Part I. Rulings — Internal Revenue Bulletin 1997-9

Section 25.—Interest on Certain Home Mortgages

26 CFR 1.25–4T: Qualified mortgage credit cer- tificate program (temporary).

The average annual aggregate principal amount of mortgages executed during 1992, 1993, 1994 are set forth for use by issuers of mortgage credit certificates in determining if the required portion of loans under sections 25(c)(2)(A)(iii)(V) and 143(h) of the Code are made available in targeted areas. See Rev. Proc. 97–17, page 15.

Section 103.—State and Local Bonds

26 CFR 1.103–1: Interest upon obligations of a State, Territory, etc.

The average annual aggregate principal amount of mortgages executed during 1992, 1993, 1994 are set forth for use by issuers of qualified mortgage bonds in determining if the required portion of loans are made available in targeted areas under section 143(h) of the Code. See Rev. Proc. 97–17, page 15.

Section 143.—Mortgage Revenue Bonds: Qualified Mortgage Bond and Qualified Veterans’ Mortgage Bond

26 CFR 6a.103A–2: Qualified mortgage bond.

The average annual aggregate principal amount of mortgages executed during 1992, 1993, 1994 are set forth for use by issuers of qualified mortgage bonds and mortgage credit certificates in determining if the required portion of loans are made available in targeted areas under section 143(h) of the Code. See Rev. Proc. 97–17, page 15.

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

26 CFR 1.213–1: Medical, dental, etc., expenses.

Medical and dental expenses. Amounts paid to obtain a controlled substance (such as marijuana), in violation of federal law, are not deductible expenses for medical care under section 213 of the Code.

Rev. Rul. 97–9

ISSUE

Is an amount paid to obtain a controlled substance (such as marijuana) for medical purposes, in violation of federal law, a deductible expense for medical care under § 213 of the Internal Revenue Code?

FACTS

Based on the recommendation of a physician, A purchased marijuana and used it to treat A ’s disease in a state whose laws permit such purchase and use.

LAW AND ANALYSIS

Section 213(a) allows a deduction for uncompensated expenses of an individual for medical care to the extent such expenses exceed 7.5 percent of adjusted gross income. Section 213(d)(1) provides, in part, that ‘‘medical care’’ means amounts paid for the cure, mitigation, and treatment of disease. However, under § 213(b) an amount paid for medicine or a drug is an expense for medical care under § 213(a) only if the medicine or drug is a prescribed drug or insulin. Section 213(d)(3) provides that a ‘‘prescribed drug’’ is a drug or biological that requires a prescription of a physician for its use by an individual.

Section 1.213–1(e)(2) of the Income Tax Regulations provides, in part, that the term ‘‘medicine and drugs’’ includes only items that are ‘‘legally procured.’’ Section 1.213–1(e)(1)(ii) provides that amounts expended for illegal operations or treatments are not deductible.

Rev. Rul. 78–325, 1978–2 C.B. 124, holds that amounts paid by a taxpayer for laetrile, prescribed by a physician for the medical treatment of the taxpayer’s illness, are expenses for medicine and drugs that are deductible under § 213. The revenue ruling states that the laetrile was purchased and used in a locality where its sale and use were legal.

Rev. Rul. 73–201, 1973–1 C.B. 140, holds that amounts paid for a vasectomy and an abortion are expenses for medical care that are deductible under § 213. The revenue ruling states that neither procedure was illegal under state law.

A ’s purchase and use of marijuana were permitted under the laws of A ’s state. However, marijuana is listed as a controlled substance on Schedule I of the Controlled Substances Act (CSA), 21 U.S.C. §§ 801–971. 21 U.S.C. § 812(c). Except as authorized by the CSA, it is unlawful for any person to manufacture, distribute, or dispense, or possess with intent to manufacture, distribute, or dispense, a controlled substance. 21 U.S.C. § 841(a). Further, it is unlawful for any person knowingly or intentionally to possess a controlled sub

stance except as authorized by the CSA. 21 U.S.C. 844(a). Generally, the CSA does not permit the possession of controlled substances listed on Schedule I, even for medical purposes, and even with a physician’s prescription.

Notwithstanding state law, a controlled substance (such as marijuana), obtained in violation of the CSA, is not ‘‘legally procured’’ within the meaning of § 1.213–1(e)(2). Further, an amount expended to obtain a controlled substance (such as marijuana) in violation of the CSA is an amount expended for an illegal treatment within the meaning of § 1.213–1(e)(1)(ii). Accordingly, A may not deduct under § 213 the amount A paid to purchase marijuana.

HOLDING

An amount paid to obtain a controlled substance (such as marijuana) for medical purposes, in violation of federal law, is not a deductible expense for medical care under § 213. This holding applies even if the state law requires a prescription of a physician to obtain and use the controlled substance and the taxpayer obtains a prescription.

EFFECT ON OTHER DOCUMENTS

Rev. Rul. 78–325 is obsoleted. Subsequent to the issuance of Rev. Rul. 78–325, the courts have upheld the Food and Drug Administration determination that generally prohibits interstate commerce in laetrile under the Food, Drug, and Cosmetic Act, 21 U.S.C. §§ 331 and 355(a). See United States v. Rutherford, 442 U.S. 544 (1979); Rutherford v. United States, 806 F.2d 1455 (10th Cir. 1986). Thus, notwithstanding state and local law, laetrile cannot be legally procured within the meaning of § 1.213–1(e)(2). Accordingly, amounts paid to obtain laetrile are not deductible under § 213.

Rev. Rul. 73–201 is clarified to reflect that the medical procedures at issue in that revenue ruling are not illegal under federal law.

DRAFTING INFORMATION

The principal authors of this revenue ruling are Donna M. Crisalli and Sharon Hester of the Office of Assistant Chief Counsel (Income Tax and Accounting). For further information regarding this

revenue ruling, contact Ms. Crisalli or Ms. Hester on (202) 622–4920 (not a toll-free call).

Section 1275.—Other Definitions and Special Rules

26 CFR 1.1275–7T: Inflation-indexed debt instru- ments (temporary).

T.D. 8709

DEPARTMENT OF THE TREASURY Internal Revenue Service 26 CFR Part 1

Inflation-Indexed Debt Instruments

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Temporary and final regulations.

SUMMARY: This document contains temporary regulations relating to the federal income tax treatment of inflation-indexed debt instruments, including Treasury Inflation-Indexed Securities. The text of the temporary regulations also serves as the text of REG– 242996–96, page 18. This document also contains amendments to final regulations to reflect the addition of the temporary regulations. The regulations in this document provide needed guidance to holders and issuers of inflationindexed debt instruments.

EFFECTIVE DATE: The regulations are effective January 6, 1997.

FOR FURTHER INFORMATION CONTACT: Jeffrey W. Maddrey, (202) 622– 3940, or William E. Blanchard, (202) 622–3950 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Background

The Department of the Treasury published final rules describing the terms and conditions of new debt instruments that it plans to issue. The payments on these debt instruments (Treasury Inflation-Indexed Securities) will be indexed for inflation and deflation.

On June 14, 1996, the IRS published final regulations in the Federal Register relating to certain debt instruments that provide for contingent payments (61 FR 30133). The preamble to the final regulations indicates that the noncontingent bond method described in § 1.1275– 4(b) might be inappropriate for the Treasury Inflation-Indexed Securities.

On October 15, 1996, the IRS published Notice 96–51 (1996–42 I.R.B. 6), which announced the IRS’s intention to issue temporary and proposed regulations that would provide guidance on the federal income tax treatment of the Treasury Inflation-Indexed Securities and other debt instruments with similar terms. This document contains the temporary regulations described in Notice 96–51. Explanation of provisions

A. In general

The temporary regulations provide rules for the treatment of certain debt instruments that are indexed for inflation and deflation, including Treasury Inflation-Indexed Securities. The temporary regulations generally require holders and issuers of inflation-indexed debt instruments to account for interest and original issue discount (OID) using constant yield principles. In addition, the temporary regulations generally require holders and issuers of inflation-indexed debt instruments to account for inflation and deflation by making current adjustments to their OID accruals.

B. Applicability

The temporary regulations apply to inflation-indexed debt instruments. In general, an inflation-indexed debt instrument is a debt instrument that (1) is issued for cash, (2) is indexed for inflation and deflation (as described below), and (3) is not otherwise a contingent payment debt instrument. The temporary regulations do not apply, however, to certain debt instruments, such as debt instruments issued by qualified state tuition programs.

C. Indexing methodology

A debt instrument is considered indexed for inflation and deflation if the payments on the instrument are indexed by reference to the change in value of a general price or wage index over the term of the instrument. Specifically, the amount of each payment on an inflationindexed debt instrument must equal the product of (1) the amount of the payment that would be payable on the instrument (determined as if there were no inflation or deflation over the term of the instrument) and (2) the ratio of the value of the reference index for the payment date to the value of the reference index for the issue date.

The reference index for a debt instrument is the mechanism for measuring inflation and deflation over the term of

the instrument. This mechanism associates the value of a single qualified inflation index for a particular month with a specified day of a succeeding month. For example, under the terms of the Treasury Inflation-Indexed Securities, the reference index for the first day of a month is the value of a qualified inflation index for the third preceding month. The reference index must be reset once a month to the current value of a qualified inflation index. Between reset dates, the value of the reference index is determined through straight-line interpolation.

A qualified inflation index is a general price or wage index that is updated and published at least monthly by an agency of the United States Government. A general price or wage index is an index that measures price or wage changes in the economy as a whole. An index is not general if it only measures price or wage changes in a particular segment of the economy. For example, the non-seasonally adjusted U.S. City Average All Items Consumer Price Index for All Urban Consumers (CPI-U), which is published by the Bureau of Labor Statistics of the Department of Labor, is a qualified inflation index because it measures general price changes in the economy. By contrast, the gasoline price component of the CPI-U is not a qualified inflation index because it only measures price changes in a particular segment of the economy.

D. Coupon bond method

The temporary regulations provide a simplified method of accounting for qualified stated interest and inflation adjustments on certain inflation-indexed debt instruments (the coupon bond method). To qualify for the coupon bond method, an inflation-indexed debt instrument must satisfy two conditions. First, there must be no more than a de minimis difference between the debt instrument’s issue price and its principal amount for the issue date. Second, all stated interest on the debt instrument must be qualified stated interest. Because Treasury Inflation-Indexed Securities that are not stripped into principal and interest components satisfy both of these conditions, the coupon bond method applies to these securities.

If an inflation-indexed debt instrument qualifies for the coupon bond method, the stated interest payable on the debt instrument is taken into account under the taxpayer’s regular method of accounting. Any increase in the

inflation-adjusted principal amount is treated as OID for the period in which the increase occurs. Any decrease in the inflation-adjusted principal amount is taken into account under the rules for deflation adjustments described below.

For example, if a taxpayer holds a Treasury Inflation-Indexed Security for an entire calendar year and the taxpayer uses the cash receipts and disbursements method of accounting (cash method), the taxpayer generally includes in income the interest payments received on the security during the year. In addition, the taxpayer includes in income an amount of OID measured by subtracting the inflation-adjusted principal amount of the security at the beginning of the year from the inflation-adjusted principal amount of the security at the end of the year. If the taxpayer uses an accrual method of accounting rather than the cash method, the taxpayer includes in income the qualified stated interest that accrued on the debt instrument during the year and an amount of OID measured by subtracting the inflationadjusted principal amount of the security at the beginning of the year from the inflation-adjusted principal amount of the security at the end of the year.

E. Discount bond method

If an inflation-indexed debt instrument does not qualify for the coupon bond method (for example, because it is issued at a discount), the instrument is subject to the discount bond method. In general, the discount bond method requires holders and issuers to make current adjustments to their OID accruals to account for inflation and deflation.

Under the discount bond method, a taxpayer determines the amount of OID allocable to an accrual period by using steps similar to those provided in § 1.1272–1(b)(1). First, the taxpayer determines the yield to maturity of the debt instrument as if there were no inflation or deflation over the term of the instrument. Second, the taxpayer determines the length of the accrual periods to be used to allocate OID over the term of the debt instrument, provided no accrual period is longer than one month. Third, the taxpayer determines the percentage change in the value of the reference index during the accrual period by comparing the value at the beginning of the period to the value at the end of the period. Fourth, the taxpayer determines the OID allocable to the accrual period by using a formula that takes into account both the

yield of the debt instrument and the percentage change in the value of the reference index during the period. Fifth, the taxpayer allocates to each day in the accrual period a ratable portion of the OID for the accrual period (the daily portions). If the daily portions for an accrual period are positive amounts, these amounts are taken into account under section 163(e) by an issuer and under section 1272 by a holder. If the daily portions for an accrual period are negative amounts, these amounts are taken into account under the rules for deflation adjustments described below.

Under Notice 96–51, the discount bond method would have allowed qualified stated interest. The temporary regulations, however, provide that no interest payments on an inflation-indexed debt instrument subject to the discount bond method are qualified stated interest. The Treasury and the IRS believe that this change simplifies the taxation of an inflation-indexed debt instrument subject to the discount bond method.

F. Deflation adjustments

The temporary regulations treat deflation adjustments in a manner consistent with the treatment of net negative adjustments on contingent payment debt instruments under § 1.1275–4(b)(6)(iii). If a holder has a deflation adjustment for a taxable year, the deflation adjustment first reduces the amount of interest otherwise includible in income with respect to the debt instrument for the taxable year. If the amount of the deflation adjustment exceeds the interest otherwise includible in income for the taxable year, the holder treats the excess as an ordinary loss in the taxable year. However, the amount treated as an ordinary loss is limited to the amount by which the holder’s total interest inclusions on the debt instrument in prior taxable years exceed the total amount treated by the holder as an ordinary loss on the debt instrument in prior taxable years. If the deflation adjustment exceeds the interest otherwise includible in income by the holder with respect to the debt instrument for the taxable year and the amount treated as an ordinary loss for the taxable year, the excess is carried forward to offset interest income on the debt instrument in subsequent taxable years. Similar rules apply to determine an issuer’s interest deductions and income for the debt instrument.

G. Minimum guarantee

Certain inflation-indexed debt instruments may provide for an additional payment at maturity (a minimum guarantee payment) if the total amount of inflation-adjusted principal paid on the debt instrument is less than the instrument’s stated principal amount. Under both the coupon bond method and the discount bond method, a minimum guarantee payment is ignored until the payment is made. If a minimum guarantee payment is made, the payment is treated as interest on the date it is paid.

In general, the temporary regulations only allow a debt instrument that is indexed by reference to the CPI–U to provide for a minimum guarantee payment. The Treasury and the IRS believe that there is only a small possibility that the total amount of principal paid on a debt instrument indexed to the CPI–U will be less than the instrument’s stated principal amount. In this case, it is appropriate to ignore the minimum guarantee payment until it is paid.

H. Principal amount for the issue date

For purposes of the temporary regulations, if an inflation-indexed debt instrument is issued with pre-issuance accrued interest, the principal amount of the instrument for the issue date includes an adjustment for inflation or deflation. This adjustment is measured by the change in the value of the reference index between the date on which interest starts to accrue (the dated date in the case of a Treasury Inflation-Indexed Security) and the issue date. The stated principal amount of a debt instrument under the regulations, however, is not adjusted for inflation or deflation between the date on which interest starts to accrue and the issue date. Therefore, the stated principal amount of the debt instrument is the same regardless of whether interest accrues on the instrument from the issue date or from an earlier date. The stated principal amount of a Treasury Inflation-Indexed Security is the par amount of the security, as defined in the final rules published by the Treasury Department describing the terms and conditions of Treasury Inflation-Indexed Securities.

When there is a difference between the stated principal amount of an inflation-indexed debt instrument and its principal amount for the issue date, the instrument’s principal amount for the issue date generally is used for purposes of applying the rules in the temporary

regulations to the instrument. For example, the debt instrument’s principal amount for the issue date is used to determine whether the instrument qualifies for the coupon bond method. The temporary regulations require the use of a debt instrument’s stated principal amount rather than its principal amount for the issue date to measure the amount of a minimum guarantee payment.

I. Strips

Treasury Inflation-Indexed Securities are eligible for the Department of the Treasury’s Separate Trading of Registered Interest and Principal of Securities (STRIPS) program. Under this program, the interest and principal components of a Treasury Inflation-Indexed Security may be transferred as separate instruments (stripped bonds and coupons). In general, section 1286 treats the holder of a stripped bond (or coupon) as if the holder purchased a newly issued debt instrument that has OID. The temporary regulations provide that the holder of a component of a Treasury InflationIndexed Security that is stripped under the Treasury STRIPS program must use the discount bond method to account for the OID on the component.

J. Information reporting

The temporary regulations do not provide any new information reporting rules for inflation-indexed debt instruments. The OID and any qualified stated interest on an inflation-indexed debt instrument should be reported on Form 1099–OID. The IRS plans to issue guidance for the reporting of OID on Treasury Inflation-Indexed Securities that are stripped under the STRIPS program.

K. Effective date

The temporary regulations apply to an inflation-indexed debt instrument issued on or after January 6, 1997.

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 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, 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.

Drafting Information

The principal author of the regulations is Jeffrey W. Maddrey, Office of Assistant Chief Counsel (Financial Institutions and Products). However, other personnel from the IRS and Treasury Department participated in their development.

- - - -

Adoption of Amendments to the Regula- tions

Accordingly, 26 CFR part 1 is amended as follows:

Part 1—INCOME TAXES

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

Authority: 26 U.S.C. 7805 - - Section 1.1275–7T also issued under 26 U.S.C. 1275(d). - - Section 1.1286–2T also issued under 26 U.S.C. 1286(f). - - Par. 2. Section 1.1271–0 is amended by—

Revising the second sentence of paragraph (a);
Revising the introductory text of paragraph (b); and
Adding entries for § 1.1275–7T in paragraph (b).

The revisions and additions read as follows:

§ 1.1271–0 Original issue discount; ef- fective date; table of contents.

(a) - - - Taxpayers, however, may rely on these sections (as contained in 26 CFR part 1 revised April 1, 1996) for debt instruments issued after December 21, 1992, and before April 4, 1994. (b) Table of contents . This section lists captioned paragraphs contained in §§ 1.1271–1 through 1.1275–7T.

- - - -

§ 1.1275–7T Inflation-indexed debt in- struments (temporary). (a) Overview. (b) Applicability. (1) In general. (2) Exceptions. (c) Definitions. (1) Inflation-indexed debt instrument. (2) Reference index.

(3) Qualified inflation index. (4) Inflation-adjusted principal amount. (5) Minimum guarantee payment. (d) Coupon bond method. (1) In general. (2) Applicability. (3) Qualified stated interest. (4) Inflation adjustments. (5) Example. (e) Discount bond method. (1) In general. (2) No qualified stated interest. (3) OID. (4) Example. (f) Special rules. (1) Deflation adjustments. (2) Adjusted basis. (3) Subsequent holders. (4) Minimum guarantee. (5) Temporary unavailability of a quali fied inflation index. (g) Reopenings. (h) Effective date.

- - - - Par. 3. Section 1.1275–4 is amended

by—

Removing the word ‘‘or’’ from the end of paragraph (a)(2)(vi);
Redesignating paragraph (a)(2)(vii) as paragraph (a)(2)(viii); and
Adding a new paragraph (a)(2)(vii).

The addition reads as follows:

§ 1.1275–4 Contingent payment debt instruments.

(a) - - (2) - - (vii) An inflation-indexed debt instrument (as defined in § 1.1275–7T); or

- - - - Par. 4. Section 1.1275–7T is added to

read as follows:

§ 1.1275–7T Inflation-indexed debt in- struments (temporary).

(a) Overview. This section provides rules for the federal income tax treatment of an inflation-indexed debt instrument. If a debt instrument is an inflation-indexed debt instrument, one of two methods will apply to the instrument: the coupon bond method (as described in paragraph (d) of this section) or the discount bond method (as described in paragraph (e) of this section). Both methods determine the amount of OID that is taken into account each year by a holder or an issuer of an inflationindexed debt instrument.

(b) Applicability —(1) In general . Except as provided in paragraph (b)(2) of this section, this section applies to an

inflation-indexed debt instrument as defined in paragraph (c)(1) of this section. For example, this section applies to Treasury Inflation-Indexed Securities. (2) Exceptions . This section does not apply to an inflation-indexed debt instrument that is also—

(i) A debt instrument (other than a tax-exempt obligation) described in section 1272(a)(2) (for example, U.S. savings bonds, certain loans between natural persons, and short-term taxable obligations); or

(ii) A debt instrument subject to section 529 (certain debt instruments issued by qualified state tuition programs). (c) Definitions . The following definitions apply for purposes of this section:

(1) Inflation-indexed debt instrument . An inflation-indexed debt instrument is a debt instrument that satisfies the following conditions:

(i) Issued for cash . The debt instrument is issued for U.S. dollars and all payments on the instrument are denominated in U.S. dollars.

(ii) Indexed for inflation and defla- tion . Except for a minimum guarantee payment (as defined in paragraph (c)(5) of this section), each payment on the debt instrument is indexed for inflation and deflation. A payment is indexed for inflation and deflation if the amount of the payment is equal to—

(A) The amount that would be payable if there were no inflation or deflation over the term of the debt instrument, multiplied by

(B) A ratio, the numerator of which is the value of the reference index for the date of the payment and the denominator of which is the value of the reference index for the issue date.

(iii) No other contingencies . No payment on the debt instrument is subject to a contingency other than the inflation contingency or the contingencies described in this paragraph (c)(1)(iii). A debt instrument may provide for—

(A) A minimum guarantee payment as defined in paragraph (c)(5) of this section; or

(B) Payments under one or more alternate payment schedules if the payments under each payment schedule are indexed for inflation and deflation and a payment schedule for the debt instrument can be determined under § 1.1272–1(c). (For purposes of this section, the rules of § 1.1272–1(c) are applied to the debt instrument by assuming that no inflation or deflation will occur over the term of the instrument.)

(2) Reference index . The reference index is an index used to measure inflation and deflation over the term of a debt instrument. To qualify as a reference index, an index must satisfy the following conditions:

(i) The value of the index is reset once a month to a current value of a single qualified inflation index (as defined in paragraph (c)(3) of this section). For this purpose, a value of a qualified inflation index is current if the value has been updated and published within the preceding six month period.

(ii) The reset occurs on the same day of each month (the reset date).

(iii) The value of the index for any date between reset dates is determined through straight-line interpolation.

(3) Qualified inflation index . A qualified inflation index is a general price or wage index that is updated and published at least monthly by an agency of the United States Government (for example, the non-seasonally adjusted U.S. City Average All Items Consumer Price Index for All Urban Consumers (CPI– U), which is published by the Bureau of Labor Statistics of the Department of Labor).

(4) Inflation-adjusted principal amount . For any date, the inflationadjusted principal amount of an inflation-indexed debt instrument is an amount equal to—

(i) The outstanding principal amount of the debt instrument (determined as if there were no inflation or deflation over the term of the instrument), multiplied by

(ii) A ratio, the numerator of which is the value of the reference index for the date and the denominator of which is the value of the reference index for the issue date.

(5) Minimum guarantee payment . In general, a minimum guarantee payment is an additional payment made at maturity on a debt instrument if the total amount of inflation-adjusted principal paid on the instrument is less than the instrument’s stated principal amount. The amount of the additional payment must be no more than the excess, if any, of the debt instrument’s stated principal amount over the total amount of inflation-adjusted principal paid on the instrument. An additional payment is not a minimum guarantee payment unless the qualified inflation index used to determine the reference index is either the CPI–U or an index designated for this purpose by the Commissioner in the Federal Register or the Internal Rev

enue Bulletin (see § 601.601(d)(2)(ii) of this chapter). See paragraph (f)(4) of this section for the treatment of a minimum guarantee payment.

(d) Coupon bond method —(1) In general . This paragraph (d) describes the method (coupon bond method) to be used to account for qualified stated interest and inflation adjustments (OID) on an inflation-indexed debt instrument described in paragraph (d)(2) of this section.

(2) Applicability . The coupon bond method applies to an inflation-indexed debt instrument that satisfies the following conditions:

(i) Issued at par . The debt instrument is issued at par. A debt instrument is issued at par if the difference between its issue price and principal amount for the issue date is less than the de minimis amount. For this purpose, the de minimis amount is determined using the principles of § 1.1273–1(d).

(ii) All stated interest is qualified stated interest . All stated interest on the debt instrument is qualified stated interest. For purposes of this paragraph (d), stated interest is qualified stated interest if the interest is unconditionally payable in cash, or is constructively received under section 451, at least annually at a single fixed rate. Stated interest is payable at a single fixed rate if the amount of each interest payment is determined by multiplying the inflation adjusted principal amount for the payment date by the single fixed rate.

(3) Qualified stated interest . Under the coupon bond method, qualified stated interest is taken into account under the taxpayer’s regular method of accounting. The amount of accrued but unpaid qualified stated interest as of any date is determined by using the principles of § 1.446–3(e)(2)(ii) (relating to notional principal contracts). For example, if the interval between interest payment dates spans two taxable years, a taxpayer using an accrual method of accounting determines the amount of accrued qualified stated interest for the first taxable year by reference to the inflation-adjusted principal amount at the end of the first taxable year.

(4) Inflation adjustments —(i) Current accrual . Under the coupon bond method, an inflation adjustment is taken into account for each taxable year in which the debt instrument is outstanding.

(ii) Amount of inflation adjustment . For any relevant period (such as the taxable year or the portion of the tax

able year during which a taxpayer holds an inflation-indexed debt instrument), the amount of the inflation adjustment is equal to—

(A) The sum of the inflation-adjusted principal amount at the end of the period and the principal payments made during the period, minus

(B) The inflation-adjusted principal amount at the beginning of the period.

(iii) Positive inflation adjustments . A positive inflation adjustment is OID.

(iv) Negative inflation adjustments . A negative inflation adjustment is a deflation adjustment that is taken into account under the rules of paragraph (f)(1) of this section.

(5) Example . The following example illustrates the coupon bond method:

Example . (i) Facts . On October 15, 1997, X purchases at original issue, for $100,000, a debt instrument that is indexed for inflation and deflation. The debt instrument matures on October 15, 1999, has a stated principal amount of $100,000, and has a stated interest rate of 5 percent, compounded semiannually. The debt instrument provides that the principal amount is indexed to the CPI–U. Interest is payable on April 15 and October 15 of each year. The amount of each interest payment is determined by multiplying the inflation-adjusted principal amount for each interest payment date by the stated interest rate, adjusted for the length of the accrual period. The debt instrument provides for a single payment of the inflation-adjusted principal amount at maturity. In addition, the debt instrument provides for an additional payment at maturity equal to the excess, if any, of $100,000 over the inflation-adjusted principal amount at maturity. X uses the cash receipts and disbursements method of accounting and the calendar year as its taxable year.

(ii) Indexing methodology . The debt instrument provides that the inflation-adjusted principal amount for any day is determined by multiplying the principal amount of the instrument for the issue date by a ratio, the numerator of which is the value of the reference index for the day the inflation-adjusted principal amount is to be determined and the denominator of which is the value of the reference index for the issue date. The value of the reference index for the first day of a month is the value of the CPI–U for the third preceding month. The value of the reference index for any day other than the first day of a month is determined based on a straight-line interpolation between the value of the reference index for the first day of the month and the value of the reference index for the first day of the next month.

(iii) Inflation-indexed debt instrument subject to the coupon bond method . Under paragraph (c)(1) of this section, the debt instrument is an inflationindexed debt instrument. Because there is no difference between the debt instrument’s issue price ($100,000) and its principal amount for the issue date ($100,000) and because all stated interest is qualified stated interest, the coupon bond method applies to the instrument.

(iv) Reference index values . Assume the following table lists the relevant reference index values for 1997 through 1999:

Date Reference index value

October 15, 1997 100 January 1, 1998 101 April 15, 1998 103 October 15, 1998 105 January 1, 1999 99

(v) Treatment of X in 1997 . X does not receive any payments of interest on the debt instrument in 1997. Therefore, X has no qualified stated interest income for 1997. X, however, must take into account the inflation adjustment for 1997. The inflation-adjusted principal amount for January 1, 1998, is $101,000 ($100,000 x 101/100). Therefore, the inflation adjustment for 1997 is $1,000, the inflation-adjusted principal amount for January 1, 1998 ($101,000) minus the principal amount for the issue date ($100,000). X includes the $1,000 inflation adjustment in income as OID in 1997.

(vi) Treatment of X in 1998 . In 1998, X receives two payments of interest: On April 15, 1998, X receives a payment of $2,575 ($100,000 x 103/100 x .05/2), and on October 15, 1998, X receives a payment of $2,625 ($100,000 x 105/100 x .05/2). Therefore, X’s qualified stated interest income for 1998 is $5,200 ($2,575 + $2,625). X also must take into account the inflation adjustment for 1998. The inflation-adjusted principal amount for January 1, 1999, is $99,000 ($100,000 x 99/100). Therefore, the inflation adjustment for 1998 is negative $2,000, the inflation-adjusted principal amount for January 1, 1999 ($99,000) minus the inflation-adjusted principal amount for January 1, 1998 ($101,000). Because the amount of the inflation adjustment is negative, it is a deflation adjustment. Under paragraph (f)(1)(i) of this section, X uses this $2,000 deflation adjustment to reduce the interest otherwise includible in income by X with respect to the debt instrument in 1998. Therefore, X includes $3,200 in income for 1998, the qualified stated interest income for 1998 ($5,200) minus the deflation adjustment ($2,000).

(e) Discount bond method —(1) In general . This paragraph (e) describes the method (discount bond method) to be used to account for OID on an inflationindexed debt instrument that does not qualify for the coupon bond method.

(2) No qualified stated interest . Under the discount bond method, no interest on an inflation-indexed debt instrument is qualified stated interest.

(3) OID . Under the discount bond method, the amount of OID that accrues on an inflation-indexed debt instrument is determined as follows:

(i) Step one: Determine the debt in- strument’s yield to maturity . The yield of the debt instrument is determined under the rules of § 1.1272–1(b)(1)(i). In calculating the yield under those rules for purposes of this paragraph (e)(3)(i), the payment schedule of the debt instrument is determined as if there were no inflation or deflation over the term of the instrument.

(ii) Step two: Determine the accrual periods . The accrual periods are deter

mined under the rules of § 1.1272– 1(b)(1)(ii). However, no accrual period can be longer than 1 month.

(iii) Step three: Determine the per- centage change in the reference index during the accrual period . The percentage change in the reference index during the accrual period is equal to—

(A) The ratio of the value of the reference index at the end of the period to the value of the reference index at the beginning of the period,

(B) Minus one. (iv) Step four: Determine the OID allocable to each accrual period . The OID allocable to an accrual period (n) is determined by using the following formula:

OID(n) = AIP(n) × [r + inf(n) + (r × inf(n))] in which,

r = yield of the debt instrument as determined under paragraph (e)(3)(i) of this section (adjusted for the length of the accrual period);

inf(n) = percentage change in the value of the reference index for period (n) as determined under paragraph (e)(3)(iii) of this section; and

AIP(n) = adjusted issue price at the beginning of period (n).

(v) Step five: Determine the daily portions of OID . The daily portions of OID are determined and taken into account under the rules of § 1.1272– 1(b)(1)(iv). If the daily portions determined under this paragraph (e)(3)(v) are negative amounts, however, these amounts (deflation adjustments) are taken into account under the rules for deflation adjustments described in paragraph (f)(1) of this section.

(4) Example . The following example illustrates the discount bond method:

Example. (i) Facts . On November 15, 1997, X purchases at original issue, for $91,403, a zerocoupon debt instrument that is indexed for inflation and deflation. The principal amount of the debt instrument for the issue date is $100,000. The debt instrument provides for a single payment on November 15, 2000. The amount of the payment will be determined by multiplying $100,000 by a fraction, the numerator of which is the CPI–U for September 2000, and the denominator of which is the CPI–U for September 1997. The debt instrument also provides that in no event will the payment on November 15, 2000, be less than $100,000. X uses the cash receipts and disbursements method of accounting and the calendar year as its taxable year.

(ii) Inflation-indexed debt instrument. Under paragraph (c)(1) of this section, the instrument is an inflation-indexed debt instrument. The debt instrument’s principal amount for the issue date ($100,000) exceeds its issue price ($91,403) by $8,597, which is more than the de minimis amount for the debt instrument ($750). Therefore, the coupon bond method does not apply to the debt instrument. As a result, the discount bond method applies to the debt instrument.

(iii) Yield and accrual period. Assume X chooses monthly accrual periods ending on the 15th day of each month. The yield of the debt instrument is determined as if there were no inflation or deflation over the term of the instrument. Therefore, based on the issue price of $91,403 and an assumed payment at maturity of $100,000, the yield of the debt instrument is 3 percent, compounded monthly.

(iv) Percentage change in reference index . Assume that the CPI–U for September 1997 is 160; for October 1997 is 161.2; and for November 1997 is 161.7. The value of the reference index for November 15, 1997, is 160, the value of the CPI–U for September 1997. Similarly, the value of the reference index for December 15, 1997, is 161.2, and for January 15, 1998, is 161.7. The percentage change in the reference index from November 15, 1997, to December 15, 1997, (inf1) is 0.0075 (161.2/160 - 1); the percentage change in the reference index from December 15, 1997, to January 15, 1998, (inf2) is 0.0031 (161.7/161.2 1). (v) Treatment of X in 1997 . For the accrual period ending on December 15, 1997, r is .0025 (.03/12), inf1 is .0075, and the product of r and inf1 is .00001875. Under paragraph (e)(3) of this section, the amount of OID allocable to the accrual period ending on December 15, 1997, is $916. This amount is determined by multiplying the issue price of the debt instrument ($91,403) by .01001875 (the sum of r, inf1, and the product of r and inf1). The adjusted issue price of the debt instrument on December 15, 1997, is $92,319 ($91,403 + $916). For the accrual period ending on January 15, 1998, r is .0025 (.03/12), inf2 is .0031, and the product of r and inf2 is .00000775. Under paragraph (e)(3) of this section, the amount of OID allocable to the accrual period ending on January 15, 1998, is $518. This amount is determined by multiplying the adjusted issue price of the debt instrument ($92,319) by .00560775 (the sum of r, inf2, and the product of r and inf2). Because the accrual period ending on January 15, 1998, spans two taxable years, only $259 of this amount ($518/30 days x 15 days) is allocable to 1997. Therefore, X includes $1,175 of OID in income for 1997 ($916 + $259).

(f) Special rules. The following rules apply to an inflation-indexed debt instrument:

(1) Deflation adjustments —(i) Holder . A deflation adjustment reduces the amount of interest otherwise includible in income by a holder with respect to the debt instrument for the taxable year. For purposes of this paragraph (f)(1)(i), interest includes OID, qualified stated interest, and market discount. If the amount of the deflation adjustment exceeds the interest otherwise includible in income by the holder with respect to the debt instrument for the taxable year, the excess is treated as an ordinary loss by the holder for the taxable year. However, the amount treated as an ordinary loss is limited to the amount by which the holder’s total interest inclusions on the debt instrument in prior taxable years exceed the total amount treated by the

holder as an ordinary loss on the debt instrument in prior taxable years. If the deflation adjustment exceeds the interest otherwise includible in income by the holder with respect to the debt instrument for the taxable year and the amount treated as an ordinary loss for the taxable year, this excess is carried forward to reduce the amount of interest otherwise includible in income by the holder with respect to the debt instrument for subsequent taxable years.

(ii) Issuer . A deflation adjustment reduces the interest otherwise deductible by the issuer with respect to the debt instrument for the taxable year. For purposes of this paragraph (f)(1)(ii), interest includes OID and qualified stated interest. If the amount of the deflation adjustment exceeds the interest otherwise deductible by the issuer with respect to the debt instrument for the taxable year, the excess is treated as ordinary income by the issuer for the taxable year. However, the amount treated as ordinary income is limited to the amount by which the issuer’s total interest deductions on the debt instrument in prior taxable years exceed the total amount treated by the issuer as ordinary income on the debt instrument in prior taxable years. If the deflation adjustment exceeds the interest otherwise deductible by the issuer with respect to the debt instrument for the taxable year and the amount treated as ordinary income for the taxable year, this excess is carried forward to reduce the interest otherwise deductible by the issuer with respect to the debt instrument for subsequent taxable years. If there is any excess remaining upon the retirement of the debt instrument, the issuer takes the excess amount into account as ordinary income.

(2) Adjusted basis . A holder’s adjusted basis in an inflation-indexed debt instrument is determined under § 1.1272–1(g). However, a holder’s adjusted basis in the debt instrument is decreased by the amount of any deflation adjustment the holder takes into account to reduce the amount of interest otherwise includible in income or treats as an ordinary loss with respect to the instrument during the taxable year. The decrease occurs when the deflation adjustment is taken into account under paragraph (f)(1) of this section.

(3) Subsequent holders . A holder determines the amount of acquisition premium or market discount on an

inflation-indexed debt instrument by reference to the adjusted issue price of the instrument on the date the holder acquires the instrument. A holder determines the amount of bond premium on an inflation-indexed debt instrument by assuming that the amount payable at maturity on the instrument is equal to the instrument’s inflation-adjusted principal amount for the day the holder acquires the instrument. Any premium or market discount is taken into account over the remaining term of the debt instrument as if there were no further inflation or deflation. See section 171 for additional rules relating to the amortization of bond premium and sections 1276 through 1278 for additional rules relating to market discount.

(4) Minimum guarantee . Under both the coupon bond method and the discount bond method, a minimum guarantee payment is ignored until the payment is made. If there is a minimum guarantee payment, the payment is treated as interest on the date it is paid.

(5) Temporary unavailability of a qualified inflation index . Notwithstanding any other rule of this section, an inflation-indexed debt instrument may provide for a substitute value of the qualified inflation index if and when the publication of the value of the qualified inflation index is temporarily delayed. The substitute value may be determined by the issuer under any reasonable method. For example, if the CPI–U is not reported for a particular month, the debt instrument may provide that a substitute value may be determined by increasing the last reported value by the average monthly percentage increase in the qualified inflation index over the preceding twelve months. The use of a substitute value does not result in a reissuance of the debt instrument.

(g) Reopenings . For purposes of § 1.1275–2(d)(2), a reopening of Treasury Inflation-Indexed Securities is a qualified reopening if—

(1) The terms of the securities issued in the reopening are the same as the terms of the original securities; and

(2) The reopening occurs not more than one year after the original securities were first issued to the public.

(h) Effective date . This section applies to an inflation-indexed debt instrument issued on or after January 6, 1997.

Par. 5. Section 1.1286–2T is added to read as follows:

§ 1.1286–2T Stripped inflation-indexed debt instruments (temporary).

Stripped inflation-indexed debt instru- ments . If a Treasury Inflation-Indexed Security is stripped under the Department of the Treasury’s Separate Trading of Registered Interest and Principal of Securities (STRIPS) program, the holders of the principal and coupon components must use the discount bond method (as described in § 1.1275– 7T(e)) to account for the original issue discount on the components.

Margaret Milner Richardson, Commissioner of Internal Revenue.

Approved December 6, 1996.

Donald C. Lubick, Acting Assistant Secretary

of the Treasury.

(Filed by the Office of the Federal Register on December 31, 1996, and published in the issue of the Federal Register for January 6, 1997, 62 F.R. 615)

Section 3402.—Income Tax Collected at Source

26 CFR 31.3402(f)(5)–1: Form and contents of withholding exemption certificates.

T.D. 8706

DEPARTMENT OF THE TREASURY Internal Revenue Service 26 CFR Parts 31 and 602

Electronic Filing of Form W–4

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

SUMMARY: This document contains final regulations relating to Form W–4, Employee’s Withholding Allowance Certificate. The final regulations authorize employers to establish electronic systems for use by employees in filing their Forms W–4. The regulations provide employers and employees with guidance necessary to comply with the law. The regulations affect employers that establish electronic systems and their employees.

EFFECTIVE DATE: These final regulations are effective January 2, 1997.

FOR FURTHER INFORMATION CONTACT: Karin Loverud, (202) 622–6060 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

The collection of information contained in these final regulations has been reviewed and approved by the Office of Management and Budget in accordance with the Paperwork Reduction Act (44 U.S.C. 3507) under control number 1545–1435. Responses to this collection of information are mandatory.

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

The estimated annual burden per respondent is 20 hours.

Comments concerning the accuracy of this burden estimate and suggestions for reducing this burden should be sent to the Internal Revenue Service, Attn: IRS Reports Clearance Officer, T:FP, Washington, DC 20224, and to the Of- fice of Management and Budget, Attn: Desk Officer for the Department of the Treasury, Office of Information and Regulatory Affairs, Washington, DC 20503. Books or records relating to this collection of information must be retained as long as their contents may become material in the administration of any internal revenue law. Generally, tax returns and tax return information are confidential, as required by 26 U.S.C. 6103. Background On April 15, 1994, a notice of proposed rulemaking [EE–45–93] containing proposed regulations relating to Form W–4, Employee’s Withholding Allowance Certificate, was published in the Federal Register (59 FR 18057).

On December 21, 1994, temporary regulations (T.D. 8577) clarifying the existing proposed regulations were published in the Federal Register (59 FR 65712). A notice of proposed rulemaking (EE–45–93) cross-referencing the temporary regulations was published in the Federal Register for the same day (59 FR 65740).

Written comments responding to these notices were received. Public hearings were requested and were held on July 15, 1994, and November 7, 1995. After consideration of all the comments, the proposed regulations under section 3402(f) are adopted as revised by this Treasury decision. The comments and revisions are discussed below.

Explanation of Revisions and Summary of Comments

Relationship between paper and electronic Forms W–4. A withholding exemption certificate (Form W–4) may be in either paper or electronic form. Therefore, an employee will furnish a Form W–4 to the employer either on paper or electronically. To clarify that an electronic Form W–4 has the same status as a paper Form W–4, the final regulations make minor revisions to § 31.3402(f)(5)–1, Form and contents of withholding exemption certificates. Further, the final regulations appear as § 31.3402(f)(5)–1(c), rather than in a separate regulations section limited to electronic forms.
Electronic filing by all employees. The existing proposed and temporary regulations require employers that establish electronic systems to provide employees with the option of filing paper or electronic Forms W–4. Several commentators requested that employers be allowed to adopt systems under which all employees file Forms W–4 electronically. These commentators stated that a system under which all employees file electronically would reduce employer burden in terms of costs and time (for example, eliminate maintenance of duplicative paper and electronic systems). Similarly, it would reduce employee burden in terms of time and choosing a filing option.

The IRS and Treasury want to assist in reducing burdens on both employers and employees and to make it as easy as possible for employers to adopt less burdensome systems. The final regulations permit an employer to adopt a system under which all employees file Forms W–4 electronically. The IRS and Treasury expect, however, that an employer will make a paper option reasonably available upon request to any employee who has a serious objection to using the electronic system or whose access to, or ability to use, the system may be limited (for example, as a result of a disability). The paper option would be satisfied, for example, if the employer informs employees how they can obtain a paper Form W–4 and where they should submit the completed paper Form W–4. The IRS and Treasury also expect that employers will comply with all applicable law governing the workplace and terms and conditions of employment, such as the Americans with

Disabilities Act (42 U.S.C. 12112(a)). Compliance with these regulations does not guarantee that a system for filing Forms W–4 electronically is in compliance with those applicable laws.

Electronic Forms W–4. Several commentators recommended that electronic systems be allowed for all Forms W–4 without exception. The prior proposed and temporary regulations specifically exclude (1) Forms W–4 required upon commencement of employment (initial Form W–4), and (2) Forms W–4 required to be furnished to the IRS by employers because more than 10 withholding exemptions are claimed or, if the employee is expected to earn more than $200 per week, exemption from withholding is claimed.

Initial Form W–4. Section 3402(f)(2)(A) of the Internal Revenue Code (Code) requires a new employee to furnish the employer with a signed withholding exemption certificate. Section 6061 requires all Forms W–4 to be signed. See discussion below under ‘‘5. Signature under penalties of perjury’’ and § 301.6061–1(b), which states that the Secretary may prescribe in forms, instructions, or other appropriate guidance the method of signing any return, statement, or other document required to be made under any provision of the internal revenue laws or regulations. The final regulations permit electronic systems to include Forms W–4 required upon commencement of employment.

Forms W–4 claiming more than 10 exemptions or exemption from withholding. Section 31.3402(f)(2)–1(g) requires employers to submit to the IRS copies of certain Forms W–4 furnished to them by their employees. The Forms W–4 required to be submitted are those on which the employee claims either (1) more than 10 withholding exemptions, or (2) exemption from withholding (and the employee is expected to earn more than $200 per week).

Under § 31.3402(f)(2)–1(g)(5), if the IRS determines that a Form W–4, a copy of which was submitted to the IRS, is defective, the IRS will notify in writing both the employer and the employee. (The notice is referred to as a ‘‘lock-in letter.’’) A Form W–4 is defective if (1) the IRS determines that the Form W–4 contains a materially incorrect statement, or (2) following communication with the employee, the IRS lacks sufficient information to determine whether the certificate is correct. The

Submission of certain Forms W–4 to IRS. Section 31.3402(f)(2)–1(g) requires employers to submit to the IRS copies of Forms W–4 on which the employee claims either more than 10 withholding exemptions or exemption from withholding (and the employee is expected to earn more than $200 per week). Generally, the copies are sent quarterly to the IRS along with the employer’s Form 941, Employer’s Quarterly Federal Tax Return. Copies can also be submitted earlier and more often to the employer’s IRS service center.

Employers that establish electronic systems will satisfy the requirement of § 31.3402(f)(2)–1(g) if they furnish the Form W–4 information on magnetic media. Before using magnetic media, employers must submit Form 4419, Application for Filing Information Returns Magnetically/Electronically, to request authorization. Rev. Proc. 92–80 (1992–2 C.B. 465) contains specifications for filing Forms W–4 on magnetic tape and

lock-in letter issued by the IRS advises the employer that the employee either is not entitled to claim exemption from withholding or is not entitled to claim more withholding exemptions than the number specified by the IRS in the notice, or both. If the employee subsequently files a new Form W–4, the employer may withhold on the basis of that new Form W–4 only if the new Form W–4 is consistent with the lock-in letter. The employer must continue to withhold on the basis of that advice until the IRS revokes in writing its lock-in letter.

The final regulations permit electronic systems to include Forms W–4 on which employees claim more than 10 withholding exemptions or exemption from withholding. However, the IRS and Treasury expect that electronic systems, alone or in conjunction with the rest of an employer’s payroll system, will ensure compliance with the advice contained in a lock-in letter. For instance, an electronic system can ensure compliance with a lock-in letter by prohibiting an employee for whom a lock-in letter was issued from filing any electronic Form W–4 or prohibiting the employee from claiming more withholding exemptions than the number specified in the IRS notice. Additionally, an employer may choose to require any employee to file a paper Form W–4 if the employee wishes to claim more than 10 withholding exemptions or exemption from withholding.

on 5¼- and 3½-inch magnetic diskettes. Electronic transmission of Form W–4 information to the IRS is not yet available.

Signature under penalties of perjury. Section 6061 of the Code requires that any return, statement, or other document required to be made under any provision of the Code or regulations be signed. Section 6065 requires that any such document contain or be verified by a written declaration that it is made under the penalties of perjury. These requirements apply to all Forms W–4, including those filed electronically, and are reflected in § 31.3402(f)(5)–1(c)(iii) of the final regulations.

Although sections 6061 and 6065 apply to all Forms W–4, the IRS and Treasury are concerned that some electronic systems established under the temporary regulations may not include a signature under penalties of perjury. The final regulations, therefore, include guidance on the perjury statement and the electronic signature.

For certain Forms W–4, the final regulations treat the signature-underpenalties-of-perjury-statement requirement as satisfied until January 1, 1999. This special rule applies only if the system precludes the electronic filing of Forms W–4 required upon commencement of employment and Forms W–4 claiming more than 10 withholding exemptions or exemption from withholding. Moreover, the special rule applies only to Forms W–4 filed electronically before the earlier of (1) January 1, 1999, or (2) the first date on which the employer’s electronic system permits the filing of Forms W–4 required upon commencement of employment or Forms W–4 claiming more than 10 withholding exemptions or exemption from withholding.

The IRS and Treasury will consider written comments pertaining to the provisions relating to signatures under penalties of perjury. Submissions should be sent to: CC:DOM:CORP:R (T.D. 8706), room 5228, Internal Revenue Service, POB 7604, Ben Franklin Station, Washington, DC 20044. 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. Submissions may be hand delivered between the hours of 8 a.m. and 5 p.m. to: CC:DOM:CORP:R

(T.D. 8706), Courier’s Desk, Internal Revenue Service, 1111 Constitution Avenue NW, Washington, DC.

Employer retention of Forms W–4 and predecessor and successor employers. One commentator requested guidance concerning the period for which paper Forms W–4 are required to be retained under § 31.6001–1(e) after the employer establishes an electronic system and in predecessor-employer/ successor-employer situations. Electronic Forms W–4 have the same status as paper Forms W–4. Therefore, guidance that applies to paper Forms W–4 also applies to electronic Forms W–4. For further information, see Rev. Proc. 91–59 (1991–2 C.B. 841) (information regarding the retention of records using a variety of automatic data processing systems); and section 5 of Rev. Proc. 96–60 (1996–53 I.R.B.) (predecessor/ successor situations).

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

Drafting Information

The principal author of these regulations is Karin Loverud, Office of the Associate Chief Counsel (Employee Benefits and Exempt Organizations), IRS. However, other personnel from the IRS and Treasury Department participated in their development.

- - - -

Adoption of Amendments to the Regula- tions

Accordingly, 26 CFR parts 31 and 602 are amended as follows:

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

Paragraph 1. The authority citation for part 31 is amended by adding an entry for Section 31.3402(f)(5)–1 to read as follows:

Authority: 26 U.S.C. 7805 - -
Section 31.3402(f)(5)–1 also issued under 26 U.S.C. 3402(i) and (m). - - Par. 2. Section 31.3402(f)(5)–1 is amended as follows:

Headings are added to paragraphs (a) and (b).
The fourth sentence of paragraph (a) is revised.
Paragraph (c) is added.
The authority citation which follows the end of the section is removed.

The revisions and additions read as follows:

§ 31.3402(f)(5)–1 Form and contents of withholding exemption certificates.

(a) Form W–4 . - - - Blank copies of paper Forms W–4 will be supplied to employers upon request to the Internal Revenue Service. - - (b) Invalid Form W–4. - - (c) Electronic Form W–4 —(1) In general . An employer may establish a system for its employees to file withholding exemption certificates electronically.

(2) Requirements —(i) In general . The electronic system must ensure that the information received is the information sent, and must document all occasions of employee access that result in the filing of a Form W–4. In addition, the design and operation of the electronic system, including access procedures, must make it reasonably certain that the person accessing the system and filing the Form W–4 is the employee identified in the form.

(ii) Same information as paper Form W–4 . The electronic filing must provide the employer with exactly the same information as the paper Form W–4.

(iii) Jurat and signature requirements . The electronic filing must be signed by the employee under penalties of perjury.

(A) Jurat . The jurat (perjury statement) must contain the language that appears on the paper Form W–4. The electronic program must inform the employee that he or she must make the declaration contained in the jurat and that the declaration is made by signing the Form W–4. The instructions and the

language of the jurat must immediately follow the employee’s income tax withholding selections and immediately precede the employee’s electronic signature.

(B) Electronic signature . The electronic signature must identify the employee filing the electronic Form W–4 and authenticate and verify the filing. For this purpose, the terms ‘‘authenticate’’ and ‘‘verify’’ have the same meanings as they do when applied to a written signature on a paper Form W–4. An electronic signature can be in any form that satisfies the foregoing requirements. The electronic signature must be the final entry in the employee’s Form W–4 submission.

(iv) Copies of electronic Forms W–4 . Upon request by the Internal Revenue Service, the employer must supply a hardcopy of the electronic Form W–4 and a statement that, to the best of the employer’s knowledge, the electronic Form W–4 was filed by the named employee. The hardcopy of the electronic Form W–4 must provide exactly the same information as, but need not be a facsimile of, the paper Form W–4.

(3) Effective date —(i) In general . This paragraph applies to all withholding exemption certificates filed electronically by employees on or after January 2, 1997.

(ii) Special rule for certain Forms W–4 . In the case of an electronic system that precludes the filing of Forms W–4 required on commencement of employment and Forms W–4 claiming more than 10 withholding exemptions or exemption from withholding, the requirements of paragraph (c)(2)(iii) of this section will be treated as satisfied if the Form W–4 is filed electronically before January 1, 1999.

§ 31.3402(f)(5)–2T [Removed]

Par. 3. Section 31.3402(f)(5)–2T is removed.

PART 602—OMB CONTROL NUMBERS UNDER THE PAPERWORK REDUCTION ACT

Par. 4. The authority citation for part 602 continues to read as follows: Authority: 26 U.S.C. 7805. Par. 5. In § 602.101, paragraph (c) is amended by:

Removing the entry for 31.3402(f)(5)– 2T from the table.

§ 602.101 OMB Control numbers.

- - - - (c) - -

§ 602.101 OMB Control numbers.

- - - - (c) - -

CFR part or section where identified and described

Current OMB control No.

CFR part or section where identified and described

Current OMB control No.

Margaret Milner Richardson, Commissioner of Internal Revenue.

Approved December 12, 1996.

Donald C. Lubick, Acting Assistant Secretary

of the Treasury.

(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. 22)

- - - 31.3402(f)(5)–2T . . . . . . 1545–1435

Revising the entry for 31.3402(f)(5)– 1 to read as follows:
- - - - 31.3402(f)(5)–1. . . . . . . . 1545–0010
1545–1435