u s t r e a s . g o v / p r o d / t a x _ r e g s / comments.html.

FOR FURTHER INFORMATION CONTACT: Concerning the regulations, Beverly A. Baughman, (202) 622–4940 regarding joint returns and penalties; Robert A. Miller, (202) 622–3640 regarding levy; Donna J. Welch, (202) 622–4910 regarding interest; Thomas D. Moffitt, (202) 622–7900 regarding court costs; and Kevin B. Connelly, (202) 622–3640 regarding compromises (not toll-free numbers). Concerning submissions, Evangelista Lee, (202) 622–7190 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

The collection of information contained in this notice of proposed rulemaking has been submitted to the Office of Management and Budget for review in accordance with the Paperwork Reduction Act of 1995 (44 U.S.C. 3507(d)). Comments on the collection of information should be sent to the Office of Management and Budget, Attn: Desk Officer for the Department of the Treasury, Office of Information and Regulatory Affairs, Washington, DC 20503, with copies to the Internal Rev- enue Service, Attn: IRS Reports Clearance Officer, T:FP, Washington, DC 20224. Comments on the collection of information should be received by March 3, 1997. Comments are specifically requested concerning: Whether the proposed collection of information is necessary for the proper performance of the functions of the Internal Revenue Service, including whether the information will have practical utility;

33 1997–8 I.R.B.

The accuracy of the estimated burden associated with the proposed collection of information (see below); How the quality, utility, and clarity of the information to be collected may be enhanced; How the burden of complying with the proposed collection of information may be minimized, including through the application of automated collection techniques or other forms of information technology; and Estimates of capital or start-up costs and costs of operation, maintenance, and purchase of services to provide information.

The collection of information in this proposed regulation is in § 301.7430– 2(c)(3)(i)(B). This information is required to obtain an award of reasonable administrative costs. This information will be used to determine if a taxpayer is entitled to an award of reasonable administrative costs. The collection of information is required to obtain the award. The likely respondents are individuals, business or other for-profit institutions, nonprofit institutions, and small businesses or organizations.

Estimated total annual reporting burden: 10 hours.

The estimated annual burden per respondent: 15 minutes.

Estimated number of respondents: 38 Estimated annual frequency of responses: On occasion.

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

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

Background

This document contains proposed amendments to the Income Tax Regulations and the Regulations on Procedure and Administration (26 CFR parts 1 and 301, respectively) relating to joint returns under section 6013, levy under section 6334, interest under section 6601, the failure to file penalty under section 6651, the failure to deposit penalty under section 6656, compromise under section 7122, and awards of costs and certain fees under section 7430.

These sections were amended by the Taxpayer Bill of Rights 2 (TBOR2) (Pub. L. No. 104–168, 110 Stat. 1452 (1996)) and the Personal Responsibility and Work Opportunity Reconciliation Act of 1996 (Pub. L. No. 104–193, 110 Stat. 2105 (1996)). The changes made by TBOR2 and the Personal Responsibility and Work Opportunity Reconciliation Act of 1996 are reflected in the proposed regulations.

Explanation of Provisions

Interest and Penalties

Section 6601 requires a taxpayer to pay interest on late payments of tax. However, sections 6601(e)(2) and 6601(e)(3) provide an interest-free period if a taxpayer pays the tax due within a certain number of days after the date of the notice and demand for payment. Sections 303(a) and 303(b)(1) of TBOR2 amended sections 6601(e)(2) and 6601(e)(3) to extend this interestfree period. Therefore, § 301.6601–1(f) of the proposed regulations extends the interest-free period from 10 days to 21 calendar days after the date of the notice and demand (10 business days if the amount for which the notice and demand is made equals or exceeds $100,000) with respect to any notice and demand made after December 31, 1996. The proposed regulations also define business day and calendar day for purposes of § 301.6601–1(f).

Section 6651(a)(3) imposes a penalty on any person who fails to pay the amount of tax that is required to be shown on a return but that is not so shown. However, a penalty-free period is provided if a taxpayer pays the tax due within a certain number of days after the date of the notice and demand for payment. Section 303(b)(2) of TBOR2 amended section 6651(a)(3) to extend the penalty-free period. Therefore, proposed § 301.6651–1(a)(3) extends the penalty-free period from 10 days to 21 calendar days after the date of the notice and demand (10 business days if the amount for which the notice and demand is made equals or exceeds $100,000) with respect to any notice and demand made after December 31, 1996. In addition, the proposed regulations amend § 301.6651–1(a)(3) to conform with changes made by section 1502(b) of the Tax Reform Act of 1986 (Pub. L. No. 99–514, 100 Stat. 2085 (1986)) to repeal the special coordination rule under section 6651(c)(1)(B).

Section 6651(a)(2) imposes a penalty on any person who fails to pay the amount of tax shown on a return by the payment due date (including extensions). Pursuant to section 6020(b), if a taxpayer does not file a tax return, the Secretary can make a substitute return for the taxpayer. Prior to TBOR2, a taxpayer with a substitute return was not subject to a section 6651(a)(2) penalty because the substitute return was not treated as a return for purposes of the penalty. See Rev. Rul. 76–562, 1976–2 C.B. 430. Section 1301 of TBOR2 amended section 6651 to apply the section 6651(a)(2) failure to pay penalty to returns prepared by the Secretary pursuant to section 6020(b). Thus, for returns due (determined without regard to extensions) after July 30, 1996, proposed § 301.6651–1(g) provides that a taxpayer with a substitute return may be subject to a failure to pay penalty under section 6651(a)(2).

Section 6656 imposes a penalty for failure to deposit taxes with a government depository by the prescribed due date. Section 304 of TBOR2 amended section 6656 to provide exceptions to the failure to deposit penalty for first time depositors of employment taxes. Accordingly, § 301.6656–3(a) of the proposed regulations provides that in the case of first time depositors of employment taxes, the Secretary will generally waive the penalty for failure to deposit if (1) the failure to deposit is inadvertent based on all the facts and circumstances, (2) the depositing entity meets certain net worth requirements, (3) the failure to deposit occurs during the first quarter the depositing entity is required to deposit any employment tax, and (4) the return for the employment tax is filed on time.

In addition, proposed § 301.6656– 3(b) provides that the Secretary may abate any penalty for failure to make deposits if the first time a depositor is required to make a deposit, the amount required to be deposited is inadvertently sent to the Secretary instead of to the appropriate government depository. Proposed § 301.6656–3 applies to deposits required to be made after July 30, 1996.

Joint Returns

Prior to TBOR2, married individuals making an election under section 6013(b) to file a joint return after filing a separate return for the same taxable year were required to pay the full amount of the tax shown on the joint return at or before the time of filing the joint return. With respect to taxable years beginning after July 30, 1996, section 402 of TBOR2 amended section 6013(b) to permit married individuals who previously filed separate returns to file joint returns for the same taxable year without paying the full amount of tax shown on the joint return. Accordingly, § 1.6013–2(b)(1) of the proposed regulations provides that the full payment requirement applies only to taxable years beginning on or before July 30, 1996.

Levy and Compromise

Section 6334 lists the items of property that are exempt from levy by the IRS. Section 502 of TBOR2 amended section 6334 to (1) increase the dollar amount exempt from levy under section 6334(a)(2) and provide that this exemption amount applies to all taxpayers, not just heads of a family; (2) increase the dollar amount exempt from levy under section 6334(a)(3); and (3) provide a yearly inflation adjustment for the dollar amounts exempt from levy. In addition, section 110(l)(6) of the Personal Responsibility and Work Opportunity Reconciliation Act of 1996, in a conforming amendment, amended section 6334(a)(11)(A) to delete the language ‘‘(relating to aid to families with dependent children)’’.

Accordingly, § 301.6334–1(a)(2) of the proposed regulations increases from $1,650 ($1,550 in the case of levies issued during 1989) to $2,500 the amount exempt from levy for fuel, provisions, furniture, and personal effects, and makes this exemption applicable to all taxpayers, not just taxpayers who are heads of a family. The proposed regulations also increase from $1,100 ($1,050 in the case of levies issued during 1989) to $1,250 the amount exempt from levy for books and tools of a trade, business, or profession. These changes are effective with respect to levies issued after December 31, 1996. In addition, for calendar years beginning after 1997, § 301.6334–1(e) of the proposed regulations provides an inflation adjustment for the exemption amounts described above and for rounding to the nearest multiple of $10.

Prior to the enactment of TBOR2, section 7122(b) required the General Counsel of the Treasury or his delegate to file an opinion with the Secretary whenever the Secretary compromised a case, unless the compromise involved a civil case in which the unpaid amount

of the tax assessed (including any interest, additional amount, addition to the tax, or assessable penalty) was less than $500. Effective July 30, 1996, section 503 of TBOR2 amended section 7122 to raise the dollar threshold for mandatory review of compromises of civil cases by the General Counsel of the Department of Treasury or his delegate from $500 to $50,000. Accordingly, § 301.7122–1(e) of the proposed regulations provides that for compromises accepted on or after July 30, 1996, no opinion is required if the unpaid amount of tax is less than $50,000.

Awarding of Costs and Certain Fees

In general, under section 7430 a prevailing party may recover the reasonable administrative or litigation costs incurred in an administrative or a civil proceeding if the proceeding relates to the determination, collection, or refund of any tax, interest, or penalty. Prior to TBOR2, the taxpayer had the burden of proving that the position of the United States was not substantially justified. Section 701 of TBOR2 amended section 7430(c)(4) to place on the government the burden of proving that the position of the United States is substantially justified. Under TBOR2, the position of the government will be presumed not to be substantially justified if the IRS did not follow its applicable published guidance. Section 701 defines applicable published guidance.

The proposed regulations reflect these changes. Further, § 301.7430–5(c)(3) of the proposed regulations clarifies that in the definition of applicable published guidance, ‘‘regulations’’ means final and temporary regulations. The proposed regulations also clarify the period during which and the issues upon which the position of the United States is presumed to be not substantially justified.

Section 702 of TBOR2 amended section 7430(c)(1) to increase the allowable hourly rate of an award of attorney’s fees and provide for a yearly inflation adjustment and rounding. Sections 301.7430–2 and 301.7430–4 of the proposed regulations reflect these changes.

Finally, section 703 of TBOR2 amended section 7430(b)(1) to clarify that any failure to agree to an extension of the statute of limitations will not affect the determination of whether a taxpayer has exhausted administrative remedies as a prerequisite to recovery of attorney’s fees. Although this is consis

tent with an example in the prior regulations (Example 4, § 301.7430–1(f)), the proposed regulations add § 301.7430– 1(b)(4) to reflect the statutory language.

Special Analyses

It has been determined that this notice of proposed rulemaking is not a significant regulatory action as defined in EO 12866. Therefore, a regulatory assessment is not required. It is hereby certified that the regulations in this document will not have a significant economic impact on a substantial number of small entities. This certification is based on a determination that in the past only an average of 38 taxpayers per year, the majority of whom were individuals, have filed a request to recover administrative costs. Accordingly, a Regulatory Flexibility Analysis under the Regulatory Flexibility Act (5 U.S.C. chapter 6) is not required.

Pursuant to section 7805(f) of the Internal Revenue Code, this notice of proposed rulemaking will be submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on its impact on small business.

Comments and Requests for a Public Hearing

Before these proposed regulations are adopted as final regulations, consideration will be given to any written comments (a signed original and eight (8) copies) or electronic comments that are submitted timely to the IRS. All comments will be available for public inspection and copying. A public hearing may be scheduled if requested in writing by any person that timely submits written comments. If a public hearing is scheduled, notice of the date, time, and place for the hearing will be published in the Federal Register .

Drafting Information

The principal authors of these regulations are Beverly A. Baughman and Donna J. Welch, Office of Assistant Chief Counsel (Income Tax and Accounting), Robert A. Miller and Kevin B. Connelly, Office of Assistant Chief Counsel (General Litigation), and Thomas D. Moffitt, Office of Assistant Chief Counsel (Field Service). However, other personnel from the IRS and Treasury Department participated in their development.

- - - -

35 1997–8 I.R.B.

Proposed Amendments to the Regulations

Accordingly, 26 CFR parts 1 and 301 are proposed to be 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 1.6013–2(b)(1) is amended by removing the language ‘‘Unless’’ and adding ‘‘Beginning on or before July 30, 1996, unless’’ in its place.

PART 301—PROCEDURE AND ADMINISTRATION

Par. 3. The authority citation for part 301 continues to read in part as follows: Authority: 26 U.S.C. 7805 - - Par. 4. Section 301.6334–1 is amended by:

Revising paragraph (a)(2).
Removing the language ‘‘$1,100 ($1,050 for levies issued prior to January 1, 1990)’’ from paragraph (a)(3) and adding ‘‘$1,250’’ in its place.
Removing the language ‘‘(relating to aid to families with dependent children)’’ from paragraph (a)(11)(i).
Redesignating paragraph (e) as paragraph (f) and adding a new paragraph (e).
Revising newly designated paragraph (f).

The additions and revisions read as follows:

§ 301.6334–1 Property exempt from levy.

(a) - - (2) Fuel, provisions, furniture, and personal effects. So much of the fuel, provisions, furniture, and personal effects in the taxpayer’s household, and of the arms for personal use, livestock, and poultry of the taxpayer, that does not exceed $2,500 in value.

- - - - (e) Inflation adjustment. For any

calendar year beginning after December 31, 1997, each dollar amount referred to in paragraphs (a)(2) and (a)(3) of this section will be increased by an amount equal to the dollar amount multiplied by the cost-of-living adjustment determined under section 1(f)(3) for the calendar year (substituting ‘‘calendar year 1996’’ for ‘‘calendar year 1992’’ in section 1(f)(3)(B)). If any dollar amount as adjusted is not a multiple of $10, the

dollar amount will be rounded to the nearest multiple of $10 (rounding up if the amount is a multiple of $5).

(f) Effective date. Generally, these provisions are effective with respect to levies made on or after July 1, 1989. However, any reasonable attempt by a taxpayer to comply with the statutory amendments addressed by the regulations in this section prior to February 21, 1995, will be considered as meeting the requirements of the regulations in this section. In addition, paragraphs (a)(2), (a)(3), (a)(11)(i) and (e) of this section are applicable with respect to levies issued after December 31, 1996.

Par. 5. Section 301.6601–1 is amended by:

Revising paragraphs (f)(3) and (f)(4).
Redesignating paragraph (f)(5) as paragraph (f)(6) and adding new paragraph (f)(5).

The additions and revisions read as follows:

§ 301.6601–1 Interest on underpay- ments.

- - - - (f) - - (3) Interest will not be imposed on

any assessable penalty, addition to the tax, or additional amount if the amount is paid within 21 calendar days (10 business days if the amount stated in the notice and demand equals or exceeds $100,000) from the date of the notice and demand. If interest is imposed, it will be imposed only for the period from the date of the notice and demand to the date on which payment is received. This paragraph (f)(3) is applicable with respect to any notice and demand made after December 31, 1996.

(4) If notice and demand is made after December 31, 1996, for any amount and the amount is paid within 21 calendar days (10 business days if the amount equals or exceeds $100,000) from the date of the notice and demand, interest will not be imposed for the period after the date of the notice and demand.

(5) For purposes of paragraphs (f)(3) and (f)(4) of this section—

(i) The term business day means any day other than a Saturday, Sunday, legal holiday in the District of Columbia, or a statewide legal holiday in the state where the taxpayer resides or where the taxpayer’s principal place of business is located. With respect to the tenth business day (after taking into account the first sentence of this paragraph (f)(5)(i)),

see section 7503 relating to time for performance of acts where the last day falls on a statewide legal holiday in the state where the act is required to be performed.

(ii) The term calendar day means any day. With respect to the twenty-first calendar day, see section 7503 relating to time for performance of acts where the last day falls on a Saturday, Sunday, or legal holiday.

- - - - Par. 6. Section 301.6651–1 is

amended by:

Revising paragraph (a)(3).
Adding paragraph (g). The additions and revisions read as follows:

§ 301.6651–1 Failure to file tax return or to pay tax.

(a) - - (3) Failure to pay tax not shown on return. In the case of failure to pay any amount of any tax required to be shown on a return specified in paragraph (a)(1) of this section that is not so shown (including an assessment made pursuant to section 6213(b)) within 21 calendar days from the date of the notice and demand (10 business days if the amount for which the notice and demand is made equals or exceeds $100,000) with respect to any notice and demand made after December 31, 1996, there will be added to the amount stated in the notice and demand the amount specified below unless the failure to pay the tax within the prescribed time is shown to the satisfaction of the district director or the director of the service center to be due to reasonable cause and not to willful neglect. The amount added to the tax is 0.5 percent of the amount stated in the notice and demand if the failure is for not more than 1 month, with an additional 0.5 percent for each additional month or fraction thereof during which the failure continues, but not to exceed 25 percent in the aggregate.

- - - - (g) Treatment of returns prepared by

the Secretary —(1) In general. A return prepared by the Secretary under section 6020(b) will be disregarded for purposes of determining the amount of the addition to tax for failure to file any return pursuant to paragraph (a)(1) of this section. However, the return prepared by the Secretary will be treated as a return filed by the taxpayer for purposes of determining the amount of the addition to tax for failure to pay the tax shown on any return and for failure to pay the tax required to be shown on a return that is not so shown pursuant to paragraphs (a)(2) and (a)(3) of this section, respectively.

(2) Effective date. This paragraph (g) applies to returns the due date for which (determined without regard to extensions) is after July 30, 1996.

Par. 7. Section 301.6656–3 is added to read as follows:

§ 301.6656–3 Abatement of penalty.

(a) Exception for first time depositors of employment taxes —(1) Waiver. The Secretary will generally waive the penalty imposed by section 6656(a) on a person’s failure to deposit any employment tax under subtitle C of the Internal Revenue Code if—

(i) The failure is inadvertent; (ii) The person meets the requirements referred to in section 7430(c)(4)(A)(ii) (relating to the net worth requirements applicable for awards of attorney’s fees);

(iii) The failure occurs during the first quarter that the person is required to deposit any employment tax; and

(iv) The return of the tax is filed on or before the due date.

(2) Inadvertent failure. For purposes of paragraph (a)(1)(i) of this section, the Secretary will determine if a failure to deposit is inadvertent based on all the facts and circumstances.

(b) Deposit sent to Secretary. The Secretary may abate the penalty imposed by section 6656(a) if the first time a depositor is required to make a deposit, the amount required to be deposited is inadvertently sent to the Secretary instead of to the appropriate government depository.

Par. 8. Paragraph (e) of § 301.7122–1 is revised to read as follows:

§ 301.7122–1 Compromises.

- - - - (e) Record —(1) In general. If an offer in compromise is accepted, there will

be placed on file the opinion of the Chief Counsel of the IRS with respect to the compromise, with the reasons for the opinion, and including a statement of—

(i) The amount of tax assessed;

(ii) The amount of interest, additional amount, addition to the tax, or assessable penalty, imposed by law on the person against whom the tax is assessed; and

(iii) The amount actually paid in accordance with the terms of the compromise.

(2) Exception. For compromises accepted on or after July 30, 1996, no opinion will be required with respect to the compromise of any civil case in which the unpaid amount of tax assessed (including any interest, additional amount, addition to the tax, or assessable penalty) is less than $50,000. However, the compromise will be subject to continuing quality review by the Secretary.

- - - - Par 9. Section 301.7430–0 is amended

by:

Adding under the heading § 301.7430–1, a caption (b)(4) to read ‘‘(4) Failure to agree to extension of time for assessments.’’.
Adding under the heading § 301.7430–5, a caption (c)(3) to read ‘‘(3) Presumption.’’.

Par. 10. Section 301.7430–1 is amended by adding paragraph (b)(4) to read as follows:

§ 301.7430–1 Exhaustion of adminis- trative remedies.

- - - - (b) - - (4) Failure to agree to extension of

time for assessments. Any failure by the prevailing party to agree to an extension of the time for the assessment of any tax will not be taken into account for purposes of determining whether the prevailing party has exhausted the administrative remedies available to the party within the IRS.

- - - - Par. 11. Section 301.7430–2 is

amended by:

Removing the language ‘‘7430(c)(4)(B)(ii)’’ from the third sentence of paragraph (b)(2) and adding ‘‘7430(c)(4)(C)(ii)’’ in its place.
Revising paragraph (c)(3)(i)(B).
Removing the language ‘‘If more than $75’’ from paragraph (c)(3)(ii)(C) and adding ‘‘In the case of administrative proceedings commenced after July 30, 1996, if more than $110’’ in its place.

The revision reads as follows:

§ 301.7430–2 Requirements and proce- dures for recovery of reasonable admin- istrative costs.

- - - - (c) - - (3) - - (i) - - (B) A clear and concise statement of

the reasons why the taxpayer alleges that the position of the IRS in the administrative proceeding was not substantially justified. For administrative proceedings commenced after July 30, 1996, if the taxpayer alleges that the IRS did not follow any applicable published guidance, the statement must identify all applicable published guidance that the taxpayer alleges that the IRS did not follow. For purposes of this paragraph (c)(3)(i)(B), the term appli- cable published guidance means final or temporary regulations, revenue rulings, revenue procedures, information releases, notices, announcements, and, if issued to the taxpayer, private letter rulings, technical advice memoranda, and determination letters. Also, for purposes of this paragraph (c)(3)(i)(B), the term administrative proceeding includes only those administrative proceedings or portions of administrative proceedings occurring on or after the administrative proceeding date as defined in § 301.7430–3(c).

- - - - Par. 12. Section 301.7430–4 is

amended by:

Removing the language ‘‘$75’’ from paragraph (b)(3)(i) and adding ‘‘, in the case of proceedings commenced after July 30, 1996, $110’’ in its place.
Revising paragraph (b)(3)(ii).
Removing the language ‘‘$75’’ from the first, second, and third sentences of paragraph (b)(3)(iii)(B) and adding ‘‘$110’’ in its place.
Removing the language ‘‘$75’’ from paragraph (b)(3)(iii)(C) and adding ‘‘$110’’ in its place.
Removing the language ‘‘$75’’ from the third sentence of the example in paragraph (b)(3)(iii)(D) and adding ‘‘$110’’ in its place.
Removing the language ‘‘$75’’ from the second and third sentences of paragraph (c)(2)(ii) and adding ‘‘$110’’ in its place.

The revision reads as follows:

§ 301.7430–4 Reasonable administra- tive costs.

- - - - (b) - -

37 1997–8 I.R.B.

The following organizations have failed to establish or have been unable to maintain their status as public charities or as operating foundations. Accordingly, grantors and contributors may not, after this date, rely on previous rulings or designations in the Cumulative List of Organizations (Publication 78), or on the presumption arising from the filing of notices under section 508(b) of the Code. This listing does not indicate that the organizations have lost their status as organizations described in section 501(c)(3), eligible to receive deductible contributions.

Former Public Charities . The following organizations (which have been treated as organizations that are not private foundations described in section 509(a) of the Code) are now classified as private foundations: Aikanes O Hawaii Inc., Tampa, FL Armi Housing Corporation, New York,

NY Chimes for Charity Inc., Union City, TN Chittenden County Senior Citizens

Alliance Inc., Burlington, VT

(3) - - (ii) Cost of living adjustment. The IRS will make a cost of living adjustment to the $110 per hour limitation for fees incurred in any calendar year beginning after December 31, 1996. The cost of living adjustment will be an amount equal to $110 multiplied by the cost-of-living adjustment determined under section 1(f)(3) for the calendar year (substituting ‘‘calendar year 1995’’ for ‘‘calendar year 1992’’ in section 1(f)(3)(B)). If the dollar limitation as adjusted by this cost-of-living increase is not a multiple of $10, the dollar amount will be rounded to the nearest multiple of $10 (rounding up if the amount is a multiple of $5).

- - - - Par. 13. Section 301.7430–5 is

amended by:

Revising paragraph (a).
Adding paragraph (c)(3). The addition and revision read as follows:

§ 301.7430–5 Prevailing party.

(a) In general. For purposes of an award of reasonable administrative costs under section 7430 in the case of administrative proceedings commenced after July 30, 1996, a taxpayer is a prevailing party only if—

(1) The position of the IRS was not substantially justified;

(2) The taxpayer substantially prevails as to the amount in controversy or with respect to the most significant issue or set of issues presented; and

(3) The taxpayer satisfies the net worth and size limitations referenced in paragraph (f) of this section.

- - - - (c) - - (3) Presumption. If the IRS did not

follow any applicable published guidance in an administrative proceeding commenced after July 30, 1996, the position of the IRS, on those issues to which the guidance applies and for all periods during which the guidance was not followed, will be presumed not to be substantially justified. This presumption may be rebutted. For purposes of this paragraph (c)(3), the term applicable published guidance means final or temporary regulations, revenue rulings, revenue procedures, information releases, notices, announcements, and, if issued to the taxpayer, private letter rulings, technical advice memoranda, and determination letters. Also, for purposes of this paragraph (c)(3), the term administrative

proceeding includes only those administrative proceedings or portions of administrative proceedings occurring on or after the administrative proceeding date as defined in § 301.7430–3(c).

- - - - Par. 14. Section 301.7430–6 is revised to read as follows:

§ 301.7430–6 Effective date.

Sections 301.7430–2 through 301.7430– 6, other than §§ 301.7430–2(b)(2), (c)(3)(i)(B), (c)(3)(ii)(C), and (c)(5); §§ 301.7430–4(b)(3)(i), (b)(3)(ii), (b)(3)(iii)(B), (b)(3)(iii)(C), (b)(3)(iii)(D), and (c)(2)(ii); and §§ 301.7430–5(a) and (c)(3), apply to claims for reasonable administrative costs filed with the IRS after December 23, 1992, with respect to costs incurred in administrative proceedings commenced after November 10, 1988. Section 301.7430–2(c)(5) is applicable March 23, 1993. Section 301.7430–0, §§ 301.7430–2(b)(2), (c)(3)(i)(B), and (c)(3)(ii)(C); §§ 301.7430–4(b)(3)(i), (b)(3)(ii), (b)(3)(iii)(B), (b)(3)(iii)(C), (b)(3)(iii)(D), and (c)(2)(ii); and §§ 301.7430– 5(a) and (c)(3) are applicable for administrative proceedings commenced after July 30, 1996.

Margaret Milner Richardson, Commissioner of Internal Revenue.

(Filed by the Office of the Federal Register on December 31, 1996, 8:45 a.m., and published in the issue of the Federal Register for January 2, 1997, 62 F.R. 77)

Deletions From Cumulative List of Organizations Contributions to Which Are Deductible Under Section 170 of the Code