Part I. Rulings — Internal Revenue Bulletin 1997-52

Section 1.—Tax Imposed

26 CFR 1.1–1: Income tax on individuals.

The Service provides adjusted tax tables for individuals, trusts, and estates for taxable years beginning in 1998 to reflect changes in the cost of living. Also adjusted is the amount of certain reductions allowed against the unearned income of minor children in computing the “kiddie tax,” either on the child’s return or, in the alternative, on a parent’s return. The amounts used to determine whether a parent may elect to report the “kiddie tax” on the parent’s return are also adjusted. See Rev. Proc. 97–57, page 20.

Section 32.—Earned Income

26 CFR 1.32–2: Earned income credit for taxable years beginning after December 31, 1978.

The Service provides inflation adjustments to the limitations on the earned income tax credit for taxable years beginning in 1998. See Rev. Proc. 97–57, page 20.

Section 62.—Adjusted Gross Income Defined

26 CFR 1.62–2: Reimbursements and other expense allowance arrangements.

Rules under which a reimbursement or other expense allowance arrangement for the cost of operating an automobile for business purposes will satisfy the requirements of section 62(c) of the Code as to business connection, substantiation, and returning amounts in excess of expenses. See Rev. Proc. 97–58, page 24.

Rules are set forth under which a reimbursement or other expense allowance arrangement for the cost of lodging, meals, and incidental expenses or meal and incidental expenses incurred by an employee while traveling away from home will satisfy the requirements of § 62(c) of the Code as to substantiation of the amount of expenses. See Rev. Proc. 97–59, page 31.

Section 63.—Taxable Income Defined

26 CFR 1.63–1: Change of treatment with respect to the zero bracket amount and itemized deductions.

The Service provides inflation adjustments to the standard deduction amounts (including the limitation in the case of certain dependents, and the additional standard deduction for the aged or blind) for taxable years beginning in 1998. See Rev. Proc. 97–57, page 20.

Section 68.—Overall Limitation on Itemized Deductions

The Service provides inflation adjustments to the overall limitation on itemized deductions for taxable years beginning in 1998. See Rev. Proc. 97–57, page 20.

Section 126.—Certain Cost-Sharing Payments

26 CFR 16A.126–1: Certain cost-sharing payments—In general (Temporary).

Certain cost-sharing payments. The Wetlands Reserve Program, the Environmental Quality Incentives Program, and the Wildlife Habitat Incentives Program are substantially similar to the type of programs described in section 126(a)(1) through (8) of the Code so that cost-share payments made under such programs and in connection with small watersheds are within the scope of section 126(a)(9) and, thereby, cost-share payments received under the programs are eligible for exclusion from gross income to the extent permitted by section 126.

Rev. Rul. 97–55

ISSUE

Are the Wetlands Reserve Program, the Environmental Quality Incentives Program, and the Wildlife Habitat Incentives Program substantially similar to the type of programs described in § 126(a)(1) through (8) of the Internal Revenue Code so that cost-share payments made under such programs and in connection with small watersheds are within the scope of § 126(a)(9) and, thereby, cost-share payments received under the programs are eligible for exclusion from gross income to the extent permitted by § 126?

FACTS

The Wetlands Reserve Program (WRP), authorized by Title XII of the Food Security Act of 1985, Pub. L. No. 99–198, 99 Stat. 1504, reauthorized by the Federal Agriculture Improvement and Reform Act of 1996 (the 1996 Farm Act), Pub. L. No. 104–127, 110 Stat. 995, is a voluntary wetlands conservation program to restore and protect wetlands on private

property. Landowners who participate in the WRP may sell a conservation easement or enter into a restoration cost-share agreement with the Department of Agriculture to restore and protect wetlands. Under a restoration cost-share agreement, a landowner agrees to undertake approved conservation-related improvements on the property in return for a cost-share payment, generally between 75 and 100 percent of the costs for restoring the wetland. A conservation easement and a restoration cost-share agreement may be combined in one agreement with the Department of Agriculture but separate payments are made for the easement and for the costshare agreement.

The 1996 Farm Act also establishes the Environmental Quality Incentives Program (EQIP) and the Wildlife Habitat Incentives Program (WHIP). EQIP and WHIP are administered by the Department of Agriculture. EQIP combines the functions of the Agricultural Conservation Program (ACP), the Great Plains Conservation Program (GPCP), the Water Quality Incentives Program (WQIP), and the Colorado River Basin Salinity Control Program (CRBSCP). ACP and GPCP are programs enumerated in § 126(a)(1) through (8) and the Commissioner determined in § 16A.126– 1(d)(1)(D) that CRBSCP was within the scope of § 126(a)(9). WQIP was funded through and administered under ACP.

WHIP was established to help participants develop habitat for upland wildlife, wetland wildlife, threatened and endangered species, fish, and other types of wildlife. Under WHIP, landowners enter into wildlife habitat development costshare contracts for a minimum of 10 years.

The Secretary of Agriculture has made the requisite determinations under § 126(b)(1)(A) that cost-share payments made under WRP, EQIP, and WHIP are primarily for purposes of conservation.

LAW AND ANALYSIS

Under § 126(a), gross income does not include the excludable portion of payments made to taxpayers by federal and state governments for a share of the cost of improvements to property under cer

1997–52 I.R.B. 7 December 29, 1997

tain conservation programs set forth in § 126(a)(1) through (8). Under § 126(a)(9), programs affecting small watersheds are eligible for § 126 treatment if they are administered by the Secretary of Agriculture and are determined by the Secretary of the Treasury or the Secretary’s delegate to be substantially similar to the type of programs described in § 126(a)(1) through (8). Even if the Secretary of the Treasury determines that a particular program is within the scope of § 126(a)(9), not all cost-share payments under such program will qualify for the exclusion under § 126. In addition to the determination requirement, the specific project must be with respect to a small watershed and then only the “excludable portion” of any payment can qualify for exclusion. See §§ 126(b)(1), 16A.126– 1(b)(5) and 16A.126–1(d)(3) for the definitions of “excludable portion” and “small watershed.”

HOLDING

The Commissioner has determined that WRP, EQIP, and WHIP are substantially similar to the type of programs described in § 126(a)(1) through (8) so that costshare payments made under such programs and in connection with small watersheds are within the scope of § 126(a)(9) and, thereby, cost-share payments received under the programs are eligible for exclusion from gross income to the extent permitted by § 126. See § 16A.126–1 to determine what portion, if any, of the cost-share payments are excludable from gross income under § 126.

DRAFTING INFORMATION

The principal authors of this revenue ruling are Leslie Finlow and Lisa Shuman of the Office of Assistant Chief Counsel (Passthroughs and Special Industries). For further information regarding this revenue ruling contact Ms. Shuman at (202) 622-3120 (not a toll-free call).

Section 132.—Certain Fringe Benefits

The Service provides inflation adjustments to the limitation on the exclusion of income for a qualified transportation fringe for taxable years beginning in 1998. See Rev. Proc. 97–57, page 20.

Section 135.—Income From United States Savings Bonds Used To Pay Higher Education Tuition and Fees

The Service provides an inflation adjustment to the limitation on the exclusion of income from United States savings bonds for taxpayers who pay qualified higher education expenses for taxable years beginning in 1998. See Rev. Proc. 97–57, page 20.

Section 151.—Allowance of Deductions for Personal Exemptions

26 CFR 1.151–4: Amount of deduction for each exemption under section 151.

The Service provides inflation adjustments to the personal exemption and to the threshold amounts of adjusted gross income above which the exemption amount phases out for taxable years beginning in 1998. See Rev.Proc. 97–57, page 20.

Section 162.—Trade or Business Expenses

26 CFR 1.162–17: Reporting and substantiation of certain business expenses of employees.

Rules are set forth for substantiating the amount of a deduction or expense for business use of an automobile that most nearly represents current costs. See Rev. Proc. 97–58, page 24.

Rules are set forth for substantiating the amount of a deduction or expense for lodging, meals, and incidental expenses or meal and incidental expenses incurred while traveling away from home that most nearly represents current costs. See Rev. Proc. 97–59, page 31.

Section 167.—Depreciation

26 CFR 1.167(a) –1: Depreciation in general.

The cost of recoverable line pack gas or cushion gas is not depreciable, and the cost of nonrecoverable line pack gas or cushion gas is depreciable. See Rev. Rul. 97–54, on this page.

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

26 CFR 1.170–1: Charitable, etc., contributions and gifts; allowance of deductions.

The Service provides inflation adjustments to the “insubstantial benefit” guidelines for calendar year 1998. Under the guidelines, a charitable contribution is fully deductible even though the contributor re

ceives “insubstantial benefits” from the charity. See Rev. Proc. 97–57, page 20.

26 CFR 1.170A–1: Charitable, etc., contributions and gifts; allowance of deduction.

Rules are set forth for substantiating the amount of a deduction or expense for charitable use of an automobile. See Rev. Proc. 97–58, page 24.

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

The Service provides an inflation adjustment to the limitation on the amount of eligible long-term care premiums includible in the term “medical care” for taxable years beginning in 1998. See Rev. Proc. 97–57, page 20.

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

Rules are set forth for substantiating the amount of a deduction or expense for use of an automobile to obtain medical services. See Rev. Proc. 97–58, page 24.

Section 217.—Moving Expenses

26 CFR 1.217–2: Moving expenses.

Rules are set forth for substantiating the amount of a deduction or expense for use of an automobile as part of a move. See Rev. Proc. 97–58, page 24.

Section 263.—Capital Expenditures

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

The cost of recoverable and nonrecoverable line pack gas or cushion gas is a capital expenditure. See Rev. Rul. 97–54, on this page.

26 CFR 1.263(a)–1: Capital expenditures; in general. (Also sections 167, 168, 471; 1.167(a)–1, 1.471–1.)

Line pack gas; cushion gas. The cost of recoverable line pack gas or cushion gas is a capital expenditure and is not depreciable. The cost of nonrecoverable line pack gas or cushion gas is a capital expenditure and is depreciable.

Rev. Rul. 97–54

ISSUES

(1) Is the cost of “line pack gas” or “cushion gas” a capital expenditure under § 263 of the Internal Revenue Code or an

December 29, 1997 8 1997–52 I.R.B.

purposes of depreciation. Accord Wash- ington Energy Co. v. United States, 94 F.3d 1557.

Line pack gas or cushion gas is recoverable if it will be available for sale or other use upon abandonment of a pipeline or storage reservoir. See Arkla, Inc. v. United States, 765 F.2d at 490. The Service will treat line pack gas or cushion gas as being available for sale or other use to the extent that such gas will be recovered from an abandoned pipeline or storage reservoir pursuant to a plan, a requirement of law, or economic feasibility, whichever method projects the greatest actual recovery of such gas.

The Service will follow the court decisions cited in this revenue ruling to the extent they hold that the cost of line pack gas or cushion gas is a capital expenditure, the cost of recoverable line pack gas or recoverable cushion gas is not depreciable, and the cost of unrecoverable line pack gas or unrecoverable cushion gas is depreciable.

HOLDINGS

(1) The cost of line pack gas or cushion gas is a capital expenditure under § 263.

(2) The cost of recoverable line pack gas or recoverable cushion gas is not depreciable, but the cost of unrecoverable line pack gas or unrecoverable cushion gas is depreciable under §§ 167 and 168. The Service will treat line pack gas or cushion gas as recoverable to the extent that such gas will be recovered from an abandoned pipeline or storage reservoir pursuant to a plan, a requirement of law, or economic feasibility, whichever method projects the greatest actual recovery of such gas.

APPLICATION

Any change in a taxpayer’s treatment of the costs of line pack gas or cushion gas to conform with this revenue ruling is a change in method of accounting to which the provisions of §§ 446 and 481 and the regulations thereunder apply. A taxpayer wanting to change its method of accounting for the cost of line pack gas or cushion gas to conform with this revenue ruling must follow the automatic change in accounting method provisions of Rev. Proc. 97–37, 1997–33 I.R.B. 18.

amount that is included in inventory under § 471?

(2) If the cost of “line pack gas” or “cushion gas” is a capital expenditure under § 263, is that cost depreciable under §§ 167 and 168?

FACTS

“Line pack gas” is the minimum volume of natural gas necessary to provide the pressure to facilitate the flow of gas through a pipeline. “Cushion gas” is the minimum volume of natural gas necessary to provide the pressure to facilitate the flow of gas from a storage reservoir to a pipeline. Recoverable line pack gas and recoverable cushion gas will be available for sale or other use upon the abandonment of the pipeline or storage reservoir, respectively. Unrecoverable line pack gas and unrecoverable cushion gas will not be available for sale or other use upon the abandonment of the pipeline or storage reservoir, but will become obsolete with that abandonment.

LAW AND ANALYSIS

Section 263(a) provides that no deduction shall be allowed for amounts paid out for permanent improvements or betterments made to increase the value of any property or estate.

Section 1.263(a)–2 of the Income Tax Regulations provides that a “capital expenditure” includes the cost of acquisition, construction, or erection of buildings, machinery and equipment, furniture and fixtures, and similar property having a useful life substantially beyond the tax year.

Section 167(a) provides that there shall be allowed as a depreciation deduction a reasonable allowance for the exhaustion, wear and tear (including a reasonable allowance for obsolescence) of property used in a trade or business or held for the production of income.

Generally, for tangible property, the depreciation deduction under § 167(a) is determined under § 168 by using the applicable depreciation method, the applicable recovery period, and the applicable convention.

Section 471 provides that whenever, in the opinion of the Secretary, the use of inventories is necessary in order clearly to determine the income of any taxpayer, inventories shall be taken by that taxpayer,

on the basis the Secretary may prescribe as conforming as nearly as may be to the best accounting practice in the trade or business and as most clearly reflecting income.

Section 1.471–1 provides that in order to reflect income correctly, inventories at the beginning and end of each tax year are necessary in every case in which the production, purchase, or sale of merchandise is an income-producing factor. Inventories should include all finished and partly finished goods and, in the case of raw materials and supplies, only those that have been acquired for sale or that will physically become a part of merchandise intended for sale.

Rev. Rul. 68–620, 1968–2 C.B. 199, amplified by Rev. Rul. 78–352, 1978–2 C.B. 168, holds that line pack gas is merchandise in transit that is intended to be sold to customers and therefore must be included in the inventory of the taxpayer.

Rev. Rul. 75–233, 1975–1 C.B. 95, holds that the cost of unrecoverable cushion gas is a capital expenditure under § 263, which is recoverable through an annual depreciation deduction under § 167.

With respect to both line pack gas and cushion gas, several court decisions have considered the capital expenditure-versus-inventory issue, as well as the depreciation issue. In Pacific Enterprises v. Commissioner, 101 T.C. 1 (1993), the United States Tax Court held that the costs of line pack gas and cushion gas are capital expenditures. Accord Transwest- ern Pipeline Co. v. United States, 639 F.2d 679 (Ct.Cl. 1980), regarding line pack gas; Arkla, Inc. v. United States, 765 F.2d 487 (5th Cir. 1985), regarding cushion gas. The United States Court of Appeals for the Fifth Circuit in Arkla further held that recoverable cushion gas was not subject to depreciation because it was not subject to exhaustion, wear, tear, or obsolescence. Accord Washington Energy Co. v. United States, 94 F.3d 1557 (Fed. Cir. 1996). The Fifth Circuit in Arkla distinguished unrecoverable cushion gas as being subject to depreciation because that gas will become obsolete along with the storage facility. Accord Rev. Rul. 75233. Finally, in Arkla, Inc. v. United States, 37 F.3d 621 (Fed. Cir. 1994), the United States Court of Appeals for the Federal Circuit held that line pack gas and cushion gas are treated the same for

1997–52 I.R.B. 9 December 29, 1997

EFFECT ON OTHER DOCUMENTS

Rev. Rul. 68–620 and Rev. Rul. 78–352 are revoked. Rev. Rul. 75–233 is superseded. Rev. Proc. 97–37 is amplified to include this change in the Appendix.

PROSPECTIVE APPLICATION

The Service will not require a taxpayer to change its method of accounting to comply with the holding that the cost of line pack gas or recoverable cushion gas is a capital expenditure for any taxable year beginning before December 29, 1997. In addition, the Service will not require a taxpayer to change its method of accounting to comply with the holding for determining the amount of recoverable line pack gas or recoverable cushion gas for any taxable year beginning before December 29, 1997, provided the method used by the taxpayer projects recoverable line pack gas or recoverable cushion gas in an amount equal to or greater than an amount that would be projected using an economic feasibility of recovery standard.

DRAFTING INFORMATION

The principal author of this revenue ruling is Jennifer L. Nuding of the Office of Assistant Chief Counsel (Income Tax and Accounting). For further information concerning this revenue ruling, contact Ms. Nuding at (202) 622-4970 (not a tollfree call).

Section 267.—Losses, Expenses, and Interest With Respect to Transactions Between Related Taxpayers

26 CFR 1.267(a)–1: Deductions disallowed.

When a payor provides a per diem allowance to an employee who is a related party, the rules set forth for the deemed substantiation to the payor of the amount of the employee’s ordinary and necessary business expenses for lodging, meal, and/or incidental expenses incurred while traveling away from home, do not apply. See Rev. Proc. 97–59, page 31.

Section 274.—Disallowance of Certain Entertainment, Etc., Expenses

26 CFR 1.274(d)–1(a): Substantiation requirements.

Simplified optional method for substantiating the amount of a deduction or expense for business use of an automobile. See Rev. Proc. 97–58, page 24.

26 CFR 1.274–5T: Substantiation requirements (temporary).

Simplified optional method for substantiating the amount of a deduction or expense for business use of an automobile. See Rev. Proc. 97–58, page 24.

26 CFR 1.274(d)–1(a): Substantiation requirements.

26 CFR 1.274–5T: Substantiation requirements (temporary).

Rules are set forth for substantiating the amount of ordinary and necessary business expense of an employee for lodging, meals, and incidental expenses or meal and incidental expenses incurred while traveling away from home when a payor provides a per diem allowance under a reimbursement or other expense allowance arrangement to pay for such expenses. Rules are also set forth for an optional method for employees and self-employed individuals to use in computing the deductible costs of business meal and incidental expenses paid or incurred while traveling away from home. See Rev. Proc. 97–59, page 31.

Section 471—General Rule for Inventories

26 CFR 1.471–1: Need for inventories.

The cost of recoverable and nonrecoverable line pack gas or cushion gas is a capital expenditure. Line pack gas or cushion gas in not inventory. See Rev. Rul. 97–54, page 8.

Section 483.—Interest on Certain Deferred Payments

26 CFR 1.483–1: Computation of interest on cer- tain deferred payments.

As defined by section 1274A, the definitions for both “qualified debt instruments” and “cash method debt instruments” have dollar ceilings on the stated principal amount. The limits to the stated principal amount are adjusted for inflation for sales or exchanges occurring in the 1998 calendar year. See Rev. Rul. 97–56, page 11.

Section 512.—Unrelated Business Taxable Income

The Service provides an inflation adjustment to the maximum amount of annual dues that can be paid to certain agricultural or horticultural organizations without any portion being treated as unrelated trade or business income by reason of any benefits

or privileges available to members for taxable years beginning in 1998. See Rev. Proc. 97–57, page 20.

Section 513.—Unrelated Trade or Business

The Service provides an inflation adjustment to the maximum amount of a “low cost article” for taxable years beginning in 1998. Funds raised through a charity’s distribution of “low cost articles” will not be treated as unrelated business income to the charity. See Rev. Proc. 97–57, page 20.

Section 877.—Expatriation to Avoid Tax

The Service provides an inflation adjustment to amounts used to determine whether an individual’s loss of United States citizenship had the avoidance of United States taxes as one of its principal purposes for calendar year 1998. See Rev. Proc. 97–57, page 20.

Section 1274.—Determination of Issue Price in the Case of Certain Debt Instruments Issued for Property

26 CFR 1.1274A–1: Special rules for certain trans- actions where stated principal amount does not ex- ceed $2,800,000.

Section 1274A.—Special Rules for Certain Transactions Where Stated Principal Amount Does Not Exceed $2,800,000

(Also §§ 1274, 483; 1.1274A–1)

Section 1274A inflation-adjusted numbers for 1998. This ruling provides the dollar amounts, increased by the 1998 inflation adjustment, for section 1274A of the Code. Rev. Rul. 96–63 supplemented and superseded.

Rev. Rul. 97–56

This revenue ruling provides the dollar amounts, increased by the 1998 inflation adjustment, for § 1274A of the Internal Revenue Code.

December 29, 1997 10 1997–52 I.R.B.

BACKGROUND

In general, §§ 483 and 1274 of the Code determine the principal amount of a debt instrument given in consideration for the sale or exchange of nonpublicly traded property. In addition, any interest on a debt instrument subject to § 1274 is taken into account under the original issue discount provisions of the Code. Section 1274A, however, modifies the rules under §§ 483 and 1274 for certain types of debt instruments.

In the case of a “qualified debt instrument,” the discount rate used for purposes of §§ 483 and 1274 of the Code may not exceed 9 percent, compounded semiannually. Section 1274A(b) defines a qualified debt instrument as any debt instrument given in consideration for the sale or exchange of property (other than new § 38 property within the meaning of § 48(b), as in effect on the day before the date of enactment of the Revenue Reconciliation Act of 1990) if the stated principal amount of the instrument does not exceed the amount specified in § 1274A(b). For debt instruments arising out of sales or exchanges before January 1, 1990, this amount is $2,800,000.

In the case of a “cash method debt instrument,” as defined in § 1274A(c) of the Code, the borrower and lender may elect to use the cash receipts and disbursements method of accounting. In particular, for any cash method debt instrument, § 1274 does not apply, and interest on the instrument is accounted for by both the borrower and the lender under the cash method of accounting. A cash method debt instrument is a qualified debt instrument that meets the following additional requirements: (A) In the case of instruments arising out of sales or exchanges before January 1, 1990, the stated principal amount does not exceed $2,000,000, (B) The lender does not use an accrual method of accounting and is not a dealer with respect to the property sold or exchanged, (C) Section 1274 would have applied to the debt instrument but for an election under § 1274A(c); and (D) An election under § 1274A(c) is jointly made with respect to the debt instrument by the borrower and lender. Section 1.1274A–1(c)(1) of the Income Tax Regulations provides rules concerning the time for, and manner of, making this election.

Rev. Rul. 97–56 Table 1 Inflation-Adjusted Amounts Under § 1274A

Section 1274A(d)(2) of the Code provides that, for any debt instrument arising out of a sale or exchange during any calendar year after 1989, the dollar amounts stated in § 1274A(b) and § 1274A(c)(2)(A) are increased by the inflation adjustment for the calendar year. Any increase due to the inflation adjustment is rounded to the nearest multiple of $100 (or, if the increase is a multiple of $50 and not of $100, the increase is increased to the nearest multiple of $100). The inflation adjustment for any calendar year is the percentage (if any) by which the CPI for the preceding calendar year exceeds the CPI for calendar year 1988. Section 1274A(d)(2)(B) defines the CPI for any calendar year as the average of the Consumer Price Index as of the close of the 12-month period ending on September 30 of that calendar year.

INFLATION-ADJUSTED AMOUNTS

For debt instruments arising out of sales or exchanges after December 31, 1989, the inflation-adjusted amounts under § 1274A are shown in Table 1.

Calendar Year 1274A(b) Amount 1274A(c)(2)(A) Amount of Sale (qualified debt (cash method debt or Exchange instrument) instrument)

1990 $2,933,200 $2,095,100 1991 $3,079,600 $2,199,700 1992 $3,234,900 $2,310,600 1993 $3,332,400 $2,380,300 1994 $3,433,500 $2,452,500 1995 $3,523,600 $2,516,900 1996 $3,622,500 $2,587,500 1997 $3,723,800 $2,659,900 1998 $3,823,100 $2,730,800

Note: These inflation adjustments were computed using the All-Urban, Consumer Price Index, 1982-1984 base, published by the Bureau of Labor Statistics.

EFFECT ON OTHER DOCUMENTS